SavingCapitalismfrom RobertReich · saving Capitalism: For the Many, not the Few by Robert b. Reich 279 pp.; alfred a. Knopf, 2015. Summer 2016 /Regulation /49 work. He comments,

48 / Regulation / Summer 2016

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Saving Capitalism fromRobert Reich✒ Review by DaviD R. HenDeRson

Robert reich, a former u.S. secretary of labor under PresidentBill Clinton and now a professor of public policy at the univer-sity of California, Berkeley’s Goldman School of Public Policy,

has written a book whose title suggests that he wants to save capital-ism. Well, not quite.

Dav iD R . HenDeR son is a research fellow with theHoover institution and professor of economics in theGraduate school of business and Public Policy at the navalPostgraduate school in Monterey, Calif. He is the editor ofThe Concise Encyclopedia of Economics (Liberty Fund, 2008).

The good news is that Saving Capitalismis nothing like Locked in the Cabinet, hisearlier memoir about being labor secretary,in which he literally made up stories thatmade himself look good, as reported byJonathan rauch in his Slate review, “robertreich, Quote Doctor,” (may 30, 1997). Inthe new book, reich starts by making animportant—probably correct—point and,to his credit, documents virtually all ofhis empirical assertions with checkablecitations. But some of his most impor-tant empirical claims are wrong, he has apeculiar sense of what is a large amountof wealth and what is a small amount, andone of his claims shows a basic misunder-standing of wealth accumulation.

Government and free markets / reichstarts by decrying the way so many argu-ments about government economic policyquickly degenerate into whether the freemarket “is better at doing something thangovernment.” In his view, that makes nosense because, he argues, “There can beno ‘free market’ without government.”The free market, he writes, “does notexist in the wilds beyond the reach ofcivilization.” That’s true. But accordingto reich, civilization is created by gov-ernment because government “generatesthe rules.” Yet there were many historicalinstances in which civilized rules were gen-erated without government. economist

edward P. Stringham has written aboutsome of these cases in his recent book, Pri-vate Governance: Creating Order in Economicand Social Life. And, of course, centuriesago there was the Lex Mercatoria, the mer-chant Law, which businesses created andenforced in europe, completely separatefrom any government.

But maybe we shouldn’tthrow out reich’s baby withthe bath water. He arguescorrectly, for example, thatcopyright law, patent law, andbankruptcy law are govern-ment creations and that theycould be set up differently. Hepoints out that much wealthin the u.S. economy consistsof intellectual property. With-out patent and copyright law,that property would be worthmuch less. For instance, in1998, Congress passed theCopyright Term extensionAct, giving corporations acopyright for 95 years afterthe date of creation. For obvi-ous reasons, wags at the timecalled it the mickey mouse extension Act.One cannot argue that this extension wasneeded to give people an incentive to pro-duce what had already been produced.

Whatever the optimal length of a copy-right is, I’m fairly confident that it is wellbelow 95 years. But the bigger-picturepoint is that reich is right that these rules,which many free-market economists likeme favor, are government-made. For that

reason, in fact, some free-market econo-mists go so far as to oppose patent andcopyright as unjustified government-cre-ated monopolies, and they make a strongercase for that policy than you might think.

Some serious problems / unfortunately,this is the high point of the book. The restof it reads like one of the standard booksthat “progressives” write advocating heavygovernment regulation of human affairs.And reich’s case is about as unpersuasiveas the cases made by others for those sameor similar interventions. It’s impossible,in a short review, to cover all of his argu-ments for all of his regulations, so I willsingle out five of the most important.

One of his biggest objections is to the2010 u.S. Supreme Court decision inCitizens United v. Federal Election Commis-sion. Citizens united is an incorporatednonprofit political group that released a

movie criticizing Hillary Clin-ton when she was runningfor the Democratic presi-dential nomination in 2008.That violated the mcCain-Feingold Act of 2002, whichforbade such actions for theperiod just before an election.The Supreme Court foundfor Citizens united. One ofthe majority’s arguments wasthat just as media corpora-tions such as the New YorkTimes are free to advocate theelection or defeat of a federalcandidate, other corpora-tions should have this samefreedom.

reich does not deal withthat argument. Instead, he

writes, “As a practical matter, freedom ofspeech is the freedom to be heard, andmost citizens’ freedom to be heard isreduced when those who have the deepestpockets get the loudest voice.” Actually,freedom of speech is not the freedom tobe heard; it’s—as the term implies—thefreedom to speak. There is no guarantee,nor should there be, that you will be heard.moreover, the New York Times is heard, or

saving Capitalism: Forthe Many, not the Few

by Robert b. Reich

279 pp.; alfred a.Knopf, 2015

Summer 2016 / Regulation / 49

work. He comments, “In effect, the newwork requirements have merely reducedthe number of poor people who are job-less, while increasing the number of poorpeople who have jobs.” It’s unclear why hethinks it’s bad for poor people to get jobs.

In a paragraph about Bank of America’s$16.65 billion 2014 settlement with thefederal government over practices con-nected to the previous decade’s housingbust, he shows a peculiar sense of what abig number is. That settlement, he writes,“paled in comparison to the bank’s earn-ings.” And what were those earnings? In2013, he writes, they were $17 billion. So$16.65 billion pales in comparison with$17 billion? It’s 98% of $17 billion. If reich

were making $300,000 ayear and the governmentforced him to pay a fineof $294,000, would hethink the fine “paled incomparison” to his pre-tax income?

One of reich’s impor-tant empirical claims

about wealth betrays a misunderstandingof how wealth is accumulated. See if youcan spot it: referring to a 2013 poll ofAmericans with more than $3 million ofinvestable assets, reich writes:

Nearly three-quarters of those over age69 and a majority of boomers just belowthem are the first in their generationto accumulate significant wealth. Forthe rich under the age of 35, however,inherited wealth is more common.

Of course, it’s more common. Accumulat-ing wealth takes time. So, naturally, theones who have great wealth at age 35 arenecessarily more likely to have inheritedit. I’m a good example. When I was 35 andmy wife was 36, our combined net worth,including all our IrAs, was about $20,000.If I continue working full-time until age69, our investable assets should be about$1.5 million. That’s what a 30-plus yearstretch of saving and investing does.

Conclusion / reich says that he wants tosave capitalism for the many. He may genu-

read, more than I am. Without the NewYork Times around, my work might be reada little more. reich’s reasoning, taken allthe way, would argue for prohibition orat least regulation of the New York Times.

In his discussion of antitrust laws,reich contradicts himself in the space of apage. He criticizes—correctly, in my view—Amazon’s successful urging of PresidentObama’s Justice Department “to sue fivemajor publishers and Apple for illegallycolluding to raise the price of e-books.”Just two paragraphs later, he complainsthat “the new monopolists have enoughinfluence to keep antitrust at bay.” But hisown example shows that Amazon did notkeep antitrust at bay, but used antitrustto go after competitors. So, apparentlyfor reich, antitrust is good except whenit’s not.

At places in the book, he makes onewonder if he understands the importanceof incentives. Consider his discussion ofstudent loans. Former students are “ladenwith student debt,” he writes. He men-tions that in 2014, student loans were awhopping “10 percent of all debt in theunited States.” He then writes, “But thebankruptcy code does not allow studentloan debts to be worked out under its pro-tection.” The “but” makes no sense. It’sprecisely the fact that student loans cannotbe discharged in bankruptcy that giveslenders an incentive to make such loans,causing the loans to be such a big percentof all debt.

reich advocates letting students usebankruptcy to get out of loans that “weremade to attend schools whose studentshave low rates of employment after gradu-ating.” That would create a huge incentiveproblem: students would have even lessincentive than they do now to get intoschools and/or majors that give them agood shot at a job. On the other hand,maybe his proposal is not so bad. Lenderswould respond by charging huge interestrates for students in such situations, andmaybe students would get the market-induced hint.

reich has long advocated a high mini-mum wage, and in this book he calls for

raising it to half the median wage. Howdoes he handle many economists’ con-cern that a high minimum wage woulddestroy job opportunities for people withthe fewest skills? He cites work by econo-mists who have found little negative effectof minimum wage increases to levels wellbelow that which he advocates. Interest-ingly, California Gov. Jerry Brown recentlysigned a law that will raise the minimumwage to about 69 percent of the medianby 2022, considerably above what reichadvocates. It will be interesting to see ifreich opposes such a move.

In response to a claim that many poorAmericans do not work hard, he claimsthat, au contraire, they do. He writes, “The

reality is that America’s poor work dili-gently, often more than 40 hours a week,sometimes in two or more jobs.” But theu.S. Bureau of Labor Statistics study hecites to back that claim is not of the poor,but of the “working poor.” It’s not surpris-ing that the working poor work, but thatsays little about the work habits of poorpeople in general.

The data on how much poor peoplework are not hard to find. According tothe u.S. Census Bureau, in 2013, 61.5 per-cent of households in the bottom fifth ofthe income distribution (and that wouldinclude all poor households because theyare about 70 percent of the bottom fifth)had no one working at any time duringthe year, even at a part-time job. Only 13.4percent of households in the bottom fifthhad someone working a full-time job formore than 27 weeks.

reich does give some news that mostAmericans would welcome, though hedoes not: in order to get certain kindsof government aid—in particular, theearned Income Tax Credit—one must

reich says that he wants to save capi-talism for the many, and he may believethat. But to save capitalism we need toeschew most of what he proposes.

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inely believe that. But he has two problems.First, he rarely if ever notes the regula-

tions that keep the fruits of capitalismfrom the many. Consider housing. He tellshow his modest-income parents were ableto buy a house in the 1950s. Left unsaidbut implicit is that it’s much harder now,especially—as he well knows—in coastalCalifornia. But why? Could it have some-thing to do with restrictions on buildinghouses? Harvard’s edward Glaeser andWharton’s Joseph Gyourko have shown

that a huge part of the premium for housesin high-priced areas is due to restrictionson building (“Zoning’s Steep Price,” Fall2002). But reich says not a word aboutsuch restrictions.

Second, the various regulations that headvocates would make economic growtheven more tepid than it is now, makingit even harder for the many to rise. We doneed to save capitalism for the many, notjust the few. And to do that, we need toeschew most of what reich proposes.

sa M batK ins is director of regulatory policy at theamerican action Forum.

The Intersection of Fiscaland Regulatory Policy✒ Review by saM batKins

Paying taxes is a sufficient annoyance for most people. The time,effort, countless forms, and accounting expenditures resultingfrom the federal tax code are just a few of the many factors why

scholars have sought fundamental reform of the system. It isn’t justthe $2.5 trillion or so in taxes taken from corporations and individualsevery year, it’s the $215 billion to $987billion in various hidden costs that makesfederal tax policy anti-growth, anti-mar-riage, and—perhaps most pervasively—pro-special interest.

In The Hidden Cost of Federal Tax Policy,Jason Fichtner and Jacob Feldman surveythe chief culprits behind flawed tax policyand offer key principles for successfulreform. Although not entirely focused onthe world of regulation, the ancillary com-ponents of current policy help to generatethe 200 forms and 2.6 billion work hoursassociated with the individual income taxand the 235 forms and 2.8 billion workhours for the business income tax. Fun-damental tax reform could save the nationbillions of hours of paperwork and tensof billions of dollars in monetary savings.Broken tax policy is more than just a con-versation about what is taken from a pay-check; it concerns what is taken from aneconomy.

