U.S. as a Capital Importer

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For a few years now, one of my mental images of the world economy is that the U.S. economy is by far the major importer of capital, while the major exporters of capital are China, Germany, and Japan. While that mental image remains true, the situation isn't as extreme as a few years back.

Here's are the pie graph for 2005, from the Global Financial Stability Report of the IMF. That year, the U.S. economy absorbed nearly two-thirds of all global capital imports. Japan was the major exporter of capital that hear, followed by China and Germany, with Saudi Arabia and Russia also playing large roles.

Now here's the comparable graph for 2011. The U.S. economy is now absorbing only about one-third of all global capital imports. Germany has become the world's largest capital exporter, edging out  China, and then followed by Saudi Arabia and Japan.

On the U.S. side, a large part  of what is driving this change is the reduction in the U.S. trade deficits. Here's a figure showing U.S. current account balances as a share of GDP, created with the ever-useful FRED website run by the St. Louis Fed. After the trade deficit had truly plummeted around 2006, at the worst of housing bubble, it is now back to the depths plumbed during the mid-1980s.


And here's a figure showing quarterly inflows of foreign capital to the U.S. economy. Notice how the U.S. economy became dramatically more dependent on inflows of foreign capital as the housing price bubble inflated during the mid-2000s. In addition, one the reasons behind the financial crisis and lack of available capital during the darkest times of late 2008 and early 2009 was that inflows of international dropped so dramatically--actually turning into outflows for a brief time. The inflow of international capital then rebounded before plummeting again, and turning into outflows during the second quarter of 2012.

Thus, it's fair to note that the U.S. economy is not absorbing the same share of global capital imports as it was a few years back--but it still absorbs an outsized share of global capital imports. In addition, the sharp drops in the quantities of foreign capital coming into the U.S. economy, both during the Great Recession and then from mid-2010 into early 2012, show how the U.S. has come to depend on these inflows of capital imports--and how the U.S. economy can be vulnerable to these inflows being disrupted.
 

Wealth-Income Ratios in the Long Run

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Thomas Piketty and Gabriel Zucman have been building up an intriguing set of estimates of wealth/income ratios, both over time and across countries. The U.S. wealth/income measures look quite mainstream by European standards, both in the last few decades and when looking back to 1870. The graphs that follow are from an October 2012 presentation called  "Capital is Back:Wealth-Income Ratios in Rich Countries 1870-2010." 

 Just to be clear, "income" to economists is a "flow" concept over a period of time--for example, it might be what you receive in compensation for your labor and in return on your savings in a certain year. Wealth, on the other hand, is a "stock" concept of the accumulation of assets over time--for a person, it would include the value of equity in your home, as well as the value of what's in your savings account or other financial investments. High income and wealth do tend to go together. But it's possible to have high income, spend it all, and have little wealth; alternatively, it's possible to have low income but steady saving, or perhaps the good luck to invest in the early days of IBM or Apple or Google, and end up with high wealth.

For starters, here's the wealth/income ratio for nine countries from 1970-2010. To help make sense of the graph, let's pick out a few of the countries. The line that peaks far above other countries in the middle of the figure, at around 700% in 1990, is Japan at the height of its stock market and property bubble. The country with the highest wealth/income level in 2010 was Spain, presumably driven by a property-market price bubble in that country. The line of black squares, marching higher in recent years, is Italy. In short, a high wealth/income ratio can be a danger signal of possible bubbles in asset markets. Meanwhile, fundamentally healthy economies like Germany (dark triangles) and Canada (light triangles) have seen a rise in wealth/income ratios, but are at the bottom of the range of this group of countries. The U.S. (hollow triangles) is in the middle of the pack. If you look closely, you can see a rise in the U.S. wealth/income ratio in the late 1990s for the dot-com bubble, and again in the mid-2000s for the housing price bubble, but the 2010 value for the U.S. is near the bottom of the range.



Now here's a longer-term perspective, from 1870 to 2010, comparing several major economies of Europe and the United States. In this long-run perspective, both Europe and the U.S. have had a U-shaped pattern of wealth/income ratios over time, but the European U rises higher and dips deeper than the American U.

Just what the wealth/income ratio telling us? Here are some thoughts:

1) When wealth/income spikes up, it's a potential danger sign of financial instability in the economy.

2) Wealth is typically much more concentrated than income, and so when the wealth/income ratio is high, the political power of those holding lots of assets is probably stronger. The power of mega-rich billionaires, not just in the U.S. and Europe, but also in China and across fast-growing economies of the world, is large and growing. 

3) The long-run data suggests that the wealth/income ratios observed from, say, 1940 up to about 1980, were historically on the low side. Thus, it may be that the rise in wealth/income ratios in the last few decades is a return to historical norms. (Piketty and Zucman make this case in more detail.)

4) As Picketty and Zucman write: "There’s nothing bad about the return of capital: k is useful; but it raises new issues about k regulation & taxation." In general, as wealth becomes relatively more important, it deserves a larger share of our social discussion and public policy attention.



For those who are interested, here's a post from June 13, 2012, on "Wealth by Distribution, Region, and Age" in the United States. 

Checkerboard Puzzle, Moore's Law, and Growth Prospects

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My father the mathematician first posed the checkerboard puzzle to me back in grade-school, perhaps on some rainy Saturday. His version of the story went something like this:

The jester performs a great deed, and the king asks him how he would like to be rewarded. The jester is aware that the king is a highly volatile individual, and if the jester asks for too much, the king might just kill him then and there. The jester also knows that the king views his promise as sacred, so if the king says "yes" to the jester's proposal, then the king will honor that promise. So in a way, the jester's problem is how to ask for a lot, but have the king at least initially think it's not very much, so that the king will give his consent.

So the jester clowns around a bit and then says: "Here's all I want. Take this checkerboard. On the first square, but one piece of gold. On the second square, two pieces. On the third square, four pieces, and on the fourth square, 8 pieces. Double the amount on each square until you reach the end of the checkerboard."

In the story, the king laughs at this comic proposal and says,  "Your great deed was so wonderful, I would have happily done much more than this! I grant your request!"

But of course, when the king starts hauling up gold pieces from the treasury, he will discover that 2 raised to the 63rd power, the final spot on the checkerboard requires about 9 quintillion gold pieces (that is, 9 followed by 18 zeros). 

I've had some sense of the power of exponential growth ever since.  But what I hadn't thought about is the interaction of Moore's Law and economic growth. Moore's Law is of course named for Gordon Moore, one of the founders of Intel, who noticed this pattern back in 1965. Back in the 1970s, he wrote a paper that contained the following graph showing how much it cost to produce a computer chip with a certain number of components. Here's his figure. Notice that the numbers of component on the horizontal axis and the cost figures on the vertical axis are both graphed as logarithm (specifically, each step up the axis is a change by a factor of 10). The key takeaway was that the number of transistors ("components") on an integrated circuit was doubling about every two years, making computing power much cheaper and faster.


Ever since I started reading up on Moore's law in the early 1980s, there have been predictions in the trade press that it will soon reach technological limits and come to and end. But Moore's law marches on: indeed, the research and innovation targets at Intel and other chip-makers are defined in terms of making sure that Moore's law continues to hold for at least awhile longer. Stephen Shankland offers a nice accessible overview of the current situation in an October 15, 2012, essay on CNET: ""Moore's Law: The rule that really matters in tech"  (The Gordon Moore graph above is copied from Shankland's essay.)

As Shankland writes: "To keep up with Moore's Law, engineers must keep shrinking the size of transistors. Intel, the leader in the race, currently uses a manufacturing process with 22-nanometer features. That's 22 billionths of a meter, or roughly a 4,000th the width of a human hair." He cites a variety of industry and research experts to the effect that Moore's law has at least another decade to run--and remember, a decade of doubling every two years means five more doublings!

It's hard to wrap one's mind around what it means to say that the power of microchipo technology will increase by a factor of 32 (doubling five times) in the next 10 years. A characteristically intriguing survey essay  from the January 10 issue of the Economist on the future of innovation uses the checkerboard analogy to think about the potential effects of Moore's law. Here's a comment from the Economist essay:

Ray Kurzweil, a pioneer of computer science and a devotee of exponential technological extrapolation, likes to talk of “the second half of the chess board”. There is an old fable in which a gullible king is tricked into paying an obligation in grains of rice, one on the first square of a chessboard, two on the second, four on the third, the payment doubling with every square. Along the first row, the obligation is minuscule. With half the chessboard covered, the king is out only about 100 tonnes of rice. But a square before reaching the end of the seventh row he has laid out 500m tonnes in total—the whole world’s annual rice production. He will have to put more or less the same amount again on the next square. And there will still be a row to go.

Erik Brynjolfsson and Andrew McAfee of MIT make use of this image in their e-book “Race Against the Machine”. By the measure known as Moore’s law, the ability to get calculations out of a piece of silicon doubles every 18 months. That growth rate will not last for ever; but other aspects of computation, such as the capacity of algorithms to handle data, are also growing exponentially. When such a capacity is low, that doubling does not matter. As soon as it matters at all, though, it can quickly start to matter a lot. On the second half of the chessboard not only has the cumulative effect of innovations become large, but each new iteration of innovation delivers a technological jolt as powerful as all previous rounds combined."

Now, it's of course true that doubling the capacity of computer chips doesn't translate in a direct way into a higher standard of living: there are many steps from one to the other. But my point here is to note that many of us (myself included) have been thinking about the changes in electronics technology a little too much like the king in the checkerboard story: that is, we think of something doubling a few times, even 10 or 20 times, and we know it's a big change, but it somehow seems within our range of comprehension.

But when something has already been doubling every 18 months or two years for a half-century--it is continuing to double!--the absolute size of each additional doubling is starting to get very large. I lack the imagination to conceive of what will be done with all this cheap computing power in terms of health care, education, industrial process, communication, transportation, entertainment, food, travel, design, and more. But I suspect that these enormous repeated doublings, as Moore's law marches forward in the next decade and drives computing speeds up and prices down, will transform lives and industries in ways that we are only just starting to imagine.

Why are U.S, Firms Holding $5 Trillion in Cash?

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One of the puzzles and frustrations of the sluggish economy since the official end of the Great Recession in June 2009 is that U.S. firms are holding enormous amounts of cash--about $5 trillion in 2011. A considerable number of pixels have been spent wondering why corporations seem so reluctant to spend, and how we might entice them to do so. But I had not know that the trend toward corporations holding more in cash very much predates the Great Recession; indeed, it was already apparent back in the 1990s. Thus, along with thinking about why events of the last few years have led corporations to hold more cash, we should be thinking about influences over the last couple of decades.

Juan M. Sánchez and Emircan Yurdagul lay out the issues in "Why Are Corporations Holding So Much Cash?" written for the Regional Economist magazine published by the Federal Reserve Bank of St. Louis.  The first graph shows "cash and short-term investments," which include all securities transferable to cash, going back to The second graph focuses just on nonfinancial, nonutility firms--thus leaving out banks, insurance companies, regulated power companies, and the like.There are some differences in timing, but the overall upward pattern is clear.



Of course, one reason for the rise in cash assets could just be overall growth of the economy. Thus, an alternative measure is to look at the ratio of cash to net assets of the firm. By this measure, which is probably more revealing, the growth of cash starts off around 1995, accelerates in the early 2000s, takes a step back in the Great Recession, and now has rebounded.

Broadly speaking, there are two reasons for firms to hold more cash: precautionary motives and repatriation taxes. Precautionary motives refer to the notion that firms operate in a situation of uncertainty, including uncertainty about what stresses or opportunities might arise, and whether they will be able to get a loan on favorable terms when they want it. Cash offers flexibility. The authors explain repatriation taxes this way: "[T]axes due to the U.S. government from corporations operating abroad are determined by the difference between the taxes already paid abroad and the taxes that U.S. tax rates would imply. Importantly, such taxation only takes place when earnings are repatriated. Therefore, firms may have incentives to keep foreign earnings abroad." To put it a little differently, if firms are thinking that they may wish to reinvest foreign profits in foreign operations, then the tax code gives them an incentive not to repatriate those profits.

Both of these factors surely make some difference, but Sánchez and Yurdagul also seek some insight into the question by looking at which industries, and which size firms, are more likely to be increasing their cash holdings. For example, information technology firms and firms focused on tech and hardware equipment are holding noticeably more in cash, although since the end of the housing bubble, building product companies have been sitting on a lot more cash, too.

When looking by size of firm, it's smaller firms that hold more cash. In part, this surely reflects that smaller firms are more vulnerable to ups and downs, and less likely to be confident that they have access to a loan when they want it. But interestingly, it's the second-smallest quintile of firms, not the smallest, that has seen the biggest rise in cash/asset ratios.

Ultimately, these arguments made me less confident that any particular policy was going to shake loose a big share of the $5 trillion cash hoard of U.S. firms. It's not quite clear to me why smallish-sized tech firms feel the need to hold so much cash, but they clearly have felt that way for a couple of decades now. In an globalizing economy, more U.S. firms are going to have foreign operations and to be focused on expanding those operations, so it's not clear to me that a much larger share of those foreign profits will be repatriated. The cash hoard of U.S. firms isn't just, or even mainly, a post-recession phenomenon.

Global R&D: An Overview

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Reinhilde Veugelers investigates the patterns of worldwide research and development spending in a Policy Contribution for the European think-tank Bruegel: "The World Innovation Landscape: Asia Rising?"  The results are a useful reminder that thinking of China and the rest of the emerging economies as depending on low wages to drive their economic growth is so very 20th century. In this century, China in particular is staking its future economic growth on R&D spending and innovation.

As a starting point, consider snapshots of global R&D spending in 1999 and in 2009. The share of global R&D spending done by the United States, the European Union, and Japan is falling, while the share done by China, South Korea, and other emerging economies is rising.

Looking at individual countries, China has now outstripped Japan for second place in global R&D spending, and China's R&D spending is similar to that of Germany, France, and Italy combined. 
Veugelers looks more closely at the group of seven countries that together account for about 71% of global R&D spending. Here is how much they spend on R&D as a percentage of their economies: by this measure, the U.S. economy does not especially stand out.

Veugelers also takes a more detailed look at government and private R&D spending in these seven countries, and finds some intriguing differences in priorities. For example, more than half of all U.S. government R&D spending goes to defense, a far higher share than any of these other countries. The U.S. government also commits a larger share of its R&D budget to health. South Korea and Germany stand out for having a greater share of their government R&D focuses on industrial production and technology. And a number of countries devote a larger share of their government R&D to the "Other" category, which includes "earth and space, transport, telecommunications, agriculture, education, culture, political systems."

In the private sector, a greater share of the U.S. private-sector R&D happens in the services sector, while the private sector in other countries focuses more of its R&D spending on machinery and equipment.

It's worth remembering that there's a lot more to innovation than just research and development spending. Yes, a nation that is the home of new innovation probably receives a disproportionate share of the gains in productivity as a result. But innovative discoveries can flow across national borders.The true economic gains from innovation are not from a discovery in a laboratory, but rather from the economic flexibility that translates the discovery into new products and jobs.

Does Income Bring Happiness?

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Back in 1974, Richard Easterlin published a paper called "Does Economic Growth Improve the Human Lot? Some Empirical Evidence" (available here and here, for example). Easterlin raised the possibility that what really matters to most people is not their absolute level of income, but their income level relative to others in society. If relative income is what matters, then an overall rise in incomes doesn't make me any better off relative to others, and so my happiness does not increase. Income becomes a sort of arms race: even as we all race to get more, it doesn't actually make us any happier.

Since then, the question of whether income brings happiness has been much-debated by economist and other social scientists. In "The New Stylized Facts about Income and Subjective Well-Being," Daniel W. Sacks, Betsey Stevenson, and Justin Wolfers offer a compact and readable summary of the evidence (much of which they generated in earlier research) that income is not just relative--and so more income does increase happiness. The paper is available as IZA Discussion Paper No. 7105, released in December.

At a basic level, this research looks at economic data on levels of income and compares it with survey data on on life satisfaction. For example, the Gallup World Poll provides data from 122 countries on the question: “Please imagine a ladder with steps numbered from zero at the bottom to ten at the
top. Suppose we say that the top of the ladder represents the best possible life for you, and the
bottom of the ladder represents the worst possible life for you. On which step of the ladder would
you say you personally feel you stand at this time?”

As a starting point, let's compare countries across the world in terms of real per capita GPD, along with their answers to this question on a scale from 0-10. The horizontal axis of the graph is a logarithmic scale: that is, rather than rising by a fixed amount between each tic mark, it rises by a fixed proportion (in this case, doubling) between each tic mark.

The general pattern is clear those in higher-income countries tend to report more life satisfaction. The best-fit straight line is drawn through the data. The much lighter dotted line is a "non-parametric" line which is a best-fit line that isn't required to be straight,and thus flattens out near the bottom and curves more steeply at the top than a straight line. Broadly speaking, it seems as if each doubling of income does lead to a distinct rise in the happiness scale, both for low-income and for high-income countries.

Of course, this result by itself doesn't prove the case either way. It could be that people in high-income countries are happier because they perceive that they are not in low-income countries, and so the happiness from their income is relative, rather than absolute. Thus, a second test is to look within individual countries at the happiness level of those with different income levels. If happiness from income is a relative concept, one might expect that, say, the rise in income from being a low-income person in the U.S to being a high-income person in the U.S. would bring more happiness, but the rise in happiness should be much less within a country than it would be across countries. However, the rise in happiness as a result of higher incomes within a country ends up looking very much like the relationship between countries.

Yet another test is to look at comparisons over time: that is, as economic growth gradually raises income levels, do people on average within a given country report a higher level of  happiness. The data here is harder to interpret, because long-run data on happiness measures isn't available for many countries, and the wording of the survey questions about life satisfaction often changes over time. While acknowledging that the existing evidence is messy and difficult to interpret firmly, the authors argue that it is at least consistent with the same finding: that is, higher income levels over time are correlated with higher reported life satisfaction.

But not for the United States! Sacks, Stevenson, and Wolfers write: "The US, however, remains a paradoxical counter-example: GDP has approximately doubled since 1972 and well-being, as measured by the General Social Survey, has decreased slightly." The authors point out that any individual country may have specific social changes that alter the reported "life satisfaction." In particular, they point out that inequality of income started rising in the U.S. economy in the 1970s, which may explain why the typical or median person in the economy isn't feeling much better off. They write: "We suggest that the US is more of an interesting outlier than a key example."

Those who want to sort through why Sacks, Stevenson, and Wolfers reach different conclusion from Easterlin can dig into the paper itself: a lot of the difference, they argue, is just that more and better data is available now.

For my own part, I confess that I find happiness surveys both intriguing and dubious. It seems to me that higher levels of income are typically correlated with more health, education, travel, consumption, and a higher quality of recreation, so it's not a surprise to me it seems to me that happiness rises iwth income. On the other side, it does seem to me that survey questions about life satisfaction are answered in the context of a particular place and time. If a person says that their life satisfaction was a 7 in 1960 on a scale of 0-10, and another person says that their life satisfaction is a 7 in 2013, are those two people really equally satisfied? To put it another way, if the person from 2013 was transported by a time machine back to live in 1960, with all their memories and knowledge of the technologies, medicines, foods, education, and travel available in 2013, would that time traveller really be equally happy in either time period? I suspect that when most people are asked to rank happiness on a scale of 0-10, they don't say to themselves: "Well, people living 100 years from now might have extraordinarily high levels of income and technology, so compared with them, I'm really no more than a 2." At best, survey questions on a scale of 0-10 seem like an extremely rough-and-ready way of measuring life satisfaction across very different countries or across substantial periods of time.

Plaudits for "The Instant Economist"

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Early in 2012, my book The Instant Economist: Everything You Need to Know About How the Economy Works, was published by Penguin Plume. Here's the Amazon link; here's the Barnes & Noble link. At the tail end of the year, the book was named an "Outstanding Academic Title" by Choice magazine, which is published by the American Library Association. It was also listed as one of the Best Books for 2012 in the "Business" category by Library Journal, another prominent trade publication for librarians. 

Here's the review from the August 2012 issue of Choice:

"Currently The Instant Economist is the most readable and up-to-date summary of a typical US college principles of economics course. Following the traditional table of contents--from microeconomics through macroeconomics and international topics--and using original, helpful metaphors (and only two graphs), Taylor (managing editor, Journal of Economic Perspectives) takes the reader through the terminology, key concepts, and controversies dominant in today's economics profession. Noteworthy additions to the standard textbook canon are a chapter on personal investing and detailed accounts of the minimum wage, corporate merger, and inequality debates, introducing readers to the data issues that lie behind these controversies. The 36 short chapters reflect the book's origin in the author's Teaching Company recording, Economics; however, the book is a valuable stand-alone option. For supplementary coverage of the history of
economic thought and more complete institutional context, see Robert Heilbroner and Lester Thurow's Economics Explained (4th ed., 1998; 1st ed., CH, Oct'82). Summing Up: Highly recommended. All levels of undergraduate students as well as general readers wanting a readable introduction to economics. -- M. H. Maier, Glendale Community College

And here's the review from the Library Journal:

"Taylor’s (managing editor, Journal of Economic Perspectives) volume can help conversationalists looking to raise the bar for their watercooler chats and casual readers who want to understand better the current economic condition of the United States. Taylor uses simple language with field-specific vocabulary to explain economic concepts, and each concept is successfully reinforced with a real-life—and usually entertaining—example. He hits all the subjects that might interest a layperson, such as division of labor, supply and demand, wages, competition and monopoly, inflation, banking, and trade, for a total of 36 petite chapters—just enough information to give the reader a basic but well-rounded understanding of the subject. VERDICT This highly readable, nonpoliticized look at some of the economic principles that shape our society, presented in an engaging, anecdotal fashion, is highly recommended for armchair economists and anyone with a general interest in the state of our economy. —Poppy Johnson-Renvall, Central New Mexico Community Coll. Lib., Albuquerque

As these reviews emphasize, the book is written for the general non-economist reader who would like to gain some insight into the terminology and structure of economic thinking. Those who are interested in knowing a bit more about the genesis of the book might check here.
As one of the reviews notes, this book was rooted in a course I several years ago for the Teaching Company, which is available here. Or if you are teaching or taking an introductory college-level course in economics, I of course recommend my Principles of Economics textbook, available here.