About Peter Radford

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Unemployment: Worse, But Better?

We have reached that part of the recession that confuses everyone. The data seems to signal a change, but getting the right words to describe that change can prove elusive. Furthermore getting a good interpretation of the message contained in the data is incredibly difficult. Separating the ‘noise’ from the information often proves well nigh impossible, so most analysts resort to their natural instincts. In other words they guess.

This morning’s unemployment data from ADP the big payroll processing firm is a good example.

Clearly the data is horrible: the economy shed 532,000 jobs in May. By any measure that’s an awful figure and should portend all sorts of grief for the economy as a whole later in the year. Especially since it follows hard on April’s figure which was just as bad.

But these are not normal times.

If we put the May data in the context of the three months of the first quarter this year it represents a noticeable improvement. The average job loss for those months was about 690,000 a month.

So should we cringe or should we celebrate?

Neither.

Obviously the economy is not shedding jobs as quickly as it was. That’s good news. But losing another half million jobs is nothing to write home about. It is simply awful.

So how do we pick apart these contradictory messages?

Well: things are not as terrible as they were. The economy seems to be approaching a point at which it will stop contracting. Employment is one of those measures that lags the overall economy: it gets worse only after the economy has started to shrink, and it improves only after a recovery has begun. That makes intuitive sense because businesses always adopt a ‘wait and see’ approach to emerging trends before they commit to making changes to the size of their workforces. And it is borne out by data stretching back through all, our previous business cycles.

So the slowing rate of growth in unemployment is a hint, but only a hint, that firms have done the majority of their workforce reductions. There will be bumps: GM’s bankruptcy may skew the June figure. Plus if the business climate doesn’t improve we may need another wave of cuts.

Take a look at some of the sectors of the economy: manufacturing has now shed jobs for thirty-nine straight months. And it clearly hasn’t finished. Likewise construction has reduced for twenty-eight months in a row and finance for eighteen. These are very long strings of continuous job losses by any stretch of the imagination.

And we still lost well over half a million jobs last month. We are nowhere near a job market turn around.

It looks as if unemployment will keep climbing right through this year. I doubt whether we will see a month of job gains until next spring. Hopefully, though the losses will fade to a minimal levels before then.

Which brings us to the larger point: what does the job situation tell us about the economy as a whole? After all that’s what we are trying to understand.

Things are not as bad as they were. But they remain precarious. We are still teetering on the edge of crisis, but we are not getting much worse.

Look at it this way: we are still digging a hole from which we will have to escape. Perhaps now we can start to see how big the hole will eventually turn out to be. The best way to measure that is to compare the shrunken economy with where it would have been had it been humming along nicely. This comparison gives us an idea of the gap we have to make up. In fact it is this measure of ‘under-utilization’ of our resources like labor and factories that is a major factor in driving Federal Reserve Board policy.

So what does the comparison tell us?

The good news is that we seem to be approaching the maximum point of the downturn. In truth no one knows where or when the bottom is. But most likely the contraction will end later this year, let’s say that’s a 60% probability. So there remains a very strong probability, 40%, that the contraction lasts into next year. Either way it appears that we will need two or three years to get back to full capacity. Some estimates have the actual-to-potential GDP gap stuck as high as 5% even during 2011. In turn, that implies the job market will remain fairly rotten for several years, with unemployment stuck between 7% and 10% throughout 2009, 2010, and 2011.

That means we have no room for easing up on any of our policy measures. It also suggests we may need another dose of stimulus. Don’t forget that the objective of the stimulus is to plug that gap between actual and potential GDP. The size of the gap gives us a rough and ready measure of the size of the needed stimulus. So far we have had a stimulus of only about half the gap. And much of that will take a couple of years to take effect: the Congressional Budget Office [‘CBO’] reported this week that only about 25% of the stimulus package will be effective this year, and even by the end of 2010 only 75% will be in effect. Unfortunately the components that will take effect first, things like tax cuts and transfer payments, have the least impact on unemployment.

Finally: I remain very skeptical of any analysis that argues for strong recovery. This employment data shows we have a very long and hard road ahead. There has been no change in the big structural problems to be overcome:

  • we still have very weak banks so the supply of credit is insufficient to fuel strong growth
  • household wealth has been hammered by the combination of the collapse in home prices and the stock market
  • jobs are scarce and likely to remain that way
  • this implies a continued debt reduction by households which will inhibit spending
  • there is no obvious non-personal consumption ‘engine’ to pull us out of the hole: exports are weak, investment is will be poor because of debt reduction by firms and the lack of credit, housing is devastated and needs years to recover [if it ever will], and state governments are in panic over their own budgets, so there’s no spending coming from that quarter.

This leaves the Federal government as our primary source of growth. Since the stimulus package was both too small and too skewed towards least effective actions, even this is a weak source of support.

In other words: nothing much has changed to persuade me that growth this year, if it occurs at all, will be anything other than miniscule, and that next year will be very weak.

Still, we should look on the bright side: at least this wasn’t a Depression.

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Reagan/Bush Failure

It’s good to see Paul Krugman weigh in on an argument I have been trying to make for years: the worldview that dominated the entire Reagan Bush era lies at the root of our current problems. In particular the pernicious view that ‘markets’ solve everything needs to be expunged from our collective memories. This piece of mischief actually predates even Reagan, but had little traction during the comfortable immediate post-war years. It was only when the seemingly inevitable onwards and upwards pattern of the American economy stuttered during the stagflation years of the early 1970’s that it became politically useful to portray the magic of the ‘market’ as the best, and, indeed, the only viable engine for economic activity.

That the Soviet Union imploded at precisely the same time left an indelible mark on American consciousness: the early 1980’s were witness to an economic revival and the ‘defeat’ of the Marxist/Leninist ‘Evil Empire’. It was simple to explain: the American form of capitalism, dominated by free-wheeling markets was invincible and could deliver unparalleled wealth.

Or so it seemed.

The nice conjunction of revived ‘new classical’ economic theory to supplant the older Keynesian version and the surge in conservatism across the US led many to believe most of the world’s economic problems had been solved. If left to its own devices the ‘market’ would encourage innovation, build wealth, and lead to ever increasing prosperity. The only thing that could get in the way was government. The dead hand of regulation had to be lifted. Government had to be demonized as perennially ineffective, chronically inefficient, and most likely corrupt.

Millions of students went through their entire education having the efficacy of free markets drummed into them. They are now the generation providing leadership in all our various elite groups: even in government itself. The worldview that presumes market supremacy is so deep rooted that we are having great difficulty in even framing discussions that lead to alternative conclusions. Instead we are leaning over backwards to protect the vision.

And this is even after Katrina, lead poisoning in imports, and the manifest failure of banking deregulation. The removal of government, the reduction in regulation, and the cutting back of oversight is the defining characteristic of the Reagan/Bush era. It was a coherent and well thought through political strategy drawing intellectual legitimacy from what is now standard text book economics.

It has even, through the work of people like Richard Posner, infected the legal system. His work and words are now eliciting a spirited debate, but his impact has been huge: good jurisprudence nowadays is concerned with establishing incentives and is continually pressing back against government ordained restrictions on business. It is a modernized and formalized version of Benthamite Utilitarianism: the greatest good for the greatest number, because we cannot possibly look after everyone. And we absolutely must not fall prey to silly notions like ‘equality’ or ‘rights’ because they are unstable and artificial constructs. They are not permanent or enduring ‘values’.

The failure of all this is clear.

We have undone the prosperity of the immediate post-war years by attacking its equalizing tendency of incomes distribution. We have unwound much of the security of the middle class. We have abandoned the poor. We have stripped away the protections we had against bad business practices. And we have exposed ourselves to economic volatility on a scale we have not seen since the Great Depression.

We have put everything up for sale. We have abandoned thrift. We have accumulated the greatest debt in our peace time history. And we have impoverished the future.

All in the name of the ‘market’.

To set all this right will take time. There is so much to do. But first we must be relentless in exposing the essential invalidity of the ‘market’ based view. Not everything is best allocated by a market. A market is amoral. Some might say immoral. And there are times when a society needs to engage itself and determine moral solutions. Relying on markets to do that for us is a lay way of avoiding tough discussions.

It was the Reagan/Bush way.

It is something we can no longer afford.

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Health Care and Rationing

I will keep this short in view of the reams we will be using as the debate roils on this year. The American health care system is irrevocably broken. It is horrible. Rotten. And the worst in any industrial country. There I said it.

What I mean is that the system is broken down. Not that care, when it is delivered is bad. And that’s an important point to keep in mind. Let’s not confuse the rotten nature of the system with the care it delivers when it finally gets around to delivering care.

Those who have an interest in the status quo will try to conflate the two issues. We need to be clear as to what we are attempting to fix.

The US heath care system delivers extremely poor value for money. By any normal measure of efficiency it produces bottom of the class performance. This is beyond argument.

We spend a full 16% of our annual national income, as measured by GDP, on health care, and get results below that of any other industrial nation. In other words we spend twice as much per person as any other nation on earth and then get less back.

“I am not so sure that America is truly ready for a strictly private health care system. But that’s what many people think they have. They don’t. By any stretch of the imagination.”

That’s not good. It is awful. It needs fixing. We simply cannot afford to continue this way, especially as demographic pressures build the case for spending more. Something has to give before the entire edifice crumbles.

Nor is helpful to go around blaming people. We are all to blame. Everyone has a finger in the mess. Doctors over prescribe. Insurance companies seek to avoid paying for care. Drug companies dump billions of R&D money into ‘lifestyle’ rather than disease treatments. The system is hopelessly under-automated. Consumers are ill informed and have no clue what their care actually costs. Businesses provide health care as a benefit and then cut wages in order to pay for it.

That last point should have grabbed your attention. Research has shown definitively that employers see health care costs and wages as a trade off. So do the unions. So in order to keep health care benefits for aging workers, think the auto industry or education as two prime examples, wages are often cut or held flat for today’s workers. Since those retirees are not productive the effect on the nation’s ability to produce future wealth is devastating. We are transferring huge wealth to retired Americans from the productive youth. We are eating away at the core of the American dream to keep retirees healthy. From a purely sterile efficiency point of view, that’s about as stupid as a society can get. The best estimate is that current wages are a minimum of 6% lower than they would otherwise be because of our health care system.

That’s a big deal.

Our problem is that our system is typically American. It is a cobbled together hodgepodge of programs resulting from decades of piece meal legislation and corporate action. We have never wanted to face up to the consequences of a national debate about health care. Most of the costs are hidden, so they are easy to avoid. Meanwhile most of us get good care, and none of us pays the true cost. There is absolutely no incentive to change. Add in the all-American love of new technology and the latest wonder drugs, plus the urge to consume cosmetic ‘medicine’ and the result is an orgy of expenditure, wild earnings opportunities for medical professionals, and no restraint.

So one of the key objectives has to be getting restraint. On doctors; on patients; on drug companies; and on insurers. That means building incentives for more cost effective behavior.

Free market types would argue we need to let the market allocate health care resources. Let the care flow to those who are willing to pay for it. Right now about half of all our spending flows through government channels like Medicare. So to get a true market allocation we would have to abolish those programs and let the current beneficiaries sort out alternatives, should they wish to.

Alternatively we can get the government more involved so that we allocate care through non-market mechanisms.

The choices are stark: do we allocate via prices – this is the market’s method of rationing. Or do we allocate via fiat – this is the centrally planned method of rationing.

Both are forms of rationing.

The word ‘rationing’ is often used pejoratively here in America. We look down at the rationed systems of Europe or Japan. But our system is ‘rationed’ too. Markets ‘ration’ by price. If you can’t afford something you don’t get it. Whenever a scarce resource like health care is allocated the effect is a rationed apportionment. We just don’t like to call it that.

And in essence that’s the debate we are about to have. Which form of rationing produces the allocation of resources we prefer?

As a nation do we want everyone to have access to health care. If so the market will fail to deliver that. Or do we prefer that only those who are willing to pay get care? If so the government will get in the way of that.

If we want the market system, then let’s have the courage to get the right incentives to reduce costs and let consumers get involved. That means aggressive cost cutting and business style efficiency on the part of doctors. It also means less focus on care and more on profit, since profit is the only viable incentive mechanism for a market.

I am not so sure that America is truly ready for a strictly private health care system. But that’s what many people think they have. They don’t. By any stretch of the imagination.

Perhaps it’s time for all those involved to recognize that the current system is both broken and not fully privatized.

At least then we can discuss what to replace it with sensibly. Defending the current system as if it is a privatized care system is to perpetuate an illusion. If those in medical profession, insurance companies, drug companies, and voting public who advocate a ‘non-European’ solution truly want one, then they should have the courage to step up and accept the consequences of market forces: lower costs and profits, reduced capacity, higher service standards, and greater customer scrutiny. Heck they may actually have to make that 1:00 appointment a 1:00 appointment rather than an an ‘any time I can get to you’ appointment. An those drugs may actually have to deliver, on time, cheaply. Patients will have to tell doctors to stop treatments that they, as newly empowered consumers deem too expensive or unnecessary. And, perhaps the most horrific, those insurance premiums had better produce a service rather than a denial of service.

Gulp.

This all sounds like a final exam:

“The watch phrase of customer service is that the customer is always right. Is that the way to run a health care system?”

Discuss.

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Stock Market Illiteracy

Sometimes my total disrespect for the stock market leaps to the fore. It is an extraordinarily skittish place and seems to be full of the most short sighted and most easily swayed folks on earth. Analytically? Don’t even go there. Let’s just say that dunderhead isn’t close to the mark. They can’t read too well either. Take today’s data on incomes from the Bureau of Economic Analysis.

It shows that personal incomes rose in April by a ‘surprising’ 0.5%. I put surprising in quote marks because it appears that the market reacts more to the level of expectation than to the news itself. I too am surprised. Will I be doing back flips? No. Will I declare the recession over and the returns to the glory days upon us no? The stock market will and has. Dumb. Very dumb.

The data also shows that disposable incomes rose even more: by 1.1%. For those of you new to this, disposable incomes gives us an after tax view of how wages and incomes flow through to the point at which they can be spent or saved. The market loves that jump in disposable incomes. Presumably the market view is that we are on the cusp of a good old all-American buying binge. Which will drive consumption up, boost profits and hence drive the stock values higher.

Ummm. I wonder if they read line three of the report: personal consumption expenditures, [‘PCE’]. Had they read that far they might have noticed that PCE fell in April by 0.1% A small fall I admit. Almost insignificant. Except that it continues a trend we all, well I did anyway, noticed last month: the strong upturn in PCE of January and February has been followed by two weak months. That upturn was one of Bernanke’s original ‘green shoots’. It has withered entirely away.

This is not good news.

Look deeper into the data:

Most of the rise in incomes comes from obscure things. Wages fell. Rental incomes and transfer payments went up and produced the rise. Not many average Americans get rental income, so even if that continues I doubt it will lead us to the promised land of consumption growth. And ‘transfer payments’? As its name implies that’s income that is being shuffled around the board, it isn’t new. Think: ‘ American Recovery and Reinvestment Act of 2009’. Sound familiar? How about ‘stimulus package’? That’s right the most important factor pushing up PCE was the stimulus package. Hardly a long term improvement.

And how about the upturn in disposable incomes. Same thing. The stimulus package sucked out taxes. Hence ‘after tax income’ shot up. ‘After tax’ equals ‘disposable’. Duh.

Now keep looking at that data: the personal savings rate rose strongly fro 4.5% to 5.7%. Terrific. That’s the highest rate for fourteen years. We need to become more thrifty. We need to return to the savings rates of the 1960’s when families routinely socked away 10% of their incomes for a rainy day.

But not just yet.

First we need to spend every penny we have to get the engine running smoothly again. Then, once we are all back working we can start to save.

So here’s my, apparently contrarian, view: this data makes me a little queasy. Wages are weak and falling. The stimulus had far too much tax rebate in it, $300 billion of the roughly $800 billion, and what there was is now being saved. Just as I predicted. That means the stimulus will have less effect than it ought to have had. In jargon: its multiplier is too low. Just as Keynes would have argued.

The economy’s problem right now is not savings, nor is it incomes – especially when incomes are temporarily distorted by transfer payments and tax rebates. The problem is spending. In the jargon: final demand is too low compared with the economy’s capacity to produce. We have idle resources: closed factories and unemployed workers. We need to get that capacity back in use. Savings don’t help. Nor do lower taxes.

There is nothing new at all in any of this.

It’s just that the stock market suffers from attention deficit disorder and seems to have forgotten. Don’t worry though: there’ll be a new report soon that will send the market careening off in a negative sense. Probably for the wrong reasons.

And that’s why none of us should pay too much attention to the stock market. They can’t read down there.

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GM: Done For

Saturday night’s agreement between a significant group of GM’s creditors, the company, and the US government has sealed the deal: GM will file for bankruptcy, most likely Monday. Thus ends an iconic chapter in American history. GM once was emblematic of American manufacturing prowess. It generated a full 3% of the country’s GDP back in the 1950’s. It was credited, more than once, with staving off national recession simply by cranking up its own production. And, of course, there was the famous rejoinder from its CEO Charles Wilson [a.k.a.’Engine Charlie’] when he was before a Senate conformation hearing: ‘What’s good for the US is good for GM, and vice versa.’

Now, not so much.

In truth the decline and fall of GM is a story worthy of the great Edward Gibbon whose ‘Decline and Fall of the Roman Empire’ is a mammoth read even in an abridged form. The tale is familiar: its cars were criticized as unsafe, it failed to adjust to higher oil prices, it could not compete with more nimble and cheaper foreign manufacturers, and above all else it failed to adapt its fundamental business model to the global market. It became a poster child for the bygone years of American industrial dominance in an era of high technology and service industry growth.

It’s failure is also the failure of middle America to adapt. The 1950’s model of high wage blue collar jobs, good benefits, and job security backed by big union clout served a couple of post-war generations well. It has left their heirs high and dry in run-down industrial towns shorn of income, hope and purpose. All that GM and the people who ran it for the past few decades have left is a shadow of what was once a mighty empire.

Will GM re-emerge?

Most likely. But there are very strong opponents of its bankruptcy plan even after the majority of bondholders have caved in. The main resistance will come from the dealership network where the economic deprivation and political clout converge in a potent way. Many dealers are local leaders in Chambers of Commerce dotted across the country. They spend big money at election time. Now might be a good time to collect on their largesse. The main approach of attack against the company’s plan is to claim that it is illegal. The veracity of this claim rests on the way in which GM is planning to re-emerge. When it moves out of bankruptcy there will be two GM’s: and “old GM” consisting of all the shuttered factories, the old debts, and discarded brands; and a “new GM” consisting of the remaining four brands and the infrastructure needed to make them. The bondholders have accepted a 10% share in the “new GM” while their debt goes with the “old GM”. They have thus contributed nothing to the newer company and may still collect a few cents on the dollar as the bits and pieces of the old company is sold off. This ‘something for nothing’ is what persuaded the bondholders to go along with the plan, but also means that they have been treated preferentially over and above other creditors with an equal claim in liquidation. A court may view this as illegal and render the whole plan improper. This would obviously trigger a round of heated negotiation and slow the entire process to a crawl.

And time is not in GM’s favor.

The company is bleeding cash at a prodigious rate, losing market share, and, most importantly, losing its share of customer loyalty. The longer the slow death lingers on the more difficult it will be to restore even a trimmed down GM to long term profitability.

As it is I am not sure that the “new GM” will have what it takes to survive in a world auto industry that still suffers from a vast over-capacity. The deal made in Germany Friday to sell GM’s European operations to Magna of Canada rather than to Fiat works against GM in the long run: Fiat would have consolidated the industry and shut down capacity. Magna is a new entrant. It is one of the world’s largest auto parts makers and currently assembles cars for other makers – it builds BMW SUV’s as a sub-contractor – but its acquisition of Opel from GM doesn’t help rationalize the auto industry at all. So, while over capacity looms over all the current car makers, it will have a disproportionate effect on the weaker: the “new GM” being on of them.

But that is all for the future.

Right now is time to mourn the passing of GM, and along with it a huge element of the post-war American success story.

These are odd times.

Addendum:

One reason that some bondholders may fight the GM plan in court is that they have insured themselves against loss of value in their bonds by purchasing credit default swaps. They would thus lose nothing. As long as their credit default swap counter-party is solvent and can pay-up. Then I suppose the counter-parties might support the GM plan so as to avoid having to pay out. Oh, what a tangled web this recession has become! Ugh.

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