Sunday, 24 April 2016

Immigration, inequality and conceptual art

The Tate has a new exhibition called 'Conceptual Art in Britain 1964-1979' if you're interested.  A BBC Radio 4 reviewer explained carefully that conceptual art is all about the concept! One of the exhibits is of a glass of water that the artist explains has been changed into an Oak Tree.

Economics is about concepts  - notions, ideas, some of them rather abstract - and the economics of inequality is one of the most important ones. Thomas Piketty's "Capital in the 21st Century" captured the mood and helped spur a huge debate about its causes and the remedies that policy-makers should or shouldn't adopt. But at 700 pages long, it wasn't an easy read. Branko Milanovic's new book "Global Inequality, A New Approach for the Age of Globalization" comes in at 299 pages and the last 34 of those are the references and the index. It's also a book with great charts, so that the first time I opened it, I just skimmed through the picture with a cup of coffee.  For those two reasons alone, anyone interested in the economics of inequality should buy it (and read it).

There is a third, rather more serious reason,to be interested in the book. Thomas Piketty's focus was on how wealth inequality in particular grew in developed economies over time, and what policy-makers should do about it. The market, in his opinion, has and will feed widening inequality. Mr Milanovic's focus is on income not wealth and on global not national trends and is far more relevant to the world we find ourselves in. Martin Wolf reviewed the book more seriously here and talked about in a speech he gave for the Toynbee Foundation a couple of weeks ago.

The chart that Mr Milanovic is most famous for makes an appearance on the second page of the first chapter. It shows changes in income over 20 years plotted against income levels and can be loosely divided into four segments. On the left, the very poor are mostly in Africa (though you can reasonably throw Yemen, Afghanistan, even Pakistan and by now, Syria into this pot as well).  The middle of the chart shows income growth for average/below-average income groups many of whom are in newly-developed economies, notably in Asia. The group in the the 70-90th percentiles of global income levels are the poor/median income groups in developed western economies (they're  being left behind)  and the far right grouping is the top 5%, or the 1%.

The second chart shows the distribution of incomes in 1998 and 2011. Average incomes have gone up, but are still low by the standards of developed western economies. And the lack of growth in incomes in the 20-40,000 (2005) dollars per annum range is very apparent.

Apart from suggesting this is a book worth reading, I'll make a couple of observations. The first is that the reduction in global inequality levels isn't evenly-distributed; a lot of people, a lot of whom live on the other side of the Mediterranean, have been left behind. And secondly,  the political debate in developed economies is going to be shaped by how the lack of growth in median/below-median incomes is tackled.

My generation has grown up with the effects of booming trade - imported goods are cheaper and industries which can't compete in the global market-place have withered. The Philips Curve has creaked and groaned in the face of a global labour market and the profit share of GDP has boomed on the back of lower labour costs. As the UK debates how (or even, whether) to keep the last bits of its steel industry alive, the issue hasn't gone away but now the main talking point is immigration, almost everywhere. It's the single biggest political issue in both Europe and the US. It fuels the 'Brexit' voters' ranks, it holds up support for Nigel Farage, Marine Le Pen  and of course, Donald Trump. Meanwhile, those 1988-2008 charts don't even try to capture earnings gap that years of QE have opened up.

The failure of developed economies to tackle the humanitarian crisis in Syria (or Libya) before mass migration took over is miserably depressing. The response to the tide of refugees arriving on our shores over the last year, equally so. But even beyond the conflict zone, migration is  globalisation's response to global economic inequality. The poor and oppressed of the world are going to go on moving and between them, the advance of technology and the aftermath of the global commodity boom, they'll go on fuelling inequality within developed economies and all the political baggage that comes with that. Maybe that won't result in Trump becoming President, or the UK voting to leave the EU, or Marine Le Pen making a serious push for power. But without structural reform aimed at boosting the earning power of median income earners in developed economies, major victory for an anti-immigration, anti-free trade, anti-liberal party in a developed economy near you and me, is inevitable within the next 5 years or so.

