Macro Roundup

James Pethokoukis, "Venture capital, Silicon Valley, and the future of startups: My long-read Q&A with Sebastian Mallaby,"American Enterprise Institute, March 9, 2022, https://www.aei.org/economics/venture-capital-silicon-valley-and-the-future-of-startups-my-long-read-qa-with-sebastian-mallaby/

Venture capital, Silicon Valley, and the future of startups: My long-read Q&A with Sebastian Mallaby

What follows is a lightly edited transcript of our conversation. You can download the episode here, and don’t forget to subscribe to my podcast on iTunes or Stitcher. Tell your friends, leave a review.

Pethokoukis: Now, I generally avoid two questions during these podcasts. I don’t like asking the guests about the title of the book or why they wrote the book. But I’m going to make an exception here because I actually really want to know the answer to those questions. We’re going to start with the name of the book, because I think it’s important for how we think about the subject of the book. “The Power Law”: Where does that come from?

Mallaby: The best way to explain the power law is to start with what it is not. It’s not a normal distribution. That’s one where you have a bell curve distribution. Most of the observations in a data set are near the average. The power law distribution refers to a skewed distribution, and so just to illustrate this, let’s just take the height of American men. The average man is five feet, 10 inches tall. Nearly all American men are within three inches of that average. And so if you think about a movie theater and there’s an NBA player right at the back, and he gets bored of the movie and walks out. Although he was seven feet tall, the average height of the residual men doesn’t really change. He’s not so way off the average that it really changes things. Now flip the example and think about the average wealth of American men.

Imagine that movie theater again. This time you’ve got Jeff Bezos at the back, he walks out. The average wealth of the residual men will crash. That’s because the distribution is way more skewed when it comes to wealth, and a power law distribution like that is what you get with venture capital investing. Most startups go to zero because most startups fail. But a handful, maybe one or two out of 10, will deliver exponential growth and returns of 10x or 20x your money. So all of the profits in venture investing come from that tail of sort of exceptional companies.

Most of the books that I see these days about capitalism broadly seem to be about an explanation of why it’s failing — why the key institutions have failed, why we’re in a stage of so-called late capitalism — and maybe there’s some speculation on what the post-capitalist world is going to look like. That is not the book you chose to write. Why did you write this book about something which is a pretty important institution of modern capitalism, but one we maybe don’t know that much about?

Well, a couple of things, actually. First of all, there’s just an intellectual mystery I was fascinated by, which is all investing involves tricky bets on an uncertain future, but in venture capital investing, you are dealing with these startups and there are no data. There are no profits. You can’t work out the price-earnings ratio. There aren’t any earnings. You can’t do the price to book value, because there’s no book value. None of the normal stuff applies. So how do you even start to allocate capital? And I try to unravel that mystery by telling lots of case study stories about how the good venture capitalists do it. But the second thing kind of gets to your question, Jim, which is that I wanted to explain the impact of venture capital on society and on economies. I believe it’s fundamentally positive.

I think this notion that we’re in late capitalism or capitalism is failing misses the fact that actually corporate forms and financial arrangements always evolve. I think there’s sort of an optical illusion created by the fact that Adam Smith came up with the idea of the invisible hand in the late 18th century and market price signals have not changed. So we think of capitalism as almost a static thing, but that’s wrong. The business side of capitalism, the shape of corporations, has changed a lot over the years. Most of those changes are driven by a combination of technological shifts and then on top of that financial shifts. So when you suddenly had an argument for having scale in corporations, because steam and electricity rail had been invented, then you have the invention of the joint-stock limited liability company in the late 19th century.

And that’s why you get big companies. Then equally with the arrival of the personal computer in the 1970s and early 1980s, there’s suddenly a case for de-layering the company, un-bundling, re-engineering. And those things are made possible by a combination of junk bonds and the leverage buyout. I think now we’re in a phase where capitalism is not late stage, but just the new phase of it is that we have lots of intangible capital and to value intangible capital, things like software and brands and patents and business processes and customer relationships. All of those things are valued only by investors if the investors are pretty close to the company, because you can’t see those things by reading the financial disclosure. So you need to be a hands-on investor and that’s where venture capital and private equity come into play. I think that’s just the new optimal type of finance for a new phase of corporate structure because of this rise of intangible goods.

When people think about venture capital, they think about them funding these disruptive companies that will disrupt a particular field in the technology sector, but you’re saying they also disrupt the basic capitalist structure of a country. They’re disrupting what the corporate form looks like and it is not a static thing and that is ongoing today.

Yeah, and then I’d also say something in addition to that, which is that Ronald Coase got the Nobel prize partly for this distinction between price signals on the one hand, that coordinate human economic activity through the arm’s length transactions that generate price signals and tell people what the market wants more of, what the market wants less of. That’s one kind of organization. Then the other kind that Coase pointed to in his Nobel work was the corporation, a way of internalizing that organizational structure. You have top-down management and so forth. I think that venture capital is really interesting because it’s like a middle ground between the two.

On the one hand, a venture capitalist is like a strategic sort of planning department inside a big corporation because the venture capitalist is deciding which experiments get funded, which kinds of research get assets and get talented people, and is shifting money and people and ideas around. That’s a bit like a sort of corporate organization function, but then also there’s a price signal because venture capitalists tend to fund things for six or nine months. And then if the startup doesn’t reach its next milestone, there’ll be a price discovery thing where nobody wants to pay the price for the next tranche of the startup and then it’ll just be closed down. So I think it combines price signals and corporate strategy. And that’s another sense in which venture capital is super interesting as a new kind of capitalist form.

