An ongoing review of politics and culture

President Obama’s Excellent New Banking Proposal

President Obama has outlined a new banking proposal:

The White House wants commercial banks that take deposits from customers to be barred from investing on behalf of the bank itself—what’s known as proprietary trading—and said the administration will seek new limits on the size and concentration of financial institutions.

The limits on size and concentration are extensions of existing caps, and the meaning of this part of the proposal can only become clear with a lot more detail.

The first, and core, concept of the proposal is the re-segregation of commercial banking from proprietary trading (or roughly what used to be called commercial banking from investment banking). This is an excellent proposal. More precisely – since, as Megan McArdle’s shoe leather work has highlighted, many important details of even this part of the proposal remain to be determined or revealed – the concept the president has proposed is excellent.

I have been arguing for more than a year that this was the direction financial regulation needed to go, and that the logic of the situation would drive us here. The reason why is straightforward.

Finance professionals, like members of all occupational categories, attempt to build barriers that maintain their own income. One of the techniques used is to shroud what are often pretty basic ideas in pseudo-technical jargon. The reason that it is dysfunctional to have an insured banking system that is free to engage in speculative investing is simple and fundamental. We (i.e., the government, which is to say, ultimately, the taxpayers) provide a guarantee to depositors that when they put their savings in a regulated bank, then the money will be there even if the bank fails, because we believe that the chaos and uncertainty of a banking system operating without this guarantee is too unstable to maintain political viability. But if you let the operators of these banks take the deposits and, in effect, put them on a long-shot bet at the horse track, and then pay themselves a billion dollars in bonuses if the horse comes in, but turn to taxpayers to pay off depositors if the horse doesn’t, guess what is going to happen? Exactly what we saw in 2008 happens.

If you want to have a safe, secure banking system for small depositors, but don’t want to make risky investing illegal (which would be very damaging to the economy), the obvious solution is to not allow any one company to both take guaranteed deposits and also make speculative investments. This was the solution developed and implemented in the New Deal. We need a modernized version of this basic construct, and as far as I can see, this is what President Obama has proposed.

This is not the full extent of what’s needed, however. Though it’s impolitic to say this now, other parts of the financial system have become enormously over-regulated over the past couple of decades. Section 404 of Sarbanes-Oxley, as an example, could be easily renamed the “more accountants, fewer IPOs” act. Here is how I put this in a recent National Affairs article:

[T]he financial crisis has demonstrated obvious systemic problems of poor regulation and under-regulation of some aspects of the financial sector that must be addressed — though for at least a decade prior to the crisis, over-regulation, lawsuits, and aggressive government prosecution seriously damaged the competitiveness of other parts of America’s financial system. Since 1995, the U.S. share of total equity capital raised in the world’s top ten economies has declined from 41% to 28%. We do not want the systemic risks of under-regulation, but we should also be careful not to overcompensate for them.

Regulation to avoid systemic risk must therefore proceed from a clear understanding of its causes. In the recent crisis, the reason the government has been forced to prop up financial institutions isn’t that they are too big to fail, but rather that they are too interconnected to fail. For example, a series of complex and unregulated financial obligations meant that the failure of Lehman Brothers — a mid-size investment bank — threatened to crash the entire U.S. banking system.

As we work to adapt our regulatory structure to fit the 21st century, we should therefore adopt a modernized version of a New Deal-era ¬innovation: focus on creating walls that contain busts, rather than on applying brakes that hold back the entire system. Our reforms should establish “tiers” of financial activities of increasing risk, volatility, and complexity that are open to any investor — and somewhere within this ¬framework, almost any non-coercive transaction should be legally ¬permitted. The tiers should then be compartmentalized, however, so that a bust in a higher-risk tier doesn’t propagate to lower-risk tiers. And while the government should provide guarantees such as deposit insurance in the low-risk tiers, it should unsparingly permit failure in the higher-risk tiers. Such reform would provide the benefits of better capital ¬allocation, continued market ¬innovation, and stability. It would address some of the problems of cohesion by allowing more Americans to participate in our market system without being as exposed — or unwittingly exposed — to the brutal effects of market ¬collapses. It would also help get the government out of the banking business and preserve America’s position as the global leader in financial services without turning our financial sector into a time bomb.

As I argued in the post a year ago, limits on executive compensation in the regulated institutions are closely related to this structure:

[L]mits on executive pay, if they have any teeth as they are really implemented, are likely to have several knock-on effects. People who are able to make millions per year in a competitive market will tend to drift away from these firms (even though these restrictions only apply to senior executives, they would change the compensation culture for the firm as a whole), and form new asset management firms, M&A advisory boutiques and so on. Along with limits on comp, the government-sponsored entities will have restrictions on investment behavior imposed by the government – they will not be issuing a lot of credit default swaps. This will mean these large institutions will be unable to offer very high rates of return as compared to the firms that don’t take government money, but will offer safety.

Think of what we would then have: a tier of government-supported, low-risk / low-return big commercial banks that are run by competent, but not exceptional, bankers who are paid like senior civil servants; and another tier of high-risk / high-return financials that look like the “old Wall Street” that everybody says is dead. This is a world of walls, not brakes. When this tiering is in place, the government should be able to get out of the business of doing things like directly setting executive compensation.

The political aspects of such reform are compelling. People are disgusted at recent bank bonuses. I’m a right-of-center libertarian businessman, and I’m disgusted by them. Make no mistake, many banking executives right now are benefiting from taxpayer subsidies. Even if they pay back the TARP money, the government has demonstrated that it will intervene to protect large banks. This can’t be paid back. And this implicit, but very real, guarantee represents an enormous transfer of economic value from taxpayers to any bank executives and investors who are willing to take advantage of it. Unsurprisingly, pretty much all of them are.

The “populist” observation that the fact of a bunch of well-connected guys each pulling down $10 million per year while suckling on the government teat constitutes almost certain evidence of self-dealing is accurate, and all the fancy finance talk in the world can’t get around it. President Obama has a clear political incentive to pursue this proposal. I assume Republicans will see that they have a clear political incentive to go along, rather than standing up for such a situation. Hopefully, this will create the political dynamic that will allow real, positive reform.

The Implications of Massachusetts

It’s important to separate the causes of Scott Brown’s win from its possible effects.

I don’t know why Scott Brown won. The causes are hard to identify, mostly because any election like this is massively over-determined. I agree with Jon Chait that structural factors (in this case specifically, the unemployment rate) have an enormous role. Further, people in the business of analyzing politicians have a vested interest in over-emphasizing the importance of rhetoric, campaign tactics and so on. For reasons that I have elaborated at length in other posts, however, I believe that we should be extremely skeptical of the ability of social science to quantify the relative impact of these factors.

In the face of this kind of uncertainty, expert opinion should be given great weight. Unfortunately, all the experts are self-interested. Elected officials are the leading experts in one thing: winning elections. The fact that so many say that they believe that this election indicates that support for health care and other elements of the Obama agenda will matter for them in November is important, but unfortunately, you can’t trust that are speaking objectively. Politicians speak in order to win elections, not to provide expert testimony. We should assume that they are using this analysis as a way of accomplishing other objectives.

What other politicians say about the causes of the election result, however, can provide much more useful clues about the effects of this election. It will obviously become much more operationally difficult for Obama / Pelosi / Reid to get health care reform in its current form passed. The loss of this senate seat matters in and of itself; the information contained in the election result will presumably negatively affect the calculation of self-interest on the part of many politicians (even though we can’t know by how much); and, it will provide cover for those who did not want to go along with this reform for other reasons to come out against it now. It’s possible that there is some inside baseball play, based on information unavailable to me or anybody else who is talking about it, to get health care reform in something close to its current form done. But it sure doesn’t look likely from here.

I didn’t believe on his inauguration day that Obama was either a genius or had an FDR-like opportunity, based on objective conditions, to change the public agenda. I don’t believe that he is somehow incompetent now, nor that – holding the presidency and with large Democratic majorities in both houses of congress – he is somehow not in a position to implement policy now. Just like retrospectively analyzing the causes of the outcome of an election, it is easy to talk about what alternatives he might have followed to: (1) his decision to prioritize health care and climate change versus jobs and the economy, and (2) his tactical approach to advancing his policy goals on the topics that he decided to prioritize. But even in retrospect, with the information available to him at the time, his choices seem defensible.

That Senator Kennedy would die, and that Massachusetts would then elect a Republican senator in a special election that happened to occur just as health care reform seemed to be nearing completion, is a true “black swan” event. What is striking to me, however, is that he has allowed himself to get into a position in which the loss of one senate seat threatens his prioritized domestic policy goal.

I have a pretty unromantic view of politicians. I don’t believe that I can see somebody on TV, and understand them very well. I do think, however, that specific previous very large-scale executive experience is the only correlate I could ever find with subsequent Presidential experience . This is correlation, not an empirical demonstration of causality, but strikes me as sensible.

One practical lesson that I believe operational experience teaches people is that you always need a lot more margin for error in any plan than you would rationally believe. In this light, Obama’s decision to push for a health care reform plan that could be threatened by losing one seat in the senate is what is troubling. You couldn’t predict this specific event, but it was always safe to assume that something would go wrong as the legislative process dragged on. It is my theory that his lack of executive experience is showing here, just as it did on cap-and-trade.

Now, it’s possible that there was no realistic alternative available as he was setting out on this a year ago – in effect, he had to go for broke, because there was no 80-vote alternative that he considered to be in any way worthwhile, and all we’re seeing now is that the coin came up tails for him on a bet that was smart at the time. Or, as I said, it might be that he has some way to pull a rabbit out of the hat now. Events will show us whether or not that is true. But barring these alternatives, it seems to me that Ross Douthat offers good advice: basically, take half a loaf and get on with things.

I say this not as a partisan, but as an American. I don’t know anybody who supports the status quo health care finance system in the U.S. Reform is required, and what is likely more important than the specifics of the first step is that we get underway on what will, if we’re lucky, be iterative reform in which we have a political system that can learn from experience.

Sensing just how much reform is possible, and getting a nation to go along with you is one mark of a statesman. FDR, Churchill and Reagan all had this mysterious ability (and good luck) – they were each able to reconcile the eternal tensions of a society, as manifest in the specifics of their time and place, inside one mind. I believe that Bill Clinton and Newt Gingrich were able to do this only in productive tension with one another; in combination, they produced pretty good governance. As per Ross’s comments, I suspect that we will discover during 2010 whether Obama is able to do this, or will require tension with a more conservative congress.

Omnibus Reply to Criticisms of Keeping America’s Edge UPDATE

In a lengthy article for National Affairs, I wrote the following sentences:

From 1980 through today, America’s share of global output has been constant at about 21%. Europe’s share, meanwhile, has been collapsing in the face of global competition — going from a little less than 40% of global production in the 1970s to about 25% today. Opting for social democracy instead of innovative capitalism, Europe has ceded this share to China (predominantly), India, and the rest of the developing world. The economic rise of the Asian heartland is the central geopolitical fact of our era, and it is safe to assume that economic and strategic competition will only increase further over the next several decades.

These have been the subject of extensive criticism in the left-of-center blogosphere. Let me take the criticisms, as I see them, one at a time.

Criticism 1: I presented incorrect numbers. Accurate data is the foundation of all empirical analysis. Without it, progress is not realistically possible. Paul Krugman wrote a blog post in which he accused me of either gross negligence or dishonesty. The specific charge he made is:

But I went back to Manzi’s source of data, and it turns out that it’s even worse than that. If you use the broad definition of Europe, which includes the USSR, it did indeed have 40 percent of world output in the early 1970s. But that share has not fallen to 25 percent — it’s still above 30 percent.

His assertion is flatly false.

First, Professor Krugman incorrectly identified my source of data.

I have never corresponded with Professor Krugman concerning data sources and analysis for the passage in question, so I can not know on what basis he asserted that the dataset to which he links is my “source of data.” It is not. As per the blog post in which I reviewed multiple data sources for the analysis in question, I averaged multiple sources of data. Professor Krugman has selected only one of these sources, presented it as if it were my sole source, and therefore (obviously) failed to replicate the published result for both the 1970s and the current day. The error is his.

Second, Professor Krugman misread the economic dataset that he did identify.

According to the dataset in question, that part of Europe excluding any part of the USSR had about 40% share of global GDP in 1973 [Cell H59 in the spreadsheet]. According to this dataset, if you add the USSR to this definition [Cell H59 + Cell H102], then such a constructed entity would have had global GDP share of about 44%, not the 40% that Professor Krugman asserted. This error is his as well.

I have invited Professor Krugman to explain how I am wrong, or failing that, to retract his charge.

[UPDATE]: Professor Krugman has responded. I will reproduce his post in its entirety here:

The debate over European economic performance has gone in two directions. One is the usual response of people when they get something very wrong: they start quibbling over minor details (which dataset was Manzi actually using? what about immigration?) to throw up dust clouds. The key thing to remember is that we had a flat assertion that social democracy leads to stagnant economies; that assertion is just wrong.

