Facing the Four Structural Threats to US Democracy


BERKELEY – It has been one year since Donald Trump was elected president of the United States, and America’s democratic institutions are clearly under strain. A mere 20% of Americans now trust the federal government to “do the right thing,” while trust in Congress has fallen below 9%.

Among congressional Republicans, in particular, a “take-no-prisoners” extremism is undermining the federal government’s capacity for action, which is precisely what many on the far right want. According to some pessimists, the US Constitution was not designed to address the challenges of a country so sharply divided by income, race, and partisanship.

Yet state and local governments are still trusted by most voters, and they have the power under the Tenth Amendment of the US Constitution to strengthen democratic institutions. Already, many states and cities are adopting reforms to encourage political compromise and improve democratic governance. Better yet, some of these reforms have national implications, because they will clean up the process by which members of Congress are elected.

State and local reform movements are focused on four structural threats to democracy: gerrymandering; poorly designed primary processes; money in politics; and legislative procedures that impede compromise.

Gerrymandering, whereby state legislators redraw congressional districts to favor their own party, allows politicians to choose voters, rather than the other way around. While the practice dates back to at least 1812, when then-Massachusetts Governor Elbridge Gerry oversaw the redrawing of his state’s senatorial districts, it has been perfected in recent decades, mainly by Republican-dominated state legislatures.

Republican-drawn districts in Texas and the six swing states of Ohio, Florida, Michigan, North Carolina, Pennsylvania, and Virginia had a clear influence in elections to the US House of Representatives in 2016. Now, almost all of these states’ electoral maps are being challenged as unconstitutional. And in Gill v. Whitford, a landmark case from Wisconsin, the US Supreme Court will soon issue its first ruling in a decade on the constitutionality of gerrymandering.

Elsewhere, state governments have taken the more radical step of establishing special redistricting commissions that are independent of the two dominant political parties. And in 24 states, voters can propose ballot initiatives to change districting rules and limit the impact of gerrymandering. Voters in California and Arizona have already done so, and similar measures will likely be on the ballot in other states in 2018 or 2020.

But even with independently drawn districts, elections in many parts of the country will not be competitive, because voters from the same party often live in close proximity. To address this, the political scientists T. Anthony Quinn and R. Michael Alvarez recommend reforming the primary process to “give voters more choices, which in turn can stimulate increased voter turnout.”

By opening up party primaries to more candidates, or by using ranked-choice voting (RCV) – which allows voters to list as many candidates as they want, in order of preference – we can ensure that elected officials represent the full spectrum of voters. RCV has already been adopted by a number of American cities and the state of Maine, and one hopes it will continue to spread in the years ahead.

A third necessary reform concerns money in politics. Ideally, we should have strict limits and transparency requirements for all political donations. But the Supreme Court made achieving that much harder with its controversial Citizens United decision in 2010, when it held that campaign donations – even from corporations – are a protected form of free speech. The court’s ruling not only invalidated existing campaign-finance law; it also overturned several prior Supreme Court decisions. Not surprisingly, hidden spending by big donors has skyrocketed in the past seven years.

Ballooning undisclosed political spending and social-media advertising – by both domestic and foreign entities – has made increased transparency an urgent necessity. With details continuing to emerge about how Russia used social media to influence the outcome of the 2016 election, a growing chorus is calling for stronger legislation to regulate online activities. Currently, platforms such as Facebook and Twitter are not subject to the Federal Election Commission’s transparency rules.

The regulation of political spending is substantially different at the state level. All 50 states require disclosure for contributions to campaigns for state offices, 39 states have a cap for individual contributions, and 22 states prohibit corporations from contributing to political campaigns altogether.

Furthermore, many states are exploring the possibility of making disclosure rules permanent through constitutional amendments. And 13 states already offer a public-financing option for candidates running for state office, with many more poised to follow suit in response to grassroots pressure.

