The G-20 Summit begins in Brisbane, Australia this Saturday, November 15. Leaders are descending on the city to tackle the biggest economic challenges facing the planet. A major theme of the discussions will likely be convergence—the rapid approach of average incomes in low- and middle-income countries towards those in advanced economies—and its sustainability. In a recent brief in the Brookings Global Think Tank 20 series, I explore this issue in the sub-Saharan African context, examining what has been holding the region back, how Africa might reach the rapid convergence seen by other emerging economies, and if and how convergence might be sustained. For my full brief, see here.

As most know, despite the “growth miracles” happening on the continent, sub-Saharan Africa still has a long way to go. Africa’s economic growth started much later and has gone much slower than the rest of the developing world; thus its per capita income gap against advanced economies still remains quite large. In fact, Africa hasn’t even converged with other emerging economies (see Figure 1). 

In addition to slow growth, Africa faces many, many challenges: Conflict-ridden countries still face a declining income per capita, and inequality is rampant. While Africa’s poverty rate is dropping, its share in global poverty is not: In 1990, 56 percent of Africans lived on under $1.25 a day, meaning that they represented 15 percent of those in poverty worldwide. Over the next 20 years, the region’s poverty rate dropped to 48 percent, but its share of global poverty doubled. At this rate, many predict that by 2030 Africa’s poverty rate will fall to 24 percent, but represent 82 percent of the world’s poor (Chandy et al., 2013). 

Of the utmost importance for convergence, though, is the issue of structural transformation in the region. If sub-Saharan Africa can reduce its reliance on unproductive and volatile sectors, it will build a foundation on which economic growth—and convergence—can be sustained.

Current African Economies: Agriculture, Natural Resources and Services

Currently, African economies are characterized by a reliance on natural resources, agriculture and a budding services sector. Natural resources are, and will likely continue to be, major drivers of Africa’s economic growth: About 20 African countries derived more than 25 percent of their total merchandise exports in 2000-2011 from them. Unfortunately, this dependence on natural resources comes hand-in-hand with challenges such as financial volatility, rent-seeking behavior, and a loss of competitiveness, among many others—making a turn away from them necessary for long-term, sustainable growth. Similarly, most African economies depend heavily on the low-yield agriculture sector—its least productive sector and with the lowest income and consumption levels.

While labor has been moving out of the agriculture sector, it is moving into the services sector. From 2000-2010, the agriculture labor force share fell by about 10 percent while services grew by 8 percent (McMillan and Harttgen, 2014). While much of the movement into the services industry has been into productive areas such as telecommunications and banking, most service sector jobs in sub-Saharan Africa are informal.  Although informal activities offer earning opportunities to many people, they are often unstable and it is far from clear that they can be an engine of sustainable and inclusive high economic growth. In addition, growth in the services sector overall has historically not shown the economic returns that industry has.

If policymakers can enhance productivity in the services sector, then growth could take off even more rapidly, but until then, the highly productive manufacturing sector will be the key to Africa’s convergence. (For more on this, see the attached PowerPoint presentation.)

The Missing Piece: African Industry

Industrialization in Africa is low: Manufacturing–the driver of growth in Asia—employs less than 8 percent of the workforce and makes up only 10 percent of GDP on the continent (Rodrik, 2014). In comparison to the 8 percent growth in the services sector from 2000-2010, manufacturing saw only 2 percent growth (McMillan and Harttgen, 2014). In addition, the region’s manufacturing sector is dominated mostly by small and informal (and thus less productive) firms. Since the research has shown that industry was key to the explosive and continued growth in Asia and Europe, without concentration on or support of the manufacturing sector, African economies are not likely to replicate those convergence dynamics (Rodrik, 2014). Thus, Africa’s slow pace of industrialization means that, in addition to its late start time and its past sluggish growth, the region has another obstacle towards convergence.

There is hope, however; there are already hints that structural transformation might be happening. The recent rebasing of Nigeria’s economy revealed some important new trends. There, the contribution from oil and gas to GDP fell from 32 to 14 percent, and agriculture from 35 to 22 percent. At the same time, the telecommunication’s contribution sector rose from 0.9 to 9 percent, and manufacturing from 2 to 7 percent.

Achieving a successful economic transformation will help capitalize on improved growth fundamentals and achieve high and sustained per capita growth rates. However, for such a process to yield lasting benefits, it is crucial to better understand the ongoing structural changes taking place in Africa. This is an important task for economists studying Africa and, in addition to achieving a “data revolution,” both meta-analysis and case study methods can be useful complements to the current body of research on the continent.

References

Chandy, Laurence, Natasha Ledlie, and Veronika Penciakova. 2013. “Africa’s Challenge to End Extreme Poverty by 2030: Too Slow or Too Far Behind?” The Brookings Institution, Washington D.C. April 2013, http://www.brookings.edu/blogs/up-front/posts/2013/05/29-africachallenge-end-extreme-poverty-2030-chandy

McMillan, Margaret and Ken Harttgen. 2014. “What is Driving the Africa Growth Miracle?” NBER Working Paper No. 20077, April. http://www.nber.org/papers/w20077

Rodrik, Dani. 2014. “An African Growth Miracle?” NBER Working Paper No. 20188, June. http://www.nber.org/papers/w20188

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Event Information

From high-profile stabilization contexts like Afghanistan to global public health campaigns to a renewed focus on sustainable food security and the looming impacts of climate change, development effectiveness is a central and hotly debated issue. As traditional donors make progress in the international aid effectiveness dialogue, they must increasingly take into account the changing global development landscape and the slew of new actors, including emerging donors, multinational corporations, mega philanthropists, high-profile advocates, and a vocal and energized global public.

2010 Brookings Blum Roundtable: Related Materials
	Read the roundtable report - Aiding Development: Assistance Reform in the 21st Century »  Read the conference policy briefs »  Download the participant list » (PDF) Download the scene setter » (PDF) Download the full roundtable agenda » (PDF)

The seventh annual Brookings Blum Roundtable, led by Kemal Derviş and co-chaired by Richard C. Blum and Strobe Talbott, convened over 40 exceptional international thought leaders, entrepreneurs and practitioners to explore the relationship between efforts to promote aid effectiveness and the anticipated shape of the global development agenda over the next decade. The roundtable discussions provided an opportunity to look beyond questions of increased resources for anti-poverty services to the effectiveness of different approaches and to systemic issues associated with the delivery of development outcomes. The high-level group of participants explored opportunities for new commitment in engaging the private sector and multilateral actors, as well as the increasingly important role of climate assistance and operations in instable arenas. Over separate meal conversations, Dr. Donald Kaberuka, president of the African Development Bank, and Dr. Rajiv Shah, administrator of the U.S. Agency for International Development (USAID), reflected on the current and future roles of their organizations, and how they could each act on the suggestions put forward at the roundtable.

       

Event Information

Since the Rose Revolution in November 2003, Georgia has grappled with the many challenges of building a modern, Western-oriented state, including implementing political and economic reforms, fighting corruption, and throwing off the vestiges of the Soviet legacy. On the path toward a functioning and reliable democracy, Georgia has pursued these domestic changes in an often difficult international environment, as evidenced by the Russia-Georgia conflict in 2008.

On March 17, the Center on the United States and Europe at Brookings (CUSE) hosted President Mikheil Saakashvili to discuss Georgia’s approach to these challenges. A leader of Georgia’s 2003 Rose Revolution, Saakashvili was elected president of Georgia in January 2004 and reelected for a second term in January 2008.

Vice President Martin Indyk, director of Foreign Policy at Brookings, provided introductory remarks and Senior Fellow and CUSE Director Fiona Hill moderated the discussion. After the program, President Saakashvili took audience questions.

Video

• Georgia Is a Transformed Country
• Georgia Is a Valuable Asset to Europe
• The Key to Effective Change Is Youth

Audio

• From Popular Revolutions to Effective Reforms: The Georgian Experience

Transcript

• Uncorrected Transcript (.pdf)

Event Materials

• 20110317_saakashvili_transcript

      

Income and wealth inequality in the U.S. is a stark reality.  Research from a variety of fields demonstrates that children born into poor families tend to end up less educated, less healthy, more prone to contact with the police, and less likely to accumulate wealth over a lifetime.  In contrast, children born into well-off families tend to exhibit better outcomes on all of these dimensions.

How should social scientists and policymakers understand and address intergenerational mobility in the U.S.? This question is difficult to answer—and highly politicized.  To start with, there are several possible mechanisms driving high intergenerational persistence of economic outcomes.  These are often characterized as factors related either to “nurture” or “nature.” 

The “nurture” hypothesis asserts that poor parents lack critical resources such as wealth or information.  Such parents may therefore find it difficult to make the education and time investments that would promote better economic outcomes for their children.  If this is true, then children born into poor families never reach their full potential because of a lack of household resources. 

A second possible mechanism is often referred to as the “nature” hypothesis.  Economically successful parents might be more likely to have successful children.  Such an account hinges on the idea that there are heritable biological traits or abilities that more successful parents “pass on” to their children.

To complicate the matter further, the mechanisms of nature and nurture almost certainly operate at the same time.  Moreover, it is likely that abilities and investments interact in complicated ways. For example, a particular investment might do more to improve the outcomes of a lower-ability child than a higher-ability child, or vice versa.  Understanding this process, and how it affects intergenerational mobility, is notoriously difficult.  However, greater clarity is precisely what is needed to guide effective policy. 

If a lack of investment is the dominant mechanism explaining intergenerational persistence in economic outcomes, then we as a society may be wasting human potential.  Policies correcting under-investments in human capital could therefore be justified as economically efficient. In contrast, if the intergenerational transmission of ability plays a role, then investments in poor children’s human capital may not be enough.  To clarify, it is critical to state that the distinction we make here between “high-ability” and “low-ability” individuals should not be interpreted as a claim that some people are naturally or biologically superior to others.  We use “ability” as shorthand to describe those traits that are rewarded in the existing labor market.  Even if these abilities are linked to heritable biological factors, this does not mean that their impact on life outcomes is immutable or fixed.  Modifying environments could substantially affect genetic disparities. The case of vision and eyeglasses offer one classic example.  There may well be biological factors that explain variation in eyesight “ability,” but these biological differences will matter more or less for life outcomes depending on the availability of glasses and other medical interventions.  In short, it is very possible that the consequences of biological differences can be moderated by appropriate changes in the environment.     

Until now, researchers have typically used variables such as cognitive test scores to measure ability endowments related to human capital.  Yet, these traditional measures are subject to the critique that they are the products of earlier investments in human capital. This makes it difficult to distinguish between the “nature” and “nurture” hypotheses using such data.  Two individuals with similar ability endowments but different levels of household resources are likely to exhibit different cognitive test scores, for example. 

Using genetic information to measure ability endowments can help us better understand the intergenerational transmission of human capital.  As a measure, genetic information has a clear advantage over cognitive test scores because it is fixed at conception. Advances in measuring differences in DNA across individuals, together with very recent advances in behavioral genetics research, now make it possible to link genetic differences across people to behavioral traits.  These new discoveries have even extended to educational attainment, which was once thought to be too complicated and removed from direct biological processes for genetic analysis.

In a recent research paper, we use genetic information to better understand the nature of intergenerational mobility.  We follow the cutting edge in behavioral genetics research, which guides us in computing a type of genetic “score” for any individual.  We compute this so-called “polygenic score” for each person in a sample of over 8,000 individuals from the Health and Retirement Study (HRS). The score, which appears to be related to cognition, personality, and facility with learning, has some predictive power for educational attainment. In particular, it explains between 3.2 percent and 6.6 percent of the variation across individuals (depending on the specification). Thus, knowing the exact value of an individual’s score will tell you very little about that person (over 90 percent of the variation is explained by other factors).  However, the average relationship in the population between the score and human capital outcomes can offer some important lessons.  

Using the polygenic score, we believe we can gain new insights into how ability endowments interact with an individual’s environment to generate economic outcomes.  There is a long-standing debate in the economics literature about how ability and investments interact.  One idea is that both ability and investments are needed for success, i.e., that they complement one another. Though our findings show evidence of this type of interaction, the story that emerges from our analysis is somewhat more nuanced.  We show that ability and the environment (measured by parents’ socioeconomic status or SES) complement one another for generating higher degrees, such as college completion, but substitute for one another in generating lower levels of educational attainment such as a high school degree.  In other words, our findings suggest that ability or being born into a well-off family are enough to get an individual through high school.  For college, however, ability and a well-off family are important predictors of success.

"In other words, our findings suggest that ability or being born into a well-off family are enough to get an individual through high school. For college, however, ability and a well-off family are important predictors of success."

Another set of results concerns the wages of high-ability individuals.  We show that individuals who completed college earned substantial returns on their ability starting in the early 2000s.  Individuals without a college degree did not. The post-2000 rise in returns may be driven in part by “skill-biased technological change.”   As new technologies are adopted in the workplace, the people who benefit most are those with the skills required to adapt to and master new ways of working.  It is not difficult to imagine that people with genetic variants associated with higher education may have found it easier to adapt to computers and other new technologies.  However, we also find that a higher polygenic score was not helpful for individuals who did not complete college, likely because the lack of a college degree shut them out of careers that would have allowed them to creatively use new technologies.  This is a troubling finding given the role of childhood SES in predicting college completion.  It means that poor children with high abilities are less likely to attend college and, subsequently, are less likely to benefit from their ability.  Again, these findings suggest wasted human potential.

Using genetic data to compare individuals from different socioeconomic backgrounds, we also find that children from lower SES backgrounds systematically acquire less education when compared to similarly capable individuals from high SES backgrounds.  Among other things, this suggests that access to education may be an important obstacle, even for the highest ability children.  Our analysis offers some suggestive evidence regarding which environments are especially harmful. For example, acute negative events like physical abuse in childhood can lead to a dramatic loss of economic potential—reducing financial wealth in late adulthood for the highest ability individuals by over 50 percent.

Of course, one must be very cautious when interpreting any genetic association.  In particular, it is important to think carefully about correlation versus causality.  The same parents that pass along genetic material predicting educational attainment may also be more likely to have the resources to invest in their children.  Still, since we base our comparisons on individuals from different socioeconomic backgrounds, but with similar polygenic scores, we offer evidence that economic disparities are not solely due to nature.

In summary, recent advances in behavioral genetics have identified specific genetic variants that predict educational attainment.  The fact that such genes exist confirms previous work (largely using data on twins) showing that “nature” matters for economic outcomes.  Our research demonstrates that “nurture” matters, too.  Perhaps more importantly, our research demonstrates that the roles of “nature” and “nurture” are intertwined and that understanding the role of “nurture” (in the form of human capital investments over the life-cycle) is key to understanding how “nature” (in the form of ability endowments) operates.  In particular, we show that similarly apt individuals with different childhood SES see very different returns to their ability.  This means that policies helping children born into disadvantaged circumstances may be justified not solely for ethical reasons rooted in social justice, but perhaps also as an economically efficient way to mitigate wasted human potential.

Finally, we believe that continued progress in understanding the mechanisms underlying how “nature” affects economic outcomes will eventually lead to policies that help people who are born with different abilities.  For example, our findings suggest that some individuals had more difficulty than others in adapting to new workplace technologies, such as computers. With a fuller understanding of this process, policymakers may be able to devise better training programs or improved school curricula that help individuals of all levels of ability to better respond to a changing technological environment.  In other words we believe that our research shows that learning more about the specifics of “nature” may help us to better “nurture” all individuals in society to help them to reach their full potential.      

Editor’s note: The authors contributed equally to this posting and to the research upon which the posting is based. They are listed alphabetically by last name.

       

Hillary Clinton’s release of her campaign finance proposals on Tuesday confirms there will be no significant substantive differences on political reform among the aspirants for the Democratic presidential nomination but a huge gulf between the two parties, whoever the nominees.

Harvard law professor and activist Larry Lessig announced his candidacy for the Democratic nomination this past weekend based on the single issue of political reform, but his quixotic and gimmicky campaign is akin to carrying coals to Newcastle. His only difference with the other Democratic candidates is his insistence that political reform (primarily on campaign finance) should be of the highest priority and other concerns (immigration, wages, climate change, economic inequality, infrastructure, national security) should play second fiddle. Lessig apparently believes that Republican and independent voters will rally to his call and create a broad base of public support for bipartisan cooperation on changing the rules of the electoral game.

If only it were that simple. The gaping differences between the parties on campaign reform are both ideological and strategic. Republicans are more philosophically disposed to elevate free speech over political equality. They also realize that as presently constituted, their party is advantaged by fewer or no restrictions on money in politics, lower turnout among minorities and youth, and single-member districts. Democrats instinctively reject the argument that money is speech and are comfortable with using public authority to set and enforce the rules of democracy. But they also know that they would benefit from restrictions on big money in elections, guaranteed voting rights for all citizens, and a more proportional translation of votes into seats.

The Clinton campaign finance proposals generally follow the thrust of liberal reformers: building a counterforce to big money through multiple matching funds for small donors, increasing transparency by requiring timely disclosure of mega-contributions and transfers that now evade public scrutiny, and overturning Citizens United, which set the stage for a Wild West of outsized contributions and spending. Her support for a constitutional amendment to accomplish the latter is a pipedream and probably wouldn’t work if it were adopted. As she acknowledges, appointing Supreme Court justices to change the current 5-4 majority is the more promising route to the desired change.

Lessig’s dream notwithstanding, this particular agenda will be achieved only if and when Democrats manage to control both ends of Pennsylvania long enough to put the policies and a sympathetic Supreme Court in place. It’s an important choice for voters to consider in the 2016 elections but by no means the only or most pressing one.

       

I was honored today to speak at the kick off meeting of the new ReFormers Caucus. This group of over 100 former members of the U.S. Senate, the House, and governors of both parties, has come together to fight for meaningful campaign finance reform. In the bipartisan spirit of the caucus, I shared speaking duties with Professor Richard Painter, who was the Bush administration ethics czar and my predecessor before I had a similar role in the Obama White House. 

As I told the distinguished audience of ReFormers (get the pun?) gathered over lunch on Capitol Hill, I wish they had existed when in my Obama administration role I was working for the passage of the Disclose Act. That bill would have brought true transparency to the post-Citizens United campaign finance system, yet it failed by just one vote in Congress.  But it is not too late for Americans, working together, to secure enhanced transparency and other campaign finance changes that are desperately needed.  Momentum is building, with increasing levels of public outrage, as reflected in state and local referenda passing in Maine, Seattle and San Francisco just this week, and much more to come at the federal, state and local level.

       

The rise of SuperPACs, the decision in Citizens United, and intensified polarization in Congress has ignited a flame under the already robust academic debate over the role of money in elections. Last week, Lee Drutman wrote an article for Vox outlining the recent contribution of Raymond J. La Raja and Brian Schaffner made to the debate with their book, Campaign Finance and Political Polarization: When Purists Prevail.

The crux of the book argues that allowing political parties to control more money, not less, is the key to reducing polarization. This runs counter to many pro-reform writings, focused chiefly on empowering small donors in order to counter big-money politics. La Raja and Schaffner counter this narrative, suggesting parties channel money to create moderation, rather than small donors, which are polarizing.

Drutman pushes back on both accounts by taking issue with some of the underlying assumptions in When Purists Prevail, including the weight they place on median voter theory and the extent parties will spend money on moderate candidates in primary elections. He marshals a host of recent research to support the critique, including: a recent Brookings paper on the strength of political parties, data on the power of outside money in congressional elections, and research showing moderate districts do not necessarily produce moderate candidates.

Click here to read the full article on Vox.

       

Policy Brief #172

Why Institutions Matter

When experts and pundits are asked what the president and Congress should do to promote economic growth, they typically respond with a list of policies, often mixed with stylistic and political suggestions. Few focus on institutional change, which is too easy to conflate with yawn-inducing “governmental reorganization.”

This neglect of institutions is always a mistake, never more than in times of crisis. Throughout American history, profound challenges have summoned bursts of institutional creativity, with enduring effects. The dangerous inadequacies of the Articles of Confederation set the stage for a new Constitution. The Civil War resulted in three amendments that resolved—at least in principle—our founding ambivalence between the people and the states as the source of national authority, between the states and the nation as the locus of citizenship, and between slavery and the equality the Declaration of Independence had proclaimed and promised. Similarly, the Federal Reserve Board, Bretton Woods international economic system, Department of Defense, National Security Council, CIA, Congressional Budget Office and Department of Homeland Security all arose through changes occasioned by great challenges to the nation.

