Time to rebalance A special report

on America’s economy April 3rd 2010

AmEconSRCOV.indd 1 23/3/10 13:21:01 The Economist April 3rd 2010 A special report on America’s economy 1

Time to rebalance Also in this section The end of the binge The consumer boom de†ed fundamentals. Now economic rules are reasserting themselves. Page 3

Look after the cents Are Americans naturally spendthrift? Page 4

Export or die With demand at home at rock bottom, American †rms are looking abroad. Page 6

Energetic progress There is every chance that in future energy will contribute less to America’s trade de†cit. Page 8

Somewhere to live Why the sunbelt and urban sprawl are down but not out. Page 9 America’s economy is set to shift away from consumption and debt and towards exports and saving. It will be its biggest transformation in Trying harder decades, says Greg Ip Can higher productivity †ll the gap? Page 11 TEVE HILTON remembers months of economy recovers, some of those jobs will Sdespair after the collapse of Lehman come back, but many of them will not, be• Work to be done Brothers in 2008. Customers rushed to the cause this was no ordinary recession. The How the government can helps things along. sales oˆces of Meritage Homes, the prop• bubbly asset prices, ever easier credit and Page 12 erty †rm Mr Hilton runs, not to buy houses cheap oil that fuelled America’s age of con• but to cancel contracts they had already sumerism are not about to return. signed. ŒI thought for a moment the world Instead, America’s economy will un• Not in the bag yet was coming to an end, he recalls. dergo one of its biggest transformations in There are still plenty of things that could go In the following months Mr Hilton decades. This macroeconomic shift from wrong with the recovery. Page 13 stepped up e orts to save his company. He debt and consumption to saving and ex• gave up options to buy thousands of lots ports will bring microeconomic changes that the †rm had snapped up across Arizo• too: di erent lifestyles, and di erent jobs na, Florida, Nevada and California during in di erent places. This special report will the boom, taking massive losses. He even• describe that transformation, and explain tually laid o three•quarters of its 2,300 why it will be tricky. employees. He also had its houses com• The crisis and then the recession put an pletely redesigned to cut construction cost abrupt end to the old economic model. De• almost in half: simpler roofs, standardised spite a small rebound recently, house window sizes, fewer options. Gone were prices have fallen by 29% and share prices the 12•foot ceilings, sweeping staircases by a similar amount since their peak. and granite countertops everyone wanted Households’ wealth has shrunk by $12 tril• when money was free. Meritage is now ca• lion, or 18%, since 2007. As a share of dis• Acknowledgments Apart from those mentioned in the text, the author would tering to the only customers able to get posable income it is back to its level in 1995. like to extend special thanks for their help to Menzie credit: †rst•time buyers with federally And if consumers feel less rich, they are Chinn, Caroline Freund, Ed Glaeser, Shane Goettle, James guaranteed loans. It is clawing its way back less inclined to spend. Banks are also less Hamilton, Gordon Hanson, Doug Irwin, Larry Katz, Michael Mauboussin, Lesa Mitchell, Richard Rathge, to health as a leaner, humbler company. willing to lend: they have tightened loan Daniel Yergin, Mark Zandi and Ivy Zelman. The same could be said for America. standards, with a push from regulators Virtually every industry has shed jobs in who now wish they had taken a dimmer A list of sources is at the past two years, but those that cater view of exotic mortgages and lax lending Economist.com/specialreports mostly to consumers have su ered most. during the boom. Employment in residential construction Consumer debt rose from an average of An audio interview with the author is at and carmaking is down by almost a third, less than 80% of disposable income 20 Economist.com/audiovideo in retailing and banking by 8%. As the years ago to 129% in 2007. If other crises of 1 2 A special report on America’s economy The Economist April 3rd 2010

2 the past half•century are any guide, Ameri• Abundant domestic shale gas should radi• ca’s consumers will spend the next six or cally reduce America’s gas imports. seven years reducing their debt to more America’s economic geography will manageable levels, reckons the McKinsey change too. Cheap petrol and ample credit Global Institute. This is already changing encouraged millions of Americans to ‡ock the composition of economic activity. to southern states and to distant suburbs Consumer spending and housing rose (Œexurbs) in search of big houses with lots from 70% of GDP in 1991to 76% in 2005 (see of land. Now the housing bust has tied chart 1). By last year it had fallen back to them to homes they cannot sell. Popula• 73%, still high by international standards. tion growth in the suburbs has slowed. For The e ect on the economy of de‡ated the present the rise of knowledge•inten• assets, tighter credit and costlier energy are sive global industries favours centres rich already apparent. Fewer people are buying in infrastructure and specialised skills. homes, and the ones they buy tend to be Some are traditional urban cores such as smaller and less opulent. In 2008 the medi• New York and some are suburban edge cit• an size of a new home shrank for the †rst ies that o er jobs along with a ordable time in 13 years. The number of credit cards houses and short commutes. in circulation has declined by almost a A burst of productivity could lift in• †fth. American Express is pulling back tant to withdraw the stimulus for fear of comes and pro†ts. That would enable con• from credit cards and is now telling cus• pushing the economy back into recession. sumers to repay some of their debt yet con• tomers how to use their charge cards Tighter credit and lower consumer bor• tinue to spend. The change in the mix of (which are paid o in full every month) to rowing are not the only drivers of eco• growth should help: productivity in con• control their spending. nomic restructuring. A less noticed but sig• struction remains low, whereas in exports Normally, deep recessions are followed ni†cant push comes from higher energy the most productive companies often do by strong recoveries as pent•up demand re• prices. A strengthening dollar and ample best. But the hobbled †nancial system will asserts itself. In the recent recession GDP supply kept oil cheap for most of the 1990s, make it hard for cash•hungry start•ups to shrank by 3.8%, the worst drop since the feeding America’s addiction to imports. get †nancing, so innovation will su er. second world war. In the recovery the That began to change a few years before The outlook for business investment economy might therefore be expected to the crisis as the dollar fell and emerging depends on whether it is for equipment or grow by 6•8% and unemployment to fall markets’ growing appetite put pressure on buildings. Spending on equipment is ex• steadily, as happened after two earlier re• global production capacity. pected to be fairly strong, having largely cessions of comparable depth, in 1973•75 A fourfold increase in oil prices since avoided excess in the boom period, and in• and 1981•82. the 1990s has rearranged both consumer deed in the fourth quarter of 2009 it raced and producer incentives. Sport•utility ve• ahead at an annual rate of 18%. In February No bounce•back hicles are losing popularity, policies to John Chambers, the boss of Cisco Systems, But this particular recession was triggered boost conservation and renewable energy a maker of networking gear, called it Œone by a †nancial crisis that damaged the †• have become bolder, and producers have of the most robust, positive turnarounds nancial system’s ability to channel savings found a lot more oil below America’s soil I’ve seen in my career. Demand for new to productive investment and left consum• and coastal seabed. Imports of the stu buildings is far lower: empty shops and of• ers and businesses struggling with surplus have dropped by 10% since 2006 and are †ces attest to ample unused capacity. And buildings, equipment and debt accumulat• likely to come down further. When natu• business investment typically accounts for ed in the boom. Recovery after that kind of ral•gas prices followed the rise in oil earlier only 10•12% of GDP, so it will never be a full crisis is often slow and weak, and indeed this decade, exploration companies used substitute for consumer spending. some nine months into the upturn GDP new methods to get at gas trapped in shale has probably grown at an annual rate of formations from Texas to Pennsylvania. The road to salvation less than 4%. Unemployment is well up As consumers rebuild their savings, Amer• throughout the country (see map), though ican †rms must increasingly look abroad it declined slightly in February. What goes up may come down 1 for sales. They have a lot of ground to make So if America is to avoid the stagnation % of GDP up. Competition from low•wage countries, that a‰icted Japan after its bubbles burst, mostly China, has increasingly taken over where is the demand going to come from? 80 the markets of domestic industries such as In the short term the federal government furniture, clothing or consumer electron• 75 has stepped up its borrowing‹to 10% of Residential investment ics. Yet shifts in the pattern of global GDP this year‹to counteract the drop in growth and the dollar are laying the private consumption and investment. 70 groundwork for a boom in exports. Over the next few years this stimulus will ŒThere’s a world view that the United be withdrawn. Barack Obama wants the 65 States is the consumer of the world and de†cit to come down to around 3% of GDP Personal consumer spending emerging markets are the producer, says by the middle of this decade, though it is 60 Bruce Kasman, chief economist at JPMor• not clear how that will be achieved. In• gan Chase. ŒThat has changed. He reckons 1980 85 90 95 2000 05 09 deed, if the rest of the economy remains that America will account for just 27% of Source: Bureau of Economic Analysis moribund, the government may be reluc• global consumption this year against 1 The Economist April 3rd 2010 A special report on America’s economy 3

2 emerging markets’ 34%, roughly the re• south of Mr Hilton’s oˆces in Scottsdale, verse of their shares eight years ago. Less cavernous 2 Arizona. Around the same time that Mr The cheaper dollar will resuscitate Current-account deficit, % of GDP Hilton was watching sales of his homes some industries in commoditised markets, dry up, Brian Krzanich, head of global 0 but the main bene†ciaries of the export – manufacturing at Intel, was †nalising boom will be companies that are already 1 plans to spend $3 billion retooling his com• formidable exporters. These companies re• 2 pany’s massive semiconductor factories in ‡ect America’s strengths in high•end ser• nearby Chandler. Mr Krzanich knew per• 3 vices and highly skilled manufacturing fectly well there was a recession going on. such as medical devices, pharmaceuticals, 4 Intel’s sales were down and 3% of the sta software and engineering, as well as cre• 5 at the factories had been laid o . But he ative services like †lm, architecture and ad• 6 also knew that once global demand re• vertising. Thanks to cheap digital technol• bounded, Intel would have to be ready to ogy, South Korea and India now knock out 7 produce a new generation of cheaper, 2000 01 02 03 04 05 06 07 08 09 the sort of low•budget †lms that compete smaller and more eˆcient chips. ŒUnless Source: Department of Commerce with standard American fare. But only you think your business is going to shrink Hollywood combines the creativity, exper• for an extended period, like seven years, it tise and market savvy to make something ances could reverse quite quickly in 2010, always pays to make that investment, he like ŒAvatar¸ which has earned $2.6 billion says an IMF sta paper. says. In the last quarter of 2009 Intel, so far, some 70% of which came from America’s current•account de†cit, the helped by resurgent demand for technol• abroad. That adds up to several jumbo jets. broadest measure of its trade and pay• ogy, enjoyed record pro†t margins, and Mr Exports are a classic route to recovery ments with the rest of the world, shrank Krzanich was approving overtime. after a crisis. Sweden and Finland in the from 6% of GDP in 2006 to 3% last year (see Mr Hilton, for his part, runs his com• early 1990s and Thailand, Malaysia and chart 2). Could it come down to zero? It pany on the assumption that the days of South Korea in the late 1990s bounced back nearly did in 1991 after †ve years of boom• easy money and exuberant consumers are from recession by moving from trade de†• ing exports. This time the de†cit started out gone for ever. In his oˆce he has a yel• cit to surplus or expanding their surplus. a lot larger and the rest of the world is lowed copy of the Wall Street Journal from But given its size and the sickly state of weaker. Still, even stabilisation around 3% September 18th 2008, the week when Leh• most other rich countries’ economies, would be a blessed relief because it would man failed and American International America will †nd it much harder. It has slow the growth in America’s indebted• Group was bailed out. ŒWorst crisis since been exporting more to emerging markets ness to foreigners. the 30s with no end in sight, reads one than to developed ones for several years, America’s imbalances were years in the headline. ŒI wish I’d had that article in but if other countries, particularly China, making and will not be undone overnight. 2005, says Mr Hilton. He keeps it around do not suˆciently boost domestic de• But the elements of a rebalanced economy as an antidote any time he is Œfeeling all mand, Œthe unwinding of the global imbal• are already visible a 40•minute drive to the happy and slappy. 7 The end of the binge

The consumer boom de†ed fundamentals. Now economic rules are reasserting themselves

T WASN’T supposed to happen. An aca• reached the age of 45 their saving rates rose iod of deregulation that enabled banks Idemic study in 1991 predicted that as the sharply, to about 30% of disposable in• and other institutions to o er countless baby•boomers aged, America’s saving rate come. Yet when their children’s genera• new †nancial products and allow millions would rise by one or two percentage tion, born in 1955•64, reached the same age, to borrow large sums of money for the †rst points by the mid•2000s. Instead it fell. Be• their saving rates remained unchanged, at time. Automated underwriting enabled tween 1995 and 2000 the share of Ameri• about 10% of disposable income. lenders to screen borrowers more eˆcient• can households owning their home This divergence is explained by two ly (and also reduced the opportunity for ra• should have dropped by a percentage events, both dating back to the early 1980s. cial discrimination). Securitisation‹bund• point as boomers passed their home•buy• First, the Federal Reserve’s success in tam• ling mortgages, car loans and credit•card ing years. Instead it rose by 4.6 percentage ing in‡ation resulted in two decades of debts into securities and selling them on‹ points, with the sharpest increases among falling real interest rates and rising share helped lenders limit their risks. Policymak• those under 45, according to Harvard Uni• and property prices. As people’s assets ers smiled on all this because it allowed versity’s Joint Centre for Housing Studies. rose in value, they felt less need to save for many more Americans to become home• The economic behaviour of Americans college, retirement or rainy days. Pricier owners at no cost to the taxpayer. In 1989 born in 1935•44 turned out to be a poor homes provided more collateral against only 47% of middle•income households guide to their children’s conduct. Accord• which to borrow. had a mortgage. By 2007 about 60% did. ing to a study by the McKinsey Global In• Second, federal ceilings on deposit and The Asian †nancial crisis of 1997•98 ac• stitute, when the parents’ generation loan rates were abolished, launching a per• centuated these trends. It sent oil down 1 4 A special report on America’s economy The Economist April 3rd 2010

2 sharply and the dollar up, raising Ameri• pro†ts. Last year Je Immelt, the conglom• than they were, baby•boomers must now cans’ purchasing power and their taste for erate’s chief executive, admitted that Œwe save harder for retirement. Lenders de• imports and oil. In its aftermath Asian let it get too big. Citigroup’s boss, Vikram mand higher credit scores, bigger deposits countries held down their exchange rates Pandit, explained in 2008 how his com• and more stringent proof of income. and began to accumulate huge trade sur• pany got into such a mess: ŒWe had a large, Policymakers, who had cheered looser pluses, both to bolster growth and as pro• long US consumer position. Unfortunate• lending standards on the way up, are now tection against future crises (and the hu• ly, he added, so did the entire world. tightening them further on the way down. miliating strictures of the IMF). They True, Barack Obama has pleaded for banks ploughed those surpluses into America’s Where consumers rule to do more lending and put a government bond market, holding down interest rates Consumers have always dominated the guarantee behind much of the mortgage and in‡ating the housing bubble. American economy. Since 1950 their share market. But he is also bent on establishing The return to earth began long before of spending (including housing) has a powerful Consumer Financial Protection the riskiness of all this became obvious. In ranged from 66% to 76%. What was di er• Agency to scrutinise lenders’ o erings. 2002 the dollar began to fall. In 2004 oil ent about the pre•crisis era was the role of Regulators are planning to hold banks to headed upwards. In 2006 the housing mar• credit: in myriad new forms it made it pos• sti er capital and liquidity rules. ket turned down. Hopes that the transition sible for consumers to spend well beyond The more that an industry depended would be gentle evaporated as the crisis their income. on consumers’ access to credit, the harder it erupted, leading to the recession of Consumption will recover, but it will has been hit. As home ownership drops, 2007•09. Many companies realised too late no longer grow faster than income, as it did developers are building smaller, simpler how much they had depended on credit• persistently for the two decades before the homes (see chart 3, next page). Steve Hil• fuelled pro‡igacy. GE, for instance, eventu• crisis; indeed, it should grow more slowly. ton, the boss of Meritage Homes, is keep• ally relied on †nancial services for half its With their shares and homes worth far less ing the price of his houses down to at most 1

Are Americans naturally Look after the cents spendthrift?

N 1867 Horace Greeley, a legendary that in every recession since 1981 Ameri• the terrorist attacks that year, shopping IAmerican newspaper editor, described can consumers cut back on going out to was presented as a patriotic activity, a way his compatriots thus: ŒWe are energetic, eat and play and on holidays. for Americans to Œstick their thumb in the we are audacious; we are con†dent in our Economists think they can explain eye of the terrorists, as Dick Cheney, own capacities and in our national desti• changes in saving behaviour over time George Bush’s vice•president, put it. Mr ny; but we are not a systematic, a frugal, and across countries without reference to Bush did not even consider raising taxes to economical people. cultural norms. An IMF sta paper as• pay for the wars in Afghanistan and Iraq; The global imbalances that led to the †• cribes the enormous di erences in saving he cut them instead. nancial crisis are often blamed on Ameri• rates between Americans, Germans and Institutions also in‡uence saving be• cans’ high•living optimism. The crisis has Japanese to demography, wealth and eco• haviour. George Akerlof and Robert brought about a Œnew creed of thrift, as nomic volatility. Germans and Japanese Shiller, in their book ŒAnimal Spirits, the Pew Research Centre, a polling organi• used to save more because they were old• note that Singapore’s sky•high saving rate sation, put it in April 2009. From the early er, had su ered more economic setbacks can be traced to employers’ and employ• 1970s to 2006 the proportion of Ameri• and were less wealthy, though Japanese ees’ compulsory contributions to the Cen• cans who considered air conditioning or saving rates have since come down as tral Provident Fund, created by the gov• dishwashers a Œnecessity rose steadily, more people retire and draw down their ernment in 1955. but in 2009 it dropped sharply, Pew found. savings. A model developed by Barack Mr Blankenhorn blames the decline in Between 1950 and 1980 personal saving Obama’s Council of Economic Advisers thrift in America on the rise of Œanti•thrift averaged 9% of disposable income. By explains the American saving rate in institutions such as rent•to•own stores, 2007 it had dropped below 2%, but last terms of wealth, credit availability and cheque•cashing and chain pawn shops, year it went up to 4%. unemployment. It predicts that it will indulgent credit•card companies and pro• Is it true that Americans are prodigal? eventually settle between 4% and 7%. liferating payday lenders. They ‡ourished David Blankenhorn, in his book ŒThrift: A Yet such exercises do not fully exoner• in America because voters and policy• Cyclopedia, argues otherwise. ŒIn this ate a culture that can in‡uence people’s makers did not object. Belatedly, that has sweet land of liberty, one part of our in• saving habits through political choices. In changed. Regulators and rulemakers now heritanceðis thrift. [It] is more than any• 1950 President Truman refused to run a insist that lenders hold more capital and thing else a restatement, in secular terms, de†cit to pay for the Korean war. Instead scrutinise borrowers more carefully. of the Judaeo•Christian concept of stew• he raised taxes and slashed spending, for Whether Americans want to save more ardship. GfK Roper, a consultancy spe• which he enjoyed the public’s over• may be beside the point: they won’t have cialising in consumer behaviour, notes whelming support. In 2001, in the wake of much choice. The Economist April 3rd 2010 A special report on America’s economy 5

2 15% more than comparable existing ones to age internet shopping. In subsequent years compete with the ‡ood of foreclosures. On Downsized ambitions 3 Amex followed up with a series of cards the garage doors of his company’s show America’s: aimed at niche borrowers, from newly• homes hang garish banners advertising Median new home size Home-ownership rate weds to young Chicago professionals. the Œno•tricks monthly mortgage pay• Square feet ’000 % But the push into credit cards cost Amex ment: $1,480 for the three•bedroom, two• 2.5 70 dear as delinquencies mounted during the bathroom Harrison, for example. ŒIt used 2.0 68 recession. Under new accounting rules it to be taboo to talk about the payment, will have to hold additional capital for the says Mr Hilton. But nowadays buyers are 1.5 66 o •balance•sheet vehicles used to securi• looking for a place to live, not an invest• tise credit•card debts. Having agreed in 1.0 64 ment, and knowing what the monthly re• 2008 to be regulated by the Federal Re• payment will be lets them compare the 0.5 62 serve, in part to qualify for bail•out funds cost of owning and renting more easily. (which it has since repaid), it may face sti • Cars, like houses, are usually bought on 0 er liquidity and capital requirements than credit, with either a loan or a lease. During 197375 80 85 90 95 2000 05 09 it would have done otherwise. Source: Census Bureau the credit boom the terms of such deals It has now ditched many of its new were exceptionally attractive, but not any credit cards except Blue and returned to its more, thanks to tight credit generally and more people to hold credit cards. Bankers roots in charge cards and services such as the woes of GMAC, the †nancing arm of say the new restrictions may cut the num• electronic payments. ŒThere are going to General Motors and Chrysler, which has ber of credit•card holders by up to 45m. be segments, not just subprime but [of] the been laid low by bad mortgage lending. In That is almost certainly an exaggeration, middle class, that are not going to have ac• most years since 1960 some 7•8% of driv• but there is bound to be a drop. cess to credit, and when they get credit it’s ing•age Americans bought a car. Last year The changed economic and regulatory going to be a lot more expensive, Ken Che• only 4% did, according to IHS Global In• environment has certainly a ected card nault, Amex’s boss, said last summer. ŒThe sight, a consultancy. It forecasts that when companies’ strategy. American Express, for charge card is even more a product for the market has recovered the †gure will instance, had long favoured charge cards these times thanðthree years ago. The settle at about 6% in any given year. over credit cards, but in 1999 it launched its company is now o ering features that help ŒBlue credit card with a charity concert in cardholders control spending. It lets them Cut up those credit cards New York’s Central Park featuring Sheryl pay for groceries with reward points and The recession also marked a Œcoda to the Crow, Eric Clapton and Sarah McLachlan. impose spending limits on kids with sup• credit•card industry’s †rst 50 years, says The card was aimed at technologically sav• plemental cards. If consumers espouse fru• David Robertson of the Nilson Report, an vy young consumers and contained a mi• gality instead of ostentatious spending, industry newsletter. The popularity of crochip to deter identity theft and encour• Amex wants to be there. 7 credit cards was bound to wane as baby• boomers moved on from their highest• spending years, he says: ŒInstead of gliding to a manageable end, it wound up blowing up. The number of holders of Visa, Mas• terCard, American Express and Discover cards shrank by 32m, or 11%, last year, ac• cording to Nilson. Outstanding revolving credit (mostly credit cards and personal lines of credit) fell by $92 billion, or 10%, the largest such drop since records began in 1968. That will have an e ect on consumer spending more generally. Credit•card companies attracted their share of the anger directed at Wall Street. With e ect from February, the Federal Re• serve and Congress banned a wide range of card•company practices, such as raising a borrower’s interest rate when he defaults on a loan extended by another organisa• tion. Parents must now give their consent before their children under 21 can get a card. ŒAt a time when our economy is in a crisis and consumers are struggling †nan• cially, credit•card companies are gouging them, said Chris Dodd, chairman of the Senate Banking Committee. Noxious as some of the card•compa• nies’ practices were, they did allow many 6 A special report on America’s economy The Economist April 3rd 2010

