In a new paper, William Galston and Elaine Kamarck argue that the laws and rules that shape corporate and investor behavior today must be changed. They argue that Wall Street today is trapped in an incentive system that results in delivering quarterly profits and earnings at the expense of long-term investment.

As Galston and Kamarck see it, there’s nothing wrong with paying investors handsome returns, and a vibrant stock market is something to strive for. But when the very few can move stock prices in the short term and simultaneously reap handsome rewards for themselves, not their companies, and when this cycle becomes standard operating procedure, crowding out investments that boost productivity and wage increases that boost consumption, the long-term consequences for the economy are debilitating.

Galston and Kamarck argue that a set of incentives has evolved that favors short-term gains over long-term growth. These damaging incentives include:

• The proliferation of stock buybacks and dividends
• The increase in non-cash compensation
• The fixation on quarterly earnings
• The rise of activist Investors

These micro-incentives are so powerful that once they became pervasive in the private sector, they have broad effects, Galston and Kamarck write. Taken together, they have contributed significantly to economy-wide problems such as: (1) Rising inequality, (2) A shrinking middle class, (3) An increasing wedge between productivity & compensation, (4) Less business investment, and (5) Excessive financialization of the U.S. economy.

So what should be done? Galston and Kamarck propose reining in both share repurchases and the use of stock awards and options to compensate managers as well as refocusing corporate reporting on the long term. To this end, these scholars recommend the following policy steps:

• Repeal SEC Rule 10-B-18 and the 25% exemption
• Improve corporate disclosure practices
• Strengthen sustainability standards in 10-K reporting
• Toughen executive compensation rules
• Reform the taxation of executive compensation

Galston and Kamarck state that the American economy would work better if public corporations behaved more like private and family-held firms—if they made long-term investments, retained and trained their workers, grew organically, and offered reasonable but not excessive compensation to their top managers, based on long-term performance rather than quarterly earnings. To make these significant changes happen, the incentives that shape the decisions of CEOs and board of directors must be restructured. Reining in stock buybacks, reducing short-term equity gains from compensation packages, and shifting managers’ focus toward long-term objectives, Galston and Kamarck argue, will help address the most significant challenges facing America’s workers and corporations.  

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Nearly two years after ousting President Muhammad Morsi, Egypt’s military continues to crack down on the Muslim Brotherhood. Much like during Egypt’s 1952-54 political transition, the recent interactions between the powerful armed state bureaucracy and the influential religious organization have had a major impact on the country’s political trajectory. In both instances, the military and Muslim Brotherhood initially cooperated before ultimately clashing violently. How has each entity determined what approach to take toward the other? What does a continued imbalance in civil-military relations mean for Egypt’s future?

In a new Brookings Doha Center Analysis Paper, Omar Ashour examines the legacies and patterns of cooperation and conflict between the leaderships of Egypt’s military and the Muslim Brotherhood. Relying on extensive field research, he analyzes how each entity has made its critical decisions regarding the other by applying various decision-making models. Ashour considers the impact of cost-benefit analysis, organizational dynamics, factional disputes, and psychological factors to gain a deep understanding of the leaders’ motives.

Read "Collusion to Crackdown: Islamist-Military Relations in Egypt"

Ashour concludes that Egypt's prospects for social stability and economic recovery will remain bleak if the relationship between the military and the Muslim Brotherhood is not redefined within institutional, democratic rules of political competition. He argues that Egypt’s military should embrace a balanced civil-military relationship to realize broad, long-term benefits and avoid otherwise inevitable and costly clashes with segments of Egyptian society. As for the Muslim Brotherhood, Ashour recommends that it reevaluate its recent decisions and work to develop a sustained, solid, and cross-ideological civilian front that can pressure the military to leave politics and allow for democratization.

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Indian Prime Minister Narendra Modi’s recent visit to the United Arab Emirates revealed New Delhi’s intention to bolster bilateral relations with the Gulf states. It was the first visit by an Indian prime minister in over 30 years, demonstrating the country’s renewed focus on expanding ties with the region it has always called “West Asia.” Although India and the Middle East share a long history of trade, immigration and cultural exchange, relations have yet to reach their full potential.

Read "Dealing with Delhi: How culture shapes India’s Middle East policy"

In this policy briefing, Kadira Pethiyagoda highlights the importance of an under-reported aspect of the relationship – culture. The author explains the role it plays in India’s policies toward the region, particularly under the current government, and argues that Gulf states need to understand the impact of Indian values and identity. Pethiyagoda provides recommendations on how the Gulf states can, through better understanding the cultural drivers of Indian foreign policy, build stronger ties with India, thereby advancing both economic and strategic interests.

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The final months of Obama’s historic terms of office as America’s first black president are taking place against the backdrop of an ugly Republican nominating race, and to the sound of ugly language on race from Donald Trump. Progress towards racial equality is indeed proceeding in faltering steps, as the president himself made clear in a commencement speech, one of his last as president, to the graduating class of Howard University.

“America is a better place today than it was when I graduated from college,” the president said. But on the question of progress on closing the race gap, he provided some mixed messages. Much done; more to do. The president picked out some specific areas on both sides of the ledger, many of which we have looked at on these pages.

Three reasons to be cheerful

1."Americans with college degrees, that rate is up.”

The share of Americans who have completed a bachelor’s degree or higher is now at 34 percent, up from 23 percent in 1990. That’s good news in itself. But it is particularly good news for social mobility, since people born at the bottom of the income distribution who get at BA experience much more upward mobility than those who do not:

2. "We've cut teen pregnancy in half."

The teen birthrate recently hit an all-time low, with a reduction in births by 35 percent for whites, 44 percent for blacks, and 51 percent for Hispanics:

This is a real cause for celebration, as the cost of unplanned births is extremely high. Increased awareness of highly effective methods of contraception, like Long Acting Reversible Contraception (LARCs), has certainly helped with this decline. More use of LARCs will help still further.

3. "In 1983, I was part of fewer than 10 percent of African Americans who graduated with a bachelor's degree. Today, you're part of the more than 20 percent who will."

Yes, black Americans are more likely to be graduating college. And contrary to some rhetoric, black students who get into selective colleges do very well, according to work from Jonathan Rothwell:

Three worries on race gaps

But of course it’s far from all good news, as the president also made clear. 

1. "We've still got an achievement gap when black boys and girls graduate high school and college at lower rates than white boys and white girls."

The white-black gap in school readiness, measured by both reading and math scores, has not closed at the same rate as white-Hispanic gaps. And while there has been an increase in black college-going, most of this rise has been in lower-quality institutions, at least in terms of alumni earnings (one likely reason for race gaps in college debt):

2. "There are folks of all races who are still hurting—who still can’t find work that pays enough to keep the lights on, who still can’t save for retirement."

Almost a third of the population has no retirement savings. Many more have saved much less than they will need, especially lower-income households. Wealth gaps by race are extremely large, too. The median wealth of white households is now 13 times greater than for black households:

3. "Black men are about six times likelier to be in prison right now than white men."

