The public had no trouble noticing the jockeying of special interests that sought favored treatment in legislation — that was plain to see — but the majority of Americans remained unaware of the contents of the president’s signature achievements, and they lacked a basic understanding of how they and their families might be affected by them. The first major piece of legislation that Obama had signed into law, the stimulus bill of February 2009, included a vast array of tax cuts: They totaled $288 billion, 37 percent of the cost of the entire bill. Among them, the Making Work Pay Tax Credit, one of his campaign promises, reduced income taxes for 95 percent of all working Americans. Yet one year after the law went into effect, when pollsters queried the public about whether the Obama administration had raised or lowered taxes for most Americans, only 12 percent answered correctly that taxes had decreased; 53 percent mistakenly thought taxes had stayed the same; and 24 percent even believed they had increased!

Healthcare reform represented Obama’s chief policy goal, and he expended a vast amount of political capital in pursuing it over his first 15 months in office. But in April 2010, just weeks after he signed the healthcare bill that extended coverage to the vast majority of working-age Americans and prohibited insurance companies from denying coverage to people who are ill, 55 percent of the public reported that they would describe their feelings about it as “confused.”

That same legislative package also contained sweeping changes in student aid policy that aimed to help more people attend college and complete degrees. Yet when Americans were asked how much they had heard about these changes, only 26 percent reported “a lot,” while 40 percent said “a little,” and fully 34 percent said “nothing at all.”

All told, the public seemed largely oblivious to the president’s major policy accomplishments.

While many who had voted for Obama grew complacent, grassroots mobilization emerged from another quarter, the insurgent Tea Party movement. Wielding placards at protests on tax day, town hall meetings and other public events, its supporters decried what they termed “government takeovers” of healthcare and student loans. At a gathering in Simpsonville, S.C., in August 2009, one man told Republican Rep. Robert Inglis, “Keep your government hands off my Medicare.” Inglis said later, “I had to politely explain that ‘Actually, sir, your healthcare is being provided by the government,’ but he wasn’t having any of it.”

While as of March 2010 only 13 percent of Americans reported that they considered themselves “part of the Tea Party movement,” nonetheless the frustration that it embodied resonated with growing numbers of Americans: 28 percent considered themselves supporters.

With the content of Obama’s legislative accomplishments appearing so opaque and incomprehensible even as the calls of opponents resonated loud and clear, most Americans registered reactions that were tepid at best, and many grew increasingly hostile. By the fall of 2010, 61 percent of likely voters told pollsters they favored a repeal of healthcare reform.

It was a sharp contrast to the warm reception given to sweeping social welfare laws achieved by earlier presidents. After Franklin D. Roosevelt signed into law the Social Security Act of 1935, 68 percent of the public voiced support for its “contributory old age insurance plan … which requires employers and workers to make equal contributions to workers’ pensions” — even though its benefits were not scheduled to begin for six years.

When Congress passed Lyndon Baines Johnson’s plan for Medicare in 1965, strong majorities repeatedly said they approved of it, as high as 82 percent in a December survey that year.

Until Obama’s presidency, perhaps never before had major laws that aimed to improve the lives of vast numbers of ordinary Americans gone so unrecognized and unappreciated by so many.

What explains the public’s reticence, frustration and confusion? Certainly its reactions owe partly to the worst economic conditions since the Great Depression, with more than two years of near 10 percent unemployment. Some of the lackluster response was inevitable, furthermore, given the sheer scope and complexity of the policy tasks Obama took on. And a share of the blame belongs to his administration’s own public relations efforts, which many observers considered underwhelming. Yet while each of these commonly cited factors undeniably played a role, they do not, by themselves, explain Americans’ blasé response to major social policy accomplishments that reflected broadly shared values. Historical comparisons make this evident. The public voiced its high approval for the Social Security Act of 1935, for example, when the nation was still mired in the Great Depression and when twice the proportion of Americans, 20 percent, remained jobless. That legislation was also multifaceted and complex, and it was even more novel for the United States than the 2010 healthcare package, marking the first major involvement of the U.S. federal government in social provision for people besides veterans and their relatives.

The main difference confronted by Obama emanated from the types of policies that he sought to reform, ones that generate particularly formidable obstacles. Any leader who seeks to transform “politics as usual” is bound to confront resistance — challenges emanating from the policies, practices and institutions already in place.

But the nature and difficulty of the task vary depending on the particular goals that reformers select and the historical context in which they pursue them. Roosevelt confronted a political landscape that presented its own challenges — not least, a Supreme Court that served as a major roadblock to his policy ambitions. His administration had to attempt to fashion policies that would circumvent the court’s reach and to build as much as possible on what already existed, such as social policies adopted by some states. But Obama’s policy agenda, in the current political context, requires him to engage in a struggle more akin to that undertaken by Progressive Era reformers, who had to destroy or reconstitute deeply entrenched relationships if they were to achieve change.

He could not follow the path of Roosevelt, finding a way around political obstacles or merely building on top of what existed; rather, he had to find ways to work through them, by either obliterating them or restructuring them.

This is because Obama, given his policy agenda, had steered directly into the looming precipice of the submerged state: existing policies that lay beneath the surface of U.S. market institutions and within the federal tax system. Contrary to opponents’ charges that his agenda involved the encroachment of the federal government into private matters, Obama was actually attempting to restructure a dense thicket of long-established public policies, but ones that are largely invisible to most Americans — and that are extremely resistant to change. Efforts to transform these policies, which have become entrenched fixtures of modern governance, generate a deeply conflictual politics that routinely alienates the public, hindering the chances of success or the sustainability of the reforms.

