Friday, February 20, 2004
previous entry | main | next entry | TrackBack (3)
The Economist vs. the New York Fed on jobs
The cover of the Economist this week is on the outsourcing issue. Here's a link to their editorial. The key graf:
Here's the cover story. It's worth a read, but there is one off-kilter point. At one juncture, the story says:
What's weird is that the story provides a link to an August 2003 Federal Reserve Bank of New York Paper on why this economic recovery is different from other economic recoveries. Their conclusion:
How different is this recovery? Take a look at this chart:
Share of Total Employment in Industries Undergoing Cyclical Changes and in Industries Undergoing Structural Changes
As the NY Fed paper notes:
posted by Dan on 02.20.04 at 06:33 PM
The Economist is quite sure that most of the jobs that will wind up moving from America to India or elsewhere are the non-creative, unremunerative ones involving such things as writing computer code and answering the telephone. Is this really true?
Granted that the more value added by a worker's skill, training and experience to a job the higher the cost of moving that job somewhere else. The gain is greater, too, though; such workers in America make very high salaries, and suitably talented and trained Indian workers can be paid much less. It may be that there are not enough people in India or other low-wage countries able to do the high value added tasks to pose a serious threat to American workers in the relevant occupations. Even if this is true now, it may not be true forever.
Henry Kissinger is about the last person I would think to consult on a matter involving economics, but he did write something three years ago that made a great deal of sense. Globalization, he said, promised great benefits to those able to compete in the global economy, but was terribly disruptive to people who are not; therein lay its potential for exacerbating political instability. There is no reason for us to assume that none of the people unable to compete effectively in a rapidly globalizing economy will be Americans.posted by: Zathras on 02.20.04 at 06:33 PM [permalink]
My commentary on this nonsense from the Economist:
* It's just the standard free-trade catechism, intellectually vacuous and morally bankrupt. Look at all the tropes --
* First of all, what trade article would be complete without a reference to Ricardo and comparative advantage? They all mention that famous theory but neglect to mention the lesser-known corollary, Ricardo's Iron Law of Wages. This holds that in a world economy with free trade, wages will invariably fall to a subsistence level because there will always be someone willing to do the job cheaper. Why does everyone seem to think Ricardo was right on the first theory, but not the second? And why do they not even bring it up at all?
* The article is filled with vague promises that new jobs will be on the horizon soon. Promises and theories don't pay bills. This is, again, standard for the usual "rah-rah-free-trade" gibberish that the media serves up.
* The article utilizes (though without referring to it by name) the crackpot "NAIRU" theory which holds that unemployment is good because having full employment might cause inflation.
* The article states that businesses will have to pick up hiring because of rising demand. First of all, they can simply demand that existing workers work more overtime, and thanks to the new Bush regulations, this comes without overtime pay. What business won't do that? And if the people are worked to the point of physical exhaustion, why not simply hire pliable Indians or Chinese instead of Americans?
* A foolish statement: "And the bulk of these exports will not be the high-flying jobs of IT consultants, but the mind-numbing functions of code-writing." Most techies are not going to take much comfort in that, since they prefer technically-oriented work and have little patience for social BS. Besides, how will people move into high-end programming jobs without entry-level programming jobs to prepare them? That is putting the cart before the horse.
* There is also the usual failure to differentiate between job obsolescence due to technical advance, and job exporting to cheap labor Third World countries.
* And, finally, the article points to Wal-Mart as one of the companies that is creating new jobs. Wal-Mart, of course, is one of the nation's worst and most unethical employers.
Color me unimpressed. This isn't an article, it's a sermon.posted by: Firebug on 02.20.04 at 06:33 PM [permalink]
You're absolutely right. The article also glosses over how benefits from free trade can be garnered while you have a systematic and growing trade deficit as well, or how population size and barriers to competition like subsidy will prevent economic parity/equilibration that would allow them to buy our goods and services back. The argument is that when the populations of India and China have higher standards of living they'll be more expensive to hire and buy more of our stuff. However, the arguments neglects to mention that the huge size of Indian and Chinese populations will prevent such an outcome happening any time in the foreseeable future.
