The emergence of China as a major strategic challenge, the acute problem of the Covid-19 pandemic, and issues of social cohesion and economic inclusion, have prompted policy makers to consider their strategy – to the extent that they have one – and the policies to pursue it. Economics as a discipline and occupation has also been challenged, with respect to both theory and practice. American Compass (AC) emerged in May 2020 as a think tank and intellectual forum that aimed to reorient economic policy, including the economics underpinning it, with a particular focus on the ‘right’, which AC claims has been too sympathetic to ‘free markets’ for too long.
This post examines and takes AC seriously, not simply because it is a fresh new voice, but because it aims to address important social and economic issues, and re-examine the key aspects of economics that underpin economic policy.
The post examines AC’s foundational documents and statements in order to understand and discuss its perspective and agenda. Later posts may examine specific AC projects, such as its ongoing project on Corporate Actual Responsibility.
Summary of American Compass’s perspective and agenda
American Compass aims to ‘restore an economic consensus that emphasizes the importance of family, community, and industry to the nation’s liberty and prosperity’. It aims to:
- shift the political focus from ‘growth for its own sake to widely shared economic development that sustains vital social institutions’.
- ‘set a course for a country in which families can achieve self-sufficiency, contribute productively to their communities, and prepare the next generation for the same’, and
- ‘help policymakers navigate the limitations that markets and government each face in promoting the general welfare and the nation’s security.’
American Compass outlines its perspective in three foundational essays. Each essay explores one of three perspectives of their approach: tradition, theory and practice.
American Compass Research Director, Wells King, provides a history of government intervention in the American economy, arguing there was a distinct American School of economics whose grand project was an American System – the Hamiltonian project of active, government-led nation-building. The American School treated ‘the nation—rather than the individual—as the principal unit of economic analysis’, and incorporated ‘social and geo-political factors that today might seem beyond the scope of economics’. The American School was a critique of the more laissez-faire school of economics from Britain. King goes on to detail the many different government projects that built the nation. The main emphases of the project were infrastructure, banking and infant industry support.
Julius Krein, editor of American Affairs, wrote the foundational theoretical essay for American Compass. Therein, he pushes back on the concept that seems to most justify laissez faire: the knowledge problem. Posed by Friedrich Hayek, it holds that planners cannot gather information for economic planning ‘as efficiently as decentralized participants’, who respond to information and incentives conveyed by prices in a market system.
Krein argues that less information is needed for government economic planning than free market advocates realise, pointing to successful examples of industry policy in east Asia, and government-led innovations such as radar, the internet and the space program, which did not involve the information and calculations that laissez faire advocates assume are needed and near impossible to gather and perform. On the contrary, government planning ‘becomes more necessary when less market and industry knowledge is available’. Investors may find it too difficult to raise capital given such degrees of uncertainty, necessitating governments lead in ‘critical areas like basic research and the development of infant industries’.
Krein also argues that Hayek’s rationale for decentralised decision making – that markets enable the ‘unconscious coordination of many decentralized individual plans, despite the imperfect knowledge and intentions of each actor’ – to be faulty. The fault lies in the secondary assumption that market participants don’t need to know why prices change, only that they do change, which provides information. Krein argues that this view confuses rationing and investment. Prices, regardless of their cause, may be sufficient for making rationing decisions, but they are not sufficient for investment decisions. Krein contends that no actual business person actually thinks like a Hayekian (in terms of not needing to know why prices change). Allocating capital requires understanding more than simply the price of a good. Not knowing the reasons for a price change can also cause problems when the price signal is caused by subsidies from a foreign government. Prices change due to interventions as well as changes in fundamentals. Following price signals in the case of foreign subsidies will lead to the domestic industry failing while the foreign competitor gains market share. This, economists argue, is fine, as the foreign competitor is harming themselves by wasting money in inefficient sectors. However, this ignores strategic considerations, such as the need for self-sufficiency as insurance against a hostile competitor.
