2017

HOOVER INSTITUTION
Summer Policy Boot Camp
Director’s Awards Winners
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 HOOVER INSTITUTION SUMMER POLICY
BOOT CAMP DIRECTOR’S AWARD
Capping off an intensive week-long study and discussion of the core principles and
tools of public policy, students were invited to apply their knowledge by researching
and developing a policy proposal. Following the principles of Hoover scholarship, the
proposals emphasize a specific recommendation using facts, data, and well-constructed
arguments. The papers summarize the significance of the new policy and the expected
result, expressed in essays of 2,000 words.

Over half of the boot camp participants submitted proposals for consideration. After
review of each submission, we recognized six participants with the Hoover Institution
Summer Policy Boot Camp Director’s Award based on their outstanding work. The winning
proposals demonstrate particular creativity in addressing complex policy issues.

We are proud to include these proposals written by the following winners of the inaugural
2017 Hoover Institution Summer Policy Boot Camp Director’s Award.

• Kishan Bhatt
• Brian J. Liu
• John McDonough
• Austin W. McLaughlin
• Danni Ondraskova
• Davis Parker

Sincerely,

Scott Atlas Joshua Rauh

David and Joan Traitel Senior Fellow Senior Fellow, Hoover Institution
Hoover Institution Ormond Family Professor of Finance
Stanford Graduate School of Business

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 CONTENTS

Modernizing Health Care Regulations 7

to Lower the Costs of Medical Services
By Kishan Bhatt

Sanctioning Ships and Slush Funds: Countering 13

North Korea’s Illicit Maritime Trade
By Brian J. Liu

Revisiting “Too Big to Fail”: A Better 20

Approach for Regulating Systemic Risk
By John McDonough

Strengthening Intellectual Property Rights 25

By Austin W. McLaughlin

Countering Russian Propaganda While 31

Providing Local-Language Services in the V4
By Danni Ondraskova

Instituting PLOP to Help Shore Up the RSA 37

By Davis Parker

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Modernizing Health Care Regulations to Lower the Costs of
Medical Services
By Kishan Bhatt, Princeton University

This essay presents supply-side initiatives to curb rising health care costs in the United
States. Proposed reforms include modernizing occupational licensing requirements
for nurse practitioners, physician assistants, and doctors. Expanding accessibility to
health care services is an empirically effective and politically bipartisan policy tool
to drive down costs without sacrificing quality.

BACKGROUND

Health care in America is expensive. Although medical innovation in the United

States outpaces that of its OECD peers, leading to some of the best population-
adjusted outcomes in the world1, these outcomes vary widely among different
racial, socioeconomic, and geographic groups2. Experts agree that America’s
advances in medical technology are responsible for much of the 5.5% average
annual growth in real health care spending over the past five decades; today, total
health care spending in the United States accounts for nearly one-fifth of national
GDP.3

In response to these growing costs and distributional inequities, the Patient

Protection and Affordable Care Act (ACA) of 2010 implemented the widest-
reaching reforms of American health care since the introduction of Medicare and
Medicaid in 1965. Republicans and Democrats deeply disagree on the merits
of the ACA’s individual mandate, the costs of its subsidies for the poor and taxes
on the rich, the wisdom of its Medicaid expansion, the status of its state-based
exchanges, and the sustainability of its insurance regulations (outlining essential
health benefits, banning annual and lifetime limits, capping medical loss ratios, and
requiring guaranteed issue and community rating). Yet their legislative standstill
over the ACA obstructs a clearer opportunity for consensus in driving down health
costs and improving patient access.

Supply-side approaches to spending reduction are underused. Today, arcane

and outmoded occupational licenses restrict the availability of medical services.
Physicians, who spend close to a decade or more in medical training, are bound
by state licensing requirements that inhibit mobility and care delivery across state
lines. Scope of practice laws often prohibit nurse practitioners (NPs) and physician
assistants (PAs) from delivering basic services such as vaccines and blood tests.
When done well, licensing protects consumers by ensuring higher quality service
providers. However, overly restrictive requirements harm consumers by limiting
supply, which consequently increases prices.4

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 Technology may be the biggest driver of health care spending growth, but health
policy ought not to restrain innovation as a default cost-cutting strategy. Instead,
modernizing regulations that limit the availability of health services from trained
professionals will help to reduce spending while maintaining quality.

ANALYSIS AND POLICY CONSIDERATIONS

As in any other market, supply and demand govern health care prices.

Policy makers have two overall strategies to rein in spending: increase the supply
of health services or decrease the demand for them. American health policy has
pursued a hybrid of both approaches, capping provider reimbursement and
increasing consumer cost-sharing to respectively lower the price and the quantity
of health services delivered. However, these traditional tools are inadequate.
Physician payment can only be cut so much before triggering an exodus from
insurance networks, just as increasing patient out-of-pocket costs too much risks
forcing Americans to decide between their health and their financial solvency.

Over twenty million newly-insured Americans will strain the capacity of the
system.

The ACA dramatically increased demand for health services by slashing the
uninsured rate from 16% in 2010 to 9% in 2016.5 This is an issue because the
share of general medical practitioners per 1,000 people in the United States ranks
near the bottom of comparable high-income countries.6 Recent data shows that
Medicaid expansion states, which experienced the largest coverage gains, met the
increase in demand with more appointment slots per physician, albeit with longer
waiting times per appointment.7 While encouraging, these results do not change
the fact that increasing appointments per physician is an unsustainable strategy.

Americans are open to receiving care from NPs and PAs

Market research surveys show that patients care most about cost and accessibility
when it comes to their health care provider.8 While about half of Americans prefer
going to a primary care doctor for routine visits, nearly two-thirds would choose an
NP or PA instead if it reduced their wait time for a visit and/or if it involved a less
expensive co-pay.9 Indeed, retail clinic use increased tenfold from 2007 to 2009,10
revealing consumers’ preference for basic health services at less expensive, more
accessible locations.

NPs and PAs deliver routine medical services at lower cost and comparable
quality to primary care physicians.

Routine medical services include administering vaccines, monitoring blood pressure,

conducting blood tests, and dispensing inexpensive medications.11 Because retail

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clinics staffed by NPs and PAs bill less for the same services, states that relaxed
scope of practice (SOP) laws between 2004 and 2007 saw declines in primary
care spending without increasing hospitalizations or emergency department
visits.12 The RAND Corporation places estimates for total cost savings from the
proliferation of these clinics as high as $4.4 billion annually.13

Doctors are also limited by SOP regulations on NPs and PAs.

SOP laws for NPs and PAs pose an opportunity cost to physicians. Instead of
addressing patients with complex diagnostic and treatment challenges, doctors
instead are required to divert time and appointments to routine medical services.
As nurses and physician assistants take over routine primary care responsibilities,
physicians will have greater availability to tackle cases that require their advanced
skills.

A useful analog comes from research on dentists’ case distribution and income
in states that expanded Medicaid dental benefits. Responding to higher patient
demand, dentists supplied more weekly visits (without working additional hours or
substantially increasing wait times) by shifting the responsibility for routine service
delivery to dental hygienists, especially in states with more permissive SOP laws.14
This research suggests that relaxing SOP laws for NPs and PAs allows primary
care doctors to similarly substitute other (less expensive) clinicians for the delivery
of routine care, while they take on more difficult cases themselves. Together, this
increased supply of services can help the health system to meet higher demand
from the newly insured while stabilizing system-wide costs.

Nonreciprocal state physician licensing does not keep pace with advances in
telemedicine.

Early adopters of remote patient monitoring systems have lower administrative

costs, better patient access to providers, and modest improvements in health
outcomes.15 However, nonreciprocal state licensure stifles telemedicine’s growth. By
law, doctors must be licensed in each state that they practice medicine (with few
exceptions), even though national standards ensure the quality of medical training
and testing.16 Because remote patient monitoring across state lines runs afoul of
these licenses, Americans are losing out on a cost-saving innovation.

There is broad bipartisan support for modernizing licensing and SOP

regulations.

Unlike with the ACA, where public opinion on the law (and its potential repeal)
splits sharply along partisan lines,17 these measures are palatable to different
constituencies. Patients benefit by having easier access, lower prices, and shorter
waiting times for comparable quality routine primary care. Physicians benefit by
having more mobility with their services that would be applied towards more

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 advanced cases and challenges. NPs and PAs would see greater responsibility by
taking on basic health service delivery, which their professional organizations have
long advocated for. Finally, payers would see across-the-board cost reductions
through less administrative overhead and lower unit prices for basic medical
services provided by nonphysicians.

The Bipartisan Policy Center commissioned a working group in 2013 to evaluate

the access and affordability of medical services. Their findings highlight a wide
gap between the demand for primary care and the projected supply of doctors
over the next decade.18 Written jointly by former Republican and Democratic
public servants, this bipartisan conclusion supports supply side reforms as necessary
health policy measures.

RECOMMENDATION

The supply side solution has two key steps to reduce regulatory costs in American
health care:

1. Incentivize states to revise SOP laws. Since 2012, the Center for Medicare and
Medicaid Innovation (CMMI) has funded voluntary demonstration projects with
nonphysician clinicians taking over routine aspects of patient care, where SOP
laws allow.19 CMMI should make use of its existing relationships with state
health regulators to encourage them to adopt more flexible SOP limitations
on NPs and PAs.

2. Accelerate mutual recognition agreements. Twenty-two states have taken the
lead in streamlining the process of domestic, cross-border medical practice
by joining the Interstate Medical Licensure Compact (IMLC), an agreement
allowing licensed physicians to practice medicine in all other participating
states. Actual implementation of mutual recognition, however, has been slow. To
speed up this state-level reform, Congress should consider a current bipartisan
proposal to fund a voluntary telehealth demonstration project through CMMI.20
Tying federal funding for this telehealth program to participation in multi-
state licensure agreements such as IMLC will expedite the ability of qualified
physicians to deliver care remotely and across state lines.

CONCLUSION

Current health policy discussions center almost entirely on the Affordable Care Act.
Yet the focus in today’s polarized climate should instead be on fact-based areas of
consensus to bring down health spending and improve patient access.

Supply-side reforms do just that. Increasing the responsibility of nonphysician

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clinicians and allowing doctors greater mobility to deliver care across state lines
represent two achievable and tangible steps to cut costs and maintain high quality
in the health care system.

The administration, as well as state governments, can and should take the lead on
these initiatives.

1
Atlas, Scott W. Atlas, Restoring Quality Health Care: A Six-Point Plan for Comprehensive
Reform at Lower Cost (Stanford, CA: Hoover Institution Press, 2016).

2
Benjamin D. Sommers, Caitlin L. McMurtry, Robert J. Blendon, John M. Benson, and Justin
M. Sayde, “Beyond Health Insurance: Remaining Disparities in US Health Care in the Post-
ACA Era,” The Milbank Quarterly 95, no. 1 (March 1, 2017): 43–69, accessed February
13, 2018, doi:10.1111/1468-0009.12245.

3
“National Health Spending 1960–2013,” Health Affairs, November 23, 2015, accessed
February 13, 2018, http://healthaffairs.org/blog/2015/11/23/national-health-
spending-1960-2013.

4
Jeffrey Zients and Betsey Stevenson, “Trends in Occupational Licensing and Best
Practices for Smart Labor Market Regulation,” Obama White House Archives, July
28, 2015, accessed February 13, 2018, https://obamawhitehouse.archives.gov/
blog/2015/07/28/trends-occupational-licensing-and-best-practices-smart-labor-market-
regulation.

5
Centers for Disease Control and Prevention, National Center for Health Statistics, “Early
Release of Selected Estimates from the National Health Interview Survey,” January–
September 2016, news release, February 14, 2017, accessed February 13, 2018,
https://www.cdc.gov/nchs/nhis/releases/released201705.htm.

6
Organisation for Economic Co-operation and Development, “Health Care Resources,
1980-2016: Physicians by Categories,” accessed September 2, 2017, http://stats.oecd.
org/Index.aspx?QueryId=30173#.

7
Daniel Polsky, Molly Candon, Brendan Saloner, Douglas Wissoker, Katherine Hempstead,
Genevieve M. Kenney, and Karin Rhodes, “Changes in Primary Care Access Between
2012 and 2016 for New Patients with Medicaid and Private Coverage,” JAMA Internal
Medicine 177, no. 4 (April 1, 2017): 588–90, accessed February 13, 2018, doi:10.1001/
jamainternmed.2016.9662.

8
“What Do Consumers Want from Health Care?” infographic, The Advisory Board. June
22, 2015, accessed February 13, 2018, https://www.advisory.com/research/market-
innovation-center/resources/posters/what-do-consumers-want-from-health-care.

9
Michael J. Dill, Stacie Pankow, Clese Erikson, and Scott Shipman, “Survey Shows
Consumers Open To a Greater Role for Physician Assistants and Nurse Practitioners,”
Health Affairs 32, no. 6 (June 1, 2013): 1135–42, accessed February 13, 2018,
doi:10.1377/hlthaff.2012.1150.

11
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J. Scott Ashwood, Rachel O. Reid, Claude M. Setodji, Ellerie Weber, Martin Gaynor, and
Ateev Mehrotra, “Trends in Retail Clinic Use among the Commercially Insured,” American
Journal of Managed Care 17, no. 11 (November 2011): e443–448.

11
Atlas, Restoring Quality Health Care.

12
Joanne Spetz, Stephen T. Parente, Robert J. Town, and Dawn Bazarko, “Scope-Of-
Practice Laws for Nurse Practitioners Limit Cost Savings that Can Be Achieved in Retail
Clinics,” Health Affairs 32, no. 11 (November 1, 2013): 1977–84, accessed February 13,
2018, doi:10.1377/hlthaff.2013.0544.

13
Robin M. Weinick, Rachel M. Burns, and Ateev Mehrotra, “Many Emergency Department
Visits Could Be Managed at Urgent Care Centers and Retail Clinics,” Health Affairs 29,
no. 9 (September 1, 2010): 1630–36, accessed February 13, 2018, doi:10.1377/
hlthaff.2009.0748.

14
Tom Buchmueller, Sarah Miller, and Marko Vujicic, “How Do Providers Respond to
Public Health Insurance Expansions? Evidence from Adult Medicaid Dental Benefits,”
NBER Working Paper No. w20053, April 21, 2014, https://papers.ssrn.com/
abstract=2427155.

15
“Scaling Telehealth Programs: Lessons from Early Adopters,” The Commonwealth Fund,
January 30, 2013, accessed February 13, 2018, http://www.commonwealthfund.org/
Publications/Case-Studies/2013/Jan/Telehealth-Synthesis.aspx.

16
Robert Kocher, “Doctors Without State Borders: Practicing Across State Lines” (blog),
Health Affairs, February 18, 2014, accessed February 13, 2018, http://healthaffairs.
org/blog/2014/02/18/doctors-without-state-borders-practicing-across-state-lines.

17
“The Public’s Views on the ACA,” Henry J. Kaiser Family Foundation, August 11, 2017,
accessed February 13, 2018, http://www.kff.org/interactive/kaiser-health-tracking-poll-
the-publics-views-on-the-aca/#?response=Favorable--Unfavorable&aRange=twoYear&gr
oup=Party%2520ID::Democrat::Republican.

18
Brian Collins, “Strengthening the Health Professional Workforce,” Bipartisan Policy
Center, August 8, 2013, accessed February 13, 2018, https://bipartisanpolicy.org/blog/
strengthening-health-professional-workforce.

19
J. Margo Brooks Carthon, Hilary Barnes, and Danielle Altares Sarik, “Federal Policies
Influence Access to Primary Care and Nurse Practitioner Workforce,” The Journal for Nurse
Practitioners 11, no. 5 (May 2015): 526–30.

20
“Gardner, Peters Introduce Bipartisan Legislation to Expand Telehealth Services,” news
release, office of U.S. Senator Cory Gardner, R-CO, March 30, 2017, accessed February
13, 2018, https://www.gardner.senate.gov/newsroom/press-releases/gardner-peters-
introduce-bipartisan-legislation-to-expand-telehealth-services.

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Sanctioning Ships and Slush Funds: Countering North Korea’s
Illicit Maritime Trade
By Brian J. Liu, University of Pennsylvania

Introduction

Over the past eleven years, the UN Security Council has enacted seven separate
rounds of sanctions against the North Korean regime. By not only foreclosing the
regime’s ability to finance and supply its nuclear program, but also curbing the
personal profits North Korean elites enjoy from trade, pressure from economic
sanctions—the thinking goes—ought to drive the regime back to the negotiation
table on denuclearization.1 Yet despite the two most recent sanction resolutions tar-
geting coal and rare earth minerals, two of its largest industries, North Korea has
still shown no indication that it intends to voluntarily step back its nuclear program.2

What the failure of sanctions on North Korea’s licit economy points to is the need
to target North Korea’s illicit economy. North Korean sponsored illicit activities,
including drug trafficking, arms sales, and the counterfeiting of foreign currency,
contributes an estimated $6.5 billion USD annually to the regime—nearly three
times the amount of all Chinese imports from North Korea.3 To effectively pressure
Pyongyang to return to the negotiation table on its nuclear program, the United
States must focus its efforts towards disrupting North Korea’s covert economy. Spe-
cifically, the United States must launch a robust campaign to target North Korea’s
commercial maritime fleet, which serves as an unchecked funnel for North Ko-
rean-produced methamphetamine, counterfeit goods, and military equipment to
enter black markets around the world.

Background and Data

The North Korean illicit economy dates to 1976, when it was forced to default
on its international debts due to an accumulated negative balance of payments.4
Shortly thereafter, North Korean embassies began smuggling illicit goods into their
host countries via diplomatic pouches to self-finance their operations, leading to a
series of high-profile arrests and ejections of North Korean diplomats from Europe.
The practice continued, but likely due to the embarrassment these diplomatic inci-
dents caused the regime, North Korea began leaning more on covert operations
conducted by “Office 39,” often referred to as a “billion-dollar crime syndicate”
and “Kim Jong-un’s slush fund.”5 Through the fall and loss of economic support
from the Soviet Union, Office 39 has overseen the production and trafficking of
opiates and methamphetamine (producing an estimated $500 million to $1 billion
USD in revenues annually), counterfeit cigarettes (estimated $80–160 million USD
annually), small arms and missiles (estimated $560 million USD annually), and
counterfeit US currency to a diverse range of customers in countries as close as
Japan and as far as Syria.6 These efforts have allowed the regime to stay afloat,
in spite of its crippling trade deficit and the foreclosure of nearly every available
trade partner to the country.7

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 These illicit goods are distributed into the Chinese and global markets through two
primary routes: land-based and maritime-based trade channels.8 The Sino-Korean
Friendship Bridge that connects the North Korean city of Sinuiju to the Chinese city
of Dandong is one such land route, responsible for approximately 80% of formal
trade between China and North Korea.9 Illicit North Korean goods that enter China
via this route are either hidden alongside regular rail or truck cargo, or are per-
mitted to pass after its traffickers pay a small bribe to customs officials.10 Another
portion of illicit goods enters across the border through the so-called “3-3-3” con-
nection system, where a complex web of North Koreans, Chinese and Chinese-Ko-
reans, and South Koreans ferry the drugs in teams of three across the North Korean
border, and then distribute the drugs within China or smuggle larger shipments to
Japan and South Korea.11

Though land-based smuggling is more often reported on, North Korean maritime
trade is a far more pernicious threat because it offers North Korea the ability to
ferry a much larger volume of cargo to a much broader base of customers around
the world. For example, various ships among North Korea’s fleet of approximately
240 commercial ships have been repeatedly apprehended for carrying metham-
phetamine shipments to Japan, or arms shipments to Syria.12 The most infamous
among the fleet is the Chong Chon Gang, a general cargo ship that had been
detained by Iran and Egypt for carrying “dangerous goods”; detained by Ukraine
for carrying drugs, alcohol, cigarettes, and AK-47 ammunition; chased and fired
upon by Somali pirates; and in 2013, detained by Panama for hiding two anti-air-
craft missile systems, nine missiles, two MiG-21 jets, and fifteen MiG-21 motors
under 10,000 tons of brown sugar.13

The fact that the Chong Chon Gang and other illicit North Korean ships remain
operable today can be attributed to two factors: first, despite agreeing to the lat-
est sanctions regime, China has largely refused to enforce mandatory inspections
of North Korean ships that dock in Chinese ports; and second, sanctioned North
Korean ships regularly take advantage of a quirk in international maritime law
known as “flags of convenience,” where unscrupulous merchant ships register under
the flag of a foreign nation to evade legal scrutiny. By flying the flag of Tuvalu, for
example—as one North Korean ship did in 2003 after being seized by Australian
authorities for smuggling heroin—North Korean ships can disguise their identities
and more easily ward off international attention.14 Iranian ships had notably em-
ployed this strategy in 2013, registering their ships under the flag of Tanzania to
continue operating internationally.15

Policy Recommendations

On the issue of land-based trade, the brunt of the effort must be made by Chinese
authorities, who control railway and bridge access to North Korea and enforce
border security along the Yalu River. To support this effort, the United States can
offer capacity-building and support for Chinese customs and border agents, who
remain direly understaffed. One recent report in the New York Times found that

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China only had enough customs officials on hand at the border to inspect one of
every twenty trucks crossing into North Korea.16 Exporting advanced scanner ma-
chinery to China—like Genia Photonics’ laser-based molecular scanners, procured
for the United States by the US government-sponsored venture capital firm, In-Q-
Tel—could help alleviate the inspection burden.