If someone asked me to name the ultimate American capitalist, I think I’d say Warren Buffet. And when I think about Warren Buffet, I think about somebody pouring through lots of annual reports. And then the other day I was following a venture capitalist on Twitter who said, “I’ve never looked at a balance sheet. I’m not sure I could read an income statement.” If that’s not where the skill lies in a venture capitalist, like the Warren Buffet set of skills, then how do they do what they do? Would Warren Buffet make a good venture capitalist?

Well, Jim, that’s a fantastic question. Because, first of all, it illustrates exactly this distinction I’m kind of getting at, where Warren Buffet can sit in Omaha, Nebraska with his financial statements and be very far away from where these companies are that he’s investing in because he can find out what he wants to know by looking at those financial disclosures and by analyzing them. And that’s great if you are a traditional value investor, but if you are doing the opposite kind of investing, in other words, growth and extremely high-charge growth in the form of these early-stage tech startups, it’s the opposite.

You’ve got to be hands on. And this is to get to your question. The way you value the software of a new software startup is that you are on the board of that startup. You yourself as the investor understands computer science. You can evaluate the code. On the disclosure, it might say “We have this project software, we’ve spent 10 million on it,” but it could be worth zero if the code is rubbish, or it could be worth a billion if it’s fantastic. Only the hands-on, venture capital-style investor who understands code and has actually got his hands into the company can tell the difference.

In the book you described the creed, if that’s the right word, of Silicon Valley as, “The belief that most social problems can be ameliorated by technological solutions. If only investors can be goaded to be sufficiently ambitious.” Has that creed held back any success in Silicon Valley? Is that still a valid creed that is useful?

There is a critique of this creed, which is that venture capitalists come along and they are too ambitious and they drive entrepreneurs to take too much risk. Then because the entrepreneur is being pushed to expand their company too fast, it blows up. They make mistakes that they would not have made if they had gone slower. Furthermore, this is not just bad for the entrepreneur, so the critique goes, it’s actually also bad for the economy at large, because what you are getting... Let’s say a disrupter like Uber comes along, is getting tons of venture capital dollars to go and disrupt the existing taxi market. So the incumbent taxi guys have to compete against ride-hailing companies that have subsidized capital. Basically, every time you got an Uber in the first 10 years of that company, you were paying for two-thirds of the fare. And the other one third of the cost was being met by some venture capitalist who was just eating the loss. And that’s not a level playing field, so goes the argument.

I actually pushed back against those critiques because it seems to me that incumbent companies have tons of other advantages. They often have the regulators in their pocket. They have existing brand. They have existing customer relationships. The incumbents always have the upper hand. And in some sense, if the challengers are getting subsidized venture capital dollars, that levels the playing field, it doesn’t distort it. So, I’m not persuaded that it’s a bad thing to push for scale. Of course, some entrepreneurs don’t want to do that kind of bit-scaling growth. That’s perfectly within their rights. They can refuse venture capital dollars. And I quote one venture capitalist in my book saying, “I sell rocket fuel. Some people don’t want to build a rocket, that’s up to them. They shouldn’t take VC dollars and that’s fine. But for the really ambitious companies, it’s the best way to go.”

You mentioned the rocket fuel, which has been very important to the success of the American tech sector in Silicon Valley. It’s not just the funding that’s important to the success. They do a lot of other things other than just supply capital, right?

Yeah. They get involved in the company. They advise it on how to scale up. Typically, a startup founder might have a fantastic product idea, but often even if it’s a good idea, it’s going to have to be adjusted and adapted before it really fits the market. But on top of that, once you get the product market fit you’ve got to then scale up your sales operation, and many founders haven’t done that before. Whereas venture capitalists have seen countless other examples of startups that have gone through the growth process and they know how to help that to happen. So, they act as mentors and coaches. They often get involved in making the first four or five hires.

They would source people from their own network of useful engineers or sales executives who could be brought into the startup. They would help to interview those people. And importantly, the brand of the venture capitalist is reassuring to those early-stage hires because it’s risky to join a startup. Startups fail all the time. I’m always struck by the story that Eric Schmidt told me about why he agreed to be the chief executive of Google. It was a risky move for him. He’d been the chief executive of Intuit, another company, before. And he was joining this startup called Google where the two founders were these punks. Larry and Sergey, PhD students who were incredibly arrogant and had very low regard for anybody over the age of 30.

In fact, Larry and Sergey had admitted that the only CEO they would accept would be Steve Jobs and he was not available. So for Eric Schmidt to take that job was risky, and the only reason he agreed to do is that the venture capitalist involved, John Doerr said, “Look, Eric. Yeah, it’s true. It’s risky. They might fire you. But if they do, I’ve got your back and I’ll slot you in as a CEO to some other company because my venture capital partnership, Kleiner Perkins, is funding new startups all the time.” So the venture capitalists de-risk the choice of joining a startup both for the entrepreneur who starts the company because capital is provided, so you take the risk with somebody else’s capital, and for the early hires. I call venture capital a machine for manufacturing courage.

Well, I think what that story also highlights is how it creates the connective tissue between the company and potential executives. Everywhere, they help create those linkages that make it all work. Every city in America, every state would love to have their own Silicon Valley, and even having lot of the ingredients doesn’t quite work unless you can all connect them together in the right recipe. And venture capital is pretty important for making sure that happens.