The “submerged state” includes a conglomeration of federal policies that function by providing incentives, subsidies or payments to private organizations or households to encourage or reimburse them for conducting activities deemed to serve a public purpose. Over the past 30 years, American political discourse has been dominated by a conservative public philosophy, one that espouses the virtues of small government. Its values have been pursued in part through efforts to scale back traditional forms of social provision, meaning visible benefits administered fairly directly by government. In the case of some programs geared to the young or to working-age people, the value of average benefits has withered and coverage has grown more restrictive.

Ironically, however, the more dramatic change over this period has been the flourishing of the policies of the submerged state, which operate through indirect means such as tax breaks to households or payments to private actors who provide services. Since 1980 these policies have proliferated in number, and the average size of their benefits has expanded dramatically.

Most of these ascendant policies function in a way that directly contradicts Americans’ expectations of social welfare policies: They shower their largest benefits on the most affluent Americans. Take the Home Mortgage Interest Deduction (HMID), for example, which is currently the nation’s most expensive social tax break aside from the tax-free status of employer-provided health coverage. Let us assume that a family buys a median-value home and to finance it borrows $230,000 at an interest rate of 6.25 percent for 30 years. The richer the household, the larger the benefit: In the first year, the average family, with an income between $16,751 and $68,000, would owe around $3,619 less in taxes; those in the next income group, with earnings up to $137,300, would reap an extra $5,146; and so forth, on up to the wealthiest 2 percent of families, with incomes over $373,650, who would enjoy a savings of $6,673. Of course, in reality, these differences are likely to be much greater. Low- to moderate-income Americans usually do not have enough deductions to itemize, so they would forgo this benefit and receive instead only the standard deduction. Meanwhile, the most affluent are likely to purchase far more expensive homes; if a family in the top income category opts for a more upscale home and borrows $500,000 for a mortgage, it will reap a benefit of $14,506 from the HMID; if this family purchases a truly exclusive property and borrows $1 million for a mortgage, it will qualify to keep a whopping $29,012!

This pattern of upward redistribution is repeated in numerous other policies of the submerged state: Federal largesse is allocated disproportionately to the nation’s most well-off households. Such policies consume a sizable portion of revenues and leave scarce resources available for programs that genuinely aid low- and middle-income Americans.

Yet despite their growing size, scope and tendency to channel government benefits toward the wealthy, the policies of the submerged state remain largely invisible to ordinary Americans: Indeed, their hallmark is the way they obscure government’s role from the view of the general public, including those who number among their beneficiaries. Even when people stare directly at these policies, many perceive only a freely functioning market system at work. They understand neither what is at stake in reform efforts nor the significance of their success. As a result, the charge leveled by opponents of reforms — that they amount to “government takeovers” — though blatantly inaccurate, makes many Americans at least uncomfortable with policy changes, if not openly hostile toward them.

Exacerbating these challenges, at the same time as the submerged state renders the electorate oblivious and passive, it actually promotes vested interests, and it has done so especially over the past two decades. The finance, real estate and insurance industries all thrived until the recent recession, and in turn they invested heavily in strengthening their political capacity, making them better poised to protect the policies that have favored them. As a result, reform has required public officials to engage in outright combat or deal making with powerful organizations. Such politics disgust most Americans and hardly epitomize the kind of change Obama’s supporters expected when he won office.

Other presidents over the past century focused their energies on legislative battles that were far more visible and thus more comprehensible to the public. Towering figures such as Roosevelt and Johnson seized the power of the “bully pulpit” to create the major direct social programs of the New Deal and the Great Society. More recently, presidents have sought to engage in retrenchment, efforts to terminate or to reduce dramatically the size of programs, but here again they concentrated on visible forms of governance. Ronald Reagan took the lead on this approach, telling the nation, “Government is not the solution to our problem; government is the problem.”

While he failed to abolish full programs, some were curtailed in scope, and benefits stagnated in several that were not protected by mandatory automatic increases. Early in his presidency, Bill Clinton did set out to restructure some components of the submerged state but met with little success, failing at healthcare reform and achieving only a modest beginning on student loan reform. Thereafter, he turned instead to the highly visible task of attempting to “end welfare as we know it,” while simultaneously enlarging the submerged state through new and expanded tax breaks. By contrast to all of these, Obama took on an especially daunting agenda: He prioritized an entire set of social policy issues that each required transformation of the submerged state in order to be accomplished.

Against great odds, Obama has largely succeeded in these pursuits, achieving both healthcare reform and major student aid legislation. Yet even these and other new policies he has signed into law still cloak government activity in ways that may make it largely imperceptible to most citizens. Their designs hinder Obama’s ability to accomplish the broader goals he articulated during his campaign, namely, “reclaiming the meaning of citizenship, restoring our common sense of purpose,” and to “restore the vital trust between people and their government.”

The problem is not simply the typical policy complexity that alienates the public; rather, policies of the submerged state obscure the role of the government and exaggerate that of the market, leaving citizens unaware of how power operates, unable to form meaningful opinions, and incapable, therefore, of voicing their views accordingly.

American politics today is ensnared in the paradox of the submerged state. Our government is integrally intertwined with everyday life from healthcare to housing, but in forms that often elude our vision: Governance appears “stateless” because it operates indirectly, through subsidizing private actors. Thus, many Americans express disdain for government social spending, incognizant that they themselves benefit from it. Even if they do realize that the benefits they utilize emanate from government, often they fail to recognize them as “social programs.” People are therefore easily seduced by calls for smaller government — while taking for granted public programs on which they themselves rely.

