Intro. [Recording date: October 18, 2022.]
Russ Roberts: Today is October 18th, 2022, and my guest is Mike Munger of Duke University, here for his 43rd appearance on EconTalk. Mike, welcome back.
Michael Munger: It is such a pleasure as always, Russ. Thank you.
Russ Roberts: Our topic for today is industrial policy, and our conversation we base on a recent article you've published in the Journal of Law, Economics, and Policy that we will link to. But let's start with a basic definition. When people talk about industrial policy, what do you think they have in mind today? And, it may have changed over time, but it's a very popular topic. What do people have in mind?
Michael Munger: Well, if you do nothing, you still have an industrial policy in the sense that there's a set of things that are going to happen, and your policy of honoring profit and loss is a policy. What people mean by industrial policy, though, is a set of decisions about what industries to invest in, what industries to discourage, what tax policies to have to encourage investment that we think is beneficial to the entire society.
So, industrial policy is not macroeconomic policy. Industrial policy is the set of conditions in which a market economy operates. And I think it is possible to talk about that as being the entire set of legal and financial infrastructure within which the economy plays out.
Russ Roberts: And, most people when they're advocating for it, are unhappy with some aspect of what you call the--and I think we should call--the profit-and-loss system. Neither of us are anarchists: we're not talking about unfettered capitalism run rampant. We're talking about allowing profits and losses, given the legal structure: profit and loss to determine which industries survive, which fail, which expand, which contract.
And, of course, throughout history, and certainly today in the United States and elsewhere, people often don't like what the profit-and-loss system produces and think it can be improved on. And, I think, advocates of industrial policy argue that steering outcomes, either through the tax and subsidy policies you alluded to or more explicitly through trade policy or other limitations, achieve different outcomes.
And, what are some of the things people are concerned about? What's the argument that the people who don't like the profit-and-loss system--what are they going to argue?
Michael Munger: Well, let's start by making it clear what the profit-and-loss system actually entails, because I find a surprising number of people don't know the basic argument for capitalism. And so, let me spend one minute on that.
So, Ludwig von Mises probably was the clearest articulator of the system of profit and loss as a industrial policy, but there was a book on industry--on industrial economics--by Mary Paley Marshall and Alfred Marshall that was published in the 1890s that I think is the first clear articulation of industrial policy.
And it goes like this: So, if I am a producer--if I decide I want to produce something--I go around and I enter into a bunch of voluntary contracts with the owners of inputs. So, owners of labor, owners of steel, owners of electricity, owners of wood; and I make a voluntary contract with each of those people.
And since they're not obliged to contract with me, it must by definition be true not only that they're better off, but they're better even than their opportunity costs--alternatives--for selling those products. So all of those people are happy.
I now go and I put these things together in some kind of form that I think consumers will like, and there's actually a specific test because consumers only buy that if they actually want it.
And so, again, every transaction I engage in the output market, each consumer who buys it is made better off because they're not obliged to buy my product. Just as the input suppliers were not obliged to sell it to me, in the output market they're not obliged to buy this product. So, every one of them is made better off by what economists call the amount of consumer surplus. And in some cases that might be very large.
Now, their question is: Is this a good activity or not? Because, so far I've made a bunch of people better off. Is this a socially desirable activity?
And the answer, according to the profit-and-loss idea, is that there's a particular price in a capitalist system which is, I compare the amount of revenue that I get from consumers, and I compare that to the costs of what it took me to make the thing. And, if my revenue exceeds my cost, we call that particular price a profit; and that profit is an indication that this activity is socially valuable.
Now, there's a bunch of problems with that argument, but that, in the main, is: I have produced benefits for all the input suppliers. I have produced benefits for all of the consumers in the output market. And I have created some benefit for myself in the form of profit. It is a signal. If those profits are significant, it is a signal to other holders of resources in the society that they should either enter into this industry and produce more, or, if they're already in the industry, that they should increase the amount of output because, at the margin, this activity is more socially beneficial than other opportunity-cost activities.
Russ Roberts: And, just a couple of footnotes there, that, obviously you could buy my product and decide you don't like it. You wanted it, you thought it was going to be a good product, and you find out you don't like it.
So, you might be able to sell it once, but to continue to sell it to be what we would say an English is a going concern--very strange phrase meaning an ongoing, a business that is sustained--a sustainable business has to cover its costs.
And it has to cover its costs with enough extra--it doesn't have to be a huge amount--but enough extra to make it worthwhile for me to continue to spend my time combining those inputs to do so. If that happens, there's a net gain, say economists, to the society; and the business continues.
If, however, the profits are not large enough to cover the costs, I can't make payroll after a while, or I can't pay for my raw inputs; and I disappear. I go out of business.
So, that's the--and, I just want to add: Milton Friedman liked to say that capitalism is a profit-and-loss system, and he liked to emphasize the loss in that conversation. Because ,if you make losses, you can make them for a while. You can borrow money to try to keep your business afloat. But if you continue to make losses, usually you're done. And no one has to make--there's no vote. No board has to decree whether you should be sustained or not. It's over. And, that is a very powerful system that underlies what you and I think of as capitalism.
So, what's wrong with it? It sounds great.
Michael Munger: Well, we make it sound as if it's smoothly functioning. And I emphasize profit, and I talked about shrinking or growing at the margin.
But, in fact, if you look at the Schumpeterian version of this, it actually may involve violent and wrenching changes, creative destruction. And so, workers who work in some industry may find themselves out of a job through no fault of their own because the business they were employed by not only failed to make profits, but started making losses; and investors pulled their money out of this industry, and the business had to close.
And so, through no fault of their own, people are unemployed, and that just seems unfair. So--
Russ Roberts: It is. It is unfair.
Michael Munger: It is absolutely unfair, because they did not deserve this.
