Posts Tagged ‘Trade’

Great Explanation Of Trade Deficits And Surpluses By Michael Pettis. A Must Read.

Monday, June 27th, 2011

I’m going to start reading this guy regularly and I’m posting a link to China Financial Markets,  his blog, particularly a recent piece explaining national trade and how various policies affect who’s going to have trade surpluses and who’s going to have deficits.  Here’s Pettis’ resume.

Michael Pettis is a Senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets. He has taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business.  He is also Chief Strategist at Shenyin Wanguo Securities (HK). 

Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.

I’m particularly interested in having Capt. read this post, entitled How To Become Virtuous And Save More.  So read it Capt!  Here’s a small sample from the piece.

For this week’s blog entry I want to go a little abstract in order to suggest how different countries that participate in the global imbalances are going to adjust.  The debate over the root causes of global imbalances is as fierce and as confused as ever.  The confusion isn’t helped by the vast army of moralizers who like to contrast the hard work and thriftiness of households in high-savings countries with the laziness and binge-buying behavior of households in high-consuming countries.  The world cannot possibly rebalance, they argue, until the later become more like the former…

There are nonetheless some obvious flaws in the argument.  First of all, if the high-consumers become as virtuous as the low-consumers, that just means that global demand will decline, and with it, global unemployment will rise.  In that case global savings won’t go up.  They will go down, since rising unemployment causes income to decline faster than consumption.

Second, lazy spendthrift Americans are actually more productive and work longer hours than people in almost any other rich country, including the harder-working and higher-savings counties in Europe.  Still, the argument does anyway fit in with a lot of cultural stereotypes about Spaniards and Greeks, with their wild lifestyles, long siestas, and dissolute charm, or about Germans and Dutch, whose tasteless food, boring sex lives, and grim movies leave them no choice but to work away at office and factory.

But is this really why people in some countries love to save and people in other countries love to consume?  No, it isn’t.  Aside from the satisfaction it brings, this moralistic argument is almost meaningless.  Individual preferences may cause some of us to save more of our income than others, but we have to be very careful about generalizing.  When entire countries have abnormally high or low savings rates, individual preferences are never the reason.  Abnormally high or low savings rates are almost always caused by trade, industrial or tax policies at home and abroad that distort the relationship between consumption and production.

As with any well written article, particularly one that seems to dismisses cultural tendencies, the article sparked a terrific series of comments, pro and con.  One in particular details a specific German company that the author says exists because of German culture.  My take is that culture does matter, but in most cases not as much as most people assume.  Here’s one of the exceptions.

I really value your blog and read it regularly. But with a caveat: like almost all modern economists you configure the world into monetary relationships and disregard culture, education et al into a black box.
Unfortunately the real world is very different. Spain might devalue its currency as much as it likes; it simply has nothing to the world to sell.
Conversely Germany (or Japan where the Plaza accord of the Eighties had no long term effect on the trade balance) can consistently hike their currencies (as Germany did with the mark appreciation from 4 to the Dollar in 1973 to 1,5 to the Dollar in 1979 and will still run a surplus (in this case with the States).
Case in point is a factory complex making low voltage circuit breakers near Mannheim in South West Germany, which I helped to evaluate for a bank loan. It was formerly called Stotz then became a unit of ABB. (Won´t be more specific for obvious reasons)
The product is not high tech but these 2000 employees churn out a good part of circuit breakers in the world and forced from the market factories in the US and in GB and companies like GE. The workers at ABB are all unionized, get huge salaries, five weeks paid vacations a year and can´t be fired without a very, very good reason.
Now people who are for unions say that is the reason for the success and other people might say it is, because workers are represented in the workers council of the factory. But the real reason why they manage to dominate the market for such a low technology product that could – theoretically – be produced everywhere (they just try in Shanghai up to now in vain) is very simple if you look closer.
It is their production line called Goliath and that was preceded by David. These are in house developments costings upwards of a hundred Million Euro. These are hugely complex machines requiring the harmonisation of workers and engineers skilled in anything from cutting metal to a thousands millimeter to an advanced knowledge of chemistry and take years to build. (Three years in the case of Goliath) These production lines take huge up front investments but once they are in place they deliver a quality product with unbeatable low productions costs. No matter how low the wages anywhere else as wages are anyhow only a small fraction of production costs as soon as something like Goliath is up and running.
And these are not machines like a car that anybody can drive. Only the people who built them can operate them as it just turns out in Shangahi where they shipped David.
First, that something like that is possible has something to do with German business culture. In the US after a take over by private equity they would have never renewed the line but squeezed profits from it until it fell apart. That would have been the end of the factory and it happened in a good many cases which are well know to their German competitors. But that is only one and not even the main point regarding culture.
Goliath and all the other in house developments in German factories are the result of a combination of fabulous in house training of the shop floor people; strong emphasis of tradition (old teaching the young) and the non existence of barriers between engineers and the people implementing their designs.
These are not simply reproducible around the world. ABB is a multinational with branches all over the world and they would love to relocate and get rid of the pesky German wages and workers rights. But they tried and didn´t succed.
In Great Britain you can´t build something like that because there´s no vocational training that´s good enough. Also there´s the problem of the cultural barrier between engineers and workers. (In Mannheim they all talk the same dialect). In the US (as BMW has discovered in its plant in Savannah Georgia) only college graduates have the required reading and mathematics skills to do, what shop floor workers in a German factory are expected to do. But these people are difficult to motivate to get their hands dirty.
In Spain there are similar problems.
These are cultural problems and in China at the moment the greatest problem is, that shop floor workers are afraid to think for themselves. But without it you can´t operate a machine like David.
About China I believe they will learn and eventually become a strong competitor. But only if there is a cultural and probably concurrently also a political shift. Right now the hierarchies are too rigid and there´s no chance for workers to think for themselves. I am confident about China because the Japanese managed this as well. And their culture is ultimately derived from China.
I don´t really see a way out of the crisis along the line that Michael Pettis has sketched. I see no way out in fact. Regarding the situation now in Europe there´s only one solution: for Germany to pay up and shut up. For indeed the advantages of Germany are not due to harder work (they work less hours that Spanish workers) but simply the product of a unique set of historical and cultural circumstances. Best would be for Germany simply to pay the Spanish to buy their products. And the Chinese (which do have the advantage of extremely low wages) to pay the US to buy theirs. Which both did until now in a way. But that will not happen I am afraid so there´s only one solution: default.

How come?

Beezer here.  Pettis writes clearly and I believe very accurately.  That said, the comment reproduced above, clearly shows that culture does matter.  This doesn’t negate Pettis’ arguments but it does show that strong cultural preferences (another comment points out the Japanese and Chinese preference for liquidity) do matter and cannot be dismissed entirely.  Great post and several great comments too. 

The ‘Superstar’ Effect And Income Shifting. We Really Need Progressive Taxes.

Wednesday, January 5th, 2011

We’ve often referred to a phenomenon called the ‘income shift’ where share of income goes more and more disproportionately to the very few at the very top of the income pyramid.  Today this ‘income shift’ has reached a lopsidedness not seen since the 1920s.

It’s hard to avoid not noticing that the 1920s income shift preceded the Great Depression while the current income shift preceded the Great Recession.  Our take has been to recommend progressive tax tables where the tax rates counter at least some of this inevitable shift of more and more income to fewer and fewer people at the top of the pyramid.  Also these types of rates tend to better pay government bills and thus reduce deficits.

As for their impact on economic growth, progressive rates don’t seem to have any negative effect on economic growth.  In fact they correlate extremely well to strong economic growth.  But we’ve shied away from trying to explain this phenomenon.  There are various explanations out there, but certainly no consensus.  Our fall back position is that,  lacking any agreed upon reason(s) why progressive rates correlate so well with robust economies, we’re going with the idea the rates themselves are not of primary importance for growth.  Other dynamics may well be far more important.  That said, they still pay the bills better and seem to counter the ‘income shift’ effect, so we like them.

Now a New York Times article by editorial writer Eduardo Porter sheds a little light on all of the above, and quite a bit more.  The article is entitled ‘How Superstars’ Pay Stifle Everyone Else.’

“IN 1990, the Kansas City Royals had the heftiest payroll in Major League Baseball: almost $24 million. A typical player for the New York Yankees, which had some of the most expensive players in the game at the time, earned less than $450,000.

Last season, the Yankees spent $206 million on players, more than five times the payroll of the Royals 20 years ago, even after accounting for inflation. The Yankees’ median salary was $5.5 million, seven times the 1990 figure, inflation-adjusted.

What is most striking is how the Yankees have outstripped the rest of the league. Two decades ago. the Royals’ payroll was about three times as big as that of the Chicago White Sox, the cheapest major-league team at the time. Last season, the Yankees spent about six times as much as the Pittsburgh Pirates, who had the most inexpensive roster.

Baseball aficionados might conclude that all of this points to some pernicious new trend in the market for top players. But this is not specific to baseball, or even to sport. Consider the market for pop music. In 1982, the top 1 percent of pop stars, in terms of pay, raked in 26 percent of concert ticket revenue. In 2003, that top percentage of stars — names like Justin Timberlake, Christina Aguilera or 50 Cent — was taking 56 percent of the concert pie….

But broader forces are also at play. Nearly 30 years ago, Sherwin Rosen, an economist from the University of Chicago, proposed an elegant theory to explain the general pattern. In an article entitled “The Economics of Superstars,” he argued that technological changes would allow the best performers in a given field to serve a bigger market and thus reap a greater share of its revenue. But this would also reduce the spoils available to the less gifted in the business.

The reasoning fits smoothly into the income dynamics of the music industry, which has been shaken by many technological disruptions since the 1980s. First, MTV put music on television. Then Napster took it to the Internet. Apple allowed fans to buy single songs and take them with them. Each of these breakthroughs allowed the very top acts to reach a larger fan base, and thus command a larger audience and a bigger share of concert revenue.”

Beezer here.  Mathematician Nassim Taleb, in his book ‘The Black Swan,’ explains this phenomenon as ‘scalability.’  Taleb says modern life is different in it’s scalabilty.  Not just in entertainment, but in almost any endeavor.  Whether it’s bank bonuses or book authors, a smaller and smaller share of ‘winners’ grab a larger and larger share of available income.  As a mathematician whose specialty is measuring risk, Taleb warns one important negative side effect of this scalability is the increase in risk.  And not just the increase of risk itself, but a dramatic increase in the effects of risk.

In our modern, scalable world, Taleb warns negative surprises will result in damages far worse than expected from past experience.  Just as positive surprises result in far greater rewards for ‘winners’ compared to past experience, negative surprises result in far more severe consequences for everyone.  Porter says capitalism depends on some inequality, it’s why we work so hard to ‘win.’  But too much inequality, he maintains, may have the opposite effect.

“Yet the increasingly outsize rewards accruing to the nation’s elite clutch of superstars threaten to gum up this incentive mechanism. If only a very lucky few can aspire to a big reward, most workers are likely to conclude that it is not worth the effort to try. The odds aren’t on their side.

Inequality has been found to turn people off. A recent experiment conducted with workers at the University of California found that those who earned less than the typical wage for their pay unit and occupation became measurably less satisfied with their jobs, and more likely to look for another one if they found out the pay of their peers. Other experiments have found that winner-take-all games tend to elicit much less player effort — and more cheating — than those in which rewards are distributed more smoothly according to performance.

Ultimately, the question is this: How much inequality is necessary? It is true that the nation grew quite fast as inequality soared over the last three decades. Since 1980, the country’s gross domestic product per person has increased about 69 percent, even as the share of income accruing to the richest 1 percent of the population jumped to 36 percent from 22 percent. But the economy grew even faster — 83 percent per capita — from 1951 to 1980, when inequality declined when measured as the share of national income going to the very top of the population.

One study concluded that each percentage-point increase in the share of national income channeled to the top 10 percent of Americans since 1960 led to an increase of 0.12 percentage points in the annual rate of economic growth — hardly an enormous boost. The cost for this tonic seems to be a drastic decline in Americans’ economic mobility. Since 1980, the weekly wage of the average worker on the factory floor has increased little more than 3 percent, after inflation.

The United States is the rich country with the most skewed income distribution. According to the Organization for Economic Cooperation and Development, the average earnings of the richest 10 percent of Americans are 16 times those for the 10 percent at the bottom of the pile. That compares with a multiple of 8 in Britain and 5 in Sweden.

Not coincidentally, Americans are less economically mobile than people in other developed countries. There is a 42 percent chance that the son of an American man in the bottom fifth of the income distribution will be stuck in the same economic slot. The equivalent odds for a British man are 30 percent, and 25 percent for a Swede.”

And of course there’s our friends in banking.  Particularly investment banking.

“Remember the ’80s? Gordon Gekko first sashayed across the silver screen. Ivan Boesky was jailed for insider trading. Michael Milken peddled junk bonds. In 1987, financial firms amassed a little less than a fifth of the profits of all American corporations. Wall Street bonuses totaled $2.6 billion — about $15,600 for each man and woman working there.

Yet by current standards, this era of legendary greed appears like a moment of uncommon restraint. In 2007, as the financial bubble built upon the American housing market reached its peak, financial companies accounted for a full third of the profits of the nation’s private sector. Wall Street bonuses hit a record $32.9 billion, or $177,000 a worker…..

This ebb and flow of compensation mimics the waxing and waning of restrictions governing finance. A century ago, there were virtually no regulations to restrain banks’ creativity and speculative urges. They could invest where they wanted, deploy depositors’ money as they saw fit. But after the Great Depression, President Franklin D. Roosevelt set up a plethora of restrictions to avoid a repeat of the financial bubble that burst in 1929.

Interstate banking had been limited since 1927. In 1933, the Glass-Steagall Act forbade commercial banks and investment banks from getting into each other’s business — separating deposit taking and lending from playing the markets. Interest-rate ceilings were also imposed that year. The move to regulate bankers continued in 1959 under President Dwight D. Eisenhower, who forbade mixing banks with insurance companies.

Barred from applying the full extent of their wits toward maximizing their incomes, many of the nation’s best and brightest who had flocked to make money in banking left for other industries.

Then, in the 1980s, the Reagan administration unleashed a surge of deregulation. By 1999, the Glass-Steagall Act lay repealed. Banks could commingle with insurance companies at will. Ceilings on interest rates vanished. Banks could open branches anywhere. Unsurprisingly, the most highly educated returned to banking and finance. By 2005, the share of workers in the finance industry with a college education exceeded that of other industries by nearly 20 percentage points. By 2006, pay in the financial sector was again 70 percent higher than wages elsewhere in the private sector. A third of the 2009 Princeton graduates who got jobs after graduation went into finance; 6.3 percent took jobs in government.

Then the financial industry blew up, taking out a good chunk of the world economy.”

Maybe it’s just a general rule about balance.  If anything gets out of balance for long, especially in this modern scalable world where the imbalance may be very great compared to previous experiences, then danger and pain lie ahead.  We avoided a Great Depression this time (at least we have so far) but if we don’t start restoring more balance–whether it’s in budgets, trade, incomes or energy and transportation–then we’re just whistling in the dark.

Globalization’s Dark Threat to Developed Countries

Sunday, December 7th, 2008

There are basically two ways to gain large wealth.  One is to invent something dramatically better than existing products or systems, and then scale that invention around the world.  Think Microsoft and Bill Gates here.

The other way is to adopt technology and put it in some place where labor and/or tax rates are cheap.  Because the competitive advantage here depends upon exploitation of labor this is, basically, a “beggar they neighbor” technique.  Unfortunately for developed countries, they are the neighbors being beggared.

Developed countries do gain some advantages here.  Companies that manufacture equipment and systems for the new facilities in cheap labor countries make increased sales.  Consumers in developed countries will see some products drop in price because of the cheap labor now employed overseas making what had previously been made domestically.

The downside is obvious.  Developed countries lose jobs.  In order to stay competitive, domestic incomes have to drop towards the competition.  Unemployment can be a clue that something is wrong.  Increases in income disparity is another clue that something is amiss. 

Another possible problem not widely noted, is noted in this report at voxeu.org.   Apparently, in developed countries, governments spend more on social programs meant to mitigate economic shocks for citizens–in part because global trade integration exposes developed country citizens to more “frequent and intense shocks.”

We are now in a pretty “intense shock.”  How much of this shock can be attributed to our global integration?  Indirectly, the loss of manfacturing jobs and related industries over the past 30 years due to globalization transformed our economy into one of “consumption.”  What we were left to produce, instead of machines and productive invention, were primarily investment vehicles and hard or soft porn, all of which we spread around the world to almost everyone’s regret.

We have to restore some balance to our productive industries, and this will mean re-negotiating trade agreements.  We are no longer in a position to fund the development of developing countries.  At the moment we can’t even lend to ourselves without government assistance.

We should trade on a level playing field.  One based on quality, not one based on who pays their labor the least.




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