Inversions and Globalization

I learned how to invert a matrix in college and I have never been the same. Which is one reason that all this political talk about inversions brings back some pretty sweaty moments at Georgia Tech. Some people think corporate inversions show that some American companies are not good citizens. Others use this occasion as a means to discuss corporate taxes and to point out how and why US taxes are too high. Still others shrug their shoulders and admit that inversions are part of a larger process going on and will be with us with or without taxes or flag waving.

What a nice way to start. I now have everyone mad at me!  But the truth is that a larger process called globalization is going on. Globalization has been going on a long time but clearly it took a leap forward after the Cold War melted.  Distance matters when it comes to trading things. If you live here, you trade more with Bloomington's Big Red Liquors than with a similar store in Seattle. But it is also true that when you take a little trip to Indianapolis to visit Aunt Hillary, you might go to Costco – since you don’t have one yet in Bloomington. Why don’t Bloomingtonians drive to Indianapolis every day for their JD if Costco is so good? Answer: the cost of distance. Whether you value your time or gas or wear and tear on your car or the chance of getting into a wreck in Martinsville, the cost of distance makes you buy most things close to home.

What happens if the cost of distance dramatically decreases?? Answer: you widen the size of your market.  The end of the cold war reduced the cost of distance. After the cold war it was safer to travel to more places. As formerly non-capitalist countries entered into global competition and offered lower priced goods it was as if someone had “shortened the road” there. Innovations and technological progress in shipping, communications, and travel also lowered the costs of doing business across continents and countries. Of course reductions in regulations, taxes, and corruption added a recognition of the improved ease and cost of transactions at distance.

Globalization is a word that describes how International trades have mushroomed since around 1990. It isn’t just greedy business people who trade more. Lower distance costs have promoted more tourism. Imagine in 1985 the Chinese being the largest groups of worldwide travelers. Churches cooperate more. International organizations meet and work together more. Governments find it easier to use Skype or Korean Air – to facilitate more frequent meetings.

That’s the backdrop. Globalization has slowed but it continues today.  In macroeconomics we often measure globalization through what are called the Balance of Payments Accounts (BOPA). These accounts measure legal cross-border transactions of an economic nature. If you are awake you noticed the word legal – so we are already admitting these measures are not perfect. But based on a lot of different information sources, nations routinely measure trade in goods, services, dividends, interest, charitable giving, bonds, stocks, bank accounts, real estate, corporate ownership positions, derivatives, and more. This information comes out quarterly. And yes, it often gets revised over time.

Pertinent to the question of inversions is the part of the BOPA called the Financial and Capital Accounts (FCA). FCA measure changes in international transactions that relate to cross-border trades in financial instruments and capital, including acquiring and merging with foreign companies. These trades are summarized in the International Investment Position (IIP). It is the IIP that is relevant to put today’s concern about inversions into perspective. You can find the kind of information I quote below at the Bureau of Economic Analysis (  http://www.bea.gov/international/index.htm#iip ).

Let’s start with one fact. At the end of the first quarter of 2014 foreigners owned US assets worth $29.1 trillion. That’s a lot of Taco Bells. Of course it wasn’t all Taco Bells. Foreigners owned approximately $16 trillion of US bonds and stocks. Add to that $5.7 trillion for enough ownership in US companies to give foreign owners some managerial control. While we are worried about money flowing out of the US please note that between 2012 and 2013, foreigners increased their ownership of US assets by about $2 trillion.

And we reciprocated the interest. By Q1 2014 we owned $23.6 trillion assets abroad, up from $22.5 trillion the year before. You own me. I own you. That’s part of globalization. Furthermore – in the last year you owned even more of us and we owned even more of you.

Some of you accountants are saying, hold on a minute. Who owns more of whom? We calculate the Net IIP by subtracting what foreigners own of us from what we own of them. The result in Q1 2014 was -$5.5 trillion. Foreigners owned $5.5 trillion more of us than we owned of them. Some people interpret this as a bad thing. Note the negative sign. Negative signs are usually interpreted negatively. J  But it sounds pretty cool to me. Foreigners like our US assets. Would you rather be in Argentina where people wouldn’t buy your assets with a ten foot pole?

Anyway, this -$5.5 trillion suggests an imbalance in which we have future financial obligations or debts to pay internationally. That could be viewed negatively but won’t be a problem so long as people believe we can pay those foreign debts. But there is more to it. All this buying of our assets leads to needs for dollars which leads to a robust demand for dollars that makes the value of the dollar higher than it might be otherwise. So this Net IIP isn’t all good. If American companies invested more abroad, it would reduce this imbalance – making us less of an international debtor and perhaps improving our competitiveness.

I know this is getting complicated. And it is. Politicians who call our companies traitors for inversions are doing what politicians always do – making up simple stories to please some of the voters. Don’t be fooled. Companies will continue to react to the cost of distance. Taxes may impact the cost of distance but taxes are only one of many factors. Let companies do what they think is right for their stakeholders and in the end they will do what is right for America. Let's not call them nasty names until they actually break laws. 

Unemployment Whack-A-Mole: Fed Futility?

What goes down must come up?

Let's suppose your friend told you about a great new diet that promised to get your weight back down to normal. Cool, eh. Now let's suppose you talked to a bunch of people who all told you the same thing -- after losing a lot of weight  on this diet they would always regain it again -- and often would end up weighing more than when they began. I would stay away from that diet. The story for the unemployment rate is not too different from this diet. The chart below helps you see the similarity.

The Fed has a dual mandate. In addition to controlling inflation it is also supposed bring about full employment. Since we don't know how to measure full employment this at least means the Fed is trying to reduce the unemployment rate. As long as UN is higher than some pre-ordained amount or so long as labor market conditions do not signal imminent inflation, the Fed stays with its mission to reduce UN.

Listening to the FED one  might think that the goal of low unemployment is something you can shoot for and then attain. Once attained all that work should pay off for a while. While  it is true that reductions can last for a while, what is also true is that once you drive the UN rate too low -- it spits back at you. Just look at the graph below. Notice the sudden upward spikes that quickly undo almost all the good that came before.

