It's always a great day when I have the opportunity to have a substantive exchange with the incredibly erudite Brad DeLong, especially when I am quite sure that I am right. Brad is convinced that the fiinancial crisis is the evil doer responsible for our prolonged downturn instead of the good old-fashioned housing bubble often featured in these pages. He points to the surge in non-residential investment coming in 2007 and 2008. He argues that this surge, along with a rise in exports, would have offset the fall in residential construction and consumption, had it not been for the financial crisis.
I see a somewhat different picture.
Source: Bureau of Economic Analysis.
The difference between my graph and Brad's is that I have pulled out construction from non-residential investment and shown net exports, rather than just exports. This is helpful because it shows that the surge in non-residential investment was entirely a surge in non-residential construction. This component rose from 2.6 percent of GDP at the start of 2005 to 3.8 percent of GDP in the fourth quarter of 2008. The rest of the non-residential investment component hovered near 9.6 percent over this period. In other words, it was going nowhere.
So what explains this enormous surge (almost a 50 percent increase in own terms) in non-residential construction? It's called a bubble. It would take me a moment to grab the data, but there was a surge in the price of non-residential properties just as the price of housing was going into reverse. Does this sound too dumb for words? Of course it is, but no one ever said that the folks in the banking system had a clue. We saw massive overbuilding in most areas of non-residential construction in this period. Even seven years later you can walk around the downtown of a relatively prosperous city like Washington and still see vacant retail and office space everywhere. This bubble was destined to burst, with or without a financial crisis.
What about net exports? I actually had some hope for net exports filling the gap, with the assumption that the dollar would drop, increasing the relative competitiveness of U.S. goods and services. There is some story here. The dollar had actually been falling since the beginning of the decade. (The over-valued dollar was an evil legacy of the Clinton years.) But the problem was that there were bubbles elsewhere in the world, most notably Europe. This meant a major export market was not going to be there for us. I don't see how we can blame the financial crisis for Europe's housing bubble.
Just to repeat my basic line, if we look at the economy after the financial markets had stabilized (2011 or 2012, pick your year) and ask what component of GDP would be higher if we did not have the financial crisis, it's hard to see a candidate. Brad's pick of non-residential investment doesn't hold water. Perhaps we can claim a bit better picture on net exports if people had not turned to the dollar as a safe haven, but this involved many factors other than the financial crisis. Also, the conscious decision of foreign central banks to prop up the dollar to sustain their export markets has to swamp this effect.
I stand by my housing bubble assessment.
Here's that commercial real estate price index I was looking for. Looks like it might be a good time to start worrying, especially if you're in the U.K.
I would also question the extent to which the further decline in house prices and construction was due to the financial crisis, as claimed by Brad in his post. It is not surprising that coming out of a bubble markets overshoot on the downside. It happened following the stock crash in 2000-2002. There was no financial crisis then. And the further decline in construction is easily explained by the overbuilding of the bubble years and the record vacancy rates. No need to talk about a financial crisis here either.
Note: typo corrected, thanks Marko.
The media regularly report the mixed signals from Japan on the state of its recovery (here, for example), but for some reason, they never seem to mention the state of the labor market. The news here is actually quite impressive. Since Shinzo Abe took over as prime minister in 2012 the employment to population ratio (EPOP) for adults under 65 rose by 2.4 percentage points. By comparison, the rise in the EPOP in United States over the same period, which has frequently been celebrated as a boom, was just 1.6 percentage points. Japan's EPOP is now 2.1 percentage points above its pre-recession level. By contrast, the EPOP in the United States is 3.2 percentage points lower for this group of workers.
In Washington policy debates, 90 percent of the story is what adjective gets applied to a particular set of facts (as in the "crushing" burden of the baby boomers' retirement). I know that I am not important enough to determine which adjective gets used, but I can take advantage of the adjectives used by others. If the United States has experienced an employment boom in the last two years, then Japan has experienced something better than a boom. It is remarkable that no news outlet has chosen to mention it.
A generous donor has agreed to give BTP big bucks for every case of a silly article complaining about deflation caused by a drop in energy prices. (I wish.) Anyhow, the NYT gave us another one today, thankfully with at least some qualifying language.
As I've pointed out many times before (most recently here), it doesn't matter if prices are falling if the decline is primarily due to an imported product like oil. The reasons that low inflation or deflation are troubling do not apply. Let's see how long the NYT takes to get it straight and maybe the rest of the media will follow.
Good piece on a study by AARP. (I was a discussant on a panel yesterday.) It will be interesting to see how Obamacare affects this story.
Since older workers can now get insurance through the exchanges, employers will be less concerned about picking up an older worker's health care costs. It will be interesting to see if this has a positive effect on their reemployment prospects.
It would have been worth mentioning this fact in a Washington Post article on the cost of providing Medicare and Medicaid patients with Sovaldi. Gilead Sciences, the manufacturer of Sovaldi, can get away with charging $84,000 for a treatment because the government will arrest anyone who tries to produce the drug without its permission.
Of course there is nothing to prevent people from going to India to get treatment there. It would be possible to pay $20,000 for the treatment and travel of a patient and family member, give them $10,000 for their troubles, and still come out $54,000 ahead. This would be a great win-win situation but apparently the Washington Post doesn't want anyone to consider ways to save the government money at the expense of drug companies.
And yes, we do have to finance the research, but patent monopolies are a horribly inefficient mechanism for this purpose.
Yes, once again Robert Samuelson stresses the urgency of cutting Social Security and Medicare. It's the usual pox on both your houses story, but as usual he leaves his thumb on the scale. In discussing the Republicans' proposals to save money by cutting spending, he says that their budget saves $2 trillion over the next decade (@ 0.9 percent of GDP) by repealing Obamacare. This is not quite right. The Republican proposal repeals the spending in the program, but leaves most of the revenue that paid for the spending in place.
In making the case for cutting Social Security and Medicare he suggests raising the retirement age to 69 or 70 over 15 years. By comparison, in 1983 the normal retirement age was raised from 65 to 67 over a 40 year period, so Samuelson is proposing a very abrupt increase in the retirement age. (The increase from age 66 to 67 is being phased in over the years 2016-2022, so Samuelson's rise would overlap with this rise.) More accurately, this should be thought of as a cut in benefits of almost 20 percent over a 15 year period. In addition, Samuelson also wants to raise the age of Medicare eligibility to 69 or 70, implying large increases in health care costs for people between age 65 and 70.
The median retiree will have virtually no income other than Social Security in retirement. The average Social Security benefit is a bit less than $1,300 a month, yet somehow Samuelson views these cuts as being progressive. He does also want to cut benefits for "wealthier" retirees. In order to get any notable savings it would be necessary to have a cutoff for benefit cuts at around $40,000 of non-Social Security income. This gives a whole new definition to the term "wealthier."
Alexandra Levit tells readers of her NYT column that we should be thankful that Generation Z is entering the workforce because, "the United States is facing a skills gap in most industries."
Really? I wonder how Ms. Levit knows about this skills gap? Usually we would look to things like high vacancy rates, longer hours for the workers that employers can find, and of course, rapidly rising wages. We don't see this for any major occupation group. So what is the basis for asserting there is a skills gap?
Note: Thanks to Stefano Monti for calling this one to my attention.
For some reason economics reporters and economists seem to have a really hard time understanding deflation. There are two lessons for today. First, we get the standard lesson: crossing zero means nothing, the problem is too low a rate of inflation.
As I've written a few thousand times, inflation is an aggregate measure that combines price changes of hundreds of thousands of goods and services. When the inflation rate gets near zero it means that than many of the price changes are already negative. Going from a near zero positive to a near zero negative just means a higher ratio of negative price changes to positive price changes (or the negative ones are larger). How can going from 45 percent negative price changes to 55 percent negative price changes be a disaster? That makes zero sense.
Furthermore, since these are all quality adjusted price changes it may not even be the case that prices are actually falling for the goods themselves. The price index for new cars in the United States is less than 3 percent above its 1998 level, yet the average new car costs considerably more in 2015 than it did in 1998. The difference is that the Bureau of Labor Statistics (BLS) attributes most of the price rise to quality improvements. The story would be even more dramatic with computers where BLS reports that prices have fallen by more than 95 percent since 1997. Does anyone believe that an economy faces disaster just because its cars and computers are getting better?
The NYT ran an a piece by Hugo Dixon that boldly proclaimed that if Alex Tsipras, the prime minister of Greece is rational, he will get tough with his left-wing supporters and impose more austerity measures. This is an interesting notion of rationality.
Greece's economy has shrunk by more than 25 percent since 2008. Its unemployment rate is close to 25 percent. The current projections from the I.M.F. and others show little improvement in these numbers by the end of the decade if it sticks to this austerity path. By contrast, if it breaks with the euro its goods and services would suddenly become far more competitive in the world economy as their price would fall due to a lower valued currency. It would also no longer have to run primary budget surpluses since it would be able to avoid payments on its debt for a period of time.
While this break would undoubtedly lead to a short-term hit to the economy as it put its new currency place and worked out patchwork arrangements on trade, it is likely that it would bounce back quickly. The model here is Argentina which went into default in December of 2001. It's economy went into a free fall for three months, then stabilized in the second quarter of 2002. By the fall of the year it was growing rapidly and it continued to grow rapidly for the next five years. It made up all the lost ground before the end of 2003.
It is worth noting that at the time, the I.M.F. and most other "experts" confidently predicted a disaster for Argentina. While there are issues about the accuracy of Argentina's numbers, this has mostly been more a problem in the post-recession period when an over-valued currency and extensive price controls have led to serious economic distortions.
If we want to use the words "tough" and "rational," they would probably better be applied to the strategy of breaking with the euro rather than continuing an austerity policy that promises a level of pain for the Greek period that far exceeds that experienced by the United States in the Great Depression.
The Washington Post likely misled many readers in an article on a Republican proposal to cut benefits for federal employees. It noted that the proposal calls for federal workers to increase the amount they pay for their pensions by 7 percent of their salary. It then quoted Richard Thissen, the president of the National Active and Retired Federal Employees Association, as saying that the higher contribution is,"nothing more than a pay cut for federal employees."
This is not just the view of a person representing the affected workers. Virtually all economists would agree that requiring workers to pay more money for the same benefit amounts to a cut in pay. This is not really an arguable point, although the Post's discussion of the topic likely led many readers to believe it is a matter of opinion.
The piece also errors in referring to the proposals of the "bipartisan Simpson-Bowles committee." The commission actually did not make any proposals since its by-laws required that to be approved a proposal needed the support of 12 of the 16 members of the commission. Since no proposal got the necessary 12 votes it is inaccurate to refer to recommendations of the commission. The proposal in question was put forward by the co-chairs and had the support of 10 of the 16 commission members.
The Washington Post missed the opportunity to correct Stanley Fisher, the vice-chair of the Federal Reserve Board, on his arguments for raising interest rates. An article on the prospect of Fed rate hikes later this year quoted Fisher on the desirability of raising rates so that the Fed would have room to use normal monetary policy (i.e. lower interest rates) if there was a shock to the economy leading to a slowdown. There are two major flaws in this logic.
First, if the Fed delays raising interest rates and allows more job creation and economic growth, we are more likely to see higher inflation. If the inflation rate starts to rise, the Fed could raise the federal funds rate along with it, leaving real interest rates unchanged. If the inflation rate goes to a somewhat higher level, this would provide the Fed with considerably more ability to boost the economy in a downturn with conventional monetary policy since it could have lower real interest rates. (The real interest rate is the nominal interest rate minus the inflation rate.) This would be especially the case if it allowed the inflation rate to rise above its current 2.0 percent target.
In this respect, it is important to remember that the 2.0 percent target is just a number chosen by former chair Ben Bernanke. It is not part of the Fed's legal mandate to promote high employment and price stability.
The other flaw in Fisher's logic is that he is effectively advocating that the Fed deliberately slow growth now so that it will have more ability to speed growth later. This is a rather peculiar argument, sort of like committing suicide to ensure that you won't be killed. Would it make sense to say, slow growth by a total of 1.0 percentage points over the next two years to ensure that the Fed has enough room to lower interest rates and thereby speed growth by 1.0 percentage point in response to a possible future shock? (Fisher undoubtedly would have different numbers.)
It is at least peculiar to argue that we should for certain take a large loss now, in the form of higher unemployment and lower wages for those at the middle and bottom of the wage distribution, in exchange for being better able to respond to a possible loss in the future. Unless the potential gains from the latter action are much larger than the certain losses from raising interest rates, this would be a bad trade-off.
Okay, for the 64,512th time, it is net exports that contribute to GDP, not exports. Apparently this distinction is difficult for people involved in economic policy to understand since they keep making the same mistake.
The point is straightforward. If the United States increases its exports because GM is exporting car parts to be assembled in Mexico and then imported back as a finished car to the United States, it will not be a net job creator. We used to have jobs at assembly plants in the United States. These are being replaced by jobs in assembly plants in Mexico. In this story exports increase, but net exports (exports minus imports) fall. Fans of intro econ know the accounting identity that GDP = C + I + G +(X-M), where the X-M stands for exports minus imports.
This is why the NYT seriously misled readers in an article on the impact of the rising dollar when it wrote:
"the sharp rise of the dollar threatens to undercut one of the principal drivers of the recovery in recent years: strong export growth for American companies."
While exports have been a positive for growth, imports have been an even larger negative. According to our good friends at the Bureau of Economic Analysis (Table 1.1.2), the fall in net exports reduced growth by 0.22 percentage points in 2014. They added the same amount to growth in 2013, but have been a net negative since 2010. Of course net exports will almost certainly be more of a drag on growth due to the recent rise in the dollar, but it is not true that they had previously been a driver of the recovery.
That is the implication of his column touting the virtues of inequality. Will seems to think that we could not get people to work hard to master skills or to be great innovators if they didn't have the prospect of earning billions or tens of billions of dollars. But if we look back through history we can identify an enormous number of tremendously talented and creative individuals who did not get fabulously wealthy or even have any plausible hope of getting fabulously wealthy.
Mays was of course well-paid, but adjusting for inflation, his best paychecks would probably be less than one-tenth of the pay of today's stars. And, there is no shortage of great athletes, writers, musicians, and other performers who never even made Willie Mays type salaries. The same is true of inventors. Jonas Salk, the inventor of the first effective polio vaccine, undoubtedly had a comfortable standard of living, but nothing approaching the wealth of a Bill Gates or even Jamie Dimon.
In fact, if we look back to the period of relative equality from the end of World War II to 1980, the economy made far more rapid progress than it did in the next three and a half decades of rising inequality. If the argument is that people need material incentive to do their best work, then Will has a case. If the argument is that people need the motivation of immense wealth to work hard and innovate, then Will is demonstrably wrong.
Note: Links added, thanks to Robert Salzberg.
Just when you thought economics reporting could not get any worse, the NYT leads the way. The headline of a news article told readers that "Japan's recovery is complicated by a decline in household savings." The piece reports that consumption is now increasing (barely), but because real wages have not risen, it has led to a decline in household savings. The household saving rate in Japan is now negative. It then tells us that businesses are big savers, but that money is needed to finance the government's budget deficit.
Okay, now if the NYT could find someone who had taken an intro econ course that person could explain to its reporters and editors that if consumers, businesses, or the government spends more money, it will lead to additional income and employment, and additional saving. If the economy is below full employment, its spending is not limited by its current saving. (If it's not below full employment then it doesn't have a problem with a recovery, by definition its economy would have already recovered.)
Anyhow, that's what folks who learned economics would say.
Robert Samuelson (sorry, he's not going to take advantage of my vacation) gets it badly wrong about the economy again. He began his Monday column by telling readers:
"The Federal Reserve is at a crossroads, and it doesn’t know where it’s going."
Really? The Fed doesn't know where it's going? How about Robert Samuelson doesn't know where it's going?
It gets worse:
"There was a time when we were more confident. We didn’t pay attention to details, because the experts had matters in hand. During the Alan Greenspan era (1987-2006), the Fed was routinely seen as an economic superman. Its surgical shifts in the federal funds rate seemed to stabilize the economy: Expansions were long, recessions rare and mild."
Umm, no. "We" did pay attention to details. We yelled as loudly as we possibly could that there was a huge housing bubble that would sink the economy when it burst. Of course papers like the Washington Post did not pay attention to us because it did not fit their story that the Fed was an economic superman. Such nonsense was the conventional wisdom at the time and the paper did not want to give those who challenged the claim a voice. Now, it wants to pretend that people who understood the basic economics of the housing bubble, and the stock bubble before it, did not exist.
And Samuelson gives us more error:
At least this is what he says in his column today. The data strongly disagree with him. In the last four years productivity growth has averaged less than 1.0 percent a year. Productivity growth measures the rate at which robots and other technology replace people. In the years from 1995-2005 productivity growth averaged over 2.5 percent annually. In the period from 1947 to 1973 it averaged close to 3.0 percent.
The data indicate that we are seeing a slowdown in technology replacing labor (which should allow for rising living standards) rather than the speedup in the robot story. As a practical matter, workers should be far more concerned that the Federal Reserve Board will take their job, by slowing the economy with higher interest rates, than a robot will take their job.
Note: correction made, thanks Ethan.
It is amazing how many reporters want to be mind readers. I guess it's hard to make a living as a mind reader. Anyhow, David Leonhardt took some steps in the mind reading direction when he told readers:
"They both [President Obama and Hillary Clinton] consider the stagnant incomes of recent decades to be a defining national issue. They both want to address the stagnation through a combination of government programs and middle-class tax cuts. They both see climate change as a serious threat. They both think workers have too little power and corporations too much."
Wow, so David Leonhardt knows what President Obama and Hillary Clinton really "consider," "want," "see," and "think." That's impressive, but readers may want to be somewhat skeptical. After all, most of us recognize that politicians don't always reveal their true thoughts. We know what they say their priorities are, but only a mind reader would try to tell us what they really think.
There are also some objective facts that provide some basis for skepticism on this topic. First, many of the big winners from rising inequality are friends and campaign contributors to Hillary Clinton (and Barack Obama). It's possible that they both want to pursue policies that would take away large amounts of money from these people, but some folks may question this fact.
