Saturday, April 22, 2023

Dean Baker: Get Over It -- China is bigger.


China is Bigger, Get Over It

It is standard for politicians, reporters, and columnists to refer to the United States as the world’s largest economy and China as the second largest. I suppose this assertion is good for these people’s egos, but it happens not to be true. Measuring by purchasing power parity, China’s economy passedthe U.S. in 2014, and it is now roughly 25 percent larger.[1]The I.M.F. projects that China’s economy will be nearly 40 percent larger by 2028, the last year in its projections.

The measure that the America boosters use is an exchange rate measure, which takes each country’s GDP in its own currency and then converts the currency into dollars at the current exchange rate. By this measure, the U.S. economy is still more than one-third larger than China’s economy.

Economists usually prefer the purchasing power parity measure for most purposes. The exchange rate measure fluctuates hugely, as exchange rates can easily change 10 or 15 percent in a year. Exchange rates also can be somewhat arbitrary, as they are affected by countries’ decisions to try to control the value of their currency in international money markets.

By contrast, the purchasing power parity measure applies a common set of prices to all the items a country produces in a year. In effect, this means assuming that a car, a television set, a college education, etc. cost the same in every country. Applying common prices is a difficult task, goods and services vary substantially across countries, which is makes it hard to apply a single price. As a result, purchasing power parity measures clearly have a large degree of imprecision.

Nonetheless, it is clear that this is the measure that we are more interested for most purposes. If we want to know the quantity of goods and services a country produces in a year, we need to use the same set of prices. By this measure, there is no doubt that China’s economy is both considerably larger than the U.S. economy and growing far more rapidly.

Just to be clear, this doesn’t mean the Chinese people are on average richer than people in the United States. China has nearly four times the population, so on a per person basis, the U.S. is still more than three times as rich as China. But, it should not be a shock to us that a country with more than 1.4 billion people would have a larger economy than a country with 330 million.

For the folks who need more convincing, we can make comparisons of various items. We can start with auto production, a standard metric of manufacturing output. Last year, China producedmore than 27.0 million cars, the United States produced a bit less than 10.1 million. (China also leads the world by far in the production and use of electric cars.) The cars made in the United States undoubtedly were better on average, but they would have to be an awful lot better to make up this gap.

To take a more old-fashioned measure, China producedover 1,030 million metric tons of steel in 2021. The United States produced less than 90 million metric tons.

China generated8,540,000 gigawatt hours of electricity in 2021, nearly twice the 4,380,000 gigawatt hours generated in the United States. The gap is even larger if we look at solar and wind energy production. China has307,000 megawatt hours of installed solar capacity, compared to 97,000 in the United States. China has 366,000 megawatt hours of installed wind capacity versus 141,000 in the United States.

We can look to some more modern measures. China has 1,050 million Internet users. The United States has 311 million. China has 975 million smartphone users, the United States has 276 million. In 2016 China graduated4.7 million students with STEM degrees. In the U.S. the numberwas 330,000 for the same year. The definitions for STEM degrees are not the same, so the numbers are not strictly comparable, but it would be difficult to make the case that U.S. number is somehow larger. And the figure has almost certainly moved more in China’s favor over the last seven year.

In terms of impact on the world economy, China accountedfor 14.7 percent of goods exports in 2020. The United States accounted for 8.1 percent. In the first nine months of last year, China was responsible for $90 billion in foreign direct investment. This compares to $66 billion for the United States.

We can pile on more statistics, but in category after category, China outpaces the United States, and often by a very large margin. If people want to put on their MAGA hats and insist the U.S. is still the world’s largest economy, they are welcome to do so, but Donald Trump lost the 2020 election and China’s economy is bigger.

Size Matters

The issue here is not just a question of bragging rights. China is clearly an international competitor, economically, militarily, and diplomatically. Many people want to take a confrontational approach to China, with the idea that we can isolate the country and spend it into the ground militarily, as we arguably did with the Soviet Union.

At its peak, the Soviet economy was roughly 60 percent of the size of the U.S. economy, China’s economy is already 25 percent larger. And, this gap is expanding rapidly. China is also far more integrated with the world economy than the Soviet Union ever was. This makes the prospect of isolating China far more difficult.

As a practical matter, it doesn’t matter whether we like China or not. It is here and it is not about to go away. We will need to find ways to deal with China that do not lead to military conflict.

Ideally, we would find areas where we could cooperate, for example sharing technology to address climatechange and dealing with pandemics and other health threats. But, if anyone wants to push the New Cold War route, they should at least be aware of the numbers. This would not be your grandfather’s Cold War.

[1] I have included both Hong Kong and Macao in this calculation, since both are now effectively part of China.

Saturday, April 15, 2023

Dean Baker: Can Jerome Powell Pivot on Interest Rates, Again?

 Can Jerome Powell Pivot on Interest Rates, Again?

When Jerome Powell took over as chair of the Federal Reserve Board in January of 2018, the Fed had already been on a path of gradually hiking interest rates. They had moved away from the Great Recession zero rate in December of 2015 and had been hiking in quarter point increments at every other meeting. The Federal Funds rate stood at 1.25 percent when Powell took over from his predecessor Janet Yellen.

Powell continued with this path of rate hikes until the fall of 2018, and then he did something remarkable: he lowered rates. He had lowered rates by 0.75 percentage points by the time the pandemic hit in 2020.

This reversal was remarkable because it went very much against the conventional wisdom at the Fed and the economics profession as a whole. The unemployment rate at the time was well under 4.0 percent, a level that most economists argued would lead to higher inflation.

However, Powell pointed out that there was no serious evidence of inflationary pressures in the economy at the time. He also noted the enormous benefits of low unemployment. As many of us had long argued, Powell pointed to the fact that the biggest beneficiaries from low unemployment were the people who were most disadvantaged in the labor.

A 1.0 percentage point drop in the unemployment rate generally meant a drop of 1.5 percentage points for Hispanic workers and 2.0 percent for Black workers. The decline was even larger for Black teens. Workers with less education saw the biggest increase in their job prospects. And, in a tight labor market, employers seek out workers with disabilities and even those with criminal records.

In short, there are huge benefits to pushing the unemployment rate as low as possible, and Powell happily pointed to these benefits as he lowered interest rates even in an environment where the economy was already operating at full employment by standard estimates. Powell was willing to put aside the Fed’s obsession with fighting inflation, even when it wasn’t there.

This was the reason that many progressives, including me, wanted President Biden to reappoint Powell. While Lael Brainard, who was then a Fed governor, would have also been an outstanding pick, as a Republican, Powell’s reappointment faced far fewer political obstacles. There was no risk that one of our “centrist” showboat senators (Manchin and Sinema) might seize on some real or imagined slight and block the nomination.

Powell was also likely to have more leeway as a second term chair in pursuing a dovish interest rate policy. Fed chair is a position where seniority matters a lot, as can be seen by the Greenspan worship that stemmed largely from his long service as Fed chair. Although Brainard was a highly respected economist, she might have a harder time staying the course if the business press pushed for higher rates.

Powell’s Pandemic Policy

Powell did pursue a dovish policy, acting aggressively to support the economy during the pandemic with both a zero federal funds rate, and also extensive quantitative easing that pushed the 10-year Treasury bond rate to under 1.0 percent in the summer of 2020. Low rates helped to spur construction and allowed tens of millions of people to refinance mortgages, saving thousands of dollars a year on interest rates.

As virtually everyone (including me) would now agree, he kept these expansionary policies in place for too long. While Fed policy was not the major factor in the pandemic inflation, it did play a role, especially in the housing market. While most of the rise in house prices and rents was driven by fundamentals in the market (unlike in the bubble years from 2002-2007), there was clearly a speculative element towards the end of 2021 and the start of 2022.

This became evident when the Fed first raised rates in March of 2022. Even though the initial hike was just 0.25 percentage points, the housing market changed almost immediately. Prior to the hike, almost every house immediately got multiple above listing offers. After the hike, many houses received no offers and it became standard for buyers to offer prices well below the asking price.

