Franklin D. Roosevelt’s New Deal built dams, levees, roads, parks, airports, power stations, reservoirs, tunnels, auditoriums, schools, and public libraries. These public investments in infrastructure and education gave a huge boost to the American economy during the Great Depression, during World War II, and in the years that followed. With the Securities Act of 1933, often referred to as the “truth in securities” law, and the re-regulation of the banking system, FDR stabilized the country’s finances, and these measures may well have saved capitalism in the United States. Moreover, with the introduction of the Social Security and unemployment insurance programs in a 1935 Fireside Chat, he founded the American social safety net, which is itself an indirect guarantor of capitalism. The competition that is central to a free-market economy produces losers as well as winners. This process of “creative destruction” so central to capitalism is just that—creative and destructive—and we cannot sustain the destruction without the social safety net that affords some protection to the losers. Without it, they might seek to bring down the very system that has made Americans wealthy. As America enters a necessary debate about how generous unemployment insurance, Social Security, and Medicare should be, it is well to remember that this social safety net ensures the legitimacy and stability of the free-market economy.
While FDR did not significantly expand immigration, which had been curtailed in the 1920s, thousands of Europeans, many of them Jews, made their way to America as refugees from Nazi Germany in the middle to late 1930s. Many were elite scientists, physicists, writers, artists, musicians, historians, and intellectuals. This “brain wave,” epitomized by Albert Einstein, played a critical role in shifting the world’s intellectual leadership from Europe to the United States.
The administration of FDR’s successor, Harry Truman, saw the enactment of the Servicemen’s Readjustment Act of 1944, known as the GI Bill of Rights, which provided college tuition and vocational training to returning World War II veterans. (After World War I, most discharged veterans got little more than a $60 stipend and a train ticket home.) According to the Department of Veterans Affairs website,
Thanks to the GI Bill, millions who would have flooded the job market instead opted for education. In the peak year of 1947, veterans accounted for 49 percent of college admissions. By the time the original GI Bill ended on July 25, 1956, 7.8 million of 16 million World War II veterans had participated in an education or training program. Millions also took advantage of the GI Bill’s home loan guaranty. From 1944 to 1952, VA backed nearly 2.4 million home loans for World War II veterans.
Also in the Truman administration came the establishment of the National Science Foundation, in 1950, through which the federal government distributed, over the years, billions of dollars for scientific research. Truman’s successor, Dwight Eisenhower, is often caricatured as a retired general more interested in golf than in legislation. In fact, he made huge contributions to America’s growth-promoting formula. He built on the government’s partnership with science during World War II, which had produced the first atomic bombs. He also capitalized on the national alarm over the Soviet Union’s launch of the first Earth-orbiting satellite, Sputnik 1, in 1957. We forget today how Sputnik both electrified and challenged Americans and why it prompted us to update our formula so energetically.
Within a year of Sputnik’s launch, Congress passed the National Defense Education Act, which supported the study of science, foreign languages, and the history, politics, and economics of foreign countries. To improve defense research and innovation, the government established the Advanced Research Projects Agency, later the Defense Advanced Research Projects Agency, which over the years made concrete contributions to the Saturn V rocket, the one that propelled the Apollo astronauts to the moon; the world’s first surveillance satellites; the research network that was the precursor to today’s Internet; new materials now used in high-speed integrated circuits; and the computer mouse.
Eisenhower, who had been impressed by the German autobahn system, also made a monumental contribution to America’s infrastructure. He won support for the creation of the interstate highway system on the grounds that it was necessary to move around military equipment, troops, and supplies more efficiently in the event of a war with the Soviet Union. Today there is a ringtone you can download on the Internet of a song called “Eisenhower Is the Father of the Interstate Highway System.”
Eisenhower was a forceful defender of immigration, more out of a sense of duty to those fleeing oppression than as a strategy to import more brainpower. Nevertheless, it had both effects. In his January 12, 1961, State of the Union speech, he noted that
over 32,000 victims of communist tyranny in Hungary were brought to our shores, and at this time our country is working to assist refugees from tyranny in Cuba. Since 1953, the waiting period for naturalization applicants has been reduced from 18 months to 45 days. The Administration also has made legislative recommendations to liberalize existing restrictions upon immigration while still safeguarding the national interest. It is imperative that our immigration policy be in the finest American tradition of providing a haven for oppressed peoples and fully in accord with our obligation as a leader of the free world.
