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Good Economics for Hard Times

Abhijit V. Banerjee and Esther Duflo, 2019 winners of the Nobel Prize in Economics, discuss alternatives for generating employment and income and reducing inequality in an increasingly automated world  

 

Central Ideas: 

1 – Since 2004, TFP (Total Factor Productivity) and GDP growth in both the United States and Europe seem to have returned to the unfortunate days of 1973-94. In the US, GDP growth picked up speed in mid-2018, but TFP growth remains sluggish. 

2 – The relationship between income and carbon emissions exists. Both run in parallel, very closely. The average estimate suggests that when income increases by 10%, CO2 emissions increase by 9%. 

3 – The addition of a robot in a commuting zone eliminates the employment of 6.2 workers and depresses wages. The effects on unemployment are pronounced in manufacturing, and especially strong among workers without higher education. 

4 – Faced with the UBI (Universal Basic Income), a social program that offers advantages and disadvantages, other possibilities are being studied. Caring for the elderly, educating, and caring for children are tasks that the State could establish for those unemployed by automation. Robots are not capable of substituting the human touch. 

5 – The call to action is not limited to academic economists – it is meant for all of us who yearn for a better, more sensible and humane world. Economics is too important to be left to economists. 

 

About the authors: 

Abhijit V. Banerjee and Esther Duflo are professors of economics at the Massachusetts Institute of Technology (MIT) and cofounders of the Abdul Latif Jameel Poverty Action Lab (J-Pal). Both won, alongside Michael Kremer, the 2019 Nobel Prize in Economics. 

 

Foreword 

We eventually decided to take a dive [into the economic universe], partly because we got tired of watching from afar as the public dialogue on core economic issues – immigration, trade, growth, inequality, or the environment – becomes increasingly messy. But also because, as we reflected, we came to realize that the problems faced by rich countries were in fact eerily similar to those we usually study in the developing world – people precluded from development, rampant inequality, disbelief in government, politically fragmented societies and states, and so on. We learned a lot in the process that strengthened our faith in what we as economists have learned to do best: to be realists about the facts, skeptical of ready answers and magic formulas, modest and honest about what we know and understand, and, perhaps most important, willing to try out ideas and solutions and find that we are wrong, as long as it leads us to the ultimate goal of building a more humane world.

Chapter 1: Making the economy great again 

One of the tasks of the International Monetary Fund (IMF) is to forecast the growth rate of the world economy in the near future. Without much success, it should be added, however competent its large team of excellently trained economists may be. The Economist magazine once calculated how far the IMF’s forecasts deviated from the actual average over the period 2000 to 2014. Two years into the forecast (say, the growth rate in 2014 predicted in 2012), the average error in the forecasts was 2.8%. This result is a little better than randomly choosing numbers between 2% and 10% every year, but just as bad as assuming a constant growth rate of 4%. We fear that this sort of thing contributes substantially to the general skepticism toward economists. 

Anyone who has watched the comic series The Big Bang Theory knows that physicists look down on engineers. Physicists develop deep reasoning, while engineers tinker with materials and try to give shape to the physicists’ complex ideas, or at least that is how the series presents reality. If there were ever a TV series that mocked economists, I think we would be several rungs below engineers, or at least the kind of engineers who build rockets. Unlike engineers (or at least those on The Big Bang Theory), we don’t have a physicist who defines exactly what it takes for a rocket to escape the force of the Earth’s gravity. Economists are more like plumbers, we solve problems with a combination of science-based intuition, some guesswork aided by experience, and a high dose of trial and error. 

 

Chapter 2. Running from the Shark’s Mouth 

An intelligent attempt to deal with some of these questions [about immigration] is David Card’s study of the Mariel exodus. Between April and September 1980, 125,000 Cubans, most with little or no education, arrived in Miami after Fidel Castro unannounced a speech authorizing them to emigrate if they wished. The reaction was immediate. The speech took place on April 20, and by the end of the month, many people were already leaving. Many of the retreatants stayed in Miami forever. The labor force in the American city increased by 7%. 

What happened to wages? To find this out, Card adopted the method that came to be called “difference-in-difference.” He compared the evolution of wages and the employment rate for pre-settled workers in Miami, before and after the migrants arrived, to what happened with the same variables for residents of four other “similar” U.S. cities (Atlanta, Houston, Los Angeles, and Tampa). The idea was to find out whether the growth in wage and employment levels of all those already living in Miami at the time of the Marielitos’ arrival was lower than the growth in wage and employment levels among comparable residents in these four other cities. 

Card found no differences either immediately after the immigrants’ arrival or a few years later: the native-born’s wages were unaffected by the arrival of the Marielitos. The situation held even when he looked specifically at the wages of Cuban immigrants who had arrived before the Mariel exodus, which tended to be the most similar to those of the migratory wave and thus the most likely to be negatively affected by the new influx of immigrants. 

This study was an important step in providing a convincing answer to the question of the impact of migration. Card’s study was very influential, both in its approach and its conclusion. It was the first to show that the conventional supply and demand model might not apply directly to immigration. 

Chapter 3. The Burden of International Trade 

Once Upon a Dream, by J. D. Vance, is a lament on behalf of the American people left behind, although in reading it, one realizes the author’s deep ambivalence about how far to blame the victims. Part of the economic hollowing out of the Appalachian areas where the book is set occurred as a result of trade with China. The fact that poor people are hit the hardest is what is expected from the Stolper-Samuelson theorem: in rich countries, it is the working poor who suffer. What is surprising is the intensity of the geographical concentration of this suffering. People left behind live in places left behind. 

The approach taken by Petia Topalova in examining the impact of international trade liberalization on districts of India has been replicated in the United States by David Autor, David Dorn, and Gordon Hanson. China’s exports are extremely concentrated in manufacturing, and, within that sector, in specific product classes. In the apparel sector, for example, sales of certain products in the United States, such as women’s non-sports shoes and waterproof covers, are completely dominated by China; in the case of other products, however, such as coated fabrics, almost nothing comes from this Asian country. 

Between 1991 and 2013, the United States was hit by the Chinese “shock.” China’s share of world manufacturing exports went from 2.3% in 1991 to 18.8% in 2013. Those who lost their jobs tightened their belts, further reducing economic activity in the area. Non-manufacturing employment in the affected areas failed to compensate. It was a period of general stagnation in wage levels, especially for low-paid workers. 

 

Chapter 4. Preferences wants and needs 

And yet society always challenges people’s choices, especially when they are poor, supposedly for their benefit, for example when we give them food or food stamps instead of money. We justify this attitude on the assumption that we know best what they really need. To partially counter this attitude – only partially, because we don’t deny that there are many errors of judgment in the world – we have taken some care to argue, in our book Poor Economics, that the choices of the poor often make more sense than we would like to recognize. We tell, for example, the story of a man in Morocco. After convincingly arguing that he and his family really had nothing to eat, he showed us his huge TV with the satellite dish. We might have suspected that the television was an impulse purchase, which he later regretted. 

But he said, “TV is more important than food.” We questioned him. However, we came to understand the reason behind the preference. There wasn’t much to do in the village, and since he wasn’t thinking of emigrating, better nutrition wouldn’t earn him much more than a fuller stomach. What the TV set offered him was relief from the problem of boredom, endemic in these remote villages where there was not even a tea stall to break the monotony.  

Chapter 5. The end of growth 

In 1973, however, or thereabouts, everything ceased [growth trend]. Over the next 25 years, TFP (Total Factor Productivity) grew on average at only one-third of the rate achieved between 1920 and 1970.  What had started as an economic crisis, with a well-defined beginning and even with foreign powers being blamed, became the new normal? At first, the persistence of the slowdown was not immediately apparent. Born and bred during the golden age of economic growth, academics and policymakers at first believed that it was just a temporary hiccup, soon to be overcome. When it became clear that slow growth was more than a point outside the curve, there was hope that a new Industrial Revolution, sparked by computing power, was just around the corner. 

Computing power was increasing at an ever-increasing rate, and computers were spreading everywhere, just as electricity and the internal combustion engine had done. This would no doubt precipitate a new era of productivity growth that would drive the economy forward. And indeed, it finally did. Beginning in 1995, we saw a few years of high TFP growth (although still well below that of the postwar Glorious Thirty). But it passed quickly. Since 2004, TFP and GDP growth in both the United States and Europe seem to have returned to the unfortunate days of 1971-94. In the United States, GDP growth actually picked up speed in mid-2018, but TFP growth remains sluggish. 

