Fault Lines: How Hidden Fractures Still Threaten the World Economy

by Raghuram G. Rajan

  The third factor contributing to the high cost of health care is the threat of malpractice suits, which cause physicians to recommend treatments that help protect them against future lawsuits, even if these treatments are strictly unnecessary for the patient’s health. Expenditures for Medicare beneficiaries in states with larger malpractice awards are about 5 percent higher: this difference is significant, though not enough alone to explain why U.S. health care is so costly.31 Nevertheless, these costs contribute to the overall cost of health care, and tort reform should be part of an effective bill.

  It is easy to minimize the complex changes that need to happen. Doctors need to recommend necessary procedures to patients, including preventative ones, but should not have an incentive to undertake excessive treatment because of the associated fees. Flat doctor salaries and flat fees per patient enrolled in a health maintenance program or for treating a particular ailment seem attractive solutions, but they are not panaceas. For instance, without other sources of motivation, flat salaries can kill the incentive to exert effort. Similarly, with better public information about the effectiveness of specific doctors, hospitals, and procedures, people can make better decisions about where and how they want to be treated. Ultimately, though, most of us will make decisions based on the advice provided by the authority, our doctor. As with education, many experiments are under way on the right mix of incentives, transparency, competition, and organizational changes that can bring doctors, hospitals, insurance companies, patients, and the government together to create an effective health care system. We need to find out what solutions work, scale them up, and continue to evaluate them as they are rolled out, recognizing that a variety of approaches will make the system more resilient. All this needs to be done quickly. Effective change will not be easy, but the benefits of affordable universal health care go far beyond the physical and moral health of American society; they extend to the economic health of the country.

  Improving Portability of Benefits and Worker Mobility

  An important element in promoting the resilience of the individual worker in downturns is the portability of savings and pension plans. Workers who are dependent on their employers for their long-run savings—for example, if they have underfunded defined-benefit pension plans, or hold large amounts of stock in the firm as part of their plans—tend to suffer a double blow when their employer gets into trouble; they lose both their jobs and their pensions. Theoretically, pension plans have to be kept fully funded, but troubled employers typically underfund their pension plans. Although the government picks up some of the tab through the Pension Benefit Guarantee Corporation, a better long-term solution is to make the workers’ savings independent of the firm’s health by ensuring that they invest in diversified defined-contribution pension plans (in which pension accumulations are invested by the employee in diversified mutual funds). More generally, making the moderately paid worker’s long-term benefits, including health care, independent of a firm’s health reduces both worker anxiety and the pressure on the government to intervene to bail out the firm to protect the workers.32

  Restrictions on worker mobility also contribute to anxiety. The workplace increasingly demands credentials and certification: for example, doctors and lawyers need different licenses to practice in each state. It is important that the United States, and indeed the world, not be balkanized by requirements that professionals reestablish credentials whenever they move. Although there are indeed legitimate concerns that testing and certification requirements (and the quality of testing procedures) may differ across regions, as could the subject matter over which mastery is required, certification is sometimes used as a means of creating more profits for certified incumbents by keeping out competition. For instance, it is hard to believe that the practice of medicine differs widely in different U.S. states. This process should be carefully reexamined to harmonize requirements or promote cross-recognition of certificates wherever possible, and to facilitate easy testing and recertification where it is not. Rich professional organizations have little incentive to give up their rents, so public pressure may be required for them to reexamine their certification requirements.

  Another factor restricting mobility, certainly in the current downturn, is home ownership. Anecdotal evidence suggests that hard-to-sell homes, and homes that are worth less than the debt that is owed, are weighing down workers and preventing them from looking elsewhere for employment. A number of financial innovations that would allow households to purchase insurance against home-price declines have been proposed, and in light of the recent crisis, demand for these instruments may increase.33 This is also a reason why the government’s focus on encouraging home ownership needs to be revisited.

  Although the modern economy needs some workers to specialize, workers like Badri, encountered in chapter 4, may tend to grow overly specialized in one industry. Robert Shiller of Yale University has argued for “livelihood” insurance—insurance that would protect workers against a decline in incomes or jobs in their particular areas of specialization. In a sense, long-term unemployment insurance is a form of livelihood insurance provided by society. The downside of such insurance is that it reduces worker incentives to keep their human capital relevant. Having an unproductive underclass that lives off their insurance payments is better than having a destitute underclass, but it is best if such payments simply help sustain them while they retool to become productive members of society again.

