How is the real US economy doing?


Call it a tale of two economies. Joseph LaVorgna and the Deutsche Bank econ team make a good point about US economic growth:

Over the past year, the US economy has demonstrated a significant acceleration. From a near-stall in late 2012 (due to Hurricane Sandy), GDP growth in year-on-year terms has accelerated from 1.3% at the start of last year to 2.6% at year-end. We expect this trend to continue in 2014. In turn, this will have significant implications for both employment and inflation. This acceleration is due to a combination of improving domestic economic drivers and significantly reduced fiscal drag. In fact, real GDP ex-government grew 3.8% last year (4.7% in H2).

Actually, the increase in fiscal drag in 2013 was accompanied by faster private GDP growth. You can probably thank for the Fed for that.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


A personal note on Larry Kudlow

Image Credit: CNBC

Image Credit: CNBC

Tonight is the final episode of CNBC’s “The Kudlow Report.” Now Larry Kudlow isn’t retiring, thank goodness. He’ll still pop up regularly on the network’s programs as senior contributor.

But early evening Monday through Friday won’t be quite the same without Larry’s lively recap and spot-on analysis of the day’s business and political events, as well as his infectious testimony on the wonder-working power of economic freedom.

I don’t know how many times I’ve appeared on Larry’s show. Maybe 300? (Is that possible?) It all started in 2006 when I was an economics writer for US News & World Report magazine. I had written a cover story on how the improving economy might affect the upcoming midterm elections. I told our media person that she should try to book me on what was then called “Kudlow & Company.” She demurred. The Kudlow show wasn’t “a good fit” for me, she said. As a fan and as someone who had been watching Larry since his “McLaughlin Group panelist days, I knew I would be a perfect fit. So I called up CNBC myself and pitched myself to producer Andrew Conti. I was on the next day. Not only did I become a “Kudlow” regular, but I started appearing on other CNBC programs, eventually becoming an official contributor. I also appear almost every Saturday morning on Larry’s syndicated WABC radio show, which he will continue to host.

My relationship with Larry Kudlow has been great for my career as journalist. I like to joke that at Thanksgiving, my family always thanks the Good Lord and Larry Kudlow, though not necessarily in that order. (Actually, that is not a joke.)

But Larry’s friendship has been far better for me as a person. Larry taught me how to disagree without being disagreeable. He taught me about the value of indefatigable optimism. Most importantly, he taught me that when life puts your butt on the mat, you need to get back up. That’s the true measure. Oh, and when you’re climbing back to your feet, it sure helps to have a few good friends around to lend a helping hand. Those friends you never forget.

And I will never forget how amazing Larry Kudlow has been to my family and me. I am just a tiny, bit player in the Larry Kudlow Story – one that took him from the New York Fed to Wall Street to the Reagan White House back to Wall Street and then television. But he’s a big, big player in my story.

So deepest thanks, Larry. Here’s to the next chapter in your adventure. And by the way, free market capitalism is the best path to prosperity!

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


Where is the 4% growth the Obama White House promised? What went wrong?


Actually, the above chart from Senate Budget Republicans understates the miss. Team Obama didn’t just predict one year of 4%+ growth. They predicted multiple years. In August 2009, the White House predicted GDP would rise 4.3% in 2011, followed by 4.3% growth in 2012 and 2013, too. In its 2010 forecast, the White House said it was looking for 3.5% GDP growth in 2012, followed by 4.4% in 2013. In its 2011 forecast, the White House predicted 3.1% growth in 2011, 4.0% in 2012, and 4.5% in 2013.

Instead of two or three years of 4%+ growth, we’ve had just two individual quarters of 4%+ growth since the end of the Great Recession. While Democrats will argue that the White House didn’t count on a debt ceiling crisis or fiscal austerity (including the income tax hikes Obama himself demanded in 2013), they forget that the White House made those predictions also not assuming extraordinary and unconventional monetary stimulus that offset the austerity. And right now it looks like 2014 will be another year of sub-4% growth. Maybe we’ll get 3% for the first time since 2005.

So what went wrong? What is the White House theory? Secular stagnation? Uncertainty? Something else? I have my own theory. And so does Goldman Sachs:

It is true that output and employment have massively underperformed pre-crisis forecasts and that most of the underperformance seems to be directly or indirectly related to the weakness in aggregate demand. We agree that the real interest rate that would have been needed to achieve full employment has been deeply negative in recent years. In our view, policymakers would have achieved more desirable results if they had steered a more expansionary—or in the case of fiscal policy, less contractionary—course.

Nevertheless, our view of the recent weakness is more cyclical than secular. The slow rate of recovery in recent years is roughly in line with the performance of other economies following major financial crises, as shown by Reinhart and Rogoff, and the reasons for the weakness in aggregate demand over the last few years have now begun to diminish. … The reasons for the long-lasting weakness resemble those of many other post-crisis episodes. They include excess supply of houses, pressure to deleverage consumer balance sheets, the global nature of the crisis, and the cyclically premature turn to fiscal retrenchment.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


How competition and markets can transform K-12 education: A Q&A with Michael McShane

Image Credit: shutterstock

Image Credit: shutterstock

Are America’s K-12 schools fixable? And do center-right policymakers have any better ideas than just school vouchers? On a new episode of the Ricochet Money & Politics Podcast, I chatted with Michael McShane, a former inner-city high school teacher and current research fellow in education policy studies at the American Enterprise Institute. Here are some highlights of our chat:

What does it really tell us about how we’re doing at educating our kids that we only score  so-so on these international education tests?

I actually tend to be somewhat skeptical of a lot of these international assessments.  Some of the sampling procedures and things that are used in other countries aren’t exactly in alignment with how we do it here in the States.

For example, you know, China only tests Shanghai. And within Shanghai – Tom Loveless of the Brookings Institution has a couple of fantastic sort of exposé pieces on this – they actually don’t test a lot of their immigrant students. So those kind of immigrated to the city from mountains and the countryside.  And even some of the other countries that we’re compared too often, things like Finland and South Korea and Singapore, they really – you know, Singapore is just one city. Finland’s a tiny, racially homogenous area. South Korea is the same. So I tend to be a little bit less worried about a lot of those international comparisons.

What worries me is more of just some sort of statistics we’ve been tracking within America over time. I mean, do you remember, back in the State of the Union address just last week, President Obama kind of praised the fact that our high school graduation rate is as high as it’s been in 30 years.

Well, if you unpack those numbers, it’s actually only about 75-77% of high school kids graduate. In an economy that is increasingly based on computers and the knowledge economy, and everything that we kind of know about these things, like, that just isn’t going to get it done. You know, we only have a quarter of our – if we have a quarter of our students perpetually not getting – which is really basic skills that are needed to graduate from high school, we’ve got problems.

If we look at long-term test scores for 17-year-olds, they’re relatively flat since the early 1970s. So there’s this sort of stagnation. We’re spending more and more money, but we’re not really getting a better result. And I think it’s definitely troubling.

Within the United States, we have some school systems that are doing great, others which are not doing so well. So when we look at these international test scores, given all the caveats that you put in there, what does it really say about how we’re doing?  I mean, we do have school districts in the United States, which if we only tested those schools, our scores would be as good as some of these Scandinavian countries, but they’d be a lot higher. read more >


How automation is transforming the US economy

Image Credit: shutterstock

Image Credit: shutterstock

Great encapsulation by the FT of the economic challenges facing the US:

New technologies are transforming the structure of the US economy but creating only modest numbers of jobs, according to the biggest official survey of businesses, conducted only once every five years.

The 2012 economic census shows how technology is creating a boom in output for new industries – such as shale gas and internet retail – but only a modest increase in their payrolls.

It highlights concerns that recent innovations in information technology tend to raise productivity by replacing existing workers, rather than creating new products that demand more labour to produce.

Tyler Cowen was quick to note this data seem to reinforce his “average is over” thesis. Two thoughts from me: one, the study also seems to support my point about the overrated labor market impact of fracking. Two, President Obama’s manufacturing nostalgia for 1950s America is misplaced:

In manufacturing, the story is of a productivity boom that allowed a solid increase in sales, coupled with falling employment and payrolls. Manufacturing sales rose 8 per cent between 2007 and 2012 to reach $5.8tn. However, the industry shed 2.1m jobs – employment falling to 11.3m – and its payroll dropped $20bn to $593bn.

The relatively greater drop in jobs than payrolls highlights how remaining jobs in the sector are becoming more skilled. Annual payroll per employee in the manufacturing sector rose from $45,818 in 2007 to $52,686 in 2012. That is among the highest of any big industry, but highlights how manufacturing increasingly employs skilled engineers to tend complex equipment, rather than being a source of well-paid jobs for less-skilled workers.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


Did the ‘Reagan Revolution’ fail?


This is quite a claim from superstar, left-wing economist Thomas Piketty in his hot new book, Capital in the Twenty-First Century (which I recently wrote about), currently all the rage on the left:

There can be no doubt that British and US decline in the 1970s, in the sense that the growth rates in Britain and the United States, which had been lower than growth rates in Germany, France, Scandinavia, and Japan, ceased to be so. But it is also incontestable that the reason for this convergence is quite simple: Europe and Japan had caught up with the United States and Britain. Clearly, this had little to do with the conservative revolution in the latter two countries in the 1980s, at least to first approximation.

What Piketty is saying is that Europe started growing faster than the US in the 1960s and 1970s, and then that stopped in the 1980s. But the stoppage wasn’t because of Reaganomics turning the tide, according to Piketty. It’s just that Europe was done playing catch-up after World War Two’s devastation. Sorry, Ronnie.

Since Piketty is French and writes a lot about France in the book, let’s compare the two nations’ economic performance over the decades.

1.) In 1960, French real per capita GDP (RPCGDP) was 64% of U.S. real per capita GDP.

2.) By 1970, French RPCGDP was 75% of US RPCGDP

3.) By 1980, the gap was even smaller. French RPCGDP was 82%

This is the phenomenon that Piketty is talking up about. But there is more to this story. France actually closed the gap even further. By 1982, French RPCGDP was 85% of US RPCGDP.

But then the narrowing stopped. Weird. In fact, that is as close as France ever got to catching America. Then in 1983, the gap began to widen again. By 2007 before the Great Recession, French RPCGDP was just 72% of US RPCGDP.  As this chart shows:

032714USFrance2Here is a theory: 1983 marked the beginning of the Reagan boom and when the Reagan tax cuts really kicked in. America had a supply-side, pro-market turn in policy — lowering marginal tax rates and deregulation — and France did not. Perhaps, just perhaps, that explains the above chart. It is very important to the left, apparently, to explain away or smear the Reagan revolution since it is an inconvenient real-world example of how the economic freedom agenda can stem national decline. President Obama is also guilty of this. But as President Reagan used to say, quoting John Adams, “Facts are stubborn things.”

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.

Economics, Pethokoukis

Why a national $10.10 minimum wage makes no sense


Government-mandated wage floors have their problems, one of which is that the “cost of living” varies greatly in a big country like America. Mark Perry and Andrew Biggs explain in The American:

For instance, in Pueblo, Colorado, housing costs are almost 30 percent lower than in the typical U.S. metropolitan area, health care costs are 14 percent lower than average, food costs are 12 percent lower, and the overall cost of living there is 17 percent below the national average. Couldn’t a low-skilled worker in Pueblo easily get by on a lower minimum wage when their cost of living is significantly below the national average? If $10.10 was the “correct” national minimum wage, it should only be about $8.25 per hour in Pueblo, adjusted for the lower cost of living there.

Likewise, why would the appropriate minimum wage be the same in, say, Birmingham, Alabama, as in Manhattan, where the overall cost of living is 2.5 times higher in comparison? A minimum wage of $10.10 per hour that is “right” nationally for the average cost of living would be way too low in Manhattan and way too high in Birmingham.

I should also add that the $10.10 target itself, although it has nice numerical symmetry, is one based more on politics than sound economics. As the Manhattan Institute’s Scott Winship explains, when the proper inflation adjustment is used, “the result is that 2012’s federal minimum wage would only have to have been $8.32 to match its 1968 level. In fact, the current minimum of $7.25 was nearly exactly the average—$7.30—from 1960 to 1980 before its steady fall during most of the 1980s.”


Will the US economy clinch the midterms for the GOP or save the Senate for the Democrats?

Image Credit: Shutterstock

Image Credit: Shutterstock

Republicans are “now slight favorites” to capture the US Senate, at least according to the number crunching of analyst Nate Silver. He arrives at that conclusion by looking at the generic congressional ballot, candidate quality, state partisanship, incumbency, and, of course, polling.

But what influence will the economy have? Tough to tell, according to Silver: “Voters’ views of the economy also have ambiguous effects in midterm years, especially when control of government is already divided.” A bad economy is bad for Obama, he finds, but that might not necessarily translate into voters blaming Democratic congressional candidates.

Perhaps, but if I were a Democrat running for election or reelection, I would still instinctively prefer a stronger economy so I could argue the pro-Obamanomics case. (“Slow and steady win the race!”) And a weak economy would allow Republicans to argue that Obama’s tax hikes and overregulation continue to drag on the glacial recovery.

So what will happen to the economy for the rest of this year? Goldman Sachs has been offering a bullish case:

The economic dataflow has weakened notably in recent months and our Current Activity Indicator (CAI) has declined one percentage point since the fall. But we see four reasons for a pickup in the dataflow in coming months: (1) data surprises appear to have bottomed; (2) weather normalization should boost growth; (3) financial conditions remain supportive; and (4) leading indicators for capital spending have picked up. We therefore expect that activity should bounce back and continue to expect 3%+ growth for the remainder of 2014.

Given the slow start to 2014, the Goldman scenario would seem to suggest GDP growth about like last year, though the economy would be showing signs of acceleration. Goldman has been particularly forward in putting a business investment revival as a key element of its forecast. Today’s durable goods report, however, urges caution. JPMorgan:

New orders for durable goods increased a larger-than-expected 2.2% in February, though the details of the report were disappointing and suggest that capital equipment spending is expanding at only a fairly tepid pace in the first quarter …  To the extent that the orders data looked weaker than the shipments data, we think a weather-related excuse is pretty tough to swallow. … After three disappointing quarters at the start of 2013, equipment spending perked up to a 10.5% growth rate in 13Q4, raising hopes that capex was set to accelerate. The latest data suggest those hopes may have been misplaced; while capex continues to expand at something close to a trend-like pace, there is thus far little evidence of an investment spending surge.

This was supposed to be a year of economic acceleration, not more of the same. Whomever a better economy was supposed to help politically, that party might be disappointed.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


Is the US counting too much on the shale boom to fix the economy?

Image Credit: Shutterstock

Image Credit: Shutterstock

Calling the shale gas and oil boom an “energy revolution” is no overstatement. Between 2005 and 2013, US production of natural gas increased by 33% and liquid fuel 52% thanks to advanced drilling technology. But I get the impression that some people — particularly on the right — see fracking as a sort of magic bullet for America’s economic stagnation. Well, that and the repeal of Obamacare.

But I urge caution in equating an America energy revolution with an American economic revolution. It’s a big economy, after all. And it’s tough for any one thing to make a dramatic, overwhelming impact. For instance: the McKinsey Global Institute has projected that so-called unconventional energy production could support 1.7 million jobs by 2020. IHS Global Insight takes its forecast out to 2035 and sees a gain of 2.4 million jobs. Those are big numbers, of course, but they seem less impressive when you consider that total US employment by then might be 160-170 million jobs.

Similarly, people may be overestimating the direct impact of oil and gas product on the US economy in recent years. Goldman Sachs estimates that the sector added roughly one-tenth of a percentage point per year to growth over the past decade. The bank also estimate that “core oil and gas employment and employment directly supported by oil and gas” accounts for less than 1% of total US employment and just 3% of the jobs added since the Great Recession.

The spillover effects from the shale boom, at least so far, also seem to fewer than generally believed. Goldman:

There is little evidence of significant “induced” employment growth in downstream manufacturing industries. Similarly, cap-ex in energy-intensive sectors that might be expected to benefit most from the shale boom has not outperformed cap-ex in other sectors during the recovery, although it did decline by less during the recession. Researchers who expect a large macroeconomic impact from shale often cite the cost advantage it will give to businesses in the US over those in other regions. Access to cheap energy might therefore influence the plant location decisions of both US and foreign businesses. … [Now] there has been a spike in FDI inflows into energy-related sectors in the last few years. … [But] the magnitudes involved are modest. FDI represents only a tenth to a quarter of total investment in these industries in the US. While the spike in energy-intensive FDI is impressive, at its peak it represented about $50 billion in extra investment per year, less than 3% of US investment spending.

Goldman’s bottom line:

Whether shale becomes a true “game changer” for the US in the long-run depends on a number of highly uncertain factors, including technological innovation and the level of investment in downstream industries. In the shorter-term, however, we see only a modest boost to aggregate macro outcomes rather than a revolution.

Now that report is from late last year. But I suddenly thought of it when reading a new report — whose numbers I use above — on the shale revolution over at VoxEU. From the summary:

Our analysis suggests that commentators and policymakers need to better distinguish between the ways in which the US shale gas boom constitutes a ‘revolution’ and the ways in which it does not. The US unconventional energy boom has reversed the decline of domestic production, significantly lowered oil and gas imports, reduced gas costs for consumers, and created a political space for tougher regulations on coal-fired power plants.

But it is not a panacea. Even if current estimates of production turn out to be accurate, the benefits to the US economy in the long run are relatively small, and the benefits to manufacturing competitiveness in most sectors are even smaller.

Supporting the shale boom is an important element of pro-growth public policy. But this welcome windfall shouldn’t preclude creative thinking about other ways to fix the sputtering American growth machine.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas

Economics, Financial Services, Pethokoukis

Is the Fed giving megabanks stress tests or ‘feather tests’?

Image Credit: jaci starkey (Flickr) CC

Image Credit: jaci starkey (Flickr) CC

Maybe I got it wrong. Maybe America really doesn’t need fundamental financial reform of the sort that finally eliminates the cronyist “too big to fail” subsidy for megabanks and establishes a less-crisis prone financial system.

Maybe it’s all fixed. After all, the Fed’s annual stress test of big banks’ financial health showed, according to the WSJ,  “29 of the 30 largest institutions have enough capital to continue lending even when faced with a hypothetical jolt to the U.S. economy lasting into 2015, including a severe drop in housing prices and a spike in unemployment.”

But just how stressful are those stress tests? Bloomberg:

Researchers at New York University have created a tool to answer the question. Drawing on the historical relationship between banks’ stock prices and the market as a whole, it estimates what the value of the banks’ equity capital would be if the market fell 40 percent over six months – similar to what happened in 2008. It then calculates, based on past crises, how much capital the banks would have to raise to be financially sound.

The results aren’t pretty. Using a start date of Sept. 30, 2013, the same as that of the Fed’s latest round of stress tests, the NYU model gives only one of the six largest U.S. banks – Wells Fargo – a passing grade. The other five – JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley – would have a combined capital shortfall of more than $300 billion. That’s not much less than they needed to get themselves out of the last crisis. …

Unfortunately, the Fed’s approach ignores a lot of the horrible things that actually happen in crises – things that NYU’s simpler approach implicitly captures. Banks’ borrowing costs, for example, tend to rise, killing profits that could offset their losses. Trouble at one bank can spread as investors wonder which others will be affected. Credit freezes can force financial institutions to sell assets at a loss, setting in motion downward spirals in which falling prices and banks’ woes reinforce each other.

The Fed also makes a passing grade too easy to achieve. Participating banks, for example, must maintain a leverage ratio of at least 4 percent, or $4 in capital for each $100 in assets. They should not be allowed to get anywhere near such a level, which research and experience suggest is well below what’s needed to avoid distress. In a crisis, banks should be a source of strength, not propagators of panic.

As Charlie Gasparino recently noted, there is a reason bankers call the stress tests “feather tests.”

032414bankFollow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas