IS the US Importing Productivity?

Stephen Roach raises some time honoured measurement problems about the current US productivity 'spurt'. The statistics in question are labour productivity statistics. The growth of oursourcing may be having the consequence of distorting the labour productivity statistics upwards. By how much we do not know. The labour component of the outsourced work may not be being adequately accounted for in the total labour hours part of the denominator. If this is happening systematically this may bias the numbers upwards. Even if this is the case, it is unlikely to be the whole picture, since Robert Gordon's argument about ongoing gains from the IT-internet symbiosis (which is of course what makes possible the outsourcing in the first place ) also is part of the explanation. As I indicated last week, the relatively advanced pace of this process in the US may also provide some explanation for the US-Europe differential, but this is a gap which may well close as Europe itself begins to extract the same benefits. I buy the "US unemployment is in-part structural" argument, and am convinced that a return to strong employment growth hinges on the question of the emergence of new employment sectors, sectors which lie further up the value chain, and which can guarantee the US 'lifestyle differential'. Absent this, a question mark has to hang - Stephen Roach style - over the sustainability of the recovery.

America’s fabled productivity miracle continues to be a key underpinning for much that is special about the US economy. With productivity in the nonfarm business sector up an astonishing 6.8% sequentially (annual rate) in 2Q03 and 4.1% on a year-over-year basis, it’s hard to deny that something quite extraordinary is going on. As I see it, what’s special is an increasingly powerful global labor arbitrage between domestic and foreign labor input that has given rise to a surge in offshore outsourcing. The result is a jobless recovery built on an increasingly tenuous foundation of “imported productivity.” The real issue is whether this new strain of productivity enhancement is sustainable. I have my doubts.

as much as a third of the so-called productivity bonanza of this recovery can be attributed to a shortfall in domestic hiring. Absent that windfall, productivity growth over the first six quarters of this expansion actually would have fallen well short of its typical recovery profile. Obviously, that has not been the case in this jobless recovery. But that doesn’t mean aggregate demand is necessarily being sourced by more efficient modes of global production that require reduced labor content. Instead, courtesy of a cross-border labor arbitrage, it may simply mean that there has been a substitution of foreign labor input for domestic labor input. For America, that has the effect of biasing domestic productivity growth to the upside. That’s because conventional measures undercount the total labor input -- foreign as well as domestic -- required to generate a given product flow. Conversely, for foreign outsourcers, productivity growth may well be biased to the downside, as low-wage employment encourages more labor-intensive production schemes.

Sourcing demand through low-cost, offshore labor input has become an increasingly important tactic to enhance the operating efficiency of US businesses. The IT-enabled global labor arbitrage has become central to this process, giving rise to the imported-productivity paradigm. While this has resulted in a significant improvement in corporate earnings, the American workforce is not sharing the benefits. The resulting clash between the owners of capital and the providers of labor has resulted in profound tensions in the US body politic. Imported productivity, together with the jobless recovery and income leakage it implies, is the stuff of heightened trade frictions, mounting protectionist risks, and a populist assault on Corporate America (see my September 29 dispatch, “Rebalancing Backlash”). The US Congress has already thrown down the gauntlet in this regard, unleashing a bipartisan barrage of China bashing. Absent a political counterweight, there is no telling how treacherous the endgame becomes -- especially as America now enters its presidential election season.

Which takes us to the bottom line: In my view, the income leakages of imported productivity raise serious questions about the sustainability of this recovery from an economic point of view. At the same time, the political reaction to the resulting jobless recovery raises equally profound questions about sustainability from a political standpoint.
Source: Morgan Stanley Global Economic Forum
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Strong US Third Quarter GDP Anticipated

A fairly Upbeat piece on the US economy from Caroline Baum in Bloomberg today, even if her immediate prognosis is downbeat: she thinks - as does nearly everone else - that the third quarter GDP numbers will be high, but that they will fall back in the fourth. Nothing really controversial here. She is however fairly positive on what this will mean for mid-term growth. I think that the jury is still out, but that we need to consider all the data, and the arguments carefully. John Snow is making noises about raising interest rates. Short term I think this is just about trying to appear 'bullish'. OTOH: the numbers do give the surprising impression that the summer tax 'stimulus' had more impact on consumption than many foresaw (although, the let-out is that the whole package was a compromise one, so there is something for all parties). With so much shouting going on, it is sometimes difficult to see what the real argument is. The notorious GWB 'tax cut' is primarily a long-term phenomenon. What we have been seeing in September is a short term package to try to lift the economy up into full recovery. Looking at the consumption numbers, it's hard to argue a bigger short-term stimulus was needed, the question is: is this sustainable. Here we enter other areas like the trade deficit, private indebtedness, the level of private saving, the baby boom and long-term fiscal stability. One of the dangers of overly politicising your interpretation of things, is that you may lose-out on the subtlety of your analysis. Of course, some people see what they want to see, and that's it.

