We've argued about the estimates for years. We've argued about whether illegal immigrant workers take jobs from US citizens (act as substitutes, in econ-speak) or do they allow US citizens to stay in better, perhaps supervisory, jobs (act as complements, in econ-speak). Now the Arizona legislature has decided that, arguments aside, these people must go. When I'm questioned about the impact of our "employer sanctions" legislation would be if it were successful, I have to ask what the goal of the law is. I usually get the response that the goal is to make illegal immigrants leave the state.

Given that goal and looking at the impact of its success is rather worrisome. The Pew Hispanic Center estimates that 8 percent of Arizona's population is here without the appropriate paperwork. If the law is successful in that given goal, one could expect Arizona to lose that portion of its population. But wait, there's more! Some of those people here illegally are related to, by marriage or birth, to US citizens. If we make the illegal immigrant leave, then surely we'll lose the US citizen too?

There is plenty of anecdotal evidence that this is happening. The problem is quantifying it. The US does not keep data on people that leave the country and a full census is only done once every ten years. For the population of illegal immigrants, driver license data is no help. School enrollment? Not a help either as many of the people who cross our border illegally leave their children at home and those that enter legally and overstay their visas may have children.

That leaves us in a quandry. Population growth helps drive economic growth, especially in Arizona. Take away that growth and we know the picture is not rosy. The problem is that we can't quantify how "not rosy" it could get.

In a recent survey that my wife took, she indicated that she supported the Fair Tax. I asked her why. Without knowing any of the details of the proposed legislation, she said “Because fairness is good”. Of course, calling something Fair, doesn’t necessarily make it fair.

The Fair Tax has been discussed, and even supported by some of the candidates, in the Republican and Democratic presidential debates, but is it really fair? I, for one, don’t think so.

The proposed Fair Tax legislation would eliminate income taxes, payroll taxes, and estate and gift taxes and replace them with a national sales tax on all retail purchases of goods and services. It would also eliminate the IRS. The legislation proposes a tax rate of 23%, but that is an “all inclusive” rate. State sales taxes are stated as “exclusive” rates, a rate that is added to the price of the good or service. That rate for the Fair Tax would be approximately 30%.

At first blush, the Fair Tax sounds simple and may even seem fair, but its not. Let’s assume that you are retired and live off of your savings and social security. Chances are that you pay little or no income tax, and certainly no payroll tax, under the current system. However, under the Fair Tax you will pay a 30% national sales tax on all of your purchases of goods (including food) and services (including haircuts). You already paid income tax on your savings (when you earned the money that you saved). Now you have to pay tax again when you spend those savings. Fair?

Let’s assume you want to buy a house to live in. You will have to pay a national sales tax of 30% on top of the price of the house. You will be competing to purchase the house with an investor who wants to hold it as a rental property. Guess what? The investor isn’t buying the house as a retail purchaser so he doesn’t have to pay the 30% sales tax. In other words, there is no way you can compete against an investor to purchase that house. Fair?

Let’s assume you are single and make $35,000 a year. No more federal income tax or payroll taxes are withheld from your paycheck. You (and everyone else) also get a “prebate”, an advance rebate of the Fair Tax equal to the amount that would be paid by someone earning at the poverty level. What a great deal! But, you have to pay a 30% sales tax on all purchases of goods and services. Would your total federal tax burden, net of the prebate, decrease? If you use all of your income for consumption of goods and services it would actually increase. Fair?

Let’s assume you make $5 million a year in compensation. You only consume $1.8 million and save the rest. Your total federal tax burden would go down by approximately 60%. It would go down by an even greater percentage if you had gains on the sale of investments, since they aren’t subject to the Fair Tax. Fair?

Other arguments for the Fair Tax are that it is simple and that it is easy to administer (thus the elimination of the IRS). I don’t agree with either of those arguments, but I’ll leave that discussion for another day.

