Allison Schrager and Rafael Mangual discuss the nuances of conservative economics, the importance of free markets, the role of incentives, and the impact of regulation. They explore the philosophical underpinnings of economic thought, the significance of risk tolerance, and the influential thinkers who contributed to modern economic understanding.

Audio Transcript

Rafael Mangual: Hello and welcome to another episode of the City Journal Podcast. I'm your host, Rafael Mangual, and I am joined by my brilliant colleague, Allison Schrager, Allison. Thank you so much for being on the show. Welcome.

Allison Schrager: I'm so excited to be here. I'm a big fan and always wondered why you never asked me before. So now here I am.

Rafael Mangual: Oh, we've been dying to have you on. We've been dying to have you on. I'm sorry we're not doing this in the studio. Unfortunately, we had some technical difficulties, so this is one of the few episodes that we're going to be doing remotely, but I think we're going to have a fantastic conversation. Before we get into that conversation, you all who are listening and watching, please do be sure to like, comment and subscribe to the show. The show has been growing, our audience has been growing. We're super excited about that, but we really want your help with the algorithm, so make sure you click all those buttons right now before you listen to this episode. But with that said, I want to jump in to our conversation. And the way that I want to set it up is a lot of times I'm asked to make comments on different policy questions in the media.

And I'm often described, not just with my official title, but with the Manhattan Institute being described as a right of center think tank or a conservative think tank. And we've been doing this series called Who We Are, where we're kind of talking about different policy areas that the Manhattan Institute and the City Journal has been covering over the years. And of course this episode's going to be on economics. And so I just wanted to start with a question of what does it mean to be conservative on economics versus liberal? You often hear people say, who are kind of middle of the roaders will say, “I'm conservative on the economy, but I'm liberal on social policy.” Well, what does that mean to be conservative on the economy?

Allison Schrager: That's actually a really good question. And maybe 10 years ago it wouldn't have been because it would've just been free markets, small government, low debt. But I mean, there's actually, I think, a debate amongst conservatives around what that means now. I mean, you have generally not economists, people who call themselves conservatives saying that arguing for maybe a bigger role in government. I think still they make some good points that I think traditional free market economists like myself really need to internalize and consider, but I still consider it what we want and what everyone wants, I guess, is more prosperity. And I think if you're a conservative economist, do you think the best way for that to happen is through free markets and for individuals making that happen for themselves rather than the government doing it for them?

Rafael Mangual: Yeah, I mean, I think that's a great and concise answer. I mean, the way that I've thought about where conservatives tend to depart from liberals or progressives on economic questions really kind of falls into how we approach markets and how we approach how we govern ourselves. And so that's kind of how I want to split today's conversation up. So let's start with markets. You've already mentioned the term “free market” a few times and allowing individuals to pursue their interests. Tell us a little bit more about what “free markets” means, why they're beneficial and what the alternatives are.

Allison Schrager: Well, I think the way I understand it or understand the world is everyone kind of walks around with what they know what's best for themselves. Everyone likes to say people are irrational, but they really aren't. They know what's best for themselves. They know their preferences. They know how much they value the future versus the past. And all these people with different preferences and ideas of what they want come together in this marketplace. And it's somehow out of all of this chaos, and I think this is so beautiful, you come up with this market price that clears this and allocates goods. So I think when you're a free market economist, you're like, I don't want to mess with that too much because once you do, you get all these distortions and that makes people worse off. So you get more prosperity when people can trade more and I mean, not just internationally, but with each other and how that not only allows individual liberty, but it actually has better economic outcomes that leads to more prosperity.

Rafael Mangual: Yeah. I mean, you kind of touched a little bit on a bit of a philosophical point there. One that always kind of spoke to me. I mean, when I was thinking through my own political philosophy growing up, I mean, I was reading Jeremy Bentham and John Stewart Mill. And one of the brilliant things that really made John Stewart Mill that made his work resonate was that it seemed that he understood that we can't actually maximize the happiness or the greater good because we don't really know. We don't have enough information about what makes every single individual happy. Those individuals are the best judges of what their interests are and what pursuits will make them happy. And so we're better off just allowing them to pursue those interests for themselves. And that was kind of the introduction to free market economics for me was really kind of from that first philosophical standpoint.

But the benefits is that it seems to, like you said, make us more prosperous. So I mean, walk us through that. I mean, why is it that a free market is more prosperous than a more heavily regulated one in which prices are controlled? I mean, you have these goods, people need these goods, things like medicine, for example, why wouldn't it be a good thing for a government to step in and cap the price of a life-saving medication?

Allison Schrager: All goods, well, almost every good exists in a finite supply, and everyone wants more of something and there's only so many resources to go around. So the idea is when you have the free market doing more allocation, that this price gets set. And again, it's like a miracle that sort of allows people who value the good most get it and be able to, or people who want to trade it, get a good price for it. Now, if that price is attractive, then you also have the incentives to create more goods, and that's partially what creates prosperity or come up with better ways to make goods or new goods. So anyway, yeah, it seems like, oh, if you have this medicine and it can save lives, we should just make a generic and sell it at cost. You need to also preserve that market price at least for some time to ensure that there's still that innovation or that people are still motivated to innovate and will make new goods because you need people to be motivated to work in the economy.

