Economics, Pethokoukis, U.S. Economy

Does innovation lead to prosperity for everyone?

Image Credit:

Image Credit:

Not all innovation is alike. Incumbent firms replacing man with machine is a kind of innovation that may lift corporate profits and boost stock prices without necessarily broadly raising prosperity. Such technological advancement and efficiency is already contributing to polarized employment markets in advanced economies. Jobs are created at the top for high-creative workers and at the bottom for high-touch workers. But jobs in the middle— especially those involving routine, repetitive, and rules-based tasks—are automated away. In other words, the executives and janitors at a bank keep their jobs, but tellers get replaced by ATMs.

But there is another kind of innovation, termed “empowering” innovation by business consultant Clayton Christensen. This is the sort of innovation generated by fast-growing startups offering new products and services. Empowering innovation is a job creator, not a job destroyer—though some jobs may shift from uncompetitive incumbents to these aggressive new challengers.

Both sorts of innovation have their place, of course. But right now efficiency innovation may be destroying jobs faster than empowering innovation creates them. So what is the key to generating greater levels of empowering innovation? Competition—and the more the better. As economist Joseph Berliner once put it: “…the effect of competition is not only to motivate profit-seeking entrepreneurs to seek yet more profit but to jolt conservative enterprises into the adoption of new technology and the search for improved processes and products.” Vibrant economies need plenty of fast-growing startups to generate empowering innovation and to also push incumbents themselves to become more innovative.

And if incumbents can’t compete, government needs to let them fail. Free and frequent entry and exit of firms is critical. Government has to make sure tax, regulatory, and spending policy is neither impeding the creation of new startups nor giving incumbents an unfair advantage.

Some politicians think “innovation policy” means spending taxpayer money on promising young firms favored by bureaucrats. rather, innovation policy means ensuring that the status quo is continuously challenged by upstart rivals and threat of failure. Those are the keys to the Schumpeterian “gales of creative destruction” that drive innovation, which in turn drives long-term economic growth and improvement in living standards.

As published in The International Economy magazine, Spring 2014 issue.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Economics, Pethokoukis, U.S. Economy

Here’s one reason why the Kansas state tax cuts aren’t working

Scott Sumner:

The past two years Kansas reduced its state income tax rates. As a result, the top rate of income tax faced by Kansas residents (combined state and federal) rose from 41.45% in 2012 to 48.3% in 2013 and then fell a tad to 48.2% in 2014 (if they don’t itemize.) That’s a pretty tiny drop in the top marginal tax rate in 2014, and a much bigger rise in 2013.

I consider myself a moderate supply-sider, but I certainly wouldn’t expect such a tiny tax cut to significantly affect behavior. And any effects that did occur would happen very gradually, over a period of many years. For instance, firms might be slightly more likely to move to Kansas. But even after the tax cut, the top rate is almost as high as in Massachusetts, so Kansas is certainly not a tax haven like Washington or Texas, which have no state income tax.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Economics, Pethokoukis, Taxes and Spending

Would President Hillary really cut taxes for the ‘deserving’ rich?

Image Credit: kyle tsui (Flickr) CC

Image Credit: kyle tsui (Flickr) CC

An interesting speculation from Politico’s Ben White based on Hillary Clinton’s recent chat with Der Spiegel:

Clinton told the German weekly: “We are very grateful for where we are today. But if you were to go back and look at the amount of money that we owed, we couldn’t even get a mortgage on a house by ourselves. In our system he had to make double what he needed in order just to pay off the debt, and then to finance a house and continue to pay for our daughter’s education.” …

It seems like the “system” Clinton was referring to was the U.S. tax system, though we don’t know for sure. Ironically, it was Bill Clinton himself who signed a top rate increase to 39.6% into law in 1993. Taken together with her previous comment to The Guardian about how people don’t resent the Clintons because they pay ordinary taxes “unlike some other people,” it seems like Hillary Clinton is not too happy with the higher rate on income and lower rate on capital gains and other investment income. … Could we be seeing the early stirrings of an economic policy platform?

Whether or not Hillary Clinton prefers to pay a lower top income-tax rate, I doubt cutting those rates would be part of her economic agenda.

