Ch21: Long-Run Economic Growth: Sources and Policies

Glenn on Economic Growth and Its Social Consequences

Adam Smith bronze statue on Royal Mile Market square in front of Saint Gilles Cathedral in Edinburgh, Scotland.

Growth matters. A lot. A slightly higher rate of economic growth, sustained over time, can make the difference between a big increase in living standards and relative stagnation. Whether we can still generate strong and steady growth is a “$64,000 question” for the economy — the question. Nobel Prize–winning economist Robert Lucas famously observed that once economists think of long-term growth, it is hard to think of anything else. A pro-growth policy agenda is a good idea because growth is a good idea.

But a deeper question remains: Is public support for growth guaranteed? Oren Cass of American Compass refers to growth and economists’ fealty to economic participation for all as “economic piety.” This critique resonates for a simple reason: Forces that propel growth invariably leave a wake of economic disruption for people in many places and political disruption for the nation. A serious discussion of pro-growth policy must account for that disruption.

A conventional pro-growth policy agenda can be enhanced by support for openness to markets, ideas, and new ways of doing things, and for the ability of firms to adapt to change. Such an enhanced agenda would center on infrastructure broadly defined, development and dissemination of better management practices, and reduced barriers to competition.

Yet the political process, and even many a conservative, is openly skeptical of such an agenda. This skepticism is rooted not in disagreement over the future of scientific advances or of organizational adaptation — but in a concern that growth’s benefits be shared broadly. Addressing this skepticism head-on is essential for rebuilding social support for growth and for countering well-meaning but potentially harmful policies.

The system that needs defending is a mature and successful one. Adam Smith, the great proponent of the “invisible hand” (not the visible hand of a state-directed economy), saw openness and competition as worth the candle. His 1776 publication of The Wealth of Nations came before what we would recognize today as industrial capitalism, though technological change and globalization were features of economic debates in the aftermath of Smith’s ideas.

Smith’s radical insight is central to economic policy today: National prosperity (the “wealth of a nation”) is represented by consumption of goods and services by its people — i.e., their living standards. The goal of the economy in Smith’s telling was to make the economic pie as large as possible. His advocacy of free markets and competition rested on their ability to boost consumption possibilities.

Two centuries later, Nobel laureates Kenneth Arrow and Gérard Debreu added the jargon and mathematics of contemporary economics to formalize Smith’s intuition. While individuals and firms act independently, competitive markets lead to an efficient allocation of resources and a maximized economic pie. Friedrich Hayek, another Nobel laureate, hailed the virtue of a decentralized competitive price system in maximizing economic activity.

Smith’s radicalism draws from his attack on mercantilism—the economic orthodoxy of the day—which stressed a zero-sum view of trade and state intervention to promote and protect certain firms and industries. (Sound familiar?) His second radical insight was that the “nation” did not mean the sovereign and the well-connected. In Smith’s view, individuals as consumers—all people—were kings. Finally, channeling the sympathetic concern espoused in his earlier classic, The Theory of Moral Sentiments, Smith championed mass participation in the productive economy as a precondition for human flourishing.

It is fair to say that Smith lacked a theory of per capita growth in the economy over time; indeed, he wrote before the massive increase in living standards attendant upon the Industrial Revolution. After 1800, per capita income in the United Kingdom — and the United States — witnessed a 30-fold increase. There have also been major improvements in the quality of goods and services that such a statistic doesn’t quite capture. And, of course, many of today’s offerings — from smartphones to computers to air-conditioning — were not available even in 1900, let alone 1800.

That lacuna in Smith’s theory partly reflects technical difficulties in modeling growth. Higher output can come from growth in inputs such as labor and capital, but what determines their growth? Today’s economists highlight population growth and society’s willingness to work, save, and invest. Still more important is growth in productivity, or the efficiency with which inputs are used to produce goods and services.

Smith’s pin-factory example — in which output rose with the specialization of tasks — links how things are done with the level of productivity. But what factors determine productivity growth over time? Today’s economic analysis focuses on technology and the process of generating ideas. Since economic growth is still crucial for people seemingly marginalized by capitalism, it’s worth asking whether the economic foundations expressed in The Wealth of Nations are still relevant today. Where does growth come from now? And do those sources still require openness and competition?

The short answer is that they do, but to see why, we need to focus on the ideas of two prominent economists after 1800: Edmund Phelps and Deirdre Nansen McCloskey.

Phelps, a Nobel laureate, has done much to connect growth to Smith’s foundational ideas. He starts with Smith’s emphasis on a great many individuals (not the state or privileged firms) searching for new and better ways of doing things. This relentless search produces innovative ideas, processes, and goods that drive growth — but only if the political economy allows openness. Smith’s messy, “bottom up” version of the market therefore puts mass innovation at the heart of economic growth. Phelps’s argument reflects how Smithian societies committed to openness are best able to prosper and promote growth.

This argument has two important applications. The first is to debunk the sometimes fashionable view of secular productivity decline — that we have run short of new things to discover and exploit. The second is to give an answer to economies struggling with growth in a period of structural changes from technology and globalization. Slowdowns in innovation are likely not due to scientific barrenness but to walls against openness and change — that is, fears of disruption.

Phelps’s concern with economic dynamism draws him to Smith’s arguments against mercantilist tinkering in the economy. Like Smith, he worries about the hidden costs of tinkering with competition by blocking change from the outside and by enabling rent-seeking on the inside. These “corporatist” policies — fashionable among some conservatives at present — inevitably embolden vested interests and cronyism, slowing change and growth. Even seemingly small interventions can subtly diminish innovation, a point to which I’ll return.

Yet such a critique must acknowledge the political consequences of disruption. Dynamism is messy. It creates growth in the aggregate, but with many individual losers as well as individual gainers.

McCloskey, an economic historian, has similarly identified the continuous, large-scale, voluntary, and unfocused search for betterment as the source of new ideas that can produce economic growth. She sees this “innovism” as primarily a cultural force, preferring the term to the more familiar “capitalism,” and connects innovism to economic liberalism. Echoing Smith, she emphasizes how an open economy allows individuals—from the moderately to the spectacularly talented—to “have a go.” This economic liberalism allows competition to enshrine liberty and mass flourishing.

In McCloskey’s telling, growth depends on a liberal tolerance and openness to change, which encourage many people to be alert to opportunity. Sustaining that tolerance as structural shifts bring economic misfortune to many individuals, however, requires more than devotion to Smith.

Therein lies the current economic-policy rub. Economists’ theories of growth bring to mind a coin: Sunny descriptions of growth and dynamism are “heads,” and hand-wringing over disruption is “tails.” As I observed earlier, growth is messy. It can push some individuals, firms, and even industries off well-worn and comfortable paths.

But Smith offers more in defense of growth than paeans to laissez-faire. Though he is sometimes caricatured as being anti-government in all cases, Smith was principally opposed to mercantilist privileges for specific businesses and industries and to the governmentalization of social affairs. He wanted government to provide what economists today call “public goods,” such as national defense, the criminal-justice system, and enforcement of property rights and contracts the institutional underpinnings of commerce and trade. He also favored support for infrastructure to keep commerce flowing freely.

