Macro Roundup

Setser has another warning about growing imbalances, US trade deficit (in $ terms) now ~ back at pre-financial crisis levels while the PRC’s current account surplus running $400B annualized

He worries this will be more than a COVID related blimp“…But it is possible that the swings will not be temporary. China has not done much to support its own household income—arguably because it has not needed to do so in a world where its exports are doing so well. And given the ongoing reluctance from Chinese policymakers toward broad-based stimulus, China’s fiscal policy response to COVID-19 may be much more tepid than the fiscal response of China’s largest trading partners. Combine that with a still-managed exchange rate that is still weak against both the dollar and the euro even with the modest appreciation in the third quarter and the PBOC’s desire for “basic stability” in the exchange rateand you have the recipe, at least in theory, for a sustained widening of trade imbalances.****….The 2009 crisis, thanks to the combination of China’s stimulus and the lagged impact of its 2007-2008 appreciation of the yuan (initially against the dollar, which translated into a broader appreciation when the dollar rallied a bit against the euro) led to a reduction in trade imbalances…. Without some policy corrections, I fear that there is a real risk that COVID-19 will lead to a sustained, rather than temporary, re-widening of imbalances…..”

Brad Setser, "China’s Surplus is Rising Rapidly. So is the U.S. Deficit. The IMF Cannot Turn a Blind Eye.," Council On Forign Relations, October 20, 2020, https://www.cfr.org/blog/chinas-surplus-rising-rapidly-so-us-deficit-imf-cannot-turn-blind-eye

New study from the Rosenthal and Burke of the Tax Policy Center finds 40% of total American equity is owned by foreigners (they use this to advocate for using the corporate tax rate as a revenue raiser as 40% of the cut went) but the evolution over time is interesting, “…Foreignersheld just 4 percent of US equity in1986(This is typo, should be 1965/1966), but their share rose steadily to 11 percent by 1980, 25 percent by 2000, and 40 percent today… foreigners now hold about 40 percent of total US equity, retirement accounts about 30 percent, and taxable accounts about 25 percent….”

This is mirrored by American ownership of foreign equity (See Figure 3)“…Over the same period,US ownership of foreign stock rose at a similar clip. This growth, by spurts, in cross-border investment is just one manifestation of globalization…”

Joseph Gagnon, "Who's afraid of zombie firms?," Peterson Institute For International Economics, October 22, 2020, https://www.piie.com/blogs/realtime-economic-issues-watch/whos-afraid-zombie-firms

Gagnon on why concerns about "Zombie Firms" are overrated in this current environment (economy operating below potential)"...When the economy is operating below potential and the forces returning it toward potential are absent or weak, the costs of killing zombie firms are huge. Killing a zombie immediately wipes out the income its workers have to spend on goods and services throughout the economy. This decline in spending drags GDP down by potentially more than 100 percent of what the zombie firm used to produce via a Keynesian multiplier effect..."

The pre-K study that you asked about that was noted inWSJ, they don’t actually seem to think pre-K has that much salience as the article seemingly implied, in that non-attenders (in terms of pre-K) make greater gains then attenders in Kindergarten even though the Pre-K grads enter kindergarten with greater skills versus the non-grads. So pre-K does work, but then people catch up. They don’t say if the residual (50%) gains from pre-K get closed further over out years.

Here is core result, “…The present investigation examined the benefits of pre-K through the end of kindergarten for children from low-income homes who lived in a large and diverse county (n = 2,581) as well as factors associated with a reduction in benefits during the kindergarten year. Results revealed that pre-K graduates outperformed nonattenders in the areas of achievement and executive functioning skills at the end of kindergarten, and also that the benefits of pre-K at the start of the year diminished by a little more than half. This convergence between groups' performance was largest for more constrained skills, such as letter-word identification, and was attributed to the fact that nonattenders made greater gains in kindergarten as compared with graduates of pre-K. Importantly, convergence in the groups' performance in kindergarten was not attributed to pre-K children's classroom experiences in kindergarten. Convergence was, however, attributable to preexisting individual differences, andthere was support for the notion that even though children's skills are susceptible to improvement as a result of pre-K, their longer-term outcomes are likely to be impacted by factors that are outside the scope of early schooling….”

