Prices, Debt, and Financial Risk
As discussed in past posts, the rise of technology and globalization contributed to income inequality and wage stagnation, but all is not negative. The idea behind the benefits of trade and globalization is simple: we each focus on producing stuff we are “better” at relative to other stuff and we exchange between each other.
Indeed, this is the basis of free exchange between individuals and countries alike. I “import” all the stuff I use by purchasing it from someone else, as I would be hard pressed to produce all the food, clothing, and other goods and services I use regularly. Access to global resources along with specialization allows the masses of all countries to access goods and services they would never have access to or would have access to at an incredibly high effort / cost / sacrifice.
Globalization and technology decrease prices and improve products. Indeed, a typical iPhone today contains an unbelievable quantity of free (or almost free) “services”, such as a built-in GPS, a global music library of all styles and country origins, sophisticated photography and video cameras, weather watching, financial market trading and analytics, apps to learn languages, Kindle book readers, Internet browsing capabilities, a flashlight, social media, and… oh yeah… I almost forgot… communication in all possible forms!
We can now fix our vision by a simple laser intervention at a price widely accessible to all — an impossible dream for the richest man in the world less than 100 years ago, as was the possibility of a short hop by plane to another country. Modern times have brought a lot of benefits relative to the past few thousand years, and things are not all bad. We have an explosion of information-rich technology allowing us to travel faster and safer, access all digital content of the world for a few dollars, and communicate fast and easy. In many ways, we could say that these are “good times.”
The issue is that the products we consume and produce do indeed create huge value and wealth, but few jobs in rich countries, and asset demand of the high-incomes are pricing out the masses from important markets. Of course, this is “normal” in a market economy. All resources must be allocated, and the price and wage allocation mechanism does indeed work quite well relative to other mass social organization systems. We are free to do what we want with our lives, free to spend lots or save lots, free to study a lot or not, free to start a business or not, and even free to just do as little effort as possible as well or to pursue non-income-generating activities such as rock climbing or traveling.
But we do have stagnating real purchasing power combined with the ever-increasing real price in markets that are quite “life-changing” such as health, education, and housing. Shelter, medical care, and tuition costs have increased at a pace that is significantly more than wages since the 1990s. This is of course in part due to relative demand that has increased in these markets while supply (and competition) has not followed nearly as much. But it still poses a challenge for the middle class and for demand (and growth) in the economy, as people will not spend more if they are maxed out and carrying huge student debt loads while facing stiff health care costs or risks, high real estate prices relative to income, alongside automation and offshoring. You can’t possibly expect sustained organic (non-stimulus) economic growth in such a context.
We sell the benefits of globalization by the “lower price” argument, and this is true. The issue is that not all goods are created equal. Low-price TVs, washers, and dryers don’t compensate for being priced out of education, health, housing, and stock markets. The increasing price in these important markets creates a growing divide between the have and the have nots who try to access them with ever increasing debt loads and financial pressure.
Financial stress and risk have moved onto the individual more and more, while the real net income has not allowed workers to handle this increasing pressure. The result is sluggish demand and a never-ending need for “macroeconomic stimulus” by deficit spending and central bank liquidity.
Stimulus may be OK for a few years or even a decade, but at one point one must realize that the bigger picture “doesn’t work.” There is considerable “inflation” except in the overall price level of goods and services, so the “consumer price index” does not properly capture the pricing out effect of the majority in markets that create financial pressure (“inelastic demand”), along with the debt buildup that comes with it.
The entire system “holds” with stimulus and debt, and debt is fine if future income can sustain it, but that is where the problem is — the higher income is not happening and is not likely to magically materialize, because the tight budget and debt reinforce weak demand, which reinforce weak wage growth, and the whole thing is reinforced by automation and offshoring, which fragilize workers and increase economic and financial risk. Productivity again does cause increases in real net purchasing power, but not for the masses anymore, because those productivity gains are created in scale-effects digital content and services in global markets.
Please note that I am NOT saying this is necessarily “unfair” or that rich people are evil. I am saying that this is a natural consequence of increasing income inequality, which itself is a natural consequence of globalization and technology. It is normal and inevitable that the real price of housing in large global cities prices out everyone but the highest incomes, simply due to relative scarcity: there is more demand than supply, so the price increases to “clear the market.” Disposable household income increased roughly with CPI (consumer price index), but university tuition, medical care, and housing increased considerably more, and the masses are starting to feel the pinch badly, as well as the entire economy… except the winners of globalization at the top…
We thus have decreasing accessibility to important life-changing markets for a huge chunk of the population stuck with stagnating purchasing power and medical bills in the USA being the number one reason for personal bankruptcies and financial stress.
In the USA, financial risk is proportionally more on the individual, who must manage health coverage and less breathing room in the case of a job loss, along with stiff education fees. This is supposed to be made better by telling people that they pay less for their TVs and computers or that they get more per paycheck than in other countries due to lower income taxes? Maybe there is partial truth to this line of reasoning, but maybe it is starting to sound hollow. It is a rough world indeed, and perhaps one that is starting to feel a bit too rough for the growing masses of frustrated people…
Before you start yelling for more taxes on corporations to finance “redistribution”, we should remember that what matters for the employer is total costs, not just wages. If workers and production costs increase and you have increasing non-wage benefits such as health insurance, pension, payroll taxes, profit taxes, and many other non-wage costs, then it is normal that “something has to give,” and that “something” is either wage growth or employment volume… or both.
EDUCATION, CONTACTS, AND EQUALITY OF OPPORTUNITY
In this context, what can the average person do to have a small piece of the growing pie? Obviously, it is not with a simple wage, as real wages have been stagnating for a long time. The most accessible and historically natural choices have been to own a house (which is physical capital) and increase their market value and general “employability” by education (which is human capital).
To a lesser extent, part of the wealth of ordinary people is also parked in stocks, either directly or via a mutual fund or pension fund. The market value of education has been rising due to the type of jobs created with the ever evolving technological and global context. This has pumped up the price of education in the USA, where education prices react more to supply and demand conditions relative to other rich countries such as Canada.
Although student debt is high and does cause issues for some individuals, the default rates are low for the students attending universities (they are higher for those in community colleges), even when taking on large debt loads, but these students do carry increasing financial pressure, hence decreased purchasing power for many years after graduation.
In the USA, student debt is a natural byproduct of the fact that the philosophy is for the individual to pay for what he wants and gets more of the returns of past risk and effort. The US tends to refrain from paying goods or services for the individual with other people’s money (taxes). Education is an investment requiring risk and effort, and there is indeed a significant return to university education, on average.
The lifetime income stream of university graduates is significantly higher than those of non-graduates, and this is perceived as a good aspect of education: anyone can go to university and then access a better lifetime income stream: equality of opportunity and “meritocracy.”
Although this is true, an interesting study by Claire Crawford and Laura Erve exposes an important twist: students of the same universities and of the same performance levels get significantly different lifetime income streams, and the difference is strongly influenced by the income of the parents.
Obviously, we all know that “perfect and complete” equality of opportunity is not possible. You are lucky right from the start just to be born in a rich country. You are also lucky if you are born into a stable and nurturing household in a safe city, as this allows better focus and efficient learning, which then helps to succeed in the labor market and life. The neighborhood you live in determines a lot of your social conditioning about school, success, and money, as does your gender and skin color. In short, although we are ultimately free of our decisions and actions and we are also responsible for our choices and their consequences, a LOT of our lifetime decisions and events are conditioned by “starting conditions.”
On average, richer families have wider networks of social contacts and this naturally helps their children. This is perfectly normal, of course. It just “is” — we all do this in one way or another, even if it is not politically correct to say it. Drama queens from the left and the right should stop pointing fingers and simply notice that everyone does it. What needs to be kept in check is excessive advantages for the well-connected, especially in politics and the public sector.
The issue is that with stagnating wages and the “contacts effect”, many individuals shy away from the financial risk of high student debt, especially if they are risk averse and liquidity constrained from the start. They are “priced out” and the result is the same phenomenon as in the old class-based world: the rich, connected, and more educated marry between each other, they send their kids to university and have a solid network of contacts to help them, which gives these kids an edge in today’s very competitive labor market, and inequality is passed on over time. Note that I did NOT say that the children of the richer families do not “deserve” their successes — most of them DO. They work hard, they get the grades, they manage the stress and pressure, and they succeed. It’s fine.
The issue is that the increasing price of education “prices out” an ever-increasing fraction of the population, and many don’t even think of trying at all, which compounds the issues already existing from the disconnect between stagnating wages and strongly increasing house prices and medical costs, along with economic risk.
EDUCATION MATTERS
Obviously, education at all levels is important for building human capital and the ability to innovate. But education also matters because it acts as a glue that makes the social fabric “stick.” It is where critical thinking should be encouraged, thus allowing open and respectful exchanges of ideas in a clear and organized way, challenging other opinions and our own. I say this with no bias, as I am aware that some teachers in all countries of the world tend to “brainwash” students on either the left or the right, feeding myths and broken logic on both sides. ALL these are unacceptable because they ultimately bring bad social and economic policies and false perceptions. Two negatives don’t make a positive.
The education system must provide the intellectual tools for people to develop judgement, decency, and a “sense of democracy,” which goes way beyond voting and “expressing your opinion” on social media. This allows the aggregate vote to represent, on average and in the long run, a collective intelligence that puts checks and balances on extremists, corruption, and political incompetence.
When you look at politicians in countries where there is high inequality alongside low-volume and low-quality education, a clear picture emerges: a weak and corrupt State, inept leaders, a bloated and inefficient public sector, and high taxes without the public services to show for them. This is Latin America in a nutshell. In Latin America, you have VERY good schools and universities, the only trouble is they are incredibly expensive! So, who attends those top institutions? The rich, of course… and what about the public sector? A few institutions are well known for high quality but can’t meet 10% of the demand, and the majority is shitty education and everyone knows it, thus putting a very low value on the “public sector” brand.
Countries stuck with stagnation, extreme inequality, and decreasing opportunity for the masses are feeding the insider-outsider divide and continuing the frustrations of those same people hoping to see some form of improvements in their daily lives and in their chances to make it.
Quality and accessible education at ALL levels is an important aspect of a successful society, both “socially” and economically. Small classes, low dropout rates, highly qualified and nuanced teachers at all levels, lots of “outside-of-class” help, support, and activities. In the long run, this brings optimal voting, sound institutions, good policies, and decency in the general population and social interactions — democracy as a social norm.
Since the big trends of technology and globalization are not about to change and will continue having the effect of concentrating income towards the educated and connected, and towards holders of capital, the only reasonable approach is to own capital, either in the form of stock or in the form of housing. Housing poses less risk of volatility, but is harder to access when wages stagnate and debts increase for decades due to liquidity constraints of most households trying to save enough for the down payment.
At one point, even if the increases in upper-incomes are “economically logical” due to globalization and technology, the general population starts to feel that the “capitalist game” has an excessive cost relative to its benefits. This may only be a perception, but perceptions matter. Capitalism has generated unbelievable prosperity for the masses relative to any other time in History, but it also comes at a cost: economic uncertainty and even social tension down the road.
The ups and downs of the business cycle create unemployment and financial risk. The normal requirement to “work for a living” means you can fall out of the loop due to sickness, old age, automation, offshoring, or any other bad luck (or laziness or bad planning, of course).
The stagnation of middle income wages competing for goods and services with the rich creates tension and frustration. At one point, it stops working and the whole thing goes down, with “anti-elite” movements seeking “change.” This entire context seems a bit explosive and certainly suboptimal, in my humble opinion.
Pascal Bedard
