Portfolio Theory and the Laboratories of Democracy

The common thinking is that the USA benefits by having many states because they will have different policies and we can thereby learn which policies are most effective.1 This idea is intuitive but actually I think the opposite is the case: as government gets larger it becomes more (theoretically) capable of doing the kind of experimentation that leads to better policy.

Think of a government as holding a portfolio of policies. Each one has an expected return and a variance.2 Some policies are less likely to succeed than others, but they make up for it by having higher potential upside or being cheaper up front. However you wouldn’t want to construct a portfolio out of only risky policies because you don’t want your whole government program to fail.

So it’s elementary that one governing body making 50 policies will have more experimentation–and learn more, and have better policy next year–than 50 governing bodies each making 1 policy. In fact in the latter case they would probably all take the safest possible policy.

To be sure, states may may differ on what they think is the safest possible policy (or what a good outcome looks like). For example, several states are moving toward legalizing marijuana and the federal government has not done so. But state “experimentation” likely crowds out federal experimentation. If we had more real, by-design experiments on the federal level, that would be the weak point that advocacy groups3 would attack. State level policy is a hole in the dike; the pressure would come through somewhere else if this channel were blocked off.

Moreover, even though states differ, they are still all doing what they think best–they are not, by and large, consciously experimenting. And experimentation has to be conscious because experiments can be designed to maximize what you learn from them.

Think for a minute about classroom size. States (or districts) have different maximum classroom size rules, so we can use differences in outcome to see the effects of classroom size on learning. But then we learn only about how classroom size matters between 20 and 30 students in a class under standard teaching methods.  On the other hand, a conscious experiment would introduce much more variation and we might find something new entirely. This is another way of saying that state “experimentation” can only tell us where the local maximum is, but we might be stuck on a very short hill next to a high mountain.

One other concern is that some policies (for example, voting rules) are harder to experiment with on a centralized level because the unit of analysis is the government. That’s a fair point–but most policy is not like this.

For most policies, looking at portfolio management theory suggests that a centralized government is likely to take more risks, do more experimentation and learn more than decentralized states.

  1. This idea is known as “laboratories of democracy” and was brought to my attention by the Charles Pierce series of the same name. []
  2. Whether you think about this on the level of “the government wanting to be effective” or “politicians wanting to seem effective to get re-elected” the analysis is the same though some of the results may be different. []
  3. Or lobbies, or special interests. []