Q3 2017 Flow of Funds

Doug Nolan
 
 
In nominal dollars, Total U.S. System (Non-Financial, Financial and Foreign) borrowings expanded $1.007 TN during the third quarter to a record $68.012 TN. Total Non-Financial Debt (NFD) rose a nominal $732 billion during the quarter to a record $48.635 TN. It’s worth noting that NFD has expanded 46% since ending 2007 at $33.26 TN.

Total Non-Financial Debt expanded at a seasonally-adjusted and annualized rate (SAAR) of $2.954 TN during Q3, the strongest Credit growth since Q4 2015. As has often been the case over the past nine years, Washington led the Credit expansion. Federal borrowings jumped to SAAR $1.656 TN, the strongest in seven quarters. Total Business borrowings expanded SAAR $751 billion, up from Q2’s $692 billion. Total Household debt growth slipped slightly q/q to $550 billion.

On a percentage basis, Non-Financial Debt expanded at a 6.2% rate during Q3, accelerating from Q2’s 3.8%, Q1’s 1.7% and Q4 2016’s 3.1%. Federal borrowings grew at a 10.3% pace, Total Business at 5.4% and Total Household debt expanded at a rate of 3.7%.

To the naked eye, percentage debt growth figures for the most part don’t appear alarming. But there’s several unusual factors to keep in mind. First, the outstanding stock of debt has grown so enormous that huge Credit expansions (such as Q3’s) don’t register as large percentage gains. Second, overall system debt growth continues to be restrained by historically low interest-rates and market yields. Debt simply is not being compounded as it would in a normal rate environment. And third, it’s a global Bubble and a large proportion of global Credit growth is occurring in China, Asia and the emerging markets. U.S. securities markets continue to be a big target of international flows.

With global Bubble Dynamics a dominant characteristic of this cycle, it’s appropriate to place Rest of World (ROW) data near the top of Flow of Funds analysis. ROW holdings of U.S. Financial Assets jumped $724 billion (nominal) during the quarter to a record $26.347 TN. This puts growth over the most recent three quarters at a staggering $2.124 TN (16% annualized). What part of these flows has been associated with ongoing rapid expansion of global central bank Credit? It’s worth recalling that ROW holdings ended 2007 at $14.705 TN and 1999 at $5.639 TN. As a percentage of GDP, ROW holdings of U.S. Financial Assets ended 1999 at 57%, 2007 at 100%, and Q3 2017 at a record 135%.

ROW holdings increased a seasonally-adjusted and annualized (SAAR) $1.657 TN during the quarter. ROW holdings of U.S. Debt Securities increased SAAR $956 billion during Q3, led by a SAAR $749 billion jump in Treasuries. Corporate Bond holdings rose SAAR $204 billion. Holdings of Equities and Mutual Fund Shares increased SAAR $114.9 billion during the quarter. Direct Foreign Investment rose SAAR $305 billion. Big numbers.

Meanwhile, the Fed’s Domestic Financial Sectors category expanded assets SAAR $2.841 TN during Q3 to a record $95.213 TN. In nominal dollars, the Financial Sector boosted assets a notable $5.085 TN over the past three quarters, almost 8% annualized growth. Notably, the sector’s holdings of Debt Securities surged a nominal $775 billion in three quarters to a record $25.425 TN. Pension Funds were a huge buyer of Treasuries during the quarter (SAAR $1.075 TN). Over the past three quarters, the Financial Sector boosted holdings of Corporate & Foreign Bonds by nominal $427 billion to $8.026 TN. More very big numbers.

Banks (“Private Depository Institutions”) expanded loan portfolios by SAAR $509 billion during Q3, the strongest expansion in a year. I still see analysis referring to tepid bank lending. And while loan growth has appeared less than boom-like, at least part of this is explained by booming capital markets. Corporate bond issuance has remained near record pace, and there has been as well even a surge in Open Market Paper (“commercial paper”) borrowings.

One doesn’t have to look much beyond the booming Rest of World and Domestic Financial Sector to explain ongoing over-liquefied securities markets. The numbers confirm a historic financial Bubble.

Total Equities Securities jumped $1.229 TN during the quarter to a record $43.969 TN, with a one-year gain of $5.923 TN (16.4%). Equities jumped to a record 224% of GDP, compared to 181% at the end of Q3 2007 and 202% to end 1999. Debt Securities gained $171 billion during Q3 to a record $42.385 TN, with a one-year gain of $1.080 TN. At 217% of GDP, Debt Securities remain just below the record 223% recorded in 2013.

This puts Total (Debt & Equities) Securities up $1.400 TN during the quarter to a record $86.080 TN. Total Securities inflated $7.003 TN, or 9.1%, over the past year. Total Securities experienced cycle tops of $55.261 TN during Q3 2007 and $36.017 TN to end March 2000. Total Securities ended Q3 2017 at a record 441% of GDP. This outshines the previous cycle peaks of 379% for Q3 2007 and 359% at Q1 2000. One more way to look at post-crisis securities market inflation: Total Securities ended Q3 $30.819 TN, or 56%, higher than the previous cycle peak in Q3 2007.

There’s no doubt that financial sector leveraging and foreign flows (especially through the purchase of U.S. securities) continue to play an integral role in the U.S. Bubble. Inflating asset prices and resulting bubbling U.S. Household Net Worth are instrumental in fueling the overall U.S. Bubble Economy.

Household Sector Assets inflated $1.920 TN during Q3 to a record $112.360 TN. And with Household Liabilities little changed at $15.241 TN, Household Net Worth expanded $1.922 TN during the quarter to a record $97.119 TN. Household Net Worth ended September at a record 498% of GDP. This is up from the 378% Q1 2009 trough level. It also surpasses the cycle peaks of 478% back in Q1 2007 and 435% in Q4 1999.

For the quarter by Household Asset category, Financial Asset holdings increased $1.449 TN to a record $78.854 TN. Real Estate holdings gained $411 billion to a record $27.428 TN. Household Net Worth increased $7.389 TN over the past year and $11.870 TN over two years. Household Net Worth has now increased 78% from Q1 2009 lows.

As we think ahead to 2018, the question becomes how vulnerable U.S. securities markets are to waning QE and reduced central bank Credit expansion. Inflating a Bubble creates vulnerability to any slowdown in underlying Credit and attendant financial flows. And it’s the final parabolic speculative blow-off that seals a Bubble's fate. It ensures market dependency to unusually large and inevitably unsustainable flows. The Fed’s latest Z.1 report does a nice job of illuminating the historic scope of the U.S. securities Bubble. U.S. securities markets have been on the receiving end of extraordinary international flows, while inflating securities and asset prices have spurred rapid financial sector expansion.


Does Amazon Create Jobs? Well, It Hired 75,000 Robots in 2017


Like millions of other people, I am a fan and a user of Amazon. They do make buying things convenient, especially little things that you might have to go to art specialty stores to find. I’m a huge user of the Kindle app on my iPad, especially since I learned that I do not technically own the books I buy from the Apple bookstore. If I ever wanted to migrate away from an Apple product, I could not take my books that I purchased on Apple to a competing platform.

Not only can I do that with the Kindle app, I can highlight and make notes in the books, and they show up on my Amazon Kindle page, where presumably they will reside forever, so that in 20 years I can go back and review what I thought was important about a particular book. If I could do that for every book I’ve read in the last 50 years, I would be dangerous.

I will admit that I don’t quite understand the Amazon business model of growth over profits, but I have noticed that most of the profits Amazon actually makes are coming from their noncommercial side – stuff like cloud services. Be that as it may, there is a semi-dark side to Amazon. They are slowly but surely eating retail jobs.

Now, to be fair, Amazon represents only a small portion of US retail sales, but it accounts for an outsized portion of the growth in retail sales. And, again to be fair, Amazon does not do even a majority of online sales, since other online retailers are just as aggressively pushing their own products.

(I suppose Mauldin Economics could be considered an online retailer of investment information services, as we actually have no print services. I discontinued doing a print letter well over 16 years ago, after having been in the publishing and printing business for almost 25 years. I have to tell you, the online world is far more difficult to navigate, especially today; but I have no romantic desire to go back to the days of mailing millions of pieces of mail and hoping to get some money back. The cost of sending out print newsletters was massive.)

To be even more fair, a great deal of the problem in American retail jobs and businesses is that we simply have too many retail stores. Reasonable analysis that I’ve read suggests that we have anywhere from 10 to 15% more retail stores than we actually need. Now, that’s good for competition and choice, but it is just one more reason why there is going to be a consolidation in retail companies and further losses of retail jobs. What’s that going to do for the wage-inflation issue?

