Brookings: Experts - Martin Neil Baily

Regulating Non-Bank Systemically Important Financial Institutions

Thu, 09 May 2013 09:00:00 -0400

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May 9, 2013
9:00 AM - 11:00 AM EDT

Saul/Zilkha Rooms
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

The Dodd-Frank Act requires federal regulators to name financial institutions that are “systemically important” (SIFIs). These institutions will be subject to greater scrutiny by regulators who will have the legal ability to impose additional regulations on them. How should authorities decide which financial institutions other than banks should be designated as SIFIs? Once designated, how should they be regulated? The analysis is particularly challenging for financial groups with life insurance units at their core, given their differences with banking.

On May 9, the Economic Studies program at Brookings reviewed the designation and regulation of non-bank SIFIs, with particular emphasis on life insurers. Panelists included experts from academia, as well as Martin Baily, senior fellow and director of the Initiative on Business and Public Policy at Brookings. Douglas Elliott, fellow in Economic Studies, served as moderator of the panel on the designation of SIFIs and also presented some views on the regulation of non-bank SIFIs once they have been designated.

Read Doug Elliott's paper, "Regulating Systemically Important Financial Institutions That Are Not Banks" »

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Regulating Non-Bank Systemically Important Financial Institutions

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A Bipartisan Case for Chained CPI

Martin Neil Baily and Glenn Hubbard — Thu, 09 May 2013 00:00:00 -0400

Over the last few days, politically driven critics have called on the president to abandon his support for changing the way the government indexes provisions in the budget to inflation by switching to “chained CPI.” Looking beyond politics, we’re here to say that these critics’ arguments are wrong on their merits.

As economists from opposite ends of the political spectrum, we would strongly urge the president and leaders in Congress to continue to support moving to chained CPI, which represents the most accurate available measure of inflation and cost-of-living increases. Switching to this more accurate measure of inflation represents the right technical, fiscal and retirement policy—and policymakers should not delay any further in making this improvement.

From a technical sense, the current CPI—or consumer price index—that is used to index many parts of the budget and tax code is widely understood to overstate inflation. This is because it fails to account for so-called “substitution bias,” in which consumers reallocate their purchases depending on the relative prices of similar goods. For example, if the price of apples goes up, consumers will buy more oranges. However, this behavior is not accounted for in standard CPI measurements.

The Bureau of Labor Statistics, which calculates the CPI, is very aware of this shortcoming, which is why it has developed and refined the chained CPI for more than a decade. The nonpartisan Congressional Budget Office states that the chained CPI “provides an unbiased estimate of changes in the cost of living from one month to the next.”

Some argue that using the chained CPI to index Social Security benefits is inappropriate because it does not reflect inflation for retirees, which critics suggest is higher than it is for working-age adults because of the elderly’s higher rate of spending on healthcare. However, the CBO has said that based on the available research, it is unclear whether the cost of living actually grows at a faster rate for the elderly than for younger people, and that the CPI-E —“E” for “experimental”—which was intended to provide a more accurate measure of inflation for seniors, has several methodological flaws that overstate inflation, including underestimating the rate of improvement in healthcare.

Beyond the technical case for the chained CPI, there is a strong fiscal case. Because current measures currently overstate inflation by about 0.25 percent per year, moving to a more accurate measure would result in real deficit reduction. Measuring inflation more accurately would generate savings from throughout government: about $390 billion in the first decade alone. Roughly one-third of those savings would come from slower growth in Social Security benefits, another third from revenue increases (as certain tax provisions such as the cutoff points of income tax brackets are indexed to inflation) and the remaining savings from a combination of other spending programs and lower interest payments on the debt. Given the very real need to begin to put our debt on a sustainable path, this would be a small but important contribution. The savings would be gradual, with only a small amount in the near term, thus protecting our fragile recovery from immediate austerity.

Finally, switching to chained CPI is the right retirement policy—or rather, a small piece of it. The Social Security program is on a path to exhaust its trust fund. Current projections indicate that this will occur in 2033, threatening cuts for all beneficiaries, including the very rich and the very poor, the very young and the very old, veterans, disabled workers and others. Improving the way we measure inflation won’t prevent the program’s looming insolvency, but it will eliminate a full fifth of the long-term funding gap.

To the extent that the overpayments under the current formula offset the shortcomings of our current retirement system for the lowest-income and most-elderly beneficiaries, a switch to chained CPI can and should be accompanied by targeted policy changes providing benefit enhancements designed to help the affected populations, rather than providing higher-than-justified inflation adjustments for all beneficiaries.

The federal government should not knowingly continue to measure inflation inaccurately, especially given the costs to the budget and to the Social Security program. Changes that cut Social Security benefits are a tough sell for Democrats, and changes that increase revenue are a tough sell for Republicans. But if they cannot even agree to a technical correction to those areas of the budget, how will they be able to make the hard choices to control our debt and reform our government over the long term?

Authors

Martin Neil Baily
Glenn Hubbard

Publication: The Hill

Image Source: © Fred Prouser / Reuters

Discussing the Global Investment in American Jobs Act of 2013

Martin Neil Baily — Thu, 18 Apr 2013 09:30:00 -0400

Introduction

I would like to thank Chairman Terry, Ranking Member Schakowsky and the members of the Committee for the opportunity to present my testimony today on the Global Investment in American Jobs Act. I have had the opportunity over the past twenty years or more to do research on issues of productivity, competitiveness and the impact of foreign investment, looking not only at the United States but also at Europe, Japan, Korea and many emerging markets.

The American economy today is improving but fragile. Real GDP growth is expected to be around 3 percent in the first quarter of this year but only about 1 percent in the second quarter and be well below 3 percent for the second half of the year because of the impact of payroll tax increases and the sequester. The number of jobs is increasing but too slowly. After flat-lining in the middle quarters of 2012, business investment picked up in the fourth quarter, but we need a lot more investment in order to create the jobs needed to raise living standards.

To a great extent, the performance of our economy over the next 10 years or so depends on the contributions here at home of U.S. workers and companies. The competitive position of this country in the global economy will play a vital role and I applaud the House for proposing a comprehensive review of how to make the U.S. economy a more attractive place to invest for foreign companies. In the years after World War II, it was American companies that went overseas, bringing with them technology and business expertise as well as capital. These companies helped spread prosperity to the rest of the world, a process that is still happening. But today successful, productive companies from around the world are investing in America, bringing jobs, capital and, in some cases, new technologies and business efficiencies. The auto company that exports the most outside North America is BMW. Toyota makes the bestselling cars in America in its factories here; and Siemens is helping fix the electric power grid.

The inflow of foreign direct investment slowed as a result of the Great Recession, not surprisingly, but there is tremendous potential to increase that flow now and in the future, bringing additional jobs and boosting the economic recovery. Making America a location that attracts good foreign companies is very important and, by the way, those same factors will also make it more attractive for U.S. multinational companies to locate more of their investment here at home.

