The Father of QE3

Now that QE3 is nearly upon us, it is worth understanding the rationale behind it from the man responsible for developing the views of policymakers. Tyler Cowen, the man responsible for giving prominence to his ideas declared September 13 "Scott Sumner Day" after the US Federal Reserve announced that it would engage in a third round of quantitative easing. Here is the man responsible for this new course of action by the Fed:

Technology and Reform: Two Steps Forward, One Step Back

Technology may be aiding reforms in a couple of ways, but it may be holding it back in another.

Today’s developing and emerging economies don’t need to spend so much time catching-up by re-inventing the wheel, so to speak. They are already standing on the shoulders of those that have come before them.  The spread and use of technology, according to some economists is all that is required for poor countries to get richer in this world of global trade, transport and communication. That point is debatable, based on the specific circumstances involved.

I would like to offer two broad areas in which I believe this holds true, and one in which it is probably less true today than it was a few decades ago.

A Step Forward

The first has to do with modern medicine in improving the health of nations. Using The Gapminder, developed by Hans Rosling, a health economist from Sweden, or even the public data explorer available on Google, we can test the assumption that modern medicine has improved the lives of millions in the developing world.

In the clip below, Rosling demonstrates just how vividly the stats stack up to prove it. Sticking to a few important indicators such as life expectancy and child mortality, he reveals that at the start of this century, most of the developing world has achieved similar levels compared to what their Western counterparts did at the some point in the last century. Modern science has allowed this gap between rich and poor to be narrowed significantly.

In the case of modern medicine, poor countries got healthy before getting wealthy. The modern public health system led to a rapid rise in life expectancy across the globe chiefly through a reduction in child mortality. Only in Sub-Saharan Africa has the yawning gap between rich and poor remained. The growth of the world’s overall population which is expected to peak at nine billion by the middle of the century owes much to this modern miracle.

And Another

The second step forward, I admit, is a little bit iffy because it is based on some demonstration cases at this point than any systematic cross country analysis. It has to do with modern devices for bringing about good governance and anti-corruption involving the Philippines and Indonesia.

In the past, the only way to guarantee that public officials didn’t behave badly was to pay them well. Lord Clive, the one responsible for establishing the East Indies Company, the global trading arm of the British Empire, was once quoted as saying that it was “absurd to give men power, and to require them to live in penury”.

With the implementation of the salary standardisation law mark two (a law which came about during the Arroyo administration), the pay packets of Philippine public officials are being raised to levels that would allow them to escape a life of penury. It cannot be denied however that a large incentive still exists for crookedness particularly in agencies that raise revenues for the government, enter contracts and issue franchises, licenses and permits, and adjudicate cases and elections.

Because of this incentive gap, it becomes necessary to equip anti-corruption agencies with the powers and resources to use modern devices to wield the proverbial stick when the carrot doesn’t work to keep erring officials in check. Indonesia’s version of the Philippine Ombudsman, the KPK (stands for Corruption Eradication Commission), has demonstrated to some degree what can be achieved when this happens. Their near-perfect conviction rate on a significant number of senior public officials is what I refer to.

In the 2010 elections, the successful use of automated voting and counting machines which many had projected to be an abject failure led to what I would regard as a watershed moment in Philippine history. Up until then, many doubted the capacity of a poor country to oversee and manage such a large scale system and deal with the inevitable bugs and prevent electoral fraud. To the credit of the officials who designed the process and the media that shone a light on it, the system worked relatively well in comparison to the doomsday scenarios being touted by conspiracy theorists.

In the second case of electronic computing technology, poorer countries are now able to gain more transparency and fight corruption in a manner they were not able to before. What prevents them from applying such tools could be a lack of political will and a bunch of laws that serve the interests of those who benefit from corruption, namely the politicians. If citizen’s groups clamoured for better methods of enforcement, the results could be as dramatic as in the case of modern medicine. Governments would be able to counteract the cancer of corruption more effectively.

Now Take a Step Back

The final backward step that I would like to highlight ironically was the one proven to be so potent in the last half-century for lifting millions out of poverty. I am referring to modern manufacturing technology which unlike the two cases I have just cited has evolved today to become less efficient or effective in spreading its benefits to the poor.

In the new growth theory developed by Stanford Professor Paul Romer from 1986-90, an economy’s output was driven not only by the productivity of labour and physical capital, but also by the diffusion of knowledge in the form of human capital and new technology. In fact the latter two made the former two even more productive. A positive feedback loop to the stock of existing knowledge amplified the growth emanating from new discoveries, and a perpetual cycle of growth would occur.

This meant the end of business cycles. It was this mistaken belief that we had entered into a “new economy” which was what fed the dot-com boom and bust of 2001. It was also part of the justification that the US Congress and Federal authorities gave for deregulating their banking system (to pave the way for “financial innovation” but led instead to corruption) which in turn led to the Enron scandal and the subprime mortgage meltdown of the late-2000s.

In his book, The Great Stagnation, Tyler Cowen talks about how the rate of technological innovation has actually slowed, not sped up since the 1970s. He says that unlike the invention of modern conveniences early in the last century, items like electricity, running water, vaccines, modern medicine in general, mass public school systems, and the car, which transformed life as we knew it and enhanced productivity tremendously, today’s inventions pale by comparison.

In terms of how this affects middle income countries such as the Philippines, there is what is known as the technology or development trap. Previously, it was observed that with the spread of new ideas, poorer societies diversified their economies as they grew wealthier. The quick catch-up that East Asia exhibited in the last half of the last century demonstrated the fact that countries by borrowing the innovations developed in the West could forego the costs associated with research and development and give birth to new industries and export opportunities.