Branko Milanovic doesn't make friends with all his opinions. But then, nor does Thomas Piketty and that hasn't stopped him from becoming an economics superstar. Income inequality is more important than wealth inequality and global inequality is more interesting in a global economy than only looking at national trends. Meanwhile, as for forecasts of median wage growth in high-income economies, well that's going to be a function of political choices, rather than Phillips Curves, isn't it! 

Sunday, 3 April 2016

25 multinationals and a big fat deficit

Awful balance of payments data fuel all sorts of responses - the UK doesn't make or export enough, or consumes too much. Is reliant on the kindness of strangers to finance the deficit, (Mark Carney) and is need of foreign direct investment that in turn probably depends on staying in the EU (David Smith). All fine arguments. But the surge in the  deficit in recent years is largely a result of the falling foreign income of a handful of huge multinational companies, whose incomes have fallen step by step with falling commodity prices. They finance themselves in international markets and are owned by international shareholders: Does that make a difference?

Heading for £100 per annum.... an awfully big hole 
The UK’s current account deficit reached £32.7bn in Q4 2015, which equates to 7% GDP and is the biggest deficit since records began. It takes the annual deficit to £96.2bn, 5.2% GDP. The £12.6bn deterioration from Q3 to Q4 was due to a £3.3bn increase in the deficit in goods and services to £12.2bn, a £2bn increase in the deficit in secondary income to £5.4bn and a £7.3bn increase in the deficit on primary income, to £13.1bn. It’s worth noting in passing that the UK’s net investment position now is in liability to the tune of £65,9bn, In other words, foreigners own £65.9bn-worth of UK assets more than UK investors own of foreign assets. All other things being equal over time, the bigger the net liability, the bigger the net investment income deficit will be.

The ONS’ chart of the overall make-up of the current account balance is below.

The trade account includes goods (a deficit) and services (a surplus). It's been pretty steady in recent years, though still significantly in deficit. The secondary income balance includes transfers provided with no expectation of payment, so things like bilateral aid and of course, payments to or from the EU. This series is volatile on a quarterly basis but not so much over a longer period. The primary income balance includes compensation of staff, rents, taxes and most of all, investment income.  Here’s a chart of that, and its constituent parts:

The primary income balance was in surplus as recently as mid-2013 and just glancing at the chart you can see that its deterioration coincides with a dramatic shift in the balance of direct investment income. The ONS took the trouble to publish an article to  explain what’s going on and the link is here:

If reading it all is too much bother on a sunny Sunday morning, the main points are as follows:

More than 80% of the deterioration in the current account since 2011is attributable to falls in net foreign direct investment (FDI) earnings.

Falling FDI credits over this period explain just under 80% of the decline in net FDI earnings, and the majority of that is attributable to the largest 25 multinational companies. This partly reflects the fact that UK FDI assets are exposed to movements in global commodity prices – most notably crude oil.

In my day job, I mostly ignore these niceties. The current account deficit is huge and leaves the UK dependent on foreign investors’ confidence in and appetite for UK assets. In the middle of a toxic debate about whether or not to remain in the EU, that’s bad for confidence and particularly bad for the pound. I’ve written extensively on that and the pound has indeed, fallen sharply in recent months and since the latest data were released.

But two questions are posed by the data. The first is whether we will see the current account deficit recover as an when oil and other commodity prices stabilize (or bounce)? The second is whether what 25 big multinationals do matters at a national level?

The UK still had a current account deficit, albeit a smaller one, when the commodity boom was in full flight. So in 2011 when the deficit was 1.7% GDP and commodity prices were at their peak, the headline figure masked the poor underlying  situation. Q4’s 7% deficit may overstate how bad things are, but I could average between the 1.7% of 2011 and the 5.2% of 2015 and conclude that 3 ½% GDP is a truer reflection of the underlying position. And that’s only small comfort. It’s still, in today’s money, an annualized international borrowing need of GBP 65bn.

