That task of estimating the social cost of carbon emissions is fraught with uncertainty. Still, it\’s a question where some answers are going to be more plausible than others–and assuming that the correct answer is \”zero\” runs a risk of incurring substantial costs in the future. Those who would like to dig down into how these estimates are done might be interested in \”Valuing Climate Damages: Updating Estimation of the Social Cost of Carbon Dioxide,\” published in January 2017 by a National Academy of Sciences Committee on Assessing Approaches to Updating the Social Cost of Carbon, co-chaired by Maureen Cropper and Richard Newell. (The report is available here, and uncorrected galley proofs of the report can be downloaded free.)
The NAS report is mainly about how these estimates are done and how they might be improved, but it also provides some background on the existing estimates. As the report explains:
The social cost of carbon (SC-CO2) for a given year is an estimate, in dollars, of the present discounted value of the future damage caused by a 1-metric ton increase in carbon dioxide (CO2) emissions into the atmosphere in that year or, equivalently, the benefits of reducing CO2 emissions by the same amount in that year. The SC-CO2 is intended to provide a comprehensive measure of the net damages—that is, the monetized value of the net impacts—from global climate change that result from an additional ton of CO2. Those damages include, but are not limited to, changes in net agricultural productivity, energy use, human health, property damage from increased flood risk, as well as nonmarket damages, such as the services that natural ecosystems provide to society. Many of these damages from CO2 emissions today will affect economic outcomes throughout the next several centuries.
The US government has for some year had an Interagency Working Group that produces estimates of the social cost of carbon. As the report notes:
The IWG’s current estimate of the SC-CO2 in the year 2020 for a 3.0 percent discount rate is $42 per metric ton of CO2 emissions in 2007 U.S. dollars. If, for example, a particular regulation was projected to reduce CO2 emissions by 1 million metric tons in 2020, the estimate of the value of its CO2 emissions benefits in 2020 for this SC-CO2 would be $42 million dollars.
It\’s worth unpacking that number just a bit. Here\’s an illustrative table giving a sense of the range of estimates under various conditions.
The social cost of carbon is based on a range of computer simulations. There are several different \”integrated assessment models,\” in which which a \”CO2 emissions pulse is introduced in a particular year, creating a trajectory of CO2 concentrations, temperature change, sea level rise, and climate damages.\” Another key parameter the \”equilibrium climate sensitivity,\” which represents a distribution of the effect that carbon emissions could have on climate in the future. There are also various scenarios for how emissions and various socioeconomic variables will evolve. The approach of the Interagency Working Group is to run a bunch of computer simulations with different combinations of these variables and different random draws of the \”equilibrium climate sensitivity\” parameter from its overall distribution, thus giving them a sense of how these different underlying assumptions can interact with each other.
The rows of the table show different years. The social cost of carbon rises over time, as the levels in the atmosphere rise and the costs become greater.
The columns show different assumptions about what economists call the \”discount rate.\” Most analysts accept the idea that if we are thinking about spending a fixed amount of current resources, it makes more sense to spend the money reducing a current harm than a future harm. To put the point more bluntly, taking an action to save 500 lives right now is more valuable in the present than taking an action to save 500 lives a century from now. Exactly how much more valuable are current benefits than future benefits? As you might imagine, the answer to that question is controversial, and so standard practice is to offer a range of estimates. A commonly used discount rate is 3%, which implies that each year a benefit is further off in the future, it\’s worth 3% less. A higher discount rate thus puts a lower weight on future benefits; a zero discount rate would mean that a benefit receives at any time in the future, no matter how far into the future, would be just as valuable as a benefit received right now.
The social cost of carbon calculation matters for public policy, because it\’s the value that is currently used by government rules and regulations when taking carbon costs into account. For perspective, the federal gasoline tax is currently 18.4 cents/gallon, and when state and local gas taxes (which vary across jurisdictions) are added to the mixture, total gasoline taxes are now about 49 cents/gallon. The usual rationale for such taxes is that they are a \”user tax\” so that those who drive also pay for updating and maintaining the roads. If the government set a carbon tax so that those who are emitting carbon through burning gasoline would would pay the cost of their emissions, a carbon tax of $42/ton of carbon emissions would work out to a gasoline tax of about 38 cents/gallon.
A few decades from now, when historians look back at the economic history of the late 20th and early 21st century, my expectation is that the most important storyline, by far, will be the rise of China\’s economy from poverty-stricken and unimportant in the 1970s to becoming the largest economy in the world less than four decades later. The Winter 2017 issue of the Journal of Economic Perspectives, where I labor in the vineyards as Managing Editor, devoted seven papers to China. Here are some of the main insights: by all means turn to the papers themselves for more. Courtesy of the publisher, the American Economic Association, all JEP papers from the most recent issue back to the first issue in Summer 1987 are freely available online.
\”Forty years ago, in 1978, China was unquestionably a socialist economy of the familiar and well-studied “command economy” variant, even though it was more decentralized and more loosely planned than its Soviet progenitor. Twenty years ago—that is, by the late 1990s—China had completely discarded this type of socialism and was moving decisively to a market economy. At that time, the question “Is China Socialist?” seemed meaningless to most people. China had shrugged off its old model of socialism, and obviously was never going back. China had officially recognized that no economy that excluded the market could hope to deliver satisfactory outcomes. Moreover, powerful trends at this time were limiting the scope of what China’s government could achieve. Government tax revenues relative to GDP had declined dramatically, substantially limiting government capacity. Social service provision had collapsed in most rural areas; inequality soared and a new wealthy class emerged; and de facto privatization enriched a group of people. At the time, it appeared that China’s economic success had been achieved at the cost of discarding socialist values. In the mid-1990s, the important question seemed to be: Would China continue to be a kind of “Wild West Capitalism,” in which almost anything might be for sale, or would it converge with the developed market economies, with improved regulation and rule of law?
