The market has sent a shot over our bow to tell us that we cannot accumulate budget and trade deficits forever.
The satisfying aspect of Niall Ferguson’s latest book can be described the same way as the unsatisfying aspect: I wanted more. The Great Degeneration: How Institutions Decay and Economies Die comes in at well under 200 pages of large, widely-spaced type, including notes, and is in every way a highly readable book. It is based on a series of BBC lectures. Ferguson has adhered to the wise speaker’s rule, which is the same as Polonius’—that brevity is the soul of wit. For books, this is not always the best rule.
In many ways The Great Degeneration is yet the latest example of the winning strategy (if one wants to sell books, that is) of doomsaying that Matt Ridley argues so powerfully against in The Rational Optimist. Nothing attracts attention quite like the idea that things are about to fall apart. Malthus and his modern-day disciples see the carrying capacity of human ecosystems (a discredited idea if there ever was one) as the constraint. Ferguson sees the constraints coming not from ecology but from the decline of essential institutions, particularly those glorified in the Scottish Enlightenment.
I am sympathetic, at the outset, to the case he is making about the degeneration of our institutions, but despite the provocative title, there is nothing in the book about economies “dying.” A book about how modern economies die ought to present at least one example of such a demise. Even the European economies in the throes of a debt crisis are very unlikely to die. Whether or not the West is thriving, however, is a very different question. To this less hyperbolic question Ferguson answers no, and his explanation of why not is worth noting (though his villains are largely the familiar ones).
The book is largely preoccupied with the recent financial crisis and the resulting recession. Ferguson lays the blame for the crisis at the feet of excessively complex regulation. This directly counters the idea held by many elites that the crisis was the result of deregulation. The problem is, given the enormous complexity of the crisis, this little book is just not the venue to make such a case convincingly.
What the financial crisis shows is that, though the market can go through decades of growth, the world financial system is, indeed, fragile in ways not observed by market players. As a champion of markets and their ability to self-correct, I don’t make such a concession lightly. What became clear during the crisis is that large, interconnected financial institutions were holding securities based on underlying assets whose value was not transparent. When prices and quantities are not transparent, markets do not work. And in finance, where so many of the assets consist of promises for future payment, this can create havoc in very short order.
No regulation or set of regulations or lack of regulations can bear the primary blame for that inherent fragility. Ferguson is right that the complex modern economy is best governed by simple rules—rather than by the hubris of government officials who think they can match that complexity with a correspondingly complex set of rules. But two questions remain: what rules, and who is to oversee it all? This book shows why the simple blame-deregulation story is not convincing, but there are so many rules and actors involved in this saga that the case Ferguson wants to make that over-regulation was the primary cause of the crisis falls short. There were just too many moving pieces to account for in such a small amount of space.
Interestingly, Ferguson’s desired response to the crisis is to go back to a world where, as he puts it, “individual prudence—rather than mere compliance—was the advisable course, precisely because the authorities were powerful and the crucial rules unwritten.” He advocates broad powers for the central banks both in terms of setting monetary policy and supervising the system. He wants those in charge to be “apprehensive as well as experienced” and to have “considerable latitude” in exercising these broad powers.
One might call this the Aristotelian model of financial regulation, based on the practical wisdom of virtuous central bankers. But why should we trust these elites more than regulation? As Ferguson himself asks, “who is to regulate the regulators?” He wants us to trust the wisdom of elites and grant them broad discretionary powers. Given the fragility of the system revealed by the recent crisis, this may be a prudent course, though it is a rather strange prescription for a book about the degeneration of democratic institutions.
The other economic concern of The Great Degeneration is public indebtedness. Here Ferguson relies excessively on Samuel Huntington’s “Great Divergence” hypothesis about Western economic growth compared to the rest of the world, which Ferguson illustrates as the relatively quick decline in the ratio of American to Chinese GDP. I find this change from divergence to convergence rather uninteresting and easily explainable by the relatively rapid rate at which China revamped its economy from oppressive communist control to widespread free enterprise.Ferguson says explicitly that he does not want to talk about the rest of the world with respect to this divergence, which is unfortunate since the story is mostly about the rest of the world—the GDP ratio is now declining rather than growing mostly because of the rise in Chinese GDP (a similar tale is told about the United Kingdom and India).
