When I was growing up in the 1960s, I recall people saying that global trends began in America, and American trends began in California. Sixty years later, that still seems to be largely true. The newest global trend is AI, which began here in America, and is dominated by firms located in California.
I thought about this recently as I read a number of articles about “American exceptionalism.” Our economy is currently booming, and the news media is full of articles about how places like Europe and China are lagging behind. In this post, I’ll argue that the exceptional economies of California and the US are better understood if considered together, not as independent entities. I’ll also argue that to some extent the US is resting on its laurels, and that’s even more true of California.
First a few data points:
1. US per capita GDP is unusually high, well above most other developed countries.
2. Most of the companies that are driving the global tech revolution are American, including Apple, Microsoft, Google, Amazon, Facebook, Tesla and Nvidia.
3. California per capita GDP is unusually high, well above most other US states.
4. Most of the companies that are driving the global tech revolution are headquartered in California, including Apple, Google, Facebook, and Nvidia. (Tesla recently moved its headquarters to Austin, while Microsoft and Amazon are up in Seattle. And even Tesla discovered that it had to keep its cutting edge research department in Silicon Valley)
In the past, I’ve argued that the success of the US is largely due to supply side policies. For instance, the level of government spending is lower than in most other developed countries. I still believe that to be true, but no longer believe that it fully explains American exceptionalism. Our GDP isn’t just slightly above other developed countries, it’s substantially above most of them. And we are even richer that countries like Australia, which has a similar size government sector.
Today, both the US and California are benefiting from the advantages of agglomeration. To a much greater extent than in the past, highly successful people and companies like to be close to each other. That was less true in the mid-20th century, when America’s industrial success was widely spread among cities like Chicago, Detroit, Cleveland, Pittsburgh, Milwaukee, Buffalo and numerous other places. Soon after, similar industrial success was achieved in places like Germany and Japan. There may be mild advantages to agglomeration in certain industrial sectors, but nothing like the advantages observed in 21st century tech.
When Elon Musk left South Africa, he could have chosen to move to Belgium, or New Zealand, or Canada. Instead he chose the US, presumably because he felt it offered the greatest opportunity for entrepreneurial success.
I find the politics of “exceptionalism” to be quite interesting. People on the right often claim that America is more successful than Europe or East Asia because we are more capitalist. Leftist grumble that we are just lucky, or deny that we are unusually successful. In the case of California, the politics flips. Leftists tout the progressive model of governance in California, while conservatives grumble that California is just lucky. Both groups are partly correct, and partly wrong.
California had a great economic model in the mid-20th century (plus good weather.). For decades, it was the number one boom state. But California’s governance has been deteriorating for decades, as the business climate has turned increasing hostile and opposition to home building has made the region unaffordable for many average people.
The quality of US governance peaked a bit later, during the Carter-Reagan-Clinton neoliberalism era, and has been deteriorating during the 21st century, with an increasing tendency toward protectionism, highly distorting subsidies, and regulation.
Fortunately, there is a “great deal of ruin in a nation”. While we’ve deteriorated in some respects, Europe has been even more hostile to industries such as fracking and GMO foods. China has recently adopted some capricious anti-business policies, which have slowed its economy. Japan seems to have difficulty breaking out of traditional ways of doing things.
In a sense, the success of both California and the US was earned through sensible economic policies (including high levels of immigration, especially the immigration of highly talented people like Elon Musk.) But now we are resting on our laurels. The advantages of agglomeration make the US the true “lucky country”, and California the lucky state (even more so than Australia.). We will be able to rest on on laurels for an extended period of time. But countries such as Canada now have substantially better trade and immigration policies than the US, and a few decades out they may begin eating into our tech dominance.
PS. The WSJ has a good article on European stagnation.
READER COMMENTS
Dylan
Feb 4 2024 at 12:40pm
They may even get better weather than us by then.
