The crisis over Ukraine is quickly becoming a geostrategic conflict. As Vladimir Putin maneuvers to restore Russia’s right to behave with a superpower’s impunity, particularly in its own backyard, the West pushes back. But economic forces also have shaped this confrontation, especially Ukraine’s record as the world’s worst-performing industrial economy over the last twenty years. It was popular discontent with this disastrous performance that drove the recent dissent, which in turn triggered such a bloody response from Viktor Yanukovych — and that response consolidated the opposition and cost Yanukovych his job. Beyond this week’s political and military maneuvers, the outstanding question is, who will bail out the Ukrainian economy — Russia, or the EU and the United States — as the price of drawing the country into its trading system?
Stated simply, Ukraine is the economic equivalent of a failed state. After gaining independence in 1991, the country moved briefly to liberalize its economy along the same lines as most of Eastern and Central Europe. But Ukraine soon jettisoned its reforms in favor of the state-oligarch model also evolving in Russia. Some twenty years later, Ukraine’s GDP has shrunk 30 percent. Even Russia’s sorry economy is 20 percent bigger than it was in 1991 — and Poland’s economy, which looked much like Ukraine’s in 1991, grew 130 percent over the same period. Ukraine’s economic performance has been so terrible, for so long, that its sovereign debts are now considered the equivalent of junk bonds. Even before the crisis, Ukraine’s credit rating was worse than Greece’s — no small feat — and no better than that of Argentina, a global financial pariah for its mismanaged debt defaults and summary expropriations of foreign-owned companies.
Ukraine’s debts soon come due, with some $15 billion in sovereign bonds maturing this year and another $15 billion in 2015. With a current account deficit equal to 8 percent of its GDP, Ukraine cannot pay off and refinance those debts without large-scale aid — some $20 billion to $25 billion — and affiliating itself with a larger trading system. An economic and trade alliance with Russia would deliver the bailout, but with little prospects of improving the underlying economy. The EU and the United States (through the IMF) also are prepared to provide the bailout, if the Ukrainian government will accept far-reaching economic reforms. The EU-US/IMF reforms should lead to better economic times down the road. But they also would mean more short-term hardships for ordinary Ukrainians. That’s why Yanukovych sided with Putin: He feared that he could lose his grip on power if times got even worse — and yet, of course, he lost power anyway.
With a new, pro-Western government in charge in Kiev, Ukraine’s fate may well lie in the hands of Europe and the United States. Their choice is simple to state, if difficult to execute — namely, do they put sufficient economic and diplomatic pressure on Putin, to convince him to pocket his own bailout and let the West pick up the pieces.
This post was originally published on Dr. Shapiro's blog
President Obama’s drive to complete new open trade agreements with the European Union and 11 Pacific Rim nations are the most critical economic initiatives of his second term. Their importance reflects the basic patterns of economic growth across the world. After a decade of unusually weak growth, job creation and income gains, America’s prospects for rising wages and employment are increasingly linked to how successfully American businesses can tap into foreign demand. Beyond the big demand issues, the two agreements also should subtly affect the tradeoffs that American multinationals face between exporting goods and services produced here, versus expanding their European and Asian operations. And those more subtle effects could produce large long-term benefits for American workers.
The Transatlantic Trade and Investment Partnership (TTIP) talks would end most tariffs and reduce countless other barriers to open trade between the United States and the 27 countries of the European Union, with their combined GDP of some $17 trillion. Not only would the agreement give American businesses and investors nearly as much access to European consumers and businesses as Germany or France, including the fast-growing emerging economies of Central and Eastern Europe. Equally important, such an agreement would recalibrate the choices that U.S. companies face today between exporting to Europe and increasing their foreign direct investments there. For the first time, America’s multinationals could enjoy nearly unfettered access to the European market without setting up more operations there.
The second proposed agreement, the Trans-Pacific Partnership (TPP), also would reduce tariffs and other barriers between and among ourselves and Australia, Brunei Darussalam, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam. Not counting ourselves and our NAFTA partners Mexico and Canada, where we already enjoy open trade, the other TPP countries represent nearly $9 trillion of potential demand for our goods and services. And much like the proposed EU-US partnership, the Pacific agreement would, at once, lower barriers to U.S. exports to those countries and change the calculus of foreign direct investment (FDI) versus exports in ways that would tilt more towards exports. If 10 percent of our current FDI flows to countries involved in the two agreements shifts to domestic investments or simply higher profits, it could boost U.S. employment by as much as 450,000 jobs.
These initiatives present a singular opportunity to open up markets that represent nearly half of all non-U.S. global GDP. As the world’s most comprehensive and productive economy, the United States will be well positioned to use this enhanced access to increase our global market shares in countless advanced goods and services. And by reducing the costs of exporting into foreign markets, as compared to setting up more new factories and offices inside those markets, these agreements could be the first new trade pacts for a global economy that genuinely favor U.S. workers.
This post was originally published on Dr. Shapiro's blog.
