Round‐​up: Can We Define Economic Dynamism?

So what is the DC government doing to help? Answer: pressing ahead with plans requiring that childcarers of young children must obtain college degrees to legally provide care.

No, really. First announced in 2016, the regulation requiring childcarers to have an associate’s degree in early childhood education, or else 24 credit‐​hours in it to add to their existing degree, will come into effect from December 2023. Center directors must have a bachelor’s degree in child education too. The insane idea seems to be that people caring for young children for cash need extensive child education training, something that will be news to the parents of the 43 percent of kids in the U.S. where nobody has at least an associate’s degree today.

Opponents of the rule tried to get it nullified through the courts, but this week suffered defeat. The obvious economic results if this goes ahead will be a further squeeze in the supply of childcarers and some childminders in the District (right now only 40 percent would qualify), reducing places available, and driving up DC childcare prices yet higher. That’s not to mention kicking away a work opportunity for many low‐​qualification workers and immigrants who will find this requirement difficult to reach financially and instructionally.

I am planning to write in more detail about this particular regulation soon, but it’s a good example of how governments gum up the supply‐​side of the economy. Childcare is a labor and physical space intensive industry. As such it is particularly prone to Baumol’s cost disease. That is: the difficulty of automating in the sector means its relative price tends to increase over time as other sectors see productivity and wage gains that it must compete with. Combine this with the fact that, as we get richer, we tend to demand more higher quality services, and there’s certainly an argument that childcare would be relative expensive anyway in lightly‐​regulated free markets — particularly in richer areas with high land rents.

But that makes it even more important not to impose a raft of supply‐​constraining regulations on staffing that raise costs higher still. Yet that is exactly what many governments in the US and UK do, in the form of stringent staff:child ratios and these sorts of occupational licensing requirements. The inevitable result is a combination of high prices, then further demands for taxpayers to step in to finance parents’ very large out‐​of‐​pocket costs. As Samuel Hammond has written, we often then end up “socializing the cost disease” through government subsidies. That itself then brings a whole range of further problems, as these tend to come with additional regulatory strings attached, or else create effective price controls that deliver local shortages of care in certain geographic markets.

I’ve been interested in the economics of childcare for a while, as it’s probably the area through my teenage and adult life where the story of government intervention begetting more damaging government intervention is clearest. We might have a macroeconomic inflation crisis right now, but there are plenty of areas where government policies raise the price of important individual goods and services in very regressive ways: childcare being Exhibit A.

I’ve no doubt that there are some pushy parents in DC who highly desire that their childcarers are “educators” — something that the market would provide through accreditation if enough people wanted it. But to impose that rule on everyone, pushing up costs and driving out cheaper options and access for the poorest households — resulting, of course, in worse life chances for kids whose parents can’t access jobs or who are then put into very informal or even illegal care arrangements — is just beyond the pale to me. It baffles the mind that the DC government is still going ahead with it in light of the current cost of living squeeze.

Can we define economic dynamism?

A lot of people talk about the need for greater “economic dynamism.” But what does it actually mean? As part of a project I’m working on, I asked the IGM Panel of Economists and a bunch of other well‐​known economists what they understood by the term. The results were all over the place, echoing the lament of Franz Machlup in 1959 that words like “dynamics” are used too ambiguously in economics.

For some of those I asked, including Nobel Prize winner Angus Deaton and Trump’s Council of Economic Advisers chief economist Casey Mulligan, “economic dynamism” has no inherent economic meaning — it is merely used for “positive connotations” or even “propaganda.”

Other economists see it as a useful term, but one synonymous with the degree of churn in the economy. Former President Obama advisor Jason Furman thinks it an overarching descriptor for an economy with high values in the rate of business creation and destruction, fluidity between jobs, and geographic mobility.

Under this definition, though, “dynamism” would not always be positive for economic welfare. A global pandemic might create a lot of sudden changes in all these proxy variables, but you’d be hard‐​pressed to believe that such a shock has really increased “dynamism” in the colloquial sense. Likewise, a new technology, such as a dramatic improvement in the quality of job search sites, might reduce the rate of job churn in the economy through better job matching. Should we really describe that outcome as an economy becoming “less dynamic”?

