Southern Copper Corp. is a high-yielding company with a forward-looking price to earnings ratio of just 10.51 times next year’s projected earnings. With a recent ticker price of $94.05, Southern Copper Corp. is ready for significant appreciation. The company’s operating profit margin is an impressive 56.33%. This results in an annual operating cash flow of $2.170B.
Southern Copper Corp. is a cash cow that has a reasonably attractive valuation. With a beta of 2.70, the company is more risky than the stock market as a whole. This information is useful, but a more careful analysis of Southern Copper Corp. reveals that the company’s risk profile is not as volatile as many of its competitors. It’s important to invest in a sufficiently liquid stock that money can be taken out of the position on every trading day and Southern Copper Corp.’s total market capitalization of $27.694B is ample proof of such liquidity.
Showing posts with label Economic Growth. Show all posts
Showing posts with label Economic Growth. Show all posts
Friday, June 29, 2007
Tuesday, June 19, 2007
Southwest Airlines
Southwest Airlines is easily the most successful American airline in history. Until just a few years ago, Southwest Airlines had earned more corporate profits than every other American airline in history. But that doesn't necessarily say very much, no other airline was even in the black.
Southwest has been an industry leader in more than profitability. Southwest's historic fight with competing airlines for space at the Dallas airport is certainly one of the turning points in industry history. Thanks to Southwest's example, discount airlines like JetBlue have entered major markets and driven transportation costs down across the country.
But the other carriers haven't exactly followed Southwest's lead. Without assigned seating, passengers boarding a Southwest flight closely resemble stampeding cattle. And despite efforts to clean up their collective act, the other major carriers can't hope to match Southwest's friendly corporate culture. With friendly snack service and stewards with personality, Southwest gives its customers a number of reasons to keep coming back.
The incessant price wars that have driven most domestic airlines into unprofitability haven't stopped Southwest yet, but increasing foreign competition is changing industry dynamics. Despite intense regulation and government scrutiny, super-efficient, super-subservient Asian airlines are taking up a larger share of the world's air traffic over time. By mid-century, the Asia-Pacific region may take over the title of world's most trafficked airspace, and Southwest doesn't look able to compete.
While Southwest has a corporate history of bucking excessive regulation, the company may join the rest of the American industry in demanding new regulations to keep out superior foreign competition.
Southwest has been an industry leader in more than profitability. Southwest's historic fight with competing airlines for space at the Dallas airport is certainly one of the turning points in industry history. Thanks to Southwest's example, discount airlines like JetBlue have entered major markets and driven transportation costs down across the country.
But the other carriers haven't exactly followed Southwest's lead. Without assigned seating, passengers boarding a Southwest flight closely resemble stampeding cattle. And despite efforts to clean up their collective act, the other major carriers can't hope to match Southwest's friendly corporate culture. With friendly snack service and stewards with personality, Southwest gives its customers a number of reasons to keep coming back.
The incessant price wars that have driven most domestic airlines into unprofitability haven't stopped Southwest yet, but increasing foreign competition is changing industry dynamics. Despite intense regulation and government scrutiny, super-efficient, super-subservient Asian airlines are taking up a larger share of the world's air traffic over time. By mid-century, the Asia-Pacific region may take over the title of world's most trafficked airspace, and Southwest doesn't look able to compete.
While Southwest has a corporate history of bucking excessive regulation, the company may join the rest of the American industry in demanding new regulations to keep out superior foreign competition.
Tuesday, June 5, 2007
A Promising Future (With Big Obstacles to Fruition)
Several factors that contributed to the success of the Asian tigers may not be possible to reproduce. For instance, the savings rates they achieved may not be attainable or even desirable for most emerging nations. Nevertheless, Mexico can learn from the experience of the Asian tigers. The Asian tigers provided several conditions conducive to the accumulation of physical resources. In most cases, they committed early on to monetary and fiscal discipline and provided predictable macroeconomic conditions for investors. They also provided fairly efficient, stable institutions, such as well-functioning legal systems. As for human capital, they made a major effort to supply basic education and health services during early stages of their catch-up period. Mexico has a long way to go in all of these areas.
Since its 1994 financial crisis, Mexico has made progress in macroeconomic discipline, bringing inflation down to its lowest level in 30 years and fiscal deficits to below 1 percent of GDP. But the government continues to depend on unpredictable oil sales for more than a third of its revenues. The government has been able to trim spending recently, but in the long run, a credible commitment to fiscal and monetary discipline demands that Mexico reduce its dependence on oil revenues. Although tax rates are not low by international standards, many individuals and corporations avoid income taxes altogether, making the tax base small. In Mexico, the informal sector accounts for an amazing 50 percent of employment. As a result, Mexico's tax-to-GDP ratio is markedly below China's and the United States'. In fact, it's low even by Latin American standards.
Ill-functioning institutions add to the unpredictability of Mexico's business environment. The biggest problem is that property rights are not effectively enforced because of an inefficient legal system. According to recent estimates, collecting on a bad check takes five times longer in Mexico than in the United States. Resolving more complicated contractual disputes can take several years.
This poor legal environment has many negative consequences. Maybe the most detrimental for growth, and a key reason investment has stagnated, is the impact on the financial sector. Mexican banks are very hesitant to lend in an environment where contracts are not properly enforced. Mexico's financial sector is very small and, if anything, getting smaller. In a World Bank survey, over half of Mexican firms described their access to financing as severely limited, compared with 15 percent of U.S. firms. In Singapore, only 10 percent of
firms reported that they face the same situation.
To make matters worse, even when they can secure financing, Mexican entrepreneurs face burdensome regulations and a notoriously inefficient bureaucracy. For example, it takes more than 65 days on average to register a firm in Mexico, compared with four days in the United States.
With regard to education, Mexico's poor performance is not due to low spending but rather its failure to emphasize basic education. South Korea made an early commitment to basic education, and in 1970, two-thirds of the country's educational spending was allocated to preprimary and primary education. As recently as 1992, only a third of Mexico's education budget was allocated to preprimary and primary education. This share has increased to one half in recent years, but it will take a generation for these efforts to begin paying off.
At the end of the day, Mexico’s progress in the past quarter century has certainly not lived up to expectations. Nonetheless, the example of the Asian tigers provides a clear path forward. Mexico needs to move past easy neo-liberal dogma toward a comprehensive concentration on developing its unique strengths. While there remains a great deal of work to be done, the potential payback is enormous.
Since its 1994 financial crisis, Mexico has made progress in macroeconomic discipline, bringing inflation down to its lowest level in 30 years and fiscal deficits to below 1 percent of GDP. But the government continues to depend on unpredictable oil sales for more than a third of its revenues. The government has been able to trim spending recently, but in the long run, a credible commitment to fiscal and monetary discipline demands that Mexico reduce its dependence on oil revenues. Although tax rates are not low by international standards, many individuals and corporations avoid income taxes altogether, making the tax base small. In Mexico, the informal sector accounts for an amazing 50 percent of employment. As a result, Mexico's tax-to-GDP ratio is markedly below China's and the United States'. In fact, it's low even by Latin American standards.
Ill-functioning institutions add to the unpredictability of Mexico's business environment. The biggest problem is that property rights are not effectively enforced because of an inefficient legal system. According to recent estimates, collecting on a bad check takes five times longer in Mexico than in the United States. Resolving more complicated contractual disputes can take several years.
This poor legal environment has many negative consequences. Maybe the most detrimental for growth, and a key reason investment has stagnated, is the impact on the financial sector. Mexican banks are very hesitant to lend in an environment where contracts are not properly enforced. Mexico's financial sector is very small and, if anything, getting smaller. In a World Bank survey, over half of Mexican firms described their access to financing as severely limited, compared with 15 percent of U.S. firms. In Singapore, only 10 percent of
firms reported that they face the same situation.
To make matters worse, even when they can secure financing, Mexican entrepreneurs face burdensome regulations and a notoriously inefficient bureaucracy. For example, it takes more than 65 days on average to register a firm in Mexico, compared with four days in the United States.
With regard to education, Mexico's poor performance is not due to low spending but rather its failure to emphasize basic education. South Korea made an early commitment to basic education, and in 1970, two-thirds of the country's educational spending was allocated to preprimary and primary education. As recently as 1992, only a third of Mexico's education budget was allocated to preprimary and primary education. This share has increased to one half in recent years, but it will take a generation for these efforts to begin paying off.
