Skewed Distribution

Blackstone's Rainmaker

2007-05-26T15:31:00.000-07:00

When China's proposed bid to buy an American oil company in June of last year backfired on baseless grounds that the deal posed security concerns to the U.S., it became pretty clear that public perception of China was sensitive at least. The U.S.'s trade deficit with China, which has expanded from 6 billion annually in the late 1980s to over 200 billion annually in recent years, is not helping China's public relations campaign either. Public opinion data show a majority (60 percent) believe China is an "unfair trading partner" and that imports from China represent a "serious threat" to U.S. jobs. Oh, and China's military rise is also viewed as suspicious at best; as is China's role in Darfur.

This is what makes Blackstone's Antony Lueng a rainmaker. Lueng has 28 years of investment banking experience and served as the minister of finance in Hong Kong before taking over Blackstone's greater China portfolio. Earlier this month, Lueng helped secure $3 billion for Blackstone's coming public offering, and importantly, he did this without attracting a great deal of attention or fear mongering from the U.S. congress or media.

With the Chinese government holding a big steak, Lueng and the others in Blackstone will be treading carefully - aka, maybe no investing in firms that design state of the art weapons.

Causes of Doha's Death

2007-05-23T19:34:00.000-07:00

It was safe to say "Doha is dead" a year ago, but it is now even more safe. Zarkozy is now calling on Europe to "protect" its farmers, meaning he will avoid the concessions in agriculture necessary to appease the Americans, Indians, and Brazilians, among others, and move the round forward. Bruce Stokes of the National Journal wrote an earlier column lucidly explaining the political impediments to Doha's survival, but here is my stab:

That the Doha Round was never really meant to be has something to do with why talks are failing now. Doha was not in the original playbook, but was largely inspired by September 11. Shortly after, the then trade representative Bob Zoellick argued that U.S. national security was intimately intertwined with open borders to trade with underdeveloped economies. In his words:

Trade is about more than economic efficiency. It promotes the values at the
heart of this protracted struggle...Erecting new barriers and closing old borders will not help the impoverished. It will not feed hundreds of millions struggling for subsistence. It will not liberate the persecuted...And it certainly will not placate terrorists. This President and this Administration will fight for open markets and free trade. We will not be intimidated by those who have taken to the streets to blame trade -- and America -- for the world's ills. The global trading system has demonstrated -- from Seoul to Santiago -- that it is a pathway out of poverty and despair.

This concept-that poverty leads to ill-will and then terrorism, and that trade reduces poverty-was manifest in Bush's Middle East Free Trade Area Initiative and then in subsequent deals with countries including Jordan, Oman, and Morocco, that brought narrow economic benefits to the U.S. but were intended to foster longer term economic relationships and shorter term political benefits. In retrospect, it's probably not surprising that a round based on geopolitical objectives, and not by the business interests necessary to make difficult concessions worthwhile in the eyes of politicians and negotiators, would start on shaky ground and not get far off of it.

There are many other reasons why Doha has failed. Among them, the issues have become more complex. The previous round (Uruguay) witnessed the introduction of intellectual property into the talks, signaling that the relative importance of lowering tariffs and other barriers to trade had deminished. In order for talks to be worthwhile-it was implied-formerly second tier issues such as IPR would need to be brought to the table. Further, the table itself was full of new, if not stronger, personalities than before. Multilateral trade wasn't so difficult in the late 1940s, when negotiating partners shared political and strategic objectives. But by the time the Doha talks got started, the players were not only greater in number but had diverse political orientations. China, India, and Russia would now play a prominent role in global trade talks. Despite U.S. rhetoric, the talks would not be based on political objectives, but on cold-hearted economics. Even if they were based on political objectives, all of the parties involved may not have shared them. Finally, it has been argued by Bhagwati and other proponents of multilateral trade that the proliferation of bilateral deals has stunted the progression of multilateral talks. Why waste time on a grand bargain that may or may not go through and will be watered down at best when the quick, meaningful bilateral deals can be negotiated in the meantime? There are other reasons for Doha's death, but in sum:

Talks have reached a point of diminishing returns which is easily seen by the introduction of new issues such as IPR. Alternatives such as bilateral and regional agreements add to this effect. The parties at the table are also more diverse and unwilling to make concessions based on political or security considerations as was the case when the GATT (now WTO) was founded. Finally, envirnmental and labor standards aren't helping, and neither are statements from Zarkozy.

Benefits of Joining the EU's Currency Regime

2007-05-23T19:28:00.000-07:00

The costs of maintaining independent monetary policy were felt in the U.K. today as Honda's persident Takeo Fukui said that its UK plant would not be expanded due to currency uncertainty.

China and the U.S. Trade Deficit

2007-05-08T20:35:00.000-07:00

Bob Samuelson outlines the problems associated with the U.S.'s trade deficit with China:

China is already the world's third-largest trading nation and seems destined to become the largest. On its present course, it threatens to wreck the entire post-World War II trading system. Constructed largely by the United States, that system has flourished because its benefits are widely shared. Since 1950, global trade has expanded by a factor of 25. By contrast, China's trade is mercantilist: It's designed to benefit China even if it harms its trading partners.

There's a huge gap in philosophy. By accident or design, China has embraced export-led economic growth. The centerpiece is a wildly undervalued exchange rate. Economist Morris Goldstein of the Peterson Institute thinks the yuan is 40 percent cheaper than it should be. The resulting competitive advantage props up exports, production and jobs. Since 2001, China's surplus on its current account -- the broadest measure of its trade flows -- has jumped from $17 billion to $239 billion. As a share of China's GDP, it has zoomed from 1.3 to 9.1 percent...

Despite popular impressions, China's trade offensive hasn't yet seriously harmed most other economies. For example, America's current account deficit (to which Chinese imports contribute) was $857 billion last year, up from $389 billion in 2001. Still, that hasn't stymied job creation; the U.S. unemployment rate is 4.5 percent. And world economic growth has accelerated.

Even Chinese officials favor higher local demand. But either they can't or won't stimulate it. Personal consumption spending is a meager 38 percent of GDP; that's half the U.S. rate of 70 percent. The Chinese save at astonishingly high levels, partly because they're scared of emergencies. The social safety net is skimpy. Health insurance is modest: Out-of-pocket spending covers half of medical costs, reports economist Nicholas Lardy of the Peterson Institute. There's no universal Social Security, and only 17 percent of workers have pensions. A mere 14 percent are covered by unemployment insurance.

It is not "protectionist" (I am a long-standing free-trader) to complain about policies that are predatory; China's are just that. The logic of free trade is that comparative advantage ultimately benefits everyone. Countries specialize in what they do best. Production and living standards rise. But the logic does not allow for one country's trade systematically to depress its trading partners' production and employment. Down that path lie resentment and political backlash.
Everyone complains about America's trade deficits, but they actually symbolize global leadership. Access to the U.S. market has promoted trade by enabling other countries to export. But the deficits cannot grow indefinitely. Imagine now a trading system whose largest member seems on accumulating permanently large surpluses. Nor, it might be added, are surpluses ultimately in China's interests. They drain too much of its production from its citizens and contribute to growing domestic economic inequality. What everyone needs is more balanced Chinese economic growth, less dependent on exports.

Given the immense stakes -- literally the future of the global trading system -- the Bush administration has been too timid in pushing China to change. The Treasury Department won't even declare China guilty of currency manipulation. No doubt doing so would irritate the Chinese. But avoidance is no solution; the longer these problems fester, the more intractable and destructive they will become.

On the first point, that China is undermining the world trading system that the United States helped create. Well, the United States is not using the mechanisms that it created to resolve illegal trading practices. The purpose of the WTO dispute settlement mechanism is to bring countries to negotiate, and if all else fails, to litigate to prevent illegal practices from continuing. Samuelson claims that China is wrecking the system. I assume that he means China is undermining the system by subsidizing its currency. But currency manipulation is not against WTO rules, and secondly, undervaluing one's currency is akin to an export subsidy AND an import tariff. The U.S. should continue to take the Chinese to court in other areas, however, where China is in violation of trade rules.

On his reference to the IIE study holding that China's currency is overvalued by as much as 40 percent. Even if China revalues, the U.S.'s trade deficit with the world will remain unchanged. Basically, Samuelson is worried about deficits and thinks that revaluing the Yuan will solve the problem. But it won't. It COULD change the composition of the U.S. trade deficit.

True Cost of the Iraq War

2007-05-08T04:43:00.000-07:00

Bob Hormats of Goldman has a new book on the historical costs of wars. The Washington Post's Lori Montgomery mentions the book and other issues related to the costs of Iraq and Afghanistan.

The global war on terror (costs of fighting in Iraq and Afghanistan)...is about to become the second-most-expensive conflict in U.S. history, after World War II.

Since the Sept. 11, 2001, terrorist attacks, Congress has approved more than $609 billion for the wars, a figure likely to stand as lawmakers rework their latest spending bill in response to a Bush veto. Requests for $145 billion more await congressional action and would raise the cost in inflation-adjusted dollars beyond the cost of the wars in Korea and Vietnam.

But the United States is vastly richer than it was in those days, and the nation's wealth now dwarfs the price of war, economists said. Last year, spending in Iraq amounted to less than 1 percent of the total economy -- about as much as Americans spent shopping online and less than half what they spent at Wal-Mart. Total defense spending is 4 percent of gross domestic product...In contrast, defense spending ate up 14 percent of GDP at the height of the Korean War and 9 percent during the Vietnam War.

And this time, the war bill is going directly on the nation's credit card. Unlike his predecessors, Bush is financing a major conflict without raising taxes or making significant cuts in domestic programs. Instead, he has cut taxes and run up the national debt. The result, economists said, is a war that has barely dented the average American's pocketbook and caused few reverberations in the broader economy...

Like all debts, however, the bill for Iraq and Afghanistan will eventually come due. While it is unlikely to cause economic upheaval, such as the devastating inflation that followed the Vietnam War, economists foresee substantial increases in government spending to rebuild the nation's exhausted armed forces, care for its disabled veterans and cover rising interest payments.

Administration officials say those payments will be easier to afford because Bush's tax cuts strengthened the economy and boosted tax collections. But even many conservative economists are skeptical. Some worry that the bill for Iraq will come just as the baby-boom generation starts retiring, further straining a budget that will require deep cuts, higher taxes or bigger deficits...

Borrowing is common in wartime. According to Hormats, virtually every U.S. war has required some debt. The title of his book, "The Price of Liberty: Paying for America's Wars," comes from a 1790 report by the nation's first Treasury secretary, Alexander Hamilton. Hamilton wrote that the heavy debt that helped finance the Revolutionary War was "the price of liberty" and insisted that the new nation scrupulously repay it to preserve its ability to borrow in the future.

Hamilton won that argument, and the government's commitment to repaying its debts has become a bedrock American principle. At the same time, most wartime presidents have tried to cover at least part of the cost of their conflicts by means other than debt, Hormats writes, often pushing radical changes in fiscal policy aimed at restraining deficits and inflation.

To help pay for World War II, by far the nation's most expensive, Franklin D. Roosevelt expanded the number of taxpayers from 4 million to 42 million, tripled tax collections as a percentage of GDP and slashed spending on his treasured New Deal programs. As the military budget devoured more than a third of the economy, Roosevelt also called for mass sacrifice, rationing food and gasoline, capping prices and wages and exhorting Americans to spend any money they could spare on war bonds and stamps.

Heavy government spending on the Korean War set off a bout of inflation that neared 8 percent in 1951. To pay for the war, President Harry S. Truman raised the top tax rates to 91 percent for individuals and an all-time high of 70 percent for corporations, while imposing wage and price controls.

Lyndon B. Johnson, who tried to protect a 1964 tax cut and his Great Society programs while escalating U.S. involvement in Vietnam, eventually signed both a tax increase and spending cuts in 1968 -- too late to avoid touching off more than a decade of inflation.

