Author: conversableeconomist

Consider this international trade conundrum: Say that a US-based multinational provides technology and managerial know-how to a firm in Europe. The firm uses these inputs to produce goods, which are then exported back to the US economy. As a result, the European economy has a trade surplus in goods vis-a-vis the US economy. However, a US firm gets all the profits. Is this good or bad for the US economy?

I won’t try to weigh and balance all the tradeoffs here, but something not too far from this example is happening in real life. Lorenz Emter, Michael Fidora, Fausto Pastoris, Martin Schmitz and Tobias Schuler present the patterns in “US trade policies and the activity of US multinational enterprises in the euro area” (ECB Economic Bulletin, Issue 4/2025).

The authors present this figure showing the “current account balance” between the US and the EU, the broad-based measure of trade flows that includes not just exports and imports of goods (which is called the “merchandise trade balance”), but also trade in services and flows of payments as a result of foreign direct investment.

The bars reaching up show trade in goods. As you can see, the euro area runs a trade surplus in goods with the US economy. The blue bar shows the share of the goods surplus due to US multinationals producing in the European Union. The bars reaching down show the areas where the US has a trade surplus with the euro area. The red bar shows the US surplus in trade of services, and the green bar shows the US surplus that is payments resulting from foreign direct investment. (For context: Seven countries in the European Union are not part of the euro area: Bulgaria, the Czech Republic, Denmark, Hungary, Poland, Romania, and Sweden.  Euro-area GDP is roughly 90% of EU GDP.) Overall, the ECB authors write:

ECB estimates suggest that almost 30% of the euro area goods surplus with the United States in 2024 involved trade by euro area affiliates of US MNEs, while these companies accounted for around 90% of the euro area deficit in services trade.

Overall, the current account balance suggests that trade between the US and the euro area is near-balance, as shown by the black line. If the imposes substantial tariffs against imports from the EU, then it presumably will reduce imports of goods from the euro-area countries–including the imports of goods from US multinationals. In addition, less production by US multinationals in the euro area means that sales of US-based services to those multinationals is likely to drop substantially as well, and payments to US-based firms as a result of their past investments in euro-area operations will fall.

Again, I will not try here to weigh and balance all these tradeoffs. But I do want to emphasize several points: 1) Using only the merchandise trade balance can be a deeply misleading way to look at trade between two regions because it leaves out the other parts of the current account balance. 2) The tradeoffs from imposing tariffs on the European Union (and elsewhere, for that matter) have some complexity to them. 3) The US-based firms that use their technological and managerial expertise to produce in other countries around the world, both to sell in foreign markets as well as in the US market, are some of America’s most productive and successful firms–indeed, they are the US firms most-envied by high-income countries around the world.

(Hat tip to Edward Conard’s Macro Roundup, which is always full of intriguing graphs and figures from a wide array of sources.)

Twice each year, the Federal Reserve is required to report to Congress, a process which involves both testimony from Fed Chair Jerome Powell and also the publication of the Monetary Policy Report, which comprises a broad statement of how the Fed is perceiving the US economy. The most recent report has a section on the movement of employment and earnings since 2019, the year before the pandemic hit.

For employment, the Fed report focuses on the employment-to-population ratio. A benefit of this approach is that categorizing those who do not have jobs as “unemployed” or “not looking for work” will always have a gray area between the two. The employment-to-population ratio sidesteps that issue.

For example, here’s are shifts in the employment-to-population ratio by age. During the pandemic, the employment-to-population ratio of the age 55+ group dropped by the least. but now, employment-to-population for the other age groups has rebounded to slightly above pre-pandemic levels, while remaining low for the 55+ group. A likely explanation here is that the pandemic causes a certain number of older folks to retire–and they just stayed retired.

Here’s a breakdown by sex and education level. The solid lines show men and women with “some college or more” education; the dashed lines show “high school or less” education. During the pandemic, employment-to-population dropped more for those with less education. At present, employment-to-population for women of all education levels has rebounded more strongly than for men.

For wages, the general pattern is that during the pandemic, those with lower wages and education way lower increases in wages, but they continued to see raises. However, those in higher wage groups and with higher education saw actual negative wage growth. But quite recently, wage increases for those with higher wage and education levels has now moved slightly ahead of other groups. two figures on the left-hand side of the panel illustrated these patterns, with corresponding patterns by race and sex on the right.

Does all of these mean that the Fed is ready to start reducing interest rates? To answer this question, you can gaze into the crystal ball that is the Monetary Policy Report youself. But in a different part of the report, the Fed discusses the recent path of inflation:

After declining modestly last year, consumer price inflation continued to ease during the first four months of this year, although at a bumpy pace and with some early signs that higher tariffs on U.S. goods imports are pushing up prices for some consumer goods. The 12-month change in the price index for personal consumption expenditures (PCE) was 2.1 percent in April, down from 2.6 percent at the end of last year (figure 1). Meanwhile, inflation for core PCE prices—which exclude often-volatile food and energy prices and are generally considered a better guide for future inflation—has also eased further this year but remains somewhat elevated, with the 12-month change receding from 2.9 percent in December to 2.5 percent in April. 

The Fed has for some years now focused on “core PCE” inflation as the key measure that it watches. By that standard, inflation has not yet fallen to the Fed’s goal of 2%.

