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The U.S. war for independence from Britain is often described in terms a desire for democratic self-government and protection of the rights of citizens. But among historians, there has been a long tradition arguing that economic factors were more important. Perhaps most famously, Charles Beard argued back in 1913 in his book, An Economic Interpretation of the Constitution of the United States that the Founding Fathers were just out to protect their own personal property. But as the decades passed, a consensus developed that Beard\’s arguments was so simplistic and contentious and stark that it was just wrong.

(This post was originally published on January 31, 2012, and is reprinted here for the July 4 holiday).

Staughton Lynd and David Waldstreicher offer a refreshing take on the role of economic forces in the U.S. Revolution in \”Free Trade, Sovereignty, and Slavery: Toward and Economic Interpretation of American Independence.\” It appears in the October 2011 issue of the William and Mary Quarterly, which is not freely available on-line, but will be available to many with academic ties if their institution has a certain kind of JSTOR subscription. Here\’s their opening (footnotes omitted):

\”What kind of revolution was the American Revolution? Four basic answers, all first suggested before 1800, continue to shape the scholarship. They can be denoted Answers A, B, C, and D.

Answer A was advanced by the Revolution\’s leaders and echoed by their friends in Great Britain, such as Edmund Burke: The American Revolution was a struggle for constitutional rights.

Answer B was that of the Revolution\’s opponents, again both in the American colonies and in Great Britain: The American Revolution was a struggle for economic independence from the British Navigation Acts and other economic restrictions. 

Answers C an D were put forward in a second round of controversy during the 1790s, as Americans tried to determine their proper relationship to the French Revolution. Answer C was that of the Jeffersonians: The American Revolution was a democratic movement essentially similar to the French Revolution. Their Federalist opponents responded with Answer D: The American Revolution was a colonialist independence movement essentially different from the French Revolution. …

We offer for further exploration what might be described as a B-D interpretation. That is, the American Revolution was basically a colonial independence movement and the reasons for it were fundamentally economic.\”

I can\’t hope to summarize their argument point-by-point, but in large part, it comes down to pointing out how economic conflicts were often prior in time other events of the Revolution,  and loomed large in importance. Britain often sought to tax or even to embargo various kinds of trade from the American colonies to the West Indies: for example, the import tax with the Molasses Act of 1733, or the way in which the British Navy tried to cut off trade between the colonies and the French West Indies during the Seven Years\’ War. The \”single most contentious issue\” in the First Continental Congress in 1774 was about the extent to which the British Parliament could regulate the U.S. economy, including these and other limits on navigation as well as acts that sought to prohibit manufacturing in the colonies (so that the colonies would need to import from Britain, instead). After reviewing the history in some detail, they write:

\”The commercial dispute preceded the constitutional, not just once but again and again in these years. It is important that colonists melded economic and constitutional arguments under the category of sovereignty–but not so important that we should ignore the originating nature of economic forces.\”

To anyone who has passed through the U.S. public school system, or who has listened to the rhetoric of politicians, thinking of U.S. independence as driven by economic motives has nearly sacrilegious overtones. Lynd and Waldstreicher respond like this:

\”If the American Revolution had fundamentally economic causes, it is not thereby demeaned. Post-World War II colonial independence movements should have taught us something about the many-sided meanings of economic sovereignty for developing nations. If not only merchants but also artisans, tenant farmers, cash-strapped yeoman, fishermen, and debt-ridden slave-owning planters can be shown to have had compelling economic reasons to favor independence, it should not seem too narrow or conspiratorial to suggest that they acted on these reasons and sought to combine them with a language that spoke to principles as well as to the bottom line.\”

To me, it seems quite plausible and believable that the urge of the colonists to move beyond protest and into actual war and rebellion needed the push of economic factors. In addition, if we have learned nothing else from last two centuries, it should be that when anyone starts talking about a revolution is needed for freedom and justice and for people to get their \”rights,\” warning sirens should go off in your brain. Such promises from revolutionaries have certainly been betrayed far more than they have been honored.

But it also seems to me that the cause of an event is often quite different than the lasting legacy of that same event. The causes of the U.S. Revolution probably were largely economic, albeit expressed in a language of constitutionalism. But the lasting legacy of American Independence was the creation of a constitutional structure that is flexible enough to adapt and strong enough to endure.

For economists around the world, 1776 means the publication date of Adam Smith\’s classic The Wealth of Nations.  Book IV, Chapter 7, is entitled \”Of Colonies.\” Smith expresses the view that Europe contributed very little to the economic success of its American colonies–except for some talented people. He also believed that the while England benefited from trade with its colonies, England also had to bear the costs of defense and of the monopolies on trade that it created. He painted a picture of how the American colonies might be allowed democratic representation, but viewed it as a politically unlikely outcome. He also predicted that even when a nation didn\’t benefit from having colonies, it was still reluctant to let the colonies go peacefully. The quotations here are from the ever-useful \”Library of Economics and Liberty,\” which has number of classic works  of economics freely available in searchable form on-line. (This post was originally published on July 4, 2013.)

\”The policy of Europe, therefore, has very little to boast of, either in the original establishment or, so far as concerns their internal government, in the subsequent prosperity of the colonies of America. Folly and injustice seem to have been the principles which presided over and directed the first project of establishing those colonies; the folly of hunting after gold and silver mines, and the injustice of coveting the possession of a country whose harmless natives, far from having ever injured the people of Europe, had received the first adventurers with every mark of kindness and hospitality…. 