What the Fed is doing and the stimulus package that Congress is likely to pass and the President sign will mitigate how long and deep a slowdown or recession will be but I don’t believe we can avoid a downturn now. As we know, monetary policy works with a lag and it will be months before the full impact of the Fed change works its way through the economy. Similarly the stimulus package most optimistically will hit in June or July of 2008. So while both will help and the beginning financial and economic responses to the Fed change should be felt much earlier than the middle of 2008, it is unlikely that this will be enough to prevent the downturn. I am glad that the Fed has moved aggressively over the last two weeks but wish the FOMC had recognized the seriousness of the credit crisis and its impact on the economy in general several months ago. Better late then never though as I suggest and I am certainly glad that the Fed has moved aggressively now.

It can take up to nine months for Federal Reserve actions to work themselves through the real economy. In the short term of the next several weeks, most of the impact of this morning's 75 point basis cut will be psychological, and the Federal Reserve knows this. If the rate cut is too large there is a risk of starting a panic over how bad the economy really is, while too conservative a move could make people think that inflation is about to take off.

Originally I thought the Fed would show some restraint so as not to worry people. However, the emergency meeting suggests either that the Fed sees the economy as worse than others see it or that they are trying to shock people into believing they are out in front of the problem. They appear to be reacting to the stock market declines of the last few days, which makes me lean to the second explanation. It is more of a slap up side the head than it is an attempt to save a patient who has gone into cardiac arrest. The markets were starting to panic and quick action is often the only effective action.

I think the Fed intends to take the federal funds rate down to 2.5 percent and keep it there for a while. I think the Fed will cut rates another 50 basis points at the next meeting on January 30th to make sure everyone gets the message that the Fed is on the job. They will then make the rest of the cuts down to 2.5 percent at the next few meetings after that. They seem to think inflation will remain under control which appears to be a view shared by the various financial markets.

It is worth noting that the Fed sees its job as keeping inflation under control. If evidence were to surface that inflation in food and fuels is spreading to the rest of the economy their willingness to hold interest rates down to help the economy could evaporate.

Here is another interesting article on the prospects of a recession this year from CNNMoney.com.

The question for many economists is not if the U.S. economy will fall into a recession. It's whether it already has.

The formal recognition of a start of a recession probably wouldn't come for at least six months if not more than a year, as official judges from the National Bureau of Economic Research (NBER) pour through various economic readings.

This is consistent with my last blog post.

With each New Year comes the usual array of pundits who forecast the future course of economic activity. What do we make of the soothsayers’ predictions this year? Perhaps this is the most uncertain time in recent economic history. The year finished with a reasonably robust equity market and a Fed seemingly poised to “rescue” the economy from the jaws of the “credit crunch.” At the same time many forecasters pointed to storm clouds such as looming trade and domestic deficits, a beleaguered consumer, buffeted by high gas prices and skidding household equity, and the continuing threat of adverse geo-political shocks. So what do we make of all of this?

To date I have been riding the optimistic wagon, suggesting that the national economy would avoid recession -- perhaps by a just a whisker. It is time to face the music. Wall Street has begun the year with a thud, the December jobs report is abysmal with the unemployment rate actually popping to 5 percent, and the real estate sector seems poised for another leg down on housing prices. There is still reason to hope that the downturn will be relatively short lived and that the latter half of 2008 will bring modest economic growth, but for now the economy has stalled. Is this a recession? Well if it walks like a duck and quacks like a duck, why not call it a duck? The NBER will probably make the official call in a few months. Let’s go with a recession that began in October 2007 and ends in late spring, with a little sign of life in real estate come mid summer. I said little, not anywhere near a return to boom times of 2005. All of this presumes that we don’t get caught watching too much election coverage this summer and forget to shop -- in which case the slowdown could linger. Here’s wishing you a prosperous new year! Now hunker down for the next 9-12 months!!

The four states where investors contributed the most to housing price increases during the housing boom were California, Nevada, Florida and Arizona. As a result, these states had some of the highest rates of housing price increase during the boom. They are also expected to suffer more than other states as a result of the current wave of housing price declines.

Is it possible to measure the relative impact of the housing bust on a state versus the nation as a whole?

Economic theory says that one of the first areas to suffer as the economy weakens is spending on durable goods. 'Durable goods' are goods that last a long time -- think big ticket items like autos, where the purchase represents a significant commitment of finances. When the economy weakens, durable good purchases are expected to react first, because they are more expensive and they are easier to delay due to their longer life.