  An alternative is for the worker to retain mobility by building flexible human capital. Clearly, firms have little direct incentive to encourage workers to acquire general skills that their employers cannot use. Yet greater potential mobility would make workers feel more secure. In order to attract good workers, firms should offer more opportunities for human capital development. Some firms already do, but many don’t. Perhaps the problem is that young, good workers don’t fear for their future, and firms don’t want to attract less-secure workers by offering opportunities for career development. Perhaps workers themselves, once they are in the firm, delay developing portable skills—going back to school is not easy—until it is just too difficult to do so.

  Whatever the reason, as the length of working lives increases and as technology changes rapidly, more and more workers, especially in knowledge-based industries, are likely to find themselves with outdated and excessively specialized human capital. Academics typically get a sabbatical year once every seven years to renew their knowledge. (University of Chicago faculty are an exception: there is a presumption that we could not possibly learn more anywhere else on earth, so we don’t have sabbaticals.) As more workers come to resemble academics, perhaps employee sabbaticals should become more widespread. As the government could well benefit from the renewal of worker human capital, it could contemplate offering tax credits for workers who have worked for a number of years and decide to take a break to study or retool. Such a move would also put pressure on employers to allow such sabbaticals.

  Universities also need to do their bit. In the United States, life expectancy has increased by about 30 years since 1900, almost the span of an entire working career.34 Although more people today acquire advanced degrees, most still stop their formal education early in life, much as they did a hundred years ago. Education is still geared toward the first job, even though technological change, competition, and greater job mobility means that for most people, that first job, or even that first career, will not be the last.

  A system of formal education that terminates when one is twenty-five probably provides too much information related to the first few years of one’s career and too little knowledge for the half-century that follows. Would it not make more sense to deemphasize early specialization and offer more doses of formal education later on, so that individuals can cope with changes in environment and preferences?

  Business schools have taken a lead here by offering open-enrollment refresher courses to senior executives who feel the skills obtained during their MBA trainin
g need updating. But there may be a reason to rethink the entire structure of U.S. higher education, a system designed when students typically left university for a lifelong career with one employer. We need more modular degrees and lifelong admission to higher education (at least for general programs) so that students can pick and choose what they want when they need it.

  Advances in distance education using the Internet will help individuals keep up to date even while working full time and help reduce the cost of higher education. A few universities already offer a full MBA degree that requires only a few weeks of in-person attendance, with much of the necessary communication and instruction provided through online discussion groups, e-mail, and lectures. These kinds of programs will expand. One important tool, therefore, in helping citizens cope with the greater uncertainty in their lives will be a revolution in higher education.

  Savings

  Finally, workers are more resilient in the face of adversity when they have adequate savings. For too many American workers, growing house prices created an illusion of increasing wealth. It was an illusion even before the current crisis—after all, you have to live somewhere, so if the value of the home you live in is rising, you really do not have extra disposable wealth—and it became even more illusory as house prices collapsed and borrowers were left staring at a mountain of debt.

  Americans need to save more, and the government should be far less eager to encourage them to spend. Savings rates are increasing as households dig themselves out of this crisis. A number of interesting ideas have been proposed to encourage savings and are worth exploring. For instance, my colleague Richard Thaler at the University of Chicago has suggested innovative ways by which households can be nudged into saving more. In his “Save More Tomorrow” plan, devised with Shlomo Benartzi, workers sign an agreement with their employer and their financial services provider that they will place some portion of future salary raises into savings plans. The idea is that when they commit to doing so, the extra amount saved does not shrink their budget and requires no sacrifice of current consumption. Thus they are “tricked” into saving more, a decision they are perfectly willing to respect over time—for they have the ability to tear up the agreement any time they want.35

  Perhaps the most important source of future security for most Americans is social security. Unfortunately, the social security system, a pay-as-you-go system whereby current payers fund the payments made to current recipients, is currently projected to become insolvent in the long run, as the population ages and the number of retirees swamps the number of payers. Current workers will have to work until a later age, and future retirees will receive fewer benefits. These real changes cannot be wished away, and we should not pretend there are painless ways to reform social security (for example, by investing its assets in corporate equities). The system needs to be reformed, most obviously by extending the age of retirement and slowing the rate of increase of benefits; the sooner it is done, the more equitably the costs can be spread across generations.

  Government Capacity

  Finally, the government’s finances have to be restored to health after the enormous toll taken by this crisis. The government’s capacity to spend is always a source of resilience for both banks and the public in downturns. Perhaps the largest unfunded liabilities of the U.S. government have to do with Medicare and Medicaid. This is one more reason why controlling the growth of health care costs has to be high on the government’s agenda.