And when we saw is that when you take that away, then what you get is more stagnation, people are less motivated. And I think this is one of the central themes of economics that people seem very reluctant to embrace is that people respond to incentives, and there's no greater incentive than a market price.

Rafael Mangual: Yeah, no, I mean, incentives is, I think, an important word in a lot of these economic debates because when people hear the term economics, they think numbers, they think prices. But in a way, economics to me has always been kind of a behavioral science in the sense that what economists are trying to do is understand what people's motivations are and how to adjust the market to be responsive to those incentives and to incentivize people to do good things like produce goods and sort of disincentivize people to do bad things like say commit crime, which is why the economics literature sometimes touches the criminal justice space. But tell me a little bit more about the importance of not undermining incentives. I mean, what does that look like in practice? I mean, I think one of the debates that people will often think about incentives in the context of is the debates about welfare. You'll have a government welfare program and that will be criticized because someone on the right might say, “Well, that's going to sap someone's incentive to work.” I mean, is that sort of the same thing that you're talking about?

Allison Schrager: Partially, I mean, I think what's interesting about a welfare state is it not only ... I mean, often the argument is, and this is kind of true, but not always true, that if you give people welfare, they have less need to work, so they don't. But it's also if the welfare state in some aspects of it are structured. So if you work more, you get less welfare. So that also ... Also, if you think about this discussion we're having even on the high end with wealth taxes is if you take away the return on risk, if you took away the return from work, you also get less of that. So it is sort of a way of thinking and seeing the world this way.

It's a very New York story, but I'm on my co-op board now and I actually really love it because I have a great co-op. It's very smart, it's very well run, but it is fascinating for me having to make financial decisions with non-economists, which is not something I've ever had to do before. And it is amazing to see that ... I said, most of them, half of them are old hippies because they live in Greenwich Village for original owners when it went co-op in the '80s, but they actually run the co-op board really well, but their way thinking about things is so crazy to me. They get to the right decision, but their way of thinking... It turns out, I didn't even know this, that we have basement storage and there's all these problems because one person is using half of it and we don't quite know how to ration it. And they keep saying, well, if we have to come up with some sort of policy, we don't know how to do that because who needs storage more than ... If you live in a smaller apartment, if you have a big family and we're supposed to these people take half of it, there's just two of them, they live in a double apartment. And I'm just like, “You know guys, there is this mechanism to allocate a scarce resource that's in demand.” I could even come up with a live auction to come up with this price and we can get revenue and we can fairly allocate storage space.

Rafael Mangual: How was that responded to?

Allison Schrager: They did not like it, but I'm not giving up on that one. I'm going to wait until our next maintenance increase to be like, we could avoid this if we make the... My building, this is in Greenwich Village is half original owners who don't have a lot of money and half trust fund people because I now know the financial background of everyone in my building, which is also really fun for me. So I was like, we can extract more from them for storage and then subsidize the other ones, which to me, as I said, the more the economic thinking. And also, I just want to create this market for basement storage. I just think that would be fun for me. I'd like to create this online auction and see where it goes.

Rafael Mangual: I love that.

Allison Schrager: But yeah, they're not into it yet, but I'm not giving up on that one. But other than that, they actually usually do come to the right decision. And it's amazing to, in some ways reassuring as an economist to see people who don't really have much of an economic background, who aren't thinking like me at all. We just did do a maintenance increase. I lost on the storage again, but the way I think about it is our maintenance is still increasing at below the rate of inflation, so it is fine

As opposed to they have to justify it all these other ways, but we come to the same spot, which shows that just anyway we're all like these actors, unless people don't have a lot of economic training, we're all sort of groping to something that is this amazing price that kind of just works.

Rafael Mangual: Yeah. Well, that brings to mind actually something I wanted to ask you about, which is a particular anniversary. Everyone this year is thinking about the 250th anniversary of America, but it's also, I think the 250th anniversary of one of the great economic works, Adam Smith's Wealth of Nations or actually, I think the full title is An Inquiry into the Wealth of Nations. Do you know the full title by heart?

Allison Schrager: It's embarrassing, but no.

Rafael Mangual: Yeah. But it is arguably the sort of foundational work that undergirded the free market movement. And one of Adam Smith's ideas that was introduced to me early on as a teenager, but that I always found just fascinating was this idea of the invisible hand, which you've kind of alluded to a couple of times, right? We have people who don't have economic training, but you and them are arriving at the same kind of consensus without anybody really pulling the strings. And so…

Allison Schrager: Well, I try, but yeah.

Rafael Mangual: Yeah. Well, the question is, how does that actually work? I mean, what do you make of the Invisible Hand Theory if you want to explain it for us and then just give us a sense of how insightful was that 250 years on?

Allison Schrager: I mean, it was so insightful. I mean, it's so brilliant. And I think Hayek also mainstreamed this idea because he was so ... I mean, with Adam Smith, I think it was a very different kind of economy as opposed to what Hayek saw, which he saw government, people trying to actually interfere with this process. As opposed to…

Rafael Mangual: And for those of you who don't know Hayek, we're talking about Friedrich von Hayek, Nobel Laureate, Chicago School, Austrian School Economist, who was very much around, I think he died in the '90s, '80s?

Allison Schrager: I think 80s, a long time. He was quite old.

Rafael Mangual: Yeah. Yeah.

Allison Schrager: But yeah, he saw that prices convey all this information, which Adam Smith was sort of dancing around. And there's no way the government or any central planner could ever know all that information because, as I said, everyone's walking around with their own values, like I said, I guess with my co-op board, or preferences. Can I tell you another anecdote?

Rafael Mangual: Please.

Allison Schrager: I'm sorry I'm all over the place with the anecdotes.

Rafael Mangual: No, no, anecdotes are great.

Allison Schrager: But speaking of, and I think it sort of sums up, I think our values at Manhattan Institute and I think the challenges we face. I went to University of Edinburgh, I'm proud alumni and I am chairman of the North American Trust, and we just did our last board meeting in Scotland and it was so kind, the university arranged for me to have a special viewing of Adam Smith's library because they have all of his books he read to really create what is economics. You see this library of everything he read. It was amazing. It was so funny because this is in the library at the university and it's under construction, so it's this really special thing. I got to see it. And we walk in and there are these couple women working on some art project. And so to be polite, we asked, we only had 20 minutes to look at this, what's this art project?

And this woman spent 30 minutes talking about the shell she's doing and how it's like a statement on North Sea oil and pollution and how we're ruining the economy and with winning the world and all this stuff. And I'm like 30 minutes of this when I'm like, I just want to see the intellectual foundations of liberalism, which is happening right here. And yet you're talking about how you're angry about North Sea Oil. And this is just what's wrong with everything right now. It's just like what happened. Eventually I felt bad. I just walked away from her talking and just started looking at the books, which were incredible. It was amazing to see what he read and that he had the history, the sociology of everything. I thought it was also really cute. He had a lot of copies of The Wealth of Nations in the different languages it was published in, which I have too of my book. So it's like my book is not The Wealth of Nations, but still it's sort of cute that he had that.

Rafael Mangual: Yeah, no, I mean, it's incredible. And when I first was introduced to that work and his other moral philosophical work, it jumped off the page to me at how spot on he was at perceiving something that I think a lot of us take for granted, which is that you don't necessarily have to know how a complex system works. The economy is just something you can trust in to sort of balance itself and reach an equilibrium on its own. And oftentimes that equilibrium is perfectly acceptable to almost everyone.

Allison Schrager: I mean, mostly, I mean, I'm a free market person, but I think also being an intellectual in this field is also talking about the limits because there are some. I mean, we're not Cato where they're just free market all the time. I think where it becomes interesting is where the limits are. And I'm generally skeptical there are, but there are some.

Rafael Mangual: Yeah, no, I think that's important and something that I want to talk about because I do think it's something that distinguishes some of the intra-right debates going on right now. But you also mentioned Friedrich von Hayek, who's someone that I wanted to ask you about. But before I even do that, I mean, is there, and maybe we've already mentioned them, but is there a favorite economist that you have or someone whose work was just more influential on your way of viewing the economy than anyone else? I mean, for me, Friedrich von Hayek, he was incredible and foundational, but also people like Thomas Sowell and Milton Friedman really helped inform how I think about the economy. But I'm curious as to what your intellectual upbringing was like.

Allison Schrager: I was really lucky. I've been really gifted with great mentors. So when I was in grad school, I worked with Glenn Hubbard, but I also got very close to Ned Phelps, who I think has this theory of dynamism and what makes an economy prosper. So that was a fantastic training. But then I'd say my number one economist who was the most influential on me and I think really did make what modern economics is, is Robert Merton, Robert C. Murton, who was my mentor for seven years and really I think created modern finance. And I think you can not call him underrated, but I still think he is, in that he really brought this new way of understanding how risk impacts markets in a way that we didn't really think very carefully about before and really sort of created this ability to put a price on risk and put a value on risk. So I said how prices clear everything. So being able to put a price on risk, you can imagine, especially when you have to move money through time and when the world is very uncertain, how transformative that is. And I think him, I mean, I've had a lot of really good mentors, so I've been just as lucky as you can be as an economist, but I really feel like Bob Merton just for me is really on par with a lot of the thinkers you just named and has been very personally influential to me too.

Rafael Mangual: Yeah. Yeah. Look, I mean, you mentioned a couple things there that I think are actually really important to focus on. So maybe we talk about it a little bit, but when I am having Thanksgiving dinners with my liberal relatives or something like that, and I'm asked about my own sort of more conservative perspective on things, when it comes to economics, I feel like the two things that really separate left from right is that people who are on the more conservative side of the spectrum are significantly more comfortable with risk.