\”The English Puritans, restrained at home, fled for freedom to America, and established there the four governments of New England. The English Catholics, treated with much greater injustice, established that of Maryland; the Quakers, that of Pennsylvania. The Portugueze Jews, persecuted by the Inquisition, stripped of their fortunes, and banished to Brazil, introduced by their example some sort of order and industry among the transported felons and strumpets by whom that colony was originally peopled, and taught them the culture of the sugar-cane. Upon all these different occasions it was not the wisdom and policy, but the disorder and injustice of the European governments which peopled and cultivated America. …\”

\”When those establishments were effectuated, and had become so considerable as to attract the attention of the mother country, the first regulations which she made with regard to them had always in view to secure to herself the monopoly of their commerce; to confine their market, and to enlarge her own at their expence, and, consequently, rather to damp and discourage than to quicken and forward the course of  their prosperity. In the different ways in which this monopoly has been exercised consists one of the most essential differences in the policy of the different European nations with regard to their colonies. The best of them all, that of England, is only somewhat less illiberal and oppressive than that of any of the rest.\”

\”In what way, therefore, has the policy of Europe contributed either to the first establishment, or to the present grandeur of the colonies of America? In one way, and in one way only, it has contributed a good deal. … It bred and formed the men who were capable of achieving such great actions, and of laying the foundation of so great an empire; and there is no other quarter of the world of which the policy is capable of forming, or has ever actually and in fact formed such men. The colonies owe to the policy of Europe the education and great views of their active and enterprising founders; and some of the greatest and most important of them, so far as concerns their internal government, owe to it scarce anything else.\”

\”To found a great empire for the sole purpose of raising up a people of customers may at first sight appear a project fit only for a nation of shopkeepers. It is, however, a project altogether unfit for a nation of shopkeepers; but extremely fit for a nation whose government is influenced by shopkeepers. Such statesmen, and such statesmen only, are capable of fancying that they will find some advantage in employing the blood and treasure of their fellow-citizens to found and maintain such an empire. Say to a shopkeeper, Buy me a good estate, and I shall always buy my clothes at your shop, even though I should pay somewhat dearer than what I can have them for at other shops; and you will not find him very forward to embrace your proposal. But should any other person buy you such an estate, the shopkeeper would be much obliged to your benefactor if he would enjoin you to buy all your clothes at his shop. England purchased for some of her subjects, who found themselves uneasy at home, a great estate in a distant country. The price, indeed, was very small, and instead of thirty years purchase, the ordinary price of land in the present times, it amounted to little more than the expence of the different equipments which made the first discovery, reconnoitred the coast, and took a fictitious possession of the country. The land was good and of great extent, and the cultivators having plenty of good ground to work upon, and being for some time at liberty to sell their produce where they pleased, became in the course of little more than thirty or forty years (between 1620 and 1660) so numerous and thriving a people that the shopkeepers and other traders of England wished to secure to themselves the monopoly of their custom. Without pretending, therefore, that they had paid any part, either of the original purchase-money, or of the subsequent expence of improvement, they petitioned the parliament that the cultivators of America might for the future be confined to their shop; first, for buying all the goods  which they wanted from Europe; and, secondly, for selling all such parts of their own produce as those traders might find it convenient to buy. … A clause in the famous act of navigation established this truly shopkeeper proposal into a law.\”

\”In order, however, to obtain this relative advantage in the colony trade, in order to execute the invidious and malignant project of excluding as much as possible other nations from any share in it, England, there are very probable reasons for believing, has not only sacrificed a part of the absolute advantage which she, as well as every other nation, might have derived from that trade, but has subjected herself both to an absolute and to a relative disadvantage in almost every other branch of trade. … \”

Smith discussed various possibilities for how Great Britain might deal with its colonies. One proposal was that Great Britain should just \”voluntarily give up all authority over her colonies,\” which would then allow Britain and America, in friendship to benefit from free trade between them. But he despaired of this possibility.

\”To propose that Great Britain should voluntarily give up all authority over her colonies, and leave them to elect their own magistrates, to enact their own laws, and to make peace and war as they might think proper, would be to propose such a measure as never was, and never will be adopted, by any nation in the world. No nation ever voluntarily gave up the dominion of any province, how troublesome soever it might be to govern it, and how small soever the revenue which it afforded might be in proportion to the expence which it occasioned. Such sacrifices, though they might frequently be agreeable to the interest, are always mortifying to the pride of every nation, and what is perhaps of still greater consequence, they are always contrary to the private interest of the governing part of it, who would thereby be deprived of the disposal of many places of trust and profit, of many opportunities of acquiring wealth and distinction, which the possession of the most turbulent, and, to the great body of the people, the most unprofitable province seldom fails to afford. The most visionary enthusiast would scarce be capable of proposing such a measure with any serious hopes at least of its ever being adopted. If it was adopted, however, Great Britain would not only be immediately freed from the whole annual expence of the peace establishment of the colonies, but might settle with them such a treaty of commerce as would effectually secure to her a free trade, more advantageous to the great body of the people, though less so to the merchants, than the monopoly which she at present enjoys. By thus parting good friends, the natural affection of the colonies to the mother country which, perhaps, our late dissensions have well nigh extinguished, would quickly revive. It might dispose them not only to respect, for whole centuries together, that treaty of commerce which they had concluded with us at parting, but to favour us in war as well  as in trade, and, instead of turbulent and factious subjects, to become our most faithful, affectionate, and generous allies …\”

As an alternative, Smith suggested that there could be taxation with representation: that is, Americans could be given representation in the British parliament. He argues that if Americans were offered such a possibility, many of their leaders would be delighted with the chance to rise in British politics. But denied such a possibility, the American leaders feel a

\”The parliament of Great Britain insists upon taxing the colonies; and they refuse to be taxed by a Parliament in which they are not represented. If to each colony, which should detach itself from the general confederacy, Great Britain should allow such a number of representatives as suited the proportion of what is contributed to the public revenue of the empire, in consequence of its being subjected to the same taxes, and in compensation admitted to the same freedom of trade with its fellow-subjects at home; the number of its representatives to be augmented as the proportion of its contribution might afterwards augment; a new method of acquiring importance, a new and more dazzling object of ambition would be presented to the leading men of each colony. Instead of piddling for the little prizes which are to be found in what may be called the paltry raffle of colony faction; they might then hope, from the presumption which men naturally have in their own ability and good fortune, to draw some of the great prizes which sometimes come from the wheel of the great state lottery of British polities.

