The following essay originally appeared in print in Palladium 02. To receive original content in future print editions, subscribe here.

I’ve always had highly libertarian instincts, for both pragmatic and ideological reasons. You say civilians should be able to own rocket launchers, I demand that these rocket launchers not face a sales tax. But for me and people like me, the East Asian economic miracle poses a serious challenge: the greatest anti-poverty program in history involved not just a lot of capitalism, but a ton of state intervention as well. The history of East Asian economic growth in the last half of the twentieth century is a history of academics and the World Bank insisting that their policies couldn’t possibly work, followed by decades and decades of torrid growth.

As it turns out, though the Miracle is largely a triumph of capitalism, it also illuminates that economic growth depends on judiciously insulating certain parts of the economy from market forces. In a way, you can look at success stories like Japan and South Korea as a different instantiation of two very American institutions: venture capital and private equity. The difference is that it was VC and PE as practiced by the state, rather than by individual companies; the timelines were longer, the plans were bolder, and the results were stunning.

No American company or investor has improved as many lives by as wide a margin as Park Chung-Hee, Deng Xiaoping, and Japan’s Ministry of International Trade and Industry (MITI). But the methods are, at heart, startlingly similar: identify a critical inflection point, make a bold bet on an unproven market, “blitzscale” as quickly as possible, deftly react to crises, and carefully expose budding monopolists to hormetic doses of competition until they’re strong enough to monopolize on their own merits.

This is not just a theoretical exercise. An active trade policy has landed suddenly back on the policy menu in the U.S. and other places. In the past, we’ve done it sort of shame-facedly, giving nice subsidies to Iowa in exchange for their tactically priceless supply of early caucus dates, periodically bailing out American companies when international exporters teach them the meaning of the word “competition,” and occasionally gesturing towards energy independence without putting any meaningful goals to paper.

But now we’re talking about trade in a more adversarial way, which is appropriate inasmuch as, in international trade, America has many adversaries. It’s not that these places hate us. But the side effects of their own policy goals end up harming American economic interests. Of the many possible trade policies, most are bad and freeish trade is—on net, and in the aggregate—the best. However, the simple Ricardian model of trade makes a few untenable assumptions, and other countries have learned to exploit them.

In that context, anyone who advocates either contemporary protectionism or contemporary free trade is wrong. But to see why, we’ll have to start at the beginning: how did East Asian countries get so rich, so fast?

The Origins of a Boom

The logic of the Miracle begins with yet another discredited economist: you can’t really understand it until you learn to think like a Malthusian. Malthus’s original thesis was that since population tends to grow exponentially and food production tends to grow linearly, we’ll always tend to grow the population to the point that maximum food output can just barely support it. The result is that a single bad harvest leads to famine.

Looking back at history, his premises arguably made some sense. Populations had gone through boom-and-bust cycles before, albeit more driven by war and disease than by famine per se. But war and disease are both symptoms of overcrowding, so the model was predictive even though it mislabeled the terms.

But as it turns out, Malthus came to the game too early. Food production can grow exponentially, while population growth slows as countries get richer and modernize their lifestyles.[1] One important thing to keep in mind when you’re thinking like a Malthusian is that if your country is close to the Malthusian limit, it means the incremental farmer is not producing enough food to feed themselves. The reasoning is simple: if the average person produces enough food for one person, and some land is more productive per labor input, the more marginal land is necessarily producing less than that average. If there were fewer people, there would be a surplus to support a non-farming population. That’s important because the non-farming population is needed to accumulate capital, which can eventually raise farms’ efficiency, at least on a per-farmer basis. While farmers invent a ton of stuff, they can’t manufacture at scale.

The story of Western Europe, starting around when Malthus published, went like this: farmers produced enough surplus to support some basic manufacturing; this manufacturing produced capital that made farms more efficient; fewer farmers required meant more manufacturing, setting off a virtuous cycle.

Arguably, the event that laid the groundwork for the Industrial Revolution was the Black Death. By killing a third of Europe, it pushed us to well below the Malthusian limit, raised workers’ wages, and limited governments’ ability to tax city-dwellers. Things really started to take off in Northern Italy, which is also where the plague first arrived. Of course, it could have happened anyway, and could have happened elsewhere—the reason it hit in the first place was that trade had globalized enough that rats and fleas from China found their way to Venice. But certainly, the Bubonic Plague accelerated things by eliminating a lot of people and raising the marginal productivity of the survivors.

For countries that didn’t have Europe’s bittersweet fortune in getting a catastrophic plague right when their technology had advanced to the point that they could rapidly scale up non-agricultural productivity, there was some more waiting involved.

As Joe Studwell points out in How Asia Works, every one of the economic miracles started with land reform—in Korea and Japan, this was part of a series of postwar changes; in China, it happened a little later with the gradual rescission of agricultural collectivization. The land-reform process redistributed land from large landowner plantations to smaller peasant-owned plots.

Land reform’s effects were paradoxical: in the short term, the net effect was more agricultural labor. Individual farmers intensively working small plots can achieve much higher productivity per acre than big plantations can, at the cost of not being very scalable. But for a country on the edge of the Malthusian trap, higher productivity is exactly what they need.

What happened next, in every successful case, was that governments decided as a matter of policy that they’d favor export industries, and in particular that they’d favor industries that could achieve long-term productivity growth. In some ways, these countries lucked out due to the Green Revolution: if overall agricultural productivity hadn’t started to rise, they would have been stuck at a slightly higher Malthusian limit.

In each case, the first inflection that set off the boom was land reform. After that, two things happened: first, each country had a trade surplus, and the smart ones invested it in capital equipment for stage two; second, birthrates rose. Since they had previously been bumping up against the Malthusian limit, an increase in food supply led directly to an increase in babies.[2]

For policymakers, the name of the game is this: you have some hard currency and some babies. In seventy years, these babies will retire, and the next generation may well be smaller. What do you do in 1950 to ensure that the retirement accounts of 2020’s 70-year-olds are as full as possible, so they can soften the impact of a high dependency ratio?

The process:

1. Invest the trade surplus from food into light industry, e.g. textiles—this is a business where the main input is unskilled labor, so any poor country with a port and a smidgen of capital is, presto, the global low-cost leader.
2. Invest the trade surplus from that into heavy industry. At first, it should be lower-level stuff like steel and basic chemicals. Eventually, move to heavy machinery, cars, specialty chemicals, and electronics.
3. Relentlessly push your heavy industry to export; sell products that can compete globally, even if you’re taxing your population to subsidize your exporters.
4. On that note: use aggressive financial repression. Force people to save a high proportion of their marginal product. Standards of living can rise, but should rise a lot less than GDP. Direct that money into industries with economies of scale.
5. Once you are the scale leader in a scale-driven industry, you can relax. But only a little! Now you have to worry about somebody else copying you. Japan’s world-beating steel industry got copied by South Korea, and their car industry faced competition there, too; Japan also lost its lead in electronics to China.

Case Study: Japan

Postwar Japan was an economic basket case. The country had lost over two million lives, and American bombings had wrecked their industrial capacity. Even before that, Japan’s militarist government had warped the country’s economic development through a focus on arming for conquest.

As a consequence of all this, Japan’s GDP per capita in 1950 was under a fifth of the U.S. level. Today, Japan’s GDP per capita is about two-thirds of the U.S. level.

When you try to evaluate the Japanese system, it’s important to note that it does not at all work the way it looks on paper.[3] In theory, Japan is a representative democracy in which voters elect legislators who pass laws. In practice, their system during the last half of the twentieth century was a sort of technocracy in which the foundational rules were not a written constitution but a set of bureaucratic social norms.

The protagonist of Japan’s industrialization is the Ministry of International Trade and Industry (MITI), which determined Japanese industrial policy. In the U.S., we’re used to thinking of government bureaucracies as slow and unambitious, but in Japan that wasn’t the case at all. MITI got the country’s best workers—the pass rate for their most challenging exam was 2%—and had an aggressive up-or-out approach. Talented people quickly got more responsibility and they wielded immense power.

When MITI decided that Japan should be a steel exporter, they gave steel companies enormous loans to increase capacity. When the industry got overbuilt, MITI forced participants to merge. Since steel had economies of scale and was a useful input for other kinds of manufacturing, MITI decided that if Japan was to have a future, it would start with steel.

And MITI was right. Japan became the world’s largest producer of steel by the early 1980s, and their dominance in steel gave them a huge boost in shipbuilding and machinery.

Here are three striking illustrations of how powerful MITI was—one political, one sociological, one cultural:

1. Japanese legislators could introduce their own bills, but these tended to get voted down. MITI could also suggest bills, which tended to get passed with near-unanimity. That Japanese Diet in the postwar period looked less like the U.S. Congress than the Supreme Soviet of the Soviet Union. Once the legislators saw the bill, it was as good as law. In MITI and the Japanese Miracle, Chalmers Johnson argues that this was an efficient system because the legislators “reigned” as the public face of government—and enjoyed the electoral consequences of policy decisions—while bureaucrats “ruled” by making the actual decisions.
2. A study of the family trees of prominent Japanese people showed that high-level MITI employees tended to have more socially prominent fathers-in-law than fathers. MITI, in other words, was where ambitious and upwardly mobile young men wanted to work. Why bother getting rich when you can get powerful instead?
3. There are no fewer than three novels about Shigeru Sahashi, a powerful MITI vice-minister. One of them got turned into a TV show. Imagine The West Wing, but with the hero working at the Department of Commerce.

MITI seems to have had a work-hard/play-hard culture. The MITI cliques tended to center around senior employees who were generous with their liquor cabinets. After a grueling fourteen-hour day of designing and implementing industrial policy, how better to relax than to throw back some Suntory and spend a couple more hours…discussing industrial policy?[4]

Senior employees did get rich, through a tradition of Amakudari (“descent from heaven”) in which senior bureaucrats would, late in their careers, land C-level jobs at the companies they had regulated. In an American context, the assumption is that this sort of revolving door becomes a way for a company to buy influence. But in Japan, it appears a bit different: Amakudari offered a way for bureaucrats to ensure that their recommendations were being implemented—and to finally get a nice company car while doing it.

The Japanese industrial growth playbook, applied in industry after industry, looked like this:

1. Bureaucrats would pressure banks to make loans and pressure companies to add capacity.
2. They’d subsidize companies based on export volume—in other words, a company didn’t have to be profitable, but it did have to compete.
3. As companies scaled up, the subsidies dialed down. Sometimes this was due to international pressure, but the bureaucrats were adept at dodging that. When Japan finally stopped directly subsidizing exports, they started allowing exporters to depreciate equipment faster instead. For a profitable company, this is economically equivalent to a direct subsidy.
4. Once the industry reached viable scale, they’d rationalize capacity—merge competing firms, shut down inefficient plants—and move on to the next.

Japanese postwar economic history was a long series of increasingly impressive export-driven economic booms, leading to a serious level of creative nicknames. Among these were the Doran bumu (“Korean war boom”), the Kokyokan-naki hanei (“prosperity without a sense of boom”), and the Iwato keiki (“boom unprecedented since the time of the sun goddess Amaterasu”).

And then, in the 1980s, things got crazy. In the 1990s, things fell apart.

The denouement of the bubble is an instructive example of the limits of policy interventions: Japan was basically forced to stop artificially devaluing their currency, which led to a property and asset bubble, and then a long period of economic stagnation. The demographic collapse didn’t help—instead of benefiting from a baby boom, Japan faced a growing population of elderly people, who tended to sit on their savings even at zero interest rates. Even now, the current yield on Japanese ten-year government bonds is −0.04%.

But still, Japan is a rich country; growth may be slow, but “growth” is the first derivative of GDP, and their GDP is quite impressive. For most of its history, Japan was a poor country. After a few decades of aggressive industrial policy, it became a rich one. And while it’s not the richest it’s ever been, that’s not the metric that matters.

Case Study: South Korea

South Korea’s economic growth is basically a gritty reboot of Japan’s story. Japan was a technocracy disguised as a democracy; South Korea was a poorly-run democracy until a major general decided that the votes that mattered were from the people with guns.

South Korea was poor, like Japan—only poorer. They’d survived a war, like Japan—but in their case, they were invaded by a nuclear power, and with the help of another nuclear power they fought back to a stalemate. Japan is surrounded on all sides by water; Korea was mostly surrounded by enemies.

And yet, they got rich. As recently as the 1960s, South Korea depended on U.S. aid to avert famines. Not only do they now export lots of steel, chemicals, cars, and phones, but their single biggest cultural export is Gangnam Style, an incredibly catchy song about the spiritual agony of living in a wealthy country.

There’s a sort of Girardian side to South Korea’s industrialization story: Park Chung-Hee’s attitude towards Japan was idolization of their success on the one hand, and fierce commitment to destroying them on the other. Park was educated in Japan and served in their military; as president, he would sometimes stay up late reading books about their economy.

The South Korean industrialization story kicks into high gear with the foundation of their steel company, POSCO. Korea needed money and expertise to build a steel plant; they got both from their historical enemy, Japan, in exchange for accepting a Japanese apology over colonialism. This is the kind of decision a popularly-elected leader can’t afford to make. Park Chung-Hee only did it because he believed that it was the right choice and that tanks matter more than votes.

POSCO construction crews were reminded that the plant was built with Japanese war reparations and that it was a matter of national honor that Korea supplant Japan. The foreman allegedly suggested to employees that if they couldn’t hit their deadlines, they should consider suicide.

From there, Korea expanded into chemicals and, famously, cars. Like Japan, their government put immense pressure on banks to lend to manufacturers and on manufacturers to sell abroad. And, like Japan, Korea depended on a loyal cadre of highly effective bureaucrats. Korea benefited from the fact that the Korean military under Japan was the best-educated segment of society. Once they ran their own show, they did it well. Interestingly enough, Korea’s civil-service exams had a 2% pass rate—exactly the same as Japan’s. There were only a few good schools, so most of the senior bureaucrats developed strong social ties—good for coordinating plans, but bad for admitting mistakes.

Since the challenges facing South Korea were direr, its actions were more extreme than those of Japan. At one point, Park Chung-Hee nationalized the banking system and imprisoned the heads of most Korean chaebolconglomerates, suspecting that they were hoarding cash. As it turned out, they weren’t; he let them go and loosened controls on the banks soon after.[5] Park insulated bureaucrats from the political consequences of their actions, which allowed them to think further ahead than typical government employees. Under a corrupt system, that would be a disaster; under an efficient one, it was a boon.

