Greg Mankiw and Lou Dobbs

The economists have looked out upon the world and pronounced it good. Just last week, Gregory Mankiw, chair of the Council of Economics Advisors, told us that outsourcing and displacement are just another installment of the historical process of economics growth and betterment and we should stay our fears about them. Somehow, the American public failed to be assuaged.

In one way, Mankiw is absolutely right, and in another, he needs to get a clue. Sure, change and displacement have always been a part of growth—ask the farmers who became industrial workers a century ago. But if change is the price of growth, what is our obligation to those displaced in the process?

One answer, particularly within the business community, is to emphasize growth, as if there were people somewhere who were against it. This school emphasizes the need for a well educated population, a culture of entrepreneurship and innovation, and a commitment to research and development and technological progress. If we have those, they argue, our economy and our people will be so deft, so agile that they will readily keep their feet amid the economy’s tremors.

This answer, like Chairman Mankiw’s, is both absolutely right and completely misses the boat. The vague promise of school later does little to alleviate fear now. And it risks being perceived as part of a political con game, in which business groups champion good schools and helpful technology, leaving the Administration to announce that there’s no money to fund them, because all the money went to the smash-and-grab tax cuts the same business groups supported.

For all of Lou Dobbs’ nightly ridicule of corporate traitors on CNN, outsourcing to India and China aren’t the driving forces behind job loss. Productivity, structural change and bad economic policy are. But ultimately, it doesn’t matter. A current of fear and protectionism is gripping the economy. It is so strong that economic progress itself has become suspect. And it leads to the inescapable conclusion that if we want to have trade, innovation, and growth, we need to have an adjustment policy.

What does adjustment policy mean? It means allowing workers to insure themselves against wage loss when they lose jobs. It means allowing them to take their health care with them as well. It means changing the tax system to expand support for the incomes and retirement of the working poor, and to treat an investment in education the same way it treats an investment in a machine. It means finding the resources to pay for national K-12 education, even if it means raising taxes and limiting Social Security and healthcare for the long term. And it means a higher minimum wage, to keep the bottom of the labor force attached to the rest of us.

I believe wholeheartedly in free trade, but the trade debate misses the point. Look at the steel industry. When they were unprotected, steel workers lost their jobs. They were protected, and the companies consolidated and workers lost their jobs anyway. Counterproductive restrictions on trade and investment won’t help working people. Nor will sermons from economists or businesspeople. A conscious adjustment policy that serves workers’ interests will.

At Home With the Ehrlichs

The debate over who will pay for social security reminds commentator Ev Ehrlich of an old-time radio drama. Listen as he and his son fight about selling off social security on "At Home With The Ehrlichs."

A Political Party on a Laptop

Back in 1937, an economist named Ronald Coase realized something that helped explain the rise of modern corporations -- and which just might explain the coming decline of the American two-party political system.

Coase's insight was this: The cost of gathering information determines the size of organizations.

It sounds abstract, but in the past it meant that complex tasks undertaken on vast scales required organizational behemoths. This was as true for the Democratic and Republican parties as it was for General Motors. Choosing and marketing candidates isn't so different from designing, manufacturing and selling automobiles.

But the Internet has changed all that in one crucial respect that wouldn't surprise Coase one bit. To an economist, the "trick" of the Internet is that it drives the cost of information down to virtually zero. So according to Coase's theory, smaller information-gathering costs mean smaller organizations. And that's why the Internet has made it easier for small folks, whether small firms or dark-horse candidates such as Howard Dean, to take on the big ones.

For all Dean's talk about wanting to represent the truly "Democratic wing of the Democratic Party," the paradox is that he is essentially a third-party candidate using modern technology to achieve a takeover of the Democratic Party. Other candidates -- John Kerry, John Edwards, Wesley Clark -- are competing to take control of the party's fundraising, organizational and media operations. But Dean is not interested in taking control of those depreciating assets. He is creating his own party, his own lists, his own money, his own organization. What he wants are the Democratic brand name and legacy, the party's last remaining assets of value, as part of his marketing strategy. Perhaps that's why former vice president Al Gore's endorsement of Dean last week felt so strange -- less like the traditional benediction of a fellow member of the party "club" than a senior executive welcoming the successful leveraged buyout specialist. And if Dean can do it this time around, so can others in future campaigns.

To understand it all better, let's go back to Coase and the world of business. Say you want to buy an appliance, or a vacation. You know there are bargains out there, but it takes time and energy to find them. That's what economists call the "transaction cost" of a purchase. This cost of acquiring information is everywhere: the time it takes to call a friend or to learn something in a newspaper. Or the time and resources it takes a company to find out where to find parts and to make sure they show up at an assembly line on time.

Back when it cost a great deal to learn and know things -- when transaction costs were very high -- big corporations had to solve the problem of coordinating information, such as what customers wanted to buy, what parts were being produced and shipped, how to make sure prices covered costs, and so on. The advent of mass production and similar "process" technologies let firms produce and sell things -- cars, steel, oil, chemicals, food -- on a much larger scale, so there was suddenly much more information to coordinate.

Companies solved this problem by creating massive bureaucratic pyramids; Alfred Sloane, chairman of General Motors, was famous for creating the multi-divisional firm. The job of these internal hierarchies is to gather, validate and store the information the company needed to coordinate all its activities. That's what "middle managers" in marketing, accounting and so on manage -- information.

Now, however, with internal communications networks and the speed of the Internet, you don't need a horde of people in a big pyramid to handle all that information. Firms have become "flatter" and "faster," and the "networked" or "virtual" company has come into being -- groups of firms that use shared networks to behave as if they were part of the same company. A generation ago, GM made all its own parts and IBM all its own chips. Not today. Now, specialized companies use networks to coordinate their activities with GM and IBM, and supply the needed components.

So the end result of the Internet revolution on companies has been exactly what Coase's theory predicted: Cheap information has allowed firms to shrink. Size is now less of an advantage in organizations, and that means more competition in the global marketplace. For companies, it's either reorganize or die. That's what Coase, who won the 1991 Nobel Prize in economics, was talking about.

Coase's ideas are no less true for political organizations, as Dean's success shows. He is the first candidate to use the Internet effectively as a political organizing device.

To put it in perspective, think about how political parties started. They began as a way of bringing like-minded people together to wield political influence, in the best and worst senses of the term. And they were a reflection of transaction costs, because that kind of large-scale, social organization was the most effective way to process political information.

Consider, for example, the first "modern" political campaign -- the Whig campaign for William Henry Harrison in 1840. Apart from some success as an Indian killer, Harrison had minimal credentials, but the Whigs figured out how to use the tremendous organizational apparatus of their party to promote him. They fabricated the image of Harrison as the "log cabin and hard cider" candidate, despite his more patrician roots, and used the party organization to enforce discipline around the fabrication -- to get everyone to say the same thing at the same time. In America's first political mass media stunt, they constructed a 10-foot-high ball of twine, wood and tin, covered it with Whig political slogans, and rolled it first from Cleveland to Columbus and then from town to town across the country (hence the expression "Keep the ball rolling").

It seems quaint now, but then it was an act of genius, because it capitalized on the Whigs' brilliant use of their party's primary asset -- the ability to coordinate information on a national scale. They got the entire party on message and then managed the activities of community supporters around the country to pull off the ball stunt. It was, a kind of primitive, analog blog. But in 1840, only a well-organized political organization could have done it.

No longer. Now anyone with a Web site and a server, a satellite transponder and about $100 million can have -- in a matter of months -- much of what the political parties have taken generations to build. Technology, of course, has changed politics before. Television changed the two parties, for example, but it didn't make the parties obsolete. In fact, in the day of Richard M. Nixon and John F. Kennedy, television strengthened the two-party duopoly (the economist's term for a shared monopoly), as only those two parties had the resources to use it competitively.

But the Internet doesn't reinforce the parties -- instead, it questions their very rationale. You don't need a political party to keep the ball rolling -- you can have a virtual party do it just as easily.

And that's what Howard Dean has done. Nor is Dean alone. The same forces make the evangelical right a powerful force in the Republican Party. With its TV stations, membership lists and money, it is a party waiting to happen. When Republicans of more moderate stripes express concerns about the evangelicals "taking a walk" on the party, they are recognizing that underlying reality.

The ability to have "virtual political parties" is the greatest challenge the two parties have ever faced. There are strategies available to them, of course -- deft positioning allows them to preempt competitors, as it does in every industry, and they can use the same technology, although Internet culture doesn't seem readily amenable to either Democrat.com or Republican.com. Being a Democrat or a Republican isn't enough of an advantage anymore -- there are simply too many other places where people can get political information and find political bedfellows in an age of low information costs.

The real question is whether -- really, how -- the two parties, like any other waning duopoly, will use non-market means to preserve their fading power -- by, for example, keeping third-party candidates out of televised debates, making it harder for other parties to get public funding or closing off "open" primaries that invite marauding forms of political organization.

But the challenge is unavoidable, and the future is coming on fast. Here are some predictions. First, if Dean loses the nomination, he will preserve his organizational advantage and reemerge as a third-party force four years from now. He has done with technology what Ross Perot could not do with money alone. Second, the evangelical right will become a separate political party in the near future, and will hold its own conventions and primaries. Like the Conservative Party in New York state, it will usually endorse Republican candidates. But evangelicals will use their inherent party-ness to make the Republican candidate stand in front of them and give a separate acceptance speech. And finally, in the next six or eight presidential elections, a third-party candidate will win the presidency. Issues -- most likely the coming fiscal debacle and the inescapable abrogation of promises made on Social Security and Medicare -- will give the third-party candidate an opening. But technology will give him, or her, the means.

Sooner or later, it's going to happen. And all because of what an economist named Ronald Coase understood 70 years ago.