Given this outcome, it would have been good if the Fed had made this move several months sooner. Speculative runups in house prices are not good news for the economy in general, even if there may be a small number of lucky sellers who might hit the peak of the market.

Anyhow, after having waited too long to raise rates, Powell felt the need to re-establish his status as a determined inflation fighter. He embarked on a series of aggressive three-quarter point rate hikes and repeatedly appealed to the ghost of Paul Volcker.

Powell went farther and faster than many of us felt was warranted. It will take time to see the full effect of past rate hikes on the economy. The rapid rise in rates did create stresses in the banking system, although the failures of the Silicon Valley Bank (SVB) and Signature Bank seem to be largely due to incredibly inept management, coupled with major regulatory failures at the Fed.

While bank failures are always fun, the more important issue is what happens to the real economy. At this point it seems the economy faces greater risk on the downside, with unemployment rising, than with inflation reversing its current downward path.

There has been a clear hit to credit availability as a result of banks tightening standards following the SVB panic. Higher rates are also having their expected effect on loan availability. Housing starts have slowed sharply, although residential construction remains strong due to a large backlog of unfinished homes resulting from supply chain problems during the pandemic.

Higher rates have also put an end to the flood of housing refinancing that helped to support consumption growth through the pandemic. And, non-residential investment has also slowed sharply in recent months.

For these reasons, there are real grounds for expecting a growth slowdown and a resulting rise in the unemployment rate. The other side of the story is that it looks as the Fed has won its war on inflation.

I’ll admit to having been an inflation dove all along, but the facts speak for themselves. We know that housing inflation will slow sharply in the months ahead based on private indexes of marketed housing units. These indexes have been showing much lower inflation, and even deflation, since the late summer. They lead the CPI rental indexes by 6-12 months.

We got the first clear evidence of lower inflation in the CPI rental indexes with the March release, with both rent indexes rising just 0.5 percent, after rising at more than a 9.0 percent annual rate in the prior three months. The CPI rent indexes are virtually certain to show further declines over the course of the year, with rental inflation likely falling below its pre-pandemic pace.

Much has been made of the big bad news items in the March CPI, the 0.4 percent rise in new vehicle prices. This is certainly bad news for the immediate inflation picture as it seems that supply chain problems continue to limit the production of new cars and trucks.

But this is not a long-term inflation issue. We have not forgotten how to build cars and trucks. This is a story where the chip shortage, resulting from a fire at a major semi-conductor factory in Japan, has proved to be more enduring that many had expected. That hardly seems like a good reason to be raising interest rates and throwing people out of work.

The picture for many non-housing services was also positive. In particular, the medical services index fell 0.5 percent in March after dropping 0.7 percent in each of the prior two months. Some of this decline is due to the peculiarities of the way health insurance costs are measured in the CPI, but it is pretty hard to tell a story of excessive inflation in this key sector of the economy.

The March Producer Price Indexshowed even better news about inflationary pressures at earlier stages of production. The overall final demand index fell by 0.5 percent in March, while the index for final demand for services dropped by 0.3 percent. While there are areas where there seem to be price pressures, the overwhelming picture in this release is one of sharply lower inflation, or even deflation. Clearly higher inflation will not be driven by price pressures at the wholesale level.

Perhaps most importantly, the pace of wage growth has slowed sharply. The annualized rate of growth in the average hourly wage over the last three months is just 3.2 percent, down from a 6.0 percent pace at the start of 2022. This is lower than the pace of wage growth in 2018 and 2019, when inflation was below the Fed’s 2.0 percent target. It is very difficult to tell a story where wage growth is under 4.0 percent, and inflation is still much above the Fed’s target.

Can Powell Change Course Again?

This raises the question as to whether Powell will again follow the path he took in 2019 and reverse course when the data indicate it is appropriate? There is still much uncertainty about the course of the economy at this point. We don’t know the full effect of the fallout from the SVB failure and it’s not clear how much of the impact of past Fed rate hikes is yet to be felt.

That makes a strong argument for a pause at the Fed’s meeting next month, which will come before we get any data from April. However, if we continue to see evidence of economic weakness, as well as slowing inflation, the Fed needs to be prepared to start lowering rates.

