FREE TRADE...IS IT BAD FOR THE U.S. ECONOMY?

Of course not! Contrary to public opinion, free trade is a boon to the economy and a real benefit to consumers. It gives consumers more options in the goods and services they can purchase; it expands the markets within which businesses operate; and generally, it lowers prices to consumers too. In fact, free trade is the only issue on which virtually all economists agree.

But still you find some economists who oppose free trade. They very likely represent the vested interests of a narrow group of businesses, or perhaps a labor union trying to protect its workers from lower priced and more efficient foreign competition. Usually, what gets lost in all the discussion, are the benefits to all consumers. At this moment, in fact, the Senate is discussing passing a bill to grant President Obama "fast track authority" to make trade deals and those Senators objecting to the bill are liberals who are supporting narrow business interests.

Among consumers there is a lot of misguided and confused talk about foreign trade. On the one hand, many complain about all the foreign goods that are invading our shores and stores, and of the jobs we are losing to foreign competition. Today the complaints are mostly about China, but we should recall that a few years back the complaints were about Japan. On the other hand,  many of those consumers go cheerfully to those same stores to buy imported goods that are significantly lower-priced, and perhaps higher quality, than the alternatives made at home.

That which is seen, and that which is not seen

Frederic Bastiat - 1801-1850

About 165 years ago, the French economist Frederick Bastiat cleverly explained the reasons why many people oppose free trade. Bastiat put it in terms of what is seen and not seen. Upon opening borders to foreign competition some specific businesses may be forced to close and lay off workers, because they can't match that competition either in prices,  quality or both. This is what is seen- people observe that and immediately conclude that free trade is bad. We can all point out to examples, recent or not, where businesses have closed and workers became unemployed because of foreign competition. But those foreign products, at lower prices and/or better quality, can now be enjoyed by everybody. All consumers benefit from this, and this is what is not seen.

The important lesson from Bastiat, one that even some economists ignore today, is that when analyzing the economic impact of some action, we must look not only at the immediate, visible effects. We must look deeper at any subsequent, delayed effects that are not immediately apparent. In most cases, those delayed effects contradict and overwhelm the "seen" impact of the immediate effects.

What do the data reveal?
But first, let's take a look at some figures. As the rest of the world inevitably has become more industrialized and economically advanced, the U.S. global dominance in all economic matters has waned, naturally- this is seen as a reason for objecting to free trade. But in reality it is not a case of us losing ground; rather other countries are becoming more advanced and are gaining. But in the end we are all better off, much better off.
We only need to look at our imports and exports. The chart "U.S. Trade as a Percent of GDP" shows that while exports and imports were about 5% of GDP in 1969, today they are 13% and 17% of GDP, respectively. And the foreign trade share of GDP has grown in tandem with U.S. GDP growth. How can trade be a bad thing then?

This level of trade represent about three trillion dollars of foreign goods that we now have access to here in the U.S. For instance, while in the 50s or 60s we had only four choices of automobile companies (Ford, GM, Chrysler and American Motors- who remembers?), many of them offering cars of perhaps low quality, today we can choose from dozens of manufacturers coming from a multitude of countries. We have a multitude of choices in terms of types, quality, prices, etc.

What about the trade deficit?
But, you will say, we are running huge trade deficits, we are losing while countries like China are winning at our expense. This is not true- we are not losing and they are not winning. We are both voluntarily exchanging one thing for another. When we import goods or services from another country, say China, we give either dollars or IOUs in exchange. We get the cars, bicycles, or whatever we imported and they get pieces of paper. Are they richer and we poorer now? No, of course not. We have things now that we wanted more than those dollars, and they have the dollars or IOUs. But they can't eat those paper documents, they have to spend them either today or sometime in the future.
So, as long as they are willing to hold those IOUs (typically U.S. government debt, shares in U.S. companies, etc.) nothing happens. They are earning a modest rate of return on the IOUs and we only pay that interest due. This is what is called the "capital account" surplus.
If at some point in the future they decide to get rid of those IOUs, we will see an impact on the dollar exchange rate.