Finally, I was also struck by a graph from the report on debt of households and nonfinancial firms. For households, total debt-to-GDP was trending up during the 1980s and 1990s from about 0.5 to 0.7. During the housing boom of the early 2000s, the household debt-to-GDP peaked at nearly 1.0. But since then, the ratio has sagged back down to about 0.7, where it was in the late 1990s.

For nonfinancial businesses, it appears that debt-to-GDP was hovering in the range of about 0.5 to 0.7 from the mid-1980s up through the mid-2000s. This debt-to-GDP ratio then appeared to be rising from the Great Recession through the pandemic, but has now sagged back to about 0.7. In short, most of the US economy does not appear to be in a debt-and-credit boom of the sort that can cause big problems when that boom turns to bust. The exception, of course, is the strongly growing debt of the US government.

There is a widespread consensus that the policy goals for any central bank should be set through the legislative and political process. But should there be one goal or several? Should the goals be fixed or changing? Should the legislative and political process both set the goals and also tell the central bank how to implement those goals?

Starting in the mid-1980s, the central bank of New Zealand was the first country to adopt what became known as “inflation targeting.” In this approach to monetary policy, the legislative and political process determines that the central bank has a single goal: control of inflation. In the case of New Zealand, the goal was an inflation rate of 0-2% annually. Having set that goal, the legislative and political process then gives the central bank the independence to pursue that goal, free of political meddling. Canada followed New Zealand on the inflation targeting path, and then dozens of other countries around the world did so as well, including the European Cetnral Bank. But Oliver Sikes focuses on the original New Zealand experience in “How one Kiwi tamed inflation” (Works in Progress, June 12, 2025). He emphasizes that although economists would later provide justifications for inflation targeting, the original policy resulted as a political response to evident failures of other approaches.

In the mid- and late 1970s, countries around the world experienced a surge of inflation. New Zealand, as an oil importer, was especially affected by the OPEC-induced rises in oil prices; in addition, New Zealand lost preferential access for its exports to the UK market when Britain joined what what then called the European Economic Community (now evolved into the European Union).

At this time, the central bank of New Zealand, called the Reserve Bank, was essentially under political control. The usual pattern was that politicians called for the Reserve Bank to fight inflation, but then when the bank tried to do so, it would be overruled.

In general, the economy of New Zealand at this time had considerable government intervention. As Sikes writes:

The government controlled large portions of many industries, including banking, insurance, and utilities, and the agricultural sector was supported by generous subsidies, price guarantees, and low-interest loans. Imports of goods were also tightly controlled – Kiwis needed government approval to subscribe to an overseas magazine. … Unlike today’s central banks, which mainly control inflation through adjusting interest rates, New Zealand used direct regulatory controls on financial institutions. The government forced banks to hold specific amounts of government debt and set limits on interest rates for savers. It used capital controls to restrict money flows in and out of the country, allowing it to retain a fixed exchange rate. … Inflation began to fall in 1982, but only after [Prime Minister] Muldoon imposed a complete freeze on prices and wages, which then coincided with an economic contraction.

In short, New Zealand by the mid-1980s had substantial reason to distrust political control of the goals and methods of its central bank. Moreover, US inflation under had fallen from 13.5% in 1980 to 3.2% by 1983, with the US Federal Reserve under the leadership of Paul Volcker, which suggested that a central bank did have the power to reduce inflation–if it was allowed to use that power.

In keeping with a strain of economic thought often associated with the work of Milton Friedman, the Reserve Bank decided that it would target the growth of the money supply, with the idea that a low and steady growth rate for money would lead to a low and steady inflation rate. But it didn’t work well. All around the global economy, shifts in financial deregulation and financial innovation were changing what “the money supply” actually measured. So what to do next?

The New Zealand government decided that it would just set a numerical goal of 0=2% inflation, with the Reserve Bank to focus on that goal. Sike notes:

Michael Reddell, head of the Reserve Bank’s monetary policy unit, said it was settled on ‘more by osmosis than by ministerial sign-off’. … David J. Archer, a former Assistant Governor, said inflation targets were eventually chosen ‘as the least bad of the alternatives available’.

But now and then, a deeper wisdom is born from these kinds of political compromises. As economists would come to argue, central bank independence and inflation targeting were useful steps to address a political conflict-of-interest: specifically, current politicians always want lower interest rates to stimulate the economy, but will almost never vote for the higher interest rates needed to fight inflation. By taking the day-to-day politics out of monetary policy, households and firms in the economy can actually believe that the goal of low inflation will be pursued, and their expectations that low inflation will be pursued can help to “anchor” a lower rate of inflation when shocks and stresses inevitably occur.

The idea that a central bank should purely be governed by the single goal of inflation targeting has become more controversial over time, especially in the aftermath of the Great Recession of 2007-09. At that time, central banks around the world took on a set of tasks that had nothing to do with fighting inflation: specifically, the task of providing short-term support to financial markets, which otherwise seemed in real danger of collapsing and causing even more severe economic damage. For the US Federal Reserve, there was no legal conflict here, because the law governing the US Federal Reserve is often described as a “dual mandate”: “price stability and maximum sustainable employment.” In practice, even central banks with an inflation-targeting mandate commonly act as if they have a dual mandate: Keep inflation low, but in a financial crisis or economic recession, act as needed to stabilize markets.