\”Unless this or some other method is fallen upon, and there seems to be none more obvious than this, of preserving the importance and of gratifying the ambition of the leading men of America, it is not very probable that they will ever voluntarily submit to us; and we ought to consider that the blood which must be shed in forcing them to do so is, every drop of it, blood either of those who are, or of those whom we wish to have for our fellow-citizens. They are very weak who flatter themselves that, in the state to which things have come, our colonies will be easily conquered by force alone. The persons who now govern the resolutions of what they call their continental congress, feel in themselves at this moment a degree of importance which, perhaps, the greatest subjects in Europe scarce feel. From shopkeepers, tradesmen, and attornies, they are become statesmen and legislators, and are employed in contriving a new form of government for an extensive empire, which, they flatter themselves, will become, and which, indeed, seems very likely to become, one of the greatest and most formidable that ever was in the world. … Almost every individual of the governing party in America fills, at present in his own fancy, a station superior, not only to what he had ever filled before, but to what he had ever expected to fill; and unless some new object of ambition is presented either to him or to his leaders, if he has the ordinary spirit of a man, he will die in defence of that station.\” 

And of course, Smith\’s prediction, published in 1776 but largely written several years earlier, came true. To repeat, on this Fourth of July: \”From shopkeepers, tradesmen, and attornies, they are become statesmen and legislators, and are employed in contriving a new form of government for an extensive empire, which, they flatter themselves, will become, and which, indeed, seems very likely to become, one of the greatest and most formidable that ever was in the world.\”

Macroprudential policy is going mainstream. At least, Janet Yellen says so in her lecture on \”Monetary Policy and Financial Stability,\” given on July 2 as the 2014 Michel Camdessus Central Banking Lecture at the International Monetary Fund. For example, Yellen says at the start of the lecture:

\”I will argue that monetary policy faces significant limitations as a tool to promote financial stability: Its effects on financial vulnerabilities, such as excessive leverage and maturity transformation, are not well understood and are less direct than a regulatory or supervisory approach; in addition, efforts to promote financial stability through adjustments in interest rates would increase the volatility of inflation and employment. As a result, I believe a macroprudential approach to supervision and regulation needs to play the primary role.\”

So what is this macroprudential policy that the Chair of the Federal Reserve says needs to play \”the primary role\” in addressing financial stability, because conventional monetary policy \”faces significant limitations\” in the task? Academics have been talking about it for a few years: for examples, see my post on \”Macroprudential Monetary Policy: What It is, How it Works\” (June 20, 2013), or for a sense of the deeper economic analysis behind macroprudential policy, a useful starting point is \”A Macroprudential Approach to Financial Regulation,\” by Samuel G. Hansen, Anil K. Kashyap, and Jeremy C. Stein, which appeared in the Winter 2011 issue of the Journal of Economic Perspectives. (Full disclosure: My job as Managing Editor of JEP has been paying the household bills since 1986.)

Yellen looks back at the controversy over the housing price bubble that emerged in the U.S. economy in the middle 2000s. For a sense of the dispute, here\’s a graph showing the federal funds interest rate, the key policy tool that the Fed focused on at the the time. Notice that with the recession of 2001, the Fed cut this rate to stimulate the economy. Reducing the interest rate in a recession is standard practice, but the rate was also cut quite far (as you can see, more than after the 1990-91 recession) and the low rate was then maintained for several years after the 2001 recession had ended. Both at the time, and since then, there has been a controversy that if the Fed had not cut interest rates quite as far, or held interest rates so low for quite as long, then the borrowing that fed the housing price bubble would have been more muted.

Yellen argues in response that higher interest rates would not have addressed many of the other issues feeding the housing price bubble: like \”gaps in the regulatory structure that allowed some SIFIs [systemically important financial institutions] and markets to escape comprehensive supervision, or the lack of \”transparency of exotic financial instruments,\” or \”deficiencies in risk measurement and risk management within the private sector.\” She argues that using higher interest rates to address financial vulnerability is \”a very blunt tool.\” The unemployment rate remained elevated for a time after the 2001 recession in what has now become the U.S. pattern of \”jobless recoveries.\” Yellen argues that higher interest rates back in the early 2000s would have had at best a modest effect in keeping housing prices lower, but it unemployment would have stayed higher for longer. She also point out that \”vulnerabilities from excessive leverage and reliance on short-term funding in the financial sector grew rapidly through the middle of 2007, well after monetary policy had already tightened significantly relative to the accommodative policy stance of 2003 and early 2004.\”

What is macroprudential policy? In the past, financial regulation typically focused on whether individual financial institutions were fundamentally healthy. It considered at one financial institution at a time. The \”macro\” in macroprudential policy is meant to suggest that regulatory policies and standards should be adjusted with macroeconomic concerns in  mind. Thus, if there is a concern over housing prices rising in a way that leads to a risk of a bubble, government can raise the standards that affect conditions under which banks make loans–leading to smaller loan sizes relative to income or higher down payments. If there is a concern that many financial and nonfinancial institutions are taking on too much debt, in a way that raises the risk of a financial crisis, regulatory standards can be used to require that the institutions hold higher reserves. If there is concern that certain financial instruments are not transparent, or that the risks of such instruments are not being taken into account, regulatory policy can require additional disclosure and require that financial institutions find ways to ameliorate the additional risks.

Yellen is in effect suggesting a division of labor. Conventional monetary policy, like raising and lowering interest rates, would continue to be the main method for addressing recession and inflation. But macroprudential policies would be the way of reducing the chance that a financial crisis would happen. As she says: \”In my assessment, macroprudential policies, such as regulatory limits on leverage and short-term funding, as well as stronger underwriting standards, represent far more direct and likely more effective methods to address these [financial stability] vulnerabilities.\”

Actually, this change is already happening. Yellen says: \”We have made considerable progress in implementing a macroprudential approach in the United States …\”

As a current example in the U.S economy, she offers the following more detailed discussion:

