Free Lunch (6 page)

CSX said it was disappointed that the
Supreme Court would not give it a chance to show that the jury and the Florida judges were wrong. CSX even suggested the
proper punitive damage was zero. Kathy Burns, one of the CSX publicists, called the punitive damage award “unwarranted and
excessive.”

Lobbyists from CSX and other companies had, in the meantime, descended on
Tallahassee to persuade the state legislature that big punitive damage awards were bad for business. Today Angelica Palank could
not get $50 million in punitive damages because of a law signed by Governor Jeb Bush. It severely limited any future damage
awards no matter how awful the misconduct.

Even with the award that the courts left standing,
the cold calculus that cutting safety is immensely profitable remains in place. The total damages to the Palank family, both to
compensate them and to punish the company, came to a bit more than $56 million. The money paid to all of the others, who settled
without litigation, was a fraction of this. Viewed in the context of what CSX saved, however, even the total damages were not
punishment at all, just a minor cost of doing business. For every dollar CSX saved by cutting corners on safety it only had to give
back four cents.

We teach children that crime does not pay, but the grown-up truth is that
“borderline criminal” behavior can pay handsomely.

From the perspective of CSX, or any
railroad, the economics of shortchanging safety continue to make sense. Two years after the Palank case ended, James E. Hall, a
former chairman of the National Transportation Safety Board, told
The New York Times
that the loss of lives in rail accidents reveals “a systemic failure…It's been something that has just not grabbed the attention,
unfortunately, of the public.” He was speaking of deaths at rail crossings, but his point is equally valid across the
board.

Although many travelers worry more, as Sergeant Palank did, about dying in a plane
crash or being hit by an 18-wheel rig on the highway, since the year 2000 Americans have been dying at the rate of about one per
day at railroad crossings. A few of these deaths are suicides by train or the bloody product of fools driving around signal arms.
Some are also the result of crossing arms that fail to activate. Others occur because signal arms sometimes bob back up after
coming down, endangering even careful drivers and their passengers. At crossings with no signals, foliage that the railroads have
not trimmed in accordance with the rules add to the death toll as people drive unaware onto tracks just as millions of pounds of
steel bear down on them.

In Britain only about 18 people per year die at rail crossings. Major
crossings have fencelike barriers that cars cannot flit around. Even after taking into account that America has five times as many
people as the United Kingdom, the death rate at crossings in America is four times that of Britain.

Between 1995 and 2000 derailments increased 28 percent, nearly triple the 10 percent increase in freight
hauled. Yet even with more accidents and more deaths, the economics of cutting spending on safety are compelling from the
railroad's perspective. The fines imposed for safety violations in the United States are minor, more like parking tickets than
deterrents. The maximum fine is $20,000. The average fine is about $1,600. So the railroads play the percentages, weighing risk
versus cost. Risk wins easily.

Most switches are safe. And not every unsafe switch will fail.
Keeping every one of the thousands of switches around the country in proper repair is very costly, especially as a competitive
market drives transportation prices down. After all, the jury-rigged repair of the backward Orlon switch held for years. Those
switches that do fail will probably damage cargo, not kill people. Even killing people doesn't cost the railroads very much. As the
CSX case demonstrated, all the injured and the families of the dead except Angelica Palank accepted their modest settlements
quickly. So long as insurance costs less than repairs, this dangerous trade-off will continue no matter what the railroad industry
says about its commitment to safety.

Since the imperfect rules of the marketplace actually
reward dangerous risk taking, the only thing that could prevent this lethal gamble is effective government regulation. In this century
just 4 of the first 3,000 rail-crossing accidents were fully investigated because of ever-tighter budgets for government safety offices.
One railroad, Union Pacific, even said that federal regulators were so overworked they told the railroad to “stop calling” after every
crash, which explained a big drop in minor accidents it reported.

The industry, since 2001, has
steadily tried to assure the public that all is fine with the railroads because accident rates are falling. Then came eight CSX
derailments in seven weeks as 2006 turned into 2007. That prompted the Federal Railroad Administration to send inspectors out
across 23 states. Their inspections of CSX found more than 3,500 violations, 199 of them rated serious cases of failure to comply
with the law.