Today’s economic crisis is reflected in three distinct but linked deficits—the fiscal deficit, the savings deficit and the investment deficit. Meeting these challenges and laying the foundation for sustained economic growth will require institutional as well as policy changes. 

	RECOMMENDATIONS
	Today’s economic crisis is characterized by three distinct but linked deficits—the fiscal deficit, the savings deficit and the investment deficit. Meeting these challenges and laying the foundation for sustained economic growth will require institutional as well as policy changes. The following institution-based recommendations would help the nation meet the current economic crisis and could help prevent future crises of similar destructiveness. To promote fiscal sustainability, change longterm budget procedures and create empowered commissions—answerable to Congress but largely insulated from day-to-day politics. To boost savings, consider new mandatory individual retirement accounts as a supplement to Social Security. To improve public investment, create a National Infrastructure Bank with public seed capital—this entity would mobilize private investment and force proposed projects to pass rigorous cost-benefit analysis as well as a market test. Today’s polarized political system is an obstacle to reform in every area, including the economy. A multi-year collaboration between Brookings and the Hoover Institution produced a series of suggestions. At least two of those suggestions are worth adopting: Alter redistricting authority, so state legislatures can no longer practice gerrymandering. Experiment, in a few willing states, with compulsory voting—to move politicians away from the red-meat politics of appealing only to their bases, which now dominate elections, and toward a more moderate and consensual politics.

Institutional reform

Promoting fiscal sustainability

Setting the federal budget on a sustainable course is an enormous challenge. If we do nothing, we will add an average of nearly $1 trillion to the national debt every year between now and 2020, raising the debt/ GDP ratio to a level not seen since the early 1950s and sending the annual cost of servicing the debt sky-high. Restoring pay-as-you-go budgeting and putting some teeth in it are a start, but not nearly enough. We need radical changes in rules and procedures.

One option, recently proposed by a bipartisan group that includes three former directors of the Congressional Budget Office, would change the giant entitlement programs: Social Security, Medicare and Medicaid. The new rules would require a review every five years to determine whether projected revenues and outlays are in balance. If not, Congress would be required to restore balance through dedicated revenue increases, benefits cuts or a combination. After a financial crisis in the early 1990s, Sweden introduced a variant of this plan, which has worked reasonably well.A number of Brookings scholars—including Henry Aaron, Gary Burtless, William Gale, Alice Rivlin and Isabel Sawhill—have suggested a Value Added Tax (VAT) as part of a program of fiscal and tax reform. Burtless offers an intriguing proposal that would link a VAT to health care finance. Revenue from the VAT would be dedicated to—and would cover—the federal share of health care programs. If the federal cost rises faster than proceeds from the VAT, Congress would have to either raise the VAT rate or cut back programs to fit the flow of funds. The system would become much more transparent and accountable: because the VAT rate would appear on every purchase, citizens could see for themselves the cost of federal support for health care, and they could tell their representatives what balance they prefer between increased rates and reduced health care funding.

Another option draws on the experience of the Base Realignment and Closure Commission, which enables the military to surmount NIMBY politics and shut down unneeded bases. The basic idea is straightforward: once the independent commission settles on a list of proposed closures, Congress has the option of voting it up or down without amendment. A similar idea undergirds the president’s “fast-track” authority to negotiate proposed trade treaties, which Congress can reject but cannot modify.

Suitably adapted, this concept could help break longstanding fiscal logjams. Here is one way it might work. Independent commissions with members from both political parties could submit proposals in designated areas of fiscal policy. To increase bipartisan appeal, each proposal would require a super-majority of the commission. In the House and Senate, both the majority and the minority would have the opportunity to offer only a single amendment. This strategy of “empowered commissions” changes the incentive structure in Congress, reducing negative logrolling to undermine the prospects of proposals that would otherwise gain majority support.

Empowered commissions represent a broader strategy—using institutional design to insulate certain activities from regular and direct political pressure. For example, the Constitution mandates that federal judges, once confirmed, hold office during “good behavior” and receive salaries that Congress may not reduce during their term of service. (By contrast, many states subject judges to regular election and possible recall.) In another striking example, members of the Board of Governors of the Federal Reserve Board are appointed to 14-year non-renewable terms, limiting the ability of the executive branch to change its membership rapidly and removing governors’ incentives to trim their policy sails in hopes of reappointment. Additionally, action by neither the president nor any other entity in the executive branch is required to implement the Fed’s decisions, and Fed chairmen have been known to take steps that vex the Oval Office.

This strategy is controversial. Officials with populist leanings often argue that fundamental decisions affecting the economy should be made through transparent democratic processes. The counterargument: experience dating back to the founding of the republic suggests that when interest rates and the money supply are set at the whim of transient majorities, economic growth and stability are at risk.

Boosting savings

An adequate supply of capital is a precondition of long-term economic growth, and household saving is an important source of capital. During the 1960s, U.S. households saved 12 percent of their income; as recently as the 1980s, that figure stood at 8 percent. By 2005–2006, the savings rate dipped into negative territory, and today it stands at a meager 3 percent. In recent years, funds from abroad—principally Asia— filled the capital gap. But evidence is accumulating that foreign governments have reached the limit of their appetite (or tolerance) for U.S. debt. To avert a capital shortage and soaring interest rates, which would choke off growth, we must boost private savings as we reduce public deficits.

For a long time, tax incentives for saving have been the tool of choice. But as evidence mounts that these incentives are less effective than hoped, policy experts are turning to alternatives. One rests on a key finding of behavioral economics: default settings have a large impact on individual conduct and collective outcomes. If you require people to opt in to enter a program, such as 401(k) retirement plans, even a modest inconvenience will deter many of them from participating. But if you reverse the procedure— automatically enrolling them unless they affirmatively opt out—you can boost participation.

To achieve an adequate rate of private saving, we may need to go even further. One option is a mandatory retirement savings program to supplement Social Security. Workers would be required to set aside a fixed percentage of earnings and invest them in generic funds—equities, public debt, private debt, real estate, commodities and cash. For those who fail to designate a percentage allocation for each fund, a default program would take effect. (Participants always would have the option of regaining control.) As workers near retirement age, their holdings would be automatically rebalanced in a more conservative direction. One version of this proposal calls for “progressive matching,” in which low-earning individuals receive a subsidy equal to half their payroll contributions; those making more would get a smaller match along a sliding scale, and those at the top would receive no match at all.

This strategy requires careful institutional and programmatic design. To ensure maximum benefits to wage earners, the private sector would be allowed to offer only funds with very low costs and fees. To ensure that the program actually boosts net savings, individuals would be prohibited from withdrawing funds from their accounts prior to retirement; except in emergencies, they would not be allowed to borrow against their accounts; and they would be prohibited from using them as collateral. And a clear line would be drawn to prevent government interference in the private sector: while government-administered automatic default investments would be permitted, government officials could not direct the flow of capital to specific firms.

Improving public investment

The investment deficit has a public face as well. Since the early 19th century, government has financed and helped build major infrastructure projects—roads, bridges, ports and canals, among others, have spurred economic growth and opened new domestic and international markets. Recently, however, public infrastructure investment has fallen well short of national needs, and often has been poorly targeted. Americans travelling and working abroad are noticing that U.S. infrastructure is falling behind not only advanced countries’ but rapidly developing countries’ as well. A study by Emilia Istrate and Robert Puentes of Brookings’s Metropolitan Policy Program, presented in a December 2009 report entitled “Investing for Success,” documents three key shortcomings of federal infrastructure investment: it lacks long-term planning, fails to provide adequately for maintenance costs, and suffers from a flawed project selection process as benefits are not weighed rigorously against costs.

Istrate and Puentes explore several strategies for correcting these deficiencies. One of the most promising is a National Infrastructure Bank (NIB), to require benefit-cost analyses of proposed projects, break down financial barriers between related types of investment (facilitating inter-modal transportation, for example), and improve coordination across jurisdictional lines. The NIB could be funded through a modest initial infusion of federal capital designed to attract private capital. Projects receiving loans from the NIB would have to provide for depreciation and document the sources of funds to repay the face amount of each loan, plus interest. In short, the NIB would be more than a conduit for the flow of federal funds; it would function as a real bank, imposing market discipline on projects and making infrastructure investments attractive to private capital, partly by providing flexible subordinated debt.

Istrate and Puentes identify diverse problems that designers of an NIB would confront. Insulating the selection process from political interference would pose serious difficulties, as would providing federal seed capital without increasing the federal deficit and debt. Requiring the repayment of loans could skew project awards away from projects that cannot easily charge user fees—wastewater and environmental infrastructure projects, for example. Despite these challenges, a properly designed bank could increase the quantity of infrastructure investment while improving its effectiveness, reducing bottlenecks and promoting economic efficiency. The potential benefits for long-term growth would be considerable.

Creating the Political Conditions for Reform

The rise of political polarization in recent decades has made effective action much more difficult for the U.S. government. Polarization has impeded efforts to enact even the progrowth reforms sketched in this paper. A multiyear collaboration between the Brookings and Hoover Institutions—resulting in a two-volume report, Red and Blue Nation?, with Volume One published in 2006 and Volume Two in 2008— has mapped the scope of the phenomenon. This effort has shown that, while political elites are more sharply divided than citizens in general, citizens are more likely now to place themselves at the ends of the ideological spectrum than they were as recently as the 1980s. With a smaller political center to work with, even leaders committed to bipartisan compromise have been stymied. The fate of President Bush’s 2005 Social Security proposal illustrates the difficulty of addressing tough issues in these circumstances.

It might seem that the only cure for polarization is a shift of public sentiment back toward moderation. The Brookings-Hoover project found, however, that changes in institutional design could reduce polarization and might, over time, lower the partisan temperature. Here are two ideas, culled from a much longer list.

Congressional redistricting

While population flows account for much of the growth in safe seats dominated by strong partisans, recent studies indicate that gerrymanders account for 10 to 36 percent of the reduction in competitive congressional districts since 1982. This is not a trivial effect.

Few Western democracies draw up their parliamentary districts in so patently politicized a fashion as do U.S. state legislatures. Parliamentary electoral commissions, operating independently and charged with making reasonably objective determinations, are the preferred model abroad.

Given the Supreme Court’s reluctance to enter the thicket of redistricting controversies, any changes will be up to state governments. In recent years, voter initiatives and referenda in four states—Washington, Idaho, Alaska and Arizona—have established nonpartisan or bipartisan redistricting commissions. These commissions struggle with a complicated riddle: how to enhance competitiveness while respecting other parameters, such as geographic compactness, jurisdictional boundaries, and the desire to consolidate “communities of interest.” Iowa’s approach, where a nonpartisan legislative staff has the last word, is often cited as a model but may be hard to export to states with more demographic diversity and complex political cultures. Arizona has managed to fashion some workable, empirically based standards that are yielding more heterogeneous districts and more competitive elections.

Incentives to participate

Another depolarizing reform would promote the participation of less ideologically committed voters in the electoral process. Some observers do not view the asymmetric power of passionate partisans in U.S. elections as a cause for concern: Why shouldn’t political decisions be made by the citizens who care most about them? Aren’t those who care also better informed? And isn’t their intensive involvement an indication that the outcome of the election affects their interests more than it affects the interests of the non-voters? While this argument has surface plausibility, it is not compelling. Although passionate partisanship infuses the system with energy, it erects road-blocks to problem-solving. Many committed partisans prefer gridlock to compromise, and gridlock is no formula for effective governance.

To broaden the political participation of less partisan citizens, who tend to be more weakly connected to the political system, several major democracies have made voting mandatory. Australia, for one, has compulsory voting; it sets small fines for non-voting that escalate for recidivism, with remarkable results. The turnout rate in Australia tops 95 percent, and citizens regard voting as a civic obligation. Near-universal voting raises the possibility that a bulge of casual voters, with little understanding of the issues and candidates, can muddy the waters by voting on non-substantive criteria, such as the order in which candidates’ names appear on the ballot. The inevitable presence of some such “donkey voters,” as they are called in Australia, does not appear to have badly marred the democratic process in that country.

Indeed, the civic benefits of higher turnouts appear to outweigh the “donkey” effect. Candidates for the Australian Parliament have gained an added incentive to appeal broadly beyond their partisan bases. One wonders whether members of Congress here in the United States, if subjected to wider suffrage, might also spend less time transfixed by symbolic issues that are primarily objects of partisan fascination, and more time coming to terms with the nation’s larger needs. At least campaigns continually tossing red meat to the party faithful might become a little less pervasive.

The United States is not Australia, of course. Although both are federal systems, the U.S. Constitution confers on state governments much more extensive control over voting procedures. While it might not be flatly unconstitutional to mandate voting nationwide, it would surely chafe with American custom and provoke opposition in many states. Federalism American-style also has some unique advantages, including its tradition of using states as “laboratories of democracy” that test reform proposals before they are elevated to consideration at the national level. If a few states experiment with compulsory voting and demonstrate its democracy- enriching potential, they might, in this way, smooth the path to national consideration.  

Conclusion

In challenging times, political leaders undertake institutional reform, not because they want to, but because they must. Our own era—a period of profound economic crisis—is no exception. Even in circumstances of deep political polarization, both political parties have accepted the need to restructure our system of financial regulation.

As well, recognition is growing that we face three key challenges—a fiscal deficit, a savings deficit and an investment deficit—that have eluded control by existing institutions and, unless checked, will impede long-term economic growth. The question is whether we will be able to adopt the needed changes in an atmosphere of reflection and deliberation, or whether we will delay until a worse crisis compels us to act.

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Policy Brief #173

America needs to transform its energy system, and the Great Lakes region (including Minnesota, Wisconsin, Iowa, Missouri, Illinois, Indiana, Ohio, Michigan, Kentucky, West Virginia, western Pennsylvania and western New York) possesses many of the needed innovation assets. For that reason, the federal government should leverage this troubled region’s research and engineering strengths by launching a region-wide network of collaborative, high intensity energy research and innovation centers.

Currently, U.S. energy innovation efforts remain insufficient to ensure the development and deployment of clean energy technologies and processes. Such deployment is impeded by multiple market problems that lead private firms to under-invest and to focus on short-term, low-risk research and product development. Federal energy efforts—let alone state and local ones—remain too small and too poorly organized to deliver the needed breakthroughs. A new approach is essential.

	RECOMMENDATIONS
	The federal government should systematically accelerate national clean energy innovation by launching a series of “themed” research and commercialization centers strategically situated to draw on the Midwest’s rich complex of strong public universities, national and corporate research laboratories, and top-flight science and engineering talent. Organized around existing capacities in a hub-spoke structure that links fundamental science with innovation and commercialization, these research centers would engage universities, industries and labs to work on specific issues that would enable rapid deployment of new technologies to the marketplace. Along the way, they might well begin to transform a struggling region’s ailing economy. Roughly six compelling innovation centers could reasonably be organized in the Great Lakes states with total annual funding between $1 billion and $2 billion. To achieve this broad goal, the federal government should: Increase energy research funding overall. Adopt more comprehensive approaches to research and development (R&D) that address and link multiple aspects of a specific problem, such as transportation. Leverage existing regional research, workforce, entrepreneurial and industrial assets.

America needs to transform its energy system in order to create a more competitive “next economy” that is at once export-oriented, lower-carbon and innovation-driven. Meanwhile, the Great Lakes region possesses what may be the nation’s richest complex of innovation strengths—research universities, national and corporate research labs, and top-flight science and engineering talent. Given those realities, a partnership should be forged between the nation’s needs and a struggling region’s assets.

To that end, we propose that the federal government launch a distributed network of federally funded, commercialization-oriented, sustainable energy research and innovation centers, to be located in the Great Lakes region. These regional centers would combine aspects of the “discovery innovation institutes” proposed by the National Academy of Engineering and the Metropolitan Policy Program (as articulated in “Energy Discovery-Innovation Institutes: A Step toward America’s Energy Sustainability”); the “energy innovation hubs” created by the Department of Energy (DOE); and the agricultural experiment station/cooperative extension model of the land-grant universities.

In the spirit of the earlier land-grant paradigm, this network would involve the region’s research universities and national labs and engage strong participation by industry, entrepreneurs and investors, as well as by state and local governments. In response to local needs and capacities, each center could have a different theme, though all would conduct the kinds of focused translational research necessary to move fundamental scientific discoveries toward commercialization and deployment.

The impact could be transformational. If built out, university-industry-government partnerships would emerge at an unprecedented scale. At a minimum, populating auto country with an array of breakthrough-seeking, high-intensity research centers would stage a useful experiment in linking national leadership and local capacities to lead the region—and the nation—toward a more prosperous future.

The Great Lakes Energy System: Predicaments and Possibilities

The Great Lakes region lies at the center of the nation’s industrial and energy system trials and possibilities. No region has suffered more from the struggles of America’s manufacturing sector and faltering auto and steel industries, as indicated in a new Metropolitan Policy Program report entitled “The Next Economy: Rebuilding Auto Communities and Older Industrial Metros in the Great Lakes Region.”

The region also lies at ground zero of the nation’s need to “green” U.S. industry to boost national economic competitiveness, tackle climate change and improve energy security. Heavily invested in manufacturing metals, chemicals, glass and automobiles, as well as in petroleum refining, the Great Lakes states account for nearly one-third of all U.S. industrial carbon emissions.

And yet, the Great Lakes region possesses significant assets and capacities that hold promise for regional renewal as the “next economy” comes into view. The Midwest’s manufacturing communities retain the strong educational and medical institutions, advanced manufacturing prowess, skills base and other assets essential to helping the nation move toward and successfully compete in the 21st century’s export-oriented, lower-carbon, innovation-fueled economy.

Most notably, the region has an impressive array of innovation-related strengths in the one field essential to our nation’s future—energy. These include:

• Recognized leadership in R&D. The Great Lakes region accounts for 33 percent of all academic and 30 percent of all industry R&D performed in the United States.
• Strength and specialization in energy, science and engineering. In FY 2006, the Department of Energy sent 26 percent of its federal R&D obligations to the Great Lakes states and is the second largest federal funder of industrial R&D in the region. Also in 2006, the National Science Foundation sent 30 percent of its R&D obligations there.
• Existing clean energy research investments and assets. The University of Illinois is a key research partner in the BP-funded, $500 million Energy Biosciences Institute, which aims to prototype new plants as alternative fuel sources. Toledo already boasts a growing solar industry cluster; Dow Corning’s Michigan facilities produce leading silicon and silicone-based technology innovations; and the Solar Energy Laboratory at the University of Wisconsin-Madison, the oldest of its kind in the world, has significant proficiency in developing practical uses for solar energy. Finally, the region is home to the largest U.S. nuclear utility (Exelon), the nation’s largest concentration of nuclear plants and some of the country’s leading university programs in nuclear engineering.
• Industry potential relevant to clean energy. Given their existing technological specializations, Midwestern industries have the potential to excel in the research and manufacture of sophisticated components required for clean energy, such as those used in advanced nuclear technologies, precision wind turbines and complex photovoltaics.
• Breadth in energy innovation endeavors and resources. In addition to universities and industry, the region’s research laboratories specialize in areas of great relevance to our national energy challenges, including the work on energy storage systems and fuel and engine efficiency taking place at Argonne National Laboratory, research in high-energy physics at the Fermi National Accelerator Laboratory, and the work on bioenergy feedstocks, processing technologies and fuels occurring at the DOE-funded Great Lakes BioEnergy Research Center (GLBRC).
• Regional culture of collaboration. Finally, the universities of the Great Lakes area have a strong history of collaboration both among themselves and with industry, given their origins in the federal land-grant compact of market and social engagement. GLBRC—one of the nation’s three competitively awarded DOE Bioenergy Centers—epitomizes the region’s ability to align academia, industry and government around a single mission. Another example is the NSF-supported Blue Waters Project. This partnership between IBM and the universities and research institutions in the Great Lakes Consortium for Petascale Computation is building the world’s fastest computer for scientific work—a critical tool for advancing smart energy grids and transportation systems.

