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Saturday, October 21, 2017

Dealer Musings (II): Ruggles on Gap Insurance

David Ruggles

Gap insurance is a by-product of the extension of car loans to longer maturities. Once only 3-4 years, loans now extend out to 7 years (and sometimes more). At current interest rates of 7.6% (quoted on a Chevy dealer website), at the end of 3 years the purchaser will have only paid $18,200 on a $50,000 loan. However, the resale value may only be $25,000 or 50%. So the purchaser will be “upside-down” on their loan by $7,000. Now there’s generally some sort of downpayment, but purchasers can add on extras that aren’t figured into the insurance value of the car but might be built into the loan. So if they total their car and are paid only the replacement cost (less deductible!), they’re in trouble. Or in this case, their truck in Texas was underwater, and their auto loan is, too.

Now consumers can be quite naive about this risk. That's not true of banks. If the borrower defaults and the bank repossesses the car, they’ll be out the “gap” between the balance of their loan and the wholesale value of the car (plus the out-of-pocket costs of hiring a “repo” specialist, and cleaning up and transporting the vehicle to auction). Hence “gap” insurance. (Of course the same issue faces anyone involved in vehicle finance.)

...don’t be surprised if some GAP insurers become insolvent...

According to Forbes and others, a million vehicles have been “totaled” by hurricanes so far this season. This begs the question, how many of the insurance payoffs will be deficient when it comes to paying off the outstanding loan against these vehicles? Many of these vehicles carry GAP insurance, to cover any difference between the lender payoff and the insurance settlement, less deductible, for a totaled vehicle that is collateral for the loan. And GAP coverage is generally “reinsured.” I’ll leave it to David Robertson, a true expert on this type of coverage, to explain the details, especially the “banding” inherent in most reinsurance coverage.

Bottom Line: Yes. Don’t be surprised if some GAP insurers become insolvent. And don’t be surprised if GAP coverage rates rise dramatically.

Some salient information follows. Many of the players are big, diversified insurance companies for whom an one sector going south, all the way to Texas, won’t threaten their viability. But gap insurance is a specialized product, and some of the players are small.

“State Farm Mutual Automobile Insurance, Allstate Insurance, Farmers Insurance Exchange, National Indemnity Company (an affiliate of Geico), the Progressive Group, and Metropolitan Property and Casualty Insurance (a unit of MetLife) are among the big companies that write a large portion of their auto insurance business in Texas.” Business Day

Friday, October 20, 2017

Friday class, Friday graph of the day: Trade

Mike Smitka

Krugman (co-author of Krugman & Wells, our Economics 102 textbook) won his Nobel Prize for work in international trade, but his "open economy" chapter remains at the end of the book. That textbook structure dates back to the first true "principles" text in 1947, written by Paul Samuelson (another Nobel laureate, and a co-founder with Heckscher and Ohlin of modern trade theory). Since then all successful new texts chose to market themselves as potential replacements, which is realistic only if they are close to what econ profs were already using. We do not see product differentiation! But that's a topic for Econ 243 (Economics of Strategy / Industrial Organization) and not Econ 102.

In 1947 trade was insignificant – Western Europe and Japan were still in ashes, China was descending into civil war while the Iron Curtain shut off Eastern Europe. Samuelson tacked on trade at the end of the book, and remains there in most books 70 years later. As Marc Levinson makes clear in An Extraordinary Time, our course supplement, the structural shift came only with the rise of OPEC and the first oil crisis, which put money into the hands of OPEC, who soon became significant importers. It is also the era when the GATT process was starting to have an impact (the Kennedy Round was signed in 1967, the Tokyo Round in 1979) while containerization was making it easier to move goods. And at the micro level it marked the point where Europe and Japan were high enough in income to matter as markets, and had caught up in an array of technologies (particularly in differentiated products such as motor vehicles) that let them also become exporters. For example, US imports were at the 5% level into the 1970s, first hit 10% in 1979, and 15% in 2004 – and were still at 15% in Q2 of 2017.

