Monday, April 30, 2007

A Lot of Money. Really. A Lot.

I generally don't waste time on this blog writing about Iraq. It's a miserable topic, and everything that I would want to say about it has already been said far more eloquently by others. But for various reasons, I've recently been trying to figure out the best way to convey how much money is currently being spent on the US effort in Iraq.

The number is in the neighborhood of $200 billion per year right now (and I'm not even getting into the enormous human costs, which are surely far greater). But the tricky part is finding a way to make that enormous but entirely abstract number mean something. That turns out to be quite a task.

Put simply, it's a really big number. And the human brain is just not equipped to really understand really big numbers like that. This problem always makes me refer to my copy of the Hitchhiker's Guide to the Galaxy for guidance. Here's what the introduction to The Hitchhiker's Guide says:
"Space," it says, "is big. Really big. You just won't believe how vastly hugely mind-bogglingly big it is. I mean, you may think it's a long way down the road to the chemist, but that's just peanuts to space. Listen..."

To be fair though, when confronted with the sheer enormity of the distances between the stars, better minds than the one responsible for the Guide's introduction have faltered. Some invite you to consider for a moment a peanut in Reading and a small walnut in Johannesburg, and other such dizzying concepts.

The simple truth is that interstellar distances will not fit into the human imagination.
And numbers as large as 200 billion are similarly out of reach of human understanding.

So instead, let's try this approach to convey the vastness of the amount of money being spent in Iraq: what else can you buy for $200 billion per year?

Would you like to provide more public services to the American people? Here are some things you could do. (Note: I'm not suggesting that we should do any of these things, just trying to give examples of how much money this is):
  • Provide free, federally-funded universal preschool to all 3 and 4 year olds in the US. Cost: ~$40 billion per year.
  • Double the number of police officers in the US from the current number of around 700,000 total. Put them all on the federal payroll. Cost: ~$50 billion per year.
  • Have the federal government pay the salary of every physician in the US. There are about 600,000 total, so if we gave each a total compensation package of around $180,000 per year (which would surely be a pay cut for many, but still isn't bad), the cost would be about $110 billion per year.
We could do all of these things together for the price of the US efforts in Iraq.

Do you like the space program? The cost of one NASA-sized space program (for that price you get a space shuttle program, numerous satellite launches, and the construction of your very own space station) is about $15 billion per year. For the price of the war in Iraq, we could have about 15 such space programs in the US. We could allocate them to all the biggest states - give one to California, one to Texas, one to Illinois, one to Ohio, etc. They could each have their own space station and shuttle fleet. They could compete over which shuttles have the snazziest paint jobs and license plates.

Or maybe construction is more your cup of tea. For $200 billion per year we could:
  • Demolish and rebuild every single high school in the US (there are about 18,000 of them) every four years or so. Since we're in the fifth year of the Iraq war, many school districts would now be getting their second new high school since 2003.
  • or, we could build 10,000 miles of interstate very year. The US interstate system has about 40,000 miles of highway, so by now every single mile of interstate highway in the US would have a duplicate lying right next to it, and many stretches of the interstate system would now be getting a triplicate.
  • or, we could build an underground rail tunnel, instead. Based on Russia's recent proposal for a cross-Bering Strait rail tunnel, I gather that it costs around $1 billion to build a mile of long-distance rail tunnel. So after five years, we would now be completing an entirely new, completely underground rail tunnel from Boston to New York to Philadelphia to Washinton to Richmond, and another complete tunnel running from San Francisco to LA to San Diego. In three more years we could run the rail tunnel from D.C. through Pittsburgh, Colombus, Indianapolis, and all the way to Chicago.
Or maybe you just like cutting taxes. The median household in the US (with income of around $55,000 per year) pays about $4,000 in federal income taxes. Dividing the money spent in Iraq by the 90 million households that pay tax comes to a bit over $2,000 per household per year, dropping the median household's federal tax burden in half.

Finally, maybe you want to just spend the money to make the American people safer from the threat of international terrorism. The budget for the FBI is around $7 billion per year, so if you wanted we could fund five more FBI's and devote them all exclusively to anti-terrorist efforts... and that would cost only $35 billion per year. Or if you prefer, we could triple the funding for the Department of Homeland Security. That would cost $70 billion per year.

Such comparisons don't necessarily mean that spending the money on Iraq was or is a bad idea. I happen to think that it is a horrible mistake, but these numbers don't make that case in and of themselves. To reach that conclusion, you need to consider the benefit that the US has received from the Iraq war effort.

Suppose you think that the US invasion and occupation of Iraq has not made the US safer. Well then, it's clear that the costs are not worth the benefits (or in this case, the harm).

But even if you think that it has made the American people safer, you still need to ask yourself this question: is the benefit from the US invasion and occupation of Iraq worth the enormous, gigantic, absolutely staggering financial cost? (Again, note that I'm not even getting into the personal costs, which are surely far greater.) Or put another way: is there really no better way to help improve the safety of the American people that might cost less than $200 billion per year? I have a hard time understanding how the answer to that question could be yes.

Sunday, April 29, 2007

Which Trade Model is Better?

As you may be aware already, there has been an interesting debate going on in the econ blog world between Greg Mankiw and Dani Rodrik. (To see the various bits of the debate put together in one place, see Economist's View.)

The most recent entry is Mankiw's Ricardo vs Hecksher-Ohlin. He asks the question: "Which model is more useful in thinking through issues in trade policy: the Ricardian model or the Heckscher-Ohlin model?" After considering the implications of mobile capital, he then writes that "[a]s a tentative conclusion, therefore, I am inclined to think that in a world with significant capital mobility, the Ricardian theory of trade is more useful than Heckscher-Olin."

I'd like to contribute a different perspective on the issue. As every economist would surely agree, Mark Thoma is absolutely correct when he writes
Choose the model that best answers the question you are interested in (and that can vary with the question you are asking) and then, if there are weaknesses in the model you choose that may affect the conclusions, those ought to be clearly identified and explored.
But that is not what Mankiw does when he reaches his tentative conclusion in favor of the Ricardian model. Rather than work from the question that needs to be answered, Mankiw seems to be comparing them based on which model is less unrealistic (after all, we must acknowledge that both models are - by design - grossly unrealistic). Since economic models are not meant to be at all realistic, but rather are intended to help teach us through analogy, I find Mankiw's answer unsatisfying.

When I teach international trade theory, my students find that the Ricardian model is the simplest and easiest-to-grasp illustration of the answer to one big question:can international trade leave both countries better off? The Ricardian model makes it easy to see that the answer is yes, which is what the model was designed to show, and is the single best thing about it.

But I don't really think that that is the only important - or even most important - question asked about trade policy today. Instead, trade policy now is at least as concerned with much more subtle questions like what specific form(s) will the gains from trade take if we pursue trade policy xyz?, or who will gain and who will lose from trade policy xyz?

For better or worse (and I think it's probably for the better), trade policy today must have as a crucial component some consideration for the distribution of the benefits of trade, and not just be concerned with whether trade liberalization will make some aggregate measure of US economic activity go up or down. These concerns are vitally important for moral, economic, and political reasons, and must be addressed when it comes to the creation of trade policy.

And when it comes to questions of the distribution of the gains from trade, the Hecksher-Ohlin (H-O) model is ideally suited to give us important answers - because that is exactly what it was designed to do. The H-O model provides us a simple and clean insight into how and why there are winners and losers from any given international trade policy, and exactly who they might be. That's why I find my mind automatically turning toward the H-O model for guidance whenever any new trade policy issue comes up, not the Ricardian model.

The Ricardian model is great for illustrating that countries as a whole can benefit from trade. But trade policy today must consider a whole lot more than just that simple calculation. So for my money, when it comes to current questions of trade policy, the H-O model is the one that has much more relevence.

Saturday, April 28, 2007

Stock Market Highs and Economic Growth: Weekly Archive Strolling

The big economic news of the week was yesterday's yucky GDP report, which was perversely greeted by a new record high for the Dow. A piece from this week's Business Week summarizes:
Dow Hits New Record After Weak GDP

The Dow Jones industrial average finished the week at another record high, while the broader market lagged behind after a report showed that first-quarter gross domestic product (GDP) growth slowed to 1.3%, much weaker than expected and the slowest pace in four years, while an inflation reading picked up steam. Microsoft's (MSFT) jump in profits helped keep some buyers around.

