America’s economy: Time to rebalance.
A special report on America’s economy
Time to rebalance America’s economy is set to shift away from consumption and debt and towards exports and saving. It will be its biggest transformation in decades, says Greg Ip
Note: This is a nine-part, 14 page report. You can read the entire thing at this blog post or on The Economist’s web site here.
Mar 31st 2010 | From The Economist print edition
STEVE HILTON remembers months of despair after the collapse of Lehman Brothers in 2008. Customers rushed to the sales offices of Meritage Homes, the property firm Mr Hilton runs, not to buy houses but to cancel contracts they had already signed. “I thought for a moment the world was coming to an end,” he recalls.
In the following months Mr Hilton stepped up efforts to save his company. He gave up options to buy thousands of lots that the firm had snapped up across Arizona, Florida, Nevada and California during the boom, taking massive losses. He eventually laid off three-quarters of its 2,300 employees. He also had its houses completely redesigned to cut construction cost almost in half: simpler roofs, standardised window sizes, fewer options. Gone were the 12-foot ceilings, sweeping staircases and granite countertops everyone wanted when money was free. Meritage is now catering to the only customers able to get credit: first-time buyers with federally guaranteed loans. It is clawing its way back to health as a leaner, humbler company.
The same could be said for America. Virtually every industry has shed jobs in the past two years, but those that cater mostly to consumers have suffered most. Employment in residential construction and carmaking is down by almost a third, in retailing and banking by 8%. As the economy recovers, some of those jobs will come back, but many of them will not, because this was no ordinary recession. The bubbly asset prices, ever easier credit and cheap oil that fuelled America’s age of consumerism are not about to return.
Instead, America’s economy will undergo one of its biggest transformations in decades. This macroeconomic shift from debt and consumption to saving and exports will bring microeconomic changes too: different lifestyles, and different jobs in different places. This special report will describe that transformation, and explain why it will be tricky.
The crisis and then the recession put an abrupt end to the old economic model. Despite a small rebound recently, house prices have fallen by 29% and share prices by a similar amount since their peak. Households’ wealth has shrunk by $12 trillion, or 18%, since 2007. As a share of disposable income it is back to its level in 1995. And if consumers feel less rich, they are less inclined to spend. Banks are also less willing to lend: they have tightened loan standards, with a push from regulators who now wish they had taken a dimmer view of exotic mortgages and lax lending during the boom.
Consumer debt rose from an average of less than 80% of disposable income 20 years ago to 129% in 2007. If other crises of the past half-century are any guide, America’s consumers will spend the next six or seven years reducing their debt to more manageable levels, reckons the McKinsey Global Institute. This is already changing the composition of economic activity. Consumer spending and housing rose from 70% of GDP in 1991 to 76% in 2005 (see chart 1). By last year it had fallen back to 73%, still high by international standards.
The effect on the economy of deflated assets, tighter credit and costlier energy are already apparent. Fewer people are buying homes, and the ones they buy tend to be smaller and less opulent. In 2008 the median size of a new home shrank for the first time in 13 years. The number of credit cards in circulation has declined by almost a fifth. American Express is pulling back from credit cards and is now telling customers how to use their charge cards (which are paid off in full every month) to control their spending.
Normally, deep recessions are followed by strong recoveries as pent-up demand reasserts itself. In the recent recession GDP shrank by 3.8%, the worst drop since the second world war. In the recovery the economy might therefore be expected to grow by 6-8% and unemployment to fall steadily, as happened after two earlier recessions of comparable depth, in 1973-75 and 1981-82.
But this particular recession was triggered by a financial crisis that damaged the financial system’s ability to channel savings to productive investment and left consumers and businesses struggling with surplus buildings, equipment and debt accumulated in the boom. Recovery after that kind of crisis is often slow and weak, and indeed some nine months into the upturn GDP has probably grown at an annual rate of less than 4%. Unemployment is well up throughout the country (see map), though it declined slightly in February.
So if America is to avoid the stagnation that afflicted Japan after its bubbles burst, where is the demand going to come from? In the short term the federal government has stepped up its borrowing—to 10% of GDP this year—to counteract the drop in private consumption and investment. Over the next few years this stimulus will be withdrawn. Barack Obama wants the deficit to come down to around 3% of GDP by the middle of this decade, though it is not clear how that will be achieved. Indeed, if the rest of the economy remains moribund, the government may be reluctant to withdraw the stimulus for fear of pushing the economy back into recession.
Tighter credit and lower consumer borrowing are not the only drivers of economic restructuring. A less noticed but significant push comes from higher energy prices. A strengthening dollar and ample supply kept oil cheap for most of the 1990s, feeding America’s addiction to imports. That began to change a few years before the crisis as the dollar fell and emerging markets’ growing appetite put pressure on global production capacity.
A fourfold increase in oil prices since the 1990s has rearranged both consumer and producer incentives. Sport-utility vehicles are losing popularity, policies to boost conservation and renewable energy have become bolder, and producers have found a lot more oil below America’s soil and coastal seabed. Imports of the stuff have dropped by 10% since 2006 and are likely to come down further. When natural-gas prices followed the rise in oil earlier this decade, exploration companies used new methods to get at gas trapped in shale formations from Texas to Pennsylvania. Abundant domestic shale gas should radically reduce America’s gas imports.
America’s economic geography will change too. Cheap petrol and ample credit encouraged millions of Americans to flock to southern states and to distant suburbs (“exurbs”) in search of big houses with lots of land. Now the housing bust has tied them to homes they cannot sell. Population growth in the suburbs has slowed. For the present the rise of knowledge-intensive global industries favours centres rich in infrastructure and specialised skills. Some are traditional urban cores such as New York and some are suburban edge cities that offer jobs along with affordable houses and short commutes.
A burst of productivity could lift incomes and profits. That would enable consumers to repay some of their debt yet continue to spend. The change in the mix of growth should help: productivity in construction remains low, whereas in exports the most productive companies often do best. But the hobbled financial system will make it hard for cash-hungry start-ups to get financing, so innovation will suffer.
The outlook for business investment depends on whether it is for equipment or buildings. Spending on equipment is expected to be fairly strong, having largely avoided excess in the boom period, and indeed in the fourth quarter of 2009 it raced ahead at an annual rate of 19%. In February John Chambers, the boss of Cisco Systems, a maker of networking gear, called it “one of the most robust, positive turnarounds I’ve seen in my career”. Demand for new buildings is far lower: empty shops and offices attest to ample unused capacity. And business investment typically accounts for only 10-12% of GDP, so it will never be a full substitute for consumer spending.
The road to salvation
As consumers rebuild their savings, American firms must increasingly look abroad for sales. They have a lot of ground to make up. Competition from low-wage countries, mostly China, has increasingly taken over the markets of domestic industries such as furniture, clothing or consumer electronics. Yet shifts in the pattern of global growth and the dollar are laying the groundwork for a boom in exports. “There’s a world view that the United States is the consumer of the world and emerging markets are the producer,” says Bruce Kasman, chief economist at JPMorgan Chase. “That has changed.” He reckons that America will account for just 27% of global consumption this year against emerging markets’ 34%, roughly the reverse of their shares eight years ago.
The cheaper dollar will resuscitate some industries in commoditised markets, but the main beneficiaries of the export boom will be companies that are already formidable exporters. These companies reflect America’s strengths in high-end services and highly skilled manufacturing such as medical devices, pharmaceuticals, software and engineering, as well as creative services like film, architecture and advertising. Thanks to cheap digital technology, South Korea and India now knock out the sort of low-budget films that compete with standard American fare. But only Hollywood combines the creativity, expertise and market savvy to make something like “Avatar” which has earned $2.6 billion so far, some 70% of which came from abroad. That adds up to several jumbo jets.
Exports are a classic route to recovery after a crisis. Sweden and Finland in the early 1990s and Thailand, Malaysia and South Korea in the late 1990s bounced back from recession by moving from trade deficit to surplus or expanding their surplus. But given its size and the sickly state of most other rich countries’ economies, America will find it much harder. It has been exporting more to emerging markets than to developed ones for several years, but if other countries, particularly China, do not sufficiently boost domestic demand, “the unwinding of the global imbalances could reverse quite quickly in 2010,” says an IMF staff paper.
America’s current-account deficit, the broadest measure of its trade and payments with the rest of the world, shrank from 6% of GDP in 2006 to 3% last year (see chart 2). Could it come down to zero? It nearly did in 1991 after five years of booming exports. This time the deficit started out a lot larger and the rest of the world is weaker. Still, even stabilisation around 3% would be a blessed relief because it would slow the growth in America’s indebtedness to foreigners.
America’s imbalances were years in the making and will not be undone overnight. But the elements of a rebalanced economy are already visible a 40-minute drive to the south of Mr Hilton’s offices in Scottsdale, Arizona. Around the same time that Mr Hilton was watching sales of his homes dry up, Brian Krzanich, head of global manufacturing at Intel, was finalising plans to spend $3 billion retooling his company’s massive semiconductor factories in nearby Chandler. Mr Krzanich knew perfectly well there was a recession going on. Intel’s sales were down and 3% of the staff at the factories had been laid off. But he also knew that once global demand rebounded, Intel would have to be ready to produce a new generation of cheaper, smaller and more efficient chips. “Unless you think your business is going to shrink for an extended period, like seven years, it always pays to make that investment,” he says. In the last quarter of 2009 Intel, helped by resurgent demand for technology, enjoyed record profit margins, and Mr Krzanich was approving overtime.
Mr Hilton, for his part, runs his company on the assumption that the days of easy money and exuberant consumers are gone for ever. In his office he has a yellowed copy of theWall Street Journal from September 18th 2008, the week when Lehman failed and American International Group was bailed out. “Worst crisis since the 30s with no end in sight”, reads one headline. “I wish I’d had that article in 2005,” says Mr Hilton. He keeps it around as an antidote any time he is “feeling all happy and slappy”.
A special report on America’s economy
The end of the binge
The consumer boom defied fundamentals. Now economic rules are reasserting themselves
Mar 31st 2010 | From The Economist print edition
IT WASN’T supposed to happen. An academic study in 1991 predicted that as the baby-boomers aged, America’s saving rate would rise by one or two percentage points by the mid-2000s. Instead it fell. Between 1995 and 2000 the share of American households owning their home should have dropped by a percentage point as boomers passed their home-buying years. Instead it rose by 4.6 percentage points, with the sharpest increases among those under 45, according to Harvard University’s Joint Centre for Housing Studies.
The economic behaviour of Americans born in 1935-44 turned out to be a poor guide to their children’s conduct. According to a study by the McKinsey Global Institute, when the parents’ generation reached the age of 45 their saving rates rose sharply, to about 30% of disposable income. Yet when their children’s generation, born in 1955-64, reached the same age, their saving rates remained unchanged, at about 10% of disposable income.
This divergence is explained by two events, both dating back to the early 1980s. First, the Federal Reserve’s success in taming inflation resulted in two decades of falling real interest rates and rising share and property prices. As people’s assets rose in value, they felt less need to save for college, retirement or rainy days. Pricier homes provided more collateral against which to borrow.
Second, federal ceilings on deposit and loan rates were abolished, launching a period of deregulation that enabled banks and other institutions to offer countless new financial products and allow millions to borrow large sums of money for the first time. Automated underwriting enabled lenders to screen borrowers more efficiently (and also reduced the opportunity for racial discrimination). Securitisation—bundling mortgages, car loans and credit-card debts into securities and selling them on—helped lenders limit their risks. Policymakers smiled on all this because it allowed many more Americans to become homeowners at no cost to the taxpayer. In 1989 only 47% of middle-income households had a mortgage. By 2007 about 60% did.
The Asian financial crisis of 1997-98 accentuated these trends. It sent oil down sharply and the dollar up, raising Americans’ purchasing power and their taste for imports and oil. In its aftermath Asian countries held down their exchange rates and began to accumulate huge trade surpluses, both to bolster growth and as protection against future crises (and the humiliating strictures of the IMF). They ploughed those surpluses into America’s bond market, holding down interest rates and inflating the housing bubble.
The return to earth began long before the riskiness of all this became obvious. In 2002 the dollar began to fall. In 2004 oil headed upwards. In 2006 the housing market turned down. Hopes that the transition would be gentle evaporated as the crisis erupted, leading to the recession of 2007-09. Many companies realised too late how much they had depended on credit-fuelled profligacy. GE, for instance, eventually relied on financial services for half its profits. Last year Jeff Immelt, the conglomerate’s chief executive, admitted that “we let it get too big.” Citigroup’s boss, Vikram Pandit, explained in 2008 how his company got into such a mess: “We had a large, long US consumer position.” Unfortunately, he added, so did the entire world.
Where consumers rule
Consumers have always dominated the American economy. Since 1950 their share of spending (including housing) has ranged from 66% to 76%. What was different about the pre-crisis era was the role of credit: in myriad new forms it made it possible for consumers to spend well beyond their income.
Consumption will recover, but it will no longer grow faster than income, as it did persistently for the two decades before the crisis; indeed, it should grow more slowly. With their shares and homes worth far less than they were, baby-boomers must now save harder for retirement. Lenders demand higher credit scores, bigger deposits and more stringent proof of income. Policymakers, who had cheered looser lending standards on the way up, are now tightening them further on the way down. True, Barack Obama has pleaded for banks to do more lending and put a government guarantee behind much of the mortgage market. But he is also bent on establishing a powerful Consumer Financial Protection Agency to scrutinise lenders’ offerings. Regulators are planning to hold banks to stiffer capital and liquidity rules.
The more that an industry depended on consumers’ access to credit, the harder it has been hit. As home ownership drops, developers are building smaller, simpler homes (see chart 3). Steve Hilton, the boss of Meritage Homes, is keeping the price of his houses down to at most 15% more than comparable existing ones to compete with the flood of foreclosures. On the garage doors of his company’s show homes hang garish banners advertising the “no-tricks” monthly mortgage payment: $1,480 for the three-bedroom, two-bathroom Harrison, for example. “It used to be taboo to talk about the payment,” says Mr Hilton. But nowadays buyers are looking for a place to live, not an investment, and knowing what the monthly repayment will be lets them compare the cost of owning and renting more easily.
Cars, like houses, are usually bought on credit, with either a loan or a lease. During the credit boom the terms of such deals were exceptionally attractive, but not any more, thanks to tight credit generally and the woes of GMAC, the financing arm of General Motors and Chrysler, which has been laid low by bad mortgage lending. In most years since 1960 some 7-8% of driving-age Americans bought a car. Last year only 4% did, according to IHS Global Insight, a consultancy. It forecasts that when the market has recovered the figure will settle at about 6% in any given year.
Cut up those credit cards
The recession also marked a “coda” to the credit-card industry’s first 50 years, says David Robertson of the Nilson Report, an industry newsletter. The popularity of credit cards was bound to wane as baby-boomers moved on from their highest-spending years, he says: “Instead of gliding to a manageable end, it wound up blowing up.” The number of holders of Visa, MasterCard, American Express and Discover cards shrank by 32m, or 11%, last year, according to Nilson. Outstanding revolving credit (mostly credit cards and personal lines of credit) fell by $92 billion, or 10%, the largest such drop since records began in 1968. That will have an effect on consumer spending more generally.
Credit-card companies attracted their share of the anger directed at Wall Street. With effect from February, the Federal Reserve and Congress banned a wide range of card-company practices, such as raising a borrower’s interest rate when he defaults on a loan extended by another organisation. Parents must now give their consent before their children under 21 can get a card. “At a time when our economy is in a crisis and consumers are struggling financially, credit-card companies are gouging them,” said Chris Dodd, chairman of the Senate Banking Committee.