About one-third of all black male Americans will spend part of their life in prison. Although whites and blacks use and/or sell drugs at similar rates, blacks are 3 to 4 times more likely to be arrested for doing so, and 9 times more likely to be admitted to state prisons for a drug offense. The failed war on drugs and the trend towards incarceration have been bad news for black Americans in particular:

Especially right now, it is inspiring to see a black president giving the commencement address at a historically black college. But as President Obama knows all too well, there is a very long way to go.

      

At the very heart of the American idea is the notion that, unlike in other places, we can start from nothing and through hard work have everything. That nothing we can imagine is beyond our reach. That we will pull up stakes, go anywhere, do anything to make our dreams come true. But what if that's just a myth? What if the truth is something very different? What if we are…stuck?

I. What does it mean to be an American?

Full disclosure: I'm British. Partial defense: I was born on the Fourth of July. I also have made my home here, because I want my teenage sons to feel more American. What does that mean? I don't just mean waving flags and watching football and drinking bad beer. (Okay, yes, the beer is excellent now; otherwise, it would have been a harder migration.) I'm talking about the essence of Americanism. It is a question on which much ink—and blood—has been spent. But I think it can be answered very simply: To be American is to be free to make something of yourself. An everyday phrase that's used to admire another ("She's really made something of herself") or as a proud boast ("I'm a self-made man!"), it also expresses a theological truth. The most important American-manufactured products are Americans themselves. The spirit of self-creation offers a strong and inspiring contrast with English identity, which is based on social class. In my old country, people are supposed to know their place. British people, still constitutionally subjects of Her Majesty Queen Elizabeth, can say things like "Oh, no, that's not for people like me." Infuriating.

Americans do not know their place in society; they make their place. American social structures and hierarchies are open, fluid, and dynamic. Mobility, not nobility. Or at least that's the theory. Here's President Obama, in his second inaugural address: "We are true to our creed when a little girl born into the bleakest poverty knows that she has the same chance to succeed as anybody else because she is an American; she is free, and she is equal, not just in the eyes of God but also in our own."

Politicians of the left in Europe would lament the existence of bleak poverty. Obama instead attacks the idea that a child born to poor parents will inherit their status. "The same chance to succeed as anybody else because she is an American…."

Americanism is a unique and powerful cocktail, blending radical egalitarianism (born equal) with fierce individualism (it's up to you): equal parts Thomas Paine and Horatio Alger. Egalitarian individualism is in America's DNA. In his original draft of the Declaration of Independence, Thomas Jefferson wrote that "men are created equal and independent," a sentiment that remained even though the last two words were ultimately cut. It was a declaration not only of national independence but also of a nation of independents.

The problem lately is not the American Dream in the abstract. It is the growing failure to realize it. Two necessary ingredients of Americanism—meritocracy and momentum—are now sorely lacking.

America is stuck.

Almost everywhere you look—at class structures, Congress, the economy, race gaps, residential mobility, even the roads—progress is slowing. Gridlock has already become a useful term for political inactivity in Washington, D. C. But it goes much deeper than that. American society itself has become stuck, with weak circulation and mobility across class lines. The economy has lost its postwar dynamism. Racial gaps, illuminated by the burning of churches and urban unrest, stubbornly persist.

In a nation where progress was once unquestioned, stasis threatens. Many Americans I talk to sense that things just aren't moving the way they once were. They are right. Right now this prevailing feeling of stuckness, of limited possibilities and uncertain futures, is fueling a growing contempt for institutions, from the banks and Congress to the media and big business, and a wave of antipolitics on both left and right. It is an impotent anger that has yet to take coherent shape. But even if the American people don't know what to do about it, they know that something is profoundly wrong.

II. How stuck are we?

Let's start with the most important symptom: a lack of social mobility. For all the boasts of meritocracy—only in America!—Americans born at the bottom of the ladder are in fact now less likely to rise to the top than those situated similarly in most other nations, and only half as likely as their Canadian counterparts. The proportion of children born on the bottom rung of the ladder who rise to the top as adults in the U.S. is 7.5 percent—lower than in the U.K. (9 percent), Denmark (11.7), and Canada (13.5). Horatio Alger has a funny Canadian accent now.

It is not just poverty that is inherited. Affluent Americans are solidifying their own status and passing it on to their children more than the affluent in other nations and more than they did in the past. Boys born in 1948 to a high-earning father (in the top quarter of wage distribution) had a 33 percent chance of becoming a top earner themselves; for those born in 1980, the chance of staying at the top rose sharply to 44 percent, according to calculations by Manhattan Institute economist Scott Winship. The sons of fathers with really high earnings—in the top 5 percent—are much less likely to tumble down the ladder in the U. S. than in Canada (44 percent versus 59 percent). A "glass floor" prevents even the least talented offspring of the affluent from falling. There is a blockage in the circulation of the American elite as well, a system-wide hardening of the arteries.

Exhibit A in the case against the American political elites: the U. S. tax code. To call it Byzantine is an insult to medieval Roman administrative prowess. There is one good reason for this complexity: The American tax system is a major instrument of social policy, especially in terms of tax credits to lower-income families, health-care subsidies, incentives for retirement savings, and so on. But there are plenty of bad reasons, too—above all, the billions of dollars' worth of breaks and exceptions resulting from lobbying efforts by the very people the tax system favors.

So fragile is the American political ego that we can't go five minutes without congratulating ourselves on the greatness of our system, yet policy choices exacerbate stuckness.

The American system is also a weak reed when it comes to redistribution. You will have read and heard many times that the United States is one of the most unequal nations in the world. That is true, but only after the impact of taxes and benefits is taken into account. What economists call "market inequality," which exists before any government intervention at all, is much lower—in fact it's about the same as in Germany and France. There is a lot going on under the hood here, but the key point is clear enough: America is unequal because American policy moves less money from rich to poor. Inequality is not fate or an act of nature. Inequality is a choice.

These are facts that should shock America into action. For a nation organized principally around the ideas of opportunity and openness, social stickiness of this order amounts to an existential threat. Although political leaders declare their dedication to openness, the hard issues raised by social inertia are receiving insufficient attention in terms of actual policy solutions. Most American politicians remain cheerleaders for the American Dream, merely offering loud encouragement from the sidelines, as if that were their role. So fragile is the American political ego that we can't go five minutes without congratulating ourselves on the greatness of our system, yet policy choices exacerbate stuckness and ensure decline.

In Britain (where stickiness has historically been an accepted social condition), by contrast, the issues of social mobility and class stickiness have risen to the top of the political and policy agenda. In the previous U.K. government (in which I served as director of strategy to Nick Clegg, the deputy prime minister), we devoted whole Cabinet meetings to the problems of intergenerational mobility and the development of a new national strategy. (One result has been a dramatic expansion in pre-K education and care: Every 3- and 4-year-old will soon be entitled to 30 hours a week for free.) Many of the Cabinet members were schooled at the nation's finest private high schools. A few had hereditary titles. But they pored over data and argued over remedies—posh people worrying over intergenerational income quintiles.