It's like pouring a boiling cup of water into a large swimming pool. The overall temperature will only go up a little. The capital flight to foreign markets will take many decades to produce any sort of parity, while at the same time there will be a domestic decline as you've mentioned in competitive wages. With brand infringement and intellectual property rights violations, there won't be any way to repatriate profits.
Finally, the early 90's recession was a sign that the real cost of living inflation had begun to deviate significantly from the CPI inflation measure. When the "jobless recovery" was here in the 90's, it was actually a recession covered by fishy numbers. GDP growth minus inflation is what drives economic expansion, e.g. real gdp growth. Over time, as the CPI has become more and more out of line with actual cost of living inflation, the Fed's policies have become more and more bankrupt.
Right now, we are at the threshold of a nascent recovery. The reason why is that actual inflation is probably in the 4-5% range, while the Fed and the CPI claim it's about 1.1%. Think about it. If GDP growth is about 4% and inflation is really about 4%, then you have zero real growth. All the economic growth is consumed by higher cost of living increases.posted by: Oldman on 02.20.04 at 06:33 PM [permalink]
"The Economist is quite sure that most of the jobs that will wind up moving from America to India or elsewhere are the non-creative, unremunerative ones involving such things as writing computer code.." First of all, anyone who thinks that writing computer code is always either (a)non-creative or (b)unremunerative just doesn't know what he is talking about, and should refrain from further commentary about the economy.
More importantly, the metric for what jobs will be offshored, vs what jobs will, not is a complex one, not simply a matter of skilled vs unskilled. Information technology jobs are particularly vulnerable because the "transportation cost" of bits is now very low. Jobs involving work in a local quarry are not, because the transportation costs of stone and gravel are very high.
It strikes me that most journalists (even many business journalists) have little understanding of how business actually works and how business decisions are actually made.posted by: david foster on 02.20.04 at 06:33 PM [permalink]
This is just like the 90-91 recession and the slow growth period that followed until about mid-'94. There were a lot of unique factors invloved in that recession that made it different from previous ones:
1) It was a relatively mild recession, short in duration and not particularly deep. When people try to compare the job creation numbers of the last 2 recessions to historical ones, they fail to mention that most historical recessions (especially the 1970's and 82-83) were real boom-bust affairs with the federal reserve reving the money supply and then stomping on the brakes to curb inflation after pre-election run-ups and the like. Employment went up quicker becasue it went down quicker in the first place.
1) The biggest differences are the tax cuts instead of tax increases,
The federal reserve pattern is almost exactly the same: flood the street with money to help lessen the Asian debt crisis in '97-'98, create an inflationary bubble(which was diverted mostly into stock market speculation as opposed to inflation), clamp down on the money supply to curb inflation pressures (or "irrational exuberance), drive the economy into recession, then slowly increase the money supply when growth doesn't pick up fast enough.
The other thing that is similar is the 90'-'91 recession is the corporate restructuring that is going on. During the 90's boom companies, as they always do, thought the good times would go on forever. They financed expansions that in employment and assets that made sense in 1998, but didn't make sense in 2001. This restructuring should lead to the same thing it did in the 90's: Labor and capital freed up from less productive pursuits will be put to work in new companies and new industries. Despite what a lot of aspiring politicians are trying to argue, government can't make that happen (although it might have the real desired effect: getting them elected). It can however get in the way, delay the process, and prolong the misery.
Here's the crux of the problem:
The government is spending the largest percentage of national income in history right now and it doesn't look to be changing any time soon. Budget deficit, budget surplus, it doesn't seem to matter. We went into a recession with a huge budget surplus (something that the "new" economics said shouldn't happen) and we failed to come out of a recession with a large budget deficit, which Keynsian economics said shouldn't happen.
Both theories are wrong because they miss the fundametal problem: The absolute size of government. Hint: it's too big right now for optimal economic growth.
