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| Productivity, the Trade Deficit, and Dark Matter: Part II ?
February 21, 2006
Productivity, the Trade Deficit, and Dark Matter: Part I
The debate over the trade deficit and dark matter goes on. Brad DeLong takes a shot at it here, concluding that:
I believe what Rudi Dornbusch said: that when highly intelligent and respected economists begin evolving plausible theories that--this time--the trade deficit is sustainable, that is the time to start running for the hills, because the crash is near.
Martin Wolf's Financial Times Economic Forum hosts a dark matter debate between Willem Buiter and Ricardo Hausmann, and others here. And Brad Setser has a very long and very thoughtful response to me here.
I believe that most of the discussion of the trade deficit and dark matter misses the big picture. Let's take a step back to get some perspective. In my view there have been two very dramatic changes in the U.S. economy compared to ten years ago. First is the remarkable and unanticipated acceleration of productivity growth. Second is the equally remarkable and unanticipated widening of the measured trade deficit, a hallmark of globalization.
These changes are enormous. Productivity growth in the nonfarm business sector has averaged 2.9% annually since 1995, compared to roughly 1.6% over the previous ten years. That means nonfarm business output in 2005 was roughly $1.2 trillion higher than if productivity growth had continued at the previous anemic pace. (Comparing the CBO’s ten year GDP forecast in 1996 with actual growth gives the same answer—GDP in 2005 was roughly $1.2 trillion higher than expected 10 years ago).
At the same time, the trade deficit today is far higher than anyone would have forecast ten years ago. In 1995, the trade deficit in goods and services was $91 billion, or 1.2% of GDP, and at least one forecaster, DRI/McGraw-Hill, projected that it would virtually disappear by 2005. Instead, the goods and services deficit was more than $700 billion in 2005, or 5.8% of GDP.
So here’s the two “big facts” which define the U.S. economy today. We produce, on an annual basis, $1.2 trillion more than expected. And our net imports are $700 billion greater than expected, inducing an equal amount of borrowing.
Seemingly, these two facts point in opposite directions. After all, if you become more productive, you would expect to borrow less rather than more. The puzzle gets bigger rather than smaller.
Remarkably, the DeLong, Setser, and Wolf pieces never mention productivity. Not once. They focus on the second fact—the larger- than-expected trade deficit—without once mentioning the first fact, the higher than expected productivity growth.
I think omitting the acceleration of productivity from the discussion of the trade deficitis a big mistake. To my mind, it is essential to come up with a framework which handles both “big facts” simultaneously. That's what I will discuss in my next post.
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Interesting Michael Mandel posts from Newmark's Door
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Tracked on March 6, 2006 05:45 AM
We are producing $1.2 trillion more than expected, but importing $700 billion more than expected, which means that whether or not exports have increased in the past 10 years, we are consuming *far* more than we were 10 years ago. How is all this consumption financed? Debt. Part of this is government debt, to be sure, but consumer debt is likely a larger cause. Mortgage debt is at an all time high. I wish I had saved a link, but I read yesterday that home ownership - in terms of actual *equity*, not property titles - is at an all time low. I believe this assertion to be true. What happens when the housing ATM (as Bill Fleckenstein likes to call it) runs out? What happens when we're so overextended on debt that we can no longer afford to support this extra consumption?
Posted by: Brandon at February 22, 2006 10:48 AM
I did a little looking around and found some graphs and a lot of discussion about my comment above.
The second graph down shows the drop in ownership-by-equity. If you question their data, take it up with them - this isn't my full-time job and I don't have the time. Also, I'm not quite sure why these people are pitching a "Reagan Renaissance" when it's obvious that several of the issues they're discussing began under the Reagan administration (just look at the graphs)... but whatever. They made some nice graphs.
Posted by: Brandon at February 22, 2006 01:46 PM
Too many people are still thinking linearly. In 1995, they projected out based on the past trend, and thus underestimated what the size of the economy would be by $1.2T.
The same will happen over the next 10-years (for the global economy at least).
No awareness of the accelerating nature of these trends means such predictions are fundamentally flawed. Acceleration-awareness is the most critical component of any long-term future prediction.
Read about how Economic Growth is Accelerating here :
Posted by: Kartik at February 22, 2006 03:42 PM
I don't know the numbers, but what if the rate at which we consume goods is greater than our increase in productivity over these years. This would account for the large trade deficit despite our productivity gains.
Perhaps instead of just the two big ticket items we should be looking at: productivity, trade deficit, and consumption.
Posted by: Jay at February 24, 2006 10:42 AM
Is this guy wrong (http://www.econbrowser.com/archives/2006/02/will_dark_matte.html)? Was the high net income a transitory thing?
Posted by: mattew at February 24, 2006 02:31 PM
>> economists begin evolving plausible theories that--this time--the trade deficit is sustainable, that is the time to start running for the hills
We've been running a trade deficit for 30 straight years. What we have to show for that after all this time is the world's foremost economy (by far) ... and one that has only built an ever-larger gap against the other developed economies of the world.
So the trade deficit is clearly sustainable: that has now been proved.
Those on the defensive are the ones who, for some reason, would claim that despite all this proof that--this time--the trade deficit is unsustainable. Perhaps they should quit running for the hills, and ask themselves why reality in no way conforms to their understanding of economic theory. Brad DeLong has reached an unfortunate point in his career, as he is unable to process the complexities that confront him.
I'm not a convert to all of what's been proffered by the dark matter theorists. But at least they are addressing the fact that reality has proved many dearly-held beliefs wrong, and are working to understand why -- which is something Brad DeLong is clearly not capable of doing.
Posted by: Kevin at February 24, 2006 06:23 PM
Jay, Brandon--there's no obvious reason why consumption should have risen so much more sharply than production.
Posted by: Mike Mandel at February 26, 2006 09:13 PM
The trade deficit is has been sustained, up to now, by the growth of the U. S. stock market and growth of value of single family homes. These are the two factors that fueled the trememdous rise in household Net worth since the end of 2002. These growth factors kept the value of the dollar high. International investors/speculators account for most of the turnover on international exchanges and they focus on countries and currencies that have, in their mind, good prospects for wealth creation in the immediate future. High value of the dollar encourages imports and discourages exports.
This experience is exactly the opposite of what Adam Smith said would happen. Poor old Adam Smith - he could not conceive that the country with the largest trade deficit would also be the country creating vast amounts of wealth, not via exporting, but by operating a gambling casino (plus, I must admit, profitable firms getting rich in the non-tradeables section of the economy).
Just wait - if foreign stock markets continue to grow faster than U. S. stock markets (as in 2005), the value of the dollar will decline and the U. S. trade will also decline.
The irony here is that export industries in the U. S. have been so damaged by the last five years that creation of export capability will take some years - years of low level of living because low level of imports.
Posted by: ReformerRay at March 15, 2006 02:04 PM