The repeating pattern in South Korea’s growth was that exporters would borrow enormous amounts, over-expand, then lose lots of money and be forced to merge or go under while the government scrambled to get enough foreign capital to pay the bills. This system can’t last forever, but it’s basically running an industrial policy by making a series of Kelly bets: you maximize your long-term returns only by accepting a surprisingly high level of volatility.

This also explains some of South Korea’s otherwise bizarre foreign policy decisions. South Korea was the second-largest contributor of manpower to the Vietnam war, sending about five times as many troops as the third-highest participant, Australia. This was a geopolitical bankshot: the point was not to keep South Vietnam capitalist, it was to guilt America into keeping troops in South Korea.

South Korea’s policies under Park Chung-Hee make sense as an effort to address the existential risk of invasion by the North. This remained a live risk for his entire tenure; North Korean commandos regularly made incursions into South Korea and they were likely involved in an assassination attempt that took the life of Park’s wife. This also explains Park’s repressive domestic policies, including the brutal suppression of student protestors and labor unions.

Park did not adhere to democratic norms, although South Korea eventually adopted a fairly representative system. What Park had instead of popularity was legitimacy: the position where society gives you permission not to ask for their permission. South Korea’s industrial policy was a series of high-risk, unpopular decisions, of the sort that would have been voted down by gigantic margins in any current representative system. Fortunately for today’s Koreans, such a system didn’t exist: Park and his junta decided that they were the right people to run things, figured out what to do, and did it.

The Missing Case Studies: Singapore and China

Singapore exemplifies the approach of using market signals for implementation while maintaining state guidance. For that reason, it’s a go-to country in discussions about successful industrial policy. But Singapore also used a much more free-market approach than other countries. As Joe Studwell argues in How Asia Works, Singapore is not a useful case study, because free-market policies work unusually well for city-states that prosper through trade and finance. Hong Kong is also a bad case study, for the same reasons. If you have a port, and if your port is close to a growing industrial powerhouse, you don’t have to plan ahead as much; you just have to avoid making any catastrophic mistakes. Singapore did exactly that; thanks to their government’s policies, they’re a lot richer than they otherwise would have been. But they’d still counterfactually be pretty rich, just by virtue of how much cargo and capital passes through their general vicinity.

Lee Kuan Yew gets a lot of mindshare for the same reason Churchill does—you can say what you want about his decisions, but he probably said it better himself in one of his books. Lee had a particular gift for gently making fun of American elite opinion as if he’d just been cheered up thinking about how the American Cambridge houses even more eccentrics than the English one.

Singapore’s position as a port city in the general vicinity of several rapidly industrializing countries meant that it could pursue truly laissez-faire policies and expect good results. Of course, the state intervened heavily in Singapore—it’s odd that such a capitalist paradise has most of its citizens living in government housing. But Singapore is an order of magnitude less economically intrusive than the other case studies.

It’s hard to prematurely optimize a port or a financial hub. You might somehow get an edge by knowing what raw materials are cheap to ship there, then assembling them and exporting, but touching the supply chain at only one point makes things tricky. At the same time, a city-state like Singapore does have the advantage that it’s relatively easier to maintain control, which means the government can tolerate more macroeconomic volatility. That, in turn, means that they can better afford to pursue the monetary stability the IMF loves so much.

The math is just different when your riot police can walk across the entirety of the country in under an hour. The lesson of Singapore is that it’s good to have a port, and if you have one, your job is a lot easier.

China has the opposite problem: if Singapore is hard to use as an example because it’s small-scale and doesn’t need to control its own destiny, China is hard to talk about because everything that happens there happens on such an enormous scale—and because, unlike the other countries I’ve discussed, China’s leaders see it playing a globally hegemonic role in the future. At one level, of course, they’d like to have a rich country because it’s nice to be rich. But at another level, they have the manpower and want a similar amount of materiel.

This is important, because development in most countries has a more boring endgame: economically, most people want to live in 1950s America. China has different plans: yes, they want their workers to be rich—rich enough that they can take a vacation to a pacified Taiwan and visit future landmarks there like Xi Jinping Plaza and the Victims Of Kuomintang Atrocities Memorial.[6]

China is also hard to analyze because the anti-capitalist faction won their civil war and capitalism only came back once those winners finally died. While their policies from the 1980s onward show a substantial amount of foresight, they didn’t need quite as much as Korea or Japan, because those countries had already done the hard work. Japan had to adopt ideas from 19th-century neo-mercantilists and Korea had to adapt them, but China just had to look at what had worked over the previous decades and do it at scale.

China also benefited from a rising tide of globalization. Their economic growth really kicked into high gear once they joined the WTO, especially since they were willing to drag their feet on issues like IP theft and protection. More so than the other cases, China managed to implement a system of free trade for thee and protectionism for me, and use it to achieve impressively dominant scale in industries with economies of scale. Their plan seems to be to keep on doing this, with more and more industries, unless someone stops them.

China did not just benefit from globalization as an abstract force: it was the direct beneficiary of growth in the other countries discussed above. When Japan started exporting manufactured goods, its cheap labor and low capital made it a good place to make things like shoes and toys—American toy companies were outsourcing some production to Japan in the 1930s. But as the country became more prosperous, wages rose, and those low value-added manufacturers were priced out of Japan.

At first, some of them moved production to places like Taiwan. But later on, Taiwan, too, became too expensive a labor market—one Taiwanese company started out making cheap tennis rackets, expanded into carbon fiber-based tennis rackets, and eventually got out of the sporting goods business to focus on aerospace components, also made out of carbon fiber. So, production moved to China. And unlike the other countries profiled, China was both vast and even more economically under-developed—under Mao, it became one of the rare countries to get more rural over time, as people fled cities. This created an abundant labor supply that could meet any demand; China’s post-famine baby boom ensured that labor supply peaked right around the time when other countries were most desperate to outsource production to cheaper places.

China also grew faster because there was a development blueprint. In some cases, that was abstract—start with cheap goods, accumulate capital, cultivate more domestic value-added manufacturing and local demand for goods. But some of it was more literal; The Next Factory of the World talks about how Taiwanese factories had Japanese foremen, Chinese factories had Taiwanese foremen, and now African factories are increasingly run and owned by Chinese managers.

While China is an interesting case, it’s also a special case; the country had more ground to make up than others, because of Mao. It had more of a template to follow, because of Japan, South Korea, and Taiwan. Its scale forced the country to use a highly decentralized approach to economic policy, which enabled local experimentation. And, increasingly, China’s economic policies tie in with its foreign policy goals. China wants to create a domestic semiconductor industry in part as one more step in capturing higher-value products, but also because doing so would reduce the risk of conflict over Taiwan and South Korea, which currently supply chips to China. One of the broad lessons of history is that for the most interesting stories, N is always equal to 1, and China’s N is a particularly special one.

Export Subsidies: Y Combinator for Steel

Japan and Korea implemented similarly heterodox policies and saw similar levels of success. But how did they work in practice, how did they combine together, and what does it mean for the U.S. today?

Export discipline is the single most powerful concept behind the East Asian Economic Miracle. The idea is simple: the only way to produce wealth is to make something people in other countries want to buy, but poor countries have a comparative disadvantage in complex manufacturing. The solution that worked for Japan, Korea, Taiwan, and China was simple: protect and subsidize exporters, but only subsidize them to the extent that they can actually sell something in other countries.

The car industry has punishing economies of scale. You need to design vehicles, source parts, and actually build them, and the minimum cost to do this is prohibitive. If you build one-tenth of General Motors, you don’t earn one-tenth of what GM does. Instead, you lose a lot of money, because you have a sub-scale factory that’s producing well below capacity.

But the counterpoint to that is that if you build something twice as big as GM, you’re going to make more than twice what GM does, which means your incremental returns on capital are far higher. GM, at least in the mid-twentieth century, was mostly selling cars to Americans, and America was the land of abundant capital, high wages, and cheap oil—all of which were de facto subsidies for domestic auto demand. But those implicit subsidies applied to imports just as much as domestically-produced cars, so the Japanese industrial planners knew that if they achieved break-even, they’d enjoy a long runway during which they’d produce higher returns.

One way to look at export subsidies is that, like in The Producers, they let a company sell more than 100% of its equity. In this case, the government is essentially “short” the exporter’s profits, and distributes the corresponding long position to the company’s management and the banks that finance its expansion. By ensuring that the people with a stake in the outcome are the ones who can make a better outcome happen, they align incentives towards growth.

This is a centralized, government-based riff on exactly the same logic as venture capital. Venture capital also provides bridge financing to subsidize some behavior that’s unprofitable at small scale but very valuable at a larger scale—export discipline from MITI is economically equivalent to VCs who will fund a negative cash-flow business as long as it has high gross margins, low user churn, and network effects.

There are a surprising number of parallels between these policies and the way startups work:

• Startups often sell to other startups at first. Salesforce did this in a big way; Y Combinator is a sort of Zaibatsu that gives startups instant access to a few hundred good customers.
• Below-market salaries and big options packages make employees hard to poach, mimicking the effects that lifetime employment and government-sanctioned monopolies have on employee incentives.
• A small group of people has no politics. Ten people working on a project is pretty apolitical. Fifty who come from the same extended social network and also share the same crazy mission will also be fairly apolitical.
• There’s no immediate need to turn a profit, but there is an intense need to show growth. A startup that gets valued at 30x sales in one round and 5x sales at IPO has a similar cadence of external cash flows to a steel company that starts out getting 50% of its revenues from export subsidies and matures with 95% of its revenues from real customers.

South Korea used a particularly interesting variant on this model, by subsidizing companies that grew according to industrial planners’ goals, but cutting off their access to capital and forcing them to merge when they underperformed. In the short term, the result was a sort of ongoing audition for the world’s next top multinational. But in the long term, it meant that the country’s economy increasingly consolidated under a handful of powerful companies. Today, Samsung is responsible for 20% of Korean exports; it’s too big to fail and too big to threaten.

Essentially, these planners were building an industrial base for a future in which they’d be about as wealthy as the Americans. Japan, MITI knew, would eventually become a country where lots of people wanted to buy cars, radios, and appliances, and the best way to sell those domestic consumers quality products was first to compete for the wallet-share of the wealthier and pickier American and Western European consumer. Even today, Japan’s auto industry is both implicitly and explicitly subsidized. Japan mandates expensive safety tests for cars after three years. Rather than pay for the tests, many consumers sell their used cars and upgrade to a newer model. The result: everyone in Ulaanbaatar drives a used Prius, and Japanese auto manufacturers remain enviably profitable.

Inflation: When It’s Not So Bad

The IMF is notorious for telling countries not to let inflation get out of control. The markets they develop are equally notorious for bouts of severe inflation. Korea went through years of high-inflation growth, Japan had extreme inflation early in its development, and other developing markets to this day go through cycles of elevated inflation.

The argument against high inflation is straightforward: it makes it hard for investors to feel confident in the value of their assets, especially fixed-income assets. If you’re an ambitious technocrat, your country needs to issue lots of bonds and your country’s banks need lots of foreign capital flows as well. High inflation makes that difficult.

The pro-inflation argument is a lot simpler: inflation is a side effect of fiscal or monetary stimulus, both of which accelerate growth when done well.

In the case of the Miracle economies, demographics and cultural norms conspired to make high inflation an unusually prudent policy. For reasons that may never obtain again, the policies that South Korea pursued—which led to inflation rates of 10% or more throughout the 1960s—were actually quite prudent. Japan’s inflation, a more modest mid-single-digit rate during that time period, was also quite acceptable.

What both countries benefited from was the combination of:

1. Population growth, driven by agricultural reform, which helped them escape the Malthusian trap and expanded family sizes. South Korea’s population, for example, grew by 2-3% per year throughout the 1960s.
2. A set of cultural norms that strongly encouraged young people to support their parents.

If mom and dad’s pension loses 80% of its value in real terms, but your wages rise by a factor of four over the same time period, it’s no big deal—your salary was their retirement plan all along anyway. Essentially, these countries could use families as an intergenerational redistribution mechanism, meaning that they only had to care about the aggregate change in the net present value of incomes, not the distribution thereof.[7]

As those same countries lapped the impact of their baby booms and started seeing low-to-negative population growth, they faced harder policy decisions. Fiscal stimulus dilutes the net worths of old people on fixed incomes, and those people vote. Meanwhile, monetary stimulus tends to help them, which pushes East Asian economies towards zero interest policies.

Corruption: Also Not So Bad

Samuel Huntington has a very illuminating line about corruption:

“In terms of economic growth, the only thing worse than a society with a rigid, over-centralized, dishonest bureaucracy is one with a rigid, over-centralized, honest bureaucracy. A society which is relatively uncorrupt—a traditional society, for instance, where traditional norms are still powerful—may find a certain amount of corruption a welcome lubricant easing the path to modernization.”

Call it Coasian corruption: you accept some level of bribery because the people who expect the best returns on investment are the ones willing to offer the largest bribes. You can’t easily write the rules in advance, though you can retroactively refine them. In a sense, corruption provides a valuable signal: if your country’s senior automotive bureaucrat lives in a mansion while the most important steel bureaucrat lives in his parents’ spare bedroom, maybe steel isn’t your country’s most competitive export.

All of the Miracle economies have had corruption problems, but they often seem to be a side effect of wealth creation. After all, something can only get stolen if there’s something to steal.

Like inflation, a surprisingly high level of corruption is tolerable in the short term, but eventually becomes a problem. While it’s hard to measure, the real heuristic is this: corruption is prosocial in a developing market when it helps skirt rules that discourage wealth creation. It becomes a problem when the prospect of corruption encourages rules that stymie growth.

In China, a major source of corruption is the sale of land. Land is, in effect, owned by local governments, which must sell it to pay their expenses. And land in China is quite valuable. Naturally, many land purchases involve consulting fees paid to offshore companies that happen to be controlled by the immediate family members of the people in charge of deciding which factory owner gets which plot of land. If the result is that factory owners competitively seek out the best places to build new plants, and start construction as quickly as possible, then it’s a net boon to Chinese growth. But it’s also a signal that the land-sale system needs to get formalized.

Loans are another source of corruption. Since banks are under the guidance of the state, well-connected borrowers can get large loans at favorable terms. This has allowed some Chinese conglomerates to build up vast, eclectic collections of assets—ownership of marquee hotels, major stakes in companies like Deutsche Bank and Sea World, and huge securities portfolios. This does not serve the state’s development goals, but it does serve the interests of those companies’ politically astute founders.

