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The Case For Optimism: Post COVID-19 Is The Time To De-Regulate And Get Rid Of The Special Interest Leeches Who Drain Our Economy.

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Things seem grim. But there is cause for optimism, perhaps even enthusiasm, for the adjustment process that we face “after the virus.” The source of that optimism, surprisingly, is a very pessimistic book, The Rise and Decline of Nations by Mancur Olson (Yale, 1982).
Olson argued that there is a strange dynamism in societal success, but an unavoidable accretion of forces that leech away the ability to sustain success. Eventually, great civilizations fail. Over the time of quarantine here in North Carolina, I read Edward Gibbon’s famous Decline and Fall of the Roman Empire. It was better than I expected, full of examples of the problems of public choice and matching private incentives and public disaster.Olson extends the logic decline to other nations, noting that there appears to be what we might now call a “common pool resource” problem in budgets and the energy of the public sector. Over time, more and more latent groups become organized interests, and they use the political power of organization to secure rents from the public purse. The problem is that once rents are secured, it is essentially impossible to take them back. Large latent groups may be difficult to organize to eliminate rents, because the individual benefits are negligible.But the real problem is that organized groups will fight to the death to preserve their ill-gotten portion.
The reason is Gordon Tullock’s simple but powerful insight about the “transitional gains trap.” Once a rent or entitlement is secured by an organized interest, there is a one-time wealth increase. But the expectation of the rent is capitalized in asset prices immediately: land prices, or the price of a taxi medallion or occupational license, increases to the point where the owner makes only a normal return. But the activity is expensive, and sucks out some of the life juices of the economy.Individually, this leech-like rent-seeking has only limited impact; that’s why each separate act of thievery can succeed: the tiny marginal impact has costs that are so widely dispersed as to appear invisible. But in the aggregate, as with any common pool resource, the effect of each separate taking adds up to collapse the society. Interest groups “overfish” the budget, and there is nothing left. California cities have no effective budget remaining, after they pay the inflated pension obligations snatched by public unions. Overall, the “ratchet” of government growth, which once expanded in an area cannot be cut, is constantly forcing nondiscretionary spending upward, leaving less and less ability to respond to needs of infrastructure and normal services.

The Upside: Saltation

The reader may be wondering, “Jeez, where’s the optimism? This sounds terrible.” And that’s right, it is terrible. My optimism is more of the “silver lining” than the “what good luck!” sort. There has always been a tendency among the economically illiterate (and I have to include Paul Krugman among those) to see destruction as an economic stimulus. Frederic Bastiat long ago identified this as the “broken window” fallacy, but it won’t disappear: every time there’s a catastrophe, someone says, “Well, actually….” No. NO, NO, NO. Destruction does not create wealth.

Except that sometimes, destruction may create an opportunity for future growth, if the destruction includes the piled-up layers of interest group guano that coats the gears of the system. We sometimes talk about technology as having this function; in my book (Platforms: Perils and Promise, IEA 2020) I give the example of how GPS has made a huge amount of human capital nearly worthless.

For decades, an entry license to drive a black cab in London required the ability to recite from memory the street location of and directions to any address in the city. And the driver needed to know at least a snippet about every tourist stop in the city. As a result, the salaries of black cab drivers were high, and it was difficult to increase the number of drivers in response to changes in demand.

But the value of what drivers called “The Knowledge” was destroyed in less than a decade. A smart phone with GPS, combined with increasingly accurate apps such as WAZE that give constantly updated information about construction and accidents en route, means that rides can be provided at a 50% discount compared to black cabs, with little difference in arrival times. I have called this kind of change “saltation,” meaning a re-sorting or leapfrogging transformation.

Which brings us back to Mancur Olson. He noticed that catastrophes caused saltation in institutions, because all the layers of interest group rent commitments were breached. Either the group did not exist in the same form, or political change was so dramatic that their implicit and morally illicit commitments to a share of taxpayers’ efforts were no longer enforceable. The most obvious way of breaking the stranglehold of organized interests was war, according to Olson. And not winning a war; that likely makes things worse. The “solution” is to lose a war, catastrophically, so that the society gets to start over free of the accretion of parasites and second-handers that had thrived on the work and thrift of others.

On p. 76 of Rise and Decline, Olson argues that the reason that Germany and Japan did so well after World War II is that they lost completely and abjectly, and had new institutions imposed from outside in ways that abrogated the commitments that would have been honored if choices had been made internally. Olson points out that the other major Axis power, Italy, managed a negotiated peace that preserved its institutions, and the result was a crippled and anemic postwar recovery compared to Germany and Japan.

Olson is quite careful to avoid the “broken window fallacy,” I should note. He does not conclude, “And therefore complete destruction following a lost war is what we want!” His point is that there is little hope for normal political processes to break up the interest group rent carnival short of losing a war, which means that the decline of nations is inevitable: either their dynamic energies are slowly choked off by institutional sclerosis (bad), or they lose a war (very bad now, later good, but overall more bad than good).

But there it is. That is the optimistic part. I would never have advocated for the intentional destruction of many of the supply chains, cronyist partnerships, and cozy iron triangles that the state has nurtured in the past 50 years. Right or wrong, though, we did that. Our economy in the fall of 2020 will look more like an economy emerging from a bitter war than any time since the fall of 1945. All those interest group commitments that normally would be sapping our national vitality will be up for grabs.

Our systems of occupational licensing—always a mook’s game, but now clearly preventing rapid response to emergencies in other states—drug and medical equipment certification, and regulating employment in the “gig” economy, have all been shown to be catastrophic. The economic justification for these grants and set-asides was never persuasive. Let’s get rid of them! Olson’s argument is that “a fresh start” on regulation is actually a great tonic for economic anemia.