Bush, in contrast, has allowed domestic spending to rise and cut taxes repeatedly since taking office, adding more than $3 trillion to the national debt. He signed a huge stimulus package two months after marching on Baghdad in March 2003. A few months later, he signed legislation to create a Medicare prescription drug benefit, the biggest expansion of the federal health program for the elderly since its creation in 1965. That combination is unprecedented...

Though the administration has not cut domestic spending, it has managed to hold the budget for discretionary programs relatively flat in recent years, Fratto said. After the 2001 terrorist attacks, a tax increase to pay for the ensuing war could have devastated the economy, he said.

"Could it have been paid for by tax increases? I suppose it could have been," Fratto said. "But at what cost to the economy?"...

Hormats called Bush's war financing "shortsighted," not only because of the potential fiscal consequences but also because it bypassed an opportunity to engage the support of the public, which has grown increasingly skeptical of the war.

"They tried to do this on the cheap and without a candid conversation with the American people about the cost," Hormats said. "But the irony is the great wartime leaders have seen it in the opposite way," theorizing that a call to sacrifice would "tie people to the war effort."

Joseph E. Stiglitz, a Columbia University professor who was chairman of the Council of Economic Advisers under President Bill Clinton and who was among the winners of the 2001 Nobel prize for economics, said Bush has undertaken a "deceptive policy of saying you can have both guns and butter" -- a strategy similar to Johnson's in the early years of Vietnam. In December, Stiglitz co-authored a study that predicts the Iraq conflict alone will eventually cost taxpayers more than $1 trillion, counting military rebuilding and health care for wounded veterans.

"It's actually turning out to be a very expensive war," Stiglitz said. But "it has been designed to be a war the American people don't feel.'"

Takeaway: Iraq is overrated in terms of its effect on the fiscal outlook. The true problems are related to rising entitlement spending a few years down the road. That said, the last way one would have hoped to prepare for the boomers' retirement and the associated social security and health care costs would have been to pile on more debt today on an exercise that was ultimately unnecessary. So Iraq, while not the driver of fiscal problems, comes at a really bad time.

Consequences of Offshoring

2007-05-06T19:01:00.000-07:00

Alan S. Blinder of Princeton University in today's Washington Post:

I'm a free trader down to my toes. Always have been. Yet lately, I'm being treated as a heretic by many of my fellow economists. Why? Because I have stuck my neck out and predicted that the offshoring of service jobs from rich countries such as the United States to poor countries such as India may pose major problems for tens of millions of American workers over the coming decades. In fact, I think offshoring may be the biggest political issue in economics for a generation...

The reason for my alleged apostasy is that the nature of international trade is changing before our eyes. We used to think, roughly, that an item was tradable only if it could be put in a box and shipped. That's no longer true. Nowadays, a growing list of services can be zapped across international borders electronically. It's electrons that move, not boxes. We're all familiar with call centers, but electronic service delivery has already extended to computer programming, a variety of engineering services, accounting, security analysis and a lot else. And much more is on the way.

Why do I say much more? Because two powerful, historical forces are driving these changes, and both are virtually certain to grow stronger over time. The first is technology, especially information and communications technology, which has been improving at an astonishing pace in recent decades. As the technology advances, the quality of now-familiar modes of communication (such as telephones, videoconferencing and the Internet) will improve, and entirely new forms of communication may be invented. One clear implication of the upward march of technology is that a widening array of services will become deliverable electronically from afar. And it's not just low-skill services such as key punching, transcription and telemarketing. It's also high-skill services such as radiology, architecture and engineering -- maybe even college teaching.

The second driver is the entry of about 1.5 billion "new" workers into the world economy. These folks aren't new to the world, of course. But they live in places such as China, India and the former Soviet bloc -- countries that used to stand outside the world economy. For those who say, "Sure, but most of them are low-skilled workers," I have two answers. First, even a small percentage of 1.5 billion people is a lot of folks. And second, India and China will certainly educate hundreds of millions more in the coming decades. So there will be a lot of willing and able people available to do the jobs that technology will move offshore.

Looking at these two historic forces from the perspective of the world as a whole, one can only get a warm feeling. Improvements in technology will raise living standards, just as they have since the dawn of the Industrial Revolution. And the availability of millions of new electronically deliverable service jobs in, say, India and China will help alleviate poverty on a mass scale. Offshoring will also reduce costs and boost productivity in the United States. So repeat after me: Globalization is good for the world. Which is where economists usually stop.

And where my alleged apostasy starts.

For these same forces don't look so benign from the viewpoint of an American computer programmer or accountant. They've done what they were told to do: They went to college and prepared for well-paid careers with bountiful employment opportunities. But now their bosses are eyeing legions of well-qualified, English-speaking programmers and accountants in India, for example, who will happily work for a fraction of what Americans earn. Such prospective competition puts a damper on wage increases. And if the jobs do move offshore, displaced American workers may lose not only their jobs but also their pensions and health insurance. These people can be forgiven if they have doubts about the virtues of globalization.

We economists assure folks that things will be all right in the end. Both Americans and Indians will be better off. I think that's right. The basic principles of free trade that Adam Smith and David Ricardo taught us two centuries ago remain valid today: Just like people, nations benefit by specializing in the tasks they do best and trading with other nations for the rest. There's nothing new here theoretically.

But I would argue that there's something new about the coming transition to service offshoring. Those two powerful forces mentioned earlier -- technological advancement and the rise of China and India -- suggest that this particular transition will be large, lengthy and painful.

It's going to be lengthy because the technology for moving information across the world will continue to improve for decades, if not forever. So, for those who earn their living performing tasks that are (or will become) deliverable electronically, this is no fleeting problem.

It's also going to be large. How large? In some recent research, I estimated that 30 million to 40 million U.S. jobs are potentially offshorable. These include scientists, mathematicians and editors on the high end and telephone operators, clerks and typists on the low end. Obviously, not all of these jobs are going to India, China or elsewhere. But many will.

It's going to be painful because our country offers such a poor social safety net to cushion the blow for displaced workers. Our unemployment insurance program is stingy by first-world standards. American workers who lose their jobs often lose their health insurance and pension rights as well. And even though many displaced workers will have to change occupations -- a difficult task for anyone -- only a fortunate few will be offered opportunities for retraining. All this needs to change.

What else is to be done? Trade protection won't work. You can't block electrons from crossing national borders. Because U.S. labor cannot compete on price, we must reemphasize the things that have kept us on top of the economic food chain for so long: technology, innovation, entrepreneurship, adaptability and the like. That means more science and engineering, more spending on R&D, keeping our capital markets big and vibrant, and not letting ourselves get locked into "sunset" industries.

In addition, we need to rethink our education system so that it turns out more people who are trained for the jobs that will remain in the United States and fewer for the jobs that will migrate overseas. We cannot, of course, foresee exactly which jobs will go and which will stay. But one good bet is that many electronic service jobs will move offshore, whereas personal service jobs will not. Here are a few examples. Tax accounting is easily offshorable; onsite auditing is not. Computer programming is offshorable; computer repair is not. Architects could be endangered, but builders aren't. Were it not for stiff regulations, radiology would be offshorable; but pediatrics and geriatrics aren't. Lawyers who write contracts can do so at a distance and deliver them electronically; litigators who argue cases in court cannot.

But even if we do everything I've suggested -- which we won't -- American workers will still face a troublesome transition as tens of millions of old jobs are replaced by new ones. There will also be great political strains on the open trading system as millions of white-collar workers who thought their jobs were immune to foreign competition suddenly find that the game has changed -- and not to their liking.

Can the French Embrace "Creative Destruction"?

2007-05-06T17:58:00.000-07:00

Sarkozy's win in France's national election could lead to greater flexibility in France's economic system. Economic growth in France is lagging and youth unemployment is above 20 percent. So maybe the country will take a new approach toward managing the changes brought about by globalization and the introduction of new technologies. But then again, what if accepting economic change, or embracing the "creative destruction" that results in the replacement of less productive jobs with more productive ones, so contradicts French cultural norms to make this acceptance difficult if not impossible?

Here is Grant McCracken:

"Last week, doing ethnographic interviews in Paris, I was told several times that the French are "equal." To an outsider like me, this is improbable. Certainly, equality is there in the model of social democracy France has embraced. Yes, the French are equal before the law and their God. And yes, equality is there in the commitment to "egalite" that survives the revolution of the 18th century. But evidence of inequality is everywhere. Indeed, the French insist on differences of class, status, wealth, power, and several kinds of capital. Respondents would not to be dissuaded, and I got to thinking how it is the French might be said to be "equal." Here's my guess, and it's only a guess. European hierarchies in the medieval and early modern periods used a relatively simple system of status marking: the notion of relative fineness. Those who ranked high exhibited fineness in their clothing, their food, the manners, their speech and their very bodies. Those who ranked low exhibited a relative coarseness in clothing, food, manners, speech and bodies. I will spare you the details except to say that fineness was finally a matter of intellectual, aesthetic, almost spiritual disposition. High standing people could make fine distinctions. Low standing people could not.

At some point, France constructed an idea of itself, its culture, its collectivity that broke with this longstanding historical convention. In France, according to this convention, everyone was capable of discerning and exhibiting fineness. Especially, in the domain of eating, food, cooking, cuisine, here the French were one. The table was the place were fineness was identified, discussed, shared, prized and that was just for starters. The main course had yet to come. (The democratization of fineness extends beyond food, of course. It is there in the language itself, which is why the lowliest clerk at the Tabac is entitled [obliged!] to sneer at our high school French.)

There was some period in which culture and economy worked hand in glove. Discernment and taste were national exports. Industries based on discernment and taste flourished. Wine, food stuffs, perfume, handbags, scarves, watches, and clothing brought in a fortune. The language itself exported well.

The grandeur that was the culture that was France...this was accessible to the rest of us, miserable cretins living in the far provinces. Everywhere in North America, there were little shrines everywhere, "French restaurants," we called them, places where middle class families could go to glimpse for a moment, to taste for a moment, what France had created with its national accomplishment. French restaurants were draped in seriousness and heavy red curtains. They were staffed by men with deep knowledge and great courtesy. The food was heavy and ornate. Tables groaned Silver, plate, and crystal. The whole thing was well off the Paris standard, of course, but obeisance was called for and obeisance was paid.

And some few years ago, we North Americans decided we couldn't care less. Several culture trends made this restaurant and many of the exports of France look suddenly too...too. We decided that formality counted for less than informality. We shifted from ceremony to spontaneity as our preferred cultural mode. We gave up solemnity for something more winning and cheerful. We abandoned heavy foods for something lighter and more "fun." Most important, food became a place to experiment, and now the French looked, even after nouvelle cuisine, positively hide bound.

Bad for France. But not, one would have thought, intolerable. If France were committed to the creative destruction that most Western economies and cultures take for granted, this should have been a simple matter. Accept your losses, make your accommodations, and move on.
But in France this was not simple. It would have meant compromising the beautiful idea, the magnificent theater of French life. (And this is very beautiful indeed. Even the smallest details of the built world exhibits the French faculty for fineness. And you find yourself thinking, "ok, this is what it looks like, when everyone in a culture, over a very long period, cares about design and execution.")

This may be the only Western culture in which the phrase "creative destruction" is fully paradoxical. All of us balk for a moment at the phrase, but the French, I think, must just shake their heads and say, "no, it's creative or it's destructive." This is a culture that approaches perfection, and for a world like this all of the things that make other Western economies go, innovation, responsiveness, competition and innovations, these, in France, are wrong. These contradict the the French style of life.

The English could invent punk because there wasn't very much to keep them from the aesthetic violence it required. The Germans could rebuild the nation state because all it demanded of them was that they tear down a place stinking of cabbage and soft coal. Americans could push us all down the bobsled of post modernity because all it meant was surviving the the bouleversement of Silicon Valley in the late 1990s.

