Tuesday, March 25, 2014

Crash Diets, Debt, and National Economic Growth

Last week I argued that the priority for economic growth had slipped and pointed out why this is a prescription for continued labor and economic problems. For a government that claims it wants to help the average guy, its opportunistic approach to labor market (and other) problems does nothing but slow the healing process. Today I want to take this discussion a little further and possibly irritate even more of my friends and relatives. I associate the government’s current shotgun approach with the popularity and (lack of) effectiveness of diet crazes.  

Some of you responded last week by admitting that economic growth is crucial for developing countries. When the average person in a country makes $1000 per year it seems pretty obvious that economic growth is the only sustainable way to lift people out of poverty and into lives that more closely approximate modern living. There is no serious debate about the negative side-effects of growth in such cases. The first priority is to improve the lives of very poor people. Of course there is always some debate. I have been lambasted more than once by questioners attending my speeches who pointed out how the serene and wonderful lives of people living in jungle huts were destroyed by the encroachment of economic development. I also remember the NAFTA debates that pointed out the deplorable conditions faced by inhabitants of northern Mexico as they traded rural lives for wealth aspirations associated with factory work in the Maquiladoras.

But while many growth critics will agree that economic growth is okay for poor countries, the party ends when we start talking about richer nations. Apparently it is okay for poor people to get richer but at some point self-appointed representatives of proper behavior draw a red line that means enough is enough. Earning one more dollar above that line is apparently not worth whatever side-effects might accompany the increase in income. This idea is not without economic foundation. Economists often cite “diminishing marginal utility of income (DMIU).” That fancy term means that as your income rises the satisfaction you get from each additional dollar gets smaller and smaller. So when a poor guy earns another $100, he is happy as a lark. But when a rich guy earns an extra $100 it means very little to him and he leaves it sitting on a park bench with his half-eaten croque-monsieur.

While DMUI sounds pretty intuitive a critical question asks when any of this actually kicks in enough to make a difference. Judging from park benches in the USA today, I see very few $100 bills sitting around. Does someone who makes $50,000 a year not value what another $100 will buy? Does someone who makes $250,000 not value the extra Benjamin? Where is the line? I will agree there is a line but I have never observed it in my family. If DMUI kicks in at a low income level then it follows that the negative side-effects of growth might dominate the good things generated by it. But if high income people value extra income sufficiently then it is not so clear that DMUI favors less emphasis on strong growth.

Another relevant economic concept comes from a psychologist named Abraham Maslow, “hierarchy of needs”. Wikipedia has a lengthy technical discussion (http://en.wikipedia.org/wiki/Maslow's_hierarchy_of_needs ) but the simple and popular version is that human beings (that means you too Charlie) first must meet their biological needs for food, water, etc. Once they have enough income to meet those needs, then they move up the ladder to such things as JD, security, friendship, self-esteem, and morality.  This is important for a couple of reasons. First, it gives a foundation for valuing all human wants and needs. Who is to say that the “higher order” needs are not important? Surely you must eat and drink to survive, but some people could barely “survive” if they missed the latest showing of Survival. Clearly people are willing to die to protect freedoms to associate, speak, protest, etc. If higher incomes allow a country to reap some of these higher order benefits, I am not sure where we are supposed to draw the line and stop the income parade.

But a more important aspect of Maslow is how it affects our political aspirations. Once a country gets richer and once basic needs are met for most of the people, then Maslow’s hierarchy might suggest a political recognition of higher needs.  More equal incomes, cleaner environment, and more humane immigration policies surely seem more important once you are easily meeting basic needs for survival. But again, the argument is not about the theory. The debate centers on the values of the tradeoffs. What if economic growth is negatively impacted by a stronger focus on equal incomes, a cleaner environment, and more humane treatment of immigrants? What if weaker economic growth then makes these higher order objectives less attainable? Or put another way, an "obvious or direct" approach doesn't always succeed. How many crash diets ultimately succeed?  Just because you think a diet will make you look like Popeye’s girlfriend Olive Oyl or Dan Marino, we have plenty of evidence from millions of people who try extreme stupid diets that do nothing but create more income for shady businesses.

