The Next Convergence: The Future of Economic Growth in a Multispeed World

• Introduction
• Remarks
• Questions and Answers

JOANNE MYERS: I'm Joanne Myers, director of Public Affairs Programs, and on behalf of the Carnegie Council, I want to thank you all for joining us.

This morning it is my great pleasure to welcome one of America's most distinguished economists to the Carnegie Council, Michael Spence. Among Professor Spence's many honors—and I do mean many—I am not only referring to the fact that he is a Rhodes Scholar or the recipient of the John Bates Clark medal, awarded to an economist under the age of 40, but he is the 2001 recipient of the Nobel Prize in Economic Sciences. We are fortunate to have him as our guest.

Today he will be addressing such critical economic questions as: How will the global economy develop over the next 50 years? What are appropriate economic models in the wake of the recent global financial crisis?

When we look around the world, we see economic change taking place everywhere. In some countries it is slow, while in other parts of the world development is taking place so rapidly that these advances will alter the history of a nation or even an entire continent within a span of years. The Industrial Revolution was one such phenomenon, when, for the first time in history, per-capita income of ordinary people began to rise and living standards started to undergo sustained growth. This occurred first in Britain, transferred to the European continent, and then the United States.

Although many lives were changed forever, this shift was confined only to industrialized nations, while the rest of the world remained below the poverty line.

Following World War II, there was a second revolution that altered the global economy. New advances in technology and increased production created more efficient economies so that profits rose. Countries that once lagged behind started growing at unprecedented rates.

In The Next Convergence Professor Spence writes that we are now witnessing the third century of the Industrial Revolution. He tells us that while the gap between advanced and developing countries is still there, for the first time in 250 years, this gap is becoming smaller and smaller. It is one of convergence rather than divergence. If these trends continue, he tells us, we will witness a merging of living standards resulting in a better life for billions of people.

Still, as with any change, there are challenges. For example, how can countries sustain this growth? What impact will this trend have on advanced economies? What will happen to populations, incomes, and natural resources when this growth appears? Will the global financial system be able to sustain the economic growth that is predicted?

In the four years that Professor Spence was chairman of the Commission on Growth and Development, a project launched in part by the World Bank, our guest had much time to think about these shifting patterns of economic activity in developing countries. When his chairmanship ended, Professor Spence knew he wanted to share what he had learned so that others could benefit from his experience. In writing The Next Convergence, I believe he has done just that. Not only has he taken the dynamics of developing economies to show how their growth and that of the global economy are interrelated, but he also provides critical insight to reveal how this new dynamic will affect us all.

In order to avail ourselves of his wisdom, please join me in giving a very warm welcome to our very distinguished guest, Michael Spence.

Thank you for joining us.

MICHAEL SPENCE: Thank you so much. Good morning, ladies and gentlemen. It's a real pleasure to be with you.

We don't have much time, so I'll just launch in.

The storyline is the one Joanne mentioned. We had negligible economic growth in the world for eight or nine centuries. Then the pattern shifted, for reasons that economic historians still study, and we had the British Industrial Revolution, absorbed then in continental Europe and what Angus Maddison calls "the European offshoots." That's the U.S., Canada, Australia, and New Zealand.

Fifteen percent of the world's population started to go off in a different direction, and that ended up being the set of countries that we now call industrialized or advanced. The rest of the world basically stayed where it was, probably for complex reasons, but having to do with the inherent asymmetries associated with colonialism and all that went with it.

Then, after World War II, several things came together. A bunch of very wise people decided that what we did after World War I shouldn't be repeated, and so a serious effort was made to restore order and build the vanquished countries back up. We created the GATT [General Agreement on Tariffs and Trade], which systematically opened the economy. Technology produced a huge tailwind in integrating the global economy in a way that none of us could see at the time.

I was born during World War II. In my young life, I thought developing countries were—we used then the term "backward"—and the terminology is fun; I talk about it in the book—and then "Third World," then something else, and eventually "developing." It was the first time we acknowledged that something might be happening to change things. So it went on like that.

But by now, we can clearly see that this pattern of 15 percent going in one direction and everybody else staying where they were was reversed at that time. There were a lot of false starts. There are still places that are stuck and not growing that are of some importance, but basically we are on a track that I characterize as a century-long journey in which we'll end up with something on the order of 75 to 80 percent of the people in the world living the way we do in advanced countries.

I wanted to do two things in the book. One is to say that, and to say these are such enormous changes that we all have to think about whether the planet will withstand it, and how we govern this thing.

