TOPICS IN POLITICAL ECONOMY

OUTLOOK FOR 2012

Believers in the business cycle should opt for modest optimism for the U.S. economy in 2012.

As I pointed a year ago, the average expansion phase of a business cycle since 1945 is 59 months. We are now just halfway - 30 months - along that path, and nearly all the key indicators remain favorable, although not buoyant.

The economy in 2011 grew at about 2%, less than my cheery forecast of 3.5%, but enough to silence the "double dip" recession fears of some. Signs of encouragement include:

• In the past 12 months, the number of unemployed has dropped by 1.3 million. Employment has being rising steadily, although is still down substantially from the cyclical peak.
• Industrial production is up 3.7% through November.  
• U.S.-assembled auto sales in December were 11% ahead of a year ago.

The private sector's weak spots continue to be employment in financial services (particularly investment banking and related activities) and residential construction,  whose sweetheart bubble burst in 2008.  Contrast the flat employment picture in these sectors with the overall economy, as charted below using BLS data.

TOTAL EMPLOYMENT, 2001-2011

 

EMPLOYMENT - CONSTRUCTION OF BUILDINGS, 2001-2011

 EMPLOYMENT - SECURITIES, COMMODITIES, INVESTMENTS

 2001-2011

As a long-time believer in the powerful dynamics of the business cycle, I would normally be comfortable in suggesting economic growth in the U.S. next year should be on the order of 3.5% or better.  This would be achieveable even with continuing sluggishness in single-family home building and important financial subsectors.

Consumer spending is clearly strengthening and capital spending budgets appear to be buoyant.  The latter is due partly to the spreading impact of gas and oil shale drilling, development, and pipeline activity on both suppliers and customers (e.g. utilities and chemical manufacturers in several regions of the country.

However, the outcomes of the European Euro-debt crisis and political gridlock in the U.S. over taking steps to avoid precipitating a similar situation on this side of the Atlantic are truly exceptionally bothersome uncertainties. 

The pessimist will side with Kenneth Rogoff, the leading historian of such events, who has written  recently about "the likely coming wave of sovereign defaults."  The optimist will concede that Greek bondholders will shortly take a bath, but that the resulting waves will be insufficient to overturn the boat.

Bottom line?  A growth rate of 3.5% for the U.S. in 2012 is my "most likely" possibility, but the downside odds are larger than usual. 

 

 

 

REGULATION, THE EPA, AND THE MING DYNASTY

After considering 16,000 years of humanity, Stanford University historian Ian Morris  concludes in Why the West Rules - For Now that the most advanced and influential society is that which is best at "getting things done." 

To quantify Eastern and Western societies' ability to get things done over 16,000 years, Morris (originally trained as an archaeologist) has designed an "index of social development."  It is based on four metrics: per capita consumption of energy, organizational capacity, the ability to process/communicate information, and the ability to wage war.

This thoughtful way of looking at history raises the issue of government regulation and "the ability to get things done."  I was reminded of this when puzzling over why China, inventor of the compass, paper, printing, gunpowder, and an early exploiter of coal and producer of iron, failed to realize its technological potential.  Instead, it discouraged innovation and eventually succumbed to European domination.

Much of the reason for China's failure can probably be found in the work of famed sinologist, Etienne Balazs commenting on the Ming and later dynasties.  As quoted by David Landes in his The Wealth and Poverty of Nations:

Chinese society was highly totalitarian . . . no private initiative, no expression of public life escapes official control . . . there is a monopoly of education, jealously guarded . . .  there are clothing regulations, a regulation of public and private construction . . . the providential State watches minutely over every step of its subjects, from cradle to grave.  It is a regime of endless paperwork and harassment.

The ingenuity and inventiveness of the Chinese . . . would no doubt have enriched China further and probably brought it to the threshold of modern industry, had it not been for this stiffling state control.  It is the State that kills technological progress in China.

Now, consider the trend of regulation emanating out of Washington, DC over the past decade or so, as depicted by a recent graphic in The Wall Street Journal.

 

 

This chart clearly shows that the pipeline of upcoming Federal regulations, each of which will impose a cost on the economy of $100 million or more, has soared over the past five years.  At the same time, Washington University's Center for the Study of American Business estimates that the cost of administering existing regulations will be $57 billion in 2012 while employing over 290,000 people.  Finally, there are the costs of investment-dampening uncertainty when firms are unsure what regulations are likely to be imposed.

