Author: conversableeconomist

When the first trans-Atlantic telegraph message was sent in 1858, the tough question was how to follow up on the famous terse line that Samuel Morse had sent in 1844 over the telegraph between Baltimore and Washington: \”What hath God wrought?\”

On August 18, 1858, the \”official\” first message to cross the Atlantic by telegraph was \”\”Glory to God in the highest; on earth, peace and good will toward men.\” Actually, with the various test messages that were sent back and forth, this was the 129th message to cross the Atlantic. It took about 17 hours to send.  Then Queen Victoria and US President James Buchanan got involved. The Queen sent a 98-word message that took 16 hours to transmit. Buchanan responded with a 149-word message that took 10 hours to transmit. Part of the problem was that the signals were weak, and needed to be confirmed and repeated a number of times. One engineer thought that the solution was to boost the voltage, which blew out the insulation on the cable after only 400 messages had been sent.

It wasn\’t until eight years later in July 1866 that functional trans-Atlantic telegraphic communication was firmly established. Helen Fessenden discusses the effects of this communication breakthrough on various markets in \”The Great Telegraph Breakthrough of 1866: The transatlantic telegraph cable amounted to the information revolution of the day, tying global markets together in unprecedented ways\” (Econ Focus, Federal Reserve Bank of Richmond, Second Quarter 2018, pp. 28-30).

At the time, cotton was the major US export, and about 70% of all US cotton was shipped to Great Britain–much of it by way of the port of New York City.  But how could the merchants of New York know how much to send, and at what price? The trans-Atlantic cable provided the information. Fessenden writes:

\”Most cotton was sent to U.S. ports for export, with New York City as the most important hub linking U.S. producers to importers in England. In turn, British textile workers spun raw cotton into finished cloth, which was sold for domestic consumption and for export. Prior to the transatlantic cable, however, there was often a lag between the price of cotton quoted in Liverpool and what was quoted in New York, often by a week or more, depending entirely on ship travel. One common problem was that the information on foreign demand that New York merchants got from Britain was outdated, so it was difficult to make accurate purchasing decisions. Moreover, foreign demand fluctuated considerably, especially on the European continent. (Building up storage capacity could only partly address this issue, due to the fire hazard posed by cotton and prohibitive construction costs.) In short, this was a classic case of information frictions causing inefficiencies in trade. …

In several recent papers, Massachusetts Institute of Technology economist Claudia Steinwender has studied the effects of the transatlantic telegraph breakthrough of July 1866, as a critical positive shock to cotton markets. … Whereas the average difference between New York and Liverpool prices was 2.56 pence per pound of cotton prior to the cable, it fell to 1.65 pence per pound — a drop of more than a third — right after. Furthermore, the transatlantic price differences were much less subject to major swings.

In turn, thanks to more timely and accurate information, New York traders were better able to adjust export volumes to meet fluctuations in foreign demand. Rather than spend money on costly storage, which required leaving some of their product idle, exporters could calibrate their shipments more efficiently. In Steinwender\’s calculations, this boosted average daily cotton exports by 37 percent. The variance in daily volume increased even more, by 114 percent — reflecting the fact that exporters were able to make these adjustments quickly. Overall, she concluded, the cotton trade experienced an 8 percent efficiency gain in annual export value, mostly from the reduced variations in price differences due to the cable. Put another way, this efficiency gain was equivalent to a 20 percent drop in storage costs, or the elimination of a 7 percent ad valorum tariff.\”

There were a number of other efficiency gains from the trans-Atlantic telegraph. In general, trans-Atlantic trade rose because of improved information about supply and demand. New regions could be developed for US cotton production. Stock and bond prices on either side of the Atlantic converged. Fassenden notes efficiency gains within the US economy, too. For example,
in the past it had been necessary to have two train tracks between locations–one outbound and one inbound. But when it became possible to have information on the location of other trains, it was possible to have only one track that, with shared information, could be used for trains using the track at different times to go both directions.

Our modern world of extremely rapid flows of information and communication is a lot more than a convenience. It\’s also a driver of economic efficiency from local markets to global supply chains.

The US economy, because of its enormous internal domestic market, is actually much less exposed to the effects of international trade than smaller economies around the world. For the world economy as a whole, the ratio of imports/GDP is about 28%, using World Bank data.  For the US economy, the ratio of imports/GDP is 15%, about the same as Japan. For China, the import/GDP ratio is 18%; for Korea, it\’s 38%; for Germany, with all of its within-the-European-Union trade, the import/GDP ratio is 40%.

For the other North American countries, the import/GDP ratio is 33% for Canada and 40% for Mexico. The only fairly large economy I know with a lower import/GDP ratio than the US is Brazil, where the import/GDP ratio is 12%.

But although imports (and exports, too) are considerably smaller share of the US economy than the vast majority of other countries, the US tends to be more concerned about potential injury from international trade. Bruce Stokes reports the results of a survey done across 27 countries, which account for about two-thirds of the world\’s GDP, in a Pew Foundation Report, \”Americans, Like Manyin Other Advanced Economies, NotConvinced of Trade’sBenefits: Emerging market publics more likely to link trade to more jobs,better wages\” (September 26, 2018).

For example, Americans are less likely to feel that \”trade is good,\” and more likely to be concerned about adverse effects on jobs and wages. However, Americans are more likely to believe that trade helps to keep prices low.

However, one of the intriguing results from this survey is that Americans area apparently have much more positive attitudes about how trade affects jobs and wages than they did in 2014. For example, The Pew results suggest that the two countries where attitudes about trade, jobs, and wages have shifted most positively since 2014 are the US and Poland.

Here are the overall shifts in US attitudes toward trade from 2014 to 2018.

When looking at public and political discussions about international trade in the US, it does not seem to reflect a public where three-quarters believe that \”trade is good.\” What\’s going on here?

1) One issue in this kind of political opinion surveys is that people bring their partisan leanings to the poll. When President Trump was elected, based in part on expressing strong anti-trade sentiments. many individuals who identify as Democrats suddenly rediscovered the virtues of trade. I wrote about this dynamic in a post last year, one shift in \”US Polling on Attitudes Toward Trade\” (April 12, 2017).

2) There is a pattern across many countries that when an economy is doing well, attitudes toward trade tend to be more positive. At the moment, US economic growth rates and unemployment rates look better than in 2014 (or 2008-9). Again, attitudes on the economic merits of trade tend to be fluid, based on factors not much related to trade.

3) Those who protest against trade tend to be louder than those who support it, and news coverage may reflect this reality.

4) It\’s perhaps worth noting that most economists don\’t view trade as having much effect on the total  number of jobs in an economy, either positive or negative. With the US unemployment rate at 4.5% or less since March 2017, it would seem peculiar to believe that trade has a strong effect in reducing the total number of jobs. The usual claim of economists is that trade reshuffles jobs, toward the sectors and skills where the US has a comparative advantage and away from others. Trade can reshuffle wages, too,  higher in some areas and lower in others. But if you asked me whether trade leads overall to net job creation, taking gains and losses into account, I\’d say \”no.\” The case for international trade is that it leads to a reshuffling of economic resources that improves overall output, not that it is a net creator of jobs.

There is a long-standing debate over the goals of corporations. Should they focus mostly or exclusively on earning profits? Should they be willing to take on broader social missions? Should they be required to do so? What follows are some notes and snippets on this controversy, from various angles.

At least among economists, the usual starting point for these discussions is an essay written by Milton Friedman in the New York Times on September 13, 1970, called \”A Friedman doctrine — The Social Responsibility of Business is to Raise its Profits.\” As with many things written by Friedman, it is a starting point both for those who agree and who disagree, because of the clarity and pungency with which his views are expressed. The essay can be tracked down through the NYT archives and at various places on the web (like here).

Friedman makes the point that most people who run companies don\’t own the company; instead, they are managing the firm on behalf of someone else. Here\’s a snippet:

In a free-enterprise, private-property system, a corporate executive is an employe of the owners of the business. He has a direct responsibility to his employers. That responsibility is to conduct the business in accordance with their desires, which generally will be to make as much money as possible while conforming to the basic rules of the society, both those embodied in law and those embodied in ethical custom. …

What does it mean to say that the corporate executive has a \”social responsibility\” in his capacity as businessman? If this statement is not pure rhetoric, it must mean that he is to act in some way that is not in the interest of his employers. For example, that he is to refrain from increasing the price of the product in order to contribute to the social objective of preventing inflation, even though a price increase would be in the best interests of the corporation. Or that he is to make expenditures on reducing pollution beyond the amount that that is in the best interests of the corporation or that is required by law in order to contribute to the social objective of improving the environment. Or that, at the expense of corporate profits, he is to hire the \”hard-core\” unemployed instead of better-qualified available workmen to contribute to the social objective of reducing poverty …

Insofar as his actions in accord with his \”social responsibility\” reduce returns to shareholders, he is spending their money. Insofar as his actions raise the price to customers, he is spending the customers\’ money. Insofar as his actions lower the wages of some of his employes, he is spending their money.

Friedman has no objection, as he states later in the essay, if the owner of a business wants to act in accordance with an idea of social responsibility. He recognizes that certain kinds of social expenditures can raise corporate profits–but points out that in such cases, calling for profit-maximization works just as well. Friedman is of course supporting the idea that corporations follow both legal obligations, and also ethical obligations. He is pointing out that if social responsibility has additional costs, someone pays for those costs.

A point Friedman does not state explicitly in this essay, but is implicit to many economists, is that the \”social value\” of a corporation lies partly in the way that it uses know-how and work to organize and combine various resources–workers, physical capital, and knowledge that can range from breakfast recipes to pharmaceutical formulas. By acting in this way, a corporation provides a service that customers believe is worth their money and jobs that workers believe are worth accepting, as well as buying inputs and supplies from other businesses and thus supporting them as well. If a company consistently makes losses and does not earn profits, these benefits will be lost. On the other side, a company that earns profits then has access to finance that could be used to expand in a way that satisfies more customer and hires more workers.

It seems to me that many discussions of the \”social responsibility\” of firms do not pay sufficient attention to these gains from pleasing customers and paying workers and suppliers. Such gains should not be taken for granted.

The Chicago Booth Review offers an interesting discussion on Friedman\’s essay and these topics in 
\”Should public companies do more than maximize profits? BlackRock cofounder Sue Wagner joins Chicago Booth’s Marianne Bertrand, Robert H. Gertner, and Luigi Zingales to discuss the business of business\” (August 28, 2018). Luigi Zingales argues:

\”Friedman recognizes that most people, when they invest, look not only at their financial returns but at other dimensions of their investment. However, he also makes an assumption that social activity and business activity are completely separable.

That assumption holds true in the case of donations. If you want to donate a lot of money to your alma mater, you can do it directly through the corporation, or you can distribute the money to shareholders and let the shareholders decide if and how they want to donate it. There is no value destroyed by the donation being made at the shareholder level, and because there is more flexibility in that route—and because I have a different alma mater than many of my fellow shareholders, and we all have different ideas about where our money should go—it is better to push that decision down to the shareholder level rather than doing it at the corporate level. So, if the only social activity we were talking about were corporate donations, Friedman’s principle would be absolutely correct.

However, for most social activities, there are some synergies to decision-making at the corporate level. For example, let’s say I really care about the environment, and I am willing to sacrifice some of my profits to have better management of oil spills. … It costs much more to manage oil spills at the shareholder level than at the corporate level. So maximizing shareholder value and maximizing shareholder welfare are not the same thing. People care about more than just money, and there are things for the sake of which people are willing to forgo some money. …

There are plenty of funds that abstain from investing in certain stocks for reasons unrelated to financial return. Environmentally friendly funds, for instance, don’t invest in oil companies. But while investing in a fund like that might save your soul, it doesn’t save the planet. If everyone who cares about the environment doesn’t invest in a particular company, it will be controlled entirely by people who don’t care about the environment, and they’ll run the company in the most environmentally unfriendly way. If you care about the environment, why not create an environmentally friendly index fund that includes oil companies, and then go to shareholder’s meetings and vote for board members who care about the environment too?

Although Zingales is a strong advocate of giving shareholders a bigger voice to express a broader range of corporate goals, he is also suitably pessimistic about how much this might actually end up accomplishing. An accompanying article in the Chicago Booth Review talks about \”impact investors\” and the \”double bottom line\” strategy when a company sets explicit goals both for profits and also for other objectives, like level of carbon emitted.

Also, it\’s worth remembering that the ultimate decisions about how corporations should pursue social responsibility will be made by corporate executives, who are not a representative group and are not accountable to a democratic process. Marianne Bertrand says:

The main thing that Friedman is worried about is that we would not want to be in an environment where the CEOs of companies, just because they happen to be the CEOs, are deciding for us as a society, as an electorate, which social objectives we care about and which we don’t. We hope that we have a political process in place where the preferences of the electorate about spending on schools or spending on alleviating homelessness would be expressed through the political system, but I think there is a concern that without some guidance as to what social goals companies should be pursuing, especially when those social goals are no longer fully aligned with long-term valuation, we might give corporations too much power.

Or as Zingales adds:

On the one hand, I recognize the gigantic failure of the political system, and so I would like corporations to do more. On the other hand, it’s a risky business because corporations, as Sue was saying, don’t represent all the people. They represent a subset of people. So, if we give them a huge amount of political power, I’m not so sure that they’ll fix the problems the right way.

Here\’s a random assortment of some other thoughts about corporations and social value that have been piling up in my files.

About 25-30% of all US workers are in a job that requires an occupational license; for comparison, 10.7% of US wage and salary workers are in a union. The usual justification given for occupational licenses is that they are needed to protect the health and safety of the public. But economists going all the way back to Adam Smith in 1776 (who focused on the issue of how overly long apprenticeships limit labor market competition in Book I, Chapter 10 of the Wealth of Nations) have harbored the suspicion that they also might serve to reduce competition in the labor market and thus help those who have the license achieve higher pay.

Occupational licenses are typically granted at the state level, which offers an interesting insight into these issues. If high quality service is the main reason for occupational licensing, then it should be pretty easy for someone who is qualified in one state to work in another state. If blocking labor market competition is the main reason for occupational licensing, then it will be pretty hard for someone who is qualified in one state to work in another state. In practice, it\’s often pretty hard to move between states. The Federal Trade Commission examines this issue in \”Policy Perspectives: Options to Enhance Occupational License Portability\” (September 2018).

The FTC cites the substantial economic literature which makes the point that \”while licensing may increase the wages of licensees at the expense of higher prices paid by consumers, studies show that it does not improve quality.\” On the issue of those with an occupation license working in another state, the FTC notes (footnotes omitted):

\”It is particularly hard to justify licensing-related barriers to entry when a practitioner qualified and licensed by one state wishes to provide identical services in another state. Because licensing rules are almost always state-based, it can be difficult for a qualified person licensed by one state to become licensed in another state. For some occupations, state licensing standards vary considerably, so applicants licensed in one state may need additional education or training to qualify to practice in another state. Even when a profession’s underlying standards are national and state licensing requirements are similar throughout the United States, the process of obtaining a license in another state is often slow, burdensome, and costly. Indeed, a recent study shows that occupational licensure requirements may substantially limit the interstate mobility of licensed workers, especially for occupations with state-specific licensing requirements.

\”State-based licensing requirements are particularly burdensome for licensees who provide services in more than one state, and thus need multistate licensing. They are also especially hard on military families, because trailing spouses often follow service members who are required to move across state lines, and therefore must bear the financial and administrative burdens of applying for a license in each new state of residence. The need to obtain a license in another state can sometimes even lead licensees to exit their occupations when they must move to another state.

\”Multistate licensing requirements can also limit consumers’ access to services. For example, licensure requirements can prevent qualified service providers from addressing time-sensitive emergency situations across a nearby state line or block qualified health care providers from providing telehealth services to consumers in rural and underserved locations.\”

Some professions in some states have addressed this issue. Some states have joined interstate compacts so that those licenses in one state would be able to work i other states in the compact: for example, such agreements exist for nursing, physicians, physical therapists, and others. Another approach is to write a model law or rule for occupational licenses, so that qualifying in one state will be the same as qualifying in another state, an approach followed by accountants, pharmacists, and some others. Related to these options, some states have provisions that allow mutual recognition of certain occupational licenses from the other state, or expedited licenses in one state for those who already have a similar license in another state.

But substantial issues remain. The canaries in the mineshaft here are the working spouses of those in the military. About 35% of them work in jobs that require occupational licenses, and they are often shifting between US states every 2-4 years. Teachers, as one common example, often find it hard to shift their licensing between states. The US economy would benefit from greater mobility and fewer workers feeling stuck in place. 

Postscript: For those who find themselves prone to dismiss anything that smacks of deregulation, especially if it arrives from a Trump/Republican administration, it\’s perhaps worth noting that the FTC has been studying this issue and expressing concerns going back at least to 1990.  Indeed, economists in the Obama administration raised essentially the same concerns about occupational licensing and the importance of portability across state lines. For a flavor of the earlier discussion, see \”Occupational Licensing and its Discontents\” (August 5, 2015). 

As President Donald Trump\’s trade war continues to escalate, it\’s perhaps worth remembering his tweet from back in March:

My focus here is on the notion that if we \”don\’t trade anymore–we win big. It\’s easy!\”

If this statement is true, then it seems to me that the Trump administration is wasting our time with wishy-washy economic diplomatic incentives to reduce imports from other countries, like tariffs and talks over trade rules. If no trade is a big win, then a serious trade policy sounds like this: Let the US announce that trucks or ships or planes carrying exports from other countries to the US will be destroyed by the US military if they approach US borders. We will extend multiple warnings and give those imports a chance to turn back. But if they do not, then carry through on the threat. After all, the goal is slashing imports. It\’s easy to win! We win big!

One might be concerned, I suppose about retaliation against US exports, or against multinational US companies that are involved in production in other countries. But there is apparently no risk of such retaliation. As Trump\’s trade adviser Peter Navarro stated back in March: \”I don\’t believe that any country in the world is going to retaliate for the simple reason that we are most lucrative and biggest market in the world …\”

However, it stands to reason that if the US economy wins big from not receiving imported products from other countries, then presumably the economies of those other countries would win big from not receiving US exports, either. If imported products hurt the recipient nation, then a literal military war against trade seems certain to be beneficial for all–rather like many countries coordinating in a public health effort to wipe out a disease that crosses national borders.

I suppose the other response is to argue that President Trump and his advisers are only opposed to trade imbalances, and would support balanced trade.  But the argument that \”no trade beats trade imbalances\” doesn\’t much affect the case for a physical war against trade. After all, the United States could allow imports as long as US exports exceed imports, but then threaten to destroy all imports above that level. I\’ve tried to explain why this view of trade imbalances is benighted (among other places, here and here), and won\’t go through it again here. But the lack of recognition of gains from trade is quite remarkable.

Moreover, when someone takes the positions that 1) no trade at all would be a big win; 2) pretty much all imports should be made in the US regardless of cost; and 3) international trade is a scoreboard where exports are points for the home team and imports are the points for the opposition; and 4) the US should ignore all existing trade agreements like the World Trade Organization in favor of bilateral tariffs–well, it requires greater mental plasticity than I can achieve to believe that their ultimate goal is to increase gains from trade by reducing barriers to movement of goods and services across international borders.

In the world of the web, perhaps it is necessary to close by adding that I do not favor a war on trade, either tariff-driven or military. I offer this rumination about a physical war on trade in the hope that it will make the anti-trade agenda look less attractive, rather than more so. 

\”The past few times unemployment fell to levels as low as those projected over the next year, signs of overheating showed up in financial-sector imbalances rather than in accelerating inflation. The Federal Reserve\’s assessment suggests that financial vulnerabilities are building, which might be expected after a long period of economic expansion and very low interest rates. Rising risks are notable in the corporate sector, where low spreads and loosening credit terms are mirrored by rising indebtedness among corporations that could be vulnerable to downgrades in the event of unexpected adverse developments. Leveraged lending is again on the rise; spreads on leveraged loans and the securitized products backed by those loans are low, and the Board\’s Senior Loan Officer Opinion Survey on Bank Lending Practices suggests that underwriting standards for leveraged loans may be declining to levels not seen since 2005.\”

A few points are worth emphasizing here. As Brainard is pointing out, the last couple of decades suggest that the primary risk of recession in the US economy is not likely to arise from a jolt of inflation. Instead, the last two recessions were associated with financial market stress: the end of the dot-com boom in 2001, and the end of the housing price boom in 2008-2009.

Since the Great Recession, a number of steps have been taken to assure that banks are safer and more resilient (higher capital requirements, stress testing, and the like). But the US financial system is a lot bigger than just the banks, and financial troubles can come from a number of directions. What about the two risks that Brainard specifically mentions: corporate debt and leveraged loans?

The financial press has a number of recent articles on the risk that a corporate debt bubble is happening: for example, here\’s a take from Jesse Colombo in Forbes (August 29) or here is  Steven Pearlstein in the Washington Post on June 8:

\”Now, 12 years later, it’s happening again. This time, however, it’s not households using cheap debt to take cash out of their overvalued homes. Rather, it is giant corporations using cheap debt — and a one-time tax windfall — to take cash from their balance sheets and send it to shareholders in the form of increased dividends and, in particular, stock buybacks. As before, the cash-outs are helping to drive debt — corporate debt — to record levels. As before, they are adding a short-term sugar high to an already booming economy. And once again, they are diverting capital from productive long-term investment to further inflate a financial bubble — this one in corporate stocks and bonds — that, when it bursts, will send the economy into another recession.\”

A report from the McKinsey Global Institute last July put some of this in global perspective.  Compared to other regions of the world, US corporations are more likely to raise money using bonds:

\”[I]f companies in Western Europe and China were to match the appetite of US corporations for bond financing, their markets would double and triple in size, respectively. …  A shift toward bond financing has been observed in all regions. In the United States, bonds accounted for 19 percent of all corporate debt financing in 2000; by 2016, that share had jumped to 34 percent. …  Companies in the United States still lead the world in issuance with $860 billion issued in 2017 …\”  

A larger share of US corporate bonds are being issues with lower ratings, and by companies that already have higher levels of debt. These bonds promise to pay high interest rates (to make up for their higher risk of default), and a large volume of such bonds will need to be refinanced in the next few years:

\”In the United States, almost 40 percent of all nonfinancial corporate bonds are now rated BBB, just a few steps above noninvestment grade, up from 22 percent in 1990 and 31 percent in 2000, according to Morgan Stanley. Overall, BBB-rated US nonfinancial corporate bonds outstanding total $1.9 trillion—almost twice the size of the high-yield bond market. Issuers are also more heavily indebted than before. The net leverage ratio for BBB issuers rose from 1.7 in 2000 to 2.9 in 2017 … Noninvestment-grade bonds carry higher default risk, which increases the vulnerability of the corporate bond market.15 In the coming years, a record amount of speculative-grade corporate bonds could need refinancing. In the United States, for instance, the share of maturing bonds that are high yield is expected to grow from 11 percent in 2017 to 27 percent in 2020. The absolute amount—at least $180 billion of high-yield bonds coming due in 2020—will be almost three times the amount in 2017. If current high-yield issuance trends continue, that share will rise even more.\”

Behind the scenes, what\’s happening here is that with bank regulation tightening up and interest rates so low, companies have turned to borrowing with bonds, including higher risk bonds that promise higher interest rates. There are dangers here for past investors in these bonds. But perhaps the bigger danger for the economy is that US companies have become accustomed in the last few years to the idea that they can raise large sums in corporate debt markets at relatively low cost. If investors decide that these corporate bonds actually are riskier than they had thought, the amount of capital flowing to the corporate sector could dry up rather quickly. This is a scenario discussed by William Cohan in an interview at the Wharton School on the topic: \”How Dangerous is the Corporate Debt Bubble?\” (August 20, 2018).  Cohan says:

\”One never knows what the catalyst is going to be for the next financial crisis. … But the truth is nobody rings a bell at the top of the market and says, `That’s it. It’s over. It’s been fun, guys. It’s all downhill from here.\’ When I was a banker 27 years ago, the management of United Airlines (UAL) was trying to take it private in what was then one of the largest management buyouts of all time. They had got the commitment letter from Citibank to finance that deal. But suddenly Citibank went back to the management and said, we can’t finance this deal, the market is not there for this buyout. This was in 1991, four years after the stock market crash of 1987. It became a huge problem and shut down the credit markets for the next two or three years. The fact that the UAL buyout could not be financed in the market was the signal that the party was over, and that we were now heading into a severe credit crunch. Anything could be a catalyst. Maybe Tesla trying to go private will be a catalyst for this market shutting down. And that is when real trouble happens. Because people who had nothing to do with it, with the excess, can’t get access to capital.\”

If this kind of scenario emerges, it will be made more difficult by the archaic ways in which corporate bonds are still traded, which makes it more difficult for them to be easily bought and sold in liquid markets. The McKinsey report notes:

\”Bond markets need to enter the digital age. Despite being worth $11.7 trillion, the market is surprisingly antiquated, with little transparency or efficiency. While equities can be traded at the click of a button, buying and selling corporate bonds often requires a phone call to a trading desk at an investment bank, and there is little transparency on the price the buyer is quoted. This method of trading still accounts for more than 80 percent of volume in the United States.\” 

Concerns about leveraged loans have been around for a few years now: for example, here are some comments I made back in 2014. The issues here also relate to corporate debt, but in the loan market, rather than the bond market. In the case of leveraged loans, a group of banks get together and make a loan to a company. The banks then package this loan (or a group of similar loans) into financial securities that are then re-sold to investors across all financial markets. Those who remember the experiences of 2008, when mortgages from subprime housing loans were packaged together and sold to investor and financial institutions around the world, will see some worrisome parallels.

Again, the financial press has a number of recent articles warning about issues with leveraged loans. For example, here\’s an article from the Credit Union Times (August 21, 2008) citing estimates that leverage loan market is now at $1.4 trillion, bigger than the market for high-yield bonds.  Here\’s Pearlstein from the Washington Post pointing out the dangers (July 28, 2018).

For variety, I\’ll describe these issues by quoting a few remarks from Robin Wigglesworth in the Financial Times (August 24, 2018).

\”But the leveraged loan boom is storing up some nasty problems. In their desperation to gobble up higher-yielding loans from riskier borrowers, investors have — initially reluctantly so, but recently with reckless abandon — accepted fewer and fewer of the legal protections that typically guard their rights. These `covenants\’ restrict how much a creditor can pay shareholders in dividends, how much more debt they can take on, or what security lenders can seize in a bankruptcy. But the average covenants are now `distressingly weak\’, according to Moody’s. Indeed, the rating agency’s index that measures the average quality of legal protections hit its worst-ever level this year. … 

\”Before the financial crisis, about a quarter of the leveraged loan market was termed “covenant-lite”; today it stands at almost 80 per cent, according to Moody’s. Almost two-thirds of the entire market now has a lowly credit rating of B2 or worse, up from 47 per cent in 2006. In other words, an already junky market has deteriorated further. … Christina Padgett, senior vice-president at Moody’s, warned: “The combination of aggressive financial policies, deteriorating debt cushions, and a greater number of less creditworthy firms accessing the institutional loan market is creating credit risks that foreshadow an extended and meaningful default cycle once the current economic expansion ends.” … 

\”Specialised investment vehicles known as “collateralised loan obligations” are the biggest buyers of leveraged loans. Issuance of CLOs reached $69bn in the first half of the year, leading S&P to lift its full-year forecast to a record $130bn. But there are a multiplying number of mutual funds and ETFs dedicated to leveraged loans. At the start of 2000 there were only 15 such funds. On the eve of the financial crisis there were less than 90. Today, there are 272 different loan mutual funds, and another eight ETFs that buy loans, according to AllianceBernstein. These have sucked in more than $84bn just since 2010. This looks like an accident waiting to happen. While CLOs have locked-up investor money, mutual funds and ETFs promise investors the ability to redeem whenever they like, despite the underlying loans trading rarely. Even the trade settlement process takes weeks. A loan market downturn could therefore escalate into a severe “liquidity mismatch” between the investment vehicles and their underlying assets, which turns a fire-sale into an inferno.\”

Dealing with financial stresses before they turn into crises is hard to do. But not doing so can have harsh consequences, as I hope we learned 10 years ago in the Great Recession.

Aaron Steelman interviews Chad Syverson in Econ Focus (Federal Reserve Bank of Richmond, Second Quarter 2018, pp. 22-27). The interview ranges from broader discussion of slower aggregate productivity growth to comments about productivity in specific industries: health care, car production, ready-made concrete, big box and mom-and-pop retail, major auditing firms, investment choices in Mexico\’s social security system, and others. Here are a few of the many points that caught my eye.

Should we be concerned about artificial intelligence replacing human labor?

\”We have always found things for people to do. If you go back to the middle of the 19th century, more than 60 percent of the workforce was employed in farming. Now it\’s about 2 percent. Well, we figured out something for the rest of us to do. So I don\’t worry about that very much. That said, if I could invent a machine that made everything we consume now and we didn\’t have to work an hour, I would take that. That\’s not a bad thing. It does create a distributional issue. Are you going to give all that output to the person or persons who own the machine? I think we could agree that\’s not a good outcome. So we would have to figure out how to distribute the produc­tivity gains that would arise. But inherently, we shouldn\’t think of it as a problem.\”

 Why are productivity differences rising among firms in the same industry?

\”An important fact is that the skewness of everything is increas­ing within industries. Size skewness, or concentration, is going up. Productivity skewness is going up. And earnings skewness is going up. To describe why our earnings are stretching out like this, why there is a bigger gap between the right tail and the median, I think you have to understand the phenome­non of increasing skewness in produc­tivity and size. Is that technological? Is it policy? Is it a little bit of both? I don\’t think we really know the answer. That said, I think it\’s less of a mys­tery now than it was when I started working on this many years ago back in graduate school. …

\”The biggest change is the amount of work that has been done on man­agement practice … and there\’s no doubt productivity is correlated with certain kinds of management practices. People have also devel­oped more causal evidence. There have actually been some randomized controlled trials where people intervened in management practices and saw productivity effects. Is that all of the story? No, I don\’t think so. If I had to guess, it\’s probably 15 to 25 percent of the story. There\’s a lot more going on. I think part of it has to do with firm structure. I have done work on that. …

\”But I do think the fact that management is often just mistaken is a nontriv­ial factor. … Also, I think even if you know you have a problem, a lot of firms can\’t simply say, well, we see this competing company over there has an inventory management track­ing system that seems really useful, so we\’ll install it on our computers and our problems will be solved. That\’s not how it works. …

\”An example I talk about in class a lot is when many mainline carriers in the United States tried to copy Southwest and created little carriers offering low-cost service. For instance, United had Ted and Delta had Song. They failed because they copied a few superficial elements of Southwest\’s operations, but there was a lot of underlying stuff that Southwest did differently that they didn\’t replicate. I think that presents a more general lesson: You need a lot of pieces working together to get the benefits, and a lot of companies can\’t manage to do that. It also typically requires you to continue doing what you have been doing while you are changing your capital and people to do things differently. That\’s hard.\”

Is vertical ownership more about data and management than about actual goods?

\”[W]e found that most vertical ownership structures are not about transferring the physical good along the production chain. Let\’s say you are a company that owns a tire factory and a car factory. When you look at instances analogous to that, most of the tires that these companies are making are not going to the parent company\’s own car factory. They are going to other car factories. In fact, when you look at the median pair, there\’s no transfer of goods at all. So the obvious question becomes: Why do we observe all this vertical ownership when it\’s not facilitating the movement of physical goods along a production chain? What we speculated, and then offered some evidence for, was that most of what\’s moving in these ownership links are not tangible products but intangible inputs, such as customer lists, production techniques, or management skills.

\”If that story is right, it suggests a reinterpretation of what vertical integration is usually about in a couple of ways. One, physical goods flow upstream to downstream, but it doesn\’t mean intangibles have to flow in the same direction. Management practices, for instance, could just as easily go from the downstream unit to the upstream unit.

\”The second thing is that vertical expansions may not be as unique as we have thought. They may not be partic­ularly different from horizontal expansions. Horizontal expansions tend to involve firms starting operations in a related market, either geographically or in terms of the goods produced. We\’re saying that also applies to vertical expansion. A firm\’s input supplier is a related business, and the distributor of its product is a related business. So why couldn\’t firms take their capital and say, well, we think we could provide the input or distribute the product just as well too? So, conceptually, it\’s the same thing as horizontal expansion. It\’s just going in a particular direction we call vertical because it\’s along a production chain. But it\’s not about the actual object that\’s moving down the chain.

\”We were able to look at this issue, by the way, because we had Commodity Flow Survey microdata, which were just amazing. It\’s a random sample of shipments from a random sample of establishments in the goods-producing and goods-conveying sectors of the U.S. economy. So, if you make a physical object and send it somewhere, you\’re in the scope of the survey. We get to see, shipment by shipment, what it is, how much it\’s worth, how much it weighs, and where it\’s going. And then we can combine that with the ownership information in the census to know which are internal and which are external.\”

For those who want more, here are links to a few examples of Syverson\’s work published in the Journal of Economic Perspectives, where I labor in the fields as Managing Editor:

• \”Challenges to Mismeasurement Explanations for the US Productivity Slowdown\” (Spring 2017)
• \”The Ongoing Evolution of US Retail: A Format Tug-of-War\” (with Ali Hortaçsu, Fall 2015)
• \”Markets: Ready-Mixed Concrete\” (Winter 2008)

Motor vehicle production and ownership is one window for looking at differences and changes in the world economy. Here are some snapshots from the Transportation Energy Data Book, produced by Oak Ridge National Laboratory for the US Department of Energy, updated August 2018. (For the record, the book includes many more figures about energy, motor vehicles, and other types of transportation, with a primarily US focus.)

The line in the two panels of this figure shows US motor vehicle ownership per 1,000 people from 1900 to the present. The top panel shows 1927 or so  to the present; the bottom panel shows 1900 to 1927. Along the line, for comparison, are various points showing motor vehicle ownership per 1,000 people at other times and place. For example, the top point on the line shows Canada\’s level of motor vehicle ownership in 2015. Down around 200 motor vehicles per 1,000 people you can see the point for Brazil in 2015.

The next panel shows what would be in the bottom left corner of the figure above, thus allowing more detail. Again, the line shows US motor vehicle ownership from 1900-1927 or so. You can see on the line where motor vehicle ownership is for the Middle Wast, China, Indonesia, countries of Africa, and India in 2015.

The likely conclusion here is that even if other countries around the world follow an extremely different path of economic development that involves many, many fewer cars–which is not a sure thing–the number of cars in the world is likely to rise dramatically in the next few decades.

Unsurprisingly, the large rise in car ownership in emerging markets around the world is already going hand in hand with large rises in car and truck production in those countries. Here\’s a figure showing the overall rise in car production n the world since 1983.

And a figure showing the overall rise in truck and bus production in the world. Just to be clear, light trucks, minivans, and sport-utility vehicles (SUVs) are classified as \”trucks.\”

Here is a comparison car and truck production in different countries between 2000 and 2015. US car production has been dropping and the US now ranks fourth in total car production, well behind the top three of China, Japan, and Germany. However, the US remains strong in truck production–which again includes light trucks, minivans and SUVs.

These patterns and trends seem to me interesting for a number of economic and environmental reasons, but let me focus here on some of the trade issues that are so much in the news.

The US produced about 7% of the world\’s cars in 2015, and about 22% of the world\’s trucks. This is not a dominant market position! I\’m of course aware that many of those who are most eager for raising tariffs and other trade barriers claim that they are doing so based on their even deeper support for free and open international trade. (I\’m dubious about their expressed motives, but time will tell.) There is a real danger that the tactics of higher trade barriers will lead to US firms being less able to participate in the global supply chains for automobile production. Given that the vast majority of future growth in motor vehicle production will be outside the US economy, this is a concerning possibility.

As the US continues to wrestle with the aftermath of the Patient Protection and Affordable Care Act of 2010 and to contemplate future changes in its health insurance programs, one useful starting poin is the facts about health insurance coverage presented by Edward R. Berchick, Emily Hood, and Jessica C. Barnett of the US Census Bureau in the annual report, Health Insurance Coverage in the United States: 2017 (Current Population Reports, September 2018, P60-264).

As the Affordable Care Act kicked in, it reduced the share of Americans without health insurance from 14-15% to about 8-9%.

It wasn\’t a surprise that the uninsured rate remains above 8%. Before the Affordable Care Act was passed, it was not projected to provide universal health insurance. As I\’ve written before, there\’s no magic here about expanding coverage. The Congressional Budget Office has documented that that the expansion of health insurance coverage is costing the US government about $110 billion annually. Thus, the cost of expanding health insurance coverage to an additional 20 million people works out to about $5500 per person per year. Personally, I\’m fine with spending the money for this expansion of health insurance coverage, although I would have preferred to see the money raised by taxing some portion of employer-provided health insurance benefits as income.

In thinking about the issue of the remaining uninsured, it\’s useful to keep the age dimension of the issue in mind. This figure shows the rate of uninsured by age for 2013, 2016, and 2017. The uninsured rate for children is low (Medicaid and the Children\’s Health Insurance Program) and the uninsured rate for the elderly is low (Medicare). The real spike in the share of uninsured is for young adults. Thinking about what kind of health insurance makes sense for this relatively healthy group seems potentially productive.

Another issue for the remaining uninsured is the state-level variation. This figure shows changes in health insurance coverage by state. The variations across states are substantial, because states have a lot of power to determined the extent of the health insurance programs for those with low incomes.  I live in Minnesota, and I\’m pleased to live in a state where the share of population that lacks health insurance is fairly small. But how you feel about lack of health insurance in the US is in some ways linked to whether you can live with the idea that majorities in other states are making other choices.

Finally, most people get their health insurance through employment-based private plans.

The surveys I\’ve seen over the years also suggest that most people who receive health insurance in this way are reasonably happy. Of course, this is why President Obama repeatedly made statements before and after the passage of the 2010 health care legislation like: \”If you like your doctor, you will be able to keep your doctor, period. If you like your health-care plan, you’ll be able to keep your health-care plan, period. No one will take it away, no matter what.” It was widely known even within the Obama administration that the promise was untrue (see here and here). But the need to make such a promise–and the extreme sensitivity on the issue–suggests that proposals to replace private health insurance with some form of Medicare-for-all will have a hard time gaining traction.

Trivia question for today: What denomination of US currency has the largest number of bills in circulation? Up until 2016, the correct answer was the $1 bill. Now, it\’s the $100 bill.

Here\’s the evidence from Tim Sablik in \”Is Cash Still King?\” written for Econ Focus from the Federal Reserve Bank of Richmond (Second Quarter 2018, pp. 18-21). Back in the 1990s and into the first decade of the 2000s, $1 bills were most common, with $20s in second place. (This ranking accurately represents my  own wallet, for what it\’s worth!). But $100s have growth steadily and taken over first place.

Indeed, the total value of US currency in circulation has been rising over time, but most of that gain in value is due to the rise in $100 bills.

Clearly, there is a puzzle here. As Sablik points out, evidence from consumer surveys finds that cash is used for about 27% of transactions in the last decade or so, but mostly for small purchases. It seems unlikely that the number of $100 bills in circulation is about typical consumers making typical purchases. In round numbers, the 12 billion $100 bills in circulation divided by a US population of 325 million implies that on average, every person in the US has 37 $100 bills in their possession. The total amount of US cash in circulation works out to about $4,800 for every person in the US. (This does not accurately represent the contents of my wallet.)

The standard explanation is that a considerable amount of US currency is being used outside the US, both as a medium of exchange and as a store of value. Some proportion of that amount–no one really knows how much–is surely helping to facilitate illegal activities. There are ongoing proposals to eliminate large-denomination bills: Sablik points out that the European Union ended production of 500-euro notes in 2016.

For some previous posts on the subject, see:

• \”Eliminate High-Denomination Bills?\” (March 18, 2016)
• \”Who is Holding the Large Denomination Bills? (August 11, 2014)
• \”The Soaring Number of $100 Bills\” (June 10, 2013)