Joel Waldfogel on Digital Renaissance

WaldfogelThe digital revolution poses a mortal threat to the major creative industries—music, publishing, television, and the movies. The ease with which digital files can be copied and distributed has unleashed a wave of piracy with disastrous effects on revenue. Cheap, easy self-publishing is eroding the position of these gatekeepers and guardians of culture. Does this revolution herald the collapse of culture, as some commentators claim? Far from it. In Digital Renaissance, Joel Waldfogel argues that digital technology is enabling a new golden age of popular culture, a veritable digital renaissance

Are we living in a digital renaissance? How can we tell?

We are absolutely experiencing a digital renaissance. There are a few big signs. The first is the explosion in the number of new cultural products being created. The number of new songs, books, movies, and television shows created and being made available to consumers has increased by large amounts. There has been a tripling in the number of new songs, and similar growth rates for other sectors.

Of course, quantity alone is not enough to qualify a renaissance. What makes the recent period a renaissance is that the recent crops of new products are appealing to consumers, compared with old products. By various measures, new music, television shows, books, and movies are really good compared with earlier vintages.

And finally, we know it’s a digital renaissance because the higher quality of the new vintages is driven by the products made possible by digitization, i.e. new technologies that make it possible for small-scale creators and intermediaries outside of the traditional mainstream to bring products to market. The fruits of the digital renaissance include the music on independent record labels, the self-published books, movies from independent film makers, and television shows distributed outside of the traditional distribution channels. Again, many of these new products are created and distributed without the support of the traditional cultural gatekeepers (major record labels and movie studios, traditional television networks, and major publishing houses).

What will happen to traditional gatekeeping? Is it going away or will we see the creation of new gatekeepers?

First, while lots of creation now happens outside of the traditional gatekeepers, those traditional gatekeepers still have an important role. Once an artist has demonstrated his or her commercial promise, the traditional players are well-placed to bring new works to a large audience. Quite often, an artist will become known using independent channels and will then get snapped up by a traditional player. This happened with the famous self-published Fifty Shades books, and it happens with many musical acts—think Arcade Fire—whom consumers first encounter on indie labels.

Even though digitization has allowed a lot of people to create their work and put it in front of potential audiences, consumers have limited attention and limited capacity to figure out which of the new products are good. This puts a lot of power in the hands of new kinds of gatekeepers, the people choosing the content at Netflix, or the people deciding which products to recommend at Spotify or Amazon.

Why has piracy been a bigger problem for some creative industries over others?

Music faced piracy first and had to “write the book” on how to respond. It’s hard to go first since there are few examples to follow. It took the music industry four years to respond to Napster, until the iTunes Music Store. For four years there were convenient ways to steal music digitally but no convenient way to buy it. In the meantime, many consumers had become accustomed to getting music without paying. Music also had the problem that digital music files are small enough to move quickly over the Internet, while movie files were initially too large.

The industries hit after were also able to learn from the experience of the music industry, and responded more quickly. For example, roughly a year after the appearance of YouTube, the major television networks were making their shows available online free of charge.

Having convenient ways to buy digital products goes a long way toward stemming piracy. One of the first impacts of Spotify—the streaming music service—was to substantially reduce music piracy. More recently, Spotify (and other paid subscription services) have also reversed the long decline in music revenue.

What are your thoughts on copyright law in the United States? Does it need to be stricter? Better enforced?

The reason we have intellectual property rules, such as copyright laws, is to provide incentives for people to create. The goal is to make sure there is a steady supply of new products that consumers find appealing.

The digital era has ushered in a great deal of piracy and has therefore threatened the revenue of creators and intermediaries. If that’s all that digitization had done, then we would expect a drop off in creative activity. And we would need a stiffening of copyright enforcement just to keep creative incentives where they were.

Fortunately, digitization has also reduced the costs of creation and distribution, along with its facilitation of piracy. And the net effect of those two offsetting forces has been to unleash a large amount of good new creative production.

Many people in the creative industries would like to see stronger enforcement of intellectual property protections. They may be right, for a variety of reasons, including just respect for property rights. But the evidence in the book shows that we don’t need a strengthening of intellectual property rights in order to maintain the creative incentives that prevailed before Napster. We are, after all, experiencing a digital renaissance.

When representatives of creative industries lobby for stricter copyright protections, are their arguments sound? How should we assess the health of their industries?

The creative industries are really good at what they do, particularly in the US. And during the digital era many creators and intermediaries have felt real pain. U.S. recorded music revenue fell  by more than half in the decade after Napster. Moreover, users in many countries have blithe disregard for intellectual property. When the industry points out these facts, they are telling the truth.

But the pain of a particular industry is not as relevant to public policy as its output. If the creative industries could no longer cover costs of creating new products and new creative activity dried up, then we would require changes in public policy to keep the consuming public happy.

When the industries go before Congress for legislative assistance to protect their revenues, however, it should be to secure a steady supply of good new products, not to protect their revenues and incomes for their own sakes.

We should assess the intellectual property regime according to whether we are seeing a steady and robust supply of new products that consumers find appealing. And that we are.

How does the old adage “Nobody knows anything” come into play in this new era of digitization?

New products in most industries typically fail. Nowhere is this more common than in the creative industries, where roughly 90 percent of new products fail to generate enough revenue to cover their costs. This “hit or miss” aspect to creative production is what makes an explosion in new products so potentially valuable.

To see this, suppose that everyone knew everything, meaning that intermediaries could accurately predict which new products would find favor with consumers. Then a cost reduction giving rise to new products would bring forth the products that were not sufficiently promising to be worth delivering before. There would be some benefit to consumers, but it would be small.

Contrast that to the real world, in which we can’t really predict which products will be good before we spend the money to test them with consumers. In that—our real—world, a tripling in the number of new products brings with it lots of unsuccessful ones as well as some really successful ones that consumers find valuable.

What are the potential pitfalls of digitization in the creative industries? What should we be wary of?

Two things come to mind. First, there is so far no evidence that the undermining of creative nurture by the traditional intermediaries— the publishers, movie studios, and record labels, for example—has undermined the quality of new products, at least in the sense of being appreciated by contemporary fans and consumers. But it will be interesting to see whether the fruits of this era are still appreciated 25, 50, or 100 years from now.

Second, the new digital economy is increasingly dominated by a small number of players. These include Google and Facebook, Apple and Amazon, and Netflix and Spotify. So far, most of what these players have done has helped to deliver the renaissance. But many of these players could become influential gatekeepers, with outsized influence on what succeeds. I don’t see any evidence of this yet, but it’s something we should be watchful about. What makes things worse is that most of these players keep their data secret, so it’s really hard to know what’s happening to the consumption of particular products. This, in turn, makes it hard to keep tabs on the health of the industries. The digital renaissance can continue only as long as a large swath of creators can continue to create, and audiences can discover the new works.

Joel Waldfogel holds the Frederick R. Kappel Chair at the University of Minnesota’s Carlson School of Management. His previous books include Scroogenomics: Why You Shouldn’t Buy Presents for the Holidays. He lives in Minneapolis.

Louise Shelley on Dark Commerce

ShelleyThough mankind has traded tangible goods for millennia, recent technology has changed the fundamentals of trade, in both legitimate and illegal economies. In the past three decades, the most advanced forms of illicit trade have broken with all historical precedents and, as Dark Commerce shows, now operate as if on steroids, tied to computers and social media. In this new world of illicit commerce, which benefits states and diverse participants, trade is impersonal and anonymized, and vast profits are made in short periods with limited accountability to sellers, intermediaries, and purchasers. Demonstrating that illicit trade is a business the global community cannot afford to ignore and must work together to address, Dark Commerce considers diverse ways of responding to this increasing challenge.

What led you to write this book?

My last book, Dirty Entanglements: Corruption, Crime and Terrorism, pointed to the centrality of illicit trade as a funding mechanism for terrorism and transnational crime. As I finished that work, I realized that illicit trade was at the core of many of our most critical contemporary problems—the perpetuation of conflict, environmental degradation, and the destruction of human life. I wanted readers to understand that there are many who profit from this dark commerce, not just those associated with traditional crime groups. I wrote this book as a wake up call to the existential challenges that we now face from the many diverse participants in illicit trade.

How has illicit trade changed profoundly with the advent of computers and social media?

In the last three decades, the most advanced forms of illicit trade have broken with all historical precedents. Old forms of illicit trade persist that have been in place for millennia, but the newest forms operate as if on steroids, tied to computers and social media. Illicit trade is developing rapidly in all sectors. No area of this trade has diminished in its volume or its geographic reach, as technology is a driver of the growth of illicit trade.

