Wednesday, July 18, 2007

It's the Balance of Paycheck, Stupid

This is homage to a thought-provoking post by Charles Fitzgerald's Platformnomics titled "It's the Balance of Profits, Stupid". Commenting on renowned economists Hal Varian (information) and Gregory Mankiw's (macroeconomics) exchange that bilateral trade balances (aka balance of trade, the source of our big national bogeyman, the trade deficit), both economists suggest the such deficits matter less than you think, when you consider that we Americans are soaking up a lot of the profits.

On the other hand, I suppose what would concern a *labor* (Mincer) vs. an information-(Varian) or macro-(Mankiw) economist is that more than two-thirds of our economy is driven by consumer spending, spurred on by net job gains, concomitant with wages + credit-use growth.

And while we steadily export hourly jobs to China, the same can't be said that domestic jobs are being replaced fast enough by "new economy" markets that stimulate and provide for net new jobs (be it measured by headcount or aggregate wages), as orthodox economic theory prescribes: Think new Boeing Dreamliner as a pertinent business model, which invests in R&D locally, sources internationally for its composite inputs and garners 80,000+ net new high-wage *manufacturing* jobs, or think of Toyota's hybrid investments in Japan while sourcing lower-end car manufacturing to rest of world.

As Mankiw indicated, the economic and trade balance numbers aren't "fake"; rather international trade can be very nuanced and certain views of [bilateral] trade have very little concrete economic meaning. What is troubling for me is that for a while now, many think of new information-based markets as the economic panacea, asserting that as long as corporate profits grow, little else matter.

This faction also imply that a significant portion of corporate profits accrue to workers' [wages]. Others, like myself, assert that growing profits accrue to investors and the owners of capital like Apple's Jobs, but collectively, American workers haven't benefited much, which,
according to the Economic Policy Institute (below chart), seems to be disproportionately so.

Source: Economic Policy Institute, “When do workers get their share?” Economic Snapshot, May 27, 2004.
Data from the National Income and Product Accounts, Bureau of Economic Analysis, U.S. Dept. of Commerce.

And thus, unsurprisingly, most Americans have resorted to "house-of-credit-cards" financing that continues to encourage end-to-end economic exuberance, now greatly over-leveraged, to the point that currently the U.S. has a net negative 0.5-1% *dis-savings* rate.

One fundamental indicator of "dis" trend is the stagnant wage growth of the past 6+ years, and, according to the progressive Center for American Progress, the Bureau of Labor Statistics report that the biggest employment gains were:
"...largely concentrated in three industries: government employment, with 40,000 new jobs—all of them occurring at the state and local government level. In addition, health care and restaurants, two sectors that have shown remarkable job strength throughout the past few years, added 42,300 and 34,600 new jobs, respectively.

In comparison, the construction sector, which had provided a lot of labor market momentum before the residential housing boom came to an end in late 2005, added only 12,000 new jobs, almost all of which happened in nonresidential construction. Residential construction employment was essentially flat, reflecting the continued weakness in the housing sector..."

This comparatively weak job growth has also contributed to slowing wage growth:

"...Hourly wages for production, ...workers who make up about 80 percent of the workforce rose by 0.3 percent in June 2007. Hourly wages in June were 3.9 percent higher than a year earlier. This is down from a monthly growth rate of 0.4 percent in May and a year-over-year change of 4.0 percent in May.

This slower wage growth comes after inflation-adjusted hourly earnings already declined in March, April, and May. In fact, after accounting for inflation [~2.5-3% average], hourly and weekly earnings in May 2007, the last month for which data are available, were the lowest since September 2006. That is, because of weak job growth, workers do not have the bargaining power to keep wage growth at least in line with price changes.

Just because job growth is better than expected doesn’t mean that it is strong. It is certainly welcome news that the economy is seeing some unexpected employment gains, but these are happening in a labor market that has been struggling for years to find a foothold. Workers who are burdened by high prices and near-record amounts of household debt need faster job and wage growth, not lowered expectations."
Deficits in the end will matter when the ratio of wages-to-credit reach a critical mass and profit growth collapse as credit-driven expansion slow drastically,
unless wages rise and we pay down our debt by saving a larger portion of our income.

Which ironically means that, meanwhile, the Chinese with their 1.33 trillion dollar reserves and other Asian net savers who have chosen to buy fewer iPods and such, at least to-date, have been fulfilling our money needs via global credit markets, yet are just financing their own demand and having Americans ultimately own the IOUs in the end.

That is, unless wage growth re-align to be more proportional to our consumer spending rate, and that is doubtful at this point. We may now be at the cusp of such a slowdown, with housing and mortgage markets steadily deflating; only time will tell.

And like nobody definitively knows many decades later what exactly the tipping point was for the Great Depression, nobody can say now what that "breaking point" wage-to-credit ratio is. But smart folks like Warren Buffet to the economic arbiters @ NBER assert that at some point, net (not bilateral) trade balances indeed have to balance, e.g. be paid back within a bounded future time horizon.

And for more then a decade, the vaunted consumer economic workhorse has largely been using inferior-grade credit-subsidized monies to drive this spectacular market boom (and help to top DJIA's 14,000+ in a record time).

Many seasoned economists and market pros see few economic fundamentals to justify this torrid rise, other than US companies vested in rapidly-growing, savings-rich developing markets whose populations and incomes are booming thus demanding basic infrastructure and commodities, which do benefit US trade and engender spectacular returns for emerging market ETF-holders.

Still, it's important to understand that trade only account for a quarter of US economic activity/GDP, and as such, there's a real need here-and-now to reform American economic policy to be more balanced and to hone in on improving the economic health of its citizenry and government.

A concrete start would be something along lines of bread-and-butter Consumer Economics 101 kicking it off at elementary education onward, significantly more savings incentives and education, greatly expanding R&D credits and loans, to pay-as-you-go gov't spending.

But it seems Americans tend to thrive under duress, and until one exerts itself, many will probably continue to assume that Tulips=Profits.