Modern nations have two economies, which exist side by side. Economy I is the tradable sector. This includes companies that make goods like planes, steel and pharmaceuticals. These companies face intense global competition and are compelled to constantly innovate and streamline. They’ve spent the last few decades figuring out ways to make more products with fewer workers.

Economy II is made up of organizations that do not face such intense global competition. They often fall into government-dominated sectors like health care, education, prisons and homeland security. People in this economy believe in innovation, but they don’t have the sword of Damocles hanging over them so they don’t pursue unpleasant streamlining as rigorously. As a result, Economy II institutions tend to get bloated and inefficient as time goes by.

For example, between 1960 and 2006, health care spending increased twice as fast as G.D.P., but there were no comparable gains in health outcomes. A study by the Institute of Medicine estimates that 30 cents of every $1 spent on health care is wasted — about $750 billion a year.

Over the past 50 years, spending on K-12 education has also skyrocketed. In 1960, Americans spent roughly $2,800 per student, in today’s dollars. Now we spend roughly $11,000 per student. This spending binge has not produced comparable gains in student outcomes. Education productivity is down, too.

If Economy I is great at generating output without generating employment, Economy II is great at generating employment without generating output.

The problem is that the bloated Economy II is becoming a burden that Economy I can no longer carry. Unless we reform Economy II and control its spending, the bloat will crush us. National productivity will slide. The economy will stagnate.

Republicans have a direct answer for this problem. Reform Economy II so it looks more like Economy I. Introduce vouchers and other consumer driven market mechanisms to health care and education.

Democrats reject that approach. Their counterargument is that Economy II can control costs using its own internal means. Strong mayors, governors and presidents can make these systems work.
The Democratic argument is nice in theory, but can it work in practice? Can Democrats confront their own special interests and deliver results?

The Chicago teachers’ strike is a test of this proposition. The Chicago school system is a classic case of a bloated, inefficient Economy II organization. The average Chicago teacher makes $76,000 a year in a city where the average worker makes $47,000 a year. Rising school costs have helped push the system deep into the red. Meanwhile, the outcomes are not good. Forty percent of students drop out and 8 percent of 11th graders meet college readiness standards.

Mayor Rahm Emanuel campaigned on real education reform, and, in office, he’s tried to push it through. The response? A strike.

By Thursday night, this strike seemed to be heading toward a resolution. Both sides are giving ground, but, as best as I can tell, Emanuel has successfully preserved the core of his reform agenda. There will be longer school days and a longer school year. A child who begins in the Chicago school system in kindergarten and goes all the way through high school will have an extra two-and-a-half years of learning time. That’s huge. There will also be no caps on parental choice. As more charters and different types of public schools are created, parents will have an array of options for their children.

Though the final details are still uncertain, there will also be a serious teacher evaluation process. The various elements of those evaluations will change for each teacher year by year, but, as teachers progress in their careers, student performance will become more and more important. That’s vital because various studies have shown that evaluations that rely in part on test scores really do identify the best teachers. Teachers who score well on these evaluations really do produce measurable improvements in their students’ performance for years to come. Rigorous teacher evaluations will give reformers a profound measuring tool.

Finally, principals will apparently be given discretion to hire who they want, and they will be held accountable for the performance of their schools. This, too, is a big win for Chicago’s children.

Emanuel’s willingness to hang tough and accept a strike was itself a hopeful sign that some Democrats are hardy enough to take on interests aligned with their own party. Emanuel certainly didn’t get everything he wanted. The unions won concessions, too. But if the final results resemble what I’ve been hearing in any way, then Chicago will move toward the forefront of the reform movement. That result would also be a national credibility booster for Emanuel’s party. It would be a sign that Democrats may be able to successfully reform ailing public institutions, so that the nation as a whole can prosper.