The Great Degeneration - How Institutions Decay and Economies Die — Niall Ferguson.

Why exactly has social mobility declined in the United States in the past thirty years, so that the probability has more than halved that a man born into the bottom 25 per cent of the income distribution will end his life in the top quartile?

Once the United States was famed as a land of opportunity, where a family could leap from ‘rags to riches’ in a generation. But today, if you are born to parents in the bottom income quintile, you have just a 5 per cent chance of getting into the top quintile without a college degree.

Darwinian forces are constantly at work

The law sets parameters in the same way that walls and fences do.

Some systems of law resemble centrally planned cities: like Moscow, with its over-wide avenues and homogenizing apartment blocks. Others are more like London: an unplanned complex of irregular streets and idiosyncratic buildings, the organic product of centuries of building and rebuilding by private and public property owners.

institutions — in the broadest sense of the term — determine modern historical outcomes, more than natural forces like the weather, geography or even the incidence of disease.

As recently as 300 years ago, the average Chinese was probably still a bit better off than the average North American. By 1978, the average American was at least twenty-two times richer than the average Chinese.

It was a conceit of the Cold War to refer to the Soviet empire as ‘the East’; in reality it was the last European empire to rule over large tracts of Asia.

Francis Fukuyama’s Origins of Political Order defines ‘the three components of a modern political order’ as ‘a strong and capable state, the state’s subordination to a rule of law and government accountability to all citizens’

The reason that Britain is richer than Egypt is because in 1688 . . . England . . . had a revolution that transformed the politics and thus the economics of the nation. People fought for and won more political rights and used them to expand their economic opportunities. The result was a fundamentally different political and economic trajectory, culminating in the Industrial Revolution.

and Robinson illustrate the power of institutions relative to geography and culture by describing the city of Nogales, which is bisected by the US–Mexican border. The difference in living standards between the two halves is shocking. The same point can be made with regard to the two great experiments run during the Cold War. Essentially, we took two peoples — the Koreans and the Germans — and divided them in two. South Koreans and West Germans got capitalist institutions; North Koreans and East Germans got communist ones. The divergence that occurred in the space of just a few decades was enormous.

The sequence is clear: first the Glorious Revolution, then agricultural improvement, then imperial expansion, then industrial revolution.

Having been more than twenty times richer than the average Chinese in 1978, the average American is now just five times richer. In a whole range of dimensions, the gap between the West and the Rest has narrowed dramatically. In terms of life expectancy and educational attainment, for example, some Asian countries are now ahead of most in the West. According to the 2009 OECD PISA study, the gap in mathematical attainment between the teenagers of the Shanghai district of China and those of the United States is now as big as the gap between American teenagers and Tunisians.

From 1689, Parliament controlled and improved taxation, audited royal expenditures, protected private property rights and effectively prohibited debt default. This arrangement, they argued, was ‘self-enforcing’, not least because property owners were overwhelmingly the class represented in Parliament. As a result, the English state was able to borrow money on a scale that had previously been impossible because of the sovereign’s habit of defaulting or arbitrarily taxing or expropriating. The late seventeenth and early eighteenth century thus inaugurated a period of rapid accumulation of public debt without any rise in borrowing costs — rather the reverse. This was in fact a benign development. Not only did it enable England to become Great Britain and, indeed, the British Empire, by giving the English state unrivalled financial resources for making — and winning — war. By accustoming the wealthy to investment in paper securities, it also paved the way for a financial revolution that would channel English savings into everything from canals to railways, commerce to colonization, ironworks to textile mills. Though the national debt grew enormously in the course of England’s many wars with France, reaching a peak of more than 260 per cent of GDP in the decade after 1815, this leverage earned a handsome return, because on the other side of the balance sheet, acquired largely with a debt-financed navy, was a global empire. Moreover, in the century after Waterloo, the debt was successfully reduced with a combination of sustained growth and primary budget surpluses. There was no default. There was no inflation. And Britannia bestrode the globe.

The heart of the matter is the way public debt allows the current generation of voters to live at the expense of those as yet too young to vote or as yet unborn.

These mind-boggling numbers represent nothing less than a vast claim by the generation currently retired or about to retire on their children and grandchildren, who are obliged by current law to find the money in the future, by submitting either to substantial increases in taxation or to drastic cuts in other forms of public expenditure. To

one of the first and most leading principles on which the commonwealth and the laws are consecrated is, lest the temporary possessors and life-renters in it, unmindful of what they have received from their ancestors or of what is due to their posterity, should act as if they were the entire masters, that they should not think it among their rights to cut off the entail or commit waste on the inheritance by destroying at their pleasure the whole original fabric of their society, hazarding to leave to those who come after them a ruin instead of an

little to respect their contrivances as they had themselves respected the institutions of their forefathers . . . SOCIETY is indeed a contract . . . the state . . . is . . . a partnership not only between those who are living, but between those who are living, those who are dead, and those who are to be born.

Not the least of these is that the young find it quite hard to compute their own long-term economic interests. It is surprisingly easy to win the support of young voters for policies that would ultimately make matters even worse for them, like maintaining defined benefit pensions for public employees.

The trouble is that the experience of the financial crisis has substantially strengthened the case for using the government deficit as a tool to stimulate the economy in times of recession, to say nothing of the wider case for deficit-financed public investment in infrastructure.

experience suggests that any government that tries seriously to reduce its structural deficit ends up being driven from power.

second scenario. Western democracies are going to carry on in their current feckless fashion until, one after another, they follow Greece and other Mediterranean economies into the fiscal death spiral that begins with a loss of credibility, continues with a rise in borrowing costs, and ends as governments are forced to impose spending cuts and higher taxes at the worst possible moment. In this scenario, the endgame involves some combination of default and inflation. We all end up as Argentina.

As our economic difficulties have worsened, we voters have struggled to find the appropriate scapegoat. We blame the politicians whose hard lot it is to bring public finances under control. But we also like to blame bankers and financial markets, as if their reckless lending were to blame for our reckless borrowing.

According to a number of influential commentators, the origins of the financial crisis that began in 2007 — and still does not seem to be over — lie in decisions dating back to the early 1980s that led to a substantial deregulation of financial markets.

it is hard to think of a major event in the US crisis — beginning with the failures of Bear Stearns and Lehman Brothers — that could not equally well have happened with Glass–Steagall still in force. Both were pure investment banks that could just as easily have been mismanaged to death before 1999.

Without rules to enforce the payment of debts and punish fraud, there can be no finance.

it is far from clear how forcing banks to hold more capital or make fewer loans can be compatible with the goal of sustained economic recovery, without which financial stability is very unlikely to return to the US, much less in Europe.

One of many new features of Basel III is a requirement for banks to build up capital in good times, so as to have a buffer in bad times.

The regulatory frameworks of the post-1980 period encouraged many banks to increase their balance sheets relative to their capital. This happened in all kinds of different countries, in Germany and Spain as much as in the United States. (We really cannot blame Ronald Reagan for what happened in Berlin and Madrid.) When property-backed assets fell in price, banks were threatened with illiquidity. The authorities found that they had to choose between a Great Depression scenario of massive bank failures or bailing the banks out. They bailed them out. Chastened by ungrateful voters (who still do not appreciate how much worse things could have got if the ‘too big’ had actually failed), the legislators now draw up statutes designed to avoid future bail-outs.

the statistician and options trader turned philosopher Nassim Taleb asks a wonderful question: what is the opposite of fragile? The answer is not ‘robust’ or ‘strong’, because those words simply mean less fragile. The true opposite of fragile is ‘anti-fragile’. A system that becomes stronger when subjected to perturbation is anti-fragile.24 The point is that regulation should be designed to heighten anti-fragility. But the regulation we are contemplating today does the opposite: because of its very complexity — and often contradictory objectives — it is pro-fragile.

regulators of the post-crisis world are doomed to fail in their efforts to make the global financial system crisis-free. They can never know enough to manage such a complex system. They will only ever learn from the last crisis how to make the next one.

The famous recommendation was that in a crisis the central bank should lend freely at a penalty rate: ‘Very large loans at very high rates are the best remedy . . .’ Nowadays we follow only the first half of his advice, in the belief that our system is so leveraged that high rates would kill it.

Those who believe this crisis was caused by deregulation have misunderstood the problem in more than one way. Not only was misconceived regulation a large part of the cause. There was also the feeling of impunity that came not from deregulation but from non-punishment. There will always be greedy people in and around banks. After all, they are where the money is — or is supposed to be. But greedy people will commit fraud or negligence only if they feel that their misdemeanour is unlikely to be noticed or severely punished. The failure to apply regulation — to apply the law — is one of the most troubling aspects of the years since 2007. In the United States, the list of those who have been sent to jail for their part in the housing bubble, and all that followed from it, is risibly short. In the United Kingdom, the harshest punishment meted out to a banker was the ‘cancellation and annulment’ of the former Royal Bank of Scotland CEO Fred Goodwin’s knighthood.

Tom Bingham, specified seven criteria by which we should assess a legal system: the law must be accessible and so far as possible intelligible, clear and predictable; questions of legal right and liability should ordinarily be resolved by application of the law and not by the exercise of discretion; the laws of the land should apply equally to all, save to the extent that objective differences [such as mental incapacity] justify differentiation; ministers and public officers at all levels must exercise the powers conferred on them in good faith, fairly, for the purpose for which the powers were conferred, without exceeding the limits of such powers; the law must afford adequate protection of fundamental human rights; means must be provided for resolving, without prohibitive cost or inordinate delay, bona fide civil disputes which the parties themselves are unable to resolve; and adjudicative procedures provided by the state should be fair.

Alexis de Tocqueville shrewdly observed when comparing the United States and France in the 1830s and 1840s, the French preferred equality to liberty. This preference resulted in a strong central state and weak civil society. When the French exported their model to their colonies in Asia and Africa, the results were even worse.

When a judge decides a case which comes before him, he does so on the basis of what he understands the law to be. This he discovers from the applicable statutes, if any, and from precedents drawn from reports of previous judicial decisions . . . In the course of deciding the case before him he may, on occasion, develop the common law in the perceived interests of justice, though as a general rule he does this ‘only interstitially’ . . . This means not only that he must act within the confines of the doctrine of precedent, but that the change so made must be seen as a development, usually a very modest development, of existing principle and so can take its place as a congruent part of the common law as a whole. In this process, what [F. W.] Maitland has called the ‘seamless web’, and I myself . . . have called the ‘mosaic’, of the common law, is kept in a constant state of adaptation and repair, the doctrine of precedent, the ‘cement of legal principle’, providing the necessary stability.

I began to read, with mounting horror, about the extent of offshore refuse dumping. It is a practice beyond the control of any government, regulator or law. Unlike a landfill site, the ocean is a free rubbish dump. Unlike the stuff earlier generations threw into it, plastic rubbish is neither biodegradable nor heavy enough to sink. Where it ends up is decided by the currents, tides and winds.

What is happening? For Putnam, it is primarily technology — first television, then the internet — that has been the death of traditional associational life in America. But I take a different view. Facebook and its ilk create social networks that are huge but weak. With 900 million active users — nine times the number in 2008 — Facebook’s network is a vast tool enabling like-minded people to exchange like-minded opinions about, well, what they like. Maybe, as Jared Cohen and Eric Schmidt argue, the consequences of such exchanges will indeed be revolutionary — though just how far Google or Facebook really played a decisive role in the Arab Spring is debatable.20 (After all, Libyans did more than just unfriend Colonel Gaddafi.) But I doubt very much that online communities are a substitute for traditional forms of association.

Tocqueville was surely right. Not technology, but the state — with its seductive promise of ‘security from the cradle to the grave’ — was the real enemy of civil society.

Of course, this is the kind of thing that the left reflexively denounces as ‘elitist’. Even some Conservatives, like George Walden, regard private schools as a cause of inequality, institutions so pernicious that they should be abolished. Let me explain why such views are utterly wrong. For about a hundred years, no doubt, the expansion of public education was a good thing. As Peter Lindert has pointed out, schools were the exception that proved Tocqueville’s rule, for it was the American states that led the way in setting up local taxes to fund universal and indeed compulsory schooling after 1852. With few exceptions, widening the franchise elsewhere in the world led swiftly to the adoption of similar systems. This was economically important, because the returns to universal education were high: literate and numerate people are much more productive workers.24 But we need to recognize the limits of public monopolies in education, especially for societies that have long ago achieved mass literacy. The problem is that public monopoly providers of education suffer from the same problems that afflict monopoly providers of anything: quality declines because of lack of competition and the creeping power of vested ‘producer’ interests. We also need to acknowledge, no matter what our ideological prejudices, that there is a good reason why private educational institutions play a crucial role in setting and raising educational standards all over the world. I am not arguing for private schools against state schools. I am arguing for both, because ‘biodiversity’ is preferable to monopoly. A mix of public and private institutions with meaningful competition favours excellence. That is why American universities (which operate within an increasingly global competitive system) are the best in the world — twenty-two out of the world’s top thirty according to rankings by Shanghai Jiao Tong University — while American high schools (in a localized monopoly system) are generally rather bad — witness the 2009 results of the Programme for International Student Assessment for mathematical attainment at age fifteen. Would Harvard be Harvard if it had at some point been nationalized by either the State of Massachusetts or the federal government? You know the answer.

