CHAPTER NINE
I ARGUE IN CHAPTER 1 THAT the pressures created by relatively stagnant incomes for many in the United States mirrored those in the typical developing country; they led U.S. politicians to push credit as a palliative. Subprime mortgage lending was the symptom, dwindling economic opportunity for many the cause.
Not all forms of income inequality are economically harmful. Higher wages serve to reward the very talented and the hardworking, identify the jobs in the economy that need the most skills, and signal to the young the benefits of investing in their own human capital. A forced equalization of wages that disregards the marginal contributions of different workers will deaden incentives and lead to a misallocation of resources and effort.
However, when the only pathways to high wages are seen to be birth, influence, luck, or cheating, wage differentials may not act as a spur to effort. Why bother when effort is not the route to rewards? Indeed, as the political economists Alberto Alesina and George-Marios Angeletos argue, perceptions in a democracy as to how high wages or wealth are obtained can create self-reinforcing patterns.1 If society believes people earn high wages as a result of their training and hard work, it is less willing to tax high earners, thereby ensuring they have strong incentives to acquire skills and exert effort. If society believes people earn high wages because of connections, chance, or crookedness, then it will tax incomes more heavily, and since few of the honest will then bother to work hard, only those with influence, the lucky, or the cheats will flourish.
Indeed, one reason why the U.S. electorate today seems so receptive to proposals to make the rich pay much more in taxes is that perceptions of who is rich may have changed. Not so long ago, the prototypical rich person in the United States was the local self-made entrepreneur who owned the car dealership and the movie theater and who came from the same high school as everyone else. Today, it is the distant, overpaid CEO, the greedy banker, or the hedge-fund manager who thrives on insider trades. Stereotypes and perceptions matter: the rich are no longer us, they are them.
The United States needs to prevent further social polarization, both in reality and in perception. The precise way of doing this does matter. If the rise in the wage inequality most people experience stems from the relative scarcity of workers with more human capital, as I argue in Chapter 1, then the response has to be to improve the quality of human capital of the workforce. Heavy taxation solely to equalize wages will do little to tackle that problem and will reduce incentives to work or acquire human capital. This is why I will take as a given that the best way of reducing unnecessary income inequality is to reduce the inequality in access to better human capital.
Equalizing access can head off brewing conflicts. For instance, if rich parents can pay for better schools, extra tuition, and eventually good universities for their children while poor parents cannot, the poor will become more intolerant of high incomes and wealth. Apart from increasing conflict between the haves and the have-nevers, unequal access may also increase resistance to economic reforms that expand opportunity. For instance, the poor urban worker who does not have access to a university education may care little for reforms that make it easier to open small businesses, because she has no chance of obtaining the financing to open one.2
What we prefer politically depends on where we stand: if we stand at very different places, it is harder for us to come together as a society to make mutually beneficial decisions. And more than the quality of its institutions, what distinguishes a developed country from a developing one is the degree of consensus in its politics, and thus its ability to take actions to secure a better future despite short-term pain. Unequal access, and the resulting inequality, destroys consensus. And although this chapter focuses on the United States, the issues addressed here are relevant in many countries, including developing ones like China and India.
The problem is that the political and economic costs of any effort to improve access—for instance, providing quality preschool care for poor children—are incurred up front, whereas the benefits lie in the future. It is hard to get the public, and consequently politicians, excited about such undertakings, especially at a time of straitened public finances. But if nothing is done, inequality will feed on itself. The costs of redressing deficiencies will only increase, and many citizens will be left irremediably ill-equipped for a productive life in society. Put differently, the status quo entails unacceptable and growing costs, and avoiding those very visible costs has to be part of the cost-benefit calculus.
In arriving at solutions we should resist two seemingly attractive but dangerous notions. One is that government spending will fix all problems. The truth is that money is rarely the key missing ingredient, as we saw with the growth of developing nations. Indeed, government largesse can crowd out, if not corrupt, individual and community initiative. That does not mean, however, that all societal problems will be solved by spontaneous voluntary initiative, the second dangerous notion. Government effort (and sometimes money) is needed at key leverage points to coordinate individual and community action. Again and again, we see that successes involve a coming together of key players, a broader definition of the problem (and hence solutions) than what seems apparent initially, and a restructuring of incentives such that all players work together rather than at cross-purposes.
