Labor and Capital in a Globalized World

I remember sitting through economics courses listening to lectures on labor mobility and capital mobility, and their flows in relation to countries competing globally. Fast-forward ‘X’ number of years [I’m not going to date myself.], and I’m looking at the same concepts, but this time with a more realistic perspective.

For a country like the US, that a generation ago was leading the world economy with manufacturing at its base labor was an especially important factor of production. Capital in the form of investable funds has always been relatively available and at relatively low costs in the US, but particularly so in the post-depression decades. Labor on the other hand was not available in similar abundance. The economic models would suggest that an economy with abundant capital and scarce labor should specialize in services versus manufacturing as services are less labor intensive.

In the time frame that the US was making strides in manufacturing, the rest of the developed world was recovering from World War II. With the US being one of the few participants that did not suffer domestic destruction from warfare, there was no recovery time between switching from war-supply manufacturing to consumer goods manufacturing as the capacity already existed. And with industrial capacity decimated across the developed world and Asia, there was artificial demand for US made goods.  The external demand would have spurred investments in manufacturing technology in the US to keep growing capacity, but also making the sector relatively more capital intensive.

By the start of the US-Korean War, manufacturing would have been on the rebound across the developing world. Again, as the economic models would suggest, countries where capital is relatively scarcer than labor should specialize in more labor intensive production, like manufacturing. So while manufacturing and export centers materialized organically across the globe, it took US government wartime spending to artificially propel the manufacturing base forward at home. This would however, be the last war to have this benefit.

Since the protectionist days of the great depression, the major trade participants of the world, and progressively more minor ones have been moving towards connectivity and away from isolation. In an ever globalizing world, capital and to a lesser extent labor would have begun moving across borders with more and more ease, which meant global imbalances became more apparent. As the global market for capital and labor sought to reach a state of equilibrium, the US economy began a fundamental shift towards services and away from manufacturing as the increasing cost of labor would have destroyed competitiveness.

By the time the Vietnam War was in full swing, the US economy was at the height of the transition from a manufacturing based economy to a service based economy. At that point, manufacturing had almost been completely eroded away by the high relative cost of labor, while the technological infrastructure to make a service based economy more viable was still in its early stages of development under the guidance of the military.

Unlike previous war-time spending campaigns by the US government, which had subsidized and stimulated the manufacturing base, spending on the Vietnam War did not ‘trickle down’ to the man on the street. He had not had a job in manufacturing in years and his skills were outdated for the technological applications. The service sectors that were emerging at the time required a re-tooling of the American workforce and so also increased in capital intensity. Though it would have been much easier at the time [and frankly still is today] to increase the capital stock in the US by allowing more foreign investments than to increase the labor stock by allowing in more foreign labor.

The period following the Vietnam War was plagued with high unemployment and high inflation, which ushered in the era of stagflation. Tracking the US Balance of Payments of accounts we can see that the US became a net importer of manufactured goods in the middle of the 1970s, but did not become a net exporter of services until the middle of the 1980s. Almost a decade of no clear base for economic growth and fiscal drag from financing war, and the threat of limited supplies of oil due in part to geopolitics, US economy was in dis-equilibrium. 

  

Balance of Payments on Services

(Billions of $US)

 

 Balance of Payments on Merchandise 

               (Billions of $US)

The level of economic hardship that was experienced by so many during that period was indicative of what happens when an economy is too heavily weighted in one sector over the many, and how artificial supports [whether intended or unintended] tend not to work over time.

During the same time period that the economy was re-inventing itself, Congress was hard at work putting together new ways to make things better now, but worse later. In 1977 Congress passed the Community Re-investment Act (CRA) and, in my opinion, this put a series of events in motion that inevitably lead to the housing market bubble of the early 2000s and the ensuing global recession. That piece of legislation, along with others de-regulating the largest banks and financial institutions, created the space for a secondary market for mortgages to develop. Along with that came the idea of securitizing mortgages and reselling them to investors, from there the rest is history.

Business as Usual

Five years after our most recent once-in-a-generation economic calamity, is it safe to say that it’s back to business as usual from here with regards to the US economy?

The question coalesced out of three things:

The change in the overall sentiment of economic data, albeit still negative by historical perspective, has been stabilizing if not improving.

 Financial asset prices have maintained a persistent march higher in spite of restrictive monetary policy guidance from the Fed, low inflation expectations by most measures, and an economy stricken with production capacity slack, and a risk of hysteresis in the labor.

In an interview on Bloomberg, the head of the IMF said something to the effect of “everyone agrees that there is slack in the US economy, and need for investment…”.  

The data, first and foremost is telling a different story from during the midst of the crisis and ensuing recession. Without that underlying shift there wouldn’t be much room to quantify the change, since on a qualitative basis not much has change for a lot of people. Following the sentiment change in the economic data feed, the persistence of financial asset prices also stand out.

Historically, the equities market has lead the real economy [GDP, employment, etc] out of a recession and back to growth by about 3-4 fiscal quarters. Well stocks recovered their losses about a year-and-a-half or so ago, and have been making a series of new highs with little time spent correcting or retracing. Bond prices have also been elevated as a byproduct of the Fed’s easy monetary policy. But, even with more guidance from the Fed trying prepare markets for a more restrictive policy stance, bond prices have resisted most of the downward pressure.

Lastly, we have world leaders talking on a worldwide platform saying things like ‘everyone agrees…’. I think that a social consensus is much easier to build than a political one, and politicians try to mirror the consensus to appear legitimate, so if the international community is talking along these lines then maybe that’s where their money is too.

In a business as usual world, the dollar trends lower for many reasons, one of which is investors around the world seeking out risk in exchange for return by selling their relatively safe [low yielding] US investments and buy relatively riskier [higher yielding] international investments. To keep my life simple, I looked at the regression trend of prices of the front month dollar index futures over a twenty-year span, a ten-year span, and a five-year span. Suffice to say the 2008 crisis had enough of an impact that it changed the long term regression trend of the dollar. But, the effects are only reflected when the price data from 2009 – 2010 are included in the five-year measure. Basically, the rest of the world in terms of economic activity and capital flows, have been back to business as usual for over two-and-a-half years now.

Let the Prices Decide

I’m seeing more and more construction cranes dotting skylines and even hearing commercials on the radio for financing options that make me think ‘they’re at it again’. Someone is financing these projects, and nine times out of ten it would be a bank; there aren’t too many billionaires with the liquidity and risk appetite to match to fund these many projects.

Basically, it’s this type of credit access that is needed for an economy to grow on a fundamental level when it runs on leverage. Thanks to the creative work of the Fed under Ben Bernanke, the banks are perfectly situated to service to the nascent demand for credit in the economy. This actually has potential to be the start of the next mega-macro business cycle. Which seem to run in 20 – 25 year boom-bust cycles by the way. It comes down to the economic environment that these credit transactions are going to take place in, which for the most part is swayed by Fed activity and the overall sentiment of monetary policy.

In the short term, however, economic data on housing looks to be losing upward momentum, which happens to be a key component of most inflation measures. Official unemployment numbers are creeping lower, but the length of time for which unemployment numbers have been elevated is a bit worrying. At this point there is a huge pool of people that are not being counted as unemployed, and not to mention the underemployed that have surplus labor that they cannot get sold. So that’s two for two with weak components of inflation measures.

With this template, we can expect the Yellen Fed to continue the slow withdrawal of stimulus as already in progress, and the economy to continue to hover at its current levels of growth.

If ever there was price inflation to be found, it would be in financial assets. Their proximity to the toxic amount of cash that is held between the banks and the Fed increased their relative values when compared to other key metrics of economic advancement. From here one of two things can happen; either the US macro-economy snaps up to be in equilibrium with financial assets, or financial assets snap back to be in equilibrium with the macro-economy. We’ll let the prices decide.

Long story short, the monetary stimulus never made it out of the financial ether that is the US banking system. Like the universal solvent that is water, money is fluid and will find even the most miniscule crack in the dyke that is the Federal Reserve, and flood the low lying areas of the economy with the inflation that has been suspiciously absent according to most contemporary observers.

Consumerism

Thumbing through 330s section [Dewey decimal system] I stumbled upon some interesting reading on consumerism in China. The author went on about the shifting tides of consumerism in China, and the expectations of the global business and political community that the Chinese consumer can step onto the world stage and provide demand for the import of foreign goods and services, enough so as to buoy the global economy.

Because of [and only because of] an ideological aligning with the political mechanism that is the Chinese government, the society is beginning to explore the nuances of mass consumerism.

Meanwhile, on the other end of the proverbial spectrum, the mainstay of the global consumerist economy is going through a once-in-a-generational deleveraging cycle, and the spillover effects are macro due in part to globalization, and in part to the misguided use of the work of Profs. Mundell and Fleming.

An over leveraged consumer in the United States has just seen their home and 401K go through big angulations in value. The burden of the debt generated by a deficit lifestyle became ever-present as unemployment numbers stagnated at record levels. Priorities had to be recalculated, but adjustments were [and still are being] made to ensure the US consumer cleans up a bit for their international financiers, that they can repeat another 20 – 25 year megamacro boom and bust economic cycle driven by a borrow and spend mantra.

Are the Chinese going to keep spending? It seems like the government supports it, and is showing its support by instituting certain social safety nets that cover expenses that people would otherwise have to save for themselves. The next step in the process of the full-fledged Chinese adoption of western style consumerism is a development of brand preferences. American and European firms have built empires from doing just that, and will have a new and modern market to ploy their craft.

Will the impact of such a shift be sudden and resounding? Maybe not, but it just maybe enough of an offset to the loss of the US consumer’s full ability to borrow and spend to keep the global economy on par for a period of mediocre but steady growth for next few years.