In this new world of illicit commerce, trade is impersonal, anonymized, and vast profits are made in relatively short periods. There is limited accountability to sellers, intermediaries, and purchasers. New technology, communications, and globalization fuel the exponential growth of many of the most dangerous forms of illegal trade—the massive sales of narcotics and child pornography online; the escalation of sex trafficking through web and social media-based advertisements; and the sale of endangered species for which revenues now total in the hundreds of millions of dollars.[1]

In the cyberworld—particularly its most hidden part, the Dark Web (entered only through special anonymizing software such as TOR)—payments no longer occur with state-backed currencies, as customers pay for their purchases in a plethora of new anonymizing cryptocurrencies of which Bitcoin is the best-known. Moreover, in this illicit world, the very commodities have changed— many can no longer be touched or exchanged through human hands. Rather, many of the most pernicious illicit traders buy commodities based only on algorithms, including malware, Trojans, botnets, and/or ransomware (denies users access to their data), marketed by malicious suppliers in both the developing and developed world.[2]

Is illicit trade less of a problem in developed countries such as in the West, or is it a problem everywhere? Many potential readers may think of illicit trade as something that is far removed from them in their everyday lives. To what extent, if at all, is this an illusion? 

Many think that the problems of illicit trade are most pronounced in the developing world, and that the developed world is largely exempt. Clearly the markets of less industrialized countries are filled with numerous types of harmful counterfeit goods such as medicines, pesticides, and electronic parts. But dangerous counterfeit medicines have penetrated the supply chain of developed countries as well. Deadly drugs such as fentanyl are readily accessible through the web and the Dark Web, and they contributed to the death of over 72,000 Americans from drug overdoses in 2017. Consumers in the developed world purchase large quantities of fish that have been caught outside of approved catches, and timber that has been cut illegally and then transformed into furniture or plywood.

The changes brought by technology are most evident in the G7 countries—the largest economies in the world—but they are by no means confined to them. Investigations of computer-facilitated crime have identified their impact in the vast preponderance of the world’s countries. For example, in one recent online ransom attack victims were identified in over 180 countries.[3]

How has illicit trade contributed to current global conflicts?

Illicit trade plays a significant role in global conflicts, one example being the crisis in Syria. The Syrian crisis started with a drought. The subsequent illicit trade in water rights that made agricultural life impossible resulted in millions migrating to marginal communities on the fringes of cities where they were neglected by the state. To give you an idea of scale, there were 8.9 million Syrians city dwellers before the American invasion of Iraq in 2002. By 2010, 13.8 million. Of this almost 5 million person rural exodus, approximately 1.5 million were fleeing the drought.[4] The story of the Syrian drought refugees does not end with the beginning of the Arab Spring. Rather, it is the beginning of a “domino effect.” The Syrians departure from rural areas was the first phase of a longer trajectory that then took a more tragic course. These rural to urban migrants had to then flee civil war and destruction, many becoming illegal migrants relying on smugglers. The Syrian case is one of the worst examples of the growth of regional conflicts that has characterized the post-Cold War period. Illicit trade has funded many of the most important disputes and clashes of recent decades in the Middle East, Africa, Latin America, Asia, and between Russia and Ukraine.[5] The illicit goods associated with conflict include not only arms, drugs, and humans, but also consumer goods, counterfeits, and natural resources such as oil, minerals, gold, and coltan—ubiquitous in mobile phones and laptops.

What do you hope readers will take away from reading this book?

Illicit trade has survived for millennia, but it has expanded in recent decades as the financial advantage grows in an ever more competitive and globalized world. The profit from this trade can be more than financial. States obtain political advantage as a result of illicit commerce, a phenomenon as old as the raids on the pirate ships of antiquity and the theft of new technologies. Yet its costs today are even higher and command greater priority from the global community.

Is there any good news in this story? Are we finding ways to combat illicit trade?

Countering illicit trade requires serious and concerted action by different sectors of society working together. We need a multilateral approach that encompasses governments, organizations, businesses, community groups, NGOs, journalists, and others working together to find effective ways to combat illicit trade. Already, exceptional individuals risk their lives for this objective, including activists and investigative journalists who counter human trafficking, the drug trade, illegal timber harvesting, and illicit financial flows. Many honest members of law enforcement are on the front lines against illicit trade, dying in the line of duty annually as they try to save human lives and protected species. New technology and data analytics tools are being developed by the government and the private sector to counter the growth of illicit trade, particularly in the cyberworld. Many individuals are involved at the local level in their communities to prevent harm to all forms of life. All these efforts must be enhanced and coordinated. Finally, citizens as consumers have an important role to play as individuals demanding more of corporations to counter the abuse of the new technology they control.

Louise I. Shelley is the Omer L. and Nancy Hirst Professor of Public Policy and University Professor at George Mason University’s Schar School of Policy and Government, and founder and director of its Terrorism, Transnational Crime and Corruption Center. Her many books include Human Trafficking and Dirty Entanglements. She lives in Washington, DC.

**

[1] Larry Greenmeier, “Human Traffickers Caught on Hidden Internet,” February 8, 2015,  https://www.scientificamerican.com/article/human-traffickers-caught-on-hidden-internet/ and also the accompanying visualization that reveals the international links, Scientific American Exclusive: DARPA Memex Data Map. Accessed July 13, 2017, https://www.scientificamerican.com/slideshow/scientific-american-exclusive-darpa-memex-data-maps/; Channing May, Transnational Crime and the Developing World (Washington, D.C.: Global Financial Integrity, 2017), xi.

[2] Ransomware is extensively used in India, see CSIS, “Net Losses Estimating the Global Cost of Cybercrime: Economic Impact of Cybercrime II,” June 2014, 15, http://www.mcafee.com/us/resources/reports/rp-economic-impact-cybercrime2.pdf, accessed Jan. 23, 2017. A major analyst of the Dark Web suggests that ten percent of the content of the dark web consists of this stolen material.

[3] Investigators identified 189. Joe Mandak, “Prosecutor’s Office Paid Bitcoin Ransom in Cyberattack,” December 5, 2016. Accessed July 15, 2017,  https://phys.org/news/2016-12-prosecutor-office-paid-bitcoin-ransom.html; Complaint U.S. Government vs. flux and flux 2, filed November 28, 2016. Accessed July 15, 2017, https://www.justice.gov/opa/page/file/915216/download; “Avalanche” Network Disrupted in International Cyber Operation,” December 1, 2016.Accessed Feb. 1, 2017,https://www.europol.europa.eu/newsroom/news/%E2%80%98avalanche%E2%80%99-network-dismantled-in-international-cyber-operation This is the Avalanche case discussed in chapter five.

[4] Ibid.; Collin Kelley et. al. “Climate change in the Fertile Crescent and implications of the recent Syrian drought,” pnas,  vol. 112 no. 11, 3241-46; http://www.pnas.org/content/112/11/3241.full, accessed March 6, 2016.

[5] Paul J. Smith, The Terrorism Ahead: Confronting Transnational Violence in the 21st Century, (London and New York: Routledge, 2015), 151-2.

Şevket Pamuk discusses the first comprehensive history of the Turkish economy

The population and economy of the area within the present-day borders of Turkey has consistently been among the largest in the developing world, yet there has been no authoritative economic history of Turkey until now. In Uneven Centuries, Şevket Pamuk examines the economic growth and human development of Turkey over the past two hundred years.

Taking a comparative global perspective, Pamuk investigates Turkey’s economic history through four periods: the open economy during the nineteenth-century Ottoman era, the transition from empire to nation-state that spanned the two world wars and the Great Depression, the continued protectionism and import-substituting industrialization after World War II, and the neoliberal policies and the opening of the economy after 1980. Making use of indices of GDP per capita, trade, wages, health, and education, Pamuk argues that Turkey’s long-term economic trends cannot be explained only by immediate causes such as economic policies, rates of investment, productivity growth, and structural change.

What did you try to do in this book ? / What does this book try to do?

This book examines economic growth and human development in Turkey during the last two centuries from a comparative global perspective. It establishes in both absolute and relative terms Turkey’s record in economic growth and human development and evaluates both the proximate and deeper causes of this record.

Why did you choose to focus on the last two centuries?

The Industrial Revolution that began in Great Britain in the second half of the eighteenth century had far reaching consequences not only for Western Europe but also for the rest of the world. During the next two centuries, along with industrial capitalism, modern economic growth spread unevenly across the globe. Most of the patterns of development as well as the disparities we observe around the world today have emerged during the last two centuries.

What is your main argument?

After studying the case of Turkey, I came to the conclusion that economic variables are necessary for understanding long term economic development but they do not tell the whole story. Long term economic development cannot be fully understood without taking into account the social and political environment as well as the historical causes.

What relevance does the book have for those interested in the developing countries and the economic history of developing countries?

Turkey is one of the larger developing countries. Like other developing countries, Turkey’s institutions and economy have received their share of influences from the outside. In each of the four historical periods I examine in the book, governments in Turkey pursued economic policies similar to those of other developing countries. Moreover, Turkey’s long term economic performance has been close to both the world and developing country averages during the last two centuries. For these reasons and in contrast to the more successful developing countries, Turkey is a more representative case and offers more insights into the experiences of other developing countries. Yet, in contrast to the more successful cases, Turkey’s long term economic development has not been studied well. An economic history of Turkey during the last two centuries has not previously been available in any language.

What are Turkey’s special features, in your opinion?

As is the case of other developing countries, Turkey’s institutions and economy have certainly been influenced by global forces and institutions. One of the special features of Turkey is that it has not experienced colonial rule in history. The area within the present borders of Turkey was part of a large multi-ethnic empire until the end of World War I and modern Turkey emerged as one of the successor states after the end of the Ottoman Empire. As a result, Turkey’s institutions during the last two centuries were shaped, in addition to the global influences, by the interaction between the new institutions shaped by the elites of the new nation state and those that existed, including the Islamic-Ottoman institutions of the earlier era.

