Are Wage Gains Ready to Skyrocket?

Most people take for granted that wages have shown lackluster growth over the last 20 years or so. So I put my data cap on and starting looking at numbers. My first takeaway is that there are way too many numbers. We might want to know how wages have kept up with productivity. That seems reasonable. But then one needs to find companion series for wages and productivity, so we can compare apples with apples. That can be done but do we want to compare these series for all workers? For all manufacturing workers? For medium-income workers? Over how many decades?

Another comparison of wages could focus instead on how wages changed compared to prices – that is, did wages keep up with inflation? Again, there are many indicators from which to choose – various measures of wages and even more measures of inflation. To makes matters even more challenging – some of the series go back to 1929 while others just got started in 2006.

What I am saying here if it isn’t obvious is that it is time for a nice cold JD. It is also time to make some decisions. No matter which choice I make some of you will want to scold me. But I made a decision anyway. I decided to focus on the years from 1968 to 2017. Going back to 1968 means we have a rich enough data set so that we can put today’s low inflation numbers in perspective with past times when US inflation was higher. I also decided to use the CPI as my inflation variable. Earnings of Production and Nonsupervisory Workers in the Business Sector is my measure of wages.

What I examined is how earnings kept up with inflation during the past half-century. To do this I calculated three times series –  % change in earnings (Edot), % change in prices (Pdot), and % change in the buying power of the earnings (calculated as the first series minus the second one (Edot minus Pdot)). For example, in 1970 the % change of earnings was 6.1%. Prices rose by 5.6%. Therefore the buying power of the earnings rose by 0.5% (6.1-5.6) in 1970. 1970 is an example of a year when earnings did quite well. The wage increase of these production and nonsupervisory workers was larger than the increase in the cost of living.

As I look down my table (below) I notice there are lots of years when the buying power of earnings was positive while there were also years when workers did not keep up with inflation (buying power of earnings was negative). When the buying power of earnings was negative – it meant that workers were getting behind – and that they might at some point want to catch up. 

The earnings buying power went down considerably from 1973 to 1975 and then again from 1978 to 1981. In those years inflation was hitting double digits and despite some good years of earnings growth – these earnings just couldn’t keep up with inflation. In 1980 earnings rose by almost 9% but since inflation was 12.5% workers fell behind. And strangely enough, it was not until 1995, after the inflation rate had fallen considerably that earnings began rising faster than inflation. The years 1995 to 2002 were catch-up years. During those years earnings rose a total of about 10 points more than inflation.   

Between 2003 and 2012 there was no real pattern. But then between 2013 and 2017 there was a very clear pattern – and brace yourself for this – wherein inflation  generally stayed below 2% per year – wages of production and non-supervisory workers were rising by about 2.4% per year. Thus, earnings were catching up as the buying power of earnings increased. 

There are lots of ways to go from this point. But let’s not forget one thing. While workers always want higher wages – the thrust for higher wages is often driven by how far wages stretch to buy goods and services. This data suggests that while there have been times when the buying power of the wages declined (in the 1970s and then from the mid-80s to the mid-90s) – the last 15 years cannot be classified as a time when inflation robbed workers of their buying power. Especially the last 15 years show just the opposite. Workers might not love the size of their wage increases – but these increases have been well above the inflation rate. And therefore, there is no clear pent-up explosion of wage increases looming around the corner.

As I said above, there are lots of ways to go from here. I am not saying that all workers are just fine. I am not saying there are no labor market issues to deal with. What I am saying is that the rate of growth of earnings compared to the cost of living is important for understanding future wage and price growth. The earnings of production and nonsupervisory workers in the USA might not be growing rapidly but they have, of late, been growing faster than the cost of living. That needs to be factored into our forecasts for the future. 

