Hooray for the Income Approach!?

The total value of a country's economic activity in a given time period - its Gross Domestic Product - can be calculated in a number of ways.  The most common is the "expenditure" approach, which involves adding up the purchases of new final goods and services ('new' to avoid wrongly counting re-sales of previously produced goods and 'final' to avoid double-counting input goods, like the glass in a car).  These purchases fall into three broad categories, consumption (C), government purchases (G) and investment (I).  Adding those up and accounting for net exports (NX; exports - imports) gives the familiar relation GDP = C+I+G+NX.

When I teach macroeconomics, I also go over the "income" approach, which calculates GDP based on all the incomes generated for the people who supply the resources used to produce goods and services (the "factors of production", primarily capital and labor).  I don't think the students particularly like this part of the class (and many instructors skip it), because its a bit trickier to do it that way.  I persist with it because I believe there's a valuable point, which is to show how income comes from the act of producing stuff, and to show how that income is distributed among the suppliers of various factors.

There may be another reason why its valuable - some have argued that income-based measures are more accurate in the short run (in principle, they should be the same, but, in practice the data is reported with a "statistical discrepancy" to reconcile them).  Moreover, the latest BEA release suggests that GDP growth is looking somewhat less anemic by the income approach.  Binyamin Applebaum at Economix explains:

There is a pleasant surprise in the latest batch of economic data released Thursday by the Bureau of Economic Analysis. Buried deep inside the government’s revised estimate of fourth-quarter growth (revised but unchanged at 3 percent annualized) is an alternate measure of economic activity that is winning increased attention. And by that alternate measure, gross domestic income, the annualized pace of growth in the final three months of 2011 actually climbed to 4.4 percent.

That’s the kind of growth we usually see during an economic recovery, the kind of growth that’s fast enough to create new jobs. Indeed, it suggests that we may have learned the answer to a fretful mystery. Until now, economists have struggled to explain why unemployment was falling so fast when the major measure of growth, gross domestic product, was rising at an exceedingly modest pace.

Appelbaum explained more in this article last year.  See also: Calculated Risk. However, Dean Baker disputes. 

Comparative Labor Laws Fact of the Day

The NY Times' Keith Bradhser reports:

When China imposed its current laws limiting overtime four years ago, the regulations set off considerable complaints from workers and companies alike. There is a limit of three hours a day of overtime and six days of work a week. 

“The law is very restrictive about what it allows,” a foreign businessman in southeastern China said Friday. He insisted on anonymity lest his comments be construed as criticism of the government or of labor advocates. Labor laws in the United States are actually less restrictive, in some ways, in allowing workers to put in even longer hours than in China. Generally speaking, as long as American workers receive time and a half pay for anything over 40 hours a week, there are no limits on total hours. 

China officially bans workers and factories from arranging longer hours even by mutual consent, for fear that employers will put inappropriate pressure on workers to put in extremely long hours. 

So, how long before we see Chinese activists boycotting goods made under "inhumane" working conditions in America??

Rebalancing Watch, China Edition

We'll be discussing the US-China trade imbalance in Econ 270 next week.  This played a prominent role in worries about "global imbalances" that were prevalent several years ago.  The concerns linger, but both the US current account deficit and China's surplus have come down significantly over the past several years. 

I discussed the US current account in a recent post.  China recently reported a trade deficit (!).  That was a bit of a fluke, according to The Economist:

China’s trade balance often dips around Chinese New Year, as export factories close for the festival. The holiday also arrived earlier this year than last, distorting the data. But even if the figures for January and February are added together, China ran a deficit of over $4 billion. Exports and imports typically rebound in sync as China gets back to work. This year, imports rebounded alone.

But the broader trend is for a significantly sinking surplus. Jeff Frankel attributes this to real appreciation:

[T]he yuan was finally allowed to appreciate against the dollar during 2005-08 and 2010-11, by 25% cumulatively [=17% + 8%]. Second, and more importantly, labor shortages began to appear and Chinese workers at last began to win rapid wage increases. Major cities raised their minimum wages sharply over each of the last three years [FT, Jan. 5]: 22% on average in 2010 and 2011 (somewhat less this year, in response to slowing demand: 8.6 % in Beijing, 13% in Shenzhen and Shanghai). Meanwhile another cost of business, land prices, rose even more rapidly.

As a result, whereas all signs still pointed to a substantially undervalued yuan as recently as four or five years ago, this is no longer the case. One important measure of undervaluation — a comparison of China’s prices with what is normal given the country’s level of income (the so-called Balassa-Samuelson relationship) — showed the renminbi as undervalued against the dollar by as much as 36% on 2000 data (Frankel, 2005) . Even after an improvement in the international price data, Balassa-Samuelson regressions estimated the undervaluation at roughly 30% in 2005 and 25% as recently as 2009. (Others had other ways of estimating undervaluation; see Goldstein, 2004, and those surveyed by Cline and Williamson, 2008.)

The renminbi’s real appreciation against the dollar over the last three years has amounted to 12%, reducing the degree of undervaluation by roughly half, depending on whether one measures it against the dollar or against all countries. More is to be expected, as Chinese relative wages continue to rise. In any case, China’s real exchange rate is already closer to this measure of equilibrium than are most countries’ exchange rates (Cheung, Chinn and Fuji, 2010).

However, Michael Pettis argues that China is trading external imbalances for internal ones (and trouble down the road...):

So is China rebalancing?  Of course not.  Rebalancing would require that the domestic consumption share of GDP rise.  Is the consumption share of GDP rising?  Clearly not.  If consumption had increased its share of GDP since the onset of the crisis, the savings share of GDP would be declining.

And yet savings continue to rise.  This is the opposite of rebalancing, and it should not come as a surprise.  Beijing is trying to increase the consumption share of GDP by subsidizing certain types of household consumption (white goods, cars), but since the subsidies are paid for indirectly by the household sector, the net effect is to take away with one hand what it offers with the other.  This is no way to increase consumption.

Meanwhile investment continues to grow and, with it, debt continues to grow, and since the only way to manage all this debt is to continue repressing interest rates at the expense of household depositors, households have to increase their savings rates to make up the difference.  So national savings continue to rise.

That sounds like trouble, though this Economist article noted that there are some reasons to believe that estimates of Chinese consumption might be understated:

China’s official statistics show private consumption growing less quickly than the economy as a whole from 2001 to 2010. But they also show retail sales growing faster than GDP from 2008 to 2010. The discrepancy is partly because China’s retail-sales figures include some things they should not (such as government purchases and sales of chemicals and other wholesale goods), and miss out other things (like health care and other services), that are a big part of consumer spending. But several economists also believe the official figures understate private consumption.

To derive an alternative measure, Yiping Huang and his colleagues at Barclays Capital, an investment bank, have tried to pick out those retail sales that are likely to reflect consumer purchases. He has combined those purchases with sales figures for service firms. By this alternative measure, consumption fell as a share of GDP until 2008, but started growing strongly thereafter. “Rebalancing of the Chinese economy has already started,” the Barclays economists conclude.

No, Greg Mankiw, We're Not, and You Know It

On his blog, Greg Mankiw provides his readers a rather deceptive bit of information:

The reason that is misleading is explained further down in the very same yahoo finance article he links to:

But despite the headline number, the statutory rate only tells part of the story.

Loopholes and other special treatment for different kinds of businesses mean that businesses pay an effective rate of only 29.2% of their income, which puts the United States below the average of 31.9% among other major economies, according to analysis by the Treasury Department.

And the Organization for Economic Cooperation and Development, the multinational group that tracks global economic growth, estimates the United States collects less corporate tax relative to the overall economy than almost any other country in the world.

I know Greg Mankiw knows that.  The headline marginal tax rates do matter, because they effect incentives, but his selective quote creates the false impression that the US corporations face an unusually large tax burden, when, by many measures, the effective corporate tax rate in the US is relatively low.

Here's another way to slice it - the share of corporate "operating surplus" paid in taxes - calculated by the US Treasury, via this CBPP report:

Yes, that's a few years old and many countries have been lowering corporate taxes, but I doubt its changed that much.  Corporate taxes are indeed a mess, though, and tricky to measure; this NY Times story is informative about some of the issues.

I'm a fan of much of Greg Mankiw's work and responsible for quite a few sales of his Intermediate Macroeconomics textbook.  I know he knows better - and would probably do an excellent job if he attempted an honest explanation of the issues associated with the US corporate tax code, and how it compares internationally.  Sigh.

Summers for State-Contingent Macro Policy

In the Washington Post, Lawrence Summers writes:

How then to respond to valid concerns about fiscal sustainability, excessive credit creation and the eventual return to normality in a world where policy credibility is essential? The right approach is policies that commit to normalizing conditions but only when certain thresholds are crossed. The Federal Reserve might commit to maintain the current Fed funds rate until some threshold with respect to unemployment or expected inflation is crossed. Commitments to fund infrastructure over many years might include a financing mechanism such as a gasoline tax that would be triggered when some level of employment or output growth has been achieved. Tax reform could phase in new rates in pace with the rising economic performance.

Contingent commitments have the virtue of providing clarity to households and businesses as to how policy will play out, and in areas where legislation is necessary, eliminating political uncertainty. They allow policymakers to project a simultaneous commitment to near-term expansion and medium-term prudence — exactly what we require right now.

Like I said back in April 2011, my idea of how I wished the ARRA (the "stimulus bill" at the beginning of the Obama administration) had been different would have been for it to be "state contingent" because it was clear by then that the downturn was deeper and longer-lasting than policymakers understood when they designed the policy.  As I noted here, Peter Orzag has also been arguing the same point.  Of course Orzag and Summers would have been in a position to do something about it had this occurred to them in 2009.

In this earlier post, I argued state-contingent policies could potentially address some of John Taylor's objections to fiscal policy.  Chicago Fed President Charles Evans has been advocating state-contingent monetary policy.

US Borrows PI from the Rest of the World

A little PI day gift from the BEA, which released a preliminary estimate showing that US Current Account deficit as a share of GDP fell slightly last year, to 3.14%.  That's down a bit from 3.24% in 2010 (the actual deficit grew, but GDP grew more), and well off its peak of 5.98% in 2006.

The current account deficit is smaller than the trade deficit, which was 3.82% of GDP, reflecting the fact that the US receives more payments from foreign assets than it sends out.  This is true even though the value of US foreign assets is less than foreign-held assets in the US, because the US gets higher returns on its foreign investment than foreigners get on their investments here.  That doesn't mean the US is a lousy place to invest - it reflects the mix of assets held.  A large part of foreign-owned assets are low-yielding US treasury bonds, while US investment abroad tends to be more weighted towards higher-return (but riskier) equity investment.

The current account deficit represents how much the US is borrowing from the rest of the rest of the world. Roughly speaking, the part of our imports that aren't covered by exports or net income from foreign assets are paid for by selling I.O.U.'s (financial assets like stocks and bonds).

In 2005-06 there was a great deal of hand-wringing about the ballooning deficit and worry about how much longer the rest of the world would be willing to lend to the US.  While it hasn't gotten much attention, amidst all the hysteria about debt, it is noteworthy that the US is now considerably less dependent on borrowing from the rest of the world than it was 6 years ago. 

Although the annual numbers suggest the US current account deficit may be stabilizing at a lower level, there are some worrying signs in the quarterly data.  In the fourth quarter, exports fell slightly and the balance on income decreased.  The widening trade deficit continued in more recent monthly data. This is where we may see the impact of rising oil prices (petroleum products account for over 40% of the US trade deficit) and the slump in Europe - not only is European demand not growing, the crisis is probably depressing the value of the Euro, which makes European exports cheaper relative to US goods.  In the actual fourth quarter data, exports to Europe increased slightly, but it is something to watch going forward.