The Pattern of Foreign Direct Investment

Figure 1 below shows the inflow of foreign direct investment to the United States and the outflow of direct investment by U.S. companies overseas. The figure shows that the magnitudes of the inflow and outflows are comparable, although the outflow has been larger than the inflow for all but one year since around 2001. There was a surge of foreign investment into the U.S. market at the time of the technology boom in the 1990s, which dropped sharply when that boom subsided. The level of foreign inflows has not reached its 2000 peak since then. Is it a problem that the outflows exceed the inflows? The U.S. economy attracts huge amounts of capital from around the world every year. The McKinsey Global Institute estimated that between 2000 and 2007, 85 percent of the international capital available in the world (in the form of total current account surpluses) came to the United States, largely in the form of purchases of financial assets. Almost certainly, the U.S. economy became too reliant on foreign capital at that time. The capital inflows were the counterpart to the large current account and trade deficits and the easy access to funds contributed to the housing boom and subsequent bust. Direct foreign investment inflows are different, however, in that they are stable and brings jobs and production. Bringing in more foreign direct investment, even while we rely less on foreign purchases of U.S. financial assets, would be a plus for the economy.

Figure 1: Foreign Direct Investment in the United States and U.S. Direst Investment Abroad, Annual Flows, 1990-2011 (in billions of dollars)

Source: U.S. Department of Commerce

Figure 2 below looks at direct investment inflows to China compared to the United States. Over the entire period from 1995 to the present, direct investment in the United States was far greater than the flow into China. Of course, China traditionally put up barriers to foreign investment and even today many companies report that it is hard place in which to invest and do business. In 2012, however, based on the first three quarters of data, direct foreign investment into China exceeded the flow into the United States. Is this a matter of concern? Yes and no. China’s economy is growing rapidly and will likely become larger than the U.S. economy in the future. It is not surprising that multinational companies want to access China’s labor pool and its market. It is also notable that the direct investment flowing into China is not coming primarily from U.S. multinationals. Some American companies, like GM or Ford, have set up business in China, but most of the investment in China is from Taiwan, Korea and elsewhere, not from the U.S. On the other hand, the recent weakness in investment inflows in the past few years, visible in Figures 1 and 2, may be indicative of the lack of relative attractiveness of the United States to foreign investors.

Figure 2: Foreign Direct Investment into China and the United States

Source: World Bank, OECD. * Figures for 2012 obtained by annualizing the first three quarters.

Figures 3 below shows information about the stock of foreign direct investment located in the United States by industry and, below that, by country. Two points are notable. First, a disproportionate fraction of foreign investment coming to the United States is in the manufacturing sector. This important sector makes up less than 10 percent of the economy today but a much larger share of foreign investment stock. Over the past twenty years or more there has been concern that the U.S. economy is not devoting enough of its investment to manufacturing, having an adverse impact on competitiveness and contributing to the large chronic trade deficit. It is notable that foreign-based multinationals have shown greater willingness to invest in manufacturing operations and are adding to competitiveness. Second, by far the largest proportion of the foreign investment (71 percent) comes from European countries, with the next largest coming from Asia, notably Japan, but also Korea. The UK, Netherlands, Switzerland, Germany and France are the largest investors from Europe. This pattern of investment coming from Europe and Asia is not perhaps surprising since these economies are among the most developed with global leading companies, strong technologies and efficient business practices. These countries are also strong allies of the United States. The economic problems in Europe and Japan help explain the decline in the inflow of investment. When foreign companies are stressed at home they are less willing to invest here.

Figures 3: The Cumulative Stock of Foreign Investment in the United States by Industry and by Geography.

The Pros of Foreign Investment in the United States

1. Foreign companies can bring new technologies and efficient operations. Overall, the U.S. economy remains the global leader in both productivity and technology, but there are large variations by firm and by industry. We cannot expect to be the country that is the source of every innovation or every good business idea, and we are not. Research that compares productivity across countries has found that the biggest benefits of innovation come from its dissemination through the economy. American innovations in computers and semiconductors now contribute to economic growth around the world. German innovations in auto parts are used by the American auto industry. Foreign direct investment is crucial to distributing innovations and allows the U.S. economy to benefit from the global pool of new ideas.

2. Foreign direct investment provides capital for jobs in America. American corporations are on average very profitable, partly because they are well-run compared to companies world-wide, but also because they set high target rates of return before they are willing to invest. U.S. corporate strategy has emphasized being lean in the use of capital and avoiding making large, risky investments unless the expected returns are high. Without making any judgment on this practice, it means that there are opportunities in America for investment and job creation where projected returns are pretty good but where U.S.-based companies are reluctant to commit the necessary capital. Foreign companies based in Asia now own and operate much of the steel capacity based in the United States. As I will discuss shortly, the energy boom is attracting many foreign companies to build highly capital intensive new plants making petrochemicals in America. Infrastructure is an area where foreign investment could make a contribution to U.S. economic performance.

3. Foreign direct investment increases the competitive intensity of the U.S. economy. A basic tenet of economics since Adam Smith has been that competition benefits consumers. Markets with a dominant single producer or with an oligopoly of companies that reach tacit agreements to limit price competition will result in prices that are too high. More recently, economic research has stressed the dynamic benefits of competition in putting pressure on all market participants to cut costs and develop new and innovative products. Global companies that have established their positions in their own domestic markets can provide important competitive pressure to American industries where the domestic companies have become complacent.

The Cons of Foreign Direct Investment in the United States

1. Foreign investment can displace jobs and production in domestic companies. There is little question that the arrival of Asian and European auto companies producing in North America has resulted in a decrease in the number of jobs in the traditional American companies in the industry. Many of those jobs were unionized. Many Americans look back to a time in history when domestic companies dominated the economy and foreign competition was minor. Much of the apprehension is about imports and the trade deficit, but the changing identity of companies producing in the U.S. market is also a concern.

2. Foreign takeovers of American companies can be motivated by a desire to capture American technology. The fight among countries and companies to take advantage of technology is older than the industrial revolution. Alexander Hamilton orchestrated an effort to bring European technology to post-revolutionary America, while today China is doing its utmost to push its economy into the twenty-first century by grabbing as much technology from around the world as it can. One reason that American companies have been reluctant to invest more in China is because of concerns about violations of property rights. The U.S. government, of course, already has in place safeguards to prevent the capture of vital technologies by foreign entities and all foreign takeovers have to be vetted. The hard question is whether or not this process is striking the correct balance between protecting vital American interests and excluding foreign investors who could contribute positively to our economy.

3. In the event of an economic downturn, foreign-owned companies may protect home country workers and operations at the expense of their U.S. operations. Some multinational companies produce the same, or very similar, products in different locations around the world. These companies have a choice about how to allocate production in situations where they have overcapacity. If workers in their home country have reached agreements to protect their own jobs, the company may decide to keep full employment at home and cut production elsewhere. This concern is a legitimate one, but should not be overstated. Shifting production is costly and most foreign-owned companies with significant operations in the United States are concerned about the long term sustainability of their U.S. operations.

Balancing the Arguments

Although there are real concerns about foreign direct investment, the benefits greatly outweigh the costs. On balance, international trade is beneficial to Americans but the case for expanding trade is a hard one to make to skeptical voters. By contrast, the case for encouraging foreign investment is much easier to make. New green field investments clearly create jobs and benefit local communities. Takeovers of domestic companies by foreign companies are also generally beneficial, providing an infusion of capital and new management that can prevent established companies from failing and allow them to make investments.