WHY DO WE IGNORE BUSINESS INVESTMENT?

Gross Domestic Product, or GDP, is commonly thought to reflect accurately the value of all goods and services provided in an economy. In the GDP model, the economy can be viewed simply as the result of adding the dollar value of five components, typically shown in the formula given below.

GDP = Consumption Spending + Investment + Government Spending + Exports - Imports

From this formula it follows that if we want to increase GDP, we only need to maneuver or increase one of its components. This explains why during and immediately after the 2008/09 recession there was a rush to increase government spending, on the misguided assumption that this would increase automatically GDP and get us out of the recession. President Obama, working with Congress, pushed through the so-called stimulus bill (the misleadingly named "American Recovery and Reinvestment Act") that called for spending of more than $800 billion by the Federal government. It was assumed that this boost in government spending would bring the economy rapidly out of the recession. The spending bill actually included several tax provisions too.

As we now know, and a few sage economists knew before, the much anticipated boost in GDP did not happen. Average GDP growth over the last six years, that is since 2009 when the stimulus spending bill was passed, has been a measly 1.4%. In contrast, the average growth of all previous economic recoveries since the end of the Second World War has been over 4.0%.
We have multiple examples, besides the recent U.S. experience, where boosting government spending has not resulted in a much heralded economic boom. Rather, the opposite has been the case, as in Japan where continuous bursts of government spending over the last 25 years have not pulled that country out of its dormant state.

Increased Government and Consumer Spending do not Lead to Growth

Given all this evidence disproving the presumably beneficial effect of government spending, it is mystifying why this approach continues to grab the attention of so many economists and businessmen.  Two plausible reasons appear to be self-interest and the burden of knowledge. Self-interest because of the benefit, direct or indirect, to those propounding government spending (the crony capitalism syndrome). Burden of knowledge because of the intellectual investment they may have in those theories and their reluctance to accept an alternative explanation of how a market economy works, thereby discarding their belief in incorrect theories.

As far as government spending goes, it's easily seen that what the government spends are funds not spent by consumers. When governments engage on additional spending, they are taking funds away from the public; either immediately in the form of taxes or in the long-run because of the new debt incurred to sustain that spending. Similarly, consumer spending does not lead to growth- at best it simply maintains the same level of goods flowing into the economy.

The Key to Growth: Savings and Business Investment

But the one element of the simplistic GDP formula above that is often neglected, investment, is the key to economic growth. It is only through investment, obtained from the savings of individuals and businesses, that real economic growth results. Most of us remember the example of Robinson Crusoe discussed in our first economics course. The purpose of bringing Crusoe to class was to explain how one day Crusoe decides not to consume all the berries he harvests (or whatever it was), and save some for a future day when the saved berries will allow him to spend his time developing a tool; a tool that will make it easier and more efficient for him to harvest berries in the future. This is the act of saving and investing that is so crucial for economic growth. But also this is the act that seems to have been forgotten in the efforts to generate growth without any effort.

There are many examples of the role investment plays in economic growth and development. We need to look no further than the Chinese economy to appreciate fully the value and impact of investment for economic growth. The phenomenal growth in the Chinese economy over the last 30 years did not result from spending by the Chinese government.  Yes, freeing up markets (to some extent) and allowing for investment to take place. This investment in capital good (facilities, machinery, etc.) is what trigger such spectacular growth. The savings came initially mostly from the Chinese diaspora in places such as Hong Kong, Singapore and Taiwan; most recently it's been from savings by Chinese nationals.

And in the U.S. investment has also historically been key in producing high economic growth. However, it also helps explain the slowdown in economic growth we have had since the beginning of the century. Although the chart "Gross Private Investment" shows what appears to be large and rising business investment in the country, except for the large dip around the 2008-09 recession, disaggregating it into its two main components helps explain that slowdown in growth, as shown below.

The two components are shown on the chart "Non-Residential Business Investment." They are investment for Replacement and Maintenance of the existing stock of capital goods, the ever rising line in red, and investment for New capital goods shown by the blue line on the top chart. At the bottom we display the ratio of New to Total investment where we can see that while in the sixties and seventies the proportion dedicated to New investment was roughly around a third of total investment, the ratio has been on a falling trend since the 1980s.

