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How Risk Fuels a Healthy Economy

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How Risk Fuels a Healthy Economy

10 Blocks podcast January 22, 2020
Economy, finance, and budgets

Allison Schrager joins Brian Anderson to discuss how risk propels economic growth and why government efforts that go too far to mitigate risk undermine America’s economic vitality.

“Risk, for better and worse,” writes Schrager for City Journal, “is at the heart of economic growth, and successfully apportioning it—not avoiding it—is the key to prosperity.” While government has a role to play in managing risk, the U.S. economy has thrived by trusting markets to allocate it efficiently. Overly intrusive efforts to reduce risk in the economy—such as California’s new law regulating freelance or “gig” work—may prove counterproductive to workers of all incomes.

Audio Transcript

Brian Anderson: Welcome back to the 10 Blocks podcast. This is Brian Anderson, the editor of City Journal. Coming up on today's show, I talk with economist and writer, Allison Schrager. Allison recently joined the Manhattan Institute as a senior fellow, and we're happy to have her back for a second appearance on the 10 Blocks podcast. She's written a piece for City Journal that we posted online over the weekend. It's called Propeller of Growth. You can find it on our website and we'll link to it in the description. That's it for the introduction. After the music, we'll be joined by Allison Schrager.

Hello again everyone. This is Brian Anderson. Joining me in the studio is economist, Allison Schrager. Allison is the newest senior fellow at the Manhattan Institute. Her new book, which we talked about last time she was on the podcast is called An Economist Walks into a Brothel: And Other Unexpected Places to Understand Risk. You can follow her on Twitter @AllisonSchrager.

Allison, thanks for joining us and welcome to the Manhattan Institute.

Allison Schrager: Well, thank you. Thanks for having me.

Brian Anderson: I want to focus on this piece you've just written for City Journal, which really gets to the heart of a big ongoing interest of yours. The article is called Propeller of Growth, and in it you write, "Risk for better or worse is the heart of economic growth, and successfully apportioning it, not avoiding it is the key to prosperity."

Brian Anderson: Can you explain your reasoning for why risk is so important to a flourishing economy?

Allison Schrager: Well, I think when we think about risk, we always think of something to avoid or to eliminate. But risk is both good and bad. Risk is the upside. It's the returns from investment if it goes well. It is the benefit of being an entrepreneur, which is a very risky endeavor.

And you can see all the sort of top Fortune 400 winners, almost all the top 10 were people who made their own money as an entrepreneur, they took a big risk. Innovation as I said, is the lifeblood of the economy. It propels economic growth. And innovation is inherently a very risky endeavor. It's what entrepreneurship is about is innovation. But when you innovate the odds are it's not going to work out. It's not going to be a good innovation. It's not going to be innovation that has a market for it. So, that's why risk is really what moves economies forward.

Brian Anderson: As you note in this piece, there are two significant ways that the federal government provides some protection against economic risk. You have unemployment insurance and then Social Security. Unemployment pools risks for workers, Social Security diversifies risk across generations. Leaving aside the unemployment insurance question, which is very fraught. There's been a lot of talk recently about expanding Social Security.

So, the Elizabeth Warren campaign for instance proposes we raise benefits by I think $200 per month, and to pay for it by raising taxes on the wealthy. What do you think about her proposal? Do we really need to do that for Social Security?

Allison Schrager: Well, no. Because I think this is what's missing from policy discussions is an appreciation for risk. Because really the purpose of policy is to do some risk reduction. I don't think anyone, even the most diehard free marketers want to live in a society where just one stroke of bad luck leaves you on the street and destitute. It is the role of government to provide sort of that basic safety net. And often what we say in economics is diversification is more efficient. If you diversify across outcomes, you get more efficient outcomes, which means just you can get... Sort of taking risk is sort of the cost of going for more. But when we say something's efficient, it means that you don't take any more risk than necessary. And this is done through diversifying.

But sometimes you just can't diversify. Suppose again you know you want to diversify the experience that you have with your 401k. Maybe you retire when the market's down, someone else retires when the market's up. You'd want to pool your risk across you and that person, but there might not be a market for that. It might just not be cost-effective, or there might be regulations that prevent it from doing it in the private sector.

So, this is where you have some scope for government is to pool risk across say generations. But the problem is, is there's only a limit of diversification. Diversification can only do so much for you. And I think the problem with Social Security is, while there is some benefit for diversification, there's also a huge systematic risk, which is the aging population. So, when you have a population that's getting progressively younger, you have this... It's not even a risk. It's almost like a certainty that this is becoming less and less viable.

I think there's a role for government in retirement, but it's not them taking on all the risk. That would actually be inefficient. There's a lot of risk around moving money into the future. The government has a role to take some of it, but individuals also have to take some of that. That's just more efficient and fair to generations, future generations.

So, expanding the program, what already requires... It takes up a significant amount of people's retirement income, and also faces an aging population problem, would just be taking it too far. It's getting to the point of inefficiency where the government taking is taking on all the risk. And the benefits of diversification there just sort of start to peter out. Does that make sense?

Brian Anderson: Yes, it does. You note in your piece as well some recent other examples of government trying to reduce risk for workers. One of these is in California, which has recently enacted a law that has turned out to be very controversial, regulating gig work or freelance work.

If our listeners, which may be the case, aren't aware of the situation in California, maybe you could talk a little bit about that new law, what it's trying to do, and why there has been a pushback against it already?

Allison Schrager: Well, I think a lot of people look at gig work and assume that it's not as good as regular work. Like having a job where you have full employment protections, you get unemployment insurance, you get benefits, it's a little harder to fire people. You have that security.