Why is social mobility a hotter topic in the old country? Here is my theory: Brits are acutely aware that they live in a class-divided society. Cues and clues of accent, dress, education, and comportment are constantly calibrated. But this awareness increases political pressure to reduce these divisions. In America, by contrast, the myth of classlessness stands in the way of progress. The everyday folksiness of Americans—which, to be clear, I love—serves as a social camouflage for deep economic inequality. Americans tell themselves and one another that they live in a classless land of open opportunity. But it is starting to ring hollow, isn't it?

III. For black Americans, claims of equal opportunity have, of course, been false from the founding.

They remain false today. The chances of being stuck in poverty are far, far greater for black kids. Half of those born on the bottom rung of the income ladder (the bottom fifth) will stay there as adults. Perhaps even more disturbing, seven out of ten black kids raised in middle-income homes (i.e., the middle fifth) will end up lower down as adults. A boy who grows up in Baltimore will earn 28 percent less simply because he grew up in Baltimore: In other words, this supersedes all other factors. Sixty-six percent of black children live in America's poorest neighborhoods, compared with six percent of white children.

Recent events have shone a light on the black experience in dozens of U. S. cities.

Behind the riots and the rage, the statistics tell a simple, damning story. Progress toward equality for black Americans has essentially halted. The average black family has an income that is 59 percent of the average white family's, down from 65 percent in 2000. In the job market, race gaps are immobile, too. In the 1950s, black Americans were twice as likely to be unemployed as whites. And today? Still twice as likely.

From heeding the call "Go west, young man" to loading up the U-Haul in search of a better job, the instinctive restlessness of America has always matched skills to work, people to opportunities, labor to capital.

Race gaps in wealth are perhaps the most striking of all. The average white household is now thirteen times wealthier than the average black one. This is the widest gap in a quarter of a century. The recession hit families of all races, but it resulted in a wealth wipeout for black families. In 2007, the average black family had a net worth of $19,200, almost entirely in housing stock, typically at the cheap, fragile end of the market. By 2010, this had fallen to $16,600. By 2013—by which point white wealth levels had started to recover—it was down to $11,000. In national economic terms, black wealth is now essentially nonexistent.

Half a century after the passing of the Civil Rights Act, the arc of history is no longer bending toward justice. A few years ago, it was reasonable to hope that changing attitudes, increasing education, and a growing economy would surely, if slowly, bring black America and white America closer together. No longer. America is stuck.

IV. The economy is also getting stuck.

Labor productivity growth, measured as growth in output per hour, has averaged 1.6 percent since 1973. Male earning power is flatlining. In 2014, the median full-time male wage was $50,000, down from $53,000 in 1973 (in the dollar equivalent of 2014). Capital is being hoarded rather than invested in the businesses of the future. U. S. corporations have almost $1.5 trillion sitting on their balance sheets, and many are busily buying up their own stock. But capital expenditure lags, hindering the economic recovery.

New-business creation and entrepreneurial activity are declining, too. As economist Robert Litan has shown, the proportion of "baby businesses" (firms less than a year old) has almost halved since the late 1970s, decreasing from 15 percent to 8 percent—the hallmark of "a steady, secular decline in business dynamism." It is significant that this downward trend set in long before the Great Recession hit. There is less movement between jobs as well, another symptom of declining economic vigor.

Americans are settling behind their desks—and also into their neighborhoods. The proportion of American adults moving house each year has decreased by almost half since the postwar years, to around 12 percent. Long-distance moves across state lines have as well. This is partly due to technological advances, which have weakened the link between location and job prospects, and partly to the growth of economic diversity in cities; there are few "one industry" towns today. But it is also due to a less vibrant housing market, slower rates of new business creation, and a lessening in Americans' appetite for disruption, change, and risk.

This geographic settling is at odds with historic American geographic mobility. From heeding the call "Go west, young man" to loading up the U-Haul in search of a better job, the instinctive restlessness of America has always matched skills to work, people to opportunities, labor to capital. Rather than waiting for help from the government, or for the economic tide to turn back in their favor, millions of Americans changed their life prospects by changing their address. Now they are more likely to stay put and wait. Others, especially black Americans, are unable to escape the poor neighborhoods of their childhood. They are, as the title of an influential book by sociologist Patrick Sharkey puts it, Stuck in Place.

There are everyday symptoms of stuckness, too. Take transport. In 2014, Americans collectively spent almost seven billion hours stuck motionless in traffic—that's a couple days each. The roads get more jammed every year. But money for infrastructure improvements is stuck in a failing road fund, and the railophobia of politicians hampers investment in public transport.

Whose job is it to do something about this? The most visible symptom of our disease is the glue slowly hardening in the machinery of national government. The last two Congresses have been the least productive in history by almost any measure chosen, just when we need them to be the most productive. The U. S. political system, with its strong separation among competing centers of power, relies on a spirit of cross-party compromise and trust in order to work. Good luck there.

V. So what is to be done?

As with anything, the first step is to admit the problem. Americans have to stop convincing themselves they live in a society of opportunity. It is a painful admission, of course, especially for the most successful. The most fervent believers in meritocracy are naturally those who have enjoyed success. It is hard to acknowledge the role of good fortune, including the lottery of birth, when describing your own path to greatness.

There is a general reckoning needed. In the golden years following World War II, the economy grew at 4 percent per annum and wages surged. Wealth accumulated. The federal government, at the zenith of its powers, built interstates and the welfare system, sent GIs to college and men to the moon. But here's the thing: Those days are gone, and they're not coming back. Opportunity and growth will no longer be delivered, almost automatically, by a buoyant and largely unchallenged economy. Now it will take work.

The future success of the American idea must now be intentional.

Entrepreneurial, mobile, aspirational: New Americans are true Americans. We need a lot more of them.

There are plenty of ideas for reform that simply require will and a functioning political system. At the heart of them is the determination to think big again and to vigorously engage in public investment. And we need to put money into future generations like our lives depended on it, because they do: Access to affordable, effective contraception dramatically cuts rates of unplanned pregnancy and gives kids a better start in life. Done well, pre-K education closes learning gaps and prepares children for school. More generous income benefits stabilize homes and help kids. Reading programs for new parents improve literacy levels. Strong school principals attract good teachers and raise standards. College coaches help get nontraditional students to and through college. And so on. We are not lacking ideas. We are lacking a necessary sense of political urgency. We are stuck.

But we can move again if we choose.

In addition to a rejuvenation of policy in all these fields, there are two big shifts required for an American twenty-first-century renaissance: becoming open to more immigration and shifting power from Washington to the cities.

VI. America needs another wave of immigration.

This is in part just basic math: We need more young workers to fund the old age of the baby boomers. But there is more to it than that. Immigrants also provide a shot in the arm to American vitality itself. Always have, always will. Immigrants are now twice as likely to start a new business as native-born Americans. Rates of entrepreneurialism are declining among natives but rising among immigrants.