\”China today is quite different both from the command economy of 40 years ago, and from the “Wild West Capitalism” of 20 years ago. The government in China has much more influence over the economy than in virtually any other middle-income or developed economy. State firms and state banks remain prominent. Government five-year plans command attention, both domestically and internationally. The Communist Party remains in power. … Today, the question `Is China Socialist?\’ can reasonably be asked and left open.\”
Naughton explores these changes over time. I found especially interesting his description of China as an \”authoritarian growth machine,\” in which local government officials have strong incentives–if they wish rise in the government hierarchy\” to promote economic growth in their local area. He writes:
\”China’s system of incentivized hierarchy—the authoritarian growth machine—was effective in mobilizing resources and maximizing growth during a “miracle growth” phase, when demographic, structural, and international factors all came together to raise growth rates. It also gave the Chinese government unprecedented control of resources and incentives, which it used predominantly to drive an enormous physical investment effort. The positive achievements are remarkable: the world’s best record of growth, tremendous success in alleviating poverty, and a national physical infrastructure built at unprecedented speed that is quickly approaching developed country standards. However, this “growth miracle” phase is now ending. Fundamental demographic changes, completion of many infrastructure programs, and a much-reduced distance to the global technological frontier are combining to lower China’s potential growth rate in a dramatic manner. China has less need for growth-before-all-else, but this also means that the incentivization of the hierarchy, so fundamental to the past growth model, is no longer central to China’s most important goals. The Chinese government has only belatedly begun to introduce a new set of instruments to achieve other objectives, and so far there is little evidence that China has developed a new way to steer the economy in a “socialist” direction while retaining some of the benefits of the developmental state …\”
Can China\’s Educational System Keep Up? China has been expanding its education system dramatically. Consider how college admissions in China rose from 1 million in 1999 to over 7 million in 2014. But will there be enough skilled workers in China to keep economic growth humming at the pace of 6-7% per year that the government seems to view as its goal?
In \”Human Capital and China\’s Future Growth,\” Hongbin Li, Prashant Loyalka, Scott Rozelle, and Binzhen Wu raise some hard questions. They point out that children from rural areas often suffer from malnutrition or other problems that hinder learning, that children of migrants within China suffer from unequal access to schools, and that some of the rise in college education involves a dubious quality of education.
The authors also carry out an interesting prediction, taking fairly optimistic estimates about the improvement and expansion of China\’s educational system in the next couple of decades, and then looking at what the education level of China\’s population will be in about 20 years. Based on the skill level of China\’s labor force, they suggest: \”In this best-case scenario, 26 percent of China’s adults will have a college degree and 42 percent will have at least a high school education by 2035.\” This would give China a level of human capital similar to the current level prevailing in Greece, and would involve an annual economic growth rate of about 3% per year. The authors write:
\”For a different perspective on why China is unlikely to experience a 7 percent annual rate of growth moving forward, consider a comparison with the US economy. At 7 percent annual growth, China’s per capita income would reach the level of $54,682 (in purchasing power exchange rate terms) by 2035, which is almost exactly the per capita income level of the US economy in 2014 ($54,629). In 2014, about 44 percent of the US labor force had at least a college education (and many more have attended college, although not graduated) and 89 percent of the labor force had at least a high school diploma. Even given the optimistic predictions above, China’s education levels will be far below these US levels in 2035. Thus, the unlikely hope for 7 percent annual growth in China over the next 20 years would mean that China would need to have a relationship between human capital and per capita income that is considerably higher than the typical global experience would suggest is plausible.\”
Can China\’s Economy Make the Transition from Manufacturing to Innovation?
\”China’s economic growth of the previous three and a half decades was based on several key factors: a sequence of market-oriented institutional reforms, including openness to international trade and direct investment, combined with low wages and a favorable demographic structure. Chinese wages are now higher than a majority of non-OECD economies. For example, China’s wages are almost three times as high as India, an economy with almost the same-sized labor force. The Chinese working-age cohort has been shrinking since 2012.\”
The authors note that in recent years, economic growth in China has been driven almost entirely by high levels of physical capital investment, not by productivity growth. To evaluate prospects for future growth, they focus on China\’s investment in R&D and on data involving patents granted to Chinese firms. When it comes to R&D, China is doing more than one would expect from a country with its level of per capita GDP.
When it comes to patents, the absolute numbers of patents going to Chinese firms have been rising substantially, and various measures of patent quality (like the extent to which US patents by Chinese firms are being cited by other patents) suggests that China\’s patents are of reasonably high quality. As they write (citations omitted):
\”Since 2003, real wages in China have grown by more than 10 percent a year. Some reckon that China has passed the so-called “Lewis turning point,” which means that an era of ultra-low-wage production is over. While patents are rising for both capital- and labor-intensive firms, the fraction of patents granted to labor-intensive firms increased from 55 percent in 1998 to 66 percent in 2009. Rising labor costs may have induced labor-intensive sectors to come up with more innovations to substitute for labor …
For those interested in this subject, I also recommend the discussion of China in the \”The Global Innovation Index 2016: Winning with Global Innovation,\” published in August 2016 by the World Intellectual Property Organization along with INSEAD and the Johnson Graduate School of Management at Cornell University.
To set the stage, here is a striking figure showing China\’s consumption of coal, compared to the rest of the world.
And alongside, here is a measure of particulate air pollution across 85 cities in China, both for the population as a whole and for cities in the 75th and 25 percentiles of the distribution.