Human capital, as described in Chapter 1, refers to the broad set of capabilities, including health, knowledge and intelligence, attitude, social aptitude, and empathy, that make a person a productive member of society. Schools and universities play a part, as do families and communities: it does take a village to create the values and attitudes that allow children to get the most out of their education! And once individuals complete their formal education, employers play an important role in training them further and encouraging them to continue building their human capital on the job. Such on-the-job development will become more important as the length of our working life increases: the typical knowledge worker may now work for nearly half a century after formal education ends. In what follows, I describe some of the important ways the quality of human capital can be improved in the United States.3
The foundation for success in life is laid early. We cannot do anything about the genes a child is endowed with, but nutrition during pregnancy and in early childhood makes an enormous difference to a child's intelligence and health later in life. Poor nutrition in a child's early years seems to be associated with the early onset of the degenerative diseases of old age such as coronary heart disease and diabetes.4 Poor habits of expectant mothers, such as drinking and smoking, also contribute to the long-term impairment of their children's health. Unfortunately, because these problems are likely to be more severe among the children of the poor and the poorly educated, they perpetuate the cycle of poverty. To break it, more resources have to be devoted to very young children in poor families, whether in the form of nutritional supplements, medical monitoring and treatment, or parental education.
Early education also seems to matter considerably. By age eight, intelligence, as measured by standard metrics, seems pretty well set.5 Therefore it is critically important that young children have access to quality pedagogic resources. Studies show that early childhood learning programs tend to reduce the likelihood that a child will drop out of high school, increase the likelihood that the child will enroll in college, and increase earnings.6 They also make it less likely that the child will become delinquent, a criminal, a drug addict, or a teenage mother.
Although evaluations of the government's Head Start program—a national program that promotes school readiness by enhancing child development through the provision of educational, health, nutritional, social, and other services—are still mixed, it is hard to believe that more attention to creating good day-care centers and preschool programs for poor children, funded by government resources, with scope for local experimentation and regular evaluation, will not produce benefits. Mexico has had tremendous success in encouraging poor parents to pay more attention to their children's nutrition, health, and education by making welfare payments conditional on parents meeting certain milestones.7 Similar conditional cash transfers are being tried by Mayor Bloomberg in New York using donated funds, and although it is too early to tell whether they are effective, the success of similar programs around the world suggests that more experimentation is warranted.
Family matters. As far back as 1966, the influential Coleman report concluded that family background was a greater influence on school achievement than any measure of the school environment, including school districts’ per-student expenditures.8 Not only are the incomes of the parents important, but so is the relationship between them, as it influences the family's access to resources and the kind of environment it provides. Being born to teenage parents, or growing up with one or both parents absent, tends to be detrimental to a child's chances of success, as is divorce. Again, these problems tend to be more common among poorer families. Although the government has only a limited role, if any, to play in strengthening families (though it certainly should not tax married couples more, as it does now), greater community recognition of the harm done to the children by teenage pregnancies, absentee parents, and broken marriages can be a force for change.
More generally, as the Nobel laureate James Heckman from the University of Chicago has argued, many of the differences between children are set at an early stage: most of the gaps in abilities observed at age eighteen are already present at age five.9 Furthermore, a child is most malleable when young: it becomes much harder and costlier to alter abilities and behavior as the child gets older. Early intervention is important for changing outcomes successfully.
Interventions are not just about improving the child's learning abilities. Success in school, as in work life, depends significantly on noncognitive abilities, such as perseverance, determination, and self-discipline.10 And whereas cognitive abilities are relatively fixed early on, noncognitive abilities can be changed for considerably longer.
Good schools inculcate values that serve students well in later life. Past studies have shown that students from Catholic schools tend to do better than students from inner-city public schools, perhaps because they produce more disciplined and motivated students.11 Substantial improvements to inner-city student performance seem to have been brought about by “paternalistic” schools that insist on discipline: students walk in an orderly way between classes, meet dress codes, sit up straight in class, do homework, use standard English, and are penalized for transgressions.12 There is, however, little systematic evidence on the success of such schools, the key ingredients that make them work, or the environments in which they work best. Nevertheless, it seems a reasonable hypothesis that both the learning environment and the learning of noncognitive skills could be improved through attempts to teach behavior as well as impart knowledge.
