[In commemoration of US federal income taxes being due today, April 15, here\’s a repeat of a post from April 15, 2014, on the subject of government filling out your taxes for you.]
As Americans hit that annual April 15 deadline for filing income tax returns, they may wish to contemplate how it\’s done in Denmark. Since 2008, in Denmark the government sends you a tax assessment notice: that is, either the refund you can receive or the amount you owe. It includes an on-line link to a website where you can look to see how the government calculated your taxes. If the underlying information about your financial situation is incorrect, you remain responsible for correcting it. But if you are OK with the calculation, as about 80% of Danish taxpayers are, you send a confirmation note, and either send off a check or wait to receive one.
This is called a \”pre-filled\” tax return. As discussed in OECD report Tax Administration 2013: Comparative Information on OECD and Other Advanced and Emerging Economies: \”One of the more significant developments in tax return process design and the use of technology by revenue bodies over the last decade or so concerns the emergence of systems of pre-filled tax returns for the PIT [personal income tax].\” After all, most high-income governments already have data from employers on wages paid and taxes withheld, as well as data from financial institutions on interest paid. For a considerable number of taxpayers, that\’s pretty much all the third-party information that\’s needed to calculate their taxes. The OECD reports:
\”Seven revenue bodies (i.e. Chile, Denmark, Finland, Malta, New Zealand, Norway, and Sweden) provide a capability that is able to generate at year-end a fully completed tax return (or its equivalent) in electronic and/or paper form for the majority of taxpayers required to file tax returns while three bodies (i.e. Singapore, South Africa, Spain, and Turkey) achieved this outcome in 2011 for between 30-50% of their personal taxpayers. [And yes, I count four countries in this category, not three, but so it goes.] In addition to the countries mentioned, substantial use of pre-filling to partially complete tax returns was reported by seven other revenue bodies — Australia, Estonia, France, Hong Kong, Iceland, Italy, Lithuania, and Portugal. [And yes, I count eight countries in this category, not seven, but so it goes.] Overall, almost half of surveyed revenue bodies reported some use of prefilling …\”
For the United States, the OECD report notes that in 2011, zero percent of returns were pre-filled. Could pre-filling work in the U.S.? Austan Goolsbee provided a detailed proposal for how prefilling might work for the United States in a July 2006 paper, \”The Simple Return: Reducing America\’s Tax Burden Through Return-Free Filing.\” He wrote:
\”Around two-thirds of taxpayers take only the standard deduction and do not itemize. Frequently, all of their income is solely from wages from one employer and interest income from one bank. For almost all of these people, the IRS already receives information about each of their sources of income directly from their employers and banks. The IRS then asks these same people to spend time gathering documents and filling out tax forms, or to spend money paying tax preparers to do it. In essence, these taxpayers are just copying into a tax return information that the IRS already receives independently. The Simple Return would have the IRS take the information about income directly from the employers and banks and, if the person\’s tax status were simple enough, send that taxpayer a return prefilled with the information. The program would be voluntary. Anyone who preferred to fill out his own tax form, or to pay a tax preparer to do it, would just throw the Simple Return away and file his taxes the way he does now. For the millions of taxpayers who could use the Simple Return, however, filing a tax return would entail nothing more than checking the numbers, signing the return, and then either sending a check or getting a refund. … The Simple Return might apply to as many as 40 percent of Americans, for whom it could save up to 225 million hours of time and more than $2 billion a year in tax preparation fees. Converting the time savings into a monetary value by multiplying the hours saved by the wage rates of typical taxpayers, the Simple Return system would be the equivalent of reducing the tax burden for this group by about $44 billion over ten years.\”
Most of this benefit would flow to those with lower income levels. The IRS would save money, too, from not having to deal with as many incomplete, erroneous, or nonexistent forms.
For the U.S., the main practical difficulty that prevents a move to pre-filling is that with present arrangements, the IRS doesn\’t get the information about wages and interest payments from the previous year quickly enough to prefill income tax forms, send them out, and get answers back from people by the traditional April 15 timeline. The 2013 report of the National Taxpayer Advocate has some discussion related to these issues in Section 5 of Volume 2. The report does not recommend that the IRS develop pre-filled returns. But it does advocate the expansion of \”upfront matching,\” which means that the IRS should develop a capability to tell taxpayers in advance, before they file their return, about what their parties are reporting to the IRS about wages, interest, and even matters like mortgage interest or state and local taxes paid. If taxpayers could use this information when filling out their taxes in the first place, then at a minimum, the number of errors in tax returns could be substantially reduced. And for those with the simplest kinds of tax returns, the cost and paperwork burden of doing their taxes could be substantially reduced.
So many important aspects of the US and world economy turn on developments in information and communications technology and their effects These technologies were driving productivity growth, but will they keep doing so? These technologies have been one factor creating the rising inequality of incomes, as many middle-managers and clerical workers found themselves displaced by information technology, while a number of high-end workers found that these technologies magnified their output. Many other technological changes–like the smartphone, medical imaging technologies, decoding the human gene, or various developments in nanotechnology–are only possible based on a high volume of cheap computing power. Information technology is part of what has made the financial sector larger, as the technologies have been used for managing (and mismanaging) risks and returns in ways barely dreamed of before. The trends toward globalization and outsourcing have gotten a large boost because information technology made it easier
In turn, the driving force behind information and communications technology has been Moore\’s law, which can understood as the proposition that the number of components packed on to a computer chip would double every two years, implying a sharp fall in the costs and rise in the capabilities of information technology. But the capability of making transistors ever-smaller, at least with current technology, is beginning to run into physical limits. IEEE Spectrum has published a \”Special Report: 50 Years of Moore\’s Law,\” with a selection of a dozen short articles looking back at Moore\’s original formulation of the law, how it has developed over time, and prospects for the law continuing. Here are some highlights.
