 My guest doesn't need any introduction, it's Michael Spence, he's Nobel Prize Nobel Laureate in Economics and that's where we're going to let it go. We'll start right with the conversation. He and I are kind of colleagues not as Nobel Laureates but we hang out occasionally at the same American campus which is Stanford. We never met and so it took us about 6,000 miles to finally meet. So Michael, this organization has scripted our conversation very tightly and I will at least obey the first rule. The first rule is to ask you what keeps you up at night? It's not my question, it's their question. I understand. So the frivolous answer is my wife. And it's not what you think. My wife's a journalist. What does she do? She's a journalist and she works until all hours at night. We tend to eat at 11.30 in the evening. What keeps me up at night and what I was hoping we could talk around today is the fact that I think we're in a pattern in which the intergenerational opportunity set is actually declining at least in the industrialized countries. I'm going to translate that. That means the kid is not going to be better off than the old man. Yeah, there's surveys in America, lots of them that suggest that people think their children and their grandchildren are going to have a reduced set of opportunities with respect to employment and that's rewarding and so on. And that keeps me up at night, Joe. Let's first start with what the reason might be for this. Well that's complicated. You know what this is called? You've got half an hour. You've got half an hour. I know. I don't know what a breakthrough is, but let me try to answer that by saying I spent the better part of the last seven or eight years working with and in developing countries on difficult issues related to growth, growth strategy, policies that support it. And I think there's a number of lessons that came out of that. But the main thing, the thing I wrote about in my book is that the developing countries are becoming large, further up the value-added chains, and are having a growing impact on each other, on the global economy, and on the advanced countries. But how does this reduce mobility in the U.S. or in the West in general? It doesn't reduce mobility, but it has impacts on the structure. So let me jump ahead. So then I decided that a lot of us, including me, were doing some hand-waving about structural changes in the advanced countries. And I went and looked at the American economy over 18 years coming into the crisis to try to figure out where we generated employment and where we generated growth, value, and so on. And the answer that we found by doing this industry by industry, paying attention to what's tradeable and what's not tradeable in the global economy, the United States generated an astonishing number of jobs in that period, more than 27 million. And 98 percent of them were in the non-tradeable sector. And that's a pattern that I don't think can persist. Which why is it, why is it worse to produce stuff that's produced and consumed at home as opposed to stuff that you can sell abroad? So if you look carefully at this evolution, what happened is that the tradeable sector actually created quite a lot of growth and quite a lot of value. Is tradeable goods, are they generally higher value added? No, but the part of the value added, the global value added chain that resides in advanced countries is the higher value added part. So these things move around pretty fast in the global economy. And so what happened is that the tradeable sector was a growth engine but not an employment engine. And all of these people flowing into the job market flowed across the tradeable-non-tradeable boundary into the non-tradeable side and found employment somewhat miraculously. Okay, the tradeable stuff which is high value added does not create employment. No, it doesn't. And is the obverse true? Tradeable, non-tradeable stuff creates employment but doesn't add high value? No, but most of the incremental value added in the non-tradeable side was used up by adding people. So if you look at the incomes in the non-tradeable side, they're flat, relatively flat. If you look at the incomes in the tradeable side, they're growing at about the same rate as the total value added created. Why? Because there's no incremental employment creation. Give us an example of how this works, what we just talked about. Big two goods which exemplify what you're talking about. Well, the best-known one is the value added chains in the technology sector because they've been studied so carefully. So if you look at the Apple products, probably 70% of the value added is created in America by Apple with relatively small numbers of people designing products, benefiting from the marketing and brand and so on. And most of the employment is created. So it's iPod versus haircut? Well, I guess so, yeah. So we mean, I mean, haircuts or definition cannot be traded. Not right now, no. No. Not for everybody. Well, some of us do go to Italy, for instance, to have our haircut, but that's a very small sector of the population. So here we are stuck with a pattern which is probably true for other Western countries too, but most of the United States because it apparently has off-shored a lot of its manufacture to other countries. That's part of the problem. The really distinctive case that's different is Germany. Because it still has industry. Because they went through a very serious set of reforms in the last 10 years under Chancellor Schroeder that were designed to make the tradeable sector of the economy remain an employment engine. So they went through a process interactively with labor, business, and government to take away the labor market rigidities in return, make a commitment to employment, to fix