\”I do see pockets of increased risk-taking across the financial system, and an acceleration or broadening of these concerns could necessitate a more robust macroprudential approach. For example, corporate bond spreads, as well as indicators of expected volatility in some asset markets, have fallen to low levels, suggesting that some investors may underappreciate the potential for losses and volatility going forward. In addition, terms and conditions in the leveraged-loan market, which provides credit to lower-rated companies, have eased significantly, reportedly as a result of a \”reach for yield\” in the face of persistently low interest rates. The Federal Reserve, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation issued guidance regarding leveraged lending practices in early 2013 and followed up on this guidance late last year. To date, we do not see a systemic threat from leveraged lending, since broad measures of credit outstanding do not suggest that nonfinancial borrowers, in the aggregate, are taking on excessive debt and the improved capital and liquidity positions at lending institutions should ensure resilience against potential losses due to their exposures. But we are mindful of the possibility that credit provision could accelerate, borrower losses could rise unexpectedly sharply, and that leverage and liquidity in the financial system could deteriorate.\”

Macroprudential policy is no magic bullet. It requires figuring out where risk-taking has become excessive, where bubbles may be forming in financial markets, and deciding how to react. There is a danger that central banks–which after all, do come under political pressure–will feel some need to prop up asset market values, not just to pop price bubbles as they threaten to inflate. But the Federal Reserve, and a number of other central banks around the world, are now embracing the challenge of macroprudential policy as part of their core mission.

A standard approach to studying discrimination in labor markets is to collect data on what people earn and their race/ethnicity or gender, along with a number of other variables like years of education, family structure, region where they live, occupation, years of job experience, and so on. This data lets you answer the question: can we account for differences in income across groups by looking at these kinds of observable traits other than race/ethnicity and gender? If so, a common implication is that the problem in our society may be that certain groups aren\’t getting enough education, or that children from single-parent families  need more support–but that a pay gap which can be explained by observable factors other than race/ethnicity and gender isn\’t properly described as \”discrimination.\” Loury challenges this approach, arguing that many of the observable factors are themselves the outcome of a history of discriminatory practices. He says:

\”By that I mean, suppose I have a regression equation with wages on the left-hand side and a number of explanatory variables—like schooling, work experience, mental ability, family structure, region, occupation and so forth—on the right-hand side. These variables might account for variation among individuals in wages, and thus one should control for them if the earnings of different racial or ethnic groups are to be compared. One could put many different variables on the right-hand side of such a wage regression.

Well, many of those right-hand-side variables are determined within the very system of social interactions that one wants to understand if one is to effectively explain large and persistent earnings differences between groups. That is, on the average, schooling, work experience, family structure or ability (as measured by paper and pencil tests) may differ between racial groups, and those differences may help to explain a group disparity in earnings. But those differences may to some extent be a consequence of the same structure of social relations that led to employers having the discriminatory attitudes they may have in the work place toward the members of different groups.

So, the question arises: Should an analyst who is trying to measure the extent of “economic discrimination” hold the group accountable for the fact that they have bad family structure? Is a failure to complete high school, or a history of involvement in a drug-selling gang that led to a criminal record, part of what the analyst should control for when explaining the racial wage gap—so that the uncontrolled gap is no longer taken as an indication of the extent of unfair treatment of the group?

Well, one answer for this question is, “Yes, that was their decision.” They could have invested in human capital and they didn’t. Employer tastes don’t explain that individual decision. So as far as that analyst is concerned, the observed racial disparity would not be a reflection of social exclusion and mistreatment based on race. …  But another way to look at it is that the racially segregated social networks in which they were located reflected a history of deprivation of opportunity and access for people belonging to their racial group. And that history fostered a pattern of behavior, attitudes, values and practices, extending across generations, which are now being reflected in what we see on the supply side of the present day labor market, but which should still be thought of as a legacy of historical racial discrimination, if properly understood.

Or at least in terms of policy, it should be a part of what society understands to be the consequences of unfair treatment, not what society understands to be the result of the fact that these people don’t know how to get themselves ready for the labor market.

When I\’m giving a talk on these issues, I point out that there are a variety of kinds of discrimination. One kind of discrimination is when an employer treats two people with the same qualifications differently because of race or gender. Another kind of discrimination can cause social conditions that lead to people being more likely to have different qualifications in the first place. I have argued that this pattern means that suing employers for discrimination should thus have a smaller place, and trying to equalize qualifications should have a bigger place. But Loury has a thought-provoking response to this approach.

In one of his papers, Loury considers various kinds of interventions that have a goal of reducing the effects of discriminatory behavior. He draws two distinctions. You can intervene early–say, trying to assure better grade-school performance, a better high school graduation rate, and a higher level of college attendance. Or you can intervene later, when people are actually applying for jobs. You can also intervene in a :\”blind\” way, which favors a broad group that will be disproportionately of a certain race, or in a \”sighted\” way that favors the group specifically. Thus, expanding government funding for preschool programs for low-income families is in these terms an early \”blind\” intervention. A quota for hiring a certain percentage of African Americans or other ethnic groups to certain jobs is a late \”sighted\” intervention.

I tend to favor the first kind of intervention, to which Loury offers a couple of counterarguments. One is that a later \”sighted\” policy is also an incentive for skills acquisition at an earlier age. As Loury puts it:

One of our key insights is that under sightedness (again, overt discrimination in favor of a particular group), the very act of boosting people’s access to slots—that is, putting a thumb on the scale in their favor at the point where they compete for positions—implies a subsidy to their acquisition of skills. … [I]f a later intervention is properly anticipated, then an earlier intervention may not be necessary; it may be redundant. … Now, this result—that we find quite interesting—requires the assumption I just referred to: that when making their decisions about how to invest in the development of their skills, people be farsighted enough to anticipate the consequences of their being favored at the point of slots allocation. That assumption will not be plausible in every case (youngsters can be unnervingly short-sighted…).\”

However, if one is willing to grant the possibility that knowing certain jobs are likely to be available will tend to encourage skills acquisition earlier, Loury then offers another point. There is a classic question in the economics of taxation that considers whether a country should impose taxes on a variety of inputs to the production process, or instead a tax on outputs. The general finding is that the negative effects of the tax are smaller if you impose them at the end of the production process, because then the taxes don\’t also have a distortionary effect on the process of production itself. There\’s a related classic question in the economics of monopolies, which asks whether it\’s worse for an economy to have a monopolist that raises the price on an input used by many producers, or for a monopolist to raise the prices to consumers. Again, the negative effects of monopoly are smaller if they result in higher prices at the end of the production process.

Loury and a co-author create a model that applies similar reasoning to the question of when to intervene to stop discrimination, with the implication being that intervention at the later stage of being hired may be less burdensome to an economy than intervention at the earlier stage. Loury says:

\”The distortion (in our case, preferences for a disadvantaged group) should take place “downstream,” at the point of competition for final positions, rather than “upstream,” at the point where people are investing in their own productivity. … Now, you’d think that for affirmative action it might be different, that, well, it’s always better to go early. … Pre-K is something people are advocating these days. And, indeed, there may be other reasons, not in our model, having to do with cycles of development and so forth, which would explain why early intervention of a different kind is warranted. But if it’s purely in the framework of our model, I think our finding is explicable in terms of intuitions that you find in other areas of economics.\”

I\’m not sure I\’m persuaded! But Loury\’s tight analysis and probing insights are always worth reading. If you would like to read more of Loury laying out these ideas, a possible starting point is an article he wrote for the Spring 1998 of the Journal of Economic Perspectives, called \”Discrimination in the Post-Civil Rights Era: Beyond Market Interactions.\” Like all JEP articles, it is freely available on-line courtesy of the American Economic Association. (Full disclosure: I\’ve been Managing Editor of the JEP since the inception of the journal in 1987.)

Every American politician favors families. But compared with other countries, the spending doesn\’t back up the rhetoric. The OECD has published its 2014 Economic Survey of the United States, and which includes a \”Thematic Chapter\” on \”Improving Well-Being.\” The chapter offers this figure on what share of GDP is spent on programs supporting families. The average OECD country spends 2.6% of GDP on programs focused on supporting families. The U.S. ranks third from the bottom on this list exceeding only Mexico and Korea.

To be clear, this figure is really focused on programs specifically aimed at families with children. It doesn\’t look at programs like health care or housing that can also help those with low incomes, but is not exclusively aimed at families with children. In the U.S. context, Medicaid isn\’t included here.

As the figure shows, many countries make substantial cash payments specifically to families with children. the U.S. has largely shifted to supporting families with children through the tax code–like the child tax credit and the earned income tax credit. Public support in the U.S. for child care and parental leave are also relatively low. For example, here is how the U.S. compares with other OECD countries in education spending. The U.S. stacks up pretty well in spending on K-12 education, but lags well behind in spending in early childhood.

Perhaps not surprisingly, a relatively smaller proportion of U.S. four-year olds are enrolled in a some kind of school or preschool program.

From time to time on this blog–for example, here, here, and here–I\’ve aired concerns that the U.S. research on benefits of early childhood education is a good deal less convincing than I would like. But the young children of today will be America\’s adults of tomorrow. For my comfort level, too high a proportion of those American children are struggling academically and socially. At the youngest ages in particular, the U.S. government just isn\’t making that much of an effort.

Perhaps economists are the only ones who feel their pulses accelerate at a title like \”Shrimp disease in Asia resulting in high U.S. import prices.\” But when explaining intro economics, there\’s always room for one more supply and demand example.  Kristen Reed and Sharon Royales from the U.S. Bureau of Labor Statistics lay out some facts about supply shocks in the shrimp market in a short \”Beyond the Numbers\” (June 2014, vol. 3, no. 14). They write (footnotes omitted):

Shrimp has become a popular purchase for American consumers, with U.S. consumption of shrimp reaching 3.8 pounds per person in 2012. Demand for shrimp has increased over the years, and shrimp is currently the largest imported seafood species, accounting for 29 percent of seafood imports by dollar value. In 2013, consumers and businesses found themselves paying higher prices with less product available in supermarkets and restaurants. For example, the popular restaurant chain Red Lobster recently saw a 35-percent increase in the price the company paid for shrimp. The price hike contributed to a 3.1-percent increase in the company’s overall food costs and, more recently, an 18-percent decrease in earnings during the quarter that ended in February 2014. Similarly, Noodles & Company noted that the cost of shrimp in its pasta dishes would rise 29 percent this year.

The reason for the higher shrimp prices is a shortage of imports from the top shrimp producers in Southeast Asia. With about 90 percent of shrimp consumed in the United States coming from imports, any change in foreign supply affects both U.S. import prices and overall consumer prices. … A large contributor to the seafood price increases was a disease-related decline in supplies from the top three shrimp-producing countries: Thailand, Vietnam, and China.

Here\’s the pattern of U.S. shrimp prices over the last 10 years from the Index Mundi website, based on price data collected by the International Monetary Fund (as part of its data on \”primary commodities\”).

The more modest price rise for shrimp back in 2010 apparently reflects, according to Reed and Royales a previous outbreak of shrimp diseases in other countries, together with the effect of the Deepwater Horizon oil spill on shrimpers in the Gulf of Mexico. Here\’s a figure from the Reed and Royales showing quantities of U.S. shrimp imports from China, Vietnam, and Thailand.

For context, here\’s some data on overall US shrimp supply from the National Marine Fisheries Service at NOAA. The most recent data available here only go through 2012, and so only show the start of the supply drop-off.

There\’s an old rule for holding a successful friendly dinner party: never seat two economists beside each other. But if you draw the short straw and end up sitting next to an economist when you\’re out for a nice seafood dinner, feel free to discuss diseased Asian shrimp, oil spills, and the resulting price fluctuations. The economist will regard it as normal meal-time conversation.

There has been enormous attention paid, and rightly so, to how slowly U.S. labor markets have rebounded since the Great Recession. But the sluggish rebound of U.S. business investment deserves attention, too. Here is the pattern of private nonresidential fixed investment in the U.S. divided by GDP, created with the help of the ever-useful FRED website. During the worst of the Great Recession, investment fell to levels comparable to troughs of recessions in the 1970s and the early 1990s. But even with some bounce-back since 2009, the level of U.S. investment remains low by historical levels.

