Merton Finkler

Author: Merton Finkler

The Second Great Contraction

Professor Gerard’s posting on the debate about the role of fiscal policy starts with the Larry Summer’s point that the debt deal “solves the wrong problem.”  As pointed out previously (see here), I agree with that conclusion.  So, what is the “right problem?”  Kenneth Rogoff’s answer requires  that we understand that this recession is not a typically recession.

The phrase “Great Recession” creates the impression that the economy is following the contours of a typical recession, only more severe – something like a really bad cold. That is why, throughout this downturn, forecasters and analysts who have tried to make analogies to past post-war US recessions have gotten it so wrong. Moreover, too many policymakers have relied on the belief that, at the end of the day, this is just a deep recession that can be subdued by a generous helping of conventional policy tools, whether fiscal policy or massive bailouts.

But the real problem is that the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation.

Rogoff and Carmen Reinhart (R & R), along with others such as economic historian Harold James, emphasize that economic growth built upon too rapid a credit build-up cannot be sustained with expansionary monetary and fiscal policy. It requires de-leveraging (perhaps, you prefer credit build down), a process that cannot be accomplished quickly and offers little positive in the short run that can be gained to soften the blows. The only solutions require that the real level of debt must be reduced to a sustainable level.  As noted in the Rogoff quotation above, somehow creditors must bear some of the burden (a “haircut” in Wall Street parlance.)  The dynamics of this process lead R & R to deem our most recent period as “The Second Great Contraction.”

Rogoff’s suggests that inflation might be the least costly way to address problem – one might argue it is THE “time honored” policy of choice when governmental commitments exceed its ability to meet them.  Of course, this suggestion is not met with great enthusiasm (see “Kids Prefer Cheese” which argues that Rogoff proposes “theft, pure and simple.”)  Is it the least bad approach?  The answer depends upon one’s view of the functionally of our governance structure.  Let’s just say that “dysfunctional” would not egregiously mis-characterize U.S. governance at present.

Recognition of the right problem and a useful framework for policy discussion must come first.  As Rogoff puts it in the article linked above,

The big rush to jump on the “Great Recession” bandwagon happened because most analysts and policymakers simply had the wrong framework in mind. Unfortunately, by now it is far too clear how wrong they were.

Acknowledging that we have been using the wrong framework is the first step toward finding a solution. History suggests that recessions are often renamed when the smoke clears. Perhaps today the smoke will clear a bit faster if we dump the “Great Recession” label immediately and replace it with something more apt, like “Great Contraction.” It is too late to undo the bad forecasts and mistaken policies that have marked the aftermath of the financial crisis, but it is not too late to do better.

The Debt Ceiling Is At Best Superfluous

In today’s New York Times Economix column, former advisor to presidents Ronald Reagan and George H. W. Bush Bruce Bartlett argues persuasively that the debt ceiling and debate about it accomplishes nothing constructive that is not already contained in the Congressional Budget and Impoundment Control Act of 1974.  Former Fed Chair Alan Greenspan made this point emphatically in his 2003 testimony to Congress.

In the Congress’s review of the mechanisms governing the budget process, you may want to reconsider whether the statutory limit on the public debt is a useful device. As a matter of arithmetic, the debt ceiling is either redundant or inconsistent with the paths of revenues and outlays you specify when you legislate a budget.

Current Fed Chair Bernanke put it even more starkly when he noted that the debt ceiling legislation is equivalent to using a credit card to buy things and then refusing to pay the bill when it arrives.

Innovation and Entrepreneurship Ride to the Rescue

Although there is some disagreement amongst economists, many argue that traditional monetary and fiscal policy will not take the US economy from its current relatively stagnant state to the robust growth needed to employ many of the 8 million who were unemployed during the recent recession as well as the new entrants into the labor force.  As those in Intermediate Macroeconomics learned, since we add roughly 1.5 million people to the work force each year, we need about that number of jobs just to keep  unemployment from worsening.

As several studies from the Kauffman Foundation have shown, the vast majority of new jobs created in the United States come from new firms (that is firms that are five years old or younger),  not from large firms or small firms and not from governments.  In recent years, fewer new firms have been created than  in the past, and each of these firms has generated fewer jobs than in the past.  The Kauffman Foundation has put together a non-partisan “Startup Act Proposal” to jump start the economy.  It is entitled “Access to Capital: Fostering Job Creation and Innovation Though High-Growth Startups.”   The four key provisions are as follows:

1.  Provide a permanent capital gains exemption to investment in startups held for at least five years.

2.  Reduce the corporate tax burden for new companies in the first three years they have taxable income. (This may be already doable under subchapter S of the corporate tax code.)