Estimating hidden costs / unsurprisingly,there are varying estimates for the benefitsfrom reforming different componentsof federal tax policy. The authors high-light how one component,accounting costs, is drivenlargely by the more than 4,000changes to the code from2001 and 2010, including 579in 2010. This accounting slateis responsible for between $67billion and $378 billion inannual burdens. For what it’sworth, the Internal revenueService estimates the indi-vidual income tax costs $33.6billion for Americans to navi-gate annually. Astonishingly,there is no estimate for themonetary burdens imposedby the business income tax,even though it generates morepaperwork and more forms.

Thesecondhiddencost liesin the infamous “Tax Gap.”

This is the difference between the revenuethe IrS is permitted to collect by law andwhat it actually collects. The authors notethe Tax Gap is roughly $450 billion—thatis, clever (or deceptive) accounting resultsin nearly a half-trillion-dollar underpay-ment. Why should the average taxpayercare about the IrS’s Tax Gap? For one,it creates a social cost of inequitable taxburdens among some taxpayers; those withmore creative accountants and lobbyiststend to help create the gap.

Finally, there are the economic costs ofa broken tax system. Again, estimates herevary wildly, between $148 billion and $609billion. As former Supreme Court ChiefJustice John marshall noted some 200years ago, “The power to tax is the power todestroy.” Taxes simply increase the cost ofdoing business, from buying materials topaying for labor. The wide range for theseeconomic costs derives from the studies overthe years trying to find an appropriate fig-ure. On the low-end, Sören Blomquist andLaurent Simula estimated in a 2010 paperthe deadweight loss of tax compliance at$148 billion, after accounting for income,payroll, and state income taxes. At the otherend,martinFeldsteinestimated$609 billionin deadweight losses with the payroll tax and$388 billion without.

Breaking the code / Theauthors spend nearly asmuch time in the book sur-veying the reasons the taxcode is mindlessly brokenas they do offering solu-tions for rational reform. Tono one’s surprise, lobbyingplays a heavy role in creat-ing tax credits, exemptions,and deductions that Ameri-cans end up subsidizing. Asthe saying goes, “If there isfood at the picnic, ants willfollow.” Given the size andscope of government, there isalways plenty of food.

Fichtner and Feldmannote that research revealsintense lobbying is often

the Hidden Cost ofFederal tax Policy

by Jason Fichtnerand Jacob Feldman

262 pp.; MercatusCenter at GeorgeMason University, 2015

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effective. They write, “Businesses thatincreased lobbying expenditures by 1percent reduced their effective tax ratesby 0.5 to 1.6 percentage points the fol-lowing year.” Diffuse costs, concentratedbenefits—if only we could all be so well-connected.

This lobbying extravaganza is oftenled by the plethora of lawyers in Washing-ton, D.C. The authors somewhat gleefullyremind the reader that there is a strongnegative international correlation betweenthe number of law students and economicgrowth. Conversely, nations with a highconcentration of engineering studentstend to have robust economic growth.regardless, we can all agree that focusingthe nation’s attention on producing taxcarve-outs, rather than actual production,will do no favors for economic growth.

Who doesn’t take tax breaks / Part of theproblem with a government of our size isthat it intrudes into virtually every area oflife: subsidizing the purchase of a home($69 billion) and health care ($185 bil-lion), to name just two. Through the years,everyone has become dependent on, ortaken advantage of, favorable tax treat-ment created by the code.

The mortgage interest deduction (mID)is singled-out for special treatment, andrightfully so. If you live near a coast or ina major city, it is likely one of your largesttax breaks; if you don’t, you’re subsidizinglarge home purchases elsewhere. As theauthors note, less than one in 10 Ameri-cans earning less than $50,000 can claimthe mID. High-income earners net a taxbenefit that is nine times larger than tax fil-ers earning between $50,000 and $100,000.middle-income Americans can thank thereal estate industry for this inequity.

And yet, this deduction does little toadvance its intended function of promot-ing home ownership, which is a dubi-ous goal of government in its own right.Instead, the mID encourages more debtand borrowing. Despite the deduction, theunited States is nowhere near the top forhome ownership rates. That title belongsto Singapore at 87 percent, yet Singapore

has no mID. The united States clocks in at65 percent, slightly lower than the unitedKingdom, which also doesn’t have a mID.

Reform / There are a million differentproposals for reforming the federal taxcode, but Fichtner and Feldman spendjust a few words on broad reform prin-ciples: simplicity, equity, efficiency, andpermanency. In the utopian world wherefederal tax policy does undergo wholesalereform, expect ancillary regulatory ben-efits as well. Consider that a 50 percentreduction in the IrS’s paperwork burdenwould generate roughly 4.5 billion hours

in savings. even assuming a conservative$20 per hour rate for IrS compliance, thatwould equal $90 billion in annual savings.

Don’t hold your breath for that, unfortu-nately. Yet, anyone interested in learning thehistoryof thecurrent taxcodeandsurveyingits failures would do well to review the workof Fichtner and Feldman.

Readings

■ “marginal Deadweight Loss when the IncomeTax Is Nonlinear,” by Sören Blomquist and LaurentSimula. uppsala university (Sweden), 2012.

■ “Tax Avoidance and the Deadweight Loss of theIncome Tax,” by martin Feldstein. Review of Economicsand Statistics, Vol. 81, No. 4 (1999).

Progressivism’s Tainted Label✒ Review by PieRRe LeMieUx

During a Democratic Party presidential debate this past Febru-ary, Hillary Clinton and Bernie Sanders sparred over who wasthe most “progressive.” The label has a connotation of social

reform. Liberals (in the American, as opposed to the classical, sense)and socialists are viewed as progressive. For many people, the term isnearly synonymous with “good.” Yet, ifyou know the history of the progressivemovement, it will seem strange that somewould try to reclaim such a tainted label.

What, really, was progressivism at thetime of its zenith in America? ThomasLeonard’s book Illiberal Reformers castsa scholarly but uncompromising eye onwhat was called the Progressive era, whichhe conceives as stretching from the mid-1870s to the united States’ entry into theGreat War in 1917. In doing this, he com-bines the Gilded Age of the last quarter ofthe 19th century with what is more com-monly considered the Progressive era,starting about 1890.

The progressives wrote in the NewRepublic and in many scholarly journals oftheir times. Their academic centers wereColumbia, Johns Hopkins, Wisconsin, andPennsylvania, as well as the Institute for

Government research, which became theBrookings Institution. many progressiveswere activists in associations such as theAmerican Association for Labor Legisla-tion (AALL).

According to Leonard, an economistand research scholar at Princeton uni-versity’s Council of the Humanities, allprogressives shared a “recognizable andhistorically specific set of intellectualunderstandings.” First, they opposed indi-vidualism and classical liberalism. Second,they wanted to replace the waste of capi-talism with the efficiency of experts andsocial engineers—the “fourth branch ofgovernment” or “administrative state”—working for the common good. Third, theyopposed what they saw as monopolies.

Eugenics / The most glaring example ofthe progressives’ illiberalism was eugenics.A signature idea of the Progressive era,eugenics, Leonard reminds us, “describesthe movement to improve heredity by the

PieRRe LeMieUx is an economist affiliated with theDepartment of Management sciences of the Université duQuébec en outaouais. His latest book is Who Needs Jobs? Spread-ing Poverty or Increasing Welfare (Palgrave Macmillan, 2014).

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social control of human breeding”:

racial health was too important to beleft unregulated. The individual’s libertyto make her reproductive, marital,labor, and locational choices free fromstate interference ended precisely whereher choices were seen to endanger thehealth of the race.

The “health of the race” was subject toexternalities (in today’s eco-nomic parlance) that justi-fied widespread governmentintervention.

eugenics was (mistak-enly) inspired by Darwin’sevolutionary theory, but witha twist: evolution could bebettered by state interven-tion. The nation, often iden-tified with the race, could beimproved if the state encour-aged the breeding of the fittestindividuals and discouragedthe breeding of individualswith bad heredity. The pro-gressives wanted “social selec-tion” to replace and improvenatural selection.

most progressives appar-ently shared biologist Jean-Baptiste Lamarck’s belief that acquiredtraits such as virtues and vices were geneti-cally transmitted. eugenics called for lift-ing the poor out of poverty by improvingtheir offspring. It also meant fighting “racepoisons” like alcohol, tobacco, meat, andpromiscuity. Progressive economist IrvingFisher viewed public health and eugenicsas a joint campaign. Lester Frank Ward,an early progressive who became the firstpresident of the American SociologicalAssociation, provided a prudential argu-ment: until science has conclusively ruledout the environmental determinants ofheredity à la Lamarck, he argued, it is pru-dent to “hug the delusion.” In case of sci-entific doubt, the state must intervene forthe good side.

If the poor and socially defective couldnot be uplifted, their breeding had to becontrolled. Political journalist Herbert

Croly, co-founder of the New republic,believed that the state had a responsibilityto “interfere on behalf of the really fittest”and improve human nature by improving“the methods whereby men and women arebred.” richard T. ely, a famous progressiveeconomist and main founder of the Ameri-can economic Association (AeA), opinedthat “there are certain human beings whoare absolutely unfit, and should be pre-

vented from a continuationof their kind.”

These were not piouswishes. Compulsory steriliza-tion was practiced in 30 states,starting with Indiana in 1907.Before he became presidentin 1913, New Jersey governorWoodrow Wilson signed hisstate’s forcible sterilizationlaw in 1911, targeting “thehopelessly defective and crimi-nal classes.” Some 30,000 per-sons were sterilized between1920 and 1939. Compulsorysterilization was approved bythe u.S. Supreme Court inan infamous 1927 decision,where the majority, includ-ing progressive justice LouisBrandeis, declared that “the

principle that sustains compulsory vaccina-tion is broad enough to cover cutting theFallopian.”

Like today’s public health movement(see “The Dangers of ‘Public Health,’” Fall2015), eugenics was both a scientific andsocial movement. most well-known scien-tists and intellectuals in the Progressiveera were eugenicists. everybody fashion-able was in favor, including conservativesand socialists. Leonard notes that FrankA. Fetter, “sometimes regarded as part ofthe Austrian tradition in economics,” alsoadhered to eugenics.

Debauch of competition / Progressive ideaswere radically opposed to classical liberal-ism. Like today’s liberals, the progressiveswere not extreme state socialists, but theylooked with great suspicion on any mar-ket that was not tightly regulated. They

enlisted in a crusade “to dismantle laissez-faire and remake American economic lifethrough the agency of an administrativestate,” Leonard writes. They saw free mar-kets as neither efficient nor moral. eco-nomic freedom was not adapted to therequirements of the new, large-scale, diver-sified business firms that depended onscientific management and planning. elybelieved that unregulated markets wereforcing “the level of economic life downto the moral standard of the worst men.”

Contrary to the populists, the progres-sives were not against business size per se; onthe contrary, they “regarded small businessas inefficient and outmoded.” The problemwas competition and the unregulated mar-ket. Large, efficient firms were necessary buthad to be coordinated by the state, progres-sives believed, and industry barons oftenagreed. As a Chicago asphalt industrialistlamented, progressivism must save human-ity from the “debauch of competition.”

For the progressives, efficiency couldonly be the product of government man-agement and economic planning. NewDealers such as economist rexford GuyTugwell were soon to buy these ideas. (See“Total regulation for the Greater Whole,”Fall 2014.)