Naturally a question to ask is what is the significance of this declining trend?

Investment and GDP Growth
By plotting this ratio against GDP growth we can get a clear idea of the relationship, and the impact that New investment has on economic growth in general. To simplify the analysis, we have plotted on the chart "New Investment Ratio & GDP Growth" the five-year averages for both of these variables- GDP growth and the New Investment ratio. This averaging was done to smooth the data and get to the essence of the relationship.

We can see that up until the mid-1990s the New investment ratio was relatively flat, and also GDP growth was fairly robust. However, afterwards the investment ratio began to decline sharply, and so did GDP growth.

What does it all mean?
The emphasis on spending, whether it's government or consumer spending, has resulted in a neglect of business investment. Further, recent economic policies have tended to be adverse to investment, or even to discourage investment. At best, we have seen that the government officials give investment lip service, but they typically prefer direct spending since their effects are presumably more visible and immediate.
But one reason that despite these policies the U.S. economy still maintains some modicum of positive growth, is because the main alternative to investors is focus on one of the European countries. And we all know that the majority of those countries operate in an environment that is yet more punitive towards businesses than the U.S., making investments in those countries a not very attractive and more risky proposition.

WHITHER GOVERNMENT EMPLOYMENT?

Government has become by far the largest employer in the nation. A few years back manufacturing was the leading sector. But, as we know, manufacturing has been declining as a result of the industry generally shifting labor-intensive work to lower cost countries, such as Mexico or China; outsourcing many labor tasks, such as cleaning for instance, to service companies that specialize on those activities; and continuously replacing capital for labor to improve productivity and reduce costs.
Government has taken manufacturing's place and it currently absorbs about one of every six U.S. workers; that is 16% of U.S. employment as shown in the chart "Employment by Sector."

All of this should come to no surprise, given the continuously increasing government expenditures and the subsequent rise of U.S. government debt. What is surprising, however, is that it is not the Federal government that is responsible for this increase; rather it is government at the State and Local levels behind the increasing predominance of government as the biggest employer.

The chart "Government Employment" shows the percentage increases in the number of workers since 1990, for the three levels of government, i.e. Federal, State and Local units.
Starting with Federal government employment, shown in the red line at the bottom, we can see that employment at the Federal level declined by 10% during the 1990s. Afterwards it has remained more or less at the same level for the last 15 years. (Note that the three sharp jumps in the red line reflect the Federal government's hiring of temporary workers hired to conduct the decennial Census mandated by the U.S. Constitution.)
In contrast State and Local governments, also displayed in the chart, show large increases in employment. Over the last 25 years State employment has increased by 20%, although that increase took place prior to the 2008 economic recession. The increase in Local government employment has been more pronounced yet, although it slowed down a little since the late 2000s because of the 2008 recession. Yet it is still 31% above its level in 1990.

Is Local Employment Growth out of Line?
An obvious question to ask, after seeing employment at the Local level rise by 30%, is whether such growth is out of proportion or far above what would be expected.
If we compare it to employment growth in the private sector- which we display in the chart labeled "Private & Local Government Employment," we can observe several interesting things.

First is that, for most of the time over the last 25 years, employment in private businesses has lagged that of government. That is, Local governments have been more aggressive in their hiring practices.
Second, and perhaps more disturbing, is the fact that while private businesses reduce employment during economic recessions, as they should, the number of employees in Local governments continues to increase. Since Local government revenues probably drop during recessions, i.e. lower receipts from taxes and fees, we would expect them to be more prudent in their hiring practices. But the data suggest otherwise.
Finally, the chart shows that only this year we see employment growth in private businesses match Local governments. This is primarily because Local government employment has remained relatively static since 2012.

What's driving State and Local Government Employment Growth?

