PPI Chief Economist, Michael Mandel, discuses the challenges facing America’s economic recovery on Marketplace:

“After a number of incremental but positive indicators that have come out in the past couple of months — the so-called “green shoots” — today’s fourth quarter GDP was a reminder that our economy is still very fragile. Like a green shoot of a plant or a tree, our economy needs a lot of nurturing to really grow.

“Mike Mandel is the chief economic strategist for the Progressive Policy Institute. He says lower-than-expected GDP in the final three months of last year reflect an economy that’s “on the road to recovery,” but it’s a “slow, uneven recovery.”

“Mandel says we still haven’t solved a key underlying problem: We’re investing too little in increasing our productivity and too much on consumption. According to Mandel, we went into this recession too focused on consuming and neither public or private investment has been enough of a priority.”

Read and listen to Mandel on Marketplace.

Can insourcing be a major source of job creation for the U.S.? The answer is yes, with a caveat. Widespread insourcing–or import recapture, as I like to call it–won’t happen without some help from government policy. In particular, the main role of the government is to provide better data about the relative cost of insourcing vs outsourcing.

Why would better statistics help create new jobs in the U.S. and accelerate insourcing? The reason is hysteresis. Hysteresis is defined as a “lag in response” when the forces acting on a situation have changed. Originally hysteresis worked in favor of keeping jobs in this country, because businesses didn’t want to switch their production to a country thousands of miles away, even if it might be cheaper.But now, with production firmly established in China, India, Mexico, and other low-cost countries, hysteresis is working against the U.S.

As a result, even if production costs have converged, there are three big obstacles to bringing jobs back to the U.S.

First, it is expensive to switch suppliers, especially for noncommodity purchases. Contracts have to be negotiated, the quality of the product has to be checked, suppliers have to be integrated into a supply chain. Wal-mart would rather work with suppliers that it already has been doing business with.

Second, it may be expensive and time-consuming to recreate a production ecosystem here in the U.S., especially if an industry has been hollowed out. That is, if you want to start making shoes in the U.S., it’s easier if you have a repairman in the area who knows have to fix shoe manufacturing machinery.

Conventional wisdom these days says that small is better when it comes to innovation and putting new ideas into practice.1 Large enterprises are typically thought of as hidebound defenders of the status quo, dominating by market power and brute force rather than technological and innovative prowess.

Yet reality is far more complicated than this simple small versus big distinction. As we all know many common-sense beliefs turn out to be only partly true, or not to be true at all.

In this policy memo we will reconsider the link between scale (size) and innovation. After 20 years where startups have rightly dominated the innovation headlines, we will show that the pendulum may be swinging back. As a result, there are reasons to believe that scale may be a plus for innovation in today’s economy, not a minus. We will then relate scale to government policy, U.S. competitiveness and prosperity.

The now-heretical idea that scale is an advantage for innovation actually dates back more than 60 years. Back then, Harvard economist Joseph Schumpeter, the inventor of the term ‘creative destruction’, suggested that large-scale firms were “the most powerful engine of progress.” Following after his work, economists developed what came to be known as the “Schumpeterian Hypothesis.” The first part of the Schumpeterian Hypothesis was the argument that bigger firms have more of an incentive to spend on innovation than a smaller one. For example, if we compare a company that manufactures 50 million t-shirts a year versus one that manufactures 10,000 t-shirts a year, the larger company is much more like to spend the big bucks needed to develop and test a new process for dyeing the t-shirts.

The second part of the Schumpeterian Hypothesis is the observation that companies with more market power might also be more willing to invest in innovation. The argument is that if a firm in an ultra-competitive market innovates, the new product or service is quickly copied by rivals, so that the gains from innovations are quickly competed away. Conversely, a firm with market power has the ability to hold onto some of its gains from innovation, so it may pay to invest in product or other improvements.

Right now policymakers are grappling with the implications of slow economic growth in the United States and the rest of the industrialized world. One response is austerity—cutting back on spending, accepting reduced living standards, and slowly digging out from the mess.

A better option, though, is innovation, which accelerates growth, creates new jobs, and makes U.S. products and services more competitive world-wide. Innovation has the potential for raising incomes, an especially important task given that real median household incomes have fallen more than 10 percent since the beginning of the recession.

While innovation can come from any industry, the technology sector is particularly important, as it has been the main source of growth and innovation in the economy for the past 35 years. The locus of innovation started with the personal computer in the late 1970s and 1980s; shifted to software and the internet in the 1990s; and now has moved to mobile, search, and more broadly communications, where U.S. companies are world leaders. Today’s technological advances have facilitated the emergence of innovation “ecosystems,” or platforms on which many different companies can build products or provide services.

The growth of tech companies stems from a combination of organic growth and business acquisitions, driven by the rapidity of innovation. It’s a virtuous circle, where successful technology companies pay large sums for small startups, which in turn induces the formation of more startups. For that reason, technology acquisitions need not diminish competitiveness, even as they accelerate innovation and job growth. Indeed, as we will see later in this paper, periods of high levels of acquisition have also been periods of rapid job growth.

America is deep in a jobs crisis. The unemployment rate is stuck around 9 percent nationally, with states such as Florida, Nevada and South Carolina in double digits. Real wages for educated workers are still plunging, while new college graduates are squeezed between rising student loans and the toughest labor market in recent memory.

Against this backdrop, the global economy looms large as both threat and promise. There’s a justifiable fear that America has lost its competitiveness, that our jobs are being siphoned to China and India, that the wages of our young people are being depressed by a global education glut. At the same time, the rapidly growing markets of the developing world could be a potent target for U.S. exports of goods, services, and intellectual capital, creating good jobs here.

In this global economy, we need to know which industries are internationally competitive, which ones aren’t, and whether the gaps are closing or widening. Unfortunately, the reality is this data currently does not exist. And what we don’t know hurts us, because it prevents us from pursuing effective strategies for boosting US jobs.

Although the government collects reams of economic data, it doesn’t measure what’s most vital to our ability to reverse America’s jobs decline: how our goods and services stack up against those of China and other competitors in terms of price.

You can’t fix what you can’t measure. We need a new national jobs strategy that begins with an accurate way of measuring America’s competitive prowess, on an industry-by-industry basis.

This policy brief proposes that the Bureau of Labor Statistics undertake a “Competitiveness Audit.” The Competitiveness Audit will compare the price of selected imports with the comparable domestically produced goods and services. That will tell us the size of the ‘price gap’ between imports and domestic production.

Read the entire brief.

In the Atlantic, PPI Chief Economic Strategist Michael Mandel discusses the two possible solutions for escaping the current economic disaster — innovation and inflation:

It all comes down to this: We have to match growth to debt. If we can’t create miracles from growth, we have to consider inflation to reduce the value of our debt

We have only two ways out of our current global economic mess: innovation and inflation. And as the saying goes, we should hope for the best (more innovation) and prepare for the worst (higher inflation).

Looking across the world, the underlying problem is that borrowers–households and governments–have taken on debt that they can’t afford to pay back, given the current rate of income and economic growth. In the U.S, too many homeowners are struggling with mortgages that far exceed the value of their homes and cannot be repaid from their current incomes. In Europe, Greece and perhaps other countries have issued bonds that they cannot pay back unless growth unexpectedly skyrockets.

Down the road the same principle of matching growth to debt allows us to perceive potential financial crises to come. Young male college graduates, for example, have seen their real earnings plunge by 19% since 2000, with young female college grads experiencing a similar decline. Meanwhile education borrowing has soared, suggesting that we are on the verge of a student loan crisis, where young grads simply cannot pay back their mountain of debt.

Read the entire article

For years when I was chief economics writer at BusinessWeek, I would write our post-Nobel piece.  I was often one of the few people who would challenge the adulation of the prize winners, notably in this 2005 piece on the Nobel in game theory.

But today’s awards to Tom Sargent and Chris Sims simply leaves me stunned.  Let me give you a brief excerpt:

“It is not an exaggeration to say that both Sargent’s and Sims’ methods are used daily … in all central banks that I know of in the developed world and at several finance departments too,” Nobel committee member Torsten Persson told the AP.

There’s a good rule of thumb–you get what you reward.

Here’s a summary of current U.S. policy towards big corporations: Invest in the U.S., create jobs, and get sued by the government.

You would think that during a business investment drought, any company that puts big money into the U.S. would be patted on the back. But no…

AT&T is the company which is putting the most money into the U.S.—almost $20 billion in capital spending in 2010. AT&T is also planning to bring back call center jobs from overseas. AT&T is also getting sued by the Justice Department to block the merger with T-Mobile.

