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A Journal Of Economic Policy A Journal Of Economic r o n f - y

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The Milken Institute Review • Third Quarter 2015 • volume 17, number 3 A dove on inflation. on dove A

bill frey bill frey frank rose frank rose larry fisher larry fisher Pay now or pay later. pay or now Pay claudia goldin claudia goldin tomas philipson philipson tomas On China’s high-wire act. On China’s On the NCAA monopoly. The bonus from diversity. from The bonus More alike than you think. than you alike More Time is the scarce resource. is the scarce Time marsha vande berg marsha berg vande On hydrogen-powered cars. On hydrogen-powered Miracles sometimes happen. Miracles On closing the gender pay gap. pay the gender On closing Pay players what they’re worth. what they’re players Pay Managing riskManaging with derivatives. On neighborhood desegregation. The key is flexible work schedules. is flexible The key On the Internet battle for eyeballs. battle for On the Internet Reform or growth – must they growth – must or choose? Reform On the coming global disaster. pension On the coming In this issue pallavi aiyar and chinaiyar hwee tan pallavi On financial engineeringOn financial R&D. pharmaceutical for thomas healey and catherine reilly thomas healey and catherine reilly allen sanderson and john siegfried On comparing the Indian and Indonesian economies. and Indonesian the Indian On comparing ABOUT US OUR WORK RESEARCH EVENTS CENTERS NEWSROOM BLOG VIDEOS The Milken Institute Review • Third Quarter 2015 volume 17, number 3 VIDEOS http://www.milkeninstitute.org/videos/ the milken institute the milken institute review Michael Milken, Chairman advisory board Michael L. Klowden, President and CEO Robert J. Barro Jagdish Bhagwati publisher Milken Institute Events George J. Borjas Conrad Kiechel editor in chief Daniel J. Dudek Peter Passell Georges de Menil From our flagship event, the Global art director Claudia D. Goldin Conference, to summits in Asia and London, Joannah Ralston, Insight Design Robert Hahn to briefings in Washington, we bring together www.insightdesignvt.com Asia Summit Robert E. Litan leaders with diverse expertise from across Lunch Program: China Today and Tomorrow managing editor Burton G. Malkiel Larry Yu sectors and industries. Van Doorn Ooms ISSN 1523-4282 Paul R. Portney Videos from hundreds of panels featuring Copyright 2015 Stephen Ross The Milken Institute leaders from some of the world’s top firms, Santa Monica, California Richard Sandor Isabel Sawhill organizations, universities and governments Morton O. Schapiro are available to view online. London Summit John B. Shoven Global Overview: Geoeconomics vs. Geopolitics The Milken Institute Review is published Robert Solow www.milkeninstitute.org/events quarterly by the Milken Institute to encourage discussion of current issues of public policy relating to economic growth, job creation and capital formation. Topics and authors are selected to represent a diversity of views. The opinions expressed are solely those of the authors and do not necessarily represent the views of the Institute.

The Milken Institute’s mission is to improve lives Partnering for Cures around the world by advancing innovative The Future of Medical Innovation economic and policy solutions that create jobs, widen access to capital and enhance health.

Requests for additional copies should be sent directly to: The Milken Institute The Milken Institute Review 1250 Fourth Street, Second Floor Santa Monica, CA 90401-1353 310-570-4600 telephone Global Conference California Summit 310-570-4627 fax Women: Key Players in High-Growth Investment Strategies Training the 21st Century Workforce [email protected] www.milkeninstitute.org

Cover: Kotryna Zukauskaite

SANTA MONICA | WASHINGTON | SINGAPORE contents

2 from the ceo

3 editor’s note 5 trends Hydrogen dreams. 67 by Lawrence M. Fisher book excerpt Diversity Explosion 84 pastimes, seriously William H. Frey explains how immigration is helping Down with the NCAA. Allen R. Sanderson and to desegregate neighborhoods. John J. Siegfried

93 currency of ideas Sample the MI blog. 14 india and indonesia Separated at birth. by Pallavi Aiyar and Chin Hwee Tan 95 institute news A little bragging. 24 how to achieve gender equality in pay 96 lists Giving women a break. by Claudia Goldin 34 china at the crossroads Can reform be postponed? by Marsha Vande Berg 42 the attention economy 3.0 The digital popularity contest. by Frank Rose 52 retirees: the new global security threat It’s much worse than you think. by Thomas J. Healey and Catherine M. Reilly 60 managing risk in drug development Financial engineering to the rescue? by Tomas J. Philipson

page 60

Third Quarter 2015 1 from the ceo

In Democracy in America, Alexis de Tocqueville described the habit of “Americans of all ages, conditions and dispositions” to “constantly unite together.” The French chronicler of the young republic noted “the endless skill with which the inhabitants of the United States manage to set a com­ mon aim to the efforts of a great number of men and to persuade them to pursue it voluntarily.” Fast forward 180 years. The philanthropic impulse that de Tocqueville witnessed has grown apace with the country. Today, Americans give some $350 billion each year to nonprofit groups. But contributions don’t al­ ways translate into effective programs. And, in light of the demonstrated potential of efforts ranging from advancing medical technology to increasing social mobility, it’s more critical than ever that we apply the sorts of performance standards to philan­ thropy that are routinely applied to business investments. This will both stretch the value of charitable resources and assure donors that their funds are truly making a dif­ ference. That’s why the Milken Institute recently established the Center for Strategic Philanthropy, bringing under one metaphoric roof our existing efforts to advance more strategic, informed and creative giving. The new structure draws on the success of FasterCures’ Philanthropy Advisory Ser­ vice. For nearly a decade, PAS has been evaluating the root causes of the problems do­ nors hope to solve and using that information to create a roadmap for effective giving. With its focus on medical philanthropy, PAS has catalyzed investments in several dis­ ease areas. Among its accomplishments: incubating a nonprofit foundation that is now the single largest private funder of melanoma research; fostering cancer immuno­ therapy research that has rapidly advanced therapeutic options for glioblastoma mul­ tiforme, an aggressive malignant brain tumor; and identifying opportunities to expand near-term clinical options for Alzheimer’s patients. Building on this foundation, our Center for Strategic Philanthropy is expanding into other areas in which philanthropic capital is poised to make a difference, notably in education and public health. We’re excited to be broadening our horizons because we know there’s a huge need here. In the coming decade, it’s estimated that Americans will donate more than $30 trillion, and it would be a tragedy if much of it were wasted. We look forward to help­ ing those who seek to help others.

Michael Klowden, CEO and President

2 The Milken Institute Review editor’s note

Correspondent JG of Passadumkeag, Maine (who has ap­ parently forgiven me for making light of her hometown), wonders whether the Milken Institute Review has been affected by California’s drought. Not yet, JG – though some have speculated that, in a pinch, we could always move our offices to the MI’s Singapore branch. I, for one, am a water glass half-filled kinda guy. I have my eye on beachfront property on Alaska’s North Slope.

Meanwhile, we’ve braved sunny, sunny skies to bring you this 67th bang-up issue of the Review. Frank Rose, a writer and consultant on digital culture, turns a gimlet eye on the “at­ tention economy” – and, in particular, on how efforts to measure the impact of Internet content are undermining the medium. “Met­ rics have so distorted the economics of the Internet that we find ourselves awash in in­ formation that is useless, even predatory,” he writes, “while information that actually de­ serves our attention often goes begging (in some cases, literally).” Claudia Goldin of Harvard explains why the gender gap in pay persists in spite of deci­ sive gains in women’s skills and experience. “Like many others, I think convergence is pos­ sible,” she writes. “However … the solution does not have to involve government inter­ vention, and it does not depend on the im­ provement of women’s bargaining skills or heightened will to compete.” Tomas Philipson of the University of Chi­ cago and the Milken Institute proposes two randy brandon/alaskastock.com

© new sorts of financial derivatives to manage

Third Quarter 2015 3 editor’s note “extensive reforms have in fact been achieved risk and increase capital for drug develop­ by a small circle of progressive nations. … For ment: “The first I call an FDA swap, which in most countries, though, the move will be con­ many ways imitates the form and function of siderably more difficult. To stand any chance the credit default swaps already widely used of survival over the long term, sponsors must to hedge risk in bond markets. The second I step up now.” call an FDA annuity, which hedges against ap­ Marsha Vande Berg at the Harvard Law proval delays by paying the investors an Program on International Financial Systems agreed-upon sum during the life of the test­ reviews China’s struggle to rekindle growth ing process.” without losing momentum on reform. “Some Larry Fisher, a former business reporter way, some day (preferably soon) the economy for The New York Times, decides that the fu­ must be rebalanced in ways that diversify out­ ture of hydrogen-powered cars is (almost) put and put services in place as the lead driver,” now. “Head-to-head,” Fisher says, “hydrogen she concludes, adding, “That will require more- may prove a match for battery-powered cars. sophisticated regulation of an economy that Fuel-cell vehicles deliver the same instant now awkwardly mixes ebullient private mar­ torque, seamless power and near silence that kets with what might be called crony socialism.” delight drivers of Teslas and Nissan Leafs Allen Sanderson of the University of Chi­ alike, with the added advantage of 300-mile cago and John Siegfried of Vanderbilt expose range and fueling that takes five minutes.” the inequity and inefficiency of the NCAA’s Pallavi Aiyar, a Jakarta-based journalist, monopoly on college sports. “Americans in­ and Chin Hwee Tan of Apollo Global Man­ advertently created a monster long ago when agement, argue that comparisons between they integrated big-time spectator sports with India and China distract from India’s more higher education,” they write. “Taming the relevant match-up. “A list of the most funda­ beast – forcing it to live by the rules we’ve set mental challenges confronting India today for other commercial enterprises – will not be could just as well be Indonesia’s,” they write. a walk in the park.” “Both nations need to boost manufacturing Last but hardly least, we’ve included a competiveness to create the millions of jobs chapter from The Diversity Explosion, Wil- required to ensure their young and growing liam Frey’s new book in which he explains populations become a demographic dividend how immigration is prying open segregated rather than a Malthusian disaster. Both must neighborhoods. And, while you’re at it, check attract foreign investment and fix creaky in­ out Lists, in which your ’umble editor ex­ frastructure, even as they assuage protection­ plores the UN’s venerable Human Develop­ ist lobbies and battle entrenched corruption.” ment Index and new variations thereon. Thomas Healey, a former assistant secre­ —Peter Passell tary of the Treasury, and Catherine Reilly, a Correction: The reference to the German na- grad student at the Harvard Kennedy School, tional anthem in Philippe Legrain’s article in the outline the impending global pension disaster prior issue of the Review is in error. The phrase and what could be done to save the Baby “Deutschland über alles” is no longer part of the Boomers’ retirement. “Despite the political anthem, nor is there evidence that Germans sang and economic complications of changing en­ the line in celebrating their World Cup victory trenched public pension systems,” they say, in 2014.

4 The Milken Institute Review trends

by lawrence m. fisher

Remember how Bullwinkle (the cartoon moose in the Rocky & Bullwinkle Show) used to offer to pull a rabbit out of his hat just before the commer­ cial break? “But that trick never works,” Rocky (his faithful squirrel companion) would scoff, to which Bullwinkle would gamely reply, “This time for sure.”

Pardon the author and his nostalgia for a TV era in which irony was still a novelty. But that routine came to mind on first glimps­ ing the latest round of hype for hydrogen- powered fuel-cell vehicles. There has always been an element of magic to the hydrogen-fueled automobile: here’s a car that would run in near silence on the most common element in the universe, emit­ ting only pure water vapor from its tailpipe. Hydrogen enthusiasm ran high during the administration of George W. Bush, who pre­ dicted in his 2003 State of the Union speech that “the first car driven by a child born today could be powered by hydrogen, and pollu­ tion-free.” But then Steven Chu, President Obama’s first Secretary of Energy (and a Nobel Prize winner in physics), brought the dreamers back to earth. For the hydrogen car to be viable, Chu said, four miracles would be needed – slashed in favor of technologies thought more better ways to produce, store and distribute promising, presumably putting the miracle hydrogen, along with sharp cuts in the cost of quartet even farther out of reach. fuel cells. Chu deemed this combination un­ Yet automakers, fuel-cell manufacturers likely, at least in the following two decades. and hydrogen producers never stopped work­ Federal research funding was subsequently ing on the technology. And at last fall’s Los Angeles Motor Show, hydrogen fuel-cell vehi­ cles were displayed by Honda, Toyota, Hyun­ LAWRENCE FISHER writes about business for The New david mareuil/anadolu agency/getty images agency/getty mareuil/anadolu david York Times and other publications. dai, Volkswagen/Audi and Daimler-Benz.

Third Quarter 2015 5 trends Zero Emission Vehicle requirement in Cali­ Moreover, these were not the chimerical con­ fornia and seven other states, have created a cepts that automakers unveil to test the mar­ less skeptical market climate. Moreover, the keting waters or just to show they’re cool. Some “better-than-expected” success of electric cars, of them are poised to appear in showrooms. like the Tesla Model S and Nissan Leaf, and You can already lease a hydrogen fuel-cell- the ever-greater market penetration of hy­ powered Hyundai Tucson compact SUV in brids like the Toyota Prius, provide a model Southern California for $2,999 down and for public acceptance of alternative fuel vehi­ $499 a month, including the hydrogen fuel cles. It’s surely no coincidence that Toyota and all maintenance. Toyota will offer its edgy and Honda, which produced the first gaso­ Mirai hydrogen cars for $58,325 later this year, line/electric hybrids, are among the first to with Honda’s as-yet-unnamed FCV sedan to market with hydrogen fuel-cell cars. follow in 2016. “I’ve been driving a fuel-cell vehicle for In fact, the hydrogen trail has already been four years and it’s great – a Honda Clarity,” blazed, albeit lightly: Honda produced a exclaims James J. Provenzano, president of handful of FCX Clarity sedans for public use Clean Air Now (an environmental nonprofit) from 2008-14. Analysts estimated each one and co-author, with Geoffrey B. Holland, cost at least $1 million to build, and only 43 of The Hydrogen Age: Empowering a Clean- of them were leased at $600 a month. Never­ Energy Future. “It’s a beautiful car; it performs, theless, the BBC’s Top Gear called it “the most and I’m coming from a Mercedes E-class. The important car for 100 years.” biggest thing is the costs have come down … So what has changed? Perhaps nothing. This technology is ready.” Hydrogen skeptics still decry the technology as an expensive boondoggle, or even a cynical wait ’til next year ploy by automakers to establish their green It is the perverse nature of new technologies credentials and to meet state zero-emissions that they rarely if ever develop as rapidly as quotas as they continue to derive the bulk of politicians, technology writers or financial their revenues from gas-chugging pickup backers expect. The idea of fuel cells, which trucks and SUVs. convert fuel into electricity without the muss Electric-car advocates have been among and fuss of combustion, can be traced back as the harshest critics. Tesla’s Elon Musk, himself far as 1838. But the first quasi-commercial ap­ once a prime target of skeptics, likes to talk plication did not come for more than a cen­ about “fool cells,” while echoing Chu’s pessi­ tury, when NASA used them to generate mism about the cost of manufacturing fuel power for probes, satellites and space capsules. cells, not to mention producing, storing and The hydrogen-oxygen fuel cell was designed distributing sufficient fuel at a low enough and first demonstrated publicly in 1959, and cost to make hydrogen cars commercially vi­ was used as a primary source of electricity in able. But while there have been no true break­ the Apollo spacecraft, which carried 24 astro­ throughs, there has been a steady incremental nauts to the moon from 1969 to 1972. progress on all the important fronts. Not bad for a proof of concept. But for At the same time, the growing urgency of more down-to-earth applications, cost re­ combating climate change and the corre­ mained a huge barrier. Hydrogen-oxygen fuel sponding changes in public policy, like the cells generate electricity by capturing the en­

6 The Milken Institute Review ergy released when hydrogen combines with early fuel cells captured only a modest por­ oxygen to form water. That sounds simple tion of the energy released by the electro­ enough. But for it to happen in the right chemical reaction, limiting their efficiency. place at the right time, the two gases first have Much credit for bringing fuel-cell cost to be processed through a membrane elec­ down and efficiency up is due to Ballard trode assembly, which includes a catalyst to Power Systems, a British Columbia-based separate the hydrogen atoms into protons company that has been quietly plugging away and electrons. That catalyst has typically been at the technology since 1983. Although the

courtesy of courtesy audi made of platinum or other scarce metals, and automotive market remained a bridge too far,

Third Quarter 2015 7 trends some developments that do verge on break­ Ballard did produce fuel cells for other pur­ throughs. A new class of catalysts developed poses, including backup power for wireless by researchers at the Department of Energy’s telecom networks, onsite power generation Lawrence Berkeley and Argonne National for remote places, materials-handling systems Labs could make fuel cells cost-competitive like forklifts and even a fleet of city buses. The with other power generators. Employing nano­ company also supplied fuel-cell know-how to technology, the researchers created a catalyst Daimler-Benz and Ford, and more recently that uses roughly one-sixth as much platinum has entered a strategic alliance with Volkswa­ and offers more than 30 times the catalytic gen. The shapely Audi A7 H-tron, the fuel- activity, making it both cheaper and more ef­ cell-powered version of Audi’s sports sedan ficient than the conventional technology. that was displayed at the Los Angeles show, employed Ballard’s technology. ubiquitous but elusive “Performance of the automotive fuel-cell Hydrogen is the most abundant element in system has improved significantly, to where the universe, but there’s a problem. It binds so it really is competitive with the internal- promiscuously with other elements that it is combustion engine, in terms of acceleration, virtually never found on its own. It is most smoothness, cold starts and efficiency,” ex­ often bound to carbon, as in fossil fuels, and, plains Guy McAree, Ballard’s director of of course, with oxygen to form water. While investor relations. “There’s still some cost re­ hydrogen gas was first synthesized in the 16th duction that has to happen, though that’s century by mixing metals with acid, produc­ come a long way, too. We are still talking about tion of the gas remains costly today. Industrial limited deployments – hundreds of cars, not production is mainly done by exposing the tens of thousands. But it’s exciting because methane in natural gas to superheated steam, two or three years ago, you didn’t see any­ and less often, by the electrolysis of water. thing like this.” Most industrial hydrogen, which is highly Honda, Toyota and Hyundai have also im­ flammable and expensive to compress for proved the efficiency and reduced the cost of transport, is employed near its production site. their fuel cells. “We’ve been working on the There have been no real breakthroughs in technology for 15 years,” says Derek Joyce, a steam reformation, which accounts for about Hyundai spokesman. “We did almost exclu­ 95 percent of U.S. hydrogen production, but sively our own development. We want to be a there have been serendipitous developments leader in the technology.” in the source of the raw material. Fracking, Toyota has been working on fuel cells for while nobody’s idea of a green technology, 22 years; indeed, it leased 104 hydrogen High­ has yielded an abundance of natural gas, driv­ lander SUVs to the public in the 2000s. ing down costs. “There were steady improvements along the Producing hydrogen requires a lot of en­ way,” notes Craig Scott, Toyota’s national ad­ ergy – the energy that heats the steam to at vanced technology vehicle manager. “The least seven times the boiling point of water – good news for fuel cells compared with bat­ but so, for that matter, does generating elec­ teries is we weren’t looking for a fundamental tricity or refining gasoline with fossil fuels. breakthrough in physics.” In a study conducted by the Union of Con­ Recently, fuel-cell technology has seen cerned Scientists comparing well-to-pedal

8 The Milken Institute Review emissions of the Hyundai Tucson hydrogen megawatt-hours of renewable power because fuel-cell vehicle with a gasoline-powered Tuc­ it was surplus to its needs at the time it was son showed a reduction of 34 to 60 percent in generated. ITM Power, a Sheffield, England- energy consumption, depending on the based company, proposes to turn that surplus source of the hydrogen. electricity into hydrogen for use in fuel cells. “At least in California, we have a renewable It has a pilot electrolyzer project in Frankfurt, hydrogen standard – a minimum 33 percent Germany, and will build three hydrogen refu­ must come from renewable sources, and we eling stations in London at a cost of £2.8 mil­ are estimating 46 percent by the end of the lion ($4.2 million). It also has two refueling year,” says David Reichmuth, a senior engi­ projects in the works in California and, over­

P roducing hydrogen requires a lot of energy — but so, for that matter, does generating electricity or refining gasoline with fossil fuels.

neer in the UCS’s Clean Vehicles Program. all, has some $15 million worth of projects “That makes it a good bit cleaner. I think the “under contract or in the final stages of nego­ promise of hydrogen – and this is similar to tiation” around the world. electric cars – is that there are a variety of Hydrogen can also be produced from bio­ ways to make it. There are cleaner ways, just mass, which a recent study by the University like there are cleaner ways to make electricity.” of California at Davis concluded could begin The cleanest way is through electrolysis, to make a significant contribution in about applying electricity to water to separate the 2020. Provenzano of Clean Air Now says he H from the O. And if that electricity comes often fuels his Honda Clarity from a hydrogen from renewable sources like wind or solar, the station attached to a sewage treatment plant cycle can be very clean, indeed. In most in­ in Orange County that produces enough hy­ stances, electrolysis remains too expensive to drogen to fill 50 cars a day. Now there’s a re­ be practical. But in areas with substantial newable resource. wind and solar power that can only be pro­ duced episodically, it could be viable as a bouncing bullets means of storing energy that would otherwise Hydrogen has long suffered from bad word go to waste. association because it brings to mind either a That largely explains why Chu, the critic really big bomb or the Hindenburg disaster. who put the kibosh on federal R&D subsidies, Both are a bit unfair in the context of fuel cells. is inching toward acceptance of hydrogen’s The hydrogen weapon of the early 1950s role as an alternative fuel. Hydrogen, Chu ex­ was a uranium or plutonium fission bomb plained to the MIT Technology Review, “could that heated a reservoir of hydrogen to temper­ effectively be a battery of sorts. You take a cer­ atures found at the center of stars, fusing the tain form of energy and convert it to hydrogen, atoms into helium and releasing humongous and then convert it back [into electricity].” quantities of energy. And while the Hinden- In 2013, the UK turned down a million burg was filled with lighter-than-air hydrogen,

Third Quarter 2015 9 The Toyota Mirai.

the proximate cause of the deadly fire was from the Internet), Toyota engineers fired probably a lightning strike or the flammable bullets of increasing sizes at the pressurized paint on the dirigible’s fabric covering. tanks; they bounced off. Not until they fired a Nevertheless, safe storage of hydrogen has large-caliber explosive shell was a tank punc­ obviously been a concern for the automobile tured – and then the hydrogen just hissed industry. In order to store enough hydrogen into the atmosphere without spectacle. to provide a range comparable to internal- “Storage is always an issue when you’re combustion-engine cars, it must be com­ comparing it against a liquid fuel like gaso­ pressed, raising the question of what happens line” that does not require high pressure, ac­ if a tank is punctured and the fuel rapidly es­ knowledges Toyota’s Craig Scott. “We are still capes. Those who have seen the Hindenburg researching new technology, but this is suffi­ film clip (which is practically everybody) en­ cient to bring it to market today.” vision cars engulfed in flames when they are Remember the BMW Hydrogen 7, pro­ rear-ended. duced from 2005 to 2007? These were not Automakers are understandably at pains to fuel-cell vehicles, but conventional BMW allay such fears. The Toyota Mirai employs 7-series sedans with internal-combustion en­ carbon-fiber-wrapped resin composite tanks, gines that had been modified to run on either which were the first in Japan to meet the in­ gasoline or liquid hydrogen. Liquid hydrogen, ternational standard for compressed hydro­ now the fuel of choice for NASA rockets, has gen storage containers for vehicle fuel sys­ high energy density and is relatively easy to

tems. In a dramatic video (since removed transport. toyota of courtesy

10 The Milken Institute Review But hydrogen must be cooled to within broadly deployed hydrogen fuel stations, con­ shouting distance of absolute zero in order to sumers won’t buy fuel-cell cars. But without a turn into a liquid. And liquefying one kilo­ critical mass of hydrogen vehicles on the road, gram of hydrogen using electricity from the business won’t have the financial incentive to U.S. grid would by itself release some 18 to 21 build the fueling stations. The solution (if pounds of CO into the atmosphere, roughly there is one) turns on the willingness of gov­ equal to the CO emitted by burning one gal­ ernments and hydrogen vehicle manufactur­ lon of gasoline. Moreover, the safety issues es­ ers to jumpstart the construction of the fuel­ calate with gas under these sorts of pressures. ing network. As Scott puts it, “Handling liquid hydrogen is A year ago, the California Energy Commis­ not for the faint of heart.” sion announced that it would invest some $47 million to accelerate the development of pub­ chicken and egg lic hydrogen refueling stations as part of its There’s still the nagging issue of hydrogen dis­ agenda to create a market for zero-emission tribution infrastructure. While electric cars fuel-cell vehicles. The Commission awarded can be recharged at home – or anywhere else funds for six fueling stations that will deliver recharging equipment can be attached to the only hydrogen derived from renewable electricity grid – hydrogen fuel-cell vehicles sources. Still to come: another 13 stations in need “gas” stations, just like their internal- Northern California and 15 in Southern Cali­ combustion counterparts. This creates a com­ fornia, strategically placed to make it practi­ mercial Catch 22: without the convenience of cal to use fuel-cell vehicles in regional centers

Third Quarter 2015 11 trends alition of electric-car advocates that formed and along major transit corridors. California after General Motors, Toyota and other manu­ has earmarked an additional $150 million, facturers withdrew their not-ready-for-prime­ with a goal of building yet another 100 new time EVs from the market in 2005. “Is there a stations throughout the state. single automaker committed to offering a Timed to the day of the Energy Commis­ mass-market FCV in every state in the U.S., or sion’s announcement, First Element Fuel, a are they just selling compliance cars that take California-based hydrogen fueling company, advantage of CARB’s higher ZEV credits for and Toyota announced an initial financial FCVs?” he asks, referring to the California Air agreement that included a $7.2 million loan to Resources Board, and to the state’s $5,000 re­ assist First Element in the operation and main­ bate to fuel-cell car buyers, which is double the tenance of 19 new stations. Separately, Toyota rebate offered for battery-powered EVs. said it will collaborate with Air Liquide, a Then there’s the unknown of what hydro­ big producer and supplier of industrial gases, gen will run at the pump. “What does it cost to build and supply a network of 12 hydrogen to fuel an FCV?” Saxton asks. “So far the au­ stations in New York, New Jersey, Massachu­ tomakers seem to be hiding the cost of fuel by setts, Connecticut and Rhode Island. bundling it with their compliance cars, but “We’re trying to solve that last miracle by this isn’t a strategy that scales up.” seeding infrastructure companies,” said Toyo­ Head-to-head, though, hydrogen may ta’s Craig Scott. “We’re building a hydrogen prove a match for battery-powered cars. Fuel- station right down the street from Tesla,” he cell vehicles deliver the same instant torque, noted, in the expectation that Silicon Valley seamless power delivery and near silence that will be as receptive a market for the Mirai as delight drivers of Teslas and Nissan Leafs it has been for electric vehicles. alike, with the added advantage of 300 mile range and fueling that takes 5 minutes. Other a diversified portfolio than Tesla’s $70,000 (and way up) Model S, One surprising, and ironic, aspect of the hy­ most EVs can go only about 80 miles on a drogen car rollout has been the amount of vit­ charge, and Tesla’s refueling, even at on-the- riol flung in its face by the electric car lobby. road supercharger stations, takes about half Ironic, because fuel-cell vehicles are electric an hour for an 80 percent charge. cars, too, and the experience of driving one is Hyundai’s spokesman said the company very similar. Put it down to sibling rivalry, be­ will sell its FCV in every state as fueling sta­ cause these two technologies are competing tions are built, though it is not offering to for public funds and market acceptance the fund them. Toyota, too, plans nationwide dis­ way brothers and sisters compete for parental tribution; the company is financing stations affection. While California continues to com­ in multiple states as well as in Denmark, Ger­ mit cash for EVs, the Obama administration is many and the UK. Honda and Volkswagen phasing out support for hydrogen. Electric-car have not announced their distribution plans, advocates would like that trend to continue. but will likely respond to market signals. “Apart from the environmental benefits, Hydrogen fuel costs remain a question what advantages do FCVs have over conven­ mark because there are so many variables, tional [electric] vehicles?” asks Tom Saxton, and the technology is still evolving. What is chief science officer of Plug In America, a co­ known is that the cost has already dropped

12 The Milken Institute Review Hydrogen-powered bus for California's Alameda-Contra-Costa Transit District.

significantly and should continue to fall as plug-in hybrids, gasoline hybrids and diesel the production technology evolves. Direct hybrids. One area where the fuel cell is likely solar electrolysis, currently under develop­ to dominate other fuel systems is in larger ve­ ment at the California Institute of Technology, hicles, like trucks and buses, where electric would make low-cost renewable hydrogen power simply requires more weight in batter­ abundant. “In quantity, the cost should be no ies than is practical. more than natural gas,” says Provenzano of “I think the [Chu] miracle quote was head­ Clean Air Now. line catching, but a little off,” says Reichmuth Lost in the hue and cry is the fact that of the Union of Concerned Scientists. “Real none of the big automakers behind the FCV drivers are going to be behind the wheel soon, are putting all their eggs in the hydrogen bas­ and there are already some on the road in ket the way Tesla has with electricity. Honda California. From our office, we see fuel-cell and Toyota have made a limited number of buses going by all the time.” battery electric vehicles along with scads of So keep your eyes on that cartoon moose gasoline hybrids and plug-in hybrids, while of TV legend. Maybe this time it really is

courtesy of transit courtesy ac Volkswagen currently offers battery EVs, for sure.

Third Quarter 2015 13 by pallavi aiyarindiatwins andunder indonesia the skin? The discourse on Asia’s so-called rise is dominated by comparisons of China and India, countries whose vast populations and buoyant economies have captured the imagina-

tion of international investors, journalists and policy analysts. Indeed, the India-China comparison is a virtual industry, born aloft on a river of books and reports that rely on j marshall, © florid bestial analogies featuring casts of tigers, elephants, dragons and tortoises. tribaleye images/alamy

14 TThe Milken Institute Review Indonesia

indonesia the skin? and chin hwee tan

“Chindia”-scented rhetoric abounds with catchphrases that state the obvious, but whose import is less so. China has the hardware, India the software; India needs China’s roads, China could do with India’s political inclusiveness. Given how fundamentally dif- ferent India and China are, though, these kinds of “lessons learned” (complete with stephen coyne/alamy stephen

© PowerPoint presentations) are of limited value. An apple cannot become an orange

Third Quarter 2015 15 india and indonesia sure their young and growing populations be­ simply because a McKinsey or Deloitte report come a demographic dividend, rather than a asserts it would be beneficial for it to do so. Malthusian disaster. Both have governments that must attract foreign investment and fix two’s company creaky infrastructure, even as they assuage The more relevant comparison in Asia – and protectionist lobbies and battle entrenched one with enormous implications for the corruption. Weak governance plagues both global economy – is between India and its nations, as both Delhi and Jakarta continue to civilizational sibling, Indonesia. These two struggle to balance power between the center eclectic democracies have more in common and provinces. than India and China, yet they are rarely “Bhinekka Tinggal Ika” (multiple but one), hyphenated. the Indonesian national motto, is in essence While China’s per capita GDP in 2013, ad­ identical to the Indian catchphrase of “unity justed for purchasing-power parity, was in diversity,” and they underscore the nations’ $9,600, the equivalent for India was a mere comparable accomplishments in having man­ $4,000, putting it much closer to Indonesia’s aged to sustain national identities in societies $5,200. China’s investment in fixed capital in fractured along ethnic and religious lines. 2013 accounted for 46 percent of its GDP, Nonetheless, ensuring the rights of minori­ compared to only 30 percent in India, a figure ties remains a fraught undertaking for both that is again more comparable to Indonesia’s countries. 33 percent. China is the global leader of mer­ China’s problems are, for the main part, of chandise trade, boasting well over a 10 percent a different nature. The country already boasts share of the world total, while India’s share is world-class infrastructure. It is an established only 1.6 percent and Indonesia’s is 1.0 percent. manufacturing powerhouse and became the On parameters of human development world’s largest recipient of foreign direct in­ ranging from sanitation to malnutrition, vestment in 2012. China’s demographic prob­ India and Indonesia are once again closer to lems look more like those of highly industri­ each other than they are to China. For exam­ alized countries with their aging populations, ple, around 37 percent of children under the low fertility rates and contracting labor forces. age of 5 in Indonesia and 39 percent in India With a single official language (India has are stunted (that is, shorter than the World 23), standardized written script, one major Health Organization’s reference population) ethnic group, and political tendency (both from malnutrition and related factors, com­ past and present) toward imposing unifor­ pared to less than 10 percent in China. mity, China is also a more homogeneous na­ A list of the fundamental challenges con­ tion in ethnic and religious terms than India fronting India today could just as well be Indo­ or Indonesia. While China does not have a na­ nesia’s. On the economic front, both nations tional motto, tianxia (“all under heaven”) is a need to boost manufacturing competitiveness dictum long associated with the Middle King­ to create the millions of jobs required to en­ dom that stresses the complete political sover­ eignty of the Chinese emperor over all the land PALLAVI AIYAR is an author and journalist based in “divinely” ordained for him. It illuminates the Jakarta. Her latest book is Punjabi Parmesan: Dispatches strong centripetal tendency that has been, and from a Europe in Crisis. CHIN HWEE TAN is a founding partner in Asia of Apollo Global Management. still is, fundamental to the Chinese polity.

16 The Milken Institute Review E ven relatively hard-line Islamic political parties have been known to hold wayang performances to boost their electoral fortunes.

Unlike India or Indonesia, contemporary China is preoccupied with foreign policy is­ sues and the pressing of territorial and mari­ time claims. Economically, it needs to move up the value chain from a manufacturing hub to a services leader and an innovation center. Politically, China’s leaders are focused on “sta­ bility” – a euphemism for ensuring the Com­ munist Party’s monopoly on power.

connections An Indian’s first reaction to China is often be­ wilderment. The language is wholly alien in sight and sound. The scale of the architecture seems outlandish. The highways are impossi­ bly smooth, and the winter cold frighteningly desolate. Despite the fact that the days of ev­ cum powder shelter in the shade of the ex­ eryone dressing in identical Mao suits are travagant malls. The call of muezzins punctu­ long over, there is an underlying uniformity ates the day, while the smell of moist earth to the physical and intellectual lives of the emanate from gardens. Chinese that is unfamiliar to Indians. Every Everywhere – embedded in the language, big Chinese city has identical glittering glass- on street signs, in political commentary and and-chrome malls. Smaller towns use bath­ on bus advertisements – are references to the room tiles as their construction material of Hindu epics of the Ramayana and Mahab­ choice. The heated political debates that are harata. An enormous statue of Krishna lead­ par for the course aboard Indian trains are ing Arjuna into battle dominates the round­ absent; the pageantry of street demonstra­ about in front of Monas, Jakarta’s main tions and strikes is missing. Calls to prayer nationalist monument. Even Indonesian and the ringing of temple bells are rarely part Muslims are commonly named after Hindu of the aural backdrop. gods and goddesses. Among the country’s fa­ Indonesia, on the other hand, is immedi­ vorite forms of mass entertainment, particu­ ately familiar to an Indian. Regular demon­ larly on the populous island of Java, is way- strations, featuring protestors who range ang kulit, shadow-puppet theater that features from workers clamoring for a higher mini­ tales from the Indian epics. mum wage to religious hardliners demanding Consequently, it remains common in both the cancellation of beauty pageants, cause countries to express values like courage, massive gridlock on the roads. Little retail strength and honesty with allusions to char­

associated press/suroto associated shops selling everything from candy to tal­ acters from Hindu stories. Even relatively

Third Quarter 2015 17 india and indonesia hard-line Islamic political parties like the Par­ tai Keadilan Sejahtera (PKS) have been known to hold wayang performances to boost their electoral fortunes. At a party convention held in Jogjakarta in 2011, for example, the PKS staged scenes from the life of Bima (a Mahab­ harata hero) to claim the need for a Bima-like entity (the PKS itself) to fight corruption. The explanation for this affinity (it was not wholesale but tempered and modified by in­ digenous culture) is that for centuries, Hindu- Buddhist kingdoms ruled over large parts of the Indonesian archipelago. And Hindu cul­ tural norms continued to infuse indigenous mores, even after large-scale conversion to Islam in the 16th century. Colonial rule – British in India’s case and Dutch in Indonesia’s – disrupted many of the and “Indonesia” arguably did not even exist direct links between Indian and Indonesian as political entities until the colonial period. kingdoms. Long established trade routes Well into the second half of the 20th century, along which textiles, spices and ideas had trav­ many Western commentators believed that elled for centuries were gradually taken over post-colonial balkanization was inevitable for by European powers from the 17th century on. both, given their eclectic mixes of languages, India and Indonesia both gained their in­ ethnicities and religions. India, the world’s dependence in the late 1940s, but the turn to­ largest democracy, is a Hindu-majority coun­ ward economic isolationism that character­ try – but is home to almost as many Muslims ized decolonization in both only cemented as Pakistan, in addition to substantial num­ the colonial disconnect. As a result, Indians bers of Christians, Sikhs, Buddhists and Zoro­ and Indonesians today are generally unaware astrians. Contemporary currency notes have of their strong cultural ties. Yet, the India- the denomination written in 15 languages. Indonesia hyphenation is a reality that finds Indonesia’s remarkable diversity is less present-day resonance not only in value sys­ widely understood. With 250 million citizens, tems, but in language. A large percentage of it is the world’s fourth-most-populous nation the vocabulary of Bahasa Indonesia, a stan­ and third-largest democracy. Superimposed dardized form of Malay, derives from Indian on the map of Europe, the Indonesian archi­ languages, including Sanskrit, Tamil and Urdu. pelago would span the distance from Ireland to the Caspian Sea. It is home to 719 languages, similarity in diversity spoken by people from over 360 ethnic groups China has long been a more territorially coher­ (although, unlike India, it does have a national ent entity than India or Indonesia. The geo­ language: Bahasa Indonesia). graphical boundaries of China over the centu­ Seven out of eight Indonesians self-identify

ries have been mutable, but what we call “India” as Muslims, implying that more Muslims live datta reuters/arko

18 The Milken Institute Review B oth countries face major challenges in ensuring that democracy does not turn into the tyranny of the majority.

in Indonesia than in any other country. The harto in 1998) is an achievement that sets state, however, also recognizes five other reli­ them apart from China. gions: Hinduism, Buddhism, Protestantism, However, both countries face major chal­ Catholicism and Confucianism. lenges in ensuring that democracy does not India and Indonesia have grappled with turn into the tyranny of the majority. Naren­ secessionism on their peripheries for decades, dra Modi (India’s current prime minister), but have nonetheless survived decolonization who is widely hailed as an economic reformer, almost intact. They have consequently defied also stands accused of doing little to stop the the European concept of the ideal nation, in 2002 religious riots that took place under his which a single religion, language and ethnic­ watch as chief minister in the State of Gujarat. ity is assumed to be the “natural” basis for a More than 1,000 people, mostly Muslims, were sustainable political state. killed. That India and Indonesia have not only Modi denies that he was complicit and has endured but are among the fastest growing been cleared by the courts; nonetheless, many economies in the world today is a testament civil-society groups continue to hold him to the fact that it is possible to create a strong, culpable. Modi’s political party is also closely common identity out of seemingly irreconcil­ affiliated with the right-wing Hindu organi­ able multiplicity. That they are able to cali­ zation, the Rashtriya Swayamsevak Sangh, brate such diversity within a democratic po­ whose objective is to establish India as a litical system (Indonesia has been a democracy Hindu nation. Thus India’s pluralism cannot

associated press/zia mazhar associated since the downfall of military dictator Su­ be taken for granted.

Third Quarter 2015 19 india and indonesia periences are for each other. Indonesia’s new leader, Joko Widodo (pop­ Religion remains a political force in each, ularly known as Jokowi), has stronger creden­ even as development and fighting corruption tials among his country’s minority communi­ have emerged as vote-winners. If the eco­ ties. When he ran for governor of Jakarta in nomic growth promised by the new govern­ 2012, for example, he chose Basuki Tjahaja ments in Delhi and Jakarta fails to materialize, Purnama, a Christian of Chinese descent, as it is possible that leaders, especially Modi, will his running mate. Yet, minority Muslim fall back on stoking religious rivalries as a groups, including Shia and Ahmadiyah, con­ strategy aimed at the next elections. It is un­ tinue to protest discrimination at the hands of clear, though, how voters would respond to the majority Sunni Muslims. Christian groups such tactics. have also complained about difficulties in ac­ quiring permits to build churches. unleashing growth India and Indonesia eschewed theocracy Although India initiated economic reforms in as the basis for nation-building. Nonetheless, the early 1990s, more than 20 years after In­ unlike in secular Europe, religion has an ac­ donesia’s liberalization under the military tive place in the public life of both. As a result, dictator Suharto, the countries share a variety they constitute important experiments in de­ of similarities on the economic front. veloping a third way for countries in which Over the past decade, both have managed religion remains a central part of the identity sustained growth in spite of slowdowns in the of most citizens, but where the more intoler­ wake of the 2008 global financial crisis. The ant aspects of religion are held in check. average real growth for India was 7.7 percent, The preamble to India’s constitution asserts while Indonesia grew at 5.5 percent. Both that it is a secular state. However, neither the have made considerable strides in opening constitution nor its laws define the relationship their economies to global forces, with exports between religion and state. Instead, secularism now amounting to one-quarter of GDP. The is understood as respect for all religions. median age in India is 27, close to the 29 in Indonesia’s constitution leaves out the Indonesia and considerably more youthful word secular altogether. The founding doc­ than the corresponding 37 in China. trine of Pancasila, which forms the basis for In 2013, the two countries were part of the the constitution, professes a “belief in the di­ so-called Fragile Five, a term coined by Mor­ vinity of the one God.” But by leaving out any gan Stanley to identify emerging economies reference to a specific God (in the face of op­ with large trade deficits. But since the elec­ position from Islamists who had wanted a tions of Modi and Jokowi in mid-2014, inves­ concrete mention of Allah), the Indonesian tor sentiment has improved. And many ana­ constitution also protects freedom of reli­ lysts argue that both nations now have a gious belief and practice. window of opportunity in which tough re­ As India and Indonesia feel their way for­ forms taken by their popular leaders could ward into the new millennium, there is inevita­ translate into long-delayed structural changes bly confusion about their founding ideas. Con­ that open the door to more-rapid growth. ceptually, both nations are works in progress, Ben Bland, then the Indonesia correspon­ rather than polished accomplishments. But dent for The Financial Times, listed “endemic this only underscores how germane their ex­ corruption, woefully inadequate physical in­

20 The Milken Institute Review frastructure, uneven law enforcement and to $10 billion this year. India, too, stopped sub­ underinvestment in health and education” as sidizing diesel prices (last October) and raised the main factors holding Indonesia back. The fuel taxes. lack of ease in doing business in Indonesia But the way the savings are redirected will and the need for smoother coordination be crucial in determining whether there is a among government ministries and between positive impact on economic growth. Given the central and local governments are the the high incidence of poverty in both coun­ other challenges cited. tries – particularly in India, where more than It is possible to substitute India for Indo­ half the population lives on purchasing power nesia and end up with a similar inventory. equal to less than $2 a day – using the extra The World Bank’s Ease of Doing Business funds to benefit the poor would serve the Index ranks Indonesia 114th out of 189 coun­ cause of growth and political stability. Part of

C onceptually, both nations are works in progress, rather than polished accomplishments. But this only underscores how germane their experiences are for each other.

tries, while India is 142nd. Health care expen­ the money might go to health, education and ditures as a percentage of GDP are a low 4 transportation. But some ought to be allo­ percent in India and an even lower 3 percent cated as direct cash payments to poor house­ in Indonesia. According to Transparency In­ holds, thereby reducing opportunities for ternational’s 2014 corruption rankings, India corruption by middlemen. placed 85th out of 175 countries, while Indo­ It will not be easy for either country, how­ nesia comes in 107th – major drags on pro­ ever, to confront the endemic problem of ductivity, innovation and capital formation. corruption. Jokowi has already run into trou­ Both countries, moreover, urgently need a ble over his nomination of Budi Gunawan, a boost in manufacturing to absorb the under­ powerful general, as police chief. Gunawan is employed labor flooding into cities in search a former security aide to Megawati Su­ of jobs. Getting from here to there won’t be karnoputri, who heads Jokowi’s political easy for either, however. The success of Modi party, and he is known to be close to her. and Jokowi in achieving this goal will depend Three days after his nomination, the KPK, In­ in large part on their skill in balancing pro­ donesia’s anticorruption agency, named Gu­ tectionist lobbies and subsidy-habituated nawan as a suspect in a corruption probe. state-owned enterprises with reforms aimed The police then arrested one of the KPK’s five at opening up to foreign investment, cutting commissioners on perjury allegations relat­ red tape and taking on entrenched elites. ing to a five-year-old case. The tumble in global crude oil prices has In the process, Jokowi’s reputation took a helped ease the fallout of Indonesia’s decision battering. The president suspended Guna­ last November to cut fuel subsidies, raising the wan’s nomination, but did not drop it until prices of petrol and diesel by more than 30 per­ more than a month later. Consequently, he cent. The move could save Indonesia $8 billion alienated both popular opinion, which saw

Third Quarter 2015 21 india and indonesia tural change in a country like India, where him as buckling to the old guard, and many voters tend to respond to short-term sops. of the political elite who viewed Gunawan as an ally. contrast in leadership How this will all play out for Jokowi’s re­ Compared to India, Indonesia is a new de­ form ambitions is unclear. But it underscores mocracy. General Suharto’s three-decades- how tough it is to curb the influence of the long dictatorship was dismantled in 1998. corrupt elite in Indonesia. However, the two countries are already politi­ cal doppelgangers. A multiplicity of parties, noisy rallies, demanding trade unionists, and a free and as­ sertive press are part of the public landscape in both nations – a far cry from the annual meetings of China’s National People’s Congress that are usually orchestrated into rigor mortis. Last year’s elections saw the ele­ vation of a new breed of popular leader in both countries. Voters were clearly disenchanted with tra­ ditional elites. Modi, whose family ran a tea stall, has risen from near the bottom of India’s caste and class hierarchies. Jokowi is from a similarly underprivileged back­ The Indonesian president’s troubles are ground. The son of a carpenter, he was a fur­ deepened by the reality that his party, the niture seller before becoming the mayor of PDI-P, is a minority in Parliament. Worse, he Solo, a midsized city in central Java. cannot even rely on the support of his own These similarities should not obscure tren­ party, which is controlled by Sukarnoputri. chant differences in temperament and policy In contrast, Modi enjoys a strong majority in inclinations that divide them. But it is these the Indian Parliament. Nonetheless, his party, divergences that are what will make the India- the BJP, was trounced in state assembly elec­ Indonesia comparison so interesting to ob­ tions in Delhi earlier this year, winning only 3 serve in the coming years. of 70 seats. As a leader, Modi is dominant and combat­ Moreover, the big winner was the newbie ive, while Jokowi is consensual and concilia­ Aam Aadmi Party (AAP), which is led by a tory. In his long reign (2001-14) as chief former anticorruption activist who ran on a minister of Gujarat State, Modi acquired a platform of increasing market-distorting reputation for governing with a firm hand as subsidies for electricity and water. It is not he pursued an aggressive, pro-business agenda. easy for any government, even one with a And since taking charge of the country, he has

strong mandate at the center, to enact struc­ concentrated power in the prime minister’s images raveendran/afp/getty right: syuflana. press/tatan associated left:

22 The Milken Institute Review office. Ministers are left with little elbow room. starting of a much-delayed public transport In contrast, Jokowi is unassuming in man­ overhaul. As president he has widened the ner. As governor of Jakarta (a post to which policy of smart cards for accessing free health he was elected in 2012) he avoided the tangi­ care and education for the poor. ble trappings of power like fancy cars and se­ curity details. He often walked around public through a glass darkly markets listening to people’s concerns first­ Analysts have forecasted six-plus percent hand, and was known for attending popular growth for India and five-plus percent growth city events like rock concerts and marathons. for Indonesia this year. Although faster than While Modi’s reputation in Gujarat was the recent norm, growth at this level is not built on the back of large infrastructure proj­ enough to be truly transformative for either ects, Jokowi’s derives from his stint as mayor of Solo, during which he trans­ formed a formerly crime-ridden city into The difference in temperament a center for regional arts and culture. It and policy inclinations of the was there that he demonstrated his media­ tion skills in relocating street vendors two leaders is what will make from a park in the city center. the India-Indonesia comparison Modi is an economic reformer with capitalist instincts. His achievements in so interesting to observe in Gujarat included attracting substantial the coming years. investments into manufacturing and power projects. He introduced business- friendly policies aimed at cutting red tape nation over the medium-term – China’s and making land acquisition easier than in growth at this stage of development was in other parts of the country. the range of 10 percent. New Delhi and Ja­ As prime minister, he has yet to make any karta must lift millions out of poverty, a task dramatic announcements on the reform front, that will require them to innovate and invest but he has made a raft of more modest pro­ on a much larger scale. posals, including relaxing foreign investment Some of the prerequisites for the sustained rules for insurers, military contractors and growth needed to reach upper-middle- real estate companies. A broad tax overhaul is income status are clear: openness to foreign also underway. And in recent months, India’s investment; suppression of corruption; regu­ growth has matched China’s for the first time. latory streamlining; and reforms in education, Jokowi, on the other hand, is a communi­ health and infrastructure. But there are a va­ tarian. In Jakarta, as in Solo, he made societal riety of imponderables – among them, rising welfare a consistent priority. His sympathies income inequality, ethnic conflict, helter- lie with small-business owners, like the street skelter urbanization, air and water pollution vendors of Solo. As governor of Jakarta, his and climate change – that will complicate flagship projects included free health care and navigation from here to there. Both India and education funds for the poor, the shifting of Indonesia seem poised to make up for lost thousands of squatters out of flood catch­ time, but the road to success is bound to ments into low-cost apartments, and the re­ be long and tortuous.

