Pethokoukis, Economics, U.S. Economy

Here’s a bit of good news about the US economy — and some really bad news

Image Credit: Shutterstock

Image Credit: Shutterstock

Many economists are looking for the US economy to break out of its funk in the second half of the year, finally returning to trend GDP growth for the first time since the start of Bernanke’s Little Depression. The 2% recovery will finally be over — but perhaps only for a little while. Capitol Economics sums up what I see as the bear case:

There are reasons to believe that the recent period of sluggish economic growth and near-zero interest rates are coming to a close. While the economy’s potential growth rate is probably now only slightly above 2%, the unused capacity means that actual growth could run at 3% for several years without triggering a rise in inflation. …

The problem that policymakers and investors have to deal with over the next couple of decades is that population growth should trend even lower, as immigration is muted and the birth rate among the indigenous population falls. In addition, even if there is a cyclical uptick over the next year or two, the labour participation rate is subsequently expected to continue the downward structural trend that began a decade ago. This decline appears to be unavoidable, as increasing numbers of the baby boomer generation retire from the workforce. The upshot of all this is that labour force growth will probably average only 0.7% per year. Even if productivity growth averages 1.5% then, over the next decade or two, real GDP growth would average 2.2%.

1. Maybe we are underestimating GDP and productivity growth.

2. If we are, we should assume we are not and still adopt pro-productivity and pro-innovation policies.

3. It is also possible to boost labor force growth.One idea: eliminating the 12.4% Social Security payroll tax for all individuals aged 62 and older which would a) encourage individuals to remain in the work force and b) make older workers more attractive to employer.

Pethokoukis, Economics, U.S. Economy

What’s behind the high level of long-term unemployment?

Credit: Boston Fed

Credit: Boston Fed

When trying to determine if high unemployment is being caused by weak demand or by some structural factor such as a mismatch between jobs and the skills of job seekers, economists look at the Beveridge Curve. It represents the relationship between the unemployment rate and the job vacancy rate. On a simple chart, vacancies are on the vertical axis and unemployment is on the horizontal.

If the curve shifts outward, it suggests that a given level of job openings is associated with higher and higher unemployment. Now in the aftermath of the Great Recession, the Beveridge Curve has shifted outward, but only among the long-term unemployed.  Rand Ghayad in a paper for the Boston Fed:

The apparent outward shift of the Beveridge curve—the empirical relationship between job openings and unemployment—has received much attention among economists and policymakers in the recent years with many analyses pointing to extended unemployment benefits as a reason behind the shift. However, other explanations have also been proposed for this shift, including worsening structural unemployment.

If the increased availability of unemployment insurance (UI) benefits to the long-term unemployed is responsible for the shift in the Beveridge curve, then allowing these benefits to expire should move many of the long-term unemployed back to work (or out of the labor force).

Evidence from decomposing the job openings and unemployment relationship using data on unemployed persons by reason of unemployment shows that a significant portion of the outward shift in the Beveridge curve is concentrated among new entrants and unemployed re-entrants—those generally not eligible to collect regular or extended benefits. The decomposition reveals that at most half of the shift in the aggregate Beveridge curve is attributable to the disincentive effects of unemployment benefit programs.

As the above chart shows, the unemployment gap is two percentage points higher than what a typical Beveridge Curve would suggest. So it would seem, if I have this right, extended unemployment benefits are boosting the unemployment rate a fair bit, but there are other factors at play for the long-term unemployed. If so, more reason for special policies targeted at that group.

Pethokoukis, Economics, U.S. Economy

Boston Fed study suggests odds of a Detroit turnaround are not good

A Boston Fed study looks at “why some US central cities experienced declines in population, employment, and resident economic well-being during the second half of the twentieth century.” You know, places like Detroit.

Blame suburbanization, sun-seeking, schools, and the downsizing of manufacturing:

1. For one thing, people and employers moved to warmer, sunnier locations. They also moved to less densely settled places, including both younger cities and the outskirts of established cities.

2. Additionally, many manufacturers downsized their workforces or moved their operations to lower-cost locations.

3. The literature also finds that cities with more highly educated populations tended to fare better than cities where a large share of the population either did not finish high school or did not go on to college.

4. Of the forces that influenced population, employment, and economic well-being, the declines and shifts in manufacturing employment are arguably the most relevant for explaining city distress. Among all U.S. central cities, those that were heavily industrial experienced the greatest negative shocks in the second half of the twentieth century. They also are the most likely to have weak economies and low family incomes today.