A final structural threat to American democracy is the partisan manipulation of legislative procedures. When the majority party in either house of Congress routinely changes the rules to suit its own ends, crafting bipartisan solutions becomes almost impossible. Similarly, at the state level, legislative supermajorities, arbitrary thresholds for passing budget and tax measures, and ballot initiatives financed by special interests can all impede bipartisan problem solving.

But as California has shown, structural barriers to good governance can be eliminated through citizen-driven reforms. In recent years, the California legislature has cleaned up redistricting, introduced “top two primaries” and an aggressive disclosure system, reformed term limits, eliminated a supermajority rule for state budgetary measures, and improved the ballot-initiative process. As a result, the legislature has become dramatically more effective, and its approval rating has gone from just 14% seven years ago to 57% today – its highest level since 1988.

There is little reason to believe that Congress will reform itself. But if the movement for progressive federalism continues to gain momentum and push through meaningful state- and local-level reforms, federal lawmakers will not be able to maintain the status quo indefinitely. With a renewed confidence in democracy, citizens can take action to ensure that elected officials are governed by the right incentives, and motivated to pursue bipartisan solutions to the country’s problems.

If California can do it, so can other states. America’s founders created the Tenth Amendment precisely because they worried about dysfunction in the capital. It’s time we used it.

Laura Tyson, a former chair of the US President's Council of Economic Advisers, is a professor at the Haas School of Business at the University of California, Berkeley, a senior adviser at the Rock Creek Group, and a member of the World Economic Forum Global Agenda Council on Gender Parity.

Lenny Mendonca, Senior Fellow at the Presidio Institute, is Senior Partner Emeritus at McKinsey & Company.

Changing Climate, Changing Cities

Lessons From Hurricane Harvey: Houston’s Struggle Is America’s Tale


The Texas city’s response to a powerful storm says much about polarized visions of the country and diverging attitudes toward cities, race, liberty and science.

HOUSTON — The mayhem that Hurricane Harvey unleashed on Houston didn’t only come from the sky. On the ground, it came sweeping in from the Katy Prairie some 30 miles west of downtown.

Water drains naturally in this stretch of Texas, or at least it used to. At more than 600 square miles, Houston has grown to be as big as Chicago, Cleveland, Detroit and Philadelphia combined, a giant spread of asphalt smothering many of the floodplains that once shuttled water from the prairies to the sea. When finished, the newest road to ring the city and propel its latest expansion, called the Grand Parkway, will encircle an area equivalent to all of Rhode Island.

For years, the local authorities turned a blind eye to runaway development. Thousands of homes have been built next to, and even inside, the boundaries of the two big reservoirs devised by the Army Corps of Engineers in the 1940s after devastating floods. Back then, Houston was 20 miles downstream, its population 400,000. Today, these reservoirs are smack in the middle of an urban agglomeration of six million.

Many of the residents living in and around the reservoirs didn’t even know they slept in harm’s way — until the water came pouring in from the prairie during Harvey.

The story of Harvey, Houston and the city’s difficult path forward is a quintessentially American tale. Time and again, America has bent the land to its will, imposing the doctrine of Manifest Destiny on nature’s most daunting obstacles. We have bridged the continent with railways and roads, erected cities in the desert, and changed the course of rivers.

Built on a mosquito-infested Texas swamp, Houston similarly willed itself into a great city. It is the country’s energy capital, home to oil and carbon-producing giants, to the space industry, medical research and engineers of every stripe. Its sprawl of highways and single-family homes are a postwar version of the American dream.

Unfortunately, nature always gets the last word. Houston’s growth contributed to the misery Harvey unleashed. The very forces that pushed the city forward are threatening its way of life.

Sprawl is only part of the story. Houston is also built on an upbeat, pro-business strategy of low taxes and little government. Many Texans regard this as the key to prosperity, an antidote to Washington. It encapsulates a potent vision of an unfettered America.

