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The End of Economic Primacy

Summary:
Periodization is an under-appreciated part of political and economic narratives.  What are the broad patterns that determine before and after?  What marks different phases or epochs?  In Capital Alone, Branko Milanovic's new book, he suggests a social-democratic form of capitalism dominated after WWII. At the start of the 21st century, a liberal meritocratic version emerged in the US.  He suggests the current period is marked by a conflict between this liberal meritocratic form and political capitalism that China illustrates. In my 2017 book, Political Economy of Tomorrow, I draw on a different periodization.  It is also based on how capitalism is organized.  While Milanovic's focus is on types and extent of inequality, my periodization is based on how capitalism is organized.

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The End of Economic Primacy
Periodization is an under-appreciated part of political and economic narratives.  What are the broad patterns that determine before and after?  What marks different phases or epochs?  In Capital Alone, Branko Milanovic's new book, he suggests a social-democratic form of capitalism dominated after WWII. At the start of the 21st century, a liberal meritocratic version emerged in the US.  He suggests the current period is marked by a conflict between this liberal meritocratic form and political capitalism that China illustrates.

In my 2017 book, Political Economy of Tomorrow, I draw on a different periodization.  It is also based on how capitalism is organized.  While Milanovic's focus is on types and extent of inequality, my periodization is based on how capitalism is organized. Hence, his social-democratic period corresponds to the Bretton Woods era.  However, Bretton Woods comes under pressure nearly as soon as it is fully implemented.  Warnings that this was unstable were articulated almost a decade before Nixon severed the last formal link between the dollar and gold. 

As Nixon imposed wage and price controls in the US amid the economic condition of stagflation, where both economic weakness and higher than desired inflation co-existed in apparent contradiction to capitalist economic thought, little did anyone suspect that a new wave of global liberalization (freeing the mobility of capital) was about to begin.  This phase can be dubbed "Reagan-Thatcher" after the two leaders who promoted this wave.  Not only was capital deregulated, but the institutional constraints, like labor unions, were intentionally weakened by government action (miners in the UK and air traffic controllers in the US) beginning what I identify as a "capital offensive."

Reagan-Thatcher, I argued in Political Economy of Tomorrow, was meant as an answer to the stagflation and malaise that characterized the period after the collapse of Bretton Woods.  The broad challenge was that with Europe and Japan rebuilt from WWII, the surplus savings that was seen earlier in the 20th century was re-emerging. 

The solution was two-fold.  First, some countries, primarily the Anglo-American economies, would act as the release valve for the surplus savings and production.  The US and the UK, and to a less extent, a handful of other small countries, would import the surplus savings and output from other countries, including emerging markets.  Second, was the solution of siphoning off the surplus savings that was no longer needed for the production of goods and services and diverting it into paper assets.  This required the creation of an expansive financial system and the monetization and securitization of non-monetary assets. It included a shift in the US, and elsewhere later, from defined benefit retirement pensions to defined contributions (the employee had to manage their own retirement savings).

This was the birth of the American equity culture.  It was born as a result of businesses shifted the burden and risks to their employees.  But that is not all.  Junk bonds themselves were a product, but so were David Bowie bonds, backed by the sales of his music and videos and local governments selling bonds backed by parking meter income, for example.   Now some exchange-traded funds and instruments focus on different parts of the US yield curve, residential and commercial property, and even foreign exchange, not to mention many foreign equity markets and nearly every US industry. 

The savings would be managed and generate better returns.  It was often recycled into portfolio and sometimes direct investment abroad.  However, the Great Financial Crisis shattered the naivete that placed American and British bankers and wealth managers on a pedestal.  They took big risks with other people's money after having lobbied for years to get rid of the post-Depression regulations.  They compromised the resiliency of the financial system, and it turns out that they were not as good financial stewards as they claimed.  Few active equity managers beat the index and often charge a management fee to boot.  The large merger and acquisition deals frequently fail to achieve the promised savings and often are unwound in whole or part with a loss of goodwill.

The End of Economic Primacy
The commodification and financial process juxtapose means and ends and virtue and vice.  Consider that for most of the 20th century, share buybacks were thought to be manipulative and were banned.  In 1982, the Securities and Exchange Commission decided to change this and passed rule 10b-18 that created the legal framework for share buybacks.  The value of share buybacks exceeds new business investment.

The capital offensive has been successful.  Its share of the GDP increased.  Combined with tax cuts,  businesses could not profitably deploy the largess, so it was increasingly returned to investors or wasted on vanity purchases.  Consider Amazon, whose CEO said before his divorce that he had so much money, he could not spend it all without going into outer space.  And this while Business Insider reported Amazon is one of the largest employers of those who receive SNAP (food stamp benefits).  This means taxpayers help support the Amazon employees and subsidize Amazon's wage bill.   It is a modern-day Midas story.

Unreconstructed Keynesians, like former Treasury Secretary Summers, argue that there is insufficient aggregate demand.  The op-ed pages in the international and financial press are replete with calls for fiscal expansion to complement the already easy monetary policy stance.  However, this is no panacea.  Consumers in high-income countries spend more on services than goods, and most services, outside of health care, are not capital intensive, which is to say they might not be sufficient to absorb the Midas-like curse of too much savings.  New technology is often capital, as well as labor-saving.  Compare the cost of computing power or data storage to even five years ago.  There is a car for every licensed driver in the US. Does the planet have the carrying capacity for India or China, for example, to have the same luxury? 

I had thought there was going to be an interregnum period between the end of the Reagan-Thatcher era and the next phase.  However, this seems less likely.  A new order is emerging, and it appears to mark the end of economic primacy.  Much has been sacrificed in the name of economic efficiency, and it has been achieved at a high cost.  The great economic historian Polanyi argued that after a wave of liberalization (the expansion of property rights), there is a counter-wave that fights back. 

One of capitalism's sharpest, even if driest critics, Marx, recognized in the essence of this:  "Accumulate, accumulate.  That is the Moses and Prophets"  Now there are several other considerations that are emerging that check the economic primacy.  They suggest there are other reasonable social objectives besides economic efficiency, and these have been ridden roughshod over in the pursuit of a material Nirvana. 

National security transcends economic efficiency.  Maybe, in the US, the modern roots can be traced back to 9/11, but under Trump, the envelope is being pushed.  Tariffs were levied on steel and aluminum imports from Canada, Mexico, Europe, and Japan, among others, on national security grounds.  The US Commerce Department report six months ago asserted that auto imports were a threat to national security.

It does not make sense that the US imports 95% of its antibiotics from China, as China RX (by Janardan Prasad Singh and Rosemary Gibson, 2018) notes, even if it can be made cheaper there.  The same is true for rare earths, which have wide applications. Similarly, from China's point of view, they should not remain dependent on the American duopoly of mobile operating systems (OiS and Android).  Nor should China rely on foreign design and fabrication of semiconductor chips.  National security, economic nationalism, and import substitution strategies overlap and blur.  Context is essential to understand. It is also a challenge to those countries that suppress domestic demand and rely on exports for growth, like Northern Europe.

Rising concerns about environmental degradation may also check the economic efficiency impulse.  There are shale deposits in New York, but concerns about the impact on the environment led to a ban on such drilling.  The environment was one of the sacrifices made in the name of economic efficiency.  Waste was conceived largely as an externality, and hence, the cost was socialized as the profits were privatized.    Often local government takes the lead in recycling efforts and discouraging single-use plastic and other green behavior.  Concerns about sustainability have become more salient for more people.  

The extent of the disparity of income and wealth within countries has also become more salient.  While I would not want to argue in the extreme, but there does seem to be a nearly universal sense of fairness (not just WEIRD--as in from Western, educated, industrialized, rich democracies).  Many countries that pursued economic efficiency the most aggressively seem to have the greatest inequality.  It has reached dimensions that even the center-right recognizes as problematic.   Perhaps greater disparity might be more acceptable if there was greater mobility.  However, class mobility has become more rigid in many countries.  

This is not some warmed-over anti-market jeremiad.  It is about emerging trends, and businesses seem to recognize it too.  A few months ago, the Business Roundtable, one of the largest US business groups (representing in the neighborhood of $7 trillion in annual revenue), demoted the shareholder, which was previously their raison d'etre, to one among several other stakeholders.  The other stakeholders include customers, employees, suppliers, and communities.  Businesses, they said, should "protect the environment and treat employees with"dignity and respect," while also still delivering profits to the shareholders.  Cynics claim it is hollow rhetoric. Still, the fact that they felt it necessary to talk in those terms is a sign that change is afoot, even if they seek to head off more extreme action and minimize their tax obligations and regulatory environment.  At the very least, affirmation through negation. 

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Disclaimer

Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.

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