Just to give you one data point. At very conservative estimates of global growth rates, in the next 20 years, we will more than triple global GDP. We already have a pretty big global economy. If you triple it, you have an extraordinary set of pressures on natural resources, energy, the environment, and so on.

Then I spent some time—and this I did in large part because as I went around the world and talked to people, including investors and businesspeople, they would ask: Is the growth at 7 to 10 percent in China sustainable? Is there something wrong with this model? Will it stop?

They weren't really asking me for a yes/no answer; they were asking, can the dynamics, the forces that produce a machine running this fast, be understood well enough so that you could make judgments about where the risks are, where the potential blockages are?

I spend a fair amount of time in in the first half of the book trying to explain the dynamics of high-speed growth. And they are fairly straightforward.

The key first input is the open global economy, which, in a sense, was a gift. It was created by the advanced countries, led by the United States. If you take it away, you can't get this kind of result. The global economy gives you three things, in principle, two of which are genuinely crucial. One is knowledge. We don't talk about it as much as we probably should. My colleague Paul Romer does. This growth is called catch-up growth, and the key element in it is the inbound transfer of what we have learned over 200, 250 years into these countries, so they don't have to learn it all over again, to invent it. That increases their potential output.

That brings us to the second key component, which is that they invest and save, when they are growing at very high rates. China in 1978, when it started growing rapidly, was investing and saving—meaning funding their own investment—at 35 percent, or a third of GDP. It's now up to a ridiculous 45 to 50 percent. But that's an outlier. That's a statistic for most people.

If a country's income per capita is $500 and you set aside a third of that to invest in the future or your children and grandchildren's future via growth and running this engine, then you are, in effect, left with two-thirds of $500. That is an extraordinary choice. Indeed, if you look across developing countries, not all of them are able to make this choice. Some of them are stuck in a trap at a low level. It's not really an economic trap. It's an unwillingness—which is understandable, if you are that poor—to make this kind of investment. It's easier once you get going.

A question you might want to walk away with is, why is the United States investment rate 13 percent of GDP in 2010, and the savings rate below that, because we are running a current account surplus? But that's not my subject for today.

The third thing that is really important—and this goes all the way back to Adam Smith—is that these countries have to sell what they make. If you look at the dynamics and watch it running, what happens is, there are a whole bunch of people in agriculture and traditional sectors in these economies, and they come into the modern sector, in the way that Sir W. Arthur Lewis described. That sector is usually the export sector. It's a sector in which they can find something to do that takes advantage of educated but relative low-skilled labor, and it's usually labor-intensive. The image now is labor-intensive, process-oriented manufacturing. They sell it to the global economy.

That turns out to be the other critical input. The domestic economy isn't big enough and doesn't buy the stuff that they are good at making. In a poor country the domestic economy spends most of its time generating housing and food, and consuming a bit of energy, and you can't scale up the economy selling to the domestic economy. The demand side won't tolerate it. Adam Smith described this somewhat mysteriously as, "Specialization is limited by the extent of the market." But it's basically right.

So these countries invest at very high rates, increase the size of this modernizing part of the economy, draw labor into it that is surplus labor, so it doesn't cost them anything to take the labor in, and then sell into a global economy.

One way to think about it is, suppose they have done this for a while and their global market share is 2 percent. Then they grow 50 percent the next year, so now it's 3 percent. The point I'm trying to make is that it doesn't make a dent in the global economy. The only country that finally got big enough to make a dent is China. China actually turns prices against itself, both on the output side, by driving prices down, and on the input side, by driving the prices, like energy, cement—name any commodity, and China is a factor in driving the prices up.

But that's not the normal case. So this engine runs, we would say in economics, linearly.

The final key piece of this dynamic is very important. That is something the Indians decided they would call "inclusiveness." It's a term that has been adopted almost everywhere. This has to do with equity, distribution, and equality of opportunity. It turns out—we can't find any counterexamples to this—that a major failure on that front, blockage of batches of people away from the opportunity, will produce some kind of bad result that cuts off the growth process. It could be violence. It could be political disruption, chaos, and so on.

I talk a fair amount about that. There are a lot of countries that are either still stuck or, at best, just starting this journey that others did. In this you will find things that, given your knowledge in general of the global economy, are fun.

There are 13 economies that have grown at 7 percent or more for 25 years or more. Why do we pick those numbers? Because you double every decade at 7 percent, and in 25 years, you have made a significant amount of progress. The first was Japan. Brazil was the second—a fascinating case. It grew very quickly and then, around 1975, just stopped for 25 years. Now it's starting again. There is a huge variety in size. A lot of the countries are Asian—the Asian Tigers and so on.