Yeah, and you could see this as actually quite a sort of leveling the mechanism because it’s a cliche to say of somebody who does well in life. “Oh, well this person did well because they had money and connections.” Venture capital is the machine for delivering money and connections. The job of the venture capitalist is to find somebody who’s really smart. Who’s got a good idea for a new product and bring those money and connections to that person. So venture capital is often accused of perpetuating inequality and one can debate that, but in some sense it’s a super democratic, super leveling, super egalitarian thing.

Is there a potential real competitor for the Bay Area? Especially since there are governance problems in San Francisco. We have remote work. We’ve heard a lot about Miami becoming the new Silicon Valley. Do you see a legitimate competitor to the Bay Area?

Yes, I do. I think what’s happened in the last 10 years is that the formula for creating Silicon Valley, which in my view is really about the venture capitalist coming along and de-risking entrepreneurship, has been understood. And the process of spreading it out to other regions has been tried and it’s worked. The biggest example is China where Silicon Valley venture capitalists went around 15, 20 years ago and they successfully built up an amazing digital economy in China. It’s not about the government’s long-term planning. Don’t believe that story. It’s about the fact that Baidu, Alibaba, Tencent, Ctrip — all of these early Chinese digital companies received American venture-style investments and were structured by American Silicon Valley lawyers with dispute settlement under New York law, a Cayman Islands parent, and the ability to issue Silicon Valley-style stock options to the early employees.

It was just basically taking the Silicon Valley formula and taking it to China. Now it’s now happening all over the place. Silicon Valley is taking its model to India. Since my book has come out, I’ve been flooded with emails from venture capitalists in India. It’s coming to Europe. It’s coming to Latin America, and it’s spreading within the United States. I absolutely do think that Austin, Miami, New York, Boston, maybe Chicago can do this. And what you need is, you need to have some flow of technical people coming out of preferably a good local university. Texas has a bunch of those: Rice as well as Texas A&M. I think there’s enough of a flow of people there. I don’t see why it shouldn’t be true of Pittsburgh with Carnegie Mellon. And I think once you’ve got that flow of technical people, if the venture capitalists move to them and set up shop locally, you can build an ecosystem that’ll flourish.

You can have a successful ecosystem without it being Silicon Valley. Just because you cannot duplicate something as wildly successful, does not mean you have not created a successful tech ecosystem. But what about more of the left-behind areas in the United States? There have been efforts to create more innovation hubs there. Can’t we have successful clusters in the middle of Ohio or pick whatever state you want?

I think this is where there is some bad news, because although what you were saying earlier, that you don’t have to be as successful as Silicon Valley to be successful, is sort of true, there’s an important saying in venture capital, “If it’s not 10x different, it’s not different.” If you are trying to persuade people to switch from some product they understand, or some service they’re familiar with, to use a completely different product, which is going to annoy them initially because they don’t know how to work it and it’s going to be expensive, they’re going to buy it and maybe it’ll just be a waste of their money because it doesn’t really work — to get over those hurdles, you’ve got to deliver something that’s really quite seriously new. Then if you succeeded in delivering that thing, it’s very difficult to do it, but if you succeed, you’re normally going to get exponential growth. And it comes back to what we began with, the power law idea.

Stuff either really works big time and goes 10x, 20x your investment or it fails. This is a skewed distribution. And so it’s difficult to say, “I’m trying to do Silicon Valley light. I’m going to do some startups, but I’m not going to be too ambitious about it.” It’s kind of an all-or-nothing game. You’ve got to really shoot for the big ambitious outcomes if you’re going to break through and do that 10x different and achieve success. I think the bad news is that the more humble vision for a cluster is probably not going to work, but what can work is that in surprising places, you do get ambitious people who break out. And so a great example is a company called UiPath, which is the global leader in robotic process automation software, which is a big category.

And it was begun in Romania. The guy who began it actually taught himself to code without a computer because there weren’t enough in Romania at the time. He couldn’t get one, so he used some secondhand computer manual, which he borrowed from the library or something, and taught himself how to code before he had a computer. It can happen in the most crazy places. There is Drive Capital, which is a Sequoia spin-out in Ohio. But I think the point is, it’s not looking for sort of reasonably good startups, even if it’s in Ohio. It’s looking for the breakouts.

Given what you’ve said though, and given the title of the book, we should not expect to have lots of successful tech hubs evenly distributed across the United States. We should expect there to be a few of them, maybe more than we have now. And they may arise, even though there are other things government can do, for sort of happenstance reasons.

Yeah, I think the power law idea is useful to understanding this issue. The power law operates on multiple levels, which is why it’s such a cool concept and it’s kind of the secret sauce of the whole sector. All startups, whether they have anything to do with tech or not, just the fact is that many startups fail and then a few do well. It operates on the level of technologies. So, when a technology really works, it tends to grow at this exponential rate. Think about Moore’s law for the way that semiconductors grow in power, doubling in power every couple of years.

Then it’s true also of things like the internet networks where you get these network effects, where the value of the network rises as the square of the number of users. And Metcalfe’s law, which is that network law on top of Moore’s law. So you can have both. If you think about an internet router, it’s got Moore’s law going on because it’s using semiconductors inside the router. It’s reaping the benefit of the router becoming more powerful because the semiconductors are more powerful. On top of that is getting the benefit of Metcalfe’s law because the internet is multiplying the value or squaring the value, as more users join. It’s got that startup effect anyway of a power law effect.

Then on top of that, you get investors who invest in companies building routers. And those investors are going to experience power law effects in their portfolio. Because of that, some venture capitalists are going to reap most of the gains in the entire venture capital area. So, there’s a power law effect if you distinguish the outlier of venture capital firms from the rest of them. And there is this final effect, which you’ve just alluded to, which is that there will be some clusters that dominate. It doesn’t mean there has to be one cluster in America. China has some activity in Beijing, some activity in Shanghai, some activity in Hong Kong, and some in Hangzhou and Xinjiang. So I think it can be distributed, but it’s not going to evenly distributed.

What role do you want government to play here? Do you want subsidies? Do you want tax breaks? Is it just very basic kinds of public good stuff? Investment, lots of R&D research to create that feedstock of ideas? What is the role of government?

I think the best illustration of how to set up this answer is the internet. The people who really believe in industrial policies say the government created the internet. They say DARPA created the internet. This is both true and sort of misleading. True in the sense that, yes, DARPA funded the early internet and built it to a point where there were 50,000 users or something. Who created the internet we know today, which is part of everybody’s life and has basically changed the way we live? Venture capital did. Venture capital discovered a sort of hobbyistic little company called UUNET, which was building routers that connected engineers who wanted to hack into the government internet. Venture capital got behind that and scaled it to the point where it just basically connected up America. That’s the story.

And then venture capital, by the way, created Netscape, which was the thing that allowed the internet to be useful to people who didn’t want to type in complicated digits every time they wanted to access a website. I think the answer to your question about the role of government is that early-stage basic science is the role of government. I’m extremely in favor of more for the National Science Foundation. I think it’s great to have more funding for scientific education in K-12. For post-docs, for people who are doing engineering and physics and math: I think we fund life sciences very well with NIH, but we don’t fund the NSF enough. But I’m not in favor of the government trying to pick winners when you get to commercializing this stuff. So I would focus on the early stage.

Sebastian, thanks for coming on the podcast.

Jim, it’s been a pleasure. Thank you.

“… That family and custodial chaos, low marriage rates, and high divorce rates and other troubling trends in black family life have worsened at a time of diminishing racism, rising economic gains, and escalating political power among black Americans strongly suggests that systemic racism, whatever the term might mean, cannot persuasively explain them. Indeed, the fact that many of these same trends are also corroding impoverished white families while leaving black immigrants (whose marriage rates are over 70% higher than those of native-born blacks) relatively untouched indicates that racism, systemic or otherwise, is not the primary driving force behind the patterns described…. People whose only offense is drug use almost never go to prison today, and if they do, they rarely spend much time there. Moreover, recidivism rates in the United States are extraordinarily high: Two-thirds of those released from prison are arrested for a new crime within three years, while half end up re-incarcerated…”

Peter Schuck, “What Systemic Racism Systematically Downplays,”National Affairs, Spring 2022https://www.nationalaffairs.com/publications/detail/what-systemic-racism-systematically-downplays

What Systemic Racism Systematically Downplays

For several years now, systemic racism has been among the most frequently mentioned concepts in American discourse. The term and its equivalents — including “structural” and “institutional” racism — appeared in the New York Times and the Washington Post roughly 10 times more often in 2019 than they did in 2013, and have greatly proliferated since then. The topic is now the subject of countless college courses, classroom discussions, books, articles, media programming, political speeches, and formal and informal conversations. It is safe to say that today, systemic racism has reached the status of a cultural meme.

Progressive advocacy groups use claims of systemic racism to shape a distinctive political agenda and rhetoric, emphasizing certain themes and downplaying others. Though their commitments are understandable, their preoccupation with the concept tends to understate progress among the black middle class while distracting from, and even undermining, a far more compelling priority: the repair of so many broken black communities in low-income areas.

The language of systemic racism does not seek to mobilize such repair, nor does it equip younger black Americans with the tools to pursue the many genuinely equal opportunities that now exist. So while it is important to take the systemic-racism thesis seriously, it is also crucial to consider what it leaves out, as well as what it obscures.

CLARIFYING THE CONCEPTS

Before discussing the imperative of individual and community repair, I shall briefly clarify the notion of systemic racism itself, which plays a central, though largely unexamined and analytically undisciplined role in our national debate.

The term “racism” is serviceably clear in its meaning, if not its application: It is the belief that one race — a human grouping distinguishable according to its inherited physical characteristics, particularly skin color — is inferior to another race, justifying stigma, separation, or mistreatment of various kinds. This concept differs from what I shall call “racialism,” which refers to a heightened consciousness of the race of another person or group.

Racism is invidious, hostile, and demeaning. It denies the inherent equality of all human beings and represents the corrosive attitude that those who denounce systemic racism have in mind. Racialism, by contrast, is morally neutral, arguably rational, and — in a society with our history of race-based slavery, discrimination, and continued social differences between whites and blacks — probably inevitable. Ongoing racial disparities mean that people are often conscious of and call attention to another’s race for reasons that lack the animus of racism, and indeed are often benign. Regardless of whether observers are animated by perceptions of blacks’ continued disadvantages in our society, the racially stratified nature of so many of our institutions, or guilt over America’s history of race-based enslavement and subjugation, they would have to be obtuse or willfully blind not to be racialist — not to mention callous to fail to sympathize with the plight of many black Americans.

Ordinarily, one cannot easily detect another person’s feelings about black disadvantage in America, much less know whether those feelings are animated by racism or racialism. Since they are both states of mind, distinguishing between them empirically is especially difficult. Some advocates may not care much about detecting this attitudinal distinction, so long as blacks’ disadvantage persists and whites fail to do what they should to eliminate it. But if whites’ attitudes are the very essence of systemic racism, then the distinction between racism and racialism matters greatly.

