Contents 2 3 5 95 96

contents

2 from the ceo 3 editor’s note 5 trends Counterfeit rice. by Lawrence M. Fisher 79 95 institute news Check us out. book excerpt Cents and Sensibility 96 lists Gary Saul Morson and Morton Schapiro explain how Airfare puzzle. Tolstoy fits in to the dismal science.

12 canada’s health care 44 squaring the deal Maybe we could do better. Merger madness. by Åke Blomqvist by John Kwoka 21 globalization 56 federal reserve Two economists, two views: independence 22 when globalization is Don’t count on it. public enemy number one by Mark Thoma We’re making a big mistake. by J. Bradford DeLong 66 a real fix for traffic 32 the trouble with globalization Not what you think. Capitalism isn’t just for capitalists. by Daniel Herriges by Dani Rodrik page 66 tk

Fourth Quarter 2017 1 from the ceo

At the Milken Institute, we This year’s class of 21 was drawn from 15 are strong believers in the countries, including Ghana, Mongolia, Paki- power of capital markets to stan and Gambia. As mid-career profession- help solve urgent social and als, each has worked for a minimum of five economic problems. But years in their government’s capital markets capital markets do not auto- authority, central bank or ministry of finance. matically deliver growth. Their eight-month program starts with a se- They can pose risks to finan- mester of rigorous coursework in economic cial stability, and in many countries are un- policy, finance and statistics, which is supple- derdeveloped and little utilized. To advance mented by a high-profile speaker series fea- prosperity, capital markets require not only turing the Institute’s wide-ranging network capable investors, but also policymakers who of financial industry leaders. The fellows then truly understand their potential. undertake demanding internships that an- When the Milken Institute was founded in chor their learning in practical experience 1991, its original focus was the interaction be- and put them in the shoes of private investors. tween education and job creation. Today, A number of fellows will cap off their time in while our work spans many areas, that link is the United States by participating in the 2018 the foundation of one of our most inspiring Milken Institute Global Conference. new programs: a partnership among the Insti- It was a delight to be with this group, and tute, the International Finance Corporation to hear about their hopes for their time in the (part of the World Bank Group) and George program. If last year’s inaugural class is any Washington University that helps up-and- indicator, their dynamism and zeal to put coming policymakers from developing coun- what they learned to practical use will have tries gain deeper understandings of capital significant benefit back home. One of our markets. long-term goals for the program is to create In August, we welcomed the latest class of an alumni group that will work across na- IFC-Milken Institute Capital Markets Fellows tional boundaries to facilitate more effective to Washington. It was not easy for them to get local capital markets. We look forward to con- there: each had to be nominated by their gov- tinuing the program, and to our engagement ernments and employers as the most promis- with these policymakers, for years to come. ing talent in their organization. The final class was selected for their passion for what they do, their eagerness to share their learning and insight, and their potential to become the next generation of capital markets leaders Michael Klowden once they return home. CEO

2 The Milken Institute Review editor’s note

JG, our tireless inquisitor from Passadumkeag, Maine, wonders whether any of the articles in the Review have been made into movies. Glad you wondered, JG.

The film “Tax Cuts – or Die,” based on change course with globalization; it is to en- Len Burman’s essay on the value-added tax, sure that the losers are compensated.” starred Javier Bardem as the one-handed “The logic of sustaining an open economy economist and Charlize Theron as the ghost by compensating those who end up with of Ayn Rand. It got off to a promising start at smaller slices of the pie is impeccable,” Rodrik the Filmfest München, where it almost won says. Instead, under the sway of market fun- the prestigious Fritz Gerlach Prize. But it damentalists, the United States let the chips bombed in test marketing in New York, when (and workers) fall where they may.” audiences discovered that the actors were For his part, Brad DeLong, an economist at speaking English, not German. Keep checking the University of California (Berkeley), chal- Netflix, though, to see if it’s been picked up. lenges the premise that globalization is largely Meanwhile, check out our latest trove for responsible for the frustrations of working- enlightenment (and entertainment) potential. class Americans. He notes that “Pascal Lamy, Åke Blomqvist, an economist at Carleton the former head of the World Trade Organiza- University in Ottawa, offers a note of caution tion, likes to quote China’s sixth Buddhist pa- to those yearning for single-payer health in- triarch: ‘When the wise man points at the surance. “A single-payer model is by defini- moon, the fool looks at the finger.’ Market tion a monopoly model,” he writes, “and thus capitalism, Lamy says, is the moon. Globaliza- almost certain to operate inefficiently. The tion is the finger.” United States would do better by emulating “The policies needed to soothe the griev- Switzerland, the Netherlands or Australia, all ances blamed on globalization seem further of which provide universal insurance but in- out of reach today than they were decades ject some degree of competition to contain ago,” DeLong concludes. “The best one can costs and to provide more choice in services hope for is that the fever subsides sufficiently and providers.” to allow for a realistic debate over who owes Dani Rodrik, an economist at Harvard’s what to whom.” Kennedy School, steps back from the furious John Kwoka, an economist at Northeast- debate over globalization to ask what we re- ern University, laments the death by a thou- ally want from global economic integration. sand cuts of U.S. merger policy. “Antitrust “Elites now concede that globalization pro- has, with time, narrowed its focus,” he writes, duces losers as well as winners,” he writes. “reversing the Progressives’ inclination to put “But the correct response, they argue, is not to the burden of proof on corporations to show

Fourth Quarter 2017 3 editor’s note too small (rice). The latter, by the way, is that increased concentration is benign. And it made from various grain remnants; reports is resolving cases in ways that have permitted of plastic rice have thus far been debunked.” consolidation and more generally blurred its Daniel Herriges, an urban planner, ex- mission and agenda.” plains why it isn’t possible to build our way Mark Thoma, an economist at the Univer- out of traffic congestion and why we shouldn’t sity of Oregon, warns that the Fed’s ability to even try. “We chase mobility like a snake eat- manage the economy without interference is ing its own tail, accruing ever-growing road by no means assured. “History shows us that maintenance obligations so that we can travel independence cannot be guaranteed by legis- more miles at higher speed, live farther afield lation,” he writes. “It requires presidents to from each other and ultimately need yet more appoint qualified people and then to support roads,” he writes. “We measure congestion their discretion. More generally, it depends costs in ‘delay,’ with the implicit assumption upon the willingness of official Washington that free-flowing traffic – as fast as the road to put the nation’s long-term interests above would safely allow us to go – is the ideal. But partisanship. On that score, it’s hard to claim this logic yields dubious benefits in terms of we’re making progress.” both economic productivity and personal Larry Fisher, a journalist who frequently satisfaction.” writes for The New York Times, takes the mea- One last thought: Don’t forget to check sure of the dark underbelly of global trade for out the marvelous excerpt from Cents and counterfeit goods. “The total value of coun- Sensibility, a new book by Gary Saul Morson terfeit and pirated goods was as much as $650 and Morton Schapiro that brings the wisdom billion in 2011,” he writes. “No product, it of humanities scholars to the economist’s seems, is too large (construction cranes) or table. Happy perusing. —Peter Passell

The caricature we’ve been teas- the tune of a different drummer. The child of ing you with on the spine this Ukrainian Jewish immigrants, he was deeply year is of the late Robert Fogel, devoted to social justice and the elimination who led the charge to bring mod- of racial discrimination. After graduating from ern analytic and statistical tech- Cornell, he spent eight years as an organizer for niques to the study of economic the Communist Party before finally quitting to history. To some, he was a passive- go to graduate school and become an academic. aggressive provocateur who pub- He subsequently published a slew of articles lished his ideas before he thought that disrupted every corner of economic history, them through. To others, he was infuriated half the profession — and earned him a remarkable innovator who revo- a Nobel Prize (1993). lutionized the way we think about But Fogel most definitely had a warm and issues ranging from the role of the fuzzy side. In his years at Rochester, Chicago and railroad in opening the American Harvard he mentored a generation of fine young West to the economic impact of slav- scholars devoted to him as well as to the use of ery on the South. novel techniques for exploiting data in unearth-

Fogel, it is safe to say, marched to ing the secrets of the past. —Peter Passell smith david

4 The Milken Institute Review trends

by lawrence m. fisher

Some millennia ago, an enterprising soul affixed a mark to his clay pots, and branded consumer goods were born. A day later, a rival potter copied the mark, launching the counterfeit products industry.

The trade in counterfeit goods may even predate the counterfeiting of currency. Pliny the Elder (A.D. 23-79) warned of counterfeit opals, and archaeologists have unearthed ancient forgeries of Roman bricks, Chinese pottery and other early branded goods dating back thousands of years. As the Economist Intelligence Unit put it, “Before people carried counterfeit handbags, smoked illicit cigarettes and used synthetic methamphet- amines, there were bogus spices, stolen antiq- uities and smuggled whiskey.” Policymakers and law enforcement have battled counterfeit goods ever since, with little success. A report for the International Chamber of Commerce in 2011 estimated that the total value of counterfeit and pirated the numbers goods was as much as $650 billion per year The market for knockoffs is broad as well as and projected that this figure would grow to deep. No product, it seems, is too large (con- almost $1.8 trillion by 2015. Now a host of struction cranes) or too small (rice). (The lat- technology companies, from tiny start-ups to ter, by the way, is made from various grain mighty IBM, promise brand protection ser- remnants; reports of plastic rice have thus vices to stem the flow of knockoff Nikes and far been debunked.) Consumer electronics counterfeit commodities of all kinds. Indeed, knockoffs are particularly popular: the OECD it is provoking an arms race in which increas- reports that one in four video game consoles ingly sophisticated counterfeiters are facing is counterfeit, along with one in five head- off with the makers of the real things. phones, one in six smartphones and one in seven memory cards and solid state memory drives. Counterfeit auto parts are also a huge LARRY FISHER writes about business for The New York therealreal.com Times and other publications. business – think airbags, brake pads and tires

Fourth Quarter 2017 5 counterfeit industry of Russia, Korea and Canada. It’s nearly twice – and so are pharmaceuticals, from the statin the defense budgets of the United States, Crestor to any number of very expensive che- China, Saudi Arabia and Russia combined. So, motherapy drugs. it is reasonable to ask, how solid is that num- China claims the dubious distinction of ber? The answer is no one knows – which is world market leader in counterfeit goods, ac- another way of saying, “Not really.” counting for a remarkable 87 percent of prod- In the absence of a Counterfeiters Industry ucts seized at U.S. ports. But the Americas, Association trumpeting its record revenues, Europe, Africa, Australia and New Zealand are researchers make do with an array of survey all producers and consumers of false goods. techniques, forensics and guesswork. Some counterfeit experts say the ICC’s number is technology’s ambiguous role much too high, that the real figure is probably In recent years, technology has been a boon – just $500 billion or so, give or take a few fake to the counterfeiters. The internet gives any Rolexes. Others say the actual number is un- producer of fake goods instant access to the doubtedly higher because only a small frac- global market. Online retailers, including tion of counterfeit goods are seized. Amazon, Alibaba and eBay, have provided a “Everyone quotes numbers like they abso- frictionless distribution network despite their lutely know what they’re talking about,” said well-publicized efforts to stem the illicit trade. Alan Zimmerman of the City University of And 3-D printers let even mom-and-pop op- New York, who has written extensively about erators copy sophisticated products with re- counterfeit trade. “The FBI was quoted thou- markable accuracy. Do vendors of brand sands of times on the Internet, and the General protection and secure solution providers Accounting Office asked them: ‘Where did stand a chance? these numbers come from? Where does the “I spoke at a couple of conferences run by original number come from?’ Nobody knows.” people who make the tech solutions, and Cigarettes are one of the mostly commonly what surprised me was the absolute faith counterfeited consumer goods, so tobacco placed in their ability to solve the problem,” companies have sought to ascertain the global Tim Phillips, author of Knockoff: The Deadly cost to their brands. “Cigarette companies did Trade in Counterfeit Goods, told me. “I was al- the most scientific study,” Zimmerman said, ways careful to point out the massive eco- with a pinch of irony. “They did discarded- nomic incentives for the people who wish to pack studies; they went around and actually find a way around these fixes. Maybe it’s an picked up garbage and tried to extrapolate insight into the way we tend to see tech, as a from that the counterfeit cigarette market.” sort of omnipotent force that we hope can One reason that counterfeit sales are hard disappear problems for us, so that we don’t to quantify is that the terminology is squishy. have to think about the social/economic There is a wide range of illicit products sold, causes of those problems.” everything from cheap knockoffs that everyone knows are fake to sophisticated copies data? what data? that can even fool the pros. Indeed, some Alert reader, did you stumble over the stats counterfeits are virtually identical to the legit- above? Maybe you should have. Put in per- imate product because they are made on the spective, $1.8 trillion is bigger than the GDPs same assembly lines after hours.

6 The Milken Institute Review Cigarette companies did discarded-pack studies; they went around and actually picked up garbage and tried to extrapolate from that the counterfeit cigarette market.

“‘Counterfeit’ is a very well-known term, more numerous and more agile. “It really is a but there are challenges with that,” explains hydra,” Chaudhry said. “If Interpol and other Andrew Stevens, an analyst with the Gartner enforcement agencies shut down one of these Group. “In some companies’ eyes, or from sites, they can readily sell from another.” some outside observer’s perspective, counter- To be sure, some countries do better than feit has to do with intellectual property issues, others at limiting the counterfeit goods trade. not with fake or substandard products, or The Economist’s Illicit Trade Environment products purposely made to deceive the pub- Index scored 17 economies in Asia-Pacific on lic into buying them. You may well find that the extent to which they enable illicit trade. ‘counterfeit’ does lock itself in as the termi- Australia and New Zealand had the cleanest nology of choice, but there is a lot of consen- scores, while institutionally weak countries, sus around the use of ‘fake.’ People understand including Myanmar, Laos and Cambodia, what it means.” scored the worst. But there are some surprises Call them what you like, counterfeit products are everywhere, and Stevens counts himself among those who say the published estimates are, if anything, low. “In my experience, the ones you see are the tip of the ice- berg,” he said.

policy and policing Like reliable estimates of the phenomenon, examples of effective public policy against counterfeiting are hard to come by. Most countries have laws on the books that bar the manufacture and sale of counterfeit goods. But many of these laws have no teeth: enforcement is inconsistent and brand owners often prefer to ignore the crime because the cost of pursuing can be higher than the expected benefits. “If you just use the United States as an example, we have a policy and we do have enforcement of intellectual property, but we still have a huge problem of counterfeit and pirated products,” said Peggy Chaudhry at the Villanova School of Business. Even where en-

rl photo rl studio photo forcement is vigorous, the counterfeiters are

Fourth Quarter 2017 7 counterfeit industry charges, there is little law enforcement can do. here, too. Hong Kong, which has historically That means it is up to the rights holders to been a mecca for counterfeit goods, now ranks pursue justice. in the top five in the region for enforcement of “Counterfeiting hasn’t really been taken se- laws against fakes. China remains in the bot- riously for a long time,” said Robert Peeters of tom half of the index, but it is making an effort the multilateral World Customs Organization. to improve its standing in order to protect its “Some companies ignore the fact that there is role in legitimate global manufacturing. counterfeiting happening. Even when I come Well-intended policy is one matter, en- back to them with the counterfeits, they say it forcement is another. Unlike the production isn’t an issue.” or use of counterfeit currency, which under- In the absence of strong enforcement, one mines the authority of the state and is pursued alternative is to cut off counterfeiters from with the full force of government, fake goods the global payments system. The Interna- merely violate trademark law. Overworked tional Anti-counterfeiting Coalition, a Wash- customs agents may spot shipments of coun- ington-based nonprofit that historically terfeit goods, but unless the rights holder files focused on legislation, now works with rights holders, credit card companies and PayPal to block payments on suspected counterfeit goods. The IACC said the program has termi- nated over 5,000 individual counterfeiters’ merchant accounts, which has affected over 200,000 websites. Separately, the IACC has

partnered with Alibaba, the giant online mart therealreal.com

8 The Milken Institute Review that has been a major conduit for counterfeit supply chain management. IBM made head- goods. The organization claims that some lines when it signed a deal with Walmart to 6,800 sellers’ storefronts have been closed and apply blockchain – the buzzword technology permanently banned, and nearly 200,000 in- that makes Bitcoin transactions verifiable fringing product listings have been removed. without third-party participation – to track “We’re the experts on identifying counter- product shipments. feit goods,” said Robert C. Barchiesi, the Many companies now have brand protec- IACC’s president, who is a former officer with tion officers; conferences and consultants the New York City Police Department. “You abound. There is even a new school at Michi- can’t expect Visa or Mastercard to be experts gan State University, the Center for Anti- on that, but they’re experts on their end. If Counterfeiting and Product Protection, with you bring those expertises together, it’s a win- its own quarterly journal, The Brand Protec- ning hand.” The crack cocaine trade “in New tion Professional. “It’s multi-disciplined, and it York City when I was there looked like a needs to be,” explained Leah Evert-Burks, the never-ending problem, and look at it now. journal’s editor. “You’re looking at three dif- The same thing will happen here.” ferent fronts: supply, or the source factory, in which you can conduct raids or factory audits; there’s an app for that distribution – the borders, working with cus- But like the war on drugs, the fight against toms of every country, enlisting distributors counterfeit goods is replete with small victo- or retailers – and demand: educating consum- ries even as the larger trend is one of un- ers on what counterfeiting is, that it’s not a abated growth. While the IACC boasts about victimless crime, that it’s tied to organized blocked payments and Interpol publishes reg- crime and violations of human rights.” ular reports of counterfeit products seized, Most brand protection products and ser- the trade mutates and moves around. For vices focus on helping rights holders identify every shipping container full of knockoffs the source of counterfeits and get them out of that is seized, how many more pass through the supply chain. One of these is Red Points, customs unexamined? a Barcelona-based start-up that monitors the “You have to keep in mind that customs web for counterfeit goods and pirated con- searches less than 5 percent of everything that tent. It seeks out impersonations, web pages comes in,” Chaudhry said. “If you look at en- and fake profiles in social networks that pro- forcement, it is a really low percentage of vide illegal copies of genuine products, fake goods coming in daily that actually gets some apps that impersonate genuine brands in kind of scrutiny.” order to sell illegal products or commit fraud, In this environment, a broad spectrum of and cybersquatting, the fraudulent registra- businesses are eager to help – for a price. tion of domain names that reproduce regis- Brand protection software and services claim tered trademarks. Red Points claims a 96 to rapidly discover, monitor, measure and percent success rate in turning detections proactively guard brands online. Providers of into removals. secure solutions offer technological authenti- “The client has a dashboard where they see cation tools ranging from holograms to RFID all the incidents we are finding, all the report- chips to mass serialization. Track-and-trace ing, and they can validate if it is an infringe- capabilities have become an integral part of ment or not,” explained Laura Urquizu, Red

Fourth Quarter 2017 9 counterfeit industry ity and Security Act, which, among other Points’ chief executive. “We have takedown things, established requirements to facilitate tools to process a request to the host or web- the tracing of prescription drugs through the site. They remove it within hours.” distribution chain. Every manufacturer and But when asked for the names of compa- repackager was obliged to affix a product nies whose losses to counterfeits declined identifier on each package sold. The Euro- meaningfully thanks to Red Points, Urquizu pean Union adopted a comparable measure demurs. Clients don’t want their stories told, at the end of 2013, and similar laws have been she said, and I found this response common passed in many countries, from China to Bra- among brand protection vendors. Presum- zil to Turkey. ably, no one would buy their products or ser- High-value products like computers and vices if they did not work – or at least not automobiles have always been identifiable by more than once – but performance metrics serial number. And customers are already fa- are missing in action. miliar with the technology that FedEx and “What has really surprised me is the sheer UPS employ to provide a unique tracking scale of the problem, and the lack of activity number for each envelope or package they The WCO estimates that 40 percent of all goods sold online are counterfeit, and in some categories the number is even higher.

from institutions and governments,” Urquizu ship. But putting a serial number on every added. “The big companies can afford to have packet of pills and every vial of vaccine is an inside teams, but most subject to the problem order of magnitude more challenging. Pfizer don’t even know there is a solution.” and GlaxoSmithKline have both turned to an One area where governments have stepped Oslo-based company, Kezzler AS, that has de- up, albeit belatedly, is in pharmaceuticals. veloped a proprietary process for generating Until recently, the United States was awash in billions of codes that can be applied to any counterfeit, stolen, adulterated and diverted kind of product. drugs. It was so easy to obtain a license to dis- By applying a unique encrypted identity to tribute pharmaceuticals in some states that every package, Kezzler can show, in real time, many former narcotics dealers – convicted exactly where and when a product went awry. felons – moved into the trade. The counter- The system never references a scanned code feits sold through licensed pharmacies and against a stored number, but rather applies an even hospitals, but every attempt at regula- encryption algorithm to verify that the code tion was put down by industry lobbyists. is valid and could only have been generated Change only came after a scandal not di- by the Kezzler platform. The operation takes rectly related to counterfeiting: a meningitis only a second or two, regardless of how many outbreak in 2012 killed 64 people because a products have been scanned or where the compounding pharmacy that wasn’t licensed customer is in the world. Because there are no to make its own drugs sold a contaminated numbers stored in a database, the system product routinely used in outpatient surgery. scales to the billions or trillions of codes. In response, Congress passed the Drug Qual- “We believe, and pride ourselves in saying

10 The Milken Institute Review we have military grade encryption,” said hands of the customs officer who is at the Thomas Kormendi, Kezzler’s chief executive. container site.” “We used to say unhackable, but it’s very hard Of course, counterfeiters can get around to say that, although it would be very, very this tool by shipping directly to customers, a difficult. We have a number of wins,” he al- strategy enabled by the same technology that lows, but many are covered by nondisclosure makes shopping on Amazon so easy. “I’ve agreements. “One of the big ones we can talk seen dramatic shifts from containers to direct about is we have joined up with one of the shipments,” said Barchiesi of the IACC. “Now world’s biggest packaging companies, Amcor, you have to track individual parcels.” to do any kind of food packaging, pharmaceuticals, blister packs.” how worried should you be? The drawback to encryption systems like The WCO estimates that 40 percent of all Kezzler’s is that someone in the field, whether goods sold online are counterfeit, and in some a customer or a customs agent, has to scan categories the number is even higher. Chances the product to see if it is genuine. How many are, you’ve already purchased counterfeit customers would actually bother to do that? goods, knowingly or otherwise. I suspect the Could a busy customs agent keep track of all MacBook power adaptor I bought online is not the different apps? genuine, and a quick Google search suggests I Ian Lancaster, a British-based specialist in have good reason to wonder. But it works. The authentication technologies, said it is unreal- prescription drugs I have ordered online from istic to expect consumers to download the Canadian pharmacies trouble me more. necessary app (out of 20 or 30 similar ones), Not only do counterfeiters operate multi- scan products before purchase and alert store ple websites, they have become adept at copy- owners (who may be complicit in the coun- ing the look and feel of legitimate ones, so terfeit trade) when they spot a fake. “If I had that consumers have no clue. Some even op- a dollar for every clever, and I genuinely erate help desks, so that customers can get an- mean clever, ingenious, technology solution swers about using their bogus products. that has been invented over the last 20 years “The sophistication with the counterfeiters for authenticating genuine goods, but the now is not just around the physical product, company has then folded because they never it’s around the services,” said Stevens of Gart- could make inroads, I’d be a damned sight ner. “They are mimicking a web portal that the richer than I am now,” Lancaster said. “They manufacturer uses for authentication. In the are too expensive, or rather too expensive in same way the manufacturers close gaps, the the perception of brand owners.” counterfeiters themselves are going through One helpful measure is a World Customs their own continual review process to make Organization program called IPM, which in- sure their products are watertight as well.” tegrates many of the most common detection Stevens said he has become more cautious and authentication tools from secure solu- in his own purchases, particularly online. tion providers like Kezzler so that an agent in “You can’t be paranoid about every single the field doesn’t have to guess at which one to product that you buy. But certainly for me, use. “IPM will tell him how to authenticate a when it comes to food, medicines, I’m very product,” explained Peeters of the WCO. cautious,” he said. “You’re never sure “It’s important to have this technology in the what’s around the corner.”

