Further Future: a 21st Century Economic Model -- Part 2

This is Part 2 of 2.  To read Part 1, click HERE.

No discussion of economics can exclude current hot button topics: income inequality, free trade, immigration and the urban/rural divide.  In the aggregate, the free trade regime promoted by every administration since Nixon’s breakthrough China policy has contributed to US economic growth.  The law of comparative advantage (first defined by David Ricardo, a disciple of Adam Smith) has been demonstrated to have the desired effect.  The US advantage in professional services, global management and innovation has served us well, creating high paying jobs in urban centers – New York, Silicon Valley, Chicago, Dallas, etc.  Unfortunately, the benefits are not universally available to everyone.  Or, to put it another way, no matter how many jobs are created for international tax experts in New York, none of them are going to be filled by a worker who has lost his job in a North Carolina furniture factory.  

In his book “The Future of Capitalism,” British economist Paul Collier proposes that we change the redistribution model.  Rather than tax the rich and give to the poor, he would have us adopt an “agglomeration tax.”  Mobility is critical to economic growth.  From the time of the Pilgrims, people all over the globe have fought to immigrate into the U.S. to take advantage of the economic freedom our social contract allows.  Within the U.S., migration between regions and from rural to urban centers is an indicator of economic success.  (That’s why the European Union adopted the Schengen Agreement permitting migration across national borders.)  Our economic growth has been driven by this agglomeration, particularly in the era of free trade.  Collier points out that not everyone benefits from their move to the big city.  Demand for housing and other retail products and services renders the cost of living much higher than outlying areas.  Those whose incomes fail to rise to the level necessary to offset the higher cost suffer.  Those whose income growth outstrips the higher cost thrive – investment bankers, lawyers, Silicon Valley entrepreneurs.  Collier’s agglomeration tax would take from the latter category and pass it on to rural communities to offset the economic damage.  

At first blush, this proposal might seem to make sense.  But redistribution hinders prosperity no matter how you design the formula.  And, in any event, such a proposal would be politically infeasible. 

The key to prosperity begins with capital formation.  If you don’t have the dough in your bank account to start a business, you have to attract investors.  And, investors are attracted to the prospect of great returns.  For government to fulfill its social purpose, it must create the conditions that attract private capital.  On the whole, the U.S. does a great job of this.  Indeed, our economic prospects rely upon our ability as a nation to attract Foreign Direct Investment (FDI).  

On a smaller scale, communities can only succeed by obeying the law of attraction.  Companies are attracted to friendly regulatory and low tax environments.  This may sound to you like an “old saw” from an old conservative (and it is!).  But that doesn’t make an invalid statement.  I’ll point to two examples of small cities who have overcome the impediments to economic development.  

Chattanooga, Tennessee famously bet the farm on high speed internet in 2010.  City government recognized that the path they were on would lead to the same type of failure experienced by other small manufacturing communities.  A $330 million project -- beyond the reach of the city’s budget, funded by $111 million from the federal government with the balance coming from municipal bonds issued by the city -- enabled the city to create no-latency internet service to any and all businesses and households.  The city has thrived by attracting high tech startups to its low-cost-of-living, superior-infrastructure setting.  More recently, the Lehigh Valley region of  Pennsylvania has begun its recovery from the shuttering of its steel plants by more traditional means.  Offering tax credits and abatements and promoting development of office parks was only the beginning.  The New York Times reports that recent economic development efforts are centered on development of urban centers to attract Millennials, featuring restaurants, bars and cultural centers.  

The critical element in these two stories is local initiative.  Attracting both federal grants and private investment is the prototype for small cities to thrive.  New ventures and established companies that will create jobs and young professionals who will settle, pursue careers and raise families is the key to success.  

States like New York, lacking the wisdom and fortitude to lower taxes and reduce regulation, make the mistake of substituting government funding for private capital.  The imposition of social criteria and friction costs reduce returns and ultimately fail the communities they endeavor to help.  

Local communities can learn from the successes of Chattanooga and the Lehigh Valley and create their own economic development strategies.  Strong communities keep talent at home, promote new ventures, support established businesses, improve city schools and create programs to train the workforce and provide transportation to where the jobs are.  

New habits, creative approaches and public buy-in are challenging.  For communities to succeed, its leaders – corporate, government and non-profit – must unite behind a common vision and convince the public to support it.  It won’t be easy; but it’s got to be done.

WHO WILL LEAD?