A Negative Sign for Investment and Job Growth

There’s a good rule of thumb–you get what you reward.

Here’s a summary of current U.S. policy towards big corporations: Invest in the U.S., create jobs, and get sued by the government.

You would think that during a business investment drought, any company that puts big money into the U.S. would be patted on the back. But no…

AT&T is the company which is putting the most money into the U.S….almost $20 billion in capital spending in 2010.  AT&T is also planning to bring back call center jobs from overseas.  AT&T is also getting sued by the Justice Department to block the merger with T-Mobile.

Frankly, this sends a signal to U.S. companies that getting out of  the reach of government regulators by going overseas is the right strategy.

Noahpinion on China and robots

Noahpinion gets what I’ve been trying to say, and says it better than I do in his post, “Are we replacing robots with Chinese people?” Here’s a meaty extract :

I’ve been critical in the past of Mike Mandel’s thesis. After all, productivity gains from outsourcing are real. Suppose I am a guy who designs and builds widgets. Hiring cheap Chinese workers to make my widgets more cheaply boosts my productivity almost the same, in the short term, as inventing a robot to make my widgets more cheaply (minus the small amount I pay the Chinese workers).

BUT…productivity is not the same thing as technology. This is a fact that often gets ignored, since economists tend to treat the two as being equivalent. But they are not. In particular, trade can boost productivity without any new technology being invented. This is what Mandel claims has been responsible for the large productivity gains in the U.S. over the past 10 years. I tend to believe him.

So why should we care whether our productivity comes from robots (technology) or from cheap Chinese labor (trade)? One answer – and I feel like this is what Cowen and Mandel may have been getting at – is that one may crowd out the other. And this brings me to the theory of endogenous growth.

Paul Romer (a physics B.A. like me!) invented the theory of endogenous growth back in the 80s. The idea is that technological progress does not simply arrive out of nowhere, but is a byproduct of economic activity. Since ideas are a nonrival production input (a.k.a. a “public good”), there is no guarantee that the market will produce enough of them. Some growth models may be a lot better at innovation than others, and policy can make a big deal. If we’re not channeling enough of our economic output into the production of new technology, we’ll all be poorer down the line.

And here’s the interesting part. Romer’s first crack at a theory of endogenous growth was this 1987 paper. His model uses this very interesting assumption:

“I also assumed that an increase in the total supply of labor causes negative spillover effects because it reduces the incentives for firms to discover and implement labor-saving innovations that also have positive spillover effects on production throughout the economy.”

In other words, if we suddenly get access to a bunch of cheap Chinese labor, we don’t bother to invent robots. Then tomorrow, when the cheap Chinese labor runs out, we find ourselves without any robots.

Yes. That’s it exactly.

Noahpinion also asks the very good question about what to do next.

 

Is Consumption the Point of Economic Activity?

On the Economist Free exchange blog, Ryan Avent objects to some of my recent writings on the production economy vs the consumption economy. In the process, he makes a statement  that I feel needs further examination. He writes:

consumption is the point of economic activity; why work except to obtain things?

I have heard this line before. To me, it sums up the essence of the consumption economy: The only purpose of work is to consume.

I would like to raise two objections to this statement–one technical, one philosophical. First, even if you believe that consumption is the only point of economic activity, presumably we  care about the consumption levels enjoyed by our children, and our children’s children’s. So if you care enough about future generations, you personally will choose to consume less and invest more today. Given that we as a society are running up big debts,  it is highly likely that our children will be better off if we choose to invest more today and consume fewer goods and services, whether they are imported or domestic. Under current circumstances, there is no moral imperative to consume.  

Second, I’m going to wax a little philosophical here.  Mr. Avent writes that “the only purpose of work is to consume.” That’s a little bit like the people who say that the main goal of life is to be happy. I would disagree with both statements. I would say that once we are above some level of income, the main goal of work (and life) is to contribute to society in the best way we can.  Happiness (and consumption) flows out of that contribution.