• In 1953 UN almost doubled in one year from 2.9% to 5.6%
• In 1958 it jumped from 4.3% to 6.8%
• Between 1969 and 1971 it jumped from 3.5% to 6%
• Between 1979 and 1981 it increased from 5.9% to 7.6%
• Between 1950 and today there were at least nine periods in which the unemployment gradually fell from a high level only to bounce back to an equally  high level. 
• If you draw a trend line through the whole chart it suggests that whatever process was making UN go up and down over time was raising the average unemployment rate in the long-run
• Drawing a trend line after 1980 you get a downward slope or a flat slope. But the minimum unemployment rates are still much higher than in the pre-1970s. 

 Notice that most of the Fed discussions these days revolve around whether or not rising inflation is imminent. So long as inflation is not ever present, the Fed seems confident that its focus on unemployment is without risk. But today's story and chart has said nothing about inflation. Today we are discussing UN and UN. The relevant question is when does Ms. Yellen stop pushing UN down? This chart says it isn't clear exactly when to stop. Before the 1970s if the Fed stopped pushning at 4% or 5% UN, they might have averted a resumption of high UN. But notice how all that changed in the 1970s. In that decade pushing UN below 6% was dangerous. 

With UN at about 6% today, Ms Yellen suggests that we look at other labor indicators as she continues with her hand on the throttle. Sixty years of UN suggests she refocus policy before we find ourselves with another horrible spike in UN -- one that will leave us with few policy tools left to employ. 

The problem we see playing out over and over is not hard to understand. Which is better when cutting down a large dead tree: a chain saw or a hundred unemployed workers with nail files? While the latter seems inefficient but human -- it is not. Unemployed workers want real solutions not temporary band-aids. The labor market can be temporarily satisfied by bursts of money but the real fixes to sustained increases in unemployment have to follow from the real causes of the unemployment problem. What is causing UN to fall so slowly in the USA? Why are people dropping out of the labor force? Why are wages so slow to increase? I doubt any of this has to do with too little money in the economy. Focus on those things and maybe we won't have to suffer another terrible UN spike in 2015. 

Income Inequality and Economic Growth

Dad, can I have some money? Why do you need it honey? Because my friend got hurt and it makes me sad and if I bought a chocolate bar I might feel better. In that case, honey, here’s a five dollar bill. I hope you feel better soon. Come on. That is the dumbest reason ever given for wanting money from Dad and no kid would ever try it. But alas, Alan Blinder is up to his old tricks again and his article amounts to asking for that chocolate bar, “The Supply-Side Case for Government Redistribution,”” Wall Street Journal, August 15, 2014, page A13.

On July 1 I wrote a post Blindly Following Alan Blinder Over a Poverty Cliff. In that case I reviewed Blinder’s desires to expand most social programs aimed at low income persons.  Blinder never bothers with evaluating these programs and just cavalierly advocates expansion. If one billion wasn’t enough then we should try 2 billion.  In this August article Blinder gets more brazen when he concludes that long-run economic growth can and should be expanded if we spend more money on social programs.

Those of you who are not familiar with economic literature or colonoscopies should know that there is nothing written much-less proved or demonstrated about poverty programs causing economic growth. There are reams of articles written about the reverse – the impact of economic growth on poverty – but alas as Alan Blinder was hitting his deadline for the WSJ, he came up with a new and earth-shattering economic truth. If you want to increase economic growth then you should spend more money on programs for the poor.

Many of you will say that it sounds intuitive that helping the poor will create more economic growth. Widely shared economic growth models explain changes in long-term economic growth with several key indicators – labor, capital, and productivity. If turning a poor under-educated and unskilled person into a new and productive worker in the labor force can be accomplished, then the growth model shows how and why poverty programs might lead to stronger economic growth. And the reverse would be true too – rising poverty leading to fewer good workers in the work force would be bad for a country’s economic growth.

But just like needing chocolate to make you happy because your friend fell off her bicycle makes sense at some level, poverty programs simply are not an explanation for economic growth. The proof is in the pudding. Blinder made this whole thing up last week. Please someone show me in a journal or a book or a classroom or on a bathroom wall at an Irish Pub in Itaewon where economists have some sort of evidence to support the relevance of this idea.

There are several ironies here beyond lack of scientific rigor and evidence. First, Blinder says he wants to talk about the Supply-side as a means to promote stronger economic growth. Please pass me more JD. Isn't he among a group of liberal economists who routinely decry and label supply-side policy in the most horrible terms like trickle-down, Trojan Horse, and more? Second, Blinder says in the article about the ethical issue of poor people, “Either side can talk until it’s blue in the face without convincing the other.” Blinder apparently believes that ethics is not going to solve the poverty problem. 

Third, Blinder then goes on to minimize the case for improving national spending.  He argues that most people spend the same. Thus if you take $100 away from a person making $200,000 per year and give it to someone with $20,000 income per year – it would have no net effect on national spending. Thus poverty and income redistribution programs get no support from Blinder for ethics and spending.

And so we are left, according to Blinder, with economic growth. Help the poor more and the economy will grow stronger and faster.  And we better do it fast because we are becoming more unequal all the time. An afterthought of his article is that this inequality is exploding in both economic and political terms. That means we are all going to suffer because this will hurt economic growth even more. This is nonsense. I personally feel better about helping the poor because it is the right thing to do. And as I said in the last post, we do that best by first evaluating the programs we already have. We have 50 years of experience with such programs. An honest evaluation would find strengths and weaknesses. Why can’t we do such an evaluation before adding more fuel to the fire? 

Trade with Africa – More Trade or Foreign Aid?

Last week the President not only met as planned with 50 or more leaders from Africa but he followed it up with a major budget proposal and a press conference. Despite wanting to watch my favorite shows on Fox Business News and the Bourbon Channel, I got the pleasure of our President announcing some new and important initiatives. If you read this blog with one or more eyes open, you know that I love trade. And I even stuck up for the US EX-IM bank because it facilitates more US exports. I love to hear plans to increase US trade – exports, imports, capital and more. So I had to listen to the President.

Meanwhile Russians were putting more troops in position to fight in Ukraine, Christians were being murdered in Iraq, Israelis were fighting in Gaza, and Republicans were doing all sorts of evil in America. So given all the items on the President’s agenda, you have to admit that Africa must be very important to the US for the President to pour out another half-million words on TV.

I decided that I haven’t bored you readers with data in a while and I was curious how the President was going to do really great things empowering Africans to help themselves and to buy a bunch more of our exported goods. To preface this data mining experiment let’s start with a few points. First, we are engaged and have long been engaged with giving foreign aid in Africa and many countries. But this speech and the $33 billion the President wants to send to Africa is not being marketed as more foreign aid. This is all about creating more business for American companies and workers. According to his speech, this is all about trade – not aid. 

Second, if it is about trade, then there ought to be some bang for the buck. A policy to increase US exports (or imports or capital) ought to have some impact. Third, it not only has to have some impact but it also ought to have the best impact. Okay so a policy might increase country A’s purchases of US goods by 49%. But if that 49% increase amounts to a tiny amount of dollar orders for Kentucky bourbon compared to a similar policy in country B, then you might prefer to direct the order to country B since that will generate more US sales, employment and profits. 

What I illustrate below is that President Obama’s new plan for Africa is mostly about more foreign aid. Africa is not a good place to increase US trade. If it is about trade – we would be better off spending that $33 billion elsewhere.

Let’s start with goods and services exports. The US wants Africa to buy more US stuff. In the first six months of 2014, the US exported $804 billion goods and services to the world. Africa bought $19 billion. The whole continent of Africa bought 2.3% of US exports. In contrast this is what other regions bought (in billions):

            

            World                                 $804

   North America                      273

   Europe                                 170

            Pacific Rim                           119

            South/Central America            91

            OPEC                                    39

            Africa                                     19

Egypt and South Africa were the two largest African buyers of US goods and services, buying $3.6 and $3.1 billion respectively. If we doubled exports to those countries it wouldn’t amount to a hill of beans to US workers operating in a $15 trillion dollar economy producing a couple trillion dollars in exports each year. 

The US Bureau of Economic Analysis (BEA.gov) also publishes direct investment data by country destination. Direct investment (plant, equipment, etc)  by US companies in the world in 2013 amounted to $4.7 trillion. That’s how much “capital” our companies owned abroad. That ownership increased by about 25% between 2010 and 2013. Below are comparison figures that put US business investment in Africa in a global perspective. First is the amount for 2013 in trillions of dollars and in parentheses is the percent change between 2010 and 2013:

            Europe                     $2.607   (28%)

            Asia Pacific                 .695  (22%)

            Islands  W. Hemis        .601   (16%)

            Canada                        .358   (25%)

            S. America                  .169   (23%)

            C. America                  .113   (15%)

            Africa                          .060   (  9%)

            Middle East                 .045   (32%)

           

When it comes to US business investments across the globe, Africa has not been a major destination. It stands out on this table for two reasons – the small amount and the very low growth rate of 9% in three years. One has to ask a question when seeing this – why haven’t companies been more interested in Africa and what is it about the President’s new program that will change those reasons substantially?

 The answer is pretty simple. By and large, African countries are dictatorships that score high in corruption and low on income. Not all African countries are the same. But spend an hour Googling lists of countries by corruption, or income per capita, or percent of people below the poverty line – and African countries are always well represented. A richer country like Egypt can be used as an example. According to the World Bank, Egypt’s income per capita is about $11,000 (South Africa was listed at about $13,000). Cubans make $19,000 and Puerto Ricans earn $35,000. Germans collect about $43,000 per year. With respect to people living in poverty, Nigeria had about 55% of the population labelled as poor. Egypt and S. Africa were more like 23-25%.  Naturally the same countries scored high on indexes of corruption.

Tourists love the diversity of colors and cultures in Africa. But such diversity is not great for US companies who want to penetrate new markets. In Africa there are 54 countries. It is believed that Nigeria alone has more than 500 languages/dialects. Our President says he wants to create more trade across the continent. But diversity in South America should be a caution to what can be expected in Africa. While South American companies have become more global in recent years they have not done it by trading with each other. Often they are more trade-loyal to their colonial pasts than to their regional presents.

The President cited many statistics that show that some Africa countries are growing and could become better trade partners. But let’s be honest – growing from a low base is one thing. Large enough to matter is another. Either call that $33 billion foreign aid and try to give it in ways that will reward and promote less corruption and more democracy and enterprise – or call it trade promotion and give it somewhere that is more apt to bring a strong return in US trade and employment. The last I checked we still have a huge national debt, a slowly growing economy,  and little room to employ precious national  resources inefficiently. 

Monetary Fables and Sand Traps

It is said so many times now it is almost a mantra – Then Fed engineered a recovery for Wall Street, leaving Main Street and most of us to suffer or at least languish. The intuition is easy. Think of Ms. Yellen in a helicopter spewing hundred dollar bills over banks that collect them in giant bins and then hide them in big vaults away from public view. What money does leak out of the banks goes to purchase bonds and stocks and sustains a financial bubble or at least a rally. Fed behavior also keeps interest rates limbo low and cause reallocations of portfolios away from money and into more risky bonds and stocks with higher promised returns. Firms are not allowed to borrow and expand and therefore employment does not increase and both consumer and business spending remain in the doldrums.

I would be surprised if this story has not already made its way into Dr. Seuss or other children’s books.   It has appealing though contradictory themes. The big bad Fed is a lackey of the right wing helping to keep the upper 1% as rich as possible while regular folks suffer. Alternatively the Fed is a willing compatriot of the liberal left, but alas needs to do even more to complete the task. The Fed pumps money into the economy willy nilly praying each evening to Paul Krugman that money will work wonders for Main Street. Surely if the Fed continues on this course and pumps in ENOUGH money, the economy will be saved. Imagine Paul Krugman in tights with a large S on his chest.

Neither of these stories is correct. 

Let’s take the first one. The first one is based on the idea that when the Fed injects money into the system it somehow prefers the filthy lucre to end up in risky financial markets instead of supporting loans that expand the economy.  This one is pretty silly. I don’t know of one money and banking book that suggests any reasons why the Fed would want the rich to get richer at the expense of the rest of us. Historically it is hard to find times when the intention of a loose monetary policy was to avoid real loans and pump up stock markets.

As for the second story, it is true that there is a lot of hope and faith when it comes to money’s magical impacts on employment and output. But this current episode goes beyond hope and even Paul Krugman seems to have lost his tights. Historical amounts of money have been pumped into the US economy and rates have been kept at zero levels for a long time. Yet, the economy stalls. John M Keynes, the great one, recognized the limits of money when he cleverly invented the so-called liquidity trap. Modern Keynesians agreed a long time ago that once a country enters the trap it is like a monetary Bermuda Triangle in which everything gets sucked onto a giant hole never to be seen again. Money can approach savior status but not when expectations are tender. It makes no sense to keep pouring money into this economy and it makes no sense for money to pull us out of slow growth. This is what Keynes and his band of merry Keynesians said to Maid Marian and Friar Tuck.

Most textbooks and Fed statements suggest some very clear avenues about money. The money mechanism is simple but it is full of traps. Here is the usual story.

·        The Fed sends a check to a bondholder in exchange for his bond. Bond interest rates fall.

·        The check is deposited in his bank.

·        Banks have more money and do not need to borrow to raise funds and the Federal Funds Rate (FFR) falls.

·        Since the FFR is a cost of funds, this causes other interest rates to fall.  

·        Households and firms hop on the first bus to their banks to borrow money.

·        With these low-priced loans consumers buy durable goods and firms buy capital goods.

·        All this spending causes firms to hire more workers and expand output.

·        Christmas comes early.

If the above sounds like a fairy tale to you it is because you have learned about the traps – all the things that could go wrong so that none of the above actually happens on your planet. So here is a brief list of these traps:

·        Liquidity Trap: Bondholders are more than happy to sell their bonds to the Fed so bond returns do not fall much.

·        Deposit Trap: Worried about banks, investors do not deposit checks in the banks. Money might leak out directly to shadow banks or financial investments.

·        Loan Trap: either banks do not trust borrowers or borrowers are too indebted to even ask, so loans do not increase.

·        Spending Trap: No loans, no spending.

·        Employment Trap: even if households and firms do begin to want more goods and services, firms may be pessimistic about the future and not want to make permanent increases in employment or output.

·        Uncertainty Trap: so long as policymakers keep trying to make things better – and they don’t get better – firms and households become even more uncertain and conservative in their decisions.

·        Left tackle Trap: when the left tackle feigns a missed block and the defender comes rushing in for glory and finds that the left guard is there to smash him to the ground.

My first point is that the Fed need not be a lackey of the left or the right if it somehow misread a golf course full of traps. Why do so many golfers end up in sand traps? Because they know they need to take risks to come from behind. They need a low score and at the moment they are way behind the leaders. With unemployment at 10% and a mandate to reduce it, the Fed chose a risky path that ended up with us in a lot of traps. Because the recession was not your run-of-the-mill downturn, the Fed did not anticipate a lot of the traps. Once in the traps we lose. You would think that recognition of such mistakes would be influential but this risky behavior carries on even today. The Fed remains unwilling to reverse its risky policy.

Which brings us to my last point before I sit down to a large bowl of JD. Yes, I know I forgot to mention JD in my last post and I got several angry letters from JD Distilleries worldwide. My last point is all this concern on the part of the Fed that without their continued hose full of money pouring on the economy, interest rates are going to rise to the stratosphere and the economy will come crumbling down. What gall. Does the Fed really have all that control over the economy? No and for several reasons.

First, all those traps listed above suggest the Fed often has little control. Second, there are huge money and financial markets out there that determine asset prices and rates in the USA and globally. If participants in those markets think rates are going to rise in the future, then they will make trades that push the rates up today. There is little to nothing the Fed can do to offset a major change in market psychology. Think of the little Dutch kid with his finger in the dyke. His T-shirt reads "I am the Fed."  In Dutch, of course. 

Finally why would the psychology change to make participants more certain that rates are going to rise? For one thing, the US economy is gathering steam. Among the many positive indicators was the recent announcement that labor costs are rising. All that money outstanding will eventually have to go somewhere. Some of the above traps will disappear – banks will make more loans, firms will replace decaying equipment, and households will buy more cars and JD. Firms will hire more workers. Prices might be under control, but there is no way for them to go except up. The best guess is for higher inflation and that too will drive up interest rates. This is not magic. This is what usually happens during an economic expansion. Rates return to normal with or without the Fed's love or encouragement. 

The Fed knows rates are going to rise and it can’t do a thing about it. It should give up this silly game of hubris and just back away. Pull that money out before it causes a fire! The longer the Fed waits, the more the negative backwash. Get on with it. The markets are ready for a return to normalcy. And I am ready for that JD. 

Corporate Inversions, Profits and Taxes

How many of you vote yes for inversions? What? What the hell is an inversion? I looked at Wikipedia and found that inversions occur in music, arts, natural sciences, mathematics, and just about everything. Typically it means you have turned things backwards or stood things on their heads. For example, the air nearest to the earth’s surface is warmer because solar radiation warms the earth’s surface. In a temperature inversion the air gets warmer, instead, at higher levels. When temperature inversions occur we get a lot of awful things like smog entrapment and freezing rain.

As such it seems almost obvious that the President would want to halt business inversions going on today. In a business inversion a successful domestic company decides it wants to move its headquarters to a foreign country. Imagine if GM decided it wanted to move its headquarters to Cuba! Now that would be an inversion! One way to conduct an inversion is to merge or be acquired by a foreign company. Suppose Toyota bought GM. In that case GM’s productive and other activities would continue in America – but GM America would become a subsidiary of a Japanese company.

Why would a US company do such a thing? According to the President the reason is taxes. Where a company like GM pays its taxes is an important issue. Many American companies are global and increasingly so. This means they have international activities all over the world. Important for the inversion issue is where they sell their goods. If GM sells cars in Hungary – then the sales revenue flows directly to a GM subsidiary in Hungary. The subsidiary is technically a Hungarian company because the Hungarian government licenses it to do business within Hungarian borders – but it is run by GM.

So American companies have sales in many different countries. The sales revenue goes to pay for business costs. Typically the American companies will report and pay profits taxes in those countries. If there is anything remaining after all that the rest of the revenue flows back to America. When and if it flows back, it is taxed again by the USA. According to an Economist Magazine article (http://www.economist.com/news/leaders/21608751-restricting-companies-moving-abroad-no-substitute-corporate-tax-reform-how-stop ) , the US is the only large rich country to tax these repatriated earnings. And since the US has the highest corporate tax rates of most major countries, US companies feel put upon and dislike the extra taxes they have to pay. An inversion, accordingly, feels good to these companies. Becoming a foreign company means they no longer have to pay the extra taxes. According to the article, most large countries have gone to a territorial tax system and few pay double taxes as in the USA.

Please notice one thing that is often not said or written adequately in inversion discussions. This has nothing to do with corporate taxes paid or earned on sales within the USA. With or without an inversion, US sales and operations will be taxed as usual. Inversions only have to do with repatriations of the already-taxed profits in other countries.

Still, the President and others do not want to reverse these tax laws. They want US companies to pay significant tax rates on repatriated earning despite being taxed once already in other countries. Instead they prefer to introduce new and more stringent regulations on how and where US companies can merge or be acquired by other companies. Interesting is the signal sent by these new regulations. The US government proposes to allow inversions in cases where real managerial control is NOT kept by the US company. That is, if the foreign merger results in the US company losing control to a larger foreign entity over its decisions, then that is okay. Talk about perverse! This is a true inversion in logic. Okay US company – we do not want you to control your operations. Let’s let the foreign company really take you over. All that risk is incurred so that the government gets a little more from the repatriated foreign earnings. Wow – now that is really backward and dangerous. You put at risk ALL the earnings and taxes of the US companies for the sake of chicken feed.

One more thing. Most mergers and acquisitions are notoriously difficult, complicated, and uncertain endeavors for large corporations. Most of them fail. Companies spend huge sums of money trying to predict the many impacts of corporate marriages. Just like in human marriages much is unknown about your partner in a corporate marriage. Despite sometimes spending billions most of these corporate marriages fail. It is not reasonable to conclude that any of the high profile large company inversions causing the President’s concern were solely done to reduce US taxes. Taxes might matter, yes, but the overwhelming reasons for inversions are for strategic reasons.

And why not for strategic reasons? It is no secret that business is increasingly global. As the President acknowledges, he would love to increase US export sales. This is because few serious companies can be profitable without taking advantage of a huge world marketplace. He wants to find ways to encourage US companies to seek out and successfully enter these international markets. He wants to do this because more profitable US companies hire more workers, pay better wages, give more to charity, and more. So why does he say he wants to motivate more exports one day and then the next day penalize the profits of these same companies with an extraordinary corporate tax system?

I vote for inversions. If the President wants more tax revenues, let him try another way that doesn’t damage the competitiveness of US companies and US exports in general. Focusing on tax loopholes and tax reform might be a place to get started. 

Exports Are Cool but Geographically Challenged

Exports are cool. Not cool enough to be in the lyrics of any rock song I know of but definitely cool enough that President Obama declared in 2010 his goal was to double USA exports to the world. I wrote about that in this blog space a while ago. It looks even less doable now than it did a while ago. So here I go again! I have some new data that shines a light on why it is next to impossible to make large gains in exports now.

It also suggests that attacking the EX-IM bank right now would be highly counter-productive. 

Before I get to that data it helps to see why the President and others think exports are so cool.  An export exists when a business firm on US soil produces a good or service and sells it to someone living outside of US soil. These people might be Canadians buying auto parts from Kokomo Indiana, Mexicans buying industrial equipment from Columbus Indiana, or UK citizens purchasing an Amtrak ticket that will take them from Indianapolis’ Union Station to the Grand Canyon.  You might say that such sales amount to the same thing as when the buyer lives on US soil – but you would be only partially right.

The important difference is the impact that exports have on our national ability to grow. USA buyer purchases are ultimately limited by what they earn. Let’s suppose you can earn $100 and you spend locally $80. The rest goes into saving or to goods and services produced abroad.  From time to time you can spend more than $80 but it can't last. The “equilibrium” spending for income of $100 is $80.  Now let’s imagine that a foreigner decides to buy from us and we are able to hire more people to produce these extra goods and services. The foreigner, therefore, expands how much our nation produces and how much income we earn.

So long as foreigners want our goods and services, this export sale permanently increases national output beyond what our own citizens earn. It raises our incomes as well. The increased income means we can buy more domestic and foreign goods. This is what is so cool about exports.

Trace the steps…more exports…more output…more income…more domestic spending…even more output.

If a country like Germany or Japan or the USA is able to win the global competition for goods and services, it can use this ongoing competitiveness as a way of permanently increasing its output and economic growth.  If you are still reading and are somewhat awake you might say something like – hold on fella. Whoa Nellie. Won’t other less competitive countries get a little irritated and make unhappy noises? The answer is yes. We have a term “beggar they neighbor” to characterize countries like China who are notorious for playing the export game. But the truth is that while the others feel jilted they can always reduce the unwanted impacts by raising the competitiveness of their own products and services. And while China is well-known for using exports for growth, there are many countries that use this strategy to a lesser degree and therefore are not as notorious. The game goes on.

