The NYT had an article discussing whether private equity firms are good or bad for the economy. The piece failed to focus on the real issues.
The focus of the piece is whether private equity increases or decreases the number of jobs in the firms it controls. This is not really a good measure of whether the industry is good or bad for the economy.
If private equity firms were successful in making companies more efficient and lowering prices to consumers, then it could lead to more jobs in the economy, even if there were fewer workers directly employed in the firms under its control. (This does not really apply in the current economy, where inefficiency means more workers are employed. This is good in the context of a poorly managed macroeconomy with high unemployment.)
However private equity firms do not profit just by making firms more efficient. Private equity also profits by financial engineering. For example, it is standard practice for private equity firms to load their firms with debt. This means that interest payments, which are tax deductible, are substituted for dividend payments, which are not tax deductible.
Private equity companies also often force firms into bankruptcy to offload debt. This can often include pension obligations, which are then taken over by the Pension Benefit Guarantee Corporation. Insofar as private equity companies are drawing their profit from this sort of financial engineering, it is not providing a benefit to the economy. In fact, it is a direct drain on the productive economy.
Clearly private equity companies engage in both practices (increasing efficiency and financial engineering). There is no definitive study showing which is more important to its profits and whether the efficiency gains exceeds the waste associated with financial engineering.
At one point the article quotes R. Glenn Hubbard, the dean of the Columbia Business School and one of Mr. Romney’s economic advisers (who also played a starring role in the movie Inside Job), saying:
“private equity firms have an impact on productivity … That doesn’t mean that people don’t lose their jobs. But the question of whether private equity adds value? It’s settled among economists.”
It would have been helpful to include the view of a less partisan economist who could have told readers that this is not true.
The NYT had an article discussing whether private equity firms are good or bad for the economy. The piece failed to focus on the real issues.
The focus of the piece is whether private equity increases or decreases the number of jobs in the firms it controls. This is not really a good measure of whether the industry is good or bad for the economy.
If private equity firms were successful in making companies more efficient and lowering prices to consumers, then it could lead to more jobs in the economy, even if there were fewer workers directly employed in the firms under its control. (This does not really apply in the current economy, where inefficiency means more workers are employed. This is good in the context of a poorly managed macroeconomy with high unemployment.)
However private equity firms do not profit just by making firms more efficient. Private equity also profits by financial engineering. For example, it is standard practice for private equity firms to load their firms with debt. This means that interest payments, which are tax deductible, are substituted for dividend payments, which are not tax deductible.
Private equity companies also often force firms into bankruptcy to offload debt. This can often include pension obligations, which are then taken over by the Pension Benefit Guarantee Corporation. Insofar as private equity companies are drawing their profit from this sort of financial engineering, it is not providing a benefit to the economy. In fact, it is a direct drain on the productive economy.
Clearly private equity companies engage in both practices (increasing efficiency and financial engineering). There is no definitive study showing which is more important to its profits and whether the efficiency gains exceeds the waste associated with financial engineering.
At one point the article quotes R. Glenn Hubbard, the dean of the Columbia Business School and one of Mr. Romney’s economic advisers (who also played a starring role in the movie Inside Job), saying:
“private equity firms have an impact on productivity … That doesn’t mean that people don’t lose their jobs. But the question of whether private equity adds value? It’s settled among economists.”
It would have been helpful to include the view of a less partisan economist who could have told readers that this is not true.
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No one reads Washington Post editorials for their astute economic analysis. The paper did not surprise readers with its balanced discussion of private equity today.
While the paper is right to point out that whether private equity firms directly increase or decrease employment is not a good measure of whether they are beneficial to the economy, it totally overlooked the main issues surrounding private equity and its impact on the economy. The question is whether the high profits earned by the partners are primarily due to increasing economic efficiency or to rents earned by dumping costs on others.
As noted here, it is standard practice for private equity to load firms with debt. This means that taxable profits are turned into tax-deductible interest payments. The difference can be a gain to Bain and other private equity firms, but it is coming at the expense of taxpayers.
In the same vein, private equity companies often in engage in complex asset shifting. This can leave a heavily indebted firm with few valuable assets. If it eventually goes bankrupt, the creditors collect little money because the private equity company has transferred the assets with value into an independent company. This can also mean big profits for Bain and other private equity companies, but this is not a gain to the economy.
Another frequent game of private equity companies is to dump pension obligations on the Pension Benefit Guarantee Corporation. The reduction in liabilities can mean big profits for Bain and other private equity companies, but does not provide any benefit to the economy.
These are the sorts of issues that appear in serious discussions of the benefits of private equity.
The Post piece also included the bizarre assertion that:
“Probably it [private equity] is one feature of U.S. capitalism that makes our system more flexible and capable of ‘creative destruction’ than Europe’s.”
This is bizarre because the U.S. economy is not obviously more flexible and capable of “creative destruction” than Europe’s economy, as people familiar with the productivity data know.
Source: OECD.
No one reads Washington Post editorials for their astute economic analysis. The paper did not surprise readers with its balanced discussion of private equity today.
While the paper is right to point out that whether private equity firms directly increase or decrease employment is not a good measure of whether they are beneficial to the economy, it totally overlooked the main issues surrounding private equity and its impact on the economy. The question is whether the high profits earned by the partners are primarily due to increasing economic efficiency or to rents earned by dumping costs on others.
As noted here, it is standard practice for private equity to load firms with debt. This means that taxable profits are turned into tax-deductible interest payments. The difference can be a gain to Bain and other private equity firms, but it is coming at the expense of taxpayers.
In the same vein, private equity companies often in engage in complex asset shifting. This can leave a heavily indebted firm with few valuable assets. If it eventually goes bankrupt, the creditors collect little money because the private equity company has transferred the assets with value into an independent company. This can also mean big profits for Bain and other private equity companies, but this is not a gain to the economy.
Another frequent game of private equity companies is to dump pension obligations on the Pension Benefit Guarantee Corporation. The reduction in liabilities can mean big profits for Bain and other private equity companies, but does not provide any benefit to the economy.
These are the sorts of issues that appear in serious discussions of the benefits of private equity.
The Post piece also included the bizarre assertion that:
“Probably it [private equity] is one feature of U.S. capitalism that makes our system more flexible and capable of ‘creative destruction’ than Europe’s.”
This is bizarre because the U.S. economy is not obviously more flexible and capable of “creative destruction” than Europe’s economy, as people familiar with the productivity data know.
Source: OECD.
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I’ve become accustomed to people in elite circles saying that I do not exist, as in “nobody saw the housing bubble,” but it still hurts. Okay, excuse the self-indulgence, there is a point here.
In his column today, David Brooks notes that rent-seekers often benefit from government programs, then complains that:
“You would think that liberals would have a special incentive to root out rent-seeking. Yet this has not been a major priority. There is no Steve Jobs figure in American liberalism insisting that the designers keep government simple, elegant and user-friendly.”
I actually have been yelling at the top of my lungs for much of the last decade about how the government has been used by the wealthy to redistribute income upward. This is the point of the not subtly titled book, The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer. And there is my more recent book, The End of Loser Liberalism: Making Markets Progressive. (Both are available as free e-books, for those interested.)
These books have not attracted much attention, I would be fairly certain that Brooks has never heard of either one. Some of this undoubtedly reflects my skills as a writer, but there is a deeper issue here.
The people who dominate what passes for “liberal” politics in the United States would have little interest in promoting the views expressed in these books. Would Robert Rubin and his Wall Street friends want to promote the argument that they got rich primarily because they could rely on too big to fail insurance provided at no cost by the government? Those who question the importance of Wall Street interests in the Democratic Party should note that making a fortune on Wall Street seems to be a pre-requisite for being chief of staff in the Obama administration.
Similarly, both books point out the enormous waste associated with patent and copyright protection. Patent protection for prescription drugs costs us more than $250 billion a year compared to having drugs sold in a free market. This is five times as much money as what is at stake with extending the Bush tax cuts to the richest two percent. But the Hollywood crew, another important base of funding support for the Democratic Party, have little interest in calling attention to the government interventions that keep their industry alive in its current form.
The books also note the protectionist barriers that make it difficult for foreign professionals (e.g. doctors, dentists, and lawyers) from competing with professionals in the United States. This ensures that these professionals will benefit from international trade, since the goods they buy (including trips to Europe) will be cheaper as a result of trade, while the services they sell will continue to command a high price. However, the professionals who design policy for the Democratic Party have little interest in calling attention to the barriers that protect the high pay that they and their family members enjoy.
In short, there are clear structural obstacles to those advancing an argument that we should restructure the government so that it does not redistribute income upward. Those who control the purse strings that finance politics and policy research and the institutions that dominate public debate (e.g. the New York Times, Washington Post, and National Public Radio) have a clear interest in not having this argument get a wide audience.
This is why David Brooks can tell his readers that there are no liberals who are trying to combat rent-seeking that redistributes income to the wealthy. His friends, in both parties, do their best to ensure that anyone making such arguments never gets heard.
(I should mention Jacob Hacker and Paul Pierson as two people who have made a similar argument to a somewhat larger audience.)
I’ve become accustomed to people in elite circles saying that I do not exist, as in “nobody saw the housing bubble,” but it still hurts. Okay, excuse the self-indulgence, there is a point here.
In his column today, David Brooks notes that rent-seekers often benefit from government programs, then complains that:
“You would think that liberals would have a special incentive to root out rent-seeking. Yet this has not been a major priority. There is no Steve Jobs figure in American liberalism insisting that the designers keep government simple, elegant and user-friendly.”
I actually have been yelling at the top of my lungs for much of the last decade about how the government has been used by the wealthy to redistribute income upward. This is the point of the not subtly titled book, The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer. And there is my more recent book, The End of Loser Liberalism: Making Markets Progressive. (Both are available as free e-books, for those interested.)
These books have not attracted much attention, I would be fairly certain that Brooks has never heard of either one. Some of this undoubtedly reflects my skills as a writer, but there is a deeper issue here.
