It's over, yet it isn't

At the time of writing we still do not know who has won the 2020 US Presidential election. Whilst it matters profoundly who gets the keys to the White House, many of the issues raised during the election campaign will remain unresolved. Above all else the election reminded us just how split the US is along cultural lines. It is not my intention to get into the details of how Trump might react if he were to narrowly lose the election or the actions Biden might take if he were pipped at the post. Such issues are well covered in the press (here for example). I wish to focus instead on what the election tells us about the nature of the economic and political system in the US (and maybe also the UK) and what the next four years are likely to bring.

We should start by pointing out that the US is not the only country going through some sort of existential political crisis. I have been highlighting such issues in the UK on this blog for quite some time, but the splits on the other side of the Atlantic have existed for longer and are more entrenched. Indeed almost 15 years ago – long before most people had ever heard of Obama – the academics Mark Brewer and Jeffrey Stonecash argued that the cultural split on social and religious lines is only half the story. Division is also fuelled by differences in income and economic opportunity, as I pointed out a few weeks ago.

With the benefit of hindsight I am not sure whether Obama’s message of hope in 2008 would carry the same resonance today, even though many of the problems remain the same. Perhaps what the US election makes clear is that we are not about to return to a world of consensus anytime soon. Trump is not an outlier representing a deviation from the norm. He is the embodiment of a large slice of the electorate that wishes to overturn the status quo because it has not worked for them. I have made the point repeatedly in recent years that governments promised a quick return to the good times following the GFC in 2008 but have on the whole been unable, or unwilling, to deliver. This was partly a consequence of deliberate actions, with the likes of the UK introducing a policy of fiscal austerity which made such a major contribution to the Brexit vote. In the euro zone it was more by accident than design but simmering tensions between southern Europe and their northern neighbours remains a fault line at the heart of monetary union.

In the US the widening gap between the haves and the have-nots is the result of benign neglect. Trickle-down economics, a corner stone of Ronald Reagan’s policies in the 1980s, has never been repealed but it increasingly appears to be leading to adverse outcomes. Research into US wealth and income equality conducted by the Pew Research Center throws some light onto why people are so dissatisfied. Average household incomes in real terms have basically stagnated over the past 20 years, growing at a miserable 0.25% per annum. In the preceding 30 years they grew at an average rate of 1.2% per year. To put it another way, real incomes are more than 20% lower than they would be had the trend over the period 1970 to 2000 been sustained. Moreover the data also show that households at the upper end of the earnings scale have continued to outperform those lower down the scale.

A similar story holds for wealth where growth in the wealth holdings of upper income families has outstripped that of lower income families. Indeed the disparity has widened in recent years, with the real value of wealth holdings for upper income families having risen since the turn of the century whilst those lower down the scale have seen the real value of their wealth holdings decline (chart). The Pew Center makes the point that high income households are less dependent on the value of their homes to generate wealth and are more likely to hold financial assets whose value has been boosted in the low interest rate environment. It does therefore seem to be the case that policies to boost the stock market really do benefit the already-rich at the expense of the less well off.

It seems obvious that the widening disparity between the rich and the less well-off is a key reason why people continue to vote for Trump. Whatever people may think of him, his electioneering is touched by genius – a multi-millionaire pretends to be on the side of the little guy, promising them they will be better off under his presidency whilst the policies he espouses, such as tax cuts, benefit Trump and his ilk. Throw in the smokescreen of blaming foreigners (in this case the Chinese) for US economic woes and he has it made. However, Trump has done nothing to make life better for his core voters. The way to alleviate some of their problems is to apply a redistributive fiscal policy but that is not going to fly in a country which sees such options as heretical socialism. Indeed, the Republicans hate Obama’s signal policy on healthcare reform because it seems so un-American.

Whoever is the next President is unlikely to redress the balance by raising taxes on higher earners. Bernie Sanders tried to popularise such a policy and look where it got him. However, under a Democratic President there might be a move towards increasing spending. Modern Monetary Theory (MMT) is popular on the left wing of the Democratic Party and may make small steps towards the mainstream. This policy (which I looked at here) in effect suggests that because governments are the monopoly supplier of money they can provide unlimited quantities of liquidity without creating inflation. There is a lot wrong with the economics of MMT – it’s the Democratic equivalent of trickle-down – but it might spark a bigger debate about how to boost public spending to benefit those left behind. The Republicans do not appear to have any new economic ideas other than more of the same. However, this will not help the left-behind and will likely lead to greater stridency as both sides continue to shout at each other across the divide.

There is little doubt that the US, like the UK, needs a radical economic and political overhaul. This is simply not going to happen. As the neoconservative commentator Bill Kristol noted in an article today, the day after the election can be characterised as a mixture of the good, the bad and the ugly. In his view, the good news is that Joe Biden is more likely to be president than Donald Trump – and this from a leading light of the neocon movement. The bad is that the election will leave both the Republicans and the Democrats worse off than before, since the fairly even showing of both parties does not suggest any incentive to rethink their strategy. The ugly is that “after four years of seeing Donald Trump govern … the American people rewarded President Trump with an increased share of the overall vote. To some very real degree … We have met the enemy and he is us.” Whoever occupies the White House in January will continue to face a restive electorate.

The last days of empire?

Most of us are not privileged to witness major historical events at close hand. Even if we did, we would be unlikely to fully understand their significance. Imagine being present at the signing of the Magna Carta in 1215, little knowing that it would represent one of the first attempts to codify individual freedoms that would echo down the centuries. Nor would many people have seen the Ninety-five Theses supposedly pinned to the door of All Saints' Church in Wittenberg by Martin Luther in 1517, but we are all familiar with the resultant splits within the Catholic Church which were arguably a first step on the road to the Age of Enlightenment.

I raise these points because it is impossible to know whether what we are experiencing today reflects a fundamental shift in the way our societies and economies will operate in future or whether it is minor diversion on a path we have been following for the past 75 years. One of the motivating factors for thinking about this was an excellent article on the Mother Jones website by the historian Patrick Wyman who looked at the decline of empire. As Wyman put it, “the fall of an empire …looks more like a cascading series of minor, individually unimportant failures than a dramatic ending that appears out of the blue.” He also makes the point that whilst all societies face challenges and setbacks, what determines the survival of the status quo is the quality of the institutions which are able to define a response. At issue in large parts of the west today is whether the institutional framework is sufficiently robust to face up to the challenges of the 21^st century.

Just weeks away from the US election the world looks on to see whether the Donald Trump experiment will be brought to a halt or whether the process of institutional erosion will be given free rein to continue. In Wyman’s view, the future popular narrative of the relative demise of the US will pin the blame on Trump, “but it’s far more likely that the real meat of the issue will be found in a tax code full of sweetheart deals for the ultra-wealthy, the slashed budgets of county public health offices, the lead-contaminated water supplies. And that’s to say nothing of the decades of pointless, self-perpetuating, and almost undiscussed imperial wars that produce no victories but plenty of expenditures in blood and treasure, and a great deal of justified ill will.” This may not be the version of the US that you recognise or accept. But the wider point is that a country as institutionally strong as the US does not suddenly go from being the only superpower to sharing the stage with others in just four years. Other factors are at play. 

Why the economics matters 

The Nobel Prize winning economist Joseph Stiglitz points to “the growing concentration of market power, which allows dominant firms to exploit their customers and squeeze their employees.” This in turn has allowed shareholders and company managers to expropriate a bigger slice of the pie, leading to widening inequality and further fuelling the sense of resentment which led to Trump being elected in the first place. In Stiglitz’s view a small number of firms dominate key sectors of the US economy, which has allowed them to attain disproportionate political influence “and as the system has become more rigged in business’s favor, it has become much harder for ordinary citizens to seek redress for mistreatment or abuse.” 

To compound these problems, evidence compiled by the World Economic Forum suggests that US social mobility has slowed and maybe even gone into reverse. For generations, workers tended to earn more than their parents. However, the evidence suggests that those born in the 1980s whose parents were in the middle of the income distribution only have a 45% chance of earning more than their parents compared to 59% for those born in the 1970s and 95% for those born in the 1940s (chart below). This is not what the American Dream is made of.

