Sam Hammond on Co-Determination, Corporate Governance, and the Accountable Capitalism Act

Sam Hammond is policy analyst and covers topics in poverty and welfare for the Niskanen Center. Sam joins the Macro Musings podcast to discuss his new article in the National Review which addresses Senator Elizabeth Warren’s new proposal, the Accountable Capitalism Act, and its potentially negative effects.

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Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected]

David Beckworth: Sam, welcome to the show.

Sam Hammond: Thanks for having me back.

Beckworth: It's good to have you on. Your article's title was Elizabeth Warren's Corporate Catastrophe. So, I think the title tells where you stand on her proposed legislation.

Hammond: The original title was Elizabeth Warren's Bad Idea. I told the editor that was overdetermined, people wouldn't know which bad idea.

Beckworth: So, he came up with the Corporate Catastrophe. All right, but it definitely captures the spirit of your article. We want to be fair in this podcast and present the other side, but at least listeners know where you're coming from as we get into the show. Before we do that, let's talk about the bill itself before we get into the good and the bad about it. Let me just lay out what I understand to be the bill, and you can correct me or maybe flesh it out some when I'm done. But currently, if you want to start a corporation, you need to get permission from the state government in the form of corporate charter. Critics like Matt Yglesias, and I listened to their podcast The Weeds about this legislation. But he would argue there's a race to the bottom, the state with the least requirements is going to get all the corporate charters. That happens to be Delaware, so a lot of corporations charter in Delaware.

Beckworth: So, their critique is look, it's a race to the bottom. Senator Elizabeth Warren's proposal would eliminate this race to the bottom because it would be now a federal government charter. So, it's not that radical to say because state governments do it already. However, there would be some big changes. First, it would require businesses with more than $1 billion in revenue to obtain a federal charter. Then they would be directed, the leaders of the company would be directed to consider the interest of all relevant stakeholders. So, shareholders who own the stock, customers, employees, the communities in which they operate when making a decision. So, you'd have now all these different people weighing in on decisions. You spoke to that in your piece, and we'll get to that later, some of the problems that would create.

Beckworth: To make this very concrete, they would have to have 40% of their directors on the board elected by the workforce, and another 60% from shareholders. So, you would have the workers being represented on the board. 40% is not a trivial number, it's pretty large. There are some other things that would be included as well, such as corporate executives would be required to hold onto the shares of stock for at least five years after they receive them. This would all be overseen by a new federal agency or a new part of the government, which would open in my mind a whole can of worms there, too. But is that a fair portrayal of what this proposal is trying to do?

Hammond: Yeah, that sounds about accurate.

Beckworth: Okay. Again, to put this in the best light possible before you tear it apart, Senator Elizabeth Warren had this to say about capitalism recently. She said, "I am a capitalist. I believe in markets. What I don't believe in is theft, what I don't believe in is cheating. That's where the difference is. I love what markets can do, I love what functioning economies can do. They are what makes us rich, they are what create opportunity. But only fair markets, markets with rules. Markets without rules is about the rich take it all. It's about powerful get it all, and that's what's gone wrong in America."

Beckworth: So she's saying, "Look, I'm not the far left. I'm the reasonable left who believes in capitalism, I just want to make capitalism better. I want capitalism to thrive, to survive." That's kind of the spirit I think she's trying to sell this. Of course, maybe this has to do with positioning for presidential run. Now, she generally believes in what she's proposing, right?

Hammond: Oh, absolutely. I don't disagree with that sort of broad strokes of what capitalism is. Capitalism is a system of rules. Corporations are creatures of the state, they do obtain a charter from the government. They're given certain privileges, like limited liability, that are unique protections that other corporate, or other organizational forms don't get. So, there is a prerogative. The state does have a prerogative to set the rules according to some end. My critique is that that end should be some view of efficiency, social welfare, productivity, and not necessarily this stakeholder model. Which I think has a lot of intrinsic problems with it. But in terms of that paragraph you just read from her, I don't have any iota of disagreement with it.

Beckworth: I think we all would. I think all the listeners, every hardcore capitalist out there would agree. There needs to be rules of the game. Capitalism is what makes us rich, it made the world rich, pulled us out of poverty. But she believes there's a problem that exists now with capitalism, in particular shareholder capitalism. So, let me just lay out a few of their arguments that they make and people who take her side would make, and then have you respond. Then later we'll get into more detail of your arguments.

Hammond: All right, let's go.

Beckworth: Okay, let's do it. So, the first one I already mentioned is that shareholder capitalism hasn't worked. So, the idea behind shareholder capitalism, and I think this was always there to some degree but with more emphasis in the past three or four decades, is tying performance to share prices. So, if you're an executive, your pay is in shares of the company stocks. You get extra stocks, so you have this incentive to do well, to invest wisely, to run things efficiently. Also, outside investors, there's these active hedge funds who might come in and try to discipline a corporation who doesn't behave well, misspends funds. The argument is that would lead to more innovation, new things, new products, ultimately faster economic growth.

Beckworth: Yes, there might be a little more inequality. Maybe there are some really rich people who own these shares, but the nice trade off would be we get faster, more robust economic growth. The Elizabeth Warrens of the world would say, "Hey, we didn't get that. We didn't get the robust economic growth. We've had some periods of nice growth, but we didn't get the sustained growth. So, shareholder capitalism simply hasn't worked." How do you respond to that?

Hammond: I heard Matt Yglesias make the same point. I think this goes to the problem of a lot of things happening at the same time in history.

Beckworth: Okay.

Hammond: So, a lot has happened since the late 1970s, and I don't think you can attribute economic stagnation to an op-ed that Milton Friedman wrote in the New York Times. Because Milton Friedman did write an article saying that shareholders have one responsibility, which is to maximize profit. But really, he was just echoing a kind of norm that already was pervasive prior to that. He didn't rewrite the law. So, attributing paradigm shift in capitalism to a libertarian economist making an argument doesn't quite follow. In terms of, there has been an explosion in executive compensation, which Elizabeth Warren has been a target of before in the past. That does trace its origin to a kind of revolution in how to structure compensation.

Hammond: Part of the irony there is that Warren is proposing this bill in part because of her view that shareholder capitalism is focused on the short term, quarterly profits or whatever. Whereas the trend in the last 20 years has been for using these compensation schemes to incentivize longterm behavior among managers, including rewarding employees with stock options and so on. The second point is that it's not the main driver in inequality. So, she's also a critic of... she also thinks that the shareholder model has driven inequality. She cites in her press release that record corporate profits have been leading to a declining labor share of income in the global economy, the national economy. But that's not true, that's just not true.

Hammond: As I pointed out in my piece, when you disaggregate capital income and labor income, the driver of labor shares decline has been rising rents. So, this is something that you've had other people on to discuss. But when rents increase, it eats into labor income and is counted in the statistics as capital income. We have this housing crisis across America where there's not enough being built. So, that is another thing that's happened since the 1980s, and it has been sort of a coincidence with shareholder capitalism. But I think she's barking up the wrong tree.

Beckworth: So, there's a lot of confounding developments that are hard to disentangle. So, globalization would be one.

Hammond: True, yeah.

Beckworth: Big development globally. But the supply side on housing is a big issue. We had Kevin Erdmann on recently and he talked about how some of the developments leading to the Great Recession were tied into the supply of housing, which now is a hot topic left and right. There's shortage of housing relative to the demand.

Hammond: And it's something Matt Yglesias has written about. I actually...

Beckworth: That's a good point.

Hammond: I kind of have a subtle jab in my piece because I have two citations. One to an actual rigorous study, and one to his Vox piece saying, "Blame housing on inequality."

Beckworth: Yeah, so there's these other things going on that can explain some of what we observe and what we see.

Hammond: On top of that, so Scott Sonner has a few posts from way back looking at the comparative performance of the United States to other countries, particularly European countries. Yes, there has been a general stagnation across the globe for reasons that people like Tyler Cowen have written about, the secular decline of productivity growth. But relative to the rest of the world, the U.S. has performed better.

Beckworth: Yes, on a relative basis, maybe shareholder capitalism has worked well. It has done things, but yeah, I liked Tyler Cowen argument when I read his book, the most recent one where he talks about this. The basic argument is, as we become wealthier, as we become successful, we become more risk averse. That's the key takeaway I get from it, and it affects all these different areas of our lives. So, it's kind of a natural byproduct of our success and we're wrestling with that.

Hammond: There's just a truism that when productivity slows down, people feel dissatisfied, right? It doesn't feel like the pie is growing and they look for scapegoats. One of the things I say in my piece is that when you have a populist politician using the general malaise of society to call out her favorite scapegoat. That's essentially populism, is most Trumpian. In Trump's case, it's immigrants or foreigners, and in this case it's the mega corporations. When really, there are red herrings in both cases.

Beckworth: So, what we need them to solve all our problems is more rapid productivity growth.

Hammond: I think it would solve a lot of things.

Beckworth: Yeah, we can all hope for that. Okay, so that kind of is the first critique, shareholder capitalism hasn't worked. Related to that I guess, maybe we've kind of touched on this, is the growing market concentration. That seems to be a big topic in the past few years. How do we think about that?

Hammond: So, I think that in my piece, I cite the book Big Is Beautiful by Michael Lind and Robert Atkinson. They have a whole chapter kind of debunking the notion of industry concentration as a major trend.

Beckworth: I highly recommend that book to our listeners. We'll put a link to it on the webpage, but go ahead Sam. Talk about what it says.

Hammond: Part of one way of seeing Warren's bill within a kind of common thread of things that she's been focused on is a kind of anti-bigness. It ties in with her sort of anti-trust revival, her going after corporate malfeasance, the biggest corporations. When you break down the stats industry by industry, there have been some industries that have consolidated, so for instance, manufacturing. But is that because of anti-competitive behavior, or is it because of trade relations with China leading to greater competition at the bottom end? So, one of the standard predictions of trade theory is that when you open up markets, the competition will lead to some level of efficient consolidation. Because the global market is a bigger playing field and the smaller fries that can compete domestically will no longer be able to compete.

Hammond: So, we have seen consolidation in areas like that. In other areas, we've seen deconsolidation. So, my critique of the structure of this bill, because it kicks in at billion dollar revenue companies, is it's very clearly going after bigness. And not really discerning the things that she cares about, so she says that she cares about wages or short term behavior or monopsony power, stuff like that. But the biggest firms in the country pay their workers more, they are responsible for two thirds of employment growth. They're responsible for almost half of R&D investment, so these aren't the targets. If you care about productivity growth in particular, it shouldn't be the targets because those are the ones driving productivity growth.

Beckworth: Yeah, it was really interesting to read their work. It really touches on a myth if you can call it that, in America that small business is where it's at, right? We need small businesses because they create the jobs. But as you just mentioned and articulated in the book and in a related article in The Atlantic, big businesses are the ones that create the most net jobs, right? They're the ones, look at job creation and destruction, they're creating more jobs. Overall, working conditions are better in these bigger corporations. They get more time off, more benefits, more stability relative to if you think about a small mom and pop store, apparently there's more turnover, more churn. The survivability is less.

Hammond: There's also worse compliance. So, she talks about theft and fraud. The end runs of the world notwithstanding, large corporations invest much more in compliance. They don't run a cash economy as many mom and pop stores do, and are in many ways better corporate citizens. That's not going to win you an election to say that.

Beckworth: Right, right. The other big thing though, going back to the productivity point, is they do most of the R&D, the big corporations. For better or for worse, they're in a position to do it. I think of the patent troll issue we see. It shouldn't be, but it's hard for smaller businesses to innovate when they have to pay huge legal fees against patent trolls and other hurdles. I think a valid critique of big business, and you've made this and your colleagues at the Niskanen Center made this, is that there is this incentive for big businesses to embrace regulations.

Hammond: Yeah.

Beckworth: That maybe empower them and keep out small. I think that's legitimate, but that's not what she's addressing in this bill necessarily is it? Or may it?

Hammond: In the past, Elizabeth Warren has, one of her quotes is, "Complexity is a subsidy." Which is something my colleagues at the Niskanen Center 100% agree with.

Beckworth: Okay, so she would agree with you on that point.

Hammond: Yeah, my point is that this is adding complexity.

Beckworth: Unnecessary complexity. But the R&D, yeah, so it's a really, really neat book. We have this myth that small businesses is where it's at, there's innovation there. But the innovation, better working conditions, they all relate to bigger businesses. They make a point about some of the concentration measures aren't so clear. One example they give and one that comes to mind for probably many people is retail.

Hammond: Right.

Beckworth: Because they see retail. One of the demons out there is supposedly Amazon, and it's true. I mean, you hear Toys R Us has gone under or Best Buy. I'll have to go window shopping at Best Buy, look at all the neat latest toys out there. My kids like to go with me too, they like to look as well. But then we go online and buy it on Amazon, maybe it's a little bit cheaper. So, you get this impression that Amazon is taking over the world, right? It's demonized, but they mention in the article that the largest retailers out there actually control a small part of the overall retail market. That includes Walmart, in fact, Amazon isn't on the top five lift of retailers. I think they said it's number seven in terms of the market share. But Walmart, Kroger's, they have a big list here. But there's a number of retailers that are bigger.

Hammond: Oh yeah, totally.

Beckworth: Much bigger than Amazon. So, we pay a lot of attention to Amazon, and it may have some of these effects. But there are other retailers that are bigger, and even the bigger ones are not taking up 90% of the market.

Hammond: Yeah. I mean, that's absolutely right. One of the things I find most striking with the American economy contrasting with the European economy is that European economies are capitalistic. They are innovative in their own way, but the striking feature that the American economy is for the ability of a firm like Amazon to, within two decades, go from a small online book retailer to the second largest employer in the United States. Employed in warehouses and now they own Whole Foods, so it's that incredible rise. One of the things, when you look across the ocean, is European countries have much less churn at the top.

Hammond: So, one of the most surprising stats that I read in recent days has been that of the top 100 companies by market cap, 40% of American companies are less than 40 years old. Whereas in Sweden, Denmark, and Germany, only 7% of their top 100 market cap companies are under 40 years old. So, they're dominated by large legacy firms. In the case of Germany, we know a name like Volkswagen.

Beckworth: Yeah.

Hammond: They do have some startup stories, but their startups tend to hit a ceiling it seems. They don't have the ability that American firms do to go from small, innovative fringe firm to a new dominant firm. Part of the resistance to fetishizing the small over the big is that startups aren't good in and of themselves. Startups are good to the extent that they're able to scale, right? Innovation follows this lifecycle where, sometimes called the S curve, where early in innovation you have a lot of small competitors. But then a few dominant ones, the most productive ones, end up scaling up rapidly. So, in the early 1900s, there will over 100 automobile startups. By the end of the 20th century, there were the big three automakers.

Hammond: Innovation tends to run through this cycle. What you kind of see in European economies, which is kind of disconcerting, is the bigger firms seemed to have calcified. There isn't that churn at the top, and os I lay some of that blame on corporate governance. It's much harder in European markets due to the shallowness of the capital markets, and because of worker representation on boards and so on, to do the kind of restructurings and to do the kind of, sort of visionary kind of things that end up displacing the giants at the top.

Beckworth: So, a Steve Jobs couldn't come along and change the industry. We'll come to that, but you mentioned VW, Volkswagen, there's other German firms. But what you're saying is that most of the big corporations over there have been there a long time and they don't change quickly. You mentioned VW and the workers who sit on the board or they help shape policy in corporations. So, this term codetermination comes up, and I want to tell a story about, or this was at least attempted, tried in the United States. It didn't go over so well. Maybe you can speak to it and in general speak to what codetermination is.

Beckworth: VW established a plant in Chattanooga and I have a lot of connections to Chattanooga. Family, my wife is from Chattanooga, so it was a big deal. When this plant came, people were excited. Politicians were thrilled, but then VW, operating under the German model, they tried to unionize it. Politicians about flipped out there in Tennessee, because this is Tennessee. This is the south, unions aren't very well liked down there. So, they were shocked to see VW do this, but this is something that's common to capitalism in Germany, to plants in Germany.

Beckworth: What's interesting is they took a vote and it wasn't... the union didn't win. It was not able to represent there, although there was a smaller part of the workforce, I believe the machinists or some of the technical folks on the floor who operate the machines and stuff. They got a union, and now VW is actually going to court, going to legal battles with this small micro-union within that Chattanooga plant. They want the whole plant unionized, not just one piece of the plant unionized. So, it's an interesting story that's still ongoing.

Beckworth: But what was striking, I guess the bigger point is that the Germans, for them it was normal to have the unions involved with the management of the plant. This goes back to the idea of codetermination, which we see in Germany. So, explain to our listeners, what is codetermination and why would it present problems here in the U.S.? This gets to one of your big critiques about maybe death by committee type arguments.

Hammond: Right. So, codetermination just means worker representation on the board of directors of a corporation. In Germany, I think it's over 2000 employees. If you have over 2000 employees, you're supposed to have 40% of your board appointed our elected by employees. It's actually not 100% enforced, so when I looked into this, nearly half of German companies that fit that definition aren't under codetermination.

Beckworth: Okay.

Hammond: Partly because it has to be forced by employees. So, if employees don't really care, it doesn't really get enforced. There's other ways around it, so when I looked across other countries that have codetermination like Denmark or Sweden, there's a lot of games going on with incorporating in Luxembourg or sheltering your companies in multiple different nonprofits and stuff like that to avoid.

Beckworth: Interesting.

Hammond: Partly because it goes to this point that, yeah, having owners of the firm having some direct control over what the firm does is incredibly valuable to owners and incredibly incentive compatible with their goals. So, the alternative version of this is codetermination, which says in the words that Warren chose that there are multiple stakeholders. There's the community, there's employers, and that they should have a representation in firm decision making.

Hammond: Now, part of the problem here is that there are many worker controlled firms. There's nothing stopping somebody from creating a worker's cooperative or a producer's cooperative. There are many ways to structure a firm. The reason corporations are dominant goes to this theory put out there by Henry Hansmann, who is a famous business ethicists, where he pointed out that in the shareholder model, ownership tends to flow towards the lowest cost owner.

Hammond: His insight was that the homogeneity of interests is relevant to the contractual cost of ownership. For instance, there's many dairy producer co-ops. A dairy producer co-op is a firm that's run by the producers, it's run by the dairy farms, and they sell their milk to the firm at a below market price. Because in the end they get a profit share, right? But part of what makes that viable is the relative homogeneity, pardon the pun, of milk.

Beckworth: Right.

Hammond: The more complex a firm gets, the harder it is to structure around that model. Because then how do you defy the profit share, right? In some ways capital, financial capital, is sort of at the limit of homogeneity. It's money, money can be divided up, it's totally fine to be used on anything. So, the Hansmann argument is that we should be looking at corporations as no different than the producer co-op or the lender's co-op or the worker's co-op. The difference is that they're a lender co-op. They're lending the firm money at potentially zero interest, and what they get in return is both an ownership stake and a profit share.

Hammond: So, it has the exact same structure, but that comes with costs, right? If you own your condominium, you have certain risks that you don't have when you rent, right? Part of the way owners are compensated is through electing a board of directors. So, out the gate, I think it's based on a faulty model. It's based on this idea of well, why should employees have corporate representation? They are choosing to have a contractual relationship with the firm rather than ownership relationship with the firm.

Hammond: The second point is that stakeholder theory kind of breaks down when you realize just the multiplicity of stakeholders. Why employees, why not suppliers? Why not customers, or why not any other sort of way you can divide the pie? Employees are kind of picked arbitrarily. When you start dividing loyalties, you both dilute the formal control of the corporation. You dilute its mission. Ironically, you make it less accountable. So, her bill is called the Accountable Capitalism Act, but one of the virtues of the shareholder model is you have a very clear directive. Maximize profits within the bounds of the law and within the bounds of market efficiency. You don't want to exploit market imperfections, that should also not be something you do, like pollute.

Hammond: But within those bounds, we give firms the permission to maximize profits because it leads to an efficient market outcome. It leads to market clearing prices, it leads to investment and growth. When firms deviate from that, like when they pour oil into rivers or they defraud their customers or they lie about their balance sheet, we have a very clear line of accountability and a very clear criteria for judging that. As soon as you start dividing loyalties, it both becomes hard to know what a firm should be doing and hard to know who to blame when things screw up.

Beckworth: So, if I can summarize your two points there, one is corporations have kind of organically emerged out of a voluntary basis because it's the least costly way to organize economic activity in a very focused manner. The second point is, I call it death by committee, that you get too many people on the committee. Too many different interests, nothing gets done, nothing gets accomplished.

Hammond: Right. So, one of my, if I can throw a bone to codetermintaion, it's that there's one view of it which is we need to stack the board with stakeholders. I reject that view. I think it's based on a mistaken view of business ethics. But there are other alternative ways of looking at it. So, if there are market failures, if there are persistent market failures, that's a totally justified way for corporate law to structure to account for market failure.

Hammond: So, Elizabeth Warren is big on the issue of monopsony, that there are these one industry towns that basically reduce wages for their workers because they have no other firms to compete with. If that were the criteria of codetermination, if your firm of your establishment was in a single commuting zone and didn't have any competing firms and had demonstrably, you could demonstrate monopsony in the same way you demonstrate markup, sort of the inverse of that. Then that could be a... you could point to the market failure theory and say, "There's a market failure here. There's a lack of competition that's not leading to the optimal market clearing price for wages." So, codetermination could be part of anti-trust enforcement on those particular establishments. Instead, she's chosen to use codetermination to target the country's biggest firms in a kind of blunderbuss manner that has nothing to do with whether they're the only employer in a small town.

Beckworth: Yeah.

Hammond: So, I don't see any, as a public policy guy, I don't see any public policy rationale. A public policy rationale means, what market failure is it solving? Or is it just based on having a different ethical theory of how corporations should behave?

Beckworth: Okay. Sam, on a related note, I read a study from the Roosevelt Institute written by Marshall Steinbaum, Ioana Marinescu, Jose Azar, and a new author they added, Bledi Taska if I said the name correctly, where they look at monopsony. They look at the study of labor market concentration and they look at online listings of job vacancies. They find that there is market power. This monopsony going on, and they have this real colorful map. It was real interesting looking at it.

Beckworth: When I got to the findings though, it's kind of surprising given all the lead up to it. It's kind of a bit of a let down to be quite frank with you. What they found was that 70% of workers are in highly concentrated markets. If you look at the map, they have a real neat map. It's color coded by kind of ZIP codes or counties, and what you find is where all of the market concentration is located is in rural areas. If you look at the urban areas, there's very little. So, that's 17%. Graphically, it looks huge. There's a lot of market concentration, that's because most people live on the coast around cities. There's a big open space kind of in the middle. So, the study quite frankly was surprising. How does this tie into what we've been talking about?

Hammond: So, if the issue is monopsony power, which she could construe as a real market failure because there's not competitors in the area, there's a case I could make for codetermination in that context. But I think it conflates a couple issues. So, for starters, it doesn't explain the time trend. So, the study that you're citing looks at a cross section of the United States and finds all these rural areas that are essentially one company towns. And then conflates it with the issue of wage stagnation over time or declining labor share of income over time. Where actually if you take them literally if not seriously, urbanization is acting against them.

Beckworth: That's a good point.

Hammond: Because urbanization is pulling employees and pulling workers from the rural area, where there is much less firm competition, into metropolitan areas where there's a lot of competition for the same set of skills. The second problem with conflating the two issues is often when you read these papers or the blog posts about them they'll say, "Look, there's all this industry concentration. At the same time, nationwide consolidation is going up because there's fewer startups or because there's mergers in acquisitions."

Hammond: But that again is conflating two things. What they're looking at for market concentration and market power are things like one industry towns, not mega firms becoming bigger. When you look at firm by firm size, the largest firms in the economy, firms of over 500 employees, pay about 56% wage premium compared to firms with fewer than 100 employees. Not only that, but within those larger firms, everyone makes more money compared to the smaller firm. Clerical workers, administrative workers, they make more than their counterparts in small firms.

Hammond: So, there's a kind of two step that goes on where people will cite, oh, there's monopsony power in all these rural areas because of industry concentration. Then take that term, industry concentration, and then jump to a new context that has nothing to do with the geographical issues that explain the first issue.

Beckworth: All right, so we need to be careful interpreting these studies. Okay, we had Jesse Eisinger on the show a wild back. One of the... he had a book that talked about how many of the big financial firms were not prosecuted, no executives went to jail. And it was a focus on the financial crisis and financial firms, but the general point of this book is that some of these big corporations have gotten away more and more with just settlements with the government as opposed to punishments and signals for better behavior.

Beckworth: I know Elizabeth Warren probably thinks about that a lot. Your response would be codetermination is not the right solution to a problem. That's a real problem, yes, but there are better ways to deal with it. Is that what you would say?

Hammond: Yeah, 100%.

Beckworth: Okay.

Hammond: So, I'm with Elizabeth Warren when she talks about the need for oversight of big corporations. One term she uses is that there needs to be a referee, right? There needs to be someone calling balls and strikes, and when you lose that then yeah, fraud happens. Like the Wells Fargo case, where they're just inventing customers, right? That's not... that has nothing to do with soaking employees or something like that. In fact, one of the issues with codetermination is it can, in theory if not in practice, lead to behavior like labor hoarding. It can lead to all the same malpractice because employees have their own pecuniary interests.

Beckworth: Right.

Hammond: That come at the expense of social welfare. So, I see no particular reason why stacking a board with employees would make it more responsible to the ultimate directive, which is welfare of all society.

Beckworth: Okay, so going back to where this conversation started on this particular point, just because they do it in Germany does not mean that codetermination is going to work in the U.S. There's a lot of reasons to believe it wouldn't carry over at all.

Hammond: Yeah, and on that specific point, Germany, Denmark, Sweden, these companies have determination because they have a long history of voluntary labor associations, collective bargaining. In Germany's case, it tends to be sort of integrated with their entire educational system, right? So, the apprenticeship system is regulated by these industry associations that give out the credentials. They're tied directly in with the firms, the manufacturing companies they'll end up hiring. So, it's an entire cohesive system.

Hammond: In Denmark, they have a long history of voluntary labor associations. Codetermination, when it became statutory in Denmark, it was really just codifying existing arrangements and sort of leveling the playing field. One of the fallacies of the Warren bill is that it's taking... it's trying to copy and paste a kind of superficial outcome, a superficial policy that exists at the surface level of German or Danish society, and trying to superimpose it in the United States. Which as you point out in Chattanooga, we don't have these underlying...

Beckworth: Social norms that would support it, right?

Hammond: You don't have the underlying social norms, you don't have the underlying labor organization. I'm fully in favor of stronger collective bargaining, right? Maybe down the road that would lead to more worker representation from a bottom up manner. But what's most disconcerting is how top down this is, and how stark of a discontinuity it is from a precedent.

Beckworth: Okay, so we've touched on the arguments one can make for it and you've pushed back. You've touched on some of the reasons you've written about in your National Review piece, but you also have another critique and it's a great story, a great counter-factual critique I guess, if we could call it that. You tell a story about Steve Jobs, so tell us that interesting story, what might've been had this been in place back when he was around.

Hammond: Yeah, so Steve Jobs is a bit of the cliched example, but it's still probably...

Beckworth: It's a good one.

Hammond: It's one everyone knows too, so it's useful. But in 1996, Apple was... people were predicting its bankruptcy. Steve Jobs, who had previously left Apple, came back at the behest of the owners. One of his first acts was to force the resignation of the entire, most of the board of directors. He ended up appointing close friends. With that sort of consolidation of power, proceeded to lay off about 3000 employees. He ended a series of product lines, sort of focused Apple on a couple key products, which ended up becoming Macintosh and iPhone and the iPod and everything that came after that, and focus on those core competencies. It took Apple from a failing company to this year, it's officially the United States' first trillion dollar company by market cap. So, that's an epic turnaround.

Beckworth: Right.

Hammond: Could he have done that with constant stakeholder management and worker negotiation? I tend to think not.

Beckworth: Right, I think that's a reasonable interpretation of the counter of actual history, that would be a very different story. Basically, we need a little cowboy capitalism once in a while to shake things up and move things in different directions.

Hammond: And this is part of my deeper sort of ethical critique of the Warren bill, is you have to have a theory of capitalism. Why do we have a system that has this adversarial... it's kind of yucky. A lot of people don't like capitalism because competition feels gross, and it feels like these predatory corporate dudes that are undercutting each other. But the moral status of profit is based on the fact that the pursuit of profit and undercutting your competitor and investing in the better mousetrap to beat your competitor, is based on the social outcome of lower prices, better quality products, market clearing prices.

Hammond: So, it's the competition. In a sense, business ethics has to account for the fact that we specifically carve out the capitalist economy as a sphere for acceptable adversarial behavior. In fact, when you're not being adversarial enough, it becomes implicitly collusion or tacit collusion and we sanction that. So, I see a lot of category errors being made where we're trying to apply the norms of, me and you are not in a direct competition across the table. I'm not trying to undercut you.

Beckworth: Right.

Hammond: Because we're in a friendly conversation. But if we were... if you were Apple and I was Samsung, if we weren't competing, that would actually be a violation of the norms.

Beckworth: Right. From one of my critiques of this proposal, and I think it's related to what you just said, is that it would if anything create more, potentially more collusion, less competition in the two following ways. One, it would in some ways empower big corporations because there would be these huge new compliance costs. Who can meet big expensive compliance costs? Well, the big corporations. So, it might prevent firms from being able to grow and becoming... it might create a barrier. You often see this if there's a new regulation that comes out. Usually it's the bigger corporations that embrace it because they know in the long run, it might serve to their benefit and keep out competition. So, that would be a concern I have. The other one though is just creating this new federal government agency that would issue the charters. To me, that would be rife with revolving doors and all kinds of...

Hammond: Right.

Beckworth: Potentially corrupting influences that we see already occurring.

Hammond: So, one of the disconcerting things for me about her bill is that it has a kind of vague language that a corporation that has this charter has to act in the interest of the community and multiple stakeholders. So, how is that enforced? Is that enforced through legal action? Can someone sue Apple because they're not maximally looking out for Seattle or wherever they're based? That's going to open up a lot of legal headaches. When you think about how having the option to choose what state you can be chartered in, and the principle behind general incorporation. In the early 1800s and prior, incorporation was relatively discretionary.

Hammond: The movement to general incorporation where anyone can apply for incorporation if you meet some basic standards, you can get your company off the ground, was a revolution. Not simply because it opened up this new institutional form, but because it enabled a relative rule of law where you didn't have the king or the president having discretion over what companies could be opened or closed. This bill provides an avenue for the Department of Commerce to remove a charter for a major corporation if they're not acting according to a vague standard, which any president could easily construe a rationale for acting on.

Beckworth: So, for example, if this bill were law and President Trump were still in office, and Harley Davidson had ticked him off because they were moving a plant overseas, he could be a stakeholder.

Hammond: Right.

Beckworth: And maybe in his mind pull the charter, right?

Hammond: Yeah, they're screwing the American worker. Maybe some company had a big layoff because it was the efficient way to restructure the company. But that didn't represent the stakeholders of those employees, who are now on employment insurance. Sorry, you lost your charter.

Beckworth: Right, right. Just again to speak to this issue, which I think is underappreciated, is that even now, the Commerce Department, they're weighing all these exemptions to tariffs. So, all these companies who maybe... because a lot of our tariffs are on intermediate goods. So, if you're producing nails and you have aluminum or steel or whatever it is, there's a lot of raw materials that come in and then produce into final goods in the U.S. It's really hurting some businesses, and so the government said, "Okay, you can apply for an exemption."

Beckworth: There are literally thousands of exemptions out there, and who's making the decision? Who gets a yes, who gets a no? That just opens the door for lobbying, for crony capitalism. It just seems like a dangerous place to go. Now, I want to go back to the point you mentioned earlier. The point of capitalism is to have this adversarial kind of space which leads to these efficient outcomes. Some listener might say, "Man, Sam, you have no heart. You're just this... you believe in just pure, unfettered capitalism," within the rules of course. But I want our listeners to know, if you go back and listen to the previous episode, because Sam has a very fascinating paper where he actually argues for a better run social safety net, right?

Hammond: Mm-hmm (affirmative).

Beckworth: So, maybe you can speak to that real quick just so they can see that other side of you on the show as well.

Hammond: So, one of my phrases is that the firm is an optimal unit of production, not an optimal unit of social insurance, right?

Beckworth: Okay.

Hammond: One of the revolutions of the 20th century is the move towards more universal systems of social protection, partly because it remains agnostic to firm structure. So, the old system of guilds where the family or the kin or the guild system was simultaneously your employer and your safety net was incredibly sclerotic. Because you couldn't, if industrial production changed, the winds shift, you can't shut down that firm without also shutting down your healthcare or your family benefits, whatever. So, part of I think the trade off, and I think a justifiable trade off, is to have this sort of unfettered capitalist system. It really does require more universal safety nets. In part because when you lack those things, you end up diverting energy towards, let's force firms to pay a higher minimum wage. Or let's force firms to... let's mandate certain benefits at the firm level. Let's have employee provided healthcare. All these things end up leading to less efficient outcomes, so...

Beckworth: Yeah, I like that. So, firms are the optimal place for production, but not the optimal place for social safety net provision. So, this great article, and go back and listen to the episode. But it's a real interesting article, and you mentioned how historically the emergence of social insurance occurs alongside the Industrial Revolution in different stages, in different levels of progression. But that's what you see historically, and the U.S. just happens to be one of the outliers in terms of these paths going together.

Beckworth: Okay, going back to Senator Warren's proposal with the time we have left, this observation I had about the bill is it seemed to set points for the cutoff that might be viewed as arbitrary.

Hammond: Sure.

Beckworth: Why billion? Why 40%? To me, those numbers aren't necessarily magical, is that right?

Hammond: Yeah, I think these were just chosen as round numbers.

Beckworth: It's not some universal constant or anything? Okay, so another observation about this proposed legislation came from Aaron Klein at Brookings. He looked at it and I don't want to say he said it's a nothing burger, but he wasn't sure it would make that much difference anyways potentially. His comment was, "Well, how important are boards now anyways? Would it really make that much difference?" You mentioned earlier in Europe, some of these organizations find ways around it.

Hammond: Yeah.

Beckworth: They circumvent the rules, they charter over in Luxembourg or something. So, he wasn't sure. One of his critiques is he wasn't sure that it would really change that much. If you do think there's a problem, it wouldn't change that much anyways. But do you think this bill would fundamentally change and impose huge costs? Do you see it as, or...

Hammond: Yeah, I do.

Beckworth: Okay.

Hammond: I infer that from firm behavior. So, if these things were costless, firms wouldn't try so hard to avoid them.

Beckworth: Okay, good point. So, what we observe... yeah.

Hammond: For instance, in Sweden, Sweden has one of the weaker codetermination laws where the firms that are eligible have to have a fixed number of board members appointed. So, it tends to be about two, but there's no cap on the board size. There's a great study that looks at this and finds that in response, Swedish board sizes have grown. Compared to Finland, which doesn't have codetermination or Denmark or Germany, Swedish boards are a few members larger.

Beckworth: Interesting.

Hammond: Right, so they maintain a veto proof majority. So, the member, the worker representative, tends to just be a kind of information conduit for workers.

Beckworth: Okay. The voice is heard, but it doesn't have an overriding vote on the board.

Hammond: Right. One of the studies that Matt Yglesias cited does this sort of cross sectional look at market valuations and the strength of codetermination laws. Just doing a kind of naïve imputation of what American market valuations would do if we adopted German style codetermination laws suggests that the total market capital stock market would fall about 25%. So, that's not insignificant.

Beckworth: Yeah, that's not trivial. So, you have a great line here in your paper where you mention this fact. Again, this is like you're inferring behavior from what organizations are doing. You put, "Forget if you like your doctor you can keep your doctor." Which is what President Obama said before Obamacare, right? So, it's kind of a funny liner. So, "Forget if you like your doctor, you can keep your doctor. Warren's plan will have you asking if you can keep your retirement savings. As Matthew Yglesias notes in his piece, codetermination could cause average share prices to plummet by as much as 25%. But don't worry, says Matt Yglesias. Quote, 'Cheaper stock would be offset by higher pay and more rights at work.' Maybe, or maybe after the dust settles we will find ourselves in a new lower equilibrium. One with less inequality perhaps, but even lower productivity as America's corporate unicorns are converted into glitter glue." Very graphic, but that's, I mean, the ultimate concern here. Our real solution is faster productivity growth, and this could possibly actually further undermine that attempt to revive it, right? It could actually pull us back.

Hammond: Yeah, absolutely. In every era, most innovative productive firms have been at the frontier of both size and employment growth. It's true today, so the main drivers of innovation for the world over is Silicon Valley, is New York, the Boston area, where they're producing these firms that become mega firms because of how successful they are. It's a real problem in Europe. I was over in Berlin in February talking with representatives from the government, and their failure to really make a dent in the tech economy is a strong, ongoing concern. They haven't quite figured it out. It might have something to do with codetermination and the shallowness of their capital markets, which is directly tied into this lower valuation issue. So, the U.S. is kind of creating a public good for the rest of the world by having a more cutthroat capitalist system.

Beckworth: Interesting, so the world is free riding off our R&D, our innovations.

Hammond: Oh yeah, totally.

Beckworth: Okay.

Hammond: I think that's hard to dispute. Even the innovations that have sort of transferred to Europe originate here.

Beckworth: So, do they have anywhere else in the world that kind of... is there a Silicon Valley equivalent other places in the world, or is Silicon Valley truly only Silicon Valley?

Hammond: The number two is China.

Beckworth: Okay.

Hammond: So, in terms of tech unicorns, the United States accounts for about half. I'd say like 30% to 40% of the remainder is China, and that's partly because China also has absolutely no qualms about scale.

Beckworth: That's right.

Hammond: Say what you will about the government, say what you will about whether they're playing fair on the international stage. A company like Alibaba is a global competitor to Amazon in many ways, same with their social networks. It's because they've allowed these companies to grow.

Beckworth: Yeah. So, Tyler Cowen and his book The Complacent Class we were talking about earlier, his argument is if anything we have a chance of falling behind and losing out because China does embrace bigness, it does embrace change. He mentioned, I don't know if it's in his book or somewhere else, how we could never build the Hoover Dam again. We're too risk averse now, that's one example of this complacency. Everything has to be safe, protected. But Silicon Valley still kind of stands out as an exception to that.

Hammond: Right.

Beckworth: For complacency. It's something that we should be happy to have and want to promote. What you're saying is, China is another place that has it. I his book, I think it's his last chapter or so in there, he mentions, where do you see a place where we don't see complacency? He mentions China. Yes, it comes at a cost. I mean, they have some real social issues and environmental issues over there, but they are rapidly transforming and allowing these big businesses to emerge.

Hammond: Right. So, in the '50s, John Kenneth Galbraith said that the mega corporations of that era, he called it the planning sector. Because these were the companies that were investing in R&D, were doing complex coordinate investments. In many ways, China, the government, is the planning sector. China has these five year, 10 year plans. For us to compete on the level of industrial policy, I don't think the United States has the sort of state capacity if you will to do what China does in terms of direct government involvement in the market. But we do it indirectly through the permissions we give to our largest firms, to have a degree of market power, to have a degree of corporate labs. Google has enormous profits, but they also have a ton of moonshot programs, developing balloons that could provide internet to the world, stuff like that. Just crazy stuff, and that's accomplished within the private sector.

Hammond: It's accomplished partly because of bigness, and so this is one of the trade offs. If we want to do more direct industrial policy, maybe we don't need the big corporate giants. But until the government can prove itself competent, this is the way America does it.

Beckworth: Okay. With that, our time is up. Our guest today has been Sam Hammond. Sam, thanks for coming on the show.

Hammond: Thanks for having me.

People: 
David Beckworth
Calendar Date: 
Sep 24, 2018
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Libsyn Podcast ID: 
7456316
Subtitle: 
As the need for welfare reform becomes more apparent, creating universal safety nets may be one of the most tenable policy solutions.

Sam Hammond on Welfare Reform and Social Insurance

Sam Hammond is a poverty and welfare policy analyst for the Niskanen Center and has recently published a new paper titled, “The Free-Market Welfare State: Preserving Dynamism in a Volatile World.” He joins the Macro Musings podcast to discuss the paper along with some of his other research. Sam and David also discuss the repercussions of the China shock, how to reform America’s welfare system, and the design characteristics that would define an ideal social insurance state.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected]

David Beckworth: Welcome to the show, Sam.

Sam Hammond: Thanks for having me David. First time, long time.

Beckworth: I know. You're one of the few faithful listeners who I can confirm that has listened to all 105 episodes so far, which makes you uniquely qualified to answer this question. What has been your favorite episodes thus far?

Hammond: Well, I'm biased, but-

Beckworth: Not including your bosses or your colleagues, which we know you love them.

Hammond: Well, then I can also say Nick Rowe, who is former professor. Cardiff Garcia who has the second best podcast on economics.

Beckworth: Nice. Second best. I like that.

Hammond: The multiple George Selgin podcasts are all interesting. Will Luther's. I like the economic historians.

Beckworth: Yeah. Those were fun. Good. You've been a longtime listener. You know the show. You vouched for it. I know you've told me several times you religiously-

Hammond: I'm an evangelist.

Beckworth: You're an evangelist and you religiously listen to it which is great. You know the question I'm about to ask you is, how did you get into your area of work? How did you become an economic policy wonk on the topics of poverty and welfare analysis?

Hammond: It goes back to, so I was fortunate enough to have a high school that had an economics class. In that program we had to review a book or do a book report. The book I picked up was called Filthy Lucre: Economics for People Who Hate Capitalism by Joseph Heath, who's actually a philosopher, not an economist. He's a very econ-literate philosopher I would say. It introduced these fallacies of the left and the right, and really got my mind spinning on the power of economic reasoning, economic ways of thinking.

Hammond: I went back and one of his earlier books was called The Efficient Society: Why Canada is as Close to Utopia as it Gets. It discusses largely the differences in the values that ... Comparing and contrasting America and Canada, what makes us different. I'm Canadian. One thing is in America we institute a liberty norm. You can think of the Constitution as being inspired by that. Canada, Joseph Heath argued, was more of an efficiency society, meaning a Pareto efficiency, win-win, positive sum outcomes.

Hammond: A lot of his examples traced to the development of Canada's social insurance system, including our Medicare system. That has been a big inspiration for me. I ended up with the recession, like a lot of people, becoming fascinated by finance and macro, reading a lot of the macro blogs. Nick Rowe, Worthwhile Canadian Initiative, Scott Sumner obviously. Initially when I was deciding where to go for grad school, didn't really do much thinking in terms of rankings or anything like that. I was like, "Where are the bloggers at?"

Beckworth: There you go. That's why university departments should be blogging.

Hammond: I think that's really underappreciated probably by faculty and department heads is how much of a marketing tool just being out there in the blog, econ blogs is for grad students.

Beckworth: Based on that, you decided to go to a grad school where Nick Rowe worked, at Carleton.

Hammond: At Carleton. Little did I know that he only taught undergrad, so we didn't really interact.

Beckworth: Come on Nick Rowe, you can do better.

Hammond: Nick Rowe is great. I think he's an exemplar of how economists and philosophers embody similar things. Because a lot of the way he writes is working it through toy models, thought experiments. I really like that style of thinking, and had the pleasure of sitting in through some of his lectures where he develops some of his toy models. He's a fascinating guy.

Beckworth: He definitely sharpened my thinking on monetary theory over the past decade, through the recession and the recovery. He's definitely been one of my favorites as well. That led you into policy work, so you went to Carleton and you got your graduate degree. You moved into the policy world. You're now at the Niskanen Center. I've had two of your colleagues on before, Karl Smith and your boss, Brink Lindsey. They've mentioned this before, but for our listeners again, explain what the Niskanen Center does and what your role is there.

Hammond: The Niskanen Center was founded as a refuge for libertarians who wanted to branch out from orthodoxy. Our founder, Jerry Taylor, his heresy was to think that climate change was a big deal. My heresy is obviously to think that a welfare state can be efficient and complement markets. I ended up going there from the Mercatus Center where I did tech policy. There's actually a bit of a gap there, like how did I go from tech to poverty. Actually, I feel like I'm doing some of the same policy work.

Hammond: As we'll get into, I'm very concerned about maximizing long-run growth potential of the economy, and don't want to do anything that comes at the expense of that. When I argue for different welfare reforms, in the back of my mind I'm arguing against someone who's a economic growth, productivity growth über alles type. That's why I lead in with the issue of dynamism.

Beckworth: Your new paper is titled The Free Market Welfare State. Very provocative, interesting paper. I'm sure you're getting lots of interesting feedback on it. I want to begin with a discussion you mentioned early on, this point of dynamism that Joseph Schumpeter had talked about, creative destruction. Tell us about his interesting insight about capitalism bringing about its own demise. What was he arguing?

Hammond: Well, I think Schumpeter's big point is that capitalism's a very unnatural phenomena. It's not like some visions of laissez faire where this is just the natural state of the world. Actually, industrialization was a total departure from millennia of human history.

Beckworth: We're the exception to human history.

Hammond: Absolutely. Schumpeter noticed that capitalism had this awesome power of creative destruction, including institutions. He has another quote in Capitalism, Socialism and Democracy where he says something like, "Capitalism destroyed the feudal system that came before it, and eventually it'll destroy itself." His reasoning there was that the amazing productive powers of capitalism produce enormous changes in society, and that can be very disruptive.

Hammond: He predicted that the disruptions within a capitalist economy would lead people to eventually backlash against it, and institute various forms of protectionism.

Beckworth: I'm thinking historically the US case we had, for example, the transition from an agrarian, agricultural-based economy to an industrial one. There was a huge uproar. The agrarian revolt. There was painful transitions whenever the economy undergoes these structural changes. More recently, you noted in a paper, there's been the effect of globalization, in particular the China shock which right now you could argue President Trump in some ways crudely responding to that. Talk about this China shock and how it has been painful and has created some repercussions for capitalism in America.

Hammond: Obviously the China shock, the term comes from David Autor's work, who I think has done a lot for me personally, but I think more broadly the economics profession to update how we think about international trade and its impact, especially for a developed economy. In the China Shock, in his big paper he outlines a set of consensus statements of what the profession thought in, say, circa 2000.

Hammond: The thinking was international trade doesn't greatly harm the sectors that it's competing against in developed economies. Workers are easily reallocated to new productive ends. Trade is a win-win. That was certainly my thinking historically, especially coming from a more free trade, libertarian background. I think the China shock belies that. His research has shown that essentially the import competition of China stemming from its ascension to the World Trade Organization led to anywhere between one and two million jobs lost.

Hammond: That could be fine. Obviously we just had a jobs report, jobs are being destroyed and created all the time. What made the China shock different was how concentrated they were in particular regions of the country, and that geographical boundedness obviously had some major implications for labor reallocation. Subsequent research that I point out in the paper has connected the China shock with changing political attitudes.

Hammond: One thing that I think free traders in general underrate is how purely economic phenomena can have lasting effects, even if they're temporary because we have a political system that is responsive to them. Depending on how that political system responds, temporary shocks can have lasting political, economic consequences. Some of the subsequent research, there's one paper called From Tiananmen to Outsourcing that shows how congressional attitudes to China have reached a low point, lower than just after the Tiananmen Square massacre, and how attitudes in Congress have shifted from human rights in China to issues of trade, intellectual property.

Hammond: How with district-level data, congressional districts that were most exposed to trade with China have polarized dramatically. It's not simply that they've gone to a reactionary right wing direction, but also Democratic districts have gone more left populist in their own way. This has a pretty robust correlation with the decisive voters in the last election. Whether or not I'm being political here in saying this, but in terms of a if/then statement, if you are a free trader, then this should make you straighten up in your seat a little bit.

Beckworth: The rise of Bernie Sanders on the far left and Trump and his populism on the right are a byproduct of this shock, this China shock. That's what this data shows, right?

Hammond: I think largely. I would also point to Dani Rodrik's paper, The Economics of Populism. I think it's probably the best overview of all the different lines of evidence here. One of the things he points out is that there is this interaction between cultural and economics. It's a perennial debate that is Trump a cultural phenomena, or a economic phenomena, and really it's both. It's hard to deny that it's both.

Hammond: Economic anxieties can get translated into cultural anxieties too. I think the weight of the evidence shows that the China shock had a big impact in the rise of a more polarized and populist politics.

Beckworth: It was also interesting you noted in your paper that the folks most adversely effected by the shock, they turned to disability insurance rather than unemployment benefits or the trade adjustment money.

Hammond: Assistance.

Beckworth: Assistance they could get. I remember David Autor talking about this, that they effectively treated disability insurance as unemployment benefits. Is there any more background on why that happened, why they turned to disability rather than traditional unemployment?

Hammond: Well, there's been a long-term erosion in unemployment benefits overall. Also, this varies by state, but states have done various things to restrict access to unemployment insurance. Some states have even moved forward with drug testing unemployment insurance beneficiaries and stuff like that. That's one factor. Another factor is simply that we lack a robust income supports system in this country. Some people will point to the generosity of social security, disability, but really in a international context, disability insurance in America is hard to get and not the most generous by any means.

Hammond: What separates us is the abject lack of an alternative. There's a path of least resistance. Moreover, partly because social security is so means tested and, I would say, cynically regulated, it's also very hard to get out of. Because once you're in, you're not supposed to be looking for work or to take work.

Beckworth: Because you have a disability.

Hammond: Yeah. Exactly. One of the points I make is not only do we need more income supports, but we could learn from the United Kingdom that has, I think, in 2012 reformed their core disability program. It's called the Personal Independence Payment. The thing they did was to make disability universal and unconditional. If you're assessed for disability insurance, you'd be assessed just like anyone would. You're set on a fixed term. Let's say short-term disability, you're assessed for two years. You get your disability payment, but there's no strictures restricting you from looking for work if magically you improve or some job comes along.

Hammond: I think that actually in some ways would reduce, what you could say, the supply side structural harms from disability insurance, while actually in some ways embracing universality, which I think is a good example of how my policy recommendations can cut across some traditional ideological commitments.

Beckworth: You use this example of China as a way to illustrate the fact that the US social insurance system is not very strong. In fact, you have a chart comparing it to the rest of the world, the rest of other advanced economies. Your argument is that we have a relatively weak social insurance system in the US, but the fact is we're getting more and more integrated into a global economy. We're more and more susceptible to economic shocks. We'll get to this later, but you argue this isn't a very sustainable arrangement that we're at. Something's going to give and something has given when someone like Donald Trump or Bernie Sanders is going to rise to power.

Beckworth: If we're going to go down this path, we might as well address it head on before it takes an ugly turn. Now, you frame this interestingly in two ways, because people like me, I'm very free market, flashes of libertarianism running through me occasionally, though some might question that. There's a part of us that worries about the heavy hand of the interventionist state, the central planner, the redistributionist, the zero sum game where you take from Peter to give to Paul.

Beckworth: You make a distinction between an interventionist state like that, that's zero sum. Maybe some could argue negative sum, but at least zero sum. There's the interventionist state and then there's what you call the social insurance state. With a social insurance state, you're making this argument it's very distinct and different than this bad image of the interventionist state in that it creates certain ex-ante, beforehand. It's a different beast altogether because it allows entrepreneurs then to flourish.

Beckworth: If you want to take risk, start a business. If you have a sufficient and well-designed social insurance system, you're more likely to go out and try that. Why don't you talk a little bit about these two different systems.

Hammond: It's a point that I first learned from reading FA Hayek who is a free marketeer extraordinaire. He drew a distinction between central planning and a comprehensive system of social insurance. One of the points he made in The Road to Serfdom, I think buried in a footnote, is that, he was writing in the 1940s, that in many ways Britain is more socialistic than Sweden, because at the time Britain had nationalized industries and stuff like that. Whereas Sweden had in many ways combined universal social insurance with a very capitalistic economy. I'm not a historian of Sweden, but early in their economic history they privatized their forests.

Beckworth: Interesting.

Hammond: Pretty radically capitalistic in that sense. The distinction was that they had these universal systems of social insurance where Bo Rothstein, who's a sociologist of welfare states, says that their motto was, "It's the people's insurance." What this distinguishes, it distinguishes not just the classical free market view of social welfare, but it also pushes back against more left-leaning egalitarian views of social welfare state, which actually in some ways are in concord with the right wing view.

Hammond: If you're an egalitarian, you agree that it's robbing Peter to pay Paul. You're for that. Whereas if it's social insurance, then it's not any different, per se, than private insurance in the sense that you have certain ex-ante benefits from having certainty about in this case your income and your standard of living. In many ways I can connect it to your preoccupation, like nominal income targeting. That is bringing a certain level of stability and certainty to the macro economy. In some ways income supports are just almost is income targeting at the micro level.

Beckworth: It's the micro version of it. You're right. I think your point is a good one in that you're saying this social insurance system actually promotes freedom, where the interventionist state actually eats away at freedom. Examples of the interventionist state that we don't like that erodes freedom, would be occupational licensing, non-compete clauses, zoning restrictions, things that actually reduce economic freedom, inhibit your ability to pursue happiness and life and all those good things.

Beckworth: What you're arguing is just like we have car insurance where we pool all our risk together and therefore I'm not nervous to go drive my car to work or drive my car and do what I want to do with it, you're arguing the same thing for our income. A universal system where you pool it. I guess what was surprising reading this is that Hayek, this Austrian economist. Most people if they know Hayek, they think of him as this hardcore libertarian. He recognized this distinction.

Beckworth: Now, you in your paper take it and say ... He was talking about Sweden and UK in the 1940s, but you compare it, you bring it up to date. What two countries do you compare in modern times to make that analogy?

Hammond: Part of the point of the socialist or the social insurance state, an interventionist state is when there are economic anxieties, when there are economic shocks, they can be in the democratic context be translated in one of two ways. Maybe three or four or five ways, but I'm bundling them two ways. One way is to increase demand for safety nets. Another way is to actually address the issues that are causing the economic anxiety in the first place.

Hammond: Emmanuel Macron recently put this as the choice we face between social protection and protectionism. In the context of modern, a modern day example is if you look at modern day Venezuela, it's often described as a social democratic country. It's the same term we use for the nordic countries, social democracy. They're totally different distinct systems. I think that Venezuela would love to have big safety nets too, but they've totally killed the goose that lays the golden egg. They have nothing left to redistribute because the approach they take is decidedly anti-capitalist, is price setting, price controls, soaking the rich to the extent that there is taxation.

Hammond: It's not this insurance-based model, which I think in some ways is not just consistent with the market but in a way completes the market. There's a gap in the market that social insurance can fill. I associate the Venezuelan case with a form of left-wing populism. We might think of Trump as being a right-wing populist, but this can come in different flavors.

Beckworth: Now, you also mentioned that Sweden and Denmark both persistently score high on economic freedom indexes put out by conservative think tanks like The Heritage Foundation. They're doing something that's very unique and different, in contrast to what we think of a typical socialistic, interventionist-

Hammond: Some people will say that's just an accident, whereas I'm saying there's method to the madness. Why do they rank consistently high? We mentioned trade. The nordic countries are some of the most open to trade in the world. I think Denmark, their export sector is 50% of GDP, thereabouts.

Beckworth: The smaller you are, by definition, almost the more you have to depend on trade.

Hammond: Part of the failure for the United States to have effective adjustment policies, let's say, is the fact that we were for most of the 20th century a third of the global economy. I think even today if you remove NAFTA countries, merchandise exports are 3% of GDP or something like that. In terms of exports in goods. We have this image of ourselves as being this free trading country, but almost just by dint of geography we're actually quite closed. I think that's actually part of the reason why we've been complacent relative to those other countries.

Beckworth: The smaller you are, the more you depend on trade. The US is large. We haven't as a percent of our economy engaged in as much trade as, say, Denmark. Denmark, in other words, is very susceptible to trade shocks. If exchange rates move, if trading partner goes somewhere else, it can really hit home hard. They've had to wrestle with this in a more serious way than we've had to wrestle with it. What they've turned to, you argue, is this universal social insurance approach.

Hammond: Specifically they have a model that's sometimes called flexicurity or flexible security. Their innovation is, I think it goes by a motto, "Your job's not protected but your employment is." They're separating employment from the job, and they have very high replacement rates for wages for lost employment, like upwards of 90% of your wages are replaced. The condition, the reciprocity of that system is that within three months if you're not finding a new job, they're ramping up the active labor market policies, retraining you, giving you subsidies to make you more desirable for employers.

Hammond: As a result, they have this incredibly dynamic labor market. Something like one in five Danes switch jobs every year, which is unheard of job mobility.

Beckworth: In the US, we have the opposite problem. One of the things we've discussed on previous shows, how labor mobility's actually declining in the US. Over there it sounds very dynamic.

Hammond: The other side of the coin is that they have very few statutory labor laws.

Beckworth: Very flexible labor markets there.

