TCS Daily

Cowboy Capitalism, Animal Spirits

By James K. Glassman - June 21, 2002 12:00 AM

Editor's note: This article is adapted from a speech given by James K. Glassman in Berlin earlier this month. He was asked to comment on the question: "Does Cowboy Capitalism Need More Regulation?"

BERLIN -- It seems I have been handed a loaded question. A cowboy, from one popular perspective, is an irresponsible loner - someone who shoots first and asks questions later, a reckless nomad who despoils the scenery, takes what he wants, and moves on.

In fact, as Germans who love American westerns such as "High Noon" and "Shane" - as well as the remarkable series of 60 Western novels, written by Karl May a century ago and still among Germany's all-time best-sellers -- know very well, there is another view of the cowboy: a simple and direct man of principle - a romantic, laconic, even phlegmatic fellow.

So what kind of cowboy do we mean? Here is a third possibility....

In The General Theory, John Maynard Keynes, the most influential economist of the 20th century, wrote:

"There is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic.

"Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits - a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities."

When Keynes talked about animal spirits, he was really referring to something similar to cowboy spirits.

And when we look at the U.S., on the one hand, and Germany or the entire European Union on the other, animal -- or cowboy -- spirits account for much of the economic difference. The differences are not simply cultural. They have to with structural arrangements, with public policies.

It's true that Keynes's statement about animal spirits has provoked decades of controversy among economists. Was he saying that investors and entrepreneurs are moved by irrationality to do the right thing economically? I think not. Animal spirits and cowboy capitalism have their roots in real-life robust policies.

Today, I want to do four things. First, contrast the performance of the U.S. economy on the one hand and the economy of Germany and Europe on the other. Second, explain why structure is so important to economic progress. Third, discuss the role and the nature of innovation. And, fourth, point to the unknowable future and the importance of this benign form of cowboy capitalism for Germany and Europe.

1. Performance

My intention here is not to gloat or to throw too many numbers at you. But here are a few:

  • In 1870, one-third of the world's Gross Domestic Product was produced in Western Europe and one-tenth in the US. That's a three-to-one ratio in Europe's favor. Today, Europe accounts for one-fifth of world GDP and the U.S. for slightly higher.

  • Since the early 1980s, unemployment in Europe has averaged 10 percent; in the US, 6 percent. Currently, Euro zone unemployment is 8.3 percent; US unemployment is 5.8 percent. The unemployment rate in Germany is 9.7 percent; in Western Germany, 7.6 percent - or about one-third higher than in the US.

  • Over the last quarter-century, Europeans added 10 million net new jobs. Americans added 46 million. In 1950, there were 111 million workers in Europe and 62 million in the U.S. Today, there are roughly equal numbers: about 140 million.

  • GDP, however, is the best measure of an economy, and European GDP for the past two decades has lagged US GDP by about a full percentage point.

  • US GDP per capita is now about 50 percent higher in the US than in Germany and 40 percent higher than in France.

  • Finally, the US has emerged as the world leader in nearly every global business sector - from computers to retailing.

2. Structure

It was Ronald Reagan, a cowboy himself, who defined economists this way:

"Economists are people who see something work in practice and wonder if it would work in theory." The U.S. economy works well in practice, but why? What's the theory?

Both the US and Europe since World War II have been liberal, mixed economies. The question is not whether government should have a role, but where and how much.

If economic growth provides health, a better environment and more human happiness - and the clear evidence is that it does - then the essential issue is how to encourage growth? What should government do in the economic sector?

Very little.

The role for government is to build a stage, a backdrop, a setting on which the players that produce economic growth can perform their act best. As The Economist magazine put it a few years ago:

"If the past century of economic policymaking has taught us anything, it is that achieving strong long-term growth often has less to do with macroeconomic policies than with good microeconomics, including fostering competitive markets that reward innovation and restricting government only to a limited role."

Government interventions hurt in many ways. They can create moral hazard (where insurance provokes the behavior it compensates), encouraging productive members of society to seek welfare and unemployment benefits, for example, rather than work. That is certainly one reason unemployment rates are so unconscionably high in Europe. (Another is inflexible labor laws that discourage hiring.) Interventions can create restrictions that deter commerce - as in the case of store-closing laws and laws that limit retail sales in Germany and other countries. They can discourage entrepreneurship through blessing labor cartels and guilds. They can hurt investment through high taxes.

