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Recent Posts

Here are the 10 latest posts from EconLog.

EconLog August 19, 2018

Prominent Economists Who Wouldn’t Sign My 1990 Statement about War for Oil, by David Henderson

In late August 1990, I published an article in the Wall Street Journal. The title was badly chosen, though not by me: “Sorry Saddam, Embargoes Don’t Hurt U.S.” My editor at the time, by the way, was David Frum, and, although he and I differed on the issue of war against Saddam Hussein, he was a fantastic editor.

I’ve published that article on my own web site here.

Here are the opening two paragraphs:

Saddam Hussein is an evil man who has no qualms about hurting innocent people. But many Americans believe that if he were to succeed in extending his control to a large part of the Arab world, he could severely damage the oil-dependent U.S. economy. No less an authority than Henry Kissinger has claimed that an unchecked Saddam would be able to “cause a world-wide economic crisis.”

But is it true that Saddam Hussein can impose large costs on our economy? Economic analysis of the oil market answers with a resounding, No. The annual cost to the U.S. economy of doing nothing in the Gulf would be less than half of 1% of the gross national product. The vaunted oil weapon is a dud.

Early in September 1990, I wrote and circulated among economists a statement making the point I made in the WSJ op/ed, and asked them to sign. It was titled “Economists Speak Out on War for Oil.” The statement, though substantially shorter than my article, was somewhat lengthy. For that reason, I’m not typing it in here unless 2 or more people demand it.

Ed Crane of the Cato Institute thought he could get some funds to publish a big ad in major publications with the statement and, underneath it, the names of signers. We hoped to get a lot of names people had heard of.

I got some but not enough and so we junked the project. The signers, in alphabetical oder, were:

Barbara Bergmann, American University

Tyler Cowen, George Mason University

Richard Ebeling, Hillsdale College

James K. Galbraith, University of Texas

George Horwich, Purdue University

John M. Heineke, Santa Clara University

Me

Dwight R. Lee, University of Georgia

William A. Niskanen, Cato Institute

David Ranson, H.C. Wainwright & Co.

Alan Reynolds, Hudson Institute

Jennifer Roback, George Mason University

George Selgin, University of Georgia

Richard Timberlake, University of Georgia

Robert D. Tollison, George Mason University

David Weimer, University of Rochester

Lawrence H. White, University of Georgia

Benjamin Zycher, UCLA

 

In going through some old files on Friday, I found some notes I had taken verbatim about my conversations on the issue with three prominent economists who had all refused to sign: Gary Becker, Paul Samuelson, and Sam Peltzman. Milton Friedman wrote me a separate letter saying that he agreed with the analysis but wouldn’t sign because many people would conclude that he was against the war, and he wasn’t.

Here are the conversations with Becker, Samuelson, and Peltman:

 

Gary S. Becker: I agree with the economic point you made. But I won’t sign. I’m not a signer. Also, Saddam Hussein is a threat in other ways. But I agree that the threat does not arise from his power over the price of oil.

 

Paul A. Samuelson: This war isn’t about the price of oil.Henderson: Maybe it’s not but that’s the justification that’s being given by Bush and Baker. [I should have said “one of the main justifications.”]

Samuelson: It is and it isn’t. But I won’t sign.Henderson: Do you agree with my analysis?

Samuelson: I don’t have any quarrel with your analysis.

Henderson: If I’m ever asked, can I quote you to that effect?

Samuelson: (Pause.) Sure. Your analysis was correct.

 

Sam Peltzman: The analysis is right but I won’t sign.

Henderson: Can I quote you as saying the analysis is right?

Peltzman: Why do you want to quote me?

Henderson: You’re a name. You said the same thing that Paul Samuelson, Murray Weidenbaum, and Gary Becker said. You guys are names. Can I quote you?

Peltzman: Sure. I don’t care.

 

Why do I post this here? First, because I’m kind of proud of the results and second, to make the point that when you ask for something that you don’t get, try to get something out of it.

(3 COMMENTS)

EconLog August 18, 2018

Charter cities in China, by Scott Sumner

Paul Romer has long advocated the creation of “charter cities”, especially in countries with a dysfunctional government. This would involve isolating a section of a larger country and replacing control from the central government with a new administration composed of technocrats.  It would feature transparency, low levels of corruption, property rights and the rule of law. Hong Kong and Shenzhen are sometimes cited as successful examples of this concept, although Shenzhen has less independence than is typically contemplated for a charter city.

In a book of essays, Simon Leys makes a case for China being place where the charter city concept was first developed, more than 2500 years ago:

[Confucius] spent virtually his entire life wandering from state to state in the hope of finding an enlightened ruler who would at last give him a chance and employ him and his team–who would entrust him with a territory, however small, where he might establish a model government. All his efforts were in vain. The problem was not that he was politically ineffectual or impractical—on the contrary. The elite of his disciples had superior competences and talents, and they formed around him a sort of shadow cabinet: there was a specialist in foreign affairs and diplomacy, there were experts in finance, administration and defence. With such a team, Confucius presented a formidable challenge to the established authorities: dukes and princes felt incapable of performing up to his standards, and their respective ministers knew that, should Confucius and his disciples ever get a foothold at court, they themselves would quickly be without employment. Wherever he went, Confucius was usually received with much respect and formal courtesy at first; in practice, however, not only did he find no political opening, but cabals eventually forced him to leave.

No wonder Romer had so much trouble finding willing partners.

I’ve ordered a copy of the Analects.  I wouldn’t be surprised if Confucius is one of those people (like Smith, Burke, Machiavelli, etc.) who is somewhat more liberal than his reputation.

(2 COMMENTS)

EconLog August 17, 2018

Think on the Margin in Airport Lines, by David Henderson

Earlier this month, I went to the Winnipeg airport to fly home. One sign of a good vacation, for me at least, is that I’m so relaxed at the end that I forget to check carefully what time my flight leaves. I did that this year. For some reason, I had etched in my mind the idea that my flight from Winnipeg to Denver left at 4:30 p.m. So I took one last somewhat leisurely visit with my friend and mentor, Clancy Smith. At about 2:10 p.m., I left his house to stop at a drug store to find chocolate bars that I have trouble finding in the United States. I dropped off my car at the Winnipeg airport and got to the United kiosk just shy of 2:55 p.m. Lots of time, I thought.

Surprisingly, though, there was no one else ahead of me in the United line. When I went to the front of the line to check my suitcase, the United employee tried to do so on the computer but was stymied. He made a quick call in which he asked another United employee to unlock the baggage check. A few seconds later, he printed out a baggage tag. He explained that the U.S. customs and immigration people don’t like people checking in when there is less an hour to go and I was checking in with 57 minutes to go. (When you fly out of Canada to the United States, you go through pre-clearance; when you go through U.S. customs and immigration, you are legally on U.S. soil and, indeed, once you’re through, you see a sign saying “Welcome to the United States.”)

“57 minutes to go,” I thought. I had thought I had over an hour and a half. But it turns out that my flight was to leave at 3:55, not 4:30. When I got to Canada’s equivalent of TSA, I told an employee that I had TSA-Pre, showing him that designation on my ticket. He laughed and said that that wasn’t recognized there.

Not to worry. There were only 8 people in front of me. But 3 minutes later, there were 7 people in front of me. Canada’s “TSA” was moving very slowly. I figured that once I got through, U.S. Customs would go quickly. (On this last, I was right.)

So I thought on the margin. There’s a dishonorable way to get further up in the line and that is to ask someone near the front if you can go ahead of him or her. That way, you impose costs not just on him but also on everyone behind him who was previously ahead of you.

There’s also an honorable way. That is to ask the person directly in front and ask if you can switch places with him. That way, the person who makes the decision is bearing the whole cost. I went with the honorable way. My plan was to do this with as many places I could before someone said no. I explained to the man in front that I had less than an hour before my flight left and asked him how much time he had before his flight. He said he had about 2 hours. So I asked him if he would switch. He looked kind of incredulous, as if my request were unfathomable. Then he said, “Forget it; you won’t make your flight anyway.” I answered, “I might or I might not, but if we switch, my odds improve a little.” He agreed and let me switch. The person in front of him heard all this and, with a twinkle in his eye, let me switch. So did the person in front of him. So within 1 minute I had moved 3 spaces up. By that point, there were only 3 or 4 people in front of me. One was a flight attendant who wouldn’t let me switch. Later I saw her on my flight; she was the only flight attendant on the flight and I could tell by the faltering way she read the directions from her cell phone that she was pretty new on the job. It made sense that she didn’t want to risk being late.

Thinking on the margin can be pretty powerful.

Oh, and I made my flight. The boarding didn’t start until about 10 minutes after I got to the gate.

(9 COMMENTS)

EconLog August 17, 2018

Bill Gates Makes Classic Error, by David Henderson

Harvard economics professor Greg Mankiw quotes from a recent book review by Bill Gates:

By the second semester of my freshman year at Harvard, I had started going to classes I wasn’t signed up for, and had pretty much stopped going to any of the classes I was signed up for – except for an introduction to economics class called “Ec 10.” I was fascinated by the subject, and the professor was excellent.

Greg’s interest, understandably, is who the professor was. He wonders if it was Otto Eckstein. I’m wondering if it was Elizabeth Allison. In December 1973, when I was in my second year at UCLA, I did a “busman’s holiday,” flying to Boston en route to Canada to visit my undergrad friend Lawrence Siskind and my econ graduate student friend Danny Steinberg. Danny invited me one evening to go with him to Elizabeth Allison’s place where she had a meeting of her teaching assistants (Danny was one) to go over some questions for an exam for a self-paced economics course she was teaching. It was an introductory course. Maybe she taught Ec 10 also.

But I have a less personal and more professional interest in the Gates’ review. After drawing a supply and demand curve correctly, Gates writes:

There are two assumptions you can make based on this chart. The first is still more or less true today: as demand for a product goes up, supply increases, and price goes down. If the price gets too high, demand falls. The sweet spot where the two lines intersect is called equilibrium. Equilibrium is magical, because it maximizes value to society. Goods are affordable, plentiful, and profitable. Everyone wins.

In the second and third sentences, Gates messes up big time. If demand for a product goes up, the price goes up. With an upward-sloping supply curve such as the one he draws, the quantity supplied rises. Net result: equilibrium price and quantity are higher. The price does not go down.

I’m criticizing Gates not to suggest that I’m smarter than he—I’m positive that I’m not—but simply to correct his analysis. One can make some pretty big follow-on mistakes if one doesn’t understand his mistake. I’m also not suggesting that he should have stayed at Harvard longer and understood economics better. If he had, almost all of us would have been at least slightly worse off.

Interestingly, in the paragraphs that follow, Gates does get at the crucial part of economics that matters for his industry. I’ll leave that part to you if you’re interested.

 

(12 COMMENTS)

EconLog August 17, 2018

Land Taxes: The Return of Henry George, by Pierre Lemieux

An article in the August 9 issue of The Economist, “The Time May Be Right for Land-Value Taxes,” suggests to reconsider the land-value tax advocated by American economist Henry George in his 1879 book Progress and Poverty.

George proposed to tax away the rent on the unimproved value of land, and to replace all other taxes by that single one. The improved value, represented for example by a house or an industrial building, would not be taxed. Presumably, the implicit rent a homeowner earns on the land on which his house stands would be taxed. The receipts from the tax would finance public goods. These goods boost land rents–think about a police station or even a park or a road–and benefit the landowners more than the landless, who have paid wage taxes and other taxes to finance the public goods. In other words, the rent tax would be redistributed to the landless in free public goods.

Maos-Great-Famine-1.jpg

By the way, the Economist article contains many good illustrations of economic theory. For example, a land tax is capitalized in land values, which decrease by the present value of future tax payments. A Danish government study apparently provided an empirical confirmation (a useful citation would have been appreciated).

A convincing argument exists for taxes on improved land, from the double perspective of economics and ethics.

EconLog August 15, 2018

A Torch Kept Lit, by David Henderson

A long-time friend gave a copy of William F. Buckley, Jr.’s A Torch Kept Well Lit to his daughter, who is in her late 20s. My friend has a Ph.D. in economics from UCLA and is a successful businessman. His wife used to be a columnist for the Wall Street Journal. Ideas and books are discussed a lot in their household.

His daughter, who got good grades at a pricey private high school, read the whole thing and, afterwards, said, “Dad, I learned nothing in school.”

Her point was that there was so much about U.S. culture, politics, literature, etc., that she didn’t know and she realized that fact after reading the book.

So I ordered the book and read half of it on a flight from L.A. to Denver last month.

It didn’t have the same effect on me because, of course, I have learned a lot over the years. Nevertheless, the book is excellent. I don’t recommend reading it in one sitting. It’s composed entirely of obituaries that Buckley wrote for politicians, novelists, thinkers, friends, etc. and reading one obit after another can get old. I would recommend a minimum of three sittings punctuated by days.

One of my favorites is the obit of Ronald Reagan. Buckley tells about an event in the spring of 1961. He and his sister-in-law were eating at one end of a restaurant while Ronald and Nancy Reagan were eating at the other end. They hadn’t yet met, but Reagan was to introduce Buckley, who was the speaker. Here’s my favorite paragraph:

He distinguished himself that night—and dismayed Mrs. Reagan—by what he proceeded to do after discovering that the microphone hadn’t been turned on. He had tried, raising his voice, to tell a few stories. But the audience was progressively impatient. Waiting in vain for the superintendent to unlock the door to the tight little office at the other end of the hall, in which the control box lay, he sized up the problem and, having surveyed all possible avenues of approach, climbed out the window at stage level and, one story above the busy traffic below, cat-walked, Cary Grant style, twenty or thirty yards to the window of the control room. This he penetrated by breaking the window with a thrust of his elbow; he climbed in, turned on the light, flipped on the microphone, unlocked the office door, and emerged with that competent relaxed smile of his, which we came to know after Grenada, Libya, Reykjavik, and Moscow; proceeding with the introduction of the speaker. And all that was thirty years before bringing peace in our time!

It probably goes without saying, given my views on foreign policy, that my quoting this does not mean that I agree with what Reagan did with respect to Grenada and Libya.

 

(0 COMMENTS)

EconLog August 15, 2018

How You Can Find Socialism in a Capitalist World, by Bryan Caplan

Before and after my “Capitalism vs. Socialism” Debate with Elizabeth Bruenig, we had quite a while to chat.  While I was nonplussed by her case for socialism, she was quite gracious in person.  There are probably plenty of socialists like her: Nice people who find capitalism disgusting.  Which gets me thinking: If capitalism made my flesh crawl and I knew socialism wasn’t coming anytime soon, how would I cope?  What is the best way for a can-do socialist to find socialism in a capitalist world?

Step 1: Live very modestly.  Shop at Walmart – or better yet, Aldi’s.  Move to a low-cost part of the country.  Don’t own a car; just take the bus – or Uber if you must.  Get books and DVDs from the library.  Buy durables at estate sales; they’re practically giving furniture away.  Use a 5-year-old phone.  Victims of consumerism may scoff at your frugal lifestyle, but you know that real happiness comes from autonomy and community.

Step 2: Cheat the rat race.  If you want to consume lots of luxury products, you’ll probably have to run capitalist rat races for decades.   But if you practice personal austerity, you have flexibility.  You can take a low-paid full-time job you enjoy.  You can take a better-paid part-time job you don’t enjoy.  You can run the standard rat race for a 5, 10, or 15 years – then shock your co-workers by retiring.  Or any mix thereof.

EconLog August 14, 2018

Interpreting public opinion, by Scott Sumner

I have now had a chance to read the paper I commented on yesterday, and I’ve seen the data that led to the conclusions reached in the abstract:

In 1932, the American electorate was surveyed in a poll that has languished in the archives. The survey was conducted by Houser Associates, a pioneer in market research. It interviewed face-to-face a representative cross section about voter choices and issue attitudes. Although conducted on behalf of the Hoover campaign, the poll was not biased in his favor. The most striking revelation is that the electoral sway of the Depression was quite limited. The government was not seen by most voters as the major culprit or as having been ineffective in alleviating it. Even many FDR voters agreed. Moreover, there was no widespread “doom and gloom” about the future. What loomed larger in 1932 was the issue of Prohibition. The American people overwhelmingly favored repeal. The Democratic stand on it—that is, outright repeal—was a sure electoral winner, given Hoover’s staunch defense of Prohibition.

This is certainly a plausible interpretation of the findings, but I still lean toward the view that the Great Depression largely explains FDR’s landslide, and I’d like to use this an example of why it is difficult to interpret survey results.  In doing so, keep in mind that Hoover won a 18 point landslide in 1928, and FDR won by the same margin in 1932.

EconLog August 14, 2018

Perverse Insurance Regulation, by David Henderson

In Leslie Scism, “The Problem With Government Flood Insurance,” Wall Street Journal, August 13, 2018 (print edition), an interview with Evan Greenberg, CEO of Chubb, Scism asks:

Will state insurance departments approve the large rate increases that insurers may feel necessary for homeowners if extreme weather leads to higher claims costs?

Greenberg answers:

For insurance lines that require filing rates with state regulators, premium increases are based on evidence of loss. You have to be able to justify the rates you charge customers. Some jurisdictions understand this and balance the needs of their constituencies. And some, for politically expedient or populist reasons, choose to ignore the need to raise prices, and I think that’s ultimately not in the interests of their constituents. When we can achieve an adequate rate, which we can in most instances, we are amenable to both maintaining and increasing our exposure. Where we can’t, we will shrink our exposure.

See the problem? I’m sure Greenberg does, but is simply happy to be able to raise rates based on past experience.

EconLog August 13, 2018

Be skeptical of surveys of public opinion, example #441, by Scott Sumner

Tyler Cowen and David Henderson recently linked to a study of the 1932 election by Helmut Norpoth.  Here’s the abstract:

In 1932, the American electorate was surveyed in a poll that has languished in the archives. The survey was conducted by Houser Associates, a pioneer in market research. It interviewed face-to-face a representative cross section about voter choices and issue attitudes. Although conducted on behalf of the Hoover campaign, the poll was not biased in his favor. The most striking revelation is that the electoral sway of the Depression was quite limited. The government was not seen by most voters as the major culprit or as having been ineffective in alleviating it. Even many FDR voters agreed. Moreover, there was no widespread “doom and gloom” about the future. What loomed larger in 1932 was the issue of Prohibition. The American people overwhelmingly favored repeal. The Democratic stand on it—that is, outright repeal—was a sure electoral winner, given Hoover’s staunch defense of Prohibition.

Here are the 10 latest posts from EconTalk.

EconTalk August 13, 2018

David Meltzer on the Doctor-Patient Relationship

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Physician David Meltzer of the University of Chicago talks about the power of the doctor-patient relationship with EconTalk host Russ Roberts. Meltzer, who also has a Ph.D. in economics, discusses a controlled experiment he has been running to measure the importance of maintaining the continuity of doctor-patient relationships. Meltzer argues that the increasing use of hospitalists–specialists who take over a patient from the patient’s regular doctor once the patient is hospitalized–has raised costs and hurt patients. The initial results from his study show that patients who stay with their doctors have fewer subsequent hospitalizations and have better mental health. The conversation closes with a discussion of the challenges facing the current medical system to adopt cost-saving or life-improving technology or techniques.

EconTalk August 6, 2018

Frank Dikotter on Mao’s Great Famine

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Historian Frank Dikötter of the University of Hong Kong and author of Mao’s Great Famine talks about the book with EconTalk host Russ Roberts. Dikötter chronicles the strategies Mao and the Chinese leadership implemented to increase grain and steel production in the late 1950s leading to a collapse in agricultural output and the deaths of millions by starvation.

EconTalk July 30, 2018

Alberto Alesina on Immigration and Redistribution

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Alberto Alesina of Harvard University talks with EconTalk host Russ Roberts about how people in the US and five European countries perceive the population and characteristics of legal immigrants. Reporting on research with Armando Miano and Stefanie Stantcheva, Alesina finds that individuals systematically overestimate the number of immigrants while underestimating their standard of living. His research also finds that support for welfare payments to the poor is related to the perception people have of the size of the immigrant population and their economic status. The conversation concludes with a discussion of why people’s perceptions are so inaccurate and the implications of perception for public policy.

EconTalk July 23, 2018

Teppo Felin on Blindness, Rationality, and Perception

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Teppo Felin of the University of Oxford talks with EconTalk host Russ Roberts about perception, cognition, and rationality. Felin argues that some of the standard experimental critiques of human rationality assume an omniscience that misleads us in thinking about social science and human capability. The conversation includes a discussion of the implications of different understandings of rationality for economics, entrepreneurship, and innovation.

EconTalk July 16, 2018

Russ Roberts on the Information Revolution, Politics, Yeats, and Yelling

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EconTalk host Russ Roberts does a monologue on how political discourse seems to have deteriorated in recent years and the growth in outrage, tribalism, and intolerance for those with different views from one’s own. Roberts suggests that part of the problem is the revolution of the market for information caused by the internet that allows people to customize what they see to fit their own political narratives and worldview. In short, the market for news works to make us feel good rather than to help us to discover the truth. The monologue closes with some suggestions for how we might improve the way we consume information and interact with those we disagree with.

EconTalk July 9, 2018

Patrick Deneen on Why Liberalism Failed

WhyLiberalismFailedBookCover.jpg Political Scientist and author Patrick Deneen of the University of Notre Dame talks about his book Why Liberalism Failed with EconTalk host Russ Roberts. By liberalism, Deneen means the modern enterprise–the push for self-actualization free of the constraints of tradition, family, and religion that typifies modern culture. He argues that both the left and the right have empowered the state and reduced liberty. He argues for a smaller, more local, more artisanal economy and a return to the virtues of self-control and self-mastery.

EconTalk July 2, 2018

Arnold Kling on Morality, Culture, and Tribalism

EconTalk.Kling.imageEconomist and author Arnold Kling talks about the economic impact of culture and morality with EconTalk host Russ Roberts. Drawing on a recent essay on the importance of social interactions, Kling explores the role of culture and norms and their broad impact on economic life. At the end of the conversation, Roberts discusses the implications of human sociality for the way economics is taught and the way economists think about public policy.

This week's guest:

This week's focus:

EconTalk June 25, 2018

Michael Pollan on Psychedelic Drugs and How to Change Your Mind

How%20to%20Change%20Your%20Mind.jpgJournalist and author Michael Pollan talks about his book, How to Change Your Mind, with EconTalk host Russ Roberts. Pollan chronicles the history of the use of psychedelic drugs, particularly LSD and psilocybin, to treat addiction, depression and anxiety. He discusses his own experiences with the drugs as well. Much of the conversation focuses on what we might learn from psychedelic drugs about their apparent spiritual dimension, the nature of consciousness, and the nature of the mind.

EconTalk June 18, 2018

Richard Reinsch on the Enlightenment, Tradition, and Populism

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Richard Reinsch, editor of Law and Liberty and the host of the podcast Liberty Law Talk, talks with EconTalk host Russ Roberts about the Enlightenment. Topics discussed include the search for meaning, the stability of liberalism, the rise of populism, and Solzhenitsyn’s indictment of Western values from his Harvard Commencement Address of 1978.

This week's guest:

EconTalk June 11, 2018

Moises Velasquez-Manoff on Cows, Carbon Farming, and Climate Change

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Journalist and author Moises Velasquez-Manoff talks about the role of dirt in fighting climate change with EconTalk host Russ Roberts. Velasquez-Manoff explains how changes in farming can allow dirt and plants to absorb carbon and potentially reduce climate change. At the end of the conversation he discusses the state of the science on hygiene, parasites, and auto-immune disorders that he discussed in his previous appearance on EconTalk in 2014.

 

This week's guest:

This week's focus:

Additional ideas and people mentioned in this podcast episode:

A few more readings and background resources:

A few more EconTalk podcast episodes:

 

| Time | Podcast Episode Highlights | | --- | --- | | 0:33 |

Intro. [Recording date: May 18, 2018.]

Russ Roberts: My guest is journalist and author Moises Velasquez-Manoff. He first appeared on EconTalk in March of 2014 discussing his provocative book, An Epidemic of Absence--his look at the idea that avoiding germs and parasites in modern times may have been the rise of very subtle immune disorders--asthma, various allergies. Today we are going to talk about a recent article he wrote in the New York Times--can dirt save the earth? And, if we have time we'll circle back to the story of germs and parasites. Moises, welcome back to EconTalk.

Moises Velasquez-Manoff: Thanks for having me. Great to be back.

Russ Roberts: No, your story in The Times starts with a little bit bizarre; and for me, as an economist, a fascinating story, even though it doesn't have that much to do with economics. But what it has to do with is complexity and emergent order, which of course I'm always interested in--as listeners know. Tell the story of John Wick and Peggy Rathmann--their cows on their porch of their house and what they discovered as they tried to live a wilder lifestyle on their ranch in Marin County--

Moises Velasquez-Manoff: Right. So yeah. So, in the late 1990s--so, Peggy Rathmann is a children's book author. And probably any parents out there, seems like anyone owns a copy of Good Night, Gorilla, including us, which is this classic children's book. She wrote that book and numerous others. So, she lives in San Francisco--lived in San Francisco in the late 1990s--and they needed more space because their apartment was getting full of their illustration. And her husband, John Wick, was then a construction foreman. So they started looking for places up north of San Francisco in Marin County and found this ranch of over 500 acres, which they ended up buying; and they bought it because they wanted--basically it had this huge barn that they wanted to turn into an illustration studio. And it gave them a lot of space. Ultimately that never panned out because the barn was oriented wrong for the light or something: it never really worked out. But, what did end up happening was that--so they were just enchanted with life up there, this bucolic life, lots of animals, and gophers; there were even mountain lions wandering around, as there are out here in the West. And, they decided to turn their land back to what they thought would be wilderness. So, it had--all that country is sort dairy country, or cow country. It's been that way for like a hundred years.

Russ Roberts: Not exactly wilderness, by the way. One of the stranger things is when you go north of San Francisco, you do see, on Route 1, you do see cows grazing. It's 1 or 101. Route 101, I think.

Moises Velasquez-Manoff: That's right.

Russ Roberts: You see cows grazing by the side of this road. Kind of wild, but they are cows--not so wild.

Moises Velasquez-Manoff: Yeah. No. Absolutely. It's a very agricultural landscape, and specifically dairy-oriented: for some reason, that climate produces--you get the marine zone wetness coming off the ocean, so even though it doesn't rain, like, except for 3 or 4 months of the year, you still get good grass growth there. I think that's one reason. At any case, so, some rancher had rights to their land, or the previous owner had sold rights, grazing rights. So they revoke those rights; they kicked the cows off the land in pursuit of going back to wilderness. And what happened was the landscape started changing right away, turning into something that they did not like. Which was, a lot of invasive weeds started moving in, and brush started moving in. I mean, if you know about ecological colonization theory, it's not that surprising. So, what happens is like, grasses are the first colonizers of a disturbed landscape; then brush moves in; then maybe some scrub--depending on what the climate allows for--some scrub trees. And they are probably the oak scrub forest or something naturally. And so, really what they were seeing was this sort of recolonization, without the grazing pressure, of these different plants which they didn't appreciate. Because, you know, you walk out to this landscape of rolling hills, verdant pasture; and all of a sudden it's becoming clogged with all these opportunistic weeds. Right? And they didn't really like it that much. So, they--first of all, John Wick went out and tried to actually, literally, kill some of the weeds back. There's one called the Woolly Distaff Thistle, which is--it's an invasive--it looks like a marigold on steroids. We have them in my backyard, too. It's prickly and has these yellow flowers--but it's a really powerful plant. It just moves in; it shoots in, and it's hard to like actually pull with your hands because it has these kind of spines on it. So, he was using these kind of herbicides and all sorts of stuff, trying to pull it out, mow it. Of course, none of that works. Because you are dealing with sort of this force of nature that's not--it's not sensitive to that kind of intervention. So, then they meet this rangeland ecologist, Jeff Creque, who says, 'Well, what you should do is instead of focusing on what you don't want to be there, trying to beat it back, you should focus on what you do want to be there.' And, so he looked at the hillsides and he said, 'I bet,' this is actually not in the article but he said, 'I bet that there are seeds in this dirt still from the old, perennial grasses that used to exist in California, pre-European contact.' So, like, in California in general, there have been grasses introduced with European, basically with cows when the Spanish first and then with the United States. So, annuals grow and then die in one year; and perennials are those more big, bushy grasses that live year after year; and they have these really deep root structures. So, he said, 'I bet there are perennial seeds in there, still, if you just graze the landscape in the right way.' So, yeah, so he said, 'If you bring back cows it could actually help with this problem that seems to have emerged after you kicked cows off.' Like, so, just to give some background again: Cows are generally, from the conservationist standpoint, are blamed for denuding landscapes; for desertifying them. And for good reason. I mean, that has happened around the globe, everywhere, throughout human history, where overgrazing has basically turned semi-arid landscapes into deserts. You know, all around the Mediterranean rim, and basically almost anywhere, throughout the American West, and anywhere that wasn't moist. And cows can be a horrible sort of environmental destructive force.

Russ Roberts: It's like--we had the same issue in Yellowstone, which I've written a little about and I think it's such a fascinating related story, where they get rid of the wolves, because people are scared of wolves, I guess; ranchers don't like 'em near the Park; the elk population grows tremendously, and as a result the elks denude--and eat down to the ground basically anything, all kinds of stuff, riparian systems around creeks and streams. And that ends up killing the beavers, because they have no stuff to make dams with any more. So you get this crazy thing that wolves are connected to beavers. If anything, you'd think wolves would eat beavers. And so, fewer wolves, more beavers. But if works the opposite way. And, you know, cows don't have any predators. So if you do keep them in one space, they will kind of eat everything. Well, they have predators; they have us. But I mean, if people want to keep a herd going, they are going to kind of eat a lot.

Moises Velasquez-Manoff: Right. So, Jeff Creque is basically making the point that if you graze cows like wild herbivores that are pursued by predators--so, the term is 'mob grazing.' That's one term. And the idea is just to keep 'em moving across the landscape. Don't leave them in one place too long. Keep a tightly packed herd, the way you can imagine a herd of buffalos pursued by those buffalo-wolves that we used to hear about back in those--those gigantic wolves that used to hunt buffalo on the plains--

Russ Roberts: 15, 20 feet long. Yeah. Hmh, hmh, hmh, hmh, hmh.

Moises Velasquez-Manoff: What, the wolves?

Russ Roberts: Yeah; I'm kidding.

Moises Velasquez-Manoff: I'm not talking about the dire wolves.

Russ Roberts: Kidding. Kidding.

Moises Velasquez-Manoff: Well, it's funny, actually--I was reading--this is a little bit of [?], but I was reading Laura Ingalls Wilder, The Little House on the Prairie, to my daughter a few months ago. And they saw some of those--you know, when those settlers are moving onto the Plains, they still saw some of huge wolves that were remnants of an older population--they were just getting killed off--that used to hunt buffalo on the Plains in the Dakota. In any case. So, he brings the cows back and then manages them in this new way: Instead of just letting them free-roam, basically, he cut up his land, if I recall correctly, like 67 different separate lots that he moved them between. So that each lot would get intensely grazed for a very short period of time. And, sure enough, the landscape responds. Their pasture returns. And, actually, what's interesting, is he tells me, John Wick tells me, that weeds actually taste very good to cows. So, the weeds are like the first things to go. I mean, in a way it makes sense: Like, any plant that has prickles and stuff all over it is a plant that probably tastes pretty good. That's why it has prickles all over it, to defend itself. So, the landscape is reverting back to what they considered to be, what they really wanted when they thought of wilderness. Which is not at all wilderness. Right? It's more of a graze ecosystem.

| | 10:14 |

Russ Roberts: It feels like wilderness to us, because we don't know what the real thing was.

Moises Velasquez-Manoff: Yeah, but honestly, if you go back to pre-, like the Native American times, that's what these ecosystems were. They had large grazers like elk. And they had lots of predators, like big cats and bears. There was grizzlies out here in California.

Russ Roberts: And humans. Yeah.

Moises Velasquez-Manoff: And humans, of course. And pre-native American, there were even larger grazers. You know? There were these mastodons, and the mammoths. I'm not sure which ones were out here. But, huge grazers were out here shaping the landscape with huge predators following them. So, this is what exists when people don't interfere. Long story short; I'll fast forward here. So, they become curious about--Jeff Creque is very interested in climate change. He's worried about it. He thinks--he's interested in the idea that you can get carbon into the soil from the atmosphere. And basically how that would work was the plants, of course, capture carbon dioxide during photosynthesis. And, they use the carbon to build their own tissues, as well as to, they excrete sugars into the soil to feed micro-organisms, that then, in exchange for those sugars give them other nutrients that the plants might not be able to get on their own. So, he urges John Wick to get in touch with the soil scientist at U.C. Berkeley, Whendee Silver, and they basically come to an agreement where she's going to study their land and see if they are getting any carbon into the soil, doing what they are doing.

Russ Roberts: And the argument-what would be the logic? Because they've got a richer grassland now?

Moises Velasquez-Manoff: Yeah.

Russ Roberts: They'd maybe absorb more carbon from the air nearby, and that carbon would show up either in the soil or the plants themselves.

Moises Velasquez-Manoff: That's right. And there is--there is a whole sort of--well, there is an argument out there that I did not go into in this article. But, I guess its major proponent is a land manager named Allan Savory. And he gave this TED Talk--he's very influential in ranching circles; very controversial in scientific circles--mostly because the evidence of what he says is possible doesn't exist yet.

Russ Roberts: Yeah, 'We'll find it. Give us time. We'll make it up if we have to.'

Moises Velasquez-Manoff: But he makes his argument-- That's where we are, kind of. So, he basically argues that if you just graze right in this way, this mob-grazing way, which he calls 'holistic management,' that you can actually--we can deal with climate change. You can [?] the world's deserts, and sort of--it's the opposite of what most conservationists think about cows, which is that we should get rid of cows because they not only denude the world, semi-arid regions; they also belch methane, which is a greenhouse gas that's about 30 times more powerful than carbon dioxide.

Russ Roberts: But the argument here is that cows are going to allow healthier--even though they themselves might not be so great, they are going to clear a path for some really good things to grow in the soil, and improve the soil so that there will be less carbon in the air. And then it's an empirical question of whether they are a net positive or negative. And then there's another empirical question of whether you can get those benefits without cows, somehow.

Moises Velasquez-Manoff: Yeah. So, I think fundamentally, if you back up: The premise that grasslands can capture huge amounts of carbon from the atmosphere and put it in the ground is absolutely true. Some of the richest soils that we have are, were formerly grasslands. Like, the Great Plains. Like the Midwest. Like the Ukrainian Steppe. These were all grasslands before we plowed them up to plant stuff. And that, like, that is it, like 7 feet of topsoil or something, in Iowa? Like some amazing amount. And that soil is just incredibly rich? Those same ecosystems also hosted huge wild grazers. Right? I mean, there were just herds of, millions of buffalo running up and down the Great Plains.

Russ Roberts: Lewis and Clark, what they saw when they went there.

Moises Velasquez-Manoff: That's right. And, in Eurasia, it was, maybe horses; I mean, since there was this sort of human footprint it was a little bit bigger there. But there were also huge grazers there, as well. So, it's fundamentally true--there's also this Paleobotanist at the University of Washington, if I remember correctly, Gregory Retallack, who argues that in deep time, the co-evolution of large grazers and grasslands became so efficient at pulling carbon out of the atmosphere that it actually reduced the amount of carbon dioxide in the atmosphere such that it triggered the ice ages, which begin around 2 and a half million years ago; before that there were no, sort of, these periodic glaciations that we call the Pleistocene. That, they weren't happening. Right? Earth was kind of in a different sort of phase, where it was just a lot warmer all the time. So, he makes this argument that it actually cooled the earth and caused this, and these periodic glaciations. So, I think that's fundamentally true. And when we think about grazing and grasslands. But, whether or not cows, which are domesticated animals, can do, replicate, what happens in nature is, you know, still an open question, I think. Right? This is this idea that's out there that John Wick and Jeff Creque were interested to see if they were doing. And, actually, I should point out that they discovered that it wasn't happening. There was not carbon getting into the ground from grazing. So, what ends up happening--I'll back up a little bit from that point--is that they start their--Whendee Silver starts their studies with a series of just baseline measurements in Marin and Sonoma Counties of rangelands, just to get a sense of how much carbon is there to begin with. Right? In the soil. So, they dig these 3-foot long soil cores out of the ground and examine them. And, what she discovers is that dairies--dairy farms--have a lot of carbon in them. And it's very recent carbon. Like, it's got there recently. It arrived into the ground recently. And, so they go around asking, 'What are you guys doing different on these dairy farms?' And what they do is they: Dairy farms, they milk their cows; they take them to a central shed. And they have a lot of manure they have to deal with. It's a huge problem, actually, in dairy farming, in the sense that you just have to manage a lot of manure. And they use water to wash it away. And so they end up with this kind of slurry, this manure slurry. And what they did, a lot of those places, a lot of those farms, is they sprayed it back on the land as a fertilizer, in a way as a way to manage it. So they were basically--what she discovers is that there are things you can do to your land that increase the carbon content of the land. Right? And that dairy farmers are already unwittingly doing this. So, they decide: Maybe we can replicate this--John Wick. He says, 'Maybe I'd like to be able to replicate this, but I don't want to use cow manure. Because cow manure releases lots and lots of methane, which is a powerful greenhouse gas, and lots of nitrous oxide--an even more powerful greenhouse gas.' So the numbers are like methane is around 30 times more powerful than carbon dioxide; and nitrous oxide is around 300 times more powerful. So, they--Jeff Creque--he had been an organic farmer, so he was very familiar with compost. And compost is basically just--it's food scraps or shredded trees or any kind of organic material, really, that's been decomposed, partly decomposed, by microbes--by--these are microbes that are not anaerobic. So, like, the key to composting is, of course, anyone who has a backyard compost pile knows, is you have to constantly sort of turn the pile to keep it aerated--to keep oxygen in there. Otherwise you start getting really nasty smells. And, from the scientific point of view, you start getting those powerful greenhouse gases. So, they put a bunch of compost--about half an inch--over a few acres. But what they discover over the following years is that compost seems to act like, on one hand, like a kind of fertilizer--a long, slow-acting fertilizer on the landscape. So that it supercharges the grass growth. This is rangeland. This is land that is being--you know, it's grass, it's being grazed at the same time. So, it makes about 50% more grass grow. Which is great. It's great for anyone who has cows on the land--which John Wick does have. And it causes--it allows more water to be absorbed or held in the soil, because the more organic material you have in the soil, the organic material acts like a sponge and holds the water. So there's more water stays in the soil. This again, this is grassland that gets water only in the winter, really; and then, the rest of the summer here in California, on the Coast, we don't really get any rain. Except we get this marine layer moisture that comes in, but that's it. And then, what's happening also is that carbon is going into the ground at an incredibly rapid rate. So, and in untreated control plots, the carbon is getting lost from the ground. This is just--nothing is happening on the land; land is being grazed; carbon is seeping out of the ground. And no one is really sure why this is the case; but it's likely that it results from that transition I mentioned earlier of the kinds of grasses that grow there: from the old, perennial kind, which are--you know, they grow, year after year of the same plant, and they have really deep root structure, so that, those deep root structures push carbon into the ground, or deposit carbon in the ground--and annuals, which don't have these deep root structures. So, the landscape had gone from perennial to annual. And that probably causes, caused over time, a loss of carbon. But, on the treated plot, the opposite happened. Carbon was getting absorbed. And most of that carbon--so, compost is very rich in carbon. Obviously, anything that's organic has a lot of carbon in it. It also has nitrogen and a lot of other stuff in it. Um, but the carbon that was going in to the treated lots was, most of it was not from the compost. Most of it was from the air. Meaning that: She had--she, being Whendee Silver--had basically caused the ecosystem there, in that treated plot, to become so, to accelerate at such degree, to accelerate photosynthesis, that there was just carbon being pumped into the ground.

| | 21:04 |

Russ Roberts: So, I'm going to pause you here, because it's a little bit complicated. And I just want to let--do a little reset here for listeners. First, I want to point out something you point out in the article, which really, an incredibly beautiful idea, that of course the carbon that we use for energy purposes, like oil, is the result of this process from billions of years ago. That, plants absorbed carbon, died, went into the ground, and eventually turned into petroleum. Correct?

Moises Velasquez-Manoff: That's right. I think oil actually comes from some--but, I mean, fundamentally, yes, you are right. But oil comes from a marine process. Coal comes from a wetland process. But, yes, you are fundamentally correct. All that carbon came from photosynthesis and got deposited somewhere. And then got buried at some point. And then was fossilized after it got buried and became this fuel that we now power civilization with.

Russ Roberts: Right. And we create civilization with it. And we pump a lot of it into the air as a result. And, it seems to be getting a little bit warmer. We can debate about how much. I'm a lukewarmer. The meaning--I think there's some warming; I don't know whether it's catastrophic; but I am worried about it a little bit, I think, because you should always worried about the downside risk that could be catastrophic. I learned that from Nassim Taleb. And common sense. And so, that's just a beautiful thing, that we could recreate that, use that same process, to get the carbon that's in the atmosphere now back into the ground. It's kind of a cool thing. The economics of it, of course--and by that I mean not the financial part, but the big picture economics--is: This does strike me as--my favorite Hayek quote: "The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design." So, part of this--your article has this really crazy idea that somehow we are going to re-engineer the soil to solve this other problem we've got over here. And we don't really understand the whole thing, really that way. We get glimpses of what's going on. We run this one study--Whendee Silver's done it--that looks encouraging, this incredible reduction of carbon. But we don't know if it's going to scale. We don't know what the other effects are. We don't know if by spreading compost in a really wide range across all kinds of different terrains, what could happen. But, the bottom line is this encouraged people to start thinking about one way to fight global warming, and climate change: Which is to change farming rather than, say, cars. Which is really interesting. Which is why we are talking.

Moises Velasquez-Manoff: That's right. And it's often these, these modifications in the agricultural world, are a lot cheaper than, you know, photovoltaic panels on all houses, or all this more high-tech stuff. Because, you are just tweaking how you do what you already are doing, in some respect. And I should point out that, um, this is often thought of in the circles of people, the proponent circles, as being beneficial to the farmers themselves--

Russ Roberts: And we're not going to punish them--

Moises Velasquez-Manoff: That's right--

Russ Roberts: for their bad use of cows and therefore put a big tax on cows, or force them to change. We're going to find a win-win, is the ideal.

Moises Velasquez-Manoff: Well, it's more that, um, by getting carbon in the soil, you actually improve the efficiency of fertilizers. So, like, you need basically less fertilization of synthetic fertilizers the more carbon you have in the ground--

Russ Roberts: They are expensive--

Moises Velasquez-Manoff: That's right. You save money. And there are a bunch of other things, as well. Like, I mean--it's interesting because, a lot of this stuff was clearly known before the advent of the modern agricultural tool kit. We know of synthetic pesticides and fertilizers. This is what farmers had to do before, you know, the 19th century when [?]

Russ Roberts: spread a lot of manure. Yeah.

Moises Velasquez-Manoff: But they knew that you had to return all organic material to the land. Otherwise your land would stop producing. Right? And so, like, there are these--there were these revolutions in Europe, for example, where they sort of centralized the cow barn to all--in terms of all the fields--so they would be in the middle of the whole operation, so that they could get the manure back to the fields easily. Right?

Russ Roberts: It's like the spoke and hub airline[?] system. It's great.

Moises Velasquez-Manoff: Right. Right. Exactly. And they were often getting human waste back to the fields. I mean, there is a point where there was competition for the nitrogen in human waste for producing making gunpowder with it, rather than putting it back in the fields. Right? In Europe.

Russ Roberts: I like your term--I think you mentioned it in one of your [?]--'humanure'. I don't know how to pronounce it--hu-manure. But that somehow--there are other words for it; we won't use them on the program, but that's an attractive name for it.

Moises Velasquez-Manoff: The other term is 'night soil,' which is used in the early 20th century, which is just, whatever is in your chamber pot, which is another nice euphemism, went back on the garden in the morning. Right? And this is part of how agriculture worked, because otherwise your land would, after repeated growing, your land would start to lose its fertility and nothing would grow there. The other aspect of this was that you would rotate what you did on your land: crop rotation. You would change what grew where, because different plants both feed the soil in different ways and also take different things out of the soil. And you would also rotate in grazing with your farming. So that, you would let one field that, let's say, grew corn last year, you would just let it go to pasture and graze on it for another year; and then plow it the following year. These are all techniques to maintain fertility. Which, I guess they are just sort of coming back, because after almost a century of doing everything synthetically, a lot of the land is, in the United States and in the world, in the developed world, is exhausted--

Russ Roberts: is tired. You have an amazing statistic in here which I just never imagined to be the case. I assume it's true. "More than one third of earth's ice-free surface is devoted to agriculture." Part of the reason it's hard to believe is the United States, which of course has, for better or for worse, probably the world's most productive agricultural system--in certain crops for sure; I don't know how widely that's the case. But, we've got some great--we've got great machinery, to keep the price down; and we've got great synthetic stuff to keep yields high. And we have great seeds; and we're at the cutting edge of everything. But most of the world is not. A lot of the other parts of the world are not, and they need a lot more land to grow food. And it just--right? It's just surprising that that--

Moises Velasquez-Manoff: That statistic also includes rangeland; and about two thirds of what we do with land in the world is grazing it. Just like one third of that is actually used to grow crops. Because, most marginal land is used for grazing--like the hills and stuff, you can't plow up. That's just--you let cows roam on it; and especially in poor countries, you are able to get another protein source from that grass, that land from which otherwise you wouldn't be able to get anything from.

Russ Roberts: Right. Cool.

| | 28:42 |

Russ Roberts: So, where are we? So, this experiment gets done. Talk about where--I just like that story; for a lot of reasons, I like it, because of the unintended consequences part of it: The fact that these people hated these cows and thought that by getting rid of them, they'd make their land better when in fact their land got, to their eye at least, worse. The other thing I like, I just want to mention because I don't want to miss this chance, Moises, is that your research interests and interests as a writer strike me as united--I'm sure; I assume you've thought about this, but maybe not--so your first book--I don't know if it was your first one: An Epidemic of Absence: A New Way of Understanding Allergies and Autoimmune Diseases is about the microbiome; it's about our gut. And this article and other stuff we are talking about is about the soil. And on the surface they have nothing to do with each other. But, they are united in a couple of ways. One way is that they are both about complex ecosystems, emergent orders that are not easy to look at.

Moises Velasquez-Manoff: That's true, yeah.

Russ Roberts: So, the soil is underneath the ground; and my gut is inside my body. And so, they are complicated systems; they are hard to get at. And as a result, there's all kinds of things to be discovered there that may not be obvious and are connections you don't get to see and might not appreciate. So, I don't know--there's a symmetry in your work there that I love. And then there's cows. Because, cows are good for the soil, and they may appear to be good for helping us fight autoimmune disorders by introducing parasites and other things into our microbiome that we've lost as we've moved away from agricultural life. If we have time, we'll come back and talk about that and the gut. But I just wanted to point those out.

Moises Velasquez-Manoff: Yeah. Well, actually, they're more closely linked, these two big themes in my work, in the sense that the microbiome of the soil is also what's responsible for the carbon sequestration. So, the plants--basically, what plants do is they capture carbon from the air, and beside making their plant forms, their actual tissues, they create sugars with a huge amount of the carbon that they get from the air. And those sugars go right into the ground to feed the microbiome of the ground. So, there is this whole microbiome in the ground--I mean, this whole ecosystem really in the ground, that's being fed--the plants are basically working as pumps. Carbon pumps. This is how it was described to me by, I think, Whendee Silver, I remember. But, the purpose of the plant in this big ecosystem is to just pump sugar into the ground, or other kinds of carbon, long carbon chain molecules, that are then consumed by this incredible array of life in the soil, that then returns other nutrients in exchange for those sugars. But that is the carbon pathway of how you get carbon from the air into the ground--is, basically, by passing it through all these life forms. And huge chunk of those life forms are microbes. In the soil. So, basically, healthy soil is basically about a healthy soil microbiota[?]

Russ Roberts: It's all about the gut. Whether it's inside you or underneath the ground. It's all about the gut.

Moises Velasquez-Manoff: That's right. You can think of the soil microbiome as a kind of analog to the gut microbiome, in a way. It sort of powers everything. Like you said. And yet we don't pay much attention to it. We haven't historically.

Russ Roberts: Well-- go ahead. Sorry.

Moises Velasquez-Manoff: Well, I was going to say that the advent of genome sequencing technology is letting us see both these microbiomes in a way we absolutely could not see them in times past. That's another part of this story.

Russ Roberts: When I was a little boy, I did not grow up in farmland. I grew up in suburban Massachusetts, mostly, in Lexington. And we'd go out--we'd play in the dirt. And we loved worms; and I like to fish; so we'd dig up dirt and find worms in there. And if you'd asked me, since I didn't have a farming background, 'What's underneath the earth's surface?' it's--well, it's dirt and worms. Well, of course, I'm getting there. But the idea of the richness of soil, the chemical composition of soil, the difference between dirt, clay, and, say, loam--a rich, fertile soil--people for most of human history were obsessed with it. We're not really that involved with it. I'm going to read one more thing from your article, by the way; and then we'll get back to the policy stuff. And I hope listeners are enjoying this, because to me it's extremely interesting. But we'll get to some policy implications in a second. It says--you are talking about when they brought the cows back to the Marin County acreage that Wick and Rathmann, the children's book author at their ranch. It says,

By summer's end, the cows, which had arrived shaggy and wild-eyed after a winter spent near the sea, were fat with shiny coats. When Wick returned the herd to its owner that fall [Russ Roberts: This is the herd that he had grazed on his land to try to get it back into shape] collectively it had gained about 50,000 pounds. Wick needed to take an extra trip with his trailer to cart the cows away. That struck him as remarkable. The land seemed richer than before, the grass lusher. Meadowlarks and other animals were more abundant. Where had that additional truckload of animal flesh come from?

And, of course, the answer is they were eating carbs. Which brings us back to other EconTalk episodes.

Moises Velasquez-Manoff: That's right--

Russ Roberts: Carbs and weight gain. So, I just thought I'd bring that in. I loved that. So cool.

Moises Velasquez-Manoff: Yeah; that's right. And, of course, those carbs were coming from the sky. I mean, that's the whole--the carbon cycle, that we often forget. But the carbon cycle basically begins with photosynthesis. And then you eat the plants that have captured the carbon; and then plants eat those--I mean, other animals eat those animals, on down the chain. And they decompose, go into the dirt; other plants grow out of it. And eventually all that carbon is released back into the atmosphere--that, the carbon represented in that first plant that grew that was eaten by the cow. But that's the short-term carbon cycle right there.

| | 34:38 |

Russ Roberts: So, what is this--this is really cool. It's fascinating to me; it's interesting; it's a beautiful example of the seen and the unseen, a theme I love in economics: emergent order, things that are complicated and related to each other in not-obvious ways. Which I love. But, is it important? Is it really a potential mitigator of climate change in any way? And, who is skeptical about it? Why are they skeptical? You know, obviously, if it was good farming practice across the board, it would just happen. Is there something that people are trying to encourage artificially? Are there subsidies, or various regulations? And, what's the potential? What do you think? It's a great story. Is it--is it of any meaning?

Moises Velasquez-Manoff: So, carbon farming with compost is just one method of carbon farming. And carbon farming is the idea that if we can get carbon into the air, into the soil or into just living trees or plants, you know, woody material that's not the atmosphere, right? So, well, so, there are other methods of doing this that don't involve compost, like, you know, cover crops. Some of the older stuff that I alluded to earlier--the older agricultural methods that, because in the past, when we didn't have synthetic fertilizers and farmers who naturally obsess with soil health--you know, they maybe call it that. They sort of developed all this stuff. And so, there's a movement now, afoot, independent of what John Wick and Peggy Rathmann are doing, sort of encompassed under the moniker 'Regenerative Agriculture,' where they are trying to--a lot of the agricultural land in the world is exhausted, because it's just, you know, we've basically plowed the hell out of it and doused it with herbicides and pesticides, and fertilizers, when it was losing fertility. So, the idea is to sort of regenerate some of the soil. So, I visit one other farmer who is doing this stuff as a way to just farm more efficiently. And, um, to answer your question: because, we have to think of this as a suite of practices, right? It's not just compost. There is a whole number of things you can do. And the idea is to get farmers who are cultivating crops to take up some of these practices. And these guys--there's a number of people around the States now doing this--Gabe Brown, I reference: he's sort of a pioneer--they say that they are producing crops with fewer fertilizers, fewer pesticides. These are not organic heads. You know. There's no ideology here. What they are trying to do is farm more efficiently so they can make more money. Right? And--

Russ Roberts: Nothing to be ashamed of there.

Moises Velasquez-Manoff: in being more efficient-- No, no. These are not--not that there is anything wrong with California hippies. But these guys are not California hippies. They are sort of middle-country, just regular farmers just looking for ways to do things. I mean, farming is a difficult business. The profit margins are so, so slim. Right? And so, anything you can do to keep more of the money that you generate is good. And what these guys do, it sounds like I've talked to a few of them, is that by focusing soil health, they reduce their pesticide use, their fertilizer use, their herbicide use. You know, they get basically nitrogen into the soil by using cover crops--cover crops like legumes. Legumes have the nitrogen-fixing bacteria in their roots. So you get that in there naturally without having to purchase synthetic fertilizer. And I know people will say fertilizer is cheap. But I also--you know, the profit margins are so slim, anything you can do is going to help you out. And so, what they do is they produce crops, they say, for about 20% less than conventionally-farming people. And so you see[?] realize[?] everyone doing this. What they are doing, right?

Russ Roberts: Let me guess--one reason is these are smaller farmers than the largest farmers in America--I assume is part of it.

Moises Velasquez-Manoff: That's part of it. But that is not the answer that they give. The answer that they give is that, people don't want to change the way they've farmed for, perhaps, generations. And, in a way admit--they know, and admit in a way that they made a big mistake--

Russ Roberts: Yeah. Sure. That's no fun. It reminds me of the doctors who thought women were dying in childbirth because the windows were open, and that brought in bad air. Right? And, while, what's his name--

Moises Velasquez-Manoff: Semmelweis--

Russ Roberts: Semmelweis,
God bless him, although it took way too long for people to agree to it--he said, 'Maybe you should just wash your hands.' He did a little, quick experiment, showed it; and they weren't convinced. Because it was one experiment. It was a small sample. For him it was so obvious, he didn't even to make it larger. But, for them, it was like, 'You're telling me that I've been murdering women because I went for the morgue, [?] in childbirth to go deliver her baby, and you're telling me for the last 30 years of my life, I'm a killer.' And he just couldn't face it. I think that's a huge part--there's a huge psychological part to that. Yeah: You've been an idiot, in this case; and maybe you've damaged the environment, too. It's no fun.

Moises Velasquez-Manoff: And, by the way, Semmelweis ended up dying in an insane asylum.

Russ Roberts: Yeah, I forgot about that. But he wasn't--go ahead. He wasn't fully appreciated. He resented the fact that in his lifetime, his ideas were seen as quackery.

Moises Velasquez-Manoff: Absolutely.

Russ Roberts: I don't know if that, literally--

Moises Velasquez-Manoff: An insane asylum.

Russ Roberts: I don't know if that literally drove him crazy or not. I wonder if--

Moises Velasquez-Manoff: I think probably syphilis drove him crazy. But that was the big--it is a huge tangent. But, the idea being that you can be right and never be recognized for it and in fact be sort of marginalized, easily, in your lifetime.

Russ Roberts: Well, Milton Friedman stayed happy and cheery even when he was in total intellectual desert and laughed at because he thought that inflation was caused by printing money. So, he's always my exemplar of the other part--

Moises Velasquez-Manoff: Well, there you go--

Russ Roberts: But, plenty of people do, at least become bitter and deeply troubled by the fact that the world doesn't recognize them for their genius. And, he was--I don't know if he was a genius or just lucky, but he was right. We know that now as much as we know anything. And it must have been no fun to think that people were dying because people didn't accept his ideas.

Moises Velasquez-Manoff: Yeah. And in this case, and in the farmers' case--so, I mean, they don't care if other farmers accept it. Because they are making a profit. They are [?] as they did before. And they also--truth be told, so the guy I profiled in Kansas, Daron Williams[?], they are also selling to these niche markets where they can get slightly more money for their product. Because they can say, you know, 'This is cows, raised in such-and-such fashion.'

Russ Roberts: Correct.

Moises Velasquez-Manoff: But, not all of them are. There is a guy, Dave Brandt, out in, I want to say, I think he's in Ohio. He's using cover crops--no animals. He's competing directly in the commodities market. And he's getting--he says, 'Yeah, I produce stuff about 20% cheaper than all my neighbors. So, it's not--it's not absolutely true that, like--for example, if we think of that, if we could scale all this up, will that little advantage of having that niche market would go away. Right? Because there would be no niche market any more. But this guy is competing in a huge market already; and he's doing fine. So, I don't know. So, I mean--

| | 41:49 |

Russ Roberts: So, I guess, just to bring in a little more economics--and I think you alluded to this in a phrase, maybe a sentence in your piece. But, if everyone did it, and it brought down the cost of production enough that it lowered price, through competition, people would eat more of some of this stuff. And that might offset some of the gains, because there would be more land, then, devoted to some of these products. And so--the world's a complicated place.

Moises Velasquez-Manoff: It is complicated. But, I think that what is indisputable, or at least somewhat indisputable, is that--

Russ Roberts: Oxymoron of all time, Moises--I love that--

Moises Velasquez-Manoff: Right, is there a softer adjective for 'indisputable?'

Russ Roberts: It's like somewhat literal. Is it figurative, or is it literal?

Moises Velasquez-Manoff: Yeah. These guys, their land is more resilient when they farm it this way. So, they are more--they are better able to withstand the inevitable shocks of farming life, like not enough rain. For example, if you have more carbon in the soil your crops are more resilient because there is more water stored in the soil. Not having to use as much fertilizer because you have more carbon in the soil. So, there's a way that it improves farming such that, you know, they are constant sort of shocks from price to weather to what have you in farming that you are insulated a little bit from those shocks because your soil is healthier. And I that is something that everyone could get on board with, in theory. The flip side, though, is this psychological aspect of tradition that we talked about. And I have to say that the one practice that people have the hardest time--and I do, too, in some ways--considering that it might have been a mistake, is plowing. So, these guys are all doing no-till growing, which means they don't plow any more. Because plowing causes carbon soil loss. So, it's like 10,000 years of agriculture [?]--

Russ Roberts: Human history--

Moises Velasquez-Manoff: right? And all of a sudden, it's been a mistake?

Russ Roberts: Yeah; we call it 'working the land.' You tell me I'm not supposed to work the land any more? It's--yeah. That's kind of weird.

Moises Velasquez-Manoff: Well, the reason it is, is because we plow because it sort of loosens up the soil, obviously. And you can use cover crops also to loosen up the soil. Like, these guys all grow these huge daikon radishes that are like--feet long. If you look at photos of what David Brandt grows, they're like 2 feet long, these radishes. And they break up the soil--these huge roots going into the soil break it up. That's number one. And number two is, you plow to limit weed growth. And, what these guys use instead is--First of all they graze their land; they rotate grazing into their land. And they use carbon crops to basically--what they are doing is engineering an ecosystem, where weeds can't get a foothold. So, when you grow crops there that grow really high, you are squeezing out the weeds. You are not allowing the weeds to take root.

Russ Roberts: It's just so incredible. Yeah. There's something really beautiful about it, right? And I love the inevitable trial-and-error: they are trying different things. Like, I'm sure the first guy trying this didn't say, 'Daikon radish. Of course.' You know, somebody thought of that idea and tried it, and it seems to work; and it's a beautiful thing.

Moises Velasquez-Manoff: Well, you know, Gabe Brown pioneered a lot of this. He's in North Dakota, in the 1990s--incidentally, because he had--his crop had been ruined by hail for three years in a row, and banks would no longer lend to him. And so, he had no way to get to pay for things he needed to pay for conventional farming. So, he said, 'Well, how am I going to farm?' And then he thought, 'Well, how did the guys used to farm before they had synthetic pesticides and all this other stuff?' And he ended up reading the journals of Thomas Jefferson, who, you know, ran, like a--

Russ Roberts: a farm--

Moises Velasquez-Manoff: Yeah. Not just a farm--a plantation. Right? So, he read, and there he learned about crop rotation and using livestock. And you know, they had all this stuff figured out. And I think maybe even some of the carbon crops[?], at least the rotation of part of the carbon crops[?]. And then he also read about how Native Americans used to farm on the Great Plains. And, there he learned about legumes and mixing crops together. Legumes and corn. You know--the legumes get the nitrogen into the ground. And they provide, like, a way--the corn provides a way for the legumes to climb up. And the sort of idea that you are really creating an ecosystem more than just growing a mono-crop. Which you then harvest.

| | 46:34 |

Russ Roberts: So, what's the potential for those? Is it going to make a difference, or is it just a cool thing for a few farmers?

Moises Velasquez-Manoff: Well, the farmers--these guys are already running with it. We'll see how--I mean, that's sort of happening on its own. How we're going to yoke all of this to deal with climate change is, I think, a bigger question. I think we need some incentivizing to happen. That is--and there are some really interesting ideas out there. Like, so basically what you want to do is to incentivize farmers to treat their land a little bit differently so that they can get paid for carbon that's stored in the soil. So, obviously that's not going to happen under the current, the Trump, regime. Right? Because they don't believe climate change is real, or at least that's what they say. But, there is this--let's just assume that we come to our senses regarding climate at some point. And, again, this is an idea that is not only good for climate, it is good for agricultural land. Right? And we are--I spoke to some people who said, 'We are facing this much bigger problem: We basically don't have any more agricultural land. But we need to start, we need to feed a lot more people.' So, it needs to be more productive than it is. Now, you could say, 'Well, yeah, let's stop giving, you know, all our spare corn to--to the animals'--

Russ Roberts: Yeeah. We've got so many other problems. We've got so many problems in the agricultural area. I mean, we've artificially privileged corn, for starters. We pay people way too much money to do something that comes naturally--which is growing food for people in the name of "food security," which I think is just a cover for giving money to your friends. So, there are a lot of things we can do to fix agriculture. But, whether agriculture could be part of a climate-change solution, if things get bad, I think is definitely important. Worth considering.

Moises Velasquez-Manoff: Yeah, but I--I think you are not going to get farmers on board talking about climate.

Russ Roberts: Nope. Right. Correct.

Moises Velasquez-Manoff: Half of them don't believe it's even real. I could mean that--I don't know that for a fact. But, for example,--

Russ Roberts:"Survey says...."--

Moises Velasquez-Manoff: Just talking to the farmers that I talk to who are doing it for regenerative agriculture, they are like, 'Climate change? Whatever.' You know, 'I just have to make sure that I manage [?]'

Russ Roberts: They are just trying to do their job. They are not so interested in public policy. I get it. I am sympathetic to that.

Moises Velasquez-Manoff: No, they--it's more than that. It's that they don't believe it's real because they read state people.

Russ Roberts: Yeah--

Moises Velasquez-Manoff: They get that media.

Russ Roberts: Well, I'm a little bit of a skeptic, too. I'm agnostic. I don't think it's false. I don't think it's fake. I think it's true that there has been some warming. We don't know how much. It's troublesome that it hasn't gone up a lot over the last 20 years--the temperature hasn't in the face of an enormous amount of extra carbon. Which suggests we don't fully understand the mechanisms. But, as I said--I think we should be cautious about it. But, for whatever reasons--not everybody agrees--and, it's--then you get the question: You're going to make them do something they wouldn't actually want to do. So that's going to be a lot harder.

Moises Velasquez-Manoff: Well, yeah, first of all, you--I think the evidence is much stronger than you alluded to, that climate change is real and caused by humans. But, that's a whole different show, and many other shows.

Russ Roberts: Yes it is. Correct.

Moises Velasquez-Manoff: So, how are you going to get farmers on board, getting carbon into the ground? Well, you incentivize it through several possibilities. One is, in California, we have this Healthy Soils Initiative, where they are helping fund some of this stuff, because it often costs, you know, changing the way of doing stuff costs money up front. So that taking money from the State's carbon mitigation funds--so, California has got this ambitious plan to reduce our carbon emissions by, you know--the number actually I think is by 80% by 2050 or something like that, even though that isn't fact checked.

Russ Roberts: If you keep raising the income tax, you'll do it easily. Because enough people will want to leave--move to other states--that you'll have fewer cars. Nah; I'm just giving you a hard time. I'm sorry. But I do think, to be serious for a second: I think the environmental movement as well as legislators need to think long and hard about how we spend our money to make the world a cleaner place. And, spending it wisely is always a good idea. No matter what you agree. No matter what the dispute. And, it's probably--right now, many things have been subsidized that are either not good or don't help or are actually counterproductive. So, it would be good to spend some money--that we already are allocating. Maybe move it away from some things and toward other things.

Moises Velasquez-Manoff: For soil, here, there's now some money available to people who want to try to get carbon in the ground. And so, actually, this has been promoted. The carbon farming idea has been promoted--just as good agricultural practice--by a Department in the USDA [U.S. Department of Agriculture]--already. The Resources Conservation Service. Which is--this is a little-known-about--sorry, the NRCS, National Resource Conservation Service--that was founded in the wake of the Dust Bowl. Which, of course, is this huge agricultural--

Russ Roberts: dramatic [?traumatic?]--

Moises Velasquez-Manoff: dramatic experience that happened that we forget about. But basically we plowed the hell out of land that shouldn't have been plowed. And then, in conjunction with some dry years and a lot of wind, the topsoil--like, the entire upper Great Plains ended up blowing away. And if you read about what was happening at the time, like, the sky was red as far away as Washington, D.C. I mean, it was like a huge environmental catastrophe. And it was driven by farming. So, they founded this organization--it wasn't called the NRCS then, but it is now. And they focus on soil health, and in recent years they've been trying to promote soil carbon. And they have like 35 practices, 30-some practices that they consider that sort of build--that deal with this problem of, if you plow your land, you are going to have a lot of the carbon blowing away, or just eroding away, from water. So, they help also fund some of these things, already. Very tiny amounts of money. Not huge amounts of money. And the idea is they are funding you to take care of agricultural land, which in a way is sort of, even though people own it, is also a resource in common for the country.

Russ Roberts: Well, it has external--how you use it can affect some people other than yourself. Obviously, when you own your own land, you have an incentive to not graze it to the ground; not take out all the nutrients. You may make mistakes--out of ignorance, or tradition, or other reasons.

Russ Roberts: But, the other thought I had was--you mention niche markets. It would be an interesting challenge for a foundation to help to fund farmers to try experiments on their own land, who would then in turn could market their products as being more environmentally friendly, and use some kind of labeling to encourage customers to pay a premium; or maybe they wouldn't have to, because it's as you say, maybe it pays for itself.

Moises Velasquez-Manoff: Yeah. I think it pays for itself. You know, there's an initial period of years where it's not paying for itself.

Russ Roberts: Sure.

Moises Velasquez-Manoff: But then, over time, as the soil gets healthier, it starts paying for itself. And you end up producing your crops for less investment per bushel than your neighbors. And so, one really interesting idea that is out there, and I actually did not talk about this in the article, is to give people who are building soil carbon--give farmers who are building soil carbon--a discount on crop insurance.

Russ Roberts: That's cool.

Moises Velasquez-Manoff: Because, in theory, their farms are more resilient.

Russ Roberts: Yep. Should happen naturally.

Moises Velasquez-Manoff: Well, crop insurance, as you know as an economist--it's a complicated--there's a complicated set of calculations that go to dictating what your premium is for the insurance.

Russ Roberts: Well, I don't know anything about it--as an economist. Or as a farmer.

Moises Velasquez-Manoff: But, you understand it [?]

Russ Roberts: Sure. It's risk. Insurance, I know a little bit about.

Moises Velasquez-Manoff: Right? So, in theory, your risk is lower [?] building [?]? You actually [?] lower premiums. So, there's one incentive right there. We use also, in New York, they are thinking about giving people, farmers who build soil carbon, tax breaks in some way or another--I don't know if they are calling them 'tax breaks.' They have another term for it. But, anyway, there are multiple ways of doing this, of helping out farmers who are doing this, besides just handing them cash--I guess is the idea. Some of them are--legislators around the country are very interested in this because they are very interested in agriculture. And some of them are also interested in climate--

Russ Roberts: It's a fascinating--go ahead. Sorry.

Moises Velasquez-Manoff: We have this healthy soils initiative: it's sort of like the example in the country of how this can be, how it can be incentivized; and they are getting some state funds to do some of this; our farmers get some state funds to do some of this stuff.

Russ Roberts: The other thing I was going to say is that, you know, farmers--we spend a lot of time eating, as human beings. And, as Americans, we eat a lot--mostly--for many of us, too much. And it's just interesting how few people are involved in agriculture. I often point this out: it's 2 to 3% of the American people are in farming: because it's so productive we don't need a big population in farming, industry, in terms of labor. And, not only is it efficient enough that we only need a few: we make so much food that we can export a bunch of it. And so, it's a very small group of people that we are talking about, to change their habits, if indeed this is a useful and productive thing to do.

| | 56:22 |

Russ Roberts: But, I want to change--we're almost out of time, and I want to talk for a bit about the human microbiome--the small part of us. And I want to turn toward your book, An Epidemic of Absence. And that book had an incredibly provocative idea, which, again, was an amazing example for me of unintended consequences, complexity, and emergent order. This idea that by cleaning up our environment and taking worms and parasites and germs--basically, making our environment as sterile as possible--and I just talked to Janet Golden about the evolution of how we treat babies, here on the program, in the 20th century and what a great triumph that was--that we took so many things that killed people and got it out. We learned that milk could spoil and we learned that germs carry disease and we learned that there are all kinds of things that people shouldn't eat and should be near each other at certain times. And that was a great triumph of civilization. It lowered infant mortality in extraordinary ways over the first half of the 20th century. Lots of other things along the way, of course--not just our scientific knowledge. But, you point out that maybe that came at a cost. Certainly it came at a cost. Maybe that cost was very large for certain people, whose bodies, without the germs to fight, started fighting themselves. The autoimmune system started to eat us, instead of the germs that were no longer there. They had to have something to do. And I found that deeply provocative. The book came out in 2012; we talked about it in 2014. And, 6 years have passed since you published the book; and more than that has passed in some of the research. And, it's an idea that's deeply appealing--to the point where you, yourself, actually put worms into yourself, deliberately. And other people continue to do that, to fight certain autoimmune disorders. Do we have any more knowledge about whether this is just a possibility? true? maybe? What's happened?

Moises Velasquez-Manoff: Well, I think the hygiene hypothesis has only gained more steam and more evidence in its favor. But, it's often, like: It depends who you ask, the meaning of what the hygiene hypothesis is, changes depending on who you are talking to. But, the idea that we need to tune our immune system early in life: that it needs to be educated early in life--I think we are just getting more and more evidence that this is true. And educated by the right set of microbes. And they are not just microbes that we are fighting against. Many of them are just commensal microbes that, because of the way we live now, and because of what, of dietary changes, for example, that we are selecting for different types of microbes that are not necessarily the ones that educate our immune systems in a way that prevents some of these diseases from arising. So, in terms of the microbiome front, that these are just the microbes and, you know, the unicellular organisms: there's so much research, it's hard to know what to look at. But, for example, I wrote an article about--a lot of this research started in Europe, with the farming stuff. So, it was: Farming kids were less allergic. Why? Because they are probably exposed to manure and cow sheds and they drink unpasteurized milk. So, then there is an interesting example--and I don't think this existed when we spoke last time--but, of Amish kids in the United States now. Where, these Amish kids, they actually come from the same part of the world--in Switzerland, German-speaking Switzerland, where a lot of this research first started. So it's an interesting comparison. Like, they are in theory comparing genetically similar people. So, what they, this most recent set of studies--of course, the Amish kids are like the least allergic of anyone they've ever seen in the developed world, of any subset of people.

Russ Roberts: It just tells you [?] that that cell phones causes allergies.

Moises Velasquez-Manoff: Well, yeah, it's funny. I visited one of these farms. And I was talking to, like, an Amish elder, and he was like, 'We can't deal with the cell phones.' Like, 'We've dealt with everything up until now. The kids are getting the cell phones and we can't stop them.'

Russ Roberts: The ultimate parasite. Yeah. It gets hold of the human host and then they have their way.

Moises Velasquez-Manoff: Yes. So like, that's a whole 'nother story. And also, it's just like a [?] idea: the Amish do get vaccinated[?]--I don't know; there's this idea that that they don't get vaccinated. They do. They get vaccinated. So it's not like they are not getting vaccinated.

Russ Roberts: They are not against science. They are against technology of certain kinds, I think. They want to do certain things in traditional ways.

Moises Velasquez-Manoff: Yeah. I mean, each sect differs. That's another thing that's not appreciated about the Amish: is that, they sort of decide in their communities what they are going to do. So each one--there are more strict ones and less strict ones. The one that I visited in Indiana: they got vaccinated. Like, they didn't want any external electrical lines coming to their houses. But they used lamps in their houses that had batteries. So, there you go. There's a paradox. One of them was a dairy farmer, and he had just upgraded to a modern dairy farming system because he was like, you know, he still plows his land with horses; but he, to be able to sell his milk into the market he has to pasteurize it and do all the stuff that modern dairy farming requires, so you can sell it. In any case, the guys, the kids were super non-allergic. And so they did this interesting study where they compared the Hutterites, which were another group that stemmed from the same area of the world. And they were sort of religious. And they destick[depict?] themselves--they live in the Upper Midwest and the Plains States of Canada--the plains, not the states, provinces of Canada. And they are as allergic as anyone else. Right? They are just as allergic as your average American, Canadian.

Russ Roberts: Even though they are living this agricultural life that many might think is protecting them.

Moises Velasquez-Manoff: Right. So, what's the major difference? Well, they keep their livestock far away. They do, like, this factory farming and they keep it far away from their homes. Whereas the Amish have these little farms where their homes are like 20, 30 feet from the barn. So, if you think of the cowshed as this factory of microbes that are, probiotic microbes that prevent allergy, they are missing all that in the Hutterite land. And they also--the men are the only people who work with the animals. So, what's interesting about the research from Europe is that they find that women who are pregnant who are working with animals have kids who are like the least allergic of all the women. It's like, the earlier your exposure begins, the less allergic you'll end up. And they think it actually--the microbes actually stimulate the mother's immune system. And that stimulation goes through the placenta--I mean, it, via, like Cytokines[?], which are these immune-signaling molecules. And starts training the infant immune system before they are even born. So, you get--so, this happens in Amish country, because pregnant women are out there milking the cows, too, and the kids are out there from an early age playing in the barn. They are getting this exposure. Whereas in Hutterite country, the kids don't have any of that exposure, and the pregnant women don't have any of the exposure. And, they did this really interesting study of the different immune profiles. And they have a different sort of--here are two populations that are genetically very close, because they come from the same part of German-speaking Switzerland; and southern Germany, I think; and they have this very different immune system. And they did these studies where--they tested in mice, and sure enough the mice were exposed to Amish cow dust, Amish cowshed dust, were less allergic than the mice that were exposed to Hutterite dust. So, I mean, like, this research is getting closer and closer to an actionable pro-biotic. Right? Based on, let's just say, an Amish cowshed pro-biotic. Where that, we would use as an intervention early in life. It's getting closer. We're still not there.

Russ Roberts: Well, you just [?] your kid. Or, you could just, when you are pregnant, go milk some cows or when your kid's early on, go have him play in the cowshed, and breathe a lot and absorb it. We should build our own cowsheds! Every house should have a cowshed.

Moises Velasquez-Manoff: That is going to be--it's going to be more complicated. Because it has to be chronic exposure.

Russ Roberts: Oh, okay.

Moises Velasquez-Manoff: So, taking your kid to a cowshed for a week--

Russ Roberts: not enough. But. But, while you are in the cowshed, you want to eat a peanut butter sandwich with your kid. Because that's another example where people are saying--this peanut allergy thing is because people are eating their peanut butter so late in life, they don't have a chance, right? Same argument, right?

Moises Velasquez-Manoff: Well, yeah, in a way. Except for we're talking about exposing yourself to the allergen versus training your immune system--

Russ Roberts: Yeah. Okay. Different mechanisms. Fair enough.

Moises Velasquez-Manoff: Different mechanisms. But you can do the peanut butter sandwich thing regardless of whether or not you are in a cowshed. Obviously.

Russ Roberts: I just wanted to kill two birds with one--I don't know, peanut butter sandwich. One trip to Pennsylvania.

Russ Roberts: Let's close with something you discuss in the--and we'll put a link up to your Amish article, which is really interesting, although it is a small sample, as you point out and that some people have pointed out may not be as reliable as we'd hope. But, it is very interesting.

Moises Velasquez-Manoff: So, the Amish are a small sample. But, the other stuff, from Switzerland, those are thousands of kids at this point. Hundreds, at least. Thousands, probably, of kids they've done over and over and over in Europe, not just in Switzerland but also in Denmark, in parts of Germany. I mean like, everywhere. This is a very solid finding over there.

Russ Roberts: That, exposure to agriculture reduces allergies? A correlation?

Moises Velasquez-Manoff: To cowsheds, in particular.

Russ Roberts: Okay.

Moises Velasquez-Manoff: And to milk. I mean, it's very--it's a strong binding.

Russ Roberts: Cool.

| | 1:06:02 |

Russ Roberts: Let's close with another world you wrote about. You called it an underworld, of people who are treating themselves for conditions which include multiple sclerosis--I don't know what else it's including. But, these are serious, debilitating problems that people are getting on the web, exploring the realities of other people who have explored this, and medicating themselves with parasites. And we talked a little bit about this the first time we talked. But, just tell us where that world is. I'm sure it's blossomed rather dramatically. And, of course, the organized medical world, not so always happy with it. Some people view it as understandable and accepted. But others are hostile to it because it is "unsupervised." But there's something beautiful and poignant about people--connecting with people around the world and learning about these techniques and getting access to this stuff that couldn't have been imagined 20 years ago.

Moises Velasquez-Manoff: Yeah. I mean, except for in the article I make the--

Russ Roberts: We're not sure it works. But other than that: yeah.

Moises Velasquez-Manoff: Yeah. But, that movie, the The Dallas Buyers Club, they were doing the same thing, beginning of the AIDS [Acquired Immune Deficiency Syndrome] epidemic. They were trying to self-treat, because there was--

Russ Roberts: no one was helping them--

Moises Velasquez-Manoff: because mainstream medicine had totally, was just ignoring them, because they considered them all to be either gay or just degenerates in general, and was not helping them in any way. So they took matters into their own hands. So, regarding--I should back up and say that, when we last spoke I think that there was a trial underway to test one of the organisms--the only organism that's really been scientifically, that is, has any rigor behind it, any scientific rigor--and that was the pig whipworm, which was developed by Joel Weinstock. And those tests failed. It did not work. Now, there are like--you go onto this community; you can talk to some of the scientists--there are lots of reasons they might have failed that don't have to do with the fact that the organism doesn't work. But also, it could be just that the organism doesn't work. And this whole idea--

Russ Roberts: And that what we saw that seemed to work just was just a placebo effect: that people were so desperate that their psychological state was what drove the result, not the worm.

Moises Velasquez-Manoff: Well, no--they had a placebo group in those studies. But, those were small studies. This is why we need big studies. And, I think one of them was not blinded, also. So, at least the investigators knew was getting this treatment and who was getting the placebo. But, they also--like, if you talk to some of the people who are in this world, the company who was making these parasites for human consumption--they changed the formula right before they did these large trials. Which is kind of, like, 'Why would you do that?'

Russ Roberts: Ooops. Yeah.

Moises Velasquez-Manoff: So, I mean, you know, I don't know. I think the most likely answer is probably most obviously--you know, Occam's Razor, right? The most likely answer is probably that it doesn't work. But, there are, I think, legitimate questions. But, so, that did not work. Meanwhile, there is a guy in Australia who is doing interesting work with a different organism. And his idea is that the pig whipworm was never going to work anyways because it's not adapted to humans. You need a human-adapted organism. Alex Lucas[?]--he had some really kind of remarkable studies, longitudinal studies, very small, like curing Celiac Disease with hookworms. Or, I should say, sending it into remission. They are very small. He is doing larger ones now, I think. But, so, you have this kind of conflicting evidence coming from the actual scientific world. And this, in the absence of any certain answer from science, this community has blossomed. And it's probably growing bigger, even as we speak. Because there's so much desperation. I've got to say that if you have one of these diseases, like, you know, multiple sclerosis, you sort of just end up progressively more or less able to move and more and more paralyzed; and eventually if it's severe you end up unable to breathe, potentially. I mean, these are horrible diseases. And we don't have lots of good treatments f or them. We have some. They are--

Russ Roberts: slow it down--

Moises Velasquez-Manoff: They slow it down. I mean, for multiple sclerosis, there is a number. Like for inflammatory bowel disease and a lot of the, for like, rheumatoid arthritis, they use, they just block an aspect of your immune system, with these TNF [tumor necrosis factor], you know, with remicades or TNF blockers, that's just a pro-inflammatory, pro-[?] immune system. So, what you are doing is you are hobbling part of your immune system. Which is good if it works to treat the disease. But, it's bad in that it opens up--

Russ Roberts: everything else, yeah.

Moises Velasquez-Manoff: Yeah. I mean, you know, like, it's, the fears are always overblown. You have to look at the actual numbers; and the actual numbers are pretty minor. But, I can tell you that, when you talk to this community of people, the potential--the fact that you might get different kind of cancers that are incurable, or infections that kills you, because you have taken these immune-suppressing drugs, looms very large, in their imagination. Right?

Russ Roberts: Yeah.

Moises Velasquez-Manoff: And so they say, 'Well, what the hell?' Why wouldn't they go try a parasite? Like, I can get rid of a parasite. It's not going to kill me. I can get rid of it.

Russ Roberts: --Yup. Psychologically, it's not a pleasant thought. But, it's--

Moises Velasquez-Manoff: Well, wait a minute. Which is not the pleasant thought? That you might die from--

Russ Roberts: No. The putting the--the direct decision to push them into your body through your skin, through a patch or whatever. Put the eggs in. It's just something--it's not a pleasant thought. I'm sorry--

Moises Velasquez-Manoff: There is an ick factor. But I mean--

Russ Roberts: Yeah, that's all. Just an ick factor. Yeah.

Moises Velasquez-Manoff: Think about the alternative--

Russ Roberts: the alternative is horrible--

Moises Velasquez-Manoff: which again is overblown in people's imagination. The numbers are quite small of people who develop this. Right? But the possibility that you might just die from taking a medicine that, to treat your disease which is incurable--it's untenable to many people.

Russ Roberts: Yep. I hear you.

Moises Velasquez-Manoff: Or, many of them have tried it, and it didn't work. You know, those drugs don't work for everyone. So--

Russ Roberts: And that's the other part of this, right? It's that--so much of this is almost certainly person-specific, right? So, it [?] might not have worked for this person but it might work for that person--both the drug or the [?].

Moises Velasquez-Manoff: Yeah. Yeah. And that's what I think--I mean, what I suspect, like, there's no real good evidence that taking worms can treat anything. But I suspect those that have worked for some subset of people--I mean, so they are of course--what happens online is, you get spectacular stories

Russ Roberts: you hear from those--

Moises Velasquez-Manoff: you get spectacular stories. And the feeling is, you don't--it's like hard to find the feelings for. They're there. You have to seek them out. But, there is no, sort of like, even-handedness, in dealing with these two types of stories. Right?

Russ Roberts: --Yep.--

Moises Velasquez-Manoff: So you get these glorious results. You read about them. You say, 'Crap. I'm going to try that.' And you try it; and, for some people it works. For many people it doesn't. I wonder about the people who feel worse in some ways. But, then again, if you are, if what your baseline is, is multiple sclerosis--the horrible pain of Crohn's Disease. The symptoms of a parasite infection might be a great improvement if that's all you're dealing [? Feeling?] ?

Russ Roberts: Right. Sure.

Moises Velasquez-Manoff: So, that's what's happening. And, where it is, is I wish scientists would actually do case studies of these people. Because I think it works for some of them. And it would be great if we knew, if we understood more about how it's working

Russ Roberts: Well, I look forward to having you back on in 5 years. If not sooner. If not sooner. To talk about: I mean, both these stories--again, I see them as linked. They are both very similar to me. It's hard to know exactly what's going on. They are really complicated. They are out of sight. And they are awfully interesting to me. And you write about them in really interesting ways.

Moises Velasquez-Manoff: Well, thanks for having me. I'll be glad to come back.

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Here are the 10 latest posts from CEE.

CEE June 28, 2018

Gordon Tullock

Gordon Tullock, along with his colleague James M. Buchanan, was a founder of the School of Public Choice. Among his contributions to public choice were his study of bureaucracy, his early insights on rent seeking, his study of political revolutions, his analysis of dictatorships, and his analysis of incentives and outcomes in foreign policy. Tullock also contributed to the study of optimal organization of research, was a strong critic of common law, and did work on evolutionary biology. He was arguably one of the ten or so most influential economists of the last half of the twentieth century. Many economists believe that Tullock deserved to share Buchanan’s 1986 Nobel Prize or even deserved a Nobel Prize on his own.

One of Tullock’s early contributions to public choice was The Calculus of Consent: Logical Foundations of Constitutional Democracy, co-authored with Buchanan in 1962. In that path-breaking book, the authors assume that people seek their own interests in the political system and then consider the results of various rules and political structures. One can think of their book as a political economist’s version of Montesquieu.

CEE February 4, 2018

Division of Labor

Division of labor combines specialization and the partition of a complex production task into several, or many, sub-tasks. Its importance in economics lies in the fact that a given number of workers can produce far more output using division of labor compared to the same of number of workers each working alone. Interestingly, this is true even if those working alone are expert artisans. The production increase has several causes. According to Adam Smith, these include increased dexterity from learning, innovations in tool design and use as the steps are defined more clearly, and savings in wasted motion changing from one task to another.

Though the scientific understanding of the importance of division of labor is comparatively recent, the effects can be seen in most of human history. It would seem that exchange can arise only from differences in taste or circumstance. But division of labor implies that this is not true. In fact, even a society of perfect clones would develop exchange, because specialization alone is enough to reward advances such as currency, accounting, and other features of market economies.

CEE February 4, 2018

Hoover’s Economic Policies

When it was all over, I once made a list of New Deal ventures begun during Hoover’s years as Secretary of Commerce and then as president. . . . The New Deal owed much to what he had begun.1 —FDR advisor Rexford G. Tugwell

Many historians, most of the general public, and even many economists think of Herbert Hoover, the president who preceded Franklin D. Roosevelt, as a defender of laissez-faire economic policy. According to this view, Hoover’s dogmatic commitment to small government led him to stand by and do nothing while the economy collapsed in the wake of the 1929 stock market crash. The reality is quite different. Far from being a bystander, Hoover actively intervened in the economy, advocating and implementing polices that were quite similar to those that Franklin Roosevelt later implemented. Moreover, many of Hoover’s interventions, like those of his successor, caused the great depression to be “great”—that is, to last a long time.

Hoover’s early career

Hoover, a very successful mining engineer, thought that the engineer’s focus on efficiency could enable government to play a larger and more constructive role in the economy. In 1917, he became head of the wartime Food Administration, working to reduce American food consumption. Many Democrats, including FDR, saw him as a potential presidential candidate for their party in the 1920s. For most of the 1920s, Hoover was Secretary of Commerce under Republican Presidents Harding and Coolidge. As Commerce Secretary during the 1920-21 recession, Hoover convened conferences between government officials and business leaders as a way to use government to generate “cooperation” rather than individualistic competition. He particularly liked using the “cooperation” that was seen during wartime as an example to follow during economic crises. In contrast to Harding’s more genuine commitment to laissez-faire, Hoover began one 1921 conference with a call to “do something” rather than nothing. That conference ended with a call for more government planning to avoid future depressions, as well as using public works as a solution once they started.2 Pulitzer-Prize winning historian David Kennedy summarized Hoover’s work in the 1920-21 recession this way: “No previous administration had moved so purposefully and so creatively in the face of an economic downturn. Hoover had definitively made the point that government should not stand by idly when confronted with economic difficulty.”3 Harding, and later Coolidge, rejected most of Hoover’s ideas. This may well explain why the 1920-21 recession, as steep as it was, was fairly short, lasting 18 months.

Interestingly, though, in his role as Commerce Secretary, Hoover created a new government program called “Own Your Own Home,” which was designed to increase the level of homeownership. Hoover jawboned lenders and the construction industry to devote more resources to homeownership, and he argued for new rules that would allow federally chartered banks to do more residential lending. In 1927, Congress complied, and with this government stamp of approval and the resources made available by Federal Reserve expansionary policies through the decade, mortgage lending boomed. Not surprisingly, this program became part of the disaster of the depression, as bank failures dried up sources of funds, preventing the frequent refinancing that was common at the time, and high unemployment rates made the government-encouraged mortgages unaffordable. The result was a large increase in foreclosures.4

The Hoover presidency

Hoover did not stand idly by after the depression began. To fight the rapidly worsening depression, Hoover extended the size and scope of the federal government in six major areas: (1) federal spending, (2) agriculture, (3) wage policy, (4) immigration, (5) international trade, and (6) tax policy.

Consider federal government spending. (See Fiscal Policy.) Federal spending in the 1929 budget that Hoover inherited was $3.1 billion. He increased spending to $3.3 billion in 1930, $3.6 billion in 1931, and $4.7 billion and $4.6 billion in 1932 and 1933, respectively, a 48% increase over his four years. Because this was a period of deflation, the real increase in government spending was even larger: The real size of government spending in 1933 was almost double that of 1929.5 The budget deficits of 1931 and 1932 were 52.5% and 43.3% of total federal expenditures. No year between 1933 and 1941 under Roosevelt had a deficit that large.6 In short, Hoover was no defender of “austerity” and “budget cutting.”


Figure 1 




Shortly after the stock market crash in October 1929, Hoover extended federal control over agriculture by expanding the reach of the Federal Farm Board (FFB), which had been created a few months earlier.7 The idea behind the FFB was to make government-funded loans to farm cooperatives and create “stabilization corporations” to keep farm prices up and deal with surpluses. In other words, it was a cartel plan. That fall, Hoover pushed the FFB into full action, lending to farmers all over the country and otherwise subsidizing farming in an attempt to keep prices up. The plan failed miserably, as subsidies encouraged farmers to grow more, exacerbating surpluses and eventually driving prices way down. As more farms faced dire circumstances, Hoover proposed the further anti-market step of paying farmers not to grow.

On wages, Hoover revived the business-government conferences of his time at the Department of Commerce by summoning major business leaders to the White House several times that fall. He asked them to pledge not to reduce wages in the face of rising unemployment. Hoover believed, as did a number of intellectuals at the time, that high wages caused prosperity, even though the true causation is from capital accumulation to increased labor productivity to higher wages. He argued that if major firms cut wages, workers would not have the purchasing power they needed to buy the goods being produced. As most depressions involve falling prices, cutting wages to match falling prices would have kept purchasing power constant. What Hoover wanted amounted to an increase in real wages, as constant nominal wages would be able to purchase more goods at falling prices. Presumably out of fear of the White House or, perhaps, because it would keep the unions quiet, industrial leaders agreed to this proposal. The result was rapidly escalating unemployment, as firms quickly realized that they could not continue to employ as many workers when their output prices were falling and labor costs were constant.8

Of all of the government failures of the Hoover presidency—excluding the actions of the Federal Reserve between 1929 and 1932, over which he had little to no influence—his attempt to maintain wages was the most damaging. Had he truly believed in laissez-faire, Hoover would not have intervened in the private sector that way. Hoover’s high-wage policy was a clear example of his lack of confidence in the corrective forces of the market and his willingness to use governmental power to fight the depression.

Later in his presidency, Hoover did more than just jawbone to keep wages up. He signed two pieces of labor legislation that dramatically increased the role of government in propping up wages and giving monopoly protection to unions. In 1931, he signed the Davis-Bacon Act, which mandated that all federally funded or assisted construction projects pay the “prevailing wage” (i.e., the above market-clearing union wage). The result of this move was to close out non-union labor, especially immigrants and non-whites, and drive up costs to taxpayers. A year later, he signed the Norris-LaGuardia Act, whose five major provisions each enshrined special provisions for unions in the law, such as prohibiting judges from using injunctions to stop strikes and making union-free contracts unenforceable in federal courts.9 Hoover’s interventions into the labor market are further evidence of his rejection of laissez-faire.

Two other areas that Hoover intervened in aggressively were immigration and international trade. One of the lesser-known policy changes during his presidency was his near halt to immigration through an Executive Order in September 1930. His argument was that blocking immigration would preserve the jobs and wages of American citizens against competition from low-wage immigrants. Immigration fell to a mere 10 to 15% of the allowable quota of visas for the five-month period ending February 28, 1931. Once again, Hoover was unafraid to intervene in the economic decisions of the private sector by preventing the competitive forces of the global labor market from setting wages.10

Even those with only a casual knowledge of the Great Depression will be familiar with one of Hoover’s major policy mistakes—his promotion and signing of the Smoot-Hawley tariff in 1930. This law increased tariffs significantly on a wide variety of imported goods, creating the highest tariff rates in U.S. history. While economist Douglas Irwin has found that Smoot-Hawley’s effects were not as large as often thought, they still helped cause a decline in international trade, a decline that contributed to the worsening worldwide depression.

Most of these policies continued and many expanded throughout 1931, with the economy worsening each month. By the end of the year, Hoover decided that more drastic action was necessary, and on December 8, he addressed Congress and offered proposals that historian David Kennedy refers to as “Hoover’s second program, ” and that has also been called “The Hoover New Deal.”11 His proposals included:

The Reconstruction Finance Corporation to lend tax dollars to banks, firms and others institutions in need.

A Home Loan Bank to provide government help to the construction sector.

Congressional legalization of Hoover’s executive order that had blocked immigration.

Direct loans to state governments for spending on relief for the unemployed.

More aid to Federal Land Banks.

Creating a Public Works Administration that would both better coordinate Federal public works and expand them.

More vigorous enforcement of antitrust laws to end “destructive competition” in a variety of industries, as well as supporting work-sharing programs that would supposedly reduce unemployment.

On top of these spending proposals, most of which were approved in one form or another, Hoover proposed, and Congress approved, the largest peacetime tax increase in U.S. history. The Revenue Act of 1932 increased personal income taxes dramatically, but also brought back a variety of excise taxes that had been used during World War I. The higher income taxes involved an increase of the standard rate from a range of 1.5 to 5% to a range of 4 to 8%. On top of that increase, the Act placed a large surtax on higher-income earners, leading to a total tax rate of anywhere from 25 to 63%. The Act also raised the corporate income tax along with several taxes on other forms of income and wealth.

Whether or not Hoover’s prescriptions were the right medicine—and the evidence suggests that they were not—his programs were a fairly aggressive use of government to address the problems of the depression.12 These programs were hardly what one would expect from a man devoted to “laissez-faire” and accused of doing nothing while the depression worsened.

The views of contemporaries and modern historians

The myth of Hoover as a defender of laissez-faire persists, despite the fact that his contemporaries clearly understood that he made aggressive use of government to fight the recession. Indeed, Hoover’s own statements made clear that he recognized his aggressive use of intervention. The myth also persists in spite of the widespread recognition by modern historians that the Hoover presidency was anything but an era of laissez-faire.

According to Hoover’s Secretary of State, Henry Stimson, Hoover argued that balancing the budget was a mistake: “The President likened it to war times. He said in war times no one dreamed of balancing the budget. Fortunately we can borrow.”13 Hoover himself summarized his administration’s approach to the depression during a campaign speech in 1932:

We might have done nothing. That would have been utter ruin. Instead, we met the situation with proposals to private business and the Congress of the most gigantic program of economic defense and counter attack ever evolved in the history of the Republic. These programs, unparalleled in the history of depressions of any country and in any time, to care for distress, to provide employment, to aid agriculture, to maintain the financial stability of the country, to safeguard the savings of the people, to protect their homes, are not in the past tense—they are in action. . . . No government in Washington has hitherto considered that it held so broad a responsibility for leadership in such time.14

Some might dismiss this as campaign rhetoric, but as the other evidence indicates, Hoover was giving an accurate portrayal of his presidency. Indeed, Hoover’s profligacy was so clear that Roosevelt attacked it during the 1932 Presidential campaign.

Roosevelt’s own advisors understood that much of what they created during the New Deal owed its origins to Hoover’s policies, going as far back as his time at the Commerce Department in the 1920s. Thus the quote at the start of this article by Rex Tugwell, one of the academics at the center of FDR’s “brains trust.” Another member of the brains trust, Raymond Moley, wrote of that period:

When we all burst into Washington . . . we found every essential idea [of the New Deal] enacted in the 100-day Congress in the Hoover administration itself. The essentials of the NRA [National Recovery Administration], the PWA [Public Works Administration], the emergency relief setup were all there. Even the AAA [Agricultural Adjustment Act] was known to the Department of Agriculture. Only the TVA [Tennessee Valley Authority] and the Securities Act was [sic] drawn from other sources. The RFC [Reconstruction Finance Corporation], probably the greatest recovery agency, was of course a Hoover measure, passed long before the inauguration.15

Decades later, Tugwell, writing to Moley, said of Hoover: “[W]e were too hard on a man who really invented most of the devices we used.”16 Members of Roosevelt’s inner circle would have every reason to disassociate themselves from the policies of their predecessor; yet these two men recognized Hoover’s role as the father of the New Deal quite clearly.

