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  1. Defining Bidenomics

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    A new American industrial policy—“Bidenomics”—has arrived, consisting of the Inflation Reduction Act (IRA), the Infrastructure, Investment and Jobs Act, and the CHIPS and Science Act. The proclaimed goals of Bidenomics are to propel a green energy transition to confront climate change, revive American manufacturing and union density, and check China’s economic and military power. President Biden recently described this economic agenda as a “fundamental break from the economic theory that has failed America’s middle class for decades now, trickle down economics.” National Security Adviser Jake Sullivan criticized “a set of ideas that championed tax cutting and deregulation, privatization over public action, and trade liberalization as an end in itself,” synthesized in the belief  “that markets always allocate capital productively and efficiently.” The Biden administration, in other words, has been forthrightly repudiating neoliberalism, at least on the level of rhetoric. 

    A new landscape for political and economic struggle is emerging, but many questions remain. Will Bidenomics actually help achieve the critical goals of reviving working class power and confronting climate change? To what degree does this new political economic paradigm signal a sharp break from neoliberalism? How closely is Bidenomics linked to US policy concerns around Chinese dominance and the threat of a “New Cold War”? Finally, where do these policies leave the global South? 

    In the following conversation, Daniel Denvir interviews Daniela Gabor, Ted Fertik, and Tim Sahay. Daniela Gabor is professor of economics at University of the West of England (Bristol). She studies development and debt with a critical macrofinance lens and researches the capitalist derisking state. Ted Fertik is a historian and strategist at the Working Families Party. Tim Sahay is the co-editor of The Polycrisis, focusing on the domestic and international political economy of climate. Listen to the discussion on The Dig here. The transcript has been edited for length and clarity, and is co-published with Jacobin Magazine.

    A conversation with Ted Fertik, Daniela Gabor, and Tim Sahay

    Daniel denvir: First coined by outside observers, “Bidenomics” is a term now embraced by the Biden administration. What is Bidenomics, and what does it have to do with industrial policy?

    Ted fertik: From the perspective of the administration, Bidenomics has three key aspects. First, there’s a distributional aspect, about building the economy “from the bottom up and the middle out,” which is an explicit rejection of trickle-down economics. Second, there’s a sectoral industrial policy aspect. Third, there’s an emphasis on place-based policy—both in a global and a domestic sense, with a lot of concern for communities that have borne the brunt of deindustrialization.

    TIM SAHAY: Bidenomics is a new legislative and macroeconomic policy mix, developed by Democratic Party elites to contain the threat of Trumpism. It’s their answer to the question social democrats are asking the world over: Why can’t the center hold? Their diagnosis is that economic and political polarization was created by the winner-takes-all, low investment, low growth, neoliberal policy regime. The gap between those with and without college degrees widened (that’s the class component) along with the gap between “Super Zips” and suburban and rural areas (that’s the place element), which created political instability. 

    They want to reverse these trends by pursuing a legislative investment agenda to restore broad-based growth. On retaking Congress, they pursued a “big fiscal” program—to put money into people’s pockets as well as increase the overall sum of public and private investment. Bidenomics also has a macroeconomic component of running a hot labor market with the Fed targeting full employment and risking inflation going above the 2% target. Together these created a high pressure economy that creates upward mobility for people at the back of the labor queue. The gaps between black-white unemployment rates and wage growth for those with and without college degrees has narrowed dramatically.

    How do you design spending packages with those class, place, race inequality-reversal goals? These policy provisions include “buy American” and “make in America” requirements, subsidies for manufacturers, federal loan guarantees for green projects, place-based incentives, and public R&D to boost future growth. They include plugging the terribly patchy welfare system through earned income tax credits, unemployment insurance, and SNAP expansion. These have been paired with pro-labor provisions that seek to increase union density and create jobs for those without college education. 

    How do you pay for it? Do you tax or do you borrow? Here their choice was to make bills “paid for” by progressive taxes on the rich and closing tax loopholes of Fortune 500 companies. This component of Bidenomics should not be forgotten. The different factions of the Democratic party—Wall Street and Silicon Valley friendly centrists and progressives—had a slugfest in Congress over taxes. That reduced the size of the spending packages, leaving behind whole swathes of Democratic caucus priorities—childcare, pre-K, schools, public housing, public transit. One must remember that Bidenomics has been hugely contested and shaped by the thin Congressional majorities that it is trying to fix.

    DD: There are three key legislative aspects to Bidenomics: the 2021 Infrastructure Act, and the 2022 CHIPS and Science Act, and Inflation Reduction Act (IRA). What does this bundle of legislation set out to do? How does it seek to expand productive capacity in particular sectors to drive the green energy transition? And how do the three pieces of legislation fit together? Can it be said, as Lachlan Carey and Jun Ukita Shepard do, that CHIPS is the brain, Infrastructure the backbone, and IRA the engine? Is it really that coherent? 

    TS: That is a good metaphor. While I don’t think that the Biden White House and Senator Schumer and Speaker Pelosi made an active decision to split up the bills—that was forced on them in negotiations with moderates—there is a coherence. CHIPS and Science Act is the “brains,” because it is aimed at improving research and development, and pours money into the entire alphabet soup of American science: technology, medicine, biotech, and all of R&D agencies. Furthemore, those agencies have their own research institutes—such as the National Institutes of Health—which are spread across the country, not just located in the high tech clusters around Cambridge, Massachusetts or Silicon Valley. Therefore they would help reverse polarization by bringing innovation and productivity to other clusters across the country. 

    As for infrastructure, the Investment and Jobs Act is the “backbone” in the sense that it’s meant to create the grid and rural broadband. For example, $60 or $70 billion have been funneled into modernizing the grid, which is presently unable to take on the huge amount of renewable energy that needs to be installed. The IRA is an “engine” in that it comprises an enormous artillery of public finance for loans, grants, and tax credits that build out this renewable energy system while driving manufacturing growth. But legislatively they have different logics. CHIPS and IIJA are bipartisan with 14 Republican senator votes, while IRA is Democrats-only. The bills were split up against the desire of progressives in Congress who lost leverage in that compromise.

    TF: Though it has perhaps been less emphasized in recent debates, the Biden spokespeople would claim that the American Rescue Plan (ARPA), which was passed on a pure party line vote in March 2021, serves as the fourth Bidenomics bill. It is based on the idea of running the economy hot, using raw fiscal power to juice aggregate demand. It also included programs like the expanded Child Tax Credit, which points towards the aspiration of Bidenomics to make structural changes to the US welfare state, even though these were ultimately shorn from what became the IRA. 

    The coherence of these bills can be found in understanding the set of problems that they’re meant to address. In an earlier talk that Tim and I gave, we laid it out as a triangle: what China’s rise means for the US economy and its “global leadership,” the question of the US political system and the sort of intertwined questions of inequality and populism, and lastly, climate. All of these three terms interact in important ways.

    DD: Daniela, you’ve argued that these measures are fundamentally flawed as they prioritize a narrow form of government intervention, namely, the derisking of private investment. What is “derisking”? And why does it fail to get us to where we need to be in terms of reaching zero emissions and other related goals like increasing union density and raising worker wages?

    Daniela Gabor: Let me take a step back from derisking and spell out how I think about Bidenomics as somebody outside of the US domestic politics process. First, what does it displace? It displaces a lack of political willingness to engage with questions relating to the climate, employment, and workers rights. Second, what does it offer as a replacement? Some form of increased state intervention in these issues. 

    As it “brings the state back,” what kind of state-capital relationship does Bidenomics put in place? I describe this relationship as “derisking,” though it’s not a term that I came up with but rather one that has been used, particularly by private finance, to conceptualize the role of the state in mobilizing private capital for the energy transition in the global South: changing risk-return profiles to make investments more attractive for private finance.

    To put it in the words of the Biden administration, it’s about “crowding in” private investment. The basic logic of the approach is to bribe private capital into fulfilling the certain policy priorities that are considered otherwise unachievable. It is constrained by the fact that we still live under an architecture of macroeconomic policymaking that puts independent central banks at the helm and subordinates fiscal policy to the priority of inflation-targeting. 

    In my view derisking is a conceptual lens to think about the relationship between state and private capital that is created through the return of the state in climate politics. This derisking approach is an inadequate script for the climate transition, and it will not achieve the structural transformation needed for alignment with the Paris targets.

    Carrots and sticks

    DD: Instead of bribing capital, you argue instead for the formation of a “big green state.” What is that? And what tools would a big green state wield to discipline capital?

    DG: Bribing is at the core of derisking in the sense that the state absorbs some risks from private investments in order to make certain public policy priorities investable—by improving the price signal or risk-return profile of those priority projects through fiscal, monetary, or regulatory measures.

    With derisking, because the logic is of partnerships for investability, the state cannot discipline private capital into strategic priorities when market conditions change or when profitability conditions change—which is precisely what a big green state can do. It can move away from the logic of the market signal by enforcing closer controls on the pace and nature of private investment or just through public ownership. Another thing the big green state can do is change the relationship between the institutions of macroeconomic policymaking, ushering closer coordination between, for example, the central bank and finance ministry to support a more disciplined approach to industrial policy.

    DD: Ted and Tim, are some of what Daniela characterizes as carrots actually sticks?

    TF: There are a few angles from which we can approach this subject. One is to ask what progressive aims were encoded in the IRA and might not in fact follow the derisking logic that Daniela articulates. Another angle is to consider things that are getting done through regulation, or that could get done through regulation, but lie outside this particular piece of legislation. Still another angle is to consider parts of the agenda that did encode a disciplining logic but did not make it into the final legislation: for example, the clean energy payments program, which essentially mandated the full decarbonization of the power sector in the United States, and which didn’t pass.

    dd: Because of the balance of political forces.

    TF: Yes. We could also consider if and how this derisking logic might be defensible from a progressive point of view. For instance, there is a real theory which posited that you could get much more fiscal bang for your buck through the use of the tax code that enabled a much greater amount of climate spending than what the Congressional Budget Office would normally allow. These uncapped tax credits are what Tim has called “bottomless mimosas.” But ultimately, we should discuss if these moves affect the balance of political forces, which is at the most basic level why we get the reality we get. 

    There’s obviously an immense amount of truth to what Daniela is saying. The core idea behind the legislation is to redirect—whether through pushing or coaxing the flow of private investment towards socially or politically useful purposes. People are very explicit that they ultimately expect the amount of private investment to be much bigger than public investment. I don’t think the situation is as extreme as some of what you see in discussions about how to get green investment flowing to the global South, where the ratios (“billions to trillions”) are astronomical. But the underlying logic is the same.

    TS: As regards the balance of political forces, let’s recall that the Bidenomics legislative package had to make its way through Congress, where it was hemmed in by three major forces. One was the deficit hawks: those who don’t want spending to be greater than revenue, and want every dollar of spending to be backed by a dollar raised through politically costly taxation. This group includes figures like Treasury Secretary Janet Yellen, speaker Nancy Pelosi, and Biden himself.

    The second was China hawks in Congress and the administration, who took the baton from the Trump administration and drove a very aggressive agenda focused on China containment. They insisted on onshoring chips and solar panel manufacturing, remaining careful about critical minerals, and increasing the Pentagon’s budget to mount a two-front war against Russia and China. 

    The third group are fossil capitalists, or fossil hawks, whose influence has grown tremendously in the last ten or fifteen years. Under Obama, Congress strongly supported the shale boom in the Appalachian and the Permian Basin with subsidies and approvals of pipelines and terminals. By 2015, the United States had become the world’s largest oil and gas producer. By 2021–2022 when these bills were being negotiated, these fossil hawks in Congress demanded an increase in drilling and no sticks on fossil capital.

    Dg: The US CHIPS Act draws on previous models of successful industrial policy, particularly in East Asia. Specifically, it mandates comparative state institutions whose purpose is to monitor and discipline capital to fulfill strategic priorities. Why was it possible for the US to build such comparative institutions into the US CHIPS Act but not in the IRA? Is it because the power of fossil capital operates differently in these different spaces? CHIPS maybe doesn’t have the same kind of political concern for fossil capital that the US IRA has.

    Dd: And also perhaps the positive motivation of geo-economic and geopolitical conflict with China —which, depressingly, seems to be the sort of motivation that can overcome almost any obstacle in American politics?

    Tf: An interesting dynamic is that CHIPS activated anxieties about corporate concentration on the left in a much more intense way than the IRA did. While the IRA offered opportunities for profit making over a ten or twenty year horizon, CHIPS promised to funnel billions of dollars directly to four or five companies that already had a massive market share within their respective sectors. The Progressive Caucus in the Congress was public about their concern. For example, the ban on stock buybacks in CHIPS—which is not actually in the legislation itself, but rather in a subsequent rulemaking that the Commerce Department undertook—was something the Progressive Caucus explicitly fought for. While we were all absolutely in favor of investments in science and technology, and understood the need for resiliency and supply chains, we did not want this to amount to a massive exercise in corporate welfare. 

    TS: Are these subsidies corporate welfare? I’m not persuaded by the binary between CHIPS and the IRA. To begin with, what do we mean by sticks?

    Certainly the IRA doesn’t have very many actual penalties, but there are two important ones. Firstly, it’s a tax bill, because the deficit hawks insisted that it be made into a tax bill that pays for itself. How is IRA spending to be calculated? Well, the Congressional Budget Office is going to score the bill, determining how much spending has occurred via tax credits, and demanding they be matched by “revenue raisers,” i.e taxes.

    The Biden administration, right from the get go in March of 2021, when the American Jobs Plan and the American Family Plan were released, also introduced an entire slew of measures that were intended to raise $4.5 trillion through taxes. That basically entailed reversing the Trump era tax cuts on Fortune 500 companies and installing a new tax on those earning more than $400,000—recall Biden promised not to raise taxes on anyone making less than that amount. But during negotiations, corporate forces essentially said, “Screw you, you aren’t going to tax us,” and so $4.5 trillion fell to $2.5 trillion, finally down to $1.75 trillion in the House bill. The final bill is still a tax bill, but it’s much smaller. It puts a 15 percent corporate alternative minimum, which will generate $200 billion of taxes. That’s a penalty on tax-avoiding corporations, and it gives the IRS more money to go after tax-evaders. And there’s a 1 percent tax on stock buybacks included in IRA.

    Dg: But this is not a penalty. It’s not a stick that ensures the companies who receive subsidies are pursuing the industrial policy objectives of the government. If anything, it’s the opposite. 

    Ts: Yes, it’s a general tax on capital and not a specific penalty on firms that obtain subsidies. My point is that the IRS—which is under threat, but partially reconstructed under the Biden administration—is the agency through which much of US industrial strategy is being channeled. The Treasury, which is interpreting Congress and writing rules, needs to hire enough staff to monitor these uncapped tax credits and prevent those bottomless mimosas from turning into champagne for the rich or into carbon sludge. Without strong enforcement, greenwashing firms could show up at the Treasury door with greenwashed projects—which then would turn the IRA programs into a form of corporate welfare.

    DG: I worry when progressives are told to celebrate a situation in which the distributional outcome favors capital. The idea that your tax officers are going to be in charge of green industrial policy is wishful thinking. Let’s not confuse that state of affairs for successful green industrial policy—let alone progressive distributional outcomes.

    I don’t know when an IRS tax officer is going to say to Ford or to Tesla “your electric vehicles are getting larger and larger and are using more and more resources.” What we need instead are regulations for smaller electric cars and legislation to support electric public transport. We have to be critical and careful as we leave behind the status quo that was against any kind of progressive climate politics, and move into a “bottomless mimosas” approach, which even some unions in the US are questioning as not so much in favor of either creating skilled jobs. There are grounds for skepticism. 


    dd: It seems like a basic point of debate here isn’t so much whether this new industrial policy is beset by the contradictions of neoliberal capitalism, which everyone accepts, but rather whether it is pointing us in any sort of promisingly new direction. 

    tf: IRA does discipline fossil capitalism in that it includes a fee on methane that was viciously fought by the fossil fuel industry. If progressives could not get outright sticks, then we pushed for carrots to encourage good behavior and this is why much of the labor movement was genuinely enthusiastic about the IRA. Consider the basic clean energy tax credit, which is going to incentivize wind, solar, geothermal, and so on. While the baseline credit you get for installing such generation facilities is 6 percent, that goes up to 30 percent if you pay prevailing wage for construction, which is a 24 percent differential. This does not guarantee union organization—not by any stretch—but it very significantly levels the playing field between nonunion and union labor. 

    There are many provisions that encourage private investors to meet certain priorities. There’s an energy communities provision that gives an additional bonus tax credit for locating generation in certain places that were heavily dependent on the fossil economy or that suffered from impacts of extraction. There’s a 20 percent bump to encourage investments in low-income communities.

    Another provision called direct pay, which progressives rightly count as a big win, means that public and nonprofit entities can for the first time receive tax credits as a direct cash payment, even though they have no tax liability. As a result, municipal governments, for example, can get in on the clean energy game in a way that they were structurally excluded from before, which creates the opportunity for public ownership. 

    DD: This was crucial to the feasibility of New York’s recently passed Build Public Renewables Act .

    tf: Absolutely. It helped move the dug in opposition of the New York Power Authority and the New York State Governor towards a basic openness because, thanks to direct pay, they could tap into a massive amount of direct federal funding to build renewables themselves. 

    There were some major progressive goals that were brought into the initial debates about how to structure industrial policy for the auto industry. A publicly owned competitor to private car companies was obviously never on the table, but everybody agreed that a key component of decarbonizing the economy was decarbonizing autos and finding the highest road pathway forward. 

    Initially the bill encoded a union bump on the EV tax credit: $4,000 on top of the $7500 general EV credit if it was made in a union facility. This was meant to be an explicit bonus to the unionized auto sector in the northern Midwest. And a disadvantage to the nonunion foreign and US automakers that mostly produce in Right to Work states in the South. The union bump was viciously opposed by the EU, as well as Canada and Mexico. And it was opposed by Joe Manchin, who anticipated foreign nonunion EV production coming to West Virginia. It was slashed.

    What emerged finally from that fight were some progressive elements from Manchin: an income cap that prevents rich households making over $300,000 from getting the EV tax credit, and $4000 used car incentive. 

    But there were significant shortcomings that people in the administration didn’t like, and that the auto unions like UAW have been rightly upset about. The structures in the clean energy tax credit don’t exist in the manufacturing tax credits—there’s little in the law on the manufacturing tax credits or in Department of Energy loans to automakers that encourages prevailing wage or any labor standards. 

    DD: It is a split-screen situation with labor and the IRA/IIJA because on the one hand, you have this recent huge win by the steel workers at Blue Bird electric bus factory in Georgia, which unionized thanks to the EPA’s rule for their clean school bus program—which states that recipients of funds must agree to union neutrality and bars the use of federal funds for anti union activity—something that the steel workers used to their advantage, and won a very notable victory in the South.

    On the other hand, the UAW just released statement from the new militant leadership of their union, attacking this DOE plan to lend $9 billion to Ford to build three battery plants with no labor strings attached. It’s part of this more general concern from the UAW that the move to EVs will accelerate, rather than reverse the decline of union density in auto manufacturing. 

    What sort of terrain has Bidenomics created for labor?

    DG: A 24 percent tax credit is a lot more than 6 percent, and so Ted’s case sounds persuasive. One of the difficulties with the Biden administration is that it is like an onion with an outside layer of progressive politics but with a hard inner core of pro-capital distributional politics. 

    I want to see the data as to the extent to which the announced IRA private investments are really using the 24 percent tax credit. Is the only possible way to achieve better working conditions to bribe private capital? I have some doubts about that. 

    But I also know being in Europe, that our trade unions were looking enviously at the Biden administration process of working with unions saying “in Europe, nobody involves us to the same extent.” 

    On the one hand, you can look at the glass half full and say, “this is the best that we could do.” But if you look at the glass half empty, in the end, this process leaves the extent to which labor rules will be adopted at the discretion of private capital. The big green state could say to a company: “you must have this level of wages, if you don’t want to come under very strict provisions for decarbonization.”

    DD: I would add to that that whether the glass is half full or half empty probably depends on what corner of the labor movement you’re looking at that glass from. The building trades have done well, while from the manufacturing side, whereas UAW has a lot less leverage provided by the IRA to unionize manufacturing workers once the facilities are built. 

    TF: I think the question about the terrain of labor struggle post Bidenomics legislative package is an interesting one. You have had episodes about the Protecting the Right to Organize (PRO act) which would have substantially increased penalties on employers and made illegal anti-union practices. But we couldn’t win it. The votes were not there to force it through in reconciliation, despite 90 percent of the Democratic caucus supporting it. 

    The IRA does absolutely encode protectionism in the form of critical minerals provisions for batteries and final assembly requirements. This creates a really significant incentive to locate production of all aspects of the auto supply chain in the US or in North America. These elements have been the source of immense controversy between the US and its trading partners. So to the extent that you have trapped private capital in the US you could say that will help union density in the auto sector by reducing the threat of offshoring, which has hung over so much of auto unionism for the past fifty years. Not just offshoring abroad, but also the even more important movement of production from union to nonunion states. 

    On the other hand, the absence of the big green state type provisions that Daniela was talking about means that so far this investment is happening in right-to-work states. Georgia has probably been the most sophisticated and aggressive in its policy of attracting those investments with subsidies, a classic Southern economic development strategy. These states are the most militantly anti-union and will fight any beachheads of UAW or other industrial unions with every tool at their disposal. 

    Still, it’s hard for me to see how labor is in a worse position within the auto sector post-IRA than it was before. I completely understand Shawn Fain criticizing the Biden administration for a $9 billion loan to Ford that has very few strings attached and withholding endorsement. That’s probably just the way that these fights are gonna play out. The UAW has to figure out a strategy for getting in there and organizing those workers and they’ll find, I think, so long as you have the Biden administration, there’s a supportive National Labor Relations Board that’s willing to really go after companies for unfair labor practices. 

    TS: The Biden administration says it will use grantmaking discretion to encourage higher labor standards. But they are not trying very hard. As Lee Harris at the American Prospect has reported, jobs in the solar industry are currently pretty crap jobs. Workers are hired mostly through temporary staffing contractors—insecurity, harassment, and abuse are rampant. Another example is TSMC, one of the big beneficiaries of CHIPS act $52 billion, which refused to sign a project labor agreement with local unions, and employed mostly nonunion labor. Can the Department of Commerce really play hardball when the US needs TSMC more than TSMC needs the US?

    DG: That anti-labor stance of the derisking state is not a specific US dimension. European private capital has fought very hard at home as well to make sure that it minimizes any progressive disposition of any of the return of the state in industrial policy or climate policy. 