When smiling politicians tell you that they have wonderful ways to redistribute incomes or improve the quality of the environment ask them how they are going to accomplish those goals when the policies of the last 50 years have done little to create lasting remedies. More important, however, is to ask them what happens if such policies create more debt and/or rob the country of its higher economic growth.  If such direct approaches to a myriad of higher order needs have dubious chances of succeeding and very strong chances of creating more debt and less income, then one has to wonder if there is a better approach.

That better approach is twofold. First you reduce debt. The more we sustain historically high levels of debt, the less wiggle room we have. Look at this latest issue with Russia. A country with no debt can easily devote more resources to an urgent military conflict. The same goes for natural disasters. But if you have a large debt, the only way for the government to spend more on the emergency without having even more debt is to spend less on other government priorities. We hate that. So we need to have less debt now to give us more room to spend tomorrow on our highest national priorities. But reducing debt isn’t enough.  What we spend is limited by our incomes. When a nation grows it generates more tax revenues that support government spending. If you want to afford expensive policies for anything – environment, income distribution, defense, security, etc – then having a higher income and more tax revenue is the surest way.

Crash diets don’t work. Healthful living does. Every diet that takes you away from a sustained healthful life plan simply makes you worse off. Shotgun approaches to numerous national problems that threaten economic growth and/or create more debt are doomed as well. 

Tuesday, March 18, 2014

National Growth, GDP, and the Geico Gecko

Aside from the articles I have been reading this week about China, it is remarkable how little focus there is about economic growth. Europeans acknowledge substandard growth but do little about it. Brazilians have their hands full dealing with protests relating to the coming World Cup. Governments in Turkey and Venezuela are two examples of demonstrations in the streets that have nothing to do with growth. Of course former Soviet States are now preoccupied with Russian aggression.  In the US we have a myriad of issues that policymakers have apparently placed above economic growth including climate change, immigration, the minimum wage, healthcare, and income redistribution.

One would think that after five years of disappointing employment and output gains, there would be more people in the street demanding stronger economic growth. One could imagine all manner of government committees hammering away at the best ways to restore economic growth. I understand that ideology has made it difficult to find a solution but that doesn’t fully explain why no one is even trying. We get steamed up when Russia exerts its will over defenseless people living on their borders – why is there no constituency comprised of the millions of small businesses and employees who are languishing in the shadows?

I have advanced some reasons for tepid approaches to growth in past posts but in this one I focus on the very meaning of macroeconomics. We take macro for granted since we have used its concepts and theories for at least half a century. GDP and inflation are macro concepts as widely known as spinach and atoms. We oooh when GDP rises and we cry when inflation accelerates. But the truth is that no one can buy a GDP and no one pays inflation. These and other concepts are made up by government statisticians and they are no more real to you and me than the Geico gecko.

GDP, inflation, and other macro concepts were designed for national cheerleaders. That is, we call the area within the boundaries of our nation the USA. Most of us are nationalist cheerleaders – we root for our Olympic teams and we revel in strong national economic growth.  In economic terms, this nation is made up of a lot of parts – bourbon is largely produced in Kentucky; skilled workers reside in California and Washington; a lot of autos are manufactured in the Midwest; Cruise ships depart in huge numbers every day from Miami and Fort Lauderdale; Las Vegas had a huge crisis in residential housing; and so on. Everything is local. The US scorecard is credited but the truth of more Recreational Vehicles produced is that most of the benefits go to Northern Indiana.

To repeat, everything is local yet we cheer for the national team. Why? One reason is that when residents of Elkhart, IN do better, the benefits often spread to a wider geographical area as Hoosiers spend their new found wealth in other places. But a stronger motivation for macro is that our elected federal policymakers in Washington have an obligation to improve the economic well-being of people across the country. Their job is to make GDP sizzle like your favorite steak.