The people who dominate what passes for “liberal” politics in the United States would have little interest in promoting the views expressed in these books. Would Robert Rubin and his Wall Street friends want to promote the argument that they got rich primarily because they could rely on too big to fail insurance provided at no cost by the government? Those who question the importance of Wall Street interests in the Democratic Party should note that making a fortune on Wall Street seems to be a pre-requisite for being chief of staff in the Obama administration.
Similarly, both books point out the enormous waste associated with patent and copyright protection. Patent protection for prescription drugs costs us more than $250 billion a year compared to having drugs sold in a free market. This is five times as much money as what is at stake with extending the Bush tax cuts to the richest two percent. But the Hollywood crew, another important base of funding support for the Democratic Party, have little interest in calling attention to the government interventions that keep their industry alive in its current form.
The books also note the protectionist barriers that make it difficult for foreign professionals (e.g. doctors, dentists, and lawyers) from competing with professionals in the United States. This ensures that these professionals will benefit from international trade, since the goods they buy (including trips to Europe) will be cheaper as a result of trade, while the services they sell will continue to command a high price. However, the professionals who design policy for the Democratic Party have little interest in calling attention to the barriers that protect the high pay that they and their family members enjoy.
In short, there are clear structural obstacles to those advancing an argument that we should restructure the government so that it does not redistribute income upward. Those who control the purse strings that finance politics and policy research and the institutions that dominate public debate (e.g. the New York Times, Washington Post, and National Public Radio) have a clear interest in not having this argument get a wide audience.
This is why David Brooks can tell his readers that there are no liberals who are trying to combat rent-seeking that redistributes income to the wealthy. His friends, in both parties, do their best to ensure that anyone making such arguments never gets heard.
(I should mention Jacob Hacker and Paul Pierson as two people who have made a similar argument to a somewhat larger audience.)
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The NYT implies that it is when it tells readers that:
“Many of those involved [in the fracking debate] said it was unlikely that Governor Cuomo would turn his back on the gas industry and ban drilling in the rich Marcellus and Utica shale deposits covering much of the economically depressed southern and western reaches of the state.”
If the industry creates relatively few jobs, most of which go to skilled workers from outside of the state, and then leaves the area permanently scarred, it is not clear that fracking is beneficial to economically depressed areas.
The NYT implies that it is when it tells readers that:
“Many of those involved [in the fracking debate] said it was unlikely that Governor Cuomo would turn his back on the gas industry and ban drilling in the rich Marcellus and Utica shale deposits covering much of the economically depressed southern and western reaches of the state.”
If the industry creates relatively few jobs, most of which go to skilled workers from outside of the state, and then leaves the area permanently scarred, it is not clear that fracking is beneficial to economically depressed areas.
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Every few months there is a mini-frenzy around the idea of allowing more people to refinance their mortgages. Today Ezra Klein picks up the cause in his Post column. This is a good idea, but the notion that this is going to provide some major boost to the economy is just silly.
The main reason is that there just are not that many homeowners tied into high cost mortgages who are going to be induced to take advantage of a refinancing opportunity. The story is that we have millions of homeowners who are badly underwater and therefore will not be able to meet normal refinancing criteria. However, the numbers who are being precluded from refinancing for this reason are likely relatively few at this point.
Fannie Mae and Freddie Mac had a policy for several years of allowing people to refinance who had mortgages that were up to 125 percent of their home value. This probably accounts for close to half of the 12 million or so underwater homeowners. Of the roughly 50 percent of mortgages insured by Fannie and Freddie, it is likely that a greater share are in the under 125 percent group, since they generally did not get the worst mortgages.
In September, President Obama persuaded the Federal House Finance Administration to remove this cap, allowing anyone with a Fannie or Freddie backed mortgage to refinance no matter how much they are underwater. Undoubtedly many people are taking advantage of this opportunity as refinancing has been very strong through the fall months. (Mortgage refis tend to run around 700k to 800k a month.)
Suppose that there were 3 million homeowners with Fannie and Freddie loans that were too underwater to be able to refinance before the change in policy in September (half of the roughly 6 million mortgages that were more than 125 percent underwater). Suppose roughly a quarter of the monthly refis over the fall were from this group, which would mean that 800k have already refinanced leaving another 2.2 million.
Of this group, some number may have plans to sell their homes or for other reasons not be interested in refinancing their mortgages. Of course some would refinance even with no change in policy, but they just have not gotten around to it. Anyhow, let’s suppose that that full court press gets 2 million of these people to refinance over the next 4 months. If we assume an average mortgage of $250k (the average house price is around $225k and the median is a bit over $160k), and we assume average savings of 2 percentage points on the new mortgage, this frees up $10 billion a year.
If homeowners spend 90 percent of this freed up money, that adds $9 billion a year or 0.06 percent to demand. And, that is before deducting any reduced spending on the part of the mortgage holders who are now getting less interest. It also doesn’t take into account that many of these mortgages would have been refinanced in any case, just somewhat later in the year.
In short, Obama should do everything he can to try to make it easy for underwater homeowners to get into lower cost loans. But the reason is that it will help these homeowners, it will not have a noticeable impact on the economy.
Every few months there is a mini-frenzy around the idea of allowing more people to refinance their mortgages. Today Ezra Klein picks up the cause in his Post column. This is a good idea, but the notion that this is going to provide some major boost to the economy is just silly.