There doesn\’t seem to be any dispute that areas of China with high levels of pollution have paid the price in terms of lower life expectancy and diminished health. However, Zheng and Kahn make the case that China\’s government is taking pollution seriously with an array of regulatory and tax policies, as well as providing incentives for local officials to make it a priority. Oil prices in China are no longer subsidized, and instead are set by global markets. China\’s future economic growth is shifting to service industries, rather than heavy manufacturing. Many countries have found an \”environmental Kuznets curve,\” that as per capita GDP increases the political imperatives for a greater degree of environmental protection increase, and Zheng and Kahn present evidence that China is following this pattern, too.
\”Yet this US housing cycle looks stable and dull relative to the great Chinese real estate boom. In China’s top cities, real prices grew by 13.1 percent annually from 2003 to 2013. Real land prices in 35 large Chinese cities increased almost five-fold between 2004 and 2015. As prices rose, so did construction. Between 2003 and 2014, Chinese builders added 100 billion square feet of floor space, or 74 square feet for every person in China. During this time, China built an average of 5.5 million apartments per year. In 2014, 29 million people worked in China’s construction industry, or 16 percent of urban employment. By comparison, construction industry accounted for 8 percent of total employment in the United States and 13 percent of that in Spain at the peak of their most recent housing booms. … Unlike in the United States, high vacancy rates are a distinct feature of Chinese housing markets. Vacancies include both completed units unsold by developers, and purchased units that remain unoccupied. We estimate that this stock of empty housing now adds up to at least 20 billion square feet.\”
Can China\’s housing prices possibly be sustainable? The answer is potentially \”yes,\” but if China wants stable real estate prices, it probably needs to constrict the growth of supply–which poses tradeoffs if its own. The author summarize this way:
\”It is tempting to view these events from afar and conclude that a price drop is imminent. As we have tried to demonstrate, this scenario is far from certain. Chinese home-buyers appear to be investing for the long run and are unlikely to sell voluntarily even if home prices decline. Nor are they heavily leveraged, so repossessions and liquidations of homes are unlikely. Chinese developers are more leveraged, but are cozy with state banks, so their loans are likely to be restructured if necessary. Even if banks repossess properties from developers, they are unlikely to dump them on the market. Compared to Chinese stocks, more inertia is built into China’s housing market. In addition, there is the critical role of the Chinese government in housing markets. The demand for urbanization in China is large, so if the government acts to sharply restrict new supply, it can probably maintain prices at close to current market levels. …
\”Yet that path may create significant social costs. Construction employment would plummet. Millions of Chinese may lose the apparent productivity advantages associated with living in Chinese cities. Local governments would lose the financial autonomy from land sales and taxes that has been their institutional basis. The alternative for the Chinese government is to accommodate high levels of construction and housing supply. As we have showed, this will lead to very low or negative expected returns to investment in housing. The welfare of potential new buyers will rise, but current owners will suffer losses.
\”Bursting real estate bubbles have traditionally done great harm when they are associated with financial crises. Bubbles that burst without banking meltdowns, as in 1980s Los Angeles, are temporary events that seem to cause little long-run damage. Going forward, an important step is to secure China’s financial system, rather than focus solely on maintaining high housing costs in Chinese cities.\”
Why Does China\’s Government Allow Critical Social Media?
Our primary finding is that a shockingly large number of posts on highly sensitive topics were published and circulated on social media. For instance, we find millions of posts discussing protests such as the anti-PX [a chemical called P-Xylene] event in 2014, and these posts are informative in predicting the occurrence of specific events. We find an even larger number of posts with explicit corruption allegations, and that these posts predict future corruption charges of specific individuals. This type of social media content may increase the access of citizens to information and constrain the ability of authoritarian governments to act without oversight. …
However, social media also provide authoritarian governments with new opportunities for political control … Social media messages are transmitted in electronic form through an infrastructure that is typically controlled by the government. Recent advances in automated text analysis, machine learning techniques, and high-powered computing have substantially reduced the costs of identifying critical users and censoring messages . Governments can use these methods to track and analyze online activities, to gauge public opinion, and to contain threats before they spread. … Most of the real-world protests and strikes that we study can be predicted one day in advance based on social media content. … Indeed, Chinese government agencies across the country have invested heavily in surveillance systems that exploit information on social media. …
Another important surveillance function of social media is to monitor local governments and officials. In China, many political and economic decisions are delegated to local governments. These decisions need to be monitored, but local news and internal reports are likely to be distorted because local politicians control the local press and administration. In contrast, national politicians regulate social media. In social media, relentless complaints about local officials are abundant. Posts exposing officials who wore Rolex watches, lived in mansions, or had inappropriate girlfriends have resulted in investigations and dismissals. Not surprisingly, we observe millions of posts with explicit corruption allegations in our data. We find that social media posts related to corruption topics are effective for corruption surveillance. These posts help identify when and where corruption is more prevalent. Furthermore, we can predict which specific politicians will later be charged with corruption, up to one year before the first legal action. …
Our findings challenge a popular view that an authoritarian regime would relentlessly censor or even ban social media. Instead, the interaction of an authoritarian government with social media seems more complex. From the government point of view, social media is not only (1) unattractive as a potential outlet for organized social protest but is also (2) useful as a method of monitoring local 120 Journal of Economic Perspectives officials and (3) gauging public sentiments, as well as (4) a method for disseminating propaganda.
How Much Did the One-Child Policy Reduce China\’s Birth Rate?
Junsen Zhang discusses \”The Evolution of China’s One-Child Policy and Its Effects on Family Outcomes.\” For a feel of the argument, consider this figure comparing fertility rates in rural and urban China to some other countries. Two facts jump out. First, China\’s fertility rate starts dropping dramatically in the early 1970s, because of a quite stringent family planning policy adopted at that time, before the one-child policy is instituted in 1979. Second, China\’s fertility rate in recent years is quite similar to other countries in east Asia like Thailand and South Korea that did not institute a one-child policy.
