Different Coloured Rust Belts

During my travels of North America I have got the chance to explore the region referred to both affectionately and disparagingly as the 'Rust Belt', an area synonymous with the rise and fall of American manufacturing and other troubles facing the middle-class over recent decades. Beyond the generalizations of the region's lunch-pale character and love of football exists considerable variation between its cities that provide useful insight into understanding some of the broader issues facing the country. To tell this story I will compare and contrast the stories of Buffalo, Detroit, and where I am just returning from, Pittsburgh.

The rise of these cities share a host of similarities. Large numbers of migrants came to the mid-west including rural Whites leaving the farm, Blacks from the south, and large numbers of immigrants from southern and eastern Europe. Detroit, the Motor City, Pittsburgh, Steel City became the biggest manufacturing centres in the world, and all three were in an advantageous geographic position to become transportation hubs in America's incredible water and rail network. It was during the boom of these cities during the 1940's through 1960's that finally modern prosperity was felt throughout the population.

The moment would not last for the mid-west. Beginning in the mid 1970's changes in technology and transportation as well as foreign competition, most notably Japan, brought an end to America's dominance of global manufacturing. Plant-closings in the region began bringing job losses, then disaster, as the early 1980's recession brought crisis particularly to MI and PA.

As if a cruel joke on the region, the bad economic conditions of the early 1980's occurred under the fierce union-fighting Reagan administration, supporting companies in their efforts to rip-off their workers as they packed-up and left town. The sustained rise in unemployment shattered communities and caused a steady outflow of population that's consequences are still visible today: boarded buildings in downtowns, poor roads and infrastructure, and a real sense of malaise from a lack of opportunity. In the 1990's the city of Buffalo was giving away houses for free as long as someone would pay the tax, and Detroit is currently in the process of demolishing a quarter of its houses. The urban public education systems are in perpetual crisis with kids being packed into fewer and less staffed schools.

Unlike its counterparts, Pittsburgh did not suffer the same stagnation, and today is a more vibrant liveable city. Though battered by the collapse of the steel industry throughout the 1970's and 80's, the city began a rebound that remains strong today. From where I explored, I did not see the same dreary urban landscapes one becomes accustomed to in Buffalo or Detroit. I was shocked when driving downtown on Friday night to a Pirates game to see as many people heading to the stadium as the theatre!

The divergent paths between the cities is notably evinced in the labour market. In Pittsburgh, the decline in manufacturing employment (Blue) was well made up for with growth in healthcare and education (Red), and finance and technology (Green):

(Data only goes back to 1990!)
They may be known for the Steelers, but the biggest buildings there all read UPMC- University of Pittsburgh Medical Center- and they're all over town! In contrast, Detroit's tallest tower remains GM, and we know how that turned out. These growth sectors in Buffalo have not compensated for the fall in manufacturing unemployment:

The Great Recession of 2008-9 was not particularly severe in Pittsburgh, but Michigan is now basically
in a depression. Buffalo was mildly hit, but there was certainly no housing-bubble to burst!



So why the divergent outcomes between the three cities? Two factors that jump out are: 1) the importance of high-level educational, and 2) the different severities of racial histories.

In Pittsburgh's dense downtown are several universities, including one of the top math and computing schools in the world, Carnegie Mellon. Like Waterloo here in Ontario, the critical mass of the highly-educated and skilled has attracted newcomers and businesses alike, making it one of the hubs of many of the industries keeping America competitive, including IT, biotech, and healthcare. These well-paying jobs have powered broader prosperity in the city, by helping grow the service sector (e.g. retail), and ensuring public services receive adequate funding.

The city's success in these areas would certainly not be possible without being a centre for higher-education that could attract a highly-educated population amid the decline of manufacturing across the rust belt. In contrast, Detroit and Buffalo had nowhere near the educational infrastructure necessary to adapt to the changing economy. Ann Arbor, home to the University of Michigan is one of that State's lone bright-spots. The growing premium of education economists cite as a driver of income inequality seems clearly on display in the different paths of these cities.

