America ignores history at its peril, warns J. Bradford DeLong. A professor of economics at the University of California, Berkeley, DeLong believes the U.S. government has always played a vital role in encouraging growth and supporting entrepreneurial innovation. But in an increasingly ideological environment, lawmakers give regulation short shrift, he fears with dangerous consequences like excessive financialization and the 2008 market meltdown.
In his latest book, Concrete Economics: The Hamilton Approach to Economic Growth and Policy, co-authored with Stephen Cohen, professor emeritus of city and regional planning at Berkeley and co-director of the Berkeley Roundtable on the International Economy, DeLong argues that things can be different. He invokes the legacy of founding father Alexander Hamilton who served as first secretary of the U.S. Department of the Treasury, founded the Bank of New York and spearheaded the creation of the U.S. Mint to show that pragmatic regulation delivers economic benefits.
DeLong, 55, who has taught at Berkeley since 1993, is no stranger to government. As deputy assistant Treasury secretary during the Clinton administration, he worked on the 1993 federal budget, the North American Free Trade Agreement and an unsuccessful effort to reform health care.
Institutional Investor: Why have new mechanisms for economic growth been elusive?
DeLong: Well, its genuinely hard to think of good ways of organizing large groups of people to coordinate what they do. Markets are a unique sweet spot for a particular set of commodities produced under a particular set of conditions that more or less approximated those that Adam Smith faced. Today its very different, and the problem of what economic theorists call mechanism design is a very difficult one. Look at the trouble were having simply trying to arrive at a functioning system, let alone an optimal system, for health insurance.
How do you see governments role in encouraging what you describe as equitable economic growth?
From the 18th century through to the 21st century, the economy became less Smithian in the sense that it was built less on the production of simple, easily classified goods produced under competitive conditions at constant returns to scale by small producers. Over time the economies of scale became more and more important. Intellectual property, as well as nonrivalry in production, became more and more important. Things like location and where we get our utility became more important as well.
All of these things move us away from a Smithian world in which the only mechanism you need to make the economy run efficiently, effectively and equitably is a publicly available competitive price for anything and for everything. In Adam Smiths world, thats enough to guide the economy to a good equilibrium.
Now things are very different, and we need new and different mechanisms, and we dont really understand what they should be. But they do inevitably involve a bigger role for the government than simply the night watchmans place of enforcing property rights and enforcing contracts.
How have behavioral economists shed light on the shortcomings of the current system?
The place where behavioral economics is most visible right now is that were paying 7 percent of GDP for financial services when we really ought to be paying 2.5 percent of GDP for financial services. The financial system we had in the 1950s seems to have functioned just as well, and yet were spending three times as large a share of GDP now as we did then, largely because were incredibly lousy shoppers for financial services.
Similarly, in health insurance were incredibly lousy shoppers for private sector health insurance and for figuring out what we really want and how we really want to pay for it. Weve also evolved a system that is sufficiently complex. One way to view the business models of many health providers is that they send us random bills and see if we pay them. And if we dont pay, then we negotiate.
I was taking my mother-in-law to CVS last Sunday, and CVS suddenly demands a $52 copay for something shes always gotten for free. She balks, and in the end they figure out that she doesnt owe them $52 but theyd have been very happy to collect it, and then they never would have refunded it.
This is what George Akerlof and Robert Shiller call phishing for phools. Increasingly, in a complicated world, figuring out how to be a good shopper who understands your interest in the market youre transacting in becomes very important. Youre up against lots of people who dont have terribly good motives and whose business model might, in fact, be based off of not being terribly good. There are right now, for people in their 50s, relatively notorious cases about how the gastroenterologist doing a colonoscopy is in a health insurance network, but the anesthesiologist is out-of-network. For relatively large expenditures and where its not easy to effectively comparison shop or even to understand the contract ones signing, it shouldnt be surprising that the market doesnt do terribly well.
What is the key to protecting people from these financial manipulations?
Repeated purchases and a large-scale community of consumers who communicate with each other about whats good and what isnt. This is important, but it requires a dense social network, and it also requires a lot of repeated purchasing behavior. The large things like a 40-year investment in a pension or health insurance, home ownership, automobiles matter. People have always feared having to buy a car because they sense theyre going to be taken one way or another, and they often are. These are difficult problems.
Figuring out how to present the information people need to know in a way thats transparent and understandable is one of the principal problems of mechanism design that economists face and one of the things that government has to do to structure the market.
Your new book starts with Alexander Hamilton and continues to explore how the U.S. government can influence economic growth. Why Hamilton, and why now?
The big point of the book is that America has always had a very activist government. Were a country that has in its Constitution not only a general power to regulate long-distance commerce but also what was for the time a kind of advanced frontier commitment to an industrial policy of patents and copyrights. This was something very forward-looking, on the grounds that you want inventions and innovations to be highly rewarded. Ever since then the American economy, when it has worked, has worked because it has been regulated by the government in a pragmatic manner.
For the people who are asking what would work today to increase wealth, what support does the market need to function well, what do we need to do to make the distribution of wealth that the market produces equitable, how do we get economic growth as fast as possible, the answer is that its whenever people have held to ideologies that things have tended to go horribly wrong, and not exclusively in any one political direction. Although I must say that the financial deregulatory effort that I was a supporter of in the 1990s has certainly had the most horrible consequences, far more horrible than our worst nightmares, in terms of what it brought on in 2008.
The years from 1980 to today have been a total bonanza for people like me, in the top 1 percent, and even more so for the top 0.1 percent and the 0.01 percent. So even if you thought that American politics was too concerned with redistribution in 1980, you pretty much have to think that we dont have a progressive enough tax system now. Given that the market has taken an enormous leap toward inequality, a set of politicians who are more focused on trying to put the governments thumb on the scale to create less inequality is certainly something thats called for.
So, the book is mostly a plea for pragmatism.
Why do extremes sell instead of pragmatism? Why do ideologies seem to reign supreme?
People want a simpler world than there is. I dont think that extremes used to sell. I was brought up in a world where people would try to think about what would be good and then Lloyd Bentsen and John Danforth from the Finance Committee would draft a bill and then call for coalition partners from either the left or the right, and play the left and the right off against each other to assemble a legislative majority. That world could still be out there. Why it collapsed into our current political circus is unclear. We could get it back tomorrow if we were smart enough to do so.