    I think there is a geopolitical angle to discuss here, about why Europeans activated all their misgivings when the US started doing large-scale derisking of the climate transition, but not when China did it. China has done this for much longer. And in many ways Europeans were much more relaxed about creating markets for Chinese solar manufacturing, than they have been about creating markets for US solar or car manufacturing. It has to do with geopolitical tensions within the US-EU alliance. 


    DD: I think that all this really gets us to the real theory of politics behind the IRA and Bidenomics more generally. Bidenomics recognizes historically that the New Deal order created a material basis for a mass political constituency for New Deal coalition politics, namely through unionization and labor winning this historically high share of the national income. It recognizes that neoliberalism—which the Biden administration refers to pretty consistently in with the phrase “trickle-down economics”—was geographically uneven, created an extremely unequal distribution of income, and that this created the material basis for reactionary populism. 

    Are the investments of Bidenomics creating a new material basis for liberal democratic politics?

    DG: From the discussion that we’ve had so far my takeaway is that, like neoliberalism, Bidenomics presents workers with the same choice: either you’re excluded or exploited. So it doesn’t seem to me that it really kind of amplifies or creates a terrain for some really radical reorganization. 

    As a European who lives in the UK and who was born in another country where the state played a much more important role in the public provision of public goods it’s hard for me to imagine, as a US worker, how much of a change I will see in my daily life from Bidenomics. The concern is we get worse jobs and a lot of the fiscal resources go into profit for private capital, and we get the same financialization of public goods that we’ve had so far. So what is it that we’re really getting? I’m not claiming to have an answer, but I don’t think the answer is “everything will be better.”

    TS: The Bidenomics idea was not only to increase union density through a legislative push, but also to structurally improve the bargaining conditions for labor by running a full employment macroeconomic policy. Biden, in a budget speech in 2021 said “instead of workers competing with each other for jobs that are scarce, we want employers to compete with each other to attract workers with higher wages.” It is a conscious push to increase employment and reduce the reserve army of labor. 

    Full employment policy was complemented fiscally by the American Rescue Plan’s generous unemployment insurance of $400 per unemployed worker per week, which allowed people to leave crappy jobs and move to higher productivity and better jobs. So structurally labor is in a much better bargaining position with some of the lowest rates of unemployment in fifty years. 

    TF: There’s a couple of distinct theories of politics that you hear articulated and I’m not sure which one the Biden people subscribe to. One theory is the “deliverism” theory of Democratic Party majorities: you deliver investments, you deliver jobs, people credit you with improvements in their lives, and they vote for you. Another theory is the political opposite of that, which is about “locking in” the policy, but not necessarily focusing on the electoral outcomes. That theory says that whether or not Republican voters continue to vote for Republicans, the flow of benefits and investments into those districts will make it awkward for Republican officials to try and eliminate the policy. This is why Biden-adjacent people celebrate the large investments in red districts which they have no hope of flipping.

    Then there is a broader theory here that goes to Daniela’s core point about derisking, which is that the left always thought that locking in climate policy would require the building up of a green capital sector, which would be able to exercise political power, at least partially, to offset the power of fossil capital within the US political economy. This will require beneficiaries of climate policy to exist—as it does for, e.g. defense policy—in every congressional district in the country.

    DD: I’m skeptical that a new material basis for a new Democratic majority will be built through investment. Consider the New Deal, where objective economic growth or rising wages didn’t build that coalition, but rather unions—intermediary organizations that help people make collective political sense of the economic situation. 

    DG: I am further skeptical of the theory that you can build up green capital, particularly in Republican states, to create political lock-in. The experience of Spain in the 2000s derisking solar industries with feed-in tariffs provides evidence against that argument. The carrots for private investment were so attractive that Spain found itself with a disorderly expansion of green solar capital. When the political cycle turned, and macrofinancial conditions turned, a new government stopped those carrots, which led to a severe crash. And the experience we have had in Europe of using these kinds of derisking approaches to building private solar capital is that it can very quickly run into fiscal constraints.

    Fossil capital

    DD: We keep touching on fossil capital, and the rollout of green energy, which is only half the energy transition, we must also just stop burning fossil fuels as soon as possible. But the Biden administration including through the IRA has, in many cases ramped up fossil fuel production. What are the Bidenomics tools, if any, for ending fossil fuel production?

    DG: In Europe from around 2017, the strategy was to explicitly combine carrots for sustainable activities with penalties on fossil capital, particularly through the European Central Bank and the Bank of England. The approach acknowledged that we cannot wait for this logic of derisking that simply waits for market processes to drive fossil fuels out. This was rather revolutionary for central banks that usually don’t want to intervene or don’t want to be seen as intervening in the allocation of capital. 

    Central banks designed “sustainable taxonomy” frameworks, to penalize dirty capital. And the European Central Bank said that climate is within our mandate of price stability, because the climate crisis can have financial stability aspects, and also because the financial sector can amplify the climate crisis by lending to fossil fuels. The logic of the approach was that if a financial entity has fossil fuel bonds in their portfolio, the central bank will penalize the holding of these bonds, driving up the price of their credit, thus eliminating subsidies to carbon capital. 

    DD: How did Bidenomics disrupt that trend in European policy making?

    DG: The carrots of Bidenomics gave more momentum to the lobbyists opposing the penalty based on regulation in Europe, because every company that was being penalized said they would move to the US! It became much more difficult politically to stay on course with Europe’s much stronger decarbonization framework that penalizes private capital. 

    TS: Fossil fuels continue to receive the lion’s share of government subsidies. Fossil fuels are extremely expensive for not just the planet but for governments to maintain, fiscally speaking. European governments did a massive amount of deficit spending after the Ukraine war began, to put money into company’s pockets and into people’s pockets to defray their energy bills. Researchers have estimated more than 800 billion euros of subsidies were given to fossil capital in just one calendar year since the Ukraine war! Compare that 800 billion euro figure with the congressional green spending from the IRA, that amounts to, according to the CBO, about $40 billion a year. 

    DD: Melanie Brusseler writes: “private asset ownership and market coordination cannot perform the synchronized dance of investment and divestment, nor bear the cost of maintaining excess capacity… a boom in private renewable projects will not on its own orchestrate a planned build out.” Why is public ownership important for achieving decarbonization? 

    TF: The part of the IRA that can contribute to public ownership are the direct pay provisions that we spoke about earlier, which many local and state officials around the country are taking advantage of. That’s one of the exciting post-IRA terrains of struggle—to build those institutions and that capacity to increase the role of public ownership.

    But that alone is not going to move us fast enough. There are the Paris goals, and there’s the reality of the acceleration of the climate crisis. Without a public balance sheet playing a bigger and more aggressive role, we are not going to tackle things like the flood exposure of so many communities, and what that does to insurance markets, and what that does to home prices—much less than we are able to gradually decommission fossil infrastructure that we have in this country and around the world.

    Without more assertive public ownership and a big green state with sticks, there is a real fear that the public just ends up absorbing the costs of the climate crisis as companies go bankrupt, as homeowners lose their shirts, and the public sector just picks up the mess in the worst kind of derisking way: the socialization of all the losses. We have to find ways to bring in the public sector more proactively, in a manner that costs less and is more equitable, and less reactive. 

    DG: A recent Common Wealth report makes a persuasive case even for fiscal hawks that public ownership, particularly of the energy sector, is cheaper than derisking private renewables. 

    There is also the long-term, orderly decarbonization case, not just for public ownership, but for a wholesale change in the current macrofinancial regime. I don’t think public ownership is enough, though it’s necessary. We also need a change in the way that we think about the state’s balance sheet in the climate crisis. At the moment we have a disorderly expansion in both green and fossil capital. We have to remind ourselves that we need to shrink certain sectors. The state will by necessity have to have a much larger balance sheet that it has at the moment. And for that, it will need a central bank that works with a very different logic of coordination with the state to support a big green state. 

    What we don’t have enough of is building institutional capacity of the state to discipline private capital into climate strategies. In my paper that informs my arguments about Bidenomics, I write about the use of monetary derisking by central banks to intervene in government bond markets, which at the moment basically preserves their stability for private finance.

    New Cold War

    DD: Let’s talk in some detail about China and what many are calling a “new Cold War.” Bidenenomics seeks to deny certain advanced semiconductor technology to China, to exclude Chinese source components and critical minerals from supply chains, and more generally, to check China’s economic development and military power. Jake Sillivan, in a much noted “new Washington Consensus” speech described this new approach as a departure from optimistic assumptions of a rules-based global order. 

    But the real US problem with China is not illiberalism—Saudi Arabia and Israel don’t bother the US. When did it become such a bipartisan norm to perceive China’s rise as an almost existential threat to the US? And lastly, what sort of state is China? Is it a derisking state, a big green state, or something else entirely?

    Tf: The first thing to note is that there is a very significant element of self-critique among the US policy making elite when it comes to how they talk about China. There was an optimism, a popular theory of “convergence,” around China’s integration into the global economic order, especially upon its entrance into the WTO in 2001. That theory said that as China liberalized economically, its political system would also liberalize. (Jake Werner and Toby Chow, for example, argue that this was actually happening for a period of time in the 2000s and early 2010s.) 

    China became much more geopolitically and militarily assertive in the wake of the 2008 crisis. While the US was rather hobbled by the collapse of the housing market, China pulled off a world-historic stimulus program and mass-building program. The investment of the Chinese state basically floated the entire world economy for about a decade. Some people see this as the moment when Xi Jinping consolidated power within the Chinese political system and began to author a much more statist economic policy, with documented cases of economic coercion. There’s a perception across the US political elite by 2018 that China had changed—they flipped positions, from seeing China as a benign partner to an active threat.  

    The self-critique then runs on two levels. Firstly on the economic level, one cannot overstate the significance that the China shock literature has had on policymakers; they cite David Autor’s articles by name, which is otherwise unheard of. Of particular impact has been the work of economists who documented how the economic opening to China, starting in 2001, led to the decimation of American manufacturing. In a paper published after the 2016 election, they showed that counties and metropolitan statistical areas that had seen the heaviest import penetration from China were those that flipped towards the Republicans. Opening up to China seemed to have had more significant domestic economic consequences than anybody had anticipated in the 90s and early 2000s. 

    Second, on a climate level, by 2021, US policymakers had woken up to the realization that China was absolutely dominant in key green manufacturing sectors, where previously it was believed that China mainly focused on “ low end assembly stuff,” while all the cutting edge, high value added stuff was still located in the global North. But suddenly, they had to admit that China controls 90 percent of the market for solar panels, controls critical minerals, dominates the battery supply chain, and so forth. As it became clear that an energy transition was necessary—that, one way or another, there is going to be a massive replacement of machines across the globe—policymakers came to fear that China was going to dominate those industries, which they would prefer to be located within the US, and producing for the domestic markets, but also competing with China in what they anticipate to be the booming export markets of the future. 

    Lastly, there are genuine conflicts of interest between the US and China when you look at Taiwan, and the broader East Asia security questions and military alliances. 

    DG: Europe faced the same concern for longer. In the 2000s, solar industries in Germany and Spain were affected quite significantly by the Chinese state’s ability to scale up manufacturing of clean tech. The response used to be, “It doesn’t matter, because we want the market to work.” There was a powerful ideological commitment to globalization. If you look at recent attempts to emulate Bidenomics in the US, there has been a shift. There’s an understanding that markets used to work well, but massive Chinese industrial policy has distorted market signals in clean tech. They now are looking to do the distortions themselves. 

    For the moment, I think there is a combination of the big green state and derisking in China. The Chinese state and the internal market allows for scaling up, and one can do many things that are not possible in smaller countries. It’s important to remember that this isn’t just a story of states, but also of financial globalization. There are lots of European companies in China, it does not simply erupt on the international scene to threaten US hegemony in isolation. Significant profits were to be made by locating in China for a long time—European and US corporations defended that arrangement, which they cannot do now for political reasons. 

    DD: What should we make of the role played by this New Cold War in motivating US green industrial policy? What does this new industrial policy represent, given the serious threat of escalation? What might a stable geo-economic and geopolitical settlement with China look like?

    TF: It is disquieting, and it should trouble us very deeply. There is a tendency among some progressive forces to want to see this geopolitical aspect as ancillary to industrial policy, but I’m not sure that’s true precisely because the shift in the US policy elite’s attitudes towards China is one of the preconditions for everything that we’ve seen. We must stay focused on these dynamics, on how industrial policy tools might get deployed to ratchet up geopolitical and military tensions. We should oppose escalatory moves, forcefully and forthrightly. And I do think it is important to oppose the semiconductor export bans, which are not an indispensable part of the overall package, and which none of the forces that came together to pass the legislation signed off on necessarily. There is less attention to these dynamics than there were, for example, to the question of how US global power manifested itself in the 2000s. 

    In my view, we need to start talking intentionally about “order building”: the institutions of international relations, security, and cooperation, especially around development and finance. This includes the idea that one can’t imagine a global political or economic order or a security order without a significant role for China. Coexistence must be the name of the game. We have to work to develop these institutional frameworks on the baseline conviction that war would be an absolute apocalyptic endpoint, that we have to do everything in our human power to avoid.

    Ts: The US policy-making elite’s theory of how to contain China is based on two premises. The first is that technology is driving China’s economic growth, and the second is that China doesn’t know how to make innovative new technology—they can only copy, acquire, or steal. Following from these premises, the containment of China is taking the form of preventing access to high-end technology. This is what Jake Sullivan means when he talks about “building high walls around a narrow yard” of AI, biotech, green tech, and so on.

    I’m not so sure that new technology is the engine behind Chinese economic growth. Chinese growth has been powered by domestic investment largely in the technologies of the second industrial revolution, together with a gigantic real estate boom, and a logistics boom that created a vast internal market. 

    As for innovation, the Chinese state has been investing heavily in R&D for at least ten to fifteen years now—tens of thousands of Chinese engineers and scientists and doctors have trained at the MITs and Stanfords of the world. They are as close to the technological frontier in many sectors, if not further ahead, than the US. Therefore, even if one believes that it is necessary to contain China, it’s unclear to me that technological decoupling can succeed on its own terms. Obviously, there is a massive risk of backlash too: it could drive away American allies, slow down innovation, slow down climate investments, increase the prices of goods, and lead to domestic inflation.

    dg: I also want to consider the possibility that China is a kind of a strawman, or a useful Trojan Horse that provides a way out of this crisis of capital accumulation. To put it another way, the Chinese threat—which is real in that it challenges US hegemony—offers a political narrative that allows for the reimagination of the role of the state, which can now become engaged in climate politics. Even in countries like the US, you can build an infrastructure or an architecture of derisking which, as it becomes bigger and bigger, can create profit and opportunities for private capital. You need a straw man, an adversary for these political forces to come together. But our planet doesn’t care about the China-US conflict. 

    dD: The climate crisis is global in scope. Do the IRA and Bidenomics point toward any sort of more internationalist approach to fighting climate change? 

    ts: The IRA doesn’t have any explicit provisions for countries in the developing world. There’s no transfer of American taxpayer dollars or cheap money. Rather, the Biden administration argues that anything the US does to accelerate production of green goods will lead to a drop in prices, allowing for cheaper exports to developing countries. That theory then requires a policy agenda of IP-free green technology transfer to developing countries that the administration is currently not pursuing.  

    The broader issue is that developing countries have a much narrower fiscal space, and much smaller tax bases from which to give out tax subsidies. Their fiscal space is very constrained by dollar debt crises, and structurally higher interest rates. For a successful global energy transition, the IMF and the World Bank would have to be reformed to make the cost of financing cheaper and not police their debt-to-GDP ratio. But that’s not been the Biden administration’s international agenda.

    DD: If the global South is not provided with an economically viable path to do green development, why would they stop burning coal?

    Dg: The progressive rhetoric of the Biden administration is at its thinnest when it comes to the “New Washington Consensus” for countries in the global South—behind which the Wall Street Consensus is very much hardwired. The derisking development paradigm recommends that global South countries need to blend a little public money with a lot of private finance to kick-start investment in the energy transition and public goods. A great irony that I see is that the US is protesting the fact that countries consume cheap, renewable tech from China—but then it turns around and says, ah, the global South should be happy the US IRA is going to reduce the cost of cleantech imports.

    The Biden administration is not supporting a mandatory involvement of private creditors in debt-ridden countries in the global South, or pushing for more grants or more concessional finance to go into public goods, or supporting technology transfers, the last of which China is doing. For example, a Ugandan state-owned company is producing electric buses for public transport with Chinese technology—this is what technology transfer looks like in a revamped, post-neoliberal framework. Such an arrangement does not exist in Bidenomics. Instead, the US and Europe are singing from the same hymnsheet—you want green industrial policy, do it through derisking—which then puts pressure on global South countries to hand more and more of the fiscal and regulatory reins to private capital to, say, make green hydrogen competitive.

    Tf: To the extent that things can change, it seems to me likely that they will be driven by geopolitical developments, much more than any enlightenment on the part of the US government or financial apparatus. Some negotiated packages, as in the case of Indonesia, have involved aspects of technology transfer, but it’s coerced. The US is making concessions because they are seeking the alignment of strategically positioned states. We’re likely to see more of these geopolitical gradients on deals relating to international development and finance, with states leveraging their relative positions. The double-edged sword is that this is feeding into dangerous escalatory dynamics. 

  2. Fragile Democracies

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    Pranab Bardhan is Professor Emeritus of Economics at University of California, Berkeley. Among the foremost global scholars of development, distribution, and trade, his twelve books and more than one hundred fifty journal articles cross disciplinary boundaries in an effort to critically grapple with the conditions needed for a more equitable society. In Land, Labor, and Rural Poverty, he considers the relationship between land tenure, agricultural employment, and rural poverty. The groundbreaking Political Economy of Development in India integrated Marxian class analysis with a rational-choice methodology and a Weberian institutional lens to reflect on the structural impediments that have slowed India’s industrial growth. His new book, A World of Insecurity, re-examines the conditions underlying democratic disenchantment. 

    In what follows, King’s College Lecturer in Comparative Political Economy Poornima Paidipaty interviews Bardhan on the rise of the global right, the nuances of decentralization, and the role of the state in pursuing paths forward.

    An interview with Pranab Bardhan

    POORNIMA PAIDIPATY: A World of Insecurity (Havard, 2022) covers a wide range of topics, from current economic inequality to the rise of populism and the importance of renewing institutions of social democracy across the globe. Maybe you can start by telling us about the inspiration behind the book—as a writer, what motivated you to piece all of this material together?

    Pranab bardhan: As a political economist, I’ve noticed that politics in many countries I’m interested in, both rich and poor, has been moving rightward (the major exception being in Latin America, but even there, leftwing victories have been fragile). I was interested in understanding this global shift. Everyone talks about the rich countries—Trump, Johnson, LePen, Meloni, the Sweden Democrats, among many others. Developing countries get less attention. In my study, I look at three developing countries: India, Turkey, and Brazil. 

    Existing work on the rise of the right revolves around the question of inequality—even in countries where it’s not rising, it is already very high. But again, much of this work is focused on Western Europe and the US, and I was interested in broadening this scope. Despite having worked quite a lot on inequality as an economist, I had a sense that this was not the full story. In particular, I felt that it doesn’t answer an essential question: Why are working people rallying under the banner of multi-millionaires? This is particularly confounding given that these billionaires, once they come to power, almost inevitably reduce taxes on the rich and weaken restrictions on the financial and corporate sector. 

    Another motivation for writing the book is that existing discussions tend to exclude any reflection on the Chinese model as an alternative. I discuss the advantages of the Chinese model of economic development, but also emphasize that many of the ugly features of Chinese development are the result of the underlying authoritarianism. After a lengthy discussion of these benefits and downsides, I suggest that authoritarianism is neither necessary nor sufficient for promoting the beneficial aspects of Chinese policy making and governance. 

    Finally, I took the book as an opportunity to reflect on what comes next—what do we do about this global trend? I devote the second half of the book to this question, trying to conceptualize what I call the rejuvenation of social democracy. How do we cultivate new thinking about social democratic transformations?

    Pp: In the last decade, many scholars have highlighted the impact of rising economic inequality on political polarization and social stratification. One of the things that distinguishes your book is the distinction you draw between inequality and insecurity. Can you talk about the importance of those terms?

    Pb: I argue for a shift in emphasis from inequality to insecurity. I question the explanatory value of inequality on the basis that on the whole, workers are far more concerned with their living standards relative to others in their community than they are with the top one percent. They don’t know or care about the lifestyle of the global elite. However, workers are acutely aware of the sources of insecurity in their life. Among these, economic insecurity is obvious: job loss, rising cost of living, and so on. This is especially true in rich countries, since China’s entry into the WTO in 2001.

    But in the book, I also discuss other sources of insecurity. One of these I call cultural insecurity. Culture is an ambiguous term, but this sort of insecurity takes specific forms—in rich countries, it often manifests as fears over immigration. In my view, the economic side of these fears are not really what is at play, especially since immigration has been repeatedly proven to bring net economic benefits. The fears are I think primarily about threats to a perceived “traditional” form of life. The role of perception is important here; firstly, because second and third generation immigrants tend to assimilate into local traditions, and secondly, because surveys have found that people tend to grossly overestimate numbers. They have an exaggerated perception of insecurity.

    Developing countries tend to attract far less immigration, and as a result, the cultural issue often takes a different form—religious majoritarianism or ethnic nationalism. This is the case in both Turkey and India, as well as in Poland and Hungary. These movements are tied together by what I refer to as “manufactured victimhood”: when the majority population somehow has a contrived fear of victimization by a minority. This is often the result of historical resentment. For example, in India there is a resentment among Hindus that Muslims ruled six hundred years ago. During the Bosnian War of the 1990s, I remember seeing a cartoon in which a Bosnian Serb and a Bosnian Muslim were stabbing each other, with one saying, “This is for 1432” and the other saying “this is for 1521.” This stoking of historical memory is something right wing demagogues are very good at. 

    Pp: I share your skepticism regarding the explanatory power of rising inequality, in terms of explaining the global shift towards rightwing populism. On the face of it, much of this rightwing support is not coming from those people hardest hit by unequal economic distribution. For instance, Modi supporters in India often come from groups that have seen quite a few economic benefits in recent years and whose prospects have not shrunk in absolute terms. Many of them are part of the rising lower middle classes.

    The fact that insecurity is a question of perception is also a great point. But just as there isn’t a direct correspondence between economic deprivation and support for rightwing populism, the people who feel insecure over rising numbers of migrants, for instance, are often located in areas with fewer immigrants (relative to large metropolitan areas). What is the relationship between this perception of insecurity and our changing global political economy?

    Pb: There is as you say a huge difference in the support base for these parties between rich economies and poorer ones. In the US and Western Europe, the right is popular among older, rural, less educated voters. By contrast, much of Modi’s support comes from aspiring urban youth. Major metropolitan areas like New Delhi, Mumbai, and Bangalore voted for Modi—this is a sharp contrast to cities like New York, Los Angeles, and Chicago. These rising groups are mobilized by resentment for what they perceive to be a Western liberal elite. 

    Pp: Can you talk us through some of the emerging alternatives to liberal capitalism?

    Pb: I think one of the tensions that we see emerging very clearly now is that between the local and the and the federal or international. Political mobilization around this issue doesn’t fall neatly onto our inherited political axes—the notion of community is often leveraged by the left, but equally one of Brexit’s key slogans as “back to the community,” i.e. back to the local community and away from Europe. 

    There is a lot to be said for communitarian ideas, given that big bureaucracies often trample upon local initiatives and local ingenuity. Much of my work has been focused on structuring decentralization in India—I’ve written theoretical papers and also collected data on village surveys carried out especially in West Bengal. But having grown up in India, I’ve seen how oppressive local communities can be. We should not have an idealized notion of how a small village operates with respect to caste, gender, and so on. 

    This debate dates back decades; it was one of the key differences between Mahatma Gandhi and one of the founders of the Indian constitution, B. R. Ambedkar. Gandhi mobilized around the notion of the village republic, while Ambedkar described the Indian village as “a sink of localism, a den of ignorance, narrow-mindedness, and communalism” during the constitutional debates of 1948. We are all familiar with the issues that arise from insiders seizing local political space—zoning restrictions, professional licensing, school financing, and so on. Decentralization thus has the capacity to worsen and entrench local inequalities.

    Government intervention can help catalyze changes of oppressive practices within communities. It can also help smooth out intra-community inequalities—in earlier research, I’ve examined how land distribution impacts political cooperation. Small communities are at a disadvantage in dealing with natural disasters, market mishaps, infrastructure investments, and the like. But there are also things local governments do very well; I try to find the balance between the two in my chapter on communities. 

    Pp: This ties back to your argument about state capacity. There is an emerging dialogue in India regarding the importance of federalist structures, with some scholars and activists arguing for more decentralization of power. This strand of thinking argues that Modi and the BJP (through their brand of populism) are not turning away from India’s foundations; instead they are building upon the historical institutions of a Nehruvian state, which used centralized power in order to expand state capacity. The solution to rightwing populism, according to this view, is more decentralization and less power in the hands of the central government. This conversation is gaining ground in light of southern states’ rejection of the BJP in recent elections. In the US, it’s exactly the reverse: the federal government is seen as a protector of civil liberties while states are seen as sites for the erosion of those liberties. 

    Pb: In the book, I argue that one advantage of the Chinese model is its unique blend of political centralization combined with economic and administrative decentralization. India exemplifies just the opposite: a decentralized political system with strong regional power groupings, combined with economic centralization whereby regions depend on finance from the government. As I mentioned earlier, this discussion dates back to the writing of the Indian constitution. At the time, Ambedkar advocated for more central power in order to combat the oppression of lower castes, like his Mahar community, a Dalit group in Maharashtra. That’s why he advocated a partial centralization. Nehru was also concerned with keeping the country together in the aftermath of Partition. As a result of these two elements, I think they gave the central government an unfair amount of power. 

    Few governments can do what the federal government has done in India—if we think, for example, of Nehru’s handling of the communist control of Kerala in 1959. As per the advice of Indira Gandhi, who was president of the Congress Party at the time, Nehru imposed President’s Rule in Kerala, whereby the central government dismissed the elected state government. That’s an example of a central government openly violating the wishes of an electorate. This has been repeated in several states over the decades.

    This happened in an even more extreme form recently, with the state of Jammu and Kashmir. Without consulting the population, the state was broken into three centrally administered territories. Can you imagine if the federal government in the US broke up California? It’s inconceivable. American federalism gives more power to local states. In the 1940s, when they considered what form an independent India should take, one idea put forward was that of a Confederation. This was proposed in order to stop Partition, but the notion was eventually dropped. 

    In China, provincial and sub-provincial governments have a lot more power. This also means that they have a far better system for managing infrastructure financing and construction at the local level. Urban infrastructure is governed by companies organized by the city government. Out of the total government expenditure for the whole country, the amount that is spent at the sub provincial level, not even at the state provincial level, is more than half of the total government expenditure. In India it is about three percent.

    Indian municipal governments lack taxation power and are therefore financially strapped. Much of social expenditure takes place at the level of states, but money is controlled by the central government. I refer to this as India’s vertical fiscal imbalance, and I think the weak performance of local bodies in India in the delivery of services and facilities is in part tied to it. By contrast, Chinese local governments are active in business development and not just in service delivery. 

    Pp: Let’s turn to some of the solutions that the book puts forward. Your recommitment to social democracy seems to resist widespread proclamations about the failure of democratic institutions. What exactly do you have in mind?

    Pb: My main focus is on universal basic income (UBI) and job creation. For developing countries with fairly weak social safety nets, UBI can be very effective–particularly in mitigating gender disparities. In countries like India, the overwhelming majority of women are not earning any income, despite performing back-breaking domestic work. But roughly 80 percent of Indians have a bank account today. A government transfer would hugely empower women who currently depend on their partners for survival. UBI becomes very appealing from the starting point of insecurity: offering an exit option for those who have been forced into work like manual scavenging for centuries due to their caste. Minimizing sources of insecurity is, I think, a more powerful justification than that of anti-poverty—it avoids the discussion of substituting income transfers for other social safety programs which may in fact be more effective at reducing poverty levels. 

    I also suggest that UBI can be effective at strengthening labor movements by unifying the interests of informal and formal, unionized and nonunionized, service and manufacturing workers. In India as in many developing countries, we see a small island of unionized workers surrounded by a vast ocean of informal workers. That small group gets access to benefits like pensions which the others do not have. Policies like UBI, which benefit both formal and informal workers, help bridge this gulf, softening labor market divisions. 

    I also stress the importance of wage subsidies for the employment of young people, who are largely unemployed or underemployed in much of the developing world. And I reiterate the power of job creation via the green energy transition, as well as the importance of giving labor a voice in corporate governance. 

    Pp: Maybe we can end by considering a few questions which are related to the issues you take on but are outside the direct scope of your book. You mention Branko Milanović’s book, Capitalism Alone (2019), which argues that whatever criticisms we may have of capitalism, it has been responsible for transformative economic mobility over the past two centuries. 

    That defense of capitalism presents crucial questions regarding sustainability: both ecological sustainability and distributional sustainability. For example, Milanović focuses on the period since the 1970s, when low inflation enabled large scale, debt-financed consumption, and subsequently a manufacturing boom, which raised commodity prices in places like Sub-Saharan Africa. This is more equitable than what we had before, but is it sustainable? 

    Pb: The challenge, I think, is to harness technological innovation towards social ends. We ought to make sure that the advances we make prioritize the interests of workers and give them a voice in decision-making. Democratizing the decision making structures in large corporations can allow us to determine the rate and pattern of innovations more collectively. We also need to democratize our politics—the largest democracies in the world (India and the US) both have elections funded by private donors. Under the anonymous electoral bond system, businessmen and companies are able to secure party favors. If we’re going to reform our politics in the interest of the public, we ought to look at the sort of public funding models used by Belgium, Spain, Germany, Sweden, and Canada.

  3. Working Capital

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    The Federal Reserve has provided payment and settlement services for more than a century. But FedNow, the instant payments service rolled out in late June 2023, is the first new Fed payments rail in fifty years. Though payment and settlement are crucial pillars of economic transations and global money flows, disinterest persists regarding these financial pipelines.

    Tim van Bijsterveldt is Executive Director-Liquidity & Account Solution Specialist at JPMorgan Chase & Co. Based in Singapore, he helps corporates free up cash and improve their cost base. In this interview, van Bijsterveldt and Elham Saeidinezhad discuss the structure of the wholesale payment system and the role of corporate treasurers in navigating and transforming it. Read Saeidinezhad’s overview on risk management and the payments system here.

    An interview with Tim van Bijsterveldt

    ELHAM SAEIDINEZHAD: Would you please walk us through what you do daily at JPMorgan Chase—who are your clients, what are their problems, and how do you help them resolve them?

    TIM VAN BIJSTERVELDT: Broadly, I’ve got two types of clients: traditional corporates and digital businesses. They’re interested in balancing short-term and long-term investments while ensuring payment obligations are met. For a corporate treasurer, aligning investment timelines with the corporate debt maturity profiles is a classic payment consideration.

    However, risk management has been added to payment-related concerns in recent years. Before, treasurers were concerned with moving money around. Today, they’re tasked with ensuring that the money is in the right currency and amount, exactly when they need it. It is worth emphasizing that the recent supply chain disruptions have added to the need for risk management. Traditionally, companies did cash forecasting on a forty-five-day or thirteen-week period. After the disruptions resulting from COVID, including the Suez Canal blockage, they’ve begun to ask whether it’s possible to bring forecasts down to one to three days. Corporate treasurers have started to look not just at risks but also at risk management strategies, such as mitigation and automation.

    This has happened across traditional corporate and digital economy clients, despite the different stakes in the supply chain issues. Digital supply chains don’t always contain goods; some may sell licenses, meaning their client will never own that product.

    On the other hand, manufacturers purchase from independent factories and sell their products to their customers. In doing so, they legally swap ownership from one party to another. As a result, traditional manufacturers generally are better positioned to forecast demand for their commodities, such as automobiles, agricultural products, etc.

    ES: A firm’s business model, traditional versus digital, shapes its sales and hence, its liquidity management strategies. There needs to be more understanding, in academia as well as policy circles, of the different techniques that corporate treasurers use to manage liquidity. A fragment of monetary theory, called Money View, pioneered by Perry Mehrling, which studies liquidity management in broader macroeconomic conditions, thinks of corporate treasurers’ function as primarily balancing between elasticity and discipline—the flexibility to meet daily payments without holding too many liquid assets. That is in the spirit of what Hyman Minsky called “the survival constraint.” What do you make of that?

    TvB: This understanding of corporate treasurers’ payment solutions, meeting daily survival constraints, is useful but somewhat incomplete. Treasurers operate with three buckets of cash. The first serves operational needs—what we need to get through the day. Based on what happened yesterday, we account for any big anticipated payments or cash influxes. If I’m short on money but know I have a cash inflow coming in later, I will likely delay my payment run rather than borrowing externally. The less external borrowing, the better. This is meeting survival constraints.

    However, corporate treasurers have other types of cash management concerns. Their solutions to these concerns might have broader implications for the modern ecosystem. The second bucket of cash is precautionary—what we keep under the mattress in case the business, or the market, suddenly falls short of liquidity. Notably, precautionary cash management is beyond deciding whether the company is liquid enough to meet today’s cash flows. Indeed, corporate treasurers regularly change payment solutions to manage precautionary cash, even when they have enough short-term liquidity. This sort of pocket cash is placed somewhere accessible, a bank account or money market fund, which we can redeem early. The corporate treasurer’s job is regularly changing how much money to hold in such funds and accounts.

    Finally, we have the reserve cash, which is invested for long-term acquisition or long-term debt payment. These might be placed in structured deposits like the FX market. In this case, the corporate treasurer might be certain that the firm can meet its daily survival constraint in the domestic currency. The firm might also have enough liquid assets in money market funds and similar institutions. Still, it is the job of corporate treasurers to manage long-term payments, for instance, the ones denominated in foreign currency, by undertaking long-term investment strategies that include structured products.

    It is important to note that risk management solutions are embedded in the second and third types of cash management strategies. In the second type, the corporate treasurer wants to safeguard the payments against funding shocks in the financial market or disruption in the supply chains. In the third type, most treasurers explicitly try to protect their firms’ cross-border payments against fluctuations in the foreign exchange market.

    ES: As you described, risk management is embedded in modern payment solutions. Traditional risk managers are usually among the corporates’ most innovative groups, whenever market conditions change. Given that corporate treasurers, traditionally tasked with managing payments, are also doing risk management, how might their approach to their job change?

    TvB: One clear example is the  change in the interest rate trajectory. Many treasurers kept their money in bank accounts, when the interest rates were near zero. It was cheaper to borrow externally than spend your own money. Since interest rates have increased, we see them using their money more. This is a change in liquidity management, induced by interest rates.

    Regarding market events, we see much more placed in the precautionary bucket and far less in the reserve bucket. Translating this into the risk management perspective means that corporate treasurers are mostly concerned about supply chain and funding market disruptions, due to the change in the interest rate environment, rather than fluctuations in the foreign exchange market. Even reserve cash companies are increasingly looking for products they can redeem early if needed.

    ES: Is there a  way to tackle such problems?

    TvB:  At the core of this problem is that many treasurers do not have a complete view of their money across entities and the world. They have different banking relationships; they have no choice in some markets. For example, you often cannot decide where people will pay in Korea. Instead, the payee tells you which bank they will pay into. And not all of these local banks are connected to global payment networks like SWIFT. For example SWIFT messages do not carry Chinese characters—that means you have a lot of banks in China that are not connected. One e-commerce company that I work with in Asia, because of what they do, they will always need local banking partners. They’ve enabled everyone they can on SWIFT, but it only gives them 60 percent visibility.

    Most of the time, we start asking how we can increase visibility and then shift to thinking about increasing control—often through cash consolidation. The level of control you have as a treasurer depends on your banking partner, but it also depends on your internal organization. Suppose you’re a company that has grown through acquisition. In that case, the financial controller of the acquired company might continue to hold onto the money, particularly if they have been doing well. In many emerging markets, we also have family-owned companies where relatives do not always want to share ownership of liquidity. In that case, you need to consider family issues—you may not have access to a company’s liquid assets.  Locations where you operate also determine whether you can mobilize cash effectively between companies, often supported by intercompany loans.

    We often look at cash on the balance sheet to assess liquidity. We look at the level of short-term debt versus long-term debt, the weighted average cost of capital. How costly is it for them to attract capital if they need it? That gives us a sense of how creditworthy the company is but also the value-add of cash consolidation. We then look at where they operate: whether in markets with fungible currencies like the US, Europe, Singapore, Australia, Hong Kong, etc.; in semi-restricted markets like Thailand, Indonesia, Chile, or some countries in the Middle East, where it’s fairly easy to move foreign currency in and out but not the local currency; or in highly restricted markets like Argentina, India, Vietnam and quite a few in Sub-Saharan Africa, where it can be challenging to get money out.

    ES: So capital control measures in different jurisdictions affect payments and firms’ ability to manage their cash. We don’t normally recognize the impact of capital controls on payments in international finance literature. Can you elaborate?

    TvB: Capital controls affect firms’ payment solutions and ability to mobilize cash. Sophisticated treasury organizations are moving towards what we call an “in-house” bank. Using the company’s resources for financing, an in-house bank consolidates treasury functions—such as funding, FX, and cash management—into one central entity, rather than having each subsidiary work through a different local bank. It allows corporates to observe banking, currency risk, and payments centrally, with little restrictions for fungible currencies.

     A firm operating in semi-restricted markets can consolidate intercompany loans through strategies such as in-house banking. Such concentration means most loans are denominated in US dollars rather than the local currency. Nonetheless, this challenges local branches of such firms because they suddenly face new US dollar exposures. This is why even when companies decide to take money out of a semi-restricted country, it is recommended to prioritize risk management strategies such as natural hedging—ensuring that the payments and collections offset each other and only taking out excess structural expenses.

    We observe a shift towards commercial arrangements between different companies rather than intercompany loans. In this case, for example, a local firm becomes the service provider to the in-house bank or central entity. In the process, this payment strategy changes the business model for the parent company. Before, the firm would deal with its clients in different countries through local entities. But now, a company in an open economy would invoice clients directly while another local company in a closed economy would provide the service to the other company’s client. For example, as a chair producer, I may not want to deliver chairs from Singapore (an open economy) to Thailand (a closed economy). Instead, I would pay a local Thai company to make and deliver the chairs the person bought. I have funded the Thai entity for its operations through commercial arrangements.

    This arrangement, called “cost-plus-funding,” doesn’t fall under inter-company loan regulations. It is a commercial flow, as if I bought something from the company. Because it’s a commercial flow, there are no capital controls.

    ES: You mentioned the benefit of a natural hedge—ensuring that the inflow and outflow match. How often do companies use this strategy to hedge against risks such as foreign exchange?

    TvB: Primarily, companies try to operate in a single currency. For example, oil and gas companies mostly care about the US dollar. They are more likely to accept the risk of a fluctuation in the value of the local currency to the dollar and hold 80-90 percent of their balance sheets in dollars. The risk is preferable to the cost of actively managing the funds in other currencies that may apply to their downstream businesses.

    However, matching the currency denomination of the cash inflows and outflows is sometimes possible and preferred for other industries, where local entities often have payment obligations and collections in the same currency. In such instances, a company should only consider structural excess to be made available to the in-house bank to avoid unnecessary conversions.

    ES: New trends like the growing global commodities market segmentation seem to make natural hedges more difficult. Indeed, the Russia-Ukraine war gave rise to severe dislocations in many commodity markets.

    TvB: Such sudden fragmentation of physical markets have potential payment repercussions and important implications for the ability of corporate treasurers to use natural hedges. This is an important consideration for the payment, and I am still waiting to see it being discussed extensively.

    ES: Now, I want to connect the hedging with the currency hierarchy. The idea is that not all currencies are created equally in global trade. Reserve currencies, such as the US dollar, are at the higher layer of the hierarchy and are the most stable, while the rest are at the lower layer. Let us, for the moment, accept such a characterization. From a corporate treasurer’s perspective, can we argue that the higher up the ladder of currencies your interests are, the less likely you are to hedge?

    TvB: It’s more about proportion than hierarchy. For example, if I’m between 70 to 90 percent dependent on a single currency, I might not want to invest time in managing the risk. On the other hand, if I have large commercial flows denominated in different currencies or operations, I want to manage this risk more actively.

    Every time firms do a Forex transaction, they might be subject to value dating. In Forex trading, the value date is a future delivery date on which counterparties to a transaction agree to settle their respective obligations by making payments. For example, converting USD to Thai Baht takes two days, simply because of the time zone difference. The converting company loses two days’ worth of money in the process. In addition, the prices can fluctuate. FX swaps help the corporate treasurers fix the rates in advance.

    So to have same-day access to Thai Baht, a company needs to open an account in Thailand. And a natural hedge helps reduce the number of time FX transaction is required. We help companies develop strategies to access foreign currencies straightaway. One is sweeping: the automated transfer of funds between two accounts. The other is notional pooling, where I can have one account in deficit if another account is in surplus. So if I have a negative Singaporean dollar but a positive US dollar, my access to Singaporean dollars is not seen as borrowing. Companies can take out a basket of fungible currencies, and as long as the overall remains positive, they can draw down against it at preferential rates. This solution also removes the risk of settlement or payment disruption because automated payments will continue to go through as long as they have sufficient money in any currency.

    ES: Let’s shift to looking at the payments system more broadly. In a loose characterization, the first step is when the payment happens, and that’s the job of treasurers. In the second stage, the clearing, the exchange of payer-payee information occurs. And in the last phase, the final settlement happens between banks. We’ve been discussing the first stage and how JP Morgan helps treasurers navigate their complex options. But once these decisions are made, the clearing and final settlement should also happen. Can you talk more about the relationship between these three stages?

    TvB: The funding of the payment obligations is indeed the responsibility of treasurers. There are different payment methods for payment initiation or collection. One is wires, either domestic or cross-border, which is often used for high-value and urgent transctions. Another is real-time payments such as FedNow but there are transactional limits on these that are often not high enough for companies to pay their invoices. Alternatively, they may use ACH for less urgent, bulk payments or leverage direct debits to collect funds.

    Each of these has a different mechanism for clearing with central banks but each also have a different processing time and risk profile. The Fed wire doesn’t require too much explanation. Cross-border wires have changed a lot in recent years. It used to take up to a week from the US, but now technologies are available that effectively wire within two minutes, using blockchain. ACH often can cancel because it gets executed the day after it is ordered, while real-time payments are guaranteed and irrevocable. Payment types may therefore feed into risk management practices.

    Some countries have a mandate system‚ where a debit authorization needs to be in place for direct debits. By contrast, in the US, anyone can just debit you, and you can go and complain afterward. You can be debited in real time if we’re employing direct debits. This makes corporates very nervous, because direct debits have no transactional limits. But companies like to set up direct debits for recurring costs, so treasurers can account for them easily with little intervention.

    Some banks have now initiated additional measures to protect clients, where they can automatically deny payments above a given amount. Banks also want to make sure they can settle all the payments that come in daily, so they are interested in limiting payments on the upper end.

    ES: I want us to talk about the liquidity transformation at the heart of the payment system. The first payment stage is often made through credit-based instruments or cash, while the last step happens through the highest quality form of money, i.e., reserves. From a financial stability perspective, how concerned should we be about this transformation?

    TvB: This is more of a concern now with the rise of digital payment providers. We have the proliferation of payment service providers which are not FDIC secured. Instead, in the US, we have “posthumous deposit insurance.” This means that after a firm collapses, government agencies have no option but to extend their clients’ deposit insurance. If I’m a client of a bank, I pass that insurance to my own clients in the US. But this doesn’t exist in Singapore or Australia. It’s on the account holder to have that additional insurance.

    These payment service providers have started to work together to expand their reach and to move money in a cost-efficient way. It does not necessarily reduce transparency, because they still need to report on what’s happening. They are often still required to get a license in the places where they operate, but central banks do have less direct control or visibility over the transactions taking place, especially when the company operates offshore.

    Central banks have responded to this through onshoring regulation, at least on my side of the world. China, Japan, Taiwan, Korea, and Indonesia, among others, created strict rules on who can access data. As I mentioned, they also require the entity to be locally incorporated. This is really the next stage in protecting the consumer. We also see the introduction of local alternatives to global payment methods like Visa or MasterCard. With these local options, central banks have become even more active risk managers in the market.

  4. Varieties of Derisking

    Comments Off on Varieties of Derisking

    In recent years, the debate over climate policy has moved away from the earlier consensus in favor of carbon pricing and towards an investment-focused approach, illustrated by the passage of the Inflation Reduction Act (IRA), along with other similar measures in the US and, to an extent, in Europe. 

    There are good reasons to welcome this shift, both as a more promising response to the challenge of climate change and as a turn away from the neoliberal consensus of previous decades. Industrial policy is better able than carbon pricing to address the real requirements and constraints of decarbonization. It offers the possibility of a more robust political coalition in support of aggressive climate policy, and a way to overcome the long-standing problem of chronically weak demand in the advanced economies.

    At the same time, the specific approach to industrial policy embodied in measures like the IRA raises a number of concerns. Do these policies target the right constraints and the most important barriers to rapid decarbonization? Do the subsidies and incentives impose sufficient discipline on private business to meaningfully redirect investment? Will the direct-pay provisions meaningfully increase the role of public and nonprofit enterprises, or will the IRA further entrench the dominance of for-profit businesses in energy and other sectors—ultimately undermining both climate and broader economic objectives? Does the industrial policy approach risk a zero-sum competition between national governments, and will it exacerbate tensions between the US and China? 

    On Tuesday June 6, Phenomenal World and the Polycrisis hosted a panel around these concerns, thinking about industrial policy, state capacity, macrofinance, and the green transition. The discussion featured Skanda Amarnath (Employ America), Melanie Brusseler (Common Wealth), Daniela Gabor (UWE Economics), and Chirag Lala (Center for Public Enterprise), and was moderated by JW Mason (John Jay College). Watch the full recording of the event here. This transcript has been edited for length and clarity.

    A discussion on industrial policy and decarbonization

    JW Mason: What are the fundamental economic constraints that industrial policy needs to overcome in the climate transition? What are the barriers to the required private investment? Is it just that private returns are too low, making subsidies an insufficient solution? Or are there other problems that require a public sector involvement—problems of finance, coordination, uncertainty, and so on? In other words, what is it that we would like industrial policy to do?

    Skanda Amarnath: The conventional wisdom about carbon taxes was that if you put a certain price on carbon and keep it in place, substitution will happen over time, and therefore it’s the only thing that needs to be done. What’s changed in the thinking is an acknowledgement that decarbonization is an investment challenge. It’s a capital stock challenge. What does it actually take to get the requisite capital stock to support decarbonized consumption? Emissions are both a production and consumption phenomenon. There is demand for oil, gas, and coal across the world, and viable substitutes have to be made available. But those substitutes require investment, which can happen but doesn’t always—hurdle rates and certainties interfere. Then there’s the technological element. There are parts of the transition that aren’t yet fully solved for, especially with regards to commercial scale. 

    While the public balance sheet is a valuable and important tool, it’s not going to solve every problem. Fiscal ambition can lead to success, but there are just as many cases of corporate welfare and corruption. We must be able to learn from how investments are deployed—are we achieving the goals we’re aiming for through investment? How do we use the power of the government purse, at least in advanced economies, to build a more capable government over time? The next five years will see hiccups as the IRA is deployed. There will be unintended consequences, and it’s important that people within government learn from those mistakes to better realign policies towards the goal of lowering carbon emissions.

    JWM: So the question is, why do we need industrial policy at all?

    CHIRAG LALA: I think we have to answer a few questions first. What do we expect investment to do? And why is investment not happening at the requisite speeds or the requisite volume in the areas we would need for decarbonization? We need not just new generation systems, but new heating systems, industrial equipment, transportation equipment, and so on. I want to dig into the work of Alex Williams at Employ America, who notes the difficulties of obtaining a stable cash flow and stable gain over time, which presents a challenge to both private and public enterprises. An example of this in energy projects—if you’re trying to put up a new solar project or a new battery, but you get stuck in an interconnection queue, there’s no risk premium that can compensate you for getting stuck in that queue. If your project doesn’t get built, it doesn’t generate income, which means undertaking that investment in the first place might not be something you even attempt. This is just one barrier for energy generation. 

    We can conceptualize industrial policy and evaluate it for whether it is sparking capital expenditure by asking how it addresses the various barriers to decarbonization across different sectors and projects. Is it opening up new capital investment opportunities for both private and public enterprises? This is industrial policy’s primary purpose. 

    JWM: It’s not simply about prices being wrong, but there are hard barriers that you can’t overcome with a subsidy or by changing prices. You need to identify specific hard constraints and try to remove them. This is a panel on derisking, and in our world, that term is associated with Daniela Gabor more than anybody else. Daniela, you’ve described the “derisking state” in both the US and perhaps even more so in Europe. You’ve identified a number of policy characteristics that fit this model.

    The derisking state focuses on the production of investability; the fundamental problem is enabling or convincing private capital to take ownership of the assets we want them to take ownership of. The derisking state works primarily through price signals, making some investments more attractive. It shifts economic risk from the private sector to public balance sheets, maintains the primacy of the central bank, and does not require any kind of central coordination or planning. That’s just a broad description, but could you explain what distinguishes this “derisking” approach from other forms of economic management? Where does the IRA fit in?

    Daniela gabor: How you frame problems of decarbonization is shaped by your understanding of the political economy of derisking. To me, Chirag framed the question of decarbonization through a derisking logic, where the problems are risks to private investment, and you have to remove them, not just by granting subsidies or tax credits, but also through what the World Bank would describe as “regulatory derisking.” I’ll take a different starting point to describe problems of decarbonization: in our current climate crisis, private capital is engaged in systemic greenwashing. From there, you get a very different diagnosis. 

    I also wanted to make it very clear that although I have spent the last few years theorizing the derisking state, I did not invent the term. Deutsche Bank introduced the term in a 2011 report for the United Nations Development Programme. They argued that private investment into renewables in the global South would require regulatory or financial derisking to escort private capital into those public policy priorities. Derisking was born in Europe as a logic of statecraft. It’s not a particular policy framework or a particular industrial policy approach. It was adopted by the World Bank in 2017 upon the introduction of “maximizing finance for development.” What is interesting now is that we have moved from saying, “We should de-risk private investment, and we need private investment from institutional capital, like BlackRock and other asset managers, to be put towards Sustainable Development Goals (SDGs) in the global South.” Now, we are saying, “We should guide capital towards industrial policy priorities.” That’s the big shift exemplified by the Biden Administration. What are the geopolitical factors that have put derisking at the center of green industrial policy? At its core, derisking sets up a particular type of relationship between the state and private capital. 

    It’s important to resist the temptation to celebrate a paradigm shift. Derisking offers a plausible political compromise to bring together Republicans and Democrats. It doesn’t require fundamental change, it just requires more fiscal resources for bribing private capital to support certain policy priorities. But it does not change the relationship between the central bank and fiscal authorities, and it does not reform institutional capital. 

    The developmentalist literature in the work of Robert Wade or Dani Rodrik emphasizes disciplining private capital. Derisking is not consistent with discipline. This is the difference between derisking and earlier experiments with industrial policy. 

    SA: “Derisking” is a term that’s used quite commonly in a lot of private sector parlance, perhaps less pejoratively than Daniela probably likes to use it. But I think descriptively it’s accurate. Many administration officials use the term “derisking” openly to describe the IRA. But does “derisking” merely entail subsidies or is it something more? Is it bad per se, or are there varieties that actually have legitimacy? 

    What BlackRock wants for their investment products is very different from how the IRA is structured. They are obviously financial beneficiaries, but the IRA is not structured to go through BlackRock. That’s a major contrast with the 2000s US housing bubble and bust, which actively celebrated the derisking of financial products to intermediate more capital towards housing and homeownership. It’s fair to say that the IRA is not trying to change its relationship with the Fed, but it is, in some ways, trying to bypass it. The derisking approaches are different—the difference between derisking a financial product for more financial inflows, leading to more fixed investment, versus subsidizing that fixed investment. 

    cl: One aspect of Daniela’s derisking definition that I really like is the concept of the production of investability. Whatever we end up defining derisking as, it’s important to acknowledge investment as such in certain sectors. What would happen under the right circumstances that often doesn’t happen, and why not? Where I would disagree with Daniela is that I think the production of investability happens both for private and public actors. There are factors that also prevent public actors from undertaking investment, and if those can be mitigated, then in some sense you’ve de-risked public investment as well. In certain cases, the public sector is not dealing with so-called risks—things you can assign probabilities to or try to hedge against, using interest rates or the pricing of capital or subsequent gains from the investment.

    The state is often certifying lines of activity for accumulation by private actors or for possible capital expenditure by public actors. These barriers cannot be compensated for by the price system. I could critique a carbon tax on this basis as well: a carbon tax functions on the idea that a high enough price carbon emissions will spark investment in alternatives, so that substitution effects can take place. The problem with this, of course, is that the carbon tax might not address any of the actual barriers to undertaking certain kinds of capital expenditure in energy. We can talk about planning, we can talk about industrial policy, but we’re ultimately talking about a space where activities are made possible or not. 

    DG: Why do I understand derisking as the intervention in price signals? I would argue that I define derisking through how European technocrats and politicians think about it—steering price signals without fixing them. You don’t have price controls, you don’t deal with inflation with a muscular state. But you steer price signals, even where they don’t exist. For example, the Germans are creating a green hydrogen market where it didn’t exist before, through a series of derisking measures that compensate private investors and reduce the uncertainty of the price signal for private investors. I’m very comfortable standing behind that definition of derisking, because that makes it conceptually clear that derisking is about the relationship between public and private capital, between the state and private capital. The state cannot de-risk itself unless it offers or has companies that operate as market companies. There are examples of the Danish state ownership of 51 percent of companies like Ørsted, who are doing energy infrastructure. 

    I think it confuses things to argue that there is a public derisking. To me, derisking is about shifting risks from the private sector onto the state balance sheet, not just by fiscal measures but also by regulatory measures. The World Bank, the UNDP, and the Deutsche Bank have, from the beginning of this discussion, emphasized the importance of regulatory derisking—removing obstacles to the formation of a price signal and market. I don’t think anybody goes around thinking that the state de-risks itself, though raising the question of the state is important. We can argue whether or not state companies should care about price signals. But there are models of capitalism where state companies do not care about price signals, where they buffer the end users from the consequences of market volatility. 

    This takes me back to Skanda’s point—Why is this a central bank story? You’re correct in the sense that BlackRock is not as important as a political actor, though of course BlackRock sent someone to the Biden administration to write the IRA. But that’s why I would make a distinction with the CHIPS Act, which to me is much better than the IRA. The CHIPS Act moves away significantly from the logic of derisking because it focuses on strategic state priorities. 

    But we have to remember is that the IRA embraces the relationship between the state and private capital—the state steers price signals and makes investability. This isn’t a smooth process, there’s no tried and tested process for this. But what the IRA did is change the European approach—there are many more “sticks” and it disciplines carbon capital. The IRA is not just a question of greening or incentivizing private investment, manufacturing, or clean tech. It’s also a question of shrinking fossil fuels and carbon capital. That’s a very different story from the standard story of industrial policy in the developmental state literature. 

    JWM: Melanie, do the IRA and the CHIPS Act constitute a fundamental shift in the intellectual climate? Is this at least a step in the direction of a broader substitution of public planning for market coordination? Or is that just wishful thinking on the part of those of us who’d like to see a shift? 

    MELANIE BRUSSELER: As several people on this panel have already argued, there’s now a greater shared understanding that decarbonization is a problem of investment and divestment. We need to transform existing capital and infrastructure stocks through investment and divestment very rapidly and at a spectacular volume. It’s important to stress that, when we talk about investment, we’re talking about capital equipment installation, not necessarily financial flows. The policy paradigm for so long has been to let market coordination more or less take over, relying on the constitutive elements of private investment—private profitability and the liquidity preference, which guide private investment but also hinder the multiple criteria that we’re trying to address right now. But market coordination is a fundamental issue for decarbonization. I’m borrowing the language of Yakov Feygin in a very Leontief vein—the fossil system and the renewable system are both very complex integrated machines. You can’t just swap parts from one to the other. They are very incongruous, so you need to synchronize investments to make sure we don’t have mass economic turbulence, in terms of price stability but also in terms of the functioning of our productive systems. 

    How do you build a coherent renewable energy system and an economy on top of that? I don’t think market coordination can do that. What would be different about non-market coordination? Regardless of the decarbonization imperative, economic democracy is an end in itself. But within the decarbonization paradigm, we want to see public coordination take over through institutions of public investment, public asset ownership, public enterprise, and pluralistic decision making, which would deliver investment and divestment directly, by having the state undertake essential activities and investments, and then coordinating amongst public institutions and private actors. There would be a much stronger hand for state bureaucracy. Macrofinancially, the price policies of the transition would move away from monetary dominance. More broadly, we would embrace the risk bearing capacity of the state through public ownership. I would like to provocatively call this the potential for “democratic derisking”—taking whole sectors into public utility models and having systemic public options for capital investment in order to stabilize and expand green production networks, as well as to stabilize green industry. 

    I think of democratic coordination as institutionally moving towards a green mixed ownership economy, with much more systemic public ownership and using equity stakes not just to passively subsidize private investment but to have strong control rights. So where does the IRA stand in this configuration? I agree and disagree with Daniela. The IRA’s passage has ushered in a spectacular volume of subsidies for private capital. That’s both compelling and frustrating, structuring the undertaking of capital expenditure to private actors. I think it’s right to point out that this is a continuation of this logic of producing investability. I love the phrase that Tim Barker revived, “bribing to capital formation,” where the fundamental issue is leaving this to private decision making. 

    At the same time, it’s important to stress that we’ve moved quite strikingly towards concern for capital expenditure. It’s a completely different animal than just worrying about how to get financial actors to do certain things. While there are pitfalls, this is a shared project to manage and coordinate this move—we have subsidies out there that could be undertaken, but it’s subject to further public investment and coordination. This is becoming the shared framework of future policymaking and experimentation, and we need to seize the opportunity. 

    SA: There is a form of derisking in the IRA—even if it doesn’t run through BlackRock, BlackRock surely benefits. But the part that sticks out to me from Melanie’s comments is that there is a certain necessary kind of fixed investment. If left to the private sector, that fixed investment, even once it has social value, tends to be a free cash flow drain—investment tends to only be justified if it overcomes certain hurdle rates in the private sector. That is a risk calculation that I don’t think of as being the same as a price mechanism. I think this will be necessary in areas where investment is subject to a lot of uncertainties. One good example would be Cleveland-Cliffs, a steel producer in the US. It is emissions intensive, and we don’t have scalable, tested solutions for emissions-free steel production. IRA incentives and IRA derisking provide very important tax credits for scaling up. If you can change industry behavior to try things that drain free cash flow in the short run, they of course need potential returns in the longer run. But changed behavior is really important to changing the system itself.

    There are many reasons the IRA looks the way it does—legislative procedure has gone through financial mechanisms, not just regulatory mechanisms, just to get through reconciliation. But we need to focus on substance over form. Sure, it may take the form of carrots that are attractive for the private sector, but the ultimate goal is to change behavior. My biggest concern with painting things with a broad derisking brush is that there are definitely examples where derisking can go wrong, but there are also places where it has a legitimate purpose in the energy transition. How are we going to tackle this challenge? 

    JWM: That was very clarifying. Can we separate derisking as a descriptive term from descriptive derisking as a normative term? Can we imagine a democratic derisking, a derisking paradigm of economic management that is nonetheless serving social needs through a democratic political process?

    DG: I would say the short answer is no. I like the idea of democratic derisking, but I think it’s fundamentally inconsistent with how I understand derisking. There’s a bigger question: Can we or should we expect to tackle the climate crisis through private capital? I’m not sure the answer is yes. Skanda and I agree on trying to change the behavior of private capital. But after living in Europe and following the policies there, I see derisking as a macrofinancial issue, not just an industrial policy issue. For the last five years, the European Commission and European governments have been trying to change behavior through discipline and penalties. You can change the cost of capital and stimulate fixed investment not just by increasing returns, but by making it far more expensive or to invest in dirty assets. There are different kinds of pathways to changing behavior of private capital. My worry is that with the IRA, we are very quickly moving far away from what we had in Europe. 

    These policies in Europe weren’t perfect, and they were open to political contestation and watering down, but the ECB tried to discipline fossil capital and change risk return profiles, changing investability and behavior through penalties on dirty credit. We don’t need democratic derisking. The harsh reality is that you can change behavior in different ways. We are now changing behavior in a way that BlackRock would approve of—adding a lot of carrots and not enough sticks. Why can’t we pursue the European version? 

    MB: On discipline, I think it can be tricky to talk about the role of credit guidance and the greening of the financial system. Credit guidance is a necessary tool in the macrofinancial toolkit, but I think positive and negative credit guidance is often overplayed in terms of driving capital expenditure and divestment. It’s unhelpful to think that penalizing carbon investments through the financial system would lead to an orderly divestment from fossil fuels. Ultimately, the phase out of fossil fuels will have to happen on the state balance sheet, because you have to maintain a certain level of capacity and then phase out. Credit guidance can help that along but it’s not the fundamental mechanism by which it’ll happen. 

    Our conversation on derisking is circling around the question: what should we be publicly invested in? And what will rely on private investment alone as a result of political constraints? The language of derisking can still be quite helpful as we turn from financial market shenanigans to the actual governing of capital expenditure. For example, in the UK, the Contracts for Difference model is a classic form of derisking—it entails backstopping private investment. But there are currently some issues with it, as we face inflation and higher interest rates. Wind turbine developers claim they need to raise their prices to expand capacity because their profits have been eroded, because private generators are fueling the lessening of subsidies through these contract pressure models, also called a reverse auction. They’re fighting for profit share in this space, we’re left with the question: which capacity do we want to be expanding? Do we want to govern the capacity to produce private wind turbines, or do we want public generation that directs that investment and stabilizes that production network? As we move into fixed capital investment, there’s a way to be appropriating this language of derisking. I don’t even know a better term for it.

    SA: Financial investment and fixed investment look very different when it comes to decarbonization. Decarbonization is about the real capital stock, both for divestment and investment purposes. The derisking logic is in the financial context, targeting certain risk financial instruments. Leaving aside the normative aspects, I’m not sure that this is going to be a key lever for how we’ll drive fixed investment. A running theme of the last few decades is that if we just give finance certain conditions, it’ll lead to certain fixed investment conditions, and I’m not convinced that this is true. 

    We need to further parse out the varieties of derisking. I don’t really see how CHIPS is that different from the IRA—industry lobbied for it. There were some Republicans and Democrats who saw the national security benefits of having an industrial base around leading edge and legacy CHIPS, but I think there’s definitely room for public and private sector alignment of interests. But I don’t think it’s actually that different in terms of governance design. Yes, there are some strings attached and some conditions, but CHIPS is largely grants that support the investment and operations of semiconductor manufacturing companies. There may be disciplining of firms, but at best, it’s collaborative, and at worst, it’s a set of conditions to make sure that firms invest a certain amount. It’s larger grants and subsidies, not a new regulatory state around semiconductor manufacturing. Daniela, what does an IRA look like without a pejorative derisking structure? What would the IRA need for fundamental change?

    CL: I want to add onto this concept of discipline. I think of industrial policy more generally as creating the possibility of spaces for investment—public or private—that didn’t exist previously. It reduces the salience of the carrot v. stick differentiation. When you look at how policies end up sparking capital expenditure, you start to miss the point where the policy goes from being an inducement to being a disciplining device on capital. One example is the American Rescue Plan. Firms were pressured to consider certain kinds of capital investment that they might not otherwise have, relative to what they might have done with free cash flow—either discard it in buybacks, return it to shareholders somehow, or just not use it and have it sitting on their balance sheet. In one sense, the ARP was an inducement because it gave firms potential customers and potential profitability opportunities. But it was also a disciplining device—the one aspect of financial capital that would have demanded certain cash flows became relatively less powerful. Other industrial policy devices can also be thought of in this way. Carrots can open a large opportunity for firms to make them consider a space that they hadn’t before. In some sense, the distinction between discipline and carrots is blurred.  

    DG: Chirag, we can play language games in which everything sounds like conditionality or discipline for private capital, but I’m not particularly interested in that. I agree that putting penalties that change risk returns on dirty assets is a necessity that also plays with a price signal. And yes, that doesn’t take us into state control of the pace or nature of credit creation. But the excessive amount of lobbying in Brussels and in London against these measures makes me think that there is something at stake that we should not discard simply because it doesn’t take us into a universe where the state is much more powerful in terms of disciplining private capital. 

    My observations simply have to do with the fact that the derisking logic of statecraft accommodates greenwashing and is inconsistent with Paris targets. I am worried that it doesn’t take us where we want to be, for reasons that Melanie pointed out. When market conditions change, some private actors may change their mind, and we cannot afford this. I use the notion of the close control of credit, which requires the state to do much more work than credit guidance. I’m putting political impossibility aside for a second, but the state must do more to restrict the free flow of capital across and within borders, and this is why decarbonization is fundamentally a macrofinancial issue. We need changes in the structures of finance, in institutions of coercion.

    I was very dismissive of the CHIPS Act at first, but Twitter conversations have persuaded me that there is some level of discipline. The Biden administration is far more ambitious than Europe, in terms of operational milestones like a restraint on share buybacks or prior due diligence. The purpose of disciplining institutions is that strategic industrial policy must ensure that capital doesn’t go in another direction when market conditions change. The state needs to have the capacity to closely steer investment. The CHIPS Act does this more than the IRA. It would require the IRA to say, we can’t shift from small electric cars to electric tanks, because that does not solve the problem of climate change. 

    SA: I think the operational milestones are quite similar in CHIPS and the IRA—the work of the Loans Programs Office, the commercial liftoff reports tied to certain projects, ensuring the goals are achieved. There are places where the Department of Energy and the Department of Commerce look quite similar. It’s a form of indicative planning.

    JWM: Melanie, to what extent is the IRA relevant in the international context, in the UK and the EU in particular? Or would you hope that a future UK Labour government, for example, would support a different kind of model?

    MB: There’s been a lot of European activity on how to respond to the IRA. The EU was certainly concerned about the trade aspects, but there were also internal politics, with some actors wanting more fiscal spending and industrial policy. In the UK, there’s a really exciting development with the potential of a Labour Government, which has pledged to spend upwards of 300 billion pounds across ten years on a “green prosperity plan,” which is still largely undefined. But it does feature a commitment to create British energy—a public renewables generator. They want to be a green energy superpower akin to Électricité de France (EDF) in France. They’ve also proposed creating a sovereign wealth fund with a green mandate, which is quite rare, and closer to the National Investment Authority proposal in the US context. 

    One lesson that the UK could take from the UK experience is to think creatively around fiscal constraints. Discussions around debt and fiscal stability should account for the fact that public assets generate revenue. In the UK, Rachel Reeves and the Labour Party still emphasize maintaining fiscal discipline. The IRA, on the other hand, is made up of uncapped tax credits—for better or for worse. The UK political project could question this fiscal rule.  

    JWM: Daniela, what would be the dangers if the EU were to follow the US example? Was there a more promising model in Europe that is in danger of getting sidelined by the IRA approach?

    DG: I’m not as optimistic as Melanie. I understand the sovereign wealth funds as derisking machines, as opposed to machines for creating public ownership. They are not articulated towards a public or state-driven decarbonization project. While this conversation is about derisking, I’m working in parallel on what I call a big green state. It summarizes a range of approaches, but it does not allow private capital to set the pace and direction of decarbonization, as is currently happening. The dangers in Europe resemble the way that different US states are competing for the IRA money. But in Europe, it’s far more obvious, because the macrofinancial relationship is far more delicate and open to political contestation. With the IRA, we have moved from the EU wanting to decarbonize quickly, even with Chinese clean tech imports. The EU now wants the global market share in clean tech. In other words, it’s industrial policy in the old, traditional way. 

    In the paper, I look through the scenarios where the European Commission uses the term “derisking multiplier,” making some bizarre approximation for the amount of money you need for a percentage of the global market share. But it’s the politics of how to get European capitals to agree on a Europe-level budget. The difficulty of the delicate arrangement, then, is that France, Germany, and countries with more fiscal space are not allowed to promote their own industries through state aid. Since the pandemic, however, the easing of these restrictions which were meant to level the playing field has mainly benefitted France and Germany. It turns back to the same problem that Melanie identified—in the end, the immense challenges we face cannot rely on market coordination. What we need is big state balance sheets and state capacity that do not repeat the mistakes of communist enterprises. My postgrad studies focused on central banks actions in post-communist countries, where they needed to dismantle state-owned companies. Now, I’m going to study how we put them back together.

    SA: I think Daniela’s piece is very provocative—is derisking a race to the bottom or the top? There’s going to be a need for experimentation and overcapacity, erring on the side of redundancy. Many countries and companies will try to figure out how to push down cost structures in a way that leads to more investment and capacity. The developed world must use its fiscal policy space to allow emerging and underdeveloped countries to also pursue decarbonization paths. We have to make that space available, and part of the IRA and derisking is worth rescuing and celebrating.

    CL: The private sector is an existing set of institutions that will continue to exist for the foreseeable future, and we need them to undertake decarbonization activities as well, in many cases against their previously expressed interest and intentions. If our policies succeed in creating a boom in green capital equipment, then we would have the political responsibility for the next steps—the fight doesn’t end there. I think if you’re looking to spark a politics of democratic investment, you have to be prepared for what comes next.

    MB: Ultimately, I think we have to view social transformation as an iterative, uncertain process of transforming institutions, tools, and enterprises. It’s going to be a constant fight. It’s up to us to move the politics towards the socialization of investment, abolition of fossil fuels, and the eventual flourishing of the planetary cooperative commonwealth.

    DG: I think the distinction between financial capital and capital investment is a bit too neat in this panel, but I am a bit more hopeful after this. I’m generally quite skeptical, but I will go with Melanie’s insight that all small political changes might take us somewhere better.

  5. Making Markets

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    The Gamestop bubble of 2021—where the value of the company’s stock increased more than a hundred times over in just a few months—exemplified the rising trend of the meme stock frenzy. This event shed light on the roles of both retail investors and market-makers in contemporary equity markets, and more recently has contributed to the US Securities and Exchange Commission’s (SEC) justifications for its proposals to overhaul how retail investors access and invest in the US markets.

    Douglas Cifu is the co-founder and Chief Executive Officer of Virtu Financial, a major retail and wholesale market-maker. In the following conversation, Cifu and Elham Saeidinezhad discuss the politics and implications of the proposed regulations, as well as the broader dynamics of equity markets. Read Saeidinezhad’s full introduction to the interview and analysis of the new regulations here.

    An interview with Douglas Cifu

    ELHAM SAEIDINEZHAD: Can you summarize the business of market makers? 

    Douglas Cifu: Market making has always been around—we can imagine a subsistence farmer who, thanks to agricultural innovations, ultimately comes to sell her excess harvest at a post in the market. The market maker is the agent who buys corn from the farmer, collects it and holds it in a warehouse, and holds it for sale to buyers looking for corn at a later date. This involves a substantial amount of risk—the market maker accumulates quantities of goods and holds them for an unknown duration of time—during which the price of corn could fluctuate—before securing buyers. 

    In the contemporary equity market, market-makers are willing to purchase and sell securities to investors looking for immediate liquidity. Like the market maker buying the farmer’s corn, today’s market maker assumes the risk of holding the position until it can find an offsetting buyer or seller who wants its inventory. As an incentive to take this risk, market makers attempt to earn a profit by offering to sell shares slightly above the price than they bid to buy shares (the bid-ask spread); however, like the market maker that bought the farmer’s corn, the market for securities can move against a market maker’s position causing it to lose money on some positions. Thus, market makers contribute to market prices through their commitments to purchase and sell all sorts of liquid and illiquid assets. 

    We make markets in 25,000 different financial instruments. At any moment in time, we may be long or short any security. In practice, we aim to bridge the temporal gap between natural buyers and natural sellers. In a perfect world, we would always buy from one person and sell to another person before the market moves against our position. That world doesn’t exist, but by aiming towards this end we facilitate market liquidity overall. Over the past fifteen years, we have invested billions of dollars to build our scaled infrastructure that can access and provide liquidity across hundreds of markets and dozens of asset classes. We are motivated to provide attractive buying and selling prices because, if we don’t, we’re not going to get the business. The farmer should be able to sell her corn for a higher price if she can find a buyer willing to pay more than another buyer. That’s what market making is, and competition among market makers has significantly improved market liquidity and reduced investors’ costs. 

    ES: The SEC’s recent proposals on equity market structure are intended to improve trading execution for retail investors. The proposals distinguish firms which service and often internalize clients’ orders from those which route orders to another market center, with the idea that all orders should be routed to a market center where more competition would help prevent profit incentives on the part of wholesale dealers. What is the SEC missing? 

    DC: The proposal assumes that market-makers have an incentive to internalize every order in order to make a higher profit margin. But, in reality, this is not the case.  

    According to the rules put forward by FINRA (the Financial Industry Regulatory Authority), retail brokers have a duty of best execution which requires them to use reasonable diligence to route orders to the best market. When a broker-dealer that is a market maker receives orders from a broker-dealer client—whether it’s Schwab, Fidelity, Vanguard or any of the 250 clients we service—we have a best execution obligation to execute the client’s order in the best market, regardless of whether that means internalizing the order ourselves or routing to another market center—such as an exchange, alternative trading system (ATS),1 or another wholesaler—if we expected that doing so would be most likely to result in the best price, immediacy, and overall execution quality for the end client. We have a committee dedicated to monitoring our execution performance and evaluating market centers, including what we internalize and externalize by routing orders to external market centers.

    In addition to the regulatory requirements to deliver best execution, there are intense competitive forces that serve as an immediate check against poor performance. Both to meet our best execution obligations and to compete for order flow, we internalize more orders than we would otherwise want to internalize. However, contrary to urban legends, only about a dozen retail brokers charge payment for order flow (PFOF) and these retail brokers do not route orders to one wholesaler or another based on PFOF amounts; in fact, each broker sets its own PFOF rate and charges that same rate to all wholesalers to avoid potential conflicts. Retail brokers reward wholesalers with more order flow if they deliver better performance than others and send less order flow to wholesalers that deliver lower performance. 

    Importantly, the SEC’s proposed regulations do not recognize that wholesalers service more than just retail brokerage firms such as Robinhood and Schwab. Large firms such as LPL Financial, Stifel, Raymond James, and JP Morgan’s Wealth Management Division also leverage wholesalers to get the best execution for their clients. These brokers and platforms—about 250 in total—and their best execution committees review our performance on an ongoing basis. If we don’t constantly provide exemplary execution service and the best prices, these large wealth management firms would send their orders elsewhere. There are no contracts or long-term agreements that require brokers to route orders to a wholesaler—the brokers are free to (and have an obligation to) make routing changes to send more flow to the marketplaces or wholesalers providing the best execution. After all, execution quality is one the of the key metrics by which retail brokers are measured so they have a commercial incentive to make sure their routing is optimized. So, the competitive market structure already encourages the best execution, and the existing rules by FINRA ensure that this continues.

    Accordingly, wholesalers are incentivized to execute in the best market. While internalizing the order will typically provide the highest probability of being the best market, for a variety of reasons wholesalers frequently obtain shares on other market centers which we refer to as externalizing the order. When we externalize an order by filling it with liquidity obtained from other sources, like an exchange, we often must subsidize the execution quality we obtained by adjusting the order’s fill price to a more favorable price for the client. By providing this supplemental price improvement, we are able to deliver price improving executions to retail investors and remain competitive versus our peers.

    Our view on these proposals is that the SEC is being over-prescriptive in trying to repeal and rewrite the existing understanding, rules, and standard operating procedures that FINRA and the industry have dealt with for the last twenty years. The proposed reforms are vague and subject to substantial uncertainties about the potential benefits, which the SEC itself acknowledges, and there’s a broadly held fear that the proposed rules will have unintended consequences for retail and institutional equity investors. The impression is that the SEC is trying to micromanage, rather than regulate, the marketplace. 

    We believe in data-driven regulatory reform, not pointed rules that pick winners and losers from the outside. But at the moment, there’s no evidence that the proposed rules are objective and data driven, but rather will pointedly harm liquidity in the market and significantly increase investors’ and issuers’ costs. In practice, the best execution rule being put forward will simply ban PFOF—the per-share fee charged by retail brokers to the wholesalers they route orders to. SEC Chair Gary Gensler expressed the desire to ban PFOF a year ago, causing a bipartisan uproar. This is because it is widely recognized that payments (or rebates) to retail brokerage firms order flows don’t impact routing decisions. The rebate that wholesalers pay to the retail broker fosters competition and innovation among brokers, and enables these retail brokers to provide commission-free trading to their clients. 

    The SEC could have opened a debate regarding PFOF. If it had done so, the SEC could have learned about how the market has solved for this already by offering choice to investors. For example, some brokers like Schwab and Robinhood charge PFOF while others like Fidelity and Vanguard do not. Generally, disclosing, quantifying, and regulating financial services and then allowing individuals to make their own decisions is far more effective and useful than prescriptive regulation that limits investors’ choices, such as an outright ban. The latter leads to years of SEC exams, potential fines, and litigation enforcement without improving the markets and would only make our markets less accessible for many first-time investors. 

    Rather than prescribing static rules for a highly dynamic market, the SEC and FINRA’s primary job should be to look for bad players and then go after them. I’m a big believer in a principles-based regulatory regime—where established principles say a broker-dealer has to make reasonable efforts to obtain the best execution for its clients.

    Additionally, we should not confuse best price with best executionBest execution means using reasonable diligence to execute in a manner that provides a good probability of achieving a price that is at least as good as prices that are reasonably available when comparing competing markets centers under the particular circumstances of the order and market conditions. When a client sends a wholesaler a big block of an illiquid stock, simply executing that order in the marketplace may move market prices overall, which—even if executed at the best posted prices available—may not be the most favorable outcome for investor’s order. Therefore, the best price for a given order should also consider the order size, the investor’s level of urgency, the time the order is received, and what liquidity looks like in the rest of the marketplace. The SEC mistakenly concludes that because the retail broker is charging a rebate, it can’t possibly offer best execution. But this doesn’t recognize the various factors that impact execution quality.

    Finally, investors always have the choice of selecting a retail broker that does not charge PFOF if they dislike PFOF. We service about 250 retail brokers in the United States and abroad, and only about ten of them charge a rebate or PFOF. Regardless of whether a broker charges PFOF, these brokers satisfy their best execution obligations in large measure by sending orders to wholesalers who can provide a better price as academics have demonstrated on many occasions

    ES: What is your response to the proposed changes to Regulation National Market System (reg NMS) that would reduce the minimum quoting increment—thus reducing the minimum difference between bid and ask prices for particular stocks, potentially allowing the market to quote closer to an asset’s fundamental value?

    DC: In 2005, reg NMS allowed securities to be traded on more venues than only a security’s primary listing exchange. One of the trade-offs was making everything trade-in “no less than a penny tick.” 

    Nearly twenty years later, there are many exchange-traded funds (ETF) and some stocks that are constantly quoted at a penny. One could make the argument that those names are tick constrained and might benefit by being allowed to quote in half-penny increments, but we should identify these symbols through data rather than arbitrarily regulating tick size. Determining whether a name is tick constrained should be a multi-factor test that also considers quoted size and average trade sizes—not simply determined by the quoted spread. Some exchanges, like the Chicago Board Options Exchange (CBOE), put out a white paper with an objective method for identifying tick-constrained stocks, which seems reasonable and is broadly supported. 

    Additionally, while the SEC’s proposed new tiny pricing increments (tick sizes) of 1/10th of a penny and 2/10th of a penny are purportedly aimed at narrowing trading costs for investors, these changes are likely to have the opposite effect and harm displayed liquidity in the market. The SEC’s proposal is meant to encourage tighter quoted spreads on exchanges, but overly narrow ticks will likely push more liquidity away from exchanges.

    For those tick constrained names, I think there is an equilibrium to be found. You may be able to determine that there is sufficient liquidity in sub-penny pricing to narrow the tick from a penny to a half-penny without negatively impacting liquidity. But unilaterally making ticks smaller than they otherwise would-be risks worsening liquidity for everyone—including retail and institutional investors as well as increasing costs for issuers—by removing incentives for participants to display their limit orders on exchanges.

    The net result will be that it will be much more difficult for institutional investors to execute in the market and more expensive for issuers to raise capital. For context, we at Virtu Financial operate retail wholesale market making, our own multi-asset principal market making, and a very large institutional business. In our institutional business, we utilize our technology investments to provide multi-asset execution services (execution algorithms), workflow solutions, and analytics products. We and the majority of comment letters from institutional investors strongly oppose the SEC proposal to reduce quoting increments to 1/10th or 2/10th of a penny.2

    ES: One of the most interesting aspects of this is the gap between the SEC’s academic theories on financial markets and what is happening on the ground. Gensler is effectively following academic theories and models, which argue that commission fees and transaction costs should equal zero in a perfectly competitive market. They believe that the price of an asset should only reflect its fundamental value, or risk-adjusted future income, and any service costs should be competed to zero. What do you say to this understanding? 

    dc: I think these tensions are well demonstrated by the auction proposal. The SEC chairman thinks there is too much intermediation in the equity market, and this can be resolved by routing every retail order to an auction. Gensler’s auction proposal mandates that retail equity orders are routed to auctions conducted by exchanges where more market participants would be able to bid (or offer) in the auction. 

    Gensler believes that buyers and sellers would then magically match with each other in the market at more favorable prices, and that wholesalers simply represent “unnecessary friction.” That’s like saying that a grocery store creates “unnecessary friction” because a customer could get a better price if they bought one gallon of milk from the farmer, regardless of the fact that selling milk one gallon at a time would be cost prohibitive for a farmer and there’s a cost to forcing consumers to make time for a separate trip to the farmer. Competition among and between brokers, exchanges, banks, wholesalers, and market makers serves to make the entire ecosystem more efficient and diverse for everyone. 

    To that point, over the years, competition amongst market makers has reduced friction and PFOF payments to retail brokers has enabled commission-free trading for retail investors. Competition has also narrowed the bid-offer spreads quoted in the market and improved execution quality dramatically. Commissions went from $300 when I was a kid to zero today. Quoting increments and trading used to happen in 25 cents, now everything is in penny increments. 

    Wholesalers are able to provide superior executions to retail investors because these are not large orders. By segmenting the typically smaller retail orders from typically larger institutional investor orders, wholesalers can fill the retail orders at a better price than what is available on exchanges. Because the retail order is for, say, a $5,000 and not $100 million, wholesalers can absorb it into inventory, expecting that the individual retail order won’t move the market against us while we’re holding the inventory, which further lowers our cost to provide liquidity. 

    When we have a lower cost of liquidity, we are able to be more competitive and share that savings by providing significant price improvement back to retail investors, often getting close to midpoint execution. That’s what the wholesaler liquidity provision service is—it offers price improvement, price discovery, and immediacy of execution—not “unnecessary friction.”

    It’s also important to go back to the value of wholesalers’ risk taking and its relevance for liquidity provision. As a wholesaler, we assume market risk when we provide immediate executions by absorbing positions from clients. There is a broad swath of securities in the United States with about 10,000 individual companies and ETFs listed on national securities exchanges. In today’s competitive market, retail brokers are able to leverage wholesalers’ investments in technology to service all of their clients’ marketable orders of fewer than 10,000 shares. If a retail investor is buying, we will sell, and if they are selling, we will buy. Retail brokers demand that we be there in every symbol—not just the popular or most active ones. We have a commercial expectation to ensure every order is filled and a regulatory obligation to ensure best execution.

    Now, of those 10,000 stocks and ETFs, there are about 7,000 illiquid securities in which we have little natural interest in being a market maker or wholesaler.3 Providing liquidity in these thinly-traded stocks or ETFs is naturally more expensive due to the lower turnover and higher capital charges—some of these might only trade a million dollars a day or less than 100,000 shares a day. However, when wholesalers receive these orders, we must fulfill them—and we need to do a good job at it to remain competitive and fulfill our regulatory obligations. So, you can see there would be little chance that orders in illiquid symbols would find meaningful liquidity if they were sent to an auction where no one is obligated to provide liquidity. 

    ES: What do you do with such unwanted inventories?

    dc: Well, we fill these orders and often hold positions overnight—or as long as it takes to find the other side. As I mentioned, being a market maker involves taking measured market risk to efficiently bridge the gap in time between when a buyer comes to the market and a seller comes to the market. But under the auction proposal, if market makers don’t want to internalize those unwanted trades at the midpoint price, which we don’t, these orders would be sent to an auction where there’s no obligation for anyone to absorb the orders. 

    This means that under the proposed auction rule, many of these retail orders will not be executed, or if they are, it will be at much worse prices. Wholesalers will send the orders to an auction, where, when no one wants to trade them or if the market is moving quickly, will go unfilled or will be filled at worse prices as compared to when the retail investor entered the order. By removing the competitive forces driving wholesalers to fill every order, we are looking at the potential for massive auction failures, left, right, and center—especially during the most volatile market conditions. This is a risk that the SEC acknowledges, yet unexplainably dismisses, in its auction proposal.

    The head of Trading and Markets, Professor Haoxiang Zhu, seems convinced that the market will fill in that size. That’s why I noted on CNBC that the SEC thinks there’s a liquidity fairy that’s just going to show up and fill these orders. This is not how the markets work. 

    Now, let’s talk about the impacts of this rule on best execution. If you’re a retail broker, such as Schwab, for instance, and you send a sell order to Virtu Financial and Virtu decides not to internalize it at midpoint, then we would send it to an auction. After the 300 millisecond auction period, the order fails to execute because nobody wants to buy the shares. At that point, the retail order’s intentions would have been broadcast to the entire market in the public auction message and the unfilled order would come back to the wholesaler. By now, the markets have moved because the market now has information about the retail order’s intent. 

    Immediately, any natural buyers that might have wanted to buy from the retail seller will stop doing so—or at least lower the price they were willing to buy at to account for the recently published information about the retail sell order. When the quoted spread widens as the best bid price in the market falls below the best bid price at the start of the auction, the auction will fail. After this failed auction, the retail seller would now need to cross a bid/ask spread that is no longer five cents wide but now is ten cents wide—raising the retail investor’s execution costs. Effectively, under the proposed auction regime, wholesalers would no longer be incentivized to compete for order flow as they do now. Wholesalers will selectively provide liquidity to internalize what they want at midpoint and then, as an agent, route the remaining orders to an auction where they have no obligation to provide liquidity.   

    Much of the proposal still needs to be clarified; however, in this scenario, wholesalers—acting as agents—would presumably cross the now wider bid-ask spread and return the order back to the retail broker. From my perspective, as a wholesaler, it’s actually a better result for me because I don’t have to take as much stock into inventoryI’m not using as much capital and I have less risk, but this comes at a cost: retail investors will get a much worse execution and incur higher costs to access the markets. This is bad policy and it’s bad for our capital markets.

    Additionally, regulators fail to appreciate that asset managers don’t typically trade in the same stocks as retail investors and often trade at different times of the day. When an asset manager trades, they are usually only a buyer or a seller—not both—and are typically only active for a few days at a time, so they’re not constantly in the market in every symbol. So, they won’t be acting as a counterparty to every trade and will certainly not follow and fulfill auctions to provide liquidity. Most importantly, by and large, asset managers are liquidity consumers—not liquidity providers—when they want to get into a position or exit the market. Several comment letters from large asset managers go into this in greater detail, but it’s a point worth mentioning. 

    Consequently, if regulators remove the competitive dynamic that obliges wholesalers to execute every order, they are effectively removing a significant amount of liquidity from the market and this change will be most acutely felt in small and mid-cap securities and thinly traded ETFs.

    A market maker provides liquidity that enables investors to immediately trade and assumes the risk of the market moving against its position while it bridges the time between when one investor buys and another sells.  In exchange for offering this immediacy to the investor, market makers attempt to earn the bid-offer spread between the price it buys and sells. Any spread successfully earned is in exchange for the risk the market maker incurred for the service of holding the position in inventory. 

    Under the auction proposal, regulators are attempting to remove the service provider from the market as well as any incentive or requirement to provide liquidity to every order. By removing these incentives for market makers, regulators are harming market liquidity as we know it. It is a monumental change that comes with significant risk to the market structure and capital formation. 

    ES: Now, let us discuss the rules from a market or financial stability perspective. Is there any prospect of a tick size reduction becoming a systemic risk or harming liquidity?

    dc: That’s a great question and the short answer is yes to both. It’s been well documented that reducing quoting increments too much can significantly harm displayed liquidity in the market. This happens for several reasons, but the end result is often counterintuitive: wider spreads and less size displayed at the NBBO.

    Additionally, every time you reduce the minimum quoting increment size, you’re going to have a multiplying effect on the number of quotes going through various systems. From a systemic perspective, you have sixteen national securities exchanges and 40-50 ATSs, all with varying degrees of technology. The physics of every quote that comes through is a certain number of bytes of data, which must be processed. And some exchanges are much better than others regarding the volume of data they can seamlessly receive, process, and then publish. 

    Every order that comes through has to be received by a national securities exchange and reformatted into whatever protocol they use. This all happens in microseconds. Then, it must be reformatted and republished to every subscriber, who absorbs it and translates it into its own system. We do this at Virtu: we digest these giant fire hoses of information and reduce them and process them for consumption by a market making application running in a data center. 

    If you just assumed that everything was in pennies today, and then everything went to tenths of pennies, you’re potentially multiplying everything by ten—or even greater depending on how it changes participants’ behavior. In times of normalcy, like on a typical trading day, that might be manageable. But at two o’clock today, when the Fed Chairman puts out a statement, and, depending on whether or not the Fed stops increasing rates by 25 or 50 basis points, I’m telling you, there will be a burst of activity in terms of information and bytes that you couldn’t even begin to understand how voluminous it is. The systemic implications of the additional technological burden created across the market would be significant if we had ten times as much messaging due to the proposed changes because now people are sending not just one order at a penny, but sending separate orders at different fractions of penny increments to all of these other exchanges. 

    Then, on top of that, if the regulations are fully implemented as they are proposed, there are going to be millions of these little retail auctions going off every day, and the volume and costs associated with the additional overhead or how millions of intraday auctions would disrupt continuous trading haven’t been considered. There will be system capacity concerns, and some exchanges may not be able to deal with the spikes in message activity. That’s when you start to have systemic problems because people’s systems could fail under the excessive load, and there will be operational and technological issues everywhere. 

    That, to me, is a systemic risk because the entire market is beholden to this change.  

  6. Emergency Prices

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    In How China Escaped Shock Therapy (2021), Isabella Weber analyzes how China applied market reforms selectively, avoiding the broad agenda of liberalization advocated for in the West. Retaining oversight of prices for critical goods was key to this strategy. 

    Recently, Weber served on Germany’s gas price commission, whose recommendations are a pillar of the country’s €200 billion response to the energy price crisis. Her new paper with co-authors Jesus Lara Jauregui, Lucas Teixeira, and Luiza Nassif Pires provides another challenge to prevailing orthodoxy by examining which prices have the greatest impact on inflation. The authors created an input-output model to identify the sectors, goods, and services that more significant drivers of inflation. They also determined three characteristics of systemically-important prices, including their weightage as inputs. 

    In December, Weber spoke to Kate Mackenzie about the links between energy sectors, inflation, and the green transition. The following conversation has been lightly edited for length and clarity.

    An interview with Isabella Weber

    Kate mackenzie: You were on the German gas price commission. Have you been involved in a policy process like that before? 

    ISabella weber: In rich countries there hasn’t been this kind of emergency management in quite some time—there have been Covid-19 measures, but they took a different form. So it was a totally new experience. In Germany, previous government commissions had been set up to address very contentious policy issues, but those were focused on, let’s say, transitioning out of coal. These were big, long-run strategy questions, and the commissions working on them met regularly over a longer period. 

    The gas price commission, by contrast, was set up on extremely short notice and it was very intense. This speaks to the question of how best to govern economic emergencies, in real time, when relevant institutions do not exist. It’s been tough trying to develop institutional innovations to deal with this extreme situation in energy prices.

    One can question whether such commissions are a good way of doing this, or whether they are democratic. But the government did try to come up with a solution, after having waited a long time, and after not having fully appreciated the severity of the situation before. 

    KM: That seems relevant to some of your earlier research about the institutional muscle that the state needs to have for critical industries.

    IW: I think part of the reason it took so long to react in the German case was because there was no mindset that these specific prices can really matter, that they have the potential to undermine not only monetary stability, but even economic and social stability. If you have a central bank that does interest rates but cannot target specific prices, then that limits people’s thinking. 

    We are living in this age of overlapping emergencies where shocks to essentials are becoming more common, possibly even systemic. It seems likely that more shocks are to come, and they’re going to be more regular than before because of climate disasters, geopolitical tensions and the unraveling of global economic order, the whole disease environment, and so on. If this is the case, we might need a mindset of disaster preparedness in economic policymaking. This requires the state to have monitoring capacity and a policy toolbox for systemically significant sectors. 

    This is not to say that we want to have constant regimes of price controls, but we do want to be able to intervene if we need to. Ideally we’d be stabilizing prices well before the point where we have a price explosion. 

    KM: You mentioned a lot of that specific capacity exists, but it isn’t coordinated. Is there an unwillingness from the macroeconomics field to engage with other areas? 

    IW: For the most part, our economic training does not include a strong education in institutional economics, or even the basic institutions that govern our economic reality, starting from our corporations to the basic government agencies that actually do economic policy. Of course you can be an energy economist, which has become more common because of climate change, or an agricultural economist, and so on. But generally speaking, the assumption behind macroeconomics is that you can talk about the economy without sectoral knowledge, which often leads to a situation where we don’t have these links between disciplines. 

    Let’s say the energy economists on the commission do not care about inflation—it’s not something they’re worried about, and they’re just concerned about the price of gas and the efficiency of corporations and households using it. The macroeconomists care about inflation but not about the specific situation in the gas market. Now, unsurprisingly, we find that the two areas are actually deeply related. What’s happening in energy markets is extremely relevant to what’s happening in inflation. It’s just that the energy experts don’t care about inflation and the macroeconomists don’t care for the energy markets. We are missing the links between sectoral developments and macro trends. 

    I think the business analysis and business literature—even business news—are probably the best on this. But in economics, we lack the expertise or theories or ways to study how these two levers are interlinked. 

    IW: In the paper on overlapping emergencies and inflation, we try to identify systemically important prices for overall price stability. The aim is to create a framework to link sectoral development with the macro level, but we of course also fall short of understanding all the critical sectors we identify in sufficient detail to come up with policy recommendations for each sector. 

    I’m thinking of this as creating a framework for a platform to bring together the people who understand all these sectors, and the literature on these sectors, with those who understand questions of macroeconomic stability, outlook, and growth. 

    KM: It seems important to identify what those sectors are. I assume it was also a very difficult modeling exercise, but it seems surprising that this hadn’t been attempted before. 

    IW: There are contributions by Saule Omarova—we are taking the terminology of systemically important prices from her work. She has been talking about many prices that also show up in our analysis. 

    In contrast to Saule’s inductive approach or the general discourse around specific inflation drivers, we’re taking a more structuralist and systemic view. This means that we run these shocks through an input/output framework, which captures all the input/output relationships in the economy, and we make use of sectoral price volatilities before the pandemic. We compare what we’d have expected to be “systemic” before the pandemic with the post-shutdown economy, and also to the war in Ukraine. We find that basically the same sectors mattered before the pandemic that also matter more recently. 

    I’d add that the inflation commentary over the last couple of months has become commonplace in all sorts of policy reports—from BIS to OECD to the Fed to the European Central Bank. Now it’s more commonplace to read that supply shocks in energy matter for inflation, that food has been a big driver of inflation, that housing has played a role, and so on. So from that perspective it’s not surprising to find these prices matter. 

    We captured three dimensions, or channels, that can render a price systemically significant for inflation:

    • Position of sector in relation to all other sectors: Upstream oil and gas—which was the second-most important sector identified in the modeling, with a particularly high “indirect” component—are an important input to all other sectors.
    • Price volatility: The price of oil is very volatile whereas the price of administrative services in companies is very stable, because it’s basically just wages which tend not to fluctuate. 
    • The weight of goods in consumer baskets: Residential housing may not appear to be hugely volatile. Compared to oil prices, housing is relatively stable. It’s also not an important input into industrial production, but it shows up as a systemically significant price because it has such a large impact on people’s consumption baskets. 

    KM: How did energy sectors show up in the analysis?

    IW: In contrast to the Consumer Price Index (CPI), our simulation is capable of capturing indirect effects. If you look at the CPI, you only see the first layer—you don’t see that the price of oil is important because it’s important for plastic or all the things that people consume made of plastic. We show a large number of indirect effects. For example, in our analysis, oil and gas extraction shows up as the second most important category for price stability, which is basically because of an indirect effect. If you think about consumer inflation, you think about gasoline at the pump, or gas for heating, but you don’t think about oil and gas extraction as a sector that matters for consumption. Even something like chemical products have a fairly large indirect component which would come through things like fertilizer—or inputs into industrial processes—which then reside in goods that people buy which affect consumer prices. 

    This all becomes important with regard to the question of how we’re going to deal with price stability in a green transition. A key finding in our paper is the fundamental importance of fossil-fuel dependence. Trying to overcome this dependence underscores the challenges for monetary stability. This is not to say that we shouldn’t try, but we should take these challenges very seriously rather than hand-waving and saying everything will be fine.

    KM: Capital investment in upstream fossil fuels is particularly lumpy, and other aspects of fossil fuels, such as their traded nature and their vulnerability to geopolitics, are volatile. Does your work also point to the possibility of a more stable future? 

    IW: I think there is potential for it to become more stable, but we should think carefully about how these systems are designed to achieve price stability instead of just assuming the new energy systems will deliver more stable prices. We should still think of our ability to avoid and manage energy shocks. If you look at what happened with China with hydro—if you have a drought you can lose a very large source of your energy supply. 

    The question is: When were design new systems, which we will have to do, how do we ensure that they don’t build in the same price volatility that we have been struggling with these last hundred years?

    KM: What does it mean for the big energy transition scenarios which smoothly swap out one part of the energy system for another? 

    IW: I think that we will need a lot of redundancy in the transition. We need to build the new stuff before we shut off the old stuff. And you even need the old capacity to build the new capacity. 

    It’s not as though you have a given amount of energy and you smoothly transition from one system to another. It’s more like first you have an oversupply, and then you shut down the system you want to get rid of. There will be a moment in which you have both, so it’s not a gradually changing composition. This also means that there will be bumps, but maybe fewer bumps than if you were to try to mimic the straight transition path. 

    KM: What are the implications of this research?

    IW: We could imagine performing these exercises for goals other than price stability, by the way. But the specific policy that follows from this would need to be informed by the insights of people working on these specific sectors. It could bring together people who’ve been arguing for specific policies—anti-trust legislation, windfall profits, public investment, price stabilization, and so on. The idea here is not to say we need these specific policies, but to say that these are the sectors that matter and here’s a set of policies that we’ve been talking about. 

  7. Sectional Industrialization

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    Few scholars have done more to elucidate the relationship between democracy and economic development in the United States and its corresponding regional—or “sectional”—antagonisms than Richard Franklin Bensel, the Gary S. Davis professor of government at Cornell University. Among Bensel’s published works are Sectionalism and American Political Development, 1880-1980 (1984), Yankee Leviathan: The Origins of Central State Authority in America, 1859-1877 (1990), and The Political Economy of American Industrialization, 1877-1900 (2000), all of which introduce key arguments about the course of US political economy that remain critical to understanding the evolution of the two-party system and its cross-class coalitions.

    The first book measures key moments of “sectional stress” between the industrial core of the United States and the parts of the country that were traditionally agrarian and underdeveloped before the postwar decades. In his treatment of the House of Representatives as an institution which primarily represents “trade delegations,” Bensel demonstrates that a fundamental core-periphery dynamic persisted over the course of the twentieth century even as the South industrialized and the geographic poles of the Republican and Democratic parties reversed. In particular, he tracks the rise and fall of the Democratic Party’s bipolar coalition and the party’s deepening support for the most economically advanced regions of the US, anticipating today’s polarization between large, prosperous metropolitan areas and rural and peri-urban counties. 

    In Yankee Leviathan, Bensel shows how the Civil War and the Union’s victory under the leadership of the early Republican Party modernized the federal government and its infrastructural power. Party-state control over national economic policy, he argues, secured the hegemony of Northeastern manufacturers and finance capital as well as the political-economic integration of the Western frontier. In The Political Economy of American Industrialization, Bensel further explores how the Republican Party forged a “developmental coalition” that provided the popular support required of rapid industrialization and the creation of a national, if starkly unequal, “home market.” The linchpin of this coalition was a “tariff complex” that melded together different sectoral, regional, and class interests across the North in spite of pronounced conflicts over monetary policy, labor rights, and corporate regulation.

    His latest book, The Founding of Modern States (2022), marks a turn toward political theory and comparative politics.  It compares democratic state formation in Britain, the United States, and France with the emergence of nondemocratic states in the Soviet Union, Nazi Germany, and the Islamic Republic of Iran.

    In this interview, Bensel presents his framework for the political construction of economic development in the US, highlighting in turn the feedback loops between the policy commitments of political elites and the regional distribution of political and economic power. 

    An interview with Richard Bensel

    JUSTIN VASSALLO: What drove you to the field of American political development, and particularly, the focus on economic development and sectionalism? 

    Richard bensel: When I started graduate school in 1973, I was very interested in rational choice theory. I wrote a dissertation on the rules of the House of Representatives—a political economy interpretation with a strong institutionalist bent, considering how rules shape politics. I had trouble publishing that sort of work at the time, though this approach later became more widespread. 

    This helped lay the ground for my first book, Sectionalism and American Political Development, 1880–1980, which studied the relationship between institutions and the larger political economy of parties. The book focuses on macro politics, and shows how the House of Representatives has played an important part as an evidentiary source—a register, that is—of sectional interests and coalition formation. But the broader project was about sectionalism. 

    What is sectionalism? I give an empirical definition based on coalitions in the House of Representatives. At the most basic level, it is an orientation towards regional interests and an interpretation of those interests in primarily economic terms. Put otherwise, it is a political-economic approach to the maintenance of coalition politics. The construction of those coalitions takes a geographic and ideational form, and those elements do occasionally come up in the book. But the approach generally challenges the notion that ideology—be it liberalism, conservatism, or something else—forms the substrate of American politics. Rather, ideological contestation itself has largely been generated out of sectional interests.

    In the US, sectionalism depends on several factors. One is the vast geographical expanse of the country, which has necessitated a high degree of economic specialization and differentiation. Political economy could not be uniform throughout the US, and that has generated different interests in the national economy, which have been filtered into different parties and institutions. Sectionalism is unlikely to play as much of a role in a small country like the Netherlands or Denmark, for example. In the US, the historical poles of sectional competition have been the Northeast and the Deep South. 

    JV: Your framework introduces socially complex developmental coalitions that comprise different interests. They are sectoral but they are also expressed in terms of class, which complicates a simplistic labor vs. capital understanding of development. The regional specialization you just described shapes the process of state formation and the evolution of the party system. One interesting example of that is your discussion of the pre-New Deal Republican Party as a political catalyst of economic development. Can you talk us through that historical moment?

    RB: After writing Sectionalism and American Political Development, I wanted to go back and look at the dynamics that created the sectionalist patterns from 1880 to 1980. That is what led me to write Yankee Leviathan. There, I approach the US as a developmental case facing the enormous challenge of southern separatism—that is, the South wanting nothing to do with the program for economic development put forward by the North. That is because they were an agrarian cotton export economy rooted in slavery and the preservation of slavery. The North was still underdeveloped, but it had an industrial orientation and the beginnings of an industrial infrastructure. Its ideological position was based on a political-economic calculation: it was incompatible with the developmental program of the North. Even if the North were willing to entertain the survival of slavery, it was unlikely to survive in a capitalist industrial economy. 

    The Republican Party was an interesting amalgamation of all kinds of impulses. One of them was free labor, another was industrial protectionism, and another was pro-immigration. Those elements came together to oppose the South, and in so doing it also came to oppose slavery. The Republican Party was not an intentionally designed vehicle for Northern industrial development; it was also a bottom-up phenomenon. I agree with Eric Foner that the Republican Party was a creature of the Northern capitalist economy, but I would add that it is also the product of voters responding to that complex of interests and possibilities. Notably, this party excluded the South, and in most southern states Lincoln wasn’t even on the ballot.

    The South remained agrarian even after the abolition of slavery. Both class and race politics played into this. The Republican Party decided to enfranchise the freedmen—now available to counter southern planters—and attempt to protect them through Reconstruction. But eventually the southern whites come back into power. This meant that the upper classes in the South were all Democrats, while the lowest classes, the freedmen, were Republicans.

    This is the reverse of what happened in the North. There, the upper classes were Republicans, and, to the extent that workers and immigrants were aligned to the major party system, they were Democrats. Within the northern working class, there were, of course, many divisions—key among them, religious—that undermined labor solidarity. That being said, northern politics largely turned on the tariff and military pensions, both of which aligned much of the native-born, Protestant, industrial working class with the sectional interests of their employers against the South. So, this disjunction in cross-regional class coalitions frustrated the sort of class-based politics we would expect in national politics.

    The lower-classes in both regions were subordinated to their respective upper classes and the latter, in turn, dominated their respective national party organizations. In sum, the national bases of the party system were incoherent in terms of class interests and, thus, lower-class insurgencies had no way, in a sectionally polarized politics, of shaping, or even entering, national political competition. Working-class parties were always going to be small and, accordingly, so was their contribution to the national debate.

    Once these southern whites came back into power, they posed a problem for northern development because their interests were contrary to that of the North. They had to be bought off somehow, they had to be assuaged. In the Political Economy of American Industrialization, I argued that the bargain was struck via the Supreme Court; it legitimated segregation in the South and struck down civil rights legislation. That was the concession to the South in exchange for the development of a national market. This national market gave rise to national industrial corporations that finally, by 1900, could compete in the international market. You can’t find an open declaration of this bargain, but it was a tacit agreement between the parties. 

    That in part explains how the developmental coalition was facilitated. The unique combination of democracy and rapid industrial development was not the product of virtue but of the compromises born out of political-economic considerations. On the one hand, this tacit agreement was a fairly transparent accommodation of sectional interests: the North got market-centered industrial expansion and the South received political autonomy, which facilitated upper-class dominance. On the other hand, American industrial expansion rested, in very important ways, on the political and social suppression of southern freedmen.

    JV: In Yankee Leviathan and The Political Economy of American Industrialization, you argue that the tariff-policy complex which emerged in the early 1860s had few, if any, equals in the nineteenth century. How did it affect the pace and scope of economic development?

    RB: There were at least three major effects of the tariff. The first is obvious: tariff protection was for industry. And the reason it was for industry and not agriculture is because the US was exporting—not importing—agricultural products, so the tariff was no use for those. During the Civil War, American industry was shielded, primarily from British, but also from European competition. And this is an example of how a policy creates the interests that sustain it; when the tariff was implemented, there wasn’t enough industry in the North to constitute a major interest, but the tariff itself created it. Part of the reason for this was that industrialists saw opportunities for investment. The other part was the need for revenue during the Civil War. The financial viability of the war effort induced a very complex system to receive tariff revenues: they were paid in gold, which went into the treasury. The gold was used to pay the interest on bonds which were issued in greenbacks. But the dividend coupons were paid in gold, so once the gold came back out it was brought back in through tariff revenue. This cycling served the need for revenue, including the revenue needed to issue the bonds that also funded the war effort.

    The national bank system was developed in order to create a market for Union debt which the banks were required to hold as a reserve when they issued their own currency. The investors who owned these banks became, in the first instance, strong supporters of the Union war effort because the value of the government bonds they held depended on northern victory. But they also became, once the war ended, opponents of a radical reconstruction of the South because that would have entailed continued military expenditures in the region.

    After the Civil War, tariff revenue was still important, not only to redeem Union bonds and return to the gold standard, but also to pay the pensions of veterans. These, of course, were Union veterans, none of whom were southerners. This complex developmental engine reinforced and furnished the base of the Republican Party in the North with the tariff protecting industrial expansion, funding Union war debt, and paying for pensions for Union veterans. At their peak, for example, Union pensions accounted for around 40 percent of the federal budget

    By 1880, this tariff lost some of its significance as a form of sectional redistribution from the South to the North. This is because at that point, the South was just too poor to generate wealth for anybody. The only thing the South had were cotton exports, which were needed to earn foreign exchange. They were used by the Treasury to redeem its own bonds and remain on the gold standard. 

    This was a great system for Northern interests, but it was not one which anyone sat down to design. It was the result of different institutions finding their own role to play in the economy. The courts extended the national market, the executive branch maintained the gold standard, and Congress constructed tariffs to the political advantages of the Republican Party. The question is, could the Republican Party have taken a different course? Personally, I am a little bit of a determinist, and in Yankee Leviathan, I suggest the Republican Party was the only kind of party the North could have produced at that point.

    JV: Parts of your books, as well as your wife Elizabeth Sanders’ book, The Roots of Reform, raise this question of coalition formation among workers and farmers during the late nineteenth century and Progressive Era. Do you have your own thoughts on why industrial workers didn’t rally behind William Jennings Bryan in 1896? 

    RB: As presidential candidate for the Democrats in 1896, Bryan had an impossible coalition to maintain. The crucial support necessary to win the election all came from the South. And in the South, where many were already disenfranchised, labor was out of the picture. There were poor whites still voting, but they were not industrial workers. The other problem was that the Populists in the South were oriented towards a market connection between tenant farmers, sharecroppers, and merchants, all of whom cared about cotton prices. In the West, Populists were oriented towards the infrastructure through which yeoman farmers marketed their crops. These farmers owned their own land, they were independent producers, so they didn’t identify with labor. In the industrial North, workers were concentrated on the wage bargain itself. Across regions, very different interests dominated, which made it hard for them to talk to one another. 

    Bryan looked for the common denominator. Although there were planks on labor injunctions in the Democratic national platform, it was ultimately the silver campaign that became the unifying element. The silver producers were willing to fund this campaign. The problem is that if Bryan had won in 1896 and the US shifted to the silver standard, the American dollar would have depreciated by 40–50 percent. That would have been a catastrophe for a major element of the Democratic Party: New York City financial elites, who were pro-free trade and pro-gold. This would have probably thrown the US into a deep depression. Considering this possibility, industrial workers moved against Bryan, and they voted against a strong labor program because of the larger implications of Bryan’s approach to political economy.

    To some extent during the Great Depression and the New Deal, the Democrats did what the Republicans did during the Civil War: they implemented national policies to create the interests that sustained them. The New Deal was an opportunity for doing that.

    JV: Turning to the Progressive Era, your book on sectionalism contains quotes in which Republican politicians and their supporters paint the Democrats as this irredeemably sectional bloc. To what degree did Northern perceptions of the Democratic Party inhibit the latter’s growth in industrial centers of the Northeast and Midwest before the New Deal realignment? 

    RB: There were several things that the industrialization program generated. One of them were trusts that were becoming undeniably big and a major force in national politics, and people were afraid of them and their influence. Progressivism comes to represent a number of alternative ways of responding to this challenge.,. At this point, the old tariff-military union pension system is also deteriorating. American industry doesn’t need tariffs, and Civil War pensioners have all died; it is vanishing as this force that might countervail this hostility to the trusts. The problem is how to incorporate this “taming of the trusts” in a party system that continues to be sectional. The Democratic Party, not Wilson but his party in Congress, wants to tame the trusts by breaking them up, by developing rigid, clear rules for legitimate combination and have them operate through the entire economy. That is the position of the Southern wing. The Northern Republican position is that monopolies are bad, but we can deal with them on a case by case basis. It’s a more accommodating, elite-centered response. Then, there are progressives within both parties, but particularly the Republican Party in the Midwest, that take a position of regulation as opposed to law [i.e. the extensive legislative program of Southern Democrats] or the accommodationist approach. They [all] converge on the hostility towards the trusts, but diverge on the solutions. These different responses arise out of the traditional political economies of the sections. Southern Democrats do not trust the central state, they want firm rules–laws–that can’t be reinterpreted by the courts and by government regulators]. That’s the only way they will contribute to the growth of central state authority. 

    The Midwestern progressives like regulation because of their experience with railroad commissions, and the reconciliation of transportation charges with the different needs of railroads and shippers. They are comfortable with commissions and this notion of a regulatory commitment to the public interest. And the national Republicans represent an elite negotiating style. They are used to national, state authority and discretion. No one has ever had a good model for the Progressive Era. Elizabeth Sanders comes closest

    But the Progressive Era runs into World War One, which eliminates the impulse to respond to the trusts. Southern Democrats oppose intervention in the war, though Wilson is strongly in favor. He becomes increasingly aligned with the interests of finance capital, which has overextended itself funding the European powers. This becomes a disaster for the Democratic Party, particularly in the North. At this point, progressivism becomes increasingly agricultural in nature and it becomes a backward-looking, retrograde interest in the view of the North that is opposed to industrialization and urbanization. 

    JV: I want to jump ahead a bit, to the last four or five decades. The last few chapters in Sectionalism and American Political Development outline the quasi-bipartisan sectional coalitions of the 1970s . Which alliances formed, and what conditions in the national and world economy led to these temporary alliances prior to the hyper-partisan, regional polarization that now exists? Is what we see today actually sectionalism, or something different?

    RB: The 1965 Voting Rights Act undercut the Southern Democratic Party by enfranchising black voters in the Deep South. This was a bet by the northern Democratic wing of the party that they could do without the white South. They also wrongly believed that national class coalitions would form. When black people were enfranchised, they voted exactly as northern Democrats had expected, which did generate some progressives in the South. However, it also drove the expansion of the Republican Party. Southern politics was adjusting to the incorporation of Black voters, and Democrats there became more accommodating in national politics as Black voters began to pursue political power under the protection of the federal government.

    By the 1970s, the federal government was very different to what it had been in the 1930s. There were now vast social welfare programs that had been, in a sense, liberated from sectional dynamics thanks to the money coming from Washington.

    Nevertheless, stagflation and other challenges generated regional pressures that in turn became new sources of disunity in both parties. During this period, Boll Weevil Democrats maintained formal membership in the Democratic Party while negotiating quite attractive policy alliances with the Reagan wing of the GOP. In the North, Gypsy Moth Republicans entered into the Northeast-Midwest Congressional Coalition in occasional partnership with Tip O’Neill Democrats. During the energy crisis and urban redevelopment of the 1970s, regional interests were often nakedly on display as congressional coalitions fought over the distribution of federal assistance. This was a time when national political parties were redeploying their respective sectional bases: the Republicans reorienting toward the South while the Democrats became increasingly dependent on the northeast and Pacific Coast littorals.

    The expansion of the southern, very conservative, often racist wing of the Republican Party appalled many northern Republicans. That’s a major reason for the emergence of the Gypsy Moth Republicans; they felt free to vote against their national party when it took extreme positions. Just as northern and southern Democrats were facing divisions, so were Republicans in the North and South. This was a major change in the sectional bases of the two parties, a major reversal of the historical alignment that had persisted for over a century. 

    The status of sectionalism today is complex. We have red states and blue states, and the differences in their political-economic positions are very stark. In some regions, communities have become very concerned with the terms and conditions of their own reproduction. It is clear these communities are interpreting the national economy in terms of the durability of cultural values, social institutions, family structure, and so on. Cultural questions are back on the agenda in a way that they haven’t been been in the past.

    JV: Do you have any thoughts on the strategic protectionism of the Biden administration?

    RB: First of all, I don’t think it is nearly as important in the scheme of long-term development as past policies have been. Biden’s policies tend to be contingent and discretionary, rather than rigid developmental policies. But the Biden administration is very clearly committed to furthering the interests of those parts of the advanced industrial economy that are aligned with the Democratic Party. That increasingly tends to be the high-tech and social media sectors. It’s a bit like [Theodore] Roosevelt and the trusts—you can talk down to them, scold them, but are you really going to go after them? The answer is no. Any Democratic administration is going to favor these interests in the long term.

    Then we have the opposing interests. The major exporters in the US are still farmers. It’s wheat, soybeans, a bit of cotton. These are massive industries that persuade some Republicans to back free trade. However, the federal and, to a lesser extent, state governments fund a vast social-welfare system that has removed a large portion of the citizenry from the rigors of the private economy. Most Social Security recipients, for example, are free to live wherever they wish and, while they are certainly concerned with the size of their pensions, they tend not to be particularly interested in their regional economies. These recipients are thus free, for the most part, to support policies without reflecting on the economic impact they would have on their particular region.

    JV: The problem for the Democratic Party seems to resemble that of the Republicans at the turn of the twentieth century: how to keep these midwestern states, the remnants of the industrial base in the US, in a Democratic coalition. Tim Ryan, the most protectionist Democrat in the modern era, lost pretty decisively in his Senate race in Ohio, but this program of reshoring and boosting renewables seems to have some potential. 

    RB: Currently, industrial labor is much more contingently aligned with the Democrats than was the case before the repolarization of the party system. Workers are torn between the promise of reshoring industrial jobs and their communities. Some workers believe that their communities are being undermined by the Democrats policies. White industrial labor in the North is still a pivotal player in all of this because of how instrumental they are to the future of the private economy. However, one of the problems facing industrial labor is that it appears to have become a very expensive coalition partner for both political parties and it is not easily incorporated into either national coalition. In fact, I’m not sure most northern industries outside of hi-tech really believe that reshoring incentives are strong enough to invest in plants that operate for thirty years. And if they don’t believe in them, they won’t do it. And if they won’t do it, they won’t create the interests necessary to sustain them. I’m very skeptical that a few new plants here and there are going to reshape national politics.

  8. Bittersweet Tides

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    The recent victories of left parties across Latin America—most recently the election of President Luiz Inácio Lula da Silva in Brazil—have prompted comparisons with the Pink Tide of the early 2000s. But with narrow margins of victory against far-right opponents, fragile coalitions, and the effects of global economic disruption fueling discontent, the current moment looks very different than the last.

    In a recent event convened by the Ralph Miliband Programme and the Latin America and Caribbean Centre at the London School of Economics, Claudia Heiss and André Vitor Singer reflect on the trajectories of left parties in Chile and Brazil, and discuss the future of the Latin American left. The event was moderated by Robin Archer, and a recording can be viewed here. This transcript has been edited for length and clarity.

    A conversation with Claudia Heiss and André Singer

    ROBIN ARCHER: We just saw the re-election, albeit narrowly, of President Lula in Brazil. A few months earlier, we saw the rejection of the constitutional reforms that the new progressive government in Chile had only recently put forward.  

    To speak about those and other developments I’m joined by an absolutely first rate panel. Professor Claudia Heiss is the head of Political Science at the Faculty of Government at the University of Chile. She is an expert on the Chilean constitution, and on the politics of constitutions more broadly—I’ve counted thirty-two articles on these subjects just in the last decade. She also sat on the technical commission which advised on the new constitution, so she’s got an insider’s view in addition to her scholarly one. 

    Joining us from São Paulo is Professor André Singer, Professor of Political Science at the University of São Paulo. He, too, has written a significant number of important books about political and social change in Brazil, and about the phenomenon of the Lula presidency in particular. He was also the managing editor of Brazil’s largest newspaper, Folha de S.Paulo. And not least, he was a spokesperson for Lula during his first presidency.

    Claudia, would you like to start with some introductory remarks?

    CLAUDIA HEISS: I’d like to make two big points and a few smaller points to begin. The first big point is that this Pink Tide carries a bittersweet feeling—it’s not filled with hope like the one we had in the early 2000s. Of course, I’m happy that Bolsonaro and José Antonio Kast lost the presidential election—not only because they were right-wingers, but also because I think they represent threats to human rights, the preservation of the planet, and to pluralism and democracy. 

    However, the previous Pink Tide coincided with a commodities boom which enabled some left-wing governments in Latin America to fundamentally change people’s lives through redistributive policies. That was clearly the case in Brazil, while Chile was slightly different. We did not build anything resembling a welfare state, but we did have direct transfers that improved people’s standard of living. 

    Today, some of the largest economies of Latin America are once again governed by the left—Argentina, Brazil, Chile, Colombia, and Mexico all have left-wing governments. We also have leftist governments in Peru and Honduras, although in those cases there is no clear left political party to sustain the governments. We also have non-pluralist left-wing governments in Cuba, Nicaragua, and Venezuela. The worries surrounding this wave begin to emerge when we look at voters, rather than the elected parties. There is of course great variation, but on the whole, we are not seeing a lot of active citizen mobilization behind these parties. On the contrary, their membership is disappearing, at the same time as trade unions are weakening. We can analyze this trend in four ways. First, we see a very strong anti-incumbent vote. The election of the left in this case was very much the result of a swing effect—people just rejected what they had before. In that sense, the elections represent a punishment of all ruling parties, rather than a positive movement in favor of the left alternative. The Chilean constitution is an interesting example of this: in October of 2020, 78 percent of voters rejected the existing constitution, but in the recent referendum 62 percent of voters rejected the revised proposal. Ultimately, voters are just rejecting what they perceive to be the establishment. 

    The second trend we see is an acceleration of political time. We see shorter and shorter honeymoons for new rulers; Boric, the current leftist President of Chile, was elected with 56 percent of the vote, and in less than a year his support has fallen to about 30 percent. The same happened to Pedro Castillo in Peru, and to the Argentine government, which had a very poor performance in the legislative elections of November 2021. 

    Third is the role of lesser evilism in coalition formation. Lula and Boric were not elected with strong and stable support, they were elected by anyone who didn’t want the extreme right to come to power. One has to wonder what the result would have been if the opponent were a centrist. Crucially, we shouldn’t read the Brazilian election results as a demonstration of broad support for Lula, because he was in a coalition with his former rivals in the center.

    Finally, I think we should be slightly cautious in celebrating this Pink Tide because of the overwhelming trend towards political fragmentation and polarization. In Chile we used to have a very stable party system, which is today composed of twenty parties in the Chamber of Deputies and new parties forming as we speak—the former Christian Democratic party, which almost had no voters, has now been divided into three separate parties. And the elites are more polarized than the electorate. 

    This bittersweet Pink Tide means that we have governments which lack the political and parliamentary support required to produce structural transformations. In Chile, for example, we are seeing huge obstacles to the constitutional process and enormous legislative difficulty in passing tax reform because the right has the majority in Congress. This divided government and the impossibility to perform is likely to create disappointment, which may mean a future swing to the right.

    The second big point I’d like to make is regarding the issues we’ve seen with political mediation mechanisms and the capacity for public representation in our democratic institutions. We clearly face deep anti-political and anti-party sentiments. Collective action that is taking place is organized around specific issues like education and pensions, rather than a broad political vision or programmatic platform.

    In Chile, the social outbursts of 2019 did not come out of nowhere, they began in 2006 with the high school student protests. As voter turnout has declined, we’ve seen very strong mobilization in the streets. People stopped voting and started marching. These social movements have represented in some cases a reaction to neoliberalism on ideological grounds, and in others a resistance against the weight of private debt (in Chile we have very low public debt, so almost all of the debt is absorbed by families who pay 75 percent of their salaries in debt for education, health, food, clothing, and so on). In 2019 in Chile, the discussion was around dignity. But what does dignity mean? The problem of mediation is one of translating expressions of discontent into a positive political program. We can have a spokesperson for people’s anger who has no capacity to build a better future. This is what Pierre Rosanvallon has called a “counter democracy,” people want to check power, but not to construct their own destiny. So, again, we have 78 percent of voters rejecting the existing constitution, but we lacked the same force to recreate the constitution—the voter turnout went from 51 percent to 43 percent. 

    So, the questions we are left with are: Who are the people? What are they rebelling against? What do they want? I have a few possible answers. Firstly, as difficult as it is to tell politicians, there is no single voice of the people. Some people march because they want socialism, others march because they want more access to consumption. Between these, there is a convergence of demand around welfare. The demand for dignity clearly has something to do with a demand for redistribution. Second, people are rebelling against institutions and elites. This creates the ground for simple answers which can be damaging to our political culture. Third, people clearly want some limitations on the abuses of the market. Inequality is not new in Chile—we are one of the most unequal countries in the world. But in recent years, inequality has become politicized and people don’t want to tolerate it anymore. People also clearly want increased recognition of excluded peoples, including indigenous peoples and gender minorities. The Chilean Congress was composed of 13 percent women, so gender parity in the Constitutional Convention was historic for us (we only legalized divorce in 2004 and abortion was illegal under any circumstances until 2017). 

    But the difficulty in political interpretation continues despite these intuitions: the right interprets the rejection of the constitution as a sign that the population supports them. The left is citing the social protests and the voice of the people in the streets. Political scientists analyzing the results of the plebiscite of course tend to focus on the mythical median voter. The truth is that we cannot simplify what people want, and legitimate political decisions can only be obtained through pluralistic democratic citizen led deliberation. Unfortunately, I think we have to stick with politics as usual, and try to see what we can do to increase citizen involvement in the political process.

    RA: You have emphasized that the electoral forces which have brought these presidential results are composed of extremely broad democratic coalitions that stretched way beyond the center and indeed into the right. They don’t even seem like the French Popular Front of the 1930s. There is of course a left-wing figurehead, but the movements themselves don’t seem left wing in any clear sense. To what degree is “Pink Tide” a relevant description of what we are seeing? 

    André singer: I think Claudia and I agree on the most important aspect of this question. If you look at the results in Chile, Colombia and Brazil, there is a Pink Tide: the left won. They won by a small margin, but they still won. But the context we are in today is entirely different from the one of the previous Pink Tide. In the first Pink Tide, we were very optimistic. In Brazil, it was the first time a left party had been elected. We were excited about all of the social improvements we could do. Some of them were achieved, others not. But the question was: what does a (reformist) left program look like? 

    Today, we are very scared about what I call authoritarianism with a fascist bias. This is a defensive situation in which the left—in Brazil as in Chile—has been placed in the middle of the hurricane. Of course, we have to ask ourselves what these governments are capable of doing. But we need to acknowledge that this is primarily a defensive movement. 

    On the economic side, we have significant challenges. There is a global pressure for austerity, at the same time as the social situation must be improved. And these improvements demand money. We’re in a difficult situation because people expect to see results, and the economic situation in Brazil has been bad for at least a decade. 

    CH: Boric did not win with the support of a broad coalition, but he did build a broad coalition with what is now called Democratic Socialism. I think it’s important to understand that the resistance we are seeing now is the product of many years of center-left governments. The first president we had after the return to democracy in the 1990s was a Christian Democrat in alliance with the left, Patricio Aylwin. Then we had Eduardo Frei Ruiz-Tagle, Ricardo Froilán Lagos, and Michelle Bachelet. We had four left-wing governments that did not make any important structural reforms to the economic model. Why? Partly because they were a broad coalition, but also partly because of the Constitution.

    The Chilean Constitution was in many ways constructed to preserve what the dictatorship called the “subsidiary state.” In Europe, this term is used to describe institutions intended to protect civil society from the state. In Chile, these institutions are understood to protect the market from the state. Our constitution emphasizes the primacy of the market—we channel public funding into for-profit health and education industries, a huge transfer from the poor to the wealthy. This model is what many students and teachers have been resisting since the “penguin” protests of 2006. These policies are all associated with center-left governments, and as Jennifer Pribble has written, the fact that center-left governments have failed to enact center-left policies has weakened people’s faith in politics and sent them to the streets.

    And it’s not just about the broadness and fragility of the political coalitions, it’s about deep-rooted dictatorial enclaves. We did not finish democratizing in 1990. We had appointed senators until 2005, we had an electoral system which completely distorted preferences until 2015. The right agreed that this was a bad constitution, but they also rejected the new proposal. Now that the negotiations are happening, and the pension fund and private healthcare companies are running open political campaigns, we are beginning to see the real economic interests at stake.

    RA: The last question I’d like to put forward is regarding the role of generational change. For older generations in each of these countries, there is a lived memory of dictatorship and profound authoritarian rule. Yet, many younger citizens must have no recollection of this at all. We know that generational change in many cases has political consequences—how does it play into present day politics in Brazil and in Chile? 

    AS: I think Brazil is a country with a very short memory of itself. What is past is past—it is very different from Chile in that respect. So the problems we experience in Brazil are understood to be more imminent problems, and the electorate votes based on the present. But there is a concerning symptom regarding this element of generational politics, which is that Bolsonaro is aiming to return to the dictatorship. It is not spoken of in explicit terms, but it’s a fact: Bolsonaro is a former military captain who was formed by the dictatorship. He speaks well of the dictatorship all the time. His movement has new aspects which make it similar to Trumpism, which have nothing to do with the old military movements. But nevertheless, he does aim to revive this pre-1964 political structure. The relationship between the new right and the old military regime may not be directly relevant to the decisions of the electorate, but it is of interest to people studying the political moment. 

    CH: We have witnessed the importance of generational change in the wave of protests over the last two decades. The first big wave was, as I mentioned, with high school students in 2006. These high school students eventually became university students, and they formed the basis for the wave of 2011. Some of these university students then entered government, some became members of Congress (one became president!). 

    At the same time, I think it’s important not to overstate this generational memory. When my students went to protest in 2019 and 2020, I was terrified that they broke the curfew. As someone who lived under a dictatorship, breaking a curfew to me meant that you could be killed. But my students were not afraid, they went out and marched while I stayed up calling the student union to make sure they were okay. Many of them were injured, actually. The police committed very serious human rights violations in 2019—more than thirty people died and more than 400 lost their eyes after being shot by the riot police. Nevertheless, these students were not as scared as the older generation would have been. And part of their political appeal is that they are seen as newcomers onto the political scene. Their views bear resemblance to some of the older centralized political programs, but they are not traditional workers’ parties. Their way of doing politics is different, but they are mobilized. Still, one thing that is clear in Chile is the notion that the poor, the young, and the less educated automatically vote for the left is not to be taken for granted anymore. 

  9. Cyborg Trucking

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    The supply and demand whiplashes of the Covid-19 pandemic snarled global supply chains, shaking up labor markets and well-established migration patterns in the process. Existing cracks in logistics and infrastructure systems widened, thereby making them newly visible. In the US and Europe, a dramatic shortage in the supply of long haul truck drivers sparked panic among businesses and policymakers in 2021.

    In her new book Data Driven: Truckers, Technology, and the New Workplace Surveillance, Karen Levy of Cornell University offers an in-depth view of the US long haul trucking industry, explaining why so few workers today are willing to take up what was once considered a respectable, skilled job. Decimated by waves of deregulation and union-busting since the 1970s, a once highly organized and well-paid workforce has fragmented over time, subjected to the intensifying discipline of markets and management.

    Over the past decade, a new technology has emerged to threaten the autonomy of truck drivers: the electronic logging device (ELD). ELDs, which became mandatory in 2017, replace the fallible, driver-completed paper logs which have long allowed drivers and companies to subvert the “hours of service” regulations which place limits on working time. But Levy compellingly shows that ELDs function simultaneously as regulatory devices, instruments of managerial control, and objects of worker resistance. Overall, they appear to undermine the skills and autonomy of truckers to the point that they singularly fail in their stated aim—reducing driver tiredness and accidents—while at the same time opening up new ways for truckers to undermine the authority of managers and regulators.

    Levy further scrutinizes some of the automation technologies coming down the line. Puncturing hyperboles about fully autonomous vehicles peddled by Silicon Valley’s prophets, she argues that “human/machine hybridization,” rather than a jobs apocalypse, is the most likely scenario over the medium term. Due to the impossibility of eliminating human labor from the complex bundle of rote and safety-critical tasks performed by truck drivers, she foresees an intensifying rollout of bundled automation and surveillance technologies. The “cyborg” trucker of the near future will face brainwave, eye pattern, heart rate, emotional, and other kinds of biophysical monitoring by a range of wearable and in-cab devices. Ostensibly to ensure safety, such devices serve another purpose—cementing managerial power over performance management and control. 

    An interview with Karen Levy

    WEI WEI: Your book discusses the impact of technological integration on workers in the trucking sector. What led you to this topic?

    Karen levy: I am a lawyer and a sociologist by training. I’ve always been obsessed with rules, and how rules are used in the world. Recently, I’ve grown interested in the use of technology to enforce rules—either by making it more difficult for people to break them, or by surveilling people and monitoring who breaks them. We have moved to digital rule enforcement in all kinds of domains, either because we think it is more cost effective, or because we think it is more consistent. But when we do so, we also discover that there were good reasons that rules were imperfectly applied to begin with—that is, that rules as they live in society are not as simple as they appear.

    In graduate school, I spent some time searching for an arena in which to study this transition from manual to digital rule enforcement. By coincidence, I heard a radio broadcast about the digital enforcement of “hours of service rules” in the US trucking industry, which determine how long a trucker must drive before taking a break. That day, I decided to visit a truck stop and speak with some truckers there, whom I found incredibly thoughtful and interesting. That led to my dissertation, and, ultimately, this book. 

    steven rolf: The US trucking sector is notable on the one hand for its prevalent libertarian ideology, and on the other hand for its legacy of militant collectivist organizing through the Teamsters. How do you square these apparently contradictory impulses in the workforce?

    Kl: On the history of unionization in the industry, the key person to read is Michael Belzer. His book Sweatshops on Wheels is indispensable to everything I think about trucking and collective action. It is true that trucking was heavily unionized in the mid-twentieth century—about 60 percent of the industry was unionized in the early 1970s. But trucking was also one of the chief industries hit by the deregulatory wave of the early 1980s. During this time, the federal government abolished barriers to entry and stopped setting standard freight rates. This prompted a race to the bottom in an increasingly competitive industry where companies were trying to cut costs in order to offer discount rates. Among the key things that were cut were the conditions of labor; the annual salary of a truck driver tanked from $110,000 annually in 1980 to $47,000 today. Union membership rates also declined dramatically; they were down to 25 percent in the 1990s and have continued to fall since. Today, it’s hard to find a unionized long haul truck driver.

    I think this deregulation is responsible for the contradiction you outlined—truck drivers work long hours under dangerous conditions and are undercompensated for their work. This is both what decimated truckers’ unions and contributed to this libertarian ideology. 

    WW: Digital surveillance of workers is increasing across various sectors. For example, in warehousing there is digital real-time monitoring through the use of wearables, and in banking, digital surveillance is used to prevent insider trading and ensure regulatory compliance. Is there something distinct about the digital surveillance of trucking work? Or can we see some sort of convergence in how digital technologies are integrated into broader systems of social control?

    KL: I ask myself all the time whether there is anything special about the sort of surveillance we see in the trucking industry. Is it just one instance of some broader dynamic? In some ways, what truckers are experiencing resembles what workers in warehouses, food services, and professionalized industries like law and medicine have seen. You could even say that trucking is just catching up with the monitoring in other low wage sectors. Because trucking is mobile and geographically distributed, truckers have been able to maintain autonomy and preserve immunity from the surveillance common in factories, offices, or warehouses. 

