Infinite Progress

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At the start of 2010, I put a positive spin on the nascent economic and psychological recovery with blogs on “The Sky Has Stopped Falling”, “Good Riddance to Utopian Views of 2000” and “Self-Improving Systems”.  Today, I want to promote the broader subject of “Infinite Progress”.

Economics has earned its label as “the dismal science”.  It has been serious, analytical, realistic, short-term and marginal.  Imitating calculus and physics, it has sought to optimize production functions and maximize results subject to multiple linear constraints.  Like other academic disciplines, economics has been shaped by the dominant culture.  Economics has progressed through the Physiocrats, Marxists and Marginalists who in turn proclaimed that land, labor and capital each held the key to economic value.  Even Paul Samuelson’s neoclassical synthesis focused on these three “factors of production”, while mentioning that there was some remaining role for “technology” and “entrepreneurship”.

The “law” of diminishing marginal returns emphasizes that in the short-run, with given technology, additional inputs eventually yield lower incremental results.  This is certainly true, but development and growth economists focusing on the international and business sectors have demonstrated that this fourth factor (technology/entrepreneurship) is the primary driver of progress.  In fact, rather than being subject to diminishing returns, knowledge is the one factor that is subject to increasing returns through time!

In spite of the slow recovery in the current economic cycle, I believe that we are only 50 years into the greatest productivity expansion in history.  Annual labor or multi-factor productivity growth of 2-4% has become commonplace.  Even in the recession, we experienced 6-8% productivity growth.  Productivity growth will accelerate in the coming years to a minimum of 5% annually, in spite of our various challenges (aging population, protectionism, extremism, political polarization, religious stagnation, terrorism, global warming, limited natural resources, multi-polar international powers).

In no particular order, knowledge and practice has expanded and will continue to expand in all of these fields:

  1. Trade.  Lessons were learned in the Great Depression.  Tariffs have continued to fall.  Multilateral treaties have stalled, but bilateral trade agreements are accelerating.  English is becoming the global language, followed by Mandarin Chinese and Spanish.  A majority of the global population produces at a near-subsistence level.  They will all generate modern western levels of output within 40 years, providing added value globally.
  2. Physics/Engineering.  Basic physics, mechanical and civil engineering continue to advance.  Modern materials, energy, devices and structures will advance and be refined in light of breakthrough understandings (supercollider).
  3. Chemistry.  “The Graduate” whispered “plastics” as the key to the 20th century.  Plastics has delivered, but has not exhausted its secrets.
  4. Biology.  Biotechnology and modern medicine is on the verge of major breakthroughs in individualized medicine, medical information, preventive medicine, devices, new drugs and nano-technology based solutions.  Mental health care is leveraging improved understanding of the mind, behavior and chemistry.
  5. Energy.  Delayed by politics and prices, energy exploration and solutions are emerging.  Wind, solar, nuclear, clean-coal, tidal and other answers are now real.  Break-through shale, gas and deep-sea extraction technologies are imminent.  Major investment in alternative transportation options is producing results.
  6. Natural Resources.  The food, fiber and natural resources sector continues its 200 year track record of innovation, with genetically modified organisms, drip irrigation, weather forecasting, satellite guided farming and fish markets adding value.
  7. Transportation. New highways, hiking, biking, high-speed trains, point to point aircraft, larger container ships and usage tolls suggesting continued progress.
  8. Electronics.  Songs, movies, video, instruments, observation, robots, entertainment, games, virtual reality, and the list goes on and on.
  9. Computer Power.  Moore’s Law. ‘Nuff said.
  10. Telecommunications.  Cell phones, internet, computer integration, GPS, much faster speeds.
  11. Integration.  Electronics, telecommunications, media, entertainment in one place, on demand.
  12. Community.  Tribes, cities, nations, world.  Clubs, games, blogs, social media, Face book, LinkedIn, Twitter, no limit.
  13. Specialization.  Professions, suppliers, outsourcing, matrix organizations, consultants, global suppliers, increasing economies of scale, niche markets
  14. Process Improvement.  Process, quality, cost of quality, value added, variability, bottleneck, ISO, TQM, benchmarking, process re-engineering, quantum leap, lean manufacturing, lean, six sigma, kaizen, self-improving systems.
  15. Computer Systems.  Automation, systematization, mainframes, minicomputers, personal computers, applications, man-machine, GUI, windows, mouse, ERP, cloud computing as a utility.
  16. Library Science.  Dewey decimal, multimedia, informatics, knowledge management, Wikipedia, Amazon.com, tripadvisor.com, Angieslist.
  17. Economics.  Markets, global trade, auctions, information, behavioral economics, EDI, e-commerce, capitalism embraced everywhere in one form or another.
  18. Finance.  Stocks, bonds, pork-bellies, futures, puts, calls, mutual funds, checkable deposits, insurance, hedges, securitized debt.
  19. Management/leadership.  Strategic planning.  Product innovation. Growth/margin. Core competencies.  Discipline of Market Leaders.  First or second. Operational excellence.  Situational leadership.  Theory X, Y, Z.  Motivators and de-motivators.  Covey’s 7 habits, urgent and important.  Meyers-Briggs, personality styles and Gallup talents.  Change management.  Engaged/disengaged.  Creativity and thinking hats.  Accountability/Oz Principle.  Good to Great, Both/And. 

