INDIA IPPON DESU
Monday, May 12, 2025
What would an Ambitious Australia look like - Substack
TL;DR — Australia has drifted from wealth creation. We should ask ourselves how to 10× GDP per capita. How? Become an energy superpower, including nuclear; green the outback with cheap desalinated water; poach global talent; own industrial-AI niches; slash bureaucratic sludge, reform taxes; fund audacious moonshots. Prosperity beats perpetual grievance. Let’s build a richer Australia.
In 1788 the First Fleet landed in Sydney Harbour to deposit its crooks and their jailers on barren shores. They almost starved to death, saved by timely supply shipments from Cape Town.
A century later Australia had the highest GDP per capita in the world.
From a desolate prison colony, Australians built one of the most prosperous and enduring societies in history.
We should be looking at the state of our nation today as though it were Day 1 — 1788 all over again. In 2125 we should be many, many times better off than we are now.
But you wouldn’t think so listening to our recent federal election. Surely the grimmest, low stakes campaign in my lifetime. Australians have gotten used to slim pickings for vision from its politicians.
What can we do to actually create wealth for Australians?
This question is totally absent from political discourse. The GST was Australia’s last true significant reform, a quarter of a century ago. Politics since has been dominated by grievance politics (The Voice), bottomless rorting and redistribution (NDIS), and boomer payoffs (franking credits, super concessions). (Although pleasingly, former PM Julia Gillard once asked former Treasurer Secretary Ken Henry how to turn Darwin into Singapore — they aren’t complete zombies.)
Immigration has become extremely politically salient, but no one wants to touch it. Whilst the ambitions around a big Australia are admirable and have merit, it’s not obviously necessary. Indians are not wealthier than Luxembourgers and aren’t set to be any time this century (India’s GDP per capita (~US$9k) is a rounding error next to Luxembourg’s (~US$135k).
What if we were laser-focused on one question: how to make Australians ten times richer. GDP per capita, not total GDP. Just how do we become super duper wealthier. Wealth solves many problems. Over a lifetime (say 70 years) 10x GDP per capita implies 3.3% real annual growth rate. Ambitious but possible.
You are welcome to read this as left-liberal coded if you like, in the vein of Ezra Klein and Derek Thompson’s Abundance.
Here are 5 ideas:
1. Energy superpower
Energy is upstream of basically everything. Cheaper energy lowers costs across the board and allows more things to happen.
Australia sits on one of the world’s largest mineral and energy reserves. Yet domestic energy prices have been increasing. Average effective residential price rose from 20.4 c/kWh in 2007-08 to 27c in 2020-21 and sits in the low-to-mid 30 c/kWh range in 2023-24. Wrong direction! We should allow all energy types: coal, gas, uranium, hydrogen, nuclear, solar, wind — no religious bans. Permit fast-track development. Kill litigation choke-points. No price caps. Adani’s Carmichael coal mine took >8 years to get approval despite passing environmental reviews. Endless lawsuits, bureaucratic reviews, political reversals. Onshore gas exploration is effectively banned or heavily restricted in NSW and Victoria — despite huge reserves.
Australia holds ~31% of the world’s uranium but has 0 reactors — a pure ideological choke. No need to believe in new tech. We could buy conventional plants off the shelf from South Korea. South Korea’s APR-1400 is fully operational and exported — they built the UAE's Barakah plant. From 2009 — 2024, the Koreans built 4 nuclear power plants in Barakah in about 7–8 years each. Korea Electric Power Corp (KEPCO) has a full export package: design + build + operate + train Australians.
Each reactor has a gross electrical capacity of approximately 1,345 megawatts (MW), contributing to a total plant capacity of 5,600 MW. Collectively, the four units are designed to supply up to 25% of the UAE's electricity needs, generating around 40 terawatt-hours (TWh) of clean electricity annually.
Nuclear could reduce costs meaningfully. In Australia coal is cheap but aging, renewables are cheap on production but intermittent, gas is expensive. Nuclear is reliable, with 24/7 baseload. The marginal baseload supply would disproportionately impact pricing. The 40TWh from a Barakah equivalent would add ~12% to Australian energy. Rule of thumb this should reduce prices by 15 - 30%.
The Barakah plants cost the UAE US$32 billion. This figure encompasses construction, financing, initial fuel supply, and related infrastructure. About the cost of 1 year of NDIS.
How about transmission?
Australia’s National Electricity Market (NEM) — the east coast grid (NSW, VIC, QLD, SA, TAS) — already manages about 65,000 MW of capacity. It's designed to handle peak loads of ~30,000 MW (high summer demand). So adding ~5,600 MW isn't totally crazy — it's ~12% more than today’s peak — manageable if intelligently placed. Current transmission is optimised around coal regions (like Hunter Valley, Latrobe Valley). Those lines are old but well-connected.
Wind/solar expansions (like in western NSW, western VIC) require building massive new transmission (like the "VNI West" project) because these sites are remote.
Nuclear plants, if located near existing coal hubs, can re-use existing infrastructure with only moderate upgrades. This would require massive government support — nuclear plants are natural monopolies (like transmission). A nation-building project, not a libertarian fantasy.
2. Terraform the desert
We should terraform the outback to 10x agricultural output.
We have the land and infinite sea water. With cheap energy we could desalinate to create new inland rivers (as proposed by US-based son of Australia Casey Handmer). Once we’ve done that, why not build new cities too?
The next Great Australian will build a new city.
Australia is the size of Europe, but much of it is uninhabitable and unproductive desert:
Australian habitability map shows land use patterns 70 years ago | Daily Mail Online Accordingly, most of it is minimally used:
Almost all Australians live on the coastlines. The US has great inland rivers, which allowed it to build great cities and wealth from internal trade.
What if we could create something similar for Australia?
Mongolia successfully transformed 6,000km² of Inner Mongolia's Kubuqi Desert into green landscape, quadrupling annual rainfall from <100mm to >400mm. That’s the size of about two-and-a-half Australian Capital Territories. Or the 18 million hectares restored so far in the Sahel as part of the Great Green Wall, a vision to create a 8,000km green belt across 11 countries. Other examples can be found in Israel’s Negev desert and the Toshka Project in Egypt.
I have seen this image a lot of times. Is a plan like to terraform Australia feasible? : r/geography Australia exports around $76bn in agricultural product per year. We should aim to 10x that number.
3. Aggressively target global talent
No, this does not mean flooding our universities with migrants to ‘skill them up’ in a fake university-profiteering visa mill farce.
It means attracting the world’s best and brightest. E.g.
Zero income tax for X years if you start a business that employs >10 people or generate >$5m in exports.
Fast-track citizenship for scientists, engineers, founders, capital allocators, builders.
Poach aggressively from places where elites are suffocating (e.g., Germany’s Mittelstand engineers, Hong Kong’s disgruntled financiers, San Franciscan favelas). Technology is probably the only way to increase productivity and for technological research we need more talent density. Australia is the best place in the world to live, why not attract more of the world’s best. It doesn’t mean we can recreate Silicon Valley — no one really knows how to do that — but we can make something better than we have.
4. AI?
AI is probably going to be the single greatest driver of global wealth over the next few decades. Can Australian industry get in on the boom? Australia is an AI client not a creator. Australia has no major foundational models (no OpenAI, Anthropic, DeepMind). Australia has no hyperscale tech companies (no AWS, Google, Meta scale). Australia imports almost all its AI tech (models, chips, cloud, SaaS) from USA, China, Europe.
It’s too expensive and it doesn’t have the AI talent density to build it anyway. Australia could become a world leader in applied AI in heavy industries. Mining, agriculture, energy — these are Australia's strengths. Build world-best AI systems for robotic mining, agriculture optimisation, energy grid AI ops to own the "industrial AI" verticals globally. These sectors are hugely valuable and underserved by Silicon Valley, which has typically focused on digital-first solutions. Precedents and talent already exist. Just a few Australian companies I’ve admired over the years or invested in include EarthAI (AI mining exploration), Farmbot (which is laying water-monitoring infrastructure to collect the data for such applications in the future), and A1Base (building Twilio for AI agents). There are many others, including across finance and housing. We could also be a source of AI compute. If we unlock cheap energy, we have infinite land, infinite water (for cooling), and are a secure American satellite — we could host ~infinite data centres for compute. The US should be able to do this itself, but there is no reason we can’t seek to leapfrog its energy capacity and help it diversify.
5. The Boring Bits
There’s no getting around cutting all the nonsense policies and bureaucratic and tax molasses that has accrued over time to gunk up our system. I’ve placed them at 5, but they may be the most important. Each are a political quagmire. NDIS: We should at least halve the NDIS, which would still make it >twice as expensive as originally promised. As it is, it’s a massive government-funded scam soaking up jobs from the productive economy.
Tax reforms: Implement all the tax reforms we know we should — reduce the income tax, broaden the GST, introduce a land tax, remove super tax concessions, immediate expensing. Political salaries: You will hate this but we should triple political remuneration. Make politics prestigious again. Let’s at least try and attract talent to politics. Probably double public servant salaries and halve the size of the public sector. Employment law reform: Ok now that we’re really dreaming the impossible, all employment law should fit on a single piece of paper. A minimum wage, [5] weeks annual leave. You can make it as generous as you like, this isn’t about cutting conditions. It’s about simplifying a totally incomprehensible employment law landscape that no one understands and that’s built on >120 separate industry awards pre-supposing 100 years of outdated employee vs employer relations. Just stipulate the minimum conditions we are willing to accept all priced into a minimum wage, minimum safety requirements, and minimum days off (we are Australian after all). And let the market do the rest. 10% GDP boost right there.
6. Moonshot
Ok, #6 of 5. Should we have a national moonshot project? Something to rally behind, something to push our industry and nation forward. Ideas: Terraforming (#2 above) definitely counts. The first fully autonomous mine. Fully Deregulated Special Economic Zones — create one or two totally deregulated, low-tax, hyper-growth cities — e.g., in NT, WA, or Far North Queensland (think Shenzhen or Dubai — but Australian, free, democratic, and rich.) Build a Singapore in the Northern Territory (Gillard can chair the project and we can call it Gillard’s Dream if it helps!). First fleet of fully autonomous navy / nuclear submarines (spicy!) Nuclear Fuel Leasing: Not that moonshot, but it’s a no brainer — could increase South Australian state revenue by 34%.
Final word
We can be a much more prosperous nation. We need only the will. Will all the above get to 10x GDP per capita? Depends on what timeline. Probably not soon. We’ve only tripled GDP per capita in the last 60 - 70 years with favourable demographic changes (women entering the workforce). But if we are ambitious and refocus national attention towards prosperity rather than squabbling over distribution, we will be better off. Surely that’s something worth getting behind. Thanks to Cameron Murray, Dan Morgan, and Aidan Morrison for input on drafts.
In 1788 the First Fleet landed in Sydney Harbour to deposit its crooks and their jailers on barren shores. They almost starved to death, saved by timely supply shipments from Cape Town.
A century later Australia had the highest GDP per capita in the world.
From a desolate prison colony, Australians built one of the most prosperous and enduring societies in history.
We should be looking at the state of our nation today as though it were Day 1 — 1788 all over again. In 2125 we should be many, many times better off than we are now.
But you wouldn’t think so listening to our recent federal election. Surely the grimmest, low stakes campaign in my lifetime. Australians have gotten used to slim pickings for vision from its politicians.
What can we do to actually create wealth for Australians?
This question is totally absent from political discourse. The GST was Australia’s last true significant reform, a quarter of a century ago. Politics since has been dominated by grievance politics (The Voice), bottomless rorting and redistribution (NDIS), and boomer payoffs (franking credits, super concessions). (Although pleasingly, former PM Julia Gillard once asked former Treasurer Secretary Ken Henry how to turn Darwin into Singapore — they aren’t complete zombies.)
Immigration has become extremely politically salient, but no one wants to touch it. Whilst the ambitions around a big Australia are admirable and have merit, it’s not obviously necessary. Indians are not wealthier than Luxembourgers and aren’t set to be any time this century (India’s GDP per capita (~US$9k) is a rounding error next to Luxembourg’s (~US$135k).
What if we were laser-focused on one question: how to make Australians ten times richer. GDP per capita, not total GDP. Just how do we become super duper wealthier. Wealth solves many problems. Over a lifetime (say 70 years) 10x GDP per capita implies 3.3% real annual growth rate. Ambitious but possible.
You are welcome to read this as left-liberal coded if you like, in the vein of Ezra Klein and Derek Thompson’s Abundance.
Here are 5 ideas:
1. Energy superpower
Energy is upstream of basically everything. Cheaper energy lowers costs across the board and allows more things to happen.
Australia sits on one of the world’s largest mineral and energy reserves. Yet domestic energy prices have been increasing. Average effective residential price rose from 20.4 c/kWh in 2007-08 to 27c in 2020-21 and sits in the low-to-mid 30 c/kWh range in 2023-24. Wrong direction! We should allow all energy types: coal, gas, uranium, hydrogen, nuclear, solar, wind — no religious bans. Permit fast-track development. Kill litigation choke-points. No price caps. Adani’s Carmichael coal mine took >8 years to get approval despite passing environmental reviews. Endless lawsuits, bureaucratic reviews, political reversals. Onshore gas exploration is effectively banned or heavily restricted in NSW and Victoria — despite huge reserves.
Australia holds ~31% of the world’s uranium but has 0 reactors — a pure ideological choke. No need to believe in new tech. We could buy conventional plants off the shelf from South Korea. South Korea’s APR-1400 is fully operational and exported — they built the UAE's Barakah plant. From 2009 — 2024, the Koreans built 4 nuclear power plants in Barakah in about 7–8 years each. Korea Electric Power Corp (KEPCO) has a full export package: design + build + operate + train Australians.
Each reactor has a gross electrical capacity of approximately 1,345 megawatts (MW), contributing to a total plant capacity of 5,600 MW. Collectively, the four units are designed to supply up to 25% of the UAE's electricity needs, generating around 40 terawatt-hours (TWh) of clean electricity annually.
Nuclear could reduce costs meaningfully. In Australia coal is cheap but aging, renewables are cheap on production but intermittent, gas is expensive. Nuclear is reliable, with 24/7 baseload. The marginal baseload supply would disproportionately impact pricing. The 40TWh from a Barakah equivalent would add ~12% to Australian energy. Rule of thumb this should reduce prices by 15 - 30%.
The Barakah plants cost the UAE US$32 billion. This figure encompasses construction, financing, initial fuel supply, and related infrastructure. About the cost of 1 year of NDIS.
How about transmission?
Australia’s National Electricity Market (NEM) — the east coast grid (NSW, VIC, QLD, SA, TAS) — already manages about 65,000 MW of capacity. It's designed to handle peak loads of ~30,000 MW (high summer demand). So adding ~5,600 MW isn't totally crazy — it's ~12% more than today’s peak — manageable if intelligently placed. Current transmission is optimised around coal regions (like Hunter Valley, Latrobe Valley). Those lines are old but well-connected.
Wind/solar expansions (like in western NSW, western VIC) require building massive new transmission (like the "VNI West" project) because these sites are remote.
Nuclear plants, if located near existing coal hubs, can re-use existing infrastructure with only moderate upgrades. This would require massive government support — nuclear plants are natural monopolies (like transmission). A nation-building project, not a libertarian fantasy.
2. Terraform the desert
We should terraform the outback to 10x agricultural output.
We have the land and infinite sea water. With cheap energy we could desalinate to create new inland rivers (as proposed by US-based son of Australia Casey Handmer). Once we’ve done that, why not build new cities too?
The next Great Australian will build a new city.
Australia is the size of Europe, but much of it is uninhabitable and unproductive desert:
Australian habitability map shows land use patterns 70 years ago | Daily Mail Online Accordingly, most of it is minimally used:
Almost all Australians live on the coastlines. The US has great inland rivers, which allowed it to build great cities and wealth from internal trade.
What if we could create something similar for Australia?
Mongolia successfully transformed 6,000km² of Inner Mongolia's Kubuqi Desert into green landscape, quadrupling annual rainfall from <100mm to >400mm. That’s the size of about two-and-a-half Australian Capital Territories. Or the 18 million hectares restored so far in the Sahel as part of the Great Green Wall, a vision to create a 8,000km green belt across 11 countries. Other examples can be found in Israel’s Negev desert and the Toshka Project in Egypt.
I have seen this image a lot of times. Is a plan like to terraform Australia feasible? : r/geography Australia exports around $76bn in agricultural product per year. We should aim to 10x that number.
3. Aggressively target global talent
No, this does not mean flooding our universities with migrants to ‘skill them up’ in a fake university-profiteering visa mill farce.
It means attracting the world’s best and brightest. E.g.
Zero income tax for X years if you start a business that employs >10 people or generate >$5m in exports.
Fast-track citizenship for scientists, engineers, founders, capital allocators, builders.
Poach aggressively from places where elites are suffocating (e.g., Germany’s Mittelstand engineers, Hong Kong’s disgruntled financiers, San Franciscan favelas). Technology is probably the only way to increase productivity and for technological research we need more talent density. Australia is the best place in the world to live, why not attract more of the world’s best. It doesn’t mean we can recreate Silicon Valley — no one really knows how to do that — but we can make something better than we have.
4. AI?
AI is probably going to be the single greatest driver of global wealth over the next few decades. Can Australian industry get in on the boom? Australia is an AI client not a creator. Australia has no major foundational models (no OpenAI, Anthropic, DeepMind). Australia has no hyperscale tech companies (no AWS, Google, Meta scale). Australia imports almost all its AI tech (models, chips, cloud, SaaS) from USA, China, Europe.
It’s too expensive and it doesn’t have the AI talent density to build it anyway. Australia could become a world leader in applied AI in heavy industries. Mining, agriculture, energy — these are Australia's strengths. Build world-best AI systems for robotic mining, agriculture optimisation, energy grid AI ops to own the "industrial AI" verticals globally. These sectors are hugely valuable and underserved by Silicon Valley, which has typically focused on digital-first solutions. Precedents and talent already exist. Just a few Australian companies I’ve admired over the years or invested in include EarthAI (AI mining exploration), Farmbot (which is laying water-monitoring infrastructure to collect the data for such applications in the future), and A1Base (building Twilio for AI agents). There are many others, including across finance and housing. We could also be a source of AI compute. If we unlock cheap energy, we have infinite land, infinite water (for cooling), and are a secure American satellite — we could host ~infinite data centres for compute. The US should be able to do this itself, but there is no reason we can’t seek to leapfrog its energy capacity and help it diversify.