On the issue of maritime-based trade, short of imposing a highly provocative, full-

scale blockade, the United States can deny North Korean access to international
trade by employing softer, diplomatic measures. One model for this exists in UANI
(United Against Nuclear Iran), an advocacy platform founded by former US spe-
cial envoy for Afghanistan and Pakistan, Richard Holbrooke, and led by former US
senator Joe Lieberman and former US ambassador to the UN, Mark Wallace.17
Since 2008, UANI has waged an international campaign calling on shipping com-
panies, flag states, marine insurance companies, and flag classification societies
to end their business with Iranian shipping companies. On the research-end, UANI
publishes “Minerva reports” on the activities of Iranian shipping vessels that track
illicit Iranian maritime activities in real time and name-and-shame companies and
countries that continue to trade with Iran. Through its efforts, UANI managed to con-
vince the countries of Barbados, Hong Kong, Moldova, and Mongolia to delist and
deny flags of convenience to Iranian ships; and convinced Russian, Korean, Chinese,
and Japanese classification societies to refuse registration to Iranian companies.18
This, in tandem with formal diplomatic efforts from Washington and Brussels, im-
posed a heavy burden on Iranian trade and undoubtedly contributed to Tehran’s
decision to come to the nuclear negotiation table in 2015.

Though the Iranian and North Korean nuclear programs are undoubtedly differ-
ent cases, a coordinated effort to deny North Korean access to the international
maritime system would contribute greatly towards crippling the North Korean illicit
economy and starving North Korean officials of vital cash flow. Implementing a sim-
ilar program against the North Korean regime would involve the following steps:

1) Initiate and provide funding for a spinoff of UANI that addresses the North
Korean threat: UANI was exceptionally successful because it remained
a public-facing and nongovernmental organization. While it leveraged
its founders’ government connections for credibility and legitimacy, the
fact that it remained a nongovernment organization allowed it to take
on a far more vocal role in naming-and-shaming foreign countries and
corporations. Though the US government can provide funding for a North
Korean variant of UANI, it is imperative that it remains nongovernmental
for the above reasons, as well as to avoid the general sclerosis of a typ-
ical governmental task force. Additionally, the US government can also
fund organizations that already produce Minerva-like reports: C4ADS,
a data analytics-focused think tank, is one notable organization that has
leveraged Palantir and other big-data tools to produce timely reports on
North Korean maritime operations.19

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 2) Expand the Proliferation Security Initiative (PSI)’s mandate beyond Weap-
ons of Mass Destruction (WMDs): The PSI is a 105-nation pact formed to
combat North Korea’s trafficking of WMDs through unflagged maritime
vessels. President George W. Bush launched PSI in 2003 in response to
the So San incident, when the United States failed to intercept fifteen
Scud missiles found aboard an unflagged North Korean freighter be-
cause at the time, there was no international treaty governing the trade
or possession of ballistic missiles.20 While the PSI has long been criticized
for being little more than a soapbox for nonproliferation issues, and for
its internecine disputes—a product of its leadership being split between
the National Security Council and the State and Defense Departments—it
offers a natural launching pad for a renewed international effort against
North Korean illicit trade.21

3) Launch a Treasury-State-Defense interagency working group: While the PSI

offers a platform to coordinate intergovernmental efforts, creating an
interagency group between the Treasury, Defense, and State Depart-
ments and other relevant government bodies could help synchronize these
efforts and minimize overlap. However, it is important to recognize that
interagency groups can just as often exacerbate, rather than alleviate,
interagency conflict. For example, the Government Accountability Office
(GAO) found that the Terrorist Financing Working Group (TFWG), a sim-
ilar trade-diplomacy-national security interagency effort, was plagued
by disputes between the Treasury and State Departments on matters of
leadership of the group, as well as a lack of measurable outcomes pro-
duced by the group.22 As such, any new interagency body would require
a clear line of leadership and optimally would be organized at the dep-
uties-level or below to minimize political infighting.

Evaluation and Summary

Overall, the desired outcome of a campaign against North Korea’s illicit maritime
shipping is to reinforce the effects of already existing sanctions: to affect a sharp
decline in the amount of money entering North Korean coffers. This policy is thus
intended as a stopgap, a plug to cover the areas where these conventional sanc-
tions fail.

However, the essential nature of illicit trade means that it would be near impossible
to fully credit the effects of interdiction on North Korean finances. Rather, measure-
ments of effectiveness should be gauged by figures like the number of countries
that agree to deregister North Korean ships, the number of ships inspected by the
United States or partner nations, or the number of Chinese companies that pledge
to sever business ties with North Korea.

Finally, it is important to recognize that addressing maritime trade alone is not a

“magic-bullet,” neither for countering the illicit goods trade nor for the broader
goal of denuclearization. On the former point, any effort to constrain the flow of

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North Korean illicit goods must also include efforts to address the reverse flow
of currency back into North Korea, which is typically facilitated by Chinese and
Macau-based banks. On the latter point, constraining ill-gotten profits is intended
only as one prong of a much larger strategy to drive the regime to the negoti-
ating table—what must inevitably follow is a comprehensive diplomatic strategy,
grounded in a firm analysis of the North Korean regime’s red lines and fundamen-
tal interests.

1
United Nations, “Security Council Strengthens Sanctions on Democratic Republic of Korea,
Unanimously Adopting Resolution 2321,” news release, SC/12603, November 30, 2016.
2
United Nations Security Council Resolution 2321 (condemning North Korean nuclear test,)
November 30, 2016, accessed February 13, 2018, https://www.un.org/ga/search/
view_doc.asp?symbol=S/RES/2321; Meng Meng and John Ruwitch, “North Korean
Ships Head Home After China Orders Coal Returned,” Reuters, April 11, 2017, accessed
February 13, 2018, www.reuters.com/article/uk-china-northkorea-coal-exclusive-idUKKB-
N17D0DA; United Nations Security Council Resolution 2270, 2016, accessed February 13,
2018, https://www.un.org/sc/suborg/en/s/res/2270%282016%29.
3
Estimate from Bruce Bechtol, professor of political science, Angelo State University: “The
money that North Korea makes from illicit activities is 40 percent of their real economy.”
The estimate of $6.5 billion is based on 40 percent of DPRK’s 2015 GDP of $16.2 billion
GDP. North Korea GDP, accessed February 13, 2018, https://tradingeconomics.com/
north-korea/gdp; Trade statistics based off of $2.34 billion figure from MIT Observatory
of Economic Complexity, accessed February 13, 2018, https://atlas.media.mit.edu/en/
profile/country/prk.
4
Richard Halloran, “North Korean Lag on Debt Reported,” New York Times, February 26,
1976. accessed February 13, 2018, www.nytimes.com/1976/02/26/archives/north-ko-
rean-lag-on-debt-reported-payments-problems-said-to-cause.html.
5
David Rose, “North Korea’s Dollar Store,” Vanity Fair, September 2009, accessed Febru-
ary 13, 2018, https://www.vanityfair.com/style/2009/09/office-39-200909; “Kim Jong
Un’s Personal ‘Slush Fund’ Known as ‘Office 39’ Hit by Sanctions, National Post, August 10,
2017, accessed February 13, 2018, http://nationalpost.com/news/world/kim-jong-uns-
personal-slush-fund-known-as-office-39-hit-by-sanctions.
6
On methamphetamine figures: Balbina Hwang, “DPRK Briefing Book: Curtailing North
Korea’s Illicit Activities,” Nautilus Institute, August 25, 2003. accessed February 13, 2018,
http://nautilus.org/publications/books/dprkbb/terrorism/dprk-briefing-book-curtail-
ing-north-koreas-illicit-activities; cigarette figures: David Asher, “The North Korean Crimi-
nal State, Its Ties to Organized Crime, and the Possibility of WMD Proliferation,” Nautilus
Institute, November 1, 2005; Sheena Chestnut Greitens, “Illicit: North Korea’s Evolving
Operations to Earn Hard Currency,” Committee for Human Rights in North Korea, 36; mis-
sile sales figures: Larry Wortzel, “North Korea’s Connection to International Trade in Drugs,
Counterfeiting, and Arms,” testimony before the Senate Governmental Affairs Subcommit-
tee on Financial Management, Budget, and International Security, Heritage Foundation,
May 20, 2003, accessed February 13, 2018, https://www.heritage.org/testimony/
north-koreas-connection-international-trade-drugs-counterfeiting-and-arms.

17
 7
Paul Rexton Kan, Bruce E. Bechtol Jr., and Robert M. Collins, “Criminal Sovereignty: Un-
derstanding North Korea’s Illicit International Activities,” Army War College, March 2010,
accessed February 13, 2018, https://ssi.armywarcollege.edu/pdffiles/PUB975.pdf.
8
North Korea’s air-based trafficking of arms shipments has been documented in the past
(see December 2009 North Korean surface-to-air missile shipment detained in Bangkok),
but there is scant evidence that it is nearly as consequential as land and maritime trade.
Typically, because of the greater risk of interdiction and the smaller allowable cargo vol-
ume, air-based transport is reserved for more sensitive shipments, like missiles and radar
technology.
9
Jane Perlez, Yufan Huang, and Paul Mozur, “How North Korea Managed to Defy Years
of Sanctions,” New York Times, May 12, 2017, accessed February 13, 2018, https://
www.nytimes.com/2017/05/12/world/asia/north-korea-sanctions-loopholes-china-unit-
ed-states-garment-industry.html.
10
Andrei Lankov, “For N. Koreans in Dandong, It’s Business as Unusual,” NK News, February
2, 2016, accessed February 13, 2018, https://www.nknews.org/2016/02/for-n-koreans-
in-dandong-its-business-as-unusual.
11
Brian Liu, “A ‘Runaway Train’? Human Rights and China’s Response to the North Korean
Meth Trade,” North Korea Strategy Center, December 18, 2015, accessed February 13,
2018, http://nksc.us/wp-content/uploads/2016/03/121815_A_Runaway_Train_BL.pdf;
“China Angry at NK Drug Trafficking,” The Korea Times, July 2011, accessed February 13,
2018, www.koreatimes.co.kr/www/news/nation/2011/07/116_90527.html.
12
Anshel Pfeffer, “Russian, North Korean Arms Ships to Dock in Syria as Bloody Crack-
down Continues,” Haaretz, May 26, 2012, accessed February 13, 2018, https://www.
haaretz.com/russian-north-korean-arms-ships-to-dock-in-syria-as-bloody-crackdown-con-
tinues-1.5163582.
13
Oren Dorell, “North Korea Ship Held in Panama Has a Colorful Past,” USA Today, July
17, 2013, accessed February 13, 2018, accessed February 13, 2018, https://www.usa-
today.com/story/news/world/2013/07/17/n-korea-ship-checkered-history/2524479.
14
Keith Bradsher, “North Korean Ploy Masks Ships under Other Flags,” New York Times,
October 20, 2016, accessed February 13, 2018, www.nytimes.com/2006/10/20/world/
asia/20shipping.html.
15
Claudia Rosett, “Have Tehran’s Tankers Hijacked the Tanzanian Flag?” Forbes, July
12, 2013, accessed February 13, 2018, https://www.forbes.com/sites/claudiaro-
sett/2013/07/12/have-tehrans-tankers-hijacked-the-tanzanian-flag/#388e6ceb3dfa.
16
Jane Perlez and Yufan Huang, “A Hole in North Korean Sanctions Big Enough for Coal,
Oil and Used Pianos,” New York Times, March 31, 2016, accessed February 13, 2018,
https://www.nytimes.com/2016/04/01/world/asia/north-korea-china-sanctions-trade.
html.
17
“About Us,” United Against Nuclear Iran, accessed February 13, 2018, https://www.
unitedagainstnucleariran.com/about.
18
“Shipping Campaign,” United Against Nuclear Iran, accessed February 13, 2018,
https://www.unitedagainstnucleariran.com/shipping-campaign.

18
19
See, for example, C4ADS, “In China’s Shadow,” Asian Institute for Policy Studies, August
2016, accessed February 13, 2018, https://static1.squarespace.com/static/566ef8b-
4d8af107232d5358a/t/57dfe74acd0f68d629357306/1474291539480/In+Chi-
na%27s+Shadow.pdf.
20
David Sanger and Thom Shanker, “Threats and Response: War Materiel; Reluctant U.S.
Gives Assent for Missiles to Go to Yemen,” New York Times, December 12, 2002, accessed
February 13, 2018, www.nytimes.com/2002/12/12/world/threats-responses-war-mate-
riel-reluctant-us-gives-assent-for-missiles-go-yemen.html.
21
Mark Valencia, “North Korea and the Proliferation Security Initiative,” 38 North,
July 29, 2010, accessed February 13, 2018, www.38north.org/wp-content/up-
loads/2010/07/38north_SR_PSI.pdf.
22
Government Accountability Office, “Terrorist Financing: Agencies Can Improve Ef-
forts to Deliver Counter-Terrorism-Financing Training and Technical Assistance Abroad,”
GAO-06-632T, April 6, 2006, accessed February 13, 2018, https://www.gao.gov/as-
sets/120/113465.html.

19
 Revisiting “Too Big to Fail”: A Better Approach for
Regulating Systemic Risk
By John McDonough, U.S. Treasury, Office of Financial Research1
Large US banks are currently subject to varying levels of enhanced regulatory re-
quirements according to the size of their balance sheets. This sized-based trigger
creates perverse incentives, imposes substantial barriers to entry on smaller firms, and
fails to account for endogenous factors such as risk propensity, or exogenous factors
like inflation. Congress should amend the Dodd-Frank Act to replace size-based regu-
lation with a risk-based approach that reduces the regulatory burden for large banks
with relatively lower risk profiles.

BACKGROUND
The recent financial crisis demonstrated the negative externalities that large fi-
nancial institutions can pose on the economy as a whole. Banks, in particular, are
vulnerable to macroeconomic shocks because of their fundamental business model
of maturity and risk transformation. That, combined with low capital levels, high
reliance on runnable liabilities from the short-term funding market, and increased
risk taking in the mid-2000s, led to a financial panic when the housing bubble burst
in 2007.

During the crisis, extraordinary measures were enacted in an attempt to contain

the fallout. The Federal Reserve stepped in to serve as the Lender of Last Resort
by providing bailouts to many banks. Additionally, Congress injected $426 billion
into the financial sector as part of the Troubled Asset Relief Program (TARP).2 These
efforts were viewed by many economists as successful in stabilizing the fragile
financial system, but not without great cost to the taxpayer.3 It is worth noting, how-
ever, that those views are not universally shared.4 Furthermore, the government’s
actions have also been criticized for promoting moral hazard by reducing the pen-
alties associated with failure.5 These banks that either received bailouts or were
perceived as potentially eligible for future bailouts became known colloquially as
“too big to fail.”

In effort to address the “too big to fail” problem, the Dodd-Frank Wall Street
Reform and Consumer Protection Act (Dodd-Frank Act) created a framework for
enhanced regulation of large financial institutions to internalize these negative ex-
ternalities. Dodd-Frank chose a tiered, asset-based threshold approach for assign-
ing various levels of stricter regulation for banks that exceed $1 billion, $10 billion,
$50 billion, and $250 billion in assets.6Of those four thresholds, the most stringent
regulatory ratchet occurs at the $50 billion level, where enhanced supervision,
including being subject to the annual CCAR stress tests, kicks in.7 Completing the
stress test requires significant expenditures to hire substantially larger compliance
staff, as well as technology costs for systems that can capture, model, and report
the necessary financial data to the Federal Reserve. There are currently forty-four

20
US financial firms (or US subsidiaries of foreign banks) with greater than $50 bil-
lion in assets on their balance sheet (see Table 1).

Table 1: US Financial Firms Above $50 Billion Threshold.8

Although proponents argue that the enhanced regulatory requirements have re-
duced risk in the banking sector, there are three fundamental flaws with the current
size-based threshold approach.

First and foremost, asset-size thresholds distort incentives for growth and risk tak-
ing. Each threshold acts as a tax on growth that banks pay upon passing the
threshold. The “tax” occurs in the form of additional compliance costs that banks
must pay to conform with the stricter regulations. While some aspects of the higher
regulatory burden may be variable, the primary cost (compliance staff and higher
capital requirements) is fixed. As a result, banks are incentivized to limit their nat-
ural growth as they approach a threshold, then accelerate their growth once they
have passed it in order to spread the fixed-compliance costs over a larger asset

21
 base. This acceleration occurs through reach-for-yield behavior, as banks pursue
higher returns to maintain return-on-capital ratios, as well as increased leverage to
support acquisitions of other banks. The ultimate effect is that it distorts the natural
growth rate of financial firms and, ironically, leads to larger and riskier banks.

Second, asset-size thresholds fail to account for variation in risk profiles and busi-
ness models among banks of similar sizes. To illustrate, consider a hypothetical
bank that holds $51 billion in risk-free US Government Bonds on its balance sheet
(but nothing else). Under the existing framework, that bank would be subject to
a greater regulatory burden than a bank with exactly $49 billion in assets that
are entirely comprised of high-risk derivative positions. From an efficiency and
risk-management perspective, this framework does a poor job of allocating regu-
latory burden to riskier firms.

Finally, these thresholds ignore the long-run impact of inflation. The thresholds set
forth by Congress are fixed to nominal values and thus are unable to adapt over
time to movements in the price level. Even if intrinsic risk remains constant, the
$50 billion trigger will slowly capture more and more firms as inflation raises the
nominal value of assets on bank balance sheets. The recent low levels of inflation
notwithstanding, the lack of an inflation peg in the statute demonstrates Congress’
short-term thinking in writing the Dodd-Frank Act.

Moving to a Risk-Based Approach

To address these shortcomings in the existing framework for enhanced regulation

of banks, Congress should amend the Dodd-Frank Act to repeal the asset-size
threshold and replace it with a risk-based approach. Although this would repre-
sent a significant shift in how small and medium-size banks are treated, regulators
already have the tools to implement a risk-based framework.

A small subset of the largest banks, referred to as “global systemically important

banks” (G-SIBs) are already identified for the highest level of regulatory oversight
by a multifactor approach that incorporates size, interconnectedness, complexity,
global activity, substitutability, cross-jurisdictional activity, and short-term whole-
sale funding .9 This enhanced methodology was created by the Basel Committee
on Banking Supervision (BCBS) to better identify systemic risk and is used by reg-
ulators around the world.10 While this balanced framework, with its focus on ad-
ditional factors besides size, currently applies only to eight US banks designated
as G-SIBs, it could be extended to small- and medium-sized banks in place of the
asset-size thresholds.

Implementation

The weights of each risk indicator, as well as the enhanced regulatory requirements
that are triggered, should be calibrated by the Federal Reserve according to a

22
statutory mandate that prioritizes efficient allocation of the regulatory burden to
riskier firms. Threshold effects would still exist in a risk-based framework, but they
would better align banks’ incentives with the financial stability goals of the mac-
ro-prudential authorities, and it would discourage excessive risk-taking by banks
after crossing a threshold.

As a result of this proposal, the overall number of banks subject to enhanced pru-
dential regulation will change and likely will decrease depending on the exact
calibration. Critics will undoubtedly complain that removing the asset thresholds
will result in less oversight, possibly leading to greater risk in the financial system.
However, in amending the statute, Congress should not be swayed by those argu-
ments for the following reasons: first, those criticisms don’t address the fundamental
flaws in the existing tiered system; and second, banks are still subject to regulation
and supervision even if the new risk-based framework exempts them from en-
hanced standards.

