America’s New Growth Strategy
Michael Spence, Nobel prize winner in economics, argues that in order to compete with developing countries, such as China, which concentrates on labor-intensive manufacturing, the US must instead create new capital-intensive jobs with higher labor productivity. The exports from the US and exports from developing countries are not necessarily substitutes. (source: FT)
America needs a growth strategy
By Michael Spence
As the International Monetary Fund warned on Thursday, America’s economy shows worrying signs of weakness. Worse, and in common with other developed countries, it also lacks a credible strategy for longer-term growth. Without such a strategy, a strong global recovery is unlikely.
The structural evolution of the US economy over the past 15 years has been driven by excess consumption, enabled by debt-fuelled asset inflation. The crisis put a stop to this, but structural deficiencies remain. America’s export sector is too small and underdeveloped. The financial sector became outsized, and is down-sizing.
A pattern of underinvestment in infrastructure has left the economy less competitive than it should be. Energy pricing issues have been ignored, causing underinvestment in urban infrastructure and transport. The education system has widespread problems with efficiency and effectiveness. Elsewhere, state budgets are in distress as a result of insufficiently conservative budget policies.
Even with a fiscal strategy that balances short-term stimulus and longer- term stability, America must still address the composition and size of expenditures, investments and revenues. To finance growth-supporting long-term investments, domestic private consumption has to shrink. This means higher taxes. In addition, existing government expenditure must be shifted away from consumption and towards investment, meaning fewer government services. Restoring fiscal balance in a way that supports longer-term growth will therefore be painful.
But even that is not enough. The real issue is employment: not just stubbornly high unemployment, but a bigger problem described recently in a thoughtful article by Andy Grove, the long-time chief executive of Intel. He argued that manufacturing is vanishing in the US, a trend that must be reversed. The question is how.
There is little doubt that America’s social contract is starting to break. It had on one side an open, flexible economy, and on the other the promise of employment and rising incomes for the motivated and diligent. It is the second part that is unravelling.
Incomes in the middle-income range for most Americans have stagnated for more than 20 years. Manufacturing jobs are moving offshore. Globally the set of goods and services that is tradable is expanding, but the US and other advanced countries are not competing successfully for an adequate share of the tradable sector.
The employment effects of these trends over the past 15 years have been masked by excess consumption and the overdevelopment of sectors such as finance and real estate. The latter are now set to shrink, as multinational companies grow where they have access to high-growth emerging markets in Asia and Latin America. Such companies will locate their operations where market and supply chain opportunities lie. In the tradable sector, in manufacturing and in a growing group of services, that means outside advanced countries.
The availability of low-cost, disciplined labour forces in developing countries reduces the incentive for these companies to invest in technologies that enhance labour productivity in the tradable sectors of the advanced economies. As a result, the evolving composition of advanced economies is increasingly weighted towards the non-tradable sector, combined with a set of high-end tradable services where both human capital and proximity matter. The rest of the tradable sector is shrinking.
The shrinkage creates problems. Over-specialisation could threaten independence and national security. Spillovers between R&D, product development and manufacturing will be lost if manufacturers leave. Employment will stagnate. Income distribution will move adversely and the social contract will erode further.
Solutions to these problems are not easy to find. The unequal distribution of income can be dealt with through the tax system, although this does not attack the underlying problem. Protectionism could alter the pattern of out-migration of manufacturing, but only by imposing costs on domestic consumers and risking the breakdown of the open global economy model.
To avoid an outbreak of protectionism, there has to be an alternative. President Barack Obama’s new export council, announced on Wednesday, is a step in the right direction. But a bolder move is needed: a broad public-private partnership to invest in the development of technology in parts of the tradable sector where there are opportunities to make advanced countries competitive. The goal must be to create capital-intensive jobs that have labour productivity levels consistent with advanced country incomes.
Would this damage developing countries? Clearly not. The US (or even developed economies combined) does not have hundreds of millions to employ. A targeted programme would leave the vast majority of labour-intensive manufacturing right where it is now: in the developing world. With new credible growth strategies in America (and other advanced countries) developing countries may even be willing to play an important complementary role in restoring global demand through, for example, the reduction of excess savings.
We are already on a lengthy and bumpy road to a new normal. That is unavoidable. The risk is that without a new direction in American economic policy, the new normal may be as unpleasant as the journey.