Harvey called that concept into question. It may have been an unusually bad hurricane, dumping trillions of gallons of water in a few days, even more to the east of the city than to the west, in the prairie, and setting all kinds of records. But it was also the third big storm to slam Houston in three years, dispelling any notion that Houston shouldn’t expect more of the same.

Climate change holds a mirror up to every place its impact is felt. Global warming may not specifically have caused Harvey, any more than a single major league home run can be attributed to steroids.

That said, scientists have little doubt that climate change is making storms worse and more frequent. The floods that ravaged Houston on Memorial Day in 2015 and in April of 2016 — now called the Tax Day flood — left behind billions of dollars in damage. Coming right after those events, Harvey has led even some pro-development enthusiasts to rethink the city and its surroundings.

“Harvey caused me to look differently at the world we live in,” said Judge Ed Emmett, the chief executive of Harris County, which encompasses Houston and much of the Katy Prairie. A self-described traditional Republican and big backer of the Grand Parkway, Judge Emmett had planned on spending his twilight years in public service saving the Houston Astrodome from demolition. Harvey altered that. Now he thinks his mission is to protect the entire region.

“Three 500-year floods in three years means either we’re free and clear for the next 1,500 years,” as he put it, “or something has seriously changed.”

After every natural calamity, American politicians make big promises. They say: We will rebuild. We will not be defeated. Never again will we be caught unprepared.

But they rarely tackle the toughest obstacles. The hard truth, scientists say, is that climate change will increasingly require moving — not just rebuilding — entire neighborhoods, reshaping cities, even abandoning coastlines.

Resettling neighborhoods, making certain places off-limits to development, creating dikes and reservoirs is difficult, both financially and politically. It takes longer than most election cycles. Memories fade. Inertia sets in. Residents just want to get their lives back to normal. Politicians want votes, not trouble.

After Hurricane Katrina in 2005, New Orleans, for better and worse, used its cataclysm as an opportunity to reboot, not just fixing levees but overhauling public schools, hospitals and many neighborhoods. It was a wrenching process. The mere suggestion of moving people out of vulnerable neighborhoods set off bitter protests, causing the city to back down from some of its most sweeping proposals.

Texas after Harvey is no different, and perhaps even less prepared to change. Like the rest of America, it is deeply divided between urban and rural, Democrat and Republican. Houston is a blue city with a black mayor in a bright red state. Here, especially in the hurricane’s wake, debates over the way ahead have split conservatives from one another and put environmentalists at odds with advocates of affordable housing.

Ultimately, though, any resolution will require that everyone face the same threats together.

The spread of asphalt and concrete has inhibited rainwater from draining naturally in Houston. When finished, the Grand Parkway, above, on the edge of Houston, will encircle an area equivalent to all of Rhode Island. 

‘Don’t California My Texas’

Jim Blackburn, a planner, environmental lawyer and something of a lightning rod around here, has been warning for years about climate change, the decrepit state of Houston’s reservoirs and the perils of developing the Katy Prairie. He remembers escaping years ago to the prairie to bird watch. One recent morning he drove me out there along the Grand Parkway and pulled into an unfinished subdivision.

A saleswoman in a model home boasted about $1 billion worth of box stores and malls being built nearby. The development, she said, adheres to county standards requiring that houses be raised above the 100-year floodplain. The woman handed Mr. Blackburn a glossy brochure and a disclaimer, which he scanned before climbing back into the car, shaking his head.

The disclaimer explained that roads outside the development, linking it to the parkway, occupy the 10-year floodplain, meaning they would have about a 10 percent chance of flooding every year.

“These days that means they’ll flood anytime you look at them funny,” Mr. Blackburn said.

“It’s the new normal.”

That’s not far-off. The number of “heavy precipitation” events in the United States has skyrocketed since the 1960s. Since 1980, instances of extreme weather — hurricanes, floods, heat waves — linked to climate change have cost the United States $1.1 trillion. Studies show that for every dollar spent upfront in preparedness, American taxpayers could save $4 in emergency relief and reconstruction — not counting health costs, the impact of lost jobs and business revenues and incalculable grief.