Fourth Quarter 2017 11 12 The Milken Institute Review Canada’sa model for

theHealth united states? Care by åke blomqvist illustrations by robert neubecker

The shortcomings of the health care system have been front and center in the American debate over social policy for decades. Canadians are also preoccupied with health care policy, but with one big difference: while Americans are highly critical of the U.S. system, Canadians think theirs is a successful one that should be defended and strengthened. Indeed, many view Cana- da’s universal health care model as a central element of national identity. The Globe and Mail, Canada’s leading newspaper, recently opined that the establishment of universal health care should be singled out as the most significant collective achieve- ment since Canada became a unified country in 1867. To Canadians, U.S. health care reform appears chaotic, bogged down in unproductive ideological debates that Can- ada left behind decades ago. Why, they ask, couldn’t the United States move past the convoluted Obamacare approach, opting instead for a version of the simpler, more transparent Canadian

Fourth Quarter 2017 13 canada’s health care States. (The surprise winner – surprising, any- single-payer model of financing to settle the way, to those disdainful of “socialized medi- issue once and for all? For their part, many cine” – was Britain.) Americans who are somewhat familiar with In what follows, I offer a sketch of how Can- the Canadian system ask the same question. ada’s health care system is organized, and out- Indeed, during the 2016 elections, Bernie line the way the existing U.S. hybrid system Sanders called for a single-payer solution to could be transformed into a Canadian-style the problem of extending coverage beyond system. In my view, however, that change the Affordable Care Act. would be a mistake. A single-payer model is by definition a monopoly model, and thus almost HEALTH CARE COSTS, 2015 certain to operate inefficiently, whether or not U.S. CANADA NETHERLANDS U.K. AUSTRALIA it is managed by government. The United

Health care . . . 16 9%. . . . 10 2%...... 10 .8%...... 9 .8%. . . . . 9 .3% States would do better by emulating Switzer- costs, land, Australia or the Netherlands, all of which % of GDP Health care . . . . $9,500. . . . $4,600...... $5,300. . . . . $4,000. . . . $4,400 provide universal insurance but inject some costs/capita, degree of competition to contain costs and to US$ PPP provide more choice among plans, services Government. . . . . 49%. . . . . 71%...... 81%...... 79%. . . . . 67%. share of and providers. total cost how the canadian system works source: OECD Health Database Every resident of Canada is covered by a gov- The Canadian system is attractive for two ernment-funded health insurance plan. big reasons: everybody’s covered, yet the cost Under Canada’s constitution, though, both of health care per person is less than half that the details and the management of health in- of the United States. As a result, Canadian surance are left to the provinces. So the sys- health care absorbs about 10 percent of GDP tem has 13 separate plans, one for each of the compared with almost 17 percent in America. 10 provinces and the three northern territo- A U.S.-Canada comparison may be a good ries. (Jeopardy contestants take note: Nunavut way to begin the story, but why end there? Can- is probably the one you didn’t remember.) ada is not alone in providing universal cover- Still, the federal government retains con- age. In fact, the United States is the only siderable leverage because some of the reve- high-income country that does not. Moreover, nue it transfers to the provinces to support in international comparisons of health system health care finance is conditioned on the performance, Canada has not come out partic- provinces’ abiding by the provisions of the ularly well in recent years. In the 2017 update Canada Health Act. So while there are minor of an often-cited ranking of 11 high-income differences among plans, they all follow the countries’ health care systems by the Com- same basic principles specified by the CHA. monwealth Fund, Canada is third from the The most important of these principles is, bottom, above only France and the United of course, universality: each province’s plan has to be “available” to all residents “on equal terms and conditions.” In the past, some ÅKE BLOMQVIST is an adjunct research professor at provinces interpreted this as allowing them Carleton University in Ottawa and health policy scholar at the C.D. Howe Institute in Toronto. to charge everyone a premium as a condition

14 The Milken Institute Review The CHA requires the plans to cover the entire cost of insured physician and hospital services — but it does not explicitly include other key health care items, notably pharmaceuticals, long-term care and dentistry. of coverage. But today the plans are financed drug costs for specific demographic groups, entirely out of provincial and federal govern- but in most provinces these plans are not yet ment revenue, so every resident is automati- universal. And even though many Canadians cally covered at no direct cost. have private insurance for these add-ons, sub- The CHA also requires the plans to cover stantial numbers go without pharmaceutical the entire cost of insured physician and hos- coverage – or insurance for dental, vision and pital services – that is, there can be no co-pays. mental health care. But it does not explicitly include other key The CHA further stipulates that a prov- health care items, notably pharmaceuticals, ince’s insurance plan must be “publicly ad- long-term care and dentistry. For this reason, ministered.” It is clear from the language in the coverage that it prescribes is sometimes the act that this refers only to the administra- referred to as “deep but narrow.” tion of the insurance plan, not to the provi- Many provinces have separate insurance sion of the services that are covered under the plans that pay for part or all of the prescription plan. And, in contrast to, for example, Britain,

Fourth Quarter 2017 15 canada’s health care a canadian system for america? most health services in Canada are, indeed, If you ask the average Canadian to describe private. As in the United States, almost all phy- the main differences between the Canadian sician services are supplied by doctors in pri- and American insurance systems, you’ll get a vate practice, who usually are paid by the two-pronged answer. First, the United States provincial insurance plans on a fee-for-service does not have a government program that basis. Hospitals are classified as private institutions, although almost all are operated as nonprofit agencies. In contrast to the United States, the funding of Canadian hospitals through provincial insurance mostly is still in the form of annually negotiated global budgets. Re- cently, though, some provinces have been ex- perimenting with activity-based funding much like the Diagnosis-Related Group method used by Medicare in the United States, which classifies services into some 500 categories for reimbursement. As noted, the “accessibility” clause in the CHA stipulates that the provincial plans cannot charge user fees. It also contains rules that implicitly prevent doctors and hospitals from “extra billing” – that is, from requiring patients to top up the payments they receive from the provincial plans. The core of the Canadian universal single-payer health care system, therefore, is tax-financed government insurance that automatically covers every resident guarantees universal access. Second, almost for the full cost of any medically necessary all health care is paid for privately, out of pa- physician and hospital service. tients’ own pockets or from their private in- It is a single-payer system in the sense that, surers. The first part of the answer is right, for the doctors and hospitals that treat in- but the second is decidedly not. sured patients, the provincial insurance plans According to the OECD, governments are generally their only source of income. (federal, state, local) in the United States cur- The reimbursement structure is determined rently pay for close to half of all health care. in centralized negotiations between provin- Most of it comes through the federal Medi- cial governments and provider organizations. care program, which covers every American Most provinces have rules that prevent, or at aged 65 or over, or from state-based Medicaid least discourage, these providers from sup- plans for low-income households that are plying services that are privately paid for. By jointly funded by the states and the feds. The the same token, the provinces discourage the government share in Canada is higher, of sale of private insurance policies that cover course. But not much higher, since a range of services included in the government plan. health-related costs are not covered by the

16 The Milken Institute Review public plans. In recent years, the figure has why the canadian system been around 70 percent. is not ideal To transform the U.S. system into a version But just because the American system could of the Canadian single-payer model, the first be converted to a Canadian-like system step would be to create a single government- doesn’t mean it should be. And I suspect that funded insurance plan that would automati- most Americans, even among those who are cally cover every American. In principle, this eager to make coverage universal, would view could be done either at the federal level by ex- a made-in-Canada model as unrealistic in panding Medicare so that it covered everyone political terms and unlikely to work well in (not just the elderly) or at the state level by practice. I share their skepticism.

I suspect that most Americans, even among those who are eager to make coverage universal, would view a made-in-Canada model as unrealistic in political terms and unlikely to work well in practice.

expanding Medicaid to become a universal Yes, all Canadians are insured. But the sys- program. The latter approach would create a tems in many other affluent countries also system similar to the Canadian model in that offer this advantage, and, in my view, interna- there would be a network of state-adminis- tional rankings such as those by the Com- trated plans, rather than a single nationwide monwealth Fund and others are right when plan. they suggest that the Canadian model doesn’t As in Canada, one would then expect a de- measure up to the best of them. gree of federal-state cost-sharing, with states By definition, a system in which all physi- being compensated with additional revenue cian and hospital services are financed transfers for taking on the responsibility of in- through a single government plan implies a suring the elderly who are covered under monopoly in the financing market. Since it is Medicare in the current system. The federal- a government monopoly, it will not exploit its state transfers would presumably be condi- market power to enrich private shareholders tioned on state plans’ meeting certain common (there aren’t any). But while elected politi- standards along the model of the CHA in cians have incentives to please both taxpayers Canada. But that’s hardly a stretch: the fund- and patients in managing the monopoly, they ing of state Medicaid plans already follows are surely influenced by provider interest this model. Nor, at least conceptually, would it groups representing everyone from physi- be hard to set common standards to include cians to nurses to hospital administrators to universal coverage, an end to premiums and drug companies. co-pays, and regulation making it difficult to In Canada, several of these groups are orga- provide or receive medical care outside the nized to bargain over compensation. And state-financed system. While decentralization there is no invisible hand of the market to might allow for some variations by state, ev- balance their interests against those of pa- eryone, rich and poor, would be entitled to the tients and taxpayers or to minimize resource same care. waste. Fee and wage settlements have typically

Fourth Quarter 2017 17 resulted in periods of rapid growth in spend- Attempts to end the stop-go cycle in health ing followed by gradually deteriorating quality spending and make the system more efficient of care as the provinces scramble to contain have been opposed by provider groups be- costs and the wrath of taxpayers. Episodically, cause change is seen as a threat to their in- hospital emergency departments become comes and working conditions. The sense overcrowded, waiting lists for non-priority that the system is in disrepair and incapable surgeries grow longer, and so on. According to of fixing itself has contributed to the low the Fraser Institute, wait times for certain rankings that Canada has received in interna- kinds of medically necessary surgery reached tional comparisons. Meanwhile, the inability record lengths in 2016, averaging 20 weeks. to check costs is also widely cited for the slow (The Fraser Institute, it should be noted, is no pace in broadening universal coverage to in- friend of the single-payer system, but its data clude pharmaceuticals. on wait lists are widely cited in Canadian Of course, the United States and Canada media.) operate in very different political environ-

18 The Milken Institute Review ments. In Canada, provincial governments’ everyone is automatically covered by the Na- bargaining positions have been weakened by tional Health Service, which functions as both recent Supreme Court decisions that have payer and provider, residents can buy private strengthened the position of unions in the insurance to help pay for care from privately public sector. While provincial medical asso- practicing doctors and private hospitals. ciations are not classified as unions, physi- In Canada, the monopolies of the provin- cians’ fees are nevertheless determined in cial health insurance plans are reinforced by a collective bargaining between doctors and plethora of rules. It is illegal – or, at best, un- the provincial governments. And in several attractive – for private insurers to cover the provinces, most recently in Ontario, doctors cost of services otherwise available through have won the right to binding arbitration if the provincial plans. Other regulations pro- an agreement cannot be negotiated. hibit or discourage doctors from supplying With state and federal governments in the services outside the provincial plans. United States operating under different rules, Rules to restrict private insurance and in- it is conceivable that they would be better dependent practice may have been necessary able to contain the influence of key interest to overcome physicians’ resistance, which was groups, allowing them to run a single-payer initially strong. There was even a doctors’ system more efficiently than has been possi- strike in Saskatchewan – when universal gov- ble in Canada. Moreover, an American single- ernment insurance was introduced. Today, payer model could be designed to allow however, universality is not under threat, so federal and state officials to collaborate more the rules now largely serve to eliminate choice effectively in financing and managing the sys- and competition on behalf of a system that tem than has been possible in Canada. does not need protection. Nevertheless, many There, a lot of political capital has been Canadians strongly support them on equity wasted in negotiations about how health care grounds. When the only health care available costs should be shared rather than expended is what is offered through the provincial on reforms that could increase the system’s plans, everyone who is sick will receive the bang for a Canadian dollar. But effective con- same care, regardless of ability to pay. More- trol of interest group influence, and intergov- over, requiring everyone to get care through ernmental collaboration in the broader public the plans is seen as indirectly helping the poor interest, are tall orders anywhere. On balance, get quality service by tying their interests to switching to a single-payer approach would those of the middle class. be a highly risky bet. The support for these principles is strong, even among government officials who have so, what are the alternatives? devoted considerable legal resources to de- A single-payer system may be the most direct fending them in cases in which doctors/pa- route to universal coverage, but universality tients have challenged the rules because they could be (and has been) attained even in sys- wanted to supply/receive private care. Wealthy tems in which there are multiple plans and cit- patients can, of course, seek care in the United izens have some degree of choice with respect States or any of a dozen other countries. And to insurance. Examples of countries that op- some do, especially when waiting lists for sur- erate this way include Switzerland, the Neth- gery and diagnostic tests in their home prov- erlands and Australia. Even in Britain, where inces become long. But as travel for foreign

Fourth Quarter 2017 19 canada’s health care ideologues attempting to roll back the Medic- country care entails high out-of-pocket costs aid expansion and subsidies for private insur- and inconvenience, the number of people ance initiated by Obamacare have met so willing to use this escape hatch remains small. much opposition suggests that the appeal of It is hard to tell to what extent the lack of universality is too strong to resist indefinitely. competition from private insurance or inde- The path is not yet clear, but the direction of pendent providers has contributed to the me- change is. A half-century ago, after all, Medi- diocre performance of Canada’s health care care was denounced as “socialized medicine” system in international rankings. (In a recent and only narrowly became law. Now, it is far one, Canada is ranked no better than 9th out too popular to touch. A half-century ago, Medicare was denounced as “socialized medicine” and only narrowly became law. Now, it is far too popular to touch.

of 11 in the subcategory of health care out- Canada’s single-payer model is universal comes.) But it is a fact that none of the coun- (if not fully comprehensive in what it covers). tries that are ranked above it follows a And it is much less costly than the current U.S. single-payer model that is as strict as the Ca- hybrid system, in part because it reduces ad- nadian one. In Switzerland and the Nether- ministrative costs and eliminates marketing lands, coverage is universal, but residents outlays. But these virtues don’t constitute a have a choice among many plans that com- good enough reason to focus long-term re- pete in various ways. In Australia, all residents form efforts on replicating it south of the are automatically covered by a state plan sim- border. In my view, the negative consequences ilar to the Canadian provincial plans. But of monopoly, in terms of efficiency and in- Australians are allowed to buy private insur- centives for innovation, are pretty serious ance that covers treatment in the country’s drawbacks, especially when better options are many private hospitals. Those who choose available. this path receive a subsidy from the govern- It’s hard to imagine a scenario in which ment to offset a portion of the premiums. America would make an overnight about-face Most Canadians who support that coun- and adopt a universal system, even one that try’s single-payer system probably do so be- contained strong elements of competition cause they believe that it both saves money along the lines of, say, Switzerland or Austra- and improves the welfare of low-income lia. But if the structure of the Affordable Care households. It does both these things – pro- Act is left intact, incremental reforms might vided the benchmark for comparison is the ultimately lead to universal coverage without U.S. system. But why limit oneself to that any one insurer dominating the market. If oddly narrow view of the world? that were to happen, one might even imagine a day in which Canadians look to the United what the united states should do States for inspiration in reforming their own While the United States remains the only ad- system. Or at least (if you find that hard to vanced country that still cannot claim univer- swallow) look more sympathetically at

sal coverage for its residents, the fact that models such as Australia and the like. images joecicak/getty

20 The Milken Institute Review With the United States in the vanguard, rich industrialized countries have laid siege to the barriers that inhibit cross-border flows of goods, services and capital for the past half-century.

Oh sure, organized labor and the industrial heartland fought a delay- ing action. And more than once Wall Street nearly drowned as it took a cold shower in the tsunami of capital that churns international markets. But the near-consensus among policymakers and talking heads was that rapid globalization was both desirable and inevitable.

Now the inevitable part is open to question. Thanks to Brexit, the

European common market is about to become a lot less common.

Meanwhile, the Trans-Pacific Partnership, which was largely tailored to U.S. economic and political interests, was cancelled by the White

House without a second thought. And the new president seems determined to negotiate “better deals” on the free trade agreements signed with such fanfare over the past few decades.

Here, Brad DeLong of the University of California (Berkeley) and Dani Rodrik of Harvard, two political economists at the top of their profession, offer insights on how this could have happened — and how bruised but wiser policymakers might rebuild a liberal global economic order that is more inclusive and less vulnerable to populist rage. —Peter Passell

Fourth Quarter 2017 21 tk

22 The Milken Institute Review When Globalization Is Public Enemy Number One The rhetoric of economic protectionism is here, there and everywhere. But is globalization — the process by which trade in goods, services and capital, and the migration of people and ideas — really the cause of what ails? For that matter, what exactly is the ailment?

by j. bradford delong tk

Fourth Quarter 2017 23 The first 30 years after World War II saw the recovery and reintegration of the world economy (the “Thirty Glorious Years,” in the words of French economist Jean Fourastié). Yet after a troubled decade — one in which oil shocks, inflation, near-depression and asset bubbles temporarily left us demoralized — the subsequent 33 years (1984-2007) of perky growth and Tstable prices were even more impressive. This period, dubbed the “Great Modera- other than themselves or those who voted for tion,” was by most economists’ reckoning them. The media, including the fact-based largely the consequence of the process of media, tend to let elected officials set the knitting the world together. The mechanism agenda. (and impact) was largely economic. But the Hence it doesn’t take much of a crystal ball consequences of globalization were also felt to foresee a few decades of backlash to global- in cultural and political terms, accelerating ization in our future. More of what is made the tides of change that have roughly tripled will probably be consumed at home rather global output and lifted more than a billion than linked into global supply chains. Busi- people from poverty since 1990. nesses, ideas and people seeking to cross bor- So why is globalization now widely viewed ders will face more daunting barriers. as the tool of the sorcerer’s apprentice? I am Some of the consequences are predictable. somewhat flummoxed by the fact that a pro- The losses to income created by cross-border cess playing such an important role in giving barriers to competition will grow. And more the world the best two-thirds of a century ever of the focus of economic policy will be on has fallen out of favor. But I believe that most the division of the proverbial pie rather than of the answer can be laid out in three steps: how to make it larger. Small groups of well- • The past 40 years have not been bad years, organized winners will take income away from but they have been disappointing ones for the diffuse and unorganized groups of losers. working and middle classes of what we now Measured in absolute numbers, an awful call the “Global North” (northwestern Europe, lot of wealth will be lost. But those losses America north of the Rio Grande and Japan). won’t approach, say, the scale of the output • There is a plausible argument linking foregone in the Great Recession. Figure on a those disappointing outcomes for blue-collar 3 percent reduction in income, equivalent to workers to ongoing globalization. the loss of two years’ worth of growth in the • In any complicated policy debate that be- advanced industrialized economies. comes politicized, the side that blames for- Most well-educated Americans, I suspect, eigners has a very powerful edge. Politicians will either be net beneficiaries of the reshuf- have a strong incentive to pin it on people fling of income or won’t lose enough to notice. Disruption often redounds to the benefit of the sophisticated who can see it coming in BRAD DELONG is an economist at the University of time to get out of the way or turn it to their California (Berkeley) and creator of the blog “Grasping own advantage. But that’s a minority of the Reality.” He was deputy assistant secretary of the Treasury

in the Clinton administration. population, even in rich countries. Real fear tetra images previous page:

24 The Milken Institute Review GLOBALIZATION OVER THE CENTURIES 60%

55 1 First Globalization: 50 • Trade: capital and resource-rich • Migration: finance and labor to resource-rich 4 45 2 Retreat: • Faster progress in factories (mass production) than transport 40 • Demand management • Beggar-thy-neighbor 35 3 Second Globalization 2 30 • Trade: North-North intra-industry 4 Hyperglobalization 3 25 • Trade: North-South low-wage 1 • Production: intercontinental value chains 20

10 Upper bound 5

SUM OF WORLD EXPORTS AND IMPORTS AS SHARE OF WORLD GDP WORLD SHARE AS OF AND IMPORTS EXPORTS WORLD OF SUM Lower bound 0 1500 1600 1700 1800 1900 2011 source: OurWorldinData.org about where next week’s mac and cheese is In the years from 1800 to 1914, which I call going to come from applies for a tenth, while the First Globalization, world trade intensity fear about survival through the hard times is tripled, driven mostly by exchange between still a thing for a quarter of humanity. capital-rich, labor-intensive and resource-rich Why do I believe all this? Bear with me, for regions. Countries with both sorts of endow- my explanation demands an excursion down ments benefit by specializing production in the long and winding road of centuries of their areas of comparative advantage. Mean- globalization. while, huge migrations of (primarily) people and (secondarily) financial capital to resource- globalization in historical rich regions established a truly integrated perspective global economy for the first time in history. On the brilliant date-visualization website, The period from 1914 to 1945 saw a dra- Our World in Data, Oxford researcher Este- matic retreat, with the relative intensity of in- ban Ortiz-Ospina, along with site founder ternational trade slipping back to little more Max Roser, has plotted best estimates of the than its level in 1800. There are multiple, relative international “trade intensity” of the complementary explanations for this setback. world economy – the sum of exports and im- Faster progress in mass production than in ports divided by total output over a very long long-distance transport made it efficient to time. In my reproduction I have divided the bring production back home to where the years since 1800 into four periods and drawn demand was. The Great Depression created beginning- to end-of-period arrows for each. a path of least political resistance in which

Fourth Quarter 2017 25 governments sought to save jobs at home at gave them powerful comparative advantages the expense of trading partners. And wars in relatively narrow slices of manufacturing both blocked trade and made governments production in everything from machine tools leery of an economic structure in which they (Germany) to consumer electronics (Japan) had to rely on others. to commercial aircraft (the United States). This retrenchment, however, was reversed After 1985, however, there was a marked after World War II. The years 1945 to 1985 saw shift to what Ortiz-Ospina calls “hyperglobal- the Second Globalization, which carried trade ization.” Multinational corporations began intensity well above its previous high tide in building their international value chains the years before World War I. But this time, across crazy quilts of countries. The Global the bulk of trade growth was not among re- South’s low wages gave it an opportunity to source-rich, capital-rich and labor-intensive bid for the business of running the assembly economies exchanging the goods that were lines for products designed and engineered in their comparative advantage in production. It the Global North. Complementing this value- largely took place within the rich Global chain-fueled boost to world trade came the North, as industrialized countries developed other aspects of hyperglobalization: a global

communities of engineering expertise that market in entertainment that created the whitney times/redux curtis/the new york

26 The Milken Institute Review beginnings of a shared popular culture; a sound,” as factories, jobs and prosperity de- wave of mass international migration and the camped for Mexico. extension of northern financial markets to the But that did not happen. Only the most la- Global South, cutting the cost of capital and bor-intensive portions of automobile assem- increasing its volatility even as it facilitated bly moved to Mexico. And by moving those portfolio diversification across continents. segments, GM, Ford and Chrysler found themselves in much more competitive posi- hyperglobalization, up close tions vis-a-vis Toyota, Honda, Volkswagen and personal and the other global giants. Of these value-chain-fueled boosts to international trade, perhaps the first example was fear of globalization the U.S.-Mexico division of labor in the auto- Barry Eichengreen, my colleague in the eco- mobile industry enabled by the North Amer- nomics department at Berkeley, wrote that ican Free Trade Agreement of the early 1990s. there is unlikely to be a second retreat from The benefits were joined to the more standard globalization: comparative-advantage-based benefits of re- U.S. business is deeply invested in globaliza- duced trade barriers. At the 2017 Milken In- tion and would push back hard against any- stitute Global Conference, Alejandro Ramírez thing the Trump administration did that seri- ously jeopardized Nafta or globalization more Magaña, the founder of Cinépolis, the giant broadly. And other parts of the world remain Mexican theater group that is investing heav- committed to openness, even if they are con- ily in the United States, summed up the views cerned about managing openness in a way that of nearly all the economists and business an- benefits everyone and limits stability risks that alysts in attendance: openness creates. Between the U.S. and Mexico, trade has grown But I see another retreat as more likely than by more than six-fold since 1994 … 6 million not. For one thing, anti-globalization forces U.S. jobs depend on trade with Mexico. Of have expanded to include the populist right as course, Mexico has also enormously benefited well as the more familiar populist left. It was from trade with the U.S. … We are actually no surprise when primary contender Bernie exporting very intelligently according to the relative comparative advantage of each coun- Sanders struck a chord by condemning Nafta try. Nafta has allowed us to strengthen the and the opening of mass trade with China as supply chains of North America, and strength- “the death blow for American manufacturing.” ened the competitiveness of the region. But it was quite another matter when the lead- Focus on the supply chain reference. Back ing Republican candidate (and now presi- in 1992, my friends on both the political right dent) claimed that globalization would leave and left feared that Nafta would kill the U.S. “millions of our workers with nothing but auto industry. Assembly-line labor in Her- poverty and heartache” and that Nafta was mosillo, Mexico had such an enormous cost “the worst deal ever” for the United States. advantage over assembly-line labor in Detroit The line of argument is clear enough. Glo- or even Nashville that the bulk of automobile balization, at least in its current form, has manufacturing labor and value added was, greatly expanded trade. This has decimated they claimed, destined to move to Mexico. good (high-paying) jobs for blue-collar work- There would be, in the words of 1992 presi- ers, which has led to a socioeconomic crisis dential candidate Ross Perot, “a giant sucking for America’s lower-middle class. U.S. Trade

Fourth Quarter 2017 27 EMPLOYMENT SHARE IN think of as typically male and typically blue- MALE BLUE-COLLAR INDUSTRIES collar has been on a long downward trend. 35% Manufacturing, construction, mining, transportation and warehousing constituted nearly

30 one-half of nonfarm employment way back in 1947. By 1972, the fraction had slipped to Total one-third, and it is just one-sixth today. 25 But consider what the graph to the left does not show: the decline (from about 45 20 percent to 30 percent) in the share of these

Manufacturing jobs from 1947 to 1980 was proceeding at a 15 good clip before U.S. manufacturing faced any threat from foreigners. And the subsequent fall to about 23 percent by the mid-1990s took 10 place without any “bad trade deals” in the pic- ture. The narrative that blames declining SHARE OF PRIVATE INDUSTRY EMPLOYMENT INDUSTRY SHARE OF PRIVATE Construction 5 blue-collar job opportunities on globalization

Mining Transportation and Warehousing does not fit the timing of what looks like a 0 steady process over nearly three-quarters of 1972 77 82 87 92 97 2002 07 12 2017 the last century. Wait, there’s a second disconnect. Look at source: The author the way the declines in output divide among the sub-sectors (see page 29). Manufacturing Representative Robert Lighthizer buys this: was about 15 percent of nonfarm production Nafta has fundamentally failed many, many in the mid-1990s and was still about 14 per- Americans. … [Trump] is not interested in a cent at the end of 2000, even as trade with mere tweaking of a few provisions and a cou- Mexico and China accelerated into hyperdrive. ple of updated chapters. … We need to ensure Indeed, the bulk of the fall in “men’s work” that the huge [bilateral trade] deficits do not has been in construction, which represented 7 continue, and we have balance and reciprocity. percent of private industry production in It’s conceivable that the Trump adminis- 1997 and represents just 4 percent today. tration will yet pay homage to the post-World Warehousing and transportation have also War II Republican Party’s devotion to open taken a big hit in terms of proportion. trade. But it seems unlikely in light of the res- The biggest factors on the real production onance protectionism has had with Trump side over the past 20 years have not been the supporters. And if the Trump administration out-migration of manufacturing, but the de- proves not to be a bellwether on globalization, pression of 2007-10 and the dysfunction of it is surely a weathervane. the construction finance market that contin- ues to this day. the real impact of globalization Portions of the case against globalization the china thing have some traction. It is, indeed, the case that The case that the workings of globalization the share of employment in the sectors we have had a major destructive effect on the

28 The Milken Institute Review SHARE OF PRODUCTION IN MALE BLUE-COLLAR INDUSTRIES 110

Manufacturing 1997 ) 100

Transportation and Warehousing 80

Mining

Construction 60 INDEX OF SHARE OF PRIVATE INDUSTRY GROSS PRODUCT ( 100 = PRODUCT GROSS INDUSTRY INDEX OF SHARE OF PRIVATE 50 1997 98 99 2000 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 2016 source: The author employment opportunities of blue-collar the world. But some perspective is needed if men over the past two decades received a one is to allow the tale of the China shock to major intellectual boost from the research of influence thinking about globalization. David Autor, David Dorn and Gordon Han- Start with the fact that, in most ways, this son on the impact of the “China shock.” is a familiar story in the American economy One of their bottom lines is that the loss that long preceded the rise of China. Disloca- of some 2.4 million American manufactur- tion associated with the relocation of producing jobs “would have been averted without tion facilities is more damaging to people and further increases in Chinese import compe- places than incremental changes in produc- tition after 1999.” Moreover, the effects on tion processes, whether the movement is workers and their communities were dislo- across state lines or across continents. cating in a way in which manufacturing job When my grandfather and his brothers loss generated by incremental improvements closed down the Lord Bros. Tannery in Brock- in productivity not associated with factory ton, Massachusetts to reopen in lower-wage closings was not. South Paris, Maine, the move was a disaster The China shock was real, and its signifi- for the workers and the community of Brock- cance shouldn’t be discounted, especially in ton – and a major boost for South Paris. the context of a close presidential election When, a decade and a half later, my grandfa- whose outcome may have a large, enduring im- ther found he could not make a go of it in pact on the United States – and, for that matter, South Paris and started a new business in

Fourth Quarter 2017 29 public enemy # 1 was due to the government’s failure to prop- Lakeland, Florida, it was the workers and the erly regulate finance to head off the housing community of South Paris who suffered. meltdown, the subsequent failure to properly The fact that, in the case of globalization- intervene in financial markets to prevent de- driven dislocation, the jobs cross interna- pression, and the still later failure to pursue tional borders adds some wrinkles, but not all policies to rapidly repair the damage. of them are obvious. As demand shifts, jobs All that said, the connection between the vanish for some in some locations and open China shock in the 2000s and increasing for others in other locations. Dollars that in blue-collar distress in the 2000s on its face the past were spent purchasing manufactures lends some plausibility to the idea that glo-

Globalization has had only a minor impact on the long decline in the portion of the economy that makes use of high-paying blue-collar labor traditionally associated with men.

from Wisconsin and Illinois and are now balization bears responsibility for most of spent purchasing manufactured imports their distress, and needs to be stopped. from China do not vanish from the circular flow of economic activity. The dollars re- the globalization balance sheet ceived by the Chinese still exist and have Last winter, in a piece for vox.com, I made value to their owners only when they are used my own rough assessment of the factors re- to buy American-made goods and services. sponsible for the 28 percentage point decline Demand shifts, yes – but the dollars paid in the share of sectors primarily employing to Chinese manufacturing companies even- blue-collar men since 1947. I attributed just tually reappear as financing for, say, new 0.1 percentage points to our “trade deals,” 0.3 apartment buildings in California or to pay points to changing patterns of trade in recent for a visit to a dude ranch in Montana or even years (primarily the rise of China), 2 percent- to buy an American business that otherwise age points to the impact of dysfunctional fis- might close. GE, which had been openly seek- cal and monetary policies on trade, and 4.5 ing a way to offload its household appliance percent to the recovery of the North Atlantic division for many years, sold the business to and Japanese economies from the devasta- the Chinese firm Haier, the largest maker of tion of World War II. I attributed the remain- appliances in the world. How different might ing 21 percentage points to labor-saving the world have been for the employees of technological change. White-Westinghouse who were making appli- This 21 percentage points has very little to ances if a Chinese firm had been trolling the do with globalization. Yes, with low barriers waters for an acquisition before the brand to trade, technology allows foreign exporters disappeared for good in 2006? to make better stuff at lower cost. But Ameri- Only with the coming of the Great Reces- can producers have the parallel option to sell sion do we see not blue-collar job churn but them better stuff for less. And thanks to tech- net blue-collar job loss in America. And that nology, consumers on both sides get more

30 The Milken Institute Review good stuff cheap. Economists slaving away in disappear because financial flows have been musty offices can invent scenarios in which withdrawn at the behest of the sinister gnomes technological change favors foreign produc- of Zurich or some other tribe of rootless cos- ers over their American counterparts and mopolites. thereby directly costs blue-collar jobs. But the Dealing with these hard to define, some- assumptions needed to get that result are times conflicting claims to rights beyond highly unrealistic. property is one of the major political-rhetor- To repeat, because it bears repeating: glo- ical-economic challenges of every society that balization in general and the rise of the is not stagnant. And blaming globalization Chinese export economy have cost some for the unfulfilled claims of this group or that blue-collar jobs for Americans. But globaliza- is a very handy way to pass the buck. tion has had only a minor impact on the long The good news is that, whatever the merits decline in the portion of the economy that of the grievances of those who see themselves makes use of high-paying blue-collar labor as losers in a globalizing economy, sensible traditionally associated with men. public policy could go a long way to making them whole. Three keys would open the lock: why is this view so hard to sell? • The failure of regional markets to sustain Pascal Lamy, the former head of the World good jobs could be managed by much more Trade Organization, likes to quote China’s aggressive social-insurance – unemployment, sixth Buddhist patriarch: “When the wise moving allowances, retraining and the like – man points at the moon, the fool looks at the along with the redistribution of government finger.” Market capitalism, he says, is the resources to create jobs where they have been moon. Globalization is the finger. lost. In a market economy, the only rights uni- • More aggressive fiscal measures to keep versally assured by law are property rights, job markets tight. and your property rights are only worth • Karl Polanyi’s key remains at hand, too. something if they give you control of re- While many Americans claim to worship at sources (capital, land, etc.) – and not just any the altar of free markets, they still believe that resources, but scarce resources that others are they have all kinds of extra socioeconomic willing to pay for. Yet most people living in rights – to healthy communities, to stable oc- market economies believe their rights extend cupations, to appropriate and rising incomes far beyond their property rights. – that are not backed up by property rights. The way mid-20th century sociologist Karl Governments could intervene on their behalf. Polanyi put it, people believe that they have That way lies tyranny, we’ve been told, but rights to land whether they own the land or also very high-functioning social democracies not – that the preservation and stability of like Sweden, Germany and the Netherlands. their community is their right. People believe The bad news, of course, is that the public that they have rights to the fruits of labor – policies needed to soothe the grievances that if they work hard and play by the rules blamed on globalization seem further out of they should be able to reach the standard of reach today than they were decades ago. Prob- living they expected. People believe that they ably the best one can hope for is that the fever have rights to a stable financial order – that subsides sufficiently to allow for a realis- their employers and jobs should not suddenly tic debate over who owes what to whom.

Fourth Quarter 2017 31 The Trouble With Globalization Undermined by the false narratives that have destabilized it, globalization is at risk.

by dani rodrik

Electorates around the world were told not only that globalization was inevitable, but also that it necessarily took the particular form they were witnessing. The nation-state, it was said, was the enemy of globalization, and therefore had to get out of the way. Globaliza- tion required ever-stronger global rules mandated by trade agreements, multilateral organizations and international networks of regulators. But not to worry: it would promote economic progress and political harmony, even if not for everyone right away. None of this was quite true. There is nothing inevitable about advancing economic integration, nor about the route that globalization takes if it does move forward. And contrary to conventional wisdom, nation-states are absolutely essential to globalization because they provide the public services ranging from law enforcement to macroeconomic stabilization that are needed for open markets to thrive. By the same token, global governance is largely superfluous: proper trade, financial, monetary and regulatory policies required to sustain an open world economy do not require much coordination when governments do their jobs well. tk

32 The Milken Institute Review tk

Fourth Quarter 2017 33 globalization trouble the world economy. To this day, despite rising Consider, too, the idea that nations needed populism, international trade is not a very to shape up to benefit from integration. This contentious issue in Europe. Anti-globaliza- transformed globalization into an end rather tion ire focuses not on Chinese or Mexican ex- than a means. The right and the left differed porters, but on faceless bureaucrats in Brussels on the regimen needed. The right emphasized and Frankfurt – and, of course, on immigrants. getting the investment environment right: The United States, too, could have moved ag- cutting red tape, for instance, and reducing gressively to compensate dislocated workers corporate taxes. The left talked about invest- in the 1990s, when it opened its economy to ment in skills, education and infrastructure. imports from Mexico, China and other low- But in both cases, globalization was assumed income countries in a major way. Instead, to be the goal, not the route to the goal. under the sway of market fundamentalists, the Now, globalization certainly has generated United States let the chips (and workers) fall benefits. The professional, managerial and where they may. capitalist class of the advanced economies – By now, the compensation approach has those who were already doing quite well – been tarred as “burial insurance.” The trade gained tremendously. Just as important, so adjustment assistance programs that are ha- did hundreds of millions of underemployed bitually tacked on to trade agreements have poor people in China and elsewhere (but provided inadequate aid – and to just a sliver mostly in Asia) who found jobs in production of the affected population. That is partly by for export markets. But look closely at China design: politicians have little incentive to im- and other East Asian countries that did so plement strong compensation programs once well and you discover that they played the trade agreements are approved. globalization game by different rules. They American workers have been the weak opened their markets only partially, govern- party in the bargain all along – if they’d had ing the pace and impact of economic integra- enough clout to obtain a robust safety net, tion with interventions ranging from they would have had the clout to reshape subsidies for favored industries to controls trade agreements in worker-friendly ways in over cross-border capital flows. the first place. Where compensation has The populist backlash epitomized by Don- worked – as in Europe – it has been part of a ald Trump’s election victory but brewing since broader settlement between business and or- the 1980s has convinced even globalization’s ganized labor in which workers accept the cheerleaders that some things must change. sort of labor-market instability that is part Elites now concede that globalization pro- and parcel of open trade in return for the duces losers as well as winners. But the correct welfare state. response, they argue, is not to change course In my view, if globalization is to be saved, with globalization; it is to ensure that the los- it won’t be by renewed promises of handouts ers are compensated. or training in computer programming and The logic of sustaining an open economy by other skills. What’s needed is a significant compensating those who end up with smaller change in direction. And fortunately, it really slices of the pie is impeccable. That’s how Eu- would be possible to preserve globalization’s ropean nations, with their extensive safety nets economic benefits and make it fairer at the

and generous social benefits, integrated into same time. There are many promising paths brenner/the times/redux new york previous page:tom

34 The Milken Institute Review that prevailing narratives have led us to over- work environment, employment security, look. In particular, we need to rebalance pol- voice in the workplace, bargaining rights – are icies toward global economic integration in scarcely paid lip service. The implicit economic three areas: from capital and business to labor model is based on the trickle-down effect: the and the broader society, from global gover- benefits to investors will spill over to society in nance to national governance, and from areas the form of better jobs and tax revenues. in which overall economic gains are small to Hence globalization has taken a skewed where they are large. form. It’s all about reducing the costs of doing business across borders and facilitating cross- from capital to labor border capital flows. The World Trade Orga- The benefits of globalization are distributed nization and the International Monetary unevenly because our current model of global- Fund command all the attention and carry ization is built on a corrosive asymmetry. Trade the big sticks, while the International Labor agreements and global regulations are de- Organization is merely a talking shop. signed largely with the needs of capital in mind. Trade agreements are driven overwhelm-

kai kai nedden/laif/redux The interests of labor – good wages, decent ingly by a business-led agenda. Protection of

Fourth Quarter 2017 35 globalization trouble across national borders, while labor is not. We property rights of investors, even when rights regard this as a natural feature of the world are nebulous (as in the case of intellectual economy, even though it is a consequence of property rights), is the first priority. Investor- our own policy choices and there is nothing state dispute settlement, which allows busi- natural about it. During an earlier era of glo- nesses to sue national governments before balization, at the tail end of the 19th century, international arbitration tribunals, has be- people were relatively free to move to coun- come ubiquitous. It is purportedly about en- tries where there were better economic oppor-

suring that governments live up to their own tunities – and they did so in great numbers. laws and commitments and do not take ad- Moreover, free movements of capital have vantage of foreign firms. But why is the privi- not always been in fashion. At the end of lege of seeking redress through international World War II, economists and policymakers arbitration granted only to firms and foreign were unanimous in regarding capital mobility investors? Why not have similar international – anything other than long-term direct busi- tribunals in which labor (or consumer) groups ness investment – as inherently destabilizing can challenge violations of core labor rights or and inimical to macroeconomic manage- consumer safety laws by trade partners? ment. By the 1990s, however, international A striking reflection of the asymmetry is capital mobility had become the global norm,

that capital and business are free to move enshrined in the practices of the OECD and fotostock mazzarini/age g.

36 The Milken Institute Review the IMF, while labor mobility remained Giving labor a bigger say would not neces- highly restricted and regulated by vastly dif- sarily produce greater worker mobility across ferent domestic laws. borders; workers in advanced and poor na- Differential mobility produces a wide tions have conflicting interests. But it might range of distributional effects that advantage at least lead to the rejection of the current capital and disadvantage labor. Most obvi- norm in which capital is globally mobile ously, investors and highly skilled profession- while labor is not. I believe this norm should als can benefit from higher returns on the be replaced by the idea that capital and labor other sides of borders; the vast majority of mobility must go hand-in-hand, with the de- workers cannot. And this in turn has implica- gree of overall mobility determined by other tions for bargaining between labor and capital. policy considerations. At present, capital is The threat of leaving or outsourcing can too mobile, while labor is not nearly as mo- force labor to take a pay cut or a smaller wage bile as it should be. So such a rebalancing would be a good thing – and for efficiency as well as for distributional reasons. A striking reflection of the corrosive asymmetry is that from global governance to national governance capital and business are free to While national economies are linked in a vari- move across national borders, ety of ways, the world economy is not a global commons and therefore does not need global while labor is not. governance in order to be managed effectively. Indeed, most failures in the world economy increase. Hence the global trend toward lower are rooted in failures of domestic governance. labor shares of total income. Capital mobility Therefore, the best fix for the global economy makes it more difficult to tax capital – and on is better domestic governance. the flip side, creates greater incentives to sub- This assertion certainly runs against the sidize it in order to bring it home. Hence the tide, but does follow directly from the eco- global reduction in corporate tax rates and nomic doctrine that underpins globalization: competition for investment. Finally, differen- the mutual gains from trade. As David Ri- tial mobility means that economic risk is cardo, the influential British political econo- borne disproportionately by the immobile mist, showed long ago and generations of factor, labor. Economic downturns mean economists have professed since, nations long spells of unemployment and wage cuts, trade because it is in their own interest. Com- while investors are partially protected by their parative advantage – the market-driven pro- global diversification. cess by which economies specialize in what To right the capital-labor imbalance, labor they do or make relatively well – generates must be given an equal say in setting the rules gains from trade for both parties. The point of globalization. In practical terms, this of opening up to trade is not to confer eco- requires reconsidering which multilateral in- nomic benefits on other nations, but to im- stitutions set the agenda of the global conver- prove your own lot. Of course, trade generates sation and who sits at the bargaining table losers in a variety of ways as production is when trade agreements are negotiated. dislocated. But trade is not different in that

Fourth Quarter 2017 37 globalization trouble same special interests that dominate domestic respect from technological progress. Well- policymaking as well. Think of the role of big functioning societies find ways of reaping the banks in setting global minimum capital stan- overall benefits by bringing the losers along. dards or pharmaceutical companies in writing Consequently, failure to adopt open-trade global patent rules. policies must be due either to complications Similar reasoning applies in other realms that undermine the standard Econ 101 argu- of international economic policy. Appropri- ment for the gains from trade, or to domestic ate prudential regulation for financial mar- policy failures. The former arises when eco- kets and sound fiscal and monetary nomic or social considerations render open management are good for the home economy. trade less than optimal. For example, society When policy fails in these areas, it is usually may value environmental amenities (say, not because one country is putting its inter- clean air) or distributional outcomes (maybe ests above others (i.e., beggar thy neighbor), Failure to adopt open-trade policies must be due either to complications that undermine the standard Econ 101 argument for the gains from trade, or to domestic policy failures.

generous blue-collar wages) that would be but for beggar-thyself reasons. Global gover- undermined by free trade, and it may not be nance sometimes can make things better by possible to offset the losses by other means. giving good-government types an advantage Consider, too, that a developing country (as in, “If we don’t do the right thing, the may benefit from sheltering infant industries World Bank won’t lend us money”). But there from foreign competition before it has devel- is no avoiding the fact that the problem is oped competitive means of production. In with domestic policy and politics. such instances, the rejection of free trade There are exceptional circumstances, of does not undermine productivity growth course, where national and global interests do from either domestic or international per- not coincide. spectives. Global agreements have no busi- Countries do sometime pursue mercantil- ness telling these countries to open up. ist policies that are of the beggar-thy-neigh- In the second case, domestic policy failure, bor kind. Thus contemporary Germany’s there is a genuine problem. But the problem suppression of wage growth in the name of lies in domestic politics – the excessive politi- boosting exports makes it that much harder cal influence, perhaps, of entrenched interests for less-productive Eurozone economies to like dairy farmers or automakers – and not in recover from the recession. And China’s the absence of proper global rules. (mostly indirect) subsidies to exporters in Empowering global governance in such order to accelerate growth did sometimes circumstances may or may not serve to man- come at the expense of efficient producers in age such rent-seeking. Global rules sometimes trade partners. But few of our major contem- act as a counterweight to protectionist inter- porary problems in global trade and finance ests. But it is equally likely that the global rules are of this type. Misguided protectionism, ex- will be written and administered by the very cessive fiscal austerity, inadequate financial

38 The Milken Institute Review regulation and poor property-rights protec- ity. If you do not respond to your constituencies’ tion are all beggar-thyself policies. expectations and aspirations, you are voted Economists often assume that global rules out. While plainly flawed, the democratic are more in control of technocrats and less state is tried and tested. Its global counter- prone to political manipulation than national parts are too distant from direct accountabil- ones. But even if that is true, it is not clear this ity and hence lack legitimacy. is an advantage. In fact, many of our existing None of this implies that there is no role modes of global governance – multilateral at all for global governance. But in rebalanc- agreements on everything from investment ing globalization toward national control, we regulations to codes of corporate responsibil- must understand that the highest priority of ity – raise troubling questions. To whom are global arrangements ought to be making the these mechanisms supposed to be account- nation-state work better, not weakening it. able? Where do these clubs of regulators, in Correspondingly, the appropriate role for ternational non-governmental organizations global institutions is to enhance key demo- or large firms get their mandates? What en- cratic norms of representation, participation, sures that the voice and interests of those who deliberation, rule of law and transparency – are less globally networked are also heard? without prejudging policy outcomes from In democratic nations, the electorate is the the perspective of the need to harmonize ultimate source of policy mandates and elec- cross-border policies.

roberto caccuri/contrasto/redux roberto tions are the ultimate vehicle for accountabil- Global conversations about the spillover

Fourth Quarter 2017 39 effects of domestic macroeconomic or regu- ing democracy at home rather than globaliza- latory policies are sometimes useful. Such tion per se. conversations can be helpful in reducing international misunderstanding about the ob- from places where net economic jective of policies and sometime in establishing gains are small to where they new behavioral norms. They can also facili- are large tate deal-making in cases in which it’s worth The argument for openness is that it produces enough for one country to pay off a second to efficiency gains and hence an expansion of stop acting in ways detrimental to the first – the total economic pie. It would stand to rea- say, by providing technology to reduce water son that negotiations on lowering trade barri- pollution that ends up downriver. ers should focus where these gains are largest But the presence of negative spillovers and domestic political costs and adverse dis- alone does not amount to a case for global re- tributional effects are smallest. Viewed from straints on domestic policy space. Nowhere is this perspective, our conventional agenda of it written that the economic interests of other globalization looks very curious. A lot of po- nations ought to take precedence over socio- litical capital is wasted on efforts that produce economic benefits to the home nation. Global little net gain, while areas in which net gains

arrangements should be focused on enhanc- could be huge remain untouched. joe raedle/getty images

40 The Milken Institute Review To see this, it helps to start with a basic Lorenzo Caliendo of Yale and Fernando Parro principle of public finance. A government- of Johns Hopkins uses all the bells and whis- imposed restriction on trade is like a tax – a tles of modern trade theory to generate an tax on imports. And the efficiency cost of a tax estimate of only a 0.04 percent gain in eco- rises disproportionately, with the square of nomic efficiency. You didn’t misread that: the rate of the tax. A tax that is twice as large four-hundredths of one percent! is four times as harmful to the economy in Nonetheless, Nafta shuffled a lot of income terms of efficiency; a tax that is four times as within the United States. The most careful large is 16 times as harmful. What this means analysis to date has been carried out by the is that a reduction in a barrier that is high pro- economists Shushanik Hakobyan of Fordham duces much larger gains than an equal reduc- and John McLaren of the University of Vir- tion in a barrier that is already low. ginia. They found that an “important minor- Redistribution of income and wealth, by ity” of U.S. workers suffered substantial contrast, creates linear effects. An equal re- income losses. A high-school dropout in heav- duction produces similar effects regardless of ily Nafta-impacted locales had eight percent- the initial height of the barrier that is imped- age points slower wage growth over 1990-2000 ing trade. compared to a similar worker in a region/sec- Now put these two realities together. The tor unaffected by Nafta trade. Wage growth in larger the amount of redistribution that is the most protected industries that lost their generated by trade opening per dollar of effi- protection fell 17 percentage points relative to ciency gain, the smaller the barriers that pol- industries that were unprotected initially. icymakers are going after. I have called this These are very large effects – especially ratio of redistribution per net gain the politi- when compared with the meager net benefits cal cost-benefit ratio of trade liberalization. noted above. Of course, there were plenty of After almost seven decades of trade negotia- big winners as well as big losers, which ex- tions and agreements, most barriers to trade plains why many corporations were in favor in industrial goods and agricultural products of the agreement. But in light of numbers have come down substantially. Chipping away such as these, it is not difficult to understand further at these barriers thus produces mod- why Nafta remains so politically charged after est net gains in efficiency accompanied by nearly a quarter-century. disproportionately large changes in income As tariffs came down, trade negotiations and wealth distribution. have evolved from a focus on direct barriers This might seem like a theoretical point at the border to indirect barriers linked to do- with little practical consequence. Not so. Con- mestic regulations (in areas like services, stan- sider the effects of the North American Free dards, patents and copyrights). Today’s trade Trade Agreement on the U.S. economy. When agreements aim at harmonizing these regula- the agreement went into effect in 1994, U.S. tions or reducing their impact so as to make barriers to Mexican imports were already it easier for firms to operate across markets. quite low. Not surprisingly, in light of the the- The costs to enterprises associated with oretical considerations above, subsequent regulatory divergence can sometimes be high. empirical analyses have found very small effi- However, unlike the case of barriers at the ciency gains for the United States: a sophisti- border, there is no general theoretical pre- cated academic study by the economists sumption that reducing or harmonizing

Fourth Quarter 2017 41 globalization trouble culated the height of the implicit barriers by these regulatory barriers enhances efficiency. estimating the income gains that would hypo- In many cases, the regulations exist to pro- thetically accrue to a worker who moved from mote social welfare (such as enhancing con- a developing nation to the United States. They sumer safety, internalizing environmental found, for example, that a Pakistani worker externalities or providing access for disadvan- would increase his income more than six-fold. taged groups). There is no reason to believe Putting it in terms used to measure barriers to that harmonizing them for the purpose of ex- goods and services, this means that in an open panding trade enhances overall welfare. The market, it would take a tax or tariff of 500 per- truth behind such negotiations is that they cent on worker income to deter voluntary serve the purpose of specific interest groups labor movement – vastly higher than anything that have managed to capture the process. in trade.

Rich and poor countries alike could benefit from a world trade regime with a lighter touch. Some of the most impressive growth miracles of the post-war era came to pass at a time when the WTO did not exist and multilateral constraints on trade barriers were limited.

The cost-benefit ratio of financial global- I have long argued for a temporary worker- ization looks even worse. Capital mobility has visa plan that would take advantage of such not only increased income inequality around unexploited gains. It would be administered the world but it has also increased the inci- bilaterally on the basis of specific home- dence and severity of financial crises. Its country quotas. To maximize home country vaunted benefit – promoting growth by trans- benefits and spread the gains around, the ferring savings from rich to poor nations – visas would be for a fixed period – say three to has not materialized. Indeed, capital often five years. The visas would not entail a path to flows uphill from poor country to rich. Yet citizenship, although guest workers would global officialdom spends inordinate effort have the full protection of the host country’s on harmonizing capital adequacy and other labor standards and regulations. prudential regulations on the discredited pre- A mix of sticks and carrots might be em- sumption that financial openness produces ployed to ensure the bulk of workers do choose large efficiency gains. to return to their home countries when their So where are the potential gains from glo- visas run out. For example, a portion of guest balization today? The political cost-benefit workers’ pay could be held in forced saving ac- ratio logic I outlined earlier suggests an easy counts, to be returned only upon repatriation. answer: where the barriers are really high. And The quotas of worker-exporting countries they are nowhere higher than in cross-border could be adjusted in relation to their success in worker mobility. Michael Clemens, an econo- attracting their workers back home. This mist at the Center for Global Development, would give home countries an incentive to pro- Lant Pritchett, the Harvard economist, and vide repatriation inducements, just as they now Claudio Montenegro of the World Bank cal- woo foreign investment and skilled expatriates.

42 The Milken Institute Review Expanding worker mobility across borders cies, patents and copyrights and capital-ac- in a negotiated, managed manner would pro- count management. For advanced economies, duce a large increase in the size of the eco- it means allowing greater scope for remedies nomic pie, both globally and nationally. Of against social dumping and unfair trade. course, it would also have some redistributive Overall, it requires a transition in global talks effects, especially in the short run. It would from “exchange of market access” to “ex- likely hurt some unskilled native workers in change of policy sovereignty.” the rich nations. But the political cost-benefit It really would be possible to design a ratio logic suggests that the redistribution global economic system that is simultane- we’d get (per dollar of efficiency gain) would ously attentive to the needs of developing and actually be comparatively small given the im- advanced economies. American progressives plicit height of current labor-mobility barriers. are unnecessarily stymied by this issue, wor- In addition, the guest workers would be em- rying that trade policies prioritizing the inter- ployed under domestic labor standards, rather ests of American workers would necessarily than home-country standards that are likely harm much poorer workers in the developing far weaker. This would remove an important world. In fact, rich and poor countries alike source of concern in host economies with re- could benefit from a world trade regime with gard to unfair trade and “social dumping.” a lighter touch. Some of the most impressive A second area where the efficiency gains growth miracles of the post-war era – Japan, from increased openness would be compara- South Korea, Taiwan – came to pass at a time tively large consists of reforms that would en- when the WTO did not exist and multilateral hance the legitimacy of the world trading constraints on trade barriers were limited. regime. For too long, trade negotiators have There is, of course, no guarantee that gov- operated in an “exchange of market access” ernments would use the maneuvering space mindset: you open your market, and in re- they are given to good effect. But at least they turn I will open mine. would not have the excuse that “globalization But openness is good for each (in terms of made me do it.” Domestic policy failures efficiency), regardless of what the other does. would be exposed for what they are. Even if one ignores the mercantilist orienta- tion that seems curious two centuries after eyes on the prize David Ricardo campaigned to eliminate tar- We should not reject globalization, but save it iffs on wheat, this approach has run its course. in a form that works better for more people. The binding constraint on global integration Economic integration has overshot in some today is not that it is insufficiently open. It is areas, such as financial globalization and reg- that too many people believe it is managed by ulatory harmonization. It has not gone far plutocratic elites for their own benefit rather enough in others, such as international labor than for the benefit of the majority. mobility. The debate we should avoid is This suggests the need for a hard look at whether globalization per se is good or bad. trade agreements and the World Trade Orga- The real question is how to rebalance it to give nization regime to remove intrusive rules that excluded groups greater voice, reconstruct so- limit the ability of nations to respond to do- cial compacts at home and focus our global mestic needs. For developing countries, it negotiations on areas where the potential means lifting restrictions on industrial poli- economic gains are still really big.

Fourth Quarter 2017 43 Squaring Dealthe by john kwoka illustrations by kris mukai

President Teddy Roosevelt’s “Square Deal” was founded on the “three Cs” – conserva- tion of natural resources, consumer protection and control of corporations. In his eight years as president, his administration brought a total of 44 antitrust suits for monopoly practices that harmed consumers. TR’s (Republican) successor, William How- ard Taft, brought 75 such suits. But that Progressive Era proved to be a high-water mark in monopoly control. And Pit stands in stark contrast to a contemporary corporate environment in which few large mergers and even fewer anticonsumer corporate practices are challenged in court.

44 The Milken Institute Review Fourth Quarter 2017 45 squaring the deal were analyzed by the regulators, why for the So it is noteworthy that in the past couple most part they were resolved without direct of years politicians from both parties, along challenge to the merger – and with what ulti- with many economists and certainly some mate effect. consumers, have raised their voices to com- As you’ll see, antitrust has, with time, nar- plain about the impact of growing market rowed its focus. It has reversed the Progres- power. In airlines and cable TV, beer and sives’ inclination to put the burden of proof pharmaceuticals, and (less visibly) industrial on corporations to show that increased con- chemicals, food processing and myriad other centration is benign. And it is resolving cases industries, the prices, choices and quality of in ways that have permitted consolidation goods and services have seemed to suffer. and more generally blurred its mission and Moreover, in addition to these market distor- agenda. tions, there is real concern that, as TR worried, While some changes made sense in light of market power is spilling over into political the evidence from economics, and many case- power, thereby threatening democracy. specific decisions may have seemed rational The Obama administration took notice of when examined out of the context of broader these trends, albeit belatedly. In April 2016, economic trends, their collective impact has the White House issued an executive order on been to significantly weaken Washington’s competition, preceded by a detailed issue brief role in promoting competition. Accordingly, from the Council of Economic Advisers titled reinvigorating antitrust would require a “Benefits of Competition and Indicators of sharpening of policy focus and a hardening Market Power.” The order set out a series of ac- of its edges – what I term, with a nod at TR, tions to be taken by executive branch agencies “squaring the deal.” to focus attention on competition concerns in all their diverse areas of responsibility. a mini-primer on merger policy This new support for competition is wel- United States antitrust law prohibits mergers come news, but raises troubling questions. and acquisitions where “the effect … may be How did we drift so far from the Progressive substantially to lessen competition, or to Era perspective? Why have concentration and tend to create a monopoly.” The idea is to tar- market power been allowed to grow? Why get market structures and business practices haven’t the antitrust agencies – the Antitrust that enhance market power, which is taken to Division of the Justice Department and the mean the ability to increase prices or other- Federal Trade Commission – been more suc- wise adversely affect market function by re- cessful in countering these trends? ducing quality or slowing innovation. Specific One way of learning what has happened is mergers are analyzed for their likely effects to take a close look at actual merger enforce- on market power using a variety of tech- ment in the present era. Here I review four niques for developing evidence and drawing major mergers over the past decade to see conclusions. what competitive issues they raised, how they Current practice is set out in the Horizon- tal Merger Guidelines, last issued by the FTC and the Department of Justice in 2010. Those JOHN KWOKA teaches economics at Northeastern guidelines describe a multistep process, first University. His latest book is Mergers, Merger Control and Remedies (MIT Press, 2015). defining the “antitrust market” within which

46 The Milken Institute Review the merging firms operate, then measuring threat of entry can limit pricing power; an- the effect of the proposed merger on concen- other is the potential for reducing production tration in that market, analyzing economic and distribution costs, which can increase the evidence about its likely effects on prices, and economy’s productive capacity and may lead evaluating the plausibility of offsetting fac- to lower prices for consumers. tors. One potential mitigating factor is ease of All that leaves room for interpretation, and market entry by would-be rivals, since the interpretation has evolved in important ways.

Fourth Quarter 2017 47 squaring the deal of United and Continental and of Southwest Today’s antitrust regulators rely less on broad and AirTran in 2010, and finally of US Air- measures of market concentration and more ways and American in 2013. on economic analysis specific to each pro- Approval of the US Airways-American posed merger. They strive to understand the merger was widely viewed as a turning point. exact mechanism of market power that might With airlines, antitrust analysis focuses on the be created by the merger. There is less atten- overlap of nonstop routes. Yet, despite their tion to the potential for collusion or coordi- huge sizes, US Airways and American had only nation among competitors. And there is less skepticism about the potential for efficiency oday’s antitrust regulators gains – and generally more inclination to ac- T cept arguments that market power will be rely less on broad measures of curbed by the potential for market entry. market concentration and more Enforcement is in the hands of the DOJ and the FTC. The two agencies are notified of on economic analysis specific mergers exceeding certain size thresholds – currently about 1,500 mergers annually. Of 12 to 15 such routes. The merger’s potential these, 50 or so go to full investigation, and impact on prices on these routes could be pre- more than three-quarters of those are subject dicted based on economic evidence regarding to some policy action. But those actions now the past effect of changing numbers of carri- overwhelmingly take the form of remedial ers serving a route and the presence of low- prescriptions rather than outright challenges. cost carriers (known to have especially large Mergers go forward subject to amendments, price effects) on the route. Against these were such as divestiture of stores or lines of busi- arrayed alleged benefits from increased con- ness, or agreement to specific limitations on nectivity (more ways to get from point A to conduct designed to minimize the anticom- point B), greater flight frequency and im- petitive impact of the merger. proved amenities (availability of backup aircraft, better airport facilities and so on). merger policy in practice The merging airlines asserted that in- A closer look at just a handful of cases cap- creased flight frequency and connectivity tures important changes in economic analysis were worth a great deal to passengers, out- and legal interpretation that have narrowed weighing any competitive harm. The DOJ ini- enforcement and facilitated consolidation. tially issued a complaint against the proposed merger, but then permitted it to go forward US Airways and American Airlines so long as the parties divested some takeoff A decade ago, the market for domestic air slots at National Airport in Washington and travel consisted of six major “legacy” airlines, gate and terminal space at a few other air- which existed before deregulation in 1978, ports where airline entry was impeded by plus a large low-cost competitor (Southwest) these constraints. and several smaller low-cost carriers (AirTran, In light of subsequent public dismay with JetBlue and Frontier, among others). In 2008, higher airline prices and declines in service, the DOJ approved the merger of Delta and many asked whether this focus on a relatively Northwest; this was followed by the mergers small number of overlapping routes fully ad-

48 The Milken Institute Review dressed concerns about the remaining carri- basis, the commission approved the merger. ers’ ability to coordinate their behavior more This resolution was tidy, but in the view of broadly, such as with respect to capacity or some did not resolve all competitive concerns. ancillary fees. Others asked about such mat- It seemed unlikely, for example, that an indus- ters as reduced competition on connecting try with a truly dominant firm would be as routes, or on non-route effects (such as re- competitive as one with three firms of similar duced competition for corporate accounts, size, even if directly overlapping assets were which are contracted regionally or nationally), divested. In addition, the 80 divested assets (drug lines) did not go to Novartis or to any to each proposed merger. There other single company, which would have increased the acquirer’s competitive muscle. is less attention to the potential Rather, they were scattered among 10 much for collusion or coordination smaller firms, further ensuring Teva-Aller- gan’s market dominance. And finally, there among competitors. was the sheer mathematical improbability that this package of 80 divestitures would fully or non-price effects (service quality, measured preserve the prior level of overall competition, in a variety of ways). Since the merger, these since that would literally require all 80 di- concerns have, if anything, increased – as have vested drug lines to succeed in the market. questions about the adequacy of a model for merger analysis that leads to this outcome. Ticketmaster and Live Nation Ticketmaster and Live Nation have long dom- Teva and Allergan inated distinct parts of the live music perfor- The 2015 merger of Teva and Allergan, pro- mance business. Ticketmaster sat astride the ducers of generic (out of patent) prescription market for ticketing services, while Live Na- drugs, stands out among the large number of tion was pre-eminent in concert promotion pharmaceutical mergers in the past 15 years. and concert venues. In 2008, after a contract Before the merger, Teva was the largest gener- dispute with Ticketmaster, which had been ics manufacturer with a portfolio of about servicing its venues, Live Nation started doing 410 drugs, while Allergan was the third largest its own ticketing and then offered the new with 370. The merger would transform the service to others. The owner of two major industry from what amounted to a “triopoly” venues quickly switched, threatening the loss (with Novartis, the second-ranked firm) to of a considerable part of Ticketmaster’s busi- one dominated by a single firm. However, the ness – at which point Ticketmaster offered to focus of antitrust attention was not this in- buy Live Nation. crease in overall concentration, but on spe- The antitrust issues seemed straightfor- cific overlapping product markets. ward: the merger would eliminate a significant The FTC identified some 80 drugs manu- new competitor in ticketing services, the first factured by both companies and insisted on di- in a generation, and so seemed a clear threat to vestiture of one of the two overlapping competition. It would also solidify the “verti- products in each category. In this fashion, it cal chain” by combining Ticketmaster’s domi- reasoned, the number of independent suppli- nant ticketing services and leading artist ers of each drug wouldn’t change – and, on that management company, with Live Nation’s

Fourth Quarter 2017 49 squaring the deal pacity constraints on their networks, allowing parallel position in venues and in promotion. them to compete more vigorously with third The parties claimed this vertical integration parties and driving down prices in their ser- would yield various efficiencies and new tech- vice markets. They further argued that their nologies. But others were concerned about customer bases were not all that similar, that the combined company’s ability to leverage there were many regional competitors to its dominant businesses. choose from and that their different pricing For example, an independent venue owner and other practices would prevent any post- that needed Ticketmaster’s ticketing services merger coordination. might find itself pressed to book artists man- Telecom and related mergers are reviewed aged by the combined company. Independent by the Federal Communications Commission promoters, for their part, were concerned that as well as by the DOJ. In this case, the FCC Ticketmaster’s information on their custom- determined that the parties’ efficiency argu- ers could be used by the combined company ment was specious, with cost savings resting to steal their business. on implausible assumptions. In addition, the The DOJ nonetheless approved the merger, agency concluded that their economic model albeit subject to a complicated remedy. The was flawed, both because of the unrealistic horizontal market concern – that Live Nation cost-savings estimates and because it relied was being eliminated as a competitor in tick- on misleading data. The FCC signaled its op- eting services – was addressed primarily by requiring Ticketmaster to license its technology to a large concert promoter so as to per- mit it to get into the ticketing business. But the licensee promptly abandoned the technology, and, eight years later, Ticketmaster remains dominant in ticketing services. The DOJ order also sought to prohibit the combined company from exploiting its vertical integration – for example, by demanding that independent rivals utilize more of its businesses than they might want, or by trans- ferring data from ticketing services to non- ticketing parts of the integrated company. Skeptics noted that these provisions seemed easy to evade and unenforceable, ultimately offering little protection to independents.