5. The Boring Bits
There’s no getting around cutting all the nonsense policies and bureaucratic and tax molasses that has accrued over time to gunk up our system. I’ve placed them at 5, but they may be the most important. Each are a political quagmire. NDIS: We should at least halve the NDIS, which would still make it >twice as expensive as originally promised. As it is, it’s a massive government-funded scam soaking up jobs from the productive economy.
Tax reforms: Implement all the tax reforms we know we should — reduce the income tax, broaden the GST, introduce a land tax, remove super tax concessions, immediate expensing. Political salaries: You will hate this but we should triple political remuneration. Make politics prestigious again. Let’s at least try and attract talent to politics. Probably double public servant salaries and halve the size of the public sector. Employment law reform: Ok now that we’re really dreaming the impossible, all employment law should fit on a single piece of paper. A minimum wage, [5] weeks annual leave. You can make it as generous as you like, this isn’t about cutting conditions. It’s about simplifying a totally incomprehensible employment law landscape that no one understands and that’s built on >120 separate industry awards pre-supposing 100 years of outdated employee vs employer relations. Just stipulate the minimum conditions we are willing to accept all priced into a minimum wage, minimum safety requirements, and minimum days off (we are Australian after all). And let the market do the rest. 10% GDP boost right there.
6. Moonshot
Ok, #6 of 5. Should we have a national moonshot project? Something to rally behind, something to push our industry and nation forward. Ideas: Terraforming (#2 above) definitely counts. The first fully autonomous mine. Fully Deregulated Special Economic Zones — create one or two totally deregulated, low-tax, hyper-growth cities — e.g., in NT, WA, or Far North Queensland (think Shenzhen or Dubai — but Australian, free, democratic, and rich.) Build a Singapore in the Northern Territory (Gillard can chair the project and we can call it Gillard’s Dream if it helps!). First fleet of fully autonomous navy / nuclear submarines (spicy!) Nuclear Fuel Leasing: Not that moonshot, but it’s a no brainer — could increase South Australian state revenue by 34%.
Final word
We can be a much more prosperous nation. We need only the will. Will all the above get to 10x GDP per capita? Depends on what timeline. Probably not soon. We’ve only tripled GDP per capita in the last 60 - 70 years with favourable demographic changes (women entering the workforce). But if we are ambitious and refocus national attention towards prosperity rather than squabbling over distribution, we will be better off. Surely that’s something worth getting behind. Thanks to Cameron Murray, Dan Morgan, and Aidan Morrison for input on drafts.
Jeremy Renner Salary op-ed
Jeremy Renner has shed light on where things stand with Hawkeye season 2, and after the actor's comments, I don't want the Marvel Cinematic Universe series to return because I feel one key element would be missing. The Multiverse Saga allowed Marvel to explore Disney+ and what it could offer to the franchise. While I know that multiple MCU TV shows have faced issues, I thought Hawkeye was easily one of the best series Marvel Studios has produced.
As such, I have been waiting for Hawkeye season 2 updates since the show premiered. There have been rumors that Clint Barton's brother from the comics, Barney, could be making his MCU debut in a second season. However, Marvel has yet to announce season 2 as one of the projects on the MCU's slate. Almost 4 years after Hawkeye debuted, we now have concrete news on season 2's status, and it sadly makes me not want the show to return anymore.
Jeremy Renner Has Revealed Why He Passed On Hawkeye Season 2 The MCU Series Has Suffered A Major Setback Marvel Studios might have never revealed that Hawkeye season 2 was in development, but Clint Barton actor Jeremy Renner has now confirmed that the MCU did have plans for the Disney+ series to make a return. Renner claimed he turned down Hawkeye season 2 over a salary dispute. According to the actor, he was offered half of his season 1 salary. Check out the full quote below:
"They asked me to do Season 2, and they offered me half the money. I’m like, ‘Well, it’s going to take me twice the amount of work for half the amount of money, and eight months of my time, essentially, to do it for half the amount. I’m like, ‘I’m sorry? Why? Did you think I’m only half the Jeremy because I got ran over? Maybe that’s why you want to pay me half of what I made on the first season.'
This is not Marvel, mind you. This is like, just Disney, not even really Disney. It’s just the penny pinchers, the accountants. I told them to go fly a kite. I mean, just at the insult offer. So we didn’t see eye to eye on it. Sadly, I still love the character. I’d still love to do it, but I had to defend myself. I didn’t ask for any more money, mind you. Just pay me what I made the first season. So it’s all disheartening that that didn’t happen, but that’s fine. I’m happy to let that go, because my body’s probably thanking me, time and time again, that I’m not doing it right now. But we’ll see."
Renner suffered a major accident in 2023. The MCU actor was crushed by his snowplow while saving his nephew's life. That led to Renner breaking several bones and going on a long journey until he was fully healed. Renner mentions his accident as a possible cause why he was offered less money for Hawkeye season 2, which would have been a terrible argument.
Posts 3 While Renner turned down the offer to return for Hawkeye season 2, the actor's comments reveal that he still loves Clint Barton and would be happy to return for the show or more Hawkeye adventures in the MCU. I can understand why Renner said no, as the work would have been harder on him after the injuries, and he would have made only half of his Hawkeye season 1 salary. That said, Hawkeye season 2 could still happen even if Renner and Marvel/Disney never agree on his salary.
Hawkeye Season 2 Could Still Happen With Hailee Steinfeld As The Lead Kate Bishop's Presence In The MCU Is Set To Grow In The Future Marvel's Hawkeye series served two purposes. On the one hand, it was the studio's way of giving the original Avengers member his own solo project. Renner's Hawkeye is the only hero from the MCU's original Avengers team to not get a solo movie, but the Disney+ series made up for that, with six episodes that gave Clint Barton quite a bit of screen time. On the other hand, Hawkeye was very much a two-hander, introducing Hailee Steinfeld's Kate Bishop to the MCU.
By the end of the show, Steinfeld's Marvel hero had shown that she has what it takes to be Clint's successor as the MCU's Hawkeye. With Renner turning down Hawkeye season 2, Marvel does not necessarily need the actor to return for the show to continue. If Steinfeld signs on, Kate Bishop could become the sole star of Hawkeye season 2, perhaps even taking on her mentor's moniker for herself onscreen. Steinfeld's Kate is still making MCU appearances after all, set up to be part of Ms. Marvel's Young Avengers team.
I Don’t Want More Hawkeye If It’s Not With The Hero Duo Coming Back Together The Dynamic Between Kate And Clint Made Hawkeye Season 1 Work [Image: Clint-and-Kate-in-Hawkeye-1]
Since Renner does not mention any further talks with Marvel about returning for Hawkeye season 2, I fear that the studio might have moved on from Clint and decided to continue the show with Steinfeld's Kate Bishop as its sole lead. While I love Kate and think she has the potential to become one of the MCU's most beloved heroes, her dynamic with Renner's Hawkeye is what made me fall in love with the show.
Kate's presence allowed us to see quite a few different sides to Clint, and I loved how she was fascinated with Hawkeye. The character is often cast aside by fans when comparing the original Avengers, and I felt that Kate being a Hawkeye super fan allowed the series to show just how exciting Clint Barton can be. They became family by the end of season 1, and I would love to watch that bond deepen with more seasons. If Jeremy Renner does not return for more, as his comments suggest he will not, then I don't want Hawkeye season 2.
From screen rant article
As such, I have been waiting for Hawkeye season 2 updates since the show premiered. There have been rumors that Clint Barton's brother from the comics, Barney, could be making his MCU debut in a second season. However, Marvel has yet to announce season 2 as one of the projects on the MCU's slate. Almost 4 years after Hawkeye debuted, we now have concrete news on season 2's status, and it sadly makes me not want the show to return anymore.
Jeremy Renner Has Revealed Why He Passed On Hawkeye Season 2 The MCU Series Has Suffered A Major Setback Marvel Studios might have never revealed that Hawkeye season 2 was in development, but Clint Barton actor Jeremy Renner has now confirmed that the MCU did have plans for the Disney+ series to make a return. Renner claimed he turned down Hawkeye season 2 over a salary dispute. According to the actor, he was offered half of his season 1 salary. Check out the full quote below:
"They asked me to do Season 2, and they offered me half the money. I’m like, ‘Well, it’s going to take me twice the amount of work for half the amount of money, and eight months of my time, essentially, to do it for half the amount. I’m like, ‘I’m sorry? Why? Did you think I’m only half the Jeremy because I got ran over? Maybe that’s why you want to pay me half of what I made on the first season.'
This is not Marvel, mind you. This is like, just Disney, not even really Disney. It’s just the penny pinchers, the accountants. I told them to go fly a kite. I mean, just at the insult offer. So we didn’t see eye to eye on it. Sadly, I still love the character. I’d still love to do it, but I had to defend myself. I didn’t ask for any more money, mind you. Just pay me what I made the first season. So it’s all disheartening that that didn’t happen, but that’s fine. I’m happy to let that go, because my body’s probably thanking me, time and time again, that I’m not doing it right now. But we’ll see."
Renner suffered a major accident in 2023. The MCU actor was crushed by his snowplow while saving his nephew's life. That led to Renner breaking several bones and going on a long journey until he was fully healed. Renner mentions his accident as a possible cause why he was offered less money for Hawkeye season 2, which would have been a terrible argument.
Posts 3 While Renner turned down the offer to return for Hawkeye season 2, the actor's comments reveal that he still loves Clint Barton and would be happy to return for the show or more Hawkeye adventures in the MCU. I can understand why Renner said no, as the work would have been harder on him after the injuries, and he would have made only half of his Hawkeye season 1 salary. That said, Hawkeye season 2 could still happen even if Renner and Marvel/Disney never agree on his salary.
Hawkeye Season 2 Could Still Happen With Hailee Steinfeld As The Lead Kate Bishop's Presence In The MCU Is Set To Grow In The Future Marvel's Hawkeye series served two purposes. On the one hand, it was the studio's way of giving the original Avengers member his own solo project. Renner's Hawkeye is the only hero from the MCU's original Avengers team to not get a solo movie, but the Disney+ series made up for that, with six episodes that gave Clint Barton quite a bit of screen time. On the other hand, Hawkeye was very much a two-hander, introducing Hailee Steinfeld's Kate Bishop to the MCU.
By the end of the show, Steinfeld's Marvel hero had shown that she has what it takes to be Clint's successor as the MCU's Hawkeye. With Renner turning down Hawkeye season 2, Marvel does not necessarily need the actor to return for the show to continue. If Steinfeld signs on, Kate Bishop could become the sole star of Hawkeye season 2, perhaps even taking on her mentor's moniker for herself onscreen. Steinfeld's Kate is still making MCU appearances after all, set up to be part of Ms. Marvel's Young Avengers team.
I Don’t Want More Hawkeye If It’s Not With The Hero Duo Coming Back Together The Dynamic Between Kate And Clint Made Hawkeye Season 1 Work [Image: Clint-and-Kate-in-Hawkeye-1]
Since Renner does not mention any further talks with Marvel about returning for Hawkeye season 2, I fear that the studio might have moved on from Clint and decided to continue the show with Steinfeld's Kate Bishop as its sole lead. While I love Kate and think she has the potential to become one of the MCU's most beloved heroes, her dynamic with Renner's Hawkeye is what made me fall in love with the show.
Kate's presence allowed us to see quite a few different sides to Clint, and I loved how she was fascinated with Hawkeye. The character is often cast aside by fans when comparing the original Avengers, and I felt that Kate being a Hawkeye super fan allowed the series to show just how exciting Clint Barton can be. They became family by the end of season 1, and I would love to watch that bond deepen with more seasons. If Jeremy Renner does not return for more, as his comments suggest he will not, then I don't want Hawkeye season 2.
From screen rant article
Friday, May 02, 2025
Saturday, April 26, 2025
The Road to Campus Serfdom
April 24, 2025
The Road to Campus Serfdom
John O. McGinnis
Federal control over education has grown so powerful because progressives empowered the government for their own ideological goals.
It seems remarkable that seemingly antisemitic protests by undergraduates, such as those at my own university of Northwestern, could threaten the biomedical research funding of its medical school. But the structure of civil rights laws as applied to universities has long allowed the federal government to cut off funding to the entire university based on the wrongful actions of particular units or departments.
Ironically, the left, now alarmed by the federal government’s intrusive reach, bears direct responsibility for crafting the very legal weapons wielded against the universities it dominates. Almost four decades ago, progressive legislators demanded sweeping amendments to civil rights law, expanding federal oversight over higher education. The sequence of events reveals a cautionary tale of political hubris: progressive confidence that state power would reliably serve their ends overlooked the reality that governmental authority, once unleashed, recognizes no ideological master. Today’s circumstances starkly illustrate how expansive federal control over civil society, originally celebrated by progressives, returns to haunt its architects. The left’s outrage ought to focus not on this particular administration but on its own reckless empowerment of the state.
The story begins with Grove City College, a small Christian institution in southeastern Pennsylvania. Grove City sought independence from the federal government and its proliferating regulations to preserve a distinctive faith-based education. To that end, it refused all direct government funding. Some of its students, however, received federal Basic Educational Opportunity Grants (Pell Grants) to pay tuition. The Department of Education argued that because the college benefited indirectly from those grants, it must certify compliance with Title IX’s prohibition on sex discrimination. Grove City refused, insisting that accepting students who had federal aid did not subject the entire college to federal rules. The dispute reached the Supreme Court in 1983.
The Reagan administration inherited this enforcement proceeding but tried to take a nuanced approach to protect against giving the government power over all the operations of a private university.
Solicitor General Rex Lee, for whom I had the privilege of briefly working, argued that Grove City was indeed subject to Title IX because the college received indirect federal funding through students’ financial aid. Lee, however, also focused on a limitation contained in the statute, arguing that the restrictions on discrimination only applied to the “program” that received the federal funds—in the case of Grove City, that was the financial aid office—not the entire institution. Thus, Lee’s argument reflected the Reagan administration’s broader policy concern for protecting civil society, including religious institutions, like Grove City, from federal rules that could transform their campus.
The left’s shortsightedness has delivered into the hands of their opponents the very instruments of coercion they forged.
By a 6–3 vote, the Court agreed with the Reagan administration’s position. It held that Title IX applied only to the specific program that received federal funds—in this case, the college’s financial aid office—rather than to the institution as a whole. In practical terms, this meant that Grove City College only had to ensure its financial aid operations did not discriminate on the basis of sex. This “program-specific” principle allowed self-determination for much of the college’s operations. It implied, for example, that Title IX would not cover a college’s athletic department unless that department itself received federal funds. It also followed that should a university refuse to end its discrimination in a program, the federal government could only withhold funds from the program that engaged in the discrimination.
As George Liebmann recently wrote for Law & Liberty, the left was enraged by the Reagan administration’s position and the Supreme Court’s decision. It pushed Congress to overturn it immediately. And after debates in Congress, in 1987, both the House and Senate passed the Civil Rights Restoration Act, which made all federal funds received by an educational institution subject to being cut off if there was discrimination by any unit. President Reagan vetoed the bill, warning that “would diminish substantially the freedom and independence” of universities. He saw it as a federal overreach—what he pungently labeled a “big government powergrab … cloaked in the mantle of civil rights.” Or, as Liebmann nicely put it in his recent essay, “Such power … allows the federal government to strangle institutions that don’t fall in line with its vision of social order.”
It is worth recognizing the intellectual roots of Reagan’s veto. Reagan was deeply influenced by Friedrich Hayek’s seminal work, The Road to Serfdom. He frequently quoted Hayek in speeches and hailed Hayek’s contributions when his successor, George H. W. Bush gave Hayek the Presidential Medal of Freedom. Hayek feared that central planning by government would crush autonomy not only of markets, but of civil institutions. Reagan’s veto was a direct application of Hayek’s liberal precepts.
But, despite Reagan’s veto, Congress nevertheless passed the bill over his veto. As a result of this change in law, all subsequent presidential administrations have enjoyed enormous leverage over universities. Any violation of Title VI or Title IX anywhere within the institution, as defined by an administration, puts a university at the risk of the loss of all federal funds in all its operations. Modern universities receive substantial federal funds. Virtually every university relies significantly on federal student aid. Research universities like my own receive substantial additional federal funding, particularly in biomedical research and in defense contracting.
And Democratic administrations made aggressive use of this leverage to change practices at college campuses in heavy-handed ways. The Obama administration’s “Dear Colleague” letter in 2011 effectively mandated that universities overhaul their procedures for sexual abuse and harassment cases or face total loss of federal funding. For instance, the letter asked that guilt be determined by a bare preponderance of the evidence standard, despite the heavy costs to a student from a guilty verdict and expulsion. It also undermined due process by discouraging cross-examination and mandating training in which investigators were encouraged to believe the accusers. The government was deploying its enormous power to dictate processes to universities and regulate their relations with their students and, by extension, students with each other.
The Obama administration did not limit itself to regulating conduct; it aggressively extended its authority to police campus speech. It argued that speech that listeners thought was of a sexual nature could lead to a finding of a hostile environment actionable under Title VI, even if that conclusion were not based on objective facts, but on subjective feelings. Such interventions encouraged speech codes and chilled debate.
In 2016, the Obama administration issued guidance interpreting Title IX to cover gender identity, advising schools that transgender students must be allowed to use facilities and participate in programs consistent with their gender identity or else be in violation of federal law. This requirement included access to bathrooms, locker rooms, and sports teams corresponding to their identity. Again, this interpretation represented an aggressive and expansive reinterpretation of Title IX. It seems plainly inconsistent with this language, which prevents discrimination based on sex—a concept that at the time of Title IX was passed—referred to biological sex. But colleges did not want to risk their federal funding by flouting such government ukases.
While many on the left decry the Trump’s administration’s attempt to use its power under the Civil Rights law to reform higher education to its liking, they did not lodge similar complaints against the Obama or Biden administrations’ exertion of power under the same authority.
We should return more autonomy to civil society, including private universities, by reducing the heavy hand of federal regulation.
Such expansive government authority validates Ronald Reagan’s Hayekian prophecy that empowering government inevitably undermines civil society’s autonomy. Hayek’s critique lays bare the dynamic of the current funding‑cutoff regime. A free society, he insisted, rests on rules that are general, abstract, and prospectively applied; once administrators may pursue favored social ends case by case, law dissolves into politics. Yet Congress now empowers federal agencies to “effectuate” anti‑discrimination norms by terminating—“in whole or in part”—every stream of federal aid to a university, while the Office for Civil Rights may invoke “any other means authorized by law.” Universities can thus face a remedial roulette, unsure how—or how severely—evolving notions of “hostile environment,” “pregnancy‑related conditions,” or “gender identity” will be enforced. The rule‑of‑law certainty Hayek prized yields to the horse‑trading of administrative justice.
Hayek also warned that central planners cannot marshal the dispersed knowledge lodged in local practice; uniform mandates inevitably misjudge context and breed perverse incentives. One federal definition of compliance now governs thousands of heterogeneous campuses. Because a single slip can imperil grants for physics or medicine, counsel imposes campus‑wide prophylaxis: mandatory trainings, speech codes, and quasi‑judicial procedures that outrun the statutory text. Washington’s abstractions flatten the landscape of academic life—precisely the epistemic error Hayek when centralized control becomes stronger.
Finally, Hayek identified a ratchet of increased government power: each discretionary intervention invites the next, converting temporary power into permanent dominion. As detailed above, Title VI and Title IX trace the pattern. Program‑specific oversight gave way to institution‑wide sanctions; race and sex have expanded into an ever‑widening catalogue of identities. Every “modest” extension prepares the ground for the next, tightening the lever and nudging higher education farther down the road to bureaucratic serfdom. Bureaucratic mandates by the government require more bureaucrats in the university who gain more power over university life, displacing the more varied perspectives and knowledge of the faculty.
Even under the old regime approved by the Supreme Court in Grove City, the government would have had influence over universities, because it could have cut off funds from units that violated its view of Title VI and Title IX. But its power would have been appropriately limited. Universities need not have feared the loss of all federal funds. They would have been in a better position to engage in a dialogue with the government rather than react to its dictates on any interpretation of Titles VI and IX.
Clumsy governmental dictates on contentious matters such as transgender rights do not merely settle disputes; they inflame societal divisions by transforming moral disagreements into winner-takes-all political battles. Civil society, by contrast, thrives precisely because it embraces diversity and facilitates compromise, allowing pluralistic communities to coexist peacefully without being conscripted into ideological warfare. The left, fixated upon uniform outcomes, consistently undervalues the power of voluntary cooperation and cultural persuasion. Their shortsightedness has delivered into the hands of their opponents the very instruments of coercion they forged, vividly confirming an enduring truth: the power you grant government today will inevitably be wielded tomorrow by your adversaries.
In the long term, the wisest course would be to return more autonomy to civil society, including private universities, by reducing the heavy hand of federal regulation. The Trump administration has demonstrated to progressives that governmental power over education is indeed a double-edged sword. Perhaps, having felt the blade’s sting, the left might now join friends of liberty in sheathing it.
John O. McGinnis
Federal control over education has grown so powerful because progressives empowered the government for their own ideological goals
The Road to Campus Serfdom
John O. McGinnis
Federal control over education has grown so powerful because progressives empowered the government for their own ideological goals.
It seems remarkable that seemingly antisemitic protests by undergraduates, such as those at my own university of Northwestern, could threaten the biomedical research funding of its medical school. But the structure of civil rights laws as applied to universities has long allowed the federal government to cut off funding to the entire university based on the wrongful actions of particular units or departments.
Ironically, the left, now alarmed by the federal government’s intrusive reach, bears direct responsibility for crafting the very legal weapons wielded against the universities it dominates. Almost four decades ago, progressive legislators demanded sweeping amendments to civil rights law, expanding federal oversight over higher education. The sequence of events reveals a cautionary tale of political hubris: progressive confidence that state power would reliably serve their ends overlooked the reality that governmental authority, once unleashed, recognizes no ideological master. Today’s circumstances starkly illustrate how expansive federal control over civil society, originally celebrated by progressives, returns to haunt its architects. The left’s outrage ought to focus not on this particular administration but on its own reckless empowerment of the state.
The story begins with Grove City College, a small Christian institution in southeastern Pennsylvania. Grove City sought independence from the federal government and its proliferating regulations to preserve a distinctive faith-based education. To that end, it refused all direct government funding. Some of its students, however, received federal Basic Educational Opportunity Grants (Pell Grants) to pay tuition. The Department of Education argued that because the college benefited indirectly from those grants, it must certify compliance with Title IX’s prohibition on sex discrimination. Grove City refused, insisting that accepting students who had federal aid did not subject the entire college to federal rules. The dispute reached the Supreme Court in 1983.
The Reagan administration inherited this enforcement proceeding but tried to take a nuanced approach to protect against giving the government power over all the operations of a private university.
Solicitor General Rex Lee, for whom I had the privilege of briefly working, argued that Grove City was indeed subject to Title IX because the college received indirect federal funding through students’ financial aid. Lee, however, also focused on a limitation contained in the statute, arguing that the restrictions on discrimination only applied to the “program” that received the federal funds—in the case of Grove City, that was the financial aid office—not the entire institution. Thus, Lee’s argument reflected the Reagan administration’s broader policy concern for protecting civil society, including religious institutions, like Grove City, from federal rules that could transform their campus.
The left’s shortsightedness has delivered into the hands of their opponents the very instruments of coercion they forged.
By a 6–3 vote, the Court agreed with the Reagan administration’s position. It held that Title IX applied only to the specific program that received federal funds—in this case, the college’s financial aid office—rather than to the institution as a whole. In practical terms, this meant that Grove City College only had to ensure its financial aid operations did not discriminate on the basis of sex. This “program-specific” principle allowed self-determination for much of the college’s operations. It implied, for example, that Title IX would not cover a college’s athletic department unless that department itself received federal funds. It also followed that should a university refuse to end its discrimination in a program, the federal government could only withhold funds from the program that engaged in the discrimination.
As George Liebmann recently wrote for Law & Liberty, the left was enraged by the Reagan administration’s position and the Supreme Court’s decision. It pushed Congress to overturn it immediately. And after debates in Congress, in 1987, both the House and Senate passed the Civil Rights Restoration Act, which made all federal funds received by an educational institution subject to being cut off if there was discrimination by any unit. President Reagan vetoed the bill, warning that “would diminish substantially the freedom and independence” of universities. He saw it as a federal overreach—what he pungently labeled a “big government powergrab … cloaked in the mantle of civil rights.” Or, as Liebmann nicely put it in his recent essay, “Such power … allows the federal government to strangle institutions that don’t fall in line with its vision of social order.”
It is worth recognizing the intellectual roots of Reagan’s veto. Reagan was deeply influenced by Friedrich Hayek’s seminal work, The Road to Serfdom. He frequently quoted Hayek in speeches and hailed Hayek’s contributions when his successor, George H. W. Bush gave Hayek the Presidential Medal of Freedom. Hayek feared that central planning by government would crush autonomy not only of markets, but of civil institutions. Reagan’s veto was a direct application of Hayek’s liberal precepts.
But, despite Reagan’s veto, Congress nevertheless passed the bill over his veto. As a result of this change in law, all subsequent presidential administrations have enjoyed enormous leverage over universities. Any violation of Title VI or Title IX anywhere within the institution, as defined by an administration, puts a university at the risk of the loss of all federal funds in all its operations. Modern universities receive substantial federal funds. Virtually every university relies significantly on federal student aid. Research universities like my own receive substantial additional federal funding, particularly in biomedical research and in defense contracting.
And Democratic administrations made aggressive use of this leverage to change practices at college campuses in heavy-handed ways. The Obama administration’s “Dear Colleague” letter in 2011 effectively mandated that universities overhaul their procedures for sexual abuse and harassment cases or face total loss of federal funding. For instance, the letter asked that guilt be determined by a bare preponderance of the evidence standard, despite the heavy costs to a student from a guilty verdict and expulsion. It also undermined due process by discouraging cross-examination and mandating training in which investigators were encouraged to believe the accusers. The government was deploying its enormous power to dictate processes to universities and regulate their relations with their students and, by extension, students with each other.
The Obama administration did not limit itself to regulating conduct; it aggressively extended its authority to police campus speech. It argued that speech that listeners thought was of a sexual nature could lead to a finding of a hostile environment actionable under Title VI, even if that conclusion were not based on objective facts, but on subjective feelings. Such interventions encouraged speech codes and chilled debate.
In 2016, the Obama administration issued guidance interpreting Title IX to cover gender identity, advising schools that transgender students must be allowed to use facilities and participate in programs consistent with their gender identity or else be in violation of federal law. This requirement included access to bathrooms, locker rooms, and sports teams corresponding to their identity. Again, this interpretation represented an aggressive and expansive reinterpretation of Title IX. It seems plainly inconsistent with this language, which prevents discrimination based on sex—a concept that at the time of Title IX was passed—referred to biological sex. But colleges did not want to risk their federal funding by flouting such government ukases.
While many on the left decry the Trump’s administration’s attempt to use its power under the Civil Rights law to reform higher education to its liking, they did not lodge similar complaints against the Obama or Biden administrations’ exertion of power under the same authority.
We should return more autonomy to civil society, including private universities, by reducing the heavy hand of federal regulation.
Such expansive government authority validates Ronald Reagan’s Hayekian prophecy that empowering government inevitably undermines civil society’s autonomy. Hayek’s critique lays bare the dynamic of the current funding‑cutoff regime. A free society, he insisted, rests on rules that are general, abstract, and prospectively applied; once administrators may pursue favored social ends case by case, law dissolves into politics. Yet Congress now empowers federal agencies to “effectuate” anti‑discrimination norms by terminating—“in whole or in part”—every stream of federal aid to a university, while the Office for Civil Rights may invoke “any other means authorized by law.” Universities can thus face a remedial roulette, unsure how—or how severely—evolving notions of “hostile environment,” “pregnancy‑related conditions,” or “gender identity” will be enforced. The rule‑of‑law certainty Hayek prized yields to the horse‑trading of administrative justice.
Hayek also warned that central planners cannot marshal the dispersed knowledge lodged in local practice; uniform mandates inevitably misjudge context and breed perverse incentives. One federal definition of compliance now governs thousands of heterogeneous campuses. Because a single slip can imperil grants for physics or medicine, counsel imposes campus‑wide prophylaxis: mandatory trainings, speech codes, and quasi‑judicial procedures that outrun the statutory text. Washington’s abstractions flatten the landscape of academic life—precisely the epistemic error Hayek when centralized control becomes stronger.
Finally, Hayek identified a ratchet of increased government power: each discretionary intervention invites the next, converting temporary power into permanent dominion. As detailed above, Title VI and Title IX trace the pattern. Program‑specific oversight gave way to institution‑wide sanctions; race and sex have expanded into an ever‑widening catalogue of identities. Every “modest” extension prepares the ground for the next, tightening the lever and nudging higher education farther down the road to bureaucratic serfdom. Bureaucratic mandates by the government require more bureaucrats in the university who gain more power over university life, displacing the more varied perspectives and knowledge of the faculty.
Even under the old regime approved by the Supreme Court in Grove City, the government would have had influence over universities, because it could have cut off funds from units that violated its view of Title VI and Title IX. But its power would have been appropriately limited. Universities need not have feared the loss of all federal funds. They would have been in a better position to engage in a dialogue with the government rather than react to its dictates on any interpretation of Titles VI and IX.
Clumsy governmental dictates on contentious matters such as transgender rights do not merely settle disputes; they inflame societal divisions by transforming moral disagreements into winner-takes-all political battles. Civil society, by contrast, thrives precisely because it embraces diversity and facilitates compromise, allowing pluralistic communities to coexist peacefully without being conscripted into ideological warfare. The left, fixated upon uniform outcomes, consistently undervalues the power of voluntary cooperation and cultural persuasion. Their shortsightedness has delivered into the hands of their opponents the very instruments of coercion they forged, vividly confirming an enduring truth: the power you grant government today will inevitably be wielded tomorrow by your adversaries.
In the long term, the wisest course would be to return more autonomy to civil society, including private universities, by reducing the heavy hand of federal regulation. The Trump administration has demonstrated to progressives that governmental power over education is indeed a double-edged sword. Perhaps, having felt the blade’s sting, the left might now join friends of liberty in sheathing it.
John O. McGinnis
Federal control over education has grown so powerful because progressives empowered the government for their own ideological goals
Sunday, April 13, 2025
What if the World stopped lending to US
Since the early 1990s, the United States has borrowed heavily from its trading partners. This paper presents an analysis of the impact of an end to this borrowing, an end that could occur suddenly or gradually.
Modeling U.S. borrowing as the result of what Bernanke (2005) calls a global saving glut—where foreigners sell goods and services to the United States but prefer purchasing U.S. assets to purchasing U.S. goods and services—we capture four key features of the United States and its position in the world economy over 1992–2012. In the model, as in the data: (1) the U.S. trade deficit first increases, then decreases; (2) the U.S. real exchange rate first appreciates, then depreciates; (3) the U.S. trade deficit is driven by a deficit in goods trade, with a steady U.S. surplus in service trade; and (4) the fraction of U.S labor dedicated to producing goods—agriculture, mining and manufacturing—falls throughout the period.
Using this model, we analyze two possible ends to the saving glut: an orderly, gradual rebalancing and a disorderly, sudden stop in foreign lending as occurred in Mexico in 1995–96. We find that a sudden stop would be very disruptive for the U.S. economy in the short term, particularly for the construction industry.
In the long term, however, a sudden stop would have a surprisingly small impact. As the U.S. trade deficit becomes a surplus, gradually or suddenly, employment in goods production will not return to its level in the early 1990s because much of this surplus will be trade in services and because much of the decline in employment in goods production has been, and will be, due to faster productivity growth in goods than in services.
The global saving glut
From 1992 to 2012, households and the government in the United States borrowed heavily from the rest of the world. As U.S. borrowing—measured as the current account deficit—grew, the U.S. net international investment position deteriorated by $4 trillion, and, by 2012, the United States owed the rest of the world $4.4 trillion. In this paper, we use a model developed by the authors (Kehoe, Ruhl and Steinberg 2013) that captures this increase in borrowing to study the different ways in which the United States can reverse its current account deficit and begin to pay down its accumulated debt. Our hypothesis for the driving force behind the United States’ borrowing is the global-saving-glut theory proposed by Ben Bernanke. In a March 2005 address, Bernanke (2005) asked,
“Why is the United States, with the world’s largest economy, borrowing heavily on international capital markets—rather than lending, as would seem more natural? … [O]ver the past decade a combination of diverse forces has created a significant increase in the global supply of saving—a global saving glut—which helps to explain both the increase in the U.S. current account deficit and the relatively low level of long-term real interest rates in the world today.”
The essence of the global-saving-glut theory is that increased saving in the rest of the world, primarily in China, resulted in foreigners purchasing U.S. assets rather than U.S. exports. As foreigners sold goods and services to the United States to finance these asset purchases, the price of these goods and services compared to those in the United States fell.
The balance-of-payments identity says that payments by U.S. residents to rest of the world (ROW) must equal payments by the rest of the world to U.S. residents:
ROW purchases of U.S. exports + ROW factor payments and transfers to U.S. + ROW purchases of U.S. assets = U.S. purchases of ROW exports + U.S. factor payments and transfers to ROW + U.S. purchases of ROW assets.
This equation is an identity because accounting conventions make it hold at all times: An excess of payments made by the rest of the world over payments made by U.S. residents, for example, is counted as purchases of assets in the rest of the world by U.S. residents, that is, U.S. residents borrowing from foreigners. We can rearrange this identity as
(ROW purchases of U.S. exports − U.S. purchases of ROW exports) + (ROW factor payments and transfers to U.S. − U.S. factor payments and transfers to ROW) = (U.S. purchases of ROW assets − ROW purchases of U.S. assets),
which says that the U.S. trade balance plus net factor payments and transfers from the rest of the world are equal to net U.S. asset accumulation in the rest of the world. The sum of the trade balance plus net factor payments and transfers from the rest of the world is referred to as the current account balance, which is also equal to net U.S. accumulation of foreign assets. The data in Figure 1 show that the U.S. current account balance is approximately equal to the U.S. trade balance because net factor payments and transfers from the rest of the world are small. Consequently, the balance-of-payments identity says that the trade deficit is approximately equal to foreign accumulation of U.S. assets.
Figure 1 also presents data on prices in the United States relative to those in the rest of the world, the real exchange rate between the U.S. dollar and a weighted geometric average of the currencies of its 20 most important trading partners. The real exchange rate between the U.S. dollar and the Chinese renminbi, whose principal unit is the yuan, for example, is
U.S.-China real exchange rate = U.S.-China nominal exchange rate x (Chinese CPI ÷ U.S. CPI),
where we measure the price level in each country using its consumer price index (CPI). To understand this real exchange rate, consider the units in which it is measured:
(dollars÷yuan) x ((yuan÷Chinese consumption basket) ÷ (dollars÷U.S. consumption basket)) = U.S. consumption basket ÷ Chinese consumption basket.
As the real exchange rate falls, fewer U.S. consumption baskets trade for one Chinese consumption basket, and the dollar appreciates.
Between 1992 and 2002, the real exchange rate between the U.S. dollar and the weighted sum of the currencies of its trading partners fell from 100 to 78.2. This means that prices of U.S. goods and services compared with those of its trading partners increased by 27.9 percent (1.279 = 100/78.2), or, equivalently, that prices in the rest of the world compared with those in the United States fell by 21.8. After 2002, the real exchange rate increased and the dollar depreciated. Between 2002 and 2012, the real exchange rate increased from 78.2 to 100.3, a depreciation of 22.1 percent. Notice that during this depreciation, the trade deficit—and the current account deficit—fell, although the timing is off in that the reversal in the movement of the trade balance occurred after 2006, while the depreciation of the dollar occurred after 2002.
The Kehoe-Ruhl-Steinberg model
We use a dynamic, multisector, general equilibrium framework with two countries: the United States and the rest of the world. U.S. households work, consume and save to maximize their utility subject to the constraint that spending and saving equal income each year. Households can save or borrow by buying or selling bonds—claims on the next year’s U.S. CPI basket of goods and services—and claims on next year’s U.S. capital stock. U.S. firms that produce goods, services and construction purchase intermediate inputs from these same three sectors as well as inputs of capital and labor to maximize profits. Investment producers use only intermediate inputs. Investment output, combined with the U.S. capital stock that remains after depreciation, becomes the next year’s capital stock. The U.S. government earns income by taxing U.S. households and selling bonds.1 The government spends its income paying off maturing bonds and purchasing goods and services according to a spending rule.
We calibrate most of the parameters of the U.S. portion of the model using an approach similar to that taken by researchers who use static, multisector applied general equilibrium models to analyze the impact of trade liberalization. (See, for example, Kehoe and Kehoe 1994.) We require that the model’s households, firms and government carry out the same transactions in the base year of 1992—the last year in which the U.S. current account was close to balanced—as do their counterparts in the data. Most of these transactions are summarized in the input-output matrix in Table 1, which we have constructed using data from the U.S. Bureau of Economic Analysis (BEA). In this matrix, each entry specifies the expenditures on intermediate inputs or factors of production (rows) made by the model’s three industries and final uses (columns). For example, the entry of 848 in the labor row of the goods column indicates that the goods sector paid U.S. $848 billion in labor compensation to households in 1992, and the entry of 3,346 in the services row of the consumption column indicates that households consumed U.S. $3,346 billion in services. U.S. gross domestic product (GDP) in 1992 was U.S. $6,342 billion, which is equal to the sum of consumption, government spending, investment and exports minus imports, which also equals the sum of labor income and capital income.
Our disaggregation of production into three industries—goods, services and construction—is not the typical one in international macroeconomics. Services and construction are usually aggregated into an industry called nontradable goods, while goods are called tradable goods. The table clearly shows that services are in fact traded, although they are not traded as much as goods. The table also shows that the United States had a large surplus in services trade in 1992, while it had a large deficit in goods trade. The time series data in Figure 2 show that this pattern persists over time. Our model closely matches this pattern between 1992 and 2012.
We use the empirical literature to set the model’s remaining parameters, the elasticities that govern substitutability: how substitutable goods consumption is for services consumption in the household’s utility function, for example, or how substitutable inputs of labor are for inputs of capital in production. Two other parameters—one for goods and one for services—govern substitutability between imports and domestic output for final uses. We choose these elasticities to be consistent with the higher volatility in the goods trade balance seen in Figure 2; that is, we assume that foreign goods are more substitutable for U.S. goods than foreign services are for U.S. services. Nonetheless, foreign goods are still imperfectly substitutable for U.S. goods in our model. That condition is how we are able to model the saving glut as driving down the relative price of foreign goods and forcing the U.S. real exchange rate to appreciate.
Our model of the rest of the world is simpler than our model of the United States. Firms in the rest of the world produce goods and services using linear technologies with labor as the only input; we abstract from capital formation, domestic input-output linkages and construction. Households in the rest of the world work, consume and save to maximize utility, and have similar preferences to their U.S. counterparts: They enjoy leisure and regard imports of U.S. goods and services as substitutes for domestic ones, with the same elasticity of substitution as in the United States. Households in the rest of the world can save or borrow only by buying or selling U.S. bonds.
The rest of the world’s intertemporal decision-making generates the saving glut. For 1992–2012, we calibrate the weights that the rest of the world puts on utility for consumption and leisure in different years so that it chooses to lend exactly enough to the United States to generate the trade balance dynamics observed in the data. During this period, the rest of the world discounts the future less than U.S. households, which induces it to postpone current consumption to be able to consume more later. It does so by buying U.S. bonds. After 2012, the rest of the world’s discount factor gradually converges to that of U.S. households so that the world economy converges to a balanced growth path in which the interest rate is 3 percent per year.
We model the sudden stop in 2015–16 in the same manner as Kehoe and Ruhl (2009), who model the Mexican sudden stop of 1995–96 as a surprise. Agents in the model have perfect foresight before the sudden stop occurs and afterward, but if and when the sudden stop occurs, it is completely unexpected. During the sudden stop, the rest of the world buys no more bonds, but households and the government in the United States make interest payments on existing bonds at the 2014 interest rate. The U.S. interest rate during the sudden stop is determined within the United States since there is no foreign lending.
We model the sudden stop as a surprise because U.S. interest rates currently indicate that financial markets do not assign a significantly positive probability to a U.S. debt crisis—just as they did not assign significantly positive probabilities to a crisis in Mexico in 1995 to or to the currently ongoing debt crises in the eurozone. (See, for example, Arellano, Conesa and Kehoe 2012.) We think of the possibility of a debt crisis striking the United States as the possibility of the sort of self-fulfilling crisis modeled by Cole and Kehoe (2000) and Conesa and Kehoe (2012).
The model incorporates additional data that are important in generating the equilibrium’s dynamics. We use projections from the UN World Population Prospects to model population growth in the United States and the rest of the world. To allow the equilibrium to converge to a balanced growth path, we assume that the population in the United States and the rest of the world converge to constant levels after 2050. We model U.S. government spending and borrowing to evolve over time using projections from the Congressional Budget Office (CBO). We use data from 1992–2011 on value added by sector to calculate annual productivity growth rates of 4.6 percent in goods, 1.4 percent in services and −1.3 percent in construction. We impose these growth rates over 1992–2030 and let productivity growth in each sector converge to 2 percent in all sectors thereafter.
Dynamics of the U.S. trade balance
Our model of the saving glut is designed to capture the impact of government policies in the rest of the world that may have been responsible for the saving glut, such as Chinese policies that discouraged consumption and promoted saving, or policies that kept the Chinese real exchange rate from appreciating against the U.S. dollar. It can also be seen as capturing factors that make saving in the United States more attractive for foreigners than saving in their own countries. (See, for example, Mendoza, Quadrini and RÃos-Rull 2007.)
Notice, however, that, besides modeling U.S. government spending and borrowing during 1992–2012, we do not model U.S. government policies such as monetary policies or policies to promote mortgage borrowing that may have been responsible for the massive U.S. borrowing during this period. See Obstfeld and Rogoff (2009) and Bernanke et al. (2011) for discussions of these policies and their interaction with the saving glut. We later argue, however, that it is unlikely that global imbalances over the period 1992–2012 were driven by lack of saving in the United States. That would imply that U.S. investment was low when, in the data, investment was high throughout this period.
Our view is that the saving glut is a temporary, albeit lengthy, phenomenon and that discounting of the future in the rest of the world will eventually revert to a value consistent with balanced growth. Bernanke (2005) takes a similar perspective:
“[T]he underlying sources of the U.S. current account deficit appear to be medium-term or even long-term in nature, suggesting that the situation will eventually begin to improve, although a return to approximate balance may take some time. Fundamentally, I see no reason why the whole process should not proceed smoothly. However, the risk of a disorderly adjustment in financial markets always exists.”
In other words, the current account imbalances associated with the saving glut will end eventually. The only question is whether the rebalancing process will be gradual or sudden. Figure 3 reports the results of two experiments, one with gradual rebalancing and the other with a sudden stop in new foreign loans to the United States in 2015–16. As explained, the model has been calibrated so that it exactly matches the U.S. trade balance in 1992–2012. The model matches the actual behavior of the U.S. real exchange rate during 1992–2002. In the model, the depreciation of the U.S. real exchange rate starts after 2006, while in the data it starts after 2002.
The model also captures much of the sectoral reallocation of labor during the saving glut, at least until the 2008–09 recession: In the data, workers in the goods industry received 19.7 percent of total U.S. labor compensation in 1992. By 2007, this number had fallen to 13.3 percent. In the model, the labor compensation that goes to workers in the goods industry goes from 19.7 percent in 1992 to 14.7 percent in 2007, capturing 78 percent of the decline observed in the data.
In construction, workers received 4.4 percent of total labor compensation in 1992 data, rising to 5.6 percent in 2007, the peak of the construction boom. In the model, reallocation toward construction is actually larger, going from 4.4 percent of total labor compensation in 1992 to 6.8 percent in 2007. The model does relatively poorly in capturing the collapse of the construction boom during 2008–12.
The intuition for the model’s performance is simple: During the saving glut, foreigners buy more U.S. bonds and less U.S. goods and services. To finance these bond purchases, the rest of the world sells its goods to the United States, lowering the relative price of these goods. The lower relative price of foreign goods shows up in appreciation of the U.S. real exchange rate. Since foreign goods are more substitutable for U.S. goods than they are for U.S. services and construction, as U.S. households and the U.S. government buy more foreign goods, they buy less U.S. goods and more U.S. services and construction.
In an experiment with the model in which the saving glut does not occur, labor compensation in goods falls from 19.7 percent of total compensation in 1992 to 16.2 percent in 2007, indicating that 70 percent of the drop in labor compensation in the model—and 55 percent of the drop in the data—is due to faster growth in productivity in manufacturing rather than to imports of foreign goods.
Notice in Figure 3 that, if a sudden stop occurs, it would have a very disruptive impact on the U.S. economy, causing the exchange rate to depreciate rapidly and the trade balance to move rapidly into a substantial surplus. Figure 2 shows that much of the improvement in the U.S. trade balance would come from goods trade because U.S. services are not very substitutable for services in the rest of the world. In Figure 4, we see that the U.S. construction industry would crash and its labor would be reallocated to goods and services production. In the baseline model that we are discussing, this reallocation is modeled as costless. In alternative specifications of the model with adjustment costs, the sudden stop is far more costly, echoing concerns expressed by Bernanke (2005):
“To repay foreign creditors, as it must someday, the United States will need large and healthy export industries. The relative shrinkage in those industries in the presence of current account deficits—a shrinkage that may well have to be reversed in the future—imposes real costs of adjustment on firms and workers in those industries.”
What do we learn from the model, and what do we still need to study? As we can see in Figures 2, 3 and 4, our model captures four key features of the United States and its position in the world economy over 1992–2012: In the model, as in the data, the U.S. trade deficit first increases, then decreases; the U.S. real exchange rate first appreciates, then depreciates; the U.S. trade deficit is driven by a deficit in goods trade, with a steady U.S. surplus in service trade; and the fraction of U.S labor dedicated to producing goods falls throughout the period, with most of the drop due to higher productivity in goods than in services.
The performance of the model over 1992–2012 gives us some confidence in the predictions of the model for the future. The model predicts than the U.S. real exchange rate will depreciate as U.S households and government begin to repay the rest of the world. Much of the U.S. trade surplus will be in services trade and, if productivity in goods continues to grow faster than that in services, as it did over 1992–2012, employment in goods, particularly in manufacturing, is unlikely to ever return to its level in 1992.
These changes will occur whether the stop in foreign lending is sudden or gradual. A sudden stop in foreign lending, however, would be very disruptive to the U.S. economy. Construction, unlike goods and services, is completely nontradable, so it would absorb much of the shock of a sudden real exchange rate depreciation. During a sudden stop, the U.S. real interest rate would jump from 2.9 percent in 2014 to 5.5 percent in 2015. A sudden stop would cause a sharp contraction in output and employment in construction, more severe than the collapse of the U.S. housing boom in 2008–12.
A sudden stop would also change the welfare analysis of the global imbalances over the period 1992–2012. Twenty years of inexpensive foreign goods, as well as the credit with which to purchase these goods, has made U.S. households better off. We can calculate the increase in real income of U.S. households generated by the saving glut as being 1992 U.S. $689 billion, 10.9 percent of 1992 U.S. GDP.
If the saving glut were to end in a disorderly sudden stop, where productivity falls as it did in Mexico in 1994–95, however, these welfare gains would be lost and, in fact, U.S. households would suffer a real income loss of 1992 U.S. $330 billion, 5.2 percent of 1992 U.S. GDP, compared with a scenario in which the saving glut had never occurred. These calculations come from a model in which the costs of the sudden stop come from its surprise nature and from the drop in productivity; with adjustment frictions, the losses in real income would be larger.
Our results leave a couple of puzzles that suggest directions for future research. In our model, the saving glut has only a small effect on U.S. interest rates, as seen in Figure 5, in contrast to Bernanke’s (2005) judgment. The largest fall the U.S. real interest rate in the model with the saving glut over 1992–2012 compared with the model with no saving glut is 46 basis points (3.70 percent per year compared with 3.24 percent) in 2009. This is in line with Greenspan’s (2005) judgment that foreign lending accounted for less than 50 basis points of the drop in interest rates. Warnock and Warnock (2009) have estimated that foreign lending drove down U.S. real interest rates by a somewhat larger amount, about 80 basis points, throughout the period.
In our model, the impact of the saving glut on interest rates depends on how substitutable foreign goods are for U.S. goods. With the elasticity of substitution parameter that we have chosen, we see that the saving glut generates the right magnitude of appreciation of the U.S. real exchange rate in Figure 3, but not the right magnitude in the drop in the U.S. real interest rate in Figure 5. If we make foreign goods more substitutable for U.S. goods, we can generate more of a drop in the U.S. real interest rate in the period 2006–12—although still nowhere near as large a drop as observed in the data—but the model would then predict a much smaller appreciation in the U.S. real exchange rate.
It is worth noting that our model predicts that the U.S. interest rate is driven up by appreciation of the dollar and is driven down by depreciation. The falling prices of foreign goods during the period 1993–2006 induce U.S. households to increase consumption faster than they do in the model without a saving glut, generating the observed trade deficit. U.S. households are willing to do this only if interest rates are higher. As the dollar depreciates during the period 2006–12, consumption grows more slowly than in the model with no saving glut and interest rates are lower.
Since our model does not provide a convincing explanation for the very low U.S. interest rates seen in the data, we need to look elsewhere, possibly at the sorts of U.S. policies discussed by Obstfeld and Rogoff (2009) and Bernanke et al. (2011).
Modeling the source of the global imbalances over the period 1992–2012 as being generated by saving behavior in the United States, however, does not work well. We have followed Bernanke (2005) in modeling a saving glut driven by forces in the rest of the world. Alternatively, we could have modeled a saving drought in the United States in which U.S. households discount the future more than foreign households. Such a U.S. saving drought would generate the sort of increase in the trade deficit, real exchange rate appreciation and movement of labor out of U.S. goods production as the foreign saving-glut model.
This alternative model would generate very different results for U.S. investment during the period of global imbalances, however, as seen in Figure 6. In the data, the correlation between changes in the U.S. trade deficit and changes in U.S. investment is −0.79. In other words, U.S. investment increased as U.S. borrowing from the rest of the world increased. The foreign saving-glut model—where households in the rest of the world increase their saving—captures this relationship, and the correlation between changes in the trade deficit and changes in investment is −0.81.
The U.S. saving-drought model—where U.S. households decrease their savings—gets this relationship wrong, and the correlation between changes in the trade deficit and changes in investment is 0.82. The data indicate that the period of global imbalances was a period of increased investment worldwide—or consistent with the foreign saving-glut model, and not with the U.S. saving-drought model.
Although the model with a U.S. saving drought is successful in generating lower U.S. interest rates during the period 1992–2006, as the dollar appreciates, it generates higher U.S. interest rates during the period 2006–12, as the dollar depreciates. The low interest rates during the entire period thus pose a puzzle for both the foreign saving-glut and U.S. saving-drought models.
As we have mentioned, the timing of the depreciation of the U.S. real exchange rate is off in our model. It may be that the same factors that are missing from the model in capturing the low U.S. interest rates would also explain the U.S. continuing to borrow even as the real exchange rate depreciated. Disaggregating the U.S. real exchange rate suggests a simpler explanation, however: Figure 7 graphs the U.S.-China real exchange rate and the average U.S. real exchange rate against its other major trading partners. Notice that, starting in about 2001, as China became more important in trade with the United States, the real exchange rate in the model looks more like the U.S.-China real exchange rate. This suggests that we should explore models that consider countries like China, Korea and Japan—which are the principle lenders to the United States—separately from other U.S. trading partners.
We have performed extensive sensitivity analysis on the model. Our main results are robust to allowing agents to be uncertain about how long the saving glut would last. They are also robust to eliminating government borrowing and making government spending a constant portion of U.S. GDP.
Our result that the long-term impact of the saving glut on the U.S. economy does not depend on how the saving glut ends does not say that the saving glut itself has not had a long-term impact. Figure 8 shows how large the long-term impact has been. The United States will have to run a substantial trade surplus in the future to repay its debt to foreign lenders. The purchasing power of the U.S. dollar—as measured by the reciprocal of the real exchange rate—will be lower. Output and employment in goods will be higher.
What should policymakers do? Our results indicate that U.S. households have benefited from two decades of low prices of foreign goods, but that these welfare gains could be erased by a disorderly sudden stop in foreign lending. Policymakers should be vigilant to ensure that a sudden stop does not take the U.S. financial sector by surprise, as it was by the collapse of the U.S. housing market during the 2008–09 recession.
The need for prudential regulation in the U.S. financial system to prevent a sudden stop in foreign lending from becoming disorderly might seem to imply the need for capital controls. Recently, the debt crises in the eurozone have generated a renewal of interest in capital controls, especially in taxes on purchases and/or sales of assets by foreigners. See, for example, Farhi and Werning (2012) and Benigno et al. (2013).
The United States is in a unique position as the provider of the world’s reserve currency, however, and any attempt to impose capital controls on purchases or sales of U.S. assets—especially of U.S. government bonds—would push foreign governments to another currency, or currencies, for reserves. Indeed, much of the holdings of U.S. assets by the Chinese, Japanese and Koreans are in the form of U.S. government bonds. Since the United States enjoys substantial economic benefits from providing the world’s reserve currency, it is very unlikely, and probably undesirable, for U.S. policymakers to consider capital controls as one of the prudential regulations to guard against a disorderly sudden stop.
Note * The authors thank David Backus, Kei-Mu Yi and Frank Warnock for helpful discussions. Participants at seminars and conferences made useful comments and suggestions. The authors are grateful to Jack Rossbach for extraordinary research assistance. The data presented in the figures are available here. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.
Endnote 1 We model households as paying taxes on capital income to be able to calibrate the model. Otherwise, we combine all the taxes and government transfers in the data into a simple tax that subtracts from household income in that year and does not depend on household decisions, a lump-sum tax. It would be useful to extend our analysis to capture the richness of the U.S. fiscal system, with distortionary taxes on labor, consumption, production and imports.
References
C. Arellano, J. C. Conesa and T. J. Kehoe (2012), “Chronic Sovereign Debt Crises in the Eurozone, 2010–2012,” Federal Reserve Bank of Minneapolis Economic Policy Paper 12-4. G. Benigno, H. Chen, C. Otrok, A. Rebucci and E. R. Young (2013), “Capital Controls or Real Exchange Rate Policy? A Pecuniary Externality Perspective,” Inter-American Development Bank Working Paper IDB-WP-393. B. S. Bernanke (2005), “The Global Saving Glut and the U.S. Current Account Deficit,” speech delivered at the Sandridge Lecture, Virginia Association of Economists, Richmond, VA, March 10. B. S. Bernanke, C. Bertaut, L. P. DeMarco and S. Kamin (2011), “International Capital Flows and the Returns to Safe Assets in the United States, 2003-2007,” Board of Governors of the Federal Reserve System, International Finance Discussion Paper 1014. H. L. Cole and T. J. Kehoe (2000), “Self-Fulfilling Debt Crises,” Review of Economic Studies, 67, 91–116. J. C. Conesa and T. J. Kehoe (2012), “Gambling for Redemption and Self-Fulfilling Debt Crises,” Federal Reserve Bank of Minneapolis Staff Report 465. E. Farhi and I. Werning (2012), “Dealing with the Trilemma: Optimal Capital Controls with Fixed Exchange Rates,” NBER Working Paper 18199. A. Greenspan (2005), “Monetary Policy Report to the Congress,” statement before the Committee on Banking, Housing and Urban Affairs, U.S. Senate, February 16. P. J. Kehoe and T. J. Kehoe (1994), “A Primer on Static Applied General Equilibrium Models,” Federal Reserve Bank of Minneapolis Quarterly Review, 18:2, 2–16. T. J. Kehoe and K. J. Ruhl (2009), “Sudden Stops, Sectoral Reallocations and the Real Exchange Rate,” Journal of Development Economics, 89, 235–249. T. J. Kehoe, K. J. Ruhl and Joseph B. Steinberg (2013), “Global Imbalances and Structural Change in the United States,” Federal Reserve Bank of Minneapolis Staff Report 489. E. G. Mendoza, V. Quadrini and J.-V. RÃos-Rull (2007), “Financial Integration, Financial Deepness and Global Imbalances,” NBER Working Paper 12909. M. Obstfeld and K. Rogoff (2009), “Global Imbalances and the Financial Crisis: Products of Common Causes,” CEPR Discussion Paper 7606. F. E. Warnock and V. C. Warnock (2009), “International Capital Flows and U.S. Interest Rates,” Journal of International Money and Finance, 28: 903–919.
Modeling U.S. borrowing as the result of what Bernanke (2005) calls a global saving glut—where foreigners sell goods and services to the United States but prefer purchasing U.S. assets to purchasing U.S. goods and services—we capture four key features of the United States and its position in the world economy over 1992–2012. In the model, as in the data: (1) the U.S. trade deficit first increases, then decreases; (2) the U.S. real exchange rate first appreciates, then depreciates; (3) the U.S. trade deficit is driven by a deficit in goods trade, with a steady U.S. surplus in service trade; and (4) the fraction of U.S labor dedicated to producing goods—agriculture, mining and manufacturing—falls throughout the period.
Using this model, we analyze two possible ends to the saving glut: an orderly, gradual rebalancing and a disorderly, sudden stop in foreign lending as occurred in Mexico in 1995–96. We find that a sudden stop would be very disruptive for the U.S. economy in the short term, particularly for the construction industry.
In the long term, however, a sudden stop would have a surprisingly small impact. As the U.S. trade deficit becomes a surplus, gradually or suddenly, employment in goods production will not return to its level in the early 1990s because much of this surplus will be trade in services and because much of the decline in employment in goods production has been, and will be, due to faster productivity growth in goods than in services.
The global saving glut
From 1992 to 2012, households and the government in the United States borrowed heavily from the rest of the world. As U.S. borrowing—measured as the current account deficit—grew, the U.S. net international investment position deteriorated by $4 trillion, and, by 2012, the United States owed the rest of the world $4.4 trillion. In this paper, we use a model developed by the authors (Kehoe, Ruhl and Steinberg 2013) that captures this increase in borrowing to study the different ways in which the United States can reverse its current account deficit and begin to pay down its accumulated debt. Our hypothesis for the driving force behind the United States’ borrowing is the global-saving-glut theory proposed by Ben Bernanke. In a March 2005 address, Bernanke (2005) asked,
“Why is the United States, with the world’s largest economy, borrowing heavily on international capital markets—rather than lending, as would seem more natural? … [O]ver the past decade a combination of diverse forces has created a significant increase in the global supply of saving—a global saving glut—which helps to explain both the increase in the U.S. current account deficit and the relatively low level of long-term real interest rates in the world today.”
The essence of the global-saving-glut theory is that increased saving in the rest of the world, primarily in China, resulted in foreigners purchasing U.S. assets rather than U.S. exports. As foreigners sold goods and services to the United States to finance these asset purchases, the price of these goods and services compared to those in the United States fell.
The balance-of-payments identity says that payments by U.S. residents to rest of the world (ROW) must equal payments by the rest of the world to U.S. residents:
ROW purchases of U.S. exports + ROW factor payments and transfers to U.S. + ROW purchases of U.S. assets = U.S. purchases of ROW exports + U.S. factor payments and transfers to ROW + U.S. purchases of ROW assets.
This equation is an identity because accounting conventions make it hold at all times: An excess of payments made by the rest of the world over payments made by U.S. residents, for example, is counted as purchases of assets in the rest of the world by U.S. residents, that is, U.S. residents borrowing from foreigners. We can rearrange this identity as
(ROW purchases of U.S. exports − U.S. purchases of ROW exports) + (ROW factor payments and transfers to U.S. − U.S. factor payments and transfers to ROW) = (U.S. purchases of ROW assets − ROW purchases of U.S. assets),
which says that the U.S. trade balance plus net factor payments and transfers from the rest of the world are equal to net U.S. asset accumulation in the rest of the world. The sum of the trade balance plus net factor payments and transfers from the rest of the world is referred to as the current account balance, which is also equal to net U.S. accumulation of foreign assets. The data in Figure 1 show that the U.S. current account balance is approximately equal to the U.S. trade balance because net factor payments and transfers from the rest of the world are small. Consequently, the balance-of-payments identity says that the trade deficit is approximately equal to foreign accumulation of U.S. assets.
Figure 1 also presents data on prices in the United States relative to those in the rest of the world, the real exchange rate between the U.S. dollar and a weighted geometric average of the currencies of its 20 most important trading partners. The real exchange rate between the U.S. dollar and the Chinese renminbi, whose principal unit is the yuan, for example, is
U.S.-China real exchange rate = U.S.-China nominal exchange rate x (Chinese CPI ÷ U.S. CPI),
where we measure the price level in each country using its consumer price index (CPI). To understand this real exchange rate, consider the units in which it is measured:
(dollars÷yuan) x ((yuan÷Chinese consumption basket) ÷ (dollars÷U.S. consumption basket)) = U.S. consumption basket ÷ Chinese consumption basket.
As the real exchange rate falls, fewer U.S. consumption baskets trade for one Chinese consumption basket, and the dollar appreciates.
Between 1992 and 2002, the real exchange rate between the U.S. dollar and the weighted sum of the currencies of its trading partners fell from 100 to 78.2. This means that prices of U.S. goods and services compared with those of its trading partners increased by 27.9 percent (1.279 = 100/78.2), or, equivalently, that prices in the rest of the world compared with those in the United States fell by 21.8. After 2002, the real exchange rate increased and the dollar depreciated. Between 2002 and 2012, the real exchange rate increased from 78.2 to 100.3, a depreciation of 22.1 percent. Notice that during this depreciation, the trade deficit—and the current account deficit—fell, although the timing is off in that the reversal in the movement of the trade balance occurred after 2006, while the depreciation of the dollar occurred after 2002.
The Kehoe-Ruhl-Steinberg model
We use a dynamic, multisector, general equilibrium framework with two countries: the United States and the rest of the world. U.S. households work, consume and save to maximize their utility subject to the constraint that spending and saving equal income each year. Households can save or borrow by buying or selling bonds—claims on the next year’s U.S. CPI basket of goods and services—and claims on next year’s U.S. capital stock. U.S. firms that produce goods, services and construction purchase intermediate inputs from these same three sectors as well as inputs of capital and labor to maximize profits. Investment producers use only intermediate inputs. Investment output, combined with the U.S. capital stock that remains after depreciation, becomes the next year’s capital stock. The U.S. government earns income by taxing U.S. households and selling bonds.1 The government spends its income paying off maturing bonds and purchasing goods and services according to a spending rule.
We calibrate most of the parameters of the U.S. portion of the model using an approach similar to that taken by researchers who use static, multisector applied general equilibrium models to analyze the impact of trade liberalization. (See, for example, Kehoe and Kehoe 1994.) We require that the model’s households, firms and government carry out the same transactions in the base year of 1992—the last year in which the U.S. current account was close to balanced—as do their counterparts in the data. Most of these transactions are summarized in the input-output matrix in Table 1, which we have constructed using data from the U.S. Bureau of Economic Analysis (BEA). In this matrix, each entry specifies the expenditures on intermediate inputs or factors of production (rows) made by the model’s three industries and final uses (columns). For example, the entry of 848 in the labor row of the goods column indicates that the goods sector paid U.S. $848 billion in labor compensation to households in 1992, and the entry of 3,346 in the services row of the consumption column indicates that households consumed U.S. $3,346 billion in services. U.S. gross domestic product (GDP) in 1992 was U.S. $6,342 billion, which is equal to the sum of consumption, government spending, investment and exports minus imports, which also equals the sum of labor income and capital income.
Our disaggregation of production into three industries—goods, services and construction—is not the typical one in international macroeconomics. Services and construction are usually aggregated into an industry called nontradable goods, while goods are called tradable goods. The table clearly shows that services are in fact traded, although they are not traded as much as goods. The table also shows that the United States had a large surplus in services trade in 1992, while it had a large deficit in goods trade. The time series data in Figure 2 show that this pattern persists over time. Our model closely matches this pattern between 1992 and 2012.
We use the empirical literature to set the model’s remaining parameters, the elasticities that govern substitutability: how substitutable goods consumption is for services consumption in the household’s utility function, for example, or how substitutable inputs of labor are for inputs of capital in production. Two other parameters—one for goods and one for services—govern substitutability between imports and domestic output for final uses. We choose these elasticities to be consistent with the higher volatility in the goods trade balance seen in Figure 2; that is, we assume that foreign goods are more substitutable for U.S. goods than foreign services are for U.S. services. Nonetheless, foreign goods are still imperfectly substitutable for U.S. goods in our model. That condition is how we are able to model the saving glut as driving down the relative price of foreign goods and forcing the U.S. real exchange rate to appreciate.
Our model of the rest of the world is simpler than our model of the United States. Firms in the rest of the world produce goods and services using linear technologies with labor as the only input; we abstract from capital formation, domestic input-output linkages and construction. Households in the rest of the world work, consume and save to maximize utility, and have similar preferences to their U.S. counterparts: They enjoy leisure and regard imports of U.S. goods and services as substitutes for domestic ones, with the same elasticity of substitution as in the United States. Households in the rest of the world can save or borrow only by buying or selling U.S. bonds.
The rest of the world’s intertemporal decision-making generates the saving glut. For 1992–2012, we calibrate the weights that the rest of the world puts on utility for consumption and leisure in different years so that it chooses to lend exactly enough to the United States to generate the trade balance dynamics observed in the data. During this period, the rest of the world discounts the future less than U.S. households, which induces it to postpone current consumption to be able to consume more later. It does so by buying U.S. bonds. After 2012, the rest of the world’s discount factor gradually converges to that of U.S. households so that the world economy converges to a balanced growth path in which the interest rate is 3 percent per year.
We model the sudden stop in 2015–16 in the same manner as Kehoe and Ruhl (2009), who model the Mexican sudden stop of 1995–96 as a surprise. Agents in the model have perfect foresight before the sudden stop occurs and afterward, but if and when the sudden stop occurs, it is completely unexpected. During the sudden stop, the rest of the world buys no more bonds, but households and the government in the United States make interest payments on existing bonds at the 2014 interest rate. The U.S. interest rate during the sudden stop is determined within the United States since there is no foreign lending.
We model the sudden stop as a surprise because U.S. interest rates currently indicate that financial markets do not assign a significantly positive probability to a U.S. debt crisis—just as they did not assign significantly positive probabilities to a crisis in Mexico in 1995 to or to the currently ongoing debt crises in the eurozone. (See, for example, Arellano, Conesa and Kehoe 2012.) We think of the possibility of a debt crisis striking the United States as the possibility of the sort of self-fulfilling crisis modeled by Cole and Kehoe (2000) and Conesa and Kehoe (2012).
The model incorporates additional data that are important in generating the equilibrium’s dynamics. We use projections from the UN World Population Prospects to model population growth in the United States and the rest of the world. To allow the equilibrium to converge to a balanced growth path, we assume that the population in the United States and the rest of the world converge to constant levels after 2050. We model U.S. government spending and borrowing to evolve over time using projections from the Congressional Budget Office (CBO). We use data from 1992–2011 on value added by sector to calculate annual productivity growth rates of 4.6 percent in goods, 1.4 percent in services and −1.3 percent in construction. We impose these growth rates over 1992–2030 and let productivity growth in each sector converge to 2 percent in all sectors thereafter.
Dynamics of the U.S. trade balance
Our model of the saving glut is designed to capture the impact of government policies in the rest of the world that may have been responsible for the saving glut, such as Chinese policies that discouraged consumption and promoted saving, or policies that kept the Chinese real exchange rate from appreciating against the U.S. dollar. It can also be seen as capturing factors that make saving in the United States more attractive for foreigners than saving in their own countries. (See, for example, Mendoza, Quadrini and RÃos-Rull 2007.)
Notice, however, that, besides modeling U.S. government spending and borrowing during 1992–2012, we do not model U.S. government policies such as monetary policies or policies to promote mortgage borrowing that may have been responsible for the massive U.S. borrowing during this period. See Obstfeld and Rogoff (2009) and Bernanke et al. (2011) for discussions of these policies and their interaction with the saving glut. We later argue, however, that it is unlikely that global imbalances over the period 1992–2012 were driven by lack of saving in the United States. That would imply that U.S. investment was low when, in the data, investment was high throughout this period.
Our view is that the saving glut is a temporary, albeit lengthy, phenomenon and that discounting of the future in the rest of the world will eventually revert to a value consistent with balanced growth. Bernanke (2005) takes a similar perspective:
“[T]he underlying sources of the U.S. current account deficit appear to be medium-term or even long-term in nature, suggesting that the situation will eventually begin to improve, although a return to approximate balance may take some time. Fundamentally, I see no reason why the whole process should not proceed smoothly. However, the risk of a disorderly adjustment in financial markets always exists.”
In other words, the current account imbalances associated with the saving glut will end eventually. The only question is whether the rebalancing process will be gradual or sudden. Figure 3 reports the results of two experiments, one with gradual rebalancing and the other with a sudden stop in new foreign loans to the United States in 2015–16. As explained, the model has been calibrated so that it exactly matches the U.S. trade balance in 1992–2012. The model matches the actual behavior of the U.S. real exchange rate during 1992–2002. In the model, the depreciation of the U.S. real exchange rate starts after 2006, while in the data it starts after 2002.
The model also captures much of the sectoral reallocation of labor during the saving glut, at least until the 2008–09 recession: In the data, workers in the goods industry received 19.7 percent of total U.S. labor compensation in 1992. By 2007, this number had fallen to 13.3 percent. In the model, the labor compensation that goes to workers in the goods industry goes from 19.7 percent in 1992 to 14.7 percent in 2007, capturing 78 percent of the decline observed in the data.
In construction, workers received 4.4 percent of total labor compensation in 1992 data, rising to 5.6 percent in 2007, the peak of the construction boom. In the model, reallocation toward construction is actually larger, going from 4.4 percent of total labor compensation in 1992 to 6.8 percent in 2007. The model does relatively poorly in capturing the collapse of the construction boom during 2008–12.
The intuition for the model’s performance is simple: During the saving glut, foreigners buy more U.S. bonds and less U.S. goods and services. To finance these bond purchases, the rest of the world sells its goods to the United States, lowering the relative price of these goods. The lower relative price of foreign goods shows up in appreciation of the U.S. real exchange rate. Since foreign goods are more substitutable for U.S. goods than they are for U.S. services and construction, as U.S. households and the U.S. government buy more foreign goods, they buy less U.S. goods and more U.S. services and construction.
In an experiment with the model in which the saving glut does not occur, labor compensation in goods falls from 19.7 percent of total compensation in 1992 to 16.2 percent in 2007, indicating that 70 percent of the drop in labor compensation in the model—and 55 percent of the drop in the data—is due to faster growth in productivity in manufacturing rather than to imports of foreign goods.
Notice in Figure 3 that, if a sudden stop occurs, it would have a very disruptive impact on the U.S. economy, causing the exchange rate to depreciate rapidly and the trade balance to move rapidly into a substantial surplus. Figure 2 shows that much of the improvement in the U.S. trade balance would come from goods trade because U.S. services are not very substitutable for services in the rest of the world. In Figure 4, we see that the U.S. construction industry would crash and its labor would be reallocated to goods and services production. In the baseline model that we are discussing, this reallocation is modeled as costless. In alternative specifications of the model with adjustment costs, the sudden stop is far more costly, echoing concerns expressed by Bernanke (2005):
“To repay foreign creditors, as it must someday, the United States will need large and healthy export industries. The relative shrinkage in those industries in the presence of current account deficits—a shrinkage that may well have to be reversed in the future—imposes real costs of adjustment on firms and workers in those industries.”
What do we learn from the model, and what do we still need to study? As we can see in Figures 2, 3 and 4, our model captures four key features of the United States and its position in the world economy over 1992–2012: In the model, as in the data, the U.S. trade deficit first increases, then decreases; the U.S. real exchange rate first appreciates, then depreciates; the U.S. trade deficit is driven by a deficit in goods trade, with a steady U.S. surplus in service trade; and the fraction of U.S labor dedicated to producing goods falls throughout the period, with most of the drop due to higher productivity in goods than in services.
The performance of the model over 1992–2012 gives us some confidence in the predictions of the model for the future. The model predicts than the U.S. real exchange rate will depreciate as U.S households and government begin to repay the rest of the world. Much of the U.S. trade surplus will be in services trade and, if productivity in goods continues to grow faster than that in services, as it did over 1992–2012, employment in goods, particularly in manufacturing, is unlikely to ever return to its level in 1992.
These changes will occur whether the stop in foreign lending is sudden or gradual. A sudden stop in foreign lending, however, would be very disruptive to the U.S. economy. Construction, unlike goods and services, is completely nontradable, so it would absorb much of the shock of a sudden real exchange rate depreciation. During a sudden stop, the U.S. real interest rate would jump from 2.9 percent in 2014 to 5.5 percent in 2015. A sudden stop would cause a sharp contraction in output and employment in construction, more severe than the collapse of the U.S. housing boom in 2008–12.
A sudden stop would also change the welfare analysis of the global imbalances over the period 1992–2012. Twenty years of inexpensive foreign goods, as well as the credit with which to purchase these goods, has made U.S. households better off. We can calculate the increase in real income of U.S. households generated by the saving glut as being 1992 U.S. $689 billion, 10.9 percent of 1992 U.S. GDP.
If the saving glut were to end in a disorderly sudden stop, where productivity falls as it did in Mexico in 1994–95, however, these welfare gains would be lost and, in fact, U.S. households would suffer a real income loss of 1992 U.S. $330 billion, 5.2 percent of 1992 U.S. GDP, compared with a scenario in which the saving glut had never occurred. These calculations come from a model in which the costs of the sudden stop come from its surprise nature and from the drop in productivity; with adjustment frictions, the losses in real income would be larger.
Our results leave a couple of puzzles that suggest directions for future research. In our model, the saving glut has only a small effect on U.S. interest rates, as seen in Figure 5, in contrast to Bernanke’s (2005) judgment. The largest fall the U.S. real interest rate in the model with the saving glut over 1992–2012 compared with the model with no saving glut is 46 basis points (3.70 percent per year compared with 3.24 percent) in 2009. This is in line with Greenspan’s (2005) judgment that foreign lending accounted for less than 50 basis points of the drop in interest rates. Warnock and Warnock (2009) have estimated that foreign lending drove down U.S. real interest rates by a somewhat larger amount, about 80 basis points, throughout the period.
In our model, the impact of the saving glut on interest rates depends on how substitutable foreign goods are for U.S. goods. With the elasticity of substitution parameter that we have chosen, we see that the saving glut generates the right magnitude of appreciation of the U.S. real exchange rate in Figure 3, but not the right magnitude in the drop in the U.S. real interest rate in Figure 5. If we make foreign goods more substitutable for U.S. goods, we can generate more of a drop in the U.S. real interest rate in the period 2006–12—although still nowhere near as large a drop as observed in the data—but the model would then predict a much smaller appreciation in the U.S. real exchange rate.
It is worth noting that our model predicts that the U.S. interest rate is driven up by appreciation of the dollar and is driven down by depreciation. The falling prices of foreign goods during the period 1993–2006 induce U.S. households to increase consumption faster than they do in the model without a saving glut, generating the observed trade deficit. U.S. households are willing to do this only if interest rates are higher. As the dollar depreciates during the period 2006–12, consumption grows more slowly than in the model with no saving glut and interest rates are lower.
Since our model does not provide a convincing explanation for the very low U.S. interest rates seen in the data, we need to look elsewhere, possibly at the sorts of U.S. policies discussed by Obstfeld and Rogoff (2009) and Bernanke et al. (2011).
Modeling the source of the global imbalances over the period 1992–2012 as being generated by saving behavior in the United States, however, does not work well. We have followed Bernanke (2005) in modeling a saving glut driven by forces in the rest of the world. Alternatively, we could have modeled a saving drought in the United States in which U.S. households discount the future more than foreign households. Such a U.S. saving drought would generate the sort of increase in the trade deficit, real exchange rate appreciation and movement of labor out of U.S. goods production as the foreign saving-glut model.
This alternative model would generate very different results for U.S. investment during the period of global imbalances, however, as seen in Figure 6. In the data, the correlation between changes in the U.S. trade deficit and changes in U.S. investment is −0.79. In other words, U.S. investment increased as U.S. borrowing from the rest of the world increased. The foreign saving-glut model—where households in the rest of the world increase their saving—captures this relationship, and the correlation between changes in the trade deficit and changes in investment is −0.81.
The U.S. saving-drought model—where U.S. households decrease their savings—gets this relationship wrong, and the correlation between changes in the trade deficit and changes in investment is 0.82. The data indicate that the period of global imbalances was a period of increased investment worldwide—or consistent with the foreign saving-glut model, and not with the U.S. saving-drought model.
Although the model with a U.S. saving drought is successful in generating lower U.S. interest rates during the period 1992–2006, as the dollar appreciates, it generates higher U.S. interest rates during the period 2006–12, as the dollar depreciates. The low interest rates during the entire period thus pose a puzzle for both the foreign saving-glut and U.S. saving-drought models.
As we have mentioned, the timing of the depreciation of the U.S. real exchange rate is off in our model. It may be that the same factors that are missing from the model in capturing the low U.S. interest rates would also explain the U.S. continuing to borrow even as the real exchange rate depreciated. Disaggregating the U.S. real exchange rate suggests a simpler explanation, however: Figure 7 graphs the U.S.-China real exchange rate and the average U.S. real exchange rate against its other major trading partners. Notice that, starting in about 2001, as China became more important in trade with the United States, the real exchange rate in the model looks more like the U.S.-China real exchange rate. This suggests that we should explore models that consider countries like China, Korea and Japan—which are the principle lenders to the United States—separately from other U.S. trading partners.
We have performed extensive sensitivity analysis on the model. Our main results are robust to allowing agents to be uncertain about how long the saving glut would last. They are also robust to eliminating government borrowing and making government spending a constant portion of U.S. GDP.
Our result that the long-term impact of the saving glut on the U.S. economy does not depend on how the saving glut ends does not say that the saving glut itself has not had a long-term impact. Figure 8 shows how large the long-term impact has been. The United States will have to run a substantial trade surplus in the future to repay its debt to foreign lenders. The purchasing power of the U.S. dollar—as measured by the reciprocal of the real exchange rate—will be lower. Output and employment in goods will be higher.
What should policymakers do? Our results indicate that U.S. households have benefited from two decades of low prices of foreign goods, but that these welfare gains could be erased by a disorderly sudden stop in foreign lending. Policymakers should be vigilant to ensure that a sudden stop does not take the U.S. financial sector by surprise, as it was by the collapse of the U.S. housing market during the 2008–09 recession.
The need for prudential regulation in the U.S. financial system to prevent a sudden stop in foreign lending from becoming disorderly might seem to imply the need for capital controls. Recently, the debt crises in the eurozone have generated a renewal of interest in capital controls, especially in taxes on purchases and/or sales of assets by foreigners. See, for example, Farhi and Werning (2012) and Benigno et al. (2013).
The United States is in a unique position as the provider of the world’s reserve currency, however, and any attempt to impose capital controls on purchases or sales of U.S. assets—especially of U.S. government bonds—would push foreign governments to another currency, or currencies, for reserves. Indeed, much of the holdings of U.S. assets by the Chinese, Japanese and Koreans are in the form of U.S. government bonds. Since the United States enjoys substantial economic benefits from providing the world’s reserve currency, it is very unlikely, and probably undesirable, for U.S. policymakers to consider capital controls as one of the prudential regulations to guard against a disorderly sudden stop.
Note * The authors thank David Backus, Kei-Mu Yi and Frank Warnock for helpful discussions. Participants at seminars and conferences made useful comments and suggestions. The authors are grateful to Jack Rossbach for extraordinary research assistance. The data presented in the figures are available here. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.
Endnote 1 We model households as paying taxes on capital income to be able to calibrate the model. Otherwise, we combine all the taxes and government transfers in the data into a simple tax that subtracts from household income in that year and does not depend on household decisions, a lump-sum tax. It would be useful to extend our analysis to capture the richness of the U.S. fiscal system, with distortionary taxes on labor, consumption, production and imports.
References
C. Arellano, J. C. Conesa and T. J. Kehoe (2012), “Chronic Sovereign Debt Crises in the Eurozone, 2010–2012,” Federal Reserve Bank of Minneapolis Economic Policy Paper 12-4. G. Benigno, H. Chen, C. Otrok, A. Rebucci and E. R. Young (2013), “Capital Controls or Real Exchange Rate Policy? A Pecuniary Externality Perspective,” Inter-American Development Bank Working Paper IDB-WP-393. B. S. Bernanke (2005), “The Global Saving Glut and the U.S. Current Account Deficit,” speech delivered at the Sandridge Lecture, Virginia Association of Economists, Richmond, VA, March 10. B. S. Bernanke, C. Bertaut, L. P. DeMarco and S. Kamin (2011), “International Capital Flows and the Returns to Safe Assets in the United States, 2003-2007,” Board of Governors of the Federal Reserve System, International Finance Discussion Paper 1014. H. L. Cole and T. J. Kehoe (2000), “Self-Fulfilling Debt Crises,” Review of Economic Studies, 67, 91–116. J. C. Conesa and T. J. Kehoe (2012), “Gambling for Redemption and Self-Fulfilling Debt Crises,” Federal Reserve Bank of Minneapolis Staff Report 465. E. Farhi and I. Werning (2012), “Dealing with the Trilemma: Optimal Capital Controls with Fixed Exchange Rates,” NBER Working Paper 18199. A. Greenspan (2005), “Monetary Policy Report to the Congress,” statement before the Committee on Banking, Housing and Urban Affairs, U.S. Senate, February 16. P. J. Kehoe and T. J. Kehoe (1994), “A Primer on Static Applied General Equilibrium Models,” Federal Reserve Bank of Minneapolis Quarterly Review, 18:2, 2–16. T. J. Kehoe and K. J. Ruhl (2009), “Sudden Stops, Sectoral Reallocations and the Real Exchange Rate,” Journal of Development Economics, 89, 235–249. T. J. Kehoe, K. J. Ruhl and Joseph B. Steinberg (2013), “Global Imbalances and Structural Change in the United States,” Federal Reserve Bank of Minneapolis Staff Report 489. E. G. Mendoza, V. Quadrini and J.-V. RÃos-Rull (2007), “Financial Integration, Financial Deepness and Global Imbalances,” NBER Working Paper 12909. M. Obstfeld and K. Rogoff (2009), “Global Imbalances and the Financial Crisis: Products of Common Causes,” CEPR Discussion Paper 7606. F. E. Warnock and V. C. Warnock (2009), “International Capital Flows and U.S. Interest Rates,” Journal of International Money and Finance, 28: 903–919.
Sunday, April 06, 2025
Tuesday, April 01, 2025
Kerala's Growth Story
How Kerala got richFifty years ago it was one of India’s poorest states, now it is now one of the richest. How did Kerala do it?
by Tirthankar Roy & K Ravi Raman
Ernakulam, Kerala, India, 2018.
India is a union of 28 states (provinces). The population in some of these states is bigger than that of the largest European countries. For example, Uttar Pradesh is home to more than 240 million people, almost three times the population of Germany. Although a part of a federal union, every state has a unique history, shaped by its environment and natural resources, princely or British colonial heritage, language and culture. Since the end of British rule in the region in 1947, their economic trajectories have diverged, too.
With roughly 35 million people, Kerala, which sits along India’s southwestern tip on the Indian Ocean, is among the smaller Indian states, though it is densely populated. In the 1970s, Kerala’s average income was about two-thirds of the Indian average, making it among the poorest states in India. This difference persisted through the 1980s. In the coming decades, a miracle occurred. Kerala, one of the poorest regions in India, became one of the richest. In 2022, Kerala’s per-capita income was 50-60 per cent higher than the national average. What happened?
Even when it was poor, Kerala was different. Though income-poor, Kerala enjoyed the highest average literacy levels, health conditions and life expectancy – components of human development – in all of India. Among economists in the 1970s and ’80s and among locals, ‘Kerala is different’ became a catchphrase. But why, and different from whom? One big difference Kerala presented was with North India, which had an abysmal record of education and healthcare. While the population grew at more than 2 per cent per year in the rest of India, Kerala’s population growth rates remained significantly lower in the 1970s. High literacy and healthcare levels contributed to this transition.
Kerala’s unusual mix of high levels of human development and low incomes drew wide attention, including from leading scholars. Among the most influential writers, K N Raj played a big part in projecting Kerala as a model for other states. Anthropologists like Polly Hill and Robin Jeffrey drew attention to some of the unique features of the society that led to these achievements. In a series of influential works, the Nobel-laureate Amartya Sen and his co-author the economist Jean Drèze praised Kerala’s development model for prioritising health and education, even with limited resources, and claimed that this pathway led to significant improvements in quality of life. Kerala vindicated the intuition that Sen and others held that health and education improved wellbeing and shaped economic change by enhancing choices and capabilities.
Why do Kerala’s differences matter? What lessons did the economists draw from the state’s unique record? Around 1975, India’s economic growth had faltered, and a debate started over whether the country should give up its socialist economic policy in favour of a more market-oriented one, in which the government would take a backseat. Kerala suggested three lessons for those engaged in the debate: (a) income growth rate was a weak measure of standards of living; (b) what mattered was quality of life, including education, good health and longer lives; and (c) the government was necessary to ensure investment in schools and hospitals. The three lessons would coalesce into the Kerala Model, an alternative recipe for development to the neoliberal model then being pushed by Right-wing lobbies.
But Kerala was about to grow even more different, confounding orthodoxies in political science and economics. In the 2000s, average income in the state forged ahead of the Indian average. Compared with Indian averages, the post-1990 growth record was less impressive regarding human development, as India caught up with Kerala (see graph below). The forging-ahead in income was offbeat and is still poorly understood. This question remains unanswered because, so far, the attention of economists has been elsewhere – welfare policies – whereas the income turnaround suggests an emerging pattern of private investment that strides in basic health and literacy alone cannot explain.
Before we tackle that question, it will be useful to discuss the huge presence of the state in development studies. Where does it come from? Why does the state fascinate so many social scientists?
From a historical perspective, Kerala has at least four distinct qualities that most states in India do not share. First, it has a centuries-long history of trade and migration, particularly with West Asia and Europe. Second, Kerala is rich in natural resources, which have been commercially exploited. Third, Kerala boasts a highly literate, skilled and mobile workforce. Finally, the state has a strong Left political movement. Any story we tell about its advances in health and education or its recent income growth must refer to some of these longstanding variables.
Why was Kerala different? In the minds of many economists, the state’s heritage of Leftist trade unions (more on this later) and successive rule by Leftist political parties helped provide the foundation for strong human development. Socialism was not just a popular ideology but had a real chance to deliver in this state. Others stressed geography, princely heritage and social reform movements. For example, the British anthropologist Polly Hill noted that Kerala differed due to its coastal position, semi-equatorial climate, maritime tradition, mixed-faith society and princely rule. The combined share of the population following Islam and Christianity in Kerala is about 45 per cent; for India as a whole, it is 16.5 per cent. The state is home to one of the oldest branches of Christianity. Further, the strategic location along the Arabian Sea facilitated interactions with traders worldwide, including Arabs, Europeans and others. The local rulers were generally tolerant of diverse religious practices.
Many economists in Kerala who noted the difference did not think there was much reason to celebrate. Some said that the record on healthcare and education hid a profound inequality from view. Others said the low and stagnant income pushed the state’s fiscals into bankruptcy, making the model unsustainable without active markets driving investment and income growth. By the 1990s, the model’s limitations became apparent as the state struggled with low economic growth and financial strains.
If the situation did not lead to a severe crisis, this was due to inward remittances. The state had a long history of labour migration, with significant numbers of people moving to the rest of India and the Persian Gulf states for work. This migration led to substantial remittances, which sustained private consumption, income and investment. By 2010, the excitement over the Kerala Model was dead, and incomes started forging ahead.
The Left changed their focus from land and educational reforms to private investment and decentralisation
The economists (above) who joined the developmental debate took Kerala’s income poverty for granted. They neither saw the income growth coming nor were prepared to explain it. Some Left-leaning economists attributed the resurgence in per-capita income to education and healthcare. But this is not persuasive. A surge in economic growth everywhere and at all times implies rising investment in productive capital, and basic education and healthcare would not deliver that.
The Indian economy in the 2000s saw robust investment and economic growth. But Kerala was not a major destination for mobile private capital. The forging ahead owed to more specific factors, some more peculiar and powerful than those driving India’s transformation.
Here, we must return to Kerala’s historical engagement with the world economy, its natural resources, its literate workforce and its distinctive political landscape. In different ways, all these reinforced private investment. Deep connections with the global economy were pivotal to the recent history of labour migration. While migration created a flow of remittances into consumption, another significant flow went into investment, especially in service sector enterprises in healthcare, education, hospitality and tourism. The state’s temperate semi-equatorial climate, mountainous topography and abundant water resources supported plantations and natural-resource extraction and processing industries for centuries. Some declined in the mid-20th century, but investment in these activities revived later.
The communist movement in Kerala began in the 1930s with the formation of the Congress Socialist Party, driven by peasant and labour movements and anticolonial struggles. The movement joined electoral politics after the formation of the state in 1956, and since then, Left-ruled governments have formed from time to time, almost always with coalition partners. The Leftist political movement in Kerala helped shape the state’s economic policies. In recent years, the Left also changed their focus from land and educational reforms to private investment and decentralisation. Capable local self-government institutions strengthened democratic governance.
In short ways, four forces of change – Kerala’s reintegration with the global economy, remittances from the Persian Gulf, strong welfare policies from a legacy of Leftist government, and private investment from individuals and businesses who shared the remittance flows – have combined to form the structure of Kerala’s miracle of human wellbeing with economic growth.
Around 1900, Kerala was a region composed of three political units: the princely states of Travancore and Cochin, and the British Indian district of Malabar. There were a few other smaller princely states as well. There was a broad similarity in the geography across the three units. India’s climatic-ecological map will show that all of Kerala is a semi-equatorial zone with exceptionally heavy monsoon rains, whereas most of India is arid or semi-arid tropical. The region has plentiful water and almost no history of famines, unlike the rest of India.