  Reducing deficits by curbing unnecessary expenditures and increasing taxes in an equitable and efficient way must also be part of the answer. We will need a bipartisan effort that looks at all possible options—including a value-added tax (a kind of national sales tax) and a carbon tax, options that have been off the table so far. The very poor can be protected from the effects of these taxes on their consumption through higher earned-income tax credits. However, the notion that only the rich need be taxed to restore government finances to health has to be set against the fact that the incentive effects on dulling the desire to work may well be higher for the rich (because they do not work to live), and they are also probably better able to avoid taxes by moving to tax havens or through tax planning. In all likelihood, all of us will have to tighten our belts.

  Summary and Conclusion

  American overconsumption is driven by policies that were framed in reaction to growing public perceptions of inequality and insecurity, and these policies have contributed to financial-sector excess. The remedies are not easy and will require further government intervention. Given the propensity for government action to go wrong, we should approach interventions with care and some skepticism. Yet inaction will make matters considerably worse.

  For the young, the answers lie in broadening the pathways that allow them to build human capital. For those who are older, we have to improve ways people can remake themselves to stay competitive even as their old skills become obsolete. For those who cannot change, we need to understand how to keep them involved as productive, valuable members of society while providing necessary support. These are not easy tasks. American society will have to balance compassion and understanding against the risk of creating a dependent and resentful underclass.

  Some of the changes that are needed today may seem to go against the grain of America’s self-image of entrepreneurial achievement unbridled by the heavy hand of government. Yet central to that self-image have been a sense that anyone who tries hard can succeed and the confidence that tomorrow will be better than today. Inequality of access to education and health care, and mounting insecurity, especially during prolonged downturns, strike at that self-image.

  An anxious America is a cause of concern for the rest of the world, for it ultimately means a more inward-looking, fractious world. The world needs America to reform. The United States has always been able to remake itself in adversity, and there is no reason why it cannot do so again. It is in America’s past that we should see hope for its future. But what of the world itself? This is the question I turn to now.

  CHAPTER TEN

  The Fable of the Bees Replayed

  IN 1714, BERNARD MANDEVILLE, a Dutchman living in England, wrote The Fable of the Bees: Or Private Vices, Public Benefits. Part verse, part prose, the tract was an indictment of the sharp practices, extravagance, and hypocrisy of the rich ruling class. For example, his portrait of lawyers in his fictitious beehive, a thinly disguised allegory for the England of his time, is one that should strike a chord with people in many countries today:

  The Lawyers, of whose Art the Basis

  Was raising Feuds and splitting Cases,…

  They kept off Hearings wilfully,

  To finger the retaining Fee;

  And to defend a wicked Cause,

  Examin’d and survey’d the Laws;

  As Burglars Shops and Houses do;

  To find out where they’d best break through.1

  But after criticizing them, Mandeville went on to make an important economic point: the luxurious living of the rich and powerful, their changing fashions and tastes, had the one enormous benefit of providing work for the many. So

  whilst Luxury

  Employ’d a Million of the Poor,

  And odious Pride a Million more

  Envy itself, and Vanity

  Were Ministers of Industry;

  Their darling Folly, Fickleness

  In Diet, Furniture, and Dress,

  That strange, ridic’lous Vice, was made

  The very Wheel, that turn’d the Trade.2

  Indeed, when the voices of opposition grow loud enough in the beehive for Jove to put an end to the corruption and excessive consumption, the bee economy collapses. Mandeville thus makes the simple point that an economy full of thrifty savers cannot flourish for long because nobody can earn income if no one else spends money. We exalt frugality and excoriate borrowing, but in a vibrant economy, you cannot have one without the other.

  In recent years, the world economy has come to res
emble Mandeville’s beehive. The United States (and a few other rich industrial countries like Spain and the United Kingdom) have been spending more than they produce or earn and thus borrowing to finance the difference. Poorer countries like China or Vietnam have been doing the opposite.

  Energy use is a good indicator of actual consumption of goods. Each person in the United States used 7.8 tons of oil in 2003, which was about twice the amount used per person in France, Germany, and Japan; about 7 times the amount used in China; and 15 times the amount used in India. Of course, per capita income in the United States is among the highest in the world, but its consumption is disproportionately high relative to other rich countries. And because its savings are commensurately low, the United States financed its spending in 2006 by borrowing 70 percent of the world’s excess savings.

  This pattern of spending emerged, in part, because U.S. policies encouraged debt-fueled spending, both in normal times and as a way out of recessions, and because international financial markets were willing to accommodate the United States’ needs. Countries like Chile, China, Germany, Japan, Malaysia, Saudi Arabia, and South Korea supplied the United States by following a pattern of growth that emphasized exports and financed it by being willing to hold U.S. debt, much as the tradesmen held the IOUs of the spendthrift lords of Mandeville’s time. For many of these countries, supplying foreign needs was a more stable path to growth than creating their own.