Great Recession - A new theory linked to productivity improvement

I wrote a couple of years back on what has come to be known as the Great Recession of the twenty-first century. I remarked that the recession appears to show no signs of abating and recent events seems to have borne that out. While GDP growth in the US is in positive territory, it barely is. And the problems in Europe and a couple of natural disasters affecting Asia (the earthquake in Japan and the flooding in Thailand) have put brakes on the emerging markets engine that was pulling the world economy along for the last 4 years.

In the meantime, a number of well-argued articles and books have been written about the genesis of the crisis, and they have largely focused on the financial sector, the US mortgage market and the excesses there. The Nobel Prize winning economist, Joseph Stiglitz, approaches this issue from a slightly different angle in a recent write-up in Vanity Fair. Stiglitz argues that the Great Recession has its roots in something more benign than mortgages gone toxic. It lay in the productivity increases in the last two decades and caused a large number of job categories employing very large portions of the labor force to basically become redundant in the economy. What is interesting about this theory is that (Stiglitz argues) this is exactly what happened leading up to the Great Depression. The productivity improvements now are in the areas of manufacturing and services and the productivity improvement then was in agriculture.To quote, In 1900, it took a large portion of the U.S. population to produce enough food for the country as a whole. Then came a revolution in agriculture that would gain pace throughout the century—better seeds, better fertilizer, better farming practices, along with widespread mechanization. Today, 2 percent of Americans produce more food than we can consume.

Extremely interesting article and a forcefully made argument on the cause of the crisis and what could be done to solve it.

The quintessential Greek (financial) tragedy

For the last 6 month, the travails of highly indebted countries in the European Union and Greece in particular has been the source of considerable turmoil in the financial system. In addition to increasing the cost of borrowing for Greece and other countries in a similar situation like Spain, Portugal, Ireland and Italy, the other impact has been to increase the overall systemic risk and push the world economy back into the 2008 depths.


The Greece story is particularly fascinating. Unlike other countries where banks made ruinous bets and had their capital wiped out, impacting lending and slowing down economic activity, the banks had no role to play in Greece. Instead it was the systemic lack of fiscal discipline, lack of enforcement of basic property and taxation principles and a proliferation of special interest driven that causes Greece to be on a slippery slope to sovereign bankruptcy and default. The inimitable Michael Lewis has written a highly entertaining but also illuminating piece on why this came to happen. Link is here.


Now what is very interesting and scary is that many of the ills mentioned here is present in many countries around the world. Talk about the aversion towards taxes, the large scale tax evasion, the rampant bribery and corruption in government circles. Seems scarily familiar to people from India and other developing countries. What do you think causes Greece to fail in such spectacular fashion (well, if it hasn't already failed, this article should convince you to "short" Greek debt).

Some end of year reading

1. Krugman on the America's own lost decade - link here
The usual Krugman rant on how things are going downhill and accelerating.

2. The Freakonomics blog on the practice of not inflation-adjusting stock returns - link here
Stock returns are seldom adjusted for inflation, transaction costs and taxes. While usually savvy investors do account for these factors, it is easy to get misled unless one reads the fine print.

3. How did buy and hold do in the last 10 years? link here
It is unfair asking a stock picker to pick just one stock. Makes for good headlines but does not really allow the stock picker to demonstrate their skills. The probability that any one company could be impacted by freak events is usually pretty high.

4. Health Statistics and the mammogram controversy - link here (from the WSJ) and here from the Numbers Guy blog
Reading any kind of reporting coming from the US (except sports, maybe) has become a painful drag through the ideology of the author.

5. Happiness - State of mind or state of body? - link here
An interesting 'light' piece of reading. Turns out that they are one and the same thing.

The new lean economy

I have commented earlier (link here) on the phenomenon of the jobless recovery that the US economy (and definitely many of the more 'open' economies) are likely to be facing in the next few years. Of course, this precludes any serious effort by the government to create jobs through stimulus like efforts - though there is going to be a limit to that as well, given the relation of stimulus efforts to future debt creation.

In my opinion, the 2008-09 Great Recession has forced companies to seriously evaluate their cost structures. A lot of what passed before has been cut (in the fat bubble years) and companies have begun to realize serious benefits from cutting out fat, leveraging efficiencies at the work place by eliminating redundancies, moving their applications to open source platforms and so on. And my intuition is that many of these changes are not going to be just a reaction to the downturn. Companies are seeing that the quality of output has not significantly suffered because there aren't enough people to do the work, or because the work is no longer being done by expensive software. Thomas Friedman, in a piece in the New York Times, wrote that the Great Recession has also brought about a Great Inflection.