Ironically, the early 90's was the last time we had a trade surplus. Didn't exactly help then, did it? The fact is that the balance of trade is a backward looking number, telling us where we've been, not where we are going. America's economy was weaker than those we traded with: Trade Surplus. Now America's economy is stronger than those we trade with: Trade deficit. The easist way to "fix" a trade deficit is to drive your economy into a deep recession.
By the way, all of the ideas for fixing this "problem" will do just that.posted by: DSpears on 02.20.04 at 06:33 PM [permalink]
"Between 1980 and 2002, America's population grew by 23.9%. The number of employed Americans, on the other hand, grew by 37.4%."
And this is what we are facing. The most efficient industrial system concentrates labor. In our case, the way to compete is to attract hundreds of millions of laborers from across the world to live in massive mega free trade zones across the Soutwest U.S.
This is the current policy and will likely work. Is this how we want to live?posted by: Matt Young on 02.20.04 at 06:33 PM [permalink]
In our case, the way to compete is to attract hundreds of millions of laborers from across the world to live in massive mega free trade zones across the Soutwest U.S.
Matt - You're misinterpreting the statistic cited by The Economist. That 23.9% growth in population includes growth due to immigration (both legal and illegal). Population growth means just that: an expansion in the population due to all factors (the surfeit of births over deaths, net immigration, etc.). Thus, during the years cited ('80-'02) the workforce in the U.S. expanded at a faster rate than the population. In other words, the workforce participation rate short up: a higher percentage of Americans were active and employed members of the labor force in 2002 than in 1980. Some of this was no doubt due to the continued increase in the participation of women in the workforce (a trend that by now has largely played itself out) and some of it was due to the more robust economic conditions of recent years (which has driven down the unemployment rate).
I consider the biggest "sinners" during this recent surge in protectionist sentiment to be the politicians, who offer the false hope to trade's victims that they can be "protected" from the vissisitudes of the global economy. News flash: they CANNOT. Which is a pity, because the focus shifts from where it ought to be: developing effective, post-industrial policies that will genuinely protect workers (truly robust job training; income security; guaranteed healthcare).posted by: P. B. Almeida on 02.20.04 at 06:33 PM [permalink]
"Thus, during the years cited ('80-'02) the workforce in the U.S. expanded at a faster rate than the population. In other words, the workforce participation rate short up"
I may be misinterpreting the statistics, but I am not misrepresenting them. The theory I propose, may be wrong, but is close enough to the facts to warrant consideration.
The theory proposed states that massive population increases, from all factors, lead to massive increases in efficiency and result in employment increases higher than the population increases.
Put another way, when the U.S. is the only laissez faire economy, then there will be a tendency to concentrate the world's industrial capacity here.
The counter argument would examine China for comparison. But China has a growing laissez faire economic policy, and it also grows via concentration of industrial capacity into giant mega industrial centers.
Massive labor mobility across international boundaries has been the main, if not the only, real mechanism that the U.S. has used to balance trade, since Alexande Hamilton. Greenspan has even stated the proposition to Congress; that one way to grow out of our twin deficits is via massive immigration.
So, be careful if you think that massive immigration is not our comparative advantage.posted by: Matt Young on 02.20.04 at 06:33 PM [permalink]
Yes we could grow out of the twin deficits by massive immigration, but only by accepting a real decline in the typical standard of living. And you're wrong. Massive immigration would affect absolute advantage NOT comparative advantage. My opinion of those who cite comparative advantage markedly lowers every time I hear one of them confuse it for absolute advantage. Hint low cost is not equal to comparative advantage! Sometimes comparative advantage means you make the thing that's more expensive for you to make than the competition makes. Which is hard for most people to grasp, why it would be more efficient to trade something you make more expensively than your trade partner.
