Wednesday, 28 August 2013

Graph of the week: A slowdown in emerging markets

From the WSJ:
Source: Wall Street Journal
For the first time since the start of the crisis, emerging economies are contributing less to global GDP than the developed ones (see graph below). Just as the developed economies are starting to bounce back, BRICs and Mexico are declining. Exports have plummeted in China, declined in India and Mexico and are slightly recovering in Brazil, while manufacturing is slowing down in all of these economies (graph above). On the other hand developed nations are finally seeing an improvement in manufacturing and exports, which will soon enough be visible in the growth numbers. The stock markets in both sets of nations show this forthcoming trend better than anything. Why is this? Shouldn't the BRICs also feel the recovery of the West and carry on growing just as they did in the pre-crisis decade? 

Certain things have changed since before the crisis. The most important one was a reverse of the outsourcing trend - the so called "insourcing", where (mainly US) companies decided to switch some of their production back home from distant Asian markets. Some claim the reason to be growing wages in China and the rest of Asia, others claim rising transportation costs and the distance being too big to service immediate desires of the customers. I think it could be both. After all, the reason Western companies decided to put up with high transportation costs were the lower wages, making the overall cost burden much lower. With both of these going up, it is only natural for a company to adjust to the changes in demand. 

Source: The Economist
Many claims have also been made that the emerging markets have failed to catch up to the developed economies, thus failing to achieve even partial convergence. It could get even worse, particularly if the main driver of BRIC growth, China, enters a recession following its inevitable bubble burst. It's a shame the developing economies have missed their chance during the past five years to close the wide income gap with the Western world, as it is likely that in the decades to come this gap will remain to be wide. However, not to sound too pessimistic, there is still a lot of scope for catching up, particularly in India and Mexico (and even China if they all of a sudden realize their policy mistakes), in terms of rising productivity, worker incomes and the consequential rise of living standards. Economic policy will play an important role (hence my optimism for the reformist Mexico), as the newly created wealth and incentives for creating wealth now need to be nurtured and allowed to produce even more. Overall, as always, it's a mixed picture. 

Friday, 23 August 2013

Eurozone's nominal rigidities

In an article published in the Journal of Economic Perspectives, Kevin O'Rourke and Alan Taylor examine Eurozone's ongoing depression and focus on monetary adjustments and Eurozone-wide automatic stabilizers that could supposedly help Europe in its painful recovery, suggesting a full-pledged banking union and a stronger consolidation of Europe's institutions. What caught my attention was the brief look at nominal wages and employment in four peripheral economies during the length of the crisis. The authors found an interesting pattern where nominal wages seem to have risen during the crisis (everywhere except in Greece), while employment was (and still is) falling. In Ireland, despite claiming to have performed an internal devaluation wages have been rather stagnant. However their employment slump was stopped in 2012. 
Source: O'Rourke, Taylor (2013): "Cross of Euros" JEP 27(3):167-92.

What could this be a signal of? First of all, as Fatas and Mihov in their article on VoxEU suggest, it could be a signal of a structural change and a "new normal" in the economy, where unemployment is likely to remain high for quite some time.

Source: VoxEU
Fatas and Mihov analyzed US recessions and recoveries in the past 60 years and calculated how costly recessions can be in terms of output loss, either because of the initial depth of the recession or the subsequent slow recovery. (Read the whole paper here.) The two worst recessions in terms of output loss were the 1981 recession (11.72%) and today's (2008) recession (22.10% and counting). In 1981 the US recovered much quicker than today, with output loss during the recovery being rather small. Today, even though output loss from the recession itself was lower than in 1981, the slow recovery caused the costs of the recession to rise substantially. The reason could be a misplaced approach to recovery. While in 1981 the US embarked on a series of supply-side reforms that changed the structure of the economy resulting in a new pattern of economic growth the US embarked on, today's recovery was characterized by a mix of failed approaches; extensive stimuli and bailouts followed by a wrong approach to austerity without any serious attempt to adjust the system to the global shock in addition to a range of half-baked temporary solutions. 

Another thing I believe their analysis suggests is that in these two recessions the magnitude of the shock was too large to be solved by standard macro policy tools. Which was exactly the policy mistake made by current administrations both in the US and in Europe. Even if we reject the premise of similarity between the two recessions and the applicability of recovery policies, the pattern of the current recovery clearly suggests that something is different. 

Does this mean European countries should succumb to being stuck in a low equilibrium with high unemployment rates? Probably for some time, especially if the pace of reforms remains the same as it is now. Europe, with its rigid structural system, is far beyond any form of stimuli. It is in desperate need of change as it has failed persistently to adapt to the new technological and consequential structural shocks that have hit the global economy and changed the patterns of trade and cross-country specialization. 