Thomas L Hutcheson
Feb 4 2024 at 2:36pm
Well put but there are other areas of “resting on laurels” beyond immigration and business regulation that Sumner could have mentioned.
Formerly less restriction on building housing in urban areas
Fewer policies that make building infrastructure more expensive than in Europe
Formerly smaller federal deficits.
Danny
Feb 4 2024 at 4:26pm
Technically Elon Musk did move to Canada for college before moving to the US to finish college.
Bobster
Feb 4 2024 at 4:32pm
The collapse of governance in California, New York and Illinois is alarming.
Let’s hope the South and interior West can take up the mantle.
Scott Sumner
Feb 5 2024 at 1:28am
Florida and Texas are going downhill under their current governors, so I’m short term pessimistic.
Andre
Feb 5 2024 at 9:13am
“Florida and Texas are going downhill under their current governors, so I’m short term pessimistic.”
This is a strange claim, given your argument about people flocking to CA (& the US).
After all, people and even businesses have been flocking from CA to TX and FL for several years now.
If FL and TX are going downhill, then why are people leaving CA to go there by the hundreds of thousands?
Scott Sumner
Feb 5 2024 at 10:21am
“If FL and TX are going downhill, then why are people leaving CA to go there by the hundreds of thousands?”
Because California’s business climate is much worse. Don’t confuse levels with rates of change.
TGGP
Feb 5 2024 at 12:30pm
I think Texas & Florida have positive net migration rates from more states than just California.
Andre
Feb 5 2024 at 12:36pm
“Don’t confuse levels with rates of change.”
Not sure what you mean in this context. Both the rates of change and absolute numbers are substantial, for CA (-) and TX and FL (+). CA has lost more than half a million in the past three years, while TX and FL have added a million each (not just from CA). These changes aren’t rounding errors – have had a large, palpable impact on all three states.
Scott Sumner
Feb 5 2024 at 2:13pm
You challenged my claim that governance in Texas and Florida is getting worse, citing migration data. But that data has no bearing on anything I said. If a state falls from 95 to 90, it can still attract migrants from states that rate at 70.
TGGP
Feb 6 2024 at 10:55am
My challenge was about states other than California. So if Texas/Florida are going from 95 to 90, it’s not just California but lots of other states that are below 90.
TMC
Feb 6 2024 at 10:27am
We should all be as lucky to go ‘downhill’ as Florida and Texas.
Robert EV
Feb 4 2024 at 6:13pm
I had read the California’s particular opposition to things such as non-competes was especially helpful in keeping the invention wheel churning.
Dale Doback
Feb 4 2024 at 6:42pm
I’ve heard similar about bankruptcy where tech entrepreneurs proudly boast about starting failed companies, vs Europe and Asia where bankruptcy is legally and socially taboo.
BC
Feb 4 2024 at 10:52pm
Does Canada have the tax and labor policies for economic dominance? How flexible is their labor market?
“Leftists tout the progressive model of governance in California”
They do? I thought leftists view Elon Musk, Facebook, Google, Amazon, etc. as policy failures. Too much income inequality, too market dominant, spreading too much misinformation, and generally too much power not controlled by government. I believe leftists primarily tout California’s climate policies, lax crime enforcement, abortion access, generous welfare, tolerance towards the unhoused, etc. Hard to take credit for the tech revolution when one is primarily concerned with apportioning blame for it.
Lizard Man
Feb 5 2024 at 7:20am
What states in the US are well governed? I cannot think of any obvious examples. Maybe Washington, with no income tax and increasingly YIMBY? It is hard to thing of a state that is both business friendly and truly YIMBY.
Lizard Man
Feb 5 2024 at 7:31am
I would define a well governed state as one that is business friendly insofar there are few legal and regulatory barriers to start and grow business, is YIMBY, has well performing schools, has good public infrastructure and does a good job maintaining its infrastructure, and is good at providing public safety. Anyone know of a state like that?
