The Pin Factory Blog

Summary: Inventory build-up was a major contribution to Q3 GDP

What the chart shows: The chart shows the contribution of the change in inventories to US quarterly annualised GDP growth

Why is the chart important: US Q3 GDP growth was surprisingly strong at 2.8% (quarterly annualised rate; in the UK, we would say 0.7%). A breakdown of the numbers shows that 0.8 percentage points was due to an accelerated inventory build-up. This was almost certainly was involuntary. Over time, the contribution of inventories change to output growth tends to cancel out. While a positive contribution for three consecutive quarters or longer is not unheard of, it is rare. Bear in mind that what matters is not the absolute change in inventories, but the change in the change. In other words, a slower pace of inventory accumulation means a drag on GDP growth. The conclusion is that the current quarter and probably the next as well, will see a possibly substantial deduction from growth due to inventories.

Two recent pieces. First, Tyler Cowen:

Michael Mandel, an economist at the Progressive Policy Institute, compares many regulations to “pebbles in a stream.” Individually, they may not have a big impact. But if there are too many pebbles, a river’s flow can be thwarted. Similarly, too many regulations can limit business activity. When the number of rules mounts, it can become hard for a business to know whether it is operating within the law’s confines. The issue is all the more problematic when federal, state and local constraints all apply. Our public sector is overregulated, too. For instance, the tangle known as government procurement has exacerbated problems with the Affordable Care Act’s health insurance exchanges. The required formal processes made it difficult to hire the best possible talent, led to nightmare organizational charts and resulted in blurred lines of accountability. It’s hard to turn on a dime and fix such problems overnight, no matter how pressing the need.

Secondly, Matt Ridley:

Political freedom eventually tends to undermine economic freedom in other ways, as is plainly evident in the furring of the bureaucratic arteries of the West. As the economist Mancur Olson pointed out, democracy is open to influence by special interests and these quickly capture the political process, influencing legislation to erect barriers to entry against competitors, to direct subsidies to themselves and to help officials maximise the budgets of their agencies — what economists call rent-seeking. That was roughly what destroyed Chinese prosperity before, under the Ming empire — an economically dirigiste regime that Europe increasingly resembles.

I understand the point, or at least the intended aim, of many of the regulations that beset me in my own working life. But I am increasingly coming to the opinion that no small company will take on a new project in anything resembling a primary or manufacturing industry inside the EU. That of course means no new companies either and that in turn means the near death of invention and innovation as both of these come primarily if not exclusively from new entrants, not from incumbents sharpening up their act.

In my gloomier moments I do wonder if that is, as Ridley fortells, what the future holds for us. An economy increasingly strangled, as was Ming China, under the weight of regulations. Which leads, in my cheerier moments, to wondering whether I will still be hale and hearty when the revolution comes and we rise up to strangle all the bureaucrats. For I am increasginly convinced that it will be the slow stranguation of the economy by ever more bureaucracy that will sap all of the life out of Europe.

Zombie firms threaten to cause a “lost decade” of economic stagnation – new Adam Smith Institute report

• Up to 108,000 “zombie firms” threaten to cause a “lost decade” of stagnant growth and productivity
• Corporate insolvencies are unusually low, suggesting that zombie firms are holding up capital and labour that could be used productively elsewhere
• “If a business can be saved, it is entrepreneurs who are best place to make the changes required” says OpCapita’s CEO Henry Jackson

Over 100,000 “zombie firms” are threatening the UK’s recovery from the Great Recession, according to a new report by the Adam Smith Institute.

Record low interest rates and the willingness of banks to show “forbearance” to unprofitable firms is damaging productivity, undermining competitiveness and preventing workers and money finding its way to the companies of the future.

The Trading Dead: The zombie firms plaguing Britain’s economy, and what to do about them, by Tom Papworth, identifies “zombie firms” as heavily indebted firms that can generate enough revenue to pay down debt interest but not debt principle and are dependent on low interest rates to continue doing so. The paper argues that many of these firms require either insolvency or restructuring for a strong economic recovery to emerge. The report is sponsored by OpCapita, an international private equity partnership that specialises in turnaround through operational change.

The report shows that Britain’s “productivity problem” may be partially due to zombie firms holding up capital and labour in relatively unproductive sectors, raising the costs of entry for new, innovative firms. The two main factors responsible for the zombie phenomenon are low interest rates and bank capital regulations. Low interest rates may be misdirecting money to unproductive zombie firms, and bank capital regulations (such as Basel III) discourage banks from foreclosing on zombie debtors, which would worsen the liability on their balance sheets. This also discourages business lending by banks in general.