What differentiates governments from the private sector, Krein argues, is not the extent of knowledge available to the decision makers, but that governments ‘are not constrained by internal profits or external market forces’. They can pursue things that are ‘important’ but ‘highly prospective endeavors’. While he concedes that public choice issues arise, this is a separate issue from issues of knowledge. Knowledge is ‘simply not a useful metric for evaluating the soundness or unsoundness of any particular government plan’.
Hayek ignores practical reality. His theories were useful anti-Soviet propaganda, but they are ‘completely useless as a guide for policy’, Krein argues.
Oren Cass wrote the foundational essay from the perspective of practice, or public policy. He wants the blinders of free market doctrine, which holds that government intervention impedes voluntary exchange and leads to inefficiency and slower growth, to be shed in favour of viewing markets as contingent upon their environment, and economic policy as playing an active role in shaping that environment with respect to the national interest.
Economic policy is generally concerned with maximising living standards. However, Cass argues that people value things other than living standards, such as security and family, which should inform goals for economic policy. This is a ‘critical task of the political process, though one that American politics regrettably has abdicated.’ Cass suggests that conservatives would likely consider the following outcomes to be important goals:
- Security: resources and capacity to assert and defend the country’s interests.
- Resilience: establishing spare capacity and stabilisers so that unforeseen events do not cause crises or excessive damage
- Pluralism: an economy that generates broad-based prosperity for people of different abilities and locations, which may not be consistent with free markets, which tend to concentrate activities in certain areas under a specialised division of labour.
- Justice: access to work opportunities, perceptions of a legitimate social order, confidence in expectations of equitable treatment, and strong social fabric,
Cass calls for policy that delivers on these goals, which requires examining the conditions in which markets operate and how those conditions could be made better by public policy. Instead of focusing on tax policy – the obsession of the free market right – policy should focus on four policy channels:
- Institutions: ‘Economic policy can shape the structure and foster the growth institutions critical to the market’s operation, such as systems of public education and organized labour, the military, social welfare, and the family.
- Investments: ‘Economic policy can direct public resources toward socially valuable ends and induce private actors to dedicate their resources to the same.’
- Rules: ‘Government regulations can strengthen the market by altering its conditions and directly mitigating socially harmful effects.’
- Public Finances: Fiscal and monetary policy. These influence the economy, but should not be obsessed over.
The following discussion is structured into background (‘Setting the scene’), ends (‘Policy objectives’), and means (‘Policies’).
Setting the scene
What is the current objective of economic policy?
Governments have what appear to be multiple economic objectives. Price stability. Full employment. Stability of the currency. Prosperity. An equitable distribution of income. Ultimately, the first three objectives are means to achieving the fourth objective – prosperity, which is the ultimate objective. For reasons both moral and self-interested, governments aim to achieve shared prosperity, which is a combination of the fourth and fifth objectives. Australian economists often talk about the tradeoff between equity and efficiency. There’s a constant tussle between these two objectives in economic policy discussion. It seems to me that equity is a secondary economic objective behind economic efficiency in the West. Not coincidentally, this is the perspective economics has taken for many years. Economic efficiency effectively equates to a goal of maximising material living standards, or the size of the economic pie. The pie is then redistributed to achieve equity goals.
It’s interesting to consider why the goal of economic efficiency has been so dominant, and for so long. The widely accepted definition of economics – maximising utility given scarce resources – naturally leads to efficiency as a policy objective, as efficiency relates to maximising the gain from finite resources. Similarly, the aim of maximising utility in economics effectively equates to human satisfaction through material accumulation. This is because the subject matter of economics is that of the market for economic goods and services. When economics came to dominate policy, the progress of society was thus to be achieved through economic efficiency and improvements in material living standards. This is a ‘value-free’ policy objective, one that avoids needing to form a consensus on a common purpose. The dominance of economics in policy may also be attributed to its perceived rigour and use of quantification, its objectivity, its relatively advanced state as a social science, and its clear and utilitarian framework. One of the most prominent proponents of maximising growth is Professor Tyler Cowen. He argues that policy should aim to maximise long-term growth, as economic growth is responsible for many great things in the world. Small changes in growth compound over time, leading to substantial differences in wealth and human progress in the long-term. However, growth should not come at the expense of human rights, and my understanding is that Cowen values environmental quality highly in this regard as well.