Immigrant children show extraordinary upward-mobility rates, shooting up the income-distribution ladder like rockets, yet by the third or fourth generation, the rates go down, reflecting indigenous norms. Among children born in Los Angeles to poorly educated Chinese immigrants, for example, an astonishing 70 percent complete a four-year-college degree. As the work of my Brookings colleague William Frey shows, immigrants are migrants within the U. S., too, moving on from traditional immigrant cities—New York, Los Angeles—to other towns and cities in search of a better future. Entrepreneurial, mobile, aspirational: New Americans are true Americans. We need a lot more of them.

This makes a mockery of our contemporary political "debates" about immigration reform, which have become intertwined with race and racism. Some Republicans tap directly into white fears of an America growing steadily browner. More than four in ten white seniors say that a growing population of immigrants is a "change for the worse"; half of white boomers believe immigration is "a threat to traditional American customs and values." But immigration delves deeper into the question of American identity than it does even issues of race. Immigrants generate more dynamism and aspiration, but they are also unsettling and challenging. Where this debate ends will therefore tell us a great deal about the trajectory of the nation. An America that closes its doors will be an America that has chosen to settle rather than grow, that has allowed security to trump dynamism.

VII. The second big shift needed to get America unstuck is a revival of city and state governance.

Since the American Dream is part of the national identity, it seems natural to look to the national government to help make it a reality. But cities are now where the American Dream will live or die. America's hundred biggest metros are home to 67 percent of the nation's population and 75 percent of its economy. Americans love the iconography of the small town, even at the movies—but they watch those movies in big cities.

Powerful mayors in those cities have greater room for maneuvering and making an impact than the average U. S. senator. Even smaller cities and towns can be strongly influenced by their mayor.

There are choices to be made. Class divisions are hardening. Upward mobility has a very weak pulse. Race gaps are widening.

The new federalism in part is being born of necessity. National politics is in ruins, and national institutions are weakened by years of short-termism and partisanship. Power, finding a vacuum in D. C., is diffusive. But it may also be that many of the big domestic-policy challenges will be better answered at a subnational level, because that is where many of the levers of change are to be found: education, family planning, housing, desegregation, job creation, transport, and training. Amid the furor over Common Core and federal standards, it is important to remember that for every hundred dollars spent on education, just nine come from the federal government.

We may be witnessing the end of many decades of national-government dominance in domestic policy-making (the New Deal, Social Security, Medicare, welfare reform, Obamacare). The Affordable Care Act is important in itself, but it may also come to have a place in history as the legislative bookend to a long period of national-policy virtuosity.

The case for the new federalism need not be overstated. There will still be plenty of problems for the national government to fix, including, among the most urgent, infrastructure and nuclear waste. The main tools of macroeconomic policy will remain the Federal Reserve and the federal tax code. But the twentieth-century model of big federal social-policy reforms is in decline. Mayors and governors are starting to notice, and because they don't have the luxury of being stuck, they are forced to be entrepreneurs of a new politics simply to survive.

VIII. It is possible for America to recover its earlier dynamism, but it won't be easy.

The big question for Americans is: Do you really want to? Societies, like people, age. They might also settle down, lose some dynamism, trade a little less openness for a little more security, get a bit stuck in their ways. Many of the settled nations of old Europe have largely come to terms with their middle age. They are wary of immigration but enthusiastic about generous welfare systems and income redistribution. Less dynamism, maybe, but more security in exchange.

America, it seems to me, is not made to be a settled society. Such a notion runs counter to the story we tell ourselves about who we are. (That's right, we. We've all come from somewhere else, haven't we? I just got here a bit more recently.) But over time, our narratives become myths, insulating us from the truth. For we are surely stuck, if not settled. And so America needs to decide one way or the other. There are choices to be made. Class divisions are hardening. Upward mobility has a very weak pulse. Race gaps are widening. The worst of all worlds threatens: a European class structure without European welfare systems to dull the pain.

Americans tell themselves and the world that theirs is a society in which each and all can rise, an inspiring contrast to the hereditary cultures from which it sprang. It's one of the reasons I'm here. But have I arrived to raise my children here just in time to be stuck, too? Or will America be America again?

Editor's note: This piece originally appeared in Esquire.

      

“A society of equals is a society in which disadvantages do not cluster,” say Jonathan Wolff and Avner de-Shalit in their book Disadvantage. Low income matters greatly in itself, of course. But it also matters because it brings other difficulties along with it, like poor health and/or a lack of health insurance. An important goal of policy is to “de-cluster” these disadvantages.  

Increased health insurance coverage has had a modest impact on access

In recent years, the State of Colorado, embracing and going beyond the Affordable Care Act, has increased health insurance coverage, especially among low-income residents. Between 2009 and 2015, the proportion of Coloradans with annual family incomes below $30,000 who were uninsured fell from one in four to one in ten.

Clearly this is good news. But the expansion of insurance has so far had a modest impact on healthcare utilization, at least according to the Colorado Health Access Survey. The Survey includes questions such as, “Have you visited a health care professional or health care facility in the past 12 months?,” and “Was there any time that you did not get doctor care that you needed because of cost?” On these and similar questions, there was relatively little change between 2009 and 2015.

Why didn’t improved health insurance coverage lead to increased use of health care resources? It may be that the survey questions simply aren’t capturing improvements in utilization rates. A more detailed study of the ACA expansion in Oregon did find an increase in utilization, along with improvements on a number of financial hardship indicators. The Colorado survey does seem to suggest financial improvement: the share of low-income white residents that reported trouble paying medical bills fell by just over 3 percentage points from 2009 to 2015; for minority residents the figure was just over 6 percentage points. It’s hard to know, however, how much of this trend is driven by the stronger economy, and how much is driven by the ACA expansion. It is also possible that people are now able to access more appropriate care, for instance using primary care, rather than resorting to the emergency room.

Dental care coverage means most low-income Coloradans now visit the dentist

Utilization rates have clearly increased in one area, however: dental health. Medicaid covers dental care for children, so Colorado’s Medicaid expansion increased the number of children in the state with government-sponsored dental insurance. In 2014, Colorado also became one of the few states to introduce limited adult dental coverage. As a result of these policy reforms, the share of low-income Coloradans with insurance for dental care has increased sharply:

Over the same time period, the proportion of low-income Coloradans who visited a dentist—especially minorities—increased, too:

Better living through dentistry

Dentistry is an important part of the health care system, and dental disease is a serious health issue. Four in ten poor Americans suffer from untreated tooth decay, according to some researchers. Better dental care helps low-income people in a range of ways, from avoiding emergency rooms, to having healthier pregnancies, and even succeeding in the job market. The dramatic improvements in dental coverage and dental care in Colorado show that the connection between policy reforms and improved quality of life can sometimes be quite straightforward. 

      

Community colleges are a vital part of America’s opportunity structure, not least because they often provide a way into higher education for adults from less advantaged backgrounds. Each year there are around 10 million undergraduates enrolled at public, two-year colleges. Among first-generation students, nearly 38 percent attend community colleges, compared to 20 percent of students with college-educated parents.

Credentials from community colleges—whether short vocational courses or two-year associate degrees—can be valuable in the labor market. In theory, community colleges also provide an on-ramp for those seeking a bachelor’s degree; in fact, four out of five students enrolling intend to get a 4-year degree.