Noxious as some of the card-companies’ practices were, they did allow many more people to hold credit cards. Bankers say the new restrictions may cut the number of credit-card holders by up to 45m. That is almost certainly an exaggeration, but there is bound to be a drop.
The changed economic and regulatory environment has certainly affected card companies’ strategy. American Express, for instance, had long favoured charge cards over credit cards, but in 1999 it launched its “Blue” credit card with a charity concert in New York’s Central Park featuring Sheryl Crow, Eric Clapton and Sarah McLachlan. The card was aimed at technologically savvy young consumers and contained a microchip to deter identity theft and encourage internet shopping. In subsequent years Amex followed up with a series of cards aimed at niche borrowers, from newlyweds to young Chicago professionals.
But the push into credit cards cost Amex dear as delinquencies mounted during the recession. Under new accounting rules it will have to hold additional capital for the off-balance-sheet vehicles used to securitise credit-card debts. Having agreed in 2008 to be regulated by the Federal Reserve, in part to qualify for bail-out funds (which it has since repaid), it may face stiffer liquidity and capital requirements than it would have done otherwise.
It has now ditched many of its new credit cards except Blue and returned to its roots in charge cards and services such as electronic payments. “There are going to be segments, not just subprime but [of] the middle class, that are not going to have access to credit, and when they get credit it’s going to be a lot more expensive,” Ken Chenault, Amex’s boss, said last summer. “The charge card is even more a product for these times than…three years ago.” The company is now offering features that help cardholders control spending. It lets them pay for groceries with reward points and impose spending limits on kids with supplemental cards. If consumers espouse frugality instead of ostentatious spending, Amex wants to be there.
Look after the cents
Are Americans naturally spendthrift?
Mar 31st 2010 | From The Economist print edition
IN 1867 Horace Greeley, a legendary American newspaper editor, described his compatriots thus: “We are energetic, we are audacious; we are confident in our own capacities and in our national destiny; but we are not a systematic, a frugal, economical people.”
The global imbalances that led to the financial crisis are often blamed on Americans’ high-living optimism. The crisis has brought about a “new creed of thrift”, as the Pew Research Centre, a polling organisation, put it in April 2009. From the early 1970s to 2006 the proportion of Americans who considered air conditioning or dishwashers a “necessity” rose steadily, but in 2009 it dropped sharply, Pew found. Between 1950 and 1980 personal saving averaged 9% of disposable income. By 2007 it had dropped below 2%, but last year it went up to 4%.
Is it true that Americans are prodigal? David Blankenhorn, in his book “Thrift: A Cyclopedia”, argues otherwise. “In this sweet land of liberty, one part of our inheritance…is thrift. [It] is more than anything else a restatement, in secular terms, of the Judaeo-Christian concept of stewardship.” GfK Roper, a consultancy specialising in consumer behaviour, notes that in every recession since 1981 American consumers cut back on going out to eat and play and on holidays.
Economists think they can explain changes in saving behaviour over time and across countries without reference to cultural norms. An IMF staff paper ascribes the enormous differences in saving rates between Americans, Germans and Japanese to demography, wealth and economic volatility. Germans and Japanese used to save more because they were older, had suffered more economic setbacks and were less wealthy, though Japanese saving rates have since come down as more people retire and draw down their savings. A model developed by Barack Obama’s Council of Economic Advisers explains the American saving rate in terms of wealth, credit availability and unemployment. It predicts that it will eventually settle between 4% and 7%.
Yet such exercises do not fully exonerate a culture that can influence people’s saving habits through political choices. In 1950 President Truman refused to run a deficit to pay for the Korean war. Instead he raised taxes and slashed spending, for which he enjoyed the public’s overwhelming support. In 2001, in the wake of the terrorist attacks that year, shopping was presented as a patriotic activity, a way for Americans to “stick their thumb in the eye of the terrorists”, as Dick Cheney, George Bush’s vice-president, put it. Mr Bush did not even consider raising taxes to pay for the wars in Afghanistan and Iraq; he cut them instead.
Institutions also influence saving behaviour. George Akerlof and Robert Shiller, in their book “Animal Spirits”, note that Singapore’s sky-high saving rate can be traced to employers’ and employees’ compulsory contributions to the Central Provident Fund, created by the government in 1955.
Mr Blankenhorn blames the decline in thrift in America on the rise of “anti-thrift” institutions such as rent-to-own stores, cheque-cashing and chain pawn shops, indulgent credit-card companies and proliferating payday lenders. They flourished in America because voters and policymakers did not object. Belatedly, that has changed. Regulators and rulemakers now insist that lenders hold more capital and scrutinise borrowers more carefully. Whether Americans want to save more may be beside the point: they won’t have much choice.
Export or die
With demand at home at rock bottom, American firms are looking abroad
Mar 31st 2010 | From The Economist print edition
CLAUDIA CUSUMANO works for a New York firm of architects, Kohn Pedersen Fox (KPF), and has often wondered if she would lose her job in America’s property bust, as many of her professional colleagues already have. In October 2008, when she was working on a huge residential and office complex in northern Virginia, the developer could not get financing. Its e-mail to contractors and consultants said: “It appears to be a good time to stop.” Her boss switched her to another project in northern Virginia but last autumn that, too, went on hold.
Just as things were beginning to look desperate, her firm landed a contract to build an upmarket hotel in the Chinese city of Hangzhou. As design work in America has disappeared, KPF’s growing portfolio of projects in China, South Korea and the Middle East has protected its 550 employees from the worst of the domestic slump. Gene Kohn, the firm’s chairman, explains that “those projects in South Korea and China were big shots in the arm. We didn’t have to let any more people go, we kept the whole New York office busy and began to hire. Last year turned out better than anyone could have imagined, yet it started out with the doom and gloom of all these jobs stopping.”
America’s economic transformation will require businesses to rely less on selling to Americans and more on selling abroad, as KPF has done. The emphasis will be on high-value products and services rather than on labour-intensive items such as furniture and clothing.
When Barack Obama in his state-of-the-union speech called for exports to double in five years, many economists thought he was asking for the impossible. Whenever exports have risen so steeply in the past, it has been thanks to high inflation that lifted nominal values. Yet exports do not have to double for trade to lead economic growth; all they have to do is to grow more rapidly or fall more slowly (in dollar terms) than imports. That has already happened. Between 2008 and 2009 exports dropped by $272 billion whereas imports fell by $589 billion. As a result, the trade deficit narrowed sharply, to $379 billion from $696 billion. As a share of GDP, that was the lowest since 1998.
The deficit may widen again in coming months as companies step up imports to build up depleted stocks, but not by much. Martin Baily of the Brookings Institution and Robert Lawrence of Harvard University predict that as a share of GDP the trade deficit this year, excluding oil, will increase only slightly even if the dollar strengthens.
What about the longer term? A country’s relative trade performance is mainly determined by two (connected) factors: its exchange rate and its growth rate in relation to those of its trading partners. The IMF expects growth globally to average 4.3% a year between now and 2014 but only 2.5% in America. And though the recession hammered overall trade, America’s trade patterns have changed to reflect the shift in global economic gravity. The share of its exports going to emerging markets topped 50% for the first time in late 2007 and has grown further since (see chart 4). All this suggests that the trade deficit will narrow a bit further.
The dollar is more of a wild card. Political or economic upheaval can trigger a flight from or to the dollar (as Greece’s current troubles have done). Other countries, such as China, may continue to hold their currencies down to keep imports in check. That could halt or even reverse the recent narrowing of the deficit.
The notion that exports can lead American growth strikes many, especially on the left, as fanciful. They point out that America’s manufacturing base has been cut down by years of competition from China and other lower-cost countries. Even if the economic climate improves, America may not benefit: it simply does not make the products the rest of the world wants to buy. Flat-screen televisions and mobile phones are made in Asia. “There are just too many products that we no longer make and too many foreign links in the industrial supply chain,” Robert Kuttner recently wrote in the American Prospect.
These prognostications are too gloomy. Experience suggests that export revivals are led by highly productive industries that already export a lot, rather than less productive industries regaining old markets. Over time a favourable global environment encourages more firms to launch new products or enter new markets abroad. Yet pinpointing those firms in advance is almost impossible.
In a 2001 paper Andrew Bernard of Dartmouth College and Bradford Jensen, now of Georgetown University, analysed the sources of America’s export boom in 1987-92. During that period American exports rose 77% in nominal terms and the trade deficit shrank from 3.2% to 0.6% of GDP. They looked at factories across America and found that only a small portion of the rise in exports came from those that had never exported before; by far the biggest gain was from those that were already exporting. Their research suggested that 90% of the export boom could be explained by the dollar’s depreciation and by relatively stronger growth in America’s trade partners.
A later paper, published in 2009, which Messrs Bernard and Jensen co-wrote with two other scholars, looked at the sources of export growth between 1993 and 2003. The increase in any given year came almost entirely from existing exporters, but over time new ones played an increasing part. For example, in 1993 alone firms exporting existing products to existing markets accounted for 91% of total export growth. But over the entire ten-year period they made up a relatively modest 35% of the total, with new firms contributing 24% and firms with new products or entering new markets as much as 42%.
Mr Bernard says these findings are at odds with the conventional view that export growth is the result of domestic firms becoming more productive. That is true only in the long run. In the short term almost all the growth comes from higher demand for products that existing firms already make. That fills him with optimism: “If you wanted to set the stage for US exporters to do well, you’d like to have rapid income growth in destinations that will be big in GDP terms. We already see that.”
America’s export boom is likely to be led by firms that are already global in scale and by sectors in which America has a clear competitive advantage: sophisticated, knowledge-intensive capital goods like microprocessors, and high-end services like engineering, oil-production services and even (witness KPF) architecture.
Few companies better capture that trend than Intel, a microprocessor giant. It is one of America’s most successful companies, and 80% of its revenue comes from outside its home country. Like almost all big companies it suffered a decline in sales and profits in the recession and had to lay off some staff. Yet it also decided to invest $7 billion in its semiconductor operations to enable them to make chips with circuitry just 32 nanometres (or billionths of a metre) wide, down from 45.
Brian Krzanich, Intel’s vice-president of manufacturing, says labour costs are an important consideration in processes such as assembling and testing systems, which are carried out in Costa Rica, Vietnam, China and Malaysia. But they matter much less in capital-intensive processes such as fabrication where the value of a technician or engineer might depend on how efficiently he or she can operate a $70m tool. If a more productive engineer can get 2% more use out of that tool, “that’s worth a lot of employees.” The difference in pay between a $50,000 engineer in China and a $150,000 engineer in America is a “nit” in that equation, he says. Thus the bulk of Intel’s investment is going into American factories in New Mexico, Oregon and Arizona. By the fourth quarter of last year Intel started shipping the new, smaller generation of chips from its Oregon plant, which helped the company achieve its highest ever gross margin.
Still, over the medium term Intel cannot correct America’s trade deficit by itself. More American companies will have to look abroad. They are the least likely to export out of 15 big economies, according to the National Association of Manufacturers, a trade group. Matthew Slaughter of Dartmouth College notes that only 4% of all American firms and 15% of American manufacturers do any exporting at all. And 80% of America’s total trade is conducted by just 1% of firms that export or import.
This does not mean there is something wrong with American firms. Rather, it reflects the fact that America’s domestic market is large enough for most firms. Exports as a share of GDP last year were estimated at 10.9%, much lower than in most of its big trading partners (see chart 5). Smaller companies are deterred by the investment in market research, distribution and product design needed to sell abroad. To succeed in foreign markets, they first have to do well at home.
The definition of exports has also become less clear-cut over the years. These days much of what America exports is buried deep inside products put together elsewhere. Apple’s iPod, for instance, is assembled in China, but a study by the Personal Computing Industry Centre at the University of California, Irvine, estimated that China accounts for only 2% of the wages involved in its manufacture, whereas America makes up around 70%, in areas such as engineering, software and distribution.
Service with a smile
Services are playing an increasingly important part in America’s exports. Their share of the total has gradually increased, to nearly 33% last year. Within that category, the private side, which covers things like business, professional and financial services, has been growing fastest. Before the recession optimists routinely cited America’s pre-eminence in financial services as a driver of future export growth. Since then the rest of the world has become much more sceptical about the real value of America’s financial engineers.
Yet America leads in many other kinds of services, from software and film to engineering and oil drilling. And as technology advances, more businesses are likely to turn global. A survey by the American Institute of Architects found that in 2008 some 7% of its members’ billings came from international work, against only 2.8% a decade earlier. That increase came almost entirely from firms that were already doing international work but had stepped up their efforts.
Building up such work can take time. KPF, for example, though founded in 1976, did not land its first foreign job until the late 1980s. Getting a toehold in Asia was particularly time-consuming, but the firm now has an office with 40 people in Shanghai that helps with local project oversight, models, presentations to clients and the notoriously opaque building regulations in Chinese cities.
The ease of exchanging information around the world has fuelled fears that even service jobs will be outsourced away from America. But those information flows also make it easier for firms like KPF to do business overseas. Once a week Ms Cusumano and her colleagues in Shanghai log into a teleconference to discuss the Hangzhou hotel and look at drawings with the aid of web-based conference software. And some nights when Ms Cusumano cannot sleep, she exchanges e-mails with her partners in Shanghai.
There is every chance that in future energy will contribute less to America’s trade deficit
Mar 31st 2010 | From The Economist print edition
JUST off the freeway in south-western Pennsylvania a quiet country road leads past picturesque barns and horses in snow-covered fields. Turn right near the top of a hill, and a dirt road seems to take you straight to Texas. An orange drilling rig the size of a block of flats hulks over the countryside, slowly chewing its way a mile below the ground. The roar of portable generators fills the air. The roughnecks in blue overalls here have chased gas from Alaska to Nigeria. Nowadays, Pennsylvania is “the hottest area in the United States, if not the world” for gas, says one.
Range Resources is drilling for gas that is trapped in shale, a dense, non-porous rock formation. For more than a century shale gas has gone largely unexploited because of the high cost of recovering it. But a fivefold increase in the price of gas a few years ago prompted companies like Range to return to two well-tried technologies: drilling horizontally instead of vertically, and releasing the gas by injecting water at high pressure into the rock.
The Barnett Shale around Fort Worth, Texas, was the first to be commercially exploited on a large scale. The Marcellus Shale, which spans West Virginia, Pennsylvania and southern New York state, is the latest (see map). Thanks to these efforts, estimates of America’s “technically recoverable” gas (a broader definition than reserves) has risen by about 500 trillion cubic feet, or a third, in the past two years.
Barely a week goes by without Barack Obama promoting new measures to spur investment in renewable energy such as wind, solar and biofuels to wean America off imported oil and to reduce greenhouse gases. The marketplace has, quietly, accomplished a lot more. After a generation of decline, America’s domestic production of oil and gas is rising again and oil consumption is dropping. If sustained, these trends could play a big role in rebalancing the American economy. In 2008 America’s net imports of oil and gas came to $416 billion, or 60% of the deficit.
The drive to import less
The oil shocks of 1973 and 1979 galvanised America’s politicians into trying to reduce the country’s dependence on imported oil. In 1975 Congress introduced the first corporate average fuel economy (CAFE) standards for cars. Electric utilities cut their use of oil and domestic production rose. But after prices crashed in 1986 conservation efforts petered out. Average car fuel economy declined, and imports began an almost continuous two-decade climb.
