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Wednesday, May 4, 2016

When Detroit looked like Silicon Valley

Mike Smitka

Autos are today a hi-tech industry; more on that in subsequent posts. The same was true circa 1900.

A quick window on the contemporary mindset lies in the pages of Scientific American. The late 19th century was the world of Thomas Edison (incandescent lighting was first used in the 1880s), of Dunlop and rubber (1889) and bicycles (1885 for the first chain), of more powerful (steam) locomotives, of battleships and bridges. Searching the titles shows only scattered mentions of automobiles. During the first half of the 1890s, the hot topics were developments railroads, followed closely by marine transport, and then steel and electricity. By the end of the decade, topics electrical dominated, with railroads close behind, followed by bicycles and then ships. Electricity remained the hot topic at the start of the 1900s, but now automobiles came in second, followed closely by ships. Railroads were fading as an area of interest for technologists of the era; bicycles were a mature technology. The last four years of the decade saw electrical developments as the most common, followed by railroads, automobiles and ships. Throughout the period 1890-1908 advances in transportation were presumed a major interest of readers.

Detroit was the Silicon Valley of the 1905 era

So did the venture capitalists of the day. Ford's first commercial attempt at making automobiles (1899) failed within 2 years, and he soon left a second venture in the hands of unhappy investors to found today's Ford Motor Company in 1903. That startup began with $28,000 in seed money. That was a tidy sum – a $2.50 workday and a six-day workweek meant a decent job paid $750 a year – but not out of reach for wealthy investors.

Ford was not alone in this. While the modern automobile originated in Germany, and many of the key technical advances were then made (and first commercialized) in France. Europe though was fragmented, and remained so through 2003, when the end of the Block Exemption finally allowed a fully integrated market across the continent. The U.S. was a bigger market, unimpeded by tariffs and in sheer numbers a larger middle class, the China of its day. Entrepreneurship was everywhere – new towns needed their retailers, farmers needed to sell their produce to people who could store and ship it, and provide financing; reapers and other new-fangled agricultural implements needed sales, financing, repairs. Dynamism is both provides the opportunities and is an outcome. Cars were just one avenue.

As with Silicon Valley, the industry was populated by serial entrepreneurs and networked individuals. For the US, Thomas Klepper [2002] analyzed data on 725 ventures for which sufficient records survived to confirm that they sold at least one vehicle. (Others have subsequently expanded that list.) About 120 were manufacturers of other products that tried their hand at cars; another 145 were spinoffs from existing car companies. Finally 108 were headed by entrepreneurs with prior industry experience. In total, just over half of all ventures were part of this broad start-up community.

Early entrepreneurs had to battle with the physical layout of cars, which gradually evolved away from being mere horseless carriages, and with what would provide the motive force – steam, electricity, or internal combustion engines. It took until 1903 for the industry to focus on the latter. Who would buy cars? The early market was partly for well-heeled enthusiasts, spurred on by racing. It took a while for them to become practical, but by 1905 there was a reasonable chance that someone would be able to both get where they wanted to go, and return. Dreamers could easily point out the limitations of horses: costly to keep up, a public nuisance because they were inefficient in eating [almost a pound out for a pound in], limited in distance, and needing a wagon to convey more than a single rider. Automobiles were touted as the way of the future.

Initially these ventures were scattered around the US, with only 1 of the first 69 firms during 1895-1900 located in Detroit. But by 1913 there were 41. In a later study, Klepper [2007] traced the process of spin-offs and the movement of experienced managers from existing firms to new firms. Detroit however had a diverse and large manufacturing base, including rolling stock for railroads, cast iron products such as stoves, shipbuilding for the Great Lakes, and other diverse industries. It was centrally located, and large enough to provide sufficient labor. Other industries, such as the (horsed) carriage makers of Flint (home to Billy Durant), were nearby, and there was a bounteous supply of wood for making car bodies. With the success of Packard and Olds, this base proved larger than in New York City, St. Louis, Chicago, Rochester (NY) or Indianapolis, which were the other five early centers. (This is from Cabral et al. [2013] who revisited the issue to focus on determinants of firm survival.) These all had a broad base, but through chance a couple Detroit-based firms did better, and spin-offs (such as Chrysler) were more numerous and more likely to survive the initial start-up period. The semiconductor industry saw entrants such as Texas Instruments outside of the Bay area, but that developed into Silicon Valley. The same thing happened with autos and Detroit.

