Sunday, February 27, 2011
Part of the exquisite beauty of such simple, classic dishes is that they leave no room for the cook to hide mistakes. For example, pasta aglio e olio has just seven ingredients: pasta, garlic, olive oil, grated parmesean cheese, chopped parsley, salt, and chili peppers. As a result, there's a type of purity to it; each flavor maintains its own identity and is strong, distinct, and with an irreplaceable role to play. The dish would be diminshed if any of those seven ingredients were missing, or prepared incorrectly. It requires a deft touch to sauté the garlic just right, for example. Overcook the garlic and the dish becomes bitter. Undercook it and the garlic will overpower everything else. But get it just right, and it creates a magical, savory oil that clings to each strand of pasta. The chili is necessary to give the dish some punch and sharpness. The parsley is crucial to freshen and enliven it. Coarse salt provides a bit of texture as well as being absolutely essential to bring out the flavors of the other ingredients. And the cheese rounds it out and helps to bind the flavors together. When correctly prepared, in each bite you can taste each of the seven ingredients. Perfection.
And then of course, one has to recognize that it's simply a beautiful dish, as well...
Friday, February 25, 2011
First, we learned this morning that the recent (and probably ongoing) contraction in the UK's economy was a bit deeper than initially revealed. It appears that the British economy was actually contracting at a 2.5% annual rate at the end of 2010:
GDP GrowthThe fact that a significant reason for the slowdown in economic activity in Britain at the end of last year was the result of a reduction in spending by businesses tells me that companies are deeply worried about the economy in 2011. Based on some conversations that I've had with upper management in a couple of UK companies, as well as plain old common sense, I feel quite certain that this pull-back in spending by businesses is primarily a reaction to the "austerity measures" that the UK's government is implementing. There is a widespread and reasonable concern among businesses that this year's substantial tax increases and cuts in government spending will make a serious dent in the recovery. After all, thanks to the austerity measures, economic forecasts for the UK for 2011 have been revised down in recent months. So naturally, businesses are pulling back on their spending, waiting to see how strong demand for their goods and services really is this year.
Contracts by 0.6% in Q4 2010
Gross domestic product contracted by 0.6 per cent in the fourth quarter of 2010, revised down from the previously estimated fall of 0.5 per cent. GDP in the fourth quarter of 2010 is now 1.5 per cent higher than the fourth quarter of 2009.
...Output in the service industries was revised down to a fall of 0.7 per cent in the latest quarter from a fall of 0.5 per cent reported in the preliminary estimate. The decline this quarter was driven by a fall in business services of 1.1 per cent, together with a fall of 1.4 per cent in transport, storage and communications services.
Household expenditure fell 0.1 per cent following a rise of 0.1 per cent in the third quarter of 2010.
And then, as if to kick the British economy while it's down, we learned this week that sentiment on the Monetary Policy Committee ("MPC") of the Bank of England is trending toward higher interest rates, not lower:
More MPC members vote for a rate hikeI must confess that I am truly mystified by this. Yes, inflation in the UK has risen in recent months. But this is almost completely explained by two very temporary factors: the recent spike in commodity prices (led by the price of oil), and the increase in the VAT in Britain, which feeds through to higher prices for nearly all types of consumer goods. Absent these temporary forces, it seems clear (even to the Bank of England's governor Mervyn King) that underlying inflation in the UK is not a problem.
UK interest rates could rise soon following news that the number of policymakers in favour of a hike increased during the last Bank of England Monetary Policy Committee (MPC) meeting.
Minutes published by the bank show member Spencer Dale joined Andrew Sentance, who has long been voting for a hike, and Martin Weale in pushing for an increase.
While six MPC members voted to keep rates frozen at 0.5 per cent, the three thought it was time to change them, with Mr Sentance preferring a 0.5 per cent hike for the first time, having previously advocated a 0.25 per cent increase.
Alas, I take this as evidence that economists and policy-makers in the UK have forgotten as much about how the macroeconomy works as they have in the US. A Dark Age of Macroeconomics has descended upon both sides of the Atlantic.
Thursday, February 24, 2011
The 2010 Wall Street bonus: $128,530On the other hand, judging by the stock price of some investment banks, investors are having serious doubts about whether those investment banks are earning enough money to be worth investing in:
NEW YORK (CNNMoney) -- Wall Street workers may be feeling a little leaner since cash bonuses fell nearly 8% last year, according to New York State Comptroller Thomas DiNapoli.
But bonuses still averaged more than $120,000. And that doesn't take into account salaries or commissions, which can significantly bump up workers' total compensation packages.
Total bonuses paid to New York City workers in the financial securities industry fell to $20.8 billion in 2010. That's a one-third drop from 2007, before the financial crisis, DiNapoli said.
The Big SqueezeThere has been a tremendous shift over the past 25 years or so in the portion of the US economy's resources that have been ending up in the pockets of people who work in the financial industry. Many observers (including me) thought that the secular trend of more and more resources being devoted toward finance (and all of the explicit and unadulterated rent-seeking behavior that much of the financial industry depends on) was going to come to an end with the financial crisis of 2008. But over the last year, that outcome has seemed unclear to me. Actually, I guess it still seems unclear to me.