3.  Reduce Sarbanes-Oxley requirements for firms with less than  $1 billion in market capitalization.

4.  Subject federal regulation to 10 year sunset.

Carl Schramm and Robert Litan, on behalf of the Kauffman Foundation also argue for removing the caps on skilled immigrants and immigrant driven entrepreneurial ventures.

These are intriguing ideas.  They should encourage Lawrence students to sample our Innovation and Entrepreneurship courses.  Check out Schramm and Litan’s presentation last week to the National Press Club.

Alan Greenspan on Excessive Risk Avoidance

In today’s Financial Times, former U.S. Federal Reserve Chair Alan Greenspan opines that we can carry risk aversion too far.   Greenspan’s discussion parallels that posted by Professor Gerard related to the interview of Vernon Smith.  In particular, Greenspan argues persuasively that the more we set aside to protect against once in 50 year or once in 100 year adverse events, the less capital we have to devote to productive activities.  He cites bank reserves in excess of $1.5 trillion as excessive private risk aversion.  Regarding public policy, he argues as follows:

What is not conjectural, however, is that American policymakers, in recent years, faced with the choice to assist a major company or risk negative economic fallout, have regrettably almost always chosen to intervene. Failure to act would have evoked little praise, even if no problems subsequently arose; but scorn, and worse from Congress, if inaction was followed by severe economic repercussions. Regulatory policy, as a consequence, has become highly skewed towards maximising short-term bail-out assistance at a cost to long-term prosperity.

This bias leads to an excess of buffers at the expense of our standards of living. Public policy needs to address such concerns in a far more visible manner than we have tried to date. I suspect it will ultimately become part of the current debate over the proper role of government in influencing economic activity.

Does China Invest Too Large a Portion of Its Income?

A recent blogpost by Professor Gerard (with the supporting observations from Dr. Doom (Nouriel Roubini) suggests that the answer might be yes.  At some point, this will be true, but I’m not sure that it will happen in the next few years.

As a recent visitor to the Middle Kingdom (last two weeks in June) and to the western part of the Middle Kingdom in particular (Guizhou Province), I observed an incredible amount of building.    Housing construction continues its rapid pace and not just in the biggest cities (such as Guiyang) but in regional (within the province) outposts such as Kai Li and even fast growing  counties (such as Danzhai.)  Furthermore, the links among these places are made by new toll ways and long tunnels through the mountainous countryside.  Airports and local road improvements are also underway.

Is it too much?  Has the marginal product of capital become small or even negative?  It’s too soon to tell.  It must be noted that China is approaching 50% urbanization which suggests that interurban transport and urban housing will be needed along with other critical infrastructure pieces such as water filtration and waste water facilities.  These items certainly have found their way into provincial budgets.

In a recent article in Seeking Alpha, Shaun Rein, the Managing Director of the China Market Research Group, begs to differ with Dr. Doom:

“However, most of Roubini’s conclusions are based on phantom facts, as is his evidence for why China will have economic problems. There is no direct flight between Shanghai and Hangzhou, nor is there a maglev train system connecting the two cities. Shanghai has two — not three — airports, and the last new one opened a dozen years ago, in 1999. Both the Hongqiao and Pudong airports have been adding runways and terminals because the airports are too crowded, contrary to Roubini’s suggestions of emptiness. Pudong’s passenger and cargo traffic grew 27% in 2010, to 40.6 million passengers. It is now the third busiest airport in the world in terms of freight traffic, with 3,227,914 metric tons handled every year. Continue reading Does China Invest Too Large a Portion of Its Income?

Why didn’t the fiscal stimulus have large effects on employment?

As noted previously,  cheap capital and expensive labor tend to lead to the substitution of capital for labor – after all capital is often called “labor saving devices” for a reason.  Now, we have solid evidence that the total cost (wages or salary and benefits) of labor has risen markedly while equipment and software costs have fallen since 2009.

For the rest of the story, see Catharine Rampall’s NY Times Economix blog last Friday entitled “Man vs. Machine.”   To put it most starkly, if your job can be replaced by an algorithm, it probably will be.  As those who took Econ 320 should know, if you attempt to implement  macroeconomic stabilization policy without understanding the microeconomics of labor markets, you may not be blessed with success.

Trade Agreements and Transitional Costs for Workers

As with many aspects of economic policy, political leadership – such as it is – often snatches defeat from the jaws of victory.  Presently, the United States has the opportunity to sign trade agreements with Columbia, South Korea, and Panama that will provide great opportunities for U.S. exporters without having to offer special privileges or changes in domestic markets related to products from these countries.

Why might Columbia, South Korea, and Panama want to sign these apparently one-sided agreements?  One answer is their economies would benefit greatly from better access to goods from the U.S.  Why have we resisted signing these agreements?  Many advocates in these country believe that trade hurts domestic workers.   This certainly is true in the short run for workers whose jobs end because the products they produce no longer are competitive with imports.  It’s also true when capital investment, often spurred by low interest rates, encourages the substitution of capital for labor.  Neither of these concerns, however, are pertinent for the trade policy opportunities before us.

Passage of the aforementioned trade deals seems to be based on support for expanded trade assistance, a policy that provides specific benefits to some who can prove that they have lost jobs as a consequence of import competition.  Matthew Slaughter and Robert Lawrence in today’s Opinion Pages of the New York Times argue that both more trade and more aid make sense, but the aid should not be specifically focused on those who allegedly lost jobs as a result of imports.  They propose an innovative program that combines the existing trade adjustment policy with unemployment compensation benefits to create a new, more efficient safety net that, among other things,  helps workers retool for different jobs and provides funds for health insurance in the interim.

I hope, but am not too optimistic, that our Congressional leaders, will recognize the equity and efficiency improvements offered by both the trade deals and the Slaughter-Lawrence proposal, pass the trade agreements for the aforementioned countries, and craft a new, improved safety net designed to help with labor market and structural unemployment transitions.

Support Your Local Cyclists

Professor Finkler will join Provost Burrows and our new women’s basketball coach Carr to cycle the the Scenic Shore 150  a two-day 150-mile bike ride along the shore of Lake Michigan on July 23-24th.  This year’s goal is to raise $700,000 for the Wisconsin chapter of the Leukemia and Lymphoma Society to support research and to help patients with blood cancers live better, longer lives (http://www.lls.org/).

We invite you  to join our effort  this year. To contribute online, use the cumbersome link below and select any of the Mythical Beasts as the vehicle for your contribution.

(http://wi.llsevent.org/pledge/team_listing.cfm?415F22087C090E0405650147515B357A050A07760D72675E431557555F570D3D0807)  [or use http://wi.llsevent.org and follow DONATE]

If you would prefer to contribute by check, you can send a check, made payable to the Leukemia and Lymphoma Society, to any of the Mythical Beasts team members listed below.

Thanks for your support.

Mythical Beasts – 2011

Andy Boryczka

Dave Burrows

Tara Carr

Marty Finkler

Kathy Greene

Teresa Leopold

Brock Spencer

Pablo Toral

Ruth Vater

Sue Vater Olson

Who is Dominique Strauss-Kahn? Why Should Anyone Care?

Answers to the first question are obvious.  Strauss-Kahn is the Managing Director of the International Monetary Fund.  As undoubtedly you have heard, he was arrested recently for sexually attacking a maid in his luxury suite at a New York Hotel.  He also was expected to be a strong candidate for the Presidency of France.  His exit from the political scene is imminent.

Why should we care?  Martin Wolf in yesterday’s Financial Times answers that question. I encourage you to read the full article but the operative words are as follows:

“Mr. Strauss-Kahn proved to be a bold decision-maker, an effective politician and a competent economist.  This combination is very rare.  None of the candidates under discussion is likely to do the job as well as he did during the worst of the global and then eurozone financial crises.”

Lawrence Alumna Addresses Mexican Immigration

Lawrence alumna, Sarah Bohn will be here Monday night at 7:30 in the Wriston Auditorium to give the Povolny lecture.  Her topic will be “Mexican Immigration and the U.S. Economy.”  Follow the link for details.

Dr. Bohn will also be guest lecturer in Econ 320 – Macroeconomic Theory on Tuesday.  The topic will be the state of U.S. labor markets.  Visitors are welcome.

Finally, for those students interested in talking to Dr. Bohn about graduate school or careers in economics, come join us for Econ Tea, Tuesday afternoon at 4:30 in Briggs 217

Let’s Declare True Independence

If energy independence really gets your juices going, you have to be inspired by Allen Sanderson’s Declaration of Independence in the Chicago Tribune, March 30th.

