The U.S. Economic Crisis: Three Growth Scenarios

When the third quarter gross domestic product report came out on Oct. 30, most of the attention focused on the drop in real consumer spending, the first since 1991. Especially in a Presidential election year, the pain for consumers (BusinessWeek.com, 10/29/08) is the most relevant political fact.

But to know where this crisis is headed over the next year or so, you need to watch a different number: the size of the U.S. trade deficit. In the third quarter, the U.S. had a trade deficit of $707 billion—equal to 5% of GDP at an annual rate. That's smaller than the peak deficit of nearly $800 billion in the third quarter of 2006, but it's still an astonishing sum, especially since every dollar of the trade deficit is another dollar that the rest of the world has to lend the U.S.

Homeowners are staggering under giant mortgages, Wall Street is flat on its back, and the country is in the throes of the greatest credit crunch since the Great Depression—yet America keeps borrowing by the truckload. If this crisis was caused by too much debt, how long can the trade deficit stay so high?

In fact, there are three possible scenarios for the trade deficit, each of which implies a different set of consequences for the U.S. economy and for the global economy:

•Business as usual One possibility is that the trade deficit remains high. The rest of the world keeps shipping goods and services to the U.S. while it continues to lend the U.S. the money to pay for the imports.

•Global restructuring Alternatively, the trade deficit shrinks because U.S. consumers cut back on imports and the rest of the world has to adjust to a global economy that lacks the U.S.'s customary demand and borrowing.

•Innovative growth The final possibility is that the trade deficit shrinks because the U.S. exports more innovative goods and services to the rest of the world.

Before going through the pluses, minuses, and likelihood of each scenario, let's take a quick step back and look at the big picture. The global boom of the past 10 years has been driven by three flows. First, multinational companies shipped technological knowledge and business know-how to countries such as China, India, and elsewhere in order to set up supply chains there. This "dark matter" is not picked up anywhere on the economic data, but it was absolutely essential for juicing up global growth. In return for this flow of knowledge, the industrialized world—and especially the U.S.—got back a river of cheap goods and services. Finally, to pay for these imports, the U.S. borrowed a steady stream of money from the rest of the world—roughly $5 trillion worth since 2000.

But here's the question no one really worried about: How did this money get into the country? The federal government borrowed about $1.5 trillion directly from overseas. But most of the borrowing—perhaps $3.5 trillion to $4 trillion worth—flowed through Wall Street in the form of corporate bonds, equities, and exotic securities. Wall Street firms were the major intermediary between the rest of the world and U.S. consumers. For example, firms would package subprime mortgages into a complex security and then sell big chunks to overseas buyers.

This flow of money, an essential part of the global boom, explains why Wall Street was so prosperous in recent years—and why it failed so suddenly. Bankers, hedge fund managers, and other Wall Street types would take their piece of the foreign money as it came into the U.S. They grew rich that way. But when it became clear that U.S. consumers could no longer afford to carry the loans, the financial flows froze up, threatening the global boom.

Thus, the financial crisis is a symptom, not a cause. At root, this is a crisis of the entire global economy as it has developed over the past 10 years.

Wall Street Crashes the 2008 Election

World Economic Forum: China Looms Large

The Secret Side of David Axelrod

David Axelrod has long been known for his political magic. Through his AKP&D Message & Media consultancy, the campaign veteran has advised a succession of Democratic candidates since 1985, and he's now chief strategist for Senator Barack Obama's bid for President. But on the down low, Axelrod moonlights in the private sector.

From the same address in Chicago's River North neighborhood, Axelrod operates a second business, ASK Public Strategies, that discreetly plots strategy and advertising campaigns for corporate clients to tilt public opinion their way. He and his partners consider virtually everything about ASK to be top secret, from its client roster and revenue to even the number of its employees. But customers and public records confirm that it has quarterbacked campaigns for the Chicago Children's Museum, ComEd, Cablevision, and AT&T.