But that requires politicians to agree.

“We suffered nothing short of a catastrophic disaster,” a veteran Texas lobbyist, Bill Miller, said. “It happens at a time when the people in the governing class in this state don’t believe in taxes and government. But they also don’t want anybody discouraged from coming here, because that’s bad for business.”

An upbeat narrative casts business-friendly Texas in the loner role of swashbuckling cowboy, disdainful of coastal elites. “Don’t California my Texas” has become a rallying cry for Republican state lawmakers and a theme repeated by the governor, Greg Abbott, who has complained about “a patchwork quilt of bans and rules and regulations that is eroding the Texas model.”

He believes cities are the culprit. For years, Texas Republicans promoted local controls to push against federal court orders on issues like desegregation and same-sex marriage. Now state leaders have made a U-turn. Mr. Abbott has complained about “political demagogues using climate change as an excuse to remake the American economy.” At a Republican gathering in June, he talked about the experience of driving out of the state’s capital, Austin.

“It starts smelling different,” he told the audience. “And you know what that fragrance is? Freedom.”

Little wonder, post-Harvey, that state and local officials have anointed different flood and recovery czars. Texas is sounding these days like Russia under the Romanovs. The system ensures nobody is clearly in charge.

Least of all in Houston. A bill that would have allowed Harris County merely to issue the equivalent of parking tickets to developers violating floodplain regulations — the sort of regulations that control flooding — was vetoed by the governor. Two other bills to study flooding in the Houston region, introduced in the last legislative session, died in committee.

And not long ago, when Houston’s Democratic mayor, Sylvester Turner, petitioned the governor to tap into the state’s multibillion-dollar Rainy Day Fund for post-Harvey debris removal, Mr. Abbott said he would not authorize money before 2019, when the Legislature is next scheduled to meet.

I met with the mayor in City Hall at the time. He noted that the Legislature had convened a special session to ban gender-neutral bathrooms. “If they can meet about toilets, why can’t they meet when the toilets overflow?” one frustrated city official said, before Mr. Abbott came up with $50 million from a separate fund to stem growing criticism.

Another official, this one with the county, made the point that the area around Houston is a patchwork of counties and municipalities with different rules and no coordination because Texans believed the upside of what became, in essence, institutionalized entropy was that it allowed residents to avoid the encumbrances of city governments, regulations and taxes.

The problem is that hurricanes and floods, worsened by climate change, do not recognize political borders or county lines. Their toll is shared by everyone. The latest estimate from Moody’s puts recovery from Harvey at $81 billion, much of which will end up paid by taxpayers across the United States.

“The whole trans-Mississippi pioneer enterprise was in fact brought to you by the federal government,” says Steven Conn, a historian and author of “Americans Against the City.”

The hypocrisy of Senator Ted Cruz, Republican of Texas, resisting federal aid to the New York region after Hurricane Sandy but then requesting it for Texas after Harvey, is in fact part of this same history.

Houston’s unregulated sprawl, Mr. Conn added, gives physical form to this politics of “decentralization and anti-statism.”

    Bruce Hooper, outside his home in Kashmere Gardens in Houston, would like to move but has no place to go. 

      Residents in some neighborhoods, like Bear Creek Village, had no inkling they lived in harm’s way before Hurricane Harvey. 

        Many neighborhoods in Houston are still piled with debris from the storm. 

    After criticism from Houston’s mayor, Gov. Greg Abbott of Texas provided $50 million to help with cleanup. 

     One estimate puts recovery from Hurricane Harvey at $81 billion, much of which will end up shared by taxpayers across the country.

A Houston Selling Point: It’s Not New York

At the same time, Houston is in many ways a forward-looking, progressive city. Before it elected Mr. Turner, it elected a mayor who was a lesbian. The city is in thrall to cars and highways and has precious little mass transit, but the municipality of Houston relies more on renewable energy than any other big city in America. Houston has more green space, relative to paved, than New York.

And what many Houston residents like about it, its supporters say, is precisely that it isn’t New York or San Francisco or Boston. They insist that its business-friendly, light-on-regulations approach helps account for a big rise in employment since 2000. A report by the city’s Center for Opportunity Urbanism, a pro-development organization, which cautions against overreacting to Harvey, said: “The city emanates a conviction that people should have the freedom to determine their destiny.”

    Houston’s sprawl, and its dependence on the automobile, contributed to the misery that Hurricane Harvey unleashed. 

Thomas Cole, director of the McGovern Center for Humanities and Ethics at the Texas Medical School of Houston, recalled how, during the 1960s, business leaders and politicians conspired with media executives to desegregate Houston quietly, seeing the turmoil that desegregation was causing elsewhere in the South. Decades later, Houston boasts of becoming the most diverse big city in the country, with comparatively low housing costs that translate to higher levels of minority homeownership.

But what does “affordable” really mean if residents have to pay hefty transportation costs and rebuild, time and again, after floods? Houston’s affordability leans on loosely regulated, low-cost immigrant labor providing an abundance of cheaply made, slab-on-grade, single-family houses that sprawl on all that open land, in areas like the Katy Prairie.

And it relies heavily on American taxpayers providing government tax credits, mortgage interest deductions, gas subsidies, artificially low flood insurance rates, highway construction money — and emergency relief, including buying out homeowners to remove their properties from harm’s way.

Harris County officials say they have received as many requests for buyouts since the hurricane (3,000) as there have been buyouts since the mid-1990s. Harvey turned out to be an equal opportunity disaster. In Meyerland, an affluent district where Brays Bayou burst its banks, Steve and Julie Sacks’s house flooded for the third time in three years. They are among the homeowners hoping for a buyout.

“But I’m not counting on one,” Mr. Sacks told me. Buying out rich homes to repurpose vulnerable areas like Meyerland for flood detention, as Mr. Sacks notes, would require loads of money and remove valuable properties from tax rolls in a county that relies on property taxes.

Bruce Hooper would move, too. During Harvey, he woke up to crackling sounds, when floodwaters started to seep into his appliances and electrical outlets. Mr. Hooper lives in a poor area called Kashmere Gardens. I found him sitting on a tattered lawn chair outside the shell of his tumbledown rental. An unemployed former parks employee, Mr. Hooper told me that he and his family of five had to be airlifted out by the Coast Guard after a detention pond overflowed and water inside the house rose from ankle to chest high in an hour. He would live elsewhere, he said, but like many others without flood insurance or savings, “we got nowhere else to go.”

Andy and Christine Kahan inside their damaged home in Bear Creek Village. “Welcome to the war zone,” Mr. Kahan said. 

As for Andy and Christine Kahan, they were among thousands who had no inkling they were especially vulnerable before Harvey. The Kahans own a single-story home in a middle-class neighborhood, Bear Creek Village.

“The damn dam did us in,” Mr. Kahan said. The Kahans’s home was among those houses flooded by the reservoirs, which Harvey for the first time filled and threatened to overflow.

Christine Kahan and her husband had lived for 28 years in their house without a flood. Now Ms. Kahan said she would entertain a buyout. A part-time real-estate agent, she advises clients to think twice about buying any home that flooded. Hers is now one of them.

But Mr. Kahan says they will stay, for the time being. “I’m not a skeptic about climate change,” he told me. “It defies logic not to believe something is going on.”

I asked how that lined up with his desire not to leave Bear Creek. “Harvey was an exception, an act of God,” he said, then added, “I know it doesn’t make sense. But I’m an optimist.

“At least, I am until the next flood.”

Andy and Christine Kahan’s house in Bear Creek Village. Josh Haner/The New York Times

Weather at the Extremes for Texas

Will Houston be any more ready by then?

One afternoon I biked with Guy Hagstette around Buffalo Bayou Park. Mr. Hagstette is director of parks and civic projects for the Kinder Foundation, which underwrote much of the $75 million downtown park. We met at Allen’s Landing, where the Buffalo and White Oak Bayous converge before flowing into the Houston Ship Channel. The Allen brothers were real estate swindlers from New York who founded Houston in 1836. After oil turned up beneath the muck and clay, they seemed like prophets.

Harvey burst the tall banks of Buffalo Bayou Park, flooding the city’s theater district and City Hall. It collapsed riverbanks and left dunes of silt that buried pedestrian paths, playgrounds and fields.

“This will take a lot more than tweaking,” Mr. Hagstette told me. He meant not just repairing and fortifying the park, but also adapting Houston to the new normal.

For starters, that will require fresh numbers. Harris County demands that new developments retain enough rainwater on site to neutralize the effects of a 100-year storm. But those 100-year numbers date back years. They are based on mitigating a storm that averages 13.2 inches of rain in 24 hours. Harvey brought 25.9 inches in 24 hours. The Memorial Day flood dropped 11 inches in three hours. The Tax Day flood dumped 17 inches in 12 hours in the Katy Prairie.

“We need to get climatologists, politicians and policymakers talking to each other,” Jeff Lindner told me. “They’re not.” As meteorologist for the Harris County Flood Control District, Mr. Lindner spent five sleepless days and nights during Harvey as an unshakable, tousled expert in a blue, button-down shirt, going on television and providing Houstonians with useful information. We met at the flood control district office one morning.

“There’s little question the earth is warming,” he said, adding as a qualifier: “Regardless of whether it’s a natural cycle or human-induced, hotter air holds more moisture. And so for Harris County that means the potential for more extreme events.”

Mr. Lindner’s concern, he said, is that “by the time policy is in place it will already lag behind the latest information.”

Considering that most people whose homes flooded had no flood insurance, getting everyone to buy it might solve one problem — but would increase another. “We ought to call federal flood insurance what it actually is,” as Phil Bedient, an engineer and colleague of Mr. Blackburn’s at Rice, put it. “It is subsidized floodplain development.” The Netherlands — the global gold standard for water management — does not offer a national flood insurance program for just this reason.

Mr. Blackburn tells a story about a local hero, Jesse Jones, the former secretary of commerce, who helped secure federal funds for the ship channel. In 1929, Mr. Jones convinced fellow Houston bankers to put aside reserves of cash that prevented city banks from failing in the Depression. What may save Houston today, Mr. Blackburn said, is another common-sense strategy involving stricter controls and infrastructural investments that somehow lets state Republicans acquiesce behind closed doors but beat their chests in public.

“The worst flood has not yet occurred,” Mr. Blackburn noted. A hurricane that pushes a massive storm surge from the Gulf of Mexico into Galveston Bay, up the ship channel, could overwhelm refineries and unleash a toxic tsunami, killing many and rattling the national economy.

The judge and mayor are among those talking about a so-called Ike Dike, named after Hurricane Ike in 2008, which killed dozens in Texas. It would be a massive sea-gate that could block a surge. The scale and engineering would be Texas-size. The cost would be, too.

It’s hard to imagine that happening in the current political climate, Washington’s included, when so little gets done. “Looking back, should we have spent more to avoid some of the flooding?” Judge Emmett asked, rhetorically, when we met in his office. “Sure. Did taxpayers want to pay more to do those things? No.

“We need a whole new structure of governance,” he insisted. “We’ve built in watersheds, paved roads and highways because we don’t have mass transit.

“Inevitably, it all catches up with us,” the judge said. “Mother Nature has a long memory.”

Urban sprawl is only part of the story of Houston. The city was also built on an upbeat, pro-business strategy of low taxes and little government.