Geologically, too, Kerala was distinct. The mighty Western Ghats mountain range runs along its eastern borders throughout. Although the southwestern coast offered little scope for agriculture because good land occurred in a narrow strip between the sea and the mountains, the uplands produced goods like black pepper, cardamom, cloves, cinnamon and ginger, which had a ready demand in the world market. Plentiful coconut trees offered scope for coir rope manufacture. The climate was suitable for rubber and tea plantations. The sailing ship construction industry on the western coast obtained timber from the Malabar forests. In the present day, plywood is a major industry.
In the interwar period, poorer and deprived people circulated more
Around 1900, the authorities in all three regions helped foreign capital, which produced or traded in plantation crops like coffee, tea and pepper, and forest-based industries including timber, rayon, coir and rubber. Some of these products were traded globally. These businesses relied heavily on local partners and suppliers, which led to the accumulation of wealth in the hands of groups like the Syrian Christians.
Some of this wealth was invested in small-scale plantations and urban businesses, which encouraged the local migration of agricultural labourers. In the interwar period, poorer and deprived people circulated more. They sought work outside traditional channels like agricultural labour where they had been at the beck and call of upper castes or caste Hindus. At the same time, protestant missions, social reformers and Leftist political movements became active in ameliorating their conditions. These forces led to a significant focus on mass education. The princely states stepped into mass education late but with greater resources on average than a British Indian district. Their investment reinforced the great strides in health and education that made Kerala different.
Nine years after India gained independence, Malabar merged with Cochin and Travancore to form the Kerala state. At that time, the livelihoods in the region, like the rest of the country, were based on agriculture. However, a much larger proportion (half or more) of the domestic product was urban and non-agricultural, compared with India as a whole. Nearly 40 per cent of the workforce was employed in industry, trade, commerce and finance, compared with 20-35 per cent in the larger states in India.
One reason for this was the scarcity of farmlands. The state’s mountainous geography made good land extremely scarce. The exceptionally high population density in the areas of intensive paddy cultivation ensured a level of available land per head (0.6 acres) that was a fraction of the Indian average (3.1 acres) around 1970, and low by any benchmark. Paddy yield was high in these areas. Still, with the low size of landholding, most farmers were families of small resources.
Urban businesses processing abundant natural resources were another story. Some of these businesses were small, non-mechanised factories processing commercial products like coir in Alappuzha (Alleppey) and cashew in Kollam (Quilon). Some areas, such as Aluva (Alwaye), had larger, mechanised factories producing textiles, fertilisers, aluminium, glass and rayon. The region also had tea estates in the hills, and rubber and spice plantations east of Kottayam. Kerala today is a leading region in Indian financial entrepreneurship. Businesses from the region established banks, deposit companies and companies supplying gold-backed loans, which have a presence throughout India. Several of these companies emerged in the interwar period to finance trading and the production of exportable crops.
Thrissur (Trichur) and Kottayam were service-based cities with a concentration of banks, colleges and wealthy churches. Most local businesses were small-scale, semi-rural and household enterprises. Foreign multinationals owned tea estates and export trading firms at the apex of the spectrum of firms. Nearly everything else – from banks to small plantations, trading firms, agencies, transport and most small-scale industries – were Indian-owned family businesses.
Before statehood began in 1956, a powerful communist movement had emerged
From this base, the two decades after 1956 saw a retreat of private investment from industry and agriculture. Partly because of adverse political pressure, the foreign firms left the businesses, and plantations changed ownership. A militant trade union movement rose in the coir- and cashew-processing industries, and most firms, being relatively small, could not withstand the pressure to raise wages. Some shifted operations across the border with Tamil Nadu, where the state did not protect trade unions and labour costs were cheaper. With the central government’s heavy repression of private financial firms and the retreat of private banks, the synergy between industry, banking and commerce was broken. Private capital retreated from industrial production and trading. Following the socialist trend present in India in the 1960s, Kerala state invested in government-owned industries, which were inefficiently managed and ran heavy losses, usually resulting in negative economic contributions.
Private investment in agriculture declined, too. The Left political movement, which was concentrated in agriculture, was again partly responsible. Before statehood began in 1956, a powerful communist movement had emerged. The movement’s leaders understood that inequality in this part of India was not based on class alone. The agricultural countryside was characterised by inequality between the landholders and landless workers, which was only partly based on landownership but also drew strength from oppression and deprivation of lower castes by upper castes.
A narrow strip of highly fertile rice-growing plains in the central part of the state was the original home of Leftist politics. From the 1940s, it was a political battleground. The Leftist political parties organised the poorest tenants and workers into unions. Class-based movements to get higher wages, better employment terms or more land merged with movements to achieve equal social status. The agricultural labourers came from the depressed castes so they were interested in both class and caste politics.
When in power for a second time (from 1967), the communists ruling in coalition delivered on a promise made long ago: radical land reform. The policy involved taking over private land above a ceiling, redistributing it to landless workers, and bringing them under trade unions. The policy was successful in the extent of land redistributed (compared with most states that followed a similar policy) and in sharply raising wages. However, it did have a damaging effect on investment.
Many employers migrated to the Persian Gulf, leaving their land unattended
From the 1970s, private investment withdrew from agriculture. The cultivation of tree crops held steady, if on a low key. But cultivation of seasonal field crops, especially paddy for which the lowlands and the river basins were especially suitable, fell throughout the 1980s. By 1990, traditional agriculture was reduced to an insignificant employer and earner, and for most people still engaged in it, the land provided no more than a subsidiary income. A relative retreat from traditional agriculture is not unique to Kerala, it happened all over India. But in Kerala, the fall was spectacular.
In this densely populated area, the average landholding was small. Most landholders were middle-class people and not particularly rich. The policy squeezed their resources. Investment and acreage cropped fell. Those who remained tied to land did so because they had nowhere to go or worked the land mainly with family labour. The first Green Revolution unfolded in the rest of India, including Tamil Nadu, and had little impact on the state. Many employers migrated to the Persian Gulf in the late-1970s or ’80s, leaving their homesteads and the land unattended. What made all this anomalous was the high unemployment rate in the countryside, possibly the highest in the country. How were high wages and the retreat of a significant livelihood possible in this condition?
The answer is Gulf remittance. Hundreds of thousands of people migrated to the Persian Gulf states like Saudi Arabia, Kuwait, the United Arab Emirates, Bahrain and Qatar to work in construction, retail and services, sectors that saw a massive investment boom following the two oil shocks of 1973 and 1979. As they did, the money from the Gulf flowed into construction, retail trade, transport, cinema halls, restaurants and shops in Kerala. An emerging service sector labour market absorbed the effort of those who had been made redundant in agriculture or did not want to work there anymore.
What drove emigration to the Gulf? And why did Kerala lead the emigration of Indians to the Gulf? One answer is that the region had for centuries deeper ties with West Asia than any other part of India. Also, high unemployment pushed skilled individuals to seek work outside the state. Kerala, for at least three decades (1975-2005), supplied a significant share of the workers who moved to these labour markets. The demand for skilled workers increased as the Gulf economies diversified from oil-based jobs to finance and business services. While offering jobs in the millions, the migration also had a series of broad effects back home on occupational diversification, skill accumulation, changing gender roles, consumption, economic and social mobility, and demographic transitions.
In the 1990s, the Indian economy liberalised, reducing protectionist tariffs and restrictions on foreign and domestic private investment. In the following decades, increased private investment led to generally elevated economic growth rates. At the same time, the political culture shifted away from emphasis on socialist ideas, becoming more market-friendly than before. Kerala was not untouched by these tendencies, but its specificities – natural resource abundance, Leftist legacy, migration history – joined the pan-Indian trend distinctly. There were three prominent elements in the story.
First, a demographic transition completed by 1990, when population growth decreased substantially. The fall in population growth rate was not unique to the state but aligned with broader Indian trends. However, the levels differed. Of all states in India, Kerala was ageing much faster than the rest and from earlier times.
Second, politics changed. Again, the legacy of Left rule was an important factor behind the shift. A communist alliance won the first state assembly elections in 1957, lost in 1960, returned to power and ruled the state in 1967-70 (with breaks), 1970-77, 1978-79, 1980-82, 1987-91, 1996-2001, 2006-11, and since 2016. The composition of the Left coalition changed multiple times, never consisting only of ideologically Left parties. It included, for example, the Muslim League and some Christian factions allied with the communists. However, until 1964, the main constituent of the coalition was the Communist Party of India (CPI), called CPI (Marxist), or CPI (M), after 1964. In no other state in India, except West Bengal (and later Tripura), did the CPI/CPI (M) command a popular support base large enough to win elections.
The Left turned friendly towards private capital and shed the rhetoric of class struggle
The Left Democratic Front, which had ruled Kerala in different years, returned to power in 2016 and has been in power since then. In the 2000s, the Leftists quietly reinvented themselves. They needed to because the older agenda was almost dead. In elections in the 1960s and ’70s, agricultural labourers in this land-poor state formed the main support base for communist victories based on the promise of land reforms. Caste-equality social reform movements coalesced around the Leftist movement. After the Leftists delivered land reforms, there was not much of an agenda.
From 2000, the Left turned friendly towards private capital and shed the rhetoric of class struggle. In practical terms, the state retreated from regulating private capital and strengthening trade unions, and focused on infrastructure investment to strengthen small businesses. The reinvention was a success and delivered election victories. As the private sector took charge of investment in education and healthcare, the state could afford to focus on decentralised governance, corruption-free administration, improved public services and urban infrastructure. The class-based politics of the 1960s and ’70s died. With private investment rising, the state had more capacity to fund welfare schemes and public administration. Tourism promotion is an excellent example of a new form of synergy: the state builds roads, private capital builds hotels, and lakes and mountains supply the landscape.
Third, investment in Kerala revived. Over the past three decades, the private sector has increasingly driven education and healthcare. Since 1990, many new types of small-scale businesses have flourished in the state. There is no single story of where the money came from and what these enterprises add to employment potential. We know much of it happened on the back of natural-resource processing. In all fields, value was added by accessing niche export markets, using new technologies, and forming many micro, medium and small enterprises. The state has one of the highest concentrations of startups. Natural resource extraction does not mean any more plantations packaging harvested spices but the extraction of nutraceuticals. Jewellery manufacture involves invention and experimentation with designs. Rubber products diversified from automotive tyres to surgical accessories.
Although foreign investment inflow, which supported business development in the princely areas, was revived via the Gulf route, most of the business development is concentrated in non-corporate family firms. Few raise significant equity capital or are publicly held. Most service sector enterprises in tourism, trade, transport, banking and real estate are relatively small. Family business remains a strong organisational model. Little research exists on the externalities that these businesses generate. The one large exception to this rule is investment in IT clusters near the big cities.
Let us start with a restatement of the main points of the story. Not long ago, Kerala was celebrated for its exceptional human development indices in education and healthcare, with many scholars attributing this to an enlightened political ideology and communist influence. These advances also resulted from factors like the princely states’ higher fiscal capacity, favourable environmental conditions, and a globally connected capitalism. During the 1970s and ’80s, government interventions weakened market activity and growth, making human development look even more striking than otherwise. Since previous commitments to social infrastructure were maintained, the state was heading toward a fiscal crisis.
In the 2000s, an economic revival came through mass migration and remittances, initially supporting consumption and construction. At the same time, a wealthier and technically skilled diaspora invested in the state, in services and manufacturing. New sectors like tourism, hotels, spice extracts, ayurvedic products, rubber products and information technology drove this revival. Remittances also flowed into new forms of consumption. The urban landscape transformed, with towns developing shopping malls, restaurants and modern businesses. While earlier regimes discouraged private investment, now there is a symbiosis between the private sector and the state, as market activity supports public welfare commitments.
The New Left, unlike the Old Left, is open to private capital and acknowledges the importance of the market, including the global market. Without compromising welfare expenditure, the state has expanded the hitherto neglected infrastructure projects, crowding in private investments. This is the second turnaround in the development trajectories of the state. The first turnaround happened during the early 1980s fuelled by remittance money. The second turnaround happened in the 2010s, when social growth, always Kerala’s strength, joined unprecedented levels of capital expenditure. If both the Left and non-Left political parties could take credit for the first turnaround, the credit for the second one should rest with the New Left.
Recent climate change and overdevelopment have increased disaster risks
Looking forward, the pathway of recent economic change has both strengths and challenges. The strengths include the generally high quality of life in small towns, improved youth aspirations often marked by an increased flow to foreign universities, better worker safety, the ability to attract skilled and unskilled migrants, unique natural-resource advantages and a degree of sociability in relations between castes and religions. The challenges are poor higher education quality, environmental threats from new forms of tourism infrastructure and climate change, a rapidly ageing population, and the possibility of a fiscal crisis.
Some of these challenges are enormous, and are already straining the budget and state capacity. Land reforms brought some equality, but the absence of follow-up actions prevented productivity improvements. Kerala produces less than 15 per cent of its food requirements, and relies heavily on central supplies and neighbouring states. To respond to this problem, the government has strengthened its public distribution system. That, along with the care of the elderly and scaling up of public services, particularly education and health, will place enormous burdens on the state’s public finances in the near future.
Historically, the state’s unique climate with abundant rainfall provided natural advantages, supporting high life expectancy and diverse agricultural opportunities. However, recent climate change and overdevelopment have increased disaster risks. The environmental transformation has been primarily driven by private construction, especially Gulf-funded developments in dwellings, hotels and service sectors. Land has become the single most speculative asset of the real-estate lobbyists. Extensive economic activities in ecologically sensitive regions, possibly accompanying tourism development with its tagline of ‘God’s own country’, allegedly led to landslides, soil erosion and environmental vulnerabilities. In recent years, an accent on ‘responsible tourism’ has tried to reduce the potential risks.
There is more. Human-wildlife conflicts and soil erosion have increased, and declining rainfall poses significant challenges. The devastating floods in 2018 and the near-disaster in 2019 highlighted the consequences of excessive construction and poor environmental management. The state now has one of India’s highest levels of consumption inequality. The quality of higher and technical education remains poor, contributing to educated unemployment.
The state’s future success will depend on balancing economic growth with environmental sustainability, improving the quality of education, improving the employability of graduates, and social equity. It is a complicated task precisely because so much of the recent growth owes to exploiting the environment. There is a real prospect of worsening inequality along caste, class, gender and age lines if the current pattern of growth slows. On the other hand, recent advancements in the digital and knowledge economy, combined with sustainable infrastructure, open fresh spaces for egalitarian development. Still, the future is hard to predict because the regional economy is deeply dependent on integration with the world economy and the ever-changing ideological alliances.
Ernakulam, Kerala, India, 2018.
India is a union of 28 states (provinces). The population in some of these states is bigger than that of the largest European countries. For example, Uttar Pradesh is home to more than 240 million people, almost three times the population of Germany. Although a part of a federal union, every state has a unique history, shaped by its environment and natural resources, princely or British colonial heritage, language and culture. Since the end of British rule in the region in 1947, their economic trajectories have diverged, too.
With roughly 35 million people, Kerala, which sits along India’s southwestern tip on the Indian Ocean, is among the smaller Indian states, though it is densely populated. In the 1970s, Kerala’s average income was about two-thirds of the Indian average, making it among the poorest states in India. This difference persisted through the 1980s. In the coming decades, a miracle occurred. Kerala, one of the poorest regions in India, became one of the richest. In 2022, Kerala’s per-capita income was 50-60 per cent higher than the national average. What happened?
Even when it was poor, Kerala was different. Though income-poor, Kerala enjoyed the highest average literacy levels, health conditions and life expectancy – components of human development – in all of India. Among economists in the 1970s and ’80s and among locals, ‘Kerala is different’ became a catchphrase. But why, and different from whom? One big difference Kerala presented was with North India, which had an abysmal record of education and healthcare. While the population grew at more than 2 per cent per year in the rest of India, Kerala’s population growth rates remained significantly lower in the 1970s. High literacy and healthcare levels contributed to this transition.
Kerala’s unusual mix of high levels of human development and low incomes drew wide attention, including from leading scholars. Among the most influential writers, K N Raj played a big part in projecting Kerala as a model for other states. Anthropologists like Polly Hill and Robin Jeffrey drew attention to some of the unique features of the society that led to these achievements. In a series of influential works, the Nobel-laureate Amartya Sen and his co-author the economist Jean Drèze praised Kerala’s development model for prioritising health and education, even with limited resources, and claimed that this pathway led to significant improvements in quality of life. Kerala vindicated the intuition that Sen and others held that health and education improved wellbeing and shaped economic change by enhancing choices and capabilities.
Why do Kerala’s differences matter? What lessons did the economists draw from the state’s unique record? Around 1975, India’s economic growth had faltered, and a debate started over whether the country should give up its socialist economic policy in favour of a more market-oriented one, in which the government would take a backseat. Kerala suggested three lessons for those engaged in the debate: (a) income growth rate was a weak measure of standards of living; (b) what mattered was quality of life, including education, good health and longer lives; and (c) the government was necessary to ensure investment in schools and hospitals. The three lessons would coalesce into the Kerala Model, an alternative recipe for development to the neoliberal model then being pushed by Right-wing lobbies.
But Kerala was about to grow even more different, confounding orthodoxies in political science and economics. In the 2000s, average income in the state forged ahead of the Indian average. Compared with Indian averages, the post-1990 growth record was less impressive regarding human development, as India caught up with Kerala (see graph below). The forging-ahead in income was offbeat and is still poorly understood. This question remains unanswered because, so far, the attention of economists has been elsewhere – welfare policies – whereas the income turnaround suggests an emerging pattern of private investment that strides in basic health and literacy alone cannot explain.
Before we tackle that question, it will be useful to discuss the huge presence of the state in development studies. Where does it come from? Why does the state fascinate so many social scientists?
From a historical perspective, Kerala has at least four distinct qualities that most states in India do not share. First, it has a centuries-long history of trade and migration, particularly with West Asia and Europe. Second, Kerala is rich in natural resources, which have been commercially exploited. Third, Kerala boasts a highly literate, skilled and mobile workforce. Finally, the state has a strong Left political movement. Any story we tell about its advances in health and education or its recent income growth must refer to some of these longstanding variables.
