Month: June 2009

Must-read health care article from the New Yorker

tylerdynamistLeave a comment

Everyone thinks we need to do something about our health care system, but there's not much agreement about what needs to be done.  I am far from an expert in this field, but have come across some interesting articles recently.  I am a big picture guy, mostly, so I'll start from the top.

The Democrats generally focus on providing coverage for the uninsured and the Republicans generally focus on the high cost of our system (if they aren't defending the status quo, which they also do).

This chart from the Economist tells us alot:

On the basic question, the Republicans appear to be more correct, the US clearly has a problem with costs, without providing better outcomes.  The fact that there is a high number of uninsured is a symptom of the fact that health insurance is expensive, not the core failing of the US system.

RULE #1 – WE SHOULD BE SPENDING LESS ON HEALTH CARE, NOT MORE

What is different about the US system that results in high costs?  Here are some possiblities:

  • We waste money on the bureaucracy of private insurance – maybe, but the chart shows that we spend as much as or more than other countries publicly, even though most people get their insurance through the private market…besides since when are government bureaucracies known for being efficient?
  • Other countries free ride on our innovation – true, but I doubt that makes up the whole difference
  • Other countries don't have large medical malpractice claims – also true, but also unlikely to make up the difference
  • Since everything is free, people overconsume – true, but it is free in other countries too, and besides, do consumers really stand a chance of figuring out what they should pay for procedures, how to negotiate prices and what is necessary and unnecessary?
  • Our care, for those insured, is better – this is true in some ways…we are more likely to make use of cutting-edge technology but our outcomes are not necessarily better in key measures
  • Other countries ration – also true, but they do not necessarily have worse outcomes…besides everything else in the world gets rationed in some way, why not health care?  Since when do we expect to get unlimited free anything?

This article from the New Yorker looks in depth at the cost issue by comparing two Texas cities with similar demograpics, similar health outcomes, but vastly different healthcare spending per capita:

http://www.newyorker.com/reporting/2009/06/01/090601fa_fact_gawande?yrail

Supposedly, Obama is making this article required reading for his staff.  Obama talks about the cost problem all the time, like he totally gets it, but then he rolls out a plan that involves spending over a trillion dollars more than we already do.  It's mindboggling.  Why, Obama, why???

Anyway, what is the punchline?

RULE #2 – LIKE WITH MOST THINGS, IT'S ALL ABOUT INCENTIVES…IT IS THE DOCTORS THAT ARE OVER-CONSUMING, NOT PATIENTS

The system incentivizes doctors to order expensive procedures, incentivizes the use of specialists, incentivizes the use of expensive drugs, incentivizes the use of tests, incentivizes the use of expensive technology, and disincentivizes the use of general practictioners, collaboration between doctors and preventive care.

The difference between the two Texas cities is that one has an entreprenurial culture among doctors whereby they rack up huge costs and the other doesn't.  Supposedly, if the high cost areas of the US were brought down to the levels of the better low-cost areas (like the Mayo Clinic), the gap between the US and other countries would vanish. 

I do suspect, however, that there is a vast medical-industrial complex that will fight this sort of change, thus we will end up just poring more slop into the trough for the health care pigs to feed off, with little actual reform.

As an final note: an article in this week's BusinessWeek highlights the medical-home model that may serve as an antidote to our health care boondoggle:

http://www.businessweek.com/magazine/content/09_27/b4138034173005.htm

On the question of how do we incentivize for outcomes (quality) rather than quantity of care?  Honestly, I have no idea.

The Recent Market Rally Explained

tylerdynamistLeave a comment

On April 24, I updated by stock market valuation model and noted it's sensitivity to the assumed inflation rate.  It was fitting that I made that observation, because it appears that virtually 100% of the rally in the S&P 500 since the March 9 bottom can be explained by a rise in market inflation expectations.

