God is a Capitalist

Friday, September 13, 2013

Five years after Lehman - Jobless Recovery Explained

Like a calf staring at a new gate, mainstream economists are mystified at the unemployment data that has given the US a jobless recovery for the past four years, five years after the collapse of Lehman Brothers.  Creative manipulation of the money supply by the Fed, massive bailouts of banks and other corporations, and historic federal spending have failed to lift aggregate demand. Why? Because all aggregate demand isn’t the problem.
Aggregate demand in mainstream economics has two sides, consumer spending and business spending, or investment. Mainstream economists forget that definition of demand. Also, they think that consumer spending drives aggregate demand because it makes up about 70% of GDP. However, GDP leads them astray because of the highly stylized and weird way it calculates business revenues. In reality, it is net domestic product, not gross, but that is a different post.
Austrian economics demonstrates that the investment side of aggregate demand does the driving, not the consumer side. Economist Robert Higgs uses net domestic investment to explain the jobless recovery in a recent article “The Sluggish Recovery of Real Net Domestic Private Business Investment"The Sluggish Recovery of Real Net Domestic Private Business Investment.”

“From these data, I have constructed the following index of real net domestic private business investment from 2005 to 2012, where the 2007 value equals 100:”


“As the figures show, real net domestic private business investment reached its recent peak in 2007 (only slightly above the level for 2006), then plunged in 2008 and dropped even more precipitously in 2009. Although it recovered somewhat during the past three years, it remains extremely depressed relative to its previous peak. Five years after its bust and partial recovery, real net private business investment in 2012 remained 41 percent below its previous peak.”
As I showed in a graph in an earlier post, profits have been unusually high in this recovery, though they have faltered recently. They are high because business investment has been weak. Investment becomes expense in accounting and reduces profits. Cost cutting, monetary pumping and sluggish investment have lifted profits to new heights, but not forever. When profits falter, the stock market crashes through the ice.

Profits that are high for the cycle are leading indicator that Hayek’s Ricardo Effect is about to kick in and end the expansion. The Ricardo Effect says that high profits in the consumer goods sector motivate businessmen to put off buying labor saving equipment and use more labor in production. It’s similar to the production possibility frontier tradeoff between capital and labor taught in microeconomics.

That sounds like it would reduce unemployment, but the highest unemployment is in the capital (or durable) goods sector. The reduction in purchases of equipment hurt sales in the capital goods sector, which increases layoffs there. Purchases of capital equipment (such as computer hardware and software) is a big part of investment. Another type of investment would be commercial real estate.

Higgs points to regime uncertainty as a cause of sluggish investment and I agree along with many economists. Regime uncertainty means that businessmen face a government that is rapidly changing the rules and creating uncertainty about business taxes and expenses in the future. The primary sources of uncertainty are the healthcare and financial regulation bills.
In an NPR report on banks recently,  Wayne Abernathy of the American Bankers Association said, “...the worst thing about the new environment for bankers is how uncertain it is. Many of the new regulations haven't been written. Others are so new it's not yet clear what impact they'll have.”
I would add high taxes and regulations. The US corporate tax rate is now the highest in the industrial world. And in spite of deception by the mainstream press, there has been no net deregulation of business. The Federal Register of new regs has averaged 70,000 pages per year since 1970 with an explosion of new regs in the past six years dealing with financial and healthcare regulations.

Update: "Higher taxes and employee benefits boost U.S. manufacturing costs to 9 percent more than the average of the country’s nine-largest trading partners, according to a Sept. 3 report by a team of JPMorgan Chase & Co. analysts." from Bloomberg.

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