Summary: Economic Policy in a More Uncertain World

Recommendation

This collection of seven academic-style papers – sponsored by the Aspen Institute and its chairs, former US Treasury secretaries Henry M. Paulson, Jr. and Timothy F. Geithner – touches on the major economic issues currently facing the United States. The papers are more reader-friendly and less pedantic than such texts tend to be, and so they are well-suited to students and nonfinancial professionals. The essays focus on productivity, innovation and the cumulative economic outcomes that incremental changes in population are having on the capabilities and resources of the American economy.

Take-Aways

• US rates of innovation and productivity are below where they need to be, and more competition – including from abroad – would help.
• Total US R&D funding remains strong, but a shrinking proportion of directly funded open-ended research is a concern.
• The birth rate in the United States is declining faster than previously forecast, and health care costs are rising.
• The US economy would benefit from more immigration.
• Job losses from the shift to green energy will require coordinated planning and aid.
• The experience of the COVID-19 pandemic suggests that “automatic stabilizers” have an important role to play in allocating federal aid to state and local governments.

Summary

US rates of innovation and productivity are below where they need to be, and more competition – including from abroad – would help.

American prosperity is the result of improving productivity, which relies on innovations that can create more and better products and services with fewer inputs and less labor. But the United States has experienced weak productivity growth in recent decades, except for a positive blip in the late 1990s and early 2000s. Competition is good for innovation and productivity, but studies show that the mark-ups above production costs charged by dominant firms – a proxy for market power and concentration – have increased since 1980. Profits as a share of GDP have also gone up, while the investment-to-output ratio has dropped. Business entry rates and the economic share of young firms, which tend to create more jobs and innovate more, have both declined.

“Close competition can incentivize firms to invest in innovations that will help them to outperform their close rivals. But growing distortions in the competitive environment, leading to a widening technological gap between market leaders and followers, are a primary factor depressing US business dynamism.”

The number and types of patents issued can be a useful metric for understanding the progress of innovation in an economy, so studying patent applications is revealing. Patents labeled as “defensive,” “strategic” or “exploitative” apply to companies’ existing portfolios, while those patents for new innovations or inventions are termed “explorative.” Studies show growth in the defensive type of patents, especially since 2000, contributing to what experts call “patent thickets.” These thickets reduce firms’ incentives to innovate, discourage new entrants and stifle the diffusion of innovation across a sector. In addition, a growing proportion of inventors are employed by incumbent firms, but history shows that innovators tend to contribute more to growth, productivity and job creation when they are part of entrepreneurial start-ups.

“Patent concentration has been trending up since the 1980s, and by 2000 those patents started to shift toward becoming more internal and narrower in scope, indicating that firms are filing patents for strategic rather than exploratory purposes.”

Research also shows that foreign competition can reduce the need for government subsidies aimed at spurring innovation, and this especially improves outcomes in concentrated sectors, although knowledge transfer abroad is a concern. Another area of potential gains lies in recognizing immigrant inventors’ disproportionate contribution to US productivity. Government R&D policies that target start-ups or small enterprises will also have a greater effect on productivity, as their innovations tend to be more radical, while blanket subsidies or tax breaks for R&D tend to benefit large companies.

Total US R&D funding remains strong, but a shrinking proportion of directly funded, open-ended research is a concern.

The government support of scientific R&D over the last century has played a big role in US innovation, and that type of spending can produce high long-run returns for the economy. Total US spending on R&D – consisting of a partnership among government, academia and the private sector – is the highest in the world, but China is catching up. R&D that is funded directly by government is “basic” R&D, which is exploratory and open-ended, whereas private-sector R&D tends to be “applied” to specific business opportunities. The less immediately rewarding and hard-to-capture benefits of basic R&D are often a prerequisite for the more profitable applied R&D, making basic R&D a valuable public good.

“These trends are noteworthy since business-funded investment tends to favor later-stage R&D while federal investment is more likely to support early-stage, exploratory research.”

But growing R&D spending by the private sector – partly incentivized through tax benefits – has now reached four times the amount of federally funded basic R&D, which has remained roughly the same in real terms but has lagged GDP growth.Since the 2000s, the policy trend has moved from direct funding to tax benefit incentives, with the bulk going to large companies: Tax support was $9.5 billion in 2000 and grew to $22.1 billion in 2018 (measured in 2015 dollars).

The birth rate in the United States is declining faster than previously forecast, and health care costs are rising.

Rich countries have seen their birth rates decrease in recent decades, and since 2007, so has the United States. Studies have found that economic conditions created by the benefit policies of different US states and by pro-natal European policy experiments have little statistical impact on birthrates, and that women of all ages are having fewer children. The 2022 Social Security Trustee Report assumes the US fertility rate to be 1.99, but 1.69 may be a more accurate estimate, well below the 2.1 replacement rate. That implies a future in which the ratio of retirees as a proportion of the population will rise, putting extra strain on government finances and requiring tax increases.

“We interpret these trends as evidence that the US fertility rate is belatedly converging toward other high-income countries’, including those with greater support systems for families and workers. US exceptionalism in this regard is likely nearing an end.”

The percentage of the US population over the age of 65 was 12.5% in 1990 and 17% in 2022, and it will plateau at 22% by 2050. This has serious implications for government budgets, as older people pay less taxes and require more retirement and medical benefits, all of which dampen economic growth. Medical costs, too, have been outpacing economic growth: Federal spending on health care was 20% of GDP before the COVID-19 pandemic, and the US Congressional Budget Office projects it will rise to 31.3% of GDP by 2050, though only one-quarter of this increase will be attributable to population aging. This extra, non-age-related rise is driven partly by increases in drug prices and doctors’ salaries, and partly by the fact that more treatments and drugs become available over time. Research shows that “no generation adequately prepays for the modernized health care they receive in retirement.”

The US economy would benefit from more immigration.

Immigration is a politically charged issue, but from an economist’s point of view, it has a positive role to play in an economy with a shrinking birth rate. Statistics reveal that immigrants participate in the labor force at a higher rate than do native-born Americans, and they move to areas that need workers. They are also disproportionately represented when it comes to metrics of innovation, entrepreneurship and patents. While immigration is good for the American workforce as a whole, it is however true that low-wage workers face competition from migrants. Although they tend to have a fiscally positive impact, large inflows of migrants in certain regions can put a strain on local services.

“All told, about one million immigrants per year (pre COVID) obtain a US green card. But the country could absorb many more without visiting significant adverse impacts on US natives…A sensible approach involves a gradual scaling up of the number of immigrants admitted annually, with numerical limits that respond to national labor market conditions.”

The US immigration system maintains quotas of immigrants per country, which limits the numbers of family members and skilled workers coming from places like Mexico, India and the Philippines. Family-based migration offers the United States economic and social benefits, as relatives care for one another and can ease the integration of newcomers. The existing rules for seasonal workers can tie migrants to their employers, keeping wages uncompetitive, and they offer no pathway to permanent residency. Some 1% of migrants overstay their visas, a group that makes up more than half the estimated 10 million undocumented people in the United States. Having so many individuals living in the shadows undermines confidence in the rule of law, and attempts to enforce the law are costly and distressing. In areas where skill shortages exist, both in high- and low-skilled sectors, the rules should be loosened to allow more productive permanent immigration, as this would discourage migrants from overstaying their visas. Whatever the policy direction, current backlogs in migrant processing need concerted attention.

Job losses from the shift to green energy will require coordinated planning and aid.

A side effect of moving to green energy will be a loss of jobs in the fossil fuel industry and in energy-dependent manufacturing. Unlike most changes of this nature that are unforeseeable, energy transition is a “shock foretold,” creating an impetus to plan for it. Jobs in the fossil fuel sector, representing up to 20% of employment in some regions, tend to be high paying for non-college-graduate workers. The sector can be crucial in bringing in money from outside the community, which circulates and supports the local employment market.

“The picture that emerges of regional adjustment to the decline of coal is bleak. Places highly specialized in coal saw declines in employment and wage rates that persisted for 20 years or longer.…The decline of coal appears to have left behind communities that are smaller, older, sicker and with sharply lower average earnings power.”