China has passed the point at which additional corruption lubricates rather than retards growth. They may have reached the dangerous point where crooks are sufficiently entrenched such that they can’t be easily dislodged, although some of the conglomerates mentioned above have been cut down to size. But Japan and Korea have had massive bribery scandals in the past while continuing to grow right through them, so while this is not ideal, it’s hardly catastrophic.

But as the economy matures, it does get catastrophic. You can take the converse of Huntington’s argument: if corruption is helpful when the rules don’t make sense, it’s harmful when they do. At 10% GDP growth, any government policy runs the risk of being obsolete by the time it’s implemented; at 2% growth or 0% growth, that’s no longer the case.

IP Piracy: Great Artists Steal

One good business model is to spend a lot of money upfront to produce some fantastic new technology and then sell a unique and high-margin product based on it.

For an even more profitable model, skip the expensive R&D and just copy somebody else’s work. This is a time-honored tradition; as Ha-Joon Chang points out in Bad Samaritans, Renaissance England once had comically aggressive industrial espionage laws: if you told the perfidious Dutch the secrets of English textiles, you could be executed.

This practice is ubiquitous—China is famous for technology-transfer deals today, but Japan did exactly the same thing to IBM and the car companies a few decades ago, as did Korea. The defense of it is a kind of quirky utilitarian argument: it’s not like Japan was going to buy very many IBM mainframes or Cadillacs at full price in 1960, so the existence of cut-rate copies is no great loss.

Both Japan and Korea significantly dialed back the IP theft as they advanced and started doing their own R&D instead. Today, there are many industries where the U.S. would benefit from filching East Asian IP—but, of course, we don’t have governmental air cover should we attempt to do so, and Japanese and Korean companies are not especially excited to invite American engineers and researchers over to tour the lab and learn their secrets.

China, on the other hand, has not pulled back. As a result, they’re facing the consequences that Japan and South Korea were able to avoid: the inability to cooperate with R&D efforts at American and European companies, as well as retaliatory trade actions.

This strategy is not unique to industrial policy. Basically, any online community that allows user-generated content will benefit from allowing users to generate lots of content by pirating it. The usual model is that you slowly crack down on the stolen stuff and grow your legitimate business to the point that when you do finally pay a fine or settle a lawsuit, you’ve grown your way out of the fine. If you get fined 100% of your revenue for allowing piracy, but you grow your business 10x by the time you actually pay the fine, you’ll survive. Perhaps China’s planners are performing exactly the same calculation.

Financial Repression

Successful industrializers use a broad array of tactics to raise the savings and investment rate in their countries. Three things quickly become evident about this regime:

1. It’s unpleasant for the people who live through it.
2. It’s nice for their descendants.
3. I don’t want to be the kind of person whose descendants grumble that all that consumption must have been fun for you, dad. Better to have kids who know that you’d chew broken glass to build them a better future.

The two basic levers for financial repression are encouraging saving and discouraging consumption. Most industralizers use high tariffs and capital controls to keep people from consuming.

Direct tariffs work as a means of reducing local consumption, but trade treaties often preclude them. Fortunately for savvy countries, there are ways to apply indirect tariffs, too. Japan has a large wholesale industry: according to Johnson’s MITI, in the late 1960s, Japan’s wholesale sector generated almost 5x the revenue of Japanese retailers, compared to a 1.3:1 ratio in the U.S. This oversized wholesale industry served two purposes: it was a welfare and retirement program for unneeded workers in manufacturing companies and it meant many layers of red tape for companies exporting to Japan. If every middleman charges foreign companies just a little bit more, the total “middleman tax” is raised to the power of the number of layers of middlemen.

One of the important levers Japan and Korea pulled was on the savings side: by reducing people’s opportunities to spend money, they forced them to save. Both countries artificially reduced interest rates on deposits, generally to below the rate of inflation. In other words, savers were literally paying banks to hold on to their money.

Why did savers do this? It’s unclear whether this was an explicit goal or a lucky accident, but macroeconomic volatility coupled with a weak safety net for individuals places enormous pressure on people to save money. If you don’t have unemployment insurance or welfare, and your friends and family are all desperately poor, you need to rely on your own savings if you get laid off. High GDP growth gave people enough money to save and the risk of a recession gave them an incentive to do so.

These savings constituted free money for banks. In return, the state required banks to make uneconomic loans. In a poorly functioning system, this would have the inevitable result that either banks would avoid taking risk—and just collect the profits on their cheap deposits—or, they’d make loans to well-connected borrowers, rather than to the companies that represented the best prospects. In a system where ambitious people work in the private sector or legislature, that’s exactly what would happen—it’s exactly what does happen, even in developed countries with stable institutions, like the U.S. But in the Miracle economies, the most ambitious people were the ones telling banks where to lend, not the ones doing the borrowing or the lending, or taking political credit for the jobs that resulted.

Financial repression is redistribution from individuals to big business. But in a less individualist country, “big business” is something closer to “national wealth held in trust.” This means it’s really redistribution from present consumers to future consumers. This is also unfair! Utilitarians would be aghast at the idea of taking money from the poor and giving it to the rich; in both global and historical terms, the Japanese in the 1950s were poor while their present descendants are rich.

Banks Over Bonds

James Carville liked to tell a joke: “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.” Markets are great at allocating resources, but they’re often quite reactive. Carville was right about that: if bond investors are mad, you’ll know about it. As a result, any business or country that relies on capital markets for funding faces immediate consequences if it doesn’t follow those markets’ conventional wisdom.

The alternative is to source capital from banks: bank loans don’t get quoted every day on an exchange, so even if something reduces the loan’s perceived odds of getting repaid, accounting rules allow bankers and borrowers to live in denial. This later turned into a huge problem in Japan, Korea, and China; all three countries suffered from zombie banks that financed zombie companies, while in a more open market the result would have been bankruptcy. But during the growth phase, a banking system can grow its way out of early problems.

Growing out of one’s problems is generally an imprudent strategy. That’s what burned the S&Ls and junk bonds in the 1980s, and it’s been the bane of consumer lenders and insurers for longer. But since the Miracle economies focused on industries with economies of scale, growing out of the problem really did work. Korea forced its marginal auto manufacturers to merge or shut down, but the survivors can service their debts.

Banks have another advantage in a country with a well-run government that can ignore near-term popular pressure: they serve as a more direct conduit between fiscal and monetary policy and economic behavior. When MITI or the Korean industrial planners decided that their economy needed a little more juice, they ordered banks to lend more, which immediately resulted in higher capital expenditures and quickly added jobs. A bank-based system, in other words, means there’s a direct conduit from a central bank’s lender-of-last-resort status to balance sheets, companies, and workers. Savers get dinged by this, but the logic of financial repression holds: savers are saving because of the risk of macro instability, so diluting the inflation-adjusted value of savings while cushioning the blows from a recession can be a wash, or even a win.

A system like the U.S. Federal Reserve has to operate more indirectly, by tweaking short-term risk-free interest rates in the hope that this will propagate through the entire rate curve and affect credit spreads in a predictable way. In 2008, Bernanke would have liked to just order every bank in the U.S. to lend, lend, and lend some more until the vaults were empty. When short-term rates hit zero, central banks have to intervene more, but in the U.S. and Western European contexts, they prefer a shotgun approach to a sniper rifle.

Policy Implications for the U.S.

As a capitalist, I believe everyone has a right to try to get rich. As an American, I welcome their efforts to do so, at the expense of any country but one.

As we’ve seen, the policies pursued by the Miracle economies produced better results than are implied by classical economic theories. That observation doesn’t invalidate the theories, it just illustrates their limitations: “If X and Y, then Z” implies “If not Z, then not X or Y.” Good candidates for X or Y include perfect competition and constant returns to scale.

In a Ricardian model, a country should always focus on whatever it has a comparative advantage in. The model that works is to focus on what you could have a comparative advantage in and to do whatever it takes to get that advantage.

Considering this, what limitations does the U.S. face in responding to these policies?

First, our government employees are not high-status, and there’s not a clear path to making them so.

The early 2019 government shutdown a striking case-in-point. The standard view of the shutdown’s adverse consequences is that 800,000 people were furloughed from their jobs. The concrete results are from how they spend their money. It’s assumed that the marginal productivity of the 800,000 least essential government employees is zero; there isn’t anything they’re supposed to be accomplishing other than cashing paychecks.

Granted, the shutdown did cause inconveniences, but these nearly always fit the same pattern: “this is illegal unless specifically approved and the person responsible for approving it has been deemed inessential and is not at work today.”

I don’t mean to imply that all government employees are completely ineffectual, just that being ineffectual is not a bar to continued employment. The most predictive model of the modal government employee in the U.S. is that they’re collecting a pension from day one, but they have to wait in line for roughly forty hours a week to receive it. Fortunately, they can entertain themselves while waiting. Or, during their long retirement, they can do volunteer work, such as effectively implementing government policy per their job descriptions.

Japan, China, and Korea all benefited from a long tradition of high-status civil servants. Korea and China had a government strongly influenced by the military—in Korea, because the military seized power; in China because the armed wing of the Communist Party conquered the country. In both cases, they traded off their recent record of military success. Even the actual U.S. military itself isn’t going to match that level of status any time soon. While it’s an incredibly impressive organization in many ways, it’s been a long time since we’ve had a morally and strategically unambiguous victory.[8]

The second limitation is that our deep capital markets make it hard for the government to direct capital to strategically important industries. Given the status gap, that’s a good thing. If the smartest and hardest-working people are in the business of convincing bureaucrats that something is a strategic business imperative, the result will be that any business that can absorb a lot of capital and employ a lot of smart people will benefit.

Robust capital markets make it hard to hide short-term pain. If the loans backing POSCO or the South Korean chemicals industry had been traded on open markets, they might have dropped from 100 cents on the dollar down to 50 or less as the project struggled to take off. But on a bank’s balance sheet, a loan that hasn’t defaulted yet can be marked as 100 every year, for as long as necessary.

This is not strictly a disadvantage. It means the American system is great at pruning deadwood. We don’t make very many televisions, shirts, or shoes these days because domestic manufacturers quickly lost access to capital. But it also means that industries going through what might be only a temporary low point can easily go to zero and never come back.

Our third limitation is that we view ourselves as the world’s good guys. When I talk to people about U.S. free trade policy, one of the concerns is the effects that our policies have on workers in the Third World. This is not necessarily a well-informed concern. Paul Krugman used to point out that if you think a sweatshop sounds bad, you should ask yourself what kind of alternative employment made that sweatshop sound so good to the people who lined up to interview for them.

But were you to look at MITI’s internal minutes, you would not see very many discussions about how their policies would affect Detroit. They seemed pretty concerned with how things would go in Nagoya. Detroit, they seem to have assumed, would take care of itself—or not.

If you’re using traditional Ricardian thinking, MITI got it wrong: the global utility-maximizing move is to have everyone focus on whatever they’re currently good at. If you’re trying to gain an advantage over someone, the deadweight loss will hit you just as hard, if not harder. That applies when comparative advantages are static, but not when they change over time. A change in comparative advantage is an abstraction. How it happens, concretely, is that a big new factory opens in one country and an older, smaller factory closes in a different, richer country.

The idealized neoliberal view is that as countries get wealthier, they lose their comparative advantage in manufacturing but gain an advantage in services. Everyone loves American movies, right? Who cares if they don’t really want our cars? But movies are actually a pretty small business: the global box office is about $40 billion dollars per year, compared to around $4 trillion dollars per year for the global auto industry. Auto revenues grow by several movie industries’ worth in a good year. And while there are economies of scale, they tend to apply to things like plugging known acting talent together with well-known directors who can raise money from the right producers, etc. These don’t produce serious, globally dominant industries with rising incremental returns on investment. They just give you Hollywood, Bollywood, and Nollywood; three small, separate local maxima.

Movies are an unfairly kind example to choose. At least we can export them. American healthcare is mostly consumed and produced domestically, our retail industry is overwhelmingly focused on satisfying local demand, and our financial services industry also primarily matches local savers to local borrowers. Neoliberal policymakers will argue that as we deindustrialize, older workers will retrain. I’ll believe it when Cato fires their economics PhDs and replaces them with much more affordable laid-off steelworkers.

Software is the big bet here. A U.S. economy whose growth is dominated by global software giants, headquartered here, would indeed allow us to deindustrialize. In fact, it would more or less force it to happen. At scale, software companies produce high margins and don’t require much capital, so their ROIs are enormous. The big incremental expense that they do have is marketing, which is increasingly just revenue for a different software company. As a result, they attract investment to the U.S.—but since they’re high-margin businesses, they don’t produce much trade surplus relative to their profits. The result is a trade deficit that’s driven as much by the supply of capital as it is by domestic demand for consumption.

This is a very big bet to make. And it’s a bet that we’re making blindly.

What we should explore instead is a policy of directly countering any country’s industrial policy to the extent that it’s designed to attack an industry that the U.S. still dominates that also benefits from scale. Basically, we’d go down the Made In China 2025 list and figure out what level of export subsidies and cheap loans would ensure that every single one of those products is Made In the USA by 2024. This may technically be against the rules, but those rules are hardly sacred.

The beauty of a policy like this is that it inverts the logic that the Miracle countries relied on. They knew that they could only earn high profits by exporting at scale; our policy just has to maintain profits at incrementally higher scales. Ideally, such a policy framework doesn’t ever actually get implemented. The point is that it’s cheaper for incumbents to stay on top than it is for challengers to get on top; as long as incumbents commit to staying that way, challengers bother somebody else.[9]

We’ve fallen victim to one of the classic blunders: never be the last to realize that you’re involved in a trade war in Asia.

The challenge America faces is that a free trade system optimizes on the margin, while industrial policy focuses on changing the overall balance of power. Once an industry moves to another country, it’s expensive to move it back, and the longer it grows, the harder it gets. This means we have a comparative advantage when defending the industries we still have, but that we lose a little more of it every year. If we don’t take manufacturing exports seriously, someone else will.

Footnotes

[1] Note that while this is true broadly, it’s not true for everybody. Some groups, particularly religious groups, have far higher fertility rates. Hutterites, for example, have about ten kids per family. That’s a lot, although the timescales are quite long.

[2] As an American who was born in the late twentieth century, I’m not used to thinking of famines as something that happens to anybody I’d know. But South Korea relied on U.S. food aid to avert famines as recently as the mid-1960s.