I might be tempted to say that the UK’s £65bn underlying deficit is just the other side of the coin with regard to the Eurozone's near-£200bn current account surplus.

I might also conclude that the commodity cycle is far more volatile than FX trends, and so the idea that a weaker pound will magically solve the UK’s balance of payments problems is absurd. It would improve them a bit, but the parts that have caused the deterioration are not terrible senstivie to sterling exchange rates.

But are big global companies different? 
The second question is more difficult. Imagine a large UK-domiciled multi-national that used to earn huge amounts on its foreigh investments, but is now no longer doing so as a result of falling oil prices. So, instead of repatriating income and paying a dividend to its (global) shareholders, it will borrow money or run down cash reserves until prices recover. ,It may well also save money by reducing employment overseas, which helps improve the situation on the balance of payments without having much impact on the UK economy. If it borrows by issuing debt, does that really have much impact on the UK? Once upon a time a large UK multinational issuing sterling bonds might have been considered to squeeze out other buyers of gilts, say, but I’m not even sure that’s a relevant factor anymore.

I’m not going to argue this doesn’t affect the national accounts – it does.  A multinational that earns money abroad is bringing pounds back home and one that issues debt is adding to the demand the rest of the UK makes on the global investor community. But to what degree does a multinational borrowing money really squeeze out the UK Government? To what extent does paying dividends to global shareholders boost the UK? And while huge changes in commodity prices have clearly been a driver of the direct investment income balance, it’s also true that whether a company reinvests in its foreign businesses, or brings cash home, is a decision determined by all sorts of factors, with international tax regulations  often at the top of the pile.

All this is framed as a question and that’s why this is a blog rather than an investment bank's sell-side research note. I’m not sure I’m aloud to write ‘I don’t know’ this often in the day job!  The UK’s 7% GDP current account deficit is frankly, embarrassingly huge. There are no positives in the data but if someone asks just how hard it will be to find foreign financing for the defiit, and whether it will go on growing in the years ahead, all I can really say is that I don’t know, because that depends on the decisions of the management of a couple of dozen huge global  companies who may think that this is a good time to be borrowing at super low rates, even if that does drive the UK’s current account deficit up.

Saturday, 11 July 2015

The Age of Migration - debt, migration and flawed architecture

With Eurozone Finance Ministers discussing suggestions ranging from a temporary Greek exit from the Euro, to a request for the Greeks to come up with 'more' (more austerity, more evidence that proposed measures actually will be carried out?), there's a long day of negotiations ahead in Brussels. But that Greek debt crisis has now opened up a debate on the notion of debt restructuring within the single currency area.

There is growing pressure for Greece's creditors to allow more formal restructuring of Greek debt, which would inevitably lead to acceptance that debt restructuring, re-profiling or relief may need to be seen across the Euro Area at times. Many people who have been looking at the mountains of debt accumulated by Eurozone governments in recent years have long believed repayment of that debt is unlikely, so what's the big deal? Even a casual glance at the history of sovereign debt shows that defaults happen more often than many people realise, often occur in clusters, and the risk of them is underpriced. Furthermore, default is, by and large, forgiven faster for sovereigns than for others, understandably.  A defaulting individual or company can be cast away, never to be seen again. Literally, in the case of debtors the English sent to the other side of the world in the 19th century. But a country won't go away. Russia defaulted and then sat there on the same bit of land as before until we all decided to do business with it again.

History, furthermore, tells us that punishing a country's people too harshly and demanding they repay the debts accumulated by their parents, leaders or even themselves, is counter-productive. At worst, it builds enmity. At best, it means an economically weakened trading partner.

So if we accept that default is occasionally necessary, why be bothered about doing it in Europe? The answer, I think, is that the idea that sovereign default is impossible in the Euro Area is a big part of the architecture of the system, put there to cope with one of its very biggest structural flaws - the fact that while national central banks do not have the ability to run independent monetary policies, national governments have a lot of autonomy over fiscal policy. This is a huge flaw, 'managed' with the rules on deficits and debt. Weaken those and the flaw is exposed, and will either bring the system crashing down or be resolved itself through adoption of a new fiscal structure.