The writer received the 2001 Nobel memorial prize in economics and chairs the Commission on Growth and Development
Cash rich yet subpar growth
I have been hoping that cash-rich US corporates will find new investment opportunities and help to drive the US economy into a “virtuous cycle” – positive corporate profits lead to improved employment and more labor income and more consumer confidence then more consumer demand. But there are signs that maybe the opposite is more likely to happen. Facing huge “unusual uncertainties” (Bernanke’s words), US firms, after completing their first inventory buildup, which has contributed to growth so far, now are unwilling to spend more on capital investment: they are looking at a prolonged unemployment scenario and consumer demand is likely to take very long time to recover. What the US needs now is how to sell more to overseas – for that, the US needs a new export strategy (I will come back later for this topic).
Here is a piece from WSJ today discussing the uncertainties the US firms are facing:
Here’s a puzzler for investors: Although second-quarter economic growth figures look rather weak, corporate earnings are nevertheless coming in reasonably strong.
Specifically, about a third of S&P 500 companies have released their second-quarter earnings so far, and 78% of them have beaten analysts’ estimates, according to Thomson Reuters. On average, earnings per share are up 42% year-on-year, compared with the 27% growth expected.
![[AOT]](https://sg.wsj.net/public/resources/images/MI-BE765_AOT_NS_20100725155235.gif)
Yet the market’s response so far has been lackluster. The S&P 500 is up only about 1.5% since the first earnings report July 12. It is hard to argue that such results were already priced in, as the market dropped by about 11% in the 10 weeks prior to earnings season. Why, then, the muted reaction?
Chalk it up to what Federal Reserve Chairman Ben Bernanke dubbed the “unusual uncertainty” over the economic outlook. For every upside surprise in corporate earnings, it seems there’s a disappointing piece of economic data.
The Commerce Department doesn’t release its tally of gross domestic product until this Friday, but it is expected to come in below the first quarter’s 2.7% annualized pace. Goldman Sachs economists last week cut their second-quarter GDP growth estimate to 2%, for example, and expect further slowing to 1.5% in the second half of this year. Moreover, they put the odds of another recession, or “double-dip,” at about one in four.
A double-dip would certainly wreak havoc on profits. But it increasingly looks as though the more likely outcome is that the U.S. economy muddles along for a while at roughly 2%, below the 3% average of the past two expansions. That doesn’t necessarily spell disaster for corporate profits.
For investors, the mixture of healthy, cash-rich corporate balance sheets but subpar growth “is not one we have a lot of experience with,” notes Credit Suisse U.S. Equity Strategist Douglas Cliggott. One likely outcome, he says, is that a higher share of total S&P 500 returns come from dividend yield as opposed to price appreciation over the next few years.
Indeed, companies like Procter & Gamble and McDonald’s may not be the most thrilling names on Wall Street. But with their above-3% dividend yields, they probably offer the best seat for investors to ride out the recovery.
Fear of double dip – How real is it?
A very nice debate from CNBC’s Kudlow:
Also read my previous post on the argument for the potential of businesses driving this recovery, “Can Corporate America Carry the Spending Torch?“.
Job picture is worse than you thought
Richard Barley at WSJ compares job loss in this recession to historical trend – the result is astonishing.
![[godek]](https://sg.wsj.net/public/resources/images/ED-AL908A_godek_NS_20100722182105.gif)
The number of nonfarm private jobs has been growing steadily since the 1950s. That number reached a peak at the end of 2007. Between 1958 and 2007, the number of U.S. jobs grew to 115.4 million from 43.5 million—about 2% per year on average. The steady upward trend reflects the long-run growth of the economy and increased participation in the labor force.
The chart compares employment and that trend. It shows the percentage difference between employment and the trend line generated from monthly employment figures over the past 50 years (July 1960 through June 2010).
What we see is astounding. For almost 25 years—between 1984 and late 2008—the level of employment never fell to more than 3% below the trend line. Over that period, total employment grew by more than 36 million.
Employment fell briefly to about 6% below the trend during two previous recessions: in 1975 and again in 1982-1983. During those periods, the unemployment-rate peaks were 9% (in 1974) and 10.8% (in 1982). The unemployment rate in 2009 peaked at 10.1%.
By 2010, however, employment had fallen to about 10% below the trend, far below any previous level in the last half-century. These figures indicate that as of the first half of 2010, the economy has generated about 12 million fewer jobs than expected. In other words, things are not as bad now as they were in the early 1980s; they are much worse. Recall as well that the unemployment rate of the early 1980s was the result of the ultimately successful battle against inflation.
update: 07/25/2010
Here is another disturbing chart looking at long-term unemployment in historical perspective (source: Greg Mankiw, click to enlarge)
Defects of finance reform bill
Gary Becker lists the major defects of Dodd-Frank finance reform bill.
Are you ready to bet on China’s successful restructuring?