The report finds that private sector rescue of zombie firms is possible, but only for some. This rescue, in the form of corporate restructuring, must also be done in a decentralised “bottom-up” fashion by individual entrepreneurs and investors such as private equity firms using their local knowledge of specific firms and industries. A government-led drive would likely suffer from chronic inefficiencies.

Tom Papworth, Senior Fellow of the Adam Smith Institute, said “We tend to see zombies as slow moving and faintly laughable works of fiction. Economically, zombies are quite real and hugely damaging, and governments and entrepreneurs cannot simply walk away.

“Zombie firms stop workers and money being redeployed to more productive uses, they prevent new, better firms entering the market, they undermine competitiveness, reduce productivity and slow the growth of the whole economy. Low interest rates and bank forbearance represent a vast and badly targeted attempt to avoid dealing with the recession. Rather than solving our current crisis, they risk dooming the UK to a decade of stagnation.

“Zombie firms need to be confronted with the reality that they are not profitable. With timely interventions by knowledgeable entrepreneurs, many firms can be restructured and saved. But others must be liquidated to allow resources to feed the growth of the future.”

Henry Jackson, CEO of OpCapita and the report’s sponsor, said: “Turnaround specialists are uniquely placed to help Zombie Companies to restructure and return to profitability – a far better outcome than that they continue to limp on indefinitely. And when private equity steps in it is using its expertise and insight to bring the radical changes required for a failing business to survive.”

The report sets out the role of investors in identifying firms that are ripe for restructuring through the seven key aspects of a successful turnaround: crisis stabilisation, new leadership, stakeholder management, strategic focus, critical process improvements, organisational change and financial restructuring.

Henry Jackson concluded:

“If a business can be saved, it is entrepreneurs and turnaround specialists who are best placed to effect the changes required. Private equity firms have the insight and knowledge to do that, and they are prepared to take the risks to get it right. Delivering change in such circumstances is often extremely hard and carries inevitable risk. But genuine improvements in profitability can create long-term sustainable value.”

To arrange an interview with the report's author or for further information, email media@adamsmith.org or phone 02072224995. The report can be read in its entirety here.

I'm often amused by people breathlessly reporting something that we would expect to be true. You know the sort of thing, capitalists pursue profits and so on. Here it's the idea that China might clean up some of the pollution it emits because people don't like seeing their children choke on the stuff.

Last week, an eight-year-old girl from China's Jiangsu province was diagnosed with lung cancer, which was caused, according to doctors, by the tiny particle PM2.5 in air pollution that is most dangerous to health. This case highlighted the reality of exposure to high levels of pollution for vulnerable groups such as children. Such headlines about the dangers of PM2.5 have become daily occurrences in China after pollution in cities such as Beijing reached unprecedented levels this year, prompting intense media pressure and public outcry that forced the government to introduce a flurry of contingency plans and bold targets to reduce PM2.5 levels by 25% by 2017.

Well, yes, all good stuff but this is exactly what we would expect to happen. It's called the Kuznets Curve. Quite simply, when people are as poor as Maoist economic stupidity can make them be they'll put up with a remarkable amount of pollution around the place if they can only get a bit more to eat, a change of clothes, that sort of thing. But as those basics (all very much part of Maslow's Heirarchy of Needs) start to turn up in some sort of abundance people then start to think that not having junior cough up his lungs every morning might be a good idea too.

So, we end up with more of the resources of a society that is getting richer being devoted to polluting the environment a little less. There's nothing odd, exciting or even exceptional about this: it's just what we would expect to happen. Which is, as I say, an occasion for amusement to me. Dog bites man, kittens arte cute, water is wet and richer countries become cleaner countries. It might be worth a newspaper piece telling us that China seems to be at the peak of the Kuznets Curve (at something like the income levels we were at when we peaked too, remarkably enough) but to portray it as some mind-boggling divergence seems very odd indeed.

It's quite extraordinary the way in which Marianna Mazzucato, in her book The Entrepreneurial State, uses the example of the iPhone as proof that it's really the State that is the entrepreneur. Here's Owen Jones taking the argument for a walk:

Clutch your mobile phone close to your bosom, stroke it tenderly, and praise the Fairy Godmother of Free Market Capitalism that you’re not walking around with an obscene brick stuck to your ear, a breadstick aerial reaching towards the heavens. “Imagine what telephones would look like if the public sector had been entrusted with designing and making them,” as an opinion piece in the Telegraph had it this week, reflecting views widely held on the Right. “The smartphone revolution would probably be at least another couple of decades away.”