The other is to point out that even rich European countries have lower GDP per capita than the United States. Indeed. But there’s a story there that is a lot more complicated than a simple table conveys. I wrote about it a few years back.

I’ll leave it to readers to evaluate this response.

Criticism 2: Defining Europe to include Russia and other parts of Eastern Europe is ludicrous when the argument concerns the trade-offs involved in the social welfare state.

Critics argue that since we all know the social welfare state is only present in Western Europe, then it is disingenuous to bundle together Western and Eastern Europe.

In the article, I explicitly defined the ‘European model’ as I used the term by methodically listing out each element of it:

Seen together, these initiatives — shifting government spending away from defense and public safety toward social programs; deeper direct involvement of the government in the operation of large corporations across a substantial portion of the economy; energy rationing in the name of managing climate change; more direct government control of health-care provision; and higher tax rates that probably include a VAT — point in a clear direction. The end result would be an America much closer to the European model of a social-welfare state, which prioritizes cohesion over innovation.

It turns out that Europe as whole is systematically different than the U.S. on each of the listed dimensions. As a further, and more severe statement, it is also true that Eastern Europe as a region (defined as Russia and other west of Urals components of the old Soviet Union and countries of the old Soviet Bloc) and Western Europe as a region (defined as all other countries in Europe from Iceland to Greece) are also each systematically different than the U.S. on each of the listed dimensions.

I’ll take each one at a time

shifting government spending away from defense and public safety toward social programs

The governments of both Eastern and Western Europe have a much higher weighting of social spending than does the government of the U.S. According to the OECD common governmental expenditure classification system, in 2006 the ratio of government spending on the sum of Housing and Community Amenities, Health, Recreation, Culture and Religion, Education, and Social Protection to government spending on the sum of Defense plus Public Order and Safety was at least about twice as high as in the U.S. in every country for which the OECD reports in Eastern Europe (Czech Republic, Estonia, Hungary, Poland, Russia [using transaction code P3CG], Slovak Republic and Slovenia), and every country for which the OECD reports in Western Europe (Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden and the UK).

deeper direct involvement of the government in the operation of large corporations across a substantial portion of the economy

In finance, according to the NBER working paper Government Ownership of Banks (2000), the share of government ownership of the assets of the 10 largest banks was as high or higher in every reported Western European country and in every reported Eastern European country than in the U.S. (where it was 0%).

In products, according to the OECD Indicators of Product Market Regulation, in 2008 product market regulation was heavier than in the U.S. in every reported Western European country (although the UK was almost tied with the U.S.) and in every reported Eastern European county.

Health care is addressed below.

energy rationing in the name of managing climate change

The following Western European countries are ratified Annex I signatories to the Kyoto Protocol that commits nations to defined emissions caps: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Liechtenstein, Luxembourg, Monaco, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

The following Eastern European countries are ratified Annex I signatories: Belarus, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Russian Federation, Slovakia, Slovenia, and Ukraine.

The United States has not ratified participation in the Kyoto Protocol.

more direct government control of health-care provision

According to the OECD Health Data 2009, in 2007 the U.S. had lower public expenditure on health as a percent of total expenditure on health than every reported country in Western Europe and every reported country in Eastern Europe.

higher tax rates

According to the OECD Factbook 2009, in 2007 the U.S. reported lower total tax revenue as a percentage of GDP than every reported country in Western Europe and every reported country in Eastern Europe.

that probably include a VAT

The following Western European countries have a VAT: Austria, Belgium, Denmark, Finland, France Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden, UK, Iceland, Norway, and Switzerland.

The following Eastern European countries have a VAT: Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, Slovenia, Albania, Belarus, Bosnia, Croatia, Moldova, Montenegro, Russia, Serbia, and Ukraine.

The U.S. does not have a VAT.

There is obviously tremendous variation across the nations of Europe, but at the level of abstraction carefully defined in the article, there are systematic differences between Europe and the U.S. in their respective approaches to the political economy of the social welfare state. In the article, I also carefully reviewed the evidence that actions to date in the late Bush and early Obama administrations, plus the publicly stated intentions of the current administration and congressional leadership, have made and/or would make the U.S. more like a European social welfare state in each of the defined dimensions.

Criticism 3: This comparison does not demonstrate that the social welfare state causes lower economic growth.

As I said almost immediately when this was pointed out, this is exactly correct. No matter what the relative growth rates (however defined) of Europe and the U.S. over any period, such a comparison could never constitute a reliable empirical demonstration of causality, because we could never know the counterfactual of what would have happened had one entity or the other executed some alternative policies. I have argued in many posts over a period of years that even less-naïve econometric methods that attempt to control for other factors are not sufficient for the task of identifying non-obvious causal relationships in human society reliably.

The purpose of the article as a whole, never mind the short passage in question, was not to provide an empirical demonstration that less regulated markets tend to provide faster economic growth under many conditions than more regulated markets. Nor did it ever claim to provide this. The purpose of the article was to describe why even though I (like many, many other people) accept the advantages that less regulated markets can provide, this does not lead to the conclusion that we should advocate a deregulation-oriented path of economic development without considering the balancing consideration of social cohesion, and modifying our proposals accordingly.

As I also said immediately, it is easy for me to see how these sentences could be read naturally to be an asserted demonstration of causality. And as I also said at that time “the responsibility for lack of clarity rests on the shoulders of the author, not the reader.” I acknowledged this, and thanked my interlocutors for improving my expression; I continue to do both.

Criticism 4: The fact that the difference in total GDP performance between Europe and the U.S. is entirely due to different population growth rates proves that it can not have been caused by the social welfare state.

In effect, this argument is that GDP = GDP / Person X Population, and that GDP / Person has grown at about the same rate in the U.S. and Europe over the past several decades, so the only real difference has been population growth. This is a factually (approximately) correct statement. There are two big problems with arguing that this shows that therefore differences in political economy of the welfare state did not matter to this difference in outcome. Both are counterfactual problems. First, just because growth in per capita GDP turned out to be the same in this period, it does not follow that had the U.S. adopted policies more like those in Europe that growth rates would not have have been lower, and per capita GDP converged. It is almost always harder to maintain a lead. Europe and the U.S. had previously been on a generally converging path of GDP / Person, and maintaining this lead in productivity (by this metric) was very far from preordained. Second, it assumes that the political economy of the welfare state can not affect population growth, either through impacting fertility or impacting immigration. There are many plausible models for how this can happen. We can’t know through econometric analysis (whether of the simple “I just know that the welfare state can’t influence fertility or immigration” variety cited in the title of this section, or of the more sophisticated variety that attempt to control for other factors) what U.S. population growth and per capita GDP growth would have been had the U.S. adopted different social welfare policies.