Nor is this point lost on contemporary historians. In his authoritative history of the Great Depression era, David Kennedy admiringly wrote that Hoover’s 1932 program of activist policies helped “lay the groundwork for a broader restructuring of government’s role in many other sectors of American life, a restructuring known as the New Deal.”17 In a later discussion of the beginning of the Roosevelt administration, Kennedy observed (emphasis added):

Roosevelt intended to preside over a government even more vigorously interventionist and directive than Hoover’s. . . . [I]f Roosevelt had a plan in early 1933 to effect economic recovery, it was difficult to distinguish from many of the measures that Hoover, even if sometimes grudgingly, had already adopted: aid for agriculture, promotion of industrial cooperation, support for the banks, and a balanced budget. Only the last was dubious. . . . FDR denounced Hoover’s budget deficits.18

Conclusion

Despite overwhelming evidence to the contrary, from Hoover’s own beliefs to his actions as president to the observations of his contemporaries and modern historians, the myth of Herbert Hoover’s presidency as an example of laissez-faire persists. Of all the presidents up to and including him, Herbert Hoover was one of the most active interveners in the economy.


About the Author

Steven Horwitz is the Charles A. Dana Professor of Economics at St. Lawrence University


Footnotes

*

This entry is adapted, with permission, from Steven Horwitz, “Herbert Hoover: Father of the New Deal,” Cato Institute Briefing Papers, No. 122, September 29, 2011, at: http://www.cato.org/publications/briefing-paper/herbert-hoover-father-new-deal

As quoted in Amity Shlaes, The Forgotten Man: A New History of the Great Depression. New York: Harper Collins, 2007, p. 149.

Murray N. Rothbard, America’s Great Depression (1963; Auburn, AL: Ludwig von Mises Institute, 2008), p. 192.

David M. Kennedy, Freedom From Fear: The American People in Depression and War, 1929-1945. New York: Oxford University Press, p. 48.

See Steven Malanga, “Obsessive Housing Disorder,” City Journal, 19 (2), Spring 2009.

Federal government spending data can be found at: http://www2.census.gov/prod2/statcomp/documents/CT1970p2-12.pdf

See the data and discussion in Jonathan Hughes and Louis P. Cain, American Economic History, 7th ed., Boston: Pearson, 2007, p. 487. Hughes and Cain also note of those deficits, “The expenditures were in large part the doing of the outgoing Hoover administration.”

See Kennedy op. cit., pp. 43-44; Rothbard op. cit., p. 228; and Gene Smiley, Rethinking the Great Depression, Chicago: Ivan R. Dee, 2002, p. 13.

See Lee Ohanian, “What – or Who – Started the Great Depression?” Journal of Economic Theory 144, 2009, pp. 2310-2335.

Chuck Baird, “Freeing Labor Markets by Reforming Union Laws,” June 2011, Downsizing DC, Cato Institute, available at http://www.downsizinggovernment.org/labor/reforming-labor-union-laws.

See “White House Statement on Government Policies To Reduce Immigration” March 26, 1931, available at http://www.presidency.ucsb.edu/ws/index.php?pid=22581#axzz1V7klWwZu. That statement opens with an explicit link between the immigration policy and unemployment: “President Hoover, to protect American workingmen from further competition for positions by new alien immigration during the existing conditions of employment, initiated action last September looking to a material reduction in the number of aliens entering this country.”

Kennedy op. cit., p. 83. The phrase “Hoover’s New Deal” is from the title of chapter 11 in Rothbard, op. cit..

Hoover’s higher tax rates backfired, as they further depressed income-earning activity, reducing the tax base, which in turn led to a fall in tax revenues for 1932.

As cited in Kennedy op. cit., p. 79.

Herbert Hoover, “Address Accepting the Republican Presidential Nomination,” August 11, 1932.

Raymond Moley, “Reappraising Hoover,” Newsweek, June 14, 1948, p. 100.

Letter from Rexford G. Tugwell to Raymond Moley, January 29, 1965, Raymond Moley Papers, “Speeches and Writings,” Box 245-49, Hoover Institution on War, Revolution and Peace, Stanford University, Stanford, CA, as cited in Davis W. Houck, “Rhetoric as Currency: Herbert Hoover and the 1929 Stock Market Crash,” Rhetoric & Public Affairs 3, 2000, p. 174.

Kennedy, op. cit., p. 83.

Kennedy, op. cit., p. 118.

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CEE February 4, 2018

Wages and Working Conditions

 

CEOs of multinational corporations, exotic dancers, and children with lemonade stands have at least one thing in common. They all expect a return for their effort. Most workers get that return in a subtle and ever-changing combination of money wages and working conditions. This article describes how they changed for the typical U.S. worker during the twentieth century.

 

Working Conditions

Surely the single most fundamental working condition is the chance of death on the job. In every society workers are killed or injured in the process of production. While occupational deaths are comparatively rare overall in the United States today, they still occur with some regularity in ocean fishing, the construction of giant bridges and skyscrapers, and a few other activities.

 

For all United States workers the number of fatalities per dollar of real (inflation-adjusted) GNP dropped by 96 percent between 1900 and 1979. Back in 1900 half of all worker deaths occurred in two industries—coal mining and railroading. But between 1900 and 1979 fatality rates per ton of coal mined and per ton-mile of freight carried fell by 97 percent.

 

This spectacular change in worker safety resulted from a combination of forces that include safer production technologies, union demands, improved medical procedures and antibiotics, workmen’s compensation laws, and litigation. Ranking the individual importance of these factors is difficult and probably would mean little. Together, they reflected a growing conviction on the part of the American people that the economy was productive enough to afford such change. What’s more, the United States made far more progress in the workplace than it did in the hospital. Even though inflation-adjusted medical expenditures tripled from 1950 to 1970 and increased by 74 percent from 1975 to 1988, the nation’s death rate declined in neither period. But industry succeeded in lowering its death rate, both by spending to improve health on the job and by discovering, developing, and adopting ways to save lives.

 

Data for injuries are scarcer and less reliable, but they probably declined as well. Agriculture has one of the highest injury rates of any industry; the frequent cuts and bruises can become infected by the bacteria in barnyards and on animals. Moreover, work animals and machinery frequently injure farm workers. Since the proportion of farm workers in the total labor force fell from about 40 percent to 2 percent between 1900 and 1990, the U.S. worker injury rate would have fallen even if nothing else changed. The limited data on injuries in manufacturing also indicate a decline.

 

Another basic aspect of working conditions is exposure to the weather. In 1900 more than 80 percent of all workers farmed in open fields, maintained railroad rights of way, constructed or repaired buildings, or produced steel and chemicals. Their bosses may have been comfortably warm in the winter and cool in the summer, but the workers were not. A columnist of that era ironically described the good fortune of workers in Chicago steelworks, who could count on being warmed by the blast from the steel melt in freezing weather. Boys who pulled glass bottles from furnaces were similarly protected—when they didn’t get burned. By 1990, in contrast, more than 80 percent of the labor force worked in places warmed in the winter and cooled in the summer.

 

Hours of work for both men and women were shorter in the United States than in most other nations in 1900. Women in Africa and Asia still spent two hours a day pounding husks off wheat or rice for the family food. American women bought their flour and cornmeal, or the men hauled it home from the mill. Women, however, still typically worked from dawn to dusk, or even longer by the light of oil or kerosene lamps. Caring for sick children lengthened those hours further. Charlotte Gilman, an early feminist leader, declared that cooking and care of the kitchen alone took forty-two hours a week. Early budget studies are consistent with that estimate. Men, too, worked dawn to dusk on the farm, and in most nonfarm jobs (about 60 percent of the total), men worked ten hours a day, six days a week.

 

By 1981 (the latest date available), women’s kitchen work had been cut about twenty hours a week, according to national time-budget studies from Michigan’s Institute of Survey Research. That reduction came about because families bought more restaurant meals, more canned, frozen, and prepared foods, and acquired an arsenal of electric appliances. Women also spent fewer hours washing and ironing clothes and cleaning house. Fewer hours of work in the home had little impact on women’s labor force participation rate until the great increase after 1950.

 

Men’s work hours were cut in half during the twentieth century. That decline reflected a cut of more than twenty hours in the scheduled work week. It also reflected the fact that paid vacations—almost nonexistent in 1900—had spread, and paid holidays multiplied.

 

In addition, the percentage of the labor force in the worst jobs has declined dramatically. Common laborers in most societies face the most arduous, dangerous, and distasteful working conditions. Their share of the U.S. labor force fell from about 30 percent to 5 percent between 1900 and 1990. Thousands of men in 1900 spent their lives shoveling coal into furnaces to power steam engines. Less than 5 percent of factory power came from electric motors. By 1990 nearly all these furnaces, and men, had been replaced—first by mechanical stokers and then by oil burners and electric motors. Tens of thousands of other men in 1900 laid railroad track and ties, shifting them by brute force, or shoveled tons of coal and grain into gondola cars and ships’ holds. They too have given way to machines or now use heavy machinery to ease their toil.

 

The largest group of common laborers in 1900 was the men, women, and children who cultivated and harvested crops by hand (e.g., cotton, corn, beets, potatoes). Most blacks and many Asian and Mexican-American workers did so. These millions were eventually replaced by a much smaller group, generally using motorized equipment. New machinery also eased the lot of those who once spent their lives shoveling fertilizer, mixing cement, working in glue-works, carrying bundles of rags, waste paper, or finished clothing, and tanning hides.

 

Such tasks remain a miserable fact of life in many societies. But the expanding U.S. economy forced improvement as workers got the choice of better jobs on factory assembly lines, in warehouses, and in service establishments. Producers increasingly had to replace departing common labor with machinery. They substituted machinery for labor across the board. (Computer software even replaced some bank vice presidents.) But many more men who labored at difficult and boring jobs were replaced by machines tended by semiskilled workers. Between 1900 and 1990 the amount of capital equipment used by the typical American worked rose about 150 percent, taking all industries together.

 

Wages

 

Rock singers, movie stars, athletes, and CEOs stand at one end of the income distribution. At the other end are part-time workers and many of the unemployed. The differences in annual earnings only partly reflect hourly wages. They also reflect differences in how many hours a year workers spend on the job.

 

Thanks to increased income tax rates since 1936, today’s workers attempt to reduce taxes by converting their earnings into other, nontaxable forms of income. Why use after-tax income to pay for medical care if you can get it as an untaxed fringe benefit? Why pay for the full cost of lunch if the company can subsidize meals at work? The proliferation of such “receipts in kind” has made it increasingly difficult to make meaningful comparisons of the distribution of income over time or of earnings in different social and occupational groups.

 

Comparing money wages over time thus offers only a partial view of what has happened to worker incomes. But what do the simple overall figures for earnings by the typical worker (before tax and ignoring “in kind” allowances) show? Table 1 reports how the average wage for nonfarm workers rose during this century. By 1980 real earnings of American nonfarm workers were about four times as great as in 1900. Government taxes took away an increasing share of the worker’s paycheck. What remained, however, helped transform the American standard of living. In 1900 only a handful earned enough to enjoy such expensive luxuries as piped water, hot water, indoor toilets, electricity, and separate rooms for each child. But by 1990 workers’ earnings had made such items commonplace. Moreover, most Americans now have radios, TVs, automobiles, and medical care that no millionaire in 1900 could possibly have obtained.

 

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TABLE 1


| |

Nonfarm Employees Annual Earnings, 1900-80


| |

Real earnings (1914 dollars)


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Real earnings (1914 dollars)


| | Year | Money Earnings When Employed (dollars) | After Deduction for Unemployment (dollars) | When Employed (dollars) | Consumer Price Index
(1914 = 100)
| Year | Money Earnings When Employed (dollars) | After Deduction for Unemployment (dollars) | When Employed (dollars) | Consumer Price Index
(1914 = 100)
| | 1900 | 483 | 523 | 573 | 84.3 | 1940 | 1,438 | 812 | 1,032 | 139.4 | | 1901 | 497 | 546 | 582 | 85.4 | 1941 | 1,593 | 931 | 1,088 | 146.4 | | 1902 | 528 | 583 | 612 | 86.3 | 1942 | 1,877 | 1,080 | 1,159 | 162.0 | | 1903 | 534 | 575 | 607 | 88.0 | 1943 | 2,190 | 1,239 | 1,273 | 172.0 | | 1904 | 538 | 555 | 606 | 88.8 | 1944 | 2,370 | 1,331 | 1,354 | 175.0 | | 1905 | 550 | 582 | 621 | 88.5 | 1945 | 2,460 | 1,338 | 1,375 | 179.0 | | 1906 | 566 | 618 | 627 | 90.2 | 1946 | 2,575 | 1,253 | 1,326 | 194.2 | | 1907 | 592 | 613 | 631 | 93.8 | 1947 | 2,802 | 1,194 | 1,262 | 222.1 | | 1908 | 577 | 545 | 631 | 91.5 | 1948 | 3,067 | 1,216 | 1,281 | 239.4 | | 1909 | 600 | 604 | 657 | 91.3 | 1949 | 3,088 | 1,190 | 1,303 | 237.0 | | | | 1910 | 634 | 608 | 669 | 94.7 | 1950 | 3,276 | 1,272 | 1,368 | 239.4 | | 1911 | 644 | 612 | 676 | 95.2 | 1951 | 3,560 | 1,317 | 1,378 | 258.3 | | 1912 | 657 | 619 | 676 | 97.2 | 1952 | 3,777 | 1,375 | 1,431 | 263.9 | | 1913 | 687 | 649 | 695 | 98.9 | 1953 | 3,986 | 1,442 | 1,499 | 265.9 | | 1914 | 696 | 613 | 696 | 100.0 | 1954 | 4,110 | 1,427 | 1,538 | 267.3 | | 1915 | 692 | 591 | 684 | 101.1 | 1955 | 4,318 | 1,529 | 1,621 | 266.3 | | 1916 | 760 | 649 | 699 | 108.7 | 1956 | 4,557 | 1,597 | 1,686 | 270.3 | | 1917 | 866 | 681 | 704 | 127.7 | 1957 | 4,764 | 1,608 | 1,702 | 279.9 | | 1918 | 1,063 | 694 | 709 | 150.0 | 1958 | 4,956 | 1,574 | 1,724 | 287.5 | | 1919 | 1,215 | 681 | 704 | 172.5 | 1959 | 5,217 | 1,674 | 1,800 | 289.8 | | | | 1920 | 1,426 | 672 | 714 | 199.7 | 1960 | 5,402 | 1,706 | 1,834 | 294.5 | | 1921 | 1,330 | 620 | 747 | 178.1 | 1961 | 5,584 | 1,719 | 1,877 | 297.5 | | 1922 | 1,289 | 688 | 772 | 166.9 | 1962 | 5,829 | 1,804 | 1,938 | 300.8 | | 1923 | 1,376 | 774 | 811 | 169.7 | 1963 | 6,045 | 1,847 | 1,986 | 304.4 | | 1924 | 1,396 | 754 | 820 | 170.3 | 1964 | 6,327 | 1,921 | 2,052 | 308.4 | | 1925 | 1,420 | 764 | 812 | 174.8 | 1965 | 6,535 | 1,968 | 2,083 | 313.7 | | 1926 | 1,452 | 801 | 824 | 176.2 | 1966 | 6,860 | 2,028 | 2,126 | 322.7 | | 1927 | 1,487 | 810 | 861 | 172.8 | 1967 | 7,156 | 2,058 | 2,155 | 332.0 | | 1928 | 1,490 | 816 | 872 | 170.9 | 1968 | 7,675 | 2,126 | 2,219 | 345.9 | | 1929 | 1,534 | 853 | 901 | 170.3 | 1969 | 8,277 | 2,165 | 2,257 | 364.5 | | | | 1930 | 1,495 | 773 | 901 | 166.0 | 1970 | 8,821 | 2,155 | 2,285 | 386.1 | | 1931 | 1,408 | 696 | 930 | 151.4 | 1971 | 9,423 | 2,181 | 2,340 | 402.7 | | 1932 | 1,249 | 585 | 918 | 135.8 | 1972 | 10,066 | 2,265 | 2,420 | 416.0 | | 1933 | 1,165 | 565 | 905 | 128.8 | 1973 | 10,767 | 2,303 | 2,437 | 441.9 | | 1934 | 1,199 | 607 | 901 | 133.1 | 1974 | 11,632 | 2,521 | 2,372 | 490.4 | | 1935 | 1,244 | 637 | 912 | 136.4 | 1975 | 12,702 | 2,148 | 2,373 | 535.2 | | 1936 | 1,296 | 701 | 940 | 137.8 | 1976 | 13,727 | 2,216 | 2,425 | 566.1 | | 1937 | 1,392 | 767 | 975 | 142.8 | 1977 | 14,743 | 2,256 | 2,447 | 602.6 | | 1938 | 1,370 | 705 | 978 | 140.1 | 1978 | 15,847 | 2,279 | 2,443 | 648.7 | | 1939 | 1,403 | 760 | 1,016 | 138.1 | 1979 | 17,183 | 2,229 | 2,381 | 721.8 | | | 1980 | 18,861 | 2,114 | 2,300 | 820.0 | |

SOURCE: Lebergott, 1984.


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Labor Productivity

The fundamental cause of this increase in the standard of living was the increase in productivity. What caused that increase? The tremendous changes in Korea, Hong Kong, and Singapore since World War II demonstrate how tenuous is the connection between productivity and such factors as sitting in classrooms, natural resources, previous history, or racial origins. Increased productivity depends more on national attitudes and on free markets, in the United States as in Hong Kong and Singapore.

 

Output per hour worked in the United States, which already led the world in 1900, tripled from 1900 to 1990. Companies competed away much of that cost savings via lower prices, thus benefiting consumers. (Nearly all of these consumers, of course, were in workers’ families.) Workers also benefited directly from higher wages on the job.

 

The U.S. record for working conditions and real wages reveals impressive and significant advances, greater than in many other nations. But the quest for still higher wages and for less effort and boredom shows no sign of halting.

 

Stanley Lebergott is an emeritus professor of economics at Wesleyan University in Middletown, Connecticut. He was previously an economist with the U.S. Bureau of the Budget and the U.S. Department of Labor. He was a member of the President’s Commission on Federal Statistics in 1971 and president of the Economic History Association in 1984.

 

Further Reading

Goldin, Claudia. “The Work and Wages of Single Women, 1870-1920.” Journal of Economic History 41 (1980): 81-89.

Lebergott, Stanley. The American Economy: Income, Wealth, and Want. 1976.

Lebergott, Stanley. The Americans: An Economic Record. 1984.

 

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CEE February 4, 2018

Unemployment Insurance

 

[Editor’s note: some of the data have changed since this article was written in 1992. The overall structure of the unemployment insurance, however, has remained intact.]

 

The United States unemployment insurance program is intended to offset income lost by workers who lose their jobs as a result of employer cutbacks. The program, launched by the Social Security Act of 1935, is the government’s single most important source of assistance to the jobless.

 

A second goal of the program is to counter the negative impacts on the national economy, and especially on local economies, of major layoffs, seasonal cutbacks, or a recession. Unemployment benefits help sustain the level of income and hence the demand for goods and services in areas hard hit by unemployment. In short, unemployment insurance supports consumer buying power.

 

Not all unemployed workers are eligible for unemployment insurance. In fact, from 1984 to 1989 the proportion of the unemployed receiving benefits was at or below 34 percent every year. Benefits are not paid to employees who quit their jobs voluntarily or are fired for cause. Nor are they paid to those who are just entering the labor force but cannot find a job, nor to reentrants to the labor force who are looking for work. In February 1991, 76 percent of the target population of “job losers”—those involuntarily laid off—received benefits.

 

The proportion of unemployed workers who receive benefits is always higher during recessions than during expansions. This is because during recessions a higher fraction of the unemployed are people who were laid off. By January 1991, 46 percent of total unemployed workers claimed unemployment benefits, the highest percentage for that month since 1983.

 

Under the joint federal-state program, most states pay a maximum of twenty-six weeks in benefits, starting after a one-week waiting period. A few extend the duration somewhat longer. These benefits replace about one-third of gross wages for people with average or below-average incomes. The average weekly benefit in 1991 was about $161. When a state’s unemployment is substantially above the national average, the program provides for up to an additional thirteen weeks of benefits. Five states were paying “extended benefits” in the winter of 1991, but this number approximately doubled by the end of April as the recession and unemployment worsened. The state and federal government share, approximately equally, the cost of extended benefits. During the eighties many states raised their “triggers”—the unemployment rate that must be reached—for extended benefits. As a result relatively few workers were eligible for extended benefits.

 

The federal government makes grants to the states for the administration of the unemployment insurance program. These grants exceeded $2 billion in fiscal 1991, ending September 30, 1991. The money helped pay the wages of about thirty-seven thousand state workers who administer the program and who dispense benefits from state unemployment insurance funds. In that fiscal year states collected about $16 billion in unemployment taxes from employers to cover the cost of the program; the federal government collected approximately $4.4 billion. Outlays on benefits were expected to run about $18.7 billion in fiscal 1991.

 

Federal law requires all state governments to impose a tax on employers of at least 0.8 percent on each employee’s first $7,000 of pay. The tax base exceeds $7,000 in thirty-six states, with a national average of about $8,500. The highest base is $21,300 in Alaska. Most states levy a higher tax rate on businesses that have higher layoffs. However, the tax rate cannot go below the minimum even for businesses that have no layoffs. Nor do states set the maximum high enough so that employers with high layoff rates generate enough tax revenues to pay all the benefits to the workers they lay off. The result is that workers and businesses in industries with low layoff rates subsidize workers and businesses in industries, such as construction, with high layoff rates. Harvard’s Martin Feldstein suggested in 1973 that this subsidization of layoffs would cause more layoffs. The evidence indicates that he was correct. Economist Robert Topel of the University of Chicago estimates that if employers could expect to repay (in taxes) the full value of unemployment benefits drawn by their laid-off workers, then the unemployment rate would fall by as much as 1 full point (e.g., from 6 percent of the labor force to 5 percent).

 

A basic tenet of economics is that when an activity is subsidized, people do more of it. Does unemployment insurance—a subsidy for being unemployed—increase unemployment by prompting the unemployed to delay their search for a new job or to search longer for a better position? Economists have found that it does. A 1990 study by Bruce D. Meyer, an economist at Northwestern University, found that a 10 percent boost in the “replacement ratio”—the proportion of after-tax work earnings replaced by unemployment benefits—causes unemployed people to extend their time without work by an average of 1.5 weeks. (During fiscal 1990 the average duration of benefits for the jobless was 13.6 weeks.)

 

Most people who receive unemployment insurance find a job or are recalled to work in the first several weeks. Meyer also found that among those who remain jobless for a longer period, the chance of a person on unemployment insurance going back to work increases rapidly as the time of benefit exhaustion approaches. Indeed, the chances of an unemployed person getting a job triples as the length of remaining benefits drops from six weeks to one week. Meyer suspects some of the jobless may have arranged to be recalled to previous work or to begin new work about the time their benefits expire. “If workers are bound to firms by implicit contracts, moving costs, specific human capital [education, experience, skills, etc.], or other reasons, firms have an incentive to base recall decisions on the length of UI [unemployment insurance] benefits,” noted Meyer in a study done for the National Bureau of Economic Research. Unionized firms tend to take greater advantage of this “layoff subsidy” than do non-union establishments. And not surprisingly, given the incentives, layoffs are more common for those eligible for unemployment benefits than for those not eligible. If benefits are extended beyond twenty-six weeks, the unemployed tend to stay out of work nearly a day longer, on average, for each week of the extension.

 

Lawrence H. Summers, chief economist at the World Bank, and chief economic adviser to Democratic presidential candidate Michael Dukakis in 1988, reaches similar conclusions. Summers, along with Harvard economist Kim B. Clark, found that unemployment insurance almost doubles the number of unemployment spells lasting more than three months, thereby encouraging long-term joblessness. Summers and Clark suggest that unemployment insurance benefits cause many of the long-term unemployed to have high “reservation wages.” Translation: to accept a job, these unemployed workers insist on getting a high wage, and if they aren’t offered that wage, they stay on unemployment insurance as long as possible.

 

Economists have proposed various reforms to reduce the adverse effects of unemployment while still assisting people who lose their jobs. One of the more modest reforms suggested has been to reduce the minimum tax rate on employers and raise the maximum tax rate, so that the taxes they pay more closely reflect their layoff rates. A more extreme proposal, made by Robert Topel, is to experience-rate individual workers so that workers with a history of long unemployment spells pay higher tax rates. The federal government has already adopted one reform suggested by economists across the ideological spectrum. The 1986 Tax Reform Act eliminates the tax bias in favor of unemployment insurance by taxing unemployment benefits just like other income.

 

David R. Francis is an economic journalist with the Christian Science Monitor.

 

Further Reading

Becker, Joseph M. Experience Rating in Unemployment Insurance: An Experiment in Competitive Socialism. 1972.

Feldstein, Martin. “The Economics of the New Unemployment.” Public Interest 33 (Fall 1973): 3-42.

Summers, Lawrence H. Understanding Unemployment. 1990.

Topel, Robert. “Unemployment and Unemployment Insurance.” Research in Labor Economics 7 (1986): 91-135.

Topel, Robert. “Financing Unemployment Insurance: History, Incentives, and Reform.” In Unemployment Insurance: The Second Half Century, edited by W. Lee Hansen and J. Byers. 1990.

 

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CEE February 4, 2018

Third World Debt

 

[Editor’s note: this article was written in 1991.]

 

By the end of 1990 the world’s poor and developing countries owed more than $1.3 trillion to industrialized countries. Among the largest problem debtors were Brazil ($116 billion), Mexico ($97 billion), and Argentina ($61 billion). Of the total developing-country debt, roughly half is owed to private creditors, mainly commercial banks.

 

The rest consists of obligations to international lending organizations such as the International Monetary Fund (IMF) and the World Bank, and to governments and government agencies—export-import banks, for example. Of the private bank debt, the bulk has been incurred by middle-income countries, especially in Latin America. The world’s poorest countries, mostly in Africa and South Asia, were never able to borrow substantial sums from the private sector and most of their debts are to the IMF, World Bank, and other governments.

 

Third World debt grew dramatically during the seventies, when bankers were eager to lend money to developing countries. Although many Third World governments defaulted on their debts during the thirties, bankers had put that episode out of their minds by the seventies. The mood of the time is perhaps best captured in the famous proclamation by the Citibank chairman at the time, Walter Wriston, that lending to governments is safe banking because sovereign nations do not default on their debts.

 

The loan pyramid came crashing down in August 1982, when the Mexican government suddenly found itself unable to roll over its private debts (that is, borrow new funds to replace loans that were due) and was unprepared to quickly shift gears from being a net borrower to a net repayer. Soon after, a slew of other sovereign debtors sought rescheduling agreements, and the “debt crisis” was officially under way. Though experts do not really understand why the crisis started precisely when it did, its basic causes are clear. The sharp rise in world interest rates in the early eighties greatly increased the interest burden on debtor countries because most of their borrowings were indexed to short-term interest rates. At the same time, export receipts of developing countries suffered as commodity prices began to fall, reversing their rise of the seventies. More generally, sluggish growth in the industrialized countries made debt servicing much more difficult.

 

Of course, the debtors were not simply hapless victims of external market forces. The governments of many of the seventeen nations referred to as Highly Indebted Countries (HICs) made the situation worse by badly mismanaging their economies. In many countries during the seventies, commercial bank or World Bank loans quickly escaped through the back door in the form of private capital flight (see Capital Flight). As table 1 shows, capital assets that “fled” abroad from the HICs were 103 percent of long-term public and publicly guaranteed debt. Loans intended for infrastructure investment at home were rerouted to buy condominiums in Miami. In a few countries, most notably Brazil, capital flight was not severe. But a great deal of the loan money was spent internally on dubious large-scale, government-directed investment projects. Though well intentioned, the end result was the same: not enough money was invested in productive projects that could be used to service the debt.

 

/

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TABLE 1


| | Capital Flight
(in billions of 1987 dollars)


| | | Flight Capital Assets | As Percentage of Long-Term Public and Publicly Guaranteed Debt | | Argentina | $46 | 111% | | Bolivia | 2 | 178 | | Brazil | 31 | 46 | | Chile | 2 | 17 | | Colombia | 7 | 103 | | Ecuador | 7 | 115 | | Ivory Coast | 0 | 0 | | Mexico | 84 | 114 | | Morocco | 3 | 54 | | Nigeria | 20 | 136 | | Peru | 2 | 27 | | Philippines | 23 | 188 | | Uruguay | 4 | 159 | | Venezuela | 58 | 240 | | Yugoslavia | 6 | 79 | | | | Total | 295 | 103 | |

SOURCES: Flight Capital, Morgan Stanley as cited in The International Economy, July/August 1989. Debt, World Debt Tables, 1988-89 edition. Data refer to external debt to private creditors. Reprinted from Journal of Economic Perspectives, 4, no. 1 (Winter 1990): 37.


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Not all of the debtor countries were plagued by mismanagement. South Korea, considered by many to be a problem debtor at the onset of the debt crisis, maintained a strong export-oriented economy. The resulting growth in real GNP—averaging 9.8 percent per year between 1982 and 1988—allowed South Korea to make the largest debt repayments in the world in 1986 and 1987. Korea’s debt fell from $47 billion to $40 billion between the end of 1985 and the end of 1987.

 

But for most debtor countries, the eighties were a decade of economic stagnation. Loan renegotiations with bank committees and with government lenders became almost constant. While lenders frequently agreed to roll over a portion of interest due (thus increasing their loans), prospects for net new funds seemed to dry up for all but a few developing countries, located mostly in fast-growing Asia. In this context bankers and government officials began to consider many schemes for clearing away the developing-country debt problem.

 

In theory, loans by governments and by international lending organizations are senior to private debts—they must be repaid first. But private lenders are the ones who have been pressing to have their loans repaid. As a consequence, official creditors saw their share of problem-country debt double—to nearly half the total—during the first decade of the debt crisis.

 

Many Third World debtors, particularly in Latin America, chafe at being asked to pay down their large debts. Their leaders plead that debt is strangling their economies and that repayments are soaking away resources desperately needed to finance growth. Although these pleas evoke considerable sympathy from leaders of rich countries, opinions over what to do are widely divided.

 

A staggering range of “solutions” has been proposed. Some of the more ambitious plans would either force private creditors to forgive part of their debts or use large doses of taxpayer resources to sponsor a settlement, or both. Current official policy, which is based on the Brady Plan (after U.S. Treasury Secretary Nicholas Brady), is for governments of industrialized countries to subsidize countries where there is scope for negotiating large-scale debt-reduction agreements with the private commercial banks. In principle, countries must also demonstrate the will to implement sound economic policies, both fiscal and monetary, to qualify. A small number of Brady Plan deals have been completed to date, the most notable being Mexico’s 1990 debt restructuring.

 

Toward the end of the eighties, a number of sovereign debtors began experimenting with so-called market-based debt-reduction schemes, in which countries repurchased their debts at a discount by paying cash or by giving creditors equity in domestic industries. On the surface these plans appear to hurt banks because debts are retired at a fraction of their full value. But a closer inspection reveals why the commercial banks responded so enthusiastically.

 

Consider the Bolivian buy-back of March 1988. When the Bolivian deal was first discussed in late 1986, Bolivia’s government had guaranteed $670 million in debt to commercial banks. In world secondary markets this debt traded at six cents on the dollar. That is, buyers of debt securities were willing to pay, and some sellers were willing to accept, only six cents per dollar of principal. Using funds that primarily were secretly donated by neutral third countries—rumored to include Spain, the Netherlands, and Brazil—Bolivia’s government spent $34 million in March 1988 to buy back $308 million worth of debt at eleven cents on the dollar. Eleven cents was also the price that prevailed for the remaining Bolivian debt immediately after the repurchase. At first glance the buy-back might seem a triumph, almost halving Bolivia’s debt. The fact that the price rose from six to eleven cents was interpreted by some observers as evidence that the deal had strengthened prospects for Bolivia’s economy.

 

A more sober assessment of the Bolivian buy-back reveals that commercial bank creditors probably reaped most of the benefit. Before the buy-back, banks expected to receive a total of $40.2 million (.06 × $670 million). After the buy-back, banks had collected $34 million and their expected future repayments were still $39.8 million (.11 × $362 million). How did creditors manage to reap such a large share of the benefits? Basically, when a country is as deep in hock as Bolivia was, creditors attach a far greater likelihood to partial repayment than to full repayment. Having the face value of the debt halved did little to reduce the banks’ bargaining leverage with Bolivia, and the chances that the canceled debt would have eventually been paid were low anyway. Similar problems can arise even in countries whose debt sells at much smaller discounts.

