Friday, March 12, 2010

The Labor Market is on the Mend

The labor market in the United State is clearly on the mend.  The number of job losses per month is now negligible (probably—see my post on the effects of the snow storm here). and unless the economic outlook deteriorates substantially we are likely to see outright gains in employment in the months to come.  Nonetheless, detailed labor market continues to point to a tepid recovery in terms of overall growth rates.

The latest JOLTS data from the BLS confirms some healing in the labor market.  The black line in the figure below shows the separation rate adjusted for quits through January 2010.  (See my description of this data here.) The separation rate has now returned to its post-2000 average.  With fewer employees losing their jobs each month, the economy is likely to continue on the path to recovery.
Lower fire rates signal economic growth for two reasons.  First, the decline indicates firms are comfortable with the current size of their labor force.  These firms, at the least, foresee stability in future output.  Clearly, the actions of firms are far more important for assessing their outlook than the responses they give to the various confidence surveys.  Second, the reduction in the fire rate indicates positive consumption growth.  The growth comes through two important channels. 

First, the reduction in the fire rate indicates lower aggregate employment risk.  The lower risk decreases the precautionary motive of households, lowers savings rates, and increases consumption.  Second, and far more important, the number of households involuntarily loosing their jobs declines.  Households with a sharp reduction in income consume less.  So, with fewer households losing their jobs this important drag to growth diminishes.  [Note:  unemployed households do not consume appreciably more.  But the drop in their consumption has already been incorporated in the National Income Accounts.  The fact that they are still not consuming has zero effect on the growth rate of consumption.]

That’s the good news.  The labor market is stabilizing and growth should resume. 

The bad news:  Weak is not strong enough of a word to describe the likely recovery.

The picture below adds the hire rate to the previous graph.  The hire rate has shown no indication of improvement.  The lack of improvement in this rate is quite interesting and is in conflict with the data from initial claims, which have improved from 700 thousand jobs per week to a little under 500 thousand per week.  The current gap between the hire rate and the average hire rate since 2000 represents a shortfall of 1.2 million jobs per month.  This is an unbelievably large number. 

To put this in perspective, the jobless recovery following the 2001 recession was characterized with the separation rate near average and the hire rate near average.  The previous “jobless recovery” had job growth of between 50 and 200 thousand jobs per month.  This leaves room for the current jobless recovery to occur in an environment with only small average job losses per month.  (Small average losses per month imply that the variability in the survey will allow some positive months.)
The low hire rate also implies that firms do not see a particularly strong recovery.  While firms are content with their current workforce, they do not, as yet, see a sufficient increase in demand to warrant an expansion of their labor force.  This bodes ill for investment going forward as well.  Firms that do not need new people also, likely, have little need for new equipment. 

So, the low hire rate implies subdued growth for two reasons.  First, the data implies little or no investment growth going forward.  Typically, during a recovery, investment grows robustly contributing substantially to growth.  Second, the data implies that movement from unemployment/out-of-the-labor-force will be extraordinarily slow relative to typical recoveries.  People who move from unemployment to employment (low income to high) increase their consumption substantially.  This channel is a drag on consumption growth. 


The labor market is healing but is far from normal, even when normal is compared to the weak job market of the last ten years.  The U.S. economy faces serious structural problems going forward.  The number of unemployed people is likely to stay at depression levels for a long period.  [The unemployment rate is still likely to fall.  People will exit the labor force rather than continue to report themselves as unemployed.]

The current social safety network is ill-equipped to handle large numbers of semi-permanently unemployed people.  The United States is going to have to make some hard choices on how to handle this social problem.  The solutions must balance the welfare of the unemployed against the need to maintain incentives to seek employment.  Further, these decisions are going to have to be made in an environment of slow revenue growth.

Saturday, March 6, 2010

Jobs and the Jobs Bill (304,000 jobs over the next 12 months)

The economy lost an additional 36,000 jobs in February.  Interpreting the numbers is difficult because of the record breaking snow storm on the East coast during the reference period for the establishment survey.  Almost every analyst I heard on topic predicted that the storm subtracted anywhere from 30 to 80 thousand jobs from the labor report.  

