Relevant and even prescient commentary on news, politics and the economy.

Windfall Profits Tax

Again we are getting the right wing line that the windfall profits tax on oil in the 1980s caused
oil production to fall and oil imports to rise as Carpe Diem at

post a story from Investors Business Daily saying that from 1980 to 1986 oil production fell.

Yes, the windfall profits tax was still on the books in 1986, but the tax was only paid when the price of oil was above $30/ B and the last time that happened was in September 1983. So by claiming a tax was effective three years after it became ineffective they are able to make that claim.

I am still waiting for one of these right wing advocates to reply to my question that if their economic philosophy is so good and superior why do they have to be so dishonest in defending it.

If their claims are correct, shouldn’t the truth be an adequate defense?

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Oil Price Controls

All the discussion about a holiday from the federal tax on gasoline this summer has brought all kinds of comments out of the woodwork about how government interference in markets, and especially the 1970s oil price controls and windfall profit tax prevented private companies from investing. Such comments seem to start out with some sort of comment about how politicians are stupid and do not know what they are doing. What I find especially amusing about these comments is that they almost always seems to come from the same people who carry on about how large corporations capture the various regulatory authorities and use their influence in Congress to stifle competition. They seem to want it both ways. But in the case of oil the point that the oil companies capture the system and get Washington to further their interest appears to be more the case. For example, if you look at drilling and exploration by the oil companies it clearly seems to be largely a function of current and lagged oil prices — see chart. This strongly implies that the oil companies and Congress acted in concert to prevent the price controls and windfall profits taxes in the 1970s from influencing oil exploration and production. Actually, the one important point this model makes is that the oil companies do not seem to be drilling as much now as the historic relationship suggest they should. Maybe the complaint that the oil companies executives have decided that there is not much future in the oil business and are returning their profits to shareholders in the form of high dividends so that the shareholders
can find more attractive investment alternatives has a certain validity.

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Inventories and GDP growth

A lot of ink is being spilled over the inventory numbers in the gdp report.

So I though I would just post on one of the available monthly data series on inventories.
This shows that the real I/S ratio fell sharply in March. But the gdp report includes no
data on March inventories. This implies that the next revision of real GDP will be down,
but that there is little reason to expect a rebuilding of inventories in the future to boost growth.
It is part of the great moderation that in todays world firms do not allow inventories to get way out of line and this sharply reduces the odds of a recession. We could still have a recession, but it
will not be a classic inventory cycle.

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Employment Report

The Wall Street Journal and others are looking at the headline numbers and reporting that we are seeing another report of moderate employment declines like the last few. But hours worked fell -0.4%, a significantly laarger drop then in the last few months.

Moreover, average hourly earnings were only up 0.1% and average weekly wages actually fell. The year over year gain in average weekly earnings is now 3.1% vs a 4.6% peak in late 2006.

My equation that makes average hourly earnings a function of inflation expectations — a 3 year moving average of the CPI — the unemployment rate and capacity utilization strongly implies that wage growth should continue to weaken. The current difference between the fitted value and the actual value is probably due to the point that falling labor participation is artificially holding the unemployment rate down.
Basically we are in a reverse of Say’s law where falling output leads to falling real wages and falling consumer spending. Hopefully, the tax rebate will cause this downward spiral to reverse.
But that will also require a weakening of inflation so that real wages start to rise. Core inflation is not a problem, so now we just have to wait and see if food and fuel inflation can moderate.

Meanwhile, auto sales fell from 15.1 Million to 14.4 million last month, one of the largest drops in recent years. Moreover, unlike the large monthly drops of a few years ago this sharp drop was not preceded by a pop in sales. It was not just short run noise. It also implies that we are starting the second quarter on a very, very weak note–especially for real PCE.

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Liberal Massachusetts Economic Growth

Economy in state outpaces US growth

Adds 4,600 jobs through March

The Massachusetts economy expanded at a healthy clip in the first three months of the year despite a national economic slowdown, breaking with the recent past when the state suffered longer and deeper recessions than the rest of the United States.