 

The fact that buy-backs tend to bid up debt prices presents difficulties for any plan in which funds taken from taxpayers in industrialized countries are used to promote debt restructurings that supposedly are for the sole benefit of people in the debtor countries. Banks will surely know of the additional resources available for repayment, and they will try to bargain for higher repayments and lower rollovers. The main focus of the Brady Plan is precisely to ensure that the lion’s share of officially donated funds reaches debtors. But the fact that debt prices have been stronger in countries that have implemented Brady Plans than in non-Brady Plan countries suggests that the effort to limit the gain for banks has been only partially successful.

 

Aside from the question of such “leakage” to private banks, there are serious equity concerns with any attempt to channel large quantities of aid relief to deal with private debt. Though poor by standards of Europe and the United States, countries such as Brazil, Mexico, and Argentina rank as middle-to upper-middle income in the broader world community. The average per capita income in the seventeen HICs was $1,430 in 1987. This compares with $470 in developing East Asia and $290 in South Asia. Even Bolivia, South America’s basket case, has twice the per capita income of India. On a need basis, therefore, Africa and South Asia are stronger candidates for aid.

 

Kenneth Rogoff is a professor of economics at Harvard University. He has served on the staff of the International Monetary Fund and the Federal Reserve board and has been a visiting scholar at the World Bank.

 

Further Reading

Bulow, Jeremy, and Kenneth Rogoff. “The Buyback Boondoogle.” Brookings Papers on Economic Activity, no. 2 (1988): 675-98.

Bulow, Jeremy, and Kenneth Rogoff. “Cleaning Up Third-World Debt without Getting Taken to the Cleaners.” Journal of Economic Perspectives 4 (Winter 1990): 31-42.

World Bank. World Debt Tables: External Debt of Developing Countries. 1990-91 edition.

 

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CEE February 4, 2018

Trucking Deregulation

 

Regulation

 

The federal government has been regulating prices and competition in interstate transportation ever since Congress created the Interstate Commerce Commission (ICC) to oversee the railroad industry in 1887. Truckers were brought under the control of the ICC in 1935 after persistent lobbying by state regulators, the ICC itself, and especially, the railroads, which had been losing business to trucking companies.

 

The Motor Carrier Act of 1935 required new truckers to seek a “certificate of public convenience and necessity” from the ICC. Truckers already operating in 1935 could automatically get certificates, but only if they documented their prior service, and the ICC was quite restrictive in interpreting proof of service. New trucking companies, on the other hand, found it extremely difficult to get certificates.

 

The law required motor carriers to file all rates—also called tariffs—with the ICC thirty days before they became effective. Anyone, including a competitor, was allowed to inspect the filed tariffs. If the proposed tariffs were protested by another carrier (such as a trucker, a regulated water carrier, or a railroad), the ICC normally suspended the rates pending an investigation of their legality. In 1948 Congress authorized truckers to fix rates in concert with one another when it enacted, over President Truman’s veto, the Reed-Bulwinkle Act, which exempted carriers from the antitrust laws.

 

From 1940 to 1980, new or expanded authority to transport goods was almost impossible to secure unless no one opposed an application. Even if the proposed service was not being offered by existing carriers, the ICC held that a certificated trucker who expressed a desire to carry the goods should be given the opportunity to do so; the new applicant was denied. The effect was to stifle competition from new carriers.

 

Purchasing the rights of an existing trucker became the only practical approach to entering a particular market. By the seventies the authority to carry certain goods on certain routes was selling for hundreds of thousands of dollars. Because the commission disapproved of “trafficking” in rights, it was hostile to mergers and purchases and attempted to restrict authority as much as possible. The result was often bizarre. For example, a motor carrier with authority to travel from Cleveland to Buffalo that purchased another carrier or the carrier’s rights to go from Buffalo to Pittsburgh was required to carry goods destined for Pittsburgh through Buffalo, even though the direct route was considerably shorter. In some cases carriers had to go hundreds of miles out of their way, adding many hours or even days to the transport.

 

ICC regulation reduced competition and made trucking inefficient. Routes and the products that could be carried over them were narrowly specified. Truckers with authority to carry a product, such as tiles, from one city to another often lacked authority to haul anything on the return trip.

 

Regulation’s Costs

 

Studies showed that regulation increased costs and rates significantly. Not only were rates lower without regulation, but service quality, as judged by shippers, also was better. Products exempt from regulation moved at rates 20 to 40 percent below those for the same products subject to ICC controls. For example, regulated rates for carrying cooked poultry, compared to unregulated charges for fresh dressed poultry (a similar product), were nearly 50 percent higher. Comparisons between heavily regulated trucking in West Germany and the United States and unregulated motor carriage in Great Britain, together with lightly regulated trucking in Belgium and the Netherlands, showed that charges in the highly regulated countries were 75 percent higher than in the nations with freer markets.

 

A number of economists were critical of the regulation of motor carriers right from the beginning. James C. Nelson, in a series of articles starting in 1935, led the attack. Walter Adams, a liberal Democrat, followed with a major critique in American Economic Review. Professors John R. Meyer of Harvard, Merton J. Peck of Yale, John Stenason, and Charles Zwick authored a very influential book, The Economics of Competition in the Transportation Industries, published in 1959.

 

In 1962 President John Kennedy became the first president to send a transportation message to Congress recommending a reduction in the regulation of surface freight transportation. In November 1975 President Gerald Ford called for legislation to reduce trucking regulation. He followed that by appointing to the ICC several commissioners who favored competition. By the end of 1976, these commissioners were speaking out for a more competitive policy at the ICC, a position rarely articulated in the previous eight decades of transportation regulation.

 

President Jimmy Carter followed Ford’s lead by appointing strong deregulatory advocates and supporting legislation to reduce motor carrier regulation. After a series of ICC rulings that reduced federal oversight of trucking, and after the deregulation of the airline industry, Congress, spurred by the Carter administration, enacted the Motor Carrier Act of 1980. This act limited the ICC’s authority over trucking.

 

Both the Teamsters Union and the American Trucking Associations strongly opposed deregulation and successfully headed off efforts to eliminate all economic controls. Supporting deregulation was a coalition of shippers, consumer advocates including Ralph Nader, and liberals such as Senator Edward Kennedy. Probably the most significant factor in forcing Congress to act was that the ICC commissioners appointed by Ford and Carter were bent on deregulating the industry anyway. Either Congress had to act or the ICC would. Congress acted in order to codify some of the commission changes and to limit others.

 

The Motor Carrier Act (MCA) of 1980 only partially decontrolled trucking. But together with a liberal ICC, it substantially freed the industry. The MCA made it significantly easier for a trucker to secure a certificate of public convenience and necessity. The MCA also required the commission to eliminate most restrictions on commodities that could be carried, on the routes that motor carriers could use, and on the geographical region they could serve. The law authorized truckers to price freely within a “zone of reasonableness,” meaning that truckers could increase or decrease rates from current levels by 15 percent without challenge, and encouraged them to make independent rate filings with even larger price changes.

 

The Success of Deregulation

 

Deregulation has worked well. Between 1977, the year before the ICC started to decontrol the industry, and 1982, rates for truckload-size shipments fell about 25 percent in real, inflation-adjusted terms. The General Accounting Office found that rates charged by LTL (less-than-truckload) carriers had fallen as much as 10 to 20 percent, with some shippers reporting declines of as much as 40 percent. Revenue per truckloadton fell 22 percent from 1979 to 1986. A survey of shippers indicates that they believe service quality improved as well. Some 77 percent of surveyed shippers favored deregulation of trucking. Shippers reported that carriers were much more willing to negotiate rates and services than prior to deregulation. Truckers have experimented with new price and service options. They have restructured routes, reduced empty return hauls, and provided simplified rate structures.

 

In arguing against deregulation, the American Trucking Associations predicted that service would decline and that small communities would find it harder to get any service at all under the new regime. In fact, service to small communities has improved and complaints by shippers have declined. The ICC has reported that in 1975 and 1976 it handled 340 and 390 complaints, respectively, against truckers; in 1980 it had to deal with only 23 cases, and just 40 in 1981. A 1982 ICC study of the effect of partial decontrol on small cities and remote parts of the country found that service quality had either been improved or remained unaffected by deregulation. Increased competition has bolstered the willingness of trucking firms to go off-route to pick up or deliver freight.

 

Deregulation has also made it easier for nonunion workers to get jobs in the trucking industry. This new competition has sharply eroded the strength of the drivers’ union, the International Brotherhood of Teamsters. Before deregulation ICC-regulated truckers paid unionized workers about 50 percent more than comparable workers in other industries. Although unionized drivers still are paid a premium, by 1985 unionized workers were only 28 percent of the trucking work force, down from around 60 percent in the late seventies.

 

The number of new firms has increased dramatically. By 1990 the total number of licensed carriers exceeded forty thousand, considerably more than double the number authorized in 1980. The ICC had also awarded nationwide authority to about five thousand freight carriers. The value of operating rights granted by the ICC, once worth hundreds of thousands of dollars when such authority was almost impossible to secure from the commission, has plummeted to close to zero now that operating rights are easy to obtain.

 

Intermodal carriage has surged sharply since 1980: from 1981 to 1986, it grew 70 percent. The ability of railroads and truckers to develop an extensive trailer-on-flatcar network is a direct result of the MCA and the Staggers Act (1980), which partially freed the railroads.

 

The motor carrier industry has made little use of the rate zone provision and instead has opted for independent filings, which have increased sharply. These independent filings have increased price competition. Such filings by definition are not agreed on through rate bureaus. Truckers have been able to slash rates mainly by improving efficiency—reducing empty backhauls, eliminating circuities, pricing flexibly, and reducing by about 10 percent the proportion of employees who are drivers and helpers. At the same time, it has cut the pay of such employees by over 10 percent relative to wages of workers in the economy generally. In other words, although wages of drivers and helpers are still considerably higher than wages of comparable workers in other industries, the differential has shrunk.

 

Savings

 

One of the economy’s major gains from trucking deregulation has been the substantial drop in the cost of holding and maintaining inventories. Because truckers are better able to offer on-time delivery service and more flexible service, manufacturers can order components just in time to be used and retailers can have them just in time to be sold. As a result inventories are leaner. Without the partial deregulation that resulted from the 1980 act, these changes would not have been possible. In 1981, inventories amounted to 14 percent of GNP; one study found that because of improved transportation services traceable to the Motor Carrier Act of 1980 and the Staggers Act, the total fell to 10.8 percent by 1987, for a saving of about $62 billion. A more conservative estimate by the Department of Transportation is that the gain to U.S. industry in shipping, merchandising, and inventories is between $38 and $56 billion per year.

 

Current Issues

 

Federal law still requires new carriers to apply for certificates of public convenience and necessity. All tariffs must be filed with the commission. Most states continue to enforce strict entry and price controls on intrastate carriers. These controls cause inefficiency. One result is that in some cases, shipping products from overseas is cheaper than shipping the same goods within the United States. Shipping blue jeans from El Paso, Texas, to Dallas, for example, costs about 40 percent more than shipping the identical jeans from Taiwan to Dallas.

 

The continuing obligation to file tariffs results in higher costs. Rates for shipping dog food, which are regulated, are 10 to 35 percent higher than the unregulated rates for other animal foods. Chicken, turkey, and fish TV dinners can be carried free of regulation, but a frozen dinner with a hamburger patty instead of a chicken leg requires trucking rates that are 20 to 25 percent higher. When the commission ruled that used beer bottles and kegs were exempt under the “used, empty shipping containers” provision, costs to haul the empties dropped 20 to 30 percent.

 

Even if the filing of tariffs did not lead to higher charges, the requirement adds to paperwork and confusion. For example, rates must be published for peanuts “roasted and salted in the shell,” but a trucker carrying peanuts “shelled, salted, not roasted or otherwise” is exempt from any need to file. Truckers must submit tariffs for carrying show horses but not exhibit horses. Motor carriers must list their prices with the ICC to carry railroad ties cut lengthwise, but not if they are cut crosswise!

 

Current law also authorizes truckers to collude on tariff increases in rate bureaus. In any other industry such agreements would violate the antitrust laws. Although any single carrier can file separate rates, a rate bureau’s filing for higher tariffs leads to pressures on all carriers to boost their prices.

 

Trucking deregulation is unfinished. According to one study, abolishing all remaining federal controls would save shippers about $28 billion per year. A Department of Transportation study done by researchers at the University of Pennsylvania’s Wharton School estimated that abolishing state regulation would save another $5 billion to $12 billion.

 

Thomas Gale Moore is a senior fellow at the Hoover Institution at Stanford University. Between 1985 and 1989 he was a member of President Reagan’s Council of Economic Advisers.

 

Further Reading

Moore, Thomas Gale. “Rail and Truck Reform: The Record So Far.” Regulation (November/December 1988): 57-62.

Organization for Economic Cooperation and Development. International Conference. Road Transport Deregulation: Experience, Evaluation, Research. November 1988.

U.S. Congress, House. Committee on Government Operations. Consumer Cost of Continued State Motor Carrier Regulation. House Report 101-813, 101st Congress, 2d sess., October 5, 1990.

U.S. Congress, House. Committee on Public Works and Transportation. Subcommittee of Surface Transportation. Hearings on Economic Regulation of the Motor Carrier Industry. 100th Congress, 2d sess., March 16, 1988.

U.S. Department of Transportation. Moving America: New Directions, New Opportunities. A Statement of National Transportation Policy; Strategies for Action. February 1990.

 

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CEE February 4, 2018

Third World Economic Development

 

[Editor’s note: this article was written in 1992.]

 

The development experiences of Third World countries since the fifties have been staggeringly diverse—and hence very informative. Forty years ago the developing countries looked a lot more like each other than they do today. Take India and South Korea. By any standards, both countries were extremely poor: India’s income per capita was about $150 (in 1980 dollars) and South Korea’s was about $350. Life expectancy was about forty years and fifty years respectively. In both countries roughly 70 percent of the people worked on the land, and farming accounted for 40 percent of national income. The two countries were so far behind the industrial world that it seemed nearly inconceivable that either could ever attain reasonable standards of living, let alone catch up.

 

If anything, India had the edge. Its savings rate was 12 percent of GNP while Korea’s was only 8 percent. India had natural resources. Its size gave its industries a huge domestic market as a platform for growth. Its former colonial masters, the British, left behind railways and other infrastructure that were good by Third World standards. The country had a competent judiciary and civil service, manned by a highly educated elite. Korea lacked all that. In the fifties the U.S. government thought it so unlikely that Korea would achieve any increase in living standards at all that its policy was to provide “sustaining aid” to stop them falling even further.

 

Less than forty years later—a short time in economic history—South Korea’s extraordinary success is taken for granted. By the end of the eighties, its per capita income (in the same 1980 dollars) had risen to $2,900, an increase of nearly 6 percent a year sustained over more than three decades. None of today’s rich countries, not even Japan, saw such a rapid transformation in the deep structure of their economies. In contrast, India’s income per capita grew from $150 to $230, a rise of about 1.5 percent a year, between 1950 and 1980. India is widely regarded as a development failure. Yet over the past few decades even India has achieved more progress than today’s rich countries did over similar periods and at comparable stages in their development.

 

This shows, first, that the setbacks the developing countries encountered in the eighties—high interest rates, debt-servicing difficulties, falling export prices—were an aberration, and that the currently fashionable pessimism about their future is greatly overdone. The superachievers of East Asia (South Korea and its fellow “dragons,” Singapore, Taiwan, and Hong Kong) are by no means the only developing countries that are actually developing. Many others have also grown at historically unprecedented rates over the past few decades. As a group, the developing countries—134 of them, as conventionally defined, accounting for roughly three-quarters of the world’s population—have indeed been catching up with the developed countries.

 

The comparison between India and South Korea shows something else. It no longer makes sense to talk of the developing countries as a homogeneous group. The East Asian dragons now have more in common with the industrial economies than with the poorest economies in South Asia and sub-Saharan Africa. Indeed, these subgroups of developing countries have become so distinct that one might think they have nothing to teach each other, that because South Korea is so different from India, its experience can hardly be relevant. That is a mistake. The diversity of experience among today’s poor and not-so-poor countries does not defeat the task of analyzing what works and what doesn’t. In fact, it is what makes the task possible.

 

Lessons of Experience

 

The hallmark of economic policy in most of the Third World since the fifties has been the rejection of orthodox free-market economics. The countries that failed most spectacularly (India, nearly all of sub-Saharan Africa, much of Latin America, the Soviet Union and its satellites) were the ones that rejected the orthodoxy most fervently. Their governments claimed that for one reason or another, free-market economics would not work for them. In contrast, the four dragons and, more recently, countries such as Chile, Colombia, Costa Rica, Ivory Coast, Malaysia, and Thailand have achieved growth ranging from good to remarkable by following policies based largely on market economics.

 

Among the most important ideas in orthodox economics is that countries prosper through trade. In the sixties and seventies the dragons participated in a boom in world trade. Because the dragons succeeded as exporters, they had abundant foreign exchange with which to buy investment goods from abroad. Unlike most other developing countries, the dragons had price systems that worked fairly well. So they invested in the right things, in ways that reflected their comparative advantage in cheap, unskilled labor.

 

Some economists still dismiss the dragons as special cases, but for reasons I find specious. They argue that Hong Kong and Singapore are small (hitherto smallness had been regarded as a disadvantage in development); that they are former colonies with traditions of excellence in public administration (like India and many others); that they have been generously provided with foreign capital (like Latin America). These economists also argue that Taiwan and South Korea received generous foreign aid (like many other developing countries), and have even argued that their lack of natural resources was an advantage. What was most unusual about these countries, in fact, was a relatively market-friendly approach to economic policy.

 

The countries that failed, often guided by “experts” in the industrialized world, are the ones that gave only a small role, if any, to private enterprise and to prices that are unregulated by government. Government planners concentrated on broad aggregates such as investment, consumption, and savings. Their priority was investment—the more, the better, regardless of its quality.

 

Most governments also thought that their economies were inflexible and could not adjust to changing conditions. The export earnings of developing countries were regarded as fixed, for instance, and so was the import requirement for any given level of domestic production. The possibilities for substituting one good for another in response to a change in price were denied or ignored. The idea that workers respond to changes in incentives was likewise dismissed. This assumed lack of responsiveness led the planners to believe that prices, rather than providing signals for the allocation of resources, could serve other purposes instead. For instance, with direct controls they could be kept low to reduce inflation, or raised here and there to gather revenue for the government.

 

Taken to the limit, this “fixed-price” approach leads to regulation by input-output analysis. The idea is to tabulate the flow of primary, intermediate, and finished goods throughout the economy, on the assumption that each good requires inputs of other specific goods in fixed proportions. When all the cells in the table have been filled in, a government needs only to decide what it wants the economy to produce in order to know exactly what the country needs to import, good by good.

 

India went in for this sort of planning in a big way. More than a few of today’s leading free-market economists have worked within India’s planning system or have studied it in detail, and intimate contact with it leads them to one inescapable conclusion: government planning of the economy does not work. Professor Deepak Lal of London University, a leading proponent of market economics for the Third World, mentions his experience with India’s planning commission in his book The Poverty of Development Economics. He calls the antimarket approach favored in so many countries the “dirigiste dogma.”

 

From Peru to Ghana

 

In the noncommunist world, the most striking recent example of this dogma at work is Peru. When Alan Garcia’s government came to power in the summer of 1985, Peru was already in a bad way, thanks largely to high tariffs and other import barriers, restrictive labor-protection laws, extensive credit rationing, high taxes, powerful trade unions, and an extraordinarily elaborate system of regulations to control the private sector. One result was Peru’s justly celebrated black market, or “informal economy,” described by Hernando de Soto in his modern classic, The Other Path. The other result was great vulnerability to adverse economic events. The early eighties delivered several, including a world recession, high interest rates, a drying up of external finance, and declining commodity prices.

 

Garcia’s policy was based, he said, on two words: control and spend. After imposing price controls, he sharply increased public spending. The program succeeded at first. Gross domestic product (GDP) grew 9.5 percent in 1986 and 7 percent in 1987. But by the spring of 1988 inflation was running at 1,000 percent a year; by the end of the year it was 6,000 percent. After that, output and living standards collapsed. In 1990, the economy a wreck, Garcia was voted out of office.

 

The dirigiste dogma has proved equally damaging in Africa. Take Ghana. When it became independent in 1957, it was the richest country in the region, with the best-educated population. It was the world’s leading exporter of cocoa; it produced 10 percent of the world’s gold; it had diamonds, bauxite, and manganese, and a flourishing trade in mahogany. Its income per capita was almost exactly equal to South Korea’s at $490 (in 1980 dollars). By the early eighties, however, Korea’s income per capita had risen fourfold, while Ghana’s had actually fallen nearly 20 percent to $400 per head. Investment slumped from 20 percent of GDP in the fifties to 2 percent by 1982, and exports dropped from more than 30 percent of GDP to 4 percent.

 

The country’s leader at independence, Kwame Nkrumah, was a spokesman for the newly independent Africa. He said the region needed to develop its own style of government, suited to its special circumstances. He spent vast sums on megaprojects. As economic troubles mounted, he nationalized companies and followed with capital repression. Under his regime capital flew abroad, and people with skills and money did the same. The kleptocrats (government officials who steal large amounts) ran the country into the ground. In the early eighties a new government came to power and at last began to steer the economy along orthodox lines. Until then, Ghana had been to Africa what Peru is to Latin America: a distillation of everything that has gone wrong with the continent’s economies.

 

In the Third World, where so many people live off the land, agricultural development is crucial. Ghana provides a startling case study in how to wreck the farm sector. The means was the agricultural marketing board—a statutory monopoly that bought farmers’ crops at controlled prices and resold them either at home or abroad. The prices paid to farmers were kept artificially low, on the assumption that farmers ignored price signals.

 

Between 1963 and 1979 the price of consumer goods went up by a factor of twenty-two in Ghana. The price of cocoa in neighboring countries went up by a factor of thirty-six. But the price paid by the cocoa marketing board to Ghana’s farmers went up just sixfold. In real terms, therefore, the returns to cocoa farmers vanished. The country’s supposedly price-insensitive farmers responded by switching to production of other crops for subsistence, and exports of cocoa collapsed. Peru and Ghana are extreme cases, but they show in the starkest way that prices do matter in the the Third World and that rejecting market economics carries extremely high costs.

 

The essential elements of a development strategy based on orthodox economics are macroeconomic stability, foreign trade, and strictly limited intervention in the economy. With policies under these three headings, governments can foster enterprise and entrepreneurship, the irreplaceable engines of capitalist growth.

 

The Macroeconomic Foundation

 

Experience shows that high and unstable inflation can harm growth. A noninflationary macroeconomic policy is, therefore, a prerequisite for rapid development. Control of government borrowing is the crucial element in such a policy. When public borrowing is excessive, governments are soon obliged to finance it by printing money, and rising inflation then follows. That is why the conventional approach to stabilization (a term that covers steps to reduce an unsustainable trade deficit as well as anti-inflation policies) usually advocates lower public spending and/or higher taxes. The International Monetary Fund has long made programs of this sort a precondition for financial assistance to countries in distress.

 

These so-called austerity programs have aroused two sorts of controversy. First, some economists question whether big changes in fiscal policy are really needed. In Latin America, for example, some governments sought “heterodox” policies to reduce inflation without the recession that the orthodox approach almost always brings on. The heterodox approach argues that in high-inflation countries, the budget deficit is caused mainly by inflation, not the other way round. The argument is twofold. First, because there is a lag between when people earn income and when they must pay taxes on it, high inflation reduces real tax revenues. Second, inflation increases the nominal interest rate (and hence the budgetary cost of servicing past government debt).

 

Hence the heterodox logic: reduce inflation with direct controls on prices and incomes and a currency reform, and the budget deficit will shrink of its own accord. This method has been tried repeatedly in Brazil and Argentina, where brief success has generally given way to a worse mess than at the outset, and in Israel, where the results were more encouraging. Israel shows that the heterodox can work—that falling inflation does cut public borrowing. What matters is whether the deficit that remains after the heterodox measures are in place is low enough to be noninflationary. In practice, the remaining deficit is almost always too high, and the program fails. Countering inflation almost always requires a dose of austerity.

 

The second controversy over austerity concerns the costs of this remedy. Many economists argue that orthodox programs put too much of the burden on the poorest parts of society. To cut their budget deficits, governments can either raise taxes or cut spending. Raising more revenue—even if that could be done without harming incentives—is hard because of weak tax administration. So stabilization nearly always involves cuts in public spending. If the cuts fall on food subsidies and welfare spending, goes this argument, they hurt the most vulnerable.

 

This argument sounds plausible, but in many countries it is wrong. A study by Guy Pfeffermann of the World Bank shows that the beneficiaries of social spending in the developing countries are not the poor. First, more public spending of any sort means more public employment. Bureaucracies in developing countries do not give many jobs to the landless rural poor, to small street traders, to unskilled manual workers, or to the urban unemployed. They recruit from the middle classes, who are, therefore, the first to benefit from public spending.

 

They often are the second and third to benefit as well. In some countries subsidies have amounted to more than 10 percent of GDP. These mainly go toward making electricity, gasoline, housing, and credit artificially cheaper for consumers. Quite apart from the massive microeconomic damage that these price distortions cause, such subsidies do not reach the poor. Many of the poor do not live in houses, which greatly reduces their need for electricity, and most do not own cars. (Gasoline subsidies alone in Ecuador and Venezuela have been equivalent to several percentage points of GDP.) Although some of the poor would benefit from credit, subsidized credit is not aimed at them and makes the unsubsidized kind harder to get and a lot more expensive. Spending on education is also, as a rule, heavily biased toward the middle classes. In some developing countries, spending per capita on university education exceeds spending per capita on primary education by a factor of thirty. Many of the poor lack access to even the most basic primary education, while the universities remain the publicly funded preserve of the middle class. And in most developing countries the coverage of heavily subsidized social security systems is strongly skewed against the poor. In Brazil in 1984, only 8 percent of workers in the poorest broad sector of the economy (farming) were covered by a social security system. Nearly 80 percent of workers in the most prosperous sector (transport and communications) were covered.

 

By and large, the scope for cutting public spending in developing countries without hurting the poor is more than enough for stabilization to succeed. In some cases (subsidized credit, for example) a reduction in public spending would actually help the poor directly, even before the broader benefits of macroeconomic stability began to flow back. Admittedly, this is not much help in political terms. It is easy to neglect the poor. That is precisely why this vast system of subsidies does not help them. But the middle classes can shout loudly when the economic distortions that help them are taken away. So the political barriers to getting economic policy right are formidable.

 

The Gains from Trade

 

For its World Development Report in 1987, the World Bank classified forty-one developing countries according to their openness to trade since the sixties. It classed economies as either inward looking (exports were discouraged) or outward looking (exports were not discouraged), with a further division according to the strength of any trade bias. The World Bank then plotted these groups against a variety of economic indicators.

 

Growth in income per capita was highest in the strongly outward-looking economies and lowest in the strongly inward-looking ones. The same was true for growth in total GDP and in value added in manufacturing, and for the standard measure of the efficiency of investment. On all these criteria the moderately outward-looking countries also outperformed inward-looking economies, although by a smaller margin. The failure of a strong inward orientation to promote domestic manufacturing—not just exports of manufactures—is particularly striking. The whole point of looking inward had been to industrialize faster.

 

The three strongly outward-oriented countries in the World Bank’s report were Hong Kong, Singapore, and South Korea. Taiwan would have been the fourth if it had been included in the sample, and would have reinforced the message. The four dragons, however, have been more diverse in their policies than is usually assumed. Hong Kong’s outward orientation is due to unalloyed free trade. The other three have been interventionist to varying degrees, using export incentives to offset the export-discouraging effects of domestic protection.

 

South Korea, by some measures the most interventionist dragon, is often cited as proof that intelligent dirigiste, rather than a broadly outward-looking trade policy, is the key to rapid development. This judgment is often based on the false premise that Korea has protected its domestic producers as much as if not more than the inward lookers have protected theirs, with the difference that it has then piled on a lot of incentives for exporters. This is incorrect. In reality, South Korea has had a moderate and declining degree of domestic protection with just enough export promotion to achieve broad neutrality in trade incentives.

 

Korea’s growth surge began in the mid-sixties. Policy began to change in the late fifties. At that time Korea’s government placed quantitative restrictions on almost all imports, but the restrictions were looser than in many other developing countries. The government began to provide export incentives to offset its protection for producers of import substitutes. At first this failed to work, perhaps because the currency was overvalued, leaving too great a bias against exports. In the early sixties the government dismantled its multiple exchange-rate system, devalued the currency, and (because devaluation helped exporters) reduced its export subsidies. These liberalizing reforms were the turning point. Exports began to grow rapidly.

 

In 1967 the government reformed its import control system, greatly reducing the number of imports subject to quotas and began to reduce its tariffs. So as the miracle proceeded in the late sixties and seventies, the background was not just outward orientation (domestic protection offset by export promotion), but a low average level of domestic protection, with relatively little variation in the rates of protection from one sector to another. Toward the end of the seventies, when Korea did increase its support for heavy industry, the economy began to run into trouble. Policymakers acknowledged their mistake and moved back toward liberalization.

 

The clear consensus among mainstream economists is that outward-looking trade policies are one of the keys to development. But why? The answer from orthodox economics is that trade allows countries to exploit their comparative advantage. Trade enables a country to consume a mix of goods that is different from the mix it produces—with prices in world markets acting as the mediator between the two. Conventional theory proves that trade, as a result, makes both partners unambiguously better off. So long as import barriers and other policies do not drive domestic prices too far away from world prices, market forces are enough to push production and consumption in the right direction. But trade does more than bring about the right mix of products. It also eliminates the inefficiencies in production caused by protection.

 

Protection may make some domestic producers monopolists or near monopolists, thus introducing an inefficiency directly (because monopolists exploit their market strength by producing less and charging more) and indirectly (because, lacking competition, they have no incentive to keep costs low).

 

Two of the world’s top trade specialists, Professors Jagdish Bhagwati of Columbia University and Anne Krueger of Duke University, have emphasized yet another source of inefficiency pervasive in developing and industrial countries alike: “rent-seeking,” or more generally, “directly unproductive profit-seeking.” These spring from the efforts of business to exploit or evade the distortions caused by protection. For instance, import licensing may drive a wedge between the official price of an intermediate good and the price that a domestic producer is willing to pay.

 

This “rent” is a potential source of profit for somebody. Resources will be spent in trying to corner the market in licenses, or in bribing the bureaucrats who decide which firms will get them, or in lobbying governments to alter the pattern of protection in ways that favor the lobbyists. Worst of all, resources will be spent in trying to win an increase in the overall level of protection. A study of Turkey (see Grais et al.) found that the costs of rent-seeking in the late seventies were between 5 percent and 10 percent of GDP. Because the study made no allowance for the effect of protection on domestic monopoly power, this is an under-estimate of the cost. A study by Joel Bergsman, which did take monopoly effects into account, found that the annual costs of protection were 7 percent of GDP in Brazil, 3 percent in Mexico, 6 percent in Pakistan, and 4 percent in the Philippines. Such results speak for themselves. The evidence shows that trade works; orthodox theory shows why.

 

Where to Intervene

 

It is often argued that all the dragons (except Hong Kong) have had highly interventionist governments. Even on the assumption that these interventions, by luck or judgment, left the economies with outward-looking trade regimes, this poses a question. Might their success be due to nothing more profound than the fact that good intervention is better than bad? It is not the extent of intervention that matters, the argument goes, but the skill with which it is done.

 

It is true that these countries, especially South Korea, have had interventionist governments. This they have in common with almost all developing countries. The difference is not only that they pursued an outward-looking approach to trade (broad lesson number one), but also that this approach molded the forms of intervention they undertook in the domestic economy (broad lesson number two). The net effect (broad lesson number three) was to leave the price system largely intact as a signaling device for the private sector.

 

More generally, an outward-looking approach to trade does not require laissez-faire (though laissez-faire does require an outward-looking approach to trade). The state has a vital role in development. Paradoxically, however, most of the Third World’s highly interventionist governments neglect this role because they are too busy doing things they should not.

 

Government has several vital jobs to do and no spare resources to waste on other things. The cost of an effective legal system, for instance, is public money well spent. This means countries need rules that define property rights, contracts, liability, bankruptcy, and so on (which most developing countries already have). It also means enforcing those rules effectively (which fewer manage to do). Spending on physical and social infrastructure is essential, for there are good (orthodox) reasons to think that the private sector will provide too little. Numerous studies have shown that the economic returns to spending on primary education, especially for girls, are extremely high. Governments need to do more in such areas, not less, though none of these tasks requires the government to be a monopolist.