And I think people on the left, I think if you look at some of the left right debates on economic questions, a lot of it, what it comes down to is comfort with/desire for security or insecurity, whether it's the social safety net or how to approach retirement or regulating the stock market, I think really what it comes down to is that people on the right are a lot more comfortable, not just with taking risk, but also having that risk be insulated in the sense that being willing to pay for the risk not paying off, as well as being able to enjoy the benefits associated with that risk. And then the other factor that really separates left from right is I think humility on economic questions. I think people on the right really took Friedrich von Hayek's work to heart. I think his best work was his essay on the knowledge problem, which I think is sort of foundational in the sense that what he was arguing in that essay is that it's impossible for any central authority to have all of the information that it would need to perfectly regulate a complex system. There's just too much information out there. We can't possibly have it. So the best thing that we can do is just allow people to aggregate in a market and eventually we'll arrive at an equilibrium that's going to be way better and less distorted than a sort of centrally controlled thing. Whereas people on the left, I think feel like they have enough to rely on the expertise of people who they think can adequately regulate a complex system in a way that we just don't trust them to. What do you make of those two arguments?

Allison Schrager: It pretty much encapsulates my book coming out later this year, what you just said.

Rafael Mangual: Oh, perfect. I wasn't aware you were working on another book.

Allison Schrager: Yeah, it comes out…

Rafael Mangual: Tease it.

Allison Schrager: And it is pretty much what you just said. So yeah, I'm inclined to agree. And it's not about... One thing is that I consider myself a financial economist because I initially did macro and then switched to finance, which is the study of risk. And there's this one central truth in financial economics. I think left wing people often forget, and that is there is no extra reward without bearing risk, right?

Rafael Mangual: Yeah.

Allison Schrager: It's true in financial markets. And that's sort of this sort of unifying theory of finance. And it actually undergirds all asset pricing and pretty much the entire financial theory. Granted, people forget that all the time. That's why people invest in Madoff. Any way they should know better, but people forget it more in macroeconomics. And it's the same principle, which is your economy is not going to grow as much if you shut out risk. So the bigger the welfare state is, the more regulation you have, you're just going to grow less. You have more security. And I think that's really the issue in Europe right now is that they, and some of this reflects values. So there's a trade-off between more return and more risk and where society lands should reflect their values. There's nothing wrong with that, but you need to be ... The problem is people are often unaware of these trade-offs.

And I think a lot of people are being sold a bill of goods right now that we can sort of create this huge welfare state. Someone else will pay for it and there'll be no impact on growth. And I said, it's a trade-off. We don't want no welfare state, even if that meant more growth, because you do want a land where your society is. And I think Europe is innately a lot more risk averse. And that's like when you read the Draghi report and they're like, “To grow more, you have to deregulate.” It's like, yeah, the regulation there exists for a reason. It reflects a series of preferences. The problem is with their aging population, they cannot afford this trade-off they've made quite as much as they have before, but you know what? Neither can we. And in fact, I just had a column for Bloomberg discussing how Mamdani, this has been his central sort of message that I'm going to create this very completely risk-averse or no risk economy in New York for New Yorkers, and yet we're still going to grow.

And that's just when you know ... It's true in finance too. I always tell people, you don't need to be worried about financial fraud unless someone tells you that they're going to beat the market and they're going to remove your risk. If that's true, that person either doesn't know what they're doing or they're a charlatan and you should run. And I think the same applies to policymakers who are like, “I will give you more security, but also more prosperity.” It doesn't work that way. It's like there are trade-offs. And I think that's the reason I said I love finance is I think it offers these sort of truths that can be definitely generalized to the macroeconomy too, and we often forget. And I think you're right that conservatives, maybe because they're more comfortable with risk, we definitely see red states being having more risk, but also often more growth or more comfortable if there's trade-off or accepting more risk. And as I said, some of that isn't just being realistic, it also is to some degree values. I think some liberals do understand that trade-off and just say, “I would take less growth for more security and those are my values.”

Rafael Mangual: Yeah, no, I think that's right. I do think that's right. But I also think that there is a population out there who is, to a degree, irrational about their tolerance for risk and that if we could just explain to them a bit more about the nature of risk, they might be more comfortable with it. Is that something that you think about? Is that something that we want to make people more comfortable with? And if so, what is it that you think is sort of the barrier? What do we need to do to get people to a better place and a more rational place on risk?

Allison Schrager: Yeah, again, that is my book coming out later this fall, which if you'll have me, I'll come on again in the fall and we can have…

Rafael Mangual: Absolutely. I can't wait.

Allison Schrager: So I think part of the reason is I've developed this theory on why we're becoming less comfortable with risk. And some of it is risk is largely your perception of things based on how much wealth you have in technology. When those things change, you tend to become more risk averse, but it's also comfort. I sort of reject the notion that some people are just more risk averse than others. I interview a lot of people because I like weird stories. And so for this book and the last one, I tend to find quirky people. And I said, I've met big wave surfers, or in this book I interview Nik Wallenda, who is a tightrope walker, he's walked across the Grand Canyon, he's walked across Niagara Falls. And I'm always like, these people are crazy. I won't even ski. I find skiing crazy. I find it terrifying. I would never do it. People put on slippery sticks and go down like an icy mountain. Wow.