But Smith went further: To prepare workers and enrich their lives, he called for government to provide universal education, and he drew a connection between education and liberty as well as work in a free society. But boosting participation in today’s economy—participation that provides support for growth—will require a bit more.

Not surprisingly, political reaction to economic disruption brings about — pardon the econ-speak—a “demand” for and “supply” of policy actions. Job losses, firm failures, and diminished industry fortunes bring about a demand for help, for adaptation. The political process responds with a supply of ideas in one of two forms: walls or bridges. Walls are protections against disruption or change. Bridges, ways to get somewhere or back, prepare individuals for the changed economy and help those whose economic participation has been disrupted reenter the workforce.

Proposals for walls are familiar. They can be physical, of course, but they needn’t be. Conservative populists advocate limits on trade and technology, in order to advance industrial policy. Some progressives advocate universal basic income. All these policies would diminish the prospects for economic advances.

The most prominent sort of wall today is what I call “modern corporatism.” It assumes that Smith was wrong: The “wealth of a nation” lies not in consumption or living standards (and so ultimately in growth) but in jobs, good jobs, even particular good jobs, with good manufacturing jobs the very paradigm. The sort of tinkering with the market that drew Smith’s ire may actually be a necessary way of recentering economic policy on jobs, so the theory goes. Opportunities for work, and for the dignity it can bring, are surely important.

A gentle industrial policy devised by social scientists who are worried about jobs is not the answer. It results in state tinkering for special interests, precisely the kind of thing that prompted Smith’s criticism of mercantilism. Moreover, as University of Chicago economist Luigi Zingales argues in A Capitalism for the People, it risks a vicious cycle: A little bit of tinkering becomes a lot of tinkering—and anyone who cannot justify special privileges is left out, calling into question social support for growth. Nevertheless, industrial policy has caught the attention of elected officials on the right, from Donald Trump to Josh Hawley to Marco Rubio. While national security and the border can be exceptions as concerns, advice from Milton Friedman to the party of Ronald Reagan this is not.

That said, economists’ invocation of Smith as a proponent of let-’er-rip laissez-faire is neither faithful to Smith nor particularly helpful to individuals and communities buffeted by disruption. With today’s rapid and long-lasting technological change and globalization, “having a go” requires support for acquiring new skills when they are needed.

That is why we need more bridges. Bridges take us somewhere and bring us back. The journey to somewhere is about preparation for new opportunities. The journey back is about reconnecting to the productive economy when economic forces beyond our control have knocked us away.

Economic bridges have three features. The first is that they help people overcome a specific challenge on their way to economic flourishing — they don’t provide that outcome directly. The second is that wider society builds the bridge, through private organizations, governments, or public–private partnerships, as globalization and technological change have introduced significant risks that individuals by themselves cannot avoid. The third feature is that they avoid restraints on openness to changes in markets and ideas.

We once did better, much better. During the Civil War, President Abraham Lincoln worked with Congress to pass the Morrill Act, directing resources to the development of land-grant colleges around the country, extending higher education to citizens of modest means, and enabling workers to develop skills for new industries, particularly in manufacturing. As World War II drew to a close, President Franklin D. Roosevelt and Congress came together to enact the G.I. Bill, helping to educate returning troops for a changing economy.

Supporting economic growth and undergirding broad participation in the economy require similarly bold ideas. To begin, community colleges are the logical workhorses of skill development and retraining, and their presence in regional economies makes them attractive partners for employers. Yet community colleges have seen their state-level public support wither. The Biden administration calls for free tuition, which would boost demand but provide no support for community college to offer a practical education and an emphasis on completion. Amy Ganz, Austan Goolsbee, Melissa Kearney, and I proposed an alternative approach based on the land-grant-college model. We proposed a supply-side program of federal grants to strengthen community colleges — contingent on improved degree-completion rates and labor-market outcomes. To further encourage training, the federal government could offer a tax credit to compensate firms for the risk of losing trained workers. It could also increase the earned-income tax credit for workers with or without children.

New ideas are also needed to promote workers’ reentry into the workforce. Personal reemployment accounts, for example, would support dislocated workers and offer them a reemployment bonus if they found a new job within a certain period of time. The “personal” refers to individuals’ choosing from a range of training and support services. Another idea is to beef up support for place-based assistance to areas with stubbornly high rates of long-term nonemployment. Such support could be integrated with an increase in the earned-income tax credit and the supply-side investment in community colleges. Building on the decentralized approach in the land-grant colleges and grants to community colleges, expanded place-based aid would be delivered via flexible block grants encouraging business and employment.

Broad public support required for growth and dynamism requires both bridge-building and a political language that frames it. Growth, opportunity, and participation are good, and we do not need a new economics. But phrases like “transition cost” and “inevitable economic forces” must give way to bridges of preparation and reconnection.

‘Why did nobody see it coming?” a quizzical Queen of England questioned a quorum of economists at the London School of Economics about the global financial crisis as it emerged in late 2008. How could major disruptive forces build up over time and yet escape the attention of experts and leaders?

Of the disruptive structural changes accompanying economic dynamism, one might ask a similar question. Growth matters. But that growth is one side of a coin whose flip side is disruption is known, certainly to economists. Why has our political discourse not emphasized this basic point?

Why did we not see fatigue with change coming among the people who most had to bear its ill effects?

However foolishly, we did not. Some so-called conservatives today have responded by saying that we should limit change. Surely a better response is that we should seek ever more growth by allowing unfettered change, but also facilitate the establishing of ever more connections in a growing economy. That classical-liberal answer has the better place in American conservatism — and in American economic life.

— This essay is sponsored by National Review Institute. Originally published h ere.

Ukraine

On Tuesday, March 1, Glenn and Tony will record a podcast on the economic consequences of the Russian invasion of Ukraine. The recording will be posted to this blog and also available through iTunes.

Some useful links

General information on developments (political and military, as well as economic):

Updates on the website of the Financial Times (note that the FT has dropped its paywall to allow non-subscribers to read this content). This article on the possible effects on the global economy is particularly worth reading.

The Twitter feed of Max Seddon, the FT’s Moscow bureau chief, is here.

The website of the New York Times has an extensive series of updates focused on military and political developments (subscription may be required).

Streaming updates on the website of the Wall Street Journal (subscription may be required).

A Twitter feed that provides timely updates on the military situation.

An article in the New Yorker discussing Russian President Vladimir Putin’s claims about the historical relationship between Russia and Ukraine.

A pessimistic blog post by a retired U.S. Army Colonel on whether the U.S. military is equipped to fight a war in Europe.

Discussions focused on economics:

As background, the following figure from the Our World in Data site shows the growth in real GDP per capita for several countries. The underlying data were compiled by the World Bank and are measured in constant international dollars, which means that they are corrected for inflation and for variations across countries in the purchasing power of the domestic currency.

In 2020, Russian GDP per capita was less than half that of U.S. GDP per capita although about 50 percent greater than GDP per capita in China. GDP per capita in Lithuania, part of the Soviet Union until 1991, and Poland, part of the Soviet bloc until 1989, are significantly higher than in Russia. These two countries have become integrated into the European economy and have grown more rapidly than has Russia, which continues to rely heavy on exports of oil, natural gas, and other commodities. Ukraine is not as well integrated into the European economy as are Poland and Lithuania and Ukraine experienced little economic growth since attaining independence in 1991. In fact, Ukraine’s real GDP per capita was lower in 2020 than it had been in 1991.