As important as what happens in schools is what happens outside. Dysfunctional families and communities make it more difficult for a child to acquire the values that can help them succeed. After-school programs and mentoring programs—pairing students with successful and caring adults—have helped remedy some of the damage. So too has community leadership and a shared sense of parental responsibility. As a U.S. senator speaking at the 2004 Democratic convention, Barack Obama said: “Go into any inner-city neighborhood and folks will tell you that government alone can't teach our kids to learn; they know that parents have to teach, that children can't achieve unless we raise their expectations and turn off the television sets.”13 This kind of parental and community responsibility is needed to make full use of any government support.
More generally, careful longitudinal studies in Chicago suggest that failing schools can be transformed through collective effort: by leadership that creates an environment where the faculty work with one another to challenge students, where the faculty themselves are encouraged to develop their skills, where the school and other social service organizations work together to attempt to improve the student's entire learning environment and not just the one in school, and where parents and the community are drawn in to support this effort.14
Studies suggest that students from low socioeconomic groups who are enrolled in public schools make as much progress on math and reading exams during their elementary-school years as children from a high socioeconomic background, though they start at a lower level because of disadvantages inherited from early childhood. However, the gap in achievement scores grows over time, primarily because the achievement levels of children from low-income families fall or stagnate during the summer, while those of children from higher-income families continue to increase.15 The learning environment in families differs, with children of high-income parents growing up with educational games, books, private tuition, and summer programs, all of which continue their learning outside school. Some economists have therefore suggested extending the school year: Japan's school year runs about 240 days, while the school year in the United States is 180 days.16 Others have suggested offering vouchers to poor families so that they can enroll their children in summer programs. Both approaches are worth experimenting with.
Clearly, the quality of teaching also affects a child's educational experience.17 Motivated, inspiring, knowledgeable teachers make an enormous difference, as many of us know from experience. So does class size.
Getting good teachers starts with hiring. When other opportunities for women and minorities were limited, many talented people went into teaching because it was a respectable occupation that was open to them. As opportunities for these groups have expanded, it has become more difficult to attract the talented into teaching. Pay has to be one component of a more attractive package. But pay increments should be tied to teacher performance in and outside the classroom, which should be measured in part by improvements in student performance. Additional increments should be given to those who teach difficult but required subjects such as math and science and to those who teach in difficult school environments, such as the inner cities. Teacher unions have resisted pay differentiation, especially on the basis of performance. However, they are slowly becoming more amenable to change.
As important as pay is a career path that makes full use of a teacher's experience. Only some teachers like, or are suited for, promotion to school administration. Others could play an important role as mentors to junior teachers, as master teachers conducting classes in pedagogy, or as subject-matter experts. These career paths need to be made clearer and rewarded appropriately.
Subject-matter expertise is important, but I am not persuaded that teachers need degrees in how to teach. Certainly, much of my own learning about teaching (admittedly only university students) has come from classroom experience and from mentoring by other colleagues. Requiring teachers to hold degrees in education or teaching tends to shrink the pool of candidates for teaching jobs substantially and likely deters many subject-matter experts who would otherwise become teachers. Instead, schools should create a more formal system of mentoring, with star teachers advising inexperienced teachers and sharing experiences. Furthermore, the school system should find ways to make use of those who are highly motivated and talented but are unlikely to see teaching as a long-term career. Both the young college graduate who wants to try out teaching, as in the Teach for America program, and more senior citizens, who want to give back to the community in a different role, should be welcomed.
Small classes help the learning experience because students get more attention. This is especially important in the early years, when children need help in developing focus and discipline. Resources will be needed to reduce class size. Resources are also needed for pedagogic aids, including computers, so tradeoffs have to be made based on a careful cost-benefit analysis.
One way for the best teachers to reach more students is through technology. Technology can help teachers share experiences, lesson plans, and homework questions. I am a director of a company, Heymath, that is based in Chennai, India, and operates in three continents. The company helps teachers with the tools and templates needed to create math lessons and homework, as well as with the assessment process. It creates a community in which math teachers around the world share best practices. Heymath also offers students assistance with problems, to the extent permitted by the teacher. Technology can thus help upgrade the quality of teaching with relatively small investments.