But the French, for them change must feel lapsarian, a fall from an exquisitely accomplished grace. The rest of us blunder from a uncertain present into the maw of a chaotic future, but then as one of my French respondents said, "it's not like you've got very much to lose." The French, you see, pay dearly for change, and sometimes they just can't bring themselves to budge."

References
Thornhill, John. 2007. Not working: why France may find its social model exacts too high a price. Financial Times. April 16, 2007, p. 9.
Thanks to Tyler Cohen for linking to this piece.

Describing Inflation

2007-04-30T19:37:00.000-07:00

Inflation is often used inconsistently in the press. For example, today's FT:

"China’s voracious appetite for commodities ranging from copper to corn is now lighting a fire in a new sector – timber. Businesses dealing in wood in Europe say the cost of timber is soaring amid an acute shortage of supplies. According to the Office for National Statistics in the UK – a big importer – the inflation rate for wood products hit 13 per cent last month – its highest level for more than a decade."

However, as described here by Mark Thoma, inflation can only be sustained if caused by an increase in the money supply. (and to be specific, in increase in velocity of money). Basically, if the money supply is increased, but the amount of goods that that money is chasing is constant, the price level will rise assuming aggregate demand is unchanged. However, in the article above refers to a price rise (or inflation as they call it) caused by "China's voracious appetite for commodities". This means that prices are rising because more people are buying, or trying to buy the product. This is not inflation in the true sense of the word. This is just a rightward shift in the demand curve for timber.

Lazy, Job Stealing Immigrants?

2007-04-30T19:15:00.000-07:00

Sebastian Mallaby examines the myths embedded in the debate over illegal immigration. His column is pasted below, but here's the gist:

Myth 1: Immigrants steal American jobs!

Not really, in fact, companies that would have located outside the United States have a greater incentive to do business here because of the supply of low skilled, low wage labor in the United States. So, immigrants also create jobs for American workers and managers.

Myth 2: Illegal immigrants drain federal, state, and local governments of revenue.

False, recent studies suggest that the effects of undocumented workers on Uncle Sam's pocketbook is about zero.

Myth 3: Even if illegals don't steal jobs from Americans, they drive down the wages of low skilled Americans.

Well...the evidence here is mixed and studies have found that undocumented workers have lowered the wages of low-skilled natives. In his column (pasted below), Sebastian Mallaby suggests that even if undocumented workers cause wage losses for some groups, the costs associated with preventing the inflows of illegals well outweigh the gains that could be achieved from stemming the inflow. I would add a footnote to that: If low skilled workers in the United States are losing jobs to or, in any way, competing for jobs with low skilled workers from Mexico that cannot speak English, policymakers should focus their attention on U.S. educational institutions. The U.S. is the richest country in the world; American workers should not be losing jobs to low skilled workers who, in some cases, cannot speak English.

Sebastian Mallaby in today's Post:

"...People say, contrariwise, that immigrants steal jobs from native-born Americans. But economists have patiently explained for years that there is no finite "lump of labor" in an economy. The presence of migrants causes new jobs to be created: Factories that might have gone abroad spring up in Arizona or Texas. Hasn't anyone noticed that California, where fully one-third of the adult population is foreign born, has an unemployment rate of less than 5 percent?

People say that immigrants burden social services while not paying taxes. Actually, undocumented immigrants are ineligible for welfare, food stamps and Medicaid; and although they do use hospital emergency rooms and schools, they also pay sales taxes and payroll taxes, and one in three pays income tax. The net result is that immigrants cost the average native U.S. household an extra $200 in taxes each year, according to a study of 1996 data. Once you take into account the boost to pretax incomes caused by immigrants' contribution to growth, the total effect of undocumented workers on native-born Americans is roughly zero, according to Gordon Hanson of the University of California at San Diego.

People say that immigrants cause wage losses even if they don't cause job losses. Here the story is subtle: Some studies find no evidence that immigrants pull down wages, while others find that native-born high school dropouts lost as much as 9 percent of their earnings between 1980 and 2000 as a result of immigration. But -- and here comes the sane scream -- there's no way that even a 9 percent wage loss can justify the policies that immigration hawks advocate.

Really, how much could draconian enforcement restore those wages? Between a quarter and two-fifths of undocumented workers originally enter legally, so stringent border enforcement could only affect about two-thirds of new arrivals. Moreover, arrivals are only part of the issue; the alleged downward pressure on wages comes less from the 400,000 illegal immigrants who show up each year than from the 35 million immigrants already here, two-thirds of them legally. And migrants will continue coming even if the entire southern border is walled off. Europe has a wall called the Mediterranean. It still has illegal immigrants.

Thanks to intensive enforcement over the past year, illegal immigration from Mexico is thought to have fallen by a quarter. Suppose even more spending could cut the number of illegal entrants from 400,000 to 200,000 a year, so that 2 million arrivals could be prevented over a 10-year period. Add in an aggressive deportation program that ejected 1 million illegals, and you are still only scratching the surface. Even if immigration has driven down wages for high school dropouts by 9 percent, it's hard to see how truly vicious counter-immigration policies could drive them up by more than about 2 percent.

That simply can't be worth it. Border security does not come cheap: We could save money on unmanned aerial drones and use it to help high-school dropouts with a more generous earned-income tax credit. And although the concern for high-school dropouts is welcome, it must be weighed against the aspirations of migrants. Is it right to push native workers' pay up by 2 percent if that means depriving poor Mexicans of a chance to triple their incomes?

Of course it isn't, and given that the total economic effect of immigration on U.S. households is a wash, the big ramp-up in enforcement spending beloved by immigration hawks is an egregious waste of money. But no politician is going to say that. Candidates with a good record on immigration -- Rudy Giuliani, Hillary Clinton, John McCain -- are trying to avoid the issue. And the demagogues and nativists are allowed to spout unchallenged nonsense."

Bob Samuelson Discusses the Benefits of a Recession?

2007-04-25T18:13:00.000-07:00

Bob Samuelson in today's Washington Post:

"Start with inflation. You may have noticed that last week's release of the March consumer price index (CPI) -- the government's main inflation indicator -- inspired much optimism. "Inflation Fears Relax," headlined the Wall Street Journal. Stock prices jumped on the supposedly good news. But if you actually examined the CPI report, you found that prices in March rose at their highest rate since September 2005 and that, over the past three months, they've increased at a 4.7 percent annual rate. Doesn't sound like retreating inflation, does it?

What explains the discrepancy is "core inflation." That's the CPI minus food and energy prices. In March, core inflation did subside, prompting the upbeat spin. But you might wonder: We must pay for food, gasoline and electricity; why strip them out? The usual answer is: These prices jump around from month to month; they often reverse themselves (oil prices were high in the early 1980s, low in the late 1980s); core inflation better reflects the underlying trend. This is hardly wishful thinking. Since the early 1980s, the two indexes (the CPI and the core CPI) have recorded -- despite many monthly differences -- virtually identical increases.
But suppose that this relationship is breaking down. We all know about oil. Prices are about $60 a barrel. They seem unlikely to return to $28, the 2000 level. The real surprise involves food prices. In the past three months, they've risen at a 7 percent annual rate. We may be seeing the first adverse effects of the ethanol boom. Corn is a main feed grain for poultry, cattle and hogs. Corn is also the main raw material for ethanol, an alternate fuel for gasoline. Competition for grain has pushed up corn prices to about $3.50 or more a bushel, almost double a typical level. High feed prices have discouraged meat producers from expanding. The resulting tight meat supplies raise retail prices...

Now switch to recession. Since 1982, there have been only two (1990-91 and 2001). That's good. In the previous 13 years, there had been four (1969, 1973-75, 1980 and 1981-82). Almost everyone dreads another one...

Hardly anyone likes what happens in a recession. Unemployment rises, production falls, profits weaken, stocks retreat. But the obvious drawbacks blind us to collateral benefits. Downturns check inflation -- it's harder to increase wages and prices -- and low inflation has proved crucial to long-term prosperity. Downturns also punish and deter wasteful speculation. When people begin to believe that an economic boom won't ever end, they start to take foolish risks. Partly, that explains the high-tech and stock bubbles of the late 1990s and, possibly, the recent housing bubble.

Some sort of a recession might also reduce the gargantuan U.S. trade deficit, $836 billion in 2006 (just counting goods). Almost everyone believes that the U.S. and world economies would be healthier if Americans consumed less, imported less, saved more and exported more. The corollary is that Europe, Japan, China and the rest of Asia would rely more on domestic spending -- their own citizens buying more -- and less on exports.

Ideally, this massive switch would occur silently and smoothly. Realistically, the transition might not be so placid. A slowdown in Americans' appetite for imports would involve weaker overall consumer spending, about 70 percent of the U.S. economy. Such a slowdown might also be needed to persuade other countries to stimulate their domestic spending.

Almost no one wishes for a recession, but the consequences might not be all bad."

What's Squeezing the Middle Class?

2007-04-24T21:41:00.000-07:00

David Leonhardt writing in today's NY Times:

"There are two different stories people tend to tell when they’re trying to explain why the middle class is feeling squeezed. The first one is about inequality. The top 0.1 percent of earners — that’s one taxpayer out of every 1,000 — now brings in 11 percent of the nation’s total income, triple the share that they did just a generation ago. This has happened because the rich have grown ever richer, while the pay of rank-and-file workers hasn’t risen much faster than inflation.

The second, related story is about instability. Layoffs seem to happen more frequently than they once did, and these job losses — combined with the spread of bonus pay — have caused workers’ incomes to bounce around a lot more than in the past. So not only have middle-class families been getting meager raises, their finances have also become more volatile.
The story about inequality is indisputably true. But we’re starting to learn that the second story, the one about instability, is more complicated. It may even end up being wrong...

Last week, the Congressional Budget Office released a study that was arguably the fullest picture of economic volatility anyone has yet put together...If you read the C.B.O. report, you can tell that its authors knew they were dealing with a delicate subject. The summary starts by noting that a “significant number of workers experience substantial variability in their total wage earnings,” which is certainly true. Only later do you come to the surprising part: there is the same amount of variability now that there was in the 1980s and 1990s. In journalism, this is known as burying the lead...

We can all tick off reasons that the economy feels so volatile. Hardly a week goes by without another big corporation — the Tribune Company, Citigroup, DaimlerChrysler — announcing a big job cut. The number of temporary jobs, meanwhile, has mushroomed. Globalization and technological innovation are causing many of these changes, and labor unions are too weak to prevent them...But there is also a whole set of other forces, harder to see and pushing in the other direction. Manufacturing, where furloughs and layoffs have always been the norm, accounts for a much smaller part of the work force than it used to, while more stable industries, like health care, have grown. This is one reason that recessions, and the job cuts they bring, haven’t happened as often as they once did.

Yesterday’s layoffs could go unnoticed by people who weren’t affected by them because they were a regular part of doing business. Today’s tend to come in big chunks and are often announced in news releases. “There have always been a lot of mass layoffs,” said Lawrence F. Katz, a labor economist at Harvard. “We didn’t count them before.” In fact, research by Henry S. Farber, an economist at Princeton, has found that job loss rates have followed a cyclical pattern since the early ’80s, peaking around the same highs during recessions and falling to similar lows during expansions. (The rate has risen for workers who went to college and fallen a bit who those who didn’t.) Americans, looking at their own jobs, realize that there hasn’t been a big change: in a recent Gallup Poll, 12 percent of respondents said it was very or fairly likely they would be laid off in the coming year. In the 1970s, ’80s and ’90s, at similar points in the business cycle, the percentage was virtually identical.

I don’t want to exaggerate how much we know about instability, because there are some conflicting signals. Mr. Farber has also found, for instance, that average job tenure has declined during this time. Maybe people are more willing to leave a job voluntarily — or maybe companies nudge more workers out the door with early retirements and other stealth layoffs.
The C.B.O., for its part, has looked only at the pay of individual workers. In the future, economists there will look at family income — which is affected by divorce and other factors — and could potentially find changes there, as some academic work has.

