David's Book Club: Unintended Consequences
Bain Capital partner Edward Conard struck a Faustian pact with the publicity Devil.
Over recent months, Conard participated in a series of interviews with New York Times writer Adam Davidson. Those interviews led to a lavish spread in the New York Times magazine a month before the publication of Conard's new book, Unintended Consequences, which in turn launched Conard on a high-velocity book tour, including an appearance this past week on The Daily Show.
Gratifying! However, the attention has come at a heavy price. Conard has seen his views reduced to cartoon form. He has been cast as the standard-bearer for the economic oligarchs, the apologist for the top 1% of the top 1%. Which is a shame. Conard has attempted something much more ambitious and important: a systematic defense of the pre-crash U.S. economic system against its post-crash critics.
Conard's mission might seem a redundant one. The pre-2008 economic status quo hardly lacks for defenders, including the country's most watched news network, the country's largest newspaper, and the country's best-funded think tanks. Yet it's also sadly true that these large and important institutions do not always bring a high level of argument to their work. Conard, the ornery lone researcher and writer, demands more of himself. You don't see him creating a false dichotomy between "free enterprise" (meaning, pre-2008 policy) and "European socialism" (meaning, any deviation from pre-2008 policy). He marshals his numbers and builds his case.
One thing he wants to debunk at the very outset: the claim that wages have stagnated in the US economy. That stagnation, Conard argues, is a statistical artifact produced by high immigration of less-skilled workers.
Here's his argument:
Despite misconceptions to the contrary, not only has U.S. productivity increased, but incomes have increased as well. Since 1980, median incomes have grown for every demographic of the U.S. workforce (SeeFigure1-6). At the same time, the composition of the U.S. workforce has shifted to demographics with lower incomes. … Since the mid-1980s, the United States increased its workforce by 40 percent, or 40 million workers - not counting the tens of millions of offshore workers the U.S. economy employed in Mexico, China, and Southeast Asia.
Indeed, it's possible to see U.S. wage stagnation as the necessary concomitant of a policy that maximizes employment. European countries, even before the Euro currency crisis, priced their less productive workers out of the labor market:
In contrast, the United States provided - at least until the Crisis - viable employment for its youth, its marginally employed, its near-retirees, and its woman, many of whom work part-time and temporarily exit the workforce to raise children. As a group, these workers have below-average productivity. Also, a large share of the forty million new American workers employed since the mid-1980s have been low-skilled, younger-than-average Hispanic immigrants, largely lacking high-school degrees and with poor English-language skills. Obviously, this group has lower productivity than the average U.S. worker.
Look only at the top half of the U.S. labor force, Conard urges, and we do see significant wage growth.
Half the jobs created by the United States between 1983 and 2005 were created at the highest end of the wage scale - doctors, lawyers, managers, scientists, etc. Prior to 1983, those jobs represented only 23 percent of the workforce.
These figures would look better if we treated the cost benefits, meaning mostly health coverage, as income to the worker.
… And the income growth reported in Figure 1-6 doesn't include benefits, which have grown about 15 percent since 2001 - substantially faster than wages over this period, which have grown about 3 percent.
The proof of the policy is the superior success of the U.S. economy as compared to that of other advanced nations:
Since 1991, France's GDP per worker, adjusted for purchasing power, has fallen from 91 percent of that of the United States to 78 percent; Germany's from 86 percent to 73 percent; and Japan's from 86 percent to 74 percent. These countries had access to the same technology and possessed similarly educated workforces; why didn't they perform as well?"
Nostalgia for the more egalitarian economy of the 1950s and 1960s is futile and misplaced. The postwar economy...
offered a cornucopia of almost impossible-to-repeat opportunities that that temporarily lifted the U.S. economy. The 1970s and 1980s provide a more relevant comparison. Revitalized U.S. competitors pulled even and slowed U.S growth. Yet despite the success of these advanced competitors, the United States distanced itself from the rest of the advanced world with the advent of the Internet.
I've stated Conard's views on wages at some length; I'll move faster through his views on growth. As he sees it, the U.S. owes its faster growth to superior innovation; innovation depends on investment; investment is very sensitive to tax rates; and rising inequality is therefore the necessary precondition of a successful economy.
But not to worry: even those who do not succeed in becoming rich benefit from the accumulation of large fortunes—not from the fortunes themselves, but from the innovation process those fortunes finance.
In addition to capturing the value of investment through lower prices and higher wages, consumers also capture the value of products over and above their price. Obviously, consumers wouldn't buy products if they weren't worth more [to the consumer] than the price they had to pay. … Economists call this this 'buyers' surplus.' GDP measures the value of goods at their prices, not at their value to purchasers. If consumers capture 70 percent of GDP as wages and 100 percent of the buyers' surplus, it clear they capture a very large share of the value created by investment - perhaps 90 percent or more.
So what are you complaining about, you ungrateful sods?
I tried to summarize Edward Conard's argument in his new book, Unintended Consequences, in an earlier post. Let's devote this part to the most interesting things he has to say, before addressing in a third part the weaknesses in his case.
Conard never loses sight of America's position as part of the world economy, not an island unto itself.
