In a recent op-ed in The New York Times, Nobel laureate and Harvard University Press author Edmund S. Phelps argued that the premise that the underlying problem with the US economy is deficient demand is wrong, and that intervention predicated on that premise is doomed to fail.
Instead, he writes, the problems with the economy are more deeply embedded: businesses and their executives, rewarded for short-term profits, are reluctant to plan for the longer term; the US hasn’t yet found the new export and investment activities that will replace the low- and middle-wage manufacturing jobs that have moved overseas, widening the income gap; businesses aren’t investing in innovation and Silicon Valley financing has dried up. Phelps suggests tax credits to encourage the hiring of certain workers and government funding of innovation via a network of “merchant” banks as two of the many needed solutions to these problems.
Phelps agreed to answer a few questions about where we are now, economically, and what a successful way forward might look like.
Q: The first edition of Rewarding Work, where you argued for government subsidization of low-wage work via tax credits to businesses, was published in 1997 (a new edition was published in 2007). How have the issues of pay inequity that you tackled in that book changed in recent years, and especially since the Great Recession?
Researchers on wage differentials tell me that the pay gap between those near the bottom and those around the middle is no worse than it was in the mid-1990s. But the job picture is alarming. Unemployment rates as well as incarceration rates among the most disadvantaged are way above the levels that we saw in the days of the “old normal,” such as the mid-1990s. I think that when we finally recover to the “new normal”, those unemployment rates—and unemployment generally—will still be much higher than they were in the mid-1990s.
Q: What sort of industries might these tax credits be best designed to subsidize? What kind of wage would you want to reach for low-wage service workers who make up so much of our economy, and why is this the best way to ensure a living wage?
Economic inclusion means not only pay adequate to live a normal life in the community but also adequate chances to find jobs offering such pay. If society pressures or mandates businesses to institute a big pay increase to low-wage employees, there will be no gain of the second kind—no increase in jobs. Not only that: these businesses will be driven to look for and in many cases find ways to get along with fewer such employees or to staff their former jobs with faster or abler workers.
Q: In an article in the January-February 2010 Harvard Business Review, you argue for a First National Bank of Innovation. Why would a network of federally funded “merchant” banks be preferable to the system of venture capital in cultivating dynamism? What sort of projects would you hope to encourage?
Unfortunately, the annual investment made by venture capital firms is less than two-tenths of one percent of the GDP. That investing needs badly to be supplemented by other kinds of financing for a great range of innovators. The big banks, which used to lend to the likes of Edison, have evidently moved to the greener pastures of mortgage backed securities and other derivatives. And the small banks are struggling with their nonperforming loans. I hope that the FNBI would be just one new arrow among many in our quiver.
Q: How do these two interests of yours—increase of low-wage pay via tax subsidies to employers, and governmental underwriting of innovation—mesh? What is the common ground between these approaches?
I am delighted with that question! My thesis is that an economy must be rich in indigenous innovative activity if work in business is to offer a high level of job satisfaction and, for most ordinary people, such job satisfaction is essential to the “good life.” Of course, if jobs were inherently unrewarding, inclusion would come down to money—inclusion could be served just by handing out money to people unable or unwilling to work so that they could share in the national happiness of consuming. If you grant my thesis of the necessity of rewards from work, though, then you will agree that inclusion is not just about money. It would be a terrible failure of inclusion not to make sure that the less advantaged can find jobs in the main activity of society—innovating, investing, and producing. Unfortunately, pay rates near the bottom are so low that many job holders in bottom-rung jobs, even if they appreciate the non-pecuniary rewards, cannot cope with the demands outside their jobs unless they have more money. That is the “common ground,” I think.
Of course, there are other reasons to favor increased pay among the less advantaged—classical reasons of economic justice. John Rawls implied that a society’s economy that did not foster the self-realization of its participants would not be just even if it was shelling out the largest sustainable subsidy for employing the lowest-paid.
Q: As director of the Center on Capitalism and Society at Columbia University, you work to develop economic models that better represent economic realities. Why is this an important project, and what sort of problems has reliance on the standard models created for the US (and global) economy?
All the problems arise from the fact that most of the leading countries have to varying degrees a modern economy (not all countries do), while the standard economic models in the classroom, and in use from Wall Street to Pennsylvania Avenue, were inspired by the mercantile economies of the 18th century. A modern economy possesses dynamism—its creativity finds a huge outlet in commercial innovation. In the standard economic models, creativity and indigenous innovation are impossible, since everything is already known. In the modern economy inclusion in the business sector is a good in itself, while today’s standard models cannot find anything of value in an inclusive business sector.
Finally, a modern economy is prone to wide asset price swings, while in the standard models, in which knowledge is complete, the market cannot put a wrong price on a single house. This “disconnect” between model and reality has consequences for how we understand history, how we make policy, and how we view modern capitalism, which is the operating system of the modern economy. The standard modelers now saying that the ailing US economy simply needs an adjustment of “aggregate demand”, or it just needs a correction of its “poorly designed incentives” in order to perform well again are, without knowing, dangerous representatives of the standard models.