And, I've actually written a few things about the question of desert--that is: deserving, [N.B. desert pronounced de-sert', meaning that which is deserved. So, neither an arid sand-covered land area (pronounced de'-sert), nor a sweet food treat--spelled 'dessert' and pronounced de-sert'.--Econlib Ed.] is too high a standard because what we have created in a capitalist system is what you may call legal entitlements. And a legal entitlement means that if I earn profits, I am entitled to keep them even if in some sense I got lucky.
Now, the question is: What are the entitlements of workers who lose their jobs through no fault of their own? And, we've actually created, as part of our industrial policy, a set of government programs to make it easier. We call it Trade Adjustment Assistance. Unemployment.
That's actually part of an industrial policy also, in the sense that people who lose their jobs get assistance from the government precisely because it wasn't really their fault.
Now, they don't get their old salaries--usually they don't get their old salaries completely given back to them. But it reduces the cost of participating in a capitalist system.
Look: the reason that I wanted to start with my sort of stripped down version of profit and loss without any other government policies is usually what we say is, 'Oh, that company is making giant profits and they don't deserve those.' The argument really is the benefit to input suppliers and the benefit to consumers.
How would you measure those?
Well, they're literally unmeasurable. We can't possibly measure consumer surplus. And this is something that we've talked about before on this show. What is the benefit to having iPhones? Well, people would pay a lot more--even though they're really expensive, people would pay a lot more for the iPhone than it actually costs them. Some of them would probably pay $10,000. So, and it costs $1000. That's a benefit to the consumer, just that one consumer, of $9,000.
But we can't measure that. What we can measure is profits.
So, the difficulty with the system of profit and loss is that once you account for what are called 'market failures,' then profits are neither necessary nor sufficient for saying that this is a socially beneficial activity.
Russ Roberts: And, I'll just put that into English, if I may: Once you start worrying about what are called market failures--and we'll talk about those in a second--profit is not a really good measure of whether a business deserves to be sustained or not. So, you might want to bring in a different measure--say, the critics: that's their word.
Michael Munger: Right? But the necessary and sufficient part is important in the sense that if I tell you that a company is earning profits, it doesn't mean it's socially beneficial. And if I tell you that a company is making losses, it doesn't mean it should be closed. And so, that means that neither of the two supposed signals is correct, and we need government action to put a thumb on the scale one way or the other, is the argument for industrial policy.
Russ Roberts: Correct.
Russ Roberts: Okay, so, let's hear some of the arguments that these critics would invoke to argue why the profit or the loss is an insufficient signal. You hinted at it a minute ago. It could cause disruption in employment, and therefore we should soften that, and some would argue more than soften it. That was just one example of how government policy might respond to it.
Michael Munger: So, the usual set of market failures are not at the core of the argument for industrial policy. So, let's put those to the side. Because, those are a justification for regulation. So, asymmetric information, public goods, externalities--all of those things are reasons why we have regulatory agencies, so let's put those to the side.
The reason for an industrial policy is that we get changes over time that are bad--that we should limit--and we fail to get changes over time that would have been good--that we should focus a fire hose of public infrastructure or investment because the market gets wrong what we should invest in.
Then there's also social programs. So, it's not just that the mix of investment is incorrect from the perspective of what economists tend to think of as an omniscient, benevolent dictator.
And so, usually the government's problem is to say: Here's the set of socially optimal investments. And then we look at the actual pattern of investments, and then we try to at least reduce the divergences between actual investment in the market and the socially optimal ones which the bureaucrat as the omniscient, benevolent dictator actually knows.
And so, so many times, if you're in an economics job talk or seminar, they'll start out by saying, 'Well, we're going to assume the existence of an omniscient, benevolent dictator and then ask what is the correct tax policy? What is the correct set of subsidies for industry?' So, we know the answer because we can study optimality and efficiency. And, then the question is, how can we reduce the distance between what's actually in the world and that pattern?
So, the sort of things that matter are employment, stability and employment, the concern for things like the environment writ large. So, we're investing too much in fossil fuels and not enough in alternative energies, and so we're going to subsidize investments in alternative energies, electric vehicles, solar panels, and bring the cost of those things down.
Russ Roberts: And, just to look at that example for a minute, because I think your point about regulatory policy versus industrial policy is helpful. Many would argue that we overinvest in fossil fuels, so what we need to do is, say, subsidize maybe research into electric battery performance rather than relying on market-based efforts by companies like Tesla and others. We should put our thumb on the scale and maybe have a government lab design a better battery, because the profit-and-loss incentive is too slow. People tell me that it's just a matter of time before we have profitable electric batteries in different sizes and quantities than we currently do, better. And so, we should spend a large sum of money now to get there quicker because it's better for the environment, is the argument.
Of course, these arguments are often more complicated than we're talking. We're going to get to some of the complications.
But, that would be the argument: That the acquisitive nature of humanity is not sufficient to speed up the innovation process in a particular area. Or the opposite: We need to slow something down that's aggressively expanding, and so we need attacks or some kind of regulatory restriction.
Those restrictions are usually different than the regulatory kind that we normally would talk about in public policy. These are specifically designed--the distinction I would make--these are specifically designed to either increase or impede the flow of capital into certain areas of the economy that, left to the profit-and-loss motive, would do so either too slowly, too quickly, not at all, or should be ended.
And so, what industrial policy is often trying to do is not so much tax this and subsidize that--although it does involve that sometimes--but more to make sure that certain industries are thriving that are under-invested in, or are curtailed that are over-invested in, if the only signals are profit and loss. Is that a good summary?
Michael Munger: It's a good summary. And the reason I want to emphasize what you said: the over- and the under-, is with reference to what is known to be correct by the omniscient, benevolent bureaucrat. So, a central figure here is: We know what is to be done. We know the correct thing to do because we are scientists. And that's an essential feature of the claims for industrial policy. The basis of 'We can do better' is: We know what is good.
Russ Roberts: And, sometimes there's a logical--what we might call an analytical--argument, which might be: Corporate America has the wrong time preference. Corporate America operates on a quarter-to-quarter profitability. We need a longer-term perspective. It's not going to come from capitalists. It's going to come--try not to smile--it's going to come from politicians or policy makers or bureaucrats who will not be constrained by the stock market's insistence on quarterly profits.
