I always enjoy reading Daniel Gross’s contrarian essays. In Pop!, he made a strong case that bubbles can be a good thing, particularly when they leave behind a legacy of valuable assets. Now Gross is arguing that the United States is poised for a robust economic revival, and naturally this argument has attracted considerable attention.

But I wonder if the story he’s telling adds up. I’ve added emphasis below.

Housing and large deficits remain serious problems. But most experts are overlooking America’s true competitive advantages. The tale of the economy’s remarkable turnaround is largely the story of swift reaction, a willingness to write off bad debts and restructure, and an embrace of efficiency—disciplines largely invented in the United States and at which it still excels. America still leads the world at processing failure, at latching on to new innovations and building them to scale quickly and profitably.

Gross goes on to offer an attractive vision, or rather a vision I certainly find attractive.

So what will our new economy look like once the smoke finally clears? There will likely be fewer McMansions with four-car garages and more well-insulated homes, fewer Hummers and more Chevy Volts, less proprietary trading and more productivity-enhancing software, less debt and more capital, more exported goods and less imported energy. Most significantly, there will be new commercial infrastructures and industrial ecosystems that incubate and propel growth—much as the Internet did in the 1990s.

But does he gives us any reason to believe that this will happen? Have we curbed subsidies for homeownership? Have we curbed subsidies for the purchase of new automobiles? Will we see actually see legislation that bans or limits proprietary trading, would it be desirable, and would such legislation prove workable? My sense is that Neil Barofsky, quoted by Hart and Zingales in their National Affairs essay on curbing systemic risk, was right:

These banks that were too big to fail are now bigger. Government has sponsored and supported several mergers that made them larger. And that guarantee — that implicit guarantee of moral hazard, the idea that the government is not going to let these banks fail — which was implicit a year ago, it’s now explicit.

As for the more productivity-enhancing software piece, have we seen a sweeping effort from the White House to scrap software patents or to limit copyright terms, or have we seen an Administration that, like its predecessor, is eager to protect the interests of entrenched incumbents in this space?

Again, I like the Gross vision. But does he give us any reason to believe that it is coming to pass?

Gross writes:

In the 1990s, Japanese policymakers deliberated and delayed before embarking on a program that included interest-rate cuts, a huge stimulus program, expanded bank insurance, and the nationalization of failed institutions. In 2008 and 2009 it took the United States just 18 months to conduct the aggressive fiscal and monetary actions that Japan waited for 12 years to carry out. And the patient responded to the shock therapy, as the credit markets and financial sector bounced back. Since the announcements of the Treasury-imposed stress tests in May 2009, banks have raised more than $140 billion in new equity capital. In August 2009, not even the most cockeyed optimists could have projected that within four months, Bank of America, Citi, and Wells Fargo would return $100 billion in borrowed funds to the taxpayers. But they did.

Is he arguing that the financial system is basically sound? And is it really safe to say that the enormous monetary and fiscal expansion we’ve seen over this period hasn’t actually exacerbated the downside risks of another sudden downturn? Jeffrey Sachs would disagree.

Gross’s essay does include one specific bit of information that I find very encouraging.

In the short term, the ruthless pursuit of efficiency translates into the uncomfortable—and unsustainable—dichotomy of rising profits and falling employment. But the focus on efficiency is creating new business opportunities for smart companies. At BigBelly Solar, a Needham, Mass.-based firm whose solar-powered trash compactors reduce the need for both labor and energy, sales doubled in both 2008 and 2009. “Cities and institutions like universities and park systems are eager to do more with less,” says CEO Jim Poss. Leasing 500 compacting units has allowed Philadelphia to cut weekly pickups from 17 to five and will save it $13 million over 10 years. BigBelly employs fewer than 50 people, but like many businesses in fast-growing markets it indirectly supports a much larger number of jobs.