The main reason is that there just are not that many homeowners tied into high cost mortgages who are going to be induced to take advantage of a refinancing opportunity. The story is that we have millions of homeowners who are badly underwater and therefore will not be able to meet normal refinancing criteria. However, the numbers who are being precluded from refinancing for this reason are likely relatively few at this point.
Fannie Mae and Freddie Mac had a policy for several years of allowing people to refinance who had mortgages that were up to 125 percent of their home value. This probably accounts for close to half of the 12 million or so underwater homeowners. Of the roughly 50 percent of mortgages insured by Fannie and Freddie, it is likely that a greater share are in the under 125 percent group, since they generally did not get the worst mortgages.
In September, President Obama persuaded the Federal House Finance Administration to remove this cap, allowing anyone with a Fannie or Freddie backed mortgage to refinance no matter how much they are underwater. Undoubtedly many people are taking advantage of this opportunity as refinancing has been very strong through the fall months. (Mortgage refis tend to run around 700k to 800k a month.)
Suppose that there were 3 million homeowners with Fannie and Freddie loans that were too underwater to be able to refinance before the change in policy in September (half of the roughly 6 million mortgages that were more than 125 percent underwater). Suppose roughly a quarter of the monthly refis over the fall were from this group, which would mean that 800k have already refinanced leaving another 2.2 million.
Of this group, some number may have plans to sell their homes or for other reasons not be interested in refinancing their mortgages. Of course some would refinance even with no change in policy, but they just have not gotten around to it. Anyhow, let’s suppose that that full court press gets 2 million of these people to refinance over the next 4 months. If we assume an average mortgage of $250k (the average house price is around $225k and the median is a bit over $160k), and we assume average savings of 2 percentage points on the new mortgage, this frees up $10 billion a year.
If homeowners spend 90 percent of this freed up money, that adds $9 billion a year or 0.06 percent to demand. And, that is before deducting any reduced spending on the part of the mortgage holders who are now getting less interest. It also doesn’t take into account that many of these mortgages would have been refinanced in any case, just somewhat later in the year.
In short, Obama should do everything he can to try to make it easy for underwater homeowners to get into lower cost loans. But the reason is that it will help these homeowners, it will not have a noticeable impact on the economy.
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Eamonn Fingleton started a debate on Japan’s slump or lack thereof with a Sunday review piece in the NYT. This has since been joined by Paul Krugman and others. Since I have been asked by a number of people what I thought, I will weigh in with my own two cents.
First I agree with Fingleton that the description of Japan as a basket case is way off the mark. While GDP growth has been weak, its productivity growth has been better than the average in the OECD.
Source: OECD.
The fact that its productivity growth has exceeded its GDP growth is explained by both the aging of the population, leading to a decline in the size of its labor force and also the reduction in the number of hours worked per year by the average worker. Neither of these seems to be obviously bad, although it is almost certainly the case that Japan still suffers from some hidden unemployment (mostly among women) in addition to its relatively low official unemployment (@ 4.0 percent).
Fingleton probably does go overboard in a few areas. First, Shadowstats is not a credible source. There are issues with the official statistics in the U.S. (as is the case everywhere), but the idea that we have overstated growth by 2 percentage points a year does not pass the laugh test.
Second, the measure of electricity use that he sees as a main determinant of living standards is likely distorted by the fact that Japan was starting from a very low base whereas the U.S. was starting from a very high base. We can get any number of new appliances that will be markedly better than the ones that they replaced and still use considerably less electricity. The same is not likely to be the case with Japan. The same applies to commercial and industrial users of electricity.
But there is an area in which Fingleton may actually understate his case. I remember refereeing a journal article at the end of the 90s about Japan’s price index for passenger trains. (Wait, this is not that boring.)
The article purported to show that the official Japanese index overstated inflation because it missed quality improvements. The main quality improvement was that the trains were less crowded. The author had compared the price of first class and second class seats and noted that the main difference between the two was that first class passengers were guaranteed a seat. However because the trains had become less crowded, almost everyone in second class could now get a seat as well. This in effect meant that a second class seat at the end of the period examined was as good as a first class seat at the beginning.
This made a substantial difference in the price index for trains, effectively showing a much slower rate of price increase when this quality improvement (less crowding) was taken into account. This issue could be an important factor in the quality of services across Japan more generally. If the reduced population has led to fewer people on planes and other forms of transportation, fewer people sharing parks and beaches and other potentially crowded public places, then it may imply a substantial improvement in living standards that would not be picked up in conventional economic measures.
I don’t know if anyone has researched this issue and tried to quantify the benefits that the Japanese may be receiving from reduced crowding, but it is plausible that the gains would be substantial.
Eamonn Fingleton started a debate on Japan’s slump or lack thereof with a Sunday review piece in the NYT. This has since been joined by Paul Krugman and others. Since I have been asked by a number of people what I thought, I will weigh in with my own two cents.
First I agree with Fingleton that the description of Japan as a basket case is way off the mark. While GDP growth has been weak, its productivity growth has been better than the average in the OECD.
Source: OECD.