AC’s high-level goals have one thing in common – they include values and considerations that are not typically valued or considered in economics or economic policy discussions. For example, social institutions, community and national security are all incredibly important in any society, yet do not have much of a place in economics or economic policy, despite their importance in sustaining people and society. Just as natural capital allows people to live but is not a specific economic resource in a specific production process, social capital and domestic and national security each contribute to a strong economy and individual welfare. However, these are not often considered, or are assumed away, in economics. It seems that AC is trying to embed economics in a broader set of considerations of things we value.
This is an important step, and reflects a maturity in economic policy thinking and the application of economics to real-world issues. Economics is often taught and practiced in a narrow way. It focuses on understanding economic models in terms of theory and less in terms of practice. Economic models feature simplifying assumptions in order to focus on specific aspects of the model. This is fine, but they are then often transplanted into the real world without consideration for the validity of the model’s assumptions. Economic models in theory assume away institutional and contextual realities. The outcomes of the model are dependent on the assumptions, so if the assumptions no longer hold, the model doesn’t work in that context. As Dani Rodrik has so beautifully argued in Economics Rules, we need to choose the right model for the right situation. It seems that, so often, proponents of laissez faire promote economic policies supported by models that are not appropriate for the situation.
Secondly, economic policies are proposed that are based on economic models that aim to increase economic efficiency. This may not always be appropriate, as governments have a broader set of objectives than simply economic efficiency; there are other objectives that people value. Economics may need to limit their role to the provision of advice on the costs and benefits of different policies. Economics is a science of means – of evaluating the tradeoffs involved in different policies, market structures, etc. – and not of ends. The ends or objectives of policy making need to include other important values. But economics has gained primacy in policy making, with economic efficiency often becoming the ‘value-free’, ‘neutral’ policy objective. Grow the pie, and later, redistribute it as needed. However, this appears to be an overreach.
It is also the wrong way to think about policy because non-economic goals, such as family and community, may actually, in the long-run, be consistent with economic efficiency. In seeking to support and sustain these important, non-economic aspects of society, the economy may be supported to become more efficient in the long-run, even if there are short-term costs. This is certainly true for national security. A nation that is torn apart by civil war or invaded by a foreign power cannot maximise the size of the pie in the long-run. Instead, it is like the person in the Talebian tale who gets rich in the short-run and buys the car and the house and struts around before ending up on the street. It is also true if economic policy can achieve outcomes in terms of family, community and social cohesion. Workers would be happier, more productive and less prone to social ills, which are a drain on the taxpayer, constituting an opportunity cost in terms of foregone government spending on productive projects, or lowering taxes. In other words, there is arguably less conflict between long-run economic efficiency and broader societal objectives than is usually thought.
In short, I think AC is right to be raising the status of non-economic considerations and criticising the practice of economics and economic policy.
Four policy outcomes – security, resilience, pluralism, justice
AC proposes four policy outcomes in its foundational essay on practice: security, resilience, pluralism and justice. I focus most of my attention on the first two outcomes.
Security and resilience are often regarded by economists as having an efficiency cost, as they require the government to support less efficient industry or build inefficient levels of redundancy. This is true, in the short-run at least. However, the incorrect thing for an economist or economic policy maker or pundit to then do would be to argue against national security or resilience measures because of the impact on economic efficiency. As I argued above, there may be less of a trade-off involved than thought. Mitigating risk and building redundancy will help in surviving shocks, attacks and conflict. Short-run economic efficiency may need to be sacrificed to support other goals, especially if these other goals allow the country to continue growing the pie in the future because it has been able to survive an external shock or attack. Therefore, economic policy needs to consider security and resilience. Ultimately, the degree of risk and redundancy a society should take on should be the judgment of democratically-elected officials, informed by society’s values and risk tolerance and the advice of well-informed experts.