For one thing, doing so would lose revenue. Of course, she could balance that off by proposing to raise investment taxes, as White speculates. But wouldn’t she rather devote any new revenue from those hikes to funding government programs to supposedly help the middle-class, like universal preschool or some such? What would be the political gain from using the tax code to transfer money from, in her view, the undeserving rich to the deserving rich? (And is she really going to push that distinction, although she apparently believes it?) More likely, I would think, she would endorse equalizing both top rates at the current top income-tax rate. (Of course, her hubby did sign a capital gains tax cut.)

Second, left-wing economists such as Thomas Piketty — whose book, “Capital,” Clinton says he is familiar with — have been arguing that top income tax rates could nearly double without causing economic damage. What would be Clinton’s economic logic for a rate reduction?

Third, if elected, Clinton might be president during a time of increasing budget deficits, according to CBO forecasts:

Between 2015 and 2024, annual budget shortfalls are projected to rise substantially—from a low of $469 billion in 2015 to about $1 trillion from 2022 through 2024—mainly because of the aging population, rising health care costs, an expansion of federal subsidies for health insurance, and growing interest payments on federal debt. CBO expects that cumulative deficits during that decade will equal $7.6 trillion if current laws remain unchanged. As a share of GDP, deficits are projected to rise from 2.6 percent in 2015 to about 4 percent near the end of the 10-year period.

Given that, revenue-losing tax cuts for wealthier Americans probably won’t be a fiscal priority for a president facing rising red ink — especially one who promised to continue her hubby’s frugal ways when he sat in the Oval Office.

Here is my speculation: Hillary will propose an Obama-esque tax plan that raises revenue by reducing tax breaks that benefit the 1% but ignores marginal rates on labor income. And add to that perhaps raising taxes further on “unearned” investment income, on top of the Obama increases. I am not sure where exactly where Clintonomics 2.0 will break sharply from Obamanomics, but I doubt taxes will be the place.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Economics, International economy, Pethokoukis

Wait, the eurozone financial crisis is still kind of a thing?

Image Credit: Shutterstock

Image Credit: Shutterstock

From the WSJ:

Worries over the financial health of a major Portuguese lender spooked global markets on Thursday, drubbing shares in southern Europe and sending U.S. stocks tumbling at the open.

As it happens, AEI’s Desmond Lachman flagged just this sort of risk in a recent note on what the Fed isn’t talking about:

Yet a third and perhaps even more serious longer-term risk to which both the markets and the Fed seem to be paying scant attention relates to the probable re-intensification of the European sovereign debt risk. This inattention is all the more surprising considering the mounting evidence pointing to a sputtering of the already feeble European economic recovery and to the move of the European economic periphery toward outright price and wage deflation.

It is also surprising considering the very clear indications, especially from the recent dismal European parliamentary election results, that European politics continues to become increasingly polarized and that austerity and economic reform fatigue has now firmly set in that region. In these circumstances, one would have thought that both market participants and the Fed would have agreed that it must be only a matter of time before serious questions are once again raised as to how the highly indebted European countries will ever bring those debt levels down to more sustainable levels.

Indeed, Portugal’s bond market has been taking a hit, with government debt prices continuing to decline, according to the FT: “The benchmark 10-year bond yield, which moves inversely to the bond price, climbed another 15.1 basis points to 3.93 per cent, having earlier hit its highest since mid-May. The yield has climbed 36 bps so far this week.”

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.


Should the US try to be a global, ‘high-IQ utopia’ for immigrants?


Noah Smith writes an excellent BloombergView piece on why the US needs more high-skilled immigrants. This bit nicely sums up his case:

They represent one of the last big juicy pieces of low-hanging fruit out there for the taking. They start lots of companies, which give people jobs. They power most of our highest-value-added industries. They don’t compete with working-class Americans; they employ working-class Americans, and their demand for local goods and services gives income to working-class Americans.

Yes, to all of the above. Familiar arguments but ones in need of reminder and restatement. But this sentence, after a paragraph dismissing counterarguments, made me pause:

Some even see bigotry in the call for high-skilled immigration — what, are we trying to create some kind of high-IQ utopia here?

I sure hope something like that is a goal. I hope policymakers would want to make America the premier destination for highly-educated, entrepreneurial people who want to live in a country where government encourages innovation and success rather than throwing up roadblocks. A place with the where it is easy to raise money, and hard to run afoul of cronyist regulation and intellectual property rights. A place with super-fast internet and a super-efficient public sector that can effectively deliver public goods.

It makes me think of the New Canaan Holdfast in the “Brilliance” book series by Marcus Sakey. (The second book in the series just came out.) In Sakey’s alternate America, a sliver of the US population is born with superhuman smarts. Many of these “brilliants” decide to live in a huge section of Wyoming purchased by a brilliant centibillionaire to both escape growing persecution and live in a place that encourages their talents. It’s the ultimate experiment in the economics of agglomeration. The X-Men meets Silicon Valley. In NCH, brilliant scientists greatly advance all manner of technology. Eventually those marvels will create a more prosperous America and world. But right now, the rest of the country is wigging out, thus creating the conflict around which the series revolves.

Of course I don’t want to bring in just the brainiacs. American immigration policy should be about more than just economic benefit. But there is nothing wrong with an immigration policy that consciously and directly tries to recruit many more people who can help America continue to push the technology and innovation frontier. Again, Smith:

In an ideal world, what would we be doing to increase high-skilled immigration? By far the most important thing is to increase the number of green cards — not H-1Bs — and to base the new crop of green cards on skills instead of family reunification. The idea of stapling a green card to the diplomas of foreigners who study in the U.S. is a good one, and something like this should be made a reality. Beyond that, we should increase the number of entrepreneurship visas, boost the number of H-1Bs, and reform the H-1B visa to make workers less tethered to specific employers. But green cards are really the key.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Economics, Pethokoukis, U.S. Economy

Think the US job market is healthy again? Well, it isn’t — and hasn’t been for a long time


It’s not enough for an economy to generate jobs. There should also be a good amount of turnover in the labor market. Workers need to move around to find the best fit for themselves, not to mention higher pay from taking a new gig. A stay-put workforce is bad news.

Now net job growth is a product of total hiring minus total separations (including layoffs and quits), as measured by the Job Openings and Labor Turnover Survey. And as a Goldman Sachs memo points out, “a given level of net employment growth can be achieved with a high or a low level of gross turnover.”

So long as there is decent net growth, should we really care how it comes about? After all, as JPMorgan point out, the 231,000 average monthly job gains in the first half of the year was the best of any six-month period in this expansion. Actually, we probably should care about these job market internals. Goldman cites two reasons:

– The first is that a less dynamic labor market is likely to see weaker wage growth as workers fail to move to jobs in which they are more productive. Fed research suggests that the impact on aggregate productivity growth could be considerable.

– The second reason for concern is that a low-turnover labor market risks locking out the unemployed and marginally attached, in some cases permanently. This “hysteresis” effect is a second channel through which a lack of dynamism can reduce potential output.

More stasis means lower wages, less productivity, and higher long-term joblessness. So is labor market dynamism or churn declining? Goldman thinks it is. The firm created a measure based on (a) the sum of the hiring and separations rates in the JOLTS data; (b) the sum of the gross job gain and job loss rates in the Business Employment Dynamics data; and (c) the share of workers making job-to-job transitions in the monthly Current Population Survey (CPS, also known as the household survey) micro data. Goldman finds:

labor market dynamism has fallen substantially since 2000, with the decline occurring during and after the last two recessions. Our dynamism tracker has bounced back only weakly during the last two recoveries, in contrast to the much stronger bounce-back following the recessions of the early 1980s and 1990s.

Why the decline? There certainly may be structural reasons. Companies may be imparting specific skills that don’t easily transfer to other firms. The decline in new firms creation may also reduce worker movement. But Goldman mostly blames weak economic growth. Insecure workers are less likely to take a risk on a new job. As I have noted before, it used to be common for the US economy to post a quarter of 4% or faster real GDP growth. In the 1980s (1981-1990), there were 18 such quarters. In the 1990s (1991-2000), another 18 quarters. But in the 53 quarters since then, the US economy has generated only six three-month periods of 4% real GDP growth or faster, including just two during the Not-So-Great Recovery.

This is one reason Fed Chairman Janet Yellen includes hiring and quits rates in her “dashboard” of labor market indicators. It also why the Fed should focus on growth right now.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Economics, Financial Services, Pethokoukis

Will Obama and the Democrats wage a ‘war on Wall Street’ to hold the Senate?

Image Credit: Shutterstock

Image Credit: Shutterstock

According to inside-the-Beltway wisdom, the Democrats’ best strategy for the fall midterms is to use social issues against the GOP. As Emma Roller writes in National Journal, “The Supreme Court just ruled 5-4 in favor of Hobby Lobby, and thereby held that some businesses may claim religious exemption and not follow Obamacare’s contraception-coverage mandate. In the run-up to a summer where midterm campaigning will begin in earnest, this may not be the worst thing for Democrats.”

If Roller is right, expect Dems to double down on “war on women” accusations. But at the same time, the party might be also wage its own war — on Wall Street. According to The New York Times, “Citigroup and the Justice Department are nearing a deal that could cost the bank roughly $7 billion to settle a civil investigation into the sale of mortgage investments, people briefed on the matter said on Tuesday.”

The NYT piece also says the Citigroup deal “raises the stakes for Bank of America, which is expected to be the next large bank to settle its mortgage case with the Justice Department.” Right now, however, talks between the feds and BofA are “dormant.” But Guggenheim Partners bank analyst Jaret Seiberg doubts whether these two legal agreements, assuming both get done, are the end of the story:

The populist dislike of the mega banks and Wall Street is as strong as ever. One just had to listen yesterday to Sen. Elizabeth Warren or Sen. Richard Shelby to see how both progressives and conservatives see upside in attacking Wall Street and the big banks. There has been no real evidence that any of these civil settlements has done anything to help the big banks on the political front and we are dubious that either the Citigroup or Bank of America deals will change the political math. This is why we continue to worry about a criminal prosecution of a large domestic bank ahead of the mid-term election. It is also why we believe the big banks will continue to be a target for civil litigation by the government. In short, we question if there is really an end in sight to all of this litigation.

And as Seiberg has also written, ” … we are not as confident that a domestic bank could survive unscathed a criminal conviction. We cannot dismiss this risk entirely as politics are driving this process. This is why we view the prospects for a Justice Department-incited financial crisis as a low risk but high impact.”

And to that, you can add this news item from last week: “President Barack Obama on Wednesday said that ‘further reforms’ of Wall Street are needed, arguing that there remains too much focus on making profits through big banks’ trading desks as opposed to investing in companies and the ‘real’ economy.”

Maybe Obama is getting ready to pursue a “break up the big banks” agenda, though I doubt it. But there is another path. Obama has shown himself willing to take executive action if Congress is unwilling to act on agenda. Immigration, climate change, and now maybe financial reform via the Justice Department.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.

Economics, Pethokoukis, U.S. Economy

Declining US business dynamism: Where are all the startups?

San Francisco Fed

San Francisco Fed

One analysis of the Not-So-Great Recovery argues that rebounds after recessions with financial crises tend to be weaker than otherwise. This is the theory posited by Carmen Reinhart and Kenneth Rogoff in their book This Time is Different. 

But that’s not quite right, according to Michael Bordo. In the paper “The Recovery of Housing and the End of the Slow Recovery?,” he focuses on the housing bust rather than the financial crisis more broadly: “Residential investment is not a large component of national expenditure but it is closely linked to the purchase of consumer durables and other housing-sensitive sectors, which stimulates consumption.”

But the housing collapse might also have led to a weaker recovery through its impact on business creation. In the paper “Slow Business Start-ups and the Job Recovery,” San Francisco Fed economists Liz Laderman and Sylvain Leduc point out that in the first year of growth following the employment bottom in the terrible 1981-82 recession, net start-up employment grew 28.3%. But in the first year after the lowest point of the 2007–09 recession, net start-up employment grew only 18.8%. From the paper:

The weakness in employment growth at start-ups is likely an important factor behind the slow jo growth in the economy as a whole. This is because start-up employment typically grows many times faster than employment at mature businesses in the early stages of recoveries, so that start-ups make outsized employment contributions relative to their small share of total employment.

A Reagan-esque recovery in startup creation would have meant an additional 760,000 jobs between March 2010 and March 2011. Blame housing, say the economists:

The experience of start-ups in the Great Recession has been linked to the drop in house prices (Fort, Haltiwanger, and Jarmin 2013). In particular, U.S. states that experienced steeper declines in house prices also saw steeper declines in employment growth at start-ups relative to mature businesses.

A link between changes in house prices and start-up growth is intuitive. Lower house prices reduce homeowners’ equity and wealth, which can restrict an important source of funding that entrepreneurs typically access to start new businesses.  … In addition, even entrepreneurs who use assets other than their home equity to start a new business may be less willing to take that risk if they don’t have enough home value as a backstop to their investment.

