Those words are from Art Rolnick, former senior VP of the Federal Reserve of Minneapolis. They're from a recently released video entitled The Raising of America - Are we Crazy about our Kids?
The basic message of the video is that investing in early childhood pays off in the long run. Here's what economist James Heckman has to say about one of the studies that concluded high-quality early childhood learning is beneficial to a child's performance later in life:
"What did we learn? Many things. It's very successful in terms of the economic performance of the children. For each dollar invested you get back somewhere between 7 and 10 percent rate of return per year over the lifetime of the child. Which is a huge rate of return."
Behind this impressive rate of return are large amount of statistics showing that the children who were enrolled in a high-quality early childhood program performed significantly better in school (and later in life) than those who weren't:
"They found that the children that were in the high-quality program were less likely to be retained in the first grade, were less likely to need "special ed", were more likely to be literate by the sixth grade, graduate high school, get a job, pay taxes and start a family. And the crime rate between the two groups -- the randomized group and the control group -- the crime rate goes down by 50 percent. So those look like pretty good outcomes."
It may sound like a strange question in light of all the talk about "too big to fail" during the last few years. But, believe or not, the idea that bank concentration has an impact on real economic activity isn't the standard view. Here's from a recent blog post by NY Fed economists Mary Amiti and David Weinstein:
The notion that financial institutions are large relative to the size of economies is not something that plays a prominent role in traditional economic theory. Macroeconomic textbooks tend to treat economies as composed of representative firms that are infinitesimal in size compared to any given market. As a result, positive and negative idiosyncratic shocks [movement in bank loan supply net of borrower characteristics and general credit conditions] to financial institutions cancel out due to the law of large numbers.
However, this representation stands in stark contrast with the reality of concentration in financial markets. A striking regularity is that a few banks account for a substantial share of an economy’s loans.
Starting from this basis, Amiti and Weinstein have examined Japanese aggregate bank lending data and other aggregates and were able to demonstrate the following: banks matter, bank concentration matters, bank lending matters. No small feat.
On the issue of bank concentration and aggregate lending, they found that
...if markets are dominated by a few financial institutions, cuts in lending due to some change in financial conditions in just a small number of banks have the potential to substantially affect aggregate lending. Moreover, if firms find it hard to find good substitutes for loans like issuing equity or debt, then it is possible for their investment rates to fall as well.
As for their take on banks' impact on the real economy, the conclusion to their paper (on which their blog post in based) gives a good summary:
Our paper contributes to this literature by providing the first evidence that shocks to the supply of credit affect firm investment rates. We find that even after controlling for firm credit shocks, loan supply shocks are a significant determinant of firm-level investment of loan-dependent firms. This result is particularly surprising because our sample is comprised of listed companies that have, by definition, access to equity markets. Moreover, the fact that so much lending is intermediated through a few financial institutions means that idiosyncratic shocks hitting large financial institutions can move aggregate lending and investment. We show that about 40 percent of the movement in these variables can be attributed to these granular bank shocks. This means that the idiosyncratic fates of large financial institutions are an important determinant of investment and real economic activity.
And the implication for policy, according to Amiti and Weinstein, is significant. Here is the relevant excerpt of their blog post on this point:
...[P]olicymakers without detailed information on the major financial institutions are likely to have a difficult time understanding the causes of lending and investment fluctuations. A large portion of Japan’s aggregate economic fluctuations can be traced to the country’s banking problems.
While many researchers have focused on the implications of banks being “too big to fail,” we show that even if large banks do not fail, granular bank shocks can have substantial impacts on aggregate investment.
For example, reductions in bank capital at large financial institutions can cause investment declines by firms that would like to borrow, while recapitalization of the right institutions can stimulate investment. In sum, this study shows that what happens to large financial institutions is important for understanding aggregate investment behavior.
While their paper looks specifically at Japanese data, the authors suggest that the overall conclusions are relevant to the situation in the US given that it too has a very concentrated banking sector.
This TED talk by Robert Gordon (Northwestern) is a must-see (do it, it's only 12 minutes long). You may recall that a paper by Gordon created quite a stir in the news a few months ago because of the bleak outlook it gives regarding future economic growth in the US.
In the talk, Gordon counters the commonly-held idea that economic growth is a continuous process. He makes the case that the rapid growth experienced during the last two and half centuries may have been an anomaly rather than the start of a new, everlasting historical trend.