That is what they have done for decades. Whether it is the Fed or Congress, we hear over and over about how their policies address national concerns with national remedies. We argue about the success of these policies but it is undeniable that macro has been a very important motivator and macro policies have been the result.

And this game has worked because of the inter-related and interdependent nature of the US economy. While each region and sector might have obvious and stark differences, these matter less if a national macro policy appears to have broad benefits spanning the country. We all know that some regions or some products or some industries or some workers are impacted more than others – but so long as the benefits and costs appear to be borne across the nation – we consider macro and macro policy a legitimate exercise.

So that gets us to where we are today. People bought this macro story in 2008 when we all felt threatened by a severe global downturn.  Helping the Saving & Loan in Fort Myers was not seen as a bailout for Florida or Real Estate. Rather it was viewed as part of what was necessary to bring the whole nation back to economic health. But that was then. Despite the fact that slow economic growth is very damaging, notice how many non-macro beliefs exist which stand against the advocacy of growth policies right now.

1.     Growth will not be shared among all workers
2.     Growth will not help the long-term unemployed
3.     Growth will not raise the wages of those with low skills
4.     Growth will not protect administrative workers from unfair business practices
5.     Growth will worsen pollution connected to energy production
6.     Growth will not solve problems of healthcare price inflation
7.     Growth will worsen illegal immigration
8.     Growth will not redistribute incomes from the rich to the poor
9.     Growth won’t solve problems associated with crime and poverty
10.                        ……….add your own here.

This is not just ideology and politics – these and other charges shake the very foundation of almost 80 years of macroeconomic analysis and policy. We can argue every one of the above points but the truth is that I cannot remember a time in my career when macro was so dubious. I checked the dictionary and one word used to describe dubious is suspect. Today macro is suspect. 

I point that out because I believe that while macro is a suspect – it is mostly not-guilty. I agree that income distribution has tilted towards the rich. I agree that the last 10 years have witnessed a time when many persons did not share equally in prosperity. But I will say that if there ever was a time when national economic growth could improve the lot of most Americans, it is now. And I will say even louder that if we spend all of our time debating the 10 points listed above, we will surely languish in substandard growth for the foreseeable future.

Let’s put it this way. There should be a time for everything. We don’t have the resources to do everything right now. Some of you would prefer to deal with a myriad of issues because you think they might goose the growth along. While some economists are making up theories that support income distribution before growth – I think there is much more evidence for the reverse. Let’s focus first and foremost on the national economic growth. Once we get a head of steam going, then we can work on the infinitely harder problems of distribution, immigration, climate change, etc.


Tuesday, March 11, 2014

Guest Blogger Nathan Brooks, Tea Party in Boston? Sorry, I won’t make it because I can’t afford the airline ticket

Nathan Brooks has worked for over 15 years in the travel business, with stints in airlines, hotels and travel agencies. He is also a 2008 graduate of the Kelley School of Business MBA program, despite the best efforts of Dr. Davidson.

When I was in the third grade, my sainted history teacher, Mrs. Smith, began to regale us with the story of the Boston Tea Party from the American Revolution. Being the excellent student I have always been (just ask Herr Doctor Davidson if you don’t believe me), I immediately raised my hand and asked “Why on earth did they waste all that tea? Shouldn’t they throw it at the British instead?”. As I was on to the principal’s office, I immediately learned the lesson of taxation without representation.

As a member of the travel industry, I am reminded about this concept every single day in the amount of taxes consumers are obligated to pay when booking an airline ticket, hotel room or rental car in the United States. If I decided to recreate the cinematic classic that is “The Hangover” today and went out and bought an airline ticket to Las Vegas, then decided to buy a case of Jack Daniels, a carton of cigarettes to wash the regret, and a shotgun to hide the evidence of my bender, I would pay more in taxes on the airline ticket than I would on all 3 other items combined. Airlines are one of the most taxed industries in the US, with taxes higher than any of the traditional “sin tax” industries.

