From a wide ranging interview of celebrated economist Daren Acemoglu, published at the Minneapolis Federal Reserve website, comes a discussion of what is called ‘directed technological change.’   Simply put, economists try to model the effects of technological changes, both at the micro and the macro level.

In one section of the interview Acemoglu talks about the conflicts between fossil fuel energy systems and technological innovation in so-called ‘clean’ energy.  Can a huge economy like that of the US navigate towards cleaner systems without damaging overall future growth? 

Directed Technical Change & Global Warming

Region: I definitely want to ask about your related work with James Robinson on economic and political transformation, but first let me jump to another of your seminal contributions in economics: directed technical change. In brief, the idea is that innovation is directed by two competing forces: the price effect that encourages innovation toward scarce factors and the market size effect that does the opposite, directs it toward abundant factors.

You and your co-authors recently applied this idea to the environment—global warming, in particular—and concluded that because of the externalities involved, sound policy should re-direct technical change toward clean technologies without delay, and also that optimal regulation with carbon taxes and research subsidies need not reduce long-term economic growth.

And you compare it to other economic analyses of climate change intervention, such as the Nicholas Stern report and William Nordhaus’ work. But could you give a quick primer on directed technical change and how you apply it to climate change?

Acemoglu: Sure. It’s useful for me to express it the following way, I think. The directed technical change idea really has two layers to it.

The first layer is sort of obvious to economists, but hadn’t really been developed and stated. It’s that just as we think all other factors go toward more profitable areas, investment in new technology and innovative activities also goes toward more profitable areas. I think in a micro sense, nobody would doubt this. We don’t talk of “technological change” in the abstract. We talk of technological change in the pharmaceutical sector, for example. We talk of technological change going after heart disease. We don’t just talk of broad technological change. And when we want to understand technological change for heart disease, we ask, What’s the market for heart drugs, beta-blockers, ACE inhibitors, statins or whatever?

So, that’s the most important part. Directed technical change was pushing this idea at the economywide level. Technology, either across sectors or across different types of factors—factor-augmenting or factor-substituting technologies—is also going to be determined by their profit incentives.

I first tried to develop these ideas in the context of inequality and skill-biased technological change. There the market size and the price effects, which you’ve mentioned, turn out to be quite important. If you want to understand how this works in a more detailed level, you need to understand how these market size and price effects work. They create countervailing forces, but one of them always dominates, and so on.

When we turn to the environment, I think the bigger picture insights seem to be more important. Market size and price effects come out in the context of the environment, and they’re in our paper, of course. But for purposes of our conversation here, I think I can do justice to the main ideas without getting into those details.

Essentially, the bulk of the literature in environmental economics has been about how we have to tax economic activity to slow it down so that we don’t damage the environment. If you think of a single-sector economy, with one sector that depends on coal, or on gas, that’s the only thing you can do: slow down that one sector. If you want to reduce carbon emissions, you just have to slow down that sector. Now, you don’t directly slow it down; you change its composition of factors, perhaps, but you can’t let that sector take off at a very rapid rate and still, at the same time, limit carbon emissions.

Our perspective was, well, the economy has several technologies; some of them are cleaner than others. How should we shift toward the cleaner ones? When you look at the climate science, there’s a lot of emphasis precisely on this and on questions such as, When is it that nuclear power will become economical? When will geothermal or wind or solar solve both their cost and their delivery problems?

Therefore, the perspective shouldn’t be, How can we slow down economic activity? Instead, it should be, How can we shift the composition of economic activity away from dirty technologies to cleaner technologies?

Now, that’s a very directed-technical-change-related question, but it already comes with a very important implication: The focus shouldn’t be on slowing down economic activity, but on changing its composition and changing the type of technological changes that the market generates.

Moreover, and importantly, we expect there to be a distinctive cumulative aspect to research. Different technologies often build on past successes in the same line of technology. So when you’re building a new car, you build on the past advances in car technology; you don’t as much build on advances in solar technology. In the same way as when you build new solar panels, you’re building on the previous solar panels, not on the diesel engine. What that means is that there’s going to be strong self-reinforcement in changing the direction of technological change. So when technological change shifts away from the dirty technologies that are so fossil-fuel-dependent to the cleaner technologies, it will also make it potentially cheaper to produce these innovations, these cleaner technologies, in the future.