There is a lot of variety in governance. You have autocratic systems, dominant single parties, full-fledged multiparty democracies. So it's an interesting sort of array to just think about as you ponder the ingredients of all this.

I didn't try to settle the issues. I reached my own conclusions and I suggested them without pretending that they are scientific fact.

It seems to me that the governments that succeed have benefited from leadership which brings multi-stakeholders together. They pick approximately the right economic model, dynamic model. That is, they get the elements I described before right. Finally, they are benign in the sense that they intend this to improve the lives of all their people over time.

The governments that fail do something else. Just look around the world at, in economic terms, failing performance. There is usually a governing group that is pursuing its own interests somehow or the interests of a subset of people. Paul Collier says that countries with natural-resource wealth tend to perform poorly in governments, and therefore in economic performance.

Why? Because the pie is bigger than it is in a poor country, and so the game turns into getting your share or expanding your share of the pie rather than increasing it.

A final thought on this. Economists forecast, and they are usually wrong, so you should discount everything I say. But in the 1950s economists believed that Africa would be the star performer in the developing world and Asia would be the basket case. What we got wrong is fairly easy to see with the benefit of hindsight. We thought that economic wealth came from natural-resource wealth, and Africa is knee-deep in natural-resource wealth, compared to any continent in the world.

Asia, which had very little of this, looked around and said, "Well, we've either got nothing or we've got people, lots of them." Asia was the poorest part of the world right after World War II. They said, "We'd better give it a try. We'll see if we can use the people." So they educated them. The global economy opened, and sure enough, that turns out to be the durable basis of the creation of wealth, human capital—a terrible term—human beings, creativity, innovation, and so on.

Very briefly, looking forward: First of all, the advanced countries should take credit and be reasonably proud of finally having created an environment in which this could happen. In ethical terms, having something on the order of 70 percent of the world's population rise from miserable poverty to enjoying the kinds of opportunities that we have—nobody cares about growth, but they do care about productive employment, contributing to society, creativity, kids and their opportunities. They make extraordinary sacrifices for that. It's a wonderful story.

But there are challenges going forward. In America, we have lots of very fine features of our economy. We are innovative. There are portions of our tradable sector that benefit from and operate in the high-growth parts of the global economy. They are doing very well.

But we are under-investing and we need to up our game. The way I describe it to people—and myself, actually—is that there are two scenarios. This is not a zero-sum game. We are going to have lots more friendly competitors in the future than we did before when the global economy is three to four times its size. But there's no reason to think we can't compete and thrive in that environment.

But we are going to have to start investing in people, knowledge, technology, and infrastructure. We are going to have to have a sensible energy policy. We are going to have to have a sensible tax system that encourages this kind of investment and creates employment. We have a fairly difficult few years, in the short- to medium-run, to deal with.

To refer briefly to some research I did after I wrote the book, last fall, in the 18 years from 1990 to 2008, just before the crisis, if you look at where the American economy created jobs—and there were a lot of them, 27 million, to be precise—almost all of them, 98 percent of them, were created in the nontradable sector. The nontradable sector of the economy is the part where other people can't compete.

I don't think that trend can continue. It was driven by health care, government, and so on. There's nothing wrong with that. People have different views on that. The tradable sector is growing, profitable, and functioning in the global economy, but it's not creating employment. So it's starkly different, for example, from the German economy, which is another advanced economy that has, for reasons we need to understand better, taken a different path. It has more employment in the industrial sector and so on.

These are all issues that will be debated and discussed in the advanced countries, maybe later than is ideal. There are problems and issues that will come to the advanced countries.

There is a set of governance issues. The governance institutions in the global economy are just way behind the market integration. This is a well-known fact. That's a world in which you can have accidents, crises, and mismanagement or incomplete management. We are trying to do something about it in the area of financial regulation, post-crisis, and that's probably going to help. There's a bit of progress there. These are hard things.

The G20 is supposed to be the main place where priorities are set and where this is coordinated. It's struggling to do that. So we create an institution that captures the major economies and puts them together. The jury's out.

Then there is an enormously important set of challenges which have to do with what the Chinese call "lifestyle." Now, there's going to be a communication problem between them and us, and I'll tell you why.

When they say "lifestyle," they mean that they are starting to realize that they can't follow the path that we followed in terms of energy intensity and impact on the environment, and they can't follow the path their predecessors in high-growth mode followed either.

The reason is that there are 3.8 million people in Asia. They are going to account for a very large fraction of the growth in the global economy in absolute terms—not rates—in the future, and they are saying to themselves that this is not something that's likely to succeed. That is, "We'll stop ourselves, by virtue of impact on natural resources and the environment." So they are going to try to change the path. They already started. If you read carefully the Twelfth Five-Year Plan in China, which we can think of as a beginning of this path, there is a pretty aggressive start on lower energy.

So Asia will probably be the driving force in trying to find incentives.

Why do they call it lifestyle? I'll conclude with this. To us, lifestyle is a thing that an individual or a family chooses. Lifestyle belongs clearly in that rather broad spectrum that we attach to where individuals make choices, individual freedom.

In Asia they don't think that way. They draw that line differently, and they don't draw it as rigidly. They draw the line wherever there is a reasonable balance between individual freedom, on the one hand, and collective interest, on the other. If they drew a line in one place and that destroys the environment, they will feel free to redraw it, with more constraints on how cities are built, how many people have cars, what kinds of cars, how the transportation works, et cetera. So they have, in some sense, a greater degree of self-imposed freedom to make those choices, and they will do it in their self-interest, meaning the ability to sustain the rest of the journey to being like us in terms of income wealth and opportunity.

I'm 67. I don't think I'll see the end of this journey, but many of you in this room will. But I sure would like to. It's really quite extraordinary. I'm not fundamentally pessimistic about it. There is a question that people have on their minds that is more short-run, which is, if we in the advanced economies have a difficult period of unemployment, relatively low growth, potential instability—Europe, Japan, and the U.S. are obviously struggling with these issues and the fiscal situation—can these emerging economies that, 20 years ago, depended entirely on our growth to create the demand that fueled their growth—can they sustain this growth? For the first time in this 100-year journey, it looks like the answer to that is yes. They look like they can generate enough of the right kind of demand, a big enough market, to sustain this growth.

So that's what is called partial decoupling. We're there. On the other hand, if America has a big second downturn—I hope not—or Europe, that would slow them down. So it's not completely decoupling.

Let me stop there and turn it over to you.

QUESTION: Rita Hauser.

One thing that you didn't mention was demography and aging populations in Europe and the U.S., but also China, and very much Japan. How will that impact on this?

MICHAEL SPENCE: We were very interested in that in the Growth Commission. I'll tell you something that's counterintuitive that the demographers, including David Bloom at Harvard, told us. Our intuition was that aging would slow us down, wherever it was occurring. David said, not necessarily. The reasoning was that there are lots of challenges associated with aging. Most of the pensions and fiscal systems that underpin them have to be changed or we'll have the kinds of problems we have now, only they will get much worse. So it's a very high-order priority in Japan, in Europe, next the U.S., and China is not far behind. But what David said is that there is a set of adaptations to longer life, which means longer working lives and more transitions that actually don't necessarily slow the growth process down.

So the answer, Rita, to the question is, to reach a judgment about this, you have to reach a judgment about whether we make the institutional and lifestyle changes that are associated with longevity. If you are pessimistic about that, then it will almost surely create fiscal problems, instability of a variety of kinds, and slow growth. And it could happen in China.

China is in a window where they can solve this problem. That is, they haven't crossed over the line the way we have so that we have to kind of redo things. They have been stalling around, actually. I was involved six or seven years ago in a project to recommend that they get on with it now. They just didn't do anything. It's very uncharacteristic of the Chinese. They normally act with lightning speed once they get a hang of this. But they didn't. Now it looks like they are starting to fix the systems, and they have the resources to fund the pension systems.

But we'll see. It could very well slow growth down.

QUESTION: Susan Gitelson.

Thank you for being so clear, even though, with all your background, you could have given us tables and statistics. It's really marvelous.

Let's take up the different interpretations of "lifestyle." On the one hand, when there are so many billions being added and oil is being depleted, China seems to see the light about alternative energy sources. On the other hand, there is this difference in values of lifestyle. When we think of Americans and Europeans—but especially Americans—the great value is on personal possessions—bigger houses, bigger yachts, this constant competition, more space—the day is going to come when it may not be possible. How do we transform the American system to be more community-minded and for people to have greater satisfaction through helping others rather than just accumulating for themselves?

MICHAEL SPENCE: Wonderful question. I'm not sure the answer will be as wonderful. My sense in the advanced countries is that our values are starting to shift—maybe slowly, but they are starting to shift—and people are thinking enough is enough. We have the Slow Food movement. We have a lot more real attention to environmental issues and are modifying our behavior. It's probably an important part of the transition to a "different set of lifestyles."

