The United States

The United States Dani Rodrik SW31/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 Source: Kumar and Woo (2010) 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.

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 Inadequate investment in future capacity and productivity; erosion of labor skills and employability Source: DeLong and Summers (2012)

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

The United States