End soapbox.

P.S. I wouldn’t have any trouble at all with a trade deficit if we had a high rate of investment. But our current level of net investment, in nominal dollars,  is less than half of what was before the recession. We’re borrowing from the rest of the world to fund our consumption today, not our investment and productivity gains.

[Added on 8/17

Here is a Keynesian post that claims Consumption – To Repeat the Obvious – Is the Sole End and Object of All Economic Activity ]

 

Consumer Pullback Not So Scary

See my latest theAtlantic.com column here.

 

China Imports: SF Fed Research Misses the Point

Recently the San Francisco Fed released a new study  entitled “The U.S. Content of “Made in China””.  The study argues that “[g]oods and services from China accounted for only 2.7% of U.S. personal consumption expenditures in 2010.”  This figure was cited approvingly by a large number of publications and bloggers,  including the LA Times, the WSJ,  Fortune, The Street.com,  and  Matt Yglesias,  who writes:

When Americans go buy stuff, they’re overwhelmingly buying things that are made in America:

Sorry, Matt. I’m going to explain why the SF Fed study shouldn’t be taken seriously. In fact, the study has two main flaws:

  • The authors did not distinguish between dollar shares and quantity shares of imports. When imported goods are much cheaper than domestic goods, then the quantity share can be much larger than the dollar share.
  • The input-output tables used by the authors contain no actual information about how much of Chinese imports are going to personal consumption.  In fact, all imports are  divided among sectors by a simple rule known as the “proportionality assumption.”  So in reality,  Chinese imports could constitute much more of PCE–or much less–than the SF Fed economists calculate.

Dollar Shares versus Quantity Shares

So first let me explain the difference between dollar shares and quantity shares. I’ve just finished the second edition revision of my intro economics text, Economics:The Basics.  When explaining the basic concepts of supply and demand to students, it’s always important to clearly differentiate between quantity (as measured in physical units) and cost (as measured in dollars).  The same cost  can correspond to higher or lower quantities, depending on the price.

The same distinction applies to Chinese imports. It is clearly true that Chinese imports are priced lower per unit than the domestic-made products that they replace.  Similarly, China-made imports are much cheaper than the Japan-made or European-made imports that they replace–that’s why U.S. retailers changed their sourcing over the past ten years.

As a result,  if we measure the share of Chinese-made products in PCE, our answer is going to be much different if we calculate the dollar share, versus calculating the quantity share. An example will make this clear. Suppose that a U.S. shirt factory sells 100 shirts at $50 a piece, for a total cost of $5000.  Now suppose a Chinese manufacturer comes into the market and offers to sell an identical shirt for $5 a piece. In the first year, the Chinese manufacturer sells 50 shirts and the American manufacturer sells 60 shirts.  What share of the market do the Chinese shirts have?

Measured in dollars,  the Chinese have 7.7% of the market ($250/($250+$3000)).

Measured in quantity of shirts,  the Chinese have 45% of the market (50/110)

Which share is right?  For sizing the  impact of imports on U.S. jobs and manufacturing, the quantity share is much more relevant than the dollar share.

In fact, it’s very easy to construct examples where the dollar share of imports goes down, but the quantity share goes up. If China offered its imports to the U.S. for a near-zero price, then China’s dollar share of the U.S. would be close to zero (assuming that there was some U.S. manufacturing left) but the quantity share would be close to 100%.

The authors of the SF study are calculating the dollar share, not the quantity share.  That’s why their number seems so low.

In order to calculate the quantity share, we need to know the relative price of Chinese imports compared to equivalent U.S. products. It would also be useful to be able to compare the price of Chinese imports with imports from other countries.  (See a recent article in the  Journal of Economic Perspectives, Offshoring Bias in U.S. Manufacturing). It makes an enormous difference whether Chinese made imports are 5% cheaper than the equivalent U.S. products, or 50% cheaper.