Progressive economists opposed eco-nomic freedom. The founding core of theAeA was comprised of young economistswho had studied in Germany. They hadcome home imbued with the theses of theGerman Historical School whose teachingswere very different from classical econom-ics and from the developing neoclassicaland Austrian schools. According to Ger-man historicists, there was no place fora general economic theory; everythingdepended on historical and national cir-cumstances, and economists were at theservice of their national state.

German political thought exerted amajor influence on the progressives. JohnBurgess, a pioneering American politicalscientist and professor at Columbia uni-versity, had also studied in Germany. Hethought that Great Britain was Ameri-ca’s motherland and that Germany was“the motherland of our motherland.”

illiberal Reformers:Race, eugenics, andamerican economicsin the Progressive era

by thomas C. Leonard

264 pp.; PrincetonUniversity Press, 2016


Charles mcCarthy, a progressive Wiscon-sin bureaucrat, argued that his state, abeacon of progressivism, was a “Germanstate” because many Wisconsinites wereof Teutonic stock. Like many observersat the time, Frederic C. Howe, a formerstudent of ely, saw Germany as the mostadvanced scientific state in the world, justas Wisconsin was in America.

religious and temperance leaderswere at the forefront of social reform.Twenty-three of the 55 charter membersof the AeA were clergymen. The reformistspreached a “social gospel” where social sal-vation substituted for individual salvation.Sociologist edward Alsworth ross believedthat sin was social in cause. Fisher thoughtthat eugenics was “the foremost plan ofhuman redemption” and that Americans“must make of eugenics a religion.” Chris-tian economic reform, said social gospelerWalter rauschenbusch, was about “savingthe social organism.”

ultimately, Leonard observes, “thesocial gospel economists, like all progres-sives, turned to the state.” “God worksthrough the state,” claimed ely. “redemp-tion,” Leonard continues, “required morethan providing the poor with what theywanted but lacked; it required teaching thepoor what they should want.”

Anti-individualism / Progressivism wasbuilt on an anti-individualist philoso-phy. Society was the first reality in botha methodological and a political sense, aconcept that was defended by the then-developing field of sociology. Society is“an enlarged individual,” Croly wrote. elybelieved it was “strictly and literally true”that society is an organism. Ward, whomLeonard label “the intellectual spearheadof the progressive assault on laissez-faire,”imagined a “collective mind of society.”

Individuals were cells of the social organ-ism, and could have no rights against thewhole. For social gospeler WashingtonGladden, an AeA charter member, respectfor individual liberty was “a radical defectin the thinking of the average American.”Woodrow Wilson thought that governmentitself was “a living thing” and that the idea

of divided government was outdated.eugenics was an application of these

anti-individualist ideas. Scott Nearing, aradical economist, thought that “personswith transmissible defects have no right toparenthood, and a sane society in its effortsto maintain its race standards would abso-lutely forbid hereditary defectives to pro-create their kind.”

The progressives harbored a naive beliefin science and management. They calledfor disinterested experts—governmentbureaucrats or advisers—to replace cor-rupted politicians in running governmentand directing society. Sociologist CharlesHorton Cooley wanted a “comprehensiveand ‘scientific management’ of mankind.”Charles r. Van Hise, president of the uni-versity of Wisconsin, favored a “govern-ment of experts.”

The progressives trusted the state com-pletely. They did not share the classicaleconomists’ conscience of government fail-ure—even those economists, such as JohnStuart mill, who accepted wider govern-ment functions. Leonard notes that “laissez-faire’s standing derived less from worshipfulcelebrations of capitalism’s self-regulatingpowers than it did from prolonged contactwith government failure.” For the progres-sives, a powerful, centralized administrativestate was needed in place of decentralizedand divided government. The progressivesnominally believed in democracy, but couldnever reconcile this belief with their desireto have experts control people’s activitiesfor the public good.

One of the many telling quotes in IlliberalReformers comes from Grosvernor Clark-son, a member of the World War I–era WarIndustries Board. According to Clarkson,the war planning effort had converted 100million “comparatively individualistic peo-ple into a vast cooperative effort in whichthe good of the unit was sacrificed to thegood of the whole.” For him, this develop-ment of collectivism had almost made war“appear a blessing instead of a curse.”

Racism and immigration / racism—a spe-cial form of anti-individualism—was anessential component of eugenics and pro-

gressive thought. All colored races werejudged inferior. “Disenfranchising South-ern blacks,” Leonard observes, “was … atypical progressive reform.” The authorof Illiberal Reformers points out that onlywhite Anglo-Saxon men (including peo-ple of German stock, of course) escapedthe charge of hereditary inferiority. evenbackward Appalachian whites could beeducated and saved from degeneracy.French Canadians and the Irish did notquite make the cut. Progressive economistJohn r. Commons estimated that 14% ofAmericans were genetically inferior: the12% who were black plus the 2% who hadmental or physical defects. The “inferior”minorities could perhaps have taken sol-ace in the conclusions of intelligence testsrun on WWI draftees and published underthe auspices of the National Academy ofSciences and the Surgeon General: 54%were classified as “morons.”

Immigrants were considered to be espe-cially dangerous. The progressives fueledthe high wave of anti-immigration senti-ment that swept America beginning in thelate 19th century. Immigrants from Asiaand eastern and southern europe broughtdegenerate heredity that threatened theAmerican “germ plasm.” Frances Willard,leader of the Women’s Christian Temper-ance union, agitated for race-based immi-gration and against Catholic immigrants.

Immigrants competed with native laborand, claimed the progressives, pusheddown domestic wages. “Competition,”complained Commons, “has no respectfor superior races.” This claim, as Leonardexplains, was based on the “living-stan-dard” theory of wages, according to whichworkers accustomed to a low standard ofliving would draw down the wages of nor-mal workingmen. This theory of wagescontradicted the neoclassical theory ofmarginal productivity developed by JohnBates Clark in the late 1880s as part ofthe marginalist revolution in econom-ics. According to marginal-productivitytheory, labor, like any other factor of pro-duction, is paid the value of its marginalproductivity—that is, what the last laborer(in a certain category of labor) adds in


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value to the economy. In this perspective, immigrants were paid less because they typically were less productive laborers, but that didn’t push all wages down.

According to living-wage theory, immigrants only compounded the same downward effect that domestic defectives and unemployables had on wages. The so-called “unemployables” were typically workers whom the progressives though should not have jobs precisely because of their supposed effect on other workers’ wages. As university of Chicago sociologist Charles richmond Henderson explained, the unemployables were those who “bid low against competent and self-supporting men.” All these inferiors, immigrants and domestic unemployables bid down wages in a race to the bottom.

Supposedly, the “competent and self-supporting” workers’ reduced wages resulted in their fathering fewer chil-dren, increasing the degenerative effect of domestic and imported defectives. An uncontrolled labor market thus led to “race suicide.” In Leonard’s words, for the progressives, “hereditary inferiority threat-ened both the American workingman and American racial integrity.”

Minimum wage for exclusion / Hence, the labor market had to be controlled with minimum wages and other standards in order to keep immigrants and domestic defectives—as well as women—out of the workforce. “A minimum wage,” writes Leonard, “was the holy grail of American progressive reform.” Progressives under-stood that a minimum wage would cause unemployment, but that’s precisely why they wanted it: to keep the less produc-tive out of the market. royal meeker, a Columbia-trained economist and founder of the International Labor Organization, also supported the minimum wage; in his opinion, the state should both push the inefficients out of work and prevent the multiplication of their breed.

In the 1910s, progressives had mini-mum wage laws adopted in 15 states, starting in massachusetts in 1912, plus the District of Columbia and Puerto rico.

But like maximum-hour legislation, mini-mum wages applied only to women (and tomale public-works and railroad workers).The progressives viewed women as bothhelpless victims of capitalism and a threaton the labor market. By pushing them outof the market, a minimum wage killed twobirds with one stone.

Womenwereviewedasbothinferiorsand“mothers of the race”—one of many contra-dictions in the progressive ideology. Com-mons,moverofWisconsin’s1913minimumwage for women, argued that it protectedthe “welfare of the race and the nation.” Inprogressive thought, race, nation, hierarchy,and state power all fit together.

Following the herd / How could so manypeople be seduced by so many noxiousideas? One easy answer lies in the powerof fads, which does not spare the intel-lectual world. (See “Following the Herd,”Winter 2003–2004.) During the Progres-sive era, a rejection of classical liberal-ism colored the whole Western world.The progressives’ totalitarian ideas couldspread unchallenged.

eugenic thought was widespread andfashionable. In england, Sidney Webb,who together with his wife Beatrice werethe figureheads of Fabian socialism, wrotethat “no consistent eugenicist can be a‘Laisser Faire’ individualist,” for the rule ofthe game is “interfere, interfere, interfere!”A free-market economy, he believed, leadsto “wrong production, both of commodi-ties and of human beings.”

Prestigious authors agreed. VirginiaWoolf thought that imbeciles “shouldcertainly be killed.” T.S. eliot favoredsterilizing “defectives” to protect society.Leonard quotes a horrible reflection (andpremonition) of D.H. Lawrence:

If I had my way, I would build a lethalchamber as big as the Crystal Palace,with a military band playing softly, anda Cinematograph working brightly, andthen I’d go in back streets and mainstreets and bring them all in, all the sick,the halt, and the maimed; I would leadthem gently, and they would smile at me.

Were American intellectuals especiallyprone to fall victims to the new ideals? It’snot too hard to imagine young Americanstudents landing in Germany and fallingunder the spell of brilliant european cul-ture and German elitist authoritarianism.

Lessons for today / Illiberal Reformers is ascholarly and prudent book, but we canalso use it as a warning for today.

Politics often amplifies popular errorsinstead of dampening them. This may havebeen especially true with the developmentof federal power following the Civil War.The Constitution and the Bill of rightswere shaky protections against abusive gov-ernment, although we later saw in Germanyhow much worse it could be without thissort of imperfect constraint on the state.

Invoking the common good or publicwelfare against individual liberty is morean excuse than a justification. As Leon-ard points out, the vision of an anthropo-morphic social organism simplified “theproblem of determining what 75 millionpeople wanted.” It is significant that theprogressives could not agree on what wasthis common good, which they claimedto represent.

In reality, the common good or thepublic interest can only be defined in termsof “public goods” (goods or services thateverybody wants but that can’t be financedefficiently by the market), and even then itmust be defined restrictively. The progres-sives did not understand that the commongood is necessarily very abstract and unat-tainable through the administrative state.

The progressive conundrum overdemocracy and the administrative statewas also unsolvable. As public choice analy-sis has since shown, the interventioniststate is bound to be captured by inter-est groups or by its own bureaucrats. AsLeonard notes, Thorstein Veblen, anotherprogressive economist, “simply did notconsider the prospect that a Soviet of engi-neers might fail to be selfless servants ofthe public good.”

Still another lesson is that politi-cal majorities are always dangerous forminorities. In the Progressive era, the rul-


ing majority (at least the majority of vot-ers) was made of white, non-handicapped, Anglo-Saxon men. Our epoch also has its unpopular minorities, although they are better hidden and sometimes oppressed more humanely. under the administrative state we have inherited from the progres-sives, who will be the persecuted minorities of the future?

We must be suspicious of hastily embraced popular ideologies. They must be constantly challenged. many observa-tions contradicted the progressive ideol-ogy. Acquired traits are not transmissible: cutting off mice’s tails, as biologist August Weisman did in 1889 to test Lamark’s evo-lutionary theory, does not produce new generations of short-tailed mice. Defining and measuring race is a difficult task: the progressives tried unsuccessfully with head sizes and shapes. World War I revealed that the German state was not all that advanced after all. Fisher admitted that German economists had been prostitutes to their idealized state, but he then proceeded to propose a new grandiose agenda for the American administrative state.

