Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

03 March 2009

Decentralization

    [As China rises, Europe integrates more fully, and the United States assumes a less dictatorial and didactic role, the topic of decentralization is rapidly increasing in importance. Here are two earlier takes on the same general subject: A Multipolar World and Reply to an Indian Colleague. For comment on China’s March 13, 2009, warning about possible financial divestiture, click here.]

    Around the turn of the twentieth century, “an emerging class of giant corporations. . . . [was] concentrating the control of American industry—and eventually global industry—on the island of Manhattan. Citigroup would prosper as their partner.New York Times, March 11, 2009
Why is Russia economically the weakest major power today? Despite its large size and population, almost everything important in it happens in Moscow or St. Petersburg. Moscow even tells residents of Vladivostok—9300 kilometers and seven time zones away—not to buy used cars from Japan. And Moscow is far more important than St. Petersburg. At most, Russia is a two-city empire.

In contrast, we’re not just Washington D.C. and New York City. We’re also Atlanta, Chicago, Dallas-Fort Worth, Houston, Los Angeles, Miami, and San Francisco, among others. Even our high technology is decentralized, with centers in California’s Silicon Valley, Washington State’s Redmond, Texas’ “Silicon Gulch,” Route 128 near Boston, and Research Triangle Park in North Carolina.

Decentralization explains why China so quickly surpassed its erstwhile Communist ally and present rival. It’s not just Beijing and Shanghai, but Guangdong and Hong Kong, too. And Taipei and Taiwan are already parts of greater China economically, as they no doubt will be politically some day.

India, too, is getting the message. It’s not just New Delhi anymore. It’s New Delhi, Bangalore, Mumbai, and Hyderabad. Each of those cities is booming economically, and new ones are growing in population and economic strength.

Decentralization also helps explain the differences between North and South. Have you ever wondered why Northern Europe and its colonies did so much better over the last four centuries than Southern Europe and its colonies?

Protestant Northern Europe developed a decentralized model of human organization. It all started with Martin Luther. He gave us the intellectual basis for decentralization by freeing individuals to relate to God directly, not just through the Church. In contrast, Catholic Southern Europe followed a centralized, authoritarian model. The Catholic Church’s hierarchy laid down the law for cities and nations; it even curtailed the progress of science.

Much of recent history followed from this enormous dichotomy in organizational philosophy. Northern Europe developed the business corporation—one of the most radically decentralizing institutions in human history. With its aid, Northern Europe colonized the world not just for glory of King or Church, but for the profit of individuals and their business organizations. The result was decentralization in both government and business. North America, Australia, and New Zealand, plus a few others, developed democratic governments with robust private sectors based on corporations.

In contrast, Latin America followed the centralized model. Until recently, its history has been a depressing succession of caudillos and dictators. Each country’s economy follows much the same model: 400 or fewer families, mostly descended from European nobility, run the show. Even the present populist backlash is centralized, as Hugo Chavez and Evo Morales follow the only model they know, namely, controlling everything from the center.

We North Americans avoided this fate through the grace of Henry VIII, whose desire for multiple wives spared us authoritarian Catholic hierarchy. From moral debauchery freedom incongruously sprang.

The last century taught stark lessons in decentralization. Two of the world’s largest and most diverse societies—China and the Russian empire—tried to centralize their economies under the banner of Communism. Both failed miserably, and both decisively rejected centralized command economics. Not only that. The one that rejected central command earlier and more decisively (China) is doing demonstrably better in every way, except in accumulating piles of nuclear weapons.

Even ancient empires taught the same lesson. Two of the most successful in human history—Rome’s and the Mongols’—relied on decentralization and inclusiveness for their success. Both held their geographically diverse empires together with local governors, who tolerated local cultures and ruled flexibly “on the spot.” Both let foreigners work and become citizens in their empires and treated them fairly—the Romans if they served in Rome’s legions and the Mongols if they just paid tribute.

We Americans owe our own success to decentralization. Politically, we are fifty separate sovereign states, each jealous of its sovereignty. Through a perpetual tug of war with the center, called “our federalism,” our states retain considerable freedom of action.

Economically, we rely on corporations more than any other major power. We give them more freedom and make them easier to start. In most states you can start a business corporation in about an hour, for $150 or less in fees. (To see how easy it is, just Google the name of your state and “LLC”—limited liability company. Then look for your state agency that governs corporations, usually the Secretary of State.)

After two millennia, you would think we humans would have learned something about the value of decentralization. But apparently we’re slow learners. So Germany had its Hitler, Russia its Stalin, and China its Mao—all quite recently in historical terms. All destroyed their countries or their countries’ economies through mindless and self-defeating centralization. Even today, Vladimir Putin seems confused. He can’t seem to decide whether to follow Peter the Great and decentralize or to emulate Ivan the Terrible and Stalin and keep all reins in his hands.

China, apparently, has learned its lesson at last. It still calls itself “Communist,” but what a difference from Mao’s day! Cautious, thoughtful technocrats are replacing the arrogant gangsters who nearly destroyed China after unifying it. Toleration for dissent and local control is rising. Private industry is thriving. Experiments in rude democracy are growing. Slowly but surely, China is decentralizing under new, more intelligent leadership. The label “Communist Party” is becoming irrelevant, even incongruous.

Lest we Americans gloat, we should recognize our own failings. We’ve got the most decentralized government known to man, at least on paper. But we let centralized power creep up on us unawares, from the private sector.

We passed the Sherman Act 119 years ago. Its goal was to insure that free business people and corporate actors don’t conspire to centralize our economy through private control. Yet for decades now we’ve forgotten how to enforce this vital law.

Not only have we neglected our antitrust laws. We also repealed our law keeping commercial and investment banking separate. That error ignored the lessons of the Great Depression and allowed our financial system to recentralize.

The wonder is how quickly it happened. With credit unions, mortgage bankers, and regulated banks, we’ve got over 10,000 financial firms in our country. But most of them don’t matter anymore. We allowed a dozen or so financial institutions to dominate our system.

Now think about that number: twelve. Each firm has a CEO, a COO, a CFO, and a Board of Directors, typically composed of nine or fewer members. That’s about twelve people per firm, who collectively control the whole. Throw in Freddie and Fannie, Moody’s and Standard & Poor’s, and the commissioners and chiefs of the regulatory agencies that were asleep at the switch, and you have less than twenty institutions. Count their leaders, and you have less than 250 people.

Isn’t human leverage amazing? Less than 250 people destroyed an economic system that supported all 300 million Americans, as well as many of the world’s 6-plus billion people. That’s central command!

Besides collapse of our financial system, we got much, much more. We got a transportation industry dependent on a single fuel: oil. We got an automobile industry that hasn’t made a significant innovation in half a century. We got fossil-fuel industries powerful enough to grab the reins of local, state and even federal local government and insure their dominance long past their economic point of diminishing returns. We even got a monopoly of personal-computer software, which gave us Vista.

But we still have a chance. We were smart enough to elect President Obama. The only power on Earth strong enough to clean house and decentralize is the U.S. government. Teddy Roosevelt—a Republican!—understood that point a century ago, as did Senator Sherman. President Obama and most of his Cabinet appear to understand it today. It remains to be seen whether Treasury Chief Geithner and Fed Chief Bernanke will get the message in time and use their bailout leverage to decentralize, and whether Attorney General Holder will revive our antitrust law.

China’s Warning

About a month ago, this blog warned of the danger of China divesting its $1 trillion investment in U.S. government securities. That act would cause an implosion of the dollar, higher interest rates here at home, and with them a drop in international confidence in the U.S. economy. The dollar’s decline and a sharp increase in interest rates would hurt our chances for success in transforming our economy and prosecuting the wars in Afghanistan and Iraq.