That might not be enough by itself, and we'll surely need other things, but I sense that's starting to happen.

The interesting thing is that this change in values will be perceived differently in the developing world. You can't go to India yet, which is about 14 or 15 years behind China at high-speed growth, and say, "Enough is enough." They are just not there yet. They will say, "Enough will be enough 35 years from now, but enough is not enough now." There are still lots of poor people.

There is a disconnect, and it shows up in some of the dysfunctional discussion over environmental and climate-change issues. We have tried to suggest that they take steps that aren't reasonable, given their goals and aspirations.

A very important member of the Growth Commission is Montek Ahluwalia, the vice-chairman of the Planning Commission in India, who has worked with Manmohan Singh, who was the head of the Planning Commission, for many years.

The first round of the UNDP human development report, the one on climate change, was released in India, and they said, "Well, we think you should probably reduce your emissions 50 years from now by 20 percent."

The per-capita emissions in carbon monoxide were ridiculous. They were half the safe level on a global basis of 2.3 tons a person. They kind of went, "What?"

So that kind of dysfunctionality has invaded that discussion. We are all going to have to learn to live and communicate with each other, recognizing the asymmetries, notwithstanding the convergence I talk about.

But for the Asians, on lifestyle, the best example is population. Population—meaning giving birth—is one of those things that actually has external effects. In India and in most of the world, and certainly where we live, that's viewed as a right. Nobody gets to tell you. There are regularities. Richer people have fewer kids, for reasons that are understood. We hope that operates in the global economy and slows the population growth down.

But basically we have this view that that, the car, how much energy you consume, and how big a house you buy, is all up to you. And the Asians just don't see it that way. It's probably, in the end, Susan, because there are so many of them, they can't. They cannot define that degree of personal freedom without having it not add up to social cohesion and performance.

The evidence is clear. China got up one morning and decided they could blow the ship up and have a one-child policy, which you just can't do in most other parts of the world.

QUESTION: Thank you. James Starkman.

Is there a self-limiting mechanism in the global economy that we have today in terms of competitive labor costs and free-floating currencies where you have competitive devaluations? For example, one of the major U.S. multinational corporations last week announced they were taking 2,000 employees out of China, probably relocating them to lower labor-cost areas such as Vietnam. How do you see this functioning going ahead?

MICHAEL SPENCE: That's a wonderful question, too. Let me take that last part first, as that will lead into the other.

In this growth process there is constant change. The biggest mistake that countries can make and do make is that they find a highly successful formula, frequently based on rapid, export-driven growth, based on low labor costs, and try to stick with it too long. It's a very successful formula, but nothing works forever.

So China is in the middle-income transition, just starting. The middle-income transition is where you have to let things die. It's where Schumpeter's "creative destruction" produces the destruction part. All of their predecessors have gone through it in one form or another, but there are only five economies, of those 13 that I mentioned, that have actually sustained the high growth through this transition, which is when your incomes are in the range of $4,000 to $10,000. After that you are going to double once and you're in the OECD category. They are all in Asia. They are Japan, Taiwan, Korea, and then the two city-states, Hong Kong and Singapore.

It has never been done at this scale before. That is the essence of the structural change in the economy that goes with that and shifting around the demand side—we could spend all morning on this—what China is going to have to accomplish. They are going to have to let market forces work and determine more of the outcomes, they are going to have to fix the financial system, they are going to have give households more income, and lots of other stuff.

I am disinclined to bet against them. There have been contrarians who have bet against China for every year in the last 31 years, and they lost a lot of money. So it's probably not the best time to bet against them. But this is a really hard transition.

I did watch it fairly carefully, when I was younger, in Korea. It occurred in the 1980s. It was brilliantly handled. The Koreans had a very intrusive government targeting things. They realized it wouldn't work. They started investing in technology and people, turned it over to market forces, recognized they had to look more like us, and it took off. It wasn't perfect. There were flaws that showed up in the late 1990s. That's point one.

Point two is that developing countries don't do what we told them to do for many years on the financial side: Float your currency, open the capital account. It doesn't work. The financial sectors aren't mature enough. And we have stopped telling them that as of the 1997-98 crisis.

But that raises an issue. So we ran de facto, with lots of shouting back and forth, a hybrid global economy for much of the postwar period, dominated by the advanced countries. After Bretton Woods, we floated the exchange rates, had open capital accounts, and the developing countries did something else. Why did that work?