Nor is venture capital new. The public, or at least the stock market, believed that cars would be the wave of the future before the rise of the "killer app" of Ford's Model. Entrepreneurs could aim for an IPO at an early stage; Billy Durant was able to scrape together a bunch of such ventures in 1908 to create General Motors, which effectively failed in 1910 and again in 1920 only to rescued by creditors. Investors wanted into the new hot thing – which included the formation of other "general" "American" and "trust" agglomerations such as General Electric (1896), American Sugar (1891) and American Tobacco (1890). Durant and his General Motors were part of a boom of such firms in the years leading up to WWI that found a ready market for their shares, even if there was not much of a market for their products.

In sum, from the perspective of technological innovation, venture capital finance and a geography-based entrepreneurial start-ups culture, Detroit was the Silicon Valley of its era.

YearelectricalrailshipsautomotivesteelenginesbicycleswoodchemistryTOTAL
1890-18941322522075313289373525962
1895-189924621913551857416225111008
1900-190438221612925992702220231213
1905-19081971851111395751111516782
Total95787258250236628423295753965
Table details. The categories represent counts based on the following search terms in the ProQuest database of back issues of Scientific American, which ends in 1908. There is likely some double counting, if for example the title included "horseless steam carriage." Search terms were: electrical = elect*; rail = rail*;ships = ship* OR boat* OR vessel* OR sail* OR steamer*; automotive = automo* or horseless; steel = steel* OR iron* OR metal*; engine = engine or engines; bicycles = bicycle*; wood = wood*; chemistry = chemi*. I did not try counting articles on geology and paleontology (lots of dinosaur finds!) or biology, medicine, agriculture, or astronomy.
Citations:

Cabral, Luis M.B. M., Zhu Wang, and Daniel Yi Xu. “Competitors, Complementors, Parents and Places: Explaining Regional Agglomeration In The U.S. Auto Industry.” National Bureau of Economic Research, 2013. 6114.

Klepper, Steven. “Disagreements, Spinoffs, and the Evolution of Detroit as the Capital of the U.S. Automobile Industry.” Management Science 53, no. 4 (April 2007): 616–31.

–––––. “The Capabilities of New Firms and the Evolution of the US Automobile Industry.” Industrial and Corporate Change 11, no. 4 (2002): 645–66.

Tuesday, April 26, 2016

Another fracking Saudi conspiracy story, or Chapter 11 is a marvelous invention

Mike Smitka

Let me revisit a topic that matters a lot to the auto industry, what's happening in the energy sector. Frank Gaffney, of the Center for Security Policy, is pushing a case against Saudi Arabia. While this may be a good thing for him to do to drum up business in the national security arena, the claim that "Saudis Waging ‘Economic Warfare’ Against U.S." (this is as reported on the web site of something called the Open Fuel Standard). This is laughably wrong, except for it involving a set of serious policy issues.

low prices can’t destroy the fracking industry, they can only change who owns the debt

To quote:

“You know, they said explicitly when they were driving down the price of oil ... that they were doing it to destroy our fracking industry. That is a hostile action. They’re now talking about dumping Treasury bills ... That’s an act of economic warfare as well."

First, the Saudis are desperate for cash flow, but the only thing they can do is to produce more. They’re simply not big enough. If they cut output 10% global output drops by under 2% and prices only go up by less. Let's be wildly optimistic and assume prices rise 2%, more than any demand elasticity estimate I've seen. That means their total revenue drops 8%. [The arithmetic is P(1+2%)Q(1-10%) which is original revenue PQ(1-8%).] So if they cut output they cut their own throats (or more accurately, invite a palace coup or worse that will cut their throats for them). Next, the secondary recovery they’re using also makes cutting output hard, they lose output permanently. [Once they stop forcing high-pressure water around the perimeter of fields and the compensating withdrawal of oil from the center, oil will flow back towards the edges and they'll be unable to get it out.] Third, OPEC is not a functioning cartel where the Saudis can get others to coordinate to cut output. It’s too big a group and there’s no enforcement mechanism, everyone cheats to the point that agreements are meaningless. That's been true in the past – empirical work by both economists and political scientists – and nothing has happened to change the incentives of Saudi Arabia's erstwhile co-conspirators. [The theoretical case requires that members can monitor output, and that they have some option to punish cheaters. For OPEC neither holds.] It’s a convenient boogeyman so the myth doesn’t go away.