One of the major shortcomings of economics is its ignorance of strategic issues. Economics typically assumes away these issues, as well as the presence of supportive institutions such as police, government, and national defence. This is fine, to a degree. It is necessary to understand the operation of an economy, and the relationships between different players, at a basic level, before adding complexity. Indeed, simplifying by exclusion can clarify key relationships and outcomes in markets. However, there are several important considerations for economics. Firstly, economics needs to better consider security issues. Geoeconomics – the study of the use of economic power and leverage to pursue geopolitical goals – appears to be mainly housed in strategy and international relations departments, not in economics departments. Secondly, when working in areas of economic policy that relate to strategy and security, economic models need to consider these typically assumed-away issues. Third, it should not be a goal of economic policy to achieve economic efficiency in the short-run, as such policies may be inconsistent with long-run economic efficiency. Policy makers need to be aware of geoeconomic issues, grand strategy and the need to build domestic capability.
In The Jungle Grows Back, Robert Kagan uses the metaphor of a garden that is inclined to the chaos of weeds in the absence of maintenance. He applied this to the global order since 1945, which he argues may seem like an organic or emergent outcome but is instead an order purposefully and actively maintained, and done so largely by America. For the order to continue, constant maintenance is required, just as a garden requires consistent attention and pruning. (This argument is similar to that of American Compass with respect to markets, and indeed, even prominent laissez-faire advocate Ludwig von Mises argues that natural law only emerged because people took up arms against authoritarians, won, and imposed it through the force of government. We should not underestimate the degree to which order is the product of deliberate action by government. We should not take peace and security for granted.) Kagan argues the global garden is at risk of becoming overgrown and chaotic. America’s retreat from its global leadership role has coincided with the rise of authoritarian governments that threaten territorial aggression and thereby the international order. America must re-engage in the role of sustaining the global international order. Just as the natural state of the garden is overgrowth, the natural state of the world is corruption, violence and chaos. Intervention is needed to maintain peace and trade.
Kagan’s argument is something economic policymakers need to consider, especially economists. Taking up the question of strategy shouldn’t mean different economic theory. Instead, it may mean building models that consider strategic consequences and events, and quantifying the trade-offs involved in gaining extra economic and strategic security. While this is no doubt done by governments, governments operate with economic frameworks informed by mainstream academic economics, which mostly ignores this issue. Departments of government with responsibility for trade and economics may not consider geoeconomics or strategic issues. There appears to be conflict within government about the threat from China and its implications for economic policy, though this may be slowly changing. Bottom line, however, is that the practice of economics needs to either consider strategy, or stick to the economic tradeoffs involved in pursuing strategic goals.
Pluralism as a policy goal is one that, on the surface, is desirable, as it recognises the diversity of society and aims to allow people to pursue the things that satisfy them. This is appropriate given the open society is one that allows people to pursue their goals, as long as they play by the rules that are consistent with the maintenance of that society. Hayek would approve of pluralism as a policy goal.
However, American Compass has framed pluralism in a peculiar way. AC implies that pluralism is threatened by the ‘agglomeration’ that occurs in the free market, which ‘tends to concentrate economic activity in narrow geographies’, and scale and specialisation favours the ‘distant conglomerate over the local provider’. The pluralism that is missing in the free market, it seems, and that AC values, is geographic and business diversity, while free markets promote what AC may consider to be the wrong diversity: specialisation.
While there’s no doubt that the market has had geographic and distributional winners and losers, the pluralism valued by AC appears to have significant costs and a difficult path to its achievement. Just how AC proposes this objective would be achieved is an intriguing question. I have some ideas but this is something to look into further in the future.