Export or die

With demand at home at rock bottom, American †rms are looking abroad

LAUDIA CUSUMANO works for a left, as fanciful. They point out that Ameri• C New York †rm of architects, Kohn Pe• Change of destination 4 ca’s manufacturing base has been cut dersen Fox (KPF), and has often wondered America’s merchandise exports, % destined for: down by years of competition from China if she would lose her job in America’s and other lower•cost countries. Even if the property bust, as many of her professional 70 economic climate improves, America may 65 colleagues already have. In October 2008, developed markets not bene†t: it simply does not make the when she was working on a huge residen• 60 products the rest of the world wants to buy. tial and oˆce complex in northern Virgin• 55 Flat•screen televisions and mobile phones ia, the developer could not get †nancing. 50 are made in Asia. ŒThere are just too many Its e•mail to contractors and consultants 45 products that we no longer make and too 40 said: ŒIt appears to be a good time to stop. emerging markets many foreign links in the industrial supply Her boss switched her to another project in 35 chain, Robert Kuttner recently wrote in northern Virginia but last autumn that, too, 30 the American Prospect. went on hold. These prognostications are too gloomy. 198889 90 91 92 93 94 95 96 97 98 99 2000 01 02 03 04 05 06 0708 09 Just as things were beginning to look Experience suggests that export revivals Source: ISI Group desperate, her †rm landed a contract to are led by highly productive industries that build an upmarket hotel in the Chinese already export a lot, rather than less pro• city of Hangzhou. As design work in Amer• narrowed sharply, to $379 billion from ductive industries regaining old markets. ica has disappeared, KPF’s growing portfo• $696 billion. As a share of GDP, that was Over time a favourable global environ• lio of projects in China, South Korea and the lowest since 1998. ment encourages more †rms to launch the Middle East has protected its 550 em• The de†cit may widen again in coming new products or enter new markets ployees from the worst of the domestic months as companies step up imports to abroad. Yet pinpointing those †rms in ad• slump. Gene Kohn, the †rm’s chairman, build up depleted stocks, but not by much. vance is almost impossible. explains that Œthose projects in South Ko• Martin Baily of the Brookings Institution In a 2001 paper Andrew Bernard of rea and China were big shots in the arm. and Robert Lawrence of Harvard Universi• Dartmouth College and Bradford Jensen, We didn’t have to let any more people go, ty predict that as a share of GDP the trade now of Georgetown University, analysed we kept the whole New York oˆce busy de†cit this year, excluding oil, will increase the sources of America’s export boom in and began to hire. Last year turned out bet• only slightly even if the dollar strengthens. 1987•92. During that period American ex• ter than anyone could have imagined, yet What about the longer term? A coun• ports rose 77% in nominal terms and the it started out with the doom and gloom of try’s relative trade performance is mainly trade de†cit shrank from 3.2% to 0.6% of all these jobs stopping. determined by two (connected) factors: its GDP. They looked at factories across Amer• exchange rate and its growth rate in rela• ica and found that only a small portion of About•turn tion to those of its trading partners. The the rise in exports came from those that America’s economic transformation will IMF expects growth globally to average had never exported before; by far the big• require businesses to rely less on selling to 4.3% a year between now and 2014 but gest gain was from those that were already Americans and more on selling abroad, as only 2.5% in America. And though the re• exporting. Their research suggested that KPF has done. The emphasis will be on cession hammered overall trade, Ameri• 90% of the export boom could be ex• high•value products and services rather ca’s trade patterns have changed to re‡ect plained by the dollar’s depreciation and by than on labour•intensive items such as fur• the shift in global economic gravity. The relatively stronger growth in America’s niture and clothing. share of its exports going to emerging mar• trade partners. When Barack Obama in his state•of• kets topped 50% for the †rst time in late A later paper, published in 2009, which the•union speech called for exports to dou• 2007 and has grown further since (see Messrs Bernard and Jensen co•wrote with ble in †ve years, many economists thought chart 4). All this suggests that the trade def• two other scholars, looked at the sources he was asking for the impossible. Whenev• icit will narrow a bit further. of export growth between 1993 and 2003. er exports have risen so steeply in the past, The dollar is more of a wild card. Politi• The increase in any given year came al• it has been thanks to high in‡ation that lift• cal or economic upheaval can trigger a most entirely from existing exporters, but ed nominal values. Yet exports do not have ‡ight from or to the dollar (as Greece’s cur• over time new ones played an increasing to double for trade to lead economic rent troubles have done). Other countries, part. For example, in 1993 alone †rms ex• growth; all they have to do is to grow more such as China, may continue to hold their porting existing products to existing mar• rapidly or fall more slowly (in dollar terms) currencies down to keep imports in check. kets accounted for 91% of total export than imports. That has already happened. That could halt or even reverse the recent growth. But over the entire ten•year period Between 2008 and 2009 exports dropped narrowing of the de†cit. they made up a relatively modest 35% of by $272 billion whereas imports fell by The notion that exports can lead Ameri• the total, with new †rms contributing 24% $589 billion. As a result, the trade de†cit can growth strikes many, especially on the and †rms with new products or entering 1 The Economist April 3rd 2010 A special report on America’s economy 7

2 new markets as much as 42%. The de†nition of exports has also be• Mr Bernard says these †ndings are at come less clear•cut over the years. These odds with the conventional view that ex• days much of what America exports is bu• port growth is the result of domestic †rms ried deep inside products put together else• becoming more productive. That is true where. Apple’s iPod, for instance, is assem• only in the long run. In the short term al• bled in China, but a study by the Personal most all the growth comes from higher de• Computing Industry Centre at the Univer• mand for products that existing †rms al• sity of California, Irvine, estimated that ready make. That †lls him with optimism: China accounts for only 2% of the wages in• ŒIf you wanted to set the stage for US ex• volved in its manufacture, whereas Ameri• porters to do well, you’d like to have rapid ca makes up around 70%, in areas such as income growth in destinations that will be engineering, software and distribution. big in GDP terms. We already see that. America’s export boom is likely to be Service with a smile led by †rms that are already global in scale Services are playing an increasingly im• and by sectors in which America has a portant part in America’s exports. Their clear competitive advantage: sophisticat• share of the total has gradually increased, ed, knowledge•intensive capital goods like to nearly 33% last year. Within that catego• microprocessors, and high•end services ry, the private side, which covers things like like engineering, oil•production services business, professional and †nancial ser• and even (witness KPF) architecture. vices, has been growing fastest. Before the Few companies better capture that recession optimists routinely cited Ameri• trend than Intel, a microprocessor giant. It ca’s pre•eminence in †nancial services as a is one of America’s most successful com• driver of future export growth. Since then panies, and 80% of its revenue comes from the rest of the world has become much outside its home country. Like almost all more sceptical about the real value of big companies it su ered a decline in sales America’s †nancial engineers. and pro†ts in the recession and had to lay Yet America leads in many other kinds o some sta . Yet it also decided to invest of services, from software and †lm to engi• $7 billion in its semiconductor operations neering and oil drilling. And as technology to enable them to make chips with circuit• that equation, he says. Thus the bulk of In• advances, more businesses are likely to ry just 32 nanometres (or billionths of a tel’s investment is going into American fac• turn global. A survey by the American In• metre) wide, down from 45. tories in New Mexico, Oregon and Arizo• stitute of Architects found that in 2008 Brian Krzanich, Intel’s vice•president of na. By the fourth quarter of last year Intel some 7% of its members’ billings came manufacturing, says labour costs are an started shipping the new, smaller genera• from international work, against only 2.8% important consideration in processes such tion of chips from its Oregon plant, which a decade earlier. That increase came al• as assembling and testing systems, which helped the company achieve its highest most entirely from †rms that were already are carried out in Costa Rica, Vietnam, Chi• ever gross margin. doing international work but had stepped na and Malaysia. But they matter much Still, over the medium term Intel can• up their e orts. less in capital•intensive processes such as not correct America’s trade de†cit by itself. Building up such work can take time. fabrication where the value of a technician More American companies will have to KPF, for example, though founded in 1976, or engineer might depend on how eˆ• look abroad. They are the least likely to ex• did not land its †rst foreign job until the ciently he or she can operate a $70m tool. If port out of 15 big economies, according to late 1980s. Getting a toehold in Asia was a more productive engineer can get 2% the National Association of Manufactur• particularly time•consuming, but the †rm more use out of that tool, Œthat’s worth a ers, a trade group. Matthew Slaughter of now has an oˆce with 40 people in Shang• lot of employees. The di erence in pay Dartmouth College notes that only 4% of hai that helps with local project oversight, between a $50,000 engineer in China and all American †rms and 15% of American models, presentations to clients and the a $150,000 engineer in America is a Œnit in manufacturers do any exporting at all. And notoriously opaque building regulations 80% of America’s total trade is conducted in Chinese cities. by just 1% of †rms that export or import. The ease of exchanging information Only mildly dependent 5 This does not mean there is something around the world has fuelled fears that Exports of goods and services, % of GDP, 2009 wrong with American †rms. Rather, it re• even service jobs will be outsourced away ‡ects the fact that America’s domestic mar• from America. But those information 0 10 20 30 40 50 ket is large enough for most †rms. Exports ‡ows also make it easier for †rms like KPF Germany as a share of GDP last year were estimated to do business overseas. Once a week Ms at 10.9%, much lower than in most of its big Cusumano and her colleagues in Shanghai China* trading partners (see chart 5). Smaller com• log into a teleconference to discuss the Britain panies are deterred by the investment in Hangzhou hotel and look at drawings with Japan market research, distribution and product the aid of web•based conference software. United States design needed to sell abroad. To succeed in And some nights when Ms Cusumano foreign markets, they †rst have to do well cannot sleep, she exchanges e•mails with Source: Economist Intelligence Unit *Estimate at home. her partners in Shanghai. 7 8 A special report on America’s economy The Economist April 3rd 2010

Energetic progress

There is every chance that in future energy will contribute less to America’s trade de†cit

UST o the freeway in south•western wind, solar and biofuels to wean America and will blow over. As unemployment JPennsylvania a quiet country road leads o imported oil and to reduce greenhouse drops, people will get back into their cars. past picturesque barns and horses in gases. The marketplace has, quietly, accom• Some is due to petrol topping $4 a gallon in snow•covered †elds. Turn right near the plished a lot more. After a generation of de• 2008. With oil now back to $80, petrol has top of a hill, and a dirt road seems to take cline, America’s domestic production of dropped below $3. you straight to Texas. An orange drilling rig oil and gas is rising again and oil consump• But IHS CERA, an energy consultancy, the size of a block of ‡ats hulks over the tion is dropping. If sustained, these trends sees evidence of a more durable change in countryside, slowly chewing its way a mile could play a big role in rebalancing the consumer behaviour. Since the mid•1980s below the ground. The roar of portable American economy. In 2008 America’s net car manufacturers had been using in• generators †lls the air. The roughnecks in imports of oil and gas came to $416 billion, creased engine eˆciency for extra power blue overalls here have chased gas from or 60% of the de†cit. rather than fuel economy. Between the ear• Alaska to Nigeria. Nowadays, Pennsylva• ly 1980s and early 2000s the average new nia is Œthe hottest area in the United States, The drive to import less vehicle gained about 800lbs in weight and if not the world for gas, says one. The oil shocks of 1973 and 1979 galvanised the time it took to reach 60mph dropped Range Resources is drilling for gas that America’s politicians into trying to reduce by about †ve seconds. Now the average ve• is trapped in shale, a dense, non•porous the country’s dependence on imported oil. hicle is getting lighter and IHS CERA pre• rock formation. For more than a century In 1975 Congress introduced the †rst cor• dicts that future advances in eˆciency will shale gas has gone largely unexploited be• porate average fuel economy (CAFE) stan• go towards mileage, not power. California cause of the high cost of recovering it. But a dards for cars. Electric utilities cut their use often leads national trends, and in 2008 its †vefold increase in the price of gas a few of oil and domestic production rose. But petrol consumption was the lowest since years ago prompted companies like Range after prices crashed in 1986 conservation 2001. Despite increased air travel, jet•fuel to return to two well•tried technologies: e orts petered out. Average car fuel econ• consumption peaked in 2000, thanks to drilling horizontally instead of vertically, omy declined, and imports began an al• more eˆcient aircraft and better practices. and releasing the gas by injecting water at most continuous two•decade climb. Richard Newell, who runs the federal high pressure into the rock. The latest oil shock was far more drawn Energy Information Administration (EIA), The Barnett Shale around Fort Worth, out than its predecessors, but the e ects thinks that with oil at current levels the be• Texas, was the †rst to be commercially ex• may be just as far•reaching. As oil rose from havioural changes will stick, helped by ploited on a large scale. The Marcellus $20 per barrel in 2002 to $147 in 2008, oil new policies. The federal Renewable Fuel Shale, which spans West Virginia, Pennsyl• companies found they could pro†tably ex• Standard, passed in 2005 and updated in vania and southern New York state, is the tract more oil from ageing †elds with tech• 2007, requires that by 2022 re†ners blend latest (see map). Thanks to these e orts, es• niques such as gas and steam injection. 36 billion gallons of renewable fuel such as timates of America’s Œtechnically recover• The oil industry had largely pulled out of ethanol and biodiesel into motor fuel. If able gas (a broader de†nition than re• the Great Plains when independent pros• the target were met, that would be about serves) has risen by about 500 trillion pectors earlier this decade found promis• 17% of consumption. CAFE standards were cubic feet, or a third, in the past two years. ing new deposits in the Bakken Formation, tightened in 2007 for the †rst time. Last Barely a week goes by without Barack below North Dakota and Montana. It is year Mr Obama brought forward their im• Obama promoting new measures to spur now thought to contain up to 4 billion bar• plementation date to the 2012 car•model investment in renewable energy such as rels of technically recoverable oil, the larg• year. Tony Hayward, BP’s chief executive, est continuous oil formation in the lower told Dow Jones last November that Œwe 48 states. And BP announced last autumn will never sell more gasoline in the US that its Tiber oil†eld in the Gulf of Mexico than we sold in 2007. could hold 4 billion•6 billion barrels. Increased supply and decreased con• The rise in the price of natural gas from sumption have radically altered the out• $2 to $11per thousand cubic feet had a simi• look for imports. Five years ago the EIA lar e ect. The price is now under $5, but forecast that by 2025 America would be Range began drilling in the Marcellus in importing 16m barrels of oil a day, or 68% 2004 and reckons it can pro†tably extract of its needs (see chart 6, next page). Now gas even below $4. that forecast has come down to less than The demand•side response to higher 9m. Disappointingly, the total bill will still prices has been just as comprehensive. be higher because prices have gone up so Americans’ consumption of petrol and the much. But at least the American economy number of miles driven peaked in 2007, will be less dependent on imported oil. and the use of public transport is up sharp• The outlook for natural gas has ly. Some of this stems from the recession changed even more. Five years ago the EIA1 The Economist April 3rd 2010 A special report on America’s economy 9

2 thought that by 2025 America would be bring down the world price. importing 28% of its natural•gas supply, What a difference five years make 6 The other unknown is policy. A cap on much of that through newly constructed Oil, barrels per day, m carbon emissions would raise the price of lique†ed•natural•gas terminals. That fore• 2005 forecast 2010 forecast fossil fuel, increasing the pressure to lower cast has now come down to 9% of its sup• 18 consumption. It would reduce the cost dis• ply. Construction of a number of LNG ter• advantage of solar, wind and biofuels, minals approved years ago is on hold. 15 which are more expensive and less reliable The exploration boom has produced 12 electricity generators than oil, coal and gas. windfalls in some surprising places. Penn• Net imports Although the domestic coal industry 9 sylvania was home to the †rst commercial would be the biggest loser, oil imports oil well drilled in America, in 1859, but pro• 6 would also drop. Domestic production duction had long ago tailed o . One indus• 3 But the prospects of a cap•and•trade try•backed study thinks shale gas will deal have faded. The climate•change con• boost employment in the state by 98,000. 0 ference in Copenhagen last December It is already making an impression on 2007 10 15 20 25 yielded no †rm commitments to new caps Source: Energy Information Administration Washington county, a mostly rural area on emissions. Prospects for passing a cap• south of Pittsburgh †rst settled before the and•trade bill in America, already uncer• American revolution. ŒTwo years ago the vehicles remain fraught with problems. tain, have dimmed further since the Demo• infrastructure was non•existent, says Sam Several big question marks hang over crats lost their supermajority in the Senate. Robinson, a consultant overseeing one of these predictions. The price of oil is notori• Legislators from coal•producing states, and Range’s drilling rigs. ŒYou had to lease ously unpredictable. In the face of higher Republicans in particular, are strongly op• everything from Oklahoma or Texas. prices the industry has repeatedly shown posed to cap•and•trade. Now Range estimates that more than 40 ingenuity in developing new sources of suppliers have set up shop locally. Several supply. The price shot up in the 1970s be• The best solution is out of reach farmers have become millionaires from cause OPEC and Iran imposed restrictions There are other ways to achieve the same leases and royalties. Gas workers are a on supply. Non•OPEC members boosted thing. Many states require utilities to de• common sight in diners and churches. production and unity within OPEC frayed rive a certain share of their electricity from Inevitably the industry has brought as conservation measures slowed con• renewable fuels, which helps to explain controversy too: some locals fear that the sumption growth. In 1986 prices collapsed. why wind in recent years has accounted drilling will contaminate the groundwater Still, this decade’s increase in oil prices for more than a third of new electric•pow• (though there is little hard evidence so far), is qualitatively di erent from that of the er capacity. The House of Representatives’ and New York state has put a hold on drill• 1970s. It is due less to supply restrictions cap•and•trade bill includes a federal stan• ing in the watershed that supplies New than to demand in emerging markets out• dard, although various exemptions reduce York City’s drinking water. stripping global production capacity. Al• its impact. Raising the federal petrol tax In the past gas and oil prices have though the recession has restored some (which has remained at just 18.4 cents per moved together, so there was little incen• spare capacity, emerging•market demand gallon since 1993) would spur conservation tive for consumers to shift between the is likely to grow steadily. Western oil com• and reduce imports even if the world oil two types of fuel. The surge in domestic panies’ access to many low•cost oil†elds is price dropped. Unfortunately, any politi• gas production has broken that link and restricted by politics. Rich countries nowa• cian bold enough to try that is liable to be could encourage a shift away from oil and days consume a smaller share of the driven from oˆce. Americans may be get• towards gas in the future, although the sup• world’s oil than they did in the 1970s, so ting used to expensive petrol, but that does ply and storage of lique†ed natural gas for their conservation e orts are less likely to not mean they are grateful for it. 7 Somewhere to live

