Stocks continued to rise on Friday after an almost perfect employment report showed healthy growth in jobs, plus a steady rise in wages that will raise real income without threatening overall inflation. On the trade front, negotiations with China continue without an imminent conclusion.
Over the weekend, Bridgewater Associates Chairman Ray Dalio was all over the news programs and on Sixty Minutes talking about the dangers of income inequality, specifically pointing to the lack of quality education, particularly in inner city schools. While we have heard that before, the conversation took on added meaning after he pledged to donate $100 million to the State of Connecticut to help improve its education product.
The Dalio argument melts into the evolving debate both within the Democratic Party as it begins the process to find its nominee for President in 2020, and the larger debate that will evolve during the Presidential race. Progressives within the Democratic Party are trying to use shock treatment with manifestos like the New Green Deal wrapped in labels like Socialism.
Democracy, socialism and capitalism are three words we are going to hear a lot about over the next two years. Modern democracy, as we know it today, was literally a creation of our own founding fathers who created a government of the people, by the people, and for the people. It was built from the ground up. There was no founding monarch and no legacy base. The creation of an executive, legislative and judicial branch of government balanced by an attempt to equal weight the powers of each was a new invention. While it has been tested many times, after over 240 years, it seems to be working rather well.
The U.S. Constitution rather precisely laid out the role of the Federal government. That role was limited to tasks that were beyond the scope of states (e.g. national defense) or not conducive to private enterprise (e.g. the court system). In today’s world, activities are separated into three silos. The biggest is the private sector and in a democracy built of a capitalist base, the profit motive is the biggest motivator, the driver of almost all activity. Whether it be making widgets, selling them, or inventing a better widget, the profit motive is the driver. There are many keys to success in such a world, including access to capital and intellectual capabilities, plus the entrepreneurial energy of corporate leadership. Since there is clearly a boundary line between fair and unfair competition, government has a role to ensure that the foxes don’t have freedom to do whatever they please in the chicken coop. Conservatives typically want less regulation and liberals want more.
Socialism removes much of the profit incentive and redistributes assets from the successful and rich to those less successful and less wealthy. Without the profit incentive, however, innovation lags as does growth. Name one major innovation of the last 100 years developed either within a socialist system or under a dictatorship. For socialism to succeed in the effort to grow and develop new and better resources, some incentive is needed to replace the profit motive.
Let me get more specific. Growth, as I often note, is a function of population growth and productivity. While, in economic terms, productivity is measured as the output per manhour, it becomes harder to define in a world less based on manufacturing and more based on services. Obviously, replacing 50 workers with robots to achieve the same level of production is productive and is easy to measure. But what about the benefits of a new highway that both shortens commuting time and, as a second derivative, allows new communities to be built nearby. The opening of a connector bridge between I-95 and the Pennsylvania Turnpike shortens the trip between Philadelphia and New York by 20 minutes or more than 15%. That’s productive.
On the other hand, look at the proposal of Cory Booker to have the government buy a bond annually for everyone born to a family below a certain income level and finance that with higher taxes on the wealthy. That is simply a transfer payment. It is no different than many of the entitlement programs in place. I am not making any judgment whether that is a good or bad proposal. What I am saying is that, by itself, it isn’t productive.
Which gets me back to Ray Dalio and the need for better education. History has shown time and time again that once income disparity gets too great, it can lead to ultimate chaos. It could be seen in the decline and fall of the Roman Empire, the French revolution, the rise of Communism, or Venezuela. More than 25 years ago, I was in South Africa right before Nelson Mandela was to become President. While one could revel in the fall of apartheid, one also could see reason to be very pessimistic about South Africa’s ultimate future. An entire generation of black youth was uneducated and living in slums like Soweto. 25 years hence, the leaders of the nation would emerge from this uneducated base. Today’s problems in South Africa are totally a result of the lack of any education a quarter of a century ago.
In our nation, Presidents serve 4 or 8 year terms. Fixing education isn’t a 4 or 8 year solution. In our world today, the rich have an alternative to inadequate public education. They send their kids to private schools. The middle class also have alternatives. They move to better school districts. What is left is the poor underbelly. States often lack the political will to support this class and it gets left further behind.
All I am doing here is identifying the problem. Ray Dalio is going a step further. He is trying to find a solution. Better books, more computers, and better training for tomorrow’s job skill set are steps in the right direction. Cities are trying to do some of that with charter schools. The point is that if the underbelly gets hopelessly behind, the risk of unintended consequences rises.
Foundations fill a gap here as well. Foundations fill the gaps that private enterprise and government leave behind. For instance, there is little profit incentive to treat malaria and, since most of those who die from the disease do so in the poorest nations, governments don’t spend the money to find the cures. Many foundations today, see the gaps in education and are trying to step in.
Unlike transfer payments, which are not productive in an economic sense, clearly having a broader base of educated workers is productive. In a world where better artificial intelligence will progressively replace the simplest remaining tasks done by humans (e.g. kiosks replacing order takers in fast food restaurants), humans will have to raise their skill levels to become incrementally productive.
This whole subject is going to be the core of the national debate over the next 18 months. Some of those that have are more willing to share than others but, after 240+ years of capitalism and democracy, I doubt only a vocal minority of Americans want a pure socialist world where government manages banks, healthcare, and all higher education. Conversely, there are some, but less than a majority, who simply want little or no tax, less government interference, and a sharp reduction in entitlements. Most are somewhere in between. Finding that center point is what the election of 2020 is going to be about. It is a healthy debate. Hopefully, it won’t be entirely overshadowed by derisive name calling and the elevated nastiness that many fear. Markets won’t be immune to the discussion. Markets are clearly on the side that says, where government is concerned, less is more. Since markets vote for policy over personality, they are generally happy with President Trump so far. But note that they were happy with President Obama as well.
Bottom line, it will be a fascinating 18 months to come. My only ending political comment is that if either side gets too far from the middle, they invite disaster. So far, the biggest noise makers within the Democratic Party have been on the far left. But just because they make the most early noise, don’t think they will still have everyone’s favor a year from now. I suspect between now and next summer at least a half dozen Democrats will rise to the top and like Humpty Dumpty will have a big fall. History is strongly in my favor on that call.
Today, Robin Wright is 53. John Schneider, one of the “Dukes of Hazzard” is 59.
James M. Meyer, CFA 610-260-2220