So exports are cool and we in the USA would like to beggar our neighbors. But the data have not been kind to the President’s goals for expansion. Notice that before the recession hit, US exports were exploding. Between 2003 and 2008 USA exports of goods and services in current dollars increased by 81%. In the five years after the recession started, from 2008 to 2013, exports increased by only 24%. That is quite a slowdown. While it is true that exports declined in 2009, they have increased in every other year and totaled $2.28 trillion in 2013. They have, however, been growing slowly.

If your horse is running too slowly you give it more JD. Right? Or you do something to speed it up. In past blogs I have pooh poohed efforts to reduce the value of the dollar among other policy remedies. In this blog my focus is geography. Before you come up with a solution for exports it might be a good idea to see which countries are buying more or less from the USA. Luckily the Bureau of Economic Analysis has data on USA exports by country destination.

It might surprise you but Canada and Mexico are the largest purchasers of US products. Apparently closeness counts when it comes to kissing and international trade. In the table below I list some key export destinations – countries and world regions. The table order is in terms of how much each destination bought from the USA in 2008 (because I inter-mix countries with regions the totals do not add).

The table below has three columns. The first column tells you export sales from the USA in 2008. The second tells you the percentage change in exports for two different time periods: between 2008 and 2013/ and 2003 to 2008. The final column tells you how much higher USA exports would have been “if” they had grown at the rate from 2003 to 2008. It shows you how much dollar exports we lost because of the slowdown in the past five years.

Some takeaways from the table:

·       

The 28 countries of the European Union accounted for the largest share of US exports in 2008. After growing by 86% between 2003 and 2008, the EU barely increased its purchases from the USA in the next five years.

·        You can understand the overall EU changes by looking down the table at the UK and Germany. Those countries were buying less USA goods and services in 2013 than they bought in 2008. That performance came after very strong increases in the previous five years of 67% and 81% respectively.

·        Nafta partners, Canada and Mexico, were the largest country destinations of USA goods and services in 2008. They bought more from the USA in the time period from 2008 to 2013, but the decline in growth was much less pronounced than for Europe. Similarly S. Korea and the Newly Industrialized Countries (NICs) slowed in their USA purchases but had relatively strong rates.

·        OPEC and China had the fastest purchases from the USA in 2003 to 2008, 153% and 233% respectively. During the next five years OPEC’s purchases of USA goods and services fell off dramatically while China’s continued growing at 84%.

·        Japan had the slowest growth of USA purchases in first five year period (31%) which fell to growth of only 6% in the last five years.

·        The final column shows what the USA lost because of these slower growth rates of exports. For example, if USA exports to these regions or countries had maintained the pace from 2003 to 2008, exports to the EU and NAFTA between 2008 and 2013 would have been much higher: $404 billion and $129 billion higher, respectively.

Between 2008 and 2013 total USA exports of goods and services to the world rose by about $440 billion. This table shows that a repeat of the growth during 2003 to 2008 would have added another $434 billion just from the EU and NAFTA in 2008 to 2013.

USA Export growth fell during the global recession but then grew slowly thereafter. While we might want to discuss national competitiveness or the overall value of the dollar or unfair trade practices – this little exercise today says that our export challenge is very much geographically oriented. Europe struggles with post crisis economic growth. OPEC is trying to adapt to new competition. Other countries, including S. Korea and China are not growing like they used to. Japan languishes.

This little exercise suggests that raising US exports will be neither easy nor global. It won’t be easy because most of our main trading partners continue to be weak. It will not be easy or global because the problems or issues in each country are not the same. Mexico is not Germany and Canada is not the UK. Discussions about the US EX-IM bank suggest old-style thinking. Europe has demonstrated its importance to US exports – but without some US financial assistance to EU buyers of USA products, it is hard to see why or how they can afford to buy even what they are buying now. We won’t double USA exports in the near future but our policies should realistically address a country/regional set of issues.

          Table. USA Export Destination

                      2008           %

                    Exports      Chg*    Higher?

        Billions                     billions

EU                   471          1/86          404

Canada            308        19/56           114

Mexico            178        44/53             15

NICs               147        34/56             32

UK                  114         -5/67             81

Japan               107          6/31             27

OPEC               92        22/233          192

China                87        84/153            59

Germany           83         -9/81              75

S. Korea           50        28/57               15

Brazil                45        56/183             56

% Chg column has two numbers. Both are percentage 

changes over a five year period. The first is from 

2008 to 2013. The second is from 2003 to 2008. 

Five Years of Chuggin' Along by Guest Blogger Buck Klemkosky

Buck was a finance professor at the Kelley School and the founding dean of SKK Graduate School of Business in Seoul. He is now affiliated with Wallington Asset Management. see http://wallingtonasset.com/robertklemkosky.html

The U.S. has experienced 11 recessions since the end of WWII and the most recent one has been the most severe. The Great Recession started in December 2007 and ended in June 2009 as determined by the National Bureau of Economic Research, an independent group of economists that has officially called the beginning and end of business cycles since the 1920s. So June 2014 marks the fifth anniversary of the end of the Great Recession.

What is the prognosis of the economic recovery thus far? Not good. It has been the slowest recovery in terms of economic growth than any other; it’s been more like a long, slow slog with growth averaging 2 percent annually over the 20 quarters. The first quarter of 2011 and 2014 even experienced negative growth although the latter may be due somewhat to the harsh winter. Economic growth in normal recoveries averages 4 to 5 percent annually. U.S. gross domestic product (GDP), the final value of all goods and services produced, did not recover from the 2007 peak until the third quarter of 2011 and it wasn’t until the second quarter of 2013 that GDP per capita surpassed the earlier peak. This is because there are 15 million more working-age people in the U.S. today than in the pre-financial crisis era. So technically, the economy has passed from recovery to an expansionary phase.