As Michael Bloomberg prepares his exit as New York City’s mayor, a new analysis suggests that his signature reforms of public education will comprise much of his legacy. Unsurprisingly, the reason is hard economics. Under his reforms, the share of NYC youths earning their high school diplomas and the share going on to college both rose sharply. For some 71,000 young New Yorkers, the “income premiums” associated with those improvements should add more than $15 billion to their lifetime incomes — and the benefits are not limited to those students. The study also found that home property values rose substantially in the neighborhoods where schools improved the most, by as much as $60 billion.
I conducted the study with my colleague Kevin Hassett, in conjunction with The Fund for Public Schools. We focused on changes in three objective measures of student performance: test scores by NYC public school students on statewide tests, high school graduation rates, and rates of college attendance.
We started with the test scores on statewide tests, to see if those scores tracked the improvements in graduation and college attendance rates. With other researchers, we found that they did: From 2006 to 2012, the “mean scale” scores of NYC students on English Language Arts tests rose two percent, twice the gains of all students across New York State. Similarly, NYC students’ scores on the statewide mathematics tests increased four percent, compared to a three percent gain across the State. Moreover, students from the poorest parts of the City, the Bronx and Brooklyn, showed the greatest improvements.
Students from low-income, minority backgrounds also account for much of the improvements in high-school graduation rates. From 2006 to 2012, the four-year graduation rate of NYC students increased from 49 percent to more than 60 percent, a jump of 23 percent. Progress by African-American and Hispanic students drove much of those increases. From 2006 to 2012, graduation rates for African-American students increased from less than 43 percent to 55 percent, a 28 percent jump. Similarly, the graduation rates of Hispanic students rose from 40 percent to nearly 53 percent, a 31 percent improvement.
It hardly bears repeating that students who graduate high school earn substantially higher incomes throughout the working lives than those who drop out. Economists use those differences to calculate the “net present value” of a high school diploma — the value in today’s dollars of the additional income which, on average, they will earn over their lifetimes. Today, that net present value comes to $218,000. Using 2006 graduation rates as our reference, we calculated that from 2008 to 2012, 41,000 more NYC public high school students earned their diplomas than would have occurred if the same share of students had graduated as in 2006. That tells us that the improvements in graduation rates under the Bloomberg reforms will raise their lifetime earnings by nearly $9 billion.
Similarly, from 2008 to 2012, nearly 31,000 more NYC public school students enrolled in institutions of higher learning than would have occurred if the college enrollment rates of NYC students in 2006 had persisted. To calculate the net present value of the additional lifetime income all of the additional NYC students who enrolled in college, compared to ending their educations with a high school diploma, we tracked the income differences, less the average cost of college tuition and their foregone income while in college. We found that the lifetime value of enrolling in college comes to $207,000, in today’s dollars – which tells us that the net present value of the additional income that the additional 31,000 NYC college attendees will earn comes to $6. 4 billion. On top of the income gains derived from higher high-school graduation rates, this suggests that improvements in student performance under Bloomberg’s reforms should raise the lifetime earnings of NYC students by some $15 billion.
Better schools also are associated with higher property values, so we tested whether these improvements had those effects in New York City. Using a technique that tests for statistical causality, called the “Granger Causality” test, we analyzed the relationship between changes in NYC property values by zip code, covering 94 NYC zip codes, and changes in graduation rates in those zip codes. It showed that each one percent improvement in the graduation rates in a zip code led to a 0. 53 percent increase in residential property values in that zip code, in the following year. On this basis, we estimate that NYC’s rising graduation rates from 2008 to 2012 have added more than $37 billion to the total value of NYC residential housing.
We also explored whether New York’s major expansion of charter schools has had economic effects. At a basic level, Bloomberg’s strategy granted schools and their principals much greater autonomy — and large funding increases to accompany it — in exchange for greater accountability for the results. The reforms also expanded school choice for NYC public school students, and then enhanced those choices by adding nearly 200 new public charter schools. This combination of greater accountability and enhanced choice intensified competition for students among schools, especially since funding follows the students.
While two national studies have found that across the country, charter schools do not outperform other public schools, three recent studies of NYC concluded that students at those schools perform better than students at other City public schools. We tested whether Bloomberg’s expansion of charter schools also has affected property values in the City, independent of changes in graduation rates. We found that across nearly 200 NYC zip codes, the addition of one new NYC charter schools in a zip code led to a 3. 8 percent increase in residential property prices in that zip code in the following year. Based on the expansion of those schools in this period, the results suggest that the charter-school reforms have added more than $22 billion to NYC residential property values. On top of the boost in property values tied to higher graduation rates, these results suggest that Bloomberg’s reforms have added nearly $60 billion to NYC residential property values.
Across the country, the record of educational reforms is mixed. Nevertheless, by several objective measures, the academic performance of New York City public school students has improved markedly under the reforms enacted since 2002. Moreover, those improvements can be expected to generate large income benefits for tens of thousands of New York City students, and they already have produced substantial economic benefits for New York City homeowners. These achievements deserve emulation.