This is the power of capitalism, I tell you! But is BigBelly Solar more representative of the economy that is emerging or the massive transfers to declining industries, the pressure on GSEs to originate mortgages of dubious value, modification efforts that amount to huge subsidies for the financial sector, and much else besides?

I also agree with Daniel Gross that the “where will the new jobs come from?” question puts the cart before the horse. We will create new business ecosystems that will prove jobs-generating. Yet one wonders what kind of burdens the entrepreneurs building these new ecosystems will face.

Now consider two interrelated systems: energy and auto manufacturing. In the past two years, the old policy of subsidizing housing and Wall Street has been replaced by a new one that seeks to boost national operating income through efficiency. Skepticism about the potential for millions of “green jobs” to materialize overnight is warranted. But in some areas, a process similar to the iTunes experience is developing.

This is an extraordinary statement. Has the United States abandoned its policy of subsidizing housing and Wall Street, or has it radically increased the extent to which future taxpayers subsidize housing and Wall Street? If the latter is true, we are propping up the most rotten sectors of the economy and diverting talent that would otherwise shift into the new interrelated systems that are slowly emerging — and this emergence will prove very slow indeed once the inevitable tax burden required to prop up aging yet politically powerful sectors hits.

Gross sees subsidies for Detroit’s legacy firms and for start-ups like Fisker Automotive to be part of a shrewd efficiency-enhancing industrial policy — being very shrewd, he avoids that polarizing term.

Fisker raised $250 million in venture capital, snapped up engineering talent on the cheap, and has tapped into the automotive supply chain, which is eager for new business. Last October the company agreed to acquire a recently shuttered General Motors plant in Wilmington, Del., for the knockdown price of $18 million. Armed with a $528.7 million federal loan guarantee, Fisker plans to spend more than $150 million retooling the plant. It’s preparing to ship the first Karma (retail price: $87,000) to dealers by the end of this year. But the rollout of electric and plug-in hybrids also has the potential to create its own ecosystem—dealers, charging stations, accessories, software applications. Henrik Fisker says: “The development of this industry will influence how we make electricity in this country.”

Perhaps Fisker will save the American economy with his new ecosystem. But that $528.7 million loan guarantee represents a diversion of resources from other entrepreneurs. Doesn’t it? That includes other entrepreneurs who don’t have the enthusiastic backing of former Vice President Al Gore and current Vice President Joe Biden, as the WSJ reported last fall.

A tiny car company backed by former Vice President Al Gore has just gotten a $529 million U.S. government loan to help build a hybrid sports car in Finland that will sell for about $89,000.
The award this week to California startup Fisker Automotive Inc. follows a $465 million government loan to Tesla Motors Inc., purveyors of a $109,000 British-built electric Roadster. Tesla is a California startup focusing on all-electric vehicles, with a number of celebrity endorsements that is backed by investors that have contributed to Democratic campaigns.

Now, it could be that this has nothing to do with politics. I’m pretty sure it doesn’t. But is this entirely encouraging? And as Neil King Jr. of the WSJ noted in another report on Fisker, venture capital firms are now shying away from start-ups that don’t receive DOE backing.

Some young companies are tailoring their business plans to win DOE cash. Private investors, meanwhile, are often pulling back, waiting to see which projects the government blesses. Success in winning federal funds can attract a flood of private capital, companies say, while conversely, bad luck in Washington can sour their chances with private investors. The result is an intertwining of public and private-sector interests in an arena where politics is never far from the surface.

I really hope that Daniel Gross is right. But when he writes the following:

In the past two years, the old policy of subsidizing housing and Wall Street has been replaced by a new one that seeks to boost national operating income through efficiency.

I’m not sure I can take his conclusion seriously. I want to emphasize, however, that I think Gross’s implicit prescription is right: we shouldn’t try to preserve a broken economy. Instead, we should allow the BigBelly Solars of the world to do their work, without burdening them with the costs of keeping GM and the big banks and the housing sector afloat.

That’s the case I made in this column, which would have been much better if I had used Daniel Gross’s evidence to paint a very different picture!