Later this term the class will turn its attention to trade balances, returning to the [accounting identity] savings-investment framework we've already developed: (S - I) + (T - G) ≡ (X - M). That framework will, with the addition of theory, help us understand why a macroeconomically significant trade deficit only opened up in the mid 1980s, why it shrank going into the 1990s, and why it then again expanded and has remained that way. One key element: ours will be a macroeconomic story, one in which "competitiveness" is not the issue.

Thursday, October 19, 2017

Dealer Musings (I): Ruggles on Recalls

David Ruggles

I wish I had something pleasant to say about things affecting dealerships. I'll try to come up with something before the end of this series. But if a person long on the sales side of the industry can't think up an optimistic story, maybe there isn't one. After all, how many perennially downbeat sales people have you met?I start though with safety recalls, and follow with gap insurance and then the latest twist in branding that pits the Factory against dealers.

Ah, those of Takata airbags! – one wonders how many potential lawsuits there are driving around with unrepentant airbags. There's the normal problem of owners who never got the word or just never took their cars to a dealer for a fix. Then there's the problem that the initial replacements were done with the same inflators that caused the problem. It hasn't helped that there are more than 100 million such airbags globally, and that there have been long waits for replacement parts. Of course Takata is the extreme as recalls go, but the issues are general.

This places dealers in a precarious position, especially if they are looking to take one of these dangerous vehicles in on trade or if they already have them in inventory. The National Highway Traffic Safety Administration has stated that automakers have the ultimate responsibility for the costs of making this right. In the meantime, what happens when a dealer “knowingly” sell a vehicle with one of the suspect airbags? And in this day and age of data, how could a dealer not know? Answer: by failing to check! That doesn’t seem to be a good excuse in today’s legal environment.

But it gets worse. It is now obvious that Kobe Steel, Ltd, a Japanese company that has subsidiaries around the globe, and supplies the automotive and aircraft industries with critical structural parts, has been falsifying inspection reports. A few days ago Kobe admitted selling potentially substandard (or suspected substandard) materials to scores of manufactures, including Ford, Volvo, Toyota, Honda, Nissan, Mitsubishi, Mercedes-Benz, Tesla, General Motors, Hyundai, and Renault and possibly Mazda. People are nervous, and they should be. Kobe materials are used to fasten the wheels onto 200 mph bullet trains. Fortunately for Ford, it appears the only vehicle impacted by this is a single Chinese model. So far, no manufacturer has flagged a specific use of their steel as a potential issue. Maybe the industry will be lucky and no bad steel is in a bad place. But if records were routinely falsified, there's no data trail to point to whether a specific batch of steel was way out of spec, much less which customer got bad material when. Car companies may have no idea where to start looking. If there were enough problems with a specific part in a specific model to cause a recall, then engineers doing teardowns would surely spot an issue with the steel. But if it's one part here and another part there, or scattered small-volume defects, then there are a few dots and no ready way to connect them.

Time will tell as the investigation plods forward. If there's any news it may come from aerospace. After all, planes get inspected regularly for premature aging in their structural parts, and the average aircraft goes through a lot of stress. The average car does not, but then there are a lot more cars out there than there are airplanes – the global "park" including construction and farm equipment is near enough 1.25 billion vehicles. Anyway, every day I pick up new information in the Japan Times. How do you replace a structural part in a vehicle under a safety recall? Takata has already taken bankruptcy protection. Can Kobe Steel Ltd. be far behind?

Even if such issues get settled in the long run, in the short run the dealer can be left holding the bag. At least one German car company got stuck with Takata airbags. Fortunately they were willing to pay dealers to hold the cars until they could be fixed. Can CarMax risk selling a car that turns out to have a recall outstanding? How about a smaller used car operation? – and remember, every new car dealership has one. A dealer who wants to close a deal today may feel they can't wait until they've checked the recall history on a trade-in. "Come back tomorrow" isn't an option, and that places the dealer at risk.