For a large set of economists, including Justin Wolfers, “dynamism” is therefore not about just looking at outcomes for the rate of churn, but more broadly captures an economy’s ability to adapt to changing circumstances, such as shifting consumer demands or resource availability. Under this definition, an economy is more dynamic if its institutions allow labor flows to be responsive to changing wage rates, house building to home prices, and investment to differential returns across industries. In this view, it’s more institutional — the absence of barriers to those needed reallocations.

Even this, however, does not seem to fully capture the rhetorical usage of “dynamic.” A world where consumer demand flits between two local pizza parlors, leading to an expansion then contraction of each, might reflect an institutional market flexibility, but in the grand scheme of things might not matter hugely for economic welfare. In some sense, economic dynamism implies a positive evolution or progress: that an economy’s inherent adaptiveness to change itself delivers meaningful innovation, or more of what Schumpeter talked of as “creative destruction” — those transformative breakthroughs that really enhance our lives.

Nobel Prize winner Ed Phelps has talked of “the dynamism of an economy” as “its innovativeness in commercially viable directions.” Under this understanding, dynamism is not just about higher GDP, which can result from efficiency improvements from fluid resources and flexible markets. It is more a reflection of its capacity to exploit new opportunities by deploying resources efficiently towards novel transformative ventures. Per Phelps, an economy characterized by greater dynamism would tend to enjoy strong rates of productivity growth at the same time as a high degree of job and business turnover, as resources move towards those productive ends.

I personally think there is something to all these definitions. If asked myself “what is economic dynamism?” I’d therefore say something like:

That might sound a mouthful and is perhaps too broad as a useful term in policy debates (think how many indicators you’d need to assess whether an economy had become more or less dynamic!)

It might therefore be easier to define it against its antithesis: induced stasis. A economy that is not dynamic is one where higher value‐​added opportunities remain underexplored or unexploited because resources cannot or do not move to these opportunities. That perhaps provides us with more clarity. Certain barriers or policies exist that restrict the flow of people, goods, or capital in ways that reduce the amount of market‐​tested exploration and, ultimately, innovation. Often this is deliberate, like policies to prevent a change in the feel of an area, or to “protect jobs,” or something else. If we are serious about improving “dynamism,” removing these obvious barriers should be our first focus.

If anyone has any further thoughts on how “economic dynamism” should be defined, please leave them in the comments.

Reagan’s lesson for Rishinomics?

My fellow Times columnist Danny Finkelstein uses the story of former Reagan Budget Director David Stockman to analogize that Trussonomics will suffer the same fate as Reaganomics: delivering tax cuts without ever getting political buy‐​in for offsetting spending cuts, so widening structural budget deficits.

Let’s leave aside for a second that Truss a) is planning merely to block Rishi Sunak’s very recent tax rises, not deeply cut taxes and b) has actually said she would do a spending review and would aim to keep the growth of state spending below the growth rate of the economy…Is the Reagan period, on the whole, such a terrifying prospect?

Stockman was right on Reagan’s tax cuts failing to “starve the beast” and reduce spending (although it still grew more slowly than pre‐​Reagan), but inflation fell during the Reagan years, contrary to Rishi’s predictions on the effects of the near‐​term widening of budget deficits. Yes, this was obviously because of Volker’s huge monetary disinflation that had already begun, and real interest rates did then remain fairly high even after this. But that’s the point I’ve been making about Rishi’s inflation claims: monetary policy dominates fiscal! Unless he thinks the Bank of England won’t do its job, it’s very misleading to imply higher deficits will lead axiomatically to inflation.

Sunak has pivoted more recently to warning about the risk of higher interest rates from tax cuts. In this view, tax cuts raise aggregate demand, causing an inflationary impulse that the Bank of England must offset. But even here, how much the larger Reagan structural deficits themselves actually *caused* elevated real interest rates the U.S. saw is more contested in the literature than I expected. Benjamin Friedman’s work is what people commonly cite to argue they played an important role, but many other decent economists seem to conclude they had little effect, especially relative to the Volker disinflation and fears of nuclear war. Other (now well‐​known) economists such as Larry Summers and Olivier Blanchard at the time suggested domestic deficits were not as important as other international factors in raising real rates too.

