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Following the Financial Crisis of 2007-2009 and ensuing Great Recession, the US has been on the slow road to recovery. So – everything’s alright, right? The worst is over, right..?
(Episode #9: Understanding the US Economy 2015)
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Earlier in 2015, I visited the US for the first time in eight years, having worked in Finance in Asia during those preceding years. As I was born in the US and spent over a third of my life there, including studying in university, it was interesting to be back, to say the least. Moreover, it was a perfect opportunity to do blog on the US economy. So let’s take a tour around the US and find out what are the major successes and challenges of the US economy in 2015. Hopefully I can give a unique perspective as both an insider and outsider.
One caveat: I’m an Equities Analyst, not an economist. However, I do take macroeconomic conditions into account in the course of my research. This video is a summary of the major successes and challenges the US economy is currently facing as of 2015, so we cannot go over everything in detail, although we may address more specific issues in future blog posts. For now, let’s focus on the basics. We have a lot of ground to cover, so let’s get started.
NYC: Immigration, Inequality, Tax System, Deficit
Our first stop is New York City, the last US city I was in before leaving in 2007. Back then, there was no iPhone, Dubya was still president, and this was the number one song. So… what’s changed since then?
The most obvious change is that everyone’s got a smartphone. And Apple is ubiquitous. This Apple Store definitely wasn’t here eight years ago. Also, everyone’s eating kale and sriracha. And noserings are back in style. But one great thing about NYC that hasn’t changed is… the food!
Being the financial center of the country means that New York City attracts immigrants… and their food! Obviously the US is known for that all-American dish, the hamburger, the cooking of which has been elevated to a high art, in my mind at least.
Man I totally forgot about the insane portions here!
On a more serious note, for many, New York epitomizes the narrative of the American dream. If you can make it here, you can make it anywhere. If you work hard enough, no matter who you are or where you’re from, you can improve your situation in life and prosper. This is one of the major strengths of the US economy – immigration.
Immigration boosts the US economy as high-skilled immigrants increase the nation’s human capital. The co-founders of Google and Intel, for example, are immigrants. Low-skilled immigrants have proven to be more controversial, as to whether they contribute to the economy or just depend on welfare. Huge debate surrounds this. Regardless, the influx of immigrants helps offset an otherwise aging population, helping keep the US relatively young compared to other developed countries and thus reducing the social security burden.
Interestingly, according to a December 2014 Pew poll, among white Americans, 64% would support allowing undocumented immigrants to stay, assuming certain conditions are met. Some studies show that immigrants to the US are more assimilated with the local population than those in Europe. And, as of 2014, non-Hispanic white children are no longer that majority of children under 5 years of age, while interracial marriages are increasing.
While we acknowledge that racism continues to be a serious problem in the US – look to recent history for tragic examples – there are signs that the US is truly moving to being nation that defines itself on its institutions, rather than “blood, soil, or tribe”.
Another key feature of the US economy is a relatively business-friendly tax system. For example, for high earners, the US taxes capital gains, which are increases in the value of financial assets, and dividends at a lower rate than ordinary income. This encourages investment and capital formation, meaning the purchase of equipment and property for business. Ideally, a pro-business tax regime would encourage business activities, helping create a meritocratic society.
But is the US really that meritocratic? The current tax regime has proven to be a double-edged sword. For as much as the US is reputed to have a relatively open, innovative economy, it is also known for its high level of inequality, relative to other developed countries.
From 1979 to 2007, after-tax income for the top 1% of American households grew at an astounding 275%, versus 18% for the bottom fifth. And while a recent study at the bipartisan Congressional Budget Office shows that growth of real median household income (in other words, middle class income) from 1980 to 2010 increases from 15% to 53% when making adjustments for taxes, benefits and household size, the actual measure of wealth paints a high degree of inequality. According to the US Federal Reserve (that’s the US’ central bank), by 2013 the wealthiest 5% of US households held 63% of the country’s wealth, versus the 1% owned by the bottom 50% of households.
