Dirk McCoy's  Instablog

For all the talk of cronyism and peak oil, the single biggest factor driving economic activity has been the massive labor shock brought on by technology and the addition of a billion new workers to the global labor pool.  After the fall of the Soviet bloc and opening of China, it took a decade of development before workers in Eastern Europe, China, and India could participate in providing labor to a global market, but they are providing it en masse now.  This has had a few effects:

1. The promise of lower-cost workers who could recieve better pay and emerge as new customers created massive support for NAFTA and WTO;
2. These low cost workers allowed massive, integrated production facilities in Low Cost Countries (integration is much easier when you're so sure of your labor cost advantage that you know your factory will be competitive);
2. These large production facilities became attractive to major companies that had previously manufactured complex products in the US, especially electronics companies;
3. This rush to low cost countries cratered US manufacturing jobs in the last recession, with over 25% of jobs being permanently lost;
4. The availability of lower-cost workers enabled lower-cost goods to be manufactured by smaller companies, and a boom for big box retailers and Wal-Mart.
5. Lower cost goods and services translated into a consumption boom and repositioning of the US economy to focus on more protectable industries such as homebuilding, banking, healthcare, financial services, and the like.
6. The ability of other nations to pay off debt with production grew, while US costs remained high relative to global competitors, thus causing the dollar to fall 33%.
7. Political winds of change between 2006 and 2008 brought higher Fed funds rates (to slow "out of control" growth), higher minimum wages, and the prospects of more protectionism and regulation.
8. Credit destruction of historical proportions created a serious recession.

So, what now?  There are a couple extreme choices:

1. Go with the flow- continue to exploit low cost country labor, continue to focus on protectable industries, continue to see dollar devaluation, reduce labor cost controls so more American workers are competitive, continue to expand global trade, continue to market low cost foreign goods and services, continue to lead the spread of capitalist principles;  or
2. Fight the tide- establish protectionist policies, centrally plan economic activity, attempt to prop up the dollar, attempt to increase wages, attempt to regulate foreign industrial activity, and let the market determine which economic principles it wishes to accept.

While the first course of action yields ongoing negative labor wage pressures, which will continue to expand as low cost countries move up the value chain into medical services, travel services, financial services, and product design and marketing, it ultimately will yield an economy creating the greatest amount of goods and services, and apportioning them to the owners, risk-takers, and producers.

The second course of action is more likely to reduce global economic activity, yield local disruptions and shortages, create under and un-employment, and apportioin goods and services to those designated by the political regulating class.

It should be helpful at this point to consider what has happened in previous labor shocks.  The industrial revolution reduced wages for those manufacturing shoes, clothing, and similar items, creating a backlash that led to better labor conditions (if still lower than average pay).  The ag revolution reduced wages for farm workers.  The percentage of GDP going to these industries, and percentage of workers, was vastly reduced.  Yet, these workers were eventually re-adsorbed into other industries as new industries were created.  And the cost of these goods dropped precipitously while the quality increased. 

While there is work required to improve the quality of goods and services (not just pet food from China, but healthcare in the US), technology and labor exist to make progress on this score.  And while we may be worried about the share of GDP that goes into healthcare or financial services, we should be thankful that the share of GDP required for food and clothing is near an all-time low.  So for those wondering if more workers producing lower cost goods and services is a good or bad thing, ask yourself this- who likely lives better, a farmer in the Sudan or a bellboy in New York City?

Consequently, I believe the US will generally continue along the first path of globalization, the dollar will continue to fall, and companies that focus on competing globally and developing new markets in low cost countries will do very well going forward for decades.

Disclosure: No positions

The current health reform bills reportedly contain provisions that would allow administration officials to create prevailing wage and government worker classification policies.  The effect of these policies would be to vastly increase the percentage of health care workers in unions, as is the case in Canada.  As has been seen in other industries, greater unionization results in higher labor costs which translate into higher prices.

Given that medical tourism is already a growing practice, with reports of insurance companies paying for travel to low cost countries for some procedures, could this create added pressure on individuals to travel for joint replacements and cosmetic surgery?

Certainly, it's possible.  The cost of hip replacement in India is $10-15,000, while in the US it's $30-50,000.  Quality of care has improved in low cost countries as well.  This situation is not unlike electronics and autos, where US labor cost disadvantages have created major shifts in production.

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Barack Obama is defending his economic policies while reminding Americans that he inherited a $1.3 Trillion dollar deficit.  Unemployment is slowing, yet high.  Projected deficits are astronomical.  The stock market is rallying.  So- who to blame?

Let's start by dividing economic performance into three time periods- the 2003-2007 boom period (as the stock market hit historic highs and official unemployment hit historic lows), the 2007-2009 bust period, and the 2009 onward recovery period.  Now, remember this- the market is a leading indicator, pricing in projections of future economic performance.  So, what did the market price in in these periods?

2003-2007: Lower interest rates, lower taxes, productivity improvements through technology, loose regulation, and globalization of all these leading to a larger, lower cost, labor pool.

2007-2009: Higher interest rates (as the Fed inverted the yield curve to combat "top-heavy, unsustainable" growth), higher taxes, more regulation, higher labor and energy costs, and specter of protectionism and more welfare.  These are fundamental tenets of Obamanomics, their likelihood increasing from the Democratic Congress of 2007 through Obama's inauguration in January of 2009;

2009 onward: Lower interest rates as the Fed not only slashes short term rates but buys down longer term rates, uncertain taxes, uncertain labor and energy costs, and uncertain protectionism and welfare;

In other words, the market just may be improving because public support for Obamanomics (and the idea that slower economic growth has some advantages) wanes.  Global cooling and increasing skepticism for viability of alternative energy in the short term have put cap and trade on deathwatch.  With widespread understanding of the role of Smoot-Hawley in the Great Depression, Obama reversed course on NAFTA to get elected.  And a new healthcare entitlement increasingly looks like a long shot.

So, what does this mean for individual stocks?  For one, a return to the story of American leadership in globalization, with big deals, big technology, and global expansion of a middle class.  This would be good for companies such as Proctor and Gamble, Boeing, McDonald's, Coke, HP, Citi, and GE, along with companies such as Emcore that have leading technology (while handling solar is a problem short term, there's no doubt that it will be key long term) and fertilizer stocks that should do well fueling the vast increase in food production required.

And second, a return to dollar devaluation as the Fed maintains strong growth environment.  Inflation will be key- thus, offsetting this with lower labor costs and technology substitution for commodities.  Companies that specialize in getting greater efficiencies using technology should do well.

In short, I'm hopeful that the economic US and global outlooks are bright.  Three billion people are living in near poverty, and there is ample idle productivity to make a significant dent in this.  The US economy can resume strong GDP growth as it resumes global economic leadership.  And, for this, Obama will not be to blame.

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Pennsylvania governor Ed Rendell announced last week that Pennsylvania will triple its solar capacity with nearly $23 million in new grants and loans, including a 135 acre solar park to power 1450 homes, and a $1M grant towards a $5.1 million project to install a 695-kilowatt rooftop solar system on a ShopRite Supermarket to help preserve 283 jobs.

A recent commercial promised the entire US could be powered by a 100 mile by 100 mile swath of land in Nevada.  But using the density of the Pennsylvania project as a guide, this area is understated by 45%.  And there are dozens of stories about solar panel prices moving below $2/Watt- so why is the ShopRite system costing over $8/watt?  And one last question- if electricity is going for $.02/kwh on the wholesale market, why is Pennsylvania spending $23 million, at what looks to be above market rates, to create power that will likely cost significantly more?

While solar, wind, tidal, geothermal, nuclear, and other energy sources will be required some day to offset declining fossil fuel stocks, investing in those alternatives today in uneconomic fashion doesn't work unless government subsidies come into play.  But government subsidies detract from other economic uses of those funds, which could include additional research and development in a variety of areas that could provide a greater improvement in living conditions.

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A Reuters report today (http://www.reuters.com/article/domesticNews/idUSTRE56C0T120090713) focuses on the trend more people working for free in this current job market.  While the official unemployment rate nationwide approaches 9%, the unofficial unemployment rate is estimated at 20%.  Teen unemployment above 24% is nearing record proportion.  As a black market in labor is developing (not to say anything of the uncompensated efforts of bloggers, gamers, and mySpace designers everywhere), it seems reasonable to question labor price controls- and how the solution will likely involve inflation and increase in equity prices.

Some 90% of economists agree that a minimum wage increases unemployment.  Detroit increased its minimum wage in 2006, and it's labor market has eroded significantly since then.  Congress voted for an increase in the Federal minimum wage that goes into effect the end of this week- forward pricing this development has certainly not helped with job creation.

Higher unemployment and price controls have three dimensions, especially damaging in the current debt-ridden position- loss of initiative, loss of income, and loss of industrial base.

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Nearly every day finds another article about solar technology and startups and their progress.  $1/Watt used to be the Promised Land of production cost- and certainly a huge advance over the $300/Watt costs of the early 80s- yet First Solar has reportedly beat that mark.  And Charlie Gay of Applied Solar has reportedly said, "The Moore's Law for solar is that as time goes by, things get thinner and still absorb light."  Heady talk, indeed.

The progress, competitiveness, and challenge in solar technology is eerily similar to two high tech markets of the past 20 years- multichip modules (MCM) and optoelectronics.  They all share the following similarities:

1. A new hope for breakthrough performance- MCMs for electronic density, optoelectronics for bandwidth, and solar for energy cost and supply;

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