An Economic Mystery

Something has been going on for years in the economic realm that is unexpected and unexplained. It is really important and no one – and I mean absolutely no one – has a clue why it is happening. This mystery is a surprisingly subdued consumer price inflation. It is a world-wide phenomenon, except of course in countries like Venezuela that have sadly mismanaged their economies. One sometimes reads purported explanations by economists but they always fail one crucial test. What they predict will happen next never does, and indeed often the exact opposite occurs.

Even now, when producer prices are generally rising and developing economies are prospering, this condition remains essentially unchanged. It is always about to change “tomorrow”, but tomorrow comes and either nothing changes or the gap becomes even more pronounced. Take the euro zone for example. In May, the year-over-year producer prices rose 4.3%. But simultaneously in May the year-over-year consumer prices actually dropped from the April level of 1.9% to 1.4%.

The Fed is perplexed. The financial community is unable to predict future conditions so it is constantly having to defer long-term commitments. The bond market is becoming schizophrenic.

No one like inflation. It can ravage assets. But when inflation appears to have miraculously disconnected from the supply/demand cycle, all the classic economic rules of thumb go overboard. This leads to the worst possible condition: uncertainty.

Personally, I think that some as-yet undiscovered factor or confluence of factors is acting like a dam, holding back the normal flow of economic consequences. This will eventually burst and we will get a sudden spike in inflation just as we did in the 70s. Whatever is the case, this situation is clearly unstable.

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Is 3% GDP growth feasible?

One aspect of Trump’s economic plan has evoked doubt and consternation. The plan depends upon achieving 3% annual GDP growth by 2021 in order to offset its cost. Most academics believe that this simply can’t happen. But here’s a relevant statistic. In the 70 years since the end of WWII, average GDP growth rate was about 2.9%. So why the skepticism?

The argument given, mostly by progressive economists, is twofold. First,  population growth was a major factor in the historical GDP trend, but this growth is now slowing significantly. And second, there are new impediments to growth resulting from government policy over the last few decades.

My thoughts are as follows. The population growth slowdown may be offset by gains from automation, robotics and AI. As I have argued before, we simply don’t need “busy hands” as much anymore, and this trend is increasing rapidly. Since I wrote, quite unexpectedly, there have even been inroads in some labor-intensive segments of the industrial farming economy. Even picking delicate fruit evidently can be effectively automated. Of course, whether this technological impact will be sufficient by 2021 is unclear, but no one can say it is impossible.

Secondly, the structural impediments in our economy are a self-imposed constraint. We could release some of them, and in fact that is a major part of the Trump agenda. These include undoing many regulations on business activity, freeing resource exploitation from some environmental protections, removing some constraints on the flow of capital, and so on. However, this entails significant risk because these impediments have benefits through engendering a safer and more stable economy. So it isn’t clear to me that this is a sensible course of action. Nevertheless, I am not so sure that following this path couldn’t restore the historical growth that built us into the dominant world power after WWII.

Thus, dismissing Trump’s plan in this way is a mistake. It is quite possible that we could achieve this ambitious goal if we are willing to accept concomitant risks. What the skeptics really mean is that it can’t be achieved safely. That isn’t the same thing as feasibility, and not speaking clearly on this topic is a serious rhetorical mistake. The real question is not whether 3% GDP growth is feasible but rather whether it is desirable, given what we must do to achieve it.

Our Economy in Perspective

One of my favorite bloggers is Mark J. Perry of AEI and the University of Michigan. Check out his economics blog Carpe Diem yourself and see if you agree. His June 6 post included this map that presents world GDP data in a unique and more relatable fashion.

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He has two major point to make. First, this provides a clever visualization for how our gigantic GDP totally dwarfs most of the rest of the world, by labeling each state with the country having approximately the same GDP in 2015. The GDP matches are not perfect of course, but they are usually well within 10%. The second point, not directly shown, is that invariably our states achieve their results with many, many fewer workers. The U.S. economic engine is receiving mostly bad reviews in our current political season. However, while it is far from perfect, I think few residents of these states would prefer the quality of life in their world counterparts.

I am reproducing the map here because I wanted to relate a few of my reactions, which range from surprise to amusement to outright astonishment. Some items jump out. Texans are justly proud of their state, perhaps a bit too much for the rest of us, but to rank equal to Canada is amazing. Maybe the chatter about breaking off and resuming independence isn’t so crazy after all! Even proud New Yorkers might be surprised to find that their GDP slightly outranks South Korea, with its plethora of technology companies whose products we see everywhere in our homes and on our streets. As to my home state, California, its massive GDP is really no surprise. Still, to rank slightly higher that the EU powerhouse, France, is a bit eyeopening.

Our rust belt states are seen as faint images of their past glory, mostly characterized by economic decline, population loss, and urban decay. Yet Ohio’s GDP still is similar to Switzerland’s, Illinois outranks The Netherlands, and Pennsylvania’s GDP is only slightly less than the growing and vibrant Turkey. This perspective makes these states seem more economically sound, doesn’t it? And New Jersey almost equaling the petroleum giant, Saudi Arabia, is astounding, although the recent decline in oil prices no doubt played a role.

Old line Massachusetts has few resources other than its well-educated people and many of its manufacturing jobs have migrated overseas. Nevertheless it ranks with Nigeria, known as “the Giant of Africa” due to its enormous population and an economy that now ranks first on the continent.

Further down the economic ladder, other comparisons probably say as much about the ancient countries of the world as it does about the economies of our states. Colorado and Egypt make an odd pair, as does Missouri and Denmark, Iowa and Greece, and the District of Columbia and Hungary. On the other hand it seems quite appropriate that Minnesota is paired with Norway. Do you think their Scandinavian roots may have contributed to comparable economies? Similarly, the island economies of Hawaii and Sri Lanka seem natural partners.

A few pairings are just amusing. Surely Kentuckians might have expected to outrank their partner, Bangladesh. And enormous but sparsely populated Montana is performing similarly to the world’s gambling mecca, the tiny enclave of Macau. While The Oriental Republic of Uruguay and Sarah Palin’s Alaska strike me as the comedy duo of this report.

I am sure that other pairings will strike your interest and amusement. Enjoy!

The Little Engine That Couldn’t

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The Federal Reserve once again did a head fake. Interest rates will remain at historic lows for yet another cycle. You can hear echoes of the children’s fairy tale from our little economic engine, “I think I can. I think I can. Hmm…maybe not this time.” This is getting old and the markets are coming to realize this. Keep this up and no one will listen to the Fed, even though it is speaking publicly at historic volumes.

Fed Chair Janet Yellen says that they really, really want to normalize rates, and the economic indicators support this if they ignore short-term effects as they should. But they always find some monster on the horizon that deters them. So far anyway, these monsters never bite, although statistically we know that one eventually will. The latest is Brexit plus a disappointing jobs report. Will there ever be a clear field ahead? Probably not. The nature of our world economic system is that threats are endemic. Sooner or later, the Fed must accept the risk and move firmly forward on rates, but if they wait until the coast is entirely clear, timidly dithering on the edge, disaster is likely.

Consider this. Remaining in an unsustainably low-interest environment removes the main lever that the Fed has to respond to a real problem when it inevitably strikes. Of course they can always print money, but that is a fool’s errand.

The Minimum Wage: Whys and Wherefores

I’ll bet you favor a government-mandated minimum wage, and you probably support current proposals to raise it. After all most state minimum wages have been stagnant for ages, and the cost of everything moves inexorably higher. Who can not be moved by stories of workers struggling even when holding down two jobs or of mothers foregoing a meal in order to feed her children? Just a little more money would help them so much and surely our vibrant economy can afford the costs. If you are a Democrat, this is party theology. Most Republicans demur, but they are just Grinches anyway, aren’t they?

As a political agnostic, I confess that the whole concept of a mandated minimum wage mystifies me. Establishing an arbitrary floor based on need disconnects work from production value. If $15, why not $45? That would produce a real living wage. Before you dismiss that as a nonsensical straw man, consider this. Proponents of $15 assert – with flimsy supporting data – that it will cost at most pennies a day for higher wage earners. If so, tripling the minimum would at worst make it perhaps 50 cents a day. Surely you could afford this small charitable contribution to raise the standard of living for so many. And why not a maximum wage too? I could make an argument for that which is just as convincing as the ones presented for a minimum.

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When “experts” evaluate the economic impact of the minimum wage they normally omit knock-on effects. However, for a change, California legislative budget analysts did do just that, at least partially, for that state’s latest proposal to go to $15 per hour by 2022. They calculate that the indirect effect on government wages alone will be $3.5B. Indirect effects include necessary increases to maintain wage bracket coherence. This analysis doesn’t include the equivalent indirect effects on private business wages, which presumable would be much greater. As good old Senator Everett Dirksen used to say “A billion here and a billion there, and pretty soon you’re talking about real money.

That money doesn’t just spring into existence. It comes from somewhere in the economy, through taxes, price increases, reduced hours or employment, lesser benefits, etc. No one is suggesting taxes, even though that is probably the best resolution. So some combination of the others will occur spontaneously. Now that might be an acceptable trade-off, but only if it is fully evaluated so that we understand the impact in advance. For proponents, price increases are the preferred approach and they usually evaluate them as small and manageable. Evidently the concept of price elasticity wasn’t discussed in their economics classes. Or do you think that perhaps such classes weren’t a part of their curriculum?

Those predicting negligible impacts of minimum wage increases point to the history of such increases. Each time there is such a proposal, the Chicken Littles guarantee horrendous consequences, but they never occur. So what is there to fear? This analysis is nonsense. The core problem is that the economy is such a complex system that isolating causes and effects is rarely feasible. We cannot know how much more robust the economy would have been in the absence of arbitrarily imposed wage increases. All we can know with any confidence is that they have costs, which we can roughly estimate, and that such costs are an impediment to growth. Such impediments rarely impact all segments of the economy equally. So don’t be so sure that your preferred clients are not among the losers.

The one argument supporting a minimum wage that does seem reasonable is that creating a livable wage structure make workers happier. A happier worker does a better job and worker turnover is reduced. These produce tangible benefits that offset costs. But there is a flaw in this argument which I can confirm from my own experience. Each salary increase is welcome and is a cause for celebration. As weeks go by, this happiness subsides and a new equilibrium is reached where I want more. More of what, you ask? Just more, I am really no happier after all. Moreover if prices go up as a consequence of my increased income, along with that of everyone else, I don’t feel better off and the cycle continues. You can achieve the same effect by just mandating that dollar bills are now worth two dollars.

Interestingly, President Obama, in a speech arguing for an increased Federal minimum wage, quoted the guru of economic theory, Adam Smith, to support his proposal. Obama translated Smith’s argument in The Wealth of Nations into modern terminology. “If you work hard, you should make a decent living.” In doing this he displayed distorted erudition. Laying aside the applicability of 18th century theory to a modern economy, that takes Smith’s discussion out of context and completely misrepresents it. Smith was writing at the dawn of the industrial revolution, before it was understood how wages are linked to marginal productivity. But in any case, he would be aghast at this profound misreading of his well-reasoned analysis of why rapid economic growth and a tight labor market are the way to benefit ordinary workers.

There is a coming storm in our work lives that will change everything. I have discussed this here. It will magnify competitive disadvantages across the economy. We ignore this at our peril. Tinkering with the minimum wage is the equivalent of bread and circuses for the Roman proletariat. It is a sideshow that diverts us from dealing with fast approaching economic and social changes that will sweep away many of the jobs now paying the minimum wage.

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When government meddles with the economy the impacts usually take time to show up. By then they are often attributed to the mysteries of the economic cycle. Everyone shrugs and goes on to their next adventure in fiddling.

The New Economic Inequality

Obviously, if you have followed political news at all, you know that the electorate is grumpy. Results in polls, news interviews, and primary results show that voters are unhappy about the state of affairs. This is the common view of the international situation, primarily involving ISIS but extending to other problems like the North Korean madman and the Russian adventurist. But at the base, the concern is with our economic future. James Carville, Bill Clinton’s campaign strategist in 1992, got it right, “It’s the economy, stupid!”

But this is a bit strange. There are certainly challenges to prosperity looming, such as China’s downturn, the collapse in commodity prices, continuing and rising national deficits, and others. And of course, this is aggravated by the uncertainties generated by an election season of unprecedented unpredictability. But a calm look at all of these issues shows that this is a minor storm which our ship of state should weather easily. This is reflected in the stock market, which is a fair indicator of the main street economy if you take the long view as shown here.

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The S&P 500 index is the most representative view of the U.S. stock market. It fluctuates of course, but the secular trend is obvious. Furthermore, the correlation with the Great Recession is clear, confirming the relation to the economy. If you extrapolate the line before the recession you can see that the index is already approaching where it would have been if no recession had occurred. In other words, the systematic upward trend remains intact. Our economy is prospering.

This doesn’t mean that there has been no lingering impact of the recession. The figure also graphs the consumer price index over the same period. This is quite stable, and indeed somewhat lower than the Fed would prefer. Note that there has been a substantial period during which the S&P 500 under-performs the CPI. Throughout that time, not only did households lose wealth but their incomes declined in real terms. It is not surprising that people are a bit grumpy. They see a glass half-empty.

However, different segments of the electorate see matters quite differently. Younger voters seem hell-bent on revolution, as the crowds attending Bernie Sander’s events clearly show. Older voters are far less dissatisfied. This reflects a subtle change in the U.S. economy that has great portent. In the past, older segments of our population were the poorest. The young were more prosperous and saw better future prospects. Unexpectedly, this has been entirely reversed. Look at this graph.FullSizeRenderOver the 30 years from 1983 to 2013, life has gotten much worse for those under 50 and much better for those older. Understandably, this is reflected by their choices in the current election.

The Dismal Science and Uncomfortable Truths

The day after Christmas, Bernie Sanders posted on Twitter: “You have families out there paying 6, 8, 10 percent on student debt but you can refinance your homes at 3 percent. What sense is that?”

I can’t imagine a more representative comment from the Dunderhead School of Economics (DSE). Is it possible that he really doesn’t see why there is a difference? Suppose he was making such loans from his own pocket, and not as a charitable contribution. Would he really charge the same rate for a secured loan to someone with a solid financial rating as he would to a young person with no resources and uncertain prospects? If so, he wouldn’t do it for long. And soon it would be he who would need to find a charity to buy his “three hots and a cot”.

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If we are speaking of charity, why charge any interest rate at all? Why not take these loans out of private hands and dispense the funds directly from government coffers. After all this is an investment in one of our most precious resources, one that could return a large profit to the community in years to come.

But then one might ask if that is really the best use of our finite resources. Should we invest in the relative few who are educating themselves for a likely prosperous life or should we provide vital support to the many in dire need of food, housing and medical care? If you say we should do both, I can safely assume that you are also an alumnus of the good old DSE. Try taking a short refresher course in Opportunity Cost. Or better yet, read the original source material in Austrian economist Friedrich von Wieser’s book Theorie der Gesellschaftlichen. I am sure an English translation of this classic is in your local library.