In short, the Great Lakes states and metropolitan areas—economically troubled and carbon-reliant as they are—have capabilities that could contribute to their own transformation and that of the nation, if the right policies and investments were in place.

Remaking America’s Energy System within a Federal Policy Framework

America as a whole, meanwhile, needs to overcome the massive sustainability and security challenges that plague the nation’s energy production and delivery system. Transformational innovation and commercialization will be required to address these challenges and accelerate the process of reducing the economy’s carbon intensity.

Despite the urgency of these challenges, however, a welter of market problems currently impedes decarbonization and limits innovation. First, energy prices have generally remained too low to provide incentives for companies to commit to clean and efficient energy technologies and processes over the long haul. Second, many of the benefits of longrange innovative activity accrue to parties other than those who make investments. As a result, individual firms tend to under-invest and to focus on short-term, low-risk research and product development. Third, uncertainty and lack of information about relevant market and policy conditions and the potential benefits of new energy technologies and processes may be further delaying innovation. Fourth, the innovation benefits that derive from geographically clustering related industries (which for many years worked so well for the auto industry) have yet to be fully realized for next-generation energy enterprises. Instead, these innovations often are isolated in secure laboratories. Finally, state and local governments—burdened with budgetary pressures—are not likely to fill gaps in energy innovation investment any time soon.

As a result, the research intensity—and so the innovation intensity—of the energy sector remains woefully insufficient, as pointed out in the earlier Metropolitan Policy Program paper on discovery innovation institutes. Currently, the sector devotes no more than 0.3 percent of its revenues to R&D. Such a figure lags far behind the 2.0 percent of sales committed to federal and large industrial R&D found in the health care sector, the 2.4 percent in agriculture, and the 10 percent in the information technology and pharmaceutical industries.

As to the national government’s efforts to respond to the nation’s energy research shortfalls, these remain equally inadequate. Three major problems loom:

The scale of federal energy research funding is insufficient. To begin with, the current federal appropriation of around $3 billion a year for nondefense energy-related R&D is simply too small. Such a figure remains well below the $8 billion (in real 2008 dollars) recorded in 1980, and represents less than a quarter of the 1980 level when measured as a share of GDP. If the federal government were to fund next-generation energy at the pace it supports advances in health care, national defense, or space exploration, the level of investment would be in the neighborhood of $20 billion to $30 billion a year.

Nor do the nation’s recent efforts to catalyze energy innovation appear sufficient. To be sure, the American Recovery and Reinvestment Act (ARRA) provided nearly $13 billion for DOE investments in advanced technology research and innovation. To date, Great Lakes states are slated to receive some 42 percent of all ARRA awards from the fossil energy R&D program and 39 percent from the Office of Science (a basic research agency widely regarded as critical for the nation’s energy future). However, ARRA was a one-time injection of monies that cannot sustain adequate federal energy R&D.

Relatedly, the Great Lakes region has done well in tapping two other relatively recent DOE programs: the Advanced Research Projects Agency–Energy (ARPA-E) and Energy Frontier Research Centers (EFRCs). Currently, Great Lakes states account for 44 and 50 percent of ARPA-E and EFRC funding. Yet, with ARPA-E focused solely on individual signature projects and EFRC on basic research, neither initiative has the scope to fully engage all of the region's innovation assets.

The character and format of federal energy R&D remain inadequate. Notwithstanding the question of scale, the character of U.S. energy innovation also remains inadequate. In this respect, the DOE national laboratories—which anchor the nation’s present energy research efforts—are poorly utilized resources. Many of these laboratories’ activities are fragmented and isolated from the private sector and its market, legal and social realities. This prevents them from successfully developing and deploying cost-competitive, multidisciplinary new energy technologies that can be easily adopted on a large scale.

For example, DOE activities continue to focus on discrete fuel sources (such as coal, oil, gas or nuclear), rather than on fully integrated end use approaches needed to realize affordable, reliable, sustainable energy. Siloed approaches simply do not work well when it comes to tackling the complexity of the nation’s real-world energy challenges. A perfect example of a complicated energy problem requiring an integrated end-use approach is transportation. Moving the nation’s transportation industry toward a clean energy infrastructure will require a multi-pronged, full systems approach. It will depend not only upon R&D in such technologies as alternative propulsion (biofuels, hydrogen, electrification) and vehicle design (power trains, robust materials, advanced computer controls) but also on far broader technology development, including that related to primary energy sources, electricity generation and transmission, and energy-efficient applications that ultimately will determine the economic viability of this important industry.

Federal programming fails to fully realize regional potential. Related to the structural problems of U.S. energy innovation efforts, finally, is a failure to fully tap or leverage critical preexisting assets within regions that could accelerate technology development and deployment. In the Great Lakes, for example, current federal policy does little to tie together the billions of dollars in science and engineering R&D conducted or available annually. This wealth is produced by the region’s academic institutions, all of the available private- and public-sector clean energy activities and financing, abundant natural resources in wind and biomass, and robust, pre-existing industrial platforms for research, next-generation manufacturing, and technology adoption and deployment. In this region and elsewhere, federal policy has yet to effectively connect researchers at different organizations, break down stovepipes between research and industry, bridge the commercialization “valley of death,” or establish mechanisms to bring federally-sponsored R&D to the marketplace quickly and smoothly.

A New Approach to Regional, Federally Supported Energy Research and Innovation

And so the federal government should systematically accelerate clean energy innovation by launching a series of regionally based Great Lakes research centers. Originally introduced in the Metropolitan Policy Program policy proposal for energy discovery-innovation institutes (or e-DIIs), a nationwide network of regional centers would link universities, research laboratories and industry to conduct translational R&D that at once addresses national energy sustainability priorities, while stimulating regional economies.

In the Great Lakes, specifically, a federal effort to “flood the zone” with a series of roughly six of these high-powered, market-focused energy centers would create a critical mass of innovation through their number, size, variety, linkages and orientation to pre-existing research institutions and industry clusters.

As envisioned here, the Great Lakes network of energy research centers would organize individual centers around themes largely determined by the private market. Based on local industry research priorities, university capabilities and the market and commercialization dynamics of various technologies, each Great Lakes research and innovation center would focus on a different problem, such as renewable energy technologies, biofuels, transportation energy, carbon-free electrical power generation, and distribution and energy efficiency. This network would accomplish several goals at once:

• Foster multidisciplinary and collaborative research partnerships. The regional centers or institutes would align the nonlinear flow of knowledge and activity across science and non-science disciplines and among companies, entrepreneurs, commercialization specialists and investors, as well as government agencies (federal, state and local) and research universities. For example, a southeastern Michigan collaboration involving the University of Michigan, Michigan State University, the University of Wisconsin and Ford, General Motors, and Dow Chemical could address the development of sustainable transportation technologies. A Chicago partnership involving Northwestern and Purdue Universities, the University of Chicago, the University of Illinois, Argonne National Lab, Exelon and Boeing could focus on sustainable electricity generation and distribution. A Columbus group including Ohio State University and Battelle Memorial Institute could address technologies for energy efficiency. Regional industry representatives would be involved from the earliest stages to define needed research, so that technology advances are relevant and any ensuing commercialization process is as successful as possible.
• Serve as a distributed “hub-spoke” network linking together campus-based, industry-based and federal laboratory-based scientists and engineers. The central “hubs” would interact with other R&D programs, centers and facilities (the “spokes”) through exchanges of participants, meetings and workshops, and advanced information and communications technology. The goals would be to limit unnecessary duplication of effort and cumbersome management bureaucracy and to enhance the coordinated pursuit of larger national goals.
• Develop and rapidly deploy highly innovative technologies to the market. Rather than aim for revenue maximization through technology transfer, the regional energy centers would be structured to maximize the volume, speed and positive societal impact of commercialization. As much as possible, the centers would work out in advance patenting and licensing rights and other intellectual property issues.Stimulate regional economic development. Like academic medical centers and agricultural experiment stations—both of which combine research, education and professional practice—these energy centers could facilitate cross-sector knowledge spillovers and innovation exchange and propel technology transfer to support clusters of start-up firms, private research organizations, suppliers, and other complementary groups and businesses—the true regional seedbeds of greater economic productivity, competitiveness and job creation.
• Build the knowledge base necessary to address the nation’s energy challenges. The regional centers would collaborate with K-12 schools, community colleges, regional universities, and workplace training initiatives to educate future scientists, engineers, innovators, and entrepreneurs and to motivate the region’s graduating students to contribute to the region’s emerging green economy.
• Complement efforts at universities and across the DOE innovation infrastructure, but be organizationally and managerially separate from either group. The regional energy centers would focus rather heavily on commercialization and deployment, adopting a collaborative translational research paradigm. Within DOE, the centers would occupy a special niche for bottom-up translational research in a suite of new, largely top-down innovation-oriented programs that aim to advance fundamental science (EFRCs), bring energy R&D to scale (Energy Innovation Hubs) and find ways to break the cost barriers of new technology (ARPA-E).

To establish and build out the institute network across the Great Lakes region, the new regional energy initiative would:

• Utilize a tiered organization and management structure. Each regional center would have a strong external advisory board representing the participating partners. In some cases, partners might play direct management roles with executive authority.
• Adopt a competitive award process with specific selection criteria. Centers would receive support through a competitive award process, with proposals evaluated by an interagency panel of peer reviewers.
• Receive as much federal funding as major DOE labs outside the Great Lakes region. Given the massive responsibilities of the proposed Great Lakes energy research centers, total federal funding for the whole network should be comparable to that of comprehensive DOE labs, such as Los Alamos, Oak Ridge and others, which have FY2010 budgets between $1 and $2 billion. Based on existing industry-university concentrations, one can envision as many as six compelling research centers in the Great Lakes region.

Conclusion

In sum, America’s national energy infrastructure—based primarily upon fossil fuels—must be updated and replaced with new technologies. At the same time, no region in the nation is better equipped to deliver the necessary innovations than is the Great Lakes area. And so this strong need and this existing capacity should be joined through an aggressive initiative to build a network of regional energy research and innovation centers. Through this intervention, the federal government could catalyze a dynamic new partnership of Midwestern businesses, research universities, federal laboratories, entrepreneurs and state and local governments to transform the nation’s carbon dependent economy, while renewing a flagging regional economy.

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Policy Brief #184

The Leahy-Smith America Invents Act (AIA) approved in September 2011 constitutes the most significant overhaul of the American patent system in decades. This policy brief examines some key patent law changes and studies mandated by the legislation, and provides recommendations for companies on successfully navigating the new landscape. [Editor's Note: the legislation was signed into law by President Obama on September 16, 2011.]

Perhaps most notably, the new law will move the United States away from a “first to invent” system and closer to the “first to file” approach used in much of the rest of the world. Other important changes include a new proceeding in the U .S. Patent and Trademark Office (PTO) for third-party challenges to the validity of a recently issued patent, an expanded mechanism for a third party to provide information to the PTO that could be used to narrow or eliminate claims in a pending patent application being prosecuted by a commercial rival, and the introduction of a new, broadly applicable patent infringement defense based on prior commercial use.

	RECOMMENDATIONS
	Under the “first to file” provision of the AIA, companies should be more careful when producing pre-filing disclosures for venues such as conferences and trade shows, with the understanding that under the AIA those disclosures may play a much larger role than in the past with respect to patentability of the associated IP.   Under the AIA, rights to an invention prior to a filing date will depend more on the history of relevant disclosures and less on nonpublic, internal company documents such as laboratory notebooks. All companies—large and small—should consider how to modify their procedures for protecting, evaluating, and filing patents on their inventions accordingly.   The AIA provides a grace period during which inventors can disclose their invention without losing the right to patent it, but leaves uncertainty regarding the definition of “disclosure”. Companies should carefully monitor case law and PTO actions that will undoubtedly help clarify this issue in the coming years.   Companies should reevaluate the extent and manner to which they use provisional patent applications to preserve IP rights.   In light of the increased number of mechanisms available to challenge the validity of pending and issued patents, companies engaged in patent prosecution should reconsider the tradeoffs of performing their own thorough prior art searches during patent prosecution. By finding and disclosing relevant prior art to the PTO, companies may reduce the likelihood that the disclosed prior art will be used successfully against them in future validity challenges.

In addition, there are several other aspects of the AIA that do not change patent law, but may have far reaching consequences. For example, an AIA mandated study by the Government Accountability Office promises to furnish vitally important information on the economic impact of patent litigation by non-practicing entities, and will almost certainly influence future patent legislation. Under the AIA, the hurdles small businesses face in protecting their patents internationally will also receive attention through a PTO study.

It will take many years to develop a mature body of case law and legal scholarship on the full impact of the AIA. What is clear today is that it will profoundly impact the ways that patents are filed, prosecuted, and litigated in the coming years. Companies and other entities that retool their patent strategies to address these changes will be in a much stronger position to maximize the value of their intellectual property (IP) portfolios.

First Inventor to File

One of the most significant components of the AIA concerns the move from a first to invent system to a first to file system. Under this provision, which takes effect 18 months after the AIA is enacted into law, an inventor may win the race to create the invention but lose the race to file the corresponding patent application, and thus lose the right to patent the invention.

However, the AIA includes an important exception in the form of a grace period allowing an inventor or others who obtained information from the inventor to make disclosures regarding the invention in advance of filing a patent application, as long as the application is filed within one year after the first disclosure. Some form of grace period has been a feature of the U.S. patent landscape since the 19th century, and allows an inventor time to examine the commercial practicability of the invention, engage in discussions with potential partners and customers and secure the resources necessary to draft a patent application.

The inclusion of both first to file language and a grace period in the new patent law creates what could amount to a hybrid between first to invent and first to file. For example, in the case of two inventors who independently disclose the same invention immediately following its conception, both the pre-AIA “first to invent” law and the post- AIA “first to file” law can favor the earlier discloser, who is by definition the earlier inventor if the disclosure is truly immediate. However, in the absence of disclosure in advance of a patent filing, pre-AIA law favors the earlier inventor, while the AIA “first to file” provision will favor the earlier filer.

As a result, under the AIA inventors and the companies that employ them must think much more carefully about how to manage pre-filing disclosures. Put simply, silence can be costly. To the extent that a company remains quiet about an invention while contemplating whether or not to pursue patent protection, it stands exposed to the possibility of losing the right to do so if a competitor files first. A company wishing to avoid this risk faces the additional challenge that the AIA does not specifically define what constitutes “disclosure” sufficient to preserve patentability. The use of provisional patent applications, which offer advantages including a more formalized way to document the dates and content of disclosures than activities such as presentations at trade shows, should also be reevaluated in light of the AIA.

Some companies may find themselves targeted by competitors’ disclosures engineered specifically to foreclose patent opportunities. To reduce vulnerability to such attacks, companies can engage in preemptive “defensive” disclosures, but must be mindful of the impacts of these disclosures on their own patent filing deadlines.

In addition, employees engaged in intellectual property creation can be made aware that there is an increased need to pursue timely steps to secure patent protection on new inventions. Internal company systems for documenting, reporting, and rewarding innovations can be modified to better match the provisions of the AIA. Companies should also consider the budgetary impact of the AIA in terms of the amount and timing of expenditures.

It is important to recognize that the AIA leaves substantial differences between the patent laws in the United States and those in other countries. For example, unlike in the United States both pre- and post-AIA, in Europe an inventor’s own public disclosures in the year prior to a patent filing can be invalidating prior art. To the extent that for financial or other reasons a company needs to defer filing a U.S. patent application to a future date, in one sense the systems have actually moved farther apart. This is due to what amounts to a newly incentivized option to buy some measure of protection in the U.S. by disclosing in advance of a filing at the cost of losing patentability in Europe. This requires careful consideration of disclosure plans.

Best Mode and Invalidity

The AIA does not alter the requirement that a patent application must “set forth the best mode contemplated by the inventor of carrying out” the invention. However, somewhat paradoxically, for proceedings commenced on or after the date of its enactment, the AIA eliminates the alleged failure to follow this requirement as grounds for asserting invalidity.

This change has the potential to alter a fundamental compact between an inventor and the government that is at the core of the patent system, which grants a patent holder the right to exclude others from practicing an invention in exchange for disclosing the best mode contemplated by the inventor. The AIA eliminates the failure to make this disclosure as grounds for asserting invalidity. Some inventors may view this as creating an incentive to intentionally withhold information on how to best carry out an invention.

Supplemental Examination

The AIA creates a new supplemental examination procedure, effective one year after enactment, allowing a patent owner to request that the PTO perform a supplemental examination to “consider, reconsider, or correct information believed to be relevant” to a patent. Subject to certain exceptions, this process can prevent a patent from being “held unenforceable on the basis of conduct” relating to this information.

The supplemental examination provision is particularly relevant to inequitable conduct allegations that are frequently raised by defendants in patent litigation. Defendants often try to identify information relating to the prosecution of patents that have been asserted against them that, in their view, indicates inequitable conduct rendering the patents unenforceable. Supplemental examination provides a way for a patent owner to preemptively attempt to inoculate a patent against such allegations.

Pre-Issuance Submissions

Beginning one year after the AIA is enacted, third parties will have the option of providing pre-issuance submissions of prior art accompanied by “a concise description of the asserted relevance of each submitted document” to the PTO in connection with a pending application. Such submissions can be used, for example, to attempt to prevent or hinder the issuance of a patent that the submitting party views as detrimental to its interests. However, to the extent that a patent examiner finds the arguments provided through a pre-issuance submission unconvincing, the resulting patent might actually be strengthened, not weakened.

Prior Commercial Use Defense to Infringement

Since 1999, alleged infringers of business method patents have had access to a “prior use” provision that can constitute a defense against infringement, provided certain conditions are met. For patents issued on or after the date of enactment of the AIA, the prior use defense can be applied, subject to certain exceptions, to patent infringement claims covering a much broader range of subject matter “consisting of a process, or consisting of a machine, manufacture, or composition of matter used in a manufacturing or other commercial process.”

Post-Grant Review Proceedings

Post-grant review proceedings are conducted through the PTO in order to reconsider alreadyissued patents, and can lead to the confirmation, cancellation, withdrawal, or modification of patent claims. T he phrase “post-grant review” is sometimes used to broadly refer to multiple types of post-grant proceedings including the ex parte and inter partes reexaminations available under pre- AIA patent law, and sometimes to more narrowly refer to a specific new review option created by the AIA (in fact, in the AIA itself the phrase is used in both the broad and narrow meanings).

Under pre-AIA patent law, a requester wishing to initiate an ex parte or inter partes reexamination provides the PTO with one or more published prior art references and an explanation why those references, in the view of the requester, raise a “substantial new question of patentability.” The PTO can either grant or deny the request; if the request is granted, an ex parte reexamination proceeds without any further input from the requester (unless the requester is the patent owner), while in an inter partes reexamination the requester participates during the reexamination process.

Both types of reexaminations have proven to be highly effective ways for third parties to challenge the validity of issued patent claims, often in tandem with or as a lower cost alternative to challenges adjudicated through the Federal court system and the International Trade Commission. According to data released by the PTO in June 2011, 92% of the requests for ex parte reexamination filed since the proceeding was introduced in the 1980s have been granted, and fewer than one quarter of patents subject to ex parte reexamination have emerged without any claim changes or cancellations. Inter partes reexamination was introduced in 1999; since then 95% of inter partes reexamination requests have been granted, and only 13% of patents subject to inter partes reexamination have survived with all claims confirmed.

The AIA leaves ex parte reexamination in place, but a year after enactment will replace inter partes reexaminations with “inter partes review” proceedings adjudicated by a newly renamed Patent Trial and Appeal Board within the PTO. The pre-AIA threshold to grant an inter partes reexamination of a “substantial new question of patentability” will be replaced with a higher threshold requiring that the PTO find a “reasonable likelihood that the petitioner would prevail with respect to at least one of the claims challenged in the petition.” This higher standard will also be applied to inter partes reexaminations filed during the transition period immediately following enactment of the AIA and preceding the shift to inter partes review. Inter partes review requests must be filed no earlier than nine months (and in some cases longer) after the grant or reissue of the patent being challenged.