The stock market has considerable buying power despite numerous skeptics, says S&P. Some investors were looking to Monday's reports on personal consumption, construction spending, and the Chicago PMI for guidance after the soft GDP and high inflation numbers left traders confused, says S&P.
Now, to the archives. Here's another piece from Business Week, this time from the issue of June 25, 1990.
Will the Rally Pull a Fast Fade? Not This Time

Remember the adage "Fool me once, shame on you; fool me twice, shame on me"? That explains why, even with the Dow Jones industrial average above 2900, stock market investors are far more jaded than jubilant. In the summers of 1987 and '89, the market took big strides and scored new highs -- only to get clobbered in the fall. So those already in stocks are wondering if it's time to get out, and many on the sidelines are afraid to come in, for fear they'll be fooled yet again.

But the timid might be the ones who get fooled this time around. The Dow is on a roll. After setting a new record of 2935 on June 4, the market made a quick retreat to 2862, only to come bounding up again. Profit-taking is normal and to be expected after the breathless runup of nearly 300 points, or 11%, in six weeks. The Dow has climbed more than 15% from its midwinter bottom.

"This market is for real," says Stephen Poling, chief investment officer of AMEV Advisers Inc., a top-performing mutual fund group. "Back in January, I would not have believed the market could snap back this way." Byron R. Wien, U. S. equity strategist for Morgan Stanley & Co., forecasts the Dow will hit 3100 before yearend.

The zip in the popular stock averages is coming from companies that show a steady rise in profits quarter after quarter, a trend that started last year. And what really separates the leaders from the rest of the pack this year is their booming business abroad... Overseas revenues will become increasingly important for many U. S. companies, says Edward M. Kerschner, chairman of the investment policy committee at PaineWebber Inc. "Many American-domiciled companies have more coming from outside the U. S. than from within," he adds. Last year's winners, such as Coca-Cola, Disney, and Procter & Gamble, are still stars -- and they look overseas for revenues.

The resurgence of technology stocks is also striking. Since the beginning of the year, the Hambrecht & Quist High-Tech Index is up 13.2%, vs. only 3.3% for the Standard & Poor's 500-stock index. Investors have spent nearly three times as much on technology stocks than energy stocks, the second-most-favored stock group (chart).

But there's more to this market than overseas sales and a high-tech comeback. There's cash, and plenty of it. Mutual funds, which have record cash reserves, have far and away been the major buyers of stocks this year (chart), along with individuals, small institutional investors, and foreigners. And the betting is that with yields on short-term cash investments such as money-market funds and certificates of deposit falling, investors will turn to stocks and equity mutual funds. In fact, the slump in real estate, the quagmire in junk bonds, and the boredom in precious metals all work to the stock market's benefit: It's the only game in town.
Note that the economy officially went into recession in July 1990. Here's the picture showing US economic growth immediately following these record highs for the stock market in June 1990:

When someone asks you why the stock market is at a record high right now even though economic growth is weak, there are a number of plausible answers, I think, including: corporate profit growth that has been strong even as the economy has been slowing, and stock market investors take their cues from corporate profits; a large number of investors are more backward-looking rather than forward-looking (and thus, in economic terms, "boundedly rational"); and the enticing and ever-likelier prospect that we will soon be entering an environment of falling interest rates, which make equities more attractive in general.

But if you don't like any of those explanations, or simply don't want to wade into them in depth, here's another way to answer that question: just shrug, and say wisely "it's happened before."

Friday, April 27, 2007

GDP Growth Update

This morning the BEA released its first ("advance") estimate of GDP figures for the January-March period of 2007.

First of all, let me give the appropriate qualifier: this is a very early estimate, and subject to substantial revision. For the fourth quarter of 2006 the advance estimate was 3.5% growth, the preliminary estimate was 2.2% growth, and the final number was 2.5%.

Now, on to today's data. From the BEA news release:
Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 1.3 percent in the first quarter of 2007, according to advance estimates released by the Bureau of Economic Analysis. In the fourth quarter, real GDP increased 2.5 percent.

...The deceleration in real GDP growth in the first quarter primarily reflected a downturn in exports, an upturn in imports, a deceleration in PCE for nondurable goods, and a downturn in federal government spending that were partly offset by a smaller decrease in private inventory investment, an upturn in equipment and software, a smaller decrease in residential fixed investment, and an acceleration in PCE for durable goods.
This is a yucky report. I do not like this report at all. The consensus forecast was for a number in the neighborhood of 1.8%-2.0%, so the overall number is clearly disappointing. But more than that, the details of this report paint a picture of a broadly slowing US economy, and that's what really makes me unhappy.

Breaking down GDP growth into its components makes it easier to see where the strengths and weaknesses in the US economy are right now. It's no surprise that residential investment is the biggest drag on the economy, now down about 17% from one year ago. But growth in other business spending is also slowing down worryingly - non-residential investment has only grown by about 3% over the past year, compared to 6-8% growth from 2004-2006. Even export growth has slowed. The only bright spot in the economy is the consumers keep steadily increasing their spending, by about 3.4% over the past year.

The thing that worries me the most is how personal consumption is now virtually the only thing keeping this economy going. But this may not be sustainable, given continued weak income growth and the end of the real-estate ATM that millions of individuals had used to bolster their consumption in recent years. If consumption growth starts to follow income growth, the US economy could be in for some serious trouble.

Thursday, April 26, 2007

The View from Europe

Things in Europe are looking pretty good these days. From this week's Economist:
Pleasant surprises continue to emanate from the euro area—notably from Germany, its biggest economy. This week Ifo, a Munich research institute, unveiled another strong reading for its monthly business-sentiment index. The country's five main economics institutes, including Ifo, have raised their forecast of GDP growth this year to 2.4%; last autumn they expected a percentage point less. French presidential candidates apart, the zone's politicians have been unusually accepting both of the currency's rise and of one of its causes: the European Central Bank's clear intention to raise interest rates further. The ECB is likely to take another step, from 3.75% to 4%, in June.

...The zone's fastest-growing markets are to the east. Julian Callow, of Barclays Capital, estimates that exports to the European Union's new and would-be members (including Turkey) and Russia went up at an annual rate of 20% in the second half of last year. They are now 19% of the total, up from 13% in 1999. Exports to Asia have also been growing fast.
The European and American economies have been a couple of years out of sync with each other for some time. That makes for good timing - it's nice to see growth in Europe getting stronger just as we're having doubts about the US economy. US exports, and the US current account balance, should benefit.

New Economist Blog

Dani Rodrik has a new blog. You know it's going to be a good one when there's an entire category for blogposts titled "Economists' blindspots"

Speaking of which, he has some interesting thoughts along those lines today:
The [previous] thought experiment clarifies, I think, why the archetypal man on the street reacts differently to trade-induced changes in distribution than to technology-induced changes (i.e., to technological progress). Both increase the size of the economic pie, while often causing large income transfers. But a redistribution that takes place because home firms are undercut by competitors who employ deplorable labor practices, use production methods that are harmful to the environment, or enjoy government support is procedurally different than one that takes place because an innovator has come up with a better product through hard work or ingenuity. Trade and technological progress can have very different implications for procedural fairness. This is a point that most people instinctively grasp, but economists often miss.
Thought-provoking stuff.

Upcoming AMT Reform?

Reported today:
The not-super rich may get AMT break

NEW YORK ( -- House Democrats on the tax writing committee may have come to a consensus on how to reform the Alternative Minimum Tax (AMT), according to a report Wednesday in Tax Notes, a trade publication published by Tax Analysts. The proposal would give the biggest tax break to middle- and upper-middle income households.

The AMT is often called the wealth tax because when it was created in 1969, it was intended to ensure the highest income filers paid some income tax. But the regular tax code and the AMT have changed greatly since then and not in tandem. Consequently, tens of millions of taxpayers are at risk of having to pay the AMT, which results in a higher tax bill.

A Democratic member of the House Ways and Means committee told Tax Analysts that the committee's tax writers gave the nod to a proposal from Rep. Richard E. Neal (D-Mass.), according to Tax Notes. Neal chairs the Subcommittee for Select Revenue Measures, and has told Tax Analysts that he hopes to have a bill on the House floor within two months.

Calls to Congressman Neal's office for confirmation were not immediately returned.

Neal's proposal, according to Tax Analysts, would do four things:
  • Exempt taxpayers from having to pay AMT if their incomes are below $250,000.
  • Increase the AMT liability of those earning more than $500,000.
  • Lower the AMT liability of those earning between $250,000 and $500,000.
  • Provide tax cuts targeting lower-income taxpayers not subject to AMT. Those cuts might include an expansion of the child tax credit.
In previous analyses of various AMT reform options, the Tax Policy Center estimated that excluding joint filers with incomes under $250,000 would mean a tax cut for 66 percent of taxpayers in the top 10 percent of the income distribution.

