Abstract
Fifteen years ago, the global financial crisis shattered the intellectual consensus that prevailed after the Cold War. Since then, economists have failed to accurately predict repeated shocks, and there’s no consensus on a sustainable model for global development. More broadly, there’s a sense that economics as a discipline may need renewal. Does the profession sufficiently represent the range of people and problems it examines? Is it too far removed from the concerns of ordinary people? Does it define economic well-being too narrowly?
Fifteen years ago, the global financial crisis shattered the intellectual consensus that prevailed after the Cold War. Since then, economists have failed to accurately predict repeated shocks, and there’s no consensus on a sustainable model for global development. More broadly, there’s a sense that economics as a discipline may need renewal. Does the profession sufficiently represent the range of people and problems it examines? Is it too far removed from the concerns of ordinary people? Does it define economic well-being too narrowly?
We asked six economists from across the ideological spectrum the following question: How must the profession change to become better at answering 21st century challenges? Here’s how they answered.
BY Angus Deaton
Questioning one’s views as circumstances evolve can be a good thing
Angus Deaton is the Dwight D. Eisenhower Professor of Economics and International Affairs, Emeritus, at the Princeton School of Public and International Affairs at Princeton University. He is the 2015 recipient of the Nobel Memorial Prize in Economic Sciences.
Economics has achieved much; there are large bodies of often nonobvious theoretical understandings and of careful and sometimes compelling empirical evidence. The profession knows and understands many things. Yet today we are in some disarray. We did not collectively predict the financial crisis and, worse still, we may have contributed to it through an overenthusiastic belief in the efficacy of markets, especially financial markets whose structure and implications we understood less well than we thought. Recent macroeconomic events, admittedly unusual, have seen quarrelling experts whose main point of agreement is the incorrectness of others. Economics Nobel Prize winners have been known to denounce each other’s work at the ceremonies in Stockholm, much to the consternation of those laureates in the sciences who believe that prizes are given for getting things right.
Like many others, I have recently found myself changing my mind, a discomfiting process for someone who has been a practicing economist for more than half a century. I will come to some of the substantive topics, but I start with some general failings. I do not include the corruption allegations that have become common in some debates. Even so, economists, who have prospered mightily over the past half century, might fairly be accused of having a vested interest in capitalism as it currently operates. I should also say that I am writing about a (perhaps nebulous) mainstream, and that there are many nonmain-stream economists.
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Power. Our emphasis on the virtues of free, competitive markets and exogenous technical change can distract us from the importance of power in setting prices and wages, in choosing the direction of technical change, and in influencing politics to change the rules of the game. Without an analysis of power, it is hard to understand inequality or much else in modern capitalism.
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Philosophy and ethics. In contrast to economists from Smith and Marx through John Maynard Keynes, Fried-rich Hayek, and even Milton Friedman, we have largely stopped thinking about ethics and about what constitutes human well-being. We are technocrats who focus on efficiency. We get little training about the ends of economics, on the meaning of well-being—welfare economics has long since vanished from the curriculum—or on what philosophers say about equality. When pressed, we usually fall back on an income-based utilitarianism. We often equate well-being to money or consumption, missing much of what matters to people. In current economic thinking, individuals matter much more than relationships between people in families or in communities.
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Efficiency is important, but we valorize it over other ends. Many subscribe to Lionel Robbins’ definition of economics as the allocation of scarce resources among competing ends or to the stronger version that says that economists should focus on efficiency and leave equity to others, to politicians or administrators. But the others regularly fail to materialize, so that when efficiency comes with upward redistribution—frequently though not inevitably—our recommendations become little more than a license for plunder. Keynes wrote that the problem of economics is to reconcile economic efficiency, social justice, and individual liberty. We are good at the first, and the libertarian streak in economics constantly pushes the last, but social justice can be an afterthought. After economists on the left bought into Chicago’s deference to markets—”we are all Friedmanites now”—social justice became subservient to markets and a concern with distribution was overruled by attention to the average, often nonsensically described as the “national interest.”
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Empirical methods. The credibility revolution in econometrics was an understandable reaction to the identification of causal mechanisms by assertion, often controversial and sometimes incredible. But the currently approved methods, randomized controlled trials, differences in differences, or regression discontinuity designs, have the effect of focusing attention on local effects, and away from potentially important but slow-acting mechanisms that operate with long and variable lags. Historians, who understand about contingency and about multiple and multidirectional causality, often do a better job than economists of identifying important mechanisms that are plausible, interesting, and worth thinking about, even if they do not meet the inferential standards of contemporary applied economics.
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Humility. We are often too sure that we are right. Economics has powerful tools that can provide clear-cut answers, but that require assumptions that are not valid under all circumstances. It would be good to recognize that there are almost always competing accounts and learn how to choose between them.
“When efficiency comes with upward wealth redistribution, our recommendations frequently become little more than a license for plunder.”
Change of heart
Like most of my age cohort, I long regarded unions as a nuisance that interfered with economic (and often personal) efficiency and welcomed their slow demise. But today large corporations have too much power over working conditions, wages, and decisions in Washington, where unions currently have little say compared with corporate lobbyists. Unions once raised wages for members and nonmembers, they were an important part of social capital in many places, and they brought political power to working people in the workplace and in local, state, and federal governments. Their decline is contributing to the falling wage share, to the widening gap between executives and workers, to community destruction, and to rising populism. Acemoglu and Johnson have recently argued that the direction of technical change has always depended on who has the power to decide; unions need to be at the table for decisions about artificial intelligence. Economists’ enthusiasm for technical change as the instrument of universal enrichment is no longer tenable (if it ever was).
I am much more skeptical of the benefits of free trade to American workers and am even skeptical of the claim, which I and others have made in the past, that globalization was responsible for the vast reduction of global poverty over the past 30 years. I also no longer defend the idea that the harm done to working Americans by globalization was a reasonable price to pay for global poverty reduction because workers in America are so much better of than the global poor. I believe that the reduction in poverty in India had little to do with world trade, and that its reduction in China could have happened with less damage to workers in rich countries had Chinese policies caused it to save less of its national income, so that more of its growth of manufacturing could have been absorbed at home. I had also seriously underthought my ethical judgments about trade-offs between domestic and foreign workers. We certainly have a duty to aid those in distress, but we have additional obligations to our fellow citizens that we do not have to others.
I used to subscribe to the near consensus among economists that immigration to the US was a good thing, with great benefits to the migrants and little or no cost to domestic low-skilled workers. I no longer think so. Economists’ beliefs are not unanimous on this but are shaped by econometric designs that may be credible but often rest on short-term outcomes. Longer-term analysis over the past century and a half tells a different story. Inequality was high when America was open, was much lower when the borders were closed, and rose again post Hart-Celler (the Immigration and Nationality Act of 1965) as the fraction of foreign born people rose back to its levels in the Gilded Age. It has also been plausibly argued that the Great Migration of millions of African Americans from the rural South to the factories in the North would not have happened if factory owners had been able to hire the European migrants they preferred.
Economists could benefit by greater engagement with the ideas of philosophers, historians, and sociologists, just as Adam Smith once did. The philosophers, historians, and sociologists would likely benefit too.
Jayati Ghosh
Economics needs greater humility, a better sense of history, and more diversity
ILLUSTRATION: ANDRÉ LAAME/SEPIA
Jayati Ghosh is a professor of economics at the University of Massachusetts, Amherst.
The need for drastic change in the economics discipline has never been so urgent. Humanity faces existential crises, with planetary health and environmental challenges becoming major concerns. The global economy was already limping and fragile before the pandemic; the subsequent recovery has exposed deep and worsening inequalities not just in incomes and assets but in access to basic human needs. The resulting sociopolitical tensions and geopolitical conflicts are creating societies that may soon be dysfunctional to the point of being unlivable. All this requires transformative economic strategies. Yet the discipline’s mainstream persists in doing business as usual, as if tinkering at the margins with minor changes could have any meaningful impact.
There is a long-standing problem. Much of what is presented as received economic wisdom about how economies work and the implications of policies is at best misleading and at worst simply wrong. For decades now, a significant and powerful lobby within the discipline has peddled half-truths and even falsehoods on many critical issues—for example, how financial markets work and whether they can be “efficient” without regulation; the macroeconomic and distributive implications of fiscal policies; the impact of labor market and wage deregulation on employment and unemployment; how patterns of international trade and investment affect livelihoods and the possibility of economic diversification; how private investment responds to policy incentives such as tax breaks and subsidies and to fiscal deficits; how multinational investment and global value chains affect producers and consumers; the ecological damage wrought by patterns of production and consumption; whether tighter intellectual property rights are really necessary to promote invention and innovation; and so on.
Why does this happen? The original sin could be the exclusion of the concept of power from the discourse, which effectively reinforces existing power structures and imbalances. Underlying conditions are swept aside or covered up, such as the greater power of capital compared with workers; unsustainable exploitation of nature; differential treatment of workers through social labor market segmentation; the private abuse of market power and rent-seeking behavior; the use of political power to push private economic interests within and between nations; and the distributive impacts of fiscal and monetary policies. The deep and continuing concerns with GDP as a measure of progress are ignored; despite its many conceptual and methodological flaws, it remains the basic indicator, just because it’s there.
“The enforcement of strict power hierarchies within the discipline has suppressed the emergence and spread of alternative theories, explanations, and analysis.”
Inconvenient truths
There is a related tendency to downplay the crucial significance of assumptions in deriving analytical results and in presenting those results in policy discussions. Most mainstream theoretical economists will argue that they have moved far away from early neoclassical assumptions such as perfect competition, constant returns to scale, and full employment, which bear no relation to actual economic functioning anywhere. But these assumptions still persist in the models that explicitly or implicitly undergird many policy prescriptions (including on trade and industrial policies or “poverty reduction” strategies), particularly for the developing world.
The power structures within the profession reinforce the mainstream in different ways, including through the tyranny of so-called top journals and academic and professional employment. Such pressures and incentives divert many of the brightest minds from a genuine study of the economy (to try to understand its workings and the implications for people) to what can only be called “trivial pursuits.” Too many top academic journals publish esoteric contributions that add value only by relaxing one small assumption in a model or using a slightly different econometric test. Elements that are harder to model or generate inconvenient truths are simply excluded, even if they would contribute to a better understanding of economic reality. Fundamental constraints or outcomes are presented as “externalities” rather than as conditions to be addressed. Economists who talk mainly to each other, then simply proselytize their findings to policymakers, are rarely forced to question this approach.
As a result, economic forces that are necessarily complex—muddied with the impact of many different variables—and reflect the effects of history, society, and politics are not studied in light of this complexity. Instead, they are squeezed into mathematically tractable models, even if this removes any resemblance to economic reality. To be fair, some very successful mainstream economists have railed against this tendency—but with little effect thus far on the gatekeepers of the profession.
Hierarchy and discrimination
The enforcement of strict power hierarchies within the discipline has suppressed the emergence and spread of alternative theories, explanations, and analysis. These combine with the other forms of discrimination (by gender, race/ ethnicity, location) to exclude or marginalize alternative perspectives. The impact of location is huge: the mainstream discipline is completely dominated by the North Atlantic—specifically the US and Europe— in terms of prestige, influence, and the ability to determine the content and direction of the discipline. The enormous knowledge, insights, and contributions to economic analysis that are made by economists located in global majority countries are largely ignored, because of the implicit assumption that “real” knowledge originates in the North and is disseminated outward.
Arrogance toward other disciplines is a major drawback, expressed for example by the lack of a strong sense of history, which should permeate all current social and economic analysis. Recently it has become fashionable for economists to dabble in psychology, with the rise of behavioral economics and “nudges” to induce certain behavior. But this too is often presented ahistorically, without recognizing varying social and political contexts. For example, the worm’s eye randomized tests that have become so popular in development economics are associated with a shift away from studying evolutionary processes and macroeconomic tendencies, to focus on microeconomic proclivities that effectively erase the background and context that shape economic behavior and responses. The underlying and deeply problematic underpinning of methodological individualism persists, largely because few contemporary economists attempt a philosophical assessment of their own approach and work.
These flaws have greatly impoverished economics and unsurprisingly reduced its credibility and legitimacy among the wider public. The mainstream discipline is sorely in need of greater humility, a better sense of history and recognition of unequal power, and active encouragement of diversity. Clearly, much has to change if economics is really to become relevant and useful enough to confront the major challenges of our times.
Diane Coyle
ILLUSTRATION: ANDRÉ LAAME/SEPIA
Fundamental economic changes require a departure from simplistic economics
Diane Coyle is the Bennett Professor of Public Policy at the University of Cambridge.
The economy of the 2020s is a world away from the economy of the mid-20th century, when much of the standard toolkit economists still use was first developed. The formalization of economics in the 1950s and ‘60s occurred in the context of a manufacturing sector that drove growth and employment, producing standardized goods, and trade was dominated by finished goods rather than components. Keynesian economics shaped the categories of statistics gathered in the System of National Accounts and in the linear input-output models and macroeconomic models newly built by econometricians.
Many of those in prominent policy roles today learned their economics from textbooks and courses based on that relatively orderly economy. In particular, the framework for evaluating policies relied on the basic theorems of “welfare economics,” the branch of the discipline that asks whether economic outcomes are desirable or not. The theory states that market outcomes are the best that can be attained—if certain key assumptions hold.
Needless to say, they rarely do. For example, for the theory to be valid, people need to have fixed preferences— including for things that do not yet exist. All goods need to be “rival,” or able to be consumed only by one person, yet many are nonrival—from the atmosphere to public roads to digital movies. There must be no externalities such as pollution or CO2 emissions. No firms can have market power—there must be perfect competition—and there must be constant returns to scale as production levels increase. What’s more, in the 1970s Nobel laureate Kenneth Arrow proved his “impossibility theorem,” which shows that it is never (on very reasonable assumptions) possible to determine the welfare of society as a whole by adding up the welfare of individuals.
Time for change
So for at least the past 40–50 years, the absence of solidly grounded welfare economics has been an uncomfortable vacuum in economics. Policymakers must choose what they think will be the best course of action for their society, using the best tools economics can provide. One of these, widely used, is cost-benefit analysis. Another is simply to aim to increase economic growth, as this drives up living standards. As the old joke goes, the economic tools work in practice even though they don’t work in theory.
But they have reached their limits. It is time for a reboot of welfare economics. And that means moving away from the simplistic set of assumptions that have shaped the worldview instilled in generations of economics policymakers. Why now? The answer is that the economy has changed so fundamentally that the discipline must follow suit.
One obvious change is the urgency of addressing the environmental crisis. Both climate change and loss of biodiversity put future economic prosperity at risk—and pose potentially existential threats. In the mid-20th century the binding constraint on economic growth was the shortage of physical and human capital, which both needed major postwar investment. In the middle decades of the 21st century, nature will be the binding constraint. Economists must make a major effort to develop natural capital statistics, devise new ways of measuring the social cost of nature’s services, and above all integrate the analysis of the human economy and nature in a meaningful way rather than relegating the issue to isolated “externalities.”
“It is time for a reboot of welfare economics. And that means moving away from the simplistic set of assumptions that have shaped the worldview instilled in generations of economics policymakers.”
Less obvious, but just as fatal for the currently prevailing default mental model of a constant returns, competitive economy of manufactures, is the structure of production today. It is highly globalized even after the shocks of recent years. It is increasingly intangible (in terms of economic value added, material inputs matter as much as ever). Global production is enabled by digital communications and logistics, and digital platforms are becoming the preeminent business model.
This means there are pervasive economies of scale, even more powerful than in the case of older industries such as steel and aircraft manufacture. In many countries and many sectors, a small number of firms have significant market power. Pinpointing the location of value creation is next to impossible given the massive movement of data and ideas along fiber-optic cables. The continuing rapid development of artificial intelligence means that this technological transition will endure. There are no definitions and statistics to monitor the economy, and governments find it difficult to collect taxes and regulate corporate activities.
