There’s no tradeoff between dynamism and safety

By Felix Salmon
December 28, 2009
Raghuram Rajan tells the WSJ's Mark Whitehouse that when it comes to capitalism, there's a natural tradeoff between security, on the one hand, and dynamism, on the other. Justin Fox adds some necessary skepticism:

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Raghuram Rajan tells the WSJ’s Mark Whitehouse that when it comes to capitalism, there’s a natural tradeoff between security, on the one hand, and dynamism, on the other. Justin Fox adds some necessary skepticism:

The greatest run of economic growth this nation has ever experienced took place from the 1940s through the 1960s, a period during which the welfare state grew and grew. And the financial innovation and dynamism of the past few decades has brought only modest rewards for most American families (measured by median household incomes).

I’m not saying there’s no tradeoff at all. Just that it’s complicated, and that there are probably some methods of providing economic security (a well-run universal health care or pension system, say) that could lead to increased economic dynamism because they encourage people to make riskier job choices.

I’d actually go further than that, and say that the dynamism of capitalism is largely a function of safety nets, dispersed risk, and limited downside. The limited-liability joint-stock company run by professional managers is a both a driver of dynamism and an exercise in maximizing the safety of as many principals as possible.

What’s more, a large reason for the excesses of the financial-services industry over the past decade is the insane level of bankers’ pay — the men in charge were so rich that they ran no real quality-of-life risk when taking enormous gambles with other people’s money. Even the biggest losers — the likes of Dick Fuld and Jimmy Cayne — are extremely wealthy men to this day.

If we want to increase the dynamism of the real economy — technology, manufacturing, services, all that kind of non-FIRE stuff — then making the finance industry smaller and less volatile is quite likely to help. After all, making it larger and more volatile did no visible good at all.

5 comments so far

it did a lot of good. it absorbed a large number of people who only cared about making money, removing them from causing problems in the real economy, for a number of years.

Posted by q_is_too_short | Report as abusive

I think this is exactly right. If you want people to take more risks, you can either:
A. Increase the benefits they get from successful outcomes (which I view as the generally Republican view, such as reducing capital gains taxes or inheritance taxes)
B. Decrease the costs they bear from unsuccessful outcomes
C. Increase the probability of a successful outcome

I think all of these are plausible goals, but in my eyes if you want me to walk a tightrope, making the wire more stable and adding a safety net is going to jack up the probability much more than adding some gold to the pot on the other side.

On a related note, I saw “Man On Wire” recently, which was an excellent movie.

Posted by Beer_numbers | Report as abusive

Dead right, Felix. And two comments on this:

1. It’s absolutely clear that the single biggest inhibitor to startup innovation in the US is the lack of health care. No engineering talent with family is going to leave GE, Microsoft, Merck, etc., to join a startup if they can’t get great health care.

2. This also reeks of classism. Frat boys with family resources can always start new businesses. But bright middle class kids, with no family money, student loans, etc., can’t interrupt salary. Like so many things in the US, it’s reverse meritocracy.

Posted by Dollared | Report as abusive

felix, actually, hayek made the same point long ago: that if we want people to listen to market signals, we need to eliminate those things that prevent or distort the market’s signals from getting through.

and as a result, hayek favored a safety net for the exact reason that it freed people to listen to the market:

There is no reason why in a society which has reached the general level of wealth which ours has attained the first kind of security should not be guaranteed to all without endangering general freedom…there can be no doubt that some minimum of food, shelter, and clothing, sufficient to preserve health and the capacity to work, can be assured to everybody…Nor is there any reason why the state should not assist the individuals in providing for those common hazards of life against which, because of their uncertainty, few individuals can make adequate provision. Where, as in the case of sickness and accident, neither the desire to avoid such calamities nor the efforts to overcome their consequences are as a rule weakened by the provision of the assistance – where, in short, we deal with genuinely insurable risks – the case for the state’s helping to organize a comprehensive system of social insurance is very strong….To the same category belongs also the increase of security through the state’s rendering assistance to the victims of such “acts of God” as earthquakes and floods. Whenever communal action can mitigate disasters against which the individual can neither attempt to guard himself or make provision for the consequences, such communal action should undoubtedly be taken….There is, finally, the supremely important problem of combating general fluctuations of economic activity and the recurrent waves of large-scale unemployment which accompany them… istsview/2006/10/tim_duy_in_defe.html

Posted by howard7 | Report as abusive

“And the financial innovation and dynamism of the past few decades has brought only modest rewards for most American families (measured by median household incomes).”

One major problem – median household income DOES NOT MEASURE the rewards for most American families. It is a point statistic that is a characteristic of a distribution, and does not describe actual economic reality for any person or group.

Would anyone willingly teleport back to 1999? 1989? 1979? We are fantastically better off than we were at each of those times, and it is entirely because of economic dynamism and not at all due to your silly “safety nets”.

Posted by nyetter | Report as abusive
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