But I'm very comfortable investing in the stock market. And I talk to him and the big wave surfers and they're like terrified of investing. Financial risk terrifies them, but I'm very comfortable with it because it is my domain. I understand it. I understand how to mitigate risk. I accept the risks I'm taking on and I know how to manage the risks I'm uncomfortable with. And that's how he sees walking across the Grand Canyon on a tightrope. So I think you need experience with risk. And it's obviously a big problem that children are being raised to take less risk with less autonomy. Because I also spoke to a neurologist who found that it really does impact brain development like those teenage years and developing the prefrontal cortex, the risk taking you take as a teenager and a way we look back on it and think it's dumb is very important to you learning how to be someone who's comfortable with risks and makes good risk choices. And so, and part of that, again, we get to this more later in the year is about how we're raising people with more wealth and more technology, which is inhibiting their ability to learn how to be good risk takers. And then they take fewer risks and then that sort of this vicious cycle of they're less comfortable with it because you need to take risks to become more comfortable taking risks. Again, I'm not a skier. If I was, I'd probably be more, if I grew up ... I actually did grow up skiing, I still hated it.

But if I was taking more, if I had parents who forced it on me, I'm taking you more comfortable with that as opposed to if Nik Wallenda spent time with me, I could probably get him more comfortable investing.

Rafael Mangual: Yeah, no, I think that's fascinating, particularly the role of upbringing in that, because I think you're right. I think in part, this is a cultural problem that we have that has informed our level of comfort with risk. And it's funny, I mean, I always tell people that I'm risk averse, and maybe that's the wrong term. People ask, “Well, why don't you go out on your own and do something more entrepreneurial?” And I like being part of an institution and sort of stability, and I'm just not wired in the same way, and I've come to accept that.

Allison Schrager: Well, it's interesting. People always tell me, and this is probably true of you too, when you say you're risk-averse, that we're brave. And I don't want to pat ourselves on the back because I feel like our way of thinking of Manhattan Institute is becoming more mainstream, but for a while it wasn't.

Rafael Mangual: Right, yeah.

Allison Schrager: I mean, again, I hate it when people say this like, “I was right, I was bold.” But in 2020, I felt like a lot of, especially you more than me, were saying a lot of things that people did not want to hear.

Rafael Mangual: Yeah. People still don't want to hear it. I was at…

Allison Schrager: That was a risk.

Rafael Mangual: Yeah. I mean, no, that's true. There is a lot of risk in that. I mean, just yesterday, actually, we're recording this on a Friday, but on Thursday, the 26th, I was speaking at an event that was hosted by the Legal Aid Society and I was the token conservative on a panel and people were groaning and hissing and very unhappy with what I had to say. But after the event, a bunch of people came up to me and they said, “Well, listen, I disagree with you, but I thought that was really brave of you to come out and say that in such a hostile environment and I could never do that. “ And it was just like, actually, I've existed in this milieu for long enough that I've just grown comfortable with it. And so I do think exposure…

Allison Schrager: Yeah, so exposure to the risk-taking. And I bet you also, I find this too, because I also think I'm also often a token conservative on panels. And, I've had audible gasps at things I've spent, but then later someone's always like, “You were right.”

Rafael Mangual: Yeah, no, I mean, I did have one person tell me that I made them think, so I'll take that as a win. But I do want to talk a little bit about then the sort of other, I think, major differentiator between left and right and economic questions, which is this sort of confidence in our ability to have a grasp of the important information that is firm enough for us to centrally regulate really complex systems. And I do think that humility is the right word to describe what separates left from right on this. Actually, I literally have my hand on my copy of A Conflict of Visions by Thomas Sowell because I think that's kind of at the core of this book, but what is it that you think is at the root of that? I mean, why is it that the sort of grow regulation crowd, particularly on the left, seems to think that they can manage an economy as complex as the U.S. economy from a central set of theories and propositions?

Allison Schrager: I think fear. I think the idea that some ... I mean, I've always been kind of anti-authoritarian, which I guess is maybe why I became an economist and not a lawyer, although you're a lawyer.

Rafael Mangual: I'm a lawyer. I feel like I'm very anti-authoritarian.

Allison Schrager: Well, I guess you want to know the rules to skirt them. I don't even want to know the rules.

Rafael Mangual: Sure.

Allison Schrager: I think feeling like someone's in charge, I think gives them a sense of peace. As I said, it's a level of risk aversion and feeling like, all right, I don't have to worry that prices are going to go up because someone's in charge of the prices and I don't have to worry that there'll ever be a financial crisis because we've regulated all risk out of markets. And so this idea that we can reduce downside, that someone's in charge. And again, a general sort of ... I guess this is a conservative thing that we share is a skepticism of authority, but although that's often, I guess seen as conservative too, but at least economic authority, it is this sort of comfort that these well-meaning bureaucrats are in charge. And also, I think they think better of bureaucrats than I do. It's like I always try to explain to young people who've gotten this narrative in their head that billionaires have too much money and we have to remove it from them. And if we do, we'll have a better outcome. And I'm always like, “Well, first of all, it’s not like their money is sitting in a mattress somewhere, they're investing it, and that creates economic growth. So what you're arguing is that their investment choices are worse than what the government would do if they allocated it instead. And what's the evidence there?” And then they tend to give in. But I think it is this sort of just general skepticism of people who make money and a belief that maybe people in government are more benevolent or maybe better at allocating that money. And I mean, maybe it's just my values or maybe it's just my read of the evidence, but I would say the opposite.

