Economic Theory

The False Claim That Inequality Rose During the Great Recession

February 17, 2015
| Reports

Income inequality has become a major topic of public concern lately, partly as a result of the release last year of Thomas Piketty’s best-selling book on inequality, Capital in the Twenty-First Century, and his writings with his colleague Berkeley economics Professor Emanuel Saez. In 2013, Saez claimed that 95 percent of growth during the recovery from the Great Recession went to the top one percent. Many commentators jumped on these results as a foreboding sign of what was to come in the future and called for a focus on redistribution, rather than growth policies. After all, if the rich are getting all the gains, why focus on overall economic growth?

However, the claim that income inequality grew following the Great Recession is nothing more than a statistical gimmick. In fact, Piketty’s own research shows that the “1 percenters” experienced the largest loss of income from 2007 to 2012.  A Congressional Budget Office report found that while the richest one percent of households saw their after-tax incomes decline by 27 percent from 2007 to 2011, the bottom 95 percent saw only one to two percent loss.

This report analyzes the data to provide a clearer picture on income inequality during the last eight years and argues, given these findings, that it would be a mistake to give up on pro-growth policies in favor of a predominant focus on redistribution. 

Efforts to Block Tesla Win ITIF’s Luddite of the Year

An Economics for Evolution

January 28, 2015
| Blogs & Op-eds

Bringing evolutionary economics to Washington will help us get out of the fifty-year-old stale debate between the left and right and help craft an economic policy to reflect the realities of the innovation-based, 21st century  economy.

The Limits of the Knowledge-Based Capital Framework

January 20, 2015
| Reports

Knowledge-based capital (KBC) investment refers to business spending on knowledge-related assets such as R&D, managerial competence, and advertising that incurs future returns for firms. However, many forms of KBC, or intangible capital as it is also known, have to date been absent from national economic accounting, and many advocate their inclusion as an important step toward a better understanding of our changing economy. Unfortunately, the KBC framework as currently conceived suffers from a number of fundamental problems: in particular, it wrongly assumes that that firms are rational investors, glossing over differences in returns to different types of capital, and it oversimplifies the aggregation of capital from the firm level to the national level. These issues need to be overcome before the KBC framework should be applied to economic theory and policy.

The KBC framework as currently promoted by its advocates suffers from two key challenges. First, by incorporating the neoclassical assumption that firms invest rationally in all capital with a positive net return, the framework effectively assumes that all classes of capital spending have the same return for firms and thus the same effect on economy-wide productivity. This assumption obscures more than it reveals. The inclusion of all forms of knowledge capital risks leading policymakers to give short shrift to certain kinds of physical capital, particularly ICT capital, that research has shown plays an outsized role in driving productivity and innovation. At the same time, the KBC framework overvalues whole classes of intangible investments that have little or no impact on growth, such as architectural designs, or that can actually destroy economic value, as we have seen in the case of investments in new financial products.

Second, the KBC framework assumes that the sum of benefits to firms from investments can be aggregated to national levels. There are a number of reasons why this may not be the case, particularly for intangible capital investments in things like advertising and brand development, in large part because much of the benefits are zero-sum in nature with one firm’s benefit coming at the expense of another.

In order to incorporate intangibles into national accounts in a more useful and accurate manner, the following changes should be made to the framework:

It should focus on the types of capital that do the most to drive productivity instead of making an artificial tangible/intangible distinction. Emphasizing KBC sends a misleading message to policymakers: that intangible capital is inherently good and tangible capital is in the “buggy whip” category. The right message, instead, is that investments must be understood first and foremost by the contribution they make to economy-wide productivity and innovation. This should be true regardless of their tangibility.  

In addition, more careful attention should be paid to the problems inherent in aggregating firm-level expenditures into national accounts, as intangibles present a particularly tricky problem due to the peculiarities of market structures. A more careful distinction needs to be made between positive- and zero-sum investments at the national level, and develop more robust estimates of the actual net value created. The value of advertising spending is particularly difficult to pin down objectively. As firms compete for a fixed supply of attention using theoretically costless information, the link between individual and aggregate benefit is elusive. As a concept KBC may be somewhat better linked to international competitiveness than to simple productivity comparisons.

Finally, additional adjustments to methodology should be made, including: finding more accurate ways of valuing human capital, reconciling important differences in international economic systems that can lead to distorted and misleading international comparisons, and including the value of prosumer capital.