And in a minute, we'll talk about why that's hard to say with a straight face. But that would be the argument. Right? That would be the claim. And that's not, 'I know what's best.' Literally it's, 'I detect a flaw in the underlying structure of the profit-loss system. It's shortsighted. It's myopic.' Or it might be--what would be another--I'm having trouble to give another example that would be analytical rather than pretending to know exactly what needs to get done.
Michael Munger: Well, the time horizon is certainly an important one, and another--
Russ Roberts: Oh, the environment would be another one--
Michael Munger: the environment is--
Russ Roberts: Climate change.
Michael Munger: Yeah. Now, you could say that's time-horizon also, but if you [inaudible 00:19:35] it's different.
Russ Roberts: Nyeah--it's a different kind.
Michael Munger: So, what you just said is great because I think--a listener commented on one of our earlier podcasts and says, 'Munger just has this trope that he always uses.' Aand that's true. I didn't realize that I do. But, what I always say is: This is a really hard problem. I thought about it for a long time, and I realized I was wrong. And, in fact, this is the way you should think about this.' And dammit, I'm going to do that again.
Russ Roberts: Go for it.
Michael Munger: So, the story that you just gave is the one that I always told. Because--you say it's hard to say it with a straight face--politicians are going to do this. That's the usual public choice objection.
And so, in fact, when I teach Public Choice I say, 'There's this nonsense that somehow capitalism has a shorter time horizon.'
Look, elected officials have a two-year time horizon until the next election. And that's in November. So, in December they have a 23-month time horizon. So, politics has a really, really short time horizon, and that's why these people who advocate for an industrial policy, they're all wet. All they need to do is read basic Public Choice, and we would stop hearing about all this nonsense.
So, we're really lucky at Duke to have such great History of Economic Thought people--so Bruce Caldwell and Steve Medema. Now, Steve Medema is a student, among other things, of A.C. Pigou--Arthur Cecil Pigou. We don't hear 'Cecil' enough, so I think that's important.
Russ Roberts: Right.
Michael Munger: Now, if you look at Pigou's writing as early as 1912, Pigou was talking about the fact, and I think I can quote it, this is--
Russ Roberts: While you're looking for it, I'll just--Pigou is P-I-G-O-U, for those of you who are googling at home. Go ahead.
Michael Munger: So the usual story, and I don't want to go into this too much, but Steve Medema has a particular bone to pick with one of my heroes, Ronald Coase, and I think he's right. Ronald Coase just mischaracterizes Pigou's thought in the 1960 paper, "The Problem of Social Cost." So, the Pigovian solution that Coase talks about is: We're going to solve the problem of externalities with a system of taxes on negative externalities and subsidies on positive externalities.
That's not really an industrial policy, as we said. Because, that's on the output. It's not subsidizing investment. Investment policy is subsidizing or taking away investment. This is a tax on the output price for externalities.
And, Coase said that Pigou said, this was the only way to solve this problem and that we had enough information to do it.
In fact, if you look at Pigou's writings, and so Wealth and Welfare--this is 1912:
It is not sufficient to contrast the imperfect adjustments of unfettered private enterprise with the best adjustments that economists in their studies can imagine. For we cannot expect that any state authority will attain, or even wholeheartedly seek, that ideal. Such authorities are liable alike to ignorance, to sectional pressure, and to personal corruption by private interest. A loud-voiced part of their constituents, if organized for votes, may easily outweigh the whole.
Now, that's 1912. So, Pigou is actually an ur-text[?] of Public Choice.
And so, after golfing with Steve Medema, I went back and looked at the history of industrial policy, advocates for industrial policy. And I was just wrong. It is not that they misunderstand the problem of political incentives. That's actually their primary concern. The reason that they think industrial policy may not work is the set of incentives that distort industrial policy politically.
So, it's not that they're saying, 'Oh well, just do this and it won't be a problem.' They recognize that politics are going to distort industrial policy.
So, the reason that I wrote this paper was that in 2000 I had come up with the idea of policy conflicts.
So, my notion of this--and so, that, it forms a triangle: the vertices are markets, politics, and experts. And, my claim in that 2000 book was that policies always seem strange if you look from the outside because it seems like they're just not rational.
Well, the answer is, they're a conflict. They're a compromise between two of the vertices of this triangle. So, markets and politics fight things out. Experts and markets have antitrust policy; experts and politics have a variety of constitutional concerns. And so, nobody--none of these sources of legitimate authority ever get exactly what they want.
So, experts, if they're going to try to regulate markets, have to deal with politics. But this actually had been a core inside of the people who had advocated for industrial policy all along.
And so, the question then is, what is--if there is an objection to industrial policy, what is the correct objection?
And so, I went back to the work of William Riker and the sort of equilibrium theorists in the Political Science branch of Public Choice, and came up with--and that's the reason the title of the paper--"A Good Industrial Policy Is Impossible." So, it is impossible to come up with a coherent way to solve the political problem.
So, recognizing the problem is not enough. The people who advocate for industrial policy actually have the--I claim this is a kind of impossibility theorem. It is impossible to achieve the experts' goal for an industrial policy in a democracy.
Now, it is possible in a dictatorship, but presumably that's not what is being advocated for. So, the difficulty that has happened all along for the people who favor industrial policy--and if you look at industrial policy in the 1930s under the Roosevelt Administration, there was a lot of admiration for Mussolini, for Fascism. And, the reason is that it was insulated from politics. Now, not the political program of Fascism, but the insulation from politics of experts.
Russ Roberts: And the plus ça change, plus c'est la même chose ['the more it changes, the more it is the same thing'--Econlib Ed.]--here we are in the modern era, and of course, for the last--I don't know--20 years, 15 years, 25 years, people have admired China because it does not--many of its policies are seen as admirable and impossible in the United States because we have the meat-grinding, sausage-making political system, whereas in China you don't have to worry about that. They've got an autocrat at the top who can just listen to experts and do the right thing. Where the right thing is presumably what's good for China as a whole. Whatever that means.