So, they look at gig work and they figure well you don't have all those things. You're effectively on demand. You don't have regular hours. You're not guaranteed a certain amount of pay and this just must be bad. But really a lot of people like the flexibility. And in fact the data shows any way we think gig work is overtaking the economy, it's actually not. The number of people in involved in contract workers, their primary job, has actually been declining over time.

What is increasing is you see increasing numbers of households who have a primary job and do gig work as like a side hustle.

Brian Anderson: So, there they are just adding to their income?

Allison Schrager: They're adding and also smoothing income shocks. So, this actually provides a good hedge against income shocks. Maybe even you lose your job, maybe you have unstable income. Or there's also evidence people were working fewer hours, so they have more time. So, boost their income and reduce income risk by having multiple sources of income.

But the key is, is that gig work has to be flexible for this to work because you have another job. So, you need something you can do on the side when you feel like or when you're able to. So AB5 is actually real... Which is this law California, which is making it very difficult to hire a contract worker. You have to go through a fairly rigorous test in court to prove that this person is indeed not critical to the mission of the firm. That they have adequate market power. It's just very hard.

Brian Anderson: Well, that costs money right in and of itself for a company that's operating that way, right?

Allison Schrager: Yeah. So the incentive is just to hire fewer people and make them employees. Which takes away this very valuable... I don't know if you've noticed, but whenever I've taken a Lyft or an Uber in California, people are lot chattier I guess than they are... Than the drivers here, where there's, I guess still that veneer of professionalism if you have more of a cab culture. And every Uber or Lyft driver I've ever had has told me about their primary job and how this is what they do on the side.

Brian Anderson: Yeah, that's been my experience as well. And in Austin and in California for sure.

Allison Schrager: Yeah. It's almost like they want you to know, hey this isn't my regular job, I'm like you. And it's almost like taking a ride from a friend.

Brian Anderson: Well, a lot of them are actors in my experience in L.A. anyway.

Allison Schrager: Well and it is very valuable for that.

Brian Anderson:  Right.

Allison Schrager: Because that way they can go to auditions. Like the flexibility is what makes it valuable. But if you make someone an employee, you necessarily take away the flexibility. And certainly if you're an actor and have very variable income, that sort of basic income floor.

So, I think it's sort of a misunderstanding of risk. People look at gig work and say, "Oh that looks risky," because I'm used to employment looking like this. But now we're in a new world where you can have very different employment and relationships and they in fact might look risky to outsiders, but if you really look a lot closer, actually are reducing risk for people. And so, by taking away the flexibility, you're in fact making people's income more variable.

Brian Anderson: Well, you're certainly seeing this with writers who are situated in California. A lot of them are suddenly discovering that they can't freelance anymore. And that's very worrisome.

Allison Schrager: It is. Especially as I said, as journalists now, it's a very precarious job. You want to get as many bylines out there as possible. So, not having access to be doing freelance is really difficult. As it for a lot of industries, not just journalists, but I think we hear about journalists a lot because they have a platform.

Brian Anderson: One of the biggest issues that has cropped up in the Democratic presidential primary so far is student debt. Both Bernie Sanders and Warren have said that they would make college basically free, and they'd take steps to cancel existing student debt, in addition to other proposals they're making. In your CJ piece, you described this as eliminating the risks associated with middle-class wealth.

What did you mean by that? Could you elaborate a little bit?

Allison Schrager: All right, so like a lot of lifecycle economists, I look at income as an asset, the way I'd look at an asset in your portfolio, right? Like a financial asset. And so, there's just overwhelming evidence that having a college degree not only means... It doesn't mean you're going to earn more than everyone else right out of college, but what it does mean is two things. Both your income grows faster than if you didn't have a college degree and that it's less variable. You have lower spells of unemployment, you're less likely to lose your job during a recession. If you do lose your job, you're going to have a shorter spell of unemployment.

So, a lot of ways it's not... You don't just go to college to earn more. It's a great risk reduction strategy. So, the idea that we're going to make... We have limited resources to reduce sort of... I mean, it is an investment. It's an investment that probably pays off more than any other investment I can think of. But to effectively make that a free investment, when we have people... Certainly other people in this country who don't have that sort of insurance, who definitely are more needy or worthy of resources, or face a lot more income risks than they do, it just doesn't really make a lot of sense.

Brian Anderson: What might be some alternative policies that would in your view make a difference with regards to risk reduction? Are there any areas where we're not doing a good job of that and we could find intelligent ways to support them?

Allison Schrager: Well, I think certainly... I mean one big thing that jumps out at me is the market for longterm care. This is a huge burden on a lot of families that often involve people having to be caregivers and give up their income. And there's really no functioning insurance market for longterm care because it's just not cost effective for insurance companies. They've tried to offer these policies, they tend to lose money on them, so they keep jacking up their premiums, still losing money despite very expensive premiums.

So, it's effectively a non-functioning market and it's not covered. A lot of people don't realize it till too late. It's not covered by Medicare. It's only covered by Medicaid. So, I mean I think there's a lot of different things we could do, but I think government intervention in the longterm care market probably... Definitely makes a lot more sense than expanding Social Security.

Brian Anderson: Thanks, Allison. Don't forget to check out Allison Schrager's piece for City Journal. It's on our website, it's called Propeller of Growth. You should also check out her terrific book, An Economist Walks into a Brothel, which we discussed in a previous podcast, and is filled with real world concrete stories illustrating different ways of assessing and managing risk. You can find it on Amazon and we'll link to it in the description.

You can follow Allison on Twitter @AllisonSchrager, and you can also of course find City Journal on Twitter @CityJournal, and on Instagram @CityJournal_MI. And always, if you've liked what you've heard on the podcast, give us a rating on iTunes.

Brian Anderson: Thanks for listening and thanks very much, Allison, for joining us.

Allison Schrager: Thanks for having me.

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