America’s Biggest Problem is Almost under the Radar

 

I’ve had several posts recently elaborating on the theme of Tyler Cowen’s new book, “The Complacent Class,” that too many Americans have become complacent about the comfortable life which they now enjoy.


Let’s take a different approach today and consider some of the problems which large numbers of Americans really are concerned about:

  • The election of Donald Trump as President. Granted, he just barely squeaked through in the Electoral College with 46% of the popular vote. He makes outlandish statements which have little, if any, basis in fact. But he has appointed many capable cabinet secretaries and other assistants and he listens to them. He adjusts his policies when struck down by the courts. In my opinion he has suffered no major mistakes so far.
  • Increasing income inequality in American society. This is a problem but, as Nicholas Eberstadt has pointed out, the real problem is income insecurity for millions of blue-collar workers. The best solution here is faster economic growth which the Trump Administration and the Republican Congress hope to achieve through tax reform and deregulation.
  • Global Warming. More and more Americans understand the increasing severity of this problem. There is a fair chance that a revenue neutral carbon tax will be implemented in the near future. This would be a big boost toward controlling carbon emissions in the U.S. and would provide more clout in establishing worldwide emission standards as well.
  • A chaotic world. Terrorism will not go away but at least ISIS will soon be defeated as an independent state. Other worldwide threats such as China, Russia and Iran can be managed with a strong U.S. military force undergirded by a strong U.S. economy.

Conclusion. The above problems are considered by large numbers of people to be serious and are therefore being addressed in one way or another. But our biggest problem of all, massive debtis off the radar for much of the political class, including President Trump. It needs to be taken far more seriously than it is before we have another, and much more severe, financial crisis.

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The Origins of Trumpism

 

Everyone is trying to figure out what Donald Trump is all about and I am no exception. My last two posts, here and here, compare his positives and negatives and what he is doing well so far and also not so well.
The American Enterprise Institute’s political economist, Nicholas Eberstadt, has an article in the current issue of Commentary, “Our Miserable 21st Century,” describing very cogently the economic and social conditions which have led to the election of Donald Trump as President of the United States. Says Mr. Eberstadt:

  • The year 2000 marks a grim historical milestone for our nation. The warning lights have been flashing for 15 years and now these signals are impossible to ignore.
  • First of all, the estimated net worth of American households has more than doubled between 2000 and 2016, from $44 trillion to $88 trillion (see below).capture103
  • At the same time the recovery from the crash of 2008 has been singularly slow and weak. By late 2016 per capita output was just 4% higher than in late 2007. In effect the American economy has suffered something close to a lost decade (see below).capture104
  • Then there is the employment situation. Between 2000 and 2016 the work rate for Americans aged 20 and older declined by 4% from 66% to 62%. To put this in different words: if our nation’s work rate today were back up to its start-of-the-century highs, 10 million more Americans would currently have paying jobs (see below).capture105
  • Half of all prime working-age male labor-force dropouts (totaling 7 million men) take opioid medication on a daily basis, typically paid for by Medicaid. In fact, 53% of prime-age males not in the labor force are enrolled in Medicaid.
  • Of the entire un-working prime-age male Anglo population in 2013, 57% were collecting disability benefits.
  • Currently 17 million men in America have a felony conviction somewhere in there past. This amounts to one of every eight adult males in the country. It is difficult for felons to find work and therefore to become productive members of society.

Concludes Mr. Eberstadt, “The abstraction of inequality doesn’t matter a lot to ordinary Americans. The reality of economic insecurity does.  The Great American Escalator is broken – and it badly needs to be fixed.  With the election of 2016, Americans within the bubble (of affluence) finally learned that the 21st century has gotten off to a very bad start in America.  Welcome to the reality.  We have a lot of work to do together to turn this around.”

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The Economic Damage Caused by Very Low Interest Rates

 

As is well known, the Federal Reserve’s main tool in responding to the Financial Crisis in 2007 – 2009 has been quantitative easing (to lower long term interest rates) and direct reduction of the Federal Funds Rate (to lower short term interest rates). These measures definitely limited the severity of the Great Recession resulting from the Financial Crisis.  But the recession ended in June 2009, more than seven years ago.
Capture37In the meantime the continuation of such low interest rates is having many detrimental effects such as:

  • Pension funds, both public and private, have become greatly underfunded,  creating crises especially for state and local governments with defined contribution plans.
  • Retirement plans for millions of seniors have been upset by erosion of savings.
  • Inequality has increased as affluent stock owners benefit from the rapid increase of asset prices as investors reach for yield.
  • An immense misallocation of capital towards bond issuers at the expense of small business is taking place.
  • Federal debt is soaring as low interest rates make it much easier for Congress to ignore large budget deficits.
  • The next recession, when it inevitably arrives, will leave the Fed in a bind. The only tools remaining are a new round of quantitative easing (additional bond purchases) and even lower (i.e. negative) interest rates.
  • The Fed’s dual mandate of low unemployment (currently 4.9%) and price stability (low inflation) is being met but is accompanied by anemic GDP growth averaging only 2% since the end of the Great Recession. Such slow economic growth is largely responsible for the populist revolt in the 2016 presidential race.

Conclusion. Monetary policy can only accomplish so much. It is critical for the Fed to wind down its $4.5 trillion balance sheet as its bond holdings mature and to keep raising short term interest rates.  This will force Congress to step up to the plate with the changes in fiscal policy which are needed to stimulate economic growth.

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Rising Prosperity around the World

 

My last post responds to a reader who is pessimistic about the future of our country and in fact of the whole world.  He thinks that the environment is deteriorating, that rapid economic growth is unsustainable and that there is too much income inequality between high and low wage earners.
My response to him is to refer to the recent book, “The Rational Optimist: how prosperity evolves” by Matt Ridley.  Mr. Ridley persuasively argues that not only has the human race made huge strides in recent times but that this progress is intrinsic to evolved human nature and is likely to continue indefinitely:

  • Since 1800 the population of the world has multiplied six times, yet average life expectancy has more than doubled and real income has risen more than nine times.
  • Between 1955 and 2005, the average human on earth earned nearly three times as much money (adjusted for inflation), ate one-third more calories of food, and could expect to live one-third longer, all this while world population doubled.
  • The rich have got richer but the poor have done even better. For example, the Chinese are ten times as rich, one-third as fecund, and 28 years longer-lived than fifty years ago. (Also see the above chart).
    Capture31
  • The spread of IQ scores has been shrinking steadily – because the low scores have been catching up with the high ones. This is known as the Flynn effect.
  • The four most basic human needs – food, clothing, fuel and shelter – have grown markedly cheaper during the past two centuries.
  • The most notorious robber barons of the late 19th century: Cornelius Vanderbilt, John D. Rockefeller, and Andrew Carnegie, got rich by making things cheaper.
  • Exchange and specialization, not self-sufficiency, is the route to prosperity.

Conclusion. As long as human beings are free to engage in exchange (trade) and specialization (acquisition of skills), prosperity will continue to evolve and human life will become better and better.

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The U.S. Middle Class Is Growing, Not Shrinking

 

One of the topics I discuss on this blog is income inequality (here, here, and here).  An interesting article in yesterday’s Wall Street Journal, “Upper Middle Class Sees Big Gains, Research Finds,” is highly pertinent to the inequality issue.
Capture1As can be seen in the above chart, the percentage of people in the middle class or above has greatly expanded between 1979 and 2014.  Furthermore, the basic research on this issue,by Stephen Rose at the Urban Institute, shows very clearly (in the chart below) what is happening: the higher is a family income, the faster it is increasing.
Capture3The best policy response to this phenomenon should be clear.  Rather than trying to decrease inequality with higher taxes on the wealthy, we should be trying to boost the less wealthy into higher income classes. The way to accomplish this is to:

  • Grow the economy faster with broad-based tax reform (lower tax rates paid for by shrinking deductions), immigration (guest worker) reform, (fair) trade expansion, and regulation reform (to help more small businesses get started). This will create more jobs and better paying jobs.
  • Improve education with early childhood education (to get minorities off to a better start in school), boosting high school graduation rates above the current 80% average (with better career and vocational education) and making college more affordable by putting more resources into community colleges and scholarships for low-income students.
  • Combat social inequality. The fraction of children with a single parent is the best predictor of upward economic mobility. The lower-income class marriage rate has dropped from 84% in 1960 to 48% in 2010. Policy should therefore focus on removing the marriage penalty in all government programs.

The basic forces of globalization and growing technology use are driving this societal change. The best way to respond is to enable more people to benefit from these basic trends.

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Can the U.S. Economy Do Better? II. It Won’t Be Easy

 

In my last post, “Can the U.S. Economy Do Better?” I laid out the view of the Hoover Institution economist John Cochrane that a few basic changes such as deep tax reform, a thorough overhaul of social programs, more educational competition and regulatory simplification would go a long way towards perking up the economy.
Capture6The banker and financial analyst, Satyajit Das, presents a contrary point of view in, “The Age of Stagnation: Why Perpetual Growth is Unattainable.”  According to Mr. Das:

  • The Global Financial Crisis (GFC) was not part of the normal boom and bust cycle, but rather the collapse of the postwar economic expansion under the weight of four main factors: high debt levels, large global imbalances, excessive financialization and an unsound build-up of future entitlements.
  • The economy risks becoming trapped in a QE-forever cycle. A weak economy leads to expansionary fiscal measures and Quantitative Easing (QE). If the economy responds then interest rates will go up and lead to a debt crisis. If the economy does not respond, then there is pressure for additional stimuli.
  • The economist Robert Gordon predicts that the future U.S. growth rate, adjusted for six big headwinds (demographics, declining educational attainment, rising inequality, effects of globalization, environmental costs, and debt overhang) may only be .2%, well below the 2.1% growth rate of the past few years.
  • The GFC may signal the zenith of globalization. The U.S. could function successfully as a closed economy, with foreign trade making up only 15% of GDP. The European Union and China could also turn inward. The rise of autarky and nationalism is a dangerous cocktail.
  • Financialization drives inequality. QE and low interest rates encourages high-income households to increase investments and therefore boosts the stock market. The increasing cost of healthcare, higher education and childcare is a big burden on low-income households.
  • Financial repression is increasingly accompanied by political repression which engenders lack of trust which in turn drives political disengagement and social disorder.

Ouch, ouch, ouch! This is a very negative assessment of the U.S. economic and social scene today.  But I report the views of Mr. Das because they are reality based and need to be dealt with.

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Reviving the Working Class Without Building Walls

 

The strangest aspect of the current presidential campaign is the staying power of the highly unconventional and controversial candidate Donald Trump. There is wide agreement that the secret of his success is his strong appeal to the members of the white working class whose incomes have been in decline for many years.
The plight of the working class is often viewed in the context of the overall increase in income inequality in the U.S.  My last two posts, here and here, are part of that discussion.
Mr. Trump appeals to these disaffected voters by vowing to wall off Mexico and cut back on foreign trade.  But it may be possible to “Revive the Working Class Without Building Walls” as Eduardo Porter suggests in the New York Times.  According to Mr. Porter, what are needed are new government programs such as wage insurance or direct government employment.
CaptureAlternatively we could meet the illegal immigration and trade protectionism problems in a much more growth oriented way as follows:

  • Immigration Reform. Set up an adequate Guest Worker program to serve only those businesses and industries which can demonstrate that they are unable to recruit enough local workers to meet their employment needs. Once the Guest Worker program is functioning properly, eVerify would be enforced to weed out unauthorized illegal workers and deport them back to their home countries. At the same time the number of H1-B visas would be expanded in order to retain more of the highly skilled foreigners getting advanced degrees in the U.S.
  • Foreign Trade. As the above chart shows, there is a close connection between world trade and world economic growth. And clearly the U.S. economy benefits from world-wide economic growth. The way to balance off job losses caused by foreign trade is with more effective trade-adjustment assistance and job retraining programs.

Whether or not Mr. Trump receives the Republican presidential nomination or is elected to be president in November, we should address the real grievances of his supporters in ways that benefit the entire economy.

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