Zhang cited estimates that China\’s working-age population peaked in 2015, and that China\’s overall population will peak around 2030. It appears likely that China will get old before it becomes rich. Comparing China\’s birth rates to those of other countries, and taking into account the strong connection between economic development and fewer children, Zhang writes:
\”Although the enforcement of the one-child policy may have mildly accelerated the fertility transition in China, it also brought substantial costs, including political costs, human rights concerns, a more rapidly aging population, and an imbalanced sex ratio resulting from a preference for sons. In retrospect, one may question the need for introducing the one-child policy in China.\”
The \”middle-income trap\” is an argument that when countries have emerged from dire poverty to middle-income status, they can become stuck at that point, and stop making progress toward higher income levels. The World Development Report 2017 notes: \”Contrary to what many growth theories predict, there is no tendency for low- and middle-income countries to converge toward high-income countries.\” The overall theme of this year\’s WDR is \”Governance and the Law,\” and as usual, the report offers a wealth of examples and insights. Here, I\’ll just focus on the arguments about the middle-income trap, where the report illustrates its underlying theme by arguing that \”the difficulty many middle-income countries have in sustaining growth can be explained by power imbalances that prevent the institutional transitions necessary for growth in productivity.\”
This figure illustrates the patterns of transition for economies between low-income, middle-income, and high-income status. On the horizontal axis, countries are plotted by their per capita income level in 1970; on the vertical axis, by their per capita income level in 2010.
To get a sense of how the graph works, look at the category of \”lower-middle income\” countries on the horizontal axis, with per capita GDP between 5 and 15% of the world leaders. Now run your eye up, and see how those countries are faring by 2010. A substantial share of them have fallen into the \”low-income\” category, although most remain in the same \”lower middle\” category as before. Only one of thee lower-middle countries from 1970, Korea, had emerged into the high-income category after 40 years. Similarly, if you start by looking at low-income countries in 1970, only two of them had risen as high as \”upper middle income\” by 2010: Equatorial Guinea (GNQ) and Botswana (BWA), which is a prosperity largely founded on oil and diamonds, respectively.
The World Bank researchers writing the WDR argue that a core problem is that the institutions and strategies that raise a country up to middle-income status are often different from the strategies that would allow taking the next step to high-income status–and entrenched interest groups can make the transition a difficult one. Here\’s some commentary from the WDR (citations and references to figuress omitted):
\”Middle-income countries may face particular challenges because growth strategies that were successful while they were poor no longer suit their circumstances. For example, the reallocation of labor from agriculture to industry is a key driver of growth in low-income economies. But as this process matures, the gains from reallocating surplus labor begin to evaporate, wages begin to rise, and decreasing marginal returns to investment set in, implying a need for a new source of growth. Middle-income countries that become “trapped” fail to sustain total factor productivity (TFP) growth. … Efficient resource allocation and industrial upgrading require a set of institutions that differs from those that enable growth through resource accumulation. …
\”The creation of these institutions may be stymied by vested interests. Creative destruction and competition create losers—and in particular may create losers of currently powerful business and political elites.This is a more politically challenging problem than spurring productivity growth through the adoption of foreign technologies, which tends to favor economic incumbents. These political challenges may be particularly great in middle-income countries because actors that gained during the transition from low to middle income may now be powerful enough to block changes that threaten their position. In this sense, the challenges that middle-income countries face go beyond policy choice to the challenge of power imbalances. … Understanding the policy arena in which elites bargain is essential for explaining the political economy traps faced by middle-income countries.
\”One such political economy trap is a persistent deals-based relationship between government and business. Deals-based, sometimes corrupt, interactions between firms and the state may not prevent growth at low income levels; indeed, such ties may actually be the “glue” necessary to ensure commitment and coordination among state and business actors. But they become more problematic for upper-middle-income countries. For example, theory suggests that as markets expand and supply networks become more complex, deals-based relationships can no longer act as a substitute for impersonal, rules-based contract enforcement. … Combating entrenched corruption and creating a level playing field for firms imply a need for accountable institutions. At upper-middle-income levels, legislative, judicial, media, and civil society checks become increasingly important.\”
The difficulties in moving toward types of governance that can offer a foundation for both representation and growth is an ongoing theme throughout the report. As another example, here are some facts about elections worldwide that raised my eyebrows. The share of countries holding elections is steadily rising, but the the share of elections rates as \”free and fair\” is steadily falling.
The number of elections is steadily rising (as shown by the bars) but voter turnout worldwide in those elections has been steadily falling.
Governments have become much less likely to censor the media in a direct way in the age of the internet, but they have become more aggressive about regulations that limit the ability of civil service organizations (CSOs) to organize themselves or to spread their messages. The report notes:
As the report notes:
\”Evidence from the last decade, however, suggests that the global trend may be a shrinking civic space (figure 8.10). Many governments are changing the institutional environment in which citizens engage, establishing legal barriers to restrict the functioning of media and civic society organizations, and reducing their autonomy from the state. For example, in the case of media, governments may award broadcast frequencies on the basis of political motivations, withdraw financial support of media organizations and activities, or enforce complex registration requirements that raise barriers to entry into a government-controlled media market. In the case of nongovernmental organizations (NGOs), governments might resort to legal measures to restrict public and private financing or pass stricter laws that restrain associational rights …\”
In short, economic growth and development isn\’t just about pulling the right economic policy levers–government budgets, monetary policy, investment in education, foreign aid, and the like. It\’s also about the extent to which economic forces have flexibility to function within the political and legal institutions of that society.