Here is a transcript of President Joe Biden’s speech imposing sanctions on Russia.

Informative Full Stack Economics blog post by Alan Cole explaining the likely reasons why U.S. and European sanctions on Russia excluded energy. Useful explanation of the role of correspondent banking in international trade.

An article in the Economist discussing sanctions (subscription may be required).

An article in the New York Times discussing the SWIFT (Society for Worldwide Interbank Financial Telecommunications) service, which is based in Belgium, and is a key component of the international financial system. Some policymakers have proposed cutting Russia off from SWIFT. The article discusses why some countries have been opposed to taking that step (subscription may be required).

An opinion column by Justin Fox on bloomberg.com examines in what sense the United States is energy independent and the economic reasons that the U.S. still imports some oil from Russia (subscription may be required).

Blog post by economic writer Noah Smith on the possible effects of the invasion on the post-World War II international economic system.

Glenn’s New Book Was Published Today

Link to Yale University Press’s website.

Link to Amazon page.

Link to availability at local independent bookstores in your area.

Glenn’s Article from the Atlantic: “Even My Business-School Students Have Doubts About Capitalism”

Glenn’s new book that this article is adapted from

Link to the article on the Atlantic’s site.

During a lecture in my Modern Political Economy class this fall, I explained—as I have to many students over the course of four decades in academia—that capitalism’s adaptation to globalization and technological change had produced gains for all of society. I went on to say that capitalism has been an engine of wealth creation and that corporations seeking to maximize their long-term shareholder value had made the whole economy more efficient. But several students in the crowded classroom pushed back. “Capitalism leaves many people and communities behind,” one student said. “Adam Smith’s invisible hand seems invisible because it’s not there,” declared another.

I know what you’re thinking: For undergraduates to express such ideas is hardly news. But these were M.B.A. students in a class that I teach at Columbia Business School. For me, those reactions took some getting used to. Over the years, most of my students have eagerly embraced the creative destruction that capitalism inevitably brings. Innovation and openness to new technologies and global markets have brought new goods and services, new firms, new wealth—and a lot of prosperity on average. Many master’s students come to Columbia after working in tech, finance, and other exemplars of American capitalism. If past statistics are any guide, most of our M.B.A. students will end up back in the business world in leadership roles.

The more I thought about it, the more I could see where my students were coming from. Their formative years were shaped by the turbulence after 9/11, the global financial crisis, the Great Recession, and years of debate about the unevenness of capitalism’s benefits across individuals. They are now witnessing a pandemic that caused mass unemployment and a breakdown in global supply chains. Corporate recruiters are trying to win over hesitant students by talking up their company’s “mission” or “purpose”—such as bringing people together or meeting one of society’s big needs. But these gauzy assertions that companies care about more than their own bottom line are not easing students’ discontent.

Over the past four decades, many economists—certainly including me—have championed capitalism’s openness to change, stressed the importance of economic efficiency, and urged the government to regulate the private sector with a light touch. This economic vision has yielded gains in corporate efficiency and profitability and lifted average American incomes as well. That’s why American presidents from Ronald Reagan to Barack Obama have mostly embraced it.

Yet even they have made exceptions. Early in George W. Bush’s presidency, when I chaired his Council of Economic Advisers, he summoned me and other advisers to discuss whether the federal government should place tariffs on steel imports. My recommendation against tariffs was a no-brainer for an economist. I reminded the president of the value of openness and trade; the tariffs would hurt the economy as a whole. But I lost the argument. My wife had previously joked that individuals fall into two groups—economists and real people. Real people are in charge. Bush proudly defined himself as a real person. This was the political point that he understood: Disruptive forces of technological change and globalization have left many individuals and some entire geographical areas adrift.

In the years since, the political consequences of that disruption have become all the more striking—in the form of disaffection, populism, and calls to protect individuals and industries from change. Both President Donald Trump and President Joe Biden have moved away from what had been mainstream economists’ preferred approach to trade, budget deficits, and other issues.

Economic ideas do not arise in a vacuum; they are influenced by the times in which they are conceived. The “let it rip” model, in which the private sector has the leeway to advance disruptive change, whatever the consequences, drew strong support from such economists as Friedrich Hayek and Milton Friedman, whose influential writings showed a deep antipathy to big government, which had grown enormously during World War II and the ensuing decades. Hayek and Friedman were deep thinkers and Nobel laureates who believed that a government large enough for top-down economic direction can and inevitably will limit individual liberty. Instead, they and their intellectual allies argued, government should step back and accommodate the dynamism of global markets and advancing technologies.

But that does not require society to ignore the trouble that befalls individuals as the economy changes around them. In 1776, Adam Smith, the prophet of classical liberalism, famously praised open competition in his book The Wealth of Nations. But there was more to Smith’s economic and moral thinking. An earlier treatise, The Theory of Moral Sentiments, called for “mutual sympathy”—what we today would describe as empathy. A modern version of Smith’s ideas would suggest that government should play a specific role in a capitalist society—a role centered on boosting America’s productive potential(by building and maintaining broad infrastructure to support an open economy) and on advancing opportunity (by pushing not just competition but also the ability of individual citizens and communities to compete as change occurs).

The U.S. government’s failure to play such a role is one thing some M.B.A. students cite when I press them on their misgivings about capitalism. Promoting higher average incomes alone isn’t enough. A lack of “mutual sympathy” for people whose career and community have been disrupted undermines social support for economic openness, innovation, and even the capitalist economic system itself.

The United States need not look back as far as Smith for models of what to do. Visionary leaders have taken action at major economic turning points; Abraham Lincoln’s land-grant colleges and Franklin Roosevelt’s G.I. Bill, for example, both had salutary economic and political effects. The global financial crisis and the coronavirus pandemic alike deepen the need for the U.S. government to play a more constructive role in the modern economy. In my experience, business leaders do not necessarily oppose government efforts to give individual Americans more skills and opportunities. But business groups generally are wary of expanding government too far—and of the higher tax levels that doing so would likely produce.

My students’ concern is that business leaders, like many economists, are too removed from the lives of people and communities affected by forces of change and companies’ actions. That executives would focus on general business and economic concerns is neither surprising nor bad. But some business leaders come across as proverbial “anywheres”—geographically mobile economic actors untethered to actual people and places—rather than “somewheres,” who are rooted in real communities.

This charge is not completely fair. But it raises concerns that broad social support for business may not be as firm as it once was. That is a problem if you believe, as I do, in the centrality of businesses in delivering innovation and prosperity in a capitalist system. Business leaders wanting to secure society’s continuing support for enterprise don’t need to walk away from Hayek’s and Friedman’s recounting of the benefits of openness, competition, and markets. But they do need to remember more of what Adam Smith said.