As for the competitiveness side of the story, will the rapid decline of nominal wages really help Greece gain competitiveness? It will as much as would a return to a depreciated Drachma - so, not very much. And in Greece, with prices of public services going up, the decline of real wages is even worse. But if Greek wages are falling while other Eurozone countries have their wages rising, shouldn't this suggest that Greece is gaining at least relative competitiveness? No. This argument would be true if lower Greek wages would result in attracting more investments into the economy vis-a-vis the stronger competitiveness. But there is much more to gaining competitiveness than a decline of real wages. It also depends on the skill set of domestic workers, the levels of education, the rigidity of domestic labour regulations, domestic business regulations, the efficiency of the domestic tax system and the legal system. In none of this does Greece score high. They are making a terrible mistake for suggesting that a decline of real wages is helping the economy. Its only effect so far is shattering domestic consumption. 

Other peripheral countries (to which Slovenia has joined in) are no better. They have all used the standard macro austerity tools without offsetting some of the effects by freeing up businesses and fostering incentives for innovation. This is why peripheral Eurozone remains in a situation of a lot of pain and still no gain.

Tuesday, 20 August 2013

New trends in education

Education is, like the whole economy in this digital age, undergoing a structural change. The newest special report from Scientific American, entitled "Learning in the Digital Age" finds that more and more universities and students are switching to online education, which offers the convenience of faster learning and is also considerably cheaper, particularly for those coming from developing countries. The quality of knowledge the online course-takers will receive is yet to be seen. This of course depends on the skills they wish to acquire and the career they wish to pursue. However, for some it presents a remarkable opportunity they would have never had the chance to obtain in their regular environment. And while many experts suggest that online education and new technologies will be welfare enhancing, particularly for the residents of developing economies, it is the change in the skill sets offered in online courses (in regular classes as well) that suggests the magnitude of change. 

People are enrolling in majors which are most relevant to the real life around them, hoping to pursue careers in finance, business, law, IT, medicine or science. Or economics. Anything that can give them a good return on their investment. After all, going through college isn't cheep - the bubble in student loans proves it. Online education is actually a perfect market response to high tuition fees on one hand and a growing thrust for knowledge the population wants satisfied with the massive technological inclusiveness on the other. The career choices are simply the indicator of what's hot and what's not. 

This reminded me of a text from the WSJ that focused on the fate of humanities. The report from the American Academy of Arts and Sciences has concluded that fewer students these days are enrolling in humanities (philosophy, religion, art and particularly literature, etc.). Does this suggest a civilizational decline? Not at all according to Lee Siegel: 
"When people wax plaintive about the fate of the humanities, they talk, in particular, about the slow extinction of English majors. Never mind that the preponderance of English majors go into other fields, such as law or advertising, and that students who don't major in English can still take literature courses. In the current alarming view, large numbers of people devoting four years mostly to studying novels, poems and plays are all that stand between us and sociocultural nightfall.
... 
At the present moment, we are experiencing the rise of new digital pleasures and distractions, the expansion of a mostly visual culture that races far ahead of the imagination, the ubiquity of social networks that redefine the pure solitude once required for reading a demanding book. And in this time of rapid changes in the workplace, life's great mysteries seem more economic than existential. A digital environment also stresses quantitative thinking, and perhaps that helps explain why the most exciting cultural advances are now in science and medicine. 
It is hardly a surprise that in this atmosphere, college students choose to major in fields that are most relevant to the life around them. What a blessing that is on literature. Slipping out from behind ivied prison doors, where they have been forced to labor as evaluative "texts," the great thoughts and feelings made permanent by art can resume their rightful place as a unique phase of ordinary experience."
Even though Siegel describes himself as someone who truly appreciates literature, he claims that it needs only to be read, not taught. Just as we don't need to know about biology or psychology in order to love. Read the text, it's very interesting.  

The whole story merges well with my observations on technological and educational change and how the demand for certain careers seems to be declining, and will continue to decline until only a few % of the people are left in the occupation, which will apparently be more than enough to cope with the needs of the profession. Just like it happened with agriculture in the 19th century, and as it will happen to manufacturing today, or the jobs requiring humanities majors - the demand for these types of occupations has declined (or  is currently in a state of decline), and the sooner the society adapts to this change, the better. However this is hard for most people to perceive, as the benefits are nor visible nor substantial in one's lifetime. Which is why the struggle against structural changes will always come as a necessary consequence of technological progress. 

As Don Boudreaux sarcastically remarks, "if only most Americans still had all those great agricultural jobs of the past..."