Today’s Outside the Box is two short notes on Amazon from the Quartz Media website. They actually have a great deal of material on Amazon, as well as on other companies – both news and analysis.

I am actually kind of teeing up this weekend’s letter, where I will first and quickly review the jobs report that comes out Friday morning and then talk about the future of jobs and why Fed policy, which is based on backward-looking models that no longer have any application to our future, may be poised for trouble. As we head into 2018, there are a few dark clouds here and there, but I am mostly optimistic. I do think the primary risk in 2018 will be major central bank policy errors. I will probably repeat these figures again this weekend, but between the $450 billion that the Fed intends to pull out of its balance sheet and the $500 billion by which the ECB is going to reduce its QE, there will be almost $1 trillion going into the market.

Since the Fed, and especially Ben Bernanke, took credit for the rise in asset prices induced by its QE, why this Fed thinks that quantitative tightening (QT) will have no effect at all on the market is quite beyond me. It’s one thing to raise rates, which they should have done years ago, and it’s another thing altogether to raise rates and fire up a QT program at the same time. As I will hopefully demonstrate this weekend, I think they will be doing this at precisely the wrong time and for the wrong reasons.

In the meantime, let’s look at one of the technological forces, Amazon, and the tidal wave of online sales that is putting pressure on the retail sales market. You wonder why there has been no wage inflation when, theoretically, unemployment is so low? Here’s one of a number of answers: Amazon has hired approximately 75,000 robots just this year.

On a personal note, I notice that winter actually seems to have come to Dallas. We had unnaturally warm weather in the spring and fall, and even enjoyed a rather cool summer. We have had three years back-to-back-to-back of exceptional weather, all things considered. I don’t ever remember the weather being this good for this long. But I have lived long enough in Texas to know that the trend won’t last forever. But if it did, I would begin to worry about tax refugees from California coming to populate our state, where they would get much lower taxes plus great weather.

I will hit the send button so that the editors can get this letter out on time. You have a great week.

Your more than a little worried about the future of work analyst,

John Mauldin, Editor
Outside the Box



Does Amazon Create Jobs? Well, It Hired 75,000 Robots in 2017

By Dave Edwards and Helen Edwards

There are 170,000 fewer retail jobs in 2017 – and 75,000 more Amazon robots.


An Amazon machine employee (Reuters/Noah Berger)

 
Amazon’s headcount is growing by 40% year-over-year. It was the eighth-largest private employer in the US at the end of 2016, and it’s poised to climb those ranks quickly. The online retailer also announced plans to build a second US headquarters that will employ 50,000 employees.

But Amazon’s growth comes at a cost. It has a well-earned reputation for overwhelming competitors. Even though Amazon represents a small portion of the overall retail industry, it dominates the industry’s sales growth.

We wondered: Does Amazon create more jobs than it destroys?

It depends – on whether you are a robot

We assembled employment data for the retail industry as a whole, and for Amazon in particular.
 
We estimated year-end results for 2017, based on current trends.


Source: Quartz Media, LLC

 
Here’s what our analysis says:

  1. Assuming the current industry trends continue through the end of the year, the number of employees in Amazon-related retail (that is, retail that Amazon competes with, such as book stores, as opposed to areas it doesn’t compete with, like gas stations) will decline by about 1% year-over-year. While that’s a small percentage, the number of job losses would be 170,000. That would be the first annual decline since 2009.
     
  2. Amazon’s employment increases won’t be enough to cover the losses in the rest of the industry. We have assumed Amazon will maintain its current year-over-year headcount growth rate and will add 146,000 employees worldwide in 2017, a 43% increase (excluding Whole Foods employees). Even with that aggressive growth assumption, and including Amazon employees worldwide, the combined employment at Amazon and Amazon-related retail would still decline by 24,000.
     
  3. Amazon has already added 55,000 robots this year and its growth rate is accelerating. The company stated it had 45,000 robots at the end of 2016, added 35,000 robots by the end of the first half of 2017, and then another 20,000 in the third quarter. We’ve assumed another 20,000 in the fourth quarter for a total of 75,000 new robots in 2017. While it may be difficult to prove causality, it’s not difficult to see the correlation between a decline of 24,000 human employees and an increase of 75,000 robot employees.

Amazon’s growth and efficiency (driven by AI and automation) are key to why its stock has performed so well. The company is increasing its investment in robotics and, in our assumptions, machines could represent 20% of the total employee base by the end of the year. That increase in automation drives efficiency and growth and makes Amazon investors happy—especially relative to the retail industry as a whole. While the S&P Retail Index is flat this year, Amazon’s stock is up 57%.


Source: Quartz Media, LLC

 
The National Retail Federation (NRF) has forecast that retail-industry sales will grow by around 4% in 2017. (US Census Bureau data also confirms that growth rate through the first nine months of the year.) Online shopping is growing even faster—at 10% so far this year. Amazon’s US business represents 35% of that growth. And Wall Street analysts estimate that the company will represent 51% of all US online sales growth by the end of the year.
 


Source: Quartz Media, LLC


Source: Quartz Media, LLC

 
That means that Amazon will represent 20% of the entire US retail industry’s growth in 2017—even though it only represents 3% of overall US retail sales. Amazon’s growing army of robots may seem helpful and benign but they are also highly effective at terminating human retail employees.

* * * * *

Amazon may have patented the next big thing in online shopping

By Helen Edwards and Dave Edwards


“How much do I get paid for watching this?” (Reuters/Elijah Nouvelage)

 
User-generated Amazon reviews are one of the most important ways that consumers find products and decide what to buy. So much so that Amazon has consistently shown itself to be Google’s competitor in e-commerce search. Almost all Amazon product reviews are written but, as business research firm L2 wrote, Amazon is now pivoting to video.

It’s a broad strategy with Amazon inviting some of its 2 million merchant partners to join the test program, where videos will be posted to the site in mid-December. According to L2, “this feature is a logical step given how often consumers watch how-to and product review videos before making purchases. By adding the feature, Amazon clearly aims to keep shoppers on its own site, preventing them from migrating to YouTube or social media platforms.”

There’s potentially another reason for Amazon to promote the use of video in e-commerce. It now has a way to offer customers discounts for watching ads. In October, Amazon was awarded a patent for “content-based price reductions and incentives.” The patent says that “customers in an electronic environment can be presented with the option to receive advertising, such as audio, video, or interactive content, in order to receive discounted pricing or similar benefits.”

One example of how Amazon sees this working is that a customer can watch a video ad on an item’s detail page, such as a product review. As the customer watches more of the ad, the displayed price for the item drops.

Depending on how strong Amazon’s patent is, no online retailer outside of Amazon’s ecosystem can offer this benefit to customers.

The background to this patent is informative as it helps explain how far reaching Amazon’s thinking could be, and how they plan to keep lowering prices for consumers. One major difference between e-commerce and in-store purchasing is that loss-leading—selling goods cheaper than what they cost—doesn’t work in e-commerce. When customers visit a physical store, they have invested their time to get there so stocking up on additional items is worth it. This doesn’t happen online. So this patent levels the playing field, allowing sellers to offer discounts to online customers based on their investment in time.

With this patent, Amazon has signaled that it is taking on YouTube, Facebook, Instagram, Snap, and other media platforms for digital ad spend. And customers will now also know the value of their time. And potentially whether their time gets more or less valuable depending on their purchasing behavior. One person’s time is inevitably more valuable than another’s, so with dynamic pricing, it’s not hard to imagine a personalized price based on a customer’s attention span and spending behavior.

Perhaps most importantly, Amazon had a lock on low-friction e-commerce with its original patent for one-click checkout, which has expired this year. The question is, with the shift to video-enabled e-commerce, is dynamically priced, attention-incentivized video advertising the next big thing that secures Amazon’s advantage for years to come?


Britain and Europe’s Messy Divorce

By George Friedman

 

A divorce can be nasty business. In most cases, one party wants to leave and the other party wants them to stay. In some cases, one side makes threats – normally financial in nature – that would prove disastrous to both. In the worst cases, children are used as weapons to hurt the other. A divorce is a form of madness where rage dominates, and both sides are often willing to destroy everything just to keep the other from getting what they want.

The United Kingdom filed for divorce from the European Union a little over 17 months ago. The EU wants the breakup to hurt the U.K., even if it hurts the EU in the process. In fact, in its delusional madness, Brussels is saying the union won’t be hurt by the loss of Europe’s second-largest economy. The British, as the side that started the divorce, has mixed feelings on it. It swings from empathetic to vindictive.