Additionally, the AIA creates a new “post-grant review” process through which a petitioner who is not the patent owner can request the cancellation as invalid of one or more claims of a patent granted or reissued within the previous nine months. The PTO can authorize a post-grant review if the information presented by the petitioner, “if not rebutted, would demonstrate that it is more likely than not that at least one of the claims challenged in the petition is unpatentable.” Under the AIA this threshold can be satisfied not only using traditional invalidity arguments based on settled law, but also by a petition that raises “a novel or unsettled legal question that is important to other patents or patent applications.” This language amounts to an invitation to address “novel or unsettled” legal questions through the PTO, raising a number of issues relating to respective roles the courts and the PTO will play in resolving them.

For companies engaged in or threatened with patent litigation or those that simply want to launch a pre-emptive strike at patents held by a competitor, post-grant review introduces a new way to challenge patents. The AIA contains estoppel and other provisions intended to prevent a requester from having two bites at the apple by challenging a claim in both a PTO post-grant (or inter partes) review and a civil action or International Trade Commission proceeding. However, in some circumstances these provisions may turn out to be largely toothless, since patent cases often involve multiple defendants who form joint defense groups and engage in coordinated attacks on patent validity. There is nothing in the AIA preventing one defendant from challenging claim validity through a post-grant or inter partes review and another from simultaneously or later asserting invalidity of the same claims in the federal court system or at the International Trade Commission.

The AIA also expressly provides that, starting one year after enactment, statements by a patent owner filed in a federal court or with the PTO regarding claim scope can be cited to the PTO for consideration in ex parte, inter partes, and post-grant review proceedings to determine claim meaning.

Other Provisions

In addition to codifying many changes to patent law, including those described above, the AIA contains other provisions that will likely have a significant impact on the operation of the PTO and on future patent legislation. Several of these provisions are discussed below.

Fee Diversion

One of the most controversial aspects of the patent reform debate has pertained to the practice of fee diversion, which arises because the PTO takes in an amount in fees that exceeds its appropriation. The Senate version (S. 23) of the AIA passed in March 2011 provided for the creation of a fund that would have allowed the PTO roll over excess funds into future fiscal years. However, in the House version (H.R. 1249) passed in June 2011 that became the template for the final legislation, this provision was removed and replaced with a newly established “Patent and Trademark Fee Reserve Fund” to be held in the treasury and into which excess fees will be deposited. This approach does not cleanly put the fee diversion issue to rest, and the details of how the reserve fund will be managed in future years remain unclear.

Studies Mandated by the AIA

The AIA mandates several studies, including one to be performed by the Government Accountability Office to examine the “consequences of litigation by non-practicing entities, or by patent assertion entities,” to gather data, among other things, on the volume of litigation, the number of cases found to be without merit, the costs to patent holders, licensees, licensors, and inventors, the economic impact of this litigation, and the “benefit to commerce, if any, supplied by non-practicing entities or patent assertion entities that prosecute such litigation.”

“Non-practicing entities” and “patent assertion entities” are terms that are sometimes used to describe companies that have little or no business other than the assertion of patents. Patent litigation involving these entities has grown significantly in recent years, in large part due to the potential for large judgments and settlements. The GAO study provides an opportunity for an unbiased examination of a significant aspect of the litigation environment, and is likely to produce information that will be valuable in drafting future patent legislation.

The AIA also mandates that the PTO perform a study on international patent protections for small businesses. T he financial burden of obtaining international patent protection is particularly heavy for small companies due to the combined costs of performing many different country-specific filings. As a result, many small companies either avoid foreign filings altogether, or perform foreign filings only for a small subset set of countries and only for the patents that they believe to be the most valuable. A goal of the AIA-mandated study is to determine whether to recommend establishing a loan or grant program to help small businesses defray the costs associated with international patent protection.

It is likely the study will conclude that such a program would be beneficial to small businesses, but it is just as likely that implementing it will prove to be extremely difficult in the current budgetary environment. However, the study may influence future patent legislation in the United States and abroad, and may be useful in multilateral discussions regarding international patent protection.

Conclusion

The AIA will reshape how United States patents are obtained, challenged, and valued in acquisition, licensing, and litigation settlement discussions. Companies that overhaul their intellectual property strategies in light of the provisions of the AIA will be in a better position to maximize the value of their patent portfolios and to strengthen their options in patent litigation matters.

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June’s jobs gains, released this morning, show that 287,000 new jobs were added in June, an impressive rebound after only 11,000 new jobs were added in May (revised down from from 38,000 at the time of the release).

This year’s monthly job gains and losses can indicate how the economy is doing once they are corrected to account for the pattern we already expect in a process called seasonal adjustment. The approach for this seasonal adjustment that is presently used by the Bureau of Labor Statistics (BLS) puts very heavy weight on the current and last two years of data in assessing what are the typical patterns for each month.

In my paper “Unseasonal Seasonals?” I argue that a longer window should be used to estimate seasonal effects. I found that using a different seasonal filter, known as the 3x9 filter, produces better results and more accurate forecasts by emphasizing more years of data. The 3x9 filter spreads weight over the most recent six years in estimating seasonal patterns, which makes them more stable over time than in the current BLS seasonal adjustment method.

I calculate the month-over-month change in total nonfarm payrolls, seasonally adjusted by the 3x9 filter, for the most recent month. The corresponding data as published by the BLS are shown for comparison purposes. According to the alternative seasonal adjustment, the economy added 286,000 jobs in June (column Wright SA), almost identical to the official BLS total of 287,000 (column BLS Official).

Data updates released today for prior months also reveal some differences between my figure and the official jobs gains from prior months. The official BLS numbers for May were revised down from 38,000 new jobs to a dismal 11,000. My alternative adjustment shows that the economy actually lost 6,000 jobs in May, down from 17,000 jobs gained at the time of the release. [i] The discrepancies between the two series are explained in my paper.

In addition to seasonal effects, abnormal weather can also affect month-to-month fluctuations in job growth. In my paper “Weather-Adjusting Economic Data” I and my coauthor Michael Boldin implement a statistical methodology for adjusting employment data for the effects of deviations in weather from seasonal norms. This is distinct from seasonal adjustment, which only controls for the normal variation in weather across the year. We use several indicators of weather, including temperature and snowfall.

We calculate that weather in June brought up the total by 25,000 jobs (column Weather Effect), but this should be considered a transient effect. Our weather-adjusted total, therefore, is 262,000 jobs added for June (column Boldin-Wright SWA). This is not surprising, given that weather in June was in line with seasonal norms.

It’s good to see the jobs numbers rebounding this month. The May number was somewhat affected by the Verizon strike. Also, it is important to remember that pure sampling error in any one month’s data is large, and that could explain part of the weak employment report for May. Averaging over the last three months, employment is expanding by about 150,000 jobs per month—a healthy pace, although a bit of a step down from last year.

a. Applies a longer window estimate of seasonal effects (see Wright 2013). The June 2015 to May 2016 values in this column have been corrected to remove a coding error that affected the previously reported values.

b. Includes seasonal and weather adjustments, where seasonal adjustments are estimated using the BLS window specifications (see Boldin & Wright 2015). The incremental weather effect in the last column is the BLS official number less the SWA number.

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[i] Note that, due to a small coding error, my alternative seasonal adjustment for May, at the time of the release, should have been 17,000 new jobs, not -4,000, as was reported in my previous post. In addition to the underlying data revisions, and correcting for this error, the revised alternative seasonal adjustment for May is -6,000 jobs added (second row of column Wright SA).

       

       

       

As I anticipated in my post on Tuesday, the Hong Kong government on Wednesday announced the details for the 2017 election of the Chief Executive (CE). Based on press commentary from China, it is clear that the PRC government, which has sovereignty over Hong Kong, approves the package. But to understand the implications for democracy in Hong Kong, it is important to look at the details of the proposal.

Since Hong Kong became a special administrative region of China in 1997, the CE has been chosen by an election committee of between 800 and 1,200 individuals. Beijing had promised that starting in 2017 the CE would be elected by the voters of Hong Kong through universal suffrage. Yesterday’s proposal is the latest step in a transition process toward that system. (For all of the recommendations, see the speech of Chief Secretary Carrie Lam to the Legislative Council.) As I outlined in Tuesday’s post, the principal point of controversy for more than a year has been Beijing’s insistence that a nominating committee choose who gets to stand for election. Hong Kong’s democratic camp believes that the nominating committee will give China an opportunity to “screen out” individuals it does not like.

The most prominent element of the Hong Kong government’s proposal yesterday is a recommendation on the procedural mechanism by which the Nominating Committee (NC) would review candidates. This was important for two reasons. One, under the plan the NC will have the authority to pick two or three final candidates to actually run in the election. Two, Mrs. Lam made clear that that the NC’s membership would be similar to the 1,200-person election committee that has picked the CE up until now and is weighted in favor of people who are biased toward Beijing.

Thus, who the NC considers before making its final nominations becomes critical. That will determine whether the election will provide a choice between the majority who have long favored a quick transition to democracy, and those who have preferred to move slower; and also between those who believe that the current economic system benefits only the rich and should be reformed, and those who are happy with current policies.

The proposed procedural mechanism mandates that any individual who can get recommendations from one-tenth to one-twentieth of the NC will be a “potential candidate” and have the opportunity to articulate his/her policy views to the NC and the public in a transparent way. In effect, this means that the NC will likely consider between five to ten individuals for final nomination. And because pan-democrats will have be at least a minority of the NC membership, as they do in the election committee, they will be able to recommend at least one democrat as a potential candidate. That in turn creates the possibility that a democrat could become a final nominee and compete to become CE. In that case, voters who have supported democracy and believe current economic policies are flawed would have a candidate who shares their general outlook. This mechanism would seem to be consistent with what the spokesman of the U.S. Consulate-General said earlier today: “The legitimacy of the chief executive will be greatly enhanced if the chief executive is selected through universal suffrage and Hong Kong’s residents have a meaningful choice of candidates.”

Let me be clear: the pan-democrats do not like this proposal. They do not like a mechanism that amounts to screening by China, and this one certainly opens a backdoor for Beijing to veto candidates it doesn’t like. In addition, the pan-democrats would like to have a promise from Beijing that this is not the end of the reform process when it comes to electing the CE, but Mrs. Lam gave no hope on that score, even though she said future circumstances might require more change.

The pan-democrats were likely unhappy about the government’s refusal to propose changes on two specific issues. Both concern the sub-sectors that will make up the NC, which will be copied from the current election committee. These subsectors represent different parts of the Hong Kong community, but the balance of voting power favors subsectors that 1) represent various business interests, 2) support Beijing on most issues, and 3) are afraid of populist movements. Back in December, the government floated the idea of shifting the balance of power among the existing subsectors so that under-represented groups got more votes, but on one condition, that the existing subsectors agreed. In the end, no change was made here, perhaps due to the stated reasons that there was no social consensus to make this change and that doing so would only create more political controversy. The more likely reason is that the subsectors that stood to lose their relative power were not willing to have their oxen gored.

The second issue had to do with “corporate voting” within subsectors. In some subsectors the constituent members decide their choices based on the preference of the leader of the member organizations. For example, in a subsector made up of commercial firms, the CEO of each member firm decides how to cast the firm’s vote. The alternative would be to have a larger number of people associated with the firm contribute to the decision, up to all the employees. As a matter of principle, the pan-democratic camp has long called for an end to corporate voting, and while there was an opportunity to do so on this occasion, the government didn’t take it.

So, the pan-democratic bloc in the Legislative Council walked out during Mrs. Lam’s presentation to the Legislative Council and has vowed to vote against this proposal. And if all of them did vote against, that would kill the proposal, because it must pass the Legislative Council by a two-thirds margin and the establishment caucus does not have enough votes on its own. On the other hand, Beijing and the Hong Kong government do not need to win over the whole of the disparate democratic camp. They just have to peel off four opposition legislators to secure the necessary majority. Presumably these would be more moderate politicians who might conclude that the reform package is “good enough” compared to the alternative. That is, Beijing and the Hong Kong government say that if the package is vetoed, election of the CE would revert to the 1,200-member election committee, delaying a one-person, one-vote election for some time. The danger for these moderates in voting for the proposal is that they will be excoriated by their colleagues for defecting and betraying principles, to the point of facing a challenge from within their camp in the next legislative election.

Hong Kong public opinion and legislators in particular have to face a couple of critical questions. The first is whether a system that produces a contest between at least one establishment candidate and one democratic candidate is indeed “good enough.” The recommended system could be improved upon in several ways, of that there is no doubt. On the other hand, if this system works as optimists think it could, then Hong Kong voters will have a real choice in picking their leader, for the first time in history.

Second, would this mechanism indeed produce an election contest between at least one establishment candidate and one democratic candidate? Is there a way in which members of the establishment could nominally consider a democratic potential candidate and then deny him or her the nomination? In fact there is. The government’s proposal specifies that after all the potential candidates have been heard from, the NC members then select two or three nominees. Each NC members get two votes, and nomination requires 50 percent. So establishment members of the NC, after going through the motions of considering a pan-democrat, could simply not give that person the majority needed for nomination. The procedure and their numerical majority give them the power to do so.

But is such a bait-and-switch tactic wise politically? If this mechanism is sold both to the public and moderate democrats as a “good enough” way to produce a competitive election but the result is a contest between two individuals associated with the establishment and the status quo, how much legitimacy will the process itself and the person ultimately selected have? Will the polarization, obstructionism, and protests that have come to mark Hong Kong politics subside or grow? Will Beijing face more stability in Hong Kong or less?

In short, does this mechanism not put the establishment in a position that it almost has to nominate a moderate democrat if it is to enjoy broad community respect? And if the establishment is being challenged to do the right thing, so are the democrats. As imperfect as they see the current package, if it creates a good enough chance of electing one of their own, would the democrats not lose community respect if they reject it and deny voters a choice (they already know that Beijing and others will blame them for reverting to the old system)?

This dual challenge creates the possibility of a compromise. The missing ingredient, of course, is the mistrust that each camp has about the intentions of the other, mistrust born of the decades-long struggle over whether Hong Kong should have a genuinely democratic system. Providing that ingredient will be a challenge itself. 

      

I was honored today to speak at the kick off meeting of the new ReFormers Caucus. This group of over 100 former members of the U.S. Senate, the House, and governors of both parties, has come together to fight for meaningful campaign finance reform. In the bipartisan spirit of the caucus, I shared speaking duties with Professor Richard Painter, who was the Bush administration ethics czar and my predecessor before I had a similar role in the Obama White House. 

As I told the distinguished audience of ReFormers (get the pun?) gathered over lunch on Capitol Hill, I wish they had existed when in my Obama administration role I was working for the passage of the Disclose Act. That bill would have brought true transparency to the post-Citizens United campaign finance system, yet it failed by just one vote in Congress.  But it is not too late for Americans, working together, to secure enhanced transparency and other campaign finance changes that are desperately needed.  Momentum is building, with increasing levels of public outrage, as reflected in state and local referenda passing in Maine, Seattle and San Francisco just this week, and much more to come at the federal, state and local level.

       

       

       

       

       

Saudi deputy crown prince and defense minister Mohammad bin Salman is just wrapping up a heavily hyped visit to Washington, aimed at reinforcing the kingdom’s partnership with the United States. Recent years have frayed what is traditionally the central strategic relationship for Riyadh, principally over the Obama administration’s nuclear diplomacy with Iran.

Since the conclusion of the Iranian nuclear deal last July, the perennial antagonism between Riyadh and Tehran has reached a dangerous pitch, fueling the violence that rages in Syria, Iraq, and Yemen and the undercurrent of instability that saturates the region. And the fallout of their rivalry has left its mark well beyond the boundaries of the Gulf, exacerbating volatile energy markets and, by extension, the global economy. 

Within OPEC, Riyadh and Tehran are eyeing each other warily, and their continuing differences torpedoed a proposed ceiling on oil production at OPEC’s latest meeting. The outcome was not surprising; a similar effort to agree on a production freeze between the group and a handful of non-OPEC producers fizzled in April. In the meantime, any incentives for drastic measures to address soft oil prices have abated as oil prices creep back up to approximately $50 a barrel. 

Iran and Saudi Arabia have plenty of reasons to continue pumping for the foreseeable future. Since the lifting of nuclear-related sanctions in January, Iranian leaders have been determined to make up for lost time and lost revenues, already defying expectations by quickly raising production to levels that hadn’t been reached since November 2011 and aggressively cutting prices in hopes of winning back its pre-sanctions export market. 

The centrality of oil to the legitimacy and autonomy of both regimes means that these plans are little more than publicity stunts.

Meanwhile, Saudi Arabia appears prepared to continue pumping at record-high levels, part of a larger strategy aimed at maintaining market share and driving down non-OPEC production. The two states’ economic incentives are compounded by their fierce geostrategic and sectarian rivalry, which has intensified, as evidenced by the standoff over Iranian participation in the annual pilgrimage to Mecca.

But even as the two states duel over oil production and prices, both Saudi Arabia and Iran are conspicuously planning for a post-oil future. Leaders in both countries have decreed an end to the era of oil dependency, endorsing ambitious blueprints for restructuring their economies that—if implemented—would ultimately transform state, society, and the wider region. The centrality of oil to the legitimacy and autonomy of both regimes means that these plans are little more than publicity stunts. Still, just imagine for a moment what it would mean for Iran, Saudi Arabia, and the Middle East if these grandiose agendas were adopted.

Competing and complementary visions

Tehran’s plan actually dates back more than a decade, with the 2005 release of its “20 Year Perspective” (sometimes called “Vision 2025”). The plan laid out extravagant expectations: rapid growth and job creation, diversification away from oil, a knowledge-based economy. Intervening developments—sanctions that targeted Iran’s oil exports and helped expand non-oil trade—have only bolstered the rhetorical commitment of Iran’s supreme leader, Ayatollah Ali Khamenei, to a “resistance economy” in which oil exports constitute a minor part.

“One of our most serious losses is dependence on oil,” Khamenei bemoaned in a 2014 speech. “I am not saying that oil should not be used. Rather, I am saying that we should reduce our dependence on selling crude oil as much as we can.” 

Not to be outdone, Saudi Deputy Crown Prince Salman announced Saudi “Vision 2030,” to address what he described as “an addiction to oil.” The plan, which has met with equal doses of fanfare and skepticism since its announcement last month, aims to create a “thriving economy” and end Saudi dependence on oil revenues by 2020. Vision 2030 includes provisions to sell off a small stake in the kingdom’s state oil company, Saudi Aramco, and create the world’s largest sovereign wealth fund to manage the country’s income, as well as goals of creating 450,000 new private sector jobs, cutting public sector wages, and tripling the country’s non-oil exports all within the same abbreviated time frame.

Jeopardizing domestic stability

There is one hitch, however: these aspirations, though laudable, are preposterously unmoored from current political and economic exigencies. The institutions of governance and the structure of power in resource-rich states such as Saudi Arabia and Iran are organized around the state’s role as purveyors of vital social and economic goods. Riyadh and Tehran distribute cash handouts, provide jobs in already-bloated state bureaucracies, and levy few taxes. Diversifying away from reliance on oil would essentially require Riyadh and Tehran to radically curtail this distributive role, inviting historic social and political changes that could ultimately compromise regime ideology and weaken state legitimacy. 

[T]hese aspirations, though laudable, are preposterously unmoored from current political and economic exigencies.

In Saudi Arabia, the supply of these benefits is central to the monarchy’s legitimacy. To diversify away from oil, which currently accounts for over 70 percent of government revenues, Riyadh would have to drastically cut spending, far more than it already has. Not only would this further slash subsidies and hike fees, it would also effectively force Saudi workers—two-thirds of whom are employed by the state—to take up private sector jobs, 80 percent of which are currently staffed by expatriates. To accomplish this transition would require fundamental changes to the incentive structure for the Saudi labor force: a much broader willingness to accept low-skill, low-wage jobs, as well as the requisite improvements in education and productivity to support larger numbers of Saudi nationals moving into private sector positions.

For the Saudi economy to be truly competitive, Riyadh would have to initiate dramatic changes to a central component of the Saudi social compact—women’s rights and freedoms. The Vision 2030 document boasts that over 50 percent of Saudi university graduates are women and pledges to “continue to develop their talents, invest in their productive capabilities and enable them to strengthen their future and contribute to the development of our society and economy.” 

