AP Macroeconomics Blog

THE U.S. NATIONAL DEBT: HOW BAD IS THE PROBLEM?

2012-01-08T09:30:00.007-05:00

BACKGROUND & FRAMING OF THE ISSUES

One of the most widely discussed and often misunderstood areas of the U.S. economy is the current amount of the United States’ national debt, which currently totals $15.2T. Yes, currently the U.S. Government owes a collective $15.2T to both American & foreign households & institutions. This borrowing was necessary since the U.S. government has spent in excess of its tax revenue over the years, which, in economic speak, is called “deficit spending”. In short, the U.S. government must borrow when its spending exceeds its tax revenue. Over the past 10 years especially, government spending has well exceeded tax revenue almost tripling during that period. A combination of two wars, two recessions, and two political parties that have not yet made deficit fighting an urgent priority accounts for this surge in debt over the past 10 years.

The shear magnitude of the U.S. national debt ($15.2T), coupled with alarmist comments by the U.S. Congress and the American press lead most Americans to conclude that our country is in a very precarious position and is perhaps on the verge of bankruptcy. Moreover, many Americans are aware that future Federal payouts for social security and Medicare alone, assuming no benefit changes, will rise at a much faster rate than the current tax revenues for those same social programs further increasing the national debt.

THE IMPORTANCE OF DEBT TO A COUNTRY

Contrary to what many Americans believe to be conventional wisdom, debt is actually a beneficial and recommended pursuit, if used correctly, since it enables a nation or an individual to equalize income and expenditures over time, and improve standards of living earlier than what would otherwise be attainable. It is easier to accept this premise on the personal front as millions of Americans have been able to improve their standard of living currently by pulling their future incomes forward via borrowing to purchase homes, cars, and education. Of course, we all know that debt, like a car, can cause damage if it is not used and managed wisely, and that is where many alarmists focus and even some go so far as saying that all debt is bad and should be avoided. Many nations, with

Russia

being a prime example, have been criticized by economists for not utilizing enough national debt to improve their economy and their citizens' standards of living. Thus, hopefully, with a conclusion that debt is actually a "good thing", if used for productive purposes, one can then proceed to the next section as to what are acceptable levels of national debt.

$15.2T: AN AFFORDABLE LEVEL OF NATIONAL DEBT?

The United States' current level of national debt, has grown, according to most economists, too rapidly over the last decade and has developed into what many economists believe to be the top fiscal problem in the United States. The problem is that with the continued rate of growth in the debt experienced over the last 10 years a "debt crisis' could develop meaning that lenders to the U.S. Government will become leary of lending because of the fear of not getting their loan money paid back. In addition, a greater loss of confidence in the U.S.'s ability to pay back their loans will cause the Government to have to raise interest rates to entice new lenders to take a chance and lend their money to the Government. This raising of interest rates will permeate through the economy and increase the cost to U.S. households and firms to borrow and purchase homes, and capital.

National accounting statistics show clearly that the U.S.'s 104% national debt/GDP percentage is, in fact, well above average compared with most other modern economies, but it is certainly not the highest as economies like Japan and Italy currently have debt/GDP levels at 204% and 130%, respectively. Moreover, the level of U.S. national debt as a percentage of GDP (104%) is relatively close to where it was back in 1950 after having financed World War II. Our nation’s highest level of debt relative to GDP was 121% back in 1945. The key point is that debt must be benchmarked to our nation’s income which is GDP.

WHO IS THE NATIONAL DEBT OWED TO?

Much has also been made of the fact that $4.6T of the U.S. national debt, or 30%, is owed to foreigners. The fact that a good chunk of the debt is owed to foreigners is not nearly as much of a concern as the growth of the national debt in general. Foreign debt is nothing more than foreigners temporarily saving their U.S. dollars, the same dollars sent to them for their products imported into our country. Some foreigners elect to temporarily save these dollars and earn interest by lending them back to the U.S. Government by purchasing bonds. I don’t consider the fact that debt is “foreign” to be a problem, as these dollars will eventually be paid back to the foreigners with interest and these same dollars will, in turn, be spent back into our U.S. economy. Debt held by foreigners is “dollar savings” just like debt held by American citizens is “dollar savings”, so, in other words, it is really not that important whether the debt is held by foreigners or US citizens since eventually those dollars will be spent back into the U.S. economy since they can’t be spent in another economy!

WHAT ABOUT THE FUTURE?