In truth, the progressive ideology was rather laughable. Inferior groups were sup-posed to be simultaneously condemned to extinction for their deficiencies and yet dangerous to “superior” humans. An eng-lish sexologist, Havelock ellis, thought that women’s physical inferiority was caused by their having more water in their blood. ely used the collective “we” in an incantatory, not scientific, fashion: “We can have just such a kind of economic life as we wish.” Lit-erally viewing society as a biological organ-ism is nonsense. French classical liberal (and Academician) Émile Faguet mocked this organicist idea appropriately: “You think you were a man,” he wrote; “in fact, you are a foot” (Le Libéralisme, Paris, 1902).

We (at least, we economists) like to think that economists are better pre-pared than other students of society to see through sociological blather, pseudo-scientific concoctions, and political snake oil because economic thinking is con-strained by established, formalized theo-ries that are based on methodological

individualism and a prejudice in favorof individual preferences and choices. Ageneration after the Progressive era, thisconstraint proved beneficial: under Ital-ian fascism, for example, the economistsdid not take the bait like the statisticiansdid. (See Jean-Guy Prévost’s A Total Science:Statistics in Liberal and Fascist Italy, mcGill-Queen’s university Press, 2009.)

But this constraint was not helpful dur-ing the Progressive era, partly because of theinfluence of the German Historical School.

Progressive economists were unable to seesimple things, such as that competitionbetween employers bid up wages as muchas competition between workers bid themdown. With a few exceptions—like WilliamGraham Sumner, “the reform economists’bête noire,” or John Bates Clark—econo-mists during the Progressive era fell head-first for the new orthodoxy.

To reflect on the significance of the Pro-gressive era, Illiberal Reformers is a must-read.

Applying Coase✒ Review by tiMotHy J. bRennan

Despite the author’s Nobel economics Prize and its standingas the most cited law review article in history, ronald Coase’s“The Problem of Social Cost” still seems unappreciated. Its

core insight, that alleged externalities are at root the result of an inabil-ity to negotiate, fails to convince many readers who see environmental

t iMot H y J. bR enna n is professor of policy sciences andeconomics at the University of Maryland, baltimore Countyand a senior fellow at Resources for the Future

problems as the result of bad pollutersharming innocent bystanders, requir-ing public policy to ensure that the badguys are stopped. For this reason, the ideathat one could best balance the benefitsof reduced environmental harm withthe costs of those reductions by creatingproperty rights to facilitate subsequentnegotiations still does not get the recogni-tion it deserves.

Free Market Environmentalism for the NextGeneration, the latest version of Terry Ander-son and Donald Leal’s compendium FreeMarket Environmentalism, follows the pathopened by Coase. The book articulates thepotential for resolving environmental con-flicts through private solutions based uponnegotiations between the beneficiaries ofenvironmental protection and those whowould bear its costs. The net of applicationsis cast far and wide, including potential mar-kets for timber, grazing, water, and fishingrights.Thecontributingauthorsmakeaper-suasive case that environmentalists should

avoidthe“nirvanafallacy”andrecognizethatgovernment action is slow, cumbersome,and—perhaps most important—too rigid toreverse error and adapt to changed circum-stances, especially with multiple agencieshaving jurisdiction.moreover,government isnot without its transaction costs. Of course,oneshouldwatchoutforthereverse“nirvanafallacy,” the belief that no market failure is asbad as any policy to address it.

Winning the battle / Because the Coase-based perspective on market failure ingeneral and environmental externalities inparticular still may not get the attention itdeserves, and because an unduly optimis-tic view of government often implicitlycolors beliefs regarding the effectivenessof policy, Free Market Environmentalismfor the Next Generation deserves a place onthe reading list in virtually any environ-mental economics or policy course. Butan instructor of such a course, or a policyadviser relying on the book, should keepa few things in mind.

One is that the admittedly appealingrenegade tone of the book is not entirely

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warranted. Because supporters of marketapproaches to policy problems often feellike outsiders, it is important to note justhow much of the battle for using marketsto address environmental issues has beenwon. There has been little if any backtrack-ing in economic policy circles regarding theuse of markets since the implementationof sulfur dioxide permit trading beginningin the 1990s. Other examples include trad-able fishing quotas or land developmentrights. To take the leading example of theday, policy disputes over climate changeare very much between those who thinkwe should do nothing and those who thinkwe should adopt market instruments toaddress it. With few exceptions (notablyPope Francis), the central dispute is notabout whether to implement a market-like mechanism—such as a cap-and-tradeof emissions permits or a carbon tax—orto adopt command-and-control. rather,the choice is whether and how to regulateat all, recognizing political constraints onthe availability of market mechanisms.even “Nth best” measures, such as renew-able fuel requirements or automobile fueleconomy standards, increasingly are imple-mented in a market-oriented way.

Assignment of property rights / The largerissue is whether government policy is nec-essary to resolve environmental conflicts,even when those policies are implementedusing market instruments. From thebook’s Coase-based perspective, the pre-ferred first step would be to create prop-erty rights so that those who benefit fromenvironmental protection and those whobear the costs of protecting it can negoti-ate a jointly beneficial solution. In someplaces, the authors lament that whenproperty rights are up for grabs, litigationand rent-seeking will not be far behind.

Ironically, this lamentation under-cuts the authors’ case. The belief that anenvironmental problem could be solvedthrough the establishment of propertyrights presupposes that those rights havenot been previously assigned. While Coaseshowed that in the absence of significanttransaction costs the efficient solution to

environmental problems can be achievedregardless of how property rights areassigned, the assignment of rights—deter-mining who has to pay whom for what—will typically have significant distribu-tional effects.

Consequently, litigation, lobbying, andother forms of rent-seeking to influence theassignment of property rightswill be inevitable. If those areto be avoided, then the assign-ment of property rights is tobe avoided, leaving govern-ment—rather than marketenvironmentalism—astheonlysolution.Theonlyalternative isa viewpoint that, but for rent-seeking, there is some intrin-sic or “natural” assignment ofproperty rights that commonlaw courts or legislators wouldinstitute as a matter of course.Whether that is so in this com-plicated world is doubtful, butin any event it invokes consid-erationsofpoliticalphilosophyoutside the scope of this book.

even if property rights canbe assigned, the next step isto show that transactioncosts are negligible. The standard view ofCoase is that when those costs are negli-gible, externalities are eliminated as longas property rights are assigned, regardlessof how they are assigned initially. How-ever, Coase (unlike many of his readers)recognized that when transaction costsare substantial, the assignment of rightscan matter. This concern forms the basisfor the economic analysis of common lawrules for tort liability, contract breach, andeven modifications to property rights suchas adverse possession and estray law.

The challenge for the contributorsto this book is to show that transactioncosts do not impede solving environmen-tal problems through negotiations ratherthan government intervention when trans-action costs seem large—most notably,when the number of polluters and numberof those willing to pay to reduce pollutionare large. One possibility could be to argue

that even with large numbers of affectedparties, common law will arrive at efficientassignment of pollution liability withoutneeding more intrusive environmentallegislation and regulation. The chaptersin the book by and large do not take thatapproach, which is understandable becausewhen large numbers are affected, either

tort lawsuits are a publicgood or the incentives to sueare internalized through classaction litigation. But theselegal actions are troublesome,especially when litigation hasbeen characterized as a formof rent-seeking.

The authors commend-ably do not ignore the “largenumbers” problem. How-ever, their solutions can takeon a kind of “assume a canopener” character, refer-ring to the joke about aneconomist on a desert islandconfronting a can of beans.Here, the can opener is somegroup like the Nature Con-servancy that can, and oftendoes, purchase property topreserve habitats and open

spaces. In defense of the authors, theseare not hypothetical can openers as in thejoke; sometimes they are real. But whetherenvironmental groups are a reliable rep-resentation of aggregate willingness topay for environmental benefits, or are anexception that proves the rule regardingthe importance of transaction costs, is notresolved here.

As numerous examples in the book illus-trate, non-governmental collective action isadmittedly more plausible in relatively smallsettings such as fishing villages or ranchingtowns. Frequently citing the Nobel Prize–winningworkof elinorOstrom, theauthorsprovide a number of settings in which localsocial norms serve the function of govern-ment in terms of managing local publicgoods. As with Coase, Ostrom’s insightsmerit a wider audience, yet another reasonthis book would be useful in classroomsettings. my guess is that social norms of

Free Market environ-mentalism for the nextGeneration

edited by terry L.anderson and DonaldR. Leal

200 pp.; Palgrave Mac-Millan, 2015


the type Ostrom identifies not only addresspublic goods, but are what keeps the onlybarber in a small town from charging amonopoly price for haircuts. Whether lib-ertarians should feel more comforted by thepower of social norms relative to the powerof collective government might be worthsome thought. Complaints from conserva-tive academics about the oppressive leftistculture inuniversities,goingbacktoWilliamF. Buckley 65 years ago, suggest that socialnormsstrongenoughtoinfluenceoutcomesmay not be an unmitigated blessing.

Conclusion / These observations will notdeter readers who are already disposedto solutions to environmental problemsbased on relatively costless negotiationsamong stakeholders with clearly definedproperty rights. The question remainshow to get this sermon to be heard beyondthe choir.

One impediment the authors could havedone something about is their book’s title.Posing the issue as between “free marketenvironmentalism” and “political environ-mentalism”—with the appendage “coerced”proving impossible to resist for the latter—will put off some readers as biased rheto-ric reflecting an ideological commitmentdisconnected from outcomes. One couldimagine the reaction from property rightsproponents if the options were “exploitativecapitalist environmentalism” and “demo-cratic environmentalism.”

A less rhetorical observation is that the“free” in “free” markets not only rhetori-cally implies a value judgment, it also restson a value judgment that the underlyingdistribution of property rights is norma-tively acceptable. “Your money or your life”is a voluntary transaction if the holder ofthe gun has a prior property right over thelife of the person staring into the barrel.

A harder challenge beyond the scopeof the book is defending the view that theobjective of environmental policy should bewhat the market produces or, at least, wouldhave produced were property rights feasibleto define and transaction costs negligible.economic efficiency—that the environmentdeserves no more protection than that for

which environmentalists are willing to payto compensate polluters—is irrelevant forthose who find environmental protectionmorally compelling in and of itself.

emphasizing Coase’s perspective andeconomic efficiency also presents chal-lenges to libertarians. The appeal of freemarket environmentalism is not the out-come as such, but the process: the viewthat (relative to the initial assignment ofproperty rights) the outcome is voluntaryand mutual. But if economic or politicalcircumstances preclude ideal transactions,economic efficiency and libertarian normscan come into conflict.

Climate policy is a powerful examplebecause of its prominence and because

there is no time machine that would allowcurrent generations to negotiate with andcompensate future generations to arriveat mutually agreeable sacrifices to limitclimate change. Basing the libertarianargument against climate policy not onthis involuntary redistribution but onalleged failures of science gives the almostcertainly inaccurate impression that if thescience were different, libertarians wouldthen find climate policy acceptable.

By clarifying the nature of environmen-tal policy choices, Free Market Environmen-talism for the Next Generation may help movethis debate away from disputes about sci-ence and toward deliberation regardingpolitical values.

Hedgehogs, Foxes,and Economists✒ Review by PHiL R. MURRay

My professor had just finished covering the chalkboard withthe First Fundamental Theorem of Welfare economics,showing that free markets allocate resources efficiently. This

was in the early 1990s, shortly after the eastern europeans abandonedcentral economic planning. I wondered whether the theorem endorsed

PHiL R. MURRay is a professor of economics at webberinternational University.

capitalism. my professor pointed out thatthe economist’s notion of Pareto effi-ciency was consistent with him being inpossession of all the goods while the restof us had none. He said, if I recall correctly,“That’s not much of an endorsement forcapitalism, is it?”

He was not taking sides in capital-ism versus socialism; he was refining ourunderstanding of efficiency in light of dis-tribution. I still ponder the relationshipbetween the First Fundamental Theoremand the real world. Does the theory exaltmarkets? If not, assuming markets out-perform central planning, how good isthe theory?

Harvard economist Dani rodrik’s bookEconomics Rules helps answer questions like

these. “I wrote this book,” he tells us, “totry to explain why economics sometimesgets it right and sometimes doesn’t.”

Modeling the world / There are two typesof economics, according to rodrik. Onthe one hand, “economics is a social sci-ence devoted to understanding how theeconomy works.” On the other, “econom-ics is a way of doing social science, usingparticular tools. In this interpretation,”he elaborates, “the discipline is associatedwith an apparatus of formal modelingand statistical analysis rather than par-ticular hypotheses or theories about theeconomy.”

rodrik prefers the latter approach. Hedefines models “as simplifications designedto show how specific mechanisms work byisolating them from other, confounding

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effects.” His first example is the model ofsupply and demand, which explains theefficient operation of a market. His secondis the prisoners’ dilemma model, whichexplains how “two firms end up in a badequilibrium in which both have to wasteresources.” His third is a “coordinationmodel”: If each of two firms in differentindustries buys capital, both will “end upprofitable and happy.” If they fail to coor-dinate, which means neither buys capital,there will be an equilibrium, though nei-ther firm will be profitable. His point isthat a market works well, or fails to work,depending on the model.

He emphasizes that there is an abun-dance of models, and that this is a goodthing. “The correct answer to almost anyquestion in economics is, it depends,”he claims. An abundance of models is agood thing because “different models,each equally respectable, provide differentanswers.”

Take this question: “Does the mini-mum wage lower or raise employment?”The standard model of supply and demandpredicts that employers faced with a higherminimum wage will lay off workers. Analternative model, in which employershave monopsony power, predicts thatemployers will hire additional workers.To paraphrase the author, the minimumwage eliminates the monopsonist employ-er’s ability to influence workers’ wages.Denied the option to pay a lower wageand hire less labor, and now able to hiremore labor without having to pay a higherwage (up to a point), the employer hiresadditional workers to increase output andrevenue. Whether the standard model orthe monopsony model is relevant dependson “critical assumptions.” According torodrik, “an assumption is critical if itsmodification in an arguably more realis-tic direction would produce a substantivedifference in the conclusion produced bythe model.” With respect to the minimumwage, the standard model’s assumptionthat employers take the wage rate as givenis critical because if it’s unrealistic, theconclusion that a minimum wage reducesemployment will not hold. Likewise for the

alternative model: assuming that employ-ers influence wages is critical because, ifthat’s unrealistic, then the conclusion thata minimum wage increases employmentwill not hold.

Verifying the models / How does one knowwhich model is appropriate? This leads torodrik’s methodology of “model selection,”or what he calls the “craft” of economics.“The key skill,” he submits, “is being able tomove back and forth between the candidatemodels and the real world.” One does this byusing these “verification strategies”:

■ Verify critical assumptions of a modelto see how well they reflect the settingin question.

■ Verify that the mechanisms posited inthe model are, in fact, operating.

■ Verify that the direct implications ofthe model are borne out.

■ Verify whether the incidental implica-tions—those that the model generatesas a by-product—are broadly consis-tent with observed outcomes.

Let’s consider each. Following theauthor, suppose a rising price of oil causesthe public to clamor for a legal maximumprice. If we assume that producers takethe price of oil as given, the “competi-tive model” of the market for oil predictsthat the legal maximum price will cause ashortage. If we assume that producers arecolluding to restrict output and raise theprice, the “monopoly model” predicts thata legal maximum price—provided that it is“not set too low”—will induce producers tocompete, increase output, and lower theprice. In the competitive model, the criticalassumption is that individual producerscannot influence the price of oil. In themonopoly model, the critical assumptionis that producers can influence the priceby forming a cartel.

Here’s how rodrik would verify whetherproducers have market power: he’d exam-ine the number of producers in the market,the market share of each, and the extentof barriers to entry. many producers, lessconcentration, and few barriers supportthe competitive model. Few producers,

greater concentration, and significant bar-riers would support the monopoly model.

Sticking with alternative models ofthe market for oil, both the competitivemodel and the monopoly model “derive,”to use rodrik’s jargon, the “mechanism”by which a decrease in the supply of oilcauses the price to rise. He verifies thatthis process is at work in the market foroil because it “makes sense intuitively” and“there are plenty of real-world examples” ofa decrease in the supply leading to a higherprice of oil. recall the 1970s.

Confirming that a model’s predictionsare consistent with what’s happening inthe real world involves more than econo-metrics. “economists employ a wide rangeof strategies to verify whether the imme-diate implications of different modelsare confirmed in the real world,” rodrikexplains, “from the informal and anec-dotal to the sophisticated and quantita-tive.” For example, being familiar with themexican economy would confirm that themonopoly model had long been appropri-ate for the mexican oil industry. Now thatthe mexican government is allowing theprivate sector to develop oil resources, thecompetitive model will be more appropri-ate so long as we observe increasing outputand falling prices.

rodrik discusses various types of eco-nomic “experiments.” “Thanks to [labexperiments],” for instance, “economistsare learning more about what driveshuman behavior besides material self-interest, such as altruism, reciprocity,and trust.” The author recognizes that“many economists remain skeptical” of labexperiments. The “field experiment” and“natural experiment” appear to be cleverand promising techniques to verify directimplications, though caution is still nec-essary because specific experimental out-comes “may not apply to other settings.”What motivates some teachers in India toshow up and do their jobs, for example, is“placing cameras in the classroom.” How-ever that tactic might not motivate teach-ers elsewhere.

models have “incidental implications.”For example, the standard model about


economics Rules: theRights and wrongs ofthe Dismal science

by Dani Rodrik

253 pp.; w. w. norton,2015

the minimum wage law focuses on thedirect implication of reduced employmentof low-skilled workers. Perhaps an inciden-tal implication is that firms will substituteworkers with more skills for less-skilledworkers and employment of the formerwill rise. Other incidental implicationsmight be the effect on non-wage benefitsor the prices of goods andservices produced with lotsof low-skilled labor. Verifyingwhether low-skilled workers,who manage to keep theirjobs following an increase inthe minimum wage, sufferthe loss of non-wage benefitshelps us to decide whetherthe standard model is correct;likewise for output prices.

Economists’ errors / A formerprofessor of mine joked thateconomists have license towreck the economy. Somewreckage follows from“errors of commission, inwhich fixation on a particu-lar view of the world makeseconomists complicit in policies whosefailure might have been predicted aheadof time.” In order to illustrate this mis-take, rodrik focuses on the ideology ofthe Washington Consensus, which hecharacterizes as “‘market fundamental-ism,’ the blanket term for the view thatmarkets are the solution to all publicpolicy problems.” market fundamental-ists, for instance, would recommend freetrade as a growth strategy for develop-ing economies. Lower tariffs encourageimports and discourage import-compet-ing industries. Simultaneously, entrepre-neurs redeploy idle resources in expandingexport industries. “In Latin American andAfrican countries that adopted this strat-egy,” rodrik tells us, “the first part of thisprediction largely materialized, but notthe second.” How could this misfortune“have been predicted”? By recognizing“the deeper institutional underpinningsof a market economy,” such as “the ruleof law” and “contract enforcement.” real

market fundamentalists, of course, wouldresist the charge that they fail to recognizethe importance of institutions.

rodrik cites developing countrysuccesses in Asia. Curiously, this is notbecause governments permitted freetrade in the context of proper institutions(property rights, rule of law, and contract

enforcement). “Instead ofliberalizing imports earlyon,” rodrik explains, “SouthKorea, Taiwan, and, later,China all began their exportpush by directly subsidizinghomegrown manufactur-ing.” Trade barriers “pro-tected” import-competingindustries so as to preventunemployment. To boot, “allof them undertook indus-trial policies to nurture newmanufacturing sectors.” Justwhen this reviewer thoughthe was supposed to swal-low the bitter pill that freemarkets don’t work and cen-tral planning does, rodrikwarns: “This interpretation

is incorrect.” The moral of the Asian suc-cess stories, according to the author, isthat economists should know when touse “models that take on board some ofthe major second-best challenges theseeconomies faced.”

Another way “economists go wrong”is through “errors of omission, in whicha blind spot shows up in the inability tosee troubles looming ahead.” In order toexplain this problem, he focuses on theGreat recession. most economists failedto forecast the financial crisis of 2008.Specifically, they “overlooked the extentof problems in housing and finance.”Why were economists unable to antici-pate the bursting of the bubble in houseprices and the financial panic that ensued?They were relying on the wrong models.“many of the favored models,” accordingto rodrik, “revolved around the ‘efficientmarkets hypothesis’ (emH).” The gist ofthe hypothesis is that the price of an asset(such as a stock) equals the value of the

asset. Proponents of the emH refrain frompredicting future stock returns. rodrikdoes not expect them to predict whenrecessions will occur. His critique is that“it is hard to square the model with reality:a sustained rise in asset prices followed bya sharp collapse.”

The author nevertheless tells us howto align the emH with the events of 2008.When expectations suddenly switchedfrom economic growth to recession,according to this account, a large sell-offoccurred. Although that story reconcilesthe emH with the crash in the stock mar-ket, rodrik finds fault in that it “reversesthe generally accepted line of causation,which goes from the financial crash to theGreat recession.”

The author argues that instead of rely-ing so heavily on the emH, economistsshould have been pondering bubbles,principal-agent problems, and behavioralfinance. It’s safe to say that he criticizes hisfellow economists for putting too much“faith” in markets and too little in govern-ment. “In sum,” he concludes, “economists(and those who listened to them) becameoverconfident in their preferred models ofthe moment: markets are efficient, finan-cial innovation improves the risk-returntrade-off, self-regulation works best, andgovernment intervention is ineffectiveand harmful.” Perhaps the zeitgeist lead-ing up to the financial crisis of 2008 wasenthusiasm for markets, globalization, andtechnology. But then, perhaps the authorcommits his own “error of omission” byneglecting to mention the role of dubiousgovernment interventions that played arole in the financial crisis, such as Fanniemae and Freddie mac, and political pres-sure that lowered lending standards.

Conclusion / rodrik is critical of a pro-market bias. “It is certainly true,” heclaims, “that economists err on the sideof markets.” But he is not anti-market.economists “think they understand howmarkets work,” he admits, “and they fearthat most of the public doesn’t—and theyare largely right on both suppositions.”

