China’s Challenge

A decent article in the LA Times about the challenges facing the Chinese:

China tries to put brakes on overheated economy – How well China succeeds in slowing its economy without triggering a slump holds enormous consequences for the rest of the world economy.


The essence is that the Chinese economy, which has been growing at 8-9% per year for nearly two decades has based it’s growth on heavy investment spending and strong exports. In particular, to help China overcome the global recession in 2008-09, the Chinese government launched a huge Keynesian-style stimulus program of government spending and support for bank lending.  It worked.  In fact, it worked better than the weaker attempts made in most other nations.  But now, China faces a challenge.  It’s been growing so fast for so long, that the really attractive investment opportunities are gone.  Now the bank lending craze and investment craze is going after very dubious and low-return projects.    The nation is starting to push up against it’s limits.  When that happens, when the economy’s resources are already fully occupied (particularly labor), then you get inflation.  Indeed China is now experiencing some moderate and rising inflation.   They already have what appears to be a real-estate price bubble.  What they have to do is to  gradually switch over to more consumption than investment, but that’s a hard transition to make smoothly.  If they fail and their economy goes into a crash or even a moderately bad recession, it’s bad news for everybody because right now, China’s one of the strongest economies on the global scene. The U.S. needs China to keep growing if the U.S. hopes to expand it’s exports.

Aftershocks: Prepare for the Slowdown

I’m back from the Higher Learning Commission conference in Chicago, which is why postings have been sparse.  I probably won’t get really back up to speed on postings for yet another few days because I’ve teaching, grading, and taxes to do.

In Japan, the aftershocks continue from the massive March 11 earthquake and tsunami.  The global economy is beginning to experience aftershocks from the triple disaster (quake-tsunami-nuclear meltdown) as well.  As readers might remember, I pointed out last month that the disaster would prove to be the first real large scale “stress test” of the concept of globalization in manufacturing.  The initial expectation of economists after the disaster was that it would prove a challenge and shock to the Japanese economy but that there really wouldn’t be much impact outside of Japan.  Now we are starting to see that this initial reaction was wrong.  We are starting to see aftershocks in the global economy.

The news for the last two weeks in the global auto industry has been about supply-chain interruptions and temporary plant closures. For example Forbes reports today on Toyota’s announcement:

Toyota Motor Corp. said today it is going to halt production in Europe for eight days due to parts supply shortages resulting from Marchs earthquake and tsunami.

The shutdowns will take place from April 21 to May 2.

Assembly plants in the U.K., France and Turkey will be impacted as well as engine manufacturing facilities in the U.K. and Poland.

The plants will then run at a limited capacity.

This is on top of earlier announcements of rolling temporary shutdowns at U.S. plants and the continued shutdown or slowed production at it’s Japan plants.  Other news reports today have Toyota advising U.S. dealers that there will likely be shortages of some models at showrooms this summer.  Other reports.

You can’t sell cars you don’t have and haven’t built.  And you can’t build cars without all the parts – less than 100% of the parts is just not enough. Phillipines, Japan, Turkey, France, U.S., Germany, Britain.  This is global. And it’s not just one company. It’s across the industry since most firms had all adopted the same globalized supply chain strategy built around single sources for key parts.

It’s also not just the auto industry. The Wall Street Journal reports how electronics manufacturers are being affected:

Over the weekend, the Nikkei reported that Sharp halted LCD panel production at its Kameyama plant in Mie Prefecture, western Japan, and at its Sakai plant in Osaka until after the Golden Week holiday season in early May. The paper cited disruptions to industrial gas supplies and said the company expects to secure more gas in about a month…

Sony said Friday it is suspending operations at its optical parts and IC cards plant in Miyagi prefecture in northeastern Japan, following a power outage caused by the biggest aftershock to hit the area late Thursday.

A Sony spokeswoman said the plant will resume operations as soon as the power supply has been restored.

“Electronics makers and auto makers are extremely sensitive to further damages as it is becoming increasingly unclear how soon companies can resume full production,” Watanabe said.

I think it’s safe now to say that Japanese earthquake-driven interruptions to supply chains are more than just a “risk” to the global economic performance. We should consider the interruptions and concomitant plant shutdowns as a factor currently slowing economic growth.  At this time, the big question is just how much they will slow growth and even potentially reduce employment.

As I’ve mentioned previously, I have no great (or little) econometric model that I use.  I just go on my intuition.  Right now, I’m thinking the supply chain interruptions reduce GDP growth in the U.S. in second and third quarter 2011 by maybe 0.2-0.3 percentage points.  That’s not much. And in normal times it could be easily absorbed.  But this is not normal times.  We only grew at 2.9% in 4Q 2010.  We won’t know 1Q 2011 growth for another two weeks, but estimates are running lower – in the 1.5 to 2.5% range.  We need growth above 4% if we are to make serious inroads on re-hiring the nearly 20 million unemployed people, so, yes, this hurts.

And, like all aftershocks, this one is not isolated. There’s other aftershocks starting to hit our economy. Aftershocks from misguided budget deals and misguided European monetary policy.  I’ll talk more about those as I get time. Unlike GE, I have to pay my taxes this weekend.

Possible Economic Effects of Japanese Disasters

Some information is starting to develop about the economic impacts of the events in Japan.  A week ago, just after the triple disasters of earthquake, tsunami, and nuclear plant partial meltdown, it was much too difficult to foresee the probable impacts of the crisis. Now it’s starting to show and the news is not encouraging for a world that was only engaged in a weak precarious “recovery” from the Global Recession/Global Financial Crisis.

This crisis is really going to be a “stress-test” of modern globalized supply-chains.  The growth of world trade, particularly trade with and within Asia in the last 2 decades has been less about traditional trade, the buying and selling of finished goods between independent agents in different countries.  Instead, “globalization” is increasingly about extended specialization that stretches production processes around the globe. In traditional trade, a disruption of supply from one region is quickly substituted by other products from other regions. Thus traditionally, a natural disaster in one area tended to harm the economy of that region but not have ripple effects elsewhere.  Now, with globalized supply chains for complex designed products like consumer electronics, automobiles, industrial equipment, and computers, a simple disruption in one region might require the shutdown of production in far distant regions as parts become scarce.  Parts of sub-assemblies are usually design-specific and cannot be easily replaced by other sources.

We’re seeing the early signs of such problems.  Last week GM announced the temporary shutdown of an assembly plant in Shreveport, LA due to a lack of parts from Japan.  The NYTimes and WSJ report, via Calculated Risk, that in Japan itself, while Nissan has announced the first re-start of an entire auto assembly plant, resumption of full production at Japanese automakes remains uncertain.  Honda has warned that full production may not restart until May.  They also report that GM has had to curtail production at at least 2 plants in Europe in Spain and Germany. Now today, USA Today reports that the GM shutdown in Shreveport has rippled back to Tonawonda, NY, where GM makes engines for the pickups that are hung up pending Japanese parts.  More on the Japanese struggles to recover at the NYTimes.

Right now, many economists, particularly investment bank economists are saying the risks to global growth are minimal.  But much of their argument is based on the past and the experience with the Kobe earthquake in Japan in 1994.  I’m not so sure.  For one thing, the global supply chains are much more complex and tightly integrated now than they were after Kobe.  It’s not just autos. It’s also a lot of other industries and production spread throughout east Asia such as Hong Kong, Taiwan, Thailand, and Korea.

Another very serious factor is how fast electrical power generation can be restored.  The Economist quotes Richard Koo:

the country as a whole might have suffered about a 12% decline in its capacity to supply electricity. Since the elasticity of electricy usage to GDP is about 2, this means that Japan’s GDP might have shrunk by as much as 6% in the wake of this disaster. Although efforts to improve electricity supply are on the way, even a momentary GDP decline of 6% is a huge shock to the economy.

I’m inclined to agree.  Electricity capacity is not quickly restored if the entire plants are scrapped as is happening with Fukashima, the site of the destroyed nuclear reactors.  This could mean a very deep contraction for Japan with a slow recovery. A 6% decline in the third largest GDP in the world and one of the most active trading partners would be a very serious dent in the world economy.  Especially at a time when Europe is struggling to grow because of it’s Euro-strait jacket monetary system and growth-reducing austerity policies.

Here in the U.S., we are facing our own threats to this very anemic “recovery” in the form of deeper state and local government spending and employment cuts.  We are also facing the prospect of higher gas prices for a protracted period which will also slow the economy.  I had hopes that the Japanese disasters, by slowing the Japanese economy, might at least weaken global demand for oil and possibly temper the recent rises in prices. But, alas, with the weekend decision to bomb Libya, oil prices have once again begun to rise.

AT&T and T-Mobile: New Boss, Same As Old Boss

The U.K. Guardian brings us the telecommunication news yesterday of a new cell phone overlord in the U.S.:

In what would be one of the biggest deals since the financial crisis broke, the US telecoms giant AT&T has agreed to buy T-Mobile USA from Deutsche Telekom for $39bn (£24bn), creating the biggest mobile operator in the US.

The deal would bring together the second and third largest mobile groups in the US and will thus face intense regulatory scrutiny. If approved, the merger would shrink the number of major national wireless operators in the US to three from four.

The article warns that the Federal Communications Commission, which has to approve such a merger, has “warned against growing concentration among mobile providers”.  I won’t hold my breath.  The FCC, and the Federal Trade Commission  for that matter, will stamp their feet a little, demand documents, and do a “review”.  Then they will approve it.  In fact, I’ll go so far as to predict that the approval will happen before the internal IT staffs can figure out how to merge the customer billing systems. There’s very, very little in the way of mergers in the last 25 years that Washington won’t approve. The concept of anti-trust is long, long dead.

This merger will create a new monster-sized cell-phone network. (ATT-Mobile?) The new combine will be a 1/3 larger than the current king-of-the-hill, Verizon Wireless. Indeed, there will be only really three networks left, the new ATT-Mobile, Verizon Wireless, and Sprint-Nextel. Consumer choices and options will narrow further. Competition, already weak, will diminish further. AT&T claims in a press release quoted in the Guardian article that:

The firm claims the US wireless industry is “one of the most fiercely competitive markets in the world and will remain so after this deal. The US is one of the few countries in the world where a large majority of consumers can choose from five or more wireless providers in their local market. For example, in 18 of the top 20 US local markets, there are five or more providers.” AT&T also argued that jointly the firms would provide a better wireless broadband service to rural areas, an Obama administration priority.

Hogwash. The reality is that there are 4 major networks now. In 18 major cities there is one or two very small, local, minor fringe players that really only compete for low-cost voice/text traffic and not for data. Think MetroPCS for example. After this merger there will be only 3 major players and maybe another small, insignificant player in each market.  I doubt that will last long either.  Verizon Wireless, having been toppled from it’s perch as largest will soon be on the prowl for acquisitions.  I can easily see Sprint-Nextel being acquired by Verizon.  If nothing else, the several little local players like MetroPCS will no doubt be sending their investment bankers to Verizon with “buy-me” proposals.  At best, we face only 3 competitors. One of those, AT&T, has proven itself reluctant to innovate or invest heavily to meet the growth in data traffic (can say “throttling on iPhone’s?”).  AT&T’s concept of innovation is to lock-in exclusive deals with phones that consumers want such as the iPhone and then milk the quasi-monopoly.  When the monopoly on iPhone ended and Verizon begins offering competition, it takes AT&T less than two months to respond by purchasing a competitor.

There’s another way that competition is lessened. T-Mobile was primarily owned by Deutsche Telekom, the European telecommunications giant created in 1996 when the German telephone and postal system was privatized.  Suppose T-Mobile were sold to another non-cell phone firm.  That would actually increase competition since DT could provide some market discipline through the threat of re-entering.  It could provide what we call a “potential new entrant” since the parent company could, if it wanted, invest and take the firm in new directions.  Now AT&T doesn’t have to worry about Deutsche Telekom.  DT will retain an 8% ownership stake in the new venture meaning that DT is eliminated as potential future competitor or new entrant.  DT will not enter or re-enter the U.S. market since it would lessen the value of their 8% investment.

It’s also an example of how globalization, which is allegedly about increasing world competition, actually lowers competition worldwide.  On a global basis, AT&T and Deutsche Telekom are competitors. They should be threats to enter each other’s markets anywhere. But in practicality they aren’t competitors. They are partners in a variety businesses. In this case, both the AT&T corporate parent and Deutsche Telekom will be co-owners of the new AT&T Cellular in the U.S.  Partners don’t aggressively compete with each other. They find ways to “live and let live” and to allow each to mutually prosper (at the expense of customers).  The partnerships then extend elsewhere. In Europe, DT is also a co-owner partner in a joint T-Mobile Europe venture with Orange, another European telecommunications firm. So now Orange, which could conceivably try to enter the U.S. market, is very unlikely to consider it. It would upset AT&T which would upset DT which could hurt the Orange-T-Mobile venture.  Got it? It’s all a giant world-wide club – the 21st century version of John D. Rockefeller’s trust arrangements. It’s all designed to create “value” for the “shareholders”, although I suspect the management will siphon off a lot of the value before it gets to the shareholders.

So where’s the “value” come from?  Consumers get ready. It’s your pockets.  The bills will get larger and the discounts scarcer and the customer service worse.  ATT explains in the same article:

The combined company is expected to earn back the price of the deal in the next three years as it makes more money from customers and reduces costs by closing retail outlets and cutting back office, technical and call centre staff.

So AT&T expects to save $25 billion over the next 3 years from “more money from customers” and “reduces costs”.  Look at those cost savings listed. That’s not efficiency. That’s cutbacks in customer service. And probably even more dropped cal…….


Boeing Learns a Lesson In Theory of the Firm – Outsourcing Isn’t Always Profitable

Boeing is learning a hard lesson in what micro-economists call the “theory of the firm”.  Theory of the firm is the branch of econ that explores the question of “why do corporations exist?” and “why do they vary in size?”.  First, from the LA Times (much more at the linked article itself):

The airliner is billions of dollars over budget and about three years late. Much of the blame belongs to the company’s farming out work to suppliers around the nation and in foreign countries…

Case in point: Boeing Co. and its 787 Dreamliner.
The next-generation airliner is billions of dollars over budget and about three years late; the first paying passengers won’t be boarding until this fall, if then. Some of the delay stems from the plane’s advances in design, engineering and material, which made it harder to build. A two-month machinists strike in 2008 didn’t help.

But much of the blame belongs to the company’s quantum leap in farming out the design and manufacture of crucial components to suppliers around the nation and in foreign countries such as Italy, Sweden, China, and South Korea. Boeing’s dream was to save money. The reality is that it would have been cheaper to keep a lot of this work in-house…

Paul Krugman summarizes the relationship to some modern theory of the firm writings:

Oliver Williamson shared the 2009 Nobel mainly because of his work on a question that may seem obvious, but is much less so once you think about it: why are there so many big companies? Why not just rely on markets to coordinate activity among individuals or small firms? Why, in effect, do we have a lot of fairly large command-and-control economies embedded in our market system?

Williamson answered this in terms of the difficulties of writing complete contracts; when the tasks that need to be done are complex, so that you can’t fully specify what people should do in advance, there can be a lot of slippage and strategic behavior if you rely on market incentives; in such cases it can be better to do these things in-house, so that you can simply tell people to do something a particular way or to change their behavior.

In Boeing’s case, they outsourced far too much, only to find that they were getting parts that didn’t do what they were supposed to — and also to find that the subcontractors were seizing a lot of the rents. They discovered, in effect, that there are times when it’s better to rely on central planning than to leave things up to the market.

Obviously this isn’t always true. There’s a tradeoff. But that’s the point — and it’s this tradeoff that determines how big firms should be. Boeing has now provided a clear motivating example. Their loss, the economics profession’s gain.

Paul Walker at Anti-Dismal offers a more complete explanation of Williamson’s ideas.  And, of course, Williamson’s books, unlike many by Nobel-winning economists, are actually rather readable by non-economists.


China: Working Conditions & Globalization

Interesting Q & A on Labor Compliance in China. Did Anyone Learn Anything from Nike? from All Roads Lead to China.

what are the biggest compliance issues that exist in china?
The more common compliance issue in China is about working time. It is found in almost every factory as the Chinese law is quite strict (40 hours per week), but the reality is that the average working time is among the highest worldwide with around 70 to 75 hours per week.

The toughest compliance issue, bounded labour (i.e. young child labour),  is rarely an issue of big factories. Second to the issue of child labor though is that we regularly meet factories that pay workers once a year only, which essentially means that workers can’t resign from their job once they have started. This kind of practice leads workers to be fully dependent on the factory, even in case of major needs to change.

Do firms (buyers)understand the conditions on the ground? do they plan well?

Most of them don’t understand. Actually to be able to claim you are working with compliant factories only is already an evidence of lack of awareness of real situation.When I do training in companies on social situation in factories, I have people astonished by actual situation, and because many figures are not easily understandable , I spend a lot of time helping them understand the meaning of these figures.

Go read the whole thing.

Will G-2o actually resist protectionism? or is Ecuador showing the way?

Ecuador resorts to protectionism in the crisis. Major nations are also leaning towards protectionism.  Can we avoid the kind of disaster that happened to world trade in the 1930’s.  More at Christian Science Monitor.

“Ecuador is really the outlier here, it’s been the most enthusiastic,” says Gary Hufbauer, a trade policy expert at the Peterson Institute for International Economics in Washington. “From what I’ve heard, it’s been the most dramatic example of protectionism.”

Guidelines to prevent such barriers from going up are a centerpiece of the Group of 20 summit today in London. But it will be no easy task. While Ecuador’s policy stands as a dramatic example, governments around the globe have put in place nearly 100 such measures since August, says Mr. Hufbauer.

The World Trade Organization estimates that the volume of global trade will shrink by 9 percent this year – the largest contraction since World War II. And if the recession continues to deepen, the political pressures on governments to prop up their domestic markets will only grow.

“Up to now, there have not been major [protectionist] policy decisions by governments.… [T]here is a powerful lesson from the 1930s, and we don’t want to go there,” says Edward Gresser, trade director at the Progressive Policy Institute in Washington. “But I think there is a pretty widely held feeling that if a major country decided to begin closing its markets, others might quickly follow. You’d get a quick chain reaction.”