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The financial sector has undergone major changes in response to the Great Recession and post-crisis regulatory reform, as a result of the Dodd-Frank Act and Basel III. These changes have created serious questions about the sector’s role in supporting economic growth and how it affects financial and overall economic stability.

On June 8, the Initiative on Business and Public Policy at Brookings explored the intersection of the financial system and economic growth with the goal of informing the public policy debate. The event featured a keynote address by Richard Berner, director of the Office of Financial Research and other participants with a wide range of views from a variety of backgrounds. Among other issues, the experts considered the changing landscape of the financial sector; growth-promoting allocation and investment decisions; credit availability for low- and moderate-income households; the ideal balance between growth and stability; and the impact of the 2014 midterm elections on regulatory reform.

 Follow the conversation at @BrookingsEcon or #Finance.

Video

• Keynote remarks by Richard Berner
• The financial sector: How has it changed?
• The view from the trenches
• The future of the U.S. financial sector

Audio

• Can the financial sector promote growth and stability?

Transcript

• Uncorrected Transcript (.pdf)

Event Materials

• Aaron Kleins presentation
• 20150608 BAER slides
• 20150608 MEHTA slides
• 20150608_financial_sector_stability_transcript

Financial advisors offer their clients many advantages, such as setting reasonable savings goals, avoiding fraudulent investments and mistakes like buying high and selling low, and determining the right level of risk for a particular household. However, these same advisors are often incentivized to choose funds that increase their own financial rewards, and the nature and amount of the fees received by advisors may not be transparent to their clients, and small-scale savers may not be able to access affordable advice at all.  What is in the best interest of an individual may not be in the best interest of his or her financial advisor.

To combat this problem, the Department of Labor (DoL) recently proposed a regulation designed to increase consumer protection by treating some investment advisors as fiduciaries under ERISA and the 1986 Internal Revenue Code.  The proposed conflict of interest rule is an important step in the right direction to increasing consumer protections.  It addresses evidence from a February 2015 report by the Council of Economic Advisers suggesting that consumers often receive poor recommendations from their financial advisors and that as a result their investment returns on IRAs are about 1 percentage point lower each year.   Naturally, the proposal is not without its controversies and it has already attracted at least 775 public comments, including one from us .

For us, the DoL’s proposed rule is a significant step in the right direction towards increased consumer protection and retirement security.  It is important to make sure that retirement advisors face the right incentives and place customer interests first.  It is also important make sure savers can access good advice so they can make sound decisions and avoid costly mistakes.  However, some thoughtful revisions are needed to ensure the rule offers a net benefit. 

If the rule causes advisors’ compliance costs to rise, they may abandon clients with small-scale savings, since these clients will no longer be profitable for them.  If these small-scale savers are crowded out of the financial advice market, we might see the retirement savings gap widen.  Therefore we encourage the DoL to consider ways to minimize or manage these costs, perhaps by incentivizing advisors to continue guiding these types of clients.  We also worry that the proposed rule does not adequately clarify the difference between education and advice, and encourage the DoL to close any potential loopholes by standardizing the general educational information that advisors can share without triggering fiduciary responsibility (which DoL is trying to do).  Finally, the proposed rule could encourage some advisors to become excessively risk averse in an overzealous attempt to avoid litigation or other negative consequences.  Extreme risk aversion could decrease market returns for investors and the ‘value-add’ of professional advisors, so we suggest the DoL think carefully about discouraging conflicted advice without also discouraging healthy risk.

The proposed rule addresses an important problem, but in its current form it may open the door to some undesirable or problematic outcomes.  We explore these issues in further detail in our recent paper.

Americans are enjoying longer lifespans than ever before. Living longer affords individuals the opportunity to make more contributions to the world, to spend more time with their loved ones, and to devote more years to their favorite activities – but a longer life, and particularly a longer retirement, is also expensive. The retirement security landscape is evolving as workers, employers, retirees, and financial services companies find their needs shifting. Once, many workers planned to stay with a single employer for most or all of their careers, building up a sizeable pension and looking forward to a comfortable retirement. Today, workers more and more workers will be employed by many different employers.  Additionally, generous defined benefit (DB) retirement plans are less popular than they once were – though they were never truly commonplace – and defined contribution (DC) plans are becoming ever more prevalent.  

