Bottom-up

I try to avoid criticizing my commenters, but this anonymous comment so perfectly crystalizes the attitude I was criticizing in my last point that I can’t resist quoting it:

For all the gassing on conservatives do about ‘family values’ and social issues and the like, the truth is as long as the state is leaving us alone and letting us keep the fruits of our labor, so to speak, people will always have the ability to buy our way past the silly blue laws that they pass.

The thing to ask about this is what does this commenter mean by “us?”

When I got married, my wife’s home state of Ohio recognized our marriage, as does every other state in the union. Every state in the union will allow us to adopt children. If I had decided to join the military at age 18, I wouldn’t have had to worry about my superiors learning I was attracted to women.

I live in a nice enough neighborhood that I’m not likely to be the victim of a wrong-door drug raid. The police are unlikely to seize my car because a drug dog detects trace amounts of illicit drugs.

I’m not likely to be wrongly accused of a crime, and if I were, I could probably afford an experienced attorney who would focus on my case and dramatically improve my chances of exoneration. Because I’m unlikely to wind up in jail, I don’t need to worry about prison rape.

I don’t do illegal drugs or hire prostitutes, but I’m smart and wealthy enough that I could probably do so without getting caught if I wanted to. I’m never going to need an abortion, but if my wife wanted one, she’d have the resources to travel to a jurisdiction where abortions are legal. I’m unlikely to be the victim of rape or domestic violence, which means I don’t have to worry about whether the police in my jurisdiction take such charges seriously.

I’m not on a TSA watchlist. There’s no risk of another country launching a preemptive war on my country, nor are foreign governments likely to secretly plot and finance a coup against my government any time soon. Other countries don’t dump poison on crops in my country. I don’t have to worry about being shot by a predator drone. I’ll never be mistaken for an “unlawful combatant” or subjected to torture.

I’m free to travel and work almost anywhere in the world. My community isn’t being impoverished by trade restrictions. I don’t have to worry about being deported to a country I barely remember because my parents brought me here when I was 2 years old. If I happen to be traveling abroad during a natural disaster or civil unrest, the most powerful nation on Earth will move heaven and Earth to get me home safely.

So it’s absolutely true that for me personally, a tax cut will make a bigger difference to my life than most “social issues.” And if what you mean by “us” is white, straight, male, American citizens with above-average education and incomes, then yeah, for “us,” the most important “social issue” may be “silly blue laws.” But personally, I’m a libertarian because I believe in freedom for everyone. And lots of people are facing government-created “social issues” much more serious than an inability to purchase alcohol on Sundays.

Over at Reason, there’s a debate about the future of libertarianism. Brink Lindsey argues that the American right has become increasingly inhospitable to libertarian ideas, and that it’s time for the dissolution of the historic “fusionist” alliance between conservatives and libertarians. Ilya Somin offers a thoughtful rebuttal.

Somin notes that Lindsey seems to be backing away from the stance he took in 2006 suggesting that there ought to be a “liberaltarian” political alliance. Somin writes:

It would be interesting to know what led to Lindsey’s change of heart about liberaltarianism. I suspect that the vast expansion of government promoted by the Obama administration and the decline of relatively pro-market views among liberal intellectuals were both contributing factors. Lindsey’s new view of liberaltarianism is now remarkably similar to the one I expressed back when he made his original proposal: that liberals and libertarians have much in common in terms of ultimate values, but relatively little common ground in terms of practical policy agendas.

I agree with Julian’s take on this: political alliances are built by concrete actions toward shared goals, not by abstract statements of philosophical agreement. But I think his point can be made stronger with some specific examples.

In 2005, I was a founding employee of the Show-Me Institute, a “free market” think tank. What we meant by “free market” is that the organization devoted itself exclusively to those issues where conservatives and libertarians agreed. We wrote about taxes, school choice, property rights, health care policy, and so forth. We had an explicit policy that we didn’t do work on “social issues,” which in practice meant any issue where libertarians sided with liberals. So we avoided writing about immigration, gay rights, free speech, abortion, drug prohibition, prayer in schools, the death penalty, and the like.