Why the slow recovery? Unlike the other 10 recessions since WWII, the Great Recession was caused by a financial crisis which in turn was caused by too much household debt (mostly mortgage) and an overleveraged financial system. Basically the U.S. experienced a credit bubble which imploded and caused the Great Recession. Evidence by Reinhart and Rogoff in This Time It’s Different: 800 Years of Financial Crises shows that recoveries from recessions caused by a financial crisis are weaker and take longer than from the normal cyclical recession. Debt has to be pared down and balance sheets strengthened before a return to normal growth. So the pace and length of the recovery was predictable.

Deleveraging since the Great Recession has occurred in households, mostly in the form of less mortgage debt, which fell from 73 percent of GDP in 2008 to 55 percent today. U.S. financial sector debt fell from 118 percent of GDP in 2008 to 82 percent today. Conversely, the federal government has levered up with debt rising from 72 percent of GDP in 2008 to 102 percent today. The government debt includes public as well as debt held by government agencies such as Social Security. The debt of non-financial corporations and state and local governments and consumer credit has been relatively stable relative to GDP, so overall the total U.S. debt-to-GDP ratio has fallen from 409 percent of GDP in 2008 to 392 percent today.

So what does the five-year recovery mean for American households? On average it has made them wealthier than ever. The aggregate wealth of U.S. households, including stocks, bonds, cash, real estate and other assets, hit an all-time high of $81.8 trillion in the first quarter of 2014, up $26 trillion since the low point in 2009. Most of this has been due to the stock market, where the S&P 500 has risen nearly 200 percent from its low of 667 in March 2009 to an all-time high recently of 1963. Housing prices have also rebounded; after falling 33 percent from 2007 to 2010, prices have rebounded 19 percent, still leaving house prices 20 percent below their peak.

So for owners of stocks, bonds and homes, balance sheets have been repaired and some households are now wealthier. The burden of household debt also has fallen as the debt-service cost (principal and interest) has fallen from more than 13 percent of after-tax disposal income to below 10 percent today. However, about half of American households do not own stocks and more than one-third don’t own homes. For many it doesn’t’ feel like a recovery has occurred.

While household wealth has more than recovered, the news for jobs and income hasn’t been as rosy. A key milestone was reached in May 2014 when U.S. payrolls surpassed the peak number employed in 2008. In other words, more jobs have been created in the recovery than lost during the recession. It took two years to wipe out 8.7 million American jobs, but more than four years to recover than all, making this the longest job recovery of any recession since WWII. Even though the unemployment rate has fallen from 10 percent in 2010 to 6.3 percent in May 2014, a look behind the jobs numbers shows that many of the jobs recovered are not necessarily the same ones lost. For example, over 3 million net jobs have been added in the healthcare, hospitality and food service areas, while over 3 million jobs have been lost in construction and manufacturing. The former are low-paying jobs and the latter higher paying jobs. 

Almost another 1 million higher-paying jobs in finance and government have been lost, and many of the new jobs created have been part-time. Also, the long-term joblessness rate is stubbornly and historically high at over a third of the unemployed. And the jobs recovery changes by region as energy states like North Dakota and Texas have done well and housing bubble states like Nevada and Arizona not so well.

While the jobs recovery has lagged normal recoveries, as expected wages also remain subdued; they have increased at about the same rate as economic growth. One constraint on wage growth has been slow growth in labor productivity, which has increased at about 1 percent annually in recent years. Even the middle class is feeling the pinch; median household income has fallen from a peak of $56,080 to $51,017 in 2013. Although improved since the recession years, subdued wages and less job security don’t bode well for consumer confidence, and why many don’t feel like an economic recovery has occurred.

Where does the economy go from here? Hopefully, because the economic recovery has been so weak, the economic expansion will prove to be more resilient than typical. At 60 months, this economic recovery and expansion is already the sixth longest since WWII. Another 13 months and it will match the 2001-2007 expansion, which included the housing boom. It has a long way to go to match the 1991-2001 tech expansion boom. But there are reasons to be optimistic: household budgets and balance sheets are in better shape, the financial system is stronger, Europe is coming out of its recession, fiscal and monetary policies are normalizing, inflation and inflationary expectations appear under control, and interest rates remain at historic lows. The best scenario is that the economy keeps on chuggin’ along but at a little better pace than the 2 percent average growth over the last five years. The economy needs more real income and wage growth to sustain the current economic expansion.

Defense and Climate Change: The Value of Waiting

Economists have models and explanations for anything and everything. Relevant to today’s top issues is the value of waiting. I am sure that many women wish they didn’t have to wait nine months to deliver but they know that trying to have a baby at the end of the third month would not have acceptable results. An economist would say something stupid like – the marginal costs of waiting one less month is greater than the marginal benefit and therefore waiting has value. In the case of pregnancy, most of us wait about nine months. Of course we wouldn’t want to wait 18 months because we know the marginal costs of waiting more would outweigh the benefits.

Maybe you don’t love my example, but we face the costs/benefits of waiting all the time. Should I wait at this red traffic signal for another minute? The young guy with slicked back hair wonders how many more songs to sit through before he asks the babe in the pink hot pants to dance. If our wait is too short, we may experience the costs of a hasty decision. Wait too long and the opportunity escapes.

This issue of waiting came to mind as I was playing with my new Nespresso machine and thinking about climate change and national defense. ( I can't drink JD all the time!) With respect to climate change we have one group of people who deem it urgent. These people advocate full speed ahead when it comes to ending reliance on coal and investing in new non-renewable sources of energy. To the climate change advocates, waiting is not a luxury we can afford. With respect to very recent changes in global terrorism and American security there are some people who also think that waiting is not a viable option. To them terrorism is on our global doorstep and needs to be addressed firmly and immediately.

The value of waiting is being evaluated seriously by climatologists and defense planners. Sadly much of the resolution to these waiting issues is ideological. Many of those who would put climate change in a speedboat are the same folks who would see no rush to deal aggressively with terrorism.  And, of course, vice versa many who favor a rapid response by the US military are those who would drag their feet on climate change. This ideological approach needs to be replaced by something more sensible.

