Saturday, October 30, 2010

Economic History: A Last (Last) Answer To Baker

Dean Baker answered again, and there is enough of substance in his long post to warrant a long reply. You don't have to read Baker first to understand my post, but it helps. I suspect we are getting a head start on debating the soul of the Democratic Party over the coming year, as we prepare for 2012.

1. Of course the US government got America out of the Great Depression by spending on WWII. By 1947, the national debt was something over 110 percent of GDP. But the interesting historical question which Baker (relying on Dorothy’s ruby slippers) cheerfully avoids is, What was so unique about the American economy after the war, in the wake of the war, that staggering rates of growth over 20 years could mitigate the potentially harsh effects of accumulated debt?

Why did American GDP grow on average at nearly 4 percent a year from 1946 to 1973 (with many years at 10 percent), and with manageable inflation? Why, then, could the national debt be reduced to about 35 percent of GDP by the early 1970s? Moreover, what were the marginal income tax rates in America that allowed the government to keep spending and still draw down the debt?

The answer is not encouraging to economists who extrapolate from that time to this. After the war, America’s economy was the unrivaled manufacturing and financial powerhouse in the world. Its multi-national corporations dominated markets all over Europe, bought into Japan, etc., and controlled sources of supply in Latin America and the Middle East.

Americans needed one of everything, and novel TV advertizing ginned up demand; American mass production factories put barely skilled workers to work, while factories across the developed world were only beginning to learn from them—and, eventually, better the instruction. (Go back and read Jean-Jacques Servan-Schreiber’s 1967 book The American Challenge to get the French take on this hegemony.)

Inflation—which was about 6 percent in the 1940s—was kept below 3 percent during the 1950s and 60s, though the US government spent greatly on (comparatively unproductive things like) defense and (very productive things like) the GI Bill and the highway system. That’s because the US dollar was the world’s only reserve currency. The worldwide demand for dollars greatly restrained inflation. Besides, marginal tax rates on wealth were at 90 percent, so the government could recoup much more quickly.

So I’ll make Baker a deal. If he can show me that Japanese, Chinese, and European global corporations will exit the competitive landscape, that the American economy will grow at, on average, 4 percent a year for the next twenty years, that the euro will stop being an increasingly attractive alternative to the dollar as a reserve currency, and the Congress will reinstate 90 percent marginal rates on wealth—oh, and also that entitlement programs (Medicare especially) will not be in crisis owing to us aging boomers—I will concede that Obama blew it. All he ever had to do was tap his heels together and say, “There is no policy like spending.”

Then again, I suspect Baker would concede that many unfortunate countries spent their way out of, or spent to preempt, depressions, and then failed to grow anywhere near fast enough to pay for the privilege. The Begin government spent wildly in 1981 and Israel had 400 percent inflation by 1984.

Look, I am not saying the American economy today is what Israel's was then. Actually, I have high hopes for American electric vehicle technology, smart grid entrepreneurship, new media platforms, and other emerging sectors that should do for economic growth in the next decade what computers, telecom, and the internet did in the 1980s and 90s. I think the sheer gains in productivity from smart networks will help us. But these are not businesses that will employ nearly as many low skilled people as the factories of 1955 did. (I’ll come back to this.)

And the bigger logic is clear: at some point governments, like businesses, have to ask, am I really going to create more value than I am using up in the effort to create it? Am I eating my seed corn? America cannot live with the global competition of 2010 and think with patterns and numbers extrapolated from the 1950s--no more than it can predict the length of recessions today as if we were still back in the 1930s, when business plans got to investors by surface mail and telegrams, and you learned about the rest of the world with short wave radios.

2. Baker, sincerely perhaps, is distorting what I mean by stimulus needing to stimulate "trillions more" in private investment. My point is not about new spending in “physical investment in equipment and software.” It is, surely, that private sector investment capital dwarfs anything the American government can spend. The private sector still employs 8-9 times more people than the public. Almost all net new jobs over the past decade have been in entrepreneurial businesses.

So it matters what managers, entrepreneurs, fund managers, in America and around the world, think the American economy is going to look like in the next three to five years. They won't just be looking at how many people are going shopping this month. They will also be thinking about whether they are in sustainable jobs; about Americans as producers, not just as consumers. (If you are not producing today, will you be consuming tomorrow?)

3. Finally, and most important, perhaps, Baker is just missing my point about globalization. The problem is not simply the current rate at which foreigners buy American debt, but how long they will if they are not also buying American products at a corresponding rate. Baker thinks, oh, fine, let them stop lending, and let the dollar plummet. That will only boost exports; then they will buy our products. Well, this is true to some degree, but to what degree relevant to this discussion? Will a lowered dollar produce a competitive advantage that will mitigate the advantage of unskilled people working for one fifth of an American wage?

The question, remember is employment, not just growth. Jobless recoveries have been plaguing us since 2001. And the falling dollar will not produce anything like the kind of employment in manufacturing industries that mirrors what we saw in the 1950s and 60s? Baker says, well, Germany is a net exporter of manufactured goods, in spite of its high wages, as if this pertains to the discussion at all. He might have said Germany has been a net exporter of manufactured goods in spite of the comparatively high euro, but then he would be undermining his point, which is that devalued currency is cause and manufactured export is effect.