However,  the Bureau of Labor Statistics does not collect such relative price data across countries.  At  no point does the BLS measure the difference in price between a shirt made in China versus one made in Italy or the U.S.  In fact, when the sourcing of a particular  good changes from one country to another,  the import price index often treats it as a new product, even if it is functionally identical.  (Take a look at the BLS explanation of its import price methodology here).

Proportionality Assumption

The second problem with the study is that the government statisticians have no information–repeat no information–about whether an imported goods or service is going to consumption, to capital spending, or being used as an intermediate input.  How could they? That question is never asked on any economic survey form.

Here’s the description of the problem from the official BEA ‘bible’,  Concepts and Methods of the U.S. Input-Output Accounts

Unfortunately, data on the use of imports by industries and final uses are not available from our statistical data sources. Thus, to develop an import matrix, we make the assumption that imports are used in the same proportion across all industries and final uses.

This is what’s known as the “proportionality” assumption. The proportionality assumption is *not* harmless, especially when it comes to calculating the contribution of a single country, such as China, to PCE (see for example the paper here).  It might very well be that Chinese imports are much more concentrated in PCE than the proportionality assumption suggests, especially in areas such as computers where the Chinese are more likely to have a low-end product (Best Buy does not sell U.S.-made supercomputers, do they?)  Or Chinese imports could go much more into investment goods than anyone realizes. The point is that there is no information to make a judgement.

So the calculations of the SF Fed economists are fundamentally based on a huge assumption which may or may not be true.  At a minimum, they should  have offered up their calculation as a range.

BTW, if the SF Fed economists still are prepared to defend their calculations, I’m happy to debate them in any forum.

Why Obama Should Cheer Google’s Purchase of Motorola Mobility

President Obama should take a moment this morning to applaud  Google’s acquisition of Motorola Mobility.

This deal is a case of an innovative and job-creating American company using its cash stockpile to invest in another American company–billions that will almost certainly be followed by more billions to develop new and innovative products.  Rather than sitting on its profits, Google is doubling down on the mobile sector, and the result is almost certainly going to be more investment and more jobs in the U.S.

In a critical sense, Google is justifying its reputation as a force for disruptive innovation by putting its money behind its words. The company could have stayed in search advertising, and continued to collect its billions in income more safely. Instead, it’s turned itself into a full-fledged competitor to Apple in the mobile ecosystems space.

For the U.S. economy, the Google deal is nothing but good news.  We’d be a lot better off if other companies with cash followed the Google example of investing in innovative U.S. companies–and President Obama should say so.

‘Production Economy’ vs ‘Consumption Economy’

In a recent post, I said that the U.S. should be a production economy, not a consumption economy. Matt Yglesias notes that “I have really no idea what that’s supposed to mean, since presumably the idea is to produce goods and services that people want to consume.”

Let me explain: I believe that the U.S. has come to a fork in the road. The direction we’ve been going leads to the  the consumption economy, putting more resources into consumption and distribution rather than production. It hasn’t been working for us.

The U.S. needs to change course to a production economy:  put more emphasis on investment in physical, human, and knowledge capital, and less on consumption as the yardstick of success.  We need to take up our fair share of the global productive burden.   

To see one indicator of the consumption economy  take a look at this chart.

It tracks the buildings used for manufacturing (production) versus buildings used for retail, wholesale, and warehouses (distribution). Around 2001 the lines crossed, a sign that distribution was becoming more important than production in the U.S. economy.

The goal of a consumption economy is to provide consumers with low prices and wide variety, with less concern about jobs and wages.

In a consumption economy, successful corporations are the ones who can best manage their global networks of suppliers to obtain the lowest costs. Offshoring is a mark of pride,  showing that companies can meet the desire of their customers for lower prices.

In theory, a consumption economy can be a great thing.  Low prices can presumably bring higher living standards for households, as real wages rise.  In theory, production is not an essential component for economic prosperity if you can create the product and organize the production and distribution process.

The great success story for the consumption economy is Apple. Apple is a spectacularly profitable creator of innovative  products and ecosystems, and a successful retailer to boot.  However, the company does not manufacture the  iPads, iPhones, iPods, and so forth that  it creates and sells.  Creation and distribution, but no production. [Edited for clarity. See below*]

However, Apple is Apple. For the rest of us, the consumption economy isn’t working  so well.

I promised myself I would stop writing excessively  long posts, so I’m going to stop here for now.

*Added:  The exact language from Apple’s  annual report

Substantially all of the Company’s Macs, iPhones, iPads, iPods, logic boards and other assembled products are manufactured by outsourcing partners, primarily in various parts of Asia

Obviously this does not include software.

While Economy Burns, Regulators Fiddle

So let me get this straight. The economy is slumping, economists are warning of a double-dip, and the Obama Administration is pleading for companies to invest.

But clearly Obama’s telecom regulators didn’t get the memo, based on the way they are treating AT&T, a company that actually invested almost $20 billion in the U.S. last year, tops in the country.  Rather than encouraging AT&T to speed up investment in this period of economic weakness, the regulators actually seem intent  on slowing down  the telecom provider.

The latest move: An indefinite postponement of AT&T’s request to buy some wireless licenses from Qualcomm, originally proposed in February. From Reuters

AT&T Inc’s $1.9 billion offer for some of Qualcomm Inc’s wireless licenses will be tied to a simultaneous review of AT&T’s $39 billion proposed takeover of T-Mobile USA, U.S. communications regulators said in a letter sent late on Monday.

The Federal Communications Commission, citing the many related issues, dropped the agency’s informal 180-day timeline for review of the Qualcomm deal. The move could significantly delay completion of the smaller Qualcomm deal because the review of AT&T’s bid for Deutsche Telekom AG’s T-Mobile is expected to span at least into the first quarter of 2012.

Qualcomm said swift action on its deal was in line with the FCC’s goal to free up more airwaves for mobile broadband use. The company said the deal would not only re-purpose unused spectrum for wireless Internet services, but it would also allow it to invest and deploy more spectrum efficient technology.

I’m sure this choice seemed perfectly reasonable to the regulators, and who knows, in some ideal world it might be the right thing to do.  But on the day that the stock market is crash,  a move to slow down a successful business sends another signal that the priority of the Obama Administration is regulation rather than the state of the economy today.  No wonder voters don’t believe Obama is serious about jobs and investment. 

Productivity Revisions Not Over

Back in March, I analyzed  the productivity ‘surge’ of 2007-2009  and declared it “highly suspect.”  (It was perhaps one of the longest blog posts ever).

Well, yes.  As I predicted five months ago, reality has won, and productivity growth has been revised down. This morning’s productivity release revised down nonfarm productivity growth in the 2007-2009 period from   2.3% to 1.5%.

But I don’t think the productivity revisions are over.   The published GDP stats, once you look under the hood, still tell a highly implausible story.  Once I do the appropriate adjustments,  the economic narrative changes:

*The bad news is that the U.S. economy is worse off than it looks, even now.

* The ‘not-so-bad news’, at least for Americans,  is that the next round of the financial crisis is likely to hit the rest of the world harder than the U.S. , even if the government does nothing.

To be continued.

Five Things to Remember

  1. The stock market is not the same as the economy. When the stock market was rising, it didn’t mean the economy was good. When the stock market is falling, it doesn’t mean the economy is bad (see here)
  2. Much of the growth of the federal deficit went to fund economic growth abroad, not in the U.S.  Yes, I know that the official data shows that real imports are smaller today than when the recession started. It’s not true.
  3. The official data are wrong. Real import growth is stronger than the numbers show, productivity and real GDP growth are much weaker. (see here).
  4. The last thing the U.S. needs is another stimulus to consumption. Consumption leaks right out the door as higher imports.
  5. The U.S. should be a production economy, not a consumption economy.  It’s time to stop chasing low consumer prices and focus on investment in physical, human, and knowledge capital. That’s the only path to sustained prosperity.

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