But the domestic Saudi labor force is overwhelmingly male, and even the plan’s modest aspirations to raise female participation in the workforce from 22 to 30 percent are likely to run into logistical and social obstacles. Shortly after announcing Vision 2030, Deputy Crown Prince Salman said Saudi Arabia is not yet ready to let women drive. A diversified economy will not emerge in the kind of constricted social environment mandated by the Saudi interpretation of sharia (Islamic law). 

Iran’s Islamic Republic doesn’t have the same degree of gender segregation, but Iran’s official interpretation of Islam has still constrained female participation in the workforce. Iran employs an equally low percentage of women—according to a 2014 U.N. report around 16 percent—and women’s unemployment is more than double that of men (nearly 20 percent).

A Saudi man walks past the logo of Vision 2030 after a news conference in Jeddah, Saudi Arabia June 7, 2016. Photo credit: Reuters/Faisal Al Nasser.

The bigger challenge for Iran will be truly opening up its economy to foreign direct investment. This remains hotly contested among the leadership, even in the aftermath of the nuclear agreement and the lifting of related sanctions. While there is some consensus around the need for foreign capital and technology, hardliners including Khamenei are determined to insulate Iran from any accompanying cultural influence and dependency. As the supreme leader recently inveighed, the global economy is “a plan and system that has been devised mainly by Zionist capitalists and some non-Zionists with the purpose of usurping the economic resources of the whole world...If a country merges its economy with the global economy, this is not a source of pride, rather it is a loss and a defeat!”

This deeply-rooted paranoia has provided a convenient platform for the Islamic Republic to galvanize citizens’ loyalty to the state and hostility to outside interference. And it also inhibits the liberalization that makes foreign investment possible: measures to enhance transparency and security, develop more attractive legal and fiscal frameworks, shrink the role of the state, and undertake an array of other structural reforms. Without these measures, Tehran will struggle to capitalize on its extraordinary reengagement with the world. 

While Saudi Arabia has maintained a more consistent and mutually beneficial pattern of foreign investment, its leadership too will have to revamp its approach if it is to broaden its economic base. For Riyadh, the challenge is less one of attracting foreign capital than of developing a sustainable influx of technology and expertise to develop sectors other than energy. The kingdom will also have to overcome serious regulatory hurdles and a proclivity for mammoth (and often white elephant) projects.

Compromising regional clout

Riyadh and Tehran will need to balance their economic aspirations and their approach to the region, too. Historically, their role in global energy markets has largely shielded both states from the fallout of regional instability. The world’s need for reliable oil at reasonable prices has inculcated the commitment of outside powers to secure transportation of resources and considerable autonomy for Riyadh and Tehran from the implications of their own policies. 

As a result, Saudi Arabia and Iran can fund nefarious activity across the region, violate the civil and human rights of their citizens and other residents, and carry out belligerent foreign policies without severe repercussions for their oil revenues. Only in the past five years has Tehran seen the limits of the world’s reluctance to jeopardize its investment with a major oil exporter; and the recent reversal of the U.N. condemnation regarding the Saudi-led coalition in Yemen demonstrates that Riyadh remains insulated.

Saudi Arabia and Iran can fund nefarious activity across the region, violate the civil and human rights of their citizens and other residents, and carry out belligerent foreign policies without severe repercussions for their oil revenues.

Regional developments make the prospect of economic diversification even less likely, as sensitivity to such developments will only increase if either country successfully develops its non-oil sectors. At the same time, regional stability is a basic prerequisite for economic diversification. Robust growth and good governance throughout the Middle East would provide the optimal context for the economic transformation of Iran and Saudi Arabia, since the marketplace for their non-oil exports is concentrated in the immediate neighborhood. But such transformation would require both countries to put economic priorities that serve their general populations above the ideological and religious agendas—supported by oil rents—that propel their regional and international influence and that provide a large portion of their autonomy in foreign policymaking. 

Technocrats in both countries understand this intuitively. At a 2015 conference on Iran’s economy, President Hassan Rouhani wondered “How long can the economy pay subsidies to politics?” He added that the country’s economy “pays subsidies both to foreign policy and domestic policy. Let us try the other way round for a decade and pay subsidies from the domestic and foreign policy to the economy to see [what] the lives and incomes of people and the employment of the youth will be like.” The problem, of course, is political will: neither country is prepared to elevate the interests of its people over the demands of ideology.

Imagining an unlikely future

Can either Iran or Saudi Arabia really kick the oil habit? It seems exceptionally unlikely. Even as Khamenei extols the need for inward-focused development, Tehran is racing to expand crude output level to four million barrels per day by March 2017. 

Oil enabled the creation of the modern Middle Eastern state and fueled the rise of both countries to regional predominance. Oil is a vector for their regional rivalry, and it provides prestige and funds to be used in other arenas of competition. A genuine diversification of the two largest economies in the Middle East and North Africa would jeopardize their revenue streams and domestic legitimacy, as well as their efforts to assert their primacy across the Islamic world.

[N]either country is prepared to elevate the interests of its people over the demands of ideology.

“All success stories start with a vision,” Deputy Crown Prince Salman is quoted as saying on the Vision 2030 website. But vision is insufficient to bridge the gap between aspiration and reality; a serious agenda to implement either the Saudi or the Iranian vision would require painful compromises to regime ideology and a fundamental overhaul of the institutions and the structure of power in both countries. 

Imagine, though, for a moment, that these far-fetched ambitions were quite serious, and that both the Saudi and Iranian leadership were determined to do what was necessary to truly wean their economies off oil dependence. Consider what it might mean for the region if these grandiose ambitions were not simply the illusions of overpriced consultants and embattled technocrats—if a leadership emerged in one or both of the Middle East’s most powerful actors prepared to invest political capital in a genuine transformation of priorities and policies. What might be possible if Tehran and Riyadh sought to compete for economic opportunities instead of fueling violence and sectarianism around the region? If instead of a vicious sectarian and geopolitical rivalry, these two old adversaries engaged in a race to the top?

What will it take to move these visions from wishful thinking to reality? More than rhetoric, to be sure. But even the articulation of improbable objectives will have its impact. As documented in a recent book, Iran’s post-revolutionary experience demonstrates that the regime’s reliance on promises of economic gains has generated public expectations for effective and accountable governance. Now Iranians and Saudis have been told by their leaders—who happen to be officially infallible—that the time has come to transcend oil. What might happen if they believe it?

       

       

       

Erica has a history of cardiac issues. She visits her doctor for a regular checkup and her doctor writes a new prescription to better control her heart disease. Unfortunately, her doctor didn't mention any instructions, except to take it once a day. Erica thanks her doctor and heads to the pharmacy. At the check-out counter, the clerk hands Erica her new prescription drug, in addition to three documents stapled to the bag that he says "will explain everything you need to know about your medication." Later on, while reviewing the materials at home, Erica is overwhelmed by the information, which is in fine print and difficult to understand. She is frustrated and confused, and tosses the documents in the trash.

This scenario is not uncommon. Research suggests that about 50 percent of Americans find it difficult to read health information.[i] Consumers who cannot find the information they need, or who do not understand the information because it is presented in a convoluted manner, are less likely to use it to prevent unnecessary medical errors. In Erica’s case, she could have ended up in the emergency room because she missed some basic warnings about her prescription. For example, one warning might have been that she should not chew the medication because it was an extended release capsule. Chewing the capsule could release the entire day’s dose at once, resulting in an unintended overdose.

We know that consumers are receiving information – sometimes too much information. Not only are consumers receiving pages of medication information, the information they receive is uncoordinated and sometimes conflicting. Some documents are written by the drug manufacturer, and others are written by pharmacies or another third party. Some medication information documents are FDA-approved and others are not.

The real question is – could medication information be presented in such a way that it would be more useful for consumers? The answer is a resounding “yes.” One study found that just 75 percent of consumer medication information met the minimum criteria for usefulness.[ii] That number might be impressive as a field goal percentage in the NBA, but for consumers it represents an unmet need for high quality medication information.

The U.S. Food and Drug Administration (FDA) has spent the past several years working with stakeholders to determine the most effective methods for conveying medication information. One overarching principle that has emerged from FDA’s engagement with the health care community is the need for a single, standardized document to replace the numerous existing documents. This document is identified as Patient Medication Information (PMI).

PMI creates an easier way for consumers to access and understand their medication information. By presenting the most salient pieces of information – including drug uses, warnings, side effects, and directions – on a single page that is easy to navigate, PMI can be a useful tool for enhancing treatments and preventing avoidable medication errors or side effects. PMI holds promise both for consumers and the broader health care system. For consumers, PMI could contribute to better outcomes and an overall improvement in patient experience. For health systems, PMI’s positive impact on medication adherence could improve performance on quality measures, such as hospital readmissions, that could lead to shared savings or other rewards.

Through a cooperative agreement, the Engelberg Center for Health Care Reform at the Brookings Institution has worked in collaboration with FDA over the past few years to convene a series of workshops focused on identifying best PMI practices – for example, how to make PMI both more usable and accessible.  Workshop participants identified several guiding principles for improving the content, format, and distribution of PMI.

PMI Guiding Principles

PMI content should be consumer-friendly. Expert stakeholders identified a lack of consumer-friendly information as one of the most important barriers to effectively communicating critical medication information. To fix this problem, the language used in PMI will need to be simplified, patient-centric, and understandable across the entire spectrum of health literacy levels. The types of information that should be included in PMI must be essential for taking a medication properly. Extraneous information, such as a discussion of previous treatments a consumer must have previously tried and failed before receiving the new prescription, may be more confusing than helpful.

The best PMI formats are simple and easy to navigate. Consumers don’t want to be given a technical-looking instruction manual when they pick up their prescriptions. Participants at the workshops generally agreed that it would be ideal to keep PMI to a single page. They also agreed that actionable headers that help consumers locate the information they are looking for are preferable to the question and answer format (e.g., “Uses” and “Directions” are more effective than “What does the drug treat?” and “How do I use the drug?”). There was consensus on the point that consumers will ultimately decide the best format.

Access to PMI will be bolstered by multiple channels of distribution. Paper is still the primary source of medication information, and is preferred by certain demographics. However, technology is revolutionizing the way consumers receive information. This is generally good for society, but it introduces some challenges, including the fact that consumers now have more access to information of questionable quality.  One method for ensuring access to consistent and high quality PMI would be to have a central repository for all PMI documents. This approach could support distribution of both printed and electronic PMI. Access to PMI could be further enhanced by making it available on smartphones and via email.

On July 1, the Center will convene a public meeting that will provide an opportunity for the health care community to discuss the issues mentioned above. Researchers will give an update on progress made since the previous meetings and share the lessons they learned from recent studies. Diverse stakeholders – including patient advocacy groups, providers, pharmacies, and drug manufacturers – will provide their perspectives on the future of PMI and assess their role in making high quality PMI a reality. 

There are many issues that need to be addressed in exploring the promise of PMI. However, one thing that participants at the July 1 meeting should remember is this: Keep it simple, stakeholders.

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Editor’s note: This post is adapted from a forthcoming full-length case study; the second in a series from the Engelberg Center’s Merkin Initiative on Physician Payment Reform and Clinical Leadership designed to support clinician leadership of health care delivery, payment, and financing reform. The case study will be presented during the Merkin Initiative’s “MEDTalk” event on July 9 from 10:30 AM to 12:30 PM EDT, featuring live story-telling and knowledge-sharing from patients, providers, and policymakers.

Oncology practices and hospitals across the nation struggle with providing sustainable, comprehensive, and coordinated cancer care. Clinical leaders with strategies and models to improve the quality and value of health care often don’t know how to navigate the landscape of payment and delivery reform options to sustain their innovations.

We use a case study approach to investigate and tell the story of the New Mexico Cancer Center (NMCC), an independent cancer center that is experimenting with innovative ways to improve patient-centered oncology care. We identify challenges for creating sustainable and supportive payments models, and we share the broader strategic and policy lessons for adopting alternative payment models.

The Clinical Scenario: Living With Cancer

Vicky Bolton, a 58-year-old full-time medical legal coordinator from Albuquerque, has stage 4 adenocarcinoma lung cancer. She started chemotherapy in 2003 and has consistently received treatments over the last 11 years. Vicky is one of 13 million Americans currently living with cancer, with more than 1.6 million new diagnoses added each year.

Although Vicky’s condition is currently stable, she is at high risk for venous thrombosis (blood clots), life-threatening infections, and other complications, which put her at high risk for repeated hospitalizations. In the past six months, she has taken advantage of “after hours” care on three occasions as an outpatient at NMCC. Fortunately, each of her providers and services — oncology, radiation therapy, labs, x-rays, and internal medicine — are centralized in a single location at NMCC, reducing the need for emergency room (ER) visits or hospitalizations for these episodes.

The Challenge: Controlling Spending While Improving Patient-Centered Care

Cancer is the second leading cause of death in the U.S. Forty-one percent of Americans will be diagnosed with cancer during their lives. Cancer care is also expensive, accounting for $125 billion of total health care spending annually. In 2011, Medicare alone spent nearly $35 billion in fee-for-service (FFS) payments for cancer care, representing 9 percent of all Medicare FFS payments.

The high costs of cancer care are driven by issues that plague the entire health system: uncoordinated care delivery, duplication of services, fragmentation, and volume-based payments. A common impact of these drivers in oncology is the use of the ER to relieve symptoms associated with adverse effects of chemotherapy or other treatments that can also result in hospitalization.

For example, research shows that the most common reasons for cancer patient ER admissions are pain, respiratory distress, nausea, and vomiting. More than half of the ER visits occurred on weekends or in the evening, and over 60 percent resulted in hospital admission. This suggests that if a patient’s symptoms could be managed at home or in the community, costly hospital admissions could be avoided. ER visits, where patients are exposed to germs and infections as they wait — often hours — to be admitted, can have catastrophic outcomes for patients that are actively in treatment since they have weakened immune systems and are more prone to infections.

In addition to the inherent issues with fee-for-service (FFS) payments — with payments incentivizing volume of procedures rather than the value of care delivered — the current payment system further exacerbates problems: If a practice provides higher-value care to patients at a lower cost to the overall system (that is, they perform fewer services and have lower revenue), the financial winner is the payer who reimburses fewer services, not the practice (which merely has less revenue). This combination of the misaligned incentives of FFS and the lack of financial benefit for improving care while reducing costs means that many practices simply cannot afford to make the transformations needed without other funding mechanisms.

The Real World: How Has An Independent Cancer Center Responded To These Challenges?

NMCC delivers care to roughly 2,700 patients and provides care to one in three New Mexicans with cancer. The changes that the center has made have focused on reducing the impact of fragmentation of care on their patients (Table 1).

A key innovation was enhancing comprehensive after-hours and weekend care on site and creating a telephone and urgent care triage program to avoid expensive emergency room and inpatient care, which NMCC termed the COME HOME model.

As part of its redesign process in 2012, NMCC – along with six community oncology practices — secured a $20 million Center for Medicare and Medicaid Innovation (CMMI) Health Care Innovation Award (HCIA), for a three-year period. The award has an explicit aim of reducing ER visits by 50 percent and hospitalizations by 20 percent to justify the program costs.

Table 1: Care Redesign Elements Undertaken by NMCC

The Key Levers: How Can COME HOME Be Sustained?

On the heels of the Affordable Care Act (ACA) and numerous quality and payment focused initiatives in the private sector, health care organizations need to enhance the competitiveness and efficiency of their systems in the marketplace.

Alternative payment models (APMs) such as Accountable Care Organizations (ACOs), bundled payments, and patient-centered oncology medical homes (PCOMH) are just a few of the initiatives supported by public and private payers to align care redesign and payment reform and encourage continuous improvement. (Clinical pathways, a strategy recently embraced by WellPoint, offer PCOMH-like incentives to encourage adherence to practice guidelines, a strategy primarily geared to encourage higher-value chemotherapy practice.)

Broader or larger case-based payments may also provide stronger incentives to limit costs, to help assure that promising delivery reforms actually lead to cost reduction, but this exposes oncologists to greater levels of financial risk, as shown in Table 2. Consequently, implementing payment reforms that are viewed as feasible and desirable by both providers and payers is difficult.

Table 2: Comparison of Alternative Payment Models for Oncology

The Path Ahead: How Can These Models Assist NMCC?

NMCC currently receives approximately $70,000 per month from the CMMI grant and has not yet identified a clear strategy to sustain the delivery reforms in the COME HOME care model past the end of the grant (July 2015). As for payment reform options, NMCC has been unable to contract as part of a comprehensive ACO due to local health care market conditions.

Clinical pathways are geared primarily to guidelines and chemotherapy adherence, and are not designed to provide funding for after-hours care or triage programs that are intended to achieve offsetting savings through avoiding costly complications. Possible remaining options include:

• PCOMH: Using the data it gathers, NMCC intends to quantify the additional costs the COME HOME model requires, and the savings that it achieves. Based on that estimate, NMCC could suggest a per-member per-month (PMPM) payment from a private insurer to cover the costs of providing higher quality care. To encourage participation, NMCC could also enter into a risk-sharing agreement, in which overall costs of inpatient care and ER visits would be compared against a target. The PMPM payment could be at-risk if the targets are not achieved after a certain period of time.

• Bundled Payments: NMCC could potentially use the medical home approach with risk sharing (described above) as a first, interim step toward a bundled payment system, NMCC’s long-term preferred model. Computing actuarially sound expected costs for the bundled payments would require merging claims data with clinical data (for example, ICD-9 codes fail to distinguish between subtypes of breast cancer that have radically different treatments). A bundled payment pilot might be performed for high volume cancers, such as breast and lung.

Lessons Learned

The experience of innovative pioneers like NMCC can shed some light on potential barriers to conceptualizing and implementing sustainable clinical redesign. The lessons learned have been sorted into three main categories: relationships with payers and networks, payment model selection, and data collection and quality improvement considerations.

Relationships with payers and networks. Though counterintuitive, merely demonstrating significant value from care design, perhaps from lower utilization of inpatient and emergency department utilization, does not automatically create a financial pathway for sustainable delivery reform. To do so, innovative providers should consider involving lead payer partners early on to help identify end-points of interest to payers and potential payment strategies that may emerge later.

Providing support for health care delivery reforms requires new activities by payers towards aligning their payments with value, rather than volume and intensity of services. However, fragmented health care markets face the challenge of the “free rider” problem: payers may be unwilling to shoulder delivery transformation costs that may benefit other payers’ clients while they wait for CMS or others to make the financial investment, pay for the program evaluation, and enact policy change). Other challenges include payer inertia and long lag times between care redesign and subsequent data demonstrating results.

Large ACOs and other integrated payer-provider plans, including those large enough to form Medicare Advantage plans, are moving forward on negotiating payment and delivery reforms. This may be more difficult for innovative, smaller practices, even if they can provide higher-value clinical services. In turn, this may have anti-competitive consequences, such as discouraging delivery innovation that leads to “demand destruction” of high-cost hospital-based services. Private and public payers should be particularly interested in developing models that enable smaller, specialized providers like oncology practices to undertake key delivery reforms.

Sustainable Payment Model Selection. While substantial attention has been paid to primary care focused APMs, specialty-focused APMs are needed for practices like NMCC. Their development should be a high priority for public and private payers. Clinical transformation grants, such as those offered by CMMI, should include clear pathways for transitioning to APMs if initial cost savings targets or projections are met. Otherwise, delivery system innovations are at high risk of failure despite evidence of improved value.

Data Collection and Quality Improvement Considerations. Timely sharing of actionable information from claims and other administrative data remains a major challenge, with complex and varied procedures for obtaining claims from payers; smaller practices are particularly challenged in interpreting the claims data. Some states, such as Maryland, Massachusetts, Vermont, and Colorado (among others) are proceeding with creating all-payer claims databases. (Maryland, for example, offers almost instantaneous provider feedback from claims through their CRISP database.)

Others, such as Minnesota, are using “distributed” approaches in which multiple payers and systems produce measures in consistent ways. As NMCC’s early efforts illustrate, practices can produce more clinically sophisticated performance measures. Strategies to achieve consistent methods for sharing key data on cost and quality need to be expanded to encourage quality improvement and payment reform.