According to Friedman, the Great Inflection is "the mass diffusion of low-cost, high-powered innovation technologies — from hand-held computers to Web sites that offer any imaginable service — plus cheap connectivity. They are transforming how business is done." Friedman talks about two examples in his piece. One is a small, not-for-profit that needs to create an ad campaign. Given constrained budgets, the need of the hour is to be innovative, but with cost efficiencies firmly in mind. The ad creator uses a mix of collaboration tools (enabled by cheap and high throughput communication), online sourcing (through the availability of online marketplaces for media products) and multimedia editing (enabled by software and hardware improvements) to deliver a solution that is both innovative and appealing as well as one that fits in the client budget.

The second example, of the furniture manufacturer Ethan Allen, talks about transformations the business has had to make to drive productivity improvements. The transformations have been both traditional: workforce reductions of over 25%, multiskilling of the remaining workers to make them more fungible, consolidation of manufacturing and process engineering. Additionally the company has also adopted other non-conventional means to conserve cash and survive. This has included moving a lot of the advertising activity in-house leveraging the multimedia desktop tools that are available today.

Finally, Friedman makes a point that the flow of credit (which is still very constrained) would make these companies create jobs. I disagree. I think it is going to take a lot for companies to start hiring again. And when they do, they are going to be the multiskilled talent that is now constituting the workforce at Ethan Allen. Companies across the spectrum have tasted blood - of keeping productivity and output high and costs low. They are not likely to go back to being fat again anytime soon.

In Indian banks, I am seeing an increasing phenomenon in the growth of branches. Most big banks are expanding their branch networks - like HDFC Bank, ICICI Bank and even the venerable State Bank of India. But the branches increasingly are being staffed at low staff levels. Staff is usually multi-skilled. Specialists are assigned across branches and are mobile. As a customer, if you need any specialized service, the representative at the branch contacts the specialist who then makes an appointment within 24 hours. Instead of having committed staff in every branch, the staffing model comprises fungible generalists allotted to branches and shared, mobile specialists across branches.

Productivity growth and the never-to-return jobs

I have talked about the economy in a couple of previous posts. This was here talking about green shoots, and about the signs of frailness in the recovery. Over the months of April through August, the life of this blog, news about the economy did seem mixed. The first clear signs that things were beginning to stabilize came around the May timeframe when the drumbeat of negative economic news first started to turn mixed. The jobless claims did not rise as quickly as anticipated, the economy continued to lose jobs but fell off from the rate of close to 0.5 million a month. Around the same time period, existing home sales started to pick up for the first time in more than 2 years and finally in August, the sales pickup translated to rise in prices, for the first time in nearly 2 and a half years.

Meanwhile, Asia continued to power ahead, creating hope and optimism that it would serve as the engine for the stabilization and subsequent growth of the US economy. But even as sectors such as auto, manufacturing and - in some geographies - retail sales have started to show modest increases, job growth still eludes the economy. Quoting the WSJ blog Real Time Economics, a rough sketch of the numbers looks something like this. Average hours worked is declining at an annual rate of nearly 3%, based on quarterly numbers from earlier this year. This is largely driven by the job cuts, but also by anaemic hiring on part of companies. On the other hand, economic indicators point to the GDP growth returning to its cruising rate of about 2-3% a year. The combination of reduced work hours and economic growth translates to a positive growth for this interesting metric called Labor Productivity. One can therefore expect a productivity jump of nearly 4-6% in the third quarter. And given that incomes are flat, this is going to be good news for corporate profits. Dow at 11,000 by the end of year, anyone?

It has been said earlier that this looks like the famous jobless recovery that everyone fears. My take on what is going on. The slumping economy has given corporations the leeway to embrace job automation and computer-driven efficiency measures in a pretty radical manner. The people getting eased out are the ones who have enjoyed a successful run at holding down 'Old Economy' jobs in a world which doesn't value these jobs any longer. When the housing bubble was on, the inefficiency of these jobs never surfaced. But as corporate bottomlines are exposed, companies are making do with fewer and more talented people. Employees who are adept at computers and the use of technology and in its power to ruthlessly driven efficiencies.

For every one of us, this is a sign of how ephemeral our much 'valued' skills are in today's economic reality. A call to action that will be heard by the smart amongst us, but which will also be sadly ignored by many.

Market chills

I have argued in a number of recent posts: here, here and here that we are nowhere close to the bottom when it comes to this economic downturn. The jobless numbers are back to sliding downwards at an accelerated pace after one month of deceleration.

And the markets seem to have caught the chills.

We discussed this at work a few months back. Someone who is very well-respected in banking circles and who has seen a few past recessions called out that you can tell that a recovery is underway when there is a sustained period where the indicators yo-yo between good and bad news. We seem to be entering this phase now.

... the Great Escape? Or the Great Deception?

In an earlier post, I commented on the now famous "Green Shoots" of recovery but the very real long term threats to continued economic growth. It turns out that the "so-called" economic recovery seems to be more of a financial market recovery. Conventional wisdom goes that the financial markets turnaround precedes the real economy turnaround by about 6 months. Early signs did point to this phenomenon. Market indices in both emerging markets and the developed markets showed smart 30%+ growths in the last 3 months. Corporate bond offerings began to surge and even below investment grade offerings jumped up (and were well subscribed) in June.