If Laderman and Leduc have the story right, rising home values should start resulting in more new business creation and more jobs. Let me add, however, that there seems to be a long-term decline in startup creation that precedes the recession.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.


The Fed should focus on boosting growth

Image Credit: shutterstock

Image Credit: shutterstock

A message of growth, growth, growth from John Makin:

It is disconcerting that the Fed has so far said virtually nothing about very weak GDP growth numbers or about its implications for possible changes to policy aimed at sustaining growth. After the June 18 Federal Open Market Committee meeting, Fed Chair Janet Yellen instead chose to look ahead to a growth rebound based on stronger growth of consumption and investment, for which there is yet no evidence. So far, the Fed’s only viable policy option has been to talk about further delaying the first interest rate increase that it mandates. Markets have set that date at about mid-2015. It will no doubt slip further to 2016, given the weakness of the US economy.

At the very least, the Fed needs to stop talking about its exit strategy and when it will start raising interest rates and perhaps start talking about things it might do to boost weak growth. That option would include purchasing a wider range of assets than those currently being purchased under the Fed’s quantitative easing program. But before that happens, the Fed will have to stop dreaming about 3 percent growth and wake up to the reality that 2014 will be a slow growth year wherein a resumption of inflation is not a risk. Given the poor forecasting performance by the Fed and most pundits, perhaps we should remember that deflation remains a risk.*

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Economics, Pethokoukis

Rubio’s ideas start to offer the GOP a challenge and an opportunity

Gage Skidmore (Flickr) (CC-BY-2.0)

Gage Skidmore (Flickr) (CC-BY-2.0)

How would a 21st century American president deal with America’s 21st century economic problems?

More than a decade in, we really don’t know. The Bush administration was consumed, by necessity, with war. The Obama administration, by choice, with preserving the FDR-LBJ welfare state and adding a key missing component: nationalized healthcare. Obamanomics has been an expensive effort in economic nostalgia to recreate the supposedly prosperous, egalitarian 1950s. The Obamacrat obsession with bullet trains, the latest in 1960s transportation thinking, is illustrative and telling.

And not that the left doesn’t know where it wants to next take America. It has a big, if unoriginal, idea: a vastly more expansive and intrusive welfare state, universal in nature, financed through higher taxes on the rich, business, and eventually middle-class through a value-added tax. If it’s good enough for Scandinavia, it’s good enough for Obama’s America.

But the right has also been backward-looking. Forget about Reagan reminiscing. Some conservatives and libertarians are yearning for a leader who can be a bridge back to the 1920s, the pre-New Deal, pre-Keynes era of Calvin Coolidge. Low marginal tax rates, balanced budgets, and hard money are touted as macropolicies of such obvious intrinsic merit that justifying how they broadly enhance prosperity and meet current challenges is an afterthought. Too often the GOP settles for cruising high at 35,000 feet, its big-picture ideas far removed from the messy, everyday problems currently afflicting flyover America.

Marco Rubio is one of the few national Republicans, Mike Lee is another, offering a path out of that ideological cul-de-sac. Not by abandoning conservative principles — but by applying them in a modern, relevant way. Rubio’s big economic speech last week tied together several earlier speeches outlining new approaches to reforming key American institutions such as higher education and the welfare state and addressing problems such as wage stagnation and retirement security in a historic time of globalization and automation. As Rubio put it:

We Americans have good reason to be hopeful, for no nation is better positioned to access the full promise of the 21st-century economy. The new economy is all about innovation, creativity and productivity – and we are the most innovative, creative and productive people on the planet.

And the changes we must make to achieve this better future come
from fundamental truths about our nation: that government exists to empower its people, and that our free enterprise economy is the greatest generator of opportunity and prosperity in human history.

From these principles we see that if we reform our taxes and regulations, we can create millions of higher paying jobs by winning the global competition for talent, investment, and innovation.

And if we modernize our outdated safety net programs and revolutionize how we acquire and pay for education, millions of people will have the skills they need for the higher paying jobs of the new economy.

20th-century America was special. But 21st-century America has the potential to be even better.

Rubio might run for president. But even if he does not, he is methodically assembling a bold, smart agenda for any reform-minded national candidate wishing to move forward both America and the Republican Party.

Follow James Pethokoukis on Twitter at @JimPethokoukisand AEIdeas at @AEIdeas.