In this Barron’s interview Ferguson makes some valuable observations of US policy, putting it into historical context. The most fundamental fallacy he cites is the idea that democratic government can eliminate risk for its populace. It cannot – it can only help individuals better manage their risk. But the risk is ever-present and the wrong government policies can make systemic risk considerably worse.
By VITO J. RACANELLI
Niall Ferguson, economic and financial historian, sees parallels between the U.S. now and the mid-20th-century U.K.
In his latest book, Civilization, The West and the Rest, the economic and financial historian Niall Ferguson argues that Western civilization’s rise to global dominance over the past 500 years was due mainly to six killer apps, as he calls them: competition, science, rule of law, modern medicine, consumerism, and the work ethic.
While “the Rest” lacked these concepts, they might not for much longer, as emerging markets are quickly catching up. Someday, they could even surpass the West. (On May 22 and 29, PBS will air a program based on Civilization.)
The Scottish-born Ferguson says that North and South American economies and institutions are converging. And, he adds, while China remains a long way from a rule-of-law democracy, anyone who thinks it will retreat from the markets is in for a rude surprise.
Lately, Ferguson, who is a professor at Harvard—Barron’s interviewed him in his Cambridge, Mass., office—and holds similar posts at Oxford and Stanford, has been worried about the market-destabilizing potential of a Middle East conflict, and says that going long oil is a good bet. And he thinks the U.S. is on a slippery slope that could turn it into a European anti-risk-taking welfare state. For more, read on.
Barron’s: There are once again concerns about U.S. growth. What factors are keeping the economy from reaching what you call “escape velocity”?
Ferguson:I’m skeptical that the U.S. can get to a self-sustaining recovery if we only increase monetary or fiscal stimulus. Part of the reason why the U.S. economy is not growing faster is policy uncertainty, and part is structural weakness. In terms of institutional policy, the U.S. is a relatively less attractive destination for investment than it used to be. A large body of literature shows a strong relationship between the quality of institutions and the growth rate. When countries improve rule of law, property rights, and investor protections, and when regulation becomes more transparent and corruption reduced, there are major payoffs. The World Justice Project says the U.S. has been deteriorating for close to 10 years by all these measures, which contrasts with improvements in some emerging markets, like Hong Kong.
The rule of law has become more expensive in the U.S. without becoming more efficient. Any business, particularly small to medium-size, that has had encounters with litigation in the past 10 years will know what I’m talking about. The rule of law in the U.S. has become, at some level, dysfunctional. One reason for that is the way Congress works. It is a honey pot for lobbyists. The result is that complex legislation is riddled with ambiguities that—guess what?—only lawyers can resolve. Dodd-Frank is designed to improve regulation, but what it actually does is institute a massive job-creation scheme for lawyers. There isn’t a financial institution in this country that doesn’t now require its compliance department to retain a whole bunch of lawyers to explain to them what this 2,000-plus-page monster means for their business. That concerns me.
If you locate a new plant in the U.S., you encounter this increasingly unfriendly regulatory and tax environment. You don’t know what the taxes are going to be, because Congress is playing a game of chicken about the deficit. It ought to be solvable. However, there are vested interests in the political system that have no interest in solving this problem because they profit from it. It is a classic problem of rent-seeking behavior triumphing over profit-maximizing innovation and entrepreneurship. If you only look at monetary and fiscal policy, it is incredible that the economy isn’t growing faster [since] it has had more stimulus than at any time since World War II.
Can you liken this to anything in history?
A parallel is the way that things went wrong in Great Britain in the mid-20th century, when a combination of overseas commitments, excessive public debt, vested interests in the form of organized labor, and incompetent management and a pretty decadent ruling elite made Britain the sick man of Europe. There are some lessons there. Over time, good institutions tend to deteriorate because of the human condition. There needs to be a renewal of American faith in the founding principles. A lot of ordinary Americans, especially businessmen, yearn for this and resent the crony capitalism they see between Washington and Wall Street.
Are you optimistic or pessimistic?
It’s always a good idea to be optimistic about the U.S. Ultimately, political leadership will materialize, because the popular instinct on many of these questions is sound and there are political leaders—[Wisconsin Republican Rep.] Paul Ryan, for example—who have integrity and are prepared to push unpopular measures that will ultimately prove beneficial. It isn’t just the tax code. It’s an incredibly complex accumulation of regulation and legislation, the net effect of which is to make it harder to be an innovator and entrepreneur. Not only is the U.S. doing less well in these terms than Hong Kong or Germany, but it is doing less well than the U.S. used to do.
What are your thoughts about the Chinese economy? Japan was supposed to overtake the U.S. years ago and didn’t.
China is not where Japan was in 1989, but where South Korea was in about the mid-1970s, which means it has a lot further to go with its export-led industrialization strategy. It is a vast version of South Korea. A fifth of humanity is currently benefiting from a transition to market reforms. Anybody who bets that will suddenly stop is going to be disappointed, and make some epically bad investment decisions, too.
The people who are certain to emerge in charge of China, like Vice President Xi Jinping and Vice Premier Li Keqiang, are sympathetic to the argument that China needs to move in the direction of markets and away from state capitalism. The model that is gaining ground wants to see more privatization of state-run enterprises, increasingly flexible capital accounts, and an end to the manipulation of the exchange rate. If this happened, not only would hot money come into China, but actually a lot of Chinese money would leave. If you wanted to make a single thing happen to stabilize the U.S. property market, it would be liberalizing China’s capital account.