Constant assumptions:

Inflation-adjusted 2009 Trend Earnings: $54.94
Normalized Payout Ratio: 50%
Inflation-adjusted Earnings/Dividend Growth Rate: 1.6%

March 9 Inputs:

S&P 500 Level: 680
Implied dividend yield: 4.0%
Implied real return (dividend + growth): 5.6%
Market Inflation Rate (30-year): 1.3%
Total Implied S&P 500 Return: 7.0% (rounded)

June 15 Inputs:

S&P 500 Level: 921
Implied dividend yield: 3.0%
Implied real return (dividend + growth): 4.6%
Market Inflation Rate (30-year): 2.5%
Total Implied S&P 500 Return: 7.1%

This is why the stock market, treasury yields and gold prices have all been positively correlated with each other for the past year.  The stock market hates deflation and adores mildly positive inflation.  To the extent that the Fed and Treasury seem to be successful in promoting reflation, the stock market goes up.  While the market will dislike runaway inflation, as I noted in my post from May 26, that is not currently a threat, despite what many commentators are saying.

So it appears that the market's equilibrium S&P return is 7%, not the 8% that I have been assuming based on historical return premium calculations.  So what changed to reduce the return premium?  Almost all of the drop in return expectations can be explained by the decrease in dividend taxes in the Bush tax cuts of 2003.  It appears that the stock market targets a 2% spread over the equilibrium after-tax return on 10-year corporate bonds.

More on American Manufacturing

tylerdynamistLeave a comment

In my previous post on US trade deficits and manufacturing productivity, I discussed how US manufacturing has actually thrived, even in the last three decades while manufacturing employment was plunging. 

Such numbers might prompt one to ask how it can be, when their are abandoned, crumbling factories all around us, particularly in the old industrial cities of the Northeast and Midwest.  There are two answers.  One is that alot of manufacturing activity has moved from the unionised North to the right-to-work South and West, where factories are allowed to be run with fewer employees that cost less.

Another is that the US has been abandoning lower tech, mostly labor-intensive, manufacturing and reallocating capital to higher tech areas.  While this is no consolation to former textile workers in the US, it's the natural evolution of things.

This chart from the Economist illustrates it nicely:

Economist mfg chart

Most advanced nations have been shifting away from low tech manufacturing and such manufacturing is being picked up by developing nations like China. In the US and Britain, where capital has been allocated the most freely, the trade balance is most positive in high tech manufacturing.  South Korea has also made great advances in high tech. 

I think the most interesting aspect of this chart is that Germany and Japan, the two largest advanced economies besides the US, have huge surpluses in mid-high tech but deficits in high tech.  I would argue the reason for this is that Germany and Japan have been among the most aggressive in promoting an industrial policy to build up the old mass market manufacturing economy (exemplified by autos) and have financial systems dominated by commercial banks.  They have very conservative systems that were great at building up the post World War II economy, but lack the venture capital/ IPO/ public stock/ high yield debt/ private equity culture that, for all its faults, relentlessly reallocates capital to the highest-return investments in innovative sectors.  They are also the two developed countries most manifestly in danger of being in secular decline.

I realize that sometime the US system gets its capital allocation very wrong, like with the recent housing bubble.  But I would like to bring up the fact that housing is the sector most heavily promoted by our government.  This "industrial policy" was successful for years, but eventually it got taken way too far and will be difficult to unwind, given all of the powerful constituencies that are now invested in promoting real estate speculation.

Housing in the US and the long term stagnation of Japan and Germany are warnings to those that would promote the heavy involvement of the US government in the economy to protect declining industries and to conduct industrial policy in growth sectors beyond the early R&D phase.

The truth about US trade deficits and US manufacturing

tylerdynamist3 Comments

One of my central economic tenets is that the total debt burden of the United States is too high. I blame economic policies that have encouraged excess consumption and housing investment, funded by money borrowed from abroad and by excess leverage in the financial system. Borrowing money from abroad in excess of money invested abroad creates a capital account surplus for the United States. If the US runs a capital account surplus, it must run a corresponding current account deficit to balance its accounts. The biggest component of a current account deficit is the trade deficit. I therefore believe that the best long-term fix for our problems is to adopt a set of policies that for a period of time encourages the US to run trade surpluses and a capital account deficit. In other words, we should sell more US goods abroad, while we increase savings and repay our foreign creditors.

