Relevant and even prescient commentary on news, politics and the economy.

Greenspan promoting “Entitlement” cuts as the necessary solution to the economy. 25% worth!

From an interview on NPR’s Here and Now comes:

“The official actuaries of the Social Security system say in order to get our Social Security and retirement funds in balance, they’d have to cut benefits by 25 percent indefinitely into the future,” he says. “Do I think it’s going to happen? Well I don’t know, but this is one of the reasons why inflation is the major problem out there. So long as you don’t do it, you’re going to cause the debt overall — the total government debt — to rise indefinitely, and that is an unstable situation.”

He adds: “In the book … discussing what the long-term outlook is all about, we say that the issue of the aging of the population and its consequences on entitlements is having a significant negative deterioration over the long run. The reason for that is what the data unequivocally show is that entitlements — which are mandated by law — are gradually and inexorably driving our gross domestic savings, and the economy, dollar for dollar. And so long as that happens, we have to borrow from abroad, which is our current account deficit.”

He also said:

“When you deal with fear, it is very difficult to classify,” he tells Here & Now‘s Jeremy Hobson. “But you can look at the consequences of it, and the consequence is basically a suppressed level of innovation and therefore of capital investment and a disinclination to take risks.”

I agree with this, but not just as it relates to “ a suppressed level of innovation…” but instead as it relates to the 2005 World Bank report on what produces wealth in a developed economy like ours. It comes down to trust.  Trust in your judicial system and trust in your education system.   I discuss this in the following 3 posts: 2007, 2009, 2011

Human capital is where it’s at!

This election at it’s core is about trust.  Destroy that, and we have no democracy, we have no economy.  It’s that simple.   That McConnell et al has decided he will not abide by the rules agreed to in conducting the business of the Senate means we have no currently functioning democracy.  That is how fragile democracy in the US is.  Our democracy comes down to two people, the leaders of each party in the Senate agreeing to the rules.  When one decides not to, there is nothing that can be done other than vote.

You can hear the full interview here:

 

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Wealth, debt, consumption…revisited

Here are reminders of Angry Bear posts and contrbutor thinking on “Wealth, debt,and consumption”.

Wealth versus income

Usually my articles present facts and data and try to drive down to a conclusion. This time, I’m going to drive down to a couple of questions.

Income and consumption jazzbumba

Part 1…spending as a fraction of net worth jazzbumpa

Part 2 … wealth and consumption jazzbumpa

Consumption and compensation Rebecca Wilder

More on wealth and consumption Rebecca Wilder

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Another Look at Wealth and Consumption – Pt 2

Correlations and Slopes Over Time

In Part 1, we looked at the ratio of consumption spending to net worth, and how it changed over time.  This time we’ll look at the correlation between net worth and consumption.

Here is the big picture: personal consumption expenditures (FRED Series PCE) plotted against Net Worth (FRED series TNWBSHNO) Data is per calendar quarter.

Graph 1  Consumption vs Net Worth, 1959 – 2011

The data set is divided into two segments, with a break point at the beginning of 1997, with net worth at $30,315 and consumption at $5,467.  In a close up view, there is a clear slope change there.  Still, the selection is a bit arbitrary, since the high point of Q3, 1994, could also have been chosen, with net worth at $25291, and PCE at $4856.  But that is a detail, and no other reasonable breaks stand out.

Notably, both the slope of the data line and R^2 are significantly less after the break.  Visually, it’s obvious that in the later data, there is a lot more scatter.  Also note that that big data moves post 1997 return to the continuation of the best fit line, pre-1997.
Slope and R^2 measurements for the entire data set and the two segments are presented in Table 1. These numbers were generated using the linear trendline function in Excel.

 Table 1
 

Not so visually obvious are the declining slopes during the earlier portion of the data set.  Table 2 presents the same characteristics for data chunks of approximately 20 year duration.

Table 2

We saw in part 1 of this series that the relationship of consumption to net worth was not stable, so this result is not surprising.  And we can now see that as net worth increases, the sensitivity of consumption to increasing net worth decreases.

I can think of two contributing factors.  As wealth increases, the need to spend on basic necessities captures a smaller portion of that wealth, so the propensity to spend decreases.  I’ll defer consideration of the other factor for now.