      

      

It is well recognized across the health care industry that the major goals of the Affordable Care Act (ACA) include not only expanding health insurance coverage, but also improving the quality of care and the patient health care experience. A key strategy in achieving these goals is improving the efficiency and delivery of care through innovative financing mechanisms and new delivery models, such as Accountable Care Organizations (ACOs), patient-centered medical homes (PCMHs), bundled payments for acute and post-acute care, and population-based models that aim to improve the health of entire communities. These alternative models emphasize quality and outcomes, while moving care away from the traditional and predominant method of fee-for-service (FFS).¹

The Frontline Work Force
Many conversations focused on the implementation of these models typically emphasize the role of physicians. However, the success of these models relies heavily on the support and manpower of a multidisciplinary team; particularly "frontline health care workers." Frontline workers may include medical assistants (MAs), medical office assistants, pharmacy aides, and health care support workers. Oftentimes, they provide routine, critical care that does not require post-baccalaureate training.²

For example, MAs can play an important role in a medical home model. Upon discharge from the hospital, frontline workers can provide direct outreach to patients that are at high risk for readmission, and discuss any lingering symptoms, worsening of conditions, or medication issues. If necessary, MAs can assign a high-risk patient to a social worker, care coordinator or nurse.³

In a team care environment, frontline health care workers are essential for taking over routine tasks and allowing physicians to employ their specialized skills on their most complex patient cases, which allows all team members to work at “the top of their license”.⁴ Frontline workers can also bridge the gap between patients and a multitude of providers and specialists; help deliver care that is culturally and linguistically appropriate; and provide critical patient education and outreach outside of regular office visits. 

A Workforce in Need of Reform
While team-based care is widely accepted as an industry norm, its current infrastructure is not well-supported. While the frontline workforce represents nearly half of all health care professionals, they are markedly underpaid, underappreciated, and lack formal training to transition into higher-skilled and/or higher paid positions.

A recent study by the Brookings Metropolitan Policy Program “Part of the Solution: Pre-Baccalaureate Healthcare Workers in a Time of Health System Change” demonstrates this glaring disparity between current frontline workforce investment and its value to health reform efforts. The study analyzes the characteristics of the top ten ‘pre-baccalaureate health care workers’ (staff that holds less than an associate’s degree) within the US’s one-hundred largest metropolitan areas (see Table 1).

Table 1: Top ten pre-baccalaureate health care workers in the US’s top one-hundred metropolitan areas

Personal care aides represent a striking example of the underinvestment in frontline workers. The study shows that personal care aides have the lowest levels of educational attainment compared to their peers (32% have no more than a high school diploma), and have the lowest median earnings ($20,000 annually). Meanwhile, The Center for Health Workforce Studies’ (CHWS) estimates that this profession is among the top three national occupations with the highest projected job growth between 2010 and 2020. They are also in highest demand: between 2010 and 2020 there will be an estimated 600,000 personal aide vacancies.⁵ According to this study, MAs are also among the least educated and lowest paid frontline professions. Ninety percent lack a bachelor’s degree and a significant share (29%) are classified as ‘working poor.’

Policy Solutions

A number of policy solutions can be applied to enhance the frontline worker infrastructure. Our recommendations include:

Invest in front line health care workforce training and education. Case studies from a recent Engelberg Center toolkit, outlines how providers are training their frontline workforce to master fundamental skills including care management, patient engagement, teamwork, and technological savviness.

For example, a New Jersey ACO carried out clinical transformation by investing in new frontline staff, and by redefining the role of medical assistants to include health coaching. The return on investment for employers is potentially large. After injecting a substantial initial investment into this project, this ACO saw a 12.3% decrease in net health care costs within the first year of the program’s implementation; as well as significantly improved efficiency, quality of care and patient experience. As the educational curricula for frontline professions are largely variable, more attention should also be spent on the quality of educational content to train these occupations, as well as on developing an understanding of how delivery systems are augmenting traditional educational curricula.

2. Active inclusion of frontline health care workers in payment reform. Although the services of frontline health care workers are beginning to play a role in new payment models, typically frontline staff does not benefit directly from any bonus payments or shared savings incentives. However, their increasingly valuable role in the care team may warrant allowing frontline health care staff to be included in the receipt of shared savings and/or bonus payments based on the achievement of specifically tailored performance and outcomes targets.

The increasing demand for frontline health care workers, driven in part by the ACA’s payment and delivery reforms, will likely spell out a brighter future for these occupations, whose services had routinely been undervalued and underpaid. Future policy efforts should be focused on extending educational grants that have been aimed at primary care and nursing to frontline workers, as well as considering dedicating portions of shared savings to enhancing the earning potential for frontline workers. Some efforts, such as the U.S. Department of Labor’s recent rule to grant wage and overtime protections to home health and personal care aides, are early suggestions of a shift toward greater respect and empowerment for these occupations. It is yet to be seen what effects the continuation of such efforts will have on their high projected attrition trends.

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Event Information

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The Brookings Institution and the American Enterprise Institute (AEI) collaborated to ask: if you were to redesign Medicare without spending more money, what would you keep and what would you change? A new report on a Center for Healthcare Decisions program provided insight into the public’s willingness to restructure Medicare in the face of tightening budget constraints. Using an interactive, computer-based system, program participants faced the challenge of making Medicare more responsive to the needs of current and future beneficiaries.

Were participants willing to accept limits on their choice of provider or reduced coverage of low-value medical care? Would they accept the need for greater personal responsibility in their use of health services? Would they agree that Medicare should adopt other policies to promote fiscal responsibility?

Watch event video.

       

Event Information

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Many clinicians have terrific ideas for improving the quality and cost of health care, but often don’t know how to navigate the frequently baffling landscape of payment and delivery reform options. To address this need in clear, practical terms, we are pleased to announce the third MEDTalk event in the “Merkin Series on Innovations in Care Delivery.” The series is designed to support clinicians and policymakers who’ve always wondered how delivery reform occurs, but didn’t know where to begin.

Our third case drew on the experiences of the Community Asthma Initiative, an enhanced pediatric asthma intervention, and their efforts in sustainability. The event featured seven brief “TED-style” talks that consider the challenges of delivering pediatric care, while tackling non-medical factors that drive suboptimal care, improving patient and family quality of life, and reducing costs. The agenda included firsthand experiences from patients, payers, policymakers, and clinical leadership from Massachusetts and Arkansas. Sustainable improvement strategies and the financial mechanisms available to encourage innovations in asthma were explored.

Video

• MEDTalk: Pediatric Asthma and Transforming Care for the Most Vulnerable
• A Day in the Life: The Patient Experience
• Challenge Accepted: Delivery of Asthma Care in a Triple Aim World
• The Community Asthma Initiative: A Case Study in Clinical Innovation
• Paying for Asthma Care: Options for Tackling Challenges
• State Medicaid Innovation: Opportunities and Barriers
• A Tale of Success: How to Get the Payer on Board
• Lessons Learned and the Path Forward
• Question and Answer Session

       

Ohio, like most other states in the country and particularly its neighbors in the Great Lakes region, is still reeling from the “Great Recession.” This economic crisis, the worst in a half century, has devastated economies across the globe.

While economists have declared that the recession has abated, it will be a long time before the businesses, households, and government treasuries across the country, and specifically in the state of Ohio, shake off the effects. And when the recession’s grip finally breaks, what will Ohio’s economy and landscape look like?

The choices that Ohio’s people and its leaders make—starting now and continuing over the next few years—will determine that answer. Ohioans can decide whether to shy away from manufacturing after the loss of so many jobs, or to transform the state’s old manufacturing strengths, derived from its role in the auto supply chain, into new products, markets, and opportunities. They can decide to opt out of the national shift to a lower-carbon economy, or to be at the forefront of developing clean coal and renewable energy industries and jobs.

They can choose a workforce system that is aligned to the true metropolitan scale of the economy and oriented to the needs of workers and employers. They can choose transformative transportation networks over more roads; smaller, greener, stronger cities; collaboration and regional cooperation to save money, reduce duplication, and bolster regional competitiveness. And instead of trying to go it alone in the 21st century global marketplace, they can maximize the federal resources on offer to support Ohio’s economic transformation and choose to compete effectively for new federal investments.

This report, Restoring Prosperity: Transforming Ohio’s Communities for the Next Economy, lays out some of the specific policy options that will help Ohioans restore the prosperity that the state enjoyed for much of the 19th and 20th centuries, but that it has been struggling to regain for at least a decade, if not longer.

Full Report »

Downloads

• Full Report
• Executive Summary
• Bruce Katz's Speech in Ohio

       

2015 is a pivotal year. Three major workstreams among all the world’s nations are going forward this year under the auspices of the United Nations to develop goals, financing, and frameworks for the “post-2015 sustainable development agenda.” First, after two years of wide-ranging consultation, the U.N. General Assembly in New York in September will endorse a new set of global goals for 2030 to follow on from the Millennium Development Goals (MDGs) that culminate this year. Second, to support this effort, a financing for development (FFD) conference took place in July in Addis Ababa, Ethiopia, to identify innovative ways of mobilizing private and public resources for the massive investments necessary to achieve the new goals. And third, in Paris in December the final negotiating session will complete work on a global climate change framework. 

These three landmark summits will, with luck, provide the broad strategic vision, the specific goals, and the financing modalities for addressing the full range of systemic threats. Most of all, these three summit meetings will mobilize the relevant stakeholders and actors crucial for implementing the post-2015 agenda—governments, international organizations, business, finance, civil society, and parliaments—into a concerted effort to achieve transformational outcomes. Achieving systemic sustainability is a comprehensive, inclusive effort requiring all actors and all countries to be engaged.

These three processes represent a potential historic turning point from “business-as-usual” practices and trends and to making the systemic transformations that are required to avoid transgressing planetary boundaries and critical tipping points. Missing from the global discourse so far is a realistic assessment of the political decisions and institutional innovations that would be required to implement the post-2015 sustainable development agenda (P2015).

For 2015, it is necessary is to make sure that by the end of year the three workstreams have been welded together as a singular vision for global systemic transformation involving all countries, all domestic actors, and all international institutions. The worst outcome would be that the new Sustainable Development Goals (SDGs) for 2030 are seen as simply an extension of the 2015 MDGs—as only development goals exclusively involving developing countries. This outcome would abort the broader purposes of the P2015 agenda to achieve systemic sustainability and to involve all nations and reduce it to a development agenda for the developing world that by itself would be insufficient to make the transformations required.

Systemic risks of financial instability, insufficient job-creating economic growth, increasing inequality, inadequate access to education, health, water and sanitation, and electricity, “breaking points” in planetary limits, and the stubborn prevalence of poverty along with widespread loss of confidence of people in leaders and institutions now require urgent attention and together signal the need for systemic transformation.

As a result, several significant structural changes in institution arrangements and governance are needed as prerequisites for systemic transformation. These entail (i) political decisions by country leaders and parliaments to ensure societal engagement, (ii) institutional innovations in national government processes to coordinate implementation, (iii) strengthening the existing global system of international institutions to include all actors, (iv) the creation of an international monitoring mechanism to oversee systemic sustainability trajectories, and (v) realize the benefits that would accrue to the entire P2015 agenda by the engagement of the systemically important countries through fuller utilization of  G20 leaders summits and finance ministers meetings as enhanced global steering mechanisms toward sustainable development.   Each of these changes builds on and depends on each other.

I. Each nation makes a domestic commitment to a new trajectory toward 2030

For global goal-setting to be implemented, it is essential that each nation go beyond a formal agreement at the international level to then embark on a national process of deliberation, debate, and decision-making that adapts the global goals to the domestic institutional and cultural context and commits the nation to them as a long-term trajectory around which to organize its own systemic transformation efforts. Such a process would be an explicitly political process involving national leaders, parliaments or rule-making bodies, societal leaders, business executives, and experts to increase public awareness and to guide the public conversation toward an intrinsically national decision which prioritizes the global goals in ways which fit domestic concerns and circumstances. This political process would avoid the “one-size-fits-all” approach and internalize and legitimate each national sustainability trajectory.

So far, despite widespread consultation on the SDGs, very little attention has been focused on the follow-up to a formal international agreement on them at the U.N. General Assembly in September 2015. The first step in implementation of the SDGs and the P2015 agenda more broadly is to generate a national commitment to them through a process in which relevant domestic actors modify, adapt, and adopt a national trajectory the embodies the hopes, concerns and priorities of the people of each country. Without this step, it is unlikely that national systemic sustainability trajectories will diverge significantly enough from business-as-usual trends to make a difference. More attention needs to now be given to this crucial first step.  And explicit mention of the need for it should appear in the UNGA decisions in New York in September.

II. A national government institutional innovation for systemic transformation

The key feature of systemic risks is that each risk generates spillover effects that go beyond the confines of the risk itself into other domains. This means that to manage any systemic risk requires broad, inter-disciplinary, multi-sectoral approaches. Most governments have ministries or departments that manage specific sectoral programs in agriculture, industry, energy, health, education, environment, and the like when most challenges now are inter-sectoral and hence inter-ministerial. Furthermore, spillover linkages create opportunities in which integrated approaches to problems can capture intrinsic synergies that generate higher-yield outcomes if sectoral strategies are simultaneous and coordinated.

The consequence of spillovers and synergies for national governments is that “whole-of-government” coordinating committees are a necessary institutional innovation to manage effective strategies for systemic transformation. South Korea has used inter-ministerial cabinet level committees that include private business and financial executives as a means of addressing significant interconnected issues or problems requiring multi-sectoral approaches. The Korea Presidential Committee on Green Growth, which contained more than 20 ministers and agency heads with at least as many private sector leaders, proved to be an extremely effective means of implementing South Korea’s commitment to green growth.

III.  A single global system of international institutions

The need for a single mechanism for coordinating the global system of international institutions to implement the P2015 agenda of systemic transformation is clear. However, there are a number of other larger reasons why the forging of such a mechanism is crucial now.

The Brettons Woods era is over. It was over even before the initiative by China to establish the Asia Infrastructure Investment Bank (AIIB) in Beijing and the New Development Bank (NDB) in Shanghai. It was over because of the proliferation in recent years of private and official agencies and actors in development cooperation and because of the massive growth in capital flows that not only dwarf official development assistance (concessional foreign aid) but also IMF resources in the global financial system. New donors are not just governments but charities, foundations, NGOs, celebrities, and wealthy individuals. New private sources of financing have mushroomed with new forms of sourcing and new technologies. The dominance of the IMF and the World Bank has declined because of these massive changes in the context.

The emergence of China and other emerging market economies requires acknowledgement as a fact of life, not as a marginal change. China in particular deserves to be received into the world community as a constructive participant and have its institutions be part of the global system of international institutions, not apart from it. Indeed, China’s Premier, Li Keqiang, stated at the World Economic Forum in early 2015 that “the world order established after World War II must be maintained, not overturned.”

The economic, social and environmental imperatives of this moment are that the world’s people and the P2015 agenda require that all international institutions of consequence be part of a single coordinated effort over the next 15 years to implement the post-2015 agenda for sustainable development. The geopolitical imperatives of this moment also require that China and China’s new institutions be thoroughly involved as full participants and leaders in the post-2015 era. If nothing else, the scale of global investment and effort to build and rebuild infrastructure requires it.

It is also the case that the post-2015 era will require major replenishments in the World Bank and existing regional development banks, and significantly stronger coordination among them to address global infrastructure investment needs in which the AIIB and the NDB must now be fully involved. The American public and the U.S. Congress need to fully grasp the crucial importance for the United States, of the IMF quota increase and governance reform.  These have been agreed to by most governments but their implementation is stalled in the U.S. Congress. To preserve the IMF’s role in the global financial system and the role of the U.S. in the international community, the IMF quota increase and IMF governance reform must be passed and put into practice. Congressional action becomes all the more necessary as the effort is made to reshape the global system of international institutions to accommodate new powers and new institutions within a single system rather than stumble into a fragmented, fractured, and fractious global order where differences prevail over common interests.

The IMF cannot carry out its significant responsibility for global financial stability without more resources. Other countries cannot add to IMF resources proportionately without U.S. participation in the IMF quota increase.   Without the US contribution, IMF members will have to fund the IMF outside the regular IMF quota system, which means de-facto going around the United States and reducing dramatically the influence of the U.S. in the leadership of the IMF. This is a self-inflicted wound on the U.S., which will damage U.S. credibility, weaken the IMF, and increase the risk of global financial instability. By blocking the IMF governance reforms in the IMF agreed to by the G-20 in 2010, the U.S. is single-handedly blocking the implementation of the enlargement of voting shares commensurate with increased emerging market economic weights.  This failure to act is now widely acknowledged by American thought leaders to be encouraging divergence rather than convergence in the global system of institutions, damaging U.S. interests.

IV. Toward a single monitoring mechanism for the global system of international institutions

The P2015 agenda requires a big push toward institutionalizing a single mechanism for the coordination of the global system of international institutions.  The international coordination arrangement today, is the Global Partnership for Effective Development Cooperation created at the Busan High-Level Forum on Aid Effectiveness in 2011.  This arrangement, which recognizes the increasingly complex context and the heightened tensions between emerging donor countries and traditional western donors, created a loose network of country platforms, regional arrangements, building blocks and forums to pluralize the architecture to reflect the increasingly complex set of agents and actors. This was an artfully arranged compromise, responding to the contemporary force field four years ago.

Now is a different moment. The issues facing the world are both systemic and urgent; they are not confined to the development of developing countries, and still less to foreign aid. Geopolitical tensions are, if anything, higher now than then.  But they also create greater incentives to find areas of cooperation and consensus among major powers who have fundamentally different perspectives on other issues. Maximizing the sweet spots where agreement and common interest can prevail is now of geopolitical importance.  Gaining agreement on institutional innovations to guide the global system of international institutions in the P2015 era would be vital for effective outcomes but also importantly ease geopolitical tensions.

Measurement matters; monitoring and evaluation is a strategic necessity to implementing any agenda, and still more so, an agenda for systemic transformation.  As a result, the monitoring and evaluation system that accompanies the P2015 SDGs will be crucial to guiding the implementation of them.  The UN, the OECD, the World Bank, and the IMF all have participated in joint data gathering efforts under the IDGs  in the 1990s and the MDGs in the 2000s.   Each of these institutions has a crucial role to play, but they need to be brought together now under one umbrella to orchestrate their contributions to a comprehensive global data system and to help the G20 finance ministers coordinate their functional programs.   

The OECD has established a strong reputation in recent years for standard setting in a variety of dimensions of the global agenda.  Given the strong role of the OECD in relation to the G20 and its broad outreach to “Key Partners” among the emerging market economies, the OECD could be expected to take a strong role in global benchmarking and monitoring and evaluation of the P2015 Agenda.  The accession of China to the OECD Development Centre, which now has over fifty member countries, and the presence and public speech of Chinese Premier Li Keqiang at the OECD on July 1^st, bolsters the outreach of the OECD and its global profile.

But national reporting is the centerpiece and the critical dimension of monitoring and evaluation.  To guide the national reporting systems and evaluate their results, a  new institutional arrangement is needed that is based on national leaders with responsibility for implementation of the sustainable development agendas from each country and is undertaken within the parameters of the global SDGs and the P2015 benchmarks.

V.   Strengthening global governance and G20 roles

G-20 leaders could make a significant contribution to providing the impetus toward advancing systemic sustainability by creating a G-20 Global Sustainable Development Council charged with pulling together the national statistical indicators and implementing benchmarks on the SDGs in G-20 countries.  The G-20 Global Sustainable Development Council (G-20 GSDC) would consist of the heads of the presidential committees on sustainable development charged with coordinating P2015 implementation in G-20 countries.  Representing systemically important countries, they would also be charged with assessing the degree to which national policies and domestic efforts by G20 countries generate positive or negative spillover effects for the rest of the world.  This G-20 GSDC would also contribute to the setting of standards for the global monitoring effort, orchestrated perhaps by the OECD, drawing on national data bases from all countries using the capacities of the international institutions to generate understanding of global progress toward systemic sustainability. 