 

Knowledge will continue to increase in every discipline.  Market pressures will ensure rapid adoption, expansion and innovation.  The work world in 2010 could not be seen in 1980.  The work world in 2040 will exhibit the same degree of discontinuous change from a much higher base.

2010 Elections

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The 2010 election campaign is about to begin in earnest.  The events of the last three months have certainly swung the Republicans’ way.  Even the “health reform” victory is likely to have a mostly negative impact on short-run Democratic prospects.  Opposing parties always make progress in midterm elections.  The real question is “how much?”  Eight months from the elections, I give a strong edge to the Republicans, but believe that the “Tea Party” movement may backfire on the right.

Politicians are experts at getting elected and re-elected.  They know that winners occupy enough of the middle to attract swing voters and enough of their edge to motivate the party faithful.  In the 1968 election, George Wallace highlighted the role that socially conservative and economically moderate voters could play.  Richard Nixon and Spiro Agnew capitalized on the interests of the silent and moral majority, realigning politics for two generations.  Ronald Reagan clarified the pitch and a more coherent philosophy, solidifying the right-wing strategy.  Subsequent moderate Republicans like the Bushes proclaimed the new message, adopted the tax cut strategy, courted the religious right and increased expectations of their new supporters. 

During this time the Republican Party has successfully shifted the definition of left and right on the critical economic scale, forcing Clinton and Obama to adopt economically conservative means, programs and terminology, while continuing to pursue their leftward goals.  The Republicans have also undercut the Democrats’ classic appeal to the economic interests of the working and middle classes by touting growth, entrepreneurship and economic freedom as higher ideals.  They have increased the weight of social issues and courted a populist libertarian strain in America through fringe candidates such as Ron Paul and Sara Palin.  The Republicans have mastered the tactical dimensions of politics, beating the Dem’s at fundraising, participation, communications and media influence.  Although taunted as “the party of ‘no’”, the Republicans have effectively avoided major responsibility for the weak economy, ongoing terrorist threats, the banking meltdown, immigration gridlock, increasing healthcare costs, wider income distribution and the coming retirement cliff.  Now that Obama has a year under his belt, they are effectively painting him with responsibility for these and other situations.

The Democrats have responded to this shift in the playing field by sending three southerners to the White House (Johnson, Carter and Clinton) positioned as moderates.  The Democrats have maintained their hold on a growing minority and shrinking union base.  They have improved their posturing skills and election tactics, especially in social media.  They have adopted some centrist programs and begun to fight for key terms such as “accountability” and “economic progress”.  The Democrats have taken care of their base through laws and funding.  President Obama has provided a message of bipartisanship, hope and change which deflects attention from controversial specific programs.  He and his colleagues have not hesitated to blame George Bush and the Republicans for a variety of “messes” and dodged their responsibility. 

It is no surprise that a weak economy (it’s the economy stupid) would catch up with Obama, especially given his pursuit of so many distracting goals.  However, the impact of “Tea Party” is something of a surprise.  Sara Palin was clearly chosen as a VP candidate by John McCain to appeal to part of the party faithful.  Her candidacy, the stirrings of Ron Paul, the unfulfilled promises to social conservatives by the Bushes and the demonization of national Democratic leaders and programs for two decades have crystallized into a true populist backlash against the evils of “big government” and its mostly Democratic supporters.

Will the “Tea Party” help or harm the Republicans?  In the short-run, it has clearly scared moderate Democrats, especially those in conservative districts.  On the other hand, it has also scared moderate Republicans, including John McCain.  In some cases, the more conservative primary winners will be defeated due to their extreme positions.

I think that there is an even greater risk that the Republican Party has unintentionally moved so far right in its rhetoric, positions, legislation and new affiliation with the “Tea Party” that it will lose touch with classic moderates and swing voters.  In 1968, Hubert Humphrey wanted nothing more than growth of New Deal and Great Society programs.  He was not seeking a social revolution or a counterculture.  However, the activists painted a picture of revolution that frightened most of the country to embrace the solid posture of twice-defeated Richard Nixon as the safest choice in an emotional time.

If the “Tea Party” continues to gain publicity and become affiliated with the Republican Party, the same kind of social distancing may take place in 2010 or 2012.  By belief or by framing, the ”Tea Party” appears to hold extremist views on the economy (radical self-sufficiency), the role of government (none, including popular entitlement programs), banking (gold standard), religion (one fundamentalist, end of times, withdrawal from society) and security (gun rights and military adventurism).  The “true believer” statements are passionate, direct and uncompromising.  They may provide the Democrats with an “extremist” straw man to replace the current “banker” straw man.

We certainly live in interesting times.

Screening for Leadership Experience

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As firms return to a normal economy where success is determined by the ability to set and implement a distinctive strategy, develop new products, processes and customers, and align functional resources in a project based matrix structure, it is time one again to screen for leadership in the hiring process. For the last 2 years, with an abundance of candidates and a preference for risk aversion, hiring managers, human resources and recruiters have laser focused on finding the very best match between a candidate’s industry, functional and positional experience for an open position, without regard to long-term considerations. Hiring managers should insert more behavioral interview questions about leadership into the process and they should screen for evidence of leadership success in the resume review and screening interview process.

Ask ten experts to define “leadership” and you’ll get ten different answers and lists of competencies, but they’ll cluster into a few areas such as building teams, being self-aware, growing personally and professionally, displaying trust and integrity, communicating effectively, motivating/influencing/persuading, helping others to succeed, setting and sharing a strategic vision, taking risks, innovating, being responsible, making tough decisions, showing tenacity and taking a long-run view of what is best for the organization as a whole. A simple leadership checklist can be used to identify candidates who have the leadership experience needed to succeed.

Leadership Screening Checklist

1. Positional responsibility, staff count, manager count, functional variety.

2. Cross-team member, positional leadership, selection by others, larger projects.

3. Non-work leadership roles, professional and civic groups.

4. Progressively responsible roles and promotions across career.

5. Professional mastery/certification and CPE in one or more areas.

6. Five year tenure at most employers.

7. Variety of recommendations available/given in 360 degree fashion.

8. Internal or external teaching, training and documentation experience.

9. Projects/assignments in new, challenging or unpopular business areas.

10. Projects/assignments in high value, visibility or risk business areas.

11. Matrix experience in product development, IT, M&A, national account management.

12. Formal mentoring, association or accountability partner experience.

13. Strategic, product, marketing, financial or operational planning leadership role.

14. Top-level responsibility for a function or business unit of any size.

15. Variety of headquarters/field, line/staff and domestic/international experience.

16. Variety of industry, function and organization size experience.

17. Change management experience through start-ups, rapid growth, turnarounds, recessions, acquisitions or reorganization.

18. Implementation of new professional methods and technologies.

19. Human resources recruiting, retention, promotions, transfers and morale.

20. Responsibility for new products, sales, suppliers and negotiations.

Organizational success today requires leaders who are experienced and confident in challenging and ambiguous environments. Screening for this broader experience and capacity may be more important than hiring someone who has done exactly the required role at the closest competitor for the last five years.

Universal Measure of Quality

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 Table of Standard Quality Levels         
               
   Mean             
   Tasks       Errors       
   Between   Error   Quality   Per       
 Level   Errors   Rate   Rate      10,000  Color     
               
            4             16 6.3% 93.8%         625  Infrared     
            5             32 3.1% 96.9%         313  Red     
            6             64 1.6% 98.4%         156  Orange     
               
            7           128 0.8% 99.2%           78  Yellow     
            8           256 0.4% 99.6%           39  Green     
            9           512 0.2% 99.8%           20  Blue     
               
          10         1,024 0.10% 99.90%           10  Indigo     
          11         2,048 0.05% 99.95%             5  Violet     
          12         4,096 0.02% 99.98%             2  Ultraviolet     
               
 
             
 All quality assurance measures can use the standard scale, levels and colors 
 shown above. The levels reflect the exponential power of 2 required to achieve   
 a given mean time between errors. For example, quality level 4 reflects 1 error 
 every 16 tasks, as 16 is equal to 2 x 2 x 2 x 2, or 2 raised to the 4th power in   
 exponential notation.             
               
 Once a process measure has been defined and the process observed to be   
 “under control”, without wide swings in daily error rates or significant one time 
 events, then the average error rate can be determined.  This will set the current 
 quality level.  For example, if the observed error rate is 2.3%, then the quality   
 level is 5, as level 6 at 1.6% has not yet been attained.       
               
 Moving from one quality level to the next higher quality level requires the   
 process owner to cut the number of errors in half.  This applies to each upward 
 step.  In practice, process owners can typically move up one step every 2-4   
 months using standard root cause analysis tools.         
               
 Once the measure for a process has been defined and approved by   
 management, then the process owner reports on the monthly measured error   
 rate. A master table should be maintained showing the current quality level for 
 each defined process, and the first date at which each level was achieved.   
               
 While the ultimate goal of any process is zero defects or errors, this   
 pragmatic, incremental approach has been shown to be most effective in   
 helping front-line staff members to own and improve their processes through   
 time.               
               
 Most unmeasured processes operate at quality level 4, with a 5-7% error rate.  
 Once a process is measured, the error rate usually drops to 3-4% very quickly, 
 at quality level 5.  Once a staff member is assigned responsibility, the move to 
 quality level 6 and a 2% error rate soon follows.  These first improvements can 
 usually be done by using common sense and a little more attention. Process   
 steps are usually documented and performed consistently at this level.   
               
 Moving to level 7 and an error rate below 1% is typically much more   
 challenging.  Staff members usually need to record the details of each error   
 and analyze the errors in a time period such as a week or a month in order to   
 identify the largest cluster of problems.  At this stage, the bottleneck   
 identification and elimination techniques described in “The Goal” are very   
 useful.  Identifying the type of error, the person, the product, the time of day,   
 the machine or other sources of variability commonly leads to rapid   
 identification of the greatest problem area.  Eliminating the bottleneck can   
 often be done through manual process changes, retraining, device calibration, 
 more frequent measurements, and changes in user settings.  While computer 
 system changes may be identified at this stage, it is best to attempt to use   
 manual changes first, until these have been exhausted.     
               
 Reaching the Yellow level of stage 7 merits some celebration.  Reducing errors 
 to below one in one hundred is an important milestone.  At this point, the   
 number of errors has been cut in half 3 times for an overall reduction of 85%.    
 Fully 5 out of every 6 errors that originally occurred have been eliminated for   
 good.  Some simple processes can move straight to level 7 within a few weeks 
 or months.  It is important for staff members not to became disappointed when 
 they do more of the same good actions, but “hit the wall”, and are unable to   
 move forward as quickly, if at all, at some point.  This is normal, but there are   
 always ways to go over, around or through the wall.       
               
 The progression to Green level 8 and Blue level 9 typically requires the   
 application of more advanced quality techniques and/or the revision of   
 computer systems.  For many processes, the Kaizen approach to rapid   
 process revision can work here.  The introduction of poke yoke or failsafe   
 devices, steps, and specialized tools is appropriate here.  Moving repetitive   
 tasks to the computer is common at this time.  Staff members should have   
 been trained in quality concepts, including the basic ISO tenets of say what   
 you do, do what you say, and be able to tell the difference.  Staff members   
 should be performing all of their own measurements.  Reliance on final   
 inspection should be diminishing, as staff work quality control steps into their   
 core process.             
               
 Until a process has reached Green level 8, it is typically unwise to attempt to   
 change the underlying customer service level that is desired.  Attempting to   
 reduce a service cycle time from 14 days to 10 days when a process is not at 
 least at level 8, is likely to lead to a reversion back 2 or 3 quality levels,   
 thereby offsetting the benefit of greater speed with lower reliability.     
               
 For most processes and customers, Blue level 9, with one error for every 512   
 transactions, is at or below the threshold of materiality.  Staff members should 
 be encouraged to apply their skills to move to the next level, but be warned   
 that further improvements often require additional invest- ments in equipment,   
 computer systems or a total process re-engineering effort, including adjacent   
 processes, suppliers and customers.  Staff members should focus their   
 attention on any processes which remain at levels 4-7, before they pursue level 
 10, where errors occur once in every 1,024 transactions.  This level is usually   
 reached by front line staff with 3 or more years of quality management   
 experience or those with access to quality specialists.       

Indiana School Finances

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Indiana state school funding will decline for the next 3 years.  The current 5% expense reduction is just the first step.   School districts need to take bold actions to reduce their underlying cost structures.  Other organizations are reducing costs by 10% and increasing labor productivity by 5-8%.  Innovative schools can achieve the same financial gains while improving the quality of education.  These 20 ideas may be infeasible, but they might help to generate some creative solutions.

  1. Rank order career & technical programs and eliminate the single least effective one.
  2. Replace some career and guidance counselors with web resources and volunteers from local civic group partners.
  3. Assign administrators to jointly teach 1 FTE of classes in a technical field.
  4. Employ technology for teaching and testing and eliminate 1 staff/department.
  5. Carefully define “special needs” education and obtain separate funding or sponsorship.
  6. Double the fees for extracurricular programs to cover all costs, including coaching supplements and subsidies for low-income students.
  7. Maximize the use of capital budgets and bond funding for capital maintenance expenses.  Refinance bonds and use savings for capital maintenance.
  8. Reduce employee benefits by one-half for the first 5 years of employment.
  9. Add an additional teaching period for tenured staff.
  10. Assign a mentee to tenured staff and provide incentives for retention/progress.
  11. Provide teachers with a financial incentive in years 3-6 to remain in place.
  12. Eliminate future degree/credit hours based compensation increases.
  13. Outsource transportation, IT, HR, marketing and financial services.
  14. Extend textbook lives by 2 years.
  15. Move to a used computer strategy, recycling the 3-year-old units from local businesses.
  16. Consolidate library/AV staff and resources with community libraries.
  17. Reduce the cost of transportation by increasing the share of walkers, reducing the number of stops and limiting extra services.
  18. Move discipline problem students to countywide alternative programs after 3 strikes.
  19. Collect fees for AP and dual credit programs.
  20. Increase the use of teacher’s assistants when they can cost-effectively increase classroom sizes while providing quality education.

All changes have costs and benefits.  In a world of 10% less funding, schools that are able to identify the areas where the greatest cost reductions can be found with the least negative impact will be the ones that best serve their students, teachers and communities.  Schools should reach out to their communities for help in generating solutions to the coming crisis.

The Sky Has Stopped Falling

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Between October, 2009 and April, 2010 the US economy lost 4.8 million jobs: nearly 700,000 jobs per month.  In the last three months it has lost a TOTAL of 100,000.

How and why employment will recover faster than expected.

  1. The change from -700,000 jobs to zero is a major trend, indicating net job creation is imminent.  Obama’s budget forecast of 100,000 adds per month is conservative political positioning so that the real results will exceed expectations.  He and his party have an election to contest in November.
  2. GDP growth was 3% in the 3rd quarter and 5% in the 4th quarter, accompanied by eye-popping labor force productivity numbers above 5%.  Some hiring is required to meet existing production needs.  It has begun.
  3. Inventory replenishment will continue as it has in all other recoveries.
  4. More than half of the stimulus money remains to work through the economy. The second stimulus package is necessary political and psychological posturing and will be too late and too little to make a material difference.
  5. Construction has nowhere to go but up after 3 years of decline.  Even with ongoing foreclosures, there is pent-up demand for new housing.
  6. Consumer durable goods’ spending is ready to bounce back.  Cars, washers and televisions have limited technical and acceptable status lives.
  7. Businesses are ready to invest in capital goods, productivity improvements, IT systems, new channels, new products and exports.  Businesses have the resources to invest after lower than average spending since 2000.
  8. 5-8% growth in China and other developing countries increases demand for US exports and raises prices for US imports.
  9. Once the global recovery is underway and the extent of US monetary expansion is plain (leading to inflation), the US dollar value will fall and US exports will increase.
  10. The retirement of the Baby Boomers will lead to specific hiring in sectors of high demand: health care, financial services, housing and travel.
  11. The retirement of Baby Boomers will increase from 2.2M per year to 3.7M per year in the next 8 years, adding an average of 1M jobs per year.
  12. The US population will continue to grow at 1% per year, leading to growth in aggregate demand of 1% per year.
  13. US labor force and total factor productivity continue at high historical rates, generating the underlying added output which leads to wages, profits and rents which create the next round of aggregate demand.
  14. There are long-term positive employment trends in a majority of the US industry sectors.  The US economy has continued its transformation into an information economy.  Manufacturing employment is now less than 10% of the total.  We may have found the bottom for this sector.

 

There are certainly national and global risks in the current economic climate.  However, the US economy has shown increasing resiliency in the last 60 years, recovering from recessions in spite of a variety of headwinds.  The economy has recovered during Republican and Democratic administrations, in spite of helpful and harmful national policies.  There are many reasons to believe that the current recovery will be strong.

10% Labor Force Growth, 1998-2007

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 US Employment by Industry         
         
   1998   2007   Change   Pct 
 Extraction/Utilities       2.3      2.5          0.2 9%
 Construction       6.2      7.6          1.4 23%
 Manufacturing      17.2    13.7         (3.5) -20%
 Wholesale/Retail Trade      18.1    19.8          1.7 9%
 Transport/Warehouse       3.9      4.3          0.4 10%
 Information       3.1      2.9         (0.2) -6%
 Finance/Insurance       5.4      6.0          0.6 11%
 Real Estate       1.7      2.0          0.3 18%
 Profl, Bus, Adm Services      21.2    25.0          3.8 18%
 Education       2.0      2.7          0.7 35%
 Health Care      11.2    14.3          3.1 28%
 Arts, Entertainment, Recreation       1.4      1.7          0.3 21%
 Accommodations/Food       8.1      9.4          1.3 16%
 Other Services       5.3      6.0          0.7 13%
 Government      18.7    20.2          1.5 8%
    125.8   138.1        12.3 10%

Where Have All the Dollars Gone?

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Economists enjoy the sense of security provided by the “National Income Accounts” where Gross Domestic Product, the value of all goods and services produced domestically, is always equal, by definition, to Consumption plus Investments plus Government plus Net Exports.  Reviewing the changes in the share of economic activity in the components of C+I+G+NX goes a long way towards explaining our current and future economic predicament.  The economy has changed dramatically since 1960. which will serve as a baseline for the post-war era.

During the bright days of Camelot, Consumption was 63%, Investment 15%, Government 21% and Net Exports +1%.  In 2008, Consumption was 70%, Investment 15%, Government 20% and Net Exports -5%.  In simplest terms, we are consuming 7% more thanks to the generosity of other exporting nations! 

Investment averages 16% of GDP: 11% business and 5% residential.  Business investment has reached peaks of 12-13% in 1978-85, 1998-2001 and 2007-08.  It experienced troughs of 9-10% in 1960-64, 1991-93, and 2003-04.  Business investment responds to tax and market opportunities, adding a pro-cyclical boost to the recovery.  Residential real estate follows its own pattern, reaching 5-6% peaks in 1962-64, 1972-73, 1977-79, and 2004-06, alternating with 3-4% troughs in 1966-67, 1975, 1981-82, 1990-93, and 2008.  The 3.3% share in 2008 is the lowest in the period, followed by an even lower share in 2009.  Residential real estate experienced an unprecedented 13 year run without a down cycle.  The over expansion in 2004-2006 means that the usual residential real estate recovery will be delayed for a few years.

Government consumption expenditures, excluding transfer payments, declined from 21% to 20% of GDP across the period.  Direct federal government, non-defense expenditures remained flat and immaterial at 2.5%.  National defense started at a high 10% in 1960 and remained at that level as late as 1968 before declining after the Vietnam conflict wound down.  The peace dividend allowed defense spending to fall to 6% for 1977-80.  Defense spending rose again in the waning years of the Cold War, reaching 7.4% in 1985-87, before sliding to as low as 3.8% from 1998-2001.  The terrorist response has triggered an increase to 5.1% of GDP by 2008.  Delivering the “Great Society” initiatives, state and local government spending grew from 9.5% in 1961-63 to 12.5% in 1974-76.  State and local government declined to 11% in 1983-85, remaining at 11.3% as late as 1998 before growing to 12.2% in 2002-03.  State and local government spending will act as a drag on the economy for at least 2 years.  Defense spending shows no clear trend.  Federal government spending on stimulus measures may be 3-5% of GDP in 2010.  The expected decline in stimulus spending will act as a drag on the economy in 2011.

Across 50 years the United States rejoined the world economy after the unusual post-war period of self-sufficiency and high global demand for U.S. goods.  Exports of services tripled from 1.3% to 3.9% of GDP in this period.  Exports of goods doubled from 4% to 8%, reaching 8.8% in 2008.  Total exports increased from 5% to 13% of GDP.  On the other hand, service imports doubled from 1.4% to 2.9%.  Goods imports increased five-fold, from 3% to 15% of GDP.  This 12% of GDP change has outpaced the growth in exports. 

A 2-3% trade deficit was experienced from 1984-88.  The competitive response reduced the deficit to an average of 1% for the next decade.  The deficit rapidly grew to 4% in 2000 and a high of 5.7% in 2005-06.  As pundits have noted, no nation has ever been able to run a 5% trade deficit for decades.  The unique situation of the US as the world’s currency and safest investment home, plus the growth of China’s economy and its willingness to finance the trade deficit has allowed this to continue.  In the long-run, the US dollar will fall relative to China’s currency and trade will rebalance.  There is no way to predict the timing of this change.  For a decade, the U.S. has consumed 5% more than it produced.  Consumption will fall.

Consumption is the 800 pound gorilla of GDP accounting.  Its rise from 63% to 70% of GDP is the counterbalance to the trade deficit.  Durable goods production held its own, maintaining 9% of GDP through 2003, before falling to 7.6% as the auto recession began in 2008.  Non-durable goods production dropped from 25% to 16% of GDP by 1995 and maintaining that level through 2008.  The 9% decline in non-durable goods production has been replaced by an increase in services from 30% to 47% of the economy. 

The service share was 30% as recently as 1969, so this 17% switch occurred in just 40 years.  The service share reached 45% in 2001 and has inched up slowly since then, reflecting the “jobless recovery” of the 2000’s.  Durable goods production will recover from its low level as autos and equipment age.  The trend in non-durable goods moving to import sources is likely to continue.  Without changes in the health care industry, this part of services is likely to keep growing: a short-term benefit for jobs and GDP.

Government budget, trade and savings deficits need to be repaid.  The retiring Baby Boomers need to be replaced in the labor force at high productivity rates.  Some form of improved health care market, incentives or rationing is required to limit the growth of this sector.  The U.S. has significant economic challenges to be faced.  The transition from Keynesian fiscal stimulus and easy money to a sustainable course is a necessary first step.  U.S. economic productivity, competitiveness and innovation have not been undermined by the Great Recession.  The business cycle provides a natural boost to recovery from inventory replenishment, capital spending and durable goods demand as we are already seeing.  Let’s hope that the president can have a real meeting of the minds with Congress and begin to address the long-term structural challenges faced by the country that go far beyond the 2010 and 2012 elections.

A Rising Tide Lifts All Boats

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“A rising tide lifts all boats”.  When economic progress is steady, or at least not interrupted for too long, this saying seems to hold true.   When everyone benefits from progress, people invest their effort into getting ahead.  Today we face the greatest economic disruption in 75 years.  Without a clear path forward, people of all political views are turning their thoughts enviously towards the boats others.  International trade, labor, spending, health care and tax policies are all being reviewed through the lens of protecting current advantages or redistributing funds.

The classic focus of redistribution is on the “rich” and the “poor”.  Bankers and corporate executives have lost the “entrepreneurial” and “value added” shields of the last 30 years.  Citizens are now concerned about the distribution of income and are willing to consider tax and regulatory changes that would have been unthinkable a decade ago.

The share of income captured by the top 1% of earners receives the most attention.  From 1917-1941, through boom, bust and preparation for war, the top 1% earned 15% of all income.  This changed dramatically during WWII and afterwards, leading to a 35 year period from 1953-1987, where income at the top was cut in half, with 8% of the total going to the top 1%.  Top 1% income grew rapidly in the late 1980’s, reaching 13% and then 15% by 1999 and 17% by 2007. 

The spread of income within the center of the population has also broadened in the last 40 years.  In real 2007 dollars, average household income has increased 30% since 1967, from $40,000 to $52,000 per year.  Families at the 20th percentile have also seen a 30% increase, rising from $17,000 to $22,000 per year.  The dollar and percentage growth at the higher percentiles has been much greater.  Households at the 80th percentile have gained 55%, with incomes rising from $67,000 to $104,000.  Those at the 90th percentile have gained 66%, boosting incomes from $85,000 to $141,000.

There is no “natural” or “optimal” distribution of income.  The US has historically had a greater concentration of wealth or income than other economically advanced nations.  As shown by the top 1%, the concentration can change dramatically through time.  However, most economists agree that there is a level of marginal taxation on income, wealth, dividends and capital gains that significantly reduces incentives for hours worked, innovation, risk taking and entrepreneurship.  

Small changes to the taxation and incentive structure of the US economy are not likely to cause too much damage.  Significant tax increases could do significant short-term and long-term damage to the economy and to those at the lower end of the economic pyramid who depend upon the rising tide to lift their boats in the long run.

Good Riddance to Utopian Views of 2000

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Much of the anxiety being expressed in the political arena today stems from the discovery that the turn of the millennium consensus views of steady assured progress were exaggerated, or just plain wrong.  The events of the last decade have shown that simple, deterministic conclusions are usually wrong.  This is not the first time that western society has had its “progressive” bubble burst.  Even the recent triple play natural disasters (hurricane, tsunami and earthquake) have a parallel in the Lisbon earthquake of 1755, which lead Voltaire to attack the belief that man was living in “the best of all possible worlds”.

In 2000, we thought that representative government would prevail as an increasing number of countries became functional democracies and established democratic traditions.  Cuba was the special exception.  Even China was seen as a potential convert.  Progress was being made in Eastern Europe, Asia, Africa and Latin America.   We now see that China’s leaders intend to maintain power, that progress in Russia and Eastern Europe is fragile and that a new Bolivarian revolution justifies dictatorships.

In 2000, the division of state and religious spheres was clear and settled in Europe, allowing a variety of religions to work within a set of rules.  The Pope spoke out for radical changes to society, but had limited impact.  Some progress in conflict areas lead to hope for progress, as nations from Turkey to Indonesia to Ireland found solutions.  The “consensus” was an illusion.  Islam, Christianity and other religions are not content to work within the context a secular humanist state.  We now see that “true believers” do not fit within the tidy scheme.

In 2000, a decade after the fall of the “iron curtain”, the U.S. stood tall as the only superpower, even after cashing in the peace dividend.  The US, Europe and the UN began to make significant progress in handling the remaining “trouble spots”, in areas that seemed unfamiliar and insignificant.  We now see that Brazil, Russia, India and China would like to join the US, Europe and Japan in a multi-polar world.  The shifting alliances of earlier centuries are the model of our future.

In 2000, after dodging the ironic Y2K threat, the world saw an unlimited future of technological progress.  The older physics, chemistry and energy based economy continued to grow at a healthy pace.  Agricultural and biological innovations promised to feed the world and heal the sick.  Information technology continued to evolve through the internet, telecommunications and knowledge management.  Even the environment was improving, as 30 years of focus on clean air, clean water and eliminating toxic waste had a cumulative positive impact.  We’re still making progress, but concerns about energy and water shortages, Frankenfoods, genetic manipulation and climate change become greater with time, as no simple “solutions” have appeared.

In 2000, international economic progress was in full-stride.  Individual, regional and global trade agreements increased trade and cross-country investment.  International financial crises were managed and outlier countries were guided through an agreed upon recovery plan.  European economic integration continued to deliver benefits with each new step.  Today, we struggle to find common ground for major trade deals.  A variety of crisis recovery models seem valid.  Further European economic integration is possible, but the benefits are not so certain.  International sensitivity to trade, labor, environmental, property rights and investment differences is growing.

In 2000, a mixed capitalist economic model dominated.  There were two flavors, traditional European and Atlantic, but these were differences in style and degree, not in fundamental substance.  Success stories in all areas of the world indicated that this model could and would be replicated.  Today, there are several varieties of state capitalism (Russia, China, France, Japan, and Venezuela) that offer alternatives.

Finally, in 2000, there was a widespread belief that we had moved into a new economic model where the rough edges of capitalism had been tamed.  The business cycle could be managed through independent monetary policy (and a touch of fiscal policy).  Productivity, inflation and unemployment goals could all be attained.  Financial guidelines like price-earnings ratios had been superseded by a “new economy”.  And, risk and volatility had been tamed through portfolio theory, hedging and new financial instruments.

The world is not in worse condition today than it was a decade ago.  Only by moving past the unrealistically utopian views of the turn of the century can we make progress in addressing the challenges we face.