Sunday, April 27, 2014

Earnings: Why Low Inflation Might Not be a Bad Thing

Earnings play a special role in many debates, including conclusions drawn about income distribution. Recent studies have been published yet lead to more than one conclusion about income growth. This is because there is more than one way to measure income. Some data include government workers. Others don’t. Some data include employee benefits while others don’t. Some data include social benefits and taxes while others do not include these. Most studies look at households at a point in time. Other longitudinal studies trace households over time. So it is pretty clear that depending on the income indicator you choose, you can come away with some very different conclusions about who earns what.

Today I want to focus on a popular indicator published regularly by the US Bureau of Labor Statistics (  ) – Average Hourly and Weekly Earnings of all employees on private non-farm payrolls. These earnings include wages, salaries, and benefits of workers – workers in what we generally consider to be the business sector of the county. It does not include workers in government or on farms but it does encompass both manufacturing and services employees. How much do these workers earn in total? How much of those earnings are from company benefits like pensions and health insurance? How have these earnings changed over time? What implications can be drawn from past changes?

Two tables at the bottom show us changes in earnings during the 10 year period from 2003 to 2013. The first table shows the data in nominal terms. The second focuses on the buying power of these earnings by removing the impact of inflation on earnings. But before we get into all that – as of December 2013, earnings were:
            Wages and Salaries       $21.77 per hour
            Paid Leave                       2.21
            Supplemental pay              .77
            Insurance                        2.84
            Retirement & Savings      1.53
            Legally mandated
            (e.g Social security)         2.45
            Total Earnings           31.77 per hour
My post looks at a decade of changes in these earnings per hour figures. The tables below divide the changes in three time periods with respect to the last recession -- before, during, and after. Earnings in the private sector show that the recession hasn’t ended. In real terms, total earnings have been stagnant during the recovery while wage and salary income per hour has declined. The leading component of earnings is health benefits. Is this stagnancy the result of the recession or other longer-term factors?

Surprising is that not much has changed in the buying power of earnings in the private sector. While it is true that in terms of nominal value earnings took a hit in the recession – so did prices and therefore the post 2007 time period does not look much different than the booming period that came before it. Real wages and salaries declined by about 1% per year during the strong growth years before the recession and continued that pace in the 6 years thereafter. So even when things seemed to be good for labor – they weren’t.

The only part of earnings that differs from this static pattern is health-related benefits. While total benefits were growing at 0.3% before the recession, real health-related benefits were growing by eight times that much or 2.4% per year. After the onset of the recession total benefits grew by a little less than 0.2% per year while health-related benefits were increasing by almost 2% per year. The recession did not slow the pace of health benefits.

The economy was blazing before the recession. On April 1, 2007 the unemployment rate bottomed at 4.5%. It previously peaked at 6.1% in 2003. The 4.5% shows that despite many adverse long-run trends, the US economy was capable of creating jobs. As recently as 2007, there was little national priority or serious concern about the employment effects of globalization, industrialization, and demographics. It was all about the economy stupid! From 2003 to 2007, the annual growth rate of the economy averaged more than 3 percent per year. Similarly from 1992 to 2000, the US economy grew rapidly and the unemployment rate fell to 3.8% in April of 2000.

The key takeaway is that we always have long- and medium-term headwinds – but the key driver of unemployment in the USA has for a long time been the strength of the economy – economic growth. And the same goes for earnings in the private sector. Since 1986, the growth of earnings has been essentially trendless with an average growth of about 3% per year for almost 30 years. Earnings growth picked up to almost 4% per year when the economy was growing rapidly –at the end of the 1980s, end of the 1990s, and around 2007. Earnings then slowed considerably during slow growth periods and recessions – falling below 3% growth in the early 1990s, early 2000s and then more recently.

As our data below shows, employment has been slow to resume growth and with that has come subpar improvements in earnings.  The reason is that this recovery has had strikingly anemic economic growth. The past data suggests that once economic growth returns to normal, so will employment and earnings. So while raising the minimum wage sounds hopeful the truth is that this will have little impact on earnings or economic growth. What we really need is a pro-growth economy hitting on all cylinders.

