Hypocrisy and confusion distort the debate on social mobility

It is the economy, not education, that really determines life chances

Martin Wolf


In the cohorts of the generations born between 1940 and the early 1980s, upward and downward mobility rates converged © Alamy


Perhaps no topic is more buried in hypocrisy and confusion than social mobility. We pretend to be in favour of it. But few middle-class parents are in favour of downward mobility for their own children. We also believe that changing individual characteristics, principally via education, will increase social mobility. But this is largely untrue. We need to be far more honest.

The broad picture of inherited class advantage is clear enough. The latest report of the UK’s Social Mobility Commission states: “Those from better-off backgrounds are almost 80 per cent more likely to be in a professional job than their working-class peers.” More­over, it adds: “Due to this gap in access to professional jobs, people from working-class backgrounds earn 24 per cent less a year than those from professional backgrounds.” So far, so familiar.

The report touches briefly on the central point: “Downward mobility is a key component of a socially mobile society.” It is right. If the class structure of the economy is unchanged, the chance that someone from a working-class background will experience upward mobility can only increase if there is a matching increase in the “relative chances that someone from a professional background will move downwards”.

This is where the hypocrisy comes in. The chief obstacle to social mobility is the family. People do not put huge amounts of time and resources into their children in order to watch them fail. Those with the material, social and intellectual resources to prevent such failure will use them. Also, they do not have to try so hard: these resources advantage their children from birth.

Given that, what determines the rate of social mobility? To have a clearer picture of this, one needs to move from the pieties of the Social Mobility Report to a brilliant lecture, “Social class mobility in modern Britain”, delivered in 2016 by John Goldthorpe, doyen of scholars of this topic. What Mr Goldthorpe calls the “underlying mobility regime” remains strikingly unchanged. But the context has become more adverse. Furthermore, he adds, “the effect of educational expansion and reform on mobility processes and outcomes has in fact been very limited”.

Mr Goldthorpe’s work focuses on class, not income, because the former decides the latter, over a lifetime. Crucially, he distinguishes relative from absolute mobility. The first refers to what would happen if the class structure stayed unchanged. The second refers to actual changes in class positions.

The proportion of male salaried managerial and professional workers in the UK economy jumped from 11 per cent in 1951 to 25 per cent in 1971, 35 per cent in 1991 and 40 per cent in 2011. More room opened up at the top, albeit at a slowing rate. This change in the job structure automatically generated a rising rate of upward mobility and declining rate of downward mobility in cohorts born before 1947. The economy delivered more of the upward mobility everybody wants, with less of the downward mobility upper-class parents fear.

Education had little to do with this. People were promoted, even though they had few paper qualifications, just as many of today’s graduates work in jobs that used not to require degrees. Society was not then more open; the economy was just more helpful.

Now move forward to the generations born between 1940 and the early 1980s. In these cohorts, upward and downward mobility rates converged. This is partly because expansion of new opportunities at the top has slowed. It is also because a larger proportion of people has inevitably been born into the professional classes and a smaller proportion into the working classes. Given the finding of constant relative mobility over time, the outcome has been a rise in absolute downward mobility and a fall in absolute upward mobility. This makes society unhappy.

The chief determinant of social mobility, then, is the class structure of the economy and its rate of change. If, as some predict, artificial intelligence demolishes many professional jobs, downward mobility will overwhelm upward mobility. The political consequences would be devastating.

Education has only second-order effects on mobility. It influences, but does not determine, the structure of the economy: that is why graduate unemployment is quite common across the world. It is, in fact, more of a positional good: relative education matters. While some from working-class backgrounds will get more of this good, professional parents will always help their offspring to outcompete them.

In sum, if we really care about social mobility, it is on the economy that we should focus most of our attention.

Facebook’s future

Mark Zuckerberg wants to build WeChat for the West

It will revolve around turning the social network’s messaging services into something akin to a Chinese mega-app



IN HIS SPARE time Mark Zuckerberg likes to run. In 2016 Facebook’s boss pledged to cover 365 miles (587km) that year and, ever the overachiever, completed the challenge by July. He does not practise martial arts, but his almost discomfiting poise could lead you to mistake him for a master of something like aikido. That would be appropriate, for in his professional life Mr Zuckerberg is trying to turn his opponents’ energy against them.