Şevket Pamuk is professor of economics and economics history at Bogaziçi University in Istanbul. His books include A Monetary History of the Ottoman Empire and The Ottoman Empire and European Capitalism, 1820–1913.

 

 

 

 

 

 

 

 

Ten years on from the collapse of Lehman Brothers: A Reading List

Gennaioli & ShleiferA Crisis of Beliefs by Nicola Gennaioli and Andrei Shleifer makes us rethink the financial crisis and the nature of economic risk. In this authoritative and comprehensive book, two of today’s most insightful economists reveal how our beliefs shape financial markets, lead to expansions of credit and leverage, and expose the economy to major risks. They present a new theory of belief formation that explains why the financial crisis came as such a shock to so many people—and how financial and economic instability persist.

To mark the 10th anniversary of the collapse of Lehman Brothers on September 15, 2008, these books shed light on the causes and effects of the financial crisis, and make suggestions for where we should go from here. 

 

 

Sandbu

Europe’s Orphan: The Future of the Euro and the Politics of Debt – New Edition
Martin Sandbu

brunnermeier

The Euro and the Battle of Ideas
Markus K. Brunnermeier, Harold James & Jean-Pierre Landau

Acharya

Guaranteed to Fail: Fannie Mae, Freddie Mac, and the Debacle of Mortgage Finance
Viral V. Acharya, Matthew Richardson, Stijn Van Nieuwerburgh & Lawrence J. White

Admati

The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It – Updated Edition
Anat Admati & Martin Hellwig

Akerlof

Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism
George A. Akerlof & Robert J. Shiller

Bernanke

The Federal Reserve and the Financial Crisis
Ben S. Bernanke

Cochrane

The Squam Lake Report: Fixing the Financial System
Kenneth R. French, Martin N. Baily, John Y. Campbell, John H. Cochrane, Douglas W. Diamond, Darrell Duffie, Anil K Kashyap, Frederic S. Mishkin, Raghuram G. Rajan, David S. Scharfstein, Robert J. Shiller, Hyun Song Shin, Matthew J. Slaughter, Jeremy C. Stein, and René M. Stulz

Rajan

Fault Lines: How Hidden Fractures Still Threaten the World Economy
Raghuram G. Rajan

Reinhart

This Time Is Different: Eight Centuries of Financial Folly
Carmen M. Reinhart & Kenneth S. Rogoff

Shiller

Irrational Exuberance: Revised and Expanded Third Edition
Robert J. Shiller

Shiller

The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do about It
Robert J. Shiller

Turner

Between Debt and the Devil: Money, Credit, and Fixing Global Finance
Adair Turner

Kip Viscusi: Pricing Lives for Policies in 2018

ViscusiAfter major catastrophes, there are often tallies of economic damages. The loss of life is often relegated to being the object of thoughts and prayers, but such losses have substantial economic value as well. Take two examples: the collapse of the bridge in Genoa, Italy on August 14, 2018, that killed 43 people; and the tourist Duck boat sinking on July 19, 2018 in Branson, Missouri that killed 17 people. How should we think about the economic value of preventing these deaths?  Court awards after fatalities are often modest, typically focusing on the earnings loss of the deceased. The approach I advocate to value fatality risks in a wide variety of situations is to use the value of a statistical life (VSL). The VSL corresponds to how much society is willing to pay to prevent a small risk of one expected death. In my book, Pricing Lives: Guideposts for a Safer Society, I estimate that the VSL in the U.S. is $10 million.

Turning to these two recent catastrophes, let us calculate the economic value of the loss. The Genoa bridge collapse involved a heavily used motorway bridge, the Morandi Bridge. A 657 foot section of the bridge with dense traffic fell 148 feet. How much would it have been worth to spend in advance of the bridge collapse to prevent it from occurring? Based on my estimates of the VSL for Italy, the economic value of this loss was $243 million, in addition to the property damage and injury costs, bolstering the importance of providing a safer infrastructure. The Duck boat incident involved a capsized tour boat during a major storm while the boat was touring Tale Rock Lake. Preventing the Duck boat disaster would have been worth at least $170 million. With at least 20 additional more people killed in Duck boat accidents since 1999, there are clearly substantial economic benefits to greater safety measures than those that have been in place.

The most frequent use of the VSL in valuing lives for government policy is prospective rather than such retrospective calculations. On August 21, 2018,  the Environmental Protection Agency (EPA) announced a relaxation of air pollution standards that according to EPA estimates would lead to as many as 1,400 health-related deaths per year (NYT, Aug. 21, 2018, “Cost of New E.P.A. Coal Rules: Up to 1,400 More Deaths a Year.”). This startling risk estimate corresponds to an annual economic loss of $14 billion. This mortality cost should loom large in any balancing of benefits and costs of the regulatory relief effort and may well offset the purported economic benefits of deregulation. The EPA news release for the Affordable Clean Energy Rule estimated that this rule, which was targeted at providing relief to limits on coal-fired power plants, would generate $400 million in compliance costs and $400 million in additional emissions reduction benefits. Actual benefits and costs will depend on implementation of the relaxed pollution rules by the states.

While the VSL has been adopted most widely in setting government safety standards, it also provides the appropriate guidepost for setting penalty levels intended to serve a deterrence function, which is the usual province of punitive damages. How much should the courts penalize those responsible for deaths or catastrophic injuries? Jury instructions are not particularly helpful in enabling juries to select a punitive damages award, but the VSL provides precise guidance. The class action suit verdict against Johnson & Johnson in St.Louis, Missouri, on July 12, 2018 awarded damages to 22 women claiming injuries related to asbestos in talcum powder. Each woman received $25 million in compensatory damages, for a total of $550 million, and the group received an additional $4.14 billion in punitive damages. This blockbuster award had no sound rationale. If the desire is to properly deter firms from marketing risky products in the future, then the awards linked to the VSL are sufficient. The result would be a payment of $10 million each plus any additional medical expenses. Appropriate penalties on the order of $220 million plus all medical expenses would total far less than the award of $4.69 billion, but would still suffice in giving Johnson & Johnson the right incentives to avoid future risks.

The settlement amount for unwarranted police shootings likewise could be linked to the VSL. If the objective it to send the appropriate financial signals to the police to stop such behavior, settlements equal to the VSL will suffice. Of the 9 publicized police settlements after victim deaths, the median settlement is only $5 million, and only one settlement has been over $10 million. In this instance, using the VSL as the guidepost would put the settlement amounts on sounder footing. At present, all but one of these settlements has fallen short of a more pertinent safety-enhancing level.

What these examples indicate is that the VSL enables us to assess the value of mortality risks in a wide variety of situations. To date, government agencies throughout the world have adopted the VSL in assessing the likely economic benefits of risk and environmental regulations. Greater use of this approach by corporations, government agencies, and the courts would eliminate the systematic underpricing of life that often occurs.

W. Kip Viscusi is the University Distinguished Professor of Law, Economics, and Management at Vanderbilt University. His many books include Economics of Regulation and Antitrust and Fatal Tradeoffs: Public and Private Responsibilities for Risk.

How the big pieces fit together: Europe’s place in the multipolar world

by Dr. John C. Hulsman

Introduction: The Lesson of the G7 train wreck

It’s official. After the calamitous G7 summit meeting in Canada, it is clear that an unbound Donald Trump is Europe’s worst nightmare. Although with typical unnecessary narcissism, he came late and left early, what Donald Trump did in his few short hours on Canadian soil will be commented on for years, as he emerged as a virtual caricature of everything Europeans hate about Americans.

Preternaturally over-confident and under-prepared, arrogant, and self-regarding, the president urged Russia be readmitted to the G7 club (despite its iron-clad control of Crimea and ruination of eastern Ukraine), doubled down on enraging European and Canadian allies alike over the brewing trade war (‘America is not a piggy bank’), and generally confirmed everyone’s worst fears that the White House actually prefers dealing with America’s authoritarian foes, such as China’s Xi Jinping, North Korea’s Kim Jong-un, and Russia’s Vladimir Putin, rather than the vexing, well-meaning, but weak democratic pygmies who populate the standard multilateral meeting. Surely, after such an odious display the rest of the democratic world must rise up in righteous indignation and…

Well, the best I can come up with is snub Trump administration appointments at formal cocktail parties. For the bleak truth lying behind Donald Trump’s appalling, wrong-headed policies and behaviour in Canada is that the rest of the democratic world is pathetically weak and bereft of agency. As such, while they seethe with disgust at having to put up with the odious president, there is nothing practically they are prepared to do to stop him. This most transactional of presidents has inadvertently but graphically illustrated how practically irrelevant America’s western allies, particularly in Europe, truly are.

Be careful what you wish for

This is all so different from the dreams of a new multipolar world that so animated European thinkers during the long days of the bipolar Cold War. Then, European policy intellectuals—particularly in France—dreamed of living in a multipolar age that would follow victory over the Soviet Union in the Cold War, a time when Europe would finally achieve the strategic flexibility to have its own independent foreign and security policy, no longer shackled to (but still vaguely allied with) the US. But this long-term strategic goal amounted to little more than emotional wish-fulfilment, predicated as it was on two unremarked upon suppositions.