This post was originally published on Dr. Shapiro's blog
President Obama deserves at least two cheers for his recent economic address. In an unusually clear-eyed assessment of how the economy has shaped our current politics and national mood, he traced most people’s disillusion with government to their “daily battles to make ends meet.” The “defining challenge of our time,” he declared, is to make “sure our economy works for every working American.” For his part, the President pledged to devote his second term to restoring upward mobility and reducing inequality.
To make progress on these fronts, the President and many progressives should first step back from some common populist myths. In his address, for example, the President stressed the populist trope that the median income today is only 8 percent higher than it was in 1979. The clear implication is that middle-class Americans have been caught in an economic squeeze for nearly 35 years, and Washington should turn away from the policies of the 1980s and 1990s.
This view, at best, is only partly right. It is the case that today’s extraordinary inequality began in the latter-1970s. In 1976, the share of national income claimed by the top 1 percent of Americans fell to less than 9 percent, its lowest point in the 20th century. Since 1977, however, their share of the economy’s rewards has grown steadily and sharply, reaching more than 23 percent in 2008, its highest level since 1928. Nevertheless, most people’s incomes continued to grow at reasonable rates through the 1980s and 1990s. If that strikes many Americans as implausible from today’s vantage, it’s only because much of those income gains were swept away over the last decade. The challenge of restoring upward mobility comes mainly from what has happened economically since 2002.
Here is what has really happened to incomes, based on data released recently by the Census Bureau. Across all households – all ages, races, and both genders -- the inflation-adjusted median income increased by an average of 1.7 percent per-year from 1983 to 1989, or by nearly 12 percent over the course of the Reagan expansion. The recession of 1990-1991 took back about one-third of that progress, leaving a typical middle-class household with net income gains of just under 8 percent from 1983 to 1991. Those gains were followed by more income growth through the Clinton expansion, averaging another 1.4 percent per-year after inflation. The recession of 2001 took back one-fifth of those gains, leaving a typical middle-class household with net income growth of more than 10 percent from the 1990s and 18 percent from 1982 to 2002. Nor did upward mobility stall out in this period: Throughout the 1980s and 1990s, those who had long lagged behind achieved the greatest gains, namely, households headed by African Americans and by women.
The income squeeze most Americans feel today owes its bite almost entirely to the developments of the last decade. Through the Bush expansion of 2002 to 2007, household income growth plummeted to just 0.2 percent per-year. Moreover, those meager gains were followed by the Great Recession, which cost the average household an unprecedented 5 percent of their incomes. Those losses wiped out not only all of the income growth from 2002 to 2007, but also 40 percent of the net gains of the 1990s. Even worse, the economic damage from the 2008-2009 crisis, on top of some new problems, continued to eat away at incomes. In 2010-2011, American households gave back, on average, another 4 percent of their incomes. Those losses finally stabilized in 2012, when household incomes were virtually unchanged. All told, the median income of American households declined nearly 10 percent from 2002 to 2012.
To get out of this hole, policymakers have to confront the two new dynamics which largely define the last decade economically, globalization and technological change. There is no possible retreat from globalization, a historic advance that has drastically reduced poverty across much of the world and driven innovation and cost savings here at home. But the intense competition generated by globalization also produces unprecedented pressures on businesses to cut their costs, and then directs those pressures to jobs and wages. Policymakers can help relieve some of those cost pressures, starting with a stronger commitment to contain the health care costs for both employers and workers. They also could help jumpstart stronger job creation with financial reforms that link a bank’s access to the Fed’s virtually-free funds to its willingness to provide capital for young businesses.
Washington also can help tens of millions of Americans to upgrade their skills for an economy that now provides few rewards for those without the training and skills to operate effectively in workplaces dense with information and internet technologies. For a modest cost, for example, the federal government can provide grants to hundreds of community colleges to keep their computer labs open and staffed on weekends and evenings, so any adult can walk in and receive free training in information and internet technologies.
The economic record also tells us that the government got a number of things right in the 1980s and 1990s. As in the 1950s and 1960s, usually sensible macroeconomic policies tempered the business cycles, especially after dealing with the oil-shock inflations of the 1970s. Successive presidents and congresses also continued to liberalize trade in the 1980s and 1990s, encouraging businesses and workers to shift their resources to areas where they held powerful advantages even as Germany, Japan and other advanced countries began to compete actively again. And from the late 1970s onward, Washington reinforced those advantages by deregulating transportation, telecommunications, and other sectors -- including finance, where policymakers went too far in the late 1990s.
Public investments in infrastructure remained generally robust until the 1990s, and even then, the private sector sunk tens of billions of dollars into new information and telecommunications infrastructure. Higher education programs helped tens of millions of Americans expand their human capital, building on the GI Bill of the 1950s and 1960s with major expansions in student assistance in the 1980s and 1990s. And science and technology policies continued to promote innovation by aggressively funding government research institutes and through technology competitions sponsored by the Pentagon (including the internet).