A few years later, under President Lyndon Johnson, the immigration pillar of our formula was further expanded when Congress liberalized laws that had severely restricted Asian immigration. The Immigration and Nationality Act of 1965 opened the doors for the massive immigration of brainpower from India. Today there are nearly three million Indian immigrants, many of them scientists, doctors, and academics, greatly enriching America’s talent pool. “In the 1970s something on the order of 80 percent of the engineering graduates of the Indian Institutes of Technology (IITs) came to America to do graduate studies and research, and the vast majority of them became permanent residents and citizens,” said Subra Suresh, the current director of the National Science Foundation, who was one of them. A large number of them became leaders in academia, industry, government labs, and start-ups in the United States. In 2009, only about 16 percent of the graduates of the IITs came to the United States for graduate studies and research. “If this trend is sustained from IITs and other similar institutions in other countries, it could have a huge impact for our research enterprise. More than 40 percent of the 375 faculty members in the School of Engineering at the Massachusetts Institute of Technology (MIT) are foreign-born,” added Suresh, who served previously as MIT’s dean of engineering.
The government has provided three of the five parts of the American formula—education, infrastructure, and research and development—through the use of taxpayers’ money. A fourth, immigration, is governed by laws Congress passes. The fifth part of that formula involves the use not of the government’s money but of its power.
Government regulation of the economy seems to contradict the fundamental principle of free-market economics. Like the social safety net, the proper extent of regulation is the subject of ongoing debate; and just as Social Security and Medicare have grown too expensive in their present form for the country to afford, so regulations have become more complicated than may be good for the health of the American economy.
President Obama admitted as much when he declared in The Wall Street Journal (January 18, 2011) that he was ordering “a governmentwide review of the rules already on the books to remove outdated regulations that stifle job creation and make our economy less competitive.” As with the social safety net, however, while it is sensible to prune the thicket of regulations within which American business operates, it would be utterly foolish to do away with government regulation altogether.
Markets are not just wild gardens that can be left untended. They need to be shaped by regulations that promote risk-taking but prevent recklessness on a scale that can harm everyone. The need for regulations arises from an unavoidable feature of any free-market economy, one that economists call “externalities.” These are the costs of free-market activities that are not captured b
y prices, for which, therefore, nobody pays, and that can injure the society as a whole. To correct this market failure, government has to step in to make sure that something closer to the full costs of the activity do somehow get paid. It can do this either by regulating the activity or by taxing it. A common and familiar externality is the pollution that industrial activity generates and that finds its way into the air that people breathe and the water that they drink. In recognition of the breadth of the problem that pollution presents, an entire federal agency was created to deal with it: the Environmental Protection Agency, established in 1970, during the administration of Richard Nixon.
Intelligent regulations and standards, often drawn up in consultation with business, also promote innovation and investment. When the U.S. government sets high energy-efficiency standards for air conditioners, for example, and every American manufacturer has to innovate in order to meet them, those companies can then compete effectively in every other market in the world. By contrast, when we lower our standards, we invite competition from every low-cost manufacturer around the world.
At the same time, regulations and regulatory bodies provide the vital foundation of trust that fosters innovation and risk-taking. The creation of the Securities and Exchange Commission in 1934 increased the importance of the New York Stock Exchange by making it a less risky place. The Federal Deposit Insurance Corporation, created by the Banking Act of 1933, substantially reduced the chance of bank runs, and the stability of the FDIC helped attract capital from around the world. The North American Free Trade Agreement, which went into effect in 1994, created a regulatory framework that has triggered massive cross-border investments and trade between the United States and both Mexico and Canada. America’s patent laws, which protect the intellectual property of innovators, encourage even foreigners to register their patents in America, where they know their ideas will not be stolen—unlike in China. In 2010, more than 500,000 patents were filed with the United States Patent and Trademark Office, thousands of them by non-Americans.
The country’s first Patent Act was signed into law by President George Washington, and over the next two hundred years successive presidents enlarged protections for all kinds of intellectual property—in the form of copyrights, trademarks, and patents. Today, the United States Patent and Trademark Office proudly boasts that over the last two hundred years it has granted patents for “Thomas Edison’s electric lamp, Alexander Graham Bell’s telegraphy, Orville and Wilbur Wright’s flying machine, John Deere’s steel plow, George Washington Carver’s use of legume oils to produce cosmetics and paint, and Edwin Land’s Polaroid camera.” America’s patent process has created a huge bank of scientific and technical knowledge in the form of roughly eight million issued patents and more than two million trademarks since its founding.
One reason America became a nation of starter-uppers is that failure did not carry the permanent stigma that it carried in old Europe. This was a cultural difference, but also one that was enshrined in our formula through steadily evolving regulations that made it possible to get a fresh start.
One of those regulations was the bankruptcy law. Beginning in the nineteenth century, the United States enacted laws to allow companies and individuals to declare bankruptcy and start over relatively easily. The banks could liquidate your assets or force you to reorganize, but then you could try again. Yes, there would be a black mark on your credit record for a few years, but then it would disappear. While no one wants to encourage bankruptcy, there was not a lot of stigma attached to bankruptcy in America—at least compared to Europe, where a single bankruptcy was a mark of Cain that usually meant the end of your business life. American bankruptcy laws emphasized rehabilitating debtors rather than punishing them. Europeans have long marveled at how easy it is for entrepreneurs in Silicon Valley to try something, fail, declare bankruptcy, try again, fail again, try again, and then strike it rich. The easier it is to go under, the easier it is to start over.