Michael Munger: Right. Because there are political problems in democracies at arriving at that.
Public Choice people--I was taught, say, 'Oh, well industrial policy will fail because of political incentives.' What I have always thought is that the devastating Public Choice response to claims that we should have an industrial policy is just to point out that political incentives are going to prevent us from having any kind of good industrial policy.
And, in fact, famously, in the 'Keynes-Hayek Rap Video, Part 2', Hayek said,
With political incentives, discretion's a joke.
Those dials you're twisting, just mirrors and smoke.
And so, the point of that is that politics are going to distort industrial policy, and so we shouldn't even talk about it.
Now, the answer of people--and I think the best; in the paper I single out as I think, the best, articulate, and most logically coherent advocate for industrial policy--is Dani Rodrik.
And, he says that there are two core problems. One is the problem of incentives and the other is the problem of information.
And, in reading the historical development of this--the sort of Cambridge Economics, and it's interesting, but it's Cambridge on both sides of the ocean, and so you can use it, the Cambridge description is whether it's actually Cambridge or whether it's Harvard and MIT [Massachusetts Institute of Technology]--but that form of macroeconomics worries both about the information and the incentives problem.
And Rodrik points out, probably rightly, that we should think of the information problem in terms of tatonnement, because in economics, tatonnement is trial and error. We've looked for the equilibrium, we grope for it.
And, Rodrik said that the government should do the same thing. The fact that the government doesn't really know what to do in advance is not a problem: We need to experiment. And, in fact, the more mistakes the government makes, the better, because that's a sign we're actually experimenting robustly. And, then Rodrik--
Russ Roberts: Get more information--
Michael Munger: Well, the AB testing where you did experiments, maybe within local school districts where the districts are otherwise pretty similar. This is something you've talked about on the show a number of times. That's one thing.
But, experiments at the macro level, where you have just a sequence of unexpected, unexplained changes in taxes and investment, those are not experiments. Those are the sort of things that Amity Shlaes talked about in The Forgotten Man as being one of the reasons why the Great Depression lasted for so long--because we were never sure what the industrial policy was going to be.
Those are not experiments: That's uncertainty. That's a different thing.
But, okay: Dani Rodrik says, neither markets nor government know what they would need to do to carry out the functions we assign to them. We need to understand that government can do experiments. We should try things, and then we should be willing--he admits--bureaucracies, once they're established, they're hard to get rid of. That, we need to work on.
But what motivated me to write this paper was what Dani Rodrik said about institutions.
He said: 'This is just a simple problem of institutional design.' And, as a longtime political scientist, I do want to thank economists for the amusement value that they provide us in saying: These things are just 'simple problems of institutional design. We'll just change the Constitution and put the regulatory authorities for industrial policy beyond the reach of politics,' as if that were something that we could just have a meeting or we'll have a committee, we'll have a group and we'll all agree, and then we'll do the right things.
Well, my claim is that's not the way that it works.
So, the frame of this paper--the logical frame of this paper--is that I concede, for the sake of argument--that is, I grant the premise that markets and government have about the same informational capacities that the tatonnement process for government is: 'Well, okay, trial and error. We actually know what the right thing to do is.' The question is: even then will the government do it? And, the answer I try to give is, No.
Russ Roberts: And, I should just say--we haven't said this because we've talked too many times on this program, and though there are at least 12 or 15 people who have heard every appearance of Mike Munger on EconTalk--all 42 before this one. In fact, I think there are thousands of people who've heard all 42. For those who haven't, it's important to point out that the usual argument that people on our side of the fence make is that, 'Sure, capitalism is flawed, but before you can invoke government as an alternative, you have to remember that government is flawed, too.' And that's the essence of what you're calling the Public Choice argument. What you're saying now is--this is a good question--'Isn't it possible that the flawed government solution will be better than the flawed profit-and-loss system?' Which of course, it--that's possible. And I think that's Rodrik's claim.
Rodrik's claim, to put it in its best light, is that: Markets grope imperfectly toward various outcomes. We--not 'we'--firms mistakenly invest in some things. Resources flow into those areas; they turn out to not be profitable, and that those resources are lost. And, markets adjust accordingly. And so government could do the same thing.
Government could--there may be a score-keeping issue which we're going to deal with in a minute. But, in theory, governments could learn, react, change, and so on.
And then the debate would be, 'Well, which one is more nimble? Which one is more flexible?' More importantly, 'Under which system are there incentives for the actors to improve on their performance?'
And, the Rodrik answer--that you've just caricatured a little bit--but his attempt to answer that question is: 'Well, it's true, there could be some problems with the incentives facing the political actors, so we just need to give them a different set of incentives.'
Milton Friedman, by the way, makes the same argument. He says: The challenge of good public policy is not getting better people into office. It's to give the people who are elected the incentive to do the right thing. And that's just a different way of saying: Institutional design.
And, your point--as, putting on your political science hat--is, 'Well, that's a huge problem.' But where does that leave us?
So, that was just to try to help listeners figure out where we are. What's the--do you think Rodrik is wrong? Okay, so it's hard to do. Would you argue he is wrong? Would you argue that industrial policy is--are--mistakes? And on what grounds?
Michael Munger: That is the perfect way to set up the question. So, let me first address--I think it is fair to say many people will think I am caricaturing Rodrik's position. So, let me read what he said,
I contend... that the first [claim] is largely irrelevant, while the second about political influence--can be overcome with appropriate institutional design. Good industrial policy does not rely on the government's omniscience or ability to pick winners. Mistakes are an inevitable and necessary part of a well-designed industrial policy program; in fact, too few mistakes are a sign of underperformance.
So, he said--
Russ Roberts: End quote--
Michael Munger: End quote. He said that the problem of political influence can be solved with appropriate institutional design, and he actually does propose that we have a committee that is appointed by experts that is not politically accountable.
So, what is wrong--you said it's hard. I want to grant his claim. I want to grant two things.
