Thursday, December 5, 2019

Revisiting the Industrial Policy Question in East Asia

Many of the world's main economic growth success stories are clustered in east Asia, including Japan, South Korea, Taiwan, Malaysia, Singapore, and now of course China. Of course, everyone wants to claim credit for success stories: in particular, it's clear that the governments of these countries have often intervened in their economies, and so they are commonly cited as examples of how "industrial policy," rather than just a "free market," is needed for rapid growth. Reda Cherif and Fuad Hasanov resurrect these arguments in "The Return of the Policy That Shall Not Be Named: Principles of Industrial Policy" (IMF Working Paper WP/19/74, March 2019)

As a starting point to sorting out these arguments, it's useful to point out that any proposed dichotomy between "industrial policy" and the "free market" is a gross oversimplification.  It is widely agreed that for sustained growth, a country must address economic fundamentals like high rate of investment in physical capital, education, and health; macroeconomic stability; a well-functioning legal infrastructure that supports an environment friendly to starting and running businesses; pro-competition policies; openness to trade; support for research and development and intellectual property, and so on. Government will play a prominent role in many of these areas, so they cannot be characterized as "free market." However, these policies do not provide direct favors to any existing company or industry; indeed, they may set the stage for types of growth that disrupt or even bankrupt existing companies and industries. Thus, they are not really "industrial policy," either.

If a government decides to carry out policies that favor certain particular industries, rather than just being satisfied with preparing the ground for growth to occur, it will need to make three choices: what industry to favor, what policy tools will be used to favor those industries, and how to decide when these policy tools should be ended (in particular, when the tools have not worked).

Cherif and Hasanov describe their preferred version of industrial policy in this way:
We argue that the success of the Asian Miracles is based on three key principles that constitute “True Industrial Policy,” which we describe as Technology and Innovation Policy (TIP). ... (i) state intervention to fix market failures that preclude the emergence of domestic producers in sophisticated industries early on, beyond the initial comparative advantage; (ii) export orientation, in contrast to the typical failed “industrial policy” of the 1960s–1970s, which was mostly import substitution industrialization (ISI); and (iii) the pursuit of fierce competition both abroad and domestically with strict accountability.
They argue that an emphasis on economic fundamentals is a "snail crawl" approach to growth, while their version of targeted industrial policy is the "moon shot" approach.

You can read their essay for the details of the case in favor of this approach. Here, I'll just point out that the arguments here come in two main categories: the question of whether government are in fact likely to enact the specific type of industrial policy being recommended; and the likely marginal effect of such an industrial policy, over and above a policy of sound economic fundamentals.

Concerning the question of whether a government can enact should enact a policy to favor specific industries, it's wroth emphasizing that their three standards for industrial policy are quite specific, and by no means a blanket endorsement of widespread government intervention in the economy.

For example, their preferred form of industrial policy pushes domestic producers into "sophisticated" industries they would not otherwise have tried. Thus, this argument for industrial policy does not offer support for policies that favor production of existing goods, or for just helping industries as they currently exist to earn higher profits. It does not favor an industrial policy aimed at saving existing jobs. Thus, the challenge is whether government can

Their second goal focuses on the idea that successful industrial policy should focus on expanding export sales, not on trying to replace imported products. Thus, they are explicitly disavowing the "import substitution" approach to economic development that has historically been popular in Latin America and elsewhere. For their preferred type of industrial policy, "tariffs are neither necessary nor sufficient to succeed," although tariffs were often used in combination with more direct financial and credit incentives.

The third goal emphasizes that this growth of "sophisticated" industries should involve both fierce competition, both at home and abroad. The focus on domestic competition means that this approach does not favor government nationalization of an industry, or trying to create a "national champion" firm to compete in foreign markets. As they write: "While specific industries may get support, intense competition among domestic firms was highly encouraged in domestic and international markets," 

When they mention "strict accountability," what they have in mind is that industrial policy in the 1970s and 1980s in places like South Korea and Taiwan set up specific targets that had to be met for a firm to benefit from industrial policy. These targets might involve a certain level of export sales that had to be reached, along with certain levels of investment or R&D effort, or setting up chains of domestic suppliers. "Accountability" means that if these pre-determined targets were not met in a timely manner, the benefits from the industrial policy could and were cut off.

The notion that this very specific kind of industrial policy can benefit an economy isn't especially new. Cherif and Hasanov mention a prominent book-length report on this subject published by the World Bank back in 1993, The East Asian Miracle: Economic Growth and Public Policy.  The report argues that by far the main causes of rapid growth in the countries of East Asia were high levels of investment in physical capital, human capital, and technology, occurring in a context of an economy that emphasized market incentives, including intense domestic competition and macroeconomic stability. However, the World Bank report also took care to note (citations omitted): 
In most of these economies, in one form or another, the government intervened--systematically and through multiple channels--to foster development, and in some cases the development of specific industries. Policy interventions took many forms: targeting and subsidizing credit to selected industries, keeping deposit rates low and maintaining ceilings on borrowing rates to increase profits and retained earnings, protecting domestic import substitutes, subsidizing declining industries, establishing and financially supporting government banks, making public investments in applied research, establishing firm- and industry-specific export markets, developing export marketing institutions, and sharing information widely between public and private sectors. Some industries were promoted, while others were not. ... 
At least some of these interventions violate the dictum of establishing for the private sector a level playing field, a neutral incentives regime. Yet these strategies of selective promotion were closely associated with high rates of private investment and, in the fastest-growing economies, high rates of productivity growth. Were some selective interventions, in fact, good for growth? ...
Our judgment is that in a few economies, mainly in Northeast Asia, in some instances, government interventions resulted in higher and more equal growth than otherwise would have occurred. However, the prerequisites for success were so rigorous that policymakers seeking to follow similar paths in other developing economies have often met with failure. What were these prerequisites? First, governments in Northeast Asia developed institutional mechanisms which allowed them to establish clear performance criteria for selective interventions and to monitor performance. Intervention has taken place in an unusually disciplined and performance-based manner. Second, the costs of interventions, both explicit and implicit, did nor become excessive. When fiscal costs threatened the macroeconomic stability of Korea and Malaysia during their heavy and chemical industries drives, governments pulled back In Japan the Ministry of Finance acted as a check on the ability of the Ministry of International Trade and Industry to carry out subsidy policies, and in Indonesia and Thailand balanced budget laws and legislative procedures constrained the scope for subsidies. ... Price distortions arising from selective interventions were also less extreme than in many developing economies. In the newly industrializing economies of Southeast Asia, government interventions played a much less prominent and frequently less constructive role in economic success, while adherence to policy fundamentals remained important ...
I quote here at some length to emphasize that it has been a commonly held and conventional World Bank view for some time that certain focused, disciplined, and strictly accountable industrial policies with an export-push focus can work. It's also possible that some of the most important interventions in these economics were policies that were anti-free market but not industry-specific, like "keeping deposit rates low and maintaining ceilings on borrowing rates to increase profits and retained earnings" or "establishing and financially supporting government banks."

But overall, the practical policy question is whether one wants to encourage governments of developing countries to enact "industrial policy," given the risk that the approach may be neither focused nor disciplined nor accountable. After all, the world is full of countries that have announced the implementation of industrial policies that were not only unsuccessful, but often wasteful and  counterproductive. 

The other main question about industrial policy is how to decide whether, for example, most of the rapid growth in east Asia was due to the extraordinary gains of those countries in economic fundamentals and how much was due to specific industrial policies. The 1993 World Bank report argued that overall, some of East Asia's industrial policies succeeded, others failed, and overall the industry-specific policies didn't much affect the direction of growth. The report says: 
Most East Asian governments have pursued sector-specific industrial policies to some degrce. The best-known instances include Japan's heavy industry promotion policies of the 1950s and the subsequent imitation of these policies in Korea. These policies included import protection as well as subsidies for capital and other imported input. Malaysia, Singapore, Taiwan, China, and even Hong Kong have also established programs--typically with more moderate incentives--to accelerate development of advanced industries. Despite these actions we find very little evidence that industrial polices have affected either the sectoral structure of industry or rates of productivity change. Indeed, industrial structures in Japan, Korea, and Taiwan, China, have evolved during the past thirty years as we would expect given factor-based comparative advantage and changing factor endowments ... 
Of course, it's very hard to separate out different factors that contribute to a country's economic growth and draw lessons that can apply to other countries. Cherif and Hasanov make a case that for Hong Kong, Korea, Singapore, and Taiwan, the industry-targeted incentives were a key and central component. I'm skeptical. My own (only lightly informed) sense is that this case is stronger case for Korea than for the other three. Also, it seems unlikely that the industry-specific incentives would have accomplished much if the strong economic fundamentals had not been in place. 

One way or another, when explaining the growth pattern of specific economies, it's hard to rule out an element of luck. Cherif and Hasanov are quick to note that when countries have enacted something close to their preferred version of industrial policy, but perform poorly, it could just be a result of bad luck or bad timing. Fair enough. But it may also be that the the East Asian economies benefited from good luck in taking certain policy steps at just the right historical moment. 

At the current historical moment, where political currents are running strongly against an expansion of international trade and the technologies of automation and information technology are transforming manufacturing, it's not clear that import substitution policies in the style of East Asia--focused on exports of increasingly sophisticated manufacturing products--is a workable development strategy for the near future. 

Wednesday, December 4, 2019

About Millennials

The "Millennials" are commonly defined as the generation that grew up and came of age in the opening decades of the 21st century: that is, those born from approximately 1981 to 1996.
Every generation finds itself caught in the twists and pressures of a different set of social and economic challenges, and the Millennials are no exception. For example, those who were struggling to enter the labor market as young adults during the Great Recession of 2007-2009 and the sluggish recovery in its aftermath were Millennials. Those who were trying to buy houses and and attend college in the 2000s, after the prices of those goods had been climbing in recent decades, were Millennials. Some long-run trends, like diminished labor market opportunities for low-skilled workers, continued for Millennials as well.

The most recent issue of Pathways magazine from the Stanford Center on Poverty and Inequality has a collection of short fact-based essays about Millenials, who are now adults in the age bracket from 23 to 38. Here are a few findings that jumped out at me.

It's perhaps no surprise that Millennials are more likely to identify as multiracial or to adopt unconventional gender identities. However, according to Sasha Shen Johfre and Aliya Saperstein,  "they are not outpacing previous generations in rejecting race and gender stereotypes. Their attitudes toward women’s roles and perceptions of black Americans are quite similar to those of baby boomers or Gen Xers."


A number of the essays focus on labor market outcomes for the Millennials. Harry Holzer describes lower labor force participation of Millennials, especially low-skilled male workers.

Labor force activity has declined for all prime-age workers, but the decline among young workers has been especially rapid. This means that millennials. who are currently 25–34 years old are working less than Gen Xers at the same age. Declines are most evident among men, though women’s labor force activity is also lower. Large gaps by education remain, with the highest labor force participation among college graduates.
Florencia Torche and Amy L. Johnson write: "The payoff to a college degree—in terms of earnings and full-time work—is as high for millennials as it’s ever been. But there is a substantial earnings gap between those who are and aren’t college educated. Millennials with no more than a high school diploma have much lower earnings in early adulthood than prior generations."

Michael Hout writes: "American men and women born since 1980—the millennials—have been less upwardly mobile than previous generations of Americans. The growth of white-collar and professional employment resulted in relatively high occupational status for the parents of millennials. Because that transition raised parents’ status, it set a higher target for millennials to hit." As Hout points out, a trend toward less social mobility was already apparent for those born in the 1960s and 1970s, but it has become stronger since then.

Kim Weeden adds some evidence on occupational segregation: "The gender segregation of occupations is less pronounced among millennials than among any other generation in recent U.S. history. By contrast, millennials are experiencing just as much racial and ethnic occupational segregation as prior generations, even though millennials are less tolerant of overt expressions of racism. Both types of occupational segregation—gender and racial-ethnic—are very consequential for wages. Among millennials, occupational segregation accounts for 28 percent of the gender wage gap and 39 to 49 percent of racial wage gaps."

Susan Dynarski argues that Millennials have become the "student debt generation."
Over the last several decades, more students have taken on debt to pay for school, and the size of their debt has grown. According to the National Center for Education Statistics, 46 percent of students enrolled in all degree-granting schools had student loans in 2016, a percentage that pertains to the tail end of the millennial generation. This is up from 40 percent in 2000, when Generation X represented much of the college population. Over the same period, the average loan amount increased by nearly $2,000, from $5,300 in 2000 to $7,200 in 2016. ... As shown in Figure 1, the default rate has increased among all types of borrowers, although the increase is far less pronounced among borrowers for selective schools and graduate schools.2 The simple conclusion: Relative to Generation
X, millennials indeed took out more student loans, took out larger student loans, and defaulted more frequently.

Darrick Hamilton and Christopher Famighetti discuss housing: "Young millennials have lower rates of homeownership than Generation X, baby boomers, and the Silent Generation at comparable ages. We have to reach back to a generation born nearly a century ago—the Greatest Generation—to find homeownership rates lower than those found today among millennials. The racial gap in young-adult homeownership is larger for millennials than for any generation in the past century. Although the housing reforms after the civil rights era reduced the racial homeownership gap, all those gains have now been lost."


Bruce Western and Jessica Simes point out: "The recent reversal in overall incarceration rates takes the form of an especially prominent decline in rates of imprisonment for black millennial men in their late 20s. The decline is far less dramatic for other population groups—such as white and Hispanic men—that never experienced the extremely high rates that black men experienced. The imprisonment rate for black millennial men—approximately 4.7 percent—nonetheless remains extremely high."