The University of Massachusetts said yesterday that the state’s economy grew at a 3.2 percent annual rate, about five times faster than the 0.6 percent national rate reported yesterday by the Commerce Department. During that period, Massachusetts employers added 4,600 jobs, even as companies nationwide cut more than 200,00.

So much for the wing-nuts that keep saying we would all be better off if we were less like Massachusetts and more like Mississippi.

It was suggested that I copy this comment here.

The real story is that because of the major investment Mass has made in education — its students rank number one in national achievement test — Mass has moved on to the new knowledge intensive industries like technology, investments, healthcare and biotechnlogy.

This means Mass generates high quality, high paying jobs. It has intensive growth while the sun belt creates jobs in the old low productivity, low paying jobs that have left Mass. They have extensive growth. The problem the sunbelt states face is that these low paying jobs are now leaving the sunbelt states for China, and other foreign producers. In essence, Mass is already where the rest of the country is going to have to follow over the coming decades.
There are many reasons for this. But much of it is the great Mass public education system and the willingness of Mass business and government leaders to work together to create the environment needed to support these high quality jobs.

Yes, the Mass model does create problems for those who do not get an education and prepare themselves to live in the post-industrial economy. That is why so many of them move out and are replaced those who come here to school and stay. A great example of that is that medical doctors in Mass have the lowest income of doctors in any state.

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Family & Household Real Income Trends

Last Friday Arnold Kling at Econlog and Russell Roberts at Cafehayek commented on Larry Bartels book Unequal Democracy and I made some comments
about what they were saying.

Bartels used family income data in his book and both Arnold and Russell ignored this point and went into long discussion about why household income data is so distorted that the comparisons in Unequal Democracy were meaningless. Both Arnold and Russell are correct that the rapid growth in single women households over recent decades is a significant factor behind recent changes in poverty and this growth in single mothers and divorced women does impact the data. But GMU libertarians are not the only ones that know the household data is distorted by the growth in single women households. The Census Bureau where the data originates and Bartels are well aware of these problems. That is why Census also publishes data on family income and why Bartel used family income data in his book.

I suspect neither Arnold nor Russell have ever looked at the data to see how the growth of single women families has impacted the data. Rather they have heard someone use these criticisms of the data and just started used it because it agreed with their priors. But the data is readily available at Census.

First, what has happened to family income growth.

As the chart shows there was a sharp slowdown in family income growth sometime in the late 1970s. The trend growth rate of real family income slowed from 2.8% from 1950 to 1980 to only
0.8% from 1975 to 2005. The more recent growth rate was only 30% of the old trend and if the old trend growth had continued family income would have been 177% higher in 2005.

So what happened to married couples real income.

Married couples — including both families where the wife worked and where the wife stayed home — experienced a very similar slowdown in real income growth from a trend growth rate of 2.8% from 1950 to 1980 to only a 1.1% trend after 1975– the new trend is 40% of the old one If the old trend for married couples had continued their real income would have been 172% larger in 2005.

Now Russell Roberts argues that the growth in single women households distorted the data so severely that one could not make meaningful comparisons. But that does not look right to me.
It is very easy to see that the growth of single person household had a modest impact on real family income growth. Essentially, it is responsible for the fact that since 1975 real family income growth was 0.8% and married couples real income growth rate was 1.1%. This 0.3 percentage point impact from the growth in single person families clearly does not look like such a sever distortion that comparisons are meaningless. Moreover, the point that total family income would have been 177% higher and married couples income would have been 172% higher if the old trends continued does not look like such a sever distortion that no one can make meaningful comparisons. A five percentage point difference over 30 years does not look like a massive distortion that makes comparisons meaningless.

I’m not sure what else to do with this information. I’m sure that both Arnold and Russell heard this criticism at some right wing think tanks or blog and just picked it up without ever thinking about it. But too many people at right wing think tanks are paid to put out research that supports a point of view that one can not trust their research conclusions. The growth in single person households sounds dramatic and it could be very easy to accept someone quoting this data when they conclude that the income data is unrealistic. But as they say down home, if you lay down with dogs you get fleas.

