Beneath the Surface

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Reducing the ransom

Like many observers, I have characterized the threat of defaulting on federal government obligations as a form of hostage-taking. The hostage is the US economy, and the ransom is the demands contained in the debt-ceiling bill passed by House Republicans.

The first thing to say about the agreement negotiated by President Biden and House Speaker Kevin McCarthy is that it would save the hostage by allowing the government to pay its bills. Saving the hostage is the main objective of a hostage negotiation. The agreement raises the debt ceiling for two years, avoiding another crisis of this kind until after the 2024 election.

A second objective of a hostage negotiation is to negotiate the ransom down to a more reasonable level. As I described in the previous post, the original ransom the House bill demanded was severe cuts to nondefense discretionary spending. That is the part of the budget that funds most government departments except the Defense Department and supports many programs that lower-income households rely on, such as nutrition programs, Medicaid, grants and loans for higher education, and housing assistance. These cuts are now to be far more modest, a $1 billion-dollar reduction in the first year and a limit of 1% on spending increases in the second year. (Both are cuts in real terms since 1% is less than the rate of inflation). Even these cuts will be mitigated by allowing some funds previously allocated to the IRS to be used for other programs.

The agreement tries to reduce spending on the Supplemental Nutrition Assistance Program (food stamps) by extending work requirements through age 54, instead of the previous limit of 50, but this will not apply to families with dependents. On the other hand, the agreement makes food stamps more readily available to veterans and the homeless. The agreement did not add work requirements to Medicaid, as House Republicans had demanded.

Republicans also tried, but failed to defund President Biden’s clean energy initiative and his proposal for student debt relief. The Supreme Court may rule that the president lacks the authority to forgive student debt anyway.

Who won the negotiation? In a way, all of us did, if winning means preserving the full faith and credit of the United States. In another way, no one did, if winning means implementing anyone’s preferred budget plan. Biden succeeded in blocking most of the House Republicans’ austerity plan, which is a good thing. (Maybe good even for Republicans, since the public might really hate the plan if they actually had to experience its consequences—sort of like banning abortion?) On the other hand, Republicans succeeded in blocking Biden’s tax-and-spend plan, which would have reduced the deficit by raising taxes on the wealthy more than it increased spending. None of this is a surprise, since such a stalemate was predictable once Biden won the presidency and the Republicans retook the House.

With the government on the brink of defaulting on its obligations, Congress will probably have to pass the compromise bill promptly. Resistance is coming mainly from MAGA Republicans who wanted the more severe spending cuts and Progressive Democrats who wanted to preserve or expand spending on domestic programs. At this time, that resistance looks surmountable.

Was it worth it?

Are the deficit reductions expected from this compromise great enough to justify putting the country at risk of default? I don’t think so. But to evaluate the deficit-reduction potential of the compromise, one must ask, “Compared to what?”

Compared to the current budget, the proposal achieves a small reduction in the deficit by cutting nondefense discretionary spending while leaving the present tax structure in place. We should remember, however, that Biden’s proposed budget called for raising tax revenue and reducing the deficit by increasing tax rates on the wealthy. Since the compromise proposal scales back the House Republican spending cuts and includes no tax increases at all, its deficit reductions will almost certainly be less than what the Biden plan would have accomplished. Republican negotiators even rejected any effort to close tax loopholes, and also demanded reductions in the IRS budget for auditing returns and catching tax cheaters.

Even if Republicans had succeeded in extorting the huge cuts in nondefense discretionary spending they originally demanded, their approach to deficit reduction would very likely have failed anyway. Steven Rattner explains why:

When the Tax Cuts and Jobs Act – former President Trump’s signature legislation – was passed in 2017, many of its provisions were slated to expire in order to conform to arcane Congressional budgetary rules. However, House Speaker Kevin McCarthy is on record as saying that he wants to extend those tax cuts. The CBO’s new report quantifies the revenues that would be lost if those tax cuts are made permanent. The revenue loss begins next year and quickly ramps up to as much as $500 billion a year. All told, over the coming decade, extending the expiring provisions of the TCJA would cost the Treasury $3.5 trillion.

If the Republicans were to succeed in making the Trump tax cuts permanent, which they would almost certainly do if they won the 2024 election, those would largely offset the spending cuts they demanded this year. Compared to that scenario, the Biden plan would achieve much greater deficit reduction, even if Biden offset some of his tax increases with more spending.