The UN is not in a position to coordinate the global system of international institutions in their functional roles in global sustainable development efforts.  The G-20 itself could take steps through the meetings of G-20 Finance Ministers to guide the global system of international institutions in the implementation phase of the P2015 agenda to begin in 2016. The G-20 already has a track record in coordinating international institutions in the response to the global financial crisis in 2008 and its aftermath. The G-20 created the Financial Stability Board (FSB), enlarged the resources for the IMF, agreed to reform the IMF’s governance structure, orchestrated relations between the IMF and the FSB, brought the OECD into the mainstream of G-20 responsibilities and has bridged relations with the United Nations by bringing in finance ministers to the financing for development conference in Addis under Turkey’s G-20 leadership. 

There is a clear need to coordinate the financing efforts of the IMF, with the World Bank and the other regional multilateral development banks (RMDBs), with the AIIB and the BRICS NDB, and with other public and private sector funding sources, and to assess the global institutional effort as whole in relation to the P2015 SDG trajectories.  The G-20 Finance Ministers grouping would seem to be uniquely positioned to be an effective and credible means of coordinating these otherwise disparate institutional efforts.  The ECOSOC Development Cooperation Forum and the Busuan Global Partnership provide open inclusive space for knowledge sharing and consultation but need to be supplemented by smaller bodies capable of making decisions and providing strategic direction.

Following the agreements reached in the three U.N. workstreams for 2015, the China G-20 could urge the creation of a formal institutionalized global monitoring and coordinating mechanism at the China G-20 Summit in September 2016. By having the G-20 create a G-20 Global Sustainable Development Council (G-20 GSDC), it could build on the national commitments to SDG trajectories to be made next year by U.N. members countries and on the newly formed national coordinating committees established by governments to implement the P2015 Agenda, giving the G-20 GSDC functional effectiveness, clout and credibility.   Whereas there is a clear need to compensate for the sized-biased representation of the G20 with still more intensive G-20 outreach and inclusion, including perhaps eventually considering shifting to a constituency based membership, for now the need in this pivotal year is to use the momentum to make political decisions and institutional innovations which will crystallize the P2015 strategic vision toward systemic sustainability into mechanisms and means of implementation.

By moving forward on these recommendations, the G-20 Leaders Summits would be strengthened by involving G-20 leaders in the people-centered P2015 Agenda, going beyond finance to issues closer to peoples’ homes and hearts. Systemically important countries would be seen as leading on systemically important issues.  The G-20 Finance Ministers would be seen as playing an appropriate role by serving as the mobilizing and coordinating mechanism for the global system of international institutions for the P2015 Agenda.  And the G-20 GSDC would become the effective focal point for assessing systemic sustainability not only within G20 countries but also in terms of their positive and negative spillover effects on systemic sustainability paths of other countries, contributing to standard setting and benchmarking for global monitoring and evaluation.    These global governance innovations could re-energize the G20 and provide the international community with the leadership, the coordination and the monitoring capabilities that it needs to implement the P2015 Agenda. 

Conclusion

As the MDGs culminate this year, as the three U.N. workstreams on SDGs, FFD, and UNFCC are completed, the world needs to think ahead to the implementation phase of the P2015 sustainable development agenda. Given the scale and scope of the P2015 agenda, these five governance innovations need to be focused on now so they can be put in place in 2016.

These will ensure (i) that national political commitments and engagement by all countries are made by designing, adopting, and implementing their own sustainable development trajectories and action plans; (ii) that national presidential committees are established, composed of key ministers and private sector leaders to coordinate each country’s comprehensive integrated sustainability strategy; (iii) that all governments and international institutions are accepted by and participate in a single global system of international institutions;   (iv) that a G-20 monitoring mechanism be created by the China G-20 in September 2016 that is comprised of the super-minister officials heading the national presidential coordinating committees implementing the P2015 agenda domestically in G-20 countries, as a first step;  and (v) that the G-20 Summit leaders in Antalya in November 2015 and in China in September 2016 make clear their own commitment to the P2015 agenda and their responsibility for its adaption, adoption and implementation internally in their countries but also for assessing G-20 spillover impacts on the rest of the world, as well as for deploying their G-20 finance ministers to mobilize and coordinate the global system of international institutions toward achieving the P2015 agenda.

Without these five structural changes, it will be more likely that most countries and actors will follow current trends rather than ratchet up to the transformational trajectories necessary to achieve systemic sustainability nationally and globally by 2030.

References

Ye Yu, Xue Lei and Zha Xiaogag, “The Role of Developing Countries in Global Economic Governance---With a Special Analysis on China’s Role”, UNDP, Second High-level Policy Forum on Global Governance: Scoping Papers, (Beijing: UNDP, October 2014).

Zhang Haibing, “A Critique of the G-20’s Role in UN’s post-2015 Development Agenda”, in Catrina Schlager and Chen Dongxiao (eds), China and the G-20: The Interplay between an Emerging Power and an Emerging Institution, (Shanghai: Shanghai Institutes for International Studies [SIIS] and the Friedrich Ebert Stiftung [FES], 2015) 290-208.

Global Review, (Shanghai:  SIIS, 2015,) 97-105.

Colin I. Bradford, “Global Economic Governance and the Role International Institutions”, UNDP, Second High-level Policy Forum on Global Governance: Scoping Papers, (Beijing: UNDP, October 2014).

Colin I. Bradford, “Action implications of focusing now on implementation of the   post-2015 agenda.”, (Washington: The Brookings Institution, Global Economy and Development paper, September 2015).

Colin I. Bradford, “Systemic Sustainability as the Strategic Imperative for the Future”, (Washington: The Bookings Institution, Global Economy and Development paper; September 2015). 

Wonhyuk Lim and Richard Carey, “Connecting Up Platforms and Processes for Global Development to 2015 and Beyond:  What can the G-20 do to improve coordination and deliver development impact?”, (Paris: OECD  Paper, February 2013).

Xiaoyun Li and Richard Carey, “The BRICS and the International Development System: Challenge and Convergence”, (Sussex: Institute for Development Studies, Evidence Report No. 58, March 2014).

Xu Jiajun and Richard Carey, “China’s Development Finance: Ambition, Impact and Transparency,” (Sussex :  Institute for Development Studies, IDS Policy Brief, 2015).

Soogil Young, “Domestic Actions for Implementing Integrated Comprehensive Strategies:  Lessons from Korea’s Experience with Its Green Growth Strategy”, Washington: Paper for the Brookings conference on “Governance Innovations to Implement the Post-2015 Agenda for Sustainable Development”, March 30, 2015).

       

       

       

       

The need to confront and drive back the forces of the Islamic State (IS) has pushed long-term reform efforts in Iraq far down the list of priorities. Yet pressing economic reforms – such as restructuring and rebuilding the country’s energy sector – increasingly seem a strategic necessity, as oil prices have fallen far below government projections. How can politicians be persuaded to invest in Iraq’s long-term future at a time of imminent security threats? How can the efforts to reform the Iraqi electricity network be harnessed to reestablish government authority in newly retaken areas?

Luay Al-Khatteeb and Harry Istepanian address these questions through analysis of past attempts at electricity sector reform. They argue that even before IS advances plunged Iraq into a deep political and security crisis, divisions within the Iraqi parliament and various government agencies had stymied efforts at reform. Still, they note that improving the provision of electricity is a clear opportunity to improve basic services to its citizens, boosting government legitimacy and acceptance in areas under its control, especially as it seeks to retake territory from IS.

Khatteeb and Istepanian hold that a comprehensive strategy is needed, one that incorporates an expanded role for the private sector, rationalized electricity tariffs, and a host of technical fixes to improve efficiency. Ultimately, they contend, much will depend on whether the government of Prime Minister Haidar al-Abadi views the IS threat as an excuse for inaction or an impetus for change.

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The Muslim Brotherhood has faced a great deal of opposition in the Middle East in recent years, with Egypt, Saudi Arabia, and the United Arab Emirates all declaring it to be a terrorist organization. Jordan’s Muslim Brotherhood, which has historically operated as a loyal opposition to the palace, has also come under fire as regional instability has dampened Jordanians’ appetite for protest and reform. While the group still enjoys significant public support, it is facing a number of internal tensions, culminating in its recent split. How can the Jordanian Muslim Brotherhood retain its political clout? Can it play a role in stabilizing and strengthening Jordan?

Read The Muslim Brotherhood in Jordan: Time to reform

In this new Policy Briefing, Neven Bondokji discusses the various reform efforts undertaken by Jordan’s Muslim Brotherhood since 2010, and argues that it urgently needs to see them through. She identifies key challenges, including the division over the Zamzam reform initiative, overlap between the movement and its affiliated political party, the inclusion of women, the ongoing ideological shifts in the movement’s political discourse, and generational tensions. Additionally, Bondokji examines how Jordan’s East Banker-Palestinian fault line is manifested within the Brotherhood.

Bondokji makes a series of recommendations, including that the Muslim Brotherhood ensure the independence of its political party’s leadership and decision-making, actively engage in and disseminate discourse on plural politics and policy debates, and introduce new leaders and styles of communication. She also asserts that Jordan’s government must empower political parties and allow for a more representative parliament. The application of such reforms, Bondokji concludes, would allow Jordan’s Muslim Brotherhood to be an asset in the country’s efforts against destabilizing extremism.

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Editor's Note: this article originally appeared in the 2012 Print Version of AARP: The Journal.

Using one platform to offer a variety of services

Known in the UK under the term “corporate platform” to indicate that it expands options available on the employer’s benefit platform, the development allows employees to use the employer’s retirement savings mechanism to save and invest for additional nonretirement purposes. When the corporate platform is fully implemented, employees will be able to man­age almost all of their investments and savings plans from one location, thus giving them a con­solidated view of their entire financial status. If carried to its full potential, the expanded saving platform will allow employees to shop for sav­ings products, among options that are available on the platform, instead of having to seek them out from individual suppliers—a search that often takes up work hours. Of even greater value, it gives employees one source to go to for indi­vidualized advice or financial literacy training.

The enhancement has special significance in the UK, where by fall 2012, the larger employers that don’t offer any other type of pension or retirement savings plan, must begin to automatically enroll their employees into basic retirement savings accounts. This requirement is causing a great deal of discussion about the future role of employer-provided benefits, as well as recon­sideration of the fees and services included in a traditional package. The platform enhancements allow an employer to differentiate its employee benefit package from the required basic account structure. It also gives younger employees a benefit of more immediate value, than they would have from a retirement savings account that they won’t access for a good 40 years.

Presentations from a variety of service providers at an October 2011 summit hosted by Pensions Insight, a UK trade journal, showed that the platform can be easily customized to meet the special needs of a specific workforce. Using a single computer interface, employees can select from a wide variety of savings and investment options that are appropriate for their income level and stage of life. Thus, an upper income manager who manages his or her own finances could see more sophisticated products, while an entry-level worker sees more basic sav­ings products. Live presentations by financial professionals who explain what is available on the computer platform add to the system’s value and increase its use.

A place to provide choice and to build financial literacy

The platform will have special value for moderate- and lower-income employees. While higher salaried employees may appreciate the opportunity to build their investments, the real value of the platform will be to enable moder­ate- and lower-income workers to find savings opportunities that they might otherwise miss because they don’t know where to go, are uncertain about what is a fair price, or for a variety of other reasons. Because employees tend to believe that services included on the corporate platform are implicitly endorsed by the employer, they usually have greater faith that the services are from legitimate providers at a fair price.

Employees at all levels can also use the site to receive guidance on individual products or basic financial literacy training. Individuals can choose from a range of options, from short videos on a specific topic by experts or fellow employees, to longer connected courses designed to meet the needs of specific age or income groups. Use is increased when employ­ees receive emails or text messages geared to birthdays or other life events, or generated after the employee visits a specific part of the website.

Understanding the value of peer evaluations to motivate others, some providers include a place where employees can post feedback about spe­cific products or savings choices. These postings help to guide other employees’ decisions and build the reputation of the platform as a source of unbiased information. The site can also include links to outside advisors who can answer specific questions, guide employees to another site for more information, or perform other services either online or over the telephone.

Differing age groups can be contacted and guided through different technologies. At the UK platform summit, David Harris, of Tor Financial Consulting, showed that younger employees preferred different communication methods than either older workers or the usual way employers provide information. However, the platform is able to use a wide variety of methods and is equally effective no matter which is used.

The platform’s value to international policy makers

Although the UK’s platform is intended as an enhancement to employer-provided benefits, it can also be used for a wide variety of policy goals, as the basic structure can be easily adapted to meet almost any nation’s specific tax and savings system. In the United States alone, policy experts have proposed dedicated savings accounts for nonretirement purposes ranging from unemployment benefits and retraining, home purchases, health care, and long-term health care coverage, to repaying student loans or building college balances for children or grandchildren. However, if all of these various accounts were established and funded, it is doubtful the employee would have any money left for food, clothing, and shelter.

Rather than having a host of specific savings programs, employees may be better served by more flexible accounts usable for a variety of purposes, as outside developments or chang­ing needs dictate. The platform concept would allow individuals to choose which purposes they need to save for and how much to save for each. Combined with targeted guidance or education, this structure could expose individuals to pos­sibilities they might not have considered before.

The structure is ideally suited to employment situations, but it could also be used by the self-employed or by consultants at sites aimed specifically at them and sponsored by trade associations, unions, or even government agen­cies. While their circumstances may preclude payroll deductions, the same products could be offered through direct debits to bank accounts.

The added value of nudge

The flexibility of the platform allows it to be used by employees with all levels of financial sophistication, but new participants would benefit from a variation on automatic enroll­ment that places certain amounts, in addition to the retirement savings amount, into a general savings account or similar vehicle. The automatic savings amounts deducted need not be large, and where the law allows, could vary according to employee age, with a larger proportion of the overall deduction going to nonretirement purpose for younger employees and to retirement for older ones.

As with automatic retirement enrollment, the employee would have the ability to vary amounts, divide the total among various accounts, and even stop all future contributions. However, automatic enrollment would offer workers direct experience with the nonretire­ment side of the platform. By varying enrollment in various accounts according to employees’ age, automatic enrollment could encourage them to consider saving for various purposes, such as a first home, college tuition for children, or additional health services.

Improving retirement security

Although the platform is applicable to a wide variety of other uses, its primary purpose is to build retirement security. Before retirement, the platform helps employees understand how to save, what they have, and how much more they need for a comfortable lifestyle. The other savings provide funds that can be used in the event of an emergency, thus helping to reduce leakage from retirement accounts in countries that allow early access to that money. At retire­ment, the platform helps individuals to see what other assets are available, and what loans or other liabilities must be factored in. In the UK, it is also being used to encourage individuals to use annuities and add them to their invest­ments. The UK experience can help to guide US policymakers in their efforts to increase the use of similar products.

The enhanced information and flexibility of the corporate platform should help individuals to better understand their finances and how to meet their goals. It moves retirement savings plans from a minor part of employees’ financial lives, to a central feature that has many more uses than just an event many years in the future. This promotes regular use of the platform, and a fuller understanding of what is necessary for a comfortable retirement.

      

American experience strongly suggests that the coming UK pension freedoms sound better in theory than they will work in practice. After nearly a decade where the UK has been the gold standard for retirement savings policy, it is about to take a step that it may regret.

As annuity purchases are not required, very few Americans buy them, feeling that they are spending a great deal of money for a comparatively small monthly income. Even those in traditional DB pension plans usually take a lump sum if they are allowed to do so. As a result, many US retirees spend unwisely, trust the wrong financial advisor, or make other financial mistakes.

Many people greatly overestimate how long their savings will last. Most others assume (often wrongly) that they can manage their own money as well as anyone else or that they can live comfortably on Social Security alone. U.S. Social Security pays a benefit that depends on the retirees’ individual income history. The average annual amount is about $13,000 (GBP 8,700).

One survey found that in West Virginia, a state with a relatively low average income, 78% of those near retirement and 67% of those at retirement would likely outlive their financial assets. Workers with lower incomes are most at risk. A recent national study found that by the 20th year of retirement, more than 81% of Americans with incomes up to $27,000 would run short of money, as would 38% of those earning up to $42,000, and 19% of those with incomes up to $65,000.  Even 8% of those with the highest incomes could not meet their expenses.

Advice alone is not likely to help. US experience shows that literally every minute that passes after general advice is given reduces the chance that the consumer will act on it – even when they have decided to do so. And even a significant number of those who consult with a financial planner fail to act on that guidance.

What does show promise is income illustration. In a 2014 U.S. survey, 85% of plan participants found estimates of the income they could anticipate from their retirement savings useful, and 35% said that they would save more. Income illustrations change the framing of retirement saving from gross amounts saved to retirement income.  Annuity-like products become insurance against running out of money, something Americans are increasingly concerned about.

Two other potential developments may help. One is longevity insurance, an annuity that provides income only after a set age. Purchasing a policy defines how long one must make retirement savings last, and the retiree is protected against running out of money. Because longevity insurance is deferred, one can receive higher amounts of monthly income for a lower cost.  In 2014, $50,000 would buy $275 a month at age 65 or $1200 a month starting at age 80.

Another idea is an automatic enrollment trial annuity. As developed by several Brookings Institution colleagues and me, new retirees would automatically use part of their savings for a two year annuity unless the retiree refused it. The rest of their savings would be available as a lump sum. After the trial period, the annuity would become permanent if they did nothing or they could cancel it and take the rest of their money as a lump sum.

The many annuity horror stories from the UK show a definite need for change, but the coming reforms go too far. US experience suggests that too many UK retirees are likely to see their savings exhausted all too quickly. There are alternatives that could do a better job of protecting retirees.

       

In many policy-related situations, the states can be useful laboratories to determine the most appropriate federal actions. Variations across states in health care programs, earned income credit rules, minimum wages, and other policies have helped inform debates about federal interventions.

In this paper, we reverse that approach. Many state and local governments currently face difficulties financing future pension obligations for their workers. The federal government, however, faced similar circumstances in the 1980s and successfully implemented a substantial reform. We examine the situation the federal government faced and how it responded to the funding challenge. We present key aspects of the situation facing state governments currently and draw comparisons between them and the federal situation in the 1980s. Our overarching conclusion is that states experiencing distress today about the cost and funding of its pension plans could benefit from following an approach similar to the federal government’s resolution of its pension problems in the 1980s.

The federal government retained the existing Civil Service Retirement System (CSRS) for existing employees and created a new Federal Employees’ Retirement System (FERS) for new employees. FERS combined a less generous defined benefit plan than CSRS, mandatory enrollment in Social Security, and a new defined contribution plan with extensive employer matching. Although we do not wish to imply that a “one size fits all” solution applies to the very diverse situations that different states face, we nonetheless conclude that the elements of durable, effective, and just reforms for state pension plans will likely include the major elements of the federal reform listed above.

Section II discusses the federal experience with pension reform. Section III discusses the status and recent developments regarding state and local pensions. Section IV discusses the similarities in the two situations and how policy changes structured along the lines of the federal reform could help state and local governments and their employees.

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Editor's Note: In the coming decade, China’s economic growth is projected to slow from its long-run average annual rate of 10 percent, sustained over the past three decades. The imminent slowdown also reflects a variety of specific structural challenges. Arthur Kroeber argues that responding effectively to these challenges requires a broad set of reforms in the financial sector, fiscal policy, pricing of key factors such as land and energy which are now subject to extensive government manipulation, and the structure of markets.

In the coming decade, China’s economic growth will certainly slow from the long-run average annual rate of 10% sustained over the past three decades. In part this is a natural slowdown in an economy that is now quite large (around US$7 trillion at market exchange rates) and solidly middle-income (per capita GDP of about US$7,500, at purchasing power parity). Despite the certainty of this slowdown, China’s potential growth rate remains high: per-capita income is still far below the level at which incomes in the other major northeast Asian economies (Japan, South Korea and Taiwan) stopped converging with the US level; the per-capita capital stock remains low, suggesting the need for substantial more investment; and the supply of low-cost labor from the traditional agricultural sector has not yet been exhausted. All these factors suggest it should be quite possible for China to achieve average annual real GDP growth of at least 7% a year through 2020.[1]

But the imminent slowdown also reflects a variety of specific structural challenges which require active policy response. Inadequate policies could result in a failure of China to achieve its potential growth rate. Three of the most prominent structural challenges are a reversal of demographic trends from positive to negative; a substantial secular decline in the contribution of exports to growth; and the very rapid increase in credit created by the 2009-10 stimulus program, which almost certainly led to a substantial reduction of the return on capital. Responding effectively to these challenges requires a broad set of reforms in the financial sector, fiscal policy, pricing of key factors such as land and energy which are now subject to extensive government manipulation, and the structure of markets. This paper will argue that financial sector reform is the best and most direct way to overcome these three major structural challenges.

