Medical expenditures by business and households and other private sources are subsidized in various ways by government at all levels, but we’ll leave that aside and say that government accounted for 45 percent of medical expenditures in 2011. This number will most likely increase as the Affordable Care Act is implemented, but let’s also leave that to the side and imagine that government will account for 45 percent of medical expenditures in 2105 — government spending on medical care alone with represent 27 percent of GDP.

This is the best-case scenario. In this world, total government expenditures (federal, state, and local) might represent as much as 60 percent of GDP. Even if we achieve fiscal balance with government expenditures at 60 percent of GDP, the space for private enterprise, civil society, and voluntary cooperation writ large will be smaller than it is today, and it is not unreasonable to believe that this might have deleterious consequences on dynamism and initiative.

So just raise taxes, right? Pre-Reagan marginal income tax rates. Maybe a VAT, too. And some Pigovan carbon and Tobin taxes for good measure. After all, if the challenge is just making the numbers work, tax away.

But as Salam adds, we also want government to, you know, deliver better services and a better quality-of-life. Value. So what is required here is not just cost cutting or deficit reduction, but massive amounts of fresh thinking and disruptive innovation.

Perhaps the most important role for government is not getting in the way, not letting established public- and private-sector players use government to preserve the status quo. Still,  center-right policymakers must not just focus on cutting government, but making the government we do need work better. McKinsey notes that the US government has not tried to measure its own productivity in nearly two decades.

But which way does the causality run? In a speech yesterday, Raskin points to globalization and automation as reasons why some two-thirds of all job losses in the recession were in middle-wage occupations, but those occupations have accounted for less than one-fourth of the job growth during the recovery. By contrast, lower-wage occupations have accounted for only one-fifth of job losses during the recession but more than one-half of total job gains during the recovery. As such, Raskin says “the earnings potential for many households likely remains below what they had anticipated in the years before the recession.”

So the middle part of the labor market is being hollowed out, what economists call “job polarization.”

Credit: KC Fed

But is inequality hurting economic growth? Brookings scholar Scott Winship has his doubts, telling the New York Times, “The evidence does not give much reason to worry that inequality saps growth, or much reason to think that it increases it.” Among his reasons:

1. It seems that way for authoritarian nations with emerging economies, but that relationship has been tough to pin down for democratic, advanced economies.

2. A highly regarded 2010 study Do Rising Incomes Lift All Boats looking at data from 1905 to 2000 found “no systematic relationship between top income shares and economic growth in a panel of 12 developed nations observed for between 22 and 85 years.”

3. A March 2012 study by Michael Bordo and Christopher Meissner, Does Inequality Lead to a Financial Crisis, concludes “low interest rates and economic expansions are the only two robust determinants of credit booms in our data set. Anecdotal evidence from US experience in the 1920s and in the years up to 2007 and from other countries does not support the inequality, credit, crisis nexus. Rather, it points back to a familiar boom-bust pattern of declines in interest rates, strong growth, rising credit, asset price booms and crises.”

In Brink Lindsey’s excellent new book, Human Capitalism, he notes a disconnect between the demand for high-skill human capital and inability of society to widely provide a fertile environment for its development. “Educational attainment has stalled, and the lowest skill jobs are increasing, not decreasing, their share of employment.”

He offers several ideas, which I will list briefly but promise to later explore in depth: 1) maintain economic growth by encouraging entrepreneurship, 2) reform K-12 education by unleashing competition, 3) compensate for disadvantaged environments through early childhood interventions, 4) combat social exclusion of low-skilled adults, 5) improve higher education by limiting tuition subsidies, 6) remove regulatory burdens to entrepreneurship and upward mobility. Rather than focus on the 1% per se, better to keep growth high and enhance the ability of more Americans to take part in a growing economy — which will boost growth further and create a virtuous circle.

As the above chart shows, the forecasted decline will be bigger than the expected falls in Europe. So why is US growth expected to continue to be OK, while EU is suffering a long recession? Capital Economics:

The big difference, though, is that activity in the private sector in the US is growing by more than in Europe. This explains why US GDP rose at an annualised rate of 2.5% in the first quarter (we think it will eventually be revised up to 2.9%) while euro-zone GDP contracted at an annualised rate of 0.9%.

The US has a fundamentally healthier and more innovative economy than Europe’s. But I would also add the US has the advantage of a more accommodative monetary policy. Again, MKM’s Mike Darda:

Despite the U.S. dramatically outperforming Europe, “hating on” Ben Bernanke/The Fed seems increasingly unpopular in the financial press and on Wall Street with one side of the extreme arguing that the Fed is sowing the seeds of bubbles and inflation and the other arguing that the Fed is simply impotent at the ZLB (the liquidity trap view). However, the data would suggest both views are incorrect.

