May 2, 2013

Niall Ferguson: 4 Reasons America Is Falling Apart

British historian recounts reasons why U.S. institutions are failing but offers hope of recovery if U.S. embraces long view

Niall FergusonNiall Ferguson, a Harvard professor equally at home in the sweep of civilization as the history of finance, explained to an audience of 400 investment professionals how it is that much of the world is growing while the U.S. is slowing.

The reason is that institutions matter—they are what made the U.S. stronger than the rest of the world—and their current decline explains America’s problems and current trajectory, the British-born historian well-known for his conservative political views, said at the Altegris investment conference in Carlsbad, Calif.

In preliminary remarks before the morning keynote, Altegris CEO Jon Sundt noted that a billionaire friend had mentioned to him that he regarded “the big picture” as the biggest factor in investment success.

Niall Ferguson’s sweeping talk provided a large contextual view of America. The author of the forthcoming book, The Great Degeneration, Ferguson noted that as recently as 1978 the average American was 22 times wealthier than the average Chinese—a longstanding pattern in the relationship of the two civilizations.

But that ratio has quickly fallen to below 5 to 1 and is soon to be less than 2 to 1, not merely because the Chinese are making enormous strides in their governmental and economic systems but because of a pronounced deterioration in America’s civilization.

Ferguson, a new father who proudly noted his son (whose mother Ayaan Hirsi Ali is also foreign-born) is an American, cited Adam Smith’s 18th century classic The Wealth of Nations as a source for America’s and the West’s historic dominance over much of the world.

China’s problem, Smith wrote, lay in its laws and institutions. And the Chinese understood that, Ferguson added, recounting a Chinese visitor’s tour of the West in the 1870s, where he noted “the guarantee of having justice done” as the key distinguishing characteristic between the two civilizations.

The rule of law is one of the “killer apps” of Western civilization that the Chinese are downloading into their system, even as Americans ignore the bugs in ours. “What if rich countries with good institutions find their institutions getting worse?” Ferguson asked. “Will all attempts to treat [our economic problems] with fiscal and monetary stimulus fail because the institutional problems cannot be overcome that way?”

Ferguson noted four key problems that “worry” him about America, and “terrify” him when it comes to Europe.

First is a breakdown in intergenerational equity. Citing the 18th century British statesman Edmund Burke’s famous dictum “History is a pact between the dead, the living and the yet unborn,” Ferguson said that older generations of Americans made sacrifices for younger ones.

“The World War II generation thought their kids were more important, but baby boomers—the me generation—think their descendants should make sacrifices for them,” Ferguson said.

He cited Boston University economist Laurence Kotlikoff’s work showing that in order to achieve generational equity—that is, to ensure our children receive roughly the same level of benefits and pay the same in taxes as adults currently do, Americans would have to either make permanent cuts in government expenditures of more than 30% or make permanent tax increases of more than 60%. Those figures will only go up, as they have now for some time. Yet the politics on display in Washington in recent years reveal that changes of that magnitude have been impossible to achieve, Ferguson said.

Indeed, in an environment where political rhetoric uses percentiles—like the 1% versus the 99%—we currently lack “the language” to discuss these issues. “We should be talking about generations,” Ferguson said, noting that today’s “elderly consume massively more than other age groups.”

A second current civilizational problem is regulation. Ferguson called out his frequent nemesis in public debate, economist Paul Krugman and those like him who argue that deregulation lay at the root of our economic crisis.

But Ferguson cites Andrew Haldane, a Bank of England official who in an attention-getting paper delivered one year ago in Jackson Hole, Wyo., demonstrated the contrary was true.

“There [were] plenty of regulations and plenty of regulators and the institutions that blew up the world were plenty regulated,” Ferguson said, noting it was regulated banks, not unregulated hedge funds, that caused the crisis.

No hands went up when Ferguson asked the audience if anyone had gotten around to reading the Dodd-Frank Act yet.

"Dodd-Frank illustrates a general problem: Our impulse is to make complex legislation. Think of the tax code,” Ferguson said, noting that the law governing the economic life of all Americans (not just the financial sector, as with Dodd-Frank) consists of 3.4 million words in the IRS tax code, or more than 9 million words if related codes are counted. Ferguson says America’s founders would recoil at this level of complexity, which he says, contrary to Krugman, destabilizes our financial system.

Beyond Washington’s regulatory morass, Ferguson identifies a broader breakdown in America’s legal order, where it’s harder for ordinary people to do business. While the economy is slowing, one area that is exhibiting robust growth is compliance. Ferguson cited a study by Canda’s Fraser Institute think tank showing that in only 20 countries has it gotten harder to do business since 2006. In a China-dominated emerging world that is actively seeking American-style economic dynamism, America itself is 18% slower in its pace of doing business. The U.S. has joined nations such as Burundi and Zimbabwe as one of the just 20 countries where business has become harder to do.

Ferguson cited another study of 22 measures of competitiveness by the Davos-based World Economic Forum, according to which the U.S. did not make it into the top 20 countries and in which Hong Kong beat the U.S. in each of the 22 measures.

Ferguson faults a legal system, once the envy of the rest of the world, whose practitioners are currently more interested in serving themselves than the public.

A final area of concern is what Ferguson sees as a breakdown in civil society. The historian noted Alexis de Toqueville’s 19th century visit to America, where the Frenchman lauded the proliferation of voluntary associations. Ferguson bracingly noticed that Americans today are “indistinguishable” from Europeans in this area.

While Americans have come to rely on the government to get things done, “the rest of the world is improving its institutions in nearly every country in the world.” The heaviness of government’s role in modern America is reminiscent of Latin America’s reputation, though Ferguson notes that government in Mexico is getting better even as it is getting worse here.

In concluding his talk, Ferguson showed a photo of Manhattan darkened in the aftermath of Hurricane Sandy, with just one building illuminated: the headquarters of Goldman Sachs. “Shine on, you crazy derivatives trader,” he joked in what was not meant as a comforting statement about global financial stability.

That said, he noted a few positives that might yet buoy America’s position in the world. One is that America is aging a lot slower than much of the rest of the world.  

“Although our immigration policies are screwed up, at least we have one,” in contrast to Japan, for example.

Another key positive—“luck,” he called it—is that “the United States just struck gas and oil,” citing the “energy revolution” that is becoming apparent from America’s vast shale discoveries and exploitation.

Looking at a slogging “national story,” one could miss the robust economic recovery that is taking place in the Great Plains, the Gulf Coast and in Southeastern manufacturing centers—not all due to shale, but importantly as a result of America’s federal system, which allows states a large measure of autonomy.

“Why are these growing when Illinois is not? Thanks to the federal system, the whole country can’t be screwed up,” he said, citing Texas, Utah and North Carolina as states pursuing economic and regulatory policies that are favorable to entrepreneurship. “If you’re Illinois, you will not grow and your people will leave,” he said.

But Americans should not take these strengths for granted, he warned, continuing his discussion of federalism.

“The energy revolution will have a happy ending if states prevail," he said. "It will have an unhappy ending if Washington’s alliance of regulators, lobbyists and environmentalists screw it up.”

Ferguson cited Secretary of State John Kerry’s recent statement, addressing a German audience, that Americans have “a right to be stupid” as symptomatic of our current decline.

“And it has been exercising that right for years,” Ferguson commented—by bankrupting future generations, by allowing civil society to wither while the welfare state takes its place.

But citing former British Prime Minister Margaret Thatcher’s death earlier this month, he added that Americans also have the right to be smart. We can make painful decisions with long-lasting benefits as she did—and afford Ferguson the opportunity to tell that story in a future book called The Great Regeneration.

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