And the Show-Me Institute is hardly unique. There’s a nationwide network of think tanks called the State Policy Network, with member organizations in almost every state, that are built on this same premise. SPN held conferences twice a year. At these conferences, everyone would spend their day listening to talks about “economic issues.” Then we’d go out for drinks and discover that there were actually lots of disagreement on the “social issues” we avoided discussing on the clock. You can see the same phenomenon inside the beltway. The Competitive Enterprise Institute is a libertarian think tank that writes almost exclusively about “economic issues.” The Institute for Justice is a libertarian law firm that focuses almost entirely on issues where libertarians and the ACLU disagree. There’s a long list of other examples.

Crucially, the basis of the alliance isn’t that libertarians and conservatives agreed on some kind of compromise position on “social issues,” we just didn’t talk about them on the job. And this works remarkably well. When you work at a “free-market think tank,” you pretty quickly get used to the fact that tax policy is on the agenda and gay rights are not. Over time, though, what started out as a marriage of convenience began to seem like a fixed part of the political landscape. “Free-market” think tanks tend to attract donors who are most interested in “economic issues,” and over time they start to cater to their own donor base. The people who work at libertarian think tanks socialize more with conservatives than liberals. (There’s an organization in DC whose entire purpose is to cultivate libertarian-conservative social ties.) And this nudges the median libertarian intellectual in a rightward direction.

After a couple of decades, you reach the point where a smart guy like Ilya Somin can claim that “liberals and libertarians have much in common in terms of ultimate values, but relatively little common ground in terms of practical policy agendas.” There are, in fact, lots of practical policy issues on which libertarians and liberals see eye to eye. The reason it doesn’t seem that way is that most libertarian organizations (with Cato an honorable exception) have made it a matter of policy to avoid writing about them.

So conceptually speaking, it wouldn’t be hard to create a liberaltarian movement. All you’d have to do is create a mirror image of the “free market” think tanks. Hire people like Radley Balko and Glenn Greenwald. Pay them to write about all the issues that “free market” think tanks don’t: foreign policy, civil liberties, gay rights, the drug war, immigration, torture, the death penalty, and so forth. Don’t hire anyone to write about taxes, school choice, guns, or other topics where libertarians and liberals have strong disagreements.

The big obstacle (other than the lack of obvious donors) to such a project is that a lot of libertarian intellectuals have so completely internalized the assumptions of the fusionist alliance that they have trouble writing about policy in a way that liberals find compelling. Many have come to regard “economic issues” as being at the core of the libertarian agenda, and their attempts at outreach to liberals too often consist of long-winded explanations of why liberals really out to support Social Security privatization, school choice, or whatever. Liberals are no more likely to be swayed by them than we are to be swayed by their arguments in the opposite direction. Making a liberaltarian alliance work would require a group of liberals and libertarians deciding that they care enough about issues of mutual concern to make those issues the focus of their work. There’s no philosophical reason this couldn’t or shouldn’t happen, it just has a half-century of institutional inertia working against it.

When I moved to the St. Louis area in 2005, I rented a townhouse in the inner-ring suburb of Richmond Heights. It was a quiet, safe, and pleasant neighborhood, but rather dull. The neighborhood was entirely residential and abutted a freeway. There was little of interest within walking distance, and as a consequence, the street was deserted the vast majority of the time

I was starting a job at a Missouri think tank, and one of my first projects was the creation of a book club for local college students. I’d been interested in Jacobs ever since I read this Reason interview of her, so I made The Death and Life of Great American Cities one of our first selections.

I enjoyed the book, and after a year in Richmond Heights, I decided I’d like to live in a neighborhood that better fit Jacobs’s theories. I chose St. Louis’s Central West End, which seems to be the closest thing St. Louis has to the high-density, mixed-use neighborhoods Jacobs championed. I lived there for two years, and I’m happy I moved. But it quickly became clear that the CWE falls far short of the urban ideal Jacobs articulated. The CWE is an island of moderately high density in a thoroughly suburban metropolitan area. I could sometimes walk to dinner or the dry-cleaners, but in practice I wound up driving almost everywhere else. There were just too many key amenities outside of a reasonable walking distance.