For some earlier posts on the hurdles in the way of economic convergence, see
A typical intro-level conception of the economy points to the household sector as net savers, who then through the financial system end up financing the investments made by firms. But while that overall pattern was a fair description of reality about four decades ago, times have changed. Peter Chen, Loukas Karabarbounis and Brent Neiman describe the shift in patterns in \”The Global Rise of Corporate Saving,\” published as National Bureau of Economic Research Working Paper #23133 (February 2017). (NBER working papers are not freely available online, but many readers will have access via a library subscription.)
Here\’s the pattern of global saving by sector. Government saving relative to government GDP hovers just a bit above zero percent. But back in 1980, households saved about 14% of GDP while firms saved about 9%. Those shares have now flip-flopped, with firms now saving 13-14% of global GDP, and households saving 7-8% in recent years.
Meanwhile, investment across the sectors of the economy has remained much the same.
The authors sum up this change: \”In the last three decades, the sectoral composition of global saving has shifted. Whereas in the early 1980s most of investment spending at the global level was funded by saving supplied by the household sector, by the 2010s nearly two-thirds of investment spending at the global level was funded by saving supplied by the corporate sector. The shift in the supply of saving was not accompanied by changes in the composition of investment across sectors. Therefore, the corporate sector has now become a net lender of funds in the global economy.\”
This change is not wholly unexpected, in the sense that it fits with other economic patterns that have been noted, like high levels of corporate profits and high levels of household borrowing. Sorting out the reasons why corporate savings have become so large are still being investigated. But at this stage, the authors point out that the pattern is theoretically consistent with a model that includes lower levels of real interest rates, lower prices for investment goods, and lower corporate income tax rates.
This shift in the source of global saving represents a shake-up in the global financial system. For example, it means that firms become less likely to turn to external capital markets when raising money, because they can use their own savings instead. At some ultimate level, of course, firms are owned by people, like shareholders and other owners. Thus, one way to describe this shift is that the underlying parameters of the global economic system have shifted so rather than households saving funds directly, households now use firms as the mechanism through which they save.
I\’m not opposed to spending more money on fixing up roads and bridges and other physical infrastructure–indeed, it\’s often an investment fully justified by cost-benefit analysis–but I am dubious that 21st century economic growth is going to be based on fewer potholes. When talking about investment to drive economic growth, I\’d like to see more focus on expansion of research and development spending.
The OECD recently updated its data on \”Main Science and Technology Indicators,\” and here\’s a figure generated from that website comparing R&D spending as a share of GDP in different places. The three countries for which there is data going back to 1981 are Germany (the purple line DEU), the United States (the olive-green line), and Japan (the red line). Notice that despite all the talk about how knowledge gains will be exceptionally important in the decades to come, US R&D spending as a share of GDP has barely budged in the last 35 years.
Of course, one can also point out that Germany\’s R&D as a share of GDP has barely budged either. And both the US and Germany have higher R&D spending, relative to GDP, than does the average for the 28 countries in the European Union (EU28, the yellow line).
On the other hand, R&D spending in Japan is higher than US levels. R&D spending in Korea (light blue line) has soared far above US levels. R&D spending in China (dark blue line) has risen to surpass EU28 levels and is moving closer to US and German levels.
One of the gentle amusements from the hours I spend editing economics articles arises when authors forget the literal meaning of their own abbreviations. (Hey, there aren\’t a lot of belly-laughs in my job; you get your amusement where you can.) Here are five examples from early draft of papers.
An author writes about \”IT technology.\” Of course, IT means \”information technology,\” and no, the context was not about a highly specialized kind of second-order technology for information technology.
An author writes the \”CPI price index.\” Of course, CPI stands for Consumer Price Index.
An author writes about \”the CAPM model.\” Of course, CAPM means \”capital asset pricing model.\”
An author writes about \”the VAT tax.\” Of course, VAT means \”value-added tax.\”
Au author writes about \”a major R&D research project.\” Of course R&D stands for \”research and development,\” and no, the author was not trying to describe a research project about R&D.
Acronyms and other specialized terminology always serve two functions. As economists and other specialists are quick to argue, they can be an exceptionally useful tool in professional communication, letting you refer to complex concepts in a compact form. But as economists and other specialists are slower to admit, the easy and casual use of acronyms and abbreviations is also a way of acting like part of an in-group, and of signalling to those outside the group your high-and-mighty status as an authority on the subject.
Again, I believe that both of these functions are always in play. One hopes that the first explanation based in the functionality gained from using acronyms and abbreviations will tend to predominate. One is always entitled to hope.
While the use of acronyms and abbreviations in economics may sometimes be overdone or even twee, at least little harm is done in the process (except for the pain suffered by hypersensitive editors). They are mostly just a sloppy signal that the author\’s brain isn\’t fully engaged and in a few cases can become comprehension-threatening, as the reader tries to figure out if the combination of abbreviation and repeated terms has some subtle meaning.
Acronyms and abbreviations are powerful medicine, and should be used in limited doses–always remembering what you are using. It doesn\’t kill many more pixels to spell out terms.
\”But close examination of China’s aggressive top-down approach to the promotion of renewable energy reveals that it has fallen far short of its ambitious goals. Turbines were quickly installed—but many of them were not connected to the power grid. After some turbines were connected, the state-owned enterprises (SOEs) that operate the national grid often refused to accept energy from them. These problems led to inefficiencies that are without precedent in the Western world. They help explain the shocking fact that although its installed wind energy capacity is 75 percent larger than that of the United States, China produces 14 percent less wind energy than the United States. Even in a political system with a strong centralized government, China’s push for renewable power faltered in the face of entrenched interests, weak incentives, and conflicting policy priorities.
