Good Read: Michael Pettis on The Great Rebalancing.

I don't make New Year's Resolutions, but I  often make lifestyle innovations in January. This year, one of those innovations was to start using my Audible account to listen to books on economics and political economy while exercising (another lifestyle change was to start regularly exercising again), driving, walking the dogs, going to the store, etc.. Beyond the efficiency gain in multi-tasking, this forces me to slow down and actually listen to every word in the book and more fully ponder what the author is saying.

Of, course now I have this stuff in my head and it needs to go somewhere. Eventually it will find its way into my courses, but first it needs to be fleshed out and reflected on some more. So, I'm going to do some of that here.

The first book to get this treatment is Michael Pettis' The Great Rebalancing: Trade Conflict and the Perilous Road Ahead for the World Economy  (2013, Princeton University Press). Pettis is a finance and economic professor at Peking University who frequently comments on China and the global economy.

The Rebalancing that he focuses on is between countries that run a surplus of savings (e.g., China and Germany) and those that run a deficit of savings (e.g., the US, Spain, Portuagl, Itay, and Greece). A surplus of savings is the amount of national savings above the amount demanded in the domestic economy at the prevailing interest rate, and a deficit is  the amount of savings below what is domestically demanded. He argues that, in a global financial market (one without capital controls between nations), deficits and surpluses must add up to zero, or balance each other.

Therefore, if a nation has financial and macro-economic policies that  result in a surplus of total national savings, this surplus will have to be balanced by a deficit in some other nation. The surplus nation will export savings and, in return, essentially import demand for its products, which is manifested in a capital account deficit and current account (or trade) surplus. This will lead to low consumption and high employment in the surplus country. The deficit nation will be compelled by international market conditions to import the savings and export demand, resulting in a capital account surplus and current account deficit (in short, it will attract foreign investment while running run a trade deficit). This will lead to high consumption and lower employment in the deficit country, the latter of which can be avoided only if the deficit nation incurs increasing debt or erects capital controls.

Now, of course, this can work the other way around. A savings deficit nation (or nations) can draw in savings if it (they) implement financial and macro-economic (and fiscal) policies that push down the national savings rate. This will produce exactly the same outcome and, therefore, the causal link runs both ways.

Pettis' main argument is that the global economy is plagued by an imbalance between savings surplus nations (primarily China and Germany) and savings deficit nations (primarily the US and struggling EU countries). Furthermore, he argues that the causality runs from the policies of the surplus nations rather than those of the deficit nations. Nations like China and Germany have pursued policies that prompted national (not necessarily personal) savings rates beyond any level that can be effectively utilized in their own economies and have dumped the surplus onto the global (or in Germany's case, the Euro zone) market. This produced conditions that  resulted in lower savings rates and increased indebtedness in the deficit nations. Because deficit nations face a choice between increasing debt or decreasing employment, governments are often politically compelled to choose higher debt, which often leads to unsustainable levels of debt.

In making this argument, Pettis rejects what he views as moralistic commentary that lauds the surplus nations and their cultures as hardworking and thrifty, while condemning deficit nations and their cultures as lazy and spendthrift. He notes that it wasn't that long ago that Chinese intellectuals lamented the laziness and lack of savings among their peasants. Also, he points out that there is a big difference between personal savings rates, which might be analyzed in terms of individuals and cultures, and gross domestic savings rates, which are better understood in terms of economic policies.

He also argues that the policies that produce the surpluses run deep in the surplus nations' economies and may not, on the face of them, appear directly related to trade. In the case of China, currency manipulation is only the tip of a policy iceberg that extends to repressive financial polices and a bloated public sector that have shrunk the household sectors share of GDP (albeit while allowing absolute household income to increase in absolute terms due to the high rate of growth in GDP).

What is interesting about Pettis' argument is that it redirects our attention away from the deficit nations (particularly in the case of the Euro crisis) and, also, away from the typical trade related policies (as in claims of currency manipulation in China).  Instead, he focuses attention on the surplus nations and the policies that overstimulate the nations' savings and understimulate their consumption. Thus, the level of household consumption in China, and steps that can be taken to increase it, become a central focus in analyzing the nation's economic prospects( as well as those of other nations like the US). Similarly, the impact of the Euro on German exports becomes a central part of the explanation for Spain's difficulties.

He also argues that the deficit nations are not the only ones at long term risk from the imbalance. When the debt they must incur to avoid lower employment becomes unsustainable, the deficit nations will have to either default or impose austerity and capital controls (or all three) that will produce the previously avoided unemployment. At this point they will no longer be able to export demand to the savings surplus country and this will make the surplus counties' policies unsustainable. Surplus countries will find themselves with excess productive capacity and a host of investments that can not pay for themseleves. Thus, they face the prospect of a so called "lost decade" of stagnant economic growth. Indeed, Pettis argues that the surplus countries face greater losses in the long run that then deficit ones.

I'll leave the summary there, but I expect to take a deeper look at a number of issues Pettis raises in the future.

Some Info on Income Inequality

The President's State of the Union has kicked off the Democrat's income inequality offensive for this elections year. Here are some interesting arguments and research findings related to the subject.

Daniel Smith's Op-ed The Myth of Wage Stagnation Smith, a colleague at Troy University, lays out the argument that the oft-quoted data on earnings, which shows that average real wages only increased 5.58% since 1964, does not reflect increases in benefits and purchasing power. He points out that total compensation, which includes benefits, has increased 45% since 1964. He goes on to refer to Mark Perry's argument that purchasing power has increased when one considers the hours people need to work to earn enough money to buy consumer goods (see next link). Of course, not only do people have to work less hours to afford, say a TV, but the quality of the product purchased (which is not factored into inflation estimates) has increased dramatically in the past decades.

Fly in the ointment: While most of Smith's article is fact driven, he ends on an ideological note by arguing that the myth of wage stagnation is being used to do away with economic freedoms that increase incomes. While I have great sympathy for any argument in favor of economic freedom, it is more tenuous than the empirical case made in the first three quarters of the essay.

Mark Perry's Data on Hours Needed to Work to Purchase Goods  Speaking of Mark Perry, he often posts information on the increasing quality and decreasing real cost of consumer products. In this post, Perry has a table that shows the cost of 11 household appliances in 1959, 1973 and 2013. He also uses the average hourly manufacturing wage from each of those years to calculate the hours a factory worker would have to work to purchase them. Even though the price of these products increased from $1,851 in 1959 to $3,289 in 2013, the hours a worker need to work to purchase them dropped from 885.6 to 170.4.

Of course, Perry used the average manufacturing wage and much of the discussion has been about minimum wage workers who generally make much less. Perry did a comparison of what a college student could purchase with the earnings from a minimum wage summer job (40 hours/week for 12 weeks) in 1973 versus 2013. Someone working for minimum wage in 1973 would earn $768 ($1.60/hour x 480 hours) and someone working for minimum wage in 2013 would earn $3,480 ($7.25/ hour x 480 hours).

Now, if you use the CPI to adjust these wages for inflation, it would appear that the 2013 worker earned 14% less in real wages than the worker in 1973. However, if you look at what the two workers could buy with their earnings, you get a very different conclusion. The 1973 worker's $768 would purchase a typewriter, a calculator, a portable TV, a Radio-Tape player, and a compact refrigerator. The 2013 worker's $3,289 would buy a laptop and printer, an iPod, an iPad, an iPhone, a GPS, a digital camera, flatscreen TV, a blu-ray player, a home theater system, a Playstation, a Kindle Paperwhite, Sonicare toothbrush, a clock radio/iPod docking station, a TiVo, a satellite receiver for a car, an espresso machine. and a calculator.

The difference between these bundles of goods is even more remarkable when you consider that a billionaire could not have purchased many of the things at any price in 1973. This leads Perry to argue that today's kids are the luckiest generation (at least until the next one).

Fly in the Ointment: In both cases, Perry looked at manufactured consumer goods, which have seen both increases in quality and decreases (or relatively small increases) in price. In comparison many things like , houses, gasoline and beef, have not increased much in quality but have increased in price.  More importantly, healthcare, which has increased in quality, has gotten much more expensive. Of course, this is why the CPI, which looks at broad range of goods, says the $768 in 1973 is worth more than the $3,480 in 2013.

The Equality of Opportunity Project: Harvard's Equality of Opportunity project reports two interesting sets of findings regarding individual income mobility, i.e., the changes in income that individuals experience in their lifetimes. This is not income inequality, per se, but mobility relates directly to individual prospects in our economy.

First, they find that the prospect for upward mobility among children who grow up in below median income families varies a great deal across different geographic regions of the US. While you really need to look at the map they posted, the areas of lower upward mobility are heavily concentrated in the southeast while the areas of highest mobility run through the plains states.

Second, they report that income mobility was very stable from 1971 to 1992. They measure this mobility in terms of the difference in the average income percentile of children born to low income families versus children born in high income families. As they sum it up, "On average, children from the poorest families grow up to be 30 percentiles lower in the income distribution than children from the richest families, a gap that has been stable over time."

Fly in the Ointment: There really isn't one here, besides the difference between income inequality and mobility previously noted.