But the potential of community college is often unrealized. Many students are not ready. Quality varies. Pathways are often unclear and/or complex. Only about 40 percent of those enrolling earn a degree within six years. Just 15 percent acquire a 4-year degree, according to analyses by Doug Shapiro and Afet Dundar at the National Student Clearinghouse Research Center.

Transfers rates from community college vary dramatically by state

The degree of alignment and integration between community and four-year colleges is much greater in some states than others. Some use common course numbering for 2- and 4-year institutions, which helps students find the classes they need without racking up costly excess credits. In others, universities and community colleges have tried to align their curriculum to ensure that students’ transfer credits will be accepted.

Individual institutions like Queensborough College (part of the CUNY system) and Miami-Dade College have streamlined course sequences to help their students stay on track to transfer into 4-year schools, as Thomas Bailey, Shanna Jaggers, and Davis Jenkins describe in their book, Redesigning America’s Community Colleges. There’s some indirect evidence that these initiatives increased retention and graduation rates.

These policy differences help to explain the very different stories of transfer rates in different states, revealed in a recent study by Davis Jenkins and John Fink. One important measure is the proportion of students transferring out of community college with a certificate or associate degree already in hand:

Florida tops the list, partly because of state legislation requiring that community colleges grant eligible transfer students degrees—but also because of concerted investments at the state and institutional levels to improve 2-year institutions.

Another measure of success is the proportion of those who transfer ending up with a four-year degree. Again, there are significant variations between states:

Since community colleges serve so many more students from poor backgrounds, the importance of the transfer pathway for social mobility is clear. Many who struggle at high school may begin to flourish in the first year or two of post-secondary education. As their skills are upgraded, so their opportunities should widen. But too often they become trapped in the silos of post-secondary education. We should continue to support efforts like pathway programs that explicitly attempt to build bridges between community colleges and high-quality four year institutions through the creation of clear and consistent major-specific program maps. Such programs allow students starting out at community colleges to easily chart out the specific, clear, and coherent set of steps needed to eventually finish their post-secondary education with a four-year degree.

Tuning an American engine of social mobility

The mission of community colleges since their inception a century ago has been to broaden access to education. Today that means providing a solid education to all students, but also providing opportunities to move on to other institutions.

       

The BBC is doing something I think is awesome but many of my American friends think is awful: gathering information of the social class background of their recruits. The move is part of an aggressive strategy to promote more diversity both on the airwaves and behind the scenes at the public service broadcaster. The civil service has been moving in the same direction.

Some questions arise:

1. Can you measure social class?

Race and gender are relatively straightforward characteristics, notwithstanding the recent nonsense over restrooms for transgender people. Defining social class is a much more complex business. Many variables could be included, including occupational status, income or wealth, as well as education or cultural capital.

But the goal here is simply to find a measure that is good enough for the purposes at hand. The BBC asks whether either of your parents has a college degree. This is not a bad approach. Education is an important dimension of social class in itself, and strongly related to others. The BBC is also going to ask whether at any point in childhood the person in question was eligible for free school meals. (The questions are voluntary.)

Such proxy measures are narrow measures of class. But they are better than the current ones, since there are none.

2. Why does it matter?

Diversity can benefit organizations by widening the range of viewpoints and perspectives. A mixed team is a better team. Class background may be as important here as other factors.

Take two people of a different race or gender, each raised by wealthy East Coast parents, attending a top-drawer private high school, and graduating from an Ivy League college. They may not be as different from each other as they are from a white man raised by a poor single mother in a small Appalachian town.

The BBC is historically an upper middle class institution: “BBC English” meant a posh accent. The British professions in general have in fact tended to draw from a narrow talent pool. Around 7 percent of students attend private high schools (or “public schools”, in British). But they are strongly over-represented in the top professions, including journalism:

From a broader societal perspective, the persistence of class inequality is of course bad news for upward social mobility.

3. What can be done about class diversity by organizations anyway?

Simply raising awareness of a potential class bias in hiring and promotions could be valuable. Reforming institutional practices—for example the allocation of internship opportunities—may also help. Broadening the search for talent beyond the marquee brands of higher education is likely to diversify the class background of recruits; the BBC is also moving to both name-blind and institution-blind applications. At the same time, greater support for less traditional hires may help them to succeed.

Time to get class conscious

The U.S. sees itself as a classless society, one reason Americans recoil against monitoring social class. It is an understandable instinct. But the perpetuation of class status is now at least as big a problem in the U.S. as in the UK. Even as white privilege and male privilege have diminished, class privilege has survived. A little more class-consciousness might not hurt.

       

Paid leave for parents is likely to be an important issue on the campaign trail this year. Hillary Clinton, positioning herself as the candidate on the side of families, argues for all parents to be paid for 12 weeks of family leave, at two-thirds of their salary up to a (so far unspecified) cap. Donald Trump has not so far ruled it out, simply saying: “We have to keep our country very competitive, so you have to be careful of it.”

Polls routinely show high levels of general support for paid leave across the political spectrum. But there are many nuances here, including how to fund the leave entitlement, how long the leave should be, and whether fathers and mothers ought to get the same treatment.

Some light can be thrown on these questions by an analysis of the American Family Survey conducted earlier this year by Deseret News and the Center for the Study of Elections and Democracy (disclosure: I am an adviser to the pollsters). 

Americans of all stripes favor at least three months paid family leave

Views differ over the optimum length of leave depending on whether it is for the mother or father, and whether it is paid or unpaid:

But even Republicans are quite supportive, backing almost four months of paid leave for mothers and three months for fathers. So on the face of it, Clinton’s plan should be a vote winner even among moderate Republicans.

More for mom than dad? Depends how you ask the question

There are important implications about gender roles here. Encouraging men to take paid leave is important not only for the quality of family life, but also for gender equality more generally. Attitudes towards the role of fathers are shifting, although the primacy of motherhood remains. Among every ideological group there was greater support for longer maternity than paternity leave. It is worth noting, however, that half the respondents supported equal leave for mothers and fathers; the variation is driven by those in the other half, who drew a distinction by gender.

It turns out that the order in which the question is asked also makes a difference. For half the respondents, the question about maternity leave came before the one on paternity leave. For the other half, the questions were asked in the opposite order. (Because of the design of the survey, respondents could not change their previous answer.) The ordering of the question had an influence on responses:

Among those who gave an answer on paternity leave first, the gap between the preferred length of leave for mothers and fathers was much less. This was especially true for unpaid leave.

Breaking gender stereotypes

When people think about paid parental leave, many may think automatically of a mother, just as they think of a man when asked to picture a “strong leader.” Asking about maternity leave first goes with the traditional cultural grain, and results in more support for mothers compared to fathers. Asking about paternity leave first interrupts the normal gender framing, and narrows the gap.

There has been a slow revolution in attitudes towards the respective roles of mothers and fathers, reflected in the strongly symmetrical attitudes towards maternity and paternity leave in this survey. But there is more work to do. Mothers and fathers both need help balancing paid work and family life. Let’s hope this can be at least one area of agreement between Clinton and Trump.