\”After accounting for the cost of building wind capacity that was not effectively utilized by the national grid, the cost of wind energy in China in the mid-2000s was twice as high as projected. A decade later costs had declined, but they were still 50 percent above projections. Consequently, the cost of carbon mitigation by replacing coal-generated electricity with wind energy has been four to six times higher than official estimates.\”
Apparently, up through about 2010, as much as 35% of China\’s wind capacity wasn\’t connected to the electrical grid at all. Since then, the electrical grid operators often \”curtail\” the electricity produced by wind power–which means they simply refuse to purchase it. The authors explain why:
\”Data from the first half of 2016 show a national curtailment rate of 21 percent—significantly higher than in any year between 2011 and 2015—and the highest curtailment rates typically lie in the second half of the year … Curtailment rates are high and rising because keeping them high serves the financial interests of the grid companies. Since 2014 the growth of China’s energy-intensive industries has sharply decelerated, limiting electricity demand. At the same time, global coal prices have fallen sharply, lowering the cost of coal-powered electricity. Overestimating energy demand, the authorities permitted the construction of too many coal plants, forcing many of them to operate well below capacity. The intermittency of wind, and the need for the grid operators to purchase and dispatch the right amount of fossil energy–generated electricity to offset that intermittency, make wind power significantly more expensive for grid companies to use than coal power. Seeking to maximize their margins, the grid companies buy increasingly cheap coal energy and increase curtailment of wind energy.\”
China\’s wind power seems to be an example of how powerful government control can push in one direction, but even in this setting, economic realities will push back. I\’ve read a lot about China\’s efforts to expand renewable energy sources in the last 10-15 years, but Lam, Branstetter, and Azevedo put the results to date in perspective when they write:
\”The still-large gap between installed capacity and renewable energy usage helps explain one of the painful realities of China’s green energy push: After a decade of unprecedented expansion, renewables have risen from 6 percent to only 10 percent of China’s total primary energy consumption—and hydropower generates 8 percentage points of that total …\”
Back before the European Union became embroiled in how the euro was affecting trade balances and government borrowing, it was focused on a more basic project: reducing trade barriers between its members in the name of creating a single market. How\’s that going?
Vincent Aussilloux, Agnès Bénassy-Quéré, Clemens Fuest and Guntram Wolff offer an overview in \”Making the best of the European single market,\” written as a \”Policy Contribution\” for the Bruegel think tank (Issue No. 3, 2017). They argue that the gains from the European single market have been substantial, that productivity and investment are lagging in the EU, and that a renewed boost for the single market might be a big help. I was particularly struck by their finding that trade across EU nations is at about one-fourth the level of trade across US states. They write (footnotes omitted):
\”Applying the synthetic counterfactuals method to various EU enlargements, Campos et al (2014) find that “per capita European incomes in the absence of the economic and political integration process would have been on average 12 per cent lower today, with substantial variations across countries, enlargements as well as over time”. This average figure is within the range found in the limited and fragile literature on this issue (5 to 20 percent, depending on the study). …
\”Still, trade between European countries is estimated to be about four times less than between US states once the influence of language and other factors like distance and population have been corrected for. For goods, non-tariff obstacles to trade are estimated to be around 45 percent of the value of trade on average, and for services, the order of magnitude is even higher. If the intensity of trade between member states could be doubled from a factor of 1/4 to a factor of 1/2 in order to narrow the gap with US states, it could translate into an average 14 percent higher income for Europeans (Aussilloux et al, 2011).\”
The US has been experiencing a slowdown in productivity growth and in investment levels. In the EU, it\’s just as bad or worse. Here\’s a figure showing the productivity slowdown in the EU, with a few illustrative comparisons across countries. The productivity slowdown is everywhere, but it\’s worse in Europe.
One factor that is intertwined with Europe\’s productivity slowdown is its investment slowdown. Notice that for the EU as a whole, the levels of saving (blue line) and investment (red line) more-or-less track each other from 2000 up through 2011. But after 2011, saving rises and investment drops. In other words, there is capital being saved in the EU, but it\’s being invested somewhere else (as illustrated by the rise in the current account balance.)
Aussilloux, Bénassy-Quéré, Fuest and Wolff note that the problem for additional moves to a single market is that many of the easier steps have been taken. Thus, they propose that the next steps should focus on a relatively small number of key industries where economies of scale and trade might be especially productive. They write:
\”The extensive literature on how the single market could be deepened generally concludes that the easy gains have already been secured. The remaining barriers to trade are now in the services sectors and are much more difficult to eliminate, since services are and should be regulated: health care, legal services or data-intensive industries all need proper regulation. Since discrimination between nationals and non-nationals has already largely been eliminated, the challenge now is to harmonise regulations so that companies can develop their activities across borders in the same smooth way as they do within a country. …
\”Despite much talk and some relative successes – for example in the air transport sector – many of the most prominent services sectors remain fragmented. This is the case in the energy sector, rail transport, telecoms, consumer insurance markets, banking and professional services, among others. Although the big players in each of these sectors have activities in several EU countries, they operate not as if there was one single market, but on a series of distinct national markets.
\”The very slow progress in the pan-European integration of these sectors over the last 20 years suggests that a new approach is needed. For sectors with strong cross-border externalities and/or the potential for large economies of scale, the EU could define a single rule book and establish a single regulator or a network of national regulators, similarly to competition authorities. In networks, the national regulators would abide by the same rules, the same principles and methods, and by the same jurisprudence under the supervision and the coordination of a European regulator. This would be compatible with different national policies in certain areas, such as the choice of different energy mixes. Creating larger and more integrated markets is particularly important in the digital sector.\”
The authors also have discussions of various other possible steps, like a common business registration system across the EU countries, creating a \”common consolidated corporate income tax base\” to make it easier for companies to deal with varying tax laws across countries, and ways to better coordinate rules across countries about environmental protection, unemployment insurance, and social security. But the overall message is that despite a few decades of effort, and wave upon wave of rules that have often been about smalls-scale details, the EU remains a long way from a \”single market\” in big industries that matter.
