Oh, what a difference

Back in 2005, Germany had the highest unemployement rate among the major economies of the EU (of the big four including France, UK, Italy and the PIGS economies of Portugal, Ireland, Greece and Spain). Ireland had the lowest. Today, as Moody's downgrades the credit rating of six European countries, Germany has the lowest unemployment among them all. How fortunes have changed in such a short span of time. It should be noted that the Deutschland during the global financial crisis went alone in not stimulating its economy.

Could this be a case of free-loading? Stimulus only works when everyone does it, otherwise some of the fiscal spending leaks out through imports of foreign made goods, not benefiting the local economy. Germany, having benefited from the stimulus spending of its neighbors during the GFC, does not relish its present role in bailing out its ailing neighbors. A classic case of "no free lunch."

"Poverty is a choice"

That seems to be the conclusion of Charles Murray, a scholar of the libertarian American Enterprise Institute and author of the controversial book, Coming Apart which looks at the growing divide among white Americans from 1960 to 1910.

After asserting in the Bell Curve a book he co-authored with Richard Hernstein that it was their inherent lack of intelligence or IQ more precisely that reduced African Americans to the bottom of the social and economic ladder, he now claims that poverty among white Americans is a result of the decline of civic culture, a result of changing preferences rather than structural policy imbalances.

Back in 1994, the unknown civil rights lawyer Barrack Obama, as a guest commentator at NPR spoke plainly regarding Murray's work then, that

He's interested in pushing a very particular policy agenda ... With one finger out to the political wind, Mr. Murray has apparently decided that white America is ready for a return to good old-fashioned racism so long as it's artfully packaged and can admit for exceptions like Colin Powell.

It doesn't seem as though there is a role for government either in closing the divide between upper middle class white Americans and their blue collar counterparts. According to Murray, the cure for this malady is for the wealthy "to drop their nonjudgmentalism and start preaching what they're practicing" (a case for cultural imperialism?). Perhaps, in Murray's policy brief, they deserve in exchange for exercising such noblesse oblige or civic duty tax cuts on top of the ones they already receive (?).

The person who could model this kind of behavior the best among the candidates is Mitt Romney. The introduction of the book comes at an opportune time as he recently stumbled over the issue of income inequality and as many independents within the party (blue collar teaparty Republicans) cast a suspicious eye at the 'Washington/Wall Street establishment' that he seems to represent. The 'non-Romney' candidates, Newt Gingrich, Rick Santorum and Ron Paul have all railed against these 'fat cats' and sought to capture the protest vote.

It turns out, these so-called elites share many of the religious and cultural preferences as the party base according to Murray (upper middle class whites more frequently go to church, marry and stay married for longer). Of course the recent research on happiness and income explains why that may be. In the end, Murray may have tried to establish a false causation here.

Given the stagnation of income and productivity in America, the 'choice' faced by ordinary Americans isn't the same as the one they faced in the 1950s when GDP and employment were rising. Consequently, people don't 'choose' to become poor because they have lost their work ethos; the lack of a work ethos comes as a result of people being poor or unemployed for an extended period of time.

The Intellectual Capital Market

An ingeniously crafted article by Philip Gerrans, a reader of philosophy at Adelaide University appearing in the Times Higher Education likens the asset bubble that happened in financial markets with the trading of intellectual capital in the Humanities.

He explains it in this manner

The academy, too, is a market - a large one in which the value of any piece of research is ultimately secured against the world. If the world is not as described or predicted in the article or book, the research is worthless...The academic market is also like the financial market in another way. Stocks trade above their value, which leads to bubbles and crashes.

So what are the safe havens in the “intellectual securities” mart? For Gerrans, the AAA rated bonds would be found in the Science department, as

... stocks in science (the papers, grant applications and CVs that secure appointments, salaries and grant funding) trade fairly close to their real value. It is hard to leverage them because there are a lot of investors who are trying to cash in their investments rather than passing them on to some other dupe and taking a fee. Other scientists want to see if the theorem is proved, the prediction verified, the world accurately described or the technology workable.

And the junk bonds? Well, according to him, this distinction belongs to the Humanities as

a lot of the market is unsecured and highly leveraged. By this I mean that people in the humanities often do not write about the world or the people in it. Rather, they write about what somebody wrote about what somebody else wrote about what somebody else wrote... None of this would matter if the market were basically self-correcting like the science market ... When people do not write directly about the world, it is hard to compare what they say against the world. So the main corrective mechanism in the humanities is reputation built on publication and, since publication is often based on reputation, the danger of a bubble is extreme.

Just as it became impossible to distinguish good picks from bad ones with the bundled financial products called CDOs or collateralised debt obligations, it has become as difficult according to Gerrans for governments and universities to do the same with the “mixed bag” existing in their humanities departments.