Schools also need a system of accountability. A national standard of student achievement, coupled with testing at regular intervals to measure performance against those standards, is key to accountability. Because schools take in students at different levels of preparation and capability, performance assessments must take into account the quality of the intake: hence performance improvements as well as absolute performance levels should be measured. We also need to find ways of publicizing school-performance assessments in a manner that is both comparable across schools and easily understood by parents. Failing schools need to be given initial support to improve, but not multiple chances to do so. The No Child Left Behind Act of 2002 goes some way toward these goals but needs to be strengthened.
Finally, parental choice can help bring the discipline of competition to schools. School voucher programs, if properly administered, can allow students to vote with their feet and prevent failing schools from holding talented but poor students hostage. Charter schools can also help. These are quasi-public schools that have more freedom from regulation than public schools in return for greater accountability. They obtain tuition payments from school districts in proportion to the students they attract from them. Evidence suggests that such schools can lead to substantial performance improvement, especially relative to public schools that face little risk of closure.18
The poorest-performing public schools clearly need more time to change, since the problems in the school and the community are deeper. Organizational capital and community involvement need to be built up (much as in the developing economies). If everyone thinks the school is likely to be closed, collective action is unlikely. Therefore, a period in which resources are made available, change is encouraged, and the threat of closure is held in abeyance may be necessary. But if there is no requirement for improvements in performance at the end of the period, and a permanent guarantee of a quiet uncompetitive life, it will be equally hard to elicit collective effort. As with the developing economies, a combination of initial nurturing and protection followed by competition may work well.
The Obama administration has laid out a path for educational reform that involves a more detailed method of evaluating schools than the pass-fail system of the No Child Left Behind Act. It proposes nationwide testing standards, evaluation of teachers based on student test performance, and the entry of more charter schools, using the lever of additional cash for states and districts that adopt reforms.19 These are important and useful ideas and, if implemented, would be a major step forward in improving education. We should not, however, underestimate the resistance to common standards, transparency on performance, and student choice from failing schools and underperforming teachers, even if these constitute the minority—the attractions of a quiet life are immense and worth fighting for.
Only 34 percent of youths from households in the bottom quintile of income distribution enroll in college, whereas 79 percent of those from households in the top quintile of family income do so.20 Moreover, only 11 percent of youngsters from the bottom quintile graduate, whereas 53 percent from the top do so. The dropout rate is thus also disproportionately high among the poor.
Clearly, the cognitive and noncognitive skills acquired earlier are a significant source of such differences, and I discuss potential remedies above. In addition though, programs could help make it easier for disadvantaged youth to apply to, pay for, stay in, and succeed in college.
Students from better socioeconomic backgrounds have access to significant resources to aid the college application process, including school counselors and relatives who have been to college. Students from disadvantaged backgrounds do not. Although a number of remedial government programs exist, their effectiveness is questionable.21 Recently, a number of programs have been established that link students with a disadvantaged background with undergraduate students who have recent experience with college applications.22 These deserve further study and expansion if worthwhile.
Financial aid can also help. Studies suggest that $1,000 of subsidy increases college attendance rates by roughly 4 percentage points, improves graduation rates, and shifts students from choosing community colleges toward choosing four-year schools.23 A substantial number of college aid programs are already in place. The key to their effectiveness is to target aid to those who would not otherwise go to college, to make the aid application process simple—currently there are a multiplicity of programs, many poorly advertised and each requiring different applications, all of which pose particular difficulties for poor children without Internet access or printers—and to make the continuation of aid contingent on student performance.24
Human capital can also be built through on-the-job training. Apprenticeships, especially in the private sector, can be important in inculcating work habits and behavior that can help disadvantaged youths hold a steady job. Because U.S. workers tend to change jobs a number of times in their careers, firms will have to be given incentives to offer these apprenticeships to compensate for the facts that they are unlikely to keep an apprentice in the long run and that such apprentices will require a fair amount of help and supervision.
Many good ideas have been, and are being, proposed for improving human capital for the disadvantaged. However, ideas that make sense on paper often do not seem to work in practice. Although we should try ideas that evidence and common sense suggest stand a good chance of success, ideally, programs should also be subject to periodic evaluation. These evaluations will help identify ineffective programs, as well as modifications that could make a program work better.
