‘Top-Down’ vs. ‘Bottom-Up’

by alexvanbuskirk

‘Top-Down’ vs. ‘Bottom-Up’

By Steve Conover @ AEI (September 2, 2012)

“We can’t afford more top-down economics. What we need are policies that will grow and strengthen the middle class.” — Barack Obama

“Top-down economics” is a hijacked phrase. Objectively, it should be the label assigned to rule-of-czar capitalism steered by government officials. Instead, campaign rhetoric has been assigning it to rule-of-law capitalism driven by consumers and entrepreneurs—supposedly a system steered by the already-rich, in which money gradually trickles down to the middle class.

As vivid as that image may be, it is a false depiction of what really happens in a properly functioning private sector. But once the false image captures the attention of enough voters, it’s a simpler step for political entrepreneurs to sell themselves as the better alternative—simpler, that is, than having to compete against the way a vibrant private sector actually works.

Entrepreneurs cause money to gush outward, not to ‘trickle down’

There is little disagreement that today’s economy needs more private-sector jobs, and there should be little disagreement that private-sector entrepreneurs are more effective creators of new jobs than politicians are. But entrepreneurial success requires three ingredients: New ideas, sufficient drive, and adequate funding. With all three, entrepreneurs can develop new products and bring them to market, creating lasting new jobs when that process succeeds.

Unfortunately, it’s the rule rather than the exception that the typical entrepreneur lacks the third necessary ingredient: Adequate funding. He or she may possess the idea and the initiative, but the necessary funding must come from an outside source.

At the macro level, solving the problem of creating millions of new private-sector jobs requires matching thousands of potentially successful entrepreneurs with the funding they need. When this match is made, the typical entrepreneur—far from starting out rich and then deciding to let money “trickle down”— starts by deciding to take on a big risk, then obtains the funding, and then dishes out a gusher of other people’s money to new suppliers and new employees. If unsuccessful, the entrepreneur is the first one to go broke; if successful, he or she is the last one to benefit. In short, the money gushes outward long before success or failure for the risk-taker becomes evident, and therefore long before the entrepreneur can be judged “rich” or “poor.”

Two ways to source seed money for entrepreneurs

The primary sources of entrepreneurs’ startup funds are—unsurprisingly—family, friends, and the already-prosperous. If family and friends are not an option, a matchmaker is needed to connect the entrepreneur with someone else’s accumulated capital. So the key question is: Who should fill the role of matchmaker?

We have two choices: Either the government assumes the role of matchmaker, or the private sector does.

More specifically: Should the government use higher taxation to forcibly extract additional money from the already-prosperous, then somehow allocate it back into the private sector as the bureaus and agencies see fit? Or would it be more effective to trust private-sector intermediaries—such as private equity firms—to select which specific entrepreneurs should be matched up with capital that the already-prosperous voluntarily make available through those intermediaries? Those who prefer government-allocated funding (“stimulus”) for job creation prefer top-down economics. Conversely, those who prefer privately allocated funding prefer bottom-up economics.

Different visions

Real top-down economics is the political equivalent of “intelligent design”: Trusting the superior abilities of government experts to ensure that the right things happen and the wrong things don’t. It requires faith that a president-appointed car czar can produce better results for auto-company bankruptcies than can a century of bankruptcy case law evolved from the bottom up. It requires faith that today’s government regulators can predict—accurately and without bias—which energy technologies and corporations deserve taxpayer subsidies and which competing technologies and corporations government should therefore discourage or demonize. It requires faith that macro decisions by a few thousand government appointees can allocate healthcare better than micro decisions by millions of sufficiently insured healthcare consumers. Top-down economics is government-knows-best economics.

Real bottom-up economics is a system that emphasizes trust in the private sector to evolve organically, independently, and in desirable directions, within a tested and evolving legal framework. Bottom-up economics—a.k.a. “emergence” or “complexity economics”—cannot and does not dictate which technologies and firms will (or should) be the winners and losers; instead, it places heavy emphasis on trusting consumers and rule of law to sort them out—in the auto industry, for example. It trusts the private sector to evolve in the favorable direction of a higher aggregate standard of living, to allocate capital from those who have it to those who need it, to add new jobs that require new, higher-level skills, and to jettison or outsource obsolete jobs that require only yesterday’s lower-level skills. It trusts adequately funded entrepreneurs to continue surprising the world with innovations rivaling those of the past and present—such as the Internet search algorithms of Google, the horizontal drilling technologies of Big Oil, the instant-communication platform of Twitter, the slicker-than-cash payment system of Square, and the low-cost mega supply chain of Wal-Mart. It trusts consumers to sort out winners from losers in a trial-and-error process. Bottom-up economics is consumer-knows-best economics.

Which path to job creation and prosperity do we prefer: A continued emphasis on trusting government with top-down economics, or greater emphasis on trusting consumers and entrepreneurs with trial-and-error bottom-up economics?