Then there are the children, Northern Ireland and the Republic of Ireland. They’re hostages in this negotiation, with the Europeans demanding one thing, the British another, and the Irish of all stripes fearing Brexit will separate them.
 
 
This is the point where I might say we shouldn’t carry this analogy too far, but it is very much a case where the analogy can’t be carried too far. When I listen to some EU figures hurling threats at the U.K., insisting that they are impervious to retaliation, or British politicians saying they should just leave, kids be damned – divorce is the only metaphor.
Geopolitics usually depersonalizes these things. The British have had a complex relationship with the Continent, and for centuries they have used the relationship to serve their own interests. Their marriage to Europe was never a passionate love affair. They were wary of European integration, and the French even wanted to keep them out. It was a union based on cold calculation, a marriage for money. Such divorces ought to be simple.

In this divorce, however, there is an emotional component that goes beyond money and position. There is a deep-seated hatred and resentment at play. It is rooted in centuries of Europe looking across the channel at perfidious Albion, and Britain looking back and seeing a continent of garlic eaters. For a time, it appeared that they could get along, and even be happy working together. Now the Europeans feel that the British betrayed them, and the British are torn over whether they ought to stay for the money or give into the fact that they really loathe their European partners.
British Prime Minister Theresa May (L) and European Commission President Jean-Claude Juncker give a press conference as they meet for Brexit negotiations on Dec. 4, 2017, at the European Commission in Brussels. JOHN THYS/AFP/Getty Images
 
But they are also at the point in the divorce where, even if they stayed, the marriage would never be the same again. Even two old fortune hunters can reach the point of no return. Still, they can’t just avoid one another. In marriage, there are too many ties for the lawyers to sever all.

There is no going back. It is only a question of whether, as in “The War of the Roses” (an old movie you must see to understand Brexit), they will find themselves destroying each other to get the last word. Geopolitical theory says they can’t be so irrational, but divorce makes people behave in strange ways. I suspect it will end as most divorces do: with a cold but amicable settlement, followed by a calming of the storm. But will the children ever be the same?


Standby For The Coming Golden Age Of Investment

by: The Mad Hedge Fund Trader



- Lower energy prices.

- Biotech waiting for its time in the sun.

- Euro, Japanese yen will sell off.

- Corporate revenue growth never been better.

- All adds up to the Golden Age in the 2020s.

 
    
I believe that the global economy is setting up for a new Golden Age reminiscent of the one the United States enjoyed during the 1950s, and which I still remember fondly. This is not some pie in the sky prediction. It simply assumes a continuation of existing trends in demographics, technology, politics, and economics. The implications for your investment portfolio will be huge.
 
What I call “intergenerational arbitrage” will be the principal impetus. The main reason that we are now enduring two “lost decades” of economic growth is that 80 million baby boomers are retiring to be followed by only 65 million “Gen Xer’s.”
 
When the majority of the population is in retirement mode, it means that there are fewer buyers of real estate, home appliances, and “RISK ON” assets like equities, and more buyers of assisted living facilities, healthcare, and “RISK OFF” assets like bonds.
 
The net result of this is slower economic growth, higher budget deficits, a weak currency, and registered investment advisors who have distilled their practices down to only municipal bond sales.
 
Fast forward six years when the reverse happens and the baby boomers are out of the economy, worried about whether their diapers get changed on time or if their favorite flavor of Ensure is in stock at the nursing home.
 
That is when you have 65 million Gen Xer’s being chased by 85 million of the “millennial” generation trying to buy their assets. By then we will not have built new homes in appreciable numbers for 20 years and a severe scarcity of housing hits. Residential real estate prices will soar. Labor shortages will force wage hikes.
 
The middle-class standard of living will reverse a then 40-year decline. Annual GDP growth will return from the current subdued 2% rate to near the torrid 4% seen during the 1990s. The stock market rockets in this scenario.

Share prices may rise very gradually for the rest of the teens as long as tepid 2-3% growth persists. A 5% annual gain takes the Dow to 26,000 by 2020.
 
After that, we could see the same fourfold return we saw during the Clinton administration, taking the Dow to 100,000 by 2030. If I’m wrong, it will hit 200,000 instead.
 
 
 
Emerging stock markets (EEM) with much higher growth rates do far better. This is not just a demographic story. The next 20 years should bring a fundamental restructuring of our energy infrastructure as well.
 
The 100-year supply of natural gas (UNG) we have recently discovered through the new “fracking” technology will finally make it to end users, replacing coal (KOL) and oil (USO).
 
Fracking applied to oilfields is also unlocking vast new supplies.
 
Since 1995, the US Geological Survey estimate of recoverable reserves has ballooned from 150 million barrels to 8 billion. OPEC’s share of global reserves is collapsing. This is all happening while automobile efficiencies are rapidly improving and the use of public transportation soars.
Mileage for the average US car has jumped from 23 to 24.7 miles per gallon in the last couple of years, and the administration is targeting 50 mpg by 2025. Total gasoline consumption is now at a five-year low.
 
 
Alternative energy technologies will also contribute in an important way in states like California, accounting for 30% of total electric power generation by 2020. I now have an all-electric garage, with a Nissan Leaf (OTCPK:NSANY) for local errands and a Tesla (TSLA) Model S-1 for longer trips, allowing me to disappear from the gasoline market completely. Millions will follow.

The net result of all of this is lower energy prices for everyone. It will also flip the US from a net importer to an exporter of energy, with hugely positive implications for America’s balance of payments.
 
Eliminating our largest import and adding an important export is very dollar bullish for the long term.
 
 
 
 
That sets up a multiyear short for the world’s big energy consuming currencies, especially the Japanese yen (FXY) and the Euro (FXE). A strong greenback further reinforces the bull case for stocks. Accelerating technology will bring another continuing positive. Of course, it’s great to have new toys to play with on the weekends, send out Facebook photos to the family, and edit your own home videos.
 
But at the enterprise level, this is enabling speedy improvements in productivity that is filtering down to every business in the US, lower costs everywhere. This is why corporate earnings have been outperforming the economy as a whole by a large margin. Profit margins are at an all-time high.
 
Living near booming Silicon Valley, I can tell you that there are thousands of new technologies and business models that you have never heard of under development. When the winners emerge, they will have a big cross-leveraged effect on economy.
 
New healthcare breakthroughs will make serious disease a thing of the past, which are also being spearheaded in the San Francisco Bay area. This is because the Golden State thumbed its nose at the federal government ten years ago when the stem cell research ban was implemented.
 
It raised $3 billion through a bond issue to fund its own research, even though it couldn’t afford it. I tell my kids they will never be afflicted by my maladies. When they get cancer in 20 years they will just go down to Wal-Mart and buy a bottle of cancer pills for $5, and it will be gone by Friday.

What is this worth to the global economy? Oh, about $2 trillion a year, or 4% of GDP. Who is overwhelmingly in the driver’s seat on these innovations? The USA.
 
There is a political element to the new Golden Age as well. Gridlock in Washington can’t last forever. Eventually, one side or another will prevail with a clear majority. This will allow the government to push through needed long-term structural reforms, the solution of which everyone agrees on now, but nobody wants to be blamed for.
 
That means raising the retirement age from 66 to 70 where it belongs, and means-testing recipients. Billionaires don’t need the maximum $30,156 annual supplement. Nor do I.
 
The ending of our foreign wars and the elimination of extravagant unneeded weapons systems cuts defense spending from $800 billion a year to $400 billion, or back to the 2000, pre-9/11 level. Guess what happens when we cut defense spending? So does everyone else.
 
I can tell you from personal experience that staying friendly with someone is far cheaper than blowing them up.
 
A Pax Americana would ensue.
 
That means China will have to defend its own oil supply, instead of relying on us to do it for them. That’s why they have recently bought a second used aircraft carrier. The Middle East is now their headache.

The national debt then comes under control, and we don’t end up like Greece.
 
The long-awaited Treasury bond (TLT) crash never happens. Fed governor Janet Yellen has already told us as much by indicating that the Federal Reserve will soon start to unwind its massive $3.9 trillion in bond holdings. What have bond prices done? Almost nothing.
 
The reality is that the global economy is already spinning off profits faster than it can find places to invest them, so the money ends up in bonds instead.
 
Sure, this is all very long term, over the horizon stuff. You can expect the financial markets to start discounting a few years hence, even though the main drivers won’t kick in for another decade.
 
But some individual industries and companies will start to discount this rosy scenario now.
 
Perhaps this is what the nonstop rally in stocks since 2009 has been trying to tell us.
Dow Average 1900-2015


Inequality Comes to Asia

LEE JONG-WHA

Pink Diamond Auction

From 1990 to 2012, the net Gini coefficient – a common measure of (post-tax and post-transfer) income inequality – increased dramatically in China, from 0.37 to 0.51 (zero signifies perfect equality and one represents perfect inequality). It rose in India as well, from 0.43 to 0.48. Even the four “Asian Tigers” – Hong Kong, Singapore, South Korea, and Taiwan – which had previously grown “with equity,” have lately faced rising inequality. In South Korea, for example, the share of income held by the top 10% rose from 29% in 1995 to 45% in 2013.

This trend is being driven largely by the same forces that have fueled Asia’s economic growth in recent decades: unbridled globalization and technological progress. Increasingly open borders have made it easier for businesses to find the cheapest locations for their operations. In particular, China’s entry into global markets has put downward pressure on the wages of low-skill production workers elsewhere.

Meanwhile, new technologies raise demand for skilled workers, while reducing demand for their less-skilled counterparts – a trend that fuels the expansion of the wage gap between skilled and unskilled. Capital owners also reap major benefits from technological progress. In short, as the Nobel laureate Angus Deaton has acknowledged, by creating new opportunities for a certain group of millions of people, while subjecting an enormous number of people to wage stagnation, unemployment, and economic precarity, globalization and technological innovation have helped to widen the gap between the haves and have-nots.

Exacerbating this trend, income inequality often goes hand in hand with inequality of opportunity. With limited educational and economic prospects, talented youth from disadvantaged backgrounds end up running in place. As inequality becomes increasingly entrenched, it can erode the consensus in favor of pro-growth economic policies, undermine social cohesion, and spur political instability.

To avoid such a future, Asian countries need to change the rules of the game, providing opportunities for youth, whatever their background, to ascend the income ladder. Market mechanisms are not enough to achieve this. Governments must take action, complementing their pro-growth policies with policies aimed at ensuring that the gains are shared much more equally and sustainably.

To be sure, some Asian governments have been attempting to tackle inequality with progressive redistribution policies. For example, South Korea’s government recently announced that it will raise the minimum wage next year by 16.4%, to 7,530 won ($6.70) per hour, and up to 55% above its current level by 2020. It will also raise tax rates for the highest income earners and companies.

But, while such measures have strong public support, they could end up hurting the economy, by reducing business investment, for example, and impeding job creation. In fact, the first rule of thumb in combating today’s inequality should be that simplistic egalitarian policies are not a permanent solution – and may, in fact, have adverse long-term consequences.

Consider the Venezuelan government’s decision, in the late 1990s, to implement populist redistributive policies, without addressing the economy’s overreliance on the oil industry and lack of competitiveness. That choice has pushed the country to the edge of bankruptcy, while fueling large-scale social unrest and political turmoil. Venezuela’s national catastrophe should serve as a warning to everyone.

The best way to enhance both equity and growth is effective development of human capital, which not only supports higher incomes today, but also ensures intergenerational mobility tomorrow. This requires enhanced social safety nets and redistributive tax-and-transfer programs, as well as access to quality education for all.

The good news is that many East Asian economies are already investing more in public education, in order to expand opportunities for all population groups. But more must be done.

Asia needs to improve further the quality of its higher education as well, reforming curricula to ensure that young people are getting the knowledge and skills they need to prepare them for the labor market. Meanwhile, the labor market should be made more efficient and flexible, so that it can match people with the right jobs and reward them adequately. As technology continues to transform the economy, life-long education and training is needed to enable workers to keep up.

Promoting the participation of girls and women in education and economic activity is also important.

Furthermore, governments should create an environment that fosters small innovative startups. And, of course, they should sustain pro-growth policies that boost overall job creation and reduce unemployment, while rejecting barriers to trade or innovation.

In today’s charged political environment, there is a growing temptation to reject globalization and embrace populist redistribution policies that could end up doing far more harm than good. Asia’s leaders must do better if they are to realize the true promise of “growth with equity.”


Lee Jong-Wha, Professor of Economics and Director of the Asiatic Research Institute at Korea University, served as Chief Economist and Head of the Office of Regional Economic Integration at the Asian Development Bank and was a senior adviser for international economic affairs to former President Lee Myung-bak of South Korea. His most recent book, co-authored with Harvard’s Robert J. Barro, is Education Matters: Global Schooling Gains from the 19th to the 21st Century.