Here is a detailed look at how the slope of the PCE vs net worth line varied over time.  Graph 2 shows the 34 quarter slope values for the data points of graph 1.  The slope is plotted in dark blue, with certain time spans highlighted in contrasting colors: recessions are in orange, and the stock market and housing bubbles are in yellow.

Graph 2 Slope of Consumption vs Net Worth

Observations:
1) Except for the bubbles and the spike in the post-bubble recession of 2008, the values are mostly contained between a low of 0.168 and a high 0.246.
2) There was an upward trend that ended in the mid-70’s, underscored with a blue line.
3) Values after the mid-70’s, including the two bubbles, are contained in a down-sloping channel, outlined in green.
4)  Except for the early 80’s and 90’s events, recessions are marked by sharp, temporary slope increases.
5) The average slope is 0.184, with a standard deviation of .038
6) The bubbles highlighted in yellow in Graph 2 correspond exactly to the data points in Graph 1 that fall below the red best fit line.
7) The post-bubble recessions brought the slope back into the range described in Observation 1.  This is illustrated in Graph 1 by the returns to the blue best fit line.

If the normal relationship between net worth and consumption is described by a slope in the range of around 0.17 to 0.25, what is there about bubbles that causes drops into the range of 0.11 to 0.12 at the peaks?  I think the answer is the second factor that I defered until now.  The stock bubble and the housing bubble represented wealth increases that were not shared equally across the population.  Specifically, as I pointed out earlier, these assets are mostly owned by the richest population segment, and growth in wealth has excessively favored the top 1% of the population.   They have the least propensity to spend, and this tendency drives the PCE slope into the low range.

This FRED graph illustrates the point in a different way.

Graph 3 PCE, Net Worth and Disposable Income

There are four lines, Net Worth in green (divided by 5 to put it on the same scale); Disposable Income in purple, PCE in red, and Disposible Income multiplied by 0.931 in blue.  Note that the last two overlap almost perfectly, as I also pointed out earlier (see link above.)

The conclusions I’m drawing are
1) Since the bubbles increased wealth in a highly skewed fashion, the relationship between average wealth and consumption broke down.
2) When the bubbles burst, the normal relationship between wealth and consumption reasserted itself.
3) The underlying cause is that during the bubbles the relationship between wealth and income broke down, and afterwards reasserted itself.
4) The relationship between disposable income and consumption is robust across time and most extraordinary financial events.
5) All the foregoing suggest that if wealth distribution were more even across the population (and thus more closely tied to disposable income,) then the relationship between wealth and consumption would be more robust.

Cross-posted at Retirement Blues.

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Another Look at Wealth and Consumption – Pt 1

 Part 1 – Spending as a fraction of Net Worth

Tim Duy weighed in on the output gap debate – not my topic, but he presented this chart of net worth as a percentage of GDP.

Graph 1 Net worth as a Percentage of GDP 

That got me thinking again about the issue of whether consumption spending is determined by income or wealth. Specifically, if consumption is determined by wealth, there should be peaks in consumption corresponding to the dot-com and housing bubbles shown on Graph 1.  However, as Graph 2 shows, there were no such peaks.

Graph 2 Personal Consumption Expenditures

I’ve argued already that, contrary to standard economic thought, consumption is directly determined by income.  (Posted at RB and at AB.) One observation was that consumption, as a fraction of income, didn’t vary much over time, averaging 90.1% with a standard deviation of 2.1%. 

I took a similar look at consumption and net worth, data from Fred.  The next three graphs show personal consumption expenditures (PCE) as a decimal fraction of net worth (blue, left scale) along with net worth (NW) (red, right scale) over different time spans.

Graph 3A  Expenditures/Net Worth and Net worth, 1959-79,

Graph 3A spans from 1959 – the beginning of the data set – to 1979.  Net worth rises exponentially as the population grows.  Adjusting for population growth does not change the shape of the net worth curve, so, in the aggregate, we were becoming richer during those years.  Note that PCE/NW follows a generally similar, though far bumpier trajectory.  As I pointed out in the prior post, the personal savings rate also increased during this period, so the average worker was able to both save and spend more.

Graph 3B  Expenditures/Net Worth and Net worth, 1975-90

Graph 3B spans from 1975 to 1990.  Net worth continues on its exponential track.  But, after about 1979, PCE/NW drops, reversing the prior trend.  By 1990, PCE/NW is no greater than it was in the early 1960’s.  Meanwhile, the personal savings rate also dropped – to a range below that of the early 60’s.

Graph 3C  Expenditures/Net Worth and Net worth, 1989-2011

Graph 3C spans from 1989 through October, 2011.  The exponential growth of net worth falters before and during the two most recent recessions.  After about 1994, PCE/NW is a roller coaster ride.  Of particular interest is the exactly contrary motion at a detail level between NW and PCE/NW, after about 1998.  During the housing bubble of mid-last decade, PCE/NW hit an all time low.

What narrative makes sense of these three graphs?  Here’s my attempt.

Through the 60’s and 70’s, the standard of living was increasing, as incomes and net worth rose together.  This allowed more discretionary spending, and therefore, the fraction of NW that was spent increased.

In the 80’s, aggregate net worth continued to rise, but consumption spending, quite dramatically, failed to keep pace.  Lane Kenworthy has repeatedly pointed out that middle class income growth has decoupled from general economic growth as the upper income percentiles have captured an increasing slice of total income.  As the wealthy grew wealthier and the middle class fell behind, the fraction of NW that was spent declined – exactly the opposite of what should happen if increasing wealth determined spending.  But exactly what should happen if increased wealth is diverted to the already wealthy who have less of a propensity to consume.

During the 90’s, growth in median family income and GDP per capita were close to parallel (see graph at the Kenworthy link)  so there was a lull in the decoupling.  For most of that decade, PCE/NW was close to constant at 0.18-.19.  But while spending was kept level, the personal savings rate continued to fall. 

During the current century, median family income has flat-lined, while GDP/Capita has continued to increase. The decoupling has resumed and the wealth disparity has widened.   During the two wealth bubbles, PCE/NW declined dramatically.  When the bubbles burst and net worth declined, PCE/NW increased  back into the 0.18-.19 range.  Most strikingly, from about 1998 on, the two lines in graph 3C exhibit exactly contrary motion at a detail level.

Conclusions:

There was a tight relationship between Net Worth and consumption through the 60’s and the 70’s, when earnings growth kept up with GDP and wealth disparity was slight by current standards.

This relationship broke down during the 80’s – though one could argue as early as the mid 70’s – as aggregate wealth and working class income decoupled.

Most recently, the relationship between NW and PCE/NW is inverse.  The big swings in NW that the bubbles provided also demonstrated that consumption spending does not depend on net worth.

As I indicated in the earlier post linked above, consumption spending does depend on disposable income, throughout the entire post war period.  A simple look at readily available data casts grave doubts on the idea that wealth, and not income, determines consumption spending.

For the longer perspective, here is the data of Graphs 3 A-C on a single graph.

 Graph 4  Expenditures/Net Worth and Net worth, 1959-2011

In part 2, we’ll look at how spending and Net Worth correlate.

Cross-posted at Retirement Blues.

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Income and Consumption

This is another look at the idea I put forth here, that – contra the standard economic idea that consumption depends on wealth – I believe that consumption depends on income.  It’s worth stressing that wealth and income are not independent variables.  Wealth is the accumulation of unspent income plus returns generated on that wealth over time.  Is it proper to say that wealth is a stock, and income is a flow? 

I believe the evidence very strongly indicates that consumption – also a flow – is tied tightly and directly to income.  This does not mean that wealth cannot play a part in consumption decisions.  People make all kinds of decisions about all kinds of things, for all kinds of reasons.  But consumption decisions are constrained, and there is no reason why they can’t be constrained in more than one way. 

I think the idea that consumption depends primarily on wealth is intuitively weak because consumption is aggregated over the population, while wealth is concentrated in a small segment of that population.  A person with little or no wealth will spend the next dollar meeting some unsatisfied need, while the person with lots of wealth has the option of devoting it to rent-seeking or accumulation in an off-shore shelter.  According to data now more than a decade old, the richest 1% of households owned 38% of all the wealth; the top 5% owned over half, and the top 20% owned over 80% of the wealth.  The trend towards rising inequality started in the mid 70’s.


A couple of proxies for wealth are home and common stock ownership.  Excluding home-ownership, the wealth concentration is even more extreme, with the top 1% owning 50% of the non-home wealth.  It’s difficult to determine the actual amount of stock ownership in private hands.  A number arrived at by elimination leaves 36% among households, non-profits, endowments and hedge funds.   Therefore, realistically, the bottom 99% of individuals share about 18% of all stocks with those other institutions.  At the bottom end, the lowest 20% have either no wealth, or negative net worth.

People at the low end live close to subsistence.  People in the middle live pay check to pay check.  For the vast majority of the population, the next marginal dollar has a high probability of being used as a consumption expense. 

That is my narrative to support the idea that consumption must necessarily be strongly dependent on income.  Now, let’s look at some data, through 2009, from the U.S. Census Bureau, Table 678.  The first graph shows Disposible Income (green) and personal Consumption Expenditures (red) back to 1929.

A careful look suggests a narrative about this relationship.  First, consider the depression years.  From 1932 to ’34, consumption averaged 99% of disposable income.  People had needs, and used their limited incomes to satisfy them, as best they could.   Then, during WW II, with rationing and other constraints, saving was forced, and consumption was artificially low.  Consumption reached an all-time low of 73.3% of Disposable Income in 1944.  Since shortly after WW II, changes in Disposable Income and Consumption have been in virtual lock-step.   I’ve put lines in a contrasting color connecting selected points in the Disposable Income curve, and dropped parallel lines for the same years onto the Consumption curve.  Since 1951, very wiggle in Income corresponds to a wiggle in Consumption.

Here is a scattergram of the two subject variables, with a best-fit straight line provided by Excel.

As has been pointed out to me, correlation is not causation.  But – when one can construct a rational narrative that explains the data, the two series display absolutely congruous motion over several decades, and R^2 is over 0.99, I’m willing to go out on a limb and say the burden of proof is on the denialists.

Here is a look at Consumption as a percentage of Disposable Income, since 1951.

I’ve expanded the Y-axis.  In a view of the entire 0 to 100% scale, the post-1950 line barely wiggles.  Over a span of 6 decades, Personal Consumption has averaged 90.1% of Disposable Income, with a standard deviation of 2.12%. 

The data points, average, and an envelope one Std Dev above and below the average are all displayed on the graph.  Despite having two clearly defined and opposite tending trends, this is still a well behaved data set, with 39 of 58 (67%) of the points within the envelope.

The two minima are in 1982 and 1984, and the bottom trend lines converge in 1982, so that is a reasonable time to define as the break point.  This also suggests a narrative.  During the post WW II golden age, typical wage earners moved incrementally above the subsistence level.  This gave them the opportunity to save a little bit.   Since 1982,  as wages stagnated, it became necessary to devote a higher percentage to Consumption.  Sure enough, savings grew through the mid 70’s, and have dropped dramatically since 1982 (or a bit earlier,) as this FRED graph demonstrates.

I won’t say that Consumption Spending is solely dependent on Income.  But I will say that it is strongly, and even predominantly, dependent on income.   Wealth might enter into the decision for those who actually have some, but they are in the minority and have few needs that can be satisfied by the next dollar of consumption.

My conclusion is that the best solution to the aggregate demand shortfall problem is to put money into the hands of the people who will actually spend it, and that the best way to do that is to give them jobs.  As stop-gaps, various relief and welfare programs also have their place. This is the rational for fiscal stimulus.  Federal spending programs provide real jobs for real people, and they will spend their earnings.  Arguing about whether this is hole-filling or pump-priming strikes me as being just about as important as arguing about how many angels can dance on a pin head.

Cross posted at Retirement Blues

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Wealth vs Income

Usually my articles present facts and data and try to drive down to a conclusion. This time, I’m going to drive down to a couple of questions.

Recently, Noah Smith had a post on the subject of economic models titled Filling a hole or priming the pump?  It did quite a bit to restore my lack of faith in the pseudoscience of Economics, but that is more or less beside the point.  Roger Farmer, cited in the post, left a long comment that Noah hoisted up the main page.  Farmer concludes:

My reading of the evidence is that consumption depends primarily on wealth rather than income. That was the lesson of work by Ando and Modigliani, Modigliani, and Friedman in the 1950s. It is for that reason that I support interventions in the asset markets that try to jump-start the economy and reduce unemployment by boosting private wealth. That, in my view, is what quantitative easing has done.

Ok – I’m taking on decades of economic research here, but my first question relates to: “My reading of the evidence is that consumption depends primarily on wealth rather than income.”

First, let’s remember that wealth distribution is on the order of the top 1% owning 40% of the wealth, and the bottom 80% owning 7% of the wealth. And that 7% is not evenly distributed.  There are significant fractions of the population who have a) no wealth at all, or b) negative net worth. Either way, they are living hand to mouth.  This suggests that 1) they have unmet needs, and 2) will spend the next available dollar trying to satisfy one of them. 

So far, this is just a thought experiment.  Let’s take a look at how personal consumption expenditures track disposable income.  Here is percent change from previous year:

Both in the grand sweep and in the year-to-year detail, the curves are pretty much in lock-step.

 Here is the data on a Log Scale:

That’s coordination about as close as you could ever hope to see in real world data.

And if wealth – or it’s perception – were the determinant, wouldn’t you expect some sort of a consumption bump during the housing bubble, when people felt wealthier than their incomes justified?  Let’s look at consumption expenditures per capita.

Here, there is a slope increase, mid last decade, but it’s not great, and it’s no greater than the slope of the late 90’s.  I suppose the tech boom must have had some people feeling wealthy then, as well.  But they weren’t that bottom 80%.  Note that the first graph indicates the personal disposable income was up in those periods as well.  In fact, they were the only up periods since about 1980.

There was also relatively low unemployment in those times, and thus more people with incomes.

Also, it just seems counter-intuitive in a world where, if real people think about money at all, it’s in a personal cash flow context, not in terms of wealth aggregates.  Consuption decision reasoning, to the the extent that it even occurs, is along the lines of: “If I buy this thing, can I still afford to feed my cat?”

So, here is question number 1:

Since to most people “wealth” is miniscule, non-existant, or worse, and given empirical data that closely links consumption to income, how can consumption depend “primarily on wealth rather than income?”

Now let’s look at Excess Reserves of Depository Institutions.

There’s 1.6 trillion QE dollars.  Any left-overs have gone to leveraged speculation causing commodity inflation.

But Farmer says: “I support interventions in the asset markets that try to jump-start the economy and reduce unemployment by boosting private wealth. That, in my view, is what quantitative easing has done.”

If any wealth has been boosted here, it is in the upper reaches of the already wealthy, not among the working stiffs who are highly inclined to spend the next dollar rather than hide it away in Luxombourg or the Cayman Islands.

So, here is question number 2:

How can QE money help the economy when it is either sitting idle or inflating commodity prices?

I have nothing in particular against Roger Farmer, about whom I know nothing, but I am also prompted to ask economists in general:

What in the hell is the matter with you?

So maybe my lack of faith in Economics is the point, after all.

Cross-posted at Retirement Blues.

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Consumption and compensation: explicit and implicit wealth effects in finance

Readers of this blog know that I am in finance, specifically global fixed income. This blog post covers wealth effects in the financial industry, which is a relatively dominant share of total US compensation, 7.3% in 2009 and likely higher now (data are truncated at 2009). My view is that economists underestimate the wealth effects on consumption in the financial industry, given that financial wealth affects not only portfolio net worth but also the present value of labor income. Therefore, the sell-off in global risk assets may hit consumption more than expected in coming quarters, given that finance is the fifth largest industry, as measured by total compensation, on average spanning the years 1989-2009.

Why US consumption matters. The outlook for the US economy is of utmost importance to that for the world, given that the US will hold an average 22.1% of World GDP through 2016 (measured in $US), according to the IMF April 2011 World Economic Outlook. And the outlook for the US consumer is of utmost importance to that of the US economy, given that personal consumption expenditures hold a large 71% share of 2010 US GDP. Therefore, holding the US consumer share constant, US consumption is expected to be 15% of the global economy on average through 2016.

How wealth usually matters for US consumption. In economics, one of the drivers of consumption patterns ‘now’ is the wealth effect, usually defined as the shift in consumption due to changes in tangible (home values) and intangible (paper assets, like stocks and bonds) net assets.

(click to enlarge)

(Read more after the jump!)
The chart above illustrates the ‘wealth effect’ on consumption as the ratio of net worth to disposable income (blue dotted line) as it’s correlated to the consumption share (outlays really, see table 1 for the breakdown) of disposable income (green line). The consumption (outlay) share is is 100 less the saving rate.

A large part of the Fed’s quantitative easing program (QE) was targeted at stimulating the positive wealth effects on consumption via higher risk asset prices. I would argue that this has been largely successful to date. The two year moving average of the consumption share (green solid line) fell precipitously following the financial crisis, only to generally stabilize since Q1 2009; this is largely coincident with the outset of QE1.

Back to why I brought up finance. There’s another effect in play here, more specifically related to the compensation structure in the financial industry. See, along with the tangible and intangible net asset values, total wealth includes the present value of labor income, i.e., the present value of lifetime compensation.

For all industries except finance, lifetime income is generally not associated with financial markets and risk assets, except via interest payments on fixed income. However, in finance total compensation is directly impacted by asset values via the bonus structure, often a large part of total compensation. Therefore, when asset markets are challenged, this likely affects the present-value of labor income adversely.

There’s an outsized wealth effect of net asset values in the financial industry: the direct wealth channel (net asset worth) plus the indirect channel (present value of labor income) on consumption.

Why is the financial industry important? It’s pretty simple: financial compensation is a large part of total US compensation, 7.3% in 2009, which has grown an average of 6% annually since 1988 in nominal terms. (Note: you can get this data from the BEA’s industry tables).

As financial markets take a turn for the worse – the S&P grew 5.4% December 31, 2010 through March 31, 2011 and is now down 4.1% since March 31, 2011 – the adverse wealth effect is likely to be stronger in the financial industry than in any other industry. For north of 7% of total US compensation, labor income is challenged in expectation, which is likely to drag consumption.

Purely anecdotal evidence. This strong wealth effect exists in my household. Both my husband (equities) and I (fixed income) are in finance; and when markets are challenged, we tend to save more. And it’s not because our stock portfolio is showing holes – actually, we don’t have much of a stock portfolio – it’s because our household income falls in expectation via the ‘bonus’ component of financial salaries.

I haven’t seen any work done on this wealth effect channel – but it does beg the question of whether there will be further downgrades to the US economic forecast if risk assets continue to sell off.

Rebecca Wilder

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Human capital is where it’s at!

Continuing from my last posting, I stated the World Bank has seen the light. It has put out a report: Where is the Wealth of Nations?
Reason Online has an interview with the prime author Kirk Hamilton.

Oil, soil, copper, and forests are forms of wealth. So are factories, houses, and roads. But according to a 2005 study by the World Bank, such solid goods amount to only about 20 percent of the wealth of rich nations and 40 percent of the wealth of poor countries.

So what accounts for the majority? World Bank environmental economist Kirk Hamilton and his team in the bank’s environment department have found that most of humanity’s wealth isn’t made of physical stuff. It is intangible…Hamilton’s team found that “human capital and the value of institutions (as measured by rule of law) constitute the largest share of wealth in virtually all countries.”

The World Bank study defines natural capital as the sum of cropland, pastureland, forested areas, protected areas, and nonrenewable resources (including oil, natural gas, coal, and minerals). Produced capital is what most of us think of when we think of capital: machinery, equipment, structures (including infrastructure), and urban land. But that still left a lot of wealth to explain. “As soon as you say the issue is the wealth of nations and how wealth is managed, then you realize that if you were only talking about a portfolio of natural assets, if you were only talking about produced capital and natural assets, you’re missing a big chunk of the story,” Hamilton explains.

The rest of the story is intangible capital. That encompasses raw labor; human capital, which includes the sum of a population’s knowledge and skills; and the level of trust in a society and the quality of its formal and informal institutions. Worldwide, the study finds, “natural capital accounts for 5 percent of total wealth, produced capital for 18 percent, and intangible capital 77 percent.”

For under developed or undeveloped countries you can see what direction they have to go in. But what about our country? We have had discussions about infrastructure. We have talked about the need for education. When I skimmed the report (200+ pages), savings was a must in order to be able to invest in the intangible capital. We have debated the share of benefit a person receives from the country’s infrastructure and institutions based on the wealth and/or income they control. We always argue about where growth comes from such that it raise all boats. (Sing that jingle!) And there is the “free market” debate revolving around regulation. Oh that nasty governance issue! If only we hadn’t signed on to form a more perfect union.

My quick assessment of this report is that it is a testament to the misdirection of our policies. We do not make money from money even though we have been trying to. You did catch the reference to “labor”. These breakouts of wealth suggest that there is a bottom limit to taxation as taxation reflects our investment in us. In the study, European countries dominate the top wealth and England is not in the top 10. This report implies that the wealthy do benefit more from the country’s structure and investment because the majority of their wealth is from this “intangible capital”. The few of the wealthy have accumulated their wealth from the investment of the many in the intangible. It also means capital gains should be tax equal to labor if not higher.

Rich countries are largely rich because of the skills of their populations and the quality of the institutions supporting economic activity,” the study concludes. According to Hamilton’s figures, the rule of law explains 57 percent of countries’ intangible capital. Education accounts for 36 percent.

With only 18% of wealth from produced capital and less from natural resources as a country becomes wealthier, freeing up money to produce money as we have been promoting is very poor investment strategy it would seem when 77% of our wealth is from the human element. In a broad sense, we are talking about what ideology concerning the conduct of human life works best to produce wealth.

An economy with a very efficient judicial system, clear and enforceable property rights, and an effective and uncorrupt government will produce higher total wealth. For example, Switzerland scores 99.5 out of 100 on the rule of law index and the U.S. hits 91.8. By contrast, Nigeria gets a score of just 5.8, while the war-torn Democratic Republic of the Congo obtains a miserable 1 out of 100.

It is not just that we need to invest in education,or just have a legal system or just fix the bridges. These can be measured as noted in the World Bank Doing Business chart.

“Trust” seems to be the real intangible the report is talking about. We as a whole can be educated to the hilt, but if we can’t trust that our efforts will be put to constructive use, we have problems. Think habeas corpus, FISA, election fraud, threatening of the press, intimidation of speech, extension of free speech to none human entities, the equating of one voice-one vote to spending of one’s money, K Street project, etc. Think of the use of fear. If only a few are educated to the hilt or have access to the governance, we can not build capital.

If the country is 100 people large, but only 10 trust each other to do for each other, then how much wealth can they actually build if 93% of the 77% of intangible capital is related to law access (trust) and education (the removal of fear; trust) of the populace? But then, our founders seemed to have already reasoned this. Jefferson started the free education to including college!

So why should this report seem so “new”. This makes me think of the years of government bashing we have been hearing from the republican side. Reagan’s infamous “nine most dangerous words in the English language: I’m from the government and I’m here to help you.” It makes me realize we have to dump the Bush/neocon ideology here and in our foreign policy if only to remove the fear so that trust can return.

Mr. Hamilton’s example of the difference in thinking is in when he discusses pollution as a resource management issue:

It’s not a pollution problem; it’s a natural resources management problem. How do you maintain soil quality? How do you generate profits with the assets that you have, which in this case is land that can be invested in other things? The problem in China is they’ve figured out how to grow 9 percent a year pretty successfully but they’re now facing the environmental consequences of uncontrolled growth.

This is policy that he is talking about. Policy of what to spend on and policy governing relationships both boiling down to regulation. (What was that Milton quote the other day?)We’re talking government. I interpret this report as making a case that shrinking government to where it can be drowned in a bath tub is not the way to build wealth. The market will not solve our problems of growth for us. It is not the answer to Save the Rust Belt’s question of how to save the rust belt? We have to do it and we have to do it in a manor that is inclusive for that is the only way to maximize the “intangible capital”. It also means we have to do as Cactus is attempting to do; qualify our policy results related to specific ideology. Just charting to see what GDP is doing or just looking at supply and demand theory won’t do it. That’s just bench racing.

The World bank has done some qualifying and changed their ideology:

Hamilton: In the old days, we thought if you built the infrastructure then development would come-the Field of Dreams model of development. It turns out to be a lot harder than that.

Dare I suggest that the World Bank has discovered that an economy exists for our benefit and not for it’s own sake? Maybe they read our Declaration and our Constitution.

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