However, some temperance seem to have set in of late. Emerging market indices like the Sensex and the Hang Seng are at least about 10-15% down from their early June peaks. Likewise with the DJIA. The steady upper trend seen for the best part of the last 8 weeks seems to have been interrupted. The yield on 10-year US treasuries had gone up to nearly 4% but is not trended back down to about 3.5%, basically signalling that everything is not as hunky-dory as we expected. There is still a high demand for quality (the irony of it all is that quality is denoted by US treasuries!). The Economist states that all economic indicators have not magically turned to positive, which is what one would expect if the markets and the media are to be believed. According to the Economist,

The June Empire State survey of manufacturing activity in New York showed a retreat. German export figures for April showed a 4.8% month-on-month fall. The latest figures for American and euro-zone industrial production showed similar dips. American raw domestic steel production is down 47% year on year; railway traffic in May was almost a quarter below its level of a year earlier. Bankers say that chief executives seem a lot less confident about the existence of “green shoots” than markets are.

We shouldn't be either. For a bunch of reasons.
1. Losses are nowhere close to bottoming out. Expectations for large credit defaults amongst corporates is expected to be higher than 11% for 2009 and continue to remain there for 2010.
2. At the individual level, unemployment is showing no signs of abating. There was a good article in the Washington Post today on how the economic recovery seems to be taking place in the absence of jobs. Check this link out. Unemployment is expected to be north of 10% and remain there for a good part of 2009 and into 2010. Unemployment is closely linked with the consumer confidence number and therefore any sluggishness in the job market is going to impact consumer spending and therefore further impact the rate of recovery of the economy.
3. Emerging markets were the promised land for the world economy, not not any longer. The markets don't seem to think so however. Indian economic growth is expected to be the slowest in the past 6 years. With much more fragile safety nets in the Asian economic tigers, these economies are going to be even more careful while navigating out of the downturn.

In short, a long haul seems clear. Also seems clear is a fundamental remaking of industries as a whole. Financial services, automobiles and potentially health-care are industries where a new business model is ripe for discovery. This should create many more opportunities for the data scientist, the topic of my next post.

Green shoots ... or bust

Equity markets, both international and US, seem to have taken to heart the signs of bottoming of the world economy and the rebound seen in Asia. The Brazilian, Chinese and Indian stock markets are at least 50% higher than the lows in Q4 2008. The DJIA went down to the 6500 for a while but has since rebounded to gyrating around the 8500 market and has on occasion, flirted with the 9000 level.

The rates of job-loss is falling in the US and despite a glut in world oil supply, crude prices are nearing the $70 mark after crashing down to the $30s only recently. Are we past the worst then? Despite the lingering weakness in W.Europe (something seen arguably since the start of WW II!), the signs of economic recovery seem to be unmistakable.

Is the US consumer then going to go back to his/her free-spending ways? While we seem to have come up a fair bit from the Q4 depths, at least from a consumer confidence standpoint, there could be a few big obstacles to growth.
1. The budget deficit. With the famous American aversion to taxes and the growing burden of entitlements (driven mainly by healthcare costs) as the baby-boomer generation retires, the deficit is only going to get worse.
2. The cost of borrowing to feed the deficit. The US Treasury's place of pride as the investment of the highest quality could be under threat as the domestic debt as a % of GDP grows. The US government will need to increasingly borrow more and pay higher interest rates for the borrowing. The higher interest burden is going to crimp the ability to make productive investments.
3. Finally, with increasing protectionism and government involvement in the economy, the vitality of US business enterprise to identify and capitalize on opportunity looks to be suppressed for the next several years.

A number of prognosticators have made some long-range predictions of the US Economy in this article. An interesting read, as the forecasters have taken a 5-10 year view rather than the 6-12 month view typically taken by realtor types. Another interesting article, about the long term speed limit of the US economy from the Economist. Summarizing the article,

According to Robert Gordon, a productivity guru at Northwestern University, America’s trend rate of growth in 2008 was only 2.5%, the lowest rate in its history, and well below the 3-3.5% that many took for granted a few years ago. Without factoring in the financial crisis, Mr Gordon expects potential growth to fall to 2.35% over the coming years.

Macro-economic indicators - a good source

I found a good source of macro-economic indicators on the Internet. This is on the NY Times web-site. Go to the Blogs section and look for a blog called Economix. There is a really good graphic along the right side of the page. The graphic covers important macro-economic metrics such as the unemployment rate, inventory-to-sales ratio, GDP growth, consumer price index (or inflation), factory orders, durable goods orders, etc. Click for a link here.

Why are these metrics important? Looking across a broad swathe of metrics gives a good blend of the various viewpoints one should consider when forming a view of the economy and where it is headed. And it is extremely clear that while some of the indicators seem to have stabilized and are pointing to a bottom having been reached, it is by no means consistent across indicators.

We have merely gone from all bad news to mostly bad news with some stable news thrown in.