Monday, April 16, 2012

“A Quiet Revolution”

Sydney M. Williams

Thought of the Day
“A Quiet Revolution”
April 16, 2012

Surreptitiously, a revolution has been going on in the heartland of America. When he became President, Mr. Obama set as one of his goals the doubling of America’s exports over the next five years. The economist Tyler Cowen recently wrote: “At the time, critics called this an unrealistic promise, one that voters would forget by the 2012 election.” Instead, it appears that Mr. Obama may have caught a wave. But success will depend on his giving up his dreams of embracing “green” energy, and instead will require his support of fossil fuels, especially natural gas.

Mr. Obama had to have had greater knowledge of recent economic history than his critics. His goal was not that radical. For the five years between 2002 and 2007, U.S. exports rose 72%, from $I.006 trillion to $1.731 trillion. As a percent of GDP over those five years, exports rose from 9.6% to 12.3%. It is expected that this year they will reach 14% of GDP and amount to $2.1 trillion. In fact as a percent of GDP, exports have been rising for the most part of the past two decades, driven first by the NAFTA treaty, signed January 1, 1994, second by a weak dollar, which characterized both the Bush and Obama Administrations, and more recently by some trends now coming into play.

Three factors – certainly more fundamental than relying on a cheap dollar – are influencing the renaissance of manufacturing, which should allow exports to continue to rise as a percent of our GDP: labor cost differentials between the U.S. and emerging countries, “smart” machines and, perhaps most importantly, an abundance of cheap natural gas, most of which is embedded in shale.

According to work done by the folks at ISI, unit labor costs in the U.S. declined 3% between 1980 and 2010, while those in Germany rose 88 percent. The Boston Consulting group has determined that, adjusted for productivity, wage rates in Shanghai are only about 30% percent cheaper than in the U.S. Certainly China has lower labor rates in their western provinces, but productivity is less positive in those regions. The point being that over that the last few years the great advantage emerging economies had over U.S. in terms of labor rates is beginning to diminish. For example, ISI notes that in 2000 average wages in China were $0.50 per hour. Today they are $3.50. Inflation, in countries like Brazil, is damaging their labor-cost advantage.

In the May/June 2012 issue of The American Interest, Tyler Cowen spoke of three forces that will allow America to again become the world’s leading exporter. (We are now third, behind China and Germany.) The forces he cited were artificial intelligence, cheap sources of energy and demand from emerging countries. Anybody who has recently visited a factory floor realizes how different it is from a few years ago. A small number of people are actually on the floor. Software driven machines do much of the work. Mr. Cowen wrote: “The more the world relies on smart machines, the more domestic wage rates become irrelevant for export prowess.” A manufacturing survey conducted last November indicated that almost one fifth of companies surveyed claimed to have brought production back from a “low-cost” country. In-sourcing may well replace the outsourcing of the past several years, as “smart” machines continue to be installed and as transportation costs from emerging nations imperils their competitive advantage.

Third, and the most important part of the story, America (and Canada) has an abundance of fossil fuels. Utilizing unconventional techniques such as deep-water drilling in the Gulf of Mexico, the tar sands in Canada and shale oil and shale gas in the U.S. could convert the U.S. from an importer of energy to an exporter over the next several years. (The Canadian tar sands are the principal reason behind the urgency of the Keystone Pipeline.) Over the past five years, North America has become the fastest growing source of oil and gas in the world. Estimates of recoverable oil and gas in the U.S. amount to about two trillion barrels and barrels equivalent – enough, at current usage rates, to last over a hundred years. While oil prices remain near highs, the price of natural gas has tumbled in response to new found sources. The cost advantage to America’s manufacturers is astounding. Jim Motavalli, writing in last Wednesday’s New York Times: claimed: “A million B.T.U.’s of natural gas that might cost $11.00 in Europe and $14.00 in South Korea is $2.25 in the U.S.”

Lower natural gas prices have a cascading effect on manufacturing by reducing operating costs. Citigroup estimates that 3.6 million jobs could be created by 2020 thanks to a boom in energy. Besides manufacturing, electricity generation and transportation costs would be reduced. Because it is “clean” fossil fuel, natural gas should gradually replace coal-fired electric utilities. Compressed natural gas is already being used in many big city vehicles, such as busses and garbage trucks. Ford, Chrysler and General Motors are in the process of producing hybrid vehicles capable of using compressed gas, as well as gasoline. While there are only 1000 natural gas re-fueling stations in the U.S. (versus 165,000 regular gas stations), companies like Clean Energy are addressing that need.

It appears that a manufacturing resurgence is underway. It should lead to a boost in exports and a reduction of our persistent trade imbalance. It requires but one additional component – the blessing of the federal government. The Obama Administration has an opportunity to let this development unfold. But will they? Will they rein in an Environmental Protection Agency gone wild? They have essentially sounded the death knell for the coal industry. They are already bringing suits against the natural gas companies for contaminating ground water. Obviously that is something the industry must guard against, but hydraulic fracking has been around for sixty-five years, and most of the shale is thousands of feet below the water tables and reservoirs. Shale gas in the Barnett, Haynesville and Marcellus regions are between 5000 and 12,000 feet below ground. Most ground water and aquifers are less than 1000 feet below the earth’s surface.

Our nation is burdened with debt and deficits that are out of control. The President has been unserious in dealing with it. (His 2012 budget that he submitted to Congress was turned down in the Senate 97-0 and in the House 414-0.) Even an optimist speaks in terms of decades when it comes to solutions. This noose, left alone, will surely strangle us. Neither side of the aisle has demonstrated they can be trusted to handle the tax dollars we provide them in a fiduciary manner. The best – I say the only – way out is through encouraging economic growth by unfettering the private sector. Fate has placed us in an enviable position in terms of natural resources. Ideology should be put aside. The situation is too serious. We shall see if our government encourages this revolution, or squelches it.

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