Taxes on business

What is a fair level of taxation for businesses in a state? How much should businesses pay relative to individuals in supporting the services provided by government? How should we even begin to answer this question?

The question is easier for individual taxation, since there are only a few possible alternatives: a flat rate income tax or a graduated income tax; more reliance on income taxes or consumption taxes; a tax system that attempts to shelter the most vulnerable in society or a tax system aimed at stimulating profitability and economic growth, ….  For individuals, the fundamental principle is clear: each individual should pay a share of the costs of government based on income, perhaps moderated by a graduated rate.

But with businesses the issues don’t seem as clear. Businesses in a state have a clear economic interest in the services provided by government, from fire and police protection, to preservation of the environment, to provision of a skilled and well-educated workforce.  Business should pay its fair share in supporting the necessary costs of the state; but what is a fair share? And what is “necessary” when it comes to state services?

The situation is even more complicated when we bear in mind that business activity is itself an important source of good for citizens. More business activity means more employment and income. More jobs and wages mean more demand for services and products of all kinds — and more income for people employed in those goods and service industries. Business disinvestment leads to significant hardship for citizens. A tax system that discourages business activity is harmful to the economic wellbeing of the state and its citizens. So business tax rates ought to be high enough to support a fair share of the costs of government, but not so high as to discourage business investment.

And the latter point in turn requires comparison with other feasible locations for business activity. If Michigan and Ohio assess business income at significantly different rates, we should expect some flow of investment from one to the other.

The state of Michigan is an interesting current example. Michigan’s governor, Rick Snyder, has proposed a major change in the structure of business taxes in the state. He proposes abolishing the Michigan Business Tax, enacted only a few years ago, and replacing it with a 6% corporate income tax that applies only to the largest businesses and corporations in the state. This reform is promoted as one that is needed to simplify the tax obligations of businesses and to improve the business attractiveness of the state for future investment, and it has been welcomed with enthusiasm by the business community.  (According the the Tax Foundation’s State Business Tax Climate Index, Michigan ranked 17th in 2010 and 2011 in the Tax Climate Index overall and ranked 48th on the corporate tax index, based on the existing Michigan Business Tax; link.)

Often tax reforms are put forward under the banner of “revenue neutrality” — the rules are changed and simplified, but the “before” and “after” rules collect the same amount of revenue. This reform in Michigan is distinctly not revenue-neutral. In 2009 businesses in Michigan paid $2.6 billion under the Michigan Business Tax. Sales taxes collected $8.8 billion, and personal income taxes collected $6.0 billion.  (These data are presented in a 2011 report of the Citizen’s Research Council in Michigan; link.)  In 2013 it is projected that the flat corporate income tax, when fully implemented, will collect only $749 million — a decline of over 1.2 billion dollars in tax revenues for the state compared to the $2.0 billion estimated under the Michigan Business Tax if applied in that year.  (These estimates are provided in a February 17, 2011 report issued by the Michigan government; link.) This amounts to a greater than 60% reduction in the taxes paid by businesses in support of the general fund.  And this shortfall is being addressed in the state’s fiscal plan through adjustments in the structure of individual taxes: pensions would be taxed for the first time and Michigan’s Earned Income Tax Credit would be abolished. In other words, a billion dollars of tax reductions for business are being paid for by sacrifices by pensioners and poor people.

So here is a question worthy of discussion: are Michigan businesses being asked to pay their fair share under the revised business tax policies? Is 6% enough? Were businesses significantly over-taxed under the Michigan Business Tax? Should the corporate income tax be applied only to the small subset of businesses in the state that qualify, or should it be applied more broadly? And is a 6% corporate tax rate competitive with other states?

Let’s look at the competitiveness question. It is broadly asserted by leading business organizations in Michigan that businesses pay too much taxes for the state to be competitive, and that 6% is about as high as the rate can go without losing investment to other states. But the facts appear to be otherwise.  The Tax Foundation provides annual data on corporate income rates by state (link). Here is the Tax Foundation data, ranked by the highest bracket.  (A number of states have a graduated rate, so small businesses pay lower rates.)