My fellow Americans,

For too long, the United States of America has been at the mercy of foreign interests — and nations in faraway lands that are often at odds with our core values — when it comes to the production of perhaps the vital resource that drives our economy. We remain far too dependent on this imported commodity that could, in the time of emergency or international political crisis, be denied to us and thus cripple our productivity and reduce us to quivering masses of migraines in a matter of hours. The time for change is now.

I speak, of course, of our complete dependence on coffee that we are importing mainly from Brazil and Colombia. It’s time to wean ourselves from this harmful addiction. My “Coffee Independence” proposal is the key first step.

We may constitute only 5 percent of the world’s population, but we consume fully a third of the planet’s coffee. This nation runs off coffee, most all of it from a sketchy continent. Should we be cut off by one of these sources, for our caffeine fix we’d be forced to drink Coca-Cola for breakfast as well as 10 other times a day.

Our most recent census figures reveal that Detroit lost 25 percent of its population from 2000 to 2010, including those who moved from the city as a result of continuing dismal performances by the Lions and Pistons. And the great state of Michigan as a whole lost population and faces one of the highest unemployment rates in the country.

Thus my administration will propose that we begin immediately to invest in this city and state and turn them into the coffee capital of North America. It will create jobs, jobs, jobs; stimulate economic development; and put Michigan back on the map. After all, it was a beer that made Milwaukee famous, and cows that turned Wisconsin into America’s Dairyland. Why not think of Michigan when you think of mocha?

Going without our morning venti half-caf latte and afternoon frappuccino grande will take some time to get used to, of course. As will building the hothouse infrastructure, turning seedlings into hearty trees; and fully implementing our “Cash for Coffee” stimulus program. And until those beans can be picked by American workers who are paid a living wage, have great health care benefits, 40l(k)s and union representation, this will call for shared sacrifice.

To complement this initiative, I will also propose to Congress that we invest in Florida orange juice production, Nicorette gum and California wines, all 100 percent American products. (And we can thus reduce Brazil to a nation known only for its Carnival, bikini waxes and getting suckered into hosting the 2016 Olympic Games.)

Once fully implemented, we will then turn our full attention to growing cocoa in New Hampshire, a state that figures prominently in the 2012 primaries, instead of importing our secondary caffeine and fat additions — chocolate — from the Ivory Coast and Ghana. After that we will move on the idiom — “For all the tea in China” — and have farmers in another early primary state, Iowa, convert some of their corn (aka ethanol) acreage to tea, thus stopping the flow of American dollars to China and India.

And then for the final phase, I am fully prepared to give new meaning to the term “Banana Republic.”

Sincerely,

Any president, past, present and future

Allen R. Sanderson teaches economics at the University of Chicago.

Greenspan rejects the Dodd-Frank Law

In today’s Financial Times, former Federal Reserve Bank chair Alan Greenspan pans the Dodd-Frank financial regulatory (2200+ page) reform act passed in July, 2010.  Greenspan points out how complex and non-transparent the world of financial market is.  He cites some negative effects of attempting to write rules for specific segments of the financial industry and for economic behavior.  As you probably know, Greenspan largely argues that “markets will self correct.”  His opinion piece, however, notes that there will be exceptions and that these will be difficult to anticipate.  He does not pose any answers – how typical of Greenspan – nor does he suggest anything to avoid situations such as occurred in 2008.  He does, however, concede that it would be  worthwhile to attempt to understand the relationship between financial innovation and economic growth.

In moving forward with regulatory repair, we may have to address the as yet unproved tie between the degree of financial complexity and higher standards of living.

Data Analyst at Hardwick-Day

Alum Seth Harris, who used to work in the admissions office at Lawrence and now works for Hardwick-Day, has posted a job opening for a data analyst.  The position involves working with a small team of people to assist colleges and universities with managing their enrollments.   If data analysis and frequent visits to colleges sound like fun to you, read the linked job announcement (Hardwick-Day Announcement) or check out the offering on the board outside Mr. Azzi’s office (BH 221).

Special Meeting for Economics Majors

On the first Wednesday of the Spring Term, the faculty in the Economics Department looks forward to meeting with all students interested in majoring in economics to discuss four topics:

  1. Next year’s class schedule
  2. The two options for meeting the Senior Experience requirement
  3. Upcoming Lawrence Scholars in Business events including the trip to Chicago
  4. Internships
  5. Discovering Kirzner and continuing reading opportunities

Of course, we will provide both food and food for thought.  We look forward to your participation. The pertinent details are as follows:

WHAT:  MEETING FOR ECONOMICS MAJORS

WHEN:  4:30 WEDNESDAY, MARCH 23RD

WHERE: BRIGGS HALL 420

“Nothing is Made in America Anymore.” NOT!