Many variants of these criticisms have been repeated over and again through a certain segment of the blogosphere. I have here answered each of them directly, and I believe comprehensively. In any event, barring new information brought to the debate, this is where I intend to leave it.

Omnibus Reply to Criticisms of Keeping America’s Edge

In a lengthy article for National Affairs, I wrote the following sentences:

From 1980 through today, America’s share of global output has been constant at about 21%. Europe’s share, meanwhile, has been collapsing in the face of global competition — going from a little less than 40% of global production in the 1970s to about 25% today. Opting for social democracy instead of innovative capitalism, Europe has ceded this share to China (predominantly), India, and the rest of the developing world. The economic rise of the Asian heartland is the central geopolitical fact of our era, and it is safe to assume that economic and strategic competition will only increase further over the next several decades.

These have been the subject of extensive criticism in the left-of-center blogosphere. Let me take the criticisms, as I see them, one at a time.

Criticism 1: I presented incorrect numbers. Accurate data is the foundation of all empirical analysis. Without it, progress is not realistically possible. Paul Krugman wrote a blog post in which he accused me of either gross negligence or dishonesty. The specific charge he made is:

But I went back to Manzi’s source of data, and it turns out that it’s even worse than that. If you use the broad definition of Europe, which includes the USSR, it did indeed have 40 percent of world output in the early 1970s. But that share has not fallen to 25 percent — it’s still above 30 percent.

His assertion is flatly false.

First, Professor Krugman incorrectly identified my source of data.

I have never corresponded with Professor Krugman concerning data sources and analysis for the passage in question, so I can not know on what basis he asserted that the dataset to which he links is my “source of data.” It is not. As per the blog post in which I reviewed multiple data sources for the analysis in question, I averaged multiple sources of data. Professor Krugman has selected only one of these sources, presented it as if it were my sole source, and therefore (obviously) failed to replicate the published result for both the 1970s and the current day. The error is his.

Second, Professor Krugman misread the economic dataset that he did identify.

According to the dataset in question, that part of Europe excluding any part of the USSR had about 40% share of global GDP in 1973 [Cell H59 in the spreadsheet]. According to this dataset, if you add the USSR to this definition [Cell H59 + Cell H102], then such a constructed entity would have had global GDP share of about 44%, not the 40% that Professor Krugman asserted. This error is his as well.

I have invited Professor Krugman to explain how I am wrong, or failing that, to retract his charge.

[UPDATE]: Professor Krugman has responded. I will reproduce his post in its entirety here:

The debate over European economic performance has gone in two directions. One is the usual response of people when they get something very wrong: they start quibbling over minor details (which dataset was Manzi actually using? what about immigration?) to throw up dust clouds. The key thing to remember is that we had a flat assertion that social democracy leads to stagnant economies; that assertion is just wrong.

The other is to point out that even rich European countries have lower GDP per capita than the United States. Indeed. But there’s a story there that is a lot more complicated than a simple table conveys. I wrote about it a few years back.

I’ll leave it to readers to evaluate this response.

Criticism 2: Defining Europe to include Russia and other parts of Eastern Europe is ludicrous when the argument concerns the trade-offs involved in the social welfare state.

Critics argue that since we all know the social welfare state is only present in Western Europe, then it is disingenuous to bundle together Western and Eastern Europe.

In the article, I explicitly defined the ‘European model’ as I used the term by methodically listing out each element of it:

Seen together, these initiatives — shifting government spending away from defense and public safety toward social programs; deeper direct involvement of the government in the operation of large corporations across a substantial portion of the economy; energy rationing in the name of managing climate change; more direct government control of health-care provision; and higher tax rates that probably include a VAT — point in a clear direction. The end result would be an America much closer to the European model of a social-welfare state, which prioritizes cohesion over innovation.

It turns out that Europe as whole is systematically different than the U.S. on each of the listed dimensions. As a further, and more severe statement, it is also true that Eastern Europe as a region (defined as Russia and other west of Urals components of the old Soviet Union and countries of the old Soviet Bloc) and Western Europe as a region (defined as all other countries in Europe from Iceland to Greece) are also each systematically different than the U.S. on each of the listed dimensions.

I’ll take each one at a time

shifting government spending away from defense and public safety toward social programs

The governments of both Eastern and Western Europe have a much higher weighting of social spending than does the government of the U.S. According to the OECD common governmental expenditure classification system, in 2006 the ratio of government spending on the sum of Housing and Community Amenities, Health, Recreation, Culture and Religion, Education, and Social Protection to government spending on the sum of Defense plus Public Order and Safety was at least about twice as high as in the U.S. in every country for which the OECD reports in Eastern Europe (Czech Republic, Estonia, Hungary, Poland, Russia [using transaction code P3CG], Slovak Republic and Slovenia), and every country for which the OECD reports in Western Europe (Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden and the UK).

deeper direct involvement of the government in the operation of large corporations across a substantial portion of the economy

In finance, according to the NBER working paper Government Ownership of Banks (2000), the share of government ownership of the assets of the 10 largest banks was as high or higher in every reported Western European country and in every reported Eastern European country than in the U.S. (where it was 0%).

In products, according to the OECD Indicators of Product Market Regulation, in 2008 product market regulation was heavier than in the U.S. in every reported Western European country (although the UK was almost tied with the U.S.) and in every reported Eastern European county.

Health care is addressed below.

energy rationing in the name of managing climate change

The following Western European countries are ratified Annex I signatories to the Kyoto Protocol that commits nations to defined emissions caps: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Liechtenstein, Luxembourg, Monaco, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

The following Eastern European countries are ratified Annex I signatories: Belarus, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Russian Federation, Slovakia, Slovenia, and Ukraine.

The United States has not ratified participation in the Kyoto Protocol.

more direct government control of health-care provision

According to the OECD Health Data 2009, in 2007 the U.S. had lower public expenditure on health as a percent of total expenditure on health than every reported country in Western Europe and every reported country in Eastern Europe.

higher tax rates

According to the OECD Factbook 2009, in 2007 the U.S. reported lower total tax revenue as a percentage of GDP than every reported country in Western Europe and every reported country in Eastern Europe.

that probably include a VAT

The following Western European countries have a VAT: Austria, Belgium, Denmark, Finland, France Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden, UK, Iceland, Norway, and Switzerland.