1. China’s growth potential

There are several strong reasons to believe that China has the potential to sustain a fairly rapid rate of GDP growth for at least another decade. We define “fairly rapid” as real growth of 7% a year, which is a very high rate for an economy of China’s size (US$7 trillion), but substantially below the average growth rate since 1980, which has been approximately 10%.

The most general reason for this belief is that China’s economic growth model most closely approximates the successful “catch-up” growth model employed by its northeast Asian neighbors Japan, South Korea and Taiwan in the decades after World War II. The theory behind “catch-up” growth is simply that poor countries whose technological level is far from the global technological frontier can achieve substantial convergence with rich-country income levels by copying and diffusing imported technology. Achieving this catch-up growth requires extensive investments in enabling infrastructure and basic industry, and an industrial policy that focuses on promoting exports. The latter condition is important because a disciplined focus on exports forces companies to keep up with improvements in global technology; in effect, a vibrant export sector is one (and probably the most efficient) mechanism for importing technology.

A survey of 96 major economies from 1970 to 2008 shows that 14 achieved significant convergence growth, defined as an increase of at least 10 percentage points in per capita GDP relative to the United States (at purchasing power parity). Eight of these countries were on the periphery of Europe and so presumably benefited from the spillover effects of western Europe’s rapid growth after World War II, and from the integration of eastern and western Europe after 1990. The other six were Asian export-oriented economies: Japan, South Korea, Taiwan, Malaysia, Thailand and China. Most of these countries experienced a period of very rapid convergence with US income levels and then a sharp slowdown or leveling off. On average, rapid convergence growth ended when the country’s per capita GDP reached 55% of the US level. The northeast Asian economies that China most closely resembles were among the most successful: convergence growth in Japan, Taiwan and South Korea slowed at 90%, 60% and 50% of US per capita income respectively. In 2010 China’s per capita income was only 20% of the US level. Based on this comparative historical experience, it seems plausible that China could enjoy at least one more decade of relatively rapid growth, until its per capita income reaches 40% or more of the US level.[2]

So China’s growth potential is fairly clear. But realizing this potential is not automatic: it requires a constant process of structural reform to unlock labor productivity gains and improve the return on capital. The urgency of structural reform is particularly acute now. To understand why, we now examine three structural factors that are likely to exert a substantially negative effect on economic growth in coming years.

2. Challenges to growth

When considering China’s structural growth prospects, it is necessary to take account of at least three major challenges to growth. Over the past three decades, rapid economic growth has been supported by favorable demographics, a very strong contribution from exports, and a large increase in the stock of credit. The demographic trend is now starting to go into reverse, the export contribution to growth has slowed dramatically in the last few years, and the expansion of credit cannot be safely sustained for more than another year or two at most.

Demographics. From 1975 to 2010, China’s “dependency ratio”—the ratio of the presumably non-working (young people under the age of 15 and old people above the age of 64) to the presumably working (those aged 15-64) fell from approximately 0.8 to 0.4. Over the same period the “prime worker ratio”—the ratio of people aged 20-59 to those 60 and above—stayed roughly stable at above 5. Both of these ratios indicate that China’s economy enjoyed a very high ratio of workers to non-workers. This situation is favorable for economic growth, because it implies that with a relatively small number of dependent mouths to feed, workers can save a higher proportion of their incomes, and the resulting increase in aggregate national saving becomes available for investment in infrastructure and basic industry.

Over the next two decades, however, these demographic trends will reverse. The dependency ratio will rise, albeit slowly at first, and the prime worker ratio will decline sharply from 5 today to 2 in the early 2030s. These demographic shifts are likely to exert a drag on economic growth, for two reasons.

The first impact, which is already being felt, is a reduction in the supply of new entrants into the labor force—those aged 15-24. This cohort has fluctuated between 200m and 230m since the early 1990s, and in 2010 it stood at the upper end of that range. By 2023 it will have fallen by one-third, to 150m, a far lower figure than at any point since China began economic reforms in 1978. Because the supply of new workers is falling relative to demand for labor, wage growth is likely to accelerate above the rate of labor productivity growth, which appears to be in decline from the very high levels achieved in 2000-2010. As a result, unit labor costs will start to rise (a trend already in evidence in the manufacturing sector since 2004) and inflationary pressures will build. In order to keep inflation at a socially acceptable level, the government will be forced to tighten monetary policy and reduce the trend rate of economic growth.

The second impact will be the large increase in the population of retirees relative to the number of workers available to support them. This is the effect described by the prime worker ratio, which currently shows that there are five people of prime working age for every person of likely retirement age. As this ratio declines, the overall productivity of the economy slows, and the health and pension costs of supporting an aging population rise. The combination of these two effects can contribute to a dramatic slowdown in economic growth: during the period when Japan’s prime worker ratio fell from 5 to 2 (1970-2005), the trend GDP growth rate fell from 8% to under 2% (though demographics, of course, does not explain all of this decline). Over the next 20 years China’s prime worker ratio will decline by exactly the same amount as Japan’s did from 1970-2005.

Export challenge. Another element of China’s extraordinary growth was its rapidly growing export sector. Exports are a crucial component of catch-up growth in poor economies because, as explained above, they act as a vector of technology transfer: in order to remain globally competitive, exporters must continually upgrade their technology (including their processes and management systems) to keep up with the continuous advance of the global technological frontier.

Precisely measuring the impact of exports on economic growth is tricky, because what matters is not headline export value (which contains contributions from imported components and materials), but the domestic value added content of exports. In addition, a dynamic export sector is likely to have indirect impacts on the domestic economy through the wages paid to workers, the long-run effect of technological upgrading and so on. If we ignore these second-round impacts and focus simply on the direct contribution to GDP growth of domestic value added in exports, we find that exports contributed 4.6 percentage points to GDP growth on average in 2003-07. In other words, exports accounted for about 40% of economic growth during that period.[3]

Such a high export contribution to growth is on its face unsustainable for a large continental economy like China’s, and in fact the export contribution has slowed substantially since the 2008 global financial crisis. In 2008-11 the average contribution of export value added to GDP growth was just 1.5 percentage points – about one-third the 2003-07 average. It is likely that the export contribution to growth will fall even further in coming years.

Credit challenge. China responded to the global financial crisis with a very large economic stimulus program which was financed by a large increase in the credit stock. The ratio of non-financial credit (borrowing by government, households and non-financial corporations) rose from 160% in 2008 to over 200% in 2011. While the overall credit/GDP ratio remains lower than the 250% that is typical for OECD nations, a rapid increase in the credit stock in a short period of time, regardless of the level, is frequently associated with financial crisis. In China’s case, it is evident that the majority of the increase in the credit stock reflects borrowing by local governments to finance infrastructure projects which are likely to produce economic benefit in the long run but which in many cases will result in immediate financial losses.[4] To avert a potential banking sector crisis, therefore, it would be prudent for government policy to target first a stabilization and then a decline in the credit/GDP ratio.

The good news is that China has recent experience of deflating a credit bubble. In the five years after the Asian financial crisis (1998-2003), the credit/GDP ratio rose by 40 percentage points (the same amount as in 2008-11) as the government financed infrastructure spending to offset the impact of the crisis. Over the next five years (2003-08), the credit/GDP ratio fell by 20 points, as nominal GDP growth (17% a year on average) outstripped the annual growth in credit (15%). This experience suggests that, in principle, it should be possible to reduce the annual growth in credit significantly without torpedoing economic growth.

The bad news is that the 2003-08 deleveraging occurred within the context of the extremely favorable demographics, and unusually robust export growth that we have just described. Not only are these conditions unlikely to be repeated in the coming decade, both these factors are likely to exert a drag on GDP growth. Given this backdrop, any reduction in the rate of credit growth must be accompanied by extensive measures to ensure that the productivity of each yuan of credit issued is far higher than in the past.

3. The role of financial sector reform

The three growth challenges described above are diverse, but they are reflections of a single broader issue which is that China’s ability to maintain rapid growth mainly through the mobilization of factors (labor and capital) is decreasing. Much of the high-speed growth of the last decade derived from a rapid increase in labor productivity which was in turn a function of an extremely high investment rate: as the amount of capital per worker grew, the potential output of each worker grew correspondingly (“capital deepening”). But the investment rate, at nearly 49% of GDP in 2011, must surely be close to its peak, since it is already 10 percentage points higher than the maximum rates ever reached by Japan or South Korea. So the amount of labor productivity gain that can be achieved in future by simply adding volume to the capital stock must be far less than during the last decade, when the investment/GDP ratio rose by 10 percentage points.

The obvious corollary is that if China’s ability to achieve rapid gains in labor productivity and economic growth through mobilization of capital is declining, these gains must increasingly be achieved by improved capital efficiency. More specifically, the tightening of the labor supply implied by the demographic transition means that unit labor cost growth will accelerate; all things being equal this means that consumer price inflation will be structurally higher in the next decade than it was for most of the last. This in turn means that nominal interest rates will need to be higher. As the cost of capital rises, the average rate of return on capital must also increase; otherwise a larger share of projects will be loss-making and the drag on economic growth will become pronounced.

On the export side, the dramatic slowdown in the contribution to economic growth from exports means the loss of a certain amount of “easy” productivity gains. Greater productivity of domestic capital could help offset the deceleration in productivity growth from the external sector. Finally, as just noted, the need to arrest or reverse the rapid rise in the credit/GDP ratio means that over the next several years, a given amount of economic growth must be achieved with a smaller amount of credit than in the past—in other words, the average return on capital (for which credit here serves as a proxy) must rise.

Conceptually this is all fairly straightforward. The problem for policy makers is that measuring the “productivity of capital” on an economy-wide basis is not at all straightforward. In principle, one could measure the amount of new GDP created for each incremental increase in the capital stock (the incremental capital output ratio or ICOR). But in practice calculating ICOR is cumbersome, and depends heavily on various assumptions, such as the proper depreciation rate. Moreover, in an industrializing economy like China’s, the ratio of capital stock to GDP tends to rise over time and therefore the ICOR falls; this does not mean that the economy misallocates capital but simply that it experiences capital deepening. Sorting out efficiency effects from capital deepening effects is a vexing task.[5]

A more practical approach is simply to examine the ratio of credit to GDP. There is no one “right” level of credit to GDP, since different economies use different proportions of debt and equity finance. But the trends in the credit to GDP ratio in a single country (assuming there is no major shift in the relative importance of debt and equity finance), which are easily measured, can serve as a useful proxy for trends in the productivity of capital, and provide some broad guidelines for policy.

Figure 1 shows the ratio of total non-financial credit to GDP in China since 1998 (all figures are nominal). Total non-financial credit comprises bank loans, bonds, external foreign currency borrowing, and so-called “shadow financing” extended to the government, households and non-financial corporations; it excludes fund-raising by banks and other financial institutions. This measure is similar to the measure of “total social financing” recently introduced by the People’s Bank of China. 

This shows, as noted previously, that the credit to GDP ratio rose sharply from 160% of GDP in 2008 to 200% in 2010. The current ratio is not abnormally high: many OECD countries have credit/GDP ratios of 250% or so, and Japan’s is around 350%. But it is obvious that the trend increase is worrying: if credit/GDP continues to rise at 20 percentage points a year then by 2015 it would hit 300%, a level much higher than is normal in healthy economies. It seems intuitively clear that to ensure financial stability, policy should target a stabilization or decline in the credit/GDP ratio. Success in this policy would imply that the productivity of credit, and capital more generally, improves.

The large increase in the credit/GDP ratio in 2008-10 is not unprecedented. Following the Asian financial crisis of 1997-98, the total credit stock rose from 143% of GDP in 1998 to 186% in 2003, an increase of 43 percentage points in five years, as a result of government spending on infrastructure and the creation of new consumer lending markets (notably home mortgages). During this period the credit stock grew at an average annual rate of 15.9%, but nominal GDP grew at just 10% a year.

Over the next five years, 2004-08, the average annual growth in total credit decelerated only slightly, to 14.8%. But thanks to a gigantic surge in productivity growth—caused by a combination of the delayed effect of infrastructure spending, deep market reforms (such as the restructuring of the state owned enterprise sector), and a boom in exports—nominal GDP growth surged to an average rate of 18.3%. As a consequence, the credit/GDP ratio declined to 160% in 2008, a decline of 26 percentage points from the peak five years earlier.

This experience shows that, in a developing country like China, it is quite possible to deflate a credit bubble relatively quickly and painlessly. To do so, however, two conditions must be met: the projects financed during the credit bubble must, in the main, be economically productive in the long run even if they cause financial losses in the short run; and structural reforms must accompany or quickly follow the credit expansion, in order to unlock the productivity growth that will enable deleveraging through rapid economic growth rather than through a painful recession. These conditions were clearly met during the 1998-2008 period: the expanded credit of the first five years mainly went to economically useful infrastructure such as highways, telecoms networks and port facilities; and deep structural reforms improved the efficiency of the state sector, expanded opportunities for the private sector, and created a new private housing market. This combination of infrastructure and reforms helped lay the groundwork for the turbo-charged growth of 2004-08.

The credit expansion of 2008-10, following the global financial crisis, was about the same magnitude as the credit expansion of a decade earlier: the credit/GDP ratio rose 40 percentage points, from 160% to 200%. But the expansion was much more rapid (occurring over two years instead of five), and while the bulk of credit probably did finance economically productive infrastructure, there is evidence that the sheer speed of the credit expansion led to far greater financial losses. A large proportion of the new borrowing was done by local government window corporations, often with little or no collateral and in many cases with no likelihood of project cash flows ever being large enough to service the loans. A plausible estimate of eventual losses on these loans to local governments is Rmb2-3 trn, or 4-7% of 2011 GDP.

Furthermore, whereas in the late 1990s restructuring of the state enterprise sector and creation of the private housing market took off at the same time the government began to expand credit, the 2008-10 credit expansion occurred without any significant accompanying structural reforms. In sum we have significantly less reason to be confident about the foundations for economic growth over the next five years than would have been the case in 2003.

On the assumption that the trend rate of nominal GDP growth over the next five years is likely be quite a bit less than in 2003-08, just how difficult will it be for China to stabilize or better yet reduce the credit to GDP ratio? For the purposes of analysis, Figure 1 proposes two scenarios. Both assume that nominal GDP will grow at an average rate of 13% in 2012-2015 (combining real growth of 7.5% a year with economy-wide inflation of 5.5%). The “stabilization” scenario assumes that total credit grows at the same 13% rate, stabilizing the credit/GDP ratio at around 200%. The “deleveraging” scenario assumes that credit growth falls to 9.5% a year, enabling a reduction in the credit/GDP ratio of 25 percentage points to 175%--about the same magnitude as the reduction of 2003-08.

A quick glance suggests that achieving either of these two outcomes will be far more difficult than in the previous deleveraging episode. In 2003-08, the average annual rate of credit growth was just one percentage point lower than during the credit bubble of 1998-2003. In other words, the work of deleveraging was accomplished almost entirely through economic growth, rather than through any material constraint on credit.

In the three years following the global financial crisis, by contrast, total credit expanded by 22.7% a year, generating nominal GDP growth of 14.1% on average. The required drop in average annual credit growth is 10 percentage points under the stabilization scenario and 13 points under the deleveraging scenario, while nominal GDP growth declines by only a point. In other words, this episode is likely to be the reverse of the 2003-08 episode: deleveraging will need to come almost entirely from a constraint on credit, rather than from economic growth.



Another way of looking at this is to examine the relationship between incremental credit and incremental GDP—that is, how many yuan of new GDP arise with each new yuan of credit. This calculation is presented in Figure 2. This shows that in 1998-2003 each Rmb1 of new credit generated Rmb0.39 of new GDP; this figure rose to 0.72 in 2003-08, an 84% increase in the productivity of credit. The GDP payoff from new credit in 2008-10 was far worse than in 1998-2003. Simply to stabilize the credit/GDP ratio at its current level will require a 73% increase in credit productivity. To achieve the deleveraging scenario, a 150% improvement will be required.

The good news is that under the deleveraging scenario, the average productivity of credit in 2011-2015 only needs to be the same as it was in 2003-08. In principle, this should be achievable. But as previously noted, the mechanism of improvement needs to be quite different this time round. In 2003-08, the productivity of credit rose because credit growth remained roughly constant while GDP growth surged, thanks to structural reforms that accelerated returns to both capital and labor. Over the next several years, by contrast, the best that can be hoped for is that GDP growth will remain roughly constant. Consequently any improvement in credit productivity must come from constraining the issuance of new credit, while substantially raising the efficiency of credit allocation and hence the returns to credit.

What are the main mechanisms for improving the efficiency of credit, and of financial capital more generally? Broadly speaking, there are two: diversification of credit channels, and more market-based pricing of credit. Historically most credit has been issued by large state-owned banks, which are subject to political pressure in their lending decisions, and the majority of credit has gone to state-owned enterprises. Diversifying the channels of credit to include a broader range of financial institutions, a more vigorous bond market, and even by encouraging the creation of dedicated small- and medium-size enterprise lending units within the big banks, should improve credit allocation by giving greater credit access to borrowers who were previously shut out simply by virtue of a lack of political connections. Over the past decade government policy has been broadly supportive of the diversification of credit channels: specialized consumer credit, leasing and trust companies have been allowed to flourish, and there is some anecdotal evidence that SME lending at the state owned banks has begun to pick up steam.

The government has been far more reluctant, however, to embrace systematic measures for improving the pricing of credit. Bank interest rates remain captive to the policy of regulated deposit rates. Guaranteed low deposit rates means that banks have little incentive to seek out and properly price riskier assets, and are content to earn a fat spread on relatively conservative loan books. Bond markets, which in more developed economies form the basis for pricing of financial risk, are in China large in primary issuance, but small in trading volumes. The majority of bonds are purchased by banks and other financial institutions and held to maturity, make them indistinguishable from bank loans. Active secondary market trading by a wide range of participants is the essential mechanism by which bond prices become the basis for financial risk pricing.

4. Conclusions and recommendations

China still has potential for another decade of relatively high speed growth, but a combination of structural factors means that “high speed” in future likely means a trend GDP growth rate of around 7%, well below the historic average of 10%. Moreover, a combination of negative trends in demographics and the external sector, and the need to constrain credit growth after the enormous credit expansion of 2008-2010, mean the obstacles to realizing this potential growth rate are quite large. In order to overcome these obstacles, the efficiency of credit, and of capital more generally, must be improved. A large increase in credit efficiency was achieved in the previous economic deleveraging episode of 2003-08, but that increase in efficiency resulted mainly from an acceleration in GDP growth due to capital deepening, rather than from a constraint on credit. Over the next several years, the best that can plausibly be achieved is a stabilization of nominal GDP growth at approximately the current level. Any increase in credit efficiency must therefore come from a constraint on credit growth and direct improvements in credit allocation, rather than from capital-intensive economic growth.

In order to achieve this improvement in credit efficiency, three improvements to China’s financial architecture are urgently needed. First, the diversification of financial channels should continue to be expanded, notably through the acceptance and proper regulation of so-called “shadow financing” activities, which reflect market pressure for higher returns to depositors and greater credit availability (at appropriate prices) for riskier borrowers. Second, the ceiling on bank deposit rates should gradually be lifted and ultimately abolished, in order to give banks incentives for increased lending at appropriate prices to riskier borrowers who (it is to be hoped) will deliver a higher risk-adjusted rate of return than current borrowers. Third, steps should be taken to increase secondary trading on bond markets, in order to enable these markets to assume their appropriate role as the basis of financial risk pricing. Particular stress should be laid on diversifying the universe of financial institutions permitted to trade on bond markets, to include pension funds, specialized fixed-income mutual funds and other institutional investors with a vested interest in active trading to maximize both short- and long-term returns.

 

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