(Actually, economists will tell us that the practice of bundling commodities, such as packing apples, performed by sellers, has been created in order to economise on transactions costs by preventing buyers from inspecting each item before making a final purchase decision)

From a public investment point of view, Gerrans argues, what is the point of governments bailing out these departments and forcing those from lower socio-economic families who he claims lack the “marks, self-esteem or cultural savvy to get past the government and university spin” to accept the toxic debt of investing in these fields of “anti-knowledge” when they become unemployable in the end?

Unlike a one-off purchase of a disposable commodity like fruit, the choice of field in higher education is something one will have to live with for the rest of his or her working life (live with the debt at least). Surely better information systems can be put in place to help improve decisional quality of aspiring college and training graduates.

Opposite Poles

Two eminent economists, Meltzer and Krugman, dispute the issue of whether inflation or deflation will be the next great challenge facing the US (and world) economy. A lot depends on which period of history is used as an analogue for this one.

Allan H. Meltzer is a professor of political economy at Carnegie Mellon University. He has authored the book “A History of the Federal Reserve.” He believes that the US is headed for “severe inflation”. In an op-ed piece for the NY Times, he points out that

the interest rate the Fed controls is nearly zero; and the enormous increase in bank reserves — caused by the Fed’s purchases of bonds and mortgages — will surely bring on severe inflation if allowed to remain (Inflation Nation, 3 May 2009).

He pins the blame on both political and monetary authorities, in particular

the (doubtful) commitment of the administration and the (lack of) autonomy of the Federal Reserve ... under Mr. Bernanke, the Fed has sacrificed its independence and become the monetary arm of the Treasury: bailing out A.I.G., taking on illiquid securities from Bear Stearns and promising to provide as much as $700 billion of reserves to buy mortgages.…
It doesn’t help that the administration’s stimulus program is an obstacle to sound policy. It will create jobs at the cost of an enormous increase in the government debt that has to be financed. And it does very little to increase productivity, which is the main engine of economic growth.

Meltzer recounts the Fed under Paul Volcker (who is presently advising the Obama administration) which tamed spiralling inflation following the Oil Shock of the 1970s. As some have argued, the present crisis could have been instigated and deepened by the Oil Shock of 2007. Meltzer further points to one indicator that inflation is already here; he argues

(S)ome of my fellow economists, including many at the Fed … point to the less than 1 percent decline in the consumer price index for the year ending in March as evidence that deflation is a threat. But this statistic is misleading: unstable food and energy prices may lower the price index for a few months, but deflation (or inflation) refers to the sustained rate of change of prices, not the price level (emphasis mine). We should look instead at a less volatile price index, the gross domestic product deflator. In this year’s first quarter, it rose 2.9 percent — a sure sign of inflation.

Quoting the father of monetarism, he says

Milton Friedman often said that “inflation was always and everywhere a monetary phenomenon.” The members of the Federal Reserve seem to dismiss this theory because they concentrate excessively on the near term and almost never discuss the medium- and long-term consequences of their actions.

Paul Krugman is on the opposing side of the debate. He teaches at Princeton University and has made a living out of studying economic crises. His latest book is entitled “The Return of Depression Economics.” He counters Meltzer in his blog with a graph that depicts the “lost decade” in Japan in the 1990s where the growth of money supply, high deficits coincided with deflation. Krugman’s attention is devoted to avoiding wage deflation, as he writes in his column for the NY Times that

…according to the Bureau of Labor Statistics, the average cost of employing workers in the private sector rose only two-tenths of a percent in the first quarter of this year — the lowest increase on record. Since the job market is still getting worse, it wouldn’t be at all surprising if overall wages started falling later this year (Falling Wage Syndrome, 3 May 2009).

His view is that wage deflation is a symptom of a deeper problem in the economy. And his prescription is for “more stimulus, more decisive action on the banks, more job creation”. Quoting the father of stimulus economics, he argues that

(T)hings get even worse if businesses and consumers expect wages to fall further in the future. John Maynard Keynes put it clearly, more than 70 years ago: “The effect of an expectation that wages are going to sag by, say, 2 percent in the coming year will be roughly equivalent to the effect of a rise of 2 percent in the amount of interest payable for the same period.” And a rise in the effective interest rate is the last thing this economy needs.

So there you have it: two renowned experts fighting over the appropriate fiscal and monetary measures to take in this crisis. Both use staitstics and history to bolster their arguments. The disagreement ultimately comes from which previous recession is deemed relevant for this present crisis – whether the Great Depression of the 1920s and lost decade in Japan of the 1990s or the post-Oil Shock era of the 1970s.

Krugman and Bernanke, the deficit hawks, believe that constricting growth particularly at this moment could hamper economic recovery, while Meltzer, the institutionalist, believes that protecting growth at all costs has consequences far greater than we imagine.