So what makes racism — a conviction held by an individual — “systemic”? Definitions of the term vary, but they tend to hinge on the claim that racism is not simply an attitude held by some individuals; instead, it is a form of discrimination inherent to policies, practices, social institutions, cultural mores, and environmental characteristics that place minority racial groups at a disadvantage relative to the racial majority. “Systemic” means that such bias is not only widespread, but practically inescapable.

In America, systemic racism is said to manifest in a socially pervasive bias against blacks that is threaded through all of our major institutions. Most, if not all, accounts of systemic racism build on both an observation of a population-level disparity — such as the differences between blacks’ and whites’ income or achievement levels in school — and a causal account of that divergence. Each of these variables raises thorny analytical questions that require solid data to answer. In order to compare how blacks and whites are treated by police or teachers, for example, one needs to know the behavioral base rates of the two groups; comparing blacks’ and whites’ arrest rates or differences in school-disciplinary actions is meaningless unless we know and can compare how the two groups actually behaved on the street or in the classroom. Yet such data are often hard to come by. Simplifying the task by presuming the base rates are the same begs the question at issue, as does assuming that the base rates differ due to racism and its continuing effects on the black population — a central premise of the systemic-racism thesis.

Adherents of the thesis identify its manifestations in numerous, if not all, domains of American life. One popular video series focuses on eight indicia of the phenomenon: the wealth gap, employment disparities, housing discrimination, and differences in rates of government surveillance, incarceration, drug arrests, immigration arrests, and infant mortality. The Fair Fight Initiative lists a similar array of social conditions in which blacks are said to be systematically and chronically disadvantaged due to five widespread forms of racism: internalized, interpersonal, individual, institutional, and structural.

Those who denounce systemic racism see the cumulative subordination of blacks throughout history as forming a racist substructure that underlies, and thus permeates, our society, producing the disparities outlined above. Such racism is said to be so deeply embedded in our most powerful institutions and cultural mores that it will persist even without new infusions of racism at the individual level. This claim is pivotal, and appears in its pure form in the December 2020 issue of Academic Medicine: “f we are White,” the article states, “we are a big part of the problem. We are part of the reason that structural racism imprisons and oppresses people of color every day, everywhere they go, and no matter what they do.” Equal treatment now and in the future may soften the effects of systemic racism, but such treatment can never fully eliminate the harm.

Systemic racism is said to pose continuing barriers to blacks’ ability to improve their socioeconomic lot — impediments that they have limited capacity to overcome thanks to the structurally racist milieu in which they operate. By the same token, it’s not clear from this account what whites can do to rid themselves of their own inherent racism or purge the system of its bias. Systemic racism’s underlying premises, then, imply little agency on either side of the racial divide.

SYSTEMIC RACISM VERSUS INEQUALITY

The notion of systemic racism resonates with many Americans today, largely because racism was indeed systemic in the United States in the not-so-distant past. Slavery, which had been a feature of human civilization for millennia, took on a decidedly racial bent as millions of Africans were shipped to the New World as slaves. The United States eventually outlawed the trans-Atlantic slave trade in 1808, but race-based slavery continued to proliferate domestically for decades, most notably (albeit not exclusively) in the South. The ratification of the 13th Amendment on the heels of a bloody civil war brought an end to slavery as a matter of law in 1865. It would take another century, however, before black Americans were fully recognized as citizens entitled to equal civil rights under the law.

The long history of de jure slavery, segregation, and categorical subordination of blacks in America may have formally ended with the civil-rights revolution of the 1960s, but even then, some of the movement’s fundamentally liberal reforms — particularly racial integration of schools, voting, public services, and accommodations — generated massive resistance, followed by slow, grudging, formalistic compliance in the South. Even in the North, efforts to integrate schools, housing, and other social domains spawned considerable public resistance. Almost three generations, decades of affirmative action, and trillions of anti-poverty dollars later, many Americans of all races remain painfully aware of continuing racial injustice and embedded inequality. This surely explains why 84% of Americans polled by the Pew Research Center in 2021 felt that more needed to be done to ensure racial equality.

But present inequality between blacks and whites, particularly in a historically stratified society like the United States, is not necessarily due to ongoing systemic racism. Black and white Americans remain unequal on a host of social indicators, to be sure. But whether each of these inequalities violates particular principles of justice poses other, more difficult analytical and normative issues that systemic-racism claimants seldom squarely address.

An important and deeply challenging feature of racism is that it is easy, and often tempting, to accuse another of harboring racist beliefs, but difficult — perhaps even impossible — for the accused to disprove the allegation. Charges of systemic racism are especially tricky to refute, as activists claim that race-based discrimination can be so subtle, so covert, and so entrenched in a culture or an institution’s fundamental structure that those who operate under it may not even recognize their complicity in the subjugation of racial minorities. Again, given our society’s long history of de jure racism and the complexities of causality over time, this claim of complicity is practically irrefutable, making such accusations easy to make and abuse.

The best that the skeptic of this account can do is identify good reasons to doubt that racism in America today is truly systemic. As it turns out, there are four such reasons, the first of which is that rates of racist beliefs among individual Americans have declined over time. Public polling about white-black intermarriage, residential proximity, and other interactions shows dramatic increases in tolerant attitudes among whites since the 1960s. Although white-supremacist hate groups often loudly avow their racist beliefs, they remain a tiny, isolated fraction of the population, and are almost universally reviled by the political left and center as well as many on the right eager to distance themselves from fringe elements.

