Comeback: America’s New Economic Boom

Charles R. MorrisWorld Economic Forum

July 11, 2013

Outline

• The argument in brief

• The energy opportunity

• Job implications

• How to fumble it away

• Infrastructure

• Health care

• Paying for it

• A new political cycle?

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The argument

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US’s new energy advantage will trigger a broader recovery, kicking long-term growth rates back to traditional real ~3.5%

• US energy production itself is a big, and growing, employer, with powerful multiplier effects• Turnaround in trade accounts adds directly to GDP• Much of the specialized supply chain for shale-based energy an American

monopoly• Oil and gas industry infrastructure spending alone is planned at $348 billion in

2013, equivalent to about 2% GDP.

• Cheaper energy is already triggering a revival of traditional energy-intensive manufacturing• Chemicals, steel, refining, cement, paper all highly sensitive to natural gas

prices• At same time, rapid cost increases in China have triggered a “reshoring”

movement independent of energy developments.

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Faster growth will ease spending constraints on job-producing public programs like infrastructure and health care

• Heavy manufacturing revival will drive investments in inland waterways, railroads, bridges, and pollution and waste control.

• As growth returns to traditional path, deficits will shrink as a share of GDP, allowing increased investment in education and health care. • Health care is the example used here: despite much resource misallocation, it

adds to GDP, just as, eg, SUV and video game production does• It is a driver of both semiconductor and biotech advances• A top creator of well-paid professional career tracks supported by training

widely available in community college and 4-year public colleges (despite current cutting)

• A favorite of Wall St and venture capital, in contrast to gloom on health care spending in Washington.

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Risks and dependencies

• Growth path will take several years to evolve and lock in: manufacturing recovery just getting under way, and heavy industrial plant takes several years to build and bring on-line

• The energy industry could fumble its opportunity without better environmental performance• The risks are manageable and the technology straightforward

• But requires highly disciplined performance, which has too often been absent

• Public sector growth-enhancing investment in infrastructure and education/training will require completing the cyclical political transition begun in 2008• Visible growth improvement before 2016 will help make that happen.

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Energy

Geology of shale

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US is rapidly building the world’s largest shale-based oil and gas industry• Geologists have long known that shale is the “source rock” for oil and

gas. • In geologic time, sea and lake-bottom mud compresses into hard, thin layers

of rock that traps and cooks biologic matter

• Conventional oil and gas wells are formed as hydrocarbons seep from the shale into sandy formations that form natural reservoirs. They are relatively easy to exploit, but hard to find.

• Probably 85% of hydrocarbons, however, remain in the shale, but neither technically nor economically feasible to get it out.

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Until recently...

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Source: EIA

Multiple enabling technologies

• Micro seismic geologic contouring

• Directional drilling and diamond drill bit designs

• Fracturing techniques – eg, guns that perforate collection pipes

• Slippery fracturing fluids – (friction of < 4 miles 3-4” pipe at very high pressure.)

• Multiple-well drill pads, and moveable rigs

• In short, thousands of small innovations

• Industry growth driven by small, entrepreneurial companies

• But important federal role, not unlike that in semiconductors.

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First commercially viable shale well only in 1998

EIA forecasts of US natural gas and oil and other liquids to 2040

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Source: EIA (both charts)

Speed of takeoff reminiscent of the internet

EIA generally quite conservative in its estimates

• In April EIA estimated 2012 oil and liquids production at 6.5 mm b/d; in June, BP upped the estimate to 8.9 mm b/d.

• Fears of early depletion in Barnett and the Bakken now seem unfounded and major new discoveries coming to light in the Southwest (Permian, Cana Woodford, etc.), plus possibly huge deposits in Monterey.

• By late 2010s, US should surpass Saudi Arabia in oil production and Russia in gas production.

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Jobs

Job implications• Daniel Yergin/IHS calculate 1.7 million jobs in the current energy economy,

growing to 2.5 million by 2015 and 3.5 million by 2035

Source: IHS “America’s New Energy Future” Vol. 1, 2012

• Direct oil field jobs generally very well paid, while workers in direct supply-chain, like steel and heavy equipment, usually have better-than-average industrial pay

• Annual Oil & Gas Journal survey shows $348 billion planned oil and gas infrastructure spending in 2013, equivalent to about 2% of GDP

Unconventional Oil & Gas Employment

2012 2015 2020 2035

Total 1,749,000 2,511,000 2,985,000 3,499,000

Direct 360,000 506,000 600,000 724,000

Supply-chain 538,000 770,000 916,000 1,074,000

Induced 850,000 1,234,000 1,469,000 1,700,000

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Economists at ACC estimated employment gain in eight energy-intensive manu-facturing industries by 2017. (US oil-equivalent natural gas a third as expensive.)

Economic Impact in Eight Industries

Employment Payroll $Bs Output $Bs

Direct 200,000 14.6 121.0

Supply-chain 462,000 31.7 143.8

Induced 517,000 24.2 76.8

Total 1,179,000 70.5 341.6

Citigroup economists forecast a total contribution of < 3.6 million jobs, including both direct and stimulated jobs, by 2020 – in the ballparkof the summed IHS and ACC estimates

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Source: American Chemical Council: “Case Study of Eight Industries” 2012

Typical projects have long lead-times, but once in place will have real staying power

• Dow Chemical is spending $4 billion in four major Texas projects that will come on line between 2015 and 2017

• Nucor converting entire US national production to natural gas, and introducing major changes in smelting technology. Total conversion over 5-6 years, now about half complete.

• America’s Energy Advantage, a heavy industry lobbying group, has compiled a list of major energy-intensive planned industrial projects• 108 separate projects

• Total investment just under $100 billion

• A third either in construction or due to start this year

• 60% to be under construction by 2015.

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Energy boost reinforces a new “Reshoring” trend

• In many industries, Chinese and American productivity-adjusted costs are nearing parity• Yangtze valley average factory wages jumped from $0.72 an hour to $8.62

over 2000-2008

• GE, the pioneer of offshoring, now a poster boy for reshoring.

• By re-engaging its design and manufacturing teams, GE reduced the production cost of a reshored appliance to 20% below the Chinese costs

• Many examples of European and Japanese companies locating in US to take advantage of low manufacturing costs

• Brutal “re-sizing” of US firms during the Crash, unattractive though it was, has made industry extremely competitive.

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Modest recovery in manufacturing employment

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Manufacturing Employment (000s) Some analysts have noted that mfrg “always picks up during a recovery.” Actually, no. Kept drop-ping 2003-2007One reason why US growth outstripping most other developed countries despite drag of shrinking public spending

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How to fumble it away

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Conventional oil and gas production is typically in highly specialized locales; shale is nearly everywhere.• Shale hydrocarbons are widely and thinly distributed

• Harvesting takes place in areas without a drilling/mining culture; eg, active wells are seeded throughout built-up areas of Fort Worth.• Large-scale water usage• Massive truck and heavy equipment traffic• Leakage and spills• 24/7 floodlights; airport-quality noise• Occasional blowouts

• Shale energy exploitation is actually least water-intensive of all hydrocarbon recovery technologies, by 8-60x. But it is unusually visible, with thousands of giant water tankers taking over the roads during well development

• Virtually all pollution issues come from surface spills, holding tank overflows, intentional venting, or poorly built or managed wells, rather than from the fracturing and drilling itself.

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Operations that would be normal in conventional oil or coal regions are shocking and disruptive in the wider world

• Problem exacerbated as fast-moving, entrepreneurial companies often lack interest/resources for environmental management.

• Industry is rapidly consolidating, however, and the bigger companies seem to realize the stakes.

• Hopeful signs abound, eg:• Environmental Defense Fund, nine of the biggest companies, and two universities

have joined to document complete well-to-customer volume of methane leakage • First results due to be out this year; additional studies already underway

• Technology for clean operations is relatively simple; but installing the management disciplines is VERY hard, especially given wild-catter ethos

• Without a serious upgrade of industry performance, its continued expansion could be at risk.

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Another risk: The energy-based manufacturing revival could be choked off by unrestricted natural gas exports• For export by ship, gas must be liquefied (LNG), which is expensive but many companies

lining up to do it

• Economists almost universally in favor – the free market way

• But marginal energy prices are set by the OPEC cartel• 90% of all oil supplies costs <$20 barrel• When a market is fundamentally distorted, a free-market tweak often makes things worse.

• Danger that large-scale exports will link US gas prices to cartel-set oil prices• Asian manufacturing companies would pay almost any price• Would balloon profits of international companies, that invest internationally, not by flag of

incorporation (ExxonMobil now largest US gas producer)• Large foreign presence in LNG export projects (Qatar is the control party of one high-profile

project) undercuts the myth that LNG export revenues would be US income• With more than modest exporting, link between LNG and oil prices almost inevitable, wiping out a

big attraction for manufacturers.

• Worst case, US could become an extractive economy supplying an East Asian manufacturing juggernaut.

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Infrastructure

American Society of Civil Engineers performs a quadrennial audit of American infrastructure

• Per its recently-released 2013 audit, the US infrastructure deficit is now $3.6 trillion through 2020, 20% higher than in previous (2009) report. Funding shortfall is $1.6 trillion.

• Heavy manufacturing recovery will place additional pressure on decaying infrastructure:• Inland waterways• Bridges• Freight rail and trucking arteries• Water and other pollution abatement facilities• Ports, harbors, other choke points• Rapid transit• Power grids

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Infrastructure…cont.

• A fully- funded program to close the infrastructure gap by 2020 would generate more than 5 million jobs each year of the program

• Opportunities for innovative funding and implementation• Infrastructure bank with capital from public and private sources

• Privatization of selected public infrastructure

• Infrastructure bonds attractive to taxable investors

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Health CareSome Propositions

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• Health care costs are generally falling. Eg:• Heart surgeons get paid less for bypasses; most bypasses are being replaced by

cheaper stents• Much breast cancer surgery now a one-day outpatient procedure, with

chemotherapy replaced by inexpensive generic drugs• Expensive psychiatric care substantially replaced by psychotropic medication, usually

generic. Etc.

• Health care spending is rising as new technologies:• Create new highly specific biotech and microprocessing diagnostic tools• Proliferate new treatments for broader ranges of diseases (lap-band surgery; neural

stimulation for Parkinson’s)• Expand patient populations by lowering costs, as in anti-depression medications• Reduce risk of standard interventions (knee arthroscopy; laparascopic gall bladder

surgery)• Cf, explosion of PC sales as they got cheaper and more powerful

• Spending increases, ie, driven in great part by market-expanding shifts on both supply and demand sides

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• Almost ALL successful health care increases spending• Heart attack rates have been fairly stable (falling slowly) for a long time; but

heart attack death rates have dropped dramatically.

• With about a 20-year time lag, cancer incidence and survival rates are on a similar curve.

• Ditto the great triumph of bringing AIDS more or less under control

• Required massive investments in research and response infrastructures, diagnostics, new drugs and other interventional techniques.

• Result: tens of millions of people walking around who have survived heart attacks, cancers, AIDS, and other previous killers. They are very expensive patients – monitoring, medications, subsequent episodes.

• William Baumol (who calls health care a “stagnant service”) says that stopping smoking would save health care costs. In fact, encouraging smoking would greatly reduce the Medicare cost curve.

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Health care arguably our largest single industry, and largest, and arguably best, employer• Pace Baumol, only about 30% of employees and 13% of revenue in

“stagnant” hands-on personal services (home health aides, etc)• About 60% in professional, semi-professional jobs

• Qualify through national certification tests in most titles• Public community and senior colleges offer panoply of career/title qualification

programs (currently being cut back)• Walk into any big-city outpatient center: hundreds of competent black and brown

kids managing $millions in machinery and technology• New specialties abound: Physician assistants, dosimetrists, inhalation therapists,

perfusionists, nurse-anaesthetists, etc

• Technology intersection at the sweet spot between biotech and semiconductor technology

• Barron’s January 2013 investors’ outlook raved over health care opportunities

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Why does American health care cost so much?• Medical professionals are paid more than in other countries (but so are lawyers,

managers, and other professionals). That won’t change.

• Uniquely, US shift to outpatient, minimally invasive delivery has improved access to, and attractiveness of, vast swathes of services. That is mostly a good thing.

• Paperwork: the cardiac surgery unit at Columbia-Presbyterian deals with 2,800 payor groups(!). This is ridiculous.

• Lack of agreed treatment standards: only about half of all services have industry-wide consensus on correct procedure.• Physicians/patients have wide practice latitude in unsettled areas• Local peer groups dominate in standards setting. Evolutionary drift creates vast practice

differences. US hospital C-section rates vary from 7-70%. (Cheaper intervention, to be fair, isn’t always the best)

• Many opportunities to exploit reimbursement systems, and many doctors and hospitals do. • These last two – standardizing interventions and rooting out exploitation – should be main

focus of policy.

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America only country that attempts to manage health care spending through payment incentives

• A micro-economist’s fantasy: How a dozen economists brought a million doctors to heel – and with almost no data feedback

• Unintended consequences abound. The outpatient movement was triggered by Nixon-era attempt to lower costs by shifting services away from hospitals

• The US health care model – an idealized market with highly rational agents – works, if at all, only for the elite (who consume a disproportionate share of US health care)

• For bottom 60-70%, Kaiser-Permanente style, salaried docs, with senior physicians establishing evidence-based treatment pathways is best solution. Such plans spreading fairly rapidly.

• Major opportunity for Obamacare federal exchanges to gradually transmute into Kaiser-style plans and establish pricing and treatment discipline.

• The new “Accountable Care Organizations” will likely founder on the challenge of combining fee-for-service payment with capitation, but may establish the required organizational base for a more manageable approach.

• Conversion to a more practical system will be a 1-2 decade-long process.

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Paying for It

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Growth solves a lot of problems

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GDP US Debt

Alarming WWII debt as share of GDP

US economy has grown by real annual 3.5% since 1950, including the Crash

Plug that figure into CBO debt forecast (1.3% pickup)

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2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

$ MMs

CBO and Adjusted GDP and Debt

CBO GDP CBO Debt Adjusted GDP Adjusted Debt

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CBO Debt Adjusted Debt

Myth of Health Care “Squeezing Out”

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1930 1940 1950 1960 1970 1980 1990 2000 2010

All Other Food (for home) Clothing & Shoes Housing & Utilities Health Care

As share of “All Other” rose, real per capita incomes tripled

And we can easily afford to pay higher taxes

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1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

Taxes As % GDP, 1965-2010

US OECD Average

US all-tax share of GDP typically 27th or 28th of 30 industrial countries.

Are we entering a new liberal political cycle?

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Post WWII cyclesConservative: pro-business, neoclassical economics, traditional religion, strong military, restrictive view of federalism.

Liberal: interventionist economics, pro-equality, secular, suspicious of military, broad view of federalism

• Wartime to late 1950s – conservative

• Late 1950s to late 1970s – liberal

• 1980 to 2008(?) – conservative

• 2016 will confirm/disconfirm whether liberal cycle has taken hold.

NB: Cycles not specifically party-based. Bill Clinton, a Democratic president during a conservative cycle deregulated more than Ronald Reagan did.

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Arthur M. Schlesinger, Sr.’s analysis of American political cyclesCycles are inherent in the electoral process“The thinking conservative finds his chief allies in the self-complacency ofcomfortable mediocrity, in the apathy and stupidity of the toil-worn multitudes,and in the aggressive self-interest of the privileged classes. The honest radicaldraws much of his support from self-seeking demagogues and recklessexperimenters, from people who want the world changed because they cannot getalong in it as it is, from poseurs and dilettanti, and from malcontents who lovedisturbance for its own sake.”

Political cycles turn when an extended period of either conservativeor liberal hegemony brings the baser, more self-interested, orbarmiest elements to the fore.Conservative regimes, perhaps, more prone to the corruptions of money, liberals tothe corruptions of power.

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