Why the Character of Governance Matters

Our book The Captured Economy is small, but it addresses a big topic, which is the confluence of sluggish growth and spiraling inequality. Most of the book gets down in the weeds of regulatory policy, showing the ways that financial regulation, intellectual property protection, occupational licensing, and zoning have redistributed income upward while inhibiting economic dynamism. But underneath all the wonkery is an argument for moving away from the current left-right divisions that have characterized our politics for the last few decades, and toward what you could call “limited big government.”

Our current Democratic-Republican debates collapse two different dimensions of politics that can be usefully pried apart. Ideological conflict focuses on the extent of collective action problems and the appropriate scope of government. Those on the right traditionally argue that collective action problems are relatively small—in other words, that most of what is worth doing in society can best be accomplished privately without government involvement. Accordingly, the proper scope of government is fairly narrow. Those on the left, by contrast, see collective action problems—things like external costs, information asymmetries, free riding, public goods, and merit goods—as widespread and important, and thus believe that government can improve greatly upon purely private outcomes through either regulation or public spending.

While our position is somewhat idiosyncratic in this debate, we come down on the side of wide-ranging and activist government. On matters involving public health and safety, environmental quality, racial and sexual discrimination, money and finance, poverty and social exclusion, education, and healthcare, we recognize a strong role for government.

But governments are not simply frictionless instruments for resolving collective action problems. Some governments, both within the United States and across nations, are better at acting in the public interest than others, are less likely to be captured by special interests than others, and are more able to address public problems in a straightforward and transparent manner rather than through a sprawling mess of disjointed measures that are incomprehensible to citizens. And within any government, there is a wide variety of policy instruments and approaches that are more or less susceptible to these pathologies of governance.

In short, politics can usefully be understood along both a “scope of government” and a “character of governance” dimension. The Captured Economy fits in the space that accepts the normative case for big government, but recognizes that the potential pathologies of governance call for constitutional and other limits on state action that push public policy toward the most effective, public-spirited, and democratically comprehensible forms. In this vision, the most important limits on government are not those that try to constrain the size or scope of government but those that shape the character of state action.

This position may seem odd because advocates of an expanded government role in the economy have often had to battle through powerful constitutional constraints on the state. Conservatives tried to spike the emergence of the modern state through principles like enumerated powers, the nondelegation doctrine, and the like, and thus progressives found themselves in the role of arguing for liberating government from formal constraints at all levels. While we did get some new quasi-constitutional rules in the emergence of the modern regulatory/welfare state (think of the Administrative Procedures Act, for instance), liberals generally found themselves in the position of supporting anything-goes constitutionalism in the realm of social and economic legislation. (On issues of personal freedom and civil liberties, by contrast, progressives have embraced strong constitutional checks on majoritarian democracy.)

We think, by contrast, that big government and some formal constraints on government action, designed primarily to correct for inherent challenges in reconciling big government and deliberative democracy, are two great tastes that taste great together. In particular, we argue for a combination of rules and informal governing norms that establish a very strong bias toward big, simple, transparent forms of government intervention—shoving rather than nudging.

Consider the issue of mortgage finance, which we discuss in our book. Our critique focuses not on the policy objective of encouraging home ownership but rather the means chosen to accomplish that objective. The simple, direct option would have been subsidizing home ownership directly through transparent, on-budget fiscal transfers, like down payment assistance for lower-income households. Instead, policymakers over the course of the past century have elected to subsidize mortgage credit by bestowing special favors on the businesses that provide it—first the savings-and-loan industry (which ended in collapse) and then the mortgage securitization industry (which experienced an even bigger collapse but has not ended)—and subsidizing borrowing through the mortgage interest deduction.

There are obvious political advantages to the path taken: the costs are hidden, so democratic accountability for taxing some to help others is conveniently attenuated. But the economic costs involved in this choice of means have been staggering, as have been the rents that in recent decades accrued to financial firms that cashed in on the securitization boom.

Or consider another issue, financial security in retirement, which we don’t tackle in our book. The United States currently runs two parallel systems. One, Social Security, takes in payroll taxes with one hand and sends out checks with the other. Now, it is certainly the case that it takes in a lot of payroll taxes and sends out a lot of checks. But it achieves its basic goals in a fairly transparent and controllable fashion. We might choose to raise payroll taxes and replace more income in retirement, or raise fewer taxes and replace less income. But the system’s basic architecture distorts private markets as little as possible given the mission it has been given. And while the system is not “means tested” in the sense of only targeting money at the poor, it does have redistributive effects. Finally, the system is immensely popular despite the large taxes that are imposed to fund it—voters have consistently and repeatedly given some form of consent for the system more or less as it is.