State corporate income tax rates (ranked by hightest bracket)
source: Tax Foundation
State Rates Brackets(a) Rank
Iowa 12.00% $250K 1
Pa. 9.99% $0 2
D.C. 9.98% 0 3
Minn. 9.80% $0 4
Ill. (c) 9.50% $0 5
Alaska 9.40% $90K 6
N.J. (b) 9.00% $100K 7
R.I. 9.00% 0 8
Maine 8.93% $250K 9
Calif. 8.84% $0 10
Del. (a) 8.70% $0 11
Ind. 8.50% $0 12
N.H. (a) 8.50% $0 13
Vt. 6% 8.50% $25K 14
W.Va. 8.50% $0 15
Md. 8.25% $0 16
Mass. 8.25% $0 17
La. 8.00% $200K 18
Wis. 7.90% 0 19
Nebr. 7.81% $100K 20
Idaho 7.60% $0 21
N.M. 7.60% $1M 22
Ore. 7.60% $250K 23
Conn. 7.50% $0 24
N.Y. 7.10% $0 25
Kans. 7.00% $50K 26
Ariz. 6.97% $0 27
N.C. 6.90% $0 28
Mont. 6.75% $0 29
Ala. 6.50% $0 30
Ark. 6.50% $100K 31
Tenn. 6.50% $0 32
Hawaii 6.40% $100K 33
N.D. 6.40% $50K 34
Mo. 6.25% $0 35
Ga. 6.00% $0 36
Ky. 6.00% $100K 37
Okla. 6.00% $0 38
Va. (a) 6.00% $0 39
Fla. 5.50% $0 40
Miss. 5.00% $10K 41
S.C. 5.00% $0 42
Utah 5.00% $0 43
Colo. 4.63% $0 44
Nev. 0.00% 45
S.D. 0.00% 46
Wash. (a) 0.00% 47
Wyo. 0.00% 48
Mich. (a)
Ohio (a)
Tex. (a)
Note: In addition to regular income taxes, many states impose
other taxes on corporations such as gross receipts taxes and franchise
taxes. Some states also impose an alternative minimum tax.
(a) Michigan, Ohio, Texas, and Washington do not have a corporate
income tax but do have a gross receipts tax with rates not
strictly comparable to corporate income tax rates. 
(c) On January 12, 2011, Illinois increased its corporate income
tax from 7.3% to 9.5%, retroactive to January 1, 2011. Illinois’s rate
includes two separate corporate income taxes, one at a 7% rate
and one at a 2.5% rate.
Source: Tax Foundation; state tax forms and instructions.

The 6% rate proposed for Michigan falls at the bottom end of this ranking; 35 states have higher rates, extending to 12% in Iowa; four states have a 6% rate; and nine states have a lower rate.  It would appear that a 7% or 7.5% rate would still leave Michigan in a competitive position when it comes to the corporate income tax.  This would result in an additional $200 million in revenue — and would permit significant dollars for the Earned Income Tax Credit.  So a larger share from business would permit a better outcome for poor and working people.

But the really difficult question is the “fair share” question: how should the costs of government be allocated across individuals and businesses? What principles of equitable contribution are helpful in addressing these issues?  And how would we try to judge whether Michigan’s corporate tax reform plan results in a fair allocation of the costs of government across individuals and business?

(Here is an interesting post by Donald Barrett and James Steele on “Are Corporations Paying Their Fair Share of Taxes?”.  In a word — no!)

Feasibility conditions on social reform

Several earlier posts have raised the issues of social change and social progress (post, post). People sometimes want society to be different (change), and they want it to be better (progress). But not all outcomes are possible, and some possible outcomes are not sustainable over time. So how should we think about sweeping prescriptions for social change? What constraints does social reality impose upon the reformer? And what kinds of moral and political constraints should be respected as we advocate for change?

Consider an analogy with the natural sciences and engineering.  Physics and the natural sciences set the boundary conditions on what kinds of structures can be built and used.  Engineering design involves acquiring a detailed knowledge of the natural properties of materials and structures, and then designing artifacts that satisfy human needs.  The human-built world is not determined by the laws of physics, since there are countless different technologies that could have satisfied human needs consistent with physics; but it is constrained by the laws of physics.  What is the corresponding relationship between the social sciences and social reform?

Let’s begin by giving a schematic definition of a reform program. A program for reform consists of several things: a representation of the existing social world; a critique of some aspects of that world; a prescription for what the reformer believes would be a better social world; and a developed strategy for moving society from here to there. Reformers think that a specified set of changes will make for a better environment for some aspect of human life, for a group or for the population as a whole.  The representation of the current social world may include several different kinds of elements: representation of typical social behavior, representation of existing institutions and practices, and representations of things like justice, power, inequality, and repression.