On a related note, NPR recently ran a story on "reshoring" of manufacturing to the US.

Trade, Redistribution, Fairness and Rhetoric

Dani Rodrik has long been a useful critic of economists' rhetoric about international trade.  In a Project Syndicate column, he raises two issues: redistributive effects and procedural fairness. 

The issue of redistribution arises from the Stolper-Samuelson theorem, which is an implication of the basic, workhorse "neoclassical" trade model.  This theory is about changes in "factor prices" - it says that trade leads to gains to the suppliers of resources that are used in higher proportions to produce a country's exports, and losses to those who have the resources demanded more by the import-competing industry.  For example, the US is a net exporter of higher education services and importer of cars, and the theory would predict that college professors would gain, while autoworkers would be hurt by trade (the theory also is very clear that the overall gains outweigh the costs).  As Rodrik put it to a group of Harvard students:

I began the class by asking students whether they would approve of my carrying out a particular magic experiment. I picked two volunteers, Nicholas and John, and told them that I was capable of making $200 disappear from Nicholas’s bank account – poof! – while adding $300 to John’s.  This feat of social engineering would leave the class as a whole better off by $100. Would they allow me to carry out this magic trick?

Those who voted affirmatively were only a tiny minority. Many were uncertain. Even more opposed the change.

Clearly the students were uncomfortable about condoning a significant redistribution of income, even if the economic pie grew as a result. 

The second issue Rodrik raises, "procedural fairness," is less familiar to economists.  He writes:

To pass judgment on redistributive outcomes, we need to know about the circumstances that cause them. We do not begrudge Bill Gates or Warren Buffett their billions, even if some of their rivals have suffered along the way, presumably because they and their competitors operate according to the same ground rules and face pretty much the same opportunities and obstacles.

We would think differently if Gates and Buffett had enriched themselves not through perspiration and inspiration, but by cheating, breaking labor laws, ravaging the environment, or taking advantage of government subsidies abroad. If we do not condone redistribution that violates widely shared moral codes at home, why should we accept it just because it involves transactions across political borders?

I've come to agree with Rodrik that economists sometimes take a too-simplistic view of trade.  In part, I think this is because we feel the need to emphasize the benefits, because we understand them, and the public often seems not to - as evidenced by the mercantilist rhetoric of politicians who emphasize beating out other countries for jobs and exports, rather than mutual gains and the welfare benefits of less expensive imports. 

The idea of comparative advantage is a subtle point that is hard for people to get their heads around.  It is one very valuable thing that people take away from an introductory economics class - and for many economists who don't specialize in trade, may be the one idea they hold in their minds about trade.  Since I've had to learn more about trade theory to teach it (I'm an "international economist," but my specialization is on the macroeconomic side of it, while trade theory is a branch of microeconomics), I've learned alot of very interesting things that most non-specialist economists probably aren't aware of that put caveats on the case for "free trade".

Rodrik concludes:

Too many economists are tone-deaf to such distinctions. They are prone to attribute concerns about globalization to crass protectionist motives or ignorance, even when there are genuine ethical issues at stake. By ignoring the fact that international trade sometimes – certainly not always – involves redistributive outcomes that we would consider problematic at home, they fail to engage the public debate properly. They also miss the opportunity to mount a more robust defense of trade when ethical concerns are less warranted.

While globalization occasionally raises difficult questions about the legitimacy of its redistributive effects, we should not respond automatically by restricting trade. There are many difficult trade-offs to consider, including the consequences for others around the world who may be made significantly poorer than those hurt at home.

There's an irony here, since, in general, economists are people who relish thinking about difficult trade-offs.  Indeed, thinking about them is arguably our comparative advantage.