To restore income gains and upward mobility, Washington also needs to revisit what works. Recommit macroeconomic policy to healthy growth by ending mindless austerity and doubling down on public investments in infrastructure and basic research and development. Further expand the markets for innovative American goods and services by completing the current trade liberalization talks with the European Union and much of Asia. Help millions of young people complete their higher education by reforming student assistance – for example, by replacing most current loan and grant programs with federally-funded free tuition at public institutions that limit their future cost increases to overall inflation.
There is no iron-clad guarantee that these approaches will restore the reasonable income gains of the 1980s and 1990s, much less the stronger progress seen in the 1950s and 1960s. Nevertheless, they provide a credible place to begin, one based on the real economic record and the actual nature of our economic problems.
This post was originally published on Dr. Shapiro's blog
In a political environment most notable today for its partisan trench warfare, serious conversations across party lines are nonetheless taking place over a major reform of corporate taxes. This unusual instance of comity comes from a genuine consensus that lowering the corporate tax rate – the favored goal would move it from 35 percent to 28 percent – would be good for the economy. As an economic matter, a revenue-neutral cut in the corporate tax rate has something for almost everyone: It should lead directly to more investment and higher profits, which in turn should produce stronger growth and, with any luck, raise the wages of some workers. Yet, serious corporate tax reform will always be a long shot unless the parties can agree on how to pay for it and what to do about all the businesses that aren’t subject to it.
The hardest piece of this puzzle involves where to find the money for a lower rate. If, as expected, profits, growth and some wages go up, part of the cost should be relatively painless – but those additional revenues would amount to more of free appetizer than a whole lunch. And one popular target for additional revenues, the special tax deductions for certain investments by oil and gas companies, would provide no more than a palate cleanser. In the end, there are only a few pieces of the corporate code large enough to finance meaningful rate reductions – and all of them are fiercely defended by the companies that benefit most from them.
The biggest target is accelerated depreciation – some $550 billion over 10 years to provide in special tax deductions that offset the cost of large corporate investments, and at a rate faster than the equipment or structure actually depreciates. For the biggest beneficiaries, think of the communications equipment industry, aircraft makers, mining and industrial equipment producers, and other heavy manufacturing. Pushing the corporate rate down to 28 percent rate would offset their economic costs, while helping other industries even more. But the revenues from ending accelerated deprivation for corporations would only be enough to lower the rate to a little less than 31 percent.
Another costly provision is “deferral” – the ability of American multinationals to delay paying any U.S. corporate taxes on their foreign profits until they transfer those profits from their foreign subsidiaries to the parent corporation back in America. While experts argue over how much revenues would actually result from ending deferral, it would spread the pain: That’s because the industries affected most by an end to deferral make relatively modest use of accelerated depreciation – think of our leading software, Internet and pharmaceutical firms. The catch lies in the indirect costs. American multinationals earn foreign profits by out-competing their German, British and Japanese rivals in foreign markets. But unlike the United States, Germany, Britain, Japan and nearly every other country taxes corporations only on the income they earn in their home markets. So, ending deferral would force only U.S. companies to pay taxes both abroad and at home, leaving them at a competitive disadvantage. Holding them harmless while ending deferral would require a corporate rate even lower than 28 percent – and the revenues gained by ending deferral, along with accelerated depreciation, wouldn’t be enough to get the rate down to even 28 percent.
Moreover, corporate tax reform is not the same as business tax reform, not by a long shot. More than half of all business profits in America are earned by companies that don’t pay the corporate tax, including most investment and legal practices, hedge funds, private equity funds, and privately held companies. They are all organized as partnerships, LLCs or S-corps, not subject to the corporate tax, and taxed as “pass-throughs:” The income of such firms is distributed among their owners and then taxed at the owners’ personal tax rate, sometimes as ordinary income and more often as capital income.
As an economic matter, the right answer is to tax all business income at the same rate, whether the business is a corporation or something else. It also would help with funding the lower rate: For example, ending accelerated depreciation for all businesses, corporate or not, would raise an estimated $775 billion over 10 years instead of $550 billion. Moreover, a 28 percent rate on all business income mighty well raise substantial revenues, since so much of non-corporate business income today is taxed at the 20 percent rate for capital income. And that’s a political problem. To begin, ending the special “carried interest” tax break for hedge funds, private equity funds and real estate trusts might well ignite a Washington firestorm – which could explain why President Obama didn’t try to do it when he held healthy majorities in both house of Congress. That’s not all: To maintain a level playing field on personal taxes, the current 20 percent tax on the capital gains and dividends of ordinary investors also would have to go to 28 percent up as well. But if that happened, the shareholders of public corporations would be at a costly disadvantage, since the same income would face a single 28 percent rate when earned by a non-corporate pass-through business, and a rate twice as high when generated by a corporation (28 percent at the corporate level and another 28 percent at the owners’ level).
This economic logic has led many conservative economists and Republicans to call for repealing all corporate taxes. Of course, there is no prospect of a bipartisan consensus for doing that. Rather, the Democratic side of the consensus for a lower corporate tax rate has always insisted that the same corporations make up for any and all revenues lost from cutting the rate. And that’s a problem which they haven’t yet solved.
This Post was originally published on Dr. Shapiro's blog
The budget and debt end games are still playing themselves out on Capitol Hill; and judging by its current behavior, Congress has developed the political equivalent of a brain tumor. A toxic byproduct of an ongoing power struggle inside the Republican Party, the cancer has caused incapacitating seizures that have virtually crippled the national government’s capacity to take care of the most elemental aspects of governance. Even if House Republicans finally agree today or tomorrow to fund the government and raise the debt limit, the tumor they have spawned will continue to damage our economy — and the longer term prognosis is not encouraging.
Congress’s recent reckless behavior may not directly affect those aspects of the economy that make the United States so productive — but it does threaten access to the low-cost capital on which the economy depends. The current fight will not diminish the education and skills of American workers, or erode the technological and organizational assets of the businesses they work for. The rash demands of the radical right also won’t lessen the competitive pressures that drive our businesses to develop new goods and services, and to adopt the innovations of others. And whatever Congress does this week, the United States will remain the world’s largest market. The catch, however, is that all of these strengths also depend on steady streams of low-cost capital, which the House GOP has now put at risk.
For nearly 70 years, the United States has been the world’s number one place to invest and lend to. The economic reason is straight-forward — with considerable consistency, American businesses generate stronger returns than their counterparts in other advanced economies. But another factor is at play here as well, one especially important to foreign lenders and investors — namely, confidence that the United States will preserve and maintain the political conditions required to protect those healthy returns.
Investors and lenders, both foreign and domestic, have long seen the United States as the most reliable country for enforcing contracts, respecting intellectual property rights, maintaining generally low taxes and light regulation, and applying the rule of law fairly. The result has been an unusually low level of political risk attached to the economic returns expected by lenders and investors. That’s why U.S. Treasury securities have long been the world’s lowest-risk financial instrument. For the same reasons, the political “risk premium” for private-sector loans and investments — the additional return required to offset any risk that political forces will reduce an investor or lender’s returns — has been negligible for decades.
But a country that finds itself unable to fund its government and unwilling to honor its government’s debts has to expect that lenders and investors will demand a considerable risk premium on any future loans and investments. In short, our current war over government funding and the debt limit is raising interest rates — and the costs could be huge. For example, a one percentage-point increase in the interest rate paid on Treasury securities will cost the government (and taxpayers) some $1 trillion in additional debt paymentsover 10 years — enough to wipe out the savings from a decade of sequester cuts.
A combination of this new risk premium, plus new wariness by foreign lenders and investors, should also push up interest rates on private loans and the required returns on private investments. Interest rates normally rise during booms, when the demand for capital expands faster than its supply. When interest rates rise without an accompanying increase in demand, however, they directly depress demand and growth. For example, a one percentage-point increase in mortgage rates today is expected to depress housing starts, housing sales and demand for related goods and services by 11 percent — and reduce GDP growth this year by 0.4 percent. Across the economy, the same increase in interest rates in the absence of strong demand could take 2 percentage-points off real GDP growth. Even if the House radicals agree to a cease fire this week, it could cost Americans $300 billion in foregone goods and services over the next year, and the 2.75 million jobs required to produce them.
The damage to growth and jobs could be long-lasting. House extremists nearly pushed the economy off the cliff over the same issues in 2011 — and they could be back for another round in a few months, when any agreement this week runs out. Such a sustained pattern of political dysfunction could lower growth for a decade and cost Americans as much as $3 trillion in lost income and wealth. And that assumes that Tea Party Republicans, in the end, will not force the government to default on its debts, a development that would likely cost the American and global economies as much as the 2008-2009 financial collapse.
This Post was originally published in Dr. Shapiro's Blog
With a good part of the federal government now closed for business, the pathologies driving it are too obvious to ignore. The diagnosis begins with the fact that there is no partisan argument this time about overall federal spending. The White House and congressional Democrats have accepted the arbitrary cuts of the sequester process, despite evidence that they are slowing the economy. Instead, the rightwing of the House GOP is holding normal government operations hostage to a variety of demands tied the Affordable Care Act.
Obamacare has been a festering focus of Tea Partiers since 2010, when its passage helped elect a number of them to Congress. Three years later, their continuing single-mindedness about those reforms has begun to look like a pathological obsession. Too strong? Their threats to close down Washington unless President Obama agrees to give up his signature achievement – and their deluded confidence that they can bend him to their will -- have been utterly unaffected by not only the results of the 2012 elections, but also by the prevailing consensus that their strategy will cost the GOP even more in 2014.