The apologists of traditional state education need to grasp a simple point: by providing ‘free’ state schooling that is generally of mediocre quality, you incentivize the emergence of a really good private system (since nobody is going to pay between £10,000 and £30,000 a year for an education that is just a wee bit better than the free option

indeed most societies — would benefit from more private initiative and less dependence on the state. If that is now a conservative position, so be it. Once, it was considered the essence of true liberalism.

Explanations that emphasize the role of geography, climate, disease or natural-resource endowments are less convincing today than they seemed in the eighteenth century. Scientific knowledge, technological innovation and market integration have greatly reduced the significance of distance, weather and germs, while mineral wealth has been revealed to be as much a curse as a blessing. Explanations that assert racial differences in intelligence or industriousness are no longer taken seriously. There are pronounced differences in IQ between genetically indistinguishable populations, such as West and East Germans

In 2007 the average income of Americans in the top 1 per cent in terms of income was thirty times that of the average income of Americans in the remaining 99 per cent.

To answer that question it is helpful to borrow former US Defense Secretary Donald Rumsfeld’s famous typology of ‘known knowns’, ‘known unknowns’ and ‘unknown unknowns’ — but to add a fourth category: ‘unknown knowns’. These are the future scenarios that are quite well known to

However, the pace of global technological diffusion seems likely to remain high and this will encourage the continued migration of people from the country to the cities. The developing world’s new ‘megacities’ — conurbations with populations of more than ten

Those with vast accumulations of assets, including sovereign wealth funds (currently in excess of $4 trillion) and hard-currency reserves ($5.5 trillion for emerging markets alone), are the ones with loaded guns. The economies with huge public debts (which now total nearly $50 trillion worldwide), by contrast, are the ones that have to dig. In such a world, it pays to have underground resources. But these are not distributed at all fairly. By my calculations, the estimated market value of the world’s proven subsoil mineral reserves is around $359 trillion, of which over 60 per cent is owned by just ten countries: Russia, the United States, Australia, Saudi Arabia, China, Guinea (which is rich in bauxite), Iran, Venezuela, South Africa and Kazakhstan.

Add to this the problem of nuclear proliferation, and it does not seem unreasonable to regard the world as a more dangerous place than it was during the Cold War, when the principal threat to mankind was the calculable risk of a worst-case outcome to a simple two-player game. Today we face more uncertainty than calculable risk. Such is the result of exchanging a bipolar world for a networked one.

Revolutions are caused by a combination of food-price spikes, a youthful population, a rising middle class, a disruptive ideology, a corrupt old regime and a weakening international order. All these conditions are present in the Middle East today — and of course the Islamist revolution is already well under way, albeit under the misleading Western label of the ‘Arab Spring

The harsh reality is that, from the vantage point of 2012, the next twenty-five years (2013–38) are highly unlikely to see more dramatic changes than science and technology produced in the last twenty-five (1987–2012). For a start, the end of the Cold War and the Asian economic miracle provided one-off, non-repeatable stimuli to the process of innovation in the form of a massive reduction in labour costs and therefore the price of hardware not to mention all those ex-Soviet PhDs who could finally do something useful.

if we succeed in protracting the life of the body but not of the mind — the net economic consequences will be negative, because we will simply increase the number of dependent elderly.

Countries arrive at the stationary state, as Adam Smith argued, when their ‘laws and institutions’ degenerate to the point that elite rent-seeking dominates the economic and political process.

Public debt — stated and implicit — has become a way for the older generation to live at the expense of the young and the unborn. Regulation has become dysfunctional to the point of increasing the fragility of the system. Lawyers, who can be revolutionaries in a dynamic society, become parasites in a stationary one. And civil society withers into a mere no man’s land between corporate interests and big government.