It\’s very hard to get an intuitive sense of the exponential power of Moore\’s law, but Dan Hutcheson takes a shot at it with few well-chosen sentences and a figure. He writes:
In 2014, semiconductor production facilities made some 250 billion billion (250 x 1018) transistors. This was, literally, production on an astronomical scale. Every second of that year, on average, 8 trillion transistors were produced. That figure is about 25 times the number of stars in the Milky Way and some 75 times the number of galaxies in the known universe. The rate of growth has also been extraordinary. More transistors were made in 2014 than in all the years prior to 2011.
Here\’s a figure from Hutcheson showing the trends of semiconductor output and price over time. Notice that both axes are measured as logarithmic scales: that is, they rise by powers of 10. The price of a transistor was more than a dollar back in the 1950s, and now it\’s a billionth of a penny.
As the engineering project of making the components on a computer chip smaller and smaller is beginning to get near some physical limits. What might happen next?
Chris Mack makes the case that Moore\’s law is is not a fact of nature; instead, it\’s the result of competition among chip-makers, who viewed it as the baseline for their technological progress, and thus set their budgets for R&D and investment according to keeping up this pace. He argues that as technological constraints begin to bind, the next step will be for combining capabilities on a chip.
I would argue that nothing about Moore’s Law was inevitable. Instead, it’s a testament to hard work, human ingenuity, and the incentives of a free market. Moore’s prediction may have started out as a fairly simple observation of a young industry. But over time it became an expectation and self-fulfilling prophecy—an ongoing act of creation by engineers and companies that saw the benefits of Moore’s Law and did their best to keep it going, or else risk falling behind the competition. …
Going forward, innovations in semiconductors will continue, but they won’t systematically lower transistor costs. Instead, progress will be defined by new forms of integration: gathering together disparate capabilities on a single chip to lower the system cost. This might sound a lot like the Moore’s Law 1.0 era, but in this case, we’re not looking at combining different pieces of logic into one, bigger chip. Rather, we’re talking about uniting the non-logic functions that have historically stayed separate from our silicon chips.
An early example of this is the modern cellphone camera, which incorporates an image sensor directly onto a digital signal processor using large vertical lines of copper wiring called through-silicon vias. But other examples will follow. Chip designers have just begun exploring how to integrate microelectromechanical systems, which can be used to make tiny accelerometers, gyroscopes, and even relay logic. The same goes for microfluidic sensors, which can be used to perform biological assays and environmental tests.
Andrew Huang makes the intriguing claim that a slowdown in Moore\’s law might be useful for other sources of productivity growth. He argues that when the power of information technology is increasing so quickly, there is an understandably heavy focus on adapting to these rapid gains. But if gains in raw information processing slow down, there would be room for more focus on making the devices that use information technology cheaper to produce, easier to use, and cost-effective in many ways.
Jonathan Koomey and Samuel Naffziger point out that computing power has become so cheap that we often aren\’t using what we\’ve got–which suggests the possibility of efficiency gains in energy use and computer utilization:
Today, most computers run at peak output only a small fraction of the time (a couple of exceptions being high-performance supercomputers and Bitcoin miners). Mobile devices such as smartphones and notebook computers generally operate at their computational peak less than 1 percent of the time based on common industry measurements. Enterprise data servers spend less than 10 percent of the year operating at their peak. Even computers used to provide cloud-based Internet services operate at full blast less than half the time.
Final note: I\’ve written about Moore\’s law a couple of times previously this blog, including \”Checkerboard Puzzle, Moore\’s Law, and Growth Prospects\” (February 4, 2013) and \”Moore\’s Law: At Least a Little While Longer\” (February 18, 2014). These posts tend to emphasize that Moore\’s law may still be good for a few more doublings. But at that point, the course of technological progress in information technology, for better or worse, will take some new turns.
There\’s a bubbling controversy over the \”secular stagnation\” hypothesis that investment levels are not only low, but likely to remain low. I\’ve posted some thoughts on the controversy here and there:
I\’m sure I\’ll return to the disputes over secular stagnation before too long, but for now, I just want to lay out some of the evidence documenting the investment slowdown. Such a slowdown is troublesome both for short-term reasons, because demand for investment spending is part of what should be driving a growing economy forward in the short-run, and also for long-term reasons, because investment helps to build productivity growth for increasing the standard of living in the future. The IMF asks \”Private Investment: What\’s the Hold-Up?\” in Chapter 4 of the World Economic Outlook report published in April 2015. Here\’s a summary of some of the IMF conclusions:
The sharp contraction in private investment during the crisis, and the subsequent weak recovery, have primarily been a phenomenon of the advanced economies. For these economies, private investment has declined by an average of 25 percent since the crisis compared with precrisis forecasts, and there has been little recovery. In contrast, private investment in emerging market and developing economies has gradually slowed in recent years, following a boom in the early to mid-2000s.
The investment slump in the advanced economies has been broad based. Though the contraction has been sharpest in the private residential (housing) sector, nonresidential (business) investment—which is a much larger share of total investment—accounts for the bulk (more than two-thirds) of the slump. …
The overall weakness in economic activity since the crisis appears to be the primary restraint on business investment in the advanced economies. In surveys, businesses often cite low demand as the dominant factor. Historical precedent indicates that business investment has deviated little, if at all, from what could be expected given the weakness in economic activity in recent years. … Although the proximate cause of lower firm investment appears to be weak economic activity, this itself is due to many factors. …
Beyond weak economic activity, there is some evidence that financial constraints and policy uncertainty play an independent role in retarding investment in some economies, including euro area economies with high borrowing spreads during the 2010–11 sovereign debt crisis. Additional evidence comes from the chapter’s firm-level analysis. In particular, firms in sectors that rely more on external funds, such as pharmaceuticals, have seen a larger fall in investment than other firms since the crisis. This finding is consistent with the view that a weak financial system and weak firm balance sheets have constrained investment.