Can investment banks make high enough returns on equity to exist?
FOR financiers, closing an investment bank is like parting with a Porsche: life is too dull without it. Yet a cull is needed. Most bulge-bracket firms made billions of dollars of profits in 2010, but not enough to compensate shareholders for the far larger amounts of capital they now have invested.
...[I]nvestors are disappointed by the low ROEs now on offer. Some firms trade at below their book value (see chart), implying they cannot deliver acceptable returns to their owners.
However, it's one thing for people in Washington and other talking heads to complain about the ridiculous compensation taken by many Wall Street employees. But it's another thing altogether if stock market investors are shying away from investment banks because they see them as insufficiently profitable. Because if that's the case, then there may be (for the first time that I can think of) some serious market pressure to limit Wall Street compensation packages. And if we have indeed finally reached a plateau in the size of the financial sector in the US economy, I see that as a very good thing.
Tuesday, February 22, 2011
Following this discussion, and particularly after reading Uwe Reinhardt's contribution from the other day ("How Convincing is the Economists' Case for Free Trade?") I am reminded of a parable that one of my graduate school professors would tell to his Econ 101 students. That professor, by the way, was named Uwe Reinhardt.
Anyway, here's my retelling of Uwe's parable:
Economic Efficiency and a Punch in the Nose
Suppose that there is a guy who used to be a competitive boxer. He was very good and very successful, but probably took one too many knock-out blows during his career. At any rate, after he retired from boxing he missed the thrill of the fight, and in particular he really missed punching people in the nose. (Don't ask me why, but for some reason, he really liked punching people in the nose. Which probably had something to do with why he was such a good boxer.)
One day his urge to punch someone in the nose becomes overwhelming to him. So he goes to his neighbor, who's a nice guy who has never boxed before - let's say he's an economist - with a proposition. He says: "Hey Bob, maybe we can help each other out. I really miss hitting people. Unfortunately, I can't just go around hitting people when I feel like it, at least not without getting arrested. But on the other hand, I do have lots of money. What would you say if I offered to give you $5,000 in exchange for you letting me punch you in the nose?"
Bob thinks about this for a minute, and figures that he would be quite happy to endure a bloody nose, and a couple of days of soreness and bruising, in exchange for $5,000. In fact, he really would have been willing to do it for $3,000, though of course he's not going to tell the boxer. So they shake hands and make the deal.
Now, an economist (Bob, for example) would say that this transaction is economically efficient, as is obvious once you realize that it will increase GDP by at least $5,000 as the boxer purchases this new "service" from Bob. Furthermore, the transaction will also make everyone better off, and thus be what economists call pareto optimal. The boxer will be better off than he was before, or he wouldn't have proposed the deal. The economist will be better off than he was before, because to him it will be well worth getting punched in the nose if he gets $5,000. Heck, he would have been willing to do it for $3,000.
Okay, fast forward to the moment of truth. The boxer winds up and gives Bob a good punch on the nose. Bob howls in pain, his nose starts streaming blood, and the boxer feels immensely better. A few minutes later, Bob is sitting down with an ice-pack on his nose, and asks the boxer for his $5,000. The boxer replies by saying that he's changed his mind, and he doesn't actually want to give the economist $5,000. And then the boxer (who was a good economics student in college) adds: "Hey, don't be glum. Yes, you got punched in the nose. Yes, you didn't get the money. But together we made the world a better place - we improved world welfare!"
The economist thinks about this for a moment and then agrees. "You're right," he says. "I only lost about $3,000 worth of happiness by getting punched in the nose. You gained more than $5,000 worth of happiness by punching me in the nose. Together we have increased welfare and made the world a happier place, even though you screwed me over."
Would anyone (with the exception of some economists) agree with the conclusion that the boxer punching Bob in the nose - and then not paying him what he had promised - makes the world a happier place? Yes, it's an economically efficient outcome. But is that really what matters here?
It's the same with trade, whether it's international trade or trade between two people in the same country. Trade is economically efficient. But there are always winners and losers, and if the losers aren't compensated for getting punched in the nose, then it's pretty tough to argue that trade has necessarily led to a good outcome.
Monday, February 21, 2011
David Wessel shows us the federal fiscal issue in one chart. The chart depicts an estimate of what the Obama administration's budget proposal would mean for spending in each major category over the next five years. "The bottom line: Spending on interest, Medicare and Medicaid and Social Security go up – a lot. Spending on nearly everything else goes down."
I prefer looking at it slightly differently. I think that when trying to understand the federal government's fiscal situation, at least on the spending side, it is more informative to see how we got to where we are. We now have an on-budget (i.e. excluding the Social Security program, which continued to run a surplus in 2010) deficit of about 9% of GDP. In the early 2000s, the budget deficit was about 4-5% of GDP. That's deterioration in the on-budget deficit of about 4-5% of GDP between 2003 and 2010.
Now take a look at the following chart, which shows federal spending on actual goods and services broken into two pieces: spending related to defense, and spending related to everything else. Then I've added federal spending on the two Meds: Medicare and Medicaid. (Note that this latter category is actually a transfer payment, not spending by the government on goods and services, since it takes the form of the government reimbursing individuals for medical spending that THEY have done.)
