Lesson 14: GDP Complaints and Super-Heroes

How are you doing? Excellent! Well, not exactly excellent. I feel great but my lower back is tight and my eyeballs are a little itchy. Okay my knee aches a little and my allergies have been flaring up.

Why don’t we have one single measure for how we are going? If we had such a single measure I could answer the above question with something like – my PSHM (personal single health measure) is up 15% this year. In August alone it rose by 15 points. Now that would be cool. But as you are questioning my sobriety right now – the point is well-taken when it comes to health. Health is highly multidimensional. We don’t really want a single measure of health. Nor do we want a single measure of how much fun you had last weekend. We clearly don’t want one indicator of how nice you are.

Then why in the world are people discussing the development of a new economic indicator to replace GDP? I see these articles all the time. The WSJ had such an article last week lamenting that GDP is too slim and there is so much going on around it. They mentioned how GDP tells you nothing about the distribution of income. It also is silent when it comes to investment versus consumer spending in China. It also says absolutely nothing about cow methane in Texas. (Betty says I can’t use four letter words starting with an F; thus methane).

I have heard similar statements since I started teaching macro in 1910. Critics lament that GDP is not a good measure of a nation’s overall welfare or happiness. They search for the Holy Grail of macro indicators. So with that as an introduction, let’s talk about GDP – what’s right with it and what could be improved.

Gross Domestic Product can be defined with one word – output. It is the output of a country where output is defined as the total amount of goods and services produced. The GDP for 2015 of about $18 trillion is the value of all goods and services produced in the 12 months of 2015. If a tall toilet got produced in 2015, it would be counted in GDP of 2015 – even if it didn’t get sold until yesterday. So be clear – GDP is not sales. GDP is output.

When we listen to complaints about GDP – keep in mind that it is pretty good at what it does – measuring national output. It is not supposed to be a measure of welfare or a measure of happiness. It’s output plain and simple.

A second issue has to do with laziness. While GDP is one number that gets publicized widely each quarter, the calculation of GDP involves at least two techniques and a large number of indicators. One approach (the Product Account) asks what happens after the stuff is produced. Some of it does not get sold and goes into inventories. The rest of it is sold to consumers, firms, governments, foreigners, etc. You can find and analyze all those details if you take the time and effort. 

A second approach (The Income Account) measures output in terms of what the factors earned/contributed in producing it.  So if you take a little extra time  you can learn how much of the output came from labor, ownership, and from barnyard animals. You could go blind reading all those details—there are so many of them published EVERY quarter. But you miss most of that detail because it is pretty boring to the press.

Is GDP perfect? Is Superwoman perfect? Of course not.  Superwoman often enlists the help of other super heroes to subdue evil. And even Superwoman has a bad hair day now and then. Even with all the details I mentioned above, GDP has two important limitations. 

First, it simply is not a good measure of welfare or happiness or distribution of income. Second, even as a measure of output, as the structure of the economy changes over time, so must GDP. Notice how over the years we have moved from producing mostly agriculture, to manufacturing, to services, to high tech, and even to pizza delivered by drones. To get the output number right, our methods of collection and estimation have to change. And that is why the Bureau of Economic Analysis has more economists than rats have fleas. 

So we continually try to improve GDP as a measure of output. And we also continue to develop measures of other important facets of economic health. If we are interested in distribution of income, the Census Department has a lot of data we can examine. If we are interested in welfare, then we know that economists have developed a number of measures exactly for that purpose. As for happiness, I know some monks you might refer to. 

The trouble with these broader measures is lack of consensus driven by varying definitions of somewhat hazy concepts like distribution of income, welfare, and happiness. We should keep trying to widen our scope of published super-statistics but keep in mind that all that activity has little to do with the usefulness and perfection of GDP, the nation's output of goods and services.

Free Trade and Burpees

I’m bothered that people don’t see trade the same way I do. Despite the fact that trade is highly multidimensional, people still focus on just one part – the trade deficit in goods. The trade deficit in goods is the telling figure to most people. We import more goods than we export. So there must be something wrong with us. Furthermore they equate years of decline in manufacturing employment with this surplus of imports. It sounds simple. We buy stuff from China instead of America and therefore we have a trade deficit and employment contracts in the USA.