For this to work in a revenue-neutral way -- meaning there would be no loss to government coffers because of the change -- the Center also estimated that lawmakers would have to raise the AMT rate to 35 percent from the current 26 percent and 28 percent rates. That would result in an average tax increase of almost 8 percent - or $30,303 - for the top 1 percent of taxpayers.
This is not a bad idea... but I really do think that the time is ripe for a complete overhaul of the tax code. I'd love to see some of the presidential candidates talk about some ideas for fundamental tax reform.

Wednesday, April 25, 2007

Thoughts on Deficit Reduction

Mark Thoma gives some very thoughtful comments on deficit reduction today:
I can't argue that an increase in taxes will not have negative consequences for the economy... [but] it's what you do with the money that matters. What I can argue is that the benefits from using the tax dollars for things such as health care, infrastructure, or other important objectives provides benefits that exceed the costs from increasing taxes, including any reduction in output. Thus, when the economy is in a state where there are highly beneficial government projects waiting in the wings and taxes that can be increased without causing substantial costs, i.e. if the benefits exceed the costs, then deficits should not be an obstacle to putting those projects in place. Focusing solely on the cost side - whether the economy will slow at all as the result of the tax increase - without focusing on the benefits from what is done with the increased tax collections misses an important part of the equation.

That is why I would oppose deficit reduction for the sake of deficit reduction presently. What are the benefits from decreasing the deficit? There do not appear to be large gains from the usual channel, i.e. from lowered interest rates and less crowding out since interest rates have been insensitive to deficits recently, and there's no evidence that growth would be strongly affected... Thus, reducing the deficit brings no great benefit presently, has large potential costs, and for me is easy to oppose on that basis. And going in the other direction the costs and benefits are reversed. There are lots of beneficial things we could do with more revenue, and though increasing taxes would have costs, it's unlikely those costs would be large enough to offset the expected benefits if we are careful to limit the spending to projects that are expected to produce a high return.
Mark is right, of course, that really we need to make guesses about both the costs and the benefits when assessing any possible change to fiscal policy. I therefore completely agree that the deficit should not be an impediment to additional spending, when that additional spending is deemed to be of reasonably positive social value.

I'd like to think a little more about one of the points that Mark made, however: that there are very limited gains to deficit reduction right now because interest rates have been insensitive to the size of the deficit in recent years. He may be completely right about this... but I haven't seen enough evidence to convince me of that quite yet. Interest rates have indeed been surprisingly low in recent years, given the US's large budget deficits, but this doesn't mean that the deficit hasn't increased them above where they would otherwise have been. So call me agnostic on the issue.

But there's one other possible side-effect of deficit reduction that also makes me reluctant to dismiss the beneficial effects of deficit reduction so quickly. This is an admittedly fuzzy notion that I have, with little empirical evidence to support it, so please feel free to fire away at it... but I have the sense that deficits are one type of signal to businesses about the way government is being run, and thus an input into the formation of business confidence.

Large structural deficits (or at least large deficits that aren't falling) tell businesses that (a) the federal government is having a problem keeping its economic house in order, and (b) that future tax increases are likely. Both of these messages could tend to make businesses less confident about the future, and thus less inclined to undertake as much long-term investment spending.

Investment spending has been surprisingly low for several years now. What's the explanation? Certainly it's not overly high interest rates. I suspect that at least part of the explanation is that businesses have been less confident about the future than they were, say, a decade ago. Furthermore, I think it's possible that at least part of that loss in confidence has to do with the signal that large and uncontrolled structural deficits have sent about the nation's economic stewardship. Furthermore, it's very easy to guess that taxes are going to have to be raised sometime soon. The uncertainty about exactly which taxes will be raised, by how much, and when, adds another element of doubt and insecurity to long-term business planning.

Okay, maybe it's a crazy theory. But I'm not quite ready to dismiss the benefits of deficit reduction. We might not be very good at measuring them, but that doesn't mean that they're there.

Now, all that said, I still stand by my earlier statement that I don't think the deficit should be an impediment to sensible additional spending. But I do think that we need to consider the subtle impact that large structural deficits might have on the nation's economic performance.

Tilting the Playing Field with OSHA

Shocking. Just shocking. Who would have imagined that the Bush administration would be taking steps to tilt the playing field in favor of corporations at the expense of average workers? From the NY Times today:
OSHA Leaves Worker Safety in Hands of Industry

[T]he Bush administration... vowed to limit new rules and roll back what it considered cumbersome regulations that imposed unnecessary costs on businesses and consumers. Across Washington, political appointees — often former officials of the industries they now oversee — have eased regulations or weakened enforcement of rules on issues like driving hours for truckers, logging in forests and corporate mergers.

Since George W. Bush became president, OSHA has issued the fewest significant standards in its history, public health experts say. It has imposed only one major safety rule. The only significant health standard it issued was ordered by a federal court.
And here's the pretty picture that tells the story in a nutshell:

You have to acknowledge the incredible consistency of the Bush administration. On every aspect of the workings of the federal government there's one unifying guiding principle that directs all policy-making: always do whatever increases corporate profits, regardless of the moral, ideological, or human implications.

Increasingly, I'm becoming convinced that stories like this explain much of the rapid rise in income inequality in the US in recent years. It's a matter of consistency, and patience... like an inexorable geological process. Each individual regulatory or policy change has no measurable effect on income inequality, but the hundreds of individual decisions on taxes, the environment, the social safety net, energy policy, Medicare, international trade, and worker safety are like countless tiny accretions that collect over time to form a mass large enough to have perceptibly changed the landscape, and to have tilted the balance of power away from average Americans and toward corporate management and owners.

It seems quite plausible to me that this explains how the shares of income that corporations and their workers each receive have been altered as a direct result of policy decisions taken by the federal government. This is just one good example (of many) of that process.

UPDATE: edited for clarity.

Tuesday, April 24, 2007

A New Planet. An Interesting One.

News like this makes for an excellent way to exercise one's imagination:
WASHINGTON - For the first time astronomers have discovered a planet outside our solar system that is potentially habitable, with Earth-like temperatures, a find researchers described Tuesday as a big step in the search for "life in the universe."

The planet is just the right size, might have water in liquid form, and in galactic terms is relatively nearby at 120 trillion miles away. But the star it closely orbits, known as a "red dwarf," is much smaller, dimmer and cooler than our sun.

There's still a lot that is unknown about the new planet, which could be deemed inhospitable to life once more is known about it. And it's worth noting that scientists' requirements for habitability count Mars in that category: a size relatively similar to Earth's with temperatures that would permit liquid water. However, this is the first outside our solar system that meets those standards.
But the details about this planet - details conjured up through a mix of very smart deduction and guesswork, some more certain, and some less so - are, for my money, the best part:
The new planet is about five times heavier than Earth. Its discoverers aren't certain if it is rocky like Earth or if its a frozen ice ball with liquid water on the surface. If it is rocky like Earth, which is what the prevailing theory proposes, it has a diameter about 1 1/2 times bigger than our planet. If it is an iceball, as Mayor suggests, it would be even bigger.

Based on theory, 581 c should have an atmosphere, but what's in that atmosphere is still a mystery and if it's too thick that could make the planet's surface temperature too hot, Mayor said. However, the research team believes the average temperature to be somewhere between 32 and 104 degrees and that set off celebrations among astronomers.

...The new planet's star system is a mere 20.5 light years away, making Gliese 581 one of the 100 closest stars to Earth. It's so dim, you can't see it without a telescope, but it's somewhere in the constellation Libra, which is low in the southeastern sky during the midevening in the Northern Hemisphere.

Before you book your extrastellar flight to 581 c, a few caveats about how alien that world probably is: Anyone sitting on the planet would get heavier quickly, and birthdays would add up fast since it orbits its star every 13 days.

Gravity is 1.6 times as strong as Earth's so a 150-pound person would feel like 240 pounds.

But oh, the view. The planet is 14 times closer to the star it orbits. Udry figures the red dwarf star would hang in the sky at a size 20 times larger than our moon. And it's likely, but still not known, that the planet doesn't rotate, so one side would always be sunlit and the other dark.
So unlike all of the other extrasolar planets that have been discovered so far (which have generally been gas giants that make Jupiter look small), this one is actually interesting to think about, because one could imagine a human being actually setting foot on it. Fun stuff!