Defense spending has gone up about 2 percentage points since the early 2000s. Med+Med spending has gone up by about 2 percentage points since the early 2000s. All other federal spending has meandered feebly between 2% and 3% of GDP. That slight lift in the green line in the last two years is the "massive" stimulus, or put another way, what "out of control government spending" apparently looks like.
If it weren't for increased defense spending and the Meds over the past several years, the federal government's budget balance would have been pretty close to unchanged. Despite the most severe economic downturn in 70 years.
I say again: what stimulus?
Thursday, February 17, 2011
Calculated Risk wrote about the same subject the other day, noting that there were a number of informed and smart individuals (including but not limited to economists) who predicted the crisis, but lamenting that warnings by "some random blogger[s]" were ignored or not taken seriously.
Davies and CR both have good points. Yes, it bears remembering that there were plenty of people out there who explicitly warned of the financial crisis. (As CR notes, there are so many examples to chose from, but I'll pick a couple of my own personal favorites.) So the Queen's premise - and that of lots of people who have asked the very same question over the past couple of years - is faulty. It's simply not the case that the "economics profession" failed to predict the crisis.
And yet. And yet it's also true that those economists with the most prominent positions in Washington and Wall Street - let's call them the "establishment economists" - did, by and large, fail to predict the crisis. Which tells me that something else was going on other than just the fact that it was difficult to do. It seems an unlikely coincidence that most establishment economists missed the crisis while many of those outside of the establishment could see it coming.
To me, this unlikely coincidence suggests that part of the explanation is something else: it was actually in the interest of establishment economists to fail to predict the crisis. When the financial markets are roaring, and Wall Street bonus checks are fat with the earnings from the housing bubble, announcing that the big firms should stop doing what they're doing to make all of that money is probably not the smartest career move. Rather, an economist would probably have done better (establishment career-wise) if their analysis happened to confirm and provide analytical support for the activities that were making so many firms so much money during the run-up to the crisis. This could well have lead to a type of selection bias: establishment economists were in their establishment positions precisely because they were the ones that could reassure and support the money-making activities of the firms profiting from the frothy financial markets.
I'm not saying that these economists were venal or corrupt. And I don't think that there was intentional dishonesty in the cheerful forecasts and palliative words from establishment economists in 2005-07. But I do think that it's important to remember that it wasn't a coincidence that establishment economists were so good at telling Wall Street that there was no reason to end the party.
Not only was the fiscal stimulus applied by the US government difficult to detect in time series data (see chart), but it apparently was also pretty puny when compared to the fiscal stimulus applied by most of the rest of the world in response to the Great Recession. In fact, even though the US was one of the countries hit first and hit hardest by the financial crisis of late 2008, it enacted one of the lowest levels of fiscal stimulus of all developed countries:
Net Fiscal Stimulus During the Great RecessionThere's nothing to be done about what happened in early 2009. However, this reminds us that there is one thing that bears repeating, over and over: serious fiscal stimulus was never really tried in the United States during the Great Recession.
Joshua Aizenman, Gurnain Kaur Pasricha
NBER Working Paper No. 16779
Issued in February 2011
This paper studies the patterns of fiscal stimuli in the OECD countries propagated by the global crisis. Overall, we find that the USA net fiscal stimulus was modest relative to peers, despite it being the epicenter of the crisis, and having access to relatively cheap funding of its twin deficits. The USA is ranked at the bottom third in terms of the rate of expansion of the consolidated government consumption and investment of the 28 countries in sample. Contrary to historical experience, emerging markets had strongly countercyclical policy during the period immediately preceding the Great Recession and the Great Recession. Many developed OECD countries had procyclical fiscal policy stance in the same periods. Federal unions, emerging markets and countries with very high GDP growth during the pre-recession period saw larger net fiscal stimulus on average than their counterparts. We also find that greater net fiscal stimulus was associated with lower flow costs of general government debt in the same or subsequent period.
Wednesday, February 16, 2011
Monday, February 14, 2011
The more I get to know this recovery, the more I’m starting to like it.
Yes, it’s been rather standoffish, giving the cold shoulder to millions of unemployed Americans. And true, through much of 2010 it was maddeningly elusive, never giving us confidence that it was here to stay. But the more data I review from the second half of 2010, the more I start liking what I see. Particularly because the data suggests to me that this recovery, while not roaring, is being built on a solid foundation, and therefore has the potential to grow into something pretty meaningful as this year progresses.
There are four things in particular that make me guardedly happy about this recovery.
1. The manufacturing sector.
I’ve spent a lot of time over the last week explaining why I am bullish on US manufacturing. The manufacturing sector is too small to make a significant dent in the US’s vast unemployment problem. However, it has been the source of some net job creation (see table), and more generally is a good indicator of the competitiveness of the US economy in terms of international trade. Which brings us to...