[3] That’s true of any country, of course. My grade school social studies class managed to explain How A Bill Becomes A Law without saying anything about lobbyists writing bills, legislators leaking trial balloons, or the crucial importance of getting Mitch McConnell on your side.

[4] “Management-by-binge-drinking” is a pattern that shows up just often enough to be worth researching some time. Other examples include the management team of RJR Nabisco (pre-LBO) and the court of Peter the Great.

[5] India recently experimented with a similar policy, on a wider scale. They, too, discovered that there wasn’t as much dirty money floating around as they’d thought. This seems to be a recurring pattern—perhaps politicians assume that corrupt businesspeople would hoard cash rather than invest in productive assets, because that’s how corrupt politicians behave.

[6] The reason the stakes are so high—for both China and America—is that China is a net oil importer with overseas territorial ambitions. Oil is a global market only because the American navy protects global oil shipments, and losing that protection, or facing a naval conflict with the U.S., would wreck the Chinese economy. But it’s the party line that Taiwan is a part of China. So China either needs to achieve naval parity with the U.S., such that we won’t try to stop them if they invade Taiwan, or they need to gradually backpedal on the whole Greater China thing. Headlines over the last few years give no indication that China plans to back down, at least while the current generation is in power.

[7] In the U.S., we’ve pursued a backward redistribution policy, where we tend to bail out asset owners, i.e. the old, at the expense of pricing young people out of those same assets. Pumping money into the banking system to support residential real estate prices is a good way to stabilize the economy, but a system that only stays solvent with a relentless rise in the price-to-rent ratio is unsustainable.

[8] The morally debatable nature of every successful U.S. military campaign since the Second World War is not because we suddenly decided to become a force for evil in the world. It’s because we’re such an important superpower that both sides of every conflict are at least making an effort to appeal to us.

[9] Sorry, Germany.

In 1971, that system collapsed when the gold system was closed—this was described as a temporary contingency, meaning that the temporary adjustment to the Bretton Woods system has lasted almost twice as long as the system itself. But the dollar has not yet lost its reserve status. Around the world, commodities are priced in dollars, corporations sign dollar-denominated contracts, and central banks keep 57% of their aggregate reserves in dollars, more than three times the share of the runner-up currency, the euro.

There’s always speculation that the dollar will be dethroned as the world’s reserve currency. This happens both in the sense that people make speculative claims and in the sense that traders make speculative bets. Whenever there’s a financial crisis—COVID-19, 2008, the dot com crash, the crash of 1987—the speculation gets louder. How can the U.S. dollar be a safe currency to hold when the U.S. runs chronic fiscal and trade deficits and when China’s economy is growing faster and will be larger than the U.S.’s in just a few years? With interest rates at zero, how can a dollar whose supply is rising, in M2 terms, by 24% annually compete with gold, whose supply increases are limited by mining technology, or Bitcoin, with a supply encoded in algorithms?

These are valid questions when it comes to estimating the near-term future of the dollar’s exchange rate, but they don’t speak to the binary question of whether or not the U.S. dollar will remain the default global currency. That question raises fascinating historical questions and provides a look at what reserve currencies—and currencies in general—really are.

Like any currency, a reserve currency serves three purposes: a means of exchange, a store of value, and a unit of account. For central banks, the store of value question is key most of the time, but means-of-exchange matters under duress. When the world trade system is simple, currency as a means of exchange requires a very direct kind of logic: for goods that a country wants but can’t make itself, what’s the currency necessary to buy them? Historically, most trade was either finished goods or raw materials: a country might export machinery and import grain or export coal and import clothes.

But modern trade has gotten more complicated, largely due to the rise of containerization. Container ships make it cheap to load and unload cargo, which makes it possible for countries to import and export intermediate goods. Most of the value of a smartphone exported from China consists of components imported from places like Taiwan, South Korea, Japan, and even the U.S. American software, for now, still wins out in this industry. These complex supply chains give currencies a stronger network effect: a company that does business with companies that use Won, Yen, New Taiwan dollars, and U.S. dollars might prefer to stick with a single currency to keep things simple. And for importers of finished goods, the calculus is even easier: very few companies in China have a strong desire to own Brazilian Real, Indian Rupees, or Nigerian Naira. Conversely, nearly everyone can find a use for the dollar.

So, the dollar’s dominance of trade is self-sustaining.

There are historical analogues. Before the dollar was dominant, the British pound was the world’s preeminent currency. American, Argentinian, and Australian entrepreneurs borrowed in pounds rather than local currency, and London was the center of the financial universe. Britain declined in relative importance in the late 19th centur, as the U.S., Germany, and France caught up with its industrialization. But the pound remained important. It was by far the dominant reserve currency in the late 1940s, representing over 85% of global reserves, and it wasn’t dethroned by the dollar as the top reserve currency until the mid-1950s. As recent as the late 1960s, pounds represented over a quarter of global foreign exchange reserves at a time when Britain was a mere 4.4% of GDP.

Why was Britain’s share of reserves over five times its share of the global economy? There are several reasons:

1. As Barry Eichengreen et. al argue in How Global Currencies Work (the source for the reserve data above), reserve currency status depends not just on economic output but also on how open a country’s financial markets are, how complex its financial institutions are, and pre-existing reserves. Britain scored well on all of these counts.
2. British policy went through constant contortions to convince banks to keep reserves in pounds.

The original reason Britain’s reserves were so extraordinarily high was that British colonies, and even ex-colonies, defaulted to keeping their reserves in pounds rather than dollars. Even after independence, countries like India, Canada, and Australia had a marked preference for the pound. Some of this was due to tradition and some due to social factors: their economic policymakers tended to be well-educated, which often meant Oxbridge-educated. They had closer social ties to the former mother country than the average person.

Britain also timed its gradual decolonization to minimize the impact on the pound. Keeping the pound as a reserve currency was a point of pride for Britain and was viewed as an important part of the country’s economic dominance. Any economy that’s weighted toward finance does much better with a widely accepted currency and does much worse if that currency falls into disuse.

The official history of Singapore’s sovereign wealth fund tells part of the story: postwar Britain had an overvalued currency and offered former colonies a carrot-and-stick option. If they kept their reserves in sterling, and in London, the British navy would continue to defend them. The U.S. engaged in similar currency diplomacy with Western European allies during the Bretton Woods era: the cost of U.S. troops in Western Germany was high, but its return was measured in Germany’s willingness to hold dollars and not redeem them for gold. By 1967, Britain found the system untenable and announced a military withdrawal from Singapore, followed by a devaluation of the pound. Singapore, in turn, made two announcements: first, that its currency reserves were much higher than Britain had thought, and second, that almost half of the country’s reserves had been quietly transitioned into U.S. dollars. This, as it turns out, was the result of some accounting chicanery: Singapore’s government had been quietly understating its budget surplus and investing the extra money in dollars.

While this illustrates the way reserve currencies fail, it also illustrates how surprisingly long they persist. Singapore had to suppress its own economic growth, engage in constant realpolitik, and mislead both allies and its own citizens to even partially escape reliance on the pound. And Singapore was and is a country with an unusually competent government; a country that doesn’t have a Lee Kuan Yew in charge will have even more difficulty with this sort of maneuver.

Today, a handful of countries are trying to escape the dollar’s orbit. But the efforts are halting and inconsistent. For example, Russia and China completed a massive gas pipeline project last year, with the gas priced in yuan rather than dollars. For Russia, this is a way to avoid sanctions; for China, it’s a way to make the yuan a more prominent currency, and, of course, to secure a supply of gas. But relations between the countries are challenged: China is much more protectionist than the U.S. and much more powerful than Russia. The paradox of reserve currencies may be that the more powerful the country that issues a currency, the more stable that currency is in the abstract, and the more that stability can come at the expense of its neighbors.

The euro has also challenged the dollar’s hegemony but in a limited way. The euro’s share has fluctuated but never come close to the dollar, in part because the euro is the descendant of the Deutsche mark, which was never widely adopted as a reserve currency. That was because of Germany’s comparatively undeveloped investment banking industry, its reluctance to accept capital inflows and outflows, and German central banks’ relative conservatism. Perhaps the best evidence that the euro is mostly a rebranded Deutsche mark is that financial researchers writing about long-term currency behavior simply use the mark to extend their euro-related time series to before the euro’s launch in 1999.

Currency is a Schelling Point in the simplistic sense that anything treated as a currency becomes one: if you expect your neighbors, coworkers, and tax authorities to accept a dollar or pound as a way to settle debts, then you’ll denominate your savings in them. But a reserve currency is a more deeply enmeshed kind of Schelling Point: the U.S.’s chronic trade deficits are not just the result of American overconsumption but of the rest of the world’s desperate demand for dollars. A trade deficit can only come about when trade partners prefer the currency they get to the goods they give up. The fact that U.S. recessions are often associated with higher trade deficits, higher fiscal deficits, and a higher dollar implies that the global demand for dollars has a larger effect than the U.S.’s demand for imported goods.

If a country’s biggest export is the dollar itself, what does it specialize in? The U.S. has a large and robust financial services industry, which has been surprisingly resilient in the face of its own tendency to periodically shoot itself in the foot with massive credit bubbles. The U.S. is the world’s largest spender on defense by far. The tech industry can be seen as an outgrowth of both: the original Silicon Valley companies were bootstrapped by defense spending, and today’s industry is built off a virtuous cycle where the previous generation of successful founders becomes the current generation of investors.

Some countries with a desirable currency, like Switzerland, put up barriers to keep inflows from disrupting their economy. Switzerland is happy with the Swiss Franc being a safe, trusted currency, but they don’t want their exporters to face ruinously competitive prices if the franc appreciates to a fairer valuation. The U.S. is temperamentally disinclined to engage in such interventionist behavior, which has the dual effects of violating free market strictures and penalizing consumers.

So, the current state of the financial world, as bizarre as it looks, has a sort of stability to it. The U.S. consumes more than it produces, year after year. And yet, year after year, central bankers and foreign savers stash dollars, and companies around the globe price in dollars by default. The U.S.’s overconsumption means it’s overrepresented as a destination for exports, keeping the dollar’s network effect firm. Meanwhile, the U.S. tradition of militarism has coevolved with its status as a reserve currency issuer, meaning that other countries think twice before threatening America’s economic interests. And the same open system that keeps dollars flowing in keeps people flowing in, too; the U.S. is a nexus for a global bidding war for talent, and its roided-up financial system ensures that such talent gets access to all the financial resources it could possibly need.

Will this last forever? If the dollar’s status as a reserve currency is permanent, it will be the first currency—reserve or not—to last forever. So, it’s worth asking what would happen if it did not. The U.S. trade deficit has typically been about 3% of GDP in the last few years, so at one level, a loss of reserve status would lead to a rebalancing that would make America roughly 3% poorer each year. Digging into the numbers, though, the U.S. has a sort of barbell distribution. America sells the world plenty of soybeans, corn, and wheat and is increasingly in a position to sell oil. The U.S. also exports planes, cars, medical equipment, and components for electronics. A comparative advantage in commodity exports comes down to differences in how much land can produce and what materials are under it; it’s basically fixed. America’s higher value-added exports are always threatened by competing products.

So, a U.S. that had to balance its trade over the long term would be a more economically uncertain country. But it would also be a country that couldn’t support as large a financial services sector as it currently has. For decades, financial institutions have been hiring ‘rocket scientists’—PhDs in physics, computer science, and electrical engineering—to design trading algorithms and value esoteric derivatives. If the U.S. did not have constant financial inflows from the rest of the world, some of those rocket scientists might find that the best use of their talents was, in fact, designing literal rockets.

For average Americans, the picture is a bit different. In the short term, a drop in global trade would hit their consumption basket particularly hard, leading to more expensive clothes, furniture, and consumer electronics. But it would also mean more localized competition, which would push inequality down. The average consumer might find that their consumption looks a bit worse, but their balance sheet looks a bit better; the portion of their earnings going to smartphones and TVs wouldn’t go as far, but their wages would be higher, so housing, healthcare, and education—all non-tradable categories—would be a bit more affordable. 

The direct effects on lifestyles might be smaller than the social effects, though. America’s reserve currency status gives the U.S. government a strange social contract with the American consumer: during a crisis, the way to help is to shop. Global economic crises generally take the form of a broad dollar shortage, and the American financial system is better at supplying dollars to domestic borrowers than overseas ones. So, the American consumer’s role in a crisis is to get dollars from the government and ship them overseas. Without a reserve currency, the U.S.’s role during a crisis would be more conventional: to adjust by curtailing spending. 

That’s the kind of change with real fallout. Cutting spending at a time of crisis is generally a recipe for riots. The EU found this out the hard way during its austerity policies. Its various political upheavals today are, in many ways, the ripples of the early 2010s. The variety of protests America saw during the pandemic are another example; when people have no work left to go to and little left to lose, it only takes some ambitious and coordinated leadership to release the valves of rage. That’s why the spending alternative is attractive. A duty to shop is easier to bear than a duty to scrimp. 

No global hegemon looks quite like the last one. Spain did not replace the Ming as the world’s dominant power by demanding tribute from its neighbors; the Netherlands did not replace Spain by seizing gold mines. The British did hew comparatively closely to the Dutch template— perhaps in the far future, historians will treat ‘North Sea-based colonial empires with free trade characteristics’ as a continuous category that flitted across the channel. 

The U.S. model does not match the British imperial model in every particular. But while immediate circumstances change, long-term tendencies are more durable: the dominant country tends to have the dominant currency, and its dominant currency status tends to outlast other trappings of hegemony.

Running in parallel to the financial savings glut is one in social capital. Like other forms of capital, people accumulate social capital throughout their lives—as they accumulate trust, responsibility, banked favors, institutional competence, and markers of social status. In a healthy system, social capital compounds over time, but new entrants can always get some; think of a company where the CEO is trusted to make good decisions, but new workers also have a realistic chance of promotion over time, which requires investment in them by more established players. In a social capital savings glut, we would expect the people in charge to stay in charge, to hoard their reputational capital by avoiding risks, and to accept stagnation as the price of stability.