Arya Ansari, Robert Pianta, Jessica Whittaker, Virginia Vitiello, and Erik Ruzek, "Persistence and Convergence: The End of Kindergarten Outcomes of Pre-K Graduates and Their Nonattending Peers,"Developmental Psychology, October 2020, https://pubmed.ncbi.nlm.nih.gov/33017159/

Note this on long term benefits, “…Accordingly, although the results clearly indicate that the benefits of pre-K persist at least 12 months after program completion,these results also support the view that targeting malleable skills that would develop absent of pre-K (or other types of early intervention) is insufficient for generating sizable long-term benefits, in part because many of these skills are likely to develop rapidly among nonattenders shortly after school entry…..That is, for the benefits of pre-K to persist, these benefits must be sizable, the skills children learn in pre-K must matter in relation to learning subsequent skills, and these skills should not develop at a fast rate among nonattenders upon kindergarten entry…”

To quote the report, “…In conclusion, the results reported herein appearconfirm two patterns of results detected in a number of studies—the benefits of pre-K indeed do persist through the end of kindergarten, and asubstantial share of these benefits diminish in the year after program exit.In short,the differential benefits converge.Moreover, it does not appear that children’s experiences in kindergarten contribute to convergence, at least in this study sample. For future studies to understand why pre-K graduates demonstrate fewer gains in kindergarten as compared with their peers who are just entering school for the first time will require closer and more comprehensive inspection of children’s experiences in the year after program completion….”

The study found that pre-K graduates entered kindergarten with greater academic and executive function skills as compared with children who did not attend pre-K at age 4, but no consistent differences emerge for their social skills. However these academic and executive function advantages are cut in half by the end of kindergarten because, even though all children make gains in kindergarten, non-attenders make greater gains, especially with respect to more constrained skills, "..That is, the associations between pre-K enrollment and the child outcomes of interest were significantly smaller by the end of the kindergarten year as compared with the start of the school year. On average, the associations between pre-K enrollment and children’s academic achievement and executive functioning shrunk by approximately 55- 60%.Convergence was largest for children’s letter word identification skills (roughly 80%) and smallest for children’s language and general knowledge skills (roughly 45%). When decomposing these estimates, we find that convergence in the benefits of pre-K, at least with regard to differences in performance between attenders and nonattenders, was largely attributable to “catch-up.”All children (regardless of pre-K participation) demonstrated improvements in their academic and executive function skills in kindergarten; however, pre-K graduates made smaller improvements than their peers who did not attend pre-K. There was also evidence to suggest that children’s socioemotional skills were changing differentially during the kindergarten year as a function of pre-K attender status (p.01). When decomposing these estimates, we found that although teachers reported that nonattenders demonstrated improvements along this dimension of development across the kindergarten year, they did not report similar improvements in pre-K attenders’ socioemotional skills..."

So from my read of the study pre-K seems to "pull forward" many benefits on kindergarten, “…Put another way, a little more than half of the original advantage associated with attending pre-K at the age of 4, relative to not attending, appeared gone seven to eight months later….”

Sangmin Aum and Yongseok Shin, “Why Is The Labor Share Declining?” Federal Reserve Bank Of St. Louis Review, Fourth Quarter 2020, https://research.stlouisfed.org/publications/review/2020/10/22/why-is-the-labor-share-declining

Software seems to be the key driver“….For manufacturing industries, import competition, computer intensity, and software intensity show significance. However, when all variables are included in the regression…only software intensity remains significant. For services, software intensity is the only variable that shows significance (Table 2).Since the flattening of the labor share in services contributed the most to the sharp drop in the aggregate labor share after the late 1990s, this analysis suggests that software can be an important part of the explanation for the trends in the labor share….”