At the end of the day, Mexico’s progress in the past quarter century has certainly not lived up to expectations. Nonetheless, the example of the Asian tigers provides a clear path forward. Mexico needs to move past easy neo-liberal dogma toward a comprehensive concentration on developing its unique strengths. While there remains a great deal of work to be done, the potential payback is enormous.
Competition with China
Mexico appears to be losing ground in U.S. markets. Its share of U.S. imports peaked at 11.5 percent in 2001 and has slipped since then. Meanwhile, China’s share of U.S. imports has grown steadily and now exceeds Mexico’s. To Mexican officials and producers this is no mere coincidence, China’s gains are being made at Mexico’s expense. China’s exports-to-GDP ratio has risen from 2 percent to 25 percent since 1970. While China’s GDP has grown at about 10 percent a year in real terms over the past 20 years, exports have grown twice as fast. Not only is China producing more than ever for export, its ability to access U.S. markets is improving with the expansion of free trade. China is making strides in many areas important to Mexico. However, there is little correlation between China’s gains and Mexico’s losses. There are many markets in which China is gaining a lot of ground but Mexico is not losing any. In such areas as computers and electrical machinery, China’s gains are being made at other countries’ expense. There are also many industries in which China is making no gains. Whatever is happening to Mexico in those areas cannot be explained by China. Among these commodities are vehicles, vehicle engines and parts, agricultural goods and oil products.
There are, of course, industries in which China’s gains are associated with Mexico’s losses. These at-risk sectors, which include TV sets and textiles and apparel, have several characteristics in common. First, they are unskilled and labor-intensive, which makes China a very attractive place to produce. Second, commodities in these sectors tend to have a high value-to-weight ratio, which makes transportation costs reasonable. Third, many products in these at-risk areas are standardized and can be mass produced. But notwithstanding these sectors in which Mexico is most exposed to Chinese competition, there is overall little correlation between China’s gains and Mexico’s losses.
The countries that appear to be bearing the brunt of China’s competition are other Asian exporters. Japan, Korea, Taiwan, Singapore, Malaysia and Thailand have lost market share in many sectors since 1999, and the losses experienced by that group of countries have been highly correlated with China’s gains. This correlation between China and the Asian tigers is exactly what we would see for Mexico if China’s advance were happening at Mexico’s expense. Instead, Mexico’s recent export difficulties are best explained by Mexico’s dependence on U.S. manufacturing activity. When a deep manufacturing recession began in the United States in 2000, no other country was hit harder than Mexico. Intermediate and capital goods account for almost 80 percent of Mexico’s exports. Mexico is a key supplier for the U.S. manufacturing sector. China, on the other hand, remains predominantly a consumption goods exporter. This greatly mitigated the impact of the recent U.S. recession on China’s export sector and largely explains China’s and Mexico’s differing fortunes since 2000.
The real problem facing Mexico is that Mexico has yet to find a way to accumulate physical and human resources the way fast-growing countries do. Its educational attainments continue to markedly lag those of industrialized nations. Its institutions do not function well, which discourages investment. Mexico’s tax system raises little revenue, which makes needed infrastructure and education investments impossible.
Mexico’s failure to marshal its physical and human resources effectively is most dramatic when compared to the Asian tigers. South Korea’s investment-to-GDP ratio reached almost 40 percent in the late '80s, very high by international standards. Interestingly, foreign investment did not play a big role in this. The investment surge was financed through exceptionally high private and public domestic savings. By contrast, Mexico's investment rate, in spite of the recent influx of foreign money, has hovered around 20 percent for most of the past 30 years. South Korea's fastest growing resource has been human capital. In 1960, almost half the working population lacked a primary school education. Today, 70 percent of working Koreans have at least some secondary education. Mexico's achievements in this area remain dismal. A third of the working population has not completed primary school, and the country today stands roughly where Korea did 40 years ago.
There are, of course, industries in which China’s gains are associated with Mexico’s losses. These at-risk sectors, which include TV sets and textiles and apparel, have several characteristics in common. First, they are unskilled and labor-intensive, which makes China a very attractive place to produce. Second, commodities in these sectors tend to have a high value-to-weight ratio, which makes transportation costs reasonable. Third, many products in these at-risk areas are standardized and can be mass produced. But notwithstanding these sectors in which Mexico is most exposed to Chinese competition, there is overall little correlation between China’s gains and Mexico’s losses.
The countries that appear to be bearing the brunt of China’s competition are other Asian exporters. Japan, Korea, Taiwan, Singapore, Malaysia and Thailand have lost market share in many sectors since 1999, and the losses experienced by that group of countries have been highly correlated with China’s gains. This correlation between China and the Asian tigers is exactly what we would see for Mexico if China’s advance were happening at Mexico’s expense. Instead, Mexico’s recent export difficulties are best explained by Mexico’s dependence on U.S. manufacturing activity. When a deep manufacturing recession began in the United States in 2000, no other country was hit harder than Mexico. Intermediate and capital goods account for almost 80 percent of Mexico’s exports. Mexico is a key supplier for the U.S. manufacturing sector. China, on the other hand, remains predominantly a consumption goods exporter. This greatly mitigated the impact of the recent U.S. recession on China’s export sector and largely explains China’s and Mexico’s differing fortunes since 2000.
The real problem facing Mexico is that Mexico has yet to find a way to accumulate physical and human resources the way fast-growing countries do. Its educational attainments continue to markedly lag those of industrialized nations. Its institutions do not function well, which discourages investment. Mexico’s tax system raises little revenue, which makes needed infrastructure and education investments impossible.
Mexico’s failure to marshal its physical and human resources effectively is most dramatic when compared to the Asian tigers. South Korea’s investment-to-GDP ratio reached almost 40 percent in the late '80s, very high by international standards. Interestingly, foreign investment did not play a big role in this. The investment surge was financed through exceptionally high private and public domestic savings. By contrast, Mexico's investment rate, in spite of the recent influx of foreign money, has hovered around 20 percent for most of the past 30 years. South Korea's fastest growing resource has been human capital. In 1960, almost half the working population lacked a primary school education. Today, 70 percent of working Koreans have at least some secondary education. Mexico's achievements in this area remain dismal. A third of the working population has not completed primary school, and the country today stands roughly where Korea did 40 years ago.
Monday, June 4, 2007
The Washington Consensus and Asymmetric Growth
According to the program of economic reform known as the “Washington Consensus”, one of the expected effects of trade liberalization is a rapid expansion of exports from lesser developed countries (LDCs), including labor-intensive manufactures. The idea is that this will improve micro- and macroeconomic performance and stimulate overall growth, since the economy-wide behavior in LDCs tends to depend quite critically on what happens in the export sector. Yet for Mexico from 1981 to 2004 a remarkably dynamic growth of exports—non-oil exports grew, on average, at 13.4% per year—has been associated with a surprisingly poor growth performance of gross domestic product (GDP)—an annual average rate of just 2.1%. Furthermore, as population grew at 1.6% during this period, GDP growth became negligible in per capita terms. The resulting "asymmetric" or "unbalanced" growth has relegated the economic masterminds behind the Washington Consensus to the popular status of "peddlers of dreams".
The failure of Mexico to cultivate widespread economic growth in an environment of explosive export growth is the most unexpected outcome of the reform process begun by President De la Madrid. This failure is best explained by the growth of the “maquiladora” industry. The term "maquiladora" is used for firms that are highly labor intensive and end-of-value chain assembly-type operations. Proximity to the US and trade liberalization opened up opportunities to develop these type of activities, particularly in the frontier states with the US. The maquiladora industry is so dangerous as a model of economic development because there is no incentive to invest in increased labor productivity. By virtue of the nature of the industry itself and the characteristics of the labor market, capital can grow by simply adding more cheap labor. Between 1982 and 2000, the sector was able to absorb more than 1 million workers while not only successfully resisting upward pressure on wages, but actually pulling off a significant cut in real wages. Indeed, the industry also seems designed to minimize the creation of production linkages (forward and backward) with the rest of the economy. Since so many maquiladora companies are owned by foreign corporations, a large degree of “transfer pricing” or pricing with the intent of producing no profit for the local company probably occurs in spite of substantial tax concessions from the state. The lack of domestic linkages ensures easy international mobility, and anecdotal evidence abounds suggesting that Mexico has lost hundreds of thousands of maquiladora industry jobs to China in the past decade.
In 2000, South Korea had a manufacturing industry with a level of exports similar to that of Mexico ("maquiladora" and "non-maquiladora" manufacturing exports together)—about $150 billion; however, Korea had a manufacturing industry generating twice the level of value added and only using half the level of imports of Mexico. Furthermore, Korea had relatively low levels of manufacturing imports despite a substantially higher level of investment in machinery and equipment, which traditionally have a high import component. Considering South Korea’s disadvantages to Mexico with regard to the Washington Consensus Model, this is a startling outcome. Yet it is also explicable in terms of the comparative absence of the maquiladora industry in South Korea. Because capital in South Korea can only consistently grow in an environment of rising productivity, significant investments in worker productivity are encouraged. In contrast, Mexico provides the paradigm case for the failure of the neoliberal model advocated by the Washington Consensus.
One of the main reasons why investment performed badly after the reforms is precisely that capital could easily end up having little incentive to invest. In this new investor framework, as capital (domestic or foreign) can increase its accumulation rate (at least for a long period of time) either via stagnant wages (in sectors with productivity growth) or via shrinking ones (where there is none), why should it make a significant investment effort? Furthermore, if in the new equilibrium of the labor market, labor loses the property rights it had over the benefits that may derive from the use of this additional capital (increased productivity), labor also can end up having little incentive to acquire human capital. If all the benefits that might accrue from human capital accumulation go to capital, workers actually have a lesser incentive to invest in themselves.
The failure of Mexico to cultivate widespread economic growth in an environment of explosive export growth is the most unexpected outcome of the reform process begun by President De la Madrid. This failure is best explained by the growth of the “maquiladora” industry. The term "maquiladora" is used for firms that are highly labor intensive and end-of-value chain assembly-type operations. Proximity to the US and trade liberalization opened up opportunities to develop these type of activities, particularly in the frontier states with the US. The maquiladora industry is so dangerous as a model of economic development because there is no incentive to invest in increased labor productivity. By virtue of the nature of the industry itself and the characteristics of the labor market, capital can grow by simply adding more cheap labor. Between 1982 and 2000, the sector was able to absorb more than 1 million workers while not only successfully resisting upward pressure on wages, but actually pulling off a significant cut in real wages. Indeed, the industry also seems designed to minimize the creation of production linkages (forward and backward) with the rest of the economy. Since so many maquiladora companies are owned by foreign corporations, a large degree of “transfer pricing” or pricing with the intent of producing no profit for the local company probably occurs in spite of substantial tax concessions from the state. The lack of domestic linkages ensures easy international mobility, and anecdotal evidence abounds suggesting that Mexico has lost hundreds of thousands of maquiladora industry jobs to China in the past decade.
In 2000, South Korea had a manufacturing industry with a level of exports similar to that of Mexico ("maquiladora" and "non-maquiladora" manufacturing exports together)—about $150 billion; however, Korea had a manufacturing industry generating twice the level of value added and only using half the level of imports of Mexico. Furthermore, Korea had relatively low levels of manufacturing imports despite a substantially higher level of investment in machinery and equipment, which traditionally have a high import component. Considering South Korea’s disadvantages to Mexico with regard to the Washington Consensus Model, this is a startling outcome. Yet it is also explicable in terms of the comparative absence of the maquiladora industry in South Korea. Because capital in South Korea can only consistently grow in an environment of rising productivity, significant investments in worker productivity are encouraged. In contrast, Mexico provides the paradigm case for the failure of the neoliberal model advocated by the Washington Consensus.
One of the main reasons why investment performed badly after the reforms is precisely that capital could easily end up having little incentive to invest. In this new investor framework, as capital (domestic or foreign) can increase its accumulation rate (at least for a long period of time) either via stagnant wages (in sectors with productivity growth) or via shrinking ones (where there is none), why should it make a significant investment effort? Furthermore, if in the new equilibrium of the labor market, labor loses the property rights it had over the benefits that may derive from the use of this additional capital (increased productivity), labor also can end up having little incentive to acquire human capital. If all the benefits that might accrue from human capital accumulation go to capital, workers actually have a lesser incentive to invest in themselves.
Mexico: A Quarter Century of Unfulfilled Potential
Mexico’s recent economic history is littered with financial instability. The recurrent currency, debt, and banking crises of the past quarter century had a ruinous effect on real economic activity. Mexico’s election years frequently intensify the risk of financial devastation. Massive devaluations, debt defaults, or both have accompanied three of the last five presidential elections – and history could easily repeat itself if the disputed 2006 elections continue to spur unrest into 2007. While Mexico is clearly not immune to economic catastrophe, Mexico has taken many strides toward ameliorating the fiscal infirmities that allowed the 1994 Tequila Crisis.
Mexico’s modern economic history begins in 1976, a tumultuous year that witnessed a rescue loan package from the Federal Reserve and US Treasury in April, the election of President Jose Lopez Portillo in June, the first peso devaluation in 22 years in August, and the discovery of enormous oil reserves. High oil prices fueled tremendous government spending, and the resultant triple threat of a weakening trade balance, yawning government budget deficits, and rapidly rising inflation endangered Mexico’s fixed-exchange-rate system. Foreign investors countered in the early 1980s by reducing their positions in Mexico and converting a large fraction of their Mexican bank deposits to dollars. In the run-up to the 1982 presidential election, the monetary authorities did little to address the country’s deteriorating financial situation and quickly found themselves unable to defend the country’s currency. Mexico sharply devalued the peso in February 1982. In August, the country announced it could no longer meet its short-term, dollar-denominated obligations. December bore witness to another sharp devaluation.
The 1982 crisis triggered Mexico’s worst recession since the Great Depression and prompted drastic policy reforms. During the 1980s, the country took steps to raise tax revenues and limit fiscal spending. Restrictions on foreign investment and trade were lifted gradually. In 1986, Mexico joined the General Agreement on Tariffs and Trade (GATT). Between 1985 and 1990, the country’s maximum tariff fell from 100 percent to 20 percent. Most sectors opened to foreign investment in 1989, paving the way for a wave of privatizations. By 1994, 80 percent of state-owned firms had been sold off.
The country’s growing commitment to policy restraint and reform began to pay off in the late 1980s with lower interest rates, lower inflation and declining debt-to-GDP ratios. In 1989, after the Brady Plan marked the completion of the debt-renegotiation process, Mexico finally regained access to international financial markets. In fact, foreign direct investment started flowing into the country at unprecedented rates. Yet by the end of 1994, in another presidential election year, Mexico once again suffered financial crisis. Unrest in Chiapas, along with the assassinations of the leading presidential candidate and the ruling party’s leader, fed uncertainty and increased speculation against the peso. As the government began to rely increasingly on short-term, dollar-denominated debt, the ratio of short-term debt to reserves rose sharply. In December, Mexican authorities announced yet another vast devaluation of the peso.
Sustained financial instability has ensured Mexico’s inability to achieve consistent economic gains. In 1983, real GDP per capita fell by more than 6 percent. Between 1982 and 1994, Mexico experienced no overall growth. During the Tequila Crisis, GDP per capita fell by almost 10 percent. Even with the past decade’s relative stability, GDP per capita has grown by an average of less than 1 percent a year since 1980.
Mexico’s modern economic history begins in 1976, a tumultuous year that witnessed a rescue loan package from the Federal Reserve and US Treasury in April, the election of President Jose Lopez Portillo in June, the first peso devaluation in 22 years in August, and the discovery of enormous oil reserves. High oil prices fueled tremendous government spending, and the resultant triple threat of a weakening trade balance, yawning government budget deficits, and rapidly rising inflation endangered Mexico’s fixed-exchange-rate system. Foreign investors countered in the early 1980s by reducing their positions in Mexico and converting a large fraction of their Mexican bank deposits to dollars. In the run-up to the 1982 presidential election, the monetary authorities did little to address the country’s deteriorating financial situation and quickly found themselves unable to defend the country’s currency. Mexico sharply devalued the peso in February 1982. In August, the country announced it could no longer meet its short-term, dollar-denominated obligations. December bore witness to another sharp devaluation.
The 1982 crisis triggered Mexico’s worst recession since the Great Depression and prompted drastic policy reforms. During the 1980s, the country took steps to raise tax revenues and limit fiscal spending. Restrictions on foreign investment and trade were lifted gradually. In 1986, Mexico joined the General Agreement on Tariffs and Trade (GATT). Between 1985 and 1990, the country’s maximum tariff fell from 100 percent to 20 percent. Most sectors opened to foreign investment in 1989, paving the way for a wave of privatizations. By 1994, 80 percent of state-owned firms had been sold off.
The country’s growing commitment to policy restraint and reform began to pay off in the late 1980s with lower interest rates, lower inflation and declining debt-to-GDP ratios. In 1989, after the Brady Plan marked the completion of the debt-renegotiation process, Mexico finally regained access to international financial markets. In fact, foreign direct investment started flowing into the country at unprecedented rates. Yet by the end of 1994, in another presidential election year, Mexico once again suffered financial crisis. Unrest in Chiapas, along with the assassinations of the leading presidential candidate and the ruling party’s leader, fed uncertainty and increased speculation against the peso. As the government began to rely increasingly on short-term, dollar-denominated debt, the ratio of short-term debt to reserves rose sharply. In December, Mexican authorities announced yet another vast devaluation of the peso.
Sustained financial instability has ensured Mexico’s inability to achieve consistent economic gains. In 1983, real GDP per capita fell by more than 6 percent. Between 1982 and 1994, Mexico experienced no overall growth. During the Tequila Crisis, GDP per capita fell by almost 10 percent. Even with the past decade’s relative stability, GDP per capita has grown by an average of less than 1 percent a year since 1980.
Necessary Ingredients for National Competitiveness
National governments have an undeniable effect on the global competitiveness of the industries that take root in their countries. In the absence of a predictably stable legislative environment, industry cannot make the long-term gambles necessary to grow the economy.
Infrastructure investments of both the traditional and technological varieties will need to either be undertaken by the government itself or within a larger understanding of non-interference from the government in order to ensure that the underlying structure of the national economy is strong enough to support economic growth.
Without a financial environment that promotes private savings and domestic investment, no country's citizens will plow their resources back into the country. They will either spend everything they earn on short-lived consumer goods or send their resources abroad. While there is nothing wrong with international capital flows per se, any country that routinely sends its resources abroad is making a firm bet that someone else's economy is a better place to do business.
Education, particularly secondary and tertiary education, as well as lifelong training, is needed to provide businesses with a labor force that can take full advantage of technological progress.
Ultimately, each nation's citizens have a unique value system that each nation will seek to preserve. Paying attention to the fragile balance between economies of proximity and the wider globe in order to ensure wealth creation is absolutely critical.
Infrastructure investments of both the traditional and technological varieties will need to either be undertaken by the government itself or within a larger understanding of non-interference from the government in order to ensure that the underlying structure of the national economy is strong enough to support economic growth.
Without a financial environment that promotes private savings and domestic investment, no country's citizens will plow their resources back into the country. They will either spend everything they earn on short-lived consumer goods or send their resources abroad. While there is nothing wrong with international capital flows per se, any country that routinely sends its resources abroad is making a firm bet that someone else's economy is a better place to do business.
Education, particularly secondary and tertiary education, as well as lifelong training, is needed to provide businesses with a labor force that can take full advantage of technological progress.
Ultimately, each nation's citizens have a unique value system that each nation will seek to preserve. Paying attention to the fragile balance between economies of proximity and the wider globe in order to ensure wealth creation is absolutely critical.
Thursday, May 31, 2007
Are Multinational Corporations Good for the Developing World?
Multinational corporations obviously have many effects both for good and for ill on the developing world. Nonetheless, it is unlikely that these cumulative effects are precisely neutral.
Given the significant technology gap between the developed and developing worlds, multinational corporations have a clearly positive contagion effect that spreads innovation quickly around the world. And even if these corporations don't directly share their expertise with anyone, the increased competition probably encourages domestic firms to be more efficient. Multinationals have greater access to worldwide capital markets, so they bring capital into the economy. They pay their workers higher than prevailing wages and provide management skills not locally available.
Taken together, these benefits clearly ensure that at least some multinational corporations are a force for good.
Yet, multinationals are also capable of exploiting their workers, maintaining control over their fiscal and intellectual resources, and preempting local development. The culture gap also introduces products that aren't appropriate because multinationals can't accurately understand local culture. And even if that doesn't occur, human rights abuses have been repeatedly documented by corporations that drop to local standards rather than rising to expectations.
A real danger for many developing countries is that multinationals create a net capital outflow, actually remitting more profits to their home country than they initially put into the local economy. When the multinationals use inappropriate technology for the country's level of development, they can actually drive many out of work and retard local development.
On balance, multinational corporations are neither an unmitigated good nor a force for evil. Rather, these corporations have numerous disparate effects, both intended and otherwise, that need to be evaluated on an individual basis. Still, the history of multinational development provides significant hope that the benefits from technology transfer outweigh most other considerations under most circumstances.
Given the significant technology gap between the developed and developing worlds, multinational corporations have a clearly positive contagion effect that spreads innovation quickly around the world. And even if these corporations don't directly share their expertise with anyone, the increased competition probably encourages domestic firms to be more efficient. Multinationals have greater access to worldwide capital markets, so they bring capital into the economy. They pay their workers higher than prevailing wages and provide management skills not locally available.
Taken together, these benefits clearly ensure that at least some multinational corporations are a force for good.
Yet, multinationals are also capable of exploiting their workers, maintaining control over their fiscal and intellectual resources, and preempting local development. The culture gap also introduces products that aren't appropriate because multinationals can't accurately understand local culture. And even if that doesn't occur, human rights abuses have been repeatedly documented by corporations that drop to local standards rather than rising to expectations.
A real danger for many developing countries is that multinationals create a net capital outflow, actually remitting more profits to their home country than they initially put into the local economy. When the multinationals use inappropriate technology for the country's level of development, they can actually drive many out of work and retard local development.
On balance, multinational corporations are neither an unmitigated good nor a force for evil. Rather, these corporations have numerous disparate effects, both intended and otherwise, that need to be evaluated on an individual basis. Still, the history of multinational development provides significant hope that the benefits from technology transfer outweigh most other considerations under most circumstances.
Saturday, May 26, 2007
China Shortchanges Its Poor
The IHT reports that while China is expected to continue its unprecedented streak of double digit economic growth, the communist nation has neglected vital social programs. The Organization for Economic Cooperation and Development issued a report that noted China's surging tax revenues have been outrunning growth in social spending. In particular, China has been engaging in a significant arms buildup aimed at Taiwan that has diverted tremendous resources from the rural poor.
The OECD predicts that China's surging exports will create an even larger trade surplus next year than its current record levels. This has enormous implications in the form of China's massive foreign reserves. Because the country has been sopping up excess liquidity by building foreign exchange reserves to prevent foreign direct investment from creating inflation, China has more than $1.2 trillion in foreign exchange.
China has recently committed itself to investing $3 billion in a US private equity group and talks about creating a national investment firm to invest its foreign exchange abroad in order to acchieve a higher rate of return.
China is an emerging economy with tremendous monetary resources. Nonetheless, in a country with hundreds of millions of people barely above subsistence levels, China could surely direct those resources more profitably toward its own citizens.
The OECD predicts that China's surging exports will create an even larger trade surplus next year than its current record levels. This has enormous implications in the form of China's massive foreign reserves. Because the country has been sopping up excess liquidity by building foreign exchange reserves to prevent foreign direct investment from creating inflation, China has more than $1.2 trillion in foreign exchange.
China has recently committed itself to investing $3 billion in a US private equity group and talks about creating a national investment firm to invest its foreign exchange abroad in order to acchieve a higher rate of return.
China is an emerging economy with tremendous monetary resources. Nonetheless, in a country with hundreds of millions of people barely above subsistence levels, China could surely direct those resources more profitably toward its own citizens.
Wednesday, May 23, 2007
Entrepreneurship Roughly Constant Over Time
Businessweek reports that an annual study by the Kauffman Foundation has come the same conclusion that it has for the last 11 years - an average of .29% of the adult US population starts a new business each month. While this means that 465,000 new businesses are started every month, the relative constancy of new business formation is unexpected.
Most people would intuitively believe that more new businesses would be formed during periods of either rapid growth or recession (due to reduced opportunity costs associated with starting a new business). Yet the data suggests that the rate of business formation is largely unaffected by macroeconomic events.
Of course, considering that most new businesses are in the construction and service industries, it isn't hard to rationalize that these areas of the economy have been less affected by volatility than the rest of the economy. Although the housing boom crashed rather spectacularly right after the last data were collected. Next year's survey will help to clear up the effect of sectoral influence on entrepreneurship.
Nonetheless, the most attention-grabbing part of the survey was the racial breakdown. Asian entrepreneurship grew faster than average from a higher basis than average, non-Latino whites were average, and African Americans actually fell from a significantly lower basis than average.
The real kicker of course is that immigrants of all racial groups clearly outdistanced even the most entrepreneurial racial group.
The geographic distribution of entrepreneurship was also interesting. Chicago (.18%) and Detroit (.13%) were both well below the rate for African Americans. The Midwest has been economically lagging, so it looks like the effect of slower growth on encouraging new business formation either doesn't exist at all, or is counter to its intuitive direction.
Entrepreneurship is critical to the future of the economy because owning your own business is one of the best ways to build wealth. Most "wage slaves" never build enough capital to get ahead because it takes dedication to save money that comes in the form of a paycheck. Business owners on the other hand, build equity in their business and have something significant to sell on retirement.
Most people would intuitively believe that more new businesses would be formed during periods of either rapid growth or recession (due to reduced opportunity costs associated with starting a new business). Yet the data suggests that the rate of business formation is largely unaffected by macroeconomic events.
Of course, considering that most new businesses are in the construction and service industries, it isn't hard to rationalize that these areas of the economy have been less affected by volatility than the rest of the economy. Although the housing boom crashed rather spectacularly right after the last data were collected. Next year's survey will help to clear up the effect of sectoral influence on entrepreneurship.
Nonetheless, the most attention-grabbing part of the survey was the racial breakdown. Asian entrepreneurship grew faster than average from a higher basis than average, non-Latino whites were average, and African Americans actually fell from a significantly lower basis than average.
The real kicker of course is that immigrants of all racial groups clearly outdistanced even the most entrepreneurial racial group.
The geographic distribution of entrepreneurship was also interesting. Chicago (.18%) and Detroit (.13%) were both well below the rate for African Americans. The Midwest has been economically lagging, so it looks like the effect of slower growth on encouraging new business formation either doesn't exist at all, or is counter to its intuitive direction.
Entrepreneurship is critical to the future of the economy because owning your own business is one of the best ways to build wealth. Most "wage slaves" never build enough capital to get ahead because it takes dedication to save money that comes in the form of a paycheck. Business owners on the other hand, build equity in their business and have something significant to sell on retirement.
Tuesday, May 22, 2007
China's Growth Comes at Environmental Cost
Businessweek reports that China's state media released data that show the country's environment is deteriorating.
While "spring sandstorms" helped to reduce air pollution by blowing the problem away from the area it was produced, the country's water supply continues its downward spiral. According to China's own "watered down" standards, less than 70% of major Chinese cities have water that ranks as "qualified". This is a drop of 5% from just a year ago. But the truly frightening truth of China's rivers and streams is obscured by these figures.
There have been a series of industrial accidents that polluted Chinese rivers which the government ineffectually attempted to cover up. One of the accidents was so bad that no amount of government intervention could disguise. The northeastern city of Harbin, with well over one million people, lost its only source of water when an industrial plant upriver completely poisoned the river with a massive dumping of benzene, a toxic chemical that is known to cause cancer.
China's political leaders are absolutely correct when they say that their efforts to clean up the environment are being effectively hamstrung by the need to continue economic growth. China's economy has grown faster than 10% per year for the last five years, but the country's primary competitive advantage in the international arena continues to be the availability of hundreds of millions of workers willing to work for almost nothing. China has made admirable progress in the urban areas that export to consumers around the world, but the countryside remains a decided work in progress.
The cleanest countries in the world are also the richest. This is no accident, as wealthy people are far more likely to pay to clean up their environment than the poor. China's problem is that the country has so many citizens trying to make a better life that they will irreparably damage their environment before they have enough money to repair their mistakes.
The environment has gained tremendous cachet in the West, perhaps most notably with the super trendy cleantech industry. China's growth is going to happen. At this point, only significant technological progress is going to enable that process to occur with minimal environmental disruption.
While "spring sandstorms" helped to reduce air pollution by blowing the problem away from the area it was produced, the country's water supply continues its downward spiral. According to China's own "watered down" standards, less than 70% of major Chinese cities have water that ranks as "qualified". This is a drop of 5% from just a year ago. But the truly frightening truth of China's rivers and streams is obscured by these figures.
There have been a series of industrial accidents that polluted Chinese rivers which the government ineffectually attempted to cover up. One of the accidents was so bad that no amount of government intervention could disguise. The northeastern city of Harbin, with well over one million people, lost its only source of water when an industrial plant upriver completely poisoned the river with a massive dumping of benzene, a toxic chemical that is known to cause cancer.
China's political leaders are absolutely correct when they say that their efforts to clean up the environment are being effectively hamstrung by the need to continue economic growth. China's economy has grown faster than 10% per year for the last five years, but the country's primary competitive advantage in the international arena continues to be the availability of hundreds of millions of workers willing to work for almost nothing. China has made admirable progress in the urban areas that export to consumers around the world, but the countryside remains a decided work in progress.
The cleanest countries in the world are also the richest. This is no accident, as wealthy people are far more likely to pay to clean up their environment than the poor. China's problem is that the country has so many citizens trying to make a better life that they will irreparably damage their environment before they have enough money to repair their mistakes.
The environment has gained tremendous cachet in the West, perhaps most notably with the super trendy cleantech industry. China's growth is going to happen. At this point, only significant technological progress is going to enable that process to occur with minimal environmental disruption.
Thursday, May 17, 2007
Bernanke Sees No Subprime Mortgage Contagion
Reuters reports that Fed Chairman Ben Bernanke has come around to the conventional wisdom that the subprime mortgage woes that so captivated the media will not metastasize into a broader recession.
Of course, the housing sector is still the weak link in the economy these days, taking more than 1% off GDP after the top of the boom. The economy's dependence on the housing sector has been both underestimated and surprisingly narrow. Economic growth in retail has collapsed as the faltering housing market cut off easy access to home equity. Yet, the industrial sector has been almost completely unfazed. Exports have been soaring, and productivity outside of the construction industry has been chugging along nicely.
One of the unanticipated consequences of the housing sector's weakness has been the fate of Latin America. Many recent immigrants of Latin American extraction have found a livelihood in the construction industry - and they routinely send remittances back to their home countries to share the wealth with relatives. Since the top of the housing market, job prospects for these immigrants have gotten much worse and remittances have collapsed. The amount of money being funneled back to Mexico has fallen by more than 30% in the past year, and this big drop will have real consequences.
Many areas of Mexico, and not just in Chiapas, are almost completely dependent on these remittances. In five Mexican states, remittances from the United States are greater than the rest of the economic activity by everyone who remains in the country.
Subprime mortgages don't seem to be holding the US economy back, but the unintended consequences for Mexico and the rest of Latin America will certainly be severe.
Of course, the housing sector is still the weak link in the economy these days, taking more than 1% off GDP after the top of the boom. The economy's dependence on the housing sector has been both underestimated and surprisingly narrow. Economic growth in retail has collapsed as the faltering housing market cut off easy access to home equity. Yet, the industrial sector has been almost completely unfazed. Exports have been soaring, and productivity outside of the construction industry has been chugging along nicely.
One of the unanticipated consequences of the housing sector's weakness has been the fate of Latin America. Many recent immigrants of Latin American extraction have found a livelihood in the construction industry - and they routinely send remittances back to their home countries to share the wealth with relatives. Since the top of the housing market, job prospects for these immigrants have gotten much worse and remittances have collapsed. The amount of money being funneled back to Mexico has fallen by more than 30% in the past year, and this big drop will have real consequences.
Many areas of Mexico, and not just in Chiapas, are almost completely dependent on these remittances. In five Mexican states, remittances from the United States are greater than the rest of the economic activity by everyone who remains in the country.
Subprime mortgages don't seem to be holding the US economy back, but the unintended consequences for Mexico and the rest of Latin America will certainly be severe.
Friday, May 4, 2007
Oil Refiners Profit - Is it Gouging?
Reuters reports that American oil refiners are set for record profits this summer as demand peaks and supplies tighten. The industry uniformly blames an aging infrastructure and new government regulations that mandate more exotic, less polluting fuels. Astonishingly, margins today are better than they were in the immediate aftermath of the 2005 hurricanes which shuttered a quarter of US fuel production.
The government has conducted repeated investigations into price manipulation at the behest of numerous populist politicians who see prices at the pump soaring far more rapidly than the price of crude oil. Those investigations found no evidence of price gouging but numerous "independent" surveys of rising prices show clear evidence of manipulation.
The root problem with rising gas prices is that demand in the United States is almost completely inelastic. Despite an enormous run up in the price of gas at the pump, Americans have not cut back on their fuel consumption at all. For all of the people loudly complaining about the prospect of higher fuel costs, the aggregate response of the nation has been to do nothing. The economy is becoming slightly more efficient at squeezing greater economic growth out of the same amount of petroleum, but the total amount of oil flowing through the nation's economic veins has remained constant.
Consider virtually any other industry with a huge, totally captive consumer base and tremendous barriers to competition that squash out new competition. Over the past fifty years, the oil industry has actually not been particularly profitable given the necessity of its product to the rest of the economy. In fact, as recently as 1998, crude oil prices as low as $9 a barrel threatened the viability of the industry.
In any event, the rest of the world has already dealt with significantly higher gas prices than the United States. European nations in particular tax oil so heavily that seven or eight dollars a gallon are more likely than three. The next time that someone suggests that current levels of gas prices are going to cause a downturn or even a prolonged recession, remember that the oil sheiks do not yet control the world economy.
The government has conducted repeated investigations into price manipulation at the behest of numerous populist politicians who see prices at the pump soaring far more rapidly than the price of crude oil. Those investigations found no evidence of price gouging but numerous "independent" surveys of rising prices show clear evidence of manipulation.
The root problem with rising gas prices is that demand in the United States is almost completely inelastic. Despite an enormous run up in the price of gas at the pump, Americans have not cut back on their fuel consumption at all. For all of the people loudly complaining about the prospect of higher fuel costs, the aggregate response of the nation has been to do nothing. The economy is becoming slightly more efficient at squeezing greater economic growth out of the same amount of petroleum, but the total amount of oil flowing through the nation's economic veins has remained constant.
Consider virtually any other industry with a huge, totally captive consumer base and tremendous barriers to competition that squash out new competition. Over the past fifty years, the oil industry has actually not been particularly profitable given the necessity of its product to the rest of the economy. In fact, as recently as 1998, crude oil prices as low as $9 a barrel threatened the viability of the industry.
In any event, the rest of the world has already dealt with significantly higher gas prices than the United States. European nations in particular tax oil so heavily that seven or eight dollars a gallon are more likely than three. The next time that someone suggests that current levels of gas prices are going to cause a downturn or even a prolonged recession, remember that the oil sheiks do not yet control the world economy.
Monday, April 30, 2007
China Raises Reserve Requirements to Fight Growth
The NYT reports that China finds itself in the rather enviable position of fighting to keep its already phenomenal growth rate from becoming excessive. So for the second time in just one month, the People's Bank of China has raised the requirement for how much of the deposits kept in major banks must be held in reserve. And changing the reserve requirements is not the only tool that China has been using to slow growth. China raised interest rates three times in the last year.
The problem China faces is that even with these adjustments, growth is unlikely to slow. China has a $46 billion trade surplus that doubled since just last year. And foreign investors have been pouring money in China's currency as they speculate that the government will have to let the currency strengthen. The stock market has been exploding, rising 130% in 2006 and about 40% so far this year.
Many intelligent people the world over have come to the conclusion that China's rise as a major economic power to rival and even surpass the United States is now a given. In this environment, the huge investments in China are justified, but they have bid down the expected rate of return well below the original potential of the market. The world is facing a level of capital liquidity that is completely unparalleled in history. This liquidity is ultimately a force for good, but a panic could turn this capital influx into an exodus.
The real question that most people are probably asking themselves is: "What's wrong with an economy that grows faster than 10% a year?" The straight answer is that there is nothing magical about growing that quickly that ensures the growth is the result of speculation and not underlying macroeconomic change. But growth of this magnitude has never been sustained before in human history. Economies that have been growing significantly more slowly have been gripped by speculative bubbles that sparked worldwide financial collapse. China treats 10% as the growth rate above which it chooses to be concerned, and with good reason. China's political structure is set up in such a way that continued economic growth is critical to social stability. If the economy stopped growing or even worse began to crash, the Communist Party would face troubles from the countryside that could loosen its grip on power.
Too much growth is actually more likely to cause economic woes for China rather than too little. A speculative bubble popping is the most likely bad scenario and China's steps are a reasonable movement to prevent that. Unfortunately for China, only a slowing world economy is likely to hold back China's export driven growth and outside of the United States, the economies of the world are doing better than they have in years. For once, America's housing bust might do something good for the world economy.
The problem China faces is that even with these adjustments, growth is unlikely to slow. China has a $46 billion trade surplus that doubled since just last year. And foreign investors have been pouring money in China's currency as they speculate that the government will have to let the currency strengthen. The stock market has been exploding, rising 130% in 2006 and about 40% so far this year.
Many intelligent people the world over have come to the conclusion that China's rise as a major economic power to rival and even surpass the United States is now a given. In this environment, the huge investments in China are justified, but they have bid down the expected rate of return well below the original potential of the market. The world is facing a level of capital liquidity that is completely unparalleled in history. This liquidity is ultimately a force for good, but a panic could turn this capital influx into an exodus.
The real question that most people are probably asking themselves is: "What's wrong with an economy that grows faster than 10% a year?" The straight answer is that there is nothing magical about growing that quickly that ensures the growth is the result of speculation and not underlying macroeconomic change. But growth of this magnitude has never been sustained before in human history. Economies that have been growing significantly more slowly have been gripped by speculative bubbles that sparked worldwide financial collapse. China treats 10% as the growth rate above which it chooses to be concerned, and with good reason. China's political structure is set up in such a way that continued economic growth is critical to social stability. If the economy stopped growing or even worse began to crash, the Communist Party would face troubles from the countryside that could loosen its grip on power.
Too much growth is actually more likely to cause economic woes for China rather than too little. A speculative bubble popping is the most likely bad scenario and China's steps are a reasonable movement to prevent that. Unfortunately for China, only a slowing world economy is likely to hold back China's export driven growth and outside of the United States, the economies of the world are doing better than they have in years. For once, America's housing bust might do something good for the world economy.
Sunday, April 29, 2007
US Economic Downturn Possible, but Improbable
Reuters reports that the President of San Francisco's Federal Reserve suggested that a downturn in the US that ripples around the world is possible. Of course, she qualified that statement to make it significantly less meaningful than the article suggests. Her analysis appears to consist of noting that the US represents 25% of world production and that the US economy hasn't been doing well recently. She goes on to say that her own opinion is that growth picks up instead of slowing into a recession, but that wouldn't make for exciting headlines.
Except for the fact that most Federal Reserve Presidents talk in the most purposefully bland, obtuse language in order to avoid spooking the markets, this would be a prime example of editorial overstretch. Yet the case for a coming economic downturn needs to be considered on its merits.
The problem with the pro-recession storyline is that it lacks a promising catalyst. One could argue that interest rates are choking growth, but does anyone really believe sub 6% rates that haven't moved upward in a while are causing a slowdown? Macroeconomic instability could be blamed for a slowdown, but what exactly is the hold up? Trade is accelerating around the world, and important markets in Asia and Europe are doing better than they have in years. US relative prominence is clearly shrinking, but that has been happening every year since the end of World War II. Absolute levels of production have been steadily rising and even the increasing costs of inputs doesn't seem to have slowed the economy. Oil could certainly be a lot cheaper, but it could also be a lot more expensive. Gas prices in excess of $3 a gallon are painful, but consumers haven't cut their consumption at all.
The most promising source of weakness is obviously the housing market. The value of housing in many areas around the country has clearly been in the midst of a speculative bubble for years and is now in the early stages of a correction. The question then becomes if the securitization of home mortgages as opposed to traditional government-backed lending has caused a structural fault to develop that will continue to suck the growth out of the economy. It's impossible to say at this point, but it seems like investor's demands for tighter lending standards has already squeezed out a lot of the risky loans that caused the trouble this time around.
The President of San Francisco's Federal Reserve thinks that a worldwide economic contagion could spiral out for the US in the event of a downturn, but she doesn't think that downturn is going to materialize. Looking at the underlying problems the economy faces, slow to moderate growth looks significantly more likely than a recession.
Except for the fact that most Federal Reserve Presidents talk in the most purposefully bland, obtuse language in order to avoid spooking the markets, this would be a prime example of editorial overstretch. Yet the case for a coming economic downturn needs to be considered on its merits.
The problem with the pro-recession storyline is that it lacks a promising catalyst. One could argue that interest rates are choking growth, but does anyone really believe sub 6% rates that haven't moved upward in a while are causing a slowdown? Macroeconomic instability could be blamed for a slowdown, but what exactly is the hold up? Trade is accelerating around the world, and important markets in Asia and Europe are doing better than they have in years. US relative prominence is clearly shrinking, but that has been happening every year since the end of World War II. Absolute levels of production have been steadily rising and even the increasing costs of inputs doesn't seem to have slowed the economy. Oil could certainly be a lot cheaper, but it could also be a lot more expensive. Gas prices in excess of $3 a gallon are painful, but consumers haven't cut their consumption at all.
The most promising source of weakness is obviously the housing market. The value of housing in many areas around the country has clearly been in the midst of a speculative bubble for years and is now in the early stages of a correction. The question then becomes if the securitization of home mortgages as opposed to traditional government-backed lending has caused a structural fault to develop that will continue to suck the growth out of the economy. It's impossible to say at this point, but it seems like investor's demands for tighter lending standards has already squeezed out a lot of the risky loans that caused the trouble this time around.
The President of San Francisco's Federal Reserve thinks that a worldwide economic contagion could spiral out for the US in the event of a downturn, but she doesn't think that downturn is going to materialize. Looking at the underlying problems the economy faces, slow to moderate growth looks significantly more likely than a recession.
Friday, April 27, 2007
US Economic Growth Slows
The IHT reports that the Commerce Department's latest figures show GDP growth slowed to 1.3% in the first quarter. This slow growth is particularly annoying in light of resurgent inflation - which rose at a 4% annual rate. The Fed prefers to consider inflation figures with food and energy costs factored out, so an adjusted 2.2% rate doesn't seem likely to spawn aggressive interest rate moves. Nonetheless, despite their volatility, food and energy prices exact a real cost for the broader economy. Four dollars a gallon for gas seems a remote possibility, but $3 per gallon is much harder on economic activity than $2.25.
The culprit for slower economic growth has been the collapse of residential real estate, which fell by 17% in spite of previous declines of 18.7% and 19.8% the two quarters before. The continuing decline in real estate prices has already made housing more affordable in many of the most expensive markets in the nation, but countless mortgages are going to keep most people's current bills the same.
The weakness in the United States is already being priced into the markets. Worst-case scenarios are being floated that seemed impossible only a year ago. One Bear Stearns analyst has already raised the spectre of stagflation - the horrific combination of sustained slow growth and high inflation.
Still, no new source of a slowdown emerged in the numbers. Analysts have known about weakness in the housing sector for quite some time and energy prices have been significantly higher in the past few years. Exports continued their trend of not following a trend by declining at a 1.2% rate. This compares with an advance of 10.6% the quarter before.
Overall, the numbers suggest that the economy looked a lot like everyone already knew it looked in the broadest outlines and unambiguously weaker than expected from a shorter perspective. These numbers are quite different from last quarter's numbers, so expect a slight upward revision when the next numbers come out. But the general health of the economy is clearly much weaker than many hope for.
Interestingly, corporate profits reported on Wall Street this week don't seem to be closely tracking this slowdown. Maybe Microsoft, Apple, Google, and the others who reported this week are somehow immune, or maybe the revision will be larger than usual next quarter.
The culprit for slower economic growth has been the collapse of residential real estate, which fell by 17% in spite of previous declines of 18.7% and 19.8% the two quarters before. The continuing decline in real estate prices has already made housing more affordable in many of the most expensive markets in the nation, but countless mortgages are going to keep most people's current bills the same.
The weakness in the United States is already being priced into the markets. Worst-case scenarios are being floated that seemed impossible only a year ago. One Bear Stearns analyst has already raised the spectre of stagflation - the horrific combination of sustained slow growth and high inflation.
Still, no new source of a slowdown emerged in the numbers. Analysts have known about weakness in the housing sector for quite some time and energy prices have been significantly higher in the past few years. Exports continued their trend of not following a trend by declining at a 1.2% rate. This compares with an advance of 10.6% the quarter before.
Overall, the numbers suggest that the economy looked a lot like everyone already knew it looked in the broadest outlines and unambiguously weaker than expected from a shorter perspective. These numbers are quite different from last quarter's numbers, so expect a slight upward revision when the next numbers come out. But the general health of the economy is clearly much weaker than many hope for.
Interestingly, corporate profits reported on Wall Street this week don't seem to be closely tracking this slowdown. Maybe Microsoft, Apple, Google, and the others who reported this week are somehow immune, or maybe the revision will be larger than usual next quarter.
Sunday, April 22, 2007
Reluctant Chinese Consumers
Businessweek reports that the Chinese government is concerned about the fiscal conservatism being demonstrated by its citizens. The Chinese have one of the highest savings rates in the world. Most people are socking away as much as 40% of their income each year. And the trends going forward don't look good. The share of GDP soaked up by private consumption is only 40%. This represents a fall from 48% as recently as 2000. To put this figure in perspective, US consumers spent 8 times as much on consumption goods even though there are only one-fourth as many Americans.
It might seem to some observers that saving a lot of money is really a good thing. And it certainly can be. The US savings rate has been hovering near zero and in fact gone negative for several years now. The problem is that only so much investment can be done at reasonable levels of profitability at any given time. In real terms, this means that every additional dollar saved goes into a slightly worse investment, because all the best investments get taken first. The cost of saving such a high percentage of income is ultimately personal privation. Foreign businesses have been trying to crack the China market for decades with little success. One reason is that the Chinese are simply much more price conscious than other consumers. By only purchasing a few, very low cost goods, the Chinese limit the marketplace by not rewarding manufacturers for catering to them.
The eternally optimistic in the world economic community envision a day when a great Chinese middle class finally starts spending and touches off a tremendous global bull market. And while continued economic growth on the level of 10% per annum makes such an eventuality much more likely, the sad truth is that a day like that is still far off in the future. For all the good press that China has been able to get in the media, the Chinese middle class only includes about 25 million people. Out of a total population well over 1 billion, it is clear that such a small minority is unlikely to move global markets anytime soon.
The real tragedy of weak Chinese consumer spending is that the quality of life of the average person in China is much lower than it could be. Most urban residents don't own cars and despite the best efforts of automakers, that won't be changing soon either.
The Chinese economic miracle is a wondrous thing, but it could certainly be a much more wonderful thing if it benefited the workers who have made it happen.
It might seem to some observers that saving a lot of money is really a good thing. And it certainly can be. The US savings rate has been hovering near zero and in fact gone negative for several years now. The problem is that only so much investment can be done at reasonable levels of profitability at any given time. In real terms, this means that every additional dollar saved goes into a slightly worse investment, because all the best investments get taken first. The cost of saving such a high percentage of income is ultimately personal privation. Foreign businesses have been trying to crack the China market for decades with little success. One reason is that the Chinese are simply much more price conscious than other consumers. By only purchasing a few, very low cost goods, the Chinese limit the marketplace by not rewarding manufacturers for catering to them.
The eternally optimistic in the world economic community envision a day when a great Chinese middle class finally starts spending and touches off a tremendous global bull market. And while continued economic growth on the level of 10% per annum makes such an eventuality much more likely, the sad truth is that a day like that is still far off in the future. For all the good press that China has been able to get in the media, the Chinese middle class only includes about 25 million people. Out of a total population well over 1 billion, it is clear that such a small minority is unlikely to move global markets anytime soon.
The real tragedy of weak Chinese consumer spending is that the quality of life of the average person in China is much lower than it could be. Most urban residents don't own cars and despite the best efforts of automakers, that won't be changing soon either.
The Chinese economic miracle is a wondrous thing, but it could certainly be a much more wonderful thing if it benefited the workers who have made it happen.
Saturday, April 21, 2007
The Hypocrisy of Islamic Debt
The IHT reports that Malayan Banking's first bond offer that complies with Islamic principles was a huge success. $300 million in securities were sold, but interested parties offered to buy as much as $2.4 billion.
Bonds are big business and the Islamic world is a traditionally under served market. And its not because rich Middle Eastern oil magnates haven't been offered the finest financial products conceivable. The reason is that Islam rather specifically forbids charging interest. A true believer in Islam is never going to buy any financial asset based on charging interest, but that didn't stop Malayan Banking.
The Islamic debt sold by Malayan Banking is based on a carefully created fiction. A borrower creates a separate holding company that issues securities to investors and rents the assets to the borrower. The rental income is paid instead of interest. At the end of the contract, the borrower buys back the assets at a guaranteed price and the principal is returned to investors.
An important point about Islamic debt is that it requires the complicity of prominent religious figures who must check to see the whole deal doesn't violate Islam. Why would someone who has dedicated their life to a religion bless a deal that is so blatantly against the basic precepts of that religion? Giant kickbacks. Pay the imam enough money to build a bunch of new mosques and he'll sign off on anything.
Of course, beyond the religious liberalism being demonstrated by Islamic, the whole region is likely to benefit enormously from the practice. Companies that have access to more capital are capable of expanding much faster than companies that have to rely solely on organic growth. Investors throughout the Islamic world have accepted returns that are significantly less than they could have attained because of deference to Islam.
True believers in Islam should be appalled by Islamic debt, but everyone else should be happy that the Islamic world has finally decided to enjoy the benefits of modern capital markets.
Bonds are big business and the Islamic world is a traditionally under served market. And its not because rich Middle Eastern oil magnates haven't been offered the finest financial products conceivable. The reason is that Islam rather specifically forbids charging interest. A true believer in Islam is never going to buy any financial asset based on charging interest, but that didn't stop Malayan Banking.
The Islamic debt sold by Malayan Banking is based on a carefully created fiction. A borrower creates a separate holding company that issues securities to investors and rents the assets to the borrower. The rental income is paid instead of interest. At the end of the contract, the borrower buys back the assets at a guaranteed price and the principal is returned to investors.
An important point about Islamic debt is that it requires the complicity of prominent religious figures who must check to see the whole deal doesn't violate Islam. Why would someone who has dedicated their life to a religion bless a deal that is so blatantly against the basic precepts of that religion? Giant kickbacks. Pay the imam enough money to build a bunch of new mosques and he'll sign off on anything.
Of course, beyond the religious liberalism being demonstrated by Islamic, the whole region is likely to benefit enormously from the practice. Companies that have access to more capital are capable of expanding much faster than companies that have to rely solely on organic growth. Investors throughout the Islamic world have accepted returns that are significantly less than they could have attained because of deference to Islam.
True believers in Islam should be appalled by Islamic debt, but everyone else should be happy that the Islamic world has finally decided to enjoy the benefits of modern capital markets.
Friday, April 20, 2007
Eastern Europe's Cheap Labor Disappearing
Speigel Online reports that Eastern Europe's dramatic economic boom is starting to drive calls for higher wages that would make the region uncompetitive with other "low wage countries". Most Americans would probably point to Singapore and Mexico as places where exactly the same phenomenon has already occurred and advise Eastern Europeans to enjoy their higher wages.
Growth in median hourly earnings has been tremendous since 2002. The Czechs have 45% higher wages, the Hungarians have 70% higher wages, and the Latvians have 168% higher wages. Obviously these trends cannot continue forever, but the average worker in Eastern Europe has witnessed a great increase in earnings and overall quality of life. Indeed, considering that entry into the European Union caused a migration of many of these countries best workers to higher paying jobs in France, England, and the Nordic countries, this broad-based rise is all the more impressive.
One of Eastern Europe's best selling points has been its highly educated workforce. If labor productivity continues to grow, the possibility for organic growth in living standards seems much higher for the region than the rest of the world in general.
Spiegel Online considers autoworkers at a Skoda plant that are demanding wages that approach those of Volkswagen in Germany. Skoda can certainly afford the 12% wage increase that the workers are proposing for now, but consider that Volkswagen workers are some of the highest paid in the world. One plant in Germany reduced the work week from 35 hours per week to only 32 in order to maintain wages that approach $70 per hour.
Not bad work if you can get it.
Growth in median hourly earnings has been tremendous since 2002. The Czechs have 45% higher wages, the Hungarians have 70% higher wages, and the Latvians have 168% higher wages. Obviously these trends cannot continue forever, but the average worker in Eastern Europe has witnessed a great increase in earnings and overall quality of life. Indeed, considering that entry into the European Union caused a migration of many of these countries best workers to higher paying jobs in France, England, and the Nordic countries, this broad-based rise is all the more impressive.
One of Eastern Europe's best selling points has been its highly educated workforce. If labor productivity continues to grow, the possibility for organic growth in living standards seems much higher for the region than the rest of the world in general.
Spiegel Online considers autoworkers at a Skoda plant that are demanding wages that approach those of Volkswagen in Germany. Skoda can certainly afford the 12% wage increase that the workers are proposing for now, but consider that Volkswagen workers are some of the highest paid in the world. One plant in Germany reduced the work week from 35 hours per week to only 32 in order to maintain wages that approach $70 per hour.
Not bad work if you can get it.
Wednesday, April 18, 2007
Dollar at Record Lows, Europe Unconcerned
Reuters reports that the dollar has fallen to a 26-year low against the British pound sterling and is nearing the lowest levels against the euro in 2 years. The abrupt change in exchange rates has been driven by concerns about slowing US growth and the spectre of lower interest rates at home compared with higher rates abroad.
The Euro zone has been receiving much more cheerleading from the press of late. The New York Times and others have recently remarked on the resurgent strength of Germany - where unemployment may fall below 9% if the current strength continues. A recent article even went so far as to observe that Chinese entrepreneurs are forsaking America for Europe. Unfortunately, as even the most ebullient euro-boosters must note, Germany's recent spate of economic growth has been driven by wild successes in niche markets. Sensors for lasers and satellite parts for Boeing are certainly growth opportunities, but Germany as a whole and certainly no other large economy can base its growth on niche manufacturing.
The manufacturing lobby in the United States has been arguing hard for a sharply reduced currency to boost exports, but now that it has finally arrived they are strangely silent. Even in the face of such favorable economic conditions, no one seriously expects all those outsourced jobs to miraculously return.
Economists will tell anyone who listens that in the long run, fluctuations in the value of currency between widely held, freely traded alternatives are irrelevant to growth rates and have a neutral effect on the economy. But as journalists are so fond of quoting Keynes, "In the long run we are all dead".
The Euro zone has been receiving much more cheerleading from the press of late. The New York Times and others have recently remarked on the resurgent strength of Germany - where unemployment may fall below 9% if the current strength continues. A recent article even went so far as to observe that Chinese entrepreneurs are forsaking America for Europe. Unfortunately, as even the most ebullient euro-boosters must note, Germany's recent spate of economic growth has been driven by wild successes in niche markets. Sensors for lasers and satellite parts for Boeing are certainly growth opportunities, but Germany as a whole and certainly no other large economy can base its growth on niche manufacturing.
The manufacturing lobby in the United States has been arguing hard for a sharply reduced currency to boost exports, but now that it has finally arrived they are strangely silent. Even in the face of such favorable economic conditions, no one seriously expects all those outsourced jobs to miraculously return.
Economists will tell anyone who listens that in the long run, fluctuations in the value of currency between widely held, freely traded alternatives are irrelevant to growth rates and have a neutral effect on the economy. But as journalists are so fond of quoting Keynes, "In the long run we are all dead".
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