What I’m curious about is what happens to the sharp 18 year old undergraduate at GMU that recognizes that their professors are dissembling and does not buy into their ideological distortions. I sure hope these professors do not grade on the basis of their students ideological purity.

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Cactus ran across this data and sent this chart along.

It implies two things to me.

One, the average duration of unemployment was much higher in this cycle then it was in the 1990s cycle. This is in line with all the other data showing the recent cycle to be weak by historic norms.

Two, the most recent drop in the median duration of employment implies to me that the odds of a recession are falling.

Do others reach the same conclusion?

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Within the Leading Index report there are series on the concurrent and lagging index. One component within these releases is a monthly estimate of unit labor cost in manufacturing. It is not the most reliable economic indicator and is subject to major revisions, but right now it is sending some very interesting information.

It implies that first quarter productivity growth is strong in manufacturing at least, which supports the various estimates that first quarter real GDP growth will be positive.

Moreover, the spread between manufacturing unit labor cost and the PPI is a major driving force explaining nonfinancial corporations profits growth. This data strongly suggest nonfinancial corporate profits are rebounding strongly in early 2008 and that in turn implies that the chances that the US is now in a recession are very low.

Of course a big share of this spread is due to higher oil and food prices that negatively impact consumer spending and create a different set of pressures implying weak or recessionary growth.

In addition one reason that stronger profits implies a stronger economy is because it means that corporations will spend these profits on new capital additions and this will sustain the economy.
However, a major portion of these profits are going to the energy companies and as this data on Exxon shows the oil companies are not spending their profits on additional drilling and exploration this cycle.

Interestingly in the 1970s oil price surge the oil majors spent every penny they could beg, borrow or steal on new exploration and drilling. So in contrast to what economic theory implies, maybe what we need to do is reimpose price controls on oil to induce the oil companies to spend their profits on drilling rather then higher dividends.

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With all the discussion of food and energy it helps sometimes to look at the data and put things in perspective. One reason that the rise in food and energy is having a smaller impact than in the 1970s is that they now account for a much smaller share of consumption. Food and energy fell from 30% of nominal consumption at the peak in 1980 to only 18% at the bottom in 2001. They still only accounted for 20.1%, of consumption in the fourth quarter, compared to 27.1% at the bottom in 1973. So the adjustment to higher food and energy prices still does not have to be as large as in the 1970s.

Second, the rise in energy’s share of consumption has been much more gradual this cycle as it rose from 4.2% of consumption in 2002 to 6.4% last quarter. From 1978 to 1980 energy’s share jumped two percentage points in two years compared to the five years it has taken this cycle. In the two 1970s cycles the rise in food prices was concurrent with the rise in energy prices. But this cycle, food costs are just now starting to squeeze the consumer as food’s share was still at near record lows at the end of 2007.
As this chart shows one of the ways consumers adjust to higher food and energy prices is putting off purchasing new cars and parts. We are seeing this adjustment this cycle just as we did in the 1970s. But again, it is being much more gradual. In 1970s cycles auto spending fell two percentage points in one year in 1974 and two years in 1978-80. So far auto sales have fallen just sort of two percentage points this cycle, but it has been spread out over six years since 2001.

This much more gradual emergence of the consumer squeeze is one of the reasons that we are not seeing a sharp jump in involuntary inventory accumulation this time and why higher energy and food prices are not generating a major recession as in the 1970s. A major recession may still emerge, but the situation this cycle is sufficiently different from the 1970s that one can not simply use the 1970s as a good guide of what to expect.

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Commodities and rates

Stormy earlier discussed the Frankel thesis that low rates leads to higher commodity prices.
I can see the argument, but I do not buy it. Rather I have alway looked at it the other way and viewed commodity prices as a leading indicator of interest rates. Rising commodity prices are a sign of strong worldwide economic growth that generally trail a period of low rates. Strong, above trend growth causes both commodity prices and rates to rise.

Moreover, if you divide commodity prices by initial unemployment claims what you get is a leading index for the Taylor Rule. Generally, but not always rising commodity prices lead overall inflation that in turn leads interest rates.

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