But even growth won’t solve all earnings problems when measured in buying power. Real wages have barely budged in the last 30 years. The problem in that regard is inflation. Since high employment and strong growth often bring higher inflation – a higher earning does not necessarily buy more.  Between 1980 and 2013 earnings grew by 194%. Prices as measured by the CPI grew by 183%. The Fed says they are not worried about inflation in the US now. But it seems to me that stronger growth coupled with low inflation might be the best thing they could do for the average private sector worker. Unfortunately policy is not headed in that direction. The Fed seems to be saying that inflation is too low right now. We'd be better off if Janet Yellen took her foot off the pedal and allowed earnings to rise relative to inflation. 

Tables. Earnings in Private Industry
Average Annual Rates of Change, 2003 to 2013
Before, During, and After the Recession
In current Prices
                             03-07    07-09      09-13
W&S                     3.3          1.9          1.8
Non-Health          3.8          1.0          2.4
Health                  5.8          3.8          3.5
Total                    3.7          1.9          2.0
In Constant Prices**
                            03-07    07-09      09-13
W&S                   -0.1        0.4          -0.2
Non-Health          0.4        -0.5          0.4
Health                  2.4          2.3          1.5
Total                    0.3          0.4          0.0
**CPI                  3.4          1.5          2.0

Tuesday, April 22, 2014

Climate Change: Where Did All the Cranky Scientists Go?

I wrote about wage gaps recently and now I want to write about climate change. Apparently I am going through the change. These are not macro issues per se. But they are as important as the Indiana Pacer’s playoff chances and therefore I am sticking my head out with full realization that my health is in jeopardy.

Before we get started let’s make something clear. I am not challenging climate change. I think it is real. I am not challenging all those climate change scientists. They know a lot more about climate change than I will ever know – and there are a lot of them.

But I am wondering out loud about their choice of information distribution. Their choices about how to communicate this information cast suspicions on the policy implications of their work. Recall that we used to think the earth was flat. I wonder if there were a few “scientists” around at that time who challenged the prevailing view? What did reporters at CNN say about those guys? I also remember when Hwang Woo-Suk reported that he had cloned a dog he named Snuppy.  A highly regarded professor at Seoul National University, his work was published in the best journals as state of the art stem cell research. It was not until one of his colleagues discovered some funny business that we found out the truth. He had really cloned Nancy Pelosi. Ha ha. Just kidding.  Remember all the buzz about cold fusion? It was going to save us all from electricity costs. Hmmm – maybe not, at least not for a couple hundred years.

Two points. 1. Science doesn’t always have it right even though a lot of highly regarded scientists agree. 2. Science is ongoing and it is skeptical. If you have been sentenced to any college courses about science they will always tell you that everything we know and learn derives from using the scientific method. No not the rhythm method Charlie – the scientific method. There is a lot of common sense in that statement. It basically says that you “don’t know nuttin” until you subject your ideas to the data. If your idea passes the empirical test – then scientists say – you failed to reject your hypothesis. Notice the wording – it DOES NOT say that you proved your point. It does say that you didn’t reject your idea this time and you get to pretend like it is true – at least until the next test of it comes around. That’s my dear friends is science.

Notice the conservative or skeptical approach to knowledge taken by scientists. The data confirms you this time fella – but we are not going to really trust this idea until we test it again. And again. And again. Even Einstein’s theories changed over time as scientists found that previous versions could not pass new tests. When I was a youthful maco-scientist and sent my path breaking articles to the academic journals, I knew that I would get an earful back. As other economists pored over my results they found weaknesses and they were quite clear and vocal about them.

Science is ALWAYS skeptical. And this gets me back to climate change. I spent the day finding and then pouring over the latest report: IPCC Intergovernmental Panel on Climate Change at

This shows you how boring my life is that I would take a perfectly good sunny afternoon and sit in my office and read this long and tedious report. Okay I did sip a little JD. The full report is not available and won’t be until later in the year. What I looked at was the Summary for Policymakers (33 pages of very small print). But give me a little credit for going through the report. I doubt that any of our policymakers or anyone in the press did that. And I am guessing even fewer people will actually read the full report when it comes out. Why? Because those scientists published a special version of the report in a press release that was two pages in length and had no real scientific terminology. It did have words like

A new report by the Intergovernmental Panel on Climate Change (IPCC) shows
that global emissions of greenhouse gases have risen to unprecedented levels despite a growing number of policies to reduce climate change. Emissions grew more quickly between 2000 and 2010 than in each of the three previous decades.
According to the Working Group III contribution to the IPCC’s Fifth Assessment Report, it would be possible, using a wide array of technological measures and changes in behaviour, to limit the increase in global mean temperature to two degrees Celsius above pre-industrial levels. However, only major institutional and technological change will give a better than even chance that global warming will not exceed this threshold.