This week, the pathology spread to Republican leaders. Since Tea Party members make up less than one-quarter of the House GOP and an even smaller share in the Senate, they always need support from their more moderate colleagues and Party leaders to carry out their threats. Those leaders and colleagues have for weeks publicly opposed the Tea Party strategy – that is, until this past weekend. After months of being held hostage themselves to Tea Party threats of insurrection and primary challenges, House Speaker John Boehner, Senate Minority Leader Mitch McConnell and most of their associates have now identified with their captors and adopted their worldview. In short, they’re suffering from a political version of “Stockholm Syndrome.” If they don’t recover quickly, much of the national government could remain closed for a long time.
This post was originally published in Dr. Shapiro's blog.
As summer ends, and investors and policymakers look ahead, the American economy faces a range of downside risks. Most of these risks are what economists call “exogenous,” which is a fancy way of saying that they come from sources outside the economy itself. Left to itself, the economy appears set to maintain its current path of moderate growth. GDP grew at a 1.8 percent rate in the first quarter of this year followed by 2. 5 percent growth in the second quarter, with no signs of the bracing job and income gains Americans remember from the 1980s and 1990s. But this may be the best-case scenario, since outside forces from lamebrain moves by Congress to developments in China could knock moderate growth off its perch.
The most clear and present threat to growth lies in the looming fight over the debt ceiling. It has to be said how truly foolish and irrational it is that this matter should pose any risk to our economic security. But the Republican Party is caught in an internal power struggle that could well result in Congress suspending the Treasury’s legal authority to issues bonds to finance debts already accrued by the current and previous congresses. It would constitute a technical default by the United States — and that would trigger an unprecedented slump in the value of all U. S. Treasury securities, until now the world’s most secure and stable financial instrument.
Interest rates on those securities would shoot up, and we would see a chaotic selloff in U.S. and global bond markets followed by a sharp economic slowdown and a precipitous nosedive in stock markets. It would all unfold like a bitter divorce, where one spouse spitefully engineers a collapse of the marital assets heedless of how it will affect their children (that’s the role for rest of us). Of course, it is not inevitable. Once the debt limit debate has produced some fiery political theater, the grownups in the GOP leadership and wealthy donors who underwrite most Republican campaigns may yet bring their party’s radicals to heel.
That outcome must be the expectation of most bond and stock traders, who are less concerned today about the debt limit than about the risks of Federal Reserve policy. The trillion-dollar question for big finance is when and by how much the Fed will step on Wall Street’s near-zero interest rates by “tapering” the Fed’s current quantitative easing program, QE3. The path of QE3 has even become an issue in the contest to succeed Fed Chair Ben Bernanke. While Vice Chair Janet Yellen believes that but for QE3, the economy would be weaker, Larry Summers has said the program doesn’t make much difference anyway. The implication is that Summers sees less risk in rapid tapering. And that may be why, according to a recent survey, most Wall Street traders prefer Yellen, despite Summers’ lucrative stints as a Wall Street adviser. While all of this makes for diverting debates on cable TV, the truth is that QE3 policy probably poses little risk to the U. S. economy. If interest rates jump in response to Fed tapering, whoever chairs the Fed will slow or suspend it.
That leaves risks from abroad to disturb the sleep of the President’s economic advisers. Two regions (the Middle East and Europe) and one country (China) have the economic heft to materially affect the path of American economy. In the Middle East, the immediate economic issue for the President is whether his coming response to Bashar al-Assad’s crimes could trigger some series of events that ultimately affects the flow of oil from the region, driving up energy prices everywhere.
Europe seems even less likely to disturb our recovery, especially as compared to a year ago, when investors’ confidence in the ability of Greece, Italy, Spain and Portugal to finance their sovereign debts nearly collapsed. A European sovereign debt crisis could still bring down the continent’s largest banks and plunge all of us into a deep recession. But for now, Mario Draghi, who heads up the European Central Bank (ECB), has convinced Germany’s Angela Merkel to muzzle her qualms about large-scale ECB interventions to head off a Eurozone meltdown.
The possibility of a different sort of debt crisis also has appeared in China. Since 2008, public and private debt in China has shot up from 130 percent of GDP to 200 percent, even as the country’s GDP has expanded nearly two-thirds. Over this brief period, corporate debt nearly doubled and household debt tripled. Worse still, in the face of these skyrocketing debts, overall growth, the returns that Chinese companies earn on assets they borrowed to finance, and Chinese wages all have slowed sharply. Already, many companies now pay their suppliers with six-month promissory notes, producing cash crunches for their own suppliers and workers. Many large banks are also writing down large numbers of non-performing loans. And as banks pull back, interest rates have risen, increasing the debt loads of firms and households, and forcing thousands of companies to downsize.
The Financial Times observed recently that “such a rapid increase in borrowing has historically led to crises in countries from Argentina to South Korea.” Some experts dismiss this prospect, pointing to China’s stringent capital controls to prevent large-scale capital flight and Beijing’s strict management on the value of the currency. But markets that lose confidence find ways to subvert such controls; for example, through bank runs, accelerating inflation, and sharp drops in foreign investment. So, even if China can sidestep a full blown credit crisis, it cannot escape much slower growth while the government and domestic firms unwind the excess debt. And that will mean slower growth in many countries that depend on rising exports to China—starting with Japan, South Korea, Taiwan, Australia and Chile — as well as here at home, in states such as California, Texas, Washington, Illinois and New York.
