“Tracking” the Economy

The fine folks at the Association of American Railroads are out with their latest edition of Rail Time Indicators. Total traffic (carloads plus intermodal) in July was about 11% higher than the dismal levels of a year ago, but remains about 10% below earlier years:

The rebound has been weaker in carloads (think bulk materials like coal, grains, minerals, and chemicals plus autos); they are up about 4% over 2009:

And stronger in intermodal (think trailers and containers), which are up about 17%:

House Prices: Demographics Giveth and Taketh Away

Over at the Bank for International Settlements, Elod Takats has a new working paper that examines how demographics may affect asset prices (ht Torsten Slok). As he notes, standard economic theories suggest that aging will lead to lower asset prices. In an overlapping generations model, for example:

[T]he young save for old age by buying assets, while the old sell assets to finance retirement. This asset transfer can happen directly or through institutions such as pension funds. In this setting, the changes in the relative size of asset buyers (the young) and sellers (the old) have consequences for asset prices. In particular, the asset purchases of a large working age generation, such as the baby boomers in the United States, drives asset prices up. Conversely, if the economy is ageing, ie the subsequent young generation is relatively smaller, then asset prices decline.

Takats tests this theory on international data on house prices and finds a significant link with population age.  He uses that relationship to estimate how much demographics affected house prices in recent decades and to project, based on demographic estimates from the UN, how population aging will affect house prices in the future:

He concludes that demographic trends boosted U.S. house prices by almost 40% over the past four decades. Given current population trends, however, his model predicts that aging will trim about 30% off of house prices over the next forty years.

I should emphasize that this does not mean that house prices will actually fall over that period. Other factors, e.g., growing incomes, should continue to boost prices. But house prices will now face a demographic headwind–blowing at about 80 basis points per year–rather than a demographic tailwind.

These headwinds will be even stronger in Europe:

The Chevy Volt Premium

The other day I noted that Amazon has been tussling with book publishers over the pricing of electronic books. Amazon would prefer a wholesale pricing model, in which it sets retail prices, rather than an agency pricing model, in which the publishers set the prices. One reason that Amazon would prefer the wholesale model is because it would allow it to sell e-books for less than publishers would prefer.

A similar pricing kerfuffle has arisen in the pricing of Chevy’s new plug-in hybrid, the Volt. Auto dealers operate under a wholesale pricing model–they buy the cars and then decide what to charge for them. In this case, however, early demand is so strong that auto retailers are charging more than Chevy (a unit of GM) would prefer. As noted on the Wheels blog over at the New York Times, some dealers are apparently charging $12,000 above the sticker price–$53,000 vs. $41,000–for scarce Volts.

This has miffed GM executives:

By law, General Motors cannot dictate vehicle pricing to its dealers. But Rob Peterson, a G.M. spokesman, noted in a telephone conversation that the company had impressed on sales managers to keep prices in line with the company’s suggested retail price.

“The dealers are independent, for better and, in very rare cases, for worse,” he said. “There are some who have moved in the opposite direction of our request. In response, what we’ve done is to urge customers who have contacted us about pricing discrepancies to shop around, because there are dealerships in their area that are honoring M.S.R.P.”

Bottom line: wholesalers are like Goldilocks, they want retail prices to be neither too hot nor too cold.

Three A’s of E-Book Pricing: Amazon, Apple, and Antitrust

A few months ago, I noted that Amazon and book publishers were tussling over the pricing of electronic books. Amazon had originally acquired e-books using a wholesale pricing model. It paid publishers a fixed price for each e-book it sold, and then decided what retail price to charge customers. Retailers usually sell products at a mark-up above the wholesale price–that’s how they cover their other costs and, if possible, make a profit. Amazon, however, often offered books at promotional prices below its costs. For example, it priced many new e-books at $9.99 even if it had to pay publishers $13.00 or more for them (often about half of the list price of a new hardback).

Several large publishers hated Amazon’s pricing strategy, fearing that it would ultimately reduce the perceived value of their product. They thus pressured Amazon to accept an agency pricing model for e-books. Under this approach, the publishers would retain ownership of the e-books and, most importantly, would set their retail prices. Amazon would then be compensated as an agent for providing the opportunity for the publishers to sell at retail. Under this approach, Amazon would receive 30% of each sale, and publishers would receive 70%.

The strange thing about these negotiations is that their initial effect appears to be lower publisher profits. As I noted in my earlier post:

Under the original system, Amazon paid the publishers $13.00 for each e-book. Under the new system, publishers would receive 70% of the retail price of an e-book. To net $13.00 per book, the publishers would thus have to set a price of about $18.50 per e-book, well above the norm for electronic books. Indeed, so far above the norm that it generally doesn’t happen. … [In addition]  publishers will sell fewer e-books because of the increase in retail prices. Through keen negotiating, the publishers have thus forced Amazon to (a) pay them less per book and (b) sell fewer of their books. Not something you see everyday.

Publishers presumably believe that the longer-term benefits of this strategy will more than offset lost profits in the near-term. What they may not have counted on, however, is the attention they are now getting from state antitrust officials such as Connecticut Attorney General Richard Blumenthal. As reported by the Wall Street Journal this morning, Blumenthal worries that the agency pricing model (which is also used by Apple) is limiting competition and thus harming consumers. And the WSJ says he’s got some compelling evidence on his side:

The agency model has generally resulted in higher prices for e-books, with many new titles priced at $12.99 and $14.99. Further, because the publishers set their own prices, those prices are identical at all websites where the titles are sold. Although Amazon continues to sell many e-books at $9.99 or less, it has opposed the agency model because it argues that lower prices, as exemplified by its promotion of $9.99 best sellers, has been a key factor in the surging e-book market.

It’s also interesting to note that Random House decided to stick with the wholesale model, and many of its titles are priced at $9.99 at Amazon.

Of course, higher prices on select books are not enough to demonstrate an antitrust problem. Publishers will likely argue that there is nothing intrinsically anticompetitive about agency pricing, which is used in many other industries. Moreover, there is nothing to suggest that they are colluding on e-book pricing. Also, they may claim that their pricing strategy will allow more online retailers to enter the marketplace, thus providing more competition and more choice for consumers (albeit along non-price dimensions).

We’re Still #1 (Unfortunately)

The Bureau of Economic Analysis rewrote history on Friday. Along with GDP data for the second quarter, BEA also published revisions to its GDP estimates since the start of 2007.

Bottom line: The recession was worse than originally thought. The economy contracted by 4.1% from peak to trough (Q2 2008 to Q2 2009), up from the 3.9% previously estimated.

The Great Recession has thus solidified its position as the worst downturn since World War II:

As painful as it has been, the recession remains a far cry from the Great Depression, when economic activity plummeted almost 27%:

Which raises an important question: Just how close did the Great Recession get to being the Great Depression 2.0?

Mark Zandi and Alan Blinder took a crack at that question in a paper released last week.  Their answer: If it weren’t for aggressive monetary and fiscal policy responses, the U.S. economy would have contracted more than 12% during 2008, 2009, and 2010 — about half a Great Depression (and arithmetically, but not economically, comparable to the demobilization after WW II).

A Silver Lining in Second Quarter GDP?

Last Friday the Bureau of Economic Analysis released its first look at GDP growth in the second quarter. BEA estimates that the economy grew at a moderate 2.4% annual pace in the quarter, notably slower than the 3.7% pace in the first quarter and the 5.0% pace in the fourth quarter of 2009 (both those figures were revised in this release).

As usual, I think it’s helpful to break down economic growth into its key components. The following chart illustrates how much various types of economic activity contributed to (or subtracted from) second quarter growth:

The chart illustrates the silver lining in an otherwise tepid GDP report: every major category of domestic demand expanded in the second quarter. Consumers, businesses, export markets, and governments all increased their purchases. That’s a good sign. Indeed, you have to go back more than five years, to the first quarter of 2005, for the last time that happened.

Investment showed particular strength. Business investment in equipment and software (E&S) grew at a 22% pace, thus adding about 1.4 percentage points to overall GDP growth. Boosted by the end (hopefully permanent) of the new homebuyer tax credit, housing investment grew at a bubble-like 28% pace (adding about 0.6 percentage points to GDP). And business investment in new structures recorded its first gain in two years

Despite solid growth in disposable incomes–up 4.4% adjusted for inflation–consumer spending grew at only a 1.6% pace.  As a result, the saving rate increased to 6.2%, compared with 5.5% in the first quarter.

And then there are imports. As I’ve discussed before, BEA calculates GDP by adding up all the components of demand for U.S. products–consumers, businesses, governments, and export markets–and then subtracting the portion of that demand that is supplied by imports. That means that any growth in imports appears as though it subtracts from overall economic growth.

That’s what happened in the second quarter. Imports grew at a brisk 29% pace, thus subtracting (using BEA’s accounting approach) 4.0 percentage points from overall growth. Which is why all those blue bars in the graph net out to only 2.4% growth in GDP.

I should hasten to add that this does not actually mean that imports are bad for growth. The big red bar is an accounting convention, not a measure of economic impact. Indeed, many imports are essential to our economy, at least in the foreseeable future (think oil for transportation and coffee for Starbucks).

I should also note that BEA’s calculation of contributions to GDP growth, which I graphed above, is subject to the same criticism that I’ve leveled at the claim that consumer spending is 70% of the economy. In a perfect world, an appropriate share of the imports (the red bar) would be netted against each of the components of demand (the blue bars). The result would be a graph of contributions that would truly illustrate how much each category of demand actually contributed to U.S. GDP growth. I will take a crack at that in the future.