Monday, April 2, 2012

From Reset to Prosperity

The recent financial crisis and subsequent recession have left many of us reflecting on our prospects for the future and even revived earlier debates about whether we should have come down from the trees in the first place. 

In “Reading About the Financial Crisis” (JEL, gated |ungated |NPR story), financial economist Andrew Lo attempts to make sense of the first wave of scholarship on the crisis. Unfortunately, according to Lo, academic economists, policymakers, and journalists have been unable to even reach agreement on the basic facts of what went wrong.

While the financial crisis still resonates because of its immediacy, several scholars have begun to make the case that the downturn occurred for systematic reasons representing broader forces. Three recent books from George Mason University (GMU) faculty, and one from a former professor at the School of Public Policy (SPP), attempt to put the recent downturn in broader perspective.

In Tyler Cowen’s provocative treatise, The Great Stagnation (2011), written for the Kindle (and only later published in hardback), we learn that the downturn is only the latest example of a broader and more  fundamental slowdown in our potential rate of growth. This slowdown arose, according to Cowen, because the costs of innovation have risen as we picked all of the low-hanging fruit. New innovations become more reliant on greater specialization and higher rates of knowledge accumulation and as a result become more difficult to produce. Since I talked at fairly great length about Cowen’s work in this earlier piece, I’ll leave it there for now.

Alex Tabarrok's Launching the Innovation Renaissance (2011) is an almost perfect companion to Cowen’s work. Tabarrok, Cowen’s co-blogger at Marginal Revolution, jumps off from the great stagnation, and then asks how we might reform our current policies to reinvigorate our innovative capacity. Tabarrok’s suggestions range from reforming our patent system, to increased reliance on prizes and other incentive mechanisms, to rethinking education and transforming our immigration system. Taken together, these two works provide a coherent view of what’s gone wrong, and one possible set of reforms we could make that would help us get back on track. In terms of "bang for the buck" you get a lot from Cowen and Tabarrok's works. Two recent books build on these themes, but devote more space and depth to their topics.

Richard Florida, a former Hirst Professor of Public Policy at SPP (and now Director of the Martin Prosperity Institute at U. Toronto) frames the recent downturn as a “great reset.” In The Great Reset (2010), Florida writes that our current recession is reminiscent of earlier severe downturns in the economy, such as the Great Depression and the Long Depression of 1873. These earlier crises are notable not just for their severity, but also because they launched new ways of thinking about the world and spurred long periods of inventiveness. These resets purge what is not working and reinforce positive trends that are leading to growth.

Throughout Florida’s narrative, we learn that our economy is currently moving through a such a reset, as we shift from a managerial economy, epitomized by General Motors, into a knowledge driven economy that relies on individuals in cities as the central unit of organization. In an interview for the Atlantic, Florida states (The Atlantic):
There are two tendencies in the world economy. There is a great tendency for low-cost, fairly standardized stuff to spread itself out, and that’s where people say, “Oh my God, the world is flat.” But there’s also this counter-tendency for things to concentrate—to take advantage of these forces of agglomeration and human capital. So what I tried to argue is that that second tendency is very important.
[…] What I tried to do in this piece is say, “I don’t think this great crisis—or great ‘reset,’ as I like to call it—will change this trend. In fact, my hunch is that, coming out of this crisis, our geography will end up more concentrated than it was before.”
One promising trend that Florida cites is the growing concentration of human capital around cities and “mega-regions” like the Boston/New York/Washington corridor. The challenge will be for isolated cities like Pittsburgh to connect to these broader networks. Connecting people in ever-denser networks has become the fundamental challenge in the 21st century.

Finally, Auerswald’s The Great Prosperity (2012) ties together these disparate themes and extends the analysis to the global economy. Auerswald sees entrepreneuers as the primary force driving the outlook and the book focuses on the remarkable actions entrepreneurs are taking to address global challenges. Like Tabarrok, Auerswald also sees incredible potential from immigration and the spread of ideas, but frames the discussion in the broader context of a growing population, which is often portrayed as a coming threat. Unlike earlier theorists like Malthus and Ehrlich, Auerswald, channeling Michael Kramer, explains how new people create new ideas and fundamentally reshape our approach to existing challenges. As in The Great Reset, we learn of the fundamental importance of creating value through connection and collaboration.

In an excellent review of Why Nations Fail, Auerswald reiterates this point (growthology, see also Fukuyama’s review for a similar take). Fundamentally the story of how institutions and economies evolve is a story about people and how: “actual people, or groups of people, acted at particular points in time to push back against incumbent interests, change institutions, and in so doing move the arrow of history."

Through case studies of disparate entrepreneurs, ranging from a mobile phone revolution in Afghanistan to Victoria Hale, who has successfully utilized “orphan drugs” to address issues of global health, Auerswald demonstrates that historically intractable problems can be solved through entrepreneurial solutions.

Our current myopic focus on the past decade and the two most recent recessions and "jobless recoveries" misses the broader and fundamentally promising trends currently underway. Florida and Auerswald both provide excellent maps of our changing terrain, and Tabarrok provides one potential path for the U.S. to escape its current malaise.

The contemporary works that Andrew Lo cites will be crucial to future historians as they reconstruct what went wrong and how we can learn from this experience. But if you're trying to get a sense of where we're headed, and why, you could instead read these two short monographs and two books. Even better, if you actaully want to participate in changing the future, these books serve as important blueprints.

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