Free Markets

President Obama received a lot of outraged criticism from the right during the 2012 campaign for his remark, “You didn’t build that.” What he meant, though he uncharacteristically said it in a fairly clumsy way, was that for every proudly self-made entrepreneur there is a huge web of supporting institutions and infrastructure built by the government. These essential supports include the obvious – the courts, the Interstate highway system, police and fire departments, etc. – but also a tremendous array of investments undertaken by national governments, many of which have provided a platform on which entrepreneurs can build. A recent article in The Economist, reviewing a new book entitled “The Entrepreneurial State,” by Mariana Mazzucato of Sussex University in England, makes this explicit. And nowhere is this investment activity more influential than the United States, supposedly the cradle of unbridled individual enterprise.

Beneficiaries of these investments include Apple: “The armed forces pioneered the Internet, GPS positioning and voice-activated ‘virtual assistants.’ They also provided much of the early funding for Silicon Valley. Academic scientists in publicly funded universities and labs developed the touchscreen and the HTML language. An obscure government body even lent Apple $500,000 before it went public.” They also include Google, which received early funding from the National Science Foundation. Pharmaceutical and biotechnology companies benefit from the $30 billion in annual funding for biomedical research from the National Institutes of Health.

As Ms. Mazzucato argues, “The entrepreneurial state does far more than just make up for the private sector’s shortcomings: through the big bets it makes on new technologies, such as aircraft or the internet, it creates and shapes the markets of the future. At its best the state is nothing less than the ultimate Schumpeterian innovator—generating the gales of creative destruction that provide strong tailwinds for private firms like Apple.”

There are reasons to be skeptical of some government investments. The Solyndra debacle, in which the Federal government provided $500 million in loan guarantees to a California manufacturer of solar panels, which promptly went bust in the face of low-cost competition from China, is a cautionary example of the dangers of bureaucrats playing at being venture capitalists. But the rallying cry of the Tea Party – the Randian (Ayn and Paul) notion that the state is essentially a parasite feeding on the efforts of bold and visionary individual entrepreneurs – is a pure fairy tale.

The Economist article asks “why are some states successful entrepreneurs while others are failures?” and it provides an answer:  “Successful states are obsessed by competition; they make scientists compete for research grants, and businesses compete for start-up funds—and leave the decisions to experts, rather than politicians or bureaucrats. They also foster networks of innovation that stretch from universities to profit-maximizing companies, keeping their own role to a minimum.” This sounds much like the blueprint for Silicon Valley, or any other successful technology-based industrial cluster.

In our current budget-cutting environment, these essential investments are under threat. According to a recent article in The Huffington Post, sequestration will cost the NIH 5% of its budget, or $1.7 billion, forcing the cancellation of 700 competitive research grants in the current Federal budget year. Similarly, the National Science Foundation is expected to issue 1,000 fewer research grants this year as a result of sequestration.

According to a statement by the Congressional Budget Office, the Federal Highway Trust Fund, which is funded by taxes on gasoline and diesel and which provides a substantial portion of the money states use to maintain state and national roads, is essentially insolvent and will run out of money completely by 2015. The only way to avoid this would be to cut transportation funding by 92% or raise the Federal gasoline tax by 50 cents a gallon, and it’s hard to imagine the Republican-controlled House of Representatives going along with the latter.

In the current political environment, much of the public investment that enables American businesses to innovate and prosper is under threat, mainly from ideologues who refuse to recognize the essential role that government initiative and funds have played since the founding of the Republic, from the Erie Canal to the interstate highway system, to nanotechnology research.