Third Quarter 2015 23 It’s no secret that, on average, women – even those with equivalent education and experience – typically earn less than men. The ratio of the average (mean) earnings of female workers (full- time, full-year, 25 to 69 years old) to that of their male counterparts was 0.72 in 2010. The pay ratio of median earners (those at the 50th percentile) for the same groups was 0.78. But that is not the whole story. how to achieve gender equality in pay

First the good news: the gender gap has nar­ rowed. The ratio of median earnings increased from 0.56 to 0.78 in the three decades prior to 2010. This narrowing of the gap in pay reflects the converging economic roles of men and women, a reality that is among the grandest social and economic advances in the last century. There are many aspects to the convergence, and each can be thought of as a chapter in a figurative book. The big question is whether the last chapter, in which the economy achieves full equality, can be

written. And if so, how? jean jullien

by claudia goldin

24 The Milken Institute Review how to achieve gender equality in pay

Third Quarter 2015 25 gender equality in pay technology, science and health. And the Like many others, I think convergence is change is reflected in the increased use of possible. However, I depart from the conven­ teams of substitute employees, as well as in tional view of what it would take to write this the more routine handing-off of clients, pa­ final chapter. The solution does not have to tients and customers from one employee to involve government intervention and it does another. It should be noted, however, that ad­ not depend on the improvement of women’s aptation has been slower in other sectors, bargaining skills or heightened will to com­ among them financial and legal services. pete. Nor must men become more responsi­ ble in the home (although that would greatly converging economic roles help). The primary convergences of the past decades What is needed are changes in how jobs have concerned the “human capital” attri­ are structured and remunerated, enhancing butes – education, experience – of men and the flexibility of work schedules. To succeed, women. By the same token, differences in the changes must decrease employers’ costs in labor force participation rates between men substituting the hours of one worker for an­ and women have narrowed. In recent years other. Firms that have family-friendly poli­ the participation rate for 25-to-54-year-old cies – and there are many of them – are mov­ females has risen to close to 75 percent, 14 ing in the right direction. But if those policies percentage points below the rate for males. are accompanied by decreases in women’s av­ Contrast that with the 46 percentage point erage hourly pay and dimmer prospects for difference in 1970 and the 29 percentage promotion because the cost of accommodat­ point difference in 1980. Meanwhile, as par­ ing flexible hours remains high, they will only ticipation rates of women have climbed, their reinforce gender differences in the workplace. time out of the labor force has decreased and The gender gap in hourly compensation their job continuity has increased. would vanish if long, inflexible work days and Years of education of women have sur­ weeks weren’t profitable to employers – that passed that of men among Americans born is, if firms did not have a financial incentive since the early 1950s. The distribution of col­ to pay employees working 80 hours a week lege majors has become more equal between more than twice what they would receive for men and women, and women now represent 40-hour weeks. A similar statement can be the majority, or nearly the majority, of stu­ made with regard to working specific sched­ dents in professional training in medicine, ules tailored to episodic increases in demand law, dentistry, veterinary medicine, pharmacy or putting in enormous amounts of time at and optometry. the start of one’s career to demonstrate alle­ But there the progress ends. Gender differ­ giance and commitment. ences in earnings are not much further re­ The costs of temporal flexibility have in duced if one corrects for factors such as edu­ fact begun to fall in some sectors – notably, cational quantity and quality because there are now few such differences that disadvan­

CLAUDIA GOLDIN is the Henry Lee Professor of tage women. But gender earnings gaps re­ Economics at Harvard and director of the National Bureau main. Why the persistent difference? of Economic Research’s Development of the American The answer turns on an understanding of Economy program. Her most recent book, written with Larry Katz, is The Race between Education and Technology. where earnings differences between men and

26 The Milken Institute Review women are found. In what occupations, at RELATIVE ANNUAL EARNINGS (FULL-TIME, what ages, and for what birth cohorts are the FULL-YEAR) OF COLLEGE GRADUATES BY BIRTH differences large or small? These provide COHORT 1958-1978 clues that allow the formulation of a frame­ .95 work for explaining the basis of pay gaps by Born 1978 gender. .90 But while this analysis tells us what might level the playing field in the labor market, it .85 doesn’t follow that the solution can be Born 1973 achieved through regulation. Actually, it sug­ .80 gests the opposite. Born 1968 earnings gaps by age, .75 cohort and occupation Born 1958 Born 1963 FEMALE/MALE ANNUAL EARNINGS The first evidence concerns gender earnings .70 gaps by age for a range of birth cohorts. The calculation should hold hours per week and 0 25 30 35 40 45 50 55 weeks per year constant, so the gap does not AGE simply reflect the fact that working more hours and weeks yields greater income. The real note: Sample consists of full-time (35+ hours), full-year (40+ weeks) college-graduate (16+ years of schooling) men and women issue here is what working more time or less (white, native-born, non-military, 25 to 69 years old). flexible schedules means for hourly pay. There­ source: U.S. Census Micro-data 1980, 1990, 2000, and American Community Survey 2004 to 2006 (for 2005), 2009 to 2011 (for 2010). fore, I only examine the experience of full-time, full-year workers, and I account for hours and ficity, which total 469. It is worth noting that, weeks above the “full” amount in the statistical while most are fairly narrowly defined (e.g., analysis. Consider earnings gaps among col­ “actuary,” “chemical engineer”), some are lege graduates now aged 35 to 55, tracked from overly broad (e.g., “physicians and surgeons”). the time they were in their late 20s. Here, it’s worth emphasizing that the rela­ Two findings stand out. First, there is a de­ tionship between the gender earnings gap creasing pay gap across cohorts. The youngest and occupations for all men and women is (born around 1978) has the smallest gender accounted for mainly (85 percent) by the gap and the oldest (born around 1958) has gaps within occupations, not across occupa­ the largest gender gap at each age. More im­ tions (the remaining 15 percent). Looking portant to the story, the gaps within cohorts only at college graduates, 65 percent of the greatly increase over time. Whereas women in gender pay gap is due to that within occupa­ their late 20s are earning around 92 percent tions and 35 percent is due to the distribution what comparable men receive, those in their of occupations by sex. early 50s receive just 71 cents on the average Putting this another way, the gender earn­ male’s dollar. ings gap would not be reduced much if women A second group of clues comes from analyz­ were distributed among occupations in ex­ ing gender earnings gaps by occupation. By oc­ actly the same proportions as men. In fact, for cupation I mean occupations defined by the the labor force as a whole, just 15 percent of U.S. Census at the “three-digit” level of speci­ the gap would be eliminated if women were

Third Quarter 2015 27 GENDER EARNINGS GAPS BY OCCUPATION 2009-2011 FULL-TIME, FULL-YEAR WORKERS IN OCCUPATIONS WITH MALE EARNINGS >$ 60,000 A YEAR

1.05

1.00

.95

.90

.85

.80

.75

.70

.65 GENDER EARNINGS RATIO (FEMALE/MALE) GENDER EARNINGS RATIO .60 Health Business Tech Science Other 0 10.9 11.0 11.1 11.2 11.3 11.4 11.5 11.6 11.7 11.8 11.9 12.0 12.1 Ln (MALE WAGE AND BUSINESS)

note: Sample consists of individuals 25 to 64 years old, excluding those in the military source: American Community Survey 2009 to 2011.

distributed exactly as were men by occupation, sured by the ratio of female to male earnings but the earnings gaps within occupations re­ and is almost always less than one. The lower mained constant. For college graduates, just the marker, the larger the gender gap. The 35 percent of the total gap would be elimi­ means of male annual earnings by occupa­ nated. Now that we know the importance of tion range from $60,000 to $170,000. the within-occupation gender pay gap we can The Business and Finance occupations focus on it. have relatively large gender earnings gaps, Although I construct the gender pay gaps while Technology and Science have relatively for all 469 three-digit occupations, I will small ones. Within the combined Tech-Science focus on individuals in occupations with av­ groups there is one big outlier – airline pilots – erage compensation exceeding about $60,000 where women earn only about 70 percent as per year, often termed “professional service much as men. This is a somewhat anomalous workers.” This group includes around 60 per­ occupation within the grouping because mili­ cent of all male college graduates and about tary experience has been an important entry­ 45 percent of all female college graduates. I way and seniority matters considerably. Gaps classify the occupations in several categories: in Health occupations are scattered through­ Business and Finance, Health, Science, Tech­ out the graph. The Health occupations with nology and a small “Other” category. This a high rate of self-ownership (e.g., dentist, categorization can be done for the higher- podiatrist) generally have larger gender earn­ income groups, but not for those with lower ings gaps than those with low rates of self- incomes. ownership (e.g., pharmacist, various types of As in the first figure, the gender gap is mea­ therapists).

28 The Milken Institute Review The gender gap in hourly compensation would vanish if firms did not have a financial incentive to pay employees working 80 hours a week more than twice what they would receive for 40-hour weeks.

Across the entire sample of full-time, full- year workers, the residual earnings ratio (fe­ male/male) for the Business and Finance oc­ cupations is 0.787 and the residual earnings ratio for the Technology and Science occupa­ tions combined is 0.892. For a sample limited to college graduates, the residual earnings ra­ tios are 0.797 for individuals in Business and Finance and 0.903 for those in Science and Technology. These very large differences between Busi­ ness and Finance on the one hand and Tech­ nology and Science on the other demand explanation. A really interesting hint concerns the role of average hours by occupation. In the analy­ sis just discussed, the sample was limited to full-time workers (35 hours plus) and mean hours for each occupation was added as a control. When instead I allow hours to affect earnings differentially for each occupation, average time worked per week in the Business and Finance occupations (plus lawyers in the “Other” category) has a very large impact on hourly pay. But weekly time worked in the understanding gender Technology and Science occupations has only differences in pay a small impact. Here, I explore what happens when employ­ That is, those in a Business or Finance oc­ ees cannot “hand off” clients, patients and cupation who work, say, 50 hours per week customers in a costless fashion. The frame­ are, on average, paid disproportionately more work fits into a model of compensating dif­ than those who work 40 hours per week. But ferentials and provides the foundations for their counterparts in Technology or Science the costs of providing a worker amenity such occupations who work 50 hours per week as flexible work hours. only increase their weekly or annual earnings Consider an employee (say someone with proportionately more than those laboring 40 a law degree) in a position (say a lawyer in a

jean jullien hours. relatively large law firm) whose work yields

Third Quarter 2015 29 gender equality in pay much to lawyers unwilling to put in Y hours $X per hour during a normal Y-hour work a week than it is to lawyers who are willing. week. But if the lawyer is on the job fewer The reason is that their clients do not view than Y hours (or is not around during partic­ two lawyers working 0.5Y hours each as good ularly vital business hours), his/her value is substitutes in the most productive positions less than $X per hour. Another lawyer’s posi­ for one lawyer working Y hours. The lawyers tion (say, in-house counsel for a business) are better substitutes for each other as corpo­ generates less value per hour than at a large rate counsels and perfect substitutes in gov­ firm. But it also comes with a lower penalty ernment positions. per hour for not being around for more than The framework suggests that “non-linear­ ity” in labor value arises when it is costly to employers to allow workers to be off the job temporarily, when it is difficult to hand off cli­ ents to colleagues, and when interdependent teams must coordinate schedules – as in many finance and legal occupations. Note that non- linearity here means that a lawyer working 30 hours a week is worth less than half what a lawyer working 60 hours is worth. Linearity, on the other hand, arises when employees can substitute for each other in a relatively costless fashion, when there are many independent team members, when in­ formation systems lower the cost of handing off clients and patients (as in health, phar­ macy). Here, a lawyer who works 30 hours a week is worth precisely half that of a 60-hour- a-week lawyer. Given the framework, what occupational characteristics should be related to residual gender gaps? I approach this question in two ways. some minimum number of hours per week. Now add a third lawyer to the mix – say, one lessons from o*net working for a government agency. This lawyer The first involves identifying relevant charac­ generates the lowest value per hour, but his/ teristics for all three-digit occupations to see her output is linear – that is, the value per if the gender gap in earnings is related to hour remains the same, regardless of how whether the job is compatible with temporal many hours are worked per week. flexibility without a significant loss in pro­ Under these conditions, the value of a law­ ductivity. The source for the data is O*NET, a yer in the labor market depends on the costs database underwritten by the U.S. Depart­ to the firm of providing temporal flexibility. ment of Labor. O*NET provides hundreds of

The big law firm won’t be willing to pay as characteristics for each occupation. Many of jean jullien

30 The Milken Institute Review them concern physical strength and cognitive lessons from the large gender abilities, which are not relevant to the issues earnings gaps in mba s and jds here. But there are a variety of characteristics Another way to gain insight into differences that are directly related to the job features in the gender earnings gap is to explore indi­ highlighted by the framework. I selected vidual occupations that have substantial pay characteristics indicating the degree to which gaps. The data I use are longitudinal or retro­ employees: spective, and contain enormously rich infor­ • are subject to strict deadlines and time mation on characteristics that are related to pressure; individual productivity. • need direct contact with others; The data for Business and Finance come • must develop cooperative working rela­ from administrative records of University of tionships with others; Chicago Booth School MBAs (1990 to 2006) • are tied to highly specific projects; • cannot, as a practical mat­ ter, determine their pace, tasks, priorities and goals. For the purposes of compu­ tation, I normalize each char­ acteristic to have a mean of zero and a standard deviation of one. A negative score implies there is less-than-average need to be around, less time pressure, more work on specific projects, and more ability to regulate one’s own pace and goals. A positive score has the opposite implication. Technology and Science oc­ cupations score far lower – that is, are far and a survey, used in my research with Mari­ more flexible in terms of time – by these anne Bertrand of the University of Chicago criteria than do Business, Finance and Law and Larry Katz of Harvard. We found that the occupations. In fact, they score about one gender earnings gap greatly increases with standard deviation below on most of the time since attainment of an MBA, so that 12 characteristics. to 15 years after earning an MBA women earn Not surprisingly, there is a strong negative just 57 percent as much as men. Even after association between the average of the correcting for MBA courses taken (some spe­ O*NET scores for the five job categories and cialties pay more) and grades, the figure is the (corrected) ratio of female to male earn­ still 64 percent, although it is about 95 per­ ings. The lower the average of the O*NET cent at the start of their careers. But the larg­ scores the higher is the (corrected) ratio of fe­ est factors explaining the gender earnings gap male to male earnings in that occupation. are weekly hours and time spent out of the

Third Quarter 2015 31 gender equality in pay highest. But unlike occupations in business, labor force, even though differences in hours finance and law, it has a small gender pay gap by gender are not large and time out for and almost no penalty for low hours. women is not extensive. Pharmacy underwent major changes in We found that, when they have children, the last several decades. Self-ownership and MBA women shift into lower paying posi­ the fraction working in independent practice tions (or out of the labor force) to gain tem­ plummeted from 1970 to the present. poral flexibility. The finance and corporate Whereas almost 70 percent of all pharmacists sectors heavily penalize lower hours for both in the United States worked in an indepen­ men and women, and flexible or low-hour dently owned pharmacy in 1970, just 14 per­ positions are rare. Half of all MBA women cent do today. Meanwhile, the fraction of who work part-time are self-employed. pharmacists who are female rose from around For the data on law degrees (JDs) I used 10 percent in 1970 to almost 60 percent today, the University of Michigan Law School and the ratio of female to male annual earn­ Alumni research data set, which contains rich ings increased from 0.65 in 1970 to 0.92 today. information on hours and earnings. The rela­ Most pharmacists are now employees of tionship between the gender earnings gap and large firms or hospitals. The spread of vast in­ time since earning the JD degree is similar to formation systems and the standardization of that for the MBAs. Because the information drugs have enhanced their ability to seam­ on hours in the law school alumni data set is lessly hand off clients and be good substitutes much better than that for the MBAs, I can for one another. The result is that short and better assess whether hourly earnings are irregular hours are not penalized. Pay is al­ non-linear with respect to hours worked. most perfectly linear in hours. Those who I examined annual earnings (in constant work fewer hours – say, because of family re­ dollars) by hours worked 15 years after the JD sponsibilities – are paid proportionately less. degree was earned for men and women who Part-time work is common, especially for graduated from law school between 1982 and women. But there is almost no part-time 1991. Earnings are clearly non-linear, with wage penalty. those working more hours per week earning more per hour. These findings stand up to where we stand controls for years off the job and years work­ We now know what must be in the last meta­ ing part-time. In addition, the fraction of phoric chapter for it to be truly the last. It women in the lower-hour group is much must involve considerable economic change, higher, and the fraction of the women who not a Band-Aid with firms offering flexible have children is also much higher in the hours and schedules to workers in return for lower-hour group. lower compensation. And to get from here to there, temporal flexibility must become less lessons from the small gender expensive for firms, pushing competitive earnings gap in pharmacy labor markets to generate more linearity of Pharmacy is a very high-income occupation. earnings with respect to the number of hours Among (full-time, year-round) male workers, and the particular hours worked. it was the eighth highest on an annual basis in A restructuring of jobs has happened or­ 2010 and among women it was the third ganically in many health care occupations, in­

32 The Milken Institute Review F or pharmacists today, short and irregular hours are not penalized. Pay is almost perfectly linear in hours.

cluding pharmacists, physicians, optometrists and veterinarians. Some physician specialties have low hours, few on-call hours, and pri­ marily planned procedures. Many of the Technology and Science occupations have built-in flexibility because work projects are often done independently and are highly spe­ cific requiring less oversight. And the spread of information systems has led to change in other sectors, enhancing substitutability across workers. Am I advocating that workers become clones of one another? Wouldn’t that degrade the work of professionals? Many of the highest earning and most prestigious professionals have almost perfect substitutes, a reality acknowledged by the way their professions are organized. Obstetricians cannot deliver two babies at the same time – or deliver them when they are on vacation in Cambodia – and thus work in group prac­ tices. Likewise, anesthesiologists generally work in groups and surgeons will generally pick a group of anesthesiologists to work convergence chronicled women’s relative with, not individual anesthesiologists. Per­ gains in education and work experience. But sonal bankers are organized as teams so that the last chapter concerns the utilization and clients can obtain help 24/7. remuneration of these productive attributes. Am I suggesting that all jobs could be It will be about how firms respond to changes structured so that clients could be handed off in technology and to the evolving preferences seamlessly, driving labor markets toward lin­ of employees as family/work issues arise. ear pay? There will always be some jobs that Don’t fall into the trap, though, of assum­ require one person to be on call. We don’t ex­ ing the last chapter is just about women. This pect the occupant of the White House to have isn’t only a woman’s problem, and it isn’t a a perfect substitute. But we have long lives, zero-sum game. The labor-market conditions and as the need to care for children declines that will generate convergence in pay between so does the need for flexible- and/or part- genders – the technological and institutional time hours (although these needs may return changes that reduce the cost of temporal flex­ with elderly parents or ill spouses). ibility – will make life better for almost

jean jullien The earlier chapters in the grand gender everybody.

Third Quarter 2015 33 China at the Crossroads

by marsha vande berg

China’s economic slowdown – three consecutive quarters of slowing expansion, with more forecast through the end of 2015 – has caught Beijing in a dilemma. Indeed, the below-target GDP growth is forcing the leadership to weigh the compatibility of policies for rekindling fast-paced expansion and the long list of institutional reforms that, just a few months ago, were widely seen as Cvital to keeping the maturing economy on track toward high-income status. At least on the surface, economic policymakers are opting for the former, declaring that growth and government-led development are now the priorities, even at the expense of delaying the structural reforms needed to support a huge and increasingly

complex economy. Xi Jinping, President of China and General Secretary of the Communist Party

34 The Milken Institute Review Third Quarter 2015 35 china at the crossroads value-added tax that replaces a hodgepodge That choice is understandable. Without of business taxes; and the refinancing of the rapid growth, the tens of millions of unem­ massive debts of local governments that accu­ ployed and underemployed Chinese stream­ mulated during the global financial crisis, ing into the country’s megacities won’t be when localities were ordered to pay for Chi­ able to find jobs, while the burgeoning mid­ na’s stimulus program. In the same vein, Bei­ dle class may fall victim to what development jing changed procedures to bring greater clar­ economists term the “middle-income trap.” ity to the relationship between central and The catch – well, one catch, anyway – is that local governments. expansion may prove self-limiting if China Moreover, the transition plan aimed at remains dependent on export-led growth in raising the growth rate is built for double an ever-more-competitive global manufac­ duty. It anticipates the imperative for en­ turing sector. hanced social-welfare programs in a better- Some way, some day (preferably soon) balanced economy as well as the need for China’s economy must be rebalanced in ways greater environmental protection and pro­ that diversify output and put services in place motion of R&D to support China’s move up as the lead driver. And that will require the global pecking order of technology. (among other things) more sophisticated reg­ Commentary from the meetings of the Na­ ulation of an economy that now awkwardly tional People’s Congress on March 5, along mixes ebullient private markets with what with subsequent statements by the party lead­ might be called crony socialism. ership at the March 21-23 Economic Summit In the meantime, a variety of develop­ and annual China Development Forum in Bei­ ments suggest that despite the emerging pref­ jing, supports the view that the government is erence for fast growth, China’s leaders are try­ hedging its bets. In his formal address to the ing to have it both ways. And this is giving nearly 3,000 delegates participating in the Na­ legitimate hope to China’s free-market cham­ tional People’s Congress, Premier Li Keqiang pions, who want to believe that reforms will affirmed that “reforms will be built around de­ continue to be rolled out in parallel with ef­ velopment and support of development rather forts to juice up sagging demand. than capital and financial market reform.” By the same token, Zhou Xiaochuan, head juggling at the apex of the central bank, has not hidden his fear Recent pronouncements from the top under­ that domestic inflation was falling too fast. score Beijing’s focus on measures that arrest What’s needed is to remain alert in the face of the growth slowdown. But reforms are clearly deflationary risks, he cautioned. And he acted still on the table. Some are designed to ratio­ on his view that the monetary authorities nalize fiscal management. Among them are a have considerable wiggle room to cut the revised national budget law that makes bud­ banks’ minimum reserve requirements in geting more transparent; a broad-based order to encourage lending. Meanwhile, the deputy prime minister, Wang Yang, turned his sights on China’s slow­ MARSHA VANDE BERG is a senior fellow in the Harvard ing trade growth, a crucial economic indica­ Law School program on international financial systems and tor for an export-led economy, calling on the a member of the advisory board of the RAND Center for

Asia Pacific Policy. government to act immediately to curb the reuters/fred dufour/pool previous page:

36 The Milken Institute Review P remier Li Keqiang affirmed that “reforms will be built around development and support of development rather than capital and financial market reform.”

downturn and prevent it from deteriorating the “new normal,” a time when China’s in­ into one continuous “speed loss.” (Something creasing integration with the global economy was lost in translation, but you get the point.) makes it difficult to expand rapidly simply by The proceedings of the Economic Summit increasing exports. “The government needs and subsequent China Development Forum, to change from being a strong government to China’s highest-level meeting between for­ being a smart government,” said Liu Shijin, eigners (among them, me) and senior eco­ vice president of the Development Research nomic policymakers, provided a somewhat Council, the State Council’s research arm. wider perspective on the leadership’s thinking. It’s all right if growth drops down to me­ And while China’s policymakers’ public state­ dium speed, explained Wu Jinglian, a widely ments are always cautious, that doesn’t stop respected China economist and DRC research anybody from reading between the lines. Par­ fellow. The quality of growth, he suggested,

associated press/hao qunying associated ticipants described China’s growing pains as was more important than the pace.