The recently announced departure of the Swiss drug company Novartis to Cambridge, Mass., is only one example of a European firm fleeing regulation and high taxes. As the Washington Post pointed out recently, the flow of capital out of France in recent years has been three times as great as the flow of capital into France. The 33 largest French companies increased employment at home by 45,000 from 1997 to 2000, but they increased employment abroad by 1.2 million.

By cutting marginal taxes in the early 1980s from a top rate of 70 percent down to 28 percent (today, about 39 percent with 20 percent for capital gains) and by beginning to constrain the growth of the regulatory apparatus in the late 1970s under Jimmy Carter -- first with transportation, then to some extent with communications and energy -- the U.S. has created an environment more conducive to entrepreneurship and innovation. Europe has moved haltingly down this path - taking one step forward and two back.

3. Innovation

It is no exaggeration to say that innovation is key to economic growth. Marx and Engels wrote in The Communist Manifesto in 1847:

"The Bourgeoisie cannot exist without constantly revolutionizing the instruments of production.... Conservation of the old modes of production in unaltered form was, on the contrary, the first condition of existence for all earlier industrial classes.... The bourgeoisie, during its rule of scarce one hundred years has created more massive and more colossal productive forces than have all preceding generations together."

And that was in 1847. Too bad Marx and Engels missed the last century and a half.
The issue for an economy is how to encourage such revolutionizing - through innovation. Again, this is really a micro-economic (that is, ground-level supply and demand) issue, not a macro-economic (that is, government fiscal and monetary policy) issue.

In an important new book, The Free-Market Innovation Machine, William J. Baumol of Princeton University writes:

"Managements are forced by market pressures to support innovative activity systematically and substantially, and success of the efforts of any one business firm forces its rivals to step up their own efforts. The result is a ferocious arms race among the firms in the most rapidly evolving sectors of the economy, with innovation as the prime weapon."

Governments must encourage that ferocious capitalist arms race. Without it, innovation - if it occurs at all - is not disseminated. Baumol, for example, points to medieval China in the Tang and Sun dynasties, between about 600 and 1100 A.D. The Chinese invented paper, movable type, the water wheel, gunpowder and many, many others. But "recurrent intervention by the state to curtail the liberty of the merchant class" meant that China's economy failed to thrive.

Partly as a result, it took the world until the early 19th century to produce anything more than a few tenths of a percentage point of annual economic growth. It was the Enlightenment and liberal economic policies that produced growth at ten times the rate of the 18th century, as Angus Maddison pointed out in The World Economy: A Millennial Perspective. During the 20th century, wealth increased seven to eight-fold, and new research shows that may be an understatement.

4. The Unknowable Future

The irony of a system that encourages animal, or cowboy, spirits is that it appears frighteningly chaotic but, in fact, it is strikingly stable.

Below the surface of the U.S. economy there is tremendous churning - while our unemployment rate is low, Americans are continually leaving jobs and finding new ones. Businesses go bankrupt; new ones are launched. Schumpeter's "creative destruction" is the dominant theme.

Yet look on the surface. In recent years, the U.S. economy has been exceptionally stable - in terms of interest rates, inflation, unemployment, GDP. Since 1982, the U.S. has had only one year in which GDP declined - and that was 0.5 percent in 1991. In the first 36 years after World War II, the U.S. economy suffered eight recessions, or one every four years. In the last 20 years, it has had only two, or one every 10 years.

Despite the recent slowdown, the U.S. has grown 1.5 percent over the past 12 months and is expected by the consensus of economists to grow 3.2 percent annually over the next two years. By contrast, German GDP declined 1.2 percent over the past 12 months and is projected to grow at an annual 1.8 percent over the next two years.

To those of you who believe you can manage the future through regulation: forget it. You are only deceiving yourselves.

Writing in L'Express, Bernard Guetta put it very well, "Europe is frightened of the new century." And Europe's response has been to restrict, to stop, to defend - at a time when success requires the opposite approach: an unleashing of animal spirits.