Rafael Mangual: Yeah. I mean, it is interesting to me because I do think that there is not just a deep skepticism of people who have a lot of money, but there is a sort of open hostility toward people who have a lot of money. And I'm not a psychologist, but if I were trying to assess the motivations of someone who harbored that kind of resentment, I would have to say that at some level, it's rooted in a kind of greed, even though it's not really understood that way. I think people on the left get away with criticizing the greed of others while at the same time advocating for policy programs that at their core take from others to give to a favored party. And why isn't that considered greed has been a question that I've never really gotten a good answer to.

Allison Schrager: Yeah. Actually, it's interesting, this was just kind of my Bloomberg column, which was like Mamdani says, “I'm going to give you all this stuff and rich people are going to pay for it.” And that is effectively like, “I'm going to give you access to these people's money.” And it's interesting because everyone wants to keep talking about it coming from widening inequality, but what you really see isn't like before, say, this isn't totally true, but roughly true in the 1960s and 70s, the income distribution in America looked like a bell curve where we had this nice big middle class and everyone seems to think that was a wonderful time. But what's happened since then is a hollowing out in the middle class, but not because people got poor, but because the income just sort of flattens this way and that you got some people who got crazy rich and then you had a lot of middle class people who became upper middle class. And what you find, I think with this class resentment isn't like lower or even middle class people being resentful of the super-rich, it's the upper middle class, the sort of petit bourgeoisie, the people who always cause problems if you look back on history are like resentful. They moved from here to here, across generations they have, but they're not here. They feel like they should be here, although they haven't done any of the things like take risks or start a business that would bring them there. I don't know why they thought working at an NGO would bring them here, but you know, you do you.

Rafael Mangual: But they're close enough to the people who are at the right tail that they feel like that proximity has given them the sense that they deserve what they have, I think, in a way because they're around enough people who are rich to say, “Well, they're not that impressive, so therefore something must be amiss if they have that and I don't.”

Allison Schrager: Yeah. I don't know if you've noticed in New York. I mean, I'm a financial economist, but I've only really worked in finance for a couple of years of my life and I enjoyed it. It was a great job. I found it interesting, but in the end, I couldn't handle the structure. I understand that people who chose to work into finance, even with less education than me, make a lot more money than I do, and I wish them well. But for some reason, other people talk about people working in finance with such negativity. You remember finance bros, all this. I'm just like, “Why? They're doing them. I wouldn't want to do that, but I'm glad they are and good for them for making the money they are.”

Rafael Mangual: I think part of it comes from one of the biggest fallacies that I think informs a lot of political debate about economic questions, which is the sort of fixed pie fallacy, this idea that if someone has, that definitionally means someone else has less. But the reality is that my financial position, the number of assets I have access to, my wealth can grow while someone else's wealth grows exponentially, without it being the case that I have somehow had something taken away from me. But I think a lot of people sort of view the economy that way, that if someone else gets rich, that means that a third party got poorer. Why isn't that true?

Allison Schrager: Well, first of all, the economy is not zero sum. In fact, that person in finance, I mean, not always, but often is helping allocate capital more efficiently, and that grows the economy, and that's better for you. And if you're working for an NGO, you probably have some billionaire benefactor somewhere anyway, and that's probably how they made their money.

Rafael Mangual: Right. When you say it grows the economy, I'm thinking it creates wealth. What does that mean? I mean, explain this to people who just don't know. What does it mean to create wealth, to grow the economy? Because I do think that that's sort of a big barrier for a lot of people who just see the economy as a sort of zero sum gain. Explain that process, what that looks like.

Allison Schrager: Okay. So economic growth is roughly GDP. And what goes into GDP is how much stuff we make roughly and how much stuff we consume. So there are inputs into that, which is how much we work our labor and the machines we have to help us work like a computer, a factory line or whatever.

Rafael Mangual: Or tractors.

Allison Schrager: Whatever. Yeah. Capital, labor. Now, we have finite amount of both, but when we come up with a new idea, we can get more from both of those. And that is what we call sustainable growth. That is growth over time. So when people talk about AI, it's going to make, let's get aside labor displacement issues aside, it would make you and I a lot more productive at our job. So if we write a report, we used to be able to write one a year, now we can write three. So it's more output, so that grows the economy. Now, how do you finance all of that stuff, all the data centers, all of the new machines, new computers? Well, you need money. And so what financial markets do is they put money into particularly risky ventures because you don't know what technology's going to work, you don't know what company ... I mean, maybe Open AI is going to be like the Mozilla of the tech era. We don't know who the winner's going to be. So what you have to have is all these people betting on all these different industries and all these different companies. And that's what financial markets do is they figure out where the money's supposed to go. And if they do a good job, they get paid a lot and the economy grows more because we have capital going to the right places. If we just have the government deciding what happens more often in Europe, then you tend to sort of have a lot of political favors deciding this rather than this is the best investment. So that's why this private sector doing finance is so important because they decide where the capital goes and that makes us more productive if they do a good job. Now they're not always perfect. They get things wrong and they get all the time, not all the time, but like some of the time. And then we have a financial crisis. And particularly when you have a new technology like AI where there's a lot of uncertainty just inherent in this and where it's going to go and who the winners are going to be, it's unknowable. It can be a little frothy. But in the end, this is how we grow because this is the only way you can really fund innovation and that is the only way we can get richer. Does that make sense?

