FRB Dallas: Good News and Bad News on the Economic Outlook

Evan Koenig of the Dallas Fed compares today's economy with the economy in 2000-01 and finds reasons to be both optimistic and pessimistic about the economic outlook:

Vive la Différence, National Economic Update, by Evan F. Koenig, FRB Dallas: There are several disturbing similarities between the U.S. economy's recent behavior and its behavior in 2000–01, but also some reassuring differences.

One similarity is the drag on growth coming from investment. Chart 1 shows the combined contribution to annualized GDP (gross domestic product) growth from residential and business equipment and software investment, measured in percentage points. Note that in 2005–06, just as in 2000–01, this contribution dropped from a positive 1 percentage point to a negative 1 percentage point.

Back in 2000–01, of course, most of the decline was due to a collapse of equipment and software investment. This time around, the housing sector has been feeling most of the pain.

Despite nearly equal drags from investment, GDP growth slowed by 4 percentage points in 2000–01, versus only 2 percentage points in 2005–06.

Chart 2 shows the source of the difference: consumption growth. In 2000–01, consumption spending’s contribution to GDP growth fell by about 2 percentage points. Over the past couple of years, in contrast, consumption’s growth contribution has held comparatively steady.

Chart 3 slices the data differently: It compares monthly nonfarm payroll job gains in the goods-producing and service-providing sectors. It is striking that while goods-producing job growth has slowed by about as much as it did in 2000, service-providing job growth has held up much better than it did in the lead-up to the 2001 recession.

Neither residential investment nor goods-producing job growth seems likely to improve anytime soon.

In the residential sector, the 30-percent plunge in building permits and decelerating new-home prices we’ve seen since the fall of 2005 are an ill omen for future investment and job growth (Chart 4). Consistent with this glum near-term outlook, new-home sales resumed their slide in January, after an upward spike in December. Sales are now down 31.5 percent from their July 2005 cyclical high. Residential construction and associated specialty-trade jobs account for about 15 percent of employment in the goods-producing sector.

Recent data on new orders for durable manufactured goods give a similarly discouraging view of near-term prospects for investment and factory job growth (Chart 5). Factories account for about 63 percent of employment in the goods-producing sector.

The big question is whether the drags from housing and manufacturing will let up before weakness there begins spilling over to the rest of the economy.

Update: See Calculated Risk for discussion of charts 4 and 5.
Update: David Altig at macroblog provides further analysis.

Comments

[Bruce Wilder]

"The big question is whether the drags from housing and manufacturing will let up before weakness there begins spilling over to the rest of the economy."

(Here I am playing hooky, again. I am so irresponsible, and feel so guilty. Not . . . at least about the guilt.)

No, I would say the "big question" is whether this pattern can be tied directly to re-distribution of income and wealth. If a narrative analysis can link this pattern to stagnant or declining wages, then even a mild recession (or even a technical non-recession) could be extremely painful for a large portion of the populace, and political notice will be taken.

A relatively small number of people in corporate management and financial services and Big Media and Big Pharma are doing quite well. But, "free trade" and foreign exchange rate policies have so tilted the investment landscape, that it is cheaper to build a brand-new factory in China, new town for the factory workers, a road from the factory to a port, a new dock at the port, a new fleet of ships to carry the product across an ocean that covers 40% of the planet, than it is to continue to employ workers in Cleveland or Detroit, where the towns and housing, roads and ports, factories, etc. already exist. Something is seriously askew here. (due credit to Stirling Newberry, my hero)

The problem of investment is not just that gross investment is a macro drag, it is that investment/savings is not enough to maintain the capital stock necessary to prop general wages in the U.S. to their accustomed high levels. Productivity is tied directly to the quality and quantity of accumulated capital stock, including public investment in infrastructure and the quality of corporate organization and infrastructure. And, we are letting that letting that capital stock erode, even as issues of resource limits (peak oil and global warming, collapsing fish stocks, spiking food prices, etc.) loom on the horizon. We have spent the last half dozen years -- the whole of the last anemic recovery -- directing investment into a bloated health care industry where real marginal productivity is probably negative, a suburban housing sector we cannot afford to drive to, and an insanely expensive and self-destructive War in Iraq over oil we are never going to be able to touch.

The BIG Picture is not a happy one, people.

[johnchx]

Bruce Wilder suggests: The problem of investment is not just that gross investment is a macro drag, it is that investment/savings is not enough to maintain the capital stock necessary to prop general wages in the U.S. to their accustomed high levels. Productivity is tied directly to the quality and quantity of accumulated capital stock, including public investment in infrastructure and the quality of corporate organization and infrastructure. And, we are letting that letting that capital stock erode....

Can you point to some evidence that this is actually true?

I've posted before that all the statistics I have seen point to the opposite conclusion: U.S. capital stock is growing faster than labor hours worked, and production is -- on average, in the aggregate -- becoming more, not less, capital intensive.

So what supports the opposite conclusion?

[calmo]

I wish it were possible to add to the titles of these graphs...just to get even, you know? For instance:Chart 4: Residential Investment to Remain a Drag on Economy (accept no other possible interpretations, you idiots). Especially ignore economists like Menzie Chinn at Econombrowser who links this data to non-residential investment.
I feel the spirit of contagion is upon me with this limp conclusion:The big question is [but only for this author's mother] whether the drags from housing and manufacturing will let up before weakness there begins spilling over to the rest of the economy. [And it's as if the data he cites so hopefully before, now overwhelms him.] Fully 117% of the "final" estimate (don't you believe it people) q4 2006 GDP growth came from personal consumption expenditures. But I don't need to tell the readers here how to interpret this official factoid with the old news that MEW has allowed consumers to obtain a negative savings rate soon to correct.
Last bothersome thing: the auto contribution (Appendix Table A) subtracted 1.3 from GDP growth of 2.5%, largely a result of incentives to clear last year's stock. The quarter before autos added 0.8 to arrive at that sobering 2.0 GDP, so you can see what a little incentives can do for these GDP numbers.

[maria]

Looking at the graphs the main impression I get is that the downturn is just beginning and hasn't really gotten going yet. This would explain the fluctuation for the past few months of the yield curve prediction of recession between 50% to 54%, and back and forth. Teetering on the brink of recession; not yet dropping into one. I would guess the continuance of the housing crisis would finally produce one, if some crisis in the Middle East doesn't do it first by sending the price of oil up toward $100 a barrel.

[Bruce Wilder]

JCX: So what supports the opposite conclusion?

At base: stagnant or falling marginal productivity of labor, i.e. wages.

An increasing per-worker capital stock would imply rising marginal productivity of labor and rising wages. Not, not.

Looking at the detail will tend to undermine any confidence you have in the aggregate, which goes much beyond the above.

A rejiggering of taxes on capital income might make capital more valuable, but does not imply an increase in the real capital stock. Likewise, a redistribution of wage rents from union workers to CEOs is not a wage increase. Nor does improved rent capture from building up a corporate giant with a stranglehold on strategic distribution channels imply an increased capital stock.

I do my grocery shopping at a Ralph's, a unit of Kroger, a supermarket giant. The basic layout of my Ralph's is pretty much the same as the A&P I worked at, in 1972. If the "capital stock" has increased, it is hardly visible. The scanner used at checkout is cheaper than the cash register they used in 1972, and the cashier has less training, and a lower real wage (thanks in part to bare knuckle and illegal labor tactics). The size and scope of Kroger would have been unthinkable in 1972, and its market power is considerable, both with regard to horizontal competition -- supermarket competition in my region is appreciably less than 10 or 15 years ago -- and vertically vis a vis the giant consumer product companies. My ability to buy $0.60 unwaxed dental floss is just a memory; but, Tyler Cowan thinks it's a Marginal Revolution that I can pay $3.00 for "innovative" dental floss in a fancy package from a national giant. And, no matter how cheap potatoes may be in the dirt in Idaho, you can be sure, they will never fall below $0.39/pound at Ralphs. Of course, Kroger will tell you that CostCo and Wal-Mart make this a far more competitive environment, but, so far, that intense competition has shown up in lower wages, not lower prices and certainly not lower margins. Funny how that works.

It can be somewhat misleading to say that any industry has become more "capital intensive" although certainly, in the aggregate, the number of workers required is much less in most manufacturing. I don't think there has been much improvement in productivity in construction since World War II; the Empire State building (1931) went up in a single calendar year.

I think I bought my first computer around about 1983 or so, and, including the printer, paid about $4000. I bought a new computer a couple of weeks ago, and paid about $800. The new PC -- a Vista-driving, 2.2 GHz dual-core, 2 GB RAM, 300 GB harddrive, wide LCD screen puny little thing -- is certainly more powerful than the 10 MHz, 512 KB RAM IBM clone I had in 1983. But, did my capital stock increase? My mind boggles even trying to make sense of the question.

My personal situation with my PC is very similar to the situation facing many businesses in the entertainment industries, which dominate my home city of Los Angeles. The music, television and movie studios and assorted supporting players are furiously replacing all kinds of computer-related equipment. A videotape editing machine, which cost $100,000 ten years ago, can be replaced with a <$6000 Apple Mac + software, and the editor needs about one-tenth the training and patience as his counterpart from ten years ago.

Everywhere in L.A., people are gnawing their own feet, trying to free themselves from this beartrap. BluRay is replacing DVD; HD is replacing film (Kodak Theatre -- "gee, Daddy, was Kodak a star in the old days? Did he win an Oscar?"), computers are replacing animators and computer animations are replacing actors.

The cost of distributing music is less than one-tenth today on-line what it was yesterday on CD in a Virgin or Tower store. How does the iTunes "capital stock" compare to Capitol Records and Tower Records, etc.?

Giants like AT&T and Time Warner or Comcast are paying on a mountain of debt, which used to be backed by a mountain of copper or coax, but the replacement cost of that mountain of copper or coax is about 1/10th of its historic cost and that replacement cost falls about 30% per annum. So, AT&T and Comcast are engaged in vicious political bullying to secure a property interest in their municipal franchise agreements, or to secure equivalent legal rights where they don't even have a franchise agreement and cannot afford to buy one. Is their capital stock increasing or declining? I'd say it was eroding rapidly, as replacement cost falls, and the opportunities for new entrants to displace the dinosaurs improve.

Look out on the landscape of America. College students pay thru the nose for an education of questionable quality, as was mentioned earlier. Is our human capital stock augmented by that? How is our transportation infrastructure holding up, under the onslaught of higher oil prices? Is the capital stock represented by the trucking company or the suburban house increasing with increasing oil prices?

[Lafayette]

BW: "AT&T and Comcast are engaged in vicious political bullying to secure a property interest in their municipal franchise agreements"

Be careful of the precedent. It is folly not to divorce content from distribution. Just like the justice department forced the movie studios to divest themselves of the movie houses.

The means of distribution must not be in the hands of the content producers, which will only practice monopoly prices for both product and its delivery.

I presume, therefore, that not only do the carriers have not affiliation with the studios but that there is sufficient competition amongst them as well. If not, there will be hell to pay ... in spades.

[Lafayette]

BW: "College students pay thru the nose for an education of questionable quality, as was mentioned earlier. Is our human capital stock augmented by that?"

Yes it is ... and all the while your bank account is depleted.

Education / skill training should be virtually free to all up to the highest level possible. There is probably no more important social investment a nation can make.

This does not mean that private universities should disappear. On the contrary. But, there should be no excuse whatsoever that students who want to learn cannot obtain a university degree AT AN AFFORDABLE COST THAT PRECLUDES INDEBTEDNESS - be it from a state or private learning institution.

[johnchx]

Bruce Wilder suggested: An increasing per-worker capital stock would imply rising marginal productivity of labor and rising wages.

Not as far as I can see. A rising per-worker capital stock would be expected to increase average productivity, which is precisely what we observe taking place. But as long as the least-productive worker is still a guy with a shovel, all the infra-marginal capital improvements in the world won't affect productivity at the margin.

I'm venturing into speculation here, but an hypothesis that is consistent with the data we see is that, due to technology changes (which is another way of saying, "for reasons I don't really understand") the highest returns to new capital investment right now are in sectors (and/or in support of occupational categories) that are already relatively capital-intensive. So, for example, there are better returns from upgrading our already very expensive computer systems than from automating, say, janitorial or landscaping tasks. In the aggregate, production becomes more capital intensive, but at the margin, productivity hardly moves.

But that's just a guess, really intended to illustrate how something like what we're seeing might happen. I'm as curious as everyone else about exactly what really is happening.

[real person from the real world]

Layfette, you are positively golden:

Education / skill training should be virtually free to all up to the highest level possible. There is probably no more important social investment a nation can make.

This does not mean that private universities should disappear. On the contrary. But, there should be no excuse whatsoever that students who want to learn cannot obtain a university degree AT AN AFFORDABLE COST THAT PRECLUDES INDEBTEDNESS - be it from a state or private learning institution.

[Bruce Wilder]

BW: An increasing per-worker capital stock would imply rising marginal productivity of labor and rising wages.

JCHX: Not as far as I can see. A rising per-worker capital stock would be expected to increase average productivity, which is precisely what we observe taking place. But as long as the least-productive worker is still a guy with a shovel, all the infra-marginal capital improvements in the world won't affect productivity at the margin.

BW replies:
You have to think harder about the relationships, here. Average productivity is just output/(total units of a factor); you cannot infer much from it. Marginal productivity is the unit cost of labor. The wage and therefore the marginal productivity of a guy with a shovel varies a lot, between economies, precisely because of differences in capital stock. A guy with a shovel in Thailand or in Mexico earns a lot less -- and his marginal productivity is a lot less -- than it would be in the United States, which is a prime reason so many guys with shovels journey to the U.S. It is not about how much capital stock is personally and immediately available to the guy with a shovel, but about the market wage. So, inframarginal capital investments can matter, because they can affect the market wage. China, Thailand and Mexico have low market wages relative to the U.S., because they have low capital stock per capita; reflecting the fact that large parts of their populations are in low-investment, low-productivity agriculture. Modern factories in those countries are modern factories; a cell-phone or a PC or an automobile or any number of other tools or artifacts of economic life can be pretty much the same. But, the guy working in the factory makes less, because the guy with the shovel makes less. And, it isn't necessarily the case that the marginal product of the factory is higher than his wage; they should still be the same. In fact, the marginal product of the factory worker in Bangkok, although it may be physically as large as the marginal product of the factory worker in, say, St. Louis, may not be as valuable. A taxi ride in Los Angeles that costs $40 costs $5 in Bangkok; the auto is the same, gas costs roughly the same, but the marginal productivity of the driver in Los Angeles is higher.