I\’ll just add a couple of figures that caught my eye. Here\’s the breakdown on how much investment levels have fallen below previous trend in the last six years across advanced economies. The blue bars show the decline relative to forecasts made in spring 2004; the red dot shows the decline relative to forecasts made in spring 2007. These don\’t differ by much, which tell you that that the spring 2004 forecasts of investment were looking fairly good up through 2007. The dropoff in investment for the US economy is in the middle of the pack.
It\’s also interesting to note that the cost of equipment has been falling over time, driven in substantial part by the fact that a lot of business equipment involves a large does of computing power, and the costs of computing power have been falling over time. Indeed, one of the arguments related to secular stagnation is that the decline in investment spending might in part be driven by the fact that investment equipment is getting cheaper over time, so firms don\’t need to buy as much of it. An alternative view might hold that as the price of business equipment falls, then firms should be eager to purchase more of it. Again, I won\’t dig into those arguments here, but the pattern itself is food for thought.
Here\’s a figure showing annual sales of cameras over time, with smartphones included. The gray bars are analog cameras (CIPA stands for the Camera & Imaging Products association, which collects this data). Compact digital cameras are the blue bars. Smaller categories of digital cameras include D-SLR, which stands for \”digital single-lens reflex\” camera, and mirrorless, which are cameras with interchangeable lenses.
Specialists still need specialized cameras, but for basic personal and business use, the camera as a separate tool is dying. I suspect that extremely cheap and easy imaging, along with technology that can recognize and \”read\” those images, will change the way we manage our personal memories, our sharing of experiences with others, our record-keeping, and all the paperwork of society in dramatic and often unexpected fashions.
Homage: This figure appears in a blog post by Michael Zhang at the PetaPixel website. He credits a photographer named Sven Skafisk for collecting the data on smartphone sales and adding it to a previously existing figure. I learned about the post from a link at the Instapundit website.
In 2013, China\’s economy was much bigger than Germany\’s, but Germany\’s trade surplus–in absolute size–was larger than China\’s. That year, China\’s GDP was $9.2 trillion, about 2½ times as large as Germany\’s GDP of $3.7 trillion. But Germany\’s trade surplus was 7.8% of GDP, compared with a trade surplus of 1.9% of GDP for China. As a result, Germany\’s trade surplus was $274 billion compared with China\’s trade surplus of $183 billion.
As this example illustrates, some of what you may think you know about the patterns of trade surpluses and deficits has been changing during the last few years, so here are a few snapshots for bringing yourself up to date. Here\’s an edited version (I left out a couple of columns) of a table from Chapter 4 of the the IMF\’s World Economic Outlook Report for October 2014.
Here are some of the changes that jump out:
1) The U.S. economy still has by far the world\’s biggest trade deficits in absolute size, but by 2013 they had dropped dramatically compared to 2006.
2) Back in 2006, the huge trade deficits as a share of GDP in Spain, Greece, and Portugal, were all signs of the economic troubles to come in the euro-zone: that is, their imports were exceeding exports by such a huge margin–with the extra imports being financed by inflows of foreign capital–that a hard landing was very likely. By 2013, on the other hand, Spain, Greece, and Portugal no longer appear among the 10 largest trade deficits.
3) In 20016, the three biggest trade surplus economies by a considerable margin were China, Germany, and Japan. China\’s trade surplus fell sharply as a share of GDP, although because of China\’s continued rapid economic growth, it stayed large in absolute size. Japan\’s long-standing trade surplus actually disappeared back in 2011, and since then Japan\’s economy has been running trade deficits. However, Germany\’s trade surplus rose substantially from 2006 to 2013, both as a share of GDP and in absolute size.
4) Many of the big trade surplus countries in both years are substantial oil exporters: Saudi Arabia, Russia, Netherlands, Kuwait, Qatar, and UAE. Back in 2013, the price of oil was still high.
Let\’s take a look at four of the world\’s major players in international trade: the US, China, Germany, and Japan. Here\’s a figure showing their trade imbalances (as measured by the current account balance) since 1990.
Again, a few observations:
1) The persistent and large US trade deficits (blue line) during this time won\’t surprise anyone who has been paying attention, but there is a recent drop in the size of these trade deficits.
2) China (purple line) actually had fairly modest trade surpluses through the 1990s. They took off in the mid-2000s, and now are back in the modest range. My belief, explained at greater length here, is that when China joined the World Trade Organization in 2001 the resulting surge of exports surprised everyone–even those in China. For several years now, China\’s government has had a publicly announced goal of lower trade surpluses, which has in fact been happening.
3) Japan (green line) ran large trade surpluses during its years of rapid economic growth in the 1960s and 1970s, and it also ran sizeable trade surpluses during most of its period of economic stagnation in the last quarter-century. This fact helps to illustrate that trade surpluses are surely no guarantee of economic health, and can in fact be a sign of economic weakness.
4) Germany (red line) stands out as the country where trade surpluses have been on the rise since the euro came into widespread use in the early 2000s.
This post isn\’t the place to rehearse the economics of trade imbalances (for starting points, see here and here). For now, suffice it to say that there is no reason why every country in the world should hope to have a trade balance of zero every year, but problems can arise when very large surpluses or deficits are a signal of economic weakness. For example, in the eurozone and in Germany (as in Japan for much of the period since the early 1990s), large trade surpluses are co-existing with slow or no increase in domestic demand. Here\’s how the US Treasury phrased the situation in its Report to Congress on International Economic and Exchange Rate Policieson October 14, 2014.