How is this possible? One reason is because of the nature of wealth between the rich and the non-rich. According to the Fed, as of 2013 the richest 10% of Americans held 85% of financial assets. This grants rich Americans two distinct advantages:
- The tax on capital gains – that is, the tax on rising asset values – and the tax on investment income is lower than the tax on income from employment. Thus, it is advantageous to hold more of your wealth in financial assets.
- When the US economy goes into recession, the potential side-effect of a loose monetary policy the Fed employs, for example, printing money, is an increase in the value of financial assets, as is the case with the most recent recession.
It also doesn’t help that the US tax code is exceedingly complicated, with various loopholes and exemptions existing such that income from capital is taxed “either too heavily… too lightly, or not at all.”
So while overall tax rates in the US are progressive, meaning that wealthier individuals theoretically pay a higher average tax rate, the details we’ve discussed may prove this picture as somewhat misleading.
So what can be done? There are several proposals, each of which has its opposition. You can read more about them in this Financial Times article (link in the description).
It is worth noting that the US is unique among developed countries for not having a federal sales tax or value-added tax, which are taxes on consumption. The consumption tax is popular among academics, as, when combined with lower income taxes, it can spur greater savings and investments. However, the tax is not popular with many politicians on the left and the right.
A complicated tax system does not help the fact that Americans are facing a major demographic problem over the next few years. The US budget deficit (meaning that expenditures are greater than revenue) is expected to grow as baby boomers retire.
As entrance of immigrants has relatively flatlined in recent years, the deficit has to be financed, and it can be done in certain ways, such as the government issuing debt, or increasing taxes.
Such measures may prove difficult enacting on an economy that is coming out a recession. One other method to finance the deficit, of course, is to have a fast-growing economy.
Let’s head down to the south of the country to look at a phenomenon that some believe will help the US economy grow.
Savannah: Manufacturing, Fracking
This is my first time in the South, and there are some noticeable differences from what I think of when I think of the US. Despite Savannah being a strikingly cosmopolitan college town, largely due to the highly-regarded Savannah College of Art and Design, it’s Southern-ness does shine through.
In terms of the economy, the South has been making a comeback. Manufacturing is returning to the US and the South specifically, with its low tax rates and competitive costs. One reason for this renaissance in manufacturing is that wages in China, a major manufacturing competitor, have increased since China joined the World Trade Organization in 2001. However, the single biggest reason is the cheap price of US energy (gas, oil) from which energy-intensive manufacturing industries have benefitted. And this is due to the development of a technology known as hydraulic fracturing, or “fracking”. Fracking is the use of a high pressure injection of water, sand, and chemicals to crack shale rocks, which are rock formations holding gas and oil that were previously thought to be impossible extract.
The advent of fracking has dramatically helped the US economy, with the oil and gas industry adding 135,000 high-paying jobs from 2007 to 2010. According to Scott Nyquist and Susan Lund from McKinsey, a massive $1.4 million buildout of the infrastructure to transport shale oil and gas could add 1.6 million jobs. There are also second-order positive effects on the US economy, such as lower gasoline prices and the aforementioned lower manufacturing costs. In fact, according to the Boston Consulting Group, the average manufacturing cost in the US is now 10-20% lower than major European economies and only 5% higher than China. Ideally, this would help the American blue-collar worker, who has suffered from the outsourcing of factory jobs to cheaper locations.
So, this is the future of the American economy, right? Well, there are some issues.
The first is that the claims of the benefits from shale may be overblown. According to a recent study by the non-profit, non-partisan Information Technology and Innovation Foundation (ITIF for short), that while there has been a rebound in US manufacturing jobs following the Great Recession, since 2010, 72% of these jobs have gone to the auto sector, which has simply benefitted from a rebound in demand for vehicles. And, while it is true that that companies are repatriating some 30,000 jobs, ITIF points out that there are still millions of jobs that don’t exist anymore within the US. In other words, the magnitude of a manufacturing revival may be overstated.
One solution that the ITIF has proposed to revive the US manufacturing sector is a national manufacturing strategy that would make the US the top destination for advanced manufacturing.
Not only that, but the cheapness of domestic oil prices made oil imports from the Middle East and Africa less competitive. The result was a price war, with OPEC refusing to cut oil production in 2015, leading to lower global oil prices. This in turn led to losses among US shale drillers. It remains to be seen how to they adapt.
Over the long term, the US shale industry may not be so resilient. The International Energy Agency predicts that US oil supply will begin to decline by 2020, with the majority of supply shifting back to Middle East. It is also worth noting that environment-friendly renewable energies, an alternative to traditional sources of energy, have been coming down in cost.
All in all, over the short to medium term, assuming that the US can balance economic growth with environmental concerns, fracking and its related benefits could be a boon to the US economy, due to related economic growth and reduction of the US trade deficit (the US has been a net importer of energy since the 1950’s). This means that fracking could help reduce the budget deficit we discussed earlier. Over the long term, however, it remains to be seen how the dynamics of the US energy industry play out.
Industries come and go. And while fracking could help with the near-term problem of the budget deficit, it does not resolve the longer, structural problem of high inequality in the US. For that, we would have to examine what should be the great social equalizer, education.
Our trip to Chicago was a very personal one for me. I graduated from the University of Chicago, and it has been nearly a decade since I left.
Quite a bit has changed. You still have the old Regenstein library, but this is new.
US universities often dominate world rankings. Ideally, then, US students are some of the best educated in the world, and should bring in high amounts of human capital as they enter the workforce. But of course, this comes at a cost – none of this is free, right?
College tuition has been increasing over the long term, with some estimating that it has been growing nearly 6% higher than the inflation rate. Many Americans take out loans to pay for this tuition, and since the recession, total student debt has doubled to $1.19 trillion – larger than the GDP of Australia.
During the Great Recession, Americans paid down other debt, even though they continued to borrow for education even as tuition continued to increase, resulting in student debt becoming the highest type of non-mortgage debt.
Fears of a student loan bubble may be overblown, however. According to Roger Aliaga-Diaz, a principal and senior economist at Vanguard Investment Strategy Group, during the peak of the US housing bubble in the 2000s, mortgage debt represented nearly two thirds of US GDP, whereas student debt represented 7% of GDP in 2014, although it is growing quickly.
So, what’s the big fuss all about? The problem is that wage growth coming out of the recession has been constrained. There is also evidence that paying down student debt is holding back other economic activity, according to the economist Amir Sufi.
The most obvious question to ask is, why is tuition so high and growing? The reasons why depend on who you ask (and that should tell you something about the transparency and oversight of the education sector) – but a debate between three economists featured in the Wall Street Journal nicely sums up the reasons.
- Declining state support for education.
- Bloated administration and associated costs, despite outsourcing much of the teaching to low-paid, but just as qualified, adjunct professors.
- Growth in entertainment spending and amenities – Students are supposed to pay for education, but they are also paying for this bundled package of education PLUS top facilities, events, high-end food, etc etc.
- Growing federal aid, which has actually helped universities raise tuition fees.
- We would add one more: Regulatory capture. This is a term from Economics, where the regulator works in the interest of the industry it is supposed to be regulating. Such is the case in the US education sector, where the private accrediting agencies are owned, operated and paid by those institutions they are supposed to regulate. One result is that there is no standardization of grading standards between different majors. Moreover, there is no comprehensive measure of what students actually learn. As one economist put it, “we don’t even know whether graduating students at… Harvard, Kansas State or Cuyahoga Community College know more or think more critically than when they entered.” Another result is that accreditation criteria include measures not directly related to student academic performance, such as quality of facilities. Is it a wonder, then, that colleges compete on rankings that involve rising cost centers, such as facilities and sports programs, which are helping increase tuition?
There may be some room to cut costs. Off the top of our heads, there’s room for administrative rationalization, as well as unbundling – in other words, just pay for the education and basic amenities. Do you really need the rest of this to get a degree? Right now, it is truly is a consumer experience.
(To be continued)
NYC: Immigration, Inequality, Tax System, Deficit
Savannah: Manufacturing, Fracking