Tight fiscal policy with reflationary monetary policy would seem to be the optimal policy mix for an environment characterized by high unemployment, high debt but low NGDP growth and inflation. If the choice is between the current policy mix in the U.S. and/or the Eurozone/pre-2013 Japan model of tight money, zero nominal GDP growth, deflation and a chronic debt overhang, one would think the choice is pretty clear

Exactly.

So, pharmaceuticals are really the classic case of where the innovation-to-imitation costs are extraordinarily high. It costs about a billion dollars to create a new pharmaceutical. The first pill costs a billion dollars; the second pill costs 50 cents. So, that’s a classic case where imitation costs really are low. That’s the best case for patents, in a field like that.

But my question is: Why does every innovation deserve or require the same 20-year patent? Why do we have a system which gives a one billion dollar pharmaceutical–where there’s $1 billion in research and development costs–we give that a 20-year patent and one-click shopping gets the same 20-year patent? That makes no sense whatsoever.

So, what I suggest is a more flexible system. I’d like to have a 20-year patent, maybe a 15-year patent, maybe a 3-year patent. Something like that. And then we could say: You want to apply for a 3-year patent? We are going to get this through the system quickly; we won’t look at it so much. Hurdle to make the case for it smaller. Exactly. You want a 20-year patent, though: You’d better show us that you really are deserving and put some costs in there.

This seems to make a lot of intuitive sense. The new study Do patent rights impede follow-on innovation? by Alberto Galasso and Mark Schankerman tends to more or less support Tabarrok’s general approach:

We find that the loss of patent protection leads to about a 50% increase in subsequent citations to the focal patent, on average. This evidence shows that, at least on average, patents block cumulative innovation. … We also find that the impact of patent invalidation on subsequent innovation is highly heterogeneous. There is substantial variation across broad technology areas. As illustrated by the figure below, patent invalidation has a large and statistically significant impact on cumulative innovation in the fields of computers and communications, electronics, and medical instruments (including biotechnology). However, we find only a small and statistically insignificant effect in the chemical, pharmaceutical, or mechanical technology field.

The researchers add that the impact of patent invalidation is strongest for fields characterized by two features: “complex technology (where new products rely on numerous patentable elements) and high fragmentation of patent ownership among diverse firms.” So when you get rid of IT patents, lots more innovation follows. Pharma? Not so much. Given that, more efficient licensing and a targeted scaling back of patent rights would be more appropriate than a broad-based scaling back of rights.

The latest CBO projections look for the federal budget deficit to hit bottom at 2.1% of GDP in FY 2015 and then gradually rise to 3.5% of GDP in 2023, the end point for the 2014-2023 10-year forecast. This convenient end point makes current policies appear to be sustainable, or at least sustainable with only gradual adjustments and fixes over the next decade.

Around 2023 demographics trends turn brutal. The latest (June 2012) CBO long-term projections show that under the more realistic “extended alternative fiscal scenario,” the federal budget deficit rises by more than 10% of GDP from 2022 to 2037. This reflects in large part the aging of the population and the movement of baby boomers into years of more intense medical needs. Increasing primary deficits also bring, over time, significant increases in interest payments as a share of GDP.

Ryan Buckingham, a particle physicist with a PhD from Oxford University, spent three and a half years at CERN before joining Goldman Sachs in London as an associate in the credit and mortgage structuring team earlier this month.  … Buckingham isn’t the only CERN alumni working in finance. Alexey Afonin, a vice president in strats and modelling at Morgan Stanley used to work there too. So did Anne Richards, the chief investment officer at Aberdeen Asset Management. So did Nikolaos Prezas, a quantitative researcher at J.P. Morgan and plenty of others. Most people seem to work at CERN early in their careers, and then move into finance.

He said a lot of ex-CERN employees move into banking because they’ve done their time on the collider and need something else to do when a permanent contract isn’t available. However, there is no indication that this happened to any of the finance professionals named above, and it seems that a move to a large international financial centre can in any case provide welcome respite to years living in Geneva or the Swiss-French countryside. “CERN is a bit of a weird place,” said the ex-CERN banker we spoke to, “- it’s very insular and incredibly competitive.” Not like banking at all then.

I have written previously about possible problems in America’s entrepreneurial culture. A 2011 Kauffman Foundation study looked at the possible impact of the US financial sector’s expansion on fast-growing young companies and the entrepreneurs who found them. In particular, it looked at the brain drain issue of big banks scooping up the best and brightest, thus lowering the quality of US startups:

The financial services industry used to consider it a point of pride to hire hungry and eager young high school and college graduates, planning to train them on the job in sales, trading, research, and investment banking. While that practice continues, even if in smaller numbers, the difference now is that most of the industry’s profits come from the creation, sales, and trading of complex products, like the collateralized debt obligations (CDOs) that played a central role in the recent financial crisis.

These new products require significant financial engineering, often entailing the recruitment of master’s- and doctoral-level new graduates of science, engineering, math, and physics programs. Their talents have made them well-suited to the design of these complex instruments, in return for which they often make starting salaries five times or more what their salaries would have been had they stayed in their own fields and pursued employment with more tangible societal benefits.