Many leaders including former Intel chief Andrew Grove seem to be convinced that American manufacturing is on the decline.  It certainly has changed.  My two trips to the Kohler plumbing factory, 25 years apart, showed me the change first hand.  In the early 1980s, there were plenty of semi-skilled workers, in a hot, nasty plant slaving 24 hours per day over an open hearth furnace to produce lavatories and toilets.  Now, Kohler produces much more, with more variety, in  clean, much healthier working conditions with far fewer workers.  As Mark Perry in Carpe Diem puts it: “25-30 years ago, U.S. manufacturing was ‘80% brawn and 20% brains,’ and today it’s ‘10% brawn and 90% brains.’  He provides evidence in two key charts.

Perry concludes as follows:

Bottom Line: The decline, demise, and death of America’s manufacturing sector has been greatly exaggerated. America still makes a ton of stuff, and we make more of it now than ever before in history, but we’re able to do it with a fraction of the workers that would have been required in the past. We’re still the world’s leading manufacturing economy by far, thanks to the world-class productivity of American manufacturing workers, the most productive in the world. Instead of bashing China, Korea, and Mexico for competing against our manufacturing sector and exaggerating the decline of our manufacturing sector, Americans should take more pride and celebrate our status as the world’s leading manufacturer.

How the Luck of the Irish Ran Out (or Was Given Away?)

In a recent issue of Vanity Fair (of all places),  Michael Lewis (of Moneyball, the Blind Side, and The Big Short fame) describes the rise and fall of the economy of Ireland.  He highlights several major policy mistakes made by those in power for which they were soundly thrashed in the Irish election yesterday.  Lewis’s article details the long list of major errors and thus the deep hole that these policies have made for the Irish people.  You should not be surprised to learn that the main problematic actions were:

1.  Huge lending by Irish banks for the vast expansion of housing and commercial activity

2. Massive foreign borrowing by these banks from other European investors

3. Government guarantee of payment on all the loans made by the Irish banks and thus for the ultimate European bondholders.

This toxic mix will require an incredible commitment of annual revenue (read taxes on the Irish.)  It was inevitable for this house of cards to fall.  How many other “houses of cards” will follow suit?  Put differently, why wasn’t Lewis’s article published in a more widely read and pertinent journal.

The Rise and Decline of Cities

Cities are central to economic growth.  The Commission on Growth and Development emphasized the strong relationship between urbanization and economic growth as central to understanding why some countries grow and others do not.

Of course, though urbanization tends to be related to economic growth at the national level,  urban areas rise and decline in prominence and economic vitality.  Some manage to maintain their status by adapting to the changing desires of their customers; others seem wedded to past glories.  In Triumph of the City, a just published book,  Edward Glaeser explains how cities make “us richer, smarter, greener, healthier, and happier.”  But some cities, such as Detroit and New Orleans, seem headed in a downward spiral.  Why?  Can they pull out of this seeming endless abyss?  Ever the optimist, Glaeser, in today’s Economix column, illustrates what went wrong in Detroit and what some community leaders are doing to turn Detroit around.   His answer, detailed in variety of a papers, is become a “skilled city”; that is, one that educates, attracts, and retains skilled people and offers them numerous opportunities to interact, to be innovative, and to start new enterprises.

Jobs (slightly up) and the Unemployment Rate (downward trend)

Last Friday, the Bureau of Labor Statistics reported that the unemployment had fallen to 9.0%, a sizable drop from December’s 9.4% and November’s 9.8%.  The BLS also released the payroll survey which indicated that the number of employed based on the non-farm payroll survey only increased by 36,000 in January.  Such a small increase fails to keep up with trend labor force growth which averages about 125,000 per month (based on a civilian labor force of roughly 150 million that grows at about 1% per year.)

So is this good news or bad news?  Actually, these two results are largely unrelated to one another.  The unemployment rate is derived from a household survey which also revealed that the number of employed people rose by 117,000, that is almost the trend rate.  The payroll survey tends to look at relatively older companies, which typically do not drive employment growth. James Hamilton, in a recent Econbrowser piece, lays out some of the relevant details.  The chart below highlights key labor market patterns.  The relatively low level of labor force participation puts downward pressure on the unemployment rate, which is why that indicator is not particularly informative with regard to the JOBS, JOBS, JOBS agenda. The details will entertain those of you who will take Econ 320 next term.