Today China’s premier, Wen Jiabao, made clear that the danger is real. China has too much experience in diplomacy (five millennia, give or take) to threaten or to speculate on future causes or effects. But Premier Wen made crystal clear that China is worried about its investment. While he knows that China’s economy is inextricably (perhaps fatally!) linked with ours, he gave clear warning that there are circumstances under which China will consider divestiture.

Wen also made something else clear. China’s decision will depend on economics, not politics. Its investment reflects decades of hard-won economic success of a billion-plus of Chinese people. That investment is too valuable to squander for political purposes. So however much China may wish to help the United States as a key trading partner and a stabilizing global force, it will not sacrifice its investment for political purposes. Those who recognize China’s quintessentially practical approach to all problems, domestic and foreign, should expect no less.

At least four things might threaten the value of China’s investment enough to provoke divestiture. The first is a fall in the dollar, with the threat of more to come. Although divesting would be difficult in a declining market, China might have few rational alternatives. The second is increasing interest rates, which would reduce the market value of China’s long-term investments. (The value of a bond at a stated interest rate falls as general interest rates rise because investors prefer bonds with higher returns.) The third is a general loss of confidence in the United States. The fourth is unemployment-related domestic disorder in China, coupled with a Chinese perception that U.S. recovery could not avoid it soon.

In the short term, all four of these things depend upon confidence. So the Obama Administration has little margin for error. Its Job One is maintaining confidence that recovery will come and that the U.S. will lead it.

The recent stock-market surge shows how much confidence matters. Two big, shaky banks reported interim profits, and the markets surged. Did the markets consider that lies or misjudgments by these very same banks were part of the cause of the crisis? Did they think that the values of toxic assets, and even the rules for valuing them (including the mark-to-market rule), are in flux and uncertain? Hell, no. Unaudited, unofficial reports from the very same folks whose rosy optimism caused this mess were enough to trigger a near-ten-percent rally. Nothing could better demonstrate how much trust and confidence lie behind the financial part of this crisis and how big a role they will play in any solution.

Our Republicans have become court jesters—professional ideological fools. They don’t need Rush Limbaugh to perform that function for them; their elected officials do pretty well all by themselves. They fear deficits more than the devil.

But the rest of the world is not so blinkered. Our dollar remains strong and interest rates low because the rest of the world has confidence in our economy and our ability to transform ourselves quickly. It also has confidence in our new, competent executive leadership, which the whole world celebrated on November 5. Unlike our own ideologues, the rest of the world knows that this smart new team can make a difference, if anyone can.

But confidence is not our only problem, nor is finance our only ailing sector. We have severe problems in infrastructure, energy, transportation, health care, and education, to name just a few. We cannot make the investment needed to solve these problems if the dollar falls or interest rates rise dramatically. Yet we must solve them to avoid falling into an irreversible secular decline. This is not an “optional” investment like Lyndon Johnson’s war on poverty. We’ve put if off for so long that it’s mandatory to maintain our international standing and avoid falling behind.

So we have a dilemma. We have to invest trillions in transforming our economy, and we have to keep the dollar strong and interest rates low to do so. So far, the world outside Republican Fairyland is willing to let us do that, at least in the short term.

How long its patience will last is unclear. China has given us notice that it is watching with the relentless realism of a nation recently risen from poverty and deeply worried about its own investments. But so far the world, including China, seems to see us as the best and quickest path to recovery.

The Obama Administration and Congress must work together to maintain that confidence. Without it loom national decline for us and chaos for the world’s economy.

That confidence could be higher and more justified, in my view, if we publicly dismissed a few of the folks who created this debacle, lessened the dependence of global finance on Manhattanites, and deconcentrated our finance and industrial sectors. We’d do better, in other words, if we tried to look more like a nation enthusiastically undertaking necessary fundamental reform and less like one justifying past mistakes and continuing to rely on the same people who let us down.


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