Back against that trend. The lesson from history that we should reflect on tonight is that those who believe in the merits of an open International Order should fight for it when it is under challenge. And that is the context, in my mind, that we are debating this and related issues tonight. We are delighted again to present the Philippe Aghion lecture. This forum has become the leading forum for debate on the transatlantic relationship and how the transatlantic relationship tackles broader global issues like globalization. It is a special honor for us tonight to add another chapter to the series and pay tribute to aghions legacy and host to notable economic scholars and authors who will address the issue of how to make earth more equitable. Philippe aghion and heather boushey. I would also like to mention how fortunate we are and grateful i am to have our brookings colleague, david wessel, joining Hutchins Center on fiscal and Monetary Policy to moderate the discussion. To conclude, i would like to thank those who have contributed to making this event a success and possible. The embassy of france for the collaboration and support. And i want to particularly recognize the ambassador with us here today and thank the French Foreign ministry and the policy planning team. So now, i will turn the floor over to philippe le corre to do a more formal introduction of our two speakers. Philippe thank you very much. Welcome, everybody. I am delighted to be introducing professor Philippe Aghion. Who i had the pleasure to host in the harvard club of france four years ago. The professor is an unusual french academic who has spent most of his career on this side of the atlantic, obtaining his phd in economics at harvard in 1987, taught at m. I. T. Before becoming a professor at the University College of london, and then at harvard, where he was made the Robert Wagner professor of economics in 2002. Philippe aghion analyzed the design of growth policies. Much of the work is summarized in the books that he coauthored in 1998. Indigenous growth theory. Growth. Osition and he was elected a fellow of the Economic Society in 1991. And a fellow of the academy of arts and sciences. This is the 13th lecture. We always try to find a link with the great 20th century french intellectual who was everything we like at workings. A political scientist, prolific author and writer, journalist, but also an engaged intellectual , who joined the Free French Forces in world war ii. And a man who was never afraid to go against the waves when expressing his view. Remember his major works such as the opium of the intellectual, a true assault on the french intelligentsia, or the critical essay he wrote on the u. S. , imperial republic, the United States 19451973. He was also a sociology professor himself. I want to use this opportunity to say a few words about this extraordinary institution, which was founded in 1630 under king francis the first. It is still located in the heart of paris in the latin quarter. One particular aspect i want to underline is that it does not grant degrees. Everyone can attend lectures by some of the worlds best professors in science and humanities. Professors are lectured by their peers. The motto of this school is it teaches everything. So if you dont live in paris, which i suspect is the case for most of you, i highly recommend you go online and watch some of the hundreds of podcasts available on itunes in french, english, and even chinese. Bouqeout,tch avon, and aghion. The subjects that we at the center on the United States and europe, part of foreign policy, is run by bruce here, is highly relevant at this critical moment. Let me also say we are very fortunate to have with us dr. Heather boushey, who is the executive director and chief economist for the Washington Center for equitable growth. Heather boushey received her phd in economics from the new school for social research and became an economist with the center for Economic Policy institute, and the United StatesCongress Joint Economic committee. Her research focuses on economic inequality and public policy, specifically employment, social policy, and family economic wellbeing. Her latest book, finding time the economics of worklife conflicts was published this year by harvard press. Let me now welcome professor Philippe Aghion for his lecture. Thank you. [applause] dr. Aghion it is a great honor to be here. Thanks so much for inviting me. And you were way too generous in your introductory word, philippe. So i would like to start with with the following quote from raymond aron. Here i have a picture of raymond aron. And i like this one because there is light coming out of him. [laughter] so in french, it is [speaking french] i tried to translate it. I translated Something Like this men are those who write history, but they dont know which history they are writing. This is particularly true of recent economic history. We did not obviously right the recent financial crisis, but we did not anticipate the effects of globalization and the effects of the recent technological revolution, and we were not adequately prepared to deal with some negative secondary effects, increasing inequality and populism we see now. So therefore, that motivates the question, how can you make growth and innovationled growth more inclusive . And i will try also to say a few things on what can europe learn from the u. S. And vice versa. What can we learn, the u. S. And europe, from each others experience on how to make growth more inclusive and to avoid or stop the rise of populism that we see now . Aron is a giant, and i would never dare to compare myself to him. We have points in common. We are both french jews. Another point we have in common is that i discovered i didnt know that, actually, but going through google and all that that he knew marx very well. Shame on me. I also studied marx a lot. In fact, we would have made ours the following quote, which is to say that marx is too good to be left to the marxist. But in fact, that