 

Governments have done too little in the areas where they can do some good because they have spread themselves too thin and been far too ambitious in areas where intervention is, at best, unnecessary. Instead of building roads, schools, and village health centers, Third World governments have built prestigious airports, universities, and big-city hospitals. Instead of letting businesses compete, they have created state-run industries and sheltered their extraordinary inefficiencies from foreign and domestic competition.

 

Advocates of state intervention often claim to be realists. Markets are not perfect, they say, so governments have to step in, especially in developing countries. They are right up to a point. The price system never works perfectly, least of all in developing countries. But it is important to be realistic about governments, too. The past forty years of development experience have shown that no resource is in scarcer supply than good government, and that nothing market forces could devise has done as much harm in the Third World as bad government.

 

Two Myths

 

A common argument is that many developing countries will be condemned to economic stagnation, regardless of the economic policies their governments pursue, by two factors beyond their control: their insupportable debts and their lack of home-grown entrepreneurs. Both ideas are wrong.

 

First, consider debt. The costs of the debt crisis of the eighties have indeed been great. At the margin, foreign capital matters a lot—not just in quantitative terms, but because of the foreign expertise that often comes with it. But the problem of debt, serious though it is, is by no means an insuperable obstacle to growth in the Third World. Even in good times, foreign capital has financed only a small part of the investment undertaken in developing countries. Debt needs to be kept in perspective.

 

In its World Development Report 1989, the World Bank compiled data on financial balances for a sample of fourteen developing countries (some now “highly indebted,” others not) for which sufficiently detailed data were available. The figures suggest that the biggest source of capital, by far, in these economies during the seventies and eighties was household saving. This was equivalent, on average, to 13 percent of GDP in the countries in the sample. Businesses saved 9 percent of GDP. The domestic supply of capital—the sum of household saving and business saving—was 22 percent of GDP, while the inflow of foreign capital was only 2 percent of GDP.

 

After the debt myth comes the myth of the missing (especially African) entrepreneur. The idea that the Third World lacks the spirit of enterprise is laughable. Peasant farmers who switch to another crop in response to a change in their government’s marketing arrangements are entrepreneurs. So are the unregistered taxi and minibus operators who keep most Third World cities moving. So are street vendors, perambulating water vendors, money changers, and informal credit brokers. So are the growers of illegal crops such as coca, who in many countries are denied the opportunity of making a decent living by legal means. So are the smugglers of just about anything that do such a roaring trade across Africa’s borders, profiting from the massive price distortions that government policies create.

 

Entrepreneurship admittedly is partly a matter of skills—in choice of technique, in management, in finance, in the ability to read the label on a bag of fertilizer. Skills have to be learned, and in many developing countries they are in short supply. But this supply is not fixed. The success of the green revolution in India and elsewhere shows that farmers are willing to learn new skills when they can see an advantage in doing so. (The green revolution involved the introduction of high-yielding crop varieties that required different methods and more sophisticated inputs such as fertilizer and an assured water supply.)

 

To see what entrepreneurship in the Third World can achieve, consider the flowering of the garment export business in Bangladesh, one of the poorest countries in the world. This started with a collaboration between Noorul Quader, a bureaucrat-turned-entrepreneur, and the Daewoo Company of South Korea. Quader’s new company, Desh, agreed to buy sewing machines from Daewoo and send workers to be trained in South Korea. Once Desh’s factory started up, Daewoo would advise on production and handle the marketing in return for royalties of 8 percent of sales. Daewoo did not lend to Desh or take any stake in the business. But it showed Desh how to design a bonded warehouse system, which the government agreed to authorize. This was crucial. In effect, it made garment exporting a special economic zone—an island of free trade within a highly protected economy.

 

At the end of 1979, Desh’s 130 trainees returned from South Korea with three Daewoo engineers to install the machines. Garment production began in April 1980 with 450 machines and 500 workers. In 1980 the company produced 43,000 shirts with a value of $56,000. By 1987 sales had risen to 2.3 million shirts and a value of $5.3 million—a growth rate of 92 percent a year.

 

Desh did so well that it canceled its collaboration agreement with Daewoo in June 1981, just eighteen months after the startup. It began to do its own marketing and bought its raw materials from other suppliers. It achieved most of its success on its own. Also, the company has suffered heavy defections of its Daewoo-trained staff. Of the initial batch of 130 who visited South Korea in 1980, 115 had left the company by 1987—to start their own garment-exporting businesses. From nothing in 1979, Bangladesh had seven hundred garment-export factories by 1985. They belonged to Desh, to Desh’s graduates, or to others following their example.

 

There is no lack of entrepreneurship in the Third World. To release this huge potential, governments first need to do much less. Above all, they must stop trying to micromanage the process of industrialization, whether through trade policy, industrial licensing, or direct control of state-owned enterprises. But they also need to do more. They must strive to keep public borrowing and inflation in check, while investing adequately in physical and nonphysical infrastructure.

 

In the early nineties, spurred by the collapse of the socialist model in Eastern Europe, a growing number of developing countries are trying to reorder their economic priorities in this way. If they persevere, the coming decades will be a time of unprecedented advance in the developing world.

 

Clive Crook is the deputy editor of The Economist.

 

Further Reading

Bergsman, Joel. “Commercial Policy, Allocative Efficiency and X-efficiency.” Quarterly Journal of Economics 88, no. 3 (August 1974): 409-33.

Crook, Clive. “The Third World.” The Economist, September 23, 1989.

Grais, W., et al. “A General Equilibrium Estimation of the Reduction of Tariffs and Quantitative Restrictions in Turkey in 1978.” In General Equilibrium and Trade Policy Modelling, edited by T. N. Srinivasan and J. Whalley. 1984.

Lal, Deepak. The Poverty of Development Economics. 1985.

Pfeffermann, Guy. “Public Expenditure in Latin America: Effects on Poverty.” World Bank discussion paper no. 5.

Soto, Hernando de. The Other Path. 1989.

World Bank. World Development Report 1987. 1987.

World Bank. World Development Report 1989. 1989.

 

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CEE February 4, 2018

Research and Development

 

Research and development (R&D) is the creation of knowledge to be used in products or processes. Table 1 gives a summary overview of postwar U.S. R&D activity performed in industry. The first column gives privately financed R&D (PR&D) conducted in industry in billions of 1982 dollars. The second column gives the ratio of PR&D to investment in plant and equipment (P&E). The third column gives the share of federally financed R&D (GR&D) as a fraction of the total R&D in industry. State government and private nonprofit financing of basic scientific research that is part and parcel of teaching in colleges and university is not considered R&D. The only financing of research at universities and colleges that is considered R&D is R&D contracts to those institutions. Total university and college R&D in the sixties was 10 percent of the total R&D conducted in industry; in the eighties it was 13 percent.

 

|

TABLE 1


| |

U.S. R&D, Decade Averages


| | Decade | Private
(billions of 1982 $)
| PR&D/P&E | Share Government R&D | |


| | 1950 | 8.84 | 0.06 | 0.49 | | 1960 | 18.95 | 0.09 | 0.54 | | 1970 | 27.29 | 0.09 | 0.37 | | 1980 | 47.00 | 0.11 | 0.32 | |


|

 

Two facts stand out in table 1. First, investment that takes the form of R&D is growing relative to investment in P&E. Investment in P&E is recognized as investment by the official economic measurements; investment in R&D is not so recognized. Second, the role of government R&D is falling in relative terms.

 

There are several important issues in the economic analysis of R&D:

 

  1. Is private R&D productive?

 

  1. Is government R&D productive?

 

  1. Is special government treatment for private producers of R&D justified?

 

  1. Why is some government R&D so successful, while other government R&D fails?

 

  1. Who benefits from U.S. R&D?

 

Is Private R&D Productive?

 

Beginning in the sixties, economists performed empirical tests confirming that investment in private R&D yields a positive return. This finding holds up for studies of R&D in general and in particular industries. Recent findings by Lichtenberg and Siegel reported an estimated rate of return of 35 percent for company-funded R&D. The older literature they surveyed reported an average rate of return of 29 percent. This is evidence of remarkable stability in the estimates of the rate of return to privately funded R&D. When Lichtenberg and Siegel decomposed R&D into basic and applied, they found that the rate of return to basic R&D was 134 percent, compared to the two older findings of 178 percent and 231 percent. When the rate of return, even after falling, is still in triple digits, one suspects underinvestment.

 

Is Government R&D Productive?

 

Econometric research almost never finds government R&D productive. Yet technical economists have long known about the remarkably high rate of return to agricultural GR&D. According to Robert Evenson, Paul Waggoner, and Vernon Ruttan, rates of return for government-financed agricultural R&D are consistently around 50 percent per annum. Ordinary people were able to see the efficacy of government-financed computers, electronics, and aviation in the Gulf War.

 

So why do broader studies find the opposite? One answer is as follows: Profit-maximizing companies use factors of production, whether they be labor, land, or R&D up to the point where their marginal value equals the marginal cost to the firm. But unlike wages paid to labor, the price that people pay to use government R&D is zero: one need only buy a technical journal to learn R&D results that cost millions to produce. Because companies pay zero for government R&D results, they use them up to the point where the marginal value equals zero. Economists looking for a positive marginal value of government R&D, therefore to find it. But all this means is that companies are using it a lot and that, while the marginal value of government R&D is zero, its total value is high.

 

There is a lively debate about whether government R&D enhances the supply of private R&D. The majority of economists, perhaps, hold that it does. Why would it? Because increasing the supply of one factor of production generally increases the marginal product of other factors. (More land, for example, makes a farm laborer more productive.) Similarly, more government R&D is likely to make private R&D more productive.

 

Is R&D Worthy of Special Treatment?

 

Knowledge epitomizes a public good. If someone produces knowledge, someone else can use it without paying for it. Therefore, the person who produced it will not be able to collect the full value of the knowledge produced. For this reason an unregulated, unsubsidized free market is likely to underproduce knowledge. As a result, most economists favor the creation of temporary monopolies through a patent system, such as the one provided for in the U.S. Constitution. With the prospect of a patent as a reward for innovation, people have more of an incentive to produce knowledge.

 

Need the government do more? Since some new knowledge is not patentable, perhaps special treatment is justified to encourage the provision of knowledge. The most dramatic case for special treatment is based on a famous argument made by Joseph Schumpeter. Schumpeter maintained that a monopoly—because it is able to garner more of the benefits to the industry from R&D (because a monopoly is the industry)—will have an incentive to invest more heavily in R&D than would a competitive industry. In economic jargon a monopoly can internalize more of the R&D benefits than a competitive industry can. Although Schumpeter himself did not argue for special treatment of R&D on this basis, the argument could be made. This consideration did not save the Bell system from breakup.

 

A much more modest argument—to give R&D tax credits—has been politically successful. But it is hard to tell whether the tax credit has been economically successful—that is, whether it has spurred private investment in R&D. One reason for not knowing the effect on R&D is that companies can get the tax credit simply by relabeling non-R&D expenditures as R&D. Nonetheless, the remarkably high rates of return to R&D that a wide range of studies report strongly suggests that there is underinvestment in R&D. Unfortunately, these studies do not allow one to suggest how to stimulate more R&D.

 

Why the Range of Government Experience?

 

If the experience with government R&D were uniformly wonderful or uniformly disastrous, students of R&D could offer easy guidance. However, the experience has been mixed. As mentioned, agricultural R&D and defense R&D in computers, electronics, and aviation have been remarkable successes. Balancing the accounts, one need only mention the supersonic transport, which was financed by British and French taxpayers, and the synfuels project, financed by U.S. taxpayers. The costs for each of these projects exceeded the benefits by billions of dollars. Yet making a list of winners and losers is somewhat beside the point when one of the winners, the computer, has changed the world.

 

This list of failures raises a question: if the government can pick winners in defense, why not elsewhere? It is important to note that in aircraft and electronic R&D, the Defense Department was the major customer for many years. This is in the context of a political decision not to match the buildup of the late Warsaw Pact man for man and tank for tank. Rather, the Defense Department was charged with matching the Warsaw Pact with higher-quality equipment. The competing branches of the U.S. armed services could be held politically accountable for their performance. The resulting incentives seem to have made the Defense Department very sensitive to how infant technologies could be developed to serve its clearly delineated mandate. Similarly, agricultural R&D has long enjoyed a politically symbiotic relationship with agricultural interest groups. When government agencies have incentives to be competent, they are competent.

 

But who monitors R&D done only for the “public good”? The usual answer is no one. Simple public choice theory suggests that government responds to incentives. When the performance of government agencies is monitored carefully, one expects very different results than when no one in particular is supposed to benefit from the R&D expenditures. Thus, there is no reason to believe that the success rate of defense and agricultural R&D could be replicated in other areas.

 

Who Benefits from U.S. R&D?

 

One difference between stocks of knowledge and stocks of physical capital is that stocks of knowledge can be shared. If I build a machine, it cannot produce for you unless it stops producing for me. If I learn something, this knowledge can produce for you and for me at the same time. If this is so, then the rest of the world should be a major beneficiary of U.S. R&D. Other countries can rent the knowledge, or even get it for free, without having to create it themselves. This suggests that a program of high-tech economic nationalism is automatically self-defeating. One can, with difficulty, block the export of a machine. But the export of knowledge is much harder to impede.

 

David M. Levy is an economics professor at George Mason University.

 

Further Reading

Evenson, Robert E., Paul E. Waggoner, and Vernon W. Ruttan. “Economic Benefits from Research: An Example from Agriculture.” Science 205 (1979): 1101-7.

Flamm, Kenneth. Targeting the Computer. 1987.

Levy, David M. “Estimating the Impact of Government R&D.” Economics Letters 32 (1990): 169-72.

Levy, David M. “Public Capital and International Labor Productivity.” Economics Letters 39 (1992): 365-68.

Lichtenberg, Frank R., and Donald Siegel. “The Impact of R&D Investment in Productivity.” Economic Inquiry 29 (1991): 203-29.

Nelson, Richard R., ed. Government and Technical Progress. 1982.

 

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CEE February 4, 2018

Takeovers and Leveraged Buyouts

 

Corporate takeovers became a prominent feature of the American business landscape during the seventies and eighties. A hostile takeover usually involves a public tender offer—a public offer of a specific price, usually at a substantial premium over the prevailing market price, good for a limited period, for a substantial percentage of the target firm’s stock. Unlike a merger, which requires the approval of the target firm’s board of directors as well as voting approval of the stockholders, a tender offer can provide voting control to the bidding firm without the approval of the target’s management and directors.

 

Because it allows bidders to seek control directly from shareholders—by going “over the heads” of target management—the tender offer is the most powerful weapon available to the hostile bidder. Indeed, just the threat of a hostile tender offer can often bring a recalcitrant target management to the bargaining table, especially if the bidder already owns a substantial block of the target’s stock (called a foothold block) and can demonstrably afford to finance a hostile offer for control. Although hostile bidders still need a formal merger to gain total control of the target’s assets, this is easily accomplished once the bidder has purchased a majority of voting stock.

 

Hostile tender offers have been around for decades, but they were rare and generally involved small target firms until the midseventies. Then came the highly controversial multibillion-dollar hostile takeovers of very recognizable public companies. By the late eighties there were dozens of multi-billion-dollar takeovers and their cousins, leveraged buyouts (LBOs). The largest acquisition ever was the $25 billion buyout of RJR Nabisco by Kolberg Kravis and Roberts in 1989. [Editor’s note: this was written in 1992.]

 

Leveraged buyouts of small companies had also been common for decades, but in the eighties LBOs of large public companies became common. An LBO is a going-private transaction involving a tender offer for all of a firm’s common stock, financed mostly by debt, made by a group usually involving some members of incumbent management. LBOs and leveraged cash-outs (first cousins of LBOs in which the target firm remains public because a small part of the compensation to selling shareholders is stock in the new, highly leveraged enterprise) rose to popularity for large public firms in the late eighties as a reaction to the hostile takeover activity. In essence the LBO was a way for management of a vulnerable public company to beat the hostile bidder to the punch, allowing management to buy out public shareholders at a premium and engage in the value-enhancing asset redeployments that otherwise would attract takeover entrepreneurs.

 

The vulnerability arises from a large “value gap”—which is the difference between a company’s value as a going concern under the policies of incumbent management and the expected higher value of the stock, factoring in the value of redeploying the target’s assets. Incumbent managements learned to tap the vast financial muscle of Wall Street in the late eighties and to engage in these control transactions to avoid being the victims of hostile attack. Indeed, many of the large leveraged restructurings were taken in direct defense after a hostile bid had been made.

 

Both economic and regulatory factors combined to spur the explosion in large takeovers and, in turn, large LBOs. The three regulatory factors were the Reagan administration’s relatively laissez-faire policies on antitrust and securities laws, which allowed mergers the government would have challenged in earlier years; the 1982 Supreme Court decision striking down state antitakeover laws (which were resurrected with great effectiveness in the late eighties); and deregulation of many industries, which prompted restructurings and mergers. The main economic factor was the development of the original-issue high-yield debt instrument. The so-called “junk bond” innovation, pioneered by Michael Milken of Drexel Burnham, provided many hostile bidders and LBO firms with the enormous amounts of capital needed to finance multi-billion-dollar deals.

 

Managers of target companies in takeover battles have access to a variety of defensive tactics, many invented during the turbulent eighties. These defensive measures have always been controversial because they necessarily pose a conflict of interest for management. A top manager’s own narrow interest is to save his job, which he often loses after a takeover. His legal obligation is to get a good deal for shareholders, which often means allowing the takeover. Not surprisingly, some managers go with self-interest.

 

The array of takeover defenses includes charter amendments that require supermajorities (i.e., votes of 70 percent or even 80 percent of shareholders) to approve a merger; dual-class restructurings that, by creating two classes of stock, concentrate voting control with management; litigation against the hostile suitor (usually alleging violations of antitrust and securities laws); and purchasing the hostile bidder’s foothold stock at a premium to end the takeover threat (so-called green-mail payments). Although these particular defenses often are effective at delaying the hostile bidder, they rarely are enough to keep a target company independent. The two modern-day defensive weapons that can be “show-stoppers” are the poison pill and the state takeover laws.

 

The term “poison pill” describes a family of “shareholder rights” that are triggered by an event such as a hostile tender offer or the accumulation of voting stock above a designated threshold (usually 15 percent of outstanding stock) by an unfriendly buyer. When triggered, poison pills provide target shareholders (other than the hostile bidder) with rights to purchase additional shares or to sell shares to the target on very attractive terms. These rights impose severe economic penalties on the hostile acquirer and usually also dilute the voting power of the acquirer’s existing stake in the firm.

 

Although poison pills are considered to be absolute deterrents to a hostile takeover, they can almost always be cheaply and quickly altered or removed by target management if they have not been irrevocably triggered. Therefore, they almost always are the subject of strenuous state-court litigation in takeover battles, and their practical effectiveness as an absolute deterrent has been decided in court more often than not. Today, the majority of large public companies are armed with poison pills of one type or another. State courts have allowed target managers to use pills to buy time (up to several months) to search for better third-party offers or develop value-creating corporate restructurings.

 

In the late eighties the Supreme Court upheld the constitutionality of state takeover laws, the most important being Delaware’s merger moratorium law. This law prohibits a hostile acquirer from formally merging with the target for at least three years after buying a controlling interest. Widely regarded as a major deterrent, the Delaware law has an exception if the hostile bidder can acquire more than 85 percent of the target’s stock, excluding shares held by inside managers and by certain kinds of employee stock-ownership plans. Since the law passed, Delaware-incorporated companies (which account for the majority of medium-size and large public companies in the United States) have engaged in various kinds of transactions to “lock up” more than 15 percent of stock in friendly hands, rendering these companies “bullet-proof” under Delaware law.

 

State antitakeover laws and the poison pill have dramatically reduced the scope for hostile tender offers in the U.S. market. Both defensive barriers can be overcome only by getting the target board of directors to approve the takeover. Therefore, hostile takeover activity has been moved directly into the boardroom, through the increasing use of proxy fights in conjunction with tender offers that are conditional on the bidder gaining control of the board or approval from the incumbent board. This hybrid proxy/tender offer approach is considerably more expensive, time-consuming, and risky than the hostile tender offer of the eighties. Consequently, hostile takeover activity has declined sharply, and the campaigns that have been waged were long, drawn-out proxy battles.

 

Was all this takeover and LBO activity good for the economy? The issue stirs strong emotions on both sides, but I believe the evidence shows that takeovers and buyouts are a good thing. Many published studies have documented the effects of tender offers and mergers on stock prices. The consensus is that these transactions confer large stock-price gains on target shareholders, averaging about 30 to 50 percent over preoffer prices during the eighties. The evidence on returns to bidders, however, is mixed. During the period from 1960 to 1980, the average stock-price gain to bidding firms was 3 to 5 percent. But during the eighties the returns to bidders began to erode, and some studies conclude that bidder firms suffered modest stock-price declines, on average, during the late eighties.

 

The principal reason for this erosion is the increased competition for targets. This increase in competition resulted from the target’s greater effectiveness at dealing with the initial suitor and at getting rival bids, including bids from the targets’ own management. The winning bidders in these auction contests of the late eighties frequently paid top dollar and saw their stock prices decline when the market learned that they had “won.”

 

Nonetheless, the huge gains to target shareholders mean that takeovers and socalled highly leveraged transactions (HLTs) have created large net economic gains. Indeed, Harvard’s Michael Jensen estimates that over the fourteen-year period from 1976 to 1990, the $1.8 trillion of tender offers, mergers, divestitures, and LBOs created over $650 billion in value for selling-firm shareholders. Moreover, this estimate does not include the additional large gains made by companies that restructured out of fear of being taken over.

 

Although this estimate excludes the gains and losses to shareholders of bidding firms, the empirical studies that find net losses for bidders also show that these losses—at 1 to 3 percent of the stock price—are minuscule compared with the enormous gains to target shareholders. These academic studies show clearly, on the basis of share prices, that hostile takeovers and highly leveraged transactions created huge increases in the values of companies. Moreover, several follow-up studies have shown that these stock-price gains are generally reliable predictors of real operating improvements and of increased corporate efficiency.

 

Critics of takeovers often complain that these share-price gains ignore the economic losses that takeovers and LBOs impose on other groups connected with the target firms. This intense debate has centered on the potential harm to corporate “stakeholders” other than shareholders, such as bondholders, employees, customers, suppliers, local communities, and taxpayers. Many takeovers in the airline industry, for example, have involved conflict between acquiring-firm management and the unionized labor of the target firm. These conflicts contributed to the popular view, shared by some economists, that shareholder premiums from takeovers come largely at the expense of labor’s wages and benefits. But the empirical research has failed to show any reliable association between takeover activity and the income of workers. According to Joshua Rosett’s recent study of over five thousand union contracts in over a thousand listed companies from 1973 to 1987, less than 2 percent of the premiums to shareholders can be attributed to wage reductions in the first six years following takeovers. In hostile takeovers the data show an increase in union wages in years following the control changes.

 

Another frequent complaint is that the constant threat of hostile takeovers forces nearly all corporate managers to stress short-term policies at the expense of more valuable long-term plans, thereby impairing the economic health and competitive vigor of their companies and the nation. Although rhetorically stirring, this theory has been studied thoroughly by economists and has received no empirical support. For example, the research shows no connection between takeover activity and public companies’ expenditures on research and development. Studies also show that share prices generally respond positively to long-term investments by corporations. Also unsupported is the charge that losses to bondholders finance the shareholder gains from takeovers. Although some shareholder gains have come at the expense of bondholders, banks, and other creditors who financed these deals, Michael Jensen estimates that the aggregate amount of these losses between 1976 and 1990 is not likely to exceed $50 billion, a small fraction of the $650 billion gain to target shareholders.

 

There is some empirical basis for the idea that reducing taxes was at least a partial motive for takeovers, and especially LBOs. Some researchers estimate that for the typical leveraged buyout, tax savings (from deducting higher interest payments) accounted for about 15 percent of the premiums paid to sellers. Still, most mergers and tender offers were not motivated by tax savings. Also, Jensen has found that, contrary to popular assertion, LBOs have actually increased total tax payments to the U.S. Treasury. That is because selling shareholders pay taxes on their gains. All in all, the evidence shows that tax savings account for only a small fraction, at most, of the huge gains to target shareholders and other selling firms.

 

In sum, although some individuals (incumbent management, for example) and some other groups obviously lose in any takeover, the empirical studies offer little or no support for the notion that the huge gains to shareholders reflect similarly large losses to other related parties. These zero-sum theories cannot begin to explain the large shareholder returns. The bottom line is that, on average, takeovers reflect wealth-enhancing and socially valuable redeployments of corporate resources.

 

Although several of these late-eighties LBOs and leveraged cash-outs ran into financial difficulties when the U.S. economy suffered a recession in the early eighties, there is much evidence that the LBO phenomenon also has been beneficial for our economy. Economists have found that the “free cash-flow” theory (developed by Michael Jensen) helps them to understand much of this activity. This theory postulates that high leverage can be a powerful disciplining device because it forces top management to undertake value-enhancing strategic changes. Companies with ample cash flow but few potentially profitable investment projects should pay out the excess cash to shareholders to maximize shareholder value.

 

According to this theory managements that fail to pay out excess cash, instead investing it in diversifying acquisitions or in low pay-off projects, will cause the stock price of their companies to be below their optimal value, creating a value gap. LBOs and other leveraged recapitalizations force managements to sell unprofitable divisions, avoid low pay-off investments, eliminate wasteful corporate expenses and diversifying acquisitions, and boost operating efficiency in order to meet the interest charges on the high level of debt. These forced efficiencies eliminate the value gap and create net economic gains for shareholders. Although this is a severe solution that exposes the firm to financial distress in the few years after the LBO, the evidence is that the LBOs and leveraged restructurings of the eighties created large net gains for shareholders.

 

In short, the U.S. market for corporate control witnessed unprecedented activity and change during the eighties as the largest public companies became frequent targets of hostile takeovers. Corporate managers reacted to this activity by lobbying hard for legal restrictions on the so-called raiders, and by restructuring and refocusing their companies while increasing debt levels and shareholder payouts.

 

Gregg A. Jarrell is a professor of economics and finance at the University of Rochester’s Simon School of Management. He was formerly chief economist at the U.S. Securities and Exchange Commission. He is the founder of the Shadow Securities and Exchange Commission.

 

Further Reading

Jarrell, Gregg A., and Michael Bradley. “The Economic Effects of Federal and State Regulations of Cash Tender Offers.” Journal of Law and Economics 23, no. 2 (October 1980): 371-407.

Jarrell, Gregg A., James Brickley, and Jeffry Netter. “The Market for Corporate Control: The Empirical Evidence Since 1980.” Journal of Economic Perspectives 2, no. 1 (Winter 1988): 49-68.

Jensen, Michael, and Richard Ruback. “The Market for Corporate Control: The Scientific Evidence.” Journal of Financial Economics 11 (March 1983): 5-50.

Rosett, Joshua G. “Do Union Wealth Concessions Explain Takeover Premiums? The Evidence on Contract Wages.” Journal of Financial Economics 27 (1990): 263-82.

Shleifer, Andrei, and Robert Vishny. “The Takeover Wave of the 1980s.” Journal of Applied Corporate Finance 4, no. 3 (Fall 1991): 49-56.

Smith, Roy C. The Money Wars: The Rise and Fall of the Great Buyout Boom of the 1980s. 1990.

Stewart, James B. Den of Thieves. 1991.

Vise, David, and Steve Coll. Eagle on the Street. 1991.

Weston, Fred J., Kwang S. Chung, and Susan E. Hoad. Mergers, Restructuring and Corporate Control. 1990.

 

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Here are the 10 latest posts from Econlib.

Econlib August 6, 2018

It’s Still Summer…

summer-books-300x225.jpg

If you are anything like us, you are busy trying to maximize these last glorious days of summer. And you are probably also desperately trying to find the time to finish the pile of summer reading you planned for yourself at the beginning of summer. We are not here to help.

As summer winds to a close, in lieu of our typical column illuminating particular economic concepts, we sought out the summer reading suggestions of many of our contributors. If you are looking for some more great reads, or are simply interested in what Econlib contributors like to read in their own free time, then we hope you will enjoy this compilation. And of course we hope you enjoy the rest of your summer!

Scott Sumner

EconLog blogger, economics professor at Bentley University, and Director of the Program on Monetary Policy at George Mason University

I look forward to reading three books this summer, The Elephant in the Brain by Kevin Simler and Robin Hanson, The Case Against Education by EconLog’s Bryan Caplan, and Inadequate Equilibria by Eliezer Yudkowsky. These books are written by people who are very good at dealing with big questions, and at utilizing material from a wide range of disciplines. It may seem premature to recommend books that I have not yet read, but a good bit of this material has already appeared in blog posts, and I’m confident that all three books will be quite interesting. It will be nice to have the arguments all in one place.

For fiction, I look forward to completing My Struggle, by Karl Ove Knausgaard, and Men Without Women, by Haruki Murakami. Knausgaard convinced me that I am not alone. For those who like science fiction, I recommend The Three Body Problem trilogy, by Cixin Liu. I almost gave up after the first volume, and am glad that I persevered. The next two volumes are excellent.

Alberto Mingardi

EconLog blogger and Director General of Istituto Bruno Leoni in Milan

The Moral Basis of a Backward Society was published by Edward Banfield some sixty years ago, in 1958. It is most famous for a felicitous expression, “amoral familism”, and for paving the way to a number of studies on “social capital”. But it is, in itself, a most interesting book. Banfield with his wife visited a small town in the South of Italy and used the empirical material at his disposal to attempt to understand why “a backward society” was desperately so. The book is full of interesting ideas, including reflections on why the little town, being a rare occurrence of Hobbes’s state of nature, with everybody having little regard for everybody else, developed a belief in government as an “external” problem-solving force. Now we have a wider appreciation of the importance of culture for economic development than sixty years ago, but reading Banfield can still be a very useful exercise.

Nationalism by Elie Kedourie is the best book I’ve read in years. Actually I feel almost guilty I bought it a few years ago, and left it on my bookshelves. It is a thorough exploration of nationalism, undertaken from an imaginative historian who sees many interplays between ideas that most of us are likely to miss. In this age of rampant nationalism, often covered up as something else, this is the book people with liberal sentiments should go back to, to remember what a tremendous threat to individual liberty nation states are. This is a first class work from a first class mind.

My Early Life by Winston Churchill. Sure you’ve enjoyed “The Darkest Hour” and thought with nostalgia at those times in which statesmen were genuinely great men, and character was king. But Winston Churchill’s political life, save 1944-1945, was a constellation of failures. Yet he never gave in and was ready for those crucial days when he was to be the indispensable man to keep Europe from Nazi rule. Reading on Churchill, you grow fonder and fonder of his weaknesses and peccadillos. You end up liking him because he was great, and greatly human. He was a splendid writer: this books is a story of his early life and evidence that indeed he “got into my bones the essential structure of the ordinary British sentence—which is a noble thing”.

Pierre Lemieux

EconLog blogger and economist with Université du Québec en Outaouais

Jean-Baptiste Say’s book, A Treatise on Political Economy is available free on Econlib. See also the biography of Jean-Baptiste Say in the Concise Encyclopedia of Economics.

Jean-Baptiste Say, A Treatise on Political Economy. This classic book is interesting not only from the point of view of the history of economic thought, but also because it remains a good book of economics. The reader will discover—or rediscover—many crucial economic concepts such as relative prices and opportunity cost. Say does not use the term “opportunity cost,” which would be coined more than a century later, but he shows that he understood it: “[T]he charges of war would be very incorrectly estimated,” he writes, “were we to take no account of the havoc and destruction it occasions; for that one at least of the belligerents, whose territory happens to be the scene of operations, must be exposed to its ravages.” The books even contains elements of Public Choice theory. The reader will also discover in the Treatise the original formulation of “Say’s Law,” according to which supply creates its own demand.

Douglas A. Irwin, Clashing over Commerce: A History of US Trade Policy. This books offers a comprehensive history of US trade policy from the War of Independence to our times. Since trade policy is related to everything, Irwin’s book also provides a review of general American history. The reader will discover how American policy has been generally protectionist, how real (unilateral) free trade was never on the agenda, and how absurd protectionism is. After the Civil War, open immigration fortunately compensated for its deleterious effects. One of the many fascinating facts reported by Irwin, is how, in 1872, Rep. Samuel Cox (D-NY) described how protectionism favors parts of the country at the expense of other parts. As Cox put it, protectionism steals from consumers from somewhere in the country to give to producers elsewhere: “Michigan steals on copper; Maine on lumber; Pennsylvania on iron; North Carolina on peanuts; Massachusetts on cotton goods; Connecticut on hair pins; New Jersey on spool thread; Louisiana on sugar, and so on.”