Wednesday, October 18, 2017

Graph of the Day: Wed 18 Oct

Mike Smitka

Today saw the latest release on residential construction. The default graph on FRED is the total number, of course with multiple series for new starts versus permits versus under construction, and by region. But between 1960 and today the US population rose 80%, from 180 million to an estimated 325 million. Everything else being equal – and it's not, we know that the baby boomers are retiring and downsizing – we would expect the desired amount of housing to reflect the size of our population. So my graph makes that adjustment, dividing by population. As you can see, the current level of housing under construction has doubled since its December 2012 trough, but remains significantly lower than at any time prior to the Great Recession.

One factor is that we clearly built a lot of housing in the years leading up to 2007, when prices suggested demand was insatiable. Housing lasts a long while – these structures will still be around in 2050. Adding to the challenge is that what's going up are multifamily dwellings. That will keep the squeeze on the construction of single family dwellings, which casual observation suggest tend to be larger and in general cost more to build, that is, create more jobs. We'll see what happens, but my sense is that it is not a good time to be an architect, and will remain that way for a decade or more to come. If housing is your passion, then go for renovations. I just wish I had the rights to This Old House!

Monday, October 16, 2017

Graph of the Day: Mon 16 Oct

October 11, 2017

Among the "headline" inflation numbers, experienced observers look not at the overall monthly, seasonally-adjusted CPI but at the CPI less food and energy. You all know what's happened to energy, but you also know that it's temporary, until the effects of Harvey wear off. Food has such effects when a droughts or floods will hit a major crop area one year but not the next. So look at the graphs – not a formal statistical test, but a start! – and look for co-movements of these three indices. Don't see any? Maybe that's why the focus is on "core" inflation!

...inflation remains below 2%...

This is not the only way to try to get at "true" inflation. One is to trim extreme values, positive and negative, resulting in trimmed mean measures. Another is to divide the data into "flexible" and "sticky" prices. Then there are alternate series – the PCE (personal consumption expenditure) index, which uses the definition of consumption in GDP (for example different housing weights) or the broadest of all, the GDP deflator, which includes all goods and services included in GDP (investment, government, imports) and not just consumption. But you don't have to be picky: with thousands of prices reported each month, you can create your own, or you can turn to the Billion Prices Project web site, which uses online data to calculate inflation. (BTW, their data closely tracks the CPI – but they don't offer their latest data for free.)

HeadlineCore Core Sticky Core Flex 16% Trimmed Mean Median Price Trimmed Mean PCE GDP Deflator
- - - - - Sept 2017 - - - - -2017Q2
2.2% 1.7% 2.1% -0.6% 1.8% 2.2% 1.6% 1.6%

Note that I only report 2 significant digits. The computer automatically spits out more, but they're not meaningful.

Oh, the bottom line: inflation remains below 2.0% with no sign of an uptick. But because incremental changes to monetary policy take 9 months to have much effect, and 18 months for the full impact, the Fed has to think about what the economy will be like 4-6 quarters ahead. If we keep adding jobs faster than mandated by demographics, at some point labor markets will tighten and wages will rise ... I hope. Will that then lead to modest inflation and a "normalization" of interest rates? (All theory-laden terms, but not for this post!)

Friday, October 13, 2017

Graph of the Day

Mike Smitka

This graph shows:

  1. the nominal interest rate, here on 3-month Treasury bills (which are short-maturity US government bonds and typically have the lowest interest rate among similar maturity instruments),
  2. the corresponding 3-month rate of inflation for the economy as a whole, in the form of the quarterly GDP implicit price deflator [which is thus much broader than the CPI measure of inflation, as befits an economy-wide interest rate, and which carries an odd name tied to the technical use that motivated developing the measure], and
  3. the difference of the two, the "real" interest rate.
Note that you can drag the bar at the bottom to narrow the time frame. If you hover over a line on the graph, it will give you the values and date. If you hover over the series name, that series will be highlighted in the graph.

What has happened these past 10 years to the real interest rate? Is it "normal" (I won't try to define today) for real interest rates to be negative?

Next up: why focus on "core" CPI?

Monday, October 2, 2017

The Price of Oil

Mike Smitka, Professor of Economics
Washington and Lee University in Lexington VA
from WashU in St. Louis MO, where I'm participating in a conference

Both governments and automotive companies are placing large bets on alternative vehicle drivetrains, above all electric vehicles. In this context Roberto F. Aguilera and Marian Radetzki's The Price of Oil, which Gavin Roberts reviews for Eh.net, appears to be a "must read." I have yet to look at it, and would certainly like to see whether more recent evidence backs up their core claims. Their bottom line is that both new technologies and new politics will keep the price of petroleum low for the next decade. In contrast, I believe both high technical and intractable political hurdles impede the commercialization of battery electric vehicles. Low oil prices amplify these challenges. Really cheap oil makes EVs unlikely to eliminate the gas engine by 2040.

...really cheap oil makes EVs unlikely to eliminate the gas engine...

The core argument of the book is that both technical and political factors will lead to a gusher of oil. Cheap oil. Fracking and horizontal drilling are proving robust. Costs continue to fall, and these will prove viable in a world not just of $100 oil but even $50 oil. Furthermore, while to date they have been used mainly in the US, they are of wide applicability. By 2016 US output had risen 70% from 2008, or from 1.8 billion barrels to 3.2 billion barrels a year. Roberts believes this book provides a compelling argument that the same technologies will enhance secondary extraction around the world, as well as the primary development of new fields. The oil boom is just starting.

...fracking and horizontal drilling are proving robust...

Politics will reinforce this. I've argued on this blog (in "Another Fracking Saudi Oil Conspiracy") that the global swing producer, Saudi Arabia, faces strong pressure to pump more, not less. In an economist's jargon, the demand for oil is insufficiently inelastic in price [yeh, I worked at that alliteration]. Politically the Saudis – and a number of other major oil producers – are desperate for more revenue, and that requires pumping as much as possible.

Aguilera and Radetzki extend that argument to other developing country producers. In particular, low prices will pressure these countries to dismantle their national oil monopolies. As long as oil prices remained high, national oil companies generated a lot of revenue for their political masters without a need to invest in new technology or even to push for good day-to-day operational capabilities. To put this in jargon, rent seeking behavior emphasizes extracting short-term profits over long-term investment.

...rent seeking behavior emphasizes extracting short-term profits...

With today's prices, these national monopolies are no longer delivering sufficient revenue. Saudi Arabia and Nigeria are poster children for this. But national champions retain latent value: outside investors would see an option value due to the possibility of future oil price increases, and could believe that new management and sources of finance could improve both current operational profitability while improving future revenue streams. Selling off national champions is an option, indeed the only short-term option. Saudi Arabia is talking about an IPO for Aramco. Pemex in Mexico and (since the book was written) Petrobras in Brazil are already being restructured. I don't know the details, and this book likely not recent enough to fill them in. Such details are however key to evaluating the strength of their argument.

...selling off national champions is an option, indeed the only short-term [revenue] option...

The other key piece is whether denationalization will bring in new and better management. Would new owners have the leeway to improve operations? Would they bring with them access to new technology and new project funding? To me that sounds like a sensible prediction, but I doubt there's as yet much real-world evidence. These changes are too recent, and the gestation period for implementing management change, much less bringing new capacity online, is too long.

Perhaps the book does have additional evidence, but I find the overall argument plausible, and with it the bad news for the market for EVs. Perhaps I'm parochial: while I've spent 8 years of my post-college career outside the US, I've only rented and not owned and operated a car in Japan and Germany. Indeed, the train systems in metropolitan Tokyo and Munich were so good that I rarely even took a taxi or bus. I may thus be overestimating the relevance of low fossil fuel prices, if elsewhere gas (or carbon) taxes keep prices at the pump high.

I'll keep revisiting this issue over the next several years. Making predictions is hard, especially when they're about the future. But in the auto industry new investments have to be made thinking about what will be needed two model cycles (8-10 years) down the road. The same is true of planning the rollout of new technology. So predict I will, but I will try to revisit then to test my expectations against real-world outcomes.

Sunday, September 17, 2017

Autos can't live without China

mike smitka

I take part in an online discussion forum on Japan that occasionally strays into economics and business topics. One ongoing thread is the potential impact of erecting a "bamboo curtain" around China. A couple posts assert that realigning global production following the elimination of trade with China would not be a big deal. They seem to forget the havoc caused by 3/11 (the Japanese tsunami/earthquake), where damage to a mere two plants impeded global automotive production. One produced a dye essential for certain black/red paints. Red isn't all that popular in most markets, but surely the firms that used it for black lost sales to rival manufacturers who had a different pigment mix. [You don't substitute a different pigment without lots of testing – it's finicky, and the pigment layer may be only 19 microns deep. A different particle size or stickiness and you get paint that looks bad or worse, doesn't adhere. BMW owners won't tolerate peeling paint!] Then there was the Renasas plant in Sendai, which was already in the process of shutting down. Work on their new plant in Southeast Asia was accelerated, and round-the-clock teams worked as well to restart production in Japan. Fortunately there were pretty big inventories and the processor involved was used in more than one function. It did mean certain option packages weren't available, but by so China however would not be just two plants.

...without a global market, it would make much less sense for European, Japanese and Chinese suppliers to set up shop in Detroit...

The quick mistake is looking at the name on the front of the building, and assuming that what could be done by a company in one place could readily and quickly be done by the same company elsewhere. Foxconn, which assembles a big slice of the world's cell phones in Shenzhen in Southern China may for example be a Taiwanese firm, but local operations are very much Chinese. Foxconn does have factories in many parts of the world, but they are not making the same things. Ditto Corning (cell phone glass) and so on. Take down China, you take down everything.

To dig deeper, I provide two examples. One is of cell phones. The other is an extended discussion of the role of China in the global automotive industry. As what I have below is already long for a blog post, and quite frankly it's time to get back to class preparation, I don't provide any numbers for automotive trade. You can find more data and more detail in the China chapter of my recent book, Smitka & Warrian, The Global Auto Industry: Technology and Dynamics, up on Amazon on January 1st. See the link at the top of the right-hand column: as an eBook it's a mere $9.99.

In the case of cell phone production, there’s no place in the US where you could hire 50,000 workers in short order, much less the 100,000+ that Foxconn employs in Shenzhen. We do not have a thousand-plus experienced production engineers and foremen and quality managers and logistics experts and purchasing managers who could be dropped into one place. No other country does, either. We do not have firms that can supply, modify and repair the specialized capital equipment. There are components made only in China, and others that flit back and forth across borders – chip/sensor packaging isn’t necessarily in the same country as either the “fab” or the circuit board assembler. Of course there are also many management systems involved, including how to keep Samsung and Apple from seeing or even hearing rumors about each other’s prototypes. It’s Foxconn that knows how to tweak Apple’s design for volume production, and that has the "creative destruction" (= prototype testing) facilities. It’s not just a bunch of low-skill workers.

That’s even more true of the 山寨机 guerilla cell phone industry. The market for niche cell phones involves a network of small companies and finance specialists, where one company can come up with an idea for a phone. An example is putting two SIM cards in a phone instead of one, not a big deal in the US, but it's important in many countries where different carriers have different service areas, and for people who cross borders frequently. So in the background it's necessary to have close ties to wholesalers who ask for something of that sort. A design house can handle the case, specialist firms tweak the circuitry, others do the software patches, other source the parts and components, and finally a job shop assembles the phones. Of course there’s finance involved, lending to such firms – except for the assembler, none may have as much as a dozen employees – is again on the basis of relational capital. It took years for this network to evolve. Pull out a piece and you have nothing. Now that’s a China-based industry, but it should convey the level of sophistication on the China end of things.

For the automotive case, the posts on the NBR Forum included lists of several global components manufacturers, with the implicit assumption that they had cookie-cutter plants in several locations. Sometimes that's the case, though if China is a big piece of the global automotive pie, there may not be enough capacity. Such plants, though, are no longer the core of what's done in China. Three different strategies governed the entrance of global suppliers into China. Let's work through them.

First, some were “simple” branch plants, which suppliers started building in numbers in the late 1990s, such as for wire harnesses or aftermarket parts or other relatively unsophisticated components. (Caution: what was unsophisticated in 1990 may be a high-tech part today!) This business strategy sought to save on labor costs and export all production. For such technologies there are often only modest economies of scale, and plants are scattered in a number of countries. For wire harnesses more are in the Philippines than China, but some production remains in Mexico. (None in the US, except for low-volume high-voltage harnesses and small-lot production for pre-production vehicles.) Assuming a location with an adequate labor force could be located – such plants quite often employ thousands, and need a hundred or more supervisors and assorted other skilled managers – production could be shifted in a few months. But in the interim automotive production would drop to zero, and for some time quality would remain low. But hey, who needs windows that roll up and not just down, or a transmission that shifts properly?

Second, another pattern was to serve as a regional supply base, but with excess capacity for what in the early 2000s were the bigger markets of the EU and NAFTA. In one particular case with which I'm personally familiar, the capital equipment and top supervisors were from Germany, but there task was to replicate a plant in Virginia (which happened to be the company’s first location for a new high-tech component). Such production in China might not be much affected by US policy, assuming they could continue to import certain components. If there was a supply crunch, it would initially be production in Thailand, Korea and Japan that would shut down. But that would be awkward for a global supplier, so surely a portion of what remained of their global production capacity would be redirected from the US to keep them running, at the expense of producers in the US.

Now in this case there was initially no particular human capital on the Chinese end, but physically moving the equipment and then getting a plant up and running again would take 9 months to a year (that's what it took to set it up in China in the first instance). Of course depending on the legal framework – there was no legal mandate for joint ventures for automotive components, but many firms chose that route – their joint venture partner might not let them ship out the capital equipment, and the Chinese government would surely discourage such, even if you could get paperwork on the US end to permit transiting the bamboo curtain. In that case, ordering new equipment and tweaking the line to get it running would take much, much longer. My sense is that it would prove impossible to do in under 3 years, because of the backlog that would arise as everyone tried to place orders simultaneously. And it might take longer – much of the underlying tool and die capacity is now in China (both machines and skilled tradesmen). In any case, when there are only two-three global plants supplying a particular component for global gasoline engines programs, there would be massive disruption. And for things such as fuel injectors or valves or bearings, engines are designed around a particular firm’s component – no double-sourcing, so the engine would have to be modified to use a rival’s fuel injector or similar component, and then re-certified. But by and large rivals have similar footprints in China, so there’d be no workaround in going to another European/American/Japanese firm.

The third pattern is now the most important. China is the world’s biggest auto market (25 million units of light vehicles, more than either the EU or NAFTA). Many models launch first in China or are variations specific to China, and 40% of sales inside China are of vehicles engineered and assembled by domestic Chinese firms, not “global cars” from VW, GM (the two biggest car firms in China) and other foreign auto companies. To serve these customers, Chinese and otherwise, global suppliers have significant operations in China. Three very large global suppliers ($8-$20 billion sales) I’ve visited recently now have major engineering centers in Shanghai that are part of their core global R&D operations. Over the past decade all three have shifted towards local specialization. As very large firms, each has a dozen-plus R&D centers, located in at least a half-dozen countries. At one time they'd each do a little bit of lots of things. Now each center focuses on a specific component or technology as a "global center of excellence". As a reflection of that strategy, R&D in Shanghai is integral to global operations. Indeed, one of these firms (quietly) moved divisional HQ operations there, too, planned over a number of years to coincide with the retirement of several key people in the home country. First the senior person worked in Shanghai for a couple years, and then his designated Chinese successor worked at divisional HQ in the home country for a couple years, with others less senior moving back and forth for shorter stays (6 months or more) over a period of years. To repeat, it took years to set up a new R&D center, to build a team who could work with each other and with the rest of the global enterprise.

One driver for this particular firm was the ability to hire engineers in China. Another, though, was that China was the division’s largest and most profitable market. Indeed, today GM’s main engineering center in Asia is at PATAC in Shanghai, with over 2000 engineers and 15-plus years effort at building up teams (subcompacts continued to be done by Daewoo in Korea, but more and more of the next larger platform is done in China, not just the "top hat"). With GM’s sale of their European operations (Opel/Vauxhall) to PSA, Shanghai is now central to GM’s ability to design vehicles (again, platforms, and not just “top hats” for the Chinese market). To my knowledge other firms (eg, VW) are less China-heavy in their engineering, particularly the Japanese and Korean firms, but all have major operations there.

In sum, the auto industry is today tightly integrated on a global basis. You can’t pull out one piece from any of the 3 major centers (NAFTA, EU, China/Japan/Korea), and major suppliers typically have additional pieces of their global R&D footprint in Southeast Asia, India and Brazil. Factories are not mobile, engineering centers less so. Building a bamboo curtain between the US and China would shut down the US industry, and not just for months. It would be particularly ironic in that a couple initial studies suggest that the role of Detroit as a global engineering center is increasing – it’s no longer just a regional NAFTA role. That includes Chinese suppliers locating R&D centers in Michigan (I’ve visited one). Of course I’ve also visited factories in the US that ship a significant part of their output to China. Without a global market, it would make much less sense for European, Japanese and Chinese suppliers to set up shop in Detroit.

But it would be a huge hit to many industries, not just autos. It wouldn’t make America great again, and if the impetus came from the Washington, it would lead global firms to not put anything of value in the US.

Thursday, September 14, 2017

Sugar tariffs

Mike Smitka
reposted from my Econ 102 Macro Principles blog

First, here are data to help you remember that import prices are not everything. Prices effectively triple between the wholesale price sugar farmers such as the Fanjul brothers receive, and the price you pay in a store. A big baker will pay something much closer to the wholesale than the retail price - if you buy by the train car (not the truckload!), delivery costs per pound are very low. The price gap between Brazilian and US sugar is about 40%. So even if the tariff was eliminated, the price would only fall by about 6¢ wholesale, and by about the same retail. How eager would consumers be to fight over 6¢ per pound? Even though I do some baking, it takes me over 1 year to use a 5 lb bag!

Prices1980's Average2013
Brazil Raw Sugar Price - 14 cents
U.S. Raw Sugar Price22.16 cents20.46 cents
US Wholesale Refined Sugar Price27.06 cents27.22 cents
Grocery Store Refined Sugar Price33.59 cents64.32 cents

Source: US Sugar Prices - American Sugar Alliance, IndexMundi for the Brazil price and XE.com for the Brazilian Real / US$ exchange rate.

Then there is the political economy. The first sugar tariff dates to 1789. Protection was strengthened during the Great Depression with the 1934 Sugar Act, including policies to raise farmer's incomes while at the same time using rationing (esp during WWII) to avoid raising consumer prices. That Act expired in 1974, but in view of his pending election campaign President Ford tripled the import tariff. Presidents Reagan, and George HW Bush also implemented protective measures, while George H Bush was able to veto the Farm Bill in 2008 knowing that Congress would (did!) override his veto. Both Carter (a farmer!) and Clinton (who grew up in a farm district) turned down policies that would have increased sugar protection. There were no changes under Obama. See the Coalition for Sugar Reform for details.

In both the EU and the US the sugar that you buy in a store or get in a restaurant sugar packet is beet sugar. Production dates to the 19th century, when new cultivars with higher sugar content made it a profitable crop, first in Europe and then in the US. In Japan sugar beets were cultivated in the 19th century, but then the expansion of the Empire southward to Taiwan (1895) led to more sugar cane. Today 2/3rds of Japan's sugar is imported, and there remains enough near-tropical land that 20% of domestic output is from sugar cane. Sugar beets are still the overwhelming domestic source. Oh, and that's because of tariffs in all 3 regions.

Sugar growers are a powerful lobby. The Fanjul brothers own over 150,000 acres of Palm Beach County, Florida. That's a potential swing state in national elections (do you know the term "hanging chad"?). Both are politically active – one a Republican, the other not by chance a Democrat. In the Midwest corn farmers are a potent lobby, and in a handful of states so are sugar beet growers. The Senate thus has a big block in favor of agricultural protection. This political economy – enough farmers in enough electoral districts that their vote is essential – is true in Japan, the European Union and NAFTA. In the former two, unless I'm mistaken, direct and indirect farm subsidies are greater than aggregate farm income. The CAP (Common Agricultural Policy) is the single biggest item in the EU budget. Through the good fortune of geography agriculture in the US is inherently more productive, so our overall subsidies are less. It is nevertheless the sector where trade is most constrained by a web of quotas, tariffs, subsidies, cropping restrictions, loan programs and tax breaks.

...trade in sugar could have sweetened the Doha Round...

This matters not just because it was a barrier to the continued integration of the European economies – agriculture has been the biggest sticking point in the various EU expansions, and with attempts to create greater policy cohesion among existing members. On the global trade front, the Doha Round was intended to extend the WTO to cover agriculture, which largely left the sector untouched, other than requesting countries adopt tariffs in place of quotas. [See the textbook for why tariffs are far the better means of protection.] But the politics – dispersed consumers but a geographically concentrated industry, big enough to affect a significant minority of electoral districts in every high-income economy – meant no progress was made. Without progress, however, there was little "benefit" for negotiators from developing countries to take home. The talks have effectively collapsed, and there is no near-term ability to renew them.

...comparative advantage implies we benefit from unilaterally making importing easier...

One real challenge is that several large developing countries are themselves facing pressure to subsidize farmers. China may not be a democracy, but the majority of urban residents have close relatives back on the farm. Keeping urban areas quiet requires making life better in the countryside. Most Chinese farmers now receive cash subsidies. Ten years ago they might have gladly offered many "concessions" to the US and Europe and Japan in agriculture. Now that dynamic is changing. We all lose. Comparative advantage implies we benefit from unilaterally making importing easier. That includes agricultural products. If we're concerned with issues of urban poverty, as is the case now in China, then agricultural imports are particularly beneficial. But because of the politics of "reciprocity," the agricultural sector impedes continued global negotiations. That would be fine if we could rest on our laurels. However, economies are not static, and so areas where all would benefit (healthcare-related sectors, under the rubric of "intellectual property") cannot be addressed because the horse-trading, multilateral most-favored-nation process of global trade negotiations has fallen under the weight of agricultural lobbies. The very real fear is that trade deals are like bicycles: unless they keep moving forward, they fall over and retrogress. Trade in sugar could have sweetened the Doha Round. Politics nixed that.

Tuesday, September 5, 2017

Automotive Employment Decomposed: New vs Used Car Dealers

Mike Smitka
...employments is centered in new car dealers and parts manufacturers...

Scott Wood of Carvana asked me about the increase in employment in automotive retail. With a bit of poking, I found that the Current Employment Survey (CES) run by the BLS provides fairly detailed breakdowns. Now I very strongly suspect that in the survey responses, employees at a new car dealer are not subdivided into those who work in service vs finance vs new sales vs used sales. All are likely classed by the main  business category of new car sales. Still, this provides a starting point. As it happens, while used car dealership employees have risen faster, the bulk of the increase in employment stems from the rise in new car dealership employees. While I'm at it, I also am posting (i) car vs parts/accessories/tires and (ii) assembly vs parts manufacturing. As expected – well, at least by me! – people who work in parts plants vastly outnumber those at "the" car companies. The latter get the political attention, but they're not the ones who "make" cars, they just put together the pieces.