There are not a lot of memorable quotations about bond markets, but one of my personal favorites is from James Carville, the chief political strategist for President Clinton, who still shows up as a talking head doing news commentary from time to time. Early in Clinton’s presidency, a particular focus was reducing budget deficits, with the belief that a lower path for future government borrowing would make US Treasury debt seem safer to investors–and thus lead to lower long-term interest rates that would stimulate the economy. For example, David Wessel and Thomas T. Vogel described the dynamic in an article for the Wall Street Journal on February 25, 1993, “Arcane World of Bonds is Guide and Beacon to a Populist President.”

The Clinton budget proposals, along with the economic “dot-com boom” of the 1990s, caused the federal budget to move from a deficit of about 4% of GDP when Clinton took office in 1993 to budget surpluses over four years from 1998 to 2001. But in early 1993, the budget legislation was still taking shape, and Clinton was being briefed on the market for federal bonds almost every morning. In the WSJ article, Wessel and Vogel quote Carville: “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”

Indeed, after President Trump announced his “Liberation Day” package of tariffs back on April 2, adverse reaction from the bond markets for US Treasury debt (along with US stock markets) pushed back, causing Trump to start declaring a series of pauses and suspensions in the tariff timelines that have continued on. Moreover, Trump’s proposed federal budget strategy is the opposite of Clinton’s: that is, Clinton moved toward a balanced budget with the goal that it would also lead to reduced long-term interest rates, while Trump’s proposed tax cuts move away from a balanced budget, and he instead seems to be relying on criticizing the Federal Reserve as a way of trying to reduce interest rates.

For a primer on US bond markets, the Spring 2025 Journal of Economic Perspectives (where I work as Managing Editor) includes a symposium on the subject. As Nina Boyarchenko and Or Shachar note in the opening paper: “US fixed income markets are among the largest in the world, with $28.3 trillion in US Treasuries, $11.2 trillion in US corporate bonds, $4.2 trillion in municipal bonds, and $2 trillion in agency debt outstanding at the end of 2024.” (“Agency debt” refers to debt issued by a government-sponsored enterprise. These agencies are often (but not exclusively) related to borrowing money that buys home mortgage debt and turns it into financial securities, like the Federal National Mortgage Association, often called Fannie Mae, and the Federal Home Loan Mortgage Corporation,  often called Freddie Mac.) For comparison, the US GDP this year will be about $28 trillion.

When we talk about bond markets “intimidating” politicians, what we are actually talking about is how bondholders view the riskiness of those bonds. But who are the bondholders? Boyarchenko and Shachar offer a useful figure, showing who is likely to hold each category of bonds. They write:

Panel A focuses on US Treasuries. Since the 1970s, foreign investors have played an increasingly dominant role, with their share rising sharply in the late 1990s and early 2000s. Their holdings peaked around 2009 before gradually declining to early 2000s levels by the end of 2024. Other significant holders include pension funds and mutual funds, though their shares have remained relatively stable over time. Panel B examines corporate bonds, where insurance companies have historically been the largest holders. However, their share has steadily declined, while mutual funds and foreign investors have gained prominence, reflecting broader shifts in investment preferences. Panel C presents the major holders of mortgage securities backed by government-sponsored enterprises. Household holdings were more significant in the earlier decades, but over time, foreign investors, mutual funds, and pension funds have increased their presence in this market. Panel D shows the holders of municipal bonds. Households have consistently been the dominant investors, although mutual funds have gained market share over time. Unsurprisingly, unlike the other securities categories, foreign investors play a minimal role in this market. This is largely due to the tax advantages that municipal bonds offer to US investors, as the interest income is generally exempt from federal taxes, and in many cases, state and local taxes. Because foreign investors do not benefit from these tax exemptions, they have less incentive to hold municipal bonds compared to domestic investors. Taken together, the figure highlights the changing landscape of fixed income ownership, emphasizing how different investor groups have adjusted to economic trends and market events over time.

Boyarchenko and Shachar go into more detail on how the Federal Reserve interacts with bond market in its conduct of monetary policy. The other papers in the JEP symposium take separate looks at US Treasury debt, US corporate bonds, and the US municipal bond market. All papers in JEP are freely available, compliments of the publisher, the American Economic Association. The four papers in the bond markets symposium are:

• “A Hitchhiker’s Guide to Federal Reserve Participation in Fixed Income Markets,” by Nina Boyarchenko and Or Shachar
• “How US Treasuries Can Remain the World’s Safe Haven, by Darrell Duffie
• US Corporate Bond Markets: Bigger and (Maybe) Better?” by Maureen O’Hara and Xing (Alex) Zhou
• “Why Is the Fragmented Municipal Bond Market So Costly to Investors and Issuers?” by John M. Griffin, Nicholas Hirschey, and Samuel Kruger

Macroeconomics is at times unfavorably compared to weather forecasting. But weather forecasts have in fact become more accurate over time: a forecast for four days inthe future, made today, today is as accurate as a one-day forecast 30 years ago. Can macroeconomics make at least a broadly similar claim to improvement? Olivier Blanchard makes the argument in “Convergence? Thoughts about the Evolution of Mainstream Macroeconomics over the Last 40 Years” (Peterson Institute for Internationl Economics, Working paper 25-8, May 2025). He writes:

Let me state my two main conclusions. First, starting from sharply different views, there has been substantial convergence, both in terms of methodology and in terms of architecture. Second, this convergence has been mostly in the right direction, allowing future research to build on the existing conceptual structure. Put strongly, macroeconomics may have a claim to calling itself a mature science. … As macroeconomists, we should stop self-flagellating and not accept flagellation from others.