Lauren Landsburg

Econlib Editor, Owner of Technique Typesetting, and Director of the ESOL Associates of Rochester, NY

This has not much at all to do with economics. It’s more aligned with interests of mine about inventors, electronics, physics, etc. But, I’m planning on reading two quite different biographies of Hedy Lamarr plus possibly her autobiography as well. She was an extraordinary inventor who changed the course of modern electronics (while researching and solving a problem in submarine warfare at the reclusive retreat of Howard Hughes alongside other inventors!) as well as her more famous profession as an actress. I’m curious to sort out the several different perspectives about her. The two I’m planning on are Richard Rhodes’s Hedy’s Folly: The Life and Breakthrough Inventions of Hedy Lamarr, the Most Beautiful Woman in the World and Stephen Michael Shearer’s Beautiful: The Life of Hedy Lamarr. Lamarr’s autobiography is Ecstasy and Me: My Life as a Woman.

Steven Horwitz

John H. Schnatter Distinguished Professor of Free Enterprise at Ball State University

I have just finished Jonah Goldberg’s Suicide of the West, which I recommend highly. Jonah locates the struggles of 21st century America in a return to tribalism that has come from a loss of confidence in, and indeed an ingratitude toward, the Western institutions that created what he calls “The Miracle” of the last 300 years. Much of his thesis is too complex to summarize quickly, but the key part for me is his sustained, and Hayekian, claim that capitalist modernity is “unnatural” while tribalism (and romanticism) are much more in tune with evolved human nature. If we do not constantly strive to understand, appreciate, and defend the institutions that have given us the peaceful and prosperous world we live in, it will become corrupted in that word’s original sense of “letting nature take its toll.” Jonah argues that much of what see in both the Trumpian right and progressive left is a revolt against those institutions which is letting the ancient demons of tribalism and romanticism back in, with a grave threat to what the West has accomplished. I think he’s onto something really important here, especially the idea that modernity is “unnatural.” As always with his work, you can expect a book that combines humor and serious thought and that is written in a very accessible style. It is also remarkably even-handed in its criticisms of both the right and left. Well worth a read.

Dan Klein

Professor of Economics and JIN Chair at the Mercatus Center at George Mason University

Both of Adam Smith’s books, The Wealth of Nations and The Theory of Moral Sentiments are available free on Econlib. See also the biography of Adam Smith in the Concise Encyclopedia of Economics.

“The poor man’s son, whom heaven in its anger has visited with ambition…” So opens Adam Smith’s parable of the poor man’s son, consisting of three paragraphs, the first the longest paragraph in The Theory of Moral Sentiments. Ask three Smith scholar what the underlying message is, and you are apt to get different answers. Did Smith fail to make himself clear? One common interpretation of the parable has fed into what German authors spoke of as Das Adam Smith Problem. But perhaps Smith brewed conundrum. In The Wealth of Nations “sympathy” never appears, “sentiment” appears only twice, and likewise “spectator” (near the very beginning and the very end). Was it deliberate? The closing words of the parable of the poor man’s son—”and the beggar, who suns himself by the side of the highway, possesses that security which kings are fighting for”—still inspire fresh commentary. (Did you know that Smith, here, has in mind a particular beggar?) The parable of the poor man’s son is an example of what Arthur Melzer’s calls pedagogical esotericism, in his landmark work Philosophy Between the Lines: The Lost History of Esoteric Writing (University of Chicago Press 2014; paperback 2017). Beyond the more obvious interpretation of the author’s meaning, the exoteric message, there is a less obvious interpretation, an esoteric message, one the reader has to work for. What else are summers for?!

James Otteson

Thomas W. Smith Presidential Chair in Business Ethics, Professor of Economics, and Executive Director of the Eudaimonia Institute at Wake Forest University

I have two book recommendations that both give me optimism about the future, in the spirit of Matt Ridley’s 2011 The Rational Optimist (which I also highly recommend). The first is Hans Rosling’s Factfulness: Ten Reasons We’re Wrong about the World—And Why Things Are Better than You Think (Flatiron Books, 2018). This was Rosling’s final book before he died, and it reflects his characteristic flair for presenting data in a way that is both compelling and understandable. It presents the current state of how the world is improving in nutrition, longevity, reduction of poverty, environmental sustainability, and much else. It is written in language accessible to the layperson, and it contains lessons along the way about how to interpret, and how not to interpret, data and statistics. It demonstrates the enormous progress we have made in recent decades, and, though there is still much work to be done, it corrects the false impression many have that things have been getting worse. In fact, by almost every measure, things are getting better in the world.

My second recommendation is Steven Pinker’s Enlightenment Now: The Case for Reason, Science, Humanism, and Progress (Viking, 2018). Pinker is a masterful writer, and in this book he traces how central ideas from the Enlightenment—including markets and trade, democracy, human rights, and science—have led to improvements in human life that are historically unprecedented. He draws on thinkers like Montesquieu, Hume, and Smith to show that their skeptical, empirical approach to understanding human nature and the human condition has made us freer, more prosperous, and happier. It is a wide-ranging and sweeping analysis, filled with facts, data, and argument. Even when he doesn’t fully persuade, one learns something new on every page and gains a new and fresh appreciation for humanity’s achievements. It also provides a cautionary warning about some contemporary movements that seek to curtail the freedoms of speech, association, and trade, and makes a compelling argument for extending, rather than limiting, these freedoms.

Edward J. Lopez

BB&T Distinguished Professor of Capitalism at Western Carolina University and President of the Public Choice Society

Joel Mokyr, A Culture of Growth: The Origins of Modern Economy, Princeton University Press, 2017. I read this book as representing the next big extension of economic history from incorporating institutions via Douglass North and ideas via Deirdre McCloskey and others, and now to culture via Mokyr. This is his next in a long line of important books like The Lever of Riches, The Enlightened Economy, and now A Culture of Growth.

Richard Wagner, James M. Buchanan and Liberal Political Economy: A Rational Reconstruction, Lexington Books, 2017. Just as Buchanan’s body of work began receiving an unexpected onslaught of attention in the summer of 2017, Richard Wagner quietly released this intellectual biography of his professor and long-time co-author. Followers of Buchanan’s work—and readers who have recently become curious, alike—will benefit from Wagner’s deep yet accessible treatment of Buchanan’s work, showing clearly how Buchanan’s arc of thought over his 50-year run of scholarship has its roots in his earliest papers from the late 1940s.


*Amy Willis is a Senior Fellow and Director of the Library of Economics and Liberty at Liberty Fund, Inc.


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Econlib August 6, 2018

Tribal Psychology and Political Behavior

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In Uncivil Agreement: How Politics Became our Identity,1 political scientist Lilliana Mason attempts to explain the recent increase in political polarization. In the process, she proposes a theory that homo politicus is tribal. I found this analysis persuasive, but I think she has yet to develop its libertarian implications.

The Theory

In political analysis, it is natural to assume that citizens are rational, so that their political preferences reflect their views on policy. These policy views in turn derive from some combination of self-interest and concern for the general welfare.

But Mason points out that social psychologists find an emotional component in political behavior.

Primal psychological influences such as motivated reasoning and social identity are capable of shifting and sometimes entirely determining the policies that citizens support.

Econlib August 6, 2018

The Bother with Brexit

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Brexit is turning out to be a much more complicated affair than both the “remainers” and the “leavers” initially surmised. The hope of an amicable divorce is vanishing. The British Government and the European Commission are edging nearer the precipice of an unwanted and unplanned total break, which neither side really wants, though in the end it could be the best solution. Theresa May, the tottering British Prime Minister, is trying to devise a way of leaving the European Union without actually leaving it. Michel Garnier, the European Commission’s chief negotiator, wants to send a message to other “exiteers” tempted by the British example, but he also strives to keep Mrs. May in office as the least bad UK negotiator he could wish for. And the clock is ticking: the moment when exit must happen is March 19, 2020, 11 pm (Greenwich Time).

Econlib July 2, 2018

Commercial Reprisals Are a Mistake, by Pedro Schwartz

Where goods do not cross borders soldiers will.
—attributed to Frédéric Bastiat

Bastiat.gif

There was a time when I understood the reasons for protectionism better than the arguments for free trade. Then I heard my doctoral supervisor, Lord Lionel Robbins, say in class that David Ricardo’s comparative cost theory of international free trade was the pons asinorum of economics, just as Euclid’s Fifth Proposition in Book I was the bridge to geometrical knowledge that donkeys refuse to take. This led me to debate with myself the pros and cons of free trade. You should have seen me walk up and down by the colonnade of the British Museum until I settled my doubts and crossed the bridge. Protection was a way for corrupt politicians to favor their clients; countries did not need protection to industrialize; and on balance, the poor fared better when interest groups were not granted powers over international trade. On the contrary, free trade was a part of individual freedom, a power for growth, and an escape hatch from poverty. I had finally reached a position that fully convinced me. My further study of economic history and political economy reinforced these new beliefs.

Econlib July 2, 2018

Commercial Reprisals Are a Mistake

Where goods do not cross borders soldiers will.
—attributed to Frédéric Bastiat1

Bastiat.gif

There was a time when I understood the reasons for protectionism better than the arguments for free trade. Then I heard my doctoral supervisor, Lord Lionel Robbins, say in class that David Ricardo’s comparative cost theory of international free trade was the pons asinorum of economics, just as Euclid’s Fifth Proposition in Book I was the bridge to geometrical knowledge that donkeys refuse to take. This led me to debate with myself the pros and cons of free trade. You should have seen me walk up and down by the colonnade of the British Museum until I settled my doubts and crossed the bridge. Protection was a way for corrupt politicians to favor their clients; countries did not need protection to industrialize; and on balance, the poor fared better when interest groups were not granted powers over international trade. On the contrary, free trade was a part of individual freedom, a power for growth, and an escape hatch from poverty. I had finally reached a position that fully convinced me. My further study of economic history and political economy reinforced these new beliefs.

The issue of free trade is being posed anew with the anti-trade measures being implemented by President Donald Trump. The President is worried about the size of the trade deficit of the United States and so are his voters. He attributes the artificially low prices of some of the imports entering America, especially from China, but also Canada, Mexico, and the European Union to unfair practices. He fears that foreign competition is sending many blue-collar workers into unemployment and stymying the progress of the middle class. As a first step he slapped a 20% tariff on foreign solar cells, thus saving inefficient producers at the cost of harming the state-of-the-art firms. And now he has variously increased the tariffs on imports of steel and aluminum, and may do so on Chinese and European cars. This is leading the governments of the countries that export to the United States to take or threaten reprisals in the form of tariffs and quotas on American goods.2 The June meeting of the G7 was thrown into disarray by President Trump refusing to sign a joint trade statement counter to his protectionist measures.

For more on the current international trade situation, see Dan Klein and Don Boudreaux on “The ‘Trade Deficit:’ Defective Language, Deficient Thinking,” Lauren Landsburg on being “Taken to the Cleaners, and the EconTalk episode with David Autor on Trade, China, and US Labor Markets.

I will address three questions in this unconventional essay: one, whether such reprisals will make the United States change its restrictive commercial policy (my answer is no); second, whether such reprisals will harm the nations taking them (my answer is yes); and whether we are thus running the danger of reducing world trade (my answer is yes again). My thesis is that taking reprisals is a mistake; no reprisals is better; unilateral free trade is best.

Trade as cooperation

Let me start with some elementary points.

  • People trade because they are different: they have different tastes, resources, and abilities. This is why people seek the goods and services offered by others.
  • A voluntary exchange of goods and services only happens if both sides gain, but they need not gain the same amount.
  • Trading within a country and trading across borders is substantially the same thing. In fact, it is not countries that trade, only people and firms do, wherever they may be placed.
  • The mistaken perception that international exchanges are special is due to their taking place between individuals and firms in different monetary and tax zones.
  • The monetary value of flows of goods and services across borders are summarized in an accounting document called the balance of payments.
    • A balance of payments in deficit is not a problem in itself. It is a symptom, but symptoms can feel very unpleasant.
  • There can be losers from international competition as there can be from competitors inside the country. But the net effect of competition in both cases is to increase national income and wealth.3
  • In sum, competition is a form of social cooperation.

Buying where it is cheapest

Adam Smith in The Wealth of Nations (1776) wrote that people have an innate tendency “to truck, barter, and exchange”. Some of his disciples, mainly David Ricardo (1817), dug a little deeper and, when discussing trade among nations, adverted the differences in tastes, resources, and abilities to explain why people specialized and exchanged goods, when they could have produced them all at home. The classical economists from David Hume to John Stuart Mill started by showing the advantage gained in trading with people of other nations, on the assumption that rational people would trade only if they (and their nation) gained by it. In the course of discussing the gains from trade, they took a second step: to try and explain what goods were exchanged and in what quantities. In sum, the classics researched two questions: (1) the benefits (or the welfare, we would say today) of trade, and (2) the amount of trade flows.

Adam Smith, as regards the advantage obtained by trade, was not as complete as Ricardo (1817). He simply said that nations, like the master of a household, would try to buy where it is cheapest. He backed his argument with a reductio ad absurdum: grapes could be grown in Scotland with hothouses and good wine could be made with them, but at a much higher cost than in Bordeaux.4

Comparative or opportunity cost

David Ricardo saw what was missing in Smith’s analysis: he showed that often it could be rational for a country to buy abroad what could be supplied more cheaply at home! This was so in the case of Portugal buying cloth in England at a greater expense than making it locally, if that allowed Portugal to concentrate all its resources in the production of much cheaper wine than the English could make. Even if Portugal was more efficient in the production of both wine and cloth than England, it would be able to get more cloth by concentrating in wine production and trading part of its wine for English cloth. The more productive country would fare better if it specialized in the good in whose production it was comparatively more efficient than in the other good, even if it was efficient in both.

Paul Samuelson illustrated this important theorem with the homely example of an exchange between him and his secretary: he was better at typing and economics, but so much better at economics, that he could specialize in economics and perhaps hire two secretaries. The opportunity cost of typing his own letters was prohibitive in terms of his production as an economist.

Ricardo thus showed that two countries would trade with each other even if one was less productive than the other in all lines. This explains why poor, inefficient countries can still find things to sell to advanced countries.5

Sharing the gains from trade

What was implicit in Ricardo is that consumers in all trading countries would profit from the greater world availability of wine and cloth, or whatever. But even from the point of view of producers in international trade, both sides gain, though not always equally. The young John Stuart Mill (1828) explained that the country with the keenest desire for the other’s good would end with a smaller share of the gain. So that, if the English were great drinkers, they would tend to send more cloth to Portugal for each barrel…6

Whether equally shared or no, the gains of free trade were clearly and un-ambiguously positive for both nations and the world as a whole: international specialization will always result in an increased world output of both cloth and wine. Free trade will foster growth and is a boon for the poor. A protectionist policy will make the world less productive and will especially reduce the welfare of producers in less efficient developing economies.

Opening of borders to international trade forces changes in the economic structure of production in both countries. The only way to study this effect is dynamically.

Who loses?

At first, textile workers in Portugal will be unemployed and so will wine producers in England. Displaced workers will have to accept lower wages and pensions or seek employment in another industry or even move to another state, at least temporarily. Foreign competition, as does national, forces greater specialization and lower costs, and makes the economy grow.

This is what happened with the motorcar industry in Detroit: it had to be saved with public money so as to sweeten a cut in wages, a reduction of pension rights, and reduction of trade union privileges with a write down of debt. A substantial part of the population had to leave the city and seek employment in other states. All this also harmed auto producers in free labor southern states.7

Joseph Schumpeter called this kind of phenomenon “creative destruction”: progress, technological and commercial, results in forced changes on the production side of the economy and the closing down of unsustainable activities. To express it otherwise, foreign competition breaks up domestic monopolies and oligopolies, including unions protected by legislation. The ensuing greater productivity creates new jobs and makes for higher wages for those who find employment under the new dispensation. The argument against free trade can also be used against the penetration of artificial intelligence and robots. Slapping tariffs on foreign goods and services is another way to try to stop progress.

Still, some people do lose, leading many to want their society to progress by kinder or more inclusive means than competition. But will it be possible for America stay at the top in innovation, entrepreneurship, and productivity while stymying competition, foreign or national? The European Union seems to have given up running this race.

Also, as Barbara Dluhosch points out (2018), such protectionist attitudes are an invitation for special interests to band together for the purpose of seeking rents. This kind of overt rent-seeking is less harmful than the more hypocritical kind tending to hide behind false pretexts: thus President Trump has announced that he is “taking action to protect America’s national security” from the effects of global oversupply of steel and aluminum. He could not justify these measures by a need to reduce unemployment, as out-of-work people today amount to 3.8% of the US population. His advisors must also have told him that Article XIX of the World Trade Organization treaty would limit these measures to a period of four years, give rise to claims for compensation, and be open to retaliation. So he plumped for Article XXI b) which allows a state to adopt all measures deemed necessary to protect “its essential security interests, relative to: (i) fissionable material; (ii) arms, munitions, and war materials […]; and (iii) in times of war and grave international tension.” In what way can cheap steel and aluminum imports endanger the safety of the United States? Beats me.

Another hoary legend is that protection promotes growth and hence free-trade makes industrialization more difficult. This is known as the ‘infant industry argument’.8 One of the accepted ‘facts’ of economic history is that the United States, the German Empire and France were able to catch up with Britain in the 19th century because they fostered their industrialization with protection. However, Bismarck’s ‘iron and rye’ 1879 tariff was a clear surrender to the interests of the great industrialists and the Junkers of East Prussia. The turn to protection by the French in 1881 and the U.S. tariffs of 1864 and 1890 changed the arrangement of industrial sectors but did not increase total production. And I need not say anything about the disastrous effects on the whole world of the 1930 Smoot-Hawley tariff.9 History is replete with examples of the failure of American protectionism.

Balance of payments deficits as a symptom

It is the fond belief of half-baked economists that tariffs and quotas can mend a balance of payments deficit by making imports more expensive and exports cheaper. People forget that the balance of payments is only an accounting document that will tell you that a country is buying more (or less) abroad than it is selling but not what causes the imbalance.

An enduring balance of payments deficit can tell you a number of things. One is that national expenditure is greater than national saving and investment and that domestic expenditure has to be topped up with borrowing from abroad. This can be good or bad. In an underdeveloped country foreign direct capital investment may not immediately and fully be paid for with exports but helps growth. In advanced economies, a sustained balance of payments deficits is largely due to the negative savings of the federal deficit. Hence tariffs will not correct such a deficit – a balanced budget will. Only the fact that the U.S. Treasury is the banker of the world can explain the huge amount of American bonds held by the rest. This is a happy result for American consumers and capitalists since they get foreign goods, both final and intermediate, in exchange for pieces of paper called dollar bills or bonds. This, however, may make life difficult for local firms and workers, who have to face more abundant imports.

Another warning given by a sustained balance of payments deficit is that it will have an effect on the currency exchange. If the rate of exchange is fixed, as within the euro area, the country will have to use its reserves to stop the currency from devaluing, and in the process it may run out of such reserves. This is what happened to Greece after the 2010 crisis when cash disappeared. If it is a floating currency, then it will depreciate with expected budget deficits, as is happening today with the Argentinian peso. A substantive depreciation is equivalent to a large cut in the money holdings of the people.

In sum, enduring balance of payments deficits and sudden excessive devaluations should lead governments to make substantive reforms of populist budget structures and of excessive regulation, especially of the labor market. Moves such as that of President Trump are cosmetic and in the end harmful.

The effects of a commercial war

So protection will not mend the foreign deficit. The effects of protection (and retaliation) will be others. It will make imports more expensive and make the price of substitutes rise. It will also make exports more expensive, in that a tariff on imports is a tariff on imported intermediate goods used by exporters.

The consequences of President Trump’s commercial policies is already being felt, both directly and indirectly through third party retaliation. It is clear that Trump’s protectionist measures point to a fall in world wealth, starting with America itself, ceteris paribus. The cycle has been on an upward drive for some time now and the cost increases and corporate investments due to action and reaction may ultimately result in the turn to a recession. There will be large increases in costs for industrial corporations in the United States and the retaliating nations. The uncertainty caused by war-monger rhetoric will surely affect investment, especially of international companies. In sum, protectionism and the ensuing trade war will only result in small corrections in balance of payments deficits by reducing trade.10

As to the likelihood of ‘victory’, a large economic area such as the United States will feel an imposed reduction of imports much less keenly than a small one, such as Belgium or a Baltic country.11 Hence reprisals against President Trump’s new policy have a high probability of failure when the aim is to punish as large an economy as the United States.

Cutting your nose to spite your face

Most people are ignorant of the well-established analysis of international trade I have put forward in the previous paragraphs. The general attitude is, you win when you export, you lose when you import. Instead of seeing the increase in total trade in goods, services, knowledge, and freedom as best for your people and nation, they feel they win when they impose a monopoly on other nations through the exercise of power.

“If you see international trade as non-designed cooperation through competition, the intelligent strategy is to let the power-hungry rival nation trip itself up by the brainless use of its own force, in the ju-jitsu tradition of unarmed self-defense.”

I believe I have given good arguments to prove that Trump’s protectionist moves will hurt the American people. But these arguments are equally applicable to reprisals. By waging a commercial war or actively replying to an offensive move, you must be ready to suffer to attain victory. In that case, the least bad (or second best) reprisal strategy would be to do nothing and simply rely on the foreseeable reduction in U.S. exports due to the increase in American prices following the higher degree of protection. If you see the world of business as the imposition of power, yours is the world of President Trump and the retaliating nations. If you see international trade as non-designed cooperation through competition, the intelligent strategy is to let the power-hungry rival nation trip itself up by the brainless use of its own force, in the ju-jitsu tradition of unarmed self-defense.

Unilateral free trade

The best measure for me would be to go further than doing nothing. What I propose is in the spirit of the slow and far from easy establishment of total and unilateral free trade in the United Kingdom from 1823 to 1860.12 Imagine the possible move by Britain as an example after having left the European Union at the end of two years of failed negotiations. ‘Hard Brexit’ would allow Britain to unilaterally and totally free its imports and repeal non-tariff barriers on services. This would of course greatly benefit British consumers. But it would also reduce UK production costs across the board. As at the same time American steel and aluminum would necessarily increase in price and so would American cars, very possibly President Trump’s protectionist measure would have no effect on British trade.

More generally speaking, the best retort against US protectionism would be to bring down the production costs of exports by the other nations. To achieve this, China, Canada, Mexico, and the European Union should unilaterally free imports from all duties, fully alleviate non-tariff barriers, and drastically reduce or repeal regulation on services, especially financial services. Such measures need no compact or international agreement: nations can implement individually. Further to this point, if most other countries harmed by President Trump choose the reprisal way, those that do not will be even more favored. This is why Frau Merkel is pleading for all EU nations to join in the reprisals and not undermine the trade powers vested on the Commission in Brussels.

“Free trade is the best reprisal.”

My conclusion is that free trade is the best reprisal. But if such a move should prove politically impossible, there always is the possibility of lying low and doing nothing. Dixi et salvavi animama meam.


Footnotes

[1] The British radicals who wanted “peace and free trade”, and decried the creation and extension of Empires were overtaken by unwilling imperialists as Gladstone and willing imperialists as Disraeli and Bismarck. The nadir of liberalism was the Congress of Berlin of 1885, which started the ‘scramble for Africa and Asia’. The wealth created by merchants, manufacturers, and inventors in the first part of the 19th century was used by States to arm themselves for what was to be World War I.

[2] See among many others the analysis by M. Conthe (2018).

[3] Costinot and Rodriguez-Clare (2018, page 21) summarize present-day estimates by various authors of the gains from trade obtained by Americans as 2 to 8% of GDP: such gains may look small, but they are “nothing to spit at”.  Do not forget that the United States is a very large mostly self-contained economy. See note 9 below.

[4] As regards trade flows, Elmslie (2018) has shown that Smith understood, and formulated in bits and pieces, what we today call ‘the gravity theory of international trade flows”. Here we mean ‘gravity’ in the sense of Newton, not in the sense of composed behavior. Tinbergen (1962) finally modelled this very powerful explanation for trade flows on the basis of cost by saying that trade flows tended to be directly proportional to the proximity and the size of the two markets, and an inverse proportion to the institutional barriers between them put up by authorities jealous of their neighbors’ prosperity. Indeed a ‘frontier effect’ is observable: so, the net border negative effect between Canada and the US has been calculated as a 44% compared with trade within each country. Adam Smith mentioned that this effect was smaller the larger the respective markets.

[5] I will not go down the way of later theories that explain Ricardian trade patterns by predicting that countries will specialize in exporting the goods they use more intensively than the resources they are more abundantly endowed with: this is what the Heckscher-Ohlin theory (1919, 1933) theorem predicts. Dluhosch (2018) however explains that, in the present day world, merely resting on abundant resources may not be very wise, because such an endowment may lose its possibilities through innovation or new markets: suddenly, a shale-oil-and-gas innovation may undercut your traditional resource advantage.

[6] Neither will I attend to more recent theories of trade that advert to changes in terms of trade or to trade under conditions of imperfect competition.

[7] One negative effect of international trade studied by Stolper and Samuelson (1941) is that it moves low skilled production abroad. This theorem is closely related to the ‘factor equalization theorem’. Trump-minded people want to correct this effect with protective measures that stop low skilled products from being imported and displacing workers. Dluhosch (2016 and 2018) notes that new information and communication technologies (ICT) also threaten high-skilled workers but also that these ICTs so much increase productivity all round that the net effect may be positive for all kinds of workers. This reasoning is similar to Ricardo’s conclusion for the world as a whole.

[8] The infant industry argument is based on the belief that imperfect competition undermines the argument for free trade. See Bhagwati’s Harry Johnson’s Lecture of 1992.  It is curious that developing countries reject free trade because their budding industries cannot compete with the returns to scale of advanced countries industries, while advanced countries want to level the world trade playing field tilted by the unfair labor conditions of the Third World. The result is that every country now complains of dumping by their trade partners. Even oligopolies such as OPEC prove to be evanescent in the face of technological progress and climate ideology.

[9] For anybody who may doubt what I say, an easy-to-read survey of present day research on the fairy-tales of protectionism can be found in Scott Lincicome (2017) Cato Institute no. 819 Policy Analysis.

[10] F. Pacicca (2018)

[11] Costinot and Rodriguez-Clare (2018, pgs. 11-12) compare the weight of foreign trade in the US economy in 2014 with that of Belgium: the US, 8%; Belgium above 32%.

[12] The slow repeal of the old mercantilist regime started in 1823, with the permission for British Governments to sign reciprocity treaties with foreign nations. It proceeded with with the permission for mechanics settle abroad and for workers to form trade unions. It was effectively dismantled with the repeal of the Corn Laws in 1846 by Robert Peel; and finally was achieved by Gladstone in 1860, reflected in the Cobden Chevalier. Commercial Treaty with France. It ended in1932, when a 10% duty was charged on imports, excepting imports from the Empire (Imperial Preference).


*Pedro Schwartz is “Rafael del Pino” Research Professor of economics at Universidad Camilo José in Madrid. A member of the Royal Academy of Moral and Political Sciences in Madrid, he is a frequent contributor to the European media on the current financial and social scene. He currently serves as President of the Mont Pelerin Society.

For more articles by Pedro Schwartz, see the Archive.


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Econlib July 2, 2018

Benefits of the American Revolution: An Exploration of Positive Externalities, by Jeffrey Rogers Hummel

It has become de rigueur, even among libertarians and classical liberals, to denigrate the benefits of the American Revolution. Thus, libertarian Bryan Caplan writes:  “Can anyone tell me why American independence was worth fighting for?… [W]hen you ask about specific libertarian policy changes that came about because of the Revolution, it’s hard to get a decent answer. In fact, with 20/20 hindsight, independence had two massive anti-libertarian consequences: It removed the last real check on American aggression against the Indians, and allowed American slavery to avoid earlier—and peaceful—abolition.”1 One can also find such challenges reflected in recent mainstream writing, both popular and scholarly.

Econlib July 2, 2018

Benefits of the American Revolution: An Exploration of Positive Externalities

It has become de rigueur, even among libertarians and classical liberals, to denigrate the benefits of the American Revolution. Thus, libertarian Bryan Caplan writes:  “Can anyone tell me why American independence was worth fighting for?… [W]hen you ask about specific libertarian policy changes that came about because of the Revolution, it’s hard to get a decent answer. In fact, with 20/20 hindsight, independence had two massive anti-libertarian consequences: It removed the last real check on American aggression against the Indians, and allowed American slavery to avoid earlier—and peaceful—abolition.”1 One can also find such challenges reflected in recent mainstream writing, both popular and scholarly.

In fact, the American Revolution, despite all its obvious costs and excesses, brought about enormous net benefits not just for citizens of the newly independent United States but also, over the long run, for people across the globe. Speculations that, without the American Revolution, the treatment of the indigenous population would have been more just or that slavery would have been abolished earlier display extreme historical naivety. Indeed, a far stronger case can be made that without the American Revolution, the condition of Native Americans would have been no better, the emancipation of slaves in the British West Indies would have been significantly delayed, and the condition of European colonists throughout the British empire, not just those in what became the United States, would have been worse than otherwise.

It’s true that the American Revolution had some mixed results from the standpoint of liberty. Like all major social upheavals, it was brought off by a disparate coalition of competing viewpoints and conflicting interests. At one end of the Revolutionary coalition stood the American radicals—men such as Samuel Adams, Patrick Henry, Thomas Paine, Richard Henry Lee, and Thomas Jefferson. Although by no means in agreement on everything, the radicals tended to object to excessive government power in general and not simply to British rule. They viewed American independence as a means of securing and broadening domestic liberty, and they spearheaded the Revolution’s opening stages.

At the other end of the Revolutionary coalition were the American nationalists—men such as Benjamin Franklin, George Washington, Gouverneur Morris, Robert Morris, and Alexander Hamilton. Representing a powerful array of mercantile, creditor, and landed interests, the nationalists went along with independence but often opposed the Revolution’s radical thrust. They ultimately sought a strong central government, which would reproduce the hierarchical and mercantilist features of the eighteenth-century British fiscal-military State, only without the British. Of course, any such sharp distinction entails some over-simplification. These differences were arrayed along a spectrum, and individuals over time might alter their perspectives. Thus, John Adams started out as a radical but became a nationalist, whereas James Madison evolved in the opposite direction.

Domestic Benefits

Caplan asks what specific benefits came about because of the American Revolution. There are at least four momentous ones. They are all libertarian alterations in the internal status quo that prevailed, although they were sometimes deplored or resisted by American nationalists.

1. The First Abolition: Prior to the American Revolution, every New World colony, British or otherwise, legally sanctioned slavery, and nearly every colony counted enslaved people among its population. As late as 1770, nearly twice as many Africans were in bondage throughout the colony of New York as within Georgia, although slaves were a much larger percentage of Georgia’s population. Yet the Revolution’s liberating spirit brought about outright abolition or gradual emancipation in all northern states by 1804. Vermont, which, despite participation in the Revolution remained an independent republic until it was permitted to join the union in 1791, was the first jurisdiction to abolish adult slavery—in 1777. In 1786, the Confederation Congress also prohibited the extension of slavery into the Northwest Territory.

There is a tendency to minimize this first emancipation because slavery had been less economically entrenched in the northern colonies than in the southern colonies and because in many northern states slavery was eliminated gradually. But emancipation had to start somewhere. The fact that it did so where opposition was weakest in no way diminishes the radical nature of this assault upon a labor system that had remained virtually unchallenged since the dawn of civilization. Of course, slavery had largely died out within Britain.  But the Somerset court decision of 1772,  which freed a slave brought from the colonies, had a limited reach. Masters continued to bring slaves occasionally into the country and were able to hold them there. Parliament did not formally and entirely abolish the institution in the mother country until 1833.

Even in southern colonies, the Revolution’s assault on human bondage made some inroads. Several southern states banned the importation of slaves and relaxed their nearly universal restrictions on masters voluntarily freeing their own slaves. Through resulting manumissions, 10,000 Virginia slaves were freed, more than were freed in Massachusetts by judicial decree. This spawned the first substantial communities of free blacks, which in the upper South helped induce a slow, partial decline of slavery. By 1810, for instance, three quarters of African-Americans in Delaware were already free through this process.

2. Separation of Church and State: Unlike the case of slavery, the revolutionary separation of church and state was more pronounced in the South than in the North. Although the British colonies prior to the Revolution already practiced a relatively high degree of religious toleration, only four of thirteen colonies had no established, tax-supported church: Rhode Island, New Jersey, Pennsylvania, and Delaware. As a result of the Revolution, the five other southern states and New York disestablished the Anglican Church. With the adoption of the Constitution and then the First Amendment, the United States become the first country to separate church and state at the national level. Several of the New England states, however, retained their established Congregational Church, with Massachusetts becoming the last to fully abolish tax support as late as 1833. In our modern secular age, it is too easy to take these accomplishments for granted, but they were unprecedented.

“Virginia reduced the number of capital crimes from twenty-seven to two: murder and treason.”

3. Republican Governments: As a result of the Revolution, nearly all of the former colonies adopted written state constitutions setting up republican governments with limitations on state power embodied in bills of rights. Only Rhode Island and Connecticut continued to operate under their colonial charters, with minor modifications. The new state constitutions often extended the franchise, with Vermont being again the first jurisdiction to adopt universal male suffrage with no property qualifications and explicitly without regard to color. Going along with this was a reform of penal codes throughout the former colonies, making them less severe, and eliminating such brutal physical punishments as ear-cropping and branding, all still widely practiced in Britain. Virginia reduced the number of capital crimes from twenty-seven to two: murder and treason.

4. Extinguishing the Remnants of Feudalism and Aristocracy: This is probably the most diffuse of the Revolution’s radical consequences. Quit-rents, a feudal land tax that had been paid either to colonial proprietors or to the Crown, had been due in all colonies outside of New England and were now terminated. All the new states abolished primogeniture (the sole right of inheritance to the firstborn son) and entail (a prohibition of the sale, break up, or transfer to outside the family of an estate) where they existed, either by statute or by constitutional provisions. Doing so not only eliminated economically inefficient feudal encumbrances on land titles but also was a blow against hereditary privilege and the patriarchal family, because it undermined traditional patterns of inheritance and facilitated the rights of daughters and widows to possess property. Anyone who has read a Jane Austen novel is aware that these legal props for the landed gentry still persisted in Britain into the nineteenth century. At the same time, all states except South Carolina liberalized their divorce laws.

Even the egregious treatment of Loyalists during the Revolution indirectly contributed to the erosion of feudal entitlements. The claim that only one third of Americans supported the Revolution, one third were neutral, and one third were opposed is still frequently repeated, but it is a misreading of a letter written by John Adams in 1812 referring instead to American attitudes about the French Revolution. The consensus of historians is that between 40 and 50 percent of the white population were active Patriots, between 15 and 20 percent were Loyalists, and the remainder were neutral or kept a low profile.2 Obviously these proportions varied across regions and over time. Yet all the new states passed laws confiscating Loyalist estates. Since many of these estates were proprietary grants to royal placemen,3 the confiscations entailed a redistributionist land reform.

The U.S. Constitution’s prohibition on titles of nobility may seem trivial and quaint to modern eyes. But such titles, still prevalent throughout the Old World, always involved enormous legal privileges. This provision is, therefore, a manifestation of the extent to which the Revolution witnessed a decline in deference throughout society. No one has captured this impact better than the dean of revolutionary historians, Gordon Wood, in his Pulitzer Prize winning The Radicalism of the American Revolution.  He points out that in 1760 the “two million monarchical subjects” living in the British colonies “still took it for granted that society was and ought to be a hierarchy of ranks and degrees of dependency.” But “by the early years of the nineteenth century the Revolution had created a society fundamentally different from the colonial society of the eighteenth century.”4

One can view this transition even through subtle changes in language. White employees no longer referred to their employers as “master” or “mistress” but adopted the less servile Dutch word “boss.” Men generally began using the designation of “Mr.,” traditionally confined to the gentry. Although these are mere cultural transformations, they both reflected and reinforced the erosion of coercive supports for hierarchy, in a reinforcing cycle. In the Revolution’s aftermath, indentured servitude for immigrants withered away, and most states eliminated legal sanctions enforcing long-term labor contracts for residents, thus giving birth to the modern system of free labor, where most workers (outside of the military) can quit at will. Contrast that with Britain, where as late at 1823 Parliament passed a Master and Servant Act that prescribed criminal penalties for breach of a labor contract.5

Wood concludes that “Americans had become, almost overnight, the most liberal, the most democratic, the most commercially minded, and the most modern people in the world…. The Revolution not only radically changed the personal and social relations of people… but also destroyed aristocracy as it had been understood in the Western world for at least two millennia. The Revolution brought respectability and even dominance to ordinary people long held in contempt and gave dignity to their menial labor in a manner unprecedented in history and to a degree not equaled elsewhere in the world. The Revolution did not just eliminate monarchy and create republics; it actually reconstituted what Americans meant by public or state power.”6

Would all of these outcomes have happened without a War for Independence? Surely some and possibly many of them might have eventually, but the real question is whether the American Revolution played a crucial role in initiating and accelerating these developments. Those denying its significance inevitably point to Canada, which remained under British rule and, indeed, harbored many fleeing Loyalists. Today it is a free, democratic polity, with a high standard of living, and as liberal as, or in some respects more liberal than, the United States. To understand why the case of Canada does not prove the point, we need to look back before the Revolution and examine the factors that ignited it.

British Designs

The British colonies of North America, through most of their early history, enjoyed a relatively mild imperial regime that Edmund Burke described as “salutary neglect.” Britain’s mercantilist restrictions were either not strictly enforced or non-binding. But in the mid-eighteenth century, as the colonies became more populous and more integral to the British economy, there emerged among imperial officials a clique who wished to impose tighter control upon the colonies. Finally at the end of the Seven Years’ War in 1763 (what in the colonies was referred to as the French and Indian War), in which the British drove the French out of North America, this clique implemented a new colonial policy.

The primary features of the new policy were: (1) stationing in North America during peace for the first time a large standing army, numbering never less than 7,500; (2) issuing the Proclamation of 1763, drawing a line along the western boundary of the colonies beyond which settlement was prohibited; and (3) imposing taxes to help defray the cost of the army. All of these measures aroused the colonists’ suspicions, suspicions that were often quite valid. A 1763 internal memo within the British bureaucracy, for instance, proposed that “under Pretense of regulating the Indian trade, a very straight line be suddenly drawn on the Back of the Provinces,” which “now surrounded by an Army, a Navy and by Hostile Tribes of Indians” will make it easier to “exact a due obedience to the just and equitable Regulations of a British Parliament.”7

Unfortunately for the British, the Proclamation line also alienated those who would become American nationalists, helping to throw them into coalition with the radicals. Until then, major land speculators such as Franklin and Washington had revered the British empire and been enthusiastic supporters of its expansion. But now the fruits of a victory to which they had contributed during the recent war were being denied them. Nor did the Proclamation line presage better treatment of Native Americans. After all, it had been the British army that had helped provoke and then ruthlessly crush Pontiac’s Indian rebellion after France had abandoned the region, even resorting to smallpox-infected blankets to spread disease during the siege of Fort Pitt. If there was ever going to be any real check on settler aggression against the indigenous populations in North America, it had already vanished with the French defeat.

Indeed, it is hard to identify any British settler colony where the aboriginal peoples were not driven from their homelands or otherwise harshly treated. Maybe so in New Zealand, but certainly not in Australia. British acquisition of South Africa in 1806 did result in the abolition of slavery and some restraints on the Dutch-descended Boer population but the country still witnessed ongoing military campaigns against the Xhosa natives, then the Zulu War, and the ultimate emergence of apartheid. As for British Canada, the dispossession of Native Americans was less bloody than in the United States but almost as thorough. The marginalization of the Mi’kmaq of Nova Scotia was completed to provide land for arriving American Loyalists after the Revolution. Canada had two violent uprisings among the Métis, people of mixed French and indigenous ancestry, the first in 1869-1870 and the second in 1885, both suppressed and led by Louis Riel, who was therefore hanged for treason. Beginning in 1847, the Canadian government forcibly removed aboriginal children from their families to boarding schools for assimilation in order to “kill the Indian in the child,” in the words of historian John S. Milloy.8 Canadian Prime Minister Stephen Harper ultimately apologized for this program in 2008.

Following the Proclamation of 1763, the relations between the colonies and the mother country went through three consecutive crises: the first over the Stamp Act (1765-1766), the second over the Townshend Duties (1767-1770), and the third over the Tea Act (1773). The first two involved British efforts to impose new taxes on the colonists, provoking colonial protests and resistance. In both cases, imperial authorities backed down, ushering in temporary but tense lulls. Once colonial opposition effectively nullified the Tea Act, however, the British government responded harshly with a series of Coercive Acts, and outright military conflict erupted in 1775.

Colonial objections to the Tea Act can be puzzling, because the act itself did not directly tax the colonists. Instead it was essentially a bailout of the British East India Company, the quintessential mercantilist monopoly, which was struggling financially. Before the act’s passage, the company was required to sell its tea exclusively in London where it paid a duty. Tea destined for shipment and eventual sale in North America would be purchased by private merchants. The colonists then had to pay an additional import tax on tea, the one Townshend Duty that had not been repealed in 1770. Under the Tea Act, the company was now given a monopoly on re-shipment of tea to the colonies along with a rebate of the British duty. The act, therefore, had the ironic effect of reducing the price of tea in the colonies.

The colonists nonetheless defied the Tea Act for several reasons. Radicals, who had been boycotting the legal importation of tea, viewed the act as a clever ruse to get the colonists to accept Parliamentary taxation in principle. The act hurt American merchants, not just those importing tea legally, but also, because it undercut the price of smuggled Dutch tea, those doing so illegally. Most important, the East India Company embodied the colonists’ worst fears about British plans. If the company could be given a monopoly on tea, it could also be given a monopoly on other activities. The colonists were well aware of the company’s horrendous record in India, where its control over taxation in Bengal had contributed to a massive famine in 1770 that had killed up to ten million people, one third of Bengal’s population.

John Dickinson of Pennsylvania, a conservative who would later oppose the Declaration of Independence in the Continental Congress, put it this way:  “Their conduct in Asia, for some Years past, has given ample Proof, how little they regard the Laws of Nations, the Rights, Liberties, or Lives of Men…. Fifteen hundred Thousand… perished by Famine in one Year, not because the Earth denied its Fruits, but this Company and its Servants engrossed all the Necessities of Life, and set them at so high a Rate, that the Poor could not purchase them. Thus,… they now, it seems, cast their Eyes on America, as a new Theatre, wherein to exercise their Talents of Rapine, Oppression and Cruelty. The Monopoly on Tea is, I dare say, but a small Part of the Plan they have formed to strip us of our Property.”9

If the colonists needed any further evidence of British designs, Parliament, along with the Coercive Acts, passed the Quebec Act in 1774, establishing a new government for the former French territory. Although the act granted full religious toleration to Catholics, it also extended the province’s boundaries into the northwest territory, reinforcing the Proclamation line. With respect to governance, it vested all authority in a royally appointed governor and council, with no provision for a colonial assembly; it re-instituted compulsory tithes to the Catholic Church; and it restored the French seigneurial system, with its feudal privileges for distributing and managing land. Even the colonies’ French peasants (known as habitants), who constituted an overwhelming majority of the population, resented the act’s aristocratic features.

In short, there is ample evidence for a claim that historian Leonard Liggio emphasized. Without the American Revolution, British hard-liners intended to fasten on North America an imperial regime in many respects similar if not identical to British rule in India. As Justin de Rivage concludes, a group that he identifies as “authoritarian reformers” had seized control of policy to implement a sweeping “transformation of the British Empire.”10

Global Repercussions

The potentially deleterious impact of these foiled British designs on North America is hinted at in a short article by Nobel Prize-winning economist Robert Lucas. The article was a response to an essay in which Harvard historian Niall Ferguson, based on his several books on the British Empire, glorified the empire’s role in spreading economic development. Lucas responded with the obvious. The only colonies to enjoy sustained economic growth were Britain’s settler dominions: Canada, Australia, and New Zealand. Looking at other colonies in Africa or Asia, Lucas concludes: “The pre-1950 histories of the economies in these parts of the world all show living standards that are roughly constant at perhaps $100 to $200 above subsistence levels.” British imperialism thus failed “to alter or improve incomes for more than small elites and some European settlers and administrators.” India is the premier case, not experiencing significant sustained growth until the late twentieth century, and Lucas could have also included among the colonies that remained poor the British West Indies and Ireland.11

The impact of the American Revolution on the international spread of liberal and revolutionary ideals is well known. Its success immediately inspired anti-monarchical, democratic, or independence movements not only in France, but also in the Netherlands, Belgium, Geneva, Ireland, and the French sugar island of Saint Domingue (modern Haiti).12 What is less well understood is how the Revolution altered the trajectory of British policy with respect to its settler colonies. Imperial authorities became more cautious about imposing the rigid authoritarian control they had attempted prior to the Revolution. Over time they increasingly accommodated settler demands for autonomy and self-government. In short, the Revolution generated two distinct forms of British imperialism: one for native peoples and the other for European settlers.

This was immediately apparent in Canada. Parliament’s Constitutional Act of 1791 divided Quebec into two colonies, Upper and Lower Canada, each with its own elected assembly. The act also ended quit-rents. Paradoxically, contributing to these outcomes was the influx of American Loyalists, many of whom embraced republican principles despite opposing independence. Nova Scotia, half the population of which was already from New England, had a representative assembly as early as 1758, and the Revolution’s outbreak forced the royal governor to propose reforms in order to maintain the colony’s loyalty. Nova Scotia received three times as many Loyalists as Quebec, leading in 1784 to the partitioning off of New Brunswick, with its own assembly.

Although Australia upon initial British settlement in 1788 began as a penal colony with autocratic rule, agitation for representative government emerged early and was consummated with the Australian Colonies Government Act of 1850. British New Zealand was originally part of the colony of New South Wales in Australia, but it was separated in 1849 and got a representative government three years later. South Africa fell under sustained British rule in 1806. By 1854, the Cape Colony had its own parliament. Even in the slave colonies of the British West Indies, as the Revolutionary crisis still raged, the colonial assemblies asserted co-equality with the British House of Commons. As Sir Guy Carleton, commander-in-chief of British forces in America during the war, complained: “It is not in the Revolted provinces alone that a Republican spirit is to be found, but the tint has . . . has spread to other parts of America and to the West Indies.”13

That brings us back to the question of slavery. A Parliamentary act of 1833 abolished slavery throughout Britain and its colonies, effective in 1834, although with an explicit exception for territories controlled by the East India Company. The act’s passage had partly been assisted by a major slave revolt in Jamaica during the previous two years, along with a tight symbiotic relationship between American and British abolitionists. The oft-repeated argument is that, without American independence, this act would have simultaneously abolished slavery in what became the United States. But this ignores the facts that British emancipation had to overcome the stiff political opposition of West Indian planters and that emancipation, by precipitating a collapse of production in the sugar islands, was costly for the British economy.

“Thus it is likely that, without U.S. independence, slavery would have persisted in both North America and the West Indies after 1834 and, indeed, possibly after 1865.”

The only conceivable way Britain could have held on to all its American colonies was through political concessions to colonial elites. If American cotton, tobacco, rice, and sugar planters had still been under British rule, they inevitably would have allied with West Indian sugar planters, creating a far more powerful pro-slavery lobby. Moreover, by 1833 American cotton had become more essential to the British economy than Caribbean sugar. Bear in the mind that it was the spread of cotton cultivation in the United States in the early nineteenth century that had reversed what little anti-slavery impulse had emerged during the Revolution in the southern states, inducing slaveholders to cease apologizing for slavery as a necessary evil and start defending it as positive good. Thus it is likely that, without U.S. independence, slavery would have persisted in both North America and the West Indies after 1834 and, indeed, possibly after 1865.

Conclusion

Any revolution that brings about benefits for a large sector of the population faces serious free-rider problems. Revolutionary activity is extremely risky and, once the revolution succeeds, excluding from any general benefits those who did not participate is difficult if not impossible. This explains why revolutions are always so messy and produce mixed results. It also explains why so few revolutions actually bestow genuine benefits. Gordon Tullock, in a classic 1971 article, contended that “Historically, the common form of revolution has been a not-too-efficient despotism which is overthrown by another not-too-efficient despotism with little or no effect on the public good.”14 Nonetheless, sometimes people will eschew the free-rider incentive to bring about a better world, bearing costs that exceed any individual material gains. The anti-slavery movement, first sparked by the Revolution, is one clear case.

The American Revolution is another such case. The embattled farmers who stood at Lexington green and Concord bridge in April 1775 were only part-time soldiers, with daily cares and families to support. Their lives were hard. The British redcoats they faced were highly trained and disciplined professionals serving the world’s mightiest military power. Yet when they fired the “shot heard ’round the world” that touched off the American Revolution, they initiated a cascade of positive externalities that not only U.S. citizens but also people throughout the world continue to benefit from today, more than two centuries later. They had no hope—indeed no thought—of charging for these non-excludable benefits. Nonetheless, they took the risk. What better reason to celebrate the 4th of July?


Footnotes

[1] Bryan Caplan, “Independence Day: Any Reason to Celebrate?” EconLog (July 4, 2007).

[2] Robert M. Calhoun, “Loyalism and Neutrality,” in The Blackwell Encyclopedia of the American Revolution, ed. By Jack P. Greene and J. R. Pole (Cambridge, MA: Basil Blackwell, 1991), p. 247.

[3] Royal placemen were British officials and other members of the elite to whom the Crown gave special privileges.

[4] Gordon S. Wood, The Radicalism of the American Revolution (New York: A. A. Knopf, 1992), p. 6.

[5] Robert J. Steinfeld, The Invention of Free Labor: The Employment Relation in English and American Law and Culture, 1350-1870 (Chapel Hill: University of North Carolina Press, 1991); Steinfeld, Coercion, Contract, and Free Labor in the Nineteenth Century (Cambridge: Cambridge University Press, 2001).

[6] Wood, Radicalism of American Revolution, pp. 6-8.

[7] As quoted in Bernhard Knollenberg, Origin of the American Revolution, 1759-1766 (New York: Macmillan, 1960), p. 92. The memo is part of the papers of Lord Shelburne, president of the Board of Trade, and was probably written by his secretary, Maurice Morgann.

[8] John S. Milloy, A National Crime: The Canadian Government and the Residential School System, 1879 to 1986 (Winnipeg: University of Manitoba Press, 1999). p. 42.

[9] John Dickinson, The Writings of John Dickinson (Bedford, MA: Applewood Books, 1895), pp. 457-58. Dickinson wrote this passage in a pamphlet written under the name Rusticus.

[10] Justin du Rivage, Revolution Against Empire: Taxes, Politics, and the Origins of American Independence (New Haven: Yale University Press, 2017), p. 103.

[11] Robert E. Lucas, Jr., “Colonialism and Growth” Historically Speaking, 4 (April 2003): 29-31; Niall Ferguson, “British Imperialism Revisited: The Costs and Benefits of ‘Anglobalization’” ibid.: 21-27.

[12] R. R. Palmer, The Age of Democratic Revolution, 2 v. (Princeton, NJ: Princeton University Press, 1959-1964).

[13] As quoted in Selwyn H. H. Carrington, “The American Revolution and the Sugar Colonies, 1775-1783,” in The Blackwell Encyclopedia of the American Revolution, p. 516.

[14] Gordon Tullock, “The Paradox of Revolution”, Public Choice, no. 9 (Fall 1971): 95.


*Jeffrey Rogers Hummel is Professor of economics at San Jose State University and the author of Emancipating Slaves, Enslaving Free Men: A History of the American Civil War, the second edition of which was released in 2014.

For more articles by Jeffrey Rogers Hummel, see the Archive.


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Econlib July 2, 2018

Get the Story Straight, by Arnold Kling

In Suicide of the West,1 Jonah Goldberg offers an ambitious intellectual defense of modern conservatism. His argument is grounded in a theory of cultural anthropology in which the stories that we tell ourselves about ourselves play a crucial role in political economy.  If we tell the right story, we can maintain political order and continue to make economic progress.  But instead the wrong story, told by people he labels Romantics, threatens to undo what he calls “the Miracle,” the progress that took off as a consequence of the Age of Reason.

Econlib July 2, 2018

Get the Story Straight

In Suicide of the West,1 Jonah Goldberg offers an ambitious intellectual defense of modern conservatism. His argument is grounded in a theory of cultural anthropology in which the stories that we tell ourselves about ourselves play a crucial role in political economy.  If we tell the right story, we can maintain political order and continue to make economic progress.  But instead the wrong story, told by people he labels Romantics, threatens to undo what he calls “the Miracle,” the progress that took off as a consequence of the Age of Reason.

In Goldberg’s view, the story that we should be telling ourselves goes something like this:

1- Once upon a time, human beings emerged as a species.  For hundreds of thousands of years, we lived in small, primitive bands of hunter-gatherers.  It was during this period that our human nature developed.  Indeed, the terms “nature” and “natural” permeate Suicide of the West, appearing at an average rate of close to once per page.

2- Our human nature made us outstanding in our ability to cooperate as a tribal band, generally in tribes of less than 150 people.  But our nature also made us unable to live peacefully with other bands.  Encounters between different bands were typically violent. Because of this, each tribe had to be self-sufficient.  A tribe could make little or no use of the advantages of specialization.

3- About 10,000 years ago, humans developed the ability to form larger agricultural societies.  We told stories that justified extended hierarchies.  These stories encouraged people to accept social classes, with people in lower classes obeying those in higher classes.  The stories supported the institution of slavery and exalted authoritarian rulers.

4- Starting around 3,000 years ago, we began telling religious stories that encouraged peaceful cooperation with strangers based on shared beliefs about God.  These stories helped hold larger societies together for long periods, but they also discouraged commerce and innovation.

5- Starting around 300 years ago, we in the West began to tell stories that insisted on the autonomy of every individual.  These stories also praised commerce and innovation.  Commerce and innovation produced a dramatic increase in economic well-being.  The insistence on the autonomy of the individual supported the institutions of democracy.  It gradually led to the promotion of equal rights for all, including ethnic minorities and women.  The institutions of the free market and democratic equality gave us the Miracle.

6- But the Miracle is fragile.  It is threatened by the stories told by the Romantics, from Rousseau and Marx down to present-day progressives, artists, and intellectuals.  These stories do not express gratitude for the Miracle produced by democratic capitalism.  Instead, they tell a story in which democratic capitalism enables some people to exploit others and despoil the environment.  They claim that democratic capitalism can be replaced by something far better.

7- But while the Romantics would tear down the existing order to make way for utopia, Goldberg warns that the destruction of democratic capitalism would instead see us revert to primitive tribalism.  Indeed, he sees in the Romantic critiques an appeal to tribal values of equality, unity, and all-encompassing belonging.  But reverting to tribal values also means reverting to violence and economic backwardness, as exemplified by Nazism and Communism.

“Lest we fall back into a state of primitive tribalism, we need to understand the story of the Miracle.”

Lest we fall back into a state of primitive tribalism, we need to understand the story of the Miracle. We need to understand that it is unnatural, and we should be grateful for the norms and institutions that restrained human nature in order to make the Miracle possible.  We need to recognize the threats posed by those who react against democratic capitalism.  We need to counter their stories that emphasize the flaws of our society with stories that emphasize its virtues.

As I noted earlier, Suicide of the West is an ambitious project.  It includes a chapter in which Goldberg uses John Locke to personify the ideas that helped produce the Miracle and Jean-Jacques Rousseau to personify what Golderg calls the “reactionary” opposition to Lockean ideas.  It includes a chapter on contemporary arts and entertainment as part of the Romantic reaction.  It includes a chapter in which Goldberg characterizes President Donald Trump as both a symptom and reinforcement of the dangerous attempts to seek an alternative to democratic capitalism.  The breadth of topics challenges the author’s (and editor’s) ability to maintain a consistent tone and direction of argument.

For more on Goldberg’s book and the reactions it has prompted, see the EconTalk episodes “Jonah Goldberg on The Suicide of the West” and “Richard Reinsch on the Enlightenment, Tradition, and Populism.”

Suicide of the West departs from typical conservatism in that Goldberg heaps high praise on innovation.  He agrees with economic historian Deirdre McCloskey that hostility toward innovation is what held back economic progress for most of human history.

This raises the question of why conservatives should fear innovation now.  Why not experiment with new family forms, sexual norms, economic policies, and political arrangements?  In the past, conservatives feared the consequences for social order of Civil Rights, feminism, and same sex marriage. If they were wrong then, why are they not wrong today?

I believe that Goldberg’s answers to these questions are implicit in his cultural anthropology.  He would say that social change that is in the spirit of preserving democratic capitalism and encouraging it to live up to its ideals is good.  He would say that social change that is in the spirit of satisfying primitive tribal instincts is bad.  But I think that his argument would work better if he made this case more explicitly.  I wish that he had given us criteria for telling the difference between movements that seek to improve democratic capitalism and those that instead would promote a reversion to tribalism.

Goldberg says that the stories that today’s educators and cultural leaders are telling us about ourselves are wrong-headed and dangerous.  Unless we get our stories right, the worst fears of Suicide of the West may be realized.


Footnotes

[1] Jonah Goldberg, Suicide of the West: How the Rebirth of Tribalism, Populism, Nationalism, and Identity Politics is Destroying American Democracy. Crown Forum, 2018.


*Arnold Kling has a Ph.D. in economics from the Massachusetts Institute of Technology. He is the author of several books, including Crisis of Abundance: Rethinking How We Pay for Health Care; Invisible Wealth: The Hidden Story of How Markets Work; Unchecked and Unbalanced: How the Discrepancy Between Knowledge and Power Caused the Financial Crisis and Threatens Democracy; and Specialization and Trade: A Re-introduction to Economics. He contributed to EconLog from January 2003 through August 2012.

Read more of what Arnold Kling’s been reading. For more book reviews and articles by Arnold Kling, see the Archive.


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Econlib June 11, 2018

Division of Labor and Specialization

Introduction

Definitions and Basics

Definitions: Adam Smith, biography from the Concise Encyclopedia of Economics

Smith saw the main cause of prosperity as increasing division of labor. Using the famous example of pins, Smith asserted that ten workers could produce 48,000 pins per day if each of eighteen specialized tasks was assigned to particular workers. Average productivity: 4,800 pins per worker per day. But absent the division of labor, a worker would be lucky to produce even one pin per day….

In the News and Examples

Division of labor and interdependence: I, Pencil, by Leonard Read.

Simple? Yet, not a single person on the face of this earth knows how to make me. This sounds fantastic, doesn’t it? Especially when it is realized that there are about one and one-half billion of my kind produced in the U.S.A. each year….

Specialization and Wealth, by Dwight Lee. From The Freeman.

A remarkable degree of social cooperation emerges through market communication. Now, let’s consider some of the advantages we realize from that cooperation. At a general level these advantages are obvious. It simply makes sense that we can produce more if our actions are in harmony than if we are working at cross-purposes. But to really understand economics, we must consider the link between cooperation and productivity in detail.

Wealth seldom comes as manna from heaven. It has to be produced by applying human effort, intelligence, and patience to natural endowments that yield their bounty reluctantly. This should be obvious. But one measure of the success of the marketplace at improving our productive powers is that it has become all too easy for people to assume that wealth is part of the natural order of things. Academics and policy wonks consider the distribution of wealth to be the primary issue, while dismissing any concern that their policy prescriptions could hamper its production. They drone on and on about the causes of poverty (or the “improper” distribution of wealth), apparently unaware that determining the causes of wealth is the serious challenge….

Mike Munger on the Division of Labor. Podcast on EconTalk exploring what Smith actually meant by “the division of labor is limited by the extent of the market”. Includes printable Listening Guide.

Mike Munger of Duke University and EconTalk host Russ Roberts talk about specialization, the role of technology in aiding specialization and how the division of labor creates wealth….

See also “I’ll Stick With These: Some Sharp Observations on the Division of Labor”, by Mike Munger on Econlib for a related article.

Adam Smith: The Invisible Hand, a LearnLiberty video.

Prof. James Otteson, using the ideas of Adam Smith, explains how the division of labor is a necessary and crucial element of wealthy nations. Division of labor and specialization in corporations:

Corporations, from the Concise Encyclopedia of Economics

To look askance at executives who supply little or none of the corporation’s capital, as many of the corporation’s critics do, is really to condemn the division of labor and specialization of function. Corporate officers operate businesses whose capital requirements far exceed their personal saving or the amounts they would be willing or able to borrow…. Division of labor in biology:

Gordon on Ants, Humans, the Division of Labor and Emergent Order. EconTalk podcast.

Deborah M. Gordon, Professor of Biological Sciences at Stanford University, is an authority on ants and order that emerges without control or centralized authority. The conversation begins with what might be called the economics of ant colonies, how they manage to be organized without an organizer, the division of labor and the role of tradeoffs. The discussion then turns to the implications for human societies and the similarities and differences between human and natural orders.

Matt Ridley on Trade, Growth, and the Rational Optimist. EconTalk podcast.

Matt Ridley, author of The Rational Optimist, talks with EconTalk host Russ Roberts about why he is optimistic about the future and how trade and specialization explain the evolution of human development over the millennia. Ridley argues that life is getting better for most of the people on earth and that the underlying cause is trade and specialization. He discusses the differences between Smith’s and Ricardo’s insights into trade and growth and why despite what seems to be strong evidence, people are frequently pessimistic about the future. Ridley also addresses environmental issues. How does Adam Smith’s explanation of the division of labor differ from David Ricardo’s explanation of comparative advantage?

Roberts on Smith, Ricardo, and Trade. EconTalk podcast.

Russ Roberts, host of EconTalk, does a monologue this week on the economics of trade and specialization. Economists have focused on David Ricardo’s idea of comparative advantage as the source of specialization and wealth creation from trade. Drawing on Adam Smith and the work of James Buchanan, Yong Yoon, and Paul Romer, Roberts argues that we’ve neglected the role of the size of the market in creating incentives for specialization and wealth creation via trade. Simply put, the more people we trade with, the greater the opportunity to specialize and innovate, even when people are identical. The Ricardian insight masks the power of market size in driving innovation and the transformation of our standard of living over the last few centuries in the developed world.

de Botton on the Pleasures and Sorrows of Work. EconTalk podcast.

Author Alain de Botton talks with EconTalk host Russ Roberts about his latest book, The Pleasures and Sorrows of Work. How has the nature of work changed with the increase in specialization? Why is the search for meaningful work a modern phenomenon? Has the change in the workplace changed parenting? Why does technology become invisible? These are some of the questions discussed by de Botton in a wide-ranging discussion of the modern workplace and the modern worker.

A Little History: Primary Sources and References

Smith’s pin factory example: par. I.I.3 in The Wealth of Nations by Adam Smith

Those ten persons, therefore, could make among them upwards of forty-eight thousand pins in a day. Each person, therefore, making a tenth part of forty-eight thousand pins, might be considered as making four thousand eight hundred pins in a day. But if they had all wrought separately and independently, and without any of them having been educated to this peculiar business, they certainly could not each of them have made twenty, perhaps not one pin in a day; that is, certainly, not the two hundred and fortieth, perhaps not the four thousand eight hundredth part of what they are at present capable of performing, in consequence of a proper division and combination of their different operations….

The Division of Labor is Limited by the Extent of the Market, Book I, Chapter 3 in The Wealth of Nations by Adam Smith

As it is the power of exchanging that gives occasion to the division of labour, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market. When the market is very small, no person can have any encouragement to dedicate himself entirely to one employment, for want of the power to exchange all that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men’s labour as he has occasion for….

International Division of Labor in Chapter 2 of Studies in the Theory of International Trade by Jacob Viner

A few writers prior to Adam Smith stated or approached closely some of the specific economic arguments for unrestricted trade which were later to serve as the core of the free-trade doctrine of Adam Smith and the English classical school….

Division of Labor, in Lalor’s Cyclopaedia of Political Science

When nations become greater and more enlightened, the division of labor becomes more marked….

Advanced Resources

Kling on Patterns of Sustainable Specialization and Trade. EconTalk podcast.

Arnold Kling of EconLog talks with EconTalk host Russ Roberts about a new paradigm for thinking about macroeconomics and the labor market. Kling calls it PSST–patterns of sustainable specialization and trade. Kling rejects the Keynesian approach that emphasizes shortfalls in aggregate demand arguing that the aggregate demand approach masks the underlying complexity of the recalculations that periodically take place in a dynamic economy. Instead, Kling invokes the mutual exploration between entrepreneurs and workers for profitable opportunities that pay well using the workers’ skills. This exploration takes time, involves trial and error, and can have false starts because businesses sometimes fail or employees are difficult to find or match with employment opportunities. Kling applies these ideas to the current crisis to explain why labor market recovery is so sluggish and what might policies might improve matters.

Part 2, Chapter 8, Human Society in Human Action by Ludwig von Mises

The principle of the division of labor is one of the great basic principles of cosmic becoming and evolutionary change. The biologists were right in borrowing the concept of the division of labor from social philosophy and in adapting it to their field of investigation. There is division of labor between the various parts of any living organism.

Related Topics

Economic Growth

Supply and Demand, Markets and Prices

Comparative Advantage and the Benefits of Trade

Exchange and Trade

 

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