The set of questions facing the United States economy is a perpetually changing mixture of recurring concerns (How will geopolitical turmoil affect business domestically?) and new uncertainties (Will fintech destabilize the financial system?). At Chicago Booth’s annual Economic Outlook event in Chicago, held this year on January 10, a panel comprising Booth’s Austan D. Goolsbee, Randall S. Kroszner, and Raghuram G. Rajan met to share and exchange insights on the state of the US economy and the forces shaping it. Oriented toward the theme of “Big Tech, Trade, and the Future of the Economy,” the discussion was moderated by Bloomberg’s Kathleen Hays.
Kathleen Hays: We’re going to start with a look at tech. More and more over time, the developments in tech are having a potential or actual impact on where the economy’s going.
Randy, I want to start with you. Big tech is moving more and more into the banking system. Now in some ways, particularly starting in the 2008–09 financial crisis, it was pretty clear that a lot of these big banks were ripe for disruption. So where are we now? Is this a risk, or is this something that’s inevitably going to happen, and maybe even make the financial system more efficient?
Randall S. Kroszner: There are a lot of challenges and potential risks, but what’s kind of amusing is that many of my friends in the banking community say, “Well, thank God for your former colleagues. It’s bank regulation that keeps those big tech firms out, because nobody wants to be regulated as a commercial bank.” It’s much more difficult for entry here than it is, for example, in China, where you have some of the tech firms becoming some of the largest financial institutions. Because in some sense, it’s natural. If you’re on your phone, and you’re thinking of buying some product through Alibaba, Tencent, someone else, and they know everything about you, and so they know what your appropriate interest rate would be, they can just offer it to you right there.
If you want to buy a refrigerator, you can click one button to pay full price now or you can just click another button and pay over the next few years. That’s a totally natural combination of things. But in the United States and actually much of Western Europe, there’s a lot of regulation that makes that very difficult. Now, part of the motivation for that is a concern about the big banks and big finance taking things over.
We have a long history in the US going back to the Jacksonians and the populists of rising up against the banking and financial system, in particular killing the Second Bank of the United States, which was a prototype for the Fed. It’s interesting that we now see tech taking on that sort of role. People are very concerned about it, but in some sense there’s an unintended piece here that banking regulation is keeping some of the tech players out.
Austan D. Goolsbee: The lesson of China and the financial payment system is a sobering one. I think there’s a major contingent of people who feel good that either because of antitrust or because of financial regulation, we’ve avoided that consolidation of the biggest retailer, the biggest payment system, and the private space.
It’s natural that fintech firms will find inefficiencies in the current financial system and improve them. That part is good. The fintech universe is maybe less concerned about financial stability than traditional financial institutions. That makes it a little more worrisome. In many of these cases, if there’s not a natural monopoly, there are big economies of scale.
Once the system rolls out, it will look like the Chinese system or others in that there’ll be a small number of very big players, and then fintech will be in exactly the same hot water and messy space that all of the other big tech firms are. We can’t help but say, “Well, look at how much power they have, and should they be broken up, and how can they be controlled?” I think we’ll have a bunch of important decisions to make. It’s just that they’re probably a couple of years away.
Hays: That’s one of the big concerns, right? Because we know that the government, understandably, has a hard time not bailing out any kind of financial firm. I don’t care if they’re nonbank, fintech, whatever. If you say, “Yeah, they might take on more risk and they kind of evade the rules,” are we just setting ourselves up for some kind of excess—and China’s had plenty of those—that we’re going to have to pay for?
Raghuram G. Rajan: That’s a very big worry. I think this is a new corporate beast. It brings together data. It brings together networks. And of course that, together with all the other stuff that they’re doing, creates an enormous amount of power. That’s what Austan was talking about. We can get to that, but on the fintech side, many aspects of fintech are trying to bring value to a place where there are economic rents.
One of the concerns is, when the rents dissipate, are they still going to be able to make money, or are they going to engage in this ruthless competition, which drives profits down, in which case you may get the excesses that you’re talking about?
Let me give you an example. There are hundreds of companies trying to get into remittances, because remittances is where you see Western Union charging an arm and a leg for transferring money across borders. “Well, we’ll get in there, we’ll charge half the price, and we’ll still be plenty rich.” The problem is once you get in there, Western Union is going to cut its prices, and you’re going to compete with five other people doing exactly the same thing. They’re not thinking beyond that first step when they disrupt the industry and then they have to compete for new business.
This is where I want to believe the marriage of big banks with fintech would be better than fintech alone or big banks alone. The problem, of course, is these are cultures that don’t necessarily mesh, and so they don’t necessarily come up with the right products when you get fintech into banks. But the banks that can figure out that issue of: “Here are some real problems we haven’t succeeded in dealing with, when we bring fintech to this problem, we can reduce transaction costs tremendously, and we can make it much easier for the customer, therefore there’s big value here.” Those are the guys who are really going to benefit from the banking side. And of course there will be fintechs that will figure it out on the other side.
Goolsbee: Though, the thing is, like with the accelerated attention paid to artificial intelligence, there are examples where A.I. and fintech are improving things a lot. But thus far, it’s still much more promise than it has been reality. If you look at Bitcoin, for example, it’s not even reducing the transaction fees. Those are actually still enormously large. In my favorite example, there was a big Bitcoin convention, and the organizers refused to accept bitcoins as payment for the convention because they said the fees were too high. They would charge 25 percent. It could be a big thing, but I still think we’re a few years away.
Kroszner: So far the major financial institutions have not been able to press their natural advantages. The large banks know an enormous amount about you. You have your mortgage with them. You have your credit card with them. You have your bank account with them. In some sense that’s the data that the fintechs would love to have. But the banks get this naturally doing these other functions.