Is the US Auto Industry Sick?

Really, it was only a matter of time before we woke up to this story:
Toyota quarterly global sales surpass GM

For the first time ever, Toyota sold more vehicles globally in a quarter than General Motors, preliminary January-March figures show, the clearest sign yet that the Japanese company is on track to overtake its U.S. rival as the world's top automaker.

Toyota Motor Corp.'s success is fueled by robust demand for its reliable, fuel-efficient models, including the Camry, Corolla, Yaris and gas-electric hybrid Prius.

It also comes at a time when General Motors Corp., which lost US$2 billion last year, has been forced to scale back production and cut costs in a bid to revive its sliding fortunes, even as it leads in China's booming market.

...Analysts say Toyota is building on its lead by investing in ecological technology, opening plants around the world, developing new models and wooing drivers with solid marketing that drives home its brand power.

Those are precisely areas that GM has fallen behind Toyota, and will be hard pressed to play catch-up, making it more likely than not that Toyota will outstrip GM for the full year, they say.
GM hasn't been contracting as fast as The Incredible Shrinking Car Company, but the writing has been on the wall for some time that Toyota was inevitably going to sell more cars than GM. Toyota is already bigger in terms of market capitalization and profits, and has been growing steadily in sales and market share while GM has stagnated, so there's nothing remotely surprising about this... but it's a milestone nonetheless.

So does this mean that the US auto industry is sick? There's a good case to be made that GM's problems are not the US auto industry's problems. Toyota, which makes around 2 million cars per year in the US in several different assembly plants, is simply taking over and replacing GM's sales and production, bit by bit. Imports are not flooding the US market; in fact, net imports of motor vehicles by the US have hovered at about 20% of total motor vehicle sales in the US for nearly a decade, and have shown virtually no growth at all in real terms over the past seven years.

But on second thought, I'm less sanguine. Take a look at the following picture, which shows a few measures of the health of the US auto industry.

Sources: Production in millions of units from the Fed's Industrial Production index; other series from the NIPA.

Purchases of motor vehicles by consumers have been stagnant for about five years. In the final quarter of 2006, production in terms of the value of motor vehicles produced in the US was almost 10% below its peak two years ago. And in terms of the actual number of units produced, US production has trailed off sharply in recent months, and has now fallen all the way to levels last seen 14 years ago.

No, I don't mourn the passing of GM as the world's biggest car company; in general, Toyota makes better cars at better prices than GM. But this news has made me take a look at the aggregate data on the health of the US auto industry, and what I see worries me. Let's hope that it's not the canary in the coal mine.

Monday, April 23, 2007

Social Security and Medicare Outlook

Today the 2007 reports on the Social Security and Medicare programs were released. For a summary, see the Status of the Social Security and Medicare Programs.

One of the most interesting things about the report is the contrast between the status of the two programs. From the summary:
The financial condition of the Social Security and Medicare programs remains problematic; we believe their currently projected long run growth rates are not sustainable under current financing arrangements.

Social Security

Projected OASDI tax income will begin to fall short of outlays in 2017, and will be sufficient to finance only 75 percent of scheduled annual benefits in 2041, when the combined OASDI Trust Fund is projected to be exhausted. Social Security could be brought into actuarial balance over the next 75 years in various ways, including an immediate increase of 16 percent in payroll tax revenues or an immediate reduction in benefits of 13 percent or some combination of the two.


As we reported last year, Medicare's financial difficulties come sooner-and are much more severe-than those confronting Social Security. While both programs face demographic challenges, the impact is greater for Medicare because health care costs increase at older ages.

...The projected 75-year actuarial deficit in the Hospital Insurance (HI) Trust Fund is now 3.55 percent of taxable payroll, up slightly from 3.51 percent in last year's report... The projected date of HI Trust Fund exhaustion is 2019, one year later than in last year's report, when tax income will be sufficient to pay only 79 percent of HI costs. HI tax income falls short of outlays in this and all future years. The program could be brought into actuarial balance over the next 75 years by an immediate 122 percent increase in the payroll tax, or an immediate 51 percent reduction in program outlays or some combination of the two.
Yes, you read that correctly. The SS program will only be able to cover about three-fourths of its expenses by the year 2041; the Medicare program will reach almost the same point in 2019. Fixing the SS shortfall would require a 16 percent increase in payroll taxes; fixing the Medicare shortfall would require a 122 percent increase in payroll taxes.

My favorite picture (little changed from last year's picture) from the report tells the same story graphically. The light blue bits are the SS shortfall. The other two colors represent the Medicare shortfall (broken down into the prescription drug benefit and the rest of Medicare).

It's getting to the point where the two problems are not even of the same order of magnitude. (Not literally, but you get my meaning.)

There's one other picture that I find illuminating from the SS report. It's the one that shows the SS trust fund balances under different assumptions: "high cost" (III), "intermediate" (II) and "low cost" (I) scenarios.

According to the "low cost" scenario, there's no SS problem, and even something between scenarios I and II could well result in the SS problem being a rather minor issue.

In case you're curious to know what separates these three scenarios, I've put together a table showing the specific assumptions underlying each scenario, compared with historical experience for each variable.

Based on historical experience, it seems reasonably safe to me to suppose that the "high cost" scenario is not very likely. (Yes, it's possible, but not likely.) It also seems to me that the "intermediate" scenario is probably a bit on the conservative side - by which I mean that it is slightly more pessimistic than one might expect - which may well be appropriate in this case.

But given the enormous variation in the outcomes one gets depending on the assumptions one makes, the main point I take from this is not to get too worked up about these long run projections - there's a good chance that they could be substantially wrong, and the problem really could just go away on its own.

The Social Security problem, that is. With Medicare, there are virtually no reasonable assumptions that one can make that make the problem go away.

Finally, it's worth noting one last interesting detail. From the summary:
The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 requires that the Medicare Report include a determination of whether the difference between total Medicare outlays and dedicated financing (such as premiums and payroll taxes) exceeds 45 percent of total outlays within the first 7 years of the projection period (2007-2013 for the 2007 Report). The Act requires that an affirmative determination in two consecutive reports be treated as a "funding warning" for Medicare that would, in turn, require a Presidential proposal to respond to the warning and expedited Congressional consideration of such proposal. The 2007 Report projects that the difference will surpass 45 percent in 2013 and therefore makes a determination of excess general revenue funding. Because the 2006 report also made such a determination, a "Medicare funding warning" is hereby triggered that requires the President to propose legislation that responds to this warning within 15 days of the submission of the Fiscal Year 2009 budget and for Congress to consider the proposal on an expedited basis. This requirement will help call additional attention to Medicare's impact on the Federal budget.
President Bush must, by law, propose legislation that at least attempts to address the Medicare problem with his next budget, next January. So after six years of ignoring the problem (and in fact making it far worse, thanks to the prescription drug benefit he championed without thinking about how to pay for it), Bush must finally go on record with how he thinks the problem should be solved.

The Last Chapter of the Familiar China Story?

This piece by Bloomberg today could really have been written any time in the past five years. But I'm starting to wonder if China's economic growth is not reaching the point where China's monetary policy is going to have to adjust considerably. If China's central bank does indeed take significant steps to cool the economy, then it may be the case that we're soon going to stop reading stories like this one.
Paulson May Be Unable to Get China, U.S. Off Collision Course

April 23 (Bloomberg) -- When China allowed a small rise in the value of its currency in 2005, Hangzhou food-company executive Wang Yuzhou saw his profits squeezed. Any further move threatens the livelihoods of his 1,000 workers and the 5,000 rural households that supply his plants, he says.

John Walker says China's currency policies have already cost 100 jobs at his Lewisburg, Tennessee, die-casting company. He wants the U.S. Congress to do ``whatever it takes'' to force an increase in an undervalued yuan that he contends gives an unfair advantage to Chinese competitors.

Wang's and Walker's interests collide next month when U.S. Treasury Secretary Henry Paulson and Vice Premier Wu Yi hold their next set of talks under a semiannual schedule set up last year. Without steps to allow a significant increase in the yuan, which most economists consider unlikely, Paulson may not be able to continue holding off moves in Congress to punish China.

"After years of talk and bluster, protectionism no longer seems like an empty threat," says Stephen Roach, chief global economist at Morgan Stanley in New York. "Trade sanctions against China are now all but inevitable."

Exports, which accounted for about 40 percent of China's economy last year, bring growth, jobs and stability that compel the nation's leaders to avoid any dramatic rise in the yuan, says Don Straszheim, vice chairman of Newport Beach, California- based Roth Capital Partners.

