Welcome to Known Unknowns, a newsletter that tries to make sense of a world that is both more uncertain (Knightian) and less risky.
An economy without risk
Some things in life are certain—gravity, death, taxes—and there is no excess reward without risking loss. That is true in financial markets, in our relationships, and the economy as a whole. Sustainable growth comes from innovation, but that is inherently a risky venture. You don’t know if your idea will work, and you need investors who will take a chance on you. You also need financial markets who can put a price on risk and distribute it throughout the economy. Risk is oxygen for innovation, and it is how we grow and prosper.
I have two stories in the City Journal about how we are removing risk from the economy to our detriment. One, in the winter issue, tells the story of a tightrope walker and America’s last homesteader. There was a time we encouraged risk-taking, like homesteading, especially for low-income people. It was the foundation of our growth and productivity boom in the 19th and early 20th century. But now things are different. The homesteader spent 10 years mired in paperwork getting that last patent. Bureaucracy has become a bigger hurdle than bears or angry moose!
And it is not like all these regulations always make us any safer. The tightrope walker is often forced to use a safety net, even though he thinks it actually makes the stunts more dangerous. Regulation can be an important tool to reduce risk in the economy in way that is healthy and productive. When done well, it forces us to internalize the costs of our risk-taking on others, and some policies, like insurance, can enhance risk-taking while protecting the most vulnerable. But it seems like things have gone too far to the point where we may undermine our prosperity and resilience.
I thought of this while watching the State of the Union this last week. I get it. We just had a few huge shocks, a pandemic, and now a major shake-up of the world order. There is a natural instinct to pull back from risk taking and seek out as much certainty as possible. But this is not the best path forward. It seems like we are channeling the Chinese model (not the repression, just the industrial policy), that if we take capital from financial markets and have the government’s direct investment, we can have risk-free growth. If history is any guide, that will not produce the innovation we need to thrive.
Western countries have a pretty good history of balancing risk and reward. Why fix what isn’t broken? As the tightrope walker story shows, you can’t prevent shocks. The world is an uncertain place. But trying to eliminate risk does not prevent uncertainty—it only makes you more vulnerable to it. Risk can be managed, but resilience and flexibility is how you survive the unexpected.
I also have a new Bloomberg column where I re-imagine the role of unions. I am generally not a fan, since it creates an insider-outsider economy. But unions have done some good in the past for workers. I reckon they made some sense in an industrialized economy, when there was a bigger premium on firm-specific capital, jobs were fairly routine, and there was a lower premium on skills. But the collective bargaining model makes less sense in a tech-driven, super-star economy. The union model reduces risk through hedging. Union members give up some upside but band together for stable wages and job security.
This makes less sense today, especially if you have high earning potential which undermines the union model. So, let’s think big. What if instead of hedging, unions offered insurance. Maybe instead of collective bargaining, they should be like guilds who offer health and disability insurance, or maybe even wage insurance(!) directly to their members. This would offer downside protection, while allowing workers to get the upside the economy offers. That would do much more for wage growth than running the economy hot.
And yet policy makers (in both parties) keep pushing old-school unions. It seems like they want to bring back the 1960s economy, and who wants that?
Inflation is still with us
And not going anywhere. Smart economists expect more inflation this year through the wage price spiral, not just too little supply and too much demand. And once you get that going, it takes more than neutral Fed policy to get inflation in line.
Inflation today has many fathers. I think some of it was inevitable coming out of a pandemic, but the government threw fuel on that fire with its policies last year, and their plans for the next year will make things even worse. Re-shoring our manufacturing means less trade which will increase prices. Biden promises that Build Back Better will reduce inflation by making the economy more productive. While it is true that productivity can reduce inflationary pressure, it takes years for that to happen, and inflation is a problem for households now. In the short run, BBB is just another inflationary stimulus.
Another source of inflation is energy prices. That is not this administration’s fault. Energy prices are set in a global market, and there is a lot of pressure on prices right now that has zero to do with reducing fracking or cancelling the Key Stone pipeline. But that doesn’t mean that pushing renewables and electric cars should be the centerpiece of our energy policy. They are compliments, not substitutes to a greener more sustainable world. It felt like only a few years ago the US was close to energy independence. What happened?
When it comes to inflation, it feels like we are using long-term iffy strategies for short-term immediate problems.
More on rebellion
Zvi Bodie on his life in economics. He took an unusual path and that made him the economist he is today. I fear that is less common now; elite economics education has less room for people who make untraditional choices. Maybe that will mean fewer creative economists in the future.
Until next time, Pension Geeks!