The bottom line, though, is that the picture is likely to look mixed. Volatility may or may not have increased over the last generation, but it does not appear to have changed in a fundamental way.

Inequality is a whole different story. It has risen enormously and is not about to stop. With the recent jump in gas prices, the pay of rank-and-file workers is once again failing to keep pace with inflation, just as it did from 2002 until early last year, despite healthy economic growth.
In fact, inequality is probably the real reason that the economy often feels more volatile. When people are stretched — when their pay has been stagnant, when they’re worried about health insurance, when they don’t know what the future holds — a jolt to their income is harder to handle.

As the C.B.O. pointed out, these jolts do happen a lot, even if they don’t happen more than in the past. In 2003, a whopping 20 percent of workers saw their earnings drop 25 percent or more compared to the previous year. (For about 22 percent of workers, earnings rose at least 25 percent.)

But it’s important to keep in mind what is really changing. As Mr. Schumer says, “If you’re holding a job but your share of the pie is getting smaller, that’s a different set of policy needs than if you keep losing your job.”

In an economy where volatility was the main problem, you might want to protect jobs by making it harder for companies to cut them. In an economy where inequality was the problem, you would want to protect people. You would help them pay for health insurance, retirement, their children’s education and other basic needs when the market, left to its own devices, was not doing so.

And if your resources were limited, wouldn’t you start with the problem you were sure that you had?"

McCain's Economic Policy

2007-04-24T20:37:00.000-07:00

McCain's op-ed in today's Financial Times provides a look into what his economic policy team has in mind:

"The world made the grave error of building walls against trade 75 years ago and it contributed to the Great Depression. Since that time, the US has been in the forefront of the fight for reduced barriers to trade and has reaped the benefits of sustained growth in standards of living, an awesome display of innovation and technical advance, an explosion in the variety, quality and affordability of consumer goods, a rise in home ownership, and ascendancy to become the world’s greatest economy.

But we must also face the fact that opening new and integrated world markets won’t automatically translate into higher quality of life for every American. It is government’s job to help workers get education and training. Instead we have outmoded and redundant training programmes and nobody in government bothers to check whether they work. This is unacceptable. We have an obligation to deliver a single, effective system for assistance, training and relocation.

Low, efficient taxes and open, level global markets are central to success, but both are threatened if reckless government spending is allowed to continue. An economy cannot be economically free if it is festooned with massive government spending."

Although it's not surprising that a conservative candidate is championing lower taxes and "economic freedom", his mention of reexamining programs to help and/or retrain displaced workers is telling. Presumably, this means that McCain plans on overhauling trade adjustment assistance, which is designed to provide unemployed benefits and retraining/job search assistance to displaced workers, but is, for the most part, badly underutilized - most workers don't know about it or don't bother to use the services it provides. In the past, the Bush administration has been accused for purposefully making it difficult for unemployed workers to access the services provided for by the program.

Here is the GAO report that takes a close look at the problems with TAA. Also, an IIE paper that offers specific proposals for improving the program.

Due Budget Deficits Matter?

2007-04-23T21:28:00.000-07:00

From Jared Bernstein (Economic Policy Institute):

Perhaps, given my bias, I should recuse myself from the argument I’m about to make. You see, on our first date, I impressed the woman who is now my wife by convincing her conservative brother-in-law that budget deficits are not always a problem. Such is DC romance.

That was over a decade ago, but the issue remains both contentious and misunderstood. That’s why I was so interested in the recent talk given at the Economic Policy Institute by Joseph Stiglitz, Nobel Laureate economist and all around interesting guy. What’s unique about Stiglitz is not that he always rejects conventional wisdom—he doesn’t. It’s that he looks at in the context of the real world, and often finds it lacking.

Both in his talk and his writings, he seems genuinely and appropriately worried about a mania for balancing budgets. If I could summarize his message in one over-arching thought, it would be: too often, our budget debates mindlessly assume that deficit reduction is the best option, both for us and for other countries with whom we do business. This simplistic, reductionist view is leading both political parties toward a philosophy of fiscal austerity which will have very negative consequences.

The debate is far from academic. Misguided thinking about deficits has led to the two options that form the core of the fiscal debate between Democrats and Republicans: the D’s want to balance the budget by holding down spending and letting (some of) the Bush tax cuts expire, the R’s want to do so by extending the Bush tax cuts and cutting spending, big time. Make no mistake, when John McCain says in a recent speech that he wants to “save entitlements,” he means he wants to save them by shrinking them. These two options have crowded out the third: raise the revenue we need to support that which will make our economy and country stronger.

Stiglitz framed the issue in terms of two pressing problems: a short-term and a long-term one.
First, there’s the fact that the economy is currently growing about one point below its trend (with real GDP growth around 2-2.5% per year instead of 3-3.5%), a problem Stiglitz attributed mostly to the slump in housing and the loss of stimulus from this sector. In this context, taking money out of the economy by pursuing deficit reduction would do more harm than good.
You don’t hit someone when they’re down, and you don’t pursue deficit reduction when the economy is already stressing out. As Stiglitz noted, “The idea that deficit reduction leads to a strong economy was an idea that Andrew Mellon tried in the midst of the Great Depression…the effect, of course was not positive. Then came Keynesian economics.”

In the current context, this is hopefully a short-term problem and one that even some pretty hawkish folks on the deficit will be okay with. The more important question is the longer-term one: what’s the proper role of deficit spending in good times?

Here’s where reductionism—a zombie-like allegiance to balancing the budget—is your enemy. Stiglitz argued “that we should never focus just on deficits, but on broader economic concepts.” What’s the magnitude of the deficit relative to GDP (it’s now a very manageable 2%)? What are we spending it on (we’re wasting far too much of it on the war and tax cuts for the rich instead of accumulating worthwhile assets)? Are we, in the interest of balancing the budget, ignoring important investments that the private sector won’t make?

It’s on this last point where I thought Stiglitz’s message was most important, and it’s where we’re furthest off track. We have large and growing needs for investments that market forces simply won’t make.

We would be much wiser to focus on these deficits: early childhood development and education; access to higher ed for those who ought to be there but can't pull it off; our public health care system, which will absolutely need to expand in coming years as the private, employer-based system unravels; safety nets: programs like unemployment insurance and job training that can help those displaced by globalization; and, one Stiglitz emphasized, environmental policy.
Yet, even the most progressive budget alternatives, such as that of the Progressive Caucus, brag on the fact their budget gets to balance before all the others. This is a disheartening example of Bob Kuttner’s observation about deficits and Democrats: they’ve elevated a defensive tactic—hawkishness on deficits to stave off wasteful tax cuts—to a principle: balance budgets regardless of whether you’re foregoing short-term stimulus or needed investments.
Which brings us to politics.

Since when did Democrats become slavishly committed to fiscal austerity? As Kuttner explains in a recent critical piece about Bob Rubin, much of this comes from the belief that balancing the budget in the Clinton years drove the 1990s boom. When asked about this at EPI, Stiglitz explained that in his view deficit reduction had little to do with it: the boom was more of function of unique conditions in the banking sector that made borrowing cheap and financed an investment boom (that ultimately became a bubble).

Alan Blinder and Janet Yellin (both were top Clinton economists; Blinder was vice-chair at the Fed; Yellin’s there now) take the closest analytic look and are unable to pin the Clinton boom on deficit reduction. Instead, lower health care and energy costs boosted the economy, and, most importantly, productivity accelerated, facilitating both low inflation and interest rates. It was the revenue growth from these developments that balanced the budget, not the other way around.

But urban legends die hard, and Rubinomics, with its emphasis on balanced budgets, still holds sway in the top reaches of Democratic power. Word is that both Hillary Clinton and Obama are listening more closely to Bob than to Joe.

This is too bad, because more than any prominent economist, he understands the damaging limits of fiscal austerity, and the extent to which it undercuts our ability to tackle the big problems of today and tomorrow, from frayed safety nets to depleted ozone, from the war on poverty to the war in Iraq.

So move over Bob, and make room for Joe. We need him, or at least his ideas, at the table too.

General Consequences of a Falling Dollar

2007-04-23T19:39:00.000-07:00

For a general look at the costs and benefits of a falling dollar, I've pasted an example filled article from Terri Belkas, a currency analyst at Daily FX:

With the Euro hovering near its record highs and the British pound having breached the psychologically important 2.000 level, the extent of the US dollar’s weakness has finally been recognized. As we have seen in the past few months, the value of the US dollar is important not only for currency traders, but also for equity traders. It is hardly a coincidence that the US stock market hit an all time high around the same time that the US dollar reached multi decade lows against currencies like the British pound, New Zealand dollar and the Euro. The strength of those currencies has made US stocks attractive values for foreign investors and looking ahead, the value of the US dollar can be a useful tool for equity traders, especially those who are looking to buy or sell the shares of big US importers and exporters.

US Dollar and the Impact of Its Value on Stocks

In order to assess the impact of the US dollar on stocks, we compare the performance of the Dollar Index with the stocks of Wal-Mart (a big importer) and Boeing (a big exporter). The chart below clearly indicates that a drop in the US dollar leads to the underperformance of Wal-Mart over Boeing. In fact, the correlation between the two components has been a whopping 74 percent over the past few months with the Dollar Index (blue line) often leading the movement of the Wal-Mart / Boeing ratio (red line). The rationale for the correlation is simple. When the US dollar weakens, importers have less purchasing power so they are faced with one of two options, which is either to increase prices or take a hit to profits. Exporters on their hand find their goods automatically more competitively priced in the global market place, which only adds to earnings. Equity traders may find it useful to keep this information in mind when picking which companies to buy or sell.

A Deeper Look Into Who Wins

When we compare Boeing to Airbus – the US and French based companies competing to sell two of the biggest passenger planes in the world, the importance of the value of dollar can be understood further. Sales of Boeing’s Dreamliner have far outpaced those of Airbus’s A380, which has been plagued by delays and production problems. Furthermore, Boeing’s profitability prospects are far greater than that of Airbus, as the Dreamliner is priced in US dollars whereas Airbus’s products are priced in Euros. Given this pricing advantage, Airbus has gone so far as to cut the price of their mid-size A350 in half in order to draw more demand. Nevertheless, a quick look at the share prices of these respective companies gives an even clearer picture: over the course of the past year, shares of EADS (producer of Airbus) have fallen nearly 22 percent while shares of Boeing have climbed 11 percent. The markets have spoken.

Other American exporters have gained from the weaker dollar as well. IBM saw stronger-than-expected quarterly profit growth on the back of a 13 percent jump in revenue from the Middle East, Europe, and Africa while US markets only saw a 1 percent gain. Meanwhile American firms like Al-jon Manufacturing LLC in Iowa have benefited from a jump in demand from Asia for scrap steel with a lengthy waiting list until the end of the year.

Not Everyone Wins When the Dollar Dwindles

Simple logic tells you that when someone wins in a deal, someone else has got to lose. As of last year, 70 percent of the goods Wal-Mart sold were produced in China. While the company has started to turn towards India for less pricey goods, there is only so much the American superstore can do to offset the implications of a dwindling dollar. European and New Zealand companies have also run into major pitfalls as the weakness of the US dollar drove the value of the Euro, British pound and New Zealand dollar higher. Corporate earnings for European companies, such as UK fashion group Burberry, were stellar for the second half of the fiscal year as demand for luxury goods have skyrocketed. However, the company reported that the British Pound’s appreciation against not only the US dollar, but the Japanese yen as well, may slash revenues by a whopping 7 million pounds. Meanwhile, Paris-based L’Oreal saw revenues beat analyst estimates, with sales up 7.9 percent in the first quarter. The devil is in the details, though, as the sales figure does not account for exchange rate fluctuations. The rapid rise of the Euro during the quarter actually produced a negative 4.1 percent impact on sales.