As my Columbia economics colleague Edmund Phelps, another Nobel laureate, has emphasized, the goal of the economic system Smith described is not just higher incomes on average, but mass flourishing. Raising the economy’s potential should be a much higher priority for business leaders and the organizations that represent them. The Business Roundtable and the Chamber of Commerce should strongly support federally funded basic research that shifts the scientific and technological frontier and applied-research centers that spread the benefits of those advances throughout the economy. Land-grant colleges do just that, as do agricultural-extension services and defense-research applications. Promoting more such initiatives is good for business—and will generate public support for business. After World War II, American business groups understood that the Marshall Plan to rebuild Europe would benefit the United States diplomatically and commercially. They should similarly champion high-impact investment at home now.

To address individual opportunity, companies could work with local educational institutions and commit their own funds for job-training initiatives. But the U.S. as a whole should do more to help people compete in the changing economy—by offering block grants to community colleges, creating individualized reemployment accounts to support reentry into work, and enhancing support for lower-wage, entry-level work more generally through an expanded version of the earned-income tax credit. These proposals are not cheap, but they are much less costly and more tightly focused on helping individuals adapt than the social-spending increases being championed in Biden’s Build Back Better legislation are. The steps I’m describing could be financed by a modestly higher corporate tax rate if necessary.

My M.B.A. students who doubt the benefits of capitalism see the various ways in which government policy has ensured the system’s survival. For instance, limits on monopoly power have preserved competition, they argue, and government spending during economic crises has forestalled greater catastrophe.

They also see that something is missing. These young people, who have grown up amid considerable pessimism, are looking for evidence that the system can do more than generate prosperity in the aggregate. They need proof that it can work without leaving people and communities to their fate. Businesses will—I hope—keep pushing for greater globalization and promoting openness to technological change. But if they want even M.B.A. students to go along, they’ll also need to embrace a much bolder agenda that maximizes opportunities for everyone in the economy.

Link to the Amazon listing of Glenn’s new book.

What’s Next for China?

When Deng Xiaoping assumed control of China following the death of Mao Zedong in 1976, he was in charge of one of the poorest countries in the world. The average person in China survived on the equivalent of $3 per day and the bulk of the population worked on government-run collective farms. Deng’s response to this dismal situation was a series of economic reforms that led China away from Mao’s socialist regime toward a free market economy. The results have been spectacular.

Since 1978, when Deng’s reforms began, real GDP per capita in China has increased from $381 (in 2010 prices) to $10,431 in 2020. Today, China is a solidly middle-income country on a par with Mexico or Indonesia. According to World Bank data, in 1981 more than 875 million people in China lived in extreme poverty. By 2019, fewer than 1 million did. The world has never seen such a high economic growth rate sustained over such a long period or as dramatic a reduction in poverty in such a short period. Deng brought about an increase in the material well-being of his people unrivaled in history.

But, as we discuss in the Apply the Concept in Section 11.5 of Chapter 11 in Macroeconomics (Section 21.5 in Chapter 21 of Economics), despite Deng’s success he failed to resolve a conflict at the heart of the Chinese system: Deng and the other party leaders saw their economic reforms as strengthening socialism and not as replacing socialism with capitalism. They had no intention of undermining the role of the Communist Party in Chinese society or of introducing democracy. The result is the peculiar situation China now finds itself in under current leader Xi Jinping: A country that extensively relies on free markets ruled by an autocratic regime that justifies its dictatorship as necessary for the preservation of socialism.

In 2022, at the 20^th Congress of the Chinese Communist Party, Xi seems likely to be elected to a third term as leader of the Communist Party, breaking with the tradition since Deng of leaders serving only two terms. Like Mao, Xi’s apparent intention is to retain his office indefinitely. Xi’s speeches indicate that he believes that China is following a path like the one that Karl Marx, writing in the 1800s, believed countries would follow, which would culminate in a socialist economy. He sees Mao as having reasserted China’s independence from Europe and the United States, although at his death China remained largely rural and agricultural with very little scope for market activity. Deng continued the evolution of the economy by establishing a market system that raised incomes and allowed for industrial development. Xi sees himself as finishing the process by leading China to become a “modern socialist nation” by 2035.

As we discuss in the Apply the Concept, there are a number of obstacles to China’s continued economic growth, obstacles that appear to have increased during 2021 as Xi’s plans have become clearer.

As part of his plan to transition China to being a socialist nation, Xi has increased government regulation of China’s economy. He has imposed large fines on technology firms such as Alibaba and Tencent and on the ride-hailing firm Didi. A government proclamation effectively ended the for-profit school tutoring industry, which seven of ten Chinese students had been using. This government action raised concern among the owners of some small and medium-sized businesses that their investments in their firms could be wiped out arbitrarily without notice. Wealthy Chinese entrepreneurs were also being pressured to devote more funds to charity. Whether increased government regulation will result in entrepreneurs pulling back from the investment needed to sustain economic growth remains to be seen.
Over the decades since market reforms began, the Chinese economy had been cutting reliance on production by state-owned enterprises (SOEs) in favor of production by private firms. Recently, some observers have concluded that Xi plans to increase the share of the economy controlled by SOEs, although his public statements have emphasized the need for SOEs to become more efficient and for the government to reduce its subsidies to these firms. Many of China’s trading partners, including the United States, have objected to these subsidies. If the importance of SOEs in the Chinese economy should increase, it would likely further slow economic growth and increase the frictions between China and its trading partners.
Economic growth has been slowing down. Between 1978 and 2011, per capita real GDP grew at an annual average rate of 8.9 percent. Between 2012 and 2020 that growth rate slowed to 6.0 percent. Although compared with most other countries, a 6 percent growth rate is quite high, some economists believe that the Chinese government has been overstating the true growth rate. As an article in the Wall Street Journal put it, “real growth has long been one of the ways officials are evaluated in China, and so there is a strong incentive to inflate it—and substantial evidence that has happened.”
China’s population is rapidly aging. Its birthrate of 1.3 children born per woman during her lifetime is well below the rate of 2.1 needed to maintain the population. The working age population has been declining since 2011, as the fraction of the population over 65 has been increasing. Although the populations of Europe, the United States, and other high-income countries have also been aging, those countries have more resources than does China to provide support to retired people, as with the Social Security and Medicare programs in the United States. Because China’s average retirement age is only 54, while its average life expectancy is 77 years, an increasing number of retirees is being supported by a decreasing number of workers. The Chinese government has announced plans to raise the official retirement age but the government has abandoned past attempts to do so in the face of public protests.
The economy’s excessive reliance on investment in real estate. Particularly during the past five years, real estate investment has been an important contributor to the growth of the Chinese economy, accounting for as much as 25 percent of GDP (as opposed to only about 7 percent in the United States). But the difficulties that the Evergrande real estate development firm encountered during 2021 seemed to be an indication that what has been the largest real estate boom in history may be ending. In some cities as many as 40 percent of apartments are empty, making it difficult for Evergrande and other developers to make the interest payments on their loans and bonds. The Chinese government has issued regulations that limit borrowing by real estate developers in an attempt to reduce what the government sees as speculative building of apartments. Whether the government can reduce the importance of real investment in the economy without causing a significant reduction in the economy’s growth rate is uncertain.
Increasing political problems with other countries. The Chinese government has drawn sharp international criticism for a number of actions: Its repression of the more than one million members of a Muslim minority in western China; its ending the political independence of Hong Kong; the expansion of its military and its threatening actions towards Taiwan (which the Chinese government believes is part of China); and its failure to be forthcoming with information about the origins of the Covid-19 virus. An additional source of disagreements with other governments has been disputes over international trade. Both the Trump and Biden administrations, as well as governments in Europe, have been critical of the Chinese government forcing foreign firms that operate in China to transfer intellectual property to Chinese firms, an action that is in violation of the World Trade Organization’s (WTO) rules. The growth of Chinese exports has been greatly helped by China’s membership in the WTO, which may be threatened by what other governments see as China’s violations of WTO rules.

The actions that Xi Jinping takes in the coming years are likely to have a large effect on not just the Chinese economy, but on the world economy.

Sources: Stella Yifan Xie, “China’s Economy Faces Risk of Yearslong Real-Estate Hangover,” wsj.com, November 8, 2021; “Xi Jinping Is Rewriting History to Justify His Rule for Years to Come,” economist.com, November 6, 2021; Sofia Horta e Costa, “Chinese Developer Controlled by Government Is Latest to Plunge,” bloomberg.com, November 8, 2021; Kevin Rudd, “What Explains Xi’s Pivot to the State?” wsj.com, September 19, 2021; “At 54, China’s Average Retirement Age Is Too Low,” economist.com, June 26, 2021; Nathaniel Taplin, “China’s Economic Data: A Guide for the Dazed and Confused,” wsj.com, January 4, 2021; Stella Yifan Xie and Mike Bird, “The $52 Trillion Bubble: China Grapples With Epic Property Boom,” wsj.com, July 16, 2020; the World Bank; and the Federal Reserve Bank of St. Louis.

Economies of Scale in Ocean Shipping and U.S. Retailers’ Response to Pandemic Supply Chain Problems

Beginning in the 1950s, several companies pioneered in developing modern shipping containers that once arrived at docks can be lifted by cranes and directly attached to trucks or loaded on to trains for overland shipping. As economist Marc Levinson was the first to discuss in detail in his 2004 book, The Box, container shipping, by greatly reducing transportation costs, helped to make the modern global economy possible. (We discuss globalization in Economics, Chapter 9, Section 9.1 and Chapter 21, Section 21.4, and in Macroeconomics, Chapter 7, Section 7.1 and Chapter 11, Section 11.4.)

Lower transportation costs meant that small manufacturing firms and other small businesses that depended on selling in local markets faced much greater competition, including from firms located thousands of miles away. The number of dockworkers declined dramatically as the loading and unloading of cargo ships became automated. Ports such as New York City, San Francisco, and Liverpool that were not well suited for handling containers because they lacked sufficient space for the automated equipment and the warehouses, lost most of their shipping business to other ports, such as Los Angeles, Seattle, and London. Consumers in all countries benefited because lower transportation costs meant they were able to buy cheaper imported goods and had a much greater variety of goods to choose from.

In the decades since the 1950s, shipping firms have continued to exploit economies of scale in container ships. (We discuss the concept of economies of scale in Econimics and Microeconomics, Chapter 11, Section 11.6.) Today, shipping containers have been standardized at either 20 feet or 40 feet long and the largest ships can haul thousands of containers. Levinson explains why economies of scale are important in this industry:

“A vessel to carry 3,000 containers did not require twice as much steel or twice as large an engine as a vessel to carry 1,500. [Because of automation, a] larger ship did not require a larger crew, so crew wages per container were much lower. Fuel consumption did not increase proportionally with the vessel’s size.”

To take advantage of these economies of scale, the ships needed to sail fully loaded. The largest ships can sail fully loaded only on routes where shipping volumes are highest, such as between Asia and the United States or between the United States and Europe. As a result, as Levinson notes, the largest ships are “uneconomic to run on most of the world’s shipping lanes” because on most routes the costs per container are higher for the largest ships for smaller ships. (Note that even these “smaller ships” are still very large in absolute size, being able to haul 1,000 containers.)

Large U.S. retail firms, such as Walmart, Home Depot, and Target rely on imported goods from Asian countries, including China, Japan, and Vietnam. Ordinarily, they are importing goods in sufficient quantities that the goods are shipped on the largest vessels, which today have the capacity to haul 20,000 containers. But during the pandemic, a surge in demand for imported goods combined with disruptions caused by Covid outbreaks in some Asian ports and a shortage of truck drivers and some other workers in the United States, resulted in a backlog of ships waiting to disembark their cargoes at U.S. ports. The ports of Los Angeles and Long Beach in southern California were particularly affected. By October 2021, it was taking an average of 80 days for goods to be shipped across the Pacific, compared with an average of 40 days before the pandemic.

Some large U.S. firms responded to the shipping problems by chartering smaller ships that ordinarily would only make shorter voyages. According to an article in the Wall Street Journal, “the charters provide the big retailers with a way to work around bottlenecks at ports such as Los Angeles, by rerouting cargo to less congested docks such as Portland, Ore., Oakland, Calif., or the East Coast.” Unfortunately, because the smaller ships lacked the economies of scale of the larger ships, the cost the U.S. firms were paying per container were nearly twice as high. (Note that this result is similar to the cost difference between a large and a small automobile factory, which we illustrated in Economics and Microeconomics, Figure 11.6.)

Unfortunately for U.S. consumers, the higher costs U.S. retailers paid for transporting goods across the Pacific Ocean resulted in higher prices on store shelves. Shopping for presents during the 2021 holiday season turned out to be more expensive than in previous years.

Sources: Marc Levinson, The Box: How the Shipping Container Made the World Smaller and the World Economy Bigger, Second edition, Princeton, NJ: Princeton University Press, 2016; Sarah Nassauer and Costas Paris, “Biggest U.S. Retailers Charter Private Cargo Ships to Sail Around Port Delays,” wsj.com, October 10, 2021; and Melissa Repko, “How Bad Are Global Shipping Snafus? Home Depot Contracted Its Own Container Ship as a Safeguard,” cnbc.com, June 13, 2021.

Glenn’s Take on the Proposal at the G7 Meeting to Impose a Minimum Tax on Corporate Profits

The G7 (or Group of 7) is an organization of seven large economies: Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. Only democratic countries are included, so China is not a member. At a recent meeting attended by U.S. Treasury Secretary Janet Yellen, the group agreed to adopt a uniform corporate tax rate of at least 15 percent.

Glenn discusses this decision in the following opinion column published in the Financial Times.

U.S. Treasury Secretary Janet Yellen and Paolo Gentiloni, European Commissioner for Economy, at a recent meeting of the G7.

Governments Should Tax Cash Flow, Not Global Corporate Income

From the Biden administration’s inception, US Treasury Secretary Janet Yellen has championed a global minimum tax for corporations. While the US walked back from a request for a 21 per cent rate (which was linked to an objective of raising the current US corporate tax of 21 per cent to between 25 and 28 per cent), it did lock in with G7 finance ministers a rate of at least 15 per cent. Secretary Yellen praised the move: “That global minimum tax would end the race to the bottom in corporate taxation, and ensure fairness for the middle class and working people in the US and around the world.”

