Recession On The Horizon

According to Bloomberg News, analysts at a number of major financial institutions see “mounting evidence” that a recession is not too far away.

In a way, their assessment is not surprising.  The current expansion, which started in June 2009, is now 99 months long, making it the third longest expansion in US history. Only the expansions from March 1991 to March 2001 (120 months) and February 1961 to December 1969 (106 months) are longer.  It is likely that this expansion will pass the 1960s expansion in length but fall short of the record.

Warning signs

The financial analysts cited by Bloomberg News did not base their warnings simply on longevity.  Rather it was the behavior of corporate profits, more specifically their downward trend, that concerned them.  Historically, expansions have come to an end because declining profits cause corporations to slash investment spending, which leads to a decline in employment and eventually consumption, and finally recession.

As the Bloomberg article explains, “The gross value-added of non-financial companies after inflation — a measure of the value of goods after adjusting for the costs of production — is now negative on a year-on-year basis.”  As an analyst for Oxford Economics Ltd. concludes, “The cycle of real corporate profits has turned enough to be a potential source of concern in the next four quarters.”

Real gross corporate value added is a proxy for profits.  Its recent decline, as shown in the figure above, means that corporate profitability is falling over time.  As long as it remained positive (the red line was above zero), corporate profits were continuing to grow, just not as fast as they did in the previous year. However, it has now become negative, which means that total profits are actually falling.  And, as we can see, whenever this happened in the past, a recession soon followed.

The primary reason recessions follow a decline in profits is that investment decisions are very sensitive to changes in profit. A decline in profit tends to produce a much larger decline in investment, leading to recession.  The investment connection to recession is is well illustrated in the following figure, taken from a blog post by the economist Michael Roberts. It shows the change in personal consumption and investment one year before the start of a recession.  As we can see, it is the decline in investment that leads the downturn, and the decline takes place more often than not while consumption is still growing.

The Bloomberg article highlights other studies that come to the same conclusion about the direction of profits and the growing likelihood of recession.  For example, as illustrated below, “The U.S. is in the mature stage of the cycle — 80 percent of completion since the last trough — based on margin patterns going back to the 1950s, according to Societe Generale SA.”

As we can see, the decline in profit margins in the current expansion mirrors the decline during other expansions as they neared their end.  It certainly appears that time is running out for this expansion.

Further evidence comes from the recent reduction in corporate buybacks. As the economist William Lazonick explains:

Buybacks have come to define the “investment” strategies of many of America’s biggest businesses. Figure 1 [below] shows net equity issues of U.S. corporations from 1946 to 2014. Net equity issues are new corporate stock issues minus outstanding stock retired through stock repurchases and M&A activity. Since the mid-1980s, in aggregate, corporations have funded the stock market rather than vice versa (as is conventionally assumed).  Over the decade 2005-2014 net equity issues of nonfinancial corporations averaged minus $399 billion per year.

In other words, corporations have been major players in the stock market, buying and retiring stock in order to drive up stock prices.  The process has, by design, enriched the top end of the income distribution.  It also helped to boost consumption spending, and by extension the expansion.  However, this corporate promotion of stock prices appears to have come to an end.  As a Fortune Magazine article reports:

The great stock buyback boom may be on the wane, undermined by falling company earnings.

U.S. company stock buybacks are down 21% in the first seven months of 2016 compared to the same period a year earlier, according to TrimTabs Investment Research, a fall driven in part by five consecutive quarters of year-over-year earnings declines among S&P 500 stocks.

Buybacks, which cancel shares and thus increase per-share earnings, have played a crucial role in supporting the stock market since the financial crisis, flattering earnings even for companies with static or falling revenues.

They, along with dividends, return cash to shareholders, a process often facilitated by borrowed money.

A decline in market values can thus be expected, adding further downward pressure on economic activity.

Social consequences

The business cycle is an inherent feature of capitalist economies and the US economy has experienced many ups and downs. But expansions and recessions do not balance out, leaving the economy on a stable long-term economic trajectory. Unfortunately, while recent cycles have greatly enriched those at the top, working people have generally experienced deteriorating living and working conditions.  The trend in job creation is one example.

The employment to population ratio is a commonly used measure of employment.  It is calculated by dividing the number of people employed by the total working-age population.  The figure below, from a report by the Chicago Political Economy Group, shows the relative employment or job creation strength of each post-World War II expansion.

As we can see, the November 2001 expansion ended without restoring the pre-recession employment to population ratio. The ratio was 2.48 percent below where it had been prior to the recession’s start.  That means the expansion was not strong enough or structured properly to ensure adequate job creation.  And, despite its length, the current expansion’s employment to population ratio remains nearly 5 percent below that lower starting point.  Moreover, this employment measure doesn’t take into account that a growing share of the jobs created during this expansion are low-paying and precarious.

 

In sum, there are strong reasons to expect a recession within the next year or so.  And it will likely hit an increasingly vulnerable working class hard.  Given trends, where the good times seem to pass most people by and the bad times punish those who gained the least the most, the need for a radical transformation of our economy seems clear.

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False Promises: Trump And The Revitalization Of The US Economy

President Trump likes to talk up his success in promoting the reindustrialization of the United States and the return of good manufacturing jobs.  But there is little reason to take his talk seriously.

Microsoft closes shop

For example, as reported in a recent article in the Oregonian, Microsoft just decided to close its two year old Wilsonville factory, where it built its giant touch-screen computer, the Surface Hub.  As the article explains :

Just two years ago, Microsoft cast its Wilsonville factory as the harbinger of a new era in American technology manufacturing.

The tech giant stamped, “Manufactured in Portland, OR, USA” on each Surface Hub it made there. It invited The New York Times and Fast Company magazine to tour the plant in 2015, then hired more than 100 people to make the enormous, $22,000 touch-screen computer. . . .

“We looked at the economics of East Asia and electronics manufacturing,” Microsoft vice president Michael Angiulo told Fast Company in a fawning 2015 article that heaped praise on the Surface Hub and Microsoft’s Wilsonville factory.

“When you go through the math, (offshoring) doesn’t pencil out,” Angiulo said. “It favors things that are small and easy to ship, where the development processes and tools are a commodity. The machines that it takes to do that lamination? Those only exist in Wilsonville. There’s one set of them, and we designed them.” . . .

But last week Microsoft summoned its Wilsonville employees to an early-morning meeting and announced it will close the factory and lay off 124 employees – nearly everyone at the site – plus dozens of contract workers. . . .

Even as President Donald Trump heralds “Made in America” week, high-tech manufacturing remains an endangered species across the United States. Oregon has lost more than 14,000 electronics manufacturing jobs since 2001, according to state data, more than a quarter of the total job base.

Microsoft is moving production of its Surface Hub to China, which is where it makes all its other Surface products.  Apparently, the combination of China’s low-cost labor and extensive supplier networks is an unbeatable combination for most high-tech firms.  In fact, the Oregonian article goes on to quote a Yale economist as saying:

“Re-shoring” stories like the tale Microsoft peddled in 2015 are little more than public relations fakery,” [providing] “lip services or window-dressing to please politicians and the general public.”

Foxconn says it is investing

But now we have another bigger and bolder re-shoring story: The Taiwanese multinational Foxconn has announced it will spend $10 billion to build a new factory somewhere in Wisconsin (likely in Paul Ryan’s district), where it will produce flat-panel display screens for televisions and other consumer electronics.

As reported in the press, Foxconn is pledging to create 13,000 jobs in six years—but only 3000 at the start.  In return, the state of Wisconsin is offering the company $3 billion in subsidies.

According to the Trump administration, this is a sign that its efforts to bring back good manufacturing jobs is working.  The Guardian quotes a senior administration official “who said the announcement was ‘meaningful,’ because ‘it [represents] a milestone in bringing back advanced manufacturing, specifically in the electronics sector, to the United States.’”  President Trump followed with “If I didn’t get elected, [Foxconn] definitely would not be spending $10bn.”

However, there are warning signs.  For example, as an article in the Cap Times points out, Foxconn doesn’t always follow through on its promises:

  • Foxconn promised a $30 million factory employing 500 workers in Harrisburg, Pennsylvania, in 2013. The plant was never built, not a single job was created.
  • That same year, the company signed a letter of intent to invest up to $1 billion in Indonesia. Nothing came of it.
  • Foxconn announced it would invest $5 billion and create 50,000 jobs over five years in India as part of an ambitious expansion in 2014. The investment amounted to a small fraction of that, according to The Washington Post’s Todd Frankel.
  • Foxconn committed to a $5 billion investment in Vietnam in 2007, and $10 billion in Brazil in 2011. The company made its first major foray in Vietnam only last year. In Brazil, Foxconn has an iPhone factory, but its investment has fallen far short of promises.
  • Foxconn recently laid off 60,000 workers, more than 50 percent of its workforce at its IPhone 6 factory in Kushan, China, replacing them with robots that Foxconn produces.

In fact, even the Wisconsin Legislative Fiscal Bureau is worried that the state may be overselling the deal, promising billions for very little.  As a Verge article reported:

Wisconsin’s plan to treat Foxconn to $3 billion in tax breaks in exchange for a $10 billion factory is looking less and less like a good deal for the state. In a report issued this week, Wisconsin’s Legislative Fiscal Bureau said that the state wouldn’t break even on its investment until 2043 — and that’s in an absolute best-case scenario.

How many workers Foxconn actually hires, and where Foxconn hires them from, would have a significant impact on when the state’s investment pays off, the report says.

The current analysis assumes that “all of the construction-period and ongoing jobs associated with the project would be filled by Wisconsin residents.” But the report says it’s likely that some positions would go to Illinois residents, because the factory would be located so close to the border. That would lower tax revenue and delay when the state breaks even.

And that’s still assuming that Foxconn actually creates the 13,000 jobs it claimed it might create, at the average wage — just shy of $54,000 — it promised to create them at. In fact, the plant is only expected to start with 3,000 jobs; the 13,000 figure is the maximum potential positions it could eventually offer. If the factory offers closer to 3,000 positions, the report notes, “the break-even point would be well past 2044-45.”

The authors of the report even seem somewhat skeptical of the best-case scenario happening. Foxconn is already investing heavily in automation, and there’s no guarantee it won’t do the same thing in Wisconsin. Nor is there any guarantee that Foxconn will remain such a manufacturing powerhouse. (Its current success relies heavily on the success of the iPhone.)

It is because of concerns like these, that the Milwaukee Journal Sentinel reports that the state’s Senate Majority Leader has said he doesn’t yet have the votes to pass the tax package Governor Scott Walker has promised.

Forget the new trade deals

President Trump has also spoken often about his determination to revisit past trade deals and restructure them in order to strengthen the economy and boost manufacturing employment.  However, it is now clear that the agreement restructuring he has in mind is what he calls “modernization” and that translates into expanding the terms of existing agreements to cover new issues of interest to leading US multinational corporations.

As Inside US Trade explains:

Commerce Secretary Wilbur Ross on Wednesday said “the easiest issues” to be addressed in North American Free Trade Agreement modernization talks “should be” those that were not part of the existing agreement, which entered into force in 1994.

“The easiest ones will be the ones that weren’t contained in the original agreement because that’s new territory; that’s not anybody giving up anything,” Ross said at an event hosted by the Bipartisan Policy Institute on May 31. “And by and large, those should be the easiest issues to get done.”

Ross added that those new issues are important “because one of our objectives will be to try to incorporate in NAFTA kind of basic principles that we would like to have followed in subsequent free-trade agreements, rather than starting each one with a blank sheet of paper.”

Among those issues — which he called “big holes” in the old agreement — he listed the digital economy, services, and financial services. . . .

Ross reiterated the administration’s stance that the “guiding principle is do no harm” in redoing NAFTA, while the second “rule of thumb” is to view concessions made by Mexico and Canada in the Trans-Pacific Partnership negotiations “as sort of a starting point” for NAFTA talks.

Asked whether the administration has set itself up for “unrealistic aspirations” on NAFTA — promising to return to the U.S. jobs that the president has often claimed were lost due to the agreement with Mexico and Canada — Ross cautioned against viewing a retooled deal as a “silver bullet.”

In short, it is foolish and costly to believe the promises made to working people by leading corporations and the Trump administration.  Hopefully, growing numbers of people are getting wise to the game being played, making it easier for us to more effectively organize and advance our own interests.

Robots And Automation Are Not The Cause Of Our Labor Market Troubles

Employment growth remains weak in the United States.  Many in the media happily encourage us to blame the growing use of robots, or automation more generally, for this situation.  Their message is that we are just experiencing the consequences of technological progress and no one should want to fight that.  However, that is just misdirection; the numbers make clear that it is corporate financial “wheelings and dealings,” not robots and automation, that is the primary cause of our current employment woes.

Productivity Trends

If robots or automation were holding back employment growth we should see rapidly rising rates of output per labor hour or what economists call productivity.  In other words, the new technology would allow companies to greatly increase their production with the same number or even fewer hours of human labor.  And, as a consequence, the demand for labor would slow, leading to weak employment growth.

Here is how the Bureau of Labor Statistics (BLS) explains productivity:

Labor productivity is a measure of economic performance that compares the amount of goods and services produced (output) with the number of labor hours used in producing those goods and services. It is defined mathematically as real output per labor hour, and growth occurs when output increases faster than labor hours. . . . Technological advances, greater investment in machinery and equipment by businesses, increases in worker skill and experience, and other improvements to production can all lead to labor productivity growth.

The problem for those who want to blame our labor market woes on robots and automation is that US productivity gains have been historically weak, not strong, during this economic expansion.

Chart 1 shows the growth in output, hours worked, and labor productivity (shown by the red bar) for the non-farm business sector over every business cycle starting in 1948, as well as for the average business cycle for the historical period.  Of course, our current cycle is not yet over, and the data in this chart only take us through the 3rd quarter of 2016.  But our current expansion is already the longest, and since productivity tends to fall the longer an expansion goes on, we are unlikely to see much of an improvement in the numbers over the rest of the cycle.

As we can see, the growth in labor productivity in the current business cycle, at 1.1 percent, is tied with the 1980-1981 cycle for the lowest rate of productivity growth for the entire historical period.  Labor productivity growth for the average cycle is 2.3 percent.  The current business cycle also has the second lowest rate of growth in output.

Chart 5 offers another way to appreciate how weak productivity growth has been during the current business cycle.  It compares the growth in labor productivity over this cycle with the growth in productivity over the previous cycle (2001 to 2007) and the longer period 1947 to 2007.

In the words of the BLS:

Through most of the Great Recession, labor productivity lagged behind historical growth rates, but then it achieved above-average gains coming out of the recession and into the early quarters of the recovery. The U.S. economy actually caught up to the long-term historical trend (the dashed red line) in the fourth quarter of 2009, although it was still slightly behind the trend from the last cycle (the dotted red line) at that point. However, after 2010, productivity growth stagnated and a substantial deficit relative to historical trends developed over the next 5 years. By the third quarter of 2016, labor productivity in the current business cycle had grown at an average rate of just 1.1 percent, well below the long-term average rate of 2.3 percent from 1947 to 2007 and even further behind the 2.7 percent average rate over the cycle from 2001 to 2007.

In short, if robots or automation were replacing workers this would be reflected in strong productivity growth.  In fact, we see quite the opposite: the weakest productivity growth for any business cycle in the post-1947 historical period.

While high productivity does not guarantee strong wage gains, workers normally find it easier to force business to boost wages when output per labor hour is significantly growing.  Low productivity gains, on the other hand, normally translate into weak wage growth.  And that is what we see today.

Chart 6 shows the growth in labor productivity, real hourly compensation, and the wage gap (difference between productivity and compensation) over the 1948 to 2016 period.

As we can see, the growth in real hourly compensation (shown by the gold bar) has been extremely weak this business cycle, growing by only 0.7 percent.  As the BLS notes:

[This] is low by historical standards. The rate is lower than the average real hourly compensation growth rate of 1.7 percent observed during other business cycles. The rate is also below the rates of all other cycles, except for a brief six-quarter cycle in the early 1980s. Note also that the low growth rate of the current business cycle is a near-continuation of the similarly low growth rate of the early-2000s cycle (0.8 percent).

 Behind The Scenes

For all the talk about technology, business investment has been weak, as illustrated in the following charts from the Economic Policy Institute.  Capital investment has been slow compared with past periods and the same is true for business investment in information technology equipment and software—the alleged drivers of technological innovation.

So, what are businesses doing with their ample profits?  The answer is that they are using them to repurchase their own stock in order to boost stock prices (and managerial salaries) and to pay large dividends to their stockholders.  In other words, engaging in financial transactions to enrich those at the top.

Figure 1, from Yardeni Research, shows the annual dollar value (in billions) of stock buybacks, which is the repurchase of shares by the company that initially issued them, for S&P 500 listed firms over the years 1999 to 2016.  Figure 2 shows annual dividend payouts for these same firms.   Each has been substantial since 2003, although the period of the Great Recession did produce a steep short term dip.

Figure 12,  by showing the value of S&P 500 buybacks and dividends as a percent of operating earnings, illustrates just how substantial this financial activity has become.  Operating earnings are a key measure of profitability and are calculated by subtracting direct business expenses–such as the cost of production, administration and marketing, depreciation, etc.–from revenues.  What we see is that business spending on buybacks and dividends has actually been greater than total operating earnings for several years since 2007, including 2016.

In short, S&P 500 listed businesses are shoveling almost all their profits, and then some in many years, into financial dealings.  No wonder real capital investment has been weak and productivity, wage, and employment growth slow.  Forget that stuff about robots and automation.

The World Economy: Trouble Ahead

Economic conditions are not good and the signs are for more trouble.  The post-Great Recession recovery has been incredibly weak and it appears that it will soon come to an end.  And here I am writing about all the advanced capitalist economies, not just the United States.  Perhaps the key indicator: investment and productivity trends.

Here is the International Monetary Fund [IMF] writing in 2015: “Private fixed investment in advanced economies contracted sharply during the global financial crisis, and there has been little recovery since.”

More specifically, the IMF finds that:

The sharp contraction in private investment during the crisis, and the subsequent weak recovery, have primarily been a phenomenon of the advanced economies. For these economies, private investment has declined by an average of 25 percent since the crisis compared with precrisis forecasts, and there has been little recovery. In contrast, private investment in emerging market and developing economies has gradually slowed in recent years, following a boom in the early to mid-2000s.

The investment slump in the advanced economies has been broad based. Though the contraction has been sharpest in the private residential (housing) sector, nonresidential (business) investment—which is a much larger share of total investment—accounts for the bulk (more than two-thirds) of the slump. There is little sign of recovery toward precrisis investment trends in either sector.

real private investment

The figure above illustrates how far advanced economy investment has fallen relative to the precrisis period and past forecasts and that there has been no recovery in investment spending (the log scale shows percentage change in investment).

The following figure, which covers only advanced economies, demonstrates that the investment slump has affected both residential and nonresidential investment.  And, as far as the latter is concerned, investment spending on both structures and real equipment are significantly down relative to past trends.

types of investment

These trends have real consequences.  As the economist Michael Roberts points out,  “Global industrial output growth continues to slow and in the case of the G7 economies (red line below), industrial production is now contracting.”

world IP

He also highlights the fact that “world trade . . . is in significant negative territory (red line below).  This is partly due to the collapse in energy and other industrial raw material prices.  But even when you strip out the impact of the deflation in prices, world trade volume is basically static (blue line) and well below even the low world GDP growth rate of around 2.5%.  Countries with low domestic demand can expect no compensation through exports.”

world trade

The investment slump has also taken its toll on productivity.  According to the Financial Times:

Output per person . . . grew just 1.2 per cent across the world in 2015, down from 1.9 per cent in 2014. A slowdown in Chinese productivity was a big driver, as was poorer output growth in commodity producing countries in Latin America and Africa because of weaker oil prices and production.

Productivity growth in the eurozone, measured by gross domestic product per hour, is set to be a feeble 0.3 per cent and barely better in Japan at 0.4 per cent.

But the US, which appeared to be outperforming other advanced economies, is now increasingly concerned at the deterioration in its own performance. Growth in output per hour slowed last year to just 0.3 per cent from 0.5 per cent in 2014, well below the pace of 2.4 per cent in 1999 to 2006.

Moreover, things are fast deterioriating in the US.  The Financial Times reports that productivity will likely fall this year for the first time in three decades. “Research by the Conference Board, a US think-tank, also shows the rate of productivity growth sliding behind the feeble rates in other advanced economies, with gross domestic product per hour projected to drop by 0.2 per cent this year.”

us-productivity-growth

Sadly, as Roberts argues, most governments still seek to rejuvenate their respective economies by some combination of monetary easing, cuts in public investment, privatization, weakening labor rights, and new free trade agreements. These policies have not worked and there is no reason to think that they ever will.

The Greek Tragedy Continues

The Greek tragedy continues.  Greece remains in depression.  The economic downturn began in 2008 and the economy has shrunk every year since, with the exception of 2014.  Although millions are suffering from poverty, the Greek government has continued to make its debt payments, first to foreign banks and now to the Troika.  This pairing is the result of two huge loans by Troika institutions in exchange for the imposition of fierce austerity policies.

The Greek people have refused to quietly accept the unraveling of their society.  According to the Greek police, there were 27,103 protests and rallies in Athens alone between 2011 and 2015.  The number of rallies attended by more than 1,000 people were 61 in 2012, 72 in 2013, 58 in 2014 and 72 in 2015.  Knowing the reliability of police record keeping, these are likely undercounts.

article-1273498-09728EC4000005DC-137_468x286

Despite popular resistance, a commitment to more austerity in exchange for yet more debt was recently approved by the Greek parliament.  It includes new cuts to pensions, increases in required social security contributions, and higher personal and business taxes.  Tragically, the current agreement was negotiated by Syriza, the political party elected in January 2015 on the basis of its commitment to end the austerity and renegotiate the country’s foreign debt.

I recently published an article in the journal Class, Race, and Corporate Power which attempts to explain the forces driving Greece’s economic crisis and the failure of Syriza to fulfill its promises.   The abstract is below.  The article can be accessed for free here, on the journal’s webpage.

 

The Pitfalls and Possibilities of Socialist Transformation: The Case of Greece

Abstract:

With its 2015 electoral victory in Greece, Syriza became the first left political party to lead a European government since the founding of the European Union. As such, its eventual capitulation to the demands of the Troika was a bitter development, and not only for the people of Greece. Because the need for change remains as great as ever, and efforts at electoral-based transformations continue, especially in Europe, this paper seeks to assess the Greek experience, and in particular Syriza’s political options and choices, in order to help activists more effectively respond to the challenges faced when confronting capitalist power.

Section 1 examines how Greece’s membership in the euro area promoted an increasingly fragile and unsustainable economic expansion over the period 2001 to 2007. Section 2 discusses the role of the Troika in Greece’s 2008 to 2014 downward spiral into depression. Section 3 discusses the ways in which popular Greek resistance to their country’s crisis helped to shape and nourish Syriza as a new type of left political organization, “a mass connective party.” Section 4 critically analyzes the Syriza-led government’s political choices, highlighting alternative policies not chosen that might have helped the government break the Troika’s strangle hold over the Greek economy and further radicalize the Greek population. Section 5 concludes with a presentation of five lessons from the Greek experience of relevance for future struggles.

Recession On The Horizon

Economic trends do not look promising, at least for working people.

The UN publication World Economic Situation and Prospects 2016 highlights the dramatic slowdown in economic activity in the years following the world recession.

Looking at the 20 leading developed economies we see that average growth fell from 2.8 percent over the period 3rd quarter 2002 to 4th quarter 2007 to 1.3 percent over the period 1st quarter 2010 to 2nd quarter 2015.  At the same time, growth became more unstable as shown by the rise in volatility. Consumption growth and investment growth also fell dramatically with volatility increasing. Trends were similar, although not as drastic for the 20 leading developing nations.

growth trends

The UN study paid careful attention to the collapse in investment.  The authors note:

The global financial crisis has had the most pronounced negative effect on investment rates. . . . After an early recovery in 2010-2011, the growth rates of fixed capital formation have sharply slowed down since 2012, exerting downward pressure on productivity, employment and growth. The growth rates of fixed capital formation nearly collapsed since 2014, registering negative quarterly growth in as many as 9 large developed and developing countries and economies in transition. . . .

Investment in productive capital has been even weaker than the total investment figures suggest, as dwelling and intangible assets account for the majority of investment in developed economies. According to OECD data on fixed capital formation, investments in intangible and intellectual property assets together represent the largest share of fixed capital formation in a number of developed economies in 2014, including in Germany (47.2 per cent) and the United States (42.3 per cent). Acquisition of intangible assets, such as trademarks, copyrights and patents, may increase financial returns to firms without necessarily increasing labor productivity or productive capacity.

Especially noteworthy is that despite their lack of investment in plant and equipment, non-financial corporations have resumed their borrowing.  As the authors of the UN study explain:

A growing disconnect between finance and real sector activities is evident in the data: fixed investment growth nearly collapsed, while debt securities (a financial instrument to raise capital) issued by non-financial corporations increased by more than 55 per cent between 2008 and 2014, representing a nearly 8 per cent increase per year [as the table below shows].

This is noteworthy because it means firms are largely going into debt to engage in mergers and acquisitions, stock repurchases and dividend payments. If world economic growth continues to slide, many of these firms are likely to find themselves in serious debt difficulties.

debt trends

For most of the post-recession period, world growth was sustained by the high rates of growth in the third world, in particular China.  However, the decline in growth in the developed world eventually produced a slowdown in Chinese exports and growth, which caused a decline in Chinese demand for commodities, triggering a dramatic slide in commodity prices and rates of growth in many developing economies.

commodity trends

The slowdown in third world growth is gathering speed.  One factor is the growing capital flight from the third world.  As the economists Joseph Stiglitz and Hamid Rashid explain:

The real worry, however, is not just falling commodity prices, but also massive capital outflows. During 2009-2014, developing countries collectively received a net capital inflow of $2.2 trillion, partly owing to quantitative easing in advanced economies, which pushed interest rates there to near zero.

The search for higher yields drove investors and speculators to developing countries, where the inflows increased leverage, propped up equity prices, and in some cases supported a commodity price boom. Market capitalization in the Mumbai, Johannesburg, São Paulo, and Shanghai stock exchanges, for example, nearly tripled in the years following the financial crisis. Equity markets in other developing countries also witnessed similar dramatic increases during this period.

But the capital flows are now reversing, turning negative for the first time since 2006, with net outflows from developing countries in 2015 exceeding $600 billion – more than one-quarter of the inflows they received during the previous six years. The largest outflows have been through banking channels, with international banks reducing their gross credit exposures to developing countries by more than $800 billion in 2015. Capital outflows of this magnitude are likely to have myriad effects: drying up liquidity, increasing the costs of borrowing and debt service, weakening currencies, depleting reserves, and leading to decreases in equity and other asset prices. There will be large knock-on effects on the real economy, including severe damage to developing countries’ growth prospects.

This is not the first time that developing countries have faced the challenges of managing pro-cyclical hot capital, but the magnitudes this time are overwhelming. During the Asian financial crisis, net outflows from the East Asian economies were only $12 billion in 1997.

The US financial sector is one of the main beneficiaries of this capital flight.  However, the inflow of funds tends to drive up the value of the dollar to the detriment of US manufacturing, investment, and employment.

It is hard to see positive signs for the world economy.  In fact, many analysts are now predicting recession for the US.  The economist Michael Roberts has long argued that key to “the health of a modern capitalist economy is . . . the direction of average profitability of capital, total business profits and its impact on business investment.” In other words, a decline in profit rates will eventually lead to a fall in total corporate profits and then investment.  When that happens a recession is not far behind.

As Roberts describes:

[R]ecently some mainstream economists have paid the movement in profits a bit more attention. . . . And . . . the economists at the investment bank JP Morgan have started to use profits and profitability as a guide to the likelihood of an oncoming recession.

They first noted that global profit margins have been drifting lower for the past two years, mainly driven by a falling profitability in emerging capitalist economies as the great commodity price boom reversed and China’s economy slowed sharply.

And now DM (developed market) margins have begun to fall as US corporations come under pressure from the rising dollar and the concentrated hit to the energy sector, JPM noted.  In another note, JPM economists looked at overall US corporate profits and calculated that corporate profits were likely down 11% annualized last quarter, and down 7% over year-ago levels.”

They “now put the probability of a recession starting within three years at a startling 92%, and the probability within two years at 67%”. However, they temper this result by pointing out that profit margins are still historically high so there is room for a fall without economic contraction and also the expectation that the US Fed will not continue with its rate hikes as quickly or as far as previously planned. On that basis, their forecast of a US recession is beginning within three years at about 2/3 and within two years at close to 1/2″. 

It is difficult to predict economic turning points, but the trends appear clear—the long post-crisis expansion is nearing its end.  Tragically, few people have benefited from the expansion and our social structures are far from sufficient to see us through the new approaching recession.

 

Election Politics And The Economy

It’s election season in the US and so politicians, supported by their favorite economists, are busy telling us how they will lift the US economy out of its doldrums, ensuring more and better jobs for Americans.

A case in point: the New York Times ran an article highlighting how most Republican presidential candidates are pushing for some form of consumption tax coupled with reductions in income and corporate taxes.

Then the story adds:

. . . the broad direction of their proposals — toward taxing spending rather than income — is one that many economists in both parties applaud. It is also one that politicians, of necessity, may eventually embrace. . . .

“Every one of the Republican plans I have looked at closely has more of a consumption basis,” said Leonard Burman, a former official in President Bill Clinton’s administration who directs the Urban-Brookings Tax Policy Center.

Democratic politicians typically oppose taxing consumption on fairness grounds; lower earners spend a greater proportion of their income than higher earners. They favor what are called progressive taxes, those that tax a higher proportion of wealthier people’s income. That instinct is especially acute in an era of stagnant middle-class wages and widening income inequality.

Yet Democratic economists, like their Republican counterparts, say taxing consumption encourages savings, investment and greater economic growth.

Whoa!—can that be true, that there is a growing consensus for a shift in taxes that would penalize consumption, and that this is the best way to promote savings, investment, and greater economic growth?

Reading this, one might well assume that weak savings must be the main cause of the low investment and stagnant economic growth in the US.  However, as the economist Michael Roberts demonstrated in a recent blog post, such an assumption would be wrong.

Roberts, drawing on both an article by Martin Wolfe (a Financial Times economic analyst), and a research study by Joseph W. Gruber and Steven B. Kamin (two US Federal Reserve Bank economists), pursues the reason for weak investment in advanced capitalist economies, including the US, by examining trends in corporate savings and investment.

As Wolfe points out,

companies generate a huge proportion of investment. In the six largest high-income economies (the US, Japan, Germany, France, the UK and Italy), corporations accounted for between half and just over two-thirds of gross investment in 2013 (the lowest share being in Italy and the highest in Japan).

Because corporations are responsible for such a large share of investment, they are also, in aggregate, the largest users of available savings, but their own retained earnings are also a huge source of savings. Thus, in these countries, corporate profits generated between 40 per cent (in France) and 100 per cent (in Japan) of gross savings (including foreign savings) available to the economy.

The following three charts all come from Wolf’s article.  This first shows trends in corporate gross savings as a percent of GDP for all six countries.  As we can see, corporate gross savings as a share of GDP grew, although marginally, in every country but France over the period 1998 to 2014.

corporate-gross-savings

The next chart shows trends in corporate investment as a percent of GDP.  In contrast to corporate savings, the investment ratio fell noticeably in every country, again with the exception of France, over the same time period.

corporate-gross-investment

Combining the two ratios yields the trend in net corporate savings as a share of GDP, which is illustrated in the following chart.  The take away is clear: corporations are saving more than they are investing, which means that the decline in investment cannot be explained by a shortfall in savings.  Thus, it is foolish to think that we will boost investment and growth in the United States, or the other countries, by taxing consumption.

corporate-net-lending

So, what explains the lack of corporate investment?  Gruber and Kamin’s investigation into what they call the “corporate saving glut led them to the following conclusions:

First, . . . in most of the G7 economies we studied, the net lending of nonfinancial corporations rose to very high levels in recent years, and this rise started even before the GFC [Global Financial Crisis]. . . . Second, consistent with other studies of recent investment behavior, we found that models estimated up through 2006 generally tracked the weakness of actual investment during the GFC and its aftermath; conversely, models estimated up through 2001 often over-predicted investment in subsequent years, both before and after the GFC. We interpret these results as suggesting that investment in the major advanced economies has indeed weakened relative to what standard determinants would suggest, but that this process started well in advance of the GFC itself. Finally, we find that the counterpart of declines in resources devoted to investment has been rises in payouts to investors in the form of dividends and equity buybacks (often to a greater extent than predicted by models estimated through earlier periods), and, to a lesser extent, heightened net accumulation of financial assets. The strength of investor payouts suggests that increased risk aversion and a precautionary demand for financial buffers has not been the primary reason firms have cut back investment. Rather, our results are consistent with views that, for any number of reasons, there has been a decline in what firms perceive to be the availability of profitable investment opportunities.

Roberts appropriately highlights the last sentence.  We know that capitalism is driven by the pursuit of private profit.  The question for us is: How well does such a system serve majority interests when during this period of great social need our leading corporations are unwilling to invest because existing opportunities do not offer them sufficient profit?

It is as good a time as ever in the US to reject false strategies for economic renewal and seriously begin conversations about alternative ways to organize our economy and political system.