The Saudis make a good foil for energy debates; it helps that no one feels much sympathy for them. But oil is a global market, and while it's not perfectly competitive, as economists define the term, changes in supply or demand in one part of the globe (the US and China) affect prices throughout the world. Furthermore, the market for petroleum interacts with developments in supply and demand for other sources of energy. In that context, the Saudis have stood out in periods when short-run increases in demand were large relative to the ability of energy suppliers to respond. But that’s not because they held back output, or otherwise did much beyond pump what they could.

Today they are desperate for revenue. What they do is thus dominated by the short run. They have not always been so thirsty, and so short-term in focus. In the past those in the government and Aramco could think about the long run, whether they should pump less when prices were low to have more oil to sell when prices were high. However, even in the past they reacted to the market, they didn't set the market. Their strategic space has shrunk, and they no longer have the option to hold oil production back. Yes, people watch Saudi Arabia. Perhaps their strategic concerns are sufficiently representative of the Middle East that this disproportionate focus isn't entirely silly. But it doesn't mean that their pronouncements will have more than a fleeting impact.

Finally, there's the US end. How long does it take to restart production? Fracking wells see output decline about 60% in the first year, it’s not like wells in Texas that have been producing for decades. [There's one under the state capital building.] If you have cash, you can kit yourself out for the next bump in oil prices at pennies on the dollar, and there are businesses that are doing exactly that. Plenty of pipes in inventory, too, not just rigs. Chapter 11 is a marvelous thing: low prices can’t destroy the fracking industry, they can only change who owns the companies and their debt.

Oh, and dumping treasuries is an old canard that is constantly touted by fearmongers but never observed in practice. If you have a lot of Treasuries and you try to dump them, prices fall and you lose a lot of money. And if you're Saudi Arabia, what will you buy with your dollars, Euros? Those will become more expensive, a double whammy. Now the reality is that the Saudis are issuing debt, not buying debt. So are they selling some Treasuries? Maybe. Have they stopped buying? Already. Have US interest rates spiked? Not at all. OK, I can't resist: what we have is one short, albeit oft-repeated paragraph, Ney-deep in Gaffs, replete with claims that are not fracked up to what they ought to be.

I've updated the content a couple times based on email interactions with others.

Friday, April 8, 2016

Thank you Baby Boomers: The new norm is 60,000 jobs

Mike Smitka, Economics, Washington and Lee University

A simple projection from pre-Great-Recession levels suggests we need 150,000 new jobs each month to keep up with population growth. (See this WSJ blog post.) This is wrong. Lower fertility 20 years ago means that we are not seeing a steady climb in the number of young people are entering the labor market, while we are seeing the baby boomers gradually exit the labor force. My bottom line: 58,390 jobs a month. Now such precision is illusory, labor market data aren't that precise, and these are projections. So let's use 60,000 as a rough guide.


The implications are significant. If we use the sort of simple projection that lies behind the WSJ projection, then (using 2007 as a base), then in a normal economy we would today have a labor force of 160 million million. With an actual labor force in the latest survey of 151 million, this would indicate that we are 9 million jobs short of where we should be, and thus still deep in recession. That's clearly not the case. Across a variety of metrics we're approaching "full employment" (which ought not be pinned to a specific number as measured using one particular data set). Jobs are easier to find, even if wages are not yet rising. To give one qualitative indicator, during the depths of the recession in 2009-2010 "quits" in the JOLTS survey (Job Openings and Labor Turnover Survey) were at 1.3%, the lowest in the history of the data. The level is now 2.0%, near the pre-recession average of 2.2%.

Why 60,000? Prior to 2007, the labor force participation rate of prime-aged workers was nearly constant. So the core of my projection was to use the Census Bureau population projections by age, and multiply by this "normal" level of participation to get the number of jobs. I did the same for younger ages (16-24, where in the Great Recession participation fell by far more than other groups), and older ages (where participation actually rose – the "Boomers" have been slower to retire than their elders). I've not redone this estimate to use the most recent population projection, but today's the last day of the W&L Winter Term, so I won't do that now. When I do, I'll provide an upper and lower bound, but I don't anticipate much change.

So how do things stack up? I provide below my own projections of "normal" employment versus where's we're at in the March 2016 data. To that I add a graph of age-specific participation levels. (Data are available to do that by gender; I don't report that here.) The bottom line is that at the current rate of job creation, we'll be back to normal in about 2 years.

One apology: at the bottom of the WSJ post they do quote FRB Chair Janet Yellen that the number is now under 100,000 jobs a month. You have to read to the bottom, however, to see that. For regular commentary on labor force development, see the Atlanta Fed's blog.

Indeed, the Atlanta Fed's latest post notes these various factors, including the one I've not built into my formal projections: the increased participation of older, post-normal-retirement, Americans. Their estimate is that over 2007-2011 increased participation fully offset the onset of "boomer" retirement. (Click HERE to see their graph.) Now that's not the case the past 5 years, but I still ought to revisit my baseline and put in adjustments for this, which shows up so vividly in the age-specific participation rate graphs I generate.

Thursday, April 7, 2016

Are our candidates Conservatives? Not Fiscally

Mike Smitka, Washington and Lee

It's still the primary season, and positions are pitched toward those voters who participate in that process. So any analysis of policy proposals needs to be read in that context: candidates do (must!) change positions come the general election campaign.

presidents propose budgets, but Congress has the real say

Now as an economist "not unmindful of the future" [W&L's motto] I note that Federal debt is at present increasing faster than the economy, while the aging of our population will lead to expenditures for which funding has not been budgeted. There are several ways of crunching the numbers, and these require using a measure of real interest rates. At present inflation is low but interest rates are even lower. At the moment that makes Federal debt well-nigh costless, so we face no crisis, and in my judgement will not be near such a point during the tenure of the next two presidential terms. Nevertheless, the longer we wait to narrow fiscal gaps, the more challenging closing them becomes. So not increasing deficits is one of my criteria for whether someone is a conservative.

These provisos noted, at first reading the most conservative candidate is actually Bernie Sanders. He's also the one who has offered the most detail. At this point neither Ted Cruz nor Donald Trump takes Federal deficits or national debt as issues worth the time needed to employ basic arithmetic. According to the Center for a Responsible Federal Budget, which compiles proposals and analyses from various sources, the proposals of our "conservative" candidates would each add $12+ trillion to debt by 2026. In contrast, Sanders provides proposals that would "enhance" revenue, offsetting the cost of his goal of providing free college, family leave and a proper national healthcare system. So his proposals might cost only $2 trillion ... but are subject to a range of assumptions that on the pessimistic side push the total up to the $12+ trillion range. That is, his proposals might not pan out on the low side. But among the candidates he is at this point the only one who takes the issue of fiscal balance seriously.

A final reminder: presidents propose budgets, but Congress has the real say in what eventually happens. That adds an additional layer of "gaming" to proposals made during campaigns. Unless a candidate trims back national security expenditures, there's insufficient fat in the budget to make good management: relative to the budget, saving a hundred million here and there is insignificant, and in practice neither Congress nor, in their proposals, our last last half-dozen Presidents have been able to do that.

So trimming the deficit requires enhancing revenues. There is no painless way to do that. Despite almost everyone wishing they owed less in taxes, our rates are well below 40%, and basic arithmetic makes it clear that cutting taxes can't deliver higher revenue. For example, at the 25% Federal income tax rate that a household with two workers likely faces, a 1% cut in rates leads to a 1/25 or 4% drop in revenues. In principle people will work more; in practice most people are employees who cannot add to their weekly hours. The actual boost in hours worked and taxable labor income will thus be very small, below the 4.2% boost that would be needed for the cut to be revenue neutral. If we had tax rates of 90% the story would be different: the revenue loss is less, the incentives are greater, and the indirect effect of moving income out of the "shadows" becomes significant. But that's not the US economy.

Thursday, March 31, 2016

NYFed's Bill Dudley Speech at VAE / VMI

Mike Smitka, Washington and Lee

Tonight I had the opportunity – perhaps I should say privilege – of hearing Bill Dudley, President of the Federal Reserve Bank of New York, speak at the Virginia Association of Economists conference at Virginia Military Institute. (Tomorrow they move next door – literally – to my own Washington and Lee, in a venue 45 seconds from my office.) I've been to many such events, and he spoke largely from script: the text of his talk, The Role of the Federal Reserve—Lessons from Financial Crises is already available on the FRB New York web site. He's been here before, and prefaced his talk with details about VMI and W&L and H. Parker Willis, the first Dean of what is now the Williams School. As a friend of Congressman and then Senator Carter Glass [of Lynchburg VA], Willis helped draft the legislation that set up the Federal Reserve System in 1913, and then went on to become the first Secretary of the Federal Reserve Board. (I'm currently sitting underneath what a century ago was Willis' office.)

Friday, March 25, 2016

"Kei" Cars in Japan: A "Galapagos" Sector?

Mike Smitka

Under Japanese taxation, licensing and inspection systems there are 3 broad classes of cars (and light commercial vehicles): full-sized, compact and "kei" minicars. The latter have to have a small engine, a narrow width and a short length (the BMW "Mini" is too big, even the Smart is too wide!). They get a different (yellow) license plate, face lower taxes and inspection fees (annual taxes of ¥10,800 – in contrast a friend pays about ¥70,000 a year for his C-class Mercedes). They also face less stringent safety regulations (basically, don't get in an accident in one). The leaders in this segment – Suzuki, Daihatsu [a subsidiary of Toyota], and Honda – spend significant resources developing new models. But as with Japanese cell phones – if you haven't seen one, there's a reason why! – is this a niche peculiar to Japan. Are they – like Japanese cell-phones – a dead-end strategy, a niche that due to the peculiar development of domestic cell phones have no market in the rest of the world? If so, it's a commercial disaster that will drag down these players, as over the next decade the level of sales confronts an aging and domestic population.

Friday, March 18, 2016

Peak Oil Revisited: Did I get anything right?

Mike Smitka, Economics, Washington and Lee University

In 2014 I wrote on the arrival of peak oil. That now appears at best premature. So what did I get wrong, and what (if anything) did I get right?

In my initial post I made two key assumptions. The first was that fracking would not be that important, because it remained a high-cost method of extraction. The second was that Saudi Arabia still had market power, and that therefore would respond to rising costs by cutting output. The third that changes in demand would be modest. Finally, though not (then and now) relevant, I assumed that alternative energy sources would remain marginal and substitution away from petroleum small.

Thursday, March 10, 2016

The Nature of Economic Knowledge: Divergent vs Convergent

Mike Smitka, Economics, Washington and Lee University

Discourse in economics presumes that knowledge is convergent: more empirical research and better theory will together refine our knowledge and helps us approach a "true" understanding. That implicit methodological assumption is not only wrong, but leads to the flawed application of economics. In practice, economics is perhaps better thought of as divergent.

Saturday, March 5, 2016

US Employment: Age-specific patterns of recovery

Mike Smitka, Economics, Washington and Lee University

Here's another quick cut on what's been happening over the past decade. Prior to 1997 employment as a percentage of the population in different age brackets was nearly constant. During the Great Recession older workers either didn't lose their jobs or found new ones.

Friday, March 4, 2016

US Employment relative to Population Growth

Mike Smitka, Economics, Washington & Lee Univ

Today's Employment Situation. Adding jobs isn't enough, because our population is growing. I've created a normalized level of employment that accounts for example for "boomer" retirement. At the current rate we'll be back pretty close to normal within 2 years. Since the are headwinds, basically the entire rest of the world, the Fed will be slow to raise rates, but raise they will, so the next President will face quite a different environment. (Note: the age-specific levels of employment for the age brackets I display were stable for the 10 years preceding the start of the Great Recession in January 2007. That provides the basis for my calculations. For details see HERE.)


Thursday, March 3, 2016

The US Market: How many brands, how many models?

Mike Smitka, Economics, Washington & Lee Univ

Toyota will eliminate the Scion brand; Ford is withdrawing from Japan. In the US, Suzuki, Hummer, Pontiac, Plymouth, Mercury, Oldsmobile, Isuzu, Renault, Yugo, Saturn, Hyundai (since returned) and others vanished years ago. Excluding upscale marques, today only 2 other brands have market shares in the US below Dodge's 3.5%: Fiat at 0.2%, and Mitsubishi at 0.6%. Meanwhile Scion averaged 0.3% for the whole of 2015, and hasn't been consistently above 0.5% since hovering near the 1% level under the high gas price era that ended in 2008. The Fiat 500 had the misfortune to launch even later, in 2011. Now my categories are arbitrarily mine. BMW's Mini is also at 0.2%, but the base two-door starts at $20,000 while net of current rebates the Fiat 500 starts at $15,000. Even the Chrysler brand, which to me is not now particularly upscale, has a 1.6% market share.

Tuesday, March 1, 2016

Trump: Time to flop, er, flip: an economic analysis

Mike Smitka, Economics, Washington & Lee Univ

Trump has run a strategically brilliant campaign, playing the media to the hilt to speak to the very specific and fairly narrow section of the electorate who vote in Republican primaries. He employed his savvy for publicity to see that, no matter how much they spent, Donald would be the name on the home page of all the news sites, every day.

Only some of today's votes are in, but so far that strategy is working.

from the start, Trump needed only a third of the primary vote to garner the nomination

Friday, February 26, 2016

Globalization

Mike Smitka, Economics, Washington & Lee Univ

i'm pondering the nature of globalization in the auto industry. In addition, suppliers are realigning their businesses, with for example JCI and Visteon selling their interior businesses to Yanfeng, Visteon selling their air conditioning business to Halla Climate Control (now Hanon), and Visteon buying Yanfeng's share in a vehicle electronics joint venture. Then there are OEMs: what was the progression of cross-border integration in Europe, as intra-European restrictions were gradually lowered following the formation of the Common Market. First I'll ponder, the blog, then write ...

Thursday, February 25, 2016

Radio Show: Looking Backward, Looking Forward

Mike Smitka
Professor of Economics, Washington and Lee University

WREL Lexington (VA) is changing its format, so today is my last regular radio show. So looking back, what have we talked about, and what then should we think about moving forward? First and foremost there's the slow but steady growth of the US economy. Because most observers are parochial, unfamiliar with the experience of other countries and of our own history, that slowness continues to be treated as a surprise. More in a moment. Looking forward I see four long-run economic issues facing the US: education, infrastructure, population aging and fiscal health. While it's a bit of a straw man, can we make America great again? More properly, will our children face a future of falling incomes and rising social tensions? I fear the answer is "no." I don't want to end my regular radio presence without a reminder that I'm a practitioner of the dismal science.

Thursday, January 28, 2016

Chinese Financial Scandals

Mike Smitka, Economics, Washington and Lee University

We'll continue to see media coverage of financial scandals in China. For example, the FT Alphaville blog has a "Bezzle Watch" on financial institutions there. This should not surprise us on three levels.

First, under the Stalinist planning system that dominated the urban sector in China there were no banks as we understand the concept. Zero. Similarly in the rural sector communes were expected to fend for themselves – even when that meant privation – so again there was no role for finance, though there were institutions that accepted small individual deposits. Reforms began in the early 1980s that opened up space for "modern" financial institutions to operate, though the legal and institutional foundations weren't put into place until 1994-95. That means that no bank has more than 20 years operating experience. Young institutions that have no experienced staff – and cannot hire from elsewhere because such individuals simply did not exist – have control and monitoring issues. It takes time to set up accounting systems, operating standards, and checks and balances against individual behavior. If global institutions have problems restraining rogue traders, then China's challenges are worse.

...with lower growth, many who operated in the shadows will find their operations cast into the light...