Picture of the Day: Growth Private and Public

Via The New York Times' Economix blog, this graph comparing private sector growth and public sector growth:

Quarterly change at seasonally adjusted annual rate.
Source: NYTimes. Data source: Bureau of Economic Analysis

You can have your own correlation and causation debate here: shrinking government  returned the private sector to growth or held overall growth down hurting the private sector.  I am in the latter camp: in a time of recession the severe austerity imposed at the state and local levels have had a big role in suppressing growth.

Update: Here is Krugman posting on the same thing.

Recovery?

Yet another sign today that the US may be on the road to recovery: the US grew at an annualized rate of 2.8% last quarter.  This is good news considering where we have been these last few years, but not good enough to may anyone feel good about the staying power of such a trend.  And the trend itself isn't good enough: at a 2.8% rate we'll be lucky to keep up with jab market growth - so we won't be making any real progress on unemployment.  But if this presages a more robust recovery, and if Europe doesn't slide into serious recession and drag us down with it, then it is good news.

As you can tell, all of the qualifiers are the problem.  But it is much better to be fretting over whether this positive momentum can be maintained and accelerated than wondering when the economy will hit bottom. Unlike recovery of years past, this does not look like one that will have a sharp and rapid recovery.  Just about everyone, myself included, think it is going to take a very long time.

One interesting aspect of the current growth is that businesses have become a little more bullish on the future, building up inventories, but consumers are not keeping pace.  There is a concern that unless consumers jump back into the market, the whole thing will sputter.  From The New York Times:

Growth in the fourth quarter ... was driven mostly by companies rebuilding their stockroom inventories, and not by consumers who were shopping more or foreign businesses buying more American-made products. And companies are likely to have only so much appetite for refilling their backroom shelves if consumers are still unwilling to buy those products.

Consumer spending rose at an annual pace of 2 percent, slightly better than the 1.7 percent in the previous quarter, Friday’s report showed. But based on early data, it looks as if consumer spending deteriorated toward the end of the year. This may be because of unseasonably warm December weather, which probably lowered families’ household electricity and gas bills, said Jay Feldman, an economist at Credit Suisse.

But the investment in inventories should help incomes and employment which, in turn, should help spur more consumption - so there is reason for some optimism there. And there is evidence that both orders for durable goods are up, and that credit for small business is easing, as the general level of confidence in the recovery grows. But then there is the old bugaboo of sharp cuts in government spending:

One of the biggest drags on growth in the last quarter was government spending cuts at the federal, state and local levels, according to the Commerce Department report. National defense spending fell a whopping 12.5 percent, for example, an unusually large dip that economists do not expect to see repeated in the beginning of 2012. Strapped state and local governments are likely to continue cutting back in 2012, as they have done nearly every quarter for the last several years.

So as long as state and local governments are still cutting and Europe is still dealing with a potentially debilitating crisis, we are unlikely to see really strong growth. I guess we'll have to be satisfied with what we can get in the interim.

IMF Predicts Recession in Europe This Year Will Slow Global Recovery

Trouble for the world economy. The IMF has lowered its global growth prediction to account for continuing weakness in Europe. They now predict that Europe will return to recession this year and that this contraction will put the brakes on world economic growth:

The IMF chopped its 2012 forecast for global growth to 3.3 percent from 4 percent just three months ago, saying the outlook had deteriorated in most regions. It projected world growth would strengthen to 3.9 percent in 2013.

The Washington-based lender said economic activity was decelerating but not collapsing. However, it warned that global growth would come in about 2 percentage points below its already soft forecast if European leaders allowed the crisis to fester.

For the first time since the debt turmoil erupted two years ago, the IMF said the 17-nation euro zone would likely slip into a mild recession in 2012, with output contracting by about 0.5 percent.

I am now guardedly optimistic about the US recovery - I have no illusions of robust growth but I think we have started the long slow climb out of the humongous hole we have dug - but the persistent headwinds blowing across the Atlantic will slow us down further and headway will be hard to make.

Interestingly, the IMF also cautions countries that are pursuing austerity measures to do so with moderation:

[The IMF] also called on governments to avoid imposing drastic spending cuts on already sickly economies. Fiscal tightening is necessary to correct the hefty debt burden left from the boom years, the IMF said, but it, "should ideally occur at a pace that supports adequate growth in output and employment".

"Countries with enough fiscal space, including some in the euro area, should reconsider the pace of near-term adjustment," it added, in a suggestion that will be widely viewed as aimed at Germany, which is pressing ahead with austerity measures despite its healthy budget position.

Economics of Growth and Location

Jack Roberts has a rather odd op-ed in The Oregonian today. I suppose I found it odd because it was about two economists written by a non-economist, but more so because it seemed to try and carve out a gulf where one doesn't really exist.

It was trying, I think, to make the distinction about how activist governments can be to try and create economic activity around a central theme. Roberts singled out Joe Cortright for his support of the 'creative class' idea that robust economies need creative individuals to drive and support them. I am skeptical of this notion but I doubt Cortright himself really pushes the link with economic growth that far. He may work closely with governments who, by their nature, like to do things - especially clearly identifiable things to 'drive economic growth,' but he is no yes man. He was a very public critic of the idea that Portland could successfully create a bio-tech sector, for example.

On the other had, Tim Duy I doubt very much would deny the existence of agglomeration externalities - what economists call the benefit like people and businesses get from locating close to each other. One only has to look at Silicon Valley to see how important these are. I think he is a pretty typical economist, however, in his skepticism of the ability to engineer the existence of such hubs of economic activity, as I am.

In the end we don't really get much out of this piece except for some vague statement about land availability and infrastructure from Duy. This surprises me as good empirical evidence about things like restrictive policies on land development and growth does not exist as far as I am aware and theoretically you can make the case either way. Infrastructure is important but the state of the state's infrastructure is far better than the public education system which has a much stronger empirical link to economic growth.

And by the way, the evidence against focusing on making Portland livable is a comparison of average wages? You have to be kidding. This is an equilibrium outcome that is affected by: peoples choices about where to live, how much to work and what kind of work to do; firms decisions about where to locate, how much they have to pay to attract qualified people (which is negatively correlated with livability by the way - it is called the compensating wage differential); and the overall level of human capital, physical capital and technology in the state - how productive we are. This is not evidence of a poor business climate, full stop.

The lesson I take from all of this is - hey guess what? - human capital. The extent to which we have to import high productivity people is an impediment to economic growth, to the ability to create agglomeration externalities, and to the business climate in Oregon in general.

So the answer to why Portland gets to be green but Seattle gets to be green and wealthy is long and complicated but probably has a lot to do with human capital. According to a quick check of some figures from 2007: Washington spends about $6,700 per student in higher ed, while Oregon spends $4,600. Not surprisingly, out net tuition is almost twice as high at $4,300 versus $2,200 for Washington. Is it any wonder our average wages are lower?

Economist's Notebook: Economic Growth - Explained

Sometimes deep economic insight pops up in unexpected places. Over the weekend my oven decided to put on a spectacular show as the main heating element fried, sparked and smoked (and in so doing, spooked the wife). So, with a batch of clay ornaments waiting to be baked, I high-tailed it over to Ankeny Hardware. A great place I had never noticed before (it is between 11th and 12th on SE Stark), Mosee had the parts and the advice I needed and in no time we were baking away again.

But before that happened I had a good time chatting with the owner of the part store/hardware store. He told me about the history of the place and his business model ('It works, I try not to think about it too much'). But then he began to tell me about his philanthropic activities and said this (and I am paraphrasing from memory): "We give 10% of our profits to charity, mostly kids charities because they are going to be paying into Social Security, and I am going to need Social Security, so we better get 'em educated."

I was startled for two reasons: one, this is essentially the topic of my most recent research project; and two, this is a pretty keen insight. Educated people are more productive people and more productive people earn more and thus contribute more into Social Security, so if we fail to invest at the front end, we are going to suffer later. Maybe I should add him as a co-author.

This is, of course, a pretty good example of economic growth in general: it takes abstinence from consumption in order to invest, and it takes investment in order to increase productivity and to grow.

Oregon's New Taxes and Economic Growth

The anti-tax forces are coming out full force to try and defeat the legislature's new taxes. I don't like what the legislature did - squandering perhaps the best opportunity to enact wholesale tax reform in favor of some band-aid, narrowly targeted new taxes - but I support them nonetheless as I believe the reality of deep cuts (in K-12 education particularly) would have been much worse for the future of the state.

There is no doubt that taxes are distortionary and create dis-incentives: in this case dis-incentives to start and invest in businesses and to locate and work in the state. Income taxes are particularly sensitive in this case, as Oregon already has some of the highest in that nation. By being an outlier, Oregon stands to loose out on skilled and entrepreneurial people who choose where to live (an argument for the diversification of revenue streams). Randall Podenza makes a good case against the taxes by emphasizing the dis-incentives that they create. Though I have some quibbles, particularly in looking at developing countries and their corporate tax rates and levels of investment - this is apples to oranges, and studies that show that taxes are distortionary are not particularly novel or helpful. The key is the cost of the distortion v. the cost of inaction in the face of a revenue crisis.

This is what is missing from this analysis: we understand the potential costs of the taxes, but what of the benefits (or perhaps more accurately - what of the costs of not adequately funding state services, particularly education)?

The rhetoric of the anti-tax types is now rising to absurd levels. Take, for example, today's op-ed in the Oregonian by Robert Millen, in which Mr. Millen paints a gloom-and-doom scenario: a little extra tax burden on top income earners will cause them to flee the state and destroy Oregon's economy! Please.

Millen states: "Recent studies indicate that this has occurred in the high-tax states of New York, Connecticut and New Jersey, all of which have experienced a net loss of high-income earners and the jobs their businesses generate." Which is a rehash of one of the most spurious arguments being employed, that since states in which raised marginal tax rates on high-income earners saw the number of millionaires decrease proves that the rich flee in droves to avoid taxes.

The problem with this is the fact that we are in the midst of the worst economic downturn since the great depression. There is a very good reason that there has been a net loss of high income earners especially, in this case, in the vicinity of Wall Street.

Millen goes on to state: "When our government raises taxes on the rich, their income tends to decline. For example, the last time the top rate was 50 percent, in 1986, the top 1 percent of income earners paid about 25 percent of all income taxes." This is not a statement about absolute incomes as he asserts, but of relative incomes, and of course the tax system is an integral part of relative income distribution. S0 the causal link is nowhere to be found - income inequality in the US has been increasing (why is a matter of some debate but a big factor has been the returns to higher education) so this statistic is completely irrelevant to the current discussion of marginal income taxes.

So what of a real cost-benefit analysis? Well, research on the effects of marginal income tax rates and growth in the US is minimal and flawed in general, due to the practical challenges of overcoming confounding factors that prevent the uncovering of a true causal link. For example, are high-tax, low-growth states low-growth because of high taxes or high-tax because of low-growth?

Nevertheless, I'll leave you with one (admittedly dated) study of the costs and benefits of taxes:

“The Effect of State and Local Taxes on Economic Growth: A Time Series--Cross Section Approach.” L. Jay Helms The Review of Economics and Statistics, Vol. 67, No. 4. (Nov., 1985), pp. 574-582.

Abstract

“Results based on pooled time series and cross section data are presented, which indicate that state and local tax increases significantly retard economic growth when the revenue is used to fund transfer payments. However, when the revenue is used instead to finance improved public services(such as education, highways, and public health and safety) the favorable impact on location and production decisions provided by the enhanced services may more than counter balance the disincentive effects of the associated taxes. These findings underscore the importance of considering the incentives provided by a state's expenditures as well as by its taxes.”

Emphasis mine. The point is that the new higher corporate and high-income taxes are costs to businesses and entrepreneurs, if they are spent well, the also create benefits to the same. In addition, those investments in the health, education and infrastructure of the state are vital to long-term growth and prosperity.

So, though I would have preferred for the legislature to have set about trying for wholesale reform of the state tax system, repealing the tax increases, flawed as they are, would be a mistake in my opinion. Hopefully in the future, the state can address its revenue system in comprehensive manner, until then, we cannot dis-invest in the future of the state and its children.