Thursday, April 27, 2017

Goodbye Mr. O'Leary

With the news that Kevin O'Leary has pulled out of the running for the leader of Canada's Conservative Party, I thought that it was a great time to post this parting shot of the "Real Kevin":


Goodbye Mr. O'Leary.  Don't let the door hit you on the butt on your way back to Boston.


What's Behind the Collapse of America's Manufacturing Sector?

As we are all aware, Donald Trump is on a mission to bring jobs back to the United States.  In large part, his plans include renegotiating trade deals that have led to job losses in what was once America's economic foundation; manufacturing.

Here is a graph showing what has happened to manufacturing jobs in the United States since 1939:


At 12.392 million jobs, America's manufacturers have shed 7.161 million jobs from the peak of 19.553 million in June 1979, a decline of 36.6 percent.  As well, since March 2010 when manufacturing jobs hit their post-Great Recession nadir of 11.453 million, the addition of 939,000 jobs is a very poor showing, particularly given the lengths that the Federal Reserve has gone to since 2008.

While there is no doubt that freer trade has led to offshoring of American manufacturing jobs, a study entitled "The Myth and the Reality of Manufacturing in America" by Michael Hicks and Srikant Devaraj at Ball State University strongly suggests that other factors are at play as you will see in this posting.

Let's start with a graphic that shows the U.S. manufacturing production index from 1919 to 2014:


As you can see, the Great Recession put significant downward pressure on national manufacturing production, pushing it well below the trend line.  Nonetheless, in real dollars (inflation adjusted), the value of manufacturing production continues to climb and, by 2014, it had recovered completely from the setback of the Great Recession. 

Here is a graphic showing the value of all manufacturing as well as nondurable goods (those used for less than a year) and durable goods (those used for more than a year) from 1987 to 2014:


While the real value of nondurable goods (in light blue) has been static for more than a decade, the real value of nondurable goods (in dark blue) continues to rise.  As well, you can see that the real value of all manufacturing goods continued to climb throughout the two and a half decades with short interruptions during recessions.  This clearly shows us that manufacturing is still a very important part of the U.S. economy.  In fact, while the total value of manufactured goods fell by 11.5 percent during the period from 2006 to 2009, rose by 32.9 percent over the period from 2009 to 2013, leaving us with overall growth of 17.6 percent from 2006 to 2013.

Now, let's look at how productivity has changed in key manufacturing sectors.  Here is a table showing how the average product of labor changed between 1998 and 2012 and the GDP growth for each sector over the same timeframe:


As you can see, when adjusted for inflation, productivity grew for all sectors over the period from 1998 to 2012, ranging from a low of 6 percent in the nonmetallic mineral products sector to a high of 829 percent in the computer and electronic products sector with an average of 90 percent for all manufacturing sectors.  This compares to overall production value increase (i.e. GDP growth) of 32 percent for all sectors.

What caused this substantial increase in productivity?  The authors note that the increase in productivity is largely related to the adoption of automation and information technology.  The authors focused on the period from 2000 to 2010 when the U.S. economy experienced the largest decline in manufacturing employment in history as shown here:


In January 2000, there were 17.284 million manufacturing jobs in the United States, by the beginning of 2010, this had dropped to 11.46 million, a decline of 5.824 million.  The authors  calculated the total number of employees needed to produce the 2010 levels of production using the 2000-level worker productivity levels.  Had the economy kept the level of productivity from the year 2000 and applied that to the 2010 production levels, manufacturers would have required 20.9 million workers rather than the 12.1 million that were employed in the sector

The study then examines the job losses in manufacturing that are attributable to trade, changes in domestic demand for goods and changes to productivity.  The authors found that losses in productivity and trade varied by sector but, overall, the share of job losses in manufacturing were relatively small when it came to international trade (13.4 percent of jobs lost) compared to losses related to increases in productivity (87.8 percent of jobs lost).  This means that only 750,000 of the jobs lost in manufacturing during the period between 2000 and 2010 were related to international trade compared to job losses of over 5 million that were related to increased productivity (i.e. the adoption of automation and information technology). 