Meanwhile, economic inequality has soared in the United States over the past 40 years, reaching levels not seen since 1929. Yet over this same period, policymakers have adamantly protected submerged-state policies that bestow their greatest rewards on the affluent.

Ordinary citizens fail to realize the upward bias of such policies. Political leaders who do seek to reform them, to make their benefits more accessible to Americans of low and moderate incomes, face charges of mounting a “government takeover.” If against the odds they manage to succeed, the policies achieved, especially if they still cloak government’s role, prove difficult to sustain.

Change is possible, however. We can expose the submerged state, reveal governance, and consequently enable citizens to become more engaged and active, reclaiming their voice in the political process. In order to make it possible to carry out reform, first policymakers must reconfigure the role of vested interests. To make reform meaningful, they must alter policies in order to ameliorate their bias toward the affluent. These changes alone, however, will be hard to achieve and even more difficult to sustain, and they will thwart the renewal of citizenship, unless leaders can transform policies to reveal to ordinary Americans their existence and basic effects. To facilitate this, specific strategies must be adopted at the stages of both policy enactment and subsequent implementation. Through policy design and delivery, as well as political communication, policymakers can shift the balance between visible and hidden policies, foster a basic awareness of government, and broaden participation in politics.

As long as the submerged state persists in its shrouded form, American democracy is imperiled. Contrary to popular claims, the threat to self-governance is not the size of government, but rather the hidden form so much of its growth has assumed, and the ways in which it channels public resources predominantly to wealthy Americans and privileged industries. We can reclaim governance, however, making it more visible and comprehensible to ordinary Americans, and using policies to ameliorate rather than to exacerbate inequality. With political will and purposeful action, public policy can be refashioned to revitalize democracy.

Reprinted with permission from The Submerged State: How Invisible Government Policies Undermine American Democracy, by Suzanne Mettler, published by the University of Chicago Press. @2011 The University of Chicago. All rights reserved.

Suzanne Mettler is the Clinton Rossiter Professor of American Institutions at Cornell University. Her most recent book is “Soldiers to Citizens: The G.I. Bill and the Making of the Greatest Generation.”

For anybody interested in understanding the reasons behind this economic travesty, economist Jeffrey Sachs’ new book, “The Price of Civilization,” is required reading. In the book, Sachs, who has focused much of his career on the developing world and eradicating global poverty, turns his eye homeward to examine the current economic crisis, tracing its roots not to the housing or financial bubbles of the ’00s, but to a shift in Washington toward smaller government that began in the early ’80s and has yet to be reversed.

Sachs talked to Salon over the phone to discuss the ills of small government and Reagan’s trickle-down economics, the Republicans’ and the Democrats’ culpability, and the need for more compassionate talk in politics.

You went to speak with the Occupy Wall Street protesters. What’s your opinion of the movement?

I’m very sympathetic to their message, and I’m glad that they’re protesting. I think that their key point — which is that the top 1 percent of society has run away with the income, the wealth and the power in this country — is correct. The income distribution in this country has gotten out of whack to a historically unprecedented extent and it has come with a very serious derangement of our political processes. A  majority of Americans are feeling very disgruntled about both the economic squeeze and their lack of political representation.

You try to dissect the current economic crisis in your book. What do you think caused it?

This story goes back a long ways.  It’s important to understand this because if we take this crisis to be something that started with the bankruptcy of Lehman Brothers in September 2008, or whatever recent event one might pick, we’re going to miss the big picture. The U.S. is facing a structural crisis that goes beyond the bursting of the financial bubble. The remedies, therefore, must also go beyond what I regard as gimmickry of a stimulus package, or a temporary tax cut – or, for that matter, even less relevant permanent tax cuts. So I try to peel back the story actually into the 1970s – from then until today.

Why the 1970s?

Beginning in the 1970s – this is crucial – the U.S. began to globalize, as did every other economy in the world. We felt it first with the competition from Japanese automobiles. But the dramatic story, of course, was the rise of China as a major world economic power when it changed its politics in 1978 [by opening its doors to foreign investors]. In the U.S., we were so focused on the Cold War and competition with a fourth- or fifth-rate economic power, the Soviet Union, that we didn’t understand that something far more consequential was occurring in the world economy.

The main effect of globalization, which is known but somehow weirdly separated from our politics, has been that those who have products, or services, or celebrity, or other things that they can sell to world markets, have found a boon in globalization. But for most of American society, and certainly for the majority of Americans who don’t have a bachelor’s degree, globalization has meant facing much lower-wage workers abroad and increasingly powerful competitive pressures.  So our society began to separate between the “haves” and the “have-nots,” really in the early 1980s. And while this crucial dynamic was underway, American politics was going in almost the opposite direction.

How so?

Reagan came to office with a diagnosis, most famously put in his inaugural speech, that government is not the solution, but the problem. This was put forward as the reason why the 1970s were so shaky, why we were experiencing more instability. Reagan made a big and wrong diagnosis, with extraordinary consequences, and a lot of the country bought it.

He was playing to a lot of powerful interests [the rising Sun Belt, conservative businessmen, etc.], and the dismantling of government began, all in the service of cutting top tax rates as a theory of how to make the economy function properly. It’s a weird idea because there is plenty of evidence that government and markets are complementary parts of a healthy society – it’s not one of the other. The interests at the top benefited from globalization through market forces, tax avoidance and tax havens — and they absolutely grabbed hold of the federal government.

