Monday, February 14, 2011

Why we keep spinning our wheels

In economics there is always a lot that we do not know. But it is just as dangerous to ignore what you do not know as to let others know what little you do know. Doctors are good at this. We have some of the poorest nutritional guidelines and most doctors buy into them even though they are wrong. But doctors do not brook renegades. Being a doctor is about respect and you get that by staying in line. So in the science of nutrition we have a great stagnation but doctors who are giving bad advice on diet and exercise continue to be revered. Is that a better state of affairs than we have in economics? Maybe not with the except that most people are unaware of it..

In economics this problem of knowledge and credibility manifests itself in two ways. There are the arrogant ‘you’re wrong and I’m right’ economic presentations. And then there are the ne’er do well know-nothings that offer competing forecasts based on odd-ball contrarianism since, hey, even brainy economists don’t know it all- maybe they don’t even know enough (...to make themselves useful).

The lack of a real perceived wisdom in economics has manifested itself in another sort of perversion which is the politicization of economics. Economists have gotten to be like lawyers. They are in fact the expert witnesses of politicians. They are on one side or another and become the talking head du jour for the cause du jour of the politician du jour. Economists like politicians are divided into schools of thought. You know the conclusion of their research before you read their studies. Like politicians you know where economists stand on an issue, before they answer the policy question.

What this has led to is a lot of confusion. We need to get back to economics and to deal fairly with what we know Vs what we THINK WE KNOW and what we NEED to know.

For example, in my view all this warning about double dip in this recovery was very little about anything we knew. The misplaced worry has served to make the recovery weaker. Democrats, not appreciating the extent of the weakness, attacked the problem with half-effective stimulus program that favored spending that benefited its constituents. The President worsened matters by denying it was a recovery from the VERY FIRST DAY because he wanted to rub the Republican’s noses in ‘their’ recession. That kept people for shifting gears into an optimistic mode.

But on closer look it was the Democrat controlled banking committees that oversaw Fannie and Freddie and pushed them to lending standards that set this crisis in motion in the name of ‘broadening home ownership’. Ratings agencies that wanted fees more than than truth did not help. Banks that wanted their fees and played a treacherous game of hot potato with bad credits were another feature as were the clueless foreign investors. Fed Chairman Alan Greenspan contributed to the view that a house was a house and that even with all the new-fangled lending rules their future behavior and stable investment characteristics would remain the same –against all logic.

Wrapping a bow around and slapping a nice label on a septic tank does make it a nice gift for the one you love. Do not go there this Valentine’s Day. Yes we can find many failings to explain the crisis. But don’t excuse those who have opinions for fees on any level. Don’t think for one minute one party was responsible and the other was not. Don’t think that anyone has been focused on what to do to help the RECOVERY be the best possible. It has been about politics and factions and ideology.

Independent thought and opinion is very little sought out on Wall Street- I can attest to that in my own business. Investors want the current spin and to stick with it. The lesson of the last financial crisis is that there is safety in numbers and in size as well as in sophistication even when it isn’t at all safe at all. A good ‘bad business model’ is like a tumor with more tentacles than can be safely removed. The patient must learn to live with it until it becomes too debilitating. That is what derivative mortgage products were.

So if we now try turn our heads to the economy and what is wrong what do we find from the conventional wisdomists? To the extent that there is a consensus it is this: the economy is too slow. It won’t create jobs. We need more growth. Consumers have been sitting on their wallets and so on.

WRONG. Wrong. Wrong.

Here is a fact a FACT that will amaze you. There is a set of data on GDP that segments the economy into goods and services and structures; it does this for the whole economy not just consumer goods. If we take these data and covert them to indices in the various business cycles guess what we find?

Are you ready?

This recovery, yes this weak and feeble recovery, has produced the SECOND strongest PERCENTAGE increase in GDP-goods of any recovery from the 1960 recession’s recovery onward. Only the recovery from the 1981-82 recession was stronger for the goods sector. Yes, the goods sector in the 2007-2009 recession’s recovery has been better than the 1973-75 recession’s expansion. At the six quarter mark this recovery’s net output of goods lags behind the strongest recovery’s goods output by 17% but is ahead of the next best spending and output by 28%. This has been very impressively strong. GROWTH in spending and output HAS NOT BEEN THE PROBLEM. The problem has been the composition of spending and output.

While Republicans and Democrats chew at one another’s ankles like packs of rabid rats, the truth of the expansion and the economy has gone unheeded and the remedy unexplored.

The truth of the expansion and its disappointing nature is this: the expansion from the 2007-2009 recession has seen the greatest weakness in the services sector of any expansion since at least the 1960 recession. Services spending in the sixth quarter of the expansion is up by 1.3% compared to an average of 5% at this time of the expansion for previous cycles and a median gain of 4.6%. Even the two ‘weak’ recoveries from the 2001 and 1990 recessions posted service sector spending gains of 3.2% and 4.2% respectively at this same time of their respective cycles. What are we doing to kill off growth in our jobs producing sector? This question should be on everyone’s lips. It’s not just that we can’t create jobs but that we are killing growth in the sector that creates jobs best.

So the real question should be not why is spending so weak but why is spending on SERVICES so weak? Until we ask that question we will get nowhere. That is THE crucial question since that is the sector where the jobs are- and for now aren’t.