What no one reported at the time is that railroads are by far the most deadly form
of commercial transportation in the country, the exact opposite of the industry's carefully orchestrated campaign to deceive with
statistics. “Freight rail is by far the safest way to move goods and products across the country,” the Association of American
Railroads tells the public.

Few people realize how deadly trains are because crashes usually
involve one or two deaths and thus get little attention in the news. They also lack the emotional appeal of plane crashes, which fill
us with a sense of dread because flying through the air at nearly the speed of sound seems to defy common sense.

Still, airliners are America's safest form of transportation by far. Some 600 million passengers board planes
each year, yet often a year and sometimes several years pass between fatal crashes. Big trucks kill about 5,100 people per year,
trains about 930, and airliners about 140.

Measure deaths by the distance traveled, however,
and trains are 52 times more deadly than trucks. Trains kill 130 people per 100 million miles traveled, compared with 2.5 deaths in
big-rig truck accidents and 1.9 deaths in plane crashes, Transportation Department statistics show. It is easy to miss that because
the official government statistics use a measure of only a million miles per accident for trains, but 100 million miles for trucks and
airliners.

Bad as those official figures are, they severely understate how dangerous trains are.
Truckers drive on highways surrounded by cars. Trains run long stretches through rural areas where there are no crossings. In
such places a crash would hurt only the engineers on board and perhaps some jackrabbits. If we had a measure of people killed
per 100 million miles of travel in populated areas, where roads cross tracks and homes are almost as close by as freight cars
parked on sidings, the death rate would be many times greater than the official figures.

Just as
the CSX workers found ways to deal with demands that they inspect more track in a shorter amount of time, government agencies
also adjust to unrealistic budgets. Some workers in private businesses fake reports and make slipshod repairs. The more noble of
them work off the clock if necessary in an attempt to set things right. Some CSX workers testified that they worked extra hours for
no pay, but that even these efforts were not enough to overcome the callousness of the railroad's management and its dogmatic
belief in market ideology.

The government agencies, without anywhere near enough money to
oversee safety, play similar games. They tell Union Pacific to not call, they write superficial reports, and when it comes to accidents
at rail crossings, they thoroughly investigate only 4 out of 3,000 cases.

These responses are
human nature at work, as predictable as eating when hungry. Give managers more than they can possibly do and they will find a
way to redefine their workload to what can be done. When cuts in budget and personnel increase gradually, the public unwittingly
accepts unsafe conditions, just as the clickety-clack of the rails lulled passengers into sleep until the Orlon Crossing's deadly
repairs gave way.

Even a reliable system of safety rules means nothing, however, if there are
no consequences for misconduct. At the end of the day, after litigation that went all the way to the United States Supreme Court, for
CSX there were no consequences. CSX paid nothing for its recklessness.

CSX simply sent a
bill to Amtrak seeking reimbursement. It sought, and got, the full amount it had paid to the injured and the families of the dead.
Amtrak even paid the $50 million that the jury ordered to punish CSX. Since the government owns Amtrak, what CSX did, in effect,
was to stick the taxpayers with its bill.

The jurors, though, had no idea. Reporter Walt
Bogdanich, who won a Pulitzer Prize for exposing unsafe rail conditions, grows animated when he describes “this sham trial, an
absolute sham in which everyone on the jury thought CSX was being punished and CSX knew that no matter what happened it
would not cost them one cent.”

When Amtrak was formed in 1971, the freight railroads
persuaded Congress to let them stop carrying passengers. But they wanted more than to shed that obligation. The freight railroads
wanted to be insulated from any claims arising from Amtrak using their rails. The railroads reasonably sought not to be responsible
for claims arising out of misconduct by Amtrak. A crash caused by a drunken Amtrak engineer or a badly repaired axle on a
passenger train should be paid for by Amtrak.

Congress looked out for the freight railroads,
which unlike Amtrak were a vibrant source of campaign support. A federal law shields the freight railroads from claims by Amtrak
passengers and anyone hurt by an Amtrak train. Under federal law all claims arising from Amtrak passengers, even in cases where
Amtrak was not at fault, must be paid by Amtrak.

