The Consumer Is Back, But In the Wrong Place?
Last week's GDP report certainly allayed conventional wisdom's fears that the economy was sliding back into recession. The headline number for personal consumption expenditures (PCE) was the clincher since it supposedly showed that the consumer, for all the worry about prices, is back and supporting the consumption economy. Sixty-nine percent of third quarter GDP growth came from additional spending on PCE; 80% of that PCE was due to increases in consumer spending on "services".
For now we will ignore the alarmingly large 1.7% decline in real disposable personal income and the obvious slowing of GDP when viewing the numbers year-over-year (stripping out seasonal adjustments) to simply focus on how these headline numbers might fit into the basic ideas of a recovery and a healthy economic system.
Everyone wants to believe that the recovery is real and unfaltering since the alternative is, to far too many people, especially policymakers, unfathomable. But the stakes here are too high to ignore compositions. The most robust segments of spending on personal services were health care and housing. Those two alone accounted for 39% of all GDP growth in Q3, and 57% of the "robust" consumer segment.
The measurement of consumer spending on housing services is far more controversial than most people realize, and it gets right to the idea of what we should be trying to measure by all these numbers. The largest component of PCE spending on housing services (and the largest single piece of overall GDP) is something called the "imputed rental value of owner-occupied housing". The Bureau of Economic Analysis (BEA) estimates how much homeowners who live in their own homes would pay themselves in rent during a certain time period.
Think about that for a moment. Nearly $1.2 trillion of total GDP comes from an estimate of how much a homeowner would pay himself in rent should that homeowner ever want to do such a ludicrous thing.
It turns out, however, that this phantom GDP component has pretty sound technical reasoning. The BEA is trying to ensure that GDP is "invariant to how certain activities are carried out". In other words, if the BEA did not include the phantom imputed rental value of owner-occupied housing, GDP, as it is currently calculated, would decline during periods of increasing home ownership. Since only rental income flows into the GDP accounts, more people buying and owning houses likely means less real rental activity, leading to a statistical decline in the GDP calculation.
The keepers of the economic accounts believe that home ownership is largely a benefit to society, so it makes some sense to have the GDP calculation reflect a beneficial trend and become invariant. The process of compiling economic data is meant to show that the measurement of goods and services produced is an accurate reflection of an improving or worsening economy. Reflecting a growing beneficial trend by conjuring a phantom number fits within this overall schematic.
But just as home ownership is thought to be universally beneficial, the housing bubble itself demonstrated an opposing case. There can be no argument that a large proportion of economic activity predicated on this socially positive trend ended up being a nightmare. But the economic accounts make no qualitative distinction between any kind of activity, including the housing imputation. All economic activity is believed, imputed or real, to be an accurate measure of a positive economic trend, so home ownership is accepted as an economic positive without further question or qualification.
That leads to an important distinction about what an economy really is. Is it really just about the quantity of goods and services produced and exchanged? If we regard the imputation of owner-occupied housing rent as valid, then what is actually being accomplished economically by owning (not creating) houses? This question is somewhat captured in the technical definition the BEA uses to explain its rationale: it is trying to measure the value of the service of "shelter".
There is clearly some kind of "good" in the concept of shelter, but I wonder if it is really a true economic concept. I counter the economic value of shelter by using an example of someone that builds their own home from scratch, right down to creating and fabricating all the material (think of a rustic cabin in the woods). That person has obviously created a means to access the social good of providing shelter, but has done so only for himself. There is no economic exchange in the procedure and therefore no real benefit to anyone in the larger economic system. But since that made-from-scratch house was actually made, it will be included in the GDP report once the BEA includes that person within the owner-occupied rent survey. Similarly, there is no exchange of the shelter "service" when one buys a house to live in, even though the "service" of shelter is being accessed or used.
The creation of goods or phantom services cannot be the sole object or arbiter of economic success. Rather, it is the process of exchange, particularly the pathway of exchange, that creates the economic "good". In exchanging goods and services, an economy that allows for labor specialization, leading ultimately to increasing productivity, defines economic success. If we all had to make our own houses and grow our own food to eat we would have little time to do anything else. The modern lifestyle, itself a social "good", is based on nothing more than expanding productivity through labor specialization.
If I build my own home and grow my own food, the economic statistics should necessarily reflect degradation in the wider economic system. If I do more for myself, then specialization is reversing and breaking down, meaning someone somewhere will not be able to specialize (to the same degree) as I withdraw from the system of exchange. But the overall quantity of goods produced is relatively similar. Should it not follow, then, that a positive or growing economy should be properly defined as a system of broadening labor specialization, perhaps independent of the quantity of goods produced? In terms of the service of shelter, unless I purchase it from someone it does not really have an economic component, even though it does exist.
Manufacturing jobs have moved overseas over the last ten years as the dollar has been devalued. That was not a pressing problem since the service sector, especially health care, education and "business services", filled in some of the gap. The majority of that gap was bridged by the "wealth effect" of rising asset prices leading to debt accumulation that fueled consumer spending (showing up as the near-zero savings rate). It follows from that that the beneficial cycle of labor specialization was increasingly based on asset prices and debt accumulation expressed through construction and service jobs, but also through increasingly imported goods where trade dollars flowed back to the U.S. as GSE debt (a unilateral system of trade where labor specialization was indirectly caused by the methodology of money circulating to households through real estate prices and debt, a cycle that no longer exists).
