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Equality of Opportunity, Invention and Growth: The Next President’s Fiscal Policy

Equality of Opportunity and Economic Growth

In case you’ve been living under a rock, it is election season in America. Both candidates have laid out their vision for America’s future, and they differ on many issues.

But on some issues the candidates agree. One example is taking advantage of low borrowing costs to invest in America’s aging infrastructure. Such a plan would create jobs, stimulating short-run growth while making America’s economy more efficient in the long-run. But with policy, the devil is in the details. Even on this area of agreement, the candidates proposed policies are very different. As has often been the case, Trump’s plan is short on specifics and is not fully funded, casting doubts on its effectiveness while increasing the deficit (more on this later).

But another piece of the economic puzzle, one that is as important to America’s long-run growth as infrastructure, is also sorely underinvested in. I am referring to human capital (education, healthcare). There are many ways to promote investment in human capital–more on the how later. First, lets examine why investing in human capital is important.

Simply put, investing in human capital is a key driver of invention, and invention is the main driver of long-run growth. This is a purposefully general statement–I do not have to know what the next paradigm shifting invention will be in order for this statement to be true.

Some people may counter that most inventions are technological in nature, and automation is leading to job loss. To that, I would say we cannot fear progress. Rather, our leaders need to figure out how to balance the need for economic growth with peoples need to be employed–how to “re-couple” the social and economic functions of the labor market. This may require some sort of large-scale guaranteed government / subsidized private sector jobs program–another debate for another day.

Back to invention. While there is no “formula” for discovering great inventions, invention does tend to flourish in certain contexts. Both the public and private sectors can spur the inventive process by investing in research and development. Strong property rights and judicial independence are needed to protect inventors, or else the incentive to invent is not there. A sound financial system is needed to match funding to good ideas, and various forms of infrastructure are needed for production and distribution.

But most importantly invention requires a well educated people, free to explore their novel ideas. The security that comes from decoupling health insurance from employment–as the ACA has done–also helps, by removing some of the risk of leaving one’s job to pursue an invention.

America has most of these things in spades. But one area America can do better (other than infrastructure) is promoting investment in human capital, particularly at younger ages and lower wealth brackets.

America’s top Universities are some of the best in the world, and we have a decent system for matching the most talented low income applicants to them. But research shows that earlier intervention is needed to truly promote equality of opportunity. The “lifecycle” approach to development states that much of the human development needed for people to realize their potential–including their innovative potential–occurs well before college. This is not to say the government should not prioritize making college more affordable. I am a proponent of free community college for low-income applicants with strong academic credentials. But college is only a part of the equality of opportunity equation.

For not only do we not know what the next great invention will be, we also do not know who will invent it. Therefore, it is the job of our government to create the largest possible base of potential future inventors. While the overwhelming majority of people will not go on to discover great inventions, well targeted investments earlier in life still benefit society by helping people maximize their future earnings (and tax bills), reducing poverty and crime (and future government spending on welfare programs and the criminal justice system).

You may be thinking, “this is all well and good in theory, but how will we pay for it all?” Aside from the higher tax revenues and savings resulting from such investments in the long-run, more immediate action should be taken to get the Federal government’s fiscal house in order.

NEEDED: Tax Then Entitlement Reform

Should interest rates on U.S. debt rise, interest payments would consume a large portion of government spending. While there is no guarantee the interest rates on U.S. debt will rise, given the global nature of contemporary investment and America’s status as a “safe haven”, it would be prudent to reduce the deficit if it can be done in a way that does not compromise economic growth and pose undue hardship on America’s poorest citizens.

Every taxpayer dollar spent servicing debt is a dollar that cannot be spent on something beneficial (human capital investment, infrastructure, defense, anything). It is in no ones interest to see this potential future come to pass, as almost everyone (except possibly Libertarians) believes there is something productive taxes could be spent on.

Responsibly closing the deficit requires both comprehensive (corporate and personal) tax and entitlement reform.

“Entitlement spending” consumes a large percentage of government spending, and for good reason–it meets important societal needs, often more efficiently than its private sector counterparts. Private sector pension coverage fell from 28% to 13% between 1993 and 2011, and private sector health insurance costs have historically risen faster than Medicaid. Due to the effectiveness of Medicaid and Social Security, they should arguably be expanded if we can figure out how to properly fund them (expanding the “public option” would help fix Obamacare, and there is a strong argument to be made for expanding Social Security to make up for the drop in people covered by private pension plans).

As a Nation, in order to have a meaningful debate about how much we can afford to spend (and on what), we have to know how much tax revenue we can expect to take in. Comprehensive tax reform endures for a long time–the last major tax reform was passed 30 years ago. Passing comprehensive tax reform would allow for meaningful revenue projections for the foreseeable future (exactly how long depends on how vigilantly Congress guards the tax code against unnecessary loopholes). Therefore, comprehensive tax reform should precede entitlement reform.

HOW to Promote Equality of Opportunity

Greater investment in human capital can be achieved in a number of ways. It can be achieved directly through new social programs, a few of which I proposed earlier, but in recent years such ideas have been political nonstarters.

With more money people will spend more in the short-run–promoting short-run growth–and invest more in themselves and their children–promoting long-run growth. But how do we get more money into peoples’ pockets without politically contentious social programs (i.e. redistribution)? A more politically viable (if admittedly less targeted) approach involves increasing the incomes of America’s less well-to-do through the labor market.

A market-based approach would include some combination of a higher minimum wage and an expanded earned income tax credit (EITC). These policies would be even more effective if paired with human capital investment programs that recognize the “lifecycle” approach to development. Both candidates claim they want to help low and middle class people, but upon examining their proposed policies, only Clinton’s would move this country the right direction.

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Green News: Access to Energy, Poverty Reduction, and a Reason to be Optimistic About Renewable Energy Use in the Developing World

The image shows projections for COemissions and global temperature changes based on different scenarios. Since we cannot know the future of environmental policies, technological advances, or economic growth, projections based on are the best way to hypothesize about these issues. One thing should become apparent after viewing these graphs–while the future is yet undetermined, failure to take action will have dire consequences.

Economic development is an essential component of poverty reduction in the worlds least developed countries (LDCs). However, economic development /poverty reduction are impossible without increased access to energy. Looking at the UN’s “My World 2015” survey, most of the 16 variables “for a better future” rely, to varying degrees, on energy access.

Original article:

In a speech on Monday in Warsaw, the United Nations’ top officer on climate change warned coal industry executives that much of the world’s coal will need to be left in the ground if international climate goals are to be met.

Godfrey G. Gomwe, chairman of the World Coal Association’s energy and climate committee, responded in a speech that, with “1.3 billion people in the world who live without access to electricity,” the questions of climate change and poverty reduction could not be separated.

“A life lived without access to modern energy is a life lived in poverty,” said Mr. Gomwe, who is also chief executive of the mining company Anglo American’s thermal coal business. “As much as some may wish it, coal is not going away.”

Todd Stern, the United States envoy on climate change, said at a news conference in Warsaw that the world’s reliance on coal is “not going to change overnight.” But, “high efficiency coal is certainly better than low efficiency coal,” he added, noting that carbon capture and storage technology was “the most important hope” for coal’s future.

Does this mean that the goals of (extreme) poverty reduction and environmental sustainability are incomparable? No, international efforts for poverty reduction have taken place in the context of “Sustainable Development“. While coal will not “go away”, the chief executive of a coal business is hardly an unbiased agent–he is likely to overstate coals importance in the global energy portfolio. In order to reconcile these two goals, LDCs must meet growing energy demands primarily with zero / low emissions renewable energy sources.

I, for one, am optimistic that LDCs will pursue sustainable development. This is not blind optimism, it is based on political and economic realities.

In the U.S., renewable energy industries face the impediment of strong, established “traditional” energy industries (such as coal power). These industries have billion dollar profit margins and employ large numbers of people. Furthermore, infrastructure or “energy grids” already exist which may not be able to distribute renewable energy, representing large “sunk costs” to switching to renewable energy. In sum, these factors lead to strong local level support and national lobbying efforts for traditional electric. The benefits of renewable energy are realized in the future, while the costs (higher energy prices) and resistance from special interests occur in the present.

In LDCs, where many people are “off the grid”, these “incumbency” obstacles do not exist. In LDCs, people rely primarily on the agrarian economy, and are therefore more likely to support environmentally sustainable energy sources. Furthermore, “off-the-grid-renewable energy” represents a way of bypassing the large fixed costs associated with building traditional energy grids–something that is extremely important in the context of the world’s poorest countries:

Sub-Saharan Africa is also seen as a promising context for renewables. An analogy with the region’s adoption of mobile phones suggests sub-Saharan Africa could dispense with polluting, grid-connected power plants – just as it skipped landline telephones — and move straight into distributed generation from renewables.

Yet a note of caution enters any forecast for any region that so consistently outwits the sharpest analysts. Bhattacharyya tallies up several points for optimism but, while sharing Cohen’s enthusiasm, expresses doubt about the scale of development.

‘The market-driven approach’ has started to ‘flourish’ in areas such as Kenya, he says. He also sees grounds for optimism in how global attention on the lack of access to clean energies by agencies such as the UN, IEA and World Bank has also raised local recognition and awareness of the issue.

In ‘an optimistic case’ he forecasts that sub-Saharan Africa could add a few gigawatts through off-grid technologies, bringing electricity to millions of its people.

‘There is surely huge potential for off-grid options but it is difficult to tell how much is really likely to materialise,’ he says.

The issue with financing renewable energy projects was supposed to be addressed by the UN Green Climate Fund; developed countries promised $100 billion a year to the developed world by 2020 to help cope with and reverse climate change. Issues over “common but differentiated responsibilities“, as well as austerity measures in response to the Great recession, call the availability of these resources into question.

One potential means of making up this funding gap is through a so-called “feed in tariff“:

The report by the World Future Council says providing feed-in tariffs for developing countries so that they can finance setting up large-scale renewable systems and feed electricity to their grids is the best way forward for the fund.

Feed-in tariffs provide the owners of small or large-scale wind and solar arrays with a guaranteed price for electricity over 20 years, so the investor is certain to get a return on their capital. The scheme has worked in developed countries like Germany and Italy to rapidly boost renewable output.

An added problem in developing countries is making sure that the national or local grid can take up and use the electricity generated. Some developed countries have already had difficulties with this, so sorting out the grid must be part of any financing package, the report says.

The report envisages 100 gigawatts of electricity being funded in this way by 2020 – the equivalent of the output of 100 large-scale coal-fired power plants. This would cost 1.3 billion euros a year to fund, sustained over two decades. 

Feed-in tariffs require energy grids to feed-into, and for that reason are not a viable option for the most impoverished / remote areas in the world which do not currently have traditional energy grids. For areas in the developing countries with traditional grids, this is a viable solution. For other areas, financing for off-the-grid renewable energy must be made available. The ability to reconcile economic development, environmental sustainability, and poverty reduction–sustainable development–depends on it.

Update: Alternatively, perhaps off the grid renewable energy can be stored in batteries and sold as part of a feed-in tariff. I know advances are being made in large scale renewable storage in large batteries, I wonder if there is a way to make this work on a small scale as well. Just a though…


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Economic Outlook: The Ripeness of Cyprus


That ripeness refers to the need for Cyprus to diversify it’s economy. Ripeness may not be the right word, as Cyprus is not willingly taking these measures but rather having them imposed, but what else rhymes with Cyprus? (Lack of ripeness, like with this peach, is often a good indicator it is time to throw out said peach, no?)

“Cyprus has a huge banking system — assets around 8 times GDP — based on a business model of attracting offshore money with high rates and good opportunities for tax avoidance/evasion.”

The problem with such a large banking sector is that it creates asset bubbles and leads to  a loss of competitiveness in other sectors. As Cyprus now faces the inevitability of having to diversify its economy away from the banking sector, it faces the difficulty of having wages that are uncompetitive with the rest of its neighbors. It is difficult to be competitive in export industries with a high cost of labor and a high cost of living, as these costs ultimately fall on producers making their goods less competitive. A high cost of living also depresses tourism, as people will choose to go to cheaper destinations.

Transitioning to export based growth is tough in today’s economic conditions, even when labor costs constitute a comparative advantage. This is due to a slump in global aggregate demand, particularly with Cyprus’s current trading partners—EU countries. The EU remains mired with high unemployment and recessions (which are currently hitting Cyprus particularly hard as well), meaning that finding markets for diversified exports would be difficult. The high unemployment (14.7%) and recession conditions (-3.3% GDP growth Q4 2012) mean that Cyprus cannot rely on its domestic markets to buy its goods either.

For these reasons, Cyprus has been reluctant to admit that it must abandon its unsustainable reliance on the financial sector. Cyprus tried to secure an EU bailout by imposing a tax on banking deposits—a measure that Cypriots forcefully rejected. It seems that ultimately Cyprus will have to agree to spare small depositors (average citizens) and force large depositors (who are often foreigners who go to Cyprus as a tax haven) to take a large “haircut”. This would undermine confidence in Cyprus’s banking sector, leading to capital flight.

Cyprus could impose capital controls to prevent capital flight, as Iceland did in a similar situation. This, along with uncertainty of Cyprus’s future in the EU, could mean less FDI (uncertainty is a huge deterrent to investment, especially in the case of a potential EU-exit) which Cyprus will need to diversify its economy due to high levels of debt (84% GDP as of Q3 2012) and high borrowing costs (7% interest rates on long term bonds).

Cyprus is currently at a crossroads, a point summarized nicely by Paul Murphy at FT Alphaville:

“Big depositors in Cypriot banks stand to lose circa 40 per cent of their money here, which has drawn plenty of fury and veiled threats from Russia.”

“Cyprus now has a binary choice: become a gimp state for Russian gangsta finance, or turn fully towards Europe, close down much of its shady banking sector and rebuild its economy on something more sustainable.”

So how are Cyprus’s prospects for economic diversification? Actually, this is a potential bright spot in an otherwise dismal picture (for data, see end of the post):

Cyprus has increased its spending, per person, at all levels of schooling over recent years. There has also been a shift to more advanced technological manufacturing, which could be a growth industry (High-technology exports as % of manufactured exports have risen from around 4% in 1990 to close to 40% in 2010). Energy production, specifically a natural gas field adjoining the Cyprus-Israel border, has been discussed as a potential growth sector.

The problem is such exploration requires large upfront costs and profits will not be realized for at least a few years. Given Cyprus’s high borrowing costs, an immediate bailout is needed—Cyprus simply cannot afford to wait for its economy to diversify, even if it was able to secure the funding needed explore it’s gas fields and / or avoid a Euro Zone exit.

Luckily, Cyprus has been laying down the seeds of economic diversification, but those seeds are not ready to sprout. Economic diversification will be painful, based on the composition of Cyprus’s labor force (agriculture 8.5%, industry 20.5%, services 71% (2006 est.); presumably a large portion of people in the services sector work in financial services).

Compounding the problem; “There’s still a real estate bubble to implode, there’s still a huge problem of competitiveness (made worse because one major export industry, banking, has just gone to meet its maker), and the bailout will leave Cyprus with Greek-level sovereign debt.”

Cyprus needs the troika (IMF, ECB, and EC) to provide emergency liquidity to allow its economy time to diversify. There will inevitably be some growing pains—hopefully harsh austerity is not imposed as a condition for receiving these loans, although recent history suggests it will be. Some internal devaluation will be needed to make Cypriot wages competitive again—something that is politically and socially undesirable (as wages tend to be “sticky”) but an inevitable consequence of losing control of monetary autonomy (being in the EU, Cyprus cannot devalue it’s currency to increase export competitiveness)

Cyprus has been investing in human capital, and already has the infrastructure for export based growth through its advanced system of ports, what is needed is stimulus spending to help mobilize Cyprus’s factors of production away from the financial sector.

Just like a child who knows he must do something he doesn’t want to do, Cyprus initially faced it’s unfortunate reality by trying to return to its security blanket—the financial sector. Ultimately, Cyprus needs to be weaned off the teat of the financial sector—even Russia, the biggest loser if large depositors take a loss, has stated it will not extend financing to Cyprus until it secures troika financing (Cyprus pursued Russian financing as an alternative to a troika bailout, presumably to allow it continue with its unsustainable banking practices, in exchange for preferential exploration rights by Russian firms of Cyprus’s natural gas fields. These talks thankfully did not bear fruit, as they would’ve moved Cyprus in the wrong direction; doubling down on an unsustainable financial sector while compromising its most obvious means of economic diversification–it’s natural gas reserves).

It is important to avoid a Euro Zone exit, as this would undermine investor confidence which is needed alongside troika loans to allow Cyprus to diversify its economy. Ultimately, investors will react favorably if Cyprus admits its financial sector is unsustainable and commits to economic diversification. A sustainable economic outlook will attract investment, especially in an industry as profitable a natural gas exploration, but also in other sectors due to low taxes (10% corporate tax rate in Cyprus–lowest in the EU, can help offset the current high wages in Cyprus and temper the social costs of internal devaluation).

Uncertainty and trying to hold onto an exposed unsustainable financial sector will drive away investors. Everybody can now see that Cyprus will have to force a “haircut” on large depositors. The sooner Cyprus “takes its medicine”, the sooner it can get on the path to sustainable economic development.

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