The fact that its productivity growth has exceeded its GDP growth is explained by both the aging of the population, leading to a decline in the size of its labor force and also the reduction in the number of hours worked per year by the average worker. Neither of these seems to be obviously bad, although it is almost certainly the case that Japan still suffers from some hidden unemployment (mostly among women) in addition to its relatively low official unemployment (@ 4.0 percent).
Fingleton probably does go overboard in a few areas. First, Shadowstats is not a credible source. There are issues with the official statistics in the U.S. (as is the case everywhere), but the idea that we have overstated growth by 2 percentage points a year does not pass the laugh test.
Second, the measure of electricity use that he sees as a main determinant of living standards is likely distorted by the fact that Japan was starting from a very low base whereas the U.S. was starting from a very high base. We can get any number of new appliances that will be markedly better than the ones that they replaced and still use considerably less electricity. The same is not likely to be the case with Japan. The same applies to commercial and industrial users of electricity.
But there is an area in which Fingleton may actually understate his case. I remember refereeing a journal article at the end of the 90s about Japan’s price index for passenger trains. (Wait, this is not that boring.)
The article purported to show that the official Japanese index overstated inflation because it missed quality improvements. The main quality improvement was that the trains were less crowded. The author had compared the price of first class and second class seats and noted that the main difference between the two was that first class passengers were guaranteed a seat. However because the trains had become less crowded, almost everyone in second class could now get a seat as well. This in effect meant that a second class seat at the end of the period examined was as good as a first class seat at the beginning.
This made a substantial difference in the price index for trains, effectively showing a much slower rate of price increase when this quality improvement (less crowding) was taken into account. This issue could be an important factor in the quality of services across Japan more generally. If the reduced population has led to fewer people on planes and other forms of transportation, fewer people sharing parks and beaches and other potentially crowded public places, then it may imply a substantial improvement in living standards that would not be picked up in conventional economic measures.
I don’t know if anyone has researched this issue and tried to quantify the benefits that the Japanese may be receiving from reduced crowding, but it is plausible that the gains would be substantial.
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That’s a good question, but Robert Samuelson doesn’t shed much light on the topic in his column today. He notes the considerable evidence of a housing bubble in parts of the country, which may now be deflating. In considering consequences he acknowledges China’s successful stimulus 3 years ago, but then comments:
“Finally, China’s government will have a harder time deploying a stimulus than during the 2008-09 financial crisis. Government debt rose from 26 percent of gross domestic product in 2007 to 43 percent of GDP in 2010.”
This one must have readers all over the world scratching their heads. A country with a debt to GDP ratio of 43 percent, that is growing at an annual rate close to 10 percent, has trouble borrowing money to finance a stimulus? That’s not true on this planet.
The United States had no problem financing its stimulus even when its debt to GDP ratio was over 60 percent, with a prospective growth rate of less than 3 percent. And Japan pays less than 1 percent interest on its debt even though it has a debt to GDP ratio of more than 200 percent of a trend growth rate under 2 percent.
It might also be a good idea if Samuelson relied on someone other than Nicholas Lardy as his expert on China’s economy. Lardy is known for predicting that China would suffer a crippling banking crisis more than a decade ago. That has not happened yet.
That’s a good question, but Robert Samuelson doesn’t shed much light on the topic in his column today. He notes the considerable evidence of a housing bubble in parts of the country, which may now be deflating. In considering consequences he acknowledges China’s successful stimulus 3 years ago, but then comments:
“Finally, China’s government will have a harder time deploying a stimulus than during the 2008-09 financial crisis. Government debt rose from 26 percent of gross domestic product in 2007 to 43 percent of GDP in 2010.”
This one must have readers all over the world scratching their heads. A country with a debt to GDP ratio of 43 percent, that is growing at an annual rate close to 10 percent, has trouble borrowing money to finance a stimulus? That’s not true on this planet.
The United States had no problem financing its stimulus even when its debt to GDP ratio was over 60 percent, with a prospective growth rate of less than 3 percent. And Japan pays less than 1 percent interest on its debt even though it has a debt to GDP ratio of more than 200 percent of a trend growth rate under 2 percent.
It might also be a good idea if Samuelson relied on someone other than Nicholas Lardy as his expert on China’s economy. Lardy is known for predicting that China would suffer a crippling banking crisis more than a decade ago. That has not happened yet.
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That’s what reporters should have been asking as the Obama administration put a positive spin on the 1.6 million job growth in 2011. The economy has to create roughly 1 million jobs a year to keep pace with the growth of the labor force. With a shortfall of jobs that is currently near 10 million, it will take more than 16 years to get the economy back to full employment at the 2011 rate of job growth.
Reporters should have been ridiculing the Obama administration for their poor grasp of arithmetic for celebrating such a dismal job performance. They certainly should have pointed out to readers the absurdity of their boasts about the recent pace of job growth.
That’s what reporters should have been asking as the Obama administration put a positive spin on the 1.6 million job growth in 2011. The economy has to create roughly 1 million jobs a year to keep pace with the growth of the labor force. With a shortfall of jobs that is currently near 10 million, it will take more than 16 years to get the economy back to full employment at the 2011 rate of job growth.