How to Make the United States More Competitive

1. Get the macroeconomics right. Chronic U.S. trade deficits since the early 1980s have been sustained by an equal shortfall of domestic saving over investment. The best policies in the world will not restore American competitiveness in the long run as long as there is gap between national saving and investment. Reducing investment is not the right approach. Alternatively, national saving will need to increase once the recovery has taken a firmer hold. There are few if any tools by which government can influence private saving; thus, the increment to national saving will be achieved most effectively by reducing or eliminating the federal budget deficit over the next ten years. It is clear from the past that insufficient levels of national saving drove up the exchange rate, priced U.S. exports out of foreign markets and swelled the volume of imports.

2. Work for trade agreements. Balance in international trade needs to be a more focused objective of U.S. foreign policy. In past negotiations, the United States traded access to U.S. markets for foreign political support or access of U.S. financial firms to foreign markets, to the detriment of admittance for U.S. exports. A major German auto company is siting an assembly plant in Mexico because that country’s free trade agreements will allow it to use the plant as an export platform to Latin America and elsewhere. In addition to obtaining more trade agreements, there is also a need to develop greater international consensus on appropriate guidance for exchange rates.[1]

3. Improve the Corporate Income Tax. The mobility of capital, technology, and production facilities makes the national taxation of production as opposed to consumption increasing impractical. The marginal rate of corporate taxation in the United States is too high, particularly in relationship to the tax rates of other countries, inducing firms to locate overseas. The United States needs to follow the lead of other countries in shifting toward greater reliance on consumption-based taxation.[2]

4. Improve skills. Both American companies and foreign companies investing in the United States say that the skills of the U.S. workforce are comparatively weak. It lags behind many other countries in developing effective vocational education and job training programs, and the educational attainment of young workers is falling behind that of countries like Canada, Japan and Korea. Furthermore, U.S. 15-year-olds rank 25th in math and 17th in science in PISA scores among OECD nations. Germany is an example of a country that has used a high-quality vocational education system to improve the skills of its workforce. While there is no space here to elaborate on what changes should be made, greater attention needs to be paid to reversing the deterioration in workforce skills.

5. Repair and improve infrastructure. Similarly, the country suffers from a deteriorating physical infrastructure that raises the costs of production. The extraordinarily low level of current interest rates suggests that now is a good time to borrow funds to finance the repair and modernization of those systems. The adoption of such a program is constrained by a concern that it is simply an excuse for added deficit spending. That issue can be addressed within a capital budget framework in which each investment is financed with amortized debt for which a portion comes due in each year and is repaid with an explicit tax or dedicated revenue source over the duration of the bond issue. Such financing, if matched by a credible dedicated revenue source, would not add to concerns about an unmanageable level of general fund debt.

6.Take advantage of the energy boom. U.S. natural gas resources have nearly doubled since 2003, driven by the development of shale deposits nationwide. The United States has the second largest recoverable shale gas reserves in the world at 24 tcm (trillion cubic meters), after China’s reserves of 36 tcm. However, the United States is substantially ahead of the rest of the world in having started to tap these reserves at increasing scale. By 2020, shale gas is expected to add 10-15 billion cubic feet per day over current levels and grow to over 25 percent of total gas production. Along with shale gas, light tight oil (LTO) production has also developed rapidly. Current LTO production estimates for 2020 are between 5 and 10 million incremental barrels per day, although even higher numbers are possible. There are environmental dangers involved in this new wave of energy production but with the right regulation it should be possible to develop the oil and gas fields responsibly. It is expected that natural gas will be priced in the United States at $4-6 per million BTUs, well below the $12 price range in Europe and $16 in Asia. Oil prices are set globally, but it is likely that U.S. domestic prices will carry a differential below imported oil and the greater security of domestic supply will be an attraction for users. Cheap natural gas will also keep electricity prices down.

The energy revolution is already making America more competitive. Global companies are investing in new plants here to take advantage of the low price of energy and natural gas as a feedstock. For example, in 2012, Shintech Louisiana LLC, a Japanese company, invested an additional $1.3 billion in a PVC plant in Louisiana.[3] Methanex Corp. (Canada) invested $550 million in the United States in summer 2012 to construct a methanol production facility in Louisiana. This was the corporation’s first U.S.-based facility in over a decade.[4] Sasol Ltd. (South Africa) agreed in December 2012 to build an “integrated gas-to-liquids (GTL) and ethane cracker complex” in Louisiana. This project alone is estimated to create 1,253 jobs directly, “with salaries averaging nearly $88,000, plus benefits,” and thousands of additional indirect job gains. Total investment is estimated to be between $16 billion and $21 billion, with ultimate value approximated at $46 billion by a Louisiana economic impact study.[5] Foreign direct investment is thus making an important contribution towards exploiting new energy sources for the benefit of the economy.[6]

Conclusion

The Obama Administration has been working to make it easier for foreign companies to build new plants and create jobs here. An interagency effort is underway to create one-stop-shopping for companies and I applaud the effort by this subcommittee to seek out ways to make America a more attractive location for foreign companies to invest. More needs to be done to coordinate federal agencies and states and localities in terms of permitting and meeting environmental requirements. Companies also report that the process of obtaining permits is much too slow and too complex.

On balance, foreign direct investment coming to the U.S. economy has been beneficial, generating jobs, making-capital intensive investments and diffusing technology developed in other countries to our economy. There are legitimate concerns about protecting our technology and workers, but these challenges can be met. America is already an attractive place for foreign companies to invest and policymakers should make sure our competitiveness is sustained and enhanced.

[1] A greater reliance on market-determined exchange rates would be preferable in most cases, but countries differ widely in their stages of development and ability to rely on such mechanisms.

[2] The United States also attempts to tax the foreign income of U.S. companies, albeit with a deferral. Most other countries use a territorial-based system in which income is taxed only in the country in which it is earned.

[3] Mark Crawford, “Hot United States FDI Sectors: Advanced Manufacturing,” Area Development Online, http://www.areadevelopment.com/LocationU.S.A/LocationU.S.A2012/U.S.-FDI-sectors-advanced-manufacturing-262000987.shtml.

[4] “At the Epicenter of the U.S. Industrial Rebirth,” Louisiana Economic Development,” http://www.louisianaeconomicdevelopment.com/led-news/articles/at-the-epicenter-of-the-us-industrial-rebirth.aspx.

[5] “Sasol Announces Largest Manufacturing Investment In Louisiana History, Creating More Than 7,000 Direct And Indirect Jobs,” Louisiana Economic Development, December 3, 2012, http://www.louisianaeconomicdevelopment.com/led-news/news-releases/sasol-announces-largest-manufacturing-investment-in-louisiana-history,-creating-more-than-7,000-direct-and-indirect-jobs.aspx?c=News%20Releases&id=39.

[6] There are exaggerated claims being made about the extent to which the energy boom will improve U.S. competitiveness and create manufacturing jobs. The discovery of new ways to extract natural gas and oil may make the U.S. self-sufficient in energy and reduce the trade deficit, but it will also increase the value of the U.S. dollar, partially or fully offsetting the cost advantage of cheap energy. This is an example of the “Dutch Disease” that afflicted Dutch manufacturing some years ago when large gas reserves were discovered.

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Testimony Prepared for the Hearing: Discussion of the Global Investment in American Jobs Act, 2013

Authors

Martin Neil Baily

Publication: United States House of Representatives, Subcommittee on Commerce, Manufacturing, and Trade, Committee on Energy and Commerce

Image Source: © Paul Vernon / Reuters

U.S. Productivity Growth: An Optimistic Perspective

Martin Neil Baily, James M. Manyika and Shalabh Gupta — Fri, 29 Mar 2013 00:00:00 -0400

ABSTRACT

Recent literature has expressed considerable pessimism about the prospects for both productivity and overall economic growth in the U.S. economy, based either on the idea that the pace of innovation has slowed or on concern that innovation today is hurting job creation. While recognizing the problems facing the economy, this paper offers a more optimistic view of both innovation and future growth, a potential return to the innovation and employment-led growth of the 1990s. Technological opportunities remain strong in advanced manufacturing and the energy revolution will spur new investment, not only in energy extraction, but also in the transportation sector and in energy-intensive manufacturing. Education, health care, infrastructure (construction) and government are large sectors of the economy that have lagged behind in productivity growth historically. This is not because of a lack of opportunities for innovation and change but because of a lack of incentives for change and institutional rigidity.

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U.S. Productivity Growth: An Optimistic Perspective

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Publication: International Productivity Monitor

Tax Policy and U.S. Manufacturing in a Global Economy

Fri, 15 Mar 2013 08:50:00 -0400

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March 15, 2013
8:50 AM - 12:30 PM EDT

Falk Auditorium
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

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In his 2013 State of the Union address, President Obama stated "Our first priority is making America a magnet for new jobs and manufacturing." His “Framework for Business Tax Reform” would support this priority by focusing and deepening the existing tax deduction for domestic manufacturing activities. Others, including Senator Orrin Hatch, ranking minority member of the Finance Committee, are cool to the idea, saying, "We're starting to come back in manufacturing, and I don't think you need the government to show the way for them."

On March 15, the Urban-BrookingsTax Policy Center and the International Tax Policy Forum hosted a conference to assess the current state of U.S. manufacturing, its contribution to U.S. economic growth, and whether tax reform should maintain, deepen, or eliminate preferential income tax treatment of manufacturing income.

Brookings Co-Director of the Tax Policy Center William Gale gave introductory remarks and moderated the first panel with Brookings Director of the Initiative on Business and Public Policy Martin Baily, and Tax Policy Center Director Donald Marron served as a panelist. Former member of the Council of Economic Advisers Laura D’Andrea Tyson delivered the keynote address. After each panel, speakers took questions from the audience.

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Tax Policy and U.S. Manufacturing in a Global Economy

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It’s Time for Sensible Regulation of Derivatives

Martin Neil Baily and Aaron Klein — Wed, 23 Jan 2013 14:51:00 -0500

The beauty of a pendulum is that once set in motion it can swing predictably forever. The difficulty is getting it to return to the middle. This seems to be the problem with regulation of derivatives.

In the 1990s, derivatives were widely heralded as new instruments that could improve the transference of risk. In 1999, then Federal Reserve Chairman Alan Greenspan stated: “By far the most significant event in finance during the past decade has been the extraordinary development and expansion of financial derivatives.” He went on to argue that they “enhance the ability to differentiate risk and allocate it to those investors most able and willing to take it. This unbundling improves the ability of the market to engender a set of product and asset prices far more calibrated to the value preferences of consumers than was possible before derivative markets were developed. The product and asset price signals enable entrepreneurs to finely allocate real capital facilities to produce those goods and services most valued by consumers, a process that has undoubtedly improved national productivity growth and standards of living.”

A Harmless Tool?

With general (although not universal) agreement in Washington that deregulation of financial services would benefit the economy, the Administration and Congress decided that the derivatives market should be largely unregulated. This position was codified in the Commodities Futures Modernization Act of 2000 and the Gramm-Leach-Bliley Act of 1999. Here is when the pendulum was set in motion.

Not all policymakers or investors were convinced that derivatives were harmless. Brooksley E. Born, Chair of the Commodity Futures Trading Commission, argued for tighter regulation of derivatives.In 2003, Warren Buffett famously stated that “derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.”

Lessons of the Financial Crisis

When the financial crisis began in 2007, derivatives played a central role. AIG among others had sold a form of derivatives, credit default swaps (essentially default insurance), on billions of dollars of complex securities ultimately backed by shaky mortgages (collateralized debt obligationsor CDOs). AIG believed it was taking on little risk by selling these derivatives because a widespread housing price collapse was not seen as a possibility. Little capital had been set aside to cover potential losses on the swaps, largely because the buyers of the swaps relied on AIG’s stellar credit rating. When CDOs began dropping in value, AIG’s large derivative exposurecaused its bankruptcy and required a large government bailout to prevent its counterparties from taking losses and triggering additional financial instability.

It is no surprise then that the pendulum began to swing the other way.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 devoted an entire title (Title VII) to re-regulating derivatives. Dodd-Frank set in place a multitude of new rules, each designed to address a different aspect of derivative regulation. Some of the more prominent ones are the Lincoln Amendment, single counterparty credit limits, clearing requirements, business conduct requirements on dealers, and varying specific rules, which apply to some, but not all, derivative contracts. The Volcker rule, which stipulates that banks cannot conduct “proprietary trading,” also affects the institutions that issue and trade derivatives.

Toward Regulation That Actually Works

One of the authors of this op-ed served in the Clinton Administration that approved financial deregulation, while the other served the Obama Administration that worked with Congress on Dodd-Frank. We want to make it clear that we both support derivatives regulation, but we also want to get that regulation right.

The bulk of derivatives are interest rate swaps, credit default swaps on corporate bonds and municipal and state bonds, commodity price derivatives, and currency swaps. These markets did not break down in the crisis and did not contribute to it. Many, many institutions took risky bets on mortgage-backed assets without any help from the derivatives markets.

Derivatives have value. Many families rely on 401(k) investments to fund their retirement, and the financial institutions that manage their money use derivatives. American companies use derivatives to lower their borrowing costs, manage their balance sheets, and hedge against risks. Airlines hedge against fuel price spikes, and exporters hedge against swings in exchange rates. Even Warren Buffett’s investment fund, Berkshire Hathaway, uses derivatives.

Dodd-Frank gave leeway to regulators to implement its rules. For derivatives trading, it gave varying responsibilities to both the Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC) to write and enforce rules. Rather than merge these two regulators into a single body, Dodd-Frank maintained the multiple regulator approach, while requiring varying levels of regulatory coordination and consultation in rule writing. The Federal Reserve was given regulatory authority over the large financial institutions that issued most derivatives contracts in the past, and its proposed rules would greatly impact the derivatives market in the future.

It is worth asking if the myriad of rules put into place in Dodd-Frank to regulate derivatives can work together effectively and coherently. Congress, and the Financial Stability Oversight Council, should ensure that the different regulatory bodies work together to craft consistent rules of the game. Tackle the problems that emerged in the derivatives market and improve the economy’s stability, while still reaping the economic benefits derivatives can and do provide.

Let’s try and stop the pendulum in the right spot and avoid the wild swings.

