Wednesday, December 7, 2016

Strategic Global Intelligence Brief for December 7, 2016


Short Items of Interest—U.S. Economy

Inhibitions and Innovation
A study from a group of economists in both the U.S. and Europe shows that competitive pressure does not always result in more innovation. In fact, competition can actually inhibit innovation. The study looked at industries that have been under pressure from Chinese imports and found that there were declines in revenue, capital, market valuation and investment in new technology. The simple fact is that a given business has two choices when faced with competition. It can step up efforts and find ways to beat that competitor, or it can yield to the challenge and abandon the market to one degree or another. When the competitor has a clear advantage in terms of cost, the most likely move is to abandon that market altogether.

CEO Enthusiasm Tempered by Specifics
For the most part, there is enthusiasm from the ranks of the leaders involved in the Business Roundtable. They are expecting generally pro-growth policies under Trump and the GOP-controlled Congress. They are enthusiastic about plans to reduce regulation and reform taxes. They are also hopeful about the planned infrastructure plan. What they are not as happy with is the kind of deal making that is taking place right now—the Carrier announcement, threats of specific tariffs, the attack on Boeing and the like. These are not policy and tend to distract from the bigger issues that should be higher priority. The leaders are well aware that political capital is limited. It is not a good idea to spend it on small things.

GOP Opposition to Tariffs
From the start of the Trump era, it was pointed out that some of his biggest battles would be with his own party. One of these will involve trade and tariffs. His tweet about imposing a 35% tariff on companies that import things sent waves through the ranks of the GOP and was instantly rejected. The Republican majority want the focus on tax reform and regulatory relief—not the imposition of more regulation through taxes and the possible launching of a trade war. It is impossible to determine which of these random tweets are going to end up as policy, but the GOP clearly doesn’t favor this one.

Short Items of Interest—Global Economy

Conspiracy Theories
The U.S. has been dealing with its fair share of these and always has. There has long been an active fringe that asserts some of the most idiotic and outlandish ideas, but the U.S. is not alone in contending with these blatantly false assertions. The Europeans and Asians have their issues as well. On occasion, these get enough traction to become a major problem. The assertions in the U.S. have already triggered an unbalanced person to attack a pizza joint and there have been assaults and beatings throughout Europe triggered by these myths. Attacks on the Islamic population have increased and attacks on Jewish institutions have been increasing as well. These threats are serious and as dangerous as any terror plot—they are also just as hard to identify and thwart.

Potential Unrest in the DRC
According to the law, the presidency of Joseph Kabila in the Democratic Republic of Congo is supposed to come to an end on December 16 when his second term expires. The problem is that a new election was not organized in time. Now, it may be sometime in 2018 before he would be required to step down in favor of a newly-elected leader. This has provoked the exiled leader of the opposition to declare that he will find a means by which to drive Kabila out. That would trigger yet another civil war in a state that has been in continuous conflict since its independence from Belgium.

Why is Training So Hard?
The world has changed for the American manufacturer. To remain competitive in the global economy, companies have been forced to adopt technology and to locate where costs are lower. The U.S. has been promising help for those workers that are displaced for the better part of four decades and little has really been done. The plain fact is that re-training is complex and expensive, but the alternative is even more costly as the middle class dwindles in terms of spending power.

Trade Deficit Widens
Given all the attention that has been lavished on trade issues over the last year, there will be considerably more attention paid to the state of the trade deficit going forward. It doesn’t mean, however, it will be better understood. Having a trade deficit is not necessarily a bad thing—all it means is that the country is importing more than it exports. There are a number of factors that go into this balance, but most notably is the issue of price. In past years, the U.S. has run a major trade deficit due to the need to import expensive oil. However, in recent years, the U.S. has been producing more of its own and the price per barrel has fallen. Therefore, the U.S. has had to spend far less. This month the deficit has risen in part due to the falling prices for farm commodities. The price for soybeans has been particularly low. The U.S. continues to be a major exporter of that commodity as well as many others.

Analysis: With trade there will always be winners and losers—this is the nature of trade. Traditionally, there are two motivations for most trade—exploitation of absolute advantage or management of comparative advantage. With absolute advantage, a country has a product or commodity that other nations don’t have. If these other states want that product or commodity, they will have to pay the price set by the state that has it to sell. This could be something like diamonds or rare earth materials or some manufactured product or service. In truth, there are not many situations where absolute advantage exists these days.

The more common rationale for trade is comparative advantage. This is far more intricate. It holds that it is possible for a country to take care of all its own needs and not have to trade with anybody, but to do so would be woefully inefficient. There are things the country can do very well and should concentrate on, while importing the things that can’t be made as cheaply or easily. The U.S. has an advantage when it comes to high tech goods and complex manufactures such as airplanes. It makes sense to make these things in the U.S. Does it make sense, though, to make plastic flip flops in the U.S. where workers are going to make a minimum of around $50 a day as compared to $2.80 a day in Burma? The U.S. maker will have many expenses that a Burmese competitor will not have. The end result is a price for the U.S. consumer which would be many times higher. The U.S. is better served by channeling people into the sectors where there is a comparative advantage.

This month’s trade gap was 17.8% higher than it was the month before—$42.6 billion. This was the steepest rise since March of 2015 and the highest deficit level seen since June. It was considerably higher than had been expected by analysts. The specific reasons for this change are varied and complex. The U.S. saw a 1.8% reduction in exports as there was less demand for many of the farm exports the U.S. generally relies on. The export of consumer goods also declined, but some of that appears to be related to increased domestic demand for these goods and a decision by producers to satisfy the domestic needs over the export needs. The U.S. imported more from China and Mexico, but that trade was widely divergent with most of the Mexican activity consisting of inter-company trade. U.S. companies with operations on both sides of the border will trade back and forth between branches and subsidiaries. The imports from China reflect the interest of consumers willing to spend more and seeking cheap prices at the same time.

Productivity and Wages Jump Up
Over the last several years, there has been continuing interest in the fact that labor productivity has been slipping. This is an important measure for economists as increased labor productivity is what allows a business to make more money without having to hike the costs to the consumer. It means more work is being done by fewer workers. This generally occurs when there is some technical innovation introduced allowing the workers to get more done. It can be a new machine that replaces people, or it can be a technology such as the cell phone that allows people to be more efficient in their assigned tasks.

Analysis: The fact that productivity has been sliding for the last few years has been perplexing and it really shouldn’t be. There are more technical innovations than ever, but it can be argued that these have not been as world changing as those that have gone before. It is also true that fewer people are doing the same work done previous to the recession. That should have improved productivity as well. The latest data suggests there has been a 3.1% increase in productivity, the best number in two years and this is the revised data. Some had expected the result to be even better than originally reported.

There has also been a boost in unit labor costs as these have risen at a 6.2% rate as opposed to the expected increase of 3.9%. This means wages are rising at a faster clip than expected—there all kinds of implications. The higher wages will start to fuel inflation. Therefore, it will be far easier for the Federal Reserve to hike rates into next year. The continued growth of wages will be dependent on the continued improvement in labor productivity.

The longer term issue remains. Productivity has been slumping for years and has accelerated since the recession. It is not clear just why this has been the case, but the prevailing opinion is that technical advances have been less dramatic and have only improved the business process marginally. There is also concern that workers are not as skilled as they once were, it takes longer to get their output up. This has been made worse by the fact that many workers no longer stay around long enough for their skills to develop and reward the company. It has also been pointed out that regulations have impeded many businesses. Not only do these regulations require expensive compliance procedures, the business is forced to spend an inordinate amount of time adhering to the welter of rules. This detracts from the time and investment needed to expand and grow.

Australian Run May be Over
The remarkable success of the Australian economy over the past three decades has been attributed to both its fortunate position in Asia and the frugal management of the government. There has been more than a little luck thrown in there as well. For the past 25 years, the country has been recession free although there have been years where economic performance has been weaker than would have been preferred. That run now seems to be coming to an end as the latest data shows that GDP shrank in the third quarter by 0.5%. This takes the annual growth rate to 1.8%—very low by Aussie standards.

Analysis: The reasons for this decline are not mysterious as the problems have been building for some time. The level of business investment has collapsed. Much of this decline has been in the mining sector; the area that has been both responsible for boom and bust. As long as China and other Asian states seemed to have an insatiable demand for the commodities Australia mines, the economy of the country boomed. The world simply couldn’t get enough iron ore or coal and the Aussies were the ones supplying it. Then China started its dramatic slowdown. The other Asian consumers soon followed suit. The demand for these commodities dropped and so did the price. There has been very little spending in that sector for the past few years and the alternatives are hardly booming. The manufacturing sector has always been weak compared to mining, while the farm sector has been hard hit by both drought and the decline in demand from those Asian states. China now supplies a lot of its own needs. In addition, it has been importing from many states other than Australia.

There has also been a decline in the rate of housing starts as the consumer has been feeling far more cautious than in the past. There have been more layoffs and there is more financial stress. This creates trepidation on the part of the mortgage lenders and the whole housing sector starts to fade. The consumer is in retreat. That has affected everything from retail to investment. In normal times, the government could be counted upon to supplement with additional public spending, but the travails of the mining sector have been hard on revenue. There has not been the wiggle room for serious stimulus.

To top it off, there has been unusual political instability. After many years under the leadership of Prime Minister John Howard (essentially 1996 to 2004) and the Liberal/National coalition, the country has been switching back and forth between the Liberals and Labor with prime ministers lasting only a year or two before being replaced by the opposition. It seems that all these new leaders do is dismantle the programs their predecessors implemented which has amplified the sense of economic uncertainty.

Is Italy a Model for the U.S.?
The world is trying to get the measure of the U.S. president-elect as are those in the U.S. This is the second president in a row that is generally an unknown when taking office. Many have asserted that Trump lacks the experience and track record one would want for the position, but this same criticism was made of Obama who came to the office after one term in the Senate and a career as a professor and community organizer. Trump is not the first wealthy person to run for office and take control. There have been over a dozen worldwide. All came to power as the antithesis of the career politician and somebody who would “shake things up.”

Analysis: The Europeans are comparing Trump to Silvio Berlusconi, the media mogul who was Italy’s prime minister for about nine years. Both are mercurial and controversial and have strong bases of support from those who do not trust the system. In Italy, that base has largely moved to support the populists of the Five Star Movement, but there are still plenty of Berlusconi faithful. Throughout his tenure, he fought one accusation of scandal after another due to his penchant for mixing his personal business with that of the country. Many think this will be the biggest impediment to the Trump regime. It is at best a major distraction. At worst, it can provoke criminal proceedings that could be grounds for impeachment.

Italy has suffered a severe and lengthy economic crisis. It can’t all be attributed to Berlusconi, but it is clear the government was not addressing the issues as diligently as it could have been. The Italians never did turn on Berlusconi as aggressively as his critics, but they eventually lost faith and went searching for another option. The collapse of the Renzi government over an attempt to streamline government in fractious Italy indicates that there is still very deep distrust of government at all levels.

The Joys of Catalogs
The Christmas season brings back pain to our postal employees. At least the ones that serve my neighborhood have a little truck. I notice that it doesn’t list as heavily once it leaves my mailbox. Each day brings another boatload of catalogs—many from companies I had never heard of previously. Most of them are of no interest to me at all—the ones with dog gear are pitched immediately lest the feline five find this cause for alarm. Others are full of items that just amaze.

The latest issue from Hammacher Schlemmer has a picture on the front page of a rather unique bicycle described as “The Victorian Futurist’s Electric Cycle.” It is a bright red rocket-shaped device with pedal power in the back. It sells for a mere $12,000. I can just see myself tooling down the bike paths with my wife in the front. I would have the appropriate goggles and scarf and she would have the hat and gloves befitting a woman of her station. This is not the only delight in the pages of this catalog. Of course, there are many other catalog temptations. I can purchase gargoyles for the side of my home or immense dragons for the yard. I can obtain a remote control fishing boat as we all know that regular fishing can be utterly exhausting.

Then, there are the gifts that have a certain specific appeal—like the items from the Doctor Who collection. I already have a watch, alarm clock, stocking hat, socks and sweatshirt with the T.A.R.D.I.S. prominently displayed. I am not sure what else I would need to make my life complete. (I also have two sonic screwdrivers and a T.A.R.D.I.S. Yahtzee set). Here’s hoping you see something under the tree that appeals to your inner child.