Tuesday, February 18, 2014

Karabell, The Leading Indicators

Traders and investors wait with bated breath for the release of key economic statistics. How fast is the economy growing? What is the unemployment rate? Is inflation (or worse, deflation) in check? What about the trade balance? How is the consumer feeling? Zachary Karabell, currently president of River Twice Research (named with a nod to Heraclitus), explains how these statistics were developed, what purposes they were designed to serve, and some of the ways in which they fall short. The Leading Indicators: A Short History of the Numbers That Rule Our World (Simon & Schuster, 2014) is a quick but often enlightening read.

Consider, for instance, the nonfarm payrolls number. “Until the nineteenth century, the concept of unemployment was alien. Most people didn’t earn a wage; they did not have ‘jobs.’ They farmed, or traded, or served, or fought. Some were artisans or blacksmiths or stevedores, but most worked the land to nurse food out of stubborn soil. Factories were small, with a few dozen workers. There were mines here and there, and, of course, servants. But there was no framework of employment versus unemployment, only of want versus plenty, hard work versus idleness, good times versus bad.” (p. 27) And “well until the end of the nineteenth century, people without work were indicted as lazy and degenerate.” (p. 28) It was certainly not the role of government to help those able-bodied men who couldn’t support themselves and their families.

The Great Depression changed all that. The Hoover administration started collecting data on how many people lost their jobs between 1930 and 1932. And during Roosevelt’s tenure the unemployment rate was born. “Of course,” Karabell writes, “it was only the birth, because the government would not start compiling an actual number until the 1950s.” (p. 42)

If the Great Depression focused attention on unemployment, “the next great global cataclysm, World War II,” catapulted the “wonky and academic” GNP figure “to the center of public policy.” (p. 68) And “because of a felicitous convergence of the marketing of the American dream in the 1950s and the demands of the United Nations that new countries measure their economies, GNP and then GDP became the litmus of economies everywhere. As Americans competed to prove that their system of free-market capitalism was superior to the Soviet system of state-driven Communism, GDP became even more important to national prestige and global image.” (pp. 50-51)

GDP is an intrinsically flawed number, but its flaws are nothing in comparison to those of the trade balance. The author argues that “it is possible that if trade numbers measured more accurately how products are made, there would be no [US] trade deficit with China.” (p. 170) According to the current rules of origin, “a product is assigned to the country where that product has undergone its final and ‘substantial transformation.’” Each product thus has a single country of origin. The iPhone “acquires its ‘substantial transformation’ in China and, hence, shows up as a US import from China. In fact, every iPhone that is sold in the United States adds $229 to the US-China trade deficit, and each iPad adds $275, at least according to the calculations of three economists who looked at the issue in 2010. That means that by 2013, Apple’s sales of the iPhone in the United States had added as much as $4 billion to the trade deficit with China every year.” (p. 172)

Karabell, as should be evident from these snippets, translates econ-speak into language that the layman can understand and appreciate. He gives historical context to economic indicators even as he points out their limitations, especially their state-centric nature (the fact that in a global economy “almost all indicators are based on the idea that an economy is a closed system with physical boundaries that define a nation-state” [p. 79]). The Leading Indicators is a thought-provoking read. I thoroughly enjoyed it.

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