2006 February 21 Tuesday
Why Is US Economy More Stable At Macro Level?
Robert Samuelson says the economy has become more stable at the macro level and less stable within industries.
Hardly a week passes without layoffs from some major company, which is "downsizing," "restructuring" or "outsourcing." And yet, the broader economy has undeniably become more stable. Since the early 1980s, we've had only two recessions, lasting a combined year and four months and involving peak unemployment of 7.8 percent. By contrast, from 1969 to 1982, we had four recessions lasting altogether about four years and having unemployment as high as 10.8 percent.
The obvious question is why? My guess is that computer tracking of inventories has a great deal to do with it. Many recessions in the past were periods where companies gradually sold off excess inventories until they needed to start producing new goods and started hiring again. But just-in-time delivery, computerized reporting of sales in individual stores, computerized tracking of shipments, computerized tracking of orders, and computerized warehouse inventories allow companies at all steps in supply chains to rapidly adjust orders and production rates.
We can all identify the usual suspects. Globalization. Deregulation. Greater domestic competition. In a series of papers, Comin, Philippon and various colleagues have shown that, for most businesses, sales, profits and employment have all become more volatile in recent decades. They bounce around more from year to year, suggesting greater industry instability. Competitive pressures have dramatically intensified. One telling statistic: In 1980 a firm in the top fifth of its industry had about a 1-in-10 chance of losing that position within a five-year period; by 1998 the odds had increased to 1 in 4.
Why has the power of incumbency decreased in business? Information travels more rapidly. That includes prices, reports of product quality problems, and reports of newer and better products. You can do web searches that compare products and that will turn up product problems from customers who complain online. Also, technogical competencies are a lot more portable. A company can find needed technical skills in the internet and is less tied to particular geographic locations in order to draw on a specialized skill base. So a competitor can pop up in more places.
Are development costs a larger fraction of total costs today than, say, 50 years ago? If so, that'd make economies less susceptible to inventory recessions. Product design rates aren't going to get adjusted in response to every increase and decrease in the rate of new orders. Also, software is a major part of the economy. Well, inventory shortages and surpluses aren't a problem with software. Production costs are very small portion of total costs. The software industry doesn't contribute to inventory recessions.
We also don't have regulation Q recessions, where the building cycle would be artificially pushed into freefall. Oil shock recessions would reveal a burst of inflation, which had been boiling under the surface, as the federal reserve expanded credit far beyond any increase in production. Then interest rates adjusted suddenly upward and beyond the usury ceiling for mortgages. Excessive inventory investment had been stimulated by the negative real interest rates obtaining during the inflationary buildup.
The business cycle has not been conquered, though. The conditions precipitating oil shock recessions exist today; and there is great potential for macro-instability in the discretionary nature of the $600+ billion dollar support. A major reduction in such currency support from foreign governments, will reveal a hidden inflation of great magnitude, when the dollar is allowed to fall.
The contrast between the steady growth of government and private borrowing and spending, and the major attrition of the great manufacturers here, is explained by foreign central bank provision of increasing subsidy to keep the dollar high enough to absorb their export manufactures. The inevitable counterpart of that, is that manufacturers here are continually further undercut. The positive side is that American manufacturers have a great unused potential to raise their prices when the dollar has its props kicked out. We're forcing the shutdown of facilities which could inrease their prices over 20%, if currency levels were less artificially determined.
Hasn't the official definition of unemployment changed during that period?
Certainly world trade and a more diverse domestic economy has something to do with the stability of the US economy. Also, the stimulus from the twin deficits keeps things humming.
But you also must credit the fed since 1980 as well. Paul Volker really demonstrated that the interest rate could be used to control inflation. That is, he demonstrated that the fed could actively combat inflation with a high interest rate and a tight money supply. People don't remember how high and for how long Volker had to peg the interest rate to convince the markets he was serious.
People also don't remember how unsure people were that the idea would even work. Even 10 years earlier in the nixon administration the understanding of the levers of the fed was very poor. In fact, many times they did essentially the opposite of what we would do now.
Once Volker tamed inflation Greenspan did a great job and maintaining that policy - up until the last 4-5 years were he was clearly loose with the $ for fear of y2k and the 9/11 attack. The dollar is a bit weak as a result and we are starting to see basic goods - gold, oil, etc., increase in price. There is still too much liquidity out there.
The key will be to sop up that liquidity without creating a crash. The whole process will be interesting to watch.
The definition of unemployment hasnt changed that much over the last 30 years.