Powell was quite vocal in recognizing the Fed’s twin mandate for full employment, as well as price stability, when he lowered rates in 2019. There is no virtue in going overboard in the effort to fight inflation. If the data show that the war on inflation has been won, and we see the prospect of a weakening economy with higher unemployment, it needs to shift course.

Powell went in the right direction four years ago when he bucked the conventional wisdom and lowered rates in 2019. He needs to be prepared to do that again this year.

Thursday, April 6, 2023

Dean Baker: Have Workers Gotten Back Their Share of Income?


Dean Baker via Patreon

Have Workers Gotten Back Their Share of Income?

I was surprised to see a Twitter thread last week from Jason Furman in which he said that the labor share of national income in 2022 was actually above its pre-pandemic level. I have been following this issue closely and the labor share of corporate income was still down by more than a percentage point from its 2019 level.

If that sounds trivial, if the wage share rose back to its pre-pandemic level, and it was evenly shared, every worker would have a 1.7 percent increase in real pay. That won’t make anyone rich, but for a full-time full-year worker earning $25 an hour, the increase would be worth $850 a year.

But Jason said there is no prospective dividend like this, because the labor share is already above its pre-pandemic level. Jason referred to the labor share of national income, and using this measure, he was right. I looked back to 2000 and saw that the labor share of national income had not fallen anywhere near as much as the labor share of corporate income, as shown above.

The question is what is going on here. My reason for preferring the labor share of corporate income is that profits and labor compensation are well defined in the corporate sector. We have a corporation that earns profits and it pays out wages and benefits to workers. The corporate sector is also about 75 percent of the private business sector, so generally what is going on in the corporate sector tells us what is going on the business sector as a whole.

But not this time. Apparently, there was a large increase in the labor share of income in the non-corporate sector. The Commerce Department has not published data for the non-corporate sector for 2022 yet, but in 2021 the labor share stood at 41.4 percent, up by 2.2 percentage points from its 39.2 percent share in 2019. A further increase in 2022 could certainly be enough to raise the economy-wide labor share above its 2019 level.

So, what do we make of this large rise in the labor share in the non-corporate sector? That’s a difficult question to answer, but it’s certainly peculiar that the labor share in the non-corporate sector would be going in the opposite direction as the labor share in the corporate sector.

There is at least one possible explanation that doesn’t involve ordinary workers in non-corporate sector gaining relative to their counterparts in the corporate sector. Most of the businesses (by revenue) in the non-corporate sector are organized as partnerships. This would include private equity and hedge funds. The earnings of the partners in these funds, which often are in the millions or tens of millions, are largely classified as wage income. If these partners were getting more wage income, or simply classifying a larger share of their fund’s earning as wages, it could lead to a larger labor share of income in the national accounts. That doesn’t especially help the worker in a fast food restaurant owned by a private equity company, but this could explain the rise in the labor share that Jason noted.

This is obviously speculative and there could be a different story here, but in the corporate sector, where we do have solid data, we know the labor share has not recovered to its pre-pandemic level. And, if we want to go back to ancient history, the labor share is still down by 7.2 percentage points from its 2000 level. It would be a useful exercise to sort out what is going on with the labor share in the non-corporate sector, but it doesn’t seem unreasonable to think that the labor share in the corporate sector would at least return to its pre-pandemic level.

Monday, April 3, 2023

Dean Baker: The Social Security Scare Story Industry


I’m on the road (literally, driving from southern Utah to western Oregon) but I thought I should quickly weigh in the on the scare stories we heard yesterday after the release of the 2023 Social Security and Medicare Trustees Reports. I’ll make four quick points:

1) The scare stories stem entirely from how we account for Social Security, as opposed to programs like education or the military;

2) We’ve already seen most of the increased burden associated with the retirement of the baby boomers;

3) It’s not true that our only choices are raising taxes or cutting benefits, as has been widely asserted;

4) We have seen great news on Medicare since the passage of the Affordable Care Act, which has been largely ignored.