The euro area\’s overall current account, which was close to balance in 2009-2011, shifted to a surplus of 2.4 percent of GDP in 2013. The euro area’s surplus averaged about 2.3 percent of GDP in the first half of 2014. Germany’s current account surplus was 7.1 percent of GDP in the first half of 2014, up marginally from the second half 2013 surplus of 6.8 percent … High surpluses in the euro area have persisted amid exceptionally weak domestic demand growth. Real domestic demand growth was positive in only two quarters in the past three years in the euro area, rendering the region reliant on demand emanating from outside of Europe for economic growth. …
Although there has been a rebound in exports in some European peripheral countries, the adjustment process within the euro area would be facilitated if countries with large and persistent surpluses took stronger action to boost domestic demand growth. For example, in Germany, domestic demand has been persistently subdued. German domestic demand growth picked up in the first quarter of 2014, but it flat-lined in the second quarter, leaving domestic demand just 0.9 percent larger in the first half of 2014 than in the second half of 2013. Weakness in investment has been particularly notable, with gross investment contributing negatively to growth in 2012 remaining effectively flat in 2013. … In 2013, the European Union’s (EU) annual Macroeconomic Imbalances Procedure, developed as part of the EU’s increased focus on surveillance, identified Germany’s current account surplus as an imbalance that requires monitoring and policy action. Notably, the EU stated that, given the size of the German economy, action was particularly important to reduce the risk of adverse effects on the functioning of the euro area.
A few year\’s back, the major risk of global imbalances was the enormous US trade deficit and the enormous Chinese trade surplus. Both of those risks have ebbed. But the risks posed by Germany\’s enormous and growing trade surplus remain.
Back in the 1980s, the New Republic magazine ran a \”most boring headline\” contest. The winner was \”Worthwhile Canadian Initiative.\” The title of this post, \”Better Batteries,\” might not have won that contest, but surely it could have placed in the top ten. However, improvements in battery technology matter immensely. Information and technology runs on electricity, and the capabilities of that technology are in many circumstances determined by whether a device can be disconnected from an electrical cord–at least for at time. Advances in consumer electronics (smartphones, tablets, computers, games), industrial electronics (robots), electric cars, and even making more widespread use of intermittent power sources like wind and solar all depend in various ways on the cost and effectiveness of rechargeable batteries.
This concern comes up regularly in news stories. For example, here\’s a story from C/NET by Ian Sherr and Shara Tibken last December 2, 2014, called \”It\’s 2014. Why is my battery stuck in the \’90s?\” The subhead reads \”The devices we all rely on continue to evolve radically. So why has the battery industry failed? Here\’s how you can take charge.\” They write:
\”A new smartwatch has more computing power than the Apollo moon landing spacecraft. Batteries are a different story. Even though consumer electronics makers, from Apple to Samsung, pour millions of research dollars into eking out more battery life for devices, the technology isn\’t expected to advance much in the next few years. … Why battery tech has stagnated is a topic of debate among researchers, many of whom claim we\’re reaching the limits of what science can muster.\”
\”There is no Moore’s law for batteries. That is, while the computing power of microchips doubles every 18 months, the capacity of the batteries on which ever more of our gadgets depend exhibits no such exponential growth. In a good year, the capacity of the best batteries in our mobile phones, tablets and notebook computers—and increasingly, in our cars and household gadgets—increases just a few percent.\”
The reason that the battery in your smartphone or laptop lasts longer than it did a decade ago is not primarily because the battery is better, but because of innovations that allow the device to run while drawing less power. The most popular rechargeable batteries in the last couple of decades have been lithium-ion technology. There is lots of research on battery technology, from improvements in lithium-ion to alternatives like supercapacitors. I\’m just a casual onlooker to this research effort. But after a few decades of reading short articles and press releases about how this or that approach is sure to revolutionize batteries, I\’ve grown cynical about the prospects for extraordinary order-of-magnitude progress.
Thus, I was startled and intrigued by a short article authored by Björn Nykvist and Måns Nilsson and called \”Rapidly falling costs of battery packs for electric vehicles\” which appears in Nature Climate Change, published online on March 23, 2015 (v. 5, pp. 329–332). Only the figures from the article are freely available on-line, although readers may be able to get access through a library subscription.
For electric cars to be truly cost-competitive with gas-fueled vehicles, battery costs need to drop dramatically. The rule-of-thumb has been that the cost of the battery pack in an electrical car needs to drop to $150 per kilowatt/hour or less. A few years back, it was standard to read that battery packs in electric cars were costing $700 per kilowatt/hour or more. Given the historically slow pace of progress in battery technology, it looked as if achieving these costs savings might be three or four decades away.
However, Nykvist and Nilsson argue that in the last few years, progress toward better batteries has been much more rapid. They collect 80 different estimates of battery-pack costs for electric cars from 2007-2014, and the pattern seems to be that costs are falling much more quickly than expected. As they write: \”Cost estimates (N=85) included are from peer reviewed papers in international scientific journals; the most cited grey literature, including estimates by agencies, consultancy
and industry analysts; news items of individual accounts from industry representatives and experts; and, finally, some further novel estimates for leading BEV [battery electric vehicle] manufacturers.\” Here\’s the figure illustrating their estimates:
They argue that the market leaders for electric cars have already reached a cost of $300 per kilowatt-hour–that is, they aren\’t just writing with another set of predictions for how batteries will improve, but arguing that they have already improved. Further, they note that global sales of battery electric vehicles are doubling annually. This sharp rise in volume seems to me making it worthwhile to push harder on the R&D specifically related to these kinds of batteries, including \”anode and cathode materials, separator stability and thickness, and electrolyte composition.\” They argue that when these factors are combined with efficiencies from economies of scale, annual productivity gains of 12-14% are conceivable in the next few years, although they view 8% annual growth as more likely.
On this trajectory, nonsubsidized electric vehicle would be commercially viable in about a decade. If gasoline prices rise again in a sustained way, it could be sooner. Moreover, it seems very likely to me that improvements in batteries for electric cars will at a minimum spill over to robotics applications, and probably to other uses of batteries as well–like the ability to charge your car battery using solar panels or wind power. The usual caveats apply. Past performance is no guarantee of future results. If a battery is charged by electricity generated at a coal-burning or oil-burning generator, the environmental gains may not be large. The materials used to make batteries pose their own environmental risks. But still, it\’s the best news about better batteries I\’ve seen in awhile.