How compatible is capitalism with China’s form of government?
More than we might assume. A one-party state was essentially the norm in most East Asian economic miracles. South Korea only moved away from a military dictatorship in the 1980s. I don’t think we’ll see multiparty democracy in China in our lifetimes, because the Chinese are right when they say our system can’t work for a fifth of humanity at this stage of China’s development. They would be very foolish to rush into the kind of things we periodically say they should do, such as allow political opposition to form. The Chinese know how dangerous that is.
The lesson of Chinese history is that this enormous entity that we call China has a capacity for centrifugal forces to take over. China will move in the direction of rule of law with a one-party state, which will become more subordinate to a meaningful rule of law in the sense that the private property rights of individual Chinese will become more secure. Most absolutist monarchs in the 19th century made that kind of transition without ceding power to parliament.
One hundred years from now, if your grandchild writes a sequel to Civilization, what will it say?
It will say two things happened, beginning in the late 20th century and carrying through into the 21st. The rest of the world learned best practices in economic and, to some degree, political terms. The people living in Asia and South America and even parts of Africa no longer live in miserable poverty with no security.
The other trend that proved far more pernicious was that the West, particularly Europe but also the U.S., failed to update its political or economic institutions, and that’s why its economies stagnated. We already see that in Japan. It is already a feature of life in much of Europe, and we have to worry about it coming here.
What made the West unusual was that risk takers were not only rewarded but honored, whether in science, exploration, or in trade. Spreading across the Atlantic from Europe is an anti-risk culture that manifests itself in two ways. One is the welfare state, designed to remove risk from your life by guaranteeing you an income from the cradle to the grave. That’s great because it means that nobody is starving in the streets for want of work. But it isn’t great if you create poverty traps and disincentives, so that people in the bottom quintile never work, which is the case in much of Europe.
The other way in which the anti-risk culture manifests itself is with the manic regulatory mentality that tries to prescribe rules for every eventuality, including the tiny, tiny risk that an asteroid will hit this building. Regulations that protect from every eventuality end up being paralyzing because the more things are proscribed, the more the ordinary entrepreneur has to be afraid that if he doesn’t comply, he will get sued.
What about the euro?
The costs of dismantling the euro are so high that the Europeans will do whatever it takes to prevent that. What it will take is a transition to something like a fiscal federal system where there are no longer bailouts; there are automatic transfers and there are going to be eurobonds so that the full faith and credit of the German government lies behind at least part of the debt of the other countries. Berlin knows this but dares not spell it out explicitly, because the bill for the German taxpayer will be quite large. You are talking about 5% to 8% of gross domestic product every year for the foreseeable future.
But it isn’t in the Germans’ interest to blow up the euro. That isn’t something Chancellor Angela Merkel wants to have in her Wikipedia entry. The principal beneficiary of the euro is German business. As long as Corporate Germany appreciates having the euro, and German voters still have some residual guilt feelings about history, then they pay. How does this transition to something more like a Federal Republic of Europe happen? It will proceed along a very bumpy road over a 12-to-18-month period. The ultimate destination will be something like a European financial authority/treasury that gradually accumulates the funds it needs. There will be painful negotiations, but they’ll get there because they have to.
Can you make a case for South America catching up to North America? Or are Venezuela and Argentina the vanguard of another cycle of falling backwards. And what about Brazil?
It would be very surprising if Brazil was to fall back. The costs of being Venezuela or Argentina are too obvious to anybody in the region, and the benefits of being Brazil are even more obvious. Not only for Brazil, but quite a substantial number of the Spanish-speaking countries—Peru, Chile, Colombia, Mexico—the picture is sustained institutional improvement, with a long way still to go. Compared with where these countries were 20 years ago, they are closer to rule of law. If you had invested in those countries 10 years ago, you would be in a much better place than if you had invested in North America. I’m cautiously optimistic about the region.
Mexico, if you just looked at the numbers, is much closer to Brazil than people realize. A good test will be whether the new president turns the Mexican oil monopoly into something like Brazil’s Petrobras. This is a story of convergence. South America is getting more like North America, and North America is getting more like South America.
What big geopolitical risks do you see?
The Arab Spring has a long way to run, with many unforeseeable consequences. The biggest risk is conflict in the Middle East. Whether it is Israel/Iran I don’t know, but there is going to be trouble. Nothing about the Arab Spring is good news for Israel. Their insecurity can only increase over time, and there is a real struggle about who is going to run the region once the U.S. essentially ceases to run it or runs it much less than it used to. It’s hard to feel really cheerful about the prospects of peace. Being long oil has to be a simple bet under those circumstances, quite apart from supply-and-demand constraints.
The other big risk is the game of congressional chicken about the U.S. deficit. It’s the most dangerous game in the world today. Are we going to replay the debt-ceiling arguments of last summer right through November and into the new year? I worry that—at a time of already high uncertainty about policy with a train called sequestration heading towards the U.S.—political brinkmanship will ultimately have real economic consequences. The U.S. is on an unsustainable fiscal path. With every passing year, it gets harder to fix because the major problem, Medicare, gets larger, and the political obstacles seem to get larger with it. At what point does the U.S. start to jeopardize its credibility as a sovereign borrower? History suggests a great power can end up with a very large debt burden before the markets lose faith. The U.S. might play this game of brinkmanship for years before the deficit is brought under control. We can end up with a debt-to-GDP ratio of 250%. That’s happened to other countries. But you can’t guarantee that the markets will cut that much slack.