From what we can see in this study, very little of the job losses in the manufacturing sector are related to international trade.  It appears that, unless America's domestic manufacturers are willing to forgo the productivity gains made by adopting automation, the U.S. economy will find it increasingly difficult to create significant numbers of manufacturing jobs.  Gone are the glory days of the factory worker no matter what Donald Trump may want. 


Wednesday, April 26, 2017

The Impact of Lowering American Corporate Taxes

With the Trump Administration moving towards lowering the corporate tax rate from its current 35 percent, a look at a study by Jane Gravelle at the Congressional Research Service is timely.   As almost people are aware, Corporate America likes to complain about the "uncompetitiveness" of the current rate particularly when compared to corporate tax rates in other nations, a factor that they claim is leading to slower economic growth in America.  In the study by Ms. Gravelle, she examines the impact of a 10 percentage point drop in the corporate headline tax rate of 35 percent and how this impacts key economic factors including corporate tax revenue, job creation and output.

There are three types of corporate taxes as follows:

1.) the statutory rate - the rate in the tax statute which, in the case of the United States, is a maximum of 35 percent.

2.) the effective rate - the tax rate paid divided by profits - this rate capture the tax benefits that reduce the taxable income base relative to profits.

3.) the marginal rate - the tax rate calculate from the share of pre-tax return that is paid in taxes.

Additionally, in the United States, corporations must pay income taxes at the state level which raises the statutory rate to 39.2 percent from 35 percent.  

Let's look at a table which shows the various corporate tax rates for the United States and its OECD peers:


As you can see, the effective corporate tax rate in the United States is roughly in line with its OECD peers.  Several other studies show similar results with U.S. effective corporate taxes being similar to those in the world's 15 largest economies including China and Brazil.

Here is a table showing the historical statutory tax rates for the United States and its OECD peers with the weighted column showing the average tax rate weighted to the size of the economy:


Now, let's look at the impact of a 10 percentage point decrease in the statutory corporate tax rate in the United States, a move that would bring U.S. corporate taxes into line with the weighted average of the OECD.  Here are the most significant impacts:

1.) Tax Revenue - over a decade, corporate tax revenues would decline by between $1.3 trillion and $1.7 trillion.  

2.) Economic Output and Wages - a one-time increase of approximately 0.62 percent at the maximum.  Some studies show that the impact on output and wages could be as low as 0.18 percent.

It is interesting to note that, even though corporate tax rates in the United States are higher than in other jurisdictions, total corporate tax revenue as a percentage of GDP has dropped substantially since the 1950s as shown here:


By way of comparison, corporate taxes as a percentage of GDP is around the 3 percent level for other developed economies.  

One of the issues that seems to develop when the United States lowers its corporate tax rate is that other jurisdictions follow the American lead.  This was the case in the period between 1986 and 1988 when the U.S. lowered its corporate tax rate from 48 percent to 35 percent as shown on this graphic:


When one nation cuts its corporate tax rate, it attracts capital from other nations, however, if all nations cut their corporate tax rates, no nations gain capital and all nations lose tax revenue.

As you can see from this analysis, the idea of reducing corporate taxes in the United States is far from a clear cut win for the U.S. economy.  While Corporate America loves to tout the advantages of a lower headline statutory corporate tax rate, this analysis shows that the economy will gain very little at the cost of much-reduced tax revenues.  As well, in our "monkey see, monkey do" world, other jurisdictions may simply follow the lead of the United States, lowering their own corporate tax rates in a move to attract business investment.  The race to the bottom will clearly lead to a situation where there are no winners except for the corporate world which will see its profits expand. 

Monday, April 24, 2017

Donald Trump and the Repercussions of Renegotiating Trade Deals


One of Donald Trump's biggest concerns seems to be international trade, particularly the free trade deal that was negotiated between the United States, Canada and Mexico back in 1994.  Here's what he had to say about NAFTA shortly after taking control of the Oval Office:


His recent announcement that he is not going to scrap NAFTA at this time, merely renegotiate to ensure a "better deal" as shown here:



...could result in significant negative impacts for Corporate America.

 A recent analysis on the Liberty Street Economics website by Mary Amiti and Caroline Freund at the Federal Reserve Bank of New York shows us the interesting relationship between U.S. exporters and the current tariff levels on products sent to Mexico and suggests that things may well be better off for American companies if Mr. Trump were to leave well enough alone.