As in all arguments about what constitutes “science,” the way in which an author defines terms matters. Blanchard uses a definition of “mature science” that includes factors like whether there is an established theoretical framework, in which researchers agree about standars of evidence, such that knowledge can be refined and can accumulate over time. A mature science needs to provide practical knowledge for addressing real-world problems. For example, pretty much every central bank in the high-income countries now uses a New Keynesian model for understanding and forecasting changes in the economy.

The specific model on which agreement has been reached, according to Blanchard is called “New Keynesian.” On one side, this model allows for households and firms to react to incentives, and to shifts in expectations about the future, and thus is built upon macroeconomic behavior. But on the other side, the model does not require that these markets involve perfect competition or smooth outcomes: that is, prices and wage can be slow to adjust, imperfect competition and imperfect information can play substantial roles, technology can shift, and more. (For those who would like more detail, Jordi Galí offers an overview of this approach in the Summer 2018 issue of the Journal of Economic Perspectives, where I work as Managing Editor.)

Blanchard argues that the virtue of the basic New Keynesian model is its flexibility: that is, it allows analyzing the effects oif a wide array of topics. \

To mix metaphors, I see the minimalist model as the basic unit in an erector set. By itself, the basic unit is not extremely useful, but you canplug into it a whole set of extensions. You can extend it to introduce myopia … and reduce the role of expectations. You can replace rational expectations with other expectation formation mechanisms. You can extend it to include borrowing constraints, which lead to a more important role for current variables and more realistic consumption dynamics. You can extend it to more than one country. You can extend it to introduce various forms of heterogeneity and derive aggregate implications. In short, it provides a common and generally understood structure from which to start and organize research and discussion.

Blanchard readily admits that the predictive power of the New Keynesian macroeconomics is limited, but I do not view that as a fatal flaw. After all, every new discovery in any field of science suggests that the previous prediction made by the subject was wrong in some way. Social sciences like economics have the additional problem that they built on some ever-shifting combination of people, institutions, and events, rather than on an understanding of fascinating but personality-free subjects like chemistry, biology, or properties of matter and energy. As a social science, economics also suffers from a feedback mechanism where improvements in macroeconomic thinking will alter the behavior of central banks and large firms, as well as affecting other policymakers and households, which in turn willl require additional improvements in macroeconomic thinking.

In short, when Blanchard refers to a “mature science,” he is talking about a framework that has proven useful and flexible for analysis, not making a claim that economists possess a crystal ball about the future. Greg Mankiw recently wrote a letter to the Wall Street Journal that encapsulated some of this perspective. Mankiw wrote:

I always find it amusing when people assert that economics isn’t a science. Such statements suggest that they don’t know what scientists do. Here’s a reminder: Scientists observe the world. They develop theories that aim to explain what they see. They collect data to test their theories and reject those that don’t conform to the data. They try their best to put aside ideological preferences and preconceived notions. Most important, they always remain open to changing their minds when presented with better theories or new data. This approach can be applied whether one is studying apples falling from a tree or gross domestic product fluctuating over time. As Albert Einstein put it: “The whole of science is nothing more than a refinement of everyday thinking.”

Many of the wealthiest people on earth hold their wealth in the form of a financial asset, like stock in a succesful company. When it comes to capital gains, there is a choice to be made between a tax on “wealth,” which seeks to estimate the value of these gains whether or not the assets have been sold, and an “income” tax that imposes taxes on capital gains only when they are sold (or “realized”). Florian Scheuer makes the case for the second approach in “Taxing capital, but right: Why realized gains, not asset values, should guide tax policy (UBS Center Policy Brief 1, 2025).

Scheuer focuses on the fact that movements in stock prices are often closely linked to interest rates. After all, the price of a stock is determined by the future stream of profits the firm is expected to produce, but the interest rate determines the “present v value” that an investor will put on that stream of future profits. Lower interest rates will tend to boost stock prices, because it means that future profits have a higher present value; conversely, higher interest rates tend to push down stock prices, because future profits will have a lower value in the present. Scheuer offers this example:

Take a stock that pays a constant dividend of $100 per year forever, and suppose the interest rate is 10%. Then the stock price, which reflects the present-discounted value of the flow of dividends, must equal $1,000. Now suppose the interest rate falls to 5%. As a result, the stock is now worth $2,000: The stock price doubles, a massive capital
gain. But notice that the dividends paid by the stock have not changed at all: They
are still $100 per year. Therefore, the income and lifetime consumption possibilities
for someone who does not sell have not gone up. The capital gains of $1,000 are a pure “paper gain.” Of course, an investor who sells the stock can cash in on the gains, resulting in an increase in consumption. Conversely, an investor buying the stock loses: She needs to pay twice the amount for the same fl ow of future dividends. In sum, sellers gain, buyers lose and those who hold the stock are unaffected. This is why a tax on realized gains is aligned with who gains and loses from asset price fluctuations. By contrast, a tax on unrealized gains (or a wealth tax) would fully tax the “paper gains” of those who neither buy nor sell even though they do not benefit from their capital gains.

Scheuer also points out that paying capital gains tax whenever a sale occurs will tend to lock investors into their existing investments–because they would owe income tax if they decided to sell one stock and buy another. Scheuer argues that sell-and-immediately-reinvest should not be taxed. The result of such a transaction is again a paper gain, rather than actually realized income. And it’s generally a good thing for investors to be able to reallocate their portfolios.