Last year my wife and I got an apartment the Passyunk Square neighborhood of South Philadelphia, and the difference has been dramatic. Passyunk Square is both much denser than the Central West End and embedded in a much larger cluster of high-density, mixed-use neighborhoods. As a result, there are literally dozens of shops and restaurants within 5 minutes’ walk, including two dozen restaurants, a dozen bars, a reasonably-priced supermarket, half a dozen convenience stores, a hardware store, a comic book shop, various clothing stores, etc. This is dramatically more than what was available near me in the Central West End. The CWE had a healthy assortment of bars and restaurants nearby, but it was sorely lacking in other amenities. The nearest hardware store and convenience stores were 17 and 19 minutes away, respectively, which is far enough away that I’d never actually walk to them.

Increasing urban density spurs powerful network effects. As the number of residents per square mile in an area goes up, the number of businesses that area can support goes up in proportion. A larger number of nearby businesses, in turn, makes the area more convenient and enjoyable place to live, creating still more demand for housing and (assuming legal barriers don’t prevent it) still higher density. And those additional residents, of course, are potential customers, which attracts still more businesses. The same story can be told of other types of amenities—churches, schools, community theaters, yoga studios, day care centers, pet sitters, and so forth—higher density means more people with whom you might engage in productive activities of all kinds.

And you don’t just get more businesses per square mile, you get different kinds of businesses. The larger pool of potential customers (and the stiffer competition) encourages entrepreneurs to take bigger risks and pursue more niche markets. A tasty one-woman organic grocery store recently opened up shop a few blocks from our apartment in Philadelphia. I don’t know if it will survive, but I do know that it wouldn’t have a chance in the Twin Cities suburb where I grew up.

Best of all, reducing costs can make new services economically viable that weren’t viable before. Clay Shirky has argued that the Sears Catalog, the Amazon.com of the late 19th century, was made possible by the rapidly falling costs of interstate shipping made possible by the railroads. Increasing urban density has a similar effect. For example, in the Twin Cities, where I grew up, it’s almost impossible to hail a cab from the street, because the low density means cabbies would waste too much time waiting for their next customer. In Philly and New York, you can catch a cab almost instantly from any major intersection, because the higher density makes the average wait time between customers manageable. And this sets off a virtuous circle, because once passengers know they can hail cabs from the street, they use more of them, which employs more cab drivers and makes the average wait time even shorter.

This is why it’s frustrating when local governments enact policies explicitly designed to limit urban density. Many municipalities set minimum lot sizes, regulate the height of buildings, require building setbacks, mandate free parking, and take other steps that places a ceiling on urban density. As a result, the densest places in America are almost all cities that achieved that high density before the rise of the automobile and the emergence of the modern regulatory state. Manhattan’s density peaked in 1910, for example. In Western and Southern urban areas regulations have systematically undermined the natural process of increasing density, forcing people instead to spread out horizontally. High-density living isn’t for everyone, but it should be an option in more parts of the country.

It’s not uncommon in economic policy debates to hear people rending their garments over the supposed decline of America’s “manufacturing base.” There has never been much factual basis for these concerns; our manufacturing output has been steadily rising for decades. But Ryan Avent makes the more fundamental point:

Economic activity isn’t about satisfying the demand for objects, it’s about satisfying demand, period, and people demand many things that have little to do with assembly lines and smokestacks — hair-cuts, mixed drinks, financial advice, dentistry, and so on. These activities are important. If they weren’t important, people wouldn’t be willing to pay lots of money for them. Economic growth, meanwhile, is about figuring out how to do more with less. There’s no reason why “doing more with less” ought to be associated with manufacturing rather than services. It’s true that some service sectors that are among the fastest growing in terms of employment — like education and health services — have experienced slow productivity growth. But I think people are far too quick to conclude that this has something to do with the nature of the services provided, rather than with the institutional environment of those sectors and simple cost constraints.

Goods and services are, to a large extent, interchangeable. They constantly replace each other. A whole range of household tasks — services, fundamentally — that used to fall to family or hired help was replaced by manufacturing — off laundry machines, dishwashers, and so on. An entire range of a clerking and administrative services has been replaced by manufacturing — of computers and related hardware. And then there’s the programming; is that production of a good or a service? These days, some of my work finds its way into physical form in the weekly print edition of The Economist. Am I a manufacturer? No, you’ll say, but the printer is. The internet threatens that printer’s job, but it increases the value of my writing (while also making it more difficult for a private firm to capture). In this world, the idea that “manufacturing” is something worth protecting for its own sake makes little sense.