As we know, countries often impose or raise tariffs on imports to discourage consumers from consuming imported goods, a methodology used to protect domestic industries.  The imposition of tariffs on goods often leads to international appeals of trading unfairness/protectionism to various trading organizations such as the World Trade Organization.  The WTO has set up a Dispute Settlement Body to resolve trade disputes as shown here:


Here is a screen capture showing some of the recent trade disputes that the WTO is dealing with:


Let's look at some background data first to help us put the trade issue into perspective.  Since the three nations signed the North American Free Trade Agreement (NAFTA) which became effective on January 1, 1994, the U.S. share of trade with Mexico has done this:


Mexico's share of trade has risen to 14 percent of total imports and exports, with imports and exports looking like this in 2016:


Here is what the share of trade with Canada looked like in 2016:


By way of comparison, the share of trade with China in 2016 looked like this:


While there is a trade deficit with Mexico totalling $63.19, the trade deficit with China is nearly 550 percent higher at $347.04 billion.  As well, the U.S. trade deficit with China is 3087 percent higher than the trade deficit with Canada which totalled only $11.24 billion.  So, as you can see, there are far bigger "fish to fry" when it comes to international trade fairness issues. 

Let's go back to the Liberty Street analysis.  The authors note that there are significant benefits to U.S. companies under NAFTA.  For instance, NAFTA grants duty-free access to the Mexican market for U.S. exporters in exchange for duty-free access to U.S. markets for Mexican importers.  To compare, exports from World Trade Organization nations that do not have free trade access to Mexico or the United States are subjected to "most favoured nation" (MFN) status.  If NAFTA didn't exist and most favoured nation tariffs were applied, the average tariff on Mexican exports to the United States would be 3.7 percent whereas the average tariff on U.S. exports to Mexico would be 7.4 percent.  As well, about 25 percent of U.S. exports to Mexico would be subject to tariffs above 5 percent compared to only 15 percent of Mexican exports to the United States.  Keeping in mind that American exporters would rather see lower tariffs on their exports, it's pretty clear that U.S. companies are benefitting from NAFTA.  

As well, without NAFTA, Mexico would be able to raise tariffs more easily than the United States because, under the WTO, the maximum rate or bound tariff rate at which Mexico can impose tariffs is well above its applied MFN rates.  In the case of the United States, tariffs are bound at applied rates so they are already at their maximum (i.e. the United States cannot raise tariffs on imports any higher than they are now to protect imports from less advanced economies).

Let's look a bit further at bound tariff rates.  In the case of Mexico, their average bound rate is 35 percent.  Were it not for NAFTA, more than 90 percent of U.S. exports to Mexico are in products with bound tariff rates above 30 percent as shown on this graphic:


The large gap between the applied tariff rates and the bound tariff rates is known as the "binding overhang" which means that Mexico could raise tariffs significantly without breaking international rules.  NAFTA prevents this occurrence.  In the past, Mexico has significantly increased tariffs; the nation's average tariff rose from 13 percent in 1995 to 18 percent in the early 2000s with significant increases in tariffs on car parts, textiles and apparel.  This increase in tariffs for imported goods eventually created consumer preferences for products manufactured within NAFTA, most particularly , the United States even when the United States was not the lowest cost producer.

Let's close by looking at the final two paragraphs of this analysis:

"In another example of the potential harm to U.S. interests, it is worth recalling that NAFTA's liberalization of U.S. corn exports was strongly opposed by Mexican growers twenty-five years ago.  The bound rate on corn - one of the largest U.S. exports to Mexico and a crop considered to be a national heritage in Mexico - is 37 percent.  Thus, Mexico could raise its tariff on U.S.-grown corn to 37 percent without breaching any international rules. (if NAFTA were rescinded)

Put simply, Mexico has a lot of room to raise tariffs, up to its bound rate of about 35 percent.  In contrast, the United States has less room to adjust its tariff rates without breaching WTO rules because the U.S. MFN tariff rates of about 4 percent are already at their bound rates.  Thus, for U.S. exporters, NAFTA offers a valuable insurance policy against Mexican tariff hikes." (my bold)

Sometimes the evil that you know is better than the evil that you don't.  Re-opening or discarding NAFTA could prove to be far less beneficial to Corporate America and American workers than it may appear on the surface.