Healthcare reform versus financial reform

My take on healthcare reform versus financial reform: I understood the goals of the final healthcare reform bill,  but I’m not sure what problem this piece of financial reform legislation  actually addresses.

1)  The healthcare reform bill had a difficult process, for sure,  but  I understood the goals of the final bill.  So when someone asked, I could explain it clearly:  this piece of legislation would definitely broaden coverage in a variety of ways.  However, it would not cut costs. That would be left to the next healthcare reform bill, several years down the road (and likely when the Republicans were in power).

I didn’t have a problem with the healthcare reform bill only doing part of the job–healthcare is a vast area, there’s lots of competing interests who really care,  and we were stuck with political gridlock.  I think Obama can justly be proud of healthcare reform.

2) Financial reform, as embodied in the current legislation, makes me scratch my head.  The Consumer Financial Protection Bureau makes a lot of sense. But the rest of the provisions? In his latest piece, my friend Allan Sloan puts it better than I can:

…with a rare exception or two, this 2,000-page bill nibbles at the toes of the problems that brought us the worldwide financial meltdown. It doesn’t go for the throat — its sponsors just pretend that it does.

And he goes on to say.

Sure, there are some useful things other than consumer protection in Dodd-Frank. But assuming the bill becomes law in its current form, we’ll have the same systemic problem we had when the meltdown started in June 2007: too many institutions that are too big to fail, and a perilously opaque financial system that will freeze if problems recur.

My view exactly.

Female Ghetto or Fortress?

Quiz: What percentage of women work in health,education, or government?

a) 26%

b) 37%

c) 43%

Government Spending, 1979 vs 2007

Given the political furor over budget deficits and the size of government, I thought it would be interesting to compare the patterns of government spending in  2007 (pre-financial-crisis) versus 1979 (pre-Reagan-Revolution). First, though, a long-term look at combined government spending at all levels (federal, state and local) as a share of GDP.

Remarkably, we see that government spending as a share of GDP moved within a relatively narrow band for a 30-year period.  Government went from roughly 30% of the economy in the early 1970s, up to 35% of the economy in 1992, and then down to about 30% again in  2000.

Now let’s look at government spending patterns. I’m going to compare 1979 and 2007, which were both business cycle peaks.  I’m going to use the BEA’s data for government current expenditures plus gross investment (slightly different from the total expenditures charted above).  Once again, this  includes all levels…federal, state, and local.

Government spending patterns were little different in 2007 (pre-bust) compared to 1979 (pre-Reagan revolution).   The biggest change was an increase in government spending on health as a share of GDP.  Defense nudged down a bit, as did economic affairs (spending on highways, roads, R&D, etc).  Spending on public order and safety nudged up.  But overall, the patterns were remarkably similar

Of course,  2009 and 2010 (not yet available) would show big changes in the patterns of government spending. But given the long period of stability, we can regard those shifts as a response to the crisis rather than part of a long-term trend.

What is China’s Share of the U.S. Market?

Everyone is familiar with this chart–total imports as a share of GDP. (In fact, I can’t count the number of times I ran this chart, or something similar, in the pages of BusinessWeek).  The chart appears to show that the import share of the economy in 2009  was basically the same as it was in 1999 (13.7% vs 13.4%).  

The only problem–this chart is nonsense, and tells us almost nothing about the size of imports relative to the U.S. economy.  Here are the problems*:

1)  Purchaser versus producer values: GDP values a shirt  in the store; the import figures value that same shirt when it enters the country, not including the cost of getting it to the store and selling it.  That difference between the store ( ‘purchaser’ ) value   and import (‘producer’) value can be enormous, depending on the particular item.  In the case of men’s clothes, for example, the BEA’s data shows that the store value of men and boys apparel is almost triple that of the producer value,  with the bulk of that difference coming in the margin of retailers.  More typically, the cost of goods to the final purchaser is roughly about double the producer value.  Adjusting for  domestic transportation, wholesale and retail margins gives us a higher share of imports in the economy. 

2) Final  vs intermediate : GDP values a car when it is bought by you, the ‘final purchaser’,  in the showroom.  It does not count separately all the ‘intermediate’ goods and services that go into that car.  So the value of the car radio, say, does not show up separately in GDP, even if it is made by a different company.  By contrast, imports include both final goods and services (sold to the ultimate purchaser) and intermediate goods and services (used by businesses, nonprofits,  and government to produce final goods and services).  So ideally we would divide imports by a measure of U.S. economic activity that includes both final and intermediate goods and services.  That’s not an easy concept, but the closest that we have is the “gross output” measure constructed by the BEA as part of its industry accounts, which counts purchased intermediates as well as final goods and services. In 2008, gross output was $26.6 trillion, roughly double the $14.4 trillion in GDP.   Adding in  the production of intermediates gives us a lower share for imports, though it has an ambiguous impact on the time trend.  

