Principles of Government

Notes on BALANCE by Glenn Hubbard & Tim Kane –  The book is a review of the experience of great powers in world history and the political and economic lessons to be learned from studying them.  Two thousand years ago, Rome was a stable and prosperous civilization. After 3 centuries of decline from the relentless stagnation of its politics and economic vitality, Rome collapsed. It took a thousand years for civilization and economic prosperity to recover to Rome’s level at its peak.  The decline of Rome was not caused by imperial overstretch or external threat. An examination of history from ancient empires to modern Europe shows that the threat to great civilizations is less barbarians at the gates than self-inflicted economic imbalance within. Over centralization of political power is a common factor in imperial decline. Even when ignorance is not a factor, perverse incentives are. For example, we are well aware of the grave threat to the United States from its runaway national debt. Many plans to fix the U.S Federal Budget would work in a technical sense, but none can be enacted. Our political institutions cannot accommodate them.  The interaction of economics and politics is the game – with governments competing to find the right balance of laws and behaviors that would yield maximum prosperity with minimum instability. There is a rising fiscal imbalance in nearly every advanced industrial economy. What changed to make the U.S debt level alarming was entitlement spending. In 1971, Medicare and Medicaid cost $11 billion, 1 percent of GDP; in 2010 their combined cost was $793 billion, 5.5% of GDP.  Adding social security gets it to 10% of GDP. The CBO projects the 3 programs will cost 15% of GDP by 2030.  The symptoms and causes of the debt crisis for every western nation are well known, but the solutions are difficult, because the political structures that support the entitlements responsible will not allow them to be reformed in a way that is sustainable. We could change the rules of the budgetary game through a fiscal amendment to the Constitution. Great power decline almost always follows the same pattern; denying the internal nature of the stagnation, centralizing power, and mortgaging the future to overspend on the present. Most nations are born and sustained by overcoming crisis. Sweden proved that welfare states can succeed with reforms and Greece seems determined to show how reform can fail. The economic crisis now is a much bigger storm than most people realize, and slower; making it more dangerous.  The world economic system is brittle, with demographics and debt compounding the risks. When great powers in the past declined, they were rarely replaced by challengers. When Rome failed, the world went dark for a thousand years.  Modern economic growth theory suggests that the miracle economies of Asia should be the norm because ideas flow freely and are copyable. Any economy should be able to adopt existing technologies – the best known successful ideas that others have discovered.  GNP is the market value of all final goods and services. Neither used goods nor intermediate goods count. In 1991, we changed from GNP to GDP to include goods made in foreign owned factories in the United States. Economics has been improving for decades in understanding the business cycle, but has failed for years in its analysis of macro trends. PWT stands for Penn World Table, a huge data base of benchmark comparisons. Angus Maddison developed an enormous amount of historical economic data on countries going back two thousand years. His data shows the growth of Soviet GDP from 1950-73 did exceed the U.S growth average, but collapsed soon after. They grew by exhausting physical resources, ignoring pollution, human welfare, investments in technology and workers’ skills. Per capita output and income were lower in 2000 than in 1973. There is a correlation between capital investment and growth rates, but it is growth that starts first and investment follows. The book, Why Nations Fail, by Acemogou and Robinson, explains that the foundation for all the various economic variables is institutions. A society’s economic institutions – property rights, work rules, market freedom – are the main factors that define relative prosperity and growth. There are three main types of growth defined economically. The first is Smithian Growth, resulting from specialization of labor. The second is growth from investment, or Solovian Growth. The third is Schumpeterian Growth, which is innovation sparked growth – technology and ideas – better ways of doing things. Politics explains human progress more than anything else. Technology is a key cause of growth, but it stands on a foundation of institutions. Invention is common, but innovation rare. The successful commercial exploitation and subsequent diffusion of inventions make all the difference economically. Institutions explain innovation. Without the right institutions there is little benefit from invention because its use does not spread. Invention itself relies on institutional ingredients – a free market and a legal system that defends intellectual property, and a stable currency.  All three types of growth rest on a foundation of institutions. Rome’s growth came from the benefits of scale through well supplied cities, through trade networks, secure borders, respect for law and public works. When the institutional development stagnated, so did growth.  Economic power is the foundation of military power. A reduction in military outlays does not automatically translate into a higher growth rate, nor is a higher growth rate incompatible with high military expenditures.  The authors have developed a measure of economic power. Economic power = GDP X productivity X the square root of the growth rate Productivity, used here, is the GDP per capita. For the formula’s math, GDP per capita is shown in thousands and total GDP in trillions. So $41,000 GDP per capita equals 41 and 12 trillion GDP equals 12. History indicates that the biggest threat to great powers is not rising adversaries, empire overstretch, or misallocation between military and economic investment. Great powers lose their leadership when they stop pushing the technological… Read More