The first was that the relative diminution in American global power would be meekly accepted by a US long used to running things. In other words, a series of President Obamas would shepherd the US to accept its new central, but relatively more limited, structural position in the multipolar world. To put it mildly, a President Trump—whose very campaign slogan ‘Make America Great Again’ is an overly emotional refutation of America’s relative decline—was not reckoned on.

Second, it was blithely assumed by European thinkers that their continent would undoubtedly and effortlessly emerge as the principal new force in this new world of many powers. As China rose during the latter days of the Cold War, following Deng Xiaoping’s historic opening in December 1978, European thinkers did foresee a world where a rising Asia would join America, Europe, Japan, and a diminished Russia as the main players on the global strategic scene (India was little thought of). But the notion that Europe would be by a long way the weakest of these great powers—politically divided, economically sclerotic, and militarily puny—never entered their thoughts.

As a result, while European thinkers seemed to pine for a multipolar world, in reality it was a new era where their continent was rising—as America was falling and the Soviets were non-existent—that was their real dream. Donald Trump’s petulant performance (and Europe’s anaemic non-response) at the just concluded G7 meeting glaringly illustrates that today’s world is simply not the sort of multipolarity European thinkers ever had in mind.

What Europe Should Do

Most foreign policy articles (and I have written over 500 of them) are cries in the wilderness, futile exercises where the analyst proposes outcomes that they know will never come to pass. Nevertheless, it remains the duty of every political risk analyst to try, to posit what can be practically done to retrieve strategic situations, for irretrievable decline is a choice and not a preordained destiny.

In this spirit, what can Europe do to make itself relevant as a Great Power in the real multipolar era we actually now live in? First, psychologically accept that while Trump is an extreme case, American leaders in general are transactional in nature; they will only take European concerns on board if it is viewed as a serious power capable of going its own way in terms of genuine practical policy consequences. Global politics is not a debating society; what matters are the views of the great strategic players, and the power they bring to bear—political, economic, strategic, diplomatic, and social—to further their interests. Europe must stop passively watching the world, and either master history, or history will surely master it.

Second, the Europeans have to act in a far more unitary manner in terms of foreign and security policy. Russia, an economic basket case in comparison (its economy is smaller than that of Italy), is the relevant comparison. For all that it is a corrupt, demographically decaying one-trick economic pony, a decrepit gas station utterly dependent on the spot price of oil and natural gas, Moscow punches far above its actual weight on the global scene.

The reason? President Putin can make decisive, unitary, foreign policy decisions for his country that are quickly acted on. Russia—as the Crimea episode illustrated—is still prepared to spend blood and treasure, to make real sacrifices to further the country’s foreign policy goals and interests. At present, I am not sure many in Brussels would be prepared to sacrifice a week’s holiday to do much of anything. For once and for all, Europe and its leaders have to decide if their foreign policy amounts to merely virtue signalling, or whether they are prepared to make the sacrifices to actually matter in the world.  

 To do so, an inner core of the key western European states—Germany, France, Italy, Spain, and The Netherlands—must move ahead, and actually begin to craft such a common foreign policy. Failure to do so will inevitably lead the other great powers to cherry pick Europe, to keep dividing the place precisely because it is inherently divided. It is not the fault of the outside powers, as states since time immemorial have taken advantage of their rival’s weaknesses. Rather it is the fault of a Europe that simply can’t get its act together.

Finally, as the mediocre age of Merkel subsides, endemic problems must be solved, rather than merely managed. Across the continent, Europe must free up its animal spirits and find a way to increase average growth rates to around two percent, if horrendous rates of youth unemployment and endemic economic torpor are to be righted. President Macron’s courageous and largely successful labour market reforms are a start, by more needs to be done.

With France as a nucleus, and after decades of torturous (and maddening) inaction, the major European countries must commit themselves to some level of serious defence spending, as without an army their moralistic lectures are just that, and nothing more. Finally, and again Macron is onto something here, ‘A Certain Idea of Europe,’ the idea of a strong, distinct, unique and blessed Europe, a sacred place whose interests and values are worth fighting for on the global stage, must be advanced as a unifying clarion call to action.

It is not too late for Europe to emerge as its thinkers once dreamed it would, and Trump’s odious behaviour in Canada surely serves as a call to arms. But it is one minute to the midnight of Europe’s strategic irrelevance.

Dr. John C. Hulsman is President and Managing Partner of John C. Hulsman Enterprises, a prominent global political-risk consulting firm. He is the author of To Dare More Boldly: The Audacious Story of Political Risk. He lives in Milan, Italy.

Michael Best on How Growth Really Happens

BestAchieving economic growth is one of today’s key challenges. In this groundbreaking book, Michael Best argues that to understand how successful growth happens we need an economic framework that focuses on production, enterprise, and governance. Best makes the case that government should create the institutional infrastructures needed to support these elements and their interconnections rather than subsidize individual enterprises. The power of Best’s alternative framework is illustrated by case studies of transformative experiences previously regarded as economic “miracles”: America’s World War II industrial buildup, Germany’s postwar recovery, Greater Boston’s innovation system, Ireland’s tech-sector boom, and the rise of the Asian Tigers and China.Accessible and engaging, How Growth Really Happens is required reading for anyone who wants to advance today’s crucial debates about industrial policy, free trade, outsourcing, and the future of work. 

Why is the study of economic “miracles” important?

National and regional experiences of rapid growth that lack easy explanations are often casually ascribed to divine intervention. Over two dozen national and regional experiences of rapid growth lacking explanation have been dubbed ‘miracles.’ These ‘miracles’ are unexpected and outside the scope of the conventional policymaking mindset. This book brings several such purported miracles back to earth. It offers an explanation in terms of an economics anchored by fundamental principles of production and business organization. The claim is that we can learn about how capitalist economies function and malfunction from examining cases of rapid and transformative growth. The lesson is that there is no divine intervention, just a man-made conjunction of capabilities.

What does the book do?

The book characterizes the economic policymaking framework and implementation means common to the rapid growth experiences. The framework is informed by a historical genealogy of major economic thinkers that have contributed to an economics of transformative growth. It is an economics of capability development and mutual adjustment processes in which changes in business organization, production system, and skill formation are inextricably bound together. The three domains are not separable and additive components of growth, but mutually interdependent sub-systems of a single developmental process. No one of the three can contribute to growth independently of mutual adjustment processes involving all three. I call this the capability triad. 

What unites the neglected economic theorists that shed light on transformative experiences?

The economic theorists whose ideas are discussed in this book examine the innovation dynamics that underlie productivity growth. They share an alternative economics methodology for understanding how economies function and for informing and conducting policymaking. Each thinker focuses on a different interactive connection in the economy to characterize an innovation dynamic within a multidimensional and complex economy. But taken together the innovation processes have common features and can interact with one another. Strategically organized, they can produce dynamic increasing returns.

These great scholars lived and wrote about the real world, which their descriptions suggest is not amenable to magic bullets. But there is no throwing up of hands in despair and depicting episodes of rapid growth as unexplained and inexplicable. Each contribution does offer, at the minimum, an analytical framework in lieu of a “growth miracle.” These models can protect policymakers from unreflective failures. Together they offer more. Economic policymaking is always informed and defended by models, but no single model can mimic modern complex economies or fit all contexts. The capability triad is a better way to understand how crises can be overcome and robust growth achieved.

How did you come to study economic miracles?

In 1969 when I started teaching economics at the University of Massachusetts, the economic outlook for the region was not encouraging. Between the 1930s and mid-1970s, with the exception of World War II, the New England economy underwent a sustained period of economic decline.  Boston’s population declined from 800,000 in 1950 to 560,000 in 1980.

What occurred next is known as the Massachusetts Miracle. Between 1975 the mid 1980’s unemployment fell from 12% to less than 3% as upwards of a half a million jobs were created most in new sectors. Michael Dukakis, governor of Massachusetts, campaigned for the US presidency in 1988 attributing the ‘miracle’ to the creation of a range of quasi-public agencies. But as a board member of one such agency, I was acutely aware this was not the case. At the same time, it was not a consequence of a spontaneous burst of ‘animal spirits’ or unleashed by laissez-faire policies and free markets.

What role did government policy play in the Massachusetts Miracle?

State policy did not plan, foresee, or drive the Massachusetts Miracle. But it was not passive. The state government funded a huge investment to increase the number of electrical engineering students in public higher education from around 600 in 1976 to over 1600 ten years later. In so doing it turned a transformative potential into a sustained growth experience. These graduates were like a high-octane fuel for an explosive growth in the size and number of engineering intensive enterprises. 

Nevertheless, the Massachusetts Miracle cannot be explained without reference to the institutionalized means by which the US economy was transformed during World War II. State education policy responded to an increase in demand driven by the post-war emergence of a large population of technology-driven enterprises themselves exploiting opportunities created by the federal government’s wartime investment in technologically advanced weapon systems. Greater Boston’s research-intensive universities and the state’s legacy of precision engineering were key components in the design, development, and implementation of the President’s wartime strategic vision and mobilization programs. The federal government oversaw the creation of a national science and technology infrastructure of which Massachusetts was and has remained a major beneficiary.