Now that the "wealth effect" has been put out of its misery, we are largely left with education and health care services. These specialized services, however, present a huge barrier to widening and broadening labor specialization due to the fundamental nature of education and health care. The fields encompassed within them require very specialized knowledge (or certifications that are not easily obtained, financially and cognitively). So, as the labor specialization of the housing bubble allowed for increasing employment in construction and finance (real estate, mortgage processing, insurance, etc.), the reversal has left those unfortunate people with little economic mobility in the economy as it exists today in an economy after ten years of dollar devaluation and manufacturing leakage.
In the "old days" of an economy that manufactured goods, labor could flow far easier in a dislocation because it was largely unskilled jobs that were eliminated and then relocated to other sectors. Such an economy with a higher proportion of manufacturing would better cope with construction jobs that might be eliminated in the collapse of a housing bubble. Construction or even real estate jobs are far more easily transferred to a manufacturing job than a health care job. The barriers to mobility are not zero in the former, but they are much lower than the barriers to transitioning to the latter.
Getting back to the statistics at the beginning of this piece, the "strength" in consumer spending on health care and housing services may not be as economically beneficial as it seems at first. In a real, self-sustaining recovery we would want to see economic activity flow to areas and sectors that represent high elements of labor mobility. Unfortunately, those sectors have been undercut by intentional dollar devaluation. It is not just that manufacturing jobs have been shipped overseas, but that process also reduced labor mobility and flexibility, leaving the larger labor pool far more rigid to cope with the disastrous collapse in labor specialization coming out of the housing bubble.
The end result is rather predictable since the economy becomes bifurcated by this lack of labor mobility. Those that have not been touched by the misfortune of the Great Recession are doing relatively well, since they are able to maintain themselves within the process of the now limited monetary cycling - staying within the reduced economic system of labor specialization. Since any increases in discretionary spending for the fortunate majority run through goods largely produced overseas or specific services, their sunny fate does not enhance the prospects of the wider system's level of beneficial labor specialization. This means that economic statistics show an increase in activity, but that activity does not directly impact employment (mortgage processors are not going to turn into nurse practitioners without significant investments in, and access to, credentialing and time).
I am not advocating that economic statistics start defining success as some measure of "happiness" or "satisfaction". Rather, I think that the one-dimensional measurements currently employed do a vast disservice to our understanding of these phenomena since the most important qualities (not quantities) of economic achievement are left unspoken and unprobed. The idea of labor flexibility has to be right at the top of that list. An economy has to be able to produce jobs that can be filled by the labor pool as it is currently construed, or it has to create and preserve relatively painless methodologies and pathways for reconstituting the labor force for jobs that will be produced. That is the essence of dislocation and contraction, flexibility and mobility.
This does not mean a government program of more control. Rather, economic incentives should be more closely aligned with these ideas. After all, it was perverted economic incentives that pushed scarce resources (labor resources as well as materials) into an unsustainable housing bubble. How much of the labor pool was "fooled" into training for construction or finance? These people expended their own resources (including time) to train and credential themselves in fields that were only sustainable by short-term money and credit creation. Now that they have made those investments, they are largely useless (the investments, not the people) in the economy as it is now composed; meaning a second, more costly (factoring in both personal and systemic opportunity cost) investment is needed to allow for mobility. This is a massive loss of resource efficiency.
If monetary policy had not diverted so many resources to the housing bubble, these hard cases might have been better served choosing avenues of labor specialization that were actually sustainable over the long run. The billions of opinions expressed through markets, including labor markets, would likely have led to far different choices for these people than the artificial "pump priming" of central bank interventions into credit production.
The modern conventions of economics, especially the notorious notion of aggregate demand, center on activity for the sake of activity. No distinction is made about the quality or sustainability of any type of activity. So the policy prescriptions that follow from this universal view are simply unsuited to a real economy that does make all these distinctions. As such, we could celebrate a huge increase in consumer spending on health care if it was accompanied by a tangible increase in labor mobility and flexibility where those gains would lead to growing labor specialization and participation.
The economy is not just a system of exchanging goods and services; it is a societal system of fostering labor specialization through that exchange - a qualitative distinction that cannot be understated. Government interventions through policies that are supposed to broadly and generically increase activity are actually impediments to that search for success. The fact that roughly the same policies have been in place for some time, hampering systemic mobility and flexibility, makes it a far more difficult transition.
A positive recovery and economy should not be judged by the dollar amount, real or imputed, of goods and services exchanged, but how and where those exchanges take place - measuring how much is less important than measuring how. There has to be a more realistic interpretation of data in the context of what an economic system is supposed to accomplish. Activity for the sake of activity, or simply circulating money from one perception to another, is a short-sighted plan that does not address the severe deficiencies still present that have been built up by past short-sighted policies.
While mainstream economics focuses on the cursory quantitative measures of economic health, there needs to be a more determined and developed evaluation of qualitative economic results. Not all economic activity is the same, and labor specialization with rising participation should be the ultimate goal. If the BEA could figure out how to impute it into the current set of measurements, it would be a large step forward in our ability to solve the economic "riddle". Unfortunately, conventional thinking is trapped in the mindset of quantity over quality. Governments desire quantity while free markets work through quality.
