The United States

The United States

Dani RodrikSW31/PED-233/Law School 2390

Spring 2013

The Great Recession: progress and prognosis Mistakes of 1930s avoided (thanks in part to economic ideas)

Monetary policy: interest rates to zero + QE Fiscal policy: stimulus did help Bank recapitalization No protectionist slide in trade (role of welfare state – another

innovation?) These efforts helped stabilize the economy and prevent a

deeper collapse But growth prospects are undermined by:

high debt overhang (both private and public) weak competitive position in global economy large increase in income and wealth inequality long-term implications of deficient aggregate demand and excess

capacity ideological polarization and political paralysis

Growing inequality…

Source: http://topincomes.parisschoolofeconomics.eu/#Home

Stagnating median real incomes

Source: Economic Policy Institute, via http://krugman.blogs.nytimes.com/2013/02/18/the-myth-of-reagans-miracle/

Private-public sector saving behavior have been reversed, with a vengeance

Source: http://research.stlouisfed.org/fred2/

… with serious implications for public debt levels

Source: http://research.stlouisfed.org/fred2/

… which, if history is a guide, will depress growth for years to come

There is a large negative effect of public debt on economic growth beyond a threshold of 85-90%, with every 10 percentage points reducing annual growth by 0.1-0.2 points or more.

Reinhart and Rogoff , 2010; Kumar and Woo, 2010; Cecchetti et al. 2011.Source: Kumar and Woo (2010)

Paradox: fiscal austerity makes things even worse!

The debt/GDP ratio depends not just on changes in debt, but also changes in GDP.

The push for fiscal austerity reduces economic growth, raising debt/GDP levels further

Plus, low level of capacity utilization today reduces future levels of potential output

Adverse long-run implications of Keynesian equilibrium

Source: DeLong and Summers (2012)

Inadequate investment in future capacity and productivity; erosion of labor skills and employability

Are there ideas in Economics?Some concrete illustrations of programmatic

proposals based on ideas from economics

Infrastructure Tax reform Inequality in pay Finance

Reinvigorating infrastructure (Alpert, Hockett, Roubini) Focus: public infrastructure ($1.2 trillion over 5 years?)

highways, railroads, ports, air transport, energy,… where there are great unmet needs

Idea: borrowing costs are low, potential returns are high Bonus: will create jobs at a time of high unemployment Vehicle: a national infrastructure bank

Issue bonds, backed by government guarantee Use U.S. Army Corps of Engineers as project manager and general

contractor of last resort (to limit private-sector overbidding) What about public debt?

program would likely improve government balance sheet, properly valued Value of physical assets created + larger tax base due to expansion of

economy

Reforming tax system (R.H. Frank) Focus: raise fiscal revenue while reducing socially

wasteful activities Moving to the right kind of taxation can be doubly beneficial

Idea: too much competition is harmful when individual rewards depend on relative performance (“the arms race”) E.g., competition for relative status, or slots in good schools/top

firms, luxury goods… Adam Smith goods versus Charles Darwin goods Need to discourage not only activities that provide direct harm

(pollution, CO2) but also those that generate indirect harm Vehicle: scrapping the current progressive income tax in

favor of a more steeply progressive tax on consumption Bonus: no tax on saving, investment

Addressing pay gaps (Freeman, Blasi, and Kruse) Focus: the gap between productivity and pay Idea: link employee earnings to firm performance Vehicle: tax-deductibility of incentive payments if

they cover all full-time employees Additional requirement: amount spent on bottom 80%

must be as large as top 5% Current tax laws subsidize incentive pay to few top

executives thru deduction for stock-options Can come in different forms: cash incentive plans,

performance shares, stock options,… Evidence: broad-based incentive compensation

systems improve firm performance and labor market performance Less turnover, more effort, more peer monitoring Not so with incentive schemes that apply to few workers

Making finance safer (S. Johnson) Focus: reduce moral hazard/systemic risk

created by banks that are “too big to fail” Idea: mega-banks provide no social benefit while

creating large amount of systemic risk and exerting political influence concentrated power government had no choice but to bail them out for fear of

complete collapse of financial system Vehicle: use anti-trust law or regulatory tools to

break-up mega-banks and put a cap on their size Citigroup, Goldman Sachs, Morgan Stanley, JPMorgan

Chase, Bank of America, Wells Fargo … Evidence: no empirical evidence that performance

correlates with size