Reporters should have been ridiculing the Obama administration for their poor grasp of arithmetic for celebrating such a dismal job performance. They certainly should have pointed out to readers the absurdity of their boasts about the recent pace of job growth.
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Economists tend not to be very good at economics. We know this because almost none of them were able to see the $8 trillion housing bubble that was driving the economy from 2002 to 2007. This was an oversight of astonishing importance, sort of like a physicist not noticing gravity.
Their failure to understand the economy has led to enormous misreporting of the December jobs data. There are two basic problems. They fail to accurately put the job growth numbers in the context of the economic downturn and they badly misread the December data leading them to overstate the true growth path we are now on.
Taking the two in turn, the reports were full of the good news that the economy had created 200,000 jobs and the unemployment rate had dropped to 8.5 percent. Creating 200,000 jobs is undoubtedly better than creating 100,000 jobs and much better than creating no jobs at all, but is this good?
From December of 1995 to December of 1999 the economy generated more than 250,000 jobs a month, and that was starting from an unemployment rate of under 6.0 percent. We expect more rapid job growth following a steep downturn like the one we saw in 2007-2009.
In the two years following the 1981-82 recession the economy generated over 300,000 jobs a month. Following the 1974-75 recession, the economy generated more than 340,000 jobs a month in the two years from December 1976 to December 1978, and this was with a labor force that was only 60 percent of the size of the current labor force. So we’re supposed to be happy about 200,000 jobs in December?
Another way to think about this is that we currently have a shortfall of around 10 million jobs. If we generate 200,000 jobs a month, then we are cutting into this shortfall at the rate of 100,000 a month, since we need 90,000-100,000 jobs a month just to keep pace with the growth of the population. This means that in 100 months we should expect to be back to full employment. So the champagne bottles for that happy occasion will be dated 2020.
Okay, but this puts too bright of a picture on the data. The 200,000 jobs number reported for December was distorted by unusual seasonal factors, the most obvious of which was the 42,200 job growth reported in the courier industry. This is primarily companies like Fed Ex and UPS who hire additional workers to deal with holiday demand.
In principle seasonal adjustments should remove the impact of seasonal fluctuations, however these adjustments are always based on historical experience. When there is a sharp departure from historical patterns, like the explosion of Internet sales, the seasonal adjustments will not pick this up. We have good reason for believing this to be the case here because in 2010 the Labor Department reported an increase of 46,300 jobs in the courier industry, all of which disappeared the next month. In 2009, it was 30,100 jobs reported in December that all disappeared in January.
Here’s the picture:
Employment in Couriers and Messengers (seasonally adjusted)
Source: Bureau of Labor Statistics.
What should we infer from this? We should assume that most, is not all of these 42,200 jobs reported in December will disappear in January. That puts our jobs number around 160,000. There were some other unusual factors that may have pumped the numbers in December slightly. Construction employment reportedly rose 17,000 in December after falling 10,000 in October and 12,000 in November. Did we turn the corner in the construction industry? Well the sector added 31,000 jobs in September. Construction employment is very erratic because of the weather. We had a relatively mild December in the Northeast and Midwest, which means that we would expect better than usual construction employment. Don’t bet on this one being part of a trend.
There were a few other anomalies of less consequence in both directions, but a clear-eyed look at the December data puts the job growth at around 150,000. If we take the average job growth over the last three months we get roughly 140,000. Maybe we have a slight pick-up, but probably not much more. At 150,000 jobs a month, the full employment champagne bottles will be dated 2028.
What about the drop in the unemployment rate, surely that is good news? Well the unemployment data come from a separate survey of households. This survey is much more erratic than the establishment survey due to the fact that it has a much smaller sample. There are often large movements in this survey that clearly cannot be explained by movements in the economy.
For example, the survey showed the unemployment rate falling from 4.7 to 4.4 percent in the second half of 2006, a period when GDP growth averaged 1.4 percent. It then rose back to 4.7 percent in the first half of 2007, a period when growth averaged 2.1 percent. The monthly employment changes can be even more erratic. In the four months from July to November 1994, the survey showed the economy adding almost 1.8 million jobs or 450,000 a month. This was a period in which the economy was growing at a healthy, but not spectacular, 3.6 percent annual rate.
More recently, the survey showed employment plunging by 423,000 last June. Fortunately no one thought to seize on that change as marking the start of another recession. Over the course of a year, these erratic movements largely even out. If we look at employment from December of 2010 to December of 2011, it increased by 1,570,000 in the household survey. This is telling us pretty much the same story as the rise in payroll employment over this period of 1,640,000 jobs.
The other point to remember is that the unemployment rate is telling us not how many people are out of work, but rather how many people are out of work and looking for jobs. Many people give up looking for work if they feel their job prospects are hopeless. A better measure for most purposes is the employment to population ratio (EPOP). By this measure, we have made little progress since the trough of the recession.
The 58.5 percent number for December is up just 0.3 percentage points from the trough of 58.2 percent hit last summer. By comparison, the EPOP hit a peak of 63.4 percent in 2006. We still have almost 5 percentage points to go before we get back to this pre-recession peak. Or to put it slightly differently: we have made up just 6 percent of the lost ground.