Authors

Martin Neil Baily
Aaron Klein

Publication: Yahoo! Finance

Image Source: © Brendan McDermid / Reuters

Is Manufacturing "Cool" Again?

Martin Neil Baily and James M. Manyika — Mon, 21 Jan 2013 00:00:00 -0500

Once upon a time, ambitious young people with a knack for math and science went to work in manufacturing. They designed planes, computers, and furniture, figured out how to lay out an assembly line, helped to make new cars faster and refrigerators more efficient, pushed the limits of computer chips, and invented new medicines. But, as the role of manufacturing diminished in advanced economies, the brightest talents tended to gravitate to finance and other service fields that were growing rapidly – and paying well.

But here’s some news: global manufacturing has the potential to stage a renaissance and once again become a career of choice for the most talented.

Of course, any manufacturing rebound in the advanced economies will not generate mass employment; but it will create many high-quality jobs. There will be more demand for software programmers, engineers, designers, robotics experts, data analytics specialists, and myriad other professional and service-type positions. In some manufacturing sectors, more such people may be hired than will be added on the factory floor.

Exploding demand in developing economies and a wave of innovation in materials, manufacturing processes, and information technology are driving today’s new possibilities for manufacturing. Even as the share of manufacturing in global GDP has fallen – from about 20% in 1990 to 16% in 2010 – manufacturing companies have made outsize contributions to innovation, funding as much as 70% of private-sector R&D in some countries. From nanotechnologies that make possible new types of microelectronics and medical treatments to additive manufacturing systems (better known as 3D printing), emerging new materials and methods are set to revolutionize how products are designed and made.

But, to become a genuine driver of growth, the new wave of manufacturing technology needs a broad skills base. For example, it will take many highly-trained and creative workers to move 3D printing from an astounding possibility to a practical production tool.

Consider, too, the challenges of the auto industry, which is shifting from conventional, steel-bodied cars with traditional drive trains to lighter, more fuel-efficient vehicles in which electronics are as important as mechanical parts. The Chevrolet Volt has more lines of software code than the Boeing 787. So the car industry needs people fluent in mechanical engineering, battery chemistry, and electronics.

Manufacturing is already an intensive user of “big data” – the use of massive data sets to discover new patterns, perform simulations, and manage complex systems in real-time. Manufacturing stores more data than any other sector – an estimated two exabytes (two quintillion bytes) in 2010. By enabling more sophisticated simulations that discover glitches at an early stage, big data has helped Toyota, Fiat and Nissan cut the time needed to develop new models by 30-50%.

Manufacturers in many other branches are using big data to monitor the performance of machinery and equipment, fine-tune maintenance routines, and ferret out consumer insights from social-media chatter. But there aren’t enough people with big-data skills. In the United States alone, there is a potential shortfall of 1.5 million data-savvy managers and analysts needed to drive the emerging data revolution in manufacturing.

The shift of manufacturing demand to developing economies also requires new skills. A recent McKinsey survey of multinationals based in the U.S. and Europe found that, on average, these companies derive only 18% of sales from developing economies. But these economies are projected to account for 70% of global sales of manufactured goods (both consumer and industrial products) by 2025. To develop these markets, companies will need talented people, from ethnographers (to understand consumers’ customs and preferences) to engineers (to design products that fit a new definition of value).

Perhaps most important, manufacturing is becoming more “democratic,” and thus more appealing to bright young people with an entrepreneurial bent. Not only has design technology become more accessible, but an extensive virtual infrastructure exists that enables small and medium-size companies to outsource design, manufacturing, and logistics. Large and small companies alike are crowd-sourcing ideas online for new products and actual designs. “Maker spaces” – shared production facilities built around a spirit of open innovation – are proliferating.

And yet, across the board, manufacturing is vulnerable to a potential shortage of high-skill workers. Research by the McKinsey Global Institute finds that the number of college graduates in 2020 will fall 40 million short of what employers around the world need, largely owing to rapidly aging workforces, particularly in Europe, Japan, and China. In some manufacturing sectors, the gaps could be dauntingly large. In the U.S., workers over the age of 55 make up 40% of the workforce in agricultural chemicals manufacturing and more than one-third of the workforce in ceramics. Some 8% of the members of the National Association of Manufacturers report having trouble filling positions vacated by retirees.

Indeed, when the NAM conducted a survey of high-school students in Indianapolis, Indiana (which is already experiencing a manufacturing revival), the results were alarming: only 3% of students said that they were interested in careers in manufacturing. In response, the NAM launched a program to change students’ attitudes. But not only young people need persuading: surveys of engineers who leave manufacturing for other fields indicate that a lack of career paths and slow advancement cause some to abandon the sector.

Manufacturing superstars such as Germany and South Korea have always attracted the brightest and the best to the sector. But now manufacturers in economies that do not have these countries’ superior track record must figure out how to be talent magnets. Manufacturing’s rising coolness quotient should prove useful, but turning it into a highly sought-after career requires that companies in the sector back up the shiny new image with the right opportunities – and the right rewards.

Authors

Publication: Project Syndicate

Image Source: © Gary Cameron / Reuters

Fostering Growth Through Innovation

Tue, 15 Jan 2013 09:00:00 -0500

Event Information

January 15, 2013
9:00 AM - 3:00 PM EST

Falk Auditorium
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

President Obama approaches his second inauguration after an electoral victory broader and deeper than most had predicted, with a slightly increased majority in the U.S. Senate, but with Republicans still holding a distinct (yet smaller) majority in the House of Representatives. While deep partisan divides still remain in Washington, the president has the chance to use his second term to make his mark on public policy. The first 100 days of this second term and his relationship with a newly seated Congress provide an opportunity for policy changes that can find support across party lines. Brookings is committed to developing a set of high-impact policy recommendations to present to the Obama administration in January in order to reinvigorate the American economy, create jobs and strengthen competitiveness.

On January 15, the Brookings Institution brought together a distinguished group of private and public sector leaders for a day-long series of panels addressing fiscal challenges, U.S. manufacturing and government performance. Brookings experts have released several new papers on these topics with recommendations focused on the first 100 days.

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Related Papers:

Cut to Invest: Create a "Race to the Shop" Competition for Advanced Manufacturing
Bruce Katz and Peter Hamp
Cut to Invest: Create a Nationwide Network of Advanced Industries Innovation Hubs
Devashree Saha and Mark Muro
Cut to Invest: Support the Designation of 20 "U.S. Manufacturing Universities"
Robert D. Atkinson and Stephen Ezell
Smart Policy: Building an Innovation-Based Economy
Darrell West, Allan Friedman and Walter Valdivia

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Structuring the Financial Industry to Enhance Economic Growth and Stability

Tue, 04 Dec 2012 08:30:00 -0500

Event Information

December 4, 2012
8:30 AM - 2:30 PM EST

Falk Auditorium
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

In light of the financial crisis and ensuing severe recession, Western governments are in the process of sharply transforming the laws and regulations for banks and other financial institutions. Yet, recent scandals and problems at major banks have given new life to calls for major structural changes beyond Dodd-Frank, Basel III and other banking reforms, including a return to Glass-Steagall’s restrictions on activities at banking groups or breaking up the largest banks. Any such changes would have significant implications for economic growth and stability, given the central role of finance in lubricating the gears of the economy.