Thursday, 15 August 2013

Graph of the week: credit and investment booms

From Credit Suisse here is a graph comparing the non-financial private sector credit growth and growth of fixed capital formation (i.e. investments), both with respect to GDP for a number of mostly developing nations: (click to enlarge) 

HT: Marginal Revolution

What it reveals immediately is the dangerous position China is currently in.

The scatter plot offers a good insight into some basic wisdom in economics; "when credit growth significantly outpaces investments into the economy, a nation could be in for a deleveraging period." We can see three very good historical examples of this almost stylized fact; the booms in Korea 94-98, USA 04-08 and Japan 85-89, after which all these countries experienced a huge slump and a painful recovery (too bad we can't see any Eurozone economies in there, particularly Britain, Ireland or Spain). 

Now look at China. One can argue it's only a matter of time before it's bubble bursts and China enters a large and painful deleveraging period (similar to what the West is going through now, and even more similar to what Japan had / is having in the past 20 years). When I predicted in a previous text that China is not far away from emulating the Japanese lost decade(s) scenario, it's slump could be even worse. The amount of malinvestment is just too high and is going nowhere, while credit growth is literally unstoppable. One can only avoid the basic laws of economics for so long. Just ask Europe. 

Monday, 12 August 2013

The pain in Spain

In June last year Spain received a €100bn bank bailout from the ESM, in an attempt to prevent a supposedly inevitable bankruptcy of its banking system, and consequently a default of its government. Recall the paradox of the situation I wrote about back then
"...who would buy the Spanish debt? Only the Spanish banks, as investors are fleeing from Spanish bonds. The big banks are also staying away from government bonds, afraid of being pulled in the turmoil. So the only banks buying government debt are the same ones that are being bailed out (!). That makes the current bank bailout in fact a government bailout – or a “credit line” to the government, to be more precise. (Technically the story is more complicated than that - even more so as the government will have to repay the European loans made to the banks, but the idea is essentially the same)."
Up around the same time, Cesar Molinas, a Spanish economist with experience in consulting, investment banking, and public administration, was writing his book on the Spanish political class that brought about the instability and degeneration in Spain. Acemoglu and Robinson, on their Why Nations Fail blog, pointed out to the work of Molinas who in an article for El Pais explained the central argument of his new book (already published, however in Spanish), on the institutional failure of the Spanish political class: 
"Molinas used the framework of Why Nations Fail to provide a penetrating analysis of Spain’s economic problems and how they have resulted from the political dynamics set in motion by the democratization in the 1970s."
As A&R point out, the problem of the Eurozone South (periphery) isn't culture, climate or religion, it's the extractivness of its political systems which have thrown their economies into the abyss - just recall the obvious and endemic corruption and negligence of domestic politicians in Italy or Greece before the crisis. Spain, according to Molinas, is no different. In fact in some aspects it might be even worse:
"...over the last few decades, Spain's political class has developed its own particular interest above the general interest of the nation, which it sustains through a system of rent-seeking. In this sense it is an extractive elite, to use the term popularized by Acemoglu and Robinson. Spanish politicians are the main culprits of the real estate bubble, of the savings banks collapse, of the renewable energy bubble and of the unnecessary infrastructure bubble. These processes have put Spain in the position of requiring European bailouts, a move which our political class has resisted to the bitter end because it forces them to implement reforms that erode their own particular sphere of interest. A legal reform that enforced a majority voting system would make elected officials accountable to their voters instead of to their party leaders; it would mark a very positive turn for Spanish democracy and it would make the structural reforms easier."
I can't shake off the feeling that this scenario as well as the potential solutions are applicable to a whole range of countries, not only of the peripheral Eurozone, but Eastern Europe as well. Read the whole article, it's very intuitive. Here are some mind-blowing excerpts from the text that to me seem all too familiar. 