According to Gordon, economic growth in the coming decades will slow as a result of six headwinds that will reduce future productivity and income growth. In the end, the impact of these six headwinds will leave long-term growth at half or less of the (near) 2 percent annual rate experienced between the mid-1800s and today.
The six negative headwinds that make up Gordon's "exercise in subtraction" are demography, education, inequality, globalization, energy and debt (for more, see Gordon, 2013).
My take on this issue is that I'm generally optimistic about the prospect of continued future growth but becoming somewhat pessimistic about the ability of governments to take the appropriate steps to encourage the type of innovation and technological advancements that promote robust long-term economic growth.*
As I've mentioned before, the current preoccupation of politicians and policymakers with slashing spending and reducing public debt levels is likely going to be detrimental to long-term growth. I doubt there are many growth theorists out there who would argue that trillions of dollars in lost output (as witnessed by the huge amount of idle resources, including unemployed workers) and cuts to public investment are beneficial to a nation's long-term growth prospects.
A few years ago, (the great) economist Albert Wojnilower summed up the problem that's emerged in the US with respect to government support for innovation in a 2011 interview as follows:
Gail Foster:What about the long term? There are many, maybe
even a majority, who believe that we are possibly in a temporary
innovation funk — maybe not so temporary. In other words, while it may
be possible to be encouraged about the short term, we are just getting
back to where we were before the recession, and there is not much that
is economically exciting to look forward to. Would you agree?
Albert Wojnilower: I wouldn’t sell the future short. There is no lack of new business
opportunities (cell phones, Facebook, electric cars, energy innovation,
services that cater to aging societies). The question is, where will
they be invented, used and exploited? And to whom will the benefits be
distributed? The United States has traditionally been a leader in this
important growth process; now it is a laggard. The shift in the U.S.’s
relative position is a matter of ideology, not economics.
GF: What do you mean by ideology?
AW: The United States has adopted a free-market,
small-government ideology, ostensibly copying what we did in the distant
past. The difference today is that there is no frontier. Most
opportunities tread on someone else’s toes (as in property rights).
There is less space for greenfield experimentation. The small-government
mentality means that there is no effective arbitrator of the trade-offs
to break the log jam. Many of our newest “innovations” have occurred
outside the traditional economic sectors — for example, creating a new
sector that today we refer to as technology. Major inventions have been
made by civil servants, at little personal benefit. The United States
has usually been pragmatic on these matters, but now it appears to be
headed in a much more dogmatic direction...
GF: Would it be fair to say that you are an optimist with respect to human ingenuity but not human nature?
Overall, our analysis suggests that the payroll tax cut during 2011-12
led to a substantial increase in consumer spending and facilitated the
consumer deleveraging process.
Based on consumers’ responses to our recent survey, expiration of the
tax cuts is likely to lead to a substantial reduction in spending as
well as contribute to a slowdown or possibly a reversal in the paydown
of consumer debt. These effects are also likely to be heterogeneous,
with groups that are more credit and liquidity constrained more likely
to be adversely affected. Such nuances may be lost in the aggregate
macroeconomic statistics, but they’re important for policymakers to
consider as they debate fiscal policy.
Paul Krugman's recent posts on the abuse use by politicians of economic studies as a way to support ideologically-driven fiscal austerity have been right on. Here's from his latest:
...the important story isn’t about the sins of the economists; it’s about
our warped economic discourse, in which important people seize on
academic work that fits their preconceptions. Even if you don’t think
Reinhart-Rogoff made much difference to actual policy, the meteoric rise
and catastrophic fall of their reputation speaks volumes about why this
slump goes on and on.
I made a similar point in an earlier column when I wrote that austerity was a
...prepackaged "solution to a problem" that fits
with today's dominant policy-making ideology, which holds that
governments have little or no purpose other than catering to financial
interests and leaving the path clear for free-market actors to find
solutions to every problem facing society.
...[F]iscal austerity is simply another example of a "solution looking for a
problem", an empty and empirically ineffectual idea with no clear
rationale other than giving the appearance that "something is being
done".
This is why I continue to think that the ones who are really responsible for austerity are the politicians who support this view. Economic studies were used to provide cover for these leaders' preferred set of policy choices.
Anyway, there's no matching Prof. Krugman's performance these last few months. Not only have his forecasts been right on, but his retrospective look at why things unfolded the way they did has been downright flawless.