The new economics
Academic economists are well aware of the changing character of the economy, and there is a good deal of exciting research taking place. But there is not yet a 21st century version of the synthesis of Keynes’ vision of how the economy as a whole works nor the statistics to measure and forecast it. This means that economists—especially if they work in the policy world, with its practical demands—default to the old mental model. So this is the challenge for the economics profession (as I discuss in my book Cogs and Monsters). How should economists analyze the highly nonlinear, interdependent, intangible global economy, with its concentration of market power and new emerging inequalities? What do good outcomes in the digital, intangible, but nature-constrained economy look like? What needs to be measured so we can tell? Above all, if economics is to be useful, what new toolkit can economists provide to help policy decision-making?
Atif Mian
ILLUSTRATION: ANDRÉ LAAME/SEPIA
Dependence on credit to boost demand imperils the world economy—we must correct the underlying imbalances
Atif Mian is the John H. Laporte, Jr. Class of 1967 Professor of Economics, Public Policy, and Finance at Princeton University.
Nature requires balance—between predator and prey in the jungle, between the push and pull of planets in orbit, and so on. The economic system is no different; it requires long-term balance between what people earn and what they spend. Loss of this balance has led to a massive debt supercycle that threatens the global economy. Breaking that cycle is one of the most pressing challenges of the 21st century.
The debt supercycle is the product of an ever-increasing buildup of borrowing by consumers and governments. For example, total debt was about 140 percent of GDP between 1960 and 1980 in the United States, but has since more than doubled—to 300 percent of GDP. The same trend holds true globally. In fact, not even the Great Recession of 2008— which in many ways was a result of the excesses of borrowing—could put a dent in debt’s relentless upward march. It would be a mistake to think that 2008 reflected merely some unfortunate policy misstep. The buildup in debt that led to the 2008 crisis stemmed from deep structural imbalances in the economy. Those imbalances persist, as do the dangers associated with them.
Behind the imbalances
There are two main forces behind the rise of imbalances that have generated the debt supercycle: the saving glut of the rich and the global saving glut. The saving glut of the rich is a consequence of rising inequality. The share of disposable income going to the very rich (top 1 percent) has been steadily rising since 1980. Since the rich also tend to save a much higher fraction of their disposable income, rising inequality has led to a large surplus of savings accumulated by the very rich. The global saving glut is driven by a group of countries, including China, that essentially mimic the saving glut of the rich phenomenon. These countries have been earning a larger share of global income and also save at a much higher rate through various government institutions, such as central banks and sovereign wealth funds. The combined consequence of these two imbalances is a rise in financial surpluses, which have financed the global debt supercycle.
The financial sector plays an important intermediation role: it takes financial surpluses from rich individuals and countries and lends them to various segments of the economy. A well-functioning financial sector would channel the financial surpluses toward productive investments, such as building and maintaining infrastructure and developing technology. Any debt resulting from such productive lending would naturally be sustainable, because returns from investment would pay it of. Unfortunately, a key feature of the debt supercycle is its failure to finance productive investment. For example, even though total debt as a share of GDP has more than doubled, real investment as a share of GDP has remained stagnant, or even fallen over the past four decades.
“Rising imbalances traceable to the very rich and certain countries have generated a global debt supercycle that largely finances unproductive indebted demand.”
Instead of financing investment, the debt supercycle has mostly financed unproductive consumption by households and governments. Whether debt finances consumption or investment does not pose a problem in the short term, because both contribute toward aggregate demand in the same way. However, debt-financed consumption, or “indebted demand,” has different implications in the long run when indebted consumers repay their lenders. Borrowers can repay their debt only by cutting consumption, which puts a drag on aggregate demand, since savers are less inclined to spend the paid-back funds on consumption.
Pushing rates down
Indebted demand thus pulls down aggregate demand in the long run. The economy attempts to compensate for this downward pressure by pushing interest rates down as well. Lower rates help ease the debt-service burden for borrowers and push aggregate demand back up. Consequently, the rise of the debt supercycle is associated with a persistent fall in long-term interest rates as well. For example, the 10-year US real interest rate has declined from about 7 percent in the early 1980s to zero or even negative values in recent years. One unfortunate implication of the fall in long-term rates is that asset valuations tend to rise, which further worsens inequality.
In short, rising imbalances traceable to the very rich and certain countries have generated a global debt supercycle that largely finances unproductive indebted demand. This significant characteristic of the debt supercycle pushes long-term interest rates down, which only further exacerbates rising wealth inequality. An equally troubling aspect of the debt supercycle is that real investment has not gone up despite the large decline in interest rates and abundant financial surpluses. Debt supercycles reflect problems on the demand side, with rising inequality and the saving glut of the rich, and problems on the supply side, with a highly restrictive investment response despite extremely low interest rates and abundant financing.
World economy’s vulnerabilities
What dangers does the debt supercycle pose to the world economy? An economy that relies on a constant supply of new debt to generate demand is always susceptible to disruptions in financial markets, which can trigger serious slowdowns. This is what happened in 2008 with household debt. Since then, the economy has relied more on government debt to generate demand. Governments in advanced economies can often borrow at a rate lower than their rate of growth, which makes it easier for them to sustain the debt supercycle and keep the economy afoat. But dependence on continuous government borrowing is politically risky because it relies on continued financial market stability. Recent rate hikes in many countries demonstrate that this reliance cannot be taken for granted.
Ultimately the economy needs to find a way to rebalance and reverse the debt super-cycle. This calls for structural changes so that growth is more equitable, which would naturally reduce the scope for imbalances. There is also a natural role for tax policy to rebalance the economy. For example, taxing wealth beyond a certain threshold can promote more spending by the very wealthy. This in turn would reduce the saving glut of the rich that finances the unproductive debt cycle. Finally, supply-side reforms, such as removing restrictions on new construction, promoting competition, and boosting public investment, can help expand investment opportunities so that debt can fund productive investment rather than unproductive indebted demand.
Governments around the world have been responding to the ills of the debt supercycle with traditional fiscal and monetary tools. However, as is well known, these tools are designed only to address temporary cyclical problems, not structural problems such as long-term imbalances. For example, looser monetary policy may help boost demand in the short term by enabling borrowers to borrow a little more. But ultimately such indebted demand will pull the economy back down again. We have at best been kicking the proverbial can down the road, and at worst further impeding eventual resolution of the debt supercycle.
John H. Cochrane
ILLUSTRATION: ANDRÉ LAAME/SEPIA
Inflation teaches us that supply, not demand, constrains our economies, and government borrowing is limited
John h. Cochrane is the Rose-Marie and Jack Anderson Senior Fellow at the Hoover Institution, Stanford University; adjunct scholar at the Cato Institute; and author of The Fiscal Theory of the Price Level.
The unexpected resurgence of inflation is a slap in the face, telling us that the consensus ideas of economic policy are wrong and need to change. Fortunately the “new” ideas we need are well tested and sitting on the shelf.
Inflation comes when aggregate demand exceeds aggregate supply. The source of demand is not hard to find: in response to the pandemic’s dislocations, the US government sent about $5 trillion in checks to people and businesses, $3 trillion of it newly printed money, with no plans for repayment. Other countries enacted similar fiscal expansions and reaped inflation in proportion. Supply is more contentious. Supply did shrink during the pandemic. But inflation spiked after the pandemic was largely over, and many “supply shock” industries were producing as much as before but could not keep up with demand.
But just how much inflation came from demand, induced by looser fiscal or monetary policy, versus reduced supply matters little for the basic lesson. Inflation forces us to face the fact that “supply,” the economy’s productive capacity, is far more limited than most people previously thought. The mantras of the 2010s—”secular stagnation,” “modern monetary theory,” “stimulus”—which preached that prosperity needed only for the government to borrow or print a huge amount of money and hand it out, are in the dustbin. You asked for it. We tried it. We got inflation, not boom.
“The mantras of the 2010s, which preached that prosperity needed only for the government to borrow or print a huge amount of money and hand it out, are in the dustbin.”
A supply-limited economy requires supply-oriented policy, not stimulus, to grow. “Jobs” are now a cost, not a benefit. With 3.7 percent US unemployment, every worker employed on a make-work project is one not doing something more important. Regulations make housing far too costly and time- consuming to build. A coherent immigration system brings in people who work, produce, and pay taxes. We need public infrastructure, but its obscene excess cost is a rathole we can no longer afford. Tariffs that force us to overpay for things foreigners can provide better are just a drain on the economy. Policy focused on who gets what must now focus on incentives, which are the key to growth.
The cancer of stagnation
Stagnation is the quietly insidious economic cancer of our era. US growth fell by half after 2000. Europe and the UK are stagnating even more. Italy has not grown in per capita terms since 2007. Reviving long-term growth drowns any other policy, and only supply, efficiency, productivity, and incentive-oriented policy can revive long-term growth.
The view that there is unlimited demand for government debt, with buzzwords like “savings glut” or “safe asset shortage,” has equally proved false. The US, UK, and Europe seem to be able to borrow about 100 percent of GDP. More debt leads to higher interest rates, trouble borrowing, and inflation as people try to spend the extra debt rather than hold on to it as a good investment.
From now on, governments must spend money as if they have to raise taxes to pay for it, now or later. They do. Projections that debt will serenely grow to 200 percent of GDP under primary deficits that are eternally 5–10 percent of GDP will simply not happen. Worse, we have lost our fiscal capacity to react to shocks. If the $5 trillion pandemic response was more debt than people will hold and caused inflation, the $10 trillion response to the next crisis will face even more trouble.
Our left wing wants to spend trillions of dollars on cost-ineffective climate subsidies, such as massively oversize electric cars built in the US, by union labor, with US parts. Our right wing wants to spend trillions of dollars on protection and industrial subsidies in a vain (and unwise) quest to bring back 1950s manufacturing. Industrial policy will do for chips what the Jones Act (the Merchant Marine Act of 1920) did for shipping. Now that money is no longer free, we can only afford spending that actually works.
Inflation’s lessons
This inflation has two deep lessons for monetary and financial policy. First, central banks do not entirely control inflation. Inflation control needs fiscal probity as well. Second, the fiscal blowout was in part a financial bailout, including support for Treasury, municipal, and corporate debt; money market funds; airlines; and others. The central “no more bailouts” promise of the Dodd-Frank financial reform failed. In my view, another 100,000 regulations will fail again, and the only answer is the simple classic vision of equity-financed banking.
These may seem like old ideas. That’s great. Progress in economics has never come from pontificators who urge someone else to throw new ingredients in the pot—say, to “care more about people,” “add psychology,” “mix politics and economics,” incorporate “real-world” complications or “heterodox” ideas—stir, and hope that a digestible soup comes out. Progress in economics has always come from answers, patiently worked out, empirically verified, simplifying reality to actionable cause and effect statements. Economic policymaking suffers from too many pundits who rush to Washington to demand trillions of spending and untold intrusions in people’s affairs, based on half-baked stewpots of novel ideas. Economic policy should rely on well-tested notions. When economists try to supply ideas in response to political demands for the appearance of novelty, they dispense bad economics and bad politics. And what seems old to us can appear novel too. Adam Smith’s 250-year-old ideas are still news to most in politics.
Michael Kremer
Economists can play a crucial role in the development of innovations for serving social, environmental, and other human needs
ILLUSTRATION: ANDRÉ LAAME/SEPIA
Michael Kremer is the director of the Development Innovation Lab and a university professor in the Kenneth C. Griffin Department of Economics at the University of Chicago. He is the 2019 co-recipient of the Nobel Memorial Prize in Economic Sciences.
We know that innovation is a key driver of economic growth, but technical and social innovation has also spurred improvements in health, inequality, and social relations. Contemporary innovations in biology and artificial intelligence have tremendous potential to promote prosperity, improve health and education (including for the world’s most disadvantaged), and address global challenges such as pandemics and climate change.
At the same time, many are concerned that these innovations could further endanger the environment, increase inequality, and lead to political polarization. As economists, we can contribute to the design of institutions to better align private incentives for the pace and direction of innovation with human and environmental needs. We can also contribute directly to the innovation process by helping develop and rigorously test social innovations.
Closing the gaps
More than 5,000 innovations have been patented related to control of the European maize borer (a pest that eats grain), but only five for the maize stalk borer, a similar pest, which affects primarily production in sub-Saharan Africa. Economic analysis can help identify cases like this, in which social needs and commercial incentives to invest in innovation diverge substantially under current institutions. It can also inform the design of policies and institutions to address these gaps. Here, I will draw examples from the interlinked challenges of climate change, food insecurity, and agricultural productivity in low- and middle-income countries. As the examples of the maize borers illustrate, this is an area with particularly large gaps between social and commercial incentives for innovation.
Perhaps most obviously, climate mitigation innovations have large positive externalities (benefits to people other than the consumer of the innovation), meaning commercial incentives to invest in them are limited. For example, methane emissions from livestock make up nearly 15 percent of all anthropogenic greenhouse gas emissions, and innovative feed additives could potentially reduce these emissions by 98 percent. However, since farmers lack strong incentives to purchase such feed additives, potential feed innovators lack strong incentives to invest in R&D.
Other innovations are public goods and will be undersupplied by the market. For example, climate change disrupts weather patterns, and advances in AI enable more accurate weather forecasts. Farmers react to these forecasts. Improved monsoon forecasts could produce benefits exceeding $3 billion for farmers over five years in India alone, perhaps 100 times as much as they would cost. Moreover, information services create benefits beyond the buyer of the goods, since farmers who don’t subscribe can still access the information from subscribers.
Innovations in government service delivery, such as new technologies for digital agricultural extension, face a monopsony buyer problem, since the government is the most plausible buyer. Innovators may also be reluctant to invest in innovations with limited barriers to entry, such as climate-resilient crop varieties that farmers are able to replant in future seasons without repurchasing seeds.
“As economists, we can contribute to the design of institutions to better align private incentives for the pace and direction of innovation with human and environmental needs.”
Policies for innovation
Economic theory and empirical analysis can also contribute to the design of research funding systems. How should research funding be allocated or divided between basic research and more translational work? What regulations are needed to protect safety? When should funding be allocated to large-scale centralized efforts and when should it be allocated through open calls for proposals from individual researchers with peer review? Are there better ways to identify and nurture potential members of the next generation of researchers who might not otherwise enter the field?
Economics can also provide guidance in designing incentives for innovation that do not require governments to pick winners in advance. There is a large literature on how patents can be optimally designed to balance incentives for innovation and monopoly-pricing distortions. It is also worth exploring alternative approaches for rewarding innovations, such as prizes or advance market commitments, under which funders commit to pay for a future innovation if it meets prespecified technical and pricing criteria and garners market demand. Following a $1.5 billion advance market commitment for the pneumococcal vaccine, three firms developed vaccines that were effective against the strains commonly found in developing economies. These vaccines have now reached hundreds of millions of children, saving an estimated 700,000 lives.
Government procurement procedures can also be designed to spur innovation. For example, cement is responsible for about 7 percent of carbon dioxide emissions. Since governments are major purchasers, accounting for half of US cement use, they could boost innovation in low-carbon cement simply by committing to factoring the social cost of carbon into procurement processes.
Economists as innovators
In addition to shedding light on the design of policies and institutions for innovation, economists can also participate directly in the innovation process. For example, economic theorists have used market design principles to design kidney transplant matching systems, and development economists are using experimental methods not just to test innovations, but also to help develop them. An analysis of Development Innovation Ventures (DIVs)— the US Agency for International Development’s tiered evidence-based social innovation fund—found that 36 percent of awards went to innovations developed by teams including development economists, scaled to reach over 1 million users, compared with just 6 percent of awards to innovations without such involvement.
Furthermore, 63 percent of DIV-supported innovations that had previously been tested in randomized controlled trials reached more than 1 million people, compared with only 12 percent of those without such trials. For example, economists helped develop a credit-scoring approach using psychometrics (psychological testing) to assess default risk for potential borrowers without credit histories, which scaled through adoption by commercial lenders.
Just as biochemists and computer scientists often develop practical innovations in their fields, economists are increasingly developing social innovations in ours. F&D