AT&T and T-Mobile The antitrust review of the 2011 proposed merger of AT&T and T-Mobile, two of the four wireless carriers with national networks, offers a useful contrast. The parties claimed that the merger would alleviate bottleneck ca-

50 The Milken Institute Review position to the merger, as did the DOJ – at avoid outright challenges, finding reasons to which point the parties abandoned it. clear mergers when accompanied by ever- The upshot of this merger-that-did-not- more-elaborate remedies. In these respects, happen was the preservation of an industry they are apt examples since this trend cap- with four national network players – and in tures much of what has happened to policy. particular of a company (T-Mobile) that would The FTC’s own data show striking changes go on to play the role of the maverick for years in its enforcement record. While the agency to come. After the merger collapse, T-Mobile has consistently challenged mergers at the upgraded its network, marketed a fuller line of highest concentration levels, in the mid-to- handsets and initiated aggressive pricing and high range of concentration just below it had service bundling practices. The other three been reducing enforcement for at least 15 major carriers had to respond, meaning that all years. Whereas beginning in 1996 it challenged wireless consumers benefited from the compe- 36 percent of mergers with five-to-eight sur- tition that T-Mobile brought to this market. viving competitors, by 2008 it had ceased enforcement actions against such mergers the upshot altogether. There were literally no court chal- These four cases can hardly capture an entire lenges and no approvals subject to remedies era of merger policy. They do, however, sug- of any type in the 2008-11 reporting period gest that regulators have been inclined to for mergers that left at least four firms in the

Fourth Quarter 2017 51 squaring the deal duced opportunities for entry by business game. In that range, mergers got a free pass. start-ups, to increased income inequality and Without knowing more about the specific to the concentration of political power. cases, it is impossible to determine how many Increased economic concentration is cer- of these approvals were problematic in terms tainly not the only cause of these ills. On the of impact on competition. But as it happens, other hand, there is little evidence suggesting there is now some evidence on this question – that greater concentration actually favors eco- although for a different set of mergers. In my nomic and social goals like rapid technologi- own research, I have compiled a database of cal change and easy entry to markets that all the high-quality economic studies of spe- virtually everyone claims to support. It would cific mergers and their outcomes. be fair to say that the retreat of antitrust has I found that, on average, they have resulted contributed directly to rising concentration in price increases of about 7 percent, with and higher prices, and in so doing indirectly more than four-fifths of them producing some to other unwelcome outcomes. price increase. Mergers have generally been anticompetitive, and antitrust remedies have merger policy: squaring the deal not been much help. Divestiture remedies The adverse effects of concentration, ranging analogous to that used in Teva-Allergan, for from the price effects to broad concerns example, have resulted in price increases about political power, are very much the is- greater than 5 percent, a bit less than for merg- sues that prompted Teddy Roosevelt to un- ers overall but hardly consistent with the claim dertake his aggressive antitrust policy more that they would preserve competition. Even than a century ago. Few doubt what his view more troublesome, conduct remedies are as- of present antitrust policy would be. sociated with price increases of about 13 per- No one advocates turning back the clock cent – although the data here are pretty sparse. to 1910. But the path of least political resis- All in all, too few mergers seem to have tance has been in the opposite direction, nar- been challenged, and of those that have been, rowing the focus of antitrust, accelerating the too many were resolved with remedies that problematic rise in concentration. Here we proved ineffective. And this “soft” merger draw on our review of the four merger cases control policy is plainly taking a toll. The plus the broader economic evidence to iden- Council of Economic Advisers’ issue brief on tify several aspects of current merger control competition cited data showing that concen- policy that deserve reconsideration. tration throughout the economy has been The first is the tendency to underestimate trending upward, a phenomenon confirmed the importance of concentration per se. The by several other studies. What’s more, research antitrust agencies do not rely on the pre- has linked this rise in concentration to various sumption stated in the Merger Guidelines socioeconomic ills beyond higher prices. and endorsed in a previous generation’s judi- A fair amount of evidence suggests, for ex- cial opinions that a significant merger in an ample, that mergers and higher concentra- already concentrated market is so inherently tion generally result in no improvement, and likely to undermine competition that little often a decline, in service quality and in the further analysis is required. Rather, the agen- pace of technological innovation. Other stud- cies appear to believe (as do the courts) that ies have linked rising concentration to re- they must specify a causal mechanism for the

52 The Milken Institute Review Fourth Quarter 2017 53 squaring the deal marketing, distribution, innovation, vertical anticompetitive behavior that will lead to control and entry deterrence. While the regu- harm in each case. But that is a difficult task lators do their best to examine such issues, if held to a rigorous standard, even if the these are areas in which economic analysis is likely harm is not difficult to anticipate. more complicated, guidelines less helpful and This search for explicit causation between (partly as a consequence) court opinions un- mergers and economic ills has handicapped even in their holdings. antitrust enforcement. It has also led to an Related to this problematic focus on nar- undue preference for bringing so-called “uni- row overlapping products for the definition lateral effects” cases rather than traditional of the relevant market is the insufficient at- coordination cases. In unilateral effects the- tention paid to mergers that eliminate a po- ory, a merger is treated as a method by which tential competitor – that is, a firm waiting in a firm captures some fraction of otherwise the wings whose threat to enter very possibly lost business that now goes to the acquired di- constrains the incumbents. When a firm al- rect competitor, and as a result is more likely ready in the market acquires or merges with The result of consolidation and the growth of large firms is often the creation of most of what the merging parties sought in the first place: greater size and control across a number of related products and markets.

to raise prices. Such mergers, of course, often such a potential entrant, there is no overlap do occur, but it’s the ability to model this mo- and hence no increase in standard measures tivation for merger that makes unilateral ef- of market concentration. Nonetheless, by fects theory seemingly objective and more eliminating the possibility of future entry, the appealing. This has resulted in de-emphasis merger relaxes a constraint on raising prices of the alternative “coordinated effects” situa- and other adverse outcomes linked to market tion – agreements or understandings among power. firms that are often at the heart of competi- Many mergers between “nearby” but not tive concerns. Indeed, the so-called structural “overlapping” competitors take this form. And presumption, which is directed toward coor- the failure to proceed aggressively against dinated effects, would simultaneously rebal- such mergers reduces both actual and poten- ance policy and simplify enforcement. tial competition in many markets. A second and related emphasis that often A third area of concern is the role of offset- leads the process astray is the very heavy focus ting positive effects to an otherwise anticom- on narrow “antitrust markets,” which are de- petitive merger. The merger guidelines state fined by consumer substitution patterns – as that acceptable efficiency gains need to be not in, “Are movies really in the same market as otherwise achievable as well as verifiable. But video games?” – but may sometimes miss im- these criteria are not always clear and cer- portant competitive concerns. Among the lat- tainly do not provide any disincentive for par- ter are the myriad other ways in which a ties to make endless claims of varying validity. merged company can gain, exploit and de- Furthermore, as the regulatory agencies fend its market power through bundling, have become more skilled in evaluating (and

54 The Milken Institute Review challenging) claims of efficiency gains, the date. The result is often the creation of most benefits alleged by merging parties more of what the merging parties sought in the first often seem to involve the potential for better place: greater size and control across a num- service and quality. These claims are more ber of related products and markets. difficult to assess than those alleging straight- forward cost savings, and may well tilt the what next? process toward acceptance of mergers. In passing the Sherman Act of 1890, Congress Similar concerns arise with the idea that declared that first antitrust statute to be “a ease of entry resolves all potential sins. The last comprehensive charter of economic liberty revision of the merger guidelines toughened aimed at preserving free and unfettered com- the analysis of entry that qualified as an offset- petition as the rule of trade.” The merger con- ting factor, but in practice the agencies often trol provisions were set out in 1914 and seem to treat ease of entry as a reliable path to strengthened in a 1950 law, which was subse- merger approval. FTC data show that the quently interpreted by the Supreme Court as agency has never taken an enforcement action intending to “arrest … a trend toward con- against any merger, regardless of how high the centration in its incipiency, before that trend resulting market concentration, where entry developed to the point that a market was left was judged to be “easy.” While entry is a legiti- in the grip of a few big companies.” mate consideration in analyzing the impact of But the force of this opinion is not matched a merger, this seemingly surefire escape ave- by the current government merger guidelines nue has encouraged merging parties to assert and the resulting enforcement practice. Cur- that entry is easy, adding to the burden of rent guidelines and practice do not seem ori- proof for the reviewing agency. ented toward aggressive oversight and control Finally, remedies that are intended to of concentration. If there is to be any hope of make mergers more competitive seem to be going back to the future – and it would take used too often in place of outright challenges considerable political will – current antitrust to the combination. Divestitures and conduct enforcement would need a serious makeover. remedies can, in principle, be useful tools, but Successful reform would turn on several the evidence is that they are often ineffective. changes. Regulators would need to be given The reasons are clear: they are difficult to the resources to do their jobs in a more deter- write and often unenforceable in practice. mined fashion. Reform would also require Not surprisingly, then, they have commonly modest revisions of the antitrust statutes to resulted in price increases. Reliance on reme- counter the drift from decades of lax enforce- dies generally, and conduct remedies in par- ment. It would require policymakers with the ticular, should be reconsidered. vision and determination to make all of this The liberal application of remedies in happen. And not least of all, it would require mergers, in conjunction with narrow defini- Americans across the political spectrum to tions of relevant antitrust markets, has con- grasp the importance of these issues and to tributed to the growth of large firms. By support vigorous antitrust enforcement. subjecting mergers of large companies to In this manner, pubic policy and practice only modest divestitures in narrowly defined could serve to control corporate power and overlapping products, this approach allows restore the benefits of competitive mar- the remainder of the companies to consoli- kets to all Americans.

Fourth Quarter 2017 55 tk

56 The Milken Institute Review In December 1965, President Lyndon Johnson met with Federal Reserve Chairman William McChesney Martin at the president’s surprisingly modest ranch in the Texas Hill Country. John- son was upset with Martin for tightening credit despite Johnson’s expressed preference for more accommodative policy. At one point, the president began pushing the Fed chairman around the room, haranguing him with one of his patented hard sells, “Martin, my boys are dying in Vietnam, and you won’t print the money I need.” Martin resisted Johnson at the time, but eventually moved policy in the direction the White House demanded. Federal Reserve Looking back years later, Martin, who was dubbed the “happy Puritan” by one Independence journalist, lamented, “To my everlasting The Never-Ending Story Ishame, I finally gave in to him.” The idea that monetary policy should by mark thoma be made independent of political influ- illustrations by john ueland ence is widely (though hardly com- pletely) accepted today. As former Fed Chairman Ben Bernanke (2006-14) noted, “Careful empirical studies support the view that more-independent central banks tend to deliver better inflation outcomes than less-independent central banks, without compro- mising economic growth.” But as the LBJ anecdote suggests, the Fed did not always enjoy the degree of independence it has today. Before the era that began with Paul Volcker (1979-87), political influence on monetary policy was the rule rather than the exception. The independence of today’s Fed is supported by its unusual institutional framework. But the primary bulwark against interference is psychological, driven less by laws and regulations and more by the convictions of key players that the economy is better off with a central bank that can exercise broad discretion in monetary policy. Hence a president inclined to dismiss Bernanke’s “careful

Fourth Quarter 2017 57 fed independence president who appointed them, while the empirical studies” who is abetted by a Con- one-term limit removes their temptation to gress unwilling to resist meddling could re- skew policy in the sitting president’s direction verse the four-decade precedent. in order to curry reappointment. To further distance monetary policy from how it works in theory … the direct influence of the president, the gov- The independence of the Fed depends upon ernors’ appointments are staggered so that two key factors: the will of the governors to one governor’s term expires every other Janu- ignore threats from politicians unhappy with ary. This is supposed to limit the number of their policies, and the ability to pay its own appointments any single president can make, bills without appropriations from Congress. with the goal of preventing the White House First, though, let me put on my pedant’s hat from stacking the board with allies. to remind you of how the arcane system is ac- One of the seven governors is chosen by tually cobbled together. the president to be chairman or chairwoman Start with the role of the leadership of the of the board for a renewable four-year term. regional Federal Reserve banks. The presi- Although this assures the president’s appoin- dents of these 12 public-private hybrid agen- tee a high profile role in policy deliberations, cies are appointed to five-year (renewable) the law doesn’t give the chairman or chair- terms by the boards of directors of each Re- woman any extra votes to influence the deci- serve Bank. The Fed board of governors in sions of the FOMC. Indeed, the whole Washington can veto the appointments. But, convoluted design is supposed to facilitate a importantly, the selection process is indepen- process in which key stakeholders are repre- dent of the White House and Congress, and sented in policymaking, but no single interest neither has the authority to remove regional can control policy. presidents. While the regional banks’ primary task is to … and in practice do most of the routine non-policy work of A little – well, not a whole lot of – history be- the Fed, five of the regional bank presidents longs here. The Fed was created in 1913 in re- also serve on the Fed’s monetary policy mak- sponse to the well-founded conclusion that ing body – the Federal Open Market Commit- the financial system of a modern economy tee – on a rotating basis. (Only the head of the can’t run on autopilot. But the system we New York Fed, which you might say is more have today, with its focus on managing the equal among equals, is a permanent member.) supply of money rather than on assuring In addition to the five rotating regional commercial bank solvency, is the product of bank presidents, the FOMC includes the seven reforms in 1935 made in response to the Fed’s members of the board of governors. The U.S. disastrous performance in the early years of president appoints the governors, subject to the Great Depression. Senate confirmation, to 14-year nonrenew- Marriner Eccles, the first Fed chairman able terms. The long term gives board mem- under the new system, believed it was his job bers a perspective that extends beyond the to support FDR’s economic recovery effort, so for all intents and purposes, White House policy was Fed policy. The Fed’s indepen- MARK THOMA teaches economics at the University of Oregon and blogs at Economist’s View. dence was thus not tested.

58 The Milken Institute Review That changed after World War II. During son and William Martin, replaced them, with the war, the Fed had pegged the interest rates Martin taking over as chairman. paid on government bonds in order to con- Truman assumed that Martin would contain the budgetary costs of borrowing for the tinue the tradition of subordination to the war effort. This commitment effectively put Treasury. But he was surprised once more. the Fed out of the business of making mone- Though Martin paid lip service to the interest tary policy. Inflationary pressures driven by rate peg, he made it clear that the peg wouldn’t defense mobilization were managed with last much longer. Thus, the Fed-Treasury Ac- price controls and taxes rather than by cord marked the beginning of the end of the squeezing private spending with tighter credit. Fed’s long honeymoon with the White House. Once the war was over, though, Eccles saw But there was still a long way to go before the need to return to what we now think of as the Fed exhibited the degree of independence conventional monetary policy. However, we view as par for the course today. Martin The Fed-Treasury Accord marked the beginning of the end of the Fed’s long honeymoon with the White House. when he tried to end the interest rate peg – and still believed the Fed had an obligation to sup- the deference the Fed had shown to Treasury port new Treasury bond issues – which trans- edicts since 1935 – President Truman decided lated as not allowing the financing of budget to bring in someone who would continue to deficits to drive up interest rates at a pace de- let Treasury call the shots. termined by the market. As a result, despite In January 1948, Truman replaced Eccles Martin’s concerns about inflation, monetary with his own pick: Thomas McCabe, the former policy remained relatively accommodating. CEO of the Scott Paper Company. However, Before concluding that Martin lacked a Truman was in for two surprises. First, Eccles backbone, it’s important to remember that did not resign from the Federal Reserve Board, Congress was threatening to force the Fed to instead choosing to stay on as a regular board support the interest rate peg if Martin didn’t member. Second for the next three years he fall into line. Since, in the end, the Federal Re- pursued his public crusade against pegging in- serve is a creature of legislation, congressio- terest rates at the expense of inflation fighting. nal threats inevitably carry weight with the The Treasury countered with its own pub- board of governors. lic campaign. And the tense standoff finally Martin survived the Johnson years, but not led the warring parties to hammer out a deal the wrath of Richard Nixon. Nixon believed known as the Fed-Treasury Accord of 1951. Martin’s management of the economy had This fuzzy pact acknowledged the Fed’s need cost him the 1960 election, and he wanted to respond to inflationary pressure, but also someone he could trust to facilitate his agenda. recognized the Treasury’s need for “stability” That someone was Arthur Burns, a conser- in government bond markets. Part of the ac- vative economics professor at Columbia Uni- cord – though it wasn’t in the actual text – versity who was appointed Fed chairman in was that both Eccles and McCabe would step February 1970. During his time in the hot seat, down. Two Treasury insiders, James Robert- Burns talked the talk of Fed independence,

Fourth Quarter 2017 59 fed independence When monetary policy is set by the 12 mem- but rarely walked the walk. Indeed, he politi- bers of the FOMC with one vote each, the cized his office by keeping interest rates control of the chair by an aggressive president down to support Nixon’s re-election in 1972. does not mean that monetary policy will be The modest independence Martin had ex- dominated by the White House. When power tracted in the Fed-Treasury Accord was all is concentrated in the hands of the chairman but gone. And, almost needless to say, the few through the exercise of bureaucratic or extra- times that Burns did deviate from the will of legal initiative, such White House dominance the White House, he was met with threats is much more likely. from Congress. Independence can also be compromised if Burns also strove to concentrate power the president is able to make more appoint- in the hands of the Fed chairman, and did ments to the board of governors than the what he could to strong-arm FOMC mem- statute intends. Although board members are The consolidation of power in the hands of the Fed chairman not only deviates from the intent of the law to give a wide variety of interests a voice in monetary policy, it also makes Fed independence more vulnerable to assaults from Congress and the White House.

bers who would not endorse his – or perhaps appointed to 14-year terms, few serve this more accurately, Nixon’s – policies. Among long. The median term, excluding the chair- other abuses, Burns asked Nixon to kick one men and chairwoman, is only five years. As a problematic governor upstairs by giving him result, most presidents have been able to ap- an ambassadorship, and he persuaded Nixon point a majority of the governors – if not all to write a letter to a board member demand- of them – by the end of their second terms. ing his cooperation. The reality that board members almost To further consolidate power, Burns also never stick around for their full terms has tried to influence the selection of regional Re- consequences that go beyond allowing presi- serve Bank presidents by threatening to veto dents to stack the board. A loophole in the appointments. This illustrates the reality that legislation creating the Fed allows a newly ap- seeding the Fed’s infrastructure with checks pointed governor to serve out the remainder and balances is not enough to guarantee of the term of a governor who has resigned, independence. Even a rule that appears to in- and then to be reappointed to his or her own sulate members of the FOMC can be short- 14-year term once the partial term is com- circuited by a determined president. pleted. It turns out that most appointments The consolidation of power in the hands are of this type. Hence, at some point, most of the Fed chairman not only deviates from governors can be considered for reappoint- the intent of the law to give a wide variety of ment, giving them incentives to court favor interests a voice in monetary policy, it also with the White House. makes Fed independence more vulnerable to The final important change under Nixon assaults from Congress and the White House. relating to Fed independence was the deci-

60 The Milken Institute Review sion in 1973 to abandon the gold standard. differently – for example, it was chaired by This had large unintended consequences for the Treasury secretary and its role was mostly the Fed’s ability to fund itself. to regulate commercial banks) covered the When the Fed was created in 1913, it was cost of its operations through an assessment freed from “the power of the purse.” Reserve on the Reserve banks. banks funded themselves by providing vari- This changed in 1935 when power was ous paid services to private banks and through centralized within the board of governors earnings on loans to private banks to cover and the Fed was given the authority to con- the latter’s required reserves. The Federal Re- duct “open market” operations – that is, to serve Board (which was then organized quite alter the money supply by buying and selling

Fourth Quarter 2017 61 fed independence As discussed above, the Fed was far from Treasury securities. When the Fed increases independent under Nixon. But by the time the money supply, it uses newly printed Nixon was replaced by Gerald Ford, reducing money (actually, electronic bank reserves) to inflation became Priority 1. At this point, the buy government bonds. It then collects inter- Fed and the president were mostly on the est on those bonds – more than it needs to same page, and the president had little incen- fund itself – so Fed is freed from the congres- tive to intervene. sional appropriations process and the strings The next big challenges to Fed indepen- that often come attached. dence began with Jimmy Carter. During his Indeed, the Fed makes far more than it first presidential campaign in 1976, Carter ar- needs to fund the Federal Reserve System. It gued that the economy needed additional turns over the remainder – which was an as- monetary stimulus to create jobs and ex- Volcker’s success in bringing down the inflation rate cemented the idea that an independent Fed could do what elected officials could not. Thereafter, it became conventional wisdom that the Fed should run free.

tonishing $92 billion in 2016 – to the Trea- pressed displeasure with Arthur Burns’s focus sury. In recent years, this has become a major on inflation fighting. Burns made no secret source of federal revenue. that he returned the enmity. So it was not sur- Congress was worried that this self-fund- prising when, in March 1978, President Carter ing ability would be abused when the modern replaced Burns with William Miller. Fed was created in 1935, but was satisfied that In fact, Miller, the former CEO of an in- the gold standard would limit its ability to dustrial conglomerate (Textron) with little self-fund through expansions in the money knowledge of central banking who might supply. (I won’t bore you with the reason.) have been expected to follow the White Once the gold standard was abandoned, House’s lead, did not fully cooperate. Carter’s though, there were no constraints at all on economists wanted tighter money and Miller the Fed’s capacity to create money – which failed to deliver. After just under a year and a was not what had been intended when au- half, Carter recruited him to be secretary of thority to conduct open market operations the Treasury, replacing him with a financial was granted in 1935. technocrat, Paul Volcker. Since the financial crisis began in 2007, the When Volcker began his term in August Fed has used this authority to buy trillions of 1979, the inflation rate was 13 percent and the dollars worth of securities – yes, trillions – as unemployment rate was 6 percent – a miser- a means of easing credit beyond the point able combination dubbed “stagflation.” Vol- possible by reducing interest rates. But for cker made it clear before accepting Carter’s many in Congress, this novel extension of offer that reducing inflation would be his pri- policymaking constituted more indepen- ority and that he would operate independence than they thought the Fed should have. dently. Carter agreed, but his deeds did not Once again, the result was congressional always track his words. For example, he lob- threats to hobble the Fed. bied for looser monetary policy before his

62 The Milken Institute Review re-election bid, but Volcker paid no attention. pointed twice by Bill Clinton, and reap- When Carter lost the election to Ronald pointed once again by George W. Bush. Reagan, the new president reappointed Vol- Though he certainly met frequently with cker. He was not Reagan’s first choice, but Rea- the presidents he served under, such was his gan feared upsetting financial markets by prestige that, if anything, influence ran from replacing him. Inflation remained a big prob- the Fed to the White House – particularly lem, both economically and politically, so the where the budget deficit was concerned. The Reagan administration shared Volcker’s desire economy had its ups and downs during the to bring it under control and chose not to in- Greenspan years, but the fluctuations were terfere with Volcker’s shock-therapy approach. mild. When financial crises and recessions The cost of fighting inflation was the deep threatened the economy, Greenspan was able 1981-82 recession. Some members of the Rea- to take effective action in concert with the gan administration did call for looser mone- Treasury. In general, the economy performed tary policy at this time, and Congress weighed remarkably well. in with the now-familiar threat of legal action Should Volcker and Greenspan – more rel- if Volcker persisted. But Volcker’s success in evant here, the degree of independence they bringing down the inflation rate cemented exercised – be given credit for sustaining the the idea that an independent Fed could do 1982-2007 period of price and growth stabil- what elected officials could not. Thereafter, it ity dubbed “the Great Moderation”? From became conventional wisdom that the Fed the perspective of 2017, it’s not clear. Though should run free. Greenspan’s reputation would eventually be tarnished by his failure to contain the hous- the fed, ascendant ing bubble that led to the Great Recession, The value of an independent Fed was rein- contemporaries were inclined to celebrate forced by contemporary academic research. both the Fed’s power to stabilize the economy Finn Kydland and Edward Prescott showed and the success of the Fed governors when that a “time inconsistency” problem – making left alone to do their job. promises to reduce inflation in the future and When the Princeton economist Ben Ber- then finding it undesirable to do so when the nanke replaced Greenspan in 2006, support time arrives – would cause higher than desir- for the idea that the Fed should have a free able inflation rates unless the monetary au- hand to manage the economy was at an all- thority was able to credibly commit to a time high. Presidents might take a run at jaw- future inflation target. Elected officials are boning the Fed into compliance, but the generally not credible when they make prom- institution had built the political capital dur- ises about future inflation; hence the value of ing the Great Moderation to act as it wished. an independent (and therefore highly credi- One important change Bernanke did make ble) central bank. was to reverse the growing dominance of the Presidents do not often appreciate Fed Fed chairman under Volcker and Greenspan. chairmen who exercise independence, and in During his term, and continuing with the August 1987, Reagan replaced Volcker with tenure of Janet Yellen, policy decisions be- the business economist Alan Greenspan. came a cooperative FOMC effort rather than Thus began an 18-year run: Greenspan was being stage-managed from the top. This, by reappointed by George H.W. Bush, reap- the way, is much more in accordance with

