Category: Equitablog

Trumpism on Trade as a Wild Goose Chase

Posted on by Brad DeLong

In the United States 24% of nonfarm workers were manufacturing workers in 1971.

It’s 8.6% today.

Maybe it would be 9% if NAFTA has not been negotiated and if China had not joined the WTO, but maybe it would still be 8.6%–analysts disagree on trade expansion vs. trade diversion here.

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Maybe it would be 12% if the United States had followed Japan’s and Germany’s roads of being high-savings low-currency value countries focused on nurturing their communities of engineering excellence, rather than running the Reagan and Bush 43 deficits and combining that with a focus on financialization and a strong-dollar policy. I certainly think that would have been a better policy road for the United States. But it gets you only to 12% at most–not back to 24%.

The fall from 24% to 12% is the technological tide: increasing labor productivity in manufacturing, large but not infinitely elastic demand for manufactured goods.

Looking forward we can say that by 2060 manufacturing in the United States is likely to be 6% of production workers, in which case whatever you think of what the most important parts of the value chain are, tuning the location of manufacturing labor–the people watching the robots and swapping them out when they go bad and break–is unlikely to be an important part. The thing that had been a major driver of growth in employment worldwide for two centuries–since the cotton masters of Lancashire realized the first automatic spinning machines needed a lot of labor to watch and maintain them because they were fragile–will no longer be salient in our economies. Gone with it for EMs will be the road to development that used labor cost advantage to find a niche making basic manufactures and a national champion firm that could export into that niche, and then relying on learning by doing and osmotic technology transfer to carry you forward. For today’s EMs that are not already well along the road: Strait is the gait. Narrow is the way. Many are called, but few are chosen.

As Pascal Lamy said last week: “There is supposed to be an old Chinese proverb: ‘When the wise man points at the moon, the fool looks at the finger’. Market capitalism is the moon. Globalization is the finger.”

The problems of market capitalism are broad and deep. They are not solved–they are not event addressed–by trade wars, by “renegotiating” NAFTA, by (falsely today) labeling China as a currency manipulator.

And Trump’s core supporters will not be happy if his trade policies sharply raise the prices of the goods they buy at Walmart.

Must-Reads: November 23, 2016

Posted on by Brad DeLong

Interesting Reads:

Should-Read: Izabella Kaminska: Global Trade Alert

Posted on by Brad DeLong

Should-Read: And how would the adverse Hayekian business shock manifest itself if not in a sharp slowdown in the growth of trans-Pacific trade? Very interesting. But I don’t now what or how to think about this yet:

Izabella Kaminska: Global Trade Alert: “Hyun Song Shin’s latest thoughts on the connection between the bank/capital markets nexus, the dollar shortage problem and the break down of covered interest rate parity arbitrage deserve some careful consideration…

…Shin reminded the audience that every argument which suggests market finance is a stabilising influence on the financial system (acting as a spare tire when the banking sector is impaired) can be offset with the argument that capital markets force banks to behave even more pro-cyclically than they might otherwise be inclined to do so….

When banks and other financial intermediaries are stretched to high levels of leverage, supported by razor-thin haircuts, any slight knock to the haircut leaves them vulnerable to forced deleveraging… [which] is the key to understanding funding pressures on banks….

The Vix no longer works as a barometer of leverage appetite…. This poses a bit of a conundrum:

On one hand, there are signs of unabated risk appetite in financial markets, as witnessed in high stock market valuations, compressed credit spreads and subdued volatility, the recent pickup notwithstanding. Yet the banking sector is going through a tough time. In contrast to the overall stock market, banking stocks are struggling, with depressed market-to-book ratios, especially for advanced economy banks outside the United States. Why is this?
Bear with us, because the answer is quite disturbing.

As Shin notes, the easy answer is the weirdness of extended monetary easing…. The more complex answer is that it’s all down to overly restrictive bank regulation…. Introduce the breakdown of covered interest rate parity (CIP) into the equation (because yes, according to Shin it’s all connected), and we find ourselves in an exceptional situation…. He proposes the gap may be persisting because banks simply do not have enough capital available to take on such transactions. Indeed, given many banks have capital comfortably above any regulatory constraints…. So what’s the real issue?

As interest rates have fallen to historically low and even to negative levels in some regions, investors searching for yield have sought higher-yielding assets. In practice, given the global role of the dollar as the borrowing currency of choice, such higher-yielding assets have been denominated in US dollars, even if the borrowers are non-US residents. Long-term yields for US dollar-denominated securities have been higher than for assets of similar maturities in Japan, the euro area or Switzerland. For institutional investors who hold a global portfolio of assets, the currency mismatch between the assets they hold and the commitments they have to their domestic stakeholders in yen, euros or Swiss francs looms large….