While African Americans make up a large portion of each city, their different racial histories are another factor that separates the three. The urban development of Pittsburgh was such that Blacks were more evenly distributed in various neighbourhoods throughout the city rather than inhabiting massive sections as in Detroit and Buffalo. In the late 1960's, growing racial tensions exploded into riots between Blacks and Whites lasting for days and traumatizing the latter two, while Pittsburgh was spared the worst. It also experienced the least severe "white flight" from the 1970's through 1990's.

Today African Americans represent around the same percentage of population in Pittsburgh's and Buffalo's Metropolitan Statistical Area, but are more concentrated in the city of Buffalo (40%) than Pittsburgh (30%), while Whites have not lived in the city of Detroit for decades. The same issues of racial inequality exist in Pittsburgh as elsewhere, yet less severe racial segregation does ease some of the worst problems of crime and poverty. Telling the stories of troubles facing cities of the mid-west thus requires not only exploring the regionally specific economic history, but the also broader issues concerning African Americans across the country. The similarities and differences between these three cities highlight the poisonous effect that racial violence, discrimination, and segregation have had on urban America.

Their respective spectacular rise and falls were driven by the same factors, leaving behind a less populous and prosperous region. The continuing rebound of Pittsburgh in the face these factors attests to the importance of higher-education and race-relations for the region's, America's, and even southern Ontario's future.

Why "Politics" doesn't win elections: Team Canada edition

Electoral turnover is an important, yet poorly understood phenomenon in modern political democracy. In particular, pundits too often fret over "politics" when in the words of Bill Clinton, "It's the economy, stupid."

Some argue the voting public have specific "values" they hope are evinced by their leaders. In the US, conservatives point to "American values" of religion, self-reliance, patriotism, blah blah blah. In Canada the narrative is reversed, the public supposedly demanding tolerant, multi-culturalist politicians that will defend the welfare state.

From this line of reasoning, the myriad of complaints against 'Obama the socialist' and 'Harper the fascist' reflect a coming electoral backlash against both controversial leaders. But then why were they elected in the first place? Furthermore if political/econ/social "values" are instrumental in deciding elections, how likely is it that public opinion on such fundamental issues is going to oscillate to point where they are deciding electoral outcomes?

To put it another way, if Stephen Harper wins a majority government in the upcoming election, would this prove Canada was shifting towards a more Conservative culture? Did the election of Barack Obama after 8 years of GWB represent a major liberal-shift in American culture? While political pundits may provide breathless accounts such changes, the answer is a resounding NO!

The more moderate, yet still politically inclined will likely agree with my argument. They would note the public is inherently centrist in their values, and will vote out incumbents if they happen to stray too far to the left or right. Yet this conventional wisdom suffers from its own problems as the term "stray too far" is completely subjective and provides little in theorizing why elections are won or lost. Considering the 2 most recent former US Presidents, while pundits may cite Bill Clinton's willingness to work with Republicans as helping him win re-election in 1996, could the same be said about GWB and his successful 2004 re-election?

If such cited political factors can not actually explain the results of national elections what can? The answer, (formulated by Princeton Political scientist Larry Bartels) is simple: The political strength of an incumbent is essentially determined by the direction of the unemployment rate.

In reality only a small portion of the voting public in either the US or Canada is devoted to their ideology enough to vote for a candidate based on their "values" or even policies! For the majority of the population, their perception of those in power is dominated by their immediate perception of economic security. Rather than concern themselves with details over policy (eg abortion, foreign wars, etc) most voters only get angry at their leaders when they can't find a job, or fear loosing the one they have. Therefore at the national stage, given the natural electoral advantage of being in office (eg fund-raising, access to the media), a prosperous economy virtually guarantees the political power of incumbency.

While the overly-political focused media in both countries seem to ignore this major point, more likely to analyze  "who would you rather have a beer with", a cursory comparison between national electoral outcomes and the state of the economy is striking.