It is worth considering these facts in the context of the current legal battle between Verizon and the Federal Communications Commission. Verizon is challenging a net-neutrality order adopted by the FCC in 2010, which states that internet service providers (ISPs) cannot block lawful content and mobile broadband providers cannot block lawful websites. Verizon contends that the order violates its First Amendment rights. More to the point, Verizon and its competitors, including Comcast and AT&T, maintain that they spent billions of dollars to build their networks and should be able to grant or deny access as they please, or charge different customers different rates for transmitting on their networks. This is a spurious argument. The broadband companies are “common carriers,” a term that applies not only to telecoms companies but also to airlines, railroads, and trucking companies: they offer their services to the general public under a license or authority granted by a public regulatory body. Common carriers are subject to licensing requirements because they are using a public resource: radio spectrum, rights of way, public roads, or air traffic control systems, without which they would be unable to operate. In the case of the telecoms company, they are also using a resource – the Internet – that was developed by DARPA, the U.S. Defense Advanced Research Projects Agency.

The Internet and the public airwaves are not the property of those companies to use as they please, free from any oversight or interference. It is time to tell them, “No, you didn’t build that.”

 

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Outgoing WTO Director-General Pascal Lamy has recently criticized EU-US and transpacific trade talks, which have the potential to create the world’s two largest free trade areas and measurably increase prosperity and growth for hundreds of millions, if not billions, of people. He has a point. Several, actually. Regional trade agreements, though they may possibly serve as stepping-stones to global agreements, can also reduce the urgency with which their members approach global trade negotiations in the WTO framework. A transpacific or transatlantic trade agreement, in addition to excluding China, which already sees hostile intent in the transpacific talks, would also leave out some of the world’s most vulnerable economies and people, especially in Africa and South Asia. Lamy also expressed doubt that either of these incipient trade agreements would address agricultural subsidies, which are the most important trade distortion of all.

All true. And yet, given the paralysis affecting the Doha Round WTO trade talks, now in their 13th year, big regional agreements may be the best deal we can get. According to a study by the European Centre for International Political Economy, a transatlantic zero-tariff agreement, reducing existing tariffs from their current levels of three to five percent to zero, would add between 0.99 and 1.33 percent to U.S. GDP. Eliminating non-tariff trade barriers such as subsidies, and harmonizing product safety and drug approval standards, could add even more. The benefits from a transpacific agreement, which could cover forty percent of global trade if Japan’s efforts to join the agreement bear fruit, could be similar. And the wonderful thing about trade is that one party’s gains are not another’s losses. These agreements could raise everyone’s prosperity.

But relatively trivial disagreements could easily stall both sets of talks or derail them entirely. France has insisted that any trade agreement would have to allow it to continue to lavish subsidies on the French film industry. Japan, whose Liberal Democratic Party owes much of its support to wealthy farmers, insists that it should be allowed to protect its producers of rice, wheat, beef, and soy from imports. Japan has long imposed non-tariff barriers against a wide range of products, including skis, claiming the imported variety are unsuitable for Japan’s unique snow conditions. Such practices are not unknown in France either. At one point, all imported videocassette recorders and players had to be inspected in the customs shed in the city of Poitiers.

The French stance on film industry protection, surprisingly, has come in for more criticism from other EU members fearful of scuppering an immensely valuable deal than from the U.S. and its film industry, which seem fairly relaxed about the whole thing. In a country that has given its highest civilian honor to both Jerry Lewis and Sylvester Stallone, Hollywood has nothing to worry about no matter how much public money French film producers receive. Japanese farmers and their political supporters are, clearly, trying their luck demanding so many exemptions. Kobe and Wagyu beef notwithstanding, none of the products for which Japan is seeking protection has the iconic cultural status of rice, which is tightly bound to Japan’s sense of nationhood. Each year the Emperor conducts special public rituals of sowing, planting, harvesting and giving thanks for rice, while the ceremonies for enthroning a new Emperor include private rites in which he eats specially cultivated sacred rice in an act of communion with his ancestor, the Sun Goddess Amaterasu-ōmikami.