The plunge of the dollar was perhaps worse for New Zealand companies, as the New Zealand dollar hit 25 year highs. Sanford, a fishing company based in Auckland, said that while demand out of Europe remained strong, exports to US markets plummeted as the company’s catches were far more expensive. Furthermore, foreign exchange losses for the firm amounted to more than NZ$7 million, which decimated earnings for the second half of the fiscal year.

Déjà vu – A Repeat of 2004?

European companies are no strangers to the impact of a dwindling dollar. Back in 2004, a crunch of the greenback sent the Euro to a record high of 1.3667. As a result, exporters like Volkswagen, which has no production facilities in the US, making the company even more susceptible to currency fluctuations, had their earnings slashed as the automaker faced a loss of $1 billion in the US in 2004 alone. LVMH faced a similar debacle, as the luxury goods producer had their profits cut in half during the year due to foreign exchange losses. While these companies had no choice but to take the hit, other exporters decided to take action. Italy-based clothier Benetton announced plans in late 2004 to shift more factories outside of the Euro-zone to lower costs in order to compete with rivals such as H&M, whose manufacturing costs were in US dollars.

Japanese companies aren’t typically viewed as being as vulnerable to currency shifts since the yen’s value is extremely low relative to the US dollar. However, 2004 also represented harsh times for exporters like Nintendo. While sales did not suffer in the US market, where stores faced a shortage of consoles in the run-up to Christmas, the company revised profit forecasts early in the year down 39 percent on foreign exchange losses. Nintendo was particularly affected by the dollar’s plunge since it holds about $5 billion worth of dollar-denominated deposits, which need to be revalued every year.

While foreign exchange losses are still an issue for companies who export goods to the US, many of them have learned the importance of hedging these losses. After a rough 2004, Volkswagen increased hedging so that the company was 75 percent covered against a future drop in the dollar from 40 percent in 2003. Following the lead of Italy’s Benetton, Volkswagen opted to shift production out of Europe to Mexico, whose peso was more closely linked to the dollar. Meanwhile, Japan’s Nintendo cut back on the amount of assets held in US dollars.

Looking Ahead, Canada and the Europe Remain the Most Vulnerable
Nevertheless, foreign companies still face a certain amount of exchange rate risk, and Canadian and European companies could remain the most assailable. The US is by far the biggest trade partner of Canada, with 85 percent of the country’s exports shipped to the US last year. During the month of January, the Canadian dollar eased back to 14 month lows against the greenback, subsequently leading to a jump in exports to the US. However, the status of Canada’s export sector may become increasingly precarious going forward, faced by the double-edged sword of commodity price and exchange rate risk. First, should commodity prices continue to ease back, the value of goods shipped out of the country could easily decline and erode Canada’s trade balance. Furthermore, if the Canadian dollar appreciates more throughout the second quarter as it has done in the first, the country’s primary trading partner may cut back on purchases of Canadian products and undermine the strength of the economy as a whole.

Europe faces a similar dilemma, with export-dependant Germany at the forefront, as the hasty appreciation of the Euro against the US dollar helped drive the 2006 Euro-zone trade balance into deficit for the first time since 2000. While the German trade balance has been buoyed to 13.8 billion euros by demand from within Europe, deficits with Russia, China, and Japan have soared amidst gains in energy prices along with marked weakness of the Chinese Yuan and Japanese yen. As a result, Germany and other countries within the Euro-zone will face even more pressure to build up domestic demand in order to pick up the slack of the export sector.

If the US dollar begins to bottom out at current levels however, expect the relationship between the Dollar Index and the ratio of importers / exporters to hold. Except this time, a rise in the dollar will begin to help importers and hurt exporters. According to our chart, when the dollar index rallied from 82.50 to 85.25 in December 2006, the ratio of Wal-Mart / Boeing increased from 0.51 to 0.55.

Who/What is Keeping the U.S. Economy Afloat?

2007-04-21T22:53:00.000-07:00

From the Big Picture:

This is the most cogent argument for what has been a key supporting element to the US markets: Overseas economic strength. Even as the US decelerates, the overseas strength, driven primarily by China, but with growth in Japan and the rest of the Pacific Rim, as well as Europe, is maintaining the global boom.

We have discussed over the past few Qs exporters, who can sell into those markets, and take advantage of the weak US currency. That continues to be the greatest market strength out there -- not so much their consumers, but their massive infrastructure development. And, as strong as the US markets appear, they continue to lag most world markets.
Barron's Mike Santoli sums it up nicely:

"THE REST OF THE WORLD IS CARRYING THE U.S. STOCK MARKET. Fast-galloping overseas economies, flush world capital markets and a sagging dollar fatten multinationals' earnings and furnish the fuel for commodity-related stocks to surge.
That's the takeaway from the earnings beats by Caterpillar (CAT) and Honeywell (HON) last week, the 22% jump in the Philadelphia Steel Producers index since March 5, the continued outperformance of foreign stock indexes, the seven-month high in copper and the run toward $700 an ounce in gold.

As a result, materials stocks are the new momentum favorites, and more broadly, traditionally cyclical sectors are being treated and valued as perpetual-growth vehicles -- a process even extending to sectors like railroads and utilities, now considered implicit plays on the commodity-demand boom."

Where Does Walmart Get It's Products?

2007-04-21T16:01:00.000-07:00

A map detailing the percentage of Wal-Mart's products coming from foreign countries

Fun Ways of Viewing Boring Data

2007-04-21T13:36:00.000-07:00

The video below is from Gapminder.org, an organization that turns really boring data into interactive video presentations. One of the cooler parts of their site allows you to plot time series data on multiple economic and development indicators collected by the World Bank and the United Nations Development Program. Check out this feature

Is World Poverty Getting Worse?

2007-04-21T13:26:00.001-07:00

Stagflation in 2007? No, Stagflation-Lite

2007-04-18T23:16:00.000-07:00

My post below discusses the tension faced by the Fed, but doesn't go into the question, "Is the high inflation and slow growth of today similar to the "stagflation" experienced in the 1970s:

Here's The Big Picture on that question:

"For some reason, the word stagflation keeps creeping back into the lexicon. It really shouldn't be. As we have noted for quite some time, we are experiencing a form of "demi-stagflation." Growth is below the long term trend, inflation is above.Call it stagflation lite or blahflation, but it is not the 10% inflation, 1% growth of the 1970s. So why are so many concerned about stagflation?

• GDP growth expected in Q1 07 to be < 2%
• CPI = 2.7%
• Spreads between 10y TIPS and non-inflation-indexed Treasuries widened
• Fed governor Miskin notes that if inflation does not moderate "we would have to do something about it"
• GDP growth expectedMiskin notes that if inflation does not moderate "we would have to do something about it"

Caroline Baum has more details:
"Is it stagflation or is it just normal, late-cycle behavior of a lagging indicator?'' says Paul Kasriel, director of economic research at the Northern Trust Corp. in Chicago. ``In the stagflation of the '70s, energy prices were rising because of absolute declines in oil production. There was a wage-price spiral because of strong unions. Neither of these holds today.''

Inflation has the distinction of being a lagging economic indicator. The change in the CPI for services is one of seven components of the Index of Lagging Economic Indicators. A second laggard is the change in labor cost per unit of output, or "wage inflation,'' another faux concept. (Wages are the price of labor. Inflation is a general rise in the price level.)

What that means is that over time, these indicators have proved to turn up after the business cycle trough and down after the peak. "Inflation typically lags growth by about a year, so the slowdown in growth since the spring of last year has only just started to depress core CPI,'' says Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, New York. "The process has much further to run.'' As always, interesting stuff from Ms. Baum."

One Child Is Enough, Apparently

2007-04-18T21:45:00.000-07:00

A recent study suggests that couples are better off with one child:

"In comparing identical twins, Kohler found that mothers with one child are about 20 percent happier than their childless counterparts; and while fathers' happiness gains are smaller, men enjoy an almost 75 percent larger happiness boost from a firstborn son than from a firstborn daughter. The first child's sex doesn't matter to mothers, perhaps because women are better than men at enjoying the company of both girls and boys, Kohler speculates.

Interestingly, second and third children don't add to parents' happiness at all. In fact, these additional children seem to make mothers less happy than mothers with only one child—though still happier than women with no children. "If you want to maximize your subjective well-being, you should stop at one child," concludes Kohler, adding that people probably have additional children either for the benefit of the firstborn or because they reason that if the first child made them happy, the second one will, too.

Thanks to Tyler Cohen at Marginal Revolution for bringing this to my attention.

The Rich and The Rest

2007-04-18T21:06:00.000-07:00

Bob Samuelson provides an overview of the economic problem that is the U.S. income distribution:

In a democracy, there is something unsettling about great extremes of wealth and poverty. One question today is whether rich Americans are claiming too much of the economic pie. Look at the latest astonishing estimates from economists Emmanuel Saez of the University of California at Berkeley and Thomas Piketty of the Paris School of Economics. They find that the richest 10 percent of the population received 44 percent of the pretax income in 2005. This was the highest since the 1920s and 1930s (average: 44 percent) and much higher than from 1945 to 1980 (average: 32 percent).

But the biggest gains occurred among the richest 1 percent. Their share of pretax income has gradually climbed from 8 percent in 1980 to 17 percent in 2005. Indeed, many others in the top 10 percent seem mainly upper middle class. For example, those in the richest 90th to 95th percentiles had incomes of about $110,000.

...As for what's caused greater inequality, we're also in the dark. The Reagan and Bush tax cuts are weak explanations, because gains have occurred in pretax incomes. Globalization, by increasing company sizes, may have boosted executive salaries and payouts. The economy also has become more competitive -- with more pressures on firms from foreign rivals, new technologies and the stock market. Pay practices de-emphasized "fairness" and focused on what the market would bear. Opportunities for huge gains -- from company start-ups, from dealmaking -- mushroomed.

...That said, the inequality debate is misleading. Up to a point, inequality is inevitable and desirable. The prospect of doing well encourages people to work hard, develop new skills and take risks. It anchors America's entrepreneurial spirit and economic success. Most of today's rich have earned -- not inherited -- their status. Among the top 1 percent, report Saez and Piketty, more than four-fifths of income comes from salaries and self-employment. In 1916, the top 1 percent relied far more heavily on income from dividends, interest and rent.
The question of whether the rich pay their "fair" share of taxes has triggered one of those debates in which both sides are half right. It's true, as liberals say, that the Bush administration pampered the rich. Tax cuts on capital gains (stock profits) and dividends weren't needed as incentives. Ending the estate tax would be similarly unwise. But it's also true, as conservatives say, that liberals popularize the fantasy that taxing the rich more will solve most budget problems.

It won't. The richest 10 percent already pay half of all federal taxes, including the 25 percent paid by the top 1 percent. Just how much these taxes could be raised without dulling economic incentives and stimulating massive tax avoidance is unclear. But increasing the taxes on the top 1 percent by 25 percent wouldn't cover even today's budget deficit, let alone pay for new programs (universal health insurance, more school aid) or baby boomers' retirement costs.
It would be healthier if the trend toward greater economic inequality reversed itself spontaneously. The poor aren't poor because the rich are richer. Their poverty reflects low skills, poor work habits or bad luck. But if the middle class thinks the rich are grabbing most of the gains from economic growth, they will feel resentful. The result could be a self-defeating debate over income redistribution, not growth. To paraphrase economist John Maynard Keynes: The rich are tolerable only so long as their gains can be held to bear some relation to roughly what they have contributed to society."