We seem to be surrounded by wave upon wave of new information and communications technology. However, measured rates of productivity growth rates have been slow for more than a decade, with the slowdown starting well before the Great Recession and continuing after its end, both in the US and around the world, Bart van Ark seeks to explain this situation in \”The Productivity Paradox of the New Digital Economy,\” which appears in the Fall 2016 issue of International Productivity Monitor (pp. 3-18). In a nutshell, his answer is that \”the New Digital Economy is still in its `installation phase\’ and productivity effects may occur only once the technology enters the `deployment phase\’.\”
At present, it\’s not just that productivity growth has slowed down, but counterintuitively, the sectors of the economy that make the biggest use of information and communications technology have been leading the way in this slowdown. Van Ark writes:
\”What\’s more, we find that when looking at the top half of industries which represent the most intensive users of digital technology (measured by their purchases of ICT [information and communications technology] assets and services relative to GDP) have collectively accounted for the largest part of the slowdown in productivity growth in all three economies since 2007, namely for 60 per cent of the productivity slowdown in the United States, 66 per cent of the slowdown in Germany, and 54 per cent of the slowdown in the United Kingdom. In the United States the contribution of the most intensive ICT-using industries declined from 46 per cent to 26 per cent of aggregate productivity growth between both periods. … The fact that ICT intensive users account for a larger part of the slowdown than less-intensive ICT users is another indication that the difficulty of absorbing the technology effectively is part of the explanation for the productivity slowdown.\”
Van Ark does believe that the growth of real output in information and communications technology is understated in the official statistics. But his broader theme is that information and communications technology is still in its \”installation stage,\” not its \”deployment stage.\” Here\’s how he sees the difference.
\”This article has argued that there are good reasons to believe that the New Digital Economy is still in the installation phase producing only random and localized gains in productivity in certain industries and geographies. … [W]we do not expect large aggregate growth effects from the New Digital Economy any time soon …\”
As an example of where the installation phase is still taking place, van Ark points to digital services and \”big data\” projects:
\”[T]he shift toward full usage of digital services is incomplete as yet. A recent survey of more than 550 companies in Europe and the United States suggests only a modest uptake on one major usage of digital services, which is \”big data\” analytics. Only 28 per cent of companies in North America and 16 per cent in Europe had undertaken big data initiatives as part of their business processes in 2015. Another 25 per cent of companies in North America and 23 per cent in Europe had implemented a big data initiative as a pilot project. Hence about half of companies surveyed had not yet undertaken any big data initiative. Strikingly, the study also found that manufacturing companies were lagging in applying big data analytics projects in regular business processes by 14 percentage points relative to the retail sector (27 per cent versus 13 per cent of companies in each sector).\”
I would be remiss not to mention that several other articles in this issue are worth particular attention, too, For example, Daniel Sichel reviews Robert J. Gordon\’s book, The Rise and Fall of American Growth,, and Gordon offers a response. Later in the same issue, Nicholas Oulton writes about \”The Mystery of TFP,\” which stands for total factor productivity: \”In all countries resources have been shifting away from industries with high TFP growth towards industries with low TFP growth. Nevertheless structural change has favoured TFP growth in most countries. Errors in measuring capital or in measuring the elasticity of output with respect to capital are unlikely to substantially reduce the role of TFP in explaining growth. The article concludes that the mystery of TFP is likely to remain as long as measurement error persists.\”
Most countries around the world and all high-income countries other than the United States have \”border adjustments\” in their tax code, but a key point to recognize is that border adjustments are typically part of a value-added tax–not the corporate income tax.
A value-added tax is essentially similar to a national sales tax in its economic effects. However, instead of being collected at the time of purchase, like the sales taxes with which Americans are familiar, a value-added tax is collected from firms throughout their production process. For example, the common \”credit invoice\” VAT works like this: As a starting point, the firm calculates what the value-added tax would be if applied to all of its sales. However, every time a firm buys a good or service from an outside supplier, it receives an invoice, and on that invoice is recorded the VAT previously paid by the supplier. The firm starts with what it would need to pay if the the VAT rate was applied to all of its sales, but then subtracts out the value-added tax that was already paid by its suppliers at an earlier stage of production. Through this \”credit invoice\” method, the value-added tax is only applied to the \”value-added\” that the firm itself has created. Also, as a matter of enforcement, every time a firm buy inputs it has an incentive to make sure that the previous firm paid the value-added tax that was due at that earlier stage of production.
It\’s important to notice that \”value-added\” is not equal to profits. The \”value-added\” of a firm includes both wages paid to its workers–who are the ones adding value, after all–as well as profits.
To understand how the \”border adjustment\” comes into play, consider the situation across US states when different states have different sales tax levels: say state A has a sales tax of 5% and state B has no sales tax. If a firm based in state B makes a sale in state A, state A will charge sales tax on the product \”imported\” across the state border. But if a firm from state A sells in state B, then no sales tax is charged on the product \”exported\” to the other state. Similarly, imagine two countries with different rates of value-added tax. When imported goods arrive across international borders into a country with a value-added tax, they need to pay a border adjustment. The purpose is not to put imports at a disadvantage, but only to avoid giving imports a special advantage of being able to avoid the value-added tax.