Of course, people harboring bigoted views often hide them in public, especially in social environments where racism is highly stigmatized. Answers in a survey are not proof that people do not hold racist views, although they do show that people are at least ashamed to admit them. That said, rates of behaviors related to or motivated by racism have fallen as well. In 2020, the FBI found that although the largest category of hate crimes (61.8%) were based on race/ethnicity/ancestry bias, the number of these incidents was under 6,000 nationwide. In a population of over 330 million, this surely does not qualify as systemic.

Second, the cohort of the U.S. population that has been most likely to hold racist views is slowly but inexorably dying out, to be gradually replaced by generations who tend to be far more accepting of racial differences. Though this theory is subject to some dispute, it is undeniable that members of younger generations seem to harbor less overtly racist beliefs than those of older generations. As these young Americans assume leadership roles in our nation’s core institutions, their views will affect those institutions’ structures, policies, and actions, as well as the people they influence. That virtually every major American institution in recent years has explicitly committed to combatting systemic racism suggests that we are already witnessing this trend taking shape.

A third reason to doubt the systemic-racism thesis is that anti-racist protests and highly publicized punishments of racist incidents have made racism much more newsworthy than it was in decades past. As a result, public discussion of the subject occurs much more often in our communities and traditional media today than it once did — and the tenor of this discourse is almost invariably opposed to racism. To the extent that systemic racism is inherently implicit or invisible, there is less room for it to hide now than there was in the past.

Additional public developments have likely heightened awareness of, as well as shame over, racism’s role in our history. These include the 1619 Project (the book derived from which is on the best-seller list at the time of this writing), officially sanctioned removals of statues and other historical symbols linked to racism, highly publicized convictions of police officers and civilians for hateful crimes against blacks like George Floyd and Ahmaud Arbery, and numerous “cancel culture” incidents in prominent institutions ranging from local governments, schools, and museums to professional groups, athletic leagues, religious communities, and others. As I have written elsewhere, this practice of “canceling” individuals is often shameful and reprehensible. But it does demonstrate how deeply stigmatized racism is in American society.

It is possible, of course, that these developments have simply driven much hitherto overt racism further underground. But if so, such furtive racism — the sort of racism that dare not speak its name — would be the very antithesis of systemic.

Indeed, these incidents and others have made many white Americans desperate to avoid being associated with criticisms of blacks. The Democratic Party in particular has embraced a tactical silence on the matter, and for perfectly straightforward reasons: Given Latino defections during the 2020 elections, blacks are now the party’s only reliable racial or ethnic constituency. Under these conditions, the party’s white activists are less willing than ever to risk offending black leaders and voters. Meanwhile, Republican-controlled state legislatures and governors — realizing that blacks overwhelmingly vote Democratic — gerrymander legislative seats to minimize black constituents’ political potency. If they believed black votes were truly up for grabs, they would surely compete for them — a logical circularity that Republicans may yet break, as they have done with Latinos.

Even if one were to ignore these facts and insist that systemic racism remains widespread in today’s America, there are good reasons to doubt that it represents the primary driver of continuing black disadvantage. For starters, the impressive upward mobility of other non-white groups — including immigrants of color — continues to confound the systemic-racism thesis. The most economically successful of these groups are Asians, particularly Chinese, Japanese, and Koreans — many of whom began life in America without American blacks’ English-language advantage. In a recent study, researchers led by Raj Chetty — a leading analyst of economic mobility among different racial and ethnic groups — found that Hispanic and Asian Americans are closing much of the income gap with white Americans, while the upward mobility of lower-class black Americans has not kept pace.

Perhaps most discrediting of the ongoing systemic-racism account is the fact that black immigrants’ economic mobility is much greater than that of blacks born in the United States. The median household income of the rapidly growing cohort of black immigrants is about 30% higher than that of American-born blacks. If systemic racism were the primary driver of blacks’ disadvantages in America, we would expect it to hold back this population as well. Yet it seems not to have done so. Causal factors other than systemic racism, then, must be contributing significantly to black disadvantage in areas where it persists.

SEEKING REMEDIES IN THE WRONG PLACES

Downplaying systemic racism as a major cause of continuing black disadvantages still leaves those disadvantages in place, of course. And for all too many of the most important social indicators, American blacks are significantly worse off on average than whites. This is true in terms of their lower income and net worth, as well as their higher rates of poverty, homelessness, criminal arrest, incarceration, marital instability, mortality, morbidity, and many other measures of social health.

Addressing these conditions should be among the highest priorities of public policy and civic and community action. Reformers frequently propose strategies to do just that. Some proposals are contained in pending legislation, and wisely target poverty across the board. A refundable child tax credit is perhaps the most compelling example, although it must be carefully crafted to minimize perverse incentives that tend to encourage the fractured-family complications discussed below. Refining and simplifying the Earned Income Tax Credit would also go a long way toward making the credit more accessible to more low-income workers. Efforts to reinforce the “success sequence” of high-school completion and delayed marriage and childbearing (discussed below) should be redoubled, as should those aimed at expanding school choice through vouchers, charter schools, and other innovative alternatives. Meanwhile racism, systemic or otherwise, must be fought wherever it is detected or suspected, both legally and socially.