Thomas Piketty is Wrong: The Benefits of Productivity Growth Don’t Only Go to the Rich

Understanding and Maximizing America’s Evolutionary Economy

October 2, 2014 - 12:00pm - 1:30pm
Information Technology and Innovation Foundation
1101 K Street, NW

In the conventional view, the U.S. economy is a static entity, changing principally only in size (growing in normal times and contracting during recessions). But in reality, our economy is a constantly evolving, complex ecosystem. The U.S. economy of 2014 is different, not just larger, than the economy of 2013.

Understanding and Maximizing America's Evolutionary Economy

October 2, 2014
| Books

Read online.

Understanding and Maximizing America's Evolutionary Economy

In the conventional view, the U.S. economy is a static entity, changing principally only in size (growing in normal times and contracting during recessions). But in reality, our economy is a constantly evolving complex ecosystem. The U.S. economy of 2014 is different, not just larger, than the economy of 2013. Understanding that we are dealing with an evolutionary rather than static economy has significant implications for the conceptualization of both economics and economic policy.

Unfortunately, the two major economic doctrines that guide U.S. policymakers’ thinking—neoclassical economics and neo-Keynesian economics—are rooted in overly simplistic models of how the economy works and therefore generate flawed policy solutions. Because these doctrines emphasize the “economy as machine” model, policymakers have developed a mechanical view of policy; if they pull a lever (e.g., implement a regulation, program, or tax policy), they will get an expected result. In actuality, economies are complex evolutionary systems, which means enabling and ensuring robust rates of evolution requires much more than the standard menu of favored options blessed by the prevailing doctrines: limiting government (for conservatives), protecting worker and “consumer” welfare (for liberals), and smoothing business cycles (for both).

As economies evolve, so too do doctrines and governing systems. After WWII when the United States was shifting from what Michael Lind calls the second republic (the post-Civil War governance system) to the third republic (the post-New-Deal, Great Society governance structure), there was an intense intellectual debate about the economic policy path America should take. In Keynes-Hayek: The Clash That Defined Modern Economics, Nicholas Wapshott described this debate between Keynes (a proponent of the emerging third republic), who articulated the need for a larger and more interventionist state, and Hayek (a defender of the second republic and a smaller state), who worried about state over-reach and loss of freedom.

Today, we are in need of a similar great debate about the future of economic policy for America’s “fourth republic.” Unfortunately, today’s debate is mostly a reprise of the 70-year-old Keynes-Hayek debate between the defenders of the third republic (liberals) and those who would try to resurrect the second republic (conservatives). However, as Lind writes, “it remains to be seen whether the global economic crisis that began in 2008 will mark the end of the Third American Republic and the gradual construction of a fourth republic by the 2020s or 2030s.”

It is in this context that the concept of evolutionary economics can play an important role, as any new economic framework for America’s “fourth republic” needs to be grounded in an evolutionary understanding. In this context, the central task of economic policy is not managing the business cycle—it’s driving a robust rate of economic evolution. It’s not about maximizing freedom or fairness as the right and left want, respectively—it’s about maximizing evolution.

Any new economic framework for America’s “fourth republic” needs to be grounded in an evolutionary understanding.

This report provides an overview of the evolutionary economics framework and the history of evolutionary economics thinking. It then discusses the three main drivers of U.S. economic evolution (geographic shifts in production, technological change, and demographic/cultural/governmental change). Finally, it lays out eight principles for an evolutionary economics-inspired economic policy:

• Support global economic integration based on firms’ market-based choices, rather than governments making political choices.

• At the same time, work to slow traded sector industry rate of loss where it makes sense.

• Don’t impede natural evolutionary loss.

• Limit government barriers to evolution.

• Foster a culture that embraces evolution, including natural evolutionary loss.

• Enact policies to spur organizations to act in ways that drive evolution.

• Support policies to speed economic evolution, especially from technological innovation.

• Develop a deeper understanding of the process of U.S. economic evolution.

Understanding and Maximizing America’s Evolutionary Economy

Understanding and Maximizing America’s Evolutionary Economy

Driving Economic Evolution

September 23, 2014
| Blogs & Op-eds

Ever wonder why innovation policy gets so little attention in Washington? One reason is the manner in which policymakers — and the economists who advise them — conceptualize the economy.

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