One of the factors underpinning this result is the sluggish pace of wage growth. Real hourly earnings, for example, have increased by only 11.7% since the mid-1960s despite a significant increase in productivity. Moreover there has been particularly rapid growth in the price of services such as health and education. Consumers thus have to devote a much higher slice of their disposable income to educate themselves and maintain their health than they did 50 years ago. The income distribution has also become increasingly skewed in favour of the well-off. According to data from the Pew Research Center households towards the upper end of the income distribution have increased their share of wage income over the past 50 years, from 28% to 48%, at the expense of those in the middle, whose share fell from 62% in 1970 to 43% by 2018 (chart below).

This matters because it is this sense of dissatisfaction that Trump tapped into in 2016. But what is driving it? It may partly be due to the decline in trade union membership since the 1980s which has prevented organised labour from acting as a counterweight to rent seeking company owners. The application of new technology further adds to the pressure by pushing down on the wages of the less well educated segment of the labour force. Of course, these issues are not merely confined to the US – this sense of dissatisfaction was a driving force behind the Brexit referendum result in the UK – but they are more extreme on the other side of the Atlantic. The extent to which politicians are willing to tackle these problems will play a big role in determining how Anglo Saxon society and its economy will look in future and whether it will still be held an example for others to follow. 

And why the response of politicians matters even more 

According to Stiglitz “US corporate executives made sure that the vast majority of the benefits from the [2017] tax cut went into dividends and stock buybacks, which exceeded a record-breaking $1.1 trillion in 2018.” This reinforces the sense that Trump’s economic policies have benefited the rich at the expense of those who voted for him. Yet there is a good reason why this should be the case: Presidential hopefuls require a big war chest, to which big business is more likely to contribute if their interests will be served by the candidate. As the experience of Bernie Sanders illustrates, politicians who are prepared to tackle the redistribution question are unable to generate sufficient buy-in to be elected. Nor is the business capture problem confined to the US. Michel Cames and Eckard Helmers argue (here) that “the European oil industry co-initiated the shift to diesel cars in the 1980s and 1990s in order to find outlets for middle distillates [diesel]” and they did so in tandem with the European Commission by selling it as a way to meet CO₂ reduction targets. Never mind the fact that it raised nitrous oxide levels, with all the attendant health consequences.

The danger in all this is that rising economic inequality and the capture of the political decision making process by big business threatens to further raise the degree of anger at the status quo. This could be used by future generations of nationalist politicians to pursue an agenda which makes that of Trump seem tame. The long-term health of the Anglo Saxon economy and the society which underpins it depends on it being seen to serve the interests of voters. After a decade of uncertainty in the wake of the financial crisis of 2008, and even more so at a time of the unprecedented Covid pandemic, the US and UK are crying out for someone to deliver genuine leadership and make voters believe that the economic system works for them. Failure to act before it is too late risks condemning the Anglo Saxon model to irrelevance. We may not understand the slow process of erosion as we live through it but it will surely be clear to future generations of historians.

Reflections from snow-topped mountains

One of the main strands of Donald Trump’s appeal to the American public is that he is an outsider. Of course, that is not true – and never has been.  As the president said in a speech in Arizona last year, “I was a good student. I always hear about the elite. You know, the elite. They're elite? I went to better schools than they did. I was a better student than they were. I live in a bigger, more beautiful apartment, and I live in the White House, too, which is really great.” So it probably should not have been a great surprise that he became the first sitting president in almost two decades to attend the World Economic Forum’s jamboree for the great and the good in Davos[1].

Not surprisingly, Trump was the star of the show and the positive message Europe heard was that “America First does not mean America alone.” But he also pointed out that the world "cannot have free and open trade if some countries exploit the system" and that Washington "will no longer turn a blind eye to unfair trade policies." The WEF’s annual report indeed highlighted that the risk of some form of conflict was high on the list of issues which could derail the current friendly economic environment. The WEF notes that “charismatic strongman politics is on the rise” that has hastened the move away from the rules-based multilateralism which has underpinned the peace and prosperity of the post-WWII economic system. The US has blocked appointments to the WTO’s seven-member Appellate Body during Trump’s tenure, and two seats are currently waiting to be filled. A weakening of the WTO’s ability to resolve disputes does nothing to assuage concerns that trade tensions between the US and China could yet become a major problem.

But one of the biggest curiosities of the Davos bash is that it should happen at all. One of the reasons why “strongman politics” is on the rise is that many millions of ordinary voters feel left behind by the advance of the global capitalist economy, which appears to benefit the very few at the expense of the many. Two weeks ago BlackRock CEO Larry Fink distributed a letter addressed to the CEOs of global companies arguing that “society is demanding that companies, both public and private, serve a social purpose.” Economists such as Milton Friedman would not agree. Writing in 1970, Friedman argued that a business executive who exercises social responsibility in the course of their work “must mean that he is to act in some way that is not in the interest of his employers”. Businesses which do anything other than maximise profits were “unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades” and were guilty of “analytical looseness and lack of rigor.”

Arguably Friedman’s view is flawed because it fails to distinguish between short-term and long-term profit maximisation and ignores the non-pecuniary benefits which flow from social activities. Companies which simply attempt to maximise profits each year, whilst failing to treat their customers and employees with respect, will fail. But that is a different proposition to suggesting that companies exist to serve a social purpose. In any case, many large firms have long since taken ideas of social responsibility on-board in drawing up their corporate sustainability programmes. Corporates do have a duty to act responsibly, of course, and those which fail to do so are held up to scrutiny. The problems faced by Volkswagen following the revelation that it falsified diesel engine emissions highlights that there are costs associated with acting in a non-socially responsible manner.

But the more I listened to what Fink had to say, the less I was convinced by his message. Another of his Davos pronouncements was that too many people are excluded from the workings of financial markets as a result of financial illiteracy and more work has to be done to ensure “they don't feel frightened of moving their money into long term instruments.” Given that Fink is the CEO of a primarily passive investment fund, there is a certain irony (to say the least) in his desire to get more people involved in financial markets. His point that a lack of involvement ultimately hampers efforts to generate decent retirement incomes was valid. But at a time when many people are finding their incomes being severely squeezed, they simply do not have the excess resources to devote to financial investing – a problem the likes of Fink do not have.

I have no doubt that Fink’s views – and those of his fellow grandees – are motivated by a genuine concern that the system from which they have benefited is under threat, and that they believe there is a strong case for redistributing some of the wealth. Perhaps they not aware of how their argument in favour of caring capitalism comes across – it does sound like a ‘let them have cake’ view.  Many people simply feel that they are being screwed and want a piece of the pie. That said, when it falls to the rich to talk about solving global inequality problems, it is small wonder that the ordinary voter has little faith in governments.

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[1] In the interests of disclosure, I should point out I was not there. I assume my invitation was lost in the post.

Generating economic policy buy-in

Just before Christmas, the FT commentator Gideon Rachman penned a column which argued very strongly that “Economics is – or should be – part of moral philosophy  …  ‘the economy’ is not just about growth. It is also about justice.” This is a very important point and one that tends to be overlooked, or at least downplayed, by large parts of the economics profession. Rachman argues – as indeed as I have done on this blog – that many voters do not buy into the economic vision offered by politicians because they do not see how it benefits them. What is even worse, they often believe they are being discriminated against in favour of other interest groups.

Making America great again speaks to the millions of voters who believe somehow that the US’s status of top dog is being eroded by emerging economies that do not play by the economic rules and that the US is being penalised for abiding by them. In a similar vein, taking back control speaks to those British voters who see the UK as being held back by a monolithic EU. As an economist, I find such statements absurd. After all, the US is still the pre-eminent economic and military superpower whilst EU membership gives the UK access to the largest and richest single market on the planet. But there is no reason why this should cut any ice with the average voter who is struggling to make ends meet at a time of low wage inflation and against a perceived backdrop of mounting job insecurity (which incidentally is not backed up by the UK evidence).

The predominant economic model in the Anglo Saxon world over the last 35 years has been a market-oriented policy in which government has tried to reduce its role in the belief that the market will provide the most efficient allocation of resources, thus boosting welfare. Prior to 2008 the evidence appeared to suggest that whilst voters were aware of the downsides of this model, the economic tide was rising sufficiently quickly to float all boats. But political and economic circumstances have changed over the past decade. Society’s sense of natural justice was offended by government actions to bail out banks whilst simultaneously imposing a policy of fiscal austerity, which sowed the seeds of a belief that the system is rigged in favour of big business at the expense of the little guy.

This has resulted in many aspects of our current model being put under the microscope and raises questions whether economic policy is going in the direction which voters are prepared to buy into. As Rachman points out, intra-generational issues are uppermost in the minds of many voters. There are concerns across the western economies that those in born after 1980 will not be as wealthy as their parents. Evidence from the UK, for example, suggests that younger adults have much less wealth to their name than previous generations did at a similar age. Over the past decade, as younger voters have gone through university and entered the labour force, many of them are beginning to question whether they will be able to reap the economic rewards they were promised. UK students no longer get the benefit of a free university education and finish their university studies with much higher levels of debt than their parents. Indeed, UK students now carry a staggering £13bn of debt – an increase of almost 190 times what they owed in 1990.

At the same time, the younger generation must pay the taxes to cover the rising costs of providing for the welfare needs of the ageing baby boomers, whilst struggling to find the high-paying jobs which previous generations were able to secure. They will also have to deal with the fallout from the populist reactions triggered by the Brexit vote and the election of Trump – both of which were propelled by the votes of the older generation. Millennials in the industrialised world can be forgiven for questioning the legacy bequeathed to them by older generations.

Policies which offer a trade-off between more market solutions and lower taxes are increasingly unlikely to find electoral favour. Nobody wants to pay more taxes, of course, but there are limits on how far countries such as the UK can continue to reduce them and still maintain the reasonable standard of public services that the public has come to expect. Scarcely a week goes by without a newspaper story decrying cuts to the armed forces or the strains imposed on a health system which struggles to cope with the strains placed upon it. It is perhaps for this reason that we are seeing renewed voter interest in “radical left” parties across Europe which promise a greater role for the state in a bid to improve the lot of those left behind (chart).

Indeed, as the IMF pointed out last week in its regular assessment of the UK economy “greater reliance on revenue measures for [fiscal] consolidation than in recent years may be warranted.” Amongst the potential measures put forward were a reduction in “the tax code’s bias toward debt” which benefits corporations, and rebalancing property taxation away from transactions and toward property values. Ironically, the US appears to have gone in the other direction with the recently unveiled changes to the tax system primarily benefiting corporates and better off individuals.

If we really are in it together (to use George Osborne’s phrase) some changes to the incidence of taxation would be a good place to start to help win over voters that the system is not biased against them. Whilst many in the policy establishment draw on the laissez-faire teachings of Adam Smith, we should not forget that “The Theory of Moral Sentiments” extensively explored ideas such as morality and human sympathy. He never advocated the devil-take-the-hindmost policy which many of his adherents claim. It is a lesson the economic and policy establishment perhaps needs to relearn.

If it's broke, fix it!

To say that Britain is a country ill at ease with itself would be an understatement. Almost every day new information comes to light which highlights that the divisions fostered by the EU referendum are not healing. Maybe my sensitivity to the issue is heightened by the fact I live in a region which voted overwhelmingly to remain in the EU and I work in an industry that depends very heavily on open borders, and now has to make preparations for the possibility that in 18 months’ time those conditions will no longer be in place. But as evidence mounts that Brexit will not be the costless process that the electorate was promised, there is some evidence of buyer's remorse. As the chart below suggests, there has been a modest, but distinct shift since May in the proportion of those believing that leaving the EU is the wrong decision. The government, however, seems intent on ploughing along its pre-defined course.

The leaked document earlier this week highlighting that the UK plans to impose tougher immigration curbs on EU citizens as soon as Brexit is implemented made for profoundly depressing reading. It certainly did not play well in Brussels and was sufficiently inflammatory that it could scupper attempts to start trade talks next month. Aside from the economic damage that migration curbs will cause, particularly in the short run, a related concern is how this changes the perception of the UK in the rest of the world. The British like to portray themselves as welcoming hosts to immigrants fleeing repression at home. It is hard to square that with the government's current policy which looks increasingly illiberal on a number of social issues.

Not for nothing did the Archbishop of Canterbury describe the current British model as "broken." I take this man's view on economics and finance more seriously than most other men of the cloth, since the Archbishop was formerly a senior executive in the oil industry and knows a thing or two about business. His comments came in the context of a report published by the Institute for Public Policy Research whose Commission on Economic Justice features senior business and public figures alongside the Archbishop. The report argues very strongly that “the British economy today is not generating rising prosperity for a majority of the population. Economic growth no longer leads to higher pay: the period from 2008 to 2021 will be the longest period of earnings stagnation for around 150 years.” The report further argues that workers are not sharing in the recovery in corporate profitability, which is furthering inequality.

Whilst this is all true, in some ways this is to miss the point. As the Chancellor of the Exchequer pointed out the Gini co-efficient measure of income inequality is at a 30-year low. There does appear, however, to be a deep-seated sense that something is wrong. For one thing, it is not income inequality per se that is the problem – everyone is being squeezed by the downward pressure on incomes as the UK economy struggles to recover from the fallout of the financial crisis at the same time as global competition is intensifying. As the IPPR points out, the UK is one of only six OECD countries where real earnings are still below their 2007 level. There is also a sense that wealth inequality is rising as younger people find themselves increasingly priced out of the housing market. In 1991, two-thirds of those aged 25-34 were homeowners: today that figure is around 36%, with the result that people of any given age cohort own less wealth today than in previous decades. But more than monetary equality measures, one of the biggest unspoken concerns is the apparent lack of equality in opportunity.

Younger generations who have entered the workforce in the last 10-15 years certainly do not have the same opportunities that their parents had. Education is a case in point. University students in the UK finish their studies with debts averaging £50,000 according to the IFS, whereas their parents educations was funded by the state. Even in the 1990s when charges were initially levied, they were relatively small and students graduated with relatively low levels of debt. Worse still, the relatively high paying jobs required to fund student loans (which, it should be noted, are subject to an almost usurious interest rate of 6.1%) are far harder to come by. This in part is the result of financial crisis of 2008-09 which has made the country poorer than it would otherwise have been. It is also the reflection of intensified global competition, which means that many skilled jobs (e.g. in manufacturing or finance) are relocating elsewhere. Automation and digitisation increasingly mean that many students emerge from education without the requisite skills. A generalist degree might have sufficed in the past as young people learned on the job, but that is increasingly no longer the case. A university degree no longer appears to be the passport to riches.

None of these problems are easy to resolve. However, the policy of successive governments to rely on markets rather than the state to improve the UK’s economic prosperity is being challenged as never before. Perhaps we have to accept that given the scale of globalisation, digitisation and environmental challenges, incomes in the UK (and indeed many other western economies) simply will not be able to grow as rapidly as in the past. That makes it all the more important that we get the policy mix right. A little less reliance on monetary policy in favour of more joined-up fiscal thinking would be a start. After all, monetary policy only brings forward consumption by enabling households to borrow more cheaply today but they have to repay those loans in the longer term. Fiscal policy will not resolve all the problems though we can be pretty certain that Brexit will exacerbate the scale of the challenges. It is thus imperative to get the Brexit strategy right – and I am not hearing any indications from either the British or EU side that this is likely to happen.

We live in troubled times

More than 30 years after the Thatcher government adopted a policy of systematic indifference to the fate of British manufacturing, it comes as no real surprise that the future of the UK steel industry once more hangs in the balance. Nine years after Tata Steel bought the remnants of the industry from Corus, the company ended up losing significant amounts of money by holding onto the Port Talbot plant in the face of a massive glut of global output, triggered largely by Chinese overcapacity.The whole issue is a microcosm of the economic problems facing the UK today and raises a number of uncomfortable questions for the future of the British manufacturing sector in general, and steel in particular. First off, how much support is the government prepared to give to an industry which is potentially of critical national importance? Second, to what extent can we rely on free markets to generate the kind of outcomes which are socially acceptable? And third, to what extent can China be relied upon to play by the rules of the international trade game?