Monthly Archives: April 2014

How to Get America Back on Track

statue-of-liberty-new-york

Introduction

In my last post, I discussed the unfortunate state of affairs in the United States today. From a pre-industrial agrarian economy controlled by wealthy landowners, to an era of industrialization marked by the creation of a middle class and a period of prosperity, and ultimately a post-industrial phase where the middle is systematically being hollowed out and the extremes once again dominate the landscape, the United States finds itself at a crossroads. The country can ignore the state of affairs or rationalize it as a byproduct of modernization, continue along its current path, where increasing income stratification creates an oligarchy controlled by wealthy elites from a few key sectors – financial services and petrochemicals, to name a few. Or, it can collectively come to terms with the fact that the country has fundamentally changed over the last four decades in ways that demand significant political and culture reform.

Identifying the problems is not sufficient. With that in mind, I want to propose solutions that address what I consider to be the root causes. The criteria is that they be practical, yet attainable. They are ambitious reforms that include a mix of proposals embraced by Democrats, Republicans, or both (or neither). While they are achievable legislatively, I am ignoring the political horsetrading and gamesmanship that would be required to have them pass.

What’s Next

The thirty years leading up to 2008 are generally considered to be a period of prosperity in the U.S. A few cyclical recessions aside, the 80’s, 90’s, and 00’s were marked by solid GDP growth and a strong increase in the overall wealth of the country. Yet, with the outsourcing of labor-intensive jobs (and the weakening of labor unions in the manufacturing sectors that remained) and the overall movement toward a service-based economy, dominated by a fast-growing financial sector, income gains largely went to the top 10% of earners, with a disproportionate share going to the top 1%. Simultaneously, short-sighted economic policies designed to control government spending steadily dismantled much of the social welfare system – a trend that continues today at an accelerating pace, with family planning and food stamps as the most recent victims of the guillotine.

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Some of this was inevitable. The depletion of the middle class is a byproduct of globalization. On a global scale, it is actually a good thing, as developing countries reap the benefits of burgeoning manufacturing sectors. The result will be the greatest migration out of poverty the world has ever seen. But there is no denying that the U.S. itself will be worse off. More specifically, the low-wage workers, the urban minorities, the recent immigrants, the rural whites, the high school-educated, and all of the other would-be chasers of the elusive American dream will find fewer opportunities in this new world, and their struggles will only get worse.

So the question remains: what can we do about it? If we are undergoing a systemic change at a global level, is the situation hopeless? The answer to the second question is no. The answer to the first question is the subject of this post.

Why Tax Reform Makes Sense

On the most basic level, an economy – whether a nation or a household – is a self-contained entity in which goods and services are exchanged. In a modern economy, the medium of exchange is money – a fiat currency issued by a central bank that regulates its volume and the cost of borrowing it. When economies trade with one another, money either comes in or goes out. Rather than trying to do everything, economies specialize in whatever they are best at doing, relative to their peers. On the most basic level, you pay a plumber to fix your pipes or a carpenter to build your cabinets because it doesn’t make sense for you to do those things yourself. Instead, you earn money by specializing in what you do, and use the money generated from your expertise to pay others who specialize in something else. On a much higher level, nations specialize in broad industries. Manufacturing in Germany, financial services in Switzerland, carmaking in Japan, and electronics in South Korea are all examples of what is known as competitive advantage – where countries excel in particular sectors and trade with one another.

Within larger economies, there are smaller economies – the household, the community, the city, the state, etc. – that also trade with one another. The doctor provides care for patients and decides to re-do his kitchen. He hires a general contractor, who subcontracts to an electrician, a painter, a plumber, and a carpenter, all of whom purchase materials at Home Depot, which employes hourly workers and buys products wholesale from equipment manufacturers, which hire truck drivers and warehouse workers to move pallets. All of these people buy food from the grocery store and clothing from retailers. They buy cars and houses and school supplies. And all of those products – known as “durable goods” – that used to be manufactured here in the U.S., are now made overseas. And the people who used to make them have find new jobs, which are now in shorter supply.