As the quality of the human capital of the disadvantaged improves, wage inequality should diminish. There is no certainty, however, about whether any interventions will be implemented, whether they will work, and, if they do, how much time they will take. There could well be political pressure from those who have fallen behind to redistribute, either directly or by the extension of more easy credit. Countervailing pressure will come from those who have to pay the higher taxes or who do not believe in income redistribution. Political strife could well continue at an elevated level for a while. We must hope, however, that as the disadvantaged see the ladder of programs that will help their children climb to a better future, the prospective redistribution of opportunities will head off potential conflict and the associated costs to growth.
As I argue in Chapters 4 and 5, the absence of a sufficient safety net to support workers who lose jobs in a prolonged downturn in the United States increases public anxiety and tends to generate a disproportionate monetary and fiscal response. The remedy is to improve workers’ resilience to economic adversity. This issue is not unrelated to that of inequality. Low incomes give people little margin of safety or the ability to save enough to tide themselves over a period of unemployment.
In searching for remedies, we should recognize that the nature of firms and the employment relationship in the United States, which emphasize flexibility and mobility, may not sit well with the kind of long-duration safety nets available in continental Europe. In what follows, I examine the broad changes that could make the U.S. worker more resilient in downturns while preserving flexibility in the system.
The current unemployment safety net (beyond the minimum in place) is a contingent one whereby politicians respond to prolonged, massive unemployment by temporarily extending unemployment benefits. Workers experience tremendous uncertainty over whether benefits will be extended and the criteria for receiving them. Moreover, politicians exploit the public demand for action to push through all manner of pet projects without much scrutiny under the guise of emergency legislation.
If U.S. recoveries have indeed changed in nature and become more jobless, it is worth debating whether unemployment benefits need to be extended on a more permanent basis. Longer-duration unemployment benefits not only entail costs but also make some of the unemployed less anxious to find jobs. A less responsive labor market may alter the nature of the employment relationship in the United States as well as the ease with which firms can take up new opportunities. The United States may want to give up some corporate flexibility for greater worker security, but that decision, because of its long-term ramifications, can be more fruitfully addressed once we have a better analysis of whether recoveries have indeed changed, and, if so, why.
There are, however, two reforms of which the net benefits are clearer. First, the United States would benefit from predetermined, contingent extensions of unemployment insurance. In other words, instead of extending unemployment benefits on an ad hoc basis according to the politics of the moment, the decision could be tied to a formula. The formula could be some simple function of the extent of overall job losses (as already offered by some states), the proportion of jobs created to jobs lost, and the time elapsed since the recession began. More complicated formulas could take into account the sectors where jobs are lost (are these industries where output tends to be cyclical, or do the job losses indicate a more permanent transformation?), as well as the nature of jobs created (are these full-time, permanent jobs or part-time and temporary ones?). The virtue of keeping it simple is that extensions could be easier for workers to forecast and plan for, and such foreknowledge is central to reducing anxiety.
The second area requiring change is health care. Much of the anxiety surrounding unemployment has to do with employees’ concerns about losing health insurance for themselves and their families. As I write, Congress has just passed a bill to create near-universal health care—near-universal because illegal immigrants will still be left uncovered even when the bill's provisions are fully implemented. The passage of the bill is just the first step in a long and arduous process to achieve effective universal health insurance. Indeed, with many of the provisions of the bill due to be implemented only years from now, with attempts by various state legislatures to opt out of the provisions of the bill, and with threats by conservatives to repeal the bill when they gain power, there is some small uncertainty still about whether even the main legislative hurdles have been overcome. Even if the legislation survives challenges, effective reform will have to make sure everyone is covered even while slowing or even reversing the rate of growth of health care costs. However, the political calculus, as reflected in this bill, is to emphasize the clear and immediate benefits of expanded coverage, while providing less detail about costs and controls. There are many good ideas in the bill (and some bad ones), but only time will tell which ideas gain momentum. The debate about universal health care and health care costs is far from settled, and it will be with us for many years to come; hence a closer look at the key issues is useful.
There is little appetite in the United States for a radical overhaul of the largely private health care system. The key to universal health care, then, is to deal with the adverse-selection problem. If an insurance plan attracts a disproportionate number of those with preexisting health problems, which make them higher insurance risks, while attracting too few of the young and healthy whose premiums are necessary to subsidize the less healthy, the economics supporting insurance breaks down, and it becomes uneconomic.