That was the basic observation that I think was most important in the approach. And that’s the source of the more optimistic conclusions. Let me explain that in the following way. If you have a Nordhaus-type model—and I don’t want to caricaturize it, because Nordhaus in other work has considered richer models—but the seminal contribution that Nordhaus made in the early 1990s, for example, was sort of a neoclassical growth model used for the environment, and reducing carbons is reducing capital accumulation. In a model like that, parameters are going to determine how aggressive you should be in reducing carbon, but when you reduce carbon, you’re reducing GDP, you’re reducing growth.

The more optimistic aspect of our perspective came from the realization that if what you’re doing with environmental policy is “tax one sector, but subsidize another sector,” you might actually achieve in the long run quite successful growth, because the other sector is going to pick up the slack. If we have enough technological ingenuity—and that is an if, which I think we tried to make explicit in the paper—and can generate cleaner technologies that avoid the negative environmental consequences of coal and oil, then there is no reason for our economy not to grow at a healthy rate in the long run. So that was the optimistic part.

So in that sense, factoring in directed technical change made this conclusion much more optimistic relative to Nordhaus and, of course, more optimistic than Stern’s review, which was much more effective, and I believe rightly so, [in warning] of the potential dangers from climate change.

But on the other hand, it also made policy prescriptions much more proactive than Nordhaus and, in that sense, far more similar to Stern. And the logic of that relates very tightly to the directed technical change aspect. In the Nordhaus approach, it’s like a ramp-up thing: You don’t want to do too much because reducing emissions today is costly, while the future is discounted. If you can cut things in the future, why do it today? Now you can also add, “We don’t know where we’re going to go, so let’s go slowly,” a very gradualist approach.

But let’s think of the logic of directed technical change with cumulative research. The less we do on green technology today, the less knowledge is accumulated in the green sector, so the bigger is the gap between fossil-fuel-based technology and energy, and the cleaner energy, so the harder it will be in the future to close that gap. With more proactive, decisive action today, we already start closing the gap, and we’re making it easier to deal with the problem in the future.

Beezer here.  The main point is that somehow the government needs to keep subsidizing technological innovation in the clean energy areas.  Without this effort, and Acemoglu argues net GDP growth may be unchanged by the subsidy, it will become harder in the future to transition into cleaner energy systems because postponing initial innovation also postpones other innovations that always follow the initial discoveries.    It’s the old saw about when is the best time to plant a tree?  Now.   As almost always, hat tip to  Mark Thoma’s economist’s view for highlighting this interview.

Princeton economist Uwe E. Reinhardt, writing in the New York Times, shows that when it comes to economics the US has a severe income inequality problem.  His article is a summation of recent academic studies comparing GDP growth with underlying income shifts.

Suppose we placed a carefully selected sample of men on a hot stove and another sample of men on dry ice. Could we reasonably conclude that, on average, they were comfortable?

As a nation we worship a deity called economic growth. The more sophisticated users of that term presumably mean by it “annual growth in average gross domestic product per capita, expressed in dollars with a constant value relative to real goods and services, and averaged over the entire population of the United States” — in short, real G.D.P. per capita.But what does an average of this sort mean for most people the United States? I am fascinated by a recent paper by Anthony Atkinson, Thomas Piketty and Emmanuel Saez in the Journal of Economic Literature. The authors, recognized experts on the study of income distributions, have constructed a long-run time series of top income shares for more than 20 countries, starting about 1915 and ending in 2007.

Much of their paper is devoted to describing the numerous methodological problems that must be overcome to construct comparable time series of this sort. But they reach some illuminating conclusions, among them this:

Over the last 30 years, top income shares have increased substantially in English-speaking countries and in India and China, but not in continental European countries or Japan. This increase is due in part to an unprecedented surge in top wage incomes. As a result, wage income comprises a larger fraction of top incomes than in the past.

Top wage incomes include the compensation of corporate executives, including those in the financial sector.

Of particular interest is their Table 1 (Page 9) which I have summarized in the two charts below.

Consider now the longest period featured in their Table 1, from 1976 to 2007. The authors estimate that over that period the average annual income of all families in the United States grew at an average annual compound growth rate of 1.2 percent. But the data reveal that for the top 1 percent of income recipients, average real income grew by 4.4 percent a year. They captured 58 percent of the growth in total income over the period.

By contrast, for the bottom 99 percent of Americans, average family income over the same period grew by only by only 0.6 percent a year. Within that broad 99 percent, however, some lower-income groups probably saw their real income fall.

As the data in second chart shows, this inequality was even greater in the period 2002-7, in which the top 1 percent of highest-income recipients garnered 65 percent of the growth in total income over the period.

Similar conclusions, by the way, were reached in a 2005 paper by Ian-Dew Becker and Robert Gordon, “Where Did the Productivity Growth Go?”

So if an American macroeconomist — a specialist who tends to think of nations as people — or high-level government officials or politicians mimicking a macroeconomist boasted on a television talk show that “average family income grew by 3 percent during 2002-7, more than in most European economies,” about 99 percent of American viewers, reflecting on their own experience, would probably scratch their heads and wonder, “What is this guy talking about?”

The third chart, below, exhibits the growth path of real G.D.P. per capita in the United States over the period 1975-2009 and the corresponding path of real median household income. The data show that over the 34-year period, real G.D.P. per capita rose by an annual compound rate of 1.9 percent. Those data come from the Economic Report of the President to the Congress (Tables B-2 and B-34).

Sources: Economic Report of the President to Congress (G.D.P.); Census Bureau (income)

According to the Census Bureau data (see Table H-6), however, median household income in the United States rose by less than 0.5 percent a year. Other than national pride in league tables, that 1.9 percent average economic growth does not mean much for the experience of the median household in the United States.

In this regard, I found even more interesting this comment by the authors, pertaining to the international league tables of which we are all so fond, especially if they make us look good:

Average real income per family in the United States grew by 32.2 percent from 1975 to 2006, while they grew only by 27.1 percent in France during the same period, showing that the macroeconomic performance in the United States was better than the French one during this period. Excluding the top percentile, average United States real incomes grew by only 17.9 percent during the period while average French real incomes — excluding the top percentile — still grew at much the same rate (26.4 percent) as for the whole French population. Therefore, the better macroeconomic performance of the United States and France is reversed when excluding the top 1 percent.

In other words, if one took away the top 1 percent highest-income recipients and their share of income and focused on what was left for the bottom 99 percent, the median representative of that cohort should not be all that impressed by economic performance in the United States relative to their peers in other countries.

It can help explain why the so-called median American voter, a concept used in political science literature, seems so angry at this time, looking around for culprits behind the economic predicament of the American middle class. It also can help explain why the high-income groups in the United States have accounted for a growing share of total federal taxes paid in the United States.

Beezer here.  If you don’t get the digital subscription to the New York Times then you are not well informed.  It’s that simple and straightforward.  Take it from a former print journalist, this newspaper is the best available in the country, by a wide margin.   As for Reinhardt’s brief column, there are links to the underlying research–a digital subscription plus.  It’s worth pointing out that studies of the Great Depression show that income inequality preceeded that collapse.  The reasons for this mal-distribution of productivity gains (that’s what causes severe income inequality) are many, but Keynes put his finger on the metric that can be accurately measured and should be placed above all others when deciding policy:  Employment.   So hire already.  And it doesn’t matter a whit who does the hiring.  Our problem is hubris in the Republican Party.  They simply cannot acknowledge, politically, that their economic theories and resulting prescriptions are hurting the nation.  Once again thanks to Prof. Mark Thoma’s Economist’s View where Reinhardt’s article is highlighted, and where a strong discussion of the article appears as well.

The Republican Party has shot itself in the foot because their budget proposal out of the House includes ‘voucharcare’ as a substitute for the current Medicare program.  Medicare is popular amongst the elderly and they vote in very high percentages.  Vouchercare, on the other hand, is turning out to be a real stinker, both politically and economically.

So the media shills for Republicans are marshaling attempts at a counter-attack.  Megan McArdle  and Andrew Sullivan, both of  Atlantic magazine, and even Fareed Zakaria of GPS have asked where the Democrat plan is in response to Ryan.

Fortunately, Washington Post columnist Ezra Klein knows better and describes some important features of the Affordable Care Act already passed by Democrats into law.

Democrats don’t just have a proposal that offers a more plausible vision of cost control than Ryan does. They have an honest-to-goodness law. The Affordable Care Act sets more achievable targets, and offers a host of more plausible ways to reach them, than anything in Ryan’s budget. “If this is a competition betweenRyan and the Affordable Care Act on realistic approaches to curbing the growth of spending,” says Robert Reischauer, who ran the Congressional Budget Office from 1989 to 1995 and now directs the Urban Institute, “the Affordable Care Act gets five points and Ryan gets zero.”

The Affordable Care Act holds Medicare’s cost growth to GDP plus one percentage point, which makes a lot more sense. It’s the target Ryan’s Medicare plan originally used, back when it was called Ryan-Rivlin. But the target is not really the important part. The important part is how you achieve the target. And the Affordable Care Act actually includes reforms and new processes for future reforms that would help Medicare — and the rest of the medical system — get to where the costs can be saved, rather than just shifted.

The Affordable Care Act’s central hope is that Medicare can lead the health-care system to pay for value, cut down on overtreatment, and cut out treatments that simply don’t work. The law develops Accountable Care Organizations, in which Medicare pays one provider to coordinate all of your care successfully, rather than paying many doctors and providers to add to your care no matter the cost or outcome, as is the current practice. It also begins experimenting with bundled payments, in which Medicare pays one lump-sum for all care related to the successful treatment of a condition rather than paying for every piece of care separately. To help these reforms succeed, and to help all doctors make more cost-effective treatment decisions, the law accelerates research on which drugs and treatments are most effective, and creates and funds the Patient-Centered Outcomes Research Institute to disseminate the data.

If those initiatives work, they head over to the Independent Payment Advisory Board (IPAB), which can implement cost-controlling reforms across Medicare without congressional approval — an effort to make continuous reform the default for Medicare, even if Congress is gridlocked or focused on other matters. And if they don’t work, then it’s up to the Center for Medicare and Medicaid Innovation, a funded body that will be continually testing payment and practice reforms, to keep searching and experimenting, and when it hits on successful ideas, handing them to the IPAB to implement throughout the system.

The law also goes after bad and wasted care: It cuts payments to hospitals with high rates of re-admission, as that tends to signal care isn’t being delivered well, or isn’t being follow up on effectively. It cuts payments to hospitals for care related to infections caught in the hospitals. It develops new plans to help Medicare base its purchasing decisions on value, and new programs to help Medicaid move patients with chronic illnesses into systems that rely on the sort of maintenance-based care that’s been shown to successfully lower costs and improve outcomes.

I could go on, but instead, I’ll just link to the Kaiser Family Foundation’s excellent primer(pdf) on everything the law does. The bottom line is this: The Affordable Care Act is actually doing the hard work of reforming the health-care system that’s needed to make cost control possible. Ryan’s budget just makes seniors pay more for their Medicare and choose their own plans — worthy ideas, you can argue, but ideas that have been tried many times before, and that have never cut costs in the way Ryan’s budget suggests they will.

That’s why, when the Congressional Budget Office looked atRyan’s plan, they said it would make Medicare more expensive for seniors, not less. The reason the deficit goes down is because seniors are paying 70 percent of the cost of their insurance out-of-pocket rather than 30 percent. But that’s not sustainable: We’ve just taken the government’s medical-costs problem and pushed it onto families.

No one who knows health-care policy will tell you that the Affordable Care Act does everything we need to do in exactly the way we need it done. That’s why Resichauer gave it a five, not a 10. But it does a lot of what we need to do and it sets up systems to help us continue doing what’s needed in the future.

Ryan’s proposal, by contrast, does almost none of what we need to do. It appeals to people who have an ideological take on health-care reform and believe we can make Medicare cheaper by handing it over to private insurers and telling seniors to act like consumers. It’s a plan that suggests health-care costs are about insurance, as opposed to about health care. There’s precious little evidence of that, and when added to the fact that Ryan’s targets are so low that even his allies can’t defend them, the reality is that his savings are largely an illusion.

The Affordable Care Act has taken a lot of hits. It’s not popular, and though very few of the political actors confidently attacking or advocating it can explain the many things it’s doing to try and control costs, people have very strong opinions on whether it will succeed at controlling costs. But the irony of everyone demanding Democrats come up with a vision for addressing the drivers of our deficit in the years to come is that, on the central driver of costs and the central element of Ryan’s budget, Democrats actually have something better than a vision. They have a law, and for all its flaws, their law actually makes some sense. Republicans don’t have a law, and their vision, at this point, doesn’t make any sense at all.

Beezer here.  The law is a reform effort that allows for incremental gains in policy based on experiences of the reform efforts.  What works will be improved and what doesn’t work will be discarded.  Ryan’s plan does nothing to slow health care cost inflation, it just shifts the costs from government back on individual families.  It’s obvious junk and unless the Republicans totally toss it out the window it will be a noose around their election necks come 2012.  Once again thanks to Prof. Mark Thoma’s economist’s view for highlighting Klein’s column.

I’m putting up this link to The Stanford Center for the Study of Poverty and Inequality because it has 20 charts pertinent to these issues, and if you click on one of the charts it takes you to the narrative, facts and such.  A good reference source, in other words, that tracks how the national economy is doing overall.

Take, for one example, child poverty. 

In the United States, 21.9 percent of all children are in poverty, a poverty rate second only to that of Mexico’s (among rich nations).

Beezer.  Irrespective of what one thinks about income inequality overall, this statistic cannot bode well for future economic development rates.