They haven’t been able to marshal that to be able to say, “Ah, and here’s the right product,” or “Here’s the thing that we should be offering to a particular customer.” I’ve talked to a lot of the banks and boards about this. They want to get there, but their cultures just don’t mesh. So what they do is they hire all these people with plaid shirts and wooly caps and long beards who get on the elevator with Jamie Dimon—and they can’t stand being on the elevator with Jamie Dimon. They go into the office, they do that for a year or two, and then they leave, and they do their own startup, and then sell it to Jamie Dimon.
The big banks haven’t been able to take advantage of that yet. It’s really quite amazing that their information-technology systems are so poorly structured that they can’t do this. Part of this is the long legs of banking and financial regulation. Because as I think I’ve mentioned to this group before, we had these completely crazy laws that made it very difficult for banks to branch. Especially in the old days when you didn’t have markets where you could diversify, the only way you could try to diversify was geographically. It’s like someone read a book on finance and said, “OK, how can we make the banks as risky as possible? Make them put all their eggs in one basket?”
Well, we eventually got rid of these laws, and all of our major financial institutions have become in some sense like Frankenstein’s monsters as a result of mergers. One of the things that the regulators didn’t think about was we should have required that they integrate their IT systems, and we should have said, “That’s great. Merge, but we won’t let you do the next major merger until you’ve integrated your IT systems.” We haven’t done that, and so they’re still struggling, and I also think that sets us up for a lot of potential cyber risks at these organizations.
Rajan: There’s also another aspect of risk, which is legal risk—especially with A.I. One of the worries for big banks is that when you actually run some of these systems, there is bias that you didn’t figure out. There’s some proxy for race or there’s some proxy for gender that doesn’t show up, but once you use it, you tend to bias your lending, and then you get the lawsuits and have so much liability, which these fintechs don’t have to worry about so much.
A second concern I have about fintech is that we haven’t been through a downcycle. Have we optimized for just the upcycle, and not optimized for the downcycle? What happens then? Can fintech companies actually collect the money when people’s incomes no longer are sufficient to make payments? That’s another thing we should be worried about. Regulators worry, fintech less so.
Goolsbee: In the financial sector, it’s fundamentally about trust in your financial institutions. That’s the strength of any bank, its reputation. With the payment systems now, it’s gone bonkers. If you’ve got a teenage kid, she will tell you, “Oh, we want you on [mobile payment service] Venmo.” I started looking at Venmo. In Venmo, every payment you make is public knowledge. It’s a social network, and there is, among young people, a level of trust in these startup companies—or maybe they haven’t thought about the issues of distrust, should they be distrustful. If there is a downturn, I wonder if a whole generation of people are going to discover, “Wait, what? What happened to my money? What do you mean?”
Hays: Bank of England governor Mark Carney gave a surprising speech in which he talked about digital currencies and how they need to be developed. The dollar has all kinds of reasons why it’s the world’s reserve currency. Raghu, where do you stand on this idea of central banks developing digital currencies?
Rajan: One of the reasons people trust the dollar―and 60 percent of pretty much every transaction in finance is in dollars―is because it is a deep, open market. The US historically—until very recently—hasn’t tried to use finance as a means of pressuring countries. One of the concerns is that this politicization of the dollar now may in fact cause people to turn away. One example is Russia, which has moved away from holding its reserves in dollars—at least to the extent that it did—and you can imagine that could expand if the dollar is used as a weapon.
But on the broader point that the dollar would be replaced, I don’t think we need to go there to argue that digital currencies could have a strong future. The question is, will it be central banks that will issue them, or will it be Facebook with [its cryptocurrency] Libra, or something like that?
Again, it’s the power of networks. It’s the power of information. One of the big concerns that central banks have about Libra is, first, this [Facebook] is not a company that is well known for protecting your information. It’s also a huge monopoly in its own right, so add to it a payments monopoly, and what else can that lead to? That’s a concern across the world. Certainly from the perspective of small countries, a very big fear is Libra will displace their own currencies because it’s so much easier to use. And if you can get in and out easily, why would you hold a depreciating currency in a small, developing country rather than move into Libra?
These are concerns that need to be addressed. One of the big concerns Libra has always had is that it has to persuade the regulators, and I have to say right now, the regulators have not yet been persuaded.
Goolsbee: I don’t understand what the circumstances are that Facebook would want to get into this. If you go look at Bitcoin, a vast chunk of the transactions are obviously not good. We had a research seminar at Booth about a paper that analyzed the whole [Bitcoin] blockchain. The author said, “Well, 25 percent of these transactions are money laundering.” In the audience, we were like, “Whoa, how do you know that?” She said, “Well, there are people coming from sites such as moneylaundering.com.” I was like, What?
Imagine now Libra becomes the big currency, and somebody makes a payment. Somebody buys whatever. I send you a payment for a terrorist action, or I buy drugs, or whatever. Every country in the world is going to view that as a massive threat to their sovereignty, and they’re not wrong, and they’re going to try to hold Facebook accountable in their country for facilitating criminal transactions.
They’re going to say, “Facebook should work with some regulator to govern what’s happening in the transactions the way banks do.” Then once that happens, they’re in the regulated world.
Rajan: Austan, just on that point, it is true that Bitcoin would be used largely for laundering, otherwise the transaction costs are not worth it, right? If you want to make a payment for your coffee, you’re not going to use bitcoins precisely because of the cost that you pointed out. But it is possible that something like Libra could be so easy to use that the vast majority of the transactions are legal and some small minority are illegal, as is true of money also.
But you’re absolutely right that they have a huge amount of reputational risk, and they will have to convince central bankers that they will be able to control the know-your-customer problem and that they will not misuse the information and the networks that they obtain as a result.