It’s amazing how confident people are in their statements.  They might be right but I am less sure.  Keith Hall, the Labor Commissioner and one of the most forthright people around, said that, while it was likely the storm had a substantial impact on the jobs report, it was not possible to tell whether the jobs number was biased upwards or down as a result.  He did not know how much the storm effected the hiring and firing decisions of firms nor did he know how much the storm impacted temporary hiring, as businesses and schools hired temporary workers to help remove the snow—temporary help rose 48,000 in February.

I think there is a more general issue.  The storm effectively shut down firms in the mid-Atlantic region for a full week in February.  It seems to me that the first order effect of the storm depends on whether the impacted firms would have hired or fired in that week.  For some companies, the storm may have served as a temporary furlough, pushing back firings and perhaps delaying them indefinitely.  For others, the storm may have prevented them from hiring.  The net effect depends on the aggregate state of hiring and firing.  I don’t know the answer and neither does anybody else. 

The Jobs Bill:  Adding 230 to 370 thousand new jobs

For those of you who are regular readers, you know my opinion of economic stimulus:  I am not a believer in big multipliers.  But I like the jobs bill.  If you want to increase employment this bill is exactly the right medicine.  I suggest exactly this program in December 2008 (here scroll down to “What can the government do?”)  My plan went farther, in line with spending almost $1 trillion, but the incentives are the same.

The jobs bill works on the margin.  New hires are exempt from the firm’s share of social security plus the firm receives and additional thousand dollars if the employee is kept on the payroll for 1 year.  For the average worker in the United States, this is a $3,600 payment per qualifying hire.  The maximum payment is close to twice that. 

This is not enough money to change the hiring decision of the average firm; fortunately, economics does not work on the average; it works on the margin.  Because the jobs bill is only allocates between $12 and $15 billion, the bill is perfectly designed to work on the margin. 

I estimate that the jobs bill (the employment portion only) will add between 230 and 370 thousand jobs over the next year.  These jobs are new additional jobs in the United States. 

Why is the jobs bill effective and ordinary stimulus not?  Because the jobs bill changes the real relative price of labor.  (Stimulus does too but with the wrong sign.)  Labor demand curves are downward sloping:  cheaper equals more.  The jobs bill is just like Cash-for-Clunkers and the Home Buyer’s Credit.  The change in real relative prices induces a real change in demand.  [Note, this does not necessarily boost GDP; it is only expected to change the demand for the particular product.  The bills have costs.]

Wednesday, February 24, 2010

Unsustainable Deficits and Growth

Just how much contraction can we expect to get the Federal budget deficit back under 3% of GDP on a trend basis if the private sector doesn't pick back up? Is the multiplier greater when cutting the deficit?  NorthGG
To answer this question, I start with the budget assumptions released by the CBO.  (In my last point, I used the much less realistic numbers published by the OMB.)  Under the CBO’s assumptions, the deficit dips under 3 percent in 2014 before unfavorable demographics push it back over 3 percent by 2020. 

We can’t adjust the deficit for growth assumptions until we pin down the relationship between revenue growth and GDP growth.  I copied the picture below from the CBOs website—ignore the scary outlays line, I only want to talk about revenues.  Between 1950 and 2007, revenues remained around 18 percent of GDP.  This implies that on average revenue growth has been the same as nominal GDP growth.  In the CBO projection (remember they are constrained by law), revenues are growing consistently faster than nominal GDP. 

So, first things first.  I adjust the CBO’s revenue line so that it matches its historical growth pattern.  This scenario, shown by the solid red line below, yields a deficit that stabilizes around 8 percent of GDP before trending negative in 2018.  If GDP growth stays low as NorthGG suggests, the deficit trends negative from 2012 forward, reaching almost 11 percent of GDP by 2020. 