The latest oil shock was far more drawn out than its predecessors, but the effects may be just as far-reaching. As oil rose from $20 per barrel in 2002 to $147 in 2008, oil companies found they could profitably extract more oil from ageing fields with techniques such as gas and steam injection. The oil industry had largely pulled out of the Great Plains when independent prospectors earlier this decade found promising new deposits in the Bakken Formation, below North Dakota and Montana. It is now thought to contain up to 4 billion barrels of technically recoverable oil, the largest continuous oil formation in the lower 48 states. And BP announced last autumn that its Tiber oilfield in the Gulf of Mexico could hold 4 billion-6 billion barrels.
The rise in the price of natural gas from $2 to $11 per thousand cubic feet had a similar effect. The price is now under $5, but Range began drilling in the Marcellus in 2004 and reckons it can profitably extract gas even below $4.
The demand-side response to higher prices has been just as comprehensive. Americans’ consumption of petrol and the number of miles driven peaked in 2007, and the use of public transport is up sharply. Some of this stems from the recession and will blow over. As unemployment drops, people will get back into their cars. Some is due to petrol topping $4 a gallon in 2008. With oil now back to $80, petrol has dropped below $3.
But IHS CERA, an energy consultancy, sees evidence of a more durable change in consumer behaviour. Since the mid-1980s car manufacturers had been using increased engine efficiency for extra power rather than fuel economy. Between the early 1980s and early 2000s the average new vehicle gained about 800lbs in weight and the time it took to reach 60mph dropped by about five seconds. Now the average vehicle is getting lighter and IHS CERA predicts that future advances in efficiency will go towards mileage, not power. California often leads national trends, and in 2008 its petrol consumption was the lowest since 2001. Despite increased air travel, jet-fuel consumption peaked in 2000, thanks to more efficient aircraft and better practices.
Richard Newell, who runs the federal Energy Information Administration (EIA), thinks that with oil at current levels the behavioural changes will stick, helped by new policies. The federal Renewable Fuel Standard, passed in 2005 and updated in 2007, requires that by 2022 refiners blend 36 billion gallons of renewable fuel such as ethanol and biodiesel into motor fuel. If the target were met, that would be about 17% of consumption. CAFE standards were tightened in 2007 for the first time. Last year Mr Obama brought forward their implementation date to the 2012 car-model year. Tony Hayward, BP’s chief executive, told Dow Jones last November that “we will never sell more gasoline in the US than we sold in 2007.”
Increased supply and decreased consumption have radically altered the outlook for imports. Five years ago the EIA forecast that by 2025 America would be importing 16m barrels of oil a day, or 68% of its needs (see chart 6). Now that forecast has come down to less than 9m. Disappointingly, the total bill will still be higher because prices have gone up so much. But at least the American economy will be less dependent on imported oil.
The outlook for natural gas has changed even more. Five years ago the EIA thought that by 2025 America would be importing 28% of its natural-gas supply, much of that through newly constructed liquefied-natural-gas terminals. That forecast has now come down to 9% of its supply. Construction of a number of LNG terminals approved years ago is on hold.
The exploration boom has produced windfalls in some surprising places. Pennsylvania was home to the first commercial oil well drilled in America, in 1859, but production had long ago tailed off. One industry-backed study thinks shale gas will boost employment in the state by 98,000.
It is already making an impression on Washington county, a mostly rural area south of Pittsburgh first settled before the American revolution. “Two years ago the infrastructure was non-existent,” says Sam Robinson, a consultant overseeing one of Range’s drilling rigs. “You had to lease everything from Oklahoma or Texas.” Now Range estimates that more than 40 suppliers have set up shop locally. Several farmers have become millionaires from leases and royalties. Gas workers are a common sight in diners and churches.
Inevitably the industry has brought controversy too: some locals fear that the drilling will contaminate the groundwater (though there is little hard evidence so far), and New York state has put a hold on drilling in the watershed that supplies New York City’s drinking water.
In the past gas and oil prices have moved together, so there was little incentive for consumers to shift between the two types of fuel. The surge in domestic gas production has broken that link and could encourage a shift away from oil and towards gas in the future, although the supply and storage of liquefied natural gas for vehicles remain fraught with problems.
Several big question marks hang over these predictions. The price of oil is notoriously unpredictable. In the face of higher prices the industry has repeatedly shown ingenuity in developing new sources of supply. The price shot up in the 1970s because OPEC and Iran imposed restrictions on supply. Non-OPEC members boosted production and unity within OPEC frayed as conservation measures slowed consumption growth. In 1986 prices collapsed.
Still, this decade’s increase in oil prices is qualitatively different from that of the 1970s. It is due less to supply restrictions than to demand in emerging markets outstripping global production capacity. Although the recession has restored some spare capacity, emerging-market demand is likely to grow steadily. Western oil companies’ access to many low-cost oilfields is restricted by politics. Rich countries nowadays consume a smaller share of the world’s oil than they did in the 1970s, so their conservation efforts are less likely to bring down the world price.
The other unknown is policy. A cap on carbon emissions would raise the price of fossil fuel, increasing the pressure to lower consumption. It would reduce the cost disadvantage of solar, wind and biofuels, which are more expensive and less reliable electricity generators than oil, coal and gas. Although the domestic coal industry would be the biggest loser, oil imports would also drop.
But the prospects of a cap-and-trade deal have faded. The climate-change conference in Copenhagen last December yielded no firm commitments to new caps on emissions. Prospects for passing a cap-and-trade bill in America, already uncertain, have dimmed further since the Democrats lost their supermajority in the Senate. Legislators from coal-producing states, and Republicans in particular, are strongly opposed to cap-and-trade.
The best solution is out of reach
There are other ways to achieve the same thing. Many states require utilities to derive a certain share of their electricity from renewable fuels, which helps to explain why wind in recent years has accounted for more than a third of new electric-power capacity. The House of Representatives’ cap-and-trade bill includes a federal standard, although various exemptions reduce its impact. Raising the federal petrol tax (which has remained at just 18.4 cents per gallon since 1993) would spur conservation and reduce imports even if the world oil price dropped. Unfortunately, any politician bold enough to try that is liable to be driven from office. Americans may be getting used to expensive petrol, but that does not mean they are grateful for it.
A special report on America’s economy
Somewhere to live
Why the sunbelt and urban sprawl are down but not out
Mar 31st 2010 | From The Economist print edition
CHANDLER and Maricopa are typical of the youthful, sprawling cities on the southern edge of Phoenix, Arizona. The thousands of stucco-walled houses with tiled roofs in Chandler’s palm-tree-lined streets could have been stamped out by a machine that then moved on to produce the same sort of houses in Maricopa 17 miles to the south-west.
Yet the two cities’ economic fortunes have followed quite different paths. In 2000 Maricopa was just a dusty crossroads with 329 homes. The housing boom was its making. As in countless “exurbs” across America, lower-income families drove ever farther afield to find a house they could afford. Maricopa soon grew to over 15,000 homes. But when America’s housing market collapsed, so did Maricopa’s. Over a quarter of its houses have received a foreclosure notice, says RealtyTrac, a property consultancy. Howard Weinstein, a local landbroker, waves at a patch of lots in the desert which the bank seized from someone who bought them for $30,000 each: “At current house prices no builder would pay anything for these lots.”
Chandler too has felt its share of pain as Arizona’s housing boom crumbled; home prices are down by half and foreclosures have soared. But its cluster of high-tech employers, anchored by Intel, have weathered the recession better than most firms and are now enjoying a global rebound in business investment in technology. Builders are snapping up scraps of empty land near the city’s centre.
Chandler’s and Maricopa’s divergent fates reflect the fact that as the crisis and recession reshape America’s economic activity, they will also redraw its economic map. For most of the post-war period the South has been catching up with the rest of the country. Land there is cheaper and land-use regulation more permissive, making it a magnet for families seeking a house with a yard, even if it means long commutes from sprawling suburbs. In the sand states—Florida, Arizona, Nevada and California—these trends went into overdrive in the years leading up to the crisis.
The rush for both sun and sprawl has now reversed, at least temporarily. Population growth has slowed in the suburbs and picked up in cities. During the recession four of the five states with the biggest job losses were in the sunbelt, led by Arizona (see table 7), according to Moody’s Economy.com. For the first time since the end of the second world war more people left Florida than moved in.