My answer to that is, because the developing countries weren't big enough to destabilize the system for most of that period, but now they are, with China in the lead. So the system that we have relied on won't work. It's probably true that we can't just expand the floating exchange-rate market, determine open capital account system, because in the developing countries it still doesn't work. So we are going to have to invent a new system, and the people in finance and macroeconomics know this. That's on the to-do agenda and has everything to do with global stability. But we don't know what it's going to look like.

It's a very hard, challenging problem, both because lots of people have to agree and because it's not an easy design problem. It's the sort of problem you would give to John Maynard Keynes to solve.

That's an example of adapting global governance to the reality. The first step was G20, instead of G7, G8. The next step is, get something done, including getting around to the international monetary and exchange rate system, and lots of other issues.

What China is doing is basically letting labor go. It's already happening. Last summer after the Foxconn suicides in the Apple assembly facilities—not owned by Apple—and the strikes at Honda, the wages have just shot up in the coastal area. You cannot be the low-labor-cost manufacturing location vis-à-vis Korea or even India and Bangladesh at $4,000 of income per person. So that's gone, and the Chinese are going to create new higher-value-added jobs. If they don't, the growth will slow down. They know all that.

If you look out, however, to the midpoint, the endpoint of my book, then you have 80 percent of the people with relatively high incomes. This puts us in a world that none of us have lived in, in which there isn't a lot of low-cost labor anymore. There may be a bit, but not big enough to serve the global economy, at which point a whole lot of relative prices are going to change. Labor-intensive stuff will become labor-intensive because we will try to replace labor with capital and technology, but some of it will still be labor-intensive, in which case it will be more expensive relative to other things. The relative price of labor in anything that's labor-intensive is going to rise on a 30-year horizon.

But we're not there yet. There is lots of surplus labor in the global economy. We probably have 25 years to go.

I hope that's responsive to what you are asking.

QUESTION: Richard Valcourt, International Journal of Intelligence.

For many of the countries in Central Europe, there has been a tremendous problem economically in the past 20 years in making the transition from the Soviet system to now. What do you believe needs to be done to make them part of the Western economy?

MICHAEL SPENCE: When the Berlin Wall came down and they were turned loose, there was a very bad period that was a decade of negative growth. When you look at the data, it is just as you said. Now they appear to be turning it around. I view this as a problem that is on the way to solving itself via what amounts to a learning curve with respect to economic management. There are lots of glitches, but the endpoint is probably integration in the eurozone, being part of a big economy. It has already started.

But there is a clear turnaround. The last ten years of the 20-year period since the end of the Cold War have been a much superior economic performance.

Coming into the crisis, they were a number of them that were in a vulnerable state. I lived in Europe. They were borrowing in euros when they weren't part of the eurozone, because they intended to be part of the eurozone. Borrowing in somebody else's currency is a no-no, for the obvious reason. If the exchange rate can change and you borrow at a certain exchange rate and then your currency goes down in value, but you have to pay back in that person's currency, then your liabilities can double overnight. That happened in Asia. It happened again in Eastern Europe.

It's a learning curve. They won't do that again. Eventually, they will be in the eurozone. But I would be more worried about them if we hadn't had this turnaround after the floundering around for the first ten years after they were really free.

QUESTION: Don Simmons.

For 40 years or so, we have all been reading about concerns everybody has about commodities and minerals running out generally. That hasn't happened, despite what may be a short-term blip of the last couple of years. You just said you thought labor would become more expensive relative to other inputs. What about commodities? Would you say the same about them?

MICHAEL SPENCE: Yes, I would, with some differences. The question you have to ask yourself is, what is the long-run elasticity of supply, commodity by commodity? In agriculture it's high, so as demand grows, we'll find a way, through efficiency and technology, to expand the supply. In the energy area, once you get oil up around where it is and leave it there, driven by the growing demand from the emerging economies, there are lots of alternatives, and there are huge incentives to create alternatives, as well as to be efficient.

So the demand- and supply-side responses are going to be pretty good and helpful in causing us to adapt. It will be painful. If we had done this to ourselves ten or 15 or 20 years ago—we have been talking about it forever in America, right?—we wouldn't have these sudden shocks when the market did it to us.

But the long-run trend is upwards. The only qualification is that once these supply responses kick in—it's not just oil. Other things aren't a perfect substitute for oil, but they're getting close. They kick in once the price gets high enough and increasingly over time, as technology is developed.

So I'm not too worried.

When I listen to experts on this talk, where the starting point is always this growing demand, the one they worry about is minerals, where you just literally run out; you can't find any more zinc or something like that.