This low level of investment is showing up in a number of recent discussions. For example, Robert Hall recently calculated that the U.S. GDP is now 13% below where it would be if it had remained on the average trend path fro 1990-2007. He attributes 3.9 percentage points of that gap to a shortfall in business capital. Lawrence Summers gave a recent speech about \”U.S. Economic Prospects: Secular Stagnation, Hysteresis, and the Zero Lower Bound.\” The secular stagnation argument, dating back to a 1938 paper by Alvin Hansen, makes the claim that a strong level of investment is needed for a full-employment economy. Hansen argues that historically, high levels of investment have been driven by three factors: 1) innovation and new technology; 2) a rising  population; and 3) the discovery of new territory and resources.  He argued in 1938 that the last two causes were looking unlikely, and so the U.S. economy needed to focus on innovation and new technology.

As Summers points out, the last two U.S. economic upswings–the dot-com boom of the 1990s and the housing boom of the mid-2000s–were driven by rising investment levels. Of course, the busts that followed these booms were not created equal. The dot-com boom led to high levels of investment in information and communications technology that has paid off in productivity gains, and was followed by a drop in stock prices and the relatively brief and shallow recession in 2001. The financial losses around 2001 were concentrated in stock prices. The housing boom led to more houses, which will not have an effect of boosting future productivity, and was followed by a financial crises and Great Recession that shook the U.S. economy to its roots. Thus, the challenge is not just to have more investment, but to have it in a way that improves productivity and doesn\’t set the stage for a financial earthquake.

The very slow rebound in investment isn\’t obvious to explain.

One possible explanation is a rise in economic uncertainty, as U.S. firms and consumers try to process what hit them during the Great Recession and how to deal with the various major pieces of legislation Congress has passed since then. At some basic level, the very slow rebound in investment is troubling because it suggests that business doesn\’t perceive the U.S. economy as having opportunities for future growth.

A second possibility is that some small and medium-size firms may be having trouble finding sources of financing for investment. However,  many larger firms have sizable profits and are sitting on cash, with what appears to be the ability to borrow if they wish to do so, but they are not choosing to invest. Here\’s a figure from Summers\’s lecture showing corporate profits in recent years.

A third possibility is that despite running budget deficits and low interest rates at levels that would have astonished almost anyone back in 2007, there is still insufficient demand in the economy to encourage sufficient business investment.

A fourth possibility is that businesses are doing a lot of investment, but it\’s often a form of investment that involves reorganizing their firm around new information and communications technology–whether in terms of design, business operation, or far-flung global production networks. As a result, this form of investment doesn\’t involve enough demand to push the economy to full employment. Summers suggests this argument as a possibility in his talk as well.

Ponder that the leading technological companies of this age—I think, for example, of Apple and Google—find themselves swimming in cash and facing the challenge of what to do with a very large cash hoard. Ponder the fact that WhatsApp has a greater market value than Sony, with next to no capital investment required to achieve it. Ponder the fact that it used to require tens of millions of dollars to start a significant new venture, and significant new ventures today are seeded with hundreds of thousands of dollars. All of
this means reduced demand for investment … 

As another way to see this point, here\’s a price index for capital equipment. As Summers says: \”Cheaper capital goods mean that investment goods can be achieved with less borrowing and spending,
reducing the propensity for investment.\”

What might be done to encourage a resurgence in business investment? Low interest rates and large government budget deficits haven\’t been a sufficient answer so far.

One suggestion from Summers is large boost in government spending on infrastructure. I confess that this idea leaves me a little cold. Sure, we can all think of examples where infrastructure spending would be useful. Summers likes to kvetch about the griminess of Kennedy Airport. Here in Minnesota, a major bridge in Minneapolis suddenly collapsed in August 2007, killing 13 people and injuring more than 100. For economists, the trick with infrastructure spending is always to think about the right mixture of price incentives to manage congestion and damage along with pouring concrete–and to try to focus on projects with a large payoff, not just pork barrel spending. While I can easily support appropriately targeted and priced infrastructure spending, I don\’t think that growth in the 21st century economy is going to be built on wider highways.

Summers also suggests actively promoting and encouraging exports, and I\’ve argued on this blog a number of times that the U.S. should be trying to build ties with the faster-growing portions of the world economy. Of course, this is a somewhat indirect way to encourage investment.

Back in the 1960s and 1970s, the government used to enact an \”investment tax credit\” when the economy was slow. The notion was that firms often have some investment plans up their sleeves, for when times get better. By offering a tax credit that expires in a year or two, you encourage firms to get off their duffs and move those future plans up to the present. The broad-based investment tax credit was always controversial, and it died off with the Tax Reform Act of 1986. Instead, there are now little mini-credits for specific investments like those in cleaner  energy. But given the current investment slump, perhaps a broader investment tax credit should be considered.

Summers also writes in general terms of \”regulatory and tax reforms that would promote private
investment,\” and that agenda seems worth pursuing, too. The U.S. corporate tax code seems clearly out-of-whack with the rest of the world. Back in 1938, Alvin Hanson wrote that one traditional stimulation to investment is the discovery of new resources, and the breakthroughs in unconventional natural gas drilling seem to offer a classic opportunity both to provide cheaper energy to the US economy in a way that respects and addresses the environmental issues. And for fans of infrastructure spending, the energy boom offers a number of opportunities for rail and pipelines.

Finally, I believe that in the 21st century, the U.S. is more dependent on an ability to translate research and development into new products and industries than ever before. R&D spending has been stagnant as a share of GDP for decades. Setting a goal of doubling R&D spending might also be a way to give U.S. business investment a big push.  But one way or another, the U.S. economy isn\’t going to be roaring again–and the U.S. labor market isn\’t likely to recover fully–until U.S. firms start making major new investments in new plant and equipment.

UNCTAD is the go-to source for information about foreign direct investment, and its World Investment Report 2014 has the most recent numbers. To be clear, the definition of FDI \”refers to an investment made to acquire lasting interest in enterprises operating outside of the economy of the investor,\” and where \”the investor´s purpose is to gain an effective voice in the management of the enterprise.\” A common practice is to use \”a threshold of 10 per cent of equity ownership to qualify an investor as a foreign direct investor.\” FDI is usefully distinguished from \”portfolio investment,\” which is foreign investment that is purely financial and does not involve a voice in management and may be quite short-term. Global data on portfolio investment is collected by the IMF.