The value of waiting is affected by the expected costs and benefits of waiting. I say “expected” because these impacts are not known and will play themselves out in the future. That means several things. First, except for your spouse, no one knows the future with certainty. Second, that means we have to use models or somehow guess about the future. Third, it means we will have plenty to argue about since no one knows the future. Fourth, the less ideology and emotions play into this valuable exercise, the better off we will be.

But we are a long way from that situation. My bearded long-hair friends say that America has suffered enough. We have no stomach left for a fight. As in the recently cited report by former Treasury Secretary Hank Paulson, these groovy dudes are sure that the costs of global warming are ever-present, immediate, and catastrophic. That’s it. Story over. For every person with those beliefs there is one who thinks that if we wait too long to weaken a growing terrorist threat, we will surely be overrun by vicious enemies who will show us no mercy. These khacki-wearing, button-downed,  crew-cuts see the immediate employment and growth impacts of vigorous environmental policies as swamping any possible future benefits.

Okay my depictions of extreme lefties and righties are pretty stupid but the point is not. We are getting nowhere and perhaps risking our future because we are letting extreme views prevent us from hard-headed analysis about our most important policies. Consider that we have four possible SOLUTIONS, two of which hardly ever get considered:

·        Conservative  Defense Fast; Environment Slow

·        Liberal           Defense Slow; Environment Fast

·        Expensive      Defense Fast; Environment Fast

·     Cataclysmic    Defense Slow; Environment Slow

To decide on one of these or perhaps some combination of these solutions means we have to do the work. We might not know the future but perhaps we can throw away the knives and swords and make use of our best experts. What do we need to know?

·        If we wait on defense, what can we expect from terrorism? What is the most likely outcome? What is the very worst that can happen? How likely is that?

·        If we wait on climate change policy, what can we expect in the way of negative impacts? What is the most likely outcome? How likely is that? 

·        If we move quickly on defense, how much will that cost? What benefits will be gained? Can these policies really accomplish their goals? If the US acts alone, can these policies really accomplish their goals?

·        If we move quickly on climate change, how much will that cost? What benefits will be gained? Can these policies really accomplish their goals? If the US acts alone, can these policies really accomplish their goals?

I know that I am unrealistic to think that our present government representatives can shed their blue and red uniforms to do something sensible for the good of the country. But without a real assessment of these questions I don’t trust either party to do the right things. As in my last post about poverty, I come off sounding naïve in the real world for suggesting that real problems have real solutions. Isn’t everything simply political and ideological? Maybe that’s true. But if people don’t demand better processes and outcomes, then it seems to me there is no way to ever get them. So I continue to spout off even if it amounts to urinating into the wind. 

Blindly Following Alan Blinder Over a Poverty Cliff

Alan Blinder wrote about income inequality in the Wall Street Journal last week ( Pikettymania and Inequality in the U.S., June 23, 2014, pA13).  The article regurgitates a lot of well-known facts that support the idea that income inequality has grown. But the article is also the poster child for what is missing in our discussions about cause, effect, and policy. Following Blinder’s hasty policy recommendations will likely make things worse and that is what I am spouting off about today.

Blinder starts with the recent work by Thomas Piketty – giving him credit for focusing on the impact on income distribution made by the richest Americans. He agrees with Piketty that among the solutions for correcting income inequality is to make the rich pay more. But Blinder thinks Piketty does not spend enough energy on the bottom half of the income distribution and therefore misses some important other policies that Blinder advocates – “giving poor children preschool education, bolstering Medicaid, raising the minimum wage, expanding the Earned Income Tax Credit, and defending anti-poverty programs like food stamps.”

It would take a cold heart to argue with Blinder. Most of us boomers supported the programs that Blinder lists. We give to our local charities and we pay taxes to support these programs. But what I find to be so irritating about Blinder is his boldness. Nowhere does he admit that there might be even the tiniest problem with any of these approaches that might make a society of people who truly care about poverty want to evaluate the effectiveness of these programs for the ends we value so much.

Notice the words that Blinder chooses in his list above – giving, bolstering, raising, expanding, and defending. These are his words – not mine. Is it abundantly clear that all these programs are perfect and simply need to be expanded and defended? Even if he wants to tax only the rich to pay $2 trillion or more for these programs – it seems fair to want to ask if this $2 trillion is getting the job done.

You and I are bound by budgets and logic when it comes to our own expenditures. When a merchant wants to charge us more for a good or service we get to work. Is the good worth the extra money? Is there a better way to get the benefits of this service? Is there a different provider who can do a better job? Whether it is getting our lawn mowed, buying a health insurance policy, or purchasing the best 10 year old bourbon, most of us try to get the best results with the least amount of outlay.

But Blinder doesn’t think that way. Nowhere in his article is one word devoted to the effectiveness of these programs. Nowhere does he ponder if $2 trillion of our dollars could be used more effectively to eliminate poverty. Nowhere does he even mention how these programs attack systemic or even cyclical causes of poverty.

I know, some of you think that just raising these issues is a smoke screen. A letter published in my local paper recently described Republicans and other fiscal conservatives as greedy, hateful, mean-spirited people who basically hate the poor. I doubt that most people agree with that but that extreme opinion is clearly out there and it makes it easy for some people to love Blinder and to hate anything that interferes with liberal, progressive doctrines.

But let’s face it – Blinder wouldn’t be writing if it weren’t for at least blemishes in these programs. Like Oliver, Blinder wants MORE. In the case of Oliver he wanted more gruel because he was hungry. Blinder wants more money thrown at social programs. But Blinder offers no connection between his policies and the root causes of poverty. He asks us to trust him. The reason policies have not worked in the past is because they weren’t big enough. So let’s add more money. After 50+ years of a Great Society and a War on Poverty with ever more poor people, I’d like to see a little more time and energy devoted to how to best fix these problems.

But that would take time, effort, and an open mind. I am wondering what Professor Blinder thinks about that?