Follow the implications of the stronger dollar for the viability of lengthy global value chains (GVCs). Long production chains make heavy demands on working capital…. The financing demand typically grows at the rate of the square of the length of the chain…. The strength of the dollar tracks closely the latest slowdown in export growth. Could it be that the tighter financial conditions resulting from the stronger dollar have been a drag on export growth?… This is an issue of first-order importance…

Should-Read: Izabella Kaminska: Dollar Shortage Alert

Posted on by Brad DeLong

Should-Read: Very smart musings from Izabella Kaminska on the potential for tail risk from an adverse Hayekian business-cycle shock when and if the global savings glut comes to an end, and the value of a lengthy and geographically distributed process of production–what we now call a “value chain”–gets repriced downward:

Izabella Kaminska: Dollar Shortage Alert: “Who funds the working capital that keeps globalised trade lubricated and in flow? Answer: hard currency investors…

…And what justifies the funding of all that suspended-in-motion value that rests upon the seas of international supply chains? Answer: the fact that even after all the additional mileage, administration and energy costs that come with running irrationally complex supply chains, a profit can be derived from the arrangements. So what ensures these bizarre global arrangements… are profitable?… Unfeasibly low wages and low living standards in manufacturing hub countries…. We begin to understand a few key points:

  1. Globalisation is a highly capital intensive economic set-up due to the sheer amount of working capital needed to make it work. It’s not necessarily optimum in a more equal world….

  2. States… with the capacity to create hard currencies to fund the working capital… provide the rest of the world with the hard currency credit they need to source the global commodities and resources required to fabricate the end-products they themselves mostly end up consuming.

  3. This credit is squared off with repayments in hard currencies once the manufactured goods arrive at location….

So what happens… if and when beneficiary countries decide the capital… can be put to better use domestically?… Supply chains shrink, but the underlying credit arrangements live on…. Manufacturing hubs… [see] their hard-currency credit deteriorate…. The global hard currency shortage–which let’s face it amounts to a global dollar shortage–stands to become the the most significant destabilising force in recent times and the most unanticipated global tail-risk…

Must-Read: Ben Bernanke: Sebastian Mallaby’s Biography of Alan Greenspan

Posted on by Brad DeLong

Must-Read: Ben has this right of it here.

Mallaby appears to have forgotten what 2003-2005 was like, and has been cherry-picking from the record of those years:

Ben Bernanke: Sebastian Mallaby’s Biography of Alan Greenspan: “Mallaby’s argument that Greenspan should have known that a tighter monetary policy was appropriate in 2004-2005 (if that was in fact the case!) strains credulity…

…In 2003 the Fed was navigating a deflation scare and a jobless recovery from the 2001 recession—no net payroll jobs were created in the U.S. economy over 2003—which had led the Federal Open Market Committee to cut the fed funds rate to a record-low 1 percent. The FOMC did not stay at that level for long, however; Greenspan began to prepare the ground for a rate increase in January 2004….

As Brad DeLong has pointed out, citing the FOMC transcript, at that point Greenspan was far from certain that the rise in housing prices was a nationwide bubble or that it could pose a threat to financial stability. Indeed, much of the increase in housing prices was still to come: According to the Case-Shiller 20-city index, house prices, which had risen 12 percent in 2003, would rise an additional 16 percent in 2004 and 15 percent in 2005 before peaking in early 2006. After Greenspan’s signaling, the Fed began a well-anticipated rate-hiking campaign in June 2004, at which point the unemployment rate was still 5.6 percent. The FOMC would go on to raise the federal funds rate at seventeen consecutive meetings.

With that background, how much credence should we give to Mallaby’s argument that Greenspan’s personality – the product of an absent, “pale” father and the presence of a “vivid” mother – was the basis of his monetary policy choices? It seems awfully implausible to me. People in Greenspan’s position (I can say, with some authority) put great weight on their reputation and legacy—how they will be regarded even after they leave office. Mallaby’s assessment of Greenspan rests on his contention that relatively modest changes in monetary policy, notably in 2004-2005, would have significantly reduced the risks of a destructive financial crisis, doing so without significant macroeconomic side effects in the near term, and that Greenspan should have recognized that….

The reason that Greenspan took the monetary actions he did, I am sure, is because at the time he thought they were the best policy. He was far from sure that the increase in house prices posed a danger that could not be managed; he would have been skeptical about the Fed’s ability to pop a bubble, at least not without large collateral damage; and he surely did not anticipate that losses in mortgage markets would touch off a global liquidity panic, which arguably made the crisis and its economic effects much worse….

The tightening cycle that began in June 2004 was arguably the most aggressive of any since the early 1980s. Perhaps Greenspan and the FOMC should have tightened even more quickly—we are still debating the issue, more than a decade later—but the fact that the pace of rate hikes in 2004-2005 was not sufficient to stop house price increases does not fit well with the view that minor tweaks in monetary policy would have done the job.