First of he points to the problem of a dysfunctional electoral system:
"For a long time now, members of party youth groups get themselves on the voting lists on the sole merit of loyalty to their leaders. This system has turned parties into closed rooms full of people where ... the air does not flow, ideas do not flow, and almost nobody in the room has personal direct knowledge of civil society or the real economy. Politics has become a way of life that alternates official positions with arbitrarily awarded jobs at corporations, foundations and public agencies, as well as sinecures at private regulated companies that depend on the government to prosper."
The decentralization has also backfired, resulting in a rise of regional barons with substantial power, and the creation of regional savings banks which had a crucial role in the bubble preceding the crisis, all resulting in an endemic system of rent-seeking: 
"...the controlled top-down decentralization was quickly overtaken by a bottom-up movement led by local elites... As a result, there emerged 17 regional governments, 17 regional parliaments and literally thousands of new regional companies and agencies whose ultimate goal in many cases was simply to extend paychecks and bonuses. In the absence of established procedures for selecting staff, politicians simply appointed friends and relatives, which led to a politicized patronage system. The new political class had created a rent-seeking system - that is to say, a system that does not create new wealth but appropriates existing wealth...
...the regional "barons" accumulated power and ... became kingmakers within their own parties. This accelerated the decentralization and loss of control over the regional savings banks. Regional governments ... filled the boards with politicians, unionists, friends and cronies. Under their leadership, the savings banks financed or created yet more businesses, agencies and affiliated foundations with no clear goal other than to provide yet more jobs for people with the right connections.
Additionally, Spain's political class has colonized areas ... such as the Constitutional Court, the General Council of the Judiciary (the legal watchdog), the Bank of Spain and the CNMV (the market watchdog). Their politicized nature has strangled their independence and deeply delegitimized them, severely deteriorating our political system ... a political system in which institutions are excessively politicized and where nobody feels responsible for their actions because nobody is held accountable. Nobody within the system questions the rent-seeking that conforms the particular interest of Spain's political class. This is the background for the real estate bubble and the failure of most savings banks, as well as other "natural disasters" and "acts of God" that our politicians are so good at creating. And they do so not so much out of ignorance or incompetence but because all these acts generate rent."
The bubble was just a disaster waiting to happen:  
...City planning is born out of complex, opaque negotiations which, besides creating new buildings, also give rise to party financing and many personal fortunes... As if this power were not enough, by transferring control of the savings banks to regional governments the politicians also had power of decision over who received money to build. This represented a quantum leap in the Spanish political class' capacity for rent-seeking..." 
There are many more examples he points out to, including the renewable energy paradox and the traffic infrastructure projects, all financed by the savings banks that are now bankrupt, meaning that no one but the taxpayers can take on the burden of the debt they left behind. Finally, some discouraging words on the Spanish extractive political system: 
"Spain's political class, as an extractive elite, cannot effect a reasonable diagnosis of the crisis. It was their rent-seeking mechanisms that provoked it...  
Spain's political class, as an extractive elite, cannot have any exit strategy other than waiting for the storm to pass. Any credible long-term plan must include the dismantling of the rent-seeking mechanisms that the political class benefits from. And this is not an option. 

Spanish political parties share a great contempt for education, innovation and entrepreneurship, and a deep-seated hostility towards science and research..."
I think the author has perfectly portrayed the culprit behind not only Spain's distress, but Europe's in general: politics! Or more precisely, an extractive political system that cares only on satisfying their own cronies and interest groups that keep them in power. Perhaps the crucial reform Europe needs is a political one, focused on dissolving the chain between political and corporate elites, and various parasitic interest groups living off political favors. Then it will be much easier to improve competitiveness and productivity, and restore growth. I hope the book gets translated into English soon. From the looks of it, it could be a very interesting read.

Wednesday, 7 August 2013

The Big Data Makeover of the US economy

There has been a lot of talk recently on the newest data revisions of some of the main US economic national accounts. The US Bureau of Economic Analysis (BEA) has revised the methodological definition of how they measure gross domestic product and has adjusted the previous US GDP data all the way back to 1929. As they usually do once every five years. The change this time is an expanded definition of investment to include intangible assets, thus adding 3.6 % to the size of GDP in 2012 (around $560bn). The revision seems reasonable enough; the BEA wanted to include all the benefits of innovation, R&D and things like intellectual property, software and even entertainment, literary and artistic originals. Certainly things the US is abundant of, and certainly things that contribute well to the US domestic output. R&D by itself added 2.5% to overall output (see graph below), as it is not anymore in the 'cost of producing other products' category. There were a number of other small revisions as well, even for some older years. You can read them all on the BEA pages. In addition, FT Alphaville has a very good guide on GDP revisions and what they really mean. The Financial Times also reports some charts that signal this significant makeover.

Source: Financial Times
The biggest piece of news from the revisions is that the Great Recession of 2008-09 wasn't that "Great" after all. It appears to have been shallower than perceived, and followed by a more stronger recovery. The decline in 2009 was apparently only 2.8%, where the 0.3 percentage point upward revision was due to changes in unpriced banking services (the value of service for holding bank accounts).

In terms of real GDP growth, things have changed as well. In 2010 growth was revised upwards from 2.4 to 2.5%, stayed the same 1.8% for 2011, and revised upwards from 2.2% to 2.8% in 2012. The average growth rate from 2009 till 2012 (since the start of the recovery) is still a mere 2.4%. For a robust recovery it needs to be above the trend for a couple of years in order to get back on it. Unless of course the US is on a completely new trend line, and on a completely new equilibrium path. Btw, the average annual growth rate of real GDP from 1929 to 2012 was 3.3% (the benchmark trend line).