When you spend a dollar on goods its impact on the economy is deflected almost immediately. Economists call this a leakage. There is a leakage of income abroad because some of the goods you buy were made overseas so the payment to some of the factors of production geos to an overseas entity. Thus ‘leakage; out of the US spending stream diminishes the multiplier for domestic expenditure. Moreover, if you buy a good the proportion of the spending that stays here is more substantially due to the efforts of capital than to labor (in comparison with spending on services). There is less in the way of job creation when monies are spent on goods in place of services even looking just at domestic dollars spent. So if jobs are the issue you want monies spent on services where nearly 100 cents on the dollar spent stays here in the US and in a sector where productivity is lower. Lower productivity means that when you expand that sector you naturally create employment. That sector’s growth has been cut short in this cycle.

So that is the problem. Have either Republicans or Democrats offered solutions based on stimulating services-based businesses? NO. But since services business are land-bound the increased focus on property taxes and mandatory medical coverage (remember these are people intensive businesses) have hurt the services sector relatively more. A manufacturer can locate a plant overseas to avoid these costs or a firm can outsource some production but services cannot do this because they tend to be point-of-delivery operations.

I am against the FORM of this medical ‘reform.’ If heath care is important and if it is construed as a modern ‘right’ then it must be provided and paid for... But why saddle employers with that cost when employers use labor unequally? Doesn’t anyone recognize that when you tie costs to labor it makes labor relatively more expensive and firms will opt away from that added cost? This division in the growth between the two key economic sectors (goods VS services) is all the proof we need that making labor more expensive is a really crappy idea.

When we look at the role of healthcare ‘reform’ on labor costs remember that the program did not save us any money it will cost us money. It pushed more responsibilities on to businesses. Legislation should NOT be permitted to legislate its own cost estimates as this bill did and tie the hands of analysts at the CBO. There are some things we do know about economics and when we do our analysis we should reference those things rather than being prohibited from using them.

When we take on this idea of adversely impacting growth it opens a real can of worms. One added thing that may never be changed is the idea of taxing income. But let’s begin to challenge the idea that taxing income is good or even fair. In a study offered up in early 2009 the folly of income is clearly revealed (see links below).

These studies show that to live the life style of a $123,000-a-year middle class person in Manhattan you need only make $50,000 if you live in Houston Texas…Houston I think we have a problem, to quote Tom Hanks (in Apollo-13 out of context, of course)… or $63,400 if you are from Chicago (Mr Obama), or $72,772 if you are in Boston (Mr Frank)...even living in Queens NY cuts your cost to $85,918 compared to being in Manhattan.

If this is true what are graduated income taxes all about? The regional differences in the cost of living explain a great deal of the variation in incomes. So why treat a guy in Houston at $50K as struggling and guy in Manhattan at $125K as rich?

And what is rich?

Oddly, ‘rich’ is a stock concept and ‘income’ is a flow concept but to get at the rich someone decided to attack income. Interestingly many of the people who make high incomes this year are not the same as the ones who made it the last year. There is a great deal of turnover in the high income ranks- not the upper-upper tiers - but in the space between middle class and ‘THE Rich’ where ’affluence’ comes in varying shades of gray. That’s yet another reason not to tax high incomes. Let the poor guy who makes a high income for one year in five keep more of it.

There is also the need for tax reform for a lot of small businesses that are not incorporated and whose owners apply the individual tax rate. Their treatment should be different under the tax laws than that of the investment banker who is an employee and earns big bucks but who employs no labor. When you hike taxes on the small businessman that does directly go to his bottom line and affect his hiring decision. May of these small businessmen log incomes that count them as ‘rich’ when, in fact, they employ a lot of capital and labor in order to earn their pay.

On balance I hope I have used this space to OPEN SOME EYES. This is not about being a Republican or a Democrat. I dislike both parties. I have been a member of each of these parties at different times in the past. I think John Adams was right and we should not have used them. But now that we have THEY OWN US. The US political system is a duopoly (with some respect to the Tea Party) and it acts like it.

We need to look at what we have become and how this has affected what we are and our economy is. We need to look at it through the clear lens of analysis not from the perspective of a partisan. Banks that everyone claimed were responsible for the financial crisis have recovered first, have gotten the most government help and have restored their bonus pools to what they were in the days of olde. How can that be? Yet people still tell me it will be years before banks are willing to lend freely again because of all the damage done to them in the recession and financial crisis… how is that? Are those low interest rates just feeding banker bonus pools?

What have we created? Why is our political system so little for the people? Why are so many elected representatives millionaires? Why is there no clear analysis brought forth on what the problem is? Why to our elected officials go to Washington only so they can get elected again instead of to enact reforms? Why do we elect such gutless self-centered wonders that they will not look at the facts of an over generous unaffordable Social Security system and deal with how to make it solvent again?

It is not true that we ‘cannot solve our problems’. It is because our leaders will not face them that we do not even address them. They will not admit we have them because if they did they would have to fix them. And if they did than we, the electorate, would get angry and we would not re-elect them. So there it is. It all comes back to us and for whom we vote. And I don’t think it is as simple as elect a Democrat or elect and Republican or to dis-elect an incumbent. It’s much more complicated than that. And as voters we need to figure it out.

Soon.

End for now

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