Anthony Bolton, the fabled British stockpicker, is staking his reputation on a £460m ($702m) bet that the Chinese economy is shifting away from exports and towards domestic consumption.
Mr Bolton’s bullish stance pits him against big-name investors such as Hugh Hendry, head of Eclectica Asset Management, and Marc Faber, author of The Gloom Boom & Doom Report, who are betting that the Chinese economy will crash.
China’s Western Push
From 2000 to 2009, Chinese government has invested $325 billion in West China, and it promised to invest $101 billion for year 2010 alone. The push westward continues…(WSJ, 07/10).
China's push westward continues. Just don't confuse it with a major new stimulus effort.
Beijing this week announced the country's western region would see $101 billion of investment this year. That has some wondering if China's starting up a new fiscal stimulus, to follow the $586 billion spending plan announced in late 2008. That's inflating expectations too far.
For a start, it's not clear how much of the $101 billion—to be spent on 23 projects from airports to power plants—represents fresh spending. As Capital Economics points out, much of this could simply be a rehash of projects that were included in China's previous stimulus plan.
Moreover, investing in China's western region has been a long-term government project dating from the beginning of this century. From 2000 to 2009 the government announced some $325 billion worth of new investment projects in the west of China as part of a strategy to develop the region. The latest announcement should be seen in that context, rather than evidence China is gearing up for a new stimulus plan, even if this year's spending is the highest in one year in the past decade.
Nonetheless, it's likely there will be more government unveiling of "new" investment in the coming months, triggering talk of a second fiscal stimulus. Such announcements are inevitable in one sense: Plenty of projects begun in the 2009-10 period will need ongoing funds to bring them to completion.
More importantly, despite policy maker efforts to raise the share of household consumption in China's economic mix, government investment is going to remain a key element for some time yet. As UBS economist Tao Wang points out, if China's government pulled back on investment spending in the near future, "infrastructure investment would collapse and overall economic growth could drop sharply."
Further investment spending in China is both a necessity and an inevitability, not a novelty.
Why banks ain’t lending
Why American banks aren't lending out the cheap money? Credit risk or supply shortage? The following WSJ article offers some great insights.
Making money too cheap carries danger. First, it fueled the housing bubble. Now, counterintuitively, it may be crimping an economic revival. That wasn't the plan. By cutting rates to near zero, the Federal Reserve helped forestall economic collapse. Yet with the recovery flagging, some worry that super-loose monetary policy may actually turn the Fed into an agent of deflation.
At issue is why banks aren't lending, especially to small businesses that are the engine of growth. One answer is there isn't demand for loans. Clearly, that is a factor. A lack of loan supply, though, also may be playing a role—and not just because credit risk is high.
Ronald McKinnon, a Stanford University economics professor, argues that near-zero rates gum up the interbank market, which crimps lending growth. He reasons that bigger banks aren't lending to smaller ones because the derisory yield on offer doesn't compensate them for lending to potentially risky counterparties. That is a particular problem, he says, because many small businesses borrow through lines of credit. Banks won't extend these unless they know they can tap the interbank market at a later date. The amount of inter-bank loans outstanding was about $160 billion at the end of May, down 60% in a year, according to Fed data.
![[FEDHERD]](https://si.wsj.net/public/resources/images/MI-BE376_FEDHER_NS_20100705175714.jpg)
The result is a scarcity of loan supply, says David Malpass, president of research firm Encima Global. "Banks claim that there's a lack of demand, but it's a two-way street."
Banks, meanwhile, are trimming lending more broadly and hoarding funds. Their May holdings of Treasury and other government-backed debt rose 19% compared with a year earlier, Fed data show. Commercial and industrial loans fell 18%.
Smaller companies have been hit hardest. In the first quarter, debt outstanding for small businesses fell by about $70 billion, according to Fed data, even as larger companies saw debt increase by $100 billion.
The reluctance to lend is understandable. Banks can borrow cheaply and earn a handy profit investing in higher-yielding, government-backed debt, in what is known as the carry trade. That contrasts with the impact of near-zero rates on investors, who were pushed into riskier assets by the pain of no yield on cash.
Making money more expensive would risk harming the economy as some companies and individuals paid more on their floating-rate debt. But it could feasibly compensate banks to lend more in the interbank market. Meanwhile, banks would face shrinking profits from their safe carry trade, potentially encouraging them to seek higher returns from traditional loans.
In that case, "raising rates could actually have an inflationary impact," says Joseph Mason, a finance professor at Louisiana State University.
Even today's experimental Fed is unlikely to embrace such an unorthodox approach. But the central bank needs to consider the unintended consequences of its super-aggressive monetary policy.