Digging deeper we find that that both at the State and Local levels education hiring is the principal driver of employment growth. The chart "State & Local Government Employment" shows that, while total state employment has grown 19% since 1990, education has risen by a remarkable 41% in the same period (here we are comparing growth using 2014 average, rather  than the monthly data shown in the trend chart "Government Employment" above.) Education employment at the Local level has also risen, a more modest 33% but still above the overall growth of 30% for all Local government employment.

Additionally, the chart reveals that the number of Hospital employees at Local governments increased sharply during this period, while at State governments it actually fell. Given the large number of state and local government units it is very difficult, short of a very extensive research, to determine the reasons underlying this uneven pattern. 

Local Government Employment: We are in charge
It's kind of ironic that the area that is presumably most under the direct control of private citizens, Local government, is the one that seems to be growing uncontrolled. But this growth may be actually a reflection of what we want. Education is seen as the key to achieve respectable income, so it should not come as surprise that this is one area that is allowed, or encouraged, to grow the most.
Of course a more meaningful explanation can only result from an analysis of the overall spending in education, employment is only one aspect, and an evaluation of the results from that spending (e.g., school graduation rates, achievement scores.)

ON MANUFACTURING RESHORING

News of manufacturing "reshoring" back to the U.S. continues to creep up on the press. Reports typically focus on one company that may be closing its factory abroad, perhaps China, and open up new facilities or expand here at home. The news suggests that the U.S. manufacturing sector is on the rebound and, misleadingly, they implicitly convey the idea that this sector's rebound is reversing the sharp decline in manufacturing employment we've seen over the last 20-30 years. But the evidence on both fronts is not so rosy, as we show below.

Manufacturing output has increased the last few years; yes, it has. But the improvement has been relatively modest, and significantly less than in previous decades. Overall, the value of manufacturing output has increased only 8% since 2009, or under two percent per year over the following four years.
Moreover, this growth rate is significantly lower than that maintained in the decade ending in 2007. During those ten years, 1997 to 2007, manufacturing output grew at an average of 4% annually; this is a growth rate faster than the 3.4% average GDP growth in that period. Does that growth rate suggest a declining industry?





But the image that we get from manufacturing employment is the reverse, as can be seen in the chart to the right. Employment has been declining for quite some time. We see, in the chart "Manufacturing Employment," that from an average of over 17 million workers in the early 90s, we are currently posting barely 12 million people employed in manufacturing. Aside from the reshoring and presumed increase in employment, the industry has been moving to using more and more capital to replace labor.


Manufacturing Output is not the same as Manufacturing Shipments
An alternative view of manufacturing output is total shipments from manufacturers. The manufacturing output data displayed above, similar to other GDP statistics, only counts "final" output, that is it excludes output from one factory that is an input to another one. For example, the output of a factory that makes batteries and ships them to an auto maker will be excluded from the "output" statistics; the figures only include the value output of the auto maker, which already includes the value of the batteries purchased from the first manufacturer.
If we look at manufacturing shipments, the picture that emerges is similar, yet more positive. The total value of manufacturing shipments reached six trillion dollars last year, this is almost 10% above the previous peak of $5.4 trillion in 2008.
In the chart labeled "Manufacturing Industry" we show for comparison the construction of manufacturing facilities in the U.S. We can see that it has been recovering nicely from the 2008 economic recession. So, two aspects of the manufacturing sector indeed indicate a rebound, and validate the reshoring argument.





It's important to point out, however, that the manufacturing sector's output (not shipments, sorry if this is confusing) is still $68 billion below the 2007 level, and only four of the 19 industries that compose this sector actually show positive gains. Also, as the chart to the right shows, the more robust industry in this sector is Computers & Electronics, it accounts for two thirds of the positive gains.

So, what's next for U.S. manufacturing?

The data suggest that the manufacturing sector is growing but still weak, and on the way to full recovery albeit slowly. But, the data also suggest that employment in the sector will not rebound significantly, much less return to previous levels. Manufacturing employment is on a secular decline. As a share of total employment, manufacturing employment has been falling since 1920, when it accounted for 39% of total U.S. employment; by 2010 its share had dropped to just 10%.
This is similar to the decline in agricultural employment that occurred in the 19th and early 20th century. The substitution of capital equipment for labor that took place in agriculture resulted in increasing levels of farm output, as is evidenced by the relative abundance of agricultural products and lower prices of agricultural goods, but employing only a very small proportion of the U.S. work force- currently under two percent of the working population.
We see the same pattern developing in the manufacturing sector. A pattern of a greater volume of production and output, with more manufactured goods available at lower prices, accompanied with fewer and fewer people employed. Although we don't expect manufacturing employment to drop sharply in the next few years to the levels of agricultural employment, the general outlook for it is, at best, general stagnation.

A TALE OF TWO STATES

Minnesota and Wisconsin are two states similar in many ways. They both originated historically out of the old "Northwest Territory." They are geographically contiguous and their population numbers are fairly close- Minnesota has 5.6 million inhabitants and Wisconsin 5.8 million.  Racially their population make up is also fairly similar- about 86% of their population is white and between 5-6% is black.
But they are also different from each other. Minnesota is the larger with a landmass of 86.9 million square miles, while Wisconsin has a smaller 65.5 million square miles. Minnesota, whose state motto is "The Land of 10,000 Lakes" actually has nearly 12,000 lakes (of 10 or more acres each). Wisconsin claims to have over 15,000 lakes according to its Department of Natural Resources (however, there are no minimum size restrictions in this figure- I guess any body of still water counts as a lake).


And, historically, their employment growth pattern was also similar. Employment in both states grew by 25% during the 1990s, significantly better than the nation as whole that saw employment growth by 20% in the same period.
But the 2000 recession broke that pattern. Since that year, as the chart to the right shows, the employment growth paths of the two states diverged, with Minnesota displaying more robust growth. In fact, employment in Minnesota has grown about 6% since 2000, besting Wisconsin's paltry growth of only 2% over the last fifteen years. We should note that both states lag the overall U.S. growth of 8% during the same period.

It is a Tale of Two Sectors
A natural question to ask is why has Wisconsin performed worse than its sibling state? The economic policies of each state are likely influencing the development patterns. But, more fundamentally, we find that it's simply the structure of industry and employment that accounts for the differences.

Wisconsin's largest economic ssector in 2000 was manufacturing, generating one-fifth of the jobs; in contrast Minnesota's largest is the services sector, also with one-fifth of its jobs. Now what is important to realize is that manufacturing employment has been declining nationwide since the 1980s, as the industry has become more mechanized and businesses substitute capital for labor- both states have gone through this decline. In contrast, the services sectors and employment in the services has been increasing. Thus, Minnesota has benefited from the overall national transition from an industrial to a services economy (from an employment standpoint).

The two charts below illustrate these differences.

Manufacturing, the sector that Wisconsin is more heavily invested in, is one in which employment is in decline- even though manufacturing output (not addressed in this post) has been increasing steadily nationwide.
The chart to the left clearly shows that both states have performed significantly better than the nation as a whole. Employment in manufacturing nationally has fallen about 30% over the last 25 years. But for Wisconsin and Minnesota, the decline has been a more modest 10%.



In contrast the Services sector, relatively more important for Minnesota's labor markets, is one of continuous growth.
It can be seen in the chart that both states have followed the national pattern closely.






Economic Policies and Manufacturing Employment
The U.S. Senate is considering a bill to designate 25 universities as "Manufacturing Universities" and provide funds to strengthen the teaching of engineering in those schools. This is fine as far as improving the skills of engineers and improve the quality and productivity of U.S. manufacturing. But this effort will not increase the number of people employed in the manufacturing industry, if that is what is intended by this bill. Better trained engineers and scientists focused on manufacturing will undoubtedly lead to yet greater mechanization of the industry. This is the correct way to go, although we must be careful not to mislead or assume that the decline in manufacturing employment, shown in the chart above, will be reversed significantly.

ARE WE BECOMING A SEDENTARY NATION?

Historically, the U.S. has been on the move. This is a metaphor for the fact that, since the nation's beginnings in Colonial times, Americans have picked up stakes after a while and moved to a different location. Initially it was the great westward migration; later a migration to the South seeking warmer climates. During the 50s and 60s we had the great migration to the suburbs. Later on,  the population has continued to move within the same county or even within a city for family or economic reasons.

But it appears that this tendency is slowly fading. The proportion of people who move continues to fall year after year, as shown in the chart to the left. While mobility hovered around 20% from the end of WWII through the late 60s, it started to fall since the 70s to its current rate of roughly 12%.
In the earlier periods, Americans used to move roughly once every five years; but today that is once every eight years.
The mobility rate has fallen roughly one percentage point every four years.

What is behind this trend?

A common assumption is that the aging of the U.S. population is driving this decline. That is, there is a greater proportion of older people in the U.S. population mix, and older people have significantly lower mobility rates (see the chart 'Trends in Mobility Rates- by Age".) This assumption is not far from the truth- a large portion of the decline in mobility can be attributed to people getting older.

Other factors driving mobility down
But we also find that, aside from the trend of a greater proportion of elderly in the population mix, mobility rates are actually falling down for all age groups. The largest declines are in the 18 to 24 years group, those who are traditionally starting to form households and may be moving from a rental unit to their own home. Mobility among this group has fallen by nearly 10 percentage points since 2000, to its current 22% mobility rate.
Similarly, the working mass of the country, those between 25 and 54 years, is also becoming less and less mobile. The rate among this group is down nearly four points since the year 2000.

Economic Impact
Gradually evolving trends such as this one also cause a gradual change in the economic structure and business of the nation. Businesses that depend on people moving to a different home are seeing and will continue to see their markets shrink. Fewer households moving means less business to moving companies, for instance. This is an industry that doesn't promise much growth in the future.
Also, the real estate industry (e.g., real estate agents) would be less busy given the fewer home sale/rental transactions taking place.
Finally, fewer home sales or rentals have well-known effects on the overall home improvement industry. People who move to a different residence, whether it's a new house or an existing one, tend to engage in remodeling or refreshing the house to fit their needs or preferences.

What's Next?
Here I focused mostly on demographic factors that are driving lower mobility rates. In a future post, I will address the economic and social factors underlying these demographic trends.

FAMILY INCOME...GOING NOWHERE?

There has been a lot of talk about income inequality lately, much of it simply assuming that income equality is the holy grail that must be attained. Once we achieve it, many think, all our problems will be solved and everyone will be happy. But it is not so.
Obscured in this discussion, often, is the more important issue of income growth. Do we care about inequality if incomes are growing? if they are flat or declining? Whatever one's views on inequality, there should be no question that growing inequality accompanied with declining income is the worst of all worlds. And currently, for the U.S. at least, lack of income growth is the more serious problem.

Here I take a look at family income data recently released by the Federal Reserve Bank, based on its triennial Survey of Consumer Finances. The picture for the last few years that emerges out of this survey is not pretty. Median income fell 3% in 2010, as a result of the 2008 recession, compared to its level three years before. Moreover, median income rose only 2% in the following three years; this means that income in 2013 is below what it was six years before in 2007.

Note that the chart reflects income that is not adjusted for inflation. If we account for inflation, the drop is even more dramatic.  Regardless of which figure we use, the fact is that family incomes have dropped over the last 6 years. Median income was $47,300 back in 2007 and, following the 2008 economic recession when it fell to $45,800, had only recovered to $46,700 by 2013- this is still 1% below its level six years before.

But yet more disturbing is the distribution of the loss of income among various age groups. The chart below shows the change in median income between 2007 and 2013 for several age groups. Most noticeable is that median income for young people, those younger than 35 years, was 6% lower in 2013 than what it was in 2007. Also, curiously, income for the middle group aged 45 to 54 yrs. also fell during this period. At the other end of the age scale, we see that those 65 years and older have seen their income increase robustly- at an average of roughly 3-4% annually during this period. It seems that being older may be preferable to younger- at least from an income gain standpoint.

But the drop in income among the younger set is not good news for the nation. After all, they are the ones that are being burdened by our current government budget deficits, coupled with the greater demands originating from social security payments for now retiring baby boomers.