Scott Sumner
Feb 5 2024 at 10:24am
All states have many serious problems. To some extent it depends on what issues you care about: Taxes, regulations, drug laws, abortion laws, public safety, education, etc.
TGGP
Feb 5 2024 at 12:31pm
I say look at how people “vote with their feet”. But by that measure, Texas & Florida are some of the best governed in the country.
Robert EV
Feb 5 2024 at 6:07pm
You also want to look at which demographics are voting with their feet. A universally better governed state would equally attract all demographics (proportionate to their ability and willingness to move).
TGGP
Feb 6 2024 at 10:56am
“All demographics” would require an enumeration of all the demographics there are, and there’s no end to the ways in which populations can be divided.
Todd Ramsey
Feb 5 2024 at 1:10pm
Lizard, just FYI: Washington State now has income taxes, implemented in the last five years: 0.58% on all wages (WA Cares Fund, employers can apply for exemptions); 0.6% on wages up to the Social Security Maximum (Paid Family & Medical Leave); and 7% tax on Capital Gains, with a $250,000 annual exemption.
Strange coincidence: Jeff Bezos recently bought a mansion in Florida. Not a coincidence: Ken Fisher moved Fisher Investments headquarters to Texas from Washington (and posted an angry open letter to the Washington State Legislature).
Washington was one of the slowest-growing states in 2023 (<0.5% growth) , after decades of being among the fastest growing states.
Scott Sumner
Feb 5 2024 at 2:10pm
I wrote something on that about a month ago, but forgot to post it. I’ll put it up soon.
Monte
Feb 5 2024 at 6:52pm
According to U.S. News & World Report, the best-managed state in America is Utah.
Lizard Man
Feb 5 2024 at 9:28pm
Thanks, that makes a whole lot of sense. It is both one of the most Yankee and religious states in the nation, so it makes sense that it would be a place with high social trust, good governance, and public spirited citizens. It does make me pessimistic that the rest of the US will improve much in the future, as I think Utah’s success is downstream of its culture, and I don’t think there is anyplace in the US where the people would even entertain the idea of simultaneously become more culturally Yankee and more religious. Probably the only place in the US that could even hope to “get to Denmark”, so to speak.
Monte
Feb 5 2024 at 10:40pm
Lizard Man,
Hope springs eternal. It’s a bit dichotomous, but, as a nation striving to “get to Denmark”, as you say, we’d have to regress (like Utah) to progress. Most of America, today, is unwilling to rely on faith instead of reason.
Trina Halppe
Feb 5 2024 at 7:59am
IMHO, American Exceptionalism in connection to per capita GDP is mostly the size effect.
Look at how important software is to the members of the “magnificent seven” that aren’t software companies: Tesla, and Nvidia. That is to say, quite important, albeit in the case of Tesla it’s by choice not an inherent requirement. Needless to say software is a huge part of how the other 5 companies create value. The size effect is really important in software. To elaborate I will just paste my whole comment of a few days ago from MR blog…
—start of pasted comment—
I’m an old programmer. If you investigate more I think you’ll find the U.S. “advantage” in software has little to do with what programmers do at their desks, so how AI can improve programmer productivity is of lesser importance when it comes to affecting where the advantage resides. I think the advantage is partly historical and largely a size effect and there is a language effect (English). If you look at programming languages, note that Java came from a Canadian. CSharp from a Dane. Python from a Dutch. Programmers are to a significant extent foreign-born in the U.S. with a lot today from India, China, Canada, Europe, and Russia. The skilled people are in many places and they could stay in those places, with or without AI augmentation, if there isn’t a size effect making them move to where business is better.
Specialist economic clusters, market size advantage, and first/early mover advantage, are all partly attributable to population size. The sheer size of the U.S. government created early demand (bureaucracy, defense, aerospace, research). A large population size in earlier days affords more demand in a business market (IBM, MSFT, ORCL) and consumer market (AAPL, META, GOOGL, AMZN). When it comes to the early demand created by the U.S. government, the relevant population is simply the population of Americans. When it comes to supplying programmers the relevant population is the Anglosphere plus the millions (or billions) of people who choose English as a second language. That the U.S. has the best universities has much to do with population size and language. Using the most advantageous language augments the population advantage. You could say there is a population size effect boosting early demand and you could say there is a language size effect boosting supply.