I find myself sympathetic to your idea that the absolute size of government is too large, but it's not true that the absolute size is what is depressing growth. What's depressing growth are structural factors added to flawed monetary policy. You're absolutely right that a trade surplus can be created by cratering an economy into the ground. However you're missing the point. The real damage isn't in imports, it's in the lack of exports. So by saying imports are too high or too low, really misses the point. Comparative advantage means that growth in the benefits of trade depends pretty much on the growth in exports and not the deficit except insofar as the deficit is a sign that imports are stripping capital that could go into exports instead. If a trade surplus appears because of an economic contraction that kills export investment, then it's just as bad as a trade deficit. The rest of your logic is similarly fuzzy and as easily refutable.posted by: Oldman on 02.20.04 at 06:33 PM [permalink]
Thanks for the nice economic summary. One of the things that makes me disbelieve the doom and gloom of free trade is the dynamic nature of the world. National Geographic has a nice story this month on China titled: China's Growing Pains; more money, more stuff, more problems. Any solutions?
China is experiencing a hyper-compressed industrial revolution. The problems associated with this include destruction of topsoil, denuding of forests, pollution of water and air. The US experienced these same problems spread out over a 100-year period while China has done it in about 25-years.
As China continues to grow richer, is it not reasonable to predict that their industrial output will be simultaneously modernized and constrained. Upgrades in efficiency will likely be reduced by worker safety and environmental regulations. Would this result in higher product costs?
Industrial reform in China, IMO, cannot be forced from outside (WTO, UN) but will eventually be forced due to internal pressures. It seems that if China does not reform industrial policy, they will eventually choke on their unconstrained effluent.
Is this another reason not to fear free trade?posted by: Horst Graben on 02.20.04 at 06:33 PM [permalink]
"...the deficit is a sign that imports are stripping capital that could go into exports instead."
But those dollars that pay for imports to foreign countries will ultimately end up back in the US as investment. That is the whole concept of balance of payments: As long as foreigners don't burn or wallpaper their houses with the dollars they receive, those dollars will end up buying exports from America or investing in dollar denominated securities. The fact that we have a "trade deficit" means that those dollars are coming back as investment not spending.
The relative numbers (deficit or surplus) are irrelevant. It's a circular game. Other countries have simply made different decisions about how much they are going to subsidize the US economy by protecting their home industries from competition. That benefits America.
posted by: DSpears on 02.20.04 at 06:33 PM [permalink]
We must be more specific concerning the definition of “massive immigration.” A large number of poorly educated immigrants will almost certainly harm our economy. However, the “massive immigration” of the educated elite will be greatly beneficial. Let’s be blunt, we are concerned about ethnic groups like the Mexicans because they usually have so little to offer except their brute strength.posted by: David Thomson on 02.20.04 at 06:33 PM [permalink]
First of all, what trade article would be complete without a reference to Ricardo and comparative advantage? They all mention that famous theory but neglect to mention the lesser-known corollary, Ricardo's Iron Law of Wages. This holds that in a world economy with free trade, wages will invariably fall to a subsistence level because there will always be someone willing to do the job cheaper. Why does everyone seem to think Ricardo was right on the first theory, but not the second? And why do they not even bring it up at all?
Why, indeed? Because using the standard assumptions of modern economic theory, you can derive comparative advantage fairly easily. You can also demonstrate that Ricardo was wrong about a race to the bottom. Economists don't worship Ricardo. Some of them do, of course, worship theory.
Firebug, you--and a number of the posters--are absolutely right that no one knows what the new jobs will be. Nor can anyone be sure that the new jobs will be, on average, higher paying.
There is a large element of faith here. However, that faith has been correct through all 225 years of American history. If you had been around for those 225 years and bet against the creation of newer, better-paying jogs, you would have kept losing and losing. Perhaps things are different now.posted by: Roger Sweeny on 02.20.04 at 06:33 PM [permalink]
You would have lost by betting against long-term economic growth. Whether you would have lost betting against better-paying jobs emerging in the short term would have depended on when you placed your bet.
There are respects in which the experience of the last two centuries is not an entirely reliable guide in the economic areas now. One example: during most of our history new jobs emerged from the base of a vital agrarian economy. The farm provided not only an income but a source of capital for new investment, a refuge to return to when investments of money or time didn't work out, a source of subsistence employment for many people with limited gifts or education, and a kind of training ground for generations who often found the habits of hard work and self-discipline demanded by farm life to be highly useful in other occupations. That base is mostly gone now, and our generation may be the first to experience fully what that means.