Now that the proposition of a 90 percent threshold (of public debt-to-GDP above which countries' economic growth would significantly slow) associated with the work of Carmen Reinhart and Ken Rogoff has been refuted, it's important that the debate now turn to the critical issue of how best to achieve growth moving forward.
On this point, one important aspect to keep in mind is that the uses toward which public debt is directed and the composition of public debt tend to have a significant impact on a country's economic growth.
A recent study by the IMF entitled "Public Debt and Growth" appears to support this view. The study, which examined the public debt dynamics in over 30 countries, found that, although the elasticity of growth with respect to public debt is -0.02, the elasticity of other variables that positively impacts growth offsets this number. For instance, as Iyanatul Islam has noted, the study shows that the elasticity of growth to initial years of schooling is above 2.0.
In other words, it's quite likely that public debt directed toward productive uses has the effect of supporting growth by cancelling out some of the negative effects associated with high public debt that impede growth.
These are the sort of issues policymakers should be discussing moving forward. I think it would go a long way to help us get out of the economic doldrums we're facing today.
Reference
Manmohan and Jaejoon, Public Debt and Growth, IMF, July 2010
John Carney reports that Wall Street is now showing signs of turning against fiscal austerity.
Apparently, the Reinhart-Rogoff fiasco has something to do with it. Perhaps.
Or is it the realization that the narrowing US federal budget deficit since the start of the sequester in early March may signal the end of bountiful corporate profits?
As I've explained before, contrary to conventional wisdom, business profits are actually positively impacted by government budget deficits. Here is my take from a macro accounting standpoint:
Proof of this direct, positive relationship between government
deficits and business profits is best demonstrated by manipulating the
basic national income accounting identity in a manner consistent with
the approach of economists John Maynard Keynes and Michal Kalecki. The
following arithmetic demonstrates that government deficits have a
positive effect on business profits.
Let Y=Total Output; C=Consumption; I=Investment; G=Government Expenditures; X=Exports; M=Imports; T=Taxes; R=Retained Earnings by Firms; Hs=Household Net Savings
Let the combination of the above (X - M) = Current Account Balance or Net Exports; (G - T) = Government Deficit; (Hs + R) = (Y - T - C) = Total Net Private Savings
To start off, here is the basic national income identity, as taught in all macroeconomic textbooks: Y = C + I + G + (X - M)
Subtract taxes (from both sides of the equation) to achieve an equation "net" of taxes: Y - T = C + I + G + (X - M) - T
Rearrange the equation to isolate total net private savings on the left side and to subtract taxes from government expenditures: Y - T - C = I + (G - T) + (X - M)
Since (Y - T - C) can be broken down into household net savings (Hs) and retained earnings by firms (R), the equation can be stated as follows (see Krugman, 1994:313): (Hs + R) = I + (G + T) + (X - M)
...and can be rearranged as such: R = (I - Hs) + (G - T) + (X - M)
In plain English, this translates into:
Firms' Retained Earnings = Investment - Household Savings + Government Deficits + Net Exports
The above equation clearly demonstrates that business profits are positively impacted by government deficits, net exports and private sector investment.*
Household net savings, on the other hand, have the effect of reducing
firms' retained earnings. Similarly, balanced budgets and government
surpluses have either no impact on profits or have the effect of reducing them.
Now, it's true that under normal circumstances other factors such as household consumption and saving behavior and trade flows can significantly affect how these variables interact. However, in the current context where household spending has been largely subdued by deleveraging concerns, and exports weakened by sluggish growth in Europe, the UK and elsewhere around the world, the budget deficit consists of an important source of demand and (from a national accounts perspective) of corporate profits.
This is news worth sharing for all those policy wonks out there. The St. Louis Fed has added over 10,000 new data series from the Bureau of Economic Analysis (BEA) National Income and Product Account tables to its excellent FRED database and research tool. FRED now counts over 70,000 series of data.
The addition of these new series means the days of cutting and pasting NIPA data from the BEA website unto an Excel worksheet to create charts are over. (As everyone now knows, using Excel worksheet to handle data can be risky business...)
Also, since I'm on the topic of FRED, I'll also mention that the St. Louis Fed added earlier this year data for US federal deficits and surpluses as a percent of GDP. This saves us the extra step of calculating the fraction of GDP every time we produce charts of the US government's fiscal position.
To those who don't use FRED, I should mention that it offers a very simple research tool for data analysis and for creating charts that are useful for socio-economic and financial analysis. I highly recommend it. It's free (although I seem to recall you must register).