My focus here, however, is not to evaluate these and other specific policy remedies, as I have done in other publications. Instead, I would like to call attention to some of the problems and opportunities that the current preoccupation with systemic racism obscures, and may even aggravate. The following discussion has two purposes, the first of which is to detail some of the facts that impede blacks struggling to escape poverty’s depredations. The second is to discredit the idea, which seems ubiquitous among reformers and activists on the left, that systemic racism continues to be a, if not the, principal cause of these enormous problems. As I emphasize above, systemic racism was indeed a most shameful, tragic feature of American history, and there is no doubt that some elements of its terrible legacy remain. But to say that ongoing systemic racism is the primary driver of current disparities between black and white Americans today is to distract attention from what may actually be causing or worsening the problem. It also likely contributes to a sense of despair that hobbles efforts to pursue meaningful change.

The first social factor contributing to socioeconomic disparities between blacks and whites in America is the fragility of the black family. Families represent the core of any healthy society, and the steady decline of two-parent households among Americans of all races is probably the most important, and most troubling, social trend that has materialized since World War II. For black families in particular, the development has been devastating.

In terms of family formation, black men today are far less likely than white men to get married. And unlike higher-income white men, who are more likely to marry than low-income white men, educated, economically prosperous black men are no more likely to marry than their poorer black counterparts. In fact, these men are less likely than poor blacks to have ever married at all.

For those who do marry, the statistics remain grim. Black men experience greater rates of divorce and separation than white men, and when their marriages dissolve, they are far less likely to remarry. Meanwhile, black women typically spend only 22% of their lives married — half the percentage of white women. And while unmarried women often cohabit with men, prominent marriage scholar Andrew Cherlin has found that these relationships tend to be relatively short-lived.

The breakup of marriages among black couples, combined with their failure to form in the first place, has had a predictably tragic impact on black children. Even as racism — both institutional and individual — in America has declined over the past century, the incidence of out-of-wedlock births within the black community has soared. According to the most recent National Vital Statistics data, 70% of black children were born to an unmarried mother in 2020 — triple the rate Daniel Patrick Moynihan cited when he first sounded the alarm over the deteriorating state of the black family in 1965. For whites in 2020, the rate was just over 28%. (Moynihan’s report placed it at 3% in 1963.)

The best predictor of low prospects for children, regardless of race, is growing up in a single-parent household. Over half of all poor children come from female-headed households, while a child raised without a father at home is four to five times more likely to be poor than a child of married parents. As family expert Kay Hymowitz has shown, these broken families often consist of “a revolving cast of stepparents, half-siblings, stepsiblings…and short-term romantic partners.” Such instability, she observes, “can be every bit as damaging to children as poverty itself.”

All of these elements — family and custodial chaos, low marriage rates, and high divorce rates — contribute to the persistence of disproportionate levels of poverty among black children. That these and other troubling trends in black family life have worsened at a time of diminishing racism, rising economic gains, and escalating political power among black Americans strongly suggests that systemic racism, whatever the term might mean, cannot persuasively explain them. Indeed, the fact that many of these same trends are also corroding impoverished white families while leaving black immigrants (whose marriage rates are over 70% higher than those of native-born blacks) relatively untouched indicates that racism, systemic or otherwise, is not the primary driving force behind the patterns described.

A second factor contributing to socioeconomic disparities between black and white Americans is isolation. Poor blacks are isolated in several ways that tend to keep them impoverished. The digital divide, for example, deprives them of information and social connections. But a related, and perhaps even more limiting, form of isolation is geographic — some of which reflects systemic racism of the past. As researchers like Harvard’s William Julius Wilson have observed, blacks tend to live in areas of low economic growth, modest wage levels, and high unemployment, which limits their access to institutions and resources that contribute to upward mobility. Extensive research by Chetty and others suggests that these geographic elements are predictive of future economic prospects.

Blacks’ isolation is not limited to geography, however; they tend to be socially isolated as well. Upward mobility depends heavily on people’s social capital — their embeddedness in social networks and institutions — which helps them gain the kind of experience, reputation, and relationships that they can use to their advantage. Orlando Patterson’s work on social networks provides dismaying insight into how social isolation perpetuates poverty among black Americans, even as a large black middle class has emerged against great odds. According to his research, blacks’ networks are smaller, denser, and include remarkably few kinsmen compared to those of other races; indeed, almost half of black individuals surveyed had no kinsmen in their networks at all. In a finding he characterized as “truly startling,” Patterson observed no relationship whatsoever between network density and education levels among this population. In other words, greater levels of education — which, as sociologist Robert Putnam has found, tend to correlate with larger social networks in the general population — did not extend blacks’ ties by much. Again, ongoing systemic racism is not the likely culprit here.

A third factor contributing to continuing black-white disparities in America is schooling. Years of education and skills training are strongly correlated with wealth and income, and in recent decades, blacks have made significant gains in their rates of high-school graduation (which hovered around 25% in 1965 and are now at 88%) and college enrollment (38% in 2018, compared with roughly 15% in 1968). This progress is laudable, but graduation statistics conceal large skill gaps that remain.

At the same time, blacks’ college-graduation rates continue to lag behind those of whites. One significant factor behind this continued disparity is black students’ greater likelihood of dropping out of post-secondary school, which frequently saddles them with substantial student-loan debt but no credentials. Those who do graduate often leave with credentials that are too meager to sustain a promising occupational future.