Exactly the opposite happened in North Dakota. For only the second time since the 1970s more people are moving in than out and the population is now its highest since 1998. Enrolment at the high school in tiny Tioga is rising as locals who moved away years ago return with their children, and the principal frets that he now has to compete with the oil industry to hire janitors.
Internal migration has been slowed sharply by the fact that a quarter of homeowners with mortgages owe more than their home is worth, according to First American CoreLogic, making it difficult to move. Moreover, an economy shifting away from consumption and housing and towards exports of high-value goods and services will tend to benefit industries that cluster in metropolitan centres, in part because such firms draw on a common pool of intellectual talent. Software publishing, sound recording, film production and securities and commodities trading all form such clusters, note Bradford Jensen and Lori Kletzer in a report for the Peterson Institute. Seattle’s share of employment in America’s software industry, for example, is 18 times its share of population. By contrast, non-tradable services like retail banking and video rental do not show much clustering at all. New York City is reeling from the devastation visited on financial services but retains a leading role in other services, from media to architecture.
Some even predict that cities will regain economic leadership from suburbs. Richard Florida, an expert on urban planning at the University of Toronto, wrote in the Atlantic last year that the economy “no longer revolves around simply making and moving things. Instead, it depends on generating and transporting ideas. The places that thrive today are those with the highest velocity of ideas, the highest density of talented and creative people, the highest rate of metabolism,” which are found in cities.
Let’s hear it for the suburbs
But that may be going too far. Powerful economic logic underpins the suburbs and car culture. The median commute by car, at 24 minutes, is half the median commute by public transport. Nathaniel Baum-Snow of Brown University has found that since 1960 residents and jobs have been moving to the suburbs at about the same rate. Cutbacks on highway construction will slow that trend but not reverse it.
Short-term trends seem as likely to benefit a city like Chandler as New York: it combines a suburb’s ease of commuting and affordable housing with a city’s clustering of workers with similar skills. Since Intel arrived in 1980, an infrastructure of suppliers and supporting industries has grown up around it. Air Products set up shop to deliver ultra-pure nitrogen, vital to chipmaking, to Intel down a two-foot-wide pipe. That pipe, in turn, attracted other semiconductor companies. Those companies and their suppliers have nurtured a pool of highly trained technical workers fed by two large state universities. Qualastat, which builds flexible circuits, recently announced it would move its headquarters to Chandler from Pennsylvania to be closer to a supply of engineers.
Chandler has all the things Intel looks for when deciding where to put a factory, says Brian Krzanich, Intel’s general manager of manufacturing and operations: space, infrastructure, the transport links that enable it to ship completed wafers to other facilities in the country around the clock and, most important of all, a “pool of talent that’s been here a long time”.
It doesn’t hurt, he adds, that a recent college graduate can more easily afford a home in Chandler than in the San Francisco bay area, where Intel is based. Still, Mr Krzanich gives warning that neither Chandler nor America can take Intel’s presence for granted: “Other countries like China are climbing up the skillset. They’re fighting fiercely for the same investment.” Intel is now building its first fabrication plant outside the rich world—in China.
As long as Americans want to own homes, the South and suburban sprawl will retain a certain appeal. Eventually those foreclosed homes in Maricopa will be reoccupied. As Mr Weinstein, the landbroker, puts it, “in the 1990s Chandler felt like Maricopa does today. The only difference is the zip code and the decade.”
A special report on America’s economy
Can higher productivity fill the gap?
Mar 31st 2010 | From The Economist print edition
LAST year Christina Romer, chairman of Mr Obama’s Council of Economic Advisers, noted that one of the costs of a bubble is that “some of our brightest minds make small fortunes arranging the deals, rather than pursuing potentially more socially valuable careers in such fields as science, medicine and education.” By that measure the collapse of the bubble may have its compensations. The share of new Harvard graduates entering finance or consulting, which in 2007 reached 47%, plunged to a mere 20% last year, according to the Harvard Crimson.
Whether those graduates who chose a career other than finance are about to launch the next technological revolution matters for the whole country. Innovation drives productivity, and productivity drives real incomes. A burst of productivity growth would make the years ahead a lot less painful. With bigger pay packets workers could reduce their debt and still spend more.
Innovation and productivity, however, are notoriously difficult to predict. They depend not just on inventors and entrepreneurs serendipitously stumbling upon a game-changing product, but on how quickly and widely firms incorporate that product into their operations. Between 1996 and 2009 productivity grew by a robust 2.7% a year as technologies that had been developed in previous decades, from personal computers to fibre optics, found their way into the mainstream.
Dale Jorgenson of Harvard University says technology is advancing more slowly than in the decade before the crisis, so productivity will too, by about 1.5% a year. Martin Baily of the Brookings Institution is more optimistic. He thinks productivity could grow by an average of 2.25% in the next few years, which would yield potential growth for the economy as a whole of about 2.6%—not spectacular, but a lot better than Japan’s during its lost decade. He cites several reasons. Growth is likely to be led by business investment and exports, both of which benefit firms with higher-than-average productivity. Conversely construction, an industry with low productivity, will make a much smaller contribution to GDP than it has done recently.
The combination of shrinking employment and rising GDP in the second half of 2009 has already translated into an impressive 7.4% advance in productivity at an annual rate. In part that reflects firms’ reluctance to hire when they are uncertain if growth is here to stay; the same thing happened after the 2001 recession. But it may also mean that the wave of technology adoption that fuelled productivity growth between 1996 and 2008 may still have further to run. Certainly the rebound in sales at firms such as Intel and Cisco Systems suggests so.
A dearth of talent
A recurrent complaint by such firms is that they cannot get enough college graduates with the right skills to staff up for such growth. Yet an extensive study found that between the early 1970s and late 1990s American colleges produced more than enough graduates in science, technology, engineering and maths to meet demand. The problem was that a growing proportion of them did not pursue careers in their field of study. It is not clear why not. Some may have been lured by the siren song of Wall Street, but others may simply have concluded that it did not offer a stable career, says Hal Salzman of Rutgers University, one of the authors.
The bigger risk to innovation is not a lack of skilled workers but a lack of finance. Recoveries after a financial crisis tend to be weak because of the damage done to the financial system. Firms that depend on external funds, such as bank loans or equity sales, are particularly vulnerable. A recent IMF study of Canadian and American manufacturers estimates that a one-percentage-point increase in corporate bond rates knocks a quarter-percentage point off the productivity growth of firms dependent on outside funding.
The withdrawal of credit in the past two years has been indiscriminate, hitting speculative residential developments and creative business start-ups alike. Small businesses moan that banks will lend to them only on draconian terms, if at all (though they also say weaker sales are a bigger problem). Robert Kiener, of the Precision Machined Products Association, cites the case of one Ohio manufacturer whose bank asked for his life-insurance policy as collateral.
Venture-capital finance has also contracted sharply. In part that reflects big losses sustained by charitable and university endowment funds on hedge funds, private equity and shares. Such endowment funds are strong backers of venture capital. Joshua Lerner of Harvard University has documented that although venture capital pays for only a small portion of total research and development, such R&D as it supports produces three to four times as many patents per dollar as regular corporate R&D. He also found that in the 1970s firms trying to commercialise personal computing and network technologies were held back for years by the venture-capital drought then prevailing. Last year venture-capital funds raised just $15 billion, half the average of the preceding four years (see chart 8).
The damage done by tighter finance can be overstated. Venture investment during recessions may actually be more productive, per dollar spent, than during booms, when money is showered on many variants of the same business plan. Research sponsored by the Ewing Marion Kauffman Foundation has found that entrepreneurship is surprisingly resilient to the business cycle, in part because many entrepreneurs turn to self-employment when they are laid off. Some 45% of firms in the Fortune 500 were born in recessions. But it would be safer not to bet on such resilience.