Of Voter’s Regret and Animal Spirits

Against the counsel of his “better angels” (the moderate Democrats in Congress) President Obama this week unveiled yet another blueprint for dealing with a section of the economy, amidst growing concerns that his agenda is getting overly ambitious under these difficult economic times. Here is just a sample of the views from various personalities:

David Brooks, columnist, moderate Republican: “…I fear that in trying to do everything at once, it (the Obama administration) will do nothing well.” (The Big Test, The New York Times, February 24, 2009)

Paul Krugman, Nobel Laureate, economist: “The Obama administration’s economic policy is already falling behind the curve, and there’s a real, growing danger that it will never catch up.” (Behind the Curve in Conscience of a Liberal, New York Times, March 9, 2009)

Warren Buffett, the “Oracle of Omaha”, investment guru: “we’ve had muddled messages (referring to government response to the crisis).” (Interviewed on Squawk Box, CNBC, March 10, 2009)

Andy Grove, Stanford professor, former Intel CEO: “I find myself wringing my hands, not over the goals President Obama has set but over the ineffectual ways the administration has pursued them.” (Mr. President, time to rein in the chaos, The Washington Post, March 11, 2009)

George F Will Op-ed columnist: “The president's confidence in his capacities is undermining confidence in his judgment.” (Paved with Magnificent Intentions, Washington Post, March 12, 2009)

An "Animal Spirits" Revival

With all this talk of a crisis in confidence, the release of Georg Akerlof and Robert Schiller's book, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism which they commenced writing in 2003, could not be more timely. Akerlof of “The Market for Lemons” fame made the term “asymmetries of information” popular in public economics parlance. Schiller co-developed the Case-Schiller Index, a gauge for the US housing market relied on for setting options and futures prices. In the book, they tackle the role that ideas, trust and sentiment play in the economy. It could be considered a reappraisal of the term made use of by Keynes.

The chief of OMB (the Office of Management and Budget), Peter Orszag, one of Obama's so-called "propeller heads" in the White House is reportedly getting himself engrossed with it.

The Bumpy Ride Has Arrived

This week marked another “defining moment” in Australia as the latest unemployment figures showed a steeper incline than expected. In the forecast made previously here back in November of 2008, we said that unemployment could reach 6 per cent by May of this year. The recently released data saw it jump from 4.8 in January to 5.2 in February (analysts were expecting it to hit just 5). The continuing fall of skilled and general vacancies suggests that we have truly entered into a bleak season.

Should this supply policymakers with a “teachable moment” that enables them to consider differing views on how to proceed from here on out? Again, here is just a pair of quotes from the week:

Tony Makin, Professor of Economics, Griffith University (formerly with the IMF): “Federal fiscal packages unveiled since October last year have aimed to boost consumption in the short term, in keeping with Treasury advice at the outset that the best fiscal response to the global financial crisis was to 'go early, go hard, go households'. However, an arguably sounder fiscal response would have been the exact opposite: go later, go easy, go firms.” (Follow the Kiwi Leader, not Obama, The Australian, March 11, 2009)

Michael Costa, former treasurer, NSW Government: “Confidence building may turn out to be the only effective role for government in directly responding to today's economic conditions.” (Hubris and vaudeville but little sound policy, The Australian, March 13, 2009)

Unemployment and the Bumpy Ride Ahead

The Australian Skilled Vacancies Index (SVI) is a monthly indicator updated by the Department of Education, Employment and Workplace Relations. It is based on a job vacancy report from various industries and occupations including the trades. It can be treated as a leading indicator for unemployment.

The chart below depicts the inverse relationship of the index with the unemployment rate. Note SVI is lagged six months, meaning the levels indicated for unemployment, say in the last observation, October 2008 is actually matched with the value for SVI back in April (hence the predictive potential of the indicator).

Source: ABS Trend Unemployment Rate, Australia, October, 2008 (Cat. 6202) and DEEWR Vacancy Report November, 2008

The reason for this sequential relationship? Labour economics tells us that the costs of acquiring skilled labour cause employers to smooth their hiring decisions during peaks and troughs in the economic cycle (see Walter Oi's article, Labor as a Quasi-fixed Factor, in the Journal of Political Economy, Chicago Press, 1962). In a down cycle, they will maintain their skilled workers for as long as possible instead of laying them off. During upswings they do not necessarily start hiring as a certain amount of "slack" has been pent up from the low season. So the skilled vacancy reports can be used as an early warning device for predicting future employment conditions.

The problem? The most recent reports show the index diving to its lowest levels in recent times. The early November report has SVI at 65.6 where dipping below the base (of 100) signals a decline. This is a bad omen especially since the downward trend has yet to hit a bottom. Even if we are to assume fiscal stimulus and monetary easing occurs this December, the sheer momentum of the current mood will see unemployment inching back up from 4.3 per cent in October to about 6 in May next year (according to our estimates).

There are of course other factors such as interest rates and industrial relations policy that need to be considered, but all other things being equal, we are in for a bumpy ride ahead. (For those who would like to read a more detailed forecast of where it is headed, please send me an email, and I can provide you with a more technical presentation of the model that underpins the analysis).