May 15 (Bloomberg) -- It’s possible, but unlikely, that small differences in culture alone can explain the greater economic success of the U.S. relative to Europe and Japan after the introduction of the Internet.
The U.S. has poured investment into innovation since the early 1990s. It opened trade borders to lower costs, freed resources and relaxed capacity constraints. When besieged by low-cost unskilled offshore labor, it transitioned quickly from manufacturing to more productive endeavors that included innovation and services that cannot be produced offshore.
In contrast, Europe and Japan remained wedded to manufacturing-based economies with attendant lower levels of innovation and slower growth rates. High costs imposed by pro-labor governments discouraged companies from exiting manufacturing, laying off workers, and redeploying them to more productive endeavors. Pro-labor governments obstructed trade borders to slow workforce dislocations. In Germany and Japan, about 20 percent of employment remains in manufacturing, compared with only 10 percent in the U.S.
Europe’s and Japan’s slower transition out of manufacturing left their best thinkers mired in a declining sector. Meanwhile, the most talented U.S. thinkers created communities of experts around companies such as Google Inc. and Facebook Inc. And the U.S.’s more valuable on-the-job training, lower labor-redeployment costs, and lower marginal tax rates increased payouts for successful risk taking.
Nonetheless, the questions remain: Why did these underlying incentives emerge in the U.S. and not elsewhere? Why does the U.S. have lower labor redeployment costs, more open trade borders, lower marginal tax rates and, ultimately, more tolerance for unequal distribution of income?
By the random dint of history, the landmark Supreme Court case Roe v. Wade of 1973 brought pro-investment voters to power in the U.S. The faction of pro-investment voters, representing about 35 percent of the electorate, combined with enough of the now-mobilized social conservatives -- principally the members of the Christian Right, who vote Republican and represent 15 percent of the electorate -- to seize the majority and permanently shift the political economic center to the right.
A similar shift in political power didn’t occur in Europe and Japan, and pro-labor, anti-investment majorities continued to control those economies. These majorities increased labor-redeployment costs and closed trade borders to slow the need for redeploying labor; supported unionism by strengthening trade barriers; failed to lower marginal tax rates as much as the U.S.; and discouraged unequal distribution of income and wealth.
The U.S. differs from Europe and Japan in four ways. Europe and Japan have parliamentary democracies where parties are represented in proportion to their share of the vote. In the U.S., it’s a winner takes all, two-party system and that makes it easier for a large minority of voters -- in this case, pro-investment tax cutters -- to join forces with another large minority of voters -- the Christian Right -- to seize power.
Roe might have had a minimal effect on U.S. politics were it not for the fact that Christian fundamentalists are a large enough portion of the country’s population to affect the outcome of an election. About 25 percent of U.S. voters identify themselves as evangelical Christians. Prior to Roe v. Wade, three-fifths of evangelical Christian voters were Democrats, and two-fifths were Republicans.
When Ronald Reagan endorsed the pro-life movement, these proportions reversed. Reagan combined the Christian Right with the pro-investment tax cutters to create a majority. Pro-investment tax cutters maintained control of the party, selecting fiscally conservative, but socially moderate, presidential candidates such as John McCain, George W. Bush, Bob Dole, George H.W. Bush and Gerald Ford.
The fact that conservative Southern Democrats controlled political power throughout the southeastern U.S. amplified Roe’s political impact. As conservative pro-life voters defected to the Republican Party because of the ruling, it became increasingly difficult for fiscally conservative Southern Democrats to win elections as Democrats. Over time, these conservative Southern Democrats changed sides, gradually shifting political power to Republicans.
Most voters don’t realize that Roe does more than legalize abortion. It legalizes controversial third-trimester abortions in certain cases and takes away the electorate’s right to vote on this issue by making the late procedures a judicial right rather than a legislative decision. Third-term abortions are illegal throughout most of the democratic world. Their legalization by Roe, even if few women chose to have them, made opposition to the ruling more tolerable to pro-choice moderates.
The court’s denial of the electorate’s right to vote on an issue where both sides have legitimate points of view -- the majority of Americans opposes third-term abortions -- further increased the tolerance for opposition to Roe by pro-choice moderates. The denial of the other side’s right to vote -- because one fears the possible outcome of that vote -- is difficult for many to swallow when they acknowledge the reasonableness of the other side’s position.
The stance of pro-investment Republicans adds to this tolerance of pro-choice voters toward their position. Pro-investment Republicans oppose outlawing abortions by shrewdly arguing that the decision should be legislative, not judicial. Studies by the Pew Research Center show that more than half the voters support Roe, and only a quarter supports a ban on all abortions. If put to a vote, support among voters for first- and second-term abortions would assure legalization in all but a handful of states. If Roe remains as a judicial matter, it is far more likely that courts will outlaw abortions.
Marriage of Convenience
This marriage of convenience between pro-choice fiscal conservatives and pro-life social conservatives brought the larger pro-investment faction in this coalition to power. Without the unique set of circumstances surrounding Roe, the U.S. would probably be in the same place politically as Europe and Japan with respect to well-intended, but misguided, anti-business economic policies. Instead, after Roe, lawmakers cut marginal tax rates to about 30 percent, from 70 percent before the decision. They also left trade borders open and allowed labor redeployment costs to remain low.