the social safety net so that they actually worked even without day-to-day employment security and so on. Why can't the great United States do that too? We can do it. I mean, in principle. Why isn't it being done? Well, this is your territory, right, Joe? In politics, they talk politics, no? Yeah. No, so this, I think, is the thing that keeps me up at night. And then we've come full circle. And I think that what I learned in the developing countries is that there's a short-run policy agenda, you know, having to do with cyclical things, business cycles, and then there's a long-term one. Structural change, the growth engines in the economy, anticipating where the employment's going to come from, you know, thinking about what kinds of investments and people and so on you need to make to do that. And my view is that the policy framework in a wide range of advanced countries is just way too narrow and short-term focus. How do you broaden it? Well, I think first you have to convince people that actually need a policy framework that has an extended time dimension and that pays attention to, in addition to sort of stability, efficiency, innovation, and growth, which is, I think, what markets we all agree markets are good at. We have to pay attention to a broader set of stability issues, certainly to equity and distributional issues and to sustainability. Okay, but, you know, if you ask the chancellor who was here last night who even is willing to concede that her low unemployment figures below 3 million down from five when she entered office were due to the Schrader's reforms, but then she adds, you know, you also lost the election for doing that. He told me the same thing. Okay, so that I think explains the political side. I think the other problem, the other difference between those two big Western economic powers is that the Germans haven't been industrialized as rapidly as the United States. So the United States has, what, about 16 percent of GDP as a manufacturer, and in Germany it was just below 30 or so. So wouldn't your problem that you've, you know, the tradeable versus non-tradeable high value low, a high employment low, wouldn't that kind of, do you think it would be solved if the U.S. of A re-industrialized? A large part of it would, yeah. And how would we do this? What about we always staring at this giant China, China is close to falling into the middle income trap where its competitive advantages are going down. Do you think we'll profit from that? Good paying jobs? No, I spend a lot of time in China trying to help them, sort of, with these evolutions. So I'm reasonably optimistic about the middle income transition. Now if you wanted to bet against that, then you'd have the data on your side, virtually all countries. I looked at them. Japan, Taiwan, South Korea, it's the growth curve, goes up like this, double-digit and comes down to a normal level or declines below zero in Japan's case. Be careful. I mean the growth rates come down as you approach advanced country status because advanced countries don't grow at 7 to 10 percent. I mean that's just the way it is. We grow by innovation. Bob Solo taught us that many years ago. But actually the countries you named actually went through the middle income transition at high speed. They hit a roadblock in 97, 98 in the Asian currency crisis, but they went through. Most other countries actually just slow down or stop. So you could be skeptical, and many people are, about China. But the answer to your question is no. There's 85 million jobs coming out of China in the labor-intensive stuff in the next few years as they go through this transition. They'll spill into the developing world at earlier stages. And that then will be a different configuration out there in the developing world. But from an advanced country point of view, we may stop fussing about China and start fussing about Vietnam and a number of other places. Is somebody there at his extended workbench where our jobs will go? This is China today. It's Timbuktu tomorrow, right? Yeah, but the advanced countries aren't competing for the very labor-intensive process-oriented manufacturing jobs, including Germany. They're in advanced manufacturing sectors with technology and highly skilled workers. And so I think that's the territory, or part of the territory, that we can think about in sort of restoring some of the competitiveness on the American side. How do we re-industriize a country which, along with the other great Anglo-Saxon economy, the Brits have come down so drastically to each about 16% of GDP being manufactured? How can you reverse that? I mean, you see anecdotal evidence in the United States, Louisville, Kentucky, all kinds of stuff where re-industriization is taking place on a kind of ad hoc. Or is there a pattern there that you could see? Well, first of all, I think most people think manufacturing is making things. If you look at manufacturing supply chains, they're long, complicated, scattered over the global economy, and a good chunk of its services of one kind or another. Managing multinational enterprises, architecting these global supply chains, designing products. And in a good chunk of those, we're competitive. So we're talking about adding at the margin a little bit where it makes sense. And that I think you can do. You can do it with education that's effective. You can do it with skills, focus on skills. You can do it in lots of ways. What's the United States not doing right here? Does it like the kind of very intricate vocational training system that the Germans and other Europeans have? Is the United States a country where mass production of 20th century didn't require much more than taking a guy off the countryside, train him for a few days and put them on the conveyor belt?