Conversely, some smaller banks that are not currently subject to enhanced reg-
ulatory supervision may find themselves facing stricter oversight due to their risk
profile or unique role in the financial system. One example of the BCBS multifactor
methodology emphasizing uniqueness and risk over pure size is as follows: the
risk-based approach identifies Bank of New York (BNY) Mellon as systemically
important, despite several larger banks (Capital One, PNC, US Bancorp, and TD
Group) avoiding being designated as G-SIBs. This prioritization of risk profile
over a pure size measure is sensible because BNY Mellon plays a critical role as
the only bank to clear US government securities following J.P. Morgan’s departure
from that market.11 Affected firms would likely exert political pressure and lobby
to avoid changes, which should be ignored to every extent possible. A risk-based
approach better aligns regulatory compliance costs with risk, leading to a more
efficient outcome.

Conclusion

The current approach for subjecting banks to enhanced regulatory standards is

inadequate because it distorts incentives for growth and risk-taking, inefficiently
allocates the regulatory burden without regard to risk, and fails to adjust over
time to the price level. Congress should amend the Dodd-Frank Act to adopt a risk-
based approach, similar to the one already used to identify G-SIBs. This shift in
policy would address all three of the aforementioned problems with the status quo.

1
Disclaimer: The views expressed in this paper are those of the author and do not reflect the
views of the Office of Financial Research or the U.S. Department of the Treasury.
2
Ryan Tracy, Julie Steinberg, and Telis Demos, “Bank Bailouts Approach a Final Reckon-
ing,” Wall Street Journal, December 28, 2014, accessed February 13, 2018, https://www.
wsj.com/articles/ally-financial-exits-tarp-as-treasury-sells-remaining-stake-1419000430.

23
 3
Alan S. Blinder and Mark Zandi, “The Financial Crisis: Lessons for the Next One,” Center
on Budget and Policy Priorities, October 15, 2015, accessed February 13, 2018, https://
www.cbpp.org/research/economy/the-financial-crisis-lessons-for-the-next-one.
4
“Market Interventions During the Financial Crisis: How Effective and How to Disengage?”
chap. 3 in “Global Financial Stability Report: Navigating the Financial Challenges Ahead,”
International Monetary Fund, October 2009, accessed February 13, 2018, https://www.
imf.org/en/Publications/GFSR/Issues/2016/12/31/~/media/Websites/IMF/import-
ed-flagship-issues/external/pubs/ft/GFSR/2009/02/pdf/_textpdf.ashx.
5
John Taylor, Getting Off Track: How Government Actions and Interventions Caused, Pro-
longed, and Worsened the Financial Crisis (Stanford, CA: Hoover Institution Press, 2009).
6
Daniel K. Tarullo, “Application of Enhanced Prudential Standards to Bank Holding
Companies,” testimony before the US Senate Committee on Banking, Housing, and Urban
Affairs, March 19, 2015, accessed February 13, 2018, https://www.federalreserve.gov/
newsevents/testimony/tarullo20150319a.htm.
7
Tarullo, “Application of Enhanced Prudential Standards to Bank Holding Companies.”
8
Source: FFIEC. Federal Financial Institutions Examination Council, “Holding Companies
with Assets Greater Than $10 Billion,” accessed February 13, 2018, https://www.ffiec.
gov/nicpubweb/nicweb/HCSGreaterThan10B.aspx. Total Assets as of Q1 2017. Green
denotes Global Systemically Important Bank subject to heightened prudential standards.
Light green denotes non-G-SIB with greater than $250 billion in assets and subject to
advanced approach regulatory capital requirements. Light blue denotes greater than $50
billion in assets and subject to annual Comprehensive Capital Analysis and Review (CCAR)
stress tests.
9
Meraj Allahrakha, Paul Glasserman, and H. Peyton Young, “Systemic Importance
Indicators for 33 U.S. Bank Holding Companies: An Overview of Recent Data,” Of-
fice of Financial Research, February 12, 2015, accessed February 13, 2018, https://
www.financialresearch.gov/briefs/files/2015-02-12-systemic-importance-indica-
tors-for-us-bank-holding-companies.pdf.
10
Basel Committee on Banking Supervision, “Global Systemically Important Banks: Updat-
ed Assessment Methodology and the Higher Loss Absorbency Requirement,” July 2013,
accessed February 13, 2018, https://www.bis.org/publ/bcbs255.pdf.
11
Katy Burne, “JPMorgan to Exit Part of its Government Securities Business,” Wall Street
Journal, July 21, 2016, accessed February 13, 2018, www.wsj.com/articles/j-p-morgan-
to-exit-part-of-its-government-securities-business-1469135462.

24
Strengthening Intellectual Property Rights
By Austin W. McLaughlin, Cornell University
Overview

This memo offers an analysis of some of the most pressing issues in the US patent
system, including bad patents, patent trolls, and patent thickets.1 Today’s patent
landscape is decidedly anticompetitive, where the US Patent and Trademark Of-
fice (USPTO) is inundated with bad patents that obscure real innovation. It is also
predatory, due in part to the practices of companies that aggressively solicit law-
suits at minimal cost without any innovation of their own—known as patent trolls.
Meanwhile, truly productive companies are forced to aggregate patent portfolios,
contributing to the problem of dense patent thickets, bureaucracy, and cross-licens-
ing issues.

Patents first flourished when the US Patent Act of 1790 refined property rights
for intellectual property (IP).2 With a low barrier fee, an impersonal patent ap-
plication process, and a “first and true inventor” system for the patentee, the act
spurred innovation in a regulated IP environment. According to Stephen Haber, this
is because IP rights are “property right[s] like any other,” and have the same effect
as other property rights on a demand curve. They are only distinct from regular
property rights because they are time limited— bounded by twenty years. Howev-
er, since 1790, IP rights have largely declined, with negative effects on the market.

Immediate prescriptions to strengthen IP rights include the following:

1. Establish an “inventive step” requirement in the patent application process;
2. Penalize patent trolls for frivolous lawsuits; and
3. Machete patent thickets produced by cross-licensing and reciprocity.

I urge the House Subcommittee on Information Technology to legislate following

these recommendations, fostering innovation and protecting free enterprise.

Bad Patents Obscure Good Inventions

The current IP rights system incentivizes companies to “declare as many patents as

possible ‘essential’ to various standards,” with the intent to demand royalties from
competitors using those standards.3 Competitors who refuse to pay are met with
a lawsuit and a block on sales. For example, a case in 2011 put the standard for
“fair, reasonable, and non-discriminatory” (FRAND) terms on essential patents into
question. Motorola and Samsung engaged in anticompetitive behavior, with their
smartphone patent cases built on FRAND terms, when they sued competitors to
“block products when there’s no agreement.”

The information technology industry is “rife with overly broad,” patents that claim
ownership over obvious or trivial designs, concepts, and technologies.4 An example

25
 of a bad patent is Amazon’s patent on the process that allows “people to buy
things with a single click.” With a flood of patents like Amazon’s, the US patent sys-
tem causes companies to compete over property rights in a gray area of unclear
patents. According to the Electronic Frontier Foundation, bad patents “threaten the
healthy competition we rely on to spur companies and technologists to experiment
and out-innovate one other.”5

These generic patents have facilitated the development of patent wars in the infor-
mation technology sector since the late 1990s. I urge you, Rep. Hurd, to encourage
the issuing of exclusively high-quality patents, and center reform around tougher
scrutiny in the USPTO.

Patent Trolls and Asymmetric Warfare

Patent trolls, or Patent Assertion Entities (PAEs), are companies that own patents
in order to solicit payments from other companies or individuals who they allege
infringe on their patent. PAEs almost never contribute to innovation and practice a
business model at odds with a free and fair market. These companies do not make
products and exist solely on the revenue generated by their patents, thus they can
be rightly called Non-Practicing Entities (NPEs).

In addition to being bad for consumers, PAEs can damage major US companies and
small and medium enterprises (SMEs) alike. NPE patent claims over IP ownership
cost US companies over $29 billion in 2011.6 Since PAEs are incapable of infring-
ing on others’ patents, as they do not create anything, they have nothing to lose in
battles over claims. They thus cannot be countersued; what Levy calls “asymmetric
warfare.” Khan and Mossoff demonstrate that these firms specializing in enforcing
patented technologies developed by invention specialists actually cause dead-
weight loss in the market.7

This systemic advantage, where it only costs “a few thousand [dollars]” for a patent
at the benefit of “easily… millions [of dollars] through litigation,” benefits PAEs.
While companies can fight off these lawsuits, the vast majority choose quick settle-
ments. Further, many claims are baseless, as defendants who fight PAEs win 92%
of the time. This unfair landscape, where it is more expensive to fight than settle,
favors PAEs and makes “trolling a multibillion-dollar industry” with no consumer
benefit. Therefore, Congressional patent reform must effort to protect consumers,
as I discuss below.

Patent Thickets: Modern Day Collusion

Carl Shapiro coined the term patent thickets and described it as “a dense web of
overlapping intellectual property rights that a company must hack its way through
in order to actually commercialize new technology.”8 In essence, because IP rights
must be licensed, actors and companies must specialize in a role in a technology’s

26
development, from applications to contracts to technological integration.9 In the
information technology industry, many patents overlap in scope so it is unclear from
whom one needs to seek a license. Due to cross-licensing, independent inventors are
stuck in a web of costly cross-licenses and claims.

In an example of patent wars, when Eastman Kodak sued Sony in 2007 for “en-
croaching on ten patents concerning digital cameras and camcorders,” Sony re-
sponded with a suit against Kodak citing ten different patents.10 Despite this back-
and-forth, the two companies came to a “cross-licensing agreement to protect their
patent portfolios.” Rather than fight a legal battle, companies often choose to
cross-license to gain royalties and grow the thicket.11

Specifically, patent pools, or the agreements between multiple patent owners to

license their patents to one another or a third party, are the cause for dense packet
thickets in the US.12 While in theory patent pools may facilitate innovation through
IP asset sharing, they “risk collusive behavior.” Patent pools may increase trans-
action costs and lead to chilling effects on new product development. Therefore,
patent thickets may distort competition, limit the rights of patent holders due to
enmeshing cross-licensing, and infringe on antitrust statutes.