quote was made myself. Er aron or shumpeter. You can see how he took a lot from volume three from capital, das kapital. I could go on, but i wont do that. So what i have done over the past 30 years with my colleagues and others is to develop a theory based on some schumpeterian ideas. When i started growth, the model of fashion was the solo model. He did a very eloquent model with only two equations to describe everything. It is very elegant and very helpful, but that model, the purpose of the model was to say without economic progress, you cannot have growth. You cannot rely on capital accumulation to grow forever. With only capital accumulation, you run out of steam and cannot have longrun growth. It was a growth model to explain to us that we cannot have longrun growth if we dont have technical progress. But the model of solo would not explain where technical progress comes from. So you needed to find something else, but there was no such model. In fact, you would hear about schumpeter, schumpeter with a very interesting ideas, but there was no model and empirical analysis. So we did is take some ideas from schumpeter and try to build a model around those ideas and see how we can dialogue between the model and the empiric to learn something about the growth process. Sorry but the model, and now it is called the schumpeter growth theory and it revolves around , three ideas. The first idea is that longrun growth is driven by innovation. The second idea is that innovations result from entrepreneurial activities that are motivated by the prospect of innovation rents. This is very important, because it tells you that institutions and policies impact on growth. Affect ofinfect incentives to do r d and other activities. I am in a country where i am expropriated, i will not do innovation, because i know the rents from my innovation will be appropriated. If i am in a place with hyperinflation, i will not engage in any innovation, because i know that all of the rents of my innovation will be expropriated from the inflation tax. So the policies and institutions shape the growth process, because they impact the incentives. The second sentence tells you that you can talk about policies and institutions of growth. There are institutions that are good for innovation and growth and institutions and policies that are bad for innovation and growth. And the sentence is creative third destruction, new innovation, particularly frontier innovation, they displace all technologies. That is a very important sentence, because it means that growth is a conflictual process. It is a conflict between the old and the new. You can talk about the political economy of growth. In the important thing about growth and that will be important when i talk about inclusiveness is that the innovators of yesterday tend to become the entrenching incumbents of today, who try to prevent new innovators from coming in. So you need to have a system that at the same time rewards innovation, but not to an extent that the innovator could use reward to prevent subsequent innovation, and that is the kind of squaring the circle problem with innovation. Some countries are better than others at dealing with this dilemma. That is the political economy of growth. There is a book entirely based on this. There are countries that deal well with it. They call them inclusive. There are countries that dont deal well with it. They call them extractive. So that is the introduction. That is the framework we have used. With this framework, we can talk about enigmas of growth. Let me go through some enigmas. And then i will go into what can europe and u. S. Learn from each other on making growth more inclusive. So the first enigma is the growth enigma. The first enigma is the middle income trap. I will take a glass of water. So i can hydrate myself. It was very bad because i went , to harvard, and you see the first, middle income trap, looks like mit, which is not fair. It was not any bad intention. [laughter] ok. So, they are our friend and competitors. So you want to understand. This is the per capita gdp of argentina compared to the u. S. You can see that between 1870 and 1930, argentina was only 0. 4 of the per capita gdp u. S. , so growing as fast as u. S. , but after 1930, they grow less than the u. S. Do you see what i mean . That is a country that started doing well, and then when they reached middle income or whatever they stopped doing that , well. And now china is obsessed by the same problem. They say we grew vast, we grew through catching up and now we , dont know if we can grow through innovating so much. They are obsessed by the middle income trap. That is their obsession. They want to make sure they avoid the argentina scenario. So the way to explain it was the schumpeterian framework is to say you have two ways to generate productivity growth. One is to catch up with the leading edge. You catch up with what we call the Technology Frontier and the other is to innovate yourself. If i was a country like china was in the late 1970s, you want to catch up. That is the main source of growth. But if you are already an advanced country, you need mostly to innovate on to yourself. And it turns out that what makes you catch up are different policies than those that induce innovating at the frontier. If you are in the business of catching up, it is no big deal to have limited competition on the Product Markets. You have big firms that catch up. It is no big deal to not have much labor market flexibility. You can have the same people working in the same firms forever. It is no big deal to have graduate schools, because you need primary, secondary, undergraduate. It is no big deal to have big Equity Financing. You need to have banks and government subsidies. When you want to do frontier innovation, it is important to have competition. You need a flexible labor market , because you need to be able to hire quickly. You see what i mean . So, Equity Financing is important. Venture capital, private equity to finance