When in early March he announced that Facebook would follow a “privacy-focused vision for social networking”, complete with encrypted messages that even the firm cannot peer into, observers interpreted this as a defensive move. Some discerned a belated response to outrage over privacy abuses on the world’s largest social network. Others saw the plan to knit together its instant-messaging services, chiefly Messenger and WhatsApp, as a way to make the company harder to break up, as some American politicians demand. Others still spied a ruse to escape liability for violent user content, now that Facebook would no longer be able to read any of it.

All three rationales probably played a part. Yet the firm’s “privacy pivot” is perhaps better seen as an aikido-like redirection of detractors’ momentum. Mr Zuckerberg’s speech at his firm’s annual developer conference in San Jose on April 30th suggested as much. Far from retreating, he is limbering up for a new contest—to reinvent social networking, this time around messaging. “The future is private,” he declared grandiosely. Though he might not admit it in public, he seems keen to turn Facebook into a Western version of WeChat, the Chinese messaging app whose array of mobile services, from payments to filing court paperwork, has made it ubiquitous in China—even if his recent pledge to store user information only in countries that respect the rule of law is an implicit admission that he has given up on the Chinese market, where Communist minders insist that Western firms must keep all data locally.

Older. And wiser?

Facebook’s core business is maturing, as its boss clearly sees. Its operating margins—42%, excluding $3bn set aside to cover an expected fine by America’s Federal Trade Commission for privacy violations—remain the envy of the tech world (see article). In the latest quarter revenue grew by 26% compared with the previous year, exceeding $15bn. But user growth is slowing. In some rich countries, especially European ones, it is flat. The young prefer social media which are more “intimate” and “ephemeral”, like Snapchat, which pioneered “stories”, messages and pictures that disappear after 24 hours—and which Facebook aped. More than 500m users of Instagram, Messenger and WhatsApp now post stories every day.

Mr Zuckerberg expects migration from the online “town square” to a digital “living room” to continue; stories may soon outnumber posts on Facebook’s newsfeed. The plan is to build it around WhatsApp, which already offers secure texting. It would let users find each other, pay digital and offline shopkeepers, or purchase a cornucopia of online services—perhaps one day using Facebook’s own currency. In time, the thinking goes, it may become as indispensable to Westerners as WeChat is in China.

Some elements of the new platform already exist; WhatsApp is testing a payment service in India. Others, such as new shopping features on Instagram, were launched in San Jose. All this falls short of a full-blown business plan. But the contours of Mr Zuckerberg’s vision are taking shape. The 34-year-old is proceeding more cautiously than in Facebook’s early years, when he was guided by the now infamous injunction to “move fast and break things”—but no less deliberately.

That is just as well, for “platform shifts” are tricky. Microsoft did not see smartphones coming and Facebook itself almost missed the rise of mobile apps. To succeed, it must clear a number of hurdles. The first is technical. Facebook wants an Instagram user to be able to send a note directly to a friend on WhatsApp. Creating a common phone book for these services, with a combined total of 2.7bn users and different source codes, presents a knotty problem for programmers. Chris Cox, one of Mr Zuckerberg’s top lieutenants, is rumoured to have left the company in March because he did not think it could be done (this week Mr Cox attributed his departure to “artistic differences” with his boss).

The second challenge is economic. WeChat could become the platform of choice on smartphones because China had no dominant app stores. Facebook must contend with incumbents such as Apple and Google. Since you can’t sell microtargeted adverts against encrypted messages your algorithms cannot see, the new platform will need a fresh way to make money. For all its ubiquity, WeChat is no cash cow (Tencent, its owner, makes most of its revenue from online games). Maintaining Facebook’s fat margins would require new revenue sources, such as charging businesses to contact users or taking a cut of any purchases, as credit-card issuers do.

Lastly, there are the entwined issues of privacy and competition. Mr Zuckerberg accepts that a lot of people dismiss Facebook’s sincerity here—his recent article in the Washington Post, imploring governments to regulate social media, notwithstanding. It will continue to collect plenty of data. Integrating these, and the underlying apps, could in turn enable Facebook to convert its dominance in public social networking into power over private messaging. This reminds seasoned competition regulators of Microsoft’s attempts to bundle its operating system with a web browser in the mid-1990s in a bid to control cyberspace. With the internet’s rise, the stakes today are bigger: no country wants one firm to become society’s de facto operating system.

Since its services cost nothing, Facebook says, it is not gouging users. It could argue that a single dominant social network is easier to police than lots of smaller ones and has greater financial and technical capacity to keep users safe from harmful content. And it would be a bulwark against WeChat, which might otherwise become a force outside China—bringing the Chinese surveillance state with it.

Indeed, Mr Zuckerberg’s Washington Post article looks like a bid to broker a 21st-century version of the Kingsbury Commitment of 1913, when AT&T, then America’s telephone monopoly, accepted government oversight and agreed to spin off some of its businesses in exchange for not being nationalised or broken up. The difference is that, unlike AT&T, Facebook’s reach extends beyond America and spans a growing range of industries, from advertising to finance. It must grapple with politicians, regulators and rivals. If enough opponents gang up at once, even the most gifted aikido master may struggle to fend them off.

Buttonwood

The quest to find companies that have a lasting competitive Edge

Finding companies protected by what Warren Buffett calls a “moat” is easy to talk about, but hard to do




IN 1965 WARREN BUFFETT acquired Berkshire Hathaway, a textile company based in New England, for his investment partnership. When he began buying the stock, in 1962, Berkshire had working capital worth $16 a share; the shares sold for $8. So Mr Buffett was getting the rest of the firm’s assets for less than nothing. This was the sort of “value investing” that had made Mr Buffett and his partners a tidy pile over the preceding decade.

Berkshire would become a wildly successful investment vehicle. On May 4th, 40,000 of its shareholders gather for its annual general meeting in Omaha, Nebraska, for a dose of Mr Buffett’s folksy wisdom. It continues to make a wide range of financial investments: witness this week’s offer to buy $10bn of debt-like securities and warrants in Occidental, an oil firm that is negotiating a merger.

Yet he came to regret buying Berkshire stock. The return on investment was paltry, because the firm had no unique edge or products. Textiles are commodities. No one ever asked his tailor for a Hathaway suit lining.

In its way, Berkshire provided a valuable lesson. Mr Buffett’s strategy shifted. Instead of “buying fair companies at wonderful prices”, he would buy “wonderful companies at fair prices”. To make the grade, a firm must have a lucrative position in the marketplace. But it needs more. To be a truly great investment, the company should also have a “moat”.

This is Mr Buffett’s shorthand for a company with a lasting competitive edge—the philosopher’s stone of business strategists and stockpickers. Its profits are secure because other companies cannot easily replicate what it does. A niche of this kind acts like a moat around a castle, keeping rival firms out. It is super-wonderful if the castle is run by a knight who spends his riches on widening the moat, rather than blowing it all on banquets or natty coats of arms. But the moat is the main thing.

Looking back, Mr Buffett has invested in firms with two sorts of moat. The first type operates in a market that has room for just one profitable firm. In the 1970s Mr Buffett’s monopoly of choice was citywide newspapers, which had a lock on advertising. BNSF, America’s largest freight railway, which Berkshire has owned outright since 2009, is a more recent example. The moat’s contours are not as clear for the second type. The firm has competitors. But it has a bond with its customers based on a reputation for products of a consistently high quality. So strong is the firm’s brand that consumers are slow to switch allegiance, even when prices are raised.

Mr Buffett’s first big bet on a consumer franchise of this kind was American Express, on which Berkshire staked a quarter of its capital in 1964. Amex had an enviable position in charge cards. Over the years, other franchise stocks were snapped up: See’s Candies, a maker of fancy chocolates; Gillette (now part of P&G); Wells Fargo; and latterly Apple. The apex of this strategy was the frenzied acquisition of shares in Coca Cola in the late 1980s. Mr Buffett saw that its profits were about to accelerate as it conquered new markets.

With hindsight, Coke, Gillette and the rest look like sure-fire winners. That Berkshire made losing bets on firms with apparently unbreachable moats shows the difficulty of foresight. An example was Tesco, a British grocery chain. It was the leading firm in an oligopoly—a classic Buffett play. But after it issued several profit warnings, Berkshire sold at a hefty loss in 2014. Other moats are springing leaks. The marriage of Heinz and Kraft, two food-manufacturing giants, brokered by Berkshire and 3G, a private-equity firm, is in trouble. New brands built on social media and online sales are challenging the established order.

“Moats are lame,” teased Elon Musk, a tech entrepreneur, last year. What gives firms a competitive edge, he said, is the pace of innovation. In fact, investors’ enthusiasm for tech firms such as Amazon, Facebook and Google has been because they appear to have deep moats. (Mr Buffett has admitted he has no insights on tech.) In any event, it is wrong to think that innovation is a guarantee of profits. Firms that come up with ideas often see rivals reap the benefit.

It is hard enough to find a firm with a moat; it is much harder not to overpay for its stock.

Many of the signature purchases of Mr Buffett’s career, such as Amex and Wells Fargo, were at knock-down prices. The strategy (buy stocks with moats) sounds simple; but it is not easy.

Carrying it out takes skill, nerve and discipline. If it were easy, everybody could do it.

Leave the Renminbi Out of US-China Trade Talks

A potential agreement could contain many “win-win” elements, notably concerning intellectual property rights and export subsidies. But pushing China to commit to a more stable exchange rate risks creating major problems when the next big Asian recession hits.

Kenneth Rogoff

rogoff180_ FREDERIC J. BROWNAFPGetty Images)


CAMBRIDGE – Will a possibly imminent US-China trade agreement exacerbate global business cycles or even plant the seeds of the next Asian financial crisis? If the eventual agreement – assuming there is one – forces China to hew indefinitely to its outmoded, overly rigid exchange-rate regime, then the answer may be yes.

Keeping the renminbi’s exchange rate stable against the US dollar would require the Chinese authorities either to match changes in US interest rates, or go through capital-control contortions to try to offset exchange-rate pressures in other ways. But China is simply too big and too global to adhere to an exchange-rate policy that is better suited to a small, open economy.

Moreover, neither approach to keeping the renminbi stable – maintaining interest-rate parity or applying capital controls – makes sense for an economy with business cycles that seldom coincide precisely with those of the United States. With its declining trend economic performance, overbuilt housing sector, and overleveraged regional governments, China will inevitably confront politically sensitive growth problems. When it does, the People’s Bank of China will need to be able to loosen monetary conditions without having to worry about supporting the exchange rate.

When a country comes under serious financial and macroeconomic pressures, maintaining an inflexible exchange rate is a well-known recipe for disaster. The International Monetary Fund, along with most academic economists, has been making this point for a very long time.

Such an exchange-rate deal between America and China would be out of tune with other elements of a potential bilateral trade agreement, many of which are “win-win.” For example, China has pledged to enforce intellectual-property rights much more vigorously, although just how strongly remains to be seen. Greater Chinese rigor in this area may benefit American and European firms in the near term, but over the long run it will help to fuel competition and innovation in China’s own manufacturing and tech sectors.

After all, back in the 1800s, the US, like China today, had little interest in protecting the intellectual-property rights of foreign (then mostly British) firms, and Americans widely copied their ideas and blueprints. However, as American innovators became more successful, they, too, needed their rights protected, and in due course the US brought its patent and intellectual-property laws up to world-leading standards.

Another win-win could result from America’s insistence that the Chinese government refrain from lavishing subsidies on exporters. Most of these subsidies go to China’s inefficient state-owned firms, sucking credit and other resources away from the more dynamic private sector.

More generally, a trade deal may well give fresh impetus to economic reforms in China, which seem to have stalled or gone into reverse in the past few years. On a recent trip to Beijing to attend the China Development Forum, I asked a very senior Chinese official about this slowdown. I had expected him to reel off a long list of inconsequential reforms, in keeping with the usual line that China is doing things very gradually all the time. So I was surprised when he candidly admitted that “we only do major economic reforms when there is a crisis, and there has not been a big enough crisis of late.”

In this sense, US President Donald Trump seems to be just what the doctor ordered, because he has forced the Chinese authorities to recognize that they can no longer rely on American consumer demand to keep China’s growth locomotive moving. Indeed, some observers joke that Trump is the savior of the Chinese economy, because panic at a possible trade war is helping to catalyze long-stalled structural reforms.

But American pressure on China to commit to a more stable renminbi-dollar exchange rate, and avoid competitively devaluing its currency, could undermine further economic reform. In particular, such a regime would prevent China from gradually adopting the greater exchange-rate flexibility required for a more independent monetary policy.

Trump’s team seems to be under the misguided impression that China has been intervening to keep its currency weak, in order to promote exports. The view that China manipulates its currency, long overblown by some commentators, downplays the fact that the root of China’s hyper-competitiveness has long been its relatively low wages.

More fundamentally, the accusation that China is manipulating the exchange rate is completely out of touch with recent history. In recent years, the pressures on the renminbi have been largely downward, and the government has responded with much tighter restrictions on capital outflows that go both over and under the table. Far from putting a ceiling on the renminbi’s exchange rate, the Chinese authorities have been putting a floor beneath it, partly out of fear that overly rapid depreciation would lead to a massive exodus of capital.

An inflexible exchange rate might not be the only potential weakness in an eventual US-China trade deal. American negotiators also have not seemed to appreciate the accounting rule that a country’s current account (a broad measure of its trade balance) is always equal to national savings minus national investment. If American consumption growth is strong and the US government runs a massive fiscal deficit, the country has to borrow from somewhere. And if China is forced to reduce its bilateral trade surplus with America, it will simply offshore the final stages of goods production, so that US imports will be recorded as coming from another Asian country, such as Vietnam.

True, pushing China to conform to conventional global trade practices is important for the entire world. Recent speeches by Chinese President Xi Jinping are encouraging in this regard (though one wishes that the trade talks would address environmental protection). But if a final deal prevents China from gaining greater monetary-policy autonomy, it could create major problems when the next big Asian recession hits. In that case, American negotiators will have demonstrated their bargaining power, but not their wisdom.


Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist of the International Monetary Fund from 2001 to 2003. The co-author of This Time is Different: Eight Centuries of Financial Folly, his new book, The Curse of Cash, was released in August 2016.

Slowing Economy, Plunging Stocks Are Forcing The Fed’s Hand

A few short weeks ago, the economy seemed to be growing, the trade war looked winnable and the Mueller Report appeared to take presidential impeachment off the table. And then…

The economy hit a rough patch. Auto sales are down and home sales are way down. This morning:

Pending home sales fall, marking the 16th-straight month of annual declines
(MarketWatch) – Pending home sales fell a seasonally adjusted 1.5% in April and were 2% lower than a year ago, the National Association of Realtors said Thursday. The consensus Econoday forecast was for a 0.5% increase. 
NAR’s index, which tracks home-contract signings, has been volatile, but the trend is solidly downward. April marked the 16th-straight month of annual declines.
Contract signings precede closings by about 45-60 days, so the pending home-sales index is a leading indicator for upcoming existing-home sales reports. 
Only the Midwest saw an increase in April, with a 1.3% uptick. Pending sales were down 1.8% in the Northeast, 2.5% in the South, and 1.8% in the West. 
On Tuesday, the widely-followed Case-Shiller index showed home prices had risen at the slowest pace since mid-2012 in March.

Interest rates cratered, inverting the yield curve. Check out the US 10-year Treasury yield in May:

Treasury yield stocks forcing Fed's hand


From 2.5% to 2.15% in a single month implies massive changes within the credit markets that signal an economic slowdown and/or a flight to safety because of external risks.

The trade war went parabolic. China refused to budge and Trump upped the ante with more tariffs, to which China responded by threatening to end rare earth exports, a terrifying prospect for US tech companies that rely on those elements. Then last night Trump shocked pretty much everyone by slapping tariffs on Mexico in retaliation for the recent surge of illegal immigration. Meanwhile, global trade flows are collapsing.

Mueller put impeachment back on the table. On Wednesday, Special Prosecutor Robert Mueller appeared to invite Congress to go after the President over Russiagate. The Democrats gleefully complied, virtually guaranteeing political chaos right through the 2020 election.
 
Growth projections evaporated. Economists have been revising year-ahead GDP estimates downward for the past few weeks and are no doubt cutting them again as this is written. The already-anemic numbers on the following chart from the Atlanta Fed are due to be updated on June 3. Look for a sharp drop.

GDP stocks forcing Fed's hand



How do modern central bankers respond when faced with this kind of perfect negative storm?

They look to the stock market for guidance, of course. If share prices are rising they assume that funky growth numbers and political turmoil are minor inconveniences. If stocks are falling they interpret the above as an existential threat and immediately start cutting interest rates and raising asset purchases.

So we really just have to watch the stock market. Which, as this is written, is tanking yet again.

The past month has been relentlessly bad – not quite as brutal as the yearend 2018 flash crash that stopped the Feds tightening, but still pretty ominous.


DJIA stocks forcing Fed's hand


One more month – or even a couple more weeks – like this, and the US, along with the rest of the world, will be back in full-on easy money mode.

This Cycle’s Most Dangerous Bubble, In Three Charts


One of the lessons of the past few decades’ boom/bust cycles is that each financial bubble emerges in a different asset class. In the 1970s it was precious metals, in the 1980s junk bonds, in the 1990s tech stocks and in the 2000s mortgage-backed bonds.

Today the only one of these with a reasonable chance of blowing up the economy is Big Tech, which is wildly overvalued by any historical measure.

But a better candidate for the title of most dangerous bubble is emerging: Corporate debt, specifically the “almost junk” portion of that market.

Let’s start with the ongoing surge in overall corporate borrowing, which as a percentage of GDP is now back to the high achieved during the Great Recession, and higher than before the previous two recessions:


Debt to GDP dangerous bubble


But not all corporations are misbehaving. The clear and present danger is coming from BBB rated debt, which means low-rated borrowers that aren’t quite as dicey as actual junk borrowers. This category was less than $1 trillion in the 2000s housing bubble and has since about tripled.


BBB rated debt dangerous bubble


Meanwhile, the terms of these loans are increasingly of the “covenant-lite” variety that don’t require companies to keep their finances within reasonable boundaries. This kind of bond is now 80% of the speculative-grade, or leveraged, loan market, up from just 6% in 2006.


Covenant lite loans dangerous bubble


Here’s how this probably plays out. As low-quality borrowers’ interest costs soak up an ever-larger share of their earnings, they’ll start dropping into junk status. This will lead investors to demand higher yields for the remaining BBB bond issuers. Higher borrowing costs will then push more iffy companies into junk, and so on, until lenders stampede for the exits, shutting off access to capital for all but the top corporate borrowers.

Credit-starved companies will start dying, spooking the stock market, and that will be that for this expansion.

The new problem this time around is that potentially bad debts are everywhere, from emerging market dollar-denominated bonds to Italian sovereign debt, Chinese shadow banks, US subprime auto loans, and US student loans. All are teetering on the edge, just waiting to be nudged into the abyss by some external crisis.

So trouble in one sector can metastasize in ways that the global financial system hasn’t seen since the 1930s, forcing central banks to do some truly extraordinary things. Which is the real story here: Not the coming crisis but the monetary authorities’ reaction to the crisis.