Each of the parties is constantly feeding at the trough of major interest groups. The Democrats, basically, were sold to Wall Street by [Bill] Clinton, and they’ve remained in Wall Street’s hands up until now. And that is one of the greatest failings of the Obama administration: the fact that he couldn’t find his way clear of the major interest group that helped bring him to office, and therefore he really couldn’t undertake deeper changes in the country.

Part of being in this straitjacket of fiscal or tax policy that Obama got himself into is that everything on the spending side has been short-term gimmicks rather than a long-term program, and it is exactly coherent with our incoherent nonstop campaign cycle. We don’t really have longer-term thinking in this country about our economic challenges.

You point to this political shift in the ’80s as a pivotal moment. What was public perception of government prior to Reagan?

When I was growing up, it was a commonly thought that America needed a mixed economy, that there were spheres of life where the market economy should prevail, and there were spheres of life where the government would be crucial. [The mixed economy] has had great history in all of the high-end democracies and there is a lot of economic reasoning behind it.

Basically, government has to be operating where the profit motive won’t suffice. The profit motive works where you have good economic competition, but if you just need one highway between city A and city B, that’s not going to be a competitive highway, so you’d better involve the government. If you want scientific knowledge in a society, for example, you don’t patent basic theorems, because everybody needs to use them, so you have to find a different way other than the profit motive to get science to develop.

I think Ronald Reagan really had a devastating effect on this. The idea that one would elect a president on the premise of demonizing government rather than making it work properly is really a shocking idea – “I’m here to dismantle the role of government.” No president since then has deviated from that line. Bill Clinton declared the end of big government. Rick Perry has been quoted as saying that he wants to make the federal government as inconsequential as possible to the American people. Well, maybe he should look for another job. That’s a lousy platform for a president of the United States.

You, in fact, call for a renewed emphasis on compassion and social responsibility.

What are our deeper economic objectives? Among these is a sense of well-being, of life satisfaction. Income can play a role in that, but so do things like social trust and honest government – and compassion for other people. This kind of discussion is considered odd and I think that is part of our problem right now. We don’t have effective ways to discuss these things in our society.

Instead, we have people who represent a cult of selfishness, what I would consider Ayn Rand libertarianism. They are political figures who say that the goal of America is to leave [people] alone, and that ideas like compassion and so on are dangerous. What the Republicans have on offer – which is based on this 30-year misdiagnosis – is cruel and deeply wrong, because they express disdain for the idea that people are suffering and they need help.

We’ve arrived at a crossroads about the real meaning of our civilization. I think that we will need to reflect on how to achieve a higher level of happiness in this country —  [and think about] issues of social trust, social connectedness, decency, compassion.

And this isn’t in conflict with the American work ethic of “pulling yourself up by the bootstraps,” and everyone doing their fair share?

This [crisis] isn’t really about hard work and effort. It is about a society in which the options for a lot of people seem to be closed off right now. One of the great visions of America has been that this is a society where if you work hard, you can make it. But today we have the lowest social mobility of any high-income democracy. One of the most pertinent measures of social mobility is the correlation between parents’ and children’s educational attainment. If you’re lucky to grow up in [a middle- or upper-middle-class] household where your parents have a college degree, you have a very good chance of getting a college degree and gaining a good position in the economy. But if you grow up in a household where your parents’ highest educational attainment is a high school diploma [or less], the chance of you getting a bachelor’s degree, which is now the tollgate for middle-class success, is very, very small. That brings us back to globalization.  There really were middle-class paths with a high school diploma before. Those don’t exist now.

You lay out an extensive plan for climbing out of this crisis. What are some of the steps you propose?

There is no quick fix right now. A quick fix would occur if we had hit a bump in the road of a normally functioning economy, but my point is that we had growing rot that was disguised by financial bubbles. Rebuilding the infrastructure, strengthening the scientific base, having an energy system that moves to a sustainable renewables, low-carbon economy, improving educational outcome so that more kids make it all the way through – those are 10-year projects, more or less. When the [national highway system] started in the mid-1950s it was understood that this was going to take a long time to do but that we were going to make the investment to build a whole national system.

How do you propose paying for this?

Americans have a pretty accurate picture of a lot of this [crisis]. They sense, first of all, the huge inequality that we have. They know that something is really wrong, that the top has really run away with the prize. About 60 percent of Americans wanted to repeal the Bush-era tax cuts at the top, and yet Obama ended up siding with the Republicans. I think that epitomizes the break between normal, American public opinion and policy. It reflects this remarkable, unprecedented since the period before 1929 swing toward  the super-rich.

I’ve been pretty impressed by the core trilogy of what opinion surveys say America wants: tax the top, end the wars [in Iraq and Afghanistan], and protect social spending. We ought to be going after the corporations that have, basically, a deal with the IRS that keep abroad what they earn abroad and they don’t pay any taxes on it. We should be taxing worldwide income, not just U.S.-based income.

But what about the threat of job flight if we were to increase tax burdens on corporations?

There is a phenomenon called the race to the bottom. It says, what counts for me is whether my taxes are lower than your taxes so that I can attract capital from you. If everybody ends up racing to the bottom, so there’s a tax-cutting arms race, everyone ends up being a loser. We definitely have part of that happening right now.

Every country has an incentive not to have their tax base disappear into a Cayman Islands post office box. There has been talk of ways, through shared action, exchange of information, and so on, of possibly closing down these havens. But it has to do with the way the rules are written by our own governments. One of the arguments against the taxation is that if we tax the rich, they’ll move someplace else. It’s not so simple. We need to recognize that in a global, interconnected economy, with highly mobile capital, we need some cooperation to make sure that we don’t end up with all our governments in fiscal crisis simultaneously.

“Today, the methods developed by Sargent and Sims are essential tools in macroeconomic analysis,” the academy said in its citation.

Sargent is a professor at New York University, and Sims is a professor at Princeton University.

Sims told a news conference in Stockholm by telephone that he was sleeping when he got the call from the prize committee and that he had not expected to win.

“Actually, at first we were called twice and my wife couldn’t find the talk button on the phone so we went back to sleep,” he said.

Sims said there was no easy way in which his work could help resolve the current financial turmoil.

“I don’t have any simple answer, but I think the methods that I have used and Tom has developed are central to finding our way out of this mess,” he added. “I think they point a way to try to unravel why our serious problems develop and new research using these methods may help us lead us out of it.”

Asked how he would invest his half of the 10 million kronor ($1.5 million) award given the turbulence of today’s financial markets, Sims said: “First thing I’m gonna do is keep it in cash for a while and think.”

Sargent told The Associated Press he was surprised by the award, and he hadn’t yet thought of how to celebrate it.

“I’m just going to teach my classes. I teach two classes today. I don’t know if that’s a celebration,” he said by phone, preparing his notes for class on a train about to depart from New York to Princeton, where he is teaching macroeconomics this semester.

He didn’t think the Nobel would change his life. “I hope not at all. I’m going to work and keep doing what I do. I like what I do,” he said.

The academy said Sargent showed how “structural macroeconometrics” can be used to analyze permanent changes in economic policy — a method that can be applied to study how households and firms adjust their expectations concurrently with economic developments.

Sims developed a method based on so-called “vector autoregression” to analyze how the economy is affected by temporary changes in economic policy and other factors, like an increase in the interest rate, the academy said.

“Sargent has primarily helped us understand the effects of systematic policy shifts, while Sims has focused on how shocks spread throughout the economy,” the academy said.

The winners developed models to measure the sometimes surprising way that people actually respond to changes in economic policy.

“People form their own ideas about what’s going to happen independently of what the economists say is going to happen,” said David Warsh, who writes the blog Economic Principles.

Warsh gave a simple example of the kinds of things Simms and Sargent shed light on: Suppose a government imposes a tax on corn to raise more money. Consumers might confound the government’s plan by substituting wheat for corn — and causing tax revenue to drop instead of rise.

The winners’ use of complicated economic models usually keeps them a step or two removed from the pressing economic and political issues of the day. But Warsh says they contributed to the models being used now to determine whether governments should be cutting deficits or spending more money to lift the economy out of its rut.

And Sargent famously weighed in on the fight against inflation in the early 1980s. Many economists believed it would take years of high interest rates to bring inflation down. But Sargent believed that inflation could be tamed much faster if the Federal Reserve acted decisively enough to break the public’s expectations that prices would continue to rise rapidly.

That is basically what happened: Then-Fed Chairman Paul Volcker raised interest rates so quickly and so much that inflation expectations were shattered.

“It is not an exaggeration to say that both Sargent’s and Sims’ methods are used daily … in all central banks that I know of in the developed world and at several finance departments too,” Nobel committee member Torsten Persson told the AP.

NYU said Sargent is currently an advisor to the Federal Reserve Banks of Minneapolis, San Francisco, and Chicago and as had an ongoing involvement with the National Bureau of Economic Research.

His current work involves developing models to understand persistently high European unemployment rates; using new statistical methods to characterize the changing behavior of the Fed since WWII and the changing responsiveness of the U.S. economy to Fed actions; and applying techniques of robust control from engineering to optimal policy and the study of individual behavior, the university said.

The economics prize capped this year’s Nobel announcements. The awards will be handed out on Dec. 10 — the anniversary of prize founder Alfred Nobel’s death. The economics prize is not among the original awards established in Nobel’s 1895 will, but was created in 1968 by the Swedish central bank in his memory.

——

Associated Press writers Paul Wiseman in Washington, D.C., Ula Ilnitzky in New York and Louise Nordstrom in Stockholm contributed to this report.

“Today, the methods developed by Sargent and Sims are essential tools in macroeconomic analysis,” the academy said in its citation.

Sargent is a professor at New York University, and Sims is a professor at Princeton University.

Sims told a news conference in Stockholm by telephone that he was sleeping when he got the call from the prize committee and that he had not expected to win.

“Actually, at first we were called twice and my wife couldn’t find the talk button on the phone so we went back to sleep,” he said.

Sims said there was no easy way in which his work could help resolve the current financial turmoil.

“I don’t have any simple answer, but I think the methods that I have used and Tom has developed are central to finding our way out of this mess,” he added. “I think they point a way to try to unravel why our serious problems develop and new research using these methods may help us lead us out of it.”

Asked how he would invest his half of the 10 million kronor ($1.5 million) award given the turbulence of today’s financial markets, Sims said: “First thing I’m gonna do is keep it in cash for a while and think.”

Sargent told The Associated Press he was surprised by the award, and he hadn’t yet thought of how to celebrate it.

“I’m just going to teach my classes. I teach two classes today. I don’t know if that’s a celebration,” he said by phone, preparing his notes for class on a train about to depart from New York to Princeton, where he is teaching macroeconomics this semester.

He didn’t think the Nobel would change his life. “I hope not at all. I’m going to work and keep doing what I do. I like what I do,” he said.

The academy said Sargent showed how “structural macroeconometrics” can be used to analyze permanent changes in economic policy — a method that can be applied to study how households and firms adjust their expectations concurrently with economic developments.

Sims developed a method based on so-called “vector autoregression” to analyze how the economy is affected by temporary changes in economic policy and other factors, like an increase in the interest rate, the academy said.

“Sargent has primarily helped us understand the effects of systematic policy shifts, while Sims has focused on how shocks spread throughout the economy,” the academy said.

The winners developed models to measure the sometimes surprising way that people actually respond to changes in economic policy.

“People form their own ideas about what’s going to happen independently of what the economists say is going to happen,” said David Warsh, who writes the blog Economic Principles.

Warsh gave a simple example of the kinds of things Simms and Sargent shed light on: Suppose a government imposes a tax on corn to raise more money. Consumers might confound the government’s plan by substituting wheat for corn — and causing tax revenue to drop instead of rise.

The winners’ use of complicated economic models usually keeps them a step or two removed from the pressing economic and political issues of the day. But Warsh says they contributed to the models being used now to determine whether governments should be cutting deficits or spending more money to lift the economy out of its rut.

And Sargent famously weighed in on the fight against inflation in the early 1980s. Many economists believed it would take years of high interest rates to bring inflation down. But Sargent believed that inflation could be tamed much faster if the Federal Reserve acted decisively enough to break the public’s expectations that prices would continue to rise rapidly.

That is basically what happened: Then-Fed Chairman Paul Volcker raised interest rates so quickly and so much that inflation expectations were shattered.

“It is not an exaggeration to say that both Sargent’s and Sims’ methods are used daily … in all central banks that I know of in the developed world and at several finance departments too,” Nobel committee member Torsten Persson told the AP.

NYU said Sargent is currently an advisor to the Federal Reserve Banks of Minneapolis, San Francisco, and Chicago and as had an ongoing involvement with the National Bureau of Economic Research.

His current work involves developing models to understand persistently high European unemployment rates; using new statistical methods to characterize the changing behavior of the Fed since WWII and the changing responsiveness of the U.S. economy to Fed actions; and applying techniques of robust control from engineering to optimal policy and the study of individual behavior, the university said.

The economics prize capped this year’s Nobel announcements. The awards will be handed out on Dec. 10 — the anniversary of prize founder Alfred Nobel’s death. The economics prize is not among the original awards established in Nobel’s 1895 will, but was created in 1968 by the Swedish central bank in his memory.

___

Associated Press writers Paul Wiseman in Washington, D.C., Ula Ilnitzky in New York and Louise Nordstrom in Stockholm contributed to this report.

The contributions these institutions made to science, technology, and the economy—including the creation of millions of high-paying jobs and entire industries—are both enormous and difficult to quantify.

Consider Bell Labs, for example. Founded in New York City in 1925 under the leadership of research director Frank B. Jewett as a joint venture of American Telephone & Telegraph and Western Electric to develop equipment for the Bell System telephone companies, the labs grew to include facilities in New Jersey, the Chicago area, and several other locations. Supporting both pure scientific research and technological developments with immediate applications to telecommunications, Bell Labs spawned or supported a startling number of scientific breakthroughs that played pivotal roles in the history of twentieth-century technology and that created entire new industries with millions of high-paying jobs. The invention of the transistor by Shockley, Bardeen, and Brattain is only the most dramatic and important example. Some others:

• The first public demonstration of fax transmission (1925)
• Invention of the first synchronous-sound movie system (1926)
• First transmission of stereo signals (1933)
• First electronic speech synthesizer (1937)
• Research underpinning the development of the photovoltaic cell (1941)
• First description of the laser (1958)
• Development of metal oxide semiconductor field-effect transistor, basis for the large-scale integrated circuits that make modern IT possible (1960)
• Creation of the UNIX operating system (1969)
• Development of cellular network technology for cellular telephony (late 1960s to 1971)
• Creation of C programming language (1973)

Seven Nobel Prizes in physics were awarded for work completed at Bell Labs. And the number of companies and entire industries built on the foundations laid at Bell Labs is almost incalculable.

However, over the last two decades, funding and staffing of Bell Labs has been drastically reduced. The number of researchers has fallen from 3,400 to fewer than 1,000. And in August 2008, its parent company, Alcatel-Lucent, announced it would be pulling out of some of its last remaining areas of basic science—material physics and semiconductor research—to focus on projects that promise more immediate payoffs.

Financial pressures made this decision inevitable. But it cost our economic system a unique asset whose value is literally incalculable, since pure scientific research often has long-term benefits that are impossible to predict.

Here’s one example. In 1948, Bell Labs scientist Claude Shannon, who is widely acknowledged today as the founder of modern information theory, published his paper “A Mathematical Theory of Communication” in the Bell System Technical Journal. At the time, it was a piece of “pure science,” with no obvious or immediate practical payoff. But years later, physicists applying Shannon’s ideas to the mathematics of data transmission discovered ways of sending digital information at ultrafast speeds over copper wires, making DSL connections possible. Today those connections bring high-speed Internet service into 160 million homes.

Thus the downsizing of Bell Labs isn’t simply a loss for scientists interested in knowledge for its own sake. It eliminates one powerful mechanism for pursuing new concepts whose potential practical benefit we will never know.

In similar fashion, the other great U.S. research institutions of the twentieth century, such as RCA, DARPA, and PARC, have also been downsized and redirected.