Kroszner: But this is the interesting thing: they really know their customer. There’s nobody else who knows the customer like some of these big tech firms. It’s very interesting to see this sort of back and forth about whether central banks should be issuing a digital currency. There’s been a lot of discussion about whether China’s going to do that. The Chinese central bank and the Chinese system work rather centrally, so if they want to eliminate currency, and if people object, the objectors are not going to get very far. They will be able to execute on that.
It’s going to be interesting to see if they do something like this, because that, again, could be an interesting test case for how things would operate. Obviously, it would be all centrally controlled. Every single transaction would be monitored. Many of the transactions are already monitored through the large fintech firms, but this would make it complete.
In some sense, it’s very interesting to see the different models around the world. You have GDPR in Europe [the European Union’s General Data Protection Regulation], which is a lot about data protection and privacy issues, a lot of fragmentation of data. China’s the opposite, where everything kind of goes into the central government’s computer, and they can monitor everything. And we’re [in the US] sort of somewhere in between. It’s going to be interesting to see how that develops. Is that something that’s going to be a strength for China? Is it going to be difficult for the West to compete with? Or is it something that is going to lead to more problems because people become outraged in China that they have the extent of this monitoring, and they rise up against it? That’s one of the big political economy questions that come out of these big tech issues.
Hays: I want to put a very broad question on the table in terms of technology innovations. It’s great to see things, many things, disrupted. They do get more efficient. New things happen. And at the same time, some people are worried about some concentration developing in the economy. Competition. Innovation. Equality. For each one of you, what’s the big question right now?
Rajan: For me, it’s what do we do about the jobs that are lost to automation. That’s going to continue to possibly increase. How do we find ways in which people can rediscover good work? The first thing is, obviously as people lose jobs and wages fall, the market will react to some extent. But the question is: Can we prepare them better for the kinds of jobs that are emerging, so that some combination of tech and human will emerge again to do a better job than tech alone or human alone?
I don’t think we’re thinking very hard about it. We throw out education as something that’s necessary, but what kind of education, and how do you get education to the places that are being left behind? What do we do in those places? What should those places do and how do we facilitate their doing it? This is the central conversation that we should be having, because this is the source of political fracture in a number of industrial countries. If the reaction to that political fracture is to actually put enormous constraints on markets and corporations, etc., we will eliminate our ability to actually react to the problem.
Kroszner: I think it’s more the fear of that than the actuality of that. If you look over the most recent jobs report [issued by the US Bureau of Labor Statistics], it’s astonishing that we’ve had basically more than 20 million jobs created over the past decade. The unemployment rate is at 3.5 percent. And what’s interesting is that there’s been more job growth in the low-skilled sector.
The reduction in unemployment has been greater there. The growth of jobs has been greater there.
We actually haven’t seen this yet, but it’s an issue because people fear that. But it actually hasn’t happened yet.
Rajan: Well, what has happened is the jobs that paid at the middle level have disappeared, and you’re getting many more jobs at the lower level, and some jobs at the upper level, but there’s a gap in between. Now whether those were protected by strong unions and there were rents there or they were truly well-paid jobs, the reality is the middle is much thinner than it used to be. This is across industrial countries.
Today to get one of those really good jobs, the leap you have to make in terms of your skilling, your education, is much higher than it used to be, where [before], with a high-school education, you got a good job at GM and you were made for life. You’re absolutely right. We’re talking about jobs in a period where unemployment is really low, so we need to ask, What jobs are we talking about? Well, not the kind of jobs that put an earpiece in your ear and tell you which bin to go to next to pick up the stuff that you put together and pack and send for Amazon.
Goolsbee: Not to add a potentially depressing component to that, but if the economy is doing well, and the unemployment rate is this low, and people are already so angry about wages and immigration and so on, imagine what happens during the next recession. It seems like this could be a dark path.
Kroszner: I see this in the United Kingdom, because the UK has near record-low unemployment and very high labor-force participation. Part of the Brexit support is exactly on these sort of labor issues, where it’s hard to make an argument that people are losing out on their jobs because of competition from immigrants, because the unemployment rate is so low and labor-force participation is high.
That’s one of the big things that’ll come with the next downturn. Not just what will happen with the risk models and fintech, but exactly as Austan said: If people are upset already when the unemployment rate is at record low in so many countries, what’s going to happen when the unemployment rate goes up?
Hays: Let’s look at what’s going to happen this year. In the jobs report, average hourly earnings were only up 2.9 percent year over year, and it’s never gotten very high since the Great Recession. It was up to maybe 3.5 percent year over year one month, but it used to be a lot faster. In an environment like this, wages can’t rise. Where are we guys? What’s happening in the year ahead? Let’s start with that aspect of it, the labor market, where is it going?
Goolsbee: If you’re of the view that the job market is about to get really hot and wages are going to start going upward, you’re in the camp of the inflation hawks, and the problem there is, they’ve cried wolf for nine, 10 straight years. In 2010, they said we’re about to unleash the wage-price inflation spiral, and in ’11, ’12, ’13, ’14, etc. Now they’re saying, “Oh look, now it’s 3.5 percent. It’s about to go up.”
That might be true, but I find it implausible just because it’s been wrong so many times before. In the jobs numbers is a microcosm of this weird thing, which is we basically have two economies. Anything that deals with the consumer and the job market looks excellent. Anything related to business investment or manufacturing [looks less rosy]—manufacturing’s actually been in decline for several months, and GDP growth has been mediocre and slow. Which of these is right? Is one of those a leading indicator of the other one? If so, we just don’t know which.