On December 4, the Economic Studies program at Brookings held a conference to review the social purposes of finance, the current structure of the financial industry, and various reform proposals. Federal Reserve Board Governor Daniel Tarullo delivered the keynote address, along with presentations by Brookings Senior Fellows Martin Baily and Donald Kohn.

Read a summary of the event by Douglas Elliott »

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Promoting Innovative Growth: Venture Capital, Growth Equity and IPOs

Mon, 03 Dec 2012 09:30:00 -0500

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December 3, 2012
9:30 AM - 2:45 PM EST

Falk Auditorium
Brookings Institution
1775 Massachusetts Avenue, N.W.
Washington, DC 20036

Young companies have been shown to be a crucial driver of employment growth and innovation in the American economy. Yet in recent years, these critical firms have struggled to raise capital. Venture capital funding—the major funder of technologically innovative firms—has never recovered from its peak in 1999-2000. Many smaller growth equity funds have struggled to raise capital as large institutions concentrate their funding into fewer funds, seeking to limit the number of relationships they must manage. Meanwhile, the path from private to public ownership has become more daunting. In response to these circumstances, Congress—in a rare display of bipartisanship—enacted the JOBS Act, which relaxes the barriers that small firms face when going public and facilitates the raising of capital through “crowdfunding.” But it remains to be seen the extent to which these policies will ease the financing challenges facing high-potential firms.

On December 3, Economic Studies at Brookings and the Private Capital Research Institute examined the challenges that the financing system faces, recent changes, and the likely future of entrepreneurial finance.

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Global Manufacturing: Entering a New Era

Mon, 19 Nov 2012 09:30:00 -0500

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November 19, 2012
9:30 AM - 11:30 AM EST

Saul/Zilkha Rooms
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

A decade into the 21st century, the role of manufacturing in global and metropolitan economies continues to evolve. After 20 years of rapid globalization in which manufacturing production shifted to emerging markets, demand for consumption is growing there, too. Emerging market demand, in fact, has unprecedented momentum as 1.8 billion people enter the global consuming class. At the same time, a robust pipeline of product innovation and manufacturing processes has opened new ways for U.S. manufacturing companies to compete.

On November 19, the Metropolitan Policy Program at Brookings hosted a forum to release a report from the McKinsey Global Institute that examines the role of manufacturing in advanced and developing economies and the choices that manufacturers grapple with in this new era of global competition. Following presentations by the authors, an expert panel discussed the key trends shaping manufacturing competitiveness, global strategies, the next era of manufacturing innovation, and what these changes imply for growth and employment in manufacturing across the globe.

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Capital Markets and the Fiscal Cliff: A Conversation with NASDAQ OMX CEO Robert Greifeld

Mon, 19 Nov 2012 13:00:00 -0500

Event Information

November 19, 2012
1:00 PM - 2:15 PM EST

Falk Auditorium
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

This event was broadcast live on C-SPAN and CSPAN.org. Click here to watch.

As the saying goes, markets like certainty. Although the election is over, the uncertainty surrounding the impending fiscal cliff, combined with long-term deficit and debt issues, may be affecting the economy—and the Congressional Budget Office estimates actually going over the cliff could push the U.S. into another recession. Business leaders have taken notice, forming coalitions to implore Congress and the White House to work together to avoid what they believe will be detrimental to the U.S. and global economies.

On November 19, Economic Studies at Brookings hosted NASDAQ OMX CEO Robert Greifeld to discuss why he believes the capital markets need a sound federal budget so they can get off the sidelines, instead of waiting for news as to whether Washington can reach a deal.

Brookings Vice Chairman Glenn Hutchins gave introductory remarks and Martin Baily, senior fellow and director of the Initiative on Business and Public Policy at Brookings, served as moderator. Mr. Greifeld also took questions from the audience.

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Foreign Investment, Economic Growth and Job Creation

Mon, 01 Oct 2012 10:00:00 -0400

Event Information

October 1, 2012
10:00 AM - 11:30 AM EDT

Falk Auditorium
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

Register for the Event
A Conversation with Volkswagen Group of America President and CEO Jonathan Browning

Investment in the United States by both domestic and foreign businesses is a major engine of economic growth and job creation, and the United States attracts more foreign direct investment (FDI) than any other nation worldwide. FDI supports more than 5.6 million American jobs, including over two million in manufacturing. Manufacturing jobs tend to pay better – on average one-third more than the national average. These investments also help drive U.S. exports. Foreign affiliates also invest in innovation, spending over $40 billion each year on research and development in the United States.

But the United States faces increased competition for these investments and the jobs they bring with them. Can policymakers help keep America at the top and create even more jobs through these foreign investments?

On October 1, the Initiative on Business and Public Policy at Brookings hosted a forum examining the key factors policymakers should consider in trying to attract global investment in America. President and CEO of Volkswagen Group of America Jonathan Browning gave the keynote address. He was followed by a panel including Assistant to the President and the Principal Deputy Director of the National Economic Council Jason Furman; Brookings Senior Fellow and Director of the Initiative on Business and Public Policy Martin Baily; Executive Director of SelectUSA Steven J. Olson; President & CEO of the Organization for International Investment Nancy McLernon; and New York Times columnist Eduardo Porter, who will served as moderator.

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Don’t Repeal Dodd-Frank, but Don’t Crush the Banks Either

Martin Neil Baily — Wed, 05 Sep 2012 00:00:00 -0400

In the clamor of election rhetoric it is hard to make clear-headed judgments about what should be done to promote stronger economic growth and more jobs. One piece of the recovery puzzle is to make sure the financial sector can do its job. Political slogans calling for the repeal of the Dodd-Frank financial reform make no sense.

First, that is not going to happen when a few senators can block either new legislation or the repeal of existing legislation. Second, after the massive financial crisis, reforms to restrain excessive risk-taking were essential and Dodd-Frank made a good start on those reforms. At the same time, efforts to blame the entire crisis and the continuing slow economy on Wall Street are equally foolish. And the way the Dodd-Frank rules are being implemented threatens to hold back new lending. Some on the left, and even a few on the right, are calling for the break up of the big banks, under the illusion this huge disruption would help us get through the economic slump.

The Slow Growth Equation

The reasons growth is so slow three years after the economy hit bottom are cautious consumers (understandably so), the weakness in the housing market, and the reluctance of businesses to invest. Nonresidential fixed investment in the first half of 2012 was still below the level reached in 2007. Large businesses mostly have plenty of cash but are hesitant to invest in major new projects. Small and medium-sized enterprises, the ones that typically power employment growth, lack cash flow and face a tough environment for borrowing.

Recoveries can generate their own momentum but this recovery has never hit takeoff speed. An important piece of a stronger recovery is a stronger financial sector. We do not want a return to a speculative bubble, but the willingness to take reasonable risks helps economic growth. The American financial sector must provide fuel to finance business sector recovery.

In the financial crisis small banks, medium-sized banks and large banks got into difficulty. There is lots of blame to go around and good reasons for improved safety and soundness regulation. Once the election is over, it will be time for a thorough review of where the new Dodd-Frank rules are working and where they are not working.