My four point plan for running a trade surplus

  1. Maintain a stable currency and discourage the building of foreign dollar reserves;
  2. Improve incentives / remove disincentives for investing abroad;
  3. Remove / scale back policies that encourage borrowing and consuming at the expense of saving and investing; and
  4. Use policy to improve our terms of trade on energy

Right now point (1) is happening, whether on purpose or by accident. I don't expect (2) to happen anytime soon, and in fact policy seems to be running in the opposite direction. Obama talks like he believes in (3), but his policies also seem to be running in the opposite direction, with higher taxes on capital and high levels of federal borrowing. On the other hand, Obama is clearly a believer in point (4).

The composition of the US trade deficit

In the first quarter of 2009, the trade deficit was equal to 2.4% of nominal GDP (subject to revision). From 1980 to 2008, the trade deficit has averaged 3.1% of GDP.

61% of the deficit in Q1 2009 was due to our trade deficit in petroleum products. Since 1980, petroleum has accounted for 45% of our trade deficit, and the petroleum deficit has been about 1-2% of GDP. This one product is the "low hanging fruit" when it comes to targeting out trade deficit.

Not surprisingly, the US typically runs a surplus in services. In Q1 2009 the trade surplus in services was 1.1% of GDP, which is near the average level since 1990.

The level of trade deficit in goods excluding petroleum has averaged about 2% of GDP. In the goods sector, the US runs at about a balance in foods, industrial supplies and capital goods. In capital goods, the US runs a surplus in civilian aircraft (Boeing) and a deficit in everything else, including computer equipment. The bulk of the non-petroleum trade deficit is tied to autos and consumer goods.

It's not surprising that the US would run a deficit in consumer goods, many of which are labor-intensive like textiles, toys and such. The US should be able to run a trade balance or even a surplus in autos, which is actually a very productive sector in the US, but one in which we are up against rather unfair trade practices abroad. The US should also be running a bigger surplus in capital goods and non-petroleum industrial supplies.

The truth about US manufacturing

It has been so long since the US has run trade surpluses that it seems we have come to believe that it would be impossible to do so again. It is commonly believed that the US has basically stopped "making stuff". Nothing could be farther from the truth. The US is actually the largest manufacturer in the world by far and in most years is the largest exporter in the world. Also, it is important to note that the US's economy is absolutely massive relative to any other country in the world, and that trade (both imports and exports) is a relatively small part of our economy compared with even large economies like China, Germany and Japan. Also, the bulk of our trade deficits since 1980 have coincided (slightly lagged) with two periods of a very strong dollar and high real interest rates, which leads to poorer terms of trade for US manufacturers and increased investment flows from abroad. If we focus on maintaining a stable dollar rather than a "strong dollar", most of the trade deficit problem goes away.

But isn't manufacturing in the United States in decline? While manufacturing employment is certainly in long-term decline, manufacturing production continued to climb right up through 2007. The recent plunge in production has brought US manufacturing back to levels last seen in 1999. Manufacturing employment, on the other hand, is back to levels last seen around the start of World War II. The difference between these two numbers is the increase in manufacturing productivity. Before the recent downturn, we were producing roughly 7.5 times what we were producing in 1948 with roughly the same amount of manufacturing workers, working out to real productivity growth of 3.3% per year.

Manufacturing production and employment:

During the same timeframe, manufacturing capacity has been growing at 3.5% per year, so capacity utilization has fallen.

Thus, when this downturn ends, the US has plenty of scope to have its manufacturing production return to its trend line, particularly in high tech equipment and other durable goods.

The key takeaways are:

Don't confuse manufacturing employment with production. Manufacturing employment since the early 1970s has been analogous to agricultural employment in the late 1800s and early 1900s, declining even while production boomed.

US durable goods manufacturing is perfectly competitive. Capital-intensive durable goods manufacturing in the US could thrive if the US government halted the currency policies that were unduly punishing it.