So why does any of this matter? Because money moves around an economy is when people spend it. After the financial crisis, the Bush administration send every American a check for $600 so that they would get out and spend it. The much-maligned stimulus package and the tactic called “quantitative easing” – otherwise known as printing money – are both massive efforts to get people to spend money. There is a term in economics called velocity, which is the number of times a dollar changes hands during a year. The velocity of money describes the speed with which people are spending money, and, in general, faster is better.

Chart showing the log of US M2 money velocity (green), calculated by dividing nominal GDP by M2 stock, M1 plus time deposits 1959–2010. Employment-to-population ratio is displayed in blue, and periods of recession are represented with gray bars).

Chart showing the log of US M2 money velocity (green), calculated by dividing nominal GDP by M2 stock, M1 plus time deposits 1959–2010. Employment-to-population ratio is displayed in blue, and periods of recession are represented with gray bars).

So when the economy is moribund and fewer people are reaping the benefits of broader economic prosperity, the solution is to spend money. And the people who spend the most money, as a percentage of their income, are the ones who have very little. As I mentioned in my last post, the bottom 20% of earners spend more than 60% of their income on clothing and housing. After food, schooling, car payments, and other incidental expenses, they have very little left to save, much less invest in the future. To make ends meet, these individuals take on debt, which traps them in an escalating spiral of interest payments that culminate in eviction and bankruptcy. Not many people are aware of debt agreement plans, the awareness of which might have solved the issues with bankruptcy.

In short, the best way to increase the velocity of money in an economy is to put it in the hands of people who have very little, because they will spend every last penny. And the people they buy goods and services from will, in turn, spend that money at the same pace. In contrast, the best way to slow the velocity of money is to give it to people with nothing to spend it on.

It is this insight that leads liberal economists to the conclusion that taxing the rich is the solution to the problem. I don’t fully agree with this point. There is a legitimate case to be made that excessive taxes on the rich create a perverse incentive toward investment. I am not advocating raising taxes on ordinary income for the top quintile of earners. But there is another road.

In my next post, I will explain what that I believe that road looks like, from a financial and economic policy perspective.

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The Convergence: America’s Long Arc of Development

The following is a four-part post about the phases of the economic development of nations – pre-industrial, industrial, post-industrial – and a discussion of the current state of affairs in the United States and the world.

Part I: How Countries Develop

For all of their differences, countries, and even civilizations, follow a similar path in their development. The timeline and specifics vary from nation to nation, but the general formula remains constant. On a high level, poor countries become rich through industrialization. The Renaissance in Europe, the Industrial Revolution in the United States, and the era of outsourcing – services in India, manufactured goods in China, and raw materials in Brazil – are all examples of the broad arc of economic development in once-poor nations. Mechanization produces efficiencies that make a country’s exports more competitive. When the value of exports exceed that of imports, it creates a trade surplus, also called a “favorable balance of trade”, as it brings more foreign currency into the country and generally makes the country richer.

As countries become richer and more industrialized, the economy shifts toward producing value-added goods. The wealth increase strengthens the currency of the country, and skilled – and unskilled – workers demand higher wages. As a result, labor-intensive industries become less competitive, leading rich countries to outsource these jobs to poorer countries. In the 1600’s, Colonial America traded cash crops and raw materials for finished goods from England – one of the factors leading up to the American Revolution. As the U.S. became richer post-WWII, it began outsourcing its labor-intensive industries to China and India. And today, these two countries are vying for influence and access to raw materials and cheap labor in a modern scramble for Africa.

Clark's Sector model for US economy 1850 -2009.

Clark’s Sector model for US economy 1850 -2009.

When a country develops in this way, the spoils are more equitably shared, as millions of jobs are created in new industries. From the textile mills in Lowell, to the garment factories in Bangladesh, to the manufacturing facilities springing up in Ethiopia and South Africa, a generation of previously unemployed people starts to work, fueled by demand from wealthier countries for more finished goods. And those new additions to the workforce are introduced to one of the perks of earning a decent wage: paying your taxes.

In pre-industrial nations, income is highly stratified, with an ultra-wealthy elite wielding a disproportionate amount of both political and economic power. On the other extreme, a huge percentage of the population is impoverished, rarely sharing in the spoils of the natural resource contracts that enrich the elites. The only voices that matter are those with access to money and influence, and the poor are marginalized, resigned to the realities of corrupt politicians and unscrupulous businessmen stifling growth and progress in the country.

As a country industrializes, however, the inexpensive labor provided by the massive percentage of the population living below the poverty line enables those disenfranchised segments by creating a middle class. With greater disposable income, poorer families can invest in education, ensuring that their children will reap the benefits of development by ushering in the inevitable move toward value-added goods that immediately follows industrialization. And that middle class – which pays a percentage of its hard-earned money in taxes – starts to demand accountability from its political leaders. As the concentration of wealth shrinks, the broader population begins demanding greater freedoms. A free press develops to satisfy the new-found demand for information, and politicians are brought out of the shadows and into the light.

A more responsive government and an expanded treasury lead to investments in infrastructure, education, healthcare, and other institutions, laying the groundwork for the shift to post-industrialization. With the foundation in place, the country steadily moves up the ladder. The call center that once offered only customer service now offers accounting, IT, and financial services. The t-shirt manufacturer becomes a fashion house. And with each step, the country becomes richer.

A snapshot of a post-industrial economy. Sectors of the US Economy as percent of GDP 1947-2009.

A snapshot of a post-industrial economy. Sectors of the US Economy as percent of GDP 1947-2009.

And what happens to this newly-created middle class? As their income increases, the percentage spent on food, clothing, and housing decline. Their buying power increases, their lifespan becomes longer, and the shocks that once destroyed their lives – an illness left untreated, a drought that destroyed their crops, a civil war erupting out of desperation – decrease, enabling them to not only invest more money in themselves – in the form of better healthcare, better schools, better houses – but also free them from the debilitating stress generated by uncertainty. Not knowing where your next meal is coming from, or whether your daughter will be able to survive a bout of typhoid, or malaria, or tuberculosis, weighs on the poor, deeply affecting their decision-making. Short-term thinking becomes long-term planning, and the whole country is better off as a result.

At some point – when a country has reached this transcendental state of development – it begins a steady decline. Some thinkers for whom I have a tremendous amount of respect, like Fareed Zakaria, describe a “post-American world” marked not by the decline of the west, but the “rise of the rest”. For a time, I agreed with his conclusions. But lately I’m beginning to think that view is a shade too optimistic.

Part II: The Great Divergence

The Great Divergence: share of income by the top 10% of the population in the U.S.

The Great Divergence: share of income by the top 10% of the population in the U.S.

It is hard to pinpoint the moment at which America turned the corner and began its march to peak decadence and subsequent decline. If you ascribe to what some economist call “The Great Divergence,” the trend began in the late 1970’s, as a number of convergent forces changed the economy of the United States. This is right around the time the U.S. began outsourcing its manufacturing sector in response to the increase in standard of living that I described above. James Surowiecki of the New Yorker explains the trend:

In 1960, the country’s biggest employer, General Motors, was also its most profitable company and one of its best-paying. It had high profit margins and real pricing power, even as it was paying its workers union wages. And it was not alone: firms like Ford, Standard Oil, and Bethlehem Steelemployed huge numbers of well-paid workers while earning big profits. Today, the country’s biggest employers are retailers and fast-food chains, almost all of which have built their businesses on low pay—they’ve striven to keep wages down and unions out—and low prices.

Incarcerated Americans as a percentage of the population, 1920-2008

Incarcerated Americans as a % of population, 1920-2008

Simultaneously, just as the middle class was starting to see its job prospects shipped overseas, the most influential conservative president of the last hundred years arrived to reshape the political system to systematically dismantle the welfare state, declare a war on drugs that crippled the socioeconomic development of a generation of African-Americans, and establish an approach to domestic economic policy – colloquially referred to as “Reaganomics” – that sought to restrain the power of the federal government and empower the free market through de-regulation, lower taxes, a tighter money supply and relentless opposition to anything might cause inflation.

President Clinton largely maintained the laissez-faire approach to the economy, presiding over a period of growth and prosperity that continued deep into the Bush years. Then, of course, the inevitable happened: the economy collapsed, having been fueled by a mythical belief that housing prices would never go down. The resulting collapse plunged the global economy into its greatest recession since 1929 – one which it is steadily climbing out of now.

I have purposefully glossed over the last 20 years because the actual events leading up to the collapse – liberal lending policies by the Federal Reserve, de-regulation of the financial sector, the repeal of Glass-Steagall, and other causes – are irrelevant. The financial collapse was a correction back to economy’s original state. It is simply the mechanism by which the truth was exposed. What is more interesting to me now is the current state of affairs. In a nutshell, the economic development trend is not only slowing, or even plateauing. Rather, it is actually happening in reverse.

Part III: The Current State of the Union

The share of income by the top 10% and 1%, respectively

The share of income by the top 10% and 1%, respectively

Income inequality – which decreased during the era of industrialization – is on the rise again. As money and power become more concentrated, fewer individuals enjoy the spoils of prosperity. Wealth concentration in isolated communities exacerbate already appalling disparities in our education system. In a 2012 study, the OECD (Organization for Economic Co-Operation and Development) quantified the relative performance of students in the 33 high- and middle-income countries. Among 16-24 year olds, the United States ranks dead last in proficiency in numeracy. In other words, rather than investing in creating a highly-skilled workforce that will enable the country to thrive in that post-industrial economy, it allows any advantage it once had to slip away, damaging the prospects of future generations.

And what about on a microeconomic level? Remember how the poor in pre-industrial nations spend a disproportionate amount of their income on food, clothing, and housing, leaving them vulnerable to financial shocks? Well, that is happening again too. Derek Thomson of The Atlantic provides a sobering analysis of the realities from the Bureau of Labor Statistics:

For the poor, food, clothes, and housing account for more than 60 percent of all spending. The rich have more left over for leisure, insurance, and savings.

The term consumption takes on a more literal meaning when you see the difference between rich and poor spending. Cash-hungry families consume more of their income immediately, spending two in three dollars on absolute essentials like food and shirts. The rich are more predisposed to spend toward the future, with eight-times more of their income going toward insurance and even more going toward savings (although the bottom 20 percent includes lots of retirees on Social Security, the next quintile doesn’t see much in the way of savings either).

There has been a good amount of research recently about how being poor changes your thinking about everything. “If you have very little, you often behave in such a way so that you’ll have little in the future,” Sendhil Mullainathan recently told Harold Pollack in Wonkblog. The poor don’t plan as much for the coming years, because they can’t afford to.

Thinking about the future is a form of luxury.

The percentage of income spent by category for the rich and poor

The percentage of income spent by category.

Why is this important? Aren’t we living in an era of unprecedented prosperity? Yes and no. If you are one of the 2.4 billion people living on less than $2 a day, life is hopefully going to get better for you. You will benefit from the broader trend of globalization and general connectedness of the modern world, by which information and goods flow more freely, regardless of borders. But if you are lower middle class, or, even worse, already poor in America, life is about to get a lot worse.

That is because this trend will continue. The concentration of wealth will only become more pronounced. The Citizens United decision, coupled with the recent Supreme Court decision to strike down the overall political donation cap, will only reinforce the increasingly disproportionate power the wealthy have over the American political system. This sad turn of events brings us one step closer to that pre-industrial political landscape, where the ultra-elite control the government.

Each of these developments bring us closer and closer to our origins as a pre-industrial country.

Part IV: The Future

This long arc of our historical development lead us to one inevitable truth, articulated nicely by the Nobel prize-winning economist, Joseph Stiglitz:

Nowadays, these numbers show that the American dream is a myth. There is less equality of opportunity in the United States today than there is in Europe – or, indeed, in any advanced industrial country for which there are data.

This is one of the reasons that America has the highest level of inequality of any of the advanced countries – and its gap with the rest has been widening. In the “recovery” of 2009-2010, the top 1% of US income earners captured 93% of the income growth. Other inequality indicators – like wealth, health, and life expectancy – are as bad or even worse. The clear trend is one of concentration of income and wealth at the top, the hollowing out of the middle, and increasing poverty at the bottom.

At the end of his article, Stiglitz says that it is not too late for the American dream to be restored. To that point, I believe it is important that we collectively remember our roots – not as individuals, but as a country, and even a civilization. Remember that we all started from humble beginnings and invested in ourselves to ensure that we provided future generations the resources and skills to thrive in a changing world. Because not only will that ensure that we as a country are caring for one another the way that a country should, but also, from a more realpolitik standpoint, income inequality leads to greater economic instability, and a higher risk that we tumble down the chasm yet again.

There is another alternative: that we do nothing, and the trend continues, expanding the gap between what the creator of the show, The Wire, David Simon calls the “Two Americas.” In a speech given at the Festival of Dangerous Ideas in 2013, Simon explains ones manifestation of these two options:

So how does it get better? In 1932, it got better because they dealt the cards again and there was a communal logic that said nobody’s going to get left behind. We’re going to figure this out. We’re going to get the banks open. From the depths of that depression a social compact was made between worker, between labour and capital that actually allowed people to have some hope.

We’re either going to do that in some practical way when things get bad enough or we’re going to keep going the way we’re going, at which point there’s going to be enough people standing on the outside of this mess that somebody’s going to pick up a brick, because you know when people get to the end there’s always the brick. I hope we go for the first option but I’m losing faith.

Like David Simon, I’m losing faith. I hope that we as a society can stand up and recognize this broader trend. In the opening song of the seminal Dead Prez album Let’s Get Free, “Wolves”, the narrator uses an interesting parable to explain how African-Americans in inner cities have been systematically disenfranchised and sabotaged by crack cocaine, the police state, and the prison-industrial complex:

I’m not a hunter but I am told, that, uh, in places like in the arctic, where indigenous people sometimes might, might, hunt a wolf, they’ll take a double edged blade, and they’ll put blood on the blade, and they’ll melt the ice and stick the handle in the ice, so that only the blade is protruding, and that a wolf will smell the blood and wants to eat, and it will come and lick the blade trying to eat, and what happens is when the wolf licks the blade, of course, he cuts his tongue, and he bleeds, and he thinks he’s really having a good thing, and he drinks and he licks and he licks, and of course he is drinking his own blood and he kills himself.

Paul Ryan, a disciple of Ayn Rand, who believed that faith is detrimental to human life, speaking at the Value Voters summit.

Paul Ryan, a disciple of Ayn Rand, who believed that faith is detrimental to human life, speaking at the Value Voters summit.

I would argue that that is what is happening to everyone. People are tricked to vote against their own self-interest after being whipped up into a frenzy about gay marriage, abortion, and other inconsequential issues.  “Look over over there,” while I reach into your pocket and steal your wallet. The party of Christianity and family values is the same party that votes against expanding healthcare, that votes against supporting the poor, that votes for the corporation that pollutes its rivers and destroys its communities. In the Dead Prez analogy, “social issues” are the blood, and economics are the blade.

Can we reverse this trend? I don’t know. I would like to hope that this is not the new world order. But, unfortunately, very little as of late has given me reason to think otherwise.

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