Here's a description of the conditions for a strong monetary union, which I took from the late Victor Argy:  "A strong monetary union is assumed to have a common currency and a common central bank. Capital markets are unified and independent monetary policy becomes impossible. Some independent fiscal policy continues to be feasible. And he goes on to list the conditions which make the costs of joining a union smaller, or the benefits larger. They are 1) that differences in growth rates and labour productivity are not large; 2) that intra-union trade is large; 3) that there is no long-run trade-off between inflation and unemployment; 4) the differences in propensities to inflate are relatively small; 5) differences in degree of domestic instability are relatively small; and 6) there is a significant degree of labour mobility." Grapes of Wrath. A better read on currency unions than anything I've written can be found here, in a discussion by Milton Friedman of the Euro in 1997. Some of the weakness he outlines have been tackled since then, but not all. 

'Some independent fiscal policy continues to be feasible'.  That is absolutely not what European fiscal policy looks like. Consider this. US State and Local debt totals 1/6th of Federal debt and less than 20% GDP.  So when California over-borrows, despite being the biggest state, it still doesn't cause a huge national crisis. Imagine California having a debt level of 120% GDP, and then asking smaller states to forgive a share of that debt based on their own share of US GDP. It doesn't happen because the US allows 'some independent fiscal policy'.

This problem of local control over debt and Federal control over monetary policy is a really, really issue. When I write that sovereign debt default is relatively common, I should differentiate between default on domestic debt, and default on foreign debt. There's a brief discussion of the top in this week's Economist here, Buttonwood. Domestic debt default is often counter-productive because of the damage it does to the domestic banking system, so default usually happens via the means of inflation.  Historically this was done through the effortless means of debasing the currency, more recently it's been done with the help of a monetary policies than boost inflate and weaken the currency. And most recently of all, global disinflationary forces have made it hard to do at all. Defaulting on foreign currency debt is more straightforward, and therefore more common. But in Europe, the domestic routes to de facto default through devaluation and inflation, simply don't exist. All debt is foreign because no single country controls the Euro printing press. And worse still, since more and more of any single country's debt is now held by that country's banks, this is now de facto foreign debt but defaulting will still cause havoc in the domestic banking system.

I still don't know how this weekend will play out, let alone how long the Greek debt can can be kicked down the road before we're back talking about debt. But I do know that Greece isn't the only European country whose debt won't ever actually be repaid in full and I know that changing the rules to accept that reality will either bring about the collapse of the Euro system or lead to a change in the way that European fiscal policy is operated.

Finally, a quick word about Puerto Rico. A very different debt crisis but one which really is a sign of the times. Puerto Rico's $72bn of debt is close to 3/4 of GDP and either huge compared to any US State (which Puerto Rico isn't) or manageable if it were an independent country with (which it isn't either).

What really makes Puerto Rico's debt unsustainable, and is both a cause and result of GDP shrinking in 7 of the last 8 years,  is the fact that its population is falling. Faced with a weak economy and poor prospects, people, especially young workers, are leaving the country. Check out this link  from the Pew research centre if you want some scary charts of where this is heading. When I first wrote about the Grapes of Wrath, I thought that labour mobility in the US in the 1930s (which resulted in huge numbers of displaced Oklahoma farmers heading down Route 66 in search of jobs in California) was both a sign of a monetary union working properly and yet, evidence that even in the US there was huge social strife caused by migration. I wasn't really wondering what would have happened to Oklahoma's ability to repay debts if it had been an independent country. Nor was I thinking forwards to a world where would have the degree of mobility in people, job and technology that we have now. In a technologically joined-up world, skills will spread globally and people will move to where those jobs are, as well as moving away from places with political or economic problems. This may 'the Age of Migration'. The politics of migration/immigration are increasingly important and for the countries they leave, while the economics of debt with shrinking populations will be equally important.