Also, the incredibly narrow list of policies that Leonhardt says is on Clinton's plate indicates that she probably is not serious about reducing inequality and promoting middle class wage growth. For example, many of the highest incomes in the economy are in the financial sector. If Clinton were serious about attacking inequality it is hard to believe that she would not be promoting a financial transactions tax. This could raise as much as $180 billion a year (more than $2 trillion over a decade). This money would come almost entirely out of the pockets of the high rollers in the financial industry. It would also increase economic efficiency and growth. Since Clinton has never indicated any interest in financial transactions taxes it is difficult to believe that she has much interest in countering inequality.
Lydia DePillis and Jim Tankersley had an interesting wonkblog piece on how even mainstream Democrats are now at least paying lip service to the argument that unions are necessary to reduce inequality. The piece includes a pro-union statement from Robert Rubin who it describes as someone "whom liberals consider overly friendly to Wall Street."
This misrepresents Rubin's background. Robert Rubin was a top executive at Goldman Sachs before coming to the Clinton administration. After leaving the Clinton administration he went to Citigroup where he made tens of millions of dollars from the marketing of subprime mortgage backed securities. The reason that Robert Rubin has influence in policy debates is because he is very rich from the money he made on Wall Street and he can get other very rich Wall Street types to donate money to Democratic candidates and favored causes. Given his background, referring to Robert Rubin as someone who is "close to Wall Street" would be like referring to Rich Trumka as someone who is close to organized labor.
The big money is sweating big time since it seems large segments of the American public have caught wind of the Obama administration's plans for the Trans-Pacific Partnership. After several decades in which trade has been a major factor depressing the wages and living standards of the country's workers, the Obama administration is going back to the well to push for more.
The immediate goal is the Trans-Pacific Partnership (TPP), which includes a number of countries in Asia and Latin America. While it excludes major countries like China and India, the explicit intention is to expand the pact so that these countries will eventually be included. This fact is important in assessing this deal.
For example, the Washington Post (which has a religious devotion to these sorts of trade deals) ran a column by three prominent economists, David Autor, David Dorn, and George Hanson (ADH), which tells readers the TPP is good for the country's workers. ADH is an interesting team to make this argument since they have written several papers showing that our patterns of trade have been an important force depressing the wages of a large segment of the U.S. workforce.
ADH start out by saying that manufacturing workers have little to lose in this deal because tariffs with the countries in the pact are already near zero, therefore we will not be opening ourselves to new competition if the few remaining barriers are eliminated. Here is where the possibility of expansion is important.
Many prominent economists, including many strongly pro-trade economists like Fred Bergsten, the former president of the Peterson Institute for International Economics, have argued the TPP should include rules on currency manipulation. While this may not be a big issue with most of the countries in this round, it is certainly a big deal with China and other countries that could join. According to calculations by Bergsten and others, actions of foreign central banks to raise the value of the dollar have added several hundred billions of dollars to our trade deficit and cost us millions of manufacturing jobs.
The Federal Reserve Board released data on profits for 2014 this week. The good news, for those who are not Mitt Romney-types, is that the profit share fell in 2014 from its 2013 peak. Before-tax profits were 0.6 percentage points lower as a share of GDP than they had been in 2013. After-tax profits were 1.2 percentage points lower.
There are several points worth noting here. First, the drop in profits as the labor market has begun to tighten some lends credence to the view that a substantial portion of the rise in corporate profits was cyclical, not secular.
The point is that we are not seeing a surge in profit shares because of the inherent dynamic of capitalism. We are seeing a rise in profit shares because incompetents who couldn't see an $8 trillion housing bubble were running the economy. When the bubble burst and the economy collapsed, the resulting weakness in the labor market led to a huge rise in profit shares.
Folks may point to a similar rise in profit shares in the earlier part of the last decade. For those old enough to remember, this also followed the collapse of an asset bubble. And contrary to popular belief, the resulting recession was actually very severe from the standpoint of the labor market. We did not get back the jobs lost in the downturn until January of 2005. This was the longest stretch without net job growth since the Great Depression, until the current downturn. In short, weak labor markets lead to high profits.
This takes us to the Federal Reserve Board. The plan to raise interest rates is a plan to weaken job growth. And, it looks like it also might mean a plan to prevent profit shares from falling and wage shares from rising.
That might sound like bad news to most folks, but of course most folks will probably never hear it. We'll just hear highly paid economist types wringing their hands over the rise in inequality. No doubt the major foundations will make large grants to researchers trying to understand the problem.