Table

	Earnings			CPI						Edot -
Year	Dec			Dec		Edot		Pdot		Pdot
1968		3.11	35.5
1969		3.30	37.7		6.1		6.2		-0.1
1970		3.50	39.8		6.1		5.6		0.5
1971		3.73	41.1		6.6		3.3		3.3
1972		4.01	42.5		7.5		3.4		4.1
1973		4.25	46.2		6.0		8.7		-2.7
1974		4.61	51.9		8.5		12.3		-3.9
1975		4.87	55.5		5.6		6.9		-1.3
1976		5.23	58.2		7.4		4.9		2.5
1977		5.61	62.1		7.3		6.7		0.6
1978		6.10	67.7		8.7		9.0		-0.3
1979		6.57	76.7		7.7		13.3		-5.6
1980		7.13	86.3		8.5		12.5		-4.0
1981		7.64	94.0		7.2		8.9		-1.8
1982		8.02	97.6		5.0		3.8		1.1
1983		8.33	101.3		3.9		3.8		0.1
1984		8.61	105.3		3.4		3.9		-0.6
1985		8.87	109.3		3.0		3.8		-0.8
1986		9.01	110.5		1.6		1.1		0.5
1987		9.28	115.4		3.0		4.4		-1.4
1988		9.60	120.5		3.4		4.4		-1.0
1989		9.98	126.1		4.0		4.6		-0.7
1990		10.35	133.8		3.7		6.1		-2.4
1991		10.64	137.9		2.8		3.1		-0.3
1992		10.90	141.9		2.4		2.9		-0.5
1993		11.18	145.8		2.6		2.7		-0.2
1994		11.47	149.7		2.6		2.7		-0.1
1995		11.81	153.5		3.0		2.5		0.4
1996		12.25	158.6		3.7		3.3		0.4
1997		12.76	161.3		4.2		1.7		2.5
1998		13.22	163.9		3.6		1.6		2.0
1999		13.70	168.3		3.6		2.7		0.9
2000		14.29	174.0		4.3		3.4		0.9
2001		14.75	176.7		3.2		1.6		1.7
2002		15.21	180.9		3.1		2.4		0.7
2003		15.47	184.3		1.7		1.9		-0.2
2004		15.86	190.3		2.5		3.3		-0.7
2005		16.36	196.8		3.2		3.4		-0.3
2006		17.05	201.8		4.2		2.5		1.7
2007		17.69	210.0		3.8		4.1		-0.3
2008		18.38	210.2		3.9		0.1		3.8
2009		18.84	215.9		2.5		2.7		-0.2
2010		19.22	219.2		2.0		1.5		0.5
2011		19.56	225.7		1.8		3.0		-1.2
2012		19.89	229.6		1.7		1.7		-0.1
2013		20.34	233.0		2.3		1.5		0.8
2014		20.73	234.8		1.9		0.8		1.2
2015		21.25	236.5		2.5		0.7		1.8
2016		21.78	241.4		2.5		2.1		0.4
2017		22.31	246.5		2.4		2.1		0.3

Inflation Part 2. The Real GDP Gap

Last week I tried to explain why I am not a big fan of the Phillips Curve. If you were not bored by that little detour then maybe you won’t fall asleep this time either. We in the USA are clearly thinking about inflation these days. Is it going to come back and scare the bejeezers out of us? Or not. Since my crystal ball is at the Hyundai place for its 30,000-mile service, I won’t regale with you with any forecasts. But I will pull out some data that I think is pretty interesting with regard to inflation. To give away the ending -- it is not easy to see a 70s style inflation roast.

Last week I punched at the Phillips Curve and concluded it was a fake for the real thing – a supply and demand analysis of inflation. Since supply and demand puts most people to sleep, I decided that I would use a close cousin called the real GDP gap. The real GDP gap measures the difference between actual output and something we call potential real GDP. Remember when you were a little kid and they said you had the potential to be the next Liberace? You were not yet the equal of Liberace and probably were not even equal to Elton John. But they thought that you had a lot of potential. Potential real GDP is similar in that it is not what we actually produced but is a measure of what we are capable of producing (if all of us were working).

When we subtract actual GDP from Potential GDP we get a gap that is a measure of how far off from potential we are. If that gap is very large, then we would be saying that demand is not strong enough to lead to output equal to our potential. That is the kind of time when prices and wages are not growing very fast. But if real GDP is a lot higher than real potential GDP, then we have a gap that represents a lot of demand compared to what we can usually produce. During those times we produce more than potential output because more of us are out of the house and into jobs! These time periods are not sustainable because most of us don’t like to work that much all the time and because it often causes inflation.

Today I look at those historical time periods in which output was a lot higher than potential real GDP. It turns out that since 1960 we have had six of those episodes. The table at the bottom contains information for those six and for the seventh one that just recently started near the end of 2017. Since the latter has lasted only three quarters, it ain’t much to look at. But those three quarters make us wonder if this will be like any of the past six time periods when real GDP exceeded potential.

The six episodes were as short as three quarters (1989) and as long as 24 (1964). The average time was about 11 quarters or just short of three years. Based on these almost 60 years of experience in the USA, output has a tendency to be higher than potential for just about three years at a time.

How much output was above potential varies too. During the 1964 episode, output started out a tiny bit above potential (0.7%) and was as high as 5.6% greater than potential during one of those quarters. It averaged about 2.6% above potential over those 24 quarters. This shows it is possible for real GDP to grow very rapidly relative to its potential. Only in the 1972 episode did output again show such strength when it averaged 2.3% above potential. Since 1978, we have very few cases of real GDP being 1% above real GDP.

What about the inflation rate? In five of the six episodes, the inflation increased. In the 24 quarters from 1964 to 1969, the inflation rate rose by 3.2 points, from 1.5% to 4.7%. In the next time frame, it increased by 6.7 points as it went from 3.3% to 10% in the early 1970s. Of course you could say the inflation rate tripled in both of those time periods.