If a politician shouts, “Tax the rich,” two-thirds of the U.S. electorate will answer, “Yes, and more!” But as lawmakers threaten to keep raising the tax rate on rich investors to distribute income to poor consumers, more and more voters will grow apprehensive about the effects on the economy, and their support will erode. A populist politician whose objective is to redistribute income seeks the highest tax rate possible on rich investors without losing 51 percent of the vote (or a few points more, perhaps, depending on the value of the margin of safety). A smaller tax increase that wins more of the vote unnecessarily leaves money on the negotiating table. Similarly, a politician aiming to lower taxes on rich investors seeks the largest tax cut that still captures 51 percent of the vote.
Richard Nixon was the last Republican president before voters contested Roe. Without the 15 percent bloc of evangelical Christian voters in his back pocket, he had to accept a 70 percent marginal tax rate to capture 51 percent of the vote. Even then, he only won the election because of the unpopularity of the Vietnam War. Dwight Eisenhower only won by accepting a 90 percent marginal tax rate. Bill Clinton was the first Democratic president to win office after voters contested Roe. With only 85 percent of the vote available to him, and with 40 percent of that vote backing tax reduction, Clinton could only support marginal tax rates as high as 39 percent and still capture 51 percent of the vote. With this 15 percent bloc of evangelical Christian voters in his pocket, Reagan was able to lower marginal rates to 29 percent and still capture the election.
Lower Tax Rates
Roe lowered the marginal tax rate from at least 39 percent -- perhaps even 70 percent to 90 percent -- to 29 percent to 34 percent.
Most pro-investment tax cutters are pro-choice. They endorse the pro-life agenda for no other reason than to bring their minority bloc of voters to power. Because of this endorsement, Republicans lose a small number of pro-investment tax cutters to the Democrats. Opposing social conservatives is more important to this group than defeating redistribution -- the raison d’etre of populist liberal politics. These defectors admonish Republicans to move to the center socially. But they fail to realize how much Republicans would have to raise taxes to win enough votes from the center of the electorate to compensate for the loss of the pro-life Christian Right.
Capturing an additional 10 percent to 15 percent of the electorate at the center likely demands at least a 10-point increase in the marginal tax rate -- probably significantly more. Ironically, the defection of these pro-investment tax cutters to the left increases the clout of social conservatives within the pro-investment coalition -- exactly the opposite of their objective.
This permanent shift in the center to the pro-investment right had a significant effect on U.S. economic policy. Americans remember the Reagan administration using its alliance with the Christian Right to cut marginal tax rates, tame inflation, and deregulate numerous industries, including trucking, telecommunications and airlines.
Less recognized is the administration’s profound effect on labor polices and private-sector unions. By deregulating industries and leaving trade borders open to international competition, Reagan put enormous pressure on heavily unionized industries, like trucking, airlines, steel and automobile manufacturing. He fired air-traffic controllers and replaced them with non-unionized workers, symbolically signaling to business leaders that he expected them to take a more aggressive stance toward unions. His ally, Margaret Thatcher, did the same thing in the U.K., enduring a long strike to weaken the coal miners’ union.
Reagan recognized that high-priced union wages were little more than a tax that transferred money to union members from consumers. He also recognized that union contracts and work rules were a significant hindrance to productivity improvements and to the creative destruction necessary for innovation. In the decade before Reagan took office, the U.S. averaged close to 300 major strikes per year involving 1,000 or more workers per strike -- a rate on par with the preceding decades. In the 30 years since Reagan, the U.S. has averaged fewer than 50 significant strikes per year, and only 20 per year in the last decade.
Private-sector union membership peaked the year before Reagan was elected and has declined steadily since. In 1979, before he took office, there were 15 million union members in the private sector -- more than 20 percent of the workforce. By 2007, there were only 9 million members, despite a 40 percent increase in the workforce -- a representation of only 8 percent of the workforce.
The defeat of private-sector unions reduced their clout within the Democratic Party. The success of the U.S. economy prior to the financial crisis further reduced employment concerns among voters. The Democratic Party shifted its focus to growing public-sector unions that were less concerned about open trade borders and government-mandated private-sector work rules and cared more about growing government employment.
Democratic lawmakers and their public-union supporters recognize that consumers (voters) ultimately bear the increased cost of private-sector unions, closed trade borders, and the restriction on trade necessary to maintain them. They result in higher prices, slower growth, and less employment. Why would public-sector unions bite the hand that feeds them? Unlike private-sector unions, they have not pushed for these inefficiencies.
(Edward Conard was a partner at Bain Capital LLC from 1993 to 2007. This is the second of two excerpts from his new book, “Unintended Consequences: Why Everything You’ve Been Told About the Economy Is Wrong,” available now as an e-book to be published in hardcover on June 7 from Portfolio, a member of Penguin Group (USA) Inc. The opinions expressed are his own. Read Part 1.)
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