Neither of these scenarios is sustainable.  Under the first scenario to reach a 3 percent deficit by 2020, total nominal spending growth can increase no more than 1 percent per year from 2012 forward.  To achieve the same goal by 2015, requires total nominal spending to fall by 2.3 percent per year beginning in 2011.  Under the slow-growth scenario, these numbers fall to zero and negative 4.5 percent.

Is the multiplier greater when cutting the deficit?

Good news.  In my view, government spending is for the most part a drag on growth.  The spending can be good or bad but it harms growth.  So, reducing the deficit by slowing the growth of outlays is positive for growth. 

Unfortunately, politicians love large government.  (Yes, this statement is true across ideologies.)  The deficit is much more likely to be attacked from the tax side rather than the spending side.  Higher taxes are the likely outcome.  This route is unambiguously bad for growth—both from distortionary taxes and distortionary spending. 

In my view, the budget doesn’t have to be balanced but spending has to be brought under control.  I don’t think it will happen, though.  At least not until, the pain of adjustment is far more difficult than mere 1 percent nominal growth of spending. 

Monday, February 22, 2010

Robert Barro on Fiscal Stimulus

Take a look at the wsj collumn by Robert Barro (here).  We are pretty much in agreement on the effects of fiscal stimulus, although I think his use of war spending provides a substantial upward bias to the spending multiplier. 

Sunday, February 21, 2010

The Economic Report of the President and Fiscal Stimulus: Romer Does it Again

Chapter 3 in this year’s ERP makes the case for the positive benefits of fiscal stimulus.  The chapter brings much evidence to bear in support of the case that fiscal multipliers are large and positive.  But perhaps the most convincing is chart 3-13.  In that graph, the ERP compares forecast errors against fiscal stimulus, measured as a percent of GDP. 

Here I have replicated the chart.  The vertical axis is the deviation in 2009Q2 growth (annual rate) from private sector forecasts in the third quarter of 2008.  The horizontal axis is the level of fiscal stimulus in 2009 as a percent of GDP.  I use data from table 3-1 in the chapter.  The dates are chosen carefully:  the first date is pre-stimulus for most economies; the second date maximizes the slope of the regression line. 

The results are impressive.  The slope is positive and highly statistically significant.  Indeed, since the time of the ERP was put to bed, data revisions—especially for the Czech Republic—have improved the relationship.  For every additional percentage point additional fiscal stimulus, the economies grew 2 percentage points faster.  Notice, because we are using annual rates that is not a multiplier of 2 but rather a multiplier of 0.25. 
But the chart is deceptive.  First, the result in the chart is specific to Q2.  If we chose any other quarter in 2009 (or the year as a whole), the result is no longer statically significant.  Second, the results as shown rely entirely on the data points for Japan and South Korea.  In the absence of these two countries, the regression line has a slope of zero and the R-squared is 0.002.  Of course, one might make the argument that it would be deceptive to exclude those two data points. 

I agree, which brings me to my third and final point.  Why didn’t they include the rest of the countries included in table 3-1.  The hard part of this exercise is finding comparable measures of fiscal stimulus but they already took the trouble to include these numbers in the chapter.  With twenty minutes of effort, I tracked down both the comparable private-sector forecast for these countries and the realization of GDP growth in the third quarter. 

The results including the omitted countries are shown in the chart below.  By coincidence, the excluded economies yield a regression with almost exactly the opposite result to the included countries.  These countries yield a line with a slope of negative 2.2—every extra percentage point of stimulus lowers GDP growth by a little more than 2.  Combining all of the data into a single line yields an insignificant regression. 

Once again, the case for fiscal stimulus does not survive the microscope.  I wish, however, that the ones responsible for deciding on the level, type, and timing of stimulus were a little more honest in their presentation of the facts.

Friday, February 5, 2010

The Deficit: On an Unsustainable Path?

The Administration published its budget this week.  I will leave others to play with the details of the budget.  (For example, this post on EconomistMom does a good job of examining the key details).  I like to look at the macro assumptions embedded in the budget. 