Scam or substance?

The meaning in the madness of initial coin offerings

There is an ICO bubble. But it holds out the promise of something important

MARKETS and manias go together. The latest frenzy is for all things crypto. The price of the best-known digital currency, bitcoin, has risen by nearly 700% this year and is now about $7,500; one enterprising firm recently quadrupled its share price simply by adding the word “blockchain” to its name.

But nowhere do alarm bells ring more loudly than in the realm of “initial coin offerings” (ICOs), a form of crowdfunding in which firms issue digital “coins” or “tokens” in return for a payment (typically in ether, another crypto-currency). ICOs have raked in more than $3.2bn this year, rivalling the money flowing to internet startups from early-stage venture capital. Although most of these tokens are supposed to be used in exchange for the companies’ products, as in a corporate loyalty scheme in the offline world, investors scent something different: the chance to be in at the birth of another bitcoin.

It is tempting to dismiss ICOs as nothing but a fraud’s charter. They are easy to pull off, requiring little more than a few enterprising souls and an ambitious-sounding plan. Unlike equity-owners, coinholders get no claim on an issuer’s earnings. Projects are being marketed to retail investors. In September America’s Securities and Exchange Commission (SEC) brought its first charges against a token-issuer, for allegedly promising hefty returns from firms that barely exist. China and South Korea have banned ICOs altogether.

Yet there is usually meaning in the madness of technology-driven bubbles. The British railway mania in the 1840s helped create a national network of train lines; the dotcom boom spawned firms such as Amazon and eBay. So it is with ICOs.

They can provide a source of finance for serious software projects which otherwise have a hard time getting off the ground. As an analogy, imagine that in the early days of the internet domain names had been sold to finance the development of the network with the promise that their value would rise as online traffic grew.

ICOs may also give rise to new forms of firm: because founders, employees and users hold coins, everyone has an interest in seeing their network grow, as this will drive up the value of the token.

One example of this is Filecoin, which in September raised $257m and will allow token-holders to buy and sell digital storage on each other’s computers. Enthusiasts say that these “crypto co-operatives” combine the advantages of a firm—lower transaction costs, aggregation of capital—with a decentralised structure that means no one controls it or the data it holds. Such hopes may prove unfounded, but there is a chance that organisations of this sort could offer an alternative to the monolithic tech giants of today.

The baby in the bathwater

For these reasons, it is wrong for regulators to ban ICOs. Fortunately, most are more thoughtful. Some, like the financial-market authorities in Quebec, have invited ICOs into a regulatory “sandbox”, where less strict rules apply. The SEC has issued a useful report giving guidance about when a token is a security, meaning that an ICO has to comply with registration requirements. This month it warned celebrities against making endorsements of an ICO (as Floyd Mayweather, a boxer, and Paris Hilton, a socialite, have done).

The big test of regulators will come when the ICO bubble pops, as it surely will, and people lose money. If the backlash is severe, ICOs and the organisations they finance might fall out of favour for years to come. A lot of today’s ICOs sound silly, and some are scams; most of the projects they finance will fail. But they might just contain the seed of a digital future that is not dominated by a few online giants.

Turkey: A Case Study in the Borrower’s Dilemma

By George Friedman and Xander Snyder

The motivations that underlie a country’s decision to borrow money are not always strictly economic.

Take Turkey, whose ratio of gross external debt (all public and private sector debt) to GDP has increased from 39% in 2012 to 52% today. Turkish President Recep Tayyip Erdogan has been pushing to increase investment by increasing available credit to spur economic activity. This is a political goal, though one motivated by economic objectives. The problem Erdogan encountered, however, is that there was not enough domestic capital available to meet Turkey’s lending needs.

When a country chooses to borrow, it has two sets of choices. First, should it borrow domestically or from abroad? Second, should its debt be denominated in domestic or foreign currency? Each option has its own implications, but it is particularly constraining when a country borrows from abroad in a foreign currency.