"The weak currency is central to China's whole growth strategy," says Straszheim, who specializes in China's economy. "They are going to take their chances and move as slowly as they possibly can." China's textile industry says it loses 8.2 billion yuan ($1.1 billion) of annual profit for each percentage point rise in the currency.

..."Margins tend to be very slim in China," says Christopher McNally, a China specialist at the East-West Center in Honolulu. "A revaluation of 20 to 30 percent would be devastating for a lot of export manufacturers."

Chinese officials say they are eager to rein in their trade surplus, but not at the cost of jobs or social harmony. Hu Xiaolian, vice governor of China's central bank, told a meeting of the International Monetary Fund in Washington April 14 that "external stability can only contribute to overall sustained stability when anchored by domestic stability."
I've long thought that China's exchange rate will only be changed significantly when it is in China's interests to do so. The easiest way to imagine a yuan appreciation being in China's interests is a) if it would help cool down an overly-hot economy, and b) if the domestic economy (or perhaps better put, its social structure) is strong enough to handle the inevitable income and job losses that will follow in some of China's export industries. Condition (a) is clearly met at this point, I think. What we need now is some confidence that condition (b) is not out of reach, either.

Saturday, April 21, 2007

Questions Economists Ask Every Day

I was amused and entertained by this article about economists by Laura Blumenfeld in the Washington Post today. I take it as only a semi-serious look at an admitedly odd profession, and I think it would be a stretch to think that most economists are constantly going through life this way... but I must confess that I do sometimes find the same types of observations and questions popping in to my head at the most everyday occurrences.
PROVIDENCIALES, Turks and Caicos -- The plane came from the north and landed near warm sand. Rachel Friedberg, a Brown University economist, stepped out, holding her black wool pea coat, squinting.

"Skin cancer. Dehydration. Sunstroke," she muttered. "Sand sticking to your body." The New England professor had arrived for vacation in Turks and Caicos, one of the Caribbean's fastest-growing economies. "Why would people on purpose, on purpose, go where the land ends, and stare at undifferentiated nothingness? Think of the opportunity cost of that time."

Lucid blue water makes most travelers forget about work. But for Friedberg, economics infuses everything: the equilibrium price of conch shells; the asset-value implications of Bruce Willis's beach compound; the labor market impact of a Filipino, rather than a Bahamian, massage therapist digging her oiled thumbs into Friedberg's sacrum.
Mostly, though, the piece made me wish that I could think of a way to get my own research to take me to the Turks & Caicos...

Friday, April 20, 2007

The Friday Archives

Since China was in the news this week, I thought it might be fun to take a look back at what people were writing about China many years ago. Clearly a lot has changed over the past fifteen years... but much remains the same.

Here's a nice little piece from The Economist, dated July 4, 1992, that sounds at the same time a bit strange and rather familiar:
China: Return to go

THESE are heady days for China's economy: reformers are winning, business is booming and foreigners are scrambling to invest. The cautious, however, will recall that when China was last like this, only four years ago, the economy went out of control and inflation reached an annualised rate of 80%. The government responded with a tight squeeze on credit and imports. Economic growth fell from 11.5% in 1988 to 4% in 1989 (a decline sharpened by Western sanctions after the Tiananmen Square killings). Will it happen again?

Most people are to thrilled with recent events to waste time on such morbid speculation. In the first five months of 1992, China's real GDP was 11% bigger than in the same period last year; industrial output was 18% higher; real income per person in the cities 16% higher. In the southern Guangdong province industrial output was up by 26% and exports by 32%.

Meanwhile, the reformist directives multiply at bewildering speed. In mid-June it was suggested that five cities along the Yangzi river would be given the latitude to attract foreign investment; this week the government announced that the Yangzi's open cities would actually number 28.

Still more significant was the formal announcement on June 25th that service businesses such as retailing, transport and banking will be opened to foreign investors. This part of China's economy offers wider scope than any other for improved efficiency, growth and profits -- and the government seems unperturbed by the social implications of allowing foreigners to shape a consumer culture in China.

The foreigners are eager to begin. In the first five months of 1992 the government approved 8,900 foreign-investment projects, with a value of $ 10.5 billion, around three times the comparable figures last year. Overseas Chinese from Hong Kong, Taiwan and South-East Asia are showing especially keen interest. They know China better than other foreigners, and as they get involved will have a farther-reaching influence.

Li Ka-shing, Hong Kong's biggest businessman, has for the first time taken a share of big property deals in northern China (in Shanghai and Beijing). He is also committed to taking stakes in bridge and highway projects in Guangdong. Robert Kuok, a Malaysian tycoon who is a partner of Mr Li's in the Beijing and Shanghai projects, recently made three Chinese Property deals in four days. Over the weekend of June 27th-28th, Shanghai signed a total of 20 property-developmen agreements with foreigners.

The worry, however, is that such developments will help the economy overheat -- as it did in 1980, 1985 and 1988 -- and the government will then cool it by the same painful methods as before.

Danger signs are already plentiful. Consumer prices in the first five months of 1992 were 11% higher in the cities than in the same period last year. The government's budget deficit last year, by IMF rather than Chinese arithmetic (which includes foreign loans as revenue), was 78 billion yuan ($ 14.6 billion) -- around 20% of government spending and 3% of GNP. This year spending continues to grow faster than revenue.

The culprits, as usual, are the loss-making state enterprises. Despite government exhortations to improve their performance, the biggest state companies lost 8.2 billion yuan in the fist five months of the year, 20% more than in the same period last year. Although the central bank has increased banks' reserve requirements, rumour -- supported by a weakening of the yuan on the free market -- has it that money supply grew at its fastest-ever rate during the first five months of this year.

Optimists are undismayed. They say things have changed since 1988: more of the economy is in private hands and there are fewer of the rigidities that stopped supply from responding to price movements in 1988. True enough. But even if an economy is efficient, which China's is not, it will inflate predictably in response to the kind of pressure China is under. Go-go could all too easily become stop-go.

Shareholder Say in Executive Compensation

In the news today:
Shareholder bill targets executive pay

WASHINGTON - The House voted Friday to give shareholders at public corporations a voice in executive pay packages that typically equal 500 times the salaries of workers at those companies.

The shareholder vote under the bill would be advisory only. But Democratic backers of this provision said that investors need a say when companies losing money or laying off workers are paying executives eight- and nine-figure salaries and retirement packages. "This is not an aberration, and there is a hue and a cry from the American people across the American landscape that is saying something must be done," said Rep. David Scott (news, bio, voting record), D-Ga.

The bill, which passed 269-134 and now goes to the Senate, was opposed by the White House and most Republicans. They argued that the
Securities and Exchange Commission has recently taken steps to make corporate pay packages more transparent and that Congress should stay out of corporate affairs.
But the following quote strikes me as one of the most interesting bits of the story:
Investor advocates, union pension funds and shareholder groups have supported the legislation, but GOP opponents expressed concerns it would give such groups an inroad to change a company's policies.

"It greatly worries me that this bill could set a precedent of giving activist institutional investors, who may have their own political and social agendas unrelated to the financial wealth of the companies, more influence," said Rep. Mike Castle, R-Del.
Exactly what "agendas unrelated to the financial wealth of the companies" do Republicans think that the owners (i.e. shareholders) of those companies have? I'm curious to know. Do we really think many shareholders buy ownership stakes in a company for reasons other than to increase their wealth?

And even if they do, then I'm curious to know what's wrong with the owner of a company having his or her own preferences regarding profits compared to other goals. Who pays the price if the owner of a company makes a decision that results in lower profits, after all? Isn't it the owner? What's the problem with that?

One last bit of related trivia: it turns out that the U.K. has had a similar law on the books since 2003. I'd be curious to see any evidence that it has had any significant impact there, either positive or negative.

Thursday, April 19, 2007

Ezra on Samuelson

Ezra Klein has the perfect response to Samuelson's latest:
Watching Robert Samuelson contort himself over economic inequality is actually sort of fun*. In a column that accurately diagnoses the problem, it's remarkable how studiously he dodges identifying any causal mechanisms that could suggest the economy is in any way unfair, or tilted against workers... [S]ays Samuelson, "as for what's caused greater inequality, we're also in the dark." Particularly when you refuse to turn on the lights in the rooms you don't want to look.

But even if Samuelson's diagnosis is riddled with omissions, his prescriptive paragraph is both brave and trenchant. "It would be healthier if the trend toward greater economic inequality reversed itself spontaneously."

