US Employment: Cyclical, Structural or What Type of Mix of the Two?

Here's a Council on Foreign Relations special report on US competitiveness. I haven't had the time to read it yet, but rest assured, I will.

And here's an earlier report from The McKinsey Global Institute on the same subject.

Both reports deal with a sobering issue in the US economy. Nominal and Real unemployment numbers are symptoms of a larger problem. In the face of growing competition from the Emerging world's markets and renewed strength from industrial powerhouses like Germany, the US needs to become more competitive in all sectors of the economy to construct a more healthy economy.

Cheers and expect more on these posts and the issue at large.

China's Five-Year Plan: Energy, Energy, Energy

China is the biggest consumer of energy in the world, largest exporter, and - depending on who you ask - will have the largest economy in the world in the next few decades. Despite a demographic bomb that is sure to explode in the future thanks to Beijing's one-child policy, China still is threatened by a growth and resource dilemma: Record numbers of rural migrants are traveling to the coastal cities for work; unrest in the Middle East and higher aggregate world demand for crude oil is creating structurally higher prices; and the sheer pace of economic growth risks degradation of China's ecosystem. Because of these threats, it's no surprise that officials in Beijing have begun to take some very needed and forceful steps. 


First, a draft of China's 12th Five-Year plan was released this Saturday, March 5th. If you are curious, the Chinese National People's Congress meets every so often to reflect upon the last Five-Year plan (2006) and whether or not the country met its goals and obligations. It is basically a road-map. A strategic plan with room for tactical tweaks of the economy if warranted. The Congress also debates and agrees upon the next Five-Year plan. Upon review of how the economy performed, a couple of things stood out: The Chinese economy grew at an annualized rate of 9% or higher for the five years in question which was 2.3 percentage points higher than their targets. The GDP growth is important here because The Plan's targets for energy use are correlated with how fast the country grows. For instance, China hopes to reach a 16 percent reduction in CO2 emissions per unit of GDP, and 17 percent by 2015. More importantly, The Plan sets a target of 11.4 percent of primary energy use to be generated through non-fossil fuels. As Deborah Seligsohn  of the World Resources Institute explains:
"China continues to exceed earlier targets in non-fossil development. For example, the five-year target for wind is 70 gigawatts of additional installation, which exceeds the 2020 target of just a few years ago. For nuclear, the plan is to install 40 additional gigawatts of capacity by 2015. China currently has around 10 gigawatts of installed nuclear capacity now, which means that if this five-year target is achieved, China is likely to exceed even the expectation of 70 gigawatts by 2020 discussed a year ago. If China achieves these numbers, it will have the world's highest installed capacity of nuclear energy by 2020".


Second, at the end of last year, we remember this piece of Reuters (or someone else):
"China, which produces about 97 percent of the global supply of rare earth minerals, cut its export quotas by 35 percent for the first half of 2011 versus a year ago, saying it wanted to preserve ample reserves." The rare earth metals in question are a group of seventeen elements that are used for making household electronic devices, clean energy technology, and guidance systems for...missiles. Also, hybrid cars are rare-earth metal intensive. So if the price of oil continues to rise, then you would assume that demand for conventional, gasoline-combustion cars would decrease. This would force producers to begin to manufacture hybrid and electric cars because the profit margin for these products would start to align more closely with combustion vehicles. However, if China - a country that controls 97% of the available rare earth metals - restricts a larger portion of its exports then the supply of said metals will fall. So as demand for these metals via hyrbid cars increases, but the supply falls, consumers get hit with a double whammy. The prices will stay high and won't necessarily reach acceptable levels for consumers given the higher costs of inputs...(sighhh!). Reuters continues: "World demand for rare earth minerals at present is about 110,000 tons a year, with China accounting for about 75 percent of total demand with the remainder split between Japan, the United States and Europe, in descending order. With global demand outside of China expected to rise further to between 55,000 and 60,000 tons in 2011, the rare earth shortages we saw in 2010 are likely to occur again in 2011 and may be even more pronounced," Molycorp's [a leading rare-earth metal mining firm] Smith said. "Demand is set to more than double to 250,000 tons by 2015, according to industry estimates." The WSJ has a more in-depth coverage here.

Thirdly, China is heavily protecting their alternative energy economy. As Michael Levi of the Council on Foreign Relations explains the procurement of solar panel technology by the Chinese government, "The situation is pretty straightforward. China hasn’t signed the WTO agreement on government procurement [of solar panels]. That means that Chinese government purchases are exempt from China’s free trade obligations. But the state is a massive piece of the Chinese economy. In practice, then, Beijing uses that loophole to mandate domestic content for a huge amount of its economic activity. The United States, whose government is a much smaller part of the economy, can’t behave similarly. The result is a perfectly legal Chinese policy that is in practice unfair." The Chinese effectively subsidize the production of some inputs to solar panels, keeping costs for their businesses to a minimum. This gives Chinese firms a lot of room to obtain market share and a solid profit margin. The US Congress, amongst other governing bodies, may have a case at the WTO, but that is not the point of this post. 

Finally, China has begun to realize that the growth of its cities is becoming unsustainable. Referring back to their Five-Year Plan released the other day, "A total of 18.06 million motor vehicles were sold, an increase of 32.4%". That's all well and good for the consumption part of the GDP calculus (Consumption + Investment + Government + Trade Balance) but it's a worrying sign for a country that has 44 metropolitan areas with populations over 1 million residents, migrants and full-time tenants. Shanghai, Beijing and Guangzhou alone have roughly 43,200,000 residents. I'm sure these numbers have something to do with the 60-mile long traffic jam that Beijing experienced in August of last year. Which is why the officials in Beijing are taking action. After an investigation into Beijing's cluttered traffic and population growth, the authorities discovered some worrying trends: "Beijing's population had topped 19.7 million by the end of 2009. This was 2 million more than official figures had suggested. In a development plan published seven years ago, the government had aimed not even to reach 18 million by 2020" (The Economist). Whoops! So the authorities are now kicking out slum dwellers and strengthening the hukou regime, a "proof of domicile that is hard to obtain when not inherited and that confers all sorts of health and welfare rights, even more difficult to get"(ibid). 

All of these changes and goals will take place under the auspices of the 12th Five-Year Plan, and the efficiency of the Party shouldn't be doubted. A couple of worrying points however. Because China won't let the yuan (renmimbi) appreciate faster, then they're forced to accept another typed of real appreciation: inflation. Consumer prices are rising, M2 or the money stock including bank loans increased by 19.7% with 7.95 trillion yuan of that being from loans. Once prices start to rise in an economy operating at full capacity, then workers demand and receive higher wages. This, along with an increase in M2 and loans outstanding, increase aggregate demand. Whenever aggregate demand increases in an economy at capacity, prices continue to rise. Eventually, Beijing must stop this free for all with higher interest rates, MORE money on down-payments for houses, restrictions on flipping of said houses, capital controls, so on and so forth. In other words, Beijing needs to slow the economy down or face a wage-spiral induced inflation bubble. But to do this could re-open fissures in the Chinese society. Many rural and city workers accept their subservience in exchange for plentiful jobs and a higher standard of living. But if exporting firms face continually rising prices and then are hit with monetary tightening, they will need to lay off workers. Rural workers who came to the city for a job will have to take the long road back home; and they won't do it willingly. This is the political element of the Chinese dilemma. 

I'll make a follow up post on this subject. I thank Dev Lewis for bring its importance to my attention. He is an acquaintance of mine, nothing more. 

Subdued Inflation: why a wage spiral enduced inflation is unlikely now in America

Free Exchange, the Economists' economic blog, has a fantastic post today that summarizes today's unemployment numbers, the labor force, and inflation (expectations). The thrust of the post talks about our economy's "new normal": That is, an economy that is failing to provide more jobs than the rate of population growth which translates into structurally higher unemployment. A side emphasis provided in this post makes the argument that both headline and core inflation - measures of inflation based upon volatile commodities like oil on the one hand, and more stable prices that are "sticky" (sticky and non-sticky prices will be discussed later) like labor prices and home mortgages - are subdued because workers aren't receiving higher wages because the "price" for labor is still very low. If workers don't receive higher wages then aggregate demand stays the same, all things being equal. This stagnation of wages keeps inflation expectations subdued because if aggregate demand remains the same then firms don't raise prices for their goods because they know consumers will demand less of those items. But once wages begin to rise for reasons such as excess credit, or money sloshing around, or because the economy is operating at full capacity and unemployment figures are low, then inflation expectations begin to rise. And if the Federal Reserve doesn't act quickly then what ensues is a price-spiral inflation scenario: higher wages leads to higher prices and higher prices forces workers to demand higher wages given their decreased real purchasing power (i.e they can't buy as many items as they did with the lower wage). This spiral can be very painful to correct. It requires the Fed to lift its funds rate and sell treasuries, effectively taking money out of the economy. That sounds nice and easy but it is also a recession because with lower prices, firms must lay off workers to compensate for lower profit margins. We've only just escaped a global recession and near depression so any measure to avoid a double-dip should be welcomed. I digress. This emphasis on subdued inflation expectations directly contradicts attacks upon Ben Bernanke and the Federal Reserve for their optimistic opinion that inflation will remain low, notwithstanding the Fed's recent securities purchases via QE2. 


Here's my response to the Free Exchange post:


"Hourly earnings did not grow, so the yearly increase fell back to 1.7%. Even if gasoline is about to lift inflation, it’s hard to see a wage price spiral developing."

You answered my burning question: Is the surge of criticism leveled at the Fed's policies justified? I've been reading a couple of columns at Seeking Alpha that claim headline and core inflation are going to rise given higher oil prices and extra money sloshing around in the economic system. But with unemployment still high, isn't it true (theoretically) that a wage spiral won't necessarily ensue because workers don't have the ability to negotiate higher wages given the low price of labor? There's so much spare capacity and so many workers seeking jobs that employers don't need to offer higher wages - which would effectively lift inflation and inflation expectations - to current employees, right? Headline inflation is a very volatile piece of data because oil prices could drop tomorrow, alleviating the indirect tax that consumers incur, making moot the discussion of whether or not employees need higher wages to cope with higher oil prices. Once unemployment numbers begin to fall to levels more consistent with an economy operating at full capacity, and once the labour force percentage grows higher than 64.2% , THEN the Fed should consider raising interest rates and selling bonds to soak up money that was injected recently to push down long-term borrowing rates.

We need to be very careful not to pull out support to the economy in the form of securities purchases and money injections by the Fed lest we squander the failed recovery underway right now. If however, wages begin to rise in aggregate, and core and headline inflation expectations rise as a result, then the time will come when the Fed should set higher interest rates on its funds rate, the rate at which banks lend to one another, and the Fed should also begin to withdraw money from the economy via selling bonds. 

Here's a link to the most recent unemployment numbers; down to 8.9%. Not perfect, but improving. And here's a link to Chairman Bernanke's testimony at the Senate Banking Committee during which time he claims emphatically that higher oil prices following unrest in the Middle East won't lead to higher inflation. Both deserve your attention.