Covid and the nature of capitalism

Philippe Aghion, Helene Maghin, André Sapir 25 June 2020

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None of us had predicted the pandemic we are currently experiencing, nor the severe global economic downturn it has caused. For all the harm it brought into the lives of so many people worldwide, the Covid crisis may have one merit: namely, to serve as a ‘wake-up call’ for reforming capitalism in the different forms it takes on both sides of the Atlantic. In the US, the epidemic has brought into focus the tragedy of all those individuals who are not insured – or only badly insured – against job losses and health problems (Furman 2020). In Europe, the crisis has shed light on the rigidities and lack of coordination in the innovation response to the Covid shock. Unavoidably, the crisis has prompted existential debates on how to think about the ‘after-Covid world’ (Goldberg 2020).

The US model of capitalism and Western European models – in particular, those of Germany and the Scandinavian countries – are often viewed as opposites: ‘cutthroat’ capitalism versus ‘cuddly’ capitalism (Acemoglu et al. 2012). Cutthroat capitalism is good for innovation but generates inequality not only in income but also in employment and health protection; cuddly capitalism is better at redistributing income and at protecting employment and health but worse at producing frontier innovation.

How are the US and Western European models dealing with and responding to the Covid crisis in terms of employment, health protection, and income support on the one hand, and innovation on the other hand? Given the nature of the Covid crisis, we devote most of our discussion to the first dimension, but will also mention the second.

A comparison of employment, health protection, and income support

We begin by comparing Germany and the US in terms of unemployment, health coverage, and the risk of falling into poverty before (in 2008-2019) and during the Covid crisis (in 2020-2021).

Figure 1 shows the evolution of the unemployment rate and the share of the population without health coverage.1 The numbers for 2019-2021 are estimates based on the relationship between the unemployment rate and the rate of health coverage during the period 2008-2018, using the actual rate of unemployment in 2019 and the IMF forecast for 2020-2021.

Figure 1 Healthcare coverage in the US and Germany

Notes: The figure plots the unemployment rate and rate of uninsured from 2008 to 2018 and infers the evolution of healthcare coverage from its past observed relationship with the unemployment rate, its value in 2019, and its forecasted rate for 2020-2021. Shaded areas are standard 95% confidence intervals.

Source: Own calculation with data from the OECD health statistics, the OECD unemployment rate, the US Census Bureau for historical data on health coverage in the US, and the IMF World Economic Outlook 2020 for forecasted unemployment rates in 2020-2021.

The differences between Germany and the US are striking. During normal years, the unemployment rate in the two countries is fairly similar, but during crisis years (2009-10 and 2020) the unemployment rate increases sharply in the US while remaining fairly steady in Germany thanks to the Kurzarbeit system among other factors (Garicano 2020). The difference is even more striking for health coverage. Even in normal times, a big gap exists between Germany, where there is universal health coverage, and the US, where even after the introduction of Obamacare in 2014, the rate of the population without health coverage was nearing 9% in 2018. We estimate that this rate will reach nearly 12% in 2020 and come down to 11% in 2021.

Compared to Germany, health coverage in the US is therefore both structurally lower and particularly deficient during downturns because it is often linked to employers. Cawley et al. (2015) showed that a one percentage point increase in the unemployment rate following the Great Recession of 2007-2009 resulted in a substantial reduction - by 1.67 percentage points (2.12%) - in the probability of retaining health coverage.

The risk of losing coverage in 2020 will depend partially on government agencies’ ability to deal with the mass inflow of new insurance requests. The Kaiser Foundation estimates that out of the 31 million people who had filed for unemployment benefits between March and May 2020, 27 million are at risk of losing their employment-related coverage. Of those, up to 48% should be eligible for Medicaid and 31% should be eligible for premium subsidies, leaving the rest ineligible for neither. However, eligibility does not guarantee full coverage, even in states that extended Obamacare (Finkelstein et al. 2019, Tebaldi 2017).

Figure 2 shows similar comparisons between the US and Western European countries in terms of unemployment and health coverage. Like Germany, all citizens of France, Italy, Spain, and the UK have universal health coverage. Hence, although some of these countries have high structural unemployment rates and are witnessing a large increase in unemployment in 2020, citizens in all of these countries will keep their health coverage despite the Covid crisis.

Figure 2 Healthcare coverage in the US and Western European countries

Notes: The figures plot the unemployment rate and rate of uninsured from 2008 to 2018 and infers the evolution of healthcare coverage from its past observed relationship with the unemployment rate, its value in 2019, and its forecasted rate for 2020-2021. Shaded areas are standard 95% confidence intervals.

Source: Own calculation with data from the OECD health statistics, the OECD unemployment rate, the US Census Bureau for historical data on health coverage in the US, and the IMF World Economic Outlook 2020 for forecasted unemployment rate in 2020-2021.