Under these rules it does not matter that
Amtrak did nothing wrong, its trains traveling below the speed limit, its crew alert and sober, its rolling stock in sound condition. It
does not matter that the courts found the cause of Paul Palank's death was CSX's reckless disregard for human life. Under the
contract, all that matters is, at the moment the rails or a switch or a shoddy repair job gives way, does the train passing overhead
belong to Amtrak? Only if a freight train is overhead when the failure occurs is the freight railroad on the hook for the
damages.

What this means is that CSX and John Snow got a free lunch. You got stuck with
their bill.

Economists have a term for situations in which someone gets rewards but has little or
no incentive to avoid risk: a
moral hazard.
The term is usually applied in insurance
cases. A policy that covers every cent with no deductible may cause people to be less vigilant about husbanding their lives or
property. A policy may even encourage the unscrupulous to burn down a failing store to collect the insurance money and avoid
bankruptcy. We are reminded of this most often by those exposés on local television in which a hidden camera captures a
firefighter or construction worker building a brick wall in his backyard at a time when he was collecting workers' compensation.
What we seldom see exposed are the roofing contractors whose disability insurance forms list 35 low-risk secretaries and 1
high-risk roofer, allowing them to cheat on their premiums.

Those who occupy the executive
suite and gamble millions of dollars on the lives of others are rarely seen as engaged in morally hazardous conduct. Yet reward
without risk is a form of moral hazard that blinds us to the consequences of our acts. The trade-off between safety and stock price
is an important part of the story of how the ideology of blind faith in markets is remaking America. But the moral hazards of this
blind faith are not limited to cutting corners on safety. We also have rules that encourage a new way to make the rich richer at the
expense of working people. It is a strategy called
labor
arbitrage.

C
HINA IS A MAGNET FOR CAPITAL. THE LOW COST OF ITS
LABOR
force and its nimble entrepreneurial class—aided by a government focused
on creating wealth, jobs, and industrial capacity—draw investment at an astonishing rate. The Chinese communist government has
created an economy that grows at 8 percent or more a year, more than twice the rate in the United States in good
years.

So much capital flows from America to China that in a single year, 2005, Shanghai built
more high-rise space than exists in New York City. A few years from now, Shanghai is expected to have 5,000 skyscrapers, more
than twice the number built in New York City since Elisha Otis invented the modern elevator in 1853. The Chinese economy is a
modern-day miracle, its growing prosperity celebrated worldwide as a victory for the forces of global free trade.

Yet free trade is hardly free. Like everything else, rules govern trade. Our rules encourage and protect trade.
Every economist knows that major shifts in trade cause economic disruption. The costs of this disruption are being paid by the
millions of Americans whose jobs are disappearing and whose hopes for the future are diminishing. How our government's rules
help the rich grow vastly richer at the expense of almost everyone else in America, sometimes in ways that threaten our national
security, is illustrated by the story of how one entire American industry, albeit small, succumbed to China's magnetic
pull.

In 1982, competing groups of scientists around the world found a way to combine iron
and boron with a somewhat rare earth called neodymium to make extremely powerful and lightweight magnets. These magnets
quickly found a market in computer hard drives, high-quality microphones and speakers, automobile starter motors, and the
guidance systems of smart bombs.

General Motors created a division to manufacture these
magnets, calling it Magnequench. The automaker used the powerful new magnets in starter motors for cars and trucks, cutting
their weight by as much as half. It even used the new magnets in the 11-pound electric motor of its Sunraycer, which won the first
solar-powered vehicle race, its skin of photovoltaic cells converting Australian sunshine into electricity. GM also made 80 percent
of the magnets used in smart bombs, the kind that can be guided to a target to maximize damage and, hopefully, minimize deaths
of innocent bystanders.

About 260 people worked at the profitable Magnequench factory. Then
in 1995 the automaker decided to sell the division. Because the deal was for only $70 million it attracted little attention. The buyer
was a consortium of three firms led by the Sextant Group, an investment company whose principal was Archibald Cox Jr., the son
of the Watergate special prosecutor whom President Richard M. Nixon famously fired.

In the
few press reports Sextant got most of the notice, but the real parties behind the purchase were a pair of Chinese companies—San
Huan New Material High-Tech Inc. and China National Nonferrous Metals. Both firms were partly owned by the Chinese
government. The heads of these two Chinese companies are the husbands of the first and second daughters of Deng Xiaoping,
then the paramount leader of China.