This is exactly right. Matt Yglesias has more.

Back in March, I listed the books that influenced me and commented that Jane Jacobs was the only one to have a significant impact on my everyday life. Jacobs was a profoundly important bottom-up thinker, and so I’m going to do a few posts about the ideas in her famous book The Death and Life of Great American Cities.

Jacobs doesn’t quite put it this way, but Great American Cities is really a treatise on the importance of network effects to urban wealth creation. The reason people flock to noisy, dirty, crowded cities like New York and Chicago is because most of the things we value are provided by other human beings, and being in a large city puts us in close proximity with many more of them. Other people help us in all kinds of ways: employing us, selling us things, hanging out with us, falling in love with us, and so forth. Human beings are constantly engaging in social “experiments”: trying out new bars or restaurants, going on blind dates, throwing parties, changing jobs, starting businesses, and so forth. A high-density urban environment produces both more experiments (new restaurant openings, say) and more people around who can benefit from the successful ones (by patronizing said restaurants).

The experiments cities foster depend on serendipity, which means that they work best when organized in bottom-up fashion. Jacobs was no libertarian, but she had nothing but scorn for efforts to re-make cities from the top down. For example, she was a vocal critic of the public housing projects that were in their heyday in 1961. The key problem, she said, was that project designers thought they could predict in advance which amenities their residents would use. As a consequence their designs tended to be literal walled gardens. They were regimented and brittle, with few provisions for the projects to grow and adapt to the actual needs of their residents.

Rather than trying to predict peoples’ specific needs, Jacobs’s approach was to pay close attention to how actual city-dwellers were already living. She favored incremental reforms designed to improve urban landscapes without destroying the value that was already there.

Jacobs’s advice for urban planners was relentlessly practical. At the heart of Great American Cities were four seemingly simple prescriptions for successful urban neighborhoods: mixed uses, short blocks, aged buildings, and high density. As we’ll see, what these prescriptions have in common is that they all facilitate the bottom-up process of social experimentation that make cities engines of wealth creation.

As the 1990s began, the Internet had a few hundred thousand hosts and was used by a narrow community of academics and computer nerds. By the end of the decade, there were tens of millions of hosts, and in 2005 the Internet added its billionth user. Today, the Internet is used by almost everyone in the developed world, and is rapidly being adopted in the developing world.

This is probably the most spectacular (and literal) example of a network effect. Network effects occur any time the value of a network or system—per user—grows with the number of users. This phenomenon is easy to see in the case of the Internet. It would have been hard to build a profitable Internet startup with fewer than a million potential users. There would have been little point in starting a blog like this one in 1990 because the universe of possible readers was tiny. And, for that matter, it would have been hard to send an email to your grandmother in 1990 because she almost certainly wasn’t on it then. And this, in turn, meant that the Internet was a (relatively) uninteresting place for ordinary users. But as the number of Internet users grew by four orders of magnitude, the number of opportunities—articles to read, friends to chat with, useful services, etc.—grew accordingly.

It’s not a coincidence that the Internet has a bottom-up design. No one controls access to the Internet, and any node can (more or less) communicate with any other node. This is in contrast to competing networks of the late 1980s and early 1990s, such as AOL or France’s Minitel network, which kept a tighter leash on who could offer services on their networks. Network owners that tried to anticipate users’ needs and optimize their networks for those specific use cases were incapable of exploiting the full power of network effects, because they made assumptions that precluded uses (like the Web) that turned out to be extremely valuable in the long run.

The value of any social system flows from making the right connections between groups of people. Social systems help connect friends, co-workers, and significant others. They connect writers with readers, entrepreneurs with investors, businesses with customers, teachers with students, programmers with users, and so forth. Bottom-up systems are good at exploiting network effects because it’s hard to predict in advance which connections will create the most value. In top-down systems, decision-makers have to anticipate in advance how best to organize people. As the system gets larger, the decision-makers will do worse and worse at this, because the number of potential connections grows faster than the size of the group. In contrast, bottom-up systems scale gracefully, because each participant pursues potentially-valuable relationships independently.