2. US exports.
Exports from the US did very well in the second half of 2010, which helped to give the US economy a substantial boost toward the end of the year. Best of all, this strong export performance was driven by sales to the growing, dynamic, developing countries of the world like China. That makes it likely that continued rapid growth in China and other developing countries will actually provide a noticeable boost to the US economy in 2011 and going forward. Compare this with what happened during the recovery from the previous recession. As shown in the chart below, in 2002-03 US export growth only provided a modest 0.45% boost to GDP. This time around, however, US export growth has been adding over a full percentage point to US GDP growth.
3. Business purchases of investment goods.
Unlike the recovery from the last recession, when businesses were extremely slow to begin purchasing new equipment and machinery, in 2010 business spending on things other than buildings grew at a healthy rate. In fact, investment spending in “equipment and software” (the “e&s” in the chart above) added over a full percentage point to GDP growth through 2010. The best part of this kind of spending is that it provides a much greater boost to productivity, and thus long-term economic growth, than personal consumption spending. The fact that in 2010 far more of the growth in real GDP came from business investment (and less from residential investment) than was true during the previous recovery is a very good sign for medium and long-term economic growth in the US.
4. Household financial retrenching.
The biggest drag on economic growth during this recovery has been the ongoing financial rebalancing that US households have been doing by paying down debt. But while this has meant that consumption has not grown as rapidly as it might have, it also means that this recovery is not (unlike the previous one) being built on borrowed money. Household debt levels have fallen dramatically over the past two years (see the chart below), and while arguably still higher than they should be, the fact that households have been reducing their debt in a pretty determined way suggests that households will be able to increase, and sustainably increase, their spending in 2011 and beyond as incomes grow faster.
Yes, all in all, I think there are some very nice things to like about this recovery. Now we just need it to set to creating new jobs in a serious way. But based on the strong foundations on which this recovery is being built, I think it won’t be much longer before we see meaningful falls in unemployment levels in the US.
I must say: after being very bearish on the US economy through all of the 2000s, it’s nice to finally have something hopeful to write about this surprisingly alluring recovery...
The chart below shows the US's exports and imports of merchandise excluding petroleum products. While both exports and imports fell sharply in 2008 thanks to the Great Recession, by the end of 2010 merchandise exports had nearly reached all-time highs. Manufactured imports had recovered somewhat, but not completely.
We'll have to see if this trend is sustained (and is therefore actually a trend), but it's starting to look like the improvement in the US's balance in manufactured goods over the past few years is significant and real. And that is an important piece of evidence of the change in US manufacturing competitiveness.
Of course, it's likely that part of this - but only a part of this - is simply the result of the (badly needed) rebalancing of global capital flows. Starting in the late 1990s and continuing until 2008, the US economy ran ever more massive current account deficits. By definition, when a country runs a current account balance it is borrowing funds from the rest of the world. (Recall that the current account balance is the broadest measure of trade flows, and includes merchandise trade, petroleum imports, exports and imports of services, and a few other more minor categories.) The level of borrowing by the US from the rest of the world through most of the 2000s was clearly unsustainable, and that flow of international lending to the US has roughly fallen by half from its peak in 2006, as illustrated below.
But the US's balance on non-petroleum merchandise has improved by even more, reaching levels not seen since the mid 1990s. I wouldn't be surprised if US's current account balance remains in the range of 3-4% of GDP for the next couple of years, as the US recovery picks up steam and saving by US corporations declines. But even if that happens, I would also not be surprised if the improvement in the US's balance on merchandise exports is here to stay.
Sunday, February 13, 2011
Replicators will need three ingredients to work.
1. The Hardware.
That's the replicator itself. The Economist article that sparked my musing about this technology analogizes this machine to a printer, and refers to the technology as "3-D printing". If that analogy is reasonable, and if this hardware follows the pattern of most types of high-tech hardware, then replicators might be expensive for a time, but will very rapidly fall in price while simultaneously improving in speed and capability.
If they really become as cheap as printers (even high-end laser printers), we could expect them to start appearing in households, just as laser printers spread from offices to homes as the price fell. Over time they will get faster at making stuff, and able to make higher resolution objects, and able to use a wider variety of materials. In other words, they'll become get closer and closer to the Star Trek version of replicators.
I agree with The Economist lede that this will revolutionize manufacturing. But I disagree with their speculation that the revolution will take the form of factories shifting to making small batches of highly customized products. Rather, it seems more likely to me that factories will disappear completely for vast classes of items. Instead, each household will just make small objects in their own personal home replicator as needed. The gain will come not from objects being highly customizable - why would I need a completely unique ballpoint pen or plastic cup? - but rather, from each household being able to make their own small objects as needed.
And this would have, I think, possibly the most profound economic effect of all: the disappearance of the retail store. Imagine how often you would visit a physical Wal-mart if you had a replicator.
2. The Designs.
A working replicator will need a design for each object that it can make. And for the designs, there will be a tension between the open-source route and the proprietary-design route. The Economist asserts that there currently seems to be some impetus for open-source designs. But I would be surprised if this were to last as the objects produced by replicators become more and more complex. For highly complex objects - suppose we use a ballpoint pen as an example - a tremendous amount of work will have to go into creating the design, because the design's resolution will have to be incredibly high. That's why I don't think it likely that replicators will lead to infinitely customizable objects - each tweak on a design will take lots of additional design work. Better to make a smaller number of designs well and at high resolution.