P.S. After this post was published, several regular readers sent along recent articles about new advances in battery technology. For example, Stanford researchers recently announced an aluminum-ion battery. Here\’s a newspaper article mentioning the aluminium battery, along with research on nanotube-based batteries, sulfur-based batteries, metal-air batteries, and solid-state batteries. Maybe some of these will pan out. But as mentioned in the post, I\’ve been following battery technology in a loose way since the 1980s, and there has been a steady stream of announcements like these that, for one reason or another, turned out not to be commercially viable in the short-term or medium-term. Maybe this time will be different?
[W]e\’re always in a second-best world. We\’re always forced to think about reform strategies that will work in the world as we find it, not in the world we would like to have. Suppose you\’re in a setting where the rule of law and contract enforcement are really weak. And you realize that they don\’t change overnight. Are you better off promoting the set of policies that presume that rule of law and contract enforcement will take care of themselves, or are you better off recommending a strategy that optimizes against the background of a weak rule of law? And I say that the evidence is that you do much better when you do the second.
The best example is China. Its growth experience is full of these second-best strategies, which take into account that they have, in many areas, weak institutions and a weak judicial system, and therefore they couldn\’t move directly to the kinds of property rights we have in Europe and the United States. And yet they\’ve managed to provide incentives and generate export-orientation in ways that are very different from how we would have said they ought to have done it, which would have been to simply open up their economy or privatize their enterprises. There, second-best strategies have been very effective. The same can be said of Vietnam, say, or farther afield, a country like Mauritius. …
The point about second-best outcomes is just a warning that you better do your homework and make sure that the second-best interactions are the wind behind you rather than the wind that\’ll be slowing you down.
I can give you examples where I think the standard recipe worked very well. Poland in 1990 did the most amazing cold turkey reforms. It opened up its economy, removed its subsidies, and removed price controls, all virtually overnight. And they did rather well, but there were a number of things that were specific to the Polish context that supported that — it had membership in the European Union as a carrot, and it received a stabilization fund to underpin the zloty. When Russia tried to do the same, it didn\’t work, because there were many things that were missing in that context compared to the Polish.
On nation-states in a global economy
Now, one can envisage a world economy where those institutions are provided not by the nation-state but by some global institutions. Conceptually, there is no reason why we can\’t have those, in which case the nation-state might become no more important than the state governments of Kansas or Nebraska are to the U.S. economy. But unless we have something like that, all we have is the nation-state. So it\’s very important for the health of markets – national and global — that the nation-state be healthy, that it be able to provide those functions. That necessarily means that economic globalization is something we can push only so far, because if we push it so far that you weaken the nation-state, it cannot provide these functions anymore — in fact you are undermining the stability and function of markets as well.
I think the financial crisis has made us see this a little bit better at least in the context of financial regulation, which is moving in a much more robust way into the national domain. But the lesson extends beyond financial regulation to many of the market-supporting functions of the nation-state.
On how economic science works and the role of models
The root of it is the problem that the profession has more or less the wrong idea about how economics as a science works. If you ask most economists, \”What kind of a science is economics?,\” they will give a response that approximates natural sciences like physics, which is that we develop hypotheses and then we test them, we throw away those that are rejected, we keep those that cannot be rejected, and then we refine our hypotheses and move in their direction.
This is not how economics works — with newer and better models succeeding models that are older and worse in the sense of being empirically less relevant. The way we actually increase our understanding of the world is by expanding our collection of models. We don\’t throw out models, we add to them; the library of models expands. Social reality is very different from natural reality in that it is not fixed; it varies across time and place. The way that an economy works in the Congo is very different from the way that it works in the United States. So the best that we can do as economists is try to understand social reality one model at a time. Each model identifies one particular salient causal mechanism, and that salient effect might be very strong in the Congo but it may be very weak at any point in time in the United States, where we may need to apply a different model.
If you look at the progress of economics all the way from perfect competition to imperfect competition, from incomplete information to behavioral economics, at every step we have said, \”Here are some additional realities for which we need newer models.\” Behavioral economics doesn\’t mean that we want to ignore models in which people are rational. There are plenty of settings where presuming people are behaving rationally is still the right way to go.
When you look at economics in that way, as a collection of models, then what does it mean to say that economics knows something about the world? Economists know how to think about various causal mechanisms that operate as part of social reality, but what they\’re very bad at in practice is navigating among the models describing them. How exactly do I pick the right model for a given setting? This is a craft because the evidence never settles it in real time. We have these periods of fads where we say the New Keynesian or the Neoclassical model explains everything. We lose sight of the fact that models are highly context-specific and we need to be syncretic, simultaneously carrying many models in our mind.
On a semi-regular basis, I find myself trying to be polite while someone explains their breathtaking \”new\” insight that while economists all worship at the altar of GDP, this wise social critic has noticed that measurements of market output are not identical to social well-being. This supposedly new insight has been obvious to economists since they started trying to measure the size of an economy back in the 1930s and it\’s been a staple of political rhetoric at least since Robert Kennedy\’s elegant comments on the subject since 1968.
But while no economist believes that GDP is identical to social well-being, many economists do hold a related belief that growth of GDP over time has a positive correlation with human well-being broadly understood. Late last year, the OECD published a report called \”How Was Life? Global Well-Being Since 1820,\” edited by Jan Luiten van Zanden, Joerg Baten, Marco Mira d’Ercole, Auke Rijpma, Conal Smith and Marcel Timmer. In the course of 13 chapters written by different sets of authors, the report looks at evidence on demography, health, personal security, political structures, the environment, and other broad measures of well-being. The volume can be read online or ordered here. Here, let\’s do a quick review of the evidence on long-term correlations between economic growth and other measures of well-being, and then return to a discussion of correlation and causation between these factors.