5. In addition to examining the sources and consequences of central city distress, the studies investigate possible remedies. Their conclusions are sobering: reversing these cities’ trajectories requires making significant civic and financial investments, and comparatively few places have succeeded in making the transition from distressed to revitalized.

Pethokoukis, Economics, U.S. Economy

If we want a bigger US economy, eliminate capital income taxes


Left-liberals and even some center-right folks argue that in the name of fairness, we should equalize statutory tax rates on labor income and capital income. But should it be the goal of US economic policy to theoretically score better on the Gini inequality index or should the goal be to create more jobs and raise incomes?

If it’s the latter — and I think it should be — we should, for instance, maintain the preferential individual income tax rates for long term capital gains and qualified dividends even though they only partially offset the tax code’s bias against savings, particularly when you account for inflation.

Even better, sound, non-controversial economics suggests we should eliminate capital income taxes of all sorts — at least if you want a wealthier America — and replace the individual and corporate income tax with a consumption tax (preferably a progressive consumption tax or “X-tax”). Businesses would be taxed at a high flat rate on their business cash flow, households at graduated rates on their wages (with exemptions and refundable credits for low-wage households). AEI’s Alan Viard (in a must-read analysis):

The income tax’s saving penalty distorts the timing of consumption by favoring consumption today over consumption in the future. The penalty therefore artificially leads taxpayers to do more spending early in life and less late in life. A number of statistical studies have found that, when the after-tax rate of return on saving is lower, individuals’ consumption grows at a slower rate, which confirms that their early consumption is greater and their later consumption is less.

The saving penalty is also likely to slow long-run economic growth. Although some business investment in the United States is financed by foreigners’ savings and some Americans’ savings are used to finance investment abroad, the level of business investment in the United States is still linked to the amount Americans save. A reduction in the amount of Americans’ saving is therefore likely to shrink the US capital stock, reducing the long-run levels of output and wages.

Prominent economists’ simulation models indicate eliminating capital income taxes through a move to consumption taxation would increase long-run output by 2 to 9 percent. A significant part of the long-run gains come at the expense of short-run consumption. The size of the gains depends on economic assumptions, which are subject to considerable uncertainty, and on the design of the consumption tax reform…..  Despite these limitations, the models usefully illustrate the potential gains from reducing or eliminating capital income taxes.

Instead we are heading in the wrong direction. As Viard points out, seven increases in capital income taxation took effect last January, all of which applied to high-income households — the group that accounts for much of US saving. Occupy Wall Street-style economics may allow folks to scratch a populist itch, but America will be poorer for it.

Pethokoukis, Economics, U.S. Economy

The role of long commute times in raising unemployment

Credit: New York Times

Credit: New York Times

A new study on income mobility, which got a big New York Times write up, shows big geographic differences in the ability to rise to the top 20% from the bottom 20%. The cities with the highest mobility are Information Age innovation hubs — San Francisco, San Jose – while the cities with the lowest mobility are former industrial powerhouses — Chicago, St. Louis, Cincinnati, Cleveland, Detroit. But at the very bottom was Atlanta, the capital of the New South. The study found that areas “in which low income individuals were residentially segregated from middle income individuals were also particularly likely to have low rates of upward mobility.”

And in Atlanta, that segregation may be partially the result of bad traffic and weak public transit: from the NYT:

The low-income neighborhoods here often stretch for miles, with rows of houses and low-slung apartments, interrupted by the occasional strip mall, and lacking much in the way of good-paying jobs. This geography appears to play a major role in making Atlanta one of the metropolitan areas where it is most difficult for lower-income households to rise into the middle class and beyond, according to a new study that other researchers are calling the most detailed portrait yet of income mobility in the United States.

The comparison of metropolitan areas allows researchers to consider local factors that previous mobility studies could not — including a region’s geography. And in Atlanta, the most common lament seems to be precisely that concentrated poverty, extensive traffic, and a weak public-transit system make it difficult to get to the job opportunities.

As it happens, another new study looks at the issue of commute times and unemployment as a way of explaining some of the unemployment gap between African immigrants in France and natives, with application to America:

The unemployment rate in France is roughly six percentage points higher for African immigrants than for natives. Why? This column argues that the explanation is spatial: recent immigrants tend to have much longer commute times. Research suggests that in the region of 20% of the employment gap between the French minority and the French majority can be put down to commute times, but more research is needed, especially in France where research into the ethnic unemployment gap is scarce. …

It appears that the different outcomes across ethnic groups in the housing market are less due to the minority receiving fewer housing offers, than to the minority receiving fewer good offers. That is, while the probability of housing offers can be the same for the minority and the majority, offers to the minority are for dwellings which are located farther away from jobs. This result is consistent with other papers on the French housing market emphasising a substantial degree of spatial mismatch and rising segregration (Bouvard et al. 2009).2

In the US, spatial factors also seem to play a role, and explain 1 to 1.5 percentage points of the difference in unemployment rates between black people and white people. However, this corresponds to only 10 to 17.5% of the total racial unemployment-rate gap because there is a larger absolute difference in unemployment rates.