Recommendations and Implications for the US Patent System

Bad Patents
In the current system, “bad actors can easily use [bad patents] to threaten all
kinds of innovators” and those that benefit are the NPEs and patent attorneys,
not inventors.13 To fix this, I recommend that you and your colleagues in the House
push legislation that augments the standard for nonobviousness in patents with an
“inventive step.”

In KSR v. Teleflex (2007), KSR argued that the decision of the Circuit Court against
it would produce too many patents of obvious inventions. The Supreme Court es-
sentially replaced the standard of nonobviousness with nonpredictability, holding
that Teleflex’s patent was obvious and invalid.14 The Supreme Court made the
argument that a “person of ordinary skill in the art,” or PHOSITA, should be able
to replicate and see the “obvious benefit” of the combination of gas pedal and
electronic sensor technology. KSR v. Teleflex serves as a lesson of the dangers of
a strict standard of nonobviousness, which lacks an element of inventiveness that
should be a requirement for patents in the USPTO.

A study by Petra Moser demonstrated a correlation between countries with

strong, enforceable patent systems and higher GDPs.15 The countries with weaker
patent systems, like Switzerland and the Netherlands, ultimately could not com-
pete across a broad variety of industries like those with strong patents systems,
such as Britain and the United States. Weakening IP rights in the United States
and a lack of an inventive step have led to an increase in bad patents.

27
 I recommend you write a bill for the USPTO to require an inventive step, as prac-
ticed in European courts, rather than only adhere to a doctrine of nonobviousness.
Such legislation may weed out bad patents and foster innovation, rather than
redundancy and overreach.

Patent Trolls
To stop patent trolls, I encourage you to support legislation that raises the penalties
“against NPEs that lose patent infringement lawsuits.”(6 It is critical to give NPEs a
disincentive to risking frivolous litigation and widespread lawsuits.

For example, The Leahy-Smith America Invents Act (AIA) of 2011 was a significant
step in leveling the playing field.17 It allows for post-grant opposition (PTO), which
allows patent holders to reissue and amend their patent and others to challenge
claims and conduct a reexamination and opposition through the USPTO. Starting
in 2013, the United States shifted from a “first to invent” to a “first inventor to file”
system, protecting independent inventors and large companies alike. This allows
the USPTO to throw out “egregious claims” before the defendants are forced into
a full trial. I encourage you and your colleagues to support legislation like the AIA
to demarcate the rights of companies against the patent flood triggered by trolls.

In TC Heartland v. Kraft Foods (2017), the Supreme Court tightened rules against
forum shopping, the filing in distant, favorable districts far from the defendant,
with respect to 45% of all cases being filed in eastern Texas.18 Aligned with TC
Heartland, it is imperative that you pursue a legislative agenda that discourages
frivolous litigation and forum shopping characteristic of patent trolls to ensure a
competitive information technology market.

Patent Thickets
Patent thickets in certain industries obstruct innovation. Similar to the solution to
bad patents described earlier, I again recommend legislating an inventive step to
reduce the amount of bad patents that must be navigated through cross licensing
within a patent thicket.

In terms of limitations on my recommendation, according to Lewis, packet thickets

“should not be viewed as a block on innovation but rather a milestone of progress.”
They appear whenever there is a “major technological advance” and stay until a
market equilibrium. Regardless of patent thickets being a temporary problem, it
is important for legislators to attempt to alleviate costly burdens of cross-licensing
on American companies.19 Patent thickets are still subject to market effects where
“transaction costs…become burdensome” as the number of “players and patented
features increase.”20 Despite Lewis’ criticism, it is clear that patent thickets still pres-
ent a major blockade to innovation in affected industries.

The largest patent thicket in the world today is that for smartphones.21 This is in
part due to its density—over 80% of patents on smartphones are valid, according

28
to a 2012 USPTO study by Director David Kappos.22 Nonetheless, companies such
as Apple, Samsung, Google, Research in Motion, Microsoft, Nokia, Motorola, HTC,
and others are enmeshed in a web of patent infringement suits. It appears that the
smartphone patent thicket is entrenched as each patent holder holds an “exclusive
right to one or many small features of the smartphone,” and thus can obstruct
others from manufacturing a whole smartphone.23 Thus, I recommend you and your
colleagues seek ways to reduce broad patents that make the thicket exceedingly
costly for companies to navigate.

Conclusion and Proposal

Based on the recent history of patents, I conclude that the most pressing issues—
bad patents, patent trolls, and patent thickets—are intimately related. Congress
must pass more strict IP-Pright enforcement. The current patent mess damages
free enterprise in the United States with unclear property rights that repress
inventors.

To solve bad patents, and by extension patent thickets, I propose you legislate an
“inventive step” as a requirement in the patent application process to clarify the
specter of nonobviousness. Last, to reduce PAEs, I urge you to legislate increased
penalties on frivolous lawsuits, shifting the burden of proof on to patent trolls and
returning power to the consumer.

1
Austin McLaughlin, “Information Technology Patent Problems and Prescriptions,” March 31,
2017.
2
Stephen Haber, “Making the US Economy Grow Again: The Role of Intellectual Property
Rights,” lecture, Hoover Institution, Stanford, California, August 23, 2017.

3 Nilay Patel, “The ‘Broken Patent System’: How We Got Here and How to Fix It,” The Verge,
July 10, 2012.
4
Steven Levy, “The Patent Problem,” Wired, November 13, 2012.
5
“Patents,” Electronic Frontier Foundation, accessed February 13, 2018, https://www.eff.
org/issues/patents.
6
Levy, “The Patent Problem.”
7
Haber, “Making the US Economy Grow Again.”
8
Stefan Wagner, “Are ‘Patent Thickets’ Smothering Innovation?” Yale Insights, April 22,
2015.
9
Haber, “Making the US Economy Grow Again.”
10
Levy, “The Patent Problem.”
11
Haber, “Making the US Economy Grow Again.”

29
 12
“Patent Pools and Antitrust—A Comparative Analysis,” World Intellectual Property Or-
ganization, March 2014.
13
Electronic Frontier Foundation, “Patents.”
14
“KSR International Co. v. Teleflex Inc,” Oyez, accessed March 31, 2017, https://www.
oyez.org/cases/2006/04-1350.
15
Haber, “Making the US Economy Grow Again.”
16
“Patent Trolls: Why No One Likes Them,” The Economist, March 3, 2015.
17
Levy, “The Patent Problem.”
18
“TC Heartland LLC v. Kraft Food Brands Group LLC,” Oyez, accessed March 13, 2017,
https://www.oyez.org/cases/2016/16-341.
19
Wagner, “Are ‘Patent Thickets’ Smothering Innovation?”

Jeffrey Lewis, “The Sky Is Not Falling: Navigating the Smartphone Patent Thicket,”
20

WIPO magazine (World Intellectual Property Organization), February 2013.

21
Haber, “Making the US Economy Grow Again.”
22
Lewis, “The Sky Is Not Falling.”
23
Lewis, “The Sky Is Not Falling.”

30
Countering Russian Propaganda While Providing Local-
Language Services in the V4
By Danni Ondraskova, Wellesley College
Since 2011, Russia has launched a propaganda war in the politically and econom-
ically allied Visegrád (V4) countries (Czech Republic, Slovakia, Poland, and Hun-
gary), creating a false moral binary between the morally degenerate West and
responsible protector Russia to gain strategic influence in the V4. Russian online,
print, and television outlets fabricate photos and sources and rely on alternative
Western “experts” to propagate their messages. Kremlin-funded networks spend
$1.4 billion annually on propaganda.1 RT alone spends $300 million a year and
has 700 million cable subscribers, comprising about 10% of the entire world pop-
ulation.2

Bolstered by the approximately 270 Russian and local language propaganda

websites in the V43 and hundreds of Kremlin-paid internet trolls, populist political
parties are gaining political influence in the region and are reshaping the narrative
on Russia.4 Antiestablishment leaders like Czech President Miloš Zeman, Hungarian
Prime Minister Viktor Orban, and Slovak Prime Minister Robert Fico support closer
ties with Russia and oppose EU sanctions on their eastern neighbor.

V4 countries and their allies have responded but are being outmatched by Russia
both financially and strategically in its propaganda war. Since 2014, the State
Department, USAID, and the Broadcasting Board of Governors (BBG) spent $100
million for Russian independent media but were dwarfed by Russia’s $400 million
in propaganda spending.5 The EU External Action Service hired eight employees
to create bilingual digests that collect and explain propaganda, but this is the only
EU body devoted solely to countering Russian “fake news.”6 The Czech government
created a twenty-member task force to educate officials and correct misleading
reports, but other V4 countries have yet to follow suit.7

Because V4 citizens have little trust in their governments and Russia has a formida-
ble campaign, civil society must be more prominent and the V4 strategically pri-
oritized.8 The second criterion is elucidated by the Senate Foreign Relations Com-
mittee hearing on Russian Violations of Treaties, Borders, and Human Rights last
summer. While Secretary Victoria Nuland rightly focused on Russia’s propaganda
spending, she may have overemphasized creating Russian language programming
for the Baltics, Russia, and Ukraine. Nothing was said about countering the Kremlin’s
local-language propaganda in V4 countries, which have a smaller proportion of
Russian speakers and are also a vital part of Europe as EU and NATO members.9

My proposed program would partner the State Department and the Visegrád
Fund, a V4 organization that already has the legal authority, procedural mecha-
nisms, and political support to disburse grants for nongovernmental institutions in

31
 the region. Every year, the Fund gives $42,000 Strategic Grants for 1—3 year
projects to organizations operating in all V4 countries and addressing Strategic
Grants priorities.10 Under my policy, the State Department would contribute $2
million over a four-year period towards the existing Strategic Grants fund called
Democratic Values and the Media.

The Visegrád Fund explicitly lays out the mission of grant winners in the Democratic
Values and the Media category as “the advancement of democratic values, human
rights, and civil liberties.” About half of the objectives listed in this grant category
are related to fact-checking, public education, and local-language investigative
reporting. The listed target groups for funding in this category are consistent with
the types of grassroots organizations that are trusted and typically engender sus-
tainable local change, including young researchers and students, small- and medi-
um-sized enterprises, and underrepresented scientists.11

Ten $50,000 grants would be added to the category annually by the United
States for the four-year trial period. Successful recipients would be able to re-
apply if they demonstrated significant social reach in the V4. State Department
embassies in V4 countries and Visegrád Fund staff would be able to tweak the
existing criteria if needed and judge entries together (for example, transparency
criteria would be added to ensure that the methodology of winners can be vetted
and corroborated by independent observers). Future grant winners could, for ex-
ample, include a research center that analyzes the influence of Russian propagan-
da on Hungary’s political parties, or a Polish think tank that creates an accessible
ranking system for Russian media outlets.