At the primary- and secondary-school levels, black students are disproportionately cited for misconduct, which leads to higher drop-out rates and what some advocates decry as a “school-to-prison pipeline.” Civil-rights officials in Barack Obama’s Department of Education (many of whom have been restored during President Joe Biden’s term) blame these discrepancies on racial bias among school administrators and teachers — accusations these groups stridently deny. John Ogbu and other educational researchers, by contrast, have pointed to an “oppositional culture” among many black students that manifests itself in less time spent on homework, high rates of truancy, elevated drop-out rates, and greater indiscipline. The latter in particular harms classroom learning for other students and has increased teacher attrition rates in many urban schools, which further undermines educational progress in black neighborhoods. The remedies for these conditions are elusive, but they surely lie to a large extent within the black community and black families.

A fourth factor contributing to social and economic disparities between blacks and whites is crime. Heightened levels of criminal activity continue to plague impoverished urban neighborhoods, where blacks not only disproportionately represent the perpetrators, but also the victims. Those who decry systemic racism often point to higher rates of incarceration as the main driving force behind disproportionate rates of black poverty. And indeed, this factor clearly contributes to racial socioeconomic disparities. Imprisonment, especially for long periods of time, ruptures a person’s ties with his family and community — both of which offer legitimate sources of upward mobility. It also harms his future employment prospects, as many employers screen for applicants with criminal records. And as systemic-racism theorists almost invariably point out, blacks in America are imprisoned at much higher rates than whites.

Activists insist that these disparities call for large-scale de-incarceration, but releasing or diverting those convicted of minor offenses would have little real impact on incarceration rates. People whose only offense is drug use almost never go to prison today, and if they do, they rarely spend much time there. Moreover, recidivism rates in the United States are extraordinarily high: Two-thirds of those released from prison are arrested for a new crime within three years, while half end up re-incarcerated. Given that the victims of these crimes tend to be overwhelmingly black themselves, the costs of de-incarceration would fall most heavily on the black community. The same is true of “defund the police” measures, which many activists called for during mass protests against highly publicized police shootings of unarmed black individuals in 2020 and 2021. Wiser public officials — many of whom are black themselves — have opposed these demands.

Historically speaking, much of the damage to black families and communities had occurred long before black incarceration rates began their rapid rise several decades ago, suggesting that these elevated rates were at least in part a result, rather than a cause, of those communities’ socioeconomic decline. To be sure, the two trends have likely precipitated a vicious cycle, whereby increased poverty begets increased incarceration and vice versa. Yet the order of the trends indicates that poverty — abetted by familial breakdown — was the leading impetus.

Fifth, many people — black and otherwise — find themselves in an impoverished state for a reason they may admit to themselves and others: They have made poor choices in the past that continue to harm them in the present. Observers who make this point are often accused of lacking compassion, “blaming the victim,” and ignoring the structural causes of behavior. Such causes obviously matter, but any analysis that fails to consider the role of self-harming choices misses an important clue to what causes and sustains some poverty in black communities — and also what might reduce it.

By “poor choices,” I am referring to decisions that squander or shut out opportunities to better one’s prospects in the future. Some of these behaviors, like excessive gambling or the abuse of alcohol or tobacco, are merely self-destructive. Others, such as the abuse of illicit drugs, are also punishable by law. If detected, they will foreclose many paths out of poverty.

Most poor choices, however, are simply shortsighted; they sacrifice the real possibility of future, durable gains for more immediate, transitory ones. Common examples include chronic truancy; mingling with anti-social people; ignoring schoolwork in favor of television, the internet, or video games; engaging in habitual indiscipline; dropping out of school; excessive borrowing and spending; parenting children whom one cannot afford or care for; and quitting jobs or training programs from which one could acquire useful skills, experience, or certifications. Here, too, systemic racism’s causal role is obscure. Though external remedies may help at the margins, solutions to these largely self-inflicted conditions must also include a change in individuals’ behavior.

Indeed, studies have long shown that simple prudence and self-discipline — of which almost anyone is capable — can nearly eliminate the prospect of poverty for black and white teenagers alike. The so-called “success sequence” analyzed by Brookings Institution scholars — finishing high school, marrying after the age of 20, and doing both before having a child — reduces the risk of falling into poverty to 2%; failure to follow this path raises it to 75%.

To reiterate, racism was indeed a systemic phenomenon for most of America’s history. And where racism persists, it remains a pernicious force in American life. But the insistence that racism continues to be both systemic and endemic, and that it alone or primarily accounts for ongoing disadvantages in black communities, is unpersuasive. The claim neither accords with crucial social realities nor points toward constructive solutions to the serious problems afflicting black Americans. As long as would-be reformers and their audiences take systemic racism as their principal target, real progress toward genuine and necessary policy and cultural solutions will be even more elusive.

AGENTS OF CHANGE

The challenge we confront today is to identify and overcome those obstacles to black Americans’ progress that were placed there not only by racist systems of the past and programmatic failures of the present, but also by behaviors over which they and their communities have some control today. All three of these elements are crucial.

The vast array of federal and state policies that have been established and expanded for decades to address the challenges black Americans face have not sufficiently accomplished their missions. For better and for worse, the community’s main challenges and opportunities today lie closer to home — in families, schools, workplaces, health practices, local mobilization, and well-targeted self-interest. This is one battleground where the future struggle must be waged and won.

Peter H. Schuck is the Baldwin Professor of Law, Emeritus, at Yale Law School and a Distinguished Scholar in Residence at New York University Law School. He is the author most recently of One Nation Undecided: Clear Thinking about Five Hard Issues That Divide Us (Princeton University Press).