First, that the experts that that committee would appoint do in fact know what industrial policy should be, and it would be better than markets.
I'm not sure that's true, but let's, for the sake of argument, grant that: They know what to do and if they were allowed to implement it, they would be able to improve, perhaps, dramatically, on the set of outcomes that we observe just from the profit-and-loss industrial policy that comes ready-made with capitalism.
And then my argument is: It is impossible for that policy to be implemented.
And so, I actually use a bit of formal theory and social choice theory to try to prove this. And I don't want to get too far down in the weeds, but I posit the existence of three alternative states of the world:
One, the one that would be delivered by letting laissez-faire investment in markets with the background of regulatory agencies like the EPA [Environmental Protection Agency], the Federal Trade Commission. So, we have the regulatory agencies whose job it is to limit the effects of market failures.
The second one is the set of outcomes that we would observe if this Industrial Policy Committee, composed of our best minds, were allowed to impose its will, beyond the control of majoritarian democracy.
And the third is: the result that we will get in a majoritarian democracy with industrial policies that are, in large measure, an attempt to benefit concentrated corporate and labor interests.
So, those are the three alternatives. What would you get from markets? What would you get from this expert industrial policy committee? And what would you get from politics?
Russ Roberts: And the third one, I just want to emphasize--because you say this is in the paper; it's really important. It's what we might call cronyism.
Michael Munger: I have called it that.
Russ Roberts: Yeah. Well, generous. It's capitalism in a democracy. Which is imperfect. It's not the capitalism you and I would want--because we're experts. We want real capitalism. Well, that's not available in a democracy. It doesn't seem to happen.
Michael Munger: This is one of the other times when I said I was wrong. Because, I used to defend capitalism, but then I realized capitalism in a democracy tends towards cronyism. And so, I wrote that book, Is Capitalism Sustainable? And, we had a podcast about it--
Russ Roberts: Yes, we did--
Michael Munger: and a bunch of people were mad at me about this.
Russ Roberts: Yes.
Michael Munger: So, now, this is the other shoe. So--
Russ Roberts: But, hang on. I just want to review. So, we've got capitalism which is the capitalism you and I love--which is a bit of a unicorn, in a democracy.
We have, quote, "pragmatic capitalism"--the capitalism that results when it interfaces with democracy. Which tends to pick some favorites among politically powerful groups, reward them for reasons that most of us would say is very disgusting: it bails out Wall Street losers, it does all kinds of things--it subsidizes big agriculture. These are things you and I oppose. Our voices don't get heard. We're not politically important. And so the capitalism we observe in the world around us is cronyism.
And, the third is this wonderful ideal--so we have our first ideal, my ideal with yours, which is, quote, "the capitalism of our dreams." Then there's the capitalism that exists in a democracy. Then there's this other ideal, this other utopian, unicornian ideal which is: the industrial outcomes that a committee of experts would choose unfettered by politics.
Is that fair? Is that the three things?
Michael Munger: It is not because you are calling me out on a trick that I tried to slip in. So, the trick that I try to slip in is I'm not assuming market perfection. What I'm assuming is--
Russ Roberts: Fair enough--
Michael Munger: this is--the capitalist outcome--is what you would get if you said, 'You know, industrial policy is not going to work. We're not going to have an industrial policy, and we're not going to open this up to political incentives that lead us toward cronyism.'
Russ Roberts: We're just going to do profit and loss.
Michael Munger: Yes, and with all the problems of--
Russ Roberts: So, pure profit and loss with all the warts. The system that we have now, which is not pure profit and loss--
Michael Munger: cronyism--
Russ Roberts: is cronyism. And, then this other alternative dream of the Progressive movement, which is: a committee of experts who would, unfettered by politics, steer capitalism of profit and loss toward a better world.
Michael Munger: And, let's suppose that it is true that the expert industrial policy would be socially better than the system of unfettered profit and loss.
Russ Roberts: Yeah, I hate that because I don't know what 'better' means. But I'm going to let you do that.
Michael Munger: Let's grant it.
Russ Roberts: Just wave your hands--
Michael Munger: I am not saying that we know what better means. I'm not saying that people would have that information. I'm saying let's grant those.
Even then, it's impossible.
Russ Roberts: Why?
Michael Munger: In 1980, William Riker published one of the most important papers I think ever written in political science about the heritability of disequilibrium. So, usually the problem--the story--that we get about the lack of equilibrium in democratic politics is a derivation of the Arrow Theorem. And, the simpler version of this is something like Condorcet's Paradox, where, if you have three alternative and fundamental disagreements--and we've talked about that before on the show, so I'm not going to get down in the weeds about it now--but, if you have difficulty agreeing among three alternatives, then one solution might be, 'Well, we'll just have institutions, and so we'll choose an institution that will allow us to solve this problem.' Riker said, 'If'--
Russ Roberts: Hang on, hang on. The people who don't go back and listen: There are three alternatives, and you just constantly are voting between two of them, say, and you're constantly choosing one that then is defeated by the third you didn't pick the other time. And so, it leads to a lot of instability.
Michael Munger: Rock, paper, scissors. It is rock, paper, scissors.
Russ Roberts: Exactly. And so, the way to avoid that inherent instability in a democracy could be to put up a set of weird institutions--committees and subcommittees and--
Michael Munger: that will prevent that from happening.
Russ Roberts: Yeah. And so, democracy in real life is a little bit ugly, but it does at least avoid this worse problem of instability.
Michael Munger: And Riker said: Think about that. So, you've got these groups that can't agree and then you say, 'Ah, but we'll propose this institution.' Well, these are smart legislators. They can look down the agenda tree. And the claim is that institutions will produce an outcome. So, if I vote for or against an institution, say, committees or a two-party system or things that are restrictions on the ability of this unfettered democracy to work, then I will look down the agenda tree, and I see that institution produces an outcome that I, the politician, don't like. It means that I'll have a harder time getting reelected. So, I will vote against the institution based on the outcome that it will produce. And so, institutions cannot be a solution.
Now, institutions might be imposed for some other reason, but the claim that 'We've got instability. We have problems with democracy. All we need is a better institutional design,' will be voted down by the legislature because there will be a majority opposed to it, precisely because they don't like that outcome.
Russ Roberts: The problem I have with all these models, by the way, is that it does require some certainty to the future.
Michael Munger: It--all it requires is expectations. This is actually--
Russ Roberts: [inaudible 00:44:59] expectations.
Michael Munger: This is pretty simple.
Russ Roberts: Yeah, but it's complicated, because there's more than one round. Things are going to change.
Michael Munger: Well, you're not going to like my next point then because--
Russ Roberts: Go for it.
Michael Munger: basically all I do is to port Riker over to the industrial policy. So, the point is politicians will not vote for the expert's outcome. The premise was that that's politically impossible: we have to insulate it from democracy. So, we bring in this institutional solution and say, 'You know what? We're going to save you. All you have to do is vote for this committee that will put industrial policy beyond the power of you to control them. Will you vote for that?' And, hell no, I won't vote for that. I won't vote for that.
Russ Roberts: Fair enough.
Michael Munger: I won't vote for that outcome. Why would I vote for that institution?
Russ Roberts: Fair enough.
Michael Munger: They can see far enough down the agenda tree to know what that outcome is. It's an outcome they don't want.
Russ Roberts: I just want to mention, by the way, that in this week's EconTalk where we talk about inflation in Argentina, one listener, Shalom Friedman--and I'm sure there are many others--said, 'Well, why doesn't Argentina--don't they realize how horrible it is to have high inflation for so long? Why haven't they figured that out?' And, the answer is, they have.
Michael Munger: They're not dumb.
Russ Roberts: [inaudible 00:46:24]. I had one sentence on it, so it's not surprising that people didn't hear it, because as an economist and someone who thinks about these issues like you and I do, it's doesn't require a lot of verbiage. But, to spell it out a little bit more, they prefer the world of high inflation with all of its horrors--
Michael Munger: They, the politicians--
Russ Roberts: The politicians, because even though it's bad for the country, they think there's something that's worse. And that worse thing is not having any money for the government because they have a really bad tax system. They don't have good compliance. They don't have a way to enforce tax compliance. They don't have a culture that encourages people to pay their taxes. So, they've decided that the easiest way for them to raise money is to print it. Which comes with a terrible cost; but so does not having an army, say, or whatever else they spend the money on. Now, it could be they're wrong, they made a mistake. But, in general, my starting point would be that they've looked--they've thought about it. Right? And it's not simply they just don't realize what's happening. I assume they really do.
Michael Munger: I'm embarrassed. I listened to that podcast yesterday, and I should have started with that example because that's perfect. That is exactly the same logic. So, if you have--
Russ Roberts: And, therefore, if some politician says, 'Let's pass a law that limits the printing of money in our country, so we'll get rid of this scourge of inflation,' they're not going to vote for it.
Michael Munger: And if you passed an institutional reform saying, 'We're going to have an independent central bank whose job it will be to prevent the printing of money,' that institutional reform also would not pass.
Russ Roberts: It will fail.
Michael Munger: Even though it's true that experts in Argentina know for a fact it would be better for the society if they wouldn't do it.
So, I have goosebumps how perfect that example is. It is precisely the same logic: So, there's no question experts know what to do--so I've granted that premise and it's right. And, if you go to the legislature and say, 'You should be so grateful. I have solved your problem. All we have to do is have a set of experts that will be independent from your control, and we'll solve this problem in no time,' it probably wouldn't get 10 votes.
There is an interesting question about time consistency, and this is usually that: what benefits me right now is different from what benefits me in the long run. And so, we have just discussed what's usually given as the rationale for having an independent central bank. And so, the claim was, for example, that the Federal Reserve would be an independent central bank. Members would be appointed to seven-year terms, and so they're beyond legislative control, as my friend and co-author Kevin Grier has written.
It's clear that the Federal Reserve actually is very conscious of the activities of the House Ways and Means Committee: they're not beyond political control. It's only so long as they do what the Congress wants that we will see, in equilibrium, the Federal Reserve will not be attacked by the legislature. But it is not true that they could do anything that they wanted.
Argentina does not have anything like an independent central bank. And they could pass it. Somebody could propose it. And they could also, you know, 'That's right. That's the right idea.' It wouldn't happen, for just the reason that you say: It is actually politically much worse. They have no other means of raising money. And, being able to have an army and being able to pay off all of the Peronista union workers that the government depends on to keep getting reelected--it's politically impossible.
So, I want to make exactly that same Rikerian argument: That you can't solve a policy problem with an institutional change because if you won't pass the policy, you won't pass the institution.
Russ Roberts: So, I'm going to give you my version of this kind of [?flawed?]-utopian design.
So: What we need is a different culture of tax compliance in Argentina. So, it's not a problem. We don't need different institutions. We need a different culture. If we could just get Argentinians to pay the taxes that are legislated--and, in fact, let's do it totally voluntarily. We don't need any tax compliance. But our culture will be so strong that, that will be sufficient to destroy the incentive for inflationary monetary policy. And Argentina will be a better place. So, quote, "all we need to do is to inculcate in Argentinians"--
Michael Munger: Education. We just need education.
Russ Roberts: Yeah, to explain to them the virtues of paying your taxes promptly, to the penny, to the peso. And everything will be fine.
Michael Munger: I think there's a lot of things that Argentinians would laugh at, but that's definitely one. That, you're going to go and explain: You know, all you need to do is pay your taxes, and it'll be great. Sure. No one else pays their taxes either.
I had a student once who did a comparison of the tax compliance cultures between Chile and Argentina, and in Chile everybody pays their taxes, 98%. And, if you don't, you're really seen--it's not just that you're going to be arrested, but it's embarrassing.
And, in Argentina, maybe 50%, probably not. So, Argentina had the idea of, 'We're going to increase tax compliance.' And so they had a bunch of soccer players--football players and famous actresses from the telenovelas--and they were on TV saying, 'You should pay your taxes.'
They had to pull the ads within a week because none of the actors had paid their taxes. It turns out that they did some investigation: The football players hadn't paid their taxes. So the whole thing was a giant joke. And, I'm not sure that the football players didn't sort of enjoy being in on the joke from the beginning. Because of course, you don't pay your taxes. Only a chump pays your taxes.
So, there's two different equilibria there, and you can't move from one to the other unless everybody moves at the same time.
Russ Roberts: No, you could do it in a journal article. You don't need to--
Michael Munger: Now, you're just being mean. You're just being mean to Dani Rodrik.
Russ Roberts: Not to Dani, no. I'm being mean to myself. I'm just going to assume a can opener--a little inside joke about inside jokes.
But, this is a--I think, a theme of a number of our recent conversations, Mike, where we concede--at least I'm conceding here and I don't know if you want to concede--but I want to concede here that some of my ideas for how to make the world a better place that I think of as realistic--and I make fun of my intellectual opponents about the unrealistic nature of their improvements--we're all kind of on the same page.
And it reminds me of the way George Stigler and Milton Friedman used to differ in their view of the world. Milton Friedman was quixotic. He believed that he would make arguments for what he considered good policy, and he would often be unheard. Unnoticed, unresponded to.
And, George Stigler would just laugh and say, 'It's a circus. You don't study it to make it better. You--it's entertainment.' So, Stigler looked at the political world and said, 'I'm not naive. I don't think that this can be improved because of the kind of issues that you and I have been talking here.'
Friedman said--I don't know what Friedman said literally, but I think he said, 'I'm doing what I can.' And, for me, even though I just made fun of my view about culture, part of the reason I like the idea of EconTalk is that I think--it's ridiculous, but I think it actually could improve discourse and conversation about controversial things. And, I mean, is there anything more naive than that? And, the answer is maybe not, but maybe there's two or three people listening who learn something. Or 200 or 300, or 2000 or 3000.
It's still a small number in the world population, but I'm doing my part. I'm doing what I think I'm supposed to do, and I'll let you respond to this in a sec. But, I think the fundamental question is: If you take your critique seriously--and I think you have to--the critique being the Riker critique ported into this industrial policy argument. Which is that: the obvious things that you think would make the world a better place actually aren't feasible. They might make the world a better place--
Michael Munger: It's not politically feasible. Right.
Russ Roberts: They're not on the table. Don't pretend they're on the--to pretend they're on the table is to indulge in illusion and delusion.
But, then it raises the question: So, we look at the world around us, we see things we don't like. When we see it in our spouse, my reaction--
Michael Munger: Not that you ever have, but if you did--
Russ Roberts: No. If I did--of course not. But, if I did, I would say: What do I need to fix about myself to make it easier for my wife to be a better person? That would be one way to respond to the imperfection of our marriage.
We can think of other ways, some would not work, some might improve a little bit, etc.
So, when you look out at the world, and the economic policies and the political policies of the world, you see all these discouraging realities. Should one just shrug and say, 'Well, there's nothing that can be done. This is the best of all possible worlds,' and this by the way is very much Gary Becker's view. He said--the incentives, this is the way the world works. You can talk all you want about how stupid it is or inefficient it is to subsidize agriculture, but it's politically very efficient--in certain countries and not in others. So, in Japan, agriculture is highly subsidized, and in the United States highly subsidized, and in other places where there are lots of farmers with no political power, not subsidized at all. And, you could talk all you want about how that's good or bad, it doesn't matter. It's just the way it is.
And is that--so, is that the lesson? You just shouldn't try to make the world a better place? You're just stuck with the reality? Because the political incentives are there. If you think you can change those incentives, you're fooling yourself. Because, Riker would say you can't get those passed: Nobody is going to vote for them, by the very essence of why the current situation is the way it is. So, just suck it up and take it. Is that your worldview now?
Michael Munger: I guess I'm going to plead Buchanan's relatively absolute absolutes. So, we have to accept--this is James McGill Buchanan who won the Nobel Prize in 1986--had this view that he called the relatively absolute absolutes. And, so--
Russ Roberts: You've talked about it here before.
Michael Munger: we have talked about it--
Russ Roberts: [inaudible 00:57:50] again.
Michael Munger: And the point of it is, by and large, we probably have to accept existing institutions and existing incentives as they are because like Samuel Beer said, every system is designed to produce the outcomes that this system is producing. And by design, I mean, in evolutionary terms.
Russ Roberts: Okay.
Michael Munger: So, the idea of design is, over time, it has come to produce these outcomes--
Russ Roberts: [inaudible 00:58:22] to emerge[?].
Michael Munger: and not some others.
So, Stan Winer, the Canadian public choice economist, has written a lot about the tax code and said that any attempt to change the tax code or to point out--the tax code is really complicated; we should change it. It's going to run into Bootlegger-and-Baptist problems because our tax code in the United States is complicated for exactly the reason that it serves politically, the set of interests that benefit from having a complicated tax code.
So, all of that's true. But, to say we can never do anything is kind of nihilism. So, I accept that, but then that's the not relatively absolute absolutes parts.
I think we can talk about policy changes--and Milton Friedman thought this, too: that if you have a ready, off-the-shelf set of policy changes and there's a crisis--so, if there's a crisis, sometimes you get an opportunity to suggest, 'There is a radically different policy proposal, and we might be able to do this.'
So, I would say getting rid of all industrial policies, and just recognizing that--Robert Pindyck did a EconTalk not long ago where he advocated for carbon tax. And you said, 'You know, we can't really be sure that that's better.' A carbon tax would mean that we would make fossil fuels more expensive, and alternative energies--we don't know which one--are likely to be relatively more competitive. And, the result is that, maybe it's solar, maybe it's wind, maybe it's a particular kind of battery for electric vehicles. We don't know which one. We're going to let ourselves work that out.
So, the industrial policy would be: Let's choose solar. And spend a lot of money on that.
The economic policy would be: Let's tax carbon, and then profit and loss will tell us whether wind or solar or some other alternative energy is the best way to do it.
So, I'm sorry: that was a long answer. I think the relatively absolute absolutes part is to say normally, by and large you should be skeptical of utopian solutions. However, if you have something like a carbon tax, as the imperfect as it is, at least then, contingent on that, you're relying on a set of profit-and-loss signals to tell us which of these alternative energies is best.
Russ Roberts: Yeah, and I guess I've got to point out here, as you know, that we don't have a carbon--we actually have a little bit of a carbon tax. We do tax gasoline in the United States. We also subsidize various forms of carbon in various ways. And, strangely enough, those are not designed by economists.
What I'm trying to say is the carbon tax of your dreams is not on the table, for exactly the reasons we've been talking about. So, is advocating for it a form of quixotic--?
Michael Munger: Yes.
But, that's why the relatively absolute absolutes is okay. Sometimes you have to try. Sometimes you can't just say, 'Everything is hopeless. I'm willing to die on the carbon tax hill because I think it's better than all of the other dumb policies.'
California, recently, because of high gas prices, sent every owner of a gasoline-powered car a $400 check. And, when you were talking to Marc Andreessen about this, Marc Andreessen was incredulous: I don't really need $400, but thanks very much. If you rode your bike and you didn't have a car, you didn't get the $400 subsidy. If you had an electric vehicle, you didn't get the $400 subsidy. So, stop doing stupid stuff; and subsidizing petroleum fuels would be a good start. So, we don't have to have a carbon tax necessarily: we should just stop all of the many subsidies that we have for the perpetuation of gasoline. You might--
Russ Roberts: But, that's like telling Argentinians, 'Stop cheating on your taxes. Just pay them.'
Michael Munger: Relatively absolute absolutes, I am willing to say sometimes we have to try even if it's quixotic.
Russ Roberts: I'm going to try a different approach. We can end on this.
The problem I really have with your perspective--which, of course, I fundamentally agree with more or less, but I want to emphasize the less for a minute. Political science is not a science. Equilibrium analysis is useful; it's provocative; it's not truth. It is not just that we grope toward the equilibrium. The whole idea of an equilibrium, which by the way is a way of saying that unless--equilibrium is the idea that if nothing else changes, nothing else will change. Right? So, the outcomes we get, they are the ones we're stuck with unless there's a change of population or there's a change in something, quote, "exogenous"--something outside the model. And of course, nothing is really outside the model. And, the truth is, is that, the world doesn't work exact like economists or political scientists say it works. In other words, the underlying processes are not the same.
And so, therefore, if we look at, say, the political outcomes of the last 10 years--which are rather extraordinary in terms of how different they are than the previous 10 years--for me, the lesson I've learned from that is that we don't understand politics. We don't have a real model of how political outcomes emerge from the institutions that we are currently saddled with or blessed with depending on your perspective. So people don't always vote their economic interest. Some models assume they do, but those models are not accurate. They're not a hundred percent accurate.
And, sometimes social movements lead to change that is unanticipated. Sometimes there is something called leadership. A person steps forward with a vision, and manages to convince a bunch of people to do things that otherwise they wouldn't have done. Maybe it's to establish an independent central bank. Maybe it changes the culture. Maybe it's to get people to an issue that was wasn't salient, to suddenly be at the front of people's minds, and motivate them to vote in a certain way. And, yes, many times those outcomes are worse than we had before, but sometimes they could be better. We could imagine it.
So, for me it's not so quixotic as it sounds. I think sometimes our models of political outcomes are not as reliable as we would sometimes contend.
So, change is possible, and we get it even when it's not a good change. It's not like--I'm not sure the world's moving in the right direction. But, I don't think the economists' or political scientists' views of the political process and the institutions we currently have are anything like our models of, say, planetary motion. So, that's what I would say.
Michael Munger: Our models are certainly not anything like our models of planetary motion, and I guess, I see that--where we may disagree is, I see that as a result.
So, political science is a science to the extent that it should teach us humility about the ability to go from interests to some aggregate outcome that represents those things in equilibrium. The equilibrium that I'm talking about is--I reference in my paper that I think is really important and is under-recognized: I think it's really fundamentally important. It's a paper by Gary Cox, Douglass North, and Barry Weingast in which they argue for something they call the proportionality theorem. And, the proportionality theorem is that institutional changes that have a distribution of power that are different from the de facto distribution of power on the ground are always going to fail, either because they won't pass or there will be a coup or some kind of violence or lack of enforcement.
And, that, I think explains--well, it explains what happened in Egypt. So, in Egypt, they had a Constitution after a long military government, and they tried to implement a set of changes. The President went too far in asserting the power of the presidency, and there was immediately another military coup. So, all of Tahrir Square--you look at the effects of Arab Spring, they ignored the Cox, North, and Weingast proportionality theorem.
Now, that's not a how-to. That's a constraint. So, I would say that I think political science does tell us that there are constraints on what we can reasonably hope to accomplish through politics. You should be humble. You should recognize that this thing you think you can do, not only probably you can't: it may make things worse. And so, you should have a more constrained vision, to use Thomas Sowell's phrase, of what can be accomplished in politics.
So, that's really what I want to argue with this paper about industrial policy.
Even if it were true--and I think it's not--but even if it were true that experts knew the right set of subsidies in taxes, the right set of industries to declare be winners and the ones that should be losers, you should be really humble about creating a politically powerful organization that could implement your vision because it is uncontrolled. It is likely to use those powers for things you do not intend. And that's why we have to settle for what looks like a really bad alternative, which is democracy. Which is really frustrating. You have to persuade people. You can't impose the right thing on them. So that, if political science teaches us--and I think it does--that there are constraints that should limit our sense that we can accomplish the good, then political science has actually served some kind of function.
Russ Roberts: My guest today has been Mike Munger. Mike, thanks for being part of EconTalk.
Michael Munger: Thank you, Russ.