The experiences of coal mining regions and of areas affected by an influx of manufacturing imports show that the devastating impact of job losses takes decades to evolve. The scarring effects of higher unemployment and lower wages lead to a gradual transfer of younger and more educated people out of the community. The results are communities that, having lost their best workers, must support a higher proportion of elderly, ill and poor residents.

“The practice of place-based policy in the United States is highly decentralized, confusingly fragmented and poorly understood outside of the regions in which it occurs.”

Governments can respond to localized job losses via “place-based policies,” which can include tax breaks for companies, subsidies for worker training and technical assistance to local businesses. Results of place-based policies can be hit or miss, however, and economists are especially skeptical of zero-sum tax-break wars that break out among municipalities and states that compete to spend large sums in subsidies to attract new business. Studies show that the best training programs are attuned to local demand, but such success is tricky to replicate. One simple lever through which government can help is to make localized unemployment insurance more generous in terms of length of time, with studies showing this does not create a negative incentive to find work.

The experience of the COVID-19 pandemic suggests that “automatic stabilizers” have an important role to play in allocating federal aid to state and local governments.

When American states experience budgetary problems during recessions and exceptional circumstances, like pandemics, the federal government helps them out, particularly as nearly all states have adopted various balanced-budget rules. The unemployment insurance and Medicaid programs already have financial structures that offer countercyclical support to states, and Congress always increases the duration of unemployment insurance during recessions. With the benefit of hindsight, many economists now conclude that the federal government gave too much financial support to states during the COVID-19 pandemic, as state revenues ended up exceeding forecasts by 2.2%. State budgets were helped by spending that was skewed more toward physical goods, which attract more sales taxes than services. Forecasts did not take into account the relief support itself and how it circulated around the economy: Aid given to companies boosted employment, and payments to individuals stimulated business demand.

“Federal fiscal relief to states and localities during the COVID-19 pandemic was too generous, ill-timed and targeted, at least in part, in accord with political pressures.”

A major improvement would consist of basing a state’s need for federal support directly on metrics reflecting that state’s sales tax revenue and income tax revenue. An ideal policy could include an algorithm for dictating whether states should be paying into – or receiving support from – a federal fund, based on an assessment of tax revenue trends. The algorithm would create an automatic-stabilizer effect and, in theory, attempt to provide a rough stab at budget neutrality throughout business cycles. If states observe their tax receipts falling, they could be confident of aid later, as the algorithm would note the decline and allocate funding. This predictability is in contrast to, for example, the budgetary uncertainty states experienced while waiting for the outcome of heated Congressional debates on support during the pandemic.

About the Author

The Aspen Economic Strategy Group is part of the Aspen Institute, a nonpartisan US think tank.

Review

Economic Policy in a More Uncertain World is a book that examines the major economic challenges and opportunities facing the United States in the 21st century. The book is based on the research and discussions of the Aspen Economic Strategy Group, a bipartisan group of former policymakers, business leaders, and academics, co-chaired by Henry M. Paulson, Jr. and Timothy Geithner.

The book is divided into seven chapters, each written by a different expert and edited by Melissa S. Kearney and Amy Ganz. The chapters cover topics such as demographic change, immigration, innovation, climate change, fiscal policy, and state and local government finance. The book aims to provide policy-relevant evidence and analysis that can inform and guide decision-makers in addressing these complex and interrelated issues.

Some of the key takeaways from the book are:

• Demographic change poses a serious threat to economic growth and fiscal sustainability. The US fertility rate has declined below the replacement level, while the population is aging rapidly. This means that the labor force will grow more slowly, productivity will decline, and public spending on health care and social security will increase. The book suggests that increasing immigration, investing in human capital, and reforming entitlement programs are possible ways to mitigate these effects.
• Immigration is a net benefit for the US economy and society. Immigrants contribute to economic growth, innovation, diversity, and cultural richness. They also help offset the demographic decline and fill labor market gaps. However, the US immigration system is outdated, inefficient, and unfair. The book proposes various reforms to improve the system, such as expanding legal pathways, streamlining visa processes, enhancing border security, and integrating immigrants into society.
• Innovation is essential for maintaining US competitiveness and leadership in the global economy. The US has been a pioneer in science and technology, but its innovation edge is eroding due to increased competition from other countries, reduced public funding for research and development, and regulatory barriers. The book recommends that the US should increase its investment in basic and applied research, foster a more dynamic and competitive business environment, attract and retain talent from around the world, and collaborate with allies on common challenges.
• Climate change is a looming crisis that requires urgent action. The US is one of the largest emitters of greenhouse gases and one of the most vulnerable to the impacts of climate change. The book argues that the US should adopt a comprehensive strategy to reduce its emissions, while also supporting the transition to a low-carbon economy. The book highlights the potential costs and benefits of various policy options, such as carbon pricing, clean energy standards, subsidies, regulations, and innovation incentives. The book also emphasizes the need to address the distributional effects of climate policies on workers and communities.
• Fiscal policy is a powerful tool for stabilizing and stimulating the economy, but it also has long-term consequences for debt and growth. The US has experienced unprecedented fiscal expansion in response to the COVID-19 pandemic, which has helped mitigate the economic damage but also increased the public debt to record levels. The book cautions that the US should balance its short-term needs with its long-term obligations, and adopt a credible plan to restore fiscal discipline once the crisis is over. The book also discusses how fiscal policy can be improved by enhancing its effectiveness, efficiency, transparency, and accountability.
• State and local government finance is a critical component of public service delivery and economic performance. State and local governments provide essential services such as education, health care, infrastructure, public safety, and social welfare. They also face significant fiscal challenges due to revenue volatility, expenditure pressures, unfunded liabilities, intergovernmental transfers, and institutional constraints. The book analyzes how state and local governments have coped with these challenges during the COVID-19 pandemic, and how they can improve their fiscal resilience and governance in the future.

Analysis:

The book is well-written and well-researched, drawing on the expertise of leading economists and policymakers. The authors present a range of perspectives and arguments, making it a valuable resource for anyone interested in understanding the challenges facing economic policymakers today.

One strength of the book is its focus on the interconnected nature of economic challenges. The authors recognize that economic policy is not a series of isolated decisions, but rather a complex web of interconnected decisions that have far-reaching consequences. This nuanced understanding of the economic landscape allows the authors to offer more effective and comprehensive policy recommendations.

Another strength of the book is its emphasis on the need for more flexible and adaptive economic policies. The authors recognize that the traditional frameworks and models used in economic policymaking are no longer sufficient for addressing the complex and interconnected challenges of the 21st century. They argue that policymakers need to be more flexible and adaptive in their approach, and to be willing to adjust policies in response to changing circumstances.

Criticisms and Areas for Improvement:

• While the book provides a comprehensive overview of the challenges facing economic policymakers, it could benefit from a more detailed examination of the policy prescriptions. Some of the policy recommendations are not fully developed, and more attention could be given to how they could be implemented in practice.
• The book could also benefit from a more nuanced discussion of the potential trade-offs involved in different policy decisions. The authors often present a range of options without fully considering the potential costs and benefits of each approach.
• The book could also benefit from a more detailed consideration of the potential impact of economic policy on different groups within society. While the authors recognize the importance of addressing the growing divide between the rich and the poor, more attention could be given to how different policy approaches may impact different groups within society.

Economic Policy in a More Uncertain World is a book that will enlighten you about the current state of affairs and future prospects of the US economy. It will provide you with rigorous evidence and analysis that can help you understand and evaluate various policy alternatives. It will also challenge you to think critically and creatively about how to address the economic problems and opportunities that lie ahead. Whether you are a policymaker, a business leader, an academic, or a citizen, you will find something valuable and relevant in this book.

In conclusion, Economic Policy in a More Uncertain World is a valuable and timely contribution to the field of economic policy. The book provides a comprehensive analysis of the challenges and opportunities posed by economic uncertainty and offers practical policy recommendations for navigating these complexities. With insights from leading economists and policymakers, it offers a well-rounded perspective on the key economic issues of our time. Whether you are an economist, policymaker, or simply interested in understanding the challenges facing the global economy, this book provides valuable insights and recommendations.