For example, suppose one was an anti-racist reformer in the US in 1850 or 1950. The diagnosis of the present may be that current institutions and majority attitudes, behaviors, and practices systematically repress, demean, and stunt members of the racial minority. The reformer’s goal may be the creation of a society in which racial oppression, discrimination, and bias do not exist. And the strategy may be to create powerful coalitions of players in society who will work effectively and quickly to disassemble racist laws and institutions and to educate the public to leave behind their racist attitudes and beliefs.

So what are some of the basic conditions of realism and feasibility that a legitimate program of reform must satisfy? For a proposed reform agenda to be rationally supportable, its goals must be feasible and accessible. The institutions, practices, and behaviors it postulates as an end state need to be consistent with what we know about how a society works. And there needs to be a possible pathway through which society can move from here to there.

In other words, the social reformer needs to demonstrate that —

  • The described social arrangement can be implemented, given ordinary people and ordinary social processes and mechanisms; in other words, the social arrangement doesn’t require a miracle to be achieved.
  • The arrangement will have a significant likelihood of being sustainable and self-reproducing, given ordinary people and ordinary social processes. No miracles are needed to sustain the new society.
  • There is a feasible pathway that can take us from here to there, consistent with ordinary people AND some set of moral constraints (democracy, commitment to legal processes, no illegal use of force). 
  • The described social arrangement will be efficacious: it will have the social effects that it is planned to have.

A little more specifically, the program of reform needs to be consistent with our best understanding of how ordinary human beings behave.  It needs to create incentives that are consistent with ordinary human behavior; and the behaviors that result from these incentives need to reinforce the stability of the institutions that the program postulates. We don’t need to offer a strong theory of universal human nature, in order to maintain that there are elements of motivation and psychology that are common among human beings and that will continue to drive their behavior in the future.

Second, the program needs to envision institutions that work correctly together: they successfully coordinate behavior, motivate citizens, raise public revenues, and maintain order as a coherent system. For example, we could have little confidence in a theory of the future that postulated a wide range of public services and a fiscal model that depended entirely on voluntary contributions by citizens to society’s coffers. And we would likewise be skeptical about a vision of the future that aggregated local functions like trash collection and building inspections to the national level.

Third, we would want to specify that we need to have a theory of democratic feasibility: that there is a strategy of change that can be successfully executed within the constraints of a democratic society. No “dictatorship of the proletariat” on the road to a more just future; no use of violence by a minority party aiming to achieve its goals by force.

The social sciences can assist with each of these challenges.  Consider first the “ordinary behavior” condition.  Empirical studies of human behavior — motivations, modes of reasoning, schemes of action — provide a rich set of tools in terms of which to assess the likely behavior of individuals within a hypothetical social context.  Ethnography, social psychology, applied rational choice theory, and the philosophy of action all have much to contribute on this issue.

Turn next to the “institutional workings” condition.  One of the central tasks of the “new institutionalism” is to provide theories of the mechanisms and processes through which specific institutions interact with human actors to bring about social outcomes.  So institutionalists from sociology, political science, and economics have many of the tools necessary to provide an assessment of the likely workings of a specified set of hypothetical institutions.

The social sciences are also relevant to assessing the democratic feasibility requirement.  Policies are implemented by governments, and governments are subject to a variety of political constraints. Within a democratic electoral system governments are unavoidably concerned about the effects of various policies on the electoral blocks upon which they depend.  We can reason in some detail, as Adam Przeworski does in Capitalism and Social Democracy, about the feasibility of maintaining an electoral majority in favor of a given reform program over the period of time that would be required.

There is an important implication in all of this.  Envisioning a better future for our society is a good thing.  But in order to have a defensible plan for creating that future, we need to make the very best use possible of the social sciences in order to assess the feasibility, stability, and efficacy of the ideas for which we advocate.  Not all visions for the future can be realized; and some visions turn out to have unintended and unanticipated consequences that have proven disastrous.

How good is deliberative democracy?

The basic idea of deliberative democracy is an appealing one. Suppose we are faced with this basic problem of social choice. There is an important issue facing a community. There are a small number of policy options that might be chosen. The community wants to choose among these options “democratically.” There are several ways in which this task might be approached. First, the options might simply be rank-ordered by a referendum. It takes an hour, the votes are counted, and a decision is reached. “The ayes have it.” Or, second, the options might be the subject of an extensive community-based forum, involving substantial debate and discussion of each option. Then, at the end of the period of debate, the community might be asked to select its preferred option — this time, however, in a context in which voters have adjusted their thinking according to the facts and values that were involved in the discussion. Citizens have learned from each other, and many have changed their prior beliefs and preferences.

The approach that starts and ends with voting among alternatives has a major shortcoming: no one gets a chance to make persuasive arguments to other citizens; no one has the opportunity of having his/her own beliefs challenged; no one is exposed to new facts or novel considerations that might make a difference in the choice. In other words, the “vote first” approach simply takes people’s preferences and beliefs as fixed, and looks at the problem of choice as simply one of aggregating these antecedent preferences.
The deliberative approach, by contrast, looks at belief formation as itself a cumulative and reasonable process; one in which the individual needs to have the opportunity to think through the facts and values that surround the choice; and, crucially, one in which exposure to other people’s reasoning is an important part of arriving at a sound conclusion.
Notice how different this process is by comparison with the talk radio paradigm — short blasts of opinion by people whose opinions are already fully cast in concrete; no opportunity for “listening for learning” among the participants; no willingness to keep an open mind in consideration of a factually and morally complex issue.
It seems intuitively persuasive that a belief in democracy ought to lead to a belief in deliberative democracy: informed and reflective preferences expressed by citizens who have taken the time to listen to the views of their fellow citizens. The advantages of deliberative democracy might include several good things:
  • a greater likelihood of a good decision (because citizens do a more adequate job of canvassing the facts and values that ought to guide the decision);
  • a deeper understanding of the idea of rational deliberation about what to do; and
  • a greater likelihood of mutual understanding and consensus among citizens.
The first point is a version of the idea of the wisdom of the crowd; by surfacing the beliefs, values, and perspectives of numerous people we are enabled to arrive at a more adequate understanding of the complexities of the problem at hand. The second point expresses the intuition that rationality doesn’t concern itself merely with finding the best means of accomplishing a given end, but also in deliberating about the ends themselves. The third point is a version of Rousseau’s idea of the general will or Rawls’s idea of reflective equilibrium: the idea that citizens will come to a shared understanding of each other’s reasoning and to something closer to agreement, by engaging in spirited dialogue with each other. So a political community is one that has engaged in deep and respectful dialogue. And a deliberative community will be a stable community with bonds of civility that sustain it through rancorous issues. This appears to be Rawls’s view in Political Liberalism. (Though for a contrary view about the value of deliberative democracy, see Ian Shapiro’s The State of Democratic Theory.)

James Fishkin has written quite a bit on the subject of deliberative democracy, from the level of pure normative theory to the level of practical implementation. See When the People Speak: Deliberative Democracy and Public Consultation and Debating Deliberative Democracy. On the practical end of the spectrum, Fishkin has developed a technique he refers to as “deliberative polling” — “a technique which combines deliberation in small group discussions with scientific random sampling to provide public consultation for public policy and for electoral issues” (link). Here is how the technique is described:

Deliberative Polling® is an attempt to use television and public opinion research in a new and constructive way. A random, representative sample is first polled on the targeted issues. After this baseline poll, members of the sample are invited to gather at a single place for a weekend in order to discuss the issues. Carefully balanced briefing materials are sent to the participants and are also made publicly available. The participants engage in dialogue with competing experts and political leaders based on questions they develop in small group discussions with trained moderators. Parts of the weekend events are broadcast on television, either live or in taped and edited form. After the deliberations, the sample is again asked the original questions. The resulting changes in opinion represent the conclusions the public would reach, if people had opportunity to become more informed and more engaged by the issues. link

The goal of this method is to allow the researcher to infer to a hypothetical result: what values, judgments, or choices would a group of citizens have arrived at if they had undergone an extensive process of deliberation about the issue? For example, the technique has been applied to the question of Vermont’s energy future:
The Deliberative Poll® questioned an initial random sample of Vermonters, recruited them to spend a weekend deliberating the issues of how Vermont should meet its future electricity needs, and then questioned them again at the conclusion of the weekend sessions. The results addressed a large number of policy issues: for example, what reliance should be placed on energy efficiency and on energy from various sources like wind, nuclear, and hydro in meeting Vermont’s future electricity needs; whether the state should continue to buy energy from existing suppliers and whether the state should rely more on a few large central facilities or a larger number of smaller and more geographically distributed ones. (link)
The approach offers several things: first, a concrete tool for approximating a deliberative process; but second, and more important, some concrete empirical evidence permitting assessment of the foundational question — does a process of deliberation change citizens’ attitudes, beliefs, and preferences? And the answer appears to be “yes”: deliberation influences ultimate choices. (It is worth visiting the website for the Center for Deliberative Democracy at Stanford University.)
Here is another interesting example — a current effort to gain more insight into informed public opinion about a highly complex issue: the principles on the basis of which U.S. citizens make judgments about what health conditions ought to be included in healthcare coverage. The Center for Healthcare Decisions in California (link) recently released the results of a study on citizens’ values surrounding healthcare policy. The study is “What Matters Most: Californians’ Priorities for Healthcare Coverage,” and it is an effort to get a more nuanced understanding of the considerations that citizens appeal to in trying to sort out issues of health policy. The study involved interviews with hundreds of respondents, based on a number of vignettes describing healthcare needs. The respondents were asked to recommend rate the priority of the vignette for inclusion within the list of conditions covered by a health plan. For example:

Scenario: A 24-year-old woman has long- standing asthma that prevents her from being active. With an inhaler and medications, she can live a more normal life.
Questions: 1) On a scale of 1 to 10, what priority would you give to cover this if you were designing a health plan for a general population in California? 2) Given that the more that health insurance covers, the more the plan may cost you and others, would you want health insurance to cover this service or not?

Researchers then followed up with focus group discussions of the same vignettes in order to arrive at a better understanding of the underlying reasoning that seemed to be at work. The results are fascinating; there is a nuanced but principled set of values that seem to guide most people’s judgments about the vignettes. The executive summary is here.
Both these approaches are interesting for much the same reason: they provide a basis for delving more deeply into the reasoning and values that citizens use when they arrive at judgments about complex and important issues. And they suggest ways in which some of the guiding intuitions underlying the theory of deliberative democracy might be introduced into practical political processes.
Is it realistic to imagine that deliberative democracy might become more of our customary way of making decisions about complex issues?

Malthus blogging on the Corn Laws

I think that Thomas Malthus would have been very much at home in the blogosphere. He weighed in on the issues of the day, bringing careful logical analysis of economic theory to bear on the policy issues that were up for debate. And he was very interested in making the connection between economic principles and real empirical evidence. This is particularly true in his contributions to the debate on the Corn Laws in 1814 and 1815. Malthus authored pamphlets on these issues in 1814 (“Observations on the effects of the corn laws”; link) and 1815 (“Grounds of an opinion on the policy of restricting the importation of foreign corn”; link), and they repay scrutiny today; they are powerful instances of a very smart economist probing the theory and the facts surrounding a complex policy issue. (Here is a nice survey of Malthus’s theories; link.)

The Corn Laws might be thought of as a form of “stimulus package” for the British economy in the early nineteenth century. By setting a high tariff on the import of wheat and other grains, Parliament aimed to protect the agricultural sector and to encourage the expansion of grain production to make Britain more independent from external grain providers. One might also compare the debate to the NAFTA debate or to policy deliberations in the 1960s concerning “import substitution” strategies. Opponents argued that removal of the tariffs would bring down the price of grain, a central component of the wage basket; this would help the poor and would also permit a significant reduction of the wage as well. So the issue divides the interests of land owners, industrialists, and the poor.

Malthus’s position in the two essays is somewhat different. In the first article he promises to lay out the issue dispassionately, dispelling false opinions about what the effects of the proposed policy might be and diving into the advantages and disadvantages of the policy. He writes that “some important considerations have been neglected on both sides of the question, and the effects of the corn laws, and of a rise or fall in the price of corn, on the agriculture and general wealth of the state, have not yet been fully laid before the public.” A bit further on, he writes:

My main object is to assist in affording the materials for a just and enlightened decision; and whatever that decision may be, to prevent disappointment, in the event of the effects of the measure not being such as were previously contemplated. Nothing would tend so powerfully to bring the general principles of political economy into disrepute, and to prevent their spreading, as their being supported upon any occasion by reasoning, which constant and unequivocal experience should afterwards prove to be fallacious.

So–“let’s do rigorous and systematic analysis based on the principles of political economy and our best understanding of the facts.” Good advice for a policy debate.

Quite a bit of the analysis is devoted to refuting an idea that Malthus attributes to Adam Smith — that “corn” is a unique commodity because increases and decreases in its price have no effect on agricultural production. The idea seems to be that the price of corn determines the wage and thereby determines all other prices in the economy; a small increase in the price of corn immediately causes an equal increase in the price of labor and all other prices. So corn is a “numéraire” to the whole economy; therefore the economy cannot be influenced by tariffs that alter the money price of corn. This is a notion that Malthus quickly and efficiently dispatches. Referring to the poverty studies of Frederick Morton Eden (1797) (whom Marx also relies on in the Grundrisse), Malthus examines the budget of the laboring poor and finds that only 40% of this budget is directly influenced by the price of grain. So the effect of the price of grain on the wage is only partial. (If we assume that the wage is at equilibrium when it equals the cost of the minimum wage basket, then an increase of 10% in the cost of the bread in the basket (40%) will have only 4% effect on the total cost of the wage basket.) Moreover, he points out that labor markets are different from many other commodity markets in the sense that it is not possible to quickly decrease the supply of labor; so the effect of changes in the price of corn will work only slowly into changes in the price of labor. “It is manifest therefore that the whole of the wages of labour can never rise and fall in proportion to the variations in the price of grain.”

Second, on the production side, Malthus goes into quite a bit of detail in the micro-economics of farming: land quality, choice of crops, improvements of land, amount of hired labor and draft animals. And he demonstrates that an increase in the price of the crop will give a clear economic incentive to investors to expand and intensify agricultural production. so quantity responds to rising prices. Higher prices => higher profits => rational incentive to invest more capital in expanded production. In short, the Smithian idea that “corn is unique” is untenable.

The central “general principles” of political economy that Malthus attributes to Smith — and which he endorses himself — are essentially these: that the price of a good varies over time according to fluctuations in supply and demand; that the quantity of a good increases when producers have a price-based incentive to invest more capital in its production (and vice versa); and that capital will flow across productive uses in such a way as to bring about an equal rate of profit across sectors and industries. Malthus argues that the idea that corn is a unique commodity directly contradicts these principles. “Corn is subjected to the same laws as other commodities, and the difference between them is by no means so great as stated by Dr Smith.”

This conclusion has a direct relevance to the topic of the corn laws. Malthus hereby concludes that a tariff or other restriction on imported grain will in fact have the effect of stimulating additional domestic production. So Britain’s grain production would increase under this set of laws. However, here Malthus makes a point about Britain’s agricultural potential and the density of its population:

On the whole then considering the present accumulation of manufacturing population in this country, compared with any other in Europe, the expenses attending enclosures, the price of labour and the weight of taxes, few things seem less probable, than that Great Britain should naturally grow an independent supply of corn.

So food self-sufficiency is impossible for Britain (in 1814!). Moreover, there is a Malthusian demographic consequence of free trade in grain that Malthus directly recognizes:

As one of the evils therefore attending the throwing open our ports, it may be stated, that if the stimulus to population, from the cheapness of grain, should in the course of twenty or twenty five years reduce the earnings of the labourer to the same quantity of corn as at present, at the same price as in the rest of Europe, the condition of the lower classes of people in this country would be deteriorated.

Malthus explicitly avoids coming to a conclusion of the overall advisability of the corn laws in this essay; but it is hard not to feel that the balance of arguments here appear to favor “open ports” — no tariffs or restrictions on the import of grain.

So it is surprising to turn to the second essay, less than a year later (“Grounds of an opinion”), because here he lays out a specific argument in favor of the tariffs. He offers as a central reason for this conclusion the fact that protection will stimulate more agricultural production which will make Britain more nearly grain-sufficient. The argument turns less on economic principles and more on the predicted behavior of grain-producing nations such as France in times of dearth. Recent historical experience demonstrated to Malthus that countries will limit their exports of grain at times when the supply is short and prices are high; but this is precisely when Britain would need to continue to have unfettered access to foreign grain markets. In effect, we might read the first essay as creating the argument in principle for free trade in grain, and the second essay as an argument based on the specific historical facts of international trade that make the free trade policy unwise. Here is how Malthus tries to reconcile theory and empirical experience:

I am very far indeed from meaning to insinuate, that if we cannot have the most perfect freedom of trade, we should have none; or that a great nation must immediately alter its commercial policy, whenever any of the countries with which it deals passes laws inconsistent with the principles of freedom. But I protest most entirely against the doctrine, that we are to pursue our general principles without ever looking to see if they are applicable to the case before us; and that in politics and political economy, we are to go straight forward, as we certainly ought to do in morals, without any reference to the conduct and proceedings of others.

It is interesting to observe that Malthus refers on more than one occasion to the effect that a proposed policy will have on the condition of the poor; he affirms that it would be decisive in favor of free trade in grain if it could be shown that this would improve the standard of living of the poor.

If I were convinced, that to open our ports, would be permanently to improve the conditions of the labouring classes of society, I should consider the question as at once determined in favour of such a measure. But I own it appears to me, after the most deliberate attention to the subject, that it will be attended with effects very different from those of improvement.

However, he believes he can show that this is not the case. (The passage quoted above, for example, follows a line of argument something like this: cheaper food => larger families => more competition for work => lower wages.) Moreover, free trade in grain would have the effect of rapidly reducing British agricultural production, and expelling more thousands of agricultural workers from the farm economy. But industrial labor is unlikely to increase sufficiently to absorb this influx in the medium term:

Our commerce and manufactures, therefore, must increase very considerably before they can restore the demand for labour already lost; for a moderate increase beyond this will scarcely make up the disadvantage of a low money price of wages.

Malthus offers something of a paean to the positive effects of industrialization that is worth quoting from “Observations”:

Yet, though the condition of the individual employed in common manufacturing labour is not by any means desirable, most of the effects of manufactures and commerce on the general state of society are in the highest degree beneficial. They infuse fresh life and activity into all classes of the state, afford opportunities for the inferior orders to rise by personal merit and exertion, and stimulate the higher orders to depend for distinction upon other grounds than mere rank and riches. They excite invention, encourage science and the useful arts, spread intelligence and spirit, inspire a taste for conveniences and comforts among the labouring classes; and , above all, give a new and happier structure to society, by increasing the proportion of the middle classes, that body on which the liberty, public spirit, and good government of every country must mainly depend. If we compare such a state of society with a state merely agricultural, the general superiority of the former is incontestable.

Who says economics is the dismal science?

Contingent historical development

Here’s a relatively limited historical puzzle to solve. A powerful new technology — the railroad — was developed in the first part of the nineteenth century. The nature and characteristics of the technology were essentially homogeneous across the national settings in which it appeared in Europe and North America. However, it was introduced and built out in three countries — the United States, Britain, and France — in markedly different ways. The ways in which the railroads and their technologies were regulated and encouraged were very different in the three countries, and the eventual rail networks had very different properties in the three countries. The question for explanation is this: can we explain the differences in these three national experiences on the basis of some small set of structural or cultural differences that existed among the three countries and that causally explain the resulting differences in build-out, structure, and technical frameworks? Or, possibly, are the three historical experiences different simply because of the occurrence of a large but cumulative number of unimportant and non-systemic events?

These are the questions that historical sociologist Frank Dobbin poses in his book, Forging Industrial Policy: The United States, Britain, and France in the Railway Age. He argues that there were significantly different cultures of political and industrial policy in the three countries that led to substantial differences in the ways in which government and business interacted in the development of the railroads. “Each Western nation-state developed a distinct strategy for governing industry” (1). The laissez-faire culture of the United States permitted a few large railroad magnates and corporations to make the crucial decisions about technology, standards, and routes that would govern the development of the rail system. The regulated market culture of Great Britain favored smaller companies and strove to prevent the emergence of a small number of oligopolistic rail companies. And the technocratic civil-service culture of France gave a great deal of power to the engineers and civil servants who were charged to make decisions about technology choice, routes, and standards.

These differences led to systemic differences in the historical implementation of the railroads, the rail networks that were developed, and the regulatory regimes that surrounded them. The U.S. rail network developed as the result of competition among a small number of rail magnates for the most profitable routes. This turned out to favor a few east-west trunk lines connecting urban centers, including New York, Boston, Chicago, and San Francisco. The British rail network gave more influence to municipalities who demanded service; as a result, the network that developed was a more distributed one across a larger number of cities. And the French rail network was rationally designed to conform to the economic and military needs of the French state, with a system of rail routes that largely centered on Paris. These differences are evident in the maps at the top of the posting.

This example illustrates the insights that can be distilled from comparative historical sociology. Dobbin takes a single technology and documents a range of outcomes in the way in which the technology is built out into a national system. And he attempts to isolate the differences in structures and cultures in the three settings that would account for the differences in outcomes. He offers a causal analysis of the development of the technology in the three settings, demonstrating how the mechanism of policy culture imposes effects on the development of the technology. The inherent possibilities represented by the technology intersect with the economic circumstances and the policy cultures of the three national settings, and the result is a set of differentiated organizations and outcomes in the three countries. The analysis is rich in its documentation of the social mechanisms through which policy culture influenced technology development; the logic of his analysis is more akin to process tracing than to the methods of difference and similarity in Mill’s methods.