\”Unlike tariffs on imports or subsidies for exports, border adjustments are not trade policy. Instead, they are paired and equal adjustments that create a level tax playing field for domestic and overseas;
\”Border adjustments do not distort trade, as exchange rates should react immediately to offset the initial impact of these adjustments. As a corollary, border adjustments do not distort the pattern of domestic sales and purchases;
\”Border adjustments eliminate the incentive to manipulate transfer prices in order to shift profits to lower-tax jurisdictions; and
\”Border adjustments eliminate the incentive to shift profitable production activities abroad simply to take advantage of lower foreign tax rates.\”
To this point, the explanation answers one question, but opens up several others. The question that (I hope) is answered is why a tariff that places a tax on imports is different from a border adjustment. The typical border adjustment is not about disadvantaging imports relative to domestic production: it\’s just making sure that imports pay the same value-added tax as is paid by all other products in the country.
The question that is opened up sounds something like: \”But the US doesn\’t have a value-added tax, and so why does the idea of border adjustment even come up when talking about corporate tax reform?\” The answer to this question is that the proposal from House Republicans for revising the corporate income tax is actually a first-cousin-once-removed of a value-added tax. The proposal is to eliminate the existing corporate profits tax, and then to replace it with what is sometimes called a \”destination-based cash-flow tax.\”
The \”destination-based\” language means that US corporations would be taxed base on the destination of where their goods are sold, not based on where they are produced. The \”cash-flow tax\” language means that the tax would look a lot like a value-added tax, except that firms would not need to pay the tax either on inputs purchased from other firms, and also not on wages paid to workers (as occurs in a standard value-added tax).
Most countries have both a value-added tax and also a corporate income tax, viewing them as two different creatures. The proposal to install a destination-based cash flow tax as a replacement for the corporate income tax is in some ways a hybrid of the two.
Alan Auerbach provides a readable academic discussion of how this kind of corporate tax can work in \”A Modern Corporate Tax,\” published jointly by the Hamilton Project at the Brookings Institution and the Center for American Progress back in December 2010. He points to a number of advantages from this kind of change.
The new destination-based cash-flow tax would be a form of a consumption tax: that is, it taxes firms based what is consumed (whether through domestic production or imported goods), but would not have a corporate tax on exports. Firms would no longer depreciate equipment over time; instead, it would be treated as an expense the year such investments are made, which should tend to encourage investment. This plan would also stop the corporate gamesmanship of juggling the accounting so that profits seem to occur in low-tax jurisdiction, and should make the US an attractive place for foreign firms to invest. Auerbach writes:
\”Most countries, including the United States, attempt to collect corporate taxes based on where a corporation’s profits are earned. The problems with this approach are that businesses and investments are increasingly internationally mobile and a business’s profits are intrinsically hard to attribute to a particular place; indeed, the fungibility of profits results in a system where a disproportionate share of the profits of multinational companies appear to occur in the world’s least-taxed countries. Current corporate tax systems generate incentives that result in the current environment where countries compete for multinational business activity by lowering their corporate tax rates. To remedy this situation, sales abroad would not be included in corporate revenue nor would purchases or investment abroad be deductible in the second major piece of the proposed corporate tax reform. As a result, the corporate tax would be assessed based on where a corporation’s products are used rather than where the corporation is located or where the goods are produced. Assessing the tax based on where a firm’s products are used eliminates issues of where to locate a business and incentives for U.S.-domiciled businesses to shift profits abroad to reduce U.S. taxes.
\”This plan therefore delivers a host of economic advantages to U.S. businesses and American workers. Promoting domestic corporate activity and encouraging investment would boost productivity, the key driver of increases in wages, employment, and living standards. Indeed, estimates of similar proposals suggest these changes could increase national income by as much as 5 percent over the long run. … This new tax system also would retain or even increase the progressive element of the corporate tax system. The proposal would effectively implement a tax on consumption in the United States that is not financed out of wage and salary income.\”
It\’s worth contrasting the ideas about corporate taxation here with the broader claim that this tax is one way that a Trump administration would \”make Mexico pay for the wall.\” The border adjustment tax would apply to all imports, not just those from Mexico, for the reasons given above. As a consumption tax, it would raise prices to American consumers, who would be the ones paying for the tax. Assuming that it leads to a stronger US dollar, as pretty much all economists who study this subject expect, it won\’t end up affecting the US trade balance: basically, any effect of the border adjustment in reducing imports would be offset by a stronger dollar that will tend to raise imports by a roughly offsetting amount.
For a quick question-and-answer about the destination-based cash flow tax, a useful starting point is the short essay by William Gale on \”Understanding the Republicans’ corporate tax reform proposals,\” (January 10, 2017). I\’ve known Bill Gale more than 30 years, since graduate school days, and lest I be accused of invoking his name in a partisan context, I should note he\’s an interplanetary distance away from being a Trump supporter. He points out a number of potential difficulties with the Trump proposal as it stands: it would raise a lot less revenue than the corporate income tax it is replacing; it may contravene World Trade Organization rules; if it leads to a stronger dollar it will simultaneously reduce the value (in US dollars) of investments that have been made in other currencies; and it could even mean that some large corporate exporters become eligible for big tax refunds. But he also writes: \”The corporate tax is ripe for reform. The DBFCT is an excellent way to kick-start the needed discussion.\”
In short, there\’s also a nubbin of a good idea here about reforming corporate taxes, although it has essentially zero to do with unfair trade, cutting better trade deals, reducing imports, or \”making Mexico pay for the wall.\” If some suitable and substantial adjustments are made–starting with a higher tax rate than is included in the current proposal from the House Republicans–a corporate tax reform along these line is a potentially practical way of addressing many of the counterproductive incentives in the US corporate income tax. For example, US firms are currently holding about $2.5 trillion in cash outside the country, rather than bring it back and have it subject to the existing US corporate income tax. That\’s just one symptom of a deeper dysfunction with the US tax code.
Correction: An earlier version of this post referred to the DBFCT proposal as being from the Trump administration. Although it has been mentioned at times by the adminstration, the proposal itself is actually from Republicans in the House of Representatives. The text has been revised above to reflect this change.