In the US:
1980- Carter looses to Reagan w/ weak econ
1984- Reagan re-elected w/ improving econ (unemployment is high, but is falling)
1988- George Bush Sr. and repubs re-elected w/ strong econ
1992- GB Sr. loose to Clinton Dems while econ is weak
1996- Clinton re-elected w/ strong econ
2000- Who knows who won!
2004- GWB re-elected during strong econ
2008- Repubs loose to Obama Dems- (Polls showed neck and neck race until financial crisis in September, don't blame Sarah Palin!)
2012- ???? (If employment still stagnant, could be a toss-up!)

In Canada the results are similar. Over the past 3 decades there have been 3 major transfers of political power at the national level. In early 80's to the Conservatives, early 90's to Liberals, and mid 2000's back to Conservatives. During the first two upheavals the Canadian economy was going through severe recession and rising unemployment, and both times the opposition managed to form a majority government. Only in the latter case were economic concerns not a primary issue in bringing down the incumbent, the result a minority government rather than a massive shift in political power.

What are the implications of the importance of the economy in determining incumbent power for the current Canadian election? While the Canadian economy is not exactly booming, the relatively short-lived down-turn following the Global recession of 2008-9 has awarded Harper enough political good-will that he is likely to retain power despite being hated by progressives. The timing of this election gives him a chance to cash-in on this good-will. Whether this will be enough to propel the Conservatives to a majority remains to be seen. However the opposition parties should not fret: once the Canadian economy slows (likely related to house-prices returning to their long-run averages), history shows the PM will be particularly politically vulnerable!

Debt, Wealth and the Great Recession

Debt, Wealth, and the Great Recession

March 2011

Understanding the American Economy

•Over the past 15 years, an underlying story is the role of credit

•GFC has thrust debt squarely into the consciousness of economists

•Likely to be integral to the future course of the economy

–Supply and Demand for credit in the Big 3: Households, Businesses and Government

–Conventional wisdom provides good framework for supply effects

•Proper diagnosis of credit-crunch

–Fails to account for demand-side deleveraging shocks and debt-overhang

•Implications on policy chosen, successes and failures

The Game Plan

1.   Theoretical consideration of credit and wealth

2.   Recent role of debt in American economy

3.   Japanese comparison

4.   Policy implications and future prospects

Credit in the Economy- Supply

•How can borrowing and lending play a driving force in the real economy?

-Fed Reserve Chair Bernanke among foremost economist on topic

•Banks monitoring costs are inverse to borrowers collateral- more wealth people have, the more bank is willing to lend- falling bank-loan rates spur investment, accelerating original increase in output

“Credit Channel Accelerator”

-Crisis can increase bank-loan rates, reducing credit in the economy, lowering output and pushing down nominal interest rates (more later)

Bank Lending Channel

•Health of banks also a clear factor in lending rates, supply of credit

–Eg. Size of collateral, balance-sheet, lines of credit, liquidity, all impact how easily they can raise money themselves, willingness to lend- resulting feedback effects

–Implies the effects of monetary policy have larger effects on real economy than accounted for

•Bank Reserve ratios, money supply, powerful tools over banking system used by policy makers in “Great Moderation” (1990-2007) to “stabilize” economy 

Credit Demand

•Framework predicts increased credit demand bids up bank rate, reducing nominal rate and overall demand

-- However fails to capture nature of how balance-sheet problems can change sensitivity of loan demand to interest rates

–Deleveraging shock? Can fall in debt limit force distress-selling/default that leaves debt-overhang?
-- Excess money can get stuck in banking system without willing borrowers, as people either paying back loans, or defaulting on them

•Rare, but there have been episodes of falling debt despite available credit- Great Depression, Japan’s Lost Decade

The Wealth Effect

–Increasing/Decreasing housing wealth is a key factor for growth in consumption/investment

–Evidence from past cycle indicates supply was prime driver during run-up- related to massive increase in lending to previously unqualified borrowers

–Demand AND supply falling during recession

•1-2 Punch

Some Historical Context

•Corporate Debt (Blue) and Household Debt (Red) as % GDP

Clearly there is a story to tell here!

Entering the decade…

•1990’s, early 2000’s a story of corporate the corporate balance sheet

–Tech boom and relatively low interest rates spur corporate investment, borrowing

–Once the cycle ends, investment/borrowing growth decreases rapidly

–Over the course of ’00-01 recession Fed cuts rate to 1% lasting 3 years

Equipment/Software Investment as % GDP vs Fed Funds Rate

2001 recession/aftermath a foreshadow of things to come

•Fall in corporate borrowing (-10%GDP) related to supply or demand for credit?

–Supply: relatively minor blip in lending mkts, bank surveys indicate tightening standards

–Demand: Interest rates still historically very low, companies with good credit ratings not increasing investment, strong growth in cash flow

•Fed Chief Alan Greenspan, so-called expert on credit-supply surprised by “Debt-rejection syndrome”

•Issue is Demand! Companies focused on repairing balance-sheets despite low interest rates

•Debt-overhang helps explains relatively slow recovery from 2002-04

Who steps in? Households

•Late 90’s, emergence of hhld credit boom- Debt/Income ratio rises from 2.2 to 3 from ‘02-’06, add $6trillion in debt

• Supply factors drive buble: low rates, foreign savings-glut, securitization/financial innovation, gov policy, etc

–Rise of credit inextricably linked to booming house prices, residential investment

–Credit primarily increasing going to ppl with falling incomes, (first time ever)

–Mortgage refinancing and expected rising prices help continue bubble

Great Recession Pt. 1 07-08: Falling Demand

-House prices peak in ‘06, debt-growth slows

-Foreclosures start rising, prices/residential investment/durable consumption start falling only in indebted (bubble) regions

-Feedback loop breaks down- wealth effect from falling assets causes people to reach debt-limit, defaults begin- people just tapped out!

–Local credit supply constraints? Unlikely, falling credit irrespective of whether

–Only focused on credit-supply, Fed reserve sits on its hands as default problem grows

•Survey results indicate falling demand for loans before supply

–Non-leveraged regions/ businesses not pulling back yet

•“The fundamentals of our economy are strong”- John McCain

•“As long as the music is playing, you’ve got to get up and dance. We’re still dancing.”- Chuck Prince (CEO Citi Group)

Hhld Liabilities/GDP (Red) vs Real House Prices (Blue)

Change in Hhld Liabilities/GDP (Red) vs Change in Real House Prices (Blue)

Household Wealth as % GDP

Crash in housing bring along drop in wealth of approx 1 year’s GDP ($13 trillion)

Great Recession Pt. 2 (08Q3-09): Credit Crunch

•Amid the rise of hhld credit the financial system takes on considerable debt

•As asset prices began falling, the illiquidity and opaque nature of securities create distress selling, asset prices and stock markets spiraling downward, job losses

–Bank rates rise, nominal rates fall- consistent with conventional wisdom

–Sept ‘08 Lehman Shock, and freezing of the short-term paper market

–Without short term borrowing companies literally would have no cash to pay their workers next paycheck!

1-2 Punch: Falling Supply AND Demand for Credit

Bank Survey Respondents:

% of banks tightening standards for consumer (blue), business (green) loans

% of banks reporting higher demand for consumer (red), business (orange) loans

-Notice low orange-line in early 2000’s- Corporate -Debt Rejection

-Red-line begins falling steadily in 06’, reaches lowest point during worst of recession

-Blue-line rises later in ’07 (credit crunch)

-Demand indicators have only returned to 0% (eg no more falling demand) despite over 3 years at very low interest rates

-Shows Debt-overhang, people paying off debt or defaulting!

Rescue efforts

•Blind-sided by the crash, authorities spring into action

-Fed Gov: Takes on the debt, primarily from falling tax revenue

–TARP, Bank Bailouts     

–700Bn stimulus in early ‘09

•Federal Reserve follow their textbooks: Save credit supply!

–Lower funds rate to 0%, pumping money into banks

–Launch Quantitative Easing- massive expansion of money supply, buys bank assets, all to lower long-term rates/prevent deflation, stimulate credit
Approach follows their theoretical disproportionate focus on credit supply: explains slow response to default problems but aggressive towards banking crisis. Shows in successes and failures of policy

Aftermath

•Recession officially ends in summer ‘09

-Unemployment, house prices finally reach a plateau, stock-market rebounds

–Interest rates remain low despite increasing government deficit

–“L-shaped” recovery consistent with financial crises

-Recent data shows slow improvements

GDP (Red) vs Long-run GDP Trend (Blue)

 

Going Forward:

Household Balance-Sheets are still struggling, concentrated in high-leverage regions

 

Debt-overhang, high unemployment concentrated in bubble States (eg Florida, Nevada)

Liquidity Trap: Broken Banks or Balance-Sheets?

-Historical there is link btw growth of Base Money (Red- amount of bills floating around), Credit (Green- eg amount of hhld debt) and the Money Supply (Blue- amount of money flowing btw all goods, financial, and credit mkts)

-Rise in Red-line (bills floating around) represents Federal Reserve money injection

-However its clear link btw Base Money and Credit is broken

-Where is this extra money? Sitting in some bank vault!

- Credit supply issue? Unclear, could be banks are unwilling to lend, maybe they are bankrupt?

-Concentration of debt-overhang indicates its likely a demand problem- households on average are paying back their debt or defaulting on mortgages! No desire to borrow despite available credit

         -Housing prices haven’t started recovering

        

Precedents? 1990’s Japan

(OECD)

•Corporations went on epic binge in late 80’s with associated rise in land prices

–Crash in ‘91 sees deceleration of  growth and credit ala Great Recession pt 1., full out deleveraging by ‘95 despite falling bank-lending rates

•By 1997 banking problems emerge causing credit crunch

•Still, demand issues override:

–Monetary actions, bank injections have no effect

–Like US, divergence btw growth in base money and credit- funds are stuck in banking system

–Survey’s indicate company’s not finding it difficult to find loans- to busy paying off debt

–Were internal banks the problem, should have been great chance for foreign banks yet few succeed

Comparisons between Japan and US

•American response to credit tightening, insolvency, has been much more aggressive, relatively stronger bank-lending channel

–Eg bounce-back in US stock prices vs 20 year decline in Japan

–Japanese loss in wealth worse than US

•Base money has lost influence on growth of credit, which drives money supply

–Falling money supply can cause deflationary spiral and rapid econ contraction

•eg US Great Depression ‘29-33: Lending= -47%, Money Supply= -33%, GDP= -50%

– In both examples MS never actually decreases, despite falling private sector credit. Why?

Implications for Fiscal Policy

-Government borrowing at start of both recessions supported M2 growth

–To date, low interest rates indicate private sector credit demand not being crowded out higher deficit

–Serious implications for deficit reduction if private sector credit unable to drive M2 growth

•Both ‘97 and ‘01 Japanese attempts at austerity seriously weaken economy undermining deficit reduction itself- policies forced to be reversed

•US 1937 deficit reduction shows similar effects

•Did the UK cut too early in summer 2010?

–Important to separate current downturn deficit from larger-scale long-run aging-population related deficits

–Will cutting now matter in 2040?

–Who knows how long before deficit noticeably undermines economy

Implications for Monetary Policy

•Raising nominal rates would likely increase debt-burden on deleveraging households

–However wild swings in base money without results display limitations of monetary policy

•Excess reserves could drive future credit bubble if remaining by time loan-demand resumes/banking issues are resolved

–Further QE likely less important for Fed’s role in helping sustain recovery than ensuring functioning banking system, lending channel

–Must learn from mistakes and consider credit demand, pursue rescue policy options that can help everyday people

Future Prospects

•Deficit reduction requires private sector recovery

•Where is there room to Grow?

–Business sector: indications of increasing optimism

•Relatively healthy balance sheets/cash-flow

•Can actually drive productive investment (eg computers) rather than residential investment (eg hot-tubs!)

–Exports: growth in developing world provides larger customer-base, aided by depreciating dollar

–Household’s role contingent on recovery in housing, credit

•Slow recovery, things stopped getting worse- high leveraged regions with debt overhang

–Clear that balance sheet of each sector will play a major role in future of the American Economy!

The End