Rajan Against the Machine: It’s Time to Invest in Talent and Entrepreneurship – Like Yesterday!

by Ryan Streeter on May 3, 2012. Follow Ryan on Twitter.

“The best short- term policy response [to our continuing economic problems] is to focus on long-term sustainable growth.”

That sums up a must-read essay by the University of Chicago’s Raghuram Rajan in the current issue of Foreign Affairs. His essay counters the Keynesian conventional wisdom – shared by policymakers throughout western nations – that governments have to prop up demand to get their economies rolling again. Rather, he writes, they need to be focusing on doing all they can to increase the supply of talented, innovative, and productive workers. And fast.

The deregulation in the U.S. and U.K. that followed the economic slump of the 1970s…

…was not an unmitigated blessing. It did boost entrepreneurship and innovation, increase competition, and forced existing firms to focus on efficiency, all of which gave consumers cheaper and better products. But it also had the unintended consequence of increasing income inequality—creating a gap that, by and large, governments dealt with not by preparing their work forces for a knowledge economy but by giving them access to cheap credit.

We have been addicted to artificially propping up GDP through demand-driven policies ever since. But that won’t fly anymore.

[T]oday’s economic troubles are not simply the result of inadequate demand but the result, equally, of a distorted supply side. For decades before the financial crisis in 2008, advanced economies were losing their ability to grow by making useful things. But they needed to somehow replace the jobs that had been lost to technology and foreign competition and to pay for the pensions and health care of their aging populations. So in an effort to pump up growth, governments spent more than they could afford and promoted easy credit to get households to do the same. The growth that these countries engineered, with its dependence on borrowing, proved unsustainable.

Rather than attempting to return to their artificially inflated GDP numbers from before the crisis, governments need to address the underlying flaws in their economies. In the United States, that means educating or retraining the workers who are falling behind, encouraging entrepreneurship and innovation, and harnessing the power of the financial sector to do good while preventing it from going off track. In southern Europe, by contrast, it means removing the regulations that protect firms and workers from competition and shrinking the government’s presence in a number of areas, in the process eliminating unnecessary, unproductive jobs. (emphasis added)

Addressing the underlying flaws is hard work. It’ll be unpopular, and the political leaders who seriously undertake it will get pilloried from all sides. And because it requires long-term thinking, it will be hard to keep the public interested in its benefits.

And if that picture isn’t ugly enough, we have to also look the deeper cultural and institutional trends squarely in the eye:

[F]or various reasons—inadequate early schooling, dysfunctional families and communities, the high cost of university education—far too many Americans have not gotten the education or skills they need.

We can’t simply import all of our talent to get the productivity we need. Rather we need to be honest that family breakdown – once a “soft issue” supposedly related only to personal choices people were making – is having directly observable economic effects, and that our ongoing lack of urgency about education reform at all levels is now punching us in the gut – over and over and over.

Read the whole thing.

Hat tip to Tyler Cowen.