Asymmetrical Information - Megan McArdle

09.26.12

America Really Is Exceptional

Our economy is bigger than anyone else's. That means we have to choose policies more carefully.

A couple of months ago, I gave a talk about entrepreneurship and innovation in America.  At the end of the talk, a very smart fellow journalist asked a very good question.  Germany, he said, doesn't do high-growth innovation industries.  But they have lots of vacation and a good quality of life.  Why would we say that they should emulate us, instead of the other way around?

A few minutes later, I heard a Dutch audience member make a similar, if stronger, point.  The average American, he said, is much worse off than the average Swede.  Why can't America be more like Sweden?  

I actually don't think that the latter point is true; if you plucked an average American (mean, median, or modal) out of Kansas City or Aurora, and plopped them down in the middle of Gothenburg, the average American would be very unhappy.  Yes, they'd have generous social benefits and lots of vacation, but they'd also be crammed into a small apartment in a very small country.  They wouldn't be able to afford services that average Americans take for granted, like lots of restaurant foods and extremely high levels of customer service, which means they'd spend a lot more time doing basic housework, childcare, and so forth.  They would find it very expensive to fuel their car, and the insular, almost formal culture would make them crazy.  

This is also true the other way, by the way; the average Swede would not be happy living in America.  Sure, they'd have a huge house, filled with cheap consumer goods, and they could drive their car everywhere, particularly to their incredible array of dining options.  But they'd miss their vacation and find America's looser safety net both terrifying and inconvenient.  They would hate the inefficiency of our government services, and miss their cozy circle of friends and family.  Part of the reason that we have different systems from the Swedes and the Germans is that we place different emphasis on various possible sets of amenities, and of course, the availability of various amenities changes what we think of as the basic package for a decent life.  In most of America it includes a house, preferably detached, and a car.  In Sweden it includes a year of mandated maternity leave and a well-run streetcar system.  Losing any of those amenities is usually more painful for people than getting whatever the other folks have--which is why most expats are some combination of young, unhappy in their home country, or wealthy enough to buy the stuff they miss.  

But that doesn't really answer the question: Germany has nice enough economic growth, and quite stable employment.  Why can't we just do what they do?  Leave aside the political question of getting people to do it, for the nonce--why shouldn't we want to do as they do?  

The answer I ultimately gave to both points is one that I've been mulling for a while--one that I probably would have blogged before, if not for my six-month break.  It's that America really is exceptional: not so much for our love of freedom or embrace of risk, but from our sheer size.  We are the biggest rich country, and the richest big country, and our per-capita GDP is higher than all but a handful of other places in the world.  

Almost definitionally, the US is where a lot of innovation is going to take place, because at the current technology frontier, innovation takes a lot of money and people, and we have more of both than almost anyone else.  

That constrains our policy actions in all sorts of ways.  Ultimately, it doesn't matter whether much whether Sweden changes its economy in ways that reduce the return to innovation, because Sweden is never going to be doing most of the innovation that drives its economic results.  This is no slam on Sweden, mind you; it's just that, numerically, the overwhelming majority of new ideas are going to come from somewhere else.  Germany is in the middle, but it's still a fraction of the size of the United States.  Small countries are like little islands floating on an ocean of trade and capital, while the US is more like the jet stream, moving all the water around.

And so what happens to US growth matters a lot, to us and to others; we're almost a quarter of the world's GDP.  If we slow down innovation, we will feel it; so will other countries, as the global economy slows.  This will perhaps not always be the case; India and China are huge, and if they get rich, their economies (and presumably, their rate of innovation) will dwarf ours.  But right now it simply matters a great deal that we get growth right, in a way that it does not matter for smaller welfare states.  

A new paper from Acemoglu, Robinson, and Verdier seems to offer some empirics for my intuition:  

Because of their more limited inequality and more comprehensive social welfare systems, many perceive average welfare to be higher in Scandinavian societies than in the United States. Why then does the United States not adopt Scandinavian-style institutions? More generally, in an interdependent world, would we expect all countries to adopt the same institutions? To provide theoretical answers to this question, we develop a simple model of economic growth in a world in which all countries benefit and potentially contribute to advances in the world technology frontier. A greater gap of incomes between successful and unsuccessful entrepreneurs (thus greater inequality) increases entrepreneurial effort and hence a country’s contribution to the world technology frontier. We show that, under plausible assumptions, the world equilibrium is asymmetric: some countries will opt for a type of “cutthroat” capitalism that generates greater inequality and more innovation and will become the technology leaders, while others will free-ride on the cutthroat incentives of the leaders and choose a more cuddly form of capitalism. Paradoxically, those with cuddly reward structures, though poorer, may have higher welfare than cutthroat capitalists; but in the world equilibrium, it is not a best response for the cutthroat capitalists to switch to a more cuddly form of capitalism. We also show that domestic constraints from social democratic parties or unions may be beneficial for a country because they prevent cutthroat capitalism domestically, instead inducing other countries to play this role.  

Or as I argued during health care reform, given how heavily we subsidize pharmaceutical development, Europeans were stupid to crow about the perceived inadequacies of US style health care.  If they'd been smart, they'd have been running ads on television saying, "No, really, it's dreadful--America wouldn't ever want to try anything like it!"  

Of course, this extends well beyond tax rates and welfare states and into things like patent law.   Since that panel, I've been thinking a lot about the differences between small countries and large, and the policy constraints that imposes.  

One thing it made me realize is that I was (I think) wrong to support full social security privatization.  Of course, that's a cheap concession for me to make, since nothing like that is on the horizon.  But this has relevance to other potential issues, so it's worth thinking through.  

When social security privatization was being debated, I looked at successful schemes like the ones in Chile and, er, Sweden. And of course, sovereign wealth funds like Norway's.  But I didn't think about the vast gulf between us and them.  The US has the largest, deepest, most liquid capital markets in the world, by a fair margin.  Small countries can safely invest in our markets (and others) without moving prices or outcomes much.  

The unfunded liability of social security, by contrast, is in the tens of trillions (net present value). Where would we put enough investment to cover that kind of liability?  Our investments would swamp markets, including our own, in a way that Sweden's just don't.  And if they were directed by a single government entity, that swamping effect would hand a disastrous amount of power to the investment committee.  

This sort of stuff is often obvious, if you think about it a bit.  But mostly we don't.  Liberals and libertarians alike are prone to look at stuff that works well in a very small society and assume that there is some way to translate it to the US.  When we think about obstacles, we tend to talk a lot about culture and institutions, but we rarely simply talk about sheer size: that what is desireable on a small scale may be disastrous writ large.