Will bystander economies be able to finance their governments?
From Jesús Fernández-Villaverde:
Will AI poison the public finances of many modern states? There is a real risk that it will.
Yesterday, I circulated a new paper, “Saving for the Machines,” which makes a simple point. Building the AI transformation will require enormous investment. The only way to induce agents to save for that investment is through a large increase in the real interest rate. For instance, in my benchmark scenario, the ten-year real yield jumps from 5.1% to 13.6% on impact.
But that means government borrowing will become much more expensive. Here is a back-of-the-envelope calculation. Take a government that owes 100% of GDP in 2025 (a typical case in Western Europe) and runs a balanced primary budget from then on (not so typical but never mind; I want to build an optimistic scenario). That means the debt ratio changes only with the gap between the real interest rate and growth.
I input the interest rate and the growth rate for my benchmark transition to full automation, and I roll over the debt at the short rate. I consider two economies. The first economy is an AI adopter, for example, the U.S., which experiences an AI boom at home. The government pays the new interest rate but also enjoys faster growth.
The second economy is a bystander, for example, Spain. This economy lives in an integrated financial market but does not adopt AI (this is an extreme case of zero adoption, just to make the exercise transparent): it pays the same world interest rate and continues growing at its old 1.6% trend.
Let’s first consider the adopter. With an intertemporal elasticity of substitution of one-half, the Euler equation implies that consumption growth is about half the real interest rate. Hence, the gap between the interest rate and growth does not close during the AI-driven growth boom. Instead, it widens. For example, with a unit elasticity of substitution among tasks, the real rate rises from 5.1% to 42% by 2040, while growth increases only from 1.6% to 22%. Debt doubles by 2038, reaches 296% of GDP in 2040, and 907% in 2045. To hold the ratio at 100%, the government needs a primary surplus of 10% of GDP in 2035 and 24% from 2045 onward. With a low elasticity of substitution of 0.2, the numbers are milder, but the pattern is the same: 204% in 2040, 397% in 2045, and a stabilizing surplus of 13% of GDP.
But the adopter has a way out. The capital share goes to one, so net capital income is about 88% of GDP, and a flat tax on it can cover the surplus. A 36% tax on net capital income holds the debt at 100% of GDP in the limit with unit elasticity, and a 20% tax does so with strong complementarity across tasks. The tax is above the gap because it slows growth, from 21.9% to 13.6% with unit elasticity and from 11.7% to 9.1% with an elasticity of 0.2, while it does nothing to the rate the Treasury pays, which technology pins at the machines’ net return. Painful, but the boom survives and the adopter can pay its debt.
The grim news is that the bystander economy has no way out. Its capital income is still a third of GDP, which grows at 1.6%, and the surplus it needs is 11% of GDP in 2030, 26% in 2035, and 44% forever with unit elasticity (18% and 24% with an elasticity of 0.2). On a balanced primary budget, its debt doubles by 2033 and triples by 2035. No tax system raises that.
Two more bad pieces of news for the bystander. First, long yields jump on impact, so a Treasury that issues ten-year debt pays more, and sooner, than rolling over at the short rate assumes: it is the same bill but front-loaded. Second, the bystander’s own capital flows to the machines abroad, so its GDP and tax base fall below trend. One relief is that households can save for other people’s machines and get rich on the returns, which the bystander’s government can tax to some extent. This back-of-the-envelope calculation is a benchmark, not a forecast of what is to come. But the arithmetic is simple, and it runs counter to the hope that an AI-fueled growth boom will take care of public debt, because growth comes with an interest rate that is twice as high. Not a pretty future for most of Western Europe. Due to AI, the choice is between default, inflation, or, most likely, financial repression: capital controls that keep domestic savers from investing in machines abroad.
I am somewhat more optimistic than this. The assumption of zero Spanish adoption already is noted, but also ideas are public goods, and Spain can benefit from American (and Chinese) AI, and the resulting scientific advances. The long-run supply of capital also might be quite elastic, we will see.
How Long Do Wealth Shocks Persist? Less Than Three Generations in England, 1700–2026
What happens across generations to wealth shocks? Do they endure and even magnify, or do they dissipate? By implication, how much modern wealth is attributable to events before 1900? This paper uses random shocks to family size in England before 1880 that created wealth shocks for the children to measure the persistence of wealth shocks. Fertility in England before 1880 was a biological lottery. For richer families, family size strongly influenced child wealth. This paper finds that such biology-induced wealth shocks had no impact on descendant wealth by three generations later. Since wealth itself persisted across more than five generations this implies that, in the long run, wealth mainly derives from sources other than inherited wealth. The observed link between nineteenth century and modern wealth does not lie in wealth transfers alone. Wealth persisted because of the familial inheritance of behaviors associated with wealth accumulation and retention.
That is from a recent paper by Gregory Clark and Neil Cummins. Via the excellent Kevin Lewis.
Thursday assorted links
2. New YouTube channel for Indian architecture.
3. Where do Math Olympiad gold medal winners end up? “By total gold medal count, China is the clear leader, followed by the pack of USA, Russia, and South Korea. Over 20 years China has 105 out of a possible 120 gold medals which means nearly all their students achieved gold. This is so successful that it’s common knowledge that it is harder to make the China IMO team than to get a gold medal in the IMO itself.”
Modern Principles of Economics!
If you are teaching economics Modern Principles is the book to use! Great and original writing, over one hundred videos, iClicker, Achieve and lots of additional support. Contact Mike Krotine to get an examination copy.
A simple point about the intertemporal regulation of AI
At some point AI will be more regulated than it is today. Furthermore, I believe that most parts of the American economy, once they are regulated, end up overregulated.
Thus it is likely that the AI sector will, at some point, end up overregulated.
Given that reality, perhaps the AI sector should be underregulated today. After all, overregulation will have decades, maybe centuries, to catch up and even the ledger.
Many regulatory issues can be considered within this framework. You can think that AI is “underregulated today”, in the static sense of that term, and still not favor additional regulation right now. You might prefer to keep it underregulated for some while to come.
Do mass shootings in universities lead to permanent effects?
Using a stacked difference-in-differences design covering shootings between 1990 and 2025, I compare cohorts at affected universities before and after the shooting with cohorts at matched control universities. I find no detectable effects on time to degree, but undergraduates enrolled at the time of the shooting are 4.2% less likely to pursue further studies. Those who do continue shift toward health: the share of exposed cohorts who later enroll in a health degree rises by 1.3 percentage points (8.8%), and this effect persists among cohorts who enroll after the shooting. Effects on students present during the shooting are consistent with a response to trauma; for later cohorts, I find evidence of sorting, as master’s students with prior healthcare experience become more likely to enroll in affected universities. These results suggest that mass shootings leave institutional and cultural legacies that outlast the students who witnessed them.
That is from the job market paper of María Medellín-Esguerra, who is currently on the job market from Brown University.
More on Elizabeth Holmes and prison
The Free Press asked me to expand upon my views of this matter, here is one excerpt from the piece:
Third, fewer women in prison does not have to mean less deterrence overall, as arguably we should concentrate more of our legal resources on deterring violent men.
Note that if we can release enough women from prison, more prison space will be freed up, and I mean more prison space for men, including violent men. It is common to read of shortfalls in jail and prison space, which lead to violent men being released early. Many of these men go on to commit violent crimes, a truly major injustice. Or they commit an ongoing string of misdemeanors, sometimes ranging into the dozens or even hundreds, such as shoplifting or disorderly conduct. Our cities become much less livable as a result.
If we can, over time, convert some of the current prison space for women into prison space for men, especially violent and destructive men, I expect a net increase of justice in this country. I also think it will be a better country to live in.
There is precedent for such a conversion of facilities. In 2013, California turned the Valley State Prison for Women into a men’s prison, as the female prison population was declining and more space was needed to relieve overcrowding among the males.
As an economist might say, sending women to prison is not a free lunch. Given that prison space is scarce, it means the release of more violent criminals, mostly male.
Some reliance on prison is unavoidable. But it amazes me how much people will go to the mat to defend an institution — whole cloth at that — that makes no real sense in terms either humanitarian or even simply organizational.
Wednesday assorted links
2. Apartments that expand at the touch of a button.
3. Has this guy composed more songs than anybody else?
4. Psychoanalyzing Elizabeth Holmes.
5. AI wrote some of the Dallas Michelin reviews. And the reviewer responds.
6. New Yorker profile of James Daunt. The last event I was at I saw three Daunt bags, one of them mine (not in the UK).
One reason I do not love AI writing, or even AI-assisted writing
Of course I read to absorb the content, but I also am in a position to meet many authors, have contact with them, and spend time with them. So reading anything also is a potential option on those future connections. But when I am reading an AI piece, the value of that option comes pretty close to zero.
The Causal Effect of Foreign Ideas on U.S. Innovation
Globalization is once again better than many people realize:
We study the role of foreign ideas in U.S. innovation by constructing a directed “genealogy” of technologies from the full text of 13 million patents filed between 1887 and 2024. By tracing which earlier technologies appear in the founding patents of new ones, we recover a large-scale input–output network of technological recombination that identifies the foreign technologies that serve as inputs into innovation in the United States. We report four main findings. First, foreign ideas are pervasive: 54% of U.S. technologies build on at least one foreign input, and the most fertile U.S. technologies rely on foreign inputs most heavily. Second, foreign ideas have large causal effects on U.S. innovation. Using the historical settlement of migrants as a source of exogenous variation in local ancestry, we show that U.S. counties more exposed to knowledge from a given foreign country absorb substantially more technologies from that country and, in turn, invent significantly more U.S. technologies building on them. Third, foreign ideas shape not only the level but also the direction of technical change: U.S. counties are far more likely to pioneer the specific technologies whose foreign inputs are already in their local idea stock, and the changing origins of foreign ideas accompany the shift of American innovation from its historical heartland toward the coasts. Fourth, these effects leave a lasting imprint on local labor markets: decades later, counties that absorbed more of an origin’s ideas host more jobs working with those ideas, and even more work with the U.S. technologies descended from them.
Here is the full paper by
Saving for the machines
From Jesús Fernández-Villaverde:
When machines can perform a growing share of tasks, growth depends on two margins: how the task structure affects the returns to accumulating machines, and how strongly capital accumulation responds to those returns. I argue that, in a standard task model, capital supply governs the size of the growth boom associated with automation, while the task structure sets the duration of this growth boom and the evolution of wages. I document how the same technology path that generates 11.7% annual growth when households choose their saving rate optimally delivers only 2.2% when the saving rate is fixed at the calibrated U.S. 2025 level of 23%. Therefore, slow growth might reflect too little capital accumulation instead of a technological bottleneck. Also, the saving rate rises mainly because automation raises the capital share, not because households become thriftier. Long yields price the growth boom: the ten-year real yield jumps from 5.1% to 13.6% on impact. In my benchmark calibration, hand-to-mouth households lose the equivalent of two-fifths to two-thirds of their consumption, while keeping them on trend temporarily costs at most a fifth of GDP.
Here is a thread on the paper. Here are the slides. More bottlenecks!
Tuesday assorted links
1. Freddie as AI skeptic (and I have given my predictions in fact).
2. Claims about Shakespeare and Marlowe.
3. How did “artificial intelligence” get its name?
4. How is the econ job market this year?
5. AI can now ace econometric coding.
6. The quasi-Riemann proof is becoming intelligible pretty quickly. And new associated math results as a result, authored by humans.
The net fiscal impact of immigration should include gains from trade
Immigration affects natives through both labor markets and public budgets, yet these channels are usually studied separately. We combine them in a general-equilibrium model with search-and-matching frictions, skill-specific progressive labor taxes, capital taxation and public goods, calibrated to 17 OECD countries over 2015-2019. The welfare effect on natives of a one-percentage-point increase in immigrant inflows varies in sign and size across countries, hinging on immigrants’ skill mix, immigrant-native wage gaps, resident unemployment, and tax progressivity. For inflows matching the skill composition of 2019-2024 arrivals, native welfare rises in 14 of 17 economies, and in most cases both skill groups gain, through different channels. Lower-skilled natives gain mainly from higher pre-tax earnings, driven by job creation and complementarity with skilled immigrants; higher-skilled natives gain mainly from lower labor-tax burdens. Evaluating immigration policy thus requires modeling labor-market and fiscal channels jointly: either channel alone gives an incomplete picture of who gains and why.
That is from a new NBER working paper by
As a side note, I do not accept the authors’ claim that the immigrants are equally productive yet underpaid, and thus the native economy benefits from capturing that surplus. The better mechanism is simply that immigrants boost market size, and (especially for the United States) that brings some gains from increasing returns to scale, more innovation, making the country a talent magnet, and so on. The point holds that the gains from trade effect can be small, and it still will overwhelm what otherwise appear to be net fiscal costs.
On Brazilian food
Every now and then I will write a piece on food for Works in Progress. Here is my piece on eating in Brazil:
Brazil, like most large nations, also offers multiple cuisines. For instance you can go to Minas Gerais for pork and beans. Minas beans would be my favorite of what I have sampled, surpassing Mexico. Belem serves cuisine from the Amazon region, including exotic river fish, dried shrimp, duck, and rice, with flavors from cassava, manioc, and the local fruit. You cannot get those dishes in many other places.
Feijoada is of slave origins, and is often associated with Rio de Janeiro, but it has evolved into a national dish, available almost everywhere. Think rice, black beans, collard greens, orange slices, and farofa, a kind of manioc flour, with different parts of the pig mixed in. At home I cook the vegetarian version of this dish. The coolness and sweetness of the orange go well with the sandy texture of the farofa, and the meal hardly costs anything to make.
Rio de Janeiro offers highly cosmopolitan options, and the city has a tradition of excellent French and Continental restaurants.
The best churrascarias I have had were on the outskirts of Curitiba in the south. You can get an excellent pasta meal combined with your choice of many kinds of meat, leading to an impossibly large quantity of food at your disposal. I favored these establishments more in my youth, but if you have never tried them, you are missing something.
Campo Grande, the booming agro-city in central western Brazil, has a derivative form of Okinawan soba (!) as a dining specialty. I regret that, due to a delayed flight connection, I have yet to try this apparent delicacy.
There is much more at the link, recommended.
The California billionaire tax is very likely a net revenue loser
This paper examines the revenue and migration impact of the 2026 California Billionaire Tax Act, a one-time 5 percent tax on the worldwide net worth of individuals exceeding $1 billion. Using data from the Forbes Billionaire List, news reports detailing the residential real estate holdings of California billionaires, and public announcements of billionaire departures from the state, we estimate the behavioral response and associated revenue loss to this new tax using several different methodologies. Even before accounting for reductions in other tax bases such as the income tax, we estimate that the Act will collect approximately $30 billion (range $28 to 36 billion), less than a third of the $100 billion projected by Galle et al. (2025). This range accounts for the publicly confirmed taxpayer migration that has already eliminated nearly 30 percent of the Act’s wealth tax base, applies a litigation-survival discount to the remaining base, and is validated by the wealth tax base elasticity literature. We estimate that California’s billionaires contribute $3.3–5.8 billion annually in state income taxes. The present value of permanently lost income tax collections from departures more than offsets the one-time wealth tax revenue, yielding a net present value of negative $38.9 billion. Across 100,000 simulated revenue and discount rate combinations, 85 percent of plausible outcomes produce a negative net present value of state revenues.
That is from a new NBER working paper by Benjamin Jaros and Joshua Rauh. Overall this issue is a good litmus test for who still thinks like an economist.