Consider, by contrast, our complex system for subsidizing retirement income through 401ks and IRAs. The system is incredibly complex, and few Americans understand how it operates. Its benefits flow in a fashion that redistributes sharply upwards. It fails to help most Americans fund their retirement, but it does subsidize the perpetuation of a very large, mostly actively managed mutual fund industry that charges large fees for which (since investors as a whole cannot, by definition, outperform the market) there is no good justification.

Both systems are big government. But one is simple, relatively transparent, and basically achieves its objectives, while the other is complicated, opaque, and fails to do much to support the retirement incomes of those who need help the most. One way of vindicating public purposes works relatively well, and the other doesn’t. We should therefore think about ways to shift away from policies of the latter kind, by making it more difficult to do policymaking through the tax system.

The concept of limited big government should make us think differently about the desirability of various forms of formal and informal constraints on government. Consider, for example, the case of state development tax incentives. Which is the “big government” position? Is it allowing states to compete to attract firms through a myriad of different handouts (which in the process narrow the state tax base)? Or should there be national rules that severely limit state handouts, rooted in the dormant commerce clause? The second option represents much better governance, is more transparent, and is less vulnerable to capture by narrow private interests. That’s true even if it has the effect of increasing the tax base of state governments.

The examples we’ve cited above are calculated to push libertarians and free-market conservatives out of their comfort zones, but we strive to be equal-opportunity irritants. Specifically, there are a number of areas where progressives need to recognize that big government works best when it works within limits.

As we show in the book, the last few decades have seen an explosion of occupational licensing, largely at the behest of professional groups seeking to increase their status and incomes. Licensing generally has the effect of redistributing upward and increasing prices for consumers, and its effects are especially mischievous in the healthcare sector. But the politics of licensing are generally such that policymakers can rarely resist the siren call of organized interests to provide it—the Olsonian logic of concentrated beneficiaries and diffuse costs is especially strong here. This is not a sign of healthy democracy at work, but of special interests exploiting a weakness in democracy’s DNA. It would be more democratic, in a deliberative sense, to establish higher standards of justification when professions seek to bar entry by law (a move that the Supreme Court is just starting to dip its toe into).

We see another example of this same dynamic in the housing market. In recent decades increasing restrictions on new construction have resulted in grossly inflated housing prices, especially in the nation’s big coastal cities. Since those cities are now our main engines of innovation and growth, discouraging people from moving there has seriously negative consequences for national economic performance as well as opportunities for upward social mobility. Legacy landowners, meanwhile, have made out like bandits: according to Northwestern University economist Matthew Rognlie, the increase in capital’s share of national income has been driven mainly by escalating home prices.

These dysfunctional outcomes flow from a dysfunctional policymaking process. The hyperlocal method of making land-use decisions—in which thousands of different municipalities decide matters typically on a parcel by parcel basis—takes the normal Olsonian dynamics and turbocharges them. In these small-scale, obscure decisionmaking settings, virtually the only interests with the incentive to organize and participate are the immediate neighbors who bear almost all the downsides of development (disruption during construction, increased congestion) and enjoy none of the upsides. Thus has NIMBY (“not in my back yard”) degenerated into BANANA (“build absolutely nothing anywhere near anything”).

This sad state of affairs, which is overwhelmingly a problem of progressive governance in big, blue-state cities, calls out for limits on local control. Moving toward metro-area-wide zoning plans for housing growth, transferring some decisionmaking to state capitals, and even federal constraints (such as by withholding federal infrastructure funds or mortgage-interest deductibility) could improve matters by restricting local authority over development decisions.

In The Captured Economy, we focus on the particular problems of slow growth and high inequality, but our “limited big government” approach is capable of much wider application. We invite readers to consider the book as a contribution to the ongoing effort to develop a “liberaltarian” synthesis that combines the best elements of “classical” and contemporary liberalism. This synthesis upholds the power and importance of core libertarian ideas that tend to be undervalued by progressives: suspicion of centralized power; alertness to the unintended consequences of government policies and the vulnerability of those policies to special-interest capture; and recognition of the immense creative power of competitive markets. But in liberaltarian hands, these ideas are deployed as tools for reforming and improving the modern regulatory/welfare state—not as reasons for dismantling it.