Bruce Greenwald: The Crisis Bigger than Global Warming April 26, 2016 by Robert Huebscher Manufacturing is dying on a global basis, according to Bruce Greenwald, and its collapse will mean the demise of economies like China that are highly dependent on exported goods. Contrary to what Robert Gordon and others have contended, productivity is growing in the manufacturing sector roughly twice as fast as the demand for those products. If third-world countries don t adjust their economies to reflect this reality, Greenwald said it would be a crisis greater than global warming. Greenwald is the Robert Heilbrunn Professor of Finance and Asset Management at the Columbia Business School and is widely regarded as the leading authority on value investing, with additional expertise in productivity and the economics of information. He spoke at the 25th Annual Hyman P. Minsky Conference at Bard College on April 12. Manufacturing is done, and it is not anybody s fault. The global productivity growth in manufacturing properly measured is 5% to 7% a year, and manufacturing demand is maybe 3% annually, he said. His views contrast sharply with that of Northwestern University Professor Gordon, who in academic papers and a recent book, The Rise and Fall of American Growth, has said that U.S. economic growth could decline to less than 1% annually, in part due to lower labor productivity, the result of reaching a plateau in the rate of technology innovation. Gordon has cited other factors like demographics and the rising national debt that will slow growth. Gordon is flat-out wrong, Greenwald said, because he like many others, including some who spoke on the same panel as Greenwald are looking only at the macro economic data. Once you look properly at the productivity data on a firm-wide micro level a more positive story for growth emerges. The global overcapacity in manufacturing is highly deflationary, Greenwald said, as is the distribution of wealth and income in the U.S. He offered prescriptions for both problems. But, first, let s look closely at what he said about manufacturing and labor trends. The hidden boom in productivity Page 1, 2017 Advisor Perspectives, Inc. All rights reserved.
Productivity occurs at the firm level, Greenwald said, and much of that data is hidden from economists who merely massage the macro data. Research by the MIT Sloan Foundation has shown that firms can exploit productivity advances to gain huge competitive advantages, according to Greenwald. In banking, for example, he said that firms have been able to win market share by lowering costs, such as providing telephone support at one-half to one-third of the industry average cost. Many of those advances have been highly episodic, he said, and in some cases productivity growth at the firm level has been negative. But studies have shown that when management allocates capital to improve processes, the results have been very powerful. Those types of process improvements are absent from the data that Gordon and others have studied, according to Greenwald. They have focused more on improvements from products themselves. Fracking has shown the power of process improvements to boost productivity. Greenwald said that it drove the U.S. economy to the highest level of productivity among G-7 economies from 2000-2011, after lagging those countries historically. The U.S. achieved this through seasoned technology, not new technology, he said. It is the fusion of technology that matters, Greenwald said, not the creation of technology. When you look at the firm level, the critical variable is the focus of management on day-to-day improvement, Greenwald said. In the aggregate data, if you don t pick the right years, you obscure what is really going on. Looking at the data by presidential administration, Greenwald said that productivity growth rates have been perfectly negatively correlated with the number of pages in the federal register produced by those administrations every year. Carter was the biggest regulator in history, according to Greenwald, when productivity growth was essentially zero. Lessons from Japan and the Great Depression The conventional wisdom surrounding Japan s post-1990 difficulties has been zombie banks, demographics, problems in its financial sector and failed monetary policy, Greenwald said. But the underlying issue has been productivity growth, which in Japan was 3% higher than in the U.S. pre- 1990, but post-1990 it has been a half a percent below that in the U.S. The differences between the two countries are more acute when you examine just the manufacturing sector. Prior to 1990, Japan s manufacturing productivity growth was 30% higher than in the U.S. But that is when manufacturing s death began, as global overcapacity grew. Japan had this wonderful managerial machine that worked so well and they focused it on a dead-end business, Greenwald said. Japan did not eliminate its manufacturing jobs at a fast enough rate. When you compare the U.S. to Japan, pre- and post-1990, the hours worked were about the same in both countries. But U.S. productivity was much higher, due to its faster transition to a service economy. Page 2, 2017 Advisor Perspectives, Inc. All rights reserved.
The death of manufacturing in export-driven countries has paralleled the decline of agriculture in the U.S. following the Great Depression, Greenwald said. Productivity in the agricultural sector continued to improve through the 1920s, he said, despite commodity price collapses in 1921-1922 and again in 1929. By the end of the 1920s, farmers were producing more food than ever before, irrespective of investment cycles, and prices collapsed, depressing farm income by approximately 80% from 1930-1934. That was 35% of the U.S. population at that time, Greenwald said. It quickly became a global issue, where everybody tried to export their way out of the problem. But that cannot succeed on a global basis because the trade surpluses and deficits must sum to zero across all countries. The world can t work its way out by exporting the problem, he said. The same thing is happening with the death of manufacturing today, Greenwald said. Everybody is trying to preserve their manufacturing sector and they are trying to do it by exporting, he said. The Germans have managed to do it by destroying the rest of Europe through the fixed parity based on the euro. Similarly, Japan, China and other Asian countries have grown their manufacturing bases through exchange-rate controls, running large and growing surpluses. Korea, Thailand, Indonesia and Malaysia actually ran deficits for a while, he said, until fears over their exchange rates caused them to collapse. They destroyed their economies because of a foreign debt burden, Greenwald said. They went from deficit to surplus, and they ll never run in deficits again. Someone still has to eat those surpluses, Greenwald said, and that is the U.S. As the provider of the reserve currency, the U.S. economy is the consumer of last resort, running a persistent trade deficit. The silver lining Just because manufacturing is dying, it doesn t mean that profits will fall. Indeed, Greenwald said, profits are likely to rise among U.S. corporations. The U.S. economy is much farther along in its shift to a service-based economy than the rest of the world, and its firms will enjoy certain benefits. One is that service-based industries enjoy greater barriers to entry and economies of scale. Once a service business such as a distributor achieves a market share of 20% to 25%, it becomes very difficult for a competitor to enter the market, he said. It s not an accident what the stock market is doing now, he said. Since 1990, profits as a share of national income have risen from approximately 8.5% to about 14% he said, mostly the result of the concentration of service industries. Much of that shift is hidden if one looks merely at the S&P industry classifications of corporations, according to Greenwald. John Deere, for example, is still classified as a manufacturing business. But much of its profits and its dominant market position is derived from service-oriented activities that are performed in local markets. Those include machinery servicing and technology, which now allows huge tracts of farmland to be plotted with GPS systems and planted with seeds using un-manned tractors. Page 3, 2017 Advisor Perspectives, Inc. All rights reserved.
Income inequality and other problems The death of manufacturing has contributed to what Greenwald called a big problem with the distribution of income in the U.S. Roughly the top 20% of the population has about 50% of the income, and they save 20% of their income, he said, resulting in a 10% savings rate. But the overall savings rate in the U.S. is approximately 5%, he said, so the other 80% of the population is dis-saving 10% (i.e., spending 110% of their income) since they have the other 50% of the income. That is unsustainable, he said. When gas prices fell and consumers had a little extra money, it should not be surprising that they did not spend it, according to Greenwald. They used it to reduce debt. The same would be true, according to Greenwald, if taxes were reduced; it would not spur spending or consumption. This is a chronic deflationary bias, he said. On top of that, Greenwald said the pension debt facing state and local governments driven low interest rates that have increased the present value of liabilities and depressed investment growth has limited their ability to provide necessary services. A bold solution A global glut of manufacturing capacity and the growth of service industries that are not capital intensive at the margin have driven down investment spending. Unless something is done about the consequences of the distribution of income, Greenwald said that investment is not likely to pick up. The solution, he said, would be a massive negative income tax similar to an earned-income tax credit. If you are going to correct these income inequalities, he said, you have to do it on a sustained basis. Greenwald said that policymakers must face the fact that they must compensate for the inevitable need for low-paying jobs. If someone, for example, earns $9,000, they would be given a $2,000 earned income tax credit. This would need to be a permanent, structural change, he said, and not a cyclical policy meant to address a recession. To address the international imbalances where every country tries to export, leaving the U.S. as the consumer of last resort Greenwald said the solution is for the IMF to print money, rather than the U.S. supplying it and using it to pay for its imports. He did not elaborate on this point during his remarks, but he has previously advocated for the IMF to control global currency flows by issuing special drawing rights (SDRs). SDRs would be a global currency with issuance that is calibrated based on the trade surpluses or deficits of individual countries. It would be implemented in such a way as to prevent the run-up of large surpluses or deficits, and would effectively remove the ability of a country to use its exchange rate as a competitive weapon in trading. Without such solutions, the consequences will be dire, according to Greenwald. As manufacturing productivity rises, he said, the value of low-cost labor, which has been the export-led path to development, gets smaller. That growth model is going to disappear over the next 25 years, he said. Page 4, 2017 Advisor Perspectives, Inc. All rights reserved.
You are going to need a source of institutional support for those countries that is permanent and that would also relieve the pressure of these international imbalances, he said. I would focus on long-term structural changes, not short-term cyclical interventions. Without such policies, he said, it will mean the end of the countries in Europe and Japan that continue to focus their management attention to a dying industry, which is manufacturing, Otherwise, Robert Gordon is going to be right, he said, but not for the right reasons. Page 5, 2017 Advisor Perspectives, Inc. All rights reserved.