Many have argued that the U.S. aging population (the "baby boomers") moving into their retirement years will cause social security and Medicare alone to "shoot through the roof" and cause the

U.S.

national debt to reach unacceptable and unmanageable levels, potentially, some say, even bankrupting the U.S. Government. Many use extrapolations of future social security and Medicare payments out into varying distant futures based on the number of retiring baby boomers and increasing life spans concluding that there are trillions of unfunded government obligations ($51T is one recent estimate) which are insurmountable. The problem with most all of these analyses is that they fail to address how simple and relatively small adjustments make these problems disappear. For example, on social security, an increase in the social security tax rate from its current rate of 12.4% (6.2% for employees matched by employer) to 15.9% is deemed by one source to fully fund social security at today's benefit structure out into perpetuity (i.e., forever). Similar analyses are out there for other actions such as updating social security retirement ages to be more consistent with longer life spans. What will likely happen, once Congress actually addresses the fiscal imbalance, will be a combination of different types of changes including reduced benefits, higher taxes, later retirement ages, and reallocations of the overall federal budget.

What is perhaps our nation's top concern regarding the growing national debt is that our Government officials have shown little political will to halt the rapid growth in the national debt. For fiscal year 2011, our annual deficit was $1.3T, or 9% of GDP, adding a corresponding amount to the growth in the national debt. Most economists would say that the nominal rise in the national debt should be no more than $0.4T, or 3% of GDP, as it is actually acceptable for the debt to rise at no greater a rate than the growth in annual GDP. Recently, the Joint Select Committee on Deficit Reduction, a group of 6 Democrats and 6 Republicans, failed to agree on any ways to achieve $1.2T in cost savings OVER 10 YEARS evidencing that our nation's political posturing is more important than the welfare of our nation (at least for now). Hopefully, this political posturing will change after the November 2012 elections.

And one final point of optimism; the national debt never has to be paid back! Many non-economists believe that the national debt must be paid back by the current or next generation through higher taxes. It does not! The U.S. Government is in a unique situation in that it can simply refinance the debt (issue new debt to pay for maturing debt) into perpetuity. The key point is that the debt must be first reduced an acceptable level of GDP (90% of GDP would be a good target, in my opinion) and then the national debt must be maintained at that 90% of GDP or less out into perpetuity. This means that the national debt can grow nominally each year as long as it does not grow any faster than the rate of growth of our economy (GDP) and tax revenues, which have been historically around 3% per year. Just like families growing in wealth continue to increase their nominal amount of debt held, Governments can do the same without any risk to their credit rating!

CONCLUSION

Today's $15.2T U.S. national debt is rising at too fast a rate. In just 10 years, the U.S. debt level has gone from 58% of GDP in 2000 to 104% today.

The U.S. economy has some sizable challenges ahead in terms of keeping our increasing national debt in line with increases in our economic growth (GDP). Most notably, our demographic trends of fewer births and increased retirees with longer life spans will put additional strains on our country's debt/income relationship.

Should we be optimistic? Our Government has shown before that we can pare our debt down. Our nation restored fiscal soundness after World War II when national debt reached an all time high of 121% of GDP and again in the 1990’s as our Government made significant changes in government spending and taxation policies to curb our debt from 67% of GDP to 58% of GDP.

On the other hand, 2011 was a miserable display of Congressional effectiveness, in my opinion, as Democrats and Republicans could not work effectively together to try and stop the high deficits and debt explosion. My view is that it may take either a debt crisis or new leadership in Washington to actually cause the welfare of the nation to trump political power and positioning.

The next 5 years will be very important years in our country to establish the fiscal discipline to restore our debt to very manageable levels. If not…well….move over Greece, here we come!

Questions:

1. How would an economist determine whether the nominal size of the national debt is too high?

2. What are your reactions to Japan's and Italy's debt being higher than the United States' debt. Does this give you some hope that our country still has several more years to fix our deficit/debt problem?

3. $1T of our $15.2T in national debt is owed to China. What would happen if we paid off that debt.? What would happen if China decided not to lend to the US anymore?

4. Explain why the United States never needs to nor will pay the national debt back and why their really isn't a $15.2T burden to be paid back by either my generation, yours, or your children's? Does this fact make you feel at least a little less concerned about the high level of the debt?

5. If you were President, what areas of government spending cuts and/or tax increases would you propose?

6. How would you balance trying to stimulate the economy (fiscal policy, lower taxes, increased goverment spending raising the debt) as our economy's rate of GDP growth is very slow (2%) and our unemployment rate is high (8.5%), relative to the need to curb the growth in our deficits (higher taxes and less government spending) which could hurt the recovery?

GDP Made Simple

2011-11-19T18:00:00.001-05:00

Within the last several weeks, the U.S. Government’s Commerce Department provided its first estimate of the country’s 3rd quarter (July-September 2011) gross domestic product or GDP, announcing an estimated, annualized quarter over quarter growth of 2.5%. GDP reports are of special interest to countries since they provide an important macroeconomic measurement of how much an economy's goods & services supply and income has grown, or recessed, compared to the last three calendar months.