Rajan: So, what’s difficult to understand is, you get into a room with business people, and you ask them, “How’s hiring?” They say, “Impossible. I can’t find the right people. I’m willing to pay. I’m paying a lot and I still can’t find people. This is a very tight labor market.” So, that would say that the old forces we thought accompanied higher wages should show up some time—we should see great inflation—but there are many steps here that have to play out.
One, your hiring at the entry level may not translate into an across-the-board hike, especially if a lot of older people at higher salaries are retiring and your average wages don’t move up that much. That used to be the Japanese phenomenon, and with the retirement of the baby boomers, it’s possibly something that’s happening in the US. Looking at the details of the labor force in your firm is actually very important.
The other thing that seems to be happening is a lot more automation. When people are hard to find, or you have trouble identifying entry-level people within the company to do higher jobs, companies react. As yet, it doesn’t seem to show up in generalized inflation of the kind we saw in the past. Some of that is possibly also because expectations are reasonably anchored. People aren’t saying prices are going to be 10 percent higher next year and are not demanding that kind of wage increase.
However, I think the hawks are wrong. It’s not going to happen tomorrow that we suddenly have an outburst of inflation. At the same time, the doves are also wrong in their sense that this is never going to happen. What we’ll see is a steady increase in the cyclical component of inflation, even though some of the longer-term trends, especially stemming from population, go the other way. We will see a steady rise in inflation if monetary policy holds. This is where the Fed has been thumping on the table and saying, “We don’t care if it goes up a little higher. We’re willing to watch it. We’re not going to be preemptive.” So interest-rate increases, for the foreseeable future, until we see inflation really pick up, are off the table.
Kroszner: I think the data on wage growth, we have to adjust it. What Raghu was saying is that you have a lot of retirements of relatively high-wage people, and you’ve had this disproportionate growth in the lower-skilled sector. When you look at the average, that’s going to understate where wage growth is. It actually is a bit higher.
The San Francisco Fed has been doing some adjustments of this. It’s not dramatically higher, but it’s not quite as low as it seems. The Fed certainly looks at those kinds of things. They’re thinking about where the wage trends are, where the pressure is. What’s very much weighing on things is the specter of Japan. Japan got into a difficult situation—and it’s still there—where they acted a little too quickly when inflation started to come up, because they were in a deflation situation.
It came up basically to zero, and then they started raising rates. They said, “We’re worried that the tight labor markets and growth are going to lead to high inflation.” Well, that led to a situation in which people no longer believed that the central bank was really very credible. Despite incredible amounts of asset purchases—they now have a central-bank balance sheet of more than 100 percent of GDP—despite Prime Minister Shinzo Abe, when he was elected, making this super salient publicly, saying fighting deflation was one of the three arrows of Abenomics, despite putting in someone to lead the central bank whose whole reputation was that the central bank could do more and had no limit, they still haven’t gotten anywhere near your 2 percent inflation target.
I think the Fed is worried about trying to get ahead of things and is worried that since they can barely get to 2 percent even in this situation, they’re going to hold back. From their risk-management point of view, that weighs on them heavily, and I think that’s a perfectly reasonable thing that’s going to leave them waiting for the inflation to come.
Also, they’re doing a bigger rethink of their fundamental model. Since 2012, they’ve had this 2 percent inflation target, and they’ve been under it for every year since they’ve had it. So, probably the new regime will say, “Well, if we’ve been under it for seven years, we’ll be comfortable with being over it for seven years, or get the average to 2 percent.” So, that, again, is trying to get people to expect that the Fed is not going to stop when they get to 2 percent, so that you don’t get into a Japan-like situation.
Hays: The longer the expansion gets, the more people think, “Gee, are we going to have recession?” I don’t really see any big recession risk right now. But Austan, I know you’re worried about manufacturing. Is that somehow where a recession is going to come from?
Goolsbee: It was barely a year ago that the Fed was saying they were confident they were going to raise rates four times in 2019, and some people were saying, “Oh, they’re being conservative. They’re going to raise it six times in 2019.” Instead, we ended up cutting rates, because it’s really hard to get out of a financial crisis. It’s a struggle.
My advice is: don’t get overoptimistic. It sounds like people are like, “Ah, well, we made it through that risk of recession. Now it’s not there.” If you look at the 14 or 15 recessions—depending on how you count them—post–World War II, the Fed raising interest rates or keeping rates high is by far the biggest cause of recession. It’s about two-thirds of the recessions. Popping asset bubbles is the No. 2 cause, and rising oil prices is the third. Now, rising oil prices is not as big of a risk, but for the other two major causes, you at least have to say there’s a yellow light there, and that the last five years of policy decision and stated understanding of the economy haven’t been that great for the Fed’s model. It’s good that they’re reevaluating the model, because the model has been wrong 37 quarters in a row, in the same direction, in the same way.
I don’t think we’re fully past the dangers of recession by any means—maybe not like the 2008-style massive Great Recession, but a 2001-style, 1991-style recession. It could come from manufacturing; it could come from international sources. If we got back on the trade-war train, it could come from that. It could come from a popping asset bubble.
Hays: Some people have been arguing lately that it’s wrong to always say, “Oh, we’ve got to keep the expansion going. We’re going to avoid recession.” At some point, recessions are healthy because they clean out excesses, things that have developed that shouldn’t be there.
Goolsbee: I would just say, I’ll take the jury trial on that one. Your advertisement is like, “Let’s embrace a recession. It’s going to be good for us.”