An economist who talks about things in such mechanistic ways is about as much help to us as a weatherman is to a farmer, or a sound engineer to a musician. Anybody who knows anything about manufacturing supply chains knows that a marginal swing in the value of the dollar will not boost exports in high labor components. Forgive the pedantry, but getting to know the business reality requires some time.

THE CHEVY VOLT, for example, will be "made" in Michigan, where it was designed, but when you increase the magnification, you see an integration of disparate components—battery pack, chassis, electronics, engine, suspension parts, etc.—each of which has a cost structure at the point of assembly that will determine where it can be made. Tax breaks, currency, etc., for component plants are a part of this puzzle but other considerations are much more important:

First, how "mature" is the component, that is, have its own sub-assemblies been integrated into a "solid state" design? (ABS brakes, for example, used to be two systems mounted on the rotors, but now they are one; how long before the additional system capturing braking energy in hybrid and electric cars will be integrated, too?) Second, how robotized are the process technologies producing the components? (People make much of "total quality" methods, pioneered in Japan, which inspired line workers to help management break conversion processes down to routine and mathematically monitored movements; actually, total quality paved the way for increasingly capable robots to replace those very workers.)

Third, how many of the same kind of component are needed for how many vehicle programs? (The more you need, the more a supplier can invest in economies of scale, automation, and so forth.) Fourth, how defensible is the intellectual property underlying a component's production? (Prototypes for very innovative components are almost always made in-house and supplied by carefully chosen partner-suppliers, no matter where they are.) Fifth, how difficult is the component to ship?

It is only now that the cost of "labor," the value of the currency, etc, in the cost structure can be seen in its proper context. A mature component, much in demand, and having no particularly innovative technology, will be mass produced in a way that requires comparatively little labor. It can be built anywhere local skill guarantees that quality standards in the plant will be met. Yes, the currency will matter, too, as will the question of unions helping or hindering production, the local costs of construction (do you need clean rooms?), and so forth. But these kinds of plants can be located anywhere near customers and they do not produce a great number of jobs.

One of the Volt's most mature components, for example, is its 1.4 liter gas engine, also used in many Opel models. It is made up of sub-assemblies now almost entirely produced by experienced suppliers whose smart machine tools and robots produce near perfect quality for whole families vehicles. The engine itself is assembled in highly automated lines, with no more than perhaps 10 per cent labor, mostly skilled technicians, in the cost structure. It is currently made in Austria, where wages are very high and quality engineering can be taken for granted. Baker's idea that Germany pays high wages and still exports is right. But he misses this point entirely: that the goods Germany exports are highly engineered, with highly skilled workers, and in production systems where the proportion of labor is small.

Then again, engines are big and heavy and expensive to ship. So Volt's production team is moving the engine's line to Flint in anticipation of the Volt hitting the mainstream market. Michael Moore will find this move satisfying, I suppose, but virtually no unskilled workers will be employed in the plant's assembly operations. What you'll need are people who can manage the robotics and flawlessly log quality data. When you consider that 14 percent of Americans are functionally illiterate, and how much higher this number is in Michigan, it is hard to see how Flint's piece of the 10 percent unemployment rate will be solved by "manufacturing"--though some of it will be solved by low-wage restaurant, hotel and custodian jobs adjacent to the plant. (McKinsey reports that most of the new employment in the 2000s were "service businesses" of this kind.)

In contrast, plastic and wire electronic harnesses on engines—also those new-fangled harnesses leading from the battery pack—require a much greater proportion of labor in the cost structure. Even mature harnesses are hard to manipulate and easy to ship. (Think clothing.) The proportion of labor in the assembly of harnesses—and in constantly changing electronic components more generally—will almost certainly remain double or even triple that of the engines. So we can forget about production of such electronic components leaving Mexico or the Far East, at least so long as UPS operates there efficiently.

IT IS COMFORTING, no doubt, for progressive Democrats to think that all we ever needed was a massive stimulus, that then there would be smooth sailing; that deficits don’t matter that much, that if the debt does not come down it only means manufacturing will be boosted (and unskilled workers will get jobs), that the problem of employment in America is simply a matter of boosting consumption—and that to think otherwise means either you are in the pocket of Goldman Sachs or gullible enough to believe their propaganda. Many of the comments I’ve read about my posts reflect this view.

I trust that Obama will continue to be skeptical of it, though he will keep droppin' his g's when he talks about endin' tax breaks for companies sendin' jobs overseas; skeptical even though Larry Summers has returned to Cambridge. That the president will continue to focus on the future and its productive foundations: investments in green mobility, greener infrastructure, investments in education, health care delivery and cost containment, immigration reform, technical standards for critical information platforms, and fiscal discipline.

Baker, no doubt, would be willing to accommodate the last thing if the other things could be advanced. But will they if we keep painting Obama the way Ted Kennedy painted Jimmy Carter, a stealth conservative who doesn't care about jobs and doesn't know what he's doing?