Tuesday, March 12, 2019

Is the Economic System Really Hollowed Out?

By Roy C. Smith

Every so often the world economic system has to adjust to major “shocks” that threaten it. Normally, these come about every other decade, but we have had three such shocks since 2000: (1) two major, highly destabilizing financial crises (2000-2002) and (2007-2009), (2) an outbreak of terrorist bombings and a huge wave of unwanted migration into Europe from Syria and North Africa, and (3) the many effects on labor markets of the US and EU of outsourcing of manufacturing activities to China. One result of all this has been the growing perception in the US and Europe that the working-and-middle class populations have been “hollowed out” by economic shifts that have increased income inequality and forced nearly half the population in the developed world into economic anxiety and uncertainly.

The aggregate effects of these changes have brought about a rise in populism, anti-globalization, a disregard for the so-called governing elite and an appetite for authoritarian solutions. These factors have generated unexpected changes in governments in the US, the UK, Germany, France, Italy, Spain, and other several other European countries. Indeed, the question seems to be: will these changes in established support for globalized free-market economic policies be enough to set the system back to what it had been in the 1950s, when market economics were not a high priority?

Cumulatively, these political manifestations are the signs of serious resistance to the idea that economic performance can be optimized by participation in the global, open-market capitalist system that was cobbled together after WWII and produced 80-years of peace and prosperity. More recently, and for the first time, such economic participation expanded into Emerging Market Countries though “globalization,” and was encouraged and sustained by a general belief that the “new” system for economic development worked far better than the old.

President Trump, however, says he disagrees. He says he is an economic “nationalist,” and the “globalists” have sacrificed US interests in building an international trade and economic system that has mainly benefited other countries.  Globalists, however, point out that the system he decries was in fact responsible for the extraordinary recovery and enormous prosperity in the post WWII world, greatly reduced world poverty and fostered democracies in replacement of authoritarian states. Bill Emmott, a former editor of The Economist, observed in a 2017 book that we have entered a “battle to save the world’s most successful political idea.” The idea being “liberalism,” or “liberal democracy,” (liberal in the British context of “liberty” being reflected in free-markets and open societies, not in the US sense of far-left politics), and he claims it is under assault. Several other books by well-known, establishment figures have described the rise of authoritarianism and the weakening of democracies and also believe a battle has begun; others have focused on the erosion of the well-being of the working-and-middle-classes in the US and Europe where the conflict is vigorously being waged with active support from both the political left and right.

Is all this right? Or, is there another narrative that simply gets less attention?

The alternative version of the story asserts that the economic division between the classes is serious but overstated. The shocks have been very powerful and have taken almost two decades to be accommodated, but the system has adapted, as it has done before, and is well-into turning around. Financial stability has been restored. Terrorism and migration are more manageable than they were, China’s threat to the world economy is in decline (and under negotiation) and now is much less than it was. And, there are signs that we have reached the end of the hollowing out period, with record low unemployment, rising wages, and some policy measures taken (or proposed) to improve the economic security of the lower half of the population?

Indeed, at the millennium (before the shocks), Americans were able to celebrate the greatest twenty-year period of wealth creation the world had ever known.  This was largely provided by a fourteen-fold increase in the Dow Jones average from 1982-1999, an annual compound growth rate of 16% for 17-years, in which 48% of US households participated (according to the Federal Reserve) through pension funds, mutual funds and investments in homes that appreciated with the stock market. Wealth creation was coming from many directions: entrepreneurs, corporate restructuring, increased global trade, mergers and other forms of deal-making and investing. New telecom, pharmaceutical and internet industries were developing, innovation and competition challenged market leaders, and polls indicated that the public was not envious or resentful of the rich, but instead appreciated that their children could be rich too.

 “Household net worth” (the value of all household financial and non-financial assets, less mortgages, personal debt and credit cards, after inflation, living expenses, tuitions and taxes) increased 8% annually for twenty years, more than twice the rate of the real economy. In the US, the median household net worth was $96.700 in 2001, it declined due to the shocks to $63,900 in 2013, but has since growth by 53% to $97,300 in 2019.

The source of the wealth creation was the private sector that employed 85% of the US workforce and had had the benefit of the liberal economic policies of the Regan-Thatcher era, carried on by their successors and emulated in developing countries and post-Communist Europe. Since 1980, China, India, the former Soviet Bloc and many emerging countries adopted the liberal economic model in one way or another, enabling more than 50% of the world’s population to prosper from it by the end of the twentieth century. The so-called “BRIC” countries (Brazil, Russia, India, China) emerged as major beneficiaries of the idea, and began to attract large amounts of foreign direct and portfolio investment.  The stock market capitalization of emerging market countries as a whole rose from $186 billion in 1980 to $18.3 trillion in 2007, nearly a ten-fold increase. Liberalism worked, and was now ascendant, broadly accepted and entrenched.  But serious vulnerabilities would soon become apparent, and the “shocks” would soon challenge the liberal economic system to its roots.

The hollowing out condition may be overstated, but there is more than a little data to support it.

In 1970, manufacturing industries employed 27% of the US workforce in well-paying jobs with health and pension benefits, often under union contracts. During the nearly 50-year period, since then, US manufacturers experienced low-cost competition from Japan, South Korea, Taiwan, and China, moved domestic production overseas, and invested heavily in automation and supply-chain management. The US is still the world’s second largest manufacturing country, employing 12 million workers in 2013, but now only 8.8% of the workforce. From 1998-2013, 5.7 million manufacturing jobs were “lost.” Some of the job loss was the result of automation and improved factory engineering, but a 32% drop in manufacturing jobs over 15 years was hard to ignore, especially in the rust-belt sectors of the economy where the relative impact on jobs, community life and families was more intense. 

China joined the World Trade Organization in 2001, when its global trade surplus was $360 billion. In 2006 the surplus peaked at $761 billion, and since then has declined 26% to $560 billion in 2017.  But, China’s trade surplus with the US reached $276 billion in 2017, a record high, when exports to the US totaled $2.9 trillion. The US is China’s second largest trading partner behind the EU – China had a trade surplus with the EU of $176 billion in 2017.

Calculating net job losses from trade with China is very inexact in a competitive economic system with lots of “creative destruction.” China’s trade surplus, is shrinking under its own weight. Its local manufacturing costs are rising, labor has become scarce, and, particularly under the Trump administration, it is encountering stronger resistance to its trade policies, barriers to entry, subsidies and other practices prohibited by WTO rules. US importers are beginning to source supply chains from countries other than China. The perception of the public, however, is that imports from China have been a major contributor to the job losses of the working-and-middle classes of the US, and the EU.

Manufacturing jobs with pension and health benefits were hard to replace with part-time, or freelance, jobs provided by the new “gig” employment universe. Wages became stagnant. A recent Pew Research study reported that US inflation-adjusted wages had no more purchasing power in 2017 than they had in 1978. By hollowing out, many observers have noted, “good” jobs have been replaced by lower valued ones, and the Great Recession and slow-down (2009-2016) have made full time employment more unstable and uncertain.

Making it all worse, the 2008 mortgage crisis shock resulted in 5.5 million home foreclosures, most among the working-and-middle classes reflecting their income decline. The share of federal income taxes paid by the lower half of US income-earners dropped to 2.8% in 2015, from 7.1% in 1988, as income inequality increased in the US. Many in the lower income half have minimal (or no) health insurance. Health care ranked as the most important issue to Americans by a nearly two-to-one margin in the 2018 midterm elections in the US, according to exit polls published by CNN. Also, for the lower income group, the costs of college education (the escape route for their children) have been rising faster than their incomes.

Despite the bull market in stocks since 2009, nearly two decades of stock market underperformance (the S&P 500 total return index, adjusted for inflation, rose less than 3% from 2000-2018, as compared to 13% for the 1980s and 1990s) has left corporate, union and state and municipal pension and retirement funds significantly underfunded. According to Vanguard, the median balance in 401k income retirement funds for those in the 65+ age group in 2017 was a mere $69,000. The great American middle class was far less financially secure in 2016 than it was before 2000.

In 2017, researchers with the Gallup-Sharecare Well-Being Index surveyed American adults about their perceptions of their financial, social and general well-being and reported the worst results in the 10-year history of the survey. Another 2017 Gallup poll surveying American between the ages of 18-29, showed only 45% approved of capitalism, a 12-point decline in young adults' positive views of economic liberalism in just the past two years and a marked shift since 2010, when 68 percent viewed it positively. Still, these approval rates tend to fluctuate over time. The young want both equality and efficiency.

Several observers of the deteriorating conditions for working-and-middle class Americans have pointed to other consequences as well: a lower college completion rate, a sharp fall in the US birth rate as marriages are delayed, reduced religious activity and participation in social organizations. So, a large segment of US society, perhaps as much as half of it, believes it has been steadily falling behind the other half. And, as should happen in a vibrant democracy, this perception of diminishing status has shown up in voting booths. Mr. Trump’s solid “base” continues to number about 43% of the electorate, but it may be larger than that. There are many former Democrats from the working class, and active or retired business executives who respond favorably to his illiberal approach to running the government.

No other candidate from either party has anything like a base of support of this Trumpian size, but his support is offset by a vigorous anti-Trump effort that recovered control of the House of Representatives, thus blocking any far-right populist legislative efforts and leaving Mr. Trump dependent on uncertain Executive Orders to govern the country. Democrats will be unable to legislate anything of their own, of course, and will largely spend their time blocking Republican efforts and investigating Mr. Trump. Even with successful trade negotiations with China and the EU (a “maybe” outcome at best), and the (fading) effects of the 2017 tax cuts, the Trump administration is unlikely to be able to add much growth to the US economy over the next two years, as reflected by the Fed’s recent growth forecasts for 2019 (2.3%) and 2020 (2.0%) as compared to 3.0% in 2018.

If these forecasts prove to be true, providing a significant reversal of economic impetus, then Mr. Trump will be in trouble by 2020.  His ability to alter economic policies so as to change back to a growth mode will be seen to be very limited. And, at some point in the next year or two Mr. Trump will have to confront debt-ceiling issues as US federal debt outstanding as a percentage of GDP reaches levels not seen since WWII.

Those who voted for Mr. Trump in 2016 did so knowing he had little experience in government and, at best, he would “shake things up.” This he has done with a series of confrontations with trade partners and important allies, that will take years to benefit the working class, if they ever do

Meanwhile, Democrats and their counterparts in Europe are trying to attract this cohort of voters with (essentially) unfinanceable public give-way programs that both conservatives and moderates dislike.

The net result of this uncompleted struggle between extremists seems to be that no one is in charge, and the economic system that Bill Emmott praised is largely adrift.

So, it’s time for moderates on both sides of the Atlantic to appear and apply some forceful common sense to the otherwise dysfunctional political/economic situation we have drifted into. The moderates, particularly from the business, academic, and political establishment should be able to see their way to support some affordable policy issues that will help rebuild the working-and-middle classes – e.g., allowing minimum wage increases, providing health care insurance no worse than Obamacare, developing effective job retraining and vocational education programs, among many other ideas that have been proposed. The moderates are essential to find solutions to these problems that can attract majority support, which the extreme liberals and conservatives presently dominating the political arena do not.

This is essentially what happened in the 1890s-1910s when “muckrakers” checked the power of Guilded-Age capitalists with much-resisted anti-trust legislation; in the early 1900s with equally resisted laws affecting the rights and activities of labor unions; in the 1930s with New Deal financial regulation, deposit insurance and social security; and in the 1960s with Great Society legislation (social security enhancement and Medicare for the elderly). Though most of these laws were introduced by Democratic administrations they passed with bi-partisan support.

Capitalists know that capitalism can only succeed in a democracy with the consent of the people, and that consent may be hard to maintain with half the population feeling left out. But maybe half of that half are sorting themselves out, and need to be heard from too. Probably what you would hear from them is “no one is entitled to a free ride, but there are times when sensible government actions can and should make things work better.” A consensus around such a policy position might begin to change to hollowed out perception.  Changing perceptions helps a lot in rebuilding growth.