A New Approach to Enforcement

Regulators have been overloaded by the task of implementing Dodd-Frank, so draft rule-making has been handed out to disparate groups with no coherent strategy for creating a regulatory and supervisory system that fosters both stability and economic growth. We want a safer regulatory system, but not every single rule has to be calibrated for maximum safety. Having both seat belts and airbags is good, probably, but seven different restraints would but make it hard to drive or hard to breath.

An important reason to provide breathing room to the financial sector is that it will have to greatly expand its role in lending. The housing market is finally showing signs of recovery after its long swoon. Residential construction is increasing and prices are stabilizing or even rising in some locations. Currently, most new mortgages and refi's are provided through government-backed enterprises, Fannie, Freddie and the Home Loan Banks, but over the next several years there must be a transition to greater reliance on private-sector mortgage lending. In the long run, taxpayers should not be the main source of mortgage funds and guarantor of mortgages, as they are today. Over the coming years, the American financial sector must be ready to take on a much bigger role in mortgage lending.

The idea of breaking up the big banks today is nuts. Yes, many of them behaved badly and needed support from taxpayers. Yes, bankers were making a ton of money. But the Dodd-Frank proposals for higher capital standards and the creation of a "resolution authority" to wind down failing institutions (as well as a half dozen other provisions) have gone a long way to respond to those excesses. Small, medium and large banks all have a role to play, providing different services to different parts of the economy. Large banks have unique expertise and capability in market-making and serving multinational companies. Attempting to break up the big banks, with an inevitable multi-year legal struggle and climate of huge uncertainty, is just a really bad idea at the current time of fragile recovery.

Either a re-elected Obama administration or a new Romney administration will be in place come January. Here's hoping that whichever it is, they will forget the slogans and apply good sense and good economics to implement a set of financial rules that will foster both recovery and safety.

Authors

Martin Neil Baily

Publication: Yahoo! Finance

Image Source: Brendan McDermid / Reuters

Economic Growth and the Presidential Election

Martin Neil Baily and Benjamin Wittes — Mon, 13 Aug 2012 00:00:00 -0400

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The economy is shaping up to be the focal point of the 2012 election. Federal government efforts to jumpstart the economy started at the end of the Bush administration, and many of the same policies continued in the Obama administration, which also added a multi-billion dollar package of tax cuts and stimulus spending. Senior Fellow Martin Baily and Campaign 2012 Project Director Benjamin Wittes discuss Obama’s policies, whether they worked, what could have been done differently, and what Mitt Romney might do differently, if he wins the race.

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Could Cheap Gas Save the Economy?

Martin Neil Baily and Philip K. Verleger Jr. — Wed, 27 Jun 2012 12:07:00 -0400

Something is badly needed to get the economy moving again and avoid another slowdown.

The good news is that cheaper gas could be the answer. America has hit the energy jackpot with new techniques to extract oil and gas from shale.

The recent widespread use of a technique called hydraulic fracturing, or "fracking," and improved drilling technologies such as horizontal completion to harvest gas from shale, could provide a much-needed economic boost.

Shale extraction represents one of the most important developments for the economy in the last 60 years. It's pushing down energy prices and creating many new opportunities for jobs, investments and manufacturing.

And the new innovations are unique to the United States. Although other countries will exploit shale, none will come close to the low costs in the U.S. That's because the U.S. has a unique governmental structure in which many powers remain with the states, along with a very competitive market for the product, as opposed to the monopolies and oligopolies that control the market in almost every other country.

While it may sound like the latest energy fad, the shale boom is for real and a serious game changer because of its size and potential longevity. Based on equivalent amounts of energy, natural gas has been about half as expensive as oil for many years.

The Energy Information Administration now predicts gas will be only a quarter or a fifth of the cost of oil through 2030, a big enough price difference to overcome the disadvantages of gas, such as its lower energy intensity by volume.

How did the situation change? Was it because of the tax advantages given to the large oil companies? In fact, no. Big oil largely gave up on drilling onshore in the U.S. to concentrate on finding big fields in other countries or offshore.

But small, innovative companies continued to drill for gas and oil here at home and figured out how to drill sideways and use computer technology to find deposits and extract them. Financial markets helped make this happen because small drillers could sell oil and gas using futures contracts and protect themselves against wild price swings.

An economic boom

The prospect of cheap gas for years to come is already spurring investment. Waste Management Inc (WM, Fortune 500). is investing in natural gas trucks that cost $30,000 more but save $27,000 a year in fuel costs.

The big engine manufacturers are developing long-haul trucks to operate on liquefied natural gas.

Eighty percent of future electricity generating capacity is expected to be from natural gas and many coal-fired plants may be shifted to gas. The market incentives are already there and jobs are flourishing.

Government could throw gas on this economic fire by allowing facilitation, better coordination and cutting of red tape between federal and state agencies. Working together, government at all levels can set clear standards that protect both people and profits, yet speed the approval process to create more jobs at a faster pace.

The industry, too, needs to cooperate by disclosing the nature of the fluids they are injecting during the fracking process, and by limiting emissions from the thousands of wells they will drill to alleviate some environmental concerns.

Environmentalists should recognize the longer-term benefits of abundant gas supplies -- burning gas emits a lot less carbon than burning oil and coal, and extracting it is far cleaner than extracting oil from Canadian tar sands -- and work to achieve a compromise that allows rapid development with the necessary safeguards.

And President Obama should help promote a cleaner fossil fuel that shows such promise and is already creating new jobs.

But government support isn't the main problem. Drilling is being authorized today at rates that exceed the industry's capacity to drill. The real problem is that drilling for shale gas and oil could be slowed or stopped if disputes over fracking are not resolved in a way that addresses the public's concerns. Activity has already been suspended in some promising areas.

Cheap gas may not be enough to offset the drag of a slowing global economy this year, but it will boost long-term investment, help the beleaguered manufacturing sector and increase exports.

Building petrochemical plants could suddenly become attractive in the United States. Manufacturers will "reshore" production to take advantage of low natural gas and electricity prices. Energy costs will be lower for a long time, giving a competitive advantage to companies that invest in America, and also helping American consumers who get hit hard when energy prices spike.

Other countries like China will attempt to replicate America's good luck, but will fail because they lack the unique legal, political and market institutions which have led to our success.

After years of bad economic news, the natural gas windfall is very good news. Let's make the most of it.

Authors

Martin Neil Baily
Philip K. Verleger Jr.

Publication: CNNMoney

Image Source: George Frey / Reuters

U.S. Manufacturing Makes a Comeback

and Martin Neil. Baily — Fri, 18 May 2012 00:00:00 -0400

Amid continuing mixed signals about the economy, one notable bright spot is the revival of U.S. manufacturing. The surprising strength of this once-battered sector holds promise for reenergizing the U.S. economy overall, and despite troubles in Europe, its new vigor may provide a boost to the global economy. In the latest “How We’re Doing” Index, a team of scholars at the Brookings Institution looked at the past five quarters of economic data to explore how growth in manufacturing is helping to support the nation’s fragile economic recovery — with a particular emphasis on key metropolitan areas in a 21st century dominated by high-tech industries.