Two fiscal policy perspectives

To see the current situation in a larger context, consider the fiscal policy perspectives of the two major parties.

For over forty years, when the Republicans have been in power, they have prioritized tax cuts over deficit reduction. Republican administrations have generally run up larger deficits than Democratic administrations, mainly through tax cuts that favor corporations and the wealthy and increases in the defense budget, notably the huge expenditures for the war in Iraq. But when a Democratic president comes in, Republicans voice their alarm about the national debt and call for cuts mainly in nondefense discretionary spending. Sometimes they also propose cuts to Social Security benefits, but they beat a hasty retreat when the public reacts badly.

When Democrats are in power, they tend to prioritize domestic social programs over deficit reduction. When they do address budget deficits, they prefer to combat them by raising taxes on the wealthy than by cutting programs for the needy.

One might think that the two approaches are fiscally equivalent, that cutting spending has the same potential to reduce deficits as raising taxes. However, if the spending in dispute is nondefense discretionary spending, we must face the fact that it is less than one-sixth of the entire budget. To expect nondefense discretionary spending to bear the full burden of reducing spending is not realistic. Cutting the taxes that support the entire budget, and then trying to compensate by making cuts to less than one-sixth of the budget, is a strategy that is doomed to fail.

Any serious deficit reduction plan must consider both tax revenue and the full range of federal spending. It must take a hard look at the defense budget, where big corporate contractors often overcharge the government outrageously on weapons systems and replacement parts. It must look at Social Security and Medicare, where benefit payouts have been rising faster than revenue because of the aging of the population. But an honest public debate is impossible when the entire discussion focuses on one area of spending, with one party playing the role of fiscal disciplinarian and the other the role of protector of the vulnerable.

To make matters worse, the entire discussion of the public debt is somewhat overblown anyway, since chronic deficits at the federal level are more manageable and economically useful than deficits of a household, or of a state or local government that lacks “sovereign monetary authority.” There is a limit to how much debt is responsible, but exactly what that limit is is not as obvious as people think.

Who needs a debt ceiling?

Most Americans probably do not realize that hardly any wealthy democracy besides the United States has a debt ceiling statute. (Denmark is one that does, but the ceiling is set high enough that it poses no real problem.) We put ourselves in an absurd situation when we allow the party that controls one house of Congress to threaten to withhold payment for expenditures the entire Congress and the President have already authorized. That’s like threatening not to pay the heating bill because you think the thermostat has been set too high. First pay the bill, and then debate the temperature!

The fact that the Republican Party is the one more likely to resort to hostage-taking to have its way is not a sign of strength, let alone fiscal responsibility. To me, it seems more a sign of weakness—weak economic arguments and weak support for the democratic process.

Defenders of the debt ceiling may argue that the country needs the threat of default to accept fiscal restraint. If so, it certainly isn’t working, since the United States does not stand out among nations for its exceptional restraint. The debt ceiling is not helping to bring about deficit reduction, encourage honest debate over the budget, or address our most pressing national needs. It serves mainly to allow a minority with a distorted view of the national interest to throw wrenches into the machinery of government.

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The current issue of The Week features a cover story called “Hostage Crisis,” with a picture of House Speaker Kevin McCarthy setting fire to a dollar bill. The subtitle is, “Will McCarthy and the GOP force the U.S. to default on its debt?” This got me thinking about the importance of language in framing issues, both by journalists and the people who follow them. Which is the more accurate description—“hostage crisis” or just “budget negotiation”?

Neutrality and truth

Many journalists have associated truth with political neutrality. Faced with vigorous political debate, they think of their job as reporting the facts without taking sides. When they report on the perennial budget battles between Republicans and Democrats, their underlying assumption is that each side has reasonable arguments. Compromise is good, even to the point of meeting the other side halfway. I am not unsympathetic to that view, since I don’t believe that either of our major political parties has been right all the time.

Nevertheless, a fair observer must be able to notice when either side’s behavior strays too far from democratic norms. Those norms call for dispute resolution by means of reasoned debate, persuasion and compromise. One cannot tell the whole truth without being able to distinguish between voluntary consensus and involuntary coercion.

To take a rather obvious case, can objective observers be neutral about the war in Ukraine? Can they ignore the fact that Russia’s invasion violates international law, and that attacks on civilian targets constitute war crimes? A negotiated settlement might be desirable, but not if it means capitulation to Russian demands, or even meeting them halfway. What should Ukrainians do for peace, give up half their territory? And what should they do when Putin comes for the other half? Donald Trump claims that he could settle the war in a day, but he also refuses to express a preference for which side wins. Is this statesmanship or indifference to democratic values?

The war in Ukraine is a long way from a budget negotiation, but maybe the same principle applies. When one side threatens to force the federal government to default on its obligations if it doesn’t get its way, that is also a violation of democratic norms. It forces the other side to negotiate with a gun to its head, or more specifically with a gun aimed at the heart of the economy. As Josh Bivens and Samantha Sanders put it in their post for the Economic Policy Institute, “Weaponing the debt limit should not be normalized.”

Deficits and debt

The public debt is an integral part of the modern economy, and the “full faith and credit” of the US government is essential to that economy, both domestically and globally. This is the reality, whether you think of the public debt as a good thing or a bad thing.

Economists disagree over the pros and cons of the public debt, but they generally acknowledge that it is very different from household debt. Household debt is usually something you would like to pay down or even get rid of altogether. Public debt is a liability for the taxpayers, but at the same time it is a nice, safe asset for the holders of the government bonds. When the federal government runs a deficit, it puts more money into the economy in spending than it takes out in taxes, but then encourages the public to invest in government by buying treasury bonds. Investing in government and growing the economy are not incompatible goals. Rolling over the public debt from year to year is never a problem, as long as the security of those bonds makes them a very desirable investment.

Historically, the public debt has grown along with the size of government and the size of the economy, and the statutory limit on the public debt has been raised repeatedly. The economy has come to rely on deficit spending, especially but not exclusively during turbulent times. Many forms of federal spending, such as infrastructure improvements and human capital investments, contribute to the strength of the economy. Economists do become concerned when the public debt grows faster than the economy itself, as it has recently. Since 2013, the total debt has exceeded the annual output of goods and services in the US economy, and many economists would like to see that trend reversed. Either a faster rate of economic growth or a slower rate of debt growth would help.

However, even economists who consider the federal deficit too large do not support defaulting on current obligations, or even threatening to do so. The full faith and credit of the United States is one of our country’s most valuable assets. Any failure of the government to pay its current bills would cause enormous immediate hardship, probably start an economic depression, and do lasting damage to the country’s credit rating. That in turn would increase the cost of borrowing and further weaken the government’s fiscal position.

The current deficit is simply a consequence of authorizing more spending than the government is getting in tax revenue. Continuing to finance the difference is far preferable to default, whatever you think of the national debt. The priorities for dealing with a large deficit are first to raise the debt ceiling to finance the difference, and then to negotiate a smaller deficit in future budgets.

The current standoff

If anything is a bipartisan accomplishment, it is the federal deficit. The Trump administration and Congressional Republicans added substantially to the budget deficit and national debt, first by cutting taxes (mainly for corporations and the wealthy), and then increasing expenditures to combat the Covid-related recession. Both political parties agreed to raise the debt ceiling three times to accommodate rising deficits. President Trump explicitly warned Congressional leaders not to use the threat of default to upset his budget plans, and they listened.

Now that we have a Democratic president, Trump and Congressional Republicans have changed their tune. They are happy to use the threat of default to derail President Biden’s plans, although his proposed deficit is smaller than Trump’s. When asked at his recent town meeting why he changed his mind, Trump shamelessly embraced his own hypocrisy by saying, “Because I’m no longer President.”

For a time, House Republicans struggled to agree on any budget proposal at all. They finally passed a bill to raise the debt ceiling, but attached to it a set of budget demands too extreme to have any possibility of becoming law. The difference between the Biden plan and the Republican plan is not that only one plan reduces the deficit; they both do. But they do differ in three important ways:

• Biden wants to reduce the deficit by rolling back some of the Republican tax cuts, while Republicans want to do it only by reducing spending. This is a longstanding disagreement between the parties.
• Only the Republicans are threatening to let the government default if they don’t get their way on the budget. President Biden and the great majority of Democrats are willing to raise the debt ceiling to meet current obligations before negotiating future budgets.
• While President Biden has submitted a complete budget plan, the Republican proposal calls for a general cap on spending without specifying the budget cuts by which the cap would be achieved.