Fourth Quarter 2017 63 how the law says the Fed is supposed to oper- spected the Fed’s independence, probably be- ate. And the decentralization, combined with cause it was pursuing policies that his advisers ongoing efforts to seek consensus on the found appealing in light of their own frustra- FOMC before it acts, probably serves to tions with being unable to use more fiscal strengthen the Fed’s independence. stimulus to speed the recovery. But the reac- After the FOMC cut interest rates to al- tion from Republicans in Congress was a fa- most nil during the Great Recession, the com- miliar one: threats to intervene. mittee took advantage of its independence to This was partly inspired by genuine fears boldly go where no Fed had gone before. that the magnitude of the quantitative easing With its “quantitative easing” program, the initiative would unleash inflation, and partly Fed purchased vast quantities of securities by a partisan inclination to attack an institu- other than Treasury bonds, flooding banks tion seen as allied with the Obama adminis- with loanable deposits. President Obama re- tration. It’s hard to know the extent to which

64 The Milken Institute Review pressure from Congress constrained the Fed’s his ire toward the Fed. But that could change actions. But the threats to audit the Fed, when Janet Yellen’s term as chairwoman ends monitor policy decisions and strip it of its in February 2018. If Trump chooses to re- regulatory powers, combined with the pub- place her (as seems likely), a big question will lic’s anger at policies that served the interests be whether he will appoint someone with the of Wall Street, certainly motivated Bernanke inclination and self-confidence to act inde- to mount an unusually public campaign de- pendently. One must assume that if the econ- fending the Fed’s independence. omy turned south during President Trump’s The congressional challenge to the Fed’s in- tenure, he wouldn’t hesitate to try to redirect dependence has receded under Janet Yellen’s the blame toward the Fed. leadership. Appointed by President Obama in An important question relating to how the February 2014, Yellen’s job has been to guide Fed will evolve under Trump is the composi- the Fed’s exit from the policies put in place tion of the Federal Reserve Board. At present, during the Great Recession without slowing – there are three openings on the board be- or inadvertently reversing – the recovery. cause congressional Republicans refused to This means deflecting criticism from the confirm Obama’s nominees. The names of left that the recovery is too slow and criticism possible Trump nominees floated to the date from inflation hawks asserting that interest of this writing all apparently support faster rates have been too low for too long. Even so, interest rate increases, a rollback in financial the sense that Congress was prepared to take regulation and adherence to a set rule for de- a significant bite out of the Federal Reserve’s termining changes in the money supply. independence has faded as the economy has If the attrition rate among current board recovered. members follows the historical pattern, one could expect more positions to open soon. through a glass darkly Stanley Fischer has already resigned. How- Faded, but not vanished. There is some con- ever, the prospect of President Trump stack- gressional support for pressuring the Fed to ing the board with people eager to reverse follow a rule-based monetary policy that existing board policies may motivate the mechanistically ties short-term interest rates other governors appointed by Obama (Lael to inflation and output. The likely impact of Brainard, Jerome Powell and Janet Yellen) to such a move on the Fed’s independence is serve until the end of Trump’s presidency. ambiguous. On the plus side, if the Fed is fol- Whether they will in fact stay on, I suspect, lowing a rule endorsed by Congress, it is rests in part on who is chosen to fill the open much harder for politicians to blame the rule seats and who is appointed as the new chair- followers. On the minus side, any rule would man or chairwoman. function as a limitation on Fed discretion. History shows us that independence can- Currently, the Fed governors are very not be guaranteed by legislation. It requires much opposed to this idea. But to the degree presidents to appoint qualified people and one can talk of a Republican monetary policy, then to support their discretion. More gener- it is strongly influenced by John Taylor of ally, it depends upon the willingness of official Stanford who is a strong proponent of rule- Washington to put the nation’s long-term in- based intervention. terests above partisanship. On that score, To date, President Trump has not directed it’s hard to claim we’re making progress.

Fourth Quarter 2017 65 a

Realfor Fix

by daniel herriges Trafficillustrations by roger chouinard tk

66 The Milken Institute Review tk

Fourth Quarter 2017 67 Few things may be certain in this world, but in the modern American cos- mology, “traffic” occupies a spot right up there with death and taxes. It scarcely matters where you live — a city of 60,000 or 600,000, amid old Boston brownstones or in a sweltering Sun Belt suburb. Indeed, “the traffic is awful and getting to suburban Pin Oak increased by 51 percent worse” is such a truism of American life that from 2011 to 2014. The five-year, $1.1 billion Farticles on the subject seem to exist outside of widening of Interstate 405 in Los Angeles has time. A search of the archives of my local similarly been deemed a failure by local media: newspaper turned up hundreds of mentions a study by traffic analytics firm Inrix found of the phrase “traffic congestion” over the that, soon after its completion, afternoon past couple of decades. Stories from 2002 are speeds on the 405 were slower than before. effectively interchangeable with ones from But if at first you don’t succeed … down- last week. It seems we’ve made about as much town Seattle’s Alaskan Way Viaduct replace- progress in conquering this scourge as we ment tunnel, plagued by more construction have in eradicating the common cold. problems than you could imagine, is up to an But what are we supposed to do about traf- estimated price tag of $3.2 billion. The east- fic congestion that we’re not already doing? ern span of the San Francisco Bay Bridge was Calls to put more money into infrastructure replaced for double that sum. are ubiquitous (and a rare point of bipartisan Not liking where this money hemorrhage consensus). But it’s far from clear that we’d seems to lead, another camp responds to con- know how to spend that money in ways that gestion by calling not for more roads but for produce results if it were available. fewer buildings, blaming rush-hour gridlock Historically the default fix has been brute on overdevelopment. This narrative holds force: more roads, more lanes, bridges, tun- that runaway growth clogs city streets with nels, bypasses. But such projects in already new people in new cars, largely to the benefit built-up areas are numbingly expensive, and of a cabal of real-estate moguls and business seem particularly misplaced at a time when interests – the coalition that sociologist Har- most localities face daunting deferred road vey Molotch famously dubbed the “Growth maintenance obligations with no plan to pay Machine” in the 1970s. If we could put sensi- for them. ble limits on growth, claim these voices, traf- In any event, the benefits of expanding the fic woes would dissipate. system can be elusive. In Houston, a $2.8 bil- This narrative holds much sway in cities lion expansion of the Katy Freeway (Interstate such as Sarasota, Florida, a popular baby 10) brought it to a jaw-dropping 23 lanes at its boomer retirement destination and the heart widest segment. Yet, after some temporary of the U.S.’s 11th fastest-growing metro area. traffic relief following the project’s comple- Downtown Sarasota is dotted with construction, rush-hour travel times from downtown tion cranes, jokingly referred to by Floridians as the state bird. There, a city election was recently won by a candidate affiliated with DANIEL HERRIGES is an urban planner and writer for a growth-control advocacy group named the online journal Strong Towns, a nonprofit advocating fiscally-sustainable solutions to urban problems. STOP! (The name, complete with exclama-

68 The Milken Institute Review tion point, is not an acronym for anything, MEAN TRAVEL TIME TO WORK BY YEAR but speaks for itself.) 26 The overdevelopment story, however, is also problematic in a number of respects. 25 Constraints on development can limit housing construction, making what housing there 24 is dauntingly expensive. The National Low In- U.S. Average come Housing Coalition estimates that, of the 23 3,007 counties in America, a full-time worker earning the minimum wage can afford a one- 22 bedroom rental home in only 12 of them. TRAVEL TIME (MINUTES)TIME TRAVEL In any case, development restrictions may 21 fail to achieve their aims. Without regional cooperation, one locality’s efforts to curb 0 growth may not so much curb it as drive it to 1980 1985 1990 1995 2000 2005 2010 2015 the nearest jurisdiction where regulation’s touch is lighter. The result is that most growth source: U.S. Census occurs on the suburban fringe, where public TOTAL TIME SPENT TRAVELING resistance to new construction is often weak- est. These are places where commutes are 95 long and amenities are fewer.

The traffic generated by population growth Weekends and holidays is not only a function of how many residents 90 are added, but of how much, on average, they Recession year drive. For this reason, scattered suburban growth makes regional traffic worse than 85 does high-intensity development in an urban Weekdays center, where new residents would likely have driven less often and over shorter distances. 80

Responding rationally to traffic concerns PER PERSON MINUTES PER DAY AVERAGE requires that we better define the problem. Is 0 traffic really getting worse? How so? And 2003 04 05 06 07 08 09 10 11 12 13 what measures stand the best shot of actually alleviating traffic woes at reasonable expense? note: Activities are based on American Time Use Survey Activity Lexicon 2011 definitions. Weekdays exclude holidays. Weekends and holidays include the following: New Year’s Day, Easter, Memorial Day, the Fourth of July, Labor Day, what a traffic problem isn’t Thanksgiving Day and Christmas Day. source: U.S. Department of Labor, Bureau of Labor Statistics, American Time The more you try to quantify the traffic prob- Use Survey 2014, available at www.bls.gov as of February 2016 lem, the more elusive it seems. There is scant evidence that it takes much longer to get Yet the frequency with which American places than it used to, and considerable evi- drivers complain about traffic is evidence of dence that costly highway expansions do little genuine, widespread frustration. Most adults to shorten commutes or reduce congestion in depend on cars as their primary mode of the long run. transportation. So it makes sense to examine

Fourth Quarter 2017 69 ANNUAL PERSON-MILES TRAVELED index. These simple explanations for what ails suggest a simple set of solutions. If the 4.0 56 problem boils down to too many cars and not Annual PMT 3.5 49 enough capacity, either we make more room Average daily PMT per person for more cars or somehow make all those cars AVERAGE DAILY PMT PER PERSON go somewhere else. 3.0...... 42 ...... The paradox of the “too many cars” notion 2.5...... 35 is that vast stretches of American automobile ...... infrastructure sit underutilized most of the 2.0 ...... 28 ...... time. Even at afternoon rush hour, congestion ...... is largely confined to a handful of busy, lim- 1.5...... 21 ...... ited-access highways and arterial roads. We ANNUAL PMT (MILLIONS) ANNUAL PMT ...... thus apparently have a traffic distribution 1.0...... 14 ...... problem, not a volume problem...... 0.5 ...... 7 Hypothesis one above – that travel times ...... are too long – is largely a misunderstanding ...... 0 0 born of repetition. In fact, travel times have 1969 1977 1983 1990 1995 2001 2009 YEARS been remarkably stable since they were first tracked nationally. The U.S. Census Bureau notes: The last National Household Travel Survey was completed in 2009. The has asked workers about their commute time 2016 National Household Travel Survey is currently underway, and results will be released in 2018. to work since the 1980 decennial census, and source: U.S. Department of Transportation, 2009 National Household Survey, annually since 2005 through its American Summary of Travel Trends, available at nhts.ornl.gov as of February 2016 Community Survey. The long-term trend for the nation as a whole: a very modest increase what a “traffic problem” actually consists of over decades. from the driver’s perspective. In broad strokes, Despite much hype about the rise of it could mean one of three things: “mega-commuters,” only about 8.5 percent of • It takes me too long to get places I want U.S. commuters travel more than 60 minutes to go. one way to work. And public transit commut- • The time it takes to get places I would like ers are disproportionately represented in this to go is too variable or unpredictable. number: among solo drivers, the share of • The experience of getting places I would these very long commutes falls to 6.5 percent. like to go is unpleasant due to traffic. Nor do we seem to be spending signifi- The default assumption for many is that cantly more time driving for non-work travel. we have a traffic volume problem – as in Since 2003, according to the Bureau of Labor “there are too many cars on the road.” Or, in a Statistics, total time spent traveling per per- variation on the theme, we have a traffic delay son per weekday has actually ticked down. problem: “All the other cars on the road are But while we’re not traveling for longer pe- slowing me down.” This assumption is perva- riods, we are traveling farther than previous sive in public discourse, fed by publications generations did. The increase in miles trav- like the Urban Mobility Report from the con- eled by the average person reflects the subur- struction-industry-friendly Texas Transpor- banization of America and the increasing tation Institute and the Inrix congestion number of people who live in far-flung, low-

70 The Milken Institute Review DENSITY VS. COMMUTE TIME FOR 350 METRO AREAS 35

20 Metros under 1 million residences Metros with 1-3 million residences Metros over 3 million residences MEAN TRAVEL TIME TO WORK IN MINUTES, 2015 INWORK MINUTES, TO TIME TRAVEL MEAN 15

0 0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 10,000 11,000 12,000 POPULATION-WEIGHTED DENSITY source: U.S. Census, American Community Survey density areas. And it does come with costs: far travel time to work falls within a relatively more infrastructure to maintain per capita, narrow window in cities that look vastly dif- more air pollution and carbon emissions, ferent from each other. more loss of farmland and wilderness. But Many Americans assume that dense devel- more time spent sitting in traffic is not one of opment leads to gridlock and long commutes. those costs. In fact, there is a lot of reason to But graphing the population-weighted den- doubt that we could significantly affect travel sity of U.S. metro areas against average travel times by building large quantities of trans- time to work shows at most a weak correla- portation infrastructure. The reason is a fas- tion between density and commute length. cinating bit of theory embodied in a number Nearly all large metros have travel times be- dubbed “Marchetti’s constant.” tween 20 and 30 minutes, whether dense or In 1994, the Italian physicist Cesare Mar- sprawling, car-dependent or transit-rich. chetti proposed the idea of a bound on city The densest 20 metro areas have an average size: a city would only grow to the extent that commute time of 28.9 minutes. Of the metros residents using the prevailing transportation that exceed Marchetti’s 30-minute (each way) technology of the era could accomplish their rule, one is Atlanta, famous for its discontinu- day’s travel in about an hour round-trip. ous, spread-out development pattern and Marchetti’s constant is remarkably accurate long freeway commutes. Another is Califor- in explaining the upper bound on the size of nia’s Inland Empire, with a high share of com- ancient Greek and medieval European vil- muters to the adjacent Los Angeles region. All lages as well as modern metropolises. And it of the others are older coastal metros, includ- is alive and well in modern America; average ing Washington, Boston and New York, that

Fourth Quarter 2017 71 a real fix for traffic formerly traveled before or after the peak hour boast relatively high public transit ridership. to avoid congestion would shift back into (Transit commuters may be willing to tolerate that peak period. Drivers who had been using longer commutes because they can multitask alternative routes would shift onto this now convenient freeway. Some commuters who in ways that drivers cannot.) The metro areas had been using transit would start driving on with a less-than-20-minute average commute this road during peak periods. Within a short are invariably smaller ones: not one city in time, this triple convergence upon the expand- this group exceeds a million residents. ed road during peak hours would make the Most of us, if offered an extremely quick road as congested as before its expansion. means of commuting to work – all else equal Not only will short-term driver behavior – would jump at it. So why don’t transporta- change, but in the medium to long term, land tion-capacity upgrades like new roads and development patterns will compensate. Peo- new lanes cause commute times to drop? The ple will live farther from work or from non- likely explanation is that all else is not equal. work destinations that are important to them, People have “travel time budgets” – the knowing they have a high-speed connection amount of time they are willing to spend on to those destinations. Homes can be built and the road – and weigh this against other fac- sold farther from downtown job clusters. The tors when making choices about where to live, incentive for outward sprawl, and more and where to work, and what time to hit the road more traffic as a result, persists until travel if they have a choice. If a road is widened to times restabilize at about the same level as be- speed travel, drivers will compensate by re- fore. In one of the more rigorous academic balancing their calculations. This is likely to studies of induced demand, conducted in lead to increasing travel on new or improved 2009, Gilles Duranton and Matthew Turner roads until congestion reappears, a phenom- found nearly a perfect 1-to-1 match between enon known in transportation planning as new lane-miles of urban freeway and in- induced demand. creased travel on those freeways. In his 1992 book, Stuck in Traffic, the econ- The idea of simply paving our way to re- omist Anthony Downs coined the idea of the duced travel times is thus a non-starter. If av- principle of triple convergence: erage travel times were well above the Visualize a major commuting freeway so heav- Marchetti constant, we might have a real ily congested each morning that traffic crawls structural problem, a situation in which for at least thirty minutes. If that freeway were many endure excruciating commutes for the magically doubled in capacity overnight, the genuine lack of another option. This is the next day traffic would flow rapidly because the case in some developing-world megacities: same number of drivers would have twice as much road space. the traffic jams of Jakarta and Manila are the But very soon word would get around that stuff of legend. this road was uncongested. Drivers who had This kind of structural problem can be

72 The Milken Institute Review eople have “travel time bud- But this kind of aggregation makes little P sense. If I save two and a half hours in an un- gets”— the amount of time they broken chunk, I can use that time in any are willing to spend on the road — number of productive ways. Saving five minutes a day for 30 days is not of equivalent and weigh this against other value, because I cannot put that 150 minutes, factors when making choices broken as it is into tiny increments, to productive use. Most likely I would not change a about where to live, where to thing about my daily routine except maybe work, and what time to hit the snoozing through the alarm in the morning. road if they have a choice. This whole-is-greater-than-the-sum-of- the-parts hypothesis is, of course, just that: a hypothesis. But thanks to high occupancy toll solved through either expanding system ca- lanes that give individuals the option to use pacity (allowing faster travel to destinations) the high occupancy lanes for a price, we know or increasing development density (bringing that people do not place great value on saving destinations closer to each other), or both. In a few minutes here and there. A 2017 study American cities, though, where the average from Louisiana State University estimates commute is around 25 minutes each way, the that the average user values time savings at Marchetti constant suggests that drivers about $3 per hour – a far cry from $20. would take advantage of the extra capacity to There is a fair counterargument here. The live farther from work or to make more op- notion of a constant travel time budget im- tional trips for shopping and recreation. plies that people will defer trips they would Costly expansions of urban freeways otherwise have made to avoid exceeding that would thus at best save commuters a minute budget. If this is the case, then avoided trips or two in the short run. Yet the benefits of will not show up in travel time statistics, but such modest savings are often sold to federal they still represent missed opportunities. funding agencies and the public using math- More mobility is good, proponents of this ar- ematical sleight of hand. A few minutes of gument say, because although new roads will travel time savings per person, aggregated induce people to drive more, that driving is over many thousands of drivers and multi- clearly of value to them or they wouldn’t do it. plied by the prevailing hourly wage, produces If this argument were on the mark, we impressive dollar amounts of supposedly re- should expect to see congestion bear a cost, claimed productivity. This is the methodol- not in the form of higher travel times but in ogy used, for example, by Inrix in its annual the form of an economic drag from the unre- Urban Mobility Scorecard, with time lost to alized value of trips not taken. This is a diffi- congestion valued at nearly $20 per hour. cult thing to measure, but a simple look at the

Fourth Quarter 2017 73 a real fix for traffic measure congestion costs in “delay,” with the list of the most congested U.S. metro areas ac- implicit assumption that free-flowing traffic – cording to Inrix’s index is reason for skepti- as fast as the road would safely allow us to cism. Here’s that list: go – is the ideal. But this logic yields dubious Los Angeles Miami Chicago benefits in terms of both economic productiv- New York Washington Seattle ity and personal satisfaction. San Francisco Dallas Atlanta Boston what a traffic problem is Inrix’s list is virtually a who’s who of places There are things to do to reduce the pain of that are prospering, with high employment, congestion. But we have to think differently, high wages and dynamic knowledge econo- abandoning the idea that our traffic problem mies. That doesn’t mean congestion isn’t tak- is one of delay or travel time itself. We can ing some sort of economic toll on these cities and should, however, address aspects two and – it’s possible they’d be even more dispropor- three of our aforementioned three-pronged tionately prosperous without it. But to claim traffic problem: the variability of commute the damage is severe would be about as sensi- time and the unpleasantness of the driving ble as Yogi Berra’s famous aphorism, “Nobody experience. goes there anymore. It’s too crowded.” Unpredictability in travel time has signifi- The underlying problem with the “travel is cant costs. It is largely caused by extreme con- good, so more travel is better” philosophy is gestion leading to breakdowns in traffic flow. that it confuses mobility for accessibility. I can In contrast to average time lost commuting, go more distance in less time in Kansas City most drivers value reliability highly: toll lane than I can in New York. I can go even farther users will pay for reduced travel time variabil- in rural Wyoming. But what can I get to in that ity at the rate of about $23 per hour. It’s impor- time? For the sheer amount of opportunity tant to know you will make it to work on time (employment, social, recreational) available for the big meeting, or to school in time to pick in a 30-minute trip, you still can’t beat Man- up your child. Gridlock, which can turn a hattan, where Inrix warns us that commuters 20-minute trip into an hour-long trip with are limited to a measly 8.23 mph – as if travel- little advance warning, is misery-inducing ing miles were the end and not the means. even when average travel times are not. We chase mobility like a snake eating its The most effective tool to combat gridlock own tail, accruing ever-growing road mainte- on limited-access roads is congestion pricing. nance obligations so that we can travel more Highway lanes can be tolled at peak hours to miles at higher speed, live farther afield from reduce the use of those lanes. Drivers making each other and ultimately need yet more roads. unavoidable trips, or those in a hurry, will pay This arms race with congestion is embedded in to use them while others will take alternate public policy and in engineering practice. We routes or defer less essential trips until rush

74 The Milken Institute Review We chase mobility like a snake eating its own tail, accruing ever-growing road maintenance obligations so that we can travel more miles at higher speed, live farther afield from each other and ultimately need yet more roads. hour is over. Toll lanes are most effective in Mr. Go is the nickname for MRGO, the this regard when the fee is not set to meet a Mississippi River Gulf Outlet, which was revenue goal but to maintain smooth traffic completed by the Army Corps of Engineers in flow, and is adjusted throughout the day as 1965. For decades it provided ship traffic traffic levels change. from the port of New Orleans a shortcut Another tool is public transit, which pro- through the river’s labyrinthine, muddy delta vides an alternative to driving at all – but with and into the Gulf of Mexico. a big caveat. I’ve avoided discussing transit The drawback to MRGO became all too thus far for two reasons. First, only a small clear when storms dropped colossal amounts share of Americans currently live in neighbor- of rain on the Gulf Coast region in a short hoods in which transit is convenient enough time. The original marshes south of New Or- to compete with driving in desirability. Sec- leans were capable of absorbing the resulting ond, the evidence suggests transit does little to huge influx of water, distributing it across directly relieve road congestion because in- hundreds if not thousands of tiny channels, duced demand applies: new drivers will fill and slowly but steadily filtering it through. the road space freed by transit commuters. These marshes were New Orleans’s best pro- Transit does generate considerable benefits tection against cataclysmic flooding. in its own right: in compact cities, its capacity The deep, dredged channel of MRGO, on and economy of space allow it to move far the other hand, would, in flood conditions, greater volumes of people than any freeway become a fire hose aimed squarely at New Or- ever could, and at considerably lower fiscal leans. It was a significant factor in the de- and environmental cost. But transit may not struction wrought by Hurricane Katrina in have a significant role to play right now in 2005, amplifying its storm surge dramatically. congestion reduction in the places where In 2009, the channel was closed for good. most Americans live. Now, a freeway in an urban downtown is Even without congestion pricing or major like Mr. Go. A complete grid of smaller sur- investments in public transit, there is hope in face streets, in which there are many equally addressing chronic rush-hour congestion in attractive routes from A to B for drivers to our cities. The key is to think differently choose from, is more like a wetland, and actu- about how we handle traffic within the road ally does a great job of dispersing traffic and network. To clarify, let me digress to intro- preventing congestion. Wide, high-speed ar- duce you to a fellow named Mr. Go. terial roads are congestion magnets.