Rajan: I think the better way of saying that is not so much to create a recession but to be wary that as the expansion proceeds, the risks build up. Now, the two traditional risks were inflation—as the labor market gets tight, inflation pops up, and we’ve just talked about it as not that big a risk, and it’s probably going to be gentler than in the past—and the second big risk is not so much asset bubbles as credit, because that’s the greater danger we’ve seen. Credit is getting a little iffy. Periods of extended liquidity—especially combined with a stronger sense that the Fed is there to back you up if things go south, which has been reinforced this year after the Fed’s about-turn in December—mean people are willing to take more risks. Where are the risks? You see in private equity, and you see in a variety of other places, that credit has expanded.
A lot of people are sitting in Baa-rated bond instruments; what if those get downgraded [to junk status] because of a downturn in the economy? There would be a lot of crowded trades around there. Lots of pension funds and insurance companies have gone out on the risk spectrum because they’re searching for yield. Now, a lot of this is predicated on interest rates remaining low. To the extent the Fed stays put, it’s not as much of a worry. To the extent that the Fed is forced in some way to raise interest rates, it’s perhaps more of a worry.
Term spreads, credit spreads, all of those could expand. They’ve tightened a lot, and higher interest rates would create that asset-bubble collapse. The reason at least some of us on this panel are a little more sanguine is we don’t really see that pop-up in interest rates coming any time soon. It’s not a reason not to be worried that the sort of fragilities are building up.
Hays: We’ve had a sudden increase in geopolitical risk [with the death of Iranian general Qasem Soleimani]. Austan just mentioned the risk of oil prices rising, and in fact, there’s tons of oil supply, so it was supposedly hard for oil to move up above $70 a barrel right now. Does this change the economic outlook for this year at all?
Goolsbee: I don’t think it does. The US has become a huge oil producer, so if the price of oil goes up, there would at least be some significant part of the US economy and manufacturing economy that benefits, not goes down. Prices haven’t moved that much, and the US economy’s gotten a lot more energy efficient per dollar of GDP than it was in the 1970s and ’80s. So, it could lead to tumultuous oil markets, if things go a certain way, but I just don’t think that that has the same economic impact that it used to.
Rajan: Well, I’ll differ from you a little bit here, because I think sentiment matters. One of the things the Iranians showed us earlier last year was they could essentially target all of Saudi Arabia’s oil facilities. It didn’t make a big difference to the oil market because there was a lot of spare capacity that came back on at the time, but the repairs are still going on because they had pinpoint accuracy in how they targeted the Saudi Arabian facilities.
I can’t believe that the Iranian reaction to what happened to their general has ended. I have to believe there is another shoe waiting to drop, and there will be more back and forth. I hope that it is mild and it doesn‘t provoke a reaction from the US, or the US doesn’t feel it needs to react. But geopolitical risk is certainly on the calendar, and I’m not sure there’s that much spare capacity in the oil markets if the Saudi facilities or the UAE [United Arab Emirates] facilities are targeted in a careful way.
The other thing we should pay attention to is trade risk. We’re again banking a lot on China and the US coming together with this interim [Phase I trade] deal. My worry is, first, it’s taking a long time to iron it out because it’s complex to get even to first base, but also, there’s a lot more to be done here. How does this play out? How do the trade frictions with Europe play out? We have a [US] president who is not very predictable, and my worry is that this could be a source of risk as we go on into this year.
Kroszner: Trade has actually had little negative impact on the US. It’s a small part of GDP. Even with these high-sounding tariffs on China, it’s just trivial for the overall economy. It’s painful in the particular areas that it’s hitting, so I don’t want to suggest otherwise. But overall, it’s had little impact. The CBO [Congressional Budget Office] has estimated very small impact on GDP from all these trade issues.
It has a much bigger impact on China. I think that’s why the president has pressed the issue of trade with China, because it’s an area where he feels he can inflict more pain on an opponent than we feel ourselves. But I very much agree that I don’t think this is over.
Goolsbee: The deal is trivial.
Kroszner: Yeah, it’s on a few soybeans and a few cars. That really isn’t going to matter all that much. Whether we have it or not, it’s not going to matter very much for US GDP, but the issue is going to continue to be there. The issue gets back to something that Raghu said about sentiment. All of these things—whether it’s geopolitical risk, the oil markets, or other things—are about sentiment. Because there’s something that we don’t fully understand about why investment has been so low.
You’ve had this astonishing recovery. Over a long period of time and a large number of countries, you’ve had unemployment rates at very low levels. You’ve had promises from central banks to keep interest rates low for an extended period of time—and they have—and many central banks have made them negative. Well, it makes a lot of investment projects look pretty good when you’ve got negative interest rates, but no one’s taking the bait. The concern had always been: when we go negative all these crazy investment projects will come up because who can’t beat a negative hurdle rate.
Well, people aren’t doing that. That’s something that I don’t fully understand, and I don’t know if you guys have a good explanation for that, but that’s the thing that worries me about the length of the recovery. Because as you know, last year, even though the stock market was down, I was relatively optimistic because I didn’t see, in the fundamentals of the data, that things were going south, and we had a reasonably good year. But my concern is that to sustain the recovery, at some point you’re going to need investment. If you have some of these risks that are there, whether they’re perceptions about trade—even if it’s not the actuality of trade—or perceptions about what’s going on in the Middle East, if we have even less investment, it then becomes harder to maintain growth.
Hays: Some people are saying the US shouldn’t even bother pursuing a Phase II deal because the Chinese can’t and won’t make the policy concessions the US would demand, such as limiting subsidies to small and medium-sized businesses, or protecting intellectual property.At some point, does everybody just move on? Should we care? One of our audience questions is asking about how much of the weakness in manufacturing has been caused by the tariffs; could there be other things that are causing manufacturing weakness, such as not enough skilled manufacturing workers?