If you believe the US is currently operating a pro-megabank industrial policy, then what we have is a misallocation of human capital that hurts US growth and innovation.

It wasn’t a perfect report — business investment was weak — but still an extremely encouraging data point for the BofJ’s new approach to invigorating a moribund economy. So now we have a) rising stocks, b) weakening yen, c) higher inflation expectations, and d) stronger real growth. Not bad.

The US central bank is also engaged in a bond-buying program. It may not have sparked a boom, but it has done a fair job of offsetting near-term fiscal drag from the fiscal cliff tax hikes and sequestration. For instance: Even though jobless claims have bounced up last week, the four-week moving average remained at the lowest levels of the expansion.  Economist David Beckworth: “The fact that the Fed has successfully offset structural fiscal austerity since 2010–as seen by the stable NGDP growth–suggest it could do far more. The Fed has made big strides with QE3, but has yet to unload both barrels of guns. It is time for a NGDP level target.”

Now US congressman Kevin Brady — an important GOP voice on monetary policy — wants to use the Fed’s 100th anniversary as an opportunity to formally review the central bank’s performance and recommend possible changes. While his proposal for a “centennial commission” has a broad and open mandate, Brady himself is a hard money guy who favors a big role for gold in monetary policy and seems to think the ECB would be a good model for the Fed. Of course, as you may have heard, the euro zone is now in its longest ever recession. That represents a stunning, calamitous failure by the ECB.

We are seeing an amazing real-world monetary policy experiment unfold before our eyes. Is anyone in the GOP noticing? They should. Look to Tokyo, not Frankfurt.

The prospect that the Fed may taper the pace of its asset purchases later this year has raised some concern that long-term interest rates could experience a 1994- like outcome, a year in which 10-year Treasury rates climbed 200bp. This concern has become so great that Chairman Bernanke even addressed it in a speech in early March. However, we believe there is limited risk that a tapering of asset purchases would produce an unwanted or accidental tightening in financial conditions at odds with the Fed’s macroeconomic objectives. … The expected QE coefficient shows that every $10bn in Fed purchases depresses 10-year yields by approximately 3.3bp;

therefore, tapering Fed asset purchases from $85bn
down to $0bn should cause 10-year yields to increase by
25-30bp.

Credit: JPMorgan

Also note that unemployment fell from 6.5% to 5.5% and GDP rose by 4.1%. Bad year for bond investors, not so much for everyone else.

Hah! Now here is the reality. From Inside Higher Ed:

The Georgia Institute of Technology plans to offer a $7,000 online master’s degree to 10,000 new students over the next three years without hiring much more than a handful of new instructors.

Georgia Tech will work with AT&T and Udacity, the 15-month-old Silicon Valley-based company, to offer a new online master’s degree in computer science to students across the world at a sixth of the price of its current degree. The deal, announced Tuesday, is portrayed as a revolutionary attempt by a respected university, an education technology startup and a major corporate employer to drive down costs and expand higher education capacity.

Georgia Tech expects to hire only eight or so new instructors even as it takes its master’s program from 300 students to as many as 10,000 within three years, said Zvi Galil, the dean of computing at Georgia Tech.

The university will rely instead on Udacity staffers, known as “mentors,” to field most questions from students who enroll in the new program. But company and university officials said the new degrees would be entirely comparable to the existing master’s degree in computer science from Georgia Tech, which costs about $40,000 a year for non-Georgia residents.

Recall Alex Tabarrok’s three advantages to online education: 1) leverage of the best teachers; 2) time savings; 3) individualized teaching via new technologies. All will likely be at play here.

Still, we are only stabilizing the important debt-GDP ratio, not putting it on a downward trajectory toward pre-recession levels — which means which we are also not fixing entitlements. And debt still matters..

Check out this case for expansionary austerity, via the econ team at Wells Fargo, using the 1990s US economic boom as an example:

Much has been made of the tax increases and budget cuts during the 1993–1995 period and the subsequent pick-up in economic growth. Here, the perspective is that both businesses and households saw the cuts in spending as less future borrowing and thereby less future taxes. Higher taxes meant paying the bills today and thereby reinforced the message that future taxes would not be raised to pay for spending today.

In both cases, reduced future taxes signaled a rise in the present value of real after-tax income for both households and businesses. Note the contrast with fiscal policy the past few years where outsized spending increases served as a signal that future taxes were going up, thereby lowering expected future after-tax income, in turn, providing a disincentive to investment and economic growth. This provides an explanation for the continued subpar pace of investment spending and job growth now in the fourth year of the economic expansion.

Is the expectations channel enough to completely offset the demand channel? I think this better works as a general  explanation of why keeping debt low is important rather than as a reason to dramatically cut spending during a downturn. (Also, what about the tech boom during that decade?  The “equipment and software” bit of GDP was adding a full percentage point during go-go years.)