The biggest economy means more efficient production which means a higher standard of living which means the U.S. can attract more programmers which means the selected ones were chosen from the biggest pool. An economist could say the U.S. industrial advantage is due to superior economic policy (on immigration, more so in the past than now) but — come on — France, Germany, U.K., Canada, and Australia can attract a lot of immigrants relative to the size of their existing populations. Yet, a huge fraction of Canadian grads move to the U.S.. Lower tax matters and other policies matter but do people really think this matters more than size and historical size?
In reality a software project is a big capex project even if the accounting rules allow it to be an expense. That kind of investment is more likely to be undertaken in a bigger addressable market.
—end of pasted comment—
In the past I said the U.S. high GDP per capita phenomenon is mostly the size effect but I got a little push-back from you. Maybe you’re coming around to my view when you say it’s agglomeration. If you accept that the place for the most successful agglomeration is likely to be the biggest economy, then historical size explains much. Apart from software, the size effect makes every industry more economical as just about everybody knows.
A person might think tax policy and regulation are more important than the size effect but if you look at the founding stories of companies it’s usually not lower tax and lighter regulation that motivated their creation and explains their success. There are plenty of places are only a little more regulated than the U.S and several places that rank better than the U.S. on one of the economic freedom indices. The U.S. is number 25.
Scott Sumner
Feb 5 2024 at 10:28am
There’s basically no correlation between a country’s size and its per capita GDP. So size doesn’t seem to matter in most cases. Tech may be special, due to the powerful advantage of agglomeration. Market size is not a big issue, as these firms serve a global market
Trina Halppe
Feb 5 2024 at 9:52pm
They serve a global market eventually. In the early days, they serve similar cultures, probably with the same language. Leaving India out of it because of low incomes, the U.S. wins because of population times average income. Early moving matters — a lot.
Anyway creating the best agglomeration in the smallest economy is less likely. (It can happen though.) What I called the size effect is not easy to disentangle from agglomeration. To me they’re almost the same thing. The wikipedia article on agglomeration puts cost savings up front in the definition and says it’s similar to economies of scale so I’d say that is very entangled with having a big market size. Weirdly they put the word “urban” in the definition but Silicon Valley was well on it’s way and did not look anything urban in 1990. Also cost is probably over emphasized and just finding like minded people is under-emphasized. You find more like minded people in the biggest “labour mobility area”. I don’t know if size effect is not the best word for that. Definitions matter, I know.
Scott Sumner
Feb 6 2024 at 12:15am
“What I called the size effect is not easy to disentangle from agglomeration. To me they’re almost the same thing.”
No they are not. Again, bigger countries are not richer than smaller countries, on average.
Trina Halppe
Feb 6 2024 at 7:28am
The way I see it, the economy of the U.S. is one of the highly productive economic agglomerations because it’s big (and other reasons like freedom) but I’m not allowed to say that since “urban economists” have already planted their flag on the word agglomeration.
As for the data that don’t support my claim that size effects explain much, I would speculate that the wrong institutions, climate, disease, language, and historical bad and good luck, and all of human history, obscure what is a fundamental driver of per capita income.
Scott H
Feb 8 2024 at 11:25am
Why is the US economy so big? Because the US economy is so big!
Trina Halppe
Feb 9 2024 at 11:49pm
Wrong. The question is why is per capita GDP higher than most other places with similar cultures and histories.
Andrew_FL
Feb 5 2024 at 11:31am
You missed a bigger one, IMO-the EU has been extremely hostile to “Big Tech”.
Scott H
Feb 8 2024 at 11:27am
Isn’t that probably more anti-americanism at this point than real domestic belligerence to tech?