Smog and Highway Signs.  Consider the Clean Air Act administered by the Environmental Protection Agency.  The Supreme Court has upheld EPA's contention that it should not consider costs when imposing new regulations. The Agency is presently finalizing rules that will probably shut down a substantial number of coal-fired generating plants in the midwest and southern states before the end of their useful lives.  The estimated all-in industry costs could exceed $80 billion (passed on to customers, of course) according to one research study.

However, when the Obama Administration's proposal to reduce ground-level ozone and the resulting smog was found to cost up to $90 billion annually, the President finally backed off, citing "the importance of reducing regulatory burdens and regulatory uncertainty."  Well, at least $90 billion catches the President's eye.

One other very small victory for regulation skeptics: in August, the Department of Transportation eliminated 46 deadlines for local communities around the country to replace existing highway signs with DOT-mandated standardized replacements. (It kept in place an additional twelve).  

DOT's reasoning?  "Local and state transportation agencies are best-equipped to determine when they need to replace signs and other items in the course of their daily work.” But apparently they can't be trusted to design the eventual replacements.

There clearly is a place for sensible, cost-effective regulation in sectors such as processed food and pharmeceuticals, although frequently law suits for damages may be more effective than regulation in heading off egregious behavior. (Note that British Petroleum has paid out to date $7.5 billion in claims arising from its 2010 Deepwater Horizon accident and oil spill in the Gulf of Mexico.)

Reduce the Burden.  While the regulatory burden may not currently approach that of the late Ming Dynasty, it is time to act.  The White House and Congress should be spending as much time and political capital on "reducing the regulatory burden and regulatory uncertainty"  - as the President puts it - as on spending and taxes.

 

 

 

 

 

 

OCCUPY WALL STREET, HIGHER EDUCATION AND JOSEPH SCHUMPETER

What are the links between the Occupy Wall Street crowd and the massive, overgrown higher educational system in the United States?

Perhaps the most penetrating answer can be found in Joseph Schumpeter's "Capitalism, Socialism, and Democracy," first published in 1942. Herewith several penetrating observations from chapter XIII of that powerful work:

One of the most important features of the later stages of capitalist civilization is the vigorous expansion of the educational apparatus and particularly of the facilities for higher education......

Inasmuch as higher education thus increases the supply of services in professional, quasi-professional and in the end all 'white collar' lines beyond the point determined by cost-return considerations, it may create a particularly important case of sectional unemployment....

It may create unemployability of a particularly disconcerting type . [such a person] becomes psychically unemployable in manual occupations without necessarily acquiring employability in, say, professional work . . . due to either lack of natural ability - perfectly compatible with passing academic tests - or to inadequate teaching.  Both cases will . . . occur more frequently as ever larger numbers are drafted into higher education.

All those who are unemployed or unsatisfactorily employed or unemployable drift into vocations in which standards are least definite or in which aptitudes and acquirements of a different order count.  They swell the host of intellectuals in the strict sense of the term whose numbers swell disproportionately.  They enter it in a thoroughly discontented frame of mind.  Discontent breeds resentment.

For substantiation of how our current situation mirrors, to a surprising extent, Schumpeter's insights, see my previous Topics in Political Economy on "Too Big to Fail: The Academic Establishment" and "Jobs Looking for Workers."

However, I am not ready to accept Schumpter's thesis that capitalism is ultimately doomed by the "inability of the capitalist order to control its intellectual sector effectively." At least, not quite yet. 

 

 

JOBS LOOKING FOR WORKERS: UPDATE

Another report on jobs looking for workers, this time in a lengthy, well-researched front page Wall Street Journal article.  Problem:  I don't think very many of the Occupy Wall Street types are trained/capable of doing them.

By one account, 83% of manufacturers report a "moderate or severe" shortage of skilled production workers to hire. At Union Pacific railroad a 27-year old who can install fiber optic cable is offered $48,000 annually plus overtime, plus a traditional pension. BA college degree not required.

Pass the word to high school administrators and counselors - and to parents of teen age children.

DEFICIT REDUCTION: THREE CHEERS FOR SENATOR TOOMEY

The clock is running out for Congress's "super committee" to come up with credible spending cuts and additional tax revenue to avoid disruptive meat axe cuts throughout the budget or "kicking the can" down the road, again, with very unpleasant consequences in financial markets.

There still is light at the end of the tunnel.  The good news is that forty House Republicans joined with 60 House Democrats in a letter to the Committee to urge it to  "consider all options for mandatory and discretionary spending and revenues" to reduce the deficit, over time, by $4 trillion.

In addition, some Tea Party types appear to have learned to how to add and discovered that even draconian spending cuts alone will not achieve desired goals.

The Toomey Proposal.These developments have now been followed up this week by super committee member Senator Toomey's eminently sensible proposal to raise tax revenues by almost $300 billion over the next decade.  This would be done largely by limiting tax breaks for those itemize deductions on their income tax returns. 

At the same time, the top tax rate would fall from 35% to 28% and the bottom rate from 10% to 8%. The net effect of the Toomey proposal is to raise taxes for individuals earning over $174 thousand and married couples making over $212 thousand and raise $290 billion in revenue.

Senatory Toomey's initiative follows closely the proposal developed by Martin Feldstein and his colleagues, discussed and advocated in this blog earlier in the year (April 19).

The Arithmetically-Challenged.  It is now liberal Democrats who appear to be arithmetically-challenged.  They don't understand that you can reduce marginal tax rates for upper income types and if you plug tax deduction loopholes at the same time, you can actually increase their total tax bill. Take a look at this post by a Daily Kos contributor, inspired by a New York Times article, for a sample of this illiteracy.

Let's hope that super committee negotiations will now revolve around the ratio of spending cuts to tax revenue increases. If liberal Democrats want more tax revenues and fewer spending cuts they should specify which remaining loopholes should be plugged.

Caveat: super committee members of both parties should not think they can outsmart financial markets by clever accounting tricks and dubious assumptions. Yes, the Greeks got away with it for several years, but they - and the rest of the Euro bloc - are now paying the price for that deception.

 

IS THE U.S. IN DECLINE?

The best "big picture" economic historian today is Harvard Professor Niall Ferguson. The favorite big picture topic of the day, "decline of the U.S." is explored in a recent and extremely well-produced 22 minute video discussion between him and Wall Street Journal editor John Bussey.

Alternatively, you can read the post on his web site which contains a summary of his analysis.  Here is an excerpt which contains most of his prescription to rejuvenate public policy in this country:

What we need to do is to delete the viruses that have crept into our system: the anticompetitive quasi monopolies that blight everything from banking to public education; the politically correct pseudosciences and soft subjects that deflect good students away from hard science; the lobbyists who subvert the rule of law for the sake of the special interests they represent—to say nothing of our crazily dysfunctional system of health care, our overleveraged personal finances, and our newfound unemployment ethic.

I take particular note of his last citation, suggesting that the European "dole mentality" is creeping into American life.  Ferguson does not buy the pessimists' argument that we are in an "inexorable" absolute decline. And he is careful to point out that there is little basis for alarm over rising living standards in China. But he makes a strong case that we are currently on a track where an absolute decline in the U.S. is a distinct possibility.

The full exposition of Ferguson's analysis is contained in his latest book, "Civilization."

JOBS LOOKING FOR WORKERS, CONT.

Caterpillar, one of the world's largest machinery manufacturers, with 59,000 employees in the U.S. alone, is building five new plants in the United States.  Their biggest problem? Not enough qualified workers.

CEO Doug Oberhelman is not shy about pointing fingers.  In a September CBS TV interview, he stated flatly, "our education system has failed all of us." 

At about the same time, Oberhelman spelled out for a Chicago business newspaper the details, as relayed by Thomas Friedman in the New York Times, as they are affecting Caterpillar:  

"We cannot find hourly production people, and, for that matter, many technical, engineering service technicians, and even welders, and it is hurting our manufacturing base in the United States . . . we have to retrain every person we hire."

Perhaps the most important retraining initiative would be to focus on those 300,000 counselors in high school systems around the country who advise graduating seniors on what their next steps should be. At the moment, collectively, they are doing a terrible job.  Call your high school principal or school board representative.

WHAT DO "OCCUPY WALL STREET" AND THE TEA PARTY HAVE IN COMMON?

Don't be misled by the presence of graying, leftwing professional protesters among "Occupy Wall Street" demonstrators, whether they are in New York, Pittsburgh, or San Francisco. 

There is sufficient discontent today with "The System" amongst enough disparate sectors and age groups in American society to encourage active participation in anti-establishment demonstrations, whether organized by Tea Party or Occupy Wall Street (OWS) types. How many common "drivers" are there behind the energy of both movements?

I count four:

1. Evil Bankers. The first, widely-shared driver is antipathy towards big banks. They are considered to have precipitated the financial crisis of 2008-2009 and the taxpayer-funded bailouts that followed. And they are reviled because their senior managers continue to enjoy hefty compensation - even when they are fired, as was the case with two high-level Bank of America executives last week, who are taking home over $5 million apiece on the way out.

In addition to this indictment, clearly shared by most Tea Party and OWS types, is a much older (but seldom articulated) criticism of bankers: charging interest is immoral and usurious. All major religions have enacted at some point strictures against charging interest (still not permitted in Islam). The concept that interest payments are "unearned income" to the lender is at the root of such thinking. Making money from money does not, in this mode of thinking, add value. Assembling automobiles or building houses does.  (In Dante's "Divine Comedy" the usurers consigned to a very unpleasant inner circle in Hell.)

In short, if you haven't taken (and passed) "Money and Banking 101," the big banks and their senior officers are an obvious target on which to take out your frustrations.

2. CEO Compensation.  Both Tea Party and OWS types tend to attack large corporations.  Here, again, hefty pay is the prime target, although entrepreneurs, like Bill Gates and the late Steve Jobs, are usually exempt.  The chief targets tend to be members of The Business Roundtable - for the most part, bureaucratic leaders of long-lived, well-established firms whose board compensation committees almost always find their CEOs are "above average". Just like the children in Lake Wobegon, Minnesota.

In 2010, according to a Hay Group study for The Wall Street Journal, CEOs at the largest corporations enjoyed compensation increases averaging 11%, bringing average pay to $9.3 million. Perhaps more important politically is CEO pay relative to their workers.  By some measures, this ratio has soared from 42 times the average worker's pay in 1980 to 343 times in 2010. 

It is hard to see a disparity of this magnitude - or even half that - as politically sustainable indefinitely. "History," as one sage has observed, "is a series of reactions against the law of compound interest." Perhaps the Tea Party and Occupy Wall Street movements are part of an emerging series. 

3. Education, Debt and Shattered Expectations. The ever-increasing cost of higher education and the debt burden that accompanies it, along with difficulties in finding that first job, are clearly sending a lot of younger people - and their parents - to both movements' rallies.  Twenty-somethings may be more prominent at OWS venues, but they are found at Tea Party events, too.

The higher education establishment has been extremely successful, up to this point, in brainwashing most politicians and much of the populace that you can't succeed without a college degree. (See my four-part series earlier this year entitled "Too Big to Fail: The Academic Establishment.) 

In turns out that in the current environment lots of young people have the degree and $20,000 plus in debt but can't get a job - despite the fact that there are over three million job openings, according to the Bureau of Labor Statistics. We have too many graduates with degrees in communications and sociology and not enough young people with the vocational training, technical smarts and work appetites that manufacturers and energy companies are looking for these days (see my recent blogs on "Jobs Looking for Workers").

4. Unemployment.  Take the first three "discontent drivers" and mix in a more traditional source of unrest - an above average cyclical rise in unemployment - and you have a steamy stew of popular unrest on the left, right and center of the political spectrum.

No matter that the bottom line number - 14 million unemployed - is made worse due to extended unemployment compensation benefits and the vast amounts of Washington-generated uncertainty about budget deficits, future tax rates and prospective healthcare costs. The job situation plus the three other drivers discussed above account (in varying proportions) for the bulk of the energy behind the Tea Party and Occupy Wall Street movements. 

Addressing the Discontent.  How to address these four drivers of discontent?  Turning around the CEO pay spiral and the higher education establishment's marketing mantra and wastefulness requires a few intellectually credible, politically-savvy leaders, whether they are politicians, academics or maybe someone off the street or the TV screen. 

Bankers will always labor under a suspicion of being evil magicians, but they usually survive concentrated popular assaults.  And the unemployment problem normally resolves itself as the business cycle moves on - if the uncertainties generated by government policy and inaction can be reduced in time.

Of course there are significant differences between Tea Party and OWS followers. The most important is the size and role of the Federal government in the economy and in our lives.  But the four common drivers are perhaps the most significant aspect of these movements today.

Are there any statesmen (or women) out there who can credibly and sensibly steer the ship of state through these choppy waters?

 

BEATING UP THE BANKS

As an economist and former banker, I think you have to start feeling sorry for senior management and shareholders of our largest banks.  After all, whatever their past sins, as a result of the recent Frank-Dodd legislation they are supposed to make their profits from low risk activities so they don't have to be bailed out by the government for high-risk debacles.

Hidden Fees? But today's supercharged political environment is creating a bizarre situation. When the major banks try to increase their prices for basic services, like checking accounts or debit cards (to make up for lost profits on activities now denied to them), they generate an avalanche of hot political rhetoric. This includes charges of "hidden fees" by President Obama, in referring to a widely publicized announcement by Bank of America that it was instituting a $5 a month fee for many debit card holders.

Aside from the President, the rhetoric tends to be from those Congressmen and "consumer advocates" who pushed into the financial reform legislation a section that put limits on the fees that bankers can charge merchants for debit card transactions. Of course, this part of the legislation had nothing to do with the subprime debacle, and everything to do with a long-standing complaint by retail merchants about bank card transaction fees. That is the way the Congressional sausage machine works.

Pay Now or Pay Later. So, consumers who paid for the convenience of bank card debit activity through higher prices when they shopped, will now pay for that convenience with higher fees on their cards. The only change is that the transaction cost of using cards will be more transparent. Do retail merchants really want customers to use dirty dollar bills?

A contributing factor to the banks' dilemma are today's extremely low interest rates (thank you, Ben Bernanke). This means that customer deposit balances cannot be invested by their bank at a significantly higher interest rate to help profit margins.

Loss of Clout.The large banks' political clout has seriously eroded over the past three years.  Even Fox News is now lumping Bank of America severance payments for recently-fired senior mangers with fuel for anti-bank Wall Street demonstrators. But while there is a reasonable argument for market-based constraints (e.g. higher capital requirements) to discourage the biggest banks from becoming too large, there is no credible economic argument to institute price controls on basic bank services.  

It would be most helpful if the President and more Congressmen, newspaper editorial writers and bloggers could understand basic economics when it comes to the cost of running the nation's payment system - and the implications of trying to set price controls on what it does.  If you want a healthy banking system, the last thing you want to do to is to start controlling prices for bank services.

WHY THE FED IS FLOUNDERING

“Most of the economic policies that support robust economic growth in the long run are outside the province of the central bank.”  Federal Reserve Chairman Ben Bernanke, August 26, 2011

 Here we go again. A majority of the high priests of monetary policy (e.g. members of the Federal Reserve's Open Market Committee) voted to institute "Operation Twist" at their most recent meeting.

This follows their efforts to stimulate growth and bring down unemployment by pumping $600 billion into the economy under the "QE2" program by purchasing U.S. Treasury securities. With little to show for that project, the Fed will now try to reduce long-term interest rates and increase slightly short-term rates by selling shorter term bonds and buying longer term ones.

If you want an insider's technical critique of this maneuver, read today's remarks by Dallas Federal Reserve Bank President Richard Fisher, who voted against Operation Twist. 

However, Fisher also makes several more important points. First, he suggests the Fed does not really know what it is doing. He does this by passing along a wry Norwegian aphorism:

Theory is when you understand everything, but nothing works.

Practice is when everything works, but nobody understands why.

[Here], theory and practice are united, so nothing works and nobody understands why.

Secondly, Fisher stressed that further monetary accommodation, of whatever form, "will represent nothing more than pushing on a string" until Congress and the Executive get their act together on spending, taxes and the deficit.

The Fed is floundering because it is trying to do too much.  In the process of doing so it has managed to simultaneously raise Congressional hopes about what it can do and stir up a hornet's nest of political critics.  Despite his message at the opening of this blog regarding the Fed's limited powers in the current situation, Chairman Bernanke still feels impelled to do "something."

A stronger Fed Chairman would put substantially more heat under the bottoms of Congressional leaders of both parties and the White House to dispel the vast amount of regulatory and fiscal policy uncertainty created by the politicians. That is Washington's real damper on the private sector's willingness to spend and invest.