Notice that the inflation rate responded heartily to gaps through 1980 but much less thereafter. This mostly reflects that gaps became smaller but might also question the response of inflation to any given gap.

            Change in the Inflation Rate

            From Beginning to End of Period

            1964-1969     3.2

            1972-1974     6.7

            1978-1980     4.2

            1989-1989   -0.4

            1997-2000     1.3

            2006-2007     0.3

            2017-2018     0.3

Nothing is proved here. But clearly it will take a while before we can say anything about how much inflation will rise in the coming years. If the growth rate of real GDP does not pick up substantially in the next years it is hard to see how a gap analysis would yield a large change in the inflation rate. If the inflation rate is close to 2% right now, then should we be worried about it rising much beyond 3%? If so, would that be a disaster? If not the gap, then what else might cause inflation to rise in the coming years? 

Table: Gap and Inflation

                           GAP*                Inflation Rate**

1964:1    0.7  5.6  0.5  2.6      1.5   4.7   4.7  3.2

1969:4          

1972:2    1.6  4.3  0.6  2.3      3.3 10.0  10.0  6.7

1974:2

1978:2    1.8  2.3  0.1  1.3      6.8  11.0 11.0 4.2

1980:1

1989:1    0.2  0.2  0.2  0.2      4.5   4.1  4.1 -0.4

1989:3

1997:2    0.3  2.0 0.7  0.9      1.8  2.5   2.5  0.7     
2000:3

2006:     0.5  0.4  0.4 0.2       3.0  3.3  3.3   0.3

2007:4

2017:    0.2  0.7  0.7  0.5      1.5  1.7  1.8   0.3

2018:1

 *Gap is the percentage that the actual GDP is above potential GDP. The four numbers represent that % gap during the first quarter, the highest quarter, the end quarter, and the average of all the quarters in that time period

** Inflation is measured by the annual change in the Personal Consumption Expenditures Deflator in that quarter relative to the same quarter in the year before. The four numbers reflect the measurement in the first quarter, the highest quarter, the end quarter, and the change from the beginning to the end quarter.

Lesson 22 The Phillips Curve

Below is something called the Phillips Curve. I thought it had expired but I read an article in the Wall Street Journal last week and realized it is back to haunt us. So I am on a mission today.

Like the Laffer Curve, the Phillips Curve is one of those graphical devices named after an economist that is misunderstood and totally abused. Like a good training bra, these curves have their time and place but can easily be misapplied.

I'll save Art Laffer and his curve for another time. A.W. H. Phillips studied wage change and unemployment in the UK from 1861 to 1957. I am not sure why his parents gave him so many initials and that deserves a lot of study, but I won't go into that today either. To make a very long story short, we Americans who wanted to be great again in the 1950s decided to steal Mr. Phillips' curve and apply it to our study of inflation and unemployment in the US.

The result of this study is to think that there might be a stable relationship between inflation and unemployment. Thus we draw the curve with a negative slope and pretend that it sits there until hell freezes over.  For you friends who are not mathematicians, this means that any reductions in the unemployment rate should cause the inflation rate to increase. Or, in other words, when the economy grows rapidly enough to reduce the unemployment rate this puts pressure on markets. Tight labor markets mean that wages rise faster. Tight goods markets mean that prices rise faster. That doesn't sound so crazy, does it?

In our current context in the US, we recently saw the unemployment rate decline to 3.9%. Applying the Phillips Curve means that inflation should be rising. Applying the Phillips Curve to the future means that if the unemployment rate remains low or heads lower -- then surely inflation will rise even more. Again, that doesn't sound so crazy. Of course, we wonder why inflation has not already soared given the tremendous declines in the unemployment rate.

The confusion is that economists are used to models that focus on supply and demand. And while discussions of the Phillips Curve often involve throwing around those words, the Phillips Curve is neither a supply curve nor a demand curve and this drives us crazy. What is it? Basically, it is a useful construct that amalgamates supply and demand but in ways that satisfy only the user. One user says one thing; another user says another.

This lack of consensus arises because we are using this construct as a proxy for an inflation forecasting equation. An inflation forecasting equation stems from a model. This explicit model has two components -- the aggregate demand for goods and services (AD) and the aggregate supply of goods and services (AS). To understand changes in the inflation rate, you must examine all the major things that impact a country's AD and AS. One of those things is the unemployment rate.

Did I underline the word one? I should have. Only one of the zillions of important things that impact inflation is the unemployment rate. Don't get me started because a zillion is a lot of things to discuss. But consider some of the important ones. Oil prices are starting to rise again these days. Might that impact inflation in the USA? What about when prices of mobile phone services fell? Would that impact the national price level? Declining productivity? Global competition? Agricultural surpluses?

Some economists understand that when any of these other inflation-causing factors change, then the whole Phillips Curve shifts. Things that cause inflation to rise cause an upward (leftward) shift. Things that cause inflation to fall cause a downward (rightward) shift. The Phillips Curve is not an immutable object nailed to the floor. It bounces around like Nolan in a bounce house. Thus, pretending that the Phillips Curve just sits around all the time is bound to lead to errors in one's inflation forecast.

Notice what we are saying these days. As the unemployment rate falls we are pulling our hair out about rising inflation. We are sure that the Fed will, then, more aggressively fight inflation. And because the Fed will react like Pavlov's pup, many are already forecasting a recession. While all that might be true, it ignores a lot of other things going on that might preclude the inflation rate from rising. Maybe the global economy is slowing down? Maybe we have plenty of workers ready to jump into the labor market or at least switch their status from part-time or from underemployment. Maybe tax reform will improve productivity and facilitate more competitive pricing. Maybe continued innovations and competition in IT products will reduce prices we pay for all sorts of products. Maybe Alexa will wash your car for free.

The Phillips Curve is a pedagogical device. It doesn't sit still for anyone. Focusing on the impact of unemployment on inflation is like trying to forecast how your kid will behave after eating a cookie. While the cookie might  have one impact, myriad environmental and emotional factors should not be ignored. Give the kid the cookie!

The Tail is Wagging the Dog

Two weeks ago I proclaimed that macro was sleeping and wouldn’t you know it, all the news lately has been about macro policy. Much of the discussion among economists and journalists shows that macro must have one eye open. These policy discussions are as confused as I have ever seen them.

Here are some of the themes. First, the Fed is pretty sure that inflation is going to rise above the cherished 2% target, and they will have to attend to a potential inflation monster with a more aggressive monetary tightening. But then they admit that inflation is not roaring back yet and there is always the worry that a rough policy would lead us into a recession. Second, recent economic growth news from the UK and Germany have us worried that global growth may be in a new tailspin. Just days ago, we were worried that the world might grow too fast. Wham bam – now we are not so sure. Third, we might be headed into a global trade war pitting the US against China, Europe, and several far-off planets. Or maybe not.

Isn’t macro policy fun? It is true that all of us except for John Travolta cannot see the future, and economists always disagree about best policies for any given 7-minute time frame. But today we find ourselves more confused than ever. Why does macro seem so lame these days? What happened to our rocket science?

My explanation begins with the vivid notion that the tail is now wagging the dog. Nolan knows that a dog is supposed to wag its tail and not vice versa. The dog is short-term macroeconomic oscillation. The tail is everything else. It used to be that everything was about the dog. Central banks and treasuries are laser focused on short-term macro stuff. Is the consumer going to be happy this year and buy another car? 

Will tax cuts cause consumers and businesses to spend more? Are firms going to build inventories? Will rising oil prices rob consumers of money they could spend on JD and potato pancakes? In that world, the dog is our focus and we use monetary and fiscal policies to buff up spending when conditions are weak and the opposite when people are spending too much.

But the dog is a mere pussycat today. And the tail is roaring. The tail is the aftermath of the worst world recession that the Tuna can remember. The world economy never entirely exited that recession. We lumber along. Some wonder if capitalism is doomed. Others worry about the lack of enthusiasm firms have for buying new and exciting equipment. Then there is that debt overhang from beer-guzzling college students to pot-smoking boomers with hip pain.

This dragging tail of an economy is also weighed down by a disenchantment of both the young and old for the labor force and the nonchalant attitudes about investment and the resulting lagging productivity gains.

The sad fact is that our dog-oriented policy makers are in the dark when it comes to the tail. They know how to fix the dog and that’s where they focus their attention. If you are a hammer, then every problem is a nail! But dudes, it ain’t the dog. Focusing on the dog means you miss the point. Focusing on the dog means that you are confused by the macroeconomic data. John Maynard Keynes said that we are all dead in the long-run so we should focus on the short-run. But today the tables have turned. We seem to be very alive in the long-run, and the short-run will be a very dull and confusing place if we don’t take care of the future.

Like a 24-hour news cycle, the Fed is always in our thoughts. But the Fed has little to do with the long-run except to provide ample money for long-term growth. All this noise about whether they are going to raise rates 3 or 9 times this year sells soap but is mainly a distraction. Whack-A-Mole economic performance in the US and abroad is similarly uninteresting. The world economy is stuck in neutral, and it has everything to do with longer-term challenges.

We need to put Keynesian economics to bed. It’s hurting our sleep. Let’s require all decision makers at the Fed and in Congress to take a course in long-run macro. But that’s silly. I doubt most of them are smart enough to understand it. And none of our 24 hour news station would find it interesting enough. 

Global Goods Competition

As the US refocuses on the impacts of international trade through the lenses of many trade agreements, it doesn’t hurt to consider from where our competitors are coming. The US wants to reduce, for example, its trade deficit with China. To do that, either China will have to buy more of our goods or we will have to buy less of theirs.