Third Quarter 2015 37 translations from the chinese rates and more-liquid bond markets. Al­ If all this still leaves you puzzled about what though there was no blueprint, the announced the leadership wants and expects to happen, deadline was the end of this decade. that probably wouldn’t bother them. This, There are some who argue that this com­ after all, is a delicate moment in contempo­ mitment remains intact, and they are sup­ rary Chinese history, as the economy teeters ported by evidence that important reforms on the edge of development and political have been put into place, albeit at a deliberate power is being consolidated under Xi Jinping, pace. What appears different between then the president and the Communist Party’s and now, however, is what lies at the heart of general secretary. One must assume that it is the current agenda to speed up growth, create an especially inauspicious time for officials to enough jobs, meet demands for more equita­ stick their heads out. ble wealth distribution and keep public order. Also notable is what actually happened be­ One of the clearest explanations of both tween November 2013 and now in the way of the quality and instance of the post-2013 re­ getting reforms into place – and what those forms comes from outside the country. Barry reforms mean for the larger picture of China’s Naughton, an economist who teaches in the economic success. Less than two years ago, Chinese Studies Program at the University of China announced a bold commitment to let­ California, San Diego, divides reforms into ting Adam Smith’s invisible hand replace the three buckets: fiscal policy, property rights government’s in guiding its economy. Many and foreign economic policy. saw this as a commitment to liberalizing the Fiscal policy reform spotlights the role of financial sector and a step toward currency Lou Jiwei, the former head of the China Invest­

convertibility, market-determined interest ment Corporation (China’s sovereign wealth imaginechina

38 The Milken Institute Review The Asia Infrastructure Investment Bank, opposed in part by the Obama administration because it could under- mine efforts to set high standards for environmental impact on infrastructure loans, was applauded by potential recipients for the same reasons.

fund), who is now Xi’s minister of finance. At who, often in collusion with local governments, the top of his agenda is a clever debt swap in­ amass land for future construction projects. tended to help local governments ease the There will now be clear laws governing the crushing debt they amassed as a result of the rental of land and its use as loan collateral. four trillion renminbi (about $650 billion) And none too soon, writes Naughton. He stimulus in 2008-09 and a hyper-active hous­ argues that “institutions must catch up with ing market. The debt-swap plan provides local the changed rural reality, notably mass migra­ governments with a vehicle for issuing munic­ tion from China’s rural to urban areas, and ipal bonds in the interbank market and then this new policy creates space for compromise applying the proceeds to repay maturing debt and facilitates a consensus in support of the over the course of this year. measure among urban elites.” The plan is labeled an interim liquidity The third bucket includes a series of initia­ measure and carries an implicit 1 trillion ren­ tives designed to lengthen China’s economic minbi (about $160 billion) subsidy. It will be reach abroad (notably in Asia), to increase ac­ helpful – but probably only modestly helpful, cess to foreign capital and to employ global given the outsized debts that local govern­ markets to help rebalance the domestic econ­ ments now carry and the dearth of revenue omy. Xi has been signaling his intentions on generated by the infrastructure built with the this front for some time. Last November’s borrowed funds. meeting of the Asia Pacific Economic Summit Still, the swap plan is an important step to­ in Beijing featured his unveiling of China’s ward putting local governments on a sounder plan to organize a multilateral credit facility, fiscal footing and ultimately to positioning the Asia Infrastructure Investment Bank, and them as engines of growth and job creation. to invite some 30 countries to join as found­ Moreover, the regulations governing the swap ing members. The initiative, opposed in part are expected to lend greater clarity to the divi­ by the Obama administration because it sions of responsibility between the two levels could undermine efforts to set high standards of government, and, with that, more effective for environmental impact on infrastructure central government oversight. loans, was applauded by potential recipients The second bucket of reforms is designed to for the same reasons. clarify and defend farmers’ property rights, The announcement received scant interna­ which could become the prototype for a tional attention at the time, but ultimately country-wide restructuring of the agricultural contributed to catapulting Xi and China’s sector that increases productivity and growth. economic diplomacy onto a wider interna­ The reforms protect farmers against the un­ tional stage. Xi, by the way, has certainly won compensated loss of property to developers the first round in this contest with the United

Third Quarter 2015 39 china at the crossroads nies (many of them state-owned-enterprises States: Australia, as well as South Korea and in transition) that before November 2014 most EU countries, has signed on. (So far, were only available to Chinese nationals and Japan has not made a decision.) pre-approved foreign investors. But the infrastructure bank is only a part These experiments, it should be noted, may of the story. China has negotiated a new trade presage the breakthrough reform of allowing agreement with Australia that includes most- China’s currency to be freely exchanged for favored-nation status for Australia, and a sim­ others, and potentially giving the renminbi ilar agreement is in the offing with South global reserve-currency status alongside the Korea. An even-more-groundbreaking initia­ dollar and the euro. This shift, urged for years tive involves the loosening of currency restric­ by China’s big trade partners and foreign tions. That initiative, the Shanghai Free Trade investors, would open the spigot for the for­ Zone, which has long been in the planning eign cash needed to modernize the nation’s stages, represents a major experiment in al­ sluggish state-owned enterprises. A market- lowing the use of China’s currency in interna­ determined exchange rate would likely also tional transactions without direct regulation. signal the end of near-total dependence on During the early stages of the Shanghai manufacturing-export fueled growth – one Free Trade Zone’s development, the port city crucial step in avoiding the much-feared of Tianjin was awarded the right to establish middle-income trap. a similar zone focused on expanding trade Notable, too, is China’s more recent an­ and commercial relations with South Korea, nouncement that it was about to implement which is just a few hundred miles away across an FDIC-like deposit insurance plan. But if the East China Sea. Other free-trade zones re­ the announcement’s real significance turns ceiving approvals include a site in Guang­ out to represent a resolution of the long­ dong province, the industrial heartland of standing debate about the effects and there­ southern China, which is intended to expand fore the pace of capital-market reform, it also the region’s already booming commerce with raises the more immediate question about Hong Kong, and yet another in Fujian prov­ the government’s role in an economy that is ince, to build on its proximity to Taiwan. increasingly driven by market forces. Complementing the free-trade zones, The official response to China’s dilemma – China is dipping another toe in the waters of government-directed growth, reforms based global securities trading. The Shanghai-Hong on markets as drivers, or something in be­ Kong Connect (soon to be joined by the Shen­ tween – depends on Xi, who has amassed more zhen-Hong Kong Connect) is a platform that power than any Chinese leader since Mao Ze­ allows investors on both sides of the China/ dong. Xi’s authority, grounded on his hard- Hong Kong border to trade stocks via regis­ hitting drive against corruption in high places, tries in each of the respective markets. Buyers has made him extremely popular. (He is affec­ and sellers on the China side pay in renminbi, tionately referred to as Papa Xi.) But it is also while their counterparts in Hong Kong settle raising questions about Xi’s views on eco­ transactions in Hong Kong dollars. The Con­ nomic reform. nect platform also gives foreigners, including Early on, it was widely believed that the an­ big institutional funds, access to so-called A- ticorruption drive’s popularity would add to Market securities – shares in Chinese compa­ the president’s political capital, allowing him

40 The Milken Institute Review Xi’s core long-term goal, it is widely believed, is to sustain market-driven economic growth without opening the door to challenges to the Communist Party’s monopoly on political power.

to override the objections of special interests to work more efficiently, even as they increase who were unhappy about reforms, especially the political legitimacy of the party as the de­ those involving state-owned conglomerates. fender of the general welfare. But these efforts But some observers are now asking whether also have the potential to disrupt the symbi­ the investigations are being used to rational­ otic relationship between China's capitalists ize a slowdown in reform efforts, thereby giv­ and their regulators. Indeed, it once again ing Xi more flexibility in agenda-setting. raises the question of whether authoritarian Either way, remarks attributed to Wang rule is fundamentally incompatible with the Qishan, a Politburo member and secretary of workings of a diversified, highly productive the nightmarishly named Central Commis­ market economy. sion for Discipline Inspection of the Commu­ We may soon know a lot more about Xi’s nist Party, are apt: the anticorruption struggle reform inclinations. This year marks the con­ is a “battle that cannot afford to be lost.” clusion of the 12th Five-Year Plan, which Xi’s core long-term goal, it is widely be­ means Xi will need to come forward with the lieved, is to sustain market-driven economic first Five-Year Plan of his own devising. It is growth without opening the door to chal­ this document that typically showcases the lenges to the Communist Party’s monopoly leadership’s thinking about the economy. on political power. Anticorruption efforts Thus, for Xi – and for China – this mo­

left: associated press/wong maye-e. right: associated press/kin cheung associated right: press/wong maye-e. associated left: help to achieve this goal by allowing markets ment may be critical.

Third Quarter 2015 41 the attention economy

by frank rose

Nearly a half-century ago, in a lecture Alas for leporidologists, Simon was not sponsored by Johns Hopkins University giving a disquisition on rabbits. His actual and the Brookings Institution, the econo­ topic was information, which even then ap­ mist and future Nobel laureate Herbert A. peared to be exploding, and he went on to Simon told a story about bunny rabbits. It make an observation that has been cited seems his neighbors had purchased a pair many times since: of bunnies for their daughter as an Easter In an information-rich world, the wealth of present, and since the rabbits were of dif­ information means a dearth of something ferent genders the neighbors soon found else: a scarcity of whatever it is that informa­ themselves living in, as Simon put it, “a tion consumes. What information consumes rabbit-rich world.” This would have conse­ is rather obvious: it consumes the attention of its recipients. Hence, a wealth of information quences not just for the neighbors but for creates a poverty of attention and a need to the local food supply. “A rabbit-rich world allocate that attention efficiently among the is a lettuce-poor world,” Simon pointed out, overabundance of information sources that “and vice versa.” might consume it.

42 The Milken Institute Review kotryna zukauskaite kotryna tk

Third Quarter 2015 43 the attention economy this won’t be easy, but it’s going to be critical And so, at the dawn of the information age, to a functioning media industry – as a grow­ was born the notion that we live in an “atten­ ing number of people are starting to point out. tion economy” in which a glut of information leaves us with a deficit of attention. It was a mau-mauing the flak catchers radical idea, since for most of human history Last January, Evan Williams became the latest it has been information that’s in short supply to speak up. Williams is a co-founder of Twit­ and attention that’s abundant. But Simon was ter, the microblogging service that went pub­ prescient. In a few quick sentences, he pre­ lic in 2013, and more recently of Medium, an dicted a reversal of the economic relationship online publication that doubles as a blogging between media producers and media con­ platform and has serious journalistic ambi­ sumers. In the future, the value of information tions. In December, Facebook announced (the stuff being produced) would trend to­ that Instagram – the popular photo-sharing ward zero, while the value of attention, which app that it bought for $1 billion in 2012 – had is owned by consumers but can be leveraged 300 million “monthly active users” (MAUs, in by companies that help them allocate it, would the lingo of the trade). This was remarkable only rise. Google, its founders as yet unborn, for a service that nine months earlier had would triumph; newspapers would collapse. only 200 million. Of course, it wasn’t quite that simple. There But commentators on Wall Street and in were other issues to be decided, chief among the media immediately ginned up a compari­ them the question of how to measure this son with Twitter, whose user base, after an newly identified resource called attention. initial growth spurt, stood a little below 300 Simon thought the answer was fairly obvious: million – much to the Street’s distress. From attention should be measured by the amount CNBC to Mashable to Adweek, one outlet of time an average business executive, a person after another proclaimed Instagram to be he identified as having a bachelor’s degree and “bigger than Twitter.” A Citibank analyst an­ an IQ of 120, spends focused on something. nounced that Facebook’s not-yet-profitable Such “attention units” would capture the cost, photo app might be worth $35 billion, far in addition to any monetary outlay, of receiv­ more than Twitter’s market cap of $24 billion. ing information. A columnist for CNNMoney opined that But Simon was a good 30 years ahead of his Twitter should sell itself to the highest bidder. time. By the time the rest of the world caught Williams’s response, delivered to a Fortune up with his ideas, other, cruder, metrics had reporter: “I don’t give a s***.” And for good come into use – metrics that have so distorted reason. Aside from the fact that they’re inter­ the economics of the Internet that we find our­ active services that live on Internet-connected selves awash in information that’s useless, even electronic devices, Twitter and Instagram predatory, while information that actually de­ have little in common. Twitter, as Williams serves our attention often goes begging. Fixing pointed out, is a “realtime information net­ work” where big news breaks first and world leaders and celebrities speak to global audi­ FRANK ROSE is a senior fellow at the Columbia ences. But while Twitter can be highly addic­ University School of the Arts and the author of The Art tive to initiates, it has not made itself friendly of Immersion: How the Digital Generation Is Remaking Hollywood, Madison Avenue and the Way We Tell Stories. to newbies – a failing that contributed to in­

44 The Milken Institute Review vestors’ feelings of relief when its CEO re­ traffic wins, regardless of how fleeting that signed in June. Instagram, on the other hand, traffic might be. is a fun and extremely well-executed app that We’ve been here before, of course. “Uniques” encourages people to connect over photos. are the online equivalent of ratings on televi­ Monthly active users can be a helpful yard­ sion. The fixation on ratings fed the lowest- stick for such online services, but as Slate’s common-denominator effect that held the in­ Will Oremus pointed out in one of the few in­ dustry in its grip from the late 1950s until just formed appraisals of the Twitter/Instagram a few years ago, when the rise of pay-TV chan­ contretemps, “they aren’t the only one. Oth­ nels and the growing sophistication of audi­ ers might include the amount of time users ences pushed television into a new

5 5 percent of the people who visit a Web page stay for less than 15 seconds. Yet the site with the most traffic wins, regardless of how fleeting that traffic might be.

spend on the network, the amount of content “golden age” typified by serials like they post, and the number of people who see Mad Men and Girls. But the situation is that content.” By those measures, Twitter far even worse online because only a third of outstrips its so-called rival: 500 million tweets Web advertising is bought on the same cost- per day compared to 70 million photos posted per-thousand basis that prevails on TV. The to Instagram; 500 million people per month rest is “performance based,” meaning that ad­ who visit the site but don’t log in (and there­ vertisers pay a fraction of a penny each time fore aren’t counted as “active users”); 185 bil­ someone clicks on their ads. So it’s not enough lion impressions per quarter. for advertisers to reach as many eyeballs as In Twitter’s case, a shortage of MAUs possible; in order for those eyeballs to count, turned off advertisers, weighed on the stock they have to generate some sort of response. price, and helped precipitate a change in lead­ That makes sense for Google, which gener­ ership. But as misleading as the MAU metric ates the great bulk of its outsized profits ($14.4 can be for social sites, the monthly tally of billion on revenues last year of $66 billion) “unique visitors” – typically used to gauge the by serving up precisely targeted ads next to importance of media sites – is worse, for the search results. But it has fed the perception in stock price and for ad rates alike. It assumes the ad business that online display advertising that if someone lands on a Web page, that – banner ads that run across the top of a Web person is going to stay there long enough to page, for instance – is ineffective because it read or watch whatever is onscreen. The real­ doesn’t generate as many clicks as search ad­ ity is quite different. According to the Web vertising. So rather than being treated as a analytics firm Chartbeat, 55 percent of the brand-building medium like television, the people who visit a Web page stay there for less Internet has devolved into a direct-response than 15 seconds. Yet the site with the most medium – a bargain-basement ad emporium

Third Quarter 2015 45 tk

46 The Milken Institute Review that’s only as good as the next click. Which will “content farm” that five years ago looked like be a problem since the Internet is where tele­ the future of journalism. vision is headed. And a dismal future it would have been: the It doesn’t help that the Internet is essen­ idea was to pay writers and videographers a tially unaffected by physical constraints. Tele­ pittance – $15 or so – to churn out near-useless vision, especially analog television, has dis­ material on topics a computer algorithm said cernible limits: there are only so many viewing people wanted to know about, then lard it up hours in the day, only so many megahertz of with ads and rely on search engines to drive bandwidth that can be devoted to broadcast­ traffic. Most visitors would go straight back to ing channels simultaneously, only so many Google, but who cared? A unique was a minutes that can be devoted to ads without unique, no matter how fleeting the visit, and audiences tuning out completely. (The cur­ Demand Media was soon getting more than rent rule of thumb in the United States is 8 100 million uniques a month, making it one of minutes out of every 30.) Not so online, where the top 20 Web properties in the United States. the potential number of ad-carrying Web Demand Media’s business model was stun­ pages is effectively infinite. ningly cynical, though the company did try to At the same time, online distribution is dress it up with self-serving rhetoric about largely controlled by users rather than pub­ “publishing what the world wants to know lishers, either through search engine queries and share.” More surprising was the number or by spreading information virally on sites of tech-savvy individuals who bought in. like Facebook and Twitter. Marc Andresson, a “They really understand consumer behavior leading Silicon Valley venture capitalist, has on the Web and how to build businesses on it,” been talking about “a golden age of journal­ Facebook COO Sheryl Sandberg said to ism” that could follow a transition to a new- Bloomberg Businessweek. Wired magazine generation audience that's mobile and always concluded at the end of a lengthy profile that connected. But with users driving distribution “the Demand way may be inescapable.” and with infinite inventory pushing ad rates Investors certainly seemed to think so. In relentlessly downward, the focus on unique January 2011, when Demand went public in visitors and click-through rates has inspired a an IPO led by Goldman Sachs, the market lot of Web publishers to try to game the sys­ valued it at $1.9 billion on opening day. Never tem – to go big by providing junk content to mind that it had lost money in each of its four go with the junk ad medium that serves it up. years of existence; it was the first IPO to top $1 billion since Google itself went public in what the algorithm said to the 2004. The New York Times Company, mean­ content farm while, was valued at $1.55 billion. The first target for abuse was search. Through That was then. By November 2013, not the miracle of search engine optimization, quite three years later, Demand Media’s traf­ Web publishers can design their sites to at­ fic had fallen by half, its CEO had resigned, tract notice from the bots that crawl the Net and its stock price had dropped from a peak on behalf of Google and other search engines. of $52.50 shortly after the IPO to somewhere Figure out how to take maximum advantage around $5. What happened? Google. of this while delivering minimal value and Days before Demand’s initial public offer­

kotryna zukauskaite kotryna you get something like Demand Media, the ing, Google’s engineer in charge of fighting

Third Quarter 2015 47 the attention economy • He Thought He Could Be a Human Ant- Web spam noted in a company blog post that eater, But What Happened Was...OMG users wanted it to take action against content These are all recent examples from Viral­ farms and the like. His advisory was largely Nova, a site most readers of this journal have ignored in the froth of the IPO. But a few probably never heard of. Nonetheless, in April weeks later, Google made good on the threat 2014 Bloomberg Businessweek declared the by introducing a significant change in the way year-old business “one of the defining media it tallied search results. Its new search algo­ companies of this convulsive era.” What made rithm, called Panda, specifically penalized it defining was the same thing that once made low-quality sites – those with thin content Demand Media defining, but with a twist. Vi­ and too many ads. ralNova lures millions of people to junk con­ Demand Media’s traffic plummeted. By tent, not through search but because it can in­ April 2011, outside analytic services were re­ duce people to link to it – mainly on Facebook, porting that visits to its sites were down as which accounted for 90 percent of the site’s much as 40 percent. The stock price started 6.6 million monthly unique visitors. falling accordingly. Copycat sites, of which ViralNova is headed by Scott DeLong, a there was no shortage, suffered a similar fate. 31-year-old entrepreneur who lives next to a Google “wouldn’t give us any relief,” one com­ cornfield in North Canton, Ohio (pop. petitor told an interviewer from Harvard’s 17,500). DeLong doesn’t have a huge news Nieman Journalism Lab, “so I realized this operation or a vast network of contributors; was not a sustainable business.” he doesn’t need them. All he requires is an eye With search out, would-be media innova­ for arresting video, the nerve to poach it from tors turned to social. You would think that other online sources (many of which have sharing through social media would be rela­ themselves poached it from someone else), a tively immune to the gamesmanship that cor­ savvy way with Facebook, and enough servers rupted search, since for something to go viral to keep the whole thing from crashing. This it presumably has to deliver on some level. last appears to be his biggest problem. (There’s a reason that homemade cat videos DeLong is not alone. Upworthy, founded tend to be insanely popular.) But that turned by the former MoveOn organizer Eli Pariser out not to be the case. No sooner did content and the former Onion editor Peter Koechley, farms implode than “clickbait” and “linkbait” pioneered the genre in 2012. After six months took their place. online, it could (and did) boast of 8.7 million We’ve all seen them – headlines that stop at uniques, with every post being shared an av­ nothing to get us to drop everything so we erage of 25,000 times. Ashton Kutcher’s new can click on the story and then link to it: site, A+, has 27.5 million monthly uniques in • 32 Freaky Times the World Was Creepy in the United States alone and was recently the Worst Ways Imaginable hailed on the news site Business Insider as • The Things You Can Find on These 25 Bi- “one of the most important media companies zarre Islands Seem Too Freaky to Be Real in America” – even though, as the writer ad­ • She Was Hit by a Car, Struck With a Ham- mitted later in the same sentence, “almost no mer, Buried...and She STILL Wags Her Tail one knows it exists.” And my personal favorite for at least the And then there’s Emerson Spartz, a 27- past five minutes: year-old Chicagoan who created a hugely pop­

48 The Milken Institute Review ular Harry Potter fan site at 12 and now runs “influentials,” the highly connected individuals a potpourri of ad-laden websites that repur­ singled out in Malcolm Gladwell’s best seller pose and repackage content for maximum vi­ The Tipping Point. Opinion leaders, contrary rality. In a recent New Yorker profile, Spartz to popular opinion, aren’t nearly as critical to made it clear he thinks originality is for spreading information as ordinary people chumps: it takes too much time, and people who are easily persuadable. are no more likely to click on the result. So he Unruly, a London-based company that and his peers feed off each other while fre­ specializes in delivering highly shareable ad

ViralNova lures millions of people to junk content, not through search but because it can induce people to link to it — mainly on Facebook, which accounted for 90 percent of the site’s 6.6 million monthly unique visitors.

quently harvesting the value of information videos, offers a far more granular approach to other people have painstakingly gathered. virality. Its proprietary ShareRank algorithm, All this is possible because we no longer developed from more than 100,000 viewer re­ have to wonder why one story or video goes actions, gauges the likelihood that a given ad viral and another does not. What used to be video will be shared, depending on (among viewed as a crapshoot is now almost a science. other things) the psychological response it Jonah Berger of the Wharton School wrote a generates and the social motivation it appeals best seller called Contagious after he and a to. Celebrities don’t have much impact, but colleague, Katherine Milkman, analyzed friends do; according to co-founder Sarah 7,000 New York Times articles that ran in the Wood, an ad that’s recommended by a friend fall of 2008. The study showed that a key fac­ is up to 50 percent more likely to trigger a tor in getting people to email stories to purchase that an ordinary recommendation. friends and colleagues was emotional arousal. But while the rate of online video sharing In general, people were more likely to email kept doubling for years, it has recently started positive stories than those that generated neg­ dropping off. The problem, Wood says, is ative emotions like anger or anxiety. But inten­ sheer volume: “We can’t take any more and sity mattered, too. Stories that sent readers pay attention to it.” into a rage were more likely to go viral than Which gets to the heart of the issue. There’s those that evoked emotions that were only nothing wrong with virality – it’s how news mildly positive, or that were negative in a deac­ and ideas spread in the Internet age. The tivating way, like sadness. In the book, Berger problem is with how we measure success and cites a handful of other factors as well, among what kind of behavior those metrics encour­ them social currency, practical usefulness and age. The focus on uniques and click-throughs good storytelling. Much less important, as assumes that value online is where it has al­ Duncan Watts, a Microsoft researcher and for­ ways been in the media business, in ad inven­ mer Columbia professor, has shown, are tory. But Web pages can multiply like