But simple things are sometimes not so simple.

First, an analogy. Ashley tells Jason he should exercise more. It’s good for you, she says. So Jason starts a new exercise routine. Hey Ashley he says, my arms and legs hurt. They are killing me. Keep exercising she says, it will help your whole body. You will thank me later.

The pains of free trade are quick and obvious. To those displaced or diminished, their plights are not to be minimized or ignored. They must be assisted. But that is an issue separate from whether or not we should incur the pain. Some people say, no pain no gain. Maybe that is extreme. But ask any Olympic athlete and they can tell you how many hours and Ibuprofen it took to master their sport. Ask any musician how easy it was to learn how to make nice music.

With international trade we see the obvious hardships the nation must incur today. But the benefits are gradual in coming, diffused and much more difficult to see. Exercise does not make you jump 17 feet over a bar today – but it does help you be stronger and more flexible as you age.

Still, you might wonder whether the US benefits from trade. Consider this. Our population is 324 million people. The world’s population is 7.4 billion. There are lot of wants and needs residing outside of the US. And those  needs are growing. World per capital income (according to the World Bank) rose from $500 per person in 1960 to $10,000 in 2015. 

The average American made more than 5 times what the average world citizen made in 2015. World GDP rose by $72 trillion from 1960 to 2015. In comparison, US GDP rose by less than $18 trillion. POINT – the rest of the world has a lot of catching up to reach the US standard of living – and as they do their incomes will rise by huge amounts. They may not be there yet, but we definitely want to position ourselves to take advantage of rising world wealth. Being hostile to foreign business is not a great way to do that.

Finally let’s look at some trade data. Today I focus on the real values of goods exports and imports. This leaves out services because they are in surplus. These measures also eliminate prices and focus on the quantity of goods coming in and out of the country. I looked at the annual data since 1967. The numbers are percentage changes. Data can be found at bea.gov.

·       Of the 48 years between 1967 and 2015, in 22 of those years US exports grew faster than imports. In 26 years imports grew faster exports.

·       Goods imports annual percentage change exceeded goods exports sporadically (1968, 1969, 1971, 1972, 1976, 1977), from 1981 to 1986,  from 1992 to 1994, 1996, and 1998 to 2004, 2010, 2014, 2015.

·       In all the remaining years, exports of goods annual percentage change exceeded import change. More recently exports growth from the US exceeded import growth from 2005 to through 2013.

·       This is not the picture of a uniformly declining competitiveness of the USA because of globalization. In fact 12 of the 26 years when imports were rising faster than exports were before globalization picked up in the early 1990s.

·       In 2004 exports of goods trailed imports – with exports just over 50% of the value of all imports. By 2013 the ratio had increased to about 70%.

It is true that the US has a large goods trade deficit with the rest of world and especially with China. It is also true that this deficit has widened in value terms. But if we focus on real values we see a comeback with exports of goods growing faster than imports. This in no way proves that all is good and fair in international trade. But as the world regains its momentum and the rest of the world stabilizes and begins to catch up with US growth, we should expect them to want even more US goods. Shutting their goods out of US markets will do little to promote their desires to buy from the US.  One more point. 

We should expect that many countries would become stronger competitors to the US once they recovered from World War II damages. We should expect as well that many countries would compete against the US after the massive reforms that occurred worldwide after the collapse of the Soviet Union and dictatorships in South America. We can’t stop any of that and it would silly to try to do so. This tsunami of competition would have occurred with or without free trade agreements. We can argue about unfair trade but the truth is that America is being tested. We can complain about the competitors or we can get busy in figuring out the best way to remain strong in this new world. Withdrawing from the global stage seems counterproductive.

The Infrastructure Scam

More Infrastructure is the new hot phrase. Hillary wants it. Trump wants it. Your local asphalt company wants it.  I think maybe even the Pope wants it. All together now – three cheers for more infrastructure.

More infrastructure will cure our ills. More infrastructure will improve productivity, wages, employment, and economic growth. More infrastructure may even shrink your horribly swollen prostate. Sorry kids – this is an adult blog.

From the above words you are ready for the punchline. Surely there can’t be anything wrong with this new focus on more infrastructure. Or can there be?