One tiny little flaw with this dystopic piece of counter-factualism: er, the public sector was entrusted with doing just that. Economics professor Mariana Mazzucato’s The Entrepreneurial State shows how – to take just one example – the Apple iPhone brings together a dazzling array of state-funded innovations: like the touchscreen display, microelectronics, and the global positioning system. The governing ideology of this country is that it is the entrepreneurial private sector that drives human progress. The state is a bureaucratic mess of red tape that just gets in the way. But free market capitalism is a con, a myth. The state is the very backbone of modern British capitalism.

So how many smartphones have been state designed? I know of a tablet being put together in North Korea but can't think of any others. So we do seem to be left with the idea that smartphones were indeed the creation of that private sector entrepreneurialism.

But other than that snark what is actually wrong with the basic argument that is being put forward here? Essentially, it's that those making it don't know their economics.

We distinguish between two things: invention and innovation. The first is thinking up entirely new things: say that GPS system mentioned. It's generally agreed that at this basic level of research and invention that the State and the market actors are equally able. The Soviets did indeed make Sputnik even if 50 years later they still couldn't make a washing machine that anyone with a choice wanted to buy.

The second, innovation, is the same as entrepreneurialism. This is taking said inventions and putting them to new uses. That State certainly never thought that the GPS system would be used to tell me I'm just passing a really great pizza joint but smartphones do indeed do that these days. But that free market did take those series of inventions, combine them in a new and interesting manner and create the technology with the fastest adoption rate ever in the history of our species.

This is all pretty standard stuff and it's been part of William Baumol's work to explain it all to us over the decades. The State can invent but finds it very difficult to innovate, the market can invent just as well but is stonkingly better at innovation. Given that Mazzucato is in fact an economics professor we might hope that she actually knew this before writing her book. Then again, she is as Sussex so perhaps not. Which is why she used the iPhone, a picture perfect example of market innovation, in her argument about state or market invention, an entirely different subject.

It rather worries me when public policy is influenced by those who seem to have no clue. As with Andy Burnham here on the infulence of technology on pay.

Employees such as legal clerks and local government administrators will see their wages collapse as new technology makes their skills less valuable, just like manual workers have, Alan Milburn said. Across the United States and Europe jobs working life has polarised into “lovely jobs” and “lousy jobs”, with the wages at the bottom end of the jobs market falling behind growth in the rest of the economy thanks to advances in technology, Mr Milburn said.

That fate will soon be shared by office workers as their jobs are outsourced to emerging economies and replaced by computers, he warns, “hollowing out the middle of the labour market”. “It is likely that as the cost of computing power continues to fall technology will replace many more middle-class jobs that rely on repetitive and routine tasks – or at least make them less valuable in the labour market,” he told the Resolution Foundation. “In other words, the earnings squeeze already felt by people at the bottom could increasingly spread to those in the middle.”

No, that just isn't what happens when technology is added to labour. Far from wages falling they rise.

At the level of the entire economy average wages will rise. For average wages are determined by the average level of productivity across the economy. This must be so for what we can all consume is determined by what we all produce and if we're all getting more productive then there's more available for us to consume.

For the individual doing a job where technology can add to productivity one of two things can happen. If there were, say, ten bank tellers and the new technology means that only five are now required then five of those tellers will lose their jobs to the new ATMs. But far from the five who retain their jobs getting lower wages they will now get higher ones. For they can now concentrate on those higher value tasks which the machines cannot do.

The addition of technology does not lower wages in the way that Burnham is describing. It raises wages in general and in the specific it either eliminates a job entirely or raises wages.

The comparison is made to manual workers. Think through what actually happened in the move from ten men with shovels to one man with a JCB. Nine lost their jobs and went off to do something else, the remaining digger earns vastly more than any of the ten did with their shovels.

Technology will eliminate jobs, yes, but it will not pauperise the positions that remain. Quite the opposite: wages for those jobs that remain rise with the addition of capital and or technology.

What worries me is that we've got people so misinformed attempting to guide public policy.

Last time around that we had some vast economic disaster we ended up with the conventional wisdom being that fiscal policy was everything and that, as Keynes pointed out, governments should just spend more in fiscal stuimulus and she'll be right. As Friedman and Schwartz then went on to point out this wasn't quite so. The real cause of the Great Depression was not the stock market crash but the monetary response to it. The Fed rather screwing up by allowing the money supply to fall.

As we went through this particular little disaster we had Ben Bernanke no less informing us that Friedman was right and that the Fed weren't going to do that again. Thus quantitative easing and the Treasry/Bank of England agreed and we did the same. The ECB over on hte Continent didn't seem to have got the message meaning that the eurozone hasn't had that monetary policy suitable for the times:

If you are going to criticize Fed policy, you really ought not mention any eurozone policymakers, especially German policymakers. The Germans were the ones pressing the ECB to adopt a tighter monetary policy. How did that work out? Well back in 2009 and 2010 the eurozone and the US had almost identical unemployment rates (close to 10%). Since then the eurozone rate has risen to 12.2% while the US rate has fallen to 7.3%. And what explains that vast difference in performance? Mostly differences in NGDP growth, i.e. monetary policy. And what explains the difference in monetary policy? The Fed was doing one QE after another, with the avowed intention of boosting aggregate demand. The ECB was raising short term interest rates in 2011 with the intention of reducing aggregate demand. Both “succeeded.”

As Sumner has also gone on to point out fiscal policy is usually ineffective anyway. For while the Keynesian diagrams might convince the politicians (who do so love to spend lots more money) the  Central Banks end up taking the monetary actions which negate that fiscal expansion.

The end result of all of this is that monetary policy is the only one that has the desired effects out there in the real world. As, in fact, most Keynesians should agree. For all would agree as long as we're above the lower zero bound and as the various US, UK and Japanese experiences have shown, given QE and expectations management there isn't actually a zero lower bound to constrain the effectiveness of monetary policy.

Or, as I say, we could just conclude that Scott Sumner is correct.

Last night I went to Bristol Freedom Society to debate Ryan Bourne, of the Centre for Policy Studies, over whether the UK should have open borders. It was very enjoyable, and while I won very marginally, convincing one person to switch sides from closed to open borders, I thought it was extremely close, and Ryan was certainly a very fluent and convincing speaker.

My main case was (a) restricting migration restricts extremely important rights, like the freedom to take a job you are offered and the freedom to offer a job to a desired applicant, (b) when we curtail these sorts of freedoms we need to have a preponderance of evidence that the costs are very high, (c) the economic evidence says immigration is pretty good for the recipient country, very good for the source country, and amazingly good for the migrant themselves, (d) the magnitude of the social/cultural impact (i.e. the effect of migrants on our institutions, customs, etc.) is unclear, (e) therefore, we ought to have open borders (or something very close to open borders).

Ryan's counterargument centred on the claim that the benefits of restricted migration would not extend if it was unrestricted or close to unrestricted, because migration of certain amounts undermines the institutions that cause migration to benefit people at all. (It was more complex, but this formed the nub of the debate). As is suggested by my point (d), I think there is some plausibility to this argument, but I also think it is under-studied. I suggested this when we were able to discuss the points we'd made in our opening statements a bit more, and we had a lot of back-and-forth over the issue, but we didn't resolve our disagreement. Without trying to guess at Ryan's position or put words in his mouth, I will stake out three claims I think we must accept to have the debate within a rational framework.

1. All positions are on a continuum from complete open borders (as much gross immigration as non-natives wish/can afford) to complete closed borders (no gross immigration). Perhaps the best way of accurately describing positions is by how much migration they favour. Open borders advocates favour something close to 100% of the amount that would occur under open borders. Everyone else is somewhere on a spectrum from no gross migration to the 100% open borders case (past societies have also had forced immigration, i.e. slavery, so these aren't the only theoretical positions, just the only persuasive ones.)

2. The supposed socio-cultural problems of migration come from particular numbers of migrants. No one thinks 5,000 migrants a year to a country the size of the UK will fundamentally undermine its customs, laws, institutions and so on. Many people think 5,000,000 migrants per year would. So to be anti-open borders you implicitly have to have an estimate of how much migration you think is going to occur. If open borders only led to 5,000 migrants per year, then almost no one would be against it. It is because open borders would be expected to lead to too much migration that people oppose it. This doesn't change if it's a question of probability distribution—then migration is opposed because it raises the chances of too much migration occuring to too high a level. Everyone must (at least implicitly) have an expected level of migration to oppose open borders.

3. Any claim that migration should be kept to a particular level, because of the risk of undermining British institutions, implies an assumption about how much damage the marginal immigrant does or will do (reliably or with some probability). One cannot cop out of the question, you need to have an answer. But no one has yet set out good evidence about exactly how much damage to institutions the marginal immigrant does or will do—typically arguments in this area depend on anecdote or things that people feel they "just know". This won't do when the benefits to immigration are so high. We cannot simply assume the cost to our institutions outweighs the other benefits.

I think once these three points have been accepted, there is a lot of room for good empirical work. But until they have, a lot of the migration debate will be unclear, vague, and people will be talking past one another.

If Amazon included uncompleted shopping baskets as "sales," Jeff Bezos would go to prison http://t.co/inFR4NeEK3

— David Burge (@iowahawkblog) November 12, 2013

I will admit to rather enjoying the ongoing trainwreck that is Obamacare. It's just so wonderful to see so many of my prejudices being validated.

The first, and the one that will explain that tweet up above, is the way in which the numbers are being openly manipulated to make it look as if tractor production is rising. Given the disaster that has been the website, the website that the Federal Government only spent $600 million on, there is a certain urgency to being able to show that no, really, lots of people are signing up.

The fight over how to define the new health law’s success is coming down to one question: Who counts as an Obamacare enrollee? Health insurance plans only count subscribers as enrolled in a health plan once they’ve submited a payment. That is when the carrier sends out a member card and begins paying doctor bills. When the Obama administration releases health law enrollment figures later this week, though, it will use a more expansive definition. It will count people who have purchased a plan as well as those who have a plan sitting in their online shopping cart but have not yet paid.

Quite: us private sector people would indeed be in jail if window shoppers were to be counted as sales.

But there's a larger point here too. It's entirely obvious that the people building the websites weren't entirely top of the programming class. Similarly, that the managers trying to manage the project were less than entirely competent. And that's something of a problem for all the policy wonks who like to think up complicated ways for government to solve problems. Perhaps, maybe, if we put aside our Hayekian objections to anyone really being able to design an economy, there really are plans and schemes that can be constructed, Heath Robinson style, to produce great government works.

But let us take the lesson of Obamacare to heart and note that we don't exactly have the A-Team implementing these plans for us. The programmers will be those who couldn't use Google Maps to find out where Silicon Valley was, the managers those that Ford or GM felt would never rise above chief filing clerk. This isn't a promising workforce with which to implement complex plans. They might be able to administer a flat tax system, or a very simple regulatory system that insisted "don't kill people". But complexity may well be beyond them which is just another argument in favour of that simplicity we all desire anyway.

Or, as I wish I'd originally said myself when some statist was waffling on years ago about the nationalised industries. His point being that there was nothing wrong with said form of ownership, or the unions, government interference. It was just that the management of the nationalised companies was terrible. To which one answered well, so you agree then that nationalised companies can only attract the terrible managers then? And that thus nationalisation isn't a good idea?

There are various ways you could try to measure how badly a government is cocking up an economy. One favourite example is when Zimbabwe stopped printing its own money as they no longer had sufficient hard currency to be able to purchase the ink to print the banknotes. In Venezuela we have for months been regaled with storis about how the shops are out of loo roll (even, with a triumphant announcement from the State that it had confiscated an entire 2,500 rolls of the stuff that were being held by a "speculator") or milk and other basic necessities. This all coming about of course by the government attempting to control prices (Ed Miliband might want to take note here).

It is entirely possible to think that the poor should have better access to various goods and that government ought to do something about it. But the control of prices is the wrong way to do it: if you set them lower than the market rate then shortages will deveop, higher then a surplus will flood the market and if at market prices then what's the damn point? The answer is, of course, if you wish for the poor to have better access then you give more money to those you condiser to be poor, not screw with the market itself.

But back to our various methods by which we might measure that government is screwing up an economy:

President Nicolas Maduro's government announced arrests of both store managers and looters on Sunday as part of what it calls an "economic war" in Venezuela between the socialist state and unscrupulous businessmen. In a major pre-Christmas campaign reminiscent of the late President Hugo Chavez's dramatic style, Maduro has sent soldiers to "occupy" one chain of electronics stores and inspectors into scores of others to check for price-gouging. Thousands of Venezuelans have been flocking to electronics stores, hoping to take advantage of new "fair prices" the government is imposing, sometimes half the previous cost.

Well, yes, that would be a good sign. Arresting the shop keepers would be high on my list of indications that something is going awry.

In a speech to the nation late on Sunday, Maduro promised there would be no let-up in what he called an "economic offensive" against Venezuela's "bourgeois parasites." Maduro said he would use decree powers that Congress is expected to grant him this week to set legal limits on businesses' profit-margins. "Zero tolerance with speculators," he thundered, flanked by most of his Cabinet and quoting biblical, Koranic and Taoist exhortations against usury and materialism.

Price fixing again, another sign that not all is going to go well.

Among the raft of new government measures announced in the last few days, Venezuela's telecoms regulator Conatel said at the weekend it would require eight local internet providers to block websites publishing black market currency prices.

But that's rather the killer blow to me. Once a government starts to insist that the citizenry should have no access to the truth then the whole system is going to spiral down in a welter of its own lies and ignorance.

Adam Smith did point out that there's a great deal of ruin in a nation: but it's not an unlimited ability to survive economic stupidity, only a large one.