So far, those who would prefer to see a wealth tax or greater taxation of capital gains presumably don’t like what they are hearing from Scheuer, at least as I have described it so far. But Scheuer also argues that perhaps the biggest loophole in capital gains taxation should be closed. I refer here to “step-up in basis at death,” which basically means that if someone dies and passes an asset along to their heirs, the capital gains of that asset are never taxed. Scheuer argues that passing along assets at time of death should be treated like a “realization” of gains.

The capital gains tax systems in the U.S. and many other advanced economies feature a particularity referred to as step-up in basis at death for inherited assets. This tax rule eliminates the taxable capital gain that occurred between the original purchase of the asset and the time of inheritance, thereby reducing the heir’s tax liability. Effectively, it completely exempts from taxation all capital gains accrued during the original holder’s lifetime if she never realizes the gains but passes them along at death. This is considered a major tax loophole, and indeed comparisons between capital gain realizations reported on income tax returns with historical stock market gains suggest that a large share of all capital gains on corporate stock was never taxed purely because of this provision. Our findings imply that this tax rule should be abolished in favor of a “carryover basis” approach, which makes the heirs subject to a tax on the full gains going back to the original purchase price, and which is already used by a number of countries including Germany, Italy, and Japan.

Relatedly, a tax avoidance strategy of wealthy families known as “buy, borrow, die” has received attention in recent years. The idea is to borrow against appreciating assets rather than selling them and then taking advantage of the stepped-up basis at death, thereby avoiding capital gains taxes altogether. Eliminating the stepped-up
basis loophole would also close the door for this avoidance strategy.

Changing the “step-up in basis at death” can be done in two ways. In the version Scheuer describes, the value of capital gains is taxed on those who receive the inheritance. An alternative method would be to tax the estate of the decedent, as if that person had realized the gains at time of death. According to estimates from the Congressional Budget Office, either approach would raise tens of billions of dollar per year. However, a tax on capital gains nominally paid by the decedent raises more revenue that a tax on capital gains paid by the heirs, because the income received by heirs is broken up into smaller chunks and taxed at lower rates.

The leading economies of the future will be driven by technologies that are now only in research and development stage, as those technologies diffuse across production processes and types of products that are available. At some level, I think pretty much everyone knows this. But policymakers often don’t seem to take the next logical steps, which are to emphasize incentives for research and development spending, along with supporting workers and firms as they adapt to the innovations still to come. Mary Cowx, Rebecca Lester, and Michelle Nessa focus on one aspect of these issues: how tax policies affect incentives for business R&D spending, in “Bad breaks: Why US tax policies put innovation at risk” (Stanford Institute for Economic Policy Research, May 2025). The authors write:

There are two types of innovation tax incentives: input- and output-based incentives. Input-based incentives are tied to amounts spent on investing in innovation, including R&D deductions and credits. Output-based incentives provide lower tax rates on income earned from a firm’s innovation assets — a system popular among several European countries and known as “patent boxes.” The U.S. primarily has input-based incentives. The two largest U.S. R&D tax incentives are the R&D tax deduction and the R&D tax credit. Together, these benefits provided U.S. companies with more than $100 billion in tax savings in 2021, the most recent year with available data (IRS 2024).

Adding these various tax provisions together, the authors show “the value of R&D tax subsidies available for large, profitable companies in countries around the world. Twenty years ago, the U.S. provided a similar amount of incentives as other OECD countries. Now, however, the level of U.S. incentives is roughly 20 percent of the OECD average and less than 10 percent of what China offers.”

“What’s going on here in the US tax code? Traditionally, going back to 1954, the money that a company spent on R&D was “expensed”–that is, the company could treat R&D spending as an expense in that same year, which reduced the taxes the company owed. In contrast, if a company bought a piece of machinery that would pay offer over time with increased profits before eventually wearing out, the standard tax treatment was that that only some of the cost of the machinery could be treated as an expense each year, as the physical equipment depreciated over time. But this tax provision was changed in 2022:

In tax year 2021, U.S. corporations deducted more than $327 billion of R&D costs on their tax returns, resulting in $69 billion in tax savings (IRS 2024). … Prior to 2022, U.S. companies could immediately deduct 100 percent of their R&D expenditures in the year incurred. This deduction significantly reduces the after-tax cost of innovation. However, beginning in 2022, U.S. companies are now required to spread the deduction for domestic R&D expenditures over a five-year period, meaning they can deduct only 10 percent of their R&D costs in the year of the investment. … Companies cut their R&D investment and their numbers of employees working on R&D in response to this new policy. The most research- intensive public companies in our sample cut their R&D by 11.6 percent in the first year alone.

There is also a tax credit for research and development spending. As the authors point out, there is strong evidence that this tax credit offers further encouragement to corporate R&D spending, but with some limitations. For example, the R&D tax credit is based on the gain in R&D spending compared to the past, which creates issues of how to measure and compare R&D over time. Also, a tax credit only pays off for a firm that is making a profit–and many innovative R&D-intensive small firms are not yet making a profit.

Yes, there are also recent tax subsidies through laws like the Chips and Science Act of 2022 (CHIPS) and the Inflation Reduction Act of 2022 (which actually focused on green energy). But these tax subsidies are mostly for production using existing technology, not for supporting R&D.