Today I want to focus on US exports of goods to China and the rest of the world. I am ignoring services exports because we have a surplus in our trade with services. Our trade problem seems to reside in goods. The IMF keeps some good statistics on goods trade, and their best database has some nice detail for the years 2013 to 2017. That’s five years – a long enough time for my buddy Nolan to reach his current age of 5 and long enough to draw some conclusions. My main conclusion is that if the US wants to raise its exports, it is not going to be easy.

The table below contains some relevant data on exports of goods. We see that in 2013, the world exported goods whose value in dollars was a bit more than $18 trillion. Since that time, goods exports did not increase; rather, they fell to a level of $17.7 trillion in 2017. The appetite for goods exports has clearly not grown. It fell by almost half a trillion dollars. Let’s agree that with a shrinking pie and a lot of eager-beaver countries, it won’t be easy to expand US exports of goods.

Comparing the next two lines, we see that as of 2017, advanced nations were selling only a bit more than the sum of all emerging nations. It was about a 60/40 split in 2017, and that split reflects the very strong desire of emerging markets to grow through exports of goods. Advanced nations will not give in easily so the future portends a time wherein both advanced and emerging nations will want to compete with the US to supply the world’s demand for goods.

The countries I chose to compare were based on foods that I love. I also chose ones that are major exporting countries and some with which the US might have a special trade relationship. Notice that with the exceptions of China, Mexico, and South Korea, all these countries shared the experiences of declining goods exports from 2013 to 2017. I am guessing that all those countries will try to do the same thing we are trying to do in the US – find a way to export more.

China’s exports increased between 2013 and 2017. China represented about 12% of the world’s exports in 2013. China was the largest country exporter. But notice even China can’t be too happy with its $67 billion increase in exports between 2013 and 2017. That represented a 3% increase in four years or less than 1% growth per year. Mexico’s was larger at 8% over four years or 2% per year. South Korea's increase was less than 4% per year. Those performances are nothing to brag about at the bar at Tacos Guaymas Mexican Restaurant. So even China, Mexico, and South Korea will not relent in their goals to produce and sell goods to the world.

In 2013, the US was the world’s second largest goods exporter and we claimed 9% of the worlds exports of goods. That’s not bad. But as I have said before, our problem with goods trade is not production or exporting. Our problem is our voracious appetite for buying goods.

Data source: http://data.imf.org/?sk=388DFA60-1D26-4ADE-B505-A05A558D9A42

Goods Exports of Selected Areas
2013 to 2017, in billions of dollars
Source: imf.org:
	2013	2017	% of             World	Change
			2013	2013 to 2017
World	18,193	17,702	100	-491
Advanced Nations	10,685	10,171	59	-514
Emerging Markets	7,509	7,136	41	-373
China	2,210	2,277	12	67
United States	1,579	1,547	9	-32
Germany	1,451	1,441	8	-10
Japan	714	687	4	-27
S. Korea	560	574	3	14
Russia	522	353	3	-169
Canada	465	424	3	-41
Mexico	380	410	2	30
India	314	299	2	-15

Macro is Asleep

Let’s suppose someone thought you were awake, and you were really sound asleep. They would talk to you and maybe they would ask you to do things and you would not move or speak. That would be surprising to your friend and maybe even upsetting. That’s why I am writing about macro being asleep. It is causing a lot of problems.

What is macro, and how could it be sleeping? I found this definition on Investopedia (https://www.investopedia.com/terms/m/macroeconomics.asp):

Macroeconomics is a branch of the economics field that studies how the aggregate economy behaves. In macroeconomics, a variety of economy-wide phenomena is thoroughly examined such as inflation, price levels, rate of growth, national income, gross domestic product, and changes in unemployment.

This definition reveals that macro is about the economy as a whole. It looks at GDP, for example. GDP is the sum of all goods and services produced. Macro does not emphasize toaster ovens or massages or the value of an airfare to Munich. It focuses on one number that represents EVERYTHING that is produced. It also doesn’t zero in on prices of jeans or a haircut – it emphasizes the average price of everything. Some people like to call it “the big picture.” As if we were looking down on the US economy from space and we couldn’t see all the detail.

In macro, we ask if national output is going to rise or fall. Will the inflation rate be 3% or 5%? With that in mind, economics or even what we might call national economics is much broader than macro. We might be interested in the parts of a national economy. How is the coal sector doing? What’s going on in Minnesota? How productive is the retail sector? What’s with Amazon.com?

So when I suggest that macro might be sleeping, I do not necessarily mean that we don’t have economic questions and challenges in the USA. Some of these issues can be national in scope but they are not MACRO.

You might react to above by saying who cares? If it is economic and if it affects the US, then why split a hair? Because it matters for both understanding and for policy. If you have a heart problem, you don’t go to a general practitioner. You go to a cardiologist. They are both doctors and both can treat you, but a GP and a cardiologist examine you differently and have very different options for your treatment.

As I see it today, we are confused about the US economy. We put on our macro hats to view our problems and policies but we don’t really have macro problems now. Macro is asleep.

What’s a macro problem? A recession with very high unemployment is a macro problem. Deflation is a macro problem. Hyperinflation or even high inflation can be a problem. A labor shortage could be a macro problem. And while we worry today that any of those problems could happen in the future, we mostly lumber along today with employment and output growing and inflation under control. 

Notice too that our typical macro policies are on hold. We had a massive government fiscal stimulus after the recession hit in 2008. We pumped money into the economy like a squadron of helicopters dousing a forest fire. But that was years ago and now we talk about normalization of these policies. We are not discussing an aggressive set of monetary or fiscal policies to either spur the economy on or to prevent rapidly rising inflation.

So whether it is macro indicators or macro policies, macro seems to be on hold, asleep. But don’t we have national economic problems? The answer is yes. They just aren’t macro and don’t require standard macro policies. But we are not used to thinking that way. It’s the economy, stupid. Get on with the macro! And that’s our problem. Macro policies don’t fit our current problems. We don’t really know what to do.

What are our national economic problems? What a question! We have plenty of them. But since we both have limited time and energy for this, let’s focus on four. The first is distribution of income. Economists have no consensus on what an ideal distribution of income is. But if it walks like a duck and quacks like a duck, then it might be a duck. What I am saying is that the distribution of income is probably out of whack. No macro stimulus policy is going to permanently change that. We need to seriously address this issue while muttering the oath that one should not throw out the baby with the bath water.

The second and related issue is poverty. President Johnson decided to have a war on poverty. Walk through the streets of any city and you will realize that we did not win that war. I know this is a crazy idea, but to win that war we probably need to focus on poverty. We don’t do that now. We have housing programs. We have food programs. We have shelter programs. We have substance abuse programs.  We have job retraining programs. How many separate programs do we have? That’s dumb. We should have one program. The goal of that program is to treat each person until they are no longer poor. Okay – some problems cannot be solved. But I would bet that a program focused on poverty would have a much better record than one with a thousand parts that is not focused on poverty.

A third solution for national economic problems would aim policy at industrial evolution. We are not a socialist country, and I am not recommending that government take over the economy, but I am suggesting that whether it is energy or artificial intelligence or small business, we could use government funds to both study and incentivize growth that would keep America competitive in an increasingly competitive world.

Finally, if I was Czar, I would work on racism in this country. You do not have to be a genius to know that the Golden Rule trumps just about everything else. We teach our children that starting a conversation with a nasty word is not the way to have a productive conversation. Racism festers in this country, and it holds us all back. We have a lot of laws that should lead to more equality but gaps remain in coverage and enforcement. Calling each other names is not going to do much to move the ball forward. Realizing that this is the most difficult of problems ought to engender open communication and respect since slogans do not accomplish the task. Talking with each other could go a long way as we hammer away at each and every vestige of hate. This one is worth the effort because this one impacts the other three I mentioned above. It is impossible to solve those and other problems in an environment of resentment and distrust.

Saving: A Little Brush Fire?

While we have been arguing the last few weeks about tariffs, saving, and trade deficits, the Congressional Budget Office was preparing its Budget and Economic Outlook 2018 to 2028 (www.cbo.gov). It might not seem obvious how the CBO’s work relates to our tariff spat, so I decided to spend a perfectly nice Sunday morning tying the two together. The main idea is that our trade deficits have very little to do with cheating and everything to do with national saving. National saving has a lot to do with government deficits. 

Some of you don’t like the convoluted explanation that insufficient domestic saving (over-consumption) draws in foreign saving, raises the value of the dollar, and creates a (larger) trade deficit. It sounds much too theoretical. And you don’t see how Americans who love their lattes and other luxuries could ever behave like folks in other countries who actually try to balance their budgets.

But that’s all recorded in the past few weeks of blogs. If that hammer wasn’t big enough, I now want to bring the CBO’s latest sledgehammer into the project. Some of you are old enough to remember the world as it was in 2007 before the global recession slapped us around. In those good old days, a cup of coffee cost 20 cents and tasted like tea and most of us drank water from a tap in a thing called a glass. In 2007, the US budget deficit was $161 billion and the net national debt was $5 trillion.

Let’s back up. A government deficit is a one-year measure. In 2007, the government spent about $2.7 trillion, collected revenue of about $2.6 trillion, and sold government bonds to the public totaling $161 billion. Yes, when the government spends more than it collects in tax revenue it must borrow the difference. The $161 billion of 2007 was pretty typical of US government borrowing between 1999 and 2007 though it oscillated from year to year and hit a high of around $400 billion during one of those years.