The Visegrád Fund has the infrastructure to handle short-term, medium-sized grants
like the one I proposed and already has an established relationship with many suc-
cessful local NGOs. The fund has an $8 million overall annual budget with equal
contributions from each V4 country and accepts foreign government donations
but has only been funded by democracies without human rights violations.12 The
Visegrád Fund is also transparent, with publicly available budget forms, selection
guidelines and criteria, and a list of past winners and their projects on its website.
Because of these factors, the Visegrád Fund would probably be a low-risk asset
from a US investment perspective.

My policy would supplement current US government efforts in an overlooked area

by re-gearing an existing V4 program to be bilateral and more explicitly geared
toward the twenty-two million Central Europeans who do not speak Russian. It
would bolster funding for local language anti-propaganda programs in the region
and avoid the distrust often associated with top-down campaigns. Traditional gov-
ernment initiatives have often fizzled out due to the fact that the region’s citizens
strongly associate their governments with corruption, and for good reason: all four
V4 countries were included in the World Economic Forum’s 2016 list of the eleven
most corrupt OECD countries.13 As one of the only institutions in the region with a

32
good track record, mission, and transparency, the Visegrád Fund is an ideal home
for US government investment.

The US State Department has allocated funding to NGOs in Europe in the past,
including $500,000 for an investigative journalism training program spanning the
Baltic States.14 My program would be the first to involve all of the V4 countries
in a grant program focused specifically on countering Russian propaganda in the
region while providing local-language services. This program would be a relative-
ly cost-efficient way to reach sixty-three million people in a region that has been
historically important for European and worldwide stability.

There are a number of relatively easy ways to measure the metrics of successful
grant applicants. The Visegrád Fund website regularly audits winners and has
publicly enumerated financial criteria for grantees to meet. In addition, winners’
performance can be measured through the final required report at the end of
the four-year term. When assessing the efficacy of these initiatives, it is important
to look beyond likes, comments, and shares. Because of the sheer volume of fake
news flooding the internet monitors of V4 citizens, efficacy must be at least par-
tially measured by numbers of stories debunked and originally investigated. Public
polling on the West’s role in Euromaidan and other Russian conspiracy theories is
another way to naturally measure whether people are being properly informed
about what is going on in their countries.

One of the main implementation challenges is public opinion on American engage-

ment in foreign countries. There is currently domestic opposition to increasing US
foreign aid stemming from confusion about the portion of the US budget going to
foreign aid. A Kaiser Foundation 2014 poll found that 5% of Americans correctly
estimated that the US budget devotes less than 1% to foreign aid; the typical re-
spondent thought the figure was 26%. Once Americans are educated on this issue,
the proportion of respondents who think the United States overspends on foreign
aid halves from 56% to 28%, showing that legislative and executive branch lead-
ership can correct public misperceptions to a large extent.15

The United States is also at a political crossroads about its foreign policy priorities
and will decide its 2018 fiscal year budget for the State Department and USAID
in September. Although most Congressmen and Senators on both sides of the aisle
vehemently oppose the proposed 32% cut to these agencies, funding is likely to
remain flat, or slightly decrease, in every region except eastern Asia.16 Keeping in
line with the fiscal and strategic streamlining philosophy the Trump administration
seems to be operating under, my policy proposal would reach out to an under-
served population and yield a high return on investment in the short term and
potentially prevent a major Russian propaganda problem from ballooning in the
long term.

V4 countries are also in an identity crisis, neither trusting Russia nor their own demo-

33
 cratic institutions.17 The majority of V4 citizens view Russia negatively, believe their
countries are somewhere between the West and East geopolitically, and have a
neutral view on NATO membership, with some notable exceptions.18 The majority of
Czechs and Slovaks disapprove of the United States’ role in Europe and think the
United States uses NATO to control smaller countries like themselves.19 In the outlier
country, Poland, strong majorities approve of NATO and the United States’ role in
Europe; the country can help guide its counterparts towards a new identity during
a time of populist turbulence on the continent.20

By providing needed funding to civil societies with limited red tape and shortened
time lags, V4 governments will incentivize innovation that will improve the public
welfare of some of the United States’ staunchest allies. As a region that is suffering
from brain drain stemming from burdensome statutes and rent-seeking govern-
ments, the V4 can begin to reverse the tide of talented young people leaving
to the United Kingdom and the United States with a new message of serving the
common good in the nonprofit and academic sectors.21

Perhaps most importantly, the United States can improve its diminished image in the
region with a relatively unobtrusive and transparent display of soft power, which
overcomes its negative legacy of Middle Eastern military action in the 2000s and
ill-timed withdrawal from Central and Eastern Europe after the Cold War. As the
country turns towards eradicating the Islamic State of Iraq and the Levant (ISIL)
and possibly increases military activity in Afghanistan and other countries, it stands
to benefit from the continued personnel support of these Central and Eastern Eu-
ropean countries.

As Central and Eastern Europe remains the key bridge between the West and
Russia, it is important for the United States to communicate that the V4 and its
neighbor countries are a priority, especially given recent unchecked Russian mili-
tary interference near the Baltic States and in Georgia, Ukraine, and the Crimea.
If successful, this pilot program can be the precedent for other government-funded
organic civil society initiatives in former Soviet countries that have been more be-
leaguered by Russia and unleash real transformational change in the region.

1
Kenneth R. Weinstein, “Testimony before the Senate Foreign Relations Committee,
November 17, 2015,” accessed August 30, 2017, www.foreign.senate.gov/imo/media/
doc/111715_Weinstein_Testimony.pdf.
2
Simon Shuster, “Inside Putin’s On-Air Machine,” Time, March 5, 2015, accessed August 31,
2017, http://time.com/rt-putin.
3
This sum is the average of the twenty Russian propaganda websites in Poland and
the 240–260 sites in the other V4 countries. “Russian Propaganda Entering Mainstream
News: Disinformation Experts,” Radio Poland, November 18, 2016, accessed August 30,
2017, www.thenews.pl/1/10/Artykul/280476,Russian-propaganda-entering-main-
stream-news-disinformation-experts; Georgi Gotev, “Commission: Russian Propaganda

34
Has Deeply Penetrated EU Countries,” EurActiv, July 14, 2016, accessed August 30, 2017,
https://www.euractiv.com/section/global-europe/news/thurs-commission-official-rus-
sian-propaganda-has-deeply-penetrated-eu-countries.
4
Alina Polyakova, Marlene Laruelle, Stefan Meister, and Neil Barnett, “The Kremlin’s
Trojan Horses,” Atlantic Council, November 15, 2016, accessed August 30, 2017, www.
atlanticcouncil.org/publications/reports/kremlin-trojan-horses.
5
Victoria Nuland and Jeanne Shaheen, “Nuland: US Spends $100Mln to Fund Russian
‘Independent Media’ to Counter Russian State Propaganda,” Russia Insight, YouTube, June
7, 2016, accessed August 30, 2017, https://www.youtube.com/watch?v=JDjW4Sgh28o.
6
EU vs Disinfo, November 21, 2016, accessed August 30, 2017, https://euvsdisinfo.eu.
7
Czech Republic Sets up Anti-propaganda Unit,” Ukraine Today, October 21, 2016.
8
OECD Public Governance Committee and the Government at a Glance Steering Group
et al., “Government at a Glance 2015,” OECD iLibrary, July 6, 2015, accessed August 30,
2017, www.oecd-ilibrary.org/docserver/download/4215081ec050.pdf?expires=14799
19674&id=id&accname=guest&checksum=4007.
9
Nuland and Shaheen, “US Spends $100Mln.”
10
“About Us,” International Visegrad Fund, accessed August 30, 2017, http://visegrad-
fund.org/about.
11
“Grants,” International Visegrad Fund, accessed August 31, 2017, https://www.viseg-
radfund.org/apply/grants.

US Embassy, Vilnius, “Notice of Funding Opportunity,” August 31, 2015, accessed August
12

30, 2017, https://vilnius.usembassy.gov/news-events/notice-of-funding-opportunity.html.

13
Thomas Colson, “These are the 11 Most Corrupt Countries in the Developed World,”
Business Insider, September 29, 2016, accessed August 30, 2017, www.businessinsider.
com/wef-corruption-index-the-most-corrupt-countries-in-the-oecd-2016-9.
14
Poncie Rutsch, “Guess How Much of Uncle Sam’s Money Goes to Foreign Aid. Guess
Again!” NPR, February 10, 2015, accessed August 30, 2017, www.npr.org/sections/
goatsandsoda/2015/02/10/383875581/guess-how-much-of-uncle-sams-money-goes-
to-foreign-aid-guess-again.
15
OECD, “Government at a Glance.”
16
Carol Morello and Anne Gearan, “Senators Sharply Question State Department Budget
Cuts,” Washington Post, June 13, 2017, accessed August 30, 2017, https://www.wash-
ingtonpost.com/world/national-security/tillerson-argues-state-departments-main-focus-
should-be-on-us-security/2017/06/13/0438ebdc-503f-11e7-be25-3a519335381c_
story.html?utm_term=.9e9f44778364.
17
Kat Devlin, “Anti-Russian Views on the Rise in Poland,” Pew Research Center, March 19,
2015, accessed August 30, 2017, www.pewresearch.org/fact-tank/2015/03/19/anti-
russian-views-on-the-rise-in-poland.
18
“Poll Reveals Hungary as the Most EU and NATO-friendly Country in Central Europe,”

35
 Ukraine Today, September 12, 2016.
19
Danielle Cuddington, “Support for NATO Is Widespread among Member Nations,” Pew
Research Center, July 6, 2016, accessed August 30, 2017, www.pewresearch.org/fact-
tank/2016/07/06/support-for-nato-is-widespread-among-member-nations.
20
Derek E. Mix, “Poland and Its Relations with the United States,” Congressional Research
Service, March 7, 2016, accessed August 30, 2017, https://www.fas.org/sgp/crs/row/
R44212.pdf.
21
Re Judy Dempsey, “How Corruption is Driving Eastern Europe’s Brain Drain,” Carne-
gie Europe, September 9, 2016, accessed August 31, 2017, http://carnegieeurope.
eu/2016/09/09/how-corruption-is-driving-eastern-europe-s-brain-drain-pub-64545.