Source: Financial Times
An important change is also in the personal savings rate, now slightly higher than before. The upward revision was about 1 percentage point higher. The reason is the way they account for pensions. Before the BEA only counted direct pensions payments, but now they calculate the full value of all pensions promised, as well as the interest on the part that wasn't paid. The real question is will this induce consumers to spend more? Not likely. This is a purely methodological revision. It doesn't mean the people suddenly have more money. It just means it's accounted for differently. Consumers (and businesses btw) still have the same expectations of future income and they still face the same constraints as before - huge household debt and massive deleveraging. So even though the savings rate is now calculated to be higher, this doesn't imply a reversal of the savings rate trend nor the reversal of the deleveraging process (more on that here).

Source: Financial Times
Finally, have in mind that the measure of gross domestic product in itself is hardly the perfect measure of economic well-being (growth rates are different, they suggest the overall trend of the economy). This is precisely why GDP is often subject to revisions. However even with all the revisions there hasn't been any dramatic effect on the overall patterns of economic activity, nor historically, nor during this business cycle. And frankly, any number of methodological revisions of national accounts are hardly going to persuade people that we in fact did have a robust recovery, and that the economy is doing pretty well at the moment. Maybe it is, maybe this is the new normal for the US, or maybe it's just a temporary restructuring and respecialization. In terms of consumer and investor confidence, revised data from the BEA won't make people or businesses spend again. Only policy changes in terms of cost-cutting incentives can do that.

Friday, 2 August 2013

Is there a new employment-population curve in the US?

The monthly unemployment report for the US came out today from the Bureau of Labour Statistics. Here's a summary from the NYT:
America’s employers added 162,000 jobs in July, fewer than expected, as the unemployment rate ticked down to 7.4 percent. 
The job gains reported by the Labor Department on Friday, were concentrated in retail, food services, financial activities and wholesale trade. The manufacturing sector gained 6,000 jobs; government employment stayed basically flat. 
While July represented the 34th straight month of job creation, the relatively strong employment gains were still not on track to absorb the backlog of unemployed workers anytime soon. At the recent pace of job growth, it would take about seven years to close the so-called jobs gap left by the recession, according to the Hamilton Project at the Brookings Institution.
We have yet to see how the Federal Reserve will react according with their QE infinity program, since the job growth is positive (almost double than a year ago), however still slightly below expectations. 

As always, due to the potential bias from the usual way unemployment data gets reported, I look at the employment-population ratio, trying to find real signals of recovery. 

Source: BLS
Unfortunately, the E-P ratio curve is still flat. As it has been for the past three and a half years, averaging around 58.5 percent, down by around 5 percentage points since the 63.3 percent peak in early 2007. 

The employment-population ratio is, in my opinion, a better estimator of labour market strength than the usual unemployment rate, as it includes all discouraged workers into the equation - an issue that became rather important during the current crisis, where a lot of people simply decided to stay out of the labour market due to poor conditions. This significant drop (which we can see in the graph from the beginning of 2008 to the end of 2009) still hasn't been reversed, meaning that even though some of the people who lost jobs in the crash got them back, others (e.g. new entries) are still reluctant to entering the market. There is also a matter of many elderly workers choosing early retirement, in addition to many old inefficient jobs being lost, while the process of rediscovering new skills and specialization patterns is rather slow. Which is why the curve remains flat. Hence this provides the best piece of evidence to stimuli advocates that their methods haven't really worked.

However, should we be looking at the curve from a different angle? Let's assume that the 2008 shock was a structural shock that finally changed the demand for certain jobs and certain industries in the US (following years of avoiding to deal with the new trends). If this is true then the trend of the E-P ratio curve is as expected, since the market is now in the process of long-term adjustment to the new structural trends in the economy. If this is true, then we shouldn't anymore compare the pre-shock E-P ratio with the post-shock E-P ratio. Furthermore we should stop worrying when our economy will come back to its pre-crisis trend (employment or GDP). It won't. Particularly if we accept the premise that the 2008 shock wasn't a typical AD shock that happens every now and then. 

The new E-P curve then looks something like this (drawn from January 2010 to July 2013): 

Source: BLS data
And it does seem to show some positive signs of a recovery in the past few months, even though the trend is still inconclusive. As long as the process of re-specialization doesn't get prevented by various interest groups seeking political protection, the trend in the labour market will turn positive. Both in the US and in Europe, which has yet to arrive at this stage of progress.