The following Eastern European countries have a VAT: Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, Slovenia, Albania, Belarus, Bosnia, Croatia, Moldova, Montenegro, Russia, Serbia, and Ukraine.

The U.S. does not have a VAT.

There is obviously tremendous variation across the nations of Europe, but at the level of abstraction carefully defined in the article, there are systematic differences between Europe and the U.S. in their respective approaches to the political economy of the social welfare state. In the article, I also carefully reviewed the evidence that actions to date in the late Bush and early Obama administrations, plus the publicly stated intentions of the current administration and congressional leadership, have made and/or would make the U.S. more like a European social welfare state in each of the defined dimensions.

Criticism 3: This comparison does not demonstrate that the social welfare state causes lower economic growth.

As I said almost immediately when this was pointed out, this is exactly correct. No matter what the relative growth rates (however defined) of Europe and the U.S. over any period, such a comparison could never constitute a reliable empirical demonstration of causality, because we could never know the counterfactual of what would have happened had one entity or the other executed some alternative policies. I have argued in many posts over a period of years that even less-naïve econometric methods that attempt to control for other factors are not sufficient for the task of identifying non-obvious causal relationships in human society reliably.

The purpose of the article as a whole, never mind the short passage in question, was not to provide an empirical demonstration that less regulated markets tend to provide faster economic growth under many conditions than more regulated markets. Nor did it ever claim to provide this. The purpose of the article was to describe why even though I (like many, many other people) accept the advantages that less regulated markets can provide, this does not lead to the conclusion that we should advocate a deregulation-oriented path of economic development without considering the balancing consideration of social cohesion, and modifying our proposals accordingly.

As I also said immediately, it is easy for me to see how these sentences could be read naturally to be an asserted demonstration of causality. And as I also said at that time “the responsibility for lack of clarity rests on the shoulders of the author, not the reader.” I acknowledged this, and thanked my interlocutors for improving my expression; I continue to do both.

Criticism 4: The fact that the difference in total GDP performance between Europe and the U.S. is entirely due to different population growth rates proves that it can not have been caused by the social welfare state.

In effect, this argument is that GDP = GDP / Person X Population, and that GDP / Person has grown at about the same rate in the U.S. and Europe over the past several decades, so the only real difference has been population growth. This is a factually (approximately) correct statement. There are two big problems with arguing that this shows that therefore differences in political economy of the welfare state did not matter to this difference in outcome. Both are counterfactual problems. First, just because growth in per capita GDP turned out to be the same in this period, it does not follow that had the U.S. adopted policies more like those in Europe that growth rates would not have have been lower, and per capita GDP converged. It is almost always harder to maintain a lead. Europe and the U.S. had previously been on a generally converging path of GDP / Person, and maintaining this lead in productivity (by this metric) was very far from preordained. Second, it assumes that the political economy of the welfare state can not affect population growth, either through impacting fertility or impacting immigration. There are many plausible models for how this can happen. We can’t know through econometric analysis (whether of the simple “I just know that the welfare state can’t influence fertility or immigration” variety cited in the title of this section, or of the more sophisticated variety that attempt to control for other factors) what U.S. population growth and per capita GDP growth would have been had the U.S. adopted different social welfare policies.

Many variants of these criticisms have been repeated over and again through a certain segment of the blogosphere. I have here answered each of them directly, and I believe comprehensively. In any event, barring new information brought to the debate, this is where I intend to leave it.

Keeping America’s Edge, Yet Again

Paul Krugman has weighed in to an ongoing debate sparked by Jonathan Chait’s criticism of a passage in my essay Keeping America’s Edge. I believe that I have responded to Mr. Chait’s assertions comprehensively. Unlike Mr. Chait, Professor Krugman has argued that I have presented incorrect data.

Professor Krugman says this:

But I went back to Manzi’s source of data, and it turns out that it’s even worse than that. If you use the broad definition of Europe, which includes the USSR, it did indeed have 40 percent of world output in the early 1970s. But that share has not fallen to 25 percent — it’s still above 30 percent.

His assertion is flatly false.

First, Professor Krugman has incorrectly identified my source of data.

I have never corresponded with Professor Krugman concerning data sources and analysis for the passage in question (unlike Mr. Chait, who was careful to contact me prior to publishing his blog post, and to whom I sent data sources and calculation details), so I can not know on what basis Professor Krugman asserts that the dataset to which he links is my “source of data.” It is not. As per the blog post in which I reviewed multiple data sources for the analysis in question, I averaged multiple sources of data. Professor Krugman has selected only one of these sources, presented it as if it were my sole source, and therefore (obviously) failed to replicate the published result. The error is his.

Second, Professor Krugman incorrectly interpreted the economic dataset that he did identify.

According to the dataset in question, that part of Europe excluding any part of the USSR had about 40% share of global GDP in 1973 [Cell H59 in the spreadsheet]. According to this dataset, if you add the USSR to this definition [Cell H59 + Cell H102], then such a constructed entity would have had global GDP share of about 44%, not the 40% that Professor Krugman asserts. Not that such a constructed entity is precisely relevant to the argument anyway – Professor Krugman is also incorrect that my “definition of Europe included the Soviet bloc (!)”. I was very careful to try to identify only economic output of those sub-components of the USSR that were West of the Urals, as per the dictionary definition of Europe. Therefore, the estimate from this dataset for Europe was about 43%. Averaged with the other dataset available to me for that year (also cited and linked in my blog post), you will find an estimated global GDP share of 39.8%, or as I said in my article, “a little less than 40%.”

Professor Krugman graciously extended to me the courtesy of saying that my analysis was “probably not a deliberate case of data falsification,” but instead assumed that I “glanced at some numbers, thought [I] saw [my] assumptions confirmed, and never checked.” I will extend to him the same courtesy.

Keeping America’s Edge, ctd. 2

In a series of exchanges that is presumably increasingly only of interest to our respective mothers, Jonathan Chait has replied to my most recent post. Mr. Chait says of me that I am trying to “reframe the argument about Western European social democracy into something other than the one [I] originally made”.

Mr. Chait says that

My problem with the essay is that Manzi does a terrible job of establishing his premise that social democracy (his label for President Obama’s agenda) destroys growth and innovation.

In his article, Manzi’s only attempt to prove this relied upon a comparison between the share of world economic output of Europe from 1973 to the present with the United States from 1980 to the present.