It doesn't mean that we are doomed or anything like it. Nothing in the economic changes we are experiencing today ought to make anyone think in terms of the Apocalypse. Nor does it mean that economic theory has changed in any fundamental way. But it does mean that our circumstances are very different from those that faced our forebears, and while the challenges they present can be overcome the fact of our overcoming them cannot be assumed ahead of time just because things worked out well over the last couple of centuries.posted by: Zathras on 02.20.04 at 06:33 PM [permalink]
Thank you for an admirable response. It's not often the oldman has a chance to go back and forth several steps beyond the superficialities of the actual issues.
My response is that you are correct technically but the oldman would argue that there are two dangers that are not being addressed in your argument.
The first is the idea of the greenback as a hard currency. The dollars don't have to come back if they have become the main form of exchange outside America. That is if we pump out dollars and Kasikstan and Turkmenistan use those dollars in a stable trade loop as their exchange currency in preference to their own, then we need never see those dollars again. This would lead to us exporting our value. Also if at some point the status of the Greenback were to collapse as a preffered exchange currency (the "new gold") we could see a tidal wave of those dollars coming back all at once.
This leads the oldman to his second point. Namely that if those dollars that do come back but they come back to finance the debt of inefficient government spending then you have a ROI or investment return loss. There is a difference between whether those dollars come back as export purchases or debt purchases because of the ROI difference. This would show up as lower growth or higher cost of living inflation. I would argue that we are already seeing significant signs of both. This is especially true as the Federal Reserve has been pursuing long term a risky monetary liquidity expansion that is generating deflation/inflation problems. The trade deficit is fueling a deflation/inflation bubble in currency valuation.
So we can lose out that way too!posted by: Oldman on 02.20.04 at 06:33 PM [permalink]
If those dollars are not coming back, i.e., permanently expatriated for used in Turkmenistan, aren't they effectively removed from circulation? Wouldn't that effectively decrease the money supply? Now the loose money policies of the Fed aren't as inflationary, at least domestically. If such a thing were really happening, at some rate the Fed would need to pump more money into the system.
Assuming such a thing could happen, what are peopel in Turkmenistan trading to get these dollars in the first place? Obviously their currency is worthless, so that's probably not possible.
Those expatriated dollars are as likely to end up buying stocks and bonds as they are government securities. What drives teh stock market is profits more than anything else, and those are strong and look to be for some time, so no danger there. Only if somebody else's investment environment is more attractive will that capital want to leave, but what are the options? Europe has higher interest rates but no growth. Japan looks to be finally growing again (for now) but they are desperately trying hold their currency down because they are still experiencing deflation and are trying to protect their exporters.
This is the same situation that has presented itself for 2 decades: we have a trade deficit due to the choices others make about protecting their own domestic suppliers through subsidy and protectionist regulation. The result that that countries like Japan and much of Europe subsidize our imports. They effectively pay us to take their products at a lower price (that's good for us). But America has been adn continues to be the best place to invest short term and long term, so they doomsday scenario never materializes. The problem is structural, not due to Fed policy.
As the rest of the world recovers these things will balance out. There will inevitably be a rise in interest rates in America. That's not a bad thing. The market will expect it and will probably get very nervous if it doesn't get it, because at these historic low rates inflation will come at some point (though maybe not as quick as some believe). I just don't see the big collapse coming.
Oldman, I'm puzzled about what you think the CORRECT Fed policy should be: You want to reduce the trade deficit, but the current Fed policy is the standard "fix" for such a thing: a weak currency makes it easier to export and more expensive to import, and makes foreign dollars invested in American earn less money, completing the cycle.
A strong dollar would cause the trade deficit to rise not fall, so that can't be what you are advocating. What should Fed policy be?posted by: DSpears on 02.20.04 at 06:33 PM [permalink]
You are sort of correct. As it turns out Turkmenistan has its natural resources to sell for hard currency:
"As the largest natural-gas producer in post-Soviet Central Asia, Turkmenistan has been seeking investors to develop its sector of the Caspian, which it estimates at 11 billion tons of crude and 5.5 trillion cubic meters of gas."
