Ed Conard at Mitt Romney’s 2016 Offsite: How Free Market Advocates Can Regain Control of the GOP

I addressed my friend and former colleague Mitt Romney’s 2016 offsite conference on how advocates of free enterprise could regain control of the Republican Party. I argue that if we ignore the true causes of growing income inequality—an abundance of unskilled labor in an economy constrained by properly trained talent and its willingness to take risk—and blame high wage-earners, it will lead to policies that slow (middle- and working-class wage) growth. One implication is that spreading constrained resources over more low-skilled workers expands employment at the expense of slower lesser-skilled productivity and wage growth relative to the rest of the economy. I suspect this is a key driver behind Trump’s support among Reagan Democrats. Given these constraints, I lay out a blueprint for raising middle and working class wages in a world with a near-unlimited supply of lesser-skilled labor. These themes are are featured in my new book, “The Upside of Inequality: How Good Intentions Undermine the Middle Class.” Pre-order a copy here.

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Ed Conard:

So Mitt, I’m always appreciative of the chance to talk to everybody but you do ask me the day before so I run back to my room and write the speech up here and then I deliver it cold the next morning. I get back there in the room the guy says, “well, do you have any notes for the confidence monitor?” I’m like, “What’s a confidence monitor?” Like when you put your notes up here where you can read them. I go, “I’m not sure I can read them when they are right here in my face”. So you’re going to have to suffer through my rough presentation and I’ll try to make up for that with content but you’ll have to be the judge of that, we’ll see.

So, I’m always struck when I talk to people from Silicon Valley, like Meg and others, that they’re so optimistic about the number of investment opportunities that are available to them, and the amount of disruption that’s occurring and the rate at which it’s occurring. And I suspect that optimism is what gives rise to tremendous trepidation on the part of the workforce about what the future holds for them. Because what they see is accelerated disruption, and then losing their jobs, and being displaced, and we hear a lot about that in the media as well.

Um, and it’s surprising because as we realize free enterprise has delivered rising prosperity for 300 years, and it’s as if now at our finest moment, all of a sudden it’s going to come to an end and we are all going to be out of work and the robots are going to take over.

So, I think what you find is that even the economists believe this. There’s many of them who are cautioning us about the slowdown in productivity. If you read Larry Summers, he believes that we may be running out of investment opportunities – hard to believe if you listen to Meg and the other people from Silicon Valley. Tyler Cowen thinks we may have picked all of the low-hanging fruit. There’s a lot of people who believe that the computer isn’t as valuable as electricity and cars were, and yet you hear about all of the opportunities to use computers and you think, wow, it’s hard to believe.

But, people do believe these things and they are very worried about them.

We’re also told that immigration and off-shore workers are going to take our jobs, that technological progress is hollowing out the middle-class, that the robots are taking– about to take over – whatever low-skill jobs are left. And, at the same time, we hear that the 1-percent is using rising crony capitalism to allocate an increasing share of the value that’s created for themselves which really belongs to the middle-and-working class.

Now, the good news is, none of it’s true. But the bad news is, nobody believes it.

And so, I thought I would just talk and give you my perspective about what I think is true and then how we might, as leaders of business and advocates of free enterprise, try to affect the political agenda.

So, what is true is that the knowledge-based economy is really transforming what investment is in the United States today. So it used to be capital-intensive companies would need a whole network of plants and equipment and inventory in order to achieve economy-wide scale. They would suck down a lot of cash on the way to building a profitable business.

But that’s not the case today where an information-intensive business like Google or Facebook can scale to economy-side success without needing any capital at all. And, in fact, often they are cash-flow positive all the way there and the only reason they do an IPO is to value the estate for the one-or-two owners that exist, who really didn’t need to give their ownership to anybody because they really didn’t need any investors.

And that pushes capital from the need for risk-adverse debt, which can be used to fund capital expansion, and often capital expansion with proven technology, to more venture-capital-like equity that really is investing in all-or-nothing propositions, which may grow to economy-wide scale but most of them are going to fail and be worth nothing.

And it also turns economic models on their head because if you look at most economic models, they are driven by two things – labor and capital. But there’s a near infinite supply of labor now and there’s a near infinite supply of capital. You can see that in the near-zero interest rates. And so if you look at economic models, most economists believe there are virtually no constraints to growth today. And that affects the way they think about a lot of different issues that are facing the economy.

But, I believe there are two things that are constraining growth.

The first is properly-trained talent. Now, we have a lot of talent, but most of it isn’t properly trained. And when you listen to the kind of technological things that people like Meg are talking about, you realize you need a lot of training to be able to add value in a world like that.

And the second is what I would describe as the economy’s capacity and willingness to take risk, which is largely a function of its equity, not its debt, because debt says, “I’ll only fund a project if somebody else bears the risk”, namely the equity.

And, so these two things today constrain growth and it’s especially true when an economy is transforming from one structural type of economy to another. So, in this case we are moving from a manufacturing, capital-intensive economy to an information-intensive economy. And when that transition occurs it obsoletes all the old assets, all the old expertise, all the old workers, who can’t really adapt to what we need in order to be successful in this new and changing world. It puts much more pressure on the properly trained talent that we have and more pressure on our capacity and willingness to take risk because we feel our way in the dark trying to find how to succeed in the new world.

Now, properly-trained talent and the economy’s capacity to take risk are really two sides of the same coin.

Investment no longer waits for demand to fill its factories and then we build more factories in order to satisfy the increasing demand.

Today, it waits for new ideas that create their own demand. So, the iPhone is created pretty much in the middle of the recession and is able to get enormous demand despite the fact that the economy’s not growing at all. And so, what’s creating those ideas? Properly-trained talent. The better the talent, the better the ideas. The better the ideas, the less risk there is for investors.

And the second thing is, as Meg pointed out, the implementation of those ideas. That you’re constantly looking for your best engineers. There’s a handful of people. You say, “I can’t afford 250 people to work on this project even though it’s important to the company because I’ve got so many, many other projects that I need my properly trained talent to work on. There’s a scarcity of that important resource. Again, they reduce the implementation of the risk of implementation which is critical in this new environment.

Now the good news is, that the US has an extraordinary advantage in this realm of the economy. So successful companies like Google and Facebook and many others, give our workers valuable on-the-job-training that they can’t get anywhere else in the world. So, imagine trying to solve these problems sitting in a café in Greece, you’ve got no shot at solving any of these problems if you haven’t worked in Silicon Valley for these companies and gotten 10 years of training, which you need to solve these technical problems. That expertise coalesces into communities of experts and networks of people who know how to work together, and there’s a synergistic value to those networks because no one person could do it all, they need to have a network of 20, 30, 40 different people with different expertise in order to do it.

And there’s tremendous spillover effect from that because those people go out into the rest of the workforce and they teach everybody what they’ve learned and they manage the teams that don’t have a complete set of all the expertise and that knowledge gets diffused out into the rest of the economy where its much slower to get diffused in the European economy and into the Japanese economy, even though they have similar trained workers and access to the same technology. They can’t really succeed like we have succeeded.

Um, and as well, the success puts equity into the hands of successful risk-takers who have the expertise to be able to continue to make the investments. Which is very difficult for the rest of us investors, who are outside of this loop, to understand it well enough to feel confident in our judgement to actually make investments in this space. And so these things have a compounding effect which increases the payoff for risk-taking and increases the probability of success.

So, guess what you find? A lot of highly skilled entrepreneurs in the United States who are motivated and incented to take the risk. And we don’t find those in other places in the world. And if you look at Europe and Japan, they’ve been surprisingly unsuccessful at being able to take advantage of this new opportunity and their growth would have been even slower if they hadn’t benefitted from all of the technology that has been created in the United States.

And so it’s no surprise that America’s properly-trained talent makes more money than properly-trained talent in the rest of the world. And that we are much more successful at achieving lottery-like successes that increase income inequality than the rest of the world, who’s been surprisingly unsuccessful at being able to do it.

So, ironically, this success hammers the status quo. So, we’re talking about how the 1-percent has used cronyism in order to allocate a greater share of the economy. I just read you a few facts:

The average tenure of a Fortune 500 firm has fallen from 65-years they stayed on the list in 1920. Today – 10 years the average Fortune 500 company stays on the list.

If you look in tech, its way more tumultuous. So the 15 largest tech companies in 2000 were worth about – today they are worth about less than 60% of the value that they were worth in 2000. And if it wasn’t for Microsoft, they’d be worth even less.

If you look at CEO tenure, it’s way shorter today than it was in the past.

If you look at the wealth of the top .01%, seventy-percent of it is owned by self-employed workers, largely successful entrepreneurs.

If you look at the Fortune 400 richest Americans, only 10% of the people who were on the list in 1982 are still on the list today.

So, it’s surprising that you hear these arguments of crony capitalism, in the face of the kind of tumultuous change we are seeing and the effect it’s had on the status quo.

But here’s the rub:

If Whirlpool moves its plant to Mexico, economists today say, “don’t worry, opportunistic entrepreneurs will swoop in and put everybody back to work and competition will force everybody to invest more capital per worker, and drive productivity back up to where it was. And the increase in productivity is critical to maintaining the high wages.”

But, the successful entrepreneurs never show up because they have all moved to San Francisco and they’ve outsourced all of the manufacturing to Foxcom, and so these guys are left saying, “Wait a minute! Wait a minute! The model doesn’t seem to work for me.” And it doesn’t work for them.

And so they’re left in Indiana to earn waiters-waiting-on-waiters’ wages – try saying that four times really fast – um, they’re there working for themselves, they’re not really working for the people who are generating all the value in this new economy. They’re left working for each other and there’s lower wages.

If you look at the work of David Autor, for example, he shows that after 10, 15 years, these economies, these local economies, never really recover fully from losing the manufacturing. Because there’s no entrepreneurs left to recreate what was lost.

Meanwhile, the Whirlpool engineers are working on products and new innovations and there’s a shortage of Whirlpool engineers because they all want to, the new kids, all want to be programmers, they don’t want to be manufacturing engineers anymore, rightly so. They’re all creating products that employ Mexican workers in Mexico, not workers in Indiana.

This is the very thing – I believe – that gives rise to Trumpism.

Underneath it all, what he’s saying is, we can’t let the constrained resources create jobs for offshore workers and newly arriving immigrants, we have to make sure that those constrained resources are creating jobs for us. And I think it’s a very powerful message – a lot of workers are willing to forgive him of the other faux pas and mistakes that he’s made, and the racism that he displays, because they believe the underlying economic message that these constrained resources need to be carefully controlled.

Now, we say, “hey, don’t constrain free enterprise. Don’t hinder our ability to lower costs, whether it’s through innovation or lower cost labor, and no surprise, they’ve lost their belief in the free enterprise system because they don’t see it working for them. So, if we, advocates of the free enterprise, want to regain control of the Republican party, and I believe we’ve lost control of the Republican party, we need to find middle ground with these workers.

Now, it’s no good to find middle ground if we slow innovation because in the long-run it’s the only thing that matters is the rate at which we increase productivity and we don’t want to throw the baby out with the bath water in order to gain control.

And so we can’t let the arguments that the robots are going to take over all the jobs prevail, when, let me go back to farming and walk you through the economics of that briefly because I think that it’s important to understand what’s happening today.

When the tractors overtook farming, all the farmers didn’t starve to death, if they had, the tractors would have had no value, because the value of a tractor is equal to the value of the work that the displaced workers can find. And if the only work that they can find is subsistence farming, then they’ll all be subsistence farming and there won’t be any tractors, because subsistence farming, their labor will be cheaper than the tractors. So, the only way that the tractors can succeed is if they lower the cost of goods more than they lower wages. It’s the only way that they can succeed and we’ve seen 300 years of this, which the costs go down, the wages basically go up relative to the costs, you know, hundreds of years in the making.

The same is true of trade. It’s only cheaper, again, if the displaced workers can find work that is got more value than the costs of goods. And so wave after wave of robots, we see nothing but an increase in the standard of living for all workers. Tractors displaced farmers, manufacturing displaced manual labor, automation displaced manufacturing, computers greatly increased the productivity of our most skilled workers, and immigrants and off-shore workers really represent waves of the most sophisticated robots we are ever going to build. We are never going to get a robot as good as these workers are, maybe we will 100 years from now, or uh, I shouldn’t say that because it will probably happen in 10 but…

And so, no serious economist believes that wages have stagnated but they do believe that the growth of lower-and-middle class wages has slowed relative to the growth of the economy, to the rest of the economy.

So the question is, how do we build a coalition with displaced workers like we did with the religious right after Roe vs. Wade and which we used to lower the marginal tax rate from 70% to 28% – its gradually grown back to 43% as the demographics of that coalition have eroded – and that leaves us in control, us being advocates of free enterprise, in control of the coalition. Because it doesn’t do us any good to be in the coalition if they are going to destroy free enterprise in the process and turn the Republican party into what I think the Democratic party already is.

And the answer, I believe, is tough, and perhaps even odious compromises.

So, let me make a few suggestions about what I think we ought to do. Let me find them here.

Okay, rather than tariffs on trade, which will slow growth, I think that we should be demanding balanced trade. If you sell us a dollar of labor, find a dollar of labor to buy from us. We’ve got lots of stuff to sell, we don’t care what you buy, find something and buy it, but your trade has to be balanced with us. Trade is critical, trade deficits are not critical. In fact, trade deficits do us harm.

The second is, unfortunately, I think we have to dial down low-skilled immigration. We have to recognize that the unemployed workers – that there is more unemployment among the lesser-skilled workers than among the most skilled workers. They are the last workers hired and they are the first workers fired, and that’s an indication that low wage workers are not low cost workers. It takes a lot of supervision, there’s a lot of turnover, you put your customer relationships at risk when you hire low-wage workers/low-skilled workers. And so, no employer is going to go through the effort to employ hard-to-employ workers unless there’s a shortage of labor, and there’s not going to be a shortage of labor in a world where there is a near infinite supply of labor unless we create it. And, if we do create it, it’s going to put pressure on employers to hire those workers and find jobs for them because they’ll be the only workers left to hire.

We have to recognize that growth manifests itself in two ways: it can manifest itself in an increase in employment, or it can manifest itself in an increase in wages. We’ve had a 50% increase in employment since 1980. Two-times Germany and France, three-times Japan. Who have been the chief beneficiaries of that increase in employment? It’s been immigrants. Today we have 40 million foreign born adults, 20 million native born adult children of the foreign born adults, and 20 million children. That’s 80 million people, 55 million of which are Hispanic. So, in a world of constrained resources, trade and immigration are going to slow middle-and-working class wage growth relative to the rest of the economy. By refusing to admit it, we leave open the door for charges that crony capitalism is what is driving down middle-and-working class wages, instead of what probably really is the chief driving issue.

I see two additional solutions that we could employ. If properly trained talent limits growth, then we should get more properly trained talent. One way to do that is to try to get people to study the right things in college, try to find the people in lower-socioeconomic groups who aren’t graduating from college at the same rate as those from high socioeconomic groups.

But another thing to do is, just use immigration and recruit it. If you look at our workforce, there’s about 100 million full time workers. If you say, really, the top 5 percent is what’s creating all the innovation, driving all the growth underneath it all, then we need about 5 million more workers to double the growth rate – 5 percent of 100 million. There’s about 7 billion people in the world, 5 percent of that is 350 million, half of whom are probably too young and too old, that’s 175 million, half of them are unidentified because, you know, they are in an economy where they aren’t taking any tests, no one really knows, and half of them are probably too established to actually move here. But that still leaves a pool of 50 million people to draw from. We should be going out and aggressively drawing.

How might we do that? I think it’s very easy. We should offer a truce on low skilled immigrants who are already living here. I’d call it a suicide mission but I don’t see what the objective of it anyway so it’s hard to call it a mission. It’s just suicide.

We should try to engineer a large increase in the most capable workers, for what the Democrats want which is a truce on low-skilled immigration. At least on the low-skilled immigrants who are already here. And, I’m not saying we should dial it down to zero, I’m just saying we should dial it back and be a little more sensitive to the low-skilled workers who are already here.

Now, if we could get another 5 million high-skilled workers, and I’m not suggesting we go to the 80^th percentile or the 70^th percentile, because then we are competing directly with the workers who are coming out of college here, but if you go to the 95^th percentile, or the 99^th percentile, if a company cannot find a worker of that capability here, they’re just going to hire them overseas, somewhere else. And the teachers and the doctors and the masseuses and the car drivers who work for those people are going to be over in another economy rather than here and they’ll be on their little screen skyping to interact with the team that’s here because you can’t just train people to be in the top 5 percent or the top 1 percent.

Um, the second is, well and I think two things if we double the growth rate this way we solve two big problems that we have. The first is, entitlements, which are going to eat us alive. And if we go down the path of having to restructure entitlements, it’s going to do major damage to our economy and it’s going to take a long time to restructure. Mitt, we’ve seen what restructuring does, it’s hard to recover from restructuring. You recover, but not without a lot of damage. And the second is, the existential threat of Chinese growth. If we double our growth rate, we have a much better shot at mitigating that threat in the future then if we just go along at the course that we have.

The second thing is if risk-taking restrains growth, then we ought to raise the payoff of risk-taking by lowering the tax rate on successful risk-taking. But how might we do that? Because we know that there is a lot of opposition to tax cuts and if you just cut taxes you’re going to blow a large hole in the budget.

I would suggest that we swap the capital gains rate back to ordinary income, for a reduction in the corporate tax rate, particularly the corporate tax rate for large companies that scale to world-size because that’s where the tax rate really matters. We have a very high tax rate, although our high-tech companies have succeeded in probably keeping it to a range of about 15%, we need to lower our corporate tax rate to 15% in order to be competitive with the rest of the world. And I think that the combination of these two – and if we do that by the way it will be very difficult for anybody to come locate their business somewhere else.

So, I think there are two synergistic effects from this: the first is, if we have the deepest pool of properly trained talent and we have a lower corporate tax rate than anybody else in the world, who’s going to locate their business elsewhere? There’s lots of businesses that can scale to world scale – we need those businesses here in order to create the jobs that drive up the demand for employment. So, I just don’t see any other way that we can that we can truly increase the growth rate of the economy. I hear lots of other ideas that all sound like wishful thinking to me and none of them seem like they’re willing to make the tough compromises that you’d actually need to get through the political process and get something done.

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