Employment to Population Ratio
Source: Bureau of Labor Statistics.
In short, a serious look at the December report does not provide much cause for celebration. The economy is still in very bad shape and the current growth path provides little hope for much relief any time soon. Economists should know this, but unfortunately few seem to pay much attention to the data. Remember the double-dip recession?
Economists tend not to be very good at economics. We know this because almost none of them were able to see the $8 trillion housing bubble that was driving the economy from 2002 to 2007. This was an oversight of astonishing importance, sort of like a physicist not noticing gravity.
Their failure to understand the economy has led to enormous misreporting of the December jobs data. There are two basic problems. They fail to accurately put the job growth numbers in the context of the economic downturn and they badly misread the December data leading them to overstate the true growth path we are now on.
Taking the two in turn, the reports were full of the good news that the economy had created 200,000 jobs and the unemployment rate had dropped to 8.5 percent. Creating 200,000 jobs is undoubtedly better than creating 100,000 jobs and much better than creating no jobs at all, but is this good?
From December of 1995 to December of 1999 the economy generated more than 250,000 jobs a month, and that was starting from an unemployment rate of under 6.0 percent. We expect more rapid job growth following a steep downturn like the one we saw in 2007-2009.
In the two years following the 1981-82 recession the economy generated over 300,000 jobs a month. Following the 1974-75 recession, the economy generated more than 340,000 jobs a month in the two years from December 1976 to December 1978, and this was with a labor force that was only 60 percent of the size of the current labor force. So we’re supposed to be happy about 200,000 jobs in December?
Another way to think about this is that we currently have a shortfall of around 10 million jobs. If we generate 200,000 jobs a month, then we are cutting into this shortfall at the rate of 100,000 a month, since we need 90,000-100,000 jobs a month just to keep pace with the growth of the population. This means that in 100 months we should expect to be back to full employment. So the champagne bottles for that happy occasion will be dated 2020.
Okay, but this puts too bright of a picture on the data. The 200,000 jobs number reported for December was distorted by unusual seasonal factors, the most obvious of which was the 42,200 job growth reported in the courier industry. This is primarily companies like Fed Ex and UPS who hire additional workers to deal with holiday demand.
In principle seasonal adjustments should remove the impact of seasonal fluctuations, however these adjustments are always based on historical experience. When there is a sharp departure from historical patterns, like the explosion of Internet sales, the seasonal adjustments will not pick this up. We have good reason for believing this to be the case here because in 2010 the Labor Department reported an increase of 46,300 jobs in the courier industry, all of which disappeared the next month. In 2009, it was 30,100 jobs reported in December that all disappeared in January.
Here’s the picture:
Employment in Couriers and Messengers (seasonally adjusted)
Source: Bureau of Labor Statistics.
What should we infer from this? We should assume that most, is not all of these 42,200 jobs reported in December will disappear in January. That puts our jobs number around 160,000. There were some other unusual factors that may have pumped the numbers in December slightly. Construction employment reportedly rose 17,000 in December after falling 10,000 in October and 12,000 in November. Did we turn the corner in the construction industry? Well the sector added 31,000 jobs in September. Construction employment is very erratic because of the weather. We had a relatively mild December in the Northeast and Midwest, which means that we would expect better than usual construction employment. Don’t bet on this one being part of a trend.
There were a few other anomalies of less consequence in both directions, but a clear-eyed look at the December data puts the job growth at around 150,000. If we take the average job growth over the last three months we get roughly 140,000. Maybe we have a slight pick-up, but probably not much more. At 150,000 jobs a month, the full employment champagne bottles will be dated 2028.
What about the drop in the unemployment rate, surely that is good news? Well the unemployment data come from a separate survey of households. This survey is much more erratic than the establishment survey due to the fact that it has a much smaller sample. There are often large movements in this survey that clearly cannot be explained by movements in the economy.
For example, the survey showed the unemployment rate falling from 4.7 to 4.4 percent in the second half of 2006, a period when GDP growth averaged 1.4 percent. It then rose back to 4.7 percent in the first half of 2007, a period when growth averaged 2.1 percent. The monthly employment changes can be even more erratic. In the four months from July to November 1994, the survey showed the economy adding almost 1.8 million jobs or 450,000 a month. This was a period in which the economy was growing at a healthy, but not spectacular, 3.6 percent annual rate.
More recently, the survey showed employment plunging by 423,000 last June. Fortunately no one thought to seize on that change as marking the start of another recession. Over the course of a year, these erratic movements largely even out. If we look at employment from December of 2010 to December of 2011, it increased by 1,570,000 in the household survey. This is telling us pretty much the same story as the rise in payroll employment over this period of 1,640,000 jobs.
The other point to remember is that the unemployment rate is telling us not how many people are out of work, but rather how many people are out of work and looking for jobs. Many people give up looking for work if they feel their job prospects are hopeless. A better measure for most purposes is the employment to population ratio (EPOP). By this measure, we have made little progress since the trough of the recession.
The 58.5 percent number for December is up just 0.3 percentage points from the trough of 58.2 percent hit last summer. By comparison, the EPOP hit a peak of 63.4 percent in 2006. We still have almost 5 percentage points to go before we get back to this pre-recession peak. Or to put it slightly differently: we have made up just 6 percent of the lost ground.
Employment to Population Ratio
Source: Bureau of Labor Statistics.
In short, a serious look at the December report does not provide much cause for celebration. The economy is still in very bad shape and the current growth path provides little hope for much relief any time soon. Economists should know this, but unfortunately few seem to pay much attention to the data. Remember the double-dip recession?
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Adam Davidson tells us in the NYT Magazine that Europe is losing its ability to compete in the world economy. This is a bit hard to see.
First, the most simple measure of competitiveness is the market test. Is Europe able to sell goods and services successfully in the world economy? On this score the continent is doing much better than the United States. Over the last decade it generally had near balanced trade. Some years the European Union had small trade surpluses and in others it had small deficits. Of course the picture differs by country. Spain and Greece had large trade deficits while Germany had large trade surpluses, but the continent as a whole had pretty much balanced trade.
This contrasts with the United States, which ran large trade deficits over most of the decade, with a peak of nearly 6.0 percent of GDP in 2006. In short, by this market test it is the United States, not Europe, that has difficulty competing.
The second issue is whether productivity is growing at a decent pace. After all, this is the main long-run determinant of living standards. If we compare productivity growth in Europe with the United States it is hard to see the case for the imminent collapse of Europe.
Source: OECD.
U.S. productivity growth over this period is better than growth in Spain and Italy, but worse than Norway and Sweden. Productivity growth in the U.S. is virtually the same as in Germany and only slightly faster than in France. (The reason for showing 2007 and 2010 as separate endpoints is that many European countries have aggressively promoted policies to keep people at work during the downturn. This lowers unemployment — the unemployment rate in Germany is just 5.5 percent — but it also reduces productivity.) Productivity is difficult to measure and international comparisons should always be viewed with caution, but it is hard to make the case here for a European continent that faced serious economic problems before the economic crisis.
There is the more subjective view of competitiveness involving items like successful tech companies and relative importance in the new economy. Even here the case is not clear. After all, one of the key developers of Linux was Linus Torvalds, a Finn. Nokia has lost market share recently but had been the world’s leading cell phone manufacturer. The Swedish company, Ericsson was another leading cell producer.
On measures of connectivity there is considerable variability across Europe. Northern European countries like Norway and Denmark tend to rank higher than the U.S. on areas like broadband penetration, Germany and France are comparable, and the southern European countries rank lower. On educational outcomes, by most measures, most of Europe does better.
In short, it would be difficult to find a generally accepted measure of competitiveness where Europe does poorly compared to the United States. The European Central Bank may be able to inflict enough damage so that in a few years this is no longer the case, but for now Europe’s fundamentals still seem solid.
Adam Davidson tells us in the NYT Magazine that Europe is losing its ability to compete in the world economy. This is a bit hard to see.
First, the most simple measure of competitiveness is the market test. Is Europe able to sell goods and services successfully in the world economy? On this score the continent is doing much better than the United States. Over the last decade it generally had near balanced trade. Some years the European Union had small trade surpluses and in others it had small deficits. Of course the picture differs by country. Spain and Greece had large trade deficits while Germany had large trade surpluses, but the continent as a whole had pretty much balanced trade.
This contrasts with the United States, which ran large trade deficits over most of the decade, with a peak of nearly 6.0 percent of GDP in 2006. In short, by this market test it is the United States, not Europe, that has difficulty competing.
The second issue is whether productivity is growing at a decent pace. After all, this is the main long-run determinant of living standards. If we compare productivity growth in Europe with the United States it is hard to see the case for the imminent collapse of Europe.
Source: OECD.
U.S. productivity growth over this period is better than growth in Spain and Italy, but worse than Norway and Sweden. Productivity growth in the U.S. is virtually the same as in Germany and only slightly faster than in France. (The reason for showing 2007 and 2010 as separate endpoints is that many European countries have aggressively promoted policies to keep people at work during the downturn. This lowers unemployment — the unemployment rate in Germany is just 5.5 percent — but it also reduces productivity.) Productivity is difficult to measure and international comparisons should always be viewed with caution, but it is hard to make the case here for a European continent that faced serious economic problems before the economic crisis.
There is the more subjective view of competitiveness involving items like successful tech companies and relative importance in the new economy. Even here the case is not clear. After all, one of the key developers of Linux was Linus Torvalds, a Finn. Nokia has lost market share recently but had been the world’s leading cell phone manufacturer. The Swedish company, Ericsson was another leading cell producer.
On measures of connectivity there is considerable variability across Europe. Northern European countries like Norway and Denmark tend to rank higher than the U.S. on areas like broadband penetration, Germany and France are comparable, and the southern European countries rank lower. On educational outcomes, by most measures, most of Europe does better.
In short, it would be difficult to find a generally accepted measure of competitiveness where Europe does poorly compared to the United States. The European Central Bank may be able to inflict enough damage so that in a few years this is no longer the case, but for now Europe’s fundamentals still seem solid.
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