I was looking at the April CPI this morning, and I got to thinking about Dropbox. I use Dropbox literally 25-50 times a day. I’m working on a file on my Apple laptop, save it to the Dropbox folder, and I can be sure that the same file will show up on my PC when I get home.

Dropbox costs me nothing for 2.5 GB worth of storage. More important, I’m getting a valuable service for nothing.

Now comes along Google Drive, which supposedly functions much the same way, and offers 5 GB of storage. Now, I’m not going to switch any time soon because Dropbox is working fine for me. But a reasonable interpretation here is that the “price” of seamless online storage has fallen.

But where does the fall in “price” of the Dropbox/Google Drive-type service show up in the Consumer Price Index? The answer: Nowhere. Free services such as Dropbox and Google Drive (or Facebook, or Yahoo Mail, or any other Web service without a price) do not affect the CPI, even as their usefulness increases.

This is not a new observation at all (see for example the 2009 working paper ”The Broadband Bonus: Account for Broadband Internet’s Impact on U.S. GDP” by Greenstein and McDevitt).

Yet this omission of free online services from the CPI, once insignificant, has become increasingly important as we spend more and more of our time online. What has the bigger impact on Americans–an increase in the price of “lunchmeats” (2.3% over the past year) or a decline in the price of online storage (arguably down by as much as 50%, though it is probably less )?

That’s a real question, incidentally, not a rhetorical one. We may have reached the point where Internet companies are providing free services that have a higher value than some things we pay for. How we change our economic statistics to reflect this new reality?

PPI Chief Economic Strategist Michael Mandel, explains in The Atlantic the surprising link between the future GOP presidential nominee and the upcoming Facebook initial public offering.

“Mitt Romney and his fellow Republicans are gleefully pounding President Barack Obama for the weaker-than-expected employment report released on May 4. Growth seems to be weakening and Romney is positioning himself as the business-minded economy savior for the country.

“At the same time, the Facebook IPO, anticipated to value the company at more than $75 billion, is a tangible sign of the vast amounts of wealth and income being generated by the communications boom and the so-called App Economy. Smartphones, broadband wireless, social media, apps — all are combining to provide a potent force for economic growth.

“So the question is: Should Romney be worried about an “App Surprise” — a sudden acceleration of growth and job creation fueled by the smartphone/communications boom?

“That might seem unreasonable given the other drags on the economy. Yet Romney and his advisers would be wise to remember the events of the 1996 election campaign.”

Read the full article at The Atlantic

We live in a world where the communications sector is driving the recovery and receiving much attention. We believe that this is the most important ongoing development in the American economy, offering the potential for long-term transformation.

But while very important, a boom in communications isn’t enough, alone, to achieve balanced and sustainable growth. We need every sector of the economy, including manufacturing, to contribute. With this in mind, the Obama Administration has taken the positive step of proposing a series of policy measures that would encourage domestic manufacturing.

In this spirit, we undertake an audacious question: In this era of apps and social media, what is a reasonable long-term goal for manufacturing employment?

We first show that manufacturing has larger job spillovers than commonly thought, based on new calculations. Next, we estimate the employment consequences of eliminating the trade gap in manufactured non-oil goods, a desirable long-term goal, without reducing our standard of living.

Assuming such a balancing, we find that the U.S. should aim to add roughly 3.5-4 million direct and indirect manufacturing jobs over the long run, raising total manufacturing employment to about 15.5-16 million, or 2001 levels. This bold effort would ease the job drought and offer millions of Americans a path to the middle class. What’s more, we would be producing more at home, while borrowing less from the rest of the world.

Achieving this admittedly aspirational goal would come at a relatively small price: we calculate that overall economy-wide prices would have a one-time rise of only 1.8-2.0%, spread out over the time it takes to close the trade gap. To put this in context, the inflation rate for gross domestic purchases has averaged well over 2% annually over the past ten years. So closing the trade gap would raise prices by less than one-year’s inflation.

Read the entire report here

Sometimes things are not what we think they are. The conventional notion is that government has become more important under President Obama, while the private sector has stagnated. Yet in some ways the data tell a different story. Take a look at this chart:

The top (blue) line shows that private nonresidential investment has rebounded smartly since early 2009, when President Obama took office. Residential investment first dropped, and then mostly came back.

The real problem is government investment, which is down 8.3% since the first quarter of 2009, and still falling. In other words, government spending on infrastructure infrastructure, building, and equipment is declining, adjusted for prices changes.

Let me get this straight. The communications boom is finally reviving the U.S. economy. There’s an incredible wave of startup activity and excitement around smartphones, mobile apps, broadband wireless. Jobs are being created, and the economy feels alive again. Sounds like a great time to be celebrating our success, doesn’t it?

Yet the Federal Trade Commission has apparently decided that it’s a good time to go after Google, one of the key leaders of the communications revolution. And, oh yes, incidentally one of the most innovative companies in the world. Are these guys serious?

According to a front page story in the NYT this morning, “[f]ederal regulators escalated their antitrust investigation of Google on Thursday by hiring a prominent litigator, sending a strong signal that they are prepared to take the Internet giant to court.” The story went on to say “the core question is whether power was abused.”

But when I look at Google, I see a company that has nourished the open-source Android platform, almost singlehandedly creating the only major competitor to Apple’s iPhone ecosystem. I see a company that provides free services that a vast number of Americans use every day.

And I see that a company, frankly, that has helped make it cool for college students to be techie again, rather than simply gravitating to Wall Street and financial jobs.

I’m not defending all of Google’s actions, by any means. A company that innovative is always going to be stepping on hidden land mines–it’s unavoidable.

But innovation has been the major force driving the communications boom, and Google has been a major source of that innovation. The FTC should open its eyes to the big picture here and think macro, rather than micro. The Obama Administration should be encouraging innovative companies like Google, not attacking them.

Cross-posted from Innovation and Growth.

The $1 billion purchase by Facebook of Instagram, a start-up with a hot mobile photo app, was played up by the New York Times as a way for Facebook to stave off competition–”eat the new start-up before it eats you, or before a competitor grabs it.”

However, there’s another way to think about the Instagram purchase. Facebook just sent a strong signal to potential entrepreneurs and venture capitalists: If you have a good idea for an app, or can find someone with a good idea for an, you can get very rich very quickly by being acquired by a Facebook, or a Google, or a Microsoft. All of a sudden starting or financing a new company, with plenty of new employees, looks a lot more appealing.

In effect, an acquisition such as this one will likely stimulate competition, investment and job growth in the App Economy. Nothing spurs business creation and job growth like the prospect of making money fast. And the existence of deep-pocketed acquirers who are willing to spend heavily accelerates entrepreneurship. One startup today (Instagram) may be replaced by five tomorrow. (This argument was made at length in a paper I wrote last fall with Diana Carew “Innovation by Acquisition: The New Dynamics of High-Tech Competition.” )

What about the argument that purchases like this one are just fueling a new bubble? My answer: Having lived through the boom and bust of the 2000s, I’d be very happy to get a repeat of the boom and bubble of the 1990s. At least the dot.com boom one left us with the Internet and a full cabinet of new capabilities, rather than a bunch of empty houses and bankrupt countries. A technology bubble beats a financial bubble, any day of the week.

When it comes to manufacturing, most politicians, economists, and journalists agree: the millions of manufacturing jobs lost in recent years are mostly not coming back. Looking at the official data, it’s easy to understand why. Productivity in the sector has continued to climb even as jobs dwindled, so it must be the case that these jobs were lost to good old human ingenuity.

But this conclusion is derived from faulty official data. Indeed, a closer look at the numbers reveals an entirely different history on what happened to U.S. manufacturing.

Specifically, this paper shows that rising imports play a much larger role in the loss of jobs since 2007 than official data suggests. In fact, we estimate that rising real imports are responsible for approximately 1.3 million of the jobs lost between 2007 and 2011, or almost one-third of total private non-construction job loss.

“We have a huge opportunity, at this moment, to bring manufacturing back…but we have to seize it.” With these words in his State of the Union address, President Obama signaled that he is getting serious about recapturing factory jobs that have been lost to imports. Since the speech, the White House has outlined a series of policy measures intended to encourage companies to ‘insource’ jobs from overseas, including changes in the tax code and increasing domestic investment.

True, many economists, both liberal and conservative, are skeptical that much can be done to bring back manufacturing jobs. They argue that American factories have become so efficient that they no longer need to hire many workers. “It’s totally implausible to think that there’s going to be a surge in manufacturing jobs,” Lawrence F. Katz, an economist at Harvard who served in the Clinton Administration, told the New York Times. Christina Romer, former head of Obama’s Council of Economic Advisors, recently wrote in the New York Times that “a persuasive case for a manufacturing policy remains to be made.”

But this skepticism about President Obama’s manufacturing initiative relies on faulty official data. In fact, government statisticians are dramatically undercounting the economic impact of imports from low-cost countries such as China, as we will explain, in this paper and the accompanying policy memo, “Trade-related Jobs Lost During the Great Recession.” The reason for this statistical problem is an important economic concept known as “import price bias.”

After doing a preliminary adjustment for import price bias, we find that 1.3 million jobs have been lost to rising imports since the recession started in 2007, accounting for one-third of the private nonconstruction job loss. Many of these are jobs that could potentially be brought back to this country by appropriate incentives that encourage investment and job creation in the U.S. We therefore conclude that President Obama’s manufacturing initiative, combined with other “pro-production” policies, can potentially be a significant source of domestic jobs.

Read the entire report here.

PPI Chief Economist, Michael Mandel, discuses the challenges facing America’s economic recovery on Marketplace:

“After a number of incremental but positive indicators that have come out in the past couple of months — the so-called “green shoots” — today’s fourth quarter GDP was a reminder that our economy is still very fragile. Like a green shoot of a plant or a tree, our economy needs a lot of nurturing to really grow.

“Mike Mandel is the chief economic strategist for the Progressive Policy Institute. He says lower-than-expected GDP in the final three months of last year reflect an economy that’s “on the road to recovery,” but it’s a “slow, uneven recovery.”

“Mandel says we still haven’t solved a key underlying problem: We’re investing too little in increasing our productivity and too much on consumption. According to Mandel, we went into this recession too focused on consuming and neither public or private investment has been enough of a priority.”

Read and listen to Mandel on Marketplace.

Can insourcing be a major source of job creation for the U.S.? The answer is yes, with a caveat. Widespread insourcing–or import recapture, as I like to call it–won’t happen without some help from government policy. In particular, the main role of the government is to provide better data about the relative cost of insourcing vs outsourcing.

Why would better statistics help create new jobs in the U.S. and accelerate insourcing? The reason is hysteresis. Hysteresis is defined as a “lag in response” when the forces acting on a situation have changed. Originally hysteresis worked in favor of keeping jobs in this country, because businesses didn’t want to switch their production to a country thousands of miles away, even if it might be cheaper.But now, with production firmly established in China, India, Mexico, and other low-cost countries, hysteresis is working against the U.S.

As a result, even if production costs have converged, there are three big obstacles to bringing jobs back to the U.S.

First, it is expensive to switch suppliers, especially for noncommodity purchases. Contracts have to be negotiated, the quality of the product has to be checked, suppliers have to be integrated into a supply chain. Wal-mart would rather work with suppliers that it already has been doing business with.

Second, it may be expensive and time-consuming to recreate a production ecosystem here in the U.S., especially if an industry has been hollowed out. That is, if you want to start making shoes in the U.S., it’s easier if you have a repairman in the area who knows have to fix shoe manufacturing machinery.

Conventional wisdom these days says that small is better when it comes to innovation and putting new ideas into practice.1 Large enterprises are typically thought of as hidebound defenders of the status quo, dominating by market power and brute force rather than technological and innovative prowess.

Yet reality is far more complicated than this simple small versus big distinction. As we all know many common-sense beliefs turn out to be only partly true, or not to be true at all.

In this policy memo we will reconsider the link between scale (size) and innovation. After 20 years where startups have rightly dominated the innovation headlines, we will show that the pendulum may be swinging back. As a result, there are reasons to believe that scale may be a plus for innovation in today’s economy, not a minus. We will then relate scale to government policy, U.S. competitiveness and prosperity.

The now-heretical idea that scale is an advantage for innovation actually dates back more than 60 years. Back then, Harvard economist Joseph Schumpeter, the inventor of the term ‘creative destruction’, suggested that large-scale firms were “the most powerful engine of progress.” Following after his work, economists developed what came to be known as the “Schumpeterian Hypothesis.” The first part of the Schumpeterian Hypothesis was the argument that bigger firms have more of an incentive to spend on innovation than a smaller one. For example, if we compare a company that manufactures 50 million t-shirts a year versus one that manufactures 10,000 t-shirts a year, the larger company is much more like to spend the big bucks needed to develop and test a new process for dyeing the t-shirts.

The second part of the Schumpeterian Hypothesis is the observation that companies with more market power might also be more willing to invest in innovation. The argument is that if a firm in an ultra-competitive market innovates, the new product or service is quickly copied by rivals, so that the gains from innovations are quickly competed away. Conversely, a firm with market power has the ability to hold onto some of its gains from innovation, so it may pay to invest in product or other improvements.

Right now policymakers are grappling with the implications of slow economic growth in the United States and the rest of the industrialized world. One response is austerity—cutting back on spending, accepting reduced living standards, and slowly digging out from the mess.

A better option, though, is innovation, which accelerates growth, creates new jobs, and makes U.S. products and services more competitive world-wide. Innovation has the potential for raising incomes, an especially important task given that real median household incomes have fallen more than 10 percent since the beginning of the recession.

While innovation can come from any industry, the technology sector is particularly important, as it has been the main source of growth and innovation in the economy for the past 35 years. The locus of innovation started with the personal computer in the late 1970s and 1980s; shifted to software and the internet in the 1990s; and now has moved to mobile, search, and more broadly communications, where U.S. companies are world leaders. Today’s technological advances have facilitated the emergence of innovation “ecosystems,” or platforms on which many different companies can build products or provide services.

The growth of tech companies stems from a combination of organic growth and business acquisitions, driven by the rapidity of innovation. It’s a virtuous circle, where successful technology companies pay large sums for small startups, which in turn induces the formation of more startups. For that reason, technology acquisitions need not diminish competitiveness, even as they accelerate innovation and job growth. Indeed, as we will see later in this paper, periods of high levels of acquisition have also been periods of rapid job growth.

America is deep in a jobs crisis. The unemployment rate is stuck around 9 percent nationally, with states such as Florida, Nevada and South Carolina in double digits. Real wages for educated workers are still plunging, while new college graduates are squeezed between rising student loans and the toughest labor market in recent memory.

Against this backdrop, the global economy looms large as both threat and promise. There’s a justifiable fear that America has lost its competitiveness, that our jobs are being siphoned to China and India, that the wages of our young people are being depressed by a global education glut. At the same time, the rapidly growing markets of the developing world could be a potent target for U.S. exports of goods, services, and intellectual capital, creating good jobs here.

In this global economy, we need to know which industries are internationally competitive, which ones aren’t, and whether the gaps are closing or widening. Unfortunately, the reality is this data currently does not exist. And what we don’t know hurts us, because it prevents us from pursuing effective strategies for boosting US jobs.

Although the government collects reams of economic data, it doesn’t measure what’s most vital to our ability to reverse America’s jobs decline: how our goods and services stack up against those of China and other competitors in terms of price.

You can’t fix what you can’t measure. We need a new national jobs strategy that begins with an accurate way of measuring America’s competitive prowess, on an industry-by-industry basis.

This policy brief proposes that the Bureau of Labor Statistics undertake a “Competitiveness Audit.” The Competitiveness Audit will compare the price of selected imports with the comparable domestically produced goods and services. That will tell us the size of the ‘price gap’ between imports and domestic production.

Read the entire brief.

In the Atlantic, PPI Chief Economic Strategist Michael Mandel discusses the two possible solutions for escaping the current economic disaster — innovation and inflation:

It all comes down to this: We have to match growth to debt. If we can’t create miracles from growth, we have to consider inflation to reduce the value of our debt

We have only two ways out of our current global economic mess: innovation and inflation. And as the saying goes, we should hope for the best (more innovation) and prepare for the worst (higher inflation).

Looking across the world, the underlying problem is that borrowers–households and governments–have taken on debt that they can’t afford to pay back, given the current rate of income and economic growth. In the U.S, too many homeowners are struggling with mortgages that far exceed the value of their homes and cannot be repaid from their current incomes. In Europe, Greece and perhaps other countries have issued bonds that they cannot pay back unless growth unexpectedly skyrockets.

Down the road the same principle of matching growth to debt allows us to perceive potential financial crises to come. Young male college graduates, for example, have seen their real earnings plunge by 19% since 2000, with young female college grads experiencing a similar decline. Meanwhile education borrowing has soared, suggesting that we are on the verge of a student loan crisis, where young grads simply cannot pay back their mountain of debt.

Read the entire article

For years when I was chief economics writer at BusinessWeek, I would write our post-Nobel piece.  I was often one of the few people who would challenge the adulation of the prize winners, notably in this 2005 piece on the Nobel in game theory.

But today’s awards to Tom Sargent and Chris Sims simply leaves me stunned.  Let me give you a brief excerpt:

“It is not an exaggeration to say that both Sargent’s and Sims’ methods are used daily … in all central banks that I know of in the developed world and at several finance departments too,” Nobel committee member Torsten Persson told the AP.

There’s a good rule of thumb–you get what you reward.

Here’s a summary of current U.S. policy towards big corporations: Invest in the U.S., create jobs, and get sued by the government.

You would think that during a business investment drought, any company that puts big money into the U.S. would be patted on the back. But no…

AT&T is the company which is putting the most money into the U.S.—almost $20 billion in capital spending in 2010. AT&T is also planning to bring back call center jobs from overseas. AT&T is also getting sued by the Justice Department to block the merger with T-Mobile.

Frankly, this sends a signal to U.S. companies that getting out of  the reach of government regulators by going overseas is the right strategy.

Crossposted from Innovation and Growth.

With the stock market plunging, we’ve heard plenty of warnings that a “pullback” in consumer spending could trigger another recession. Let me suggest an alternative. The last thing this economy needs is more debt-fueled consumer spending which mainly creates jobs overseas. Instead, we should be focused on boosting investment in physical, human, and knowledge capital.

Now, who am I to be dissing the American consumer? Don’t I know that consumer spending “accounts for 70% of economic activity,” as many economic reporters have written in recent weeks? (Indeed, if I have to read that number in another story, I might be forced to go all Office Space on a piece of expensive consumer electronics.)

It’s true that consumer spending creates economic activity. But it’s not true that all that economic activity is in the United States. Many of the consumer goods we buy are imported. If you buy a shirt or television, you are stimulating manufacturing jobs in China, or perhaps Mexico. You aren’t doing as much to stimulate jobs at home.

Where can Americans cut back if the economy slips back into recession again? After all the talk about the “new frugality” and the deepest recession in 75 years, it might seem like households have tightened their belts as much as possible.

Surprisingly, however, the economic figures show several key areas where Americans have actually increased consumption compared to 2006, the year when housing prices peaked. Judge for yourself whether we can cut back more or not. (Note: all consumption changes are measured in inflation-adjusted 2005 dollars, comparing the 2nd quarter of 2011 with the second quarter of 2006)

When President Obama took office in January 2009, he promised that ” to lay a new foundation for growth….we will build the roads and bridges.” And in his 2011 State of the Union address, he promised to “put more Americans to work repairing crumbling roads and bridges.”

But as all attention is focused on the debt ceiling battle, here’s what’s happening on the infrastructure front. Highway, street, and bridge construction jobs through the first five months of 2011 are running 18% below 2007 levels, and the stimulus money is fading. House Republicans are proposing to cut future federal infrastructure funding by roughly one-third. And any defaults among state and local governments would raise borrowing costs for infrastructure bonds across the country and in some cases make the bonds unsellable.

In short, a difficult infrastructure situation is about to turn worse. The U.S. seems likely heading for an infrastructure crash that will terribly damage both our prospects and those of our children.

On July 17 the online edition of the WSJ published a widely-cited story entitled Wireless Jobs Evaporate Even As Industry Expands. The main point of the story (my emphasis):

In May, on the heels of a record year for industry revenue, employment at U.S. wireless carriers hit a 12-year low of 166,600, according to U.S. Labor Department figures released earlier this month. That’s about 20,000 fewer jobs than when the recession ended in June 2009 and 2,000 fewer than a year ago. While the industry’s revenue has grown 28% since 2006, when wireless employment peaked at 207,000 workers, its mostly nonunion work force has shrunk about 20%.”

In addition, the Journal digs further into the official data and claims that:

The number of customer-service workers at wireless carriers dropped to 33,580 last year from 55,930 in 2007, according to the Labor Department

Seems like a pretty straightforward story, doesn’t it? The Journal is quoting directly from authoritative BLS data to demonstrate that the wireless industry has been losing jobs, despite the mobile boom. The big picture message: Innovation does not equal job growth.

Unfortunately, the reporters and editors at the WSJ fell into the same trap that has ensnared many other journalists, policymakers, and even economists. They looked at the label on a piece of official economic data, and assumed that they understood it. But as we saw during the financial crisis and subsequently, government economic data can all too easily be misinterpreted.