Sunday, 14 June 2015

Over 50s, the new thirty-year olds

I've been reading about the "older" (over-50) worker - something I've been for a few years now. 

A recent paper by the Institute of Leadership and Management  which got a fair amount of coverage in the press week starts with the encouraging observation that "Baby Boomers (aged 51–70) are seen as loyal, skilled and knowledgeable members of the workforce – but they aren’t viewed by their colleagues and managers as the ‘organisational stars’ of the future and they are perceived as having little potential for further progression or development in their organisations". Well, isn't that nice!

I recognise some of the things written in the paper although in the world of finance, I'm not sure it's all about oldish workers being seen as lacking in leadership potential. In the latest flurry of redundancies at a variety of firms, I know a number of over-50s who have lost their jobs. Nothing too shocking in that perhaps  - I know more over-50s than under-30s so the sample of my acquaintances is biased - but I do remember being surprised when I was told me over 15 years ago that there only three over 50s left on the Bishopsgate  trading floor of NatWest Markets.

What happened 15 yrs ago still happens now - when numbers need cutting, the older worker is a prime candidate. The justification is usually that organisations get too top-heavy: the number of people with  business cards that say 'Managing Director' is high relative to those who cards read 'Associate'. The management pyramid is inverted and better to lose someone who is not seen as 'an organisational star of the future' than  some bright young thing. And why not? This is the City, where dog eats dog and so on.  Mind you, if more and more people are living longer, having families later and working into well their 50s or 60s, I can't help feeling that a decade-long flow of workers from sell-side investment banks to buy-side fund managers means there's a role for the fifty-something sales-person who has known these clients for half a lifetime.

Separately, I was signed up a fortnight ago by a colleague to participate in a '100-day journey' measuring how much exercise people take. It's a team event, run by some people called GCC and my employer has decided that this would be good for the staff, or fun, or something. I was handed a step counter and sent on my way. I dutifully fill in the number of steps every day, with the intention of making sure that I take more exercise than the average. No problem there, the global GCC average is a little over 12000 steps a day. My (erratic) round of golf yesterday morning ran my total up to 16000 before lunch. Looking at average steps for various cohorts on the website I find that men step more than women and that 50-54 year-old men step more than the average man.

This isn't a complete surprise.  By and large, my generation of late baby-boomer over-50s is pretty motivated to stay in decent-ish shape. We got the message about smoking ages ago and even if the one about alcohol has been largely ignored, we have gym memberships and we force our 'dad bods' into luminescent lycra cycling clothes with far too much enthusiasm. We're (mostly) no longer taking children to the Pirate's Playhouse or the zoo on Saturday mornings - or even to football/skating/ballet.   Instead, we have time to get some exercise in before we take the children to the Oval to watch T20 (where £8 for Pimms makes the prices for ice cream at the zoo seem almost reasonable).

Another thing I recognise in my age group is that they turn up for the morning meeting.
The average age of people in a dealing room is in the 30s, but at 6:45 a.m, it's a good bit older. The young worker finds getting out of bars and clubs in time to get enough sleep and make it to the morning meeting hard. The young parent is sleep-deprived. A decade ago, when asked how long I would go on working I said I couldn't imagine stopping, but I could easily imagine giving up morning meetings. Yet I find it easier to wake up now than I used to and travelling round London after 7 a.m is almost too hideous to contemplate. Nowadays, the choice is between being at my desk early, or connecting to it from a computer far away from London.

Of course, the fact that I'm a fan of the over-50s work ethic and would happily employ them if I were an organisational star (future or present) won't change employers' attitudes towards them. But what will go on changing is the number of older people who are still working. It's going to go on growing. I may not take the children to Alexandra Palace ice rink on Sunday mornings any more, but they're not likely to be financially independent any time soon. My generation can't afford to stop working even if it wants to. But if "having little potential for further progression" means we aren't competing for the top jobs, "loyal, skilled and knowledgeable" has its merits. The over-50s I know who've lost their jobs mostly seem to find new ones pretty quickly, even if they have to take a cut in pay. In the process, they act as an anchor on wage growth across the pay scale (except for CEOs, but that's another story).

The changes in the workforce aren't limited to the over-50s male of course, it's just that this is the group I know best. If I were a woman, I might be inclined to think about the number of women who either have, or want to return to the workforce and have a deep pool of skill as well as a huge amount of motivation after taking some time away. If I were bit older, I'd point to the desire to shift the work-life balance around, without actually stopping work. Thoughts on the world from members of these groups can be found here (from @LadyFOHF on twitter) or here from (@georgemagnus1).

Mostly, I think too many employers are woefully out of touch with the way the labour force is changing and are  still wedded to an antiquated understanding of what 'work-life balance' means. They regard surfing the internet in your office as 'work' and reading The Global Economy in transition at home as 'life'. And if they think older workers are loyal, skilled and knowledgeable but have little potential, they'll end up finding out how much they have in common with dinosaurs.

Saturday, 6 December 2014

Does the (US) Phillips Curve work in leisure & hospitality?

The US employment data released yesterday are worthy of a short post. The bare bones of the report are that a strong monthly increase in employment and a modest acceleration in wage growth (321,000 jobs, wage growth from 2% to 2.1%, unemployment rate steady at 5.8%) have prompted excited headlines like the FT's... (US Heads for best jobs growth since 1999). The growth rate of employment has picked up from an above-trend 1.95% annual rate to a whopping 1.99% rate. That doesn't really answer anyone's questions about whether falling unemployment will drive wage growth up, or whether the US is going to return to less pathetic rates of productivity growth any time soon for that matter but with some cracking (i.e., low) CPI and PCE inflation likely to turn  up shortly, real incomes are rising in time for Christmas; and a 2% growth rate in unemployment will underpin GDP growth nicely above that in the coming months.

All of this you can read all about to your heart's content elsewhere. What I've been spending more time on is the make-up of the labour market, which has continued to see the strongest employment growth in the lowest-paid sectors, and some of the weakest in the highest-paid sectors. But one thing that was striking in the November data was a further acceleration in wage growth for the lowest-paid of all the sectors - leisure and hospitality. This is a sector where wages average $14.10 per hour, compared to $24.66 for all workers and over $30 in mining, finance and information. But over the last year, wage growth has picked up to 3.75% at this end of the spectrum. I've plotted wage growth in leisure and hospitality, along with overall wage growth and (inverted) the unemployment rate, in the chart below.

The picture tells a simple enough story. The lowest-paid workers in the US saw their pay levels fall in the aftermath of the recession, suffering far worse than the average. And their wage growth (let alone their wage levels) lagged until late last year. But as the unemployment rate has gone on falling, they have started to see pay rises. The Phillips curve for the overall US economy still looks pretty useless - wage growth trending sideways, while unemployment falls - but tightness in the labour market may finally be turning into more cash at the bottom end of the scale. And since those are the people who spend the largest share of any additional income (because they need to), the impact on demand may be greater.

The main causes of weak real wage growth over the last decade (technology, globalisation) would also suggest that a sector where out-sourcing jobs and replacing them with robots are both difficult, should see wages respond to falling supply of workers. So this pattern does nothing to allay longer-term concerns that the policy response to weak demand caused by weak real wage growth, itself due to major structural forces, is ineffective: An orgy of monetary accommodation has sent up asset prices (which do very little to address falling real incomes for low-income families), helped increase the profit share of GDP at the expense of the wage share and fuelled bubble-like pricing in commodities and currencies, many of which are now deflating.

However, for all those long-term, concerns, I can't think of any reason not to cheer on a boost in wage growth for the lowest-paid sector of the (US) economy at last, even if we need to see this filter up to sectors with higher wage rates before it is reflected in faster average wage growth.

Sunday, 23 November 2014

Basic maths and a big headache

A three-hour train journey to see my daughter en route to bothering clients in Scotland tomorrow leaves me with time to write, though less access to data than I need to fully explain my point. Still,  I'm grateful to Matthew Boesler (@boes_ on twitter)  for drawing my attention to the presentation on the US economy by David Altig, the Atlanta Fed's Director of Research, which he gave at Georgia State University's Economic Forecasting Conference this week (Link).

The amount and quality of research that comes out the Fed's regional offices is incredible. The whole presentation is worth looking at but I've been playing with slide 15, which shows US employment growth since June 2009 in various sectors of the economy and compares it to the wage level. It's not a surprise that the majority of the employment growth has been in lower-paid work and this is something that is as true in the UK as it is in the US. Spend much time reading Brinjolfsson and McAfee and you'll end up convinced this is a trend which can persist.

I started playing with the data behind the chart on Friday and look forward to hours of fun doing so in the next week or two.  For a really simple exercise, I looked at wage growth across the different sectors. Overall, US hourly earnings growth in October was running at 2.0% y/y, and the average hourly wage was USD 24.57, pretty close to the $24.96 earned in manufacturing, the sector with the fastest employment growth since 2009 and 4th of the 8 sectors in the chart.

At the extremes, wage growth in 'information', the top sector on this list, is 3.3%, and the wage growth in the lowest-earning sector is 3.6%. Both higher than the average. Not every sector is seeing higher than average wage growth, but they could be. The average growth of wages in the two mentioned sectors is 3.15%, a good bit lower than in either of them, simply because of one year's change in relative employment between the two sectors.

There's one immediate conclusion: Even as the overall US economy approaches full employment, that may cause more wage growth only in the (lower-paid) sectors where the labour shortages will be felt first and even then only if the effect is not simply a return of discouraged workers to the labour force.

What I really need to time to do, is to replicate these figures in the UK. Mark Carney, Governor of the Bank of England, sounded confident about a pick-up in wage growth in the press conference after the release of the latest Inflation Report. The bank expects a pick-up to around 3%, and I can only assume that they are hearing positive noises from their Agents. But if that 3% figure reflects the belief that each sector will see a 3% increase in wages, while the make-up of the labour force changes, the actual number could still be a fair bit lower. So I'll note the optimism and reserve judgement....

The implications for fiscal policy are even more disturbing. If the shift in the make-up of employment drags average wage growth below the average of each sector, it wreaks even more havoc to income tax receipts. More people are paying less tax. And the trend is not about to change. I'll leave those with a political agenda to draw their own conclusions, while I focus on what this means for inflation, interest rates and the pound...

Saturday, 11 October 2014

Hopelessly over-optimistic....

Where do you think trend growth is for the US economy in the years ahead? Maybe that's not a question you ask yourself much but as another IMF World Economic Forecast is published and the great and good meet and greet each other in Washington, it's a question I would love to answer. After all, it's a key input into global growth, global interest rate trends and asset prices. And I fear the answer is  - slower than most economists appear to believe.
The picture below, shows how the consensus forecast for US real GDP growth collated by Bloomberg has shifted over time. The darker blue line on the left-hand side shows how the consensus forecast for 2011 growth was around 3% in early 2010, but fell sharply in mid-2011 as it become clear the eventual outcome would be somewhere between 1 1/2 and 2%. Back in early 2010, the consensus forecast for 2012 was even more optimistic, flirting with 3 1/2% but sadly, this too was gradually revised lower in 2011. And the 2013 forecast started life at just above 3% but ended below 2%. And the 2014 forecast, back in early 2012, was above 3% but we now know that too, is too optimistic. The pattern is obvious - a tale of dashed hope and disappointment. You won't be surprised to see that at this point the 2015 and 2016 forecasts are around 3%. And yes, in case you wondered, the IMF's forecast for  2015 is 3.1%.

A friend told me hat he thought this optimism was admirable and a feature of  human nature as opposed to evidence of massive failure by economic forecasters. And I caught an echo in this response to the England football teams 5-0 win over might San Marino from the Daily Telegraph.....