This administration, following the grand and old tradition of budget forecasting, makes economic assumptions that are possible but on the extreme edge of possible.  In other words, the Administration sticks to the broad outlines of the macro models but whenever there is a choice it errs in the favorable direction:  growth is a little higher, inflation a little faster, spending a little slower.  In addition, the Administration likes to cut programs in its budget that it knows Congress will reinstate.  An old favorite is threatened military programs.  A new favorite is sun setting tax provisions. 

I like to take the budget and tweak each of these assumptions back into the reasonable range.  Sometimes the result is a little worse; sometimes it is a lot worse.  In the current case, things end up a lot worse, because the jumping off point for the budget is so bad. 

I recalculate the budget forecast assuming 10 percent (not percentage points) lower nominal GDP growth, 18 percent faster expenditure growth (still faster growth than any time since the early 1990s), and 15 percent slower revenue growth. 

My forecast for government outlays as a percent of GDP is shown as the red line below.  Outlays as a percent of GDP start at a record 26 percent and grow steadily thereafter. 

The next picture shows my forecast for the deficit, using the same adjustments.  Notice, the assumptions in the OMB budget are exactly those that stabilize the deficit as a percent of GDP by 2014.  Using more reasonable assumptions, the deficit improves in the near term but then begins to explode as Social Security and Medicare expenditures rise sharply with the coming surge in retirements. 

What I have not considered is the cost of higher interest rates.  The Administration assumes almost no increase in interest rates despite the robust recovery and relatively rapid inflation path.  In itself, this is not realistic.  But it is especially not realistic if the markets come to believe the path I have written down.  If my path becomes the standard, the market will begin to demand a premium to hold U.S. debt.  (Of course, the good news is that the spread between corporate debt and U.S. Treasuries will narrow.  Oh wait …)

Wednesday, February 3, 2010

How (Not) to Destroy American Jobs: Bad Analysis and Misleading Statistics

“The fundamental assumption behind [the Administration’s proposals to tax U.S. multinationals] is that U.S. multinationals expand abroad only to "export" jobs out of the country. Thus, taxing their foreign operations more would boost tax revenues here and create desperately needed U.S. jobs.
Academic research, including most recently by Harvard's Mihir Desai and Fritz Foley and University of Michigan's James Hines [here], has consistently found that expansion abroad by U.S. multinationals tends to support jobs based in the U.S. More investment and employment abroad is strongly associated with more investment and employment in American parent companies.”  Slaughter, WSJ 2010  
A group of international economists have been pushing two ideas for some time:  When multinational firms expand their overseas operations, jobs in the U.S. increase; when multinational firms increase their overseas investment, they also increase their investment in the United States.  Therefore, because these firms are also productive, taxing or inhibiting the growth of these firms harms the United States and slows domestic growth.  The seeds of the idea have merit: international trade should make the United States a wealthier country, at least when the driving force for the trade is not regulatory or tax avoidance.

Estimates from Desai et al. (2008) show that a 10 percent increase in foreign investment results in a 2.6 percent increase in domestic investment.  That is, for every dollar these multinational corporations spend abroad, they drop 25 cents in the United States.  They find similar results for sales, compensation, and employment.  They conclude, “These results do not support the popular notion that expansions abroad reduce a firm's domestic activity, instead suggesting the opposite.” 

First, and most important, their conclusion, as well as Slaughter’s in other work, is based on a flawed counterfactual.  Desai et al, in concluding the firms boost output in the United States, consider a counterfactual world in which the firms do not exist.  They do not consider a world in which the firms continue to exist but are prohibited, either through taxes or fiat, from expanding overseas.  The implicit assumption is that there growth would have been zero but for the expansion. 