While the US has been reducing tax incentives for R&D spending, other countries have been ramping up. While the US tax rules as of 2022 require that R&D expenses be spread over five years, countries like Brazil and China are offering “super-deductions” for R&D, where a company can write off 200% of its R&D spending. Countries like the United Kingdom and Netherlands have “patent boxes” in their tax laws, which means that income earned from innovation is taxed at a lower rate: “The U.K.’s patent box, for example, reduces the corporate tax rate on qualifying innovation income from 25
percent to just 10 percent — a cut of 60 percent.”

Corporate taxes serve multiple goals. For example, if corporate taxes didn’t exist, then people could invest corporations and let their money grow untaxed for years or decades. But the way in which corporate taxes are constructed also creates incentives for corporate behavior. Lower incentives for US corporations to pursue R&D is not a good long-term bet on America’s economic future.

Back in 2000, the World Bank published a report with the provocative title, “Can Africa Claim the 21st Century?” The tone of the report was carefully-hedged optimism. For example, it said:

The question of whether Sub-Saharan Africa (Africa) can claim the 21st century is complex and provocative. This report does not pretend to address all the issues facing Africa or to offer definitive solutions to all the challenges in the region’s future. Our central message is: Yes, Africa can claim the new century. But this is a qualified yes, conditional on Africa’s ability—aided by its development partners—to overcome the development traps that kept it confined to a vicious cycle of underdevelopment, conflict, and untold human suffering for most of the 20th century

So how is overcoming the development traps coming along? A quarter-century later, the World Bank has published a follow-up report, 21st-Century Africa
Governance and Growth, a collection of eight chapters on different aspects of development, edited by Chorching Goh. From the “Main Message” section at the start of the report, here’s some of the flavor. On one side, substantial and undeniable progress has been made.

Over the past 25 years, Africa has achieved notable progress … Mortality rates have fallen, with life expectancy rising from 50 years in 1998 to 61 years in 2022. School attendance has improved, with primary school enrollment increasing from 80 percent in 1999 to 99 percent in 2022 and secondary school enrollment increasing from 26 percent to 45 percent over the same period. The early 2000s saw strong economic growth fueled by high commodity prices. China emerged as a trade and investment partner, and the continent experienced a massive inflow of foreign capital from 17.6 percent of gross domestic product (GDP) in 1998 to 38.1 percent in 2018. Consequently, African countries have shown significant growth performances: from 2000 to 2019, 7 of the world’s 10 fastest-growing economies were in Africa. Aid dependence has declined, tax revenues have increased, and the median poverty rate fell by about 10 percentage points to about 43 percent.

On the other side, as the report notes, “Africa remains the world’s biggest development challenge.” Here are some bullet-points:

• Persistent poverty. By 2030, 90 percent of the world’s extremely poor population will live in Africa.
• Economic stagnation. Sub-Saharan Africa’s share of the global economy remains at 2 percent, with minimal change in the region’s merchandise exports.
• Investment levels. Private investment remains low, with the informal economy accounting for 59 percent of total nonagricultural employment.
• Limited growth. The reliance on smallholder agriculture limits economic growth due to low investment and productivity.
• Electricity access. Only 51 percent of the African population has access to electricity, compared to the global average of 91 percent. …
• Political upheaval. Violent conflicts increased eightfold between 2000 and 2023 throughout the continent, leading to increases in conflict-related deaths and the number of internally displaced people.
• Governance challenges. The issues of corruption, political instability, and a lack of trust in government and institutions persist.

The report also notes up front that “Africa’s income level per capita would be 40% higher if it had grown at the global average since 1990,” “Nearly 83% of Africa’s employment is informal,” and “86% of 10 year-olds in Africa can’t read and understand a simple paragraph.”

The volume includes chapters on all of these topics and more. My own sense is that if the authors of the 2000 volume could have looked forward to the situation in 2025, they would be more disappointed than pleased.

Here, I’ll add a few words on Chapter 3 of the volume, “Productivity,” by Cesar Calderon and Ayan Qu. Per capita GDP can serve as a rough measure of standard of living, as well as a rough measure of productivity. By that measure, the countries of Africa are struggling relative to the rest of the world. The subregion of West Africa had a little spurt from about 2000-2015, but has now given back those modest gains.

To get a sense of why this pattern is so disappointing, remember that lower-income countries have some potential for “catch-up growth.” They can draw on technologies developed elsewhere, and sell into markets of higher-income countries. A low-income country should have numerous opportunities. When starting from a low base, then achieving a higher rate of growth is somewhat easier. But the countries of Africa are instead experiencing only fall-further-behind growth. Here’s a figure comparing Africa, South Asia, and the East Asia/Pacific region to the US economy in labor productivity. Two of the regions are catching up to the US, at least somewhat, in the last two decades; Africa is below its relative level in the late 1970s.

As Calderon and Qu dig into the underlying data, they point out that the share of productivity differences explained by investment in physical capital is relatively small, and the share explained by human capital differences is only a little larger. The biggest factor is “total factor productivity,” in the lingo of economists, which is efficiently the economy translates these inputs into outputs. Thus, while investing more in human capital and infrastructure can pay off for these economies, the big challenge is to accomplish dramatic structural changes.