The Fed Can Rest Easy

2007-04-18T20:54:00.000-07:00

As mentioned in previous posts, the Fed has been walking a tightrope between providing sufficient liquidity to support economic growth during a time of distress in some sectors of the economy, notably housing, while also keeping inflation in hand. This got a bit easier yesterday, when inflation data was surprisingly low in the United States, meaning the Fed can hold off on raising rates while still keeping a close eye on economic growth and inflation.

According to Lehman's Drew Matus (cited in today's FT):

"The inflation numbers give the Fed more breathing room. This gives them a little more time to wait and see and let things develop."

In a related story, going to graduate school in London just got a bit more expensive. The dollar is now trading 2 to 1 against the pound. Ouch!

Should Clean Water Have a Price?

2007-04-10T20:48:00.000-07:00

From Jesse Shapiro, Becker Center on Chicago Price Theory, University of Chicago, writing in this week's Forbes:

"Each year some 1.6 million people, most of them small children, die form diarrhea caused by poor water quality. Many of these deaths are avoidable. Anyone with a back-yard pool knows dirty water is easily made safe by using good old-fashioned chloring...so why could charging more (for Clorin, a water sanitizer) help solve this problem?...First, it might be that charging a price means only people who intend t use it will show up to buy. with free products there's a risk that people will take a sample with no intention of using it. I'll gladly accept a free subscription to a boring magazine; whether I'll read it is another question. Second, it could be that paying, or paying more, makes the buyer feel that he should use the product. This is why I'd finish an expensive bottle of wine even if it tasted like perfectly aged mouthwash, but I'd toss a cheap bottle with the same iffy flavor down the drain."

Fortunately, Dr. Shapiro tested the theory:

"In the spring of 2006, in collaboration with PSI, we sent marketers to visit 1,000 households in Lusaka, Zambia. At each house a marketer offered to sell a single bottle of Clorin at a randomly chosen discounted price. If the household agreed to buy Clorin at that price, we then surprised them with a second discount, again chosen randomly. here's what we found: Households that agreed to pay more for Clorin did use it more; their water was more likely to be chlorinated when we showed up to test it two weeks later. As for the surprise discount, we found that when we gave people a deal, it didn't affect how much Clorin they used. But there is some evidence that those who paid something were more likely to use their Clorin than those who got it for free. That is, the data hint that the act of paying in itself may make people more likely to put Clorin in their water...the results do show that pricing can help to get lifesaving products into the hands of those who will use them most. What's more, charging a price may cause people to use more than they otherwise would."

America's Trade Debate: Commentary from a Free Trader

2007-04-09T18:53:00.000-07:00

To follow up on Martin Wolf's post in last week's FT discussed below, Jagdish Bhagwati argued in today's FT that 1) U.S. economic policy geared toward signing bilateral trade deals as a second best alternative to multilateral trade is undermining progress on the Doha Round of multilateral trade talks, and 2) That opponents of free trade who support minimum environmental and labor standards are actually economic protectionists using the environment and labor rights to justify mask their self-interested economic motives for reducing import competition.

In his own words, argument #1:

"First, they (bilateral deals) have diverted the attention of top policymakers from multilateral negotiations. Second, they have helped to undermine political support for trade liberalization in the U.S. Congress, chiefly among the democrats. Amid anxiety over wages and jobs, wrongly blamed on trade and globalisation, it makes no political sense to take one piffling PTA (preferential trade agreement) after another to Congress...Each time a congressman votes for it, he expends scarce political goodwill. This applies particularly to Democrats whose constituents include a high proportion of workers. Asking Congress members to go repeatedly to a poisoned well has reduced their willingness to do so."

Argument #2

"...the democrats insist on inclusion in trade treaties of labour and environmental standards as elements of "fair trade" in a tougher way than ever before. The old Democrats, previously more sympathetic to free trade, are playing along, some from changed conviction and others from changed circumstances. Such standards may be demanded out of empathy for others or they may be required because of fear and self interest. The latter motive is clearly at play. It is hoped by those terrified by competition from poor countries that raising standards and therefore costs abroad will moderate the competitive ability of foreign companies...But, instead of admitting that this is their game, they want to mask their demands behind the language of altruism.; oh, we are doing it for your workers. The hypocrisy is astonishing and offensive..."

Federal Reserve and the U.S.'s Economic Outlook

2007-04-08T16:20:00.000-07:00

The Jobs report released on Friday by the Department of Labor showed a 180,000 increase in non-farm payrolls, and an employment rate that had fallen to 4.4 percent. The report should increase the Fed’s confidence that job growth will keep the economy on a stable trajectory, even with consumer confidence at low levels and with the difficulties in housing. The report should also allow Fed chair Ben Bernanke to breath a little easier for the time being. The Fed has primarily been focused on reducing inflation, whereas some commentators--including former Fed chair Alan Greenspan!--have suggested that a slowing economy is the biggest risk to the U.S. The data suggested that the U.S. economy could get through the year okay, but tight labor market data and the inflation numbers suggest that the Fed will need to raise rates to reduce inflation pressures.

Expect the market to fall on Monday as the news above reduces the chances of a rate decrease at the next FOMC meeting.

Are Bilaterals Good or Bad?

2007-04-04T18:01:00.000-07:00

There has been a lot of talk recently about the proliferation of bilateral trade agreements. Are they worth pursuing? Will they enhance or decrease the likelyhood of a multilateral trade deal in the future? The most recent round of multilateral trade talks (Doha Round) has stalled so countries have turned to negotating bilitaral deals which are much easier to negotiate and where the U.S. can take off the table its subsidies to politically sensitive areas.

The real question in this debate boils down to whether or not bilaterals are "building blocks" or "stumbling blocks" to multilateral trade. Underpinning pro-trade liberalization arguments is the number produced by the Peterson Institute for International Economics that complete trade liberalization would bring $500 billion in benefits to the U.S. per year.

The proponents of bilateral trade deals offer the following arguments:

1) More trade is good, so if we can't get a multilateral deal, bilaterals are the next best.
2) Bilateral deals can offer political benefits; Following 9/11 the U.S. negotiated trade deals with predominantly Muslim countries (Bahrain, Jordan, Morocco).
3) If we don't do bilateral deals, other countries will continue to negotiate them amongst themselves, at the expense of the United States.

For the opposing arguments, I refer to Martin Wolf in today's FT who comments on the recent deal awaiting approval by the U.S. congress between the U.S. and South Korea:

"The number of preferential trade agreements has exploded upwards in recent years. An agreement between the US and South Korea is itself a quantum leap in this progression. The US was the world's largest importer of merchandise products and South Korea the sixth largest in 2005. The US is also the world's largest importer of commercial services, while South Korea is the 12th largest. Other countries will be desperate to avoid the adverse effects upon them. This makes probable yet another jump in the prevalence of such agreements. That will have at least two further economic consequences. First, an increasing proportion of the world's trade is sure to be governed by the diverse rules of origins and special procedures of a host of discriminatory bilateral and plurilateral agreements. That guarantees an explosion in administrative complexity. Second, every further bilateral agreement will alter the degree of preference enjoyed by existing suppliers. That guarantees an explosion of business uncertainty. These are indeed inevitable results of what Prof Bhagwati has called the "spaghetti bowl" of preferences.
The political consequences of this development are, however, at least as important. First, a company's market access will depend increasingly on the power of its own government to lever open other markets rather than its competitiveness. Second, big powers will compete with one another to wrest more favourable terms for their own producers. The emergence of such power-driven trading blocs is a world away from the hopes of the founding fathers of the Gatt system.

Political and diplomatic capacity is also limited. While the US is focusing on preferential agreements, the Doha round of negotiations is incomplete. The EU is at least as culpable as the US for the failure to complete a round that would bring far greater benefits to world trade than any conceivable bilateral agreements. But if the attention of the US is diverted from multilateral to bilateral trade agreements, the Doha round is even less likely to be completed.
I am not totally opposed to the idea of preferential trade agreements. Regional agreements at least have a natural political and economic logic. More imaginatively, a free trade agreement open to the world could be the best route to global liberalisation, after the Doha round. Liberally minded countries could agree to a single free trade agreement open to any country prepared to sign up. Such an agreement could then ultimately be a template for global free trade.
As it is, however, it is far more likely that the move to discriminatory trade will end up fragmenting the world economy rather than integrating it in this imaginative way. If they were so minded, the members of the World Trade Organisation could sign some 10,000 different bilateral agreements among themselves. Does anybody think that this would be sensible? If not, at what point would the Gadarene rush cease? If the US, as the dominant economic player, makes discrimination a central principle of its own policy, how can it fail to become a global model, with predictable and disturbing results?"

Victimized by Bad US Trade Policy

2007-04-04T17:21:00.000-07:00

I can finally say that I was personally (negatively) effected by bad U.S. trade policy. Last week, the United States slapped tariffs on imports of glossy paper from China claiming that "the glossy paper is subsidized by the Chinese state". The US commerce department said they had no choice but "to act in a petition filed by an aggrieved U.S. paper company whose sales have been undercut by cheap Chinese imports." This is no good for me and the non-profit I work for as we print our electronic newsletters on glossy paper and send them to our funders. I was pretty shocked last week when color copies of our newsletter on glossy paper cost $15 for 16 pages! Apparently cheap Chinese paper has not yet found its way to the DC market; or it has but is about to get much much more expensive.

I find it funny/depressing that we use words like "cheap, unfair, predatory, ect." to describe China's subsidies of products imported to the U.S. By subsidizing paper, the Chinese are doing two things, 1) Making a calculated decision that it is worth taxing their people for the sake of the well being of their glossy paper industry, and 2) Indirectly subsidizing buyers of glossy paper in the United States, such as the company I work for. Do they think that the market for glossy paper is an excessively profitable enterprise? Whatever their reasoning for the subsidy is, it benefits my company, and on the whole it benefits the United States.

Instead of accusing the Chinese of attacking our suppliers of glossy paper, Secretary Paulson should:

a) Thank them for not subsidizing something else, like terrorism, their military, internet watchdog services, or the constuction of prisons to lock up their political dissidents. That would also make for a funny letter.

b) Laugh at them for providing subsidies to the glossy paper industry (am I missing something; is glossy paper a really valuable resource that the Chinese think will command high prices in the future? We're subsidizing research in the hard sciences and their subsidizing companies that cut down trees and process wood? I feel like I'm going crazy here)

c) At the very least commerce could calulate the benefits that the imports of glossy paper from China bring to the U.S., find that they outweigh the costs born by US suppliers of the glossy stuff, and (through the tax system) use a large chunk of the benefit to pay off the U.S. suppliers hurt by the imports.

What's Up with Sub Prime Loans?

2007-03-19T19:13:00.000-07:00

Over the past few months---and really over the past year---columnists and financial analysts have been making a wide range of predictions about the consequences of a slowdown in housing on economic growth. There have been a wide range of opinions raised about why home values are declining and what should be the focus of public policy on this issue, put one potential culprit for a decline in housing is getting a disproportionate share of attention: rising defaults among borrowers of subprime loans.

This post is meant to be a primer on the housing decline and the role of subprime loans in what could be a wider economic malaise.

1) What is a subprime loan?

A subprime loan is a loan issued to a borrower with a low credit rating that is unable to qualify for a mortgage from a traditional lender. Subprime mortgages are riskier loans--or else the mainstream lenders wouldn't have had a problem issueing them---to weak borrowers who usually have to borrow the down payment on a home purchase, leaving them with mortgage obligations equal to 100 percent of the purchase price. Obviously, they also bear a higher interest rate to compensate the lender for the greater degree of default risk.

When thinking about whether a subprime loan is a good or bad thing, it's important to realize that the benefit of the subprime market is that it is intended to provide home loans for people with impaired or limited credit histories. These borrowers are lower income individuals and likely have unstable income, savings, or employment, and a high level of debt relative to their income.

2) Why are you hearing about subprime loans now?