I find Mallaby’s psychological hypothesis puzzling, not only because it is at best weakly supported, but also on Occam’s Razor grounds—it’s not necessary to explain Greenspan’s policy choices. Indeed, The Man Who Knew provides us, in its narrative, a much better motivation for Greenspan’s approach—namely, his experience, as Fed chairman, in dealing with periods of financial instability…. Greenspan responded to each episode of instability during his chairmanship—the 1987 crash, the 1990s credit crunch, the Asian crisis, the collapse of Long-Term Capital Management, the Russian default, the tech bubble—either through direct measures (such as standing ready to lend through the discount window following the 1987 stock crash, or the negotiations that saved LTCM in 1998) or through monetary policy responses after the fact. Greenspan would have seen all these episodes as successful, in that none involved serious damage to the broader economy…. The factors that would make the 2007 crisis so unprecedentedly catastrophic, including the collapse of key funding and securitization markets, were not foreseen.

As Mallaby shows, Greenspan believed that financial instability poses significant risks…. But… in 2004-2005, he had every reason to think that targeted measures or after-the-fact monetary responses could limit the consequences of financial stresses on the broader economy. That Greenspan’s policies were conditioned by his experiences in coping with financial instability as Fed chairman seems the right conclusion…

Lack of market competition, rising profits, and a new way to look at the division of income in the United States

Posted on by Bridget Ansel
Susan Stacy moves a tube to sort recycled plastic bottle chips being processed at the Repreve Bottle Processing Center, part of the Unifi textile company in Yadkinville, N.C., Friday, Oct. 21, 2016.

Two important trends for the U.S. economy might seem inconsistent at first glance. The decline in the labor share of income in the United States (and the resulting increase in the share of income going to capital) alongside the decline in U.S. interest rates seem to be at odds. If capital is gaining an increasing share of income, then why does the rate of return on capital appear to be on the decline?

The answer appears to be that income shouldn’t be thought of as divided in two (between labor and capital) but instead split three ways—among labor, capital, and profits. A new paper by Simcha Barkai, a PhD student at the University of Chicago, shows how profits have gained more and more of total U.S. income, arguing that declining competition in the U.S. marketplace is behind this worrying trend  Luigi Zingales, a finance professor at the university’s Booth School of Business, notes in writing about the paper that Barkai ditches the convention of looking at only labor and capital for a new understanding.

Economists generally assume that, when looking at the labor share of income, any income that wasn’t going to labor was flowing to capital. But that’s not necessarily true. If we think wages are the price that firms pay to hire labor in the same way that the rate of interest is the price that firms pay to borrow capital, then after the payments to capital and labor, there’s residual income: profits.

Barkai breaks out the share of income that doesn’t go to labor to see how much actually goes to capital and how much is going to profits. What he finds is that not only is the labor share of income declining but so too is the share of income going to capital. From 1984 to 2014, the labor share of income in the United States declined 6.7 percentage points and the capital share declined by 7.2 points. Because the capital share is smaller than the labor share, the percentage decline is much larger for capital (30 percent) than for labor (10 percent). The result is an increasing share of income going to profits. Over the 30-year period studied, the profit share of income increased by 13.54 percentage points, according to Barkai’s calculations.

The proposed culprit behind this increasing profit share is higher markups on goods and services over the cost of production. Barkai finds support for this hypothesis in a model he builds in the paper as well as some simple analysis that finds lower labor shares of income in industries where there has been increased concentration. This increase in markups from firms facing less competition in the marketplace has empirical support from other research.

Barkai’s finding also helps explain why productivity in recent years hasn’t increased much and why business investment is relatively weak amid a period of high profits and low interest rates. Increased business concentration and increased markups would explain why those two factors might not boost investment as much as we might expect. Given that profits are more likely to be distributed to those at the top of the income distribution means that this trend is both inefficient and inequitable.

Should We Use Expansionary Fiscal Policy Now Even If the Economy Is at Full Employment? Yes!

Posted on by Brad DeLong

When should you use fiscal policy to expand demand even if the economy is at full employment?

First, when you can see the next recession coming: that would be a moment to try to see if you could push the next recession further off.

Second, if it would help you prepare you to better fight the next recession whenever it comes.

The second applies now whether we are near full employment or not. Under any sensible interpretation of where we are now, using some of our fiscal space would put upward pressure on interest rates and so open up enormous amounts of potential monetary space to fight the next recession. It would do so whether or not it raised output and employment today as long as it succeeded in raising the neutral interest rate–and if a large enough fiscal expansion does not raise the neutral interest rate, we do not understand the macroeconomy and should simply go home.

Fiscal Policy in the New Normal: IMF Panel

Note to Self: Regulatory Uncertainty and Housing Finance

Posted on by Brad DeLong

The U.S. Treasury seized Fannie and Freddie in 2008, and said that housing finance would be differently organized in the future.

Private Residential Fixed Investment FRED St Louis Fed

It is now more than eight years later. There is still no plan for how housing finance is going to be different. Would you make a thirty-year fixed nominal rate loan to anyone in such an environment?

I think it is a miracle that Wells Fargo is willing to make mortgage loans.

I think that U.S. residential investment is one place where regulatory uncertainty may genuinely be having massive effects. We now have had nine years of seriously depressed residential construction–nine years’ worth of household formation of pent up demand. And yet U.S. residential construction continues to be substantially subnormal. Housing prices have recovered to 2004 mid-boom levels. Yet construction has not.