The Danger of Playing It Safe

A top economist says the war on terror may stifle growth

William J. Baumol believes that the best guarantor of a nation's security is economic strength. The respected New York University economist cites a counselor to Louis XII of France, who once said a king needs three things to win wars: "First, money; second, money; and third, money."

That's why Baumol warns against trying to combat terrorism by locking down the homeland. He says tight restrictions on communications and travel would disrupt the flow of scientific ideas that are vital to innovation and economic strength. "It's one thing to move in the direction of tightening security," says Baumol. "It's another to engage in an anticipatory surrender."

Baumol deserves a hearing. He's a past president of the American Economic Assn. and a perennial contender for the Nobel prize in economics. At 80, and still going strong, he is among the last working members of the great generation of post-World War II economists. He has contributed to fields ranging from antitrust theory to the origins of productivity growth. "His breadth is amazing," says Paul A. Samuelson, the Nobel prize winner. "I used to say I was the last generalist in economics, but maybe I should add a few other names, like Baumol's."

In a new essay, Baumol also advocates reducing preparations for combating conventional enemies, on the grounds that the U.S. has more than enough firepower for any current adversary, and that by the time another superpower emerges, weapons purchased now will be obsolete. He advocates redirecting some defense spending to education, basic research, and other "foundations of future economic growth." That would raise living standards and give the U.S. the wherewithal to build--if needed--armed forces to handle "any unforeseeable military emergency the future may bring," he writes.

Baumol's take on security reflects his longtime focus on economic growth and the organizational structures for achieving it. He has collaborated with such Nobel laureates as Samuelson, Gary S. Becker, Robert H. Solow, and the late James Tobin. He invented the idea that service industries are plagued by "cost disease," as well as "contestability"--the idea that companies whose markets are easy to enter can't charge monopoly profits even if they have no current competition. And with colleague Robert D. Willig of Princeton University, he devised a widely used rule for determining how much a company should be allowed to charge when it's forced to share its facilities, such as phone lines to the home (table).

The courtly Baumol claims not to have a single enemy, a rarity in academia. He has spent his entire career at two institutions: Princeton, from 1949 to 1991, and NYU, where he taught for the overlapping period of 1971 to the present. He has also made a tidy sum as an expert witness in regulation and antitrust cases, testifying on behalf of railroads, airlines, and AT&T. To top it off, he's a trained artist who taught sculpture at Princeton for 20 years. His education was in painting, but he says he learned woodcarving from German prisoners of war he guarded in France during World War II.

Baumol is true blue in his admiration for the wealth-producing power of capitalism. "Capitalism has its warts. But there is one thing it does fantastically well, and that's innovation and the growth to which it leads," he says. He notes that per capita real income in the U.S. grew at least eightfold during the 20th century. In contrast, there was zero per capita income growth in Western Europe in the 1,500 years before the Industrial Revolution began.

The idea that capitalism forces the pace of innovation isn't exactly new. Karl Marx and Joseph Engels made the same point in 1847, when they wrote: "The Bourgeoisie cannot exist without constantly revolutionizing the instruments of production." Nonetheless, most modern economists have failed to appreciate the centrality of innovation, focusing instead on the efficiency with which the free market allocates resources. Even when they do acknowledge the importance of innovation, says Baumol, they don't pay attention to the conditions needed to foster it.

Baumol probes innovation in a book published this month, The Free-Market Innovation Machine: Analyzing the Growth Miracle of Capitalism. He says companies don't like to compete on price alone. To preserve a bit of pricing power, top companies constantly tinker with their products and license ideas from others. He says companies with valuable ideas have a financial incentive to share them--either for license fees or for reciprocal access to a rival's patents.

Such innovative activity requires open markets and a free flow of ideas. America is being forced to trade some of the innovation that drives economic growth for more security, says Baumol: "It is a price that terrorists have exacted from us." He simply argues that we shouldn't pay a higher price than is absolutely necessary.

Corrections and Clarifications ``The danger of playing it safe'' (Economics, June 24) gave an incorrect first name for Friedrich Engels, co-author with Karl Marx of The Communist Manifesto. Also, the manifesto was published in 1848, not 1847.

By Peter Coy in New York

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