But once the design is created, it can be sold to millions of potential users. Companies will specialize in producing the designs for objects that replicators can make. And then they will sell the designs, competing with one another on price and quality as manufacturing companies do today.
This is how I imagine it. You need a ballpoint pen. You walk over to your replicator, and ask it for available designs of pens. You may be limited by the capabilities of your replicator (maybe a low-end version will only produce all-plastic pens, or pens that only write in black ink, while a high-end replicator can produce fancy ballpoint pens with metal parts), but given your replicator's capabilities you may well have a selection of pens that you could ask it to make. You review the designs for pens that are floating around out there (which the replicator can access via the internet, of course), you check the price of each pen design, and then you select one that you like. The design-maker takes electronic payment from you, immediately transmits the design to your replicator for either one-time or multiple use, and your replicator can get to work.
I imagine that a competitive market will spring up for designs. (And of course, an active market would likely spring up for pirated designs as well.) In fact, most day-to-day advertising that people see could eventually be for object designs for your replicator. The only difference will be that the Bic ad will not be urging you to buy physical ballpoint pens at the store, but rather urging you to buy the design for your replicator.
3. The Material Inputs.
If we want to pursue the printer analogy (and I'm not entirely sure it's the best one, but for the time being let's go with it), replicators will need the equivalent of printer cartridges. But the inputs that the replicators will use to make objects will probably involve lots of different types of materials. Certainly to make a complex object like a ballpoint pen, one could easily imagine that it might take a dozen different incredient-compounds to produce it.
The fancier that replicators get, and the more varied the objects are that they can make, the more different types of ingredient materials that the replicator will need. Eventually I could imagine sophisticated replicators having to be filled with hundreds of different types of compounds. I don't think the printer cartridge analogy would work, though, because it seems unlikely to be efficient to replace the entire suite of material inputs at once. More likely, there would be a way to individually refill the store of each ingredient-compound.
But this brings us to an interesting implication: there would still be some important traffic in physical objects. Whether by delivery, pipeline, or a "grocery store" for inputs, homes with replicators will have to receive a steady physical supply of the materials that their replicators will use to build the objects that they make.
Maybe it's a bit reassuring to realize that households will still have to have some physical interaction with the outside world...
Saturday, February 12, 2011
Print me a StradivariusAnd I think to myself: wait, I've seen enough Star Trek to know what this is. This is a replicator. (It's a much more evocative name than "3-D Printer", don't you think?)
How a new manufacturing technology will change the world
THE industrial revolution of the late 18th century made possible the mass production of goods, thereby creating economies of scale which changed the economy—and society—in ways that nobody could have imagined at the time. Now a new manufacturing technology has emerged which does the opposite. Three-dimensional printing makes it as cheap to create single items as it is to produce thousands and thus undermines economies of scale. It may have as profound an impact on the world as the coming of the factory did.
It works like this. First you call up a blueprint on your computer screen and tinker with its shape and colour where necessary. Then you press print. A machine nearby whirrs into life and builds up the object gradually, either by depositing material from a nozzle, or by selectively solidifying a thin layer of plastic or metal dust using tiny drops of glue or a tightly focused beam. Products are thus built up by progressively adding material, one layer at a time: hence the technology’s other name, additive manufacturing. Eventually the object in question — a spare part for your car, a lampshade, a violin — pops out. The beauty of the technology is that it does not need to happen in a factory. Small items can be made by a machine like a desktop printer, in the corner of an office, a shop or even a house; big items—bicycle frames, panels for cars, aircraft parts—need a larger machine, and a bit more space.
Wait... really? Are you telling me that one of the most incredible, futuristic, magical technologies available on Star Trek - the replicator in every room that could make whatever object the user asked for - is starting to become a reality? May become an actual, working technology in my lifetime? I'm stunned.
Obviously there's a long way to go in the technology before we'll be able to just walk over to the machine in the corner of the room and say "tea, Earl Gray, hot," but given the pace of technological change over the past couple of decades, I wouldn't be surprised if we get there a lot sooner than I could have possibly imagined when I first started watching Jean Luc Picard on board the Enterprise.
Friday, February 11, 2011
I know, it sounds like a line that a politician would say on a stump speech in some midwestern factory. But actually, for the first time in my career as an economist, I can write that and actually believe that it’s true.
First, as I pointed out earlier, manufacturing in the US has been doing relatively well, both compared to its past (lousy) performance and compared to the rest of the US economy. But the US manufacturing sector also looks quite healthy compared to other developed countries. The following chart illustrates.
Manufacturing output in the US is nearly back to where it was in 2006. That’s generally not true for other developed countries (Korea being an obvious exception in the chart above), which are typically still 10 or 15% below their 2006 levels.
Why is that? The red bars in the graph above contain an important piece of the explanation. Unit labor costs – that is, the amount that companies have to pay to labor for each unit of output that they manufacture, and which depends on both labor compensation and labor productivity – actually fell in the US from 2006-09. In nearly all other developed economies, labor costs per unit of output rose during that time. (Note that the BLS database that has these international comparisons won’t contain 2010 figures for several more months, unfortunately.)