Yes Robert. Yes it would.

*Fun may be the wrong word here.
The lesson: read Ezra more.

Forecasting the Forecast

Who will forecast the forecasters? Now we know, at least when it comes to the weather. From this week's Economist:
How to forecast the forecasters

IF YOU think the weather is unpredictable, consider the weathermen. They are constantly revising their forecasts, causing inconvenience not only to those pondering whether or not to take an umbrella, but also to commodity traders placing bets on how much gas and electricity will be needed for heating. When their predictions turn from cold snap to heat wave, say, it can play havoc with the forward price of gas.

WSI, a firm that owns the Weather Channel and sells forecasts of its own to airlines and other weather-dependent companies, has been grappling with this problem. Its solution is a new product called MarketFirst, a sort of forecast of the forecast. Every day, an hour before America's National Oceanic and Atmospheric Administration releases its updated forecast for the world's weather, WSI issues its own prediction of how the new bulletin will differ from the previous one. It does the same for the EU's official forecast. A year's subscription to MarketFirst, launched last November, costs $90,000, and WSI says it has already signed up a dozen customers.

...The more widespread MarketFirst becomes, the less useful it will be to its subscribers, Mr Scharf concedes, since markets would begin to move in response to its release, rather than to the forecasts it anticipates. So WSI considered various methods of selling it, including releasing it earlier to certain customers for a higher fee... [or selling] a forecast of the forecast of the forecast.
The same principle could apply to economic forecasts, of course, and that is essentially the service that good investment analysts and advisers provide to their clients. But whereas WSI boasts a 70% success rate in forecasting changes to weather forecasts, I think that most financial forecasters would be pretty happy with a success rate considerably below that.

China's GDP Growth

Turns out that the astonishing estimates I showed you the other day of China's economic growth were... well, not astonishing enough.
China's Economy Surges at Faster-Than-Forecast 11.1%

April 19 (Bloomberg) -- China's economy grew at a faster- than-forecast 11.1 percent pace in the first quarter from a year earlier, raising the likelihood the government will increase interest rates to curb the risk of overheating.

Growth accelerated from 10.4 percent in the previous quarter, the statistics bureau said in Beijing today. China's benchmark stock index fell 4.7 percent before the release, triggering declines in Asian and European shares, on speculation borrowing costs will rise.

Premier Wen Jiabao said the government will take steps to curb lending and investment in factories and property and rein in the record trade surplus. Inflation accelerated to 3.3 percent, the fastest pace in more than two years, and breached the central bank's 3 percent target for the year.

"Growth has been driven by continuing strength in investment and continuing strength in politically sensitive exports," said Glenn Maguire, chief Asia economist at Societe Generale in Hong Kong. "China needs to cool profits and the easiest way to do that would be to allow the yuan to appreciate at a faster rate."
Red hot? Yellow hot? White hot? I'm not sure exactly what the appropriate temperature description for China's economy is, but it's clear that it is growing really, really fast, even for China. The potential implications for China's monetary policy are clear. And the fear that China's central bank might have to take steps to cool down the economy provoked a continent-wide selloff in stocks today, as Reuters reports:
SINGAPORE (Reuters) -- Asian shares fell sharply on Thursday as investors worried that Chinese economic data could show an overheating economy and prompt Beijing to announce more interest-rate hikes or other growth-cooling measures.

...China stocks fell 3.3 percent in Shanghai as investors worried that strong data could lead to more government measures to reign in the booming economy.
Yes, there can be too much of a good thing...

Wednesday, April 18, 2007

Medicare Drug Purchases

I have a difficult time understanding how the Democrats could have failed to take better charge of the debate over the issue of whether or not the US government should be allowed to negotiate for bulk discounts when buying pharmaceuticals for the Medicare program. It's so easy to make the Democratic proposal sound sensible, and to make the Republican position sound ridiculous... yet Democrats were apparently unable to convince five more Republican senators of that.
WASHINGTON, April 18 — A pillar of the Democratic political program tumbled today when Republicans in the Senate blocked a proposal to allow Medicare to negotiate lower drug prices for millions of older Americans, a practice now forbidden by law.

Democrats could not muster the 60 votes needed to take up the legislation in the face of staunch opposition from Republicans, who said that private insurers and their agents, known as pharmacy benefit managers, were already negotiating large discounts for Medicare beneficiaries.

Fifty-five senators, including 6 Republicans, supported a Democratic motion to limit debate and proceed to consideration of the bill, while 42 senators voted against it.

...Republicans framed the issue as a choice between government-run health care and a benefit managed by the private sector. The drug benefit is delivered and administered by private insurers, under contract to Medicare.

Senator John Cornyn, Republican of Texas, denounced the bill as “a step down the road to a single-payer, government-run health care system.”

Democrats said they were merely trying to untie the hands of the secretary of health and human services, so he could negotiate on behalf of 43 million Medicare beneficiaries. “The Department of Veterans Affairs is able to negotiate for lower-priced drugs,” said the Senate majority leader, Harry Reid, Democrat of Nevada. “H.M.O.’s can negotiate. Wal-Mart can negotiate. Why in the world shouldn’t Medicare be able to do that?”

...Mr. Reid said the Democrats fell short today because of “the power of the insurance industry and the pharmaceutical industry” and their close ties to Republicans in Congress.

But the vote also reflected ineffectual advocacy by Democrats, who were slow in responding to criticism from knowledgeable, well-prepared Republican senators like Charles E. Grassley of Iowa.

“Private competition works,” said Mr. Grassley, a principal author of the 2003 Medicare law. “The government has very little experience and a dismal track record figuring out what to pay for drugs.”
I really can think of no general economic benefit of the current rules, which create a fairly straightforward transfer of money from US taxpayers to pharmaceutical companies. It seems to me very similar to an industry subsidy, though a hidden one that is not explicitly on the government's books. Why the pharmaceutical industry needs a government subsidy is unclear to me.

But of course, I suppose that such reasoning does mean that there is substantial economic rationale for the status quo if you're a pharmaceutical company...

Industrial Production

It's a day late, but here's the newest data on the amount produced by US industry, as reported by CNN/Money:
WASHINGTON (Reuters) -- U.S. industrial production unexpectedly fell 0.2 percent in March as utility output retreated sharply from robust February gains fueled by cold weather, a Federal Reserve report showed Tuesday.

The Federal Reserve said utility output fell 7 percent in March after a 7.6 percent gain in February, more than offsetting a strong 0.7 percent March gain in manufacturing output. Analysts had expected a modest industrial production gain of 0.1 percent after February output expanded a downwardly adjusted 0.8 percent.

The capacity use rate of factories, mines and utilities eased to 81.4 percent, from a downwardly revised 81.6 percent in February, a figure previously estimated at 82 percent. Analysts polled by Reuters had predicted the overall capacity use rate would edge lower to 81.9 percent in March.
This was a mixed report, with some good news and some not-so-good news. Unfortunately, it does nothing to soothe my worries about the warning signs that these measures of economic activity have generally been flashing over the past six months or so. The following picture shows recent trends in overall industrial production, and in capacity utilization in manufacturing.

After a short-lived burst of production during the second half of 2006, industrial activity in the US has become quite sluggish. It's worth noting that even when industrial activity has done well in recent years (generally growing at a 3-4% per year), it has paled in comparison to what we had grown accustomed to during the 1990s, when growth rates of production were generally in the range of 4%-8% per year.

Here's to hoping for a summer upturn in these indexes...

Subprime Buyer of Last Resort?

This is interesting. From Bloomberg:
April 18 (Bloomberg) -- Freddie Mac, the second-largest source of money for U.S. home loans, is offering to buy as much as $20 billion of mortgages in an effort to maintain the financing available for subprime borrowers, Chief Executive Officer Richard Syron said today.

"To the maximum extent possible we want to approach this from a market driven kind of approach," Syron told reporters in Washington during a housing market summit in Washington led by Senate Banking Committee Chairman Christopher Dodd.

Subprime mortgage bond sales have slowed this year after late payments on the underlying loans reached a four-year high of 13.3 percent in the fourth quarter, according to the Mortgage Bankers Association. The sale of subprime mortgage bonds had grown to $450 billion last year from $95 billion in 2001, the Securities Industry Financial Markets Association says.

Syron's offer would effectively guarantee that there is demand from Freddie Mac for as much as $20 billion in new mortgage bonds so long as lenders refinance some of the loans outstanding into more favorable terms for subprime borrowers.
This seems a little bit like Freddie Mac wants to ensure a price floor for subprime mortgage bonds, which would be an interesting development.

Important questions remain, though. Will $20 billion in purchases be enough to prevent the prices of those bonds from falling significantly? What is Freddie's motivation for this offer? Are they hoping to stem greater losses in the subprime market by effectively doubling-up on their existing subprime bets? How heavily can they engage in such price-supporting actions, if $20bn turns out not to be enough?

I'm curious to learn more about this...

Tuesday, April 17, 2007

Inflation Update

Some new data on inflation has been released by the government over the past week, including new data on the PPI and the CPI. This gives us a good chance to update our inflation picture.

The chart below shows inflation as measured by the CPI and PPI, including both the measures that capture all goods and services in each category as well as those measures that exclude food and energy prices (the "core" rate).

The rise in energy prices over the past couple of months shows up in the upward movement in the overall price indexes for consumers and businesses. But, unlike some, I am not worried about which way inflation is headed. After a bit of a surge in non-energy inflation during the second half of 2006, those inflation measures have moderated and remain comfortably in the neighborhood of 2%.

While the rate of core inflation doesn't give us a complete picture about how the purchasing power of the dollar is changing, it does tell us a lot about how strong inflation pressures are throughout the non-energy economy. The verdict seems to be that they remain quite moderate.

Monday, April 16, 2007

Some Astonishing Numbers

Bloomberg gives us some astonishing numbers on China's economy today:
China's Economy Probably Grew 10.4 Percent as Exports Boomed

April 17 (Bloomberg) -- China's economy, the world's fourth largest, probably grew more than 10 percent for the fifth straight quarter on booming exports and an investment rebound.

Gross domestic product expanded 10.4 percent from a year earlier, according to the median estimate of 24 economists surveyed by Bloomberg News, the same pace as in the fourth quarter. The statistics bureau will release first-quarter figures in Beijing on April 19.

China's foreign-exchange reserves grow by $1 million a minute, flooding the economy with cash and fueling investment and inflation.

...China's economy has more than doubled in size since the end of 2000 and last year's 10.7 percent expansion was the biggest since 1995. Growth for each of the past four years was at least 10 percent.

...Urban investment in factories and real estate probably climbed 23 percent in the first three months from a year earlier, the survey showed. That compares with 13.8 percent in December and 24.5 percent for all of last year.

I'll leave it at that.

On the Macroeconomic Effects of Tax Changes

Jim Hamilton points us to a new paper by Christine and David Romer called "The Macroeconomic Effects of Tax Changes". See Jim's post for an excellent discussion of the paper's methodology and principal conclusions.

As much as I admire the Romers' earlier work, I have to say that I am rather skeptical of their methodology in this case. They attempt to distinguish tax cuts and tax increases that are "exogenous" - which basically boils down to those motivated by philosophical reasons - from those tax changes that were simply the result of the business cycle or concerns about the deficit. They then find that "exogenous" tax increases tend to slow down the economy. By a lot.

By an implausibly huge amount, in fact. According to their estimate, the 2001 tax cut boosted GDP growth over the subsequent 2 years by about 3%. Actual GDP growth between 2001:Q2 and 2003:Q2 was about 3%, so their conclusions suggest that without the 2001 tax cut, there would have been zero GDP growth for the entire two-year period of 2001-2003.

That would have made the 2001 recession - despite an incredibly expansionary monetary policy - as severe as the 1981-82 recession, which itself was the most severe economic contraction in the US since the Great Depression. Do we really think that the 2001 recession was going to be of that historical magnitude if it hadn't been for the 2001 tax cut?

I think the reason for this highly improbable result is that Romer & Romer use a very arguable classification system for their analysis of tax changes - one that seems to have some flaws in it. For example, they classify most of the 2001 tax cut and all of the 2003 tax cut as being done for "exogenous" (i.e. "philosophical") reasons, rather than for counter-cyclical reasons. Yet in both cases, despite the fact that I'm sure those tax cuts were not originally conceived in order to jumpstart the US economy, that is how they were sold. There would have been little chance for tax cuts the magnitude of the 2001 and 2003 tax cuts passing Congress if they had not been portrayed as medicine for the sluggish economy.

Let me be more specific. According to Romer & Romer, the 2003 tax cuts had no counter-cyclical component to them. Yet the 2003 ERP (caution: large pdf file) reads as follows, on pages 54-55:
[T]he recovery in investment could be delayed by weaker-than-expected profit growth, higher required rates of return arising from geopolitical and other risks, or a prolonged period during which companies focus on repairing their balance sheets. More general risks to recovery in 2003 include an increased sense of caution, which could lead households to pull back on their spending plans, and the potential for further terrorist attacks. To insure against these near-term risks while boosting long-term growth, the President has proposed a focused set of initiatives. Specifically, the President’s plan would [cut taxes in various ways.]

...Accelerating the marginal tax rate reductions would insure against a softening of consumption by putting more money in consumers’ pockets through long-term tax cuts, which have been shown to be more effective than temporary cuts in boosting near-term spending.
That sure sounds like selling the tax cut as a fiscal stimulus to me. This is just one example of the problems that I have with the Romers' classification scheme, and one of the reasons why I am skeptical of their conclusions. (See Jim Hamilton's post for more notes of caution about their results.)

Estimating the effect of changes in tax laws on economic growth is a hugely important topic, but I don't think that this is the way to go about doing it. The Romers had great success identifying and classifying changes in monetary policy by looking at the minutes of the FOMC, but the primary conclusion I take from this paper is that the same technique has major flaws when applied to fiscal policy.

Monetary policy is determined by one group of about a dozen people, with two policy objectives - inflation and economic growth - and one policy variable - interest rates. Fiscal policy, on the other hand, is determined by a complex interplay between executive and legislative branches, involves changes to hundreds of spending and tax provisions, and is the result of hundreds of individuals pursuing scores of very different policy objectives, from macroeconomic performance to deficit management to philosophy to satisfying lobbying pressure to pure self-interest. So it is not surprising to me that something that works to analyze monetary policy does not work to analyze fiscal policy.

So as interesting as I found this paper, I didn't find it at all convincing. This is simply not a good way to get at the question of how tax policy changes impact the economy, I fear.

UPDATE: I did a bit of editing to the text for clarity.

Friday, April 13, 2007

The Friday Stroll Through the Archives

This week for our look back at recent economic history I thought I'd share a simple little piece from the news wires in 1990. It's nothing more than a typical report about the previous day's stock market activity, actually. But it makes a nice point.

This version of the story is from the St. Petersburg Times (because I like the headline they chose), May 12, 1990:
Economy brings out the bulls

The stock market rose sharply to near-record heights Friday in an exuberant reaction to favorable inflation news and falling interest rates. Trading volume picked up to its heaviest pace of the year as the market extended a two-week rally.

The Dow Jones average of 30 industrials climbed 63.07 points to 2,801.58, its highest close since it hit 2,809.73 on Jan. 3. Over the past 10 sessions the average has risen 156.53 points, or 5.9 percent.

Advancing issues outnumbered declines by more than 7 to 2 in nationwide trading of New York Stock Exchange-listed stocks, while volume hit 234.04-million shares the largest total since a 240.39-million-share day Dec. 15.

"Money's coming into the market," said Peter G. Grennan, senior vice president of Shearson Lehman Hutton. "You don't want to be left on the sidelines on this one."

The surge followed a series of reports pointing to stable interest rates and inflation.

Friday morning, the government reported that the producer price index of finished goods dropped 0.3 percent in April, in contrast to Wall Street's expectations of a 0.1 percent to 0.3 percent increase. Separately, the Commerce Department said retail sales fell 0.6 percent last month.

Analysts said the figures provided the markets with a double dose of evidence that economic growth remains slow enough to subdue inflation. That served to allay whatever fears persisted on Wall Street that the Federal Reserve might move soon to tighten credit.

Maury Harris, chief economist at Paine Webber, said stock prices were strong "because interest rates are down, commodity prices are down, producer prices are down and so are retail sales. So stock and bond prices went up because investors are less worried about inflation."
For context, here's a picture showing how the economy did in the months after May 1990.

The thing that I like about this story is the reminder not to rely overly much on the stock market for cues about which way the economy is headed. The statement "the stock market is near record highs" is no evidence that the economy is headed in the right direction.

