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This edition was written by Chesapeake Dowdy, Andrew Rosin, Jack Spira, and Louise Sheiner
The Qualified Small Business Stock (QSBS) program, which reduces capital gains taxes on investments in eligible small businesses, became much more generous in 2009 and 2010, when Congress excluded first 75% and then 100% of qualifying gains from taxation. Analyzing data on 158,000 investor-firm relationships between 2004 and 2022, Murillo Campello and Guilherme Junqueira of the University of Florida find that the reforms led venture capitalists (VCs) to make riskier, higher-upside investments. Following the reforms, venture capitalists were 81% more likely to invest in pre-commercial startups in eligible sectors, nearly twice as likely to back startups with pre-existing debt, and 60% more likely to provide a startup's very first round of funding. Consequently, VC-backed startups in eligible sectors were 71% more likely to fail, but those later acquired or taken public had 131% higher valuations and were nearly four times as likely to reach unicorn status, meaning a valuation of at least $1 billion. The authors find that these effects were limited to VCs and were not observed among angel or corporate investors, likely because VCs use outside capital and are compensated in ways that magnify the upside gains while limiting their own exposure to downside losses.
Will falling birth rates—and the resulting aging and shrinking of the population— reduce economic growth? Using country-level variation in birth rates, Daron Acemoglu of MIT and co-authors find that a one percentage point lower birth rate in 1950 is associated with 23 log points higher GDP per worker over the next 50 years. Similarly, using variation in birth rates across local labor markets in the U.S., they find that a one percentage point lower birth rate in 1940 is associated with 15 log points higher wage growth between 1960 and 2020. The authors find no relationship between birth rates and aggregate GDP or earnings, which suggests that falling birth rates—and the subsequent reduction in labor supply—have historically been fully offset by increases in the capital stock and improvements in productivity. Specifically, the authors argue that lower birth rates lead to the development and adoption of labor-saving technology. Across both countries and commuting zones, lower birth rates are associated with a shift in economic activity toward high-tech sectors, a reallocation of workers away from labor-intensive industries, significantly faster TFP growth, and a higher share of patents filed by labor-intensive industries. The authors caution, however, that these historical productivity responses may not persist as aging and population decline intensify.
Changes to U.S. monetary policy can spill over to financial markets and economic activity abroad, with emerging market economies (EMEs) especially exposed. Shaghil Ahmed of the Federal Reserve Board and co-authors ask how EMEs fared during the rapid U.S. monetary tightening of 2022-2023 relative to predictions of a two-country New Keynesian model calibrated to capture key EME vulnerabilities and monetary spillover channels. Using shifts in expected federal funds rates and survey forecasts of U.S. growth, they infer that the episode was driven more by adverse U.S. monetary shocks than by positive U.S. growth shocks, though both played a role. They then compare actual exchange rates, corporate borrowing spreads, and GDP with the model’s predictions for EMEs classified as more or less vulnerable based on macroeconomic factors including debt, inflation, credit growth, current account balances, and foreign exchange reserves. More vulnerable EMEs performed better than predicted, with less financial stress and stronger GDP growth. Less vulnerable EMEs also had lower-than-predicted corporate borrowing spreads, but exchange-rate depreciation was closer to predicted and GDP growth was weaker. The authors suggest that the unexpectedly strong performance of more vulnerable EMEs may reflect developments outside the U.S. during this period or improvements in policy frameworks not captured by standard vulnerability measures.
"Each shock is a new blow to European growth, to its ability to create jobs and prosperity for its people. And as the shocks overlap and their effects compound, so too does the economic damage. Let’s face it: it’s a harsh world out there. Europe needs to toughen up," says Kristalina Georgieva, IMF Managing Director.
"But instead, it keeps lagging. I’m sorry to say it—we are all friends of Europe here—but that is the fact. When I came to Brussels in 2010 as EU Commissioner, Europe had the same nominal GDP as the United States; now, it is significantly lower, while China has caught up to it. After two decades of weak productivity growth, European income per person is 70 percent of America’s, and the gap is widening.
"How could this happen? There are many reasons, but one is that far too many successful European innovators end up abroad and far too few new EU firms grow in size to become globally competitive. The average listed EU firm has a market capitalization of about half the U.S. average. And as for European peers to match the American AI “hyperscalers,” there are none to be seen. Europe’s strength—policy predictability—is diminished by regulatory fragmentation and national gold-plating.
"With weak growth comes fiscal weakness. National budgets are under ever-increasing strain from long-term spending pressures, including the rising pension and healthcare costs of an aging population, the costs of the energy transition, and defense needs."
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