It is tough to argue that corporate income shouldn’t pay its “fair share”. But the global minimum tax raises both political and economic questions.

Politics first. Approval in the US is likely to be tough. The minimum tax is estimated by the OECD to raise as much as $50bn-$80bn per year, much of it from successful American firms. Revenue to the US Treasury would be part of this amount, but small relative to the substantial expansion in spending proposed by the Biden administration. Will other governments engage their own political costs to achieve a deal that may be ephemeral if it fails to get US legislative approval? Even if the deal succeeds, might it hand a competitive victory to China? As a non-party to G7 or OECD proposals, could it not use both tax rates and subsidies to draw more investment to China?

But it is on economics that the global minimum tax draws more sensitive questions in two areas. The first is the design of the tax base. The second addresses the foundational question of the problem policymakers are trying to solve and whether the new minimum tax is the best way to do so.

A 15 per cent rate is not particularly useful without an agreement on what the tax base is. Particularly for the US, home to many very profitable technology companies, the concern should arise that countries will use special taxes and subsidies that effectively target certain industries. The US has had a version of a minimum tax of foreign earnings since the Tax Cuts and Jobs Act of 2017 enshrined GILTI (Global Intangible Low-Taxed Income) provision into law. The Biden administration wants to use the new global minimum tax to raise the GILTI rate and expand the tax base by eliminating a GILTI deduction for overseas plant and equipment investments.

For a 15 per cent minimum rate to make sense, countries would need a uniform tax base. Presumably, the goal of the new minimum tax is to limit the benefits to companies of shifting profits to low-tax jurisdictions, not to distort where those firms invest. The combination of a global minimum tax with the broad base advocated by the Biden administration could reduce cross-border investments and reduce the profitability of large multinational firms.

A still deeper economic issue is that of who bears the tax burden. I noted above that projected revenue increases are small compared to G7 government spending levels. It is not corporations who would pay more, but capital owners generally and workers, according to contemporary economic views of who bears the burden of the tax.

There is a better way to achieve what Yellen and her finance minister colleagues are trying to accomplish. To begin with, countries could allow full expensing of investment. That approach would move the tax system away from a corporate income tax toward a cash flow tax, long favoured by economists. In this revision, the minimum tax would not distort new investment decisions. It would also push the tax burden on to economic rents—profits in excess of the normal return to capital—better satisfying the apparent G7 goal of garnering more revenue from the most profitable large companies. And such a system would be simpler to administer, as multinationals would not need to set up different ways to track deductible investment costs over time in different countries.

In the debate leading up to the 2017 US tax law changes, Congress considered a version of this idea in a destination-based cash flow tax. Like a value added tax, this would tax corporate profits based on cash flows in a given country. The reform, which foundered on the political desirability of border adjustments, limits tax biases against investment and boosts tax fairness.

Returning to the numbers: countries with large levels of public spending relative to gross domestic product, as the Biden administration proposes, fund it mainly with value added taxes, not traditional corporate income taxes. A better global tax system is possible, but it starts with a verdict of “not GILTI.”

Glenn on Keynes, Hayek, and What It Will Take to Return to Full Employment

Glenn wrote the following opinion column for the New York Times.

How to Keep the Economy Booming — And Meet the Demand for Workers

In recent economic news, optimists and pessimists could both find evidence to support their outlooks.

The May jobs report showed a gain of 559,000 jobs in May and a decline in the unemployment rate to 5.8 percent. It also showed a marked improvement from last month’s weaker showing across a number of sectors, and average hourly earnings continued to rise. Ahead of the monthly report, the unemployment insurance weekly claims report on Thursday showed the number of new unemployment insurance claims fell from 405,000 the week before to 385,000 — lower than levels typically indicative of a recession (400,000). This is the first time this has happened since the pandemic-induced closures began. Further wage growth should help draw more workers back to the labor force.

Yet at the same time, the recent jobs report showed a big miss relative to the expected gain of 650,000 jobs. Constraints in supply chains and business reopenings still complicate the return to work. And workers still aren’t out of the woods: Thursday’s report indicated the total number of already unemployed individuals claiming benefits hasn’t dropped since mid-March. If job creation is robust, that contrast between falling new claims and those still on the jobless rolls is odd.

What explains these confounding tensions? To unpack them, consider the legacies of the economists John Maynard Keynes and Friedrich Hayek.

In his day, Keynes argued for boosting aggregate demand during a recession to keep workers afloat — a prescription that has clearly shaped the ultra-stimulative fiscal and monetary policies from both the Trump and the Biden administrations. His influence also resonates in the recent jobs reports: The coming rebound in the consumption of services — restaurant meals, entertainment and travel — will lift demand above its prepandemic level, and reopening and abundant consumer cash, bolstered by policy, will increase the demand for workers.

While Keynes may have lit the path to recovery after last spring’s cataclysmic job loss, he offers little to guide us through the coming labor-supply crunch. If policy actively disincentivizes the unemployed from returning to the fold, as recent reports suggest, there will be no one in place to meet the coming surge in demand, imperiling our economic rehabilitation.

To preserve the still-shaky recovery, we must now turn to Hayek, the godfather of free-market thinking. He argued that policy should allow workers to adjust to changes in the economy. Looking ahead, policymakers must consider curbing elevated unemployment benefits and a focus on old, prepandemic jobs in order to let workers and the economy adjust to new activities and new jobs that are more promising in the postpandemic world. We don’t want unemployed workers to find the postpandemic economy has passed them by.

As demand revives, supply will need to keep pace. Those in some industries, like carmakers, can simply sell off excess inventories, something that is already happening. Tool and machinery makers can increase imports to keep up. But eventually, demand must be met by higher domestic production from workers. Once businesses are freed from pandemic restrictions, we can expect to see some improvements in supply.

But holding back a faster improvement in employment and output are the very challenges Hayek identifies, including slowing down the process of matching dislocated workers to new, postpandemic jobs. That is to say, demand growth with supply constraints won’t produce the sustainable jobs recovery we need.

Many workers are taking their time to find a new job or are choosing to work less, thanks to their generous pandemic unemployment insurance benefits. These benefits provided extra income for those who lost their jobs early in the crisis. As a result, the economy’s adjustment to a postpandemic paradigm will be slow. These benefits also slow future gains in the form of higher wages workers might earn from a new and better job. But as Hayek tells us, the longer it takes for these workers to rejoin the work force, the longer it will take for them to gain these benefits.

In the coming months, we will be able to assess the potency of dealing with these forces of supply and demand by comparing employment gains in the 25 states choosing to end federal pandemic benefit supplements with the 25 states retaining them. While employment is likely to rise quickly as the pandemic fades and extra unemployment insurance benefits fall away, unemployment rates are still likely to remain high relative to prepandemic levels for another year.

If we look ahead, wage gains should be robust for those employed, particularly for lower-skilled service-sector workers — especially if some employees delay returning to work. Those higher real wages are good news for recipients.

A less welcome wild card would be inflationary pressures, fueled by demand outstripping supply. Those pressures could be a brief blip in an adjusting economy. Or they could suggest a reduction in purchasing power from higher inflation for an extended period. Higher recent inflation readings in consumer prices are a cause for concern.

Whether this happens hinges on whether the federal government and the Federal Reserve dial back their extra Keynesian demand support in time to avoid increases in expected inflation. Inflation risks robbing them of purchasing power gains from their higher wages.

The latest jobs report, then, favors a more Hayekian solution — with a nudge: Policy should support returning to work and matching workers to jobs by supporting re-employment and training for new skills, not just boosting demand. That shift offers the best chance for a sustained lift in jobs as well as demand as the pandemic recedes. In the matter Keynes v. Hayek, then: Let Hayek now prevail.

The Debate over Macro Policy

The current debate over monetary and fiscal policy has been particularly wide-ranging, touching on many of the issues we discuss in the policy chapters of the principles textbook.

Here are links to recent contributions to the debate.

Glenn and Tony discuss fiscal policy in a podcast HERE.

And monetary policy in a podcast HERE.

We discuss the Fed’s new monetary policy strategy HERE.

We discuss the current state of the labor market HERE.

The President’s Council of Economic Advisers discusses the need for additional fiscal policy measures in this POST on their blog.

An article on politico.com summarizes the debate HERE.

Harvard economist and former Treasury secretary Larry Summers has argued that fiscal and monetary policy have been too expansionary. A recent op-ed by Summers appears in the Washington Post HERE (subscription may be required).

Jason Furman, who was chair of the Council of Economic Advisers under President Obama gives his take on the division of opinion among academic economists in this Twitter THREAD.

Glenn Is Interviewed by the Financial Times

The Financial Times recently interviewed Glenn. Here is an edited version. The full interview can be found here.

Financial Times (Gillian Tett, editor-at-large for the United States): Gross domestic product data show that the economy is rebounding very fast from the pandemic; the Federal Reserve just said that it doesn’t intend to raise rates any time soon; and President Joe Biden has pledged a massive fiscal package. So what is your forecast for the American economy?

Glenn: Re-opening as the virus recedes would always lead to a very significant pop in GDP growth. So the near-term is not really the big question. There will certainly be a transitory increase in inflation. But I think the Fed on balance is correct, that boost is likely to be transitory. My worry is when I hear the Fed talk, as its chair Jay Powell has done, about wanting to watch for labor market “re-healing” to finish. The problem in the labor market is [largely] structural. Just running the economy hot by the Fed doesn’t fix that.

On fiscal policy, this is not just a “boost”.… The American Rescue Plan was intended as stimulus. But the American Jobs Act, the American Families Plan, those are really a remaking of the size of government. It has to be paid for and arithmetically can’t be paid for by taxes on the rich. There’s just not enough there. So the honest conversation with the American people is a matter of public choice: if you want a big government that does what President Biden wants [it to do], you’ll have to pay for it.

GT: How confident are you that inflation pressures are transitory?

GH: One can never be completely confident, but I think if the Fed had a clearer policy story I could be confident that commodity price increases are transitory. What worries me is the Fed thinking it can lean against structural changes in the labor market with monetary policy. One might worry a bit about inflation risks in the long-term—some of the structural headwinds against inflation to do with demography and growth in the emerging world, particularly in China, are going away.

GT: Do you think that the Fed should be indicating that it’s willing to raise rates if inflation rises?

GH: I think the Fed is unlikely to do that. [But] one of the reasons you are seeing implied volatility in rates and credit markets so high relative to equities, is the fear in the bond market that, maybe, the Fed is saying one thing but if backed into the corner could do another. Remember that the Fed bought around half of Treasury issues last year, and owns 40 per cent of all of the outstanding 10-year plus maturity treasuries, so the Fed’s thoughts there, which aren’t really clear to the bond market, are very, very important.

GT: Larry Summers has said this is way too much [stimulus], way too fast and will create inflation risks. You and Larry don’t often agree, but would you agree on this?

GH: I would agree on the risk, but it’s [not] the problem that is worrying me the most. What worries me even more is [in trying to] create a government that large . . . if you want a government that does those things, tax burdens will have to be higher.

If you look at the math on the tax burden, the [proposed] corporate tax increase or capital gains tax increase are not remotely large enough. The other structural thing that worries me is that I do see productivity reductions and investment reductions as a result of these large tax increases.

GT: Biden said if you are earning less than $400,000 a year you will not see your taxes go up.

GH: Well, it’s just not true, [neither] in the near-term [nor] the long-term. Take the corporate tax. Many economists have concluded that much of the burden of the corporate tax is borne by workers. In the 1970s and early 1980s, we thought it was capital that bore the burden of the corporate taxes. [But] that is not what economists believe today. So you simply cannot say that people who make less than $400,000 aren’t going to bear a part of the burden of the tax.

Likewise with capital gains, the president says: “I’m only going after 0.3 per cent of taxpayers,” meaning [those] that make more than a million dollars a year and have capital gains. But those individuals don’t have 0.3 per cent of the capital gains—they likely have the bulk of them. So if there are any effects on risk-taking, on saving and investment, the [risks] are very large.

Those effects are borne by the economy, not by the top 0.3 per cent …. And in the longer term … if you look at the budget math here, there’s going to be a large revenue hole. Somebody has to pay for it.

GT: Well, what about that “somebody” being companies?

GH: Let’s put the tax changes into two buckets. On the rates, I don’t think we want to go as high as the president is proposing, certainly not back to the old rates. On the base, president Biden is proposing a tax increase by base broadening—it’s a very, very big change. I expect companies will acknowledge they need to pay some minimum level, but the math isn’t going to add up.

GT: What about taxes under the guise of climate change action, such as a fuel tax or value added tax?

GH: I think it’s a great idea. For years I have supported a carbon tax because I do believe that it is one of the best ways to deal with climate change. I’m very skeptical of subsidies in green things but if you put a price on carbon, businesspeople will rush around and innovate and do it efficiently and it does not have to be regressive .…

About [a value-added tax] VAT—there is no question that if we want the government President Biden is suggesting, you absolutely have to have a VAT.

European states that have much bigger [state sectors] than the American state as a share of GDP are not financed with taxes on capital. In fact, in many European countries capital taxes are lower than they are in the United States. They’re financed by consumption taxes [such as the VAT].

…

GT: Why do you think Biden’s package is undermining productivity?

GH: Let me just take one step back. Some discussions of secular stagnation come from insufficient aggregate demand. Another school of thought thinks that structurally we have a problem with productivity growth, in terms of the supply side of the economy and the economy’s potential to grow. That is where I’m coming from. The tax plans are definitely anti-investment, as the lack of capital deepening explains low productivity growth and capital gains tax increases can affect risk-taking. There’s certainly nothing to enhance productivity [in Biden’s plans] and a lot to discourage productivity.

It is not just the tax policy. I worry about a monetary policy that could lead to zombification of firms—an environment of very low interest rates that sustain low-productivity firms. To President Biden’s credit, pieces of what he’s proposing that are true infrastructure could, in fact, raise productivity, but that is a small part of what he’s actually calling infrastructure.

GT: Are you concerned about a future debt crisis?

GH: Well, we are the reserve currency country, and we are borrowing in our currency, so I think a slow and steady malaise is more likely. To give a practical example, the Medicare trust fund could run out of money within a year or so, social security within five or so years. That will force discussions in Washington as to whether the public may wish to have a government this size.

GT: So you don’t expect a debt crisis per se because of the reserve currency status?

GH: [Not] at the moment.

GT: Should Republicans be co-operating to create a bipartisan bill?

GH: You could get bipartisan support for a new “GI bill” to prepare workers to adjust from the Covid world. For example, support in community colleges.

I’m not talking about free community college but supply side support—increasing their capacity to train people. Where you won’t get bipartisan support is [for] the notion that we need to move away from a work-supported social insurance system to a broader cradle-to-grave safety net.

The administration really fuzzed that up by calling it an infrastructure bill. Infrastructure doesn’t have to be just roads and bridges and airports—it could be broadband. But not healthcare.

GT: Are childcare support and elderly support part of “infrastructure”?

GH: No—those are social spending.

GT: One of the interesting ways you frame this debate is with the contrast between Keynes and Hayek, i.e. whether you’re trying to prop up the current system or encourage more rapid transformation. What do you mean?

GH: You could think of Covid [in terms of] a Keynesian response — we have a collapse in demand. The Keynesian response is not fanciful. But Hayek would say the new world after Covid isn’t going to look like the old world, so why support every single business? Both are right. We did a good job in policy on the Keynesian part. [But] we’ve done less well [thinking about Hayek].

GT: What do you think about Larry Summer’s concept of secular stagnation?

GH: There’s a scene in Dickens’ A Christmas Carol, when Scrooge asks, [something like] “are these the shadows of things that are or might be?”. I feel the same way about Bob Gordon’s descriptions of the American economy — Larry and Bob are talking about the shadows of things that could be if we have bad enough public policy, going back to the anti-productivity story. But I don’t think they’re inevitable.

Every businessperson with whom I speak is pretty optimistic about the technology frontier in productivity. If there’s a reason for pessimism, it’s more about the political system’s ability and willingness to let that productivity growth [run free].

GT: Do you think that the Republican party knows what it stands for with economics?

GH: … [An] approach Republicans could take is to go past the neoliberalism to liberalism (with a small L), to Adam Smith. He was anti-mercantilist—that’s what got him angry in The Wealth of Nations—and he was very interested in the ability of everybody in the economy to compete.

So a new Republican agenda might do more to help people compete—that sounds more like Lincoln, or like Roosevelt’s GI bill. In that lies a new agenda. But I don’t see the party really moving in that direction.

GT: What about the second book of Smith’s, The Theory of Moral Sentiments?

GH: Smith referred to “mutual sympathy”, which today we would call empathy. Forward-leaning businesspeople and business leaders think that way. I don’t see [the environmental, social, and governance] ESG [approach to investing] as somehow an enemy of shareholders—this isn’t Milton Friedman versus socialism—it’s more a matter of what really is in the long-term interest of the firm.

Remember, Smith railed against the British East India Company, which he thought of as a cancer. He thought you had to be very careful in the social framing of corporations. Businesspeople today need to understand the corporate structure is a social gift. In fact, capitalism is a social gift. If the public doesn’t want it, it won’t happen.

GT: I have a book coming out in a few weeks’ time that stresses this social and cultural aspect of business and finance and economics, and argues that business leaders need to move beyond tunnel vision to use lateral vision. Do you agree with this?

GH: Yes. When I teach students political economy, I remind them that great thinkers like a Friedman or Hayek or Smith wrote [for] the times in which they lived. Friedman and Hayek were writing in response to a very slovenly and inefficient corporatist economic system and were horrified by fascism. If Ronald Reagan were with us today, I don’t think he would be the 1980s Ronald Reagan. If Friedman and Hayek were with us today, they might have a different view. Context shifts.

GT: Friedman was also operating when people assumed that they could outsource the difficult social decisions to government and when there wasn’t radical transparency and customers, clients and employees couldn’t see exactly what firms were doing. Does that matter?

GH: Yes. If Friedman were here he might correctly remind us that there are big social externalities no one company can fix. But there is no reason businesspeople can’t be leaders. When the Marshall Plan was passed, that was not because Congress in its great wisdom decided to do something. It was because the business community came together and said: “Good Lord, we are going to have communism in western Europe and what’s that going to do to our economic system?” They pushed Congress. I understand that [today business is] afraid. But it’s not an excuse not to act. At many companies, their own employees are going to put pressure [on them to act].

GT: You are starting to see a level of company collaboration which was unimaginable when we had Thatcherism and Reaganism. Will this last?

GH: I do [think so] and Hayek would have celebrated this co-ordinated response because it bubbled up from the bottom. If you compare the production of vaccines, which was largely a private-sector activity, to the distribution of vaccines, which was more a public-sector activity, I think we know which one seemed to work better.

There are things that could help that—imagine if Biden put applied research centers all around the country that were linked with universities. That might help companies fix localities, as well as solving big problems like vaccines.

…

GT: Are you concerned that we have an ESG bubble?

GH: I am, in several aspects. We are running the risk of industrial policy and rent seeking, with just subsidizing “green things.” I also worry about how CEOs can deal with this—you don’t want the CEO spending half of his or her day responding to social concerns.

GT: What about protectionism? Can the Republicans present an alternative voice on this?

GH: I hope so, but I’m not sure. Like almost all economists … I believe in free trade. So why is something that is obvious in Econ 101 not so popular with the public?

I think for two reasons. One is whenever your Econ 101 professor talked about the gains from trade, he or she always [had] the idea that there would be losers, but compensation would somehow occur—and it hasn’t.

[Second] free trade is one of those examples, like the old classical gold standard, of a system that’s outside-in. You have to sign up for the rules of the game and then you just adjust. I think we need to go back to a period that says, look, we do need to understand domestic constituencies. That could mean much more support for training, it could be wage insurance, it could be lots of things rather than just saying free trade.

GT: So it’s about trying to talk about free trade with both parts of Adam Smith.

GH: Yes, exactly. Even Smith, who was the champion for openness, would not have countenanced whole areas just being left behind. Smith talked a lot about places—he said something like a man is a sort of luggage that’s hard to move, meaning you really have to look after places, not just jobs . . . its culture.

GT: Hey, anthropology can mingle with economics!

GH: Exactly—two social sciences, peas in a pod.

GT: So what’s happening to the economics profession? With issues like [the debate around Larry Summers’ criticism of Biden’s policies] are we seeing a tribal warfare break out between economists? Is there a rethink of economics? Is Biden moving away from them?

GH: Well, let me start with some good news: the young stars in the [economics] profession today tend to be people who are talking about big problems with new tools and techniques, ranging from development to monetary policy to labor markets. I think that’s entirely healthy.

I think the government needs people who have big macro views [too]. If I were in Janet Yellen’s shoes, I’d want to be talking to economists who could continue to give me that perspective, but also get micro perspectives from labor and financial markets. So there needn’t be a war. [But] I do worry from the way the Biden administration is talking about policies that economists just aren’t very involved at all. That’s not the first administration I’ve seen that happen—but it is a concern for the economics profession.