Notice that more infrastructure spending mostly means spending more on our existing infrastructure. Most discussions mention dilapidated bridges, pot holes in highways, and leaky water systems. We can add sagging power lines and possibly an inefficient network of information technology equipment.  

When we refer to infrastructure we are legitimately singling out another dimension in the list of factors that produce output in a country. We know that how much output we get depends on how much input we use. Labor and capital are the two traditional labels for organizing our thinking about the inputs we use to alter the amount we produce. Now we are emphasizing a third factor – infrastructure.

Imagine a manufacturing company that produces those lovely little outfits worn by female beach volleyball players. That company has sewing machines (capital) and it has workers (labor). But notice that even the tiniest of these garments has to be shipped via truck or airplane. Orders might come in from the Internet. While having capable workers and great sewing machines is important to Tiny Garments, Inc, so is the quality of roads, airports, and computer networks.

The basic theory of infrastructure is not being questioned by me today. It is pretty clear why more and better infrastructure would be better for companies and therefore for their customers. I am not doubting the need for improvements in infrastructure. I am doubting the magnitude of the impacts of the current proposals. 

The questions I have are practical. For one thing, we are not talking about Tiny Garments Inc deciding on the best machines to create their very tiny garments. We are instead talking about society ordering improved roads for all the companies of America. Wow. Can you imagine the mess when the studly representatives of Wyoming get into a duel over whether they need the highway improvements more than brainy Connecticut. Or when kindergartners stage rallies demanding an equal share of the new fiber being laid for the purpose of America’s productivity.  There is only so much we can spend on infrastructure though listening to our main candidates suggests that the sky is the limit.

Which brings me to the next point – what is the optimal amount to spend on infrastructure if our goal is to increase America productivity, wages, and employment? Can you imagine Paul Krugman and Rush Limbaugh coming to some consensus about that. Surely we don’t want too much or too little? After all we have a pretty big national debt and infrastructure won't come cheaply, right?

Once we know how much we want, there is this question about whether or not more infrastructure today will really work to raise productivity, employment, and wages. Remember that this is 2016 and not 1956. In 1956 Eisenhower was President, manufacturing was dominant, and I had a full head of black hair with a pompadour. Putting in a new highway system was a lump sum investment and probably was worth every penny we spent on it after 1956. But in 2016 will another $300 billion or more have similar impacts? I know I have a few black hairs among the few hairs that populate my head and I know Eisenhower is no longer President.

I also know that trucks are already very efficient even on crappy roads and that drones are elbowing their way into delivery. Will $300 billion worth of better roads really make today's workers more valuable to companies? How much better will companies be able to compete because of the better roads? How much will they lower prices because of these efficiencies? How much will our spending and employment increase as a result of these price reductions?

And hold on – is it not possible that in today’s globally competitive high technology environment that some firms may react to improvements in infrastructure by using even less labor? Recall that some equipment is called labor-saving equipment. Some machines replace labor. Is it not possible that infrastructure improvements will mean a smaller demand for labor and lower wages? If infrastructure spending switches from roadways to super IT highways, might we need fewer workers?

I know we don’t expect our politicians to actually think about the things they say. But as I see it, this More Infrastructure thing is more complicated than they explain. It is clearly not a slam dunk no matter what they legislate. But that puts the cart before the donkey. What will they really legislate? Is this a serious attempt to improve economic growth or just another backdoor scam that appears to look like they are doing something? Or are we getting agreement from both parties because a new investment in infrastructure is rife with opportunities for rewarding friends and gaining from corruption? 

Alan Blinder's Priorities for Raising Wages in the USA

Alan Blinder, Professor of economics and public affairs at Princeton University, wrote a piece in the WSJ last Tuesday, Only One Candidate Can Make Wages Grow Again. As you might guess, this liberal economist is not writing in favor of Donald Trump or Alfred E. Neumann. Blinder apparently wishes he was as famous as Paul Krugman (or perhaps Karl Marx) and therefore has shed any pretense of objectivity or neutrality. He is a full bore Hillary supporter.

But don’t get distracted by my name calling. His piece is nonsense and I wanted to dissect it piece by piece.  The main problem is that Blinder ignores cause and effect. He starts with a liberal passion that says if a person’s wage is not high enough then we should simply raise it. It’s like if there is blood rushing out of a bullet wound then just push it back in. Pushing blood back into the hole totally ignores WHY it is gushing out.