Network effects are critical to the success of disruptive innovation. Disruptive technologies are cheap technologies, and cheapness accelerates innovation in two ways, illustrated by the success of the microcomputer. First, more users means more people like Dan Bricklin inventing software like the spreadsheet. Second, more users meant more potential customers for those innovations once they were invented. Hence, a virtuous circle: VisiCalc made the Apple II more valuable, which caused more people to buy it, which further increased the incentive to create innovative products like VisiCalc. Multiply that by hundreds of other examples, and you have a good explanation for why so many cheap, simple technologies so often triumph over more complex and expensive technology that, on paper, seem more sophisticated.

Serendipity is key to this process. Theoretically, DEC could have given Bricklin a PDP-11 in 1970 and paid him to write a spreadsheet for it. But DEC didn’t know Bricklin would be able to create a hit product—indeed, Bricklin himself probably couldn’t have predicted how popular his spreadsheet would be. So VisiCalc became possible only after Apple IIs became cheap enough that Bricklin (and thousands like him) could buy one for his own use.

In other words, disruptive technologies lower the costs of experimentation, which makes bottom-up organization possible where it wasn’t before. The cheaper experimentation is, the more feasible it is for small firms, or even individuals, to cover the costs out of pocket. That allows them to try experiments on their own dime that they wouldn’t be able to convince anyone else to finance. And more experimentation allows more effective exploitation of the opportunities created by network effects.

Matt Yglesias points to this excellent Dana Milbank column pointing out that Arizona governor Jan Brewer has been running around telling whoppers about immigrants in her state, including rumors that undocumented immigrants have been beheading people in Arizona’s border towns. This is, of course, complete nonsense, and Milbank points out that it’s not the only vicious rumor being spread by Arizona politicians:

Brewer’s mindlessness about headlessness is just one of the immigration falsehoods being spread by Arizona politicians. Border violence on the rise? Phoenix becoming the world’s No. 2 kidnapping capital? Illegal immigrants responsible for most police killings? The majority of those crossing the border are drug mules? All wrong.

Matt says this creates a “toxic cycle of misinformation”:

Conservative politicians and media celebrities spread these ideas. Their fans believe them. Then when Dana Milbank or I or anyone else tries to set the record straight, that just goes to show that we’re liberals. So anyone who wants to be seen as credible in conservative circles doesn’t want to take these ideas on. So people become even more entrenched in the view that illegal immigration is causing a plague of violence.

This analysis is exactly right, but it’s worth pointing out that this is not a new problem. In decades past, there were people who repeated malicious falsehoods about blacks, Jews, homosexuals, or other unpopular groups of people. And this resulted in exactly the same toxic cycle: cooler heads would debunk the rumors, but the refutations never traveled as far as the original rumors because the rumors confirmed a lot of peoples’ prejudices. So the prejudices got re-enforced, which in turn built support for discriminatory policies. Exaggerated fears of black crime built support for segregation. Unsupported rumors of gay pedophilia led to excluding them from classrooms. And so forth.

The way we collectively broke out of this “toxic cycle” is that we began talking about the process in explicit terms, and we began stigmatizing people who contributed to it. When someone repeated canards about Jewish bankers or homosexual pedophiles, we didn’t just correct the information, we called the person anti-semitic or homophobic (respectively). And those labels began to carry with them powerful stigmas. People who perpetuate malicious stereotypes about Jews or black people now face potentially career-ending backlashes. And that, in turn, causes people to think twice before repeating a negative stereotype or rumor about an unpopular minority group, which slows the spread of misinformation.

Unfortunately, there’s nothing analogous in our national conversation about immigration. There might be enough of an uproar about Gov. Brewer’s comments that she’ll be forced to admit she had her facts wrong. But she won’t face anything like the backlash Mel Gibson is facing. She’s not going to face any serious pressure to resign, or even to go hat in hand to immigrant-rights groups, as Mel Gibson will surely do to the leaders of civil rights groups. We don’t even have a specific term for the kind of bigot Gov. Brewer is, and I’m afraid the “toxic cycle of misinformation” about undocumented immigrants will continue until we have a word, and associated stigma, for people who foster prejudice against them.

One of the reasons I’ve been belaboring the limitations of top-down management is that I’ve found this is a subject on which some libertarians get confused. Because political debates often pit governments against businesses, there’s a tendency for those of us who are skeptical of government power to idealize the operation of businesses. (And conversely, of course, those who are skeptical of big business have a tendency to idealize government agencies.) Probably the most forthright and extreme example of this is free-market economist Ludwig von Mises. Here he is in Bureaucracy (page 26 of the Liberty Fund edition):

The entrepreneur is in a position to separate the calcuation of each part of his business in such a way that he can determine the role that it plays within his whole enterprise. For the public every firm or corporation is an undivided unity. But for the eye of its management it is composed of various sections, each of which is viewed as a separate entity and appreciated according to the share it contributes to the success of the whole enterprise. Within the system of business calculation each section represents an integral being, a hypothetical independent business as it were. It is assumed that this section “owns” a definite part of the whole capital employed in the enterprise, that it buys from other sections and sells to them, that is has its own expenses and its own revenues, that its dealings result either in a profit or a loss which is imputed to its own conduct of affairs as separate from the results achieved by the other sections. Thus, the general manager of the whole enterprise can assign to each section’s management a great deal of independence. There is no need for the general manager to bother about the minor details of each section’s management. The managers of the various sections can have a free hand in the administration of their sections’ “internal” affairs. The only directive that the general manager gives to the men whom he entrusts with the management of the various sections, departments, and branches is: make as much profit as possible. And an examination of the accounts shows him how successful or unsuccessful they were in executing the directive.

In a large-scale enterprise many sections produce only parts or half-finished products which are not directly sold but are used by other sections in manufacturing the final product. This fact does not alter the conditions described. The general manager compares the costs incurred by the production of such parts and half-finished products with the prices he would have to pay for them if he had to buy them from other plants. He is always confronted by the question: Does it pay to produce these things in our own workshops? Would it not be more satisfactory to buy them from other plants specializing in their production?

He goes on in this vein for several pages, fetishizing data in precisely the same way that Robert McNamara did. Mises seems to believe that senior management doesn’t have to know very much about what his subordinates are doing because the firm’s financial statements will tell him everything he needs to know. Yet a firm’s financial reports (like any leaky abstractions) can hide nasty surprises. In the case of Wall Street circa 2006, firms were taking reckless bets that offered short-term profits at the risk of long-term insolvency—examining the accounts wouldn’t have revealed this fact.

There are lots of other examples. A manager might be deferring critical maintenance or reducing research and development spending. He might be cutting corners in areas like customer service that will damage the long-term reputation of the firm. He might be hogging shared corporate resources to make his own division look good at the expense of other divisions. A competitor might be about to introduce a disruptive innovation into the market that will destroy the division’s profitability.

Financial results are also difficult to interpret because firms operate in a dynamic and unpredictable marketplace. Suppose a company’s widget division lost money last quarter. One plausible explanation is that the guy in charge of the widget division was incompetent and should be replaced. But there are other possibilities. Maybe the price of widgets collapsed, and the widget division would have lost even more money if not for the hard work of its management. Or maybe the division’s expenses are up because it’s spending money on developing an improved widget that will sell like hotcakes next quarter. There’s no way to distinguish among these cases (or many others) simply by examining the company’s books. You have to actually spend time understanding the business and its place in the larger marketplace.

This isn’t to deny that private firms (even large ones) in competitive markets will generally perform more efficiently than monopolistic government agencies. But it’s the “competitive market” part, not the “private firm” part, that’s doing most of the work here. Private firms are more efficient than public ones not because the private firms are inherently better-managed, but because private firms are more likely to face effective competition that keeps them disciplined, and because inefficient firms are allowed to fail.

This has important policy implications. Mises’s argument suggests that we should be indifferent between an industry dominated by a handful of large firms or one comprised of many smaller firms. After all, the large firms is effectively just a group of “hypothetical independent businesses” that happen to be grouped under the same corporate umbrella. But Mises is wrong about this. A single large firm is fundamentally different from a bunch of small firms. The group of small firms is likely to (collectively) be more efficient and more innovative than the single large firm would be. So policymakers should prefer policies that promote decentralization and competition, and they should be skeptical of policies that give large firms too much control over sectors of the economy.