I agree that their expansion would have been smaller had they not been able to take advantage of the cheaper, more lightly regulated, and lower tax foreign environment.  But do Desai, Foley, and Slaughter believe that Proctor & Gamble would not have grown at all between 1982 and 2004 if they had not been able to expand internationally.  So, to find direct evidence of the gains from outsourcing production, we need to compare the outcomes of the multinational firms with other U.S. firms.  I will do so in a moment.

Second, their statistical results rely on using the full sample.  Take a quick look at figure 1 in Desai et al (here  – scroll down to page 26).  The scatter plot shows foreign sales growth versus domestic sales growth over the sample period.  A positive relationship is easy to discern but is not particularly strong.  What the picture hides is the change in the relationship late (and early) in their sample.  Data post 1999 are very different than data before 1999, particularly the data between 1994 and 1999. 


The picture below uses aggregate data from the BEA (table 1 here).  The red bars show the annual average growth rate of employment in the foreign affiliates of U.S. multinationals (MNCs), the parents, and overall U.S. employment between 1982 and 2004.  Based on this aggregate data, the relationship between job creation at home and abroad is stronger than implied by the micro data, implying almost 80 jobs for every foreign job. 

However, job creation at multinationals in percentage terms pales in comparison to overall job creation in the United States.  Employment increased 1.8 percent per year on average between in 1982 and 2004 in the United States as a whole while growing a mere 0.6 percent at parent companies.  Indeed, the growth in employment of foreign affiliates is quite similar to the growth of overall U.S. employment. 

MCNs diminished net job creation in the United States.

But the picture is much worse for Slaughter’s argument if we simply examine the last 5 years of data.  Between 1999 and 2004, the growth rate of foreign affiliate employment was almost unchanged, near 1.8 percent, but the parents shed jobs.  Indeed, over this period, parents cut 2 jobs for every job created at a foreign affiliate.  Overall U.S. employment slowed over the period but remained positive.  Continuing the sample through 2007, does not change the picture.  U.S. and foreign affiliate employment remain positive while parent employment is still negative.  Although we do not have data beyond 2007, an increase in parent company employment during the recession is unimaginable, especially given the outsize decline in U.S. trade. 

What surprises most is that neither Desai et al. nor Slaughter acknowledge this point.  Nobody can work with the data as closely as these economists have and not notice such a basic fact.  In fact, the paper by Desai et al. never uses the words decline, slowing, reversal, or drop.  They have panel data and never include a time dummy.  They almost appear to be hiding the inconsistent fact in their data. 

Other Evidence

The two main other points brought up by Slaughter and Desai et al are the investments of MCNs and the value added (which leads to measured productivity).  The picture below shows gross value added for parents, foreign affiliates, and the nonfarm business sector in red and shows annual average growth rate of capital expenditures (gross investment for the non-farm business sector) in blue.

Parent’s growth is positive both in terms of investment and value added.  However, again the growth rates are well below that of both the foreign affiliates and the non-farm business sector. 

MCNs lowered investment and value added growth in the United States. 

By the way, the growth in value added combined with a decline in employment is what gives the parents their measured productivity edge. 


The expansion of international trade very likely has benefits for the United States.  But the expansion of trade has also had its costs.  The net benefit to the United State may be positive or negative (likely positive). 

With true facts before us, we can discuss the taxation of multinationals.  Taxing these companies will slow their growth, reduce their investment, and lower total U.S. employment.  That’s what taxes do; they reduce the profit incentives of firms.  But taxing U.S. companies and U.S. households has exactly the same effect.  If we make a public policy decision to have a large government, we must also make a public policy decision to tax heavily – either now or in the future. 

There is no data (which I consider credible) to support the idea that taxing multinationals is any worse than taxing any other company or for that matter than taxing the household sector. 

In any event, the overall employment, value added, or investment of these companies or any other is not the metric by which we decide which sectors to tax most heavily.  Optimal tax theory relies on relative elasticities.  The least elastic sector should face the highest tax burden, thereby minimizing the overall tax distortion. 

So, I don’t know whether we should tax the multinationals.  But there is zero evidence for taking them off the table before the discussion is even begun.