       

Britain’s Conservative Party just tore itself apart over the EU referendum; David Cameron was forced to resign as prime minister. Yet the party in meltdown is Labour. Polling out this past weekend shows Labour drawing 31%, vs. 37% for Conservatives, if a general election were held tomorrow.

The Conservative Party, showing once again its extraordinary capacity for self-preservation, is closing ranks behind new Prime Minister Theresa May. Still, how can the Tories be riding so high after such a political omnishambles? One doesn’t have to look far for an answer: the hard-left Labour leader, Jeremy Corbyn.

Asked who is or would be the best prime minister, just 16% of British voters give Mr. Corbyn the thumbs-up, compared with 52% for Ms. May. Fewer than half of Labour supporters (48%) think Mr. Corbyn would be the best PM. In her first outing in the House of Commons, Ms. May easily trounced Mr. Corbyn. (Her performance was described by the left-leaning Guardian newspaper as a “brutally brilliant” debut.) No wonder most of his parliamentary colleagues have abandoned him, forcing a leadership contest.

Again, the Conservative Party has just presided over an amateurish, disastrous session of British political history. That Tories still dominate is less about their strength than their political opponents’ weakness.

So: What will happen? I’ve just been in London, and conversations with political insiders suggest that this is the most likely scenario to play out:

First, Jeremy Corbyn, having attracted many left-wingers onto party rolls, fends off challenger Owen Smith to retain the leadership of the Labour Party.

Next, the majority of Labour MPs set themselves up as a separate parliamentary group.

As the second-largest group in parliament, these MPs would become the official opposition. They could call themselves anything–say, New Labour Party. (Read this excellent summary of the constitutional implications by Meg Russell of the University College London). This means money and status. If the anti-Corbyn MPs can’t get a new leader, they’ll get a new party.

In the meantime, a few remaining anti-Corbyn MPs stay behind and try to recapture their party. The key here, for those interested in the details, is to take control of Unite, the U.K.’s largest trade union. (Unite’s leader, Len McCluskey, is a strong supporter of Mr. Corbyn and has rallied the union’s members behind him, but his term ends soon.)

If the Labour Party, reduced to a parliamentary rump, remains in Mr. Corbyn’s hands, the next general election would be the moment when the split becomes formal. The New Labour Party would try to attract Liberal Democrat and Green supporters, as well as pro-European conservatives.

Theresa May is likely to wait until the next scheduled general election, in 2020, to face voters. But if Labour were to split, she might decide to call a snap general election to take advantage of opponents’ disarray. Either way, it seems likely the Tories would win.

Center-left parties across the globe seem to be struggling to connect with the anxieties of ordinary voters, leaving them at the mercy of populist appeals. Between populist surges and volatile electorates, we are seeing destabilizing forces at work in politics. Strong political parties act as stabilizers in stormy waters. Whatever one’s individual politics, the fate of the Labour Party in Britain, and perhaps the Republican Party in the U.S., should concern us all.

---

Editor's note: This piece originally appeared in The Wall Street Journal. 

       

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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Time and again, China has defied the skeptics who claimed its unique mixed model—an ever-more market-driven economy dominated by an authoritarian Communist Party and behemoth state-owned enterprises—could not possibly endure. Today, those voices are louder than ever. Michael Pettis, a professor at Peking University's Guanghua School of Management and one of the most persistent and well-regarded skeptics, predicted in March that China's economic growth rate "will average not much more than 3% annually over the rest of the decade." Barry Eichengreen, an economist at the University of California, Berkeley, warned last year that China is nearing a wall hit by many high-speed economies when growth slows or stops altogether—the so-called "middle-income trap."

No question, China has many problems. Years of one-sided investment-driven growth have created obvious excesses and overcapacity. A weaker global economy since the 2008 financial crisis and rapidly rising labor cost at home have slowed China's vaunted export machine. Meanwhile, a massive housing bubble is slowly deflating, and the latest economic data is discouraging. Real growth in GDP slowed to an annualized rate of less than 7 percent in the first quarter of 2012, and April saw a sharp slowdown in industrial output, electricity production, bank lending, and property transactions. Is China's legendary economy in serious trouble?

Not just yet. The odds are that China will navigate these shoals and continue to grow at a fairly rapid pace of around 7 percent a year for the remainder of the decade, overtaking the United States to become the world's biggest economy around 2020. That's a lot slower than the historical average of 10 percent, but still solid. Considerably less certain, however, is whether China's secretive and corrupt Communist Party can make this growth equitable, inclusive, and fair. Rather than economic collapse, it's far more likely that a decade from now China will have a strong economy but a deeply flawed and unstable society.

China's economic model, for all its odd communist trappings, closely resembles the successful strategy for "catch-up growth" pioneered by Japan, South Korea, and Taiwan after World War II. The theory behind catch-up growth is that poor countries can achieve substantial convergence with rich-country income levels by simply copying and diffusing imported technology. In the 1950s and 1960s, for instance, Japan reverse-engineered products such as cars, watches, and cameras, enabling the emergence of global firms like Toyota, Nikon, and Sony. Achieving catch-up growth requires an export-focused industrial policy, intensive investment in enabling infrastructure and basic industry, and tight control over the financial system so that it supports infrastructure, basic industries, and exporters, instead of trying to maximize its own profits.

China's catch-up phase is far from over. It has mastered the production of basic industrial materials and consumer products, but its move into sophisticated machinery and high-tech products has only just begun. In 2010, China's per capita income was only 20 percent of the U.S. level. By most measures, China's economy today is comparable to Japan's in the late 1960s and South Korea's and Taiwan's around 1980. Each of those countries subsequently experienced another decade or two of rapid growth. Given the similarity of their economic systems, there is no obvious reason China should differ.

For catch-up countries, growth is mainly about resource mobilization, not resource efficiency, which is the name of the game for lower-growth rich countries. Historically, about two-thirds of China's annual real GDP growth has come from additions of capital and labor. Mainly this means moving workers out of traditional agriculture and into the modern labor force, and increasing the amount of capital inputs (like machinery and software) per worker. Less than a third of growth in China comes from greater efficiency in resource use.

In a rich country like the United States—which already has abundant capital resources and employs all its workers in the modern sector—the reverse is true. About two-thirds of growth comes from efficiency improvements and only one-third from additions to labor or capital. Conditioned by their own experience to believe that economic growth is mainly about efficiency, analysts from rich countries come to China, see widespread waste and inefficiency, and conclude that growth must be unsustainable. They miss the larger picture: The system's immense success in mobilizing capital and labor resources overwhelms marginal efficiency problems.