So here is a modest proposal. Each country gets a free pass to protect or subsidize one thing, regardless of fairness or logic. If the French want to give their money to cineastes in the form of subsidies rather than fork out 10 Euros to go see their films, fine. If Mrs. Watanabe wants to buy Japanese rice at a price some 700 percent higher than what she would pay for Thai or American rice, let her. It may not, strictly speaking, be fair to American rice farmers, but it is no more unfair than the subsidies those same farmers get from the U.S. Government (see my recent post on the farm bill), which apparently are legal under current international trade rules. The same rule, of course, would mean that the U.S. would have to choose just one thing to protect or unfairly subsidize. Arkansas rice or cotton growers? Florida sugarcane growers? New England dairy farmers? Archer Daniels Midland? Solar panel manufacturers? And once the choice is made, it’s made. No switching around based on election-year vote counting, depending on who is doing the counting.

On second thought, this is far too reasonable a proposition. It’ll never fly.

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With the debates over, the presidential candidates on their last, gasping try to grasp those elusive Electoral College votes in Iowa, Colorado, Nevada, Virginia, Wisconsin, New Hampshire, or Ohio needed to put them over the top, and the polls to open in less than 48 hours, it is a bit late to be offering strategic advice to Barack Obama – advice that by all indications he would have ignored – but he could have done much worse than to cloak himself in Adam Smith’s mantle. Yes, the same Adam Smith whose profile adorns the neckties of more than a few Wall Street bankers and right wing think-tankers.

The thing is, the Adam Smith Mitt Romney and Paul Ryan and their followers claim to revere bears scant resemblance to the real Adam Smith, friend of Enlightenment philosopher David Hume and author not only of An Inquiry Into the Nature and Causes of the Wealth of Nations but also of The Theory of Moral Sentiments, which predated The Wealth of Nations by more than 15 years. “I think Adam Smith was right,” said Romney in a January debate, “and I’m going to stand and defend capitalism across this country, throughout the campaign.” In a subsequent speech at the University of Chicago, Romney proclaimed, “When the dead hand of government replaces the invisible hand of the market, economic freedom is the inevitable victim.”

Paul Ryan, better known for his enthusiasm for Ayn Rand, has also paid homage to Smith. In the introduction to his Roadmap for America’s Future: A Plan to Solve America’s Long Term Fiscal and Economic Crisis, he writes: “The Founders…understood the importance and value of free enterprise. In addition to the Declaration of Independence, the year 1776 saw the publication of Adam Smith’s treatise The Wealth of Nations, which argued in part that the ‘system of natural liberty,’ or free markets in commerce, would vastly increase national wealth.” This, at least, is empirically true, and no less than Karl Marx recognized it as such. But just as the Devil can quote scripture, so has the extreme right wing of the Republican Party (one can legitimately ask whether, today, any other wing even exists) appropriated Adam Smith as its own, by quoting his works selectively and out of context.

Adam Smith, it must be remembered, was not merely an economist but a moral philosopher, concerned not simply with economic efficiency but with social justice. As such, he wrote at length and with great eloquence about the obligations that bind us together as a society, and also about the need for free markets to be regulated. He was also a radical, mistrustful of inherited wealth and position and scathing as to the inflated self-regard of the wealthy.

Hedge-fund manager Leon Cooperman, in an open letter he sent to President Obama in late 2011, wrote of himself and his fellow billionaires, “As a group we employ many millions of taxpaying people, pay their salaries, provide them with healthcare coverage, start new companies, found new industries, create new products, fill store shelves at Christmas, and keep the wheels of commerce and progress (and indeed of government, by generating the income whose taxation funds it) moving. To frame the debate as one of rich-and-entitled versus poor-and-dispossessed is to both miss the point and further inflame an already incendiary environment.” One suspects Mr. Cooperman would have received scant sympathy from Adam Smith, who writes, in The Theory of Moral Sentiments, “This disposition to admire, and almost to worship, the rich and the powerful, and to despise, or, at least, to neglect persons of poor and meand condition…is…the great and most universal cause of the corruption of our moral sentiments…. It is scarce agreeable to good morals, and even to good language, perhaps, to say, that mere wealth and greatness, abstracted from merit and virtue, deserve our respect.”

