Sunday, December 6, 2009

America's Competitive Edge

How did America become and why does it remain a super power? Here some possible factors:

  • Large size - Basic economics tells us that there are huge advantages to be gained from specialization and trade. However, the magnitude of the advantage depends on the size of the market. For example, I can't specialize in making toilets if I live in a small village of population 100 and have no contact with the rest of the world. Why not? Because I won't have a large enough market to be able to sustain myself in that specialty. As a result, when someone does need a new toilet in my small isolated village, they will have to either produce it themselves, or hire someone in the village who has made toilets before to make one. Needless to say, quality will be low, and price will be high. America has at times been somewhat isolated from the rest of the world in trade terms. However, even during those times the US was a relatively large country with a large market for goods and services, and so it captured a large benefit from specialization within the market. I think this is also much of the explanation for the Soviet Union's ability to remain a super power for many decades during which it was economically isolated from the west.

  • Free Market Capitalism - There are a couple of important features of free market capitalism that I believe make a big difference to the amount of wealth that is produced within the society. First, the freedom to compete within the marketplace spurs innovation, both for market incumbents and for new entrants to the market. I feel this every day at work (I'm an engineer working for a manufacturing firm) as we are constantly seeking to improve our processes and products in order to remain viable within the market. Everyone in the company knows that standing still means we'll all be out of jobs in a very short time because our competitors will beat us in the market with better products at lower prices. The second part of free market capitalism that is important is that it rewards good ideas and good execution, and punishes bad ideas and bad execution. Inefficient firms die while efficient firms take market share. The image below illustrates how differently capitalism is viewed in much of the rest of the world. If free market capitalism really IS an important part of high productivity and high standard of living, then those who reject it are putting the gun to their own heads.

  •  Regime Certainty - This is the opposite of regime uncertainty, where no one is sure if the law will be the same today as it is tomorrow, whether there will be civil war tomorrow, whether property rights will be respected tomorrow, etc. The US has been stable and secure, with mostly predictable application of the law, for decades. This matters! When there is regime uncertainty investment drops because the value of any investment is a value that will mature over time, and uncertainty about the future of something as basic as the law or property rights decreases the value of any and all investment. Look to sub-Saharan Africa for an example of what regime uncertainty does to growth. Of course, the concept of regime certainty also embraces the fact that America was not ravaged by two world wars during the 20th century.

  •  Immigration - The US accepts more immigrants than does any other country in the world. The US is characterized by its immigrant population, including those of us whose ancestors came here prior to the 1930s, and now think of ourselves as 'typical' Americans. I think that it is the case that the US has been very successful at attracting the best minds and the most innovative people from around the globe, in part because of the benefits of free market capitalism and regime certainty. Innovative people are drawn to places where they will be free to innovate. Entrepreneurs are drawn to places with regime certainty. I think this is much of the explanation for why the US is such an innovative and entrepreneurial nation. Listen to Paul Graham's comments on immigrants starting businesses to get a better idea of what I mean.

Now I know that this list isn't exhaustive, but these are the main things that come to my mind when I puzzle about the US and its accomplishments and place in the world. What have I left out? Or better yet, what is wrong in my approach altogether to this question?

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