Mr. Chait then proceeds to reiterate several concerns he has previously raised concerning the geographic and time period definitions that I used to show that Europe has ceded very large amounts of global GDP share, while the U.S. has not. Further he reiterates the concern that I evaluated total GDP, when GDP per capita would be a better proxy for living standards.

Mr. Chait then writes that I’m trying to change my argument to really be about the fact that “Ultimately, absolute size of an economy matters because economic clout represents the latent capacity for military and cultural power.”

But, Mr. Chait says:

The problem is, that isn’t what Manzi was actually arguing in his essay. He was making a traditional right-wing argument that social democracy (and, by implication, the Obama agenda) inhibits economic growth.

…

Now that its been pointed out that Reagan’s policies did not cause higher per-person growth, Manzi is focusing on total growth, which is almost entirely the function of a more rapidly growing population. In other words, we can ignore all that rhetoric about the welfare state strangling innovation. His real argument is that the welfare state prevents rapid population growth.

Unfortunately, each of Mr. Chait’s claims is incorrect. Let me take them one by one.

1. I “do a terrible job establishing his premise that social democracy (his label for President Obama’s agenda) destroys growth and innovation.”.

I don’t “do this job” at all. As per an earlier post, the purpose of the article was not to provide an empirical demonstration that less regulated markets tend to provide faster economic growth under many conditions than more regulated markets. Nor did it ever claim to provide this. The purpose of the article was to describe why even though I (like many, many other people) accept the advantages that less regulated markets can provide, that this does not lead to the conclusion that we can or should continue on the deregulation-oriented path on which we find ourselves without considering the balancing consideration of social cohesion. Mr. Chait apparently wishes that I had written an article designed to convince people who don’t believe that less regulated markets tend to drive faster growth than more government-directed markets, but this is not the article that I was writing, and again, never claimed that it accomplished that purpose.

2. The statistical analysis that supports the conclusion that Europe lost massive global GDP share and the U.S. did not over the past several decades is flawed.

Again, as shown in detail in a prior post, my conclusion is supported by any interpretation of the data. Mr. Chait has now raised this objection several times. While exact magnitudes will vary slightly, I defy Mr. Chait, or any critic, to present any responsible analysis using any reasonable definition of Europe or any relevant time periods or any reputable data source that does not support this conclusion.

3. We now know that “Reagan’s policies did not cause higher per-person growth”.

Also as per a prior post, we know that per-person GDP growth was similar between Europe and the U.S. over the period in question. This does not address the counterfactual question of what growth would have been in the U.S. had different policies been followed. In the period between 1950 and 1980 Europe had, broadly speaking, been catching up to the U.S. in per capita GDP, and the expectation was that convergence would likely continue. Maintaining a lead in per capita GDP was an unexpected advantage for the U.S.

4. Most centrally, in the article, I “was making a traditional right-wing argument that social democracy (and, by implication, the Obama agenda) inhibits economic growth.”, but am now changing my tune in the face of criticism to say it was really about explaining that “Ultimately, absolute size of an economy matters, because economic clout represents the latent capacity for military and cultural power.”

Once again, I asserted (and also, once again, neither proved nor attempted to prove) that government direction of resources will tend to produce less economic growth and prosperity than freer markets under many conditions. There are therefore many quotes in the article that are, in part, predicated on this belief. I also argued that one of the most important pernicious implications of less growth is loss of global economic clout that will very likely be translated into loss of global power in the long-run. This is not an after-the-fact change. Mr. Chait has repeatedly focused on two sentences that describe changes in relative share of total GDP. Here are the sentences that immediately follow them in the article:

The economic rise of the Asian heartland is the central geopolitical fact of our era, and it is safe to assume that economic and strategic competition will only increase further over the next several decades.

It is common to think of the post-war global economy as a baseline of normalcy to which we wish to return. But it seems more accurate to see that era as an anomaly: the apogee of relative global economic dominance by the West, and by the United States within the Western coalition. The hard truth is that the economic world of 1955 is gone, and even if we wanted it back — short of emerging from another global war unscathed with the rest of the world a smoking heap of rubble — we could not have it.

Yet the strategy of giving up and opting out of this international economic competition in order to focus on quality of life is simply not feasible for the United States. Europeans can get away with it only because they benefit from the external military protection America provides; we, however, have no similar guardian to turn to. We do not live in a Kantian world of perpetual commercial peace. Were America to retreat from global competition, sooner or later those who oppose our values would become strong enough to take away our wealth and freedom.

I stand by these words, just as I stand by every other word in the article.

Keeping America’s Edge, ctd.

Several intelligent critics of my piece on Keeping America’s Edge have emerged in the past couple of days, generally focused on two sentences in it. I’ll try to deal with the lines of criticism in one place.

1. Correct facts are presented misleadingly. This was central to Jonathan Chait’s criticism, in two parts: (i) I presented an apples-to-oranges comparison of Europe and the U.S. in terms of both timeframe and geographical extent, such that the conclusion that Europe has ceded enormous share of global GDP and the U.S. has not over the past several decades is not supported by a fair reading of the facts, and (ii) I focused on absolute GDP rather than GDP per capita. As I said in response, lack of clarity is always the fault of the author. As I have also shown, I believe convincingly, the conclusion is supported by any interpretation of the data. While exact magnitudes will vary slightly, I defy any critic to display any analysis using any reasonable definition of Europe or any relevant time periods or any reputable data source that does not support this conclusion. As I believe that I have also shown, I never claimed that absolute GDP was the proper measure of “how good is an economic system”, but was clear that I believe it is, rather, a measurement of long-run geopolitical power potential.

2. I asserted, rather than proved, that entrepreneurial markets can generally be expected to lead to greater growth over decades in contemporary societies than more centrally-directed economies. This is exactly correct, and you don’t have to parse the two sentences in contention to show this. In the third paragraph of the article, I state flatly:

After all, we must have continuous, rapid technological and business-model innovation to grow our economy fast enough to avoid losing power to those who do not share America’s values — and this innovation requires increasingly deregulated markets and fewer restrictions on behavior.

The purpose of the article as a whole, never mind a single phrase, was not to provide an empirical demonstration that less regulated markets tend to provide faster economic growth under many conditions than more regulated markets (that debate has been going on for some time). Nor did it ever claim to provide this. The purpose of the article was to describe, given that I accept the advantages that less regulated markets can provide (or if you do not accept this premise, even if one were to accept this), this does not lead to the conclusion that we can or should continue on the deregulation-oriented path on which we find ourselves without considering the balancing consideration of social cohesion. In effect, I am accepting that in the long-run, we must find some way to address the dysfunctions that free markets always engender (or at least leave unaddressed). I don’t, on the other hand, accept that there is a free lunch available to us – if you restrict creative destruction, you will restrict growth versus what it would otherwise be, at least at the scale of decades. (Again, for clarity, I assert that I believe this to be true, rather than assert that I have proven it empirically in this post.)