For example, Europe is on the brink of a severe loss of population, yet it cannot seem to bring itself to adopt sensible immigration policies for fear of changing its culture. In the U.S., it is conservatives that have championed immigration because conservatives understand the importance of the animal spirits that immigrants like the Indians who started great businesses in Silicon Valley and Massachusetts can provide - as well as the improvements to culture that committed non-natives can offer. It is Indians who understand cowboy capitalism.

Paul Romer of Stanford University, the most prominent of the growth economists, points out that the world is made up of people, things and recipes. People use their imagination to order the things into different recipes, trying to find the ones that work best - at least for a time. The new recipes take their places.

The number of possible recipes is staggering. "Take, for example, six standard Duplo blocks, the larger size version of Legos," writes Virginia Postrel, author of The Future and Its Enemies and a great proselytizer of Romerian ideas. "According to the company, these six blocks can be combined 109 milllion ways.... An ordinary deck of 52 cards can be recombined 1 68 different ways - one followed by 68 zeroes - which means that any time you shuffle a deck of cards, that particular order has probably never come up before in the history of cards."

What governments often do - unwittingly or not - is restrict both the activity that seeks to find new recipes and, when they are found, the recipes themselves. Look at the opposition in Europe to genetically modified foods, which can feed the world inexpensively and abundantly. Or the antique opposition to mergers like GE-Honeywell. (European merger policy may, however, be changing at last, thanks to the most market-oriented of the EU's institutions: the European court.)

What are the preconditions for innovation? The rule of law, the preservation of property rights, an inobtrusive government, the free flow of capital, goods, services and people, and a respect for cost-benefit analysis.

Here, incidentally, is where we differ on climate change. The U.S. administration is skeptical of many of the extreme claims, wrung out of computer models, of the effect of potential global warming. But, even if one accepts these dubious claims, the costs of Kyoto overwhelm the benefits of possible climate mitigation. To Europeans, environmental policies are often simply high moral aspirations, rather than the sensible outcome of weighing costs and benefits.

In the end, societies that want to improve the lives of their citizens - their health, wealth and freedom - need to create conditions for, well.... cowboys, of whatever nationality and sex.

One of my favorites is a woman from New Orleans who died earlier this year. I knew her. Her name was Ruth Fertel. A divorced lab technician trying to send her kids through college, she mortgaged her home for $22,000 to buy a steak house. It became a chain of 82 restaurants in the U.S. and abroad with annual sales of $328 million.

Or a married couple at Stanford. The husband and wife worked in different departments and couldn't send each other electronic love notes because their computers couldn't talk to each other. So they invented a cyber-bridge, which became a company - Cisco Systems, now with a market capitalization of $115 billion.

Mentioning Cisco, I have to add that this company did have a market cap of more than half a trillion dollars in 2000. Yes, a feature of free-market capitalization is indeed volatility among firms and sectors. But, overall, American markets have been stable compared with others. Currently, the Dow Jones Industrial Average is down about 15 percent from its all-time high. That is the smallest decline among all developed world markets - by a wide margin.

Or consider a man that David McCullough wrote about in 1977....

"He was the entrepreneur extraordinaire, with all the requisite traits for the role: nerve, persistence, dynamic energy...."

Now here was a true cowboy capitalist: Count Ferdinand de Lesseps, born in Versailles, France, in 1805. The man who built the Suez Canal.

Finally, there is the consequential matter of human freedom. It is perhaps a lucky coincidence that the best system for producing economic growth also happens to be the one that offers people the most choice and variety. So we don't have to choose. If we did, I would go for freedom first and growth second. But we don't.

Adam Smith established more than 200 years ago that individuals making their own decisions provide the best allocation of capital. He wrote in The Wealth of Nations:

"What is the species of domestic industry which his capital can employ, and of which the produce is likely to be of the greatest value, every individual, it is evident, can, in his local situation, judge much better than any statesman or lawgiver can do for him."

In this respect, the U.S. - especially with its embrace of the unknowable future - has more in common today with developing nations like Korea and India than with nations in sclerotic Europe.

Cowboy capitalism, animal spirits. Call it what you want. At its heart, the successful economy and the successful society nourish liberty, even when it uncertain where liberty will lead.



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