Rajan: A bigger issue than trade is that of investment and global supply chains. This conflict has thrown up a lot of uncertainty. If I produce in China, will I be able to supply my factories in the US, because something may get in the way? Will I be forced to excise a Chinese company from my supply chain because the US either increased tariffs or banned that company from supplying? So, there’s a lot of uncertainty about this, and the natural reaction over time is, “Let me separate myself from China. Let me make sure that my supply chain goes through friendlier countries that are not going to be influenced by this.” That same logic is playing out in China. Am I going to have enormous exposure to the US market? Am I going to buy a lot of chips from US companies when I know that a ban can emerge?
They are, in a sense, trying to innovate, to find a way out of this. Expect that in the next five years they will be far less dependent on some of the key US products that they buy today. China, by the way, has made enormous strides in innovation. So, at some point, and this has been a fact of history, when countries innovate themselves, they strengthen property rights.
China’s getting to that point, so I wouldn’t be too pessimistic about China protecting intellectual property. What I would say is they’re much stronger competitors now in some areas, and that’s the reason they’re protecting property, not because they don’t want to steal anymore.
Hays: That’s a good point. They did even set up a couple of intellectual-property courts. I don’t know how much they’re using them.
Rajan: They’ve made enormous improvements there, enormous improvements.
Hays:Turning toward Europe, Brexit is now something that’s going to happen. There’s this question of trade with the US and Europe. And there’s this question of Germany’s still being pretty weak, and it’s in large part because China’s slowed down—because isn’t Germany one of the most export-dependent countries in the world, even more than China? When we look at the outlook for this year, it’s a big story, it’s very important, but does it really affect the US economic outlook for the next year or so?
Kroszner: Certainly there are a lot of challenges in Europe. It’s no accident that the Europeans picked Christine Lagarde to be head of the ECB [European Central Bank]. She’s been a finance minister, she was actually head of a law office here in Chicago, and she was head of the IMF [International Monetary Fund]. As Raghu and others well know, people often joke that IMF stands for, “It’s Mostly Fiscal.” So they put someone who’s focused on fiscal policy as head of their monetary institution.
I think the reason for that is precisely because Europe is trying to get more fiscal easing from Germany. French president [Emmanuel] Macron has been skillful in getting the people he wants into key EU positions, to convince the Germans that they need to ease fiscal policy, because they’ve been running an extraordinarily tight policy.
In her first speech as ECB governor, she talked more about fiscal policy than she did about monetary policy. The Germans are now actually talking about fiscal expansion, which had been seen as complete anathema before. So you’re going to get more fiscal expansion, and that’s going to help Europe, at least in the short run, to survive this next year. But they are very dependent on China. That’s why US tariff policy on China has much more of an effect in Germany than it does in the US.
Hays: Of course, Germany is not the only one. Australia, which has a surplus, says, “Things have been slowing down.” The head of the Reserve Bank of Australia, Phil Lowe, would really love not to even think about starting a quantitative-easing bond-purchase program against negative rates. Even as they’ve got all this money they could spend, up until now they’ve been very reluctant to do any fiscal spending at all.
Maybe it’s going to change more, but the last couple of times I’ve interviewed [Australian treasurer] Josh Frydenberg at the IMF, he’s said, “No, we promised the people a surplus.” But it seems that this is a problem around the world, or maybe it’s not a problem if you want a surplus. But then it seems to me that the tough part is that it puts so much onus on central banks when things slow down.
Do you want negative rates? A lot of people think they’re a really bad idea. But it puts central banks in a position at some point where that’s all they can do. They can buy more bonds, they can shove liquidity in, and they can increase people reaching for yield, and they’ll have negative rates.
Rajan: We’ve had three forces. We have this crisis that Randy talked about. We have the cycle, which we’ve been talking about. The third is the structure of transformation as a result of aging, etc., of our economies. Our economies are changing day by day. There’s that transformation. There’s also the place-based transformation. Some places doing extremely well—the big cities—and some places are doing extremely poorly—the semi-urban areas that lost big employers.
We focused a lot on the recovery from the crisis, which was really good. Since then, we’ve been really focused on the cyclical component. How do we get this back up? But we’re not able to distinguish the structural components, that, in fact, we have aging populations; we have development needs in part of the country. How do we fix those?
Whenever the talk gets to fiscal policy, it’s always loosely the Keynesian fiscal concept: let’s dig holes and fill them up again. What are we going to do with fiscal policy? These structural issues are deep problems that we need to tackle. We should have been tackling them right from the get-go, but if we have to do it now, it requires design, and nobody’s talking about design.
How do we get money to Janesville[, Wisconsin], for example? How do we get Janesville to pick itself up, because the GM factory has closed there? That’s the kind of thing we should be thinking about. We’re really just talking about fiscal in a very airy-fairy way. That it’ll fix the cycle. But unemployment is not the problem; the nature of employment is the problem. That’s a structural problem. It’s not a cyclical problem.
Kroszner: Whether it’s government investment or private investment, we just haven’t seen the investment. If there are countries that have relatively low amounts of debt outstanding and interest rates are astonishingly low, are there ways that you can build infrastructure or reduce some bottlenecks or do something that will help to catalyze private-sector investment?
That has not been the focus and that should be the focus. There’s a lot of discussion about, oh, every city wants to open its own incubator. Everywhere I go—and I’ve been doing a lot of traveling around Europe, the Middle East, and Africa to visit our alumni there—they always want to bring me to their incubator. But that’s not helpful if every city is building an incubator. You’re just competing with each other for that; that’s not actually necessarily helping the growth of innovation.
We’re not using fiscal resources appropriately. A carefully thought-through plan, where you are focusing on bottlenecks, focusing on high returns, and doing things that can catalyze private-sector investment, that makes sense. Spending money for spending money’s sake doesn’t make sense.