This post was originally published in Dr. Shapiro's blog
Today, the Bureau of Economic Analysis (BEA) will put in place a set of critical changes in how it measures America’s gross domestic product (GDP). The most important change reclassifies what businesses spend on research and development, which now will be counted as an economic investment rather than an ordinary business expense. By so doing, the country’s official national accounts finally recognize that ideas play the same role in prosperity and income growth as new factories and equipment. More important, the change signals that Washington — or at least its accountants — accept that the country has an idea-based economy.
I was present at the creation of these changes. In the late 1990s, while overseeing the BEA as Under Secretary of Commerce for Economic Affairs, I helped them set up the first tests of how to approach R&D as an investment. Then as now, this shift was a no-brainer. Those of us who study what makes economies grow learned as students that innovations drive growth even more than new capital investments. Based on the strict patent protections which the United States has embraced since the time of the Constitution, Americans always have known this intuitively. So for more than 200 years, the world’s most market-based economy has granted temporary monopoly rights to anyone who comes up with a new invention.
Investors clearly believe in the value of patents and the inventions they animate. A new study covering more than eight decades of patents (1926-2010) has found that when a company receives a new patent, its stock market value increases on average by $19.2 million (in 2013 dollars). Even setting aside such blockbuster patents as the core inventions from Apple or Google, the researchers found that the median bump in a firm’s stock market valuation after receiving a patent was $5.9 million.
In fact, intellectual property and, more broadly, intangible assets now virtually dominate American business. Since the mid-1990s, American firms have invested more in new, intangible assets — databases, brands, worker training and competencies, as well as R&D and patents — than they have in new physical assets. That tells us that businesses now expect to earn more from ideas in their various forms than from their plant and equipment.
Here, too, investors agree. In 1984, the “book value” of the 150 largest U.S. corporations — what their physical assets would bring on the open market — was equal to about three-quarters of their stock market value. So, nearly 30 years ago, large American businesses were worth about one-quarter more than the plant, equipment and real estate that generated their profits. By 2005, the book value of America’s 150 largest companies equaled just 35 percent of their stock market value. By that time, about two-thirds of their value came from their intangible assets, because those assets had become the main source of the value and profits which large companies generate.
This shift to intangible assets is not confined to popularly-recognized “idea-based” industries such as information technologies and biotechnology. A 2011 analysis by Kevin Hassett and myself found that by 2009, intellectual property, strictly defined, accounted for at least half of the market value of not only the software, telecom and pharmaceutical sectors, but also such disparate industries as food, beverages and tobacco, media, healthcare, professional services, household and personal products, consumer services, and autos. And when we expand the category to all intangible assets, broadly defined, those idea-based assets accounted for at least 80 percent of the market value of all of the industries just mentioned, plus capital goods, materials, transportation, and consumer durables and apparel. That covers every major industry except retail, real estate, banking, energy, and utilities.
Now that the official accounts for the American economy finally treat the R&D that leads to most patents and innovations as economic investments, we can also better track and compare their value. For instance, we now know that U.S. businesses have spent less on R&D in recent years than they did in the 1990s — and that nevertheless, the United States spends more on R&D than all of Asia and Europe combined.
U.S. companies and individuals hold about 25 percent of the world’s patents, a share close to America’s 22 percent share of worldwide GDP. America’s real advantage in this area, however, probably lies in its outsized willingness to fund the young enterprises that often develop new, patented advances. So, while the United States claims 25 percent of all patents, the Organization for Economic Cooperation and Development (OECD) reports that we also account for roughly half of all worldwide venture capital investment.
America’s shift to an idea-based economy inevitably will shape much of our economic future. The information and Internet technologies so integral to creating and managing ideas have spread across every economic sector. Within each industry, those firms most adept at applying those technologies to their operations will, on balance, be the ones most likely to succeed. That has already become gauge for investors to use and watch. More important, a widening gap has opened between the incomes of most Americans and the incomes of the top 20 percent of workers who are already adept at creating and managing ideas or at least operating in workplaces dense with information and Internet technologies. Finding new ways to enable most Americans to prosper in an idea-based economy is now the most pressing economic challenge facing Washington policymakers.
This post was originally published in Dr. Shapiro's blog
The economic recovery is now four years old -- the anniversary comes this month – yet job growth remains a big problem. Since the recession technically ended in June 2009, American businesses have expanded their workforces at an average annual rate of 1.4 percent, creating some 6.1 million new jobs. The good news is that we’re creating new jobs at twice the rate seen in the first four years of the last expansion. Nevertheless, the job gains are much smaller than those seen in the early years of the expansions of the 1980s and 1990s. So, is this ongoing problem simply a feature of the slower economic growth of this cycle, or have American businesses lost some of their storied capacity for generating new jobs? The answer is, some of both – and over the next decade, new technologies could further aggravate the problem.
