In the old days in the investment business when you were studying a company you would sometimes send a young fellow out back of the factory with a clicker to count the widgets emerging to be shipped. Easy enough to check production. Quite different now! Your fellow with his clicker can’t tally sales of mutual funds or hotel or movie bookings or insurance policies: the service sector.
The other day the Chinese government announced they’d noticed a little, tiny trifling mistake in their national figures: China’s GDP was understated by 20%! All of a sudden an economy the size of Turkey had surfaced within China’s. Again, the reason was that they’d underestimated the service sector. The murky part of this sector, which is extremely hard to measure, is beginning to be called “dark matter” by economists.
Not that misleading, but still very weak(1), are the official U.S. deficit figures: savings, the federal budget, and trade.
As to the first, you often hear that Americans aren’t saving as much as they should. That may be, but the reality is not so simple. You see this clearly in two places: housing, and retirement savings. Compared to a Japanese worker’s house, that of an American is a cathedral, even if in dollar terms the values might be similar. Most people with Japanese friends have heard the reluctant apology, “I’d invite you home, but our house is so small… my wife would be ashamed.” Indeed, American middle-class families may have a second home that is vastly larger than a Japanese primary residence, and which they eventually retire to, selling, usually for a big profit, the one in town they occupied while the husband was employed. (Or the family can get a reverse mortgage and live off the proceeds.) All this is not counted as savings. Similarly, the corporate contribution to a company pension fund is not counted, even though it can amount to quite a packet; neither is the fund’s subsequent capital growth.
Most American workers can expect to retire with dignity, between their pension fund, Social Security and home equity, so they don’t absolutely have to save money. The Japanese retirement system, however, is much more modest (and the Chinese even more). So they must save. (Your Japanese retiree often finds that he has to open a noodle shop to sustain a reasonable lifestyle. Another Japanese variation is to buy an SUV, run it as a taxi until it expires, and then let the children look after him. Quite a few go and live more cheaply in the Philippines, oddly enough.)
Furthermore, our figures count money put into children’s education as consumption, but for most people in our information economy education should be considered at least partly as an investment.(2)
Anyway, once you make some of these adjustments our personal savings rise from negative to positive.
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Now let’s consider the corporate level. One need merely look around to see that except for some heavily unionized, over-regulated or troubled industries like airlines and cars the American economy is chugging right along, particularly in the high-tech and service areas in which we’re the world leaders. Most of the great growth companies in the whole world are right here. Many of them derive their superiority from their skill at innovation. A security analyst likes to see that an outstanding company has introduced half of its products in the last three years. Where do they come from? Research! A first-class pharmaceutical company, for instance, may well spend fifteen percent of its sales on research and development. Several spend twenty. Other companies, five or ten percent. But all this R&D is expensed, written off, not counted as savings/investment. A splendid tax incentive, but not realistic accounting.
If the same company were putting up a factory it wouldn’t be allowed to write off the cost. It would have to capitalize the investment. And yet the research may yield products with a longer life – a Windows or a Lipitor – than what comes out of the factory. So really, you could almost reverse all this: since often the life of a software program is longer than that of the box it goes into, maybe the box you buy should be expensed and the software capitalized. Thus, when analyzing a company with a very high research budget I conceptually add back about half, let’s say, to earnings. That doesn’t change the growth rate, only the price/earnings ratio.
This R&D boosts productivity growth, though, and helps explain why ours is so much faster than that of Europe and South America. But as I say, research, the key to all this goodness, is not shown as corporate savings and investment, which it is, but just disappears as another expense. To be specific, all corporate earnings amount to roughly $700 billion,(3) while research comes to about $300 billion. It can also be argued that some other intangibles, such as brand development and training, which total about $200 billion, should be capitalized, but I think that’s going too far.
American companies are extraordinarily rich just now. Many of the best are excessively liquid.
Quite a similar miscalculation is found at the federal level. If the Japanese government spends money on old-age pensions, let’s say, the money is rightly expensed. But if it builds a bridge that should last for fifty years, it’s considered capital. Our federal government, on the contrary, writes everything off in the year it’s spent, bridges included, as though they would collapse overnight.
And as with people and companies, federal research and education, much of which is a kind of savings/investment and should be capitalized, are expensed. Anyway, if you reshuffled all this you would reduce the official federal deficit by several hundred billion dollars. Of course, whatever it’s called, the government does have to come up with the cash. (Federal debt held by the public, as distinct from the annual deficit, is about 40% of GDP, between 5 and 6 months’ worth: quite low.) Fortunately, our cities and states are quite flush these days.
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Our international trade deficit, currently 6% of GDP, is hard to analyze. Quite a lot comes from imports from foreign subsidiaries of American firms, which, incidentally, are four times more profitable than foreign firms in the U.S. In any event, the balance of payments does balance, so the money that goes abroad in the trade deficit reappears here as investment, which can help the U.S. economy, and if the imports that give rise to the deficit are productive assets, such as machinery, they’re beneficial, unlike cheap Chinese clothes, which are pure consumption. In fact, much of the incoming investment is going into real estate, not production. Anyway, trade deficits ordinarily cure themselves, as the deficit country’s currency drifts down and makes its imports more expensive, and its exports cheaper. But nobody wants the dollar to decline significantly. To adjust it gently will take coordination on a global basis, which is lacking. To help, Europe should stimulate housing and consumer demand. (The reason the dollar held up in 2005 is partly tax-encouraged repatriation of foreign profits of U.S. firms.)
A large part of our over-importing arises just because the Chinese want it that way: they underprice their wares to stimulate their export industries. If they moved up to world prices, things would change. We seem to have a tacit deal with the Chinese: we absorb their cheap shirts as long as they put the proceeds into our Treasury paper. When they stop buying the paper, we might make it hard on their shirts. Taking note of the instability of this situation, speculators have been moving into gold and other commodities.
There’s an odd positive element in this whole equation that people don’t think about: our importing of intellectual capital through immigration. When skilled professionals arrive here – formerly refugees from Hitler or Communism, and then Vietnam or Castro – they may bring very valuable knowledge that cost a lot to acquire, which we gain for nothing. In France and elsewhere in Europe many of the immigrants bring little to the picnic, and indeed seem willing to disrupt it.
Anyway, for some reason, high economic growth often seems to go hand in hand with trade deficits: in part, no doubt, because the growth attracts investment.
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Alas, in addition to these miscountings, we face a notorious pair of entirely real future deficits, notably Social Security and Medicare, including the new prescription drug benefits. We are not going to be able to make all the scheduled payments. In the past we have been able to grow our way out of profligacy, but this time the problem is overwhelming. So let’s suppose the worst: that the money simply won’t be there. Peter G. Peterson, former Secretary of Commerce, and now an investment banker and chairman of New York’s Council on Foreign Relations, has been scolding everybody about this problem for ages, and in a recent book, Running on Empty, he both explores it and suggests the inevitable solution.
As to Social Security, instead of tying the benefits to the beneficiary’s highest salary earned, we must index them only to inflation. And the retirement age should gradually rise. In other words, Social Security ceases to be a contract and becomes just a safety net. According to Peterson, that does it. (Incidentally, the Social Security Trust Fund is a cheat: There has never been a trust fund in the usual sense. Our premiums just buy government bonds, which fund government spending and pay much less well than other investments. The Trust Fund only moves those payments higher up on the government’s scale of obligations than they were: no longer merely a line item in the budget.)
As to the medical entitlements, the Peterson school calculates that there has to be conditionality, called in medicine triage. In due course society will decide that many categories of medical treatment should not be paid for with public money. As things stand now, the U.S. spends around 16% of GDP on health care – one working day in six – of which about half – one working day in twelve, or so – is spent on the last months of life, the terminal illness. We will some day have to resolve how much we want to spend on heroic measures at the end of life – an agonizing decision.(4) Similarly, we will have to decide how much we want to allocate to surgery and other steps in response to conditions that the patient brought upon himself or that are not absolutely necessary: liposuction, nose jobs, ailments created by smoking or drinking, or whatever. I have no specific wisdom to furnish in this matter, just the observation that in time society will need, reluctantly and painfully, to make up its mind.
My conclusion is that in any event we must limit this category of outlay to the truly needy, and not help those who don’t need it. In the lingo, these payments must be means-tested. And we should start these reforms as soon as possible. The longer we wait the worse the situation gets. ■
Footnotes
(1) Last December 15th the Treasury issued the 2004 financial statement of the Federal government. Attached was an announcement by Comptroller General David Walker that he could not render an opinion on the accuracy of the figures!
(2) The latest Annual Economic Report of the President states that the “U.S. still has great potential for increases in the schooling level of its residents.” I like this way of sharing the news that our schools aren’t very good. The Department of Education reports that our high school seniors are at the very bottom of all major countries in math, and ahead only of Italy in science.
(3) The shareholders pay Wall Street well over $100 billion for telling them to buy and sell to each other.
(4) The February 3rd Wall Street Journal states that 60% of British prostate cancer patients are denied access to an oncologist.