The measures of labor cost shown above are expressed in local currency terms, and thus do not reflect any impact of changes in exchange rates. But the fact is, as illustrated below, the US dollar has generally been depreciating over the past several years. (And yes, most of this depreciation pre-dates QE2, so don’t bother trying to blame it on that.) That means that when multinational companies are comparing the cost of production in the US to the cost of production in other countries, the US has been looking like an increasingly better deal.
This trend depreciation in the dollar just serves to magnify the way that unit labor costs in the US are looking lower and lower compared to other countries.
The End of Offshoring?
This data matches with the stories that we’re increasingly hearing, as well as my own personal experience in talking to managers and executives of multinational firms: companies are increasingly finding that it makes business sense for them to keep their remaining production in the US. (Or even move some of it back to the US.) For example, the Seattle Times recently reported that Boeing is now regretting its decision to aggressively push much of the production of its new 787 Dreamliner jet overseas. It turns out that they would have been better off leaving more production in the US.
My suspicion is that nearly all of the low-hanging fruit that could be gathered by shifting production from the US to low-cost countries like China has already been picked. Companies for which it made sense to shift production to other countries have already done so. Most of the manufacturing left in the US is, by and large, stuff that I think will probably stay in the US. (Yes, of course there will still be incidents and examples to the contrary, but I'm talking in general terms, and you know what I mean.)
The fact is that the manufacturing that remains in the US in 2011 is incredibly efficient, and thanks to a combination of productivity gains, very weak wage growth (terrible for workers but great for US manufacturing competitiveness), and a favorable exchange rate, is highly competitive with manufacturing in other countries – even low-cost countries like China. And that's an important part of the reason that US exports to China have been growing so rapidly. (Of course, it doesn't hurt that China's economy is so big and growing so fast, either.)
A Lean, Mean, Manufacturing Machine
I’ve never been one to particularly bemoan the shift of manufacturing from the US to low-cost countries. (Blame my training in international trade for that.) For the most part, I think it made sense, was inevitable, and was probably a good thing in the long run, both for the individual companies involved as well as for the US economy as a whole. But there’s no doubting that the transition has been a terribly painful process for a lot of people. (And I have always thought that we needed to do more for those who were negatively impacted – both directly and indirectly – by the offshore relocation of US production.)
However, I now think that the US economy is starting to see the benefits of the shift of large segments of US manufacturing to other countries over the past 15 years. The manufacturing that remains in the US is incredibly competitive, and, in my opinion, is probably largely here to stay. And that certainly provides an encouraging bit of foundation on which the US economy can hopefully build a lasting recovery.
The big story regarding US exports over the past couple of years has been the tremendous shift in their geographical destination. Rich countries (i.e. Western Europe, Canada, Japan, and Australia) substantially reduced their purchases of goods from the US during the Great Recession of 2008-09, and have yet to fully recover. On the other hand, less developed countries such as Mexico and China have been sucking in US-made products at a growing rate. The following picture illustrates.
If we look at the dollar value of US merchandise exports by country, we see the shift in demand for US-made goods even more clearly. The overall level of US exports in 2010 was about the same as in 2007. But they were distributed very differently around the globe, with a dramatically larger share going to China (and to a lesser extent, Mexico).
Wow. That's all you can really say about China on this table.
In a follow-up post later today I’ll tie this phenomenon back to US manufacturing performance.
Thursday, February 10, 2011
Weekly U.S. jobless claims drop 36,000It's just one week, and this result would have to be supported by several more weeks of initial claims in the 400k or lower range, but... the journey of a thousand miles starts with one step, or something like that....
WASHINGTON (MarketWatch) -- New applications for regular state unemployment-insurance benefits fell 36,000 to a seasonally adjusted 383,000 in the week ended Feb. 5, hitting the lowest level since July of 2008, the Labor Department reported Thursday. Economists polled by MarketWatch had expected an initial-claims level of 410,000. The level of claims helps observers to analyze the health of the labor market, and economists say claims would have to remain below 400,000 before there's a substantial gain in hiring. The last time claims were below 400,000 was in late December. In recent weeks weather has been behind some volatility in the data. The four-week average of new claims, which smoothes out some volatility, fell 16,000 to 415,500.
Wednesday, February 09, 2011
SEC to wean markets off credit ratingsI happen to be one of those people that think that the credit ratings agencies were enormously culpable in the financial debacle of 2008. That's why I was very disappointed that the financial regulatory reform passed last year did so little to address that particular problem. So moves like this that weaken the deeply institutionalized authority of the ratings agencies are probably on the right track.
(Reuters) - U.S. securities regulators moved to scale back markets' reliance on credit rating agencies, after the financial crisis laid bare the industry's shortcomings.
The Securities and Exchange Commission voted 5-0 on Wednesday to propose that several of its key documents for securities offerings no longer include ratings references designed to give investors confidence in the quality of the securities.
(They're not even very good at what is supposed to be their core competency... a topic I think I'll delve into for a future post...)