The government borrows mostly from US savers. Borrowing $200 billion or so per year did not put too much stress on US saving. But imagine what happens when the borrowing rises from $161 billion in 2007 to $1.4 trillion in 2009. You are correct. That’s a 10-fold increase. If households and business firms are trying to borrow from savers at the same time, you can imagine how domestic saving might be insufficient or at least less sufficient to cover the borrowing. In such cases foreigners make up the difference. They bring their savings from countries around the world to the USA.

But wasn’t that $1.4 trillion government deficit a one-time thing? We had a huge and scary recession, and our government did what it was supposed to do to generate more spending in the economy – tax less and spend more. That’s true. And all looked pretty good as government deficits began to get smaller. Then along came two events: the Tax Reform of 2017 and the Bipartisan Budget Act of 2018. Between these two waves of the magic wand, we took the budget deficit from $665 billion in 2017 to $1 trillion in 2020 and $1.5 trillion in 2028.

John Maynard Keynes thought the government should use a deficit in short-term situations with the intent of stimulating output. The fiscal dividend of the rising output would be a surge in tax revenues and a decline in government spending. Viola – a temporary deficit then vanishes into thin air. Keynes would be scratching his head about how nearly a decade after the recession started we are still stoking the fires with larger and larger deficits.

What sorts of things are wrong with this situation besides causing Keynes to roll over in his casket? First, the government is gobbling up our saving in the USA and sucking even more in from abroad. This makes it harder for US firms to borrow, to expand, modernize, and otherwise raise productivity. Economists call this “crowding out” of investment spending. Second, these government deficits that reduce available saving raise the value of the dollar and hurt our trade balance.

Third, these government deficits accumulate. If the US borrows $500 billion one year and another $1 trillion the next, then in those two years it has added $1.5 trillion to the national debt. The US net national debt was about $5 trillion in 2007. By 2017 it tripled to just under $15 trillion. The CBO says it will rise to $29 trillion by 2028. What a ride! In 2007 the net debt was 35% of the national economy. By 2017 it rose to 77%, and by 2028 it will be closing in on 100% of the economy.

Keep in mind that these forecasts extrapolate from current law only. It is possible to imagine this government raising spending (or lowering tax rates) even more during the next 10 years. It is also a sure thing that the US will encounter another recession before 2028. Either of those eventualities will cause the deficits to bleed even more and the national debt to be taller than a giant beanstalk. 

Need I say more? Between households, firms, and our lovely government, we are spending our brains out and the impact is to lower national productivity and competitiveness. We have too little business spending on capital and a corresponding trade deficit. Are we sure we don’t want to tend to this brush fire? Whether it is the government or the consumer, can we not find a way to restore more balance between revenue and spending? I guess we can always start over after the fire ravages our nation. 

Cheaters, Saving, and Investment

It is easy and perhaps even fun to describe the US balance of trade as born of cheaters and clearly unfair to US workers. The logic seems simple and intuitive. We are a great nation, and yet we import more goods from other countries than we can export to other countries. If trade was perfectly fair, then, of course, Americans could not lose. After all, we are smart, educated, attractive, competitive, and whatever else you want to add. How could we possibly be so uncompetitive? Surely those other guys are cheating. End of story. Where is my celebratory JD?

Not so fast. Economists have another explanation, and it has to do with how much a country saves and invests. Whammo, the intuition vanishes and the reader is pretty sure that economists are from another planet. In defense, I will point out that intuition has an advantage when people decried the Earth flat. From anyone’s vantage point, the world did not look round. This “saving and investment thing” lacks intuition but that doesn’t make it wrong.

One more point. Some friends have told me that maybe saving and investment do matter to the trade balance – but there is no way to get Americans to consume less and save more. While it might seem like an uphill climb, the data in the table below suggest that the USA is an outlier. When compared to other countries and other regions of the world, we are second-class citizens of saving. Maybe if people understood that this imbalance is truly a problem we might begin to do something about it. If the choice was between a devastating trade war and inducing Americans to save more, might one not entertain policies to raise saving?

To review: If a nation spends more (and saves less) than its ability to produce then it will import the difference. Or put another way, the paucity of saving means that firms and government will have to draw in or borrow foreign money to meet its spending needs. This capital inflow raises the value of the dollar, increases imports of goods, and reduces exports of goods. Viola. A lack of saving leads to trade deficits in goods.

What do the numbers in the table show you?

First, I have 15 countries and regions listed in the table (data taken from an International Monetary Fund report). The highest saving rate among those 15 in 2017 was the 40.5% of GDP for emerging Asia. Just below are Japan and Germany with respective saving rates of 27% and 28%. The lowest in the list is the United Kingdom at 13.4%. At 17.5%, the US was in the third place from the bottom. We clearly do not save very much. I knew that Japan saves more than us by a long shot. But so do 12 of the 15 in the table. The average for all developing countries was 31.7%, and for all advanced countries, 22%.