All developing economies eventually reach the point where they have moved most of their workers into the modern sector and have installed roughly as much capital as they need. At that point, growth tends to slow sharply. In countries that fail to make the tricky transition from a mobilization to an efficiency focus (think Latin America), real growth in per capita GDP can virtually grind to a halt. Such countries also find themselves stuck with high levels of income inequality, which tends to rise during the resource mobilization period and fall during the efficiency phase. Some worry that China—which for the last decade has had by far the highest capital spending boom in history—is already on the edge of this precipice. But the data do not support this pessimistic view. First, much surplus agricultural labor remains. Just over one-third of China's labor force still works in agriculture; the other northeast Asian economies did not see their growth rates slow noticeably until the agricultural share of the workforce fell below 20 percent. It will take about a decade for China to reach this level.

And despite years of breakneck building, China's stock of fixed capital—the total value of infrastructure, housing, and industrial plants—is not all that large relative to either the economy or the population. Rich countries typically have a capital stock a bit more than three times their annual GDP. For China, the figure is about two and a half. And on a per capita basis, China has about as much fixed capital as Japan did in the late 1960s and less than a third of what the United States had as long ago as 1930. Further large-scale investments are still required. So China's economy can continue to grow in part based on capital spending, though a gradual transition to a consumer-led economy does need to begin soon.

One illustration of China's enduring capital deficit is housing. Scarred by the catastrophic U.S. housing bubble, many observers see an even scarier property bubble in China. Robert Z. Aliber, who literally wrote the book on financial manias, called China's housing boom "totally unsustainable" this January. And it's true: Since 2005, land and housing prices have rocketed, and the outskirts of many cities are dotted by blocks of vacant apartment buildings.

But China's housing situation differs dramatically from that of the United States. The U.S. bubble started with too much borrowing (mortgages issued at 95 percent or more of a house's supposed market value), which caused a rise in housing prices far beyond the well-established trend of the previous 40 years and sparked the construction of far more houses than there were families to buy them. In China, mortgage borrowing is modest; price appreciation was mainly a one-off growth spurt in an infant market, rather than a deviation from established trend; and there is a desperate shortage of decent housing.

Since 2000, the average house in China has been bought with around 60 percent cash down, according to research by my firm, GK Dragonomics, and the minimum legal down payment has been something in the range of 20 to 30 percent—a far cry from the subprime excesses of the United States. House prices rose rapidly, but that's partly because they were artificially low before 2000, when state-owned enterprises allocated most of the housing and there was no private market. Much of the home-price appreciation of the last decade was simply a matter of the market catching up with underlying reality. And despite articles about "ghost cities" of empty apartment blocks, the bigger truth is that urban China has a housing shortage—the opposite of what typically happens at the end of a bubble.

Nearly one-third of China's 225 million urban households live in a dwelling without its own kitchen or toilet. That's like the entire country of Indonesia living in factory dormitories, temporary shelters on construction sites, basement air-raid shelters, or shanties on city outskirts. Over the next two decades, if present trends continue, another 300 million people— equivalent to nearly the entire population of the United States—will move from the countryside to China's cities. To accommodate these new migrants, alleviate the present shortage, and replace dilapidated housing, China will need to build 10 million housing units a year every year from now to 2030. Actual average completions from 2000 to 2010 were just 7 million a year, so China still has a lot of building to do. The same goes for much basic infrastructure such as power plants, gas and water supplies, and air cargo facilities.

Yet the housing market also illustrates China's true problem: not that growth is unsustainable, but that it is deeply unfair. The overall housing shortage coexists with an oversupply of luxury housing, built to cater to a new elite. Although most Chinese have benefited from economic growth, the top tier have benefited obscenely—often simply because of their government or party connections, which enable them to profit immensely from land grabs, graft on construction projects, or insider access to lucrative stock market listings. A 2010 study by Chinese economist Wang Xiaolu found that the top 2 percent of households earned a staggering 35 percent of national urban income. A handful of giant state firms, secure in monopoly positions and flush with cheap loans from state banks, has almost unlimited access to moneymaking opportunities. The state-owned banks themselves earned a staggering $165 billion in 2011. Yet private firms, which produce almost all of China's productivity and employment gains, earn thin margins and suffer pervasive discrimination.

At the root lies a political system built on a principle of unfairness. The Communist Party ultimately controls the allocation of all resources; its officials are effectively immune to legal prosecution until they first undergo an opaque internal disciplinary process. Occasionally a high official is brought down on corruption charges, like former Chongqing party secretary Bo Xilai. But such cases reflect elite power struggles, not a determined effort to end corruption. In a few years' time, China will likely surpass the United States as the world's top economy. But until it solves its fairness problem, it will remain a second-rate society.

      

The recent gyrations in the Chinese interbank market underscore that the chief risk to global growth now comes from China. Make no mistake: credit policy will tighten substantially in the coming months, as the government tries to push loan growth from its current rate of 20% down to something much closer to the rate of nominal GDP growth, which is about half that. Moreover, in the last few months of the year the new government will likely start concrete action on some long-deferred structural reforms. These reforms will bolster China’s medium-term growth prospects, but the short-term impact will be tough for the economy and for markets.

The combination of tighter credit and structural reforms means that with the best of luck China could post GDP growth in 2014 of a bit over 6%, its weakest showing in 15 years and well below most current forecasts. A policy mistake such as excessive monetary tightening could easily push growth below the 6% mark. Banks and corporations appear finally to be getting the message that the new government, unlike its predecessor, will not support growth at some arbitrary level through investment stimulus.

The dire performance of China’s stock markets in the past two weeks reflects this growing realization among domestic investors, although we suspect stocks have further to fall before weaker growth is fully discounted.

Slower growth… but no Armageddon

But the China risk is mainly of a negative growth shock, not financial Armageddon as some gloomier commentary suggests. Financial crisis risk remains relatively low because the system is closed and the usual triggers are unavailable. Emerging market financial crises usually erupt for one of two reasons: a sudden departure of foreign creditors or a drying-up of domestic funding sources for banks. China has little net exposure to foreign creditors and runs a large current account surplus, so there is no foreign trigger. And until now, banks have funded themselves mainly from deposits at a loan-to-deposit ratio (LDR) of under 70%, although the increased use of quasi-deposit wealth management products means the true LDR may be a bit higher, especially for smaller banks. The danger arises when banks push up their LDRs and increasingly fund themselves from the wholesale market. So a domestic funding trigger does not exist—yet.

The People’s Bank of China clearly understands the systemic risk of letting banks run up lending based on fickle wholesale funding. This is why it put its foot down last week and initially refused to pump money into the straitened interbank market. Interbank and repo rates have dropped back from their elevated levels, but remain significantly above the historical average. The message to banks is clear: lend within your means. This stance raises confidence that Beijing will not let the credit bubble get out of control. But it also raises the odds that both credit and economic growth will slow sharply in the coming 6-12 months.

If the economy slows and local stock markets continue to tumble, doesn’t this mean the renminbi will also weaken sharply? Not necessarily. Beijing has a long-term policy interest in increasing the international use of the renminbi, which can only occur if the currency earns a reputation as a reliable store of value in good times and bad. Allowing a sharp devaluation now runs against this interest, and also would be a sharp break from a long-established policy of not resorting to devaluation to stimulate growth, even at moments of severe stress (as in 1997-98 and 2008-09). So while our call on China growth has been marked down, our call on the renminbi has not.