3) The import-domestic price differential:  In many cases, the producer price of importing an item from China or another country is substantially less than the price of the same or similar item produced domestically. It has to be–that’s what drives the whole offshoring movement.  No one would source from overseas unless it was cheaper.

However,  when we divide the dollar value imports by the dollar value of GDP (as in the chart) and use that as a measure of import penetration, we are implicitly assuming that the price of imports is the same as the price of the comparable domestic goods.  Let me give you an example.  In 2007,  Americans bought about $100 billion in furniture (valued at producer prices).  We imported about $30 billion in furniture.  How much has imported furniture penetrated the American market? If we divide  $30 billion into $100 billion (30%), we are assuming that  $1000 buys the same physical amount of furniture, whether it is spent on imported or domestic furniture. But what if imported furniture is roughly one-third cheaper (producer prices) than the comparable piece of domestic furniture? Then $1000 actually buys much more imported furniture (perhaps a table plus chairs) than  the same  $1000 spent on domestic furniture.   Then the ‘real’ import penetration–measured in physical pieces of furniture–might be closer to 40% or 45%.  Adjusting for the import-domestic price differential would tend to raise the measured share of imports.

Unfortunately, there is no statistical agency that collects data on the import-domestic price differential. None. The BLS does an underfunded job of collecting data on changes in import prices, but there is as yet absolutely no official data on the import-domestic price differential (see here for an outline of how the BLS might do it).   

However, anecdotal evidence suggests that the import-domestic price differential for goods from China is on the order of one-third.  That is, the price of goods sourced from China is roughly two-thirds of the same goods sourced domestically.     (see, for example,  BusinessWeek’s 2004 story “The China Price”).   New research by Susan Houseman of the Upjohn Institute and Christopher Kurz, Paul Lengermann, and Benjamin Mandel of the Fed  finds “systematic import price differentials between products from advanced versus developing and intermediate countries,”  which suggests ranges for the import-domestic price differential for the U.S.   

Using one-third as a starting point for the China-U.S. import-domestic price differential  gives us a chance to calculate China’s ‘real’ share of the U.S. market for manufactured goods. 

This chart shows China’s goods imports, as a share of U.S. domestic market for non-oil manufactured goods, under the assumption that goods imported from China are one-third cheaper than the comparable goods manufactured in the U.S.   The denominator is the gross output of non-oil manufacturing at producer prices (from the BEA’s industry accounts) minus exports plus the adjusted value of imports.  Imports are adjusted under the assumption that non-oil imports from developing countries are one-third cheaper than comparable U.S. products,  and non-oil imports from intermediate countries are one-quarter cheaper.

Using this procedure, I estimate that the ‘real’ import penetration of  Chinese-made goods  was roughly 9.7% of non-oil manufacturing in 2008, up from 2.9% in 1999.  

China also has a much bigger real import penetration than other major import partners of the U.S. Japan, Germany, and Canada are advanced countries, and we would expect a relatively small import price differential. Mexico is somewhere in the middle–a smaller price differential than China, but bigger than industrialized countries. So assuming a 33% import-domestic price differential for China and a 25% import-domestic price differential for Mexico gives us the following chart.

 China’s penetration into the U.S. manufacturing market is more than twice as big as Mexico and Canada (omitting oil). That explains why China has become so much the focus of political debate, rather than Canada and Mexico, or Japan and Germany.

IMPORTANT CAVEAT: These are preliminary calculations. Have fun, shoot holes in them, tell me that I’m an idiot. But in exchange, I reserve the right to change them and put out new calculations without an ounce of apology.

*Yes, I know the correct denominator is gross domestic purchases rather than gross domestic product.  When I do the calculations for China and the other countries at the end of the post, I adjust appropriately for exports and imports

Too Little Spent on the Human Genome Project?

I’ve got a lot of responses, pro and con, to my previous post on the Human Genome Project. I appreciate them all. But I just came across one (hat tip to Warren in the comments) that I find interesting. Mike “the mad biologist” writes in his post with a great title The Human Genome Project: What Happens When You Do Budget-Limited Science (or You Get What You Pay For):

Far too expensive. When budgets are limited, you’re forced to generate the data that is easier to get–and cheaper. So when Mandel describes the HGP as an economic flop so far–and he would be inclined to do so since he is interested “the innovation shortfall”–he fails to understand that we didn’t invest in the HGP adequately. Seriously, compare the $3 billion for the HGP to the billions in tax breaks companies get every year for R&D. Or inflation-adjust the Manhattan Project. Let’s not even talk about the Marine Corps’ Osprey program. By comparison, the HGP was done on the cheap.