We can’t know what Adam Smith would have thought of any specific social welfare programs such as Medicaid or unemployment benefits any more than we can know which baseball team God roots for (though I’m pretty sure it’s the Red Sox). But Smith was no advocate of abandoning the less fortunate to their fate. As he wrote in Book 1 of The Wealth of Nations, “Servants, labourers and workmen of different kinds, make up the far greater part of every great political society. But what improves the circumstances of the greater part can never be regarded as an inconveniency to the whole. No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. It is but equity, besides, that they who feed, cloath and lodge the whole body of the people, should have such a share of the produce of their own labour as to be themselves tolerably well fed, cloathed and lodged.”

Mitt Romney, who by all accounts gives 15% of his income to the Mormon Church and devotes a substantial amount of his time to helping co-religionists who have fallen on hard times, may think private charity from church and community is an adequate social safety net, but Adam Smith would almost certainly disagree. As he wrote in The Theory of Moral Sentiments, “The wise and virtuous man is at all times willing that his own private interest should be sacrificed to the public interest of his own particular order or society. He is at all times willing, too, that the interest of this order or society should be sacrificed to the greater interest of the state or sovereignty, of which it is only a subordinate part. He should, therefore, be equally willing that all those inferior interests should be sacrificed to the greater interest of the universe, to the interest of that great society of all sensible and intelligent beings, of which God himself is the immediate administrator and director.”

Smith did not get into the specificities of tax policy, but he would probably take a dim view of subjecting the working class to higher tax rates than the 0.1 percent. Indeed, he supported progressive taxation: “The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state.”

Obama’s midsummer “You didn’t build that” comment gave Republicans the opportunity for endless riffs on the theme of self-reliant entrepreneurs building their companies and their fortunes from scratch, ignoring Obama’s point, which was true, if inelegantly expressed. Adam Smith put it better: “That the erection and maintenance of the publick works which facilitate the commerce of any country, such as good roads, bridges, navigable canals, harbours &c. must require very different degrees of expence in the different periods of society, is evident without any proof. The expence of making and maintaining the publick roads of any country must evidently increase with the annual produce of the land and labour of that country, or with the quantity and weight of the goods which it becomes necessary to fetch and carry upon those roads.” He also had no problem asking the wealthy to pay a little more: “When the toll upon carriages of luxury, upon coaches, post–chaises, &c. is made somewhat higher in proportion to their weight, than upon carriages of necessary use, such as carts, waggons, &c. the indolence and vanity of the rich is made to contribute in a very easy manner to the relief of the poor, by rendering cheaper the transportation of heavy goods to all the different parts of the country.”

Smith supported what today we would call public-private partnerships, harnessing private capital and initiative to provide a public good such as a toll road, but he was clear on the need for such partnerships to be closely regulated to make sure the operators maintained the facilities rather than simply pocketing the proceeds. And when user fees and tolls are not sufficient to build and maintain essential infrastructure, Smith advocated a more active role for government: “When the institutions or publick works which are beneficial to the whole society, either cannot be maintained altogether, or are not maintained altogether by the contribution of such particular members of the society as are most immediately benefited by them, the deficiency must in most cases be made up by the general contribution of the whole society. The general revenue of the society, over and above defraying the expence of defending the society, and of supporting the dignity of the chief magistrate, must make up for the deficiency of many particular branches of revenue.”

Adam Smith probably would not have approved of the Dodd-Frank law regulating financial institutions, not because it represents an intolerable intrusion on free markets but because it failed to fix the principal causes of the 2008 financial crisis, leaving banks that are too big to fail, thus doing nothing to prevent future government bail-outs for losses on risky and speculative investments and trades. Smith did, however, see financial regulation as no less important than building codes:   “Such regulations may, no doubt, be considered as in some respect a violation of natural liberty. But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments; of the most free, as well as or the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty, exactly of the same kind with the regulations of the banking trade which are here proposed.”

Adam Smith probably would not be an enthusiastic supporter of President Obama. Not because Obama is a socialist, but because his signature initiatives, including Obamacare and Dodd-Frank, are weighed down with opaque language and impenetrable regulations virtually guaranteed to create uncertainty in big swathes of our economy, fail to achieve much of what they were intended to achieve, and incur costs we can’t even calculate.  Smith probably would have disapproved of direct government investments in companies like Solyndra, the solar panel manufacturer that famously evaporated along with half a billion dollars in public funds, though he almost certainly would approve of public investments in basic science. He would be likely to disapprove of mandatory corporate average fuel economy standards for cars – and subsidies for electric vehicles – instead opting for a more market-based and neutral approach such as a carbon tax, which would eliminate the need for energy subsidies of all kinds, including tax breaks for oil companies and direct subsidies and mandates for corn-based ethanol, and which would also an effective way to reduce greenhouse gas emissions. He would probably favor a much more liberal immigration policy (he wrote at some length about the need for labor mobility) to replace the idiocy of our current policies that every year send home tens of thousands of recently graduated foreign students instead of inviting them to stay here and help grow our economy.

Obama, it is true, seems to be more comfortable with some aspects of crony capitalism than with unbridled free markets, but then so does Romney. On almost every other dimension, however, Adam Smith would find Barack Obama at least slightly more supportive of his ideas than Mitt Romney and Paul Ryan, who apparently see in Adam Smith a proto-social Darwinist. I too find that Barack Obama more closely reflects Adam Smith’s view of governance than does Mitt Romney. And as an enthusiastic adherent of Adam Smith, on Tuesday I will vote to re-elect Barack Obama.

 

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In these dark days of an ever-widening political divide, it is nice to know there is still something on which Republicans and Democrats can agree: foreign aid. Both sides are against it. John Sides, writing in his “The Monkey Cage”  blog, cites a YouGov poll conducted in early March of this year, in which a sample of Republican primary voters and a sample of all voters agreed that foreign aid is the budget item they would most like to cut. Okay, it was 90% of the Republicans and only 73% of all voters, but in the sample of all voters no other item came even close to 50%, while among Republicans, the environment, housing, and unemployment benefits – no surprise there – were the only other items that got more than a 50% share.

 

 

 

 

 

 

These numbers are unsurprising in light of another poll  conducted last November, in which respondents, asked “Just based on what you know, please tell me your hunch about what percentage of the federal budget goesto foreign aid,” gave an average response of 27%. When asked what they thought an appropriate percentage would be, the mean answer was 13%. When told that we spend much, much less than this on foreign aid, most people said it still should be cut.

Not that cutting foreign aid would have the slightest effect on the deficit. In an excellent analysis of the cuts the Romney-Ryan budget – which would cap Federal spending at 20% of GDP and maintain defense spending at 4% of GDP – would require, Richard Kogan and Paul Ven de Water of the Center on Budget and Policy Priorities demonstrate that “if policymakers repealed [Obamacare] and exempted Social Security from cuts, as Romney has suggested, and cut Medicare, Medicaid, and all other entitlement and discretionary programs by the same percentage to meet Romney’s overall spending cap and defense spending target, then they would have to cut nondefense programs other than Social Security by 22 percent in 2016 and 34 percent in 2022 If they exempted Medicare from cuts for this period, the cuts in other programs would have to be even more dramatic — 32 percent in 2016 and 53 percent in 2022.”

It’s not easy to make sense of the Federal budget for foreign assistance (try it yourself and see what numbers you come up with http://www.state.gov/documents/organization/183755.pdf ) but 2012 commitments amount to about $35 billion, less than one percent of the total budget of $3.8 trillion, and barely a third of that amount consists of the kind of humanitarian, public health, and economic development assistance most people think of when they think of foreign aid. The big-ticket items include:

  • Roughly $10.4 billion in foreign military and security assistance – things like fighting terrorism abroad, military training, underwriting foreign arms purchases, the war on drugs, and the annual payments of $3 billion to Israel and $1.3 billion to Egypt (the price we continue to pay for the Camp David accords);
  • $8.1 billion on global health and child survival programs;
  • The $5.8 billion Economic Support Fund, which gives direct grants to foreign governments for them to spend on infrastructure and development projects (thus freeing up funds to buy U.S. arms); and,
  • About $4.1 billion on economic and agricultural development.

Except for Ron Paul supporters, most Republicans and not a few Democrats would resist cutting foreign military assistance and our annual subsidy to Israel. Indeed, to judge by his recent pronouncements on the subject, Mitt Romney would be more than happy to increase support to Israel, though it might come out of Egypt’s share.

A Romney-Ryan budget would probably keep all or most of the $10.4 billion for security-related foreign assistance and the $5.8 billion Economic Support Fund (at least those portions most directly linked to arms procurement) and take an axe to the aggregate $12.2 billion health, child survival, and economic and agricultural development budgets, which in the context of the overall budget are hardly more than a rounding error.

Dana Millbank, writing in The Washington Post, tells us that Rep. Darrell Issa, Republican chairman of the House Oversight and Government Reform Committee, called a hearing earlier this week to probe the security lapses that led to the recent deaths of Ambassador Christopher Stevens and three other Americans in Benghazi, Libya.

“The purpose of the pre-election hearing, presumably, is to embarrass the administration for inadequate diplomatic security. But Issa seems unaware of the irony that diplomatic security is inadequate partly because of budget cuts forced by his fellow Republicans in Congress…House Republicans cut the [Obama] administration’s request for embassy security funding by $128 million in fiscal 2011 and $331 million in fiscal 2012. Ryan, Issa and other House Republicans voted for an amendment in 2009 to cut $1.2 billion from State operations, including funds for 300 more diplomatic security positions. Under Ryan’s budget, non-defense discretionary spending, which includes State Department funding, would be slashed nearly 20 percent in 2014, which would translate to more than $400 million in additional cuts to embassy security.”

Romney has criticized the Obama Administration for trying to “lead from behind” in situations like Libya and Syria, and says he wants the United States to lead from the front, “using the full spectrum of our soft power to encourage liberty and opportunity for those who have for too long known only corruption and oppression,” in the words of his September 30 op-ed piece in The Wall Street Journal. What is soft power, if not effective diplomacy and assistance in – to use Mr. Romney’s own words again – “promoting human rights, free markets and the rule of law?” Much of the development assistance provided by he U.S. Government and U.S. Government-supported institutions such as the World Bank promotes precisely these values.

Cutting foreign assistance and State Department budgets sends a very different message. Since the proposed diplomacy and foreign aid budget cuts are so insignificant in fiscal terms they must have been chosen for their symbolic value, effectively consigning emerging and transition countries to the international equivalent of Mr. Romney’s famous 47 percent: food stamp and welfare recipients and miscellaneous moochers he is not going to worry about.

There are certainly ways to improve foreign assistance, which could involve reducing or eliminating aid to some current beneficiary countries, but which would equally involve innovative new approaches to the problems of poverty, disease, climate, and growth, which could end up costing less, more, or about the same amount as we currently spend.

Lord Leverhulme, the founder of Lever Brothers – now Unilever –  is reputed to have said, “I know half my advertising isn’t working, I just don’t know which half.” Foreign aid is a bit like that. As much as half, but not all, of it is wasted, and if we could figure out which half to chuck out and which to keep we, together with the recipients, would be all the better for it. But just as Lever Brothers kept on advertising and, presumably, wasting half of what it spent, eliminating the foreign aid budget or cutting it in half is a lousy idea.

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It must come as some reassurance to Mitt Romney that he is not the only would-be President who says remarkably silly things while visiting foreign lands. Last month Hillary Clinton, on a tour of sub-Saharan Africa, delivered a speech in Senegal in which she said that the United States would stand up for democracy and universal human rights “even when it might be easier or more profitable to look the other way, to keep the resources flowing.” In a barely veiled dig at China, she added, “Not every partner makes that choice, but we do and we will.”

China is widely seen as engaging in an aggressive grab for Africa’s energy and mineral wealth in ways many African leaders find irresistible. Unlike the United States and multilateral institutions such as the World Bank, in which the U.S. has a dominant position, the Chinese offer money and technical assistance without attaching bothersome conditions on human rights, democracy, and free markets. [click to continue…]

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