That last point deserves some elaboration. Calling for only a cap on future spending allows Republicans to claim the high ground of fiscal responsibility without having to defend specific cuts to the voters. All they will say is what they will not cut, like Social Security, defense spending, and interest on the existing debt. Trouble is, what they promise not to cut is almost 90% of the budget! That means that the budget axe has to fall heavily on the non-defense discretionary spending that remains. The Congressional Budget Office estimates that everything else the government does would have to be cut 47%. But don’t worry, that “everything else” only includes the Departments of Homeland Security, Agriculture, Interior, Commerce, State, Health and Human Services, Education, Energy, Labor, Justice, Housing and Urban Development, and the Environmental Protection Agency. The list of specific services that would have to be cut is very long—How about cutting half the air traffic control towers, or half the nutrition services for seniors, or half the Head Start programs? No wonder Republicans only want to talk about vague goals and not specific programs most Americans support.

The Republican proposal also calls for rescinding funding that has already been authorized, such as money for clean energy tax credits and money being used by the IRS for better customer service and tax-law enforcement. The CBO says that the IRS cuts would actually increase the deficit by losing tax revenue.

The Republican position consists essentially of a ludicrously extreme set of demands backed by a threat of economic destruction. It deserves to be called extortion, blackmail, hostage-taking—choose your adjective.

The challenge to democracy

I have been arguing recently that Republicans are increasingly willing to violate democratic norms because they are starting to lose policy debates that they are accustomed to winning. In my post, “Whatever happened to Republicans,” I elaborated on Dana Milbank’s observation that the GOP has become “an authoritarian faction fighting democracy” because “democracy is working against Republicans.” Milbank was mostly talking about how demographic change was moving against the party, but I think that the argument applies to economic changes as well. The dominant fiscal policy position for Republicans, which calls for tax cuts for the wealthy and austerity for the rest of us, has become increasingly unpopular. The Trump tax cuts were already unpopular when they were passed. Many forms of spending that Republicans have opposed—Obamacare, Medicaid expansion, new energy initiatives, and infrastructure improvements—are receiving strong support.

The coercive stance of House Republicans on the debt ceiling debate is consistent with other undemocratic behaviors, such as trying to overturn a presidential election. (147 Congressional Republicans voted not to accept certified results from key states.) The continuing effort at the state level to suppress or dilute the vote from Democratic areas is another example.

Republicans accuse President Biden of refusing to negotiate. But how does one negotiate with hostage-takers? Give too little and they may carry out their threat; give too much and you reward coercive behavior. Certainly the victim of a hostage-taking cannot be expected to meet the perpetrator halfway, but should do only what is necessary to save the hostage. If we could get the threat of default off the table, then we might have an open and honest debate over the budget. Both sides should have to present specific proposals and defend them in the public arena. We should also expect that if political leaders can manage such a debate, journalists will cover it seriously, and the American people will listen and learn. Idealistic, yes. But so is democracy.

Continued

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Can anyone really be surprised that Donald Trump has finally been indicted for a crime? After all, allegations of his serious misconduct have been circulating for a long time. Trump and his organizations have been accused of fraud (against real estate investors, bankers, contractors and Trump University students), tax evasion, misuse of charitable contributions, racial discrimination, campaign finance violations, theft of classified documents, influence peddling, Russian money laundering, illegal income from foreign countries while president, and personal misconduct including sexual abuse and even rape. Then there are the most serious allegations relating to the 2016 and 2020 presidential campaigns: election tampering, collusion with foreign hackers, obstruction of justice and inciting insurrection. I doubt if this is a complete list.

Nevertheless, leading Republicans are shocked—SHOCKED!—that a grand jury could actually accuse the former president of a crime. How could anyone do such a thing?

During the 2016 and 2020 campaigns, Trump declared that the only way he could lose was if the Democrats committed election fraud. When he actually did lose in 2020, that explanation became the Big Lie that the Democrats had managed to rig the election, and did so in every battleground state Trump lost. Now we have a new Big Lie, that any prosecution of Trump by a legal authority could only be a grave abuse of power. Once again, Republican leaders, with very few exceptions, are marching to the same drummer, fearing a loss of support from the base if they don’t fall in line.

Witchhunt! Conspiracy! Police state! Weaponization of the legal system! These are the terms Republicans are using to describe this predictable and long-awaited development. In their minds, the indictment is the outcome of a massive conspiracy orchestrated by President Biden and the radical-left Democrats. Or so they say, whether they actually believe it or not. Even Trump’s would-be opponents in the next election, like Mike Pence and Nikki Haley, are getting on the bandwagon. Florida Governor Ron DeSantis went so far as to proclaim that he would not cooperate with Trump’s extradition to New York, although federal law would require him to do so if Trump failed to surrender voluntarily.

The appeal of the new conspiracy theory has little to do with the law or the facts. Never mind that the indictment in question comes from a New York investigation over which President Biden had no authority. Never mind that the most serious federal investigations are the responsibility of a Special Counsel independent of the White House. Never mind that most of the witnesses against Trump in the January 6 investigation and others have been Republicans who put their civic duties above their party affiliations. Never mind that nothing in the Constitution or federal statute places a former president beyond the reach of the criminal law.

Day in court

The Republicans who are loudly condemning the indictment would be wiser to focus their remarks on the presumption of innocence and respect for the legal process. The allegations I listed above are exactly that—allegations. (A few of them, such as the misuse of charitable funds and the rip-off of Trump University students, have been established by judgments in civil cases.) As always, defendants and their accusers deserve their day in court. That is when, according to the ideals of our justice system, the truth can come out and justice can be done.

Only when Trump filed suit to overturn the 2020 election did we learn that evidence to support his claims was practically nonexistent. Only when Dominion Voting Systems sued Fox News for defamation did we learn that Fox’s prime-time commentators did not actually believe the Big Lie that the election was rigged. They helped spread it anyway, apparently because the Fox business model called for telling their viewers what they wanted to hear, to keep their ratings high and the advertising dollars flowing. Did they learn their lesson? Apparently not, since they are now eagerly promoting the New Big Lie. Here too, the country may need some legal proceedings to sort out truth from fiction.

Telling the truth-seekers from the Big Liars is not rocket science, pardon the cliché. The Big Liars are the ones who would rather engage in wild speculation than examine the facts of the case. In the New York case, they have rushed to judgment without even waiting to see the actual charges. In other investigations, leading Republicans have worked hard to keep the facts from emerging by delaying and impeding the legal process. Republicans with front-row seats to the events of January 6, like Mike Pence, Mark Meadows and Keven McCarthy, have been dredging up every possible excuse for not testifying about what they know. Trump himself usually contests subpoenas to testify or responds to questions by taking the fifth.

The truth and justice that the legal system might provide is exactly what Trump supporters most fear. The Trump playbook in this respect is the one recommended by Roger Stone. Whatever the accusation, always deny it, and then turn the tables by attacking the accuser. In legal cases, that means attacking the investigators, the prosecutors, the judges, and the witnesses. They are all politically motivated liars, not to be confused with that paragon of honesty and civic virtue, Donald Trump. Give me a break! Give us all a break.

I am trying to retain my faith in the two-party system, but one of our parties is sorely testing it. A democratic country needs at least two responsible parties, both of which are deeply committed to the democratic process and the rule of law. In our current political crisis, we seem to have only one.

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I want to give special attention to one other chapter of Haskel and Westlake’s Restarting the Future, and that is Chapter 5, “Financial Architecture: Finance and Monetary Policy in an Intangible-Rich Economy.” The authors summarize their argument in an opening statement:

An intangible economy makes borrowing harder and riskier. It also lowers the natural interest rate and so squeezes monetary policy. We need reform that allows pension funds and insurers to fund innovative companies and that allows fiscal policy to provide commitment to stabilising the economy with less space for monetary policy.

There’s a lot to unpack in this statement.

Financing investment

Where do companies get the financing they need for their capital investments? How is financing different for investments in intangible capital? Here I will focus on the financial needs of smaller businesses whose good ideas may well exceed their financial means, but whose potential for growth is essential to an innovative economy.

Small businesses are especially likely to rely on debt financing in the form of bank loans. A very few are able to get funding from venture capitalists. Bigger, more established businesses are likely to raise capital through public stock offerings.

Lenders tend to favor borrowers with tangible assets that can be used as collateral for the loan. (Bigger firms are more often able to borrow against their large cash flow.) But intangible assets are harder to use as collateral. Their value is harder to assess, and their worth may drop to next to nothing if the borrower’s business fails. Investments in intangibles carry other risks, such as the ease with which a competitor may latch onto the same idea. These are the issues of sunk costs and spillovers discussed earlier. The authors point out that as the intangible economy has developed, commercial banks have increasingly favored real estate loans over business loans because of their more predictable returns.

Even for companies that raise capital by selling stock, the intangible economy may increase the advantages of the most established firms. Consider the competition between two companies. The first has implemented a successful business plan and scaled its operations up to a high level, achieving high profits and a high stock price. The second is very innovative but not yet very profitable. If both companies owned traditional assets like plants and equipment, a stock investor might consider the second firm worth buying if its stock price were low in relation to its assets. With harder to evaluate intangible assets, such “value investing” becomes more difficult and less successful. A stock investor can do just as well buying the big “glamour stocks,” despite their high price.

One of the ways to overcome a shortage of financing for promising startups is to look to large pension funds and insurance companies. The authors recommend that we “alter financial regulations to make it easier for investment managers to back intangibles-rich firms, especially ones whose securities are less liquid.” They also recommend establishing “a collective fund (or funds) that…would spread risk and also achieve economies of scale to enable the kind of monitoring of companies that investment in illiquid assets requires.”

Some investment funds already engage in ESG investing, meaning that they favor companies with good records on environmental, social, and governance issues. (Social issues include things like human rights and data protection; governance issues include things like fair pay scales and freedom from corruption.) ESG policies may encourage certain kinds of intangible investments, such as new knowledge that can benefit the common good.

Funds with an ESG mandate should put a premium on firms that invest heavily in R&D, in design, and in training and other assets with positive spillovers, and asset owners who care about the future of the world should seek out funds with such a mandate.

I should mention that ESG investing is controversial, since it violates the neoliberal “Friedman doctrine” that a corporation’s only responsibility is to generate profits for its shareholders. Under the Biden administration, the Labor Department has issued a regulation that would give money managers more freedom to consider ESG factors when selecting investments, but Republicans are trying to kill it either with lawsuits or legislation. Some Republican politicians even want states to refuse to do business with companies that apply ESG criteria to investments. That, however, has produced a backlash not only from liberals, but from conservatives who think government should let private organizations invest as they please.

Monetary and fiscal policy

Macroeconomic policy to promote a thriving economy may also have to be different in the age of intangibles. Conventional policy in recent decades favors the manipulation of interest rates by the central bank to moderate expansions and contractions in economic activity. The idea is to cut interest rates to encourage borrowing and spending when weak demand creates high unemployment, but to raise interest rates to discourage borrowing and spending when excess demand creates inflation. Assigning this responsibility to an independent central bank like the U.S. Federal Reserve is supposed to minimize political interference with sound economic policy.

This approach may be losing much of its effectiveness in the intangible economy. Because business loans in intangible assets are riskier, money flows toward safer assets like treasury bonds. Interest rates on those assets fall, since buyers who prioritize safety are willing to tolerate lower returns. If the real interest rate is not far above zero even when the economy is doing well, the central bank has little room to lower rates when the economy suffers from weak demand and high unemployment.

On the other hand, raising interest rates to curb inflation may not have the desired effect either. Higher rates create additional financing problems for the small company with mainly intangible assets. At the same time, the more established company may be unfazed by higher rates, since it finances its expansion less by bank loans and more by retained earnings and equity. A big company with intangible assets of proven worth can also deliver software or stream entertainment to more customers at little additional cost.

Given the uncertainties surrounding monetary policy, the authors expect a greater role for fiscal policy in the management of the intangible economy. One danger, however, is that taxing and spending policies are more vulnerable to political conflict and lobbying. A possible solution is to give more authority to “independent auditors of fiscal policy” such as the Congressional Budget Office. Another is to agree on some automatic stabilizers that adjust taxes and/or spending to economic conditions. Governments do some of that already with means-tested social programs like Medicaid, for which more people become eligible as incomes drop. Another proposal—not discussed in this book—is the Public Service Employment program recommended by Stephanie Kelton and other proponents of Modern Monetary Theory. It would maintain full employment by expanding when private employers are laying workers off and contracting when they are rehiring. That is in sharp contrast to conventional monetary policy, which tolerates high unemployment as the price society must pay for low inflation.

The intangible economy is a work in progress, and a book of this kind inevitably combines description and speculation. We are moving into uncharted territory, where conventional ideas about how the economy works are due for some revision.

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Jonathan Haskel and Stian Westlake believe that the advanced economies of the world are experiencing something like growing pains. They are becoming economies in which intangible forms of capital are more important than ever, but the institutions such economies require are not yet fully developed.

I found this general framework very helpful for understanding recent economic problems like underinvestment, chronic stagnation and increased inequality. The thesis is very abstract, however, and that poses challenges for both the authors and their readers. We have to try to imagine what fully developed intangible economies will look like, although many of the details are yet to be filled in. I found many of their descriptions and recommendations rather vague, but maybe that is unavoidable in a book of this nature.

With that warning in mind, I turn to the authors’ discussion of public policy, especially their treatment of public investment and intellectual property in Chapter 4.

Public investment

The main issue here is finding the right balance between public and private investment in intangible capital. The private firms of industrial capitalism have a lot of experience investing in tangible capital equipment. They do it in the belief that it can boost productivity and generate sales revenue in excess of capital costs. No investment is a sure thing, but tangible capital at least provides reasonably secure ownership, as well as some residual value even if its particular use is less successful than expected. Investment in something as intangible as a worker’s expertise or a software design entails special risks. Intangible assets are harder to control, since they are more easily copied or shared (the problem of spillovers). And they may disappear into thin air if an investment doesn’t pay off (the problem of sunk costs).

From the perspective of public policy, however, spillovers have a positive side. The fact that knowledge and ideas are so easily shared makes them a public good. Public investment in such intangibles can pay off in any number of ways—many hard to foresee—resulting in a wealth of contributions to the common good. Compared to a private firm, a democratic society often has more to gain—and less to lose—from investment in intangibles.

Governments, along with nongovernmental bodies such as universities, fund or subsidise education and training, R&D, and artistic and creative content for the benefit of firms and citizens. They also invest in intangibles for their own benefit, and some of these intangibles have wide and important spillovers.

Many of the most successful products seemingly created by private enterprise actually depend on previous investments in intangibles by government.

You think of the iPhone as a private-sector triumph, but it is nothing of the sort. In fact, all its component parts, from its touchscreen display to the architecture of its chipsets to the protocols used to encode the web pages and music files you can download, had their origins in significant amounts of government investment.

The importance of public investment does not mean that a centrally planned economy is a good idea. That’s because a high quantity of investment is not enough. The quality of an investment often depends on the particular combination of intangibles that create a useful product. This relates to another feature of intangibles, their synergies. Putting investment decisions in the hands of a central authority is useful for creating intangibles with many possible uses. But encouraging investment decisions by entrepreneurs is useful for harnessing the creativity of decentralized actors with their own information and expertise. Both are important.

A capable state providing generous intangible investment subsidies (such as R&D or student loans) may not on its own be enough to encourage enough productive investment, which also requires an active entrepreneurial ecosystem to generate variety and the valuable synergies that arise when you hit upon the right combination…. A strong state can coexist with strong businesses.

The reference to student loans is a hint that this analysis is relevant to the debate over educational funding. Historically, the U.S. economy got a great boost in productivity from its public investment in primary and secondary education. Public spending accomplished a great quantitative increase in years of education. One might wish to extend the quantitative approach by publicly funding college education as well. However, as a student gets older, the need for a general education coexists with a need for the more specific knowledge and skills required for an occupation. The public may be less enthusiastic about underwriting the traditional four-year degree without regard to the content of a student’s curriculum.

As a retired college professor, I am a strong believer in higher education in both its general and more specialized aspects. As a sociologist, I believe in the potential of the liberal arts and social sciences to help create the informed citizens democracy requires. I disagree with popular critics like Bill Maher who have taken to deriding college education as a waste of time. But I do grant that advocates of human capital investment must consider education for work as well as education for life. Taxpayers may reasonably resist fully funding baccalaureate degrees for children of the wealthy, as long as vocational education for working-class children remains poorly supported. College graduates still make more money than other workers, but the gap is now shrinking. Maybe that is because more employers are willing to consider applicants with fewer years of formal education but more relevant skills.

As my reference to class implies, more careful consideration of both the quantity and kind of human capital investment could also address the problem of economic inequality. Much of the resentment directed at more educated “cultural elites” comes from people whose opportunities to acquire today’s job skills are currently too limited.

Consistent with their emphasis on investment quality, not just quantity, the authors make this recommendation:

[W]e should increase public funding for other types of intangibles alongside basic research and education, including more investment in well-designed vocational training (including training provided directly by state-owned businesses such as national broadcasters or national arts organisations), more investment in big open-data and open-source software projects, and more industrial development (for example, by funding R&D tax credits or public research centres…

Intellectual property

From the standpoint of an individual company, a spillover of intangible capital from one user to another can be a threat. Why invest in new knowledge or product designs if they can easily flow to one’s competitors? The protection of intellectual property by means of patents and copyrights is a very big issue for an increasingly intangible economy. One of the functions of government is to act as the “spillover police.” Government “overcomes the spillover problem by granting inventors a temporary monopoly over the intangible asset they have created, banning others from taking advantage of the spillover.”

Here too, government faces a dilemma. Too little protection of intellectual property reduces the incentive to innovate. But too much protection inhibits further innovation by preventing companies from using existing intellectual property in creative ways. Some companies make money buying up patents they have no intention of using, except to extort money from other companies that are trying to innovate. For example, “war by patent has become an integral part of the smartphone industry.”

While some observers have advocated the elimination of intellectual property rights altogether, the wiser course is probably a more moderate policy. The “Tabarrok curve” (named after economist Alex Tabarrok) represents the relationship between intellectual property rights and innovation as an inverted U. The most innovation is expected where property rights are neither too weak nor too strong. The authors then recommend some moderation of the existing intellectual property regime:

[W]e should cautiously weaken IP rights, rolling back patents in areas where their remit has grown—for example, by ending patents on software and straightforward business processes, reducing patent lengths in selected industries, requiring genuine disclosure of what makes underlying technologies work, and introducing prizes or patent buyouts for certain socially desirable inventions, such as antibiotics.

Patent regulation is an example of the kind of administrative job that requires great expertise. What the intangible economy needs is not so much smaller government or bigger government, but smarter government. This is a recurring theme in the book’s policy discussions.

The politics of public policy

In both Chapter 4 and the Conclusion, Haskel and Westlake address the political challenges of making government more responsive to the needs of the intangible economy. They acknowledge that it won’t be easy to move from the present polarization and gridlock to a set of policies that a majority can understand and support.

The authors distinguish two kinds of challenges. The first is to build state capacity. This is “partly a matter of resourcing: hiring technically skilled staff, building analytical capacity, and using these capabilities to invest in intangibles and administer well-run IP [intellectual property] regimes.” Government agencies need rules to constrain their discretion and limit their susceptibility to political influence, but not so rigid rules that they cannot respond flexibly to technological change.

The second kind of challenge is to achieve political legitimacy by earning and spending political capital. If people feel that government isn’t working for them, they become suspicious of—and resistant to—government initiatives. They become hostile to those who produce and manage intangible assets, especially government experts. Government investments that pay off in actual improvements to the quality of life build trust, which helps generate support for more such investments. Part of the art of politics is trying to “craft narratives to make intangible investment more politically resonant.”

The authors acknowledge that the policy agenda they have in mind is somewhat “unfashionable” across the political spectrum, but they regard its unpopularity with conservatives as especially obvious. “[S]ince at least the Reagan and Thatcher eras, many on the right have sought to cut not just the state’s size but also its agency and even its knowledge.” I would add that in the U.S., the increasing unpopularity of the Republicans’ anti-tax, anti-regulation policies has led the party to rely on culture wars to retain a degree of power. The party offers little by way of policy proposals for strengthening the intangible economy, but devotes its time instead to attacking immigration, reproductive rights, LGBTQ rights, and efforts to address systemic racism.

Liberals are more receptive to building state capacity and investing in human capital, but they may rely too heavily on quantitative, centralized approaches that spend too much money carelessly. It is one thing for government to pick up the bills for existing forms of health care or education, but another thing to steer investment toward the kinds of health care or education that are most cost effective.

Subsidizing intangibles—for example, through tax breaks, public funding, or direct government investment in training or R&D—helps solves the quantity problem of underinvestment… But, at the margin, these policies can reduce the quality of investment by encouraging gaming or low-quality research, or simply because the funding rules have not kept pace with the latest practices and technologies.

This book got me thinking a lot about the state of our two-party system and how it might be reformed. Instead of playing on fears of cultural change and trying to take the country back to the 1950s, the conservative party might more usefully represent the interests of economic innovators willing to work with government rather than against it to strengthen the intangible economy. For its part, the liberal party could represent not just more taxing and spending, but support for those profit-motivated investments most compatible with the common good. Idealistic, perhaps, but certainly more sustainable than the present state of antagonism and standoff.

Continued