by Robert Huebscher, AdvisorPerspectives.com
Niall Ferguson is the champion of anti-Keynesian economists. Last week, he explained why America’s pursuit of Keynesian policies is leading to disastrous consequences.
Ferguson gave four symptoms of U.S. degeneration as evidence that Keynesian policies have created underlying weaknesses.
Ferguson, a professor at Harvard, gave the opening talk at last week’s Strategic Investment Conference in San Diego, hosted by Altegris Investments and John Mauldin. His remarks were based on his newly released book, The Great Degeneration: How Institutions Decay and Economies Die.
Keynes argued for aggressive policy interventions to address short-term economic needs famously saying that,
“In the long run, we are dead.”
But those monetary and fiscal policies have served to justify an unacceptable expansion of the deficit, according to Ferguson.
He said,
“Short-run fixes, regardless of the long-run consequences, got us to where we are.”
We face deeply-rooted troubles, and misguided fiscal and monetary stimuli are merely a symptom of a more profound structural malaise, Ferguson said.
Ferguson drew an analogy between the U.S. and 19th-century China. In the 1800s, the average U.S. citizen was 22 times wealthier than the average Chinese. But over the next century, China closed the gap to a 5-to-1 ratio. The Organization for Economic Co-operation and Development (OECD) projects the ratio will be 2-to-1 in a few decades.
China fell behind in the time leading up to the 19th century because it had become what Adam Smith called a “stationary state.” Ferguson said that the guarantee of justice and the rule of law distinguished Europe and the U.S. from China at that time. Chinese reforms to its institutions helped it close that gap in the ensuing years.
Ferguson said,
“Institutional problems explain low growth and why countries are poor.”
The west now faces the danger of becoming a stationary state.
Let’s look at the four symptoms of institutional failure that Ferguson said imperil the U.S. – and pose a far greater threat to Europe. Ferguson was optimistic about the future of America, and I’ll conclude with his reasons for why we will ultimately succeed.
Breakdown of Intergenerational Equity
Ferguson cited the 18th-century philosopher Edmund Burke, who argued that the primary social contract that governments must honor is between the dead, the living and the unborn. France violated that contract in Burke’s time until its government was overthrown in the Revolution, and now the U.S. is following suit, according to Ferguson.
Western governments are forcing future generations to pay for benefits that accrue to those alive today. Ferguson said that the “great generation” – those who fought in World War II, for example, made sacrifices for the good of baby boomers. But the boomer generation has decided that future generations should make sacrifices for them, he said.
Much of those sacrifices are in the form of healthcare spending for the elderly.
Ferguson cited research by Boston University professor Larry Kotlikoff, who claims that an immediate and permanent 30% cut in government outlays or a tax increase of at least 30% is necessary to achieve intergenerational equity. That is politically impossible and inconceivable, Ferguson said.
Excessively Complex Regulation
Ferguson said that economist Paul Krugman, with whom Ferguson has an ongoing public rivalry, argues that the 2008 crisis was caused by deregulation, mostly at the behest of Republicans.
Ferguson said,
“This is completely and historically untrue.”
Ferguson cited a paper presented at the Federal Reserve’s Jackson Hole conference by Andy Haldane, which argued that regulation increased starting in 1980, even as the numbers of those working in the financial services industry fell over the same period.
As another example, the Basel Accords, which govern bank capital requirements, have grown from less than 50 pages in 1988 to more than 600 today. The tax code, he said is approximately 3.4 million words – more than 9 million if one includes all tax-related regulation – and has grown by 20% since 1995.
Moreover, Ferguson said the institutions that blew up in the 2008 crisis were highly regulated banks, not hedge funds.
Ferguson said,
“It’s not plausible to blame it in on deregulation.”
The key issue, he said, is that the financial system is highly complex and inherently unstable. The complexity that is added by additional regulation has made it even less stable, according to Ferguson.
The Rule of Law Has Become the Rule of Lawyers
The U.S. has the most expensive legal system in the world, Ferguson said, which impedes commerce.
He said,
“The rule of law now benefits the legal profession more than the people it represents.”
Ferguson said that it was harder to set up his advisory business in Boston than it would have been in his native Scotland. He said,
“I was stunned by the lawyers who saw my partnership as an opportunity to extract rent.”
He cited research by the Fraser Institute in Canada, which assessed the legal system across various countries. It measured the time it takes to perform seven specific tasks, such as founding a business. The U.S. was one of only 20 countries where it has gotten harder to do business since 2000.
Ferguson said the Davos-based World Economic Forum uses 22 measures of institutional quality to compile its competitiveness index. Those measures include the protection of property rights, ethics and shareholder rights. The U.S. is not in top 20 countries for 21 of the 22 measures, he said.
Ferguson said,
“This issue doesn’t get any attention, but should be a huge cause for concern.”
Decline in Civil Society
Ferguson said that there has been a “simultaneous degeneration” in the way government and law work and in the way we work as citizens. The direct evidence of this, he said, is that membership in voluntary associations in the U.S. has declined steadily over the last 20 years. That is significant because it indicates Americans’ willingness to rely on governmental institutions to solve problems.
He said,
“In terms of their participation in civil society, Americans are essentially indistinguishable from Europeans.”
Ferguson cited the Worldwide Governance Indicator dataset, which he said shows a decline in key metrics in the U.S., such as accountability, political stability and absence of violence, government effectiveness, regulatory quality, rule of law and control of corruption.
He said,
“This is Latin America. But there the trend is opposite. Governance is getting better in Mexico and worse here.”
Some Good News
Despite these four failings, Ferguson said there is good reason for Americans to be optimistic.
He said,
“We may be in the process of slowly destroying the great institutions we inherited from the founders, but some things are going our way.”
He said that it is getting easier to do business in the rest of the world – especially in China – but establishing a rule of law there comparable to that of the U.S. will be difficult. In Asia, he said, the rule of law has been established in only a few select places, like Hong Kong.
He said,
“Chinese governance is still woeful.”
Compared to Asia, Ferguson said the U.S. has demographics on its side, despite a “screwed up” immigration policy.
He said,
“Our energy policy is flawed. But through luck and innovation we just struck gas and oil. The significance of the energy revolution is only now becoming apparent.”
But the energy revolution will have an unhappy ending, Ferguson warned, If Washington’s alliance of regulators, lawyers, lobbyists and environmentalist cooperate to impair it.
Success in the U.S. is a regional – and not national – story, Ferguson said. States like North Carolina, Texas and Utah are “getting it right” by offering regulations and tax policies that are friendly to entrepreneurship. Those states have overcome the institutional breakdowns prevalent at the federal level, he said.
Ferguson said,
“Despite all that is wrong, growth is happening.”