Incidentally, it also reminds us not to be surprised if we see a bit of a (temporary) stock market rally this year as evidence comes in that inflation is slowing and the prospects for an interest-rate cut grow. In fact, I'd suggest that such a rally is quite likely (and perhaps we're in the midst of it right now). But as a corollary, it's worth keeping in mind that such a rally is not necessarily evidence that there's no reason to worry about the economy.

Doha Wheezes On

The Economist reports on the negotiations that are ongoing for the chronically ill Doha Round of trade talks, with Doha insisting "I'm not dead yet":
The Doha round looks for salvation in Delhi

America's trade negotiators arrived in Delhi arguing that they cannot ask their farmers to accept bigger cuts in state handouts unless they can also offer them better opportunities to sell their crops overseas. But the World Trade Organisation's poorer members, led by India, are reluctant to cut tariffs much on a category of “special products”. This is supposed to be limited to staple goods—such as rice, wheat, onions and poultry—on which the poor depend for their nourishment and vulnerable farmers depend for their livelihood. Countries like Indonesia and the Philippines would probably settle for shielding a handful of such products from the full force of a tariff cut. India, on the other hand, has a wish list of about 80, which reportedly includes even whiskey, a staple form of nourishment for India's urban elite.

It appears to be this deadlock, more than any other, that prompted Susan Schwab, America's trade representative, to lower expectations for the Delhi talks, describing them merely as a stocktaking exercise, before she returned to the original purpose of her trip, a long-scheduled meeting of America and India's bilateral Trade Policy Forum. Her EU counterpart, Peter Mandelson, on the other hand, has described the talks as “timely and important”. As The Economist went to press it was still too soon to say which description was more apt. But unless the four parties, which have been privately talking to one another since January, cook up a compromise in Delhi or soon after, the rest of the WTO's 150-strong membership will lose patience with them.
Unlike bilateral free-trade agreements like CAFTA or the US-Korea FTA, which I think do little to help anyone other than a few specific industries or companies, the Doha Round would have changed WTO rules in important ways that would have actually improved the lives of tens of millions of average people, both in the US and (especially) in the developing world. There are lots of good reasons to support Doha.

As this story illustrates, the negotiations continue to register some sort of vital signs, so yes, Doha is not technically dead yet. But without serious political will from the Bush administration there is no prospect of a recovery. And the Bush administration has had years to demonstrate that they don't really care much about whether Doha lives or dies, and are not willing to put any serious energy into it. That's why I've often thought that it may just be kinder to put Doha out of its misery, declare it a failure, and try again with a new round of negotiations once there is a new and committed president in office.

But that hasn't happened yet. Instead, they insist on keeping Doha on life-support... for what reason, I'm not entirely sure.

Thursday, April 12, 2007

China's Reserves

China accumulated more that $300 billion in additional foreign reserves last year:
BEIJING - China's foreign reserves, already the world's largest, have risen past $1.2 trillion, a state news agency said Thursday, amid surging trade and plans to create a multibillion-dollar company to invest some of the stockpile.

The figure, as of the end of March, represented a 37.4 percent rise over the same period last year, the Xinhua News Agency said, citing the central bank.

China's reserves have risen rapidly as huge trade surpluses and foreign investment force Beijing to drain billions of dollars from the economy every month through bond sales to hold down pressure for prices to rise. The money is stockpiled in U.S. Treasury bonds and other foreign assets.

The government announced last month it will create a multibillion-dollar company to invest a portion of the reserves in hopes of making more profitable use of the money.
That's an additional $300 billion in one year. Needless to say, that's a lot of money. It will be interesting to see what China comes up with as a "more profitable" way to invest those spare dollars. And it will be interesting to see if that means that China will demand fewer US government and agency bonds.

Note as well that even if most of that money went into buying US dollar assets (some small portion probably went toward buying European, Japanese, and other currencies), today's figures from China still only represent a relatively small portion of the US's international borrowing needs. Other countries around the world must have lent an additional $600 billion to the US last year.

It's a good reminder that the world's international financial imbalances are a US-China problem... but are not only a US-China problem.

Wednesday, April 11, 2007

Ritholtz v. Luskin, Round 3

This week Barry Ritholtz is engaging in a debate with Donald Luskin over at Capital Commerce, the economics blog for US News and World Report. The central theme of the debate is Luskin's relative bullishness versus Barry's relative bearishness about the short and medium-term prospects for the US economy.

Needless to say, Barry has the debate well in hand. But after reading Luskin's entry today, I couldn't help but take a few minutes to address one of Luskin's central assertions so far: that the US economy, other than the housing sector, is actually doing well, and even improving.

The evidence that Luskin cites when he makes that assertion comes from last quarter's GDP numbers. They show that the fall in residential investment (i.e. new house construction) subtracted 1.2% from the nation's overall real GDP growth.

But one could just as easily exclude any other disliked portion of GDP, and come up with the opposite conclusion. How about "real GDP actually grew by 2.5%, but was propped up by the large rise in government spending, without which economic growth would have only been an anemic 1.9%," or "falling imports (which may well signal falling consumer demand) artificially boosted GDP growth, which would otherwise have been only 2.0%."

The point is a simple one: it makes no sense to exclude portions of the economy when trying to discern its direction, since all sectors of the economy contribute to its overall performance.

Barry does a good job trying to explain why many observers are worried about the recent slackening of broadly-measured economic growth, citing a number of important measures of economic growth that are flashing warning signs. I'd like to add just a couple more. The two primary components of private-sector economic growth - consumption by individuals and investment by businesses - have both slowed noticeably over the past year, as the following chart shows.

Production by US industry has also stalled. The growth of ndustrial production has slowed sharply over the past six months, and excess productive capacity in the US has risen.

One last point. In his post, Luskin questioned the importance of mortgage equity withdrawals (MEW) in sustaining consumption spending in the US in recent years. From Luskin's post:
MEW is nothing more than a hypothetical explanation for consumption. If it were a good explanation, you'd expect personal consumption growth to have surged when MEW started rapidly expanding in 2002. But it didn't.
A few sentences later Luskin admits that consumption is largely explained by income, as is commonly known. Given that income growth has been very weak during this economic expansion (see this post for details), we would NOT have expected consumption growth to have surged due to high levels of MEW. Instead, we would have expected consumption growth to have merely been sustained at a moderate level despite weak income growth... which is exactly what we did see.

In other words, MEW did a nice job filling the gap between income growth (which was low) and consumption growth (which was moderate) during the period 2002-06. Given that, however, it makes all kinds of sense to start worrying about what might happen to consumption growth in the next year or two as MEW dries up, given that income continues to grown only anemically.

In short: it seems to me that Barry has good reason to worry.

The Bafflingly Weak Recovery, Part 2

In the previous post I discussed how the extremely loose monetary policy of the first half of this decade makes the relative weakness of this economic expansion all the more baffling. I thought that to round out that argument I should update and expand on some of the data that demonstrates exactly how weak this expansion has been.

By virtually any measure of the amount of money flowing into the pockets of Americans, this recovery has done poorly. In the following series of graphs I compare this expansion with other economic expansions of the past 35 years. As we'll see, by almost every measure the US economy has failed to live up to the standards set by previous economic expansions.

Let's start with GDP growth. Those who tout the "strong" economic growth of the past few years neglect to put such figures in context. As the following picture shows, GDP growth has not been particularly good in recent years.

Note: In each case I counted the start of the expansion as the first post-recession quarter where GDP growth exceeded 2% over a 6-month period, and I count the end of the expansion as the quarter in which GDP growth turns negative.

Even by the economy-boosters' favorite measure, this economic expansion looks pretty weak. But what has soured the opinion of average Americans much more than this is the poor growth in their incomes during this recovery. No matter how you measure income, it looks pretty bad.

Growth in wages and salaries? Looks pretty weak:

Note: All income measures adjusted for inflation using the PCE deflator.

Okay, well maybe workers have simply been compensated more through benefits than through wages and salaries. So let's take a look at total compensation. Nope, still looks pretty bad:

Well, what about if we take into account the nice tax cuts people have received during the Bush years in office. That must have helped, right?

Nope. Growth in per capita disposable income also looks bad:

Given these measures of how well the US economy has been doing overall, it's not surprising that most Americans feel a bit let down by this economic expansion. It doesn't take a media conspiracy to make people grumpy about the economy; they just need to look at their own bank accounts.

POSTSCRIPT: It is worth remembering that there is actually one type of income that has grown very strongly during this economic expansion: income to the owners of US corporations, otherwise known as after-tax corporate profits. Why profits have grown so extraordinarily while overall income has done so poorly during this expansion is another profound question that still awaits a conclusive answer.