Sunday, January 4, 2009
The $740 billion -$1 trillion fiscal stimulus plan is an all-but done deal. Alongside a serious focus on the creation of jobs - 3 million to be exact - and jobless aid, including unemployment benefits for part-time workers and added health insurance coverage, the plan highlights investment in domestic infrastructure. Obama calls it the American Recovery and Reinvestment Plan, and on it lies hope for a U.S. recovery.
But there is one thing that always bothered me about this plan : if the rise of domestic construction production was to blame for the loss of productivity in the first half of 2000, why are the longer-term spending initiatives centered on construction projects? The focus should be on expanding our most productive sectors – manufacturing and exports - to stimulate innovation and productivity.
According to the NY Times, the American Recovery and Reinvestment Plan will appropriate at least $775 billion toward the following:
- $140-$200 billion for state budget relief efforts. That is interesting because states jointly require $1 trillion to stay afloat over the next year. States will start cut spending if the bills cannot be paid – this would seriously offset the stimulus (let’s leave that to another post).
- Extending unemployment benefits that are set to expire in March.
- Tax credits and cuts for all but "the most affluent Americans".
- And “billions of dollars for construction projects that Mr. Obama has called “shovel ready.” This could include any type of infrastructure: roads, public buildings, renewable energy, etc.
I understand that investment in capital equals economic growth (anybody who has heard of Robert Solow would know this), but the economic growth path is based on technical innovation, i.e. productivity gains. And if long-term growth is the name of the game, why focus on inefficient domestic construction efforts?
The chart illustrates two measures productivity and payroll growth spanning the years 1990 through 2008. Nonfarm business productivity growth in the 1990s and the 2000s was strong: 1.91% and 2.54%, respectively. Furthermore, there is a negative correlation between nonfarm productivity growth and nonfarm job growth: -0.30 and -0.60, respectively. Productivity tends to correlate with job loss: efficient capital implies that the rate of production for each worker improves, and thus fewer workers are needed to maintain the same rate of production.
The relationship between productivity growth and job loss is most evident in the first half of the 2000s. During Greenspan’s tenure as Chairman of the Federal Reserve Bank, and amid a decade of prolonged productivity growth, the labor market saw its longest contraction in modern history. Nonfarm payroll contracted for roughly 30 consecutive months - 22 months longer than the economy contracted. The prolonged labor contraction was one reason that Greenspan left the federal funds rate at 1% for two years – June 2001 through June 2003 – which led the peak of the housing boom.
Obama's plan: new infrastructure projects equals new jobs, rather than job loss. True, but inefficient.
As the housing sector grew and peaked (measured by prices, the Case Shiller index), manufacturing and nonfarm business productivity declined precipitously. Resources were transferred into the less productive sectors of production, housing and construction, leading to a sharp decline in manufacturing productivity and a surge in construction employment.
As the housing market peaked, the trade balance initiated its steady rise, improving since the second quarter of 2007 on a weak dollar and strong export growth - quarterly export growth averaged 10% (annualized) 2006-2008, up from the 3% average spanning 2000-2006. Resources were re-allocated toward the most productive export industries, mostly manufacturing – industrial supplies, capital goods ex automotive account for 30% and 38% of exports, respectively - and those sectors saw profit growth. But heavy job loss occurred simultaneously, as evidenced by durable goods manufacturing seeing consecutive job loss since June 2007. But job loss will not last forever.
Exports are highly productive, and productivity means profits; profits means new investment and the expansion of those highly productive industries; and expansion eventually creates new jobs and new technologies. It may take a while job growth to resume, but the productive efficiency is worth a grace period. And furthermore, Obama will put in place household tax credits and insurance programs designed to protect workers as they retrain to work in the new industries.
So why are we building roads? The focus on construction and infrastructure as the primary long-term stimulus is highly inefficient. I concur with Joseph Stiglitz, as reported in the International Herald Tribune:
I've been a bit astonished that all the discussion around the private-sector stimulus has centered on infrastructure," he [Stiglitz] said. "Bailouts, too, are aimed at correcting mistakes of the past, so they are backward-looking. We would be much better off spending our money forward-looking. If we spend $700 billion on new technology and innovation, we'd have a stronger, new, real economy. Up to now, the discussion has focused on the sectors that have been mismanaged rather than the sectors that are creating our future.