At the time of the sale, GM was trying to win permission to
become a player in the burgeoning automobile and truck markets in China. Many companies made accommodation deals with
China to get approval to enter the market there (though none dare call it commercial bribery). This was no ordinary concession for
commercial reasons, but part of a policy by Beijing to acquire high-technology industries with military significance. One of those
daughters, Deng Nan, was at the time vice minister of China's State Science and Technology Commission, whose responsibilities
included acquiring military technologies by whatever means necessary.

Complaints about the
sale of Magnequench were made to the U.S. government because of the military applications for the magnets. Still, the Clinton
administration, an ardent proponent of globalization, approved the sale. It did impose one condition: that the new owners keep
magnet production and technology in the United States.

Soon the new owners of
Magnequench were busy buying up other magnet factories in the United States, including GA Powders, an Idaho firm that had
used taxpayer money to develop the powerful new magnets. Once the new owners had a monopoly on production of these
powerful magnets in the United States, they began shutting down facilities and moving manufacturing to China. By 2003, the
original GM factory in Indiana was the last American production line for the powerful magnets. Once it closed and its equipment
was hauled off, the United States became dependent on China for these magnets, including the ones needed for smart
bombs.

Clearly, the promise to the Clinton administration had become hollow. Senator Evan
Bayh of Indiana wrote to President Bush in 2002 expressing concern that shutting down magnet production and moving it to China
was not improving national security. How could this sale possibly be good for America? Bayh asked. The senator, a Democrat,
later told colleagues that “it's not very smart to rely on China for a critical component of an important weapons system for our
country.”

The significance of this became clear when the Chinese launched a missile in early
2007 that shot down one of their own satellites. In a war with the United States, the ability to knock out American eyes in the sky
would give China a huge advantage. Few Americans got the point, however, after only one day of short articles and brief newscast
reports, hardly any of which connected the dots.

That production of magnets made with
neodymium is now a Chinese monopoly is not the end of the story. America cannot just resume making these magnets at any time.
Not only is the technical knowledge largely gone, but America's only neodymium mine shut down in 1996. And 85 percent of our
planet's known stores of neodymium are in one country: China.

The Bush administration has
never answered Senator Bayh's questions about why it allowed this specialized form of magnet manufacturing to move to China. It
has instead issued blanket statements asserting it has taken all appropriate steps to safeguard Americans from foreign threats.
However, the Government Accountability Office, the investigative arm of Congress, does not share the administration's sanguine
view of magnet production moving to China.

When foreign governments or firms want to
acquire American companies whose business affects national security, the deals are supposed to be examined in advance by an
official government review panel known as the Committee on Foreign Investment in the United States. Studies by the Government
Accountability Office show the committee does little to secure the national interest. More than 1,500 such deals have been
approved since the committee was created in 1988, only a dozen of which were sent to the White House for review. Only one of
these was denied. That occurred in 1990 when the first President Bush killed the sale of a Seattle aerospace-parts maker to
China.

The accountability office found that, in many of these deals, the committee examination
took place only after the sale to foreign interests was completed, an exercise not in locking the barn door after the horse ran off, but
in merely affirming that the latch had been left open.

Lax oversight has particular ramifications
for national security, but broader and equally dire economic consequences arise from the unique way that the United States
subsidizes offshoring through our tax system. This important story begins with a most curious Chinese law.

After President Nixon's visit to China in 1972, American oil companies sought to explore there. Right off, they
asked the Chinese to enact a corporate income tax. The Chinese were bewildered. To a Communist Party official, taught that the
state should own the means of production, a corporate income tax was a bizarre idea. Besides, who ever asks to be
taxed?

All became clear when the Americans explained their intent. The American oil
companies did not want to actually pay taxes, but to reduce their obligations to the United States government. The American
businessmen and their tax lawyers explained that Congress taxes corporations (and individuals) on their worldwide income. With a
Chinese corporate income tax, however, the taxes they owed to the United States would go down for two reasons. The first reason
is that American business profits earned overseas are not taxed so long as the money stays offshore. The second reason is that
the United States allows American companies to reduce taxes on their profits by the amount they pay to foreign governments. This
is not the usual deduction worth 35 cents on the dollar, but a dollar-for-dollar credit. Thus a dollar of tax paid by Exxon Mobil to
Beijing is a dollar not paid to Washington.

Like the Chinese income tax, this U.S. tax credit
originated with the oil industry. Back in the 1920s, when drilling for oil was a risky game with many dry holes, the oil industry paid a
uniform 12.5 percent royalty to the owners of oil taken from the ground. The House of Saud, having emerged victorious over the
competing Arabian Peninsula warlords and in need of cash to maintain its newly consolidated power, wanted to raise the royalty
rate. The Treasury secretary at the time, Andrew Mellon of the Pittsburgh banking and oil family, suggested a different approach. He
recommended that the Saudis just tax the oil companies to raise money. Mellon then persuaded Congress to adjust the corporate
income tax to give the oil companies—and any other companies earning profits overseas—the dollar-for-dollar credit against taxes
due to Washington.

Mellon's change in the government's rules was brilliant from the point of
view of an oilman. The Saud family would get more money, the oil companies would be indifferent because American taxpayers
would be picking up the cost of enriching the Saudis and, most important of all, there would be no competition over royalty rates,
no risk that royalty rates would increase. Adam Smith would not have approved. He had warned of government fixing the market to
benefit those with power and property. But then, who wants to compete when the government will fix the market for
you?

The Chinese communists agreed to the request that they enact a corporate income tax,
having experienced one confirming example of Lenin's dictum that “the capitalists will sell us the rope with which we will hang
them.”

The corporate income taxes paid in China are not like those in the United States.
Instead of going for the general support of the government, money paid to Beijing is often used to benefit the company that pays.
Taxes may finance a new road or railroad spur or police presence and other services the company requires.

The lesson in all this is that the top Chinese communist officials may have learned more from Adam Smith
than the American capitalists who so often invoke his name. What the Chinese took from Smith is a deeper understanding of how
government policy can guide, and misdirect, the invisible hand of the market. And, from their perspective, they fully grasped the
idea of acting in your own self-interest.

But wait, there's more.

A company with operations in the United States and another country can borrow money at home, deducting
the interest and thus lowering its American taxes. At the same time it can earn interest on untaxed cash it keeps overseas. So when
an American company closes a factory here and moves it to China, provided it meets some technical rules, it can deduct the
interest charges on its United States tax return while building up profits offshore that may never be taxed.

On top of all of this, a company that moves its factory to China will not have to worry about pesky union
organizers seeking more pay or even reasonable work rules, like toilet breaks and job safety committees. Mao said that political
power grows out of the barrel of a gun, a cruel reality known to every grassroots union organizer in China.

During the Reagan years, China grudgingly agreed to play by a set of civilized rules in return for receiving
most favored nation status with the United States, a huge benefit for countries trading with America. Later China joined the
worldwide trade movement. China was supposed to impose basic environmental controls, treat unions fairly, and respect human
rights.

For their part, China and other poor countries complain that such requirements were
not imposed on America and Europe when they developed.

These demands by first-world
trading partners were an attempt to level the playing field with workers in other parts of the globe while bringing rudimentary
workplace advances to Chinese laborers. No one was under the illusion that China would follow the highest American or European
standards for pollution controls or welcome organized labor demands, but by forging agreement on these issues, the humane
aspects of modern life might get a toehold in China's developing economy. At least that was the plan. There is one significant
group fighting proposals to give Chinese workers the right to organize—American businesses that want to pay as little as possible
in China.

With near total impunity, China ignores rules it finds inconvenient. Counterfeit copies
of American software turn up in the offices of the Chinese government. Pirated movies and music are openly sold on the streets of
major Chinese cities. Reports of forced labor abound. Only government-controlled unions are allowed—and independent
organizers sometimes are shot. Toxins pour into China's rivers and foul not just its air, but the air everyone in the Northern
Hemisphere breathes. Dangerous additives designed to create the appearance of high protein content have been found in animal
food, killing some American pets by destroying their kidneys. Later, toxic ingredients were discovered in some human food, toys,
and toothpaste that China had exported to the United States in 2007. Beijing did act to stem this particular scandal, by executing a
former senior government official.