There is, in fact, evidence of this glut across many domains. In business, the average birth year of incoming Fortune 500 CEOs has stayed the same from 2005 through 2019. In politics, the two major party presidential candidates are 77 and 74. They’ve been well-known public figures since the 1980s, a generation ago. Trump was getting a full-length profile in New York Magazine in 1980. Biden, likewise, was prominent enough to pursue the Democratic nomination in 1988, and even received a single vote at the 1984 convention. While they’re opposites in terms of how much their nominations represented a party’s desire to rally behind its establishment, what they have in common is that they’ve been public figures for so long that their name recognition is self-fulfilling.The Senate Majority Leader is 78, and the House Majority Leader is 80. In entertainment, the people remain young, but the most valuable brands are old: of the 20 top-grossing movies in 2019, two were remakes, nine were sequels (including one sequel to a remake), seven were part of existing franchises, and only two were originals. Even ostensibly timeless parts of popular culture are determined by older people: the most popular Christmas songs of the day were overwhelmingly songs released in the 1950s and ‘60s.

At one level, this could be viewed as a positive development. Perhaps we’ve gotten so good at identifying talented leaders that the same natural talents will be at the top of their career for decades. Perhaps Marvel Comics and Star Wars have fully fleshed out all of the compelling narratives the world needs. Christmas music, too, may be a solved problem. But it creates a strange syncopation of ambition. In a healthy society, people in their 20s, 30s, and 40s can believe that they could be at the top of their career with 10 years hard work. But it’s disconcerting for this thought to be most realistic for people over 65.

In more measurable domains like economics, it’s easy to sketch out how this problem could come about. The economist Thomas Piketty points out in Capital in the Twenty-First Century that any time the real return on wealth exceeds the real growth rate of the economy, this necessarily leads to large and growing income inequality. If r > g can explain continuous wealth accumulation, a similar model could explain the continuous accumulation of status and influence. In economics, r > g implies that if someone is already wealthy, and passively invests their money in a diversified portfolio, their share of economic output will rise over time. The equivalents ripple throughout society: in a company, management’s power rises over time; in the arts, the famous get gradually more fame and funding; in politics, each party’s leading lights get more airtime and influence through simple compounding.

American political history offers some evidence for this. As Piketty notes in Capital, crises tend to destroy accumulated wealth faster than they destroy the economy as a whole. When a country loses a war, big business often loses its factories, and the political allies of the wartime elite have their power drastically curtailed. Even a victorious outcome can be wealth-depleting; for example, the First and Second World Wars were immensely destructive to the British elites. The British military lost 12% of its soldiers and 17% of its officers in WWI, including 20% of the officers who attended Eton, and the survivors had to deal with massive tax increases to pay for it all. After WWII, decades of taxes and inflation further depleted the upper class’s resources, while the end of Britain’s colonial system meant that ambitious elites had fewer opportunities to leave the country to seek status and wealth in Britain’s colonial holdings. Meanwhile, the workers still had 24 hours a day, just as they did before the conflict, so they experienced an increase in their share of the wealth.

Wars are an important mechanism for redistributing political status to the young. After the Revolutionary War, the first five presidents had served in the military in some capacity. Even John Adams, while not in uniform, had been chairman of the Continental Congress’ Board of War. Six of the seven presidents elected after the Civil War had served in the military, and every post-WWII president did the same until the election of Bill Clinton in 1992.

So, one way to understand the high average age of American politicians today is to note that the U.S. has not been involved in many recent conflicts where the conflict was seen as unambiguously righteous and resulted in a clear victory. Mass mobilization is an inherently leveling force, and the chaos of wartime means leaders are quickly identified, regardless of their backgrounds.

There are other avenues for ambitious people to make their mark, but these fields generally don’t represent a direct path to national leadership. Working for an investment bank, a consulting company, or a growing tech company is a path to rapid career advancement—but precisely because these organizations are so optimized for profits, they’re bad at influencing policy. The story of large tech companies is a story of growth that crushes every obstacle until the only one left is regulation, at which point the company has to quickly recruit a bevy of expensive advisors. For example, Uber hired Obama campaign manager David Plouffe on the way up, and then Eric Holder, his Attorney General, on the way down.

There are a handful of successful technology entrepreneurs who have made a splash politically, but in general, the way tech CEOs participate in the political process is by testifying before Congress. As Mark Zuckerberg once said, “If you want to change the world, the best thing to do is to build a company.”

What’s the mechanism? It may have something to do with the complementarity between specialists and generalists. A national politician or a CEO needs to be able to address many different topics. Ergo, politicians have to have a view on foreign policy, taxes, healthcare, the environment, law enforcement, and social issues. And generally, those views are backed up by more specialized staffers who help them craft coherent policy proposals and bullet-proof them against obvious rejoinders. A CEO has to recruit, deal with investors, make strategic decisions around product launches and cancellations, and negotiate mergers and acquisitions. And, like politicians, these CEOs need a staff of narrower experts to help them deal with complex tradeoffs.

For anyone who is considering their immediate options, being a specialist who reports to a generalist is the ideal trade: it means having a significant impact on a subset of the world, instead of the risky choice of having fewer constraints and zero impact. This tends to make established leadership self-perpetuating. Job security at the top makes specialization a safer choice for everyone else trying to enter the game, and that specialization reinforces the top’s job security by removing potential competitors.

And this, too, has compounding effects. People build up social capital during their careers—a balance sheet of favors owed and favors earned. In general, that balance sheet’s assets and liabilities expand over time, so career leverage rises with seniority. In economics, stability raises the returns from leverage; an unstable company or a volatile economy can’t support heavily-indebted companies and individuals, but any system where change is gradual is one where it’s safe to borrow. Early-stage biotech companies and R&D-driven semiconductor designers typically have little or no debt, while a mature company selling packaged food or cigarettes can afford to borrow immense sums, knowing that most of their customers will keep coming back at a predictable pace.

Financial systems have a self-correcting way to deal with excess leverage driven by long periods of stability: they crash. The economist Hyman Minsky described a cycle where investors accustomed to high returns have to borrow ever larger sums to achieve those returns, and eventually the magnitude of this borrowing makes the entire system brittle enough that a small disruption can topple it. One of the other points Minsky makes, though, is that there’s a twilight period to these bubbles, where the primary driver of growth is the existence of leverage itself. In the subprime bubble, this was exemplified by hot real estate markets where a disproportionate share of the workforce was involved in construction and housing finance. In the telco/tech bubble of the 90s, it was when telecom network operators borrowed money and spent it on telecom equipment, or when dot coms raised money based on the performance of companies like Yahoo and AOL, and used that money to buy banner ads from Yahoo and AOL.

The analogous bubble-amplifying behavior in politics is to agree with senior politicians—only more so. This creates a dynamic where the collective behavior of ambitious young members of a campaign or administration tends to push that administration’s policies further from the center. Ultimately, national political leaders become more partisan than the base, but much less partisan than their staffs. It’s an unstable coalition that naturally breeds elitism. One illustrative example of this is the case of Jonathan Gruber, a healthcare economist at MIT. Gruber built simulations of the impacts of healthcare policies, and was one of the minds behind both Romneycare in Massachusetts and Obamacare nationwide. Gruber worked off two premises: first, that healthcare policies have to redistribute money from healthy people to sick people if they’re going to provide broader care at a given cost, and second, that voters don’t like this idea. Both are close to tautological. What Gruber also did, though, was admit this on video, attributing the complexities of the Affordable Care Act to “the stupidity of the American voter.” Gruber’s bracing cynicism is part of why he’s a successful wonk and a terrible politician. When his remarks were publicized, the PR blowback against the ACA was immense.

Unfortunately, the self-correction takes a long time. Unlike companies, there isn’t a quoted market tracking the value of a politician’s social capital, so there’s no way for the market to visibly crash—and there are few rewards for contrarian short bets. The payoff from not backing Jeb Bush in 2016 is tiny: saving a bit of money, and saving some faint embarrassment. But there isn’t an easy way to structure an asymmetric bet that a given politician’s chances are wildly inflated, except by supporting the underdog. And any system where specialists thrive is one where they’re essential. An outsider who wins power has to surround themselves with insiders to wield it, and those insiders refract the information they share with their boss and the interpretation they apply to policies.

The gap between branding and implementation is reflected throughout the modern system. Trump’s judicial picks are pre-vetted the same way George W. Bush’s were: by the Federalist Society. Large companies tack left on social issues while staying to the right on economic ones. They’d prefer controversy over their position on hot-button culture war topics to a discussion of where they’re shifting jobs and paying taxes. It’s the bullfighter’s logic: by waving the red cloth, you distract the charging animal and protect what really matters.

The status savings glut is self-perpetuating, and its most visible impact is the steady graying of authority figures. Advances in lighting, cosmetics, unobtrusive teleprompters, and perhaps stimulants have allowed politicians to remain videogenic for decades after they hit retirement age. With few limits on how long someone can remain a public figure, other than extreme senility or death, the social status savings glut can persist until the institutions themselves break down. In the case of companies, that can happen at a rapid pace; it only took a decade for IBM to go from setting the pace in its industry to veering close to bankruptcy.

But for governments, stagnation can continue for a long time before a sufficiently jarring reaction forces a change. That means the resulting crisis can become all the more destructive when it finally breaks.

The state, too, is an abstraction. It is a set of norms and agreements that govern behaviors—increasingly, behaviors which are tracked and influenced by the powerful companies built upon those wires. States and tech companies wield power over each other, as well as against their rivals. This leads to strange confrontations: most recently, India sparked a global wave of technological nationalism by banning TikTok, an app mainly renowned for letting teenagers share short dance videos. Soon after, the U.S. followed suit with its own prelude to a ban.

India and the U.S.’ actions against TikTok reveal deep truths about modern international relations. Countries have always competed economically, spied on one another, and engaged in tit-for-tat retaliation over real and perceived slights. But in a globalized world where life and politics are increasingly mediated by software, retaliatory protectionism doesn’t mean autonomy. It means choosing which superpower to be a vassal to. The alternatives to Chinese apps are generally not home-grown competitors, but American ones. Saying no to Beijing means saying yes to Silicon Valley. In turn, saying yes to Silicon Valley means saying yes to Washington.

China, the U.S., and India each experience different dynamics between state power and the private tech sector. In China, the party-state holds the reins and strategic firms are private only in a nominal sense. On the other hand, the U.S. government seems to be increasingly in conflict with its tech giants. Google and Facebook need foreign policies, and theirs are not necessarily that of the American state and its departments, which are barely unified on that front anyway. But despite this, U.S. attacks on foreign tech giants de facto benefit its domestic players. India represents a third model: its private telecom giant took the initiative to forge deep links with the state. In each of these cases, a similar strategy emerges: markets as a testing ground, network effects and state protections—direct or indirect—as invaluable to scaling up.

Americans have the peculiar privilege of setting the world’s defaults. Mandarin is the world’s most common native language, with 920 million native speakers. But the most common second language—spoken in addition to the native mother tongue—is English, at 900 million speakers. This makes it more than three times more popular than the next most common second language, Hindi. It’s a linguistic equivalent to the power of the dollar, a value which is universally recognized. Countries in developing markets tend to measure costs internally in dollars, even if their external reporting is in reals or naira. Similarly, they’ll use English at conferences and in advertising, while speaking something else at the water cooler.

As a consequence, what looks like globalization to Americans reads as Americanization to everyone else. The metric system is perhaps the only significant aspect of globalization that doesn’t treat American preferences as a universal default.

In the case of software, most of the world does searches on Google’s search engine, socializes on Facebook, Instagram, and WhatsApp, and uses Microsoft’s operating systems on desktops and Google’s Android OS on mobile. E-commerce is a bit more diffuse—it’s easier to add server racks than fulfillment centers, but even so, American companies dominate. The number one e-commerce company in Japan is Amazon Japan; the number two, Rakuten, uses English as its primary language internally. In the UK, Germany, France, Italy, and Spain, Amazon similarly ranks at the top. And, over time, this dominance has gotten even more extreme. Ten years ago, five search engines had gained the lead in at least one country: Yandex in Russia, Seznam in the Czech Republic, Naver in Korea, Baidu in China, and Google almost everywhere else. Now, Google, Baidu, and Yandex are left.

In India, the immediate result of the TikTok ban was a spike in popularity for local competing apps, one of which was adding 100,000 new users an hour. But these apps can’t muster the same funding TikTok had—some of them have raised small rounds, but TikTok’s growth was fueled by endless advertising on competing social networks. And now, those competing social networks are much more direct competitors: days after the TikTok ban, Facebook expanded its competing service to India.

A month after India’s ban, the U.S. followed suit, giving TikTok 45 days to sell to an American company or be shut down. The U.S. calculus is a bit different from India’s: there are multiple American companies that can operate and monetize a business at TikTok’s scale, and technology companies are a core part of U.S. global economic competitiveness. India has less to lose from a dramatic shutdown, but in the U.S. case it’s more important for outside investors to know that they’ll get some of their money back. A further complication is that many of ByteDance’s outside investors are American venture capitalists and hedge funds.

All of this seems somewhat trivial. TikTok videos are not exactly the axis around which world history revolves. But TikTok is not to be underestimated: one security researcher who reverse-engineered the app called it “a data collection service that is thinly-veiled as a social network,” adding that “[i]f there is an API to get information on you, your contacts, or your device…well, they’re using it.” There are two good explanations for TikTok’s incredibly aggressive data-collection tactics, which are not mutually exclusive. One is that the app shows users content based on machine learning algorithms—though new users get a lot more of an instant boost than on other platforms, providing a powerful hook—and every data point provides a slightly better signal for what to show users. The other is that the app is a tool of the Chinese state, designed to spy on as many people as possible. TikTok assures the American public that they’re not controlled by their Chinese parent company, ByteDance; in reality, China’s national intelligence law gives the state broad powers to demand data from Chinese companies, even on non-Chinese citizens.

To the extent that other countries care about their sovereignty, the only difference between these outcomes is which problem is more immediate. From India’s perspective, a spyware network controlled by a country that is fighting a low-level border dispute, with fatalities on both sides, is problematic enough. But an app that’s designed to control attention as aggressively as possible, and to monetize that attention through advertising, is a deeper longer-term threat. TikTok’s parent company, ByteDance, has been credibly accused of censoring anti-China content in Indonesia, and India’s politicians may worry that the same thing has happened in India.