Third Quarter 2015 49 the attention economy that, unlike television, the Internet can actu­ bunny rabbits – and the more they do, the less ally tell advertisers if anybody is looking. valuable each ad opportunity becomes. What’s The brand issue is critical, and not just for needed is an injection of scarcity – and “the advertisers. When a publisher relies on tran­ only unit of scarcity on the Web,” as Chart­ sient traffic from Google or Facebook and beat’s CEO, Tony Haile, recently told Advertis- tries to maximize uniques at the expense of ing Age, is time. Herb Simon would approve. delivering a satisfying experience, it’s never going to develop brand loyalty. So publishers in search of lost time have to make a choice: what kind of site do It follows that, as with any scarce resource, they want to run? those who capture users’ time should be able Upworthy’s founders say they’ve decided to charge a premium. The question is, how do to mend their ways, focusing on engagement you capture it? Time online is owned by users, factors like comments and time spent reading. not publishers, so it’s theirs to spend. But if Instead of optimizing for Facebook shares they spend it on your content, then it should and page views, they plan to return to their be yours to monetize – or so argues Haile, original mission, helping people “find impor­ whose company measures traffic for clients tant content that is as fun to share as a FAIL ranging from the Financial Times to Gawker video of some idiot surfing off his roof.” Media. Haile evangelizes for what he calls the For people like Upworthy’s Peter Koechley, Attention Web, a Web that looks beyond Chartbeat’s Tony Haile and Twitter’s/Medi­ clicks, links, uniques, and monthly active um’s Evan Williams, attention metrics are a users to actual engagement – something that make-or-break proposition. “We are in an all- no longer has to be guessed at, now that com­ out war for attention between the forces of panies like his can capture it on a user-by- inanity and the forces of things that actually user, second-by-second basis. matter to society,” Koechley told The Guard- Last September, Chartbeat became one of ian before speaking at its annual Changing several ad tech companies whose metrics for Media Summit last spring. “We feel like peo­ time spent and other not-yet-common fac­ ple paying attention and being aware of im­ tors are accredited by the Media Rating Coun­ portant issues is one of the big roles of media.” cil, the industry body in charge of such things. Implicit in this critique is the idea that Meanwhile, research by Chartbeat and other short-attention-span behavior is neither the companies – among them Google, Microsoft users’ fault nor the result of shallowness en­ and Yahoo – has demonstrated that the lon­ demic to the Web. Television didn’t have to be ger an online display ad is in view, the higher the “vast wasteland” that Newton Minow de­ the brand recall. This challenges the myth cried in the 60s, and neither does the Internet. that banner ads don’t work. True, they don’t Wastelands happen when advertisers, publish­ get a lot of click-throughs – but neither do ers and investors allow shallow metrics to highway billboards or 30-second TV spots or guide their decisions. We reward what we mea­ double-truck magazine spreads. Just because sure, and we get what we reward. No one wants a banner ad can be clicked on doesn’t mean it to turn the Web into some endless educational needs to be. Done well, display ads online TV channel, all uplift and gruel. There’ll be should be as effective at brand-building as room for LOL cats and listicles galore. The

television spots have been. The difference is question is, what else will we get? zukauskaite kotryna

50 The Milken Institute Review tk

Third Quarter 2015 51 O tk

52 The Milken Institute Review One great threat to social, economic and political stability around the world has nothing to do with extremism or authoritarian rule. It is that most gov­ ernments currently lack the means to ensure comfortable lives for ballooning growing numbers of retirees without shortchanging the young or bankrupt­ ing public coffers. There are troubling signs everywhere you look. Public pension systems that were never designed to cope with rapidly aging populations are strug­ gling to meet their obligations – and some are already cracking under the strain. Meanwhile, the rise in government debt-to-GDP ratios that followed the global financial crisis, along with paltry interest returns on the fixed- Oincome portfolios of retirement systems, has exacerbated the problem. To be sure, the pension imbroglio manifests itself differently from coun­ try to country. Brazil has an extraordinarily generous system that, for example, allows daughters of military personnel to keep their fathers’ pensions after the fathers die. This retirees kind of largesse has served to ramp up infla­ the new global tion, fray public finances and suck resources security threat from productivity-enhancing investment. by thomas j. healey By contrast, in South Korea, a mere third and catherine m. reilly of retirement-age citizens have pensions. Couple that with the fact that Koreans are backing away from the tradition of providing for elderly parents, and you have a recipe for political and cul­ tural conflict. One grim consequence is already in evidence: faced with the prospect of living out their final years in poverty, Koreans who are too old to work are committing suicide at a rate that’s tripled over the past 15 years. Indeed, for this and other reasons, South Korea now has the highest suicide rate of any high-income country. Brazil and South Korea may be polar opposites in their shortcomings in

j.d. king j.d. retirement planning, but they share a formidable challenge. In both countries,

Third Quarter 2015 53 retirees sectors, we included both sources of funding the number of people over 65 is expected to in our study.) grow threefold by 2050, leaving their current Moreover, a pension system that is appar­ pension systems increasingly inadequate or ently fiscally viable but inadequate to the task unviable, or both. To identify the sorts of still poses a risk to public finances in the long pressures and problems governments face – run. Even if the fiscal burden is not currently as well as to pinpoint remedies based on best great in countries like South Korea, China practices employed by the most-foresighted and India, they could eventually pay a steep nations – we studied pension systems in 33 price when their governments are forced to countries across five continents. provide public assistance to increasing num­ We uncovered a host of practical ways in bers of the elderly without the means to make which countries could provide for retirees ends meet. In other words, low levels of pen­ without pushing already-stressed govern­ sion-system adequacy may eventually trans­ ment budgets to the brink. Doing that, how­ late into equally low levels of sustainability. ever, calls for a difficult balancing act in On the other side of the coin, the pension which nations improve both systems of countries in­ the sustainability and the cluding Austria and adequacy of their pension Hungary are among the systems. most adequate – but also Countries are often good among the shakiest in at one task, but seldom both. terms of sustainability. For example, South Korea, While they’ve promised China and India rank ample income for retir­ among the top-five most- ees, that generosity will sustainable – that is, their come at a price. The pro­ programs place the least jected burden on public burden on public finances finances is so heavy that to provide the benefits promised. By no coin­ unless these countries seriously address sus­ cidence, though, they also rank among the tainability, they will almost certainly be un­ lowest five in terms of adequacy, as measured able to keep their promises. by their capacity to ensure sufficient income By our reckoning, the U.S. system falls to retirees, which we defined as providing within the inadequate group of pension pro­ at least 60 percent of the average wage to grams. This may come as something of a sur­ those who retire at 65. (Since pensions can prise because this country relies so heavily on originate from either the public or private private pension assets, which masks inade­ quacies in the public retirement realm. In

THOMAS HEALEY, a former assistant secretary of the truth, though, the U.S. system is highly frag­ Treasury and former partner at Goldman Sachs, is a senior mented, combining government-provided fellow at Harvard’s Kennedy School of Government. Social Security, corporate- or state-sponsored CATHERINE REILLY, formerly chief economist of Pohjola Asset Management in Finland, is a student in the Master defined-benefit (annuity-like) pension plans of Public Administration program at the Kennedy School. and tax-sheltered direct-contribution plans A more technical version of this article, “M-RCBG Associate like IRAs and 401(k)s, as well as personal sav­ Working Paper No. 39,” can be downloaded free on the

Kennedy School website. ings. Thus, while aggregate private pension king j.d.

54 The Milken Institute Review savings is impressively high, roughly half TOP AND BOTTOM COUNTRIES ON of the working population has no access to SUSTAINABILITY AND ADEQUACY employer-sponsored plans and little in the SUSTAINABILITY INDEX ADEQUACY INDEX way of private savings. Large numbers will COUNTRY SCORE COUNTRY SCORE thus be dependent on woefully inadequate TOP S. Korea...... 82 Luxembourg. . .97 FIVE Social Security checks. Australia. . . . . 75 Russia...... 83 Other countries whose benefits appear in­ India...... 74 Hungary...... 74 adequate to meet the needs of retirees include Indonesia. . . . .72 Netherlands . . .74 Mexico, Indonesia and Australia (in addition China...... 70 Austria...... 67 BOTTOM Italy...... 12 Germany. . . . . 30 to the previously mentioned China, South FIVE Austria...... 11 China...... 22 Korea and India). Australia, incidentally, reg­ Greece...... 10 Mexico...... 20 istered the lowest spending on public pen­ Hungary...... 9 S. Korea...... 4 sions as a share of GDP of all the developed Belgium...... 9 India...... 2 countries we studied. European nations, on the other hand, can source: World Bank boast of high levels of pension adequacy. However, with a few notable exceptions, in­ former Eastern Bloc countries – Poland, Esto­ cluding Switzerland and the Netherlands, nia and both the Czech and Slovak Republics – they have done little to ensure sustainability also reside within the efficient category. That’s through advance funding. At the other end of a two-sided coin, though, since their efficiency the adequacy spectrum are developing coun­ follows from the fact that, on average, retirees tries with typically meager public benefits collect pensions for a shorter period (generally and few private pension resources. 15 to 20 years) because life expectancy is lower Which countries, then, can be considered than in high-income countries. the world’s top pension stewards, balancing sustainability and adequacy to land in the ef­ what can be done? ficient space mapped out in our study? As policymakers in the United States have The Netherlands is clearly a leading inno­ learned over the past half century, there is no vator in pension-plan design. Its pension sys­ set-it-and-forget-it formula for calibrating tem is built on a combination of a universal the sustainability and adequacy of pension flat-rate pension and quasi-mandatory occu­ systems. The recipe will differ by country pational pensions covering 95 percent of the based on differences in demographics and working population. Employers and employ­ plan dynamics, and may require politically ees alike contribute to the occupational pen­ difficult midcourse corrections. Before weigh­ sion fund. Employers must fund their ing what reforms might work, however, it’s actuarial obligations each year, but after that helpful to look more closely at the nature of bear no further risk. Pensions are paid as a the problems they’re intended to address. career-average-income-based annuity, but One core reason that government pension employees share the risk, as payments can be systems are under so much stress, particularly lowered if the plan fails to meet its solvency in Western countries, is that they were de­ requirements. signed predominantly on a pay-as-you-go Other high achievers include Switzerland, basis. In a pure pay-as-you-go plan, current Denmark, Sweden and Britain. A number of revenues cover current pension benefits. If

Third Quarter 2015 55 ADEQUACY VS. SUSTAINABILITY: THE TRICKY TRADE-OFF

100 Luxembourg

90 Russian Federation 80 Hungary Netherlands

70 Austria Czech Republic Slovak France Republic Immproving efficiency 60 Belgium Portugal Countries in shaded area have Poland Switzerland fairly good balance of adequacy vs. sustainability. Italy Estonia 50 Greece Finland Denmark Countries below trade-off line United Kingdom should aspire to move in to the Slovenia Ireland Sweden shaded area. 40 United States Indonesia

ADEQUACY INDEX ADEQUACY Japan Spain Australia 30 Germany Canada China Mexico 20 Trade-off Line

10 Korea India 0 0 20 40 60 80 100

SUSTAINABILITY INDEX

source: Authors’ calculations Over-Generous Efficient Less Efficient Inadequate

the share of the population receiving benefits even as life expectancy is rising, the retire- remains stable, that is a perfectly reasonable ment age is falling in many countries, increas- way to fund a pension program. The logic be- ing the expected time spent as pensioners for hind such plans suffers, however, when the countless millions around the globe. As if this demographic profile changes. Case-in-point: weren’t enough, the problem is further com- the Baby Boomers. pounded by the fact that so many public pen- Because this post-World War II generation sion plans offer fixed monthly (and in some is far larger in numbers than its predecessors, cases, inflation-indexed) payments, with little the share of population in retirement is in- if any automatic adjustment to the plans’ ca- creasing rapidly in many parts of the world. pacities to actually sustain those payouts. Combine this with another shifting dynamic, The math is simple and the conclusions the increase in life expectancy, and you’re left troubling: the population still working will with a precipitous decline in what’s known as have to shell out ever-larger sums to cover the the old-age support ratio – that is, the ratio of cost of pensions. Indeed, barring unantici- working-age people to the population over 65. pated gains in productivity, the burden on In plain English, there are fewer people the working population will surely become available to pay for pensions and more people intolerable. In most of the countries we stud- receiving them than there were in the past. ied, that breaking point is forecast to occur Gilding this poisonous lily is the fact that, between 2030 and 2040.

56 The Milken Institute Review Early retirement is a particularly big prob­ OLD-AGE SUPPORT RATIOS ARE DECLINING GLOBALLY lem in Europe. France, for example, has one 14 of the lowest retirement ages and one of the highest life expectancies, leading to an ex­ 65 12 pected retirement duration of 25 years. By China India comparison, in countries that fit our efficient 10 parameters, the maximum expected duration is 20 years. The inescapable conclusion for 8 countries like France? They need to raise their Japan retirement age. 6 Hiking the age of retirement to track in­ U.S. creases in life expectancy (and thus stabilize 4 average years in retirement) is, indeed, an ex­ Netherlands tremely powerful tool for improving the sus­ OVER POP. TO 16-65 AGE OF POP. RATIO 2 tainability of pension systems. Even relatively 0 small increases could have a large fiscal impact. 1970 82 94 2006 18 30 42 54 The catch, of course, is that raising the re­ YEAR tirement age is hugely unpopular. In fact, source: Authors some countries (including France and Ger­ many) have actually moved in the opposite linked to final-year earnings – a practice that direction, reversing previous increases in the opens the systems to gaming at the expense of minimum age of pension eligibility. However, the funders. Happily, a growing number of there does appear to be a growing awareness countries are shifting to benefit formulas in the countries we studied that something based on lifetime earnings. This fundamental must give. A crucial step, we believe, to get­ change is not just aligning payouts with ac­ ting from here to there without a serious tual employee contributions, but significantly backlash is to raise the retirement age in grad­ reducing expenditures across entire pension ual increments. systems. There are other sound approaches policy­ Another route to improved sustainability, makers could deploy to ensure that pension of course, is to increase workers’ incentives to costs are in sync with increases in life expec­ stay on the job longer. To that end, Finland tancy. One is to introduce a longevity coeffi­ and Britain have experimented with offering cient into the pension-benefit calculus. The higher pension-accrual rates to those who concept is rather simple: as life expectancy prolong their careers. Sweden allows employ­ rises, the expected monthly payment for new ees to choose their own retirement ages with retirees automatically falls sufficiently to off­ no upper limit, adjusting monthly pension set the expected rise in cost. Finland and Italy entitlements accordingly. currently use longevity coefficients, and other governments are exploring their potential. toward broader Adding longevity coefficients alone, how­ pension coverage ever, would not put pension plans on a sus­ Countries have inadequate pension programs tainable footing if the underlying entitlements either because the share of the population are excessive. Traditionally, benefits have been that is covered is low or the promised payout

Third Quarter 2015 57 is insufficient to meet retirees’ needs. In the ing a plan to introduce compulsory annuiti­ United States, for example, just half of em­ zation of retirement savings, preventing ployees are covered by occupational pension retirees from imprudently putting their core plans. And the proportion is even lower in savings at risk and eliminating the chance Canada and South Korea, with 40 percent they will outlive their nest eggs. and 30 percent coverage, respectively. President Obama’s proposal for myRA ac­ Clearly, one key to protecting more people counts, while modest, is also a step in the is to take the decision out of their hands – right direction. These accounts would give saving for retirement is an area in which people without employer-sponsored plans households make notoriously myopic choices such as 401(k)s access to affordable retire­ – by introducing compulsory or, at a mini­ ment savings accounts with automatic depos­ mum, opt-out enrollment as part of well- its from their paychecks. designed pension programs with adequate contribution rates. building to last Governments also need to ensure that em­ The ultimate reward for countries optimizing ployees have easy access to pension systems both sustainability and adequacy is improved they can take with them as they change em­ pension efficiency. Improving efficiency is of ployers. Under U.S. regulations, 401(k) plans particular interest for countries in our less- effectively become portable after five years on efficient bracket – among them Ireland, Japan, the job. Meanwhile, Britain has introduced Germany, Spain, Canada and Finland. First, the National Employee Savings Trust, which they must build strong and durable links be­ gives workers who lack access to an employer- tween payments and long-term sustainability sponsored plan a low-cost, portable retire­ into their pension systems. This means both ment savings account with automatic sponsors and beneficiaries must share the risks,

enrollment. Meanwhile, Australia is consider­ a characteristic clearly at odds with traditional king j.d.

58 The Milken Institute Review defined-benefit plans in which plan sponsors achieve the best results, the assets should be (and sometimes government pension insur­ invested in diversified portfolios that include ers) bear the lion’s share of the risk. risky assets. For plans in which beneficiaries Two intriguing new approaches in this have discretion in investment choices, it is vein are “notional defined contribution plans” important to provide savers with appropriate, and “collective defined contribution plans.” low-cost default portfolios, as many savers With an NDC, contributions are recorded as lack the financial literacy to make optimal in­ notional accounts, to which a rate of return vestment decisions for themselves. (typically the rate of GDP growth) is applied. The balance in the account is then converted beacons of encouragement to an income stream upon retirement. By Despite the political and economic complica­ linking contributions to GDP growth, no­ tions of changing entrenched public pension tional accounts prevent the pension burden systems, extensive reforms have in fact been from outstripping the economy’s ability to achieved by a handful of progressive nations. fund them. They are typically used for re­ The Netherlands and Denmark, for example, forming pay-as-you-go systems. have introduced collective defined contribu­ Under collective defined contribution tion plans in which payouts are adjusted if plans, which are used in conjunction with solvency limits are breached. Sweden now has advance or prefunded plans, proceeds are a notional defined contribution plan in which pooled in centrally administered investment benefits depend on GDP growth, while Brit­ funds rather than put in individual accounts. ain and Poland have expanded their direct Beneficiaries thus bear both market and lon­ contribution systems. gevity risks collectively rather than individu­ For most countries, though, the shift from ally, giving the plans some of the risk-sharing inadequacy and/or unsustainability to high characteristics of traditional defined-benefit efficiency will be considerably more difficult. systems. Since the pool contains members in In Europe, for example, many countries with different phases of their lives, the fund is able steep pension liabilities are also saddled with to maintain higher investment rates and thus high government debt. While raising the re­ deliver better returns over the long run than tirement age in line with life expectancy individual plans. Benefit payments are calcu­ would clearly help put these systems on a lated on the basis of lifetime contributions more sustainable course, it would first require and annuitized upon retirement. major labor market reforms to make it easier It makes eminent sense for plan sponsors for people to extend their working lives. to seek to maximize returns on advance- If inefficient pension systems are to stand funded assets within acceptable risk parame­ any chance of survival over the long term, ters. But some collectively managed pension sponsors must step up now and push for dra­ funds – including some of those in the United matic change. They can take inspiration from States, China and Japan – are constrained by governments that have already retooled pub­ requirements that they invest their funds in lic pension systems to reflect changing demo­ domestic government bonds. This means graphics, while drawing on best practices they are not reaping the full potential rewards from other systems. Successful pension re­ of advance funding their pension assets. For formers can and should serve as beacons collectively managed pension programs to for policymakers everywhere.

Third Quarter 2015 59 managing

riskin drug development The Case for FDA Swaps and Annuities

by tomas j. philipson

Profit in the global health care industry is highly concentrated in the United States, the largest market for pharmaceuticals and medical devices in the world. As a result, most health care innovators around the globe seek approval from the U.S. Food and Drug Administration. However, as is well known, the costs of gaining this approval are formi- Pdable. The average development cost for each drug and biologic (medicine derived from living organisms) is $1.2 billion, typically spread over about a decade of R&D, testing and review. Even more dispiriting, roughly seven out of eight candidates for approval never reach market.

60 The Milken Institute Review Third Quarter 2015 61 fda swaps and annuities that could be used to hedge the risk of non- It’s widely agreed that rigorous testing is es­ approval or unanticipated delays in approval. sential to ensure public safety. Plainly, though, The first I call an FDA swap, which in many the process creates substantial uncertainty for ways imitates the form and function of the investors. I believe that hedging tools similar credit default swaps already widely used to to those routinely used in financial markets hedge credit risk in bond markets. The sec­ could improve the risk-return trade-off, at­ ond I call an FDA annuity, which hedges tracting investors to a field that would benefit against approval delays by paying the inves­ from access to more private capital. tors an agreed-upon sum during the life of the testing process. running the fda gauntlet In seeking FDA approval, innovators face two fda swaps risks. First, they may never earn a penny if the The swaps would work as insurance against FDA concludes that the innovation in ques­ non-approval. The basic idea is straightfor­ tion isn’t up to U.S. standards of safety and ef­ ward. The buyer of the swap contract pays a ficacy. Second, the time-consuming process of monthly premium to the seller. If the drug is regulatory review reduces investors’ return be­ not approved (or if the product isn’t resub­ cause approval may be unexpectedly delayed mitted for consideration to the next stage in by months or years, commensurately shorten­ the approval process) by the maturity date of ing the period in which the owner of the pat­ the contract, the buyer is paid an amount ent has market exclusivity. I propose creating specified in the contract. financial instruments that would help to man­ The devil is, as usual, in the details. The age these risks by encouraging outside inves­ swap contract would also need to specify what tors to share them with the innovators. would happen if there were a change in owner­ The FDA’s approval process can be charted ship of the product and whether the seller of by several milestones: the swap would gain possession of the buyer’s • Filing an initial drug application. intellectual property in the event of non- • Safety testing in Phase I. approval. Contracts, moreover, would need • Further safety and dosage tests in Phase II. to precisely specify what constitutes non- • Larger-scale efficacy testing in Phase III. approval. They would also need to specify • Final approval of the new drug applica­ how much would be paid, and when, if testing tion, which is filed after all the evidence has were prolonged. But these issues are hardly been generated and assessed. unique to FDA swaps. They are faced (and Drugs can be rejected at any stage – even surmounted) every day in the creation of de­ after successful completion of Phase III test­ rivative contracts that are used to manage ing. (A similar process governs approvals of risks ranging from interest-rate variation to biologics and medical devices.) extreme weather. I consider two sorts of financial derivatives fda annuities

TOMAS J. PHILIPSON is a senior fellow at the Milken FDA swaps would insure innovators against Institute, the Daniel Levin professor of public policy at the the risk of non-approval. By contrast, FDA University of Chicago, director of the health care program annuities would serve as insurance against at the university’s Becker Friedman Institute and a founder

of Precision Health Economics LLC. the risk that success in the approval process john ueland previous page:

62 The Milken Institute Review would take longer than expected. For small- SURVIVAL CURVES FOR FINAL APPROVALS molecule drugs (most often, drugs taken 100% orally), the first three FDA phases of clinical development are estimated to take an average 90 1979-86 of about 24 months, 30 months and 42 80 months, respectively, with the final approval averaging an additional year. 70 1986-92 However, as the figure to the right sug­ 60 gests, there is large variance, and thus devel­ oper risk, in approval times. The graph shows 50 the share of products that have not yet been 40 decided upon by the FDA, before and after PDUFA II (1997) passage of the Prescription Drug User Fee Act 30 of 1992 (PDUFA I) and the amended Act of REMAINING APPROVALS PERCENT 20 1997 (PDFUA II), which permitted the FDA PDUFA I (1992) to charge fees that cover the cost of speeding 10 the review process. 0 The risks inherent in these regulatory “sur­ 0 6 12 18 24 30 36 42 48 54 60 66 72 78 84 90 vival curves” could be insured by annuity-like APPROVAL TIME (MONTHS) instruments, just as human survival times are source: Author insured by lifetime income annuities. For even if a product ultimately gains FDA ap­ mulation period ended, the annuity would proval, the statistical tails on approval times click on, just like a standard lifetime income can create enormous variability in the rate of annuity. return on the developer’s investment. Consider the consequences of a delay of, one size needn’t fit all say, six months for a blockbuster drug with Given the many milestones along the way to likely monthly earnings of $100 million. The a regulatory decision at which non-approval $600 million in lost earnings can never be re­ or delays can take place, one would expect covered, because the patent expiration date that swaps and annuities would be tailored to remains unchanged. Note, moreover, that the specific testing and evaluation stages. For ex­ losses are in near-term revenue, which is more ample, swaps might be written only for the heavily weighted in rate-of-return calcula­ phase a product is entering, or for non- tions because future income flows must be approval in any of the remaining phases until discounted to adjust for the opportunity cost approval. of the investors’ capital. Swaps might also be created for whole bas­ FDA annuities would insure investors kets of compounds being reviewed by the against delays in the process, assuming the FDA. One could imagine, for example, that product ultimately received approval. The the entire pipeline of a given manufacturer buyer of the annuity would make monthly might be hedged, not unlike the way credit de­ payments to the seller for an agreed-upon pe­ fault swaps are sometimes written on indexes riod (or, alternatively, buy the annuity up­ or specific baskets of bonds. Consider, too, front with a single payment). After this accu­ that securitized default obligations, similar to

Third Quarter 2015 63 fda swaps and annuities rights, acquirers agree to make additional pay­ credit default obligations, could be created for ments once the acquired companies hit speci­ these baskets of products. fied regulatory benchmarks. For example, Cel­ gene’s $3 billion deal for Abraxis BioScience in if we built it… 2010 included a contingent-value-rights pro­ These instruments mimic many instruments vision conditioned upon regulatory approval used successfully outside of health care. of the cancer drug Abraxane. The terms of the Credit default swaps are like the proposed $20 billion sale of Genzyme Corp. to Sanofi- FDA swaps because lenders’ defaults are simi­ Aventis in 2011 was tied to the performance of lar to FDA non-approval. They were intro­ Campath, another cancer medication. An in­ duced in the early 1990s, and their use has teresting aspect of the aforementioned rights blossomed in the decades since because they is that they were listed separately on exchanges are so attractive for both hedging and specu­ and proved quite liquid in trading.

T he corporate acquisitions of biotech innovators completed in recent years offer indirect evidence of the potential value of hedging contracts for medical innovations.

lating. In 2012, their reported aggregate no­ Regulations to ensure transparency would tional value exceeded $25 trillion (yes, tril­ be needed for both over-the-counter and lion) worldwide. exchange-traded hedging instruments. But Credit default swaps are non-standardized much of the heavy lifting in this regard would contracts and are thus not traded on exchanges. likely be done by private enterprise with little However, markets for non-standardized FDA official prompting. There are already firms swaps and annuities could still prove to be (such as Claravant) emerging in the market­ quite liquid, just as markets for non-medical place that rate the risks associated with pipe­ swaps are today. Indeed, one would presume line medical products in much the way that the stakeholders willing to participate Moody’s rates the bonds underlying credit in such markets for corporations engaged default swap contracts. In addition, many fi­ in medical R&D – especially portfolio mana­ nancial institutions conduct their own sur­ gers, hedge funds and pension funds, as well veys of independent experts to better assess as pharma companies with competing or development-related FDA risk. complementary drugs whose value could be Despite transparency issues, it is impor­ affected by approval or non-approval – tant to keep in mind that many markets ex­ would also have an appetite for FDA risk hibit substantial liquidity despite asymme­ instruments. tries in information, in which one party to a The corporate acquisitions of biotech inno­ transaction knows a great deal more than the vators completed in recent years offer indirect other. Indeed, issuers of stocks and bonds evidence of the potential value of hedging con­ often know much more about the value of tracts for medical innovations. In deal struc­ these securities than buyers, yet substantial li­ tures involving so-called contingent value quidity exists in most initial public offerings.

64 The Milken Institute Review FDA swaps and annuities may be particu­ R&D derivatives might assist broader func­ larly valuable for products in late-phase devel­ tions. In a liquid market, trading prices serve opment because the acquisition of companies an important informative role. Speculation with early-stage pipeline products by large may arise because of differences in opinion pharmas essentially serves as non-approval in­ about risks affecting the value of a financial surance for smaller biotech companies. On the instrument. In addition, if public pricing of sell side, the small biotech gets a fixed payment the instruments discussed becomes available, even if it fails to deliver valuable products later. it will be useful for understanding how the In effect, the small biotech purchases insur­ market assesses regulatory risks, in much the ance by giving up part of its potential profit to same way that corporate debt yields com­ the big pharma buyer in exchange for a limited pared to Treasury yields offer information downside in case of non-approval. On the buy about the markets’ views on corporate de­ side, the big pharma company may acquire faults. FDA swap prices would be valuable in portfolios of potential drugs of which, perhaps, predicting future FDA rejection rates for the one in ten or so compounds succeeds. It thus same reason corporate yields predict defaults. acts like an insurance company, reducing risk For single-product biotechs, there will be ar­ through diversification. bitrage opportunities for exploiting any mis­

john ueland Note, too, that market-making in medical pricing of regular debt or FDA swaps.

Third Quarter 2015 65 fda swaps and annuities ties. Life insurance offers a useful analogy. A policy has value for individual customers be­ enter the nonprofits cause it removes the financial uncertainty as­ The liquidity of these instruments might be sociated with mortality. This is true even enhanced by the infusion of capital from third though aggregate mortality rates may be cer­ parties, notably from nonprofit patient groups tain, making them easy to absorb by counter­ and foundations that are increasingly taking parties offering the insurance. on the role of equity investors rather than Another characteristic of the market for mere donors in the development of new drugs FDA derivatives that increases the potential and devices. Such organizations are legally value to counterparties is how the risk relates permitted to profit from investments. They to their other holdings. The holy grail of differ from for-profit firms, however, in that financial-portfolio investment is diversifica­ they must reinvest the gains in ways that fur­ tion that allows investors to maximize ex­ ther their philanthropic missions. So-called pected returns for the level of risk they deem venture philanthropy (in which nonprofits fi­ acceptable. But true diversification is not easy nance for-profits) may be particularly useful to manage in an era in which the returns in boosting incentives for small firms. from the big, liquid securities markets are For example, the Cystic Fibrosis Founda­ positively correlated. And it is likely to be­ tion sold the rights to its patented drugs, in­ come even harder as the global economy be­ cluding Kalydeco, for $3.3 billion. This left the comes increasingly integrated. foundation in the enviable position of need­ By contrast, it is unlikely that approval be­ ing to find other productive ways to fight the havior on the part of the FDA, driven largely disease. One potential approach would be to by the biological reaction of new molecules in make an otherwise-illiquid market for medi­ humans, varies with aggregate economic be­ cal R&D derivatives liquid by providing fund­ havior, such as the business cycle. This lack of ing and eliminating any negative bid-ask correlation with other asset classes implies spreads between for-profit parties. In other that FDA derivatives ought to be especially at­ words, third-party nonprofits might choose tractive to investors seeking diversification in to subsidize part of a swap or annuity pur­ their financial portfolios. So in the process of chase with the goal of creating a viable market. reducing the real cost of medical innovation Such third-party subsidies might even by making it cheaper to manage risk, medical come from less-obvious sources within the R&D derivatives would offer an attractive way biopharmaceutical industry. For example, to tame financial portfolio risk to the parties new regulations might be written to allow on the other side of the transaction. pharmas to repatriate foreign earnings with­ It is, of course, important to keep the pri­ out incurring tax liability if the funds were mary goal here front and center: by making it used to eliminate negative bid-ask spreads on easier to manage risk, derivatives could pro­ FDA swaps. vide a much-needed boost to private invest­ ment in medical technology. But they could the other side of the trade also provide an intriguing bonus in the form The less variation there is over time in aggre- of a new resource for financial diversification gate FDA approval behavior, the more attrac­ in a world in which true diversification is tive these instruments may be to counterpar­ becoming ever more elusive.

66 The Milken Institute Review book excerpt

Diversity Explosion

Regular readers of the Milken Institute by william h. frey Review are familiar with the byline of the

eminent demographer Bill Frey. He’s a fre­

quent contributor to the Review as well as a senior fellow at the Institute, offering the latest on who lives in America (and Rwhere and why) in the form of bite-size “charticles.” Bill, by the way, apparently

never sleeps. He’s also a senior fellow in the Metropolitan

Policy Program at the Brookings Institution and a research

professor at the University of Michigan’s Population Studies

Center. ¶ If you’ve found Bill’s charticles as interesting as I

have, you’re going to devour his latest book, Diversity

Explosion: How New Racial Demographics Are Remaking America. He’s sifted through

Himalayas of data to explain in nontechnical terms how the country is being radically

transformed by population dynamics. Here, we excerpt the chapter on neighborhoods.

It’s an upbeat story – one that suggests that the conditions creating racial conflict from

Ferguson to Baltimore may be on the wane. —Peter Passell

Third Quarter 2015 67 One of the most intimate settings of American life — one that has an especially important role in shaping community race relations — is the neighborhood.

Neighborhoods are where Americans so­ AVERAGE BLACK-WHITE SEGREGATION LEVEL Ocialize, shop and attend school and where civic matters have the most impact. Most di­ rectly related to the subject of this book is the fact that the racial makeup of a neighborhood can either foster or prevent interactions with 65% 68% 73% other groups. And for many Americans, the term that comes to mind when thinking about 656873 747361535047 1930 1940 1950 race and neighborhoods is segregation. This term conjures up the image of the stark sepa­ ration between blacks and whites across broad note: Segregation levels represent percent of blacks who would have to move to other neighborhoods to be distributed similarly swaths of American neighborhoods that pre­ to whites. Values range from 0 (complete integration) to 100 (complete segregation). vailed for much of the 20th century, when seg­ source: Cutler, Glaeser and Vigdor, Journal of Political Economy (1999); regation was hardly voluntary on the part of U.S. Census, 1990-2010 blacks. It was deeply rooted in the discrimina­ tory forces that denied blacks anything re­ suburbs or other parts of the country. sembling equal access to jobs, adequate The 21st century began with some ves­ schooling and public services – both before tiges of past segregation – but also in the and after the civil rights movement of the midst of the new diversity explosion, which 1960s. holds the potential to reshape the concept of A less stark type of segregation, most neighborhood segregation and integration as pronounced in the earlier part of the 20th the country moves forward. In the case of century, was seen in the separate neighbor­ blacks, the emergence of a middle class, their hoods composed of white ethnic immigrant continuing flow to prosperous metropolitan groups in major cities as they assimilated regions in the South and their more wide­ into American life. The immigrant en­ spread movement to the suburbs are driving claves of Irish, Poles, Italians, Jews and oth­ a shift toward less segregated neighborhood ers created economic and cultural comfort settings than was the norm for much of the zones for them and their co-ethnics. But 20th century. compared with black ghettos, these enclaves The 21st-century counterpart to early were relatively transitory, usually lasting no 20th -century immigrant enclaves is the longer than a generation. As emigration from neighborhood composed of new minorities – Europe waned in the middle of the 20th cen­ Hispanics and Asians. Yet their recent, tury, these areas became less prominent as widespread dispersion beyond the traditional later generations voluntarily moved to the melting pots also provides opportunities

68 The Milken Institute Review for greater integration at the local level, borhoods. It ranges from a value of 0 although perhaps after an initial period of (complete integration), where blacks and self-segregation. whites are distributed similarly across neigh­ borhoods, to 100 (complete segregation), from ghettos to the decline in where blacks and whites live in completely black segregation different neighborhoods. Values can be inter­ The recent decline in black segregation is preted as the percentage of blacks who would especially remarkable when viewed in the have to change neighborhoods to become context of what might be termed the “ghetto­ completely integrated with whites. Values of

65687374% 73% 61% 53% 74736153504750% 47% 1960 1970 1980 1990 2000 2010

ization” of America’s black population for 60 and above are considered high; values of much of the 20th century. The rise of black 30 and below are considered low. neighborhood segregation in large urban ghettos is one of the most defining and re­ the great migration and the rise grettable episodes in America’s social and of black segregation demographic history. The Great Migration of blacks from the Beginning more than a half-century after South to Northern cities was a major factor the Emancipation Proclamation, black ghet­ in the rise of black ghettos, which were toization was bound up in the separation of later perpetuated by a host of private- most of the nation’s black population from and public-sector forces. The first wave mainstream society, which limited blacks’ ac­ of the Great Migration, between 1910 cess to schools, public services, private-sector and 1930, drew large numbers of blacks to amenities and, ultimately, opportunities for Northern cities including Chicago, Detroit, upward mobility. Black neighborhood segre­ Cleveland, New York and Philadelphia. gation continued unabated until 1970, after However, after arrival they found that they which it began to loosen over the next two de­ were allowed to live only in certain neigh­ cades, with declines becoming more pervasive borhoods because of the white backlash as the country approached the 21st century. against integration. This pattern is depicted in the figure above, That backlash first erupted as open vio­ which shows average black-white segregation lence in the form of riots, bombings and other levels for U.S. metropolitan areas between forms of intimidation to keep blacks from en­ 1930 and 2010. Segregation levels are mea­ tering all-white neighborhoods. In addition, sured by the “dissimilarity index,” which, as homeowner associations were formed to work used here, compares black and white popula­ with real estate agents and city planning of­ tion distributions across metropolitan neigh­ fices to find ways to restrict black movement.

Third Quarter 2015 69 One common device was to attach a restric­ right refusal to sell or rent homes to blacks in tive covenant to a deed, specifying that a those locations. Local suburban governments property could not be occupied by blacks or also practiced exclusionary zoning to limit other groups deemed undesirable for a long areas where blacks could obtain residences. period, such as 99 years. These covenants Lending practices such as “redlining” also were deemed legal by the Supreme Court in were designed to restrict blacks, continuing a 1926, a decision that was only overturned in process that began in the 1930s. Their impact 1948 at the behest of the NAACP. was magnified in the postwar period due to Even when population pressure made the expansion of mostly suburban housing black expansion into white neighborhoods and the availability of federally insured loans inevitable, coalitions of real estate agents em­ that, in practice, were given largely to whites.

A national survey in 1942 showed that 84 percent of whites agreed that “there should be separate sections in towns and cities for Negroes to live in.”

ployed a strategy called blockbusting – induc­ At the same time, the concentration of poor ing a black family to become the first black urban blacks in city neighborhoods was exac­ occupants in a neighborhood in order to erbated by 1960s-era public housing pro­ scare resident whites into moving. Blockbust­ grams that, while eliminating blighted ghetto ing ensured that black expansion could be re­ neighborhoods, re-segregated black residents stricted to selected neighborhoods as they into large housing complexes. turned over from white to black, and it en­ Although heavily focused on cities in the abled agents to reap above-market profits Northeast and Midwest, these practices oc­ from black buyers. In 1940, black segregation curred in all regions of the country. In 1970, already was high and most urban blacks the average black-white segregation level lived in almost exclusively black ghettos. A among all metropolitan areas was well above national survey in 1942 showed that 84 70. But in the large metropolitan areas where percent of whites agreed that “there should most blacks lived, segregation levels were be separate sections in towns and cities for much higher, with levels of 90 or more in Negroes to live in.” Chicago, Detroit and Los Angeles. Segrega­ The second wave of the Great Migration tion levels greater than 80 were found in the took place during the post-World War II pe­ Southern metropolitan areas of Atlanta, Dal­ riod, but for the most part, blacks were ex­ las, Miami and Washington, D.C. cluded from the postwar suburbanization movement. Again, strong resistance among segregation in decline whites to accepting blacks as neighbors led On the heels of large urban riots in the 1960s real estate agents to employ discriminatory and the Kerner Commission’s warning that practices in selling and renting homes, in­ America was evolving into two racially and cluding the steering of blacks away from spatially separated societies, Congress passed available white neighborhoods or the out­ the 1968 Fair Housing Act – key civil rights

70 The Milken Institute Review BLACK-WHITE SEGREGATION LEVELS IN SELECTED METROPOLITAN AREAS

Chicago Detroit Cleveland Dallas Atlanta Houston 1970 9292% 9191% 8888% 8787% 8282% 7878% 1990 8484% 8888% 8383% 6363% 6666% 6666% 2010 7676% 7575% 7474% 5757% 5959% 6161% note: 1970 pertains to all blacks, while 1990 and 2010 pertain to non-Hispanic blacks. source: Douglas S. Massey and Nancy Denton, American Apartheid: Segregation and the Making of the Underclass for 1970; 1990 and 2010 U.S. censuses. legislation that prohibited racial bias in the attainment for black households did not sale and rental of housing and, by extension, translate into access to appreciably more inte­ discouraged racial segregation. grated or higher status neighborhoods. Areas These events raised awareness of the hard­ with the largest, most concentrated black ship that extreme racial segregation was im­ populations, including Chicago, Detroit posing on blacks, cities and the society at and Cleveland, remained highly segre­ large. Soon thereafter, as part of the “open gated, with minimal black suburban­ housing” movement, additional legislation ization. On average, large non-Southern and court decisions as well as government metropolitan areas showed declines of and citizen-initiated efforts were put in ac­ fewer than 5 points in segregation between tion to discourage discriminatory lending 1970 and 1980. and real estate practices. For example, the In American Apartheid, published in Home Mortgage Disclosure Act required fi­ 1998, Douglas Massey and Nancy Denton nancial institutions to report information on argued that the open housing efforts in the the race and income of those who obtained or immediate post-civil rights years had little were denied mortgages. impact on the strong institutional forces that Segregation began to decline between maintained segregation. 1970 and 1980, although the greatest declines In spite of legislation, an array of informal occurred in modest-size metropolitan areas and quasi-legal discriminatory practices on the in the South and West that housed relatively part of the real estate industry and financial small numbers of blacks. Unlike with other institutions continued, some of which were groups, an increase in income or educational documented in housing market “auditing”

Third Quarter 2015 71 Although all minority groups still show a preference for members of their own group as neighbors, there is also tolerance for other groups — particularly in multiracial settings.

investigations by the Department of Housing the beginnings of and Urban Development. Yet declines in black-white integration black-white segregation continued between The 2010 census shows that black-white segre­ 1980 and 1990, again with the greatest reduc­ gation is still quite evident in the United States. tions occurring in Southern and Western cit­ But it also reveals forces that will lead to an eas­ ies – including those with considerable black ing of segregation to well below the ghettoized populations. Between 1970 and 1990, segre­ patterns of the mid-20th century. Among all gation levels declined from 87 to 63 in Dallas, metropolitan areas, the average segregation from 82 to 66 in Atlanta, and from 78 to 66 in level is 47. Among the 100 largest metropoli­ Houston. tan areas, including those with the largest Many of these areas were beginning to at­ black populations, segregation stands at 55 – tract black migrants, part of the emerging re­ well below the levels of 70 or more in the im­ verse black movement to the South. The mediate postwar decades. A total of 93 of these overall population gains in these areas, part areas showed declines in segregation between of a general migration to the Sun Belt, helped 1990 and 2010, making neighborhoods with­ to trigger increased suburban development out any black residents extremely rare. and growth. Because substantial suburban Some of the trends spurring these shifts growth in these areas took place after the were suggested in the 1990s. One is the contin­ passage of the Fair Housing Act, the impact ued decline in segregation in Southern areas of that law in reducing segregation was that are magnets for both blacks and whites, greater there than in more stagnant areas of as well as in areas in the West where new sub­ the country. urban housing continues to be constructed. The large Northern areas with the high­ As more of the black population moves to est segregation levels were still most resistant these areas, fewer of the nation’s blacks will to integration. As of 1990, Chicago, Cleve­ live in highly segregated neighborhoods. land and Detroit continued to show segre­ The pattern of declining segregation is be­ gation levels above 80, and the majority of ginning to spread outward from Atlanta, Dal­ their Northern counterparts registered levels las and other larger Southern metropolitan in the high 70s or above. Most of these areas areas. For example, Tampa, Bradenton and had relatively modest growth and therefore Lakeland (all in Florida) are among the cities little new housing compared with their where segregation has declined markedly Southern and Western counterparts. Within since 1990. them, old stereotypes persisted about which In the North, black population losses in communities were appropriate for whites and cities, the demolition of large public housing blacks, with whites expressing a strong dis­ projects and increased suburbanization of taste for integrated neighborhoods. blacks are contributing to declines in segrega­

72 The Milken Institute Review BLACK–WHITE SEGREGATION, 2010 FOR THE 87 OF THE LARGEST 100 METROPOLITAN AREAS WHERE BLACKS REPRESENT AT LEAST 3 PERCENT OF THE TOTAL POPULATION.

Milwaukee Detroit Cleveland Chicago

New York Philadelphia Denver Washington, DC

Las Vegas Raleigh Los Angeles Charlotte

Tucson Atlanta Dallas

Houston Tampa

SEGREGATION LEVEL 0 indicates complete integration, 100 indicates complete segregation Below 50 50 to 60 60 to 70 70 and over source: 2010 U.S. Census tion. In Detroit, segregation levels declined In the 1980s and 1990s, there already was from 88 in 1990 to 75 in 2010. Chicago and a marked tendency for black-white segrega­ Cleveland, among others, also experienced tion to decline in multiracial metropolitan marked declines during this period. areas, especially those in Melting Pot re­ Another impetus toward less segregation is gions such as Houston, Dallas, Los Angeles the growth of the Hispanic and Asian popu­ and Riverside (Calif.). The 2010 census lations. Although all minority groups still shows that some of the lowest black-white show a preference for members of their own segregation scores are in areas with large or group as neighbors, there is also tolerance for growing new minority populations, includ­ other groups – particularly in multiracial set­ ing Phoenix, Las Vegas, Riverside, Tucson, tings. That leaves open the possibility that in Stockton and San Antonio. Several South­ metropolitan areas where blacks are one of eastern areas that have had notable recent de­ two or more major minority groups, other clines in black-white segregation, such as the minorities can serve to buffer these divisions. cities in Florida cited above, also are home to

Third Quarter 2015 73 BLACK-WHITE SEGREGATION RANKS, 2010 and white incomes. The upward mobility of a segment of the black population now brings MOST SEGREGATED LEAST SEGREGATED SEGREGATION SEGREGATION the promise of greater declines in segregation. RANK/AREA LEVEL RANK/AREA LEVEL The current geography of black-white seg­

1 Milwaukee...... 82 1 Tucson...... 37 regation shows a noticeable regional differ­ 2 New York...... 78 2 Las Vegas...... 38 ence, but segregation scores are generally 3 Chicago...... 76 3 Colorado Springs. . . 39 lower than in 1990. Among 87 large areas with 4 Detroit...... 75 4 Charleston...... 42 at least minimal black populations, 47 areas, 5 Cleveland ...... 74 5 Raleigh...... 42 located primarily in the South and West, show 6 Buffalo...... 73 6 Phoenix...... 44 7 St. Louis...... 72 7 Greenville...... 44 scores below a “high” value of 60. In contrast, 8 Cincinnati...... 69 8 Lakeland...... 44 in 1990 only 29 areas registered such scores. 9 Philadelphia...... 68 9 Augusta...... 45 Among the new areas with segregation levels 1 0 Los Angeles...... 68 1 0 Riverside ...... 46 below 60 are Atlanta, Louisville, Dallas, Nash­ ville and Tampa. Three Northern metros, source: 2010 U.S. Census Minneapolis-St. Paul, Des Moines and Provi­ dence, also fell below 60. About one-fifth of substantial Hispanic populations. The in­ these metros have segregation scores below 50, creased multiracial character of New Sun Belt including Western metros such as Phoenix metropolitan areas, both inside and outside and Las Vegas and Southeastern metros such the South, should pave the way for even fur­ as Charleston and Raleigh. ther attenuation of segregation in metropoli­ Even more revealing is the reduction of tan areas. segregation in areas with traditionally higher Another reason to expect further mean­ levels of separation. ingful declines in black-white segregation is Each of the areas with segregation levels of the emergence of the black middle class, 60 or more showed declines – by more than 5 along with the increased ability of blacks to points for most – since 1990. In 1990, 27 areas translate economic advancement into hous­ had segregation scores exceeding 70, with five ing in less segregated and higher quality areas (Detroit, Chicago, Cleveland, Milwau­ neighborhoods. Because of the refusal of kee and Buffalo) exceeding 80. By 2010, only whites to accept any blacks in their neigh­ seven areas were above that level, and only borhoods, there was scant evidence as recently one (Milwaukee) stayed above 80. A number as 1980 of any translation of improvement of forces – increased black suburbanization, in blacks’ personal economic circumstances demolition of urban public housing, losses of into better neighborhood quality. black residents and some reduction in the White attitudes began to change in the discriminatory practices of financial institu­ 1990s. Although still more limited by persis­ tions and real estate agents – are contributing tent discriminatory attitudes and social iner­ to new reductions in segregation in places tia than Hispanics and Asians, upper-income where, until recently, segregation would not and more educated blacks are now more able budge. to live in integrated, affluent neighborhoods The recent widespread reduction in black- than blacks who are less well off. Segregation white segregation should not be confused is also less prevalent in metropolitan areas with its elimination. Segregation levels in the where there is greater convergence of black 50 to 60 range, found in many large metropol­

74 The Milken Institute Review itan areas, are still substantial by any reason­ BLACK, HISPANIC AND ASIAN AVERAGE able standard. Social and demographic inertia, SEGREGATION LEVELS FOR 100 LARGEST particularly in older, slower-growing metro­ METROPOLITAN AREAS politan areas, still isolates many black children Blacks Hispanics Asians in high-poverty areas in ways that perpetuate disadvantages across generations and deprive a substantial segment of the black population of the wherewithal to relocate to higher qual­ 1990 61% 39% 38% ity communities. Yet new forces affecting black-white segre­ 613938 gation are ushering in an era that will be quite different from the era of wholesale ghettoization of the black population 50 2000 59% 44% 40% years ago. The shift of the black population to 594440 more prosperous areas in the South, the movement of younger generations of blacks to the suburbs, the general change in racial 2010 55% 44% 40% relations among blacks and whites, and the substantial period that fair housing laws and 554440 practices have had to take root have dramati­ cally expanded the opportunities to increase note: Segregation levels represent the percent of blacks, Hispanics or Asians who would have to move across neighborhoods to be distrib- integration. uted similarly to whites. Values range from 0 (complete integration) Moreover, the growth and dispersion of to 100 (complete segregation). source: 1990-2010 censuses new minority groups to all parts of the coun­ try, especially to the New Sun Belt where all groups are moving, have the potential to ease the country. Hispanic and Asian segrega­ the animosities associated with the long­ tion levels are, on average, markedly standing black-white divide. Asian, Hispanic lower than those for blacks. Yet as black and soon multiracial groups will serve to buf­ segregation levels continue to decrease fer those animosities at the neighborhood for the majority of metropolitan areas, no and community levels. similar trend exists for the newer minorities. In fact, among the 100 largest metropolitan hispanic and asian segregation areas, average Hispanic and Asian segrega­ in flux tion appears flat between 2000 and 2010 The severity and persistence of black segrega­ after increasing somewhat in the 1990s. tion in the 20th century stand in contrast to Although this may not appear to follow the lower, more transitory segregation trends the transitory paths of ethnic immigrants a of earlier white immigrant groups as well as to century ago, there is an important caveat. the current segregation patterns of Hispanics Both Hispanic and Asian communities con­ and Asians. Both Hispanics and Asians owe tinue to be replenished with new immigrants, their growth in numbers to the more open whose segregation levels are higher than those immigration laws since 1965, and like earlier of their native-born counterparts. So the aver­ groups, they have continued to disperse across age “static” segregation picture for Hispanics

Third Quarter 2015 75 HISPANIC-WHITE SEGREGATION, 2010 SEGREGATION FOR THE 93 OF THE LARGEST 100 METROPOLITAN AREAS WITH HISPANIC POPULATIONS OF AT LEAST 3 PERCENT OF THE TOTAL POPULATION.

Springfield Boston

Salt Lake City New York Chicago Philadelphia

Las Vegas Nashville Los Raleigh Angeles Phoenix Greenville

Atlanta Dallas Orlando

Houston Palm Bay

Honolulu

SEGREGATION LEVEL 0 indicates complete integration, 100 indicates complete segregation Below 40 40 to 50 50 to 60 60 and over

source: 2010 U.S. Census

and Asians conflates both a turn toward inte­ play out across individual metropolitan areas gration among long-term residents and higher that vary in size, growth and makeup with re­ segregation levels among new immigrants. gard to their Hispanic and Asian groups. Be­ In Where We Live Now, the sociologist cause there is no typical segregation pattern John Iceland of Penn State provides evi­ for metropolitan areas, it is useful to see how dence that “spatial assimilation” into more they differ. integrated neighborhoods is occurring among Hispanics and Asians who have lived Hispanic Segregation Across in the United States the longest and among Metropolitan Areas those who were born in the United States. It Hispanic segregation patterns vary across re­ is also the case that Hispanic and Asian resi­ gions of the country, reflecting Hispanic set­ dents with higher incomes and education are tlement histories and the locations of primary able to translate their status into residence in Hispanic groups. The map above displays more integrated neighborhoods. These trends Hispanic-white segregation levels in 2010 for

76 The Milken Institute Review 93 large metropolitan areas with a significant GREATEST INCREASES IN HISPANIC-WHITE Hispanic population. Segregation levels range SEGREGATION, 1990–2010 from a low value of 25 to a high value of 63. SEGREGATION LEVEL Two kinds of metropolitan areas are posi­ 2010 1990-2010 tioned at the upper end of the Hispanic seg­ RANK/AREA LEVEL INCREASE regation spectrum. First are the areas that are 1 Miami...... 57...... +25 home to the largest Hispanic populations and 2 Nashville...... 48...... +24 have served as major gateways for Hispanic 3 Scranton...... 53...... +23 immigration. Both Los Angeles and New York 4 Indianapolis...... 47...... +21 5 Tulsa...... 45...... +20 have segregation levels of 62. Miami, Chicago, 6 Memphis...... 51...... +18 San Francisco, San Diego, Dallas and Hous­ 7 Raleigh...... 37...... +17 ton register scores of 50 or higher. Segrega­ 8 Greensboro...... 41...... +17 tion in most of these areas did not change 9 Little Rock...... 40...... +16 dramatically in the past two decades because 10 Birmingham ...... 45...... +16 11 Charlotte...... 48...... +15 these areas continue to attract new immi­ 1 2 Richmond...... 45...... +15 grants who begin to establish themselves in 13 Atlanta...... 49...... +14 clustered racial enclaves.

A second set of areas with Hispanic-white source: 1990 and 2010 U.S. censuses segregation levels above 50 are in the North­ east and Midwest, particularly those areas tracted Hispanics as part of the larger disper­ with large Puerto Rican enclaves. This in­ sion phenomenon. cludes a swath of areas of all sizes in New These areas have lured Hispanics who are England and Pennsylvania, including Boston, more likely to be foreign-born, to be less flu­ Providence, Philadelphia and Allentown. Also ent in English and to have lower levels of ed­ included in this group are industrial areas ucation attainment than Hispanics residing such as Milwaukee, Cleveland and Buffalo. in other kinds of areas. As a consequence, Metropolitan areas with lower Hispanic- these Hispanics are less likely to assimi­ white segregation levels – in the 40s and late quickly, especially in places where below – are spread over the country, espe­ the Hispanic population is new and sub­ cially in the South and interior West. These ject to indifferent or discriminatory behavior tend to be areas in which Mexicans are the on the part of established whites and blacks. primary Hispanic group and areas with small The table above lists large areas with the or quickly growing Hispanic populations. greatest increase in Hispanic segregation be­ Among the larger areas in this category are tween 1990 and 2010. For the most part, Atlanta, Charlotte and Nashville in the South, these are new Hispanic destinations, lo­ and Phoenix, Las Vegas and Salt Lake City in cated primarily in the South, including the West. The smaller areas are located in Nashville, Memphis, Raleigh, Charlotte, swaths of New Sun Belt states in the South­ Greensboro and Atlanta. New destinations east, Mountain West and interior California. outside the South, Scranton and Indianapolis, One of the reasons that Hispanic segrega­ also showed noticeable gains in segregation. tion, on average, has not declined is that seg­ Overall, 27 of the 93 metropolitan areas regation is increasing in many of the new showed meaningful (at least 10-point) gains destination metropolitan areas that have at­ in segregation during the two-decade period.

Third Quarter 2015 77 ASIAN-WHITE SEGREGATION, 2010 SEGREGATION FOR 45 OF THE 100 LARGEST METROPOLITAN AREAS WITH ASIAN POPULATIONS AT LEAST 3 PERCENT OF THE TOTAL POPULATION

San Francisco New York Chicago

Denver

Las Vegas Raleigh

Los Angeles Atlanta

Dallas

Orlando

Honolulu

SEGREGATION LEVEL 0 indicates complete integration, 100 indicates complete segregation Below 30 30 to 40 40 to 50 50 and over

source: 2010 U.S. Census

In most of these areas, the Hispanic popula­ destinations more segregated than before, tion is small, new and rapidly growing. And they are still less segregated than the former in all but three (Miami, Scranton and gateway areas. In addition, if these new resi­ Memphis), the 2010 segregation levels dents are able to translate their opportunities were relatively low – below 50, and in sev­ into economic mobility for themselves and eral cases in the 30s. In Raleigh, for example, their children, they will be following the tra­ the Hispanic population grew more than 150 jectories of earlier immigrant and racial percent as its segregation level rose from 20 in groups toward even greater integration. 1990 to 37 in 2010. So, at present, the Hispanic population is Asian Segregation Across dispersing away from highly segregated areas Metropolitan Areas to new areas that provide greater opportuni­ The Asian population is growing even more ties than earlier gateway regions. Even though rapidly than the Hispanic population. Well new Hispanic enclaves are making these new over half of Asians in the United States are

78 The Milken Institute Review Asians residing in many new destinations have high education attainment, so segregation in these areas does not conform to the low-skilled profile associated with some Hispanic and immigrant groups. foreign-born and they are far more concen­ segregation of at least 5 points are Richmond, trated in established gateway areas than His­ Atlanta, Las Vegas, Dallas, Orlando and Phoe­ panics are. But there is still variation across nix. Most of these areas have modest or low metropolitan areas in Asian-white segrega­ levels of segregation. Other areas with estab­ tion levels. Among the 45 largest metropoli­ lished Asian populations, such as Los Angeles tan areas with significant Asian populations, and San Jose, showed only small increases in segregation levels range from 29 (for Las segregation. Vegas) to 52 (for New York). Asians residing in many new destinations Metropolitan areas that have served as tra­ have high educational attainment, so segrega­ ditional Asian immigrant gateways tend to tion in these areas does not conform to the have higher levels of Asian-white segregation. low-skilled profile associated with some His­ New York, Los Angeles and San Francisco reg­ panic and immigrant groups. Yet if the past ister segregation levels in the 47 to 52 range, experiences of other Asians and other immi­ though those levels are markedly lower than grant groups are an indicator, their segrega­ for Hispanics. Other areas with segregation tion levels should decline with increased levels exceeding the mid-40s tend to be those length of residence in their new locations. with large established Asian populations (Sac­ ramento, San Jose, San Diego, Boston and Chi­ toward new multiracial cago), those with quickly growing Asian neighborhoods populations (Houston, Dallas, Atlanta and Ra­ I’ve focused thus far on segregation lev­ leigh), and a few older Northeast and Midwest els as measured by the dissimilarity areas (Philadelphia, Detroit and Wichita). index. Although it serves its purpose, in Areas with the lowest levels of Asian segrega­ a sense the measure is detached from reality tion tend to be in the Mountain West (Las because it does not give an on-the-ground Vegas, Salt Lake City and Denver), Florida (Or­ picture of the kinds of neighborhoods in lando and Jacksonville), interior California which a typical white, black, Hispanic or (Modesto and Fresno) and “suburban-like” Asian resides. That is because real-world areas (Oxnard and Bridgeport) that are near neighborhoods are composed of multiple major metros. racial groups, not just pairings of one Changes in Asian segregation for individ­ group with whites. Furthermore, the size of ual areas are not as pronounced as changes in each racial group in a given neighborhood is Hispanic segregation, although areas experi­ affected by the overall racial makeup of the encing large Asian population increases, in­ metropolitan area. cluding new Asian destinations, experienced For example, an average neighborhood in higher segregation in 2010 than in 1990. a multiracial metropolitan area like Los An­ Among areas showing a 20-year increase in geles will look very different from an average

Third Quarter 2015 79 RACIAL MAKEUP OF THE NEIGHBORHOOD hood where whites live in Los Angeles will be SURROUNDING THE AVERAGE RESIDENT more diverse than an average neighborhood LOS ANGELES METRO AREA, 2010 where whites live in Minneapolis-St. Paul. The fi gure to the left shows the neighbor- hood racial composition for the average resi- 4% 14% Other Asian dent of each racial group in Los Angeles. The 4% average white Los Angeles resident does, in- Black Average deed, live in a neighborhood that has a healthy White 54% Resident White smattering of Hispanics and some black and 25% Asian residents. But there are also far more Hispanic white residents – 54 percent – in this average neighborhood than in neighborhoods that are 3% Other 8% home to the average black, Hispanic or Asian. Asian 17% So segregation still matters in the way that it 54 4314u White affects on-the-ground neighborhoods, even

28% Average in Los Angeles. Black Black That is not to say there are no neighbor- Resident hoods that are completely white or completely 44% 2% Hispanic Hispanic in Los Angeles. But, on average, resi- Other 10% dents of each race (especially Hispanics) are Asian 18% 7% White somewhat exposed to members of all races. Black The multiracial character of the Los Angeles Average 17 44 38u region does spill over across the area’s neigh- Hispanic Resident borhoods. Such spillover is also seen in many of the other places in the Melting Pot regions 63% Hispanic of the country. Of course, the situation is different in re- 31% 30% gions that have quite different racial makeups. Asian 18 72u White Both Detroit and Atlanta are metros in which Average Asian blacks are the predominant minority. Yet they Resident 3% also differ in important respects. Detroit is a Other 32% stagnating metropolitan area, located in the 4% Hispanic nation’s Heartland region. It has lost black Black migrants for decades while registering only modest population gains from other minori- source: 2010 U.S. Census 30 43u ties. In contrast, Atlanta has been the primary magnet for black migrants and has also expe- neighborhood in a much whiter metro like rienced rapid growth in its Hispanic and Minneapolis-St. Paul. Both areas show some Asian populations. segregation between whites and blacks, His- Moreover, in recent decades, black migra- panics and Asians. But there are many more tion waves included many middle-class blacks minorities in Los Angeles than in Minneapolis- and occurred in a post-civil rights environ- St. Paul, meaning that an average neighbor- ment in which new residential development

80 The Milken Institute Review RACIAL MAKEUP OF THE NEIGHBORHOOD SURROUNDING THE AVERAGE RESIDENT

DETROIT METRO AREA, 2010 ATLANTA METRO AREA, 2010

3% 5% 2% 2% Asian Asian Other Other

3% 8% Hispanic Black 18% Black Average Average White 8% White Resident Hispanic Resident

83% 67% White White

832% 2% 38u 672% 3% 818 25u Other Asian Other Asian

23% 28% White White Average 3% Average Black Hispanic Black Resident 57% Resident 9% Hispanic 70% Black Black source: 201023 U.S. Census 3 2u 28 957 3u Detroit is a stagnating metropolitan area. Atlanta has been the primary magnet for black migrants and has also experienced rapid growth in its Hispanic and Asian populations. was subject to stricter antidiscrimination reg- neighborhoods while in Atlanta whites ulations. For these reasons (among others), make up just 67 percent of white resident Atlanta witnessed a greater decline in black- neighborhoods. Blacks in Atlanta also white segregation than Detroit did. live in neighborhoods that are somewhat A comparison of typical white and black more integrated, with greater percentages of neighborhoods in each metropolitan area whites and Hispanics and smaller percent- shows noticeable differences. In both, the av- ages of same-race neighbors than one fi nds erage white person lives in a neighborhood in Detroit. that is mostly white. But in Detroit, whites Of course, even in Atlanta, there is a high constitute 83 percent of white resident rate of segregation. Blacks, on average, live in

Third Quarter 2015 81 RACIAL MAKEUP OF THE NEIGHBORHOOD a national neighborhood SURROUNDING THE AVERAGE RESIDENT snapshot

UNITED STATES, 2010 America’s racial mosaic is changing in cities, suburbs, states and regions. Although the 2.7% 3.6% Asian broad Melting Pot, New Sun Belt and Heart- 6.8% Other Black land regions are still somewhat distinct, the dispersion of new minorities virtually every- 9.5% where and the continuing southward move- Hispanic Average ment of blacks are leading to shifts that will, White Resident for the most part, blur long-maintained spa- tial divisions, even at the neighborhood level. 77.5% White Therefore, it is useful to observe the kind of 2.7% 3.3% neighborhood in which the “average” white, Asian Other black, Hispanic and Asian resident lives to 77 634u provide a benchmark of where things stood 35.6% at the time of the 2010 census. This picture is 44.7% White Average given in the fi gure to the left, which is drawn Black Black from all of the neighborhoods in the United Resident States – including those in metropolitan and 5.3% 2.7% 13.8% non-metropolitan areas of all sizes and in Asian Hispanic Other every part of the country – for the average

10.3% resident of each racial group. Black 36.8% The average white resident, for example, 35White 14 453u Average lives in a far less diverse neighborhood – one Hispanic Resident that is more than three-quarters white – than residents of any other group. Nonetheless, the 44.9% Hispanic average white person today lives in a neigh- borhood that includes more minorities than 20.5% was the case in 1980, when such neighbor- Asian hoods were nearly 90 percent white. More- 374.2% 45 35u Other Average 48.3% over, the average member of each of the White 8.5% Asian nation’s major minority groups lives in a Resident Black neighborhood that is at least one-third white, 18.5% and in the case of Asians, nearly one-half Hispanic white. Hence, there is a tendency toward more integrated living among these groups as more minorities relocate to white-dominated source: 2010 U.S. Census 48 94u or multiracial neighborhoods. One issue that is especially important is neighborhoods that are more than one-half the segregation of minority children into black while whites live in neighborhoods that neighborhoods and school districts that often are two-thirds white. But the segregation in have fewer resources and show poorer overall Atlanta is becoming less extreme. performance. National statistics comparing

82 The Milken Institute Review NEIGHBORHOOD MAKEUP OF AVERAGE YOUTH AND ADULT RESIDENT, 2010

BLACKS HISPANICS ASIANS

2.9% 4.2% 4.5% 4.1% Asian Asian Other Other

19.9% 26.7% 10.6% 28.6% Asian White White Black 41.3% Black Hispanic 6.7% Asian White 48.4% Youth Youth Other Youth Black Resident Resident 9.3% Resident 17.4% Black Hispanic 52.5% 22.8% Hispanic Hispanic

2.1% 3.4% 5.8% 27 4853u292.2% 52 114u41 97u Other Asian Asian Other

10.2% 21.0% Black Asian 38.3% 3.4% White 39.4% Black Hispanic White Other Asian 43.7% 50.4% Adult Adult 8.2% Adult Black White Resident Resident Black Resident 42.4% 17.0% 12.5% Hispanic Hispanic Hispanic source:38 2010 U.S. Census 4423u40 42 26u51 83u neighborhood profi les for average black, His- whiter New Sun Belt and Heartland panic and Asian children show them to be de- regions will almost certainly continue cidedly more exposed to members of their to alter the neighborhood experiences own racial group – or having less contact of these groups by bringing them into with whites – than is the case for their adult more contact with whites than was the case population. in the past. The nation’s blacks have seen a In part, that refl ects a continuing tendency marked shift from a mostly ghettoized exis- for white families to choose local areas with tence fi ve decades ago to one that more better resources and schools and fewer mi- closely follows the path of other racial mi- norities than the local areas that are available norities and immigrant groups as more to minorities. Given today’s more diverse blacks move to more suburban and inte- youth and their important role in the future grated communities, particularly in the workforce, the inequality of opportunities as- South. So the broader migration patterns of sociated with their segregation across neigh- blacks, Hispanics and Asians are moving in borhoods needs to be addressed. the direction of greater neighborhood racial Still, overall, population shifts that are integration, even if segregation is far bringing Hispanics and Asians to previously from eliminated.

Third Quarter 2015 83 pastimes, seriously

by allen r. sanderson and john j. siegfried

As America goes through the annual rituals of college football bowl games and the national basketball tournaments (a k a March Madness), one seemingly straightforward question hardly ever gets asked: why is the nation’s higher- education system home to a vast organization of big-money sports? After all, not a single one of the institutions that spend tens of millions supporting intercollegiate athletics mentions the goal of providing commercial entertainment in its charter.

But that question is now being asked, al­ The disjuncture between the NCAA- beit indirectly, by a variety of courts trying to peddled myth of college athletes as “amateurs” reconcile the commercial aspects of intercol­ who are first and foremost “student-athletes” legiate sports with the conventional views of and the reality that they are poorly paid pro­ the job of the nation’s colleges and universi­ fessionals who all too often are not up to the ties. How this will play out is anyone’s guess. academic demands of higher education has led to scandals with monotonous regularity. how we got here In many cases, underpaid star players are While only 15 years old, this century has al­ caught with their hands in the cookie jar. For ready seen both the best and worst of times example, the 2005 Heisman Trophy award to for the National Collegiate Athletic Associa­ USC running back Reggie Bush was vacated tion and its member universities. On the one after discovery that he and his family received hand, massive revenues and robust television massive concealed payments. ratings from football and men’s basketball – In many other cases, athletics programs not to mention the celebrity status and seven- are caught greasing the academic wheels for figure compensation packages going to the athletes who could not otherwise have (liter­ most successful college coaches – attest to the ally) made the grade. National Basketball As­ popularity and vitality of the college game. sociation star Derrick Rose submitted fraud­ On the other, the NCAA has never been so ulent SAT scores to the University of Memphis, regularly on the defensive regarding the whose coach at the time was John Calipari. image of its players and coaches. Memphis was slapped on the wrist for the transgression, but the coach moved on to even

ALLEN SANDERSON and JOHN SIEGFRIED are greener pastures at Kentucky. Meanwhile, the economists at the University of Chicago and Vanderbilt University of North Carolina (Chapel Hill) University, respectively. This essay is based on the authors’ was caught enrolling players in ghost courses article in the Winter 2015 issue of Journal of Economic

Perspectives. to keep non-student-athletes on the roster – university of athletics alabama kent gidley,

84 The Milken Institute Review tk

Third Quarter 2015 85 pastimes, seriously compensation constituted restraint of trade a practice that had apparently been going under the Sherman Antitrust Act, leaving the on for decades. Not to be outdone, University next shoe to drop to a federal appeals court. of Georgia coach Jim Harrick was fired over But we get ahead of ourselves. The validity academic fraud involving bogus courses and of these challenges can be evaluated only in grading. the context of the remarkable state of NCAA These various forms of cheating shock – sports. just shock! – the talking heads of sports and provide plenty of fodder for righteous news­ the college athletics landscape paper editorials. But once the ripples die down, Most colleges and universities in America one can be almost certain that nothing much field a variety of men’s and women’s intercol­ will change. The same cannot be said, though, legiate sports teams. Given that all but a score for the current round of legal challenges to the of these programs lose money in a strict organization of big-time college sports. bottom-line accounting sense, one must ask • In a petition to the National Labor Rela­ why financially pressed institutions continue tions Board, several Northwestern University to subsidize them with a combination of football players argued that they were em­ mandatory student fees, general institutional ployees rather than students and thus should funds, cash pried from state legislatures, and be entitled to employee medical benefits and contributions solicited from alumni and well- be allowed to bargain collectively over com­ heeled donors. All this money, one should pensation and work conditions. And in note, might have been directed toward reduc­ March 2014, a regional NLRB regulator ing tuition or improving academic programs. agreed, raising the prospect that college In the private sector, recurring losses serve sports programs will be treated like the busi­ as a signal to redeploy assets elsewhere. But in nesses they sometimes are. intercollegiate athletics, losses seem more • In the same vein, a collection of cases likely to induce university administrators to challenge the legal authority of the NCAA double-down, attracting winning coaches and the big sports conferences to cap grants- with salaries worthy of Fortune 500 CEOs and in-aid (read: salaries) for “student-athletes.” spending lavishly on recruiting and physical These cases, incidentally, may be turbo­ facilities. charged by a class-action lawsuit in federal USA Today annually compiles stats on court against the NCAA and the conferences these direct and indirect subsidies for indi­ by sports attorney Jeffrey Kessler, claiming in­ vidual universities. We used these data to get jury to all college athletes harmed by limita­ some perspective on the magnitude of the tions on compensation. support at a sampling of public universities • A lawsuit brought by former UCLA player with Division I teams. Ed O’Bannon argues that, after players leave Not all state-supported universities with college, they are entitled to a share of reve­ Division I teams need outside help. In 2013, nues generated by the commercial use of their Texas, Ohio State, Oklahoma, Louisiana State, images. And in July 2014, Federal District Penn State, Nebraska and Purdue covered all Court Judge Claudia Wilken ruled in favor of of their intercollegiate athletic expenses with O’Bannon. Indeed, she went further, suggest­ sports-generated revenues. And some univer­ ing that any collective agreement to cap player sities that did subsidize athletics – for exam­

86 The Milken Institute Review MEDIAN FINANCIAL STATS FOR 126 DIVISION I UNIVERSITIES WITH BOWL-ELIGIBLE FOOTBALL TEAMS ($ MILLIONS, EXCEPT AS NOTED)

TOTAL GENERATED ALLOCATED SUBSIDY AVERAGE # OF ATHLETES YEAR REVENUE REVENUE REVENUE PERCENTAGE REVENUE ON SCHOLARSHIP

2004...... $28 .3 ...... $22 8...... $5 .4...... 19 .1%...... $28 .3...... 577 2005...... 32 .8 ...... 24 3...... 8 .5...... 25 .9...... 31 .6...... 589 2006...... 35 4...... 26 .4 ...... 9 .0...... 25 .4...... 32 .4...... 588 2007...... 37 6...... 26 .1 ...... 11 .5...... 30 .6...... 33 .5...... 598 2008...... 41 1...... 30 .5 ...... 10 .6...... 25 .8...... 34 .8...... 602 2009...... 45 7...... 32 .3 ...... 13 .4...... 29 .3...... 37 .9...... 603 2010...... 48 3...... 35 .3 ...... 13 .0...... 26 .9...... 39 .7...... 611 2011...... 52 7...... 38 .8 ...... 13 .9...... 26 .4...... 42 .3...... 616 2012...... 56 0...... 40 .6 ...... 15 .4...... 27 .5...... 44 .2...... 615 2013...... 61 9...... 41 .9 ...... 20 .0...... 32 .3...... 48 .2...... 611

ple, by paying the tuition component of SUBSIDY 2013 SUBSIDY/ SUBSIDY AS ($ MILLIONS, UNDERGRADUATE % IN-STATE grants-in-aid out of general university funds UNIVERSITY 2013) STUDENT 2014 TUITION

– earned sufficient revenues so that they did Alabama- not need those subsidies to break even. This Birmingham. . . $18 .1 ...... $1,601...... 22 .2 group includes Alabama, Michigan, Florida, Arizona...... 7 .3 ...... 232...... 2 .5 Oregon, Michigan State, Kentucky, Kansas, Connecticut. . . . 18 .9 ...... 1,076...... 11 .6 Delaware...... 26 .1 ...... 1,435...... 13 .5 Washington, Indiana, Missouri, Texas Tech, Georgia State . . .22 .6 ...... 917...... 14 .7 Kansas State and Mississippi State. Minnesota ...... 8 .1 ...... 235...... 1 .9 But these exceptions are the few and far North Carolina- between. More than 90 percent of Division I Chapel Hill...... 9 .2 ...... 495...... 7 .7 Rutgers...... 47 .0 ...... 1,487...... 13 .9 public universities do subsidize their intercol­ Tennessee...... 2 .4 ...... 594...... 6 .9 legiate athletics programs. In 2013, the high­ UCLA...... 2 .6 ...... 94...... 0 .8 est subsidy was at Rutgers, which was in the red by almost $50 million. That, however, amounted to less than $1,500 per undergrad­ could have been reduced if all of the intercol­ uate student because of Rutgers’s large enroll­ legiate athletics subsidies had been diverted ment. Many of the highest sports subsidies to that end. It ranges as high as 14 percent, per student, frequently exceeding $2,000, are even if Alabama-Birmingham and Georgia at the half-dozen or so academically selective State are excluded. (The latter is just entering private universities with more-modest enroll­ Division I, so the high outlays may reflect ments that field teams in the five major con­ only startup costs.) It is thus clear that inter­ ferences (Atlantic Coast, Big 12, Big Ten, Pac- collegiate athletics constitutes a non-trivial 12 and Southeastern). Alabama-Birmingham part of tuition paid by many students and is included in our sampling because it an­ their families to public universities. nounced last year that it would discontinue Division I football due to escalating costs. and for what? The subsidy data explain that decision. This substantial addition to the cost of a uni­ The last column in the table above reports versity degree (so the argument goes) is worth­ the percentage by which 2014 in-state tuition while to the students, families or taxpayers

Third Quarter 2015 87 who foot the bill. Specifically, supporters of the most successful sports programs have a the status quo say that success in intercolle­ way of expanding their budgets to absorb the giate athletics convinces state legislatures to surplus. As a result, the amounts that are ac­ increase appropriations for other university tually available for use beyond the athletic de­ programs, as well as attracting private dona­ partments are never very large. tions from alumni and local boosters who call Does the presence of high-profile intercol­ the teams their own. A modest accumulation legiate athletic programs attract better quali­

of research supports this argument. But even fied applicants or students paying full tuition? duke jon photography gardiner,

88 The Milken Institute Review legiate athletics could have had a greater pos­ itive impact on the relevant institutions if they were instead allocated directly to univer­ sity fund-raising efforts or marketing to pro­ spective applicants – or even, heaven forbid, to moderating the seemingly relentless rate of increase in college tuition.

seventy years and counting In the early 1950s, to hold down its costs, the NCAA established a binding ceiling on the re­ muneration that could be given to an inter­ collegiate athlete – a grant-in-aid restricted to room, board, tuition, fees and books. A col­ lective practice like this would be illegal in al­ most any other enterprise. But it flourishes in colleges, especially in cooperation with the professional sports leagues. Minimum age requirements established by the National Football League and the National Basketball Association restrict alternatives available to prospective college athletes, giving the NCAA virtually total control over the labor market for young athletes who hope to become pro­ fessionals. In return, the professional leagues can foist the costs of training their future re­ cruits on universities. The NCAA’s market power is not only re­ flected in substantially below-market com­ pensation for the best players, but also leads to overuse of this chief “input” in sports en­ tertainment through a steady expansion of regular-season football and bowl games (which now number 39, with some teams without winning records participating), mon­ Again, the evidence suggests some favorable eymaking post-season conference basketball effects for successful teams. But the advan­ tournaments and steady expansion of the tages are fleeting, and, in any case, success March Madness field (now up to 68 for the serves no greater societal purpose since it men’s tournament). The long, long seasons serves only to shuffle enrollments by appli­ reduce the time available for the athletes to cants who were planning to go to college in even pretend to be students, and increase the the first place. Moreover, it is likely that the risk of injuries that will prevent the very best government funds used to subsidize intercol­ players from ever cashing in with the pros.

Third Quarter 2015 89 College players, it goes without saying, have most of their expenses. In our view, amateur no voice in decisions to expand schedules, status should not be defined by whether stu­ and no claim on the incremental revenues dent-athletes are paid directly or have their that are generated by additional games, ex­ bills paid for them, but rather by the nature of panded playoff schedules and post-season the relationship between the player and the in­ tournaments. stitution. The real issue is restraint of trade – The core issue is not, as often claimed by that, through the NCAA, universities collec­ advocates for intercollegiate sports, whether tively agree to cap their players’ compensation, college athletes should be paid. Apart from a which in other businesses would violate Sec­ few “walk-ons,” most of the players are, in fact, tion 1 of the Sherman Antitrust Act.

already being paid via grants-in-aid that cover This is not to say that the average college communications athletic mitchell/msu matthew

90 The Milken Institute Review athlete is “underpaid.” We know this is not 2013-14 fiscal year, in addition to fees col­ the case because virtually all university sports lected directly by its member colleges and programs require subsidies to stay afloat. But universities. Its surplus reached $80 million, a it changes the distribution of compensation 30 percent increase over the prior year. The dramatically. The artificial ceiling holds down NCAA’s accumulated surpluses now amount benefits that otherwise would accrue to the to $700 million – quite a sum for a not-for- most talented collegiate football and men’s profit organization, and apparently sufficient basketball players, many of whom are African-­ to justify paying its chief executive officer Americans from low-income households. In $1.7 million and his second-in-command contrast, athletes in non-revenue sports, most about $1 million during calendar year 2012 of whom are white and middle-class, are (the latest year that figures are available). winners. Consider, too, that the restraint of trade facilitates the diversion of surpluses to half measures coaches’ salaries, which in many cases exceed In an effort to head off serious challenges to the compensation of university presidents. its business model, the NCAA recently made Coaches were not always paid employees. modest upgrades to rules governing maxi­ Prior to 1892, college football coaches were mum player compensation in the five “power all volunteers. That ended when the Univer­ conferences,” adding unrestricted meal plans sity of Chicago offered legendary coach Amos and multiyear scholarships and meeting other Alonzo Stagg a salary to leave Springfield Col­ incidental out-of-pocket costs for players. But lege and take over the helm of the Chicago these changes fall well short of competitive team – which he managed so successfully that labor-market compensation for star players the Cook County stadium (where the atomic and are mainly an attempt by the NCAA to bomb was developed during World War II) stay one town ahead of the sheriff. The incen­ was later renamed for him. tives to overuse players and the glaring dis­ The question that naturally follows is why parity in pay between coaches and athletic players should be unpaid volunteers. Why department administrators, and the players shouldn’t teams be forced to compete for doing the heavy lifting on the field, have student-athletes’ services the way other em­ hardly changed. ployers compete for CEOs or security guards As several pending lawsuits (noted above) (and the way intercollegiate teams compete involving various aspects of NCAA collective for coaches)? After all, the American Library action play out, commercialized intercolle­ Association does not coordinate a maximum giate athletics a decade from now could be­ wage for student library employees at colleges come very different. If labor and antitrust across the country. laws are applied to college sports, universities The explosion of revenues flowing to will no longer be able to exercise market NCAA members from television revenues, power that transfers income from young mi­ stadium seat sales and brand licensing has nority players (and, arguably, from the pock­ created growing unease in the media and the ets of degree-seeking students hard-pressed court of public opinion over the distribution to cover tuition) to the paychecks of coaches of the largesse. The amounts are truly stag­ and athletic directors. Indeed, in 40 of the 50 gering. The NCAA organization itself en­ states, the most highly paid public employee joyed total revenue of almost $1 billion in the is a university football or basketball coach,

Third Quarter 2015 91 pastimes, seriously used to bid up the salaries of coaches and ad­ with most of them earning that distinction in ministrators, it could take a long time to reach competition with medical-school deans and that equilibrium. As a result, many more uni­ university presidents. versity trustees and state legislators will be forced to ask whether it is ethical or politic to moving forward pass on the costs to tuition-paying students. The current arrangements in the labor mar­ ket for big-time college athletes are inefficient, Intercollegiate athletics* * seems* poised to move inequitable – and probably unsustainable in the direction we describe, fostering net under current law. Some 40 years ago, profes­ gains in productivity. But, as with most sional sports leagues were forced to ease re­ changes in market institutions that increase strictions on their player labor markets, mov­ efficiency – think freer international trade, ing from total league control of salaries to a anti-discrimination laws, tax reform, regula­ hybrid model mixing broad constraints on tion that internalizes the costs of pollution – compensation with more balanced individual there will be losers as well as winners. While and collective bargaining. It’s now time to some athletes will be paid more, some will see end the price-fixing that restrains compensa­ their grants-in-aid trimmed. Meanwhile, tion received by college players and let them some Division 1 sports programs are likely to share in the windfalls generated by Ameri­ fold, or at least downsize, implying fewer cans’ enthusiasm for college spectator sports. chances for less accomplished athletes to par­ When asked about one of the pending law­ ticipate in intercollegiate athletics. suits that seeks an injunction against the The key to successful change is to prevent NCAA’s practice of restricting player com­ the potential losers from vetoing adaptation. pensation to expenses, NCAA president Mark In this case, that might not seem an especially Emmert said it would “blow up college sports.” daunting hurdle since the courts that are Moving to a free market for intercollegiate forcing change are partly insulated from athletes would, indeed, be disruptive. But we interest-group pressure. But the NCAA and believe that big-time college athletics would the high-profile coaches whose seven-figure not be demolished because the market value salaries would ultimately be at risk would al­ of the entertainment is so high. For one thing, most certainly press for legislation to exempt paying star players what they’re worth in a college sports from the antitrust and labor competitive market would require a major laws. And resistance to such rollbacks might adjustment in outlook from both the players not hold. Who, after all, could be counted on who would be left behind and from university to defend the rights of a few thousand mostly communities as a whole that have swallowed poor, mostly minority student-athletes, some the notion that student-athletes are truly a of whom are likely to get rich anyway once part of higher education. they put in their years as college players? More tangibly, it is likely to increase the in­ Truth is, Americans created a monster vestment required of universities that want to when they integrated big-time spectator compete at the highest levels in men’s football sports with higher education. Taming the and basketball. While one would expect that beast – forcing it to live by the rules we’ve set some of the cash needed to pay more to star for other commercial enterprises – will players would come out of the surpluses now not be a walk in the park.

92 The Milken Institute Review currency of ideas

I know, I know … the blogosphere is so big that it’s next to impossible to separate the nu- tritious stuff from the empty calories. But you owe yourself a look at the Milken Institute’s Currency of Ideas for a sense of what’s happening at the Institute. Here’s an hors d’oeuvre of posts from staff and fellows that might just tempt you to become a regular diner.

Let My People Grow While Israel has grown more rapidly than other advanced economies, with 10 percent of the workforce in the high tech sector gen­ erating over 50 percent of industrial exports, the disturbing transformation of its income distribution and society has made Israel one of the most unequal societies in the world. … The share of Israel’s population living on less than half the country’s median income has more than doubled since 1992, from 10.2 per­ cent to 20.5 percent. Even more disturbingly, the share of children living in poverty qua­ drupled over the same period, from 7.8 per­ cent to 27 percent. … The need for a bridge to the middle class for young people has become glaringly obvious, with housing prices having increased more than 68 percent over the past nine years, and an astounding 70 percent of and defeating the fingerprint check (or worse, workers earning below the average wage rate. cutting off fingers)? No, it is much simpler —Glenn Yago than that. Criminals are buying payment cre­ dentials online, loading them onto iPhones, Apple Pay and Pay and Pay and then using Apple Pay to buy things with A Washington Post story describes an ob­ the stolen card. There is a fiendish brilliance served elevated rate of fraud on Apple Pay, to it: the thief doesn’t need to have the card, with one analyst, Cherian Abraham, placing which means the card isn’t missing, which the rate at about 6 percent – which, as the means the card’s actual owner may not know Post points out, is about 60 times the rate of the card was compromised until the state­ swipe transactions. … Have hackers infil­ ment arrives (if they even read the statement).

reuters/ronen reuters/ronen zvulun trated Cupertino? Are people stealing iPhones —Brian Knight

Third Quarter 2015 93 currency of ideas Generation Deferred Think Global, Act San Joaquin Valley Despite being saddled with criticism ranging When it comes to bridging the skills gap, col­ from narcissism to laziness, many millennials laboration is the new competition. … In the have stuck with the plan. You know the plan: past, companies harvesting fruit or drilling for work hard in school, go to college and maybe oil may not have needed to invest heavily in grad school, and you will end up with a well- human capital. Many jobs in natural resource-­ paying job and a home of your own. Some­ rich economies typically required low-skill, where along the line this plan became more of low-wage labor. Yet innovations in plant sci­ a fantasy, especially in California. … Com­ ence and the mechanization of labor-intensive pared to other states, California home prices processes have led to increased productivity, appear untethered to the incomes actually and with it, an increasing need for more earned by residents. The lack of affordable skilled workers, especially in the STEM fields housing has caused California to lose some of (science, technology, engineering and mathe­ its best young talent. … In the past 20 years, matics). Agricultural companies in Kern California has seen an exodus of almost 4 mil­ County and the greater San Joaquin Valley lion people to other U.S. states. Most of those are collaborating with each other and with leaving were young families, the group most local educational institutions to leverage pub­ likely to become first-time homebuyers. lic, private and philanthropic funds. … Not —Matt Horton and Kristen Keough only are the programs focused on high-skill agriculture occupations with jobs connected Delphi on the Potomac to them, they also provide students with a As is often the case when central bankers head-start on getting an advanced degree. speak, those on the receiving end parse every —Priscilla Hamilton and Minoli Ratnatunga word, and interpretations vary. The Federal Reserve chair, Janet Yellen, gave analysts and Sunshine for the Golden State market participants much to ponder in her California is known for technological innova­ recent testimony before committees of Con­ tion. Netflix, Google and Apple (among hun­ gress. Although her remarks offered insight dreds of other pioneering companies) were on the FOMC’s view of economic conditions, founded here, and the state consistently ranks she did not provide a clear timeline for the among the top-five in the Milken Institute’s course of monetary policy. Or did she? State Technology and Science Index. So why, The Fed chief stated, “The FOMC’s assess­ then, does it find itself looking up at many ment that it can be patient in beginning to other states when it comes to creating a cohe­ normalize policy means that the Committee sive open-data policy? … At present, each in­ considers it unlikely that economic conditions dividual state agency follows its own standards will warrant an increase in the target range for for publishing data, and the lack of a stream­ the federal funds rate for at least the next cou­ lined policy threatens to create confusion and ple of FOMC meetings.” mixed signals. To maximize ease of use for In my view, this implies that the Federal both users and agencies, the state must de­ Open Market Committee, or FOMC, will velop a uniform strategy that dictates how and raise the federal funds rate as early as mid- when machine-readable data are published by June. —Keith Savard its agencies. —Jason Barrett

94 The Milken Institute Review institute news

where the action is FasterCures convened 100 representatives It’s no secret: small and mid-size businesses from leading sources of R&D finance and pa­ are the source of much dynamism in the tient foundations, along with industry execu­ American economy, and capital is the fuel tives and health care researchers, to work on that keeps the wheels churning. To find out solutions to the problems of bringing patient more about how owners and managers in the perspectives into coverage and reimburse­ vital SMB sector gain access to capital, the In­ ment decision-making. Part of a growing ef­ stitute partnered with the National Center for fort to expand opportunities for hands-on the Middle Market on a unique survey. Sam­ connection to discovery, development and pling more than 600 firms, the survey con­ delivery of new therapies, the event was high­ firmed that businesses far and away preferred lighted by a webinar hosted by FasterCures to self-finance where possible, even in the and the Patient Centered Outcomes Research current low-interest-rate environment. Debt Institute. The goal: education on building remains the second choice – and everything and leveraging effective patient registries, and else is a distant third. Encouragingly, the ma­ the release of a video history on patients’ en­ jority of these firms said they plan to expand gagement in medical research. in the near future and don’t view the cost of capital as a deterrent. we did it again! To read the entire report, “Access to Capi­ With some 700 speakers, 170 events and 3,500 tal: How Small and Mid-Size Businesses Are attendees, this year’s Milken Institute Global Funding Their Futures,” check the Institute Conference was bigger and better than ever, website. celebrating the power of ideas to drive change. In addition to exploring solutions to pressing part of the solution? challenges in everything from financial regu­ For more than a decade, the Institute’s Faster- lation to health care R&D to education re­ Cures group has worked to advance biomedi­ form, the 2015 conference focused on how to cal innovation and to ensure that better treat­ bring women into the global mainstream. ment is not only developed, but available in Most of the panels are available for streaming timely fashion to those who need it. In June, on the Milken Institute website. courtesy the of courtesy milken institute

Third Quarter 2015 95 lists

When One Is Not Enough Man (and woman) does not live by bread alone. (I gotta remember to write that one down…) And, these days, the media, as well as the academic and think-tank worlds, brims with talking heads describing the limitations of GDP as a measure of societal welfare. Truth is, no single num­ ber or index of weighted numbers can capture everything we’d want to know about absolute or relative welfare for a whole country. But one of the most venerable attempts is the UN’s Human Development Index, which factors in life expectancy and education along with income. More re­ cently, the UN has added an HDI adjusted for income inequality, as well as a Gender Inequality Index. The latter index factors in maternal mortality rates, adolescent birth rates, education and labor force participation. Among high-income industrialized countries, all three indices are strongly correlated. But there are some interesting outliers – including the United States. Here’s a sampling, selected for general interest and, in a few cases (in bold), unusual results.

HUMAN GDP DEVELOPMENT INEQUALITY- GENDER PER CAPITA INDEX ADJUSTED HDI INEQUALITY $, PPP, 2014 RANK 2013 RANK 2013 RANK 2013

Norway ...... $55,400...... 1 ...... 1...... 9 Australia...... 43,000...... 2 ...... 2...... 19 Switzerland...... 54,800...... 3 ...... 4...... 2 Netherlands ...... 43,300...... 4 ...... 3...... 7 United States. . . . . 52,800...... 5 ...... 28...... 47 Germany ...... 39,500...... 6 ...... 5...... 3 Canada...... 43,100...... 8 ...... 10...... 23 South Korea...... 33,200...... 15 ...... 35...... 17 Japan...... 37,100...... 17 ...... 23...... 25 Slovenia ...... 27,400...... 25 ...... 16...... 1 Saudi Arabia ...... 31,300...... 34 ...... ??...... 56 Russia ...... 18,100...... 57 ...... 54...... 52 Iran ...... 12,800...... 75 ...... 109...... 109 China...... 9,800...... 91 ...... ??...... 37 India...... 4,000...... 135 ...... 135...... 127 Niger ...... 800...... 187 ...... 184...... 151 richard levine/alamy ©

96 The Milken Institute Review ABOUT US OUR WORK RESEARCH EVENTS CENTERS NEWSROOM BLOG VIDEOS The Milken Institute Review • Third Quarter 2015 volume 17, number 3 VIDEOS http://www.milkeninstitute.org/videos/ the milken institute the milken institute review Michael Milken, Chairman advisory board Michael L. Klowden, President and CEO Robert J. Barro Jagdish Bhagwati publisher Milken Institute Events George J. Borjas Conrad Kiechel editor in chief Daniel J. Dudek Peter Passell Georges de Menil From our flagship event, the Global art director Claudia D. Goldin Conference, to summits in Asia and London, Joannah Ralston, Insight Design Robert Hahn to briefings in Washington, we bring together www.insightdesignvt.com Asia Summit Robert E. Litan leaders with diverse expertise from across Lunch Program: China Today and Tomorrow managing editor Burton G. Malkiel Larry Yu sectors and industries. Van Doorn Ooms ISSN 1523-4282 Paul R. Portney Videos from hundreds of panels featuring Copyright 2015 Stephen Ross The Milken Institute leaders from some of the world’s top firms, Santa Monica, California Richard Sandor Isabel Sawhill organizations, universities and governments Morton O. Schapiro are available to view online. London Summit John B. Shoven Global Overview: Geoeconomics vs. Geopolitics The Milken Institute Review is published Robert Solow www.milkeninstitute.org/events quarterly by the Milken Institute to encourage discussion of current issues of public policy relating to economic growth, job creation and capital formation. Topics and authors are selected to represent a diversity of views. The opinions expressed are solely those of the authors and do not necessarily represent the views of the Institute.

The Milken Institute’s mission is to improve lives Partnering for Cures around the world by advancing innovative The Future of Medical Innovation economic and policy solutions that create jobs, widen access to capital and enhance health.

Requests for additional copies should be sent directly to: The Milken Institute The Milken Institute Review 1250 Fourth Street, Second Floor Santa Monica, CA 90401-1353 310-570-4600 telephone Global Conference California Summit 310-570-4627 fax Women: Key Players in High-Growth Investment Strategies Training the 21st Century Workforce [email protected] www.milkeninstitute.org

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The Milken Institute Review • Third Quarter 2015 • volume 17, number 3

bill frey bill frey frank rose frank rose larry fisher larry fisher Pay now or pay later. pay or now Pay claudia goldin claudia goldin tomas philipson philipson tomas On China’s high-wire act. On China’s On the NCAA monopoly. The bonus from diversity. from The bonus More alike than you think. than you alike More Time is the scarce resource. is the scarce Time marsha vande berg marsha berg vande On hydrogen-powered cars. On hydrogen-powered Miracles sometimes happen. Miracles On closing the gender pay gap. pay the gender On closing Pay players what they’re worth. what they’re players Pay Managing riskManaging with derivatives. On neighborhood desegregation. The key is flexible work schedules. is flexible The key On the Internet battle for eyeballs. battle for On the Internet Reform or growth – must they growth – must or choose? Reform On the coming global disaster. pension On the coming In this issue pallavi aiyar and chinaiyar hwee tan pallavi On financial engineeringOn financial R&D. pharmaceutical for thomas healey and catherine reilly thomas healey and catherine reilly allen sanderson and john siegfried On comparing the Indian and Indonesian economies. and Indonesian the Indian On comparing