Here\’s the pattern of FDI since 1995. The \”traditional pattern\” of FDI, as the report calls it, has been that developed countries received a greater share of such inflows than developing countries. But as you can see, the inflows of FDI to developed economies have been fairly volatile, while the inflows to developing economies have been rising more steadily. The \”traditional pattern\” is gradually shifting toward the developing countries. Total FDI for 2014 looks to be about $1.6 trillion.

For 2013, total stock of foreign direct investment around the world is about $26 trillion, total income is about $1.7 trillion, which works out to a rate of return of about 6.5%. About 70 million people around the world are employed by foreign affiliates of companies based elsewhere.
Here\’s a more detailed breakdown of FDI inflows and outflows. To me, one of the facts that jumps out is the preeminence of the U.S. economy in foriegn direct investment–it leads the way by a wide margin in inflow and in outflows. In a globalizing economy, the deepening of these interrelationships of U.S. firms with firms around the world should be viewed as a considerable strength.

In looking at the rest of the FDI inflows, it\’s interesting to me that no EU country shows up until Spain (#9 on the list). It\’s also notable that after developing and transition economies are so well-represented on the list of FDI inflows. After the U.S., the next few top countries for FDI inflows are all developing and transition economies. I would not have guessed off-hand that FDI inflows to India exceed those for Germany, nor that FDI inflows to Chile and to Indonesia would exceed inflows to Italy. In looking at the rest of FDI outflows, the developing and transition economies are less well-represented, as one might expect.

For each of the following questions, consider your own answer. Then compare it with the results of a national poll of Americans conducted by the Pew Research Center and Smithsonian magazine. the questions are taken from the script used by the interviewers. Other questions and more detail on the answers are available in the report.

\”Now I have a few questions about the future. Some books and movies portray a future where technology provides products and services that make life better for people. Others portray a future where technology causes environmental and social problems that make life worse for people. How about you? Over the long term, you think that technological changes will lead to a future where people’s lives are mostly better or to a future where people’s lives are mostly worse?\”

The overall response is 59% think technology will mostly make people\’s lives better, while 30% think it will mostly make people\’s lives worse. To me, the notion that almost one-third of Americans think future technology is mostly a negative is startling and unwelcome. Men are more likely to think that technology will make lives mostly better (67%) than are women (51%). Those with a college education are more likely to think that technology will make lives mostly better (66%) than are those who have not completed a college education (56%).

Next, here are some other things that might happen in the next 50 years. For each, tell me if you think it would be a change for the better or a change for the worse if this happens. How about [INSERT ITEMS; RANDOMIZE]?
a. If lifelike robots become the primary caregivers for the elderly and people in poor health
b. If personal and commercial drones are given permission to fly through most U.S. airspace
c. If most people wear implants or other devices that constantly show them information about the world around them
d. If prospective parents can alter the DNA of their children to produce smarter, healthier, or more athletic offspring.

A majority believes that all four of these would be a change for the worse. The least unpopular is wearing implants or devices, with 53% saying it would be a change for the worse. For the other three, between 63-66% think it would be a change for the worse.

The report notes: \”Men and women have largely similar attitudes toward most of these potential societal changes, but diverge substantially in their attitudes toward ubiquitous wearable or implantable computing devices. Men are evenly split on whether this would be a good thing: 44% feel that it would be a change for the better and 46% a change for the worse. But women overwhelmingly feel (by a 59%–29% margin) that the widespread use of these devices would be a negative development.\”

Next, here are some things that people might be able to do in the next 50 years. For each, tell me if this were possible, would YOU PERSONALLY do this… (First,) Would you [INSERT ITEMS; RANDOMIZE]?
a. Eat meat that was grown in a lab
b. Ride in a driverless car
c. Get a brain implant to improve your memory or mental capacity

This question struck me as a little odd, because the 50-year horizon seems pretty far away. The first hamburger grown from stem cells in a lab was served in August 2013 in London, and cost about $335,000. But the possibility of factory meat production at commercial prices may be only a few years away, and growing meat in a lab involves far less use of energy, water, and land than does agricultural production. Driverless cars have been on the roads on an experimental basis for a few years now.  While we don\’t yet have brain implants, we do have computers and smartphones that many of us use all the time in ways that may actually be altering how we use memory and mental capacity.

About half of people would be willing to try a driverless car–and it\’s interesting to me that about half say they would not.  From the report: \”College graduates are particularly interested in giving driverless cars a try: 59% of them would do so, while 62% of those with a high school diploma or less would not. There is also a geographical split on this issue: Half of urban (52%) and suburban (51%) residents are interested in driverless cars, but just 36% of rural residents say this is something they’d find appealing.\”

People are more opposed to eating meat from a lab (78% would not) than they are to a memory brain implant (72% would not). Apparently, there are people out there who are willing to have brain implants if only they can eat a cow-sourced cheeseburger while doing it. College graduates stand out here as more willing to experiment, with 37% of them would be willing to get a performance-enhancing brain implant if given the chance, and 30% willing to try lab-grown meat. There may be a commentary here, both positive and negative, on what we are teaching college graduates.

Public attitudes toward new technology are of course malleable over time. Many people in the past might well have opposed having electrical wires running through homes, for example. But public attitudes shape attitudes toward support of research and development and whether new technologies will have to face extensive regulatory hurdles. Because new companies are chasing consumer dollars, people\’s attitudes determine which technologies will be pursued with greater intensity and, ultimately, what new technologies will succeed.