The point is clear: the economy lost the war. Many of our industries and normal ways of doing business got blown up. That’s done; we lost a war we did not even want to fight. But it happened, and now we have an opportunity for saltation. We can make the rebuilt political economy better than the bloated, creaky rent-selling machine that we had at the start of 2020.

Michael Munger is a Professor of Political Science, Economics, and Public Policy at Duke University and Senior Fellow of the American Institute for Economic Research.

Welcome To Turn-Key Capitalism And Functional Markets In A Box!

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Adapting to change is the key to survival. Social systems must be able to serve people in periods of stability, by creating predictable patterns of rules and expectations, and to serve people in times of disruption, by fostering innovation and entrepreneurship without breaking down.

In evolution, the tension between these two imperatives—the need to match features to specific settings, and the need to adapt quickly to unpredictable changes in circumstances—is the driving force that explains survival. The dinosaurs ruled much of the planet because they were adapted to the environments they lived; mammals took over because their smaller size, fur coats, and fast metabolism let them adapt to changing circumstances.

In human societies, disruptive changes are internally generated. Competition among societies, and innovation within societies, generates change that has to be managed by institutions. Since these institutions are often the products of the need to generate stability and predictability, managing fundamental change can be a problem.

The Ottoman Empire lasted for more than 600 years; it was stable and internally peaceful. On the other hand, this stability was purchased at the price of economic stagnation, and retarded progress in the sciences, of a dozen nations.  As my Duke colleague Timur Kuran argues, stability and coherence alone are not enough.

On the other hand, the activities of Enron Corporation  showed that rapid adaptation, moving ahead of the ability of market institutions or property rights to adjust, can be catastrophic. The Industrial Revolution wiped out social and cultural institutions and traditions on a wide scale.

Some analysts (including me) are now arguing that we are on the threshold of similarly disruptive changes. The nature of work, our sources of income, and the way we own and use things may be profoundly different in just a few decades.

Saltation

One kind of disruption, which in my book Tomorrow 3.0 I called “saltation,” is mostly—though not entirely—good, because it means that the institutional and legal preconditions for development in poor nations will no longer be necessary. The word “saltation” is rarely used in conversation.  It means an abrupt movement or transition, or (in evolutionary terms) a sudden discontinuous jump in a line of descent.

Much of what we think we know about development, entrepreneurship, and the function of government and markets is based on certain assumptions about institutions and preconditions.  Software will allow even a nation with a corrupt government and police force, rudimentary banks and broken capital markets to produce useful services. Development economists have long told developing nations that they must follow a particular path of rule of law, independent judiciary, financial system, and so on. This essentially material, marginalist notion of “stages” of development is clear in Karl Marx, who said “The country that is more developed industrially only shows, to the less developed, the image of its own future.” (Capital, p. 13).

But what if blockchain apps and cryptocurrency could simply operate on top of a corrupt system? Turn-key capitalism!  Functioning markets in a box! Or an “app,” at least. The reduction in prices, and the availability of an increasing variety of services and activities for free, or for a very low cost, is likely to provide a platform for leapfrogging the traditional stages of development and the usual institutions required for starting and running a business. This jumping will disrupt the banks, the courts, the political entities that try to regulate and control business activities, but it will also allow people in nations that lack financial intermediaries, a system of law, and state capacity to provide infrastructure to become competitive.

Separation

The other kind of disruption, which is already commonly called “separation,” is mostly—though not entirely—bad, because it means that many people will be left behind, in most cases through no particular fault of their own, and will be relegated to second class status in wealthy nations.

I’m not convinced that separation is inevitable; much of the discussion of the “stagnation” of the total compensation of the middle class has ignored the dramatic decline in prices for many goods and services, especially on-line platforms such as Facebook, Twitter, and Wikipedia. Still, it’s true that software is replacing a lot of service jobs, and this may continue for years to come.

I have argued that the key feature of the new economy is the commodification of excess capacity. Like the commodification of labor in the 18th and 19th centuries, this may result at first in a “stretching” of the income distribution.  Those without knowledge of how to gain access to programming skills, and who don’t have durables, such as cars for Uber or houses for AirBnB, may find themselves in a difficult position economically.

The three most important impacts of the new “sharing” economy are likely to be:

(1) a dramatic reduction in the amount of physical stuff, in the form of consumer durables, being produced in factories by workers.

(2) an equally dramatic decline in the cost of having access to a variety of stuff, and a sharp reduction in costs of storage.

(3) an ambiguous, but unsettling, effect on real wages, with both the direction and variance of real wages very much in flux.

Over the last twenty years, two things have happened in U.S. manufacturing: The total number of jobs in manufacturing has fallen from about 18 million to just over 10 million. But the total value of manufacturing has increased steadily.  This increase in productivity is good; in fact, it’s great!

The problem is that it means that there are fewer people working in these kinds of jobs. In the past, the service sector has taken up the slack, but it’s not clear that will happen this time. The reason is that, as Marc Andreessen famously said back in 2011, “Software is eating the world.”

I don’t have a crystal ball, and I have shown in the past that I am terrible at making predictions. So I won’t make you laugh by drawing conclusions. But I will say this: if there is a way to encourage saltation,  because it levels the differences between developed and less developed nations, we should explore. And if there is a way to mitigate the harmful political effects of separation, we should explore those, too.

People fear change, because they don’t know what to expect. As a society, if we can ease the adaptation to changing circumstances, we may be able to do a much better job of accommodating a future that is coming whether we like it or not.

 

This article appeared at AIER.org on May 1, 2019.

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