I don't know how to evaluate that. I'm not technically expert enough to evaluate that side of it. But it looks to me as if, if we are actually going to run out of something in a way that we'll have to invent our way around, it's going to be a mineral, a rare earth metal.

QUESTION: You started out by saying that the United States is under-investing. Yet our GNP is growing—not too fast, but growing—with materially fewer people. Somehow, then, we are more efficient than we used to be.

My question is, economists seldom talk about efficiency of investing. They talk about the amount of investing. In the annual reports of corporations, they boast about how much they invest, but, really, they don't give a damn how much they invest; they care how well they invest.

MICHAEL SPENCE: That's true.

QUESTIONER: That's what all of us in business do. Can you comment on that?

MICHAEL SPENCE: An excellent point. In education, we are not under-investing in terms of total commitment of resources. Our problem is an efficiency problem. It's outputs vis-à-vis inputs, as best I can tell. It's a crucial piece of fixing it.

On infrastructure, we are just under-investing, period. In the high-growth emerging economies—and I don't want you to take this as a prescription for us, it's not; it's our best guess as to what a high-growth emerging economy has to do—about 5 to 7 percent, as a fraction of GDP, has to be public-sector investment that creates the environment that supports the private-sector investment and supports the growth. But ours is so ridiculously low, we can't be in the right place. If you look at infrastructure, we could generate a fair amount of employment, if we could find a way to afford it, in the short run and have the long-run growth-promoting effects as an additional benefit. I'm clear on that.

This is probably too much for today, but when you look carefully at the American economy and its structure, there are lots of parts that are doing just fine. The problem is that people in the middle-income range are experiencing a declining set of employment opportunities. We managed to put them all in the nontradable sector for about 20 years. Now I don't think we can do that. We are going to have to figure out a way to deal with that.

People, if you listen to them carefully, care about whether the opportunities for their children and grandchildren are going to be diminished relative to where they are. That's the path we're on. It's not an easy problem to solve.

Chrystia Freeland wrote this Atlantic piece in which she basically said that there are two groups of us. One group is highly educated, operating in the tradable economy, happy as clams, and doesn't understand what the other people are complaining about. The other people are experiencing this sort of shrinking universe of opportunity. Part of it is a combination of technology, infrastructure, education, and so on. We have to vault more people into a position where they have expanding opportunities in an open global economy. I'm not sure we can fix it completely, but it's sure worth a try.

QUESTION: Harry Langer.

My concern is the USA. We have a real jobs crisis here, and yet we are the innovative, cutting-edge-technology country of the world. What would you think about this idea to create the jobs here: We pass a law that would restrict the production of the innovation within this country for three years, and then after that, it would be free to be licensed or given away elsewhere, produced overseas?

Wouldn't that create the jobs that we need and the service jobs to go with it?

MICHAEL SPENCE: It might very well. One would have to think it through. The idea that you modify, without doing extensive damage to the kind of unfettered market incentives, is not a crazy idea. In your proposal, I would worry about damage to the incentives to invest in the technology.

QUESTIONER: The cutting-edge innovation creates its own markets. That way you would create markets around the world and supply the technology the undeveloped countries can use to upgrade their economies.

MICHAEL SPENCE: I understand. I'm not saying it won't work. But, nevertheless, a restriction is a restriction, and if you put it in a high-cost production environment, then you at least have to think about whether or not you have diminished the incentives to invest at the start.

We talk as if unrestricted trade is a kind of religious belief now. But back in the 1970s and 1980s, when the Japanese were finally succeeding and importing cars, you will recall that we imposed quotas on Japanese imports. They were done in units, so the Japanese started shipping in Lexuses and things at the very top end, which held up value for a while. But basically the effect of that was to cause the building of manufacturing and assembly facilities in the South of the United States.

I'm trying to respond sympathetically to this. There are a number of ways that don't do very high amounts of damage long-term to the global economy that solve these distributional issues in various countries on the way. They shouldn't necessarily be rejected out of hand, but they should be used cautiously, as it's very easy to go into an escalating mode, where you are sort of shutting down the global economy.

But that's the kind of pragmatic approach that we should adopt. Your proposal might very well turn out to be a good one.

QUESTION: John Richardson.

You said some very interesting things about China and Asia, which are going to take me a few weeks to digest. But I have a question about the United States. Just let me recall that a week or so ago, Francis Fukuyama was here, and he made a remark which I thought was very revealing. He said that just prior to the French Revolution, the French monarchy had privatized things much to the point that it was rather like the United States now.

If I look at this choice between a single five-year plan, the Chinese model, or our deregulated market-forces approach, what, unfortunately, I see is an airline cartel, an energy cartel, a communications cartel, a banking cartel, and a Wall Street cartel, or worse. So I am not very optimistic that our post-Enlightenment/individual-effort world really works. Could you comment on that a little bit?

MICHAEL SPENCE: One of the things you learn in the emerging markets is that they don't have a very well-developed competition policy. What you just described here is actually endemic in developing countries as well. If they could improve performance in the regulation of the exercise of competition in the way our antitrust law is supposed to—and does, to some extent—that would actually be a step in the right direction. So I'm on your side.

The more general question is finding the right balance between market forces and a combination of regulation and public-sector investment. The successful developing countries have gone to neither extreme and found, in varying places, some happy middle, with the view being that the state, functioning properly, is a complement to, not a substitute for, the private sector. Central planning is gone, because it fails on incentives, decentralization, and all the things Adam Smith talked about. Then we proved it wouldn't work by conducting several large-scale experiments that were abandoned. So that's gone.

But at least in the developing-country context, the minuscule government built into the Washington Consensus has been largely proved not to function very well either—that is, the assumption that government should be restricted as much as possible, on the ground that if it's any larger than that, it (a) makes mistakes, (b) wastes resources, and (c) is corrupt. Even if you believe all that, that's a model that doesn't work.

The way Latin America tended to interpret the Washington Consensus was not what John Williamson intended at all—this kind of privatize-everything-including-the-airport. The successful countries have found this middle ground. Of course, in the middle ground, you are making judgments, whether it's about exchange rates, if you are managing them, or exactly where to draw this line. Good policy isn't not making the judgments; it's making mistakes and fixing them when you goof. That pragmatic spirit, along with clear long-long-run time horizons and objectives, is what has served these countries so well.

In America, to be perfectly honest with you, the discussion of these things lacks the pragmatism that I associate with the early days in our country and tends to be ideological, to an extent that goes beyond what's helpful.

QUESTION: Anthony Faillace.

You alluded earlier in your comments to some of the environmental issues that come out of the growth of large numbers of people on the planet, and you talked about how China understands this and they are trying to be more energy-efficient. But my question is, what does the architecture look like internationally to negotiate the kinds of things we are going to need if we have that many people developing? Clearly it's an externality, and clearly people aren't going to do this on their own without tradeoffs on other parties.

MICHAEL SPENCE: The good news is that what I just said about China will cause them to not worry as much about having everybody else coming along, because they have to do it anyway. So you get this kind of internalization of what used to be viewed as an externality in one part of the world.

I'm making a couple of assumptions. I'm assuming that India will join the party, for the same reason, a little bit later, and the two of them together will sort of dominate Asia enough, and Asian thinking, that you can basically count on Asia going in this direction. It's not a done deal.

That changes significantly the way one thinks about this. Take the global-warming issue. When we were thinking about global warming in the last even two or three years, we were thinking that we had to have global agreements of some kind or we would make no progress at all. In other words, the incentive to move first is bad and the incentive to free-ride is high, and the combination of those two is fatal unless you have an enforceable international agreement.

What I'm trying to say to you today is that it's a little better than that. There is one region that will lead the charge. That means the rest of us can get on the boat with fewer worries about being out front. A lot of our citizens, a lot of us, want to make some progress on this, but we don't want to be mugs about it. But if Asia is driving this because it's in their own self-interest and they are the main event, then it may be easier for us to convince ourselves and then eventually enact policies and legislation that move us along.

That's my hopeful version of the scenario. Let me say one other thing.

When I was in graduate school, we studied decision making under uncertainty with the founder of that field, Howard Raiffa. This is the extreme case of making decisions under very great amounts of uncertainty, with learning over a 50-year time horizon. The first approach to that was to try to get countries to agree to a 50-year target. If Howard were standing in this room, he would say the last thing you do in making decisions under uncertainty is pick the endpoint. What you do is, you pick a path and you go along it and then you branch out in different directions as you discover what the costs and the opportunities are.

Now, doing that with 180 countries is not a simple exercise. It hasn't been done before. But trying to resolve the question by getting India, China, and everybody else to agree on where they will be 50 years from now without knowing what the cost of getting there will be is pretty close to nonsense. So it failed on faulty design and has evolved into what amounts to an informal, parallel process of proceeding on our own. It looks like it's more or less moving in the right direction, to me.

JOANNE MYERS: I want to thank you for a wonderful discussion.