A different kind of People Mover: Let’s flood Detroit with immigrants

Adam Ozimek of the Modeled Behavior blog wants to set up a regional visa system to direct a flood of immigrants to troubled Detroit:

 Yes, an immigrant is made worse off by forcing them to go to Detroit rather than anywhere in the U.S. they want. But right now visas already only allow immigrants to go places where they can find an employer prior to moving here, and then they are effectively tied to that employer. And you don’t have to actually restrict the movement of these immigrants; they should be free to travel throughout the country. They will simply be restricted to working in Detroit. Again, visa holders are already effectively tied to working in a particular city as a result of being tied to an employer within that city. Paired with a plan to help regional visa workers who prove themselves get normal green cards also should help reduce concern about limiting mobility. …

Right now,  the population of New York City is 36.8% foreign born. In comparison, Detroit is only 5.1%. foreign born. This means Detroit would have to let in around 360,000 immigrants just to reach the percent foreign born of New York City. However many immigrants they let in, it’s not likely to approach this. But even if it did, it would not be unprecedented by U.S. city standards. More modestly, increasing the foreign born population to 20% would fall far short of New York City standards, but would still mean 133,000 new immigrants. This would go a long way towards sopping up the 99,000 vacant homes that are plaguing the city.

I’ve been thinking along the same lines, though Ozimek takes a deeper dive. This actually syncs quite nicely with my “charter city” idea for Detroit since its goal is to attract labor and entrepreneurs to the Motor City with a pro-growth environment. As Ed Glaser puts it: “Cities work best when they are filled with smart people and small companies that innovate by exchanging ideas.” Even if that means importing them.

Pethokoukis, Economics, U.S. Economy

Is America richer than it thinks?

Image Credit: Falling Money on Shutterstock

Image Credit: Falling Money on Shutterstock

As mentioned earlier, the US Commerce Department will soon release recalculated GDP numbers that will reclassify “intangible” asset spending as investment, particularly research and development spending. Also, as Bloomberg BusinessWeek notes, “intellectual property, original works of art such as films, music, and books will be treated for the first time as long-lived assets.”

The net effect is to expand the size of the US economy by 3%. But BBW’s Peter Coy points out that “economic theory is ahead of accounting practice” and with the right yardsticks, even more of the intangible economy would go on the books:

The U.S. generates a disproportionate share of its wealth from the likes of patents, copyrights, trademarks, designs, cultural creations, and business processes. … If all forms of intangible investment were officially recorded, they would exceed investment in bricks, mortar, and machines, according to estimates by economists Carol Corrado of the Conference Board and Charles Hulten of the University of Maryland. Intangibles include brand-building, worker training, and the development of advanced organizational practices like total quality management, which meet the definition of an investment because they create assets that will produce revenue a year or more in the future, says Hulten. Those, however, will continue to be treated by the government as expenses. Brent Moulton, the BEA’s associate director for national economic accounts, says their investment nature can’t yet be measured accurately enough to use as official data.

1. Maybe the US economy is stronger and Americans are richer than we think, explaining the disconnect between job growth and GDP growth.

2. Poor accounting tools also suggest GDP and productivity numbers are understating US innovation, even beyond all the free online goods that don’t make it into the official data.

Pethokoukis, Economics, U.S. Economy

Income mobility study shows the value of families, schools, and innovation

Credit: The New York Times

Credit: The New York Times

With income mobility, as with real estate, location matters a lot. According to a New York Times analysis of new research, a lower-income kid in the bottom 20% growing up in Atlanta has a 4% chance of making it to the top 20% vs. an 11% chance for a lower-income kid growing up in San Francisco or San Jose. In other words, depending on where you live in America, upward mobility could be at Scandinavian levels or at the lowest levels found among advanced economies.

But why does location matter? The researchers offer four reasons:

All else being equal, upward mobility tended to be higher in metropolitan areas where poor families were more dispersed among mixed-income neighborhoods. Income mobility was also higher in areas with more two-parent households, better elementary schools and high schools, and more civic engagement, including membership in religious and community groups.

That intact families, good schools, and a healthy civic society are pretty important is hardly surprising to conservatives. (And especially in the case of Atlanta, effective mass transit in less concentrated cities is also important). By contrast, there was little or no correlation between mobility and the sort of stuff that left-liberals might prefer to focus on: taxes (tax credits for the poor or higher taxes for the rich), college tuition rates, or the amount of extreme wealth in a region.

The study effectively outlines what an effective pro-mobility, anti-poverty agenda might look like: a) discouraging regulations that limit urban density (reporter Ryan Avent calculates that various urban land-use regulations cost US GDP growth as much as half a percentage point per year), b) a pro-family tax code, c) education reform, d) unemployment insurance that aids mobility. Reihan Salam adds that “effective crime control is an effective policy lever for reducing the concentration of poverty and improving cognitive outcomes among poor children.”

It should also be noted that the cites with the highest levels of mobility — San Jose, San Francisco, Seattle, Boston, New York — are ones economist Enrico Moretti has identified as innovation hubs whereas many of the low mobility cities — Detroit, Cleveland, Chicago — are the industrial cities of old. As Moretti wrote in the Wall Street Journal:

Today the economic performance of American cities is more uneven than ever before. Some cities are growing fast, attracting innovative employers and adding well-paying jobs. Other cities are falling behind, shedding jobs and losing population. As the economic fortunes of American communities keep growing apart, the financial return for geographic mobility keeps increasing, but only some Americans exploit this opportunity. Unfortunately, government seems to have little idea about how to directly create an innovation hub.

Unfortunately, as Moretti points out, government has a poor record of directly trying to turn cities into innovation centers — which involves attracting high-skill workers and entrepreneurs.

Economics, International economy, Pethokoukis

6 lessons on how to forecast China’s economy

From McKinsey’s China guru, Gordon Orr:

New Year forecasting is a widely practiced business art in most areas of the world, but in China it carries particular risks and rewards. Here are a few reflections to help leaders trying to plan ahead in this fast-changing land:

1. As long as you are directionally correct, growth in China will make your predictions right at some point, and often very quickly. Having a sense for the pace of change is critical.

2. Don’t rely too heavily on government statistics. In the past, at least, the government struggled to gather quality data, and what data it had were often heavily massaged.

3. Trying to forecast exactly when discontinuities will happen is a fool’s game. But identifying what types of discontinuities will happen is a fool’s game. But identifying what types of discontinuities could occur—and having a plan to deal with them if they do—is a basic corporate responsibility.

4. Volatility is a central feature of the Chinese economy. Consumers and businesses still overreact to signals to spend, to invest, and to cut back, so there will be unexpected jumps in demand—and setbacks. Don’t forecast in straight lines.

5. Economics is still economics in China. If something looks odd, it probably is. Find out why before you forecast (or invest).

6. It is more important for forecasting to be interesting—thereby encouraging debate, scenario planning, and a flexible mind-set—than comprehensive.

As for my own modest efforts, I’ve learned to live with the fact that public forecasts never disappear; people still circulate the old ones online. So I’m developing a thick skin, while trying to balance my role as provocateur with my desire to avoid saying something today that will embarrass me in years to come.

Pethokoukis, Economics, U.S. Economy

The US is about to add another New Jersey

Photo Credit: rozipulous/Flickr

Photo Credit: rozipulous/Flickr

Upcoming GDP revisions will add about 3%, or about $500 billion, to the size of the US economy. Some context via Credit Suisse:

– Comprehensive benchmark revisions to the national income and product accounts will be released on July 31st. There will be significant conceptual changes to how GDP is scored.

– The most important change is the reclassification of “intangible” asset spending as investment, the largest item being research and development spending. As a consequence, GDP, as well as its income-side sibling GDI (Gross Domestic Income), is expected to be roughly 3% larger in size than currently measured. That’s akin to tacking on another New Jersey, Ohio or Virginia to the nation’s broadest measure of output.

– The GDP will be larger in a statistical sense, but not any healthier. Think of the revision as analogous to measuring something with a ruler denominated in meters as opposed to yards. The unit of measurement is different, but the object being measured is not any different.

– Other “routine” annual revisions might deliver more GDP growth to the very recent past, which would narrow the wedge somewhat between the stronger labor market data and the relatively weaker GDP data. However, second quarter growth is currently tracking sluggish (latest forecast is 1.1%).

Another way to think of it: the US will be adding a Norway.