Now there’s an interesting thought.  I’ve been going on the assumption that we were spending as fast as the science could absorb the money, but is it possible that we spent too little? The inflation-adjusted cost of the Manhattan project looks in the $22 billion range (Wikipedia number, which I rechecked).

Teacher Firing Prevention Fund?

In his letter to Congress on June 12,  President Obama called for a “Teacher Firing Prevention Fund.” Now, I’m as much in favor of teachers as the next person. My mom was a teacher. I sometimes travel around the country speaking in favor of better funding for early childhood education, which I think is very important.  I run a business, Visible Economy, that combines news and education. Human capital, and especially education, is essential for the U.S. economic future.

But, boy, if Obama wants to make a case for more money for elementary and secondary education, calling it a Teacher Firing Prevention Fund is just not the way to go. Why not a Factory Worker Firing Prevention Fund? Or a Journalist Firing Prevention Fund?   After all, everyone’s pay contributes equally to the macroeconomy–doesn’t everyone’s jobs deserve protection?

The Debt Crisis and the Human Genome

My nomination for the most significant economic event of the past decade:  The failure of the Human Genome Project to  thus far deliver medically significant results.

Let me explain my thinking, and why there may be reason to be guardedly optimistic about the future.

Right now there are three depressing aspects to the current course of the U.S. economy.  First, the growth of healthcare spending, if it continues, will put a stranglehold on employers and taxpayers.  Second, the apparent inability of the private sector to generate well-paying jobs for college grads, if it continues, will put a squeeze on young workers.  Third,  the apparently inability of the U.S. to export enough to close a huge trade deficit,  if it continues, will leave the country exposed to a  dollar collapse and a sharp fall in living standards.

I could have arranged and described these differently, but that’s the outline of the negative picture.

The Human Genome Project had–and still has–the potential to be a powerful antidote to all three of these problems.  Let’s start with healthcare spending.  I’ll quote from today’s New York Times article (“A Decade Later, Gene Map Yields Few New Cures”):

..the primary goal of the $3 billion Human Genome Project — to ferret out the genetic roots of common diseases like cancer and Alzheimer’s and then generate treatments — remains largely elusive.

….At a [2000] news conference, Francis Collins, then the director of the genome agency at the National Institutes of Health, said that genetic diagnosis of diseases would be accomplished in 10 years and that treatments would start to roll out perhaps five years after that.

Cancer. Alzheimer’s. Diabetes. These are the expensive medical problems that eat up so much of our economy’s resources.  The possibility of a cure, say, for Alzheimer’s, could potentially turn the horrible economics of healthcare upside down. (see, for example, ”Forecasting the Global Burden of Alzheimer’s Disease“).  Similarly, a cure or at least effective treatments for diabetes could sharply reduce healthcare outlays for diabetes, which are expected to triple over the next 25 years  from $113 billion to $336 billion (inflation-adjusted dollars).

What about jobs? Successful new innovations create new jobs–that’s what history tells us. If the Human Genome Project had led to a wave of new diagnostic test and treatments, the jobs would have followed.

Instead, what happened is that the pharma industry invested heavily in ‘genomics’ and got hit hard when it didn’t produce a flood of new diagnostics and treatments.  As a direct result, big pharma companies have been merging and laying off workers, not adding them. When’s the last time you heard someone talking about biology as a hot field for jobs?

This chart shows what happened over the past twenty years. In the 1990s,  job growth in pharma and biotech was able to keep up, more or less, with job growth in health services.  But over the past decade, just when you ‘d think that the mapping of the human genome would have created more jobs at pharma companies to take advantage of new discoveries, the opposite happened.  The drug pipeline dried up, and the big drug companies went into job-cutting mode.

This had an unfortunate domino effect. Cities around the U.S. had built their economic development strategies around attracting biotech jobs,  which looked like a great idea for getting ahead of a growth wave. But recent cuts have meant that the jobs gains have been relatively small.  Take St. Louis,  for example, which has been among the most successful areas in attracting  biotech research.  In 2006, for example, an article proclaimed “St. Louis And Its Companies Benefit From Biotech Push”:

St. Louis is coming of age as a biotech center…It has spent six years and added $500 million dollars in venture capital to build itself into a biotechnology hub. It has attracted new talent for companies already here, such as Monsanto Co. (MON), Pfizer Inc. (PFE) and Sigma-Aldrich Corp. (SIAL), and now is home to more than 15,000 employees at 400 more ventures, particularly in plant and life sciences.

Research, yes, for sure.   The number of jobs in the St. Louis area at “scientific research and development services” (including biotech) rose from  3500 in 2002 to 8300 in 2008.  That increase of +5K is  a fantastic performance, under the circumstances.

But research alone is not enough to make up for the loss of manufacturing jobs (down 28K over the same period).  You need production of real products, which require real production workers. Unfortunately,  employment in “pharmaceutical and medicine manufacturing”  in the St. Louis metro area appears to have peaked in 2006 (based on data through 2008). In November 2009 Pfizer announced that it was cutting 600 out of 1000 employees in its St. Louis research facility.

In fact, the “Biotech Strategy” used in St. Louis and elsewhere would have produced much bigger job gains if the research had been more successfully commercialized over the period.

Now let’s turn to trade. China, India, and the rest of the developing countries sell the U.S. an increasingly diverse array of goods and services. What does the U.S. provide in return? There’s the usual list of suspects, such as commercial aircraft (which is increasingly drawing on parts made outside of the country).  But they are not enough to avoid a huge trade deficit, even now.

The logical candidate for the next wave of U.S. exports should have been biotech products and knowledge. The U.S. is the acknowledged world leader; the research is expensive and lengthy; the production processes are complicated, delicate, require skilled technicians,  and cannot be easily offshored. And the category–treatments to deal with major medical problems–is something that everyone wants.

But what happened? Without compelling new biotech products, the big pharma companies were “me-tooed” to death. In fact, pharma trade went from roughly balanced to a big deficit.

This chart is simply astonishing.  Life sciences–the area where the U.S. is the clearly the world leader, where we have outspent everyone on research by a wide margin–has turned into a trade deficit.

Okay, it must feel like I’ve punished you all with negativism. I promised up top that I would be guardedly optimistic.  Here’s how I see it: The U.S, and more broadly the “advanced” countries, did what they were supposed to. They invested heavily in the cutting-edge new technology, biotech, which promised to make the biggest difference in the most important areas–health, food, energy.  The research has gone great, tremendous progress has been made. Commercialization thus far has sporadic–but the gap between research and commercialization is one which has been repeatedly bridged in the past. So I’d say that the odds are good that the Human Genome Project will have a significant economic impact over the next 5-10 years.

The big danger–that there are structural impediments in the U.S. innovation system which are slowing down commercialization. These include a lack of communication between academic scientists and pharma companies; excessive regulation by the FDA; a misguided patent system; and excessively short term thinking at pharma companies.  (You can add your own possibilities to the list).

I’m thinking about putting together a conference called “Fixing Pharma,” with the goal of identifying structural impediments to successful application of genomic knowledge. That’s just so important economically.  Anybody who wants to know more, drop me a note at mmandel@visibleeconomy.com

Service Sector Inflation Accelerates

Is inflation accelerating or decelerating? It depends on where you look.

The inflation story differs tremendously depending on whether you look at goods or service inflation. Goods inflation is very low and stable–the producer prices for finished goods less food and energy are rising at only 1% per year. 

By comparison, service sector inflation is accelerating.   Over the last few years, the Bureau of Labor Statistics has started reporting producer prices for what it calls “traditional service industries.” These include such services as healthcare, finance, information services, legal, accounting, management consulting,  security guards, employment services, janitors, advertising, and so forth and so on.  Many of these services are mainly bought by businesses, so they don’t show up in the CPI. They also tend to be labor intensive and more domestic.

Which one of these should the Fed be watching?  I’d say that service sector inflation may turn out to be a better indicator of domestic price pressures.

Job Market Improves for Foreign-Born

Today’s job release showed a very surprising pattern: Compared to a year ago, the labor market for foreign-born workers appears to have improved. Meanwhile, the labor market for native-born workers appears to have worsened compared to a year ago

Foreign born workers had an unemployment rate of 8.6% in May 2010, compared to 9.1% a year in May 2009.  Native-born workers had an unemployment rate of 9.5% in May 2010, compared to 9.0% a year ago.

Let’s look at the changes over the past few months.  In this chart, remember that the unemployment rate is not seasonally adjusted. The unemployment rate for the foreign-born took a big drop between March and April. Maybe it’s the result of change in sampling procedures, maybe it has something to do with the decadal census, or maybe it’s real.

In the middle of the big immigration debate, I’m almost reluctant to put up this post–it feels like throwing fuel on the fire. But I’m a firm believer in letting numbers speak for themselves.

Innovation Conference at Wharton this week

In my role as a senior fellow at the Mack Center for Technological Innovation at Wharton,  I will be  the lead-off speaker  at a conference on “Innovation for the Long Run: Certain Costs, Uncertain Payoffs and Impatient Capital.” It looks like a great conference.