Short-term pain is better than long-term stagnation

From a broader perspective, the biggest China risk is not that the country suffers a year or two of sharply below-trend growth. If that slowdown reflects more rational credit allocation and the early, painful stages of productivity-enhancing reforms, it will be healthy medicine. And even a much slower China will still be growing faster than all developed markets and most emerging ones.

The real risk is rather that the new government will show a lack of nerve or muscle and fail to push through financial sector liberalization, deregulation of markets to favor private firms, and fiscal reforms to curtail local governments’ ability to prop up failing firms, overspend on infrastructure, and inflate property bubbles. The old government wasted the last three years of its term doing none of these things despite the obvious need. The new leaders are talking a better game, but they have a year at most to articulate a clear reform program, begin implementation (liberalizing interest rates and freeing electricity prices would be a good start), and ruthlessly removing senior officials who stand in the way. If they fail to deliver, then the short-term slowdown could become a long and dismal decline.

       

The rapid development of China’s shadow banking sector since 2010 has attracted a great amount of commentary both inside and outside the country. Haunted by the severe crisis in the US financial system in 2008, which was caused in part by the previously unsuspected fragility of a large network of non-bank financial activities, many analysts wonder if China might be headed for a similar meltdown. The concern is especially acute given China’s very rapid rate of credit creation since 2010 and the lack of transparency in much off balance sheet or non-bank activity.

This paper will address the following questions:

1. What is shadow banking?
2. Why does the sector matter?
3. What was the Chinese credit system like before shadow banking?
4. What is the nature of shadow banking in China now?
5. How big is shadow banking in China?
6. Why has Chinese shadow banking grown so fast?
7. How does Chinese shadow banking relate to the formal banking sector?
8. Why has the Chinese sector developed as it has?
9. How does the size and structure of shadow banking in China compare to other countries?
10. Will there be a major shadow banking crisis in China?
11. How do Chinese authorities intend to reform shadow banking?

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Despite being a developed and prosperous country, Japan faces a host of basic challenges today and going forward—some of its own creation and others beyond the country’s control. For example, Japan lacks essential natural resources, while also facing overcrowding in cities and depopulation in rural areas. As a result, food and energy self-sufficiency is low. Also, while the dual phenomena of a low birthrate and an ageing population have long been deemed problematic, these issues are rapidly growing more serious. The problems Japan faces today are potentially the same problems the rest of the world will face in the near future. Japan, therefore, may serve as a bellwether for the global community as many nations anticipate similar challenges in the future.  

On October 26, the Center for East Asia Policy Studies at Brookings and the U.S.-Japan Research Institute co-hosted Hiroshi Komiyama, chairman of the Mitsubishi Research Institute and president emeritus of the University of Tokyo, for a discussion of his recent book, “Beyond the Limits to Growth: New Ideas for Sustainability from Japan.” In this book, Komiyama examines the issues facing Japan—and the world—presenting a number of potential viable solutions and offering insights into Japan’s experiences and the lessons it can provide for a more sustainable future.

 

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The confluence of the agreement on 17 Sustainable Development Goals (SDGs, or Global Goals) in 2015, and the increased attention being paid to the role of non-traditional actors in contributing to shared prosperity, provide a unique opportunity to focus attention on attempts to identify promising new solutions to the barriers that impede the full development of the world’s youngest citizens. Current estimates indicate that 200 million children globally under the age of 5 are at risk of not reaching their development potential. With these goals, the global community has a tremendous opportunity to change the course of history. There is evidence that certain early childhood development (ECD) interventions—spanning the nutrition, health, water and sanitation, education, social protection, and governance sectors from conception to age 5—have high potential to help to achieve the SDGs related to child development. Furthermore, early childhood interventions have been found to improve adult health and education levels, reduce crime, and raise employment rates, which will be paramount to achieving global economic, climate, and physical security.

Impact bonds have the potential to address some of the main financing and delivery constraints faced in ECD. By providing upfront private capital, impact bonds could help to address service provider liquidity constraints and leverage public capital by allowing the government to connect preventive programs with future benefits to individuals, society, and the economy. Impact bonds also have the potential to drive performance management, support monitoring and evaluation, and create accountability, which all help to address quality and capacity constraints. By fostering innovation, experimentation and adaptive learning in service delivery, cost-effective solutions could be identified through impact bonds. By producing evidence of outcome achievement, impact bonds could shift the focus toward effective ECD programs. Finally, collaboration across stakeholders—a necessary component of impact bonds—has the potential to allow for alignment of interests and a win-win situation for investors, outcome funders, and program beneficiaries alike.

The high participation of non-state actors and potentially significant returns in ECD make it a promising sector for impact bonds. Unlike other services that may have entrenched interests, the multitude of agencies and non-state entities financing and providing ECD services potentially allows for more experimentation. The preventive nature of ECD programs also fits well with the core feature of SIBs, which is that preventive investments will result in valuable short- and potentially long-term outcomes. There is evidence that ECD interventions can have immense effects on later-life outcomes. For example, a longitudinal study of a program in Jamaica, in which participants received weekly visits from community health workers over a 2-year period, was found to increase the earnings of participants by 25 percent, 20 years later.

There may, however, be some particular challenges associated with applying impact bonds in the ECD sector. Impact bonds (and other Payment by Results mechanisms tied to outcomes) require meaningful outcomes that are measureable within a timeframe that is reasonable to the outcome funder (and investors in the case of an impact bond). Meaningful outcomes are outcomes that are intrinsically or extrinsically valuable. Intrinsically valuable outcomes that are measureable within a reasonable timeframe could be extrinsically valuable if they are proxies for long-term benefits to individuals, society, or the economy. The delay between ECD interventions and later-life results may prove an impediment in some cases. By identifying appropriate interim measures such as language development, socioemotional development, and schooling outcomes that may proxy for desirable longer-term outcomes, the issue of delay could be mitigated. For example, there is evidence that early stimulation and health programs can have statistically significant effects on schooling outcomes in the short-run. An increase in focus on the intrinsic value of short-term outcomes that result from ECD interventions, such as child survival, is also important.

As the global community moves beyond the Millennium Development Goals to a set of Global Goals and associated targets linked to measurable outcomes, there is an opportunity to demonstrate a commitment to invest in future generations. Leveraging upfront funding, focusing on outcomes through adaptive learning and testing new ways to deliver early childhood interventions more effectively are all means of achieving the ECD-related goals. Despite the hype around all of the new financing mechanisms, the keys to creating high-quality, locally appropriate programs remains simple—real-time collection of outcome data, the freedom to fail, and the flexibility to course-adjust. In some circumstances social service provision based on outcomes and adaptive learning may require mechanisms like impact bonds or other Payment by Results mechanisms. In other circumstances it may not. As this very nascent field continues to grow, more research will be needed to capture lessons learned, contextualize them within the larger landscape of ECD financing and service provision, and apply them to real-world social challenges with the world’s youngest and most disadvantaged populations at the forefront of the conversation. 

Read the previous report on the landscape of impact bonds across sectors and geography »

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