Goolsbee: I would add also, Randy’s admonition about the haunting nature of Japan also haunts this discussion, because that was their thinking: “We’ll engage in massive infrastructure spending. We’ll engage in massive public spending of various forms,” and it didn’t increase the natural growth rate of the economy. You can look and you can say, “Well, maybe they chose the wrong things,” but it does haunt us.
Hays: I want to throw out an audience question now. Everything seems to be a challenge. Is there anything you guys are excited about as you look into the next year, or maybe three to five years?
Rajan: You have to look at the technology that’s coming and say, “We can do so much more.” Technology has to be the source of optimism, even though there is a lot of pessimism about the way we’re using it now. But the possibilities it affords us are so enormous, whether it’s in energy, whether it’s in fintech—every area is going to get disrupted.
There was a question earlier: “Which industry do you think is most ripe for disruption?” Education. We still teach in the classroom the way we taught 3,000 years ago. Students come to the classroom and they listen to us drone on in front of the class. That’s the way it’s been for 3,000 years. But that could get disrupted.
How much better it would be for people around the globe if they could get the best teachers at relatively low cost, and they could learn fast. We have all these possibilities. I’m optimistic. We’ll figure out a way as long as we don’t put roadblocks in the middle.
Goolsbee: Since the financial crisis, we recovered in the US better than anybody else. Well, let’s pat ourselves on the back. Somehow we did a bunch of things right. The unemployment rate is remarkably low, and anything having to do with the job market and consumers has been both very strong and pretty sustainable.
In the mid-2000s, much of the expansion that we experienced was fueled by falling savings. The savings rate for the US literally got to 0 percent. The savings rate has remained 5-plus percent in the US since the financial crisis. This is by some measures as good as any time for that. We should view that positively even in the short run.
Kroszner: We’ve made a lot of progress on health around the world. There’s just been incredible improvements there, and I see that trend continuing, whether it’s just basic things such as mosquito nets, so that people don’t get bitten by mosquitoes that have particular diseases, or innovations in all sorts of areas of medicine. Progress may be a little bit slower in the US than it has been, but if you look globally, a lot of people’s lives are much better than they had been, and I think that trend is certainly going to continue.
Hays: One of the audience questions was about student debt, how that affects where the economy is and where it’s going. There are some who are running for office who say, “Yeah, just forgive all student debt.” There are others who say, “Well, maybe we should at least means test this a little bit.” What’s the answer? What’s important here? Is there something that should be done, something that shouldn’t be done?
Goolsbee: I’ll give you three ways to think about it. The first is, you will hear some people say, “There’s $1.2 trillion-$1.5 trillion of student debt.” And they will say, “Is that the next subprime housing bubble?” I think that’s the wrong way to think about student debt, because the thing about subprime housing is that you got a lot of debt and then the value of the asset went down, and so there were a bunch of people underwater. Here, the underlying asset—if you want to call it the asset—of human capital has never been more valuable. There is no sense in which the value of the asset went down.
There’s still a lot of debt, and if you look at where the debt is versus where the defaults are, they aren’t exactly the same. The biggest holders of student debt are people—and the dean is going to get mad at me here—who go to professional schools. If you look at law schools, business schools, medical schools, they have the largest amount of debt, but they have high payback rates. That’s not where the default is.
On the default side, the crisis is predominantly people who are starting programs and dropping out and not finishing the program. They get a bunch of debt but they don’t get the degree. The for-profit education sector represents about 5 percent of the students and 50 percent of the defaults. That space needs a deep reexamination.
The payoff for community colleges is the highest it’s ever been, and they’re the most starved for resources that they’ve ever been. All of the states are saying, “We don’t have any money. Yes, there’s huge benefits, but we can’t give you the money.” The enrollments are shrinking, and that’s pushing more people into more-expensive programs in the for-profit sector. When they drop out, they have this debt. So it’s centered there, and that means life is going to be difficult for people who are in that space. But that’s something different from a threat to the financial system, which I don’t think it is.
Hays: One of the audience questions is: “Does deflation or very low inflation in the US relate in any way to large debts and deficits? Does that somehow tie into why we don’t see prices rising?”
Kroszner: I don’t see a direct link between the two. Certainly you could find some examples of that, but I don’t think there’s systematic evidence of that. Now, the challenge is that I’m not giving you a good alternative explanation. I think it was Austan or Raghu who was also saying that we’re not quite sure why we’re having such low inflation.
Hays: But is it partly because we have technology that puts all kinds of prices out there? It makes it much clearer how much goods cost, maybe how much services cost, maybe how much you’re worth. Or does it have something to do with China many years ago having pegged their currency to the dollar? They’ve had very low wages. Don’t low wages in overseas countries have some impact on wages domestically? Aren’t there a lot of things that are holding prices down and holding wages down?
Goolsbee: Maybe, but just remember, most of the US economy, as Randy said before, doesn’t face foreign competition. We’re mostly domestic.
Hays: But technology has had a huge impact. That’s one reason why we’ve lost a lot of middle-class jobs, because all those middle-class jobs started being outsourced years ago.
Rajan: But Kathleen, that’s absolutely right that the labor market expanded into being a world labor market, and that put pressure on wages for a long time. But with unemployment where it is, there is wage pressure building, and if, in fact, the world is so competitive, we should see some of that demonstrated in higher prices, right? Because you’re saying companies have very little margin. Instead, the talk today is that they’re absorbing some of these wage increases in their margins. That would suggest it’s less competitive, at least at the firm level. We don’t really understand what’s going on very well.
Hays: Do you feel tech giants are subject to a sufficient amount of antitrust regulation today?