Why the sunbelt and urban sprawl are down but not out

HANDLER and Maricopa are typical of 2000 Maricopa was just a dusty crossroads a local landbroker, waves at a patch of lots C the youthful, sprawling cities on the with 329 homes. The housing boom was in the desert which the bank seized from southern edge of Phoenix, Arizona. The its making. As in countless Œexurbs across someone who bought them for $30,000 thousands of stucco•walled houses with America, lower•income families drove each: ŒAt current house prices no builder tiled roofs in Chandler’s palm•tree•lined ever farther a†eld to †nd a house they would pay anything for these lots. streets could have been stamped out by a could a ord. Maricopa soon grew to over Chandler too has felt its share of pain as machine that then moved on to produce 15,000 homes. But when America’s hous• Arizona’s housing boom crumbled; home the same sort of houses in Maricopa 17 ing market collapsed, so did Maricopa’s. prices are down by half and foreclosures miles to the south•west. Over a quarter of its houses have received have soared. But its cluster of high•tech em• Yet the two cities’ economic fortunes a foreclosure notice, says RealtyTrac, a ployers, anchored by Intel, have weath• have followed quite di erent paths. In property consultancy. Howard Weinstein, ered the recession better than most †rms 1 10 A special report on America’s economy The Economist April 3rd 2010

2 and are now enjoying a global rebound in business investment in technology. Build• ers are snapping up scraps of empty land near the city’s centre. Chandler’s and Maricopa’s divergent fates re‡ect the fact that as the crisis and re• cession reshape America’s economic ac• tivity, they will also redraw its economic map. For most of the post•war period the South has been catching up with the rest of the country. Land there is cheaper and land•use regulation more permissive, making it a magnet for families seeking a house with a yard, even if it means long commutes from sprawling suburbs. In the sand states‹Florida, Arizona, Nevada and California‹these trends went into over• drive in the years leading up to the crisis. The rush for both sun and sprawl has now reversed, at least temporarily. Popula• services, from media to architecture. tering of workers with similar skills. Since tion growth has slowed in the suburbs and Some even predict that cities will regain Intel arrived in 1980, an infrastructure of picked up in cities. During the recession economic leadership from suburbs. Rich• suppliers and supporting industries has four of the †ve states with the biggest job ard Florida, an expert on urban planning at grown up around it. Air Products set up losses were in the sunbelt, led by Arizona the University of Toronto, wrote in the At• shop to deliver ultra•pure nitrogen, vital to (see table 7), according to Moody’s Econ• lantic last year that the economy Œno lon• chipmaking, to Intel down a two•foot• omy.com. For the †rst time since the end of ger revolves around simply making and wide pipe. That pipe, in turn, attracted oth• the second world war more people left moving things. Instead, it depends on gen• er semiconductor companies. Those com• Florida than moved in. erating and transporting ideas. The places panies and their suppliers have nurtured a Exactly the opposite happened in that thrive today are those with the highest pool of highly trained technical workers North Dakota. For only the second time velocity of ideas, the highest density of tal• fed by two large state universities. Qual• since the 1970s more people are moving in ented and creative people, the highest rate astat, which builds ‡exible circuits, recent• than out and the population is now its of metabolism, which are found in cities. ly announced it would move its headquar• highest since 1998. Enrolment at the high ters to Chandler from Pennsylvania to be school in tiny Tioga is rising as locals who Let’s hear it for the suburbs closer to a supply of engineers. moved away years ago return with their But that may be going too far. Powerful eco• Chandler has all the things Intel looks children, and the principal frets that he nomic logic underpins the suburbs and car for when deciding where to put a factory, now has to compete with the oil industry culture. The median commute by car, at 24 says Brian Krzanich, Intel’s general manag• to hire janitors. minutes, is half the median commute by er of manufacturing and operations: space, Internal migration has been slowed public transport. Nathaniel Baum•Snow infrastructure, the transport links that en• sharply by the fact that a quarter of home• of Brown University has found that since able it to ship completed wafers to other fa• owners with mortgages owe more than 1960 residents and jobs have been moving cilities in the country around the clock their home is worth, according to First to the suburbs at about the same rate. Cut• and, most important of all, a Œpool of tal• American CoreLogic, making it diˆcult to backs on highway construction will slow ent that’s been here a long time. move. Moreover, an economy shifting that trend but not reverse it. It doesn’t hurt, he adds, that a recent col• away from consumption and housing and Short•term trends seem as likely to lege graduate can more easily a ord a towards exports of high•value goods and bene†t a city like Chandler as New York: it home in Chandler than in the San Francis• services will tend to bene†t industries that combines a suburb’s ease of commuting co bay area, where Intel is based. Still, Mr cluster in metropolitan centres, in part be• and a ordable housing with a city’s clus• Krzanich gives warning that neither Chan• cause such †rms draw on a common pool dler nor America can take Intel’s presence of intellectual talent. Software publishing, for granted: ŒOther countries like China sound recording, †lm production and se• Don’t go south, young man 7 are climbing up the skillset. They’re †ght• curities and commodities trading all form Change in employment levels by state, 2007-09* ing †ercely for the same investment. Intel such clusters, note Bradford Jensen and % is now building its †rst fabrication plant Lori Kletzer in a report for the Peterson In• Top five Bottom five outside the rich world‹in China. stitute. Seattle’s share of employment in North Dakota 1.8 Georgia -7.4 As long as Americans want to own America’s software industry, for example, Alaska 0.6 Florida -7.8 homes, the South and suburban sprawl is 18 times its share of population. By con• South Dakota -1.4 Michigan -9.4 will retain a certain appeal. Eventually trast, non•tradable services like retail bank• those foreclosed homes in Maricopa will Texas -1.5 Nevada -9.8 ing and video rental do not show much be reoccupied. As Mr Weinstein, the land• clustering at all. New York City is reeling Oklahoma -1.5 Arizona -9.9 broker, puts it, Œin the 1990s Chandler felt from the devastation visited on †nancial Sources: Bureau of Labour *Excludes territories and like Maricopa does today. The only di er• Statistics; Moody’s Economy.com District of Columbia services but retains a leading role in other ence is the zip code and the decade. 7 The Economist April 3rd 2010 A special report on America’s economy 11

Trying harder

Can higher productivity †ll the gap?

AST year Christina Romer, chairman of pend on external funds, such as bank loans LMr Obama’s Council of Economic Ad• Look back in envy 8 or equity sales, are particularly vulnerable. visers, noted that one of the costs of a bub• American venture capital raised, $bn A recent IMF study of Canadian and ble is that Œsome of our brightest minds American manufacturers estimates that a 120 make small fortunes arranging the deals, one•percentage•point increase in cor• rather than pursuing potentially more so• 100 porate bond rates knocks a quarter•per• cially valuable careers in such †elds as sci• centage point o the productivity growth ence, medicine and education. By that 80 of †rms dependent on outside funding. measure the collapse of the bubble may 60 The withdrawal of credit in the past have its compensations. The share of new two years has been indiscriminate, hitting Harvard graduates entering †nance or con• 40 speculative residential developments and sulting, which in 2007 reached 47%, 20 creative business start•ups alike. Small plunged to a mere 20% last year, according businesses moan that banks will lend to to the Harvard Crimson. 0 them only on draconian terms, if at all Whether those graduates who chose a 199091 92 93 94 95 96 97 98 99 2000 01 02 03 04 05 06 0708 09 (though they also say weaker sales are a Source: Thomson Reuters career other than †nance are about to bigger problem). Robert Kiener, of the Pre• launch the next technological revolution cision Machined Products Association, matters for the whole country. Innovation The combination of shrinking employ• cites the case of one Ohio manufacturer drives productivity, and productivity ment and rising GDP in the second half of whose bank asked for his life•insurance drives real incomes. A burst of productivi• 2009 has already translated into an im• policy as collateral. ty growth would make the years ahead a pressive 7.4% advance in productivity at an Venture•capital †nance has also con• lot less painful. With bigger pay packets annual rate. In part that re‡ects †rms’ re• tracted sharply. In part that re‡ects big workers could reduce their debt and still luctance to hire when they are uncertain if losses sustained by charitable and univer• spend more. growth is here to stay; the same thing hap• sity endowment funds on hedge funds, Innovation and productivity, however, pened after the 2001 recession. But it may private equity and shares. Such endow• are notoriously diˆcult to predict. They also mean that the wave of technology ment funds are strong backers of venture depend not just on inventors and entrepre• adoption that fuelled productivity growth capital. Joshua Lerner of Harvard Universi• neurs serendipitously stumbling upon a between 1996 and 2008 may still have fur• ty has documented that although venture game•changing product, but on how ther to run. Certainly the rebound in sales capital pays for only a small portion of to• quickly and widely †rms incorporate that at †rms such as Intel and Cisco Systems tal research and development, such R&D as product into their operations. Between suggests so. it supports produces three to four times as 1996 and 2009 productivity grew by a ro• many patents per dollar as regular cor• bust 2.7% a year as technologies that had A dearth of talent porate R&D. He also found that in the 1970s been developed in previous decades, from A recurrent complaint by such †rms is that †rms trying to commercialise personal personal computers to †bre optics, found they cannot get enough college graduates computing and network technologies their way into the mainstream. with the right skills to sta up for such were held back for years by the venture• Dale Jorgenson of Harvard University growth. Yet an extensive study found that capital drought then prevailing. Last year says technology is advancing more slowly between the early 1970s and late 1990s venture•capital funds raised just $15 bil• than in the decade before the crisis, so pro• American colleges produced more than lion, half the average of the preceding four ductivity will too, by about 1.5% a year. enough graduates in science, technology, years (see chart 8). Martin Baily of the Brookings Institution is engineering and maths to meet demand. The damage done by tighter †nance can more optimistic. He thinks productivity The problem was that a growing propor• be overstated. Venture investment during could grow by an average of 2.25% in the tion of them did not pursue careers in their recessions may actually be more produc• next few years, which would yield poten• †eld of study. It is not clear why not. Some tive, per dollar spent, than during booms, tial growth for the economy as a whole of may have been lured by the siren song of when money is showered on many vari• about 2.6%‹not spectacular, but a lot bet• Wall Street, but others may simply have ants of the same business plan. Research ter than Japan’s during its lost decade. He concluded that it did not o er a stable ca• sponsored by the Ewing Marion Kau man cites several reasons. Growth is likely to be reer, says Hal Salzman of Rutgers Universi• Foundation has found that entrepreneur• led by business investment and exports, ty, one of the authors. ship is surprisingly resilient to the business both of which bene†t †rms with higher• The bigger risk to innovation is not a cycle, in part because many entrepreneurs than•average productivity. Conversely lack of skilled workers but a lack of †• turn to self•employment when they are construction, an industry with low pro• nance. Recoveries after a †nancial crisis laid o . Some 45% of †rms in the Fortune ductivity, will make a much smaller contri• tend to be weak because of the damage 500 were born in recessions. But it would bution to GDP than it has done recently. done to the †nancial system. Firms that de• be safer not to bet on such resilience. 7 12 A special report on America’s economy The Economist April 3rd 2010

Work to be done

How the government can helps things along

NTIL the †nancial crisis hit, America’s must not run foul of World Trade Organisa• is a bit like †lms: failures far outnumber Umounting imbalances drew scant at• tion rules and refrained from telling successes, but the successes are often spec• tention from presidents. George Bush’s ad• bailed•out banks and carmakers how to tacular. Marc Melitz of Harvard University visers would routinely portray the gaping run their businesses. notes that making just one foreign sale en• current•account de†cit as good news: since These tensions are coming to a head. tails big †xed costs: †nding a buyer, setting it was matched by incoming foreign capi• Mr Obama may formally declare China a up distribution and learning to deal with tal, it simply proved that America was a currency manipulator soon. Some in Con• regulations that might be tilted in favour of great place to invest. By contrast, imbal• gress want to make it easier to impose du• local companies. Many companies that ex• ances have been a recurrent theme of Ba• ties on Chinese imports to compensate. port once never do so again. But those that rack Obama’s. His speeches often sermo• Protectionism and industrial policy are do so regularly often grow at a remarkable nised about the evils of bubbles, easy tempting and might, at the margin, hasten speed. Eventually, exports come to be credit and borrowing from China. He in• rebalancing. But they would in‡ame rela• dominated by †rms and products that sur• sisted that America had to live within its tions with trading partners, provoke retali• vive this winnowing process. means. ŒAs we rebuild we must also rebal• ation and ultimately slow the restructur• ance, he said in the introduction to Febru• ing of the economy towards more product• Reach for the watering can ary’s Economic Report of the President. ive, export•oriented businesses. Import This suggests that the right role for govern• Although Mr Obama diagnosed the protection generally shelters the least pro• ment is not to shower money on a handful problem correctly, he has yet to come up ductive industries and therefore the ones of putative winners but to take a portfolio with a solution. Indeed, circumstances least likely to export. approach: †nding companies on the mar• have forced him to pursue policies that ac• The argument for protecting or subsi• gin of exporting and helping as many as tually slow the rebalancing. A wider feder• dising Œinfant industries until they have possible overcome the †xed costs of entry. al de†cit o sets private retrenchment (see become strong enough to compete abroad Eventually some should become big, pro• chart 9) but prolongs America’s depen• is complicated. Sometimes it has worked: ductive exporters. Consular services that dence on foreign savings. Tax credits and defence spending, for example, was critical guide companies through foreign markets mortgage guarantees keep the housing to the early development of computers, are one form of support; trade †nance is market alive yet compound distortions semiconductors and the internet. But how another, particularly since the seizure in †• that contributed signi†cantly to the debt can it be made to †t in with world trade nancial markets impaired private trade †• mountain in the †rst place. rules? New †ndings on the nature of ex• nancing. The Export•Import Bank has au• Mr Obama’s supporters on the left porting reveal a potentially productive role thorised record volumes of trade credit, want him to attack imbalances by support• for government. but Fred Hochberg, its president, says ing domestic manufacturers (an activity It starts with the insight that exporting America still spends less on such e orts delicately termed Œindustrial policy) and than China or Canada do, even though its punishing other countries, particularly economy is much larger. China, that they say trade unfairly. Mr When will they meet again? 9 Further trade liberalisation would en• Obama initially shared those instincts. But Net saving, % of GDP courage †rms to export by o ering certain• in the White House he is surrounded by or• ty of continued market access. Mr * 9 thodox economists who are sceptical of in• Private sector Obama’s free•trade agenda, however, has dustrial policy and protectionism. These 6 focused on the enforcement of existing di erences have produced a schizophrenic 3 trade laws. Though he has recently shown + mix of policies. The president slapped ta• 0 renewed interest in free•trade agreements ri s on cheap tyres from China, proposed – with Panama, Colombia and South Korea, 3 making it harder for multinationals to de• only the †rst seems likely to be ready for a 6 fer taxes on pro†ts from abroad, ear• Public sector Senate vote this year. marked stimulus money for green•tech• 9 A similar approach should be applied nology investment and agreed to impose 12 to innovation. In the 1970s and 1980s the Œbuy American provisions on anything 1970 75 80 85 90 95 2000 0510 11 federal government poured billions of dol• bought with stimulus funds. On the other Source: Department *Goldman Sachs lars into the Synthetic Fuels Corporation to of Commerce forecasts hand he insisted that those provisions develop liquid and gas fuel from coal, and 1 The Economist April 3rd 2010 A special report on America’s economy 13