Why was Kerala different? In the minds of many economists, the state’s heritage of Leftist trade unions (more on this later) and successive rule by Leftist political parties helped provide the foundation for strong human development. Socialism was not just a popular ideology but had a real chance to deliver in this state. Others stressed geography, princely heritage and social reform movements. For example, the British anthropologist Polly Hill noted that Kerala differed due to its coastal position, semi-equatorial climate, maritime tradition, mixed-faith society and princely rule. The combined share of the population following Islam and Christianity in Kerala is about 45 per cent; for India as a whole, it is 16.5 per cent. The state is home to one of the oldest branches of Christianity. Further, the strategic location along the Arabian Sea facilitated interactions with traders worldwide, including Arabs, Europeans and others. The local rulers were generally tolerant of diverse religious practices.
Many economists in Kerala who noted the difference did not think there was much reason to celebrate. Some said that the record on healthcare and education hid a profound inequality from view. Others said the low and stagnant income pushed the state’s fiscals into bankruptcy, making the model unsustainable without active markets driving investment and income growth. By the 1990s, the model’s limitations became apparent as the state struggled with low economic growth and financial strains.
If the situation did not lead to a severe crisis, this was due to inward remittances. The state had a long history of labour migration, with significant numbers of people moving to the rest of India and the Persian Gulf states for work. This migration led to substantial remittances, which sustained private consumption, income and investment. By 2010, the excitement over the Kerala Model was dead, and incomes started forging ahead.
The Left changed their focus from land and educational reforms to private investment and decentralisation
The economists (above) who joined the developmental debate took Kerala’s income poverty for granted. They neither saw the income growth coming nor were prepared to explain it. Some Left-leaning economists attributed the resurgence in per-capita income to education and healthcare. But this is not persuasive. A surge in economic growth everywhere and at all times implies rising investment in productive capital, and basic education and healthcare would not deliver that.
The Indian economy in the 2000s saw robust investment and economic growth. But Kerala was not a major destination for mobile private capital. The forging ahead owed to more specific factors, some more peculiar and powerful than those driving India’s transformation.
Here, we must return to Kerala’s historical engagement with the world economy, its natural resources, its literate workforce and its distinctive political landscape. In different ways, all these reinforced private investment. Deep connections with the global economy were pivotal to the recent history of labour migration. While migration created a flow of remittances into consumption, another significant flow went into investment, especially in service sector enterprises in healthcare, education, hospitality and tourism. The state’s temperate semi-equatorial climate, mountainous topography and abundant water resources supported plantations and natural-resource extraction and processing industries for centuries. Some declined in the mid-20th century, but investment in these activities revived later.
The communist movement in Kerala began in the 1930s with the formation of the Congress Socialist Party, driven by peasant and labour movements and anticolonial struggles. The movement joined electoral politics after the formation of the state in 1956, and since then, Left-ruled governments have formed from time to time, almost always with coalition partners. The Leftist political movement in Kerala helped shape the state’s economic policies. In recent years, the Left also changed their focus from land and educational reforms to private investment and decentralisation. Capable local self-government institutions strengthened democratic governance.
In short ways, four forces of change – Kerala’s reintegration with the global economy, remittances from the Persian Gulf, strong welfare policies from a legacy of Leftist government, and private investment from individuals and businesses who shared the remittance flows – have combined to form the structure of Kerala’s miracle of human wellbeing with economic growth.
Around 1900, Kerala was a region composed of three political units: the princely states of Travancore and Cochin, and the British Indian district of Malabar. There were a few other smaller princely states as well. There was a broad similarity in the geography across the three units. India’s climatic-ecological map will show that all of Kerala is a semi-equatorial zone with exceptionally heavy monsoon rains, whereas most of India is arid or semi-arid tropical. The region has plentiful water and almost no history of famines, unlike the rest of India.
Geologically, too, Kerala was distinct. The mighty Western Ghats mountain range runs along its eastern borders throughout. Although the southwestern coast offered little scope for agriculture because good land occurred in a narrow strip between the sea and the mountains, the uplands produced goods like black pepper, cardamom, cloves, cinnamon and ginger, which had a ready demand in the world market. Plentiful coconut trees offered scope for coir rope manufacture. The climate was suitable for rubber and tea plantations. The sailing ship construction industry on the western coast obtained timber from the Malabar forests. In the present day, plywood is a major industry.
In the interwar period, poorer and deprived people circulated more
Around 1900, the authorities in all three regions helped foreign capital, which produced or traded in plantation crops like coffee, tea and pepper, and forest-based industries including timber, rayon, coir and rubber. Some of these products were traded globally. These businesses relied heavily on local partners and suppliers, which led to the accumulation of wealth in the hands of groups like the Syrian Christians.
Some of this wealth was invested in small-scale plantations and urban businesses, which encouraged the local migration of agricultural labourers. In the interwar period, poorer and deprived people circulated more. They sought work outside traditional channels like agricultural labour where they had been at the beck and call of upper castes or caste Hindus. At the same time, protestant missions, social reformers and Leftist political movements became active in ameliorating their conditions. These forces led to a significant focus on mass education. The princely states stepped into mass education late but with greater resources on average than a British Indian district. Their investment reinforced the great strides in health and education that made Kerala different.
Nine years after India gained independence, Malabar merged with Cochin and Travancore to form the Kerala state. At that time, the livelihoods in the region, like the rest of the country, were based on agriculture. However, a much larger proportion (half or more) of the domestic product was urban and non-agricultural, compared with India as a whole. Nearly 40 per cent of the workforce was employed in industry, trade, commerce and finance, compared with 20-35 per cent in the larger states in India.
One reason for this was the scarcity of farmlands. The state’s mountainous geography made good land extremely scarce. The exceptionally high population density in the areas of intensive paddy cultivation ensured a level of available land per head (0.6 acres) that was a fraction of the Indian average (3.1 acres) around 1970, and low by any benchmark. Paddy yield was high in these areas. Still, with the low size of landholding, most farmers were families of small resources.
Urban businesses processing abundant natural resources were another story. Some of these businesses were small, non-mechanised factories processing commercial products like coir in Alappuzha (Alleppey) and cashew in Kollam (Quilon). Some areas, such as Aluva (Alwaye), had larger, mechanised factories producing textiles, fertilisers, aluminium, glass and rayon. The region also had tea estates in the hills, and rubber and spice plantations east of Kottayam. Kerala today is a leading region in Indian financial entrepreneurship. Businesses from the region established banks, deposit companies and companies supplying gold-backed loans, which have a presence throughout India. Several of these companies emerged in the interwar period to finance trading and the production of exportable crops.
Thrissur (Trichur) and Kottayam were service-based cities with a concentration of banks, colleges and wealthy churches. Most local businesses were small-scale, semi-rural and household enterprises. Foreign multinationals owned tea estates and export trading firms at the apex of the spectrum of firms. Nearly everything else – from banks to small plantations, trading firms, agencies, transport and most small-scale industries – were Indian-owned family businesses.
Before statehood began in 1956, a powerful communist movement had emerged
From this base, the two decades after 1956 saw a retreat of private investment from industry and agriculture. Partly because of adverse political pressure, the foreign firms left the businesses, and plantations changed ownership. A militant trade union movement rose in the coir- and cashew-processing industries, and most firms, being relatively small, could not withstand the pressure to raise wages. Some shifted operations across the border with Tamil Nadu, where the state did not protect trade unions and labour costs were cheaper. With the central government’s heavy repression of private financial firms and the retreat of private banks, the synergy between industry, banking and commerce was broken. Private capital retreated from industrial production and trading. Following the socialist trend present in India in the 1960s, Kerala state invested in government-owned industries, which were inefficiently managed and ran heavy losses, usually resulting in negative economic contributions.
Private investment in agriculture declined, too. The Left political movement, which was concentrated in agriculture, was again partly responsible. Before statehood began in 1956, a powerful communist movement had emerged. The movement’s leaders understood that inequality in this part of India was not based on class alone. The agricultural countryside was characterised by inequality between the landholders and landless workers, which was only partly based on landownership but also drew strength from oppression and deprivation of lower castes by upper castes.
A narrow strip of highly fertile rice-growing plains in the central part of the state was the original home of Leftist politics. From the 1940s, it was a political battleground. The Leftist political parties organised the poorest tenants and workers into unions. Class-based movements to get higher wages, better employment terms or more land merged with movements to achieve equal social status. The agricultural labourers came from the depressed castes so they were interested in both class and caste politics.
When in power for a second time (from 1967), the communists ruling in coalition delivered on a promise made long ago: radical land reform. The policy involved taking over private land above a ceiling, redistributing it to landless workers, and bringing them under trade unions. The policy was successful in the extent of land redistributed (compared with most states that followed a similar policy) and in sharply raising wages. However, it did have a damaging effect on investment.
Many employers migrated to the Persian Gulf, leaving their land unattended
From the 1970s, private investment withdrew from agriculture. The cultivation of tree crops held steady, if on a low key. But cultivation of seasonal field crops, especially paddy for which the lowlands and the river basins were especially suitable, fell throughout the 1980s. By 1990, traditional agriculture was reduced to an insignificant employer and earner, and for most people still engaged in it, the land provided no more than a subsidiary income. A relative retreat from traditional agriculture is not unique to Kerala, it happened all over India. But in Kerala, the fall was spectacular.
In this densely populated area, the average landholding was small. Most landholders were middle-class people and not particularly rich. The policy squeezed their resources. Investment and acreage cropped fell. Those who remained tied to land did so because they had nowhere to go or worked the land mainly with family labour. The first Green Revolution unfolded in the rest of India, including Tamil Nadu, and had little impact on the state. Many employers migrated to the Persian Gulf in the late-1970s or ’80s, leaving their homesteads and the land unattended. What made all this anomalous was the high unemployment rate in the countryside, possibly the highest in the country. How were high wages and the retreat of a significant livelihood possible in this condition?
The answer is Gulf remittance. Hundreds of thousands of people migrated to the Persian Gulf states like Saudi Arabia, Kuwait, the United Arab Emirates, Bahrain and Qatar to work in construction, retail and services, sectors that saw a massive investment boom following the two oil shocks of 1973 and 1979. As they did, the money from the Gulf flowed into construction, retail trade, transport, cinema halls, restaurants and shops in Kerala. An emerging service sector labour market absorbed the effort of those who had been made redundant in agriculture or did not want to work there anymore.
What drove emigration to the Gulf? And why did Kerala lead the emigration of Indians to the Gulf? One answer is that the region had for centuries deeper ties with West Asia than any other part of India. Also, high unemployment pushed skilled individuals to seek work outside the state. Kerala, for at least three decades (1975-2005), supplied a significant share of the workers who moved to these labour markets. The demand for skilled workers increased as the Gulf economies diversified from oil-based jobs to finance and business services. While offering jobs in the millions, the migration also had a series of broad effects back home on occupational diversification, skill accumulation, changing gender roles, consumption, economic and social mobility, and demographic transitions.
In the 1990s, the Indian economy liberalised, reducing protectionist tariffs and restrictions on foreign and domestic private investment. In the following decades, increased private investment led to generally elevated economic growth rates. At the same time, the political culture shifted away from emphasis on socialist ideas, becoming more market-friendly than before. Kerala was not untouched by these tendencies, but its specificities – natural resource abundance, Leftist legacy, migration history – joined the pan-Indian trend distinctly. There were three prominent elements in the story.
First, a demographic transition completed by 1990, when population growth decreased substantially. The fall in population growth rate was not unique to the state but aligned with broader Indian trends. However, the levels differed. Of all states in India, Kerala was ageing much faster than the rest and from earlier times.
Second, politics changed. Again, the legacy of Left rule was an important factor behind the shift. A communist alliance won the first state assembly elections in 1957, lost in 1960, returned to power and ruled the state in 1967-70 (with breaks), 1970-77, 1978-79, 1980-82, 1987-91, 1996-2001, 2006-11, and since 2016. The composition of the Left coalition changed multiple times, never consisting only of ideologically Left parties. It included, for example, the Muslim League and some Christian factions allied with the communists. However, until 1964, the main constituent of the coalition was the Communist Party of India (CPI), called CPI (Marxist), or CPI (M), after 1964. In no other state in India, except West Bengal (and later Tripura), did the CPI/CPI (M) command a popular support base large enough to win elections.
The Left turned friendly towards private capital and shed the rhetoric of class struggle
The Left Democratic Front, which had ruled Kerala in different years, returned to power in 2016 and has been in power since then. In the 2000s, the Leftists quietly reinvented themselves. They needed to because the older agenda was almost dead. In elections in the 1960s and ’70s, agricultural labourers in this land-poor state formed the main support base for communist victories based on the promise of land reforms. Caste-equality social reform movements coalesced around the Leftist movement. After the Leftists delivered land reforms, there was not much of an agenda.
From 2000, the Left turned friendly towards private capital and shed the rhetoric of class struggle. In practical terms, the state retreated from regulating private capital and strengthening trade unions, and focused on infrastructure investment to strengthen small businesses. The reinvention was a success and delivered election victories. As the private sector took charge of investment in education and healthcare, the state could afford to focus on decentralised governance, corruption-free administration, improved public services and urban infrastructure. The class-based politics of the 1960s and ’70s died. With private investment rising, the state had more capacity to fund welfare schemes and public administration. Tourism promotion is an excellent example of a new form of synergy: the state builds roads, private capital builds hotels, and lakes and mountains supply the landscape.
Third, investment in Kerala revived. Over the past three decades, the private sector has increasingly driven education and healthcare. Since 1990, many new types of small-scale businesses have flourished in the state. There is no single story of where the money came from and what these enterprises add to employment potential. We know much of it happened on the back of natural-resource processing. In all fields, value was added by accessing niche export markets, using new technologies, and forming many micro, medium and small enterprises. The state has one of the highest concentrations of startups. Natural resource extraction does not mean any more plantations packaging harvested spices but the extraction of nutraceuticals. Jewellery manufacture involves invention and experimentation with designs. Rubber products diversified from automotive tyres to surgical accessories.
Although foreign investment inflow, which supported business development in the princely areas, was revived via the Gulf route, most of the business development is concentrated in non-corporate family firms. Few raise significant equity capital or are publicly held. Most service sector enterprises in tourism, trade, transport, banking and real estate are relatively small. Family business remains a strong organisational model. Little research exists on the externalities that these businesses generate. The one large exception to this rule is investment in IT clusters near the big cities.
Let us start with a restatement of the main points of the story. Not long ago, Kerala was celebrated for its exceptional human development indices in education and healthcare, with many scholars attributing this to an enlightened political ideology and communist influence. These advances also resulted from factors like the princely states’ higher fiscal capacity, favourable environmental conditions, and a globally connected capitalism. During the 1970s and ’80s, government interventions weakened market activity and growth, making human development look even more striking than otherwise. Since previous commitments to social infrastructure were maintained, the state was heading toward a fiscal crisis.
In the 2000s, an economic revival came through mass migration and remittances, initially supporting consumption and construction. At the same time, a wealthier and technically skilled diaspora invested in the state, in services and manufacturing. New sectors like tourism, hotels, spice extracts, ayurvedic products, rubber products and information technology drove this revival. Remittances also flowed into new forms of consumption. The urban landscape transformed, with towns developing shopping malls, restaurants and modern businesses. While earlier regimes discouraged private investment, now there is a symbiosis between the private sector and the state, as market activity supports public welfare commitments.
The New Left, unlike the Old Left, is open to private capital and acknowledges the importance of the market, including the global market. Without compromising welfare expenditure, the state has expanded the hitherto neglected infrastructure projects, crowding in private investments. This is the second turnaround in the development trajectories of the state. The first turnaround happened during the early 1980s fuelled by remittance money. The second turnaround happened in the 2010s, when social growth, always Kerala’s strength, joined unprecedented levels of capital expenditure. If both the Left and non-Left political parties could take credit for the first turnaround, the credit for the second one should rest with the New Left.
Recent climate change and overdevelopment have increased disaster risks
Looking forward, the pathway of recent economic change has both strengths and challenges. The strengths include the generally high quality of life in small towns, improved youth aspirations often marked by an increased flow to foreign universities, better worker safety, the ability to attract skilled and unskilled migrants, unique natural-resource advantages and a degree of sociability in relations between castes and religions. The challenges are poor higher education quality, environmental threats from new forms of tourism infrastructure and climate change, a rapidly ageing population, and the possibility of a fiscal crisis.
Some of these challenges are enormous, and are already straining the budget and state capacity. Land reforms brought some equality, but the absence of follow-up actions prevented productivity improvements. Kerala produces less than 15 per cent of its food requirements, and relies heavily on central supplies and neighbouring states. To respond to this problem, the government has strengthened its public distribution system. That, along with the care of the elderly and scaling up of public services, particularly education and health, will place enormous burdens on the state’s public finances in the near future.
Historically, the state’s unique climate with abundant rainfall provided natural advantages, supporting high life expectancy and diverse agricultural opportunities. However, recent climate change and overdevelopment have increased disaster risks. The environmental transformation has been primarily driven by private construction, especially Gulf-funded developments in dwellings, hotels and service sectors. Land has become the single most speculative asset of the real-estate lobbyists. Extensive economic activities in ecologically sensitive regions, possibly accompanying tourism development with its tagline of ‘God’s own country’, allegedly led to landslides, soil erosion and environmental vulnerabilities. In recent years, an accent on ‘responsible tourism’ has tried to reduce the potential risks.
There is more. Human-wildlife conflicts and soil erosion have increased, and declining rainfall poses significant challenges. The devastating floods in 2018 and the near-disaster in 2019 highlighted the consequences of excessive construction and poor environmental management. The state now has one of India’s highest levels of consumption inequality. The quality of higher and technical education remains poor, contributing to educated unemployment.
The state’s future success will depend on balancing economic growth with environmental sustainability, improving the quality of education, improving the employability of graduates, and social equity. It is a complicated task precisely because so much of the recent growth owes to exploiting the environment. There is a real prospect of worsening inequality along caste, class, gender and age lines if the current pattern of growth slows. On the other hand, recent advancements in the digital and knowledge economy, combined with sustainable infrastructure, open fresh spaces for egalitarian development. Still, the future is hard to predict because the regional economy is deeply dependent on integration with the world economy and the ever-changing ideological alliances.
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