Before you call this smoke and mirrors, and label me as a partisan shill for unregulated markets, you ought to confront the fact that 2 of the 4 recommendations I make are for certain kinds of regulation: (1) a modernized version of New Deal financial services regulation, and (2) pursuing competition and family / student empowerment in education within the regulated public school system, rather than (at least for a long time) across public and private schools.

3. It’s all population growth. In effect, this argument is GDP = GDP / Person X Population, and that GDP / Person has grown at about the same rate in the U.S. and Europe over this period, so the only real difference has been population growth. This is a factually (approximately) correct statement. There are two big problems with arguing that this shows that therefore policy differences didn’t matter. First, it is almost always harder to maintain a lead. Europe and the U.S. had previously been on a generally converging path of GDP / Person, and maintaining this lead in productivity (by this metric) was very far from preordained. Second, it is difficult for a society to maintain aggregate power indefinitely if its population share becomes small enough relative to other countries. Said differently, as much of the rest of the world applies some approximation of basic techniques of market capitalism and technological development, it will be very hard to maintain a huge enough productivity advantage for the West to retain aggregate power. DiA, in this vein, amusingly charges that

…if Mr Manzi thinks America needs to maintain its GDP share to counter the rising third-world menace, then he is arguing that Americans should allow more immigration and have more babies.

Of course, one of the four recommendations I made was precisely to “reconceptualize immigration as recruiting”, both as a mechanism for increasing the GDP / Person impact per immigrant, and maintaining population growth (among other reasons).

The key practical point of the article is that I believe there is a different efficient frontier of smarter political action available to us than is currently being provided by our two major parties if we can try to see both sides of the eternal argument more clearly – that is “the inherent conflict between the creative destruction involved in free-market capitalism and the innate human propensity to avoid risk and change”, that in our case is exacerbated by both “ever-increasing international competition” and “the growing disparity in behavioral norms and social conditions between the upper and lower income strata of American society”.

As I also said in the piece, I believe that this three-part problem “has actually undergirded most of the key political-economy debates of the past 30 years. But a dysfunctional political dynamic has prevented the nation from addressing it well”. It’s a shame to see that dynamic replicated in this instance.

Update: As I re-read that last sentence, it sounds like I am blaming my interlocutors for misinterpreting me. I believe what I said about the responsibility for lack of clarity resting on the shoulders of the author. I stand by every word in the article, but I should have exerted greater powers of imagination to understand the reaction of somebody who does not share some of my premises, and should have reflected this in the article. The rough-and-tumble of direct exchange always improves thought and expression, so I thank all of my critics linked to in this post for their focused attention.

More Reactions to Keeping America’s Edge

Ross Douthat very generously devoted the bulk of his New York Times column to the article and its key themes. He adds two items to the agenda that I proposed: entitlement reform and tax reform. I agree with both of these concepts, and expect to go into much more detail on both in the book, likely with some preliminary ideas hashed out here on these blogs. Michael Barone was also very generous, and also proposed adding pro-family tax reform to the agenda.

Chrystia Freeland devoted her New Year’s Day column in the Financial Times to some of they key themes in the article, and emphasized some of its sociological aspects. In the article I said of the old Wasp ascendancy that they “developed a social matrix that offered broadly shared prosperity to generations of Americans.” Ms Freeland’s wording of this idea makes me wish she were there for the rewrites:

The genius of that elite was its ability to bring the American dream within reach of nearly everyone. If it hopes to emulate the longevity of America’s Wasps, and, more importantly, the political system they created, today’s global plutocracy must figure out how to do the same.

Jonathan Chait at TNR wrote that the piece does “have some interesting observations and decent proposals”, which is gratifying, as I saw a lot of the agenda I was proposing as being capable of gathering broad support. He also criticized the presentation of some of the data. Here are the relevant sentences from my article:

From 1980 through today, America’s share of global output has been constant at about 21%. Europe’s share, meanwhile, has been collapsing in the face of global competition — going from a little less than 40% of global production in the 1970s to about 25% today. Opting for social democracy instead of innovative capitalism, Europe has ceded this share to China (predominantly), India, and the rest of the developing world.

Mr. Chait has two basic criticisms of these sentences, as I see it. He asserts that:

1. While technically accurate, the statements present the data in a misleading way because (i) I am comparing a period starting in the 1970s with one starting in 1980, and (ii) I quote a GDP figure for all of Europe, and then proceed to describe Europe “opting for social democracy”, which implies that this should have referred only to Western Europe.

2. I discuss total GDP, rather than GDP per capita, which is a better measure of prosperity.

Let me take these one at a time.

1. I used the word Europe as per its dictionary definition. I apologize for any confusion the wording might have created; as always, such confusion is the fault of the author, not the reader. I don’t think, however, the statement is misleading. The basic conclusion that Europe has ceded enormous global GDP share, while the U.S. has retained close to constant GDP share, holds for any reasonable geographic definition of Europe, for any time periods beginning in the 1970s or 1980, and when using any data source that I investigated for comparing currencies.

I’ll start with the change in U.S and European shares of global GDP, using Mr. Chait’s preferred (and entirely reasonable) definitions: a common start date of 1980, and the EU15 as a proxy for Western Europe. According to the US Economic Research Service Macroeconomic Dataset; GDP Shares by Country and Region Data Table; 11/4/09 update, the U.S. share of global GDP was 26.2% in 1980, and grew very slightly to 26.7% in 2009. This is a net share change of +2% (1 – 26.7/26.2) for the U.S. over this period. Germany, as another example, had a global share of 8.2% in 1980, which declined to 5.85% in 2009. This is a net share change of -29% for Germany over this period.

According to this data source, the net share changes from 1980 to 2009 are:

U.S. +2%

EU15 -22%
Of which,
Germany -29%
France -20%
Italy -32%

Now I’ll show almost the same analysis with a different data source – the OECD Publication The World Economy: Historical Statistics – that only has data through 2006. (In general, these calculations show slightly worse performance for both the U.S. and Europe as compared to the rest of the world, but almost identical U.S. vs. Europe performance). This table will show the change in share of global GDP between 1980 and 2006 for a core group of 12 European economies identified by the publication, plus each of the “big three” continental social democracies individually, plus the U.S.