 

Chapter 6. In hot water 

The Intergovernmental Panel on Climate Change’s (IPCC) 2018 report details what would need to be done to cut emissions and limit warming to 1.5°C. Some initiatives could already be underway; adopting electric cars, building carbon-free buildings, and expanding the rail network; all would help. The conclusion, however, is that even with technological advances, and even if we could get rid of coal completely, without a move towards more sustainable consumption, any future economic growth will have a strong direct impact on climate change. 

This is because as consumption increases, we need the energy to produce everything that is consumed. We generate CO2 emissions not only when we drive away, but also when we leave the car in the garage since we use energy to produce the car and to build the garage. This conclusion applies even to electric cars. Many studies try to consider the relationship between income and carbon emissions. The answer varies with climate, family size, and so on, but the two go more or less in parallel, very closely. The average estimate suggests that when income increases by 10%, CO2 emissions increase by 9%. 

Chapter 7. Pianola 

The difficulty is that Doomsday (if it is coming) has not yet arrived. Robert Gordon, who, as we have seen, does not hold current innovations in high regard, likes to play “find the robot” when he travels. Despite all the talk, it is still human employees who check you into hotels, clean your room, serve you coffee, and so on. 

For now, human beings have not yet become unnecessary. At the time of writing this book, first quarter of 2019, unemployment in the United States is at an all-time low and continues to fall. With more and more women working, the share of the population in the labor force increased substantially until about 2000 (when it began to stabilize and recede. There has been no shortage of work for those willing to work, despite the rapid advance of labor-saving technologies. 

It is undoubtedly true that we are probably still very early in the process of AI automation. The perception that artificial intelligence is a new kind of technology makes it difficult to predict its consequences. Futurologists talk about a “singularity,” a sharp acceleration in the rate of productivity growth driven by infinitely intelligent machines, although most economists are very skeptical that we are close to such a reality. 

In a study on the impact of automation, researchers calculated, for each region, a metric of exposure to industrial robots, considering the diffusion of robots in local industries. They then compared the evolution of jobs and wages in the most affected areas with those in the least affected areas. 

The study revealed large negative impacts, to the surprise of the authors, who had written an earlier paper emphasizing the forces that should lead to recovery. The addition of a robot in a commuting zone eliminates the employment of 6.2 workers and depresses wages. The effects on unemployment are pronounced in manufacturing and especially strong for workers without college-level education, especially those performing routine manual tasks. 

Chapter 8. Legit.gov: legitimate government 

Another reason people resist tax increases in exchange for more services is the skepticism of many people in the United States (but also in the United Kingdom and in several developing countries) toward state interventions. At least since Reagan, we have been fed the mantra that, “in the present crisis, the government is not the solution to our problems, government is the problem.” 

In 2015, only 25% of Americans felt they could trust the government “always” or “most of the time”; 59% had a negative opinion of it; 20% felt that the government lacked the tools to improve equality of opportunity between rich and poor, and 32% felt that reducing taxation on the rich and corporations to encourage investment would be a more effective way to expand equality of opportunity than raising taxes to fund social programs. 

Many economists, perhaps most of them, believe that government incentives are always problematic, and therefore government interventions, while often necessary, tend to be clumsy or corrupt. 

But bad in relation to what? The problem is that there is no substitute for many things that government does (although, of course, many rulers do more than they should, such as running an airline in India or a cement plant in China). When a tornado hits a region, when an indigent person needs medical care, or when an industry closes its doors, there is rarely a “market solution.” Government exists, in part, to solve problems that no other institution, realistically, can tackle. To demonstrate that government is wasteful, one must show that there is an alternative, more functional way to organize the same activity. 

There is undoubtedly government waste in most countries. A number of studies conducted in countries such as India, Indonesia, Mexico, and Uganda have shown that changes in the way governments act can lead to substantial improvements. In Indonesia, for example, simply distributing a card indicating that someone was eligible for a program increased the subsidies received by the poor by 26 percent. 

Ultimately, the depiction of bureaucrats and politicians as incompetent idiots or corrupt parasites, for which economists are largely responsible, is deeply damaging. 

First, it provokes an automatic reflex against all proposals to expand government, even when it is clearly indispensable, as in the United States today. Second, it affects those who wish to work for the government. Attracting qualified personnel is essential to the smooth operation of government. For a talented young person in America, however, a career in government, given its reputation, is not attractive. 