In order to recommend the proper per-


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Liberty and the Ruling Class✒ Review by tHoMas a. HeMPHiLL

Larry Lindsey knows whereof he speaks. As a former governor ofthe Federal reserve System from 1991 to 1997, and as directorof the National economic Council under George W. Bush, he

has helped craft economic policy at the highest levels of government.However, while the Harvard-educated economist views himself—along

t HoM as a . HeMPHiLL is professor of strategy, innova-tion, and public policy in the school of Management at theUniversity of Michigan, Flint, and a senior fellow at thenational Center for Policy analysis.

spective for an economist, the author turnsto the difference between a “hedgehog” anda “fox.” According to rodrik,

The hedgehog’s take on a problem canalways be predicted: the solution liesin freer markets, regardless of the exactnature of and context for the economicproblem. Foxes will answer, “It depends”;sometimes they recommend more mar-kets, sometimes more government.

Given this taxonomy, the author rea-

sons that “economics needs fewer hedge-hogs and more foxes engaged in publicdebates.” This raises questions. Does heconsider economists with a penchantfor government intervention to also behedgehogs? Does he think we need fewerof them? What economists are quintes-sential examples of hedgehogs and foxes? Ifgood economists are foxes, was another ofmy professors correct to claim that “Goodeconomists are like good lawyers: they canargue both ways”?

with many other people with whom heserved in government—as “getting the jobdone and moving on,” he is concernedabout a different group of top-level gov-ernment employees who, he says, have avery different agenda. As he writes in hisnew book, Conspiracies of the Ruling Class:

The purpose of their government servicewas to accumulate personal power andto exercise that power over others. Theydidn’t have a noble cause, even thoughthey always acted as though they did, buta hidden need to wield power and main-tain control of their little domain.

Lindsey notes that he did not take“these people” too seriously until theybegan expanding their fiefdoms and turnedtheir attention from the bureaucracy to thecountry itself and individuals like him.“These people” are politicians, appointees,and bureaucrats who are career govern-ment employees and academics who waitfor their opportunities to assume positions

of political power. He dubs them “the rul-ing Class” and describes them thus:

They view their jobs not as leaders,who encourage the rest of us to makethe most of our talents, but as peoplewho are superior—as though they arethe shepherds and we the sheep. Theyridicule the successful and do every-thing they can to make the populationdependent on them.

Lindsey identifies “progressives,” ormodern liberals, as the ideological groupthat is the latest incarnation of the rulingClass. Secure in their control of the media,the entertainment industry, and academia,a member of the ruling Class will adoptan ideal such as “social justice” when ingovernment service and attempt to imple-ment this vision of a “just” world by taxingand spending, thus redistributing wealth bytaking money from one person and givingit to another.

Lindsey divides his book into threeparts. In the first, he discusses the rulingClass’s threat to individual liberty. Begin-ning with a historical view of the imperi-

ous ruler having absolute or near absolutecontrol over his subjects through most ofthe history of humanity, to the uniquenotion of a constitution embodying fed-eralism and the rights of the individualresulting from the heroic efforts of theFounding Fathers, he lays out anteced-ents to the modern progressives’ ongoingassaults on the u.S. Constitution. As henotes, “The ruling Class have rebrandedthemselves from the beneficiaries of a des-pot who inherited his position to a newkind of despot who inherited his positionfor the benefit of his society.”

In part two, Lindsey evaluates the gov-erning performance of the ruling Class inAmerica over the latter part of the 20th cen-tury throughtheyearsof theObamaadmin-istration. Increasing economic inequality forAmerica’s minorities; a burgeoning nationaldebt and inadequate sustainable fundingof Social Security and medicare; decliningperformance of American children in read-ing, writing, and arithmetic (as compared toother developed nations); bureaucratic andeconomic mismanagement of the nation’sphysical infrastructure;ongoinggovernmen-tal threats to limit the rights of Americansto arm themselves for their self-defense; andexpansion and abuse of the government’spowers (andconsequentdeteriorationindueprocess and accountability) in the civil tak-ing of citizens’ property are explained anddescribed with publicly available data andexplicit examples of ruling class behavior.

Inpart three,heoffershispolicyprescrip-tions for regaining the liberties that havebeen slipping away from Americans. Thisis the section of the book that fulfills hissubtitle—HowtoBreakTheirGripForever—andhe explains what activities and policies hebelieves Americans must embrace to throwoff control by the ruling Class.

Securing liberty / Lindsey makes an empiri-cal case that there is a pro-liberty majorityin America, noting that in an April 2012survey, potential voters said they wantedsmaller government by a 22-point marginand believed that government regulationmade society less fair by a 28-point mar-gin. moreover, in a march 2015 rasmus-

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sen poll of likely voters, 52% responded thatincreased government spending hurts theeconomy while just 28% disagreed.

Yet President Obama, an advocate ofexpansive government, won re-electionin 2012 with a 4 percent majority of vot-ers. Why? According to Lindsey, Obama’srepublican opponent, mitt romney, failedto connect with voters on one key self-oriented value, “Cares aboutpeople like me,” even thoughromney was viewed by vot-ers as preferable to Obamaon the leadership qualitiesof strength, vision, and val-ues. While Lindsey does notbelieve that a liberty-orientedcandidate should enter into a“bidding war” with a progres-sive ruling Class candidatefor votes, those voters whobelieve they are being abusedby the government bureau-cracy need to believe that acandidate embraces libertybecause he or she genuinelycares about voters like them.Thus, a presidential candi-date who frames the electionas a choice between libertyand the progressive ruling Class will winover the pro-liberty majority.

Lindsey also believes that a philosophyfor a winning political campaign shouldbe focused on improving people’s livesthrough increased independence andindividual control. When it comes to taxincreases, the previously mentioned march2015 rasmussen survey found that 50% ofvoters believe tax increases hurt the u.S.economy while just 23% disagree. Lindseyrecommends that, to be “philosophicallypopulist and operationally libertarian,”one should propose tax code simplifica-tion, for example a flat tax that is simple aswell as fair in terms of taxes paid by differ-ent groups. As for the Affordable Care Act(ACA), he recommends repealing the indi-vidual mandate, repealing the employermandate, and ending federal mandatesand restrictions on what policies mustcover and who may offer coverage. Those

steps would address the desires of 49% ofthose surveyed in a December 2015 ras-mussen poll who wanted to go through thelaw piece-by-piece and improve it.

He next turns to what must be doneonce a pro-liberty majority has been rees-tablished in Congress. First, he argues thatCongress must reassert control of its consti-tutional responsibilities over administrative

rulemaking. Federal lawmak-ers have delegated this author-ity to so-called “experts” in theexecutive branch and indepen-dent agencies. The first reformis to move this decisionmak-ing away from the “experts”and return it to Congress,while the executive branchfocuses on enforcementresponsibilities. Second, helooks to end lifetime careers infederal policymaking, both byimplementing term limits forCongress and—more impor-tantly—removing employmentprotections from ruling Classbureaucrats who have numer-ous rights of appeal and whoare rarely penalized for poorperformance, much less fired.

(unfortunately, he offers no specific sug-gestions for civil service reforms.) He alsorecommends the federal court system endlifetime appointments to the bench, sug-gesting an 18-year term instead, which hebelieves is long enough to avoid the threatof political pressure.

As to the critical issue of budget reform,Lindsey first recommends that all gov-ernment spending must go through theappropriations process (not just the pres-ent 30%, which excludes costly and expand-ing entitlements programs). Second, hewould force Congress and the president,when enacting either a new entitlement orchanging an existing one, to honestly esti-mate and designate a funding source forthe long-term costs. Third, he would havelong-term budget scoring in present-valueterms be applied to both taxes and spend-ing. Fourth, the currently weak PAYGOrules (which ostensibly require any increase

Conspiracies of theRuling Class: Howto break their GripForever

by Lawrence b. Lindsey

263 pp.; simon &schuster, 2016

in federal spending or reduction in taxesbe offset by other fiscal changes) wouldbe reformed so they better adhere to long-term, honest budgeting principles. Fifth,he wants to establish a systematic methodof addressing any political impasse thatcould result in a government shutdown.Sixth and most importantly, he wants away to enforce these recommendations,suggesting that members of Congressmust remain in Washington, D.C. (andaway from family members) until the nec-essary compromises are reached.

Lastly, he confronts the public’s dis-trust of the Federal reserve. According toa November 2013 rasmussen survey, only34% of Americans viewed the Fed favor-ably, while 50% held an unfavorable view. Headdresses some of the public’s major criti-cisms of the Fed, and makes short shrift ofthem. For example, some Fed-bashers arguethat it should follow some explicit “rule”when making monetary policy. However, henotes that if history provides little guidanceon the relationship between Fed policy inthe short-term and its effect on inflation, arule that works well at one time might provedisastrously inappropriate at another. As forcritic demands to “audit” the Fed, Lindseypoints out that all expenses incurred bythe Fed are already audited extensively byboth internal and external auditors, and theFederal reserve balance sheet is disclosedand audited. This demand, he argues, isreally an effort to “second guess” Fed policy.Finally, he dismisses “end the Fed” slogan-eering, pointing out that another institu-tion, such as Congress, would step in toset interest rate and money supply targets,unless the nation returns to an inelasticcurrency, which raises the specter of suddenfinancial crashes like those of the late 19thand early 20th centuries.

Lindsey offers what he characterizes as amodest “reform” proposal (yet “philosophi-callypopulistandoperationally libertarian”):pass a constitutional amendment that pro-tects people’s right to use something otherthan Federal reserve notes to write a con-tract.Thatrightdoesexist today,but itcanbesuspendedatanytimebypresidentialdecree,as Franklin roosevelt did in 1933.


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Great Data, DisappointingEconomics✒ Review by DaviD R. HenDeRson

Northwestern university economist robert J. Gordon’s latestbook is on u.S. economic growth from 1870 to 2014. With hiscareful sifting of the data, he shows how far we’ve come over

that time span, and especially between 1870 and 1970. examining theeconomy sector by sector, he finds progress in every area: life expectancy,

Dav iD R . HenDeR son is a research fellow with theHoover institution and professor of economics in theGraduate school of business and Public Policy at the navalPostgraduate school in Monterey, Calif. He is the editor ofThe Concise Encyclopedia of Economics (Liberty Fund, 2008).

Lindsey concludes his book by arguingthat the progressive ruling Class is erod-ing economic opportunities in America by“actively compressing, enervating, extin-guishing, and stupefying us with complexrules, taxes, and obligations.” The rulingClass, he says, views America as a coun-try and not as a cause, and has “nothingto offer but empty promises built on thequicksand of ever-increasing demands onthe resources, energy, and freedom of therest of us.” In contrast, in his philosophy,liberty and the subsequent advancementof humankind is the moral high ground,and this political philosophy will be thefoundation for permanently breaking theruling Class’ grip on the levers of power.

Populist and libertarian? / The phrase“philosophically populist and operationallylibertarian” sums up Lindsey’s political andpolicy approach to throwing off the shack-les of the progressive ruling Class. As henotes,his academic trainingasaneconomistallows him the comfort of thinking in termsof “tradeoffs” in public policy and winningelections. After 100 years of embeddingthemselves in public institutions, it will be adaunting challenge to remove progressivesfrom their ruling Class positions.

His “populist” approach to regaininga pro-liberty majority will not make die-hard libertarian/constitutional conserva-tives joyful, but it may begin to turn thetide of modern progressivism in federalinstitutions. How? Through the success-ful election of more pro-liberty politicalcandidates who will begin the arduous taskof changing government from its increas-ingly active role as coercer/regulator ofthe American populace to a return to theFounding Fathers’ vision of government asthe protector of individual rights.

While most of his public policy propos-als have broad public support and have astrong “common sense” basis to them, Itake issue with a few of them. Granted,attempting to deal with key provisions ofthe ACA could effectively implode the leg-islation. But repealing it and immediatelylegislatively substituting a real health carereform law that embraces market-based

options, supports individual choice inhealth care management, and offers thepotential for real cost controls (and limitedgovernment oversight) would be a far moreeffective response than keeping much ofthat 2,700-page legal and regulatory mon-strosity in effect. Allowing Congress toactively reembrace its rulemaking author-ity—if it were circumscribed to being man-datory (as it is presently optional and rarelyoperationalized) for major rules, i.e., costing$100 million or more—would be a welcomefirst step for the legislative branch exercis-ing its constitutional authority. I wouldalso agree with Lindsey that his recom-mendation for a constitutional amend-ment to use something other than Federalreserve notes to write a contract is a “mod-est” proposal. I doubt, however, that thiswould be any game-changing policy for apro-liberty candidate to run on success-fully, and may actually appear to manyvoters as an avoidance of what is emotion-ally their primary issue: the continued exis-tence of the Federal reserve.

I enjoyed reading Lindsey’s book. Heprovides a wonderfully accessible descrip-tion of the foundations of ruling Classphilosophy throughout the ages, and athorough, empirically based analysis of thefailures of progressive ruling Class publicpolicies in recent decades. I also appreciatedhis honest approach to legislatively dealingwith the national budget and the need todirectly discuss major entitlement programssuch as Social Security and medicare on anannual versus continuing basis. While I likehis overall approach to evaluating publicpolicy issues, and I think it has merit as apractical approach to politically coalescinga pro-liberty majority of voters, I did findmyself a little disappointed by his policyprescriptions inthefinal sectionof thebook.Nevertheless, he writes exceptionally well,with a remarkable ability to blend data witha measured narrative flair—no mean feat foran economist. I certainly would recommendthis book for anyone who values liberty andwould like to be a better informed voter inthis election cycle.

food, housing, transportation, workplaceconditions, clothing, entertainment, andhealth care, to name some of the mostimportant areas analyzed. In almost allcases, his data are impeccable. For those whofondly wish to return to the “good old days,”he has important news: the “good old days,”compared to now, were really bad.

The book’s strengths are its data andGordon’s common-sense interpretationof that data. unfortunately, he does notdo nearly as good a job of using basic eco-nomics to explain the causes of economicgrowth and the ways to offset the lowerfuture growth that he anticipates. At times,he shows an awareness of the harm doneby many government regulations: policieson drug regulation, housing, entry intooccupations, and airline security, to namefour. However, he actually claims positive

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effects of a now-defunct regulatory agency,the Interstate Commerce Commission,that economists have definitively shownwas almost wholly destructive. Also, henever explains why we’ve had the kind ofinnovation and capital investment thathas driven our standard of living. When hediscusses tax policy, he seems unaware thatone of his proposals would likely reducethat investment and innovation.

Getting better / First the good news, andthere’s a lot of it. We are massively bet-ter off than people were in 1870. I knowthat’s not earth-shattering news, but thedetail that Gordon gives makes this caseoverwhelmingly.

Consider life expectancy. In 1870, lifeexpectancy at birth for u.S. white maleswas 45.2 years. By 1940, it had risen to64.2 years, and by 2010 to 77.9 years. Themain reason for this increase was a hugeimprovement in health, and major con-tributors to good health were better food,better working conditions, sewers, run-ning water, vaccinations, penicillin, andthe replacement of horse-drawn publictransit with motorized vehicles.

Between 1870 and 1940, the kinds offood people ate and the way they boughtit changed dramatically. In the 1920s, therewas a huge shift from local merchants tochain stores such as A&P. even in chainstores, though, “customers lined up andwaited while clerks fetched items fromshelves behind them.” Later, of course,there was a large saving in labor as peoplestarted picking their own items off con-sumer-accessible shelves. Disappointinglyfor a fact-filled book, Gordon does notdiscuss that transition. He does, however,lay out the tremendous increase in foodvariety resulting from food processing,canning, and refrigeration, all of whichhappened in that 70-year period.

Housing also improved dramatically,mainly because most houses became “net-worked.” That is, between 1870 and 1940,most houses obtained access to clean run-ning water, sewage, electricity, and tele-phone lines. All of these were enormouslybeneficial: running water saved carrying

pails of water from an outsidepump (which my mother didin our small town in manitobauntil 1958); sewage allowed formuch safer disposal of humanwaste; electricity led to labor-saving devices in the home,plus lighting, which made eve-nings much more enjoyable;and telephones dramaticallyincreased people’s access to thebigger world.

A bumper sticker I used tosee in the early 1970s in LosAngeles was “Cut Pollution:ride a Horse.” my impression,talking to fellow Angelenos,was that they saw no irony inthis. People who think thathorses were non-pollutingwould do well to read Gordon’s book. Hewrites, “The horse was not only inefficient,eating up one-quarter of the nation’s grainoutput, but also a source of urban pollu-tion, disease, and occupational misery forthe workers unlucky enough to have jobsin horse waste removal.” And later: “Horsesdropped thousands of tons of manure andgallons of urine on city streets; died in ser-vice, leaving 7,000 horse carcasses to becarried away in Chicago alone; and carrieddiseases transmissible to humans.” On NewYork’s Liberty Street, at one point, a manureheap measured seven feet high.

The advent of electric streetcars andthen the internal combustion enginechanged all that, making transportationeasier, cheaper, and healthier, and extend-ing people’s range dramatically. One of thebest parts of Gordon’s book is his descrip-tion of technological improvements in carsbetween 1906 and 1940, along with largereductions in price. I was pleased that hedidn’t bring the modern intellectual’s dis-dain for cars to this book; Gordon wellrecognizes their huge value.

entertainment also became incrediblymore varied, easier to access, and cheaper.The three main improvements between1870 and 1940 were the motion picture,the phonograph, and the radio. All becamewidespread during that time. By 1940, for

instance, 80 percent of Amer-ican households had a radio.Gordon also documentsthe huge improvement inentertainment between1940 and 1970 (mainly TV)and between 1970 and now(smart phones that doubleas computers and music andvideo players).

If you aren’t already con-vinced that health care in1870 was primitive, you willbe when you read Gordon’sbook. In a subsection titled“What Did Doctors Do?” heshows that they didn’t domuch good. For one thing,they still hadn’t bought intogerm theory, which was rela-

tively new. A few decades later, they had.Between 1870 and 1940, not only theirknowledge, but also their tools, improved.These included the stethoscope, the oph-thalmoscope, the laryngoscope, the X-raymachine, and the electrocardiogram.

Gordon understates medical progresssince 1970, mainly, it seems, because thebig increases in life expectancy had alreadyhappened. But there have been significantimprovements since 1970 in quality-of-lifemedicine. If I need a knee replacementnow, I can have one; in 1970 or even in1980, I couldn’t.

To his credit, he points out that regula-tion by the Food and Drug Administra-tion has now slowed innovation to a crawl.referencing work by Jan Vijg, a moleculargeneticist at the Albert einstein Collegeof medicine in New York, Gordon writes,“Had the regulatory norms of today existedin the 1940s, Vijg argues, innovations suchas kidney dialysis and antibiotics mightnever have come to fruition.” Who knowshow many diseases we would have a betterhandle on now if not for the FDA’s heavyregulatory hand?

The kinds of jobs we have and our payhave also improved dramatically. Although,surprisingly, Gordon presents no aggregatedata showing the huge drop in workplacefatalities and injuries since 1870, he does

the Rise and Fall ofamerican Growth: theU.s. standard of Livingsince the Civil war

by Robert J. Gordon

762 pp.; PrincetonUniversity Press, 2016


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give enough of a narrative to make youfeel lucky not to be working under theconditions of the late 19th century. Hourswere long, jobs were tedious and danger-ous, and pay was low. The nature of workchanged also. He writes, “The big shiftover the century after 1870 was from trulydisagreeable jobs mainly to repetitive occu-pations, leaving room for a small shift tononroutine cognitive employment.” After1970, there was another shift. “The ratio ofdisagreeable to non-routine cognitive jobsshifted from 7.9 in 1870 to 2.1 in 1940 to0.1 in 2010, one of the great achievementsof American economic growth over thepast fourteen decades.” On pay, Gordonshows that between 1870 and 2010, realhourly compensation for production work-ers roughly twelve-tupled.

He shows that the first big improve-ment in clothing was the shift from homeproduction to factory production, whichhelped women to pursue higher-valuework outside the home. A much later shiftwas to imports. “The post-1980 years,”he writes, “observed a near total replace-ment of domestic-produced clothing byimports.” Because of increased imports, henotes, the rate of decline of clothing prices“more than quadrupled.” Their declineaveraged 0.6 percent per year from 1940 to1980, and then 2.6 percent per year from1980 to 2013. Gordon cautions that thedownside was the loss of 650,000 appareljobs between 1997 and 2007, when Chineseimports increased rapidly. But given his ear-lier emphasis on the shift to “nonroutinecognitive jobs,” isn’t this decline largely agood thing? How, after all, are we Ameri-cans to get more interesting jobs if we don’tgive up the less-cognitive jobs that can bedone more cheaply in other countries?

moreover, the main way we get progress,as Gordon shows, is with increased produc-tivity, and increased productivity meansdoing more and more with fewer and fewerpeople. Consider u.S. agriculture, which isvery productive. A table in his book showsthat farmers were 46 percent of the workforce in 1870 and only 1.1 percent in 2009.

Butheseemsat timestoforgethowprog-ress comes about. He thinks that Amazon.

com has “weakened the economy” becausehe predicts that “there will be fewer jobs forconstruction workers building new shop-ping malls and fewer jobs for clerks, stockingstaff, and managers at retail stores.” This isshocking coming from an economist who,elsewhere in the book, shows his under-standing that producing greater outputwith fewer people is good, not bad.

Bad news? / Other reviews of Gordon’sbook have given considerable attentionto two of his claims: economic growth hasslowed since 1970, and it will slow evenmore in the future.

His data do show lower growth since1970. The good news is that economicgrowth since 1970 is higher than thedata suggest. The reason is that the GrossDomestic Product Deflator and the Con-sumer Price Index (CPI), both of whichare used to adjust for inflation, overstateinflation, and therefore understate eco-nomic growth. Gordon would almost cer-tainly agree with this point. In 1996, hewas a member of the Boskin Commission,appointed by the Senate Finance Com-mittee and headed by Stanford universityand Hoover Institution economist michaelBoskin. The commission estimated thatthe CPI overstated inflation by 1.3 percent-age points annually before 1996. AlthoughGordon published some of his differenceswith the commission’s report, they weresmall. In a 2006 study published by theNational Bureau of economic research, heestimates the bias to be at least 1.0 percent-age point per year. If he’s right, official u.S.government data substantially understatecurrent growth. Of course, that doesn’tundercut his point that growth since 1970has been lower than before 1970 becausethe data before 1970 also overstated infla-tion and, therefore, understated growth.

But then the big question is “Why hasgrowth fallen?” And here, Gordon disap-points. There seems to be a big elephant intheroom,namelytheincrease ingovernmentscope and power, yet he doesn’t mentionthat. In 1966, medicare and medicaid, twohugegovernmentprograms,beganandgrewexponentially. In 1970, President richard

Nixonsignedanexecutiveorderandcongres-sional legislation creating two large agencies:the environmental Protection Agency andthe Occupational Safety and Health Admin-istration.Sincethen,regulationhasexplodedeven further, at the federal, state, and locallevels. So there’s a good case to be made thatthe drop in growth is due, in part, to a largegrowth in government.

