The importance of questioning our economic measures

The holidays have finally arrived! After a month of family events, Christmas preparations, gift wrapping, and custom Christmas cards wrapped around long work days, we are finally starting Christmas weekend.

It’s been a awhile since my last blog post, but certainly not from a shortage of ideas, so I’m just going to throw together a number of incomplete narratives to explore to get the seeds on paper.

I’m fascinated with economic and sociological trends. My core training from my undergrad years is Mechanical Engineering. UC San Diego would always stress the need to state and question your assumptions- something I still take very much to heart. So here goes:

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How well do the headline numbers we constantly see reflect what they are assumed to show?

1. CPI: We have heard for years about the problem of persistently low inflation because of the low CPI. Yet anyone actually struggling through today’s economy will talk about the soaring cost of living as rents, food, healthcare, tuition, fuel, electricity, etc go up in price (I know oil is down a bit now, but the gas stations in LA don’t seem to be aware of the fact).

My hypothesis is that the CPI actually measures consumer discretionary income rather that the cost of living, making it a good proxy on wage gains but little else.

2. Unemployment rate: This number suggests a very tight labor market which means it should be very easy to find a good job with solid benefits and incomes should be rising substantially. However, it is still very common for people with college degrees, particularly age 30 and older, to be chronically underemployed. People displaced from solid careers still face long periods of unemployment between jobs and end up settling for something that pays significantly less, often with minimal or no benefits.

My hypothesis is that the nature of the job market has drastically changed because of the shift from small businesses to large corporations. Small businesses were the big hiring force of the past, looking for talented and experienced individuals who could see the bigger picture, take on complex roles, and make good decisions. Large corporations work differently… they prefer to bring on younger employees who can all be trained to specific roles, while decision making is centralized. The “big picture” skill sets can get in the way… picture an experienced 50 year old following a directive from a much younger boss that he sees as needless micromanaging. He’s more likely to challenge it and make suggestions counter to the ‘corporate culture.’

This is not without historical precedent… think of the loss in wages combined with the increase in productivity when skilled manufacturing was replaced by unskilled factory work in the industrial revolution.

3. GDP: Increasing the value of this complex measure of economic spending is often treated as the end-goal of economic policy making – but should it be?

I often hear the claim that we need all the immigration we can get, because GDP = labor force times productivity, so it will help GDP rise. But do we really want this? Applying the basic law of supply and demand, increasing the supply of labor will decrease its price. This will lead to a point further down the demand curve where the number of jobs can increase simply because employers don’t have to pay as much for them. But why do we want to increase GDP so bad that we allow GDP-per-capita and the standard of living to plummet? Isn’t that just pushing us toward ‘third world country’ status?

The other peculiarities with GDP can be seen more clearly when you look at the big political fights in the 30’s for what should and shouldn’t be included in the measure. Should it include and therefore encourage government spending? (“yes” won out). Should it really measure goods as sold when they are shipped to local distributors, leading to a temporary rise in GDP from inventory buildup followed by a fall in GDP when the inventory is allowed to shrink back down?

My suggestion is that economic goals are more broadly stated in policy as things like ‘increase the standard of living’, ‘increase discretionary incomes’, ‘increase economic mobility’, and so on. GDP and other factors can be cited as measures in support of these goals, but their effectiveness should always be questioned. Arbitrary measures certainly should not be become the goal themselves, as any measure can be gamed to the detriment of the overall goal.

4. Vacancy Rate: The modern housing market is certainly peculiar. Housing prices in most major cities (not just in the US, but worldwide) are higher than ever, especially related to median incomes. The reason always quickly provided: supply shortage. The low vacancy rate makes this obvious. But how short is supply really? And what does this vacancy rate actually measure? What do we think it measures?

The vacancy rate is often thought of as the number of dwellings that have no occupants. This is generally true for apartments or hotels, but not necessarily for houses or condos. For these, an unoccupied unit that is owned but not for rent or sale is not considered vacant. I think this difference is crucial to understanding what’s going on in the market.

Consider some recent history… the housing bubble turned in 2006 and really began to collapse in 2008. The government was worried about the banks. A flurry of programs were started to stem the losses in housing. Early on, banks were encouraged to ease off on foreclosure proceedings. Sounds great, right? The problem came with the large so-called ‘shadow inventory’ of empty homes owned by the banks but treated as loan assets and kept off the market. Around 2012 they brought in the big hedge funds. Black rock started the trend which quickly grew – buy existing homes all cash and rent them out. This grew in spades and housing became a new big asset class to be filled by easy money from the central banks. Occasionally you’d see an article about areas with monopolized housing ownership, annual rent increases, and sky high rents. Usually this wasn’t considered news.

My hypothesis is that we’re seeing the classical economic situation of a monopolistic supply of housing. Big investors can focus on areas and buy enough to significantly affect the local market. They can then restrict supply by strategically keeping vacant homes and condos off the market to push rents higher. In the old system if a landlord hiked the rent, people would move elsewhere. When you control enough supply, people have nowhere else to go – they simply have to find a way to live with the higher rent. I’ve heard plenty of anecdotal stories … someone seeing a condo for lease in a big building, asking if they have anything else, and finding out that the building is mostly vacant and only a few of the places are listed at a time so as not to affect the rents.

If there is any way of measuring the actual number of housing units that are not lived in, I would really like to know. Of course this would have a lot of political implications if it showed the picture I just described.

I’m going to stop here, but I hope you’re questions keep going. What kind of future should we build? What should our economic goals be? What measures would help us get there? I caution you not to jump to conclusions and get frustrated with the answers … politically factionalized fighting benefits no one. I tend to think about these issues in the third person … assessing trends and theorizing rather than influencing decisions or changing. As you think it over, remember that the Christmas Holidays are about building positive connections with family.

About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at gluskinsheff.com. Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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