All these regulations, notes the Stanford University historian David Kennedy, “were not about creating more state control and less private ownership. They were about creating the right synergy between the two.” When you undergird markets with the right government rules, regulations, and incentives, “you set the stage for more risk-taking,” said Kennedy. “Predictability actually creates the opportunity and more incentives to innovate.”
The country’s economy would scarcely be what it is today without highly motivated risk takers such as Warren Buffett, Bill Gates, and Steve Jobs. But their achievements would not have been possible without the public side of America’s unique public-private partnership for success.
And that is why we are worried.
The Secret of Our Success Is Too Secret
While it is true that in driver education class one of the first things a student learns is not to pass on the turns, in economic history classes students learn that turns are where you get passed. So in a high-speed turn, a country has to drive with much more determination than on a straightaway. The end of the Cold War has coincided with the fastest turn America has ever faced. It is driven by the merger of two major trends: globalization and the IT revolution. We need to win in this turn. So we need to upgrade and improve our American formula—now more than ever. Unfortunately, our politics have moved in the opposite direction.
Again, former representative Bob Inglis, the South Carolina Republican, can testify to this. He recalled a vivid example from a town hall meeting on health care that he held in Simpsonville, South Carolina, during the 2010 campaign. “I was talking about health-care issues and an elderly man stands up and says, ‘Keep your government hands off my Medicare.’
“I said to him, ‘Well, sir, of course Medicare is a government program.’ ‘Yes,’ he says, ‘but I am paying for it.’ And I say, ‘Yes, you are. You are paying—25 percent of the premium—and the government is picking up 75 percent’ through Medicare Part B. Now he is threatened, and he says, ‘Yes, but I paid for it while I was working.’ And I say, ‘Yes, 1.45 percent you, and 1.45 percent your employers, paid a Medicare tax on your payroll.’ I was trying to be as diplomatic as I could be. He looked to be about seventy-five years old, a man in okay health. So I added: ‘And I have to say, if you had one or two hospital admissions you have used up all that you and your employer have ever paid in.’ He sat down, angry. That man’s self-conception was that he rode out onto the prairie on his own horse and tamed this country and got what he has entirely by his own effort. Deep down, though, he knew that he had not gotten this on his own. He was dependent on other people and that threatened his identity.
“What I needed to say to win him over and win my election,” Inglis said, “was that ‘I am going to prevent that socialist in the White House, who is probably not even an American citizen and who is illegitimately in the White House, from getting his hands on your Medicare.’ Then I would have been a political hero—but I would have left them in ignorance. What is tragic right now is that we have people—leading people—who choose to leave audiences in ignorance or even encourage stupidity.”
That same ignorance can be found in sectors of the business community, where scorn for the government and regulation has become the norm. Who can ever forget Ronald Reagan’s famous campaign line: “The nine most terrifying words in the English language are, ‘I’m from the government and I’m here to help.’” Of course, every businessperson in America wants lower taxes and less regulation. Most Americans do. But every one of us also benefits from, indeed depends upon, the five pillars of the American formula. Failing to recognize that fact endangers one of the major sources of our strength.
Fortunately, at least some of America’s most prominent investors and entrepreneurs do fully appreciate how much our formula enables the American economy to create more wealth from fewer and fewer inputs. “You always have to renew your lead,” Bill Gates remarked to us. “But we have to ask: Where did this lead come from in the first place? It was that we educated more peopl
e than the other guys, and we attracted more talent,” and we built better infrastructure. We need to get back to work in “renewing the sources of our advantage,” he said.
Jeffrey Immelt, the chairman and CEO of General Electric, one of the largest private companies in the world, noted the dangers to America of the mistaken belief that the government has no constructive role at all to play in the economy: “We worship false idols in terms of the power of the free market. The U.S. government has been the catalyst for change for generations. The National Institutes of Health shaped a generation of leading-edge health-care technology. And all of the defense spending has spawned the nuclear power industry and the Internet.
“I’m a free-market guy,” Immelt added. “I believe in the endless possibilities of individual choice and private initiative. But there’s a long history in this country of government spending that prepares the way for new industries that thrive for generations.”
Warren Buffett likes to make this point about his own spectacularly successful career, explaining that the billions of dollars he has made as an investor have been due in large part to the fact that his career unfolded in America, with this country’s vibrant institutions, free markets, rule of law, and formula for prosperity.
“I was born in the right country at the right time,” Buffett said in an interview on ABC (November 28, 2010). “Bill Gates has always told me if I had been born, you know, many thousands of years ago, I’d have been some animal’s lunch because I can’t run very fast, I can’t climb trees, and some animal would be chasing me and I would say, Well, I allocate capital. The animal would say, Those are the kind that taste the best.”
That Used to Be Us: How America Fell Behind in the World It Invented and How We Can Page 6