He argues (winningly, in my opinion) that the housing boom of the 2000s was driven, not by lax Federal Reserve policy, but by the vast accumulation of dollar assets by China and other emerging-market exporters. Those exporters wanted someplace safe and liquid to stash their dollars, and Wall Street went to work with a will to manufacture triple-A bonds to meet that demand.
There's a lot to be said about Wall Street's behavior in this regard, little of it good. Wall Street's behavior, however, is not Conard's focus. He is interested in the hydraulics of supply and demand, and that demand originated primarily overseas.
Likewise, Conard tells the wage story as one driven by international events: more globalized markets (which opened U.S. labor to competition from cheaper workers in East Asia) and immigration (which brought 40 million of those workers into this country)
In neither case does Conard much worry whether anything could or should be done—the world is as it is.
Yet here are the more important things that Conard misses.
1) Conard omits even to try to prove his bedrock argument: that (1) more inequality leads to (2) more investment which leads to (3) more innovation which leads to (4) higher GDP growth.
Did we see more innovation as the economy became more unequal? Conard relies almost entirely on assertion and citation to support this point. Again and again, he cites Facebook and Google as examples of new, ultra-innovative companies that emerged in our more unequal America.
Yet in their day, Ameriquest and Enron looked like innovators too, and were hailed as such. The technology sector is glamorous, admired, and exciting. But the FIRE sector (finance, insurance and real estate) was and is vastly larger—and actually more important as a driver of inequality. As the Financial Crisis Inquiry Commission pointed out, salaries in the financial sector in the early 2000s were double those of the economy as a whole, and represented a huge portion of the very largest salaries. We all know what Google did for its money. What did AIG do? Goldman Sachs?
It should also be recalled that the reason the owners of companies like Google and Facebook have become so rich is not because their companies had such fantastic sales and profits, but because the financial sector attached such huge valuations to them.
Here's Fortune's most recent list of America's most profitable companies:
Google is there, but not Facebook. The most profitable technology company—Apple—is as much a high-end retailer as a tech innovator. The second-most profitable, Microsoft, is nobody's idea of a cutting-edge company, and ditto the third most profitable tech company, IBM.
There is a lot of innovation in the oil business, the business of the #1 and #2 most profitable of all U.S. corporations, ExxonMobil and ConocoPhillips, but energy companies go uncited by Conard perhaps because they are even less popular than banks and bankers.
2) Quantifying innovation is notoriously difficult, but business historians often focus on the 1930s as one of the most innovative periods of the 20th century. The passenger aviation industry and the supermarket industry were born then, as were television, electric refrigeration, and computing—and all despite high taxes, heavy regulation, and a collapse of the wealth of the wealthiest.
Likewise, the semiconductor industry as we know it today originated in the highly taxed 1970s, not the 1980s.
As a matter of history rather than theory, the Conard model of concentrated wealth leading to investment leading to innovation does not seem accurate.
3) Nick Hanauer makes the important point that the investible funds that flow to entrepreneurial activity are not generally owned by the richest Americans. The money is owned by pension funds, insurance companies, sovereign wealth funds, and other repositories of "other people's money." The richest people in the financial world—like Conard himself—have made their money as employees rather than entrepreneurs.
You could argue that the real secret behind the greatest financial fortunes of the 2000s was not financial entrepreneurship, but the success of financial-sector employees in persuading their investors to compensate them as if they were entrepreneurs (the famous 2 and 20 formula: 2% management fee, 20% of the gains)—and then to persuade the government to tax their earnings not at income-tax levels, but as if they were capital gains (the famous carried interest rule).
4) Conard is right to insist on global competition as a factor in suppressing the wages of less-skilled Americans. But he also deploys two moves that seem a little sneaky on closer inspection. Remember his claim that half the jobs created since the 1980s were created in highly skilled categories? Yet he never does get around to mentioning that while those categories of labor have seen growth, their wages have not. In fact, the wages of college graduates stagnated between 2000 and 2006. Likewise, Conard suggests that things look better for the ordinary worker if we measure benefits as well as wages. But the decision to treat soaring health costs as proof of rising standards of living seems perverse. Fewer and fewer workers are insured at all, those who are insured face rising co-pays, and despite rising costs we see little evidence of improvements in public health.
5) As we evaluate Conard's argument, we also need to be hard-headed about our metrics. If most Americans are not seeing improvements in their standard of living—if much of the overall GDP gain of the 2000s proved an illusion caused by mispricing of real estate assets—if the crash of 2008 has put the US economy on a trajectory whereby total growth over the longer period 2000-2020 will look frankly miserable compared to other equivalent periods in US history—in what sense can we call the performance of the US economy during the period he champions any kind of success at all?
Conard spends a lot of effort severing the causes of the crash of 2008 from the apparent expansion of 2003-2007. This seems an untenable project. The real-estate bust of 2008 was rooted in the real-estate bubble of 2003-2007. Yes, the record of the 2000s looks better if you treat the bust as some kind of exogenous event caused by overbearing government. But in that case, you also have to treat the real-estate bubble as an exogenous event. And without that bubble, the economic record of the 2000s is the worst for any period since World War II.
Which means that the question we need to study is not the secret of our success, but the causes of our disappointment.