A while back I wrote about the trouble that can occur when the managers of large organizations overestimate the utility of large data sets and sophisticated statistical tools, with Robert McNamara’s problems in Vietnam as a poster child. In 2010 that example seems remote, so let’s talk about an example that’s closer to home: the financial crisis.

We’ve seen that decision-makers are at greatest risk of being seduced by data when there are several layers of abstraction between themselves and the people on the “front lines.” Consider the case of making a loan. In a traditional small bank, you might have a president who establishes guidelines for the kinds of loans that are issued, and a handful loan officers who evaluate individual applications and make decisions based on the guidelines. There’s not much danger of the bank president getting out of touch with reality here: if a loan officer thinks the rules don’t make sense, he can probably go down the hall and talk to the president about his concerns.

Things get trickier as the bank gets bigger. There will be more applications to evaluate, and that requires branches, more loan officers and a more complex bureaucracy to manage them. This can create problems. For example, if loan officers are paid on commission, they might not have much incentive to report if the rules are too lax.

Still, things get a whole lot worse when securitization comes along. Securitization works like this: a bank approves a bunch of loans to various customers, combines those loans into a big bundle called a Collateralized Debt Obligation, slices them into “tranches” (so that each slice has a piece of each loan), and sells the slices to a bunch of third parties.

Now there are many layers of abstraction and bureaucracy between the guy evaluating an individual loan application and the guy who will ultimately lose his money if the loan goes bad. And the incentives have become extremely perverse. The bank earns fees the moment it originates a loan, but it may bear little or no long-term risk for making bad loans. Meanwhile, the assets are so fragmented that it’s not practical for buyers to do due diligence. In hindsight, this seems like an obviously terrible idea. Yet lots of otherwise smart people endorsed the concept. What happened, in a nutshell, is that the financial industry fell prey to the same intellectual error that befell Robert McNamara: confusing large amounts of data for knowledge.

In the last decades of the 20th Century, Wall Street developed what they thought were sophisticated statistical tools that allowed them to accurately estimate the riskiness of complex portfolios without firsthand knowledge of the underlying assets. For example, as banks got larger, they increasingly relied on numerical standards like income and credit scores, rather than more subjective personal factors, to decide which loans to approve. This made a certain amount of sense because as banks got larger, it became more important to have consistent standards across the organization.

Second, investors increasingly relied on a handful of large credit ratings agencies who evaluated CDOs for riskiness. The firms creating the CDOs carefully packaged these bundles of securities so that as many slices as possible would get an “investment grade” rating. This was important not only because it gave buyers confidence, but also because government regulations mandated that financial institutions hold a certain fraction of their balance sheets in investment grade assets.

Finally, the buyers themselves developed (ostensibly) sophisticated statistical techniques like value at risk that purported to give the institution a high-confidence estimate of the maximum amount the institution could lose on a given portfolio. Wall Street had armies of well-paid “quants” whose job it was to compute these figures.

As the system became more complex and centralized in Wall Street, it became increasingly difficult for the people creating the securities to do a “reality check.” The Wall Street quant who never looked at individual mortgage applications is in precisely the same situation as a general who’s never been to the front lines in Vietnam. In both cases, the people who are on the front lines had a strong incentive to skew the data to make themselves look good. And they began doing just that. Loan officers began encouraging their customers to fudge the information on their loan application to ensure they’d be approved. Companies came up with ever more elaborate CDO structures designed to convince ratings agencies to give a large fraction of their securities investment-grade ratings. So for Wall Street executives, the numbers looked great right up until the moment his balance sheet imploded.

The fundamental problem, I think, was the size of the firms and the complexity of the financial instruments. No statistic can perfectly summarize a messy, real-world asset. There’s no substitute for understanding the (literal) “facts on the ground”: for knowing something about the individual properties and property owners who are the ultimate anchor for any loan. And the more complex and fragmented an asset is, the harder it is to perform due diligence. Yet as firms grow larger, senior management is forced to rely on increasingly abstract statistical measures. Ken Lewis couldn’t possibly have developed an in-depth understanding of all the CDOs (and other exotic financial instruments) Bank of America was buying in the years before the financial crisis, both because they were extremely complex and because there were just too many of them.

