Sunday, April 23, 2017

What will government look like after the fourth revolution?

“Democracy in Australia is sinking into a self-destructive spiral. The sickness at its heart is the demise of individual responsibility and expecting more from the state when the national interest says state responsibilities should be cut, not increased. Our democratic system now works to undermine economic progress.”

That is how Paul Kelly, Australia’s most widely respected journalist, concluded an article in The Australian a few weeks ago. The article entitled “Crisis time: We can take a stand – or solve a problem” (probably gated) was published on March 29.

As far as I can see there hasn’t been much public reaction to this article. Only a small proportion of the population read articles of this kind, and most readers would still feel complacent about the Australian economy and the future of democracy in this country. It will become easier to convince people that they should be alarmed about the self-destructive spiral when the crash is imminent. The malfunction began over a decade ago and it might be another decade, or more, before crunch time.

Some other informed commentators take a more optimistic view than Paul Kelly. For example, Gary Banks, former chairman of the Productivity Commission, acknowledges that policy development is now a problem. He has suggested the a “loss of policy capability within government – Commonwealth and State - is palpable and multidimensional”. He is hopeful, nevertheless, that the problem can be ameliorated by improvements to policy-making processes:
Yet, if this diagnosis is correct, there is hope. Unlike the adverse changes evident in our parliaments and media, changes which are arguably reflective of changes in society itself, the decline in capability is not irreversible. Unless it is turned around, however, we cannot tell whether reform has truly become ‘too hard’, as many now seem to assume”.

A few years ago I was similarly optimistic. I still support efforts to improve policy capability within government. I agree with Gary that improvements to the policy-making system are an essential pre-condition for improvements in policy. However, I doubt whether much economic reform will be achievable until we see substantial changes in the rules of the political game that will provide political representatives with appropriate incentives to pursue the broader interests of the community, rather than the narrow interests that too many of them currently seek to protect. And, unfortunately, that seems unlikely to occur until a major economic crisis is upon us.

In his article, Paul Kelly drew inspiration from The Fourth Revolution: The global race to reinvent the state, by John Micklethwait and Adrian Wooldridge. 

The authors of this book make a case that western societies have seen three and a half revolutions in government over the last four centuries:
  • The rise of the nation state in 17th century Europe. Europe’s network of competing Leviathans threw up a system of ever-improving government.
  • The rise of the liberal state in the 18th and 19th centuries following the American and French revolutions.
  • The advent of the welfare state in the 20th century.
  • And the half revolution in the 1980s, associated with economic reforms promoting a partial return to classical liberalism in a few countries.

This history of the revolutions in government seems broadly accurate. Micklethwait and Wooldridge associate each of these revolutions with a notable contributor to ideas about government. In sequence, the four revolutionary thinkers they chose were: Thomas Hobbes, J S Mill, Beatrice Webb and Milton Friedman. It is possible to quibble about that choice, but I will refrain. I want to focus here on what the authors have to say about the fourth revolution.

The authors argue that the fourth revolution is occurring as a result of a confluence of three forces: failure, competition and opportunity.
  • The West has to change because it is going broke:“Debt and demography mean that government in the rich world has to change. … For the foreseeable future the Western state will be in the business of taking things away – far more things than most people realize”
  • Competition from the “Asian alternative” is prompting change:“Chinese-oriented Asia offers a new model of government that challenges two of the West’s most cherished values: universal suffrage and top-down generosity. This ‘Asian Alternative’ is an odd mixture of authoritarianism and small government, best symbolized by Singapore’s long-term ruler, Lee Kuan Yew”.
  • There are opportunities to “do government” better: “New technologies offer a chance to improve government dramatically, but so does asking old questions such as the most basic question of all: “What is the state for?”

So, what will government look like after the fourth revolution? The authors would like to see greater individual liberty emerging as a consequence of reforms that reduce government spending and relieve governments of some of their responsibilities. I would too, but we need to be careful not to confuse what we hope will happen with what we see as most likely to happen.

Micklethwait and Wooldridge published their book a couple of years ago, but it was apparent even then that many voters were becoming cynical about politicians representing the mainstream political parties. The European Union had become a breeding ground for populists who were speaking out against “incompetent and arrogant elites”. Even then, that cynicism was also apparent elsewhere. The authors suggested:
Such cynicism might be healthy if people wanted little from the government. But they continue to want a great deal. The result can be a toxic and unstable mixture: dependency on government on the one hand and disdain for government on the other”.

Perhaps the victories that the populists appear to be winning at the moment will cause the elites to become less complacent, and less incompetent and arrogant. The political cycle may be turning, as Tyler Cowan suggested in The Complacent Class (recently discussed here). Over the longer term, the elites may come to embrace dynamism, rather than protection of their professional turf, so we might see the battle lines being drawn more clearly between dynamism and stasis. That might correspond broadly to Tyler Cowan’s depiction of the political battle as between talent (human capital) and authoritarianism, stemming from underlying fears of disruption. Since this is also a battle between talented young people and fearful old people, in my view the odds favour talent in the longer term.

It would be easier to predict what government will look like after the fourth revolution if some western democracies provided models of a successful revolution in government. Micklethwait and Wooldridge suggest that reforms in Sweden, necessitated by economic crisis, have produced “a highly successful update of the old middle way”. New Zealand provides a model of what effective government can achieve following a natural disaster. The response to crisis in Sweden and New Zealand provides better protection for citizen’s rights than would adoption of something like Lee Kuan Yew’s model of technocratic government. However, democratic government in Sweden and New Zealand might well revert, within a few years, to taking upon itself more responsibilities, until another economic crisis ensues.

It seems to me that the fourth revolution is likely to involve changes in the rules of democratic politics. This might require constitutional change in some countries, but revolutionary change might be possible in Australia and other countries similarly afflicted by voter cynicism and political fragmentation, if the major parties were to adopt a convention for accountable government. What I have in mind is that the major parties should agree that whichever party wins government has a mandate from the people to implement the tax and expenditure policies it has taken to the election. What could be more democratic than that?

Saturday, April 1, 2017

What reasons do we have to look forward to the future?

In his book, Progress: ten reasons to look forward to the future, Johan Norberg spends a lot of time looking back on progress that has been made. 

In brief, his ten reasons for optimism are:
  1. The incidence of famine has declined. Only a few hundred years ago famine was a fairly regular phenomenon, occurring more than twice a century even in countries like France. In recent years the death toll from famine has been only about 2% what it was a century ago, even though the world population has increased fourfold.
  2. Sanitation improvements since the “Great Stink” in London in 1858 have helped improve longevity and reduce infant mortality over much of the world. About two-thirds of the world’s population now has access to proper sanitation facilities.
  3. Average life expectancy in the world is now 71 years, having risen from 31 years in 1900.
  4. Poverty has declined because of economic growth. In the early part of the 19th century the standard of living of the average world citizen was equivalent to that of the average citizen in the poorest countries today (e.g. Haiti, Liberia and Zimbabwe).
  5. Violence has declined. For example, the annual European homicide rate declined from 30 to 40 per 100,000 people in the 14th century to around 1 per 100,000 in recent years.
  6. Although environmental damage tends to increase initially with economic growth it subsequently tends to decrease as people become wealthier. Technological advances seem likely to enable future generations to reduce climate change risks and still enjoy higher living standards.
  7. Literacy levels have risen with economic development. The global literacy rate rose from around 21% in 1900 to 86% in 2015.
  8. Freedom has increased. Slavery is now banned just about everywhere. Democracy now limits the abuse of government power in many parts of the world. Economic freedom has risen: the global average rose from 5.3 to 6.9 on the Fraser Institute’s ten-point scale between 1980 and 2013.
  9. There has been growing recognition of equality of rights, irrespective of ethnicity, gender and sexual orientation.
  10. Children are now seen as worthy of being given the best conditions for a long and happy life, rather than as resources for the household economy to exploit.

Many readers of this blog will probably be thinking at this point that they already knew most of that. However, readers of this blog tend to be exceptionally well informed. In the epilogue of his book Johan Norberg provides evidence that in the broader population most people consistently underestimate the progress that has been made. For example, in the U.S. apparently 66% of the population think that world poverty has almost doubled in the last 20 years, and only about 5% are aware that it has almost halved over that period.

This book provides a vast amount of useful ammunition for those of us trying to get the message across that “the good old days” were not so great.

However, I doubt whether the ten reasons provided will actually encourage many pessimists to look forward to the future. It is too easy to acknowledge the progress that has been made and yet to hold to pessimistic views of the future. The author acknowledges that being worried about the future may be in our genes:
The hunters and gatherers who survived sudden storms and predators were the ones who had a tendency to scan the horizon for new threats rather than those who were relaxed and satisfied”.

The author also acknowledges threats to progress such as large scale war, more extensive terrorism with advanced technology, climate change and more large scale financial crises. He is most concerned that “people led by fear might curtail the freedom and the openness that progress depends upon”.

On a more optimistic note, he observes that in our era of globalization many countries now have access to the sum of humanity’s knowledge and are open to the best innovations from other places. “In such a world, progress no longer depends on the whim of one emperor”.

Johan Norberg’s message is not one of complacency. He claims that the book was written as a warning not to take progress for granted and that is the message of his final sentence:
If progress is to continue, you and I will have to carry the torch”.
That means, in my view, that we will need to encourage people to contemplate optimistic visions of how the future might evolve.

Monday, March 20, 2017

Is the cycle of political complacency beginning to turn in the United States?

The villain in Tyler Cowen’s latest book, The Complacent Class: The self-defeating quest for the American Dream, is “us”. Tyler is writing about America, but much of what he has written is relevant to other high-income countries. The problem, as Tyler sees it, “is that peace and high incomes tend to drain the restlessness out of people”. Many people have become complacent – “satisfied with the status quo”. Most people don’t like change much and “they now have the resources and the technology to manage their lives on this basis more and more, to the country’s long run collective detriment”.

Tyler has not persuaded me that complacency is a problem of itself. It would be nice to be able to feel more complacent. (According to Tyler’s questionnaire - international version here - I am a striver: “You embrace newness, but you need to strive harder to break the mold”.) As I see it, complacency only becomes a problem when people are complacent about things that they have good reason to be alarmed about.

Tyler provides a fair amount of evidence that Americans have become more complacent. For example:
  • ·         People now switch jobs less frequently.
  • ·         Geographical mobility has declined.
  • ·         There has been a decline in start-ups relative to total business activity.
  • ·         There are fewer unicorns (miracle growth firms).
  • ·         Market concentration has risen.
  • ·         There is more pairing of like with like e.g. people are choosing marriage partners with similar education levels, and housing is more segregated by income and race.
  • ·         Upward mobility in income and education has stopped rising.
  • ·         People are now more inclined to stay at home and use delivery services.

That is all very interesting. It changes my perceptions about America. I have to get used to the idea that Americans are no longer as mobile and innovative as they were a couple of decades ago. But that does not necessarily mean that complacency is a problem. If peace and high incomes have made Americans more complacent, isn’t that a good thing? There is not much point in striving for more of anything once you are satisfied with what you have already. How is complacency leading to bad outcomes?

When Tyler looks in detail at some of these changing characteristics, he points to the failure of political decision-making to cope with interest groups seeking to protect themselves from change. How does complacency come into that? The NIMBY advocates who are using their political muscle to protect their interests against higher density building can hardly be described as complacent. The people at Donald Trump’s rallies who are supporting his policies to protect jobs - by reducing immigration and constraining import competition - do not seem complacent. The complacency must lie with the general public, who are not yet sufficiently outraged by the stasists to cast their votes for candidates who will constrain their political influence.

Tyler’s discussion of declining geographical mobility provides a good example of political market failure. He points to research showing potential for a substantial increase in GDP if more people were to move from low-productivity cities to high-productivity cities. Regulatory constraints prevent this from happening:
“Residents in Manhattan, San Francisco, and many other high-productivity locales just don’t want all of those new people moving in, and so they have passed overly strict building and land use regulations or in some cases they have limited infrastructure so that adding more residents just isn’t practical. Without good bus or subway connections, for instance, a lot of neighbourhoods just don’t work for people with jobs downtown”.

Tyler uses the terms ‘stasis’ and ‘dynamism’ quite frequently in this book, but I couldn’t find any reference to Virginia Postrel’s pathbreaking book on this topic, The Future and Its Enemies, published 18 years ago (my discussion here). I would have been satisfied with a footnote to explain how Tyler’s views build on, or differ from Virginia’s views. Similarly, it would have been nice to see a footnote discussing the affinity between Tyler’s views and Mancur Olson’s argument that stable societies tend to accumulate distributional coalitions that slow down their capacity to adopt new technologies and reallocate resources. See: The Rise and Decline of Nations.

Early in the book Tyler suggests that “the growing success of the forces for stasis” are linked to complacency. That argument has most force it the final chapters of the book where he discusses politics.

Tyler makes the point that much of the U.S. federal government budget is locked in to spending programs that are politically untouchable. Political change occurs at the margin and is the result of complex battles among interest groups, political manoeuvring and use of public relations campaigns. The Trump administration is unlikely to change this situation much. The pre-allocation of tax revenues will ultimately become unsustainable:
“At some point this country will face an immediate crisis, and there won’t quite be the resources, or more fundamentally the flexibility to handle it”.

Tyler presents a view about the tendency of governments to take on more responsibilities than they can cope with effectively that is similar to the view I expressed in Chapter 8 of Free to Flourish. I argued that there is a growing gap between the expectations that many people have of what democratic governments can deliver and what they are capable of delivering.

However, Tyler seems to present a more optimistic view of the ability of western democracies to reform themselves rather than to collapse and to be replaced by authoritarian regimes. That is just my impression. I find it hard to point to particular passages that support that view. The scenario that Tyler presents of a possible future that would be more dynamic does not feature less dysfunctional government, although smaller government may be implied.

Although I'm not sure why, after reading the book I was left feeling hopeful that the cycle of political complacency has reached its peak and that, over the next few years, American politics might become less shrill and more focused on problem solving. Perhaps the actions of the Trump administration will further erode political complacency in ways that will lead to a public reaction favouring a more constrained role for government. So, democracy will probably survive in the U.S. I’m also reasonably confident that a fiscal crisis in Australia will eventually result in rule changes needed to make democracy sustainable in this country. I’m less complacent about the future of democracy in some of the countries of southern Europe. 

Tyler Cowan has provided some grounds for optimism in a recent Cato article entitled "Between authoritarianism and human capital". An extract:

"So we’re going to see a kind of intellectual war, and possibly war in other, more violent forms too. That war, using that word in the broadest sense possible, will be between today’s amazing accumulated stock of human capital — and the emotional momentum behind authoritarianism, which is encouraged by the political fraying that stems from underlying fears of disruption.
Right now, I’d still put my money on the positive side of talent and human capital. But in recent times, I can’t say I’ve seen the odds moving in my favor."

Friday, March 10, 2017

Should trade policy be about "the art of the deal" or about facilitating economic growth?

"We must protect our borders from the ravages of other countries making our products, stealing our companies, and destroying our jobs.  Protection will lead to great prosperity and strength" - Donald Trump, Inaugural Address, Jan. 20, 2017 

How should the Australian government respond to the potential for the crazy trade policies of President Trump to take the world into a new era of trade protectionism? Since Trump’s inauguration the depth of his commitment to trade protectionism has become clearer. In my view we should be prepared for the unravelling of much of the international trade liberalisation encouraged by the U.S. in the latter half of the 20th Century.

If the Australian government continues with the current directions of international trade policy – viewing trade policy from an economic diplomacy perspective – there is a real risk that it will take ill-considered retaliatory action to foreign protectionism. Politicians who put their faith in trade diplomacy – the art of the export deal – think that they are pursuing the national interest when they make access to the Australian market contingent upon foreigners allowing our exporters to gain access to their markets. In terms of that mindset, if foreigners restrict access to their markets, it would appear logical for us to retaliate.

By contrast, political leaders who view trade policy as part of economic growth policy are more likely to keep in mind that the substantial trade liberalisation effort that Australia has made over the last 40 years has occurred unilaterally, rather than as part of any international deal. A growth policy perspective recognises the contribution that unilateral trade liberalisation has made to our prosperity.

The substantial trade liberalisation efforts made in Australia since the beginning of The Tariff Review, established in 1971, have all occurred for domestic reasons. Except for the 25 percent tariff cut of 1973, which was motivated primarily by macro-economic objectives, all of the reductions in industry assistance have occurred primarily to promote the micro-economic reform objective of providing incentives for greater productivity throughout the economy. That applies to reductions in non-tariff barriers, including reform of agricultural marketing arrangements, as well as reductions in reductions in tariff barriers.

As with other microeconomic reform policies, trade liberalisation efforts in Australia have not been pursued with equal enthusiasm by all governments. However, a sustained push toward trade liberalisation was initiated by Bob Hawke (then prime minister) and Paul Keating (treasurer) in May 1988 as part of a major package of microeconomic reform measures. In delivering the statement, Keating commented:
The way forward for Australia is not to be closeted and sheltered, but to be open and dynamic, trading aggressively in the world. Only this kind of economy can provide the employment and rising living standards that Australians aspire to”.

In the light of the toxic political environment currently prevailing in Canberra it is worth remembering that those reforms were facilitated by support from the Liberal–National Party Opposition.

The trade liberalisation that was being undertaken in pursuit of microeconomic objectives was subsequently ­offered, and accepted, in Uruguay negotiations as our market-opening contribution to global trade reform. As the Tasman Transparency Group has noted, this approach enabled us to secure all the gains available from trade negotiations — the major gains in efficiency from reducing the barriers protecting our less competitive industries, as well as those available from access to external markets. That exercise should have provided the model for all subsequent international trade negotiations.

Unfortunately, the opportunity for further gains from the pursuit of microeconomic reforms has been missed in subsequent trade negotiations. Australia’s agenda in recent negotiations establishing a range of preferential trading agreements (PTAs) was simply a market access wish list. Following the conclusion of PTAs, governments have measured their success solely on the basis of whether the outcomes improved access to external markets.

The academic research that the Department of Foreign Affairs and Trade is now sponsoring on “the effectiveness of economic diplomacy in contributing to Australia’s exports and inflow of foreign investment” does not seem to be directed at answering a comprehensible, policy-relevant question. Research being undertaken by the Productivity Commission on implications for Australia’s trade policy of possible international shifts towards a more protectionist stance seems more likely to provide a basis for sensible policy development.

Previous research on the consequences of PTAs suggests that there are no grounds for complacency that the economic benefits even exceed costs. For example, using an analytical framework developed by the Productivity Commission to assess our much-heralded trade agreement with the United States, Australian National University economist Shiro Armstrong found that the agreement was responsible for reducing — or ­diverting — $53.1 billion of trade with the rest of the world. He has suggested that “the data shows that … Australia and the United States … are worse off than they would have been without the agreement”. 

Recent Australian governments have at times acknowledged that trade policy should be part of a wider productivity promoting agenda. Nevertheless, the government seems to have been at a loss to know how to counter the argument that Australian governments should be seeking to provide a level playing field for domestic industries vis a vis subsidized foreign competitors. This argument has figured prominently in lobbying in some quarters for further government assistance by way of anti-dumping action and government procurement preferences. The government has been slow to point out that if we are to use a playing field analogy – and our interest is in promoting the wellbeing of Australians rather than conducting trade wars – the relevant basis for comparison is the relative assistance levels of different Australian industries. As a rule, if industries need assistance to compete internationally, they can’t be making efficient use of resources. 

If the Australian government is serious about its commitment to lift national productivity it should place trade policy in the Treasury department – the department with central responsibility for facilitating economic growth. This would add some much-needed economic discipline to the conduct of trade policy as we face a more difficult world trading environment. The last thing we need in this environment is a bureaucratic structure for trade policy that is biased toward mindless deal-making and retaliation