Monday, December 2, 2019

Whose Charitable Giving (And for What Purposes) Gets a Tax Break?

When people who itemize deductions on their taxes donate to charity, they can take a tax deduction. When people who don't itemize deductions donate to charity, they don't get a tax deduction. Only about 11% of taxpayers itemize deductions, usually those with higher income levels. So the charitable priorities of this group gets a tax break, while others don't. Robert Bellafiore lays out these facts and offers some possible policy suggestions in "Reforming the Charitable Deduction," written for the Social Capital Project of the Joint Economic Commitee (SCP REPORT NO. 5-19, November 2019). Here are some background facts:

Overall charitable giving as a share of GDP (including both those who itemize deductions and those who don't) had a step-increase in the 1990s, and has stayed at that higher level since then.

However, the share of Americans giving to charity has been declining in the last couple of decades. The bright blue line shows the overall decline, while the rest of the lines show that the decline cuts across income groups.
These patterns have a strong effect on what kind of charitable giving gets a tax break. The figure below shows the total amount given by those in four big income groups. For example, the total amount given by households with under $100,000 in income is considerably more than the total amount given by households with incomes of over $1 million. However, about two-thirds of the giving of those with under $100,000 goes to religious charities, while only about one-sixth of the giving  of those with over $1 million in income goes to religious charities. Those in the lower income group give much more to "helping meet basic needs," while the higher income group gives more to arts, education, and health care nonprofits. Because those in the $1 million and more income category are far more likely to itemize deductions, their charitable priorities get a tax break.
In addition, the share of charitable giving that comes from individuals has been gradually falling, while the share coming from foundations has been rising. 
The report quotes a 2013 article in the Atlantic on the very largest individual gifts given by those with the highest incomes:
Of the 50 largest individual gifts to public charities in 2012, 34 went to educational institutions, the vast majority of them colleges and universities, like Harvard, Columbia, and Berkeley, that cater to the nation’s and the world’s elite. Museums and arts organizations such as the Metropolitan Museum of Art received nine of these major gifts, with the remaining donations spread among medical facilities and fashionable charities like the Central Park Conservancy. Not a single one of them went to a social-service organization or to a charity that principally serves the poor and the dispossessed. More gifts in this group went to elite prep schools (one, to the Hackley School in Tarrytown, New York) than to any of our nation’s largest social-service organizations, including United Way, the Salvation Army, and Feeding America (which got, among them, zero).
The tax deduction for charitable giving reduced federal tax revenues by $56 billion in 2018. Because more than 90% of those with over $200,000 in annual income itemize deductions, the overwhelming share of this tax break goes to those with higher income levels.

The JEC report calculates that for someone in the middle or bottom of the income distribution, giving $100 to charity cost about $100, because so few take the tax break. But for those in the top 1%, giving $100 to charity costs only about $71 after the tax deduction is taken into account. 

What are some proposals for altering the tax break for charitable contributions? The JEC report focuses on ways to expand the tax break for charitable contributions to everyone, not just those who itemize deductions. 

For example, one possible is to allow everyone to deduct their charitable contributions from their income before paying taxes, whether you itemize or not. Another option would be to create a tax credit, which might let everyone take 25% off their income taxes of any amount given to charity. Both of these proposals would expand the tax break for charitable giving, probably resulting in a reduction of $20-$30 billion per year in total federal tax revenues.  They would also probably increase the amount of charitable giving and perhaps also the share of people making charitable contributions. 

The other way to go would be to reduce the existing tax break for charitable giving. For example, the Congressional Budget Office estimates revenue gains from two change to the charitable contributions deduction. One would allow donors to deduct only the amount that is greater than 2% of their adjusted gross income.  Another approach would require that only cash donations to charity would be eligible for a deduction. This change would be aimed at the common practice where someone owns an asset--say, a share of stock--which was bought for a lower price in the past, and then is donated to charity for its higher current value. If that asset first had to be sold and then converted into cash, capital gains taxes would need to be  paid before the charitable donation is made. CBO estimates that either change would increase revenue by about $15 billion per year in a few years.

I'm not wedded to any particular change, but a situation where the charitable giving of the top 1% gets a tax break for contributions that disproportionately goes to education, arts, and health institutions heavily used by that same 1% doesn't seem equitable.

For a brief history of the deduction for charitable contributions, see "The Charitable Contributions Deduction and Its Historical Evolution" (September 26, 2019).