Frankly, this sends a signal to U.S. companies that getting out of  the reach of government regulators by going overseas is the right strategy.

Crossposted from Innovation and Growth.

With the stock market plunging, we’ve heard plenty of warnings that a “pullback” in consumer spending could trigger another recession. Let me suggest an alternative. The last thing this economy needs is more debt-fueled consumer spending which mainly creates jobs overseas. Instead, we should be focused on boosting investment in physical, human, and knowledge capital.

Now, who am I to be dissing the American consumer? Don’t I know that consumer spending “accounts for 70% of economic activity,” as many economic reporters have written in recent weeks? (Indeed, if I have to read that number in another story, I might be forced to go all Office Space on a piece of expensive consumer electronics.)

It’s true that consumer spending creates economic activity. But it’s not true that all that economic activity is in the United States. Many of the consumer goods we buy are imported. If you buy a shirt or television, you are stimulating manufacturing jobs in China, or perhaps Mexico. You aren’t doing as much to stimulate jobs at home.

Where can Americans cut back if the economy slips back into recession again? After all the talk about the “new frugality” and the deepest recession in 75 years, it might seem like households have tightened their belts as much as possible.

Surprisingly, however, the economic figures show several key areas where Americans have actually increased consumption compared to 2006, the year when housing prices peaked. Judge for yourself whether we can cut back more or not. (Note: all consumption changes are measured in inflation-adjusted 2005 dollars, comparing the 2nd quarter of 2011 with the second quarter of 2006)

When President Obama took office in January 2009, he promised that ” to lay a new foundation for growth….we will build the roads and bridges.” And in his 2011 State of the Union address, he promised to “put more Americans to work repairing crumbling roads and bridges.”

But as all attention is focused on the debt ceiling battle, here’s what’s happening on the infrastructure front. Highway, street, and bridge construction jobs through the first five months of 2011 are running 18% below 2007 levels, and the stimulus money is fading. House Republicans are proposing to cut future federal infrastructure funding by roughly one-third. And any defaults among state and local governments would raise borrowing costs for infrastructure bonds across the country and in some cases make the bonds unsellable.

In short, a difficult infrastructure situation is about to turn worse. The U.S. seems likely heading for an infrastructure crash that will terribly damage both our prospects and those of our children.

On July 17 the online edition of the WSJ published a widely-cited story entitled Wireless Jobs Evaporate Even As Industry Expands. The main point of the story (my emphasis):

In May, on the heels of a record year for industry revenue, employment at U.S. wireless carriers hit a 12-year low of 166,600, according to U.S. Labor Department figures released earlier this month. That’s about 20,000 fewer jobs than when the recession ended in June 2009 and 2,000 fewer than a year ago. While the industry’s revenue has grown 28% since 2006, when wireless employment peaked at 207,000 workers, its mostly nonunion work force has shrunk about 20%.”

In addition, the Journal digs further into the official data and claims that:

The number of customer-service workers at wireless carriers dropped to 33,580 last year from 55,930 in 2007, according to the Labor Department

Seems like a pretty straightforward story, doesn’t it? The Journal is quoting directly from authoritative BLS data to demonstrate that the wireless industry has been losing jobs, despite the mobile boom. The big picture message: Innovation does not equal job growth.

Unfortunately, the reporters and editors at the WSJ fell into the same trap that has ensnared many other journalists, policymakers, and even economists. They looked at the label on a piece of official economic data, and assumed that they understood it. But as we saw during the financial crisis and subsequently, government economic data can all too easily be misinterpreted.

As the key gatekeeper for pharmaceutical and device innovation, the Food and Drug Administration (FDA) has a tough job. If it is too lenient, it will allow the sale of drugs and medical technology that could harm vulnerable Americans. Too tight, and the U.S. is being deprived of key innovations that could cut costs, increase health, and create jobs.

With this in mind, this paper addresses the question: Is the FDA unintentionally choking off cost-saving medical innovation? First, I discuss the difficulty of assessing whether the FDA is under-regulating or overregulating new drugs and devices, given the desire for safety. I then show how the FDA is clearly applying “too-high” standards in the case of one noninvasive device currently under consideration—MelaFind, a handheld computer vision system intended to help dermatologists decide which suspicious skin lesions should be biopsied for potential melanoma, a lifethreatening skin cancer. I then draw analogies to development of the early
cell phones and personal computers.

Many economists are racing to declare a ‘manufacturing revival.’ The latest to join the bandwagon is Paul Krugman. In his latest column, Krugman writes (my emphasis added)

Manufacturing is one of the bright spots of a generally disappointing recovery…..Crucially, the manufacturing trade deficit seems to be coming down. At this point, it’s only about half as large as a share of G.D.P. as it was at the peak of the housing bubble, and further improvements are in the pipeline…one piece of good news is that Americans are, once again, starting to actually make things.

Oh, how I wish Paul was right. Unfortunately, I still don’t see it in the trade numbers. In fact, the real trade deficits in capital and consumer goods are both nearing all-time (negative) records.

In 1987 the G6 countries (Canada, France, Germany, Italy, Japan, and the UK) accounted for 55 percent of U.S. goods imports. That same year, China, Mexico and Brazil only accounted for 8 percent of imports.

In 2010 the U.S. reached a milestone–for the first time, imports from China/Mexico/Brazil exceeded imports from the G6 countries. In the year ending March 2011, imports from China/Mexico/Brazil equaled 32 percent of goods imports, compared to 31 percent for the G6 countries. Here’s another way of seeing the same thing. Please note that OPEC’s share, and the share of “all other countries,” don’t change very much. It’s really the G6 versus a handful of low-cost importers.

There’s been a lot of happy talk recently about the revival of U.S. manufacturing . According to an article in the New York Times, “manufacturing has been one of the surprising pillars of the recovery. “ In a Forbes.com column entitled “Manufacturing Stages A Comeback,” well-known geographer Joel Kotkin talks about “the revival of the country’s long distressed industrial sector.” The Economist writes that “against all the odds, American factories are coming back to life.”*

Truly, I’d like to believe in the revival of manufacturing as much as the next person. Manufacturing, in the broadest sense, is an essential part of the U.S. economy, and any good news would be welcome.

Unfortunately, the latest figures do not back up the cheerful rhetoric.

Newly-released data suggest that the manufacturing recession was deeper than previously thought, and the factory recovery has been weaker. On May 13 the Census Bureau issued revised numbers for factory shipments, incorporating the results of the 2009 Annual Survey of Manufacturers. The chart belows shows the comparison between the original data and the revised data (three-month moving averages):

America’s job drought is really America’s capital spending drought. As of the first quarter of 2011—a year and a half after the recession officially ended—business capital spending in the U.S. is still 23 percent below its long-term trend. If domestic businesses are not expanding and investing, they are not going to create jobs.

The weakness in domestic capital spending is both perplexing and disturbing. It’s accepted wisdom that we needed to work off the aftereffects of the housing and consumption bubbles, but very few economists believe that the U.S. suffered from an excess of business capital spending in the years leading up to the financial crisis. And there’s no sign of a credit crunch for large businesses, which mostly seem to have access to sufficient funds to invest if they wanted.

Read the Policy Brief

I was just revising a portion of my textbook, Economics:The Basics and I happened to come across this March 21, 2011 entry in the Federal Register where the Air Force is granting a waiver from the Buy American requirements of the American Recovery and Reinvestment Act of 2009. This is what the waiver said:

The domestic nonavailability determination for these products is based on extensive market research and thorough investigation of the domestic manufacturing landscape. This research identified that these products are manufactured almost exclusively in China.

Which products are they talking about?

Imagine that you had an industry where customer satisfaction was increasing faster than any other part of the economy. Now imagine that the same industry showed rising real investment, even during the worst recession in 75 years. Finally, imagine that industry charged falling prices for both consumers and businesses.

But of course, that industry is not imaginary: The telecom industry, and in particular the wireless sector, has outperformed the rest of the economy on key measures such as customer satisfaction, investment, and price. Moreover, at a time when President Obama is calling for more innovation, the wireless industry has produced more genuine new products and services than anyone else.

A new story from the Associated Press argues that there’s been a big productivity surge in the U.S., post-financial crisis. Paul Wiseman writes: (my emphasis added)

Companies are producing and profiting more than when the recession began, despite fewer workers. They’re hiring again, but not fast enough to replace most of the 7.5 million jobs lost since the recession began.

According to the conventional wisdom, as summarized by Wiseman, the U.S. has sailed through the crisis in better shape than our industrialized rivals. The conventional wisdom also says to the degree that we have a jobs problem, it’s because we are so good at boosting output and productivity.