36
Instituting PLOP to Help Shore Up the RSA
By Davis Parker, University of Georgia
Public pension plans have existed since the dawn of the Roman Republic. In 13 BC,
Augustus formalized a state-sponsored retirement plan for veterans who served in
Roman military campaigns. In 1775, the United States of America began guaran-
teeing retirement income for its Army and Naval forces, and after the Civil War,
Congress passed a series of laws organizing the modern pension program for
veterans—a fixed percentage of base income after a set number of years.1

It was not until the Progressive movement at the turn of the twentieth century that
states expanded access to public pensions from military to civilian employees. And
by 1930, the federal government was providing pension plans to all federal em-
ployees, with many state and local municipalities following suit. Yet the popularity
of defined-benefit pensions did not spread to the private market, where fewer
than 15% of employees had guaranteed pensions.2

Today, over 80% of state and local full-time employees have a defined-bene-
fit contribution plan, compared to less than one-third of private employees.3 Ac-
cording to the Hoover Institution, the total unfunded public pension liability in the
United States is $3.846 trillion, over $2 trillion more than governments recognize
in actuarial reports.4 In Alabama, the Retirement Systems of Alabama (RSA) held
assets of $29.4 billion and liabilities of $44.6 billion as of 2013, equating to
an unfunded liability of $15.2 billion and a funded ratio of 66 %5; yet, under a
more accurate accounting of market value, the unfunded liabilities jumps to $46
billion and the funded ratio drops to 40%—the eleventh worst-funded ratio in the
country. Moreover, Alabama’s current unfunded liability is five times the value of
its 2015 tax revenues. To simply prevent a rise in its unfunded liability, Alabama
would have to more than double its yearly contribution from 4.1% of revenue to
9.5% of revenue.6 Among Alabama’s deeply conservative populace and legisla-
ture, the prospect of raising taxes to fund pension obligations is dead on arrival,
while meeting those obligations through current revenues is unlikely as the state can
barely fund basic services such as indigent defense, much less capital investments.

While there are no easy solutions or silver bullets to Alabama’s pension problem,
there are small steps legislators can take to ease the burden of state obligations.
One of them is the institution of a Partial Lump-Sum Options Payment (PLOP) fi-
nanced by a one-time bond issuance at historically low rates.

At the present, Alabama state employees and retirees may pick from a handful
of retirement options: lifetime monthly pension, return of contributions plus interest,
lifetime annuity, and lifetime annuity with survivor benefits. The PLOP would add
another option to this bouquet: a one-time lump-sum payment equal to the total
or partial actuarial value of a worker’s lifetime annuity or some portion of that
annuity. In simpler terms, employees would receive a single retirement check today
instead of a stream of smaller checks later.

37
 Per most the recent publicly-available financial statements, the RSA has 420,512
total members with 218,164 of those who are current employees.7 To properly
fund the pension obligations of its members, the RSA assumes an investment return
of roughly 7.75%. When this goal is not met, the state is required to fund the short-
fall out of state general revenues. With $29.4 billion in assets, even a 1% shortfall
costs the state $300 million per year, and in 2016 Alabama altogether contribut-
ed over $900 million to the RSA. Considering the State General Fund (SGF), the
discretionary budget controlled by the legislature, is less than $2 billion, the RSA’s
failure to meet its investment target represents a weighty albatross around the
state’s financial neck.

The financial value of the PLOP is that it would replace the state’s pension obliga-
tions with long-term bond debt obligations. While pension obligations assume a
yearly return of 7.75%, a thirty-year bond deal could be financed at ~4.5% per
year. In essence, this creates a “reverse arbitrage” play in which 7.75% liability
is replaced with 4.5% liability, saving 3.25% per year on every dollar withdrawn
from the RSA and replaced with a bond. For example, if the total value of the
PLOP were $100 million, the state would save 3.25% times $100 million, which
equals $3.25 million per year.

To accomplish this, the state would issue a one-time bond payment to finance the
PLOP. Immediately, the unfunded actuarially-accrued liability of the state lowers
by the value of the bond issuance—lowering the state’s annual required contribu-
tion to the RSA. The state then pays its debt service on its bond and can redirect
savings to the SGF or back into the RSA.

The states net savings from the PLOP would be determined by the total size of the
bond deal, which would be determined by the rate of participation among retirees
and the present day value of their retirement plans. At present, there are an esti-
mated 113,000 current retirees, 6,000 unretired former employees, and 23,000
retirement-age current employees eligible to receive PLOP; a total of 142,000.8
The participation rate of individual retirees is hard to predict, but we can develop
a theoretical framework for why a person might opt for PLOP. A retiree may have
a present liquidity or debt crisis in their personal finances, such as high-interest
credit card debt or an underwater mortgage. A retiree might have other streams
of long-term, predictable retirement income and a desire to make a large, one-
time purchase or investment (home, car, education for children, etc.). Or, a retiree
may just enjoy the freedom of managing his or her own retirement portfolio.

Next, we need to determine the average pension values of potential PLOP partic-
ipants. Unfortunately, the RSA’s financial reporting makes that hard to do, as they
do not report the average value of pensions as a function of years worked or
benefits previously withdrawn. So, we must do our best to estimate these values us-
ing available information. As of September 30, 2014, the RSA has 420,512 total
participants and $44.6 billion in liabilities. (For the sake of this analysis, we use the
state actuarial numbers, not the amounts calculated by Rauh 2017.) That equates
to an average liability of $106,061 per RSA member. While this number is a

38
rough estimate and does not adjust for the potential uniqueness of the PLOP-eli-
gible population, it can be informative as a tool for estimating the potential value
of PLOP. With 142,000 retirees eligible, that gives an estimated potential PLOP
value of $15.1 billion. Table 1 calculates the value of the PLOP as a function of
participation percentage. For every 1% increase in participation, the state saves
$4.9 million per year. Meaning, even if only 5% of eligible retirement benefits are
cashed out via PLOP, the state would save nearly $25 million per year—totaling
almost $750 million over the course of the bond.

Since PLOP is a purely financial policy proposal, it’s efficacy is a question of

mathematics, not broader market forces and incentive structures. If properly imple-
mented, it cannot fail to save the state money. At its root, PLOP is like refinancing a
home mortgage—exchanging a high interest rate for a low one and ensuring that
the transactional costs do not exceed the potential savings. With that in mind, it is
worth considering how a PLOP might be implemented.

Similar to other governmental initiatives, the state would have a three-month long
registration period where eligible participants can sign up to receive the PLOP.
During that time period, the state would send out informational guides and retire-
ment overviews to employees and retirees. These retirement forms would include
the individual’s current retirement situation (expected yearly payment, etc.) as well
as the potential PLOP value of their retirement account. Moreover, potential par-
ticipants would be granted access to financial advising through either an online
tutorial or an RSA advisor. Participants would then register online or by mail, and
the state would calculate the total PLOP amount at the end of the registration
period. At the close the registration period, the state officials would have three
months to negotiate and secure a thirty-year bond deal at the value of the PLOP,
and at the end of that three-month period, the state would send PLOP payments
to individual retirees.

From a tax perspective, PLOP payments would not be subject to state income tax
but would be subject to the federal income tax, though retirees would be able to
rollover their PLOP tax-free into an IRA or other tax-sheltered retirement account.

In many ways, this policy seems like a no-brainer for legislators. It gives employees
greater choice in deciding how to manage their hard-earned retirement, while also
taking advantage of the unique financial climate to deflate the state’s ballooning
pension obligations and/or fund necessary state agencies. Moreover, it provides
an effective talking point on the campaign trail for legislators concerned with re-
election. Lastly, a bond-financed PLOP would allow greater flexibility in the event
that the state goes into bankruptcy. As Detroit, Michigan and Jefferson County,
Alabama illustrate, municipalities tend to be more successful reneging on bond
obligations than guaranteed pensions.9

Yet, state pension funds and their managers have incredible political clout and
would potentially be opposed to any bill that shrinks their balance sheets. Not only
do they have sizable financial resources, but they also have the means to organize

39
 current and former state employees to persuade lawmakers against supporting
the bill. This is a very real challenge, but it can be overcome by a consistent, deter-
mined adherence to the facts and reason.

While policy mechanisms like PLOP will not single handedly turn the tides of in-
creasing unfunded pension liabilities, they are small steps in the right direction and
can provide policy makers with increased flexibility to shore up the RSA and fund
necessary state functions.

Senator Everett Dirksen was once famously misquoted as saying, “A billion here, a
billion there, and pretty soon you’re talking real money.” Lawmakers often seem to
forget that the numbers in the budget are real money and that the billions of dol-
lars they spend each year come from the pockets of some hardworking Alabamian.
It is their unique responsibility to preserve and spend that money wisely, and any
move that better allows them to do so is worth the effort.

1
Lee A. Craig, “Public Sector Pensions in the United States,” in EH.Net Encyclopedia, ed.
Robert Whaples, March 16, 2003.
2
Robert L. Clark, Lee A. Craig, and Jack W. Wilson, A History of Public Sector Pensions in
the United States (Philadelphia: University of Pennsylvania Press, 2003).
3
Employee Benefit Research Institute, EBRI Databook on Employee Benefits (Washington, DC:
EBRI, 2015).
4
Joshua Rauh, “Hidden Debt, Hidden Deficits: 2017 Edition,” Hoover Institution, 2017.
5
James Barth and John Jahera, “Alabama’s Public Pensions: Building a Stable Financial
Foundation for the Years Ahead,” Alabama Policy Institution, 2015.
6
Rauh, “Hidden Debt.”
7
Barth and Jahera, “Alabama’s Public Pensions.”
8
Barth and Jahera, “Alabama’s Public Pensions.”
9
Lester Graham, “Detroit Bankruptcy Lesson: Underfunded Pension Funds Could Trip Up
Other Municipalities,” Michigan Radio, December 1, 2015.

40
NOTES

41
42
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 #HISPBC

Hoover Institution, Stanford University

434 Galvez Mall
Stanford, CA 94305-6003
650-723-1754

44