2 into the fast•breeder nuclear reactor. Both balanced their economies. failed because of political interference and Cheap and cheerful 10 For America it will be tougher. The priv• a collapse in the price of conventional en• Dollar trade-weighted index, major currencies ate sector remains so weak that an early ergy. Ignoring those lessons, Mr Obama March 1973=100 and sustained attack on the budget de†cit has pledged $1billion to FutureGen, a joint 150 could push the economy back into reces• government•industry project to generate sion. The Federal Reserve at present has lit• electricity and hydrogen from coal and se• 130 tle scope to compensate because interest quester the carbon dioxide. Both the feder• 110 rates are already at zero. Ms Romer of the al government and private partners have Council of Economic Advisers notes that periodically pulled their support. Because 90 whereas in theory tight †scal and loose its electricity would be costly, commercial 70 monetary policy should get an economy success is far from assured. back to full strength, the interest rate need• One study found that federal energy•re• 50 ed to achieve that might sometimes be neg• search spending became more productive ative, which is beyond the scope of con• 1980 85 90 95 2000 05 10 when it switched from large•scale demon• ventional monetary policy. That may be Source: Federal Reserve stration projects to lots of smaller•scale why Japan has been unable to wean itself technologies. Many failed, but the handful o government spending. Still, the Fed can that succeeded, such as advanced refrigera• by corruption and rent•seeking than sub• play a part, either through unconventional tor and freezer compressors, generated sidising domestic industries. In this in• policies, such as bond purchases, or by outsize returns. stance they were writing about China and simply keeping its rate near zero for longer. Supply•side incentives go only so far. other emerging markets, but the same is In energy the necessary price signal is When Rebecca Henderson of Harvard broadly true of rich countries. also obvious: raise the price of carbon. University and Richard Newell of Duke America explicitly sought to drive the That is Mr Obama’s stated aim, but the University (now head of the federal Ener• dollar down to help its trade balance in prospects for a comprehensive cap•and• gy Information Administration) reviewed 1985, and again in 1989•90. A repeat is not trade bill look poor. An alternative would the history of federal innovation policy, on the cards. It would risk panic among the be to raise the tax on petrol. At a stroke, that they concluded that one of the state’s most foreign investors who still †nance much of would narrow the budget de†cit, encour• e ective roles was Œstimulating or provid• America’s public debt, and anger trade age conservation, reduce oil imports, make ing demand. Simply put, if policymakers partners whose own currencies would ap• renewable energy more competitive and get the price signals right, †rms and con• preciate, hurting their exports. Nor is the reduce carbon emissions. It would not sub• sumers will of their own accord reorient dollar as obviously overvalued as it was in stitute for cap•and•trade, but would leave their e orts away from consumption and 1985 (see chart 10). less work for it to do. Yet it will not happen, towards exports and cleaner energy. A more benign route to the same desti• because a higher petrol tax is politically nation would be a combination of tight †s• even more unacceptable to Mr Obama and Trust the dollar cal and loose monetary policy. Standard Congress than cap•and•trade. In exports the most important price signal economic models predict that when inter• The process of rebalancing America’s is the dollar. ŒThe best attainable of indus• est rates are low and governments borrow economy has begun. Consumers are trial policies for sustained development is less, foreign capital in‡ows dry up, drag• spending less, borrowing less and driving an undervalued exchange rate, write Ste• ging the exchange rate down and shifting less. The trade de†cit has narrowed and ex• phen Cohen and Brad DeLong in ŒThe End growth from domestic demand to exports. ports are rebounding. Encouraging though of In‡uence. It is Œbetter, more automatic, That is how smaller countries such as Can• all this is, there are still plenty of ways that less manipulable and less easily distorted ada in the 1990s and Ireland in the 1980s re• the rebalancing could be halted. 7 Not in the bag yet

There are still plenty of things that could go wrong with the recovery

MERICAN consumers showed signs of did when credit was easy and home prices negative•amortisation and Œpick•a•pay• Alife in the †rst quarter, with retail sales bubbly. Many households will not be able ment mortgages are now shutting banks and car•buying picking up a bit. But hous• to borrow against their homes for years be• weekly and second•guessing the decisions ing is still struggling and consumer spirits cause they have become worth less than of those that survive. remain low. A bit depressing‹but proof the mortgages on them. The torrent of Higher oil prices are part of this rebal• that the country is learning to live within credit•card solicitations ‡owing through ancing process. With a lag, they are chang• its means. the letter box has slowed to a trickle and ing the behaviour of American †rms and Americans will not return to their pro• millions of Americans are cancelling their consumers. For example, the share of light ‡igate ways soon. Consumer spending credit cards or are having them with• trucks in total vehicle sales has been falling will recover as employment grows, but it drawn. Regulators who once nodded ap• since 2004. General Motors is winding will no longer outpace incomes the way it provingly as †nancial companies ‡ogged down its Hummer brand, launched when 1 14 A special report on America’s economy The Economist April 3rd 2010

†ts of exchange•rate stability. If the rest of the world does not help America grow, some grim scenarios await, according to Messrs Blanchard and Milesi• Ferretti. The country might try to prop up growth by extending its †scal stimulus. But that would mean its persistent budget def• icits would push up its debt even higher‹ and perpetuate its dependence on foreign savings. The current•account de†cit, hav• ing halved to 3% of GDP since 2006, would widen again. Alternatively America might withdraw the stimulus, which could make its economy stall. Another source of risk is the dollar. Its steady decline since 2002 has played an important role in reducing the de†cit, and in theory a relatively slower recovery in American demand should continue to nudge it down. But the dollar often refuses to do as told. During the crisis it rose sharp• 2 petrol was less than half today’s price, after they rely too heavily on exports instead of ly as borrowers were forced to repay dollar a sale to a Chinese company fell through. domestic demand. Between 1998 and 2007 loans. This year feels like a re•run, with in• Pricey petrol has also aggravated foreclo• consumption in emerging markets shrank vestors who doubt the euro’s future ‡ock• sures in the exurbs. from 60% to 53% of GDP, according to ing to the dollar. This special report has argued that JPMorgan Chase, and their current ac• A further question mark hangs over the America’s economy has begun to rebal• counts swung from de†cit to surplus. price of oil. A big increase would pummel ance away from consumption and debt to• There is a risk that every country will look consumers and sharply increase the trade wards exports and saving. But it is not yet to exports to lead its recovery. Clearly that de†cit, slowing growth and making the im• clear whether this transition will bring cannot work for all of them. balances worse. A big drop would help in strong, steady growth and declining unem• China has gone some way to reducing the short term, but in the longer run it ployment or sluggish growth and stub• its reliance on exports by launching one of would dissuade consumers from cutting bornly high unemployment. Much could the bigger †scal•stimulus programmes in down, sap political support for conserva• still go wrong. the G20. As a share of GDP its current•ac• tion and alternatives and discourage the Even if Mr Obama’s policies for the re• count surplus has shrunk by half between industry from looking for more. covery were ‡awlessly crafted, a lot is out 2007 and 2009. Its †scal stimulus, how• Rebalancing may be highly desirable, of his hands. Heading the list of potential ever, has mostly boosted investment. A far but that does not mean it is inevitable. It spoilers is the rest of the world. Americans more e ective way to shift China’s growth took a long time for America to reach the could not have run up so much debt with• from exports to consumers would be to let debt•laden state that brought on the crisis. out foreigners lending them the money. its currency, the yuan, appreciate. But so far It will take time, and lots of luck, for it to re• The rest of the world has to consume more its oˆcials are still talking about the bene• cover in full. 7 and rely less on exports to America, or the imbalances could return. ŒStopping in O er to readers Future special reports midstream is dangerous, wrote Olivier Reprints of this special report are available at a IMF Innovation in emerging markets April 17th Blanchard, the ’s chief economist, and price of £3.50 plus postage and packing. Television May 1st Gian Maria Milesi•Ferretti last December. A minimum order of †ve copies is required. International banking May 15th Water May 22nd Corporate o er We’d love to help, butð South Africa June 5th Customisation options on corporate orders of 100 Human genome June 19th If a country has su ered a crisis, the nor• or more are available. Please contact us to discuss mal script for recovery is for the rest of the your requirements. world to help restore it to health. But what Send all orders to: if the rest of the world is unable to do so? This is not a theoretical question. In the The Rights and Syndication Department fourth quarter of last year only one of the 26 Red Lion Square WC1R 4HQ euro area’s four largest economies, France, London Tel +44 (0)20 7576 8148 saw any growth. Were Greece to default, a Fax +44 (0)20 7576 8492 new crisis would rip through thinly capi• e•mail: [email protected] talised European banks which hold plenty of debt of the region’s weaker economies. For more information and to order special reports Previous special reports and a list of Emerging economies such as China, In• and reprints online, please visit our website forthcoming ones can be found online dia and Brazil are growing faster, yet they, Economist.com/rights Economist.com/specialreports too, could inhibit America’s rebalancing if