When you buy an airline ticket, you get to pay for all sorts of taxes, regardless of where you are going and how much you paid for your ticket. In an average $300 domestic US round trip ticket (with a connecting flight each way) you will pay about $66 in taxes (22% in taxes).

Type of tax
Excise tax
7.5% x $300
Segment fee
$3.90 x 4 segments
Passenger facility charge
$4.50 x 4 segments
TSA ("Sept. 11th") fee
$2.50 x 4 segments
Grand total


Car rental taxes can even be worse, depending on where you rent your car. Particularly in airport locations, legislators are sure of two things: You don’t own a car in that city and you can’t vote them out of office for raising their taxes. If you have ever looked at your car rental receipt, you release that you have probably paid for someone else’s sidewalk repairs, the city Holiday party and the mayor’s new in-ground swimming pool at his house. As a longtime resident of the Phoenix area, I would like to personally thank each and every one of you for the fabulous 8 new spring training ballparks, all built with rental car taxes collected at the airport. Next time you are in town, be sure to go down to city hall and ask the mayor for a free hot dog to take to the ballpark.

In some cities, the taxes and fees can actually be more than the actual cost of the rental car. In most cities, it is actually cheaper to find a local pick-up location for a rental car and take a taxi to that location from the airport than to pay the “You’re a tourist, please take a barrel and head towards the falls” tax.
So, what can we do, other than figure out how to smuggle a crate load of English Breakfast tea past the TSA agents? We need realistic taxes on the travel industry, which are driven towards creating necessary improvements in the infrastructure. Next time you are sitting at the airport bar during a delay, simultaneously wondering how your flight from Indianapolis to Dallas can be delayed because of weather in Los Angeles and how is it possible the guy next to you can sit be upright after 8 Jack Daniels, realize that the air traffic control system hasn’t fundamentally changed in 70 years. This money, which is critical for growing the industry and adding more flights, cars and hotel rooms, is instead paying for baseball stadiums, convention centers and shopping malls.

However, the odds of politicians giving up tax revenue from folks that have no say in the matter ranks right up there with the Los Angeles Angels finally returning my calls about playing left field for them. As budget pressures continue to rise on cities, states and countries, these taxes will continue to rise and get more and more creative. All you can do is understand why these are occurring, sit back, raise your mug of tea and smile.

Tuesday, March 4, 2014

Government Taxes and Spending Threaten Economy This Year

Earlier this year I wrote about momentum being an important factor keeping the US economy rolling along. In a subsequent post I pointed out how the current growth was very unbalanced and why that was a risk factor for sustaining the weak expansion. Today I continue that theme, but this time looking at some details about personal income growth. The bottom line is that little of the economic success experienced this year comes from sustainable gains in the private sector. Government is responsible for much of the temporary improvement last year and at the center of why there is little hope for a stronger rebound this year. The data supporting this conclusion come from a table posted by the Bureau of Economic Analysis at http://www.bea.gov/newsreleases/national/gdp/2014/gdp4q13_2nd.htm

See the bottom of this post for BEA’s Table 10 where BEA breaks down Personal Income (PI). I deleted a lot of the quarters from the original table. The table below shows you figures for the final quarter of 2013 and the percentage change since the final quarter of 2012.  Table 10 is worrisome with respect to future US growth. While most GDP figures reported are in real or deflated terms, most of what you see in Table 10 is nominal, meaning that each item is measured in current prices. The top line shows that PI in the US was about $14.3 trillion in the fourth quarter (annualized). It increased by about $230 billion during 2013. That amounted to a nominal increase of 1.6%. By historical terms that increase was very weak. 

But the story is much worse:
·        If we deflate PI for inflation what remains was a 0.6% real increase in Personal Income in 2013.
·        During that same time period real GDP increased by 2.5% and Real Personal Consumption expenditures increased by 2.1%.
·        Thus real PI is not a sustaining force when it comes to driving spending in the economy.
·        At the bottom of the table under addenda you see something called Personal Disposable Income in chained dollars (RPDI).  RPDI is a better proxy for the impact of income of spending since it removes inflation and taxes from nominal Personal Income.
·        RPDI declined by 0.2% in the past year.

I come to two conclusions. First, spending in 2013 was not being driven by real income gains. Second, spending has been driven by more debt or depletion of saving. Near the bottom of the chart you see that the rate of Personal Saving declined from 6.6% of GDP down to 4.5% in just one year. Or if you prefer dollar terms, US Personal Savings declined by $259 billion between the end of 2012 and the end of 2013.

Let’s understand better the sources of the problem. In 2013 PI rose by $230 billion. It sounds impressive that Wages and Salaries accounted for $146 billion of the increase. But also included in the gain in PI was $76 billion in government transfer payments to households. These transfers include money the government sends to us in the way of benefits for welfare, pensions, healthcare and so on. It is remarkable that government transfers were responsible for more than half as much as the entire private sector’s wage and salary growth.

So while government was a main contributor in 2013 to the gains in PI, it was also the main detractor. In 2013 households paid money to the government – money for personal income taxes and also their contributions to Social Security system – or what we call payroll taxes. The combined total of income and payroll taxes in 2013 was about $2.8 trillion – or $280 billion more than in 2012. Say what? PI increased by $230 billion in 2013 while household taxes increased by $280 billion. Now you can more easily see why RDPI decreased in 2013. Although the government is propping up income through increased transfer payments of $76 billion, they were taking it away from spending by increasing taxes by $230 billion.

Bottom line. Wages and salaries grew by $146 billion in 2013. The government added to those income gains by increasing transfer payments by $76 billion (as you can see from the table there are other sources of PI but I am intentionally ignoring that detail here).  So the sum of the increases of W&S and Government Transfers in 2013 was about $222 billion. The government wiped out that entire increase with the $230 billion increase in taxes.

And we wonder why households are not spending more. The result of course is that people have to buy things. Without sufficient income growth they borrow or run down their precious savings. This is bad for a lot of reasons. But the main point of this posting is that household spending is the core of the economy representing 70% of all spending. Our policymakers cannot handle financial planning. Our government deficit is such a problem that we must tax our households to death. To make up for that fact, they give some of us transfer payments but that does little to support spending. Worse yet, because of government debt, there is pressure to reduce transfer payments and raise taxes. Under current budget and taxation policy it is hard to see how the engine of the economy will be coming back anytime soon.

Table 10.--Personal Income and Its Disposition
[Billions of dollars; quarters seasonally adjusted at annual rates]

                                     2013Q4r    %Chg
Personal income1........................... 14303.4 1.6
  Compensation of employees................ 8968.8 2.1
    Wages and salaries..................... 7232.5 2.1
    Supplements to wages and salaries...... 1736.3 2.1
  Proprietors' income with inventory       
   valuation and capital consumption       
   adjustments............................. 1356.2 8.7
    Farm................................... 112.9 51.5
    Nonfarm................................ 1243.3 6.0
  Rental income of persons with capital    
   consumption adjustment.................. 602.7 8.5
  Personal income receipts on assets....... 2030.6 -1.6
    Personal interest income............... 1240.9 1.8
    Personal dividend income............... 789.7 -6.5
  Personal current transfer receipts....... 2463.6 3.2
  Less: Contributions for government       
   social insurance, domestic............. 1118.5 15.6
Less: Personal current taxes............... 1681.9 8.3
Equals: Disposable personal income......... 12621.5 0.8
Less: Personal outlays..................... 12056.3 3.1
Equals: Personal saving.................... 565.2 -31.4
  Personal saving as a percentage of       
   disposable personal income.............. 4.5
  Personal income excluding current        
   transfer receipts, billions of          
   chained (2009) dollars2................. 10997.0 0.3
  Disposable personal income, billions of  
   chained (2009) dollars2................. 11723.1 -0.2