 

Chapter 9. Money and Care 

There is nothing more fashionable today, at least among social programs than the universal basic income (UBI), or basic citizenship income. Elegant in its simplicity, it is the mid-century modern social welfare program, popular with Silicon Valley entrepreneurs, media gurus, certain types of philosophers, and eccentric economists and politicians. Advocates of RBU as a social program imagine the government paying all people, regardless of whether they need it or not, a significant guaranteed basic income (it has been mused in the United States at around $1,000 per month). 

This may be a pittance to Bill Gates, but it is a lot of money to someone who is unemployed, allowing him, if the situation gets that far, to go his whole life without a paid job. Silicon Valley likes the RBU idea because it fears that its innovations could cause too much social upheaval. Benoit Hamon, the Socialist candidate to replace Francois Hollande as President of France, tried to use this proposal to liven up his ill-fated campaign; Hillary Clinton mentioned it again and again (she also lost); in Switzerland, there was a referendum on it (but only a quarter of the voters voted for it); in India, RBU recently appeared in an official Finance Ministry document, and both parties running for election had some version of an unconditional cash transfer program in their platform, although in neither case was it universal.

A more realistic strategy might be for the government to expand the demand for labor-intensive public services by increasing the amount of money allocated to them without necessarily providing them directly. An important consideration, especially in the developing world, is not to create jobs where people work little and earn a lot. 

As we have seen, the presence of such jobs freezes the labor market, because everyone is lining up to get them. The consequence is that the total employment level may actually decrease. The jobs need to be useful and the pay must be fair. There are many possibilities. Elderly care, education, and child care are sectors in which the productivity gains from automation, at least for now, are still limited. In fact, it seems likely that robots will never be entirely able to replace the human touch in caring for very young children and very old people, although they can supplement it quite effectively.

Another reason why humans are unlikely to be passed over in schools and preschools is that if robots take over all the functions that require limited technical skills (from mechanical tasks to bookkeeping), people will be increasingly valued for their flexibility and empathy. In fact, research shows that social skills have become more valued in the job market in the last decade, compared to cognitive skills. 

Conclusion: The good and the bad economy 

Many of these policies stand on the shoulders of good and bad economics (and social science, in general). Social scientists were already writing about the insane ambitions of Soviet dirigisme, the need to unleash the entrepreneurial genius in countries like India and China, the potential of environmental catastrophes and the extraordinary power of network connections long before these issues became obvious to the world. Smart philanthropists were practicing good social science by insisting on distributing antiretroviral drugs to HIV patients in the developing world, ensuring much more extensive testing, and saving millions of lives. Good economics prevailed over ignorance and ideology by promoting the free distribution in Africa of insecticide-treated bed nets, instead of selling them at subsidized prices, which reduced child deaths from malaria to less than half. 

Bad economics, on the other hand, drove the reduction of the tax burden of the richest and the squeezing of social programs, sold the idea that the state is impotent and corrupt and the poor are lazy and paved the way for the current impasse of exploding inequality and rabid inertia. Myopic economics has told us that trade is good for everyone and that accelerated growth is everywhere. It is just a matter of trying harder and enduring all the pain. A blind economy has failed to notice the explosion of inequality worldwide, the resulting worsening social fragmentation, and the impending environmental disaster, procrastinating action. 

As John Maynard Keynes, who transformed macroeconomic policy with his ideas, wrote: “Practical men, who consider themselves free from all intellectual influences, are generally slaves of some deceased economist. The insane in positions of authority, who hear voices in the air, have their follies inspired by some academic scribbler of a few years ago.” 

Ideas are powerful. Ideas drive change. Good economics alone cannot save us. But without it, we are doomed to repeat the mistakes of the past. Ignorance, hunches, ideology, and inertia combine to give us answers that seem plausible and promising but predictably betray us. As history never tires of demonstrating, the most promising ideas, in the end, can be either good or bad. The only recourse we have against bad ideas is to remain vigilant, to resist the lure of the “obvious,” to doubt the promises of miracles, to question the evidence, to be patient with complexity, and to honestly admit what we know and what we don’t know. 

The call to action is not limited to academic economists – it is intended for all of us who long for a better, more sensible, and humane world. Economics is too important to be left to economists. 

 

FACT SHEET: 

Title: Good economics for Hard Times 

Authors: Abhijit V. Banerjee and Esther Duflo 

 

Photos: Scott Blake, Lorenzo Herrera, Joshua Rawson-Harris, Lenny Kuhne, Ronald Reagan Library, Dominik Lange / Unsplash; Ucamari Photography, James Chen, Jakub Michankow / Flickr

Review: Rogerio H Jönck

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