Rafael Mangual: Yeah, no, I think that's probably the best I've ever heard that explained, so kudos. I want to go back to something that we talked a little bit about or at least hinted at earlier in the conversation, which is the sort of distinction between conservatives and completely laissez-faire libertarians on economic questions. It's not the case that... It's like, yes, we support free markets, but it's not the case that we support a system in which those markets are completely unfettered. So let's talk a little bit about those limits because you've already sort of hinted at mistakes being made, particularly in financial markets. I'm old enough to remember the crash in 2008 and the subsequent crises associated with that crash. And I think that has sort of formed the thinking of a lot of people, particularly on the left in America, who say, “Well, this is the prime example of why we ought not give too much freedom to the people who are operating our markets.”

Allison Schrager: Yeah, I mean, you want to strike the right balance. We have a need for financial regulation. We also have a need for a welfare state. I mean, we are a rich, moral society, so we don't want people living on the street, not only for mental health reasons, but poverty. So I think with finance, it's tricky what the purpose of regulation is because you want people to take risks, but some people want to take bigger risks than others. The problem is sometimes those risks can end up harming other people. And they said, we all have our risk tolerances and preferences. You don't want people taking these outsize risks because that's what they like to do and then have someone else bear the cost of that. So that's why you can justify some financial regulation to make sure that those risks that you're taking that might pose negative externalities to other people are internalized.

There's also other problems with information. You want to make sure that people take risks knowing the full information set or someone doesn't have an unfair amount of information or secret information that they're being used to their advantage in a way that's as sort of immoral or improper. So this is sort of where we get into a lot of financial regulation, making sure that if you're taking, especially with large companies now, we have big banks, if they take an outsized risk, it could sank the whole economy. So as taxpayers, we all have to come in and bail them out. So that's not really fair. So you put more regulations on them to make sure that they're internalizing those risks.

And also things like insider information or fraud. So you want to make sure that information is fair and transparent as much as possible. I've been thinking a lot about this because we’re in this sort of strange place. My book is all about how we don't take enough risk and everything's disaster and we need to take more risk. At the same time, we have this segment of the economy that's taking insane risks largely through more nasty drugs they're taking, more sports gambling or gambling on Kalshi on pretty much anything. We do have this segment of the economy taking risks that I would say not advise. Anyway, I'd like people to take more risks. I think part of it is what I was saying is if you don't take smart risks and you're not exposed to risks, you tend not to be that thoughtful about the risks you're taking. But it's kind of also weird to me, especially with the drugs and gambling thing, that we went from these things being so regulated to the point where they were prohibited to now a complete free for all. So I think in that way, we are also not full libertarians because I think at Manhattan Institute, we definitely are like, “Hey, maybe you should have a little regulation on the marijuana and the gambling because certainly marijuana is a different thing, but for different good reasons.” But certainly with the gambling, there is scope for negative externalities. There is scope for people not internalizing their costs. There is scope for people not having complete information or honestly, even if they have a gambling problem, not really being able to make informed choices.

Rafael Mangual: Yeah, no, I think those are really good examples of why we need to make room for exceptions to the general bent toward free markets. I want to talk a little bit about one other area of regulation that often comes up in my very rudimentary debates with people on the left about the economy and how to regulate it. One example that's always almost thrown in my face with predictable regularity is this accusation about price gouging. And it's one of the most difficult things to explain to someone on the left why raising prices in a crisis on a particularly scarce good is a good thing rather than just a terrible crime against humanity. But when there's a snowstorm or some kind of shortage, they'll see bottles of water being sold at 3X the normal price or gallons of gas being sold at 3X the normal price that critics of quote unquote “price gouging” get wrong.

Allison Schrager: Well it’s that prices clear. And without them going up when you have a shortage, you lose ... Not only do you create a shortage because you have people buying things more than ... You have too much demand. But so an example of this is there's a lovely man, an immigrant who owns a stationary store in Greenwich Village. And during the pandemic, if you recall in those early panic days when everyone is looking for hand sanitizer and masks, he managed to track them down through his contacts. I think he's Nepali or Bangladeshi, one of those. And through his contacts, he got access to these. He had to pay a premium for them and go drive all the way to New Jersey to pick them up, load them up in his own car, put them in his store. So of course he had to charge a markup. He, one, had to pay money to get them at a premium, and he had to spend a lot of his own time in labor collecting it. And then he got hit with price gouging because the prices went up more than the government thought it did. And now he had a $20,000 fine when all he was doing is providing these really valuable, necessarily ... Well, maybe it wasn't necessarily, but we thought it was at the time, goods for society in the middle of a pandemic. And so I think it's that problem. It's like one, you create a bigger shortage because you have more demand than you have supply and you won't let the prices clear, but you also reduce the incentives for suppliers to procure those goods.

Rafael Mangual: Yeah, no, I do think that's actually a really important point because I generally tend to try to explain my side of that debate by saying, well, look, if you leave the prices low, what happens is that people with more resources will just buy up that thing because it's a good deal. And then there'll be less of it to go around for the people who need it, you'll basically create more incentives for people to hoard. But I do think that that other side of the coin is really important, which you brought up, which is that actually it's important to allow people to maintain the incentive to go out and get the things that are difficult to get or to produce the things that are difficult to produce, which you're going to be less likely to do if they can't charge that premium for it. And I think that's an important question that I wish more people would ask themselves, which is like, what would it take for me to do X, Y, or Z? And to try and put a number on that in their daily life, I think that would probably make people think a little bit more clearly about economic questions. What about you?

Allison Schrager: Yeah, for sure. I said, I think people want to have that certainty. Or I think in times of stress, feeling like someone's in charge, I mean, that doesn't provide any comfort, but I think it provides other people comfort.

Rafael Mangual: Yeah. I mean, the other thing that I wanted to talk about before we run out of time about the regulation of markets is the importance of predictability, which is not something that I feel like gets a ton of attention in these debates. But we have a political system in this country, we have a representative democracy. Every four years we have federal elections, we have midterm elections in between those. Sometimes things can change pretty significantly, not just because of the elections, but also there could be a court ruling that will open the door to some massive regulation. And so things can swing back and forth with a relative regularity or irregularity depending on the outcome of some of these events. How important is it for our decisions to regulate the economy to reflect a concern about how predictable market outcomes are going to be for the players in that market?

Allison Schrager: Well, it depends on the market. I mean, as I said, some people want more predictability in their life and they choose jobs that probably have a lower pay to get that. I mean, of course there's nothing that's ever guaranteed and other people are more comfortable with risk and you do want to have that sorting. And I think people are concerned about a lot of uncertainty right now because the market's being transformed with a new technology, financial markets are a little frothy. But I think the way to think about it is that the government, it's not their job to create predictability because as I said, if you have predictability, it is no risk. And if you have no risk, we have no growth. And if we want to be a prosperous society that's growing, I put up high premium on that.

But what the government can do is give you downside protection. I think that's largely its function, is to create a solid welfare state that if the bad thing happens, you only go this low rather than this low. And I think that's better than a world where, again, this all comes back to financial markets. It's the different trade-offs of how you reduce risk. You can either reduce risk where we call hedging, which is investing more in treasury bonds versus the stock market, and that you give up upside. There's also stock options, which is effectively an insurance contract on ... So it's sort of like, I'm going to buy the S&P 500, but I know for sure if I have to sell it, I only have to sell it for this price so I can lock in my losses. And with that, you keep all the upside. And I think that's ... I like to think of good government policy as like a stock option. It's like it's an insurance contract. You know that you'll get a certain amount of money if you lose your job. You know that welfare will be there for you, but on the other hand, we still give people upside and let them thrive. And that's the world I like.

Rafael Mangual: Yeah. No, I mean, that's actually really informative. It's a bit different than what I was getting at, which I don't think I explained very well. I guess what I was trying to ask about is, when you don't constrain the government's ability to regulate markets, you maximize the possibilities for it to step in and regulate. And that can create a level of uncertainty that might disincentivize the kind of risk-taking that we know produces benefits and helps grow the economy. I guess I was asking what you make of that argument in favor of a smaller government approach to economic regulation.

Allison Schrager: Yeah, I mean, for sure, because people are less predictable than markets. So in that way, I think you're better off with less government. And as you said, more government, particularly now where we get more government from executive order. So we end up with a very significant economic policies from both parties given in by executive orders, which means they disappear as easily as they come. And it's just really hard to make economic decisions under that because it's sort of willy-nilly of whoever is in office and what the political fashion is at the time rather than markets that, as I said, sort of have all these preferences coming together and on average end up being a lot more predictable.

Rafael Mangual: Great. Great. All right. So I want to close with this question, which is maybe one that's kind of impossible to answer, but if there were one economic takeaway that you would want people who tend or are more inclined to disagree with you on economic questions to internalize and understand and operationalize, what would it be?

Allison Schrager: Incentives matter. Incentives matter and there's no growth without risk.

Rafael Mangual: Okay. Well, I love that and I loved having you on. I hope we can have you on again when your new book comes out, which I'm so excited to hear about. I didn't know that you were working on a second book, so that's fantastic news. But thank you so much for joining us, Allison, and thank you all for watching another episode of the City Journal Podcast. Again, please do not forget to like, comment, subscribe, ring the bell, leave a question, do all the things for the algorithm. We love it. We've been loving seeing your questions and comments come in over the Transom, and we look forward to bringing you more content like this. Until next time, see you soon.

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