A foreign company that’s not an arm of the state will still make allowances for the preferred narratives of states whose patronage they rely on. American technology companies are similarly sensitive to the regulatory and PR risk of allowing some kinds of content on their platforms. China’s government recognizes the value of media soft power, and gently nudges overseas media companies away from damaging narratives. So far, the results impact American life on the margin. For example, a video game about China invading the U.S. turned into a game about North Korea invading the U.S. The time travel movie Looper was partly funded by a Chinese investor, and includes several scenes in which time travelers from the future mention how prosperous China has gotten. This is hardly wholesale censorship. It’s just a gradual, barely-noticeable shift in the Overton Window, and it moves in only one direction.

For countries that don’t house global social media powerhouses, an app with a global content feed makes the media environment less focused on local issues and more focused on internationally attention-grabbing viral outrage. India, despite its enormous population, is decidedly lacking in digital influence on this front. This means that its near term decisions consist mainly of deciding which foreign organization will determine what news its citizens read on social media. TikTok’s content moderation has led to controversy in the past, with videos about Hong Kong and the Uyghurs getting removed from the app’s main feed.

Somewhat paradoxically, India has achieved more digital self-determination in a more challenging field: network equipment. China is the world’s largest exporter, but has only two globally-recognized brand names: TikTok and Huawei. Huawei is the dominant provider of 5G equipment, and there is ample evidence that Huawei is controlled by the Chinese state. Huawei is the world’s largest provider of 5G equipment. There is also evidence that their equipment has security flaws, though the extent to which these were deliberate weaknesses is unknown. As with TikTok, there’s a plausible, comforting explanation: the company is just another heavily-subsidized national champion, and the Chinese state is willing to earn a poor return on its investment in exchange for the prestige of being the top seller of a technologically-impressive product. The darker version of the Huawei story—that it’s installing espionage equipment in the heart of global telecom systems—is both hard to prove and hard to refute. There are precedents for this behavior. A Swiss encryption hardware company turned out to be a CIA front, after decades of selling strategically broken hardware to the U.S.’s international foes.

In the case of 5G, India has a national champion of its own: the vast oil refining, petrochemicals, retail, and now telecom conglomerate Reliance. Reliance is an enormous company, accounting for 2.6% of India’s GDP, and it has long exercised a high degree of control over India’s economy. In 2016, Reliance launched a new mobile phone service, Jio, which now has nearly 400m subscribers, and which has raised $20bn from outside investors. In 2018, Jio acquired a U.S.-based telecom company that made 5G hardware, and earlier this year, Jio promised a “made-in-India” 5G solution, ready for use in 2021 and ready for export thereafter.

India’s Prime Minister, Narendra Modi, has called for “Atmanirbhar Bharat”: self-reliant India. And when Jio announced their 5G plans, Reliance’s CEO proclaimed that he would “dedicate Jio 5G solution to PM Modi’s Atmanirbhar Bharat.” This sounds like over-the-top corporate puffery, and from another country it would be. But Reliance has a storied history of close ties to the Indian government. Like Samsung in Korea, it’s an open question as to whether they’re almost a department of the government or if the government itself is a subsidiary of the firm. Companies like these are essential instruments of national sovereignty. In some fields, like heavy industry, government-owned companies and public-private partnerships have gotten acceptable results, but this is less common in bleeding-edge technology. After decades of effort, China still hasn’t reached parity with Taiwan, the U.S., or Korea in semiconductor fabrication. National champions in this kind of business benefit from the government’s power to veto competitors, but they still tend to be private sector creations. India’s government would have a hard time creating a 5G equipment company by fiat, but would have much more luck protecting a local one that already existed.

The U.S., with its vast technology industry, has both more options and more constraints. American companies can clone TikTok—Facebook is already on its second attempt, and Twitter previously operated Vine, a short video app. American companies can also build 5G hardware. But the U.S. faces more risks because its successful tech companies are global: a focus on dominating the U.S. market risks losing share in the 60% of the global economy that’s neither the U.S. nor China. Moreover, the U.S. economy is also dependent on continuous inflows of foreign capital: eroding property rights to strike back at one tech company will make investors think twice when investing in American corporate bonds, mortgage-backed securities, and other financial products. India benefits from foreign capital flows, but doesn’t rely on them, while they’re an important component of the U.S. economy. This means that American technological nationalism is constrained in the same way that American economic nationalism is: the breadth of U.S. power makes abusing that power prohibitively expensive.

Technology companies all benefit from capital availability and economies of scale, and rising technological nationalism means that fewer and fewer countries will have the scale necessary to support local champions. At the same time, this nationalist trend increases the importance of home-grown solutions. Having a choice between the whims of the Chinese Politburo or those of The New York Times editorial board does not exactly sound like freedom to most heads of state. India is not alone in worrying about this—Japan has subsidized its own 5G champion, which is already making inroads into Western markets. It’s an important time: if relatively large countries with a strong domestic tech ecosystem, like Japan and India, can’t build their way to digital sovereignty, then other nations don’t have a chance. Such a scenario would mean that every country will be actively choosing to align itself with China, or defaulting to alignment with the U.S. Neither option results in an immediate loss of sovereignty, but both cause a gradual shift in the bounds of acceptable discourse—the game of politics still plays out domestically, but the rules of the game are set somewhere else.

The techno-optimist perspective is that code is intrinsically neutral, and that the most technologically advanced solution will be the ultimate winner. The radically pessimistic view is that the fixed cost of each new technological paradigm is so high that only global superpowers can afford it—like nuclear weapons, a few places will produce their own and everyone else will have to operate under a major power’s umbrella. But part of statecraft is the conviction that a country can determine its destiny. China achieved an extreme form of digital sovereignty when it was still a very poor country: the Great Firewall dates back to 1997, when China’s GDP per capita was under $800. States with a less authoritarian bent and smaller ambitions can still get some measure of self-determination, albeit at a cost.

When it comes to predicting who will achieve digital sovereignty, wealth is the wrong thing to bet on. The ability to create private tech actors in strategic industries, and to protect them, matters more. Having a large population and a linguistic barrier to entry helps too, although it hasn’t been the killer app for India. Finally, the country has to be able to project power into a global market of platforms and influence. North Korea probably enjoys a type of digital sovereignty, but not one that will make it a relevant actor in the technological destiny of the human race.

What technological optimists miss is that systems are colored by adversarial behavior. At the local level of sorting algorithms or graphical computations, it’s true that the best technology wins and it tends to be neutral. But telecommunications equipment is immensely complicated, and needs to interface with other complex products. At sufficient levels of complexity, technology is a system beyond just the hardware and software itself. It includes the people who build and maintain it, and the laws under which it operates.

A country that can’t build its own digital infrastructure is unlikely to be in a position to evaluate what’s on offer from other countries. The optimists may have a point: perhaps Huawei is popular because it’s cheap, perhaps the Chinese state subsidized it because it’s a sound business, and perhaps the massive Nortel hack was unrelated. But if one element of statecraft is ambition, another is precaution. After all, countries don’t last forever. A single strategic mistake in who decides one’s technological future could bind you to another power’s whims for generations.

But the parallels are more literal than that. In the COVID-19 crisis, it was tech companies that provided coordination, logistics, and a safety net to mitigate an unparalleled healthcare and logistics crisis. There have been 40.8 million unemployment claims filed in the U.S. since the start of the COVID-19 lockdowns, and many companies that haven’t laid employees off have instituted hiring freezes and wage cuts. Amazon, by contrast, hired 175,000 temporary workers in March and April and increased their pay by $2/hour through the end of May. Since then, Amazon has extended full-time offers to 125,000 of them. Instacart hired 300,000 in March and April and plans to hire 200,000 more.

In both cases, the companies are not just responding to a crisis, but adapting to a new normal. Internet infrastructure providers have also adapted; AT&T, for example, has handled an increase in bandwidth larger than their network’s total bandwidth in 2014, without service interruptions. Infrastructure users have accommodated larger increases—Zoom’s meeting participant count rose 20x from the start of the pandemic.

This rapid adaptability stands in stark contrast to the way states have responded.

At the start of the outbreak, the state of California had a stockpile of 21 million N95 masks. Unfortunately, these masks were past their expiration date—they’d been accumulated over ten years, since the H1N1 pandemic. California donated the masks to hospitals, but they were reluctant to use them. Fortunately, there were other sources: Facebook donated 720,000 masks. Salesforce sourced 5 million. Apple gave 30 million and manufactured millions of face shields. Flexport didn’t have masks on hand, but bought them anyway, and gave them to the city.

This doesn’t just extend to logistics and personal protective equipment. Companies were also more proactive at enforcing social distancing. Twitter sent employees home on March 3rd. Facebook did so on March 5th.

It even extends to information. A New York Times profile of changes in Facebook’s corporate governance had a buried lede: “On Jan. 27, at a regularly scheduled Monday morning meeting with top executives at Facebook, Mark Zuckerberg turned the agenda to the coronavirus. For weeks, he told his staff, he had been hearing from global health care experts that the virus had the makings of a pandemic, and now Facebook needed to prepare for a worst-case scenario…” Mark Zuckerberg is a busy guy; he’s trying to fend off Google, Snapchat, the U.S. government, the EU, and the media. He had time to read up on an obscure public health issue in China months before it was on most people’s radars. Jeff Bezos was a bit later to act, but he, too, took more day-to-day control over his company as the crisis ramped up.

Why did these companies succeed where the U.S. federal and state governments failed?

Metrics, Goals, Competence—and Hormesis

Facebook is a business. It has a mission statement (“give people the power to build community and bring the world closer together”), which doesn’t mean much, but it also produces quarterly financial statements, which mean a lot. Facebook can frame its decisions in terms of whether or not they serve its goals. Moreover, Facebook’s stock price gives the company signals about how to trade-off between the present and the distant future. There’s plenty they could do right now to increase profits at the cost of hurting the long-term viability of the business (those annoying social games were very lucrative, for example). And, by the same token, there are some costs that they’re willing to pay in order to reduce long-term risks.

The masks were part of the latter consideration. Facebook had masks on hand because, in 2018, California had its worst fire season in recorded history. This caused deaths, evacuations, and a drop in air quality—as well as a mask shortage. So Facebook was fortunate: they had a dry run during a natural disaster that cost dozens of lives, and it prepared them for a disaster a few years later that cost hundreds of thousands.

Facebook is not the only institution that has benefited from a hormetic dose of crisis ahead of COVID-19. Many of the countries that most successfully addressed COVID-19 were near China—and they acted quickly because of their experiences with SARS and MERS. South Korea had a pandemic plan; Taiwan had procedures; Singapore was ready, too. This raises the question: why do some countries and companies respond to a crisis by planning for the next one, while others, like the state of California, languish? A paradoxical contributing reason for this is that fighting fires is part of the government of California’s job description, so they could respond through conventional channels. In early 2020, when COVID-19 was spreading but not yet visible in the U.S., California was dutifully fighting the last war by raising its budget for fighting wildfires.

The gap between Facebook’s response at one end and California’s at the other showcases the difference between high-agency institutions and institutions ruled by drift and inertia. Facebook is not supposed to be a government—handwavy claims about its 2.6 billion digital citizens notwithstanding—Facebook is ultimately subordinate to the requests of national governments and doesn’t exercise any form of sovereignty.

It does, however, have part of the incentive structure of good government: since Facebook is so large, and its roster of advertisers is so lengthy, it’s exposed to broad negative and positive externalities. All else being equal, anything that makes U.S. small businesses grow a bit faster will make them spend more money on Facebook; anything that makes it harder for the average person to access the Internet—or that makes the average person less willing to bother—will hurt them. This doesn’t mean that Facebook’s incentives align perfectly with the greater good (they want to grow the pie, but they’re just as happy to take a bigger slice instead). But it does mean that they can act according to their indirect interests rather than direct ones.

Financial markets ultimately help with this, because Facebook is valued highly relative to its sales. Every dollar of incremental sales for Facebook creates about $9 of market value, about $2.50 of which accrues to Mark Zuckerberg personally. And that value is based on Facebook’s long-term outlook; a high-multiple stock establishes a favorable exchange rate between the distant future and the immediate present, giving companies an incentive to make very long-term decisions even at the cost of short-term harms. Facebook, for example, noticed in 2018 that news stories led to vigorous discussion but fewer emotionally rewarding interactions, so they penalized those stories in their algorithm. This hurt their 2018 ad revenues, but benefited their 2020 active user counts, exactly the sort of trade-off a controlling shareholder would prefer to make.

It’s instructive to note that one part of the government did react swiftly to the crisis: the Federal Reserve cut rates and injected more capital into markets. This was not exactly a comprehensive solution, but given the Fed’s limited toolset and limited mandate, it was the most they could contribute at the time. Dealing with an epidemic is hard, but dealing with an epidemic and a financial crisis at the same time is much harder.

Why was the Fed effective? In part, because it has specific goals: its mandate is to ensure maximum employment, stable prices, and moderate long-term interest rates. In other words, the Fed can frame every decision it makes in terms of how it achieves specific, measurable goals. An economic collapse brought about by COVID-19 could cause deflation (as revenues decline, businesses would lay off employees and default on debts, leading to a deflationary cascade) or inflation (a drop in production and a run on consumer goods could make prices spiral upward). By acting quickly to stabilize the market, the Fed narrowed the immediate scope of possible outcomes.

Operationally, the Fed functions differently, too. Its deliberations mostly occur in private, with a small group of people. It’s uncomfortably non-transparent, but it does mean they can hash out the argument for or against an extreme policy move, and then present it as a finished product. Legislation develops more publicly; since a bill can’t pass without widespread support, the contents of a new bill will leak as its sponsors try to corral backers—and anyone who dislikes the bill (or some part of it) can produce damaging leaks to scuttle it. The twelve members of the Federal Open Market Committee can convene on a single conference call, but the 218 House members necessary to pass a bill can’t.

The Fed was also effective because they, too, had received a hormetic dose of crisis. While COVID-19 is primarily a health crisis, its secondary effects could have quickly led to a financial crisis. The Fed and other central banks had experience dealing with such crises, and they knew that a hit to the real economy could be compounded by a collapse of the banking system. The mistake they made in 2008 was to view the subprime mortgage crisis as “contained” because it was small; it turned out to produce enough uncertainty to lead to a much larger financial crisis. Rather than risk repeating the mistakes of 2008, the Fed quickly cut rates and signaled that it was ready to engage in unconventional economic stimulus.