Figure 1, below, shows the change from DB to DC that has occurred over the past three decades.

In the past many retirees struggled financially towards the end of their lives, just as they do now, but even so, the changes to the retirement security landscape have been real and marked, and have had a serious impact on workers and retirees alike. DB plans are dwindling, DC plans are on the rise, and as a result individuals must now take a more active role in managing their retirement savings. DC plans incorporate contributions from employees and employers alike, and workers much choose how to invest their nest egg.  When a worker leaves a job for retirement or for a different job he or she will often roll over the money from a 401(k) plan into an Individual Retirement Account (IRA). While having more control over one’s retirement funds might seem on its face to be a net improvement, the reality is that the average American lacks the financial literacy to make sound decisions (SEC 2012).

The Council of Economic Advisers (CEA) expressed concern earlier this year that savers with IRA accounts may receive poor investment advice, particularly in cases where their financial advisors are compensated through fees and commissions. “[The] best recommendation for the saver may not be the best recommendation for the adviser’s bottom line” (CEA 2015). President Obama echoed these concerns in a speech at AARP in February, asking the Department of Labor (DoL) to update its rules for financial advisors to follow when handling IRA accounts (White House 2015). The DoL receives its authority to craft such rules and requirements from the 1974 Employee Retirement Income Security Act (ERISA) (DoL 2015a).

The DoL recently proposed a regulation designed to increase consumer protection by treating some investment advisors as fiduciaries under ERISA and the 1986 Internal Revenue Code (DoL 2015b). The proposed rule has generated heated debate, and some financial advisors have responded with great concern, arguing that it will be difficult or impossible to comply with the rule without raising costs to consumers and/or abandoning smaller accounts that generate little or no profit. Advisors who have traditionally offered only the proprietary products of a single company worry that the business model they have used for many years will no longer be considered to be serving the best interests of clients.

Rather than offering detailed comments on the DoL proposals, this paper will look more broadly at the problem of saving for retirement and the role for professional advice. This is, of course, a well-travelled road with a large literature by academics, institutions and policy-makers, however, it is worthwhile to think about market failures, lack of information and individual incentives and what they imply for the investment advice market.

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Nearly 30 years ago, the economists Robert Solow and Stephen Roach caused a stir when they pointed out that, for all the billions of dollars being invested in information technology, there was no evidence of a payoff in productivity. Businesses were buying tens of millions of computers every year, and Microsoft had just gone public, netting Bill Gates his first billion. And yet, in what came to be known as the productivity paradox, national statistics showed that not only was productivity growth not accelerating; it was actually slowing down. “You can see the computer age everywhere,” quipped Solow, “but in the productivity statistics.”

Today, we seem to be at a similar historical moment with a new innovation: the much-hyped Internet of Things – the linking of machines and objects to digital networks. Sensors, tags, and other connected gadgets mean that the physical world can now be digitized, monitored, measured, and optimized. As with computers before, the possibilities seem endless, the predictions have been extravagant – and the data have yet to show a surge in productivity.

A year ago, research firm Gartner put the Internet of Things at the peak of its Hype Cycle of emerging technologies.

As more doubts about the Internet of Things productivity revolution are voiced, it is useful to recall what happened when Solow and Roach identified the original computer productivity paradox. For starters, it is important to note that business leaders largely ignored the productivity paradox, insisting that they were seeing improvements in the quality and speed of operations and decision-making. Investment in information and communications technology continued to grow, even in the absence of macroeconomic proof of its returns.

That turned out to be the right response. By the late 1990s, the economists Erik Brynjolfsson and Lorin Hitt had disproved the productivity paradox, uncovering problems in the way service-sector productivity was measured and, more important, noting that there was generally a long lag between technology investments and productivity gains.

Our own research at the time found a large jump in productivity in the late 1990s, driven largely by efficiencies made possible by earlier investments in information technology. These gains were visible in several sectors, including retail, wholesale trade, financial services, and the computer industry itself. The greatest productivity improvements were not the result of information technology on its own, but by its combination with process changes and organizational and managerial innovations.

Our latest research, The Internet of Things: Mapping the Value Beyond the Hype, indicates that a similar cycle could repeat itself. We predict that as the Internet of Things transforms factories, homes, and cities, it will yield greater economic value than even the hype suggests. By 2025, according to our estimates, the economic impact will reach $3.9-$11.1 trillion per year, equivalent to roughly 11% of world GDP. In the meantime, however, we are likely to see another productivity paradox; the gains from changes in the way businesses operate will take time to be detected at the macroeconomic level.

One major factor likely to delay the productivity payoff will be the need to achieve interoperability. Sensors on cars can deliver immediate gains by monitoring the engine, cutting maintenance costs, and extending the life of the vehicle. But even greater gains can be made by connecting the sensors to traffic monitoring systems, thereby cutting travel time for thousands of motorists, saving energy, and reducing pollution. However, this will first require auto manufacturers, transit operators, and engineers to collaborate on traffic-management technologies and protocols.

Indeed, we estimate that 40% of the potential economic value of the Internet of Things will depend on interoperability. Yet some of the basic building blocks for interoperability are still missing. Two-thirds of the things that could be connected do not use standard Internet Protocol networks.

Other barriers standing in the way of capturing the full potential of the Internet of Things include the need for privacy and security protections and long investment cycles in areas such as infrastructure, where it could take many years to retrofit legacy assets. The cybersecurity challenges are particularly vexing, as the Internet of Things increases the opportunities for attack and amplifies the consequences of any breach.

But, as in the 1980s, the biggest hurdles for achieving the full potential of the new technology will be organizational. Some of the productivity gains from the Internet of Things will result from the use of data to guide changes in processes and develop new business models. Today, little of the data being collected by the Internet of Things is being used, and it is being applied only in basic ways – detecting anomalies in the performance of machines, for example.

It could be a while before such data are routinely used to optimize processes, make predictions, or inform decision-making – the uses that lead to efficiencies and innovations. But it will happen. And, just as with the adoption of information technology, the first companies to master the Internet of Things are likely to lock in significant advantages, putting them far ahead of competitors by the time the significance of the change is obvious to everyone.

Editor's Note: This opinion originally appeared on Project Syndicate August 6, 2015.

Introduction

I would like to thank the Department for giving me the opportunity to testify on this important issue. The document I submitted to you is more general than most of the comments you have received, talking about the issues facing retirement savers and policymakers, rather than engaging in a point-by-point discussion of the detailed DOL proposal¹.

Issues around Retirement Saving

1. Most workers in the bottom third of the income distribution will rely on Social Security to support them in retirement and will save little. Hence it is vital that we support Social Security in roughly its present form and make sure it remains funded, either by raising revenues or by scaling back benefits for higher income retirees, or both.

2. Those in the middle and upper middle income levels must now rely on 401k and IRA funds to provide income support in retirement. Many and perhaps most households lack a good understanding of the amount they need to save and how to allocate their savings. This is true even of many savers with high levels of education and capabilities.

3. The most important mistakes made are: not saving enough; withdrawing savings prior to retirement; taking Social Security benefits too early² ; not managing tax liabilities effectively; and failing to adequately manage risk in investment choices. This last category includes those who are too risk averse and choose low-return investments as well as those that overestimate their own ability to pick stocks and time market movements. These points are discussed in the paper I submitted to DoL in July. They indicate that retirement savers can benefit substantially from good advice.

4. The market for investment advice is one where there is asymmetric information and such markets are prone to inefficiency. It is very hard to get incentives correctly aligned. Professional standards are often used as a way of dealing with such markets but these are only partially successful. Advisers may be compensated through fees paid by the investment funds they recommend, either a load fee or a wrap fee. This arrangement can create an incentive for advisers to recommend high fee plans.

5. At the same time, advisers who encourage increased saving, help savers select products with good returns and adequate diversification, and follow a strategy of holding assets until retirement provide benefits to their clients.

Implications for the DoL’s proposed conflicted interest rule

1. Disclosure. There should be a standardized and simple disclosure form provided to all households receiving investment advice, detailing the fees they will be paying based on the choices they make. Different investment choices offered to clients should be accompanied by a statement describing how the fees received by the adviser would be impacted by the alternative recommendations made to the client.

2. Implications for small-scale savers. The proposed rule will bring with it increased compliance costs. These costs, combined with a reluctance to assume more risk and a fear of litigation, may make some advisers less likely to offer retirement advice to households with modest savings. These households are the ones most in need of direction and education, but because their accounts will not turn profits for advisors, they may be abandoned. According to the Employee Benefits Security Administration (EBSA), the proposed rule will save families with IRAs more than $40 billion over the next decade. However, this benefit must be weighed against the attendant costs of implementing the rule. It is possible that the rule will leave low- and medium-income households without professional guidance, further widening the retirement savings gap. The DoL should consider ways to minimize or manage these costs. Options include incentivizing advisors to continue guiding small-scale savers, perhaps through the tax code, and promoting increased financial literacy training for households with modest savings. Streamlining and simplifying the rules would also help.

3. Need for Research on Online Solutions. The Administration has argued that online advice may be the solution for these savers, and for some fraction of this group that may be a good alternative. Relying on online sites to solve the problem seems a stretch, however. Maybe at some time in the future that will be a viable option but at present there are many people, especially in the older generation, who lack sufficient knowledge and experience to rely on web solutions. The web offers dangers as well as solutions, with the potential for sub-optimal or fraudulent advice. I urge the DoL to commission independent research to determine how well a typical saver does when looking for investment advice online. Do they receive good advice? Do they act on that advice? What classes of savers do well or badly with online advice? Can web advice be made safer? To what extent do persons receiving online advice avoid the mistakes described earlier?

4. Pitfalls of MyRA. Another suggestion by the Administration is that small savers use MyRA as a guide to their decisions and this option is low cost and safe, but the returns are very low and will not provide much of a cushion in retirement unless households set aside a much larger share of their income than has been the case historically.

5. Clarifications about education versus advice. The proposed rule distinguished education from advisement. An advisor can share general information on best practices in retirement planning, including making age-appropriate asset allocations and determining the ideal age at which to retire, without triggering fiduciary responsibility. This is certainly a useful distinction. However, some advisors could frame this general information in a way that encourages clients to make decisions that are not in their own best interest. The DoL ought to think carefully about the line between education and advice, and how to discourage advisors from sharing information in a way that leads to future conflicts of interest. One option may be standardizing the general information that may be provided without triggering fiduciary responsibility.

6. Implications for risk management. Under the proposed rule advisors may be reluctant to assume additional risk and worry about litigation. In addition to pushing small-scale savers out of the market, the rule may encourage excessive risk aversion in some advisors. General wisdom suggests that young savers should have relatively high-risk portfolios, de-risking as they age, and ending with a relatively low-risk portfolio at the end of the accumulation period. The proposed rule could cause advisors to discourage clients from taking on risk, even when the risk is generally appropriate and the investor has healthy expectations. Extreme risk aversion could decrease both market returns for investors and the “value-add” of professional advisors. The DoL should think carefully about how it can discourage conflicted advice without encouraging overzealous risk reductions.

The proposed rule is an important effort to increase consumer protection and retirement security. However, in its current form, it may open the door to some undesirable or problematic outcomes. With some thoughtful revisions, I believe the rule can provide a net benefit to the country.

^{1. Baily’s work has been assisted by Sarah E. Holmes. He is a Senior Fellow at the Brookings Institution and a Director of The Phoenix Companies, but the views expressed are his alone.}

^{2. As you know, postponing Social Security benefits yields an 8 percent real rate of return, far higher than most people earn on their investments. For most of those that can manage to do so, postponing the receipt of benefits is the best decision.}

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The regional banks play an important role in the economy providing funding to consumers and small- and medium-sized businesses. Their model is simpler than that of the large Wall Street banks, with their business concentrated in the U.S.; they are less involved in trading and investment banking, and they are more reliant on deposits for their funding. We examined the balance sheets of 15 regional banks that had assets between $50 billion and $250 billion in 2003 and that remained in operation through 2014.

The regionals have undergone important changes in their financial structure as a result of the financial crisis and the subsequent regulatory changes:

• Total assets held by the regionals grew strongly since 2010. Their share of total bank assets has risen since 2010.

• Loans and leases make up by far the largest component of their assets. Since the crisis, however, they have substantially increased their holdings of securities and interest bearing balances, including government securities and reserves.

• The liabilities of the regionals were heavily concentrated in domestic deposits, a pattern that has intensified since the crisis. Deposits were 70 percent of liabilities in 2003, a number that fell through 2007 as they diversified their funding sources, but by 2014 deposits made up 82 percent of the total.

• Regulators are requiring large banks to increase their holdings of long term subordinated debt as a cushion against stress or failure. The regionals, as of 2014, had not increased their share of such liabilities.

• Like the largest banks, the regionals increased their loans and leases in line with their deposits prior to the crisis. And like the largest banks, this relation broke down after 2007, with loans growing much more slowly than deposits. Unlike the largest banks, the regionals have increased loans strongly since 2010, but there remains a significant gap between deposits and loans.

• The regional banks’ share of their net income from traditional sources (mostly loans) has been slowly declining over the period.

• The return on assets of the regionals was between 1.5 and 2.0 percent prior to the crisis. This turned sharply negative in the crisis before recovering after 2009. Between 2012 and 2014 return on assets for these banks was around 1.0 percent, well below the pre-crisis level.

As we saw with the largest banks, the structure and returns of the regional banks has changed as a result of the crisis and new regulation. Perhaps the most troubling change is that the volume of loans lags well behind the volume of deposits, a potential problem for economic growth. The asset and liability structure of the banks has also changed, but these banks have a simpler business model where deposits and loans still predominate.

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The White House Council of Economic Advisers (CEA) was created by Congress in 1946 to advise the president on ways “to foster and promote free competitive enterprise” and “to promote maximum employment, production and purchasing power.” President Truman, who signed the Employment Act of 1946 into law, was unenthusiastic about the Council and didn’t nominate members for nearly six months. Yet the CEA, comprised of three individuals whom Congress says are to be “exceptionally qualified,” has not only survived but also prospered for 70 years and remains an important part of the president’s economic policy decisionmaking.

On February 11, the Hutchins Center on Fiscal and Monetary Policy at Brookings marked this anniversary by examining the ways the CEA and other economists succeed and fail when they set out to advise elected politicians and tap the expertise of some of the “exceptionally qualified” economists who have chaired the Council over the past four decades.

You can join the conversation and tweet questions for the panelists at #CEAat70.

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• Panel 1: The CEA in Moments of Crisis
• Panel 2: The CEA and Policymaking
• Panel 3: Current Economic Policy Issues

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• The Council of Economic Advisers: 70 years of advising the president

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A major oil spill will result in cleanup spending that boosts GDP, but no one thinks oil spills are good. Oil spills and other forms of pollution are examples of negative externalities — harm caused to others by the economic activity of a firm or industry. These externalities represent a failure of the market, and unless there is corrective action, their presence means that there is too much production of something that causes negative spillovers.

That criticism can be applied to the financial services industry. Many say that it grew too large, triggered a financial crisis and damaged the rest of the economy. Is that still the case, and is financialization spoiling the economy? Despite the alarmist rhetoric around today’s finance sector, the answer is generally “no” because of changes made to financial regulation.

First, a check on the facts: How large is the industry and how much has it grown? The broad definition of the financial sector includes finance, insurance and real estate, known by the acronym “FIRE.” It was 17.5 percent of gross domestic product in 1990 and rose to 20.0 percent in 2014, but that figure is misleading as it includes office and apartment rents and leases — stuff that has little to do with Wall Street.

Finance and insurance separately peaked well before the financial crisis at 7.7 percent of GDP, which was up from 5.8 percent in 1990. In 2014, it was 7.0 percent of GDP. Employment in finance and insurance has been on a downtrend since 2003 and is currently 4.25 percent of total nonfarm payrolls. Most of those jobs are in offices and bank branches around the country. (The output data given here are drawn from the Bureau of Economic Analysis, GDP by Industry data. The employment data are from the Bureau of Labor Statistics, Payroll Employment data. Author’s calculations.)

Still, salaries and bonuses at the top are extremely attractive, so perhaps the externality plays out by drawing the best and brightest away from other more productive activities. The Harvard Crimson reported that in 2007, 23 percent of graduating Harvard seniors said they planned to enter finance. That is an impressive number, but things turned around sharply, with the 23 percent figure falling to 11.5 percent in 2009 after the financial crisis. At this point, the financial industry really isn’t large enough to crowd out other parts of the economy.

Meanwhile, the insurance industry serves an important social purpose providing life, property, and casualty insurance. AIG got into trouble in the crisis because it strayed into providing very risky financial services, not because of its main insurance business. Likewise, the core value of banks is financial intermediation between savers and investors, giving savers relatively secure and liquid assets while also funding investment.

There are critics of how well our banking industry serves this core purpose, a quality that is hard to determine. My judgment is that it does the job pretty well compared to most other countries. As the IMF reported in September 2015, the non-performing loan problem among European banks remains severe, whereas most U.S. banks now have strong balance sheets. Good financial intermediation means that most of the savings dollars are transferred to investors and are not lost through inefficient bank operations. A 2002 study that I participated in found bank productivity higher in the United States than in France or Germany.

The parts of the financial sector that give rise to the most concern are market-making, deal-making and the creation and trading of derivatives on Wall Street. The volume of market trading has increased exponentially because of the increased speed of computers and communications. Up to a certain point, the increased volume is helpful because it adds to the liquidity of markets, but the advent of high-frequency trading has taken us over the top. As Michael Lewis describes in his book Flash Boys, the high speed traders are finding ways to shave milliseconds off the time needed to make trades. That is thoroughly wasteful. As for deal-making, it has been going on for a long time — indeed the go-go years for deals were in the 1980s — so it is hard to blame the recent slowing of economic growth on this activity.

Still, the explosion of derivatives and other overly-complex instruments was problematic, and it is crystal clear that the mortgage market became too opaque and removed accountability from the system. The layering of complex derivatives on top of lousy mortgages (and other shaky assets) distorted the economy, resulted in the overbuilding of houses, and caused the financial crisis. There are plenty of people at fault besides the bankers, but the smart people on Wall Street were driving the process, and they should have known better. The excessive financialization obscured the reality of loans that depended upon ever-rising home prices and thus were never going to be paid back. There was an externality because the private calculations of potential profit ignored the risks being imposed on society.

Is that still the situation today? No. Things have changed. Banks and other financial institutions that create risks for the whole economy are now required to hold sufficient capital to cover losses even in periods of economic and financial stress, plus a liquidity buffer (they must pass “stress tests” administered by the Federal Reserve). The screws have been turned pretty tight, and the owners of large financial institutions will bear the costs of future failures — not taxpayers. This brings private incentives in line with the public interest, getting rid of the externality that gave us too much financialization in the first place. But to keep the future safe, we’ll have to make sure no one forgets what happened in the last crisis, and ensure that new risks are not created in other, less-regulated parts of the industry.

Editor's note: This piece originally appeared in the Washington Post.

Australia's economic performance has been the standout among advanced economies for several decades. With economic growth at nearly twice the pace of US or Germany over the past decade, a remarkable 25 years without a recession and a large, highly competitive mining sector despite the end of the resources boom, Australia remains a strong economic participant in a region of the world where future global growth is likely to be generated.

But with drivers of growth over the past 25 years unlikely to be the engines of growth in coming decades, now is not a time for complacency. And if there's one lesson from Britain's decision to leave the EU, it's that that disruptive forces are sweeping through the global economy. Australia, with its cohesive politics and economic success, has been able to avoid the worst of these problems, but the dangers are present if the economic challenges are not met.

To start with, the impacts of the reforms of the 1980s and 1990s are fading. The investment boom in mining is over, and the prices for mining and agricultural exports will probably remain subdued with slower growth in China. While Australia's incomes were boosted by the improved terms of trade, this has partially reversed. The housing boom will inevitably eventually slow.

As evidenced by the results of the Brexit referendum, there is a distrust of the political and economic elites that have led the world's biggest economies. Disruptive, rapid changes in technology have not led to broad-based productivity growth. Workers in many countries have been left with stagnant incomes and governments with rising public debt.

Industry policy has a bad name among American economists who see it as a manifestation of "capture" where special interests are able to obtain subsidies from taxpayers or special protections that are not in the national interest. The modern theory of industry policy, however, recognises that a well-designed policy can actually help markets work better, therefore helping an economy like Australia's make the transition to a new growth path when faced with changing economic conditions. Productivity is the key to high growth and rising incomes – and well-designed industry policy can help.

Structure of trade competitiveness

Take, for example, Australia's manufacturing sector. Mostly because of comparative advantage, it is the smallest among all advanced economies relative to the size of its economy. In 2010, Germany had 21.2 per cent of its workforce in manufacturing while Australia's was 8.9 per cent. While it's not surprising that Australia's structure of trade competitiveness differs from Germany's because of its enormous export strength of mining and agriculture, it will benefit by taking advantage of its highly skilled workforce and the potential to develop industries based on this human capital – including advanced manufacturing industries.

One of the traditional strengths of the American economy is the close link that exists between leading universities and businesses – an area Australian policymakers are seeking to improve upon. At MIT and Stanford, professors of engineering, biology, finance or economics finish their lectures and head off to the companies they run or advise. They often enlist graduate or undergraduate students to help them with their commercial projects and these collaborations often result in jobs as well as experience. There is a danger in this model if pure research loses out to business interests, but the interaction between academia and the practical needs of companies can largely improve both research and business profitability. It's worth recalling that even the giants of science in the 18th century were motivated by the need to improve navigation or build new machines or design buildings. Funding for research should support greater industry-university cooperation as highlighted by the Watt Review.

Another important element in Australia's continued economic success is the growth of its service industries. With most jobs in these industries, the performance and productivity of services will be the largest determinant of Australia's living standards. Productivity comparisons between Australia and the United States show that Australian productivity lagged behind the US as recently as the mid-1990s, but there has since been substantial catch-up taking place. Smart regulation that promotes competition and rewards innovation are necessary to bring up the laggards. While there is a continuing debate about the possible end of productivity growth in advanced economies, Australia can still do much to catch up to global best practice.

The winners of this weekend's election will be charged with answering an important question: what is the role of government in a modern economy? How they answer that will determine future prosperity for all Australians.

Martin Baily is a senior fellow at the Brookings Institution in Washington and a former chair of the US President's Council of Economic Advisers. He has been invited by the Australian Ministry of Industry Innovation and Science to report on lessons from the US for policies to enhance economic growth, innovation and competitiveness.

Warwick McKibbin AO, is the director of the Centre for Applied Macroeconomic Analysis in the ANU Crawford School of Public Policy and is a non-resident senior fellow at the Brookings Institution.

Editor's note: this opinion first appeared in Australian Financial Review.

Event Information

In a close referendum last week, voters in the United Kingdom voted to leave the European Union, setting off financial and political shockwaves in Europe and around the world. British PM David Cameron has resigned, while Scotland has renewed calls for another independence referendum, global stock markets lost nearly $2 trillion on Friday, and the British pound is at a 30-year low. Many view the British referendum as commentary not only on economic and immigration trends in the UK, but as a possible forecast of the broader wave of anti-globalization and nationalistic political movements in the U.S. and Europe.

On June 29, Brookings hosted a discussion of the immediate fallout and medium- to long-term consequences of Britain’s departure from the EU. Panelists addressed how the process of exiting the EU might unfold, effects on the U.S.-U.K. and U.S.-EU security and trade relationships, on global development, and the future of the EU project.

Join the conversation on Twitter using #Brexit.

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As Turkey prepares for highly-contested elections on November 1, concerns are growing about the country’s politics, economy, security, and foreign policy. Just a few years ago Turkey was recognized as a model of democracy and beacon of stability and economic growth in a challenging region. However, more recently, Turkey’s economy has lost its dynamism, its leaders’ commitment to democratic principles seems to be eroding, and doubts are emerging about the country’s interests and engagement in the region. Even more disturbing, as the conflicts in Syria and Iraq continue unabated and massive refugee flows spill over into Europe, violent Islamic extremism has now surfaced in Turkey. With the government and opposition trading accusations, the horrific, recent bombing attack in Ankara has further polarized an already deeply-divided and anxious country.

On November 2, the Center on the United States and Europe at Brookings will host a discussion on the Turkish elections. Panelists will discuss how recent events might influence voters what the election results might portend for Turkey’s strategic orientation. Panelists will include Ömer Taşpınar of the National War College and Brookings; Gönül Tol of the Middle East Institute; Kadir Üstün of the SETA Foundation; and Robert Wexler of S. Daniel Abraham Center for Middle East Peace. Brookings Turkey Project Director and TÜSİAD Senior Fellow Kemal Kirişci will moderate the discussion.

After the program, panelists will take questions from the audience.

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Abstract

An individual-based computational model of smallpox epidemics in a two-town county is presented and used to develop strategies for bioterror containment. A powerful and feasible combination of preemptive and reactive vaccination and isolation strategies is developed which achieves epidemic quenching while minimizing risks of adverse side effects. Calibration of the model to historical data is described. Various model extensions and applications to other public health problems are noted.

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Published version of the CSED October 2007 Working Paper

ABSTRACT

Background

In classical mathematical epidemiology, individuals do not adapt their contact behavior during epidemics. They do not endogenously engage, for example, in social distancing based on fear. Yet, adaptive behavior is well-documented in true epidemics. We explore the effect of including such behavior in models of epidemic dynamics.

Methodology/Principal Findings

Using both nonlinear dynamical systems and agent-based computation, we model two interacting contagion processes: one of disease and one of fear of the disease. Individuals can “contract” fear through contact with individuals who are infected with the disease (the sick), infected with fear only (the scared), and infected with both fear and disease (the sick and scared). Scared individuals–whether sick or not–may remove themselves from circulation with some probability, which affects the contact dynamic, and thus the disease epidemic proper. If we allow individuals to recover from fear and return to circulation, the coupled dynamics become quite rich, and can include multiple waves of infection. We also study flight as a behavioral response.

Conclusions/Significance

In a spatially extended setting, even relatively small levels of fear-inspired flight can have a dramatic impact on spatio-temporal epidemic dynamics. Self-isolation and spatial flight are only two of many possible actions that fear-infected individuals may take. Our main point is that behavioral adaptation of some sort must be considered.”

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Event Information

From “American Crossroads” to “Americans for a Better Tomorrow, Tomorrow,” so-called "super PACs" have emerged as the dominant new force in campaign finance. Created in the aftermath of two landmark court decisions and regulatory action and inaction by the Federal Election Commission (FEC), these independent spending-only political action committees are collecting unlimited contributions from individuals, corporations and unions to advocate for or against political candidates. The legal requirements they face—disclosure of donors and non-coordination with the candidates and campaigns they are supporting—have proven embarrassingly porous. Increasingly, super PACs are being formed to boost a single candidate and are often organized and funded by that candidate’s close friends, relatives and former staff members. Their presence is most visible in presidential elections but they are quickly moving to Senate and House elections.

On March 1, on the heels of the FEC’s February filing deadline, the Governance Studies program at Brookings hosted a discussion exploring the role of super PACs in the broader campaign finance landscape this election season. Anthony Corrado, professor of government at Colby College and a leading authority on campaign finance, and Trevor Potter, nonresident senior fellow at the Brookings Institution, a former chairman of the FEC and lawyer to Comedy Central’s Stephen Colbert, presented. 

After the panel discussion, the speakers took audience questions. Participants joined the discussion on Twitter by using the hashtag #BISuperPAC.

Video

• Full Video: The Rise of Super PACs
• Why Corporations Spend on Elections
• GOP Likely to Benefit Most from Super PACs

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• Campaign Finance in the 2012 Elections: The Rise of Super PACs

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