"For 21 second-half minutes at Wembley on Thursday night, the statisticians who follow the England team were left scrambling for the record books. The half-time introduction of Alex Oxlade-Chamberlain for Jordan Henderson had swollen the number of Arsenal players on the pitch to five and it was soon confirmed that you had to go back to the days of Herbert Chapman in the 1930s for when the club were last responsible for half of England’s outfield all follows a definite trend in the composition of the previous two World Cup-winning squads. The Spanish in 2010 had seven players from Barcelona and five from Real Madrid while Germany’s triumphant squad from Brazil comprised seven from Bayern Munich and four from Borussia Dortmund". 

Now, I'm as patriotic as the next English football-watcher, but putting such a positive spin on a win against  a team from a country smaller than Islington with the help of 5 playrs from a club lying 8th in the Premiership is a bit too much, even for me... 

Anyway, back to the US economy....The good news for next year, is that the 2015 forecast is holding up better than in previous years. By this time in 2013, the 2014 forecast was slipping as the effects of a massive jump in bond yields (far greater than we have seen this summer) took its toll on emerging markets and then US housing. And we'll never know how much of the 2014 disappointment was due to the awful weather at the start of the year.

But away from where we should pitch the 2015 forecast, what the chart really prompts me to do is to question where 'trend' GDP growth is heading in the US. This tendency to forecast growth at 3% next year, the year after and for ever represents a very rose-tinted view of the US outlook. Economists will quickly assert that after a deep recession a few years of 'above-trend' growth can reasonably be expected but as the unemployment rate falls below 6%, that story has a shortening shelf-life. And the 3%-plus forecasts all assume trend growth is somewhere above 2%. Which may be much too optimistic. The next two charts both worry me in this regard.

This first one shows my preferred way of looking at the monthly jobs report - as the annual growth rate of non-farm payrolls. Employment growth is running at 1.9% per annum and has steady for the last three years. GDP growth meanwhile has been growing at a disappointing rate - disappointing for those who keep on thinking it should be above 3%, at any rate. The green line, on the right-hand axis, shows the difference, smoothed over three years and just under 1/2%. This is an over-simplification of productivity growth but does get away from the nonsense that I am currently reducing my productivity by 'working' outside 'work hours'. Since 1960 US GDP growth has averaged 3.1% and employment growth 1.8%. So this is a very disappointing period for GDP growth relative to a rather normal period for job creation. The general view of trend GDP growth being above 2% assumes that productivity will magically revert to the long-term average. And you can see that productivity is cyclical, because employers hoard workers in recessions and then are slow to hire - usually. But in this cycle productivity is weakening years after the recession, which makes alarm bells ring. 

Trend growth, in the longer run, is a function of where we think full employment is, what we think productivity is, and how fast the labour force is growing. The final chart shows the US labour force, growing gradually more slowly of late. The second line is the 3-year average growth rate, currently just under 1/2%. That line has been trending lower since the late 1970s. The US Bureau for Labor Statistics writes a about longer-term trends and at the end of last year they produced this piece whose opening summary reads... 

"Labor force projections to 2022: the labor force participation rate continues to fall: Because of the decreasing labor force participation rate of youths and the prime age group, the overall labor force participation rate is expected to decline. The participation rates of older workers are projected to increase, but remain significantly lower than those of the prime age group. A combination of a slower growth of the civilian noninstitutional population and falling participation rates will lower labor force growth to a projected 0.5 percent annually."

So labour force growth has averaged 0.5% in the last three years and the BLS thinks it will do so the next decade, give or take. The gap between employment growth and GDP has been 1.3% since 1960 but 0.5% since 2011. There's room for GDP to 'do better' as the remaining slack in the labour market is used up. After that, trend growth is probably between 1% on a bearish view that the recent past is a sign of the 'new normal' times to come, and 1.8% on the optimistic view that we will return to the long-run average. You're welcome to you own guess, but I reckon hoping that 'trend' US GDP growth is above 2% is wishful thinking. As is believing that beating San Marino tells us anything about England's chances of winning a major football tournament in the next decade or two.