Institutional Autopilot

In October 2019, the Johns Hopkins Center, the Nuclear Threat Initiative, and the Economist Intelligence Unit released a pandemic preparedness index, ranking every country in the world in terms of its ability to handle a deadly disease outbreak. The United States ranked first in the world. On paper, the U.S. was prepared; there were government and non-profit organizations whose mandate included pandemic preparedness, and the U.S. spends $3.6 trillion on healthcare. The budget was there. What was missing was agency: since a pandemic is a rare event, people at the CDC did not get promoted on the basis of preventing plagues so much as on the basis of being the sort of person who seemed like they’d be good at plague prevention.

Idealists believe that every institution exists to build a better future for its participants. Cynics think every institution exists to perpetuate its own existence for the current benefit of whoever is in charge. The realist approach is to accept the cynical view as the ultimate asymptote to which all institutions trend, and to create incentives that align cynical self-preservation with prosocial behavior. Amazon employees who worked extra hours and took personal risks to keep delivering packages weren’t doing it to keep the economy afloat; they wanted bonuses, and they didn’t want to get fired. Facebook and Twitter didn’t send employees home out of pure altruism; they did it because operational disruptions are bad for business.

The economics of technology companies encourage them to insert themselves into the highest-margin gap they can find between supply and demand. But this gives them a peculiar form of altruism: what’s good for the country is good for Big Tech because Big Tech gets a disproportionate share of the upside. And because of how their stocks are valued, the long-term is what matters. Most of the net present value of a growth stock is far in the future, so they’re deeply sensitive to systemic risks. The paradoxical combination of risk tolerance (they have to continuously reinvent themselves to grow) and risk aversion (Amazon trades at over 100 times earnings, so its value is almost entirely based on what happens a long time from now) basically forces tech companies to be high-agency.

Institutions can stay on autopilot for a long time. Especially in the U.S., an extraordinarily wealthy country whose government is keenly sensitive to the needs of powerful interest groups, it’s possible for many business and political leaders to shrug off distant systemic risks. But lower demand for agency did not significantly impair the supply of agency. Growing up, Jeff Bezos dreamed of space colonies, and Mark Zuckerberg obsessed over Roman orators. But Bezos didn’t get a job at NASA, and Zuckerberg didn’t run for office; they found a better place to be ambitious. Expertise doesn’t always transfer across domains, but agency does. And in a crisis, the people in charge aren’t determined by organizational charts and delineated responsibilities but by who acts first.

This is a relatively recent phenomenon. Had Bezos been born a few decades earlier, his obsession with space travel would have led him to get a job at NASA, because NASA was one of the only organizations in the world that could plausibly get humans into space and to join the other one, you had to speak Russian. NASA today has a budget and a staff; NASA in the 1960s had those things, but it also had a plan, a deadline, and a meaningful competitor. The plan to land a man on the moon was arbitrary, and the deadline was a nice round number, not an informed estimate of how long the project would take. It would be hard to have an informed estimate in 1961 when Kennedy promised to put a man on the moon by the end of the decade. Much of the necessary technology hadn’t been invented yet, so estimating production timelines was fraught.

During the COVID-19 epidemic, we’ve all learned to think more deeply about immune systems and infectious disease. It’s worth thinking about the memetic immune system. The U.S. government has few natural vulnerabilities; the widely-known gap between Congress’ 15-25% approval rating and its 98% incumbent reelection rate shows that popular approval is not strictly necessary. But even the largest technology companies are deeply vulnerable to outside threats: everything Apple sells will be obsolete in a few years; Facebook’s core mobile ad product generated $0 revenue when they went public; Amazon has faster-growing competitors in every business it’s in. So, tech companies have a vigorous immune response to threats; they’re constantly encountering them, evaluating, and responding, often writing the rulebook as they go.

The U.S. government doesn’t have such a robust immune system; it can remain oblivious to problems almost indefinitely because almost no problem represents an existential risk. In fact, the internal incentives of the U.S. government actively encourage low-grade problems: any harmful social issue or geopolitical threat represents job security for whoever is responsible for addressing it, and solving problems means losing one’s justification for working. Prior to the COVID-19 epidemic, the single largest increase in unemployment in U.S. history was the result of the government solving a problem: in September 1945, unemployment rose by nearly two million as the U.S. demobilized.

A problem like winning a war is visible and measurable, and it creates incentives that overcome institutional inertia. Smaller problems, though, don’t affect this. The U.S. slowly losing its domestic manufacturing base and international relevance is an issue, but it’s not an issue with a discrete win/loss condition, just one with a long-term trend. Disability fraud, corporate welfare and tax avoidance, expensive healthcare and education—all of these problems fit the same framework. There’s no external threat; they worsen at a smooth cadence instead of in discrete steps, and attempting to solve them without ever succeeding is a sinecure.

The memetic immune system is the set of institutional practices and individual habits that lead an institution to accept some ideas and vigorously reject others. It can only be trained through risk; if a company accepts the idea of managers without metrics, or of employees who can’t achieve goals but don’t suffer consequences, it quickly falls behind. But a rich government is too hard to analyze at that level, and incentives are too diffuse. When institutional sclerosis is everyone’s problem, it’s nobody’s problem.

Technology companies responded fast because they’re in the habit of acting. Other institutions responded slowly because they’re in the habit of reacting, and a novel infectious disease did not have a default institutional reaction.

Ultimately, there’s a teleological difference between these institutions. Tech companies have a defined purpose, and they’re a vehicle for achieving that purpose. Google wants to organize the world’s information, and turning a gigantic profit while doing so is one of their operating constraints. SpaceX wants to make humans a multi-planetary species, and submitting competitive bids for rocket launches is an early step to accomplish this.

But the U.S. government doesn’t have a defined purpose, just a long list of functions, and those functions aren’t regularly interrogated. It’s uncomfortable for modern Americans to ask what the ultimate goal of the government is. The very idea is both utopian (do we really think the U.S. government can accomplish it?) and non-democratic (can 330 million people agree on a single goal?). But an institution without an ultimate purpose is functionally dead. The only question is how long it takes for entropy to win.

For something that doesn’t really exist yet, Libra has already caused its sponsor a lot of problems. Libra is a whitepaper, a plan, some code, a series of promises not to do anything without the explicit permission of U.S. regulators—and a colossal PR disaster for Facebook. Libra has led to a steady trickle of negative headlines, as one partner after another defects, and as Mark Zuckerberg gets hauled in front of Congress for hours of testimony.

The original plan was vague enough to sound either straightforward or sinister: Libra was launched as a global payments system that would allow anyone in the world to transfer money. The project was currency-agnostic, with Libra tokens backed by a basket of currencies. When Libra launched, it had a long roster of partners across industries—payments companies like Visa, Mastercard, Stripe, PayU, and Paypal; ecommerce companies like Booking Holdings, eBay, Uber, and Lyft; telcos; cryptocurrency companies; venture capitalists; and nonprofits.

Since then, they’ve lost all of their payments-industry partners with the exception of PayU and several other partners besides. They’ve been lambasted by competitors and lawmakers, and been asked to halt the project before it’s actually started.

Some cynics expected this to happen, but you can find cynics predicting failure for anything a successful company does. Historically, it’s been a bad move to bet against Facebook. The Atlantic wrote about the company’s bubbly nature and inevitable failure in 2007, less than a year after the company turned down a billion-dollar acquisition offer and months before it raised money at a $15bn valuation. It’s now worth $540bn. The cynics will eventually be right, but only on a scale too long to matter.

The two more interesting reasons Libra failed are institutional. They face institutional constraints at micro and macro scales.

• At a micro scale, Facebook has fallen victim to the meta-Malthusian trap every successful organization runs into. It’s good at solving one set of problems (user growth and profitability), so its constraints are mostly from problems it’s bad at dealing with (politics and PR).
• At a macro scale, Libra is a transnational effort that misunderstands the context of cross-country collaboration. Realistically, most of the forces Americans think of as inevitable features of progress—increasing freedom, fewer wars, greater international cooperation, globalization, breaking down of cultural barriers—were accidentally imposed by the U.S. in the wake of the Second World War. As the global order loses legitimacy with local electorates, these projects become untenable. Libra is half a century late, and a navy short.

The Earned Hubris Of The Successful Tech Titan

Like all Internet companies, Facebook benefits from two simple truths: human behavior is easier to track and manipulate when it’s done in digital form, and digitizing your life keeps getting cheaper.

While Mark Zuckerberg is extraordinarily rich, the story of Facebook is not a story of a get-rich-quick scheme or even a get-very-rich-slow scheme; his wealth is a side effect of his determination to retain control of Facebook. Zuckerberg has had several opportunities to sell out, most notably the Yahoo offer in 2006. At the time, the only reason the company didn’t sell was that Zuckerberg controlled the board.

(According to How the Internet Happened, a board member told Zuckerberg to consider all the things he could do with the money from the sale. His response: “I don’t know what I could do with the money… I’d just start another social networking site. I kind of like the one I already have.”)

Zuckerberg, then, is analogous to Russian President Vladimir Putin: a very rich person who essentially has billions and billions of dollars because petty cash is handy for his long-term goals. Facebook has been profitable since early in its existence, and has relentlessly invested the proceeds. This has some odd side effects: in Chaos Monkeys, a memoir of working at Facebook, Antonio Garcia Martinez articulates a sort of postmodern Marxist labor alienation. His job is to help Facebook make money from ads, and this grubby, profit-seeking work is frankly boring to senior management. Facebook’s ad exchange is just a short-term tool to help Facebook pretty-up its profits before IPO, so it can raise more money—so it can improve its product and absorb more of people’s time and attention.

Facebook has relentlessly excelled at attracting and maintaining attention, and at digitizing more of people’s lives. From the beginning, Facebook was able to target small markets, achieve dominant market share, and move on, confident that its position was unassailable (in The Unwinding, George Packer calls this “a benign version of the Brezhnev Doctrine.”)

As the product matured, Facebook had to shift their strategy to the defensive, identifying new ways people used the Internet to relate to one another, and quickly intercepting companies that spearheaded them. Sometimes, this took the form of acquisitions, like Instagram and WhatsApp. In other cases, it involved copying products and choking off competitors’ access to the Facebook platform.

Facebook hasn’t lost its user-acquisitive mojo. Some people stop using Facebook, but as more people’s lives are mediated by the platform, it gets harder and harder. You might decide you’re too cool for the app, but once you have kids, grandparents will lobby fiercely for more pictures, and you’ll reluctantly find yourself installing it again.

Facebook solved one competitive problem after another, usually by crushing the competition—they have the dominant directory of real-names, a strong position in logins, the most-used photo-sharing app, and two of the world’s most popular messaging platforms. They’ve even reached the point that, rather than waiting for users to digitize the real world, they’re using virtual reality to build a digital-first reality.

For a decade now, Zuckerberg has described Facebook as a “utility,” showing a keen awareness that cool products have a half-life and utilities last forever. But once a product is a utility, it becomes a necessity, and necessities invite regulation.

Facebook’s success as a product and as a business has eliminated all the obstacles except formal and informal political ones. Formally, Facebook faces antitrust scrutiny (regulators have retroactively upgraded their assessment of the company’s strategic brilliance and decided that the Instagram and WhatsApp acquisitions should probably not have happened). They’re also getting criticized for enabling foreign political manipulation, and for hosting child abuse content. Informally, most people instinctively believe that if there’s an institution they rely on, they ought to have a say in how it’s run. Like any other utility or large company, Facebook is ultimately answerable to public and state interest, not its own private goals.

Facebook has become a victim of its own success. They wanted to be the first app people checked in the morning and the last one they looked at before bed, which made them the best app for foreign intelligence to target with propaganda campaigns. They reacted by building up a gigantic human and technical infrastructure to track and moderate content. It is, outside of China, the single biggest investment ever made in controlling what people hear and what they can say. As Zuckerberg put it in a leaked speech: “Twitter can’t do as good of a job as we can. I mean, they face, qualitatively, the same types of issues. But they can’t put in the investment. Our investment on safety is bigger than the whole revenue of their company.” (According to the transcript, this was followed by laughter—you have to give them credit for maintaining their esprit in the face of so much criticism.)

Facebook has political obstacles because they’ve so effectively crushed the technical and business obstacles. It’s the exact converse of the problem a representative government faces: they have, by definition, a popular mandate to enact certain policies. But the people who are good at winning elections are not the same people who can effectively implement policies. Facebook’s periodic congressional hearings are a showdown between a company that can effectively execute plans but doesn’t want to be told what to do, and politicians who know exactly what their constituents want but are totally ineffective at getting it.

The Libra hearings did not focus all that much on Libra itself. Libra was a good excuse to get Mark Zuckerberg to fly to DC, but his questions addressed other problems—Russian and Iranian election interference, child porn, antitrust, cyberbullying, and a general sense of arrogance. One Congresswoman chastised Zuckerberg for his failure to solve the student debt crisis. Clearly, Congress has a higher opinion of Facebook’s ability to solve problems than Congress’.

There wasn’t much to say in part because Facebook has already bent over backwards to be as accommodating as possible. Per Zuckerberg, “we’re not going to launch anything that is a product or a part of this until we have full support from U.S. regulators regardless of what the international regulators say.” He tried to cast the project in national security terms as well, noting that “China is moving quickly to launch a similar idea in the coming months.”

All to no avail. Congress made demands, some impossible to fulfill, and some that Facebook is already engaged in. As Zuckerberg repeatedly points out in his testimony, the reason there are so many headlines about bad actors on Facebook is that Facebook invests more than anyone else in catching them.

Facebook’s regulatory troubles happen at the intersection of two Malthusian limits: a company so successful it becomes too important not to be regulated, and regulators who can measure public opinion but not act on it.

The Wrong Time For Libra

History is inevitability plus random contingency. The First World War was the inevitable result of a complex series of alliances and great-power competition between the German Empire and the British Empire, but the catalyst was an assassination attempt—four attempts, actually, three of which failed.

Economic growth also happens at the intersection of technological and political possibilities. The space race made economic sense because of a series of historical coincidences—atomic theory developing in the early twentieth century, a critical mass of physicists fleeing Europe in the 1930s and ending up at Los Alamos, Hitler’s obsession with rockets, and Soviet Russia’s post-war position as a major power not under U.S. influence. If the U.S. didn’t have both the means and motive to demonstrate that they could launch nuclear warhead–sized payloads to anywhere they chose, humans would still not have walked on the Moon.

Libra is in an unfortunate position: just as it became technologically feasible, it was rendered politically pointless.