The gathering storm
The United States faces unparalleled fiscal challenges. Over the next decade, the gap between revenue and spending that would result from continuing current tax and spending policies appears unsustainable. This imbalance is driven by the demographic and entitlement challenges created by the imminent retirement of the Baby Boom generation and the interest on our publicly held debt. Our political leaders differ on the relative contribution that spending cuts or tax increases should make in bringing the federal budget closer to balance. However our leaders address spending and tax policy in the face of these deficits, the direct and indirect consequences on business will be far-ranging.
Tax and spending implications of the federal deficit crisis
I read it, and I sigh. Of course. "The imbalance is driven by... entitlement[s]". No mention of the contribution of tax cuts - it's purely a spending problem.
See, the thing is, I know how the communications departments of these sorts of companies work. They're not trying to be slanted or biased. In fact, I'm sure that they think that they're being neutral. They recognize that they're so big, and have so many diverse clients, that they can't afford to appear ideologically biased in any way.
Which is why this is so depressing. The notion that the federal deficit is simply the result of out-of-control spending is so deeply entrenched in corporate America - by which I mean millions of individuals, good and bad, liberal and conservative (and mostly middle-of-the-road), who work in large corporations - that they don't even have an inkling of the possibility that there's another part of the story:
This is just more evidence of a massive PR failure by those who are truly concerned about the deficit. Because there's no way to fix the problem if its true causes are still obscure to most Americans.
So if I could offer one piece of advice to people who are genuinely concerned about the federal budget deficit, and want to actually take constructive steps to fix the long-term problem, it would be this: hammer the message that taxes are too low given the government services that Americans want. Repeat it. Over and over. Don't deviate.
Taxes are too low given the government services that Americans want.
Taxes are too low given the government services that Americans want.
Taxes are too low given the government services that Americans want.
It's not that complicated, is it? And maybe, with time and enough repetition, Americans outside of policy circles will start to understand, or at least consider, that possibility.
Tuesday, February 08, 2011
Is it Autos?
Part of the story is the recovery of the US auto industry, of course. But really, that’s just a small part of the story. The picture below shows US manufacturing production in the motor vehicle & parts industry, compared to the rest of the US manufacturing sector. While the motor vehicle industry has recovered substantially from its nadir in 2009, output remains about 25% below its peak in 2007. The rest of the US manufacturing sector, on the other hand, is only about 5% below its 2007 peak. Note as well that the motor vehicle industry accounts for only about 20% of US manufacturing output.
Making Stuff that Businesses Want
So what else accounts for the relatively good performance of US manufacturing? The following picture shows that its growth has been driven largely by production of business equipment, and more generally, by durable goods production.
The reason for this strong growth in the production of business equipment is something that I think has largely been overlooked: business did actually begin spending on investment goods in 2010. Much of this was simply catching up from the extreme slowdown in spending on equipment in 2008 and 2009, but nevertheless, in 2010 it was definitely true that business spending on equipment and software grew at a very healthy rate.
Note that this matches my personal (i.e. anectdotal) experience over the past 12 months; senior management of the companies I meet with almost universally tell me that the purse strings have finally loosened, and their companies are beginning to make major purchases and investments that had been put off.
The next picture shows the growth in demand in the US economy. Business purchases of equipment and software (capital machinery, furniture, IT equipment, etc.) grew extremely rapidly in 2010. Yes, it was growing from the very low base of 2008 and 2009 levels, but still, such growth is signficant. And this picture also makes clear that demand from consumers is not the primary driver of growing US manufacturing output.
What about International Trade?
The other obvious feature of the picture above, of course, is that US exports of merchandise also grew at a very healthy clip in 2010. This is another important explanation for the relatively strong performance of the US manufacturing sector.
But international trade - or in a sense, the lack of it - is also responsible for growing US manufacturing output in another way: during this recovery (unlike the last two), increased demand by US businesses for equipment and machinery has been satisfied by US production of those items, rather than imports, to a greater degree than many of us (or at least me, speaking for myself) would have expected.
The picture below shows the growth in purchases by businesses of equipment and software over the past 25 years, and compares it with the growth in US manufacturing of business equipment. Following the recessions of 1990 and 2001, businesses did not ramp up their purchases of equipment nearly as rapidly as they have done in this recovery. Furthermore, in the 1990s and 2000s much of the increase in US demand for those types of products must have been met by imports, since US production of those types of goods did not grow by nearly the rates we’ve seen over the last year (at least not until right at the peak of the business cycle).
The Bottom Line
I don’t want to overstate things here. US manufacturing is doing surprisingly well, but in part it’s simply making up for the enormous downturn in 2008 and 2009. And the simple fact that the manufacturing sector is relatively small in the US means that there’s only so much that it can do to pull the rest of the US economy into high gear.
However – and this is a pretty big however – this is the first time in 25 years that the manufacturing sector of the US economy is not underperforming the economy as a whole. And it’s being driven in large part by solid growth in domestic demand for durable goods and business equipment. The last piece of the puzzle – the role of international trade in the relatively strong performance of US manufacturing – is also an extremely important one, and suggests that some fairly profound shifts in the US’s international competitiveness may be happening. I’ll take a look at that later this week.