With most of the third-quarter economic data reported, economists are honing (read: raising) their forecasts for gross domestic product growth. Last Friday's report of a smaller-than-expected August trade deficit and Wednesday's upward revision to July and August retail sales were the latest data points to raise the consensus GDP forecast to something on the order of 6 percent. With two-thirds of the economy -- consumer spending -- growing at an estimated 6.5 percent rate last quarter, it's hard to manufacture a much weaker GDP number. Tax cuts, auto incentives -- probably the weather -- will be cited as the reason for the strength in third-quarter consumer spending and the reason to expect a fourth-quarter retrenchment. No disagreement here. Real consumer spending has increased an annualized 6 percent or more in only three quarters in the past decade -- none of them back-to-back. It's tough to make a case that the consumer will follow his third-quarter shopping bonanza with a strong second act. That doesn't mean the expansion is doomed. Growth dynamics may change from one quarter to the next without jeopardizing growth itself. Some of what consumers bought in the third quarter came out of inventories. With business stockpiles at an all-time low relative to sales (almost as ``unsustainable'' as the current- account deficit), companies will have to step up production so they don't lose sales.

``A key cyclical dynamic is the boost to growth that comes from the inventory cycle,'' says John Ryding, chief market economist at Bear, Stearns & Co. Not only are inventories at an all-time low relative to sales, but accumulating them is also starting to make good business sense. With industrial commodity prices soaring and the federal funds rate pegged at 1 percent, ``the holding profits on inventory have been rising sharply, which should result in a boost to inventory investment over the next two quarters,'' Ryding says. All-consumer-all-the-time isn't a necessary prerequisite to sustain economic growth. Just as consumer spending started the summer quarter off strong and ended it weak, production went in the opposite direction. Manufacturing output posted its biggest increase (0.7 percent) in September since April 2000. The 2.9 percent annualized third-quarter increase was powered by a 25.6 percent jump in high-tech output. Excluding motor vehicles and parts, the September manufacturing increase was a modest 0.2 percent. Still, the breakdown of that output confirms that businesses are taking some of the load off the consumer. The output of business equipment rose for a fifth consecutive month in September. The third-quarter rise of 5.2 percent (annualized) was the biggest in three years. Business equipment production fell for 15 consecutive months from October 2000 through December 2001, alternating an occasional monthly increase with losses for the next 15 months. From May through September, the changes were all positive, confirming the more optimistic outlook in CEO surveys and the increased demand reflected in new orders. Inventories could easily make a positive contribution to GDP growth in the current quarter and in the first half of 2004, according to Henry Willmore, chief U.S. economist at Barclays Capital Group. In addition, consumer spending should get a boost from ``a significant tax refund because of over-withholding,'' he says. (The tax cut was retroactive to January 2003. Employers adjusted the withholding schedules in July.)

Come the second half of next year, however, ``we'll need to have job growth'' to sustain the expansion, Willmore says. Job growth may already be in the process of accelerating. Weekly unemployment claims fell to an eight-month low last week even as the total number of people receiving unemployment benefits failed to show any improvement. Firing has to stop before hiring can begin. If yesterday's buoyant reading from Philadelphia-area manufacturers is any indication, the latter is in the cards. The employment index rose to a three-year high of 5.5 while the gauge of employment six months from now rose to a two-decade high of 33.3. Employment was only one part of the upbeat Philly Fed survey, with the general activity index at a seven-year high of 28. New orders and shipments showed sizeable increases as well. The regional and national purchasing managers surveys, while qualitative in nature (increase, decrease or no change?), tend to lead quantitative data, such as industrial production. The upswing in a variety of manufacturing indicators, including the rise in commodity prices, ``is normally associated with a resumption in employment growth,'' Ryding says. Strong sustained growth, which isn't relegated to consumer spending, will deliver jobs.
Source: Bloomberg
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German Pension Reform on the Move

The FT describes this as a dangerous gamble, I think it is the first gambit in what is bound to be a fairly long and protracted process. The key question is what is Germany's trend growth? Most calculations are based on the idea that recent economic growth in Germany has been sluggish due to the impact of re-unification in the ninetees. This may be part of the story. But my own opinion is that there is more to it, and that nobody knows what 'German trend growth' really is. Perhaps we are about to see. One way or another the outcome will have a significant impact on the viability of public finaces there in the years to come.

Chancellor Gerhard Schröder took a dangerous gamble on Sunday by ordering what amounted to the first cut in pension benefits in post-war German history.The cut was one of five emergency measures agreed at a meeting of cabinet ministers and government coalition leaders to plug an estimated €8bn (£5.6bn, $9.3bn) shortfall in the state pay-as-you-go pension schemes next year without raising contributions. Mr Schröder sided with the majority of his cabinet, leaders of the Green party, the ruling coalition's junior partner, and business, all of whom had warned a rise in pension contributions would smother any hope of an economic recovery next year. But the move could alienate segments of the chancellor's Social Democratic party and complicate his efforts to push Agenda 2010, his ambitious package of structural reforms, through parliament before the end of the year.

"This was one of the most difficult discussions, and these were among the most painful decisions our government has had to make," Mr Schröder said after the five-hour meeting. Sunday's compromise shows how a lethargic economy has been blocking the chancellor's path to reforming the welfare state and boosting competitiveness. His reforms are designed to promote employment by lowering what are among the world's highest non-wage labour costs. Pension contributions, which at 19.5 per cent of the gross wage form a substantial part of these costs, would have risen to 20.3 per cent next year without corrective measures.

From next year, pensioners will have to pay full contributions into an old-age care scheme, part of which had hitherto been covered by the pension funds. Since a planned pension benefit increase due in the middle of next year would also be cancelled, Mr Schröder admitted this amounted to a benefit cut. In addition, the pension funds' legal reserves will be reduced from 50 to 20 per cent of one month's total benefit payments and new pensioners will now be paid at the end of the month. The state's annual subsidy to the pension funds next year will be €1bn higher than provided for in a bill adopted by the lower house of parliament last Friday. However, Mr Schröder said additional savings totalling €1bn would be required of all ministries in the 2004 budget.

This should prevent a further rise in Germany's budget deficit next year and help save the face of Hans Eichel, finance minister, after he threatened to resign if the subsidy was raised. The cabinet also endorsed longer-term measures for a reform of the pension system. These will be put to parliament before the end of the year, where they will require the backing of the opposition-dominated upper chamber. The chancellor said the recommendation by a government-appointed commission to raise the legal retirement age from 65 to 67 would not be considered until 2010. But the actual retirement age would have to rise from the current 60 to 63 by 2008. Separately, the government said it would make investing in private pension schemes easier and more tax efficient.
Source: Financial Times
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Row Over Resona Bailout

This is obviously part of the backdrop to the election campaign, and it is always hard to judge the significance of things in this context. But Resona is interesting, since it is a strange case, and it could give us some clues as to the real determination for serious reform in Japan. On the face of it, not encouraging.

The Democratic Party of Japan, the country's main opposition, is accusing the government of Junichiro Koizumi of "state-sponsored window dressing and fraud" when it bailed out Resona, the Japanese bank. DPJ officials will meet representatives of the Financial Services Agency, the banking regulator, on Monday and will argue that the government was aware that Resona was insolvent when the FSA decided to inject Y1,960bn ($17.9bn) to prevent the bank collapsing. The opposition's decision to accuse the government of acting illegally escalates the potential political fallout from the Resona rescue and is designed to put pressure on the prime minister and his ruling Liberal Democratic party ahead of a general election in November.

The DPJ will argue that the government deliberately used an inappropriate clause of the Deposit Insurance Corporation law to avoid the stigma of an embarrassing nationalisation as well as protecting shareholders from having the value of their holdings completely wiped out. Following the bail-out, Resona's share price rose sharply.

When it bailed out Resona, the government cited a section of the DIC law that can only be used for banks with a positive net worth. Other sections, however, are for use with "bankrupt financial institutions or financial institutions where assets are unable to fully repay liabilities".

An official at a credit rating agency who asked not to be named said: "In Resona's case, if it did have negative net worth at end-March 2003, as is suggested by the subsequent independent audit, it should have been declared insolvent and dealt with either under [sections] 102(2) or under 102(3)." Section 102(2) allows for the failed institution to be merged with another company, while section 102(3) allows for the full nationalisation of the bank, which would result in shareholders' equity being written down to zero.

Controversy over the Resona bail-out intensified after it was announced this month that the bank would report a far higher than expected loss of Y1,760bn for the first half of the year - a figure almost equal to the Y1,960bn injected by the government.
Source: Financial Times
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