I have to admit, this literature jarred with my prior somewhat, which was that the bigger deficits would, all else equal, raise rates. Ultimately, I thought, the debate was whether a “looser fiscal, tighter monetary” stance would be better or worse economically judged by other metrics. But perhaps I should have been more skeptical about there being such a firm link. I mean, the Trump tax cut hardly led to a take‐​off in interest rates, nor did the UK’s vast post‐​financial crisis borrowing. The relationship between deficits and real rates seems a lot less obvious empirically than I once would have thought. There’s some theoretical reasons why, which we can perhaps touch on another week…

Yet if those who think there is a very strong relationship between deficits and rates really *do* believe that fiscal tightening can make the Bank of England’s job significantly easier and deliver more desirable results, why stop the tax rises at exactly where Sunak has planned? Why not eliminate the deficit entirely and run a surplus right now? Why not cut spending too? [That it wasn’t in a manifesto seems a weak get‐​out, given the manifesto ruled out raising national insurance rates too, which Sunak breached.] I don’t see any Sunak supporters arguing for any of this. So it seems more like a status quo bias. With the UK seemingly entering recession, would they even be proposing Sunak’s big tax rises now (particularly on corporation tax and marginal national insurance rates) if they weren’t already on the books?

Look, I still remain concerned about longer‐​term fiscal sustainability, but perhaps over time have become slightly less so about short‐​term borrowing. I wrote previously that Sunak’s corporation tax rise in lieu of COVID-19 debt was very premature given we didn’t know where the public finances would shake out. And if a looser fiscal policy for a couple of years helps grease the wheels for additional important supply‐​side tax and regulatory reforms, then I think it would be a price worth paying for Truss. Indeed, if Truss can get growth going as Reagan did after 1982, I suspect she’d be considered an extremely successful PM!

On Finkelstein’s central lesson, too, I wonder whether he has the analogy backwards. His major criticism is that Republicans like Stockman (Reagan’s budget director) delivered their promised deficit‐​expanding tax cuts first and then hoped to win support for spending cuts, which ultimately never came because Republican politicians opposed cutting government programs. I read this warning for Truss as: don’t ever do something that is expansionary unless you are certain you have the political backing to then ultimately finance it. And that’s a view I’ve been broadly sympathetic with: I have written in favor of a fiscal rule that would force politicians to raise taxes *first* for a number of years, before they could permanently increase spending.

Yet the problem for Rishi is that he delivered the Conservatives’ policy of promised extra NHS and social care spending, and indeed COVID-19 relief, without, ultimately, getting the enduring support from the party required for the permanent tax rises he tried to deliver. Indeed, the Tory manifesto in 2019 explicitly said they would not raise national insurance and said nothing about raising corporation tax or holding down income tax thresholds. In this election, his position is being trounced, making it clear now that the party rejects the package as a whole. Sunak introduced all these tax rises, then, without a rigorous mandate. If anyone risked worsening structural borrowing — in this case by raising spending without ensuring he actually had the buy‐​in to fund it sustainably — isn’t it the former Chancellor?

Other things:

• The Game of Thrones prequel, House of the Dragon, debuts this weekend. I previously wrote a rather geeky piece asking: Why Does Westeros Have A Stagnant Economy? (contains spoilers). It’ll be interesting to see how Westeros looks nearly two centuries before the previous series.

• My Cato colleague Marian Tupy has a new book out very soon, Superabundance: The Story of Population Growth, Innovation, and Human Flourishing on an Infinitely Bountiful Planet, which has been getting rave reviews. The blurb jacket includes endorsements from Angus Deaton, Steven Pinker, Jordan Peterson, Jason Furman and George Will. Worth pre‐​ordering!

• My Times column this week was on how, depressingly, economists have been routed on climate change policy. Whatever you think about climate change, basic economics says the least bad policy is to account for the estimate of the social costs of emissions through a carbon tax, and then let markets discover how to mitigate or where to adapt. Instead, both in the US and UK, we’ve opted for different industrial policies, subsidizing certain technologies, industries, and activities. Perhaps this is “good politics” — it certainly creates interest groups for mitigation and people like the tall tales of “green growth.” But having government picking winners rather than adopting a market‐​led process is inevitably more costly in terms of efficiency, albeit with those costs more opaque.