To get at why this is happening, you have to first take account of the character and basic features of these economic cycles. For example, job creation bounces back more sharply after a deep recession than following a milder downturn. So, we start by comparing the job gains seen over the last four years, following the Great Recession of 2007-2009, with those following the deep downturn of 1981-1982. The gap is very large: The 1.4 percent annual growth in private employment over the last four years is 61 percent less than the 3.6 percent annual job gains seen during the first four years of the 1982-1989 expansion. We see a similar disparity between job creation in the first four of the two most recent expansions that followed more moderate recessions. The 0.7 percent annual rate of job growth over the first four years of the 2002-2007 expansion was 68 percent less than the 2.2 percent annual job gains seen in the first four years of the 1991-2000 expansion. Something has changed.
The most obvious change is that every successive expansion since the 1980s has seen progressively lower rates of economic growth, especially in the early years. U.S. GDP grew by an average of 5 percent per-year in the first four years of the 1980s expansion, followed by 3.4 percent annual gains in the first four years of the 1990s expansion, 3.0 percent growth per-year in the early years of the 2002-2007 expansion, and just 2.3 percent average annual growth over the last four years. As Keynesians have insisted, the slower economy should explain much of the recent slowdown in job gains – although not all of it.
We can calculate roughly how much of the slowdown in job gains can be traced to the slower economy by adjusting the rates of job creation for the rates of overall growth. Those calculations suggest that if the economy had grown as fast over the last four years as it did in the first four years of the 1980s expansion, we could have seen 3.0 percent annual job gains instead of just 1.4 percent average job growth. Since jobs actually grew in the early 1980s by an average of 3.6 percent per-year, as much as 80 percent of the current slowdown in job creation may simply reflect slower economic growth. So, while recent austerity measures – the sequester, increases in payroll and income tax rates, and so on – do not explain all of the slowdown in growth, their apparent impact on jobs is powerful testimony to how misguided those measures have been.
Thinking through job creation in this way, then, tells us that some 20 percent of our current employment problem, and perhaps more, is “structural.” Put another way, U.S. businesses now respond to economic growth by creating fewer jobs than they used to.
Technological advances, of course, are one of the driving forces at play here. The countless applications of information technologies (IT) across every industry and economic activity have created considerable wealth, but they also displace more jobs than they create. Consider our manufacturing workforce, which contracted nearly 28 percent over the last two decades, falling from 16,480,000 positions in 1992 to 11,951,000 in 2012. All of these job losses can be accounted for by workers with high school diplomas or less, whose number in manufacturing declined by more than 40 percent. The picture is different for workers with the skills to operate in an IT-dense workplace: Over the same 20 years, manufacturing jobs held by college graduates increased by 2.4 percent and the number with graduate degrees jumped 44 percent.
The latest threat to jobs, according to many technologists, is coming from robotics, the application of information technologies to new forms of kinetic hardware. Today, businesses worldwide employ some 1.4 million industrial robots, mainly in automobile and electronics assembly. Those numbers appear to be rising quickly. For example, FOXCONN, the Taiwan-based giant that assembles 40 percent of the world’s consumer electronics -- and employs 1.2 million workers around the world -- has announced plans to purchase 1 million new robots over the next three years.
A new report from the Atlantic Council catalogues the growing number of large-scale, public-private R&D programs underway. The U.S. effort is led by DARPA, NASA and firms such as Raytheon and iRobot, with grants from the NSF National Robotics Initiative playing a venture capital role. In Japan, the FANUC Corporation and the Ministry of Economy, Trade and Industry have taken the lead. In Korea, the Ministry of the Knowledge Economy is working with LG and Samsung. And in Europe, the European Network of Robotic Research is collaborating with companies such as Philips and the ABB Group.
No one can predict the direction or dimensions of robotics a decade from now. Nevertheless, the next generation of the technology will be able to draw on important recent developments, such as the first, open source Robot Operating System as well as advances that allow robots to retrieve and manipulate objects outside the structured environment of an assembly line. In the last year, for example, Willow Garage released a new personal robot that can fold laundry and pour beer, the French firm Robotsoft showcased robots that monitor elderly patients, Italian and Swedish firms offered robotic landscapers, a Japanese company unveiled its new robot teachers, and South Koreans developed robots to assist firefighters and provide basic child care. The first large-scale application of the technology may well involve transportation. Drone technology could force early retirement on thousands of pilots, and future variations of Google’s driverless car could displace tens of thousands of teamsters, cabbies and bus drivers. In any case, our structural problems with job growth are likely to worsen.
This post was originally published in Dr. Shapiro's blog
"Older politicians will have to get beyond their ideological blinders to recognize the opportunity waiting for any candidate or political party that can embrace both halves of the Millennial era civic ethos paradox."