What can we learn from the US World War II experience about industrial policymaking?

World War II was a period of policymaking experimentation and government intervention much as the Great Depression that preceded it. But while the Great Depression inspired an emerging Keynesian macroeconomic demand management perspective, the successful policy regime of the wartime American economy, namely to create and grow new industries and transform existing industries to meet unprecedented performance targets, did not inspire a new supply side, production development perspective within the economics profession.

In fact, the World War II US policymaking experience was an unparalleled industrial policy success. GDP nearly doubled in a four-year period, far exceeding all other nations. Its unmatched performance can be measured by comparing national rates of expansion in munitions production Over the period from 1935-9 to 1944, munitions output expanded 7 times in Germany; 10 times in the USSR; 15 times in Japan; 22 times in the UK; and 140 times in the US (Goldsmith 1946). Furthermore, the US alone produced guns and butter; guns were not produced at the expense of the civilian standard of living (Edelstein 2001; Overy 1995).

President Roosevelt’s vision to create the Arsenal for Democracy was not enacted by either an invisible hand or by central planning but purposefully by an industrial policy and economic governance agenda that organizationally integrated and diffused rapid technological and production innovation. Three complementary productive structures were pivotal. 

The first was the integration of science and industry to design, develop, produce, and deploy new technologically advanced products (e.g., radar systems, penicillin). The second was the diffusion of mass production principles to build and ramp up new organizationally complex products/plants/industries (e.g., aircraft, ships), and to convert existing factories to new products (e.g., cars to jeeps) and to extend mass production and enterprise output coordination principles throughout and across supply chains. The third was the design, administration, and implementation of a participatory management philosophy and skill formation methodology to foster workforce involvement in job design, quality improvement, and new technology introduction. Each of these productive structures is examined using case studies that take us inside the real-world economics of production, business, work, universities, and industrial organization to examine how US industrial policy transformed the nation’s industrial innovation system.

What unites the policy frameworks of the successful transformative growth experiences examined in the book?

Explosive growth experiences are many. I apply the Capability Triad framework to explain other success stories including West Germany, Ireland’s Celtic Tiger, Japan and China as well as policy framework failure in the UK, Italy and the US in recent decades.

We know that they are not explained by stabilization policy. No amount of adjustment of stabilization and market reform policies are sufficient to address matters of productivity and growth. We find in the success stories the crafting and implementation of strategic development policy frameworks. This takes us beyond the terrain of the economics equilibrium and optimal resource allocation, although economics is critical to it. But it is an economics of capability development and mutual adjustment processes in which changes in business organization, production system, and skill formation are inextricably bound together.

This does not mean that macro policy instruments are irrelevant; it means that the transformative experiences are better understood as capability informed macro policies. The idea is to characterize successful economic policies from an organizational capabilities perspective.

In the success stories we find a unified or coordinated set of extra-enterprise, capability-development infrastructures that galvanize a population of companies to engage in product development and technology management capabilities; we find macro-policymaking guided by a production-centric awareness of where a region or country fits within the global competitive environment and the use of the critical barrier analysis to inform infrastructural investment priorities. These can include access to a machine tool industry, engineering support services, development finance and skill formation institutions which, if inter-connected, enable a whole group of firms to innovate and grow without generating severe skill gaps and thereby curtailing progress.    

Why is the formulation of a conceptual policy framework important?

The historical experiences described in this book tell us that a development policy framework is important for success. The case studies reveal extraordinary leaders responding to daunting challenges by crafting appropriate strategic policy frameworks at both enterprise and government levels. At the same time, luck plays a large part in successful outcomes. The expected external conditions needed to support success do not always arrive conveniently, and their absence may frustrate otherwise admirable policy initiatives. Nor is the true significance of the internal elements of a strategy always fully understood even by its own designers. But luck and chance, however random, can be handled best within well-thought-out and coherent frameworks that take full account of the nature of the external environment (opportunities and threats), as well as realistic views of domestic capabilities (strengths and weaknesses). What we can add, as well, is that the resulting SWOT (strengths, weaknesses, opportunities, and threats) analysis can be much richer if it is guided by the alternative economic baseline of the capabilities and innovation perspective and of the dynamic growth processes that it illuminates.

Perhaps the most daunting aspect of the capability triad is that it treats the scope for public policy as being almost completely and seamlessly blended into the detailed mechanics of change that occur within private firms. In this framework, public policy and private entrepreneurial actions do not operate in isolation from each other but become mutually reinforcing. There is some scope for a separable public policy, such as in skill formation, to ensure that the right mix of education and skills is produced to accommodate the changing demands of the economy as it develops. But even here, the links between public and private activity are crucial.

In the quest to break free from narrow, dependent, and reactive policy mindsets, the capability triad framework proposed here does not provide all the answers. But it helps those who hope to fashion transformative policies to be smart when time is pressing and when financial and human resources are limited. Such policies are essential if we wish to bring focus and synergy to the disparate policies that make up a broad enterprise-development strategy in a national, provincial, or local economy.

What is the relationship between conceptual framework and policy success?

Conceptual frameworks and policy design, implementation, and renewal usually evolve in parallel with each other. Frameworks are rather like maps that tell you where you are, where you need to go, and the direction that you must take to get there. Policy design and implementation deal with the messy business of gathering resources, making pragmatic choices, overcoming obstacles, and bringing the team along to a collective goal. To confuse these separate but interrelated elements of strategy, or to emphasize one at the expense of the other, will almost certainly lead to failure. Having a wonderful map, but of a route that would take you over impassable terrain, is useless. Wandering aimlessly in the wilderness bereft of any maps is equally futile.

Fortunately, the capability triad is not like the weatherman! It can offer diagnoses, and  even contingent predictions, and it can also suggest ways forward. The country case studies examined in this book suggest that the logic of the capability triad, based as it is on a distillation of actual experience, provides both structure and content to strategy design. To neglect its lessons, and to focus on price competition and stabilization processes as advocated in standard economics, has condemned national and regional economies to stagnation and decline and to all the social problems that such failures propagate.

What about research methodology in economics?

The economics advanced by a review of the historical experiences of rapid growth and decline in this book do not advance a policy framework with the clarity or certainty of the market fundamentalist or even Keynesian perspectives. Together they tell us that economies are inherently complex and not reducible to mechanical relationships. The methodological argument is that an alternative paradigm, beginning with case studies and empirical research rather than formal models grounded in a priori principles, is a more fruitful approach to understanding real-world economies and guiding policy. This is the position taken by all the thinkers in the production-centric paradigm.

Why have Nobel prizes overwhelmingly gone to the economics of optimal resource allocation? Part of the answer is that it is a comprehensive, context-free theory of individual rationality tractable to elegant simplification. Capabilities do not fit; they are about activities that cannot be done alone or at once.

My book goes the route of a different research methodology of which Darwin is the most prominent. This is systemic observation in which one searches for general principles, applies them to more experiences and in the process subjects them to tests. Not a complete answer but we start with what goes on inside the business enterprise because it is here that innovation and value creation either take place or do not take place. My book links Edith Penrose’s capabilities theory of the growth of the firm with Charles Babbage’s principles of production and Darwin’s evolutionary principles of variation, descent with adaptation and population dynamics. All three operate within the systemic observation methodology that distinguishes the production-centric economics perspective. 

Michael H. Best is professor emeritus of economics at the University of Massachusetts, Lowell, where he was codirector of the Center for Industrial Competitiveness. He has held numerous academic fellowships and participated in development projects with the United Nations, the World Bank, and governments in more than twenty countries. He is the author of The New Competition: Institutions of Industrial Restructuring and The New Competitive Advantage: The Renewal of American Industry.

Dr. John C. Hulsman: The North Korean Summit Hiccup Belies the Greater Problem of the White House’s Failure to ‘Game Out Lunatics’

HulsmanLegend has it that at the height of the Third Crusade (1189-1192), Count Henry of Champagne spoke at length with the mysterious, charismatic “Old Man of the Mountain,” Rashid ad-Din Sinan. The story goes that the haughty Crusader claimed that he had the most powerful army in the Middle East, one that could at any moment defeat the Hashashin, the Old Man’s threadbare cohort of followers. Count Henry went on, pointing out that his force was at least ten times larger than that of Sinan’s.

Unimpressed, the Old Man calmly replied that the Count was mistaken, and that it was his unremarkable-looking rabble which constituted the greatest army in the field. To prove his point, he beckoned one of his men over to him and casually told him to jump off the top of the Masyaf mountaintop fortress in which they were holed up. Without hesitating, the man did so.

Through the many centuries that separate us from Count Henry, the myriad twists and turns on Western politics, culture, and life that come between us, there is absolutely no doubt at all that Westerners today would share his horrified reaction to what the Old Man of the Mountain had demonstrated to him.

“This guy is totally nuts.”

***

This telling historical vignette was eerily reenacted last week, in Donald Trump’s ‘break-up’ letter to Kim Jong-un, the far-out leader of seemingly indecipherable North Korea. Playing the part of Count Henry, the President not so subtlety hinted that America, as the greatest military force in the world, could wipe North Korea off the map at any moment it chose. Like Count Henry, Trump was making it clear to his rival that in essence their contest was so strategically lopsided that meek surrender—in this case with the policy end game of unilateral North Korean nuclear disarmament as the only possible outcome—really was the only possible option.

But as was true for Count Henry, that assumes your enemy is playing by the same rules that you are, and makes the same calculations. If, to our horror, we found that they do not, it is far too easy to simply say our enemies are ‘crazy,’ meaning their motives simply cannot be fathomed, letting us off the hook far too easily.

Throughout history, both decision-makers as well as geopolitical analysts have always had a very hard time getting past the wholly understandable first reaction that those with very different belief systems from ours are simply unknowable. In the Old Man in the Mountain’s case, given his effective strategy for engaging in strategic assassinations, Westerners took to calling his followers Hashashin, or “users of hashish,” as drugs became the only possible (and incorrect) rationale the Crusaders could come up with to explain their intensity, morale, and absolute personal commitment to Sinan, rather than to the Western value of the sanctity of human life. It has always been all too easy for decision-makers to write off ‘lunatics,’ lazily saying to themselves that the different and the strange simply cannot be understood.

There has been a lot of this misdiagnosis going on regarding Kim Jong-un’s totalitarian hermit kingdom; former National Security Adviser H.R. McMaster forthrightly said Kim Jong-un was ‘crazy,’ and is therefore unable to be deterred by the threat of a nuclear counter-strike, meaning that the nuclear deterrence which has kept the global peace for these past seventy-plus years does not apply to North Korea’s nuclear programme. But have Kim’s actions really proved so unknowable, just because North Korea’s politics and culture are so admittedly different from our own?

Far from it. While there is no doubt Kim Jong-un would serve as an excellent Bond villain—between very publicly poisoning his half-brother Kim Jong-nam with sarin and executing his pro-Chinese uncle and former mentor Jang Song-thaek by blowing him to pieces with artillery—there is surely method to his madness. 

While the North Korean dictator is certainly odious, he seems to have a very well-defined and rational sense of self-preservation; in fact, he killed his uncle and his brother precisely because he feared they might emerge as threats to his continued rule and also to his life. In not allowing any alternate sources of leadership to emerge within the famously closed-off North Korean regime, Kim is clearly enhancing his chances of survival in the political shark tank he calls home.

Nor is Kim’s single-minded pursuit of an advanced nuclear weapons program capable of striking the US lunacy; rather the dictator has read some recent history, as the recent spat over the Libya model—a point which led to the temporary postponement of the summit—makes eminently clear. A North Korea in possession of such weapons has a ‘get out of jail free’ card, being able to ward off the oft-stated US desire for regime change in Pyongyang. Kim would be able to definitively avoid the recent fate of Libya’s Muammar Gaddafi and Iraq’s Saddam Hussein, who relinquished their nuclear programs, only to be overthrown and brutally killed.

For National Security Adviser John Bolton and Vice President Mike Pence to bring this up, illustrates that it is they and not the ruthless North Korean dictator who are living in an illogical fantasy world. For the Libya model, given the horrendous outcome for Libyan dictator Gaddafi, would obviously seem to be the last framework of choice for Kim Jong-un to embrace, given his rational desire for survival. As ever, American hawks overrate the objective global power position of the United States, as we live in a world where America, for all that it remains the most powerful nation on earth, is simply no longer the only game in town.

By understanding neither the basic structure of the world we live in—that it is comprised of many powers—nor that Kim Jong-un might be put out by the Gaddafi comparison, senior figures in the Trump White House seem to have forgotten that any negotiation short of unconditional surrender usually involves give and take by both sides, in this case over the terms, time frame, and pace of North Korea disarmament, as well as over the security guarantees that are necessary for a surprisingly rational Kim to be given, in securing both his position and his life.

The Old Man of the Mountain must never be forgotten by modern-day decision-makers, as in the end his seemingly unfathomable against-the-odds strategy was crowned with an improbable victory in the Third Crusade. His successful career underlines the vital need to game out ‘lunatics’ such as Kim Jong-un. For not only is there almost always method to their madness. Sometimes they actually win.

Dr. John C. Hulsman is President and Managing Partner of John C. Hulsman Enterprises, a prominent global political-risk consulting firm. His new book, To Dare More Boldly: The Audacious Story of Political Risk, was published by Princeton University Press in April and is available on Amazon. He lives in Milan, Italy.

Dr. John C. Hulsman: Delphic priestesses were the world’s first political risk consultants

by Dr. John C. Hulsman

In 480 BCE, the citizens of Athens were in more trouble than it is possible for our modern minds to fathom. Xerxes, the seemingly omnipotent son of Darius the Great, had some unfinished business left to him by his father. A decade earlier, at the Battle of Marathon in August 490 BCE, the miraculous had happened: the underrated Athenian army had seen off Darius and his mighty Persian horde, saving the threatened city-state from certain destruction. Now Xerxes had invaded Greece again, to finish the work his father had started, and he’d assembled a vast army that the Greek historian Herodotus (typically exaggerating) put at 5 million, but – though modern scholars disagree on precise numbers – was likely to have been a still-overwhelming force of 360,000, on top of a gigantic armada of 750 ships. Confronted with an insurmountable foe and almost certain destruction, the hard-pressed Athenian leadership requested the services of the world’s first political risk consultant.

Already, by 480 BCE, the Pythia of Delphi was an ancient institution. Now commonly known as the Oracle of Delphi – when, in ancient Greek, the oracles were the pronouncements that the Pythia dispensed – the Pythia were the senior priestesses of the Temple of Apollo, the Greek God of Prophecy. For more than 1,100 years (until 390 CE, when radical Christians chased the last Pythia out of Parnassus), they were viewed as the most authoritative soothsayers in Greece. Pilgrims descended from all over the ancient world to the temple on the slope of Mount Parnassus to have their questions about the future answered. From the small, enclosed chamber at the base of the shrine, the Pythia (there were three priestesses on call at any time) delivered her oracles in a frenzied state – the likely result of imbibing the hallucinogenic vapours rising from the clefts in the rock of Mount Parnassus, which we now know sits atop the intersection of two tectonic plates.

The Pythia would be sitting in a perforated cauldron astride a tripod. Pilgrims reported (and Plutarch, who for a time served as high priest at Delphi, assisting the Pythia in her mission, confirmed) that as she inhaled the strange vapours her hair would stand on end, her complexion altered, and she would often begin panting, her voice assuming an otherworldly tone. In classical days it was said that the Pythia spoke in rhyme, in pentameter or hexameter. To put it in modern terms, the Pythia was clearly as high as a kite. But let’s look at the Pythia afresh, for I would argue that the Temple at Delphi was effectively the world’s first political risk-consulting firm.

Since the height of the Persian Wars, political and business leaders have looked to outsiders blessed with seemingly magical knowledge to divine both the present and the future. While the tools of divination have obviously changed, the pressing need for establishing the rules of the road for managing risk in geopolitics have not. The question for political risk analysis remains the same as it was during the heyday of the Pythia: with superior knowledge (spiritual or intellectual), can we reliably do this?

The Pythia’s prognosticating advantages, not least her outsider status, curiously track the qualities that political risk firms look for in their best analysts today. In their isolation at Mount Parnassus, the Pythia were not in danger of elite capture, and the curse of analytical groupthink that so often follows, in terms of what they predicated. This is the curse that doomed so many modern-day analysts to be so very wrong about the Brexit vote because they didn’t bother to look outside the hermetically sealed elite shell of London; or the startling advent of Donald Trump (they never left the East Coast corridor). Physical, intellectual and emotional distance have great analytical value.

Yet despite being isolated, the Pythia had limited but regular contact with the elites of the day who made the arduous trek to visit them. Over time, the priestesses at the Temple of Apollo came to understand what it was their clients wished to know, and how to provide exactly what they lacked; independent, outside, authoritative advice. It should be noted that the Pythia were chosen from a group of highly educated women, well-acquainted with the world. It is this strange and unique mix of special knowledge, education, distance from (and yet connection to) the centres of corruption and power, that describes the ideal CV for political risk analysts today.

The Pythia offered practical counsel that could shape future actions, just as political risk analysts do today – though we’d use modern jargon and call it ‘policy’ in the public sphere, and ‘corporate strategy’ in the business world. It is amazing how good a political risk record the priestesses actually had. Between 535 and 615 of the oracles have survived to the present day, and well over half of these are said to be historically correct. (I can name a goodly number of modern firms that would kill for that record.)

There has always been a market to answer basic political risk questions: can the Persians be stopped, and if so how? Will the UK vote for Brexit? Will Trump become president? Then as now, those with a reputation for getting basic political risk questions right were venerated, just as those who failed were over time discredited. Crucially, on the biggest political risk question Delphi was ever presented with – Xerxes’ invasion – the Pythia came through with flying colours. In her peculiar poetic and riddling fashion she suggested a ploy to get the Athenians off the hook. She recounted that when Athena, Greek goddess of wisdom and the patron of her namesake city, implored her father Zeus to save Athens, he told her that he would grant them ‘a wall of wood that alone should be uncaptured, a boon to you and your children’.