Justice is a human virtue and fundamental value. Any policy should consider justice, but the type of justice pursued is important to get right. AC sees economic opportunity and support as important in achieving justice, as well as perceptions of legitimacy in the social order and fairness. This relates to how people earn their money and whether people are receiving what’s fair. This is a tough standard to reach in a complex, open society where the instincts of the tribe can override the logic of the market, and with the rise of zero marginal product workers. Justice is an important objective, although the concept of justice can be abused and distorted, leading to undesirable sub-objectives, and corresponding policies.
Conclusion: This section has examined the policy objectives of American Compass, and criticised economics and economic policy as being too focused on narrow economic concerns. The discussion now turns to the issue of policies (means of achieving the policy objectives). While AC’s foundational documents are not rich in policy detail, the theory essay criticises the idea that free markets are an appropriate means of achieving economic prosperity.
Policies and their underlying theory
The theory essay by Julius Krein is a good critique of the main justification for laissez faire economics: Hayek’s knowledge problem. The essay makes several points: that less knowledge is needed in planning than Hayek recognised, and that the price signal is inadequate in informing economic decision making because more information is needed than simply the current market price of a good or service. The causes of price changes are important, argues Krein, for investment decisions. Prices alone, on the other hand, are important in rationing decisions. The causes of price changes are important to understand if price changes are being driven by a foreign government’s industrial policy. If the domestic government does not recognise and respond to this, domestic industry policy is effectively determined by the foreign government. Finally,Krein argues, government planning can be done, has been done, and needs to be done. It needs to be done because government is not bound by profit and loss, and can therefore take on larger, more speculative but potentially more beneficial projects.
Krein’s essay makes interesting points. I’ve been enamoured with Hayek’s knowledge problem since I first encountered it. However, I’ve never seen it as a winning argument, one that would close the debate against planning. It’s a valid point, and one the other side must contend with, but it’s not decisive. Hayek seemed to consider the issue of the transmission and use of knowledge in a large society being, if not the ultimate issue, then certainly being one of the most important. I agree, and I find his analysis profound and important. But I find Krein’s distinction between investment and rationing to be a useful one. I’m not sure of the degree to which Hayek considered strategic issues, but it strikes me as important that price changes due to strategic actions taken by foreign governments are important to understand and may be justification for our government to take action. Channelling the Theory of the Second Best, the presence of price distortions may require further ‘distortions’ in the form of strategic intervention to pursue security and resilience goals that are aligned with long-run economic prosperity. Indeed, AC Oren Cass has made this point, arguing that intervention is justified in such a situation.
He also argued that what countries choose to invest in will determine their comparative advantage, rather than countries discovering their comparative advantage. If a competitor chooses to specialise in a certain line of production that is strategically important, and our government allows ‘market forces’ to allocate resources, our country loses strategically. But by intervening and choosing to specialise in important strategic lines of production, a country can become efficient and achieve strategic goals.
I find this latter point on comparative advantage to be thought-provoking, but perhaps overcooked. He seems to be implying that there will be no efficiency tradeoff by choosing a specialty. While I have argued above that there may be no, or less of an, efficiency tradeoff in the long-run from pursuing security objectives, there will be limitations in the degree to which each country can do this.
Moreover, with respect to Krein’s other points – that governments require less information and knowledge than is assumed and that they are better placed to carry out blue-sky projects – I don’t feel equipped to comment on these points, which seem to be an empirical issue that I’m not familiar with. I’ll keep this in my mind as I continue to engage with AC’s ideas.
Hayek’s knowledge problem is but one of several issues that need to be considered to assess the suitability of a laissez faire approach to economics. Therefore, even if Krein’s arguments were to carry the day, there would be other arguments to win. I don’t think Krein saw his piece as the ultimate checkmate against free marketeers, but it was a useful critique of a major piece of intellectual capital used by his opponents.
There was much to consider from AC’s foundational documents about the practice of economics and the goals of economic policy. While the initial essays and founding goals were fairly general, there was much to either agree with or want to pursue further, and the specific application of AC’s ideas will be interesting to observe going forward. Overall, I’ve found AC’s entry into the policy debate in America to be a useful one and I hope it is taken seriously by others.