Work to be done
How the government can help things along
Mar 31st 2010 | From The Economist print edition
UNTIL the financial crisis hit, America’s mounting imbalances drew scant attention from presidents. George Bush’s advisers would routinely portray the gaping current-account deficit as good news: since it was matched by incoming foreign capital, it simply proved that America was a great place to invest. By contrast, imbalances have been a recurrent theme of Barack Obama’s. His speeches often sermonised about the evils of bubbles, easy credit and borrowing from China. He insisted that America had to live within its means. “As we rebuild we must also rebalance,” he said in the introduction to February’s Economic Report of the President.
Although Mr Obama diagnosed the problem correctly, he has yet to come up with a solution. Indeed, circumstances have forced him to pursue policies that actually slow the rebalancing. A wider federal deficit offsets private retrenchment (see chart 9) but prolongs America’s dependence on foreign savings. Tax credits and mortgage guarantees keep the housing market alive yet compound distortions that contributed significantly to the debt mountain in the first place.
Mr Obama’s supporters on the left want him to attack imbalances by supporting domestic manufacturers (an activity delicately termed “industrial policy”) and punishing other countries, particularly China, that they say trade unfairly. Mr Obama initially shared those instincts. But in the White House he is surrounded by orthodox economists who are sceptical of industrial policy and protectionism. These differences have produced a schizophrenic mix of policies. The president slapped tariffs on cheap tyres from China, proposed making it harder for multinationals to defer taxes on profits from abroad, earmarked stimulus money for green-technology investment and agreed to impose “buy American” provisions on anything bought with stimulus funds. On the other hand he insisted that those provisions must not run foul of World Trade Organisation rules and refrained from telling bailed-out banks and carmakers how to run their businesses.
These tensions are coming to a head. Mr Obama may formally declare China a currency manipulator soon. Some in Congress want to make it easier to impose duties on Chinese imports to compensate. Protectionism and industrial policy are tempting and might, at the margin, hasten rebalancing. But they would inflame relations with trading partners, provoke retaliation and ultimately slow the restructuring of the economy towards more productive, export-oriented businesses. Import protection generally shelters the least productive industries and therefore the ones least likely to export.
The argument for protecting or subsidising “infant industries” until they have become strong enough to compete abroad is complicated. Sometimes it has worked: defence spending, for example, was critical to the early development of computers, semiconductors and the internet. But how can it be made to fit in with world trade rules? New findings on the nature of exporting reveal a potentially productive role for government.
It starts with the insight that exporting is a bit like films: failures far outnumber successes, but the successes are often spectacular. Marc Melitz of Harvard University notes that making just one foreign sale entails big fixed costs: finding a buyer, setting up distribution and learning to deal with regulations that might be tilted in favour of local companies. Many companies that export once never do so again. But those that do so regularly often grow at a remarkable speed. Eventually, exports come to be dominated by firms and products that survive this winnowing process.
Reach for the watering can
This suggests that the right role for government is not to shower money on a handful of putative winners but to take a portfolio approach: finding companies on the margin of exporting and helping as many as possible overcome the fixed costs of entry. Eventually some should become big, productive exporters. Consular services that guide companies through foreign markets are one form of support; trade finance is another, particularly since the seizure in financial markets impaired private trade financing. The Export-Import Bank has authorised record volumes of trade credit, but Fred Hochberg, its president, says America still spends less on such efforts than China or Canada do, even though its economy is much larger.
Further trade liberalisation would encourage firms to export by offering certainty of continued market access. Mr Obama’s free-trade agenda, however, has focused on the enforcement of existing trade laws. Though he has recently shown renewed interest in free-trade agreements with Panama, Colombia and South Korea, only the first seems likely to be ready for a Senate vote this year.
A similar approach should be applied to innovation. In the 1970s and 1980s the federal government poured billions of dollars into the Synthetic Fuels Corporation to develop liquid and gas fuel from coal, and into the fast-breeder nuclear reactor. Both failed because of political interference and a collapse in the price of conventional energy. Ignoring those lessons, Mr Obama has pledged $1 billion to FutureGen, a joint government-industry project to generate electricity and hydrogen from coal and sequester the carbon dioxide. Both the federal government and private partners have periodically pulled their support. Because its electricity would be costly, commercial success is far from assured.
One study found that federal energy-research spending became more productive when it switched from large-scale demonstration projects to lots of smaller-scale technologies. Many failed, but the handful that succeeded, such as advanced refrigerator and freezer compressors, generated outsize returns.
Supply-side incentives go only so far. When Rebecca Henderson of Harvard University and Richard Newell of Duke University (now head of the federal Energy Information Administration) reviewed the history of federal innovation policy, they concluded that one of the state’s most effective roles was “stimulating or providing demand”. Simply put, if policymakers get the price signals right, firms and consumers will of their own accord reorient their efforts away from consumption and towards exports and cleaner energy.
Trust the dollar
In exports the most important price signal is the dollar. “The best attainable of industrial policies for sustained development is an undervalued exchange rate,” write Stephen Cohen and Brad DeLong in “The End of Influence”. It is “better, more automatic, less manipulable and less easily distorted by corruption and rent-seeking” than subsidising domestic industries. In this instance they were writing about China and other emerging markets, but the same is broadly true of rich countries.
America explicitly sought to drive the dollar down to help its trade balance in 1985, and again in 1989-90. A repeat is not on the cards. It would risk panic among the foreign investors who still finance much of America’s public debt, and anger trade partners whose own currencies would appreciate, hurting their exports. Nor is the dollar as obviously overvalued as it was in 1985 (see chart 10).
A more benign route to the same destination would be a combination of tight fiscal and loose monetary policy. Standard economic models predict that when interest rates are low and governments borrow less, foreign capital inflows dry up, dragging the exchange rate down and shifting growth from domestic demand to exports. That is how smaller countries such as Canada in the 1990s and Ireland in the 1980s rebalanced their economies.
For America it will be tougher. The private sector remains so weak that an early and sustained attack on the budget deficit could push the economy back into recession. The Federal Reserve at present has little scope to compensate because interest rates are already at zero. Ms Romer of the Council of Economic Advisers notes that whereas in theory tight fiscal and loose monetary policy should get an economy back to full strength, the interest rate needed to achieve that might sometimes be negative, which is beyond the scope of conventional monetary policy. That may be why Japan has been unable to wean itself off government spending. Still, the Fed can play a part, either through unconventional policies, such as bond purchases, or by simply keeping its rate near zero for longer.
In energy the necessary price signal is also obvious: raise the price of carbon. That is Mr Obama’s stated aim, but the prospects for a comprehensive cap-and-trade bill look poor. An alternative would be to raise the tax on petrol. At a stroke, that would narrow the budget deficit, encourage conservation, reduce oil imports, make renewable energy more competitive and reduce carbon emissions. It would not substitute for cap-and-trade, but would leave less work for it to do. Yet it will not happen, because a higher petrol tax is politically even more unacceptable to Mr Obama and Congress than cap-and-trade.
The process of rebalancing America’s economy has begun. Consumers are spending less, borrowing less and driving less. The trade deficit has narrowed and exports are rebounding. Encouraging though all this is, there are still plenty of ways that the rebalancing could be halted.
Not in the bag yet
There are still plenty of things that could go wrong with the recovery
Mar 31st 2010 | From The Economist print edition
AMERICAN consumers showed signs of life in the first quarter, with retail sales and car-buying picking up a bit. But housing is still struggling and consumer spirits remain low. A bit depressing—but proof that the country is learning to live within its means.
Americans will not return to their profligate ways soon. Consumer spending will recover as employment grows, but it will no longer outpace incomes the way it did when credit was easy and home prices bubbly. Many households will not be able to borrow against their homes for years because they have become worth less than the mortgages on them. The torrent of credit-card solicitations flowing through the letter box has slowed to a trickle and millions of Americans are cancelling their credit cards or are having them withdrawn. Regulators who once nodded approvingly as financial companies flogged negative-amortisation and “pick-a-payment” mortgages are now shutting banks weekly and second-guessing the decisions of those that survive.