When debt is borrowed in another country’s currency, the borrowing country no longer has the option to depreciate its own currency through monetary policy in order to decrease the relative value of its debt. The other risk involved in foreign currency borrowing—beyond the risk already inherent in borrowing—is that the borrower’s currency will decline in value and increase the cost of debt service.

For example, if a country borrowed $100 million at 10% in US dollar-denominated debt, it would owe $10 million per year. If the exchange rate between the borrower’s currency and the dollar is 2 to 1, then that $10 million is equal to $20 million of its own currency per year. If its currency depreciated and the exchange rate to the dollar became 4 to 1, it would still owe $10 million, but in terms of its own currency, that figure would have doubled to $40 million in debt service per year.

Turkey’s Dilemma

The pitfalls are clear, but for Turkey, domestic borrowing is not a sufficient option. Banks lend money that is entrusted to them in the form of deposits. The quantity of deposits is determined by a society’s proclivity to save. If deposits are lacking, then the bank will have only so much domestic capital to lend. Herein lies Turkey’s dilemma: The government wants to boost economic growth by extending greater credit to encourage investment, but there isn’t enough domestic capital in the banks to meet these goals. Turkey’s savings rate, at about 15% of GDP, is lower than that of other economies categorized by the International Monetary Fund as being at a similar stage of development.

Turkey’s solution to this capital shortfall has been external borrowing, albeit with some restrictions. Households are not allowed to take out consumer debt that is denominated in foreign currency.

Instead, it is primarily financial institutions that borrow in foreign currency—mainly US dollars and euros—and once the capital flows into Turkey, banks extend credit domestically in Turkish lira.

With this maneuver, Turkey is essentially accepting greater long-term financial risk for short-term economic growth. More credit is available for projects now, but with every dollar or euro that is borrowed, Turkey faces an incrementally greater challenge to service its debt should the lira’s value fall relative to the dollar or euro. But Erdogan, who overcame a coup attempt just last year, cannot afford the risk to his presidency that a flailing economy would create. Though he consolidated his position last year after the coup with major political purges, and this year with a referendum that expanded his presidential powers, maintaining positive economic momentum is critical to ensuring the continued support of his base.

There are other ways that Erdogan could increase the availability of capital for lending within Turkey, but they come with their own constraints. Raising interest rates would increase savings and attract more lira deposits. Turkey has done this to some extent, but it can push rates only so high. For while higher interest rates encourage people to deposit money in interest-earning accounts, they also increase the cost of borrowing money domestically. When deposit rates go up, borrowing rates must also go up so that the bank can maintain a spread and, therefore, profitability.

Opening a Rift

The need to both maintain a strong lira and keep credit freely available has opened somewhat of a rift between Erdogan and Turkey’s central bank. The bank sees the abundance of credit and growing inflation as a threat to the lira’s strength—and thus Turkey’s ability to service its foreign debt—and so it wants to increase interest rates. But higher rates mean less credit, and Erdogan needs to keep the debt tap open to prevent an erosion of his control over the country.

Turkey’s problems aren’t just its own. Turkey has the 17th-largest economy in the world. If it were to falter, the implications for its lenders would be severe. But its finances also affect regional security. If Turkey is financially stable and politically united, it can turn its gaze outward and try to exert greater control over its near abroad. But if Turkey’s financial system is compromised in a run on foreign exchange reserves, then its economy will be threatened, and with it, Turkey’s ability to maintain its ever-growing military deployment in Syria. Without a Turkish presence in western Syria, then Iran, which has been Turkey’s rival since the days of the Ottoman Empire, would have a freer hand to influence areas farther west in Syria—areas that Turkey would prefer it to stay out of.

Turkey’s approach entails greater, but not unmanageable, risk. Should it fail, such as in the event of a rapid fall in the value of the lira, Turkey’s financial system—and thus its immediate ability to project power—would be weakened.