Gordon’smorecontroversialclaimisthatfuture growth will fall even further. He fore-casts1.2%annualgrowthinoutputperhourfrom2015to2040.Thatcomparestoannualgrowth of 2.71% between 1948 and 1970. Hethen makes three adjustments, all of whichdrive the number lower. The 1.2%, he argues,falls to a 0.8% increase per person because ofthe retirement of the baby boom generation.The0.8%thenfalls to0.4%growthinmedianoutput per person because, he argues some-what plausibly, a disproportionate shareof the gains from growth will go to higher-income people. Finally, he reduces the 0.4%to 0.3% annual growth in disposable medianincome per person because the governmentwill find itself raising taxes to bail out SocialSecurity and medicare.

This does sound grim. The good news,as noted earlier, is that both the CPI andthe GDP Deflator overstate inflation andunderstate growth. So, even in Gordon’spessimistic scenario, growth of mediandisposable income per person could be,say, 1% annually.

But his most questionable numberis the 1.2% annual growth in output perhour. How does he reach this? By takingthe average growth from 1970 to 2015 andreducing it somewhat for a slowdown inthe growth of educational attainment. Inother words, he extrapolates from the last45 years. That’s pretty iffy. He quotes Joelmokyr, an economic historian and Gor-don’s Northwestern university colleague,who observes, “History is always a badguide to the future and economic histo-rians should avoid making predictions.”Gordon doesn’t heed that advice.

He does realize that growth dependson economic policy. unfortunately, withsome important exceptions, the policies heproposes would reduce growth. Because he


Cigarette Taxes and Food Stamps“Behavioral Responses to Taxation: Cigarette Taxes and Food

Stamp Take-Up,” by Kyle Rozema and Nicholas Ziebarth. March

2015. SSRN #2586410.

In recent issues of Regulation, authors have presented evidencethat the consumption of cigarettes by those who continueto smoke—both adults and teenagers—is now unaffected by

cigarette tax increases (“Cigarette Taxes and Smoking,” Winter2014–2015 and “Working Papers,” Winter 2015–2016). That is,current smokers have such strong preferences for smoking thatadditional cigarette tax increases do not reduce smoking furtherand cannot be justified by health benefits.

For low-income smokers, the price effects of the tax increasesare large. From 2000 to 2010, cigarette prices doubled from $3 to$6 a pack. A full-time minimum-wage worker’s expenditure on apack a day has increased from 4% to over 10% of a day’s income.

How have they managed? It appears that many have turned tofood stamps. During the same time period, the share of the popula-tion receiving food stamps has more than doubled, from 6% to 15%.And low-income smoking households are 50% more likely to enrollin food stamps relative to low income non-smoking households.

Are these stylized facts causally related? The authors examinewhether exogenous variation in the imposition of state cigarettetax increases changes food stamp enrollment. They conclude that

each dollar of tax increase raises the probability of an eligible(low-income) non-enrolled smoking household signing up forfood stamps by between 2 and 3 percentage points from a baselineprobability of 25%.

President Obama proposed increasing federal cigarette taxes byabout $1 in 2013. The estimated revenue increase was $8 billion.The authors use their work to estimate that, because of the highertax, food stamp enrollment would increase by about 400,000people, costing the program $500 million.

E-cigarettes and AdolescentSmoking“How do Electronic Cigarettes Affect Adolescent Smoking,” by

Abigail S. Friedman. April 2015. Available at http://scholar.harvard.

edu/files/afriedman/files/how_do_electronic_cigarettes_affect_

adolescent_smoking_circulate_0.pdf.

In may the u.S. Food and Drug Administration issued regula-tions on e-cigarettes under authority granted by the TobaccoControl Act of 2009. In response, many policy analysts, includ-

ing my Cato colleague, Walter Olson, have argued that requiringe-cigarettes to navigate an FDA-approval process is a bad ideabecause e-cigarettes are less harmful than traditional cigarettes.(“The FDA’s Slow-motion Ban of e-Cigarettes,” Ricochet, may 9,2016.) To be sure, the FDA, in its final rule, acknowledged thatmany believe that “the aerosol is completely harmless or signifi-

Working Papers ✒ by PeteR van DoRenA SummArY OF reCeNT PAPerS THAT mAY Be OF INTereST TO REGULATION’S reADerS.

PeteR van DoRen is editor of Regulation and a senior fellow at the Cato institute.

worries so much about income inequality,he advocates raising the minimum wageand substantially increasing tax rates ondividends and capital income.

On the minimum wage, he writes:“Standard economic theory implies thatan increase in the minimum wage wouldraise the unemployment rate of the low-wage workers. However, a substantial bodyof economic research indicates little or noeffect.” really? Is he unaware that another,much more substantial body of economicresearch indicates a bigger effect? So wehave theory indicating an effect, some evi-dence of little or no effect, and more evi-dence indicating a bigger effect. Doesn’t itmake sense, then, if one is worried aboutgrowth, to go with the theory?

And surely Gordon must be aware that

taxing capital more heavily, as increased taxrates on capital gains and dividends woulddo, would reduce the incentive to investin capital. With a lower growth of capital,there would be lower growth of productiv-ity and, therefore, output. Yet he mentionsnot a word about this large downside tohis proposal. At that point in the book, Igot the impression that one of his agendaitems was to push for his preferred policiesregardless of their effects on growth.

Tohiscredit,hedoescall for largedosesofderegulation.Hewouldreducethe imprison-mentrateofAmericans,which,hepointsout,is a large multiple of the rate in europe. Thatwould save taxpayer money and increase thereal incomes of people who would otherwisebe in prison. He also calls for drug legaliza-tion, pointing out the savings to taxpayers

and the gains in tax revenues from taxingdrugs, although not mentioning the gains topeople who, as a result of legalization, don’tend up in prison. Possibly he thought thatthisgainwasobvious.Healsocalls for rollingbackregulationsonlanduse,whichhenotes,citing Harvard economist edward Glaeser,transfer wealth from the less affluent to themore affluent and also reduce productivity.Finally, he would get rid of many regulationsthat restrict occupational choice and thereby“restrict upward mobility for lower-incomeindividuals.”

If you want to see how far we have comeand how tough life was a century and a halfago, read Gordon’s book. If you want thatprogress to continue, eschew his tax andwage policy recommendations and go forlarge cuts in regulation. R


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cantly less harmful than tobacco smoke from combusted tobaccoproducts.” And the “FDA recognizes that the aerosol that is exhaledby users of some e-cigarettes and similar electronic apparatus maynot pose as much harm as smoke emitted from combusted tobaccoproducts.” But, sadly, “the Tobacco Control Act does not requirethat FDA make a finding that a product is harmful in order todeem it subject to chapter IX of the FD&C Act; FDA is authorizedto deem any product that meets the definition of a “tobacco prod-uct” pursuant to section 901 of the FD&C Act.”

At least according to the FDA, Congress did not instruct it toreduce the risks associated with traditional tobacco use. Instead,Congress told the FDA to regulate tobacco or anything, such as nico-tine, derived from tobacco, and that is what the FDA is going to do.

If the courts or Congress instructs the FDA to consider riskreduction in its treatment of e-cigarettes, then the findings ofAbigail Friedman’s paper would seem relevant. She comparesconventional smoking rates in states that have enacted e-cigarettesales bans for minors to smoking rates in states that have notbanned sales to minors. She includes controls for state and yearfixed effects. She concludes that cigarette use among 12–17 year-olds increases by 0.7 to 1 percentage points (relative to other states)after a ban on e-cigarette sales to minors is enacted.

Does easy access to e-cigarettes induce kids to “smoke” whowould not smoke if only conventional cigarettes were available?Friedman estimates propensity-to-smoke regressions using demo-graphics and other relevant variables. Those predicted to be unlikelyto engage in conventional smoking show no change in recent use ofe-cigarettes, while those predicted to be likely smokers exhibit fallingconventional cigarette use over time and increased e-cigarette use.

Corporate Inversions“Are Corporate Inversions Good for Shareholders?”by Anton Babkin,

Brent Glover, and Oliver Levine. December 2015. SSRN #2700987.

Among industrialized countries, the united States hasthe highest corporate tax rate, at 35 percent. To takeadvantage of lower rates in other countries, some u.S.

firms elect to sell themselves to smaller foreign firms, a processcalled “inversion.” These sales have drawn considerable ire fromu.S. politicians and activists, and the Obama administration hasvowed to “do something” about it.

In April, the u.S. Treasury Department issued regulations tothrow sand in the gears of inversions. The commentary on theseregulations—both pro and con—was the usual food fight aboutgrowth, taxes, and investment in the united States. underlying allof that talk was the assumption that inversion reduces taxes forshareholders. But that assumption is incorrect in many instances.

The tax consequences of inversions are complicated becausethey are taxable events. That is, individual shareholders are taxedon the increased value of their shares. This can result in differenttax outcomes from inversions for shareholders who have held

the stock for a long time prior to the inversion and short-termshareholders (including corporate officers exercising companystock options).

For an inversion to be advantageous, the present value of thecorporate tax reduction must be larger than the capital gains taxpayments. When the reduction in the effective corporate tax rateis modest, those shareholders who purchased the stock near thecurrent market price and thus have little individual capital gainto be taxed are net winners while longer-term shareholders whopurchased the stock at a price much lower than the current marketprice, and thus have large capital gains, are net losers.

The authors study 73 inversions that occurred from 1983 to2014 for which equity price data are available. using historical priceand turnover data for the 73 inversions, the authors estimate returnsfor the average, median, 10th percentile and worst-off shareholder.For those investors who had owned stock for five years or more andwhose firms had 35 percent foreign earnings, the average return (inthe worst 10 percent of the distribution of inversions) was –2.21%.

So if many long-term shareholders lose from inversions, whydo they occur? The authors focus on the difference in returns toCeOs and long-term shareholders. The return earned by CeOs ofinverted companies is different than the return of average share-holders because the CeOs have options rather than stock and thedifference between the option strike price and market price is not acapital-gain taxable event. In their data, the average CeO had capitalgains of $1.3 million and paid a capital gains tax of $538,000, butthey also had increased value of options of $530,000.

In many circumstances, the CeO has incentives to invest thatare not well-aligned with long-term shareholders. The authorsshow that the higher the option compensation of a CeO, thegreater the likelihood of an inversion, controlling for industryand year fixed effects, normal firm characteristics, as well as theforeign share of taxes.

Public Housing and Crime“Externalities of Public Housing: The Effect of Public Housing

Demolitions on Local Crime,” by Danielle H. Sandler. March 2016.

SSRN #2749322.

High-rise public housing has long been associated withcrime in popular culture. This paper examines crimerates at the block level before and after the demolition

of public housing buildings in Chicago from 1995 through 2010.The “treatment” radius is within 0.25 miles of demolition. Thecontrol sample radius is within 3 miles of demolition. Crime isreduced 0.047 crimes per month per block for every 100 unitsdemolished or 2.4 percent for every building demolished. Noincrease in crime occurred within the control area around ademolition, so crime was not merely displaced. For the averagedemolition, total crime decreased by over 8% and murders andassaults decreased by over 30%. R

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SavingCapitalismfrom RobertReich · saving Capitalism: For the Many, not the Few by Robert b. Reich 279 pp.; alfred a. Knopf, 2015. Summer 2016 /Regulation /49 work. He comments,