Todd Ramsey
Feb 5 2024 at 1:18pm
The US has low capital gains tax rates compared to most developed countries. That’s plausibly a factor explaining why high-growth companies are founded here.
California doesn’t fit that narrative. But it plausibly explains why Microsoft and Amazon are headquartered in Washington, which historically had neither income nor capital gains taxes.
Rajat
Feb 5 2024 at 2:54pm
I think much of the complacency outlined in this post also applies to Australia. As far as ‘luckyness’ is concerned, the US as you say has the huge advantage of agglomeration economies, which Australia lacks. The biggest ‘free kick’ Australia has given up compared to the US is restrictions on fracking and unconventional gas exploration. Australia has huge prospective reserves of unconventional (particularly shale) gas but landowner and climate-related opposition has limited development. Instead, we now restrain LNG exports to keep domestic prices below international prices. When one sees how much gas and oil the US now produces, it appears likely that Australia has given up several percentage points of GDP over the last decade alone.
Scott Sumner
Feb 6 2024 at 12:18am
I’m amazed at how few countries have adopted fracking–Europe is like Australia in that regard. The US dominates not because we have lots of oil (our reserves are low), it’s because we have decided to use the technology.
Rajat
Feb 6 2024 at 3:32am
I would be curious to learn how the US (or the relevant US states) got around landowner objections to fracking. While environmentalists’ objections can often be overridden in ‘Red’-type states, in Australia, farmers have had a lot of influence. The concern seems to be that fracking will ruin high-quality farmland and stop us from producing clean local food. In the US, have farmers just been paid off? If so, perhaps it reflects America’s biggest advantage – the willingness to pursue valuable exchanges over ideological attachments. I believe one of your past presidents even wrote a book about it, called something like “The Art of the Deal” 🙂
Robert EV
Feb 6 2024 at 8:51pm
Sometimes money, otherwise eminent domain, or threats thereof (which does result in money, but under force or duress, so not at the price that the landowners value the rights). In other cases I am guessing that the landowners find out that the mineral rights had been sold off long before. I don’t know if the US is unique in these severable property rights, but we do have them.
Most fracking does indeed occur in “red states”. And the red states it does happen in aren’t necessarily the farming breadbasket states.
Rajat
Feb 7 2024 at 4:31am
Thanks Robert, very interesting.
steve
Feb 5 2024 at 3:17pm
Meh. People are leaving CA and 0ther states and moving to states with lower housing costs. That is the primary driver. As to Europe there are a number of issues but I think we should remember that growth is not as strong a motivator. I think history is more of a motivator for them and I think they remember WW2 much better than we do. I think they have been more focused on developing Europe into an entity in which they would not go to war with themselves. We have never faced that kind of devastation.
Steve
Robert EV
Feb 6 2024 at 8:55pm
I certainly agree with these points, Steve! I’d add the particular kinds of natural disasters California has.
Simon
Feb 6 2024 at 12:25pm
I think going all the way back to the original 13 colonies, the US has had higher wages than Europe. The US does have some huge natural advantages over other developed economies, but I think Americans’ ability to co-operate among various ethnic, religious, socioeconomic groups is under-rated-in economic terms. There’s still huge class divides within European countries-some still have royals lol!-and then there are also some very homogeneous countries religiously and ethnically as well. I’d chalk the difference up to diversity.
Robert EV
Feb 7 2024 at 4:31pm
I think the lack of class divides is an oversold idea in the US.
Mark Brophy
Feb 8 2024 at 1:22pm
AI doesn’t benefit from agglomeration in California. It’s separated between the San Francisco Bay and the Los Angeles areas with almost none in Sacramento. If agglomeration were beneficial, the AI industry in Sacramento would be larger than the AI industry in Los Angeles. There are also similar tech industries in Seattle, Austin, Dallas, Houston, Boston, New York, and Washington, DC.
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