Ah yes, there's planning and then there's operations. Rarely do they coincide. What to do? This is one place where risk management comes in.
In an earlier post, I referred to a very large problem here in the Northwest caused by assuming past sales are a good predictor of future sales. Utility planning's failure to address sales risk led to literally billions in wasted money, money that could have been used to provide goods and service people wanted. This was quite a spectacular event. One result of that event was the creation of a new regional planning agency chartered by an act of Congress. Another result was a change in forecasting methods that contributed to this spectacular failure.
How does a small business with little money for sophisticated resources and guidance navigate these waters? One answer is to seek guidance from organizations like the Small Business Administration, USDA, and local and regional organizations established to provide technical assistance to such businesses.
There are some fairly simple methods that small businesses and start ups can use to try and at least narrow the amount of uncertainty they face. One approach is to develop multiple budgets. As was mentioned in an earlier post, it's often the case that a business oscillates between a conservative budget and a dream budget. This can be 'modeled' using what's called a triangular risk distribution.
Here's the approach,
1. Make a judgment call about what you think your most shaky variable is in your budget (there are likely more than one).
2. For that variable, determine what you think the most conservative value is, what you think a typical - or average value is, and what you think a very optimistic value is.
3. Build three budgets using the three values for what you consider the most risky element in your budget.
This is a very simple approach to do on your desktop in EXCEL. You can easily expand from one to more variables, with not too much more complication using EXCEL.
Now, one very subjective element of this approach is your personal attitude towards risk. What this means is different people have different reactions to risk. This is what underlies portfolio recommendations by age with a younger person advised to hold a riskier portfolio than someone closer to retirement.
This doesn't need to get fancy. When you've developed several different budgets, then step back and consider how you respond to risk. If you're more conservative, you'll prefer the budget somewhere between the most conservative you could think of and what you considered your average or expected budget. If you're more of a gambler, you'll prefer a budget somewhere between the expected budget and your aggressive one.
While this can be made very complex, and there are models that use large amounts of data to include risk in making decisions, that's not what we're talking about here. We don't want to go there. Though, we also don't want to just develop one budget and assume life will in fact mirror that budget. It will not.
Thursday, March 11, 2010
Monday, March 8, 2010
What About When Costs and Revenues Are Interdependent?
In the prior post, it was implicitly assumed that costs and revenues are independent. This is how you can develop costs and then determine needed revenues. What about when costs and revenues are interdependent?
It's not uncommon for costs and revenues to be interdependent. While discussions like those in the prior two posts are easier with an assumption of interdependence, this is not often the case. Some of the links mentioned in the prior post did touch on this issue. For example, one link raised issues like insufficient inventory or sales support staff when sales exceed expectations.
If your business has a fixed monthly payment for a space, such as a monthly lease, then this cost is clearly known. However, what if you rent space as the need arises? What if you're able to have all your costs as flexible - variable - as this? Here then, costs and revenues are interdependent. Thankfully, if you have very little lead time between incurring a cost and meeting a demand for your product or service, there's little problem with this type of interdependence.
However, when this lead time lengthens, for example, with advertising costs, staffing needs, space rental, it becomes more difficult to simplify the budgeting problem by working with costs. In these situations, costs and revenues are linked.
One other implication of this kind of linkage is that to simplify it as much as possible by keeping costs as variable as possible with the shortest lead times possible before needing to commit to a cost.
It's not uncommon for costs and revenues to be interdependent. While discussions like those in the prior two posts are easier with an assumption of interdependence, this is not often the case. Some of the links mentioned in the prior post did touch on this issue. For example, one link raised issues like insufficient inventory or sales support staff when sales exceed expectations.
If your business has a fixed monthly payment for a space, such as a monthly lease, then this cost is clearly known. However, what if you rent space as the need arises? What if you're able to have all your costs as flexible - variable - as this? Here then, costs and revenues are interdependent. Thankfully, if you have very little lead time between incurring a cost and meeting a demand for your product or service, there's little problem with this type of interdependence.
However, when this lead time lengthens, for example, with advertising costs, staffing needs, space rental, it becomes more difficult to simplify the budgeting problem by working with costs. In these situations, costs and revenues are linked.
One other implication of this kind of linkage is that to simplify it as much as possible by keeping costs as variable as possible with the shortest lead times possible before needing to commit to a cost.
Forecasting (Budgeting) When You Have Little Solid Data
In an earlier post, I raised the challenge of forecasting revenues for budgeting noting that it's likely the most challenging step in budgeting for a new business. One link that addresses this issue confirms that perspective. In this link, the authors talk about ways to narrow the range of uncertainty - risk - around what you think will happen by focusing on reactions to your pre-launch marketing survey.
Another link contains an interesting give and take with various people on this issue. One writer aptly notes that it's more art than science when you've really not got any good data. A post by rogercbryan on 1-4-08 contains a good deal of wisdom. Among his sage advice are the following:
- "Start with expenses, not revenues. When you're in the startup stage, it's much easier to forecast expenses than revenues"
He then includes some rules of thumb for cost forecasting that seem on point. Note: Much the same advice is contained in this link.
On revenue forecasting, he proposes that you "Forecast revenues using both a conservative case and an aggressive case. If you're like most entrepreneurs, you'll constantly fluctuate between conservative reality and an aggressive dream state..."
What's good in his advice is the idea of making multiple revenue forecasts. Very large multi-billion dollar businesses have made fatal errors by not forecasting multiple revenue scenarios. These multiple scenarios reflect different sales possibilities. Here in the Pacific Northwest, this very error was committed in the past with electric utility panning that ultimately led to billions of wasted dollars and mothballed and incomplete nuclear plants.
One approach I like is to work your cost numbers hard and gin up several different cost scenarios. Then, for each cost scenario, generate a revenue forecast - in terms of customers, product sold, prices, etc., that supports that cost scenario. Then, you step back and examine the various product sales projections, examine their likelihood, or what would need to happen for it to be true. At the beginning, this is again more art than science.
This is a way of being systematic and structured in your analysis, even in the presence of a great deal of uncertainty about both costs and revenues. Through this process, you'll document your assumptions. At this point, even though you have a great deal of uncertainty - risk - in your analysis, at least you've proceeded with a systematic approach. Now, subject your analysis to rigorous review by some others not involved with your dream. Use them to challenge your assumptions and analysis. Use them to identify what is strong and what is weak in your analysis.
Another link contains an interesting give and take with various people on this issue. One writer aptly notes that it's more art than science when you've really not got any good data. A post by rogercbryan on 1-4-08 contains a good deal of wisdom. Among his sage advice are the following:
- "Start with expenses, not revenues. When you're in the startup stage, it's much easier to forecast expenses than revenues"
He then includes some rules of thumb for cost forecasting that seem on point. Note: Much the same advice is contained in this link.
On revenue forecasting, he proposes that you "Forecast revenues using both a conservative case and an aggressive case. If you're like most entrepreneurs, you'll constantly fluctuate between conservative reality and an aggressive dream state..."
What's good in his advice is the idea of making multiple revenue forecasts. Very large multi-billion dollar businesses have made fatal errors by not forecasting multiple revenue scenarios. These multiple scenarios reflect different sales possibilities. Here in the Pacific Northwest, this very error was committed in the past with electric utility panning that ultimately led to billions of wasted dollars and mothballed and incomplete nuclear plants.
One approach I like is to work your cost numbers hard and gin up several different cost scenarios. Then, for each cost scenario, generate a revenue forecast - in terms of customers, product sold, prices, etc., that supports that cost scenario. Then, you step back and examine the various product sales projections, examine their likelihood, or what would need to happen for it to be true. At the beginning, this is again more art than science.
This is a way of being systematic and structured in your analysis, even in the presence of a great deal of uncertainty about both costs and revenues. Through this process, you'll document your assumptions. At this point, even though you have a great deal of uncertainty - risk - in your analysis, at least you've proceeded with a systematic approach. Now, subject your analysis to rigorous review by some others not involved with your dream. Use them to challenge your assumptions and analysis. Use them to identify what is strong and what is weak in your analysis.
Starting a new Business - A Flight into the Unknown
Where I live - Joseph, Oregon - there's a group of people who want to start a new art school. They're starting a new non-profit group, working to bring in people from other places to teach, want to buy two older buildings, and want to do all of this at the same time with virtually no money. This is a good example of how to start a new business with an immense amount of risk.
Are all these ideas worthy? Sure. Why not? Yet, that's not the question. One good question is what are the priorities? What do you really want to do? What do you really want to accomplish? What is your primary purpose?
Start-ups need cash reserves. Start-ups don't have a track record which significantly complicates budgeting. Under such conditions, budgeting is a shot in the dark. Because of the great many unknowns a start-up faces, there's a need to build in a lot of ability to flex with circumstances you really have very little idea about.
Not only are costs challenging to scope, they are probably easier to scope than revenues. This is especially true when there is little hard data that can be used to firm up the revenue forecasts. Now, people will say "oh, that's not really that much of a problem. There's other places that hold art classes and we can just use their experience." There's a host of reasons why that view is dangerous.
Extrapolating from the experience of other's - which is what that argument amounts to - is problematic. There's a good deal of statistical discussion on this issue - extrapolating beyond your data. By it's very nature, extrapolation is a journey into the unknown. It might be the best you've got. Here's the thing though, you need to look at the broader circumstances of the experience of others and compare those circumstances to your own to come to some sense of how relevant their experience is to your new enterprise.
I'm not saying it's a wrong path to travel down. Rather, that you need to be cautious as you travel down that path. I've seen people who are really just grasping for confirmation grab onto whatever data they can get their hands on as justification for what they want to be true. Whether it's actually true or not is another story, and people who question such approaches are sometimes treated as inconvenient pessimists.
Are all these ideas worthy? Sure. Why not? Yet, that's not the question. One good question is what are the priorities? What do you really want to do? What do you really want to accomplish? What is your primary purpose?
Start-ups need cash reserves. Start-ups don't have a track record which significantly complicates budgeting. Under such conditions, budgeting is a shot in the dark. Because of the great many unknowns a start-up faces, there's a need to build in a lot of ability to flex with circumstances you really have very little idea about.
Not only are costs challenging to scope, they are probably easier to scope than revenues. This is especially true when there is little hard data that can be used to firm up the revenue forecasts. Now, people will say "oh, that's not really that much of a problem. There's other places that hold art classes and we can just use their experience." There's a host of reasons why that view is dangerous.
Extrapolating from the experience of other's - which is what that argument amounts to - is problematic. There's a good deal of statistical discussion on this issue - extrapolating beyond your data. By it's very nature, extrapolation is a journey into the unknown. It might be the best you've got. Here's the thing though, you need to look at the broader circumstances of the experience of others and compare those circumstances to your own to come to some sense of how relevant their experience is to your new enterprise.
I'm not saying it's a wrong path to travel down. Rather, that you need to be cautious as you travel down that path. I've seen people who are really just grasping for confirmation grab onto whatever data they can get their hands on as justification for what they want to be true. Whether it's actually true or not is another story, and people who question such approaches are sometimes treated as inconvenient pessimists.
Wednesday, February 17, 2010
De-Regulation and Economic Implosion
There's been some interesting news the last few days.
1. Evan Byah retiring.
For some odd reason, he's being portrayed as a centrist democrat. I think Bill Mahar is right on labeling him a corporatist.
2. Frontline Program on Derivatives Regulation
They ran a great overview of the political and personal dynamics that underlies how the fierce opposition to regulating derivatives led to the financial implosion. They did a good job of showing how Brooksley Born was demolished in her attempt to promulgate regulating derivatives. Those who have followed this story have known about her efforts for over a decade. This show first aired in October '09.
Frontline on derivatives.
3. De-regulation under Clinton and U.S. Employment
I hope - but sadly doubt - that this story helps to re-write the role of Bill Clinton in de-regulating so much of the economy and thereby help set up the massive financial implosion and job exodus from the U.S. to China. Frontline did a story some time ago titled "Is Wall-Mart Good for America?" That program lays out the domestic economic impacts of the Clinton's trade policy with China that opened the door to massive job exodus to China, largely to the benefit not of consumers but of Wall-Mart stock holders.
1. Evan Byah retiring.
For some odd reason, he's being portrayed as a centrist democrat. I think Bill Mahar is right on labeling him a corporatist.
2. Frontline Program on Derivatives Regulation
They ran a great overview of the political and personal dynamics that underlies how the fierce opposition to regulating derivatives led to the financial implosion. They did a good job of showing how Brooksley Born was demolished in her attempt to promulgate regulating derivatives. Those who have followed this story have known about her efforts for over a decade. This show first aired in October '09.
Frontline on derivatives.
3. De-regulation under Clinton and U.S. Employment
I hope - but sadly doubt - that this story helps to re-write the role of Bill Clinton in de-regulating so much of the economy and thereby help set up the massive financial implosion and job exodus from the U.S. to China. Frontline did a story some time ago titled "Is Wall-Mart Good for America?" That program lays out the domestic economic impacts of the Clinton's trade policy with China that opened the door to massive job exodus to China, largely to the benefit not of consumers but of Wall-Mart stock holders.
Thursday, January 28, 2010
Employment Much Worse in this Recession
Below are three charts comparing unemployment and labor force growth in this recession compared to other post WWII recessions. NOTE: Click on a chart to open it larger in a separate window.
Before we get into the charts, these charts certainly underscore the critical need to do much more for job growth than worrying about debt. The Obama Administration and Congress really need to place a much greater emphasis on jobs. This is both a Main Street issue and is also a key piece of shoring up the housing sector.
Looking at Chart 1, it's sobering to see how much higher unemployment has risen, and how fast it's risen in this recession, compared to other recessions. Keep in mind that the vertical axis is percent so the fact that the labor force itself is larger is not a factor in these results. The unemployment rate is a ratio determined by dividing total unemployment by the total labor force. Chart 1 shows that jobs have been shed at a much greater rate than in previous recessions. I suspect that's due to (a) fewer restrictions on an employer's ability to reduce their workforce, and (b) employer's perception of the likely depth and length of the recession.
What I find even more shocking is Chart 2, the percentage change in the civilian employment by month across post WWII recessions (Charts 1 and 2 aren't directly comparable). Chart 2 is just the monthly percent change in civilian employment and it's a dramatic drop.
Chart 3 shows the percentage change by month of the civilian labor force. The civilian labor force is defined as people 16 years old or older who are not in the military, prison, institution, school and are employed or looking for work. Chart 3 shows that the civilian labor force kept growing, but at a slowing rate, up until about this past October. Then, the civilian labor force actually began to shrink.
A drop in civilian labor force can be due to a variety of reasons though a significant reason right now is it likely reflects people dropping out of the labor force as they stop looking for work. Another factor may be immigrants, legal and otherwise, returning to their prior home since labor force includes U.S. citizens as well as legal and illegal aliens. One aspect of the labor force decline that concerns me is I suspect there's a good deal of older folks (over 40) in this pool whose jobs are not likely to return. This type of unemployment problem is called structural unemployment. It's the most difficult type of unemployment to solve. Another concern with a declining labor force is that it also reduces what the economy can produce, absent an offsetting productivity gain.
Before we get into the charts, these charts certainly underscore the critical need to do much more for job growth than worrying about debt. The Obama Administration and Congress really need to place a much greater emphasis on jobs. This is both a Main Street issue and is also a key piece of shoring up the housing sector.
Looking at Chart 1, it's sobering to see how much higher unemployment has risen, and how fast it's risen in this recession, compared to other recessions. Keep in mind that the vertical axis is percent so the fact that the labor force itself is larger is not a factor in these results. The unemployment rate is a ratio determined by dividing total unemployment by the total labor force. Chart 1 shows that jobs have been shed at a much greater rate than in previous recessions. I suspect that's due to (a) fewer restrictions on an employer's ability to reduce their workforce, and (b) employer's perception of the likely depth and length of the recession.
What I find even more shocking is Chart 2, the percentage change in the civilian employment by month across post WWII recessions (Charts 1 and 2 aren't directly comparable). Chart 2 is just the monthly percent change in civilian employment and it's a dramatic drop.
Chart 3 shows the percentage change by month of the civilian labor force. The civilian labor force is defined as people 16 years old or older who are not in the military, prison, institution, school and are employed or looking for work. Chart 3 shows that the civilian labor force kept growing, but at a slowing rate, up until about this past October. Then, the civilian labor force actually began to shrink.
A drop in civilian labor force can be due to a variety of reasons though a significant reason right now is it likely reflects people dropping out of the labor force as they stop looking for work. Another factor may be immigrants, legal and otherwise, returning to their prior home since labor force includes U.S. citizens as well as legal and illegal aliens. One aspect of the labor force decline that concerns me is I suspect there's a good deal of older folks (over 40) in this pool whose jobs are not likely to return. This type of unemployment problem is called structural unemployment. It's the most difficult type of unemployment to solve. Another concern with a declining labor force is that it also reduces what the economy can produce, absent an offsetting productivity gain.
For a bit of good news, Chart 6 illustrates that the official unemployment rate is nowhere near the official rate of the Great Depression. By official unemployment rate I mean to suggest that the actual unemployment rate is greater. The official rate does not count people who would like a job but have stopped looking for work. These people are referred to as discouraged, despite whatever they might be called on FOX News!
Wednesday, January 27, 2010
Bankers, Economics, and when will Obama REALLY Work for Main Street?
Joseph Stiglitz spoke today at the Davos World Economic Forum. In a wide-ranging talk, Bloomberg reports that he chastised bankers for creating 'negative value' for society. Reuters reports that banks are doubling-down on risk.
No doubt there are those that argue that bankers are just being rational when using government bail out money to make money for the bank's shareholders. These folks argue that it's not the banks fault. Rather, it's government's fault for not instituting the 'correct' rules. Yes, let's blame the rape victim for the rape. What me? I did nothing wrong. I was presented with such an opportunity that any hot blooded male would have done the same thing. Right.
I, for one, supported the bank bailouts. I still do. There was a problem with not putting stringent lending strings and so forth on those bailouts. That's why Tim Geitner and others need to be replaced. They never should have been part of the Obama Administration. Though, law is conservative, and Obama has certainly been conservative in his economic support for the middle class.
The Administration's recently announced measures aimed at the middle class are like feeding crumbs to the people of Haiti. Sure, they'll take those crumbs. What would you do? I would. That doesn't absolve Obama of his insane economic policies, the latest one being a spending freeze. Recall that during the campaign, McCain proposed such a policy and candidate Obama ridiculed it saying it was like using a hatchet when what you need is a scalpel. He's just handed the opposition a gift. As Krugman rightly points out, it's a stupid, cynical, wrong-headed political stunt. In an earlier post, I addressed the need for more stimulus spending rather than addressing the debt. Professor of Economics James Galbraith characterized the spending freeze proposal as like tossing red meat to the sharks in hopes that the sharks won't go after the people. Ouch. He's right, in my view.
Robert Reich hit the nail on the head in saying "...Obama’s package of middle class benefits is small potatoes. They’re worthwhile but they pale relative to the size and scale of the challenge America’s middle class is now facing. Obama can no longer afford to come up with lists of nice things to do. At the least, he’s got to do two very big and important things: (1) Enact a second stimulus. It should mainly focus on bailing out state and local governments that are now cutting services and raising taxes, and squeezing the middle class. This would be the best way to reinvigorate the economy quickly. (2) Help distressed homeowners by allowing them to include their mortgage debt in personal bankruptcy — which will give them far more bargaining leverage with morgage lenders. (Wall Street hates this.)"
Rachel Maddow had a great segment last evening in which she showed a series of bar charts on GDP and job losses by quarter for the last two years of the Bush Administration and the results during the Obama Administration. The results are striking, GDP growth and the reduced job loss numbers are a good start at turning the economy around. The economy has begun to recover, and the banking sector's not on it's death bed. This is the beginning of a recovery. Yet, what's your view of how the Obama Administration has done? They have both houses of Congress, 59 seats in the Senate (more than the R's had at the end of the Bush years) and what does Obama propose? A spending freeze. As Ms. Maddow put it "there he is on the one yard line and what does he decide to do? He decides to punt from the one yard line rather than driving it in for the score."
Monday, December 28, 2009
The 'Chicago School' and the Real World of Human Beings - Minimum Wage
Recently, some people have argued that the minimum wage should be reduced to employ more people. Krugman has posted several responses to this proposal. Since I've linked them, you may read his analysis of this proposal.
We do know that from the view of an individual employer, he/she will likely argue that if they paid their employees less, they'd be able to hire people for more hours. Whether this leads to more income overall is questionable. Though that is a question. From Econ 201 (literally), minimum wage lies above the equilibrium wage in the labor market, by definition otherwise you don't need minimum wage. This then leads to a quantity supplied of labor greater than the quantity demanded by employers. This is usually as far as the analysis is taken. What about the view from the economy as a whole?
Recall that a 'factor of demand' that is, one of the 'things' that affect demand for goods in the economy is income. Now income and a wage are two different things, but let's just say that a cut in wages is a cut in income and vice versa (this is the assumption that minimum wage critics use). Higher minimum wage leads to more income and then leads to more goods being demanded. In turn, since the demand for labor is what's called a 'derived demand,' the higher demand for goods by workers leads to higher demand for labor by employers. In this way, a higher minimum wage can lead to more people being employed than before the minimum wage was increased.
People will counter with:
1. Higher minimum wage will lead to lower profits for the employer.
Perhaps. Not clear though given the higher sales from people having more income. Let's say it does lead to lower profit. Yes, the employer will buy less stuff. Though, I suspect the minimum wage employee will spent a greater percentage of his/her income than will the employer, though there will certainly likely be cases where this is not so.
What strikes me about this entire argument is how self-serving it is.
The July 18, 2009 issue of the Capitol Times notes the following:
""The source of wealth has changed over the past 30 years; corporations have become the engine of inequality in the U.S.," says Sam Pizzigati, associate fellow at the Institute for Policy Studies in Washington D.C. "In the past, wealth came from ownership: Today it comes increasingly from income."
The highest incomes come from executive pay at top corporations. In 2007, the ratio of CEO pay to the average paycheck was 344 to 1, lower than the record 525 to 1 ratio set in 2001, but substantial.
This year's ratio is estimated to decrease to 317 to 1. In the '60s, '70s and '80s, the average ratio fluctuated between 30 and 40 to 1.
Over 40 percent of GNP comes from Fortune 500 companies. According to the World Institute for Development Economics Research, the 500 largest conglomerates in the U.S. "control over two-thirds of the business resources, employ two-thirds of the industrial workers, account for 60 percent of the sales, and collect over 70 percent of the profits."
Corporations systematically created a wealth gap over the last 30 years. In 1955, IRS records indicated the 400 richest people in the country were worth an average $12.6 million, adjusted for inflation.
In 2006, the 400 richest increased their average to $263 million, representing an epochal shift of wealth upward in the U.S.
In 1955, the richest tier paid an average 51.2 percent of their income in taxes under a progressive federal income tax that included loopholes. By 2006, the richest paid only 17.2 percent of their income in taxes. In 1955, the proportion of federal income from corporate taxes was 33 percent; by 2003, it decreased to 7.4 percent. Today, the top taxpayers pay the same percentage of their incomes in taxes as those making $50,000 to $75,000, although they doubled their share of total U.S. income.
"Over the past 30 years, the income of the top 1 percent, adjusted for inflation, doubled: the top one-tenth of 1 percent tripled, and the top one-one-hundredth quadrupled," says Pizzigati. "Meanwhile, the average income of the bottom 90 percent has gone down slightly. This is a stunning transformation."
Meanwhile, wages for most Americans didn't improve from 1979 to 1998, and the median male wage in 2000 was below the 1979 level, despite productivity increases of 44.5 percent. Between 2002 and 2004, inflation-adjusted median household income declined $1,669 a year. To make up for lost income, credit card debt soared 315 percent between 1989 and 2006, representing 138 percent of disposable income in 2007. "
We do know that from the view of an individual employer, he/she will likely argue that if they paid their employees less, they'd be able to hire people for more hours. Whether this leads to more income overall is questionable. Though that is a question. From Econ 201 (literally), minimum wage lies above the equilibrium wage in the labor market, by definition otherwise you don't need minimum wage. This then leads to a quantity supplied of labor greater than the quantity demanded by employers. This is usually as far as the analysis is taken. What about the view from the economy as a whole?
Recall that a 'factor of demand' that is, one of the 'things' that affect demand for goods in the economy is income. Now income and a wage are two different things, but let's just say that a cut in wages is a cut in income and vice versa (this is the assumption that minimum wage critics use). Higher minimum wage leads to more income and then leads to more goods being demanded. In turn, since the demand for labor is what's called a 'derived demand,' the higher demand for goods by workers leads to higher demand for labor by employers. In this way, a higher minimum wage can lead to more people being employed than before the minimum wage was increased.
People will counter with:
1. Higher minimum wage will lead to lower profits for the employer.
Perhaps. Not clear though given the higher sales from people having more income. Let's say it does lead to lower profit. Yes, the employer will buy less stuff. Though, I suspect the minimum wage employee will spent a greater percentage of his/her income than will the employer, though there will certainly likely be cases where this is not so.
What strikes me about this entire argument is how self-serving it is.
The July 18, 2009 issue of the Capitol Times notes the following:
""The source of wealth has changed over the past 30 years; corporations have become the engine of inequality in the U.S.," says Sam Pizzigati, associate fellow at the Institute for Policy Studies in Washington D.C. "In the past, wealth came from ownership: Today it comes increasingly from income."
The highest incomes come from executive pay at top corporations. In 2007, the ratio of CEO pay to the average paycheck was 344 to 1, lower than the record 525 to 1 ratio set in 2001, but substantial.
This year's ratio is estimated to decrease to 317 to 1. In the '60s, '70s and '80s, the average ratio fluctuated between 30 and 40 to 1.
Over 40 percent of GNP comes from Fortune 500 companies. According to the World Institute for Development Economics Research, the 500 largest conglomerates in the U.S. "control over two-thirds of the business resources, employ two-thirds of the industrial workers, account for 60 percent of the sales, and collect over 70 percent of the profits."
Corporations systematically created a wealth gap over the last 30 years. In 1955, IRS records indicated the 400 richest people in the country were worth an average $12.6 million, adjusted for inflation.
In 2006, the 400 richest increased their average to $263 million, representing an epochal shift of wealth upward in the U.S.
In 1955, the richest tier paid an average 51.2 percent of their income in taxes under a progressive federal income tax that included loopholes. By 2006, the richest paid only 17.2 percent of their income in taxes. In 1955, the proportion of federal income from corporate taxes was 33 percent; by 2003, it decreased to 7.4 percent. Today, the top taxpayers pay the same percentage of their incomes in taxes as those making $50,000 to $75,000, although they doubled their share of total U.S. income.
"Over the past 30 years, the income of the top 1 percent, adjusted for inflation, doubled: the top one-tenth of 1 percent tripled, and the top one-one-hundredth quadrupled," says Pizzigati. "Meanwhile, the average income of the bottom 90 percent has gone down slightly. This is a stunning transformation."
Meanwhile, wages for most Americans didn't improve from 1979 to 1998, and the median male wage in 2000 was below the 1979 level, despite productivity increases of 44.5 percent. Between 2002 and 2004, inflation-adjusted median household income declined $1,669 a year. To make up for lost income, credit card debt soared 315 percent between 1989 and 2006, representing 138 percent of disposable income in 2007. "
Monday, December 21, 2009
Structure-Conduct-Performace
One way I've found that's helpful in organizing information for doing policy analysis is using this Structure-Conduct-Performance (SCP) framework. One thing I like about it is I'm able to use economic principles and purge out all the material like dead weight loss, inefficiency of government 'intervention' and so forth. There's a great deal of micro principles that are useful in helping evaluate possible impacts of a policy. For example, we can still use all the price analysis, elasticity concepts, the crucial concept of opportunity cost, and the notions of inter-dependence between markets as well as using these tools to predict who might win and who might lose.
The Structure pertains to the rules, laws, prices, and so forth that are relevant to the policy you are examining. What gets included under Structure is quite flexible. Generally, think of it as whatever you understand as important to the evaluation you are conducting that is presently in existence and considered critical to describing the problem you're hoping to solve.
The Conduct pertains to the choices that various players make in response to the Structure as it currently exists. For example, by choice we could be referring to how much electricity a customer uses given the prices, technology, income, and other traits that are known to affect consumption.
The Performance pertains to what are the value of key outcomes you are concerned with. For example, the amount of electricity used at a given time of day, or month of the year and so forth.
Note that there's some flexibility between what you consider Conduct and what you consider Performance. One way to think about this distinction is the Performance are the dependent variables that you would like to impact and the Conduct are the independent variables that pertain to actions by one or more parties. In my example, it would be the consumer's use of electricity. Note also that there may be other variables, and virtually always will be other variables, that influence the dependent variable(s). If they are not associated with choices by some party, then they describe aspects of the Structure that are considered important. I use this equation structure loosely as a way to give you a sense of how to organize the SCP concepts.
Then, we can use analysis, information, theory and so forth to test various hypotheses. For example, let's say we want to reduce electric use overall. If we have information from some studies on electric use and prices, we might be able to propose how to change the current Structure in order to affect consumer Conduct sufficient to after Performance by reducing electric use by the desired amount.
As you can see, the SCP is a shell that has great flexibility. What I like about it is it's provides a systematic way to gather and organize information. It doesn't tell you what to do or what not to do. That's one of it's benefits over the partial equilibrium comparative statics model (PECS) from micro economics, although we still need to rely on the analysis tools of the PECS model that helps us predict impacts. Another aspect of the SCP framework that I like is it allows for all sorts of information to be combined. This might include assessment of the how receptive consumers might be to the proposed prices change. Or, what consumers might support it and what consumers might oppose it. It also allows for consideration of the chance of confronting a legal challenge on procedural and/or substantive grounds, for example.
I've seen decision-makers discuss and reach decisions, often in a convoluted way. This SCP framework can also be helpful to the analyst responsible for organizing information for both analysis and presentation.
The Structure pertains to the rules, laws, prices, and so forth that are relevant to the policy you are examining. What gets included under Structure is quite flexible. Generally, think of it as whatever you understand as important to the evaluation you are conducting that is presently in existence and considered critical to describing the problem you're hoping to solve.
The Conduct pertains to the choices that various players make in response to the Structure as it currently exists. For example, by choice we could be referring to how much electricity a customer uses given the prices, technology, income, and other traits that are known to affect consumption.
The Performance pertains to what are the value of key outcomes you are concerned with. For example, the amount of electricity used at a given time of day, or month of the year and so forth.
Note that there's some flexibility between what you consider Conduct and what you consider Performance. One way to think about this distinction is the Performance are the dependent variables that you would like to impact and the Conduct are the independent variables that pertain to actions by one or more parties. In my example, it would be the consumer's use of electricity. Note also that there may be other variables, and virtually always will be other variables, that influence the dependent variable(s). If they are not associated with choices by some party, then they describe aspects of the Structure that are considered important. I use this equation structure loosely as a way to give you a sense of how to organize the SCP concepts.
Then, we can use analysis, information, theory and so forth to test various hypotheses. For example, let's say we want to reduce electric use overall. If we have information from some studies on electric use and prices, we might be able to propose how to change the current Structure in order to affect consumer Conduct sufficient to after Performance by reducing electric use by the desired amount.
As you can see, the SCP is a shell that has great flexibility. What I like about it is it's provides a systematic way to gather and organize information. It doesn't tell you what to do or what not to do. That's one of it's benefits over the partial equilibrium comparative statics model (PECS) from micro economics, although we still need to rely on the analysis tools of the PECS model that helps us predict impacts. Another aspect of the SCP framework that I like is it allows for all sorts of information to be combined. This might include assessment of the how receptive consumers might be to the proposed prices change. Or, what consumers might support it and what consumers might oppose it. It also allows for consideration of the chance of confronting a legal challenge on procedural and/or substantive grounds, for example.
I've seen decision-makers discuss and reach decisions, often in a convoluted way. This SCP framework can also be helpful to the analyst responsible for organizing information for both analysis and presentation.
Economics and Policy
Economists, or many of us, LOVE to tell decision-makers what they ought to do. Though, far too many of those in the profession also want to cling to the illusion that they are also being 'objective.' Oh, yes, don't you know that economics is a 'positive' science? Positive as in 'objective' and 'value neutral.'
One might reasonably ask how a profession that deals to such a degree with money, and writes so extensively about what does and does not constitute value, can possibly think of itself as being value neutral. Thankfully, there are esteemed practitioners of the craft who know otherwise. Of course, they are seen as being a minority of crack pots. Or worse, they are labeled as journalists or sociologists. But whose complaining?
Sadly for those who continue to swallow the cool aid, such eminent economists as Joan Robinson are among the ranks of economists who understood how economics can better serve society. Stiglitz has written cogently about development after his stint as the chief economist of the World Bank and it's senior vice president. Baumol wrote years ago that economics is more like biology than physics even though physics type models were more the type employed in the profession.
What has worked for me is to borrow the structure-conduct-performance framework from Industrial Organization and apply it to policy. I'll describe how I use this approach in a subsequent post.
One might reasonably ask how a profession that deals to such a degree with money, and writes so extensively about what does and does not constitute value, can possibly think of itself as being value neutral. Thankfully, there are esteemed practitioners of the craft who know otherwise. Of course, they are seen as being a minority of crack pots. Or worse, they are labeled as journalists or sociologists. But whose complaining?
Sadly for those who continue to swallow the cool aid, such eminent economists as Joan Robinson are among the ranks of economists who understood how economics can better serve society. Stiglitz has written cogently about development after his stint as the chief economist of the World Bank and it's senior vice president. Baumol wrote years ago that economics is more like biology than physics even though physics type models were more the type employed in the profession.
What has worked for me is to borrow the structure-conduct-performance framework from Industrial Organization and apply it to policy. I'll describe how I use this approach in a subsequent post.
Thursday, December 3, 2009
"Mainstream" Economics, Heterodox Economics, and the Real World
This post picks up a thread begun in one of my first posts. How can economics be helpful to "real world" choices.
Within the profession, academic prestige comes with publishing in the 'elite' journals and getting contracts from the 'elite' sources. Unfortunately, for the most part, publishing in those 'elite' journals has little to do with solving actual problems of actual people. This system goes so far as to purge those economists from the ranks of the well regarded who have the temerity to challenge the Economic Gods of efficiency and objectivity.
Thankfully, there are those practitioners who take the path less traveled - as Thoreau put it - by most academic economists and actually work in the area of pragmatic problem solving. They are scattered around the profession. While a student at Michigan State University, I encountered Warren Samuels, A. Allan Schmid, Harry Trebing, and James Schaffer who at the time were among the main flag bearers of Institutionalist Economics.
Within the profession, academic prestige comes with publishing in the 'elite' journals and getting contracts from the 'elite' sources. Unfortunately, for the most part, publishing in those 'elite' journals has little to do with solving actual problems of actual people. This system goes so far as to purge those economists from the ranks of the well regarded who have the temerity to challenge the Economic Gods of efficiency and objectivity.
Thankfully, there are those practitioners who take the path less traveled - as Thoreau put it - by most academic economists and actually work in the area of pragmatic problem solving. They are scattered around the profession. While a student at Michigan State University, I encountered Warren Samuels, A. Allan Schmid, Harry Trebing, and James Schaffer who at the time were among the main flag bearers of Institutionalist Economics.
One thing that strikes me about 'mainstream' economists and economics overall is its desire to offer policy prescriptions and guidance while at the same time wanting to be seen as being objective. Ah, who doesn't want to have his/her cake and be able to eat it too? What I've worked to do is use tools from price theory, for example, and purge all the prescriptive stuff as much as possible. I worked setting electric rates for half the wholesale electricity used in the Pacific Northwest. Guidance like marginal cost pricing is useful AND how that's done etc. is a crucial part of the problem solving process. And, as you know, that part isn't of much interest to mainstream economics as it's practiced today. That, of course, is an understatement. The 'How' of policy work is derided as having nothing to do with economics. Rather, that's political science, sociology, psychology, history, and so forth. As Karl Marx quipped "History is economics in action." While in the 'real world' economics and politics are inseparable, in the fantasy world of the High Priests of the profession, there is absolutely NO room for such matters (and I include Gary Becker in that camp).
I like the structure-conduct-performance framework from Industrial Organization as a policy analysis framework, again purging as many of the 'shoulds' as possible from the economic principles. As I see it, there's no reasons to throw the baby out with the bath water! Opportunity cost is a wonderfully powerful concept. When I'm teaching, I simply do not teach the stuff about 'deadweight loss,' the inefficiency of government 'intervention' into the market etc. etc. I do talk about how the government is an integral part of the market economy since without rules and a way to enforce them via contract and the courts, there is no market. To drive the point home, without government there is no market!
What I've worked to do is blend some very useful tools from price theory, like elasticity and opportunity cost to name but two useful concepts, along with more pragmatic ways to solve actual, 'on the ground,' problems. I do strongly feel that there's a good deal of microeconomics that is essential and very useful to help solve and frame solutions to 'real world' problems. And, there's a whole lot of the inefficiency, deadweight loss, etc, etc, stuff that is so tied to the prescriptive aspects of partial equilibrium - comparative statics model as to be useless at best and darn right dangerous at worst.
I shifted from economics as an undergraduate student to Ag. economics as a graduate student for these reasons. I suspect you might find some fertile fields for real-world policy analysis in the heterodox approach.
Tuesday, December 1, 2009
When $4 per gallon gas was cheap
One aspect of the growing deficit and debt problem that I've noted that I was not addressed is it's impact on the value of the U.S. dollar on world currency markets. I want to address this issue here.
One very provocative commentary from the Financial Times of London concisely lays out the problem. World currency markets are another kind of market where the value of the U.S. dollar in terms of any other world currency is determined by the demand for and the supply of dollars on world markets. Much the same points were made today by Yale Finance professor Jeffrey Garten. An extended article on these dynamics written by Doug Noland from The Asia Times is available here. One of Doug Noland's more unsettling passages is his view about what's needed from the U.S. "It is my thesis that there is no alternative other than a major transformation of the underlying structure of the US economy. In simplest terms, we must produce much more, consume much less and do it with a lot less credit creation. "
The underlying gist is that our debt levels cannot be reduced through spending cuts or tax hikes since the magnitudes required are politically untenable. Given the political gridlock we're in, he's probably right. Therefore, the only way left to reduce the U.S. federal debt is to decrease the dollar's value. We do this by lowering the value of the dollar on world markets. Since the dollar's value is not fixed, but rather is determined by the market itself, we have to use tools to 'influence' the dollar's value. (NOTE: Reducing the dollar's value on world markets is different from the term 'deflation' used to describe the situation when the price level in the economy drops).
When countries want to hold fewer dollars, they put them up for sale. This increases the supply of dollars on world markets. Without a counter-veiling increase in the demand for dollars, the dollar's value falls relative to other currencies. While the linked writings above assume that foreign holders of U.S. dollars will release some of those dollars, I have a question about how they go about doing that knowing that doing so will likely result in a drop in the value of their remaining dollar holding. The U.S. government can increase dollars on world markets not by "printing" money. Rather, they buy U.S. government securities from holders like banks and large investors and that puts more U.S. dollars in circulation and thereby lowers the dollar's value of world currency markets.
How does a falling dollar help reduce the Federal debt? As the dollar weakens in value, products made in the U.S. are cheaper overseas, more production happens here, people overseas buy more U.S products, they travel to America more, and they buy American assets. In turn, GDP (the measure of overall economic activity) rises, and more tax revenue is earned. However, the cost of imports to the U.S. go up for Americans. This will also tend to increase consumption here of domestically produced goods since we will tend to substitute American made goods for imported goods, another incentive to greater domestic economic activity (GDP).
What about the price of gas? Ouch! RIght now, the price of oil is denominated in U.S. dollars on world commodity markets. This means that if the oil exporting country wants the same buying power of U.S. dollars after the dollar falls in value, they increase the price of oil. As a result, the price of oil, and therefore, the price of EVERYTHING made from it, goes up in the U.S. This is basically what happened when gas was over $4 per gallon about 16 months ago. The U.S. dollar has been the world's reserve currency. This means that the U.S. dollar has been the currency other's flock to in periods of crisis. This is what's been happening and that's helped keep us afloat during this recession. That all is beginning to change.
The political optics of all this will be interesting. WalMart's been doing well during the recession, and a drop in the dollar's value will really hit them. They'd have to either raise prices or take a bigger hit to their bottom line as the cost of goods they import from China rise with the dollar's fall. (They import the vast majority of their product from China). Also, how will such a strategy play out among other governments and bankers in other Industrialized countries? We do know that the domestic political optics are going to put increasing pressure on the Administration to take action for political reasons, I believe.
What to do? What's the timing of all this? Good question about the timing. In general, the cost of taking that overseas trip, or buying that foreign made product will only go up. Personally, I have 15 percent of my retirement invested in foreign stocks indexes and only 5 percent in U.S. stock indexes. Talk to your investment analyst who knows about international currency markets and commodity markets. Buy that Prius sooner rather than later (or other high mileage import), begin to figure out how to reduce your 'oil footprint.' Maybe look at parking some U.S. dollars in some foreign currency or at least foreign stocks (basically what I did when I invested in foreign stock indexes).
One very provocative commentary from the Financial Times of London concisely lays out the problem. World currency markets are another kind of market where the value of the U.S. dollar in terms of any other world currency is determined by the demand for and the supply of dollars on world markets. Much the same points were made today by Yale Finance professor Jeffrey Garten. An extended article on these dynamics written by Doug Noland from The Asia Times is available here. One of Doug Noland's more unsettling passages is his view about what's needed from the U.S. "It is my thesis that there is no alternative other than a major transformation of the underlying structure of the US economy. In simplest terms, we must produce much more, consume much less and do it with a lot less credit creation. "
The underlying gist is that our debt levels cannot be reduced through spending cuts or tax hikes since the magnitudes required are politically untenable. Given the political gridlock we're in, he's probably right. Therefore, the only way left to reduce the U.S. federal debt is to decrease the dollar's value. We do this by lowering the value of the dollar on world markets. Since the dollar's value is not fixed, but rather is determined by the market itself, we have to use tools to 'influence' the dollar's value. (NOTE: Reducing the dollar's value on world markets is different from the term 'deflation' used to describe the situation when the price level in the economy drops).
When countries want to hold fewer dollars, they put them up for sale. This increases the supply of dollars on world markets. Without a counter-veiling increase in the demand for dollars, the dollar's value falls relative to other currencies. While the linked writings above assume that foreign holders of U.S. dollars will release some of those dollars, I have a question about how they go about doing that knowing that doing so will likely result in a drop in the value of their remaining dollar holding. The U.S. government can increase dollars on world markets not by "printing" money. Rather, they buy U.S. government securities from holders like banks and large investors and that puts more U.S. dollars in circulation and thereby lowers the dollar's value of world currency markets.
How does a falling dollar help reduce the Federal debt? As the dollar weakens in value, products made in the U.S. are cheaper overseas, more production happens here, people overseas buy more U.S products, they travel to America more, and they buy American assets. In turn, GDP (the measure of overall economic activity) rises, and more tax revenue is earned. However, the cost of imports to the U.S. go up for Americans. This will also tend to increase consumption here of domestically produced goods since we will tend to substitute American made goods for imported goods, another incentive to greater domestic economic activity (GDP).
What about the price of gas? Ouch! RIght now, the price of oil is denominated in U.S. dollars on world commodity markets. This means that if the oil exporting country wants the same buying power of U.S. dollars after the dollar falls in value, they increase the price of oil. As a result, the price of oil, and therefore, the price of EVERYTHING made from it, goes up in the U.S. This is basically what happened when gas was over $4 per gallon about 16 months ago. The U.S. dollar has been the world's reserve currency. This means that the U.S. dollar has been the currency other's flock to in periods of crisis. This is what's been happening and that's helped keep us afloat during this recession. That all is beginning to change.
The political optics of all this will be interesting. WalMart's been doing well during the recession, and a drop in the dollar's value will really hit them. They'd have to either raise prices or take a bigger hit to their bottom line as the cost of goods they import from China rise with the dollar's fall. (They import the vast majority of their product from China). Also, how will such a strategy play out among other governments and bankers in other Industrialized countries? We do know that the domestic political optics are going to put increasing pressure on the Administration to take action for political reasons, I believe.
What to do? What's the timing of all this? Good question about the timing. In general, the cost of taking that overseas trip, or buying that foreign made product will only go up. Personally, I have 15 percent of my retirement invested in foreign stocks indexes and only 5 percent in U.S. stock indexes. Talk to your investment analyst who knows about international currency markets and commodity markets. Buy that Prius sooner rather than later (or other high mileage import), begin to figure out how to reduce your 'oil footprint.' Maybe look at parking some U.S. dollars in some foreign currency or at least foreign stocks (basically what I did when I invested in foreign stock indexes).
Saturday, November 28, 2009
Should Tim Geithner be Replaced?
More and more people are calling for Treasury Sec. Tim Geithner's resignation. Among them calling for his resignation include Jim Rodgers, Peter DeFazio,
I particularly like this passage from The New Republic article,
"Finally, on the deficit and unemployment, it's true that Geithner has been outspoken about reining in the deficit. It's also true that dwelling on the deficit can seem beside the point or worse with unemployment stuck in double digits. But it's worth considering the role of a Treasury secretary here. As one Treasury official told me a couple months ago, almost every Treasury secretary embraces somewhat more fiscally conservative views than he actually holds,** because one of the Treasury secretary's jobs is to reassure our creditors we'll pay them back. Were Geithner to suddenly argue that the deficit isn't a big deal--even though there's a strong economic case that we should ignore it for the next year or two and focus on stimulus--the bond markets would probably go nuts. By reassuring the bond markets, Geithner buys the administration a little cover."
Elliot Spitzer lashed out at Sec. Geithner on a recent episode of the Rachel Maddow show especially hitting hard the notion that the Obama Administration owns none of the financial collapse. He basically said that they do in the presence of Sec. Geithner. Spitzer has also written on this matter in The Daily Bail.
A sure sign of his impending departure is the political heat he's drawing to the Obama Administration. Dumping him might reduce that heat, but will it lead to a fundamental change in Administration policy? I suspect that either the Administration will have him resign and we'll also see a greater focus on job creation rather than debt reduction or the Administration won't fundamentally change course. I hope they use his departure as an opportunity to roll out a new approach to the economy.
I particularly like this passage from The New Republic article,
"Finally, on the deficit and unemployment, it's true that Geithner has been outspoken about reining in the deficit. It's also true that dwelling on the deficit can seem beside the point or worse with unemployment stuck in double digits. But it's worth considering the role of a Treasury secretary here. As one Treasury official told me a couple months ago, almost every Treasury secretary embraces somewhat more fiscally conservative views than he actually holds,** because one of the Treasury secretary's jobs is to reassure our creditors we'll pay them back. Were Geithner to suddenly argue that the deficit isn't a big deal--even though there's a strong economic case that we should ignore it for the next year or two and focus on stimulus--the bond markets would probably go nuts. By reassuring the bond markets, Geithner buys the administration a little cover."
Elliot Spitzer lashed out at Sec. Geithner on a recent episode of the Rachel Maddow show especially hitting hard the notion that the Obama Administration owns none of the financial collapse. He basically said that they do in the presence of Sec. Geithner. Spitzer has also written on this matter in The Daily Bail.
A sure sign of his impending departure is the political heat he's drawing to the Obama Administration. Dumping him might reduce that heat, but will it lead to a fundamental change in Administration policy? I suspect that either the Administration will have him resign and we'll also see a greater focus on job creation rather than debt reduction or the Administration won't fundamentally change course. I hope they use his departure as an opportunity to roll out a new approach to the economy.
Wednesday, November 25, 2009
Housing and Jobs
There's a new report out talking about renewed weakness in housing. My take on this is it reinforces the importance of added stimulus to help the economy along. Residential investment in housing as a percent of GDP is in the 4 - 6 percent range (see graph here) It's interesting to go back to 2008 and see how these issues were talked about then. While that article mentioned the drop in exports, later last year, net exports (exports minus imports) grew and were a bright spot in the GDP numbers. Click here. It's striking to note the decline in consumer spending and the dramatic drop in both housing and non-residential investment, with the latter falling off a cliff. Housing prices aren't going to recover until consumers are feeling more flush rather than flushed out. In turn, the jobs and income situation is going to need more improvement before consumers start spending more.
While analysts point to the drop in housing prices as the trigger for the recession and the current drag on the economy, I think the fall in housing prices is more symptomatic of the problem (they certainly are part of the problem). It's housing prices and their impact on equity, and how drops in equity combined with greater financial uncertainty, and bank's reluctance to lend that have combined to undercut consumer spending. Consumer spending is the key to economic recovery.
While analysts point to the drop in housing prices as the trigger for the recession and the current drag on the economy, I think the fall in housing prices is more symptomatic of the problem (they certainly are part of the problem). It's housing prices and their impact on equity, and how drops in equity combined with greater financial uncertainty, and bank's reluctance to lend that have combined to undercut consumer spending. Consumer spending is the key to economic recovery.
Monday, November 23, 2009
How is the U.S. Government debt like our personal debt?
Republicans and conservative Democrats have done a very good job over the years beating the 'debt is bad drum.' We've been told many falsehoods, and many have drunk the cool-aid.
One tune is how the government needs to balance it's budget just like we balance our home budget. If in any month your spending exceeds your income, you run a deficit that month. This is just like how the government runs a deficit. When we as consumers and workers run a deficit, we then need a way to make up the shortfall. We do that by some combination of borrowing or taking money out of savings. When we borrow to finance our monthly deficit, we incur debt. This is just like how it works for the government.
When we incur more and more personal debt, and have no increase in income, we do find it more and more difficult to carry that debt. We pay more of our income in interest payments and we have less flexibility in our budgets.
When the government incurs debt, that debt also is income to the economy! Yes, the interest payments on the debt is simultaneously income to the bond holders. This is one difference between government debt and personal debt. With personal debt we experience the interest payment as money leaving. With interest on government debt, the interest payments leave when they go to people and institutions (like other governments) outside the U.S. This raises the question of who holds the bonds that the government issues to finance the deficit?
It quickly gets tricky addressing questions about who owns the debt and what amount of debt we have. I am limiting myself here to debt of the U.S. Federal government. This excludes debt we as private citizens and businesses owe, and it also excludes the debt of other levels of government. An interesting overview of federal debt, deficits, and economic activity is contained in a report by the Government Accountability Office. A quick snapshot on the issue is available here. While these studies are a few years old now, they still provide a good overview of the issues. Whereas, the MSNBC article identifies Japan as the largest foreign owner of U.S. federal debt, China has now surpassed Japan as the largest foreign owner of U.S. Federal government debt.
Keep in mind when someone compares debt to GDP, they are comparing a cumulative amount (debt) to an annual amount (GDP). This would be like you adding up your mortgage and installment principal balances and comparing it to your annual income. It's unclear what such a comparison indicates. Whereas, comparing deficit or surplus to GDP compares annual amounts for both. By analogy, this is comparable to you adding up your mortgage and installment monthly payments and dividing that by your monthly income. As we know, this comparison is made when buying a home.
The largest single holder of U.S. Treasury bonds (how we finance deficits) is the U.S. Government itself! Yup, it's not China. China is the single largest foreign owner of U.S. government debt. About 25-30 percent of all U.S. government debt is owned by foreigners. That means that about 70 percent of the bonds are held in the U.S. Cut the debt, cut the income to holders of the debt.
From a political perspective, I find it striking that the total U.S. Federal debt increased from about $6 trillion in 2000 to about $9 trillion in 2009, a 50 percent increase. The causes of this rise is no mystery - two wars and two tax cut.
There are geo-political implications to foreign owners of U. S. debt. This is especially true as more and more of the foreign ownership resides in one country. Also, just as in our personal budgets, as debt grows, our ability to respond to emergencies declines, so to with increases in government debt.
This short overview has not discussed the value of the dollar and debt and it has simplified the discussion by not considering how those receiving interest from government debt sped it in the U.S. versus overseas.
One tune is how the government needs to balance it's budget just like we balance our home budget. If in any month your spending exceeds your income, you run a deficit that month. This is just like how the government runs a deficit. When we as consumers and workers run a deficit, we then need a way to make up the shortfall. We do that by some combination of borrowing or taking money out of savings. When we borrow to finance our monthly deficit, we incur debt. This is just like how it works for the government.
When we incur more and more personal debt, and have no increase in income, we do find it more and more difficult to carry that debt. We pay more of our income in interest payments and we have less flexibility in our budgets.
When the government incurs debt, that debt also is income to the economy! Yes, the interest payments on the debt is simultaneously income to the bond holders. This is one difference between government debt and personal debt. With personal debt we experience the interest payment as money leaving. With interest on government debt, the interest payments leave when they go to people and institutions (like other governments) outside the U.S. This raises the question of who holds the bonds that the government issues to finance the deficit?
It quickly gets tricky addressing questions about who owns the debt and what amount of debt we have. I am limiting myself here to debt of the U.S. Federal government. This excludes debt we as private citizens and businesses owe, and it also excludes the debt of other levels of government. An interesting overview of federal debt, deficits, and economic activity is contained in a report by the Government Accountability Office. A quick snapshot on the issue is available here. While these studies are a few years old now, they still provide a good overview of the issues. Whereas, the MSNBC article identifies Japan as the largest foreign owner of U.S. federal debt, China has now surpassed Japan as the largest foreign owner of U.S. Federal government debt.
Keep in mind when someone compares debt to GDP, they are comparing a cumulative amount (debt) to an annual amount (GDP). This would be like you adding up your mortgage and installment principal balances and comparing it to your annual income. It's unclear what such a comparison indicates. Whereas, comparing deficit or surplus to GDP compares annual amounts for both. By analogy, this is comparable to you adding up your mortgage and installment monthly payments and dividing that by your monthly income. As we know, this comparison is made when buying a home.
The largest single holder of U.S. Treasury bonds (how we finance deficits) is the U.S. Government itself! Yup, it's not China. China is the single largest foreign owner of U.S. government debt. About 25-30 percent of all U.S. government debt is owned by foreigners. That means that about 70 percent of the bonds are held in the U.S. Cut the debt, cut the income to holders of the debt.
From a political perspective, I find it striking that the total U.S. Federal debt increased from about $6 trillion in 2000 to about $9 trillion in 2009, a 50 percent increase. The causes of this rise is no mystery - two wars and two tax cut.
There are geo-political implications to foreign owners of U. S. debt. This is especially true as more and more of the foreign ownership resides in one country. Also, just as in our personal budgets, as debt grows, our ability to respond to emergencies declines, so to with increases in government debt.
This short overview has not discussed the value of the dollar and debt and it has simplified the discussion by not considering how those receiving interest from government debt sped it in the U.S. versus overseas.
Reduce Federal Debt or Grow Jobs?
The New York Times is running a story (series) on the "problem of the debt." One of their Op-ed writers, Paul Krugman, counters in an op-ed piece today that the "problem" is overblown.
Should we be more concerned about the debt than unemployment? No.Unemployment is a greater problem. There will come a time when more and more government spending (and debt) will run a greater risk of triggering inflation, but not now. We need to be spending - 'priming the pump' - its called, incur more debt, and help the economy recover.
There are rumblings of a Republican proposal to cut taxes to stimulate the economy. I can guarantee you this has more to do with appealing to the Republican Base than it does to any desire to actually stimulate the economy. Here's why.
A $100 billion tax cut and a $100 billion injection of new government spending will not affect the economy the same way. There are these things called multipliers. They do just what their name suggests - they multiply the impact from a tax cut versus an injection of new government spending. It turns out that cutting taxes has less stimulative effects than an increase in new government spending. In other words, there is more 'bang for the buck' from new government spending than there will be from an equal amount of tax cuts.
With Roubini indicating unemployment will increase to at least 11 percent (earlier post), we need stimulus now.
Should we be more concerned about the debt than unemployment? No.Unemployment is a greater problem. There will come a time when more and more government spending (and debt) will run a greater risk of triggering inflation, but not now. We need to be spending - 'priming the pump' - its called, incur more debt, and help the economy recover.
There are rumblings of a Republican proposal to cut taxes to stimulate the economy. I can guarantee you this has more to do with appealing to the Republican Base than it does to any desire to actually stimulate the economy. Here's why.
A $100 billion tax cut and a $100 billion injection of new government spending will not affect the economy the same way. There are these things called multipliers. They do just what their name suggests - they multiply the impact from a tax cut versus an injection of new government spending. It turns out that cutting taxes has less stimulative effects than an increase in new government spending. In other words, there is more 'bang for the buck' from new government spending than there will be from an equal amount of tax cuts.
With Roubini indicating unemployment will increase to at least 11 percent (earlier post), we need stimulus now.
Monday, November 16, 2009
Recession, Recovery, and Unemployment
Now that the recession is officially over, we can all get back to work!
Except that the unemployment rate is forecast to continue to rise. This is according to one economist who predicted the thing in the first place - Nouriel Roubini. In an article Sunday, 11/15/09, he predicts it will rise to around 11 percent and stay there for some time. What I find fascinating isn't the prognosis for unemployment but his setting of a specific number. When the economy was humming along back about six years ago, that recovery was dubbed "the jobless recovery." It is appearing that is again the case - another jobless recovery has begun. How would anyone imagine that unemployment would dramatically decline as we now turn the corner from recession to growth? Keep in mind, the tools used to define the beginning and end of a recession are technical and pertain to changes in overall economic output. These do not necessarily have anything to do with employment.
According to Sean Bisceglia, CEO of TalentDrive, a Chicago-based job search technology startup, almost half of the companies he surveyed in August and September either had cut their hiring budget or didn't have one. He says that more efficient technology is replacing workers in many industries. That is one reason productivity has been rising -- and why jobs have been harder to come by. Click here for the full text of the article.
Bank Lending and Economic Recovery
There's a news story out that Fed Chairman Ben Bernanke targets tight bank lending as a key reason for the current unemployment levels.
While I count myself among those who supported the bank and financial industry bailouts, the Bush Administration was caught in their ideology when they made a huge blunder in not being more aggressive in setting requirements on the use of those funds, executive pay caps, and regulation of derivatives. Early in the Obama Administration, Treasury Secretary Geithner announced a plan on setting requirements on those same banks.
While I count myself among those who supported the bank and financial industry bailouts, the Bush Administration was caught in their ideology when they made a huge blunder in not being more aggressive in setting requirements on the use of those funds, executive pay caps, and regulation of derivatives. Early in the Obama Administration, Treasury Secretary Geithner announced a plan on setting requirements on those same banks.
Thursday, November 12, 2009
Economics, Community, and Health Insurance
With the current debate about if and how to change the health insurance system in America becoming more heated over the summer, I had the opportunity to attend a Town Hall meeting hosted by Oregon's Sen. Jeff Merkeley. At times it was quite "spirited" with a not insignificant contingent representing what I'll graciously call the Libertarian wing of the electorate. At one point, one audience member quite clearly stated to Sen. Merkeley that it is the Senator's job to preserve his right to not buy health insurance.
Sen. Merkeley is Oregon's junior senator, recently elected, unseating Sen. Gordon Smith. In this part of the state, its not an exaggeration to say that former Sen. Smith was revered. This was Sen. Merkely's first Town Hall meeting in this part of the sate. Also, he followed Sen. Wyden by several weeks. As a result, people dis-satasfied with Sen. Wyden's meeting laid in wait for Sen. Merkeley.
Economics has something to say about the issue of whether or not people should be required to carry health insurance. One aspect of what economics has to say on the issue pertains to how individuals without insurance impact services available to others, even when those not carrying health insurance pay for their health care out of their own pockets. You can read my perspective on the matter - Wallowa County Chieftain.
While the argument I make in this piece is grounded in mainstream economics practiced today, the perspective I take in this letter is troubling to people who have an inordinate belief in the 'free' market.
My arguments rest on a sub-area of economics often referred to as environmental economics. This sub-area is very extensive with a massive body of conceptual and empirical literature. Part of this literature focuses on externalities. Within that literature, the externality I speak of in my essay is called a network externality. More specifically, network effects in health care and health insurance. (A note to the more specialized reader - in my short essay, I don't distinguish between network effects and network externalities).
There are many in and out of the economics profession who hold the belief that externalitie do not exist. They have very influential advocates, perhaps most notably Uncle Milty - Milton Frriedman and the Chicago School.
With The Chicago School there is even a brand of Institutional Economics that extends free market principles to the study of institutions! I subscribe to a different bread of Institutionalism that is related to the Land Economics of John R. Commons. A somewhat humorous view of part of that school may be viewed at - American Institutionalist School.
I will likely pick some of these themes up in future posts.
Sen. Merkeley is Oregon's junior senator, recently elected, unseating Sen. Gordon Smith. In this part of the state, its not an exaggeration to say that former Sen. Smith was revered. This was Sen. Merkely's first Town Hall meeting in this part of the sate. Also, he followed Sen. Wyden by several weeks. As a result, people dis-satasfied with Sen. Wyden's meeting laid in wait for Sen. Merkeley.
Economics has something to say about the issue of whether or not people should be required to carry health insurance. One aspect of what economics has to say on the issue pertains to how individuals without insurance impact services available to others, even when those not carrying health insurance pay for their health care out of their own pockets. You can read my perspective on the matter - Wallowa County Chieftain.
While the argument I make in this piece is grounded in mainstream economics practiced today, the perspective I take in this letter is troubling to people who have an inordinate belief in the 'free' market.
My arguments rest on a sub-area of economics often referred to as environmental economics. This sub-area is very extensive with a massive body of conceptual and empirical literature. Part of this literature focuses on externalities. Within that literature, the externality I speak of in my essay is called a network externality. More specifically, network effects in health care and health insurance. (A note to the more specialized reader - in my short essay, I don't distinguish between network effects and network externalities).
There are many in and out of the economics profession who hold the belief that externalitie do not exist. They have very influential advocates, perhaps most notably Uncle Milty - Milton Frriedman and the Chicago School.
With The Chicago School there is even a brand of Institutional Economics that extends free market principles to the study of institutions! I subscribe to a different bread of Institutionalism that is related to the Land Economics of John R. Commons. A somewhat humorous view of part of that school may be viewed at - American Institutionalist School.
I will likely pick some of these themes up in future posts.
Sunday, November 8, 2009
Commodities and Specialty Products
In this post, I'll just refer to product rather than product and service. This is simply for brevity. Consider that I am referring to product or service. Your business be selling Real Estate, for example, which is a service than a product.
As we know, the bottom line is determined by your revenues and your costs. I have seen businesses that do a good job at managing one but not the other, with the result being a drop in the bottom line. This post focuses on the revenue side of your business.
A commodity is a product that is just like every other business's product - in the eyes of the consumer of your product. When your product is viewed this way, how much you can charge for your product is determined by the 'market' in which you sell your product. Your revenues are then largely determined by forces outside of your control.
One important alternative is to market your product or service as a specialty product. This helps to separate your product from the mass of alternative suppliers of your product. This is a crucial step towards having greater control over your revenues. You have greater control over your revenues when you are able to charge a premium for your product. In the parlance, this premium is often referred to as a higher value added.
If there are legal limitations on your ability to set a higher price (fee) for your product, then the question is how can you charge that maximum.
If the market in your business already has a standard fee that 'everyone charges' then the question might be how do you use other tools to distinguish your product from others with the same or similar price? Here again, the goal is the same - getting greater control over your revenue stream.
As we know, the bottom line is determined by your revenues and your costs. I have seen businesses that do a good job at managing one but not the other, with the result being a drop in the bottom line. This post focuses on the revenue side of your business.
A commodity is a product that is just like every other business's product - in the eyes of the consumer of your product. When your product is viewed this way, how much you can charge for your product is determined by the 'market' in which you sell your product. Your revenues are then largely determined by forces outside of your control.
One important alternative is to market your product or service as a specialty product. This helps to separate your product from the mass of alternative suppliers of your product. This is a crucial step towards having greater control over your revenues. You have greater control over your revenues when you are able to charge a premium for your product. In the parlance, this premium is often referred to as a higher value added.
If there are legal limitations on your ability to set a higher price (fee) for your product, then the question is how can you charge that maximum.
If the market in your business already has a standard fee that 'everyone charges' then the question might be how do you use other tools to distinguish your product from others with the same or similar price? Here again, the goal is the same - getting greater control over your revenue stream.
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