Net share changes from 1980 to 2006 are:

U.S. -7%

Euro 12 -29%
Of which,
Germany -37%
France -28%
Italy -34%

However you slice it, the same observation holds true: European countries as a whole, and especially the major “social market” economies of Germany, France and Italy, have lost 20% – 30% of their share of global GDP versus the U.S.

2. Exactly as Mr. Chait indicates, GDP per capita would be a far better measure of prosperity – which is why I used that metric when discussing relative prosperity earlier in the piece. I used total GDP in the paragraph in question for the reasons I stated in the article. This was a description of the loss of European economic power to Asia. Ultimately, absolute size of an economy matters, because economic clout represents the latent capacity for military and cultural power. Not all large, successful economies become military powers, but many do. And per capita wealth will not protect a society from a large, aggressive military power. As an extreme illustration, annual GDP per capita is more than $40,000 in Hong Kong and more than $30,000 in Taiwan, but this did not allow Hong Kong to remain independent of PRC China, which has annual GDP per capita of about $6,000, and would not allow Taiwan to do so without the presence of the U.S Navy.

This is why the sentence that immediately follows the ones quoted by Mr. Chait is this:

The economic rise of the Asian heartland is the central geopolitical fact of our era, and it is safe to assume that economic and strategic competition will only increase further over the next several decades.

And it is why this is almost immediately followed by the following paragraph:

Yet the strategy of giving up and opting out of this international economic competition in order to focus on quality of life is simply not feasible for the United States. Europeans can get away with it only because they benefit from the external military protection America provides; we, however, have no similar guardian to turn to. We do not live in a Kantian world of perpetual commercial peace. Were America to retreat from global competition, sooner or later those who oppose our values would become strong enough to take away our wealth and freedom.

If we do consider per capita GDP, as noted in the piece, “economic output per person is now 20 to 25% higher in the U.S. than in Japan and the major European economies”. As Reihan Salam notes in his blog post on this, as of 1980 the consensus was that the U.S. and Europe should be converging on a reasonably common level of economic output per person. The roughly comparable growth rates in output per person over the past quarter century represent the unexpected maintenance of a U.S. lead.

More on Keeping America's Edge

My article on Keeping America’s Edge has generated a decent amount of commentary. I thought I’d round it up and reply a bit in one place.

Among the first comments were those at The Daily Dish. Our own Conor Friedersdorf and Andrew Sullivan excerpted reasonable chunks of it, and generally had very kind things to say. Conor focused one of his posts on the immigration recommendation, which I think is the most radical recommendation, and something I believe in very strongly.

Arnold Kling at EconLog (implicitly) provided an excellent criticism:

But I do not know exactly what we mean by social cohesion. I mean, if you have a civil war, that would seem to represent a loss of cohesion, and clearly civil wars are very bad things. But beyond that, the concept has a vague, “I know it when I see it” connotation.

In other words, I never defined social cohesion well. Here is my working definition (that I should have made clear in the piece, and will do in the book): the widespread and irrational willingness and propensity to sometimes and to some extent sacrifice narrowly-defined rational self-interest to the needs of a greater collective, and the expectation that others will do the same. In general, in a capitalist democracy this does not mean the expectation that everyone (or even most people) will become martyrs to the Greater Good, but more that they will pursue narrow self-interest within the written and unwritten rules of the society which tend to channel self-interest “as if by an invisible hand” to the good of the society as a whole over time.

David Brooks, in his New York Times column on Tuesday, very generously named the piece one of the better articles published in 2009. Lots of things in life look easy – until you try them. As the guy who wrote the actual article, I can’t see how I would improve on his five sentence summary:

Jim Manzi’s essay, “Keeping America’s Edge,” in National Affairs, explores two giant problems. First, widening inequality; second, economic stagnation, the fear that without rapid innovation, the U.S. will fall behind China and other rising powers.

Manzi investigates a dilemma. Most efforts to expand the welfare state to tackle inequality will slow innovation. Efforts to free up enterprise, meanwhile, will only exacerbate inequality because the already educated will benefit most from information economy growth.

Finally, Steve Pearlstein devoted his column in today’s Washington Post to reacting to the article. In spite of confusing me with a different Jim Manzi, he had a very interesting take.

He writes:

But the debate, it seems to me, needs to go beyond simply determining where the pendulum should come to rest. For equally important is how effective the two sectors are in actually delivering all that social justice and growth-inducing innovation.

I agree entirely with this. He goes on to criticize, in a very even-handed way, the effectiveness of both businesses and governments in delivering the goods. I’ll focus on the criticisms of business in this comment, concerning which, he writes:

Americans understand that free markets are the best vehicle for generating innovative products and ever more efficient ways of producing them. But recent experience also reminds that innovation and the competitive dynamic are not always what they are cracked up to be.

When investors engage in herd behavior and deploy scarce capital merely to bid up the price of real estate or financial assets, that does nothing to improve economic output or efficiency.

…

What good is competition if it drives corporate executives to knowingly engage in increasingly risky behavior simply to boost short-term profits and stock prices even at the expense of long-term value creation?

What this seems to ignore (or at least discount) is the centrality of the knowledge problem. All real markets will have bubbles, speculative excess, obnoxious rich people who confuse luck with merit, and so on. This is because markets are a method for making decisions in the face of deep uncertainty. As I tried to go into in the piece, I believe that the trick is to construct a political economy that can withstand these problems, rather than one that tries to eliminate them.

Keeping America's Edge

The United States is in a tough spot. As we dig ourselves out from a serious financial crisis and a deep recession, our very efforts to recover are exacerbating much more fundamental problems that our country has let fester for too long. Beyond our short-term worries, and behind many of today’s political debates, lurks the deeper challenge of coming to terms with America’s place in the global economic order.

Our strategic situation is shaped by three inescapable realities. First is the inherent conflict between the creative destruction involved in free-market capitalism and the innate human propensity to avoid risk and change. Second is ever-increasing international competition. And third is the growing disparity in behavioral norms and social conditions between the upper and lower income strata of American society.

So begins a very long article that I’ve written for the current issue of the new magazine National Affairs that Yuval Levin has started with great attention as the modern successor to the legendary The Public Interest.

This article is my best shot at summing up why I think the current political debate in Washington seems to me to be so disconnected from reality, what I think are our key problems, and what I think we should do about them. Readers of my posts at this blog will have seen (and in some cases participated in) the development of some of these ideas. This work comprises part of a chapter of the book that I’ve been working on that has caused my near radio silence for the past few months.

You can read the whole article through the link, so I won’t try to summarize it here, but comments are more than welcome.