    But there are some things that distinguish trucking and the digital surveillance which takes place in the sector. One is that trucking constitutes a very unique workplace—truckers live in their cabs for days or even weeks on end, which is very different from entering a workplace and leaving to go home. If you talk to truckers about why they do the work that they do, they will often tell you that they didn’t want someone looking over their shoulder all the time. In this context of total independence, surveillance strikes at the core of a deep occupational identity. It is very deeply connected to their sense of self and their self worth. 

    Another key issue is what I call surveillance interoperability. In trucking, some of the data collection is mandated by the federal government through those timekeeping regulations I mentioned earlier. But that government monitoring, which is actually not so extensive on its own, serves as a scaffold for corporate surveillance from companies. Now that these companies had to buy and install these electronic logging devices, they may as well use them to fulfill their own organizational goals. These include fine-grained performance monitoring of drivers—how much fuel they use, how hard they break, how fast they drive. There are cameras trained on their faces to see if their eyelids are fluttering and so on. This is easy and cost effective for companies because it also operates for government data collection. On top of that, there is third party data collection—this data is very interesting to third parties who want to do things like sell parking spots to drivers. In the book, I talk about how these different forms of surveillance are mutually constitutive and interoperable not just technically, but economically, culturally, and legally. 

    WW: In the book, you describe what trucking might look like in the future. Can you describe how the relationship between automation and surveillance is evolving in the trucking sector?

    KL: In the 1960s, Manfred Clynes and Nathan Kline wrote about the cyborg and the idea of technology as an augmentation of the human, giving humans greater control over their environment. In the workplace, that integration between humans and machines has had the opposite effect, where technology has been used to more closely supervise and control workers.

    For the future of the industry, I think we can continue to expect that automation and surveillance will have a complementary relationship. There is a lot of fear over worker displacement—via autonomous vehicles for instance—but we are not nearing this reality for a number of technical, social, legal, and economic reasons. In the short term, the role of artificial intelligence and automation is to hybridize the human trucker forcibly with machines, with wearables, cameras, and other technologies. This relationship between automation and surveillance is something we can expect to see in all kinds of contexts. Even “autonomous” systems require the human to interact with the machine in some way, and this will result in surveillance over that worker. 

    SR: We’ve recently done some research on the trucking industry in Brazil and China, in which we found that services like route planning and automated pricing are far more widespread in middle income countries than advanced ones. Just yesterday, I read an interview with the CEO of Uber Freight in which he said that they account for 2 percent of all freight moved in the US market. Why have these digital disruptors made such quicker strides in poorer economies? 

    KL: It definitely seems to be the case that services like Uber Freight seem to have more of an influence in middle income countries. That might in part be due to how concentrated the long haul trucking market is in the United States. Brazil and China have much greater concentration of ownership in small fleets, and those types of carriers can really benefit from things like load matching—matching unassigned loads to carriers with available capacity. In the US, 80 percent of assets are carried by 20 percent of trucking firms, which is to say that there are some big firms that are really dominant.

    Load matching could be useful for owner-operators—where drivers lease or own their trucks—and small fleets, but many of the drivers in these arrangements find themselves in exploitative situations, like long term lease-to-own agreements. This means they can often only drive for a particular company, and they’re beholden to that company for deciding what they’ll carry and when. Steve Viscelli’s The Big Rig explains how companies keep workers in really precarious positions where they have neither the employment protections that an employment arrangement might afford them, nor the freedom to decide what or for whom they’ll haul. I think these constraints on autonomy are part of the reason digital companies have been less successful in the US. 

    SR: From our perspective, it is interesting that platformization has so far predominated in non-critical industries. You can platformize take out food or a cab. But for critical logistics, we are reaching an entirely new level of co-ordination problems. Assets and people need to be in the right place at the right time, so the degree of coordination is far more demanding. How far do you think this can go? Can the entire industry be reliably organized on a just-in-time basis?

    kl: That is very difficult to imagine given the current political economy of the industry. The coordination costs may not be so high, but the incumbents in the industry do have a lot of power. When we think of the number of assets and people that need to be utilized, it feels like a very distant future.

    SR: At the beginning of the book, you observe that despite the truck worker shortage in North America and Europe, firms continue to provide low quality jobs which results in high employee turnover and labor market dropouts. How will automation impact the value of trucking labor?

    kl: More experienced workers tend to object more to greater digital supervision, and it’s not difficult to understand why. These workers have enjoyed a great amount of autonomy for years and have millions of miles of safe driving under their belt, when suddenly they are told they have to start doing things completely differently because they are no longer trusted to perform their job correctly. Many truckers I spoke to said that in-cab monitors made them feel like criminals or children.

    The younger truckers have fewer objections. They’ve never done it any other way, and there aren’t many jobs requiring relatively little training that are not subject to deep workplace surveillance. So, ironically, the more experienced workers are driven out by these technologies which are meant to promote safety.

    When it comes to automation, people like to suggest that workers who lose their jobs can be upskilledinto leadership positions. But anyone who thinks this is going to happen in trucking hasn’t spoken to many truck drivers. People’s occupational identities matter, and we can’t pretend that they don’t. When we think about automation and reskilling, we need to remember that people aren’t cogs, they carry histories and occupational pride. You can’t just reconstruct the identities people build over long periods of time. 

    SR: Your book does point to some examples of resistance. But overwhelmingly, it seems, these avenues for resistance are being closed off with greater turnover and the declining occupational identity you describe. 

    kl: I think you’re probably right that it has become more difficult over time, but there is still a fair amount of informal informational exchange among truckers—at truck stops, on message boards—where drivers can exchange some of these strategies. 

    When writing the book, I found it surprising the degree to which resistance is sometimes accepted or even encouraged by companies. Companies want monitoring and compliance with federal rules, but they also want stuff to move quickly. If that requires breaking the law, they will encourage truckers to break the rules. To some degree then, we can expect resistance to persist in part because it serves corporate interests.

    SR: I’ve been struck by the reactionary nature of recent collective action in the North American trucking sector, from the 2019 Black Smoke Matters anti-regulatory protests that you describe in the book, to the more recent Canadian trucking protests against vaccine mandates. Do you see any prospect for a shift towards more progressive mobilization? 

    kl: We have seen some progressive action when it comes to unionization rates among workers for delivery tracking companies, like UPS. There, people work locally and get to know one another. Things are more complicated in the long haul segment, where the work is geographically distributed and fairly isolated. The culture is consequently very focused on preserving autonomy; in my own conversations with truckers I didn’t find a single one who seemed excited about collective action. 

    In order to think about progressive actions for workers in this industry, we have to look to other mechanisms. One of the most impactful tools in this regard has to be a reform of the pay structure to make sure truckers are paid for the work they do. At the moment, truckers are exempt from the Fair Labor Standards Act, which provides access to things like workplace protections and overtime pay. This would allow us to address things we tend to sidestep like monitoring fatigue—you remove the incentive to overwork if you pay people well for the work that they do.

    Ww: One of your key arguments in the book is that technology on its own is not deterministic. Factors like culture, economy, and institutions matter. What role do these other factors have in protecting workers, promoting the public interest, and upholding human dignity?

    kl: That is the million dollar question. I think the most important thing we can do is recognize that when technology seems to be used to solve a problem, it is often actually being used to avoid confronting an even deeper problem. This is sometimes called the digital band-aid or digital duct tape—technology keeps things together enough while not addressing the root causes of a social, economic, legal, or cultural issue. 

    Truckers are a good example. They are subject to all this fatigue monitoring because they’re overworked, overtired, and underpaid. But instead of resolving these underlying elements, we manage the situation using digital surveillance. I’ve also done some work in collaboration with a gerontologist about monitoring in nursing homes, where people put monitoring devices in the rooms where their elderly relatives live. This technology is perceived to be necessary because people don’t trust nursing home facilities, and that is because they are underfunded and understaffed. 

    The tricky thing about technology policy is that it’s not really about technology at all. The center of required policymaking is often in the economy or through social organizations, and technology might have an important role in how we address the problem. But we should use technology as kind of a lens on that broader social landscape rather than as a substitute for resolving underlying issues. 

  10. Ventures & Networks

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    The past year of rampant inflation and energy system chaos is a clear indication that we need paradigmatic change. Any new economic system is going to be anchored by major scientific innovations; historically, spurring these technological transformations has required a mix of initial state action followed by entrepreneurial execution. Sebastian Mallaby’s The Power Law is a cutting, prescient analysis which argues that the individual who currently stands as a symbol of market excess—the venture capitalist—will be required for such a transformation.

    Mallaby’s 2022 book recounts the origins and evolution of an industry that aims to upend the economic order while still working within its structural confines. Along the way, it punctures several myths. While the Silicon Valley press heralds founders as iconoclastic saviors, Mallaby illustrates how the top venture capitalists (VCs) mold them, systematically finding ways to get a seat at the table—if not making the table outright.

    VCs—through capital allocation, ingenuity, and often straight-up guile—shape the parameters of the future. But the industry is not simply a history of big checkbooks. Mallaby emphasizes the social basis of innovation: the power of social networks in cultivating new ideas, resolving conflicts, and generating outsized economic returns. The network is select, and the gains from the innovation are not evenly distributed. But is that still the price to pay for technological progress?

    An interview with Sebastian Mallaby

    NIKHIL KALYANPUR: Over the course of writing the book, how did you change your thinking on the value of speculation?

    SEBASTIAN MALLABY: If one understands speculation to be a somewhat reckless risk-taking attitude, hedge fund investors are not always speculators, whereas venture capitalists are. Hedge fund investors in public markets often have crunchy statistical bases for the bets they make. When they pile on big, they’re not taking crazy risks. They have very solid logic for making their trades. 

    A “power law” style of investing—investing under conditions intense uncertainty—is speculation on steroids. When two individuals walk into your office and say they’ve got a vision, you’re making a bet on whether that vision will come true. You always know you’re going to be at least as likely to be wrong as right. But you make the bet anyway, because you’re hoping for that right tail upside. Venture capital is highly speculative, requiring a kind of superhuman risk appetite.

    NK: The VC model implies that there’s something wrong with the efficient markets hypothesis. Do you think we need private sector bubbles for big innovations to take place?

    SM: Inefficient markets allow skilled investors to generate alpha—better-than-expected risk-adjusted returns. I do think markets are efficient to a first approximation. But they are not perfectly efficient, so active managers—hedge fund managers or venture capitalists—can generate alpha through skill. 

    Do you need bubbles? I don’t think you need bubbles to generate innovation, because entrepreneurs and VCs would want to develop new technologies even in the absence of market overshoots. But if you turn the question around, when you do have successful technologies, they almost always come with bubbles. There’s almost always a moment when the euphoria overshoots—the railways in the 1850s, bicycles in the 1890s, and the internet in the 1990s. 

    NK: One of the core tensions in the book is the diverging role of the investor and different market actors. At one level, we really want the venture capitalists to come out swinging and take risks, yet we want the public market investor—the hedge fund type or the institutional investor—to be the disciplinary force. What does that tell us about how our markets are operating today?

    SM: A diversity of actors that have slightly different objective functions or analytical processes is ultimately a healthy thing. You get different types of investors with different levels of risk appetite, and different specialties in terms of which part of the economy they understand. That diversity is more likely to yield sound capital allocation than a monolithic system in which all the capital is allocated either by the government or by banks or by some other particular player. 

    NK: There are so many varying approaches just within the VC industry itself. Historically, you describe the initial venture capitalists as taking such an active role that they’re working with founders to eventually replace them and bring in new CEOs. We’ve also got the other extreme, characterized by Peter Thiel, where VCs just hand the money off and let the founders run. Is there something specific about the venture capital industry that allows for such different models to thrive at the same time?

    SM: Venture capitalists invest in people and ideas, and those can be pretty diverse. Different personalities and technologies will come into your office. Peter Thiel is special in his professed reluctance to get involved with companies after he invests, but in many cases, the venture capitalist may need to bond quite deeply with the entrepreneur. They can’t bond with everybody. Maybe the personality types won’t mesh, maybe their skills are not complementary enough, maybe their strengths and weaknesses don’t match up. 

    We talk about startups as if they make up one bucket of things. But there’s a massive difference between a social media company and “deep tech”—people building advanced batteries or whatever it might be. In my book, I describe how different sorts of technology opportunities will come with different types of entrepreneurial personalities. The kinds of founders that you’ll back when looking to fund routers in the 1980s will be distinct from those getting into web 2.0 in 2004. 

    NK: Thiel seems to represent thinking in the other extreme, to the point where he argues that capitalism needs to avoid competition. Do you think that we require monopolies to make the VC model work? Would a more credible US antitrust policy harm the VC model?

    SM: I think his argument is thought-provoking, but Thiel exaggerates for effect. Sure, every business wants to accumulate as much pricing power as possible. But one business’s power is another business’s problem, and VC-backed startups are often on the losing end of that. 

    If the US government were more aggressive about fighting tech monopolies, it would arguably be better for venture capital. VC is funding the challengers to the monopolies, and those challengers would have more of a chance to grow. I’ve talked to VCs who are quite bothered by the tech behemoths and would much rather have an antitrust policy that reigned them in. People talk about a “kill zone” around the tech giants—if you launch a startup that competes with Alphabet or Microsoft, they may clone your product. For example, Yelp has a long-standing campaign to persuade antitrust authorities to get tougher on Alphabet. And of course Microsoft was the target of the Department of Justice back in the 1990s for alleged predatory practices towards the upstart browser company, Netscape. 

    Now, that is just one side of the argument. There are many VC exits that take the form of mergers and acquisitions (M&A), but in many cases the acquired startup is too small to trigger regulatory scrutiny, and would be too small even under an enhanced M&A regime. Set against VCs’ desire for M&A exits is VCs’ desire to grow a startup as much as possible without a large competitor crushing it. 

    I think there’s also a bit of a myth that VCs are always pushing for early exits, including through M&A, and that therefore they must be on the side of lax antitrust. Sarah Frier’s book on Instagram documents how it wasn’t the VCs who were pushing for a sale to Facebook, but rather the founders. In my research, I found other cases where an acquisition offer comes in and the founder is initially tempted to take risk off the table, but the VC prefers going it alone for longer in hope of a larger exit.

    NK: One of the big themes in your book is this progression towards the founder having more power. How much of the lionization of the founder do you attribute to the changes in the interest rate environment?

    SM: Over the period covered in my book, capital had progressively less leverage over founders for two reasons. First, interest rates were falling, eventually leveling off at a very low base. Second, and probably more profoundly, technological changes made creating a company less capital-intensive. Both forces pointed in the same direction. Thanks to low interest rates, capital was cheap and plentiful, so the capital providers had less negotiating power. At the same time, founders needed less capital and therefore had even less reason to defer to capital providers. Between the low interest rate effect and the rise of cloud computing, I would say the latter was more important in the rise of founder power versus the VCs. 

    NK: You make the point that it’s neither market nor hierarchy, but the network that’s doing the work. There’s an image of Silicon Valley where anyone can come in and be creatively disruptive, but when looking at the figures you highlight, it seems that having an MBA is a prerequisite to joining one of these funds. These networks are quite closed—you even bring up the idea of the white man from Stanford basically being the architect of this world. Can we harness the power of these networks without reinforcing this elitism? 

    SM: Networks are super important. A key example is the Israeli tech scene, which is remarkably strong for such a small country. The success of tech there is linked to the military: a high proportion of people in the Israeli tech world pass through a special unit of the Israel Defense Forces. That, first of all, trains you to be a technologist, but more importantly, it means that everybody who’s graduated from that unit can check each other out. The network is so tight that only one degree of separation is needed to understand whether a person is to be trusted with capital. 

    Networks are tight and often narrow, but there’s an incentive to extend them. I would argue that VCs deliberately extend the network to make themselves more productive and profitable. Think about the PayPal Mafia—the former PayPal employees who went on to found companies like SpaceX, LinkedIn, and Yelp, among many others. In the same way, somebody coming out of Google may have a good shot of being a VC, because they will know people leaving Google to become founders. After Moderna’s success with mRNA technology, VC partnerships focusing on biotech will try to hire more PhDs in that field. 

    All these examples of deliberate network extension tell us that at some point, VCs will put aside that clubby white male Stanford elitism. In recent years, we’ve seen that happen with ethnic and immigrant networks. Chinese American, Indian American, and Persian American communities have all contributed to the tech industry, so of course VCs are hiring from those groups. Still, African American representation remains especially woeful. 

    NK: Do you think Silicon Valley in particular represents something unique about America?

    SM: I think the success of Silicon Valley demonstrates the importance of the US law, particularly around non-competes. In the UK, when you hire somebody from another company, it could take four to six months of gardening leave to get them to join. If you’re a VC-backed startup with a runway of four to six months, that’s a problem. American VCs who come to the UK are often shocked by that barrier. In California, non-competes are non-enforceable, and this has contributed to the flourishing of the startup ecosystem in Silicon Valley. 

    US law regarding limited partnerships has also had a major influence. US venture partnerships are pass-through entities, meaning that investing partners, called the limited partners, pay tax on their capital gains, but the partnership itself is untaxed. The US partnership structure also allows for the use of different classes of stock: common stock for founders, preferred stock for investors, and stock options for employees. One of the reasons that Europe has been slow in developing its venture ecosystem is that, until recently in several countries, it was unattractive to grant employees stock options because the tax provisions were too harsh. 

    The attractiveness of the US legal model is illustrated by China. Starting in the late 1990s, when companies such as Alibaba began to take investments from western financiers, Chinese startups borrowed the entire US playbook. With the help of Silicon Valley lawyers, they were set up so that they used New York law for dispute resolution and could issue employee stock options. This would have been impossible for a normal Chinese firm. But Silicon Valley lawyers created Cayman Island parents for the Chinese startups, and these parents could issue stock options, preferred stock, and so forth. 

    NK: You’ve documented the connections between US and Chinese VCs with great depth—the links between the early founders, the different models adopted, and the laws eventually adopted. How different would the Chinese venture capital industry look if it were more state-directed as opposed to American VC-inspired?

    SM: Until the late 1990s, venture-backed tech startups that made a big impact were highly concentrated not just in America, but in Northern California. Absent this special formula of risk capital, you don’t get world class tech companies. Before the recent crop of unicorns in Europe, the biggest tech company and almost the only large-scale software company in the region was SAP. A continent with rich consumers and lots of trained engineers simply didn’t generate that kind of startup because of a lack of risk capital. If there had been the same lack of venture capital in China, it wouldn’t have mattered that China was becoming richer. Lots of talented Chinese engineering graduates would not have translated into the formation of companies like Tencent and Alibaba without American input.

    In the late 1990s, Shirley Lin of Goldman Sachs, the first investor to back Alibaba, also advised on government-backed attempts to build technology in semiconductors. SMIC was going to be the rival to TSMC. The strategy didn’t work, and twenty-five years later, China is still trying to build a strong semiconductor sector.

    But the other half of Lin’s work—backing startups like Alibaba—clearly did work. I argue in the book that western investment and western legal structuring made all the difference to that success. Jack Ma built a world class company by attracting world class talent. He hired Joe Tsai to be the chief operating officer and chief financial officer, which would have been impossible without the ability to offer Tsai equity options. Likewise, he hired John Wu, the chief technology officer at Yahoo. Wu explained to me how his decision to quit a prestigious Valley firm and join the upstart Alibaba boiled down to the options package that Ma was able to offer. 

    NK: How should we then conceive of the role of the state in the innovation process? The book outlines a few different models—the Mazzucato view of needing the state, or a competing view that the state is only required for large fundamental innovations, and the market can function after that. Yet the conclusion of your book focuses on the state’s role in tax policy. 

    SM: Investing in basic research, science, and education is a government role. Connected to that is the training of the scientists who can become professors or entrepreneurs. Certain kinds of big tech, like building a semiconductor fab, are too capital-intensive for normal venture capital to back. The government must also provide good intellectual property (IP) rules to govern the technology transfer out of universities. In the United States, the Bayh-Dole Act of 1980 allowed inventions generated with the help of federal grants to become the property of the inventors, who could then form startups to commercialize the inventions or license the IP to entrepreneurs. 

    I argue in my book that putting government money into VC funds is less effective on the whole than giving tax assistance to VC funds. I favor tax rules that facilitate the use of employee stock options and allow venture partnerships to be pass-through entities, so that capital gains aren’t taxed twice. I am not a fan of the carried interest loophole—this takes tax subsidies too far. 

    However, I think the idea that venture capital’s role is unimportant and indeed suspect, because it’s reaping subsidies from government investment in science, is too extreme. This is a case of reacting against the mistaken view that venture capitalists are the sole agents of innovation and embracing the opposite mistake of saying that the state is the sole agent of innovation.

    NK: Do you think there’s more room for collaboration between VCs and government? There’s also a redistribution question in that relationship: at what point should the government be trying to equalize the gains out of these technologies?

    These companies see huge gains, which are some way are needed for venture capitalistic risk, but there’s also a large societal cost. For example, Silicon Valley has been a substantial driving force behind the rise of the billionaire class. What billionaires do to democracies is an open question, but there’s a compelling case that more billionaires leads to more capture and less democratic representation.

    SM: I don’t think the government’s record as a limited partner is particularly good. When EU funds dominate capital allocation for startups and they don’t have to generate a market rate of return, the incentives are messed up. The same is true for the state “guidance funds” in China. I’m comfortable with a commonsensical recognition that government is very important in some things, and risk capital in the private sector is very important for other things. At the same time, I agree with your point on redistribution. I think the right remedy for that is a higher personal tax, and much higher wealth and inheritance taxes. I’m not keen on more billionaires.

    NK: At what point do you think inheritance tax or a potential higher income tax is going to change the innovation landscape in the US? One argument against higher taxes is that when it comes to billionaires, people who are really good at picking winners have the money to pick winners. We could have Bill Gates pushing innovation in the climate tech space.

    SM: I think that the winners could win a fraction of what they’re getting, and they would still be highly incentivized to do what they do. I don’t think higher taxes will dampen innovation. But we can’t have it both ways when it comes to billionaire philanthropy. If we’re going to argue that billionaires threaten state capture, we can’t make an exception for the billionaire we like. Bill Gates is doing great stuff for climate tech, but we’re going to have to tax him too. 

    I don’t think taxing the billionaire philanthropists will shut down an irreplaceable driver of innovation. We already have savings institutions that allocate to venture capital, including university endowments and pension funds, which arguably have their own useful public purposes. I think one can be anti-individual billionaire, but pro-innovation.