A few years ago, defaults in subprime mortgages wouldn't have been a big deal becuase subprime mortgages represented only a small fraction of the total mortgage market. Today subprime mortgages comprise almost one quarter of all mortgage originations. From 1994 to 2005, the subprime home loan market grew from $35 billion to $665 billion. Another fun fact, from 1998 to 2006, the subprime share of total mortgage originations climbed from 10 percent to 23 percent. So let's say that subprimes constitute 20 pecent of the mortgage market. the Center for Responsible Lending predicts that 20 percent of the subprime loans will end in forclosure. So a total of 2.2 million people could lose their homes. If you put about 4 or 5 percent of these homes back on the market within the next few months, there could be a serious effect on home valuations.

Writing in the WSJ on 3/21/07, Andy Laperrier of ISI Group:

"It's no coincidence that the five-fold growth in subprime lending occurred at a time when home prices soared to nose bleed territory." As home prices kept rising, fewer loans went bad because the homeownder could almost always refinance or sell the property at a profit...As the home price boom gained momentum and delinquencies dropped, lenders offered progressively easier and riskier lending terms...According to Credit Suisse, the number of no lor low documentation loans-so-called "liar loans"-has increased to 49 percent last year from 18 percent of purchase loans in 2001. The investment bank also found that borrowers put up less than a 5 percent down payment in 46 percent of all home purchases last year."

2) Why are borrowers of subprime loans defaulting?

One reason is that loans issued in the past few years--of which there were many!---were structured such that the interest rates on the loan were low at first, but rose dramatically after some period of time (maybe after 1 or 2 years depending on the structure of the loan). It could be that more borrowers are now seeing the spike in their ARMs (Adjustable Rate Mortgages).

There is probably more to it than that. Unless one believes that the low income borrowers were completely duped into believing that the loan were carry a low interest rate all the way through. It is true that there are genuine scams going on, otherwise known as predatory lending. But it's more likely than borrowers figured that, if the value of home prices kept rising as they were between 2000 and 2005, they would be able to refinance at a lower interest rate down the road, when they had achieved a degree of equity in the house. Unfortunately for borrowers, the value of homes have been declining, not rising, making it nearly impossible to refinance at a lower interest rate, and possibly leading to defaults.

3) What will the impact of increasing default rates be on the economy?

In a worst case scenario, a wave of anticipated defaults on subprime mortgages and tighter lending standards could combine to drive down home values. That could make homeowners feel a little less wealthy, and lead to a decline in confidence among consumers and then a subsequent decline in spending. But there are a few things that would need to happen for subprimes to infect the rest of the economy in a broad way. As mentioned above, subprimes are only a portion of the home mortgage market. If subprime loans are going bad, but home values in other areas are stable or rising, then one would not expect problems with subprimes to filter there way through the economy. But, if collapses in subprime markets lead to declines in home prices in a broadbased way, than it could be possible that subprime problems will spread through the entire housing industry, then to consumer confidence, and then into other areas of the economy.

Writing in the FT on 3/21/07, Krishna Guta writes:

"Like the market, the Fed sees the main risk to growth coming from housing...But the Fed sees little evidence that this (subprime loans) crisis will have much of an impact on the economy as a whole. Subprime borrowers contribute a relatively small slice of consumer spending and, with delinquency rates up only a fraction, lenders are not seen as likely to draw back from offering credit more broadly."

Economist Attacks

2007-03-10T15:14:00.000-08:00

So a Michigan State economics professor decides to bite a police officer at an airport in Sarasota. Things are already bad enough in East Lansing, and this surely will not help recruitment for MSU's football team.

Why the World Isn't Flat

2007-03-06T21:01:00.000-08:00

Pankaj Ghemawat in this Foreign Policy essay

"In truth, the world is not nearly as connected as these writers would have us believe. Despite talk of a new, wired world where information, ideas, money, and people can move around the planet faster than ever before, just a fraction of what we consider globalization actually exists. The portrait that emerges from a hard look at the way companies, people, and states interact is a world that’s only beginning to realize the potential of true global integration. And what these trend’s backers won’t tell you is that globalization’s future is more fragile than you know....

One favorite mantra from globalization champions is how “investment knows no boundaries.” But how much of all the capital being invested around the world is conducted by companies outside of their home countries? The fact is, the total amount of the world’s capital formation that is generated from foreign direct investment (FDI) has been less than 10 percent for the last three years for which data are available (2003–05). In other words, more than 90 percent of the fixed investment around the world is still domestic. And though merger waves can push the ratio higher, it has never reached 20 percent. In a thoroughly globalized environment, one would expect this number to be much higher—about 90 percent, by my calculation. And FDI isn’t an odd or unrepresentative example....

[T]he levels of internationalization associated with cross-border migration, telephone calls, management research and education, private charitable giving, patenting, stock investment, and trade, as a fraction of gross domestic product (GDP), all stand much closer to 10 percent than 100 percent. The biggest exception in absolute terms—the trade-to-GDP ratio shown at the bottom of the chart—recedes most of the way back down toward 20 percent if you adjust for certain kinds of double-counting. So if someone asked me to guess the internationalization level of some activity about which I had no particular information, I would guess it to be much closer to 10 percent—the average for the nine categories of data in the chart—than to 100 percent. I call this the “10 Percent Presumption.”

From Dan Drezner's Blog

The Market for Marriage: Why Prenups are Good

2007-03-05T19:51:00.000-08:00

This is funny:

Tim Hartford in today's Financial Times:

"Marriage is a market. There is a supply, there is a demand. Markets work better when contracts work too. Economists know perfectly well that one of the many reasons why marriage has always been popular is that it is economically efficient. It is based on the division of labor...one spouse brings home the bacoon, the other cooks it. It is a joint effort, an efficient one - and one under serious threat if the contract is ambiguous...A good pre-nuptial agreement should be able to specify one of the many reasonable ways in which things will be resolved if the marriage does not work out. If she is a financial powerhouse and he is a toy boy, marriage need not be beyond them: the prenup can fix compensation arrangmenets, by the hour if necessary. It is not romantic but neither is a messy divorce."

The Left Debates Globalization

2007-03-01T19:39:00.000-08:00

Brad LeLong (Economist, UC Berkley) and Jeff Faux (President, Economic Policy Institute) recently had a fairly violent debate on the merits of the economic aspects of globalization. In the end, they're both advocating trade (Faux is much less confident), but Faux believes that labor standards are necessary in not just trade with China, but with all countries. This is relevant because when the Doha Round fails in the coming months (Doha is the latest round of multilateral trade negotiations), the U.S. will continue negotiating bilaterals with smaller, poorer countries because they are much easier to negotiate (see below for why) and bring benefits more immediately than multilateral deals which tend to phase out subsidies and tariffs over several years if not decades. DeLong thinks that tying trade with labor standards is a form of economic protectionism designed to increase the cost of labor in low skilled countries and minimize the chance that U.S. companies will transfer production out of the U.S., among other things. I am staying out of this specific question because 1) I don't have a strong enough preference for either view at the moment, and 2) Because there is a middle ground between the two views. For example, allowing a company (especially a U.S. subsidiary) to do what it wants to workers abroad can't be in the U.S.'s long term interests and could undermine support for globalization among proponents of human rights in the U.S. (and from U.S. residents that have morals). But, presumably, labor standards should not be a one size fits all approach either (think trade deal with Canada versus trade deal with Saudi Arabia). Finally, I found the comments made at the end of the debate troublesome, with some of TPM Cafe's readers arguing, in some form or another, that economic globalization is bad on balance. I agree that some of the U.S.'s bilateral agreements are somewhat predatory. If the U.S. negotiates an agreement with a country like Oman, Oman has MUCH more to gain from preferential treatment to the U.S. market than does the U.S., and this gives the U.S. leverage to bargain for whatever it wants in the agreement (namely for protection for industries that could be hurt by the deal). But on the whole, trade usually has to bring net benefits, or else countries wouldn't do it. I understand that this is too simplistic an argument for bilateral deals and trade in general, but enough from me, check the debate.

The Link Between Free Trade and Democracy in China

2007-02-28T19:55:00.000-08:00

There is a popular belief of among the United States foreign policy elite that trade can be used as a tool to promote democracy...over time...over a very long time. The belief has been around for decades and it makes sense why it's so popular: if the U.S. can help countries that are generally hostile to U.S. interests become friendlier through trade, than the U.S. can avoid to engaging them in more costly ways (ie military force or simply refusing to invite them to the ambassador's residence - ouch!) and get away with making money, all while accomplishing broader foreign policy objectives. If only it were true. I originally became skeptical about the link between trade and democracy after reading James Mann's new book on China, and became more skeptical earlier today after reading an article in the Washington Post on this subject. First, Mann's book:

Mann argues that U.S. policy toward China has been heavily influence by the "soothing" theory that trade/integration with China will eventually lead to political change within that country. "With God's help, we will lift Shanghai up and up until it is just like Kansas city," said Senator Kenneth Wherry of Nebraska in the 1950s during Chiang Kai-shek's Nationalist China. To a large extent, Chinese citizens living in big cities today such as Shanghai do resemble Americans in their lifestyles, and in contrast to what some observers argue, they are also anxious for democratic openness.

But...:

"Yes, Chinese people dress differently now than in 1989, yet people can wear tank tops or Armani suits and still not live under a democratic system. Yes, Chinese kids can eat pizza and drink coke, but doing so won't necessarily create a free press or an opposition political party...On the surface, things certainly appear to be better than in 1989, because the People's Liberation Army is no longer opening fire on the streets of Beijing. But why is that? The main reason Tienanmen Square remains so quiet today is that China's security apparatus goes to extraordinary lengths to make sure there will never again be large-scale demonstrations there to challenge the regime. These days, the police don't wait for protests in China's major cities to gather momentum; they stop them much earlier. China remains politically stable in part because the repression is speedier and more thorough now than it was in 1989."

Other arguments that integration and economic change will lead to political change are based on the idea that the Chinese leadership will at some point, no longer be able to control the greater information flows necessary for continued economic liberalization and expansion. The forces toward openness will simply be too strong. Friedman's argument in the Lexus and the Olive Tree was that Chinese leadership would need to provide "unrestricted financial information to maintain public faith in its stock markets and that this would lead to broader press". But this prediction has so far failed to materialize just like Senator Wherry's did over fifty years ago. Instead of being stifled by more rapid information flows, the Communist Party has adapted along with the information technologies that make communication more available to the Chinese people. Again, Mann:

"the Chinese security apparatus has become increasingly sophisticated in its ability to block Web sites on the Internet. Key phrases like "Tienanmen massacre" attract immediate scrutiny...Let's suppose that someone in China wants to organize a political entity...If that person tries to post a notice of a meeting for that new organization on the Web, he or she will quickly find that the posting vanishes and that it has succeeded only in attracting a crowd of security officials."

Here is the real question:

"Even if people in China now have the ability to receive information from the Internet, what can they do with it? Chinese people can keep close track of an election in Taiwan, but they can't have their own. They can't even hold a meeting of fifteen people to sign a petition proposing that China hold elections...The Internet has indeed changed Chinese politics, but in a circumscribed way. It has carried China from an old era of clueless authoritarianism to a new era of aware authoritarianism."

Okay, after all that, I then read an article in today's Washington Post (Page A13), entitled "China's Premier Calls Democracy a Distant Goal":

"The Communist Party cautioned China's increasingly impatient reformers and intellectuals Tuesday that political liberalization and democracy are still a long way off despite the rapid pace of economic change over the past few decades."

In Premier Wen Jiabao's words:

"We are still far away from advancing out of the primary stages of socialism...We must stick with the basic development guidelines of that sage for 100 years."

Bottom-Line: The Communist Party is proving that globalization and censorship are not incompatible. Further, the party has reached out to other undemocratic regimes such as Burma and Zimbabwe, and has reportedly supplied Mugabe with surveillance equipment to crack down on Internet traffic. None of this is meant to imply that the U.S. and China are on military or diplomatic collision course, but it raises questions about whether this idea that "everything will be okay" in China in five, ten, fifteen, or fifty years. We should start thinking about the possibility that China's regime will look much 20 years down the line as it does today.