As a starting point, here\’s a quick review of the evidence on growth of GDP over time.
\”The good news is that since the 1820s the average GDP per capita of the world’s population has increased by a factor of 10, a growth that contributed immensely to increased economic well-being. … The bad news is that GDP growth was very unevenly distributed across the various regions: during the 19th century, rich countries became richer and poor countries fell behind, resulting in a substantial increase in global inequality in GDP per capita. Global inequality kept rising during the first half of the 20th century, when the United States economy grew more rapidly than the rest of the world. After the 1950s, however, this process slowly started to reverse. For the first time, the economic growth rates experienced by poor economies were of a similar magnitude as those of rich economies. And, since the 1970s, low-income countries, in particular in Asia, grew much faster than high-income countries.\”
So how have other dimensions of human well-being been correlated with this rise in per capita GDP, both over time and across countries? The short answer is that there is a strong positive correlation between per capita GDP and and indicators of education and health status. There is a weaker but still positive correlation between higher per capita GDP and participatory political institutions. There is no clear-cut correlation between per capita GDP and personal security. The relationship between per capita GDP and the environment (viewed as a whole) seems to be an inverted U-shape: that is, growth of per capita GDP is first associated with higher environmental damage, but at some point it seems to be associated with lower damage. The relationship between per capita and income inequality seems to follow a regular U-shape: that is, growth of per capita GDP is first associated with greater within-country income equality up to about the 1970s, but since then is associated with greater inequality. Here are some details.
1) Education
Gains in education have a strong positive correlation with per capita GDP over time and across countries, probably a part of a virtuous circle: that is, a more educated workforce helps economic growth, and an economy with higher per capita income can afford to spend more on education. Here\’s an illustrative figure showing growth in global literacy rates over time.
2) Health status over the long-term can be proxied by measures like life expectancy and height. It seems clear that higher per capita GDP is associated with gains in both, although there is some evidence that at the highest levels of GDP, higher incomes are not associated with larger health gains. The report says:
\”Life expectancy at birth was about 33 years in Western Europe around 1830, 40 years in 1880, and almost doubled in the period after, with the largest improvements occurring in first half of the 20th century. In the rest of the world, life expectancies started to increase from much lower levels, rising in particular after 1945. Worldwide life expectancy increased from less than 30 years in 1880 to almost 70 in 2000. There is strong evidence of a shift in the relationship between health status and GDP per capita over the past two centuries. Life expectancy improved around the world even when GDP per capita stagnated, due to advances in knowledge and the diffusion of health care technologies.\”
Here\’s a figure showing population height compared with GDP per capita.
3) Personal security over the long-run can be approximated by using data on homicide rates and on war. The report summarizes the evidence on per capita GDP and homicide rates like this: \”Western Europe was already quite peaceful from the 19th century onwards, but homicide rates in the United States have been high by comparison. Large parts of Latin America and Africa are also violent crime “hotspots”, and so is the former Soviet Union (especially since the fall of communism), while large parts of Asia show low homicide rates. Homicide rates are in general negatively correlated with GDP per capita – the richer a country, the lower the level, but there are important exceptions.\” Here\’s a figure showing homicide rates in some selected countries since 1950, with the US rate far above the others.
4) The overall pattern of political institutions over time is toward greater participation, but the path has often been a bumpy one. Here\’s a figure showing an Index of Democracy, where the measure of competition is based on what share of the vote is received by the winning party (when a winning party receives nearly all the votes, competition is low) and a measure of participation based on the share of the adult population that votes. On a worldwide basis, both are rising since 1820. But the rise is bumpy and spiky at times.
5) Environmental quality is proxied by three measures in this report: biodiversity, and emissions of sulfur dioxide and carbon dioxide. The summary reads: \”A negative correlation with GDP per capita is clearly in place when looking at quality of the environment. Biodiversity declined in all regions and worldwide as land use changed dramatically. Per capita emissions of CO2 increased after the industrial revolution in Western Europe and its Offshoots, accelerating in the mid-20th century as other regions increased their GDP, and is still increasing globally. Per capita emission of SO2 (a local pollutant) also increased alongside higher industrial production, but were curbed since the 1970s thanks to the advent of cleaner technologies.\” Here\’s a figure showing sulfur dioxide emissions over time:
A key question is whether countries will tend to find ways to reduce environmental damage as their per capita GDP rises–as appears to be happening with SO2. Another way of making the point is that the ways in which economic growth affects the environment are strongly affected by public policy choices. As the report notes:
To some extent SO2 emissions follow an environmental Kuznetscurve, with declining emissions beyond a certain level of GDP per capita, and in recent periods biodiversity is also less directly (negatively) related to real income levels. Overall, there is still a rather strong negative link between environmental quality (as measured by these indicators) and GDP per capita, but this link has been weakening in recent years (since the 1970s), probably as a result of successful policies to lower emissions (SO2 probably being the best example).
6) Inequality of incomes is hard to summarize, in part because we live in a time when there is growing inequality of incomes within countries at the same time that global inequality of incomes is falling (with the rise of incomes in countries like China and India). Here\’a figure showing the evolution of the global distribution of income over time.
For the global distribution of income, the curves in the figure are gradually moving out to the right as economic growth raises the average world income. The area under the curves is also getting larger, which captures the fact that world population has dramatically expanded. It\’s interesting to notice that in 1970 and 1980, the global distribution of income had two humps, one at a lower income level and one at a higher income level. By 2000, the world is back to a one-hump income distribution.
From a national and regional level, the patterns show look different: \”Long-term trends in income inequality, as measured by the distribution of pre-tax household income across individuals, followed a U-shape in most Western European countries and Western Offshoots. It declined between the end of the 19th century until about 1970, followed by a rise. In Eastern Europe, communism resulted in strong declines in income inequality, followed by a sharp increase after its disintegration in the 1980s. In other parts of the world (China in particular) income inequality has been on the rise recently. The global income distribution, across all citizens of the world, was uni-modal in the 19th century, but became increasingly bi-modal between 1910 and 1970 and suddenly reverted to a uni-modal distribution between 1980 and 2000.\”
Overall, what should one take away from this exercise in thinking about the relationship economic growth as measured by GDP and other dimensions of human well-being? Here are a few of my own observations.
GDP is clearly not the same as real social welfare. However, it tends to be true that societies with a higher level of per capita GDP are better off on some other dimensions of well-being, not just consumption but also other factors including health, education, and personal freedom.
Many dimensions of social well-being are not includes here: for example, average hours worked per week, protection against economic risks, degree of personal freedom, traffic congestion, and others.
Patterns of international migration around the world suggest that of those people who want to move, the vast majority prefer to destination with an equal or higher per capita income.
Every social science student is inoculated with the knowledge that \”correlation is not causation.\” The correlations presented here do not prove causation. Economic growth can happen in many ways, and be accompanied by a wide range of public policies. It\’s easy to come up with examples where growth has been accompanied by greater or lesser degrees of educational improvement, greater or lesser degrees of political participation, greater or lesser degrees of environmental damage. Moreover, there will often been two-way causalities: for example, economic growth may help to foster democracy, but democracy may also foster economic growth. The correlations are what they are, but the causal factors will depend heavily on institutions and laws within countries and localities.
When I hear people offer the the stale and hoary complaint about how wrong it would be to equate GDP and social welfare, it seems to me that they they typically don\’t mean to argue that society would necessarily be better off if GDP were reduced. Instead, they are arguing that they would prefer to have the output of the economy and society–with output very broadly understood–reshaped so that a greater share of output went to areas like helping the poor, protecting the environment, providing health and education services.
An economy that is not growing is a zero-sum game. Groups can only gain if other groups lose. One set of social priorities can only expand if other priorities are diminished. A growing economy is a positive-sum game, and in such games, conflict can be much diminished. Those who are concerned about an overemphasis on GDP growth might meditate on the possibility that a larger social pie in and of itself is not your enemy–and in fact a certain kind of economic growth might be your best friend.
The World Bank is facing what I think of as a March of Dimes moment. The well-known March of Dimes charity was founded in 1938 with a focus on fighting polio. But after the Salk vaccine was licensed for use in 1955 and polio declined rapidly, the charity did not close up shop. Instead, it shifted its focus first to birth defects, and then to issues of healthy pregnancies and premature births.
A combination of growth in lower-income and middle-income countries around the world and change in their economic development challenges is leading to a similar crisis in the mission of the World Bank. Scott Morris and Madeleine Gleave lay out many of the issues in \”The World Bank at 75,\” published in March 2015 as Policy Paper 058 by the Center for Global Development. They write: \”As a lender to “LICs” and “MICs,” the World Bank will be reaching the limits of its usefulness in much of the developing world in the years ahead. It will continue to play an essential role in a relatively small number of fragile states, but the rest of its core lending model could very quickly become irrelevant to most of its other current borrowers. … On its current path, the World Bank will soon enough be viewed as no longer essential.\”
Although the rhetoric used by the World Bank to describe its mission has changed over time, most of what the World Bank actually does has been broadly the same for decades. It makes loans to national governments, with a heavy focus on infrastructure investment, with one set of loans and conditions for low-income countries and another for middle-income countries. This model is under challenge from several directions.
First, with sustained growth in many low-income and middle-income countries around the world, the number of countries eligible for World Bank loans is likely to fall the next few years. Morris and Gleave offer a map of the countries eligible for World Bank lending in 2015, with the countries meeting the low-income (per capita) guidelines in orange and the middle-income countries in blue. They then project what countries will fall into those categories just four years from now in 2019. Either the World Bank is going to adjust its income guidelines substantially, or it is going to become very focused on Africa and south Asia in the next few years.
A second issue is that developments in the world financial system mean that governments and economies of low-income and middle-income countries now have access to many more alternative sources of finance. Here are some of the rising sources of finance as listed by Morris and Gleave (footnotes omitted):
Low-income countries have had growing success in obtaining sources of financing other than official development assistance (ODA). Perhaps most prominent is the recent cohort of countries engaged in first time sovereign bond issuances, as well as the coupons on those issuances (see Figure 3). Both the incidence and interest rates reflect what is an extraordinary period in global financial markets, where investors are increasingly “chasing yields” after a sustained period of low interest rates associated with quantitative easing by major economy central banks. …
More generally, financing outside of traditional ODA sources (including the World Bank) are becoming increasingly important for developing countries. Foreign direct investment (FDI) from OECD countries has more than doubled over the last ten years, and is now 1.7 times as large as total ODA. Remittance flows to developing countries, too, are growing rapidly, totaling $430 billion in 2014. And due to their nature as direct income transfers, remittances have a first-order effect on poverty unmatched by many other flows. … And domestic resource mobilization has become an increasingly important source of public financing, as least-developed and lower-middle income countries have doubled domestic tax revenues in the last decade to total almost $14 billion.
Along with the financial flows from remittances, foreign direct investment, and a newfound ability for low-income countries to issue sovereign debt, there is even new competition in the world of development banks. There are existing regional development banks with growing financial clout like the Inter-American Development Bank (IDB), the African Development Bank (AfDB), and the Asian Development Bank (AsDB). As the authors note: \”In 2014, the World Bank’s third largest shareholder, China, announced the creation of a new multilateral development bank for Asia, the Asian Infrastructure Investment Bank (AIIB). At the same time, the Chinese also joined with the other “BRICS” countries, representing over one-fifth of the World Bank’s shareholders and some of the bank’s biggest borrowers, to plan for a new global MDB, the New Development Bank.\”
If the World Bank is going to stay relevant, it needs to evolve. But how? Morris and Gleave discuss the alternatives, which include:
Maybe instead of a focus on infrastructure, the World Banks should shift some of its emphasis to public goods like research and development for agriculture or disease prevention or reducing air pollution. Or course,these kinds of projects typically involve a large component of grants, rather than loans.