Hammond: They have collective bargaining agreements. That's how most of this is regulated, but they still have at-will employment.

Beckworth: You can fire and hire someone very easily. You want to keep the labor market flexible, fluid, responsive to changes in the markets.

Hammond: I just want to put this out there at the top is that I'm not saying the US can be like Denmark. There are many, let's say, let's call it invariant factors that we can't just replicate a different country. We could have a system with American characteristics, that's maybe moving within the Anglo tradition.

Beckworth: Toward that direction.

Hammond: That direction. Right.

Beckworth: You come up with a list of design principles or characteristics that would define this social insurance state, that would promote economic freedom and capitalism. I'm going to list them off real quick, four of them, and then we'll work our way through them in more detail. The first one is it would enable entrepreneurial risk taking. The second one is easing adjustment and search costs. Third one is benefit portability or detaching social benefits from your job with the market you're in. Then finally, making the economy more robust to immigration.

Beckworth: Let's start with the first one, a well-designed social insurance state would make entrepreneurial risk taking more easy. It would enable it. Tell us about that idea.

Hammond: This paper is setting out a kind of research and reform agenda, a way of thinking about things, not necessarily putting forward any specific policy. Of those four principles, the first one, entrepreneurship and risk taking. A free market welfare state should be one that enables people to take risks without fearing catastrophic outcomes if they fail. In any dynamic market, failure is always an option, because we don't want to keep failed businesses alive just for the sake of people's social security.

Hammond: In this case I cite the work of Gareth Olds who's now assistant professor at Harvard Business School. At the time, I think it's his dissertation work at Brown looked at the relationship between entrepreneurship and the safety net and the connection to food stamps. If you search for food stamp entrepreneurs, you can find one of his papers. What he finds is that there was this big enrollment increase in food stamps in the 2000s.

Hammond: Looking at the geographical variation in that, he shows that it led to a 20% increase in new business formation for eligible population. The most interesting thing there is that it wasn't necessarily people who had enrolled in food stamps. It was just people who had become newly eligible, suggesting that this is insuring against entrepreneurial risk taking. This, I point out, is an accident. Food stamps, SNAP is a nutrition program. It's meant to supplement the groceries of low income households. It's not meant to be this income support, but, in fact, because grocery spending is fungible, it functions in this way and has the characteristics of this.

Hammond: Part of the point I make in the paper is how would we construct this if we took the complementarity between markets and social insurance as our starting point, and used that as a way to think about the design of that program? How would we go about enhancing the ability to take risks, rather than just stumbling into it?

Beckworth: You say you wouldn't cut food stamps, but you'd simplify enrollment and convert it into more cash benefits. In other words, this is a quasi-income support program. You said it's fungible. It makes it easy to people, smoother consumption, or to spend on what they need to spend it on.

Hammond: Since publishing this paper I had one person reach out to me saying that they're starting a startup company, and they were nodding along to the paper because they're having cash flow issues. Let's put it that way.

Beckworth: SNAP would be useful for them. I guess you're not a big fan, then, of President Trump's recent proposal to turn the SNAP program into deliver packages to your house.

Hammond: I don't know how alive that proposal is.

Beckworth: It would take it away from the spirit of what it is now though. It would make it-

Hammond: Right. In some ways it is like a communist commissar for food. They wanted to replace SNAP benefits, which right now you get SNAP on a card, EBT card, sort of like a debit card. It's redeemable at eligible grocery stores. They wanted to reduce "abuse" of the system because people were spending the money on unhealthy foods. Really when you look at the stats it's no different than any other population. To make it more in line with the mandate of a nutritional program, one proposal was that they start sending beneficiaries a subscription box service essentially, filled with-

Beckworth: Blue Apron.

Hammond: Yeah. Sort of like Blue Apron. I called it gray apron, because it's kind of sad.

Beckworth: Communist apron.

Hammond: There would be canned beans. I don't know. Beans are pretty healthy.

Beckworth: It did strike me as strange. It's taking choice away and also forcing, the very thing we criticize, big government into making decisions for these households that are very diverse, very different.

Hammond: I think it also stems naturally from a view of this program as just a have to have not program, as supplying some basic needs. Whereas if you start thinking of it in terms of insurance and risk taking and this ex-ante risk pooling arrangement, then you think about the program differently. You are less worried about how people spend the money, because in many cases maybe they want the flexibility to roll that money into a venture.

Beckworth: I had this discussion with someone recently about the abuse of the food stamp program. I looked up the stats, and it is very small, as I recall. It isn't a huge waste. There's not a lot of waste going on in the program.

Hammond: You got to be careful how you think about what counts as abuse. Under the law as it stands, selling your food stamp benefit, selling more than $100 of it is a felony with a maximum penalty of five years in prison. That's abuse, but some people have phone bills.

Beckworth: It might be a legitimate use of the funds, but legally it's not. That's the first one, so the first one is if you have a robust social insurance state, it's going to allow you to be more entrepreneurial, take risks because you feel relatively safe, as this business reached out and told you firsthand. Your second point is it also helps with search and adjustment costs. Walk us through that argument.

Hammond: This is an argument that we touched on with the China shock issue. There's a great book called Failure to Adjust by Edward Alden, that goes a deep dive in how we got to the current state we're in, and the lack of adjustment policy in the United States, that I would highly recommend. Essentially most open economies that we've already mentioned have robust systems for helping labor reallocate in the face of adjustment costs, because equilibrium is not just this automatic thing, like in our new classical models where there's a trade shock and people automatically ... Human beings are not widgets and we're not financial capital. We can't just be-

Beckworth: Quickly move to the newest job.

Hammond: Unfortunately the Cayman Islands is a long flight away from me. It's not a click of a mouse. These adjustment costs are serious and they're a big part of a modern economy. This goes back to the fact that capitalism is a very unnatural state of affairs. The development of unemployment insurance itself stemmed from industrialization. As I point out in the paper, if you look at the history of unemployment insurance, there was really no function for it in agrarian economies prior to the Industrial Revolution because in an agricultural economy we're all working the farm. To the extent that we have social insurance, it's the family or tight knit communities.

Hammond: We're all subject to the seasonality of agriculture. There could be a blight but that's a shock that affects everybody, so it's very hard to pool those risks. With the Industrial Revolution you have this enormous increase in specialization and trade. As a result you have idiosyncratic risks to your employment, where you are a podcaster and I am a policy person, and there's people outside who are working in services, and there's people down the road who are regulating banks. We're all doing different things.

Hammond: Depending on how the patterns of trade shift, you could have a shock whereas I would have a boon. There's new opportunities for pooling risk, and that was reflected in the development of unemployment insurance.

Beckworth: The idea, again, is that with the Industrial Revolution we get incredibly labor specialized which is great on one hand and it makes us more productive. You specialize in what you do. You get better at it. You learn it. Productivity grows. We're better as a whole, richer as a whole. At the same time, we're also more susceptible to shocks. It's more likely you could lose your job to innovation, productivity, competition. We're more susceptible to shocks with the Industrial Revolution. Idiosyncratic shocks that are unique to me.

Beckworth: That creates this need for some kind of way to cushion the blow. One of the arguments was, and you alluded to this before. One of maybe the critiques of your paper would be, "Well, why don't we rely on private charity, churches, your family structure?" As you mentioned, that was in the past something that was used. With increasing labor specialization and the transition from farming to industrial output, that social safety net broke down, didn't it? What's the story there? Why don't we see private charities doing more? Is government crowding it out? What's happening?

Hammond: Well, there's a few different accounts here. I've done some early work on social capital and its role in local social insurance. The actual story, I think, is actually complicated. I've an essay, if you search for separation anxiety and my name, you can find an essay I wrote on this. The development of commercial insurance in the 1800s was in my view the key thing that disrupted mutual aid societies. In essence, mutual aid societies, they used to be called flat rate societies, because everyone paid the same flat rate.

Hammond: If you were out there chain smoking tonight and I was an example of health, we'd pay the same flat rate to be a member. What that implied is that we weren't pricing risk, in essence. The development of commercial insurance coincides with the development of actuarial tables, the first life tables for life insurance, the development of early statistics, the Gaussian curve and stuff like that. That's all being discovered. There was this massive boom in commercial insurance in the 1800s in the UK and across Europe as nascent insurance companies realized these supernormal profits that could be had by accurately pricing risk.

Hammond: You saw the death spiral of mutual aid societies being brought about by skimming off the low risk people and leaving the high risk people, so to speak. Not only that, but because there are economies of scale, there were winning commercial insurance agencies that became nationwide.

Beckworth: The mutual aid societies, those were the early forms of private charity.

Hammond: Right.

Beckworth: Fraternal societies.

Hammond: Fraternal. There are definitely benefits to having, let's say, insurance administered at a low level, subsidiarity. I have a different piece, Don't Abolish the Welfare State, Decentralize It, which looks at the relationship with social capital and the welfare state. One of the interesting things about big welfare states like Sweden is that they have very high rates of social capital. Bo Rothstein is, again, the go-to person on this. Part of the reason for that is they have a very decentralized system of administration. A lot of it is administered at the municipal and county level.

Hammond: There are different ways of preserving the social capital of a community that are congruent with a more universal system. Maybe a faceless bureaucrat sending you a check is not the best in that sense.

Beckworth: You mentioned the 1800s. We go move forward, we have the Great Depression. Daniel Hungerman's done some research on this question, did government crowd out private charities. Maybe you could summarize his research on that.

Hammond: Hungerman has a study looking at the New Deal programs of the Great Depression and how they impacted our religious affiliation. I think he looks at church charitable giving. My main commentary on that is there is a crowd out effect. If you think of it in terms of an elasticity for government spending and charity, yes, there was a substantial reduction in church philanthropy, but it was 90 to 1 for increased government spending.

Hammond: In essence, you couldn't have modern day mutual aid societies replace the roles that the state has taken on, not by a long shot. There's another book called It Takes a Nation that makes this point, playing off the "it takes a village." In fact, modern social insurance systems really do take a nation. They take this, both to get optimal risk pooling, and because the dollar amounts are just staggeringly higher than what was ever provided in the past by mutual aid societies and churches.

Beckworth: Let me summarize your point here, is that what worked in the past probably can't work presently. These private charities may have functioned in the past but may not work presently because of the size of the problem, the complexity of the problem as well.

Hammond: And the fact that we now price risk.

Beckworth: And we price risk. Back then we didn't price risk.

Hammond: This is why my essay on this is called Separation Anxiety, because there's this jargon in economics between a pooling and a separating equilibrium. You can think of mutual aid societies with the flat rate that they paid as being the pooling equilibrium. They weren't looking for signals of risk type. With the development of commercial insurance, we started to actually price risk appropriately, "appropriately." Those pooling arrangements unraveled. In some ways, universal welfare states are basically reinforcing a pooling equilibrium in insurance at the nation state level.

Beckworth: Just, again, it'd be almost impossible, for example, for churches to fill in what governments are doing in terms of social insurance.

Hammond: In terms of spending, right. To the extent that we can decentralize administration or harness civil society as a window to especially case management and stuff like that, I think that's totally realistic.

Beckworth: Well, let's move to your third characteristic or way you would design this social insurance state. That is benefit portability. Talk about that.

Hammond: Benefit portability is just the notion that we think of firms as optimal units for production, not social insurance. If a nation state is the optimal risk pool, maybe Amazon will one day have an optimal risk pool, because it will be a big enough company. The example I use is our weird health care system in America that for really complex, convoluted historical circumstances provides most people, about half of people's health care through their employer.

Hammond: That, very well established, creates job lock. You're less likely to switch jobs if you're worried in the interim that you lose your health insurance. It also distorts firm distribution, because bigger firms have an easier time with compliance for various health care regulations. They also have bigger internal risk pools. The issue of benefit portability, again, goes to that Danish motto of "we want to protect your income or your employment, but not your job, per se."

Hammond: We want a system that provides economic security without propping up failing businesses, without propping up failing industries. Because we ultimately want that stuff to liquidate and be replaced by the new industry, and for people to be retrained and to be brought back into those industries. That's just, I think, one of the more important design principles. Actually one of the reasons why I point towards more universal public option style policy prescriptions is that they tend to be ...

Hammond: There have been proposals to make complex legislative carve outs that you could have some kind of saving account that followed you from employer to employer. I would rather just do something simple and look at direct provision of insurance.

Beckworth: You mentioned for health care, and that's a long conversation. Maybe we don't want to get into it right now. One simple suggestion is universal catastrophic insurance, maybe an expansion of Medicaid. That'd be just for catastrophic health problems.

Hammond: This is a proposal that goes back to the 70s. Back then it was called maximum liability insurance, and it was a Nixon proposal actually. Martin Feldstein, who later became chief economic advisor to Reagan, endorsed it.

Beckworth: You said Milton Friedman also.

Hammond: Milton Friedman in the-

Beckworth: Which was pretty surprising to read.

Hammond: If you sat some economists in a room to design the ideal program, you would. The issue, going back to this point about insurance, is, I don't know the exact statistic, but something like 5% of sick people drive half the costs. There are these catastrophic outcomes that can just bankrupt a person. You couldn't possibly self-insure through savings because part of the issue is that the expected value is not the standard deviation.

Hammond: An elegant solution is to provide a universal catastrophic program that would essentially give everyone automatically enrolled in a high deductible plan that would cover catastrophic costs for health care. Then that would also, I think, fix a lot of the private market, because you could purchase supplemental insurance and you wouldn't have insurance companies being as worried about preexisting conditions and all that stuff. Because they'd be focused on smaller bore costs.

Beckworth: The last characteristic is migration robustness. Tell us about that one.

Hammond: Well, this goes to the argument that social welfare and immigration have a tension. I didn't want to come into this paper denying that that tension existed. Because I think it is a real tension. The point I would like to make is that it really depends on how you design these programs. If you had unconditional flat benefits that anyone was immediately eligible for when they entered the country, that would be a problem.

Hammond: As a matter of fact though, most of our biggest social insurance programs like Medicare and social security are what economists call contributory. You pay into the system. Even if it's not fully funded, you still have the sense that I'm eligible for what I've paid into through my payroll or through other fees. Work by Martin Roos has found that depending on the ratio of contributory versus non-contributory benefits, you can do a lot to modulate the net fiscal impact of immigration on a country.

Hammond: Then there are obviously other ways to do this too, through time limits on new immigrants before they're eligible for benefits. I would point to Switzerland which has a pretty robust social safety net and also very high rates of foreign born. They've done a lot of innovative things on making those two things compatible.

Beckworth: You have a quote from the namesake of your institution, who says, "Build a wall around the welfare state, not the country."

Hammond: That's Bill Niskanen's famous line. I would just modify that and say that there are ways of making the wall porous around the edges through contributory benefits. Obviously the benefits of an unemployment insurance system to the extent that we've talked about search and adjustment costs apply equally to non-citizens. Unemployment is another example of a benefit that we have to pay into first before we become eligible to receive.

Beckworth: These are some interesting ideas, and I can see the appeal to them. I can also see people maybe having knee-jerk responses to them. I won't mention any names, but just prior to this recording we ran into a colleague here in Mercatus who wasn't too excited about this paper. I guess part of this is your political mood affiliation and how you frame this and how you package it, the marketing of this. I think it's easy for us to, again, think, when you make this proposal, Sam, to think the interventionist state model versus the social insurance state model.

Beckworth: You have in the paper a table that has these different buckets, different categories to help us put the proper framework on what we're thinking about here. Talk us through that. What is the proper way to think about this idea?

Hammond: As a graduate of George Mason University, I'm very influenced by public choice economics. Part of my argument is that small government free marketeers have not absorbed the public choice critique of themselves, that there are certain limits to how small of a government you can have that is simply compatible with a democracy. There are examples of governments that have both deregulated markets and very small social transfers, but they tend to be authoritarian city states. They tend not to be big.

Beckworth: Like Singapore.

Hammond: Like Singapore or Hong Kong, or even Chile to some extent. This goes to my distinction between social transfers or insurance and what you could think of as central planning or interventionism. I have a two by two that draws the distinction between if you're pro market and pro transfer, or anti market or anti transfer and the vice versa. I point out that our traditional ideological spectrum, the big government, small government spectrum running from your right-wing libertarians to your left-wing social democrats doesn't actually align with the regimes that we see in the world.

Hammond: There aren't these pure libertarian countries or these pure social democracies. Instead you have interesting mixes of capitalist economies with large transfers and what you could think of as more reactionary economies with small transfers but high amounts of regulation and protectionism. The United States when you plot this on a graph, and I have a graph there that plots social transfers against regulation, the US is sitting by itself in the quadrant.

Hammond: I'm arguing that that's somewhat unstable, that we have a dynamic where we are relatively unregulated but have low income supports, and that we're starting to see the outcome there through that economic anxiety that that generates being translated into populist candidates, and also protectionist regulations, both the macro level and through third or fourth best policies like occupational licensing.

Beckworth: I want to restate what you said but use the term economic freedom. You use less regulation, but let me put it in a flavor that some listeners might like. Economic freedom.

Hammond: Yay.

Beckworth: We love economic freedom. We do, liberty, freedom to choose, start a business, move where you want to move. What you find, and it's a pretty striking graph, so I recommend our listeners go to this paper, look at this figure three which will be posted on the SoundCloud page for the podcast. It shows this really strong positive link between income transfers and economic freedom. Maybe more simply, a strong link between a robust social insurance and economic freedom.

Beckworth: That by itself is interesting, but what's also interesting is the US is way off the trend here. There's a fitted line, shows a strong relationship and the US is an outlier. Your argument is, and it seems plausible on one hand, that we're at a point and a condition that can't persist. We're beginning to see it already emerge, the fraying of the edges, through the interest in the Bernie Sanders, Donald Trumps of the world.

Beckworth: Let me just take the other side. Well, we've been here several hundred years. Why can't we persist in this equilibrium? Is it just that we finally are getting to the point where we're seeing the tensions really emerge, the contradictions emerge from the arrangements we have?

Hammond: Well, it's not just that. We talked earlier about how historically the US has been a de facto closed economy. China coming online has made us not the large economy in the international models that we used to be. That's one big factor, globalization. I point also at trade, or at technology. I'm a big believer that technology has had a secular slowdown. We've been relatively stagnant for the last, say, 40 years. We're not having the same big disruptions that we used to, like people living through the Industrial Revolution experienced.

Hammond: If you think that that might happen again, you think there might be some kind of fourth industrial revolution or IT revolution, artificial intelligence, robotics, you have to start thinking about the social upheaval that will ... History doesn't repeat, but it rhymes. If this happens again, how is that upheaval going to be translated in the United States? Will it be into an interventionist mode, or into a social insurance mode? That's the things I point at as being worrying.

Hammond: In the jargon of economics, my chart, I think, represents a saddle path. Countries that deviate from that saddle path, they can do it, but there are forces that draw them back. The countries that get drawn down to the reactionary equilibrium where you have low economic freedom but also low transfers, we have stories about how that happens and we have stories about how countries like Sweden get buy-in for high levels of economic freedom through social insurance.