Libra’s goal is to be a transnational payment system, allowing anyone to transact with anyone, anywhere. To an American, this is a historical inevitability: over time, barriers to global interaction have fallen. It’s easier to travel where you want, buy what you want, watch what you want, eat what you want, and it’s only been getting easier. A Marxist or a Whig historian might treat this as one of those relentless grinding historical forces, but this is actually a story with a protagonist of sorts: to countries other than the U.S., “globalization” is a story of increasing American hegemony.

To put it succinctly, the nation-state was born in Westphalia in 1648, got a terminal illness at Los Alamos in 1945, and finally died at a meeting of the Texas Railroad Commission in El Paso in 1972.

Westphalia is an obvious starting point for the nation-state; it was the point at which countries agreed that national borders were meaningful and that domestic policy was the business of a single sovereign government.

At Los Alamos, physicists invented a new kind of weapon so powerful it would define international relations, but so expensive that it meant most countries were relegated to protectorates of nuclear powers.

El Paso doesn’t have the same historical resonance, but it’s an important turning point: this was where the Texas Railroad Commission decided to end oil production quotas due to a nationwide hydrocarbon shortage. It wasn’t enough: for decades after, the U.S. was increasingly dependent on oil imports, particularly from the Middle East.

This was not just a case study in Ricardian comparative advantage, in which America focused on one set of competitive advantages, while Saudi Arabia and Venezuela focused on another—it formalized a world order in which the United States Navy kept the seas safe for trade, which allowed the U.S. economy to grow, and made America the safest place to stash assets.

This had far-reaching implications: it imposed a partial free-trade zone on the world’s oceans, allowing countries with large labor forces and high savings rights (e.g. Japan, Korea, and Taiwan) to become export powerhouses selling to the U.S. and Western Europe. It meant that the U.S. had an interest in wars far beyond our borders—when Iraq invaded Kuwait in 1990, they demonstrated the capacity to conquer, or at least disrupt, Saudi Arabia’s massive oil production, which would have turned oil from a freely traded commodity subject to market forces into a geopolitical tool subject to Saddam Hussein’s whims.

In a literal sense, the first Gulf War was a war for oil, but in a broader sense it was a war to defend a global order—an order that served the United States well, but that the United States served in turn by maintaining safe sea lanes.

This does not imply that globalization was an American conspiracy for world domination, just that when the U.S. reacted to threats, it did so in a way that protected globalization. Conspiracies are an unnecessary part of a theory when reactive behavior predicts the same outcome. It’s not a conspiracy that America is a dominant importer of goods and exporter of brand names and culture; it’s just the inevitable result of a system where we’re in charge. Our pax Americana is a bit less classy than the Roman version, but still serviceable, as long as you believe that civis romanus sum can be roughly translated into “I said, ‘Where is the nearest McDonald’s?'”

The Decline Of Pax Americana

Four forces combined to weaken this global system:

1. The fall of the USSR
2. The rise of China
3. Fracking
4. Nationalist politicians

The collapse of the USSR temporarily fulfilled the long-term promise of the American political agenda: at last, Russia could enjoy the bounties of the American system—elections, private property, pop music, and hedge funds. But the end of the USSR meant the end of a large military as an existential necessity. An American military large enough to go toe-to-toe with the Soviets was large enough to squash any other country handily, which kept non-U.S. countries from doing anything that made them seem too much like sovereign states. Without that threat, we prudently dialed back our ability to project power worldwide.

Russia’s collapse was fait accompli long before it happened; only the fortunate timing of OPEC and the Saudi embargo, coupled with Russian oil discoveries, bailed them out. But China’s growth has been a longer-term threat, because China sees clearly what the U.S. misses: a global market, denominated in dollars and protected by the U.S. Navy, is an American market in all but name.

There’s a revealing passage in Steve Coll’s excellent history of Exxon, Private Empire: Bush administration officials were puzzled by China’s insistence on owning oil assets in Africa, rather than just buying oil on the open market. They hired an economist to make a PowerPoint presentation to Chinese officials, articulating the free-market view on energy and contrasting it with the more mercantilist Chinese approach. (This was their first mistake; America is a country run on PowerPoint presentations, but China is the sort of country where policy is made in Excel.) The U.S. Navy made oil a fungible commodity, but only to people whose foreign policy goals didn’t conflict with the U.S. Clearly, China—a country that claims sovereignty over the island of Taiwan—did not always expect the American navy to be on their side.

These geopolitical problems didn’t get resolved in Beijing or Washington, though. They got fixed in Texas and North Dakota, where the U.S. has suddenly, over the last decade, basically eliminated its energy deficit through fracking. A country full of suburban voters (many of whom drive Suburbans) will do whatever is necessary to maintain access to cheap gasoline. As it turns out, thanks to massive overinvestment in new extraction technologies, “whatever is necessary” has switched from aggressive foreign policy abroad to lax environmental policy at home.

We haven’t seen the geopolitical implications of this just yet, and the U.S. response to Iran’s drone attacks on Saudi Arabia indicates that the American military establishment maintains its commitment to keeping the Middle East free from any oil-disrupting conflicts. But, over time, energy independence allows the U.S. to adopt a less intrusive foreign policy, and to allow other countries to reassert their sovereignty.

Back when Dick Cheney was a hard-headed realist about foreign policy (which is to say, back when he was an energy executive), Cheney once said, “The good Lord didn’t see fit to put oil and gas only where there are democratically elected regimes friendly to the United States. Occasionally we have to operate in places where, all things considered, one would not normally choose to go. But, we go where the business is.” Perhaps he should have considered the lilies of the field. Perhaps the Lord saw fit to give Americans enough oil to distract them from bombing the Middle East after all.

The final force pushing against the global consensus is a more literal one: voters. In the U.S., U.K., Italy, Hungary, and many other places have elected leaders who pursue a more nationalist and less internationalist approach. This isn’t happening because changes in the energy market enable more autarky, but those changes might make the shift to nationalism more durable.

This change is hard to explain—you can blame the financial crisis for destroying faith in elites, or Russian propaganda, or simply the fact that the rich world is aging and old people are conservative. Regardless, internationalism is becoming less politically viable, just as the forces that made it possible and necessary are dwindling.

Libra Itself

Where does that leave Libra? Facebook’s public goal for Libra is to give underbanked people access to the global payments system, but that’s closer to a slogan than a business plan. They wouldn’t take the risk—either the literal upfront cost or the inevitable political backlash—if they didn’t have a more ambitious plan.

The most likely explanation is that Facebook worked backwards from what they’re good at to what problems they could solve. Payments are, fundamentally, a problem of identity. Excluding the small fraction of commerce done using bearer instruments (such as dollar bills), most payments are fundamentally a question of identity. Who is buying that high-resale-value iPad? A legitimate customer, or a hacker syndicate that’s stolen their credit card?

Facebook’s founding was enabled by a user-ID hack of sorts: every Harvard student already had a profile on Harvard’s official Facebook, and they all had post.harvard.edu email addresses, so it was trivial to verify that someone was who they said they were. As Facebook grew, it became more obvious that real-world identities mattered, and that a site full of real people was a competitive advantage in a world where MySpace users could friend any of ten thousand accounts purporting to be the Flying Spaghetti Monster or Osama Bin Laden.

Since then, Facebook has developed numerous tools and heuristics to identify real users, and to map their behavior to their Facebook account. Some of these are obvious (using phone numbers to verify new users, demanding photo ID from users who sign up using VPNs or Tor), and some are doubtless part of the company’s most prized IP.

With that as a foundation, and the blockchain as both a payments substrate and a way to attract programming talent, they can have a comparative advantage at cheaply authenticating new users. And if the world’s underbanked tend to be people with low net worths, a drop in the fixed cost of getting them onto the system means more people can get access.

While these people don’t have much money, payments systems benefit from network effects. Visa and Mastercard have very cheery shareholders because the size of each company’s cardholder network encourages merchants to accept them, and vice-versa. If Facebook can onboard hundreds of millions of first-time electronic spenders, they can bootstrap their own monopolistic payments network—but, just because of how skewed global spending and GDP are, they also need users in the rich world to have access to Libra.

Facebook could build a payments system like this on top of the dollar. Why don’t they? There are at least two reasonable explanations:

1. There’s already a regulatory apparatus for managing dollar-based transactions, and Facebook would rather make something different enough that the rules get written de novo. Purely dollar-based cryptocurrencies have a mixed reputation. The biggest, Tether, is essentially dollars minus money laundering laws, but—because it didn’t avail itself of the most trustworthy, regulated banking partners—is also finding itself short of dollars.
2. Facebook would like Libra to be international, and if it’s backed by a basket of currencies rather than a single currency, its volatility to anyone using anything other than dollars is lower. For example, a hypothetical Libra that’s half dollars and half Euros has half the volatility, to a Euro-denominated user, of an all-dollar Libra. American users may find this off-putting, but Facebook knows that even though dollars are used almost everywhere, they’re not the predominant currency used by everyone.

Libra is effectively a global currency, but we already have one of those: the U.S. dollar is the default means of pricing and settling international deals. In fact, fluctuations in the dollar have an outsize impact on global trade. One might look at the global airline industry—with Boeing planes, USD-benchmarked fuel prices, English-language technical manuals—as America’s own accidental Belt and Road initiative.

The only drawbacks to using the dollar for everything are a) being stuck with the results of American fiscal and monetary policy, and b) being subject to America’s tendency to control dollar flows as a political tool. There have been multiple cases in which non-U.S. banks dealt with countries the U.S. didn’t like (e.g. Libya, Russia, and Iran) and got punished because all dollars ultimately flow through New York, putting essentially all international commerce under U.S. supervision.

Libra is certainly not Facebook’s attempt to make it easier for Mullahs to Venmo Hamas. It’s a project built from first principles about how currency should work, but it ignores the fact that currency is contingent on a social and political consensus. In other words, it’s an attempt to intelligently design something without understanding evolution.

There was a time when designing a currency system from first principles made sense, and that time was the immediate aftermath of the Second World War, when the U.S. had conventional military superiority over every other country and a new superweapon—and had the only industrial base that hadn’t been bombed flat.

The Bretton Woods system was designed in 1944 and implemented in 1945. It called for currencies pegged to the U.S. Dollar, with the dollar itself convertible into gold. To maintain the agreement, the participants either created or dramatically expanded entities like the IMF, the World Bank, and the Bank of International Settlements in order to ensure that participants did not face potential currency crises.

This put almost all of the non-Soviet world in the same currency zone. (The Soviets did not ultimately join in, though they sent delegates to Bretton Woods. Also, the main U.S. negotiator was a Soviet spy, so they had rather significant input.)

Bretton Woods tells us several things about global currency systems: first, they can work for a while, and can actually work quite well. The frequency of banking crises plummeted after the system started, and then rose once it ended. Second, they’re hard to maintain. Bretton Woods was fully operational in 1945, but ended in 1971 when the United States ended the dollar’s convertibility into gold due to a balance of payments crisis. And third, they’re always backed by military hegemons. The dominant currency in every era has been produced by the dominant military power of that era: Roman denarii, Spanish reals and escudos, British Pounds, USD. In every case, the default currency happened to be the one issued by the country with the biggest military.

One member of Congress articulates the situation quite well in the Libra hearings: “The US dollar is an excellent currency as a means of account. It serves all the needs except it’s really bad for tax evaders, drug dealers, terrorists, and that unmet need can be met by new currency.” Later, another asks: “Given your history, why should Congress, regulators, and the public trust you to create what amounts to the world’s largest bank, what really amounts to a shadow sovereign government?”

That about sums it up: to the extent that Libra is useful, its utility is a superset of the dollar’s. But the dollar serves the same goals Libra intends to, and also gives the American government a useful policy tool.

Facebook’s argument for Libra also indirectly assumes a dollar-dominant context: at one point, Zuckerberg says, “The financial industry is stagnant, and there is no digital, financial architecture to support the innovation that we need. I believe that this problem can be solved and Libra can help.” The U.S. financial sector is, in fact, stagnant; payments are faster and cheaper in other countries. And yet, American banks are quite profitable.

The way to square this circle is to treat banks as rent-seekers who profit from investment inflows into the U.S., which, as a simple matter of accounting, match our trade deficit. As long as either a) American consumers are more willing to spend than to save, or b) overseas investors prefer stable dollar-denominated assets to other options, there will be a persistent deficit—which means a persistent flow of funds that can be profitably shuffled around in Manhattan, Chicago, and Greenwich.

Finance, as a sector, only really took off in the U.S. after the Bretton Woods system died. Finance, real estate, and insurance were 15% of GDP when Bretton Woods ended and are now around 21%. Investment banks typically had a few dozen employees; Fred Schwed’s 1955 Where are the Customer’s Yachts characterizes Wall Street as a whole as a group of about 10,000 people. Goldman Sachs alone employs over 36,000 today.

Clearly, while the system isn’t working especially well for people who want to make small cross-border transactions, it’s working just fine for other people.

Libra is not an attempt to topple the current financial system, just an endeavor that somewhat misses how the system works, and identifies the wrong problem to solve.

Libra’s Place In History

Mark Zuckerberg is hardly unaware of world history, and probably has a better classical grounding than most of his critics. Zuckerberg is perhaps the only major company CEO to exclaim “Carthago delenda est” about a competitor. The competitor was Google+, and Facebook did indeed salt the earth in that instance, carrying home spoils and chattel. He’s frequently cited classics as an important influence, listed Latin as one of the languages he spoke on his Harvard application, and named one of his kids after Augustus.

He’s doubtless aware that he’ll have a place in history, and for a company of Facebook’s size any decision big enough to matter to the firm is potentially big enough to matter to history. But Libra is both too ambitious and the wrong sort of ambition; the Roman Senate kept meeting after Rome was ruled by emperors, and, in fact, continued meeting even after the Western Empire fell, but ambitious Romans didn’t aspire to the Senate once the Senate didn’t matter.

But history is always easier to read when we have a few millennia for context. A good history of the twenty-first century won’t be written for a long time, because in the moment, propaganda is more important than understanding. If we knew how modern institutions actually worked, rather than how they ostensibly work, those institutions would lose their legitimacy.

If the global order is still in place—if the rise of nationalism in the U.S. and Europe and the rise of China as a global power are both temporary flukes—then Libra is an attempt to usurp the role of the dollar, but without the military necessary to make that viable. If that global order no longer applies, then the age of transnational cooperation is passing, and Libra will be increasingly unfashionable.

Libra is a very nice idea, and under other circumstances it would work perfectly well. But under the present regime it’s presumptuous, and under the next it will be an anachronism.