These words are not science-skeptical and they give very little clue about disagreements of any kind in the analysis. They did explain that 31 teams from across the globe worked on the report. In fact, this press release is nothing but ringing an alarm bell and endorsing public policy. I am not sure what these scientists know about public policy but they didn’t explain that either. Clearly most of the press didn’t care. They were ready to spread the religion.

What is missing in the 2 page press release, sadly, is also missing in the longer report for policy makers. The longer report does have a lot of scientific jargon. But it doesn’t have a scientific attitude. It is skeptical about nothing. I would love to get some of the round-earth-ers together – people who thought some results of the flat-earth consensus were weaker than others. There must be some scientists inside this IPCC group who agreed with some general principles and conclusions but who saw some weaknesses in the models.

Some of these caveats come out but they are dispensed with as soon as they are mentioned. The recent 15 year hiatus in global warming is attributed to deep water or some such thing. I was a kid 15 years ago. That’s a lot of time to dismiss because it flies in the face of other facts. Real scientists love it when things fly in the face of their assumptions. Sherlock Holmes would find the smallest clue and that would take him to the killer. These were the same clues missed by other detectives. It is also interesting that many global climate change models work for the world – but somehow don’t explain specific regions.  If I had an economic model that explained Indiana’s spending but the model could not explain spending of Hooisers who live in Indianapolis, you might wonder about that model. Climate change scientists admit this but then move on as if it were an afterthought. They sweep it under the rug.  In economics we would call that an aggregation problem. It clearly bears further investigation. What would Sherlock do with that? 

And speaking about models, the real test of models is how they predict the future.  It is nice if a model can explain the past but the future is the real litmus test. This report admits that previous forecasts using similar models that were used to predict the last 15 years are totally off – we got cooling instead of warming. So we are supposed to believe the predictions of the newer models for the next 15 years. If I predicted stocks wrong for the last 15 years – few of you would let me invest your money today.

Of course, the easiest test of models is to see how they “predict” the past. These are trial runs. How did our model do? Scientists look at model errors to ascertain how much to trust its results or validity. Students who take statistics courses learn about model errors, and t tests and R squares,and such things which help us be very quantitative about the accuracy and validity of models. But in all 33 pages of this Summary for Policymakers there are no such statistics. Are policymakers devoid of statistical understanding? Instead these learned scientists use terms like “high, medium, or low confidence”  to give credence to their long string of individual results. Two footnotes on page 3 explain the meaning of these terms and I can tell you that the assigned meanings have more to do with camaraderie of scientists than statistics. To be a “likely” outcome of the model, the assessed probability of occurrence would be between 66-100%. 66% is likely? Is 66% enough to support major changes in the way we live?

I am not a climate change scientist. But I do know good scientific principles. The press release says that it will take “substantial investments” to mitigate the worst of climate change. They estimate a reduction of world output of about .06% -- a very small number. Then they conclude this “the underlying estimates do not take into account economic benefits of reduced climate change.” I wonder where they got those figures?And I wonder where the scientists are who take a more Sherlock Holmes approach to the finding of this august body.  

If policymakers are to know how to deal with climate change – they need more precision about the nature, degree, and timing of climate change. What they get in this report is only half the story. Where are the scientists who are brave enough to tell the full story and reveal the weaknesses in these models? Where are the caveats? Where are the probabilities that the model makes errors? Where is the real science? Perhaps they are right about urgency. A more scientific communication might sway some of us in that direction. Until then we will wonder what the full story is.  

Tuesday, April 15, 2014

Wages Gaps Vive la Difference

Whether it is income inequality or the gap between men’s and women’s wages, we have a President who single-handedly wants to kill that difference. And while it is impossible to argue on moral grounds that it is a good thing for people to be discriminated against, it seems the President is missing some real fundamentals in his quest.

Think of all the cases of differences we mostly accept. Some guys and gals get really tall and become successful basketball centers…and millionaires. Danny DeVito was a tiny man who became a successful actor. Napoleon was pretty tiny too. These guys never would have played center on any basketball team. We say men are from Mars and women from Venus. We celebrate these differences. On a lot of Saturday nights we dance, go to movies, have debates, and otherwise enjoy being with the opposite sex. Vive la difference.

Already some of you are fuming. Larry – it just isn’t fair for a man and woman to have the same job and be paid differently. But that just isn't the case. Before you explode, keep reading. 

What we all want is fair treatment when it comes to pay. But let’s face it – fair is not equal. I was a prof for 30 something years. I saw some pretty horrible profs who neither prepared for class nor did any research. It would have been unfair to pay those jerks the same as others. I also saw award winning profs who were incredible teachers. 
They got better pay raises than most of us and deserved them.

Think about every job you ever had. There were people who came in early, took short breaks, and went home late. Others were not so wedded to their jobs and couldn’t wait to bust out of the building so they could watch their kids play soccer or otherwise enjoy their non-business lives. While you don’t want to stop people from having balanced lives, it also does not seem fair or right to penalize those people who made disproportionate contributions to the organizations’ successes.

And then there is the path to the job. You and I might have the same job and work the same hours – but let’s suppose you grew up in a low income family and were very motivated to exit that status. You worked very hard at school and took the courses that would prepare you for a high income career. Me, on the other hand, born with a golden spoon in my mouth, spent more time playing cards than attending classes and majored in any field that provided a quick path to graduation. Uncle George helped me get my job and I demand to be paid the same as you. Yet I am not not the sharpest tool in the shed and don’t come close to your productivity. Somehow, it doesn’t seem fair to pay us equally.

I could go on and on but the point is made. What someone gets paid ought to have something to do with their contribution to the company or organization. It shouldn’t matter how tall they are, what race they are, their sex, or their parentage. We have laws in this country to prevent discrimination and they should be used and enforced.

What about the 77% stat (or other similar ones) that shows women make less than men for similar jobs? These figures are provocative but not rich enough to support the conclusions. Already there is a competition of stats that show the true number lies somewhere between 77% and 98%. But the truth is that all these numbers fail for pretty much the same reason – they do not bring in all the relevant facts to make comparisons. And they don’t even bring in the most relevant fact of all – how productive are these workers.

One does not have to be a crank to point out that really short people do not excel as basketball centers. Or that music majors often make poor astrophysicists. It is possible that these comparisons work against women for a lot of reasons that have nothing to do with misogyny or discrimination. Recall the women are from Venus thing? Women historically and still often play the larger role at home and/or with the children. Women have often been called the second income earner as a choice to promote family stability. Women often need flexible work schedules which sometimes put them at jobs that pay less or which work fewer hours. I haven’t kept up with the latest on women’s schooling or with women’s occupations. But surely women are different from men and these differences imply statistical gaps that have nothing to do with discrimination.

So why does all this really matter? It matters when it comes to every woman in the marketplace who earns a wage. Every woman who works for an organization should be paid according to her productivity. While productivity is no simple thing to measure, every co-worker, every supervisor, every VP, and everyone somewhere close to that woman’s work knows what her productivity is. I have never worked for any organization where productivity was a secret. I was an Airman in the Air Force and worked in an office with about 10 guys. We all knew who the slouches were – and we all knew the guys who made the difference. Let the companies make the decisions. And then let discrimination laws take care of any discrimination that results.

We don’t need the President of the USA sticking his nose into these matters. It doesn’t hurt to raise consciousness so that all people are treated fairly. But proposals requiring even more data from firms won't stop discrimination and have all the potential to harm what is already a very weak economy. The best thing we can do for women is what we do for men. Make them aware of the importance of productivity to one’s material well-being through advising about good choices with respect to education, training, career choices, family decisions, and so on. A woman has the right to choose and those that prefer to NOT maximize future income should have the right of lifestyles that meet their goals while paying them somewhat less along the way. To me that seems fair to those people who choose the opposite. 

Tuesday, April 8, 2014

The Fed -- One-Armed Juggler with Hand Grenades

As many of you know I am a retired professor. That means prunes for lunch followed by a well-deserved nap. Recently I was invited to a lecture at my local university and in a fit of insanity I decided to encounter traffic, parking, and students-walking-with-phones. I am happy to report that I made it to the lecture and back home without incident.