Figure 3 shows the evolution of the unemployment rate and of the share of the population at risk of poverty in Germany and the US since 2008. The figures for the risk of poverty are taken from the Eurostat database. Eurostat’s definition of the rate of poverty is the fraction of the population below 60% of the national median income for each country. We used the same definition to construct the risk of poverty for the US. As with health coverage, we estimated a relationship between the risk of poverty and unemployment, which we then used together with the 2019 unemployment figures, and the IMF forecasts for 2020-2021, to extrapolate it. 

Figure 3 Poverty in the US and Germany

Notes: The figure plots the unemployment rate and rate of people at risk of falling into poverty from 2008 to 2018 and infers the evolution of the risk of poverty from its past observed relationship with the unemployment rate, its value in 2019, and its forecasted rate for 2020-2021. The Eurostat risk of poverty index is defined as the fraction of the population below 60% of the national median income for each country. For the US, we construct manually an equivalent measure as the fraction of the population whose income is less than 1.75 times the poverty line, which corresponds with 60% to 64% of the median income. Shaded areas are standard 95% confidence intervals.

Source: Own calculation with data from the Eurostat’s at risk of poverty index, the OECD unemployment rate, the US Census Bureau historical poverty tables, the US median income from the American Community Survey, and the IMF World Economic Outlook 2020 for forecasted unemployment rate in 2020-2021.

Prior to 2020, the risk of poverty was substantially higher in the US than in Germany. We estimate that the gap between the two countries will increase dramatically during the Covid-19 crisis. Between 2019 and 2020, the share of the population at risk of falling into poverty is set to increase from 24.4% to 30.7% in the US, while it should increase only from 16% to 16.4% in Germany.

In both countries, the risk of falling into poverty is counter-cyclical. It increases in difficult times as people lose their jobs and their primary means of subsistence. In the US, the cyclicality is stronger for reasons ranging from the low level of public subsidies to the degree of individual indebtedness.

The actual risk of falling into poverty in the US in 2020 will depend partly on the government’s ability to efficiently implement the relief packages approved by Congress. Their implementation so far, as well as that of the Paycheck Protection Program, shows mismanagement (Hirsh and Johnson 2020). An estimated 35 million Americans are still waiting for their stimulus checks (Konish 2020).

Figure 4 shows similar comparisons between the US and Western European countries. In each of these countries, the risk of poverty was lower than in the US before the Covid crisis, and none of them is expected to witness a substantial increase in 2020 or in 2021.

Figure 4 Poverty in the US and Western European countries

Notes: The figures plot the unemployment rate and rate of people at risk of falling into poverty from 2008 to 2018 and infers the evolution of the risk of poverty from its past observed relationship with the unemployment rate, its value in 2019, and its forecasted rate for 2020-2021. The Eurostat risk of poverty index is defined as the fraction of the population below 60% of the national median income for each country. For the US, we construct manually an equivalent measure as the fraction of the population whose income is less than 1.75 times the poverty line, which corresponds with 60% to 64% of the median income. Shaded areas are standard 95% confidence intervals.

Source: Own calculation with data from the Eurostat’s at risk of poverty index, the OECD unemployment rate, the US Census Bureau historical poverty tables, the US median income from the American Community Survey, and the IMF World Economic Outlook 2020 for forecasted unemployment rate in 2020-2021.

A comparison of innovation inputs and outputs

We now turn to the issue of innovation, where the US enjoyed a strong advantage before the Covid crisis, which will probably help it to recover more quickly from the crisis than European countries.

The US strength in innovation, compared to EU countries, can be seen by examining both innovation inputs (such as money) and outputs (such as patents).

Starting with innovation inputs, Figure 5 indicates that the EU invests nearly one point of GDP less than the US, although there are important differences across countries, with Germany now spending more than the US as a share of GDP.

Figure 5 R&D intensity by country

Notes: EU includes France, Germany, and the UK. Data for the US in this figure reflect international standards for calculating gross expenditures on R&D, which vary slightly from the NCSES’s protocol for tallying US total R&D.

Source: The State of US Science and Engineering 2020 from the NSF.

Europe’s innovation weakness is a question of both money and organisation. In the US, federal institutions such as BARDA (Biomedical Advanced Research and Development Authority), DARPA (Defense Advanced Research Projects Agency), NIH (National Institutes of Health) and NSF (National Science Foundation) play a crucial role in pushing forward the frontier of knowledge and enabling private-sector R&D in key domains. These four institutions, which in 2020 have a combined budget of $55 billion ($2 billion for BARDA, $42 billion for NIH, $8 billion for NSF, and $3 billion for DARPA), often work separately but sometimes together (and with others), as in the BRAIN (Brain Research through Advancing Innovative Neurotechnologies) Initiative. The EU budget, through Horizon 2020, already devotes sizeable amounts of public money to fund innovative initiatives (roughly €13 billion in 2020), including through the European Research Council (ERC) and the European Innovation Council (EIC), but Europe still has a long way to go before it seriously competes with the innovation potential of the US. 

As far as innovation outputs are concerned, over the period 2010-2017, the US was far ahead of Germany, France, and the Scandinavian countries in terms of the number of patents per million inhabitants. The US dominant position was even more striking if we restrict attention to patents among the top 5% most cited.

Table 1 Annual average patents 2010-2017

Source: Aghion et al. (2020), The Power of Creative Destruction, forthcoming, Harvard University Press.

Another measure of innovation output is the share of the EU and the US in the global value- added output of high R&D intensive industries shown in Figure 6. During the period 2003-18, the EU accounted for around 20-22 % on average of global VA in R&D intensive sectors, roughly in line with its average share of global GDP (26%). By contrast, the US accounted for around 30% of high R&D VA, while its average share in global GDP was only 24%. In other words, the US has been punching much above its weight.

Figure 6 Value-added output of high R&D intensive industries by country

Notes: Value added is the amount contributed by a country, firm, or other entity to the value of a good or service and excludes purchases of materials and inputs.

Source: The State of US Science and Engineering 2020 from the NSF.

Conclusion

Both ‘cutthroat’ and ‘cuddly’ capitalisms are implementing changes to deal with their structural weaknesses during the Covid crisis. The US has implemented some short-term income support measures to reduce the risk of poverty, but it has not adopted structural measures to reform its system and move towards a cuddlier capitalism. In Europe, on the other hand, the Covid crisis may be an opportunity to move towards a new model of capitalism in which both innovation and the protection of citizens are promoted. This is not a naive ideal: states can have it all. The Scandinavian model of flexi-security has shown that countries can have both generous social protection and vibrant innovation. Germany has also achieved an impressive balance in this regard. Other European countries need to move in the same direction by incentivising innovation while continuing to protect citizens from social and health risks. The Next Generation EU package currently discussed by European leaders has the potential to stimulate a transformative recovery, making Europe a caring and innovative place. 

References

Acemoglu, D, J A Robinson and T Verdier (2012), “Can’t We All Be More Like Scandinavians? Asymmetric Growth and Institutions in an Interdependent World”, MIT Department of Economics Working Paper No. 12-22.

Aghion, P, C Antonin and S Bunel (2020), The Power of Creative Destruction, Harvard University Press, forthcoming. 

Cawley, J, A S Moriya and K Simon (2015), “The Impact of the Macroeconomy on Health Insurance Coverage: Evidence from the Great Recession”, Health Economics, 24(2): 206-223.

Konish, L (2020), “35 million stimulus checks are still outstanding. What you need to know if you’re waiting for your money”, CNBC, 8 June.

Finkelstein, A, N Hendren and M Shepard (2019), “Subsidizing Health Insurance for Low-Income Adults: Evidence from Massachusetts”, American Economic Review, 109(4): 1530-1567.

Hirsh, M and K Johnson (2020), “A Tale of Two Rescue Plans”, Foreign Policy, 24 April.

Furman, J (2020), “Protecting people now, helping the economy rebound later”, VoxEU.org, 31 May.

Garicano, L (2020), “The COVID-19 bazooka for jobs in Europe”, VoxEU.org, 20 March.

Goldberg, P (2020), “Policy in the time of coronavirus”, in Baldwin R and B Weder di Mauro (eds.), Mitigating the COVID Economic Crisis: Act Fast and Do Whatever It Takes, London: CEPR Press.

Garfield, R, G Claxton, A Damico and L Levitt (2020), “Eligibility for ACA Health Coverage Following Job Loss”, Kaiser Foundation, 13 May.

Tebaldi, P (2017), “Estimating Equilibrium in Health Insurance Exchanges: Price Competition and Subsidy Design under the ACA”, Becker Friedman Institute for Research in Economics Health Economics Series, Working Paper 2017–05.

Endnotes

1 Our estimate of the health coverage ratio in the US is based on a lower bound strategy. For states that did not take advantage of Obamacare to extend their health coverage, we assume that the proportion of individuals without health coverage will evolve with unemployment exactly as it did during the 2008-2018 period, i.e. prior to Covid. For states that took advantage of Obamacare, we make the conservative assumption that the percentage of individuals without health coverage remains the same as in 2018: we thus fully factor in the long-term benefits of the Obamacare reform, while ignoring the potentially negative effects associated with the change of administration and the Covid crisis.

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Topics:  Covid-19 Europe's nations and regions Global economy Institutions and economics Poverty and income inequality Productivity and Innovation

Tags:  capitalism, Europe, US, COVID-19, reform, social protection, innovation

Professor, College de France and London School of Economics; CEPR Research Fellow

PhD candidate in Economics, KU Leuven

Professor, Universite Libre de Bruxelles; Senior Fellow, Bruegel; Research Fellow, CEPR

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