During discussions of US health care policy, there is often be a moment when someone asks–sometimes angrily, sometimes plaintively, sometimes just wondering–\”Why can\’t the U.S. just have a universal coverage single-payer system like every other country seems to have?\” The question is at some level reasonable, but it\’s also makes me wince a bit. It seems to presume–sometimes angrily, sometimes plaintively, sometimes just wondering–that other countries have all found a clear and simple answer to health care financing issues. But other high-income countries actually have a fair amount of variety in their health care systems, and they are all struggling in different ways with the unavoidable realities of health insurance. Mark Stabile and Sarah Thomson discuss \”The Changing Role of Government in Financing Health Care: An International Perspective,\” in the June 2014 issue of the Journal of Economic Literature (52:2, pp. 480-518). (The JEL is not freely available on-line, but many readers will have access through library subscriptions._

Stabile and Thomson focus on seven countries: Australia, Canada, France, Germany, Switzerland, the United Kingdom–and for comparison purposes, the United States. In my own reading of their paper, here are some of the practical challenges and issues that arise, even when health insurance is universal.

How should health care be financed?

Funds for health care can come from several sources: general government revenues, an earmarked tax for health care, private insurance, out-of-pocket payments by patients, and other sources including charitable foundations. The figure shows how these differ across countries. The UK, Canada, and Australia, for example, rely heavily on general tax revenues. The U.S., with its earmarked Medicare tax, is more similar to France, Germany, and Switzerland in using an earmarked tax. Private insurance is predictably a larger share of health care finance in the U.S. than in these other countries–but all of them continue to have non-negligible private health insurance. Out-of-pocket payments are common in other high-income countries: indeed, the share of total health spending that comes out-of-pocket from patients is larger in several of these countries than in the United States, although many countries have some cap on the total out-of-pocket payment.

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The choice of how to finance health care is necessarily linked to the incentives for spending on health care. General fund spending means that health care competes directly against other spending priorities. An earmarked tax insulates health care from such competition, but it creates a different kind of pressure–to limit health care spending to what the earmarked tax provides.

Does universal mean government-provided? 

In a strict logical sense, \”universal\” health insurance coverage doesn\’t specify how people get health insurance, only that everyone has it. For example, a legal requirement that people have private health insurance, followed up by a backstop plan of public insurance, can provide universal coverage. Universal insurance is administered by regional governments in Canada and Australia, and by central governments in the UK and France. In Switzerland, there is 100% coverage by universal private insurance. Germany lets those with high incomes opt out of the government health insurance system–that is, they do not pay into the system or receive benefits from it–and about 10% of Germany\’s population is covered by private health insurance.

The health care finance arrangements in several of these countries have evolved fairly recently. Stabile and Thomson explain (citations omitted):

Universally compulsory coverage is a relatively recent development in France, Germany, and Switzerland. Switzerland introduced compulsory universal coverage in 1996 to address concerns about unequal access to health insurance, gaps in coverage and rising health expenditures. Before 2000, SHI [statutory health insurance] in France was compulsory for workers and their dependents and voluntary for everyone else; those who could not afford to pay the fixed (nonincome-related) contribution for voluntary coverage relied on locally administered government subsidies. In 2000, France broke the link with employment and extended income-related contributions to all residents, with free access to health insurance for those with very low incomes. In 2009, Germany introduced compulsory universal coverage to stem the growing number of uninsured people, but it maintained the link between statutory coverage and employment. Germany is the only OECD country to allow higher earners to opt out of contributing to the SHI scheme and to be privately covered, instead.

How can problems of risk pooling? 

These countries all wish to allow a fair degree of choice for patients between primary care physicians and hospitals. In this setting, how should the health care providers who treat a higher-than-average share of those with more costly health conditions be compensated?

For example, one option is to subsidize high-risk individuals with vouchers or payments that let them purchase health insurance. Another option is to subsidize an insurance company for accepting high-risk patients. For example, in Switzerland people choose among 35 health insurance companies, and those with pre-existing health risks and conditions get a government subsidy so that what they pay for health insurance is the same as what others would pay. Another option is to adjust payments to health care providers in a way that is linked to the kinds of patients they treat–but also seeks to avoid having health care providers game the system by finding ways to receive extra compensation. As Stabile and Thomson note, all of these countries are tweaking how their payment systems respond to risk.

How to pay for performance? 

In a system of universal coverage, there is still a wish to have different providers compete to some extent against each other, so that there can be incentives for innovation and finding ways to hold down costs. There are a variety of ways to do this, and the approaches have been evolving over time.

For example, one basic approach is to pay for the total number of patients treated, and to pay an amount that represents the average cost per patient treated. The hope is that hospitals, knowing they won\’t get extra pay, will find ways to trim costs. The harsh reality is that many hospitals will find ways to undertreat patients or avoid treating sick patients, as a way of holding costs down. Thus, a fallback approach called \”diagnostic related groups\” involves defining different diagnoses, and paying hospitals the average cost for each diagnosis. It\’s a little harder to game this system, but not much. Hospitals have some power to manipulate who is in what diagnostic related group in the first place, and to be very available to patients with some conditions and not others.

Thus, there have been experiments with various pay-for-performance health care systems, where there is some kind of formula that includes how many patients, their condition, their waiting times, the use of preventive care, the prevalence of avoidable infections, and many other factors to come up with a formula for payment. For example, UK physicians have a list of 65 indicators of quality of care. Again, the question of what indicators apply to what patients, and how much the pay of the doctor is adjusted for each indicator, open up possibilities for gaming the system. These systems only become more complex when trying to encourage experimentation with new technologies and methods of care delivery.

These experiments with diagnostic related groups and pay-for-performance do seem, on average, to improve care and efficiency. But they are a continual work in progress.

Overall

My point here is not to defend the U.S. system of health care finance, either as it existed before the Patient Protection and Affordable Care Act of 2009 or since. I\’ve noted that the U.S. health care system had genuine problems, and that the 2009 act is at best a partial and quite disruptive way to address those problems. Instead, the point is that even universal coverage health care financing systems require a bunch of practical choices and challenges. Setting up a health insurance system that offers the right incentives to patients and providers for cost-effectiveness and innovation is a fundamentally difficult task, and those practical challenges don\’t disappear just by invoking talismanic phrases like \”universal coverage\” or \”single-payer.\”

Full disclosure: The Journal of Economic Literature is published by the American Economic Association, which also publishes the Journal of Economic Perspectives, where I have worked as Managing Editor since 1987.