various undertakings. The policies that enhance innovation are not the same for developed nations as they are for frontier nations. If you want to advance growth in advanced countries, you need to invest in High Education and have a flexible labor markets. This represents the effect on growth of a higher entry rate as a measure of competition on u. K. Firms. The blue firms are the firms of the frontier. On them, more competition induces them to innovate to escape the competition from foreign entrants. When you are a red firm, you are lagging in the sector, you are already discouraged by the leaders, and more competition from foreigners will discourage you more. We can see right away that competition tends to enhance innovation for those already doing very well and discourages innovation from those who are behind. The more advanced the country is, the more you have blue firms compared to red firms. The more advanced a country is, the more growth enhancing it needs to have to liberalize the Product Market and have more liberalized competition. That is an example, but it is true also for the labor market and higher education. Whereas, if you are an emerging market economy, what you want is essentially like china did. They forced their technology transfers, they relocated their and production, and a they improved Management Practices. Here is a diagram due to my friends that shows the Management Practices for various countries. You see that the u. S. Has very Good Management scores. Compared to japan, germany, sweden, and you can see latin america and Central Europe below. You see south america and then you see africa at the bottom. So, you have scores for Management Practices. The idea is that when you are the catching up country, you can improve through improving your management practice. That is a big margin on which we can improve. Explain to middle income trap explaining it in a very simple way, you have countries that started to grow because they were not catching up. At some moment, they should have switched to policies that favor frontier innovation. But they did not because you have incumbent interest. In korea, we have the big firms that grew during the catching up period of korea. Bigapan, you have these conglomerates that grew very big period of catching up japan, and they somehow slow down innovation. So that is something that you would explain to middle income, japanese high income. That may explain the transition from imitation days to innovation days. France had the same kind of problem. We were very good, and we were catching up. But now the problem of france is to have institutions of a more innovationbased economy. We are dragging our feet in making that transition. The second enigma is that there is a debate on secular stagnation. So here comes robert gordon, who i respect. That canto say you hear me from their . You have the first with their, and then you have the second wave of productivity and chemistry. Then you have the wave of the innovation communication. Each of these waves got smaller. Innovations which we call general, Public Technology it is like fruit on a tree. You climb higher to get other fruit, and the fruits you get are not so good. It can be a bit bitter. Innovations are like fruits. The best ones are the ones you get first, and then they get worse and worse. In 1820, with the english revolution, and now essentially it is almost finished. It will be no more. I disagree with this view. First off, there is the idea that the revolution not only transferred technology to goods and services it also challenged technology to produce ideas. Now, when i work on a paper, ype every day with my colleagues, and we can collaborate much better than we could before. The technology to produce ideas has never been as good as it is today thanks to the i. T. Revolution. The second thing is that the run to innovation has never been as big as it is now. Now, you have the whole world thanks to globalization. Innovationeed for such as in european energies. We would like to see the day where maybe we can do 3d thing of a liver and then replace my old liver with a new i do not itw if that will happen, but would be a very big revolution on health. Believe in this innovation . How can you predict when the new innovation will happen . But you see, you can pick when it will happen. You know exactly when it will happen. The second objection is missing growth. I am doing some work with a leader on growth today, and what we do with it is to say we do not know how to measure growth. Why dont we know how to measure growth . The problem is that we know the value in dollars. We know good in dollars and you can compare dollars to dollars. But the problem is there is inflation and real growth. We do not know how much is in inflation and how much is in real growth. It is worth much more than yesterday. We do not know how much of it was due to inflation, and how much of it was real growth adjustment. If it is the same good yesterday and today, we know it is inflation. If it is good but slightly improved, we know by how much we improved. But when you have a new product, a new product that is replacing an old product, you do not know. So what you do is, most of the time, you impute the growth brought about by the real good. You replace it with existing goods. In europe, they conduct extrapolation. Whether one or the other, you essentially use the existing to infer what the new would bring to the old. You see what i mean . Because of that, we calculated that you are missing one percentage point of productivity growth. You see what i mean . If they say growth is 1. 5 in the u. S. , then it is really 2. 5. I do not call that stagnation. The finance minister said that 0 was good news in france. But 2. 5 is great news, i believe. I would not call that stagnation. That is my second argument. There is a third argument. Europe, we have the advantages of our drawbacks. The drawback is that we are far behind the frontier. Look at sweden. Sweden is here. Sweden is growing at