Formed in 1935 and based since 1942 in Princeton, New Jersey, RCA Labs (formally known as the David Sarnoff Research Center) was even more focused on wireless communication than Bell Labs. RCA Labs helped to perfect the science of black-and-white TV and laid the technical foundations for both the color television broadcast network and its system components. This new industry generated enormous demand and millions of jobs in programming, advertising, manufacturing, and TV station operation. RCA Labs went on to make discoveries that enabled space communication, satellites, disc recording, low-power MOSFET and CMOS technology, liquid crystal displays, and a host of other breakthroughs.

Today, DARPA’s [Defense Advanced Research Projects Agency, the Department of Defense's agency for the development of new technology] focus and methods have changed dramatically. Partly in response to the trauma of 9/11, DARPA has shifted its emphasis from broad-based scientific inquiry to projects with short-term military applications. Funding has been moved from universities to military contractors; publicly available research designed to spur further advances by others in the field has given way to classified programs conducted in secrecy.

PARC, Xerox’s Palo Alto Research Center—the original gestation place for the technology that ultimately gave rise to E Ink, the Kindle, and a growing array of related products—offers another, somewhat different example of the challenges now facing America’s discovery and innovation machine.

In the 1970s, PARC thrived thanks to generous funding by its corporate founder and sponsor, as well as a hands-off philosophy that encouraged independent, farsighted work regardless of immediate applications. Note that PARC was established in 1970 some three thousand miles away from Xerox’s headquarters in Connecticut—a move that both symbolically and practically emphasized its freedom to establish its own direction.

In its heyday, PARC employed some 280 researchers. It was a powerful magnet for many of the most brilliant and creative minds in its fields. And as at Bell Labs, the discoveries and breakthroughs made at PARC fed on one another, creating a uniquely valuable upward spiral of creativity and innovation. Fueled by the extraordinary talent that had grown up doing DARPA projects in the 1960s, PARC produced perhaps the greatest set of discoveries in the shortest time of any innovation engine in history: the graphical user interface, the personal computer, the Ethernet, WYSIWYG (what-you-see-is-what-you-get) design software, laser printing, and many others.

Today, the number of researchers at PARC is about 165. The focused profile and business goals of today’s PARC typify the fate of America’s once-enormous, well-funded research institutions. Although smaller versions of the great industrial labs continue to operate, the gigantic research infrastructure filled with freewheeling, visionary scientists has been dramatically reduced.

The decline of the twentieth-century discovery engines forces the question: Who is going to produce the scientific breakthroughs that will create the new industries on which tomorrow’s demand will be based?

The hopeful news: The creative spark once embodied in places like Bell Labs still burns — on a smaller scale, but as intensely as ever — at a handful of institutions that are pioneering new approaches to scientific discovery and technological innovation.

The first is a twenty-first-century microcosm of Bell Labs—a corporate-sponsored research institution that is focused not on projects with obvious commercial viability and short-term payoff but on open-ended exploration of diverse technological challenges. Honda Research Institute (HRI), a division of the automaker with facilities in the United States, Japan, and Europe, is the group behind ASIMO, a humanoid robot that boasts an amazing array of capabilities. Why would a car company be involved in such a project? And what does this have to do with demand?

Today the Honda Research Institute focuses on open-ended exploration of diverse technological challenges, with the explicit goal of “contributing to society.” Top researchers are recruited and given the resources to pursue their own projects, even if they have no direct value to the corporation’s current product line—or bottom line. ASIMO’s systems for monitoring and controlling robotic movements have yielded technologies now being used in developing Honda’s Walk Assist devices to improve the mobility of people who are elderly, frail, or disabled, such as hip/leg pads that respond to signals from the walker to provide support as needed. Just count the number of people over the age of seventy-five, and you can begin to sense the magnitude of the potential.

ASIMO also spawned DiGORO, a robot that learns how to clean and keep house by imitating human movements glimpsed through a camera on its head. And back in the auto industry, ASIMO technology has also led to Honda’s Lane Keeping Assist System, which uses cameras and steering controls to help keep cars from drifting. Thus ASIMO and the other projects under way at HRI have the potential to solve consumer hassles and human problems on a global scale—and to unlock a series of huge streams of twenty-first-century demand for Honda.

Another effective discovery-producing model for the twenty-first century is the “demo or die” research model exemplified by the famed MIT Media Lab. In the Media Lab’s new glass building, researchers working on a range of projects, including cars, robots, biomechatronic limbs, hyper-instruments, and early education projects can all watch and interact with one another—a “fish-scale model” of overlapping disciplines that reinforces the multidisciplinary nature of the lab.

Considering its relatively small size—an approximately $35 million operating bud get supporting some 40 faculty members, senior researchers, and visiting scholars, and close to 140 graduate students—the lab’s output is prodigious and broad. In twenty-five years, more than eighty start-up companies have been spun out of it. The lab’s E Ink spin-off (1997), for example, is the key to legible, low-power-consumption e-readers. One Laptop per Child, a Media Lab spin-off, was the spark that inspired ASUSTeK’s Eee netbook. Another spin-off, Sense Networks, uses cell phone data to map the real world, much as Google indexes the Internet. Harmonix (the music technology behind Rock Band video games) and TagSense (RFID and wireless sensing) also came from the lab. Other products and projects have been co-developed with industry, including WebFountain, an architecture for text analysis of billions of pages for IBM, and wireless mesh networks for Nortel.

The Media Lab is, in many ways, the antithesis of a corporate R&D lab. It focuses on human needs, but has no blinders—no time constraints or deadlines, no shareholders to please. It celebrates openness and collaboration between different disciplines and entities. But it winnows ideas quickly because of the emphasis on testing concepts through prototype building. The discoveries that work find their way into the world, with E Ink as exhibit A.

And then there is SRI. Founded in 1946 in Menlo Park, California, as the Stanford Research Institute, it is now the largest nongovernmental lab in the United States, with roughly $500 million in government-and corporate-funded projects. Like the Media Lab, SRI stretches the R&D horizon far beyond the typical corporate three-to-five-year view. But SRI shows that a research lab armed with a system for commercialization of ideas can successfully cross the so-called valley of death that separates the lab from the marketplace—a route littered with unread papers and long-forgotten patents describing products that never connected with customers.

Siri, a virtual personal assistant for the iPhone, is one of SRI’s latest spin-offs. When users speak to their phones, Siri understands the question or command, performs research, and responds. Over time, Siri adapts to users’ individual preferences, making a tailored, concierge-like experience possible.

The development of this super-sophisticated virtual assistant would not have been possible without almost $200 million in DARPA funding for artificial intelligence research spread over twenty-five universities. Then the disparate research findings were pulled together under the auspices of SRI’s CALO (Cognitive Assistant that Learns and Organizes) project. One application born from the research project was shaped for the market by Dag Kittlaus. A former research engineer at Motorola who was frustrated by the slow pace of commercialization in a large corporate environment, Kittlaus found SRI a fast and effective launch pad for vanguard products. After roughly half a year at SRI, Kittlaus spun off Siri in 2009 with $24 million in venture capital backing; a year later, the company was bought by Apple for an undisclosed amount thought to be in the $200 million range.

SRI held a stake in Siri and enjoyed one of its best investment returns ever. It’s an unusual financial model for a research lab, but one that SRI has perfected. In the last fifteen years, SRI has spun off more than forty companies, creating new industries and billions of dollars in market value. Three of the spin-offs—Nuance, Intuitive Surgical, and Orchid Cellmark—have been taken public, with a combined market cap of nearly $20 billion and more than six thousand employees.

Each quarter, an SRI Commercialization Board meets to pore through dozens of the best market-ready ideas, looking for disruptive market opportunities and a “golden nugget” solution that meets SRI’s criteria for value creation—and has a champion who has assembled a team. Once an idea is selected, SRI recruits an entrepreneur in residence—someone like Siri’s Kittlaus—who works on-site for three to eight months to prepare the venture for funding and spin-off. Throughout this period, SRI’s nVention advisory board provides close ties with Silicon Valley venture capital funds, a set of connections whose value is difficult to overstate. Out of many candidates, the Commercialization Board moves about ten opportunities a year through its pipeline—winnow, winnow, winnow—and actually launches two to four ventures.

Two very different business creation myths have long coexisted in Silicon Valley’s business culture. The better-known narrative is that of the venture-funded entrepreneur in a garage whose invention leads to an IPO. The older, now largely forgotten, story is one of the government-funded initiative, like the DARPA projects that led to personal computers, networking, and the Internet. SRI has helped build companies following both pathways, and is arguably the first institution to meld them into one coherent and potentially more powerful narrative of innovation for the twenty-first century.

Carlson sometimes worries about the long-term future of the SRI model. One reason for his concern is America’s flagging production of new scientific talent. “If it were not for our foreign-born researchers,” he observes, “America’s growth would stop.” And he points out that China today has more honor students than the United States has students. Partly as a result, America’s strategy for innovation is “inadequate.” “Solar cells were invented here,” he says, “but most of the value is going to China. Compared to America, China is buying forty-one times more manufacturing equipment for solar cells.”

Part of Carlson’s response would be a shift in national immigration policy: “I would let in all the smart, educated folks I could find,” he recommends — and he adds with a smile, “. . . and all the chefs.”

According to hoary legend, Charles Duell, commissioner of the U.S. Patent Office, is supposed to have said, in 1899, that “everything that can be invented has been invented.” Researchers have failed to unearth evidence that Duell said any such thing, and in fact he appears to have been quite bullish about the prospects for twentieth-century technological innovation—and rightly so.

But there’s this much truth in the Duell myth: Despite the brilliant work of today’s great demand creators, we are living largely off inherited riches. Many of the breakthroughs on which today’s demand is based came from four sources: RCA Labs, Bell Labs, DARPA, and PARC. The transistor, on which so much of today’s demand depends, was invented way back in 1947.

There’s no shortage of challenges that have large-scale human, social, and economic implications and—equally important for the true scientist—offer fascinating lifelong work for those who choose to tackle them. The list of Grand Challenges for the twenty-first century created by the National Academy of Engineering testifies to that. But exactly when and where will tomorrow’s big breakthroughs finally appear? The answer is still unknown—and it depends, in part, on our readiness to do two things: rebuild the engines of industry creating discovery, and make science prestigious again, in a way that encourages the best minds to take up the challenge that only they can meet—to make the basic discoveries that lead to tomorrow’s new industries and tomorrow’s new forms of demand.

Excerpted from “Demand“ by Adrian J. Slywotzky with Karl Weber © 2011 Oliver Wyman. Reprinted by permission of Crown Business, an imprint of the Crown Publishing Group.

Adrian J. Slywotzky is the author of “The Profit Zone,” (selected by BusinessWeek as one of the ten best books of the year), “Value Migration,” “How to Grow When Markets Don’t” and “The Upside.”  The Times of London has named him one of the top 50 business thinkers, and Industry Week has named him one of the six most influential management thinkers.

Karl Weber is a writer specializing in business, politics, and social issues. He has collaborated with Adrian Slywotzky on four previous books, including “The Upside” and “How Digital Is Your Business?”