Beckworth: Your model, in short, is predicting the US is going to converge to one of two points over time. One point being authoritarian, low economic freedom, or more economic freedom but with a bigger, more robust social insurance system. We should be smart and help guide that, pick that path before the path is picked for us.

Hammond: It requires us overcoming aspects of our traditional ideological equilibrium. This, I think, ties back again with what makes the Niskanen Center unique, is we're willing to deviate from that spectrum, and go on the off diagonal.

Beckworth: In the minutes we have remaining, I wanted to ask you about a couple of observations you made at the close of your paper. Number one is Wagner's Law. You mentioned Wagner's Law, and you also mentioned that Tyler Cowen who is my boss and the head of the Mercatus Center, Tyler Cowen brings up the paradox of libertarianism. Why don't we close by fleshing out what those two things mean and how it ties into your paper?

Hammond: Wagner's Law, it's a stylized fact really, it's not really necessarily a law. We just don't have any examples that counter it. The law is that as countries get wealthier, their governments get bigger. It's just something we observe. We don't have the economy of the 1900s with no income tax and small tariffs and very small federal government. Countries around the world that have gotten wealthy all look similar to the extent that they have bigger governments.

Hammond: This ties in with Tyler's essay, Paradox of Libertarianism, where he says, to some degree libertarianism is in a bit of a intellectual ... I think the quote is, "The intellectual crisis of libertarianism today is that they don't accept the package deal of modernity." The package deal is that economic freedom requires big government. Not just as a incidental fact, but as something that, as I argue, has a causal relationship with economic freedom.

Hammond: This goes, again, to the public choice critique. The public choice critique has to be turned on ourselves a little bit, and suggests that the political economy of welfare states means that they're probably not going away, but if they go away that we'll have something worse. Overall, there's been this, you could say, the anti-entitlement orientation of conservatives within America. The thing is, to the extent that spending can substitute for more interventionist approaches, if you take a hard line against entitlement spending, you're going to start looking for off-budget alternatives, things that don't appear to cost anything because the costs are borne by society.

Beckworth: Takeaway is we're going to be moving in one of two directions in the future. Let's pick the direction carefully now. Let's have some forethought in it, and let's hopefully make the choice to move toward economic freedom. The package that comes with that is a robust social insurance system.

Hammond: Right. We don't have to reinvent the wheel, but we can absorb the fact that there is complementarity between markets and social insurance, and do something novel to the extent that we build that into our design, that we design these programs with the complementarity in mind. We don't have to become like Denmark. We could become something totally new.

Beckworth: Well, on that happy note, our time is up. Our guest today has been Sam Hammond. Sam, thanks for coming on the show.

Hammond: Thank you very much.

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David Beckworth
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May 28, 2018
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Subtitle: 
The China shock is rethinking our attitude towards globalization, what should the government’s response be?

Sam Hammond and Brink Lindsey on *Faster Growth, Fairer Growth: Policies for a High Road, High Performance Economy*

Sam Hammond is the director of poverty and welfare policy at the Niskanen Center and Brink Lindsey is vice president and director of the Open Society Project at the Niskanen Center. Both are returning guests to the podcast, and they join David again on Macro Musings to talk about their new pro-growth report titled, *Faster Growth, Fairer Growth: Policies for a High Road, High Performance Economy.* Specifically, they detail a number of different policies the US government could adopt to achieve faster and fairer economic growth, including social insurance modernization, child allowances, and more.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth:  Brink and Sam, welcome back to the show.

Brink Lindsey:  Hey, thanks for having us on, David.

Sam Hammond: Yeah. Thank you.

Beckworth:  Good to have you back on the show with us gentleman and glad to see that you have survived the pandemic and another presidential election.

Lindsey:  Surviving.

Beckworth:  Surviving. It's true as of this recording nothing is definitive although it's pretty clear where the direction is going in the election right now. But you have a really interesting report that you put out and I agree with much of it. I have a few questions and it's definitely great material for the podcast. I'm really looking forward to jumping into the material you've provided. Before we get into it though, I want to think about what you guys are doing at the Niskanen Center itself. What prompted this is actually part of your report. You have this Niskanen synthesis.

Beckworth:  It's a very mysterious, but enticing term, the Niskanen synthesis. I want to read a paragraph, which I think summarizes the Niskanen synthesis. It's from your paper. It says, "While traditional ideological battle lines pit a pro-market right against a pro-government left, we reject this choice as a false dichotomy. In our view addressing the daunting challenges facing the country today require simultaneous moves in both directions. We need greater reliance on entrepreneurship and competition and we need more robust provision of social insurance and other public goods."

Beckworth:  In other words we need a free market welfare state. Is that a fair characterization of the Niskanen synthesis, and then what does that tell us about the broader vision of the Niskanen Center?

Lindsey:  Yeah. I think that's a pretty fair staying on foot version of our distinctive spot on the ideological spectrum that we're trying to pioneer and settle. The Niskanen Center is a new-ish think tank. We'll be six years old in January. Trying to innovate think tank practice on operational as well as ideological lines. On operational lines, we've gone back to the original Heritage Foundation vision of a think tank as being really oriented towards engaging on a day-to-day basis with policy makers, especially on Capitol Hill.

Lindsey:  We have policy departments in immigration, in poverty and welfare, and in climate where this kind of really in the trenches work, knitting together coalitions, working on legislative language, really getting into the weeds on policy detail is our bread and butter work. Whereas a lot of think tanks in recent decades have kind of wandered away from that and more towards sort of general engagement with public opinion through a focus on being prominent in the media. We try to do that too, but we also want to be there in the trenches.

Lindsey:  Ideologically, as you hinted at, we're trying to define new terrain on the ideological spectrum. We see these are traditional left-right divide about the size and scope of government pitting a pro-market, anti-government right against a pro-government, anti-market left is a false dichotomy. We see a huge major domestic challenge facing the United States as a kind of double whammy melees, a combination of much slower growth than we experienced in the 20th Century, sputtering dynamism relative to the kind of innovation and productivity growth we saw in the 20th Century, combined with high inequality both along socioeconomic lines and along geographic lines that means that the benefits of this slowed down growth are skewed to people at the top.

Lindsey:  People in the middle and downwards are doing even worse than the slow growth numbers would indicate. That leads us to this idea that we need to work on producing both a more thriving private sector and a more thriving public sector and that these are complementary pillars of a thriving society.

We need to work on producing both a more thriving private sector and a more thriving public sector and that these are complementary pillars of a thriving society.

Beckworth:  Okay. Now, this report, is it a concrete steps version of that vision? I mean what was the motivation behind it?

Lindsey:  Sam can elaborate on this, but we came out with a paper about a couple of years ago or at the end of 2018, sort of a vision paper to lay out this synthesis, this new synthesis that we're trying to champion called *The Center Can Hold.* That was really sort of a 30,000 foot view of general principles. We've got that and meanwhile we've got our in the weeds day-to-day policy work. This is sort of the mezzanine level.

Lindsey:  We wanted to flesh out our concrete policy ideas beyond the specific departments where we're doing day-to-day work, but bring that big picture vision down from the clouds a bit and to show what a move towards a free-market welfare state would actually look like in practice on a number of key policy issues.

Hammond: Yeah. There's a sense in which our philosophy and our methodology are consistent with one another. On the ideological philosophical side, we actively sort of maintain that the synthesis of social insurance and public goods and a generally pro-government or high-performance government attitude, what maybe Tyler Cowen would call state capacity is actually more coherent when combined with a very robust free market orientation, because in some ways the market and the government both belong to a common set of institutions. We just call it are our institutions, American institutions and when you have problems in one, they often reflect problems in the other and vice versa.

Hammond: But this doesn't get picked up on the ideological level, because ideologically people want to sort based on mood, based on, are you anti-government in mood or pro-government in mood? Are you anti-market in mood or pro-government in mood? Because those things are presented as antagonists, people ideologically sort in a way that is actually kind of perpendicular to the reality. The reality is when you have well-functioning governments, you also have well-functioning markets and when you have dysfunctional governments you often have dysfunctional, corrupt, and captured markets.

Hammond: What we identify with this growth slowdown and the inequality that has increased over the last four years is a consequence of both the market and our systems and the machinery of government both decaying to some level and with harms to both productivity and equality. On a philosophical level, we maintain that you can solve both at the same time without sacrificing one or the other, because they really are both determined by this common factor, the quality of our institutions.

Hammond: Then, on the day-to-day practical level or our strategic orientation, the Niskanen Center, we're a non-partisan think tank, but we're not… We call ourselves moderate, but we're not bipartisan, we're trans-partisan, so rather than trying to split the difference between the left and the right, we want to formulate ideas and policies that they can stand alone on their own, but simultaneously appeal to the values and interests of the left and the right. A family benefit appeals to the family interests. The pro-family values of the conservative and the anti-poverty values of a progressive, it's not trying to make them compromise on their values, it's trying to construct a policy that synthesizes their values and can forge agreement in that way rather than promote the kind of bipartisan compromise in which everyone is dissatisfied.

Beckworth:  Okay. Now your report begins by looking at this question of stagnation, which you both have alluded to already. The economy hasn't grown as rapidly, the inclusive prosperity has not been there as it was in the past, and as a consequence, we have these growing divides. It's probably contributed to the polarization we've just seen in our election. You give in this first section of your paper two stories for why this has happened.

Beckworth:  The first one is it's just getting harder to have rapid growth when you're this advanced of economy. The low-hanging fruit's been picked already, right? We've educated people to quite an extent, population growth has slowed down, total factor productivity growth has slowed down, but then you also point out policy failures and mistakes that have happened.

Beckworth:  In fact, Brink, you have a book on, it's on the show last time you came on we talked about it, *The Captured Economy,* how finance, housing and healthcare and we'll talk about this later in more details, have been captured. You got these two, I think areas. One, we've picked the low hanging fruit too. There's policy choices we could do differently and just kind of looking ahead, if you could tweak these as you've envisioned in this paper, what is like the bottom line number you would see?

Beckworth:  I mean do you have an idea of how much more growth we would get? We've been averaging around 2% real GDP growth on trend for the past decade or so. I mean are we talking about a 1% more so we're going at 3%, 4%. I mean what's your vision? What can we gain? If we followed your plan to the letter, where would we be?

How to Build More Economic Growth

Lindsey:  That's a very tempting question to speculate about, but a very dangerous one to just speculate about because we just… Economists can do a pretty good job of estimating the static welfare losses of bad policies that if resources were reallocated to their more efficient use, then you can measure the difference between the output and scenario one and scenario two.

Lindsey:  Measuring how fast the economy would grow if conditions were more favorable to innovation, and therefore innovations that none of us have even dreamed of would occur at a more rapid rate, there's just absolutely no way to foresee the path of the future development of the economy that way. I do think that over the course of the 20th Century GDP per capita growth in real inflation-adjusted terms averaged about 2% a year. It's averaged just a little bit more than 1% a year during the 21st Century.

Lindsey:  We identify a number of policy problems that if corrected could add tenths of a percentage point to growth. If you do that, so right now we're growing a little bit more than 1% a year, if you add tenths of a percentage point up to an additional percentage point, you could be doubling the growth rate in the economy. I don't think we're talking about chump change. I think we're talking about big structural problems in the economy, and therefore currently big sacrifices to potential output and potential improvements and well-being.

Hammond: If we just take two areas that we talked about in the paper, housing and healthcare. On housing if you believe Enrico Moretti's research, the spatial misallocation from housing sacrifices nine percentage points of GDP a year. That estimate can be quite a bit off for it to still be a substantial cost, and likewise of healthcare, the US spends double what most other industrial countries do in healthcare. We identify a number of supply side barriers and ways in which our healthcare sector has been captured contributing to this heightened cost and you could imagine if we could take health care as a percentage of GDP down from 17% to I don’t know, 9% or 10% and that's another seven percentage points of GDP per year that we can use in better ways.

Hammond: So even just in those two areas, and we haven't even talked about our sections on innovation policy, which sort of imagine new technologies that could drive us to a whole new frontier just within the current technological paradigm, those two sources of stagnation and dysfunction alone could contribute double digits to GDP growth.

Lindsey:  But just to be throwing a note of caution and realism, we did emphasize in the paper that the task of achieving inclusive prosperity has grown harder. As you mentioned, there is sort of diminishing returns to innovative activity is a pretty robust conclusion from a survey of the past hundred years. We've had an enormous increase in both the absolute number and the percentage of the workforce comprised by engineers and scientists. People who engage full-time in innovative activity and had seen nothing like a corresponding increase in the pace of innovation and productivity growth, so that suggests that we're getting less bang for the buck from every person hour of innovative activity than we used to.

Lindsey:  There's a wonderful paper by Charles Jones and Nicholas Bloom and others called *Are Ideas Getting Harder to Find?* They cite the kind of eye-popping stat that to get one more iteration of Moore's law these days, to double the processing power you can put on a single chip, takes 18 times as many engineers now as it did a few decades past. We do have natural processes making it more difficult to grow as robustly as we did in the past. Likewise, there are natural or deep structural factors that are leading towards higher inequality.

Lindsey:  The skill bias, technological change, the superstar market effects that are pushing towards incomes skewed towards the top. Policymakers have their work cut out for them, but the problem is that we've… Nature put us in this hole and we've responded by just continuing to dig. We need to go the other way.

We do have natural processes making it more difficult to grow as robustly as we did in the past. Likewise, there are natural or deep structural factors that are leading towards higher inequality... Nature put us in this hole and we've responded by just continuing to dig. We need to go the other way.

Beckworth:  In short we have picked a lot of the low-hanging fruit. It's going to be much harder to reach up high and pick up the next level of growth.

Lindsey:  But it's who knows, right? There's possibilities of breakthrough innovations in nanotechnology or in life extension.

Beckworth:  Sure.

Lindsey:  …just open up gigantic vistas of opportunities for improving well-being, but-

Beckworth:  Yeah. Using the tree analogy there, maybe the tree will come down closer to us when this new innovation comes along. I like to be optimistic too. I mean some of the things you mentioned in this report they're really like immigration. I think we really don't fully appreciate the extent how immigration could change our future, not just with more bodies, but the more people we have, the greater the chance of an Einstein being in those people.

Beckworth:  The outcomes could be very different. I mean I recently had Matt Yglesias on the show, *One Billion Americans.* The whole Julian Simon view of the world. I think Paul Romer view of the world is an important one, which could change like you said the whole dynamic there. Also, I just want to bring this up and I know we're getting ahead of ourselves. We need to get into the actual sections of the paper, but you mentioned near the end of your paper about how we become more risk averse to making decisions in terms of building things, roads, structures, some great examples. How it's taken like three decades to renovate the Penn Station in New York City? Costs have gone up.

Beckworth:  Part of that is we've become more risk averse, and so my boss Tyler Cowen had a book out a few years ago, how as you get richer, more fluent, is this kind of, I don't know, maybe a feature of nature? We tend to be more risk-averse, more careful what we do and I wonder if that is also a big constraint in being able to move forward? So even if we had these great inventions, there's always going to be people who are careful and cautious because we are so affluent and so comfortable. Is that a constraint we can see past?

Risk Averseness as a Growth Constraint

Lindsey:  I have come to believe it is real barrier to growth, sort of a deep civilizational level that once you get rich and fat and happy, you get complacent and you get risk-averse and you've got… Most people are much more concerned about keeping what they've got than getting additional stuff. That is the loss aversion is a big motive. When more people have more to lose, there is more potential vetoes to some change in the status quo that's going to upset that status quo.

Lindsey:  Yes. I think we talk specifically about environmental review under the National Environmental Policy Act as a barrier to growth and as a major inflator of infrastructure and building costs, but sort of lurking beneath that is this general accretion like Mancur Olson described over time of these kind of barnacles that attach to the economy of vested interests, distributional coalitions that are working to push income and wealth their way.

Lindsey:  The rich, the longer you go through sustained peace and prosperity, the more of those barnacles grow and the harder it is to scrape them off. That I think is probably the deepest challenge is to summon up the willpower to take on the vested interests and distributional coalitions that are gumming up the works.

I think ... probably the deepest challenge is to summon up the willpower to take on the vested interests and distributional coalitions that are gumming up the works.

Hammond: It goes beyond just building bridges. The fact that countries like Spain, which no one thinks of Spain as having a particularly functional economy, but that they can build infrastructure at a fraction of the cost the United States can. It's not because of unions, there's things that clearly influence that are different in the US above and beyond sort of the things that are obvious and NEPA is one of the things that we do very differently.

Hammond: In the '70s a lot of countries including European countries adopted a kind of American style environmental review regime and most of those countries, same countries have moved away from it in recent decades. Germany, Australia, Canada, they've all gone through different phases where they had very long and time-consuming environmental reviews, and then over time had to streamline it, simplify it.

Hammond: The US for our own reasons hasn't yet made that leap. We're still working under a paradigm that the rest of the world has kind of moved beyond, because they've realized it's too costly. I just want to add that environmental review like I said isn't just about bridges. When I was at Mercatus back before joining Niskanen, we did this work on reviving supersonic flight. You wouldn't know it, but supersonic over land was banned in 1973 out of this sort of fear, kind of optimistic fear if you think about it that Concords would be flying over the United States hundreds of them every day.

Hammond: That turned out not to be the case, but it's incredibly difficult for the FAA to repeal that ban and they could do it, because it's just a regulation. It's not in statute. But if they do repeal it they have to justify it under NEPA that it won't increase pollution. In this case noise pollution. The only way you can justify it under the environmental review rules is to have some sort of data. They need data on airplanes that don't exist to justify repealing the rule that would make it possible to develop the market so the planes exist in the first place.

Hammond: It's this incredible catch-22 and that affects not just infrastructure, but something like supersonic flight, which is really next generation transportation technology. We have no idea what the foregone economic benefits of that are.

Lindsey:  I don't want to get in to just a sense of doom that we're destined to go into decline, because of complacency and tying ourselves in knots. One way you shake yourself out of complacency is when some new challenge comes along that makes existing ways of doing things manifestly not good enough. We're facing a bunch of those right now.

I don't want to get in to just a sense of doom that we're destined to go into decline, because of complacency and tying ourselves in knots. One way you shake yourself out of complacency is when some new challenge comes along that makes existing ways of doing things manifestly not good enough. We're facing a bunch of those right now.

Lindsey:  We've had the experience of this shambolic response to the pandemic showing that our state capacity in our governance structures and institutions just aren't nearly as good as we might have imagined. We have the longer-term challenge of climate change that if we are not able to innovate and we're not able to build a whole lot of new infrastructure with new clean energy, then we're going to be in a whole lot of trouble.

Lindsey:  We are potentially facing national security challenges with a rising and very rich China that is increasingly autocratic and hostile towards our values. Then, finally, we're right in the middle of just a terrible democratic dysfunction that we believe is at least partially attributable to the disappearance of inclusive prosperity and to the frustrations and resentments that breeds. The motivations to get off the couch and get going are staring us in the face. We're just going to have to respond.

Beckworth:  Brink, I was thinking along those lines you just mentioned. We need a shock sometimes to awaken us from our complacency. COVID has done that in some cases, and again, I don't want to jump too far ahead here, but allowing medical professionals to cross state lines, go practice in New York, for example. That's some kind of fresh thinking that we need, but it took a pandemic to get us to that.