These economies need to move away from a focus on small-holder agriculture. The three channels to productivity discussed by Calderon and Qu are: 1) within-firm productivity growth, in which a well-managed company improves its worker skills, technology adoption, and innotation; 2) between-firm productivity growth, in which the high-productivity firms make up a bigger share of the economy than low-productivity firms, so the growth of the successes outweighs the failures; and 3) net entry of productive firms, in which more productive firms are more likely to enter and less-productive firms are more likely to exit. At the end of the day, economies only raise productivity when these dynamics are operating, and for roughly a jillion reasons (see the World Bank volume for details), these dynamics have not been operating especially well across sub-Saharan Africa as a whole.

Thirty years ago and further, before 1994, the Federal Reserve did not make any announcement at all when it altered monetary policy. Instead, market-watchers had to detect changes in interest rates as they occurred. Now, the Fed announces a target range for the specific interest rate that it targets (the “federal funds interest rate”) and holds a press conference to explain its choice. The Fed also releases a Summary of Economic Projections, which reports 19 different projections of key economic variables from the 19 participants in meetings of the Federal Open Market Committee. The Fed publishes minutes of FOMC meetings with a three-week lag. Members of the seven Fed Board of Governors in DC as well as presidents of the 12 regional Federal Reserve banks often comment on the reasoning behind the Fed’s policy choice during Congressional testimony and speeches as well.

Should the Fed be taking addition steps to explain its choices more fully? Ben Bernanke (Nobel ’22) offers some ideas in “Improving Fed Communications: A Proposal,” presented at the Fed’s Second Thomas Laubach Research Conference (May 15-16, 2025, full text, audio, and video for the six research papers and other presentations available at the website).

For a sense of what is at stake, Bernanke notes the positive aspect of communication when he writes: “Effective communication—about what the Fed sees in the economy and how it plans to respond—helps households and businesses better understand the economic outlook, clarifies and explains the Fed’s policy strategy, and builds trust and democratic accountability.”

Lest this comment sound like boilerplate, it is perhaps useful to note that, as I see it, the opposite of this statement is also true. That is, one could restate Bernanke’s comment: “Ineffective communication—about what the Fed sees in the economy and how it plans to respond—makes it harder for households and businesses to understand the economic outlook, muddles perception of the Fed’s policy strategy, and diminishes trust and democratic accountability.”

Bernanke proposes one main change to Fed communications practices. As he points out, it’s common for other central banks around the world to present an actual economic forecast, with the underlying assumptions and calculations spelled out. A quarterly forecast could also include discussion of the range of uncertainty, and alternative scenarios that might emerge. Bernanke writes:

The centerpiece … would be forecasts of key economic and policy variables at varying horizons, drawn from a comprehensive macroeconomic forecast led and “owned” by the Board staff (possibly with some input and commentary from policymakers …). Because the underlying forecast would be internally consistent and based on explicit economic assumptions, it would provide greater insight than the projections of individual FOMC participants into the factors affecting the outlook for the economy and policy. Critically, a fully articulated baseline forecast would also facilitate the public discussion of economic scenarios that differ from that baseline. Besides highlighting the inherent uncertainty of economic forecasts, the publication of selected alternative scenarios and their implications could facilitate a subtle but important shift in the Fed’s communications strategy. Specifically, it would allow the FOMC to provide policy guidance that is more explicitly contingent on how the economy evolves, underscoring for the public that the future path of policy is not unconditional (“on a preset course”) but depends sensitively on economic developments and risk management considerations.

For a sense of how this might work in practice, Bernanke refers back to the public discussion in 2021 of whether the surge of inflation was transitory.

To illustrate the use of alternative scenarios in communication, suppose—with a large dose of hindsight—that in mid-2021 the Fed had not, figuratively speaking, put all its chips on its central forecast that inflation would prove “transitory” but instead had said the equivalent of: “For the following reasons we think that the most likely scenario is that the increases in inflation will be transitory. However, should inflation prove to be higher and more persistent, perhaps for these reasons, our response would be to do this [where “this” could be a projected path for rates and the balance sheet, perhaps described only qualitatively]. Similarly, if inflation sinks lower than in the modal forecast, we expect to do that.” Even if lacking in quantitative details, a more explicitly conditional approach would have better conveyed to the public the intrinsic uncertainty of the outlook, and discussion of the reaction function would have provided the public some advance notice about how the Committee would likely respond in less probable but still plausible scenarios.

On one side, it’s hard to quarrel with the idea that the Fed should seek to spell out its thinking more fully. Other central banks around the world do so. Open and honest communication is a beautiful thing, and Bernanke’s proposal seems sensible to me.

On the other side, how easy will it be for the Fed to acknowledge when it is wrong, or to explain that projections of a certain scenario turned out differently in the real world? The Fed is probably strongest when it is perceived to be sticking to the pursuit of its goals of stable prices and maximum employment. If and when the Fed starts producing economic forecasts and scenarios, it will be even more open to the accusations and reality of political lobbying and motivations. Even setting politics aside, the instinct to defend past predictions, or to make a range of predictions vague enough that they become unfalsifiable, are real things, too.

The US Court of International Trade has acted to block pretty much all of President Trump’s tariffs. I guess the first question is “what the heck is the US Court of International Trade? The story seems to be that back in 1890, Congress created a “Board of General Appraisers, a quasi-judicial administrative unit within the Treasury Department. The nine general appraisers reviewed decisions by United States Customs officials …” In 1926, Congress replaced the Board of Appraisers with US Customs Court. The status of this court evolved over time, and in 1980 became the US Court  of International Trade, a “national court established under Article III of the Constitution”– the part of the constitution that establishes the federal judicial branch.