Fourth Quarter 2017 75 a real fix for traffic roadway capacity, but nearly 100 percent of Channeling the vast majority of vehicle the congestion. These roads enjoy a travel trips to freeways rather than to a distributed time advantage at off-peak hours, but under network of small surface streets does give rush-hour conditions they offer no advantage travelers an efficiency boost at off-peak times. over slower, less direct alternate routes. But it almost guarantees that when the free- You can test this – albeit unscientifically – way “floods” with cars at peak commuting in your own city. Find a location where two hours, painful gridlock will result. routes parallel each other: a high-capacity Dallas-based urban designer Patrick Ken- thoroughfare, and a small, local street with nedy is a vocal advocate for the removal of perpetually slow traffic. At weekday rush hour, Dallas’s I-345 freeway – a once-longshot proj- when the thoroughfare is busy, drive one route, ect that has gained remarkable political mo- then loop back and drive the other. Compare mentum in a city in which the car is still king. your times. In my own (equally unscientific) experi- Cities would be well served to ment in Sarasota, I first tried parallel east- west routes at rush hour. One was a principal reconnect their fragmented grids, artery with a 30 mph speed limit and a lot of slow traffic on wide, busy roads, lights; the other was a two-lane road slowed by angled parking and lots of pedestrian traf- and thus spread out urban traffic fic (and a 15 mph speed limit). Travel times instead of concentrating it. proved identical. I repeated the experiment with an analo- His argument for the teardown does not cen- gous north-south pairing: one four-lane arte- ter on a critique of car dependency, but on rial with a 35 mph speed limit and six the notion that the dispersed downtown Dal- stoplights, followed by one parallel two-lane las grid has more latent capacity to handle urban street with a 25 mph speed limit, three traffic than I-345 does, and scrapping the stoplights and a roundabout. In this case, the freeway would have the added benefit of re- narrower, “slower” urban street proved to be viving a blighted swath of city and reconnect- dramatically faster, cutting my travel time by ing downtown to adjacent neighborhoods. one-third. There is precedent for such radical action. This kind of experiment suggests a solu- When San Francisco opted not to rebuild its tion to congestion that is precisely the oppo- damaged Embarcadero Freeway after the 1989 site of 20th-century engineering dogma: Loma Prieta earthquake, the city did not gain cities would be well served to reconnect their a traffic apocalypse but, rather, a revitalized fragmented grids, slow traffic on wide, busy waterfront. When Seoul, South Korea, re- roads, and thus spread out urban traffic in- moved a freeway and restored the Cheonggye- stead of concentrating it. cheon Creek through downtown (and created Note, moreover, that this approach not a linear park along its course), property values only removes congestion choke points, but in the immediate vicinity soared by 30 to 50 that it would be easier to maintain out of percent. local government budgets because it does not Wide arterials and expressways in an urban involve extensive new construction. It may setting account for a small fraction of total even raise property values in places where the

76 The Milken Institute Review high-speed, congested thoroughfare has de- and attainable speed is psychologically un- pressed them. comfortable – it’s responsible for the anxiety Driving in the marsh city, rather than the that accompanies crawling along at 20 mph Mr. Go city, also has the potential to be more on a freeway built for 70 mph traffic. enjoyable and less stressful. There is no com- “Traffic calming” is an engineering term for prehensive research on the psychology of efforts to decrease the design speed of a street driving – which types of street environments by narrowing lanes, adding visual obstacles make drivers comfortable, and which make and generally creating an environment that them stressed out and jumpy. But there are induces drivers to travel more slowly without some rules of thumb we can distill from expe- the need for stepped-up speed enforcement. riences that should be familiar to anyone who As the Sarasota experiment shows, two traf- drives a car. fic-calmed streets at rush hour were able to A key one: traveling slowly is not unpleas- transport me and my car at the same effective ant. Traveling slowly when you feel you speed – about 12 mph – as two much larger should be able to travel quickly is unpleasant. thoroughfares with much higher design Streets have a design speed, which is the speeds. And the experience was safer for pe- maximum speed at which most drivers feel destrians and cyclists I encountered, and comfortable and safe, based on features such more pleasant for me. as the width and straightness of the lanes, the Roundabouts are another low-cost inter- presence of visual obstructions such as me- vention that would help smooth traffic flow dian trees and signposts, and the amount of in many urban places. They facilitate the traf- open space between the road and adjacent fic-calming effect by allowing travel at a buildings. A mismatch between design speed steady 15 mph instead of the stop-and-go of

Fourth Quarter 2017 77 commuting. But a more compact city and suburbs with a well-connected grid offer high accessibility, not high mobility. You can get anywhere, from anywhere, by a large number of different routes – albeit not at high speed. Marchetti’s constant suggests that changes of this ilk would be accompanied by changes in land use over time: an increased demand for denser cities and less development on the far suburban fringe as residents seek to keep their overall travel time “under budget.” Charles Marohn of Strong Towns, an organization that advocates an incremental, fiscally sustainable model of urban development, observes that the most effective long-term congestion remedy in- volves these changes in land use: For nearly seven decades, our national transportation obsession has been about maximiz- accelerating to 30 only to brake at the next ing the amount that you can drive. We now red light or congested stretch. They are less need to focus on minimizing the amount you expensive than stoplights to maintain and are forced to drive. operate, and the Federal Highway Adminis- No city can be expected to transform its tration estimates they can reduce crash rates land-use patterns overnight, and opportuni- by 70 percent or more. ties to alter the street grid are rare because of These changes are low-cost and incremen- vested property rights. However, cities can, at tal. But the end result of enough of them minimal cost, require that new development would be a very different type of city – one feature a highly connected street grid. And characterized by high connectivity, with many they can seek out opportunities to create such routes between any two points. This different connections where they do not currently exist kind of city would lack the clear hierarchical – for example, when large urban sites are re- distinctions between neighborhood streets developed. Finally, they can use the tech- and through streets that exist in many places niques of traffic calming to distribute the today. That hierarchy – a regional road net- burden of rush-hour traffic across a greater work that channels most traffic onto a hand- number of routes. ful of large, high-speed roads like flood waters The result for drivers would not be less into MRGO – is the fundamental cause of time spent in traffic – Marchetti’s constant much urban traffic congestion. suggests that is an unattainable goal. It would, The marsh city, rather than the MRGO however, with any luck, be less time spent city, is not very conductive to long-distance miserable in traffic.

78 The Milken Institute Review book excerpt

Cents and Sensibility What Economists Can Learn From the Humanities

It’s unusual to come upon a serious book illustrations by that is a collaboration between a research yevgenia nayberg economist and a humanities scholar. But Cents and Sensibility*, by Gary Saul Morson and Morton Schapiro, is no ordinary book. Indeed, this work by a Slavic literatureI professor at Northwestern (Morson) and an economist who’s written extensively on education and is now the president of Northwestern is almost as difficult to describe as it is a pleasure to read. ¶ Here, we excerpt the chapter on the great puzzle of economic development: why some economies thrive while others languish. Morson and Schapiro classify the ideas of brand-name thinkers from Jared Diamond to Walt Rostow to the Harvard-MIT troika of Daron Acemoglu, Simon Johnson and James Robinson in a way that is uniquely influenced by the humanities. ¶ They use philosopher Isaiah Berlin’s iconic distinction between “hedgehogs,” who view the world through the lens of an overarching idea, and “foxes,” who resist the urge to distill simple explanations from complex events. Think Marx in the former category, and Shakespeare – or, for that matter, Isaiah Berlin himself – in the latter. But don’t be misled by my name-dropping. Cents and Sensibility is a witty, ubersmart series of essays making it clear that the humanities really have a contribution to make in weighty analyses of the great issues of modern economics. — Peter Passell *princeton *princeton university press all ( 2017 ). rights reserved.

Fourth Quarter 2017 79 Economists examine a wide range of important topics. But are there any more critical than why some countries experience rapid (or at least respectable) levels of economic growth while others lag far behind?

Begin with the South Korea-Ghana puzzle. invention on one occasion a few thousand EBack in the mid-1960s, these two countries years ago.” had very similar levels of per capita income. In the pursuit of “inexorable explanations,” But Ghana had rich reserves of natural re- no contingency is allowed to have had a sources (especially oil) and precious metals significant lasting effect. It follows that (namely, gold); South Korea did not. Who narratives can explain nothing but temporary would have guessed that 50 years later citizens fluctuations with no long-term significance. of South Korea would be almost 20 times richer than those in Ghana? We turn first to a non-economist who offers to explain differential economic development in terms of a single factor. Why the focus on someone outside economics? Our hope here is that through an examination of how a non-economist explains economic facts in non-economic terms – in other words, seeing economics treated the way the great hedgehog economist Gary Becker treats sociology and anthropology – economists may come to appreciate how they often look to others. If the reasoning seems clearly fallacious when done by other social scientists, it will be easier to see the flaws when the same reasoning is em- ployed by economists themselves. In polymath Jared Diamond’s Guns, Germs and Steel: The Fates of Human Societ- ies, the diversity of apparent causes reduces to a single one, the way Newton’s laws explain a vast diversity of astronomical and other observations. “The whole modern world,” writes Diamond, “has been shaped by lopsided outcomes. Hence, they must have inexorable explanations, ones more basic than mere details concerning who hap-

pened to win some battle or develop some tk

80 The Milken Institute Review Beyond that, narratives can only illustrate ducible to any one of them. In Mokyr’s ac- how the single cause operated over time. We count, narrative plays an indispensable see here the same impulse that leads explanatory role. Of course, his book invites economists to avoid narrative explanations in counterargument and might still prove mis- favor of mathematical models – and for the taken, but that is the nature of “foxy” accounts. same reason: narrative is needed when there is They do not promise certainty and arrive at no genuine contingency, that is, when important ultimate, let alone inexorable, explanation. facts cannot be derived from the preferred model. the hedgehog of geography As an alternative, we discuss a thinker who At its best, a hedgehog account can, for all its is both an economist and a historian. Joel shortcomings as an overall explanation, offer Mokyr’s The Enlightened Economy: An Eco- surprising and important insights that others nomic History of Britain, 1700-1850, explains have overlooked or understated. And the rise of Britain to economic preeminence Diamond unquestionably does that. No one through a complex plurality of factors irre- to our knowledge had ever pointed to the tk

Fourth Quarter 2017 81 distribution of potentially useful plants or velopment over the very long term. And that large domesticable animals as an important is the nature of the best hedgehog approaches, factor in explaining why some countries where monomaniacal attention to a single develop faster than others. factor can illuminate surprising facts about It comes as a shock to discover how much its operation. later some parts of the world were settled than Diamond begins by raising the question of others, and therefore how much less time differential economic development in an in- some cultures had to develop useful innova- triguing way. While walking on a beach in tions. We are accustomed to thinking in terms New Guinea with a local politician named of vast stretches of evolutionary time next to Yali, he was asked, “Why is it that you white which human activity seems both short and people developed so much cargo and brought foreshortened. But if we focus on the much it to New Guinea, but we black people had

After the fact, when one’s prediction has proven wrong, one goes back and revises the theory to yield the prediction that one now knows would have been the correct one and then claims the new theory has been vindicated! We wish we could say that this escape of any possible falsification is uncommon, but it is not.

briefer stretch of human existence, significant little cargo of our own?” In Diamond’s re- differences in time spans become visible. phrase: “Why did human development pro- The geographical ease of diffusion turns ceed at such different rates on different out to play a long-overlooked role. No matter continents?” how inventive a culture may be, most Although Diamond pays lip service to the inventions come from somewhere else. possibility of non-geographical explanations, Cultures located among others from whom he repeatedly considers them only to describe they can borrow, therefore, are much more them as “proximate” causes, which are them- likely to develop than isolated ones. The larger selves explicable in geographical terms. In the available population and the absence of book’s epilogue, Diamond proposes as the geographical barriers gave the Eurasian next step the extension of geographical expla- landmass an enormous advantage over nation to shorter time spans. The shorter the Tasmania, New Guinea or even sub-Saharan time span that can be explained by geograph- Africa. So did the fact that this landmass ical factors, of course, the less role there is for extends from east to west rather than north to any other explanation. south, making crops, which are typically suited For example, Diamond offers a geograph- to a given latitude and amount of sunlight, ical explanation for why Europe, rather than more readily movable across large distances. China, led the world in technological devel- These and similar observations establish opment – a development that, given his Diamond’s book as an important contribu- theory, “is initially surprising, because China tion to our understanding of differential de- enjoyed undoubted advantages.” But Dia-

82 The Milken Institute Review mond rejects any cause but other geographi- ing institutional ones (like patents), social cal factors. ones (like individualism) and intellectual Why, then, did the Fertile Crescent and ones (like religions compatible with techno- China eventually lose their enormous leads of logical development). In addition to these, thousands of years to late-starting Europe? which all favor economic development, some One can, of course, point to proximate factors have cited factors that, they say, sometimes behind Europe’s rise ranging from its devel- work one way and sometimes the other, such opment of a merchant class, capitalism and as war, centralized government, climate and patent protection for inventions to its Greco- resource abundance. Judeo-Christian tradition of critical empirical Diamond dismisses the last group because, inquiry. Still, for all such proximate causes, to him, if a cause can work both ways, it does one must raise the question of ultimate cause: not seem to be much of a cause. For a human- why did those proximate factors themselves ist, that wouldn’t count as much of an objec- arise in Europe, rather than in China or the tion any more than one could dismiss, let us Fertile Crescent? say, envy, acquisitiveness or just about any This reasoning allows for no counterevi- other emotion as explanations for crime be- dence. Apparently, if China had wound up on cause sometimes they lead elsewhere. That is top, it would have been because of the geo- the nature of many things human. graphical factors. The theory would have been But Diamond is trained as a physiologist vindicated. But as it happened, what the the- and has written on ecology and ornithology, ory would have predicted did not turn out to which, for all their complexity, do not entail be the case. That doesn’t mean the theory has the complex interactions of self-conscious been falsified, or even that some good coun- human agents. Predictably enough, he rejects terevidence has been presented. Rather, it the other “proximate causes” because they are, means only that some other geographical fac- well, merely proximate. tor must be at work. And, of course, you can His reasoning is entirely circular. To prove always find one to do the trick. that an explanation must be geographical, he After the fact, when one’s prediction has asks for other possibilities and, when he finds proven wrong, one goes back and revises the them, discounts them because they are not theory to yield the prediction that one now geographical. Needless to say, proponents of knows would have been the correct one and other all-encompassing systems – say, Marxist then claims the new theory has been vindi- economic ones – also dismiss other explana- cated! We wish we could say that this escape of tions as merely proximate, including geo- any possible falsification is uncommon, but it graphical ones. Just as Diamond can ask why is not. And one can only wonder if, in the next risk-taking or property rights could not 40 years, China should come to dominate the themselves be accounted for in geographical world, Diamond will find a geographical ex- terms, Marxists can ask why the effectiveness planation for that, too – one that accounts not of geographical causes does not itself depend only for Chinese domination, but for why it on economics. Whichever factor one chooses, did not dominate 40 years earlier? If so, why one can, with sufficient ingenuity, resolve all doesn’t he predict it now? the others into it. Just as the many advocates Diamond lists 14 “proximate causes” in- of a unique religious revelation all refute each voked by historians and economists, includ- other, so do the many forms of hedgehogism.

Fourth Quarter 2017 83 Diamond is especially keen to eliminate and mathematical abilities, and that those are racist explanations of differential develop- what most people have in mind when they ment and, of course, he is not unique in this speak of intelligence, Westerners must be respect. The odd thing about Diamond is that smarter. Even if New Guinea favors some he refutes one sort of racism with another. aspects of intelligence, they are not the ones He asserts that, in his experience, not only that matter. are industrialized people no smarter than res- Diamond does not appear to choose argu- idents of New Guinea and similar places, they ments for their cogency and then discover are actually less smart. Speaking from the per- they lead to his desired conclusion. He seems spective of more than three decades of work- to select any argument that leads to his de- ing in New Guinea, he concludes that New sired conclusion even if it is easy enough to Guineans impress him “as being on the aver- construct arguments of the same cogency age more intelligent, more alert, more expres- that lead to the opposite conclusion. That is sive and more interested in things and people not what respect for the truth entails. But it is around them than the average European or where hedgehogism often leads the most American is.” intelligent people. Having thus established the genetic superi- Diamond isn’t shy, as indicated in the first ority of New Guineans (apparently his own sentence of the volume: “This book attempts impression is proof enough), he proceeds to to provide a short history of everybody for ask how it might have come about. He arrives the last 13,000 years.” Diamond says that at two explanations. First, low infant and “geography obviously has some effect on child mortality rates in the Western world history; the open question concerns how mean that most infants survive regardless of much effect.” But there is little doubt left in intelligence and genes. In traditional New his conclusion: Guinea societies, with high levels of mortality, In short, Europe’s colonization of Africa smarter people are more likely than less intel- had nothing to do with differences between ligent ones to survive. European and African peoples themselves, as One might reply that it is hard to see why white racists assume. Rather, it was due to accidents of geography and bio-geography – the fact that American children do not suc- in particular, to the continents’ different areas, cumb to diseases preventable by inoculation axes and suites of wild plant and animal spe- makes them on average less intelligent. Mi- cies. That is, the different historical trajectories crobes do not single out the stupid. of Africa and Europe stem ultimately from While this natural selection argument cer- differences in real estate. tainly seems to warrant documentation, the Diamond writes as if there were no alter- second explanation seems even more fraught. native to racism or other objectionable theo- While Western children grow up being pas- ries but his own. Pretending that it is either sively entertained by television, radio and one’s own explanation or an obviously unac- movies (of course, today his worry would be ceptable one is a rhetorical trick more likely about the Internet), children in New Guinea to be found among advertisers and political spend their time engaging with others, devel- propagandists than in serious academic work. oping their mental abilities. In his discussion of technology, Diamond But here again, one might as well argue asks whether it is possible that the existence that since Western societies select for verbal of some genius, and the creation of some

84 The Milken Institute Review surprising invention, might have made a paths he will find no place to go. But that difference. As he is aware, the question applies doesn’t mean that, at an intersection of several not just to technology but to all aspects of the roads, it does not matter which one is taken. historical process. If one asks whether Edison, They may lead to very different places. By the Gutenberg or some other inventor made a same token, it is difficult to imagine what the decisive difference, one might ask (as he does) world would be like if Alexander the Great the same question about Napoleon, Alexander had not Hellenized it, or if Napoleon had not the Great or Julius Caesar. What if each of spread the ideas of the French Revolution. these men had not crossed his Rubicon? Diamond also returns to what might be Diamond allows that Watt, Edison and the called the “factor out” (or “average out”) ar-

Diamond seems to select any argument that leads to his desired conclusion even if it is easy enough to construct arguments of the same cogency that lead to the opposite conclusion. That is not what respect for the truth entails.

Wright brothers made important im gument. The fact that people have suggested provements and that, without them, resulting so many reasons for innovativeness makes inventions might have been “somewhat dif- the historian’s task paradoxically easier, by ferent.” Nevertheless, “the question for our converting societal variation in innovativeness purposes is whether the broad pattern of into essentially a random variable. That means world history would have been altered signif- that, over a large enough area (such as a whole icantly if some genius inventor had not been continent) at any particular time, some pro- born at a particular place and time. The an- portion of societies is likely to be innovative. swer is clear: there has never been any such By the same token, some proportion of in- person.” dividuals in a society is likely to be innovative. Diamond offers two main explanations for It follows that prediction is possible in history this conclusion. First, inventors must appear in “when the unique features of millions of a culture favorable for such inventions. Oth- small-scale brief events become averaged out.” erwise, the invention lacks its needed prede- Diamond is not the only hedgehog to get cessors and cannot be made or, if made, around contingency by statistics – that is, by cannot be implemented. Yes, indeed, but that is assuming that things average out. But in to answer a different question. many cases they don’t. There may be “black Of course, if Edison were born in 16th-cen- swans,” rare and unpredictable events that tury Tasmania he would not have invented the change everything. Small contingencies that light bulb or the phonograph. But suppose not might easily have been different can sometimes Edison but someone else had taken advantage lead to one path instead of an alternative that of American opportunities; could she not might just as well have been chosen and, in have invented something radically different, the process, “lock in” a different course of sub- something that came to suggest yet other in- sequent events. ventions we cannot imagine? A contingent event is one that, as Aristotle If you leave someone in a forest with no explained, “may either be or not be; events

Fourth Quarter 2017 85 also therefore may either take place or not ogy, ecology, paleontology and evolutionary take place.” Chance, choice or an unpredict- biology. able combination of causes can all create such Each of these deals with “chains of proxi- contingency. When it happens, the future mate and ultimate causes” with the former course of events may swerve. To understand traceable to the latter. As more than one critic it, one must resort to narrative. of his book has pointed out, Diamond’s am- Diamond wants to establish human his- bition, like others who have claimed to have tory as a hard science. He recognizes that it discovered “the laws of history,” accounts for cannot resemble physics because experiment history by removing everything historical and precise prediction are not to be had, but from it. he believes that it can resemble acknowledged Leo Tolstoy observed that if one stands historical sciences, such as astronomy, geol- back from the historical process and isolates a

86 The Milken Institute Review we are offered a choice between Diamond and absurdity, with no alternative possible. But surely there is something between hard historical laws and sheer chance with no pattern. Stephen Jay Gould in fact placed evolutionary biology itself in that middle ground. If one were to play the tape of historical events over, he argued, history would be likely, at point after point, to take a different path. But that does not mean there are no patterns at all. Rather, there are general regulating principles operating in the background while contingency plays an important role in the foreground. For Gould, the truly Darwinian position is “laws in the background and contingency in the details,” with the contingent able to set things on very different paths.

foxy and other economists When trying to explain growth rates, economists – like geographers, biologists and historians – employ approaches ranging from hedgehog to fox and everything in between. Technology is usually at the forefront of these analyses, with the absence of technological change leading to little or no growth in output. Of course, simply saying that technology matters doesn’t necessarily suggest a particular growth strategy. What factors give rise to the discovery and adoption of new technologies? Most agree few moments (always placing special weight that education plays a critical role, as invest- on the present), it is always possible to con- ments in human capital make workers more struct a simple narrative, which in turn can productive and speed the pace of innovation. be seen as the effect of a few simple laws. But Innovation is at the heart of growth, accord- that simplicity is the result of a sort of histor- ing to Joseph Schumpeter, as a process of cre- ical optical illusion. Tolstoy likens it to a per- ative destruction makes old technologies and son who views a distant hill where only trees products obsolete. are visible and imagines that the hill contains Much of this work is quite technical. But in nothing but trees. some cases, it is also unusually eclectic, at least Diamond imagines that unless one can for economists, drawing on a wide range of have hard historical science, history reduces influences. Studies that focus on physical cap- to one damn thing after another. Once again ital and the natural endowment of resources,

Fourth Quarter 2017 87 for example, may fit easily into economic each nation’s experience.” Nevertheless, that models. But there is also work that stresses uniqueness takes place within the five stages law, climate, geography, politics, religion and applying universally. even culture, which usually do not. We give In one form or another, controversy over examples of a hedgehog, an imaginative and arguments like Rostow’s have dominated influential approach that is hard to character- Western culture since the late 18th century. As ize, and then a couple of foxes. Enlightenment thinkers sketched out a single possible line of progress, romantics viewed Rostow: Modern History as a Whole cultural and national differences as signifi- Those of a particular age undoubtedly remem- cant. For them, different paths of develop- ber Walt Rostow’s 1960 analysis of economic ment are possible. growth. His five stages were once well-known Since the single path typically made France far beyond economics. Whether Rostow actu- the leader, Germans tended to favor a model ally meant this model to be exclusive, he was of multiple paths. As France took itself to be taken to have believed exactly that: if not a the model of all “civilization,” Germany fa- hedgehog, he was rapidly hedgehogized. vored a plurality of “cultures.” Civilization It is all very neat and predictable. You came to stand for a single path and goal; cul- begin with subsistence agriculture, limited ture for a plurality of them. In the former case, technology and little economic mobility, then history had an inherent direction and the de- move to stage two where the demand for raw tails really affected nothing. In the latter, the materials induces investments in physical in- details made all the difference. frastructure and the onset of social mobility. In Russia, this argument played out in the The takeoff stage, stage three, is characterized 1840s as a dispute between “Westernizers” by increasing urbanization and industrializa- and “Slavophiles.” The Westernizers thought tion, while stage four occurs when the indus- that the only way to progress was to follow trial base diversifies and the nonprofit sector precisely in the footsteps of Western Europe, grows. Eventually, stage five means a con- whereas the Slavophiles thought that, to suc- sumer-driven economy, where income levels ceed, modernization had to be adapted to the are high enough to promote widespread peculiarities of a specific culture. prosperity. It is a common mistake to think that the Once again, the search for universal laws Slavophiles were Luddites. Quite the contrary: leads a scholar down the road to hedge- they thought that, for modern technology and hogism. Don’t countries vary in so many ways institutions to “take,” they could not just be – in size, in location, in their colonial legacies, imposed from above but had to grow out of their religions, their customs? Details, details, the culture adapting them. You can’t just ex- details. Hedgehogs are sure that all that messy port the American or British constitution to complexity hides simple, far-reaching truths. Russia, Mexico or Iran and expect it to work. Rostow saw these stages as universal. To And what is true of institutions is true of tech- be sure, Rostow recognized that there are nology as well. major differences between “Khrushchev’s In Anna Karenina, the hero Konstantin Russia, Meiji Japan … Bismarck’s Germany Levin at first tries to increase the productivity and Nasser’s Egypt,” and insisted that his of his estate by adopting Western machinery, model allows one to see “the uniqueness of seed oats and work patterns. But he finds that

88 The Milken Institute Review somehow the machines that work in England lustrates how the same issues keep arising. always seem to break, the seed oats get ruined, Rostow’s many critics disagreed with his and the peasants just don’t seem to be able to analysis in the strongest terms. They said that, follow English work norms. at best, this was a model that explained West- Levin at last finds a prosperous peasant ern development but certainly not economic who has innovated not from the top down but growth in Asia or Africa. And it was so prede- from the bottom up. He has borrowed some termined: you do this and it leads to that. Western technology where it fits, adapted other innovations to fit local circumstances, and jury-rigged solutions loosely inspired by the inventions he has read about, while then adjusting the new pattern to operate as a whole. Instead of following a trajectory given in advance, at

Hedgehogs are sure that all that messy complexity hides simple, far-reaching truths. each stage he assesses how earlier innovations have worked, drops some, and pursues promising lines of development suggested by others. The result could not have been predicted in advance but works quite well. Levin realizes that this is the way to in- novate successfully. And the point applies not Growth becomes inevitable, even though it is only to technology narrowly defined but also hard to find such inevitability in the real to what might be called social technology. world. One reason Russian history is so impor- A controversial (and many would say tant is that it was the first country to undergo problematic) economic model at least pro- rapid modernization, a process followed by vokes discussion and stirs others to contrib- many since. Japan, Turkey and Iran all had ute to the literature. But if its author takes his their equivalents of Slavophiles and Western- view into the policy arena, the stakes are izers, and the comparison of Ataturk and the heightened. Rostow became a highly influen- Shah of Iran to Peter the Great – all autocrats tial presidential adviser, serving in a promi- using their power to modernize rapidly – il- nent role in both the Kennedy and Johnson

Fourth Quarter 2017 89 administrations. It isn’t clear whether his un- zle of Ghana. This study asks specifically mistakable anti-communism and faith in whether the dismal growth history in Africa capitalism came from the confidence he had results from factors such as Diamond’s favor- in his economic growth model or whether ite, geography, or from any of a number of those principles influenced the model itself. non-institutional causes. Their answer is no. But in either case he carried those beliefs with Instead, Africa is poorer than other conti- him during his government service. nents due to its weak institutions. But why, In fact, observers point to Rostow’s hawk- you might ask, did a poor institutional frame- ish attitude toward Vietnam as an important work develop in the first place? Are some contributor to our nation’s stance in building countries randomly blessed with the right in- toward and then continuing that war. One stitutions and others cursed with the wrong wonders if Rostow imagined the United States ones? If we want to foster economic develop- could impose a single path of social and polit- ment, we’d better know that answer. ical development on another culture, a tempt- The authors tease this out in terms of the ing but usually dangerous error in judgment. colonial experience. Europeans, they argue, If so, it is a way of thinking still very much used different colonization strategies, which with us. led to different institutions. In the United States, for example, European powers settled Alternative 1: in the colonies, setting up institutions that Acemoglu, Johnson and Robinson protected property rights and encouraged in- For an approach that rejects the acultural vestment. In much of Africa, however, colo- model of Rostow (as well as the single-path nial powers set up extractive states whose model of Diamond), we turn next to a partic- main purpose was to transfer resources back ularly impressive and influential paper by home. The institutions that resulted had a Daron Acemoglu, Simon Johnson and James long-term negative influence on economic Robinson, which draws liberally on a variety progress. of literatures. The authors recognize that But why did colonialists settle in some countries that invest more in physical and places and not others? Where mortality rates human capital develop faster. No surprise were very high, the Europeans stayed away; in there – even for Rostow. But then they step others, they could safely settle. back and ask, what encourages those invest- So the authors nest their questions in an in- ments? Numerous economists have attrib- triguing way. Economic growth comes largely uted this positive growth environment to the from investments in capital; investments in presence of the “right” institutions – a legal capital tend to come from the presence of the system that enforces well-defined property right institutions; the right institutions by and rights, a government that encourages entre- large are developed where colonialists settle; preneurial activity, and so on. Still, they ask, is colonialists often settle where mortality rates it the institutions that give rise to growth or are low. the growth that provides the wealth to afford Hard to believe that factors affecting where better institutions? Europeans could settle in the distant past It turns out that institutions have a large, would be linked to economic development independent impact on economic perfor- today, but the authors show that early institu- mance throughout the world. Recall the puz- tions powerfully affect institutions today and

90 The Milken Institute Review that those institutions have a strong causal tional investments help? What about “great link with economic development. What’s men” who seem to have an outsize impact on more, the authors control for a myriad of the world? Would Singapore have developed other factors – latitude, climate, the current as well without Lee Kuan Yew or China if the disease environment, religion, natural re- Gang of Four had won out instead of Deng sources, soil quality, ethnolinguistic fragmen- Xiaoping? And why is it that in some places tation and current racial composition – and entrepreneurs are rewarded and in others they still institutions play a prominent role. are reviled? Finally, it is not the case that a country that Does this approach claim to explain all dif- used to have bad institutions is doomed to ferential economic growth? No. But it does poverty. Nations that improve their institu- offer a fascinating story – one where institutions experience significant economic gains. tions matter, even if their origin is explained South Korea is presented as an example of in a way that surely would make some histo- just such a change. rians and sociologists a bit uncomfortable. Of course, one could also point out that the effects of colonialism were not quite so Alternative 2: uniform. The English and the Portuguese Easterlin and Social Capability treated their colonies differently, and even We turn now to a foxy hero, Richard Easterlin Ethiopia, which was never successfully colo- (University of Southern California), and then nized, did not have much economic success. move on to another highly influential In general, one wants to avoid the impression economic historian, Joel Mokyr (North that everything about a culture is due to West- western). They are willing and eager to cross ern influence – that is, to the culture of most the boundaries set by traditional economic of the people doing the analysis – whether for models. good or ill, a position that seems to take away In his book Growth Triumphant, Easterlin all agency from others. asks, “Why isn’t the whole world developed?” We decided to highlight this paper because While technology underpins much of eco- we consider it a tour de force. In their exten- nomic growth, inducing investments in both sive bibliography, the authors cite not only physical and human capital and in the mobil- economists but legal scholars, historians, de- ity of labor and capital, why did the diffusion mographers, political scientists, biologists, of technology vary so greatly country by physicians and more. They have come a long country? His answer: some had the appropri- way from a model that explains all of develop- ate institutions and some did not. Without ment in simple economic terms. the right institutions, economic growth could Still, no one would argue that Yali’s ques- not take root. tion has been definitively answered. Institu- But how did favorable institutional conditions matter, and, surprisingly, they appear to tions develop? Education is key, fostering reflect health conditions (mortality rates) modern economic growth by increasing the from long ago. But what of all the other possi- mobility of the population. But the overrid- ble explanations for why countries develop? ing factor is “social capability,” a term refer- Do certain religions foster more growth than ring not just to the level of educational and others? Why did India develop differently technological competence but also to the from Pakistan? Do certain kinds of educa- presence of flourishing financial institutions

Fourth Quarter 2017 91 along with political and social characteristics Not an answer that would give a hedgehog that foster economic activity and reward en- much comfort. But the world is foxy, and per- trepreneurs both financially and in terms of haps that is why explanations that purport to social esteem. work in all places and at all times seldom hold Easterlin astutely argues that education up to empirical scrutiny. doesn’t always promote economic growth; it depends whether it is secular and rationalistic. Alternative 3: And what of the government? Does it estab- Mokyr and What People Believe lish a judicial system that encourages the pur- In his book, The Enlightened Economy, Joel suit of economic opportunity? A helpful Mokyr poses what he calls “the big problem” government might not assure economic and “the little problem.” The “big problem” growth, but an unhelpful one sure can ham- recalls Yali’s question: per it. It is clear that some factors shaping Why did Western Europe succeed in doing institutions can’t be explained in purely eco- something that no society in history had ever nomic terms. done, that is, break through the confining One final point regarding Easterlin: He negative feedback barriers that had kept the bulk of people who had ever lived before 1800 provides an interesting analysis of the ques- at a level of poverty that is by now practically tion of the impact of population change on unknown in the West? Despite their formida- economic growth. He is especially interested ble scientific and technological achievements in whether the rapid increase in population in years past, neither the Ottoman world, nor that resulted from mortality declines in the China, nor India, even came close. developed world has impeded their economic The “little problem”: why was it Britain development. that took the (temporary) lead in this process? On the one hand, doomsayers follow a long “The answers to both questions,” Mokyr tradition going back to Thomas Malthus, contends, “need to be sought in the realm of arguing that rapid population growth leads to knowledge and institutions, not geography.” a range of horrific scenarios. However, Mokyr rejects any single-factor explana- Easterlin argues, such scenarios have not tion quite persuasively. He cautions against come to pass. Perhaps the improvement in “hindsight bias” and “teleology” – that is, as- health itself promotes economic growth, or an suming that the outcome we know was inev- expanding population has a positive impact itable and somehow managed to pull earlier on the creation and diffusion of knowledge. events toward it. And he cautions against Or maybe the threat of population pressure thinking that the story he singles out is all induces changes in behavior that are beneficial that was going on in the economy, let alone to economic increases. elsewhere. With theories for and against the negative A great deal happened in the British econ- versus positive impact of population growth, omy that was in no way or only tangentially re- Easterlin looks to the empirical evidence on lated to the Industrial Revolution. Just because the link between population increases and the Industrial Revolution took place does not economic changes. The result? Variations in imply that everything before and during it population growth rates have no consistent necessarily “caused” or even facilitated it or relationship with growth in real per capita that everything after was caused by it. income. There were many stories, each with many

92 The Milken Institute Review causes, interacting in complex and unpredict- cial role. People did not always act in their able ways. Nothing was inevitable, and con- own self- or class-interest and were some- tingency played a crucial role. Mokyr’s way of times persuaded to act for the good of the na- explaining is rich in narrative. There is no tion. There is no simple answer as to why way around stories. some ideas win out and others do not. In particular, Mokyr rejects the tendency A humanist would add that a lot depends among economists to derive everything from on particular people. And particular people, economic factors. As with their antagonists, too, may or may not emerge. Without Co- the Marxists, mainstream economists tend to lumbus someone else would have discovered attribute beliefs, ideology and cultural factors America, but it defies common sense to assert to economic causes. The causal efficacy of that without Milton someone else would have these apparently non-economic factors is written Paradise Lost. I f after the fact it looks as if the idea was inevitable, that is only because we are the product of it and it is hard to imagine any other possibility.

therefore economic at one remove, just as, Ideas are closer to literary masterpieces with Diamond, the same factors are geo- than undiscovered continents because there graphical at one remove. In this perspective, are many possible ideas that could arise at any nothing is “exogenous,” and everything “en- time, each with its own trajectory to other dogenous,” to economics. ideas. If after the fact it looks as if the idea was Mokyr insists that, to the contrary, beliefs inevitable, that is only because we are the that cannot be entirely reduced to economic product of it and it is hard to imagine any factors played a crucial role. His book begins, other possibility. The same is true of techno- “Economic change in all periods depends, logical ideas: there is no inherent direction to more than most economists think, on what inventions. people believe.” Mokyr above all has in mind Mokyr observes, “Just as in evolutionary the European Enlightenment, and he quotes biology we can never know precisely why John Maynard Keynes’s famous 1936 passage some highly fit species emerged and others, on the importance of ideas irreducible to eco- just as fit, did not, there is a baffling indeter- nomics: “the power of vested interests is vastly minacy in history. Good timing and contin- exaggerated compared with the gradual en- gency explain outcomes.” And both require croachment of ideas… soon or late, it is ideas, explanation in terms of narrative rather than not vested interests, which are dangerous for overarching laws. good or evil.” Britain emerged as preeminent, but it may But note that Mokyr stresses ideas “in addi- well have been some other country. And al- tion to,” not instead of, other factors. It, too, is though one can give a plausible account of why one factor in complex interaction with others. Europe, rather than China, created the Indus- Ideas, in turn, depend often enough on yet trial Revolution, plausibility is not certainty. It another non-economic, indeed literary, fac- derives not from timeless laws but from histor- tor for their success or failure. Rhetoric – or ical circumstances and human choices, which as Mokyr calls it, persuasion – played a cru- require narrative to understand.

Fourth Quarter 2017 93 the harm that hedgehogs do tions varying in no predictable way, the role of The hubristic claim that economists (or ex- tacit knowledge that no one can specify but perts in some other discipline) have arrived at that can make all the difference – and, above hard scientific knowledge, capable of success- all, the need to proceed step-by-step to check fully guiding development, has led to disaster whether one change has worked before imple- after disaster. These experts, armed with that menting the next. By their very nature, hedge- putative knowledge, construct master plans hogs lack the humility necessary to prevent of development often put into practice by au- mistakes from becoming catastrophes. thoritarian regimes. For obvious reasons, ex- In Tanzania, Scott argues, the World Bank perts have aided such regimes when they are and an ideology of planning expertise com- willing to put their schemes into practice. The bined to back Julius Nyerere’s ujamaa villages messiness of democratic institutions makes campaign. Beginning in 1973, nomads and the imposition of a comprehensive scheme al- farmers were taken from their abodes and re- most impossible. settled along main roads so that they could By their very nature, hedgehogs lack the humility necessary to prevent mistakes from becoming catastrophes.

Cataloging the many “huge development easily receive the appropriate public services, fiascos” in Eastern European and Third World and replace traditional practices with scien- countries, the Yale political scientist James C. tific agriculture. Torn from the environment Scott points to the towering human cost that with which they were familiar, they lacked all overconfidence in all-embracing theories has local knowledge. The result was ecological di- entailed. saster and famine. The Great Leap Forward in China, collec- These are mistakes a fox would be less likely tivization in Russia and compulsory villagiza- to make. Experience seems to show that, in tion in Tanzania, Mozambique and Ethiopia development, generalized economic theory is are among the great human tragedies of the not enough. One needs an understanding of 20th century in terms of both lives lost and culture, local institutions and history as well – lives irretrievably disrupted. At a less dra- in short, everything that entails narrative. matic but far more common level, the history To be sure, we still don’t have a definitive of Third World development is littered with answer to Yali’s question. Why Korea and not the debris of huge agricultural schemes and Ghana? No one knows for certain. But should new cities (think of Brasilia and Chandigarh) we ever find the answer – or answers – we sus- that have failed their residents. pect it will involve some factors that are far re- It would appear that nothing causes greater moved from traditional economic analyses. It evil than comprehensive schemes to abolish it. will almost certainly involve institutions and Time and again, supposed experts, backed by customs and faith. And it will be much too massive force, have put into practice develop- random and too unpredictable for a hedge- ment plans that did not take into account the hog to force into a universal model. peculiarities of particular belief systems, the If there were ever an area to be a fox, importance of local experience with condi- this is it.

94 The Milken Institute Review institute news

The View From Asia The Institute’s fourth Asia Summit, held in Singapore in September, brought together some 500 regional and global leaders and 170 speakers. (New this year: a full-day Women Leaders’ Summit.) The summit program provided fresh insight in how to manage the challenges facing Asia. A special focus was to assay how the region has changed since the 1997 financial crisis, and how economic, social and political trends are likely to shape Asia’s path in the Michael Milken, Al Gore and S Iswaran at the Asia Summit next 10 years. Advisory Council to work with the team. Heavy Hitters in Housing Finance “We are bringing a powerful combination The Institute’s efforts to help policymakers of industry, government and policy experi- frame a sustainable housing finance system is ence to provide leadership in the vital effort to gaining new traction. In September, Staci War- restore a vibrant housing market,” said War- den, head of the Institute’s Center for Finan- den in announcing the appointments. cial Markets, announced the appointment of Eric Kaplan as director of the Housing Finance A New Center for Program. Kaplan has spent nearly a quarter Regional Economics century in the residential mortgage industry The Institute is known for its work in regional and spearheaded “RMBS 3.0,” the principal economics – research into how local econo- industry-led task force on reforming mort- mies can best foster employment and growth. gage-backed securitization, which operates Annual indexes, including Best-Performing within the Structured Finance Industry Group. Cities (rankings of more than 300 metros in In addition to Kaplan, the Center’s biparti- the United States) and for the past three years, san team of senior fellows adds to the Insti- Best-Performing Cities China, are widely used tute’s expertise: Theodore Tozer, until recently by policymakers, analysts and journalists. In president of the Government National Mort- recognition of the success of our work in this gage Association (Ginnie Mae); Michael Steg- area, Institute president Richard Ditizio re- man, senior policy advisor for housing at the cently announced the creation of the Milken National Economic Council from 2015-16; Institute Center for Regional Economics. The and Phillip Swagel, assistant secretary for eco- new center will be home to our regional economic policy at the Department of Treasury nomics research team as well as the staff of our from 2006-9. Institute founder Michael California Center. Kevin Klowden, the former Milken and mortgage finance industry pioneer executive director of the California Center,

courtesy the of courtesy milken institute Lewis S. Ranieri will co-chair a new Housing leads the regional economics initiative.

Fourth Quarter 2017 95 lists

Half the Fun? Price-savvy travelers are aware how widely airfares vary within countries – not to mention country to country. Thanks to Kiwi.com, a Czech-based online travel start-up, we now have hard numbers on just how dramatic the differences can be. Some of the variations are cost-driven: maintaining domestic air service on lightly traveled routes, especially in harsh climates, is very expensive. Some are no doubt driven by how well individual airlines make use of computer-facilitated “price discrimination,” going as high as they dare with deep-pocket business passengers and as low as they must to fill the other seats. And that (though we all grumble) strategy is a good thing, provided competition serves as a check on market power. But it’s still a strain to explain why fares average twice as much in France (per 100 kilo meters traveled) as in Portugal and four times as much in Egypt as in India. One plausible explanation: some governments actively encourage air travel by means of subsidies and friendly regulation in order to encourage tourism or to please their growing middle classes. Another, of course, is that, in much of the world, airline owners (often governments) exploit market power in order to generate excess profits or employment – or simply to allow incom- petent management to bumble on. I’ve picked a bunch of countries of special interest, either because they are large markets or serious outliers.

(US$ PER 100 KILOMETERS) SHORT-HAUL FLIGHTS LONG-HAUL FLIGHTS AVERAGE

LOW-COST FULL SERVICE LOW COST FULL SERVICE

India ...... 3.88...... 4.25...... 5.18...... 6.51...... 4.96 Portugal ...... 3.96...... 15.43...... 2.61...... 3.98...... 6.50 Thailand ...... 4.01...... 8.23...... 4.55...... 10.17...... 6.74 Sweden...... 7.40...... 15.90...... 1.31...... 3.22...... 6.96 South Africa ...... 6.71...... 6.71...... 7.28...... 7.28...... 7.25 Russia...... 6.53...... 9.45...... 6.99...... 7.42...... 7.60 New Zealand . . . . . 4.41...... 13.65...... 7.82...... 7.82...... 8.43 U.K...... 3.71...... 9.06...... 5.35...... 26.11...... 11.06 China ...... 17.90...... 19.64...... 2.00...... 6.18...... 11.43 U.S...... 5.41...... 6.48...... 6.35...... 27.77...... 11.50 France ...... 6.58...... 6.58...... 4.45...... 29.12...... 11.68 Egypt...... 20.22...... 20.22...... 6.75...... 16.28...... 15.86 Brazil...... 3.98...... 3.98...... 28.66...... 28.66...... 16.32 Israel...... 36.52...... 36.52...... 3.11...... 3.47...... 19.91 Australia ...... 41.77...... 52.29...... 9.68...... 18.86...... 29.39 source: Kiwi.com

96 The Milken Institute Review