The latest broad economic reports have been somewhat disappointing. The economy grew at a 3 percent rate in the fourth quarter of 2011, but the advance estimate for the first quarter of 2012, 2.2 percent, was lower than expected. Monthly jobs growth averaged more than 250,000 positions from December through February, but the increase slowed to 154,000 jobs in March and the economy added only 115,000 positions in April. The unemployment rate is still inching downward, but it remains above 8 percent. Stronger payroll growth will be needed for continued improvement.

Because households contribute about two-thirds of U.S. economic demand, the fairly strong pace of consumer spending — it rose 2.9 percent in the first quarter — is encouraging. Unfortunately, disposable income is growing more slowly than consumption, a trend that must change if consumers are to keep spending. If U.S. employment gains expand, incomes are likely to rise and the fragile recovery will strengthen. But faltering employment growth could still trigger a self-reinforcing cycle of weakness. The chances are good that the U.S. economy is on a self-sustaining path of recovery, but it could be derailed, notably by a worsening crisis in Europe or conflict in the Middle East that pushes up oil prices.

Amid all this uncertainty, U.S. manufacturing is returning. The industry was knocked to its knees by the recession, but it should not be counted out. Some 16,000 manufacturing jobs were added in April — a weaker number than those of the previous two months but still an increase. Manufacturing employment, output and exports are headed in the right direction: In April, the number of U.S. manufacturing jobs was up 489,000 from the January 2010 low of 11.5 million. The Institute of Supply Management’s manufacturing index has shown 33 consecutive months of expansion.

"The surprising strength of this once-battered sector holds promise for reenergizing the U.S. economy overall, and despite troubles in Europe, its new vigor may provide a boost to the global economy."

Overall, the U.S. economy remains strongest in advanced manufacturing sectors with high technological and skills requirements, such as aerospace, industrial and energy equipment, automobiles and medical devices. These types of manufacturing are prominent in several metropolitan areas that were hit hard by the recession but are recovering, thanks to the sector’s sharp rebound. Detroit benefited greatly from the revival of the auto industry after the federal rescue of General Motors and Chrysler in 2009, and it has added jobs rapidly over the past year. Firms in the Cleveland and Charlotte areas have ramped up production to take advantage of the shale-gas boom sweeping much of the country. By contrast, manufacturing employment has grown more weakly or continued to slide in services- or government-oriented economies such as Las Vegas and the Washington region. A new Brookings report on trends in the industry shows how manufacturing employment has retrenched toward more specialized areas of the Midwest and Northeast after three decades of steadily southward movement.

Manufacturing accounts for 12 percent of U.S. gross domestic product and less than 10 percent of national employment; alone, it cannot power the economic recovery. Yet manufacturing accounts for 70 percent of private-sector research and development in the United States. High levels of investment in R&D, the potential to reduce the trade deficit and the ability to produce good jobs for middle-skilled workers merit the increased attention the sector is receiving after decades of policy drift. The administration, for example, has included a manufacturing initiative of roughly $1 billion in its fiscal 2013 budget, and notable plans have been proposed in Massachusetts and in Chicago.

Supporting basic science and technology development, providing advanced infrastructure and financing to help more manufacturers export to growing foreign markets such as East Asia and Latin America, and building a manufacturing workforce equipped with quality science, technology, engineering and math skills are essential for long-term economic recovery.

Authors

Martin Neil Baily

Publication: The Washington Post

Give the JOBS Act the Benefit of Any Doubts

Martin Neil Baily and Robert E. Litan — Thu, 29 Mar 2012 17:35:00 -0400

One of the more remarkable recent findings about the U.S. economy is that from 1980 until the recession, firms five years or younger accounted for the creation of essentially all net new private sector jobs. If the future is anything like the past, and there is no reason to think differently, a healthy rate of firm formation and growth therefore are keys to a sustained recovery.

Yet firms cannot launch and certainly cannot grow without capital. And though technology — the Internet and the growth of cloud computing in particular — has dramatically lowered the costs of entering many lines of business, firms in a variety of sectors still require money to get started and grow. The examples of biotechnology, energy, and franchises in multiple sectors, immediately come to mind.

One of the casualties of the recession is that money for newer ventures is much harder come by. Banks have cut credit card and home equity lines of credit. Venture capital firms have essentially been out of “seed” stage financing since the bursting of the Internet bubble in 2000. And even wealthy angel investors seem interested only in “quick exit” opportunities in the tech sector.

The JOBS Act, passed overwhelmingly by the House and, with some amendments, by a smaller but significant majority in the Senate, should help change this environment after it is signed by the president (whose administration also supported the bill). The act’s “crowd-funding” provisions should make it easier for some new firms to raise equity over the internet, and other more established firms to raise additional funds without going public. And for those companies that do want to access the public markets, the act makes it cheaper to do so by exempting companies in their first five years after an initial public offering (IPO) from complying with much of the Sarbanes Oxley Act, especially the costly rules mandating audits of companies’ “internal controls.” At roughly $1 million a year in additional audit fees, it is uncertain at best whether the benefits of this audit requirement outweigh the costs for smaller public companies. Even for larger ones, we can’t resist observing that SOX did little to prevent the excessive risk-taking by major banks and other financial institutions that helped lead to the financial crisis of 2008.

The only other real controversy about the bill is whether the investor protections for crowd-funding that were added by the Senate are adequate to prevent fraudsters from separating unwitting investors from their money. Among the most important: a requirement that issuers have audited financial statements if they are trying to raise any more than $500,000 in a single year; that issuers only make their offerings on platforms, such as Facebook, Kickstarter, and Kiva, that are registered with the SEC; and civil liability for misrepresentation in any offering documents or oral communications about the offering. In addition, investors would be subject to reasonable limits on how much they can put into any crowd-funded issuer: the greater of $2,000 or 5 percent of the investor’s annual income or net worth if the investor’s earnings or net worth is less than $100,000, or up to $100,000 for other investors.

Taken together, we believe these are reasonable protections and strike the right balance between being too onerous and sufficiently light touch to let the crowd-funding market take off. We would note, however, that the best protections are likely to come from the market and technology themselves, since platforms hosting issuers will want to preserve their reputations. Just as Ebay figured out a way to convince customers that they could trust the sellers on their site, we are confident that crowd-funding platforms, or those serving them, will find equally effective ways to validating the trustworthiness of issuers on their sites. These measures won’t prevent all fraud, just as eBay cannot, but they should keep it to an acceptable minimum so that investors generally can be confident that they are not dealing with crooks. It will be important for regulators to monitor the progress of crowd-funding platforms and step in with new rules if fraud becomes too big a problem.

Finally, despite its title, it’s essentially impossible to predict in advance how many jobs the JOBS Act actually will create. It may be a few, or it could be a lot. One of the surprising things learned from the Kauffman Firm Survey — the only longitudinal data base on US entrepreneurs — is that many growth companies got their start from humble beginnings, when the entrepreneur was just a sole proprietor. Making it easier, as the JOBS Act will do, for risk-takers like these individuals to launch and grow their companies is clearly in our national interest.

Authors

Threats to the U.S. Economic Recovery

Martin Neil Baily — Mon, 12 Mar 2012 16:10:00 -0400

At a recent event, Martin Baily discussed threats to the recovery of the U.S. economy, including a continued weak global economy and increasing oil prices.

Authors

Martin Neil Baily