There’s been a lot of talk about the need for a systematic risk regulator to monitor the entire financial sector and raise the alarm if major financial institutions are making loans that are too risky. But if the financial system continues to be structured the way it was in 2007, then it’s not clear how much good such a regulator can do because he’ll be fundamentally in the same boat as the CEO. The balance sheets of the largest banks were so complex that regulators had no real alternative than to rely on statistics supplied by the bank itself. And that means that the regulator is going to have the same blind spots as the bank’s management.

So the most important part of any reform package has to be limiting the size of financial firms. A financial institution with $2 trillion of assets under management is a recipe for disaster. Smaller firms not only reduce the risk of too big to fail problems, which is important in its own right, but it also makes it easier for everyone—bank executives, regulators, and members of the general public—to understand what these institutions are doing. No executive can possibly manage it responsibly, and no regulator can possibly understand it well enough to conduct meaningful oversight.

Unfortunately, the Brown-Kaufman amendment to the financial reform bill, which would have limited the growth of large financial firms, failed in May. All signs point to continued consolidation on Wall Street. Which seems like a recipe for another crisis and more bailouts in the coming years.

Will Wilkinson has had a big influence on my thinking about migration, nationalism, and related subjects, so I read his pro-immigrant case for ending birthright citizenship with interest. At the heart of his argument is a kind of “grand bargain”: more people would be allowed to live and work in the United States, but they’d be excluded from the benefits of America’s generous welfare state. Will argues that this bargain can only be struck if we end birthright citizenship, because otherwise the children of immigrants will automatically be eligible for the same government benefits as other citizens.

Will is in good company. Milton Friedman, for example, was for open borders in principle but believed that it was incompatible with the welfare state, and Will’s proposal can be seen in the same vein. Still, I found his argument completely unpersuasive. Ending birthright citizenship is a terrible idea, both as a matter of policy and as a matter of pro-immigrant political strategy.

To start with, Will doesn’t really acknowledge how important birthright citizenship is in its own right. I’ve written before about the DREAM Act, which is designed to help thousands of non-citizen kids whose parents brought them to the United States when they were young. These kids are the clearest-cut victims of our immigration system. Through no fault of their own, they live in a kind of legal limbo; they’re not allowed to live or work in the country they’ve called home for as long as they can remember. Ending birthright citizenship would dramatically expand the number of kids who wind up in this predicament and risk creating a permanent, multi-generational underclass.

We also shouldn’t forget that the most important constituency for immigration reform is the immigrant community itself. In the long run, the good guys are likely to win the immigration debate because today’s anchor baby is tomorrow’s pro-immigrant voter. Ending birthright citizenship would permanently reduce the political clout of the immigrant community and harming the long-term prospects for immigration reform.

Will counters that ending birthright citizenship would make it politically feasible to enact other reforms that would help immigrants more. But I’m not so sure. For starters, there’s no reason to think birthright citizenship is the key obstacle to decoupling migration from government benefits. Legal immigrants and their children are already eligible for many government benefits. Green card holders are generally eligible to send their children to public schools. They have restricted access to Medicaid and S-CHIP, but they generally get full eligibility after 5 years, and hospitals will generally treat immigrants (legal or otherwise) that show up in their emergency rooms. Similarly, adult immigrants’ access to food stamp is limited for the first five years, but legal immigrant children are eligible for food stamps immediately. So if you think the problem is that immigrants impose too large a burden on taxpayers (which, to be clear, I don’t), there’s plenty of room to restrict immigrants’ access to benefits without amending the Constitution.

More importantly, I don’t think concerns about immigrants receiving government benefits are the major political obstacle to immigration reform. Generally speaking, ordinary voters who are afraid immigrants will go on welfare are also afraid they’ll steal our jobs, sell drugs to our children, refuse to learn English, and vote for Democrats. Ending birthright citizenship will make those people happy, but it won’t make them more likely to support immigration reform. I think Yglesias is right that opponents of birthright citizenship are generally opponents of migration in general. There’s a rarified class of libertarian intellectuals who follow Milton Friedman in being strongly pro-immigrant conditional on limiting their access to government benefits, but this cohort is too small to be electorally significant, and most of them are on board with reasonable immigration reforms anyway.