Given that a number of the young and healthy prefer to stay uninsured—the young have a strong and misplaced sense of their own immortality—the key to successful universal insurance, in which no private plan can refuse those with preexisting conditions and premiums are kept at a reasonable level, is to ensure that the young and healthy pay in. Incentives can include a mix of carrots—such as rebates for not making claims—and sticks—penalties for not joining. These have to be high enough to deter healthy individuals from paying the penalty and joining the system only when the need arises. Moreover, plans that attract a disproportionate number of high-risk individuals need to be compensated with transfers from those that don't.
Universal health insurance will also require subsidies for the poor. This requirement clearly creates some tension with the American aversion to unconditional redistribution that I discuss in Chapter 4. Yet it is implausible that many Americans truly believe that their fellow citizens who have bad luck, or earn little, should pay with their health or the health of their children. Moreover, many of the uninsured sick eventually do receive treatment, but without any of the benefits of preventive care, thus exacerbating both health problems and treatment costs. Finally, there is a broader benefit to universal insurance. The reduction in anxiety among the population in downturns, and the associated reduction in the need for expansionary macroeconomic policies, will make the United States better able to calibrate fiscal and monetary policy to its actual needs, while serving notice on policy makers in the rest of the world that they need to become more expansionary.
The major problem in expanding coverage, once the adverse-selection problem is dealt with, is that U.S. health care does not seem cost-effective. The United States spent 15 percent of GDP on health care in 2006, compared to 11 percent in France and Germany, 10 percent in Canada, and 8 percent in the United Kingdom and Japan.25 On a per capita basis, the United States spent $6,347, while Japan spent $2,474. The difference has been growing: in 1970 the United States spent 40 percent more on health care per capita than peer countries; in 2004 this difference had widened to 90 percent. But health outcomes have not improved commensurately: every country in the United States’ peer group had a higher increase in life expectancy at age 65 over the period 1970–2004, except Canada, which experienced the same 3.7-year increase.26
Three factors seem important in driving up costs.27 First, the United States has high prices for inputs: hip replacements in the United States, for example, cost twice as much as in Canada. Part of this difference is explained by higher compensation for doctors in the United States.28 Second, because doctors and hospitals get paid for services provided rather than for outcomes, and because insurance picks up the bill, the system tends to promote overutilization of health care. Finally, the system tends to adopt innovations even when the evidence of effectiveness is weak. For instance, nuclear particle accelerators, costing more than $100 million, are very effective in treating rare brain and neck tumors; but they are also used to treat more common prostate cancers, with little additional benefit.29 A good bill would encourage more competition, a move to paying for outcomes rather than inputs (as well as setting the per-visit deductible cost to each user at a level that encourages sound judgment about whether to visit the doctor), and a greater focus on using only proven treatments that offer significant improvements over cheaper alternatives.
Three other factors contribute to the high cost of health care in the United States but are not central. The first is administrative costs. These are notoriously difficult to estimate precisely, but one estimate indicates that the United States spent $465 per capita in 2006, while Japan spent only $52.30 Clearly, given that the overall difference in health care costs between the United States and Japan is about ten times the difference in administrative costs, they are not the sole explanation. However, measures to improve cost efficiency are important. The information technology revolution could finally be brought to health care by, for example, standardizing electronic patient records so that they can be transferred easily among different providers.
The second is operational efficiency. Hospitals in the United States could learn more from each other, as well as from hospitals elsewhere, including India, where costs have been brought down by bringing mass-production techniques perfected in manufacturing to health care. Indian hospitals have found that error rates are reduced when their doctors specialize and perform many procedures of a similar kind. The time for operations is also cut down, with no loss of safety. A focus on eliminating unnecessary frills and on utilizing expensive resources like doctor time most effectively also helps: even though good surgeons in India earn about as much as surgeons in the United States, the cost of operations is often an order of magnitude lower. Regulations that force hospitals in the United States to be “full-service” hospitals rather than permitting specialization tend to drive up costs. Greater competition between hospitals could also bring down costs; an easy way of encouraging cross-border competition is to authorize Medicare and Medicaid reimbursements for procedures performed by authorized hospitals in other countries, like Mexico and Thailand.
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.
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 training 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.
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.
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.
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.