ASK's predilection for operating in the shadows shows up in its work. On behalf of ComEd and Comcast, the firm helped set up front organizations that were listed as sponsors of public-issue ads. Industry insiders call such practices "Astroturfing," a reference to manufacturing grassroots support. Alderman Brendan Reilly of the 42nd Ward, who has been battling the Children's Museum's relocation plans, describes ASK as "the gold standard in Astroturf organizing. This is an emerging industry, and ASK has made a name for itself in shaping public opinion and manufacturing public support."

Lowest of Low Profiles

Eric Sedler, 39, a former public relations director at AT&T and corporate-reputation specialist at PR giant Edelman, is the "S" in ASK and the company's managing partner. The "K" is John Kupper, 51, a former congressional press secretary and ad-industry consultant, while the "A," of course, is Axelrod, a onetime Chicago Tribune reporter who got his start in politics when he managed Illinois Democrat Paul Simon's first election to the U.S. Senate. Sedler says opponents mischaracterize what ASK does. "I reject the notion that a company can't advocate a public policy," he says. "These issues are complicated, and people have different points of view." Axelrod, 53, did not respond to phone messages and e-mails.

Though the consultancies share management—Kupper, like Axelrod, is also a partner at AKP&D—and loft space, the two firms come across as polar opposites. On its Web site, AKP&D lists dozens of candidates and referendums it has worked on. Sample ads are available for downloading. Employees are named. ASK's site is minimalist, revealing little more than that its three partners do all their work themselves. Sedler says, in fact, that in his six years at ASK, he had never done an interview with the media before. "We're not in a business that warrants a huge public profile," he explains.

Axelrod's political connections can cross over into his corporate business. Mayor Richard M. Daley, one of Axelrod's friends and earliest clients, is pushing construction of a new Children's Museum in Grant Park to replace a facility on Navy Pier that the museum says it has outgrown. So far, though, "open-space" foes such as Reilly have stymied the move. The museum retained ASK early in 2007. Sedler says Axelrod's ties with Daley had nothing to do with the contract.

ASK is counseling the museum, which reports annual revenue of more than $11 million, including government grants, on its message strategy. It is also writing ads, including a 60-second radio spot that stresses how the new quarters would blend into Grant Park and be more accessible. Sedler won't say how much ASK is receiving, joking that it's "about 30 per hour." Consultants at other PR firms say corporate clients pay monthly retainers of up to $25,000, though nonprofit groups usually pay less. In addition, firms typically get 15% of whatever clients spend on advertising.

ASK's relationship with ComEd goes back much further: The Chicago-based utility says ASK has been an adviser since at least 2002. ASK's workload picked up in 2005, as the Exelon subsidiary was nearing the end of a 10-year rate freeze and preparing to ask state regulators for higher electricity prices. Based on ASK's advice, ComEd formed Consumers Organized for Reliable Electricity (CORE) to win support.

Obama’s Secret Digital Weapon

Why Small Manufacturers Are Going Green

As a maker of conveyor systems for manufacturers, Shuttleworth always changed with the times. The 100-employee Huntington (Ind.) company's strong business in electronics dropped off about five years ago as more production moved overseas. After that, the company focused on conveyors for food, health care, automotive, and paper products—until this year, when it entered what could be its most profitable niche yet: solar panels.

"It's got some of the biggest potential of the markets we've been in," says Jim Bonahoom, Shuttleworth's vice-president for finance. Even though Shuttleworth only just entered the market, the company expects solar to account for one-fifth of its roughly $20 million in revenue this year, Bonahoom says.

The green movement has become increasingly mainstream in the small business world (BusinessWeek SmallBiz, Summer 2006) in recent years as small consumer companies have embraced environmental principles to address shoppers' concerns about climate change. Now small manufacturers like Shuttleworth are also betting on growth in green industries. Market researcher Clean Edge predicts that making and installing solar power systems will grow from a $20 billion to a $74 billion industry globally in the next decade, and the firm expects wind power installations to grow from $30 billion to $83 billion. Clean energy advocates envision a sea change on the scale of a "low-carbon industrial revolution," as a recent Deutsche Bank (DB) report called it, to halve carbon emissions by 2050.

New Frontier for Manufacturers

Both presidential candidates have proposed caps on carbon emissions. Barack Obama has called for $150 billion investment in clean energy technology over the next decade; John McCain has pledged $2 billion annually toward advancing clean coal, among other initiatives. Policymakers also hold out clean energy as a panacea for America's troubled manufacturing sector, which have shed 3.7 million jobs in the past decade, or more than 20% of its workforce, according to the Bureau of Labor Statistics.

A September report by the Center for American Progress, a progressive think tank, calls for an economic stimulus plan that would create 2 million green-collar jobs through $100 billion in tax credits and direct investment. Van Jones, a senior fellow at the center and author of The Green Collar Economy, says small businesses that offer ways to use less energy and produce it more cleanly could grow fast. For example, construction firms can focus on retrofitting buildings to be more efficient, and manufacturers can supply components for renewable power sources. "Wind in particular has some features that make building stuff here smart, because [facilities are] heavy," Jones says. "The towers are 20 tons of steel. The turbines are made of 8,000 parts."

One entrepreneur ready to create such green-collar jobs is Richard Wheat, president of Eagle Hoist in Louisville, Ky. The company makes heavy-duty lifts to move people and materials at high-rise construction and industrial sites. A wind farm developer asked him eight months ago to design a hoist that could fit inside wind turbine towers, so technicians don't have to climb 20 stories—with their tools—to get to the top.

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Humdinger’s Wind Power Alternative

Better Off? Probably Not

"Are you better off?" It's a question the candidate of the challenging party asks during each Presidential campaign. The economy, of course, is the No. 1 issue this election, and that question has been raised in cities, suburbs, and small towns across the country. With the recent stock market meltdown and the collateral damage to 401(k) plans, many voters are indeed poorer. But in terms of real wages and the cost of consumer goods, are we truly worse off? For most Americans, the answer is, sadly, yes.

On Jan. 22, 2001, when President George W. Bush took over the White House, the Nasdaq was in the midst of a post-dot-com freefall. Bush had the bad luck of taking office just before the economy went into a recession that March. But after a mini downturn, the American economy experienced a period of recovery and expansion, with the gross domestic product growing at a steady clip and productivity surging 22%. That measure of prosperity, however, hasn't translated into gains for most families.

In 2000 the median U.S. household income was $50,557 (adjusted for inflation), according to the U.S. Census Bureau. Seven years later, the median income fell to $50,233. "That might not sound too bad," says Edward Wolff, professor of economics at New York University, "but normally, median income increases. That's not good news for the middle class." Consider that the median household income would be almost $64,000 had paychecks kept pace with the GDP.

Overblown Claims?

While workers' paychecks have stagnated, corporate profits jumped an average of 10.8% per year, according to data from the Bureau of Economic Analysis. "The fact that middle-income households ended up below where they were in 2000 despite strong productivity growth—that's the heart of the problem," says Jared Bernstein, an economist at the Economic Policy Institute, a liberal think tank. "It's one thing if you're looking at a period like now, when the macroeconomy is dysfunctional, but for most of this decade the economy has been pumping along." However, economists at the conservative American Enterprise Institute counter that claims of income stagnation are overblown, pointing out, for example, that household income data does not take into account total compensation, including companies' burgeoning contributions to employee health insurance.

Even though inflation has not been severe for most of the decade, the cost of living has outpaced wages. The consumer price index has risen by 25% since January 2001, while core inflation jumped 18%. But the core consumer price index can be deceptive because it excludes food and energy. Once, after reporting that core inflation had been relatively tame that quarter, Conference Board economist Ken Goldstein came back to the office to find an irate e-mail: "Hey, dummy, what the hell do you think we spend our money on?" The point was taken: When energy and food skyrocket, families feel it.

And skyrocket they have. In early 2001 you could fill your car with regular gas for $1.47 a gallon. But on Oct. 24, three months after regular unleaded peaked at $4.11 a gallon, the average cost was leveling off around $2.78, according to the AAA online Daily Fuel Gauge Report. Grocery store sticker shock has been almost as acute. Take, for example, the price of a dozen eggs, which has risen 97% since 2001, from a nationwide average of $1.01 to $1.99. "You could look at inflation and think it hasn't been that much of a problem, but in fact, if you look at the components of the middle-income consumption basket—tuition, housing, childcare, gas, food—all of those have been rising a lot more quickly," says Bernstein.

Retirees Are Really Feeling It

There are consumer goods that have come down in price. And some economists don't buy the argument that families are being hit where it hurts most. "People are more attuned to price increases than declines, so their perceptions are biased," says Wolff. He points out that the price of goods such as toys and clothing have remained fairly stable because we have benefited from inexpensive imports. Electronics have come down, too, especially when adjusted for advances in technology. In 2001 the base model of Apple's iBook, with its paltry 500MHz chip and 10GB hard drive, sold for $1,499. Today, the basic white 13-inch MacBook laptop will run you $999 for a 2.1 GHz chip and 120GB drive. That's $500 less for nearly four times the speed and 12 times the storage capacity.

For consumers, there's no argument over the impact of the current economic crisis. They're feeling it, especially retirees. Take Patricia Wehrs, a Washington State resident who retired from her federal government job in 2000. She and her husband were all set for a comfortable, though modest, retirement. Then their retirement fund started losing money every month, while the cost of living crept up. "Our basic bills—electric, telephone, water, and cable—went up, in some cases 90%, over the past two years. I've kept the food bills under control with a budget and a diet," jokes Wehrs. "However, fuel costs have drained any extra money, so no more theater, no dinners out, and smaller gifts to the grandchildren for special occasions."

See BusinessWeek.com's slide show for examples of today's higher cost of living.

The Great Inflation Debate

Nestlé Combats China Food Scandals

As the food safety crisis in China escalates—the latest news reports suggest that fish, pork, and chicken, along with milk and eggs, could be contaminated with the industrial chemical melamine, which has already sickened tens of thousands and killed at least four (BusinessWeek.com, 9/26/08)—multinationals are beginning to realize that simple reassurances are no longer sufficient. Indeed, in an effort to calm ever more skittish consumers, companies are now starting to trumpet what they call major measures aimed at ensuring food safety.

So on Oct. 28, Wal-Mart (WMT) rushed to pull Hanwei-brand Chinese eggs off its shelves in China following reports that they might be tainted (BusinessWeek.com, 10/30/08). This followed its Oct. 22 announcement of a major overhaul of its mainland supply system (Wal-Mart sources almost $10 billion annually from China), aimed in part at better ensuring the safety of its products. "Cheating on the quality of products is the same as cheating on customers. We will not tolerate that at Wal-Mart," said Chief Executive H. Lee Scott in Beijing on Oct. 22 (BusinessWeek.com, 10/24/08).

Now one of the biggest moves to date: On Oct. 31 the head of Swiss food products giant Nestl (NESR.DE) announced the opening of a $10.2 million Beijing research and development center, complete with advanced product testing machines that can detect chemicals including melamine (melamine has been used to fake higher levels of protein in Chinese dairy products). "The safety of consumers is quite clearly our top priority," said Nestl CEO Paul Bulcke, whose company has invested about $1 billion in Greater China over the last 20 years. "This center will serve as the base and the reference in food safety for Nestl in Greater China."

Protecting a Key Market

It's no surprise Nestl is now at the forefront of talking up efforts to ensure food quality. Despite its insistence that its mainland-made products—including powdered milk, Kit Kat chocolate bars, and Nestl ice cream—are safe, there are widespread fears in China that use of melamine may affect much more of the dairy and meat industry than so far has been revealed. And China is a key export manufacturing base as well as market for Nestl, the world's largest food company. The Swiss giant last year had revenues of close to $2 billion in Greater China. Earlier this month, Taiwan authorities banned sales of China-made Nestl infant formula and powdered milk after reportedly finding traces of melamine in the products. (Nestl insists that all its China-made products are safe.)

Nestl's new center, which along with a second one in Shanghai brings total China R&D spending up to more than $16 million, will be key in ensuring mainland-produced dairy products are safe, the company says. (The Beijing center also will do traditional product research and development.) "Two highly sophisticated analytical tools for detecting trace amounts of residues and undesirable compounds like melamine or veterinary drugs or natural toxins are currently in operation here at R&D Beijing," Nestl Chief Technology Officer Werner Bauer said in Beijing. At the center's opening, Nestl also announced that since the milk crisis broke, it has sent 20 specialists from its Swiss headquarters to 5 of its 20 China plants to strengthen chemical testing for dangerous substances like melamine.

Consumer Confidence Collapsing

Despite the latest corporate measures, confidence in the mainland food industry is hardly growing. Besides Taiwan's recent move against Nestl products, over the last month the Hong Kong government has banned baby food and wafer crackers made by Heinz (HNZ), British candy maker Cadbury (CBY) has pulled its chocolate off mainland shelves, and on Oct. 30 the Financial Times reported that the Indonesian government destroyed 2,000 boxes of China-produced Mars, Snickers, and M&M chocolates. In all cases, there were fears the food products had been contaminated with melamine.

The latest news reports that the melamine problems could affect China's entire meat, fish, and poultry market are sure to shatter already fragile consumer confidence. In response to the reports, the Shanghai government has begun inspecting more than 100 fish farming operations in that city. "The feed industry seems to have acquiesced to agree on using the chemical [melamine] to reduce production costs while maintaining the protein count for quality inspections," the official English-language China Daily wrote in an Oct. 31 editorial.

"We cannot say for sure if the same chemical has made its way into other types of food. We hope it has not. But if fodder can be confirmed as the source of contamination for both eggs and milk, action must be taken to check how widespread the use of this chemical is."

Lewis Hamilton: The Tiger Woods of Racing?

The eyes of motor sports will be on So Paulo on Nov. 2 for the final grand prix of the 2008 Formula One season. At stake isn't just the F1 World Drivers' Championship—the crowning moment in a global sport whose annual revenues rank behind only the National Football League and Major League Baseball. Equally compelling for fans around the world is the driver likely to win it: Lewis Hamilton. If his performance measures up, the 23-year-old Briton will become the youngest champion in Formula One history. With his broad marketability and multimillion-dollar sponsorship deals, Hamilton already is drawing comparisons to sports megastars Tiger Woods and David Beckham.

Companies such as Reebok (ADSG.DE), Vodafone (VOD), and Hugo Boss (BOSG.DE) have flocked to be associated with Hamilton because of his remarkable life story. Signed by Formula One racing team McLaren when he was only 13, Hamilton worked his way up from teenage go-karts to F1 speed machines by winning at each level along the way. Clean-cut, media savvy, and the first black driver in Formula One's history, Hamilton missed winning the 2007 drivers' championship in his rookie season by just one point. Continued success in his second season—and his growing media visibility—have turned Hamilton into Formula One's poster boy as it expands into lucrative new markets such as China and India.

If Hamilton clinches victory in Brazil, his appeal looks set to leap beyond motor sports into wider popular culture. With his good looks and celebrity friends—he hangs out with hip-hop stars Diddy and Pharrell Williams and dated Pussycat Dolls singer Nicole Scherzinger—Hamilton already has become tabloid fodder. Sponsors are drooling to tap the "Hamilton Effect," leveraging his popularity to reach customers who don't normally follow Formula One.

Transcending the Sport

"Hamilton represents the changing of the guard for Formula One," says Iain Ellwood, head of consulting at Interband in London. "He's highly attractive to any sponsor and can easily go beyond F1 into a wider market." Earlier driving champions such as Michael Schumacher, Fernando Alonso, and Kimi Rikknen achieved fame within the sport but didn't necessarily transcend it, the way Tiger Woods has with golf.

Hamilton also could help Formula One itself. In his 2007 rookie year, average television audiences for F1 in Britain nearly doubled from 2006. Grand prix from Shanghai to Singapore sold out this year as fans sought a glimpse of their F1 idol. Hamilton might even help Formula One get a foothold in the U.S., where it is completely overshadowed by Nascar.

Boeing Deal: Expect a Close Vote

For some workers at Boeing (BA), 56 days on the picket line is not enough. As 27,000 machinists prepare to vote Nov. 1 on a contract that could get them back on the job by Nov. 3, signs are emerging that the vote could be close. It's no sure thing that the deal will pass, some workers say. "The contract is a lukewarm, Band-Aid version of the first one we got," says 21-year Boeing mechanic Russell Wise, who plans to vote against the tentative settlement. "People are unhappy about that."

Under pressure from Washington, Boeing and the leaders of the International Association of Machinists and Aerospace Workers came to terms on the tentative settlement Oct. 28 (BusinessWeek.com, 10/28/08). They had reconvened talks in the nation's capital under the guidance of the federal mediation service and hammered out a deal after five days of intense talks. Both the company and union leaders praised the proposed pact, with IAM District 751 President Tom Wroblewski saying, "we won the battle and made some significant gains."

The union leaders point to better terms than the company initially offered on medical benefits, pensions, and higher wages for new hires, as well as stronger language on job security for more than 5,000 employees. Under the proposed contract, wages would rise 5% in the first year, 3% in each of the next two years, and 4% in the final year. The addition of a fourth year, backers say, would give members more security than the ordinary three-year contracting cycle.

Dreamliner Outsourcing Is Maintained

For their part, company officials were happy to preserve their freedom to outsource as much work as they'd like on the forthcoming 787 jet, the Dreamliner, which will be a mainstay of Boeing's future. The company also preserved its ability to use subcontractors, in controlled circumstances, on construction of its other planes. Still, a top Boeing official, Vice-President of Engineering Michael Denton, said in an interview posted on a company Web site that Boeing will reduce the amount of outsourced work for future models, citing the delays and other difficulties experienced on the 787 program.

Critics say the pact isn't generous enough—or fair enough to all employees—to make it fly. Boeing, they say, is in its healthiest shape in years, with a huge order backlog, and should share more of its wealth with workers. Don Grinde, a 31-year crane operator, objects that janitors in the factories, who he says earn as little as $8.75 an hour, are denied hikes in their starting pay, and he warns they eventually could be replaced by contract workers. He is bothered, too, that it takes as long as six years for some workers to rise from such modest pay levels to top rates.

Grinde runs a Web site, 751 Rank and File Voices, where he details pros and cons of the contract. He also polls readers on attitudes toward the deal. As of the afternoon of Oct. 31, the sentiment was running about 53% against the deal, with some 959 readers registering their views.

Will a Silent Majority Vote Yes?

Such Web polls are hardly scientific, since they may draw only the most motivated voters and miss the undecided who lean one way or the other. Indeed, company officials are hoping a "silent majority" of backers will turn out to endorse the pact. But Grinde claims his poll was fairly accurate in tracking sentiment before the Sept. 6 walkout, where some 87% of the IAM members backed the stoppage. He says his poll at the time showed some 83% support for a strike.

IAM officials expect the contract proposal to pass, but they will be ready to bargain anew if it is shot down. The last time members turned down a contract that leaders had recommended was in 1995, union spokeswoman Connie Kelliher says. Before the current walkout, union leaders were booed in meetings for delaying the shutdown for a couple of days past the strike vote, as they tried to keep talks moving.

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Pressure Builds for Boeing and Machinists to Settle