I will get to some of Blinder’s points below. But first let’s discuss the data he quotes with respect to real wages. He prefers to use the buying power of what the workers earn as wages and salary – but he leaves out a very important part of earnings – the benefits. Benefits matter. The more benefits a worker gets, the richer he or she is. As our politicians are fond of reminding us – the more of our wage and salary that we don’t have to spend on healthcare – the more we can spend on other things. The Bureau of Labor Statistics has data on wage & salary, benefits, and the sum of the two, total compensation. They have nice tables showing quarterly data from 2004 to 2015. Here is what I found from the end of 2004 to the end of 2015:

            W&S rose by 28%

            Benefits rose by 43%

            Compensation rose by 33%

            Inflation rose by 24%.

In terms of buying power, real W&S rose by only 4% (28%-24%) over those 12 years. That’s yucky. But notice that benefits rose strikingly so that the buying power of compensation increased 9%. When Blinder uses real W&S he greatly understates the growth of the buying power of what a worker earns. He never even mentions compensation or benefits. I wonder why. No I don't. We know why. It spoils his progressive story. 

The other issue is history. Wages are characterized as a lagging indicator. That means labor is like your Grandpa. You have to call him three or four times before he finally comes to the dinner table. It often takes a few years after a recession before labor market tighten enough for wages to rise faster. Wages have repeated that pattern after our last recession albeit very slowly and so far wages continue to rise at a slow pace. Note that if labor supply begins to improve, this alone won’t help wage change. It will take a stronger bounce in labor demand. Firms, therefore will need to be more optimistic about the future and be convinced they need more capital and labor. But Blinder is silent about any policies that might make business feel more optimistic about the future. He prefers the following Clinton/Marx options.

            Increasing the minimum wage

            Profit-sharing (firms would receive a tax incentive if they profit-share with labor)

            Increased vocational training for non-college bound

            Provide pre-K education for all American children

            More generous Earned Income Tax Credit and expanding it to people without children

That’s his whole list. Thoughts…

While increasing the minimum wage increases the wage for some people, it will probably reduce the wage to zero for others. My friend Chuck T. says this is a full employment act for robots. But worse, what does this do to improve the optimism of the businesses that hire these workers?

What does forced profit-sharing do to improve the outlook of businesses?

We have a healthy industry of folks who provide alternatives to college education. What Blinder really means is FREE vocational training. But you get what you pay for. Right? I wrote about free education a couple of weeks ago.

Blinder implies that we don't work hard enough to move students away from college and into vocational training. I agree. The Germans seem to be very good at it. But why don't we do that? He should ask his liberal friends how we should target people who they might think are potential Einsteins into being plumbers. Who gets targeted? How is this done? Don't counselors already do that? 

Pre-K education might take 30 years. That’s a real winner. Please note sarcasm. What happens if we give more kids a great Pre-K experience without moving them out of a culture of poverty, drugs, and violence?

Giving the EITC to everyone seems like a big increase in spending. This is widely regarded as a good poverty program. So does Blinder advocate ending dead-end poverty programs and shifting the money to EITC? He doesn’t say. Piling more and more money onto already failing poverty programs does not make sense to me. I like EITC. But let's have it replace those programs that don't work. 

In fact he is totally silent about the implications of his suggestions for the national debt. Is there no end to how big our national debt can become without negative ramifications for business firms?

Business firms are the ones we want to hire people and then give them increases in wages and benefits. I would think that any balanced program to improve incomes in the USA might offer a few constructive ways to make firms optimistic about the future. Or is this just a backdoor way to increase the extent of government and reduce the scope of private enterprise in our economy? Mr Blinder, what is the truth here?

Lesson 13 Free Trade

I thought I knew the meaning of the words free trade. But listening to political dialogue these days I am more confused than Charlie Sheen at a lesbian AA meeting. I am mostly confused because some candidates say they are for free trade and then they explain why they oppose actual attempts to make trade freer. It is like you saying that you are for motherhood, but you think that women should not be allowed to fertilize their eggs. Wow – this is supposed to be a family blog and I used the word fertilize. I apologize.

You don’t have to have a PhD in meteorology to know that free trade is a desirable outcome. Can you imagine people protesting with big signs in favor of Not-Free Trade? It sounds pretty weird. We like things that start with Free. Like Free Love. What could be wrong with that? Then there is Free Enterprise. Free is the first four letters of the word freedom.

When I was a little economist with long pants and an Adam Smith tie I learned that free trade was a really good thing. Imagine free trade within your borders. Free trade means that Charlie can produce rose hip wine for Pete and Pete can sew doilies for Charlie. Both Pete and Charlie are made better off because Pete is lousy at making wine (he drinks more than he makes) and Charlie couldn’t sew his way out of a Goldman Sacks bag. Letting these two lovely fellows trade makes them both happier and richer.

The same basic idea can be applied to Paco and Juergen. Paco lives in Barcelona and Juergen lives in Germany when he is not globetrotting. Paco can make wonderful paella and Sangria and Juergen can produce machines and large spears of white asparagus (in the spring). They trade and both are made better off.

All that seems pretty clear. But economists can’t stand it when easy ideas don’t have complicated names and mathematical formulas – so they call this process comparative advantage. You could read a chapter in an economics book called comparative advantage and then want to kill yourself. But believe me, it is easy stuff. It explains why you don’t make your own t-shirts and why you’d prefer to buy one from the local t-shirt shop or maybe one made in China. The cool idea is that whether you buy the t-shirt (that says I sat by the window at the Mucky Duck) from Bloomington or China, you are not making the shirt yourself! Someone who knows how to make a really good shirt is making it for you. Apparently you are pretty good at making something else.

So what’s the problem? The problem is that in the real world there are three parties. Genevieve has been making t-shirts for three years. Along comes Nolan and he decides to make t-shirts too. Nolan's t-shirts glow in the dark. Brendan quits buying Jen's shirts and buys Nolan's shirts. Jen's business is threatened. Jen’s class erupts into chaos at their scheduled kickball time and begins chanting down with Nolan slogans.

The problem with free trade is that it advances mankind. You read that right. Free trade is all about free choice – freedom to replace one thing with another. We replaced the horse with the auto and the tractor. We quit eating fatty ribeye steaks and replaced them with corn on the cob and Brussel Sprouts. We threw away our wonderful phonographs and now use Spotify. Enough? Every one of those choices has a plus and a minus, but most of the choices make us all better. Proof? I don’t see many of you wanting to replace your new electric vehicle with a horse named Nathan.

Society does not like it when some people suffer. Society especially doesn’t like it when the person hurting seems to be suffering because we made a choice for a foreign-made product. There will always be a constituency that wants to help neighbors who lose jobs and income and careers because of either domestic or foreign competition. But don't forget. Helping these people means you restrain the benefits of trade and are hurting others. 

So that gets me to free trade agreements. FTAs are ways to promote free trade. That means removing or reducing tariffs or other obstacles that discourage trade across borders. FTAs encourage those positive results I wrote about above. My Google search says that the US has FTAs with 20 countries. Among the 20 are Australia, Canada, Israel, Korea, Mexico, and Singapore. We are contemplating more FTAs with Pacific countries and Atlantic countries. And while our candidates say they are proponents of free trade, they are also saying these new agreements are not good and Mr Trump says he might want to rip up some of those 20 we already have.

How do we get the benefits of free trade without FTAs? The answer is that that we don’t. Keep in mind that when countries negotiate a new FTA they require each country to do something to improve access to their markets. They might reduce a tariff or eliminate a quota. They might change a regulation that purportedly changes food safety or labels or names of products. There are many ways that countries protect themselves from the benefits of trade. Thus there are many ways to reduce those protections and encourage freer trade.

Our candidates are stepping back from these FTAs and are saying that we opened our economy more than our partners did. And thus our partners got more of the benefits of trade than we did. But keep in mind these points. First and foremost – all parties benefited from freer trade. Second, it is impossible given the diversity among the partners and the multitude of ways trade impacts a nation to insure that each country gets exactly the same benefits. Third, as in my examples above, all countries create losers in the process of opening up trade.

Free trade helps us. FTAs are the best way to keep expanding these benefits. Some politicians will point out the imperfections of these FTAs but any move away from free trade is going to hurt us. If I had my equations with me I could prove this with math.