Tag Archives: GDP

The Middle Class Crunch: Bipartisan Program for New Members of Congress

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       On December 3-5, 2014, the Institute of Politics at Harvard University held its biannual Bipartisan Program for Newly Elected Members of Congress.  Most of the congress-people come.   This year I was on a panel on the domestic US economy, titled the “Middle Class Crunch.”    In Part I, presented here, I briefly reviewed recent economic statistics.   Part II, laying out 8 recommended policies, will follow.

       The standard economic statistics indicate that the US economy has been doing well lately, not just relative to the severe 2007-09 recession, but relative also to what most Americans think and relative to how other advanced countries are doing.  This applies to (1) GDP, (2) jobs, (3) the stock market, and (4) the budget.

      (1)  GDP growth has averaged an impressive 4.2% over the last 2 quarters.   It has averaged a more moderate 2.4% over the last 4 quarters, but even that is still above the disappointing 2.1% in 2011-13.  See  Figure 1.

Figure 1. Growth has been gradual since the recession’s end in June 2009, but faster lately

Picture1_billionsofchaintype2009dollar

Source: Macroeconomic Advisers, Nov. 18, 2014; monthly numbers derived from US Bureau of Economic Analysis quarterly series. E

        (2) Employment growth has shown  an unprecedented string of positive numbers. The private sector has added 10.6 million jobs over 56 straight months of job growth, easily the longest streak on record. and has added at least 200,000/mo. for nine consecutive months. See Figure 2.

Figure 2.  Change in private sector employment.

Picture2_privatesectoraddedjobs

     (3) The stock market is setting record highs.

(4) The budget deficit has experienced a record improvement since 2009: a decline of more than 2/3.  (See Figure 3.)   It is now  2.8% of GDP, which is below the average deficit since 1980 (3.2%).

Figure 3. The 2014 federal budget deficit is down to 2.8% of GDP.

Picture3_2014federalbudgetdeficit

      If the economy is doing so well, then why don’t Americans see it that way?   The “middle class” doesn’t feel better off because the gains have accrued to people at the top. Median family income  is still 8 per cent below its pre-recession level and even further below its 2000 peak.  It has barely risen above its 1990 level.  See Figure 4.

Figure 4. Real median household income is barely above its 1990 level.

Picture4_whydoamericansfeelworse

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 Has Italy Really “Gone Back Into Recession”?

Italians and the world have now been told that their economy slipped back into recession in the first half of 2014.  This characterization is based on the criterion for recession that is standard in Europe and most countries:  two successive quarters of negative growth.  But if the criteria for determining recessions in European countries were similar to those used in the United States, this new downturn would be a continuation of the 2012 recession in Italy, not a new one.  A common-sense look at the graph below suggests the same conclusion: the 2013 “recovery” is barely visible.

Worse, Italy under U.S. standards would probably be treated as having been in the same horrific six-year recession ever since the shock of the global financial crisis in 2008:  the recovery in 2010-11 was so tepid that the level of Italian economic output had barely risen one-third the way off the floor, before a new downturn set in during 2012.  And the two earlier downturns were severe:  Italy’s GDP remains 9% below the level of 2008.

  Graph of real GDP in Italy, 2007 (Q1) – 2014 (Q2)  

Italy Real GDP

What is the difference in criteria?   Economists in general define a recession as a period of declining economic activity.   European countries, like most, use a simple rule of thumb:  a recession is defined as two consecutive quarters of falling GDP.    In the United States, the arbiter of when recessions begin and end is the NBER Business Cycle Dating Committee.  The Committee does not use that rule of thumb, nor any other quantifiable rule, when it declares the peaks and troughs of the US economy.   When it makes its judgments it looks beyond the most recently reported GDP numbers to include a variety other indicators, in part because output measures are subject to errors and revisions.

Furthermore the Committee sees nothing special in the criterion of two consecutive quarters.  For example, it generally would say that a recession had taken place if the economy had fallen very sharply in two quarters, even if there had been one intermediate quarter of weak growth in between the other two quarters.  Further, if a trough is subsequently followed by several quarters of positive growth the NBER Committee does not necessarily announce that the recession has ended, until the economy has recovered sufficiently well that a hypothetical future downturn would count as a new recession instead of a continuation of the first one.

Fortunately, the US economy has had positive economic growth for the last five years, so these issues are not currently active on our side of the Atlantic.   But things are not always so quiet.   The US economy contracted three quarters in a row in 2001, for example, measured with the revised GDP statistics that are available today.  But at the time when the NBER committee declared that there had been a recession in 2001 (based on various other indicators, particularly employment and the income-based measure of GDP), the official demand-based GDP statistics did not show two consecutive quarters of declining output, let alone three.  That episode is a good illustration of the benefits of a broader approach to the task of declaring business cycle turning points.  The NBER Committee has never yet found it necessary revise a date, let alone erase a recession, once declared.

One cannot say that the two-quarter rule of thumb used by individual countries in Europe and elsewhere is “wrong.”   There are unquestionably big advantages in having an automatic procedure that is simple and transparent, especially if the alternative is delegating the job to a committee of unelected unaccountable ivory-tower economists.   The press statements of the NBER Committee are seldom greeted appreciatively.  Each time, many critics express puzzlement at the need for a secretive committee, as compared to the alternative of an objective two-quarter rule.  (Other critics each time complain that the committee has “only said what everybody has known for a long time.”  Some critics have managed both complaints simultaneously — even when the two-quarter rule would not have given this answer that “everybody knows.”)

But there are also disadvantages to the rule of thumb.  One disadvantage is the need to get out the white-out when the statistics are revised, as Britain had to do a year ago when its reported recession of 2011-12 was revised away.  Claims that in 2012 had appeared in the speeches of UK politicians and in the writings of researchers, made in good faith at the time, were rendered false in 2013.

There is also a potentially more far-reaching and serious disadvantage. Citizens in Italy have now been given the impression that they have entered a new recession.  Voters may draw the conclusion that their new political leaders must have done something wrong.   But the picture is different if Italy has been in the same recession for six years.  The implication may be that the leaders have been doing the same wrong things throughout that period.   It’s not an unimportant difference.

The loss in output since 2008 means that the debt/GDP ratio in Italy has risen during this period of fiscal austerity, not reversed as was supposed to happen under the plans to restore debt sustainability.  The same is true of other countries in the European periphery, making investor enthusiasm for their bonds over the last two years puzzling.

What are the right policies to get Italy and the others growing again?  The answer is the same as it has been for the last six years.  At the FrankfurtBerlin-Brussels level, ease rather than austerity and deflation.  At the Rome-Lisbon-Athens level, reforms on the supply side, especially in labor markets.  It is true that supply-side reforms take time to have their full effect.  But if authorities in Italy started handing out more taxi licenses to (qualified) drivers, employment would go up within a week.

 

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China Is Not Yet #1

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Widespread recent reports have trumpeted: “China to overtake US as top economic power this year.”  The claim is basically wrong. The US remains the world’s largest economic power by a substantial margin.

The story was based on the April 29 release of a report from the ICP project of the World Bank: “2011 International Comparison Program Summary Results Release Compares the Real Size of the World Economies.”     The work of the International Comparison Program is extremely valuable.  I await eagerly their latest estimates every six years or so and I use them, including to look at China.  (Before 2005, the data collection exercise used to appear in the Penn World Tables.)

The ICP numbers compare countries’ GDPs using PPP rates, rather than actual exchange rates.   This is the right thing to do if you are looking at real income per capita in order to measure people’s living standards.  But I would argue that it is the wrong thing to do if you are looking at national income in order to measure the country’s weight in the global economy.

The bottom line for China is that by both criteria, income per capita (at PPP rates) or aggregate GDP (at actual exchange rates), it still has a ways to go until the day when it surpasses the US.  This in no respect detracts from the country’s impressive growth record, which at about 10% per annum for three decades constitutes a historical miracle.

ChinaUSGDPgraphblog

(click on the graph for larger image)

At current exchange rates, the American economy is still almost double China’s, 83% bigger to be precise.  But the cross-over day is not far off, as the graph shows.  If the Chinese real growth rate continues to exceed US growth by 5% per annum and the yuan appreciates at 3% a year in real terms (inflation is higher there), then China will pass the US by 2021. Soon, but not imminent.

The PPP-versus-exchange rate issue is familiar to international economists.   This annoying but unavoidable technical problem arises because China’s output is measured in its currency, the yuan, while US income is measured in dollars.  How should you translate the numbers so that they are comparable?  The obvious solution is to use the contemporaneous exchange rate.  (Multiply China’s yuan-measured GDP by the dollar-per-yuan exchange rate, so that is expressed in dollars.)

Someone then points out, however, that if you want to measure the standard of living of Chinese citizens, you have to take into account that many goods and services are cheaper there.   A yuan goes further if it is spent in China than if it is spent abroad.  Some internationally traded goods have similar prices.   T-shirts are virtually as cheap in the United States as in China, in part because we can buy them from there. (Oil is almost as cheap in China as abroad, because it can import oil.)   But haircuts, a service that cannot readily be traded internationally, are much cheaper in China than in the US.  For this reason, if you want to compare income per capita across countries, you need to measure local purchasing power, as the ICP does.

The PPP measure is useful for many purposes, like knowing which governments have been successful at raising their citizens’ standard of living.  A second application is estimating whether the country’s currency is “undervalued,” controlling for its productivity.  A third is judging whether it is reasonable to expect that the country has the means to start cutting pollution.   (The turning point for sulphur dioxide in international data has been estimated at roughly $10,000 per capita in today’s dollars.  China is now there.)

Looking at income per capita, China is still a relatively poor country, even by the PPP measure and even though it has come very far in a short time.  Its income per capita is now about the same as Albania’s, in the middle of the distribution of 199 countries (99th).

But Albania doesn’t often get headlines.   Why are we so much more interested in China?  Partly because it is such a dynamic economy, but not just that.  China has the world’s largest population.  When you multiply a medium income per capita times 1.3 billion “capita,” you get a large number.  The combination of a very large population and a medium income gives it economic power, and also political power.

Why do we consider the United States the incumbent number 1 power?   Partly because it is rich, but not just that.  If income per capita were the criterion, then Monaco, Qatar, Luxembourg, Brunei, Liechtenstein, Kuwait, Norway and Singapore would all rank ahead of the US.  For purposes of that comparison, it does not much matter whether you use actual exchange rates to make the comparison or PPP rates.  Relative rankings for income per capita don’t depend on this technical choice as much as rankings of size do.  (The reason is that the PPP rates are highly correlated with income per capita, the phenomenon known as the BalassaSamuelson relationship.)

If you are choosing what country to be a citizen of, you might want to consider one of these richest countries.   But we don’t consider Monaco, Brunei and Liechtenstein to be among the world’s “leading economic powers,” because they are so small.  What makes the US the #1 economic power is the combination of having one of the highest populations together with having one of the higher levels of income per capita.

So there is a widespread fascination with the question how China’s economic size or power compares to America’s, and especially whether the challenger has now displaced the reigning champ as #1.  It seems to me that PPP rates are not the best ones for making this comparison.  Why?

When we talk about size or power we are talking about such questions as the following.  From the viewpoint of multinational corporations, how big is the Chinese market?  From the standpoint of global financial markets, will the RMB challenge the dollar as an international currency?   From the viewpoint of the IMF and other multilateral agencies, how much money can China contribute and how much voting power should it get in return?   From the viewpoint of countries with rival claims in the South China Sea, how many ships can its military buy?   For these questions, and most others where the issue is total economic heft, you want to use GDP evaluated at current exchange rates.  It’s how much the yuan can buy on world markets that is of interest, not how many haircuts or other local goods it can buy back home.

It is sometimes objected that using the current exchange rate subjects the comparison to the substantial fluctuations that exchange rates often exhibit.   This is true.   But the large and variable measurement errors in the PPP adjustment are considerably worse.  There is a good case for using a five-year average of the exchange rate instead of the exchange rate in one particular year. It doesn’t make much difference for the US-China comparison during this period.  But even when exchange rate fluctuations seem large, the difference is relatively small compared to the other statistical issues at stake here.

[A shorter op-ed version of this article appeared at Project Syndicate. Comments can be posted there. A version at VoxEU will include references.]

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