He opens his argument with concern over the end of U.S.-China divergence, yet closes the book by suggesting that China’s prospects are dim because the Chinese have failed to adopt reforms regarding the rule of law. These two claims make an odd pairing, and neither one has much to do with the decline of Western institutions. Comparing the growth of rich and long-established democracies with the recent growth spurt of China and India does not tell us much of anything about the prospects for economic growth in the West.
Ferguson also makes too much of the intergenerational inequalities involved with public debt. The idea that we are borrowing from the future makes for nice campaign sound bites. But the simple fact is that no one has ever borrowed from the future; we can only borrow from the present. The growing debt burden raises interesting questions about income distributions and economic inequalities across different groups in the future, but little about economic growth.
The exception to this is the rise in debt held by foreigners, particularly in fact China. This would have been an analysis worthy of more attention than Ferguson gives it. The Chinese have decided to subsidize their exports by buying up U.S. debt and keeping their currency weak compared to the dollar. At some point they will stop doing that. This means that Americans in the future (including current borrowers and their descendants) will have to pay back the Chinese, but what will the Chinese do with all those dollars? One thing they will do is increase demand for U.S. exports.
The idea that we are “borrowing from our children” is a misleading and tiresome mantra. Ferguson would have been well-served to pay more attention to the distributional and international issues related to indebtedness, rather than the intergenerational ones. Even more important is the question of where the dollars we borrowed have gone. How government spends its money is a much, much more important question than whether it finances that spending through taxes or debt.
The book’s examples of institutional degeneration that I have covered so far —complex regulation and indebtedness—are attributable in part to a third malady: the decline in the rule of law in favor of “the rule of lawyers.” Ferguson gives a nice description of the importance of the rule of law, particularly the role of property rights, in the success of the West. He also ties this in with a discussion of the superiority of English common law to over-codified civil law systems that piggybacks nicely with his point about the burdens of regulation. He rightly decries the economic burden of rent-seeking, though he has disappointingly little to say about how to reform the underlying institutions that give rise to rent-seeking.
Ferguson’s final example of degeneration is the decline of civil society and the replacement of private associations with the state. This, I believe, is his most profound and compelling critique. And this, in particular, is where I would have liked to see more. His brief analysis of independent (charter) schools was fascinating but didn’t connect much to the extensive empirical literature on the topic. And, of course, the replacement of private associations and initiatives with government ones goes far beyond the case of education. Maybe in the next book?
In the concluding pages, Ferguson does at least bring up the role of technology, though its quick dismissal is the signature flaw of this and many another doomsaying book. Failure to account for technological growth has, since Malthus, been the Achilles heel of the doomsaying industry, at least as far as economic growth is concerned.
Probably the most important chart for the U.S. economy is the most basic one: real per capita GDP. The figure below is from the Federal Reserve Bank of St. Louis and tracks per capita GDP from 1929 through the present. This trend line includes recessions, inflations, wars, and a host of bad policy decisions. The Great Recession has flattened the line since 2008. Ferguson thinks that that flattening will continue. Perhaps this time the doomsayers are right.
Of all the goods created by capitalism, none is more important than knowledge. Anti-capitalists have always failed to understand the intimate and powerful feedback loop between the profit motive and the development of knowledge and technology. Fortunately, Ferguson does understand that relationship. Indeed, the weaknesses he identifies pose a fundamental threat to the continued success of free markets and free societies.
Even though I share his concerns, particularly about the ever-expanding role of the state replacing civil society, I think Ferguson underestimates the power of the “collective brain” that Ridley talks about, and its capacity to generate new technologies. Tyler Cowen is in Ferguson’s camp and makes the claim (in The Great Stagnation) that the low-hanging fruit is mostly gone and we cannot, therefore, expect the sort of growth we saw in the 20th century.
But I remain skeptical of the skeptics. My evidence is that for the past quarter millennium they have always been wrong. A respect for history ought to give that evidence more weight.