Higher oil prices are part of this rebalancing process. With a lag, they are changing the behaviour of American firms and consumers. For example, the share of light trucks in total vehicle sales has been falling since 2004. General Motors is winding down its Hummer brand, launched when petrol was less than half today’s price, after a sale to a Chinese company fell through. Pricey petrol has also aggravated foreclosures in the exurbs.
This special report has argued that America’s economy has begun to rebalance away from consumption and debt towards exports and saving. But it is not yet clear whether this transition will bring strong, steady growth and declining unemployment or sluggish growth and stubbornly high unemployment. Much could still go wrong.
Even if Mr Obama’s policies for the recovery were flawlessly crafted, a lot is out of his hands. Heading the list of potential spoilers is the rest of the world. Americans could not have run up so much debt without foreigners lending them the money. The rest of the world has to consume more and rely less on exports to America, or the imbalances could return. “Stopping in midstream is dangerous,” wrote Olivier Blanchard, the IMF’s chief economist, and Gian Maria Milesi-Ferretti last December.
We’d love to help, but…
If a country has suffered a crisis, the normal script for recovery is for the rest of the world to help restore it to health. But what if the rest of the world is unable to do so? This is not a theoretical question. In the fourth quarter of last year only one of the euro area’s four largest economies, France, saw any growth. Were Greece to default, a new crisis would rip through thinly capitalised European banks which hold plenty of debt of the region’s weaker economies.
Emerging economies such as China, India and Brazil are growing faster, yet they, too, could inhibit America’s rebalancing if they rely too heavily on exports instead of domestic demand. Between 1998 and 2007 consumption in emerging markets shrank from 60% to 53% of GDP, according to JPMorgan Chase, and their current accounts swung from deficit to surplus. There is a risk that every country will look to exports to lead its recovery. Clearly that cannot work for all of them.
China has gone some way to reducing its reliance on exports by launching one of the bigger fiscal-stimulus programmes in the G20. As a share of GDP its current-account surplus has shrunk by half between 2007 and 2009. Its fiscal stimulus, however, has mostly boosted investment. A far more effective way to shift China’s growth from exports to consumers would be to let its currency, the yuan, appreciate. But so far its officials are still talking about the benefits of exchange-rate stability.
If the rest of the world does not help America grow, some grim scenarios await, according to Messrs Blanchard and Milesi-Ferretti. The country might try to prop up growth by extending its fiscal stimulus. But that would mean its persistent budget deficits would push up its debt even higher—and perpetuate its dependence on foreign savings. The current-account deficit, having halved to 3% of GDP since 2006, would widen again. Alternatively America might withdraw the stimulus, which could make its economy stall.
Another source of risk is the dollar. Its steady decline since 2002 has played an important role in reducing the deficit, and in theory a relatively slower recovery in American demand should continue to nudge it down. But the dollar often refuses to do as told. During the crisis it rose sharply as borrowers were forced to repay dollar loans. This year feels like a re-run, with investors who doubt the euro’s future flocking to the dollar.
A further question mark hangs over the price of oil. A big increase would pummel consumers and sharply increase the trade deficit, slowing growth and making the imbalances worse. A big drop would help in the short term, but in the longer run it would dissuade consumers from cutting down, sap political support for conservation and alternatives and discourage the industry from looking for more.
Rebalancing may be highly desirable, but that does not mean it is inevitable. It took a long time for America to reach the debt-laden state that brought on the crisis. It will take time, and lots of luck, for it to recover in full.
Sources and acknowledgments
Mar 31st 2010 | From The Economist print edition
Apart from those mentioned in the text, the author would like to extend special thanks for their help to Menzie Chinn, Caroline Freund, Ed Glaeser, Shane Goettle, James Hamilton, Gordon Hanson, Doug Irwin, Larry Katz, Michael Mauboussin, Lesa Mitchell, Richard Rathge, Daniel Yergin, Mark Zandi and Ivy Zelman.
The following books, reports and articles were valuable sources for this special report.
On consumers, leverage and saving
“Talking’ Bout My Generation: The Economic Impact Of Aging U.S. Baby Boomers”. The McKinsey Global Institute, June 2008
“Debt and deleveraging: The global credit bubble and its economic consequences”. The McKinsey Global Institute, January 2010
“U.S. Demographics and Saving: Predictions of Three Saving Models”. By Alan J. Auerbach, Jinyong Cai and Laurence J. Kotlikoff, NBER Working Paper No. 3404, July 1990
“The State of the Nation’s Housing”. The Joint Center for Housing Studies, Harvard University 2009
“After the Crisis: Lower Consumption Growth but Narrower Global Imbalances?” By Ashoka Mody and Franziska Ohnsorge, International Monetary Fund Working Paper No. 10/11, January 2010
“Thrift: A cyclopedia”. By David Blankenhorn, Templeton Foundation Press, 2008
“Animal Spirits”. By George A. Akerlof and Robert J. Shiller, Princeton University Press, 2009
“2010 Economic Report of the President”. White House Council of Economic Advisers, 2010
“Entry, Expansion, and Intensity in the U.S. Export Boom, 1987-1992”. By Andrew Bernard and J. Bradford Jensen, September 2001
“The margins of U.S. trade (long version)”. By Andrew B. Bernard, J. Bradford Jensen, Stephen J. Redding and Peter K. Schott, January 2009
“The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity”. By Marc J. Melitz, published in Econometrica, November 2003
“Special Report: Why Nothing is made in the USA anymore”. In The American Prospect, January/February 2010
“International Trade In Services and Intangibles in the Era of Globalization”. Edited by Marshall Reinsdorf and Matthew J. Slaughter, National Bureau of Economic Research, 2010
“Innovation and Job Creation in a Global Economy: The Case of Apple’s iPod”. By Greg Linden, Jason Dedrick and Kenneth L. Kraemer, Personal Computing Industry Center, UC Irvine, January 2009
“Annual Energy Outlook 2010 Early Release Overview”. US Energy Information Administration, December 2009
“Shale Gas, a Game Changer for U.S. and Global Gas Markets?” By Richard Newell, Administrator, US Energy Information Administration, March 2010
“The Rise of the Sunbelt”. By Edward L. Glaeser and Kristina Tobio, Harvard Institute of Economic Research, April 2007
“Sprawl and Urban Growth”. By Edward L. Glaeser and Matthew E. Kahn, Harvard Institute of Economic Research, May 2003
“‘Fear’ and Offshoring: The Scope and Potential Impact of Imports and Exports of Services”. By J . Bradford Jensen and Lori G. Kletzer, Peterson Institute for International Economics, January 2008
“Changes in Transportation Infrastructure and Commuting Patterns in U.S. Metropolitan Areas, 1960-2000”. By Nathaniel Baum-Snow, January 2010
“How the crash will reshape America”. By Richard Florida, The Atlantic, March 2009
“Steady as She Goes? Three Generations of Students through the Science and Engineering Pipeline”. By B. Lindsay Lowell, Hal Salzman, Hamutal Bernstein, with Everett Henderson, October 2009
“Financial Shocks and Total Factor Productivity Growth”. By Marcello M. Estevão and Tiago Severo, International Monetary Fund Working Paper 10/23, January 2010
“The Economic Future Just Happened”. Dane Stangler, Ewing Marion Kauffman Foundation, June 2009
“The End of Influence: What Happens When Other Countries Have the Money”. By J. Bradford DeLong, Stephen S. Cohen, Basic Books, January 2010
“Accelerating Innovation in Energy: Insights from Multiple Sectors”. Edited by Rebecca Henderson and Richard Newell, National Bureau of Economic Research, Forthcoming
“Global Imbalances: In Midstream?” By Olivier Blanchard and Gian Maria Milesi-Ferretti, International Monetary Fund Staff Position Note 09/29, December 2009