We do better at investment. The almost 20% investment ratio for the US is bigger than our desire to save.  But in looking down the list, our investment ratio is bigger than only Germany, Italy, UK, and Sub-Saharan Africa. The average for developing countries was 32%; for advanced 21.1%. So we are a laggard when it comes to both saving and investment. Does the low saving retard investment?

What really matters for the trade deficit is how short our saving is relative to investment since that gap is the key to capital inflows as explained above. Half of the regions included have negative saving ratios – meaning that saving is less than investment and those countries will have capital inflows and trade deficits. Our saving deficit of 2.3% of GDP puts us in the middle of those countries with the (negative) deficit sign. So it looks like we are in the bottom third of the whole group when it comes to saving insufficiency as a percent of GDP.

If so many of these countries can have adequate savings, then why can’t we in America? Do we really need all that crap we buy? Are there no policies that might improve incentives for saving? 

Table. Saving and Investment as a Share of GDP, 2017

USA and Selected other Countries and Regions

	Saving	Investment	S-I
United Kingdom	13.4	17	-3.6
Sub-Saharan Africa	15.3	18.7	-3.4
USA	17.5	19.8	-2.3
Italy	19.6	16.9	2.7
Canada	19.9	23.3	-3.4
Advanced nations	22	21.1	0.9
France	22.1	23.1	-1
Spain	22.5	20.6	1.9
Emerging Europe	22.5	24.8	-2.3
Middle East, Africa, etc	25.2	26.8	-1.6
CIS	25.6	24.3	1.3
Japan	27	23.4	3.6
Germany	27.6	19.4	8.2
Emerging and developing nations	31.7	32	-0.3
Emerging Asia	40.5	39.6	0.9

10,000 Tariffs

In working on my last post about import villains, I stumbled across an incredible realization. Steel and aluminum are just the tip of the iceberg. Most of us mere mortals have not tried to explore the labyrinth of information called the Harmonized Tariff Schedule (HTS) where we list all the tariffs levied against our trading partners. My reaction to perusing that schedule is a lot like the feeling one gets when they first try to understand all the notes on the neck of a guitar. Yikes, I didn’t realize all those notes were in so many places! Luckily, on a six-string guitar in one octave, there are only 72 places for notes.

The HTS contains 22 sections of goods categories broken into 99 chapters covered on 3,710 pages including over 12,000 import tariffs. Are you kidding me? I didn’t even know there were 12,000 goods.

What’s my point? My point is that a trade novice evaluates or judges the change in the tariff on steel imports without any real understanding of the whole tuna. Imagine such a novice who thinks that we don’t have many tariffs and that a 25% tariff is weirdly high or unusual. In that case you might come to one kind of conclusion about steel and aluminum. I am tired of typing steel and aluminum so let’s just say S&A.

But now, after a fascinating morning with my friend Google, I know there are more than 12,000 goods tariffs. One of them is the 127% levied on Chinese paper clips. Paper clips! I found examples of very high tariffs including those on canvas sneakers, leather and foot ware, synthetic yarns, canned tuna, and a large variety of lovely foods from the EU including cured ham, truffles, oats, and mineral water.

Inasmuch, a less naïve person would interpret the newly increased S&A tariffs in a different light. A 10% or even a 25% tariff is neither startling or unusual. That does not mean I am supporting or advocating these new tariffs – it simply means we need a more realistic approach to evaluating them. From the reactions in the press, you would have thought that CNBC had purchased Fox Business News. Not so.

These new tariffs are really like a blip in the ocean. Given all the tariffs we already have on imports, I doubt these new tariffs are going to drastically change those 3,710 pages. But it is interesting that among all those 12,000 goods that somehow S&A avoided a tariff and that past attempts to levy them had been so unsuccessful.

Why do we have so many import tariffs? Is the world so unfair to the US that we had to slap on tariffs to be competitive and save US jobs? Or is this more of the same game of government spoils that is applied so routinely by companies within our borders? The government has a lot of elected officials with lovely salaries and benefits. Perhaps we have so many protections because it pays well?

I am asking more questions than I am answering. But this thing with S&A really opens a much bigger set of questions once we view it in a wider context:

Why have we not had tariffs protecting S&A when we protect so many other industries?

What does any of this have to do with US national security?

How many of these 12,000 existing tariffs improve national security?

How many other goods should have tariffs because of national security?

Do we really need any tariffs to protect national security?

How can we preach the values of competition when we seem so far from the ideal?

While the WTO made initial progress in removing barriers to trade, why is the Doha Round dead after so many years of negotiation?

Have we given up on the idea that reduced trade barriers are good for the global economy?

Where is my JD?