Goolsbee: I don’t think there has been enough antitrust scrutiny of purchases of small companies that could be potential competitors. I’ve been on the side of a more muscular and aggressive posture toward the big tech companies. That said, the knee-jerk, break-them-up approach doesn’t really make sense. If you start thinking through situations where there are network externalities, breaking up Microsoft in the old days into two separate operating-system companies would just have led very rapidly to one of those becoming a dominant operating system again, because of the economics.
I was tempted to give this as the answer when you asked about a pressing issue that we should be thinking about. It’s worth remembering the last time there was this much disruptive technological change, in the Industrial Revolution and the turn of the century, and how much it changed politics. And it was precisely in response to the feeling that the US government was not doing anything that they literally changed the Constitution multiple times. They made senators directly elected. Women got to vote. They instituted all kinds of antitrust policy. They changed the Constitution to allow an income tax, where it never existed before.
If you just keep stuffing things under the rug, eventually the piles of dirt get so big that everyone starts tripping on them. I wonder if we’re approaching that environment. Some of the audience questions have been about [US presidential candidate] Bernie Sanders; it must drive Bernie Sanders bonkers that a billionaire, Tom Steyer, has spent 10 times more on television advertising and 100 times more on campaign expenses, and in the latest poll in South Carolina, I think Tom Steyer just passed Bernie Sanders in support. A world in which billionaires are competing in the same primary with populists who are saying, “Let’s burn it down and break them up,” is a strange world, and that’s the one we’re in.
Rajan: On tech, we have to be careful. The old ways of regulation may not work, but we have to recognize the old concerns about excess power. There are alternatives to breaking them up.
For example, two of the big concerns are networks and data. On networks, interoperability, which everybody says can’t be done, would give smaller guys a much bigger leg up, because now they can access the same network that the big platform has and they can reach everybody. That might be another way rather than breaking up.
The second concern is data. There’s a lot of data being captured and monopolized. Should they be captured and monopolized, or are there ways of sharing them so that everybody has a level playing field? The reality is these are companies that are giving a good service to the ordinary consumer, but that can’t be our only metric. Our metric has to be, What else is going on? Who else is paying for this? Because there’s no such thing as a free lunch. It could be we’re paying today through the advertisers paying them. It could be we’re paying tomorrow because of lower innovation. The question is, How do we fix these? Maybe a different antitrust than in the past?
Kroszner: The example that Austan gave of the attempt to break up Microsoft because it’s the dominant operating system, that’s just laughable today. That’s what was killing them: they were trying to stick to just what they were doing in the past. [Microsoft CEO] Satya Nadella, who’s a Booth graduate, saw that Microsoft should do something completely different, should effectively compete with what it was doing, should acknowledge that people are not buying as many laptops, go to the cloud, and do other sorts of things.
To have broken up Microsoft, it’d be completely irrelevant and crazy today. It shows that those kinds of structural remedies may seem sensible today, but in five years, they may seem kind of crazy. I very much agree that we need to rethink antitrust for digital firms, because it used to be one of the key issues in antitrust was power over price. But now so many digital transactions appear to be free.
Goolsbee: Yeah, but it’s never free, is it?
Kroszner: Yeah, exactly. Obviously, you’re paying for them—there’s a reason that tech firms are profitable. But it’s not the traditional price mechanism at work. It’s a data mechanism; it’s an information mechanism. It’s something that’s very different. And because so much of our antitrust law is about traditional markets, where power over price is a reasonable metric, we have to think of new metrics when price may not be the most relevant issue. And we’re not there yet.
Hays: I’m just going to ask one final question, because we’ve just about run out of time. When you guys look out over this year, what’s the No. 1 thing you’re watching? What’s important?
Kroszner: The biggest risk or concern that I have that we’re not well prepared for is cyber risks. Let’s say you have some disgruntled employee of a large financial institution who helps some bad actors to get in—cyberattacks are often not just the work of someone from the outside somehow getting into a system and disrupting things; usually it’s someone who has the keys and then may work with some bad actor. And let’s say that large financial institution becomes somewhat uncertain about how much is in everybody’s account. What happens to the payment system? It completely grinds to a halt. Now maybe the Fed could step in and say, “Well, we’ll make good on all those accounts.” It’s possible they can do that, but that’s not something they’re ready to do. They don’t have the information for it, and that could be extraordinarily disruptive. That’s something that we’re just not well prepared for.
Rajan: He’s taken cyber, so I have to look elsewhere. I would say geopolitical. I’m worried that the world has too many strongmen. Most of them are men who have sharp elbows and seem to have enormous egos. I worry that that gets us into a situation where people are unable to back off. We’ve seen that in the China-US relationship—I’m glad that we seem to be finding at least a pause in that tension, but around the world, there are so many areas of potential conflict.
We haven’t talked about North Korea. We certainly haven’t talked about the various people in the Middle East. Russia is another potential area. We do need to recreate a new world order. We’ve just thrown the previous one out the window, but I don’t see momentum behind that. To my mind, this is a process of the next decade before we feel safe again.
Goolsbee: Let’s ask, “At our meeting next year, what will have been the biggest change?” And then, “If we are still meeting here 10 years from now, what will be the thing to be watching?”
For next year, the election in the US is going to have the biggest impact on policy. That’s all we’re going to be talking about next year.
Over the longer term, the thing that you should keep your eye on is the productivity growth rate, especially in the US but everywhere, because we economists have always said that is where our standard of living comes from. In the past five-10 years, for reasons we mostly don’t understand, it’s slowed way down. That might explain why wages haven’t been rising for some time. It might explain a bunch of things. When we come back in 10 years, let’s hope we’ve gotten it back, that it’s back to something like historical trends. Otherwise, I fear it’s going to be even nastier and people are going to be even angrier.