I won’t go into the details but it was a very prestigious group of speakers with prominent alumni in the audience and many of the grad students wearing their finest coveralls. Some of the speakers represented the past and present of the Fed.  

I am both glad and sorry that I attended. I am sorry because I am not used to sitting so long in regular (not sweat) pants with a belt. I am also not used to other speakers going on and on and on. It isn’t so bad when I excite my audience with thirty minute explanations about totally obvious points – but when I am at the receiving end it is quite another matter.  But I am not sorry I went because I learned a lot from these speakers. 
They spoke about the onset of the last recession, about policies aimed at the recession, and they ended by speaking about the future.  Much of what they said I agreed with. But some of what they said really alarmed me.

Agreement – in the face of the worst financial and global economic crisis since the Great Depression, the government and the Fed needed to provide some quick liquidity and some stimulus. I am not one of those economists who believe that in 2008 Adam Smith’s so-called Invisible Hand was the best approach. The Fed should have played the role of lender of last resort. The government should have applied some stimulus. But once we agree on that then we start to take different paths.

This is not the place to enumerate all the differences. Instead I want to focus on a couple of threads that really scared me. The first has to do with the assessment of the Fed’s use of quantitative easing or QE. One panel member said that when interest rates get to zero, then QE is necessary. So it was perfectly okay and successful for the Fed to begin actively buying mortgage-backed securities and long-term government bonds. The reason this was okay and successful was evidenced, according to this speaker, by stabilizing inflation expectations.

Note: These speakers said a lot of things and I have to admit that I was dozing now and then. So it is perfectly okay for the reader to interpret my remarks as targeting some unspecified speaker if I have not faithfully represented  views actually espoused that fine day.

One could say that since inflation is the key objective of the Fed, it goes without saying that a policy to address inflationary expectations was well in the purview of the Fed. Since demand and inflation were falling at the onset of the recession, it seems the Fed did the right thing with QE. But that would be too simple for several reasons. First, with its usual tools, the Fed’s mandate has always been macroeconomic. The Fed is not supposed to bailout a tornado-damaged community or help a beleaguered furniture industry. It had a dual mandate to approach national goals for inflation and unemployment. Buying short-term government bonds so as to influence the federal funds rate was compatible with stabilizing the economy. But buying mortgage bonds and long-term government bonds is a horse of a different color.

Second, buying mortgage bonds is basically what it is – helping out the mortgage market and the housing industry. You might argue that if the mortgage market was the source of national problems then it made sense to buy mortgages. But that’s a sticky wicket since QE started well after the beginning of the recession and continues today. Many would say that this practice of focusing on a particular industry is simply inappropriate because it is really fiscal policy. I would also say that it has already become ingrained in Fed policy and thinking. Somehow the Fed has gone from monetary policy to fiscal policy. Since the government is supposed to be the one doing fiscal policy is just doesn’t make sense. The Fed has neither the appropriate tools nor the jurisdiction to have permanently changed its modus operandi. Remember what the Fed does is determined by national law. As far as I know the law didn’t change.

Third, buying long-term government bonds is also another change and a ruse at that. It is no secret that government stimulus programs dramatically increased the need for the government to borrow. Having the Fed in these markets creating a huge demand has certainly made it much easier for the government to borrow – and keep borrowing long after the storm has passed. Was this QE done to stabilize inflation or to support government borrowing? If it was the latter then in just a few years this Fed has thrown away both its independence and credibility.

The second worry is that the Fed has no real plan to stop QE. Sure it has been slowing purchases for a few months but there is still no clear evidence it will stick to this path when Chair Yellen regurgitates Bernanke’s promise to keep interest rates at near zero until the economy is clearly strong enough. But is the road to Hell not paved with good intentions? Every time the economy reaches another milestone the Fed smiles and tapers, and then the markets react badly. Good news is bad news? Postponing the tapering then leads to market jubilation. Is Janet Yellen really going to remove the punch bowl? If markets bless less tapering – the Fed takes this as a sign of policy success. When the market hisses at more tapering, surely the Fed will cave to the markets drug addiction for Fed asset buying.

The Fed put itself and us between a rock and a hard place by promising low interest rates when every indicator is that rates will and should rise to more normal levels. If the Fed does the right thing and returns to a normal policy, rates will likely overshoot and create another recession. The government will accuse the Fed of terrible acts since it will have to borrow at higher rates. Housing market participants will cry even louder.  If the Fed does the wrong thing QE will feed bubbles in housing, government bonds, and stock markets, facilitate the spending and debt appetite of the government, raise inflation expectations, raise interest rates, and likely cause a quick growth spurt followed by a recession.

There are good reasons why the Fed had a simple mandate. A one-armed juggler can only keep so many balls in the air. This Fed has too many balls in the air and they will soon be landing on our heads. No more seminars for me!

Tuesday, April 1, 2014

Happy Fifth Anniversary by Guest Blogger Buck Klemkosky

It all began on March 9, 2009 – a time of skepticism, despair and pessimistic thinking. Some were even questioning the future of capitalism. It had been a turbulent decade in the stock market with the S&P 500 peaking at 1527 in March 2000 before falling 49 percent to 777 in October 2002. The market then rallied 101 percent to peak at 1565 in October 2007 before suffering a 57 percent decline to close at 677 on March 9, 2009. The U.S. was in its worst recession since the 1930s, the financial system had nearly collapsed and housing prices had also declined for the first time since the 1930s. In total U.S. households had lost more than $13 trillion of wealth from the stock market ($9 trillion) and housing ($4 trillion). Investors had plenty of reason to be pessimistic.

While difficult to do psychologically, investing during pessimistic times provides opportunity, and March 9, 2009 would have been one of the best stock buying opportunities in two decades. The S&P 500 has increased 177 percent from March 9, 2009 to March 7, 2014 and total returns, including dividends reinvested, have exceeded 200 percent. During the five-year period, $15 trillion of wealth was created in U.S. stocks. A good five years to be invested in the stock market for sure.

Unfortunately, many investors have not participated in the bull market. Using mutual fund flow data, individual investors were net sellers of equity mutual funds every year from 2008 to 2012, to the tune of $500 billion. Equity fund investors did turn optimistic in 2013 and purchased a net of $19 billion. The opportunity costs of keeping the money in cash would have been huge given the low Fed-induced interest rates. Net inflows into bond funds during this period were $1 trillion, much greater than the net outflows from equity funds. An indexed bond fund would have provided five-year annual returns of 4.42 percent, much less than equity returns of 24 percent, but better than cash.

The sectors of the market that did the best and outperformed the S&P 500 during this five-year bull market were the ones that did the worst during the bear market and recession, namely consumer discretionary, financials, industrials, technology and materials. The more stable sectors of the economy, health care, energy, consumer staples, telecom and utilities, underperformed the S&P 500, although all had positive five-year returns.

Five years on, the bull market celebration continues. How does this one compare with prior post-WWII bull markets? Bull and bear markets are arbitrarily defined as market moves of +20 or -20 percent respectively. By that definition, there have been seven bull markets in the post-WWII era and the present one is the sixth longest and still counting; two more months and it will move up to number four. The granddaddy of all bull markets was the one that lasted from October 1987 to March 2000, 4,494 days, compared with the present one of 1,824 days as of March 7, 2014. This bull market’s return of 202 percent would rank it second to the one in 1987-2000.

Corrections of 5 to 10 percent are normal for any bull market, and the present one is no exception. The S&P 500 experienced declines of 16 percent in 2010, 19.4 percent – almost a bear market – in 2011 and declines of 9.9 percent and 7.7 percent in 2012. Volatility wise, this has been a fairly normal bull market.

Is this bull market starting to look long in the tooth? It may be starting to show its age but certainly hasn’t reached an exhaustion stage yet. Most investors have been skeptical of this bull market, which is understandable given the two bear markets since March 2000. It has climbed a wall of worry and skepticism with little of the speculative euphoria seen in the 1990s and other bull markets. The market is fairly valued by most valuation metrics but these are not normal times with historically low interest rates, strong corporate balance sheets, a stronger financial system and less-indebted households. Still, expectations of a growing U.S. economy and higher corporate revenues and earnings will have to materialize in order for this bull market to continue past its fifth anniversary.