Beckworth:  Also, going back to immigrants. I think this is another reason why we need more immigrants. Immigrants bring in a fresh perspective and by nature they're more risk-loving if they want to give everything up to come here. We need new perspectives. Occasionally, we need to be pushed. Now, I'm not asking for pandemics, but I do think it's useful that we are awakened from our complacency.

Beckworth:  Okay. Let's move into your paper more directly. This actually was like the first section of your paper what we've been discussing, but let's move into the actual policy prescriptions that you outline and there's three sections where you do this. The first one is about supporting workers and families and you have several policy proposals there. I'm going to work down the list.

Beckworth:  I'm going to fly by the first one because listeners of the show know that first one very well, but it's a call for nominal GDP level targeting. I'll just mention this in passing and we can move on to the next one, but our good friend, Karl Smith, I like the way he summarizes this point. He says, "Capitalism really hasn't been tried until we are at full employment." So unless you really got a healthy, full employed labor market, you really don't get the full benefit of capitalism. What this would do is push us there and I think all our listeners understand this point.

Beckworth:  Let's move onto your second point here. You make the case for comprehensive social insurance modernization. Explain to us what does that mean?

The Case for Comprehensive Social Insurance Modernization

Hammond: Yeah. Sure. We began work on this paper before COVID, but COVID has only brought home the extent to which social insurance and our social insurance systems should be really thought of as a kind of public infrastructure, right? We're living through a moment where whether you have access to paid sick leave is not merely a nice thing to have, but potentially implicates public health concerns about coming to work convalescent because you are faced between a choice between paying your bills or coming in to work sick and infecting your co-workers and causing an outbreak in a way that any employer would not really internalize the cost of providing that paid leave.

Hammond: On top of that our technical infrastructure for social insurance has proven very inadequate to say the least. Circa March and April this year when every Thursday, the job report would come out and we'd have another million or two million unemployment insurance claims. Websites across unemployment offices and their websites across the country would fail, you had lineups around the block. Meanwhile, there was a manhunt to find people who could program in COBOL, which is a programming language that dates back to the Kennedy administration.

Hammond: There was just a total breakdown of our systems. What we call for this paper is both to recognize that just like any other form of public infrastructure, when you rebuild, when you build that bridge back, you can add new lanes, you can add new capacities, and we have to think seriously about what it will take to revamp our social insurance system. Everything from the IRS down to state unemployment insurance programs, so that they can actually respond in times of crisis, but then also be there and be highly functional in normal times to provide the kinds of income smoothing and other social benefits that they exist to provide.

Hammond: We have a number of strategies of how to do that including everything from having a flexible technological modernization fund at Congress, to expanding the ability for agencies like the IRS to hire people outside of the normal civil service schedule so they can actually bring in software developers and other talented engineers to move the tax system into the 21st century.

We have a number of strategies of how to do that including everything from having a flexible technological modernization fund at Congress, to expanding the ability for agencies like the IRS to hire people outside of the normal civil service schedule so they can actually bring in software developers and other talented engineers to move the tax system into the 21st century.

Hammond: It's really an area where under normal circumstances, whether your unemployment program is programmed on COBOL or something else is an incredibly boring topic that no one ever wants to touch, but it's one of those prosaic issues that when the you know what hits the fan, it turns out to be all important.

Beckworth:  Yeah. You mentioned this in your paper and I remember vividly the challenge the IRS had with getting all those checks out, finding everybody, making sure you hit the right names, people who weren't on the roles of the IRS. This is a point I guess that goes to your state capacity argument, right? You need to have better or stronger state capacity and that takes investment. It doesn't just happen. It takes a concerted effort.

Beckworth:  All right. Let's move on to your next one. You have employment security and workforce development. What's the argument there?

Employment Security and Workforce Development

Hammond: Yeah. This really builds off to the modernization point once we've modernized we can talk about not just replacing the system, returning to the same system we have, but building a new and better system. What we talk about in this section is really transforming our unemployment insurance system to a re-employment system.

Hammond: A lot of companies, a lot of businesses during this COVID crisis pursued what you could call a strategy of strategic unemployment where they basically shelved a lot of the workers and pushed them onto the unemployment insurance system in lieu of paying them short time pay. That's better than nothing, but if you look across the ocean, you see much, much lower rates of unemployment in European countries, even European countries that had even more aggressive lockdowns than the United States.

Hammond: The reason for that is because they have well-developed short-time work-sharing programs. The US has technically a work-sharing system. It's just the participation is very low. Work sharing is basically this idea where instead of pushing someone onto unemployment, you reduce their hours and the unemployment program will make up for some of their loss pay. It's a way of sort of having flexible wages so to speak and to trade off hours for unemployment.

Hammond: The other part of this is according to some estimates, one-third of the people laid off due to COVID represent a reallocation shock. Meaning this isn't just a cyclical effect, this isn't just a normal recession, these are people in service industries and the cruise lines and all sorts of industries that are not going to bounce back the way they were prior to the pandemic simply because people's preferences have changed. The actual economy has changed.

Hammond: There's going to be a large reallocation of the workforce into new lines of employment. That's going to require retraining and transitional support. Right now our system is not set up for that. It's set up to basically hold you in limbo until you find a new job rather than train you and get you connected with the employers who are filling in the void of the jobs that were destroyed.

There's going to be a large reallocation of the workforce into new lines of employment. That's going to require retraining and transitional support. Right now our system is not set up for that.

Beckworth:  Okay. You've got two more prescriptions here in this section and just to be clear, this section is all about providing a social safety net, social insurance for the home, the family. Is that fair when they're moving between businesses and firms?

Hammond: Supporting workers and protecting families.

Beckworth:  Okay. Of course, keeping them fully employed if at all possible. But your last two ones on here are strengthening families with child allowances. What do we do now in the US that doesn't meet that standard?

Strengthening Families with Child Allowances

Hammond: Well, just building up the last section. We talk a little bit about active labor market policy and active labor market policy are things that encourage you to enter the workforce. The US has had basically steadily declining spending on active labor market policy since the '80s, and not surprisingly we also have declining labor force participation.

Hammond: Now, meanwhile when we turn to the discussions of child benefits, the US also has one of the highest rates of child poverty in the industrial world. A big reason for that is the absence of direct income support for households of children. In 20 other industrialized countries they have either family benefits, family allowances or child allowances. They're really two names for the same thing, but the idea is you have a young one that's a mouth to feed when you're raising dependents, on a first order the issue is essentially one of cash flow.

Hammond: You have more mouths than workers and maybe the libertarian answer is to repeal child labor laws, but in lieu of that, we need some way of filling that gap. Quite frankly, the debate has been set back somewhat in the US due to this concern of labor force participation. The concern that if we give parents money for their kids, yes, it leaves, it maximizes their choice. It gives them the ability to use their daycare or to use their church. It's pluralistic in that sense, but on the other hand we risk disincentivizing work.

Hammond: One of the reasons we put that active labor market piece ahead of the child allowance piece is to say, "Look, there's two ways you can promote a high labor force participation. You can remove disincentives or you can create incentives." When you look across the world, the US actually has declining labor force participation in spite of our relatively paltry and threadbare social safety net. The reason is not because we're super generous and the Great Society was too great, but because we have sort of fallen down on creating the carrots that draw people into the labor force.

When you look across the world, the US actually has declining labor force participation in spite of our relatively paltry and threadbare social safety net. The reason is not because we're super generous and the Great Society was too great, but because we have sort of fallen down on creating the carrots that draw people into the labor force.

Hammond: It turns out that child allowances are actually one of those carrots. It's a little counterintuitive, but when Canada expanded their child allowance in 2014, the central bank governor Stephen Poloz actually gave a press conference saying that they were going to have to raise interest rates sooner than expected, because the child allowance was stimulating the economy too much. It only makes sense because, again, when you have that extra mouth to feed, parents, families have a very high marginal propensity to consume. Moreover, at the very low end, among the poorest households, even a little bit of liquidity, a little bit of cash is what is required to hire that babysitter so you can go hand out resumes or to basically take the first steps to enter the labor market.

Hammond: We come at this as both understanding the need to promote work and actually work as being valuable to families per se, because earned income, you can't replace earned income with welfare benefits. On the other hand, we are so below the curve of diminishing returns when it comes to support for families and children that actually pushing up the family benefits we provide to the poorest households will actually, in our view, have a positive labor market effect.

Lindsey:  Just to bring this back to the kind of ideological framing. In the conventional left/right division, you hear these proposals for upgrading and modernizing and expanding social insurance. Sounds like a whole bunch of big government, anti-market socialism. We very much do not see it that way. We see our proposals as very much pro-market and that comes out of our sense of things.

Lindsey:  Let me just back up here and say both of us are recovering libertarians. For Sam, it was a youthful phase. For me, it was 20 years of career, but we both retain the sense that competitive markets are an amazing social technology and their creative power is almost impossible to overstate. However, I have come to see in a way that I did not earlier. The extent to which markets are neither self-executing nor self-sustaining. That is markets work well when they are embedded in a set of supportive policies and institutions.

Lindsey:  I think most libertarians recognize that when it just comes to things like the rule of law, which is an incredibly valuable public good that the government provides, but we see that the case for market enabling public goods goes beyond just enforcement of contracts and the like that just to take the child allowances, children raised in poverty are almost certain to be not very productive workers in their adulthood. So if we can have the child poverty rate, we see that as a very pro-market move that is going to expand the capacities of people to participate in and thrive in the market economy. If we can have active labor market policies that can, with less friction, move people from one job to another, from one sector to another job to another, help them make these transitions, then we have a more fully engaged labor force that is working at close to maximum potential rather than the waste that comes from friction and depressed labor participation.

Markets work well when they are embedded in a set of supportive policies and institutions.

Lindsey:  This is our pushback against this sort of hoary ideological frame that would see anything like what we're proposing as anti-market when we see it is very much essential to good market performance.

Beckworth:  No. I completely buy that. Go ahead, Sam.

Hammond: I think one of the last times I was on your program, David, we talked about the China Shock. The striking thing about the China Shock and David Autor's work there is not just the devastation to economic variables like household earnings, but the effects on marriage and family, right?

Hammond: The ability to transition people out of declining industries into new industries is a pro-family policy in a strange way, and likewise, providing families with direct cash benefits is in a weird way a pro-work policy. Brink mentioned a bit of our libertarian background. You should think of it this way. We've abandoned our fiscal libertarianism. We think that what matters is not the quantity of government but the quality.

Hammond: When it comes to issues like family benefits, we much rather just give parents money and let them make informed choices based on their local knowledge than say having an elaborate bureaucratic universal daycare program or something like that. We remain very leery about the potential for bureaucracies to be captured, but we're critical of the sort of quantitative anti-government stance as sort of flattening a lot of the differences in the ways of going about different programs.

Beckworth:  Now, this is all very good and I'm very sympathetic to it, but I do want to flesh this out just a little bit more. In this specific case, we're talking about evolving or changing the existing child tax credit into an allowance. I'm a parent, I have three kids. I can claim that tax credit. I mean how is a child allowance different? How would it help someone on a lower income level? Tell me the concrete steps that would be different.

We remain very leery about the potential for bureaucracies to be captured, but we're critical of the sort of quantitative anti-government stance as sort of flattening a lot of the differences in the ways of going about different programs.

Child Allowances vs. the Child Tax Credit

Hammond: Right now we kind of have a two-tiered system in the United States. If you're very poor, if you're a single mom or just very low income, you probably do not qualify for the child tax credit. You might qualify for a partial child tax credit, but even then you have to have a minimum income. So if you're out of work or maybe you just can't work because you're home raising the kids, you're kind of out of luck. But what you end up falling into are these safety net programs like TANF. The traditional welfare system in the United States, which can provide you some cash benefits and some social services.

Hammond: Meanwhile, as you said, David, someone comfortably middle class, you just get a simple tax credit. We kind of have this bifurcated system where if you're poor and have kids, you're treated with a level of suspicion and if you're middle class and have kids, you basically have full degrees of freedom on how you choose to spend that money.

Hammond: A child allowance is partly about simplifying the system, but also extending the equal dignity that you are shown through the tax code, to the entire suite of families up and down the income ladder, to say, "We're going to treat the poorest of the poor with the same dignity and respect as we treat David Beckworth." It's to say, "We are going to trust you to make the best decisions for your family and not put all these strings, not attach so many strings to the meager benefits we're providing you."

Hammond: If there are cases where you do need social support services, those should still exist, but the idea that just because you're poor means you are basically untrustworthy is mistaken. When you look at this internationally, in Canada, for instance, when they implemented their universal child allowance, low-income families reduced their alcohol and tobacco consumption by about seven cents on the dollar. Now, that surprised a lot of people who thought, "Well, they're just going to spend this money on alcohol and cigarettes."

Hammond: What it actually sort of validated was this theory of household stability. When you give parents money, the benefits flow both in educational inputs like direct inputs to rent, to the kid's education, to food, and groceries, but also to these intangible channels of household stability where there's less stress, less internal domestic dispute, marriages end up being stronger, and all that has compounding benefits that go above and beyond sort of the first order of things you'd expect and end up building stronger families.

Hammond: When we go full circle, when we talked about the China Shock last time, it wasn't just the destruction of those jobs. It was the breakdown, the abject breakdown of family formation that has really I think awoken a lot of people, especially on the conservative right, to the need to do something more proactive, because if you look across the country, there is no marriage crisis among people who earn upper middle-class existence that the marriage and family crisis is really highly concentrated on this working-class population that we've decided for various reasons belong on a totally different track when it comes to social policy.

Lindsey:  Right now we have a child tax credit that is heavily constrained. Its availability is heavily constrained by you have to pay taxes to claim it. We've introduced some refundability recently, but not full. A tax credit like that is absolutely in terms of its economic effects completely the same as if you pay the normal taxes that everybody else does and the government writes you a check. Right now the government is sending checks to middle and upper middle class families for their kids and not to poor folks and that's wacky. We want to change that.

Beckworth:  Okay. Makes a lot of sense. All right. For the sake of time, we're going to fly through some of these policy prescriptions, but I'll mention them.

Lindsey:  We did a whole thing earlier about the captured economy, so that middle section is…

Beckworth:  Yeah. That middle, you have a whole section on the captured economy and you have one more item here. I'm going to skip for the sake of time, but you make the case for universal catastrophic care. I'll let the listeners go check out your paper. Let's move to the last section of your paper where you talk about reviving innovation and dynamism. Let's begin with your first proposal there and that is to pursue aggressive decarbonization. Tell us about that.

Reviving Innovation and Dynamism: Decarbonization

Lindsey:  The first step in innovation is and encouraging innovation is innovation needs to be innovation in the correct direction. Developing more addictive and carcinogenic cigarettes is a form of innovation, but it's not really what we're looking for, right? In the presence of externalities, you can have increases in measured economic activity, which look like growth, but if the costs are being shunted over onto other people, then it could be and those costs are not being taken into account by the people partaking in the activity, then you can have bad innovation.

Lindsey:  We want to get the prices right. We want people to internalize the costs of their activity and right now the costs of increasing carbon dioxide in the atmosphere are global in scope and ramping up over time. So to orient all of our innovative activities towards improved well-being rather than just towards improving numbers on a GDP spreadsheet, we need to address this massive externality, which is threatening all of us, and so we see the cleanest, most market-friendly way to address this is through putting a price on carbon through some kind of carbon tax.

To orient all of our innovative activities towards improved well-being rather than just towards improving numbers on a GDP spreadsheet, we need to address this massive externality, which is threatening all of us, and so we see the cleanest, most market-friendly way to address this is through putting a price on carbon through some kind of carbon tax.

Lindsey:  Beyond that, I think there is a clear government role in encouraging scientific advances in R&D that is a public good that we believe is an important government role. In this case, there are a whole range of policies that can be broadly seen as encouraging research and development of nuclear energy technologies and we lay out what those possibilities are.

Beckworth:  That's a nice segue to one of your other proposals and that is to increase federal spending on R&D and you raise a good question in here that you answer, why do we need federal spending in R&D? Why can't the private sector do all the heavy lifting here? Why is it important to have both partner in research and development?

The Importance of Research and Development

Lindsey:  Yeah. Firms can be expected to invest in innovation when they see a good prospect of commercializing that innovation, and then actually monetizing it in terms of additional… That they can capture the benefits of that innovation on their own bottom line. When scientific advances are too sort of abstract and remote so that you can't see an immediate commercializing possibility or they're so broad in their welfare enhancing potential that it's very difficult for you to capture the benefits of them, everybody is going to benefit, then we should expect firms to under invest in that kind of activity.

Lindsey:  I think that is a very well established market failure that governments can correct. The problem in our case is kind of twofold. First, government R&D spending as a percentage of GDP has declined rather markedly in recent decades, as it happens in sync with declining productivity growth. At the same time and to some extent because of this declining investment in R&D, public investment in R&D, the whole process of funding R&D has become more cludgy, bureaucratic, and unwieldy.

Lindsey:  The percentage of grants that succeed or grant proposals that succeed has gone way down in recent decades, and therefore the amount of time you have to spend raising money has gone way up. We've cited figures that something like 40% of researchers' time is now spent on compliance issues rather than actually inventing a better mousetrap, and some of that is because there's less dollars, and so there's more of a scramble to chase scarce dollars, but in addition there's just a kind of a bureaucratization, ossification of the whole public research enterprise.

Lindsey:  We both think we need more money and we need to spend it more wisely and we need to restructure how scientific funding is done, so we get more bang for the buck.

Hammond: One of the things we say is we should really, instead of prescribing one way to fix say NSF grant funding for research and development, that we should take a scientific approach to science itself and allow some of these agencies to set aside a certain portion of their budget, say 10% a year to just trialing new ideas, to changing the committee process for evaluating grant proposals, to experiment with peer review.

Hammond: We referenced one proposal, which is actually has been implemented in New Zealand of setting aside a portion of research money for a lottery system where the most sort of innovative out there risk-taking ideas, the top 40% of them are taken and put into a pool and taken out by lottery. There's actually a theory in economics, the theory of contests which suggests that a lottery system like that reduces the need to spend and waste so much time writing and rewriting grant proposals, because there's a sense in which if you made it into that 40% pool, but weren't lucky enough to get pulled, that your grant is still good enough and you should just reuse that grant again rather than have to go all the way back to the drawing board.

Hammond: These things are, you can't know them in advance, what's the best way to fund science, but instead we should turn science in on itself and apply an experimental method. Right now we can't actually run those experiments because the degree of bureaucratization is just so great, even minor tweaks to the way NSF does grant funding require multiple year rule making processes and so on, and a base a lot of this comes down to a kind of lack of trust, right?

Hammond: The bigger and more bureaucratized and organization becomes, part of it is we can no longer monitor people on a sort of micromanaged basis, so we have to start implementing a process and process is the enemy of any kind of creativity, and to some extent the underlying solution is just to restore trust in scientists.

The bigger and more bureaucratized and organization becomes, part of it is we can no longer monitor people on a sort of micromanaged basis, so we have to start implementing a process and process is the enemy of any kind of creativity, and to some extent the underlying solution is just to restore trust in scientists.

Beckworth:  Well, I want to go back to this question I raised that you answered, Brink, about the need to have the federal government kind of complement what the private sector does in terms of R&D because the private sector can't see beyond the bottom line. I want you to use a concrete example that you did in the paper, GPS. Walk us through that story, because that was a long journey that could have easily been ended along the way, but it lasted and today we benefit immensely from it. Tell us the story about GPS.

The Story of GPS

Lindsey:  Okay. We can peek behind the curtain of co-authorship here, Sam wrote that, so I'm going to turn it over to him.

Beckworth:  Okay.

Hammond: I mean the story of GPS is that it really emerges out of the DARPA research project. DARPA being the main sort of defense research agency at the Department of Defense. DARPA is very unique in that it has a relatively small team. I think currently really no more than 100 program managers. Again, going back to this theme of trust. They're invested with a ton of trust. They're incredibly smart, driven people. They come in on a short-term basis and have the ability to get an idea approved, it could be a very far out there idea and have a lot of pre-approved money to go and sort of make it happen.

Hammond: GPS emerges out of DARPA as America's sort of like wake up call to Sputnik. What was striking about it is early on the only idea, the only application that the Department of Defense understood was, "Oh, this will help our weapon system. We need to target missiles better." It became very unwieldy. It was delivering very minor benefits even in that context.

Hammond: In 1979, the GPS program at the DOD had its budget slash by 30%, $500 million, and actually for several years in the 1980s, the budget was entirely zeroed out. I think in 1980, we dropped, we went from 24 satellites down to something, either dropped 2 or 12. Anyway, we were taking satellites out of the sky because we couldn't figure out how to use them.

Hammond: In retrospect this seems kind of insane, because global positioning satellites and satellites in general, power, communications, and navigation, the world over. Elon Musk is about to turn on Starlink, which will use low-earth satellites to broadcast broadband internet, high-speed internet around the world. The delta between the potential of the technology and what was seen at the time is just enormous with GPS. It's one of those stories where if you ran back the experiment a thousand times, you can't be guaranteed that we'd be sitting here today with satellites up in the sky.

Beckworth:  Okay. Well, that's a fascinating story and I encourage our listeners to go read that account, but it really speaks to this ability to see, to be able to do research beyond a short horizon that many private firms would have to operate within. All right. In this section on reviving innovation and dynamism you also speak to immigration. We've spoken about that earlier so we'll pass that up. But one of the big things you touch on here is promoting a diversified economic development approach or development policy.

Beckworth:  I want to reframe this because this is I think the friendly version of industrial policy in the paper. Industrial policy is a word that creates allergic reaction among some people, including myself, I'll be honest. It's not the first word I would like to use. I've followed some of the discussions online that you've had, particularly you, Sam, with some of my colleagues, will remain unmentioned.

Beckworth:  You've tried to make the case that there's a nuanced way of looking at industrial policy, right? I mean when I think of industrial policy, you know what comes to my mind? India. 1940s, state planned industries. It really was a disaster, but there's other examples and other ways of thinking about this. Help me out. Help David Beckworth see this in a more nuanced light.

Reframing Industrial Policy

Hammond: Well, in that section we also talk a lot about bad examples of industrial policies. The way I kind of think about it is every country has an industrial policy whether they like it or not. It's sort of like tax policy, you got one. The question is, is it good policy or bad policy? 100% expensing of investment could be seen as a good tax policy, because it promotes capital deepening and so on. An 8% wealth tax is probably a bad tax policy, but it's hard to be against tax policy per se.

The way I kind of think about it is every country has an industrial policy whether they like it or not. It's sort of like tax policy, you got one. The question is, is it good policy or bad policy?

Hammond: The US has an industrial policy, we see it all around us. We have an industrial policy for ethanol. We have an industrial policy for sequels by the Disney corporation.

Lindsey:  We have a medical policy for finance. We subsidize that heavily. We have an industrial policy for single-family home construction.

Beckworth:  It's everywhere, huh?

Hammond: Exactly. If you want to look at this in a different way, is what is your industrial policy oriented towards? In my view and my evolution on this question was really influenced by Joe Studwell's book, *How Asia Works.* Because he really walked through what is this Asian development miracle? How did China and Korea, Japan, Taiwan not just grow at remarkable speeds, but surpass countries like Bangladesh and the Philippines who were liberalizing their economies around the same time?

Hammond: The way they did it was, again, through diversification. Under conventional sort of Ricardian theory of trade, your goal as a country should be to specialize, to become the best at doing what you do, and then you just focus on that and trade your surplus with other countries. That is actually a very good description of what sort of happens on autopilot.

Hammond: You look at Bangladesh, their economy has tripled in size in the last 40 years. On the other hand, China's economy has quintupled in size. What did they do differently? Well, Bangladesh leaned into its comparative advantage, which at the time was low-wage labor, sweatshop labor, and lo and behold 30 years later they still are heavily specialized in the garment and textile industries.

Hammond: China took a different approach. It said, "If we want to break out of the middle income trap, if we want to become a truly developed economy, we need to invest in moving up the supply chain, moving up to higher value goods." We do that not by picking winners and losers and micromanaging the economy, but in some cases by turning on capitalism's power of creative destruction to the max, right? These special economic zones are both a free market success story and also a kind of industrial policy, because they are really… Like the Shenzhen Zone is really a kind of mega industrial park.

Hammond: You can sort of apply pressure on the economy to be more innovative and more embracing of creative destruction than it would be on its own and to channel those energies into sectors where you don't have any pre-existing endowment, because if you leave your economy sort of running on autopilot, it will just pursue your natural endowment. As we talk about in the paper, America's natural endowment as a wealthy country are a certain form of human capital, namely college-educated labor.

Hammond: Over the last 20 years, as we sort of have let the economy go on autopilot, we've become highly specialized in the kind of intangible knowledge work that gets done in cities like New York, Boston, and San Francisco by software engineers, finance, investment bankers, intellectual property lawyers, what all these industries have in common is they are exportable global services that are done by people with graduate degrees or bachelor degrees otherwise and the result has been this phenomena of job polarization, where it's not just that the median income has stagnated, but that the type of jobs, the kind of monopoly of jobs that are available in the US economy has bifurcated, has pulled away and hollowed out the middle.

The result has been this phenomena of job polarization, where it's not just that the median income has stagnated, but that the type of jobs, the kind of monopoly of jobs that are available in the US economy has bifurcated, has pulled away and hollowed out the middle.

Hammond: You have these very low-skill service sector jobs that pay poorly and a growing number of highly paid knowledge working jobs, creative jobs that are, unfortunately, out of the reach and aptitudes of two-thirds of Americans. Only 30% of the country ends up getting a bachelor's degree, and so part of the point of diversifying is not just moving our economy to another frontier, to not be satisfied with sort of walking down a developmental cul-de-sac where we become highly specialized, and therefore highly fragile, but also to promote a kind of productive pluralism where maybe on paper the most efficient outcome is for New York City to become 99% of the economy and for the rest of the country to hollow out, but that is not politically stable.

Hammond: The upshot is that this is both good for GDP and good for growth over the long run and it can kind of redistribute the fruits of economic growth in a more geographically distributed way.

Lindsey:  I'm I like you, David, I'm allergic to the term industrial policy part of this. I convinced Sam to not use the term in the paper. Let's use development policy instead. Part of this is temperamental. I'm old. I fought a lot. Sam likes to use it because it riles people up. I'm world weary to want to rile people up unnecessarily anymore, but I like the term development policy, because it gets at this terrible false dichotomy between developing economies and developed economies like it's this one-off thing that you move to develop status, then you don't have to worry about the future structural changes in your economy anymore. It's done. You're developed, which is silly, right?

Lindsey:  Development is a perennial challenge and keeping things going in the correct direction is a perennial challenge and so two things. First, it's just a fact that government has massive effects on technological progress and the direction of innovation. If through no other channel than through military competition. That has been a driver of technological progress throughout human history. It's a sad fact, but it's the case. There's a huge payoff in better weaponry. Governments have a huge incentive to invest in it.

Lindsey:  Capitalism is very good at taking spin-offs from military progress and turning it into stuff that we enjoy around the home. But that's just sort of a completely, which kinds of technologies you're going to get. Then, is just this sort of weird artifact of what happens to be militarily advantageous rather than what happens to be advantageous for human beings in their civilian lives.

Development is a perennial challenge and keeping things going in the correct direction is a perennial challenge.

Hammond: Can I give you a quick example of that?

Lindsey:  What's that?

Hammond: Can I offer a quick example?

Beckworth:  Please do.

Hammond: We mentioned DARPA, one of the proposals we endorsed in this piece would basically create a new directorate at the National Science Foundation that has sort of DARPA like authorities. The same level of flexibility and risk-taking ability as DARPA. The reason we like that idea is because DARPA does a lot of cool stuff. DARPA helped launch driverless cars and so on, but the imperative of framing it in a militarized or defense context leads to a lot of strange things.

Hammond: A good example of this is DARPA is leading some of the research on gene editing, but the program that they're leading on is to temporarily alter the genetics of soldiers so that they are resistant to radioactivity.

Beckworth:  Wow.

Hammond: Right? That's a current DARPA project, and maybe mutant soldiers are a good thing and maybe we need mutant soldiers. I think that comes with some moral hazard.

Beckworth:  Certainly.

Hammond: I would rather we have similar agencies that are able to invest in breakthrough and sort of science fiction stuff that isn't necessarily militarized from the get-go.

Lindsey:  The other kind of big picture point that led me away from my sort of instinctive knee-jerk aversion to anything that sounds like industrial policy is just this idea that industrial policy is like tax policy, everybody's got one. It's just in the nature of large governments that they have a big influence on the structure of the larger economy and in all kinds of ways that weren't necessarily intended.

Lindsey:  We've got an industrial policy that subsidizes heavily. The financial sector, it subsidizes perverse land use patterns through zoning. It subsidizes the incomes of health care providers to way above and beyond what is necessary to provide for the health of the citizenry. First, there's a theory of second best here that there's all kinds of ways that the government is destroying the economy in a bad way that perhaps if we could completely root out all of those perverse interventions, a laissez faire might be in a more positive direction, but if we can't, then we very much need government to step in and encourage positive economic developments to counter balance against the bad things it's doing.

Lindsey:  All of that plus always recognizing the theoretical possibility that government could accelerate progress, but worried about the downsides of crony capitalism. My cost-benefit calculation has changed just after decade after decade of depressed productivity growth that what we've been doing just isn't working and it's getting harder as for reasons mentioned already to get high productivity growth. We need to try some new things.

Beckworth:  Just to summarize and if I understand correctly, what you're saying is whether we like it or not, we have industrial policies here with us, why not use it to promote capitalism, to promote creative destruction in a manner that would increase our growth as opposed to just kind of ignoring it and not pretending it is there?

Hammond: Yeah. Dani Rodrik, the economist says as a kind of taxonomy of good and bad industrial policy. One of the signs of a bad industrial policy is picking winners and losers. It's targeting particular firms and that is very fraught. What seems to work a lot better are targeting certain kinds of activities and certain sort of high productivity sectors.

What we've been doing just isn't working and it's getting harder as for reasons mentioned already to get high productivity growth. We need to try some new things... One of the signs of a bad industrial policy is picking winners and losers. It's targeting particular firms and that is very fraught. What seems to work a lot better are targeting certain kinds of activities and certain sort of high productivity sectors.

Hammond: Germany has these well-known institutes for small and medium manufacturers, they're publicly funded, but their job is basically to take practical research and development and translate it and transfer it to their manufacturing sector to keep it competitive. That is directly supporting sort of a particular type of activity, a willingness for a firm to upgrade its processes rather than going out and saying, "We're going to pick Volkswagen and give it a bunch of money."

Hammond: Those two things they get conflated a lot, but they're actually two very different approaches. One of the things that annoys me with the industrial policy conversation is there's often this conflation of totally different styles of policy all under one roof, right? We're very much against industrial policy for sports stadiums. There's all kinds of bad stuff that is clearly not aligned with the lodestar of productivity growth.

Beckworth:  Okay. Well, we are nearing the end of the show here. I want to end on a question tied to the current environment we're in. I'm wondering how do you see this proposal unfolding within the Biden administration? Do you see it jumping on board, embracing some of your proposals? What direction do you see it going?

Prospects for Pro-Growth Proposals in a Biden Adminstration

Lindsey:  Well, in President-elect Biden in his stump speech stresses again and again sort of three big crises, the COVID crisis, the economic crisis that grows out of the pandemic, and then the longer-term climate crisis. All of those are areas that indicates an openness to the kinds of policies that we're pushing, a recognition that improvements in state capacity is important, a recognition that revving up dynamism and prosperity is important, and a recognition that technological change in a particular clean energy direction is important.

Lindsey:  We have no illusions that our whole agenda is going to be blocked, stocked, and barreled by anybody, but we think that there are definitely possibilities for making headway in the coming years.

Hammond: One of the theses that the paper is on the progressive left there are elements whose theory of political change is basically, we have to wait until America becomes California and we have united government and have stacked the deck with progressive politicians, and then we're just going to impose our vision of America on the rest of the country. For various reasons, national politics is always going to be much more competitive than California politics and that vision is very unlikely to come true, and if it was to come true, I wouldn't be sure it's desirable, right?

Hammond: The American system is built for compromise and going into a Biden administration where it looks like Republicans retain control of the Senate, I think the policies we offer provide not just a kind of coherent way that the moderates in both parties can sort of form an identity, but also a roadmap for areas that they can cooperate and work towards that as a byproduct turns down the heat of our politics.

I think the policies we offer provide not just a kind of coherent way that the moderates in both parties can sort of form an identity, but also a roadmap for areas that they can cooperate and work towards that as a byproduct turns down the heat of our politics.

Beckworth:  Okay. With that our time is up. Our guests today have been Brink Lindsey, Samuel Hammond and their paper is titled *Faster Growth, Fairer Growth: Policies for a High Road, High Performance Economy.* Brink and Sam, thank you so much for coming on the show today.

Lindsey:  Thanks so much for having us.

Hammond: Thanks, David.

Image by Al Drago via Getty Images

People: 
David Beckworth
Calendar Date: 
Nov 30, 2020
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Libsyn Podcast ID: 
16978496
Subtitle: 
The US is currently plagued by a climate of stagnant growth, rampant inequality, and extreme political polarization, but there are clear and possible solutions to repair this damage.

Make America Boom Again

October 27, 2016

In 1973, the Federal Aviation Administration (FAA) banned civil supersonic flight over the United States, stymieing the development of a supersonic aviation industry. Eli Dourado and Samuel Hammond show that it is time to revisit the ban. Better technology—including better materials, engines, and simulation capabilities—mean it is now possible to produce a supersonic jet that is more economical and less noisy than those of the 1970s. It is time to rescind the ban in favor of a more modest and sensible noise standard.

BACKGROUND

Past studies addressing the ban on supersonic flight have had little effect. However, this paper takes a comprehensive view of the topic, covering the history of supersonic flight, the case for supersonic travel, the problems raised by supersonic flight, and regulatory alternatives to the ban. Dourado and Hammond synthesize the best arguments for rescinding the ban on supersonic flights over land and establish that the ban has had a real impact on the development of supersonic transport.

KEY FINDINGS

The FAA Should Replace the Ban on Overland Supersonic Flight with a Noise Standard
The sonic boom generated by the Concorde and other early supersonic aircraft was very loud, and as a result the FAA banned flights in the United States from going faster than the speed of sound (Mach 1). This ban should be rescinded and replaced with a noise standard. A noise limit of 85–90 A-weighted decibels would be similar to noise standards for lawnmowers, blenders, and motorcycles, and would therefore be a reasonable standard during daytime hours. The noise limit during nighttime hours could be lower.

  • The noise standard for supersonic aircraft should be more lenient than for subsonic aircraft. While new subsonic aircraft cannot be certified below the FAA’s Stage 4 noise standard, subsonic planes are still allowed to operate at the more lenient Stage 3. Given the relative lack of experience with supersonic aviation and the fuel economy tradeoffs associated with airport noise, new supersonic aircraft should be certified if they meet Stage 3 requirements.
  • Supersonic travel has been stifled by government intervention. The overland ban has delayed the development of supersonic travel in general. Government-sponsored efforts to develop commercial supersonic aircraft failed largely because they couldn’t adapt to market signals about the demand for supersonic flight.
  • A noise standard would allow the aviation industry to use trial and error to develop commercially viable supersonic transport. In order to figure out how to attract passengers, get noise levels down, and make a profit on supersonic flights, firms need to be able to experiment. Aviation has always been characterized by an industry learning curve.

Concerns about the Environment, Noise Levels, and Affordability Can Be Addressed
Atmospheric science has advanced significantly since the 1970s, and today it is widely accepted that emissions from supersonic aircraft in the lower stratosphere pose minimal risk to the ozone layer. Advances in aviation technology allow planes to be quieter than they could be decades ago.

WHY PAST ATTEMPTS AT COMMERCIAL SUPERSONIC FLIGHT FAILED

The sonic booms generated by the Concorde were too loud to allow over land. Although quieter supersonic planes can now be built, federal law has not been updated and planes today are not going any faster than they were 50 years ago.

  • The stagnation and regress in supersonic aviation over the past 40 years broke a trend of rapid progress beginning with the Wright brothers’ first flight in 1903, which was estimated to achieve 6 mph. By 1953, jets had reached Mach 2. By 1976, Mach 2 flight was commercialized, and military jets had reached Mach 3. (At Mach 2 it is possible to fly from New York to California in two hours.)
  • The Concorde, which flew between Europe and the United States, had numerous problems: It was too heavy, its afterburners guzzled fuel, and it relied on government subsidies from France and the United Kingdom.
  • The US government subsidized the development of the Boeing 2707, intended to rival the European Concorde. But the project was stymied by unrealistic goals: the government wanted a commercial jet that could seat 300 and fly at Mach 3. (The Concorde could fly at Mach 2 and seat 128.) The project was delayed for numerous years as engineers sought a titanium alloy capable of withstanding air friction at Mach 3.

The limitations that dogged the Concorde and the Boeing 2707 need not hold back commercial supersonic transport today.

CONCLUSION

Aircraft engineering has significantly improved since the time when the Concorde was flying. With lighter materials, more efficient engines, better computer modeling, and more experience, it is more than possible to create an aircraft today that is both faster and more affordable than the Concorde was.

Do Consumer Drones Endanger the National Airspace? Evidence from Wildlife Strike Data

March 14, 2016

In December 2015, the Federal Aviation Administration (FAA) announced a new interim final rule that for the first time imposed regulation on the operation of unmanned aircraft systems (UAS) as model aircraft. In the name of a safe national airspace, the new regulations require operators of drones weighing more than 250g (0.55 pounds) to register with the agency.

Yet many drones weighing more than 250g are little more than toys. Do they really pose a risk to the airspace? To explore this question, we examine 25 years of data from the FAA’s wildlife strike database. Although aircraft collide with birds many thousands of times per year, only a tiny fraction of those collisions result in damage to the aircraft, much less human injuries or deaths. The most serious reported incidents typically involved flocks of large birds. Since the addition of UAS to the airspace is similar in many respects to an increase in the bird population, we conclude that the risk to the airspace caused by small drones (for example, weighing up to 2kg, or 4.41 pounds) flying in solitary formation is minimal.

Overview of the Data

US national airspace is home to an estimated 10 billion birds, some of which occasionally interfere with civil aviation. To track the risk this wildlife poses to human flight, the FAA has been collecting reports of aircraft collisions with wildlife in the National Wildlife Strike Database since 1990. Strike reporting is voluntary. When a wildlife strike occurs, airlines, airports, pilots, or other parties report the incident through an online portal, with data about the aircraft, the flight, the species of wildlife struck, and extent of damage caused.

Compared to the enormous population of birds, damaging bird strikes are rare. Since 1990, there has been a sevenfold increase in reported bird strikes owing both to growing bird populations and to the growing ease of reporting strikes online. But as figure 1 shows, strikes causing damage have actually declined from a peak of 764 in 2000, thanks to bird management efforts from airports. Specifically, airports have mitigated bird hazards by focusing on eliminating natural attractants of the large bird species that are responsible for the most serious incidents, like waste disposal areas and wetlands.

Figure 1. Reported Wildlife Strikes Causing Damage, 1990–2014

Source: Federal Aviation Administration, Wildlife Strike Database.

When large birds are ingested in jet engines, they may cause substantial damage, including crashes. While these birds do not number in the billions, they still maintain a significant presence. The US is home to nearly 1.9 million turkey vultures, for instance, and between 2 to 3 million snow geese enter the United States each winter. Contrary to sensational media headlines, the skies are crowded not by drones, but by fowl.

Figure 2 illustrates that while the FAA has recorded over 160,000 wildlife strikes since 1990, only 14,314 bird strike incidents have resulted in damage. Of these, 80 percent were caused by medium- to large-sized animals. On average, only 3 percent of reported small-bird strikes ever result in damage, compared to 39 percent of large-bird strikes. Given the voluntary nature of strike reporting, the true percentage of strikes causing damage is probably much lower, as strikes that do not cause damage can be either missed or underreported.

Figure 2. Reported Wildlife Strikes, 1990–2014

Source: Federal Aviation Administration, Wildlife Strike Database.

Injuries are even less common. Among the 398 people who have sustained injuries as a result of bird strikes, 100 stem from a single incident: the famous 2009 crash of US Airways Flight 1549 into the Hudson River. This spike can be seen in figure 3. Prototypically, the culprit was determined to be a gaggle of geese, an unknown number of which were sucked into both jet engines immediately following takeoff.

Figure 3. Casualties from Wildlife Strikes, 1990–2014

Source: Federal Aviation Administration, Wildlife Strike Database.

In total, there have been 238 wildlife strike incidents in which there were injuries or fatalities. To get an idea of how many of these affect commercial aviation, we can exclude incidents in which the operator is listed as “business,” “privately owned,” “government,” or “unknown” to narrow the total number of commercial incidents to 37. We should view these 37 incidents over more than 25 years in the context of approximately 27,000 commercial flights per day.

In more than 25 years of data, only 12 wildlife strike incidents resulted in fatalities. Out of these incidents, three of the aircraft were helicopters, one was a homebuilt aerobatic plane, one was an experimental aircraft, and one was a privately owned McDonnell Douglas A-4 Skyhawk, a Vietnam War–era fighter jet. One aircraft was a Cessna Citation jet, and four others were small Cessna or Piper propeller-driven aircraft. Out of the 12 incidents with fatalities, only one involved a commercial airline: In 2000, an Embraer EMB-120 operated by Atlantic Southeast Airlines hit a pair of white-tailed deer on its landing roll. The passenger in seat 3C suffered injuries and eventually died from an infection. Not a single one of the fatal incidents involved a bird that was reported as “small.”

Estimating the Probability of Casualties and Damage 

Although the number of reported bird strikes has increased substantially since 1990, the increase is probably due to the improved ease of reporting. Figure 4 shows over time both an increase in the number of reported wildlife strikes and a decrease in the proportion of reported incidents with reported damage. This is consistent with the hypothesis that in the early part of the observed period, reports were frequently not filed at all if there was no damage to the aircraft. For our econometric analysis of the probability of a strike causing damage or injury, we focus on the years 2009 and later to compensate for the effect of limited participation in reporting in earlier years.

Figure 4. The Relationship between Wildlife Strike Reporting and Damage, 1990–2014

Source: Federal Aviation Administration, Wildlife Strike Database.

We use probit regressions of casualty and damage reports on bird species weight for birds (and flying mammals) for collisions taking place in 2009 or later with a single animal to estimate the probability of casualty or damage conditional upon a strike with an animal of a certain weight. Figure 5 shows our estimate that damage to an aircraft will occur in around 20 percent of strikes with animals weighing around 2kg. And in figure 6, we further estimate that the probability of the incident resulting in passenger injury or death is about 0.2 percent for animals weighing around 2kg.

Figure 5. Probability of Damage by Bird Size, Single Collision

Note: This chart uses data from 2009–2015 only.

Source: Federal Aviation Administration, Wildlife Strike Database.

Figure 6. Probability of Injury or Death by Bird Size, Single Collision

Note: This chart uses data from 2009–2015 only.

Source: Federal Aviation Administration, Wildlife Strike Database.

Estimating the Probability of a Collision

Bird strikes provide an excellent parallel phenomenon for estimating the magnitude of damage a small UAS could cause by colliding with a manned aircraft. But as previously mentioned, without an estimate of UAS strike frequency, the magnitude of damage is insufficient to properly gauge risk. The size of the effect has to be multiplied by the chance of it actually occurring.

In 2014, there were 13,414 reported collisions with birds and flying mammals, counting incidents in which flocks of birds hit an aircraft as a single collision. As there are on the order of 10 billion birds in US airspace, this means that plausibly 1 bird in 1 million collides with an aircraft every year.

Even if we take UAS operators to be about as deliberate and skilled at avoiding aircraft as birds, we cannot similarly estimate that 1 UAS in 1 million UAS will collide with aircraft every year. Not only are UAS operators able to reason about human-piloted aircraft and airfield landing patterns better than birds are, UAS have very short battery lives and may sit idle for months at a time. In contrast, an observational study of bird behavior near wind turbines found the average bird spends roughly equal amounts of time flying as perching. Flight time is much more variable, however, with some migratory birds potentially flying as long as six months nonstop. 

FAA commonly refers to “acceptable risk levels” for general aviation in terms of fatalities per 100,000 flight hours. Using the aforementioned finding that birds spend roughly half their lives in flight, the fact that there were 13,414 bird strikes in 2014, and an estimate of 10 billion birds in US airspace, we estimate that there are 3.06x10−5 bird strikes (both damaging and not) per 100,000 bird flight hours. This risk level is comparable to the 5x10−5 fatality risk cited by the drone registration task force as acceptable for general aviation, without even adjusting for the probability of injury or fatality.

To date, no commercial drone or consumer quadrocopter has ever collided with an aircraft in US airspace. Given that there are likely now more than 1 million UAS in US airspace, if they had equivalent flight hours to birds we might expect at least one UAS collision with an aircraft per year. However, taking into consideration human agency and the far more limited time most UAS spend in the air, the true UAS collision rate is likely orders of magnitude lower.

What Bird Strikes Reveal about UAS Risks to the Airspace

The FAA has based its rationale for a consumer UAS registry on a growing incidence of UAS sightings and “near misses.” As its docket argued, “Pilot reports of UAS sightings in 2015 are double the rate of 2014. Pilots have reported seeing drones at altitudes up to 10,000 feet, or as close as half-a-mile from the approach end of a runway. . . . The risk of unsafe operations will only increase as more UAS enter the national airspace.”

In a 2015 investigation, the Academy of Model Aeronautics (AMA) called the validity of these near miss reports into question. Of the 764 near miss incidents recorded by the FAA, the AMA found only 27, or 3.5 percent, were genuine UAS near misses. Instead, the FAA had been counting simple sightings as near misses—even when the operators were fully compliant with current UAS regulation. The FAA has also counted several cases where the pilot had explicitly reported that it was not a near miss, and more than a dozen cases where the flying object was officially unidentified. The AMA therefore accused the FAA of creating fuel for sensationalized and inaccurate media reports which, with the benefit of hindsight, helped build momentum for its rulemaking.

Our analysis has been based on actual bird strikes, not near misses or simple sightings. We find in general that small UAS under 2kg pose a negligible risk to the safety of the national airspace. We estimate that 6.12x10−6 collisions will cause damage to an aircraft for every 100,000 hours of 2kg UAS flight time. Or to put it another way, one damaging incident will occur no more than every 1.87 million years of 2kg UAS flight time. We further estimate that 6.12x10−8 collisions that cause an injury or fatality to passengers on board an aircraft will occur every 100,000 hours of 2kg UAS flight time, or once every 187 million years of operation. This appears to be an acceptable risk to the airspace.

Our analysis has some limitations. First, birds and UAS are composed of different materials, so it is possible that UAS-aircraft collisions are more likely to cause damage or casualties than bird-aircraft collisions. Although the FAA requires jet engines to undergo bird strike tests, it does not require them to undergo UAS strike tests, so it is not possible to empirically assess the additional degree of damage potentially caused by more rigid materials. Second, our assessment of the damage and casualties caused by birds has focused on incidents in which aircraft collide with individual birds, as opposed to flocks of birds. The rationale for this decision is that UAS do not typically fly in flocks, and therefore, collisions with individual birds provide a better point of comparison. However, if swarms of UAS were to become an increasingly common operational pattern, one would want to revisit our analysis to account for that fact.

Since the probability of any collision with any UAS is around 3.06x10−5 per 100,000 flight hours, countries that have even higher cutoffs for regulation than 2kg can be said to be acting responsibly. For example, the United Kingdom and Denmark have a 7kg threshold above which recreational UAS operators must inform their nearest air traffic controller or fly in an approved flying site. For registration, France recently moved to a 2kg threshold, while Canada still has a generous 35kg threshold.

Although UAS at the above thresholds are more likely to cause damage and injury than the 250g cutoff adopted by the FAA, we still estimate that the probability of a collision remains at an acceptable level.

Registration and Marking Requirements for Small Unmanned Aircraft

January 15, 2016

Introduction

The Federal Aviation Administration (FAA) has issued an interim final rule creating a new electronic registration system for unmanned aircraft systems (UAS) and requiring, for the first time, the registration of model aircraft operators. This comment highlights an omission in the agency’s alternative scenario analysis, questions some of the purported benefits of the rule, and points out some of the continuing legal shortcomings associated with the FAA’s approach. While we support the advent of a simple and streamlined registration system, we object to the extension of the registration requirement to model aircraft operators.

The Technology Policy Program of the Mercatus Center at George Mason University is dedicated to advancing knowledge of the impact of regulation on society. It conducts careful and independent analyses employing contemporary economic scholarship to assess rulemaking proposals from the perspective of the public interest. As such, this comment on the FAA’s interim final registration and marking requirements for small unmanned aircraft does not represent the views of any particular affected party or special interest group but is designed to assist the administration as it carries out Congress’s mandate to safely, efficiently, and legally integrate UASs into the National Airspace System.

Problems with the Regulatory Evaluation

1. The agency fails to consider all regulatory alternatives.

The FAA’s regulatory evaluation of its interim final rule (IFR) is inadequate in many crucial respects. First and most importantly, it does not fulfill the agency’s obligation, under Executive Order 12866, to “assess all costs and benefits of available regulatory alternatives, including the alternative of not regulating.” In particular, the agency ignores the alternative of proceeding with its new electronic registration scheme for drones, but continuing to exempt model aircraft operators from the registration requirement.

This omission is conspicuous. The agency evaluates the benefits and costs of its IFR, of the status quo paper-based registration system, and of an alternative that is paper-based but also imposes a new registration burden on model aircraft operators. There are two parameters that the FAA appears to be considering at the same time: 1) whether to create a new, electronic registration scheme for UAS, and 2) whether to require model aircraft operators to register. These two parameters can be visualized in a 2x2 matrix (table 1), producing four possible alternatives, of which the FAA evaluates three. Yet it is the fourth alternative—in which a new electronic registration scheme is developed, yet without any new burdens on model aircraft operators—that by the FAA’s own estimates has the lowest quantifiable costs.

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Clarification of the Applicability of Aircraft Registration Requirements for Unmanned Aircraft Systems

November 6, 2015

The Department of Transportation (DOT) is proposing to implement a national registration system for small Unmanned Aircraft Systems (UASs), the details of which are to be recommended by a task force no later than November 20. The stated aim of the registry is to assist in identifying owners and operators of UASs that violate the law and endanger safety, thereby closing a perceived gap in enforcement. This comment highlights several major procedural concerns, followed by an examination of whether the safety benefits of a registry are likely to outweigh the societal and budgetary costs. 

The Technology Policy Program of the Mercatus Center at George Mason University is dedicated to advancing knowledge of the impact of regulation on society. It conducts careful and independent analyses employing contemporary economic scholarship to assess rulemaking proposals from the perspective of the public interest. As such, this comment on the Federal Aviation Administration’s (FAA) UAS registration task force does not represent the views of any particular affected party or special interest group but is designed to assist the administration as it carries out Congress’s mandate to safely integrate UASs into the National Airspace System.

Procedural Concerns

We welcome the FAA’s reversal on mandatory registration for all UASs. In its February notice of proposed rulemaking, the agency stated that unless explicitly exempted by statute, 49 U.S.C. 44101(a) provides that “a person may not operate a civil aircraft that is not registered,” and therefore its hands were tied with respect to registration. As we pointed out in our comment, the FAA has a good deal more flexibility than it previously stated. We are glad to see the agency adopting our view in the current rule. Nevertheless, we have significant concerns about the process through which the FAA is examining the issue of registration.

The FAA’s sudden creation of a taskforce that may produce unprecedented rules on recreational and hobbyist UAS operators raises questions about the legality of the action under the FAA Modernization and Reform Act of 2012 (FMRA). Section 336 of the FMRA provides that “notwithstanding any other provision of law relating to the incorporation of unmanned aircraft systems into Federal Aviation Administration plans and policies . . . the Administrator of the Federal Aviation Administration may not promulgate any rule or regulation regarding a model aircraft” as long as certain conditions are met by those aircraft.

The FAA asserts that because registration has been exempted for model aircraft only through the use of its own discretion, prior law unrelated to the incorporation of UASs into FAA plans and policies, specifically 49 U.S.C. 44101(a), gives it the authority to require registration of model aircraft.

We question whether the current proceeding is truly independent of provisions of law “relating to the incorporation of unmanned aircraft systems” into the FAA’s plans and policies. The FMRA is cited in the opening line of the present docket’s background supplementary information. The stated justification throughout the docket for the expansion of aircraft registration and the creation of the task force is to accommodate an increase in UAS activity. The FAA’s point of contact is the director of its UAS Integration Office. We therefore believe that the current proceeding relies quite directly on laws that by statute may not be used as justification for an expansion of the regulatory obligations of model aircraft operators. Unless the FAA reverses course and restarts the process without reference to its UAS integration mandate under the FMRA, there is a possibility that registration of noncommercial drones will be overturned if challenged in court.

The pace at which the DOT intends to implement the registry is also problematic. Secretary Foxx’s statement to the press that he aims to have registration requirements in place by mid-December leaves no time for public notice and comment. Under the Administrative Procedure Act, federal agencies may only issue a direct substantive final rule when a notice-and-comment period is “impracticable, unnecessary, or contrary to the public interest.” In general, agency inaction leading to perceived deadline pressure does not constitute good cause to dispense with public notice and comment. As any requirement to register UASs potentially adversely affects numerous noncommercial operators, a public notice-and-comment period is necessary and in the public interest. The issuance of a final rule without notice and comment opens the registration requirement to reversal if challenged in court.

Finally, we believe that under Executive Order 12866, a rule on noncommercial UAS registration may be economically significant and require a cost-benefit analysis. FAA officials have estimated that 1 million UASs could be sold during this year’s holiday season. As the recommendations of the task force may apply not only to those 1 million UASs, but also all existing model aircraft and future sales, the impact of a new rule could well exceed the $100 million annual threshold used by OIRA for economic significance. The DOT’s regulatory evaluation should also consider the costs and benefits of all relevant alternatives, as required by Executive Order 12866.

A National Registry Is Impractical

If these procedural issues are rectified, the DOT task force will then need to determine criteria whereby small UAS registration makes sense given the DOT and FAA’s limited internal resources. While the current FAA definition of small unmanned aircraft includes anything below 55 pounds, use of this standard would capture millions of multi-rotor helicopters typically considered to be toys. Yet such toys can still, in principle, violate restricted airspace and cause damage. Indeed, the model of small UAS that famously crashed on the White House lawn, the DJI Phantom, weighs less than 3 pounds. Another bestselling model, the Parrot Bebop Drone, weighs only 400 grams, or 0.88 pounds. This suggests that no matter what criteria are settled on, either the size of the registry will balloon and become unmanageable, or the criteria will be ill suited to the safety concerns the DOT claims the registry is meant to address. 

Past experience with national registry systems suggests there will be dramatic implementation and compliance costs that the DOT may be systematically underestimating. Consider the Canadian Firearms Registry, which had cost overruns resulting in an estimated final bill of between $629 million and $2 billion, compared to a 1995 estimate of $119 million. This was the cost to register fewer than 8 million guns held by fewer than 2 million owners, before the bulk of the registry was scrapped. 

The well-established issues with registry systems are only likely to be exacerbated in this event that the FAA adopts mandatory registration for a wide swath of UASs, for reasons that include but are not limited to:

  • The relative ease of constructing do-it-yourself UASs from basic components.
  • The difficulty of enforcing retroactive compliance.
  • The high sheer volume and speed at which UASs are being produced.
  • The ability of owners to modify every aspect of their UAS, creating a “Ship of Theseus” paradox.
  • The fast UAS depreciation and replacement rate.
  • The desire of consumers to resell or transfer UAS ownership, bypassing point-of-sale. 
  • The multiplicity of foreign manufacturers and online sellers. 

These enormous implementation difficulties are contrasted with the relative ease with which bad actors will still be able to evade the (at best) minor accountability a registration system provides. All these factors, combined with the historical experience of national registries, point to large costs relative to trivial benefits, and thus militate against instituting a registration system for recreational UASs. 

Instead, the DOT and FAA should use this opportunity to define thresholds that liberalize most small UASs, requiring registrations for only the largest and highest-powered UASs, while continuing to focus on integrating all nongovernmental UASs within a framework based on the principles of permissionless innovation. 

Instead of an impractical registration scheme, the FAA could adopt Transport Canada’s model and require simple online notification for commercial operations within a middle weight class. Doing so would move the United States into greater harmony with a neighboring jurisdiction that is reaping major economic benefits from UASs. Canada’s success is supported by its lack of a national registration system for hobbyists and its broad exemptions to permitting processes—both of which it maintains without sacrificing safety.