Maybe the World Bank should put more of its focus on crisis response, like its recent response to the Ebola outbreak, or on dealing with economic risks like the danger that the price of a key agricultural export commodity will fall.
Maybe instead of focusing on loans to national governments, the World Bank should consider loans to subnational areas, like water or transportation infrastructure for a certain city, or loans to regional areas, like transportation and electricity networks across national borders.
Maybe instead of making loans based national per capita income, the World Bank should focus on countries where high levels of deep poverty remain, or on countries that combine low income with issues like a high level of debt accumulated in past decades that is hindering future growth, or a lack of capacity to manage public finances and collect taxes.
Many researchers naturally look at the World Bank as an institution that could be a knowledge leader and a clearinghouse for what is known about how to make economic development work. This mission would emphasize that World Bank loans and projects should be designed to produce the kinds of measureable inputs and outputs that can be the grist for academic research.
The World Bank has tinkered with some of these kinds of evolution. In particular, the branch of the World Bank that works with private sector investors (the International Finance Corporation) has been growing in size. The idea is that these investments will focus not just on profitability, which they are achieving, but also on projects that bring additional development benefits and that would not otherwise get funding from private investors, which are harder to demonstrate.
But as the World Bank takes a good look at itself in the mirror, here\’s the hard question it needs to face. It\’s easy to list global problems that need solving. But is the World Bank only trying to justify its continued existence by looking for new tasks? Or can the World Bank identify areas where its own specific skills and capabilities will have a high payoff for economic development?
When I read media discussions about deflation,\” three separate meanings are often used more-or-less interchangeably.
One meaning is the way that economists use the term, in which \”deflation\” means \”inflation happening at a negative rate.\” Inflation means that the buying power of a certain amount of currency is reduced over time. Deflation means that the buying power of currency rises over time.
A second usage is a drop in asset prices: thus, you sometimes hear someone talk about the \”deflation\” in housing prices or the stock market. But a drop in housing prices or in the stock market has no direct effect on GDP, which only measures what is actually produced. (Housing prices do affect GDP in an indirect way, because GDP treats homeowners as people who are producing housing services and selling those services to themselves, using an \”imputed\” value that will be linked to the cost of renting a house, which in turn is linked to the price of the house.)
A third use of \”deflation\” refers to a drop in economic output. I think that when a lot of people hear the term \”deflation,\” they interpret it as meaning the same thing as \”recession\” or \”depression.\” It\’s of course true that a price deflation may be accompanied by a recession, but this has not always been true.
What are the relationships between price deflation, sharp falls in asset prices, and recession or depression? Claudio Borio, Magdalena Erdem, Andrew Filardo, and Boris Hofmann tackle this question in \”The costs of deflations: a historical perspective,\” published in the Bank of International Settlements Quarterly Review for March 2015.
To get an intuitive feeling for what history teaches about the connection from price deflation to recession or depression, here\’s a useful figure showing when deflations actually occurred. Annual episodes of deflation are shown by circles, while persistent deflation is shown by a horizontal line. (The reader should also note not all countries have price data over this entire period, and in those cases, the triangles show the start of when data is available.)
Clearly, there are many episodes of deflation in the late 19th and early 20th century, and then again during the \”interwar period\” that includes the Great Depression, followed by fewer episodes of deflation since then. The authors note that deflation and Depression clearly go hand in hand, but they also point out that in the 19th century, the 1920s, and the period since World War II, price deflation does not seem to have any strong correlation with economic growth. Indeed, as they point out, economic historians have sometimes referred to 19th century deflation as \”good deflation.\” In the post-World War II years, although the deflations are mostly transitory and this difference is not statistically significant, \”the growth rate has actually been higher during deflation years, at 3.2% versus 2.7%.\” The Annual Report of the BIS released last summer also made the case that deflation does not have an overall strong historical connection with recession or depression, as I noted here.
To what extent are changes in asset prices correlated with recession or depression? Borio, Erdem, Filardo, and Hofmann use the available data on stock market prices, as well as a newly expanded set of data on historical housing market prices. Thus, they can explore the question of what is the biggest danger for economic growth: price deflation, or a fall in asset prices? Of course, the Great Depression experienced both changes. Here\’s there conclusion:
Output growth is consistently lower during both property and equity price deflations, and the slowdown is statistically significant except in the classical gold standard period for house prices. The importance of property prices is again greater in the postwar period. … Once we control for persistent asset price deflations and country-specific average changes in growth rates over the sample periods, persistent goods and services (CPI) deflations do not appear to be linked in a statistically significant way with slower growth even in the interwar period. They are uniformly statistically insignificant except for the first post-peak year during the postwar era – where, however, deflation appears to usher in stronger output growth. By contrast, the link of both property and equity price deflations with output growth is always the expected one, and is consistently statistically significant. … [I]t is misleading to draw inferences about the costs of deflation from the Great Depression, as if it was the archetypal example. The episode was an outlier in terms of output losses; in addition, the scale of those losses may have had less to do with the fall in the price level per se than with other factors, including the sharp fall in asset prices and associated banking distress.
As the authors readily admit, this analysis is far from conclusive. But it does tend to support the possibility that concerns over price deflation may be overdone, while worries about bubbles in asset prices like stock markets or housing prices may have been underdone. Remember that the last two US recessions in 2001 and 2007-2009 were not preceded by deflation, but where preceded by an asset bubble popping–the dot-com bubble in the earlier episode and the housing price bubble more recently.