Sunday, February 06, 2011
The following chart shows the change in real GDP and manufacturing production through the last three recessions (1990-91, 2001-02, and 2007-09). In each case manufacturing contracted much more sharply than the economy as a whole. And in the recessions of 1990 and 2001, manufacturing was slower to recover than the economy as a whole, and didn’t really enjoy a period of rapid expansion until well into the recovery in each instance. But this time is different; manufacturing output has actually been growing faster than overall GDP, right out of the gate.
The employment picture below tells the picture even more clearly. In the previous two recessions, manufacturing lost more jobs (proportionately), and recovered jobs more slowly (if at all), than the private sector as a whole.
Unlike the previous two recessions, this time around the manufacturing sector has recovered more quickly than the economy as a whole, and begun adding jobs sooner than the rest of the economy.
Let me add that in my work I interact with lots of manufacturing companies, and my personal observations match the data; manufacturing in the US is booming right now, despite the weakness in the economy overall.
Why does this recovery (and for that matter, the recession that preceded it) look so much different in the manufacturing sector of the US economy? It’s an interesting question, and one that I plan to examine in a few different ways this week.
Update: third chart added, and text edited slightly for clarity.
Saturday, February 05, 2011
Now I feel ready to dip my toes into the blogging waters again. I will write as the work and family demands of my life allow. I expect, as before, to offer commentary on the state of the economy and recent economic news releases (with lots of charts and graphs), as well as to think about broader economic trends and themes. One difference that I anticipate from my blogging of 4 years ago, however, is that now I will have more to say about the intersection between economics and business, drawing on my day-to-day experiences with the business world.
Thanks for checking in with me again.
Friday, February 04, 2011
The heart of the paper is, as has been noted by others, a picture like this, which while not actually in Glasner’s paper nicely illustrates its central point:
Note that inflation expectations are estimated as the difference in yields between 10 year US government bonds and their inflation-adjusted counterparts.
The point is that there was a statistically significant - one might say profound - structural break in the relationship between inflation expectations and asset prices, somewhere in 2008. Before that time, inflation expectations and asset prices had little or no correlation with each other; after that time the correlation was nearly perfect.
Some commenters have cited this as further proof that the US economy has been characterized by an insufficiency of demand for the past three years. Kevin Drum asks for a better understanding of the specific reasoning behind that inference, however. Kevin is a very smart guy, and generally understand economics better than most people. He writes:
Sadly, neither Glasner, Sumner, nor Krugman explain in terms someone like me can understand why this correlation implies that aggregate demand is what's behind our economic woes. I feel a bit like a dummy, since they seem to expect this to be obvious, but hopefully someone out there in the econ blogosphere will take pity and explain this in laymen's terms.
Kevin, I think that you’re smarter than you give yourself credit for in this case. The reason it doesn’t seem obvious to you that this is evidence that the US economy is facing a shortfall of demand is because it’s not. Not by itself, anyway.
Think of it like this. Normally, when stock market investors think that inflation is rising, there are two conflicting reactions. First comes a jump for joy, because rising prices mean rising profits for the companies represented in the NYSE. But next comes a depressed reality check, as stock market investors realize that inflation rising means that the Fed is likely to raise interest rates, which tells them that maybe stocks are not going to be the best way to get a good rate of return in the future. These two reactions roughly cancel each other out (sometimes one is bigger, sometimes the other), resulting in no net correlation between inflation expectations and the stock market.
Now, however, things are different. The reason is because the Fed has already pushed interest rates (at least short term rates) as low as they can go. In fact, the Fed would probably have pushed them below zero if that was possible. In other words, the Fed’s target, or optimal interest rate is probably negative.
So in this world where we’re up against the zero lower bound for nominal interest rates, stock market investors only have the first reaction – the jump for joy – when they think that inflation is rising. They don’t have to endure the depressed reality check, because they’re not at all worried about the Fed raising interest rates any time soon. If anything, it just means that the Fed’s optimal interest rate is less negative. But the nominal interest rate, stock market investors reason, is still going to be zero. Since there’s no countervailing effect, the jump for joy rules the day and the stock market goes up with inflation expectations.
The implication is that Glasner’s evidence says something about asset price behavior and the relationship between real and nominal interest rates when we’re up against the zero lower bound on nominal interest rates (which are the conclusions he draws in his paper), but doesn’t really tell us anything more than that. In other words, the strong correlation between inflation expectations and asset prices starting in 2008 is fully explained by the fact that 2008 is when we hit the zero lower bound on nominal interest rates. No other explanation for this correlation is needed. The chart below illustrates.
It's not a coincidence that as soon as the green line (representing nominal short term interest rates, as measured by the 4 week Treasury bill rate) hits zero, the correlation between inflation expectations and asset prices is almost perfect. Starting in 2008 stock market investors no longer had to endure that depressed reality check whenever inflation expectations rose.
Of course, I know that the US economy has been facing insufficient demand for the past 3 years, as surely as I know that the earth revolves around the sun. There is a host of other evidence confirming that (very obvious) assessment of the situation. But I don’t think that this post-2008 correlation between inflation expectations and asset prices is part of that evidence.