Core insight, “….Once IPP capital was recognized as investment, it had to be included in value added and in the income account has since been counted as capital income. From the definition of the labor share (4), with a larger denominator but the same numerator, the labor share decreases mechanically. Because investment in IPP capital has been growing in the United States, as shown in Figure 3A, the inclusion of IPP in value added results in the fall of the measured labor share over time. Figure 3B shows the labor share with and without IPP: the green line is the labor share with IPP treated as investment (the current accounting method), and the orange line is the labor share with IPP treated as expenses (the pre-1999 accounting method). Since the labor share without IPP is more or less flat at least until the 2000s, the divergence between the two lines is evidence that IPP is an important factor in the decline of the labor share….”

The theory is starting around 2000 software started substituting for workers in cognitive intensive occupations. So software innovation have and will further reduce the labor income share. Their core evidence is Figure 6. “…From the occupational contributions to the labor share, shown in Figure 6, we see thatthe trend break in the aggregate labor share around 2000 can be entirely attributed to the stagnation of cognitive-intensive occupations, although routine-intensive occupations have been responsible for the gentle, longer-run downward trend….”

Good note published by FRBSL presenting evidence that the fall in labor’s share has been driven by the rise in software investment, which had a larger impact on the service sector (versus manufacturing) and on high skill cognitive occupations, “…the literature emphasizes the gentle decline since the 1980s and has been silent about the more stark fall since 2000. Taking a detailed look at sectors, occupations, and types of capital, we provide evidence that service industries and cognitive occupations merit more attention in order to fully understand the trends in the labor share. In particular, separating software investment from other types of capital promises to be a fruitful avenue for research…”

German Gutierrez and Thomas Philippon, “Some Facts About Dominant Firms,” National Bureau of Economic Research, https://www.nber.org/papers/w27985

Since 2000 relative productivities have been flat or declining“…Fact 3. The relative productivity of dominant firms has not increased over the past 20 years. This fact is important because the super-star literature is motivated by the examples of Google, Facebook and Amazon. Amazon was founded in 1994, Google in 1998, and Facebook in 2004. Since these years, the stars have become neither larger nor more productive than the rest of the economy. Figure 6 in the appendix breaks down the relative productivity by sectors: manufacturing, non manufacturing, ICT-intensive and non-ICT-intensive. The trends are broadly similar to the ones in Figure 3 but Figure 6 brings some new insights. Thefirst insight is that the results are the same if we use Census data instead of Compustat. The second insight is that ICT intensive industries lag other industries. We find that non-ICT top firms doubled their relative productivity advantage in the 1970s from 19% to 38%. ICT stars experienced the same increase later, between 1985 and 2000. Since 2000, however, relative productivities have been either flat or declining…”

There is no productivity gap btw leaders and followers since 1995 “…Fact 2. The value gap between leaders and followers has not increased. 4 Are Top Firms Becoming More Productive? Panel A of figure 3 shows the relative productivity of top US firms. The left graph compares their productivity to BEA average productivity in their respective industries. We observe an increasing trend in the 1970s and 1980s. After 1995, however, relative productivity remains roughly constant. The right graph compares star firms to other firms in Compustat. This comparison is thus within a group of large firms. As expected, the productivity gap is smaller, around 10% instead of 40%, but the trends are similar. In particular, star firms’ relative productivity has not increased since 1995. Panel B figure 3 considers global stars, starting in 1990. The productivity gap on the left figure is larger than in Panel A, reflecting higher overall dispersion of productivity outside the US, a fact which is consistent with Hsieh and Klenow (2009). The global trends, on the other hand, are similar to the trends in the US. In particular the relative productivity of the global stars has declined since 2000. This basic fact is inconsistent with models that assume that star firms enjoy a growing productivity advantage….”

Size is not a defining feature of top firms“…Fact 1. The market share of dominant firms has not increased. Fact 1 is important because it appears to be inconsistent with theories that argue that today’s stars have relatively higher productivity advantages than the stars of the past. In standard models an increase in the relative productivity of the top firms leads to increase in their relative size measured by sales. Relative productivity differences could of course be present lower in the distribution of firms and in specific sectors of the economy. But Fact 1 says that size is not a defining feature of today’s top firms….”

They go on to highlight these three facts:

I though market capitalization was more compelling then sales numbers as it should be a leading indicator. This is how they interpret the market value of equity, “…Panel A of Figure 2 looks at US stars. The first plot uses the market value of equity. Across all industries the top firm is roughly 75% more valuable that its direct follower and there is no upward trend. The red circle line expands the comparison group to the top 5 firms. On average, the top firm is 1.5 times more valuable than the average of its top 4 followers. Once again, we do not see an upward trend. The right plot shows relative sales. There is no overall trend but we do see a decline in the 1990s followed by a recovery, which is consistent with the view of the 1990s as a period of fast entry and growth by relatively young companies. Panel B considers global stars and reaches similar conclusions. Consider for instance the top 10 global firms of a particular industry. The average revenues of a top-3 firm are double those of a top 4-10 firm, and its market value is about three times higher. These are large differences indeed,but they have not increased in recent years…”

Their overall conclusions, “..Our results challenge the common wisdom about dominant firms in the new economy and shed light on the productivity paradox. The paradox is often framed as a gap between tremendous innovations at large digital companies and lackluster aggregate productivity growth. Our findings suggest there might not be a paradox after all: the top firms of today are neither larger, nor more productive than the top firms of the past. In fact, their contribution to overall growth has declined in recent years, therefore explaining (some of) the paradox instead of reinforcing it. If we are correct, the most important question is to understand what has changed between the 1990s and the 2000s. During the 1990s large firms made tremendous contributions to overall growth, both internally (Hulten) and externally (reallocation). In the 2000s these beneficial effects have all but disappeared. Why are star firms not contributing as much as they used to? We do not have a definite answer but it is clear that something changed around 2000. Perhaps ideas are becoming harder to find as Bloom et al. (2018) argue. Or perhaps declining competition and rising barriers to entry have allowed incumbents to cut genuinely useful investment and innovation as Gutiérrez and Philippon (2019) argue….”

Here are their findings1)The market share of dominant firms has not increased. 2)The value gap between leaders and followers has not increased. 3)The relative productivity of dominant firms has not increased.4)Their Hulten growth contribution has decreased to approximately zero(note this is contribution of an individual firm to aggregate productivity growth equals its own productivity times its Domar weight. The Hulten contribution is defined as the Domar weight times the firm level increase in log sales per employee) 5)The contribution of top firms to aggregate labor productivity has decreased by about 40%.

They also do this exercise using market capitalization. “…Firms’ Consolidated Sales, Profits and Market ValueWe use firm-level sales, market value and employment data to identify stars. All nominal quantities are converted to US dollars using the exchange rates provided by Compustat. Compustat covers 100% of market capitalization in the U.S. and Canada; over 96% in Europe and over 88% in Asia. Data for the US starts in 1950 but provides stable coverage since 1965. Global data starts in 1987 but provides good coverage for most countries starting in 1990….”

Bottomline they find using, “…Our contribution to the literature is simply to look directly at the largest, most valuable companies in the world. We define two main sets of global stars: the top 100 firms by global sales in any given year, and the top 20 firms in each of our 25 industries. Similarly, we define two set of US stars: the top 20 firms by (global) sales and the top 4 firms within each 3-digit industry…“…We measure the evolution of dominant firms in the U.S. economy since 1960, and globally since 1990. Contrary to common wisdom, dominant firms have not become larger, have not become more productive, and their contribution to aggregate productivity growth has fallen by more than one third since 2000…”

Just an FYI, Philippon pushing back on the idea that market leaders are more productive