One of the ways economists track durable goods is to watch auto sales, because sales data for autos is available nationally and by state. The volume of auto sales is estimated nationally based on a survey of retailers. But these surveys are not conducted on a state level. In states like Arizona, information on auto sales is collected as a result of the state sales tax. Even though these two measures are not precisely comparable, taken together they do illustrate broad trends.

In Arizona auto sales have been flat or negative since December 2006. Year to date through September 2007 sales were down 6.2 percent compared to the same period last year. In contrast, national auto sales are actually doing better than last year -- up 2.6 percent for the year through September.

When auto sales are subtracted from total retail sales, Arizona shows an increase of 3.6 percent year to date, a period when retail minus auto nationally showed a 4.0 percent increase. Retail sales growth in Arizona typically outpaces sales activity for the nation as a whole by a significant margin, due to our greater population growth. This past year, however, while Arizona absorbed the shock of the housing downturn, auto sales are fared much worse than the national average, while non auto sales simply slowed to the national average.

The housing bust hit incomes because people can no longer refinance their homes. People working in real estate and real estate related areas saw their earnings drop, and investors watched income from real estate related investments evaporate. The sign on the street that people are in pain is fewer new cars. It appears that the impact of the housing bust on Arizona is greater than the national average, particularly with regard to durables like autos.


Retail Auto Sales Growth
AZ US
2003 6.90% 2.60%
2004 7.00% 2.80%
2005 10.10% 2.70%
2006 2.50% 1.40%
2007 through September -6.20% 2.60%

Everyone is talking about the employer sanctions law that comes into effect in January. Who will be affected? Seems to me that the small businessman sees himself (herself) as a likely target. Taking away the business license from someone who hires only two employees results in the loss of just two Arizona jobs. Shut down a large business that hires, for example, 500 employees and the economic impact is suddenly more serious. Is that how we should look at it?

If you're driving along a highway and see a curiosity at the side of the road, such as the carnival just south of Phoenix on the I-10, it's easy to spend a second or two looking at it. The problem is that the couple of seconds spent by each driver adds up to a long tie-up for the people at the back of the line. This is what could happen with small business and the employer sanctions law. Because small business sees itself as a likely target, small business hesitates to invest. While each small business is, well, small, the aggregate effect of small business in Arizona is large. We can't think of small business as just another two jobs.

Here’s a charity you might not be aware of: a math teacher in a Rochester, NY, public school is accepting donations to enable the class to conduct “experiments in calculus” as part of the math curriculum. The campaign goal is $247 and charitable donations have covered 46% of that amount so far. Only about $125 to go!

How do I know about this charity? Through the marketplace for charitable donations at DonorsChoose.org, a website that specializes in connecting donors with opportunities for charitable donations.

Columbia University held a “Hacking Philanthropy” mini-conference this past September (2007) and published the transcript of the discussions that took place there. “Hacking” is a term of respect: it refers to an effective, innovative and efficient solution to a challenging problem. “Hacking philanthropy” represents a new movement in which web technology is doing for the world of charitable donations what it has already done for many for-profit businesses: it is providing a marketplace where donors and charities communicate directly with each other.

Commentary on the conference pointed out how radical a departure a marketplace is from the more traditional large-charity-based pattern of giving. The degree of departure is illustrated by the fact that the top 25 charities (in terms of total annual donations received) in the Philanthropy 400 are the same today as they were 40 years ago with the exception of only two new entries (Habitat for Humanity and AmeriCares are the only ones to have entered the top 25 since 1965). Compare this stability to the top 25 for-profit companies in 1965 and today in the Forbes 100 list, where a third of today’s top 25 didn’t exist 40 years ago.

The Philanthropy 400 received $62.7 billion in donations in 2006, up 13% from the year before. This represents more than one-fourth of the total donations made that year. The Chronicle of Philanthropy charges a fee for the full listing of the top 400 but publishes highlights from the list. The top spot on the list for 2006 is the United Way with $4 billion in donations; the Salvation Army, AmeriCares, the American Red Cross, and the American Cancer Society round out the top five.

Why philanthropic markets are emerging now as an alternative to the big charities was debated at the Columbia conference. One theory is that, much as the 1937 article on the theory of the firm pointed to the importance of transaction costs in determining the need for an intermediary in for-profit economies, the same principle applies in philanthropy: as transactions (and connectivity) costs plunge due to decreased computing and communication costs, a marketplace connecting donors and recipients can replace firms (charities) that used to provide that service for a fee.

A donation of $25 to a large charity may not feel like much, but it represents 10% of the total campaign for a Rochester, NY, calculus class charity – that appeals to some donors. A philanthropic (virtual) marketplace makes that donation a real option for many givers. Emerging markets like DonorsChoose.org may become the new organizing principle for philanthropy much as free markets have shaped for-profit economic activity. Charles Best of DonorsChoose.org explains why he thinks the marketplace is a more effective philanthropic mechanism:

We push production to the front-end user in a way that makes them feel like they are partners with us. So that starts with frontline classroom teachers being the ones to come up with the micro solutions that will most help their students. And we actually see that these teachers come up with ideas that are far more innovative and creative than any top-down program would be. And we turn to those teachers to help screen and authenticate proposals submitted by teachers in other regions. We turn to the students who benefited to describe the impact of the project rather than having a staff person go in and record things….

One venture capitalist is already sold on this market.

In a recent Knowledge@W. P. Carey article, the findings of Hoskisson and Kim align with my priors. It would seem sheer folly to believe that major multinationals would locate in a region simply to reap the short run tax benefits. R&D investments by businesses pay off in an array of ways but the size of the ROI depends on the quality of the people available to conduct the analysis. And R&D, no doubt, is more dependent on proximity to quality technical workers than are regular manufacturing positions or even high tech manufacturing positions. The lesson for policymakers should be clear. Maintain a business climate conducive to attracting and retaining people with technical skills, and if you don’t, no amount of R&D tax incentives will substitute.

The article reminds me of a related thread. Many businesses may find advantages in locating R&D and related manufacturing facilities in close proximity. Pressures for reducing the cost of manufacturing invariably increase the pressure to locate in less developed countries. But there remain challenges of finding technical talent in the same location where manufacturing labor costs are low. When confronted with this challenge, Motorola responded by maintaining R&D facilities in Arizona and manufacturing in nearby Sonora Mexico. US border States are uniquely positioned to leverage this location advantage and should be devoting more energy to using this advantage in economic development initiatives.

It’s tough being an optimist for the next few quarters when it comes to forecasting the U.S. economy. But let me give it a shot.

U.S. GDP growth 1st Q 2007 was .6% -- not a pretty number. Naturally everyone pointed to the housing sector. Yet a significant part of the slowdown was the result of unexpected inventory adjustments and slower consumer spending. However, the revised 2nd Q growth rate was a booming 4.0%. Consequently growth over the first half of 2007 turned out to be an annualized 2.3%.

The most recent Blue Chip consensus forecast in September for overall growth in 2007 is 2.0%. In other words, these 50 top forecasters in consensus are anticipating growth over the second half of 2007 to be an unremarkable 1.7%. I disagree for a variety of reasons.

Before I go into why, keep two points in mind. First, since the sharp downturn in the U.S. economy in 1982, for the past 25 years the U.S. has experienced only two minor recessions (1991 and 2001). Real GDP growth averaged 3.3% from 1982 to 2002, and a number of economists today (including Ben Bernanke) refer to the post-1982 era as the Great Moderation. The U.S. economy is remarkably more stable than at any time in its history and rebounds more quickly from shocks.

Second, since 1987 the world economy has not experienced a recession. Think about that! Over this 20-year period worldwide real GDP growth has averaged a strong 3.7%. This bodes well for the U.S. economy since free trade is sweeping the world.

Coming back to the present, over the past year the housing problems have subtracted 1.0% from U.S. growth, whereas previously housing was adding 1.0%. This explains why growth today is closer to 2.0% than 4.0%. So where has been the strength of the U.S. economy?

Let’s start with the consumer. Nearly 70% of GDP is consumer spending. After a five-year run up, it finally slowed down in the 4th quarter of last year and the first quarter of this year. Then it rebounded in the 2nd quarter. Those predicting slow growth or recession believe that consumer spending will be tepid the next several quarters for a number of reasons: houses can no longer be used as ATM machines to withdraw cash for a host of purchases, rising energy costs will eat into discretionary income, and labor markets are about to go into the tank. Maybe.

Another factor contributing to the U.S. growth has been the sharp increase in exports due to the weakened dollar. Estimates are that net export growth has contributed 1.4% to real GDP growth over the past year.

A third area of strength has been corporate earnings. They grew at double-digit levels from 2003 through 2006 and contributed to the commercial building boom the past three years and to the strong employment numbers. Remarkably, in August the Bureau of Labor Statistics originally reported a loss of 4000 non-agricultural jobs, then revised it upward to over 80,000 new jobs!.

Finally, remember that the Federal Reserve has stepped forward with a big rate cut in September and will likely cut the federal funds rate again when it meets October 30-31. It recognizes that raising rates at this time in order to fight inflation will have negative consequences right now.

So, is it a time to worry? Again, maybe. The housing numbers just seem to get worse every week. Corporate profits are projected by the Blue Chip crowd to increase only 3.4% this year. American consumers are hesitant. Jobless claims are on the rise and the stock market has just gone through a terrible week.

But take heart. Never underestimate the American consumer, especially baby boomers. We love to spend and will continue to do so until we drop. Yes, the overall employment numbers are down, but jobs are still being created and this serves as the backbone of consumer spending. Even with the decline in housing prices, household net wealth is near record highs.

Also, the world economy remains strong, and with the weak dollar, U.S. export growth will continue to flourish. Prices of U.S. imports are edging up, helping to shrink the trade deficit.

The Fed will continue to cut rates as a credit-led recession seems a reasonable possibility. Leading American banks are establishing a fund to trade mortgage backed securities, thereby giving greater transparency to this market and reducing the chances for a credit freeze throughout the economy. And I expect all kinds of government action to protect a host of people from losing their homes due to the fall out of the sub-prime mess.

All things considered, I would not be surprised if growth in the 3rd quarter comes in at 3.0% and much the same in the 4th quarter. If so, overall growth this year will be in the 2.5% range rather than 2.0%. After the stock market crash of 1987, the recession of 1991, the Asian contagion – Russian bond default -- Long Term Capital Management collapse of 1997-98, the dot-com crash of 2000, the recession of 2001 with 9-11 thrown in, many forecasters predicted major recessions yet they never materialized. It is not a time to be Pollyanna. But it is also not a time to worry yourself to death over an impending plunge in the U.S.

From its origin as an economical means of preserving dried fish to its current ubiquitous presence in supermarkets and five-star restaurants, sushi presents a fascinating glimpse of the rise and fall (and rise again) of Japan's modern economy and the similarly wild ride of sushi's culinary centerpiece, the bluefin tuna. Sasha Issenberg's "The Sushi Economy: Globalization and the Making of a Modern Delicacy" is a great read for the student of global economics or a raw-fish fanatic who wishes to learn about the people, places and technologies that make up the popular phenomenon known as sushi.

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Paralleling the boom in private equity deals in recent years has been a growing sense of alarm about these multibillion dollar transactions. One aspect that has elicited special concern is the growing trend of "club bidding" -- the formation of consortia of two or more private equity firms to acquire companies at public auction. But determining whether consortium bidding undermines competition is not a simple matter, according to Elizabeth Bailey, clinical assistant professor of economics at the W. P. Carey School of Business.

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Some of the benefits of scientific research conducted in universities are obvious. Great laboratory discoveries expand our understanding of the world, cure diseases, and make life better in myriad ways. In a study for the Science Foundation Arizona public-private partnership, a team of scholars from the W. P. Carey School of Business and the Eller College of Management at the University of Arizona have identified another important benefit of university-based research: regional economic development.

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In the past year, the U.S. government took strong measures to seal the border with Mexico, and the U.S. Border Patrol is reporting that arrests are down 10 percent from last year. Advocates of tougher enforcement point to these facts and say that the crackdown is deterring would-be illegals. But Dawn McLaren, research economist at the W. P. Carey School of Business and a specialist in border issues, has another explanation. The effect of increased security on the border is actually indirect, she says: much of the recent drop can be attributed to labor economics instead.

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