Only once they had caught up to the West would they then need to focus on innovating themselves. Around the ten thousand dollars per capita mark was when this happened. Around this point countries had to begin specializing in certain sectors to remain competitive. The problem is that today, countries like the Philippines seem to be specializing much too early in the catch-up process, before they even reach a decent level of income per capita. This has led to pockets of industry surrounded by a sea of poverty.

The “jobless recovery” phenomenon that was observed in the country throughout the 2000s is being observed in the United States today, with weak jobs growth coinciding with successive quarters of economic growth. This has led many analysts to say that a structural shift has taken place in the economy. I have commented on this development highlighting the fact that too much innovation rather than too little of it could be what is driving down industry’s demand for workers. But regardless of what the cause is, what is true is that developing countries today have a much tougher time catching-up than they had half a century ago (and we haven’t even tackled the problem of climate change).

The Takeaway Message

There are potentially three points we can take from the preceding discussion on technological breakthroughs and their impacts on reform-minded governments:

• If with the help of modern medicine, poorer countries like the Philippines are able to achieve better health and well-being, then this could compensate them for the lack of growth somehow. Perhaps the king of Bhutan got it right, we ought to be focusing more on boosting gross national happiness instead of gross national product,
• If with modern computing, poorer countries can restore a sense of fairness and a sense of public trust in public institutions and govern themselves more effectively, then that would strengthen social cohesion and a sense of civic responsibility, things which have been eroded in the past in their quest for modernity, and
• If we are indeed on the cusp of a new technological frontier, one in which less inputs from manual labour will be required to produce things, then this means that nations will have to exert greater effort to locate industries within their borders, more than ever before. This will be the only way to finance the entitlement programs on which their citizens depend.

Indeed many things can derail countries on the straight and narrow paths (emphasis on the plural, there is more than just the one path) to wealth and well-being. To avoid falling even further behind, they will have to employ new ideas and ways of doing things more intelligently and effectively to reach their final destination.

Is Too Much Regulation or Too Much Innovation Responsible for Killing Jobs?

Earlier this year, Tyler Cowen suggested that the Great Stagnation in productivity and incomes observed recently in the West primarily in the United States has been occurring since the 1970s and is a result of it having exhausted the "low-hanging fruit" of innovation.

An opposite case can also be made that too much innovation has led to this slowdown. The Economist through its science and technology blogger comments on the practical advances occurring in the field of Artificial Intelligence or AI:

Today, automation is having an impact not just on routine work, but on cognitive and even creative tasks as well. A tipping point seems to have been reached, at which AI-based automation threatens to supplant the brain-power of large swathes of middle-income employees.

The pace of technological progress rather than having slowed down, appears to be speeding up. So much so that as "capital becomes labor" in many industries, leading to cheaper goods and better products, income growth for workers has stagnated while corporate profits have soared.

Advanced manufacturing, financial engineering, creative industries and even mining no longer require as much labor as their first wave cousins might have. Yet to attract such industries, governments have had to cut taxes, lower regulatory hurdles and so forth. This in turn has led to more constrained fiscal spending on their side.

The one area in which more regulation has led to greater innovation is that of climate change and environmental policy. The White House under the Democrats has elected to shelve its proposed cap-and-trade scheme in favor of greater powers for its Environmental Protection Authority to promote greater air quality for the health of its citizens.

The increased restrictions on the carbon emissions of power generators is causing a shift away from carbon intensive coal fire plants in favor of gas fired stations. The adjustment into a low carbon economy is creating just about as many jobs as it destroys according to economists.

Whether or not regulation encourages or discourages jobs however is beside the point, as one Stanford policy expert was quoted by the Washington Post as saying. The adoption of regulation should be based on whether it benefits society, he says. I couldn't agree more.

Tyler Cowen's The Great Stagnation

George Mason University's economics professor Tyler Cowen's new book The Great Stagnation: How America Ate All The Low-Hanging Fruit of Modern History,Got Sick, and Will (Eventually) Feel Better has been making waves since it was released in January as an e-book. His main thesis is that the rate of technological progress has slowed since the 1970s leading to stagnant median wages.

In February, he sat down with EconTalk to discuss the reasons for this slowdown. He identified three major causes which are outlined below:

Technological plateaus. He uses the invention of the car at the start of the last century as an example. He says

If we look at the broader sweep of history, growth tends to come in spurts. The car was a big deal but the next thing after the car, while it will come someday, is really hard. 

As The Economist pointed out, 

The most transformative of modern innovations—the internet—generates fewer jobs and revenues than past technologies. General Motors once employed over 600,000 people; Facebook serves 500m customers with a staff of 2,000. Americans spend and borrow much as before the advent of the web.

Government distortions. He talks about the problem of measuring the value of investments in health and education

Considering our economy right now: about 17% of it is health care; about 6% in terms of GDP is education; and with some overlap, 15-20% is what we call government consumption--government activity, not just transfers. At all levels of government, including state and local. Add those all up, take out the overlap, and it's a pretty big chunk of the economy, like 20-30%. Those are all sectors where there are massive subsidies, massive distortions of incentives, a lot of bad policy; and it's hard to measure value.

Education. As a broader proportion of the population has become college educated, it becomes harder to generate producitivity improvements through higher participation rates.

Anyone in college at the beginning of the 20th century, it was very easy to educate the marginal person. You get a big gain out of it and it's easy to do…To make them much more productive through education is simply a much harder endeavor. And, we are relying on distorted institutions. 

Here he is discussing the same ideas with a fellow blogger Matthew Yglesias: