As the media focuses on the dysfunction in Washington, there is a stealth recovery occurring led by innovation in the private sector. An article from the Economist dated March 16th, 2013 titled “Cheer Up” by Edward McBride, discusses how the economy in the US is much more vibrant outside the Washington Beltway than the media conveys and the general public believes. Here’s a synopsis of the writing. Few of us remember the US government agency called Advanced Research Projects Agency (ARPA). It was founded to help the US compete with the Soviet Union’s space race after Sputnik. In 1958 when NASA was formed, ARPA focused on developing computer science and information processing for military purposes. One of its projects was to protect the ability of the US military during a missile attack. That project led to the creation of ARPAnet — the world’s first multiple-site computer network. The research company Bolt Beranek and Newman based in Cambridge, Massachusetts was a lead contractor in the development of the project and in 1969 created the first working ARPAnet which twenty years later became known as the internet. Just as the initial innovation on the internet by the defense industry did not result in the World Wide Web for decades, so too much of the innovation we see now has occurred gradually, over time, and the effect on our economy has only been obvious since the 1990s. At first, the effect is moderate but over time the coming tech boom will likely rival the 1980s and 1990s in economic prosperity. Ironically, the most prosperous period for the boom will occur in the 2020s; the ROARING 20s all over again! This possibility is ironic since the worst economic crisis in the 20th century occurred in 1907-1909; it was so bad that the US created the Federal Reserve Bank to prevent such a disaster from occurring again. In retrospect and reflection, we learn how well our protections from disaster meet the situation; consider 1929 and 2008.
Presently, we are seeing the first signs of real change in two areas that effect everyday life, energy and manufacturing. In energy we are witnessing the fruits of decades of research in accessing the oil and gas trapped in shale. In the 1970s the price of oil first spiked the discussion about Oil Shale. A company called Oil Shale went from $3.50 per share to $45.00 a share in a ten year period. This was my first investment; I sold my investment $40.00 per share and watched with curiosity as the shares collapse to $1.50 per share. Oil Shale languished at this level for almost a decade before becoming part of the oil refiner TOSCO (The Oil Shale Company). Tosco is now part of ConocoPhillips and does not exist as a separate company. So, the oil drilling technologies of fracking combined with horizontal drilling have been around for decades but only became economically feasible in the last decade. The result of the commercialization of those two technologies has been an explosion in the amount of recoverable natural gas and oil in the United States. First, the price of natural gas in the United has plummeted from $13.0 per million British Thermal Units (MMBTU) in 2008 to around $1 to $2 in 2012, as the flow from natural gas from shale gushed! As a result, natural gas prices in the United States are about 1/3 lower than prices outside the US and Canada. The effect of this price difference is stunning!
In the meantime, Allegheny Technologies spent $1.1 billion on a new steel mill in Brackenridge, Pennsylvania to exploit the difference in gas prices in the US which are about 1/3 the price in Germany and ¼ the price in South Korea. Both Germany and South Korea have large manufacturing bases in steel. Ohio, close to the PA border, saw billions in steel development as Vallourec spent $650 million and US steel opened a new $100 million mill to supply steel to the oil and gas industry for pipes and rigs. US gas prices are half that of Chile and Mexico which explains why Methanex is dismantling its plant in Chile and rebuilding it in Louisiana alongside chemical plants in the Gulf Coast that have been expanded by Formosa Plastics of Taiwan, Dow Chemical, Chevron Phillips, Occidental Petroleum and Williams. CF Industries is expanding its local fertilizer production, Nucor is building a new steel mill and Sasol of South Africa is petitioning to build a refinery to turn natural gas into gasoline. All of these investments will increase productivity for years and are occurring despite Washington where the US has lagged private industry in allowing fracking since the Obama administration has been elected.
Another area that receives too little attention is the area of Research and Development (R&D). Politics has harmed the US’ lead in stem cell research, which moved to Europe and Asia when the Bush Administration stopped funding to that industry. Per a National Science foundation study, US R&D spending has fallen from 38% to 31% between 1999 and 2009, the last year it conducted the study. And per GDP, we rank 9th spending about 2.9% of GDP on R&D. The US tax credit for R&D is a stingy 6% compared to 14% in China and 29% in Denmark.
That having been said, the US continues to spend more than any other nation on R&D. According to ITIF statistics, the US is the 4th most nurturing place for innovation, ranking less than Singapore, Finland and Sweden (their economies are so small that the effect is not relevant to the US). Unlike most countries, the US government does not dominate R&D, others in the private sector do. The US government funds only 31% of R&D and that research is skewed much more towards foundational research such as creating the internet, rather than enhancing existing technologies. US R&D spending on health care is around $140 billion in 2011, per the RearchAmerica analysis. The US government spends about $30 billion and falling while China announced that its government will spend about $60 billion per year over the next five years. So, although the US government’s share of spending is falling, the amount spent on medical research in the US still represents more than half of all medical research. As in all R&D, the trend is that other countries are spending more rather than the US ceasing, which is beneficial to mankind. Furthermore, the US has built upon innovations sourced outside its borders, so R&D spending is not a zero sum game. An example of this is innovations in automobiles from Asia helped to transform the US auto industry to construct better cars.
In education, we are struggling and experimenting from preschool through high school, but on almost all measures US universities continue to dominate. An analysis by Leiden University in the Netherlands stated that of the top 30 universities cited in research papers, 27 were American universities. However, approximately 42% of Americans have a college degree, placing us 10th globally and 16 percentage points behind the leader, South Korea.
As the boom in the US economy takes hold and grows, despite Washington’s dysfunction, the current deficit in tax revenues will grow substantially whether or not the current tax rate rises. At that time, the government will probably face the same issues that confronted it in the 1980s and 1990s, a shrinking budget deficit even though entitlements are scheduled to rise sharply. The hope is that at that time, the government can come up with a deal similar to what happened between Tip O’Neal and President Reagan rather than go the route of more recent presidents, which was spend more until the government get buried under a massive debt load.
The lesson from the Euro zone proves that politicians the world over, do not make tough decisions when facing economic hardship and voter anger. During those periods, they make the least hurtful decision, which usually delays the really painful decision. Our current political dysfunction shows the truth of that situation. It is much easier to make hard decisions when the pain from that decision won’t be felt for many years, such as the Tip O’Neil/Ronald Reagan bargain increasing the age of receiving Social Security benefits for people twenty or thirty years into the future. All of the proposals doing the same for those 10 to 15 years in the future since then have not been successful. Our only hope will come when the economy improves; and that is dependent upon both how strong the economic rebound is to absorb the pain and how much foresight those politicians possess.
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