The Problem is Largely Accounting

Starting with the accounting, Social Security is a program that we have decided to fund from dedicated taxes, primarily the 6.2 percent tax that employers and employees pay on the first $160,200 of income. (Part of the program’s problem is that the share of wage income going over the cap, and avoiding taxation, rose from 10.0 percent in 1982 to almost 20 percent today. This is because of the huge upward redistribution of wage income over the last forty years.)

Most other items in the budget are not funded by a dedicated tax. If they were, we would have had many scary moments in the past and possibly in the future. For example, government spending on education increased from 1.3 percent in 1946 to a peak of 3.8 percent of GDP in 1970. This 2.5 percentage point increase in spending to accommodate the baby boomers needs when we were kids, is far larger than 1.8 percentage point projectedincrease in spending in Social Security from 2000 to 2040, the peak pressure of the baby boomers’ retirement.

If we had funded education from a dedicated tax and were looking at accurate projections of future spending in 1946, it would have looked far more scary than the Social Security projections do now. In the same vein, many people want the U.S. to have a Cold War with China. China’s economy is already more than 20 percent larger than ours and is growing considerably more rapidly. (The Soviet economy peaked at around 60 percent of the size of the U.S. economy.)

We are currently spending a bit more than 3.0 percent of GDP on the military. We spent 6.0 percent of GDP during the Reagan military buildup in the 1980s. If we went to this level of spending, or higher, to match the spending of a larger enemy, the projections would look much worse than anything we see with Social Security.

We’ve Already Seen Most of the Cost Increase

The Social Security trust fund built up a large surplus in the years when most of the baby boomers were in the labor force. This trust fund is helping to cover the current costs of the program. However, the cost themselves have been rising for the last fifteen years.

We went from spending 4.19 percent of GDP on Social Security in 2000 to spending 5.22 percent of GDP this year, and increase of 1.03 percentage points. This cost is projected to increase further to 6.03 percentage points by 2040, a rise of 0.81 percentage points.

This increased cost will impose some burden on the economy, but less than the increased burden we have seen to date. So, the idea that we are looking at some horror story down the road doesn’t make any sense, unless we think we are already living a horror story.

It’s not True that Our Only Choices are Raising Taxes or Cutting Benefits

Contrary to what NPR told us yesterday (“Patching the program will require higher taxes, lower benefits or some combination of the two”) there is an alternative. Historically, Social Security has been funded by its designated taxes, as noted earlier. But, if we are changing the law, we can also change this feature of Social Security.

We could have it funded in part from general revenue, like the military or almost every other program. There are reasons we may not want to make this switch, but it is wrong for NPR and others to tell us that it is not a possible option. It is.

Can we spend more from general revenue without raising some taxes? That is an open question. From an economic standpoint, it doesn’t matter whether spending comes from past surplus accumulated in the trust fund or whether it’s simply an appropriation from general revenue. As noted above, we have already seen most of the burden associated the retirement of the baby boomers, perhaps we could see the additional burden without any additional taxes.

If the economy’s main problem is secular stagnation (a lack of demand) as economists like Larry Summers had arguedbefore the pandemic, there is little reason to believe that the additional deficits associated with higher Social Security spending will be a major problem. This would especially be the case if artificial intelligence leads to the huge productivity boom that many analysts are predicting.

The Untold Great Story on Medicare

The Trustees Report released yesterday showed a further improvement in Medicare’s finances. This is a huge deal that has gone largely unreported. In 2000, the Medicare Hospital Insurance Trust Fund was projected to face costs of 1.91 percent of GDP this year and 2.54 percent of GDP in 2040. In the most recent report we are projectedto spend 1.52 percent of GDP this year and 2.12 percent in 2040, a savings of 0.39 percentage points of GDP this year and 0.42 percentage points for 2040.

These savings have hugely helped the program and meant that we have far more resources to spend elsewhere. People pushing scare stories probably don’t want to promote these facts, but that is the world.

Anyhow, there are clearly issues with how we will deal with the retirement of the baby boomers, but the situation is not nearly as dire as many would like us to believe.