As it turns out, preferred currency is already dollars.
So yes, as long as the dollar remains a preferred exchange currency in expatriated trade loops, it's effectively removed from domestic money supply. This would cause a money supply contraction UNLESS as has happened the Fed was accommadating and loosened monetary policy to supply both domestic and foreign needs. This is what occurred throughout the last two and a half or so decades. Interest rates or the price of money have been steadily declining compared to historical trends.
You suggest further that interest rates will rise, but the Fed has in fact signalled that they intend to keep them low. It would be ahistorical to expect such low interest rates to stay that way for long, but Japan as a matter of fact has achieved such a trend. I wouldn't rule it out in us yet.
You ask what correct Fed policy should be. I agree that this is a structural problem and that the Fed is managing it. The problem is that in the long run (long run means today since this has been going on for a long time) there is an intrinsic conflict between managing price stability and using the dollar as a preferred exchange currency. I don't exactly blame the Fed but it's doing a least evil choice given their lack of policy influence.
Look in the short term, what is going to happen is this. The world economy is recovering. This in part fuels the downward spiral of the dollar. At some point, its position as a preferred currency medium destabilizes. If you doubt this consider that the price of oil has recently risen from $28 dollars a barrel to $35 a barrel just on the dollars devaluation alone.
At the same time, the expanding fiscal deficit puts pressure on the yeild curve and debt prices - basic supply and demand. A correction in the currency exchange would mean buying less debt or selling US debt. This would fuel more downward pressure on the dollar and upward pressure on the yeild curve.
The yeild curve typically informs the Fed's actions these days. They'd have to act as buyer of last resort to redeem US debt. So interest rates go up. At the same time you have an inflationary shock to the money supply. You get a stagflation scenario. Rising prices and a to control it a higher interest rate regime, killing the economy and popping the stock market.
That's the scenario. At that point, the "trade deficit" becomes real in the sense that wealth has just been destroyed. The transferral of the trade deficit into debt depressed real growth by exchanging high ROI US exports into low ROI US national debt. All the chickens come home to roost.
In effect what we've been doing is not converting imports into debt purchases. What we've been doing is by importing more than we export, sending our capital overseas. This has seen an increasing expansion of the economic sphere. Essentially countries that use the US currency as a preferred exchange currency become extensions of the US currency/economic market.
However like all monetary expansions if the underlying structural fundamentals get out of line, they eventually correct. So the monetary sphere contracts. That's the story. If they don't want our dollars or debt no more, then the aggregate demand drop combined with the increase in money supply stops us in our tracks.posted by: Oldman on 02.20.04 at 06:33 PM [permalink]
Oldman, this is the corollary to our discussion on sustainable deficits. While the current account doesn't have to balance on its own, the current account and capital accounts do have to balance. The value of our currency is the equalizer if they do not. If trading partners do not buy or invest in Dollar denominated assets, the value of our currency will fall as all of the unwanted Dollars pile up.
The location of Dollar denominated assets doesn't matter. Dollar denominated assets are all subject to the Fed. Owners of Dollar denominated assets only control demand for Dollars versus other currencies. If Turkmen want out of Dollars, they can push down its value relative to other currencies but the Fed still controls the supply of Dollars.posted by: Stan on 02.20.04 at 06:33 PM [permalink]
"At the same time, the expanding fiscal deficit puts pressure on the yeild curve and debt prices - basic supply and demand. A correction in the currency exchange would mean buying less debt or selling US debt. This would fuel more downward pressure on the dollar and upward pressure on the yeild curve."
Correct me if I'm wrong but, if the Fed buys less debt (releasing fewer dollars in exchange for govt seccurities) or sells debt (taking in dollars in exchange for US securities) wouldn't that contract the money supply and exert UPWARD pressure on the dollar?
Another mitigating factor here is that the Bank of Japan has been buying dollars in an effort to keep their currency lower so they can still export and to stop deflation which is still a big problem there as in a lot of Asia. They are effectively taking dollars out of circulation, reducing the money supply (of dollars). That won't go on forever as their economy recovers, but their deflationary environment and their addiction to exporting at all costs would tend to indicate it won't end tomorrow.
The real foreign culprit keeping our currency low is Europe. For a variety of reason they cannot inflate their currency even a little, so they are stuck in permanent Eurosclerosis (not my word but I think it conveighs the correct image) where the economies of these countries are so structurally biased towards inflation that they cannot increase the money supply even with 10%+ unemployment. Europe is the only place where the Phillips Curve actually applies: Growth and Employment = Inflation. If the European Union opened the spigot, they would have stagflation.
But the Fed has repeatedly said that it will not and can not continue it's loose money policy forever. The real problem is that this is an election year and Fed tradition is to stay away from action coming up to an election, even if waiting means problems down the road (like in 2000). Greenspan may not be perfect, but he believes in the soft landing and I don't see him jacking interest rates up in a fashion that would wreck the economy.
I find it hard to see stagflation in an era where we have no inflation, the economy is growing and productivity is at an alltime high. Stagflation took over a decade to create AND still required continued bad policy for years in order to sustain it even after inflation got into the double digits (hardly the case today). The Fed knows a lot more about what causes inflation these days and I have confidence that they will return to fighting when it IS a problem. That may very well be shortly.posted by: DSpears on 02.20.04 at 06:33 PM [permalink]
DSpear, you said:
"The government is spending the largest percentage of national income in history right now and it doesn't look to be changing any time soon. Budget deficit, budget surplus, it doesn't seem to matter. We went into a recession with a huge budget surplus (something that the "new" economics said shouldn't happen) and we failed to come out of a recession with a large budget deficit, which Keynsian economics said shouldn't happen.
Both theories are wrong because they miss the fundametal problem: The absolute size of government. Hint: it's too big right now for optimal economic growth."
True we did not experience a typical Keynsian/monetarist (small "m") economic contraction, but the problem isn't with our basic Keynsian/monetarist model. The problem is from having economic blinkers on due to economic biases.
This recession is similar to what Japan experienced 10 odd years ago. When the land bubble popped in Japan essentially the whole economy went bankrupt. Tons of highly leveraged companies could afford to pay down their debts, but no company needed or wanted additional capacity. Despite large amounts of government spending long-term interest rates declined. Supply of funds outstripped demand for funds. Companies have been using existing capacity to pay down debt while Japan's aging society continues to prepare for retirement.
The U.S. experience is different in that our bubble was confined to a smaller portion of the U.S. economy. Also U.S. companies were not nearly as leveraged as their Japanese counterparts. Nonetheless long-term U.S. interest rates declined. Again investment supply outstripped demand. With the huge implied U.S. budget deficits and large amounts of equity refinancing that has taken place that is no mean feat.
The only problem with our models is the basic assumption of increasing demand for investment funds as interest rates decline. Under post-bubble conditions, there is a period where demand is nearly inelastic as you approach the lower interest rate bounds for affected portions of the economy. If rates go up borrowing will decline, but some portions of the economy are not going to increase borrowing as you near zero. (For more information read Richard Koo's "Balance Sheet Recession". Warning it reads a lot like an LDP apology.) Combine these effects with the terrorist attacks ecetera that you described above - adding weak global demand - and you have a slow rebound of the U.S. economy.
posted by: Stan on 02.20.04 at 06:33 PM [permalink]
"Your theory doesn't square with low long term interest rates. If government spending was the problem you suggest, long term interest rates would be much higher."
Actually no. Long term interest rates are affected by a variety of things. High government spending has lowered the real rate of growth of the economy. That in itself is not a condition for high or low long term interest rates. The rate of government spending by itself cannot drive interest rates in either direction. The government spending has driven money from productive uses (through taxing and borrowing) to less productive activities (government programs). There is a loss of both present and future economic activity in that proposition. Even Keynes understood this. What he was wrong about was his so-called multiplier effect which was supposed to magically produce something out of nothing by the government simply moving the money around.
A large trade surplus, a highly inflexible and inefficient domestic economy with high prices (relative to the rest of the world), high barriers to trade and government tax and regulatory policies that discourage spending and encourage saving, have all lead to Japan's problems. These are all diametrically opposed to the conditions in America.
But the real problem is that they have relied on Keynsian economic prescriptions like large public works projects that were supposed to create budget deficits, that were in turn supposed to stimulate demand. It didn't work because it's a flawed idea.
Japan is also one of the most protectionist developed nations in the world. Simply importing more goods could easily rouse those Yen bound up in savings accounts into action if Japanese consumers had more product and service choices at cheaper prices. But their corrupt corporatist government has stubbornly refuse to drop these barriers. This means that the extra Yen that the average Japanese consumer spends on domestic goods (over what they would pay in America for the same thing) is used to subsidise cheaper prices in America. Why would they spend their money?
The real problem in Japan is that everything costs too much, so nobody buys anything. Deflation will have to continue unabated for a long tiome to come before prices in Japan drop to a level that will encourage spending.posted by: DSpears on 02.20.04 at 06:33 PM [permalink]
DSpears, yes long term rates are effected by a lot of things, but you suggested that our government is spending too much. If so we would expect government spending to crowd out investment. If excessive government spending was a problem, this is how we would know it. Our current long terms rates do not seem to indicate that this is the case. There does not appear to be excessive competition for investment funds. Government spending can very well be too high, but right now our rates do not seem to show that to be the case.
Despite the massive structural differences, Japan is in a similar position as the U.S. regarding demand for funds. Japan's government spending is not holding back the Japanese economy. Zero percent long term rates say that supply is not a problem. Japan's structurally induced problems don't undermine how this applies to the U.S. In both cases it is clear that investment demand is constrained. The length of time Japan's investment demand has been constrained is a function of those structural problems and the leverage of Japan companies prior to the bust. Interest rates suggest that investment supply is sufficient for government spending levels in both Japan and the U.S.
Our technology sector on the other hand has sunk investments greatly in excess of current demand. Indeed, we may never light large amounts of the fiber optic we have laid. While these companies write off debt and restructure, they are not going to be very interested in investing. Investment demand will have to be carried by other sectors of the economy. This is what the data seems to reveal. The structural changes being brought on by China and India's entry into the global market are also captured in the data. Our basic models seem to capture this downturn fairly well with an understanding of these differences from the norm.
Continued deficit spending will likely lead to problems in the future, but it doesn't appear to be a problem at this time. Indeed, we have had significant GDP growth over the last 12 or so years. There do not seem to be any significant government induced structural problems currently holding back the U.S. economy. In other words, while we might be able to increase our economic efficiency, we don't appear to be hamstrung by any major flaw.posted by: Stan on 02.20.04 at 06:33 PM [permalink]
There is really no contradiction here. The Fed paper is saying that there is structural *shift* in the composition of employment going on at the same time as the cyclical downturn, not that there is structural *loss* of employment (which would mean a higher structural rate of unemployment).
Put a structural shift together with a cyclical loss, and it becomes easy to see it as a structural loss, but it isn't.
Now on to the claim that "... if we pump out dollars and Kasikstan and Turkmenistan use those dollars in a stable trade loop as their exchange currency in preference to their own, then we need never see those dollars again." Actually you *will* see those dollars again, instantaneously. The withdrawal of these dollars from circulation would put upward pressure on U.S. interest rates, leading the Fed to expand the money supply in order to maintain its policy target. In effect the Fed prints dollars to replace those lost overseas, dollars that are available to finance domestic investment the U.S.
By holding onto those dollar bills, the Kazhaks and Turkmen are lending money to the U.S. as surely as if they used the money to buy Treasury bonds, except that now they don't earn any interest on their investment: this goes instead to the Fed, which turns it over as seignourage to the Treasury. An interest-free loan! You can't get a better deal than that.posted by: Daniel Lam on 02.20.04 at 06:33 PM [permalink]
Post a Comment: