How to Prevent a K-Shaped Recovery
Art by Klaus Kremmerz
Who can blame the Reddit trader for playing the market in quest of a financial score?
Wealth disparity has worsened significantly over the past 40 years as power has moved from labor to capital. Wages have stagnated, organized labor has declined, and automation and globalization-driven offshoring of jobs have decimated once-well-paying US employment. Disinflationary forces run rampant. For many, it seems the stock market is the only game left in town. But, of course, not everyone can afford to keep playing.
No one found it surprising then when the standoff over GameStop and the like, between the day traders on Robinhood and the hedge funds, was portrayed as a populist uprising. Many consider it the result of long-simmering resentments in the US between the haves and the have-nots. Some veteran investors were not shocked. Ray Dalio, leader of the Bridgewater Associates hedge fund firm, has said he understands the social media investors, and may even have joined them were he a younger man.
What the episode does highlight is a growing belief that capitalism requires a structural rethinking. It no longer works for many Americans who feel that they cannot improve their situations no matter how hard they work.
Statistics illuminate why they feel this way. By the measure of the Economic Policy Institute, since the 1970s, worker productivity has expanded six times more than hourly pay, when in prior decades they rose in tandem. At the same time, income inequality in the US is growing, just as it is decreasing in the rest of the world, according to the Gini Coefficient, a statistical measure of inequality. The cost of ignoring this problem, Dalio recently said, could mean outright “civil war.”
“We’re going to see more social unrest, we’re going to see more riots, we’re going to see more protests, more Occupy Wall Streets,” said Chris Schelling, managing director at Windmuehle Companies, an alternative investments firm. “We’re going to see more of that until there’s enough appreciation for how much things need to change.”
Here are four ideas to possibly remedy the situation, with their pros and cons, in the estimation of some thinkers:
Changes in the Capital Markets
What does need to change is a question some allocators are deliberating as the economy continues its uneven recovery from the pandemic. For some investors, there’s a concern that “maybe we’re building products and we’re building cities and we’re building resources that a significant portion of the population won’t participate in,” said Kim Lew, president and chief executive officer of the Columbia Investment Management Company. How, she asked, can managers build products that can be widely adopted by the majority of people?
Of course, if capital markets continue to gain, that would benefit portfolios, but an economy that leaves more and more people behind, including students and active workers, can only hurt everybody. And how would that affect future contributions for pension plans?
“While we might do a good job on the asset side, I think the thing that most concerns me is what the impact will be on the liability side,” said Mansco Perry III, chief investment officer at the Minnesota State Board of Investment.
To former PIMCO Managing Director Paul McCulley, what the US needs to do—after running bigger budget deficits to furnish relief during the pandemic—is increase inflation.
In the fall, McCulley told Bloomberg Markets that higher inflation would be a “delightful” thing for democracy, because it would hand more power to labor over capital. Capital markets have benefited over the past four decades of falling interest rates. However, reversing the trend would also fundamentally change how investors manage portfolios.
McCulley said: “If what has worked in investment management for the last 40 years were to continue working—not immediately today, tomorrow, or the next day, but if it were to work on a secular basis for the next five years, 10 years, 20 years—then we have unambiguously failed as a democracy.”
Greater Taxes
Wealth and income disparity in the US can be reduced with income, wealth, and estate taxes. Progressive tax reform means the wealthy pay more to the government, and the lower-income folks would presumably benefit from more public services that the extra revenue would garner.
The question is: How much more would make a difference? In 2019, two notable economists at the University of California at Berkeley, Emmanuel Saez and Gabriel Zucman, proposed a steeper capital gains tax, which they believe would reverse the massive “inequality spiral” in the US.
Now, the federal levy on profits from selling investments and other assets—which the well-off predominantly benefit from—is 15%, but it’s 20% for those with significant six-figure incomes or more. That’s a lot lower than the tax on ordinary income, with the highest rate at 37%.
The system is skewed against those of modest means. The pair of researchers found in 2018 that the 400 wealthiest families in the US paid just a 23% marginal tax rate, compared with the 24.2% paid by the bottom half of all American households. It was the first time in a century that the richest paid less in taxes than the lowest earning members of society, which include many in the middle class. But just 50 years ago, the picture was very different. In 1970, the wealthiest 400 families paid 52.7%; the bottom half of the US paid 25.4%.
A progressive tax code could reverse the trend, the researchers say. The question is how effective it would be.
Many remain leery that raising taxes would work because of the power of the wealthy to thwart it with their influence among lawmakers and their accountants’ wiles. Why wouldn’t the well-heeled block such an attempt? After all, their donations to politicians give them an outsized say in shaping public policy. Even billionaires like Bill Gates who have pledged to give their wealth away over the course of their lifetimes through tax-advantaged charity foundations have qualms about soaking the rich.
They’ve publicly expressed discomfort with the idea, dismissing a wealth tax proposed by Senator Elizabeth Warren. The Massachusetts lawmaker seeks to sock it to the income of very, very rich: 2% tax on every dollar of net worth above $50 million and a 6% tax on every dollar of net worth above $1 billion.
Not to mention, it is very easy for the rich to hide their wealth, either through tax havens or accounting loopholes, even when it comes to their estates. Both Barack Obama and Bill Clinton raised taxes on the rich, yet that failed to reverse the inequality problem, thanks to clever tax planning.
Antitrust Regulation
Following the example of the Europeans, who have doubled down on antitrust regulation lately, may also be the answer. Increasing competition among businesses is key to dispersing wealth, says Windmuehle’s Schelling, who has a book coming up on the subject.
“We’ve come to view capitalism as meaning monopolies, and I think that’s incorrect,” Schelling said. “Capitalism works when you have lots of competitors in the market and, frankly, you have dispersed ownership of the means of wealth production.”
He pointed out that the number of mergers and acquisitions (M&A) in the US has grown exponentially since the 1980s, as society shifted into an information economy. In 2020, even after a drop in deals from the year prior because of the pandemic, roughly 15,270 mergers still took place valued at $1.1 trillion, according to data from the Institute for Mergers, Acquisitions, and Alliances (IMAA). By comparison, in 1990, about 6,000 mergers occurred, valued at about $254 billion. At the same time, antitrust litigation by federal regulators has declined year after year.
All of this means that consumers and smaller competitors have a dwindling set of options in all sectors of the economy, while wealth increasingly consolidates in the hands of a few businesses and their major stakeholders. On the downside, critics say antitrust regulation results in higher prices for consumers, who pay low prices thanks to company cost savings.
Greater Education
What might be most needed over the long term is education to reduce inequality. The current educational system is not helping society attain such a goal. At-home learning has resulted in a mixed picture, to say the least.
A Brookings Institute study found that students in K-8 public schools have broadly made some gains in both reading and math since the pandemic onset. Drill down deeper, however, and researchers found that the progress in math was about 5 to 10 percentage points lower in fall 2020 than it was the prior year.
It’s a small snapshot into a growing concern for people who worry that the longer students go without classroom learning, the more it will hinder their future earning ability. Hurt even worse are those students who either do not have the technology to access remote instruction or who have dropped out of school.
There are no easy solutions. But what might be needed going forward are skills training programs that would train workers for future job sectors. Just as automation displaced blue-collar workers, tomorrow it could displace white collar laborers such as computer programmers and aviation engineers or even financial asset managers. Better programs to relocate workers would also be needed.
Whatever the problem, it’s clear it needs addressing with flexibility, and some grace.
Related Stories:
Pandemic Will Slice 7% from World’s Wealth in 2020, Says BCG