The research establishes several important things. First, it refutes any sort of technological determinism, according to which the technical characteristics of the technology determine the way it will be implemented. To the contrary, Dobbin’s work demonstrates the very great degree of contingency that existed in the social implementation of the railroad. Second, it makes a strong case for the idea that an element of culture — the framework of assumptions, precedents, and institutions defining the “policy culture” of a country — can have a very strong effect on the development of large social institutions. Dobbin emphasizes the role that things like traditions, customs, and legacies play in the unfolding of important historical developments. And finally, the work makes it clear that these highly contingent pathways of development nonetheless admit of explanation. We can identify the mechanisms and local circumstances that led, in one instance, to a large number of firms and hubs and in the other, a small number of firms and trunk lines.

Social surprises

The near meltdown of the US financial system this week came as a surprise to most of us — experts, legislators, and citizens alike. That isn’t to say that the components of the disaster were unknown — the subprime crisis, the earlier financial undoings of Fannie Mae and Bear Stearns this summer, and the sudden collapse of Lehman Brothers last week. But what has come as a surprise is the severity of the warnings by the Federal Reserve and Treasury that the entire financial system is only a few steps from seizure and collapse. This is a catastrophic system failure — and no one would have anticipated its possibility six months ago.

Think of a few other surprises in the past thirty years — the collapse of the Soviet Union, the Iranian Revolution, or the emergence of China as a roaring engine of market-based growth. In each case the event was a discontinuous break from the trajectory of the past, and it surprised experts and citizens alike. (The photo above depicts the surprising Yeltsin standing on a tank in 1991.)

So what is a surprise? It is an event that shouldn’t have happened, given our best understanding of how things work. It is an event that deviates widely from our most informed expectations, given our best beliefs about the causal environment in which it takes place. A surprise is a deviation between our expectations about the world’s behavior, and the events that actually take place. Many of our expectations are based on the idea of continuity: tomorrow will be pretty similar to today; a delta change in the background will create at most an epsilon change in the outcome. A surprise is a circumstance that appears to represent a discontinuity in a historical series.

It would be a major surprise if the sun suddenly stopped shining, because we understand the physics of fusion that sustains the sun’s energy production. It would be a major surprise to discover a population of animals in which acquired traits are passed across generations, given our understanding of the mechanisms of evolution. And it would be a major surprise if a presidential election were decided by a unanimous vote for one candidate, given our understanding of how the voting process works. The natural world doesn’t present us with a large number of surprises; but history and social life are full of them.

The occurrence of major surprises in history and social life is an important reminder that our understanding of the complex processes that are underway in the social world is radically incomplete and inexact. We cannot fully anticipate the behavior of the subsystems that we study — financial systems, political regimes, ensembles of collective behavior — and we especially cannot fully anticipate the interactions that arise when processes and systems intersect. Often we cannot even offer reliable approximations of what the effects are likely to be of a given intervention. This has a major implication: we need to be very modest in the predictions we make about the social world, and we need to be cautious about the efforts at social engineering that we engage in. The likelihood of unforeseen and uncalculated consequences is great.

And in fact commentators are now raising exactly these concerns about the 700 billion dollar rescue plan currently being designed by the Bush administration to save the financial system. “Will it work?” is the headline; “What unforeseen consequences will it produce?” is the subtext; and “Who will benefit?” is the natural followup question.

It is difficult to reconcile this caution about the limits of our rational expectations about the future based on social science knowledge, with the need for action and policy change in times of crisis. If we cannot rely on our expectations about what effects an intervention is likely to have, then we can’t have confidence in the actions and policies that we choose. And yet we must act; if war is looming, if famine is breaking out, if the banking system is teetering, a government needs to adopt policies that are well designed to minimize the bad consequences. It is necessary to make decisions about action that are based on incomplete information and insufficient theory. So it is a major challenge for the theory of public policy, to attempt to incorporate the limits of knowledge about consequences into the design of a policy process. One approach that might be taken is the model of designing for “soft landings” — designing strategies that are likely to do the least harm if they function differently than expected. Another is to emulate a strategy that safety engineers employ when designing complex, dangerous systems: to attempt to de-link the subsystems to the extent possible, in order to minimize the likelihood of unforeseeable interactions. (Nancy Leveson describes some of these strategies in Safeware: System Safety and Computers.) And there are probably other heuristics that could be imagined as well.

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