Let me try and make the concept of GDP easy to understand and why it is considered perhaps the most important, single macroeconomic measurement.

GDP is simply a calculation that measures the market value (final price) of all the final goods and services produced within the borders of our country. Thus, U.S. GDP includes Toyotas produced in Alabama but excludes Cadillac’s made in Canada. GDP includes all U.S. exports but excludes all U.S. imports since imports, by definition, are produced in another country and are a more direct employment, income, and “goods & services” benefit of the foreign country.

If you think about it, ultimately our country's economic satisfaction is best measured by the goods and services that are produced and that we, as citizens, have access to, which is why GDP is the measurement that is synonymous with “economic growth” or growth in goods & services for its citizens. In addition, rising GDP (more goods and services) is the ultimate economic goal of any economy which can best be accomplished through the means of the two other key macroeconomic measurements of employment and productivity, which are not the subject of this particular blog.

Let’s describe how the GDP calculation is made. Each quarter, the Government (Commerce Department, right Minwoo!) compares the final value of the domestic goods produced and services rendered in the current quarter to the final value of the goods produced and services rendered in the previous quarter. The calculation then takes the percentage gain, current quarter versus previous quarter, and annualizes the percentage. The comparison is always restated for inflation so that the figures are comparable from one period to the next. For purists, we call this “real GDP” which is the only GDP reported by the media, even though the word “real” is almost always dropped to avoid confusion with the average citizen. For example, the third quarter 2011 U.S. GDP report highlighted a 2.5% estimated GDP annualized growth rate. This means that the third quarter final value of goods and services produced was approximately .625% or 2.5%/4 higher than the second quarter production value.

Now let me get to my favorite point on GDP, which most adult Americans do not understand. GDP growth is precisely the same as income growth! For example, in the third quarter of 2011 we can say that incomes for American households and American businesses grew by 2.5% restated for inflation. Said another way, our country’s purchasing power grew by 2.5% which represents the income to purchase the increasing supply of goods and services. You probably never thought about it this way but every time you purchase something, every dollar you spend is going to someone as income, whether it is the workers as wages or benefits, the landlords as rent, a bank that has made a loan as interest income, or to the owners of the business as profits. In short, Real GDP = Real Income and the only question is how that real income is dispersed among owners (profits), workers (employee wages and benefits), lenders (interest), and lessors (rent). Many citizens are unaware that the Government calculates GDP both in terms of the final market value of the goods and services PRODUCED under the “expenditure method”, which is the version that the media uses which focuses on what goods and services are produced and purchased, as well as a GDP calculation version called the “income method”, which focuses on the REAL INCOME (gains in purchasing power) earned from that same production.

I find the preceding paragraph, GDP = Income, to be a break through moment for a citizen, or a first time economic student, in truly understanding the value of the GDP measurement. It is easier for most to think in terms of percentage growth in income in lieu of a fuzzier wording like GDP percentage growth. Most citizens are surprised to find that our national incomes or GDP, restated for inflation, increased by 17.4% from 2000 – 2007, just prior to the onset of this current recession. This 7-year growth rate in GDP or incomes still equates to a below average historical average performance. More specifically, over the last 7 years our average annual GDP or income growth rate was only 2.6% versus our historical average growth rate of 3.5%. However, the final point of caution is that the GDP or income growth rate is a collective average, thus the growth in GDP or incomes does not indicate how those real income gains are accruing to the various socioeconomic classes or professions. That is also a topic of a future blog on "income distribution" or equality.

Discussion Questions:

1. When we substitute the word "income" for "GDP" to understand Real GDP more simply, can this be a misleading increase since prices may have risen ?

2. Which four groups earn the income generated by the production of goods and services?

3. Although GDP has still risen this decade, despite two recessions (2001 and 2007), many analyses show that our nation's middle class has made virtually no real income gains this decade. How could this be so if GDP = Income and our real GDP has grown this decade?

4. What are the most important determinants of real GDP growth?

5. What would need to occur in the U.S. for the average 2025 "standard of living" (more goods & services or rising real GDP per person) to be less than the 2011 "standard of living"?

Should Obama Send A Thank You Note To The Chinese?

2011-11-04T19:09:00.000-04:00

Should President Obama consider writing a thank you note to Chinese leaders for artificially manipulating the Chinese Yuan in the foreign currency markets?

For many years now, Chinese authorities have intervened in the foreign currency market by buying up U.S. dollars spent on Chinese products and, in turn, investing those same U.S. dollars in U.S. Treasury Securities (ie, bonds and notes). For those that are not familiar with the foreign currency market, Chinese authorities buy the same U.S. Dollars provided by the U.S. to purchase Chinese products and, thus, leave or supply Chinese Yuan to the currency traders resulting in a decrease in the price of the now more plentiful Yuan and a correspnding increase in the price of the now more scarce U.S. dollar. The Chinese authorities intervene in the foreign currency market for the sole purpose of depreciating (weakening) the Yuan relative to the U.S. Dollar, thereby helping Chinese exporters to become more price competitive in global markets. It is estimated by many economists, that the Yuan may be overvalued (stronger) versus the U.S. dollar (weaker) by approximately 30% due to China's foreign currency intervention.

So, while it is true that this action taken by Chinese authorities clearly depreciates the Yuan and appreciates the Dollar, thus, unfairly harming U.S. exporters due to higher relative US export prices; it is also hitting the “sweet spot” by sending those same U.S. dollars back to the U.S. Government to fund the record federal deficit spending expecting to total $1.3T in 2011 as well as providing American citizens with reduced prices on imports via the stronger dollar! More specifically, this currency intervention by Chinese authorities provides needed loanable funds back to the U.S. Government lowering borrowing costs or interest rates during this slow and tentative U.S. economic recovery time.

It also appears that US leaders are sending mixed messages to Chinese leaders as in 2010, Secretary of State Hillary Clinton visited Beijing to encourage Chinese leaders to continue to purchase U.S. Government securities, which only occur through currency intervention! This seems at odds with other US leaders admonishment to China for intervening in the foreign currency markets, which if heeded by China, would dry up a significant source of deficit financing causing the U.S. to borrow elsewhere and, thus, raise interest rates to entice that newly sought lending.

In summary, perhaps in the short term the United States should consider not pressuring China, as Treasury Secretary Tim Geihtner, Obama and the media have done regularly in 2011. Perhaps US leaders should lay low, at least for awhile, and start pressuring the Chinese once again in several years or after the U.S. Government gets its fiscal budget in order by reducing considerably its deficit spending and resultant borrowing needs.

Review Questions

1. What specifically are Chinese leaders doing to keep the Yuan weak against the U.S. dollar?

2. Why are Chinese leaders intervening in the foreign currency market?

3. Which parties, both American and Chinese, are helped and hurt by this currency intervention?

4. What would happen, other things equal to U.S. interest rates if Chinese authorities immediately stopped intervening in the currency market? Why?

5. What would be the immediate impact on the U.S. poor and working class if the Chinese immediately stopped intervening in the currency market?

6. What policy position would you take as President of the United States on this currency issue? Why?

Unemployment & How To Avoid It!

2011-10-29T08:29:00.004-04:00

I was thinking about the great students that I teach and wondering what they should be doing today to increase their odds of NOT being one of the future unemployed in our country’s unemployment statistics. But before I give that advice, let’s first look at the composition of the unemployed using the official unemployment statistics as reported by the Government's Bureau of Labor Statistics (BLS) for the most recent September 2011 monthly unemployment report:

The current 9.1% national unemployment rate consists of the following:

4.2% unemployment for those with a college degree or advanced degree

8.4% unemployment for those with some college, but not a bachelor degree

9.7% unemployment for those with a high school degree, but no college

14.0% unemployment for those with less than a high school degree

It is easy to see from the above trend that one should get as much education as you can! The jobs in today’s advanced economies are clearly biased towards those with advanced skills, and education is the clearest path to get those 21st century skills!

Besides teaching Economics, I also teach Personal Finance. When learning about careers in Personal Finance, I suggest to my students that they should be concerned more about majoring in “LIFE”, rather than majoring in Marketing, History, Education, Economics, or Political Science. Moreover, they should even be just as concerned about "majoring in LIFE" as they are in whether they will be accepted to Virginia Tech, William & Mary, Duke, or Georgetown. By majoring in LIFE they are more apt to have the best college experience and career possible, and increase their likelihood of never being unemployed.

So, you might be asking, what exactly is this LIFE major?

I’m glad you asked!

LIFE is an acronym for what I, and many others, consider the 4 key skill sets to thrive in 21^st Century future careers, which will include a rate of technological, social, and global change never seen before. Those four employment key skill sets for the future are:

Leadership

Interpersonal skills

Flexibility

Emerging technology mastery

Leadership

Are you thinking about how you will learn to become more optimistic (not pessimistic and sarcastic) and a confident initiative taker? Having been a member of management for many years, the companies I worked for were always quicker to lay off (made unemployed) those that lacked initiative (“it’s not my job!”). Very often, we would somehow find a new job for the employee whose job was going away if they were strong in leadership and initiative. Often, “initiative” hurts, as it causes one to work harder with more stress, which is why so many workers do not have it!

Interpersonal Skills

Tomorrow’s career “winners” will need to combine their leadership skills and be better at teaming with others more so than ever before. The rate of specialization is increasing at an increasing rate which necessitates the need to collaborate more effectively than ever to get any job done. Consider reading Thomas Friedman’s The World Is Flat to learn about how specialization and collaboration will continue to increase in any future career. Continue to work on your flexibility and your ability to team successfully with others in all that you do. Don’t be the person who has 5 reasons on why it won’t work, but rather, be the person that can explain to the team the 5 reasons why it will work!

Flexibility

Those that are not “lifetime learners” or those that do not embrace constant learning will soon be unemployed as the rate of constant change in our globalized world will leave them behind. Assess your own tolerance to setbacks and your personal reaction to the need to continuously change directions. If you get “bent out of shape” too easily when your plans go awry, or when you are faced with unforeseen obstacles, it is time to start now, while in high school to change your levels of patience, perserverence, and commitment to success. Flexibility and patience can be learned; it is not genetic and is not linked to toilet training.

Emerging Technology Mastery

Embrace, love, and continuously pursue and integrate the latest in technology into your daily life and education. Tomorrow’s employment and career winners will have “in their blood” the ability to be a technology step ahead from the average worker. Start immediately as it is delusional to avoid being an early adopter today and think you will become an early adopter in the future. Be sure to take a computer science course in your freshman year of college, consistently use your laptop in planning and course work, and be sure to be the one that other students go to for application and technology help.

Let me end this blog by letting you in on a “dirty little secret” known by managers and industry leaders across the globe: when it is time for a promotion or when it is time to reduce the work force due to a slowing business, managers get very creative and are biased towards promoting, or not laying off, those that have majored in LIFE…whether you went to Virginia Tech, Duke, William & Mary, or Georgetown makes little difference in career success in the long run, although it certainly opens more doors in the short run. So sure, aim for that bachelor's degree or higher in a specialized major that you are passionate about, but don't forget to double major in LIFE!

Discussion Questions:

1. Does the above breakdown of unemployment by educational category surprise you? What message, if any, do you take away from these statistics?

2. Is the LIFE acronoym pursuit valid, in your opinion, as an early focus to help avoid unemployment? Do you think the LIFE major is a necessary, intentional focus/practice along with your college major or do you think the development of these LIFE skills will just progress naturally?

3. Which area of the LIFE acronym are you strongest at? Weakest?

4. What percent, based on 100%, do you think becoming unemployed is just "bad luck" or deteriorating business conditions, versus you can help ensure your own employed destiny by continued employment through focus on the LIFE major? Did my “dirty little secret” referenced above make common sense to you?

What? Product Prices Are Cheaper Than Ever Before?

2011-10-22T15:12:00.000-04:00

I wonder how many people in countries like the United States, Switzerland, South Korea, Brazil, Canada, Russia, and China would be surprised to learn that prices of products and services in their countries have become much less expensive over the years.

Say what? You must be crazy, you say! Prices are not falling; they are rising too fast!

Yes, most citizens see their purchases as becoming more expensive when, in actuality, things are becoming relatively less expensive, at least over the last several decades. Of course, the paradox is that although nominal prices (the actual price tags) are, in fact, increasing, nominal income (the average, actual wage) has been growing even faster over the decades. This is a topic that in economics is called “real income” or a macroeconomic measurement that compares a nation’s nominal income growth relative to the nominal growth in prices that the same income buys. In the United States, and virtually every country around the world, nominal income has grown at a faster percentage than nominal prices causing real income to increase, meaning the average American enjoys greater access to more and better goods and services than ever before.

Let’s take some specific facts:

In the United States real median household income grew from $41,318 to $50,811 from 1970 through 2006 for a total percentage gain of 23% (source: Pew Research Center). Both of the aforementioned median household incomes are stated in 2008 or current dollars which makes the comparison now valid. Median household real income is an attempt to quantify the progress that the “middle American” family or typical family has made over time. So, in summary, the median household in America can buy 23% more with their income today than they could in 1970. In other words, relative prices are lower than they have ever been before. Due to productivity (think PPC curve shifts right due to technology, education, more labor, and trade) we are producing more products and services than ever before and anytime there is more of something the price will fall relative to income.

If we look at the same United States income data over the same period for real average household income, there is real income growth of nearly 60%. The higher growth rate (60%) in real incomes for the average household versus the median (middle) growth rate (23%) is explained by the fact that much of the growth in United States’ real incomes has accrued disproportionately to the college educated and highly skilled driving up real income average growth rates much faster than the median or middle household. (Hint: continue your education!)

Now let’s get back to the main premise of the title of this blog and the opening assertion that prices are lower than ever. What we are really saying is that you have to benchmark price increases to income increases to really understand whether things are becoming more expensive relatively. The vast majority of products & services are cheaper today in all nations than they have ever been before, which helps explain why more citizens than ever before can afford to own their own, much larger houses, drive more and better cars, have cable and computers, and have much easier access to better healthcare. The reason we are led to believe differently (ie, prices are out of control!) is because we are victims of our own human nature which tend to focus on the problem areas (higher actual or nominal prices) and not the true picture (lower relative prices when compared to income). Most all citizens observe things “at the margin” and quickly notice those products and services that are rising faster than normal like gasoline prices, education, and healthcare! Hey, even gasoline prices are not at an all relative price high. If gasoline prices are restated for inflation they are $2.65 today vs. $3.17 in 1981 and $3.50 in 1918! Hopefully, a 180-degree moment!

Now, you may say to yourself that statistics can lie or mislead and you are sure in your gut that things are getting more expensive relatively. You can try to validate that incorrect “gut feeling” by examining whether a country’s middle class is enjoying less or more products and services. “Real income” really is just a measurement of the quantity and quality of products and services that the median family personally has. The median and average American continually has more actual products & services in the aggregate as U.S. income gains have averaged 6.0% per year, over the last 40 years, outpacing higher price increases averaging 3.0% per year leading to a real, overall gain in products and services or income of 3.0% per year. True, there are many individual products and services that have risen in price faster than incomes (and big ones like education, energy, and health care!) but we must look at the whole picture of all prices to understand how our citizens, on average, are becoming economically better off.

Now let me introduce one word of caution; over the last 15 years in the United States, there has been an increase in real average incomes of 2.7% per year, but none of those real income gains have accrued to our nation's middle class, working class, or poor, but rather to the more highly educated and skilled. The purchasing power (real incomes) of the middle class is essentially the same as it was in 1996. The primary reasons for this flattening out of real incomes is attributed to increased global competition and increased technology integration into companies, which tends to keep wages down (more supply as middle class workers are less needed). The educated and highly skilled, however, have seen their real incomes increase consistently over that same period.

So fellow APers, my first new car that I bought out of college costing $7,000 was a lot "more expensive" than the first new car of comparable status that you are going to buy for $20,000! Get it?

Review Questions:

1. Before reading this blog, did you have an impression created by the media that the average American was somehow worse off economically than 30 or 40 years ago?

2. Why has nominal income grown faster than nominal prices? Hint: the answer is above in the blog and has nothing to do with "money".

3. In Fairfax County, have prices relative to income caused product prices to be relatively more or less expensive than the rest of the United States? Hint: you can get the correct answer if you trust your observation and know what real income really is...no research is necessary!

4. What has happened to the purchasing power or real income of the working & middle class in America over the last 15 years? What has caused this leveling out in their standard of living? Do you have any recommendations or policy actions that you would take if you were President?

5. Can you explain the "car riddle" in the very last paragraph of the blog?

Socialism vs Capitalism: A Simple Analogy!

2011-09-09T16:37:00.000-04:00

This week in class we will be discussing the three different “economic systems” or the way that economies tend to organize themselves. We described the three types of economic systems in terms of a continuum with a purely free market economy at the one extreme and a command economy at the other extreme, with anything in between the two extremes being called a mixed system.

Often in the media, we use a word called “socialism”, which is economically close to “communism” in terms of households all earning closer to the same incomes even though workers provide varying skills and value to society. Usually, socialism, from an economic perspective, is characterized by the wealthy paying progressively much higher taxes, relative to the poor, to the government, which are, in turn, spent by the government for common goods (national defense, health care, roads, airports, etc.) or directly transferred to the poor (more welfare, higher unemployment benefits, etc.)

Relatively more non-economists than economists would be in support of a more socialistic system.

Let’s consider a hypothetical experiment in socialism (communism) using our very own, talented (and good-looking!) AP Macroeconomics’ class: What if I announced a new grading policy built on the principles of socialism effective next week. Let’s see what might logically happen. Effective immediately, all grades will be averaged and everyone will receive the same grade. My guess is that after the first test the grades might average to a B. The students who studied hard would become upset and the students who studied little would be happy. But, as the second test rolls around, the students who studied little would study even less and the ones who studied hard would decide not to study as hard as they did on the first test. My guess is that the second test would average to a D! No one would be happy, especially with me. When the 3rd test rolled around the average would probably fall to an F. Attempts by certain classmates to rally the class higher would probably not be effective, even though their grade or standard of living would be at risk. I would predict that the scores would never increase and bickering, blame, and name calling would result in hard feelings as no one would study any longer for the benefit of anyone else. All of you may end up failing, and I would quickly be fired for not following the handbook.

Socialism is ultimately economically inferior to capitalism because under capitalism (free market economy) when the reward is great, the effort to succeed is great; but when the government levels the playing field and takes more of the reward system for the achiever away; few will try or want to succeed as much as before and things tend to worsen with less productivity.

And that, PVI students, is why virtually all economies tend to move in the direction of capitalism or free markets, as opposed to moving more towards communism or socialism.

Discussion Questions
1.Is the classroom grading experiment discussed above a valid analogy, in your opinion, as to why most economists say that a capitalistic society will increase standards of living much faster than a more socialistic system (more leveling as the government transfers wealth from the rich to the poor)?

2.What positives can be achieved through a socialistic system, either economically or otherwise?

3.Many Republicans say that President Obama and the Democratic-controlled Congress is intentionally leading the nation towards socialism and bigger government. What do you think? Is this view simply an unsupported bias asserted by mostly Republicans since they currently don’t control Congress or the White House and want to gain reelection?

Economics: The 180 Degree Science!

2010-06-26T10:14:00.042-04:00

Now is that time of year when thousands of high school and college students across the world, from Fairfax to Frankfurt, will be taking their very first economics course. Perhaps it will be a basic, high school introductory economics’ course, or perhaps an even more challenging AP or IB economics’ course. Or perhaps you are a freshman or sophomore in college taking an introductory macroeconomics or microeconomics course.

Whatever your situation, you will soon read that all introductory economic text book authors make the point, usually in their respective text’s first chapter, that a primary benefit of studying economics is that it aims to transform one into a more effective and influential citizen by enabling one to better understand and conclude on the economic positions and promises of those running for public office. The underlying logic is that a citizen or voter that is well-versed in basic economic principles will be a smarter citizen and more likely to vote for the political candidate or referendum that will deliver the greatest economic gain for the citizens of the locality, state, and/or nation. In fact, this “economics for citizenship” reason is why a growing number of states now require completion of a basic economics course as a requirement for high school graduation.

In my classroom, I informally call the study of economics “the 180 degree science” because as the student studies this social science for the very first time they often develop conclusions that are precisely the opposite (hence, the “180 degrees”) of what they had originally believed before taking their first economics course.

For example, here are two “180 degree moments”, which are applicable to the United States’ economy, that you may well learn in your first year economics’ course:

1. Pre-Econ Course or Uninformed View: “We don’t make anything anymore in America. America’s manufacturing prowess is in a state of constant decline. It seems like almost everything bought and used in the U.S. is made in China”

Post-Econ Course and 180 Degree View: The dollar value of manufactured goods in the United States, restated for price level changes so the comparison is accurate, is up over 50% for the last 13 years ending in June of 2010! Yes, it is true that the U.S. has lost several million jobs in manufacturing over that same time period, but that is primarily due to rising manufacturing productivity (think machines & technology replacing humans), where the U.S. can now produce more valuable manufactured products than ever before freeing up those displaced manufacturing workers who now have found or must find employment in other more labor-intensive service-related businesses.

Moreover, the US has maintained its percentage share of rising global manufacturing product over that same aforementioned time period, whereas other countries, such as Japan and Germany, have actually decreased their percentage share of global manufactured product. More specifically, in 2006 U.S. manufacturing revenue, profits, exports, and productivity per employee reached their all time peak, just prior to the onset of the Great Recession! Although manufacturing output is at its highest level ever and will continue to rise into the foreseeable future, it will also continue to decline as a percentage of overall economic activity as the United States is growing faster in services than in manufacturing.

2. Pre-Econ Course or Uninformed View: “It is patriotic for U.S. citizens to “buy American” so that we can help our own economy. When we buy foreign products (i.e., exports), in lieu of American products, we hurt our U.S. economy as we lose American jobs and incomes.

Post-Econ Course and 180 Degree View: The U.S. will benefit the most economically if Americans buy what they consider to be the very best product, in terms of price and quality, regardless of whether it is a foreign-produced product or an American-produced product. One of the greatest “ah-ha” moments in all of economics is when an economics’ student or citizen learns for the first time that every time a U.S. buyer purchases a foreign product (i.e., an “import”) that those same U.S. dollars spent on the foreign product circle back to a U.S.- based company, not a foreign company. Yes, I am telling you that when you (or Wal-Mart, for example) buy Chinese shirts, your same U.S. dollars spent quickly end up in the hands of, say, an Apple, Microsoft, IBM, or General Electric to maintain or increase U.S. employment, profits, and stock prices!

Let me try to explain this concept in more detail so that I may actually be able to convince you of this amazing “180 degree” revelation. I always say the more accurate slogan should be “Buying American is Un-American”, since it creates a weaker America!

Let’s say that the United States (we’ll say Wal-Mart) decides to buy some shirts costing $400 from a Chinese shirt manufacturer, in lieu of buying similar shirts from, say, a shirt manufacturer in Elon, North Carolina (USA). The first key point is that when Wal-Mart buys the shirts from China for $400 it can only pay China with US dollars. Why? Because Wal-Mart has only US dollars! It has no Chinese currency (Yuan). It literally drains its bank account of US dollars that are transferred/paid to China! The second key point is that when China receives that same $400 US dollars for the shirts, China cannot, unfortunately, spend any of the $400 in its own economy since only the Yuan is accepted as a medium of exchange in China! China is now forced to either throw the U.S. currency away (not advised!), or immediately spend the money back to the USA (advised!).

In summary, China has initially traded a product (shirts!) for paper (US dollars!), and those US dollars cannot be spent in China. For China to receive any value at all for the shirts it sent to America, China must now spend the $400 back into the US economy for, say, a few i-Pods from Apple (USA). Cutting through to simplicity, in essence, it’s almost as if Wal-Mart (USA) just paid Apple (USA) $400 directly! Yes, the economic “punch line” is that all spending by the domestic nation on foreign products (imports), in turn, are spent immediately back to the domestic nation increasing or maintaining that domestic nation’s employment, income, and standard of living.

And, yes, let’s not forget about that Elon, North Carolina shirt maker that did not get the original $400 from Wal-Mart in our above example! Any good economy promotes competition and I will be excited to see if that North Carolina shirt manufacturer can “raise their game” (increase productivity and/or quality), and hopefully get the next shirt contract from Wal-Mart! If not, well, that North Carolina firm may just have to close down. But remember the key point is that the $400 spent for the Chinese shirts went to Apple, in lieu of the Elon, North Carolina shirt manufacturer. If Wal-Mart would have “bought American” by buying from the Elon shirt manufacturer, even though the Chinese shirts were preferable, Wal-Mart would have prevented the more effective U.S. business (Apple, in this example) from getting your U.S. dollars by giving them to the less efficient Elon manufacturer. In short, you would have contributed to American inefficiency and mediocrity, hurting our country! And that is un-American!

Now, you may be thinking the following if you have a little economics’ background: “But the US has a growing trade deficit with China, so China may not immediately buy those i-Pods from Apple for $400. And, you are correct, but that is also not a problem for either the United States or China. What China is really doing right now is deciding to temporarily save or invest a minority percentage of their US dollars received from U.S. import purchases. Said another way, China is not buying as many US i-Pods as the US is buying Chinese shirts and, of course, we call that situation the US trade deficit which immediately seems to speak “problem”. But it is really not as big a problem as most people think! China is still spending their “saved” US dollars back into the US economy, but in different ways. China is saving and investing some of those US dollars directly into the United States economy by building plants in America, buying US stock to fund American companies’ expansions, and temporarily saving some of their dollars, for future US purchases, by buying US bonds to help the US government pay for other US government initiatives necessitating borrowing. Eventually, China will sell these US bonds and be forced to use those U.S. dollars to buy those i-Pods or build more plants in America to employ more Americans!

I decided to highlight this particular “180 degree moment” because of the fact that the recently passed $800 Billion U.S. stimulus bill has some “buy American” provisions within it. Based on my intuition, I believe that over 95% of adult Americans believe that these “buy American” clauses somehow help our economy more so than if the stimulus bill was silent on “buy American”, thus allowing stimulus money to be spent on foreign-produced products as well. Yes, it is an economic principle that if U.S. citizens “buy American” driven solely by patriotism (and not because they think the product is superior) the American economy actually becomes weaker as the U.S. dollars spent out of patriotism on that American company are, therefore, unintentionally withheld from another more efficient and deserving American company.

In summary, when citizens of any country in the world buy the product that is best for them based on a combination of quality and price, they will be taking the most patriotic action possible to help their own country they love so much! If a domestic citizen sees the foreign product as a better alternative to the domestic product, buy it! Your money spent will immediately find its way back through the “trade loop” to another business within your country!

Of course, this is why all economists from around the world know that international trade, and not protectionism, helps a country’s standard of living and promotes efficiency and rising standard of livings!

Well enough for now. I could go on and on with more 180 degree moments relating to areas such as standard of living, unemployment, the minimum wage, gasoline taxes, and many others. But we’ll discuss some of those in class and I will cover others through this blog site. For now, I just really hope you look forward to and work hard in your economic course so that, you too, will become a more informed and influential citizen as you begin to see your nation’s economy, and our global economy, in a whole new light!

Discussion Questions:

1. What is the primary reason that employment in the U.S. manufacturing sector decreases over time, yet manufactured output continues to rise?

2. Would you be surprised to know that manufacturing employment is also decreasing at the same rate in Germany and Japan as it is in the United States? Why do you think it is? Where do these displaced workers need to find jobs if it is not in manufacturing? Is this a good or bad situation for an advanced economy's future growth in standard of living?

3. What happens to the U.S. dollars we send to Saudi Arabia to buy their oil? Can the Arabs use our U.S. dollars in their own economy? What are two logical choices that Saudi Arabia can do with their U.S. dollars?