The Carry Trade is Screwing up My Graph

2007-02-26T21:40:00.000-08:00

The carry trade has been screwing up the graphs of many international trade and finance economists, so The Economist took the time to explain why. Here's the gist of the article:

The carry trade describes the speculative investment strategies of currency traders that are making money by borrowing Japanese Yen at interest rates of around 1 percent, and then converting Yen to Dollar assets offering a higher rate. When the dollar denominated assets reach maturity, traders convert the dollars back to Yen at a profit.

According to the theory of uncovered interest parity, the only way one currency can offer a higher real interest rate than another is if the high rate currency is expected to lose value (depreciate) against the low rate currency over the time horizon of the investment, thereby eroding the gains from the interest rate differential. So, if dollar assets bear higher interest rates than Yen assets, we would expect---or the theory would predict---that the dollar will lose value relative to the Yen so that when the trader converts his/her dollars back to yen, all of the profit from the interest rate differential is lost.

In the carry trade, not only are traders making money, which they shouldn't, but the dollar is appreciating against the Yen.

One possibility is that "the actions of carry traders are self-fulfilling; when they borrow yen and buy the dollar, they drive the former down and the latter up."

New Economic Policy for the Left

2007-02-24T19:58:00.000-08:00

Despite the non-partisan nature of this blog, James Galbraith's article in the March 5 edition of The Nation was mindblowing, turning upside down the policies being advocated by Washington's democratically oriented economics crew that I've mentioned in a previous post (The Hamilton Project at the Brookings Institution). But here is a glimpse.

Galbraith: "The facts are clear: NAFTA is a done deal, and China is a success story we have to live with. Progressives need a trade narrative that moves past these two issues. Broadly, this means accepting manufactured imports and dropping the idea that we can control--or that it matters much--who assembles television sets or stitches shirts. Standards to guard against flagrant abuses such as child and prison labor are fine, but it's an illusion to think they will, or should, dent the flow of goods from China. A progressive trade agenda should focus, instead, on building stronger world markets for our exports, and in ways that do not trample on the needs and rights of poor people in poor countries. That should provide plenty of room for future fights with free-trade absolutists."

Encouraging Innovation by Reforming Health Care?

2007-02-24T19:27:00.000-08:00

In today's WSJ, Bob Litan offers several proposals that could help encourage innovation in the U.S. The usual suspects on his list include lowering barriers to entry, making teachers and principals in K-12 more accountable, and improving ways for university-developed ideas to be commercialized. What suprised me was his linking of innovation with health care reform, namely that we should delink healthcare from employment for the sake of encouraging entrepreunerial activity. He writes:

"Escalating health-care costs rank high on entrepreneurs' lists of concerns. They're not alone. Workers are anxious about losing their own health insurance, especially if they take the risk to leave their stable jobs to form their own businesses."

Job Security: Lessons from Europe

2007-02-24T18:22:00.000-08:00

As growth in the EU stalled in the mid-1990s, it was a popular view that policies designed to provide security to workers would lead to slower economic growth. In other words, that there was a tradeoff between achieving workforce security and achieving income growth. Things are becoming a bit more complicated now, especially because EU growth is approaching U.S. levels making it harder to justify conventional wisdom.

Recently, European countries have begun rearranging their mix of labor policies to allow for more flexibility in their systems, while at the same time offering substantial aid to workers whose jobs are lost as a result of greater flexibility. For example, France, Germany, and Denmark have all eased worker protections in some areas of their economy, giving employers more leeway to hire and fire workers. This moves them in the direction in the U.S. system and should be good for growth as it will make it easier for workers in failing industry and companies to be released, and soaked up by faster growing ones. However, flexibility comes with costs to workers and their families who must deal with the often difficult transitions that accompany layoffs. This fact has not been lost on the poster child of worker security, Denmark.

Louis Uchitelle in today's NY Times online edition:

"Employers in Denmark are relatively free to lay off workers, but the state then steps in with benefits that replace 70 percent of the lost income for four years. Government also finances retraining and education, pressuring the unemployed to participate and then insisting that they accept reasonable job offers or risk cuts in their benefits.

THE Danish government devotes 3 percent of the nation’s gross domestic product to retraining, compared with less than 1 percent in the United States. And, of course, everywhere in Europe, the state pays for health insurance and for pensions that often encourage early retirement by replacing big percentages of preretirement income."

Thanks to The Economist's View for bringing Uchitelle's article to my attention.

Relieving Worker Anxiety

2007-02-22T20:18:00.000-08:00

There is a paradox in the policy debate surrounding further trade liberalization and U.S. tax policy. On the one hand, so-called prescriptions to relieve worker anxiety toward job displacement as a result on international trade and technology are costly (kind of). Robert Rubin's group at the Brookings Institution has recently released several papers advocating the expansion of trade adjustment assistance to not only manufacturing workers, but to service workers as well. Additionally, recent wage insurance proposals which would subsidize the wages of workers who lose their jobs and are reemployed at a much lower salary would also cost money. The problem is that these programs, while relatively small compared to their European counterparts, are still a tough sell in the U.S. where neither party is advocating increasing worker adjustment assistance to anywhere near the levels currently present in some European countries. In essence, we look to countries like Denmark and want to learn from how they've coped so well with globalization, but then we look at our constituents and even our history and see that support for serious programs in the area of job displacement has always been small. We want to help workers but there's no support for the kind of spending necessary to do it well.

Harold Meyerson in today's Washington Post :

"The cost of creating this economic security while remaining globally competitive isn't cheap. In the March issue of the American Prospect (which I edit), my colleague Robert Kuttner calculates that these nations devote roughly 15 percent more of their GDP to governmental outlays than the United States does. That pencils out to roughly $2 trillion a year that we'd have to shift to the public sector to build an economy in which globalization wouldn't be viewed as so dire a threat. Neither Rubin, a true believer in balanced budgets, nor anybody functioning in the real world of American politics is calling for anything this far-reaching to reshape the U.S. economy."

So far, the U.S. has been able to get away with the consequences of capitalism on the cheap. At this moment, the U.S. is spending, say 1 percent of GDP on programs broadly fitting worker security (UI, worker retraining, trade adjustment assistance). In part, this is because we want help for some types of job loss but not others. For example, workers in the U.S. have demanded assistance when they lose out as a result of trade, but most workers don't worry as much if they lose their job as a result of a new technology that makes their job extinct. In Europe, workers are aided regardless of the cause of job loss. In other words, they don't care whether it's trade or tech leading to the loss.

I'm going to end here since I'm tired and bad at conclusions.

The Minimum Wage isn't The Worst Idea in the World, But...

2007-02-20T19:13:00.000-08:00

Mario Pisani joins the anti-minimum wage bandwagon in today’s FT (subscription required). The theoretical case outlined in his essay is standard, namely that the imposition of a minimum wage prevents employers from hiring workers whose productivity levels are beneath the wage floor. The minimum wage then acts as a tax on the hiring of employees whose productivity levels are between $0 per hour and the level of the minimum wage. Taxing work is not a good idea if one believes that work has positive externalities like Pisani does. For Pisani, taxes should be imposed on activities with ugly social consequences, such as drinking and smoking, and should subsidize activities that result in positive benefits for society (charitable giving, working). Pisani could also have mentioned that it is plausible that employers will respond to the minimum wage hike by allowing work conditions to deteriorate, a reasonable assumption if bargaining power within low-skilled labor markets is weak, and evidence suggests it is.

If the minimum wage is so bad, why have 650 economists, including several Nobel Prize winners, expressed their support for it? Well, a cynic might say that given the minimum wage is the only source of aid to low income workers being seriously considered by the 110th Congress, it was nothing or the 10th best alternative that this group was advocating. The truth is that the real effects of minimum wage hikes are obscure, difficult to measure, and in the end, relatively small. As Megan McCardle argues, low-skilled labor markets are relatively volatile, making it difficult to disentangle multiple effects moving in opposite directions on the employment of low-skilled workers. Most economists would agree that the effects of a minimum wage increase such as the level passed in the House earlier this year would have very minor, negative effects on employment---the negative effects are mitigated by the positive effects in the form of a sturdier balance sheet for those benefiting from the hike (the winners spend more). But the fear is not so much that unemployment will increase, but that overtime, the increasing cost of labor will lead to input substitutions away from labor, toward labor saving machines. There is also the concern that a minimum wage hike will hurt the most vulnerable in the low-income distribution, namely individuals with criminal records or those workers who have been out of the labor market for an extended period. Employers will be unlikely to hire those workers who they were disinclined to hire at the previous wage floor.

What struck me most about this essay is what Pisani chooses not to include from his laundry list of minimum wage critiques. Here's the real issue: If a minimum wage hike is designed to help the workers at the very bottom rungs of society’s income ladder, it does not do a particularly good job of hitting its target. Of the 2.5 million full and part-time workers earning the minimum wage, 53 percent fall in between the ages of 16 and 24, and within this age group, average household income tops $64,000. Older minimum wage earners (25+) are not nearly as well off, with average household income hovering around $33,000. But still, $33,000 is $14,000 above the poverty level.

It is wrong to say that the minimum wage completely misses the mark: 19 percent of minimum wage earners are living in poverty, and these workers would benefit from the hike. Further, the increase in minimum wages should also boost the wages of those earning just above the minimum wage today, as their employers need to pay more to prevent these workers from working in occupations that require less skill, but pay the same amount. However, the point is that hourly wages are not the best statistic to look at when determining social welfare policy. Policymakers should avoid mistakenly aiding a 20 year old worker living in a $64,000 household while leaving the family of four to make ends meet at $20,000. The fact that the minimum wage doesn’t do that bad, isn’t of great consolation to the lowest skilled workers who lose their job because of its passage, nor does it help the family to whom the benefits of the minimum wage pass by.

If the minimum wage is not the answer, what is? Pisani advocates one sensible alternative, the earned income tax credit (EITC) paid to low-income workers (low income as measured by household income). The EITC acts as a subsidy to work as opposed to a tax on it. Greg Mankiw has argued that the minimum wage “is a tax on low-skilled workers paid for by low-skilled workers”. The EITC can be financed more broadly, and more progressively, enabling policymakers to spread the costs of the tax across the population. The EITC is not a permanent fix to the problems encountered by low-skilled workers in today’s economy, but the incentives to work embedded in that program are sensible and the effects on the household incomes of the poorest are more positive. In conclusion, the minimum wage isn't the worst thing we can do, but it falls just short of being adequate.

Is Europe's Welfare State Sustainable?

2007-02-18T22:23:00.000-08:00

In her new book, The Primary of Politics: Social Democracy and the Making of Europe’s Twentieth Century, Sheri Berman looks at the development of the European welfare state and speculates on its future. I haven't read the book, but apparently she concludes that the welfare state is there to stay. Tyler Cohen disagrees:

"If a country grows at two percent per annum, rather than one percent, the difference in wealth or welfare in a single year is relatively small. Over time the difference becomes very large. For instance, had America grown one percentage point less per year, between 1870 and 1990, the America of 1990 would be no richer than the Mexico of 1990. Growth laggards fall behind..."

According to Cohen, high productivity in the western European countries masks policies that weed out low-skilled workers (such as UI), but

"...this will not sidestep the broader and persistent problem of shrinking populations. Most European birthrates are under the 1.5 mark and it is quite possible that many national populations will be cut in half by 2050...Since older populations also tend to be less productive, it is hard to see how Western Europe might reassume world economic leadership or even hold its current relative ground."

"...The bottom line: European social democracy will go down in history as a glorious moment in the sun. But its deep structural problems, most of all for delivering ongoing economic growth, mean that 21st century Europe will have to take a very different course."