Naturally, the Pythia’s mysterious oracular pronouncements required interpretation by the city leaders of Athens. One of them, Themistocles, argued that a wall of wood specifically referred to the Athenian navy, and persuaded the city’s leaders to adopt a maritime-first strategy against the Persians. This policy – concocted by the Pythia – led directly to the decisive naval Battle of Salamis, the turning point that brought to an end the Persian risk to Athens’s very survival. To put it mildly, the Pythia had proven to be well worth her political-risk fee – both the direct monetary payment customarily made to her by pilgrims, and the larger donations to the gods, which secured petitioners an advanced place in the line.

To Dare More Boldly: The Audacious Story of Political Risk by John C Hulsman is out now via Princeton University Press.Aeon counter – do not remove

This article was originally published at Aeon and has been republished under Creative Commons.

Sebastian Edwards on American Default: The Untold Story of FDR, the Supreme Court, and the Battle over Gold

EdwardsThe American economy is strong in large part because nobody believes that America would ever default on its debt. Yet in 1933, Franklin D. Roosevelt did just that, when in a bid to pull the country out of depression, he depreciated the U.S. dollar in relation to gold, effectively annulling all debt contracts. American Default is the story of this forgotten chapter in America’s history. At a time when several major economies never approached the brink of default or devaluing or recalling currencies, American Default is a timely account of a little-known yet drastic experiment with these policies, the inevitable backlash, and the ultimate result.

Americans believe that the Federal government has never defaulted on its debt. Yet in your book, you tell the story of a massive debt restructuring that happened only eight decades ago, in 1933. A debt restructuring that changed contracts unilaterally and retroactively, and imposed losses of 61% on investors. Why do you think that this episode is so little known?

This is a case of “collective amnesia.” Americans think of themselves as law-abiding citizens. We think of the United States as a country where institutions work and where contracts are sacred; a country where the rule of law prevails at all times. Reneging on contracts is not something this nation does. And, certainly, we don’t change contracts retroactively. It is something that “banana republics” do. And when they do it, we scold them and denounce them. We also demand compensation for damages.

When the Supreme Court heard the gold clause cases in 1935, most analysts thought that these were among the most important cases ever considered by the Court. Today, however, they are not even taught in most law schools. We have forgotten the episode because it is convenient, because it helps us maintain the view we have about our nation: a nation that always pays its debts. But, as I show in this book, this is not the case.

Your book is about the annulment of the gold clauses in 1933, and the Supreme Court decisions that ruled that it was legal to change debt contracts retroactively. What were the gold clauses, exactly? And what was their role?

Historically, most long-term debt contracts in the United States were written in terms of gold. That is, the borrower committed himself to paying back an amount of gold (or gold equivalent) equal to the amount borrowed, plus interest. This practice started during the Civil War to protect lenders from possible inflation.

In 1933, when President Franklin D. Roosevelt took the U.S. off the gold standard, all public debt included the gold clause. In addition, most railway and public utility bonds had gold clauses, as did most mortgages. Overall, debt equivalent to approximately 120% of GDP was subject to these escalation riders. That is a huge number. To put things in perspective, it is about twice as large as the debt that Argentina restructured unilaterally in 2002.

You write that the abrogation of the gold clauses was closely related to the abandonment of the gold standard in 1933.

In 1933, President Roosevelt thought that the U.S. could benefit from devaluing the dollar with respect to gold. This had been done by the United Kingdom in September 1931, and it appeared to be helping the UK get out of the depression. However, FDR was told by his advisers that the gold clauses stood in the way of a devaluation. With the gold clauses in place, a devaluation of the USD would immediately trigger an increase in debts by the same amount as the devaluation. This would bankrupt almost every railway company, and many other businesses. It would also be extremely costly for the government. It was at this point that FDR decided to abrogate the gold clauses. The actual annulment took place on June 5, 1933.

When emerging countries, such as Argentina, devalue their currency and restructure their debts, we often brand them as “populists.” Was there a populist element in FDR’s decision to abandon the gold standard and abrogate the gold clauses?

One of the main issues in 1933 was how to raise agricultural prices, which had declined by almost 70% since 1919. After the 1932 election there was a large bloc of populists, pro-agrarian members in Congress. The better known one was Senator Huey Long, but there were others. Two very influential ones were Senator Elmer Thomas from Oklahoma, and Senator Burton Wheeler from Montana. They were “inflationists,” and believed that getting off gold would help increase commodity prices. To a large extent the devaluation of the dollar—from $20.67 to $35 per ounce of gold—was to placate this group of “populist” lawmakers. Wheeler was also an isolationist. In Philip Roth novel The Plot against America, Wheeler is a fictional vice president, and aviator Charles Lindbergh is the president.

There are still some people who believe that getting off gold was a mistake. Was it necessary? Did it work? Should the U.S. go back to gold?

Most economic historians—including Milton Friedman and Ben Bernanke—agree that one of the main consequences of devaluing the dollar in 1934 was that the country received a huge inflow of gold. This additional gold was monetized by the Federal Reserve. As a consequence, there was a large increase in credit. This triggered a recovery, and helped reduce unemployment. A key question, which I address in the book, is whether it was possible, at the time, to put in place an expansionary monetary policy and still maintain some form of a gold-based standard. This is a controversial issue; British economist John Maynard Keynes believed that it was possible; many modern economists believe that it was not.

You argue in the book that at the time most economists were perplexed and didn’t know how to face the Great Depression. Apparently they didn’t understand the effects of fluctuating exchange rates.

In the 1930s the economic analysis of currency values and currency adjustments was in its infancy. Some well-known economists, such as Yale’s Irving Fisher, were very critical of the gold standard, and suggested pegging the value of the dollar to a basket of commodities. Other, including Princeton’s Edwin Kemmerer and Chicago’s Jacob Viner, were convinced that, in spite of some shortcomings, the gold standard was the best available monetary system. In the book I tell the story of how these two groups for FDR’s ear. I discuss who said what and how the President reacted to their advice.

You write that in 1933 George F. Warren was the most influential economist in the world. However, today almost no one knows his name. Who was he, and why was he so important?

George F. Warren was a professor of agricultural economics at Cornell, and a friend of Henry Morgenthau Jr.

Morgenthau was a neighbor and friend of President Roosevelt, who eventually became Secretary of the Treasury. In 1931, Warren published a book titled Prices, where he argued that agricultural prices were related in a one-to-one fashion to the price of gold. If the price of the metal increased through a devaluation of the USD, the price of wheat, corn, cotton, eggs and so on would increase immediately and by the same amount. Starting in July 1933, Warren became Roosevelt’s main economic adviser. In October the president put in place a “gold buying program” based on Warren’s theories. Every morning FDR would determine an arbitrary price at which the government bought small amounts of gold. The president’s expectation was that agricultural prices would follow in short order. But that didn’t happen; the program did not work as expected. John Maynard Keynes criticized it strongly, and in January 1934 the program was abandoned. In the book I discuss, in great detail, Warren’s theories and I compare them to those of other prominent economists, including Irving Fisher’s.

You devote quite some time to the cases argued in front of the Supreme Court. What can you tell us about them?

At the time, the Court was deeply divided. There was a conservative bloc led by Justice James Clark McReynolds, and a liberal bloc that included Justices Brandeis and Cardozo. Charles Evans Hughes, the Chief Justice, was often the swing vote. The cases were fascinating for several reasons; first, the Administration used a “necessity” argument to support the Joint Resolution that abrogated the gold clauses. This argument is very similar—in fact, almost identical—to the argument used recently by countries such as Argentina when restructured their debts unilaterally. Second, the government made very sophisticated economic arguments; in order to support them, it included a number of charts and diagrams in its briefs. Third, the rulings were very convoluted and controversial. In the case involving public debt (a Liberty Bond, to be more precise), the Court ruled that Congress had exceeded its power, and that the abrogation was thus unconstitutional. However, the Court said, there were no damages involved. That is, the government had violated the Constitution, but didn’t have to compensate bond holder for losses.

In modern times, countries that default and/or restructure their debts unilaterally pay a cost. Generally speaking, they have great difficulties accessing the capital markets. However, this was not the case for the U.S. What do you think are the reasons for this?

I discuss this issue in great detail in the book. Milton Friedman argued that by expropriating property rights the abrogation had severe negative effects on the U.S. economy. It negatively affected investment. I combed the data and didn’t find significant dislocations or signs of distress in the weeks and months following the Supreme Court rulings. In the final chapters of the book I give a possible explanation for this. I point out why the U.S. case is so different from recent default episodes, including Argentina and Greece.

Sebastian Edwards is the Henry Ford II Professor of International Economics at the University of California, Los Angeles. His books include Toxic Aid: Economic Collapse and Recovery in Tanzania and Left Behind: Latin America and the False Promise of Populism. He lives in Los Angeles.

Against metrics: how measuring performance by numbers backfires

by Jerry Muller

More and more companies, government agencies, educational institutions and philanthropic organisations are today in the grip of a new phenomenon. I’ve termed it ‘metric fixation’. The key components of metric fixation are the belief that it is possible – and desirable – to replace professional judgment (acquired through personal experience and talent) with numerical indicators of comparative performance based upon standardised data (metrics); and that the best way to motivate people within these organisations is by attaching rewards and penalties to their measured performance. 

The rewards can be monetary, in the form of pay for performance, say, or reputational, in the form of college rankings, hospital ratings, surgical report cards and so on. But the most dramatic negative effect of metric fixation is its propensity to incentivise gaming: that is, encouraging professionals to maximise the metrics in ways that are at odds with the larger purpose of the organisation. If the rate of major crimes in a district becomes the metric according to which police officers are promoted, then some officers will respond by simply not recording crimes or downgrading them from major offences to misdemeanours. Or take the case of surgeons. When the metrics of success and failure are made public – affecting their reputation and income – some surgeons will improve their metric scores by refusing to operate on patients with more complex problems, whose surgical outcomes are more likely to be negative. Who suffers? The patients who don’t get operated upon.

When reward is tied to measured performance, metric fixation invites just this sort of gaming. But metric fixation also leads to a variety of more subtle unintended negative consequences. These include goal displacement, which comes in many varieties: when performance is judged by a few measures, and the stakes are high (keeping one’s job, getting a pay rise or raising the stock price at the time that stock options are vested), people focus on satisfying those measures – often at the expense of other, more important organisational goals that are not measured. The best-known example is ‘teaching to the test’, a widespread phenomenon that has distorted primary and secondary education in the United States since the adoption of the No Child Left Behind Act of 2001.

Short-termism is another negative. Measured performance encourages what the US sociologist Robert K Merton in 1936 called ‘the imperious immediacy of interests … where the actor’s paramount concern with the foreseen immediate consequences excludes consideration of further or other consequences’. In short, advancing short-term goals at the expense of long-range considerations. This problem is endemic to publicly traded corporations that sacrifice long-term research and development, and the development of their staff, to the perceived imperatives of the quarterly report.

To the debit side of the ledger must also be added the transactional costs of metrics: the expenditure of employee time by those tasked with compiling and processing the metrics in the first place – not to mention the time required to actually read them. As the heterodox management consultants Yves Morieux and Peter Tollman note in Six Simple Rules (2014), employees end up working longer and harder at activities that add little to the real productiveness of their organisation, while sapping their enthusiasm. In an attempt to staunch the flow of faulty metrics through gaming, cheating and goal diversion, organisations often institute a cascade of rules, even as complying with them further slows down the institution’s functioning and diminishes its efficiency.

Contrary to commonsense belief, attempts to measure productivity through performance metrics discourage initiative, innovation and risk-taking. The intelligence analysts who ultimately located Osama bin Laden worked on the problem for years. If measured at any point, the productivity of those analysts would have been zero. Month after month, their failure rate was 100 per cent, until they achieved success. From the perspective of the superiors, allowing the analysts to work on the project for years involved a high degree of risk: the investment in time might not pan out. Yet really great achievements often depend on such risks.

The source of the trouble is that when people are judged by performance metrics they are incentivised to do what the metrics measure, and what the metrics measure will be some established goal. But that impedes innovation, which means doing something not yet established, indeed that hasn’t even been tried out. Innovation involves experimentation. And experimentation includes the possibility, perhaps probability, of failure. At the same time, rewarding individuals for measured performance diminishes a sense of common purpose, as well as the social relationships that motivate co-operation and effectiveness. Instead, such rewards promote competition.

Compelling people in an organisation to focus their efforts on a narrow range of measurable features degrades the experience of work. Subject to performance metrics, people are forced to focus on limited goals, imposed by others who might not understand the work that they do. Mental stimulation is dulled when people don’t decide the problems to be solved or how to solve them, and there is no excitement of venturing into the unknown because the unknown is beyond the measureable. The entrepreneurial element of human nature is stifled by metric fixation.

Organisations in thrall to metrics end up motivating those members of staff with greater initiative to move out of the mainstream, where the culture of accountable performance prevails. Teachers move out of public schools to private and charter schools. Engineers move out of large corporations to boutique firms. Enterprising government employees become consultants. There is a healthy element to this, of course. But surely the large-scale organisations of our society are the poorer for driving out staff most likely to innovate and initiate. The more that work becomes a matter of filling in the boxes by which performance is to be measured and rewarded, the more it will repel those who think outside the box.

Economists such as Dale Jorgenson of Harvard University, who specialise in measuring economic productivity, report that in recent years the only increase in total-factor productivity in the US economy has been in the information technology-producing industries. The question that ought to be asked next, then, is to what extent the culture of metrics – with its costs in employee time, morale and initiative, and its promotion of short-termism – has itself contributed to economic stagnation?Aeon counter – do not remove

Jerry Z. Muller is the author of many books, including The Tyranny of Metrics. His writing has appeared in the New York Times, the Wall Street Journal, the Times Literary Supplement, and Foreign Affairs, among other publications. He is professor of history at the Catholic University of America in Washington, D.C., and lives in Silver Spring, Maryland.

 

This article was originally published at Aeon and has been republished under Creative Commons.

Eric Posner & Glen Weyl on Radical Markets: Uprooting Capitalism and Democracy for a Just Society

Radical MarketsMany blame today’s economic inequality, stagnation, and political instability on the free market. The solution is to rein in the market, right? Radical Markets turns this thinking—and pretty much all conventional thinking about markets, both for and against—on its head. The book reveals bold new ways to organize markets for the good of everyone. It shows how the emancipatory force of genuinely open, free, and competitive markets can reawaken the dormant nineteenth-century spirit of liberal reform and lead to greater equality, prosperity, and cooperation. Only by radically expanding the scope of markets can we reduce inequality, restore robust economic growth, and resolve political conflicts. But to do that, we must replace our most sacred institutions with truly free and open competition—Radical Markets shows how. Read on for an interview between the two authors. 

Eric: I’ve never thought of myself as a radical, yet our book is called Radical Markets. Is this a marketing gimmick or are the ideas really radical?

Glen: Our proposals seem pretty radical to me. In our scheme, private property turns into a kind of an auction, so there would be a price on most property all the time and the benefits would flow equally to all citizens, eliminating most inequality of wealth.  The conventional system of democracy—one-person-one-vote and judicial protection of most minority rights—would turn into a market-based system of trading voice credits and using them to buy votes. The current immigration bureaucracy would be radically decentralized, as ordinary people would take over sponsorship of migrant workers. There are certainly ideas more radical than these, but not many that you hear discussed seriously by our academic colleagues.

Eric: Yet, unlike true radicals, we urge a go-slow approach. Test things out, we say. Things could go wrong, we warn. And then we claim to be in favor of markets. That doesn’t sound like Saint-Simon or Marx. Sure, enough our book is #1 on Amazon in the category of libertarianism, though neither of us think of ourselves as libertarians.

Glen: True revolutions occur in slow motion; they begin with ideas. Democracy is a revolutionary idea in a world of kingdoms; it did not happen overnight. Unions began as working men’s associations and only gradually gained power and state sanction. Even Saint-Simon inspired small-scale utopian communities. Revolutions that move rapidly to take over a whole society, like the French or Russian, usually quickly determine they didn’t have their plans fleshed out and end in chaos or greater tyranny than the system they replaced. We have radical, even revolutionary, aims, but we want the changes we propose to stick and that will only happen if they are fully developed, their weaknesses exposed by experimentation.

Eric. I’m still not sure. I like the title because I’m a sucker for word play. The root of the word radical is, well, root. Being radical means getting to the root of things. I think we do that. A radical in math is the root of a number, and several of the ideas in the book have their origin in quadratic equations. And then there is the idea of radical as left-wing. Here, I’m not so sure. In fact, one of our goals is to appeal to people with different political views.

Glen: Well, radical doesn’t necessarily mean left wing, though I guess it depends how you define it.  In fact, The Economist defines its ideology as the “radical center.” To me, that sense of radical is more about favoring fundamental changes to the social order rather than, say, putting the government in charge of everything or redistributing wealth. In that sense, I think we are very much radicals

Eric: We even appeal to Adam Smith and Milton Friedman. What could be less radical than that?

Glen: Adam Smith has an unfair reputation as a “conservative” these days only because his ideas were so successful. He put the finishing touches, intellectually at least, on the unthinking feudalism of the day. In fact, Smith helped found the first major political movement to identify itself as “Radical,” the Philosophical Radicals who are our inspiration. Not surprisingly, ideas that were radical in the eighteenth century can be reactionary in the twentieth, when Friedman wrote. But we give Friedman credit for seeing that central planning and a certain kind of bureaucratic mindset leads to a dead end.

Eric: And for market thinking: Friedman was right to emphasize the value of competition and exchange—essential features of market system—but, like many economists, took our system of property rights and politics for granted, as if thinking on these topics had stopped centuries ago. One way you can tell that you are being radical in an intellectual sense—the sense I care about—is that you find yourself being criticized by people with different political views. If you’re radical enough, people will get angry. We’ve already seen a bit of this. Immigrant advocates and alt-right types don’t agree on much, but they seem to be scandalized by our foreign worker proposal. I’ll be curious to see how people react to our other proposals.

Eric A. Posner is the Kirkland and Ellis Distinguished Service Professor at the University of Chicago Law School. His many books include Climate Change Justice. He lives in Chicago. E. Glen Weyl is principal researcher at Microsoft and visiting senior research scholar in economics and law at Yale University. He lives in Boston.