I’ve written before that a legal challenge to the Trump tariffs seemed inevitable. The key issue is that the Article 1 of the US Constitution–the part which lays out the structure and powers of the legislative branch–states in Section 8: “The Congress shall have Power To lay and collect taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States …” Over the years, Congress has written a number of exceptions into the law. For example, the International Emergency Economic Powers Act of 1977 (IEEPA) lets the President address “unusual and extraordinary” peacetime threats. For example , when Iran took US hostages in 1979, President Carter could immediately respond with trade sanctions.

The legal question is whether President Trump has the authority to invoke the “emergency” provisions and rewrite all tariffs for countries and goods all around the globe in whatever way he wishes. The law firm Reed Smith has been producing a “tariff tracker” that shows the results. The US Court of International Trade held that Trump has stretched the “emergency” provision considerably too far, that US importing firms are adversely affected, and that previous laws do not mean that Congress has given away all of its Constitutional power in this area to the President. (For those who keep score in this way, the Court decision was a 3-0 vote, and the three judges were appointed by Trump, Obama, and Reagan.)

The Trump administration justifications for its tariffs are full of goofy statements. For example, President Trump argues that the tariffs will all be paid by foreign companies, with no effect on US consumers and firms. Seems unlikely, but say that it’s true. In that case, foreign exporters to the US would have lower profits, but would be exporting the same quantity of goods at the same price to US markets. The idea that tariffs won’t affect the quantities or prices of what foreign exporters sell in the US market is inconsistent with the idea that the tariffs will give breathing space to US producers.

Or Secretary of Commerce Howard Lutnick explained in an interview a few weeks ago what kind of manufacturing jobs were going to return from China to the United States. He said, “The army of millions and millions of human beings screwing in little screws to make iPhones — that kind of thing is going to come to America …” I suppose Lutnick deserves some credit for expressing a concrete idea, but my guess is that most supporters of Trump’s tariffs do not have in mind a US economy based on an “army of millions and millions of human beings screwing in little screws to make iPhones …”

The trade economist Richard Baldwin has just published an e-book called The Great Trade Hack: How Trump’s trade war fails and global trade moves on. He rehearses the arguments over tariffs at some length: how they will not reduce the trade deficit, or revive US manufacturing, or help the middle class. Baldwin writes fluently, and this book is for a generalist readership. Here, I want to touch on one of Baldwin’s themes that I haven’t discussed recently. He writes:

Tariffs persist precisely because they fail economically, yet succeed politically. They provide symbolic relief, project toughness, and shift blame onto external actors without confronting difficult domestic policy challenges like higher taxes or expanded social programmes. …

Tariffs don’t coordinate investment across firms and sectors. They don’t train workers. They don’t bridge skill gaps or modernise vocational education. They don’t fund infrastructure, improve logistics, or support research and development. They don’t unlock capital, align upstream and downstream firms, or connect regions to supply chains. In short, tariffs can defend an industrial base, but they cannot create one.

Reindustrialisation requires more than tweaking relative prices. It needs a strategy. A real one. With planning, sequencing, and sustained commitment. It needs a trained workforce, one that matches the needs of 21st-century manufacturing. And to get those workers, federal and local governments must partner with industry. Firms can’t do it alone. No company will invest heavily in training workers if they’re unsure those workers will stay once their skills are upgraded. That’s why, in most countries, governments step in – funding training with tax dollars to solve the coordination problem. It’s a public good with private benefits, and it only works when governments and employers pull in the same direction.

It also needs reliable infrastructure, stable regulation, and targeted investment incentives. It needs the trust of industrialists – not just that the cost of imported goods will be higher this year, but that America will be a profitable place to make things for decades to come. And this is critical: building a modern manufacturing operation is a long-term proposition. From planning to permitting, from equipment procurement to workforce training, the timeline is measured in years, not months. For investors to commit, they need confidence that support policies – tariffs, subsidies, tax credits, training programmes – will remain in place long enough to generate a return. If the policy environment is unpredictable or politicised, those factories won’t get built.

That’s the real shortcoming of Trump’s pray-and-spray, tariff-first and tariffs-only approach to reshoring manufacturing. There’s no plan to use the breathing room tariffs might create. Without that plan, the most likely outcomes from the 2 April tariffs are higher prices, reduced manufacturing, riled allies, and retaliation against exports from industries where America is competitive today.

We are seeing with President Trump one of the dangers of electing someone with a business background to government: the lessons of business and government overlap in some areas, but are not the same. Baldwin writes:

Trump’s real estate experience also taught him one simple rule: the seller is ripping off the buyer. From that premise, it’s just a logic hop-skip-and-jump to the idea – which the President is firmly convinced of and which shapes his attitude towards trade – that a bilateral trade deficit is theft. … This notion is completely false – as anyone versed in mainstream, positive-sum business practices would attest. Nevertheless, it is a cornerstone of Trump’s belief system.

I’m confident that the US Court of International Trade decision will be appealed to the US Supreme Court, but I suspect that President Trump might benefit politically if the courts take his tariff plans off the table. Trump blocked by the courts is a powerful political force. On the other side, if Trump is forced to face the actual effects of his tariffs, my expectation is that as the gains from international trade are diminished, he won’t come out looking so good.