Capitalism—The Best Game in Town
Most economists and analysts don’t deal with longer-term trends, which are harder to predict because the variables fluctuate and change over time. That being said, key capital allocation drivers are generally longer term by nature, drive capital preferences and, consequently, longer-term capital returns.
In this piece, I want to address these longer-term factors and provide my thoughts around changes I believe might have a profound impact on future financial asset preferences and performance.
Free, Market-Based Systems and Processes Necessary
I have reached the conclusion that, over the long term, capitalism works. It does have flaws—unfettered capitalism is rather savage and at times is not inclusive.
But if the main driver of any societal economic system is the extension of life expectancy not just for some, but for all, including not just how long all live, but also how well all live, then capitalism, as opposed to strong centralized government-controlled systems, has proven to be the best game in town. Capitalism has proven over the centuries to be the best-known economic system to create societal wealth, and that wealth is used for research/development of better and longer livelihoods for mankind.
William Bernstein “Birth of Plenty”
A number of years ago, I read William Bernstein’s book “The Birth of Plenty,” in which the author outlines the main factors, or characteristics, that successful societies have shared. According to Bernstein, there are four characteristics that drive longer-term worker productivity trends, which contribute to societal wealth creation and drive improved livelihoods.
According to Bernstein, these four factors are:
- An acceptance and enforcement of private property rights
- A realization and acceptance of “scientific methods”
- An establishment and nurturing of effective and open transportation and communication systems
- The establishment and maintenance of effective, open public capital markets
Which countries epitomize these four long-term necessary drivers? In varying degrees, I believe the U.S., some countries in Southeast Asia and countries in Europe fit most strongly. On the other hand, countries with excessively high tax rates (not respecting private property rights), societal mores guided by religious beliefs (many in the Middle Eastern countries don’t believe in “scientific” methods), or countries in which private property rights don’t exist (communist countries) fail in these productivity tests.
A Look Back
Why do I say that a focus on worker productivity is important? If a worker produces more than they consume, then they create savings, which are then invested in society’s needs for future growth. Let’s take a look back in time for perspective.
In his book, Bernstein highlights the fact that until 1870, the vast majority of Americans worked on the farm, growing food necessary for society to simply survive. Most of annual production of the economy was consumed yearly with little left over for “investment” (savings) and longer-term growth purposes.
Along came the mechanization of agriculture through the development of the cotton gin, the tractor and reaping systems. Farmer productivity blossomed (real worker productivity blossomed), which allowed many to leave the farm, providing labor resources to fuel the industrial revolution. The world opened to increased worker productivity and rising life expectancy. This development occurred in both the U.S. and Europe. The increased societal wealth (worker productivity) went hand in hand with increased life expectancy.
|Long-term Data for Life Expectancy in the U.S.1|
|1860: 39||1950: 67|
|1875: 39||1975: 71|
|1900: 48||2000: 76|
|1925: 58||2020: 79|
During the 75 years from 1875 to 1950, life expectancy increased by 28 years. This rapid increase in life expectancy was accompanied by a strong increase in worker productivity, where workers’ output exceeded the cost of manufacture by a widening margin. This “profit margin” was invested, which brought about more productivity… you get the picture.
At the same time, scientific developments took form through strong research and development efforts. This research was funded by the “excess” productivity (savings) mentioned above. The four factors mentioned, which again according to Bernstein are necessary for productivity to rise, led to this period of rapid increased life expectancy and, I would argue, better, more comfortable lives.
Without the maintenance and nurturing of these four factors, societies face slower wealth creation and slower overall improvements in life expectancy and experience. The economic “pie” grows more slowly. Therein lies one of my views: With today’s increased focus on factors that invade private property rights, society can expect to see a period of lower-than-normal economic growth and lower worker productivity gains.
Benefits of High Productivity Levels and Open Trade
In the past, I have written at length about my view that the world’s including the GDP growth of the U.S. won’t live up to our experiences from the recent past.
I recall periods early in my career when double-digit inflation was present and interest rates eclipsed 15%. Recently I was involved in a conversation with my wife about the most meaningful changes the world’s economy has experienced over the last 40 years.
One of the most meaningful changes that took place was the blossoming of global trade activity, the systemic lowering of inflation pressures and, consequently, the lowering of the cost of capital. This factor has, over the last 40 years, gone hand in hand with a massive lowering of “deep poverty” rates on a global scale. As noted in the chart, there are now about 600 million people living in deep poverty as compared to 1.9 billion in 1990. And this is over a period when global human population increased from 5.3 billion to 7.8 billion people.2
Deep poverty rates have dropped from 35% of the world’s population to 8%. Deep poverty has been eliminated in Asia over this 30-year period. Worker productivity growth blossomed in many emerging economies over this long period, which was financed through the opening of the world’s financial system.
We need to understand that productivity growth has, over the long term, led to a massive broadening of societal wealth, which has helped drive more than a billion people out of deep poverty. For those who say capitalist systems work only for the few and exclude many from participating, I suggest they keep this fact in mind: Capitalist systems helped drive more than a billion souls out of deep poverty over the last 40 years.
Over that 40-year period, global trade activity grew from 37% of global GDP to a peak of 61% of global GDP.3 We have since seen a contraction in the importance of trade to GDP activity. Trade-to-GDP activity fell to 52% of GDP in 2020.4 This is a changed trend, which runs counter to the period of massive poverty reduction.
From a political standpoint, I suggest the pro-globalization movement was driven initially by the Reagan/Thatcher leadership teams, which were focused on lowering the reach and power of centralized government control pressures and increasing global trade, which importantly drove global inflationary pressures to the downside, just as the classical economist David Ricardo theorized in his comparative advantage concepts.
Higher Inflation Factors Taking Hold
As noted, it appears globalization trends have been reversing as nations focus more on “nationalistic” trends. Politicians around the globe have caught on to the sentiment of voters that “I have been left behind in the trends that have made so many others better off.” Nationalistic trends are present in the U.S., certain segments of Europe, Russia and China—not to mention the more radical end of many Middle Eastern states.
A significant majority of the world’s productive capacity is being negatively affected by these trends, which, in the end, lowers globalization, raises inflation and ultimately lowers “real” income growth levels. Recently, a Wall Street Journal article about inflation stated, “Increased flows of trade, money, people and ideas flourished with the Cold War’s end and China’s entry into the international trading system in the 1990s. Multinational companies using new technologies constructed global supply chains focused on driving down costs by finding the cheapest place and workers to produce products. This helped keep U.S. inflation stable. Over the 20 years that ended in 2019, U.S. goods prices rose an average of 0.4% a year, while services prices grew 2.6% annually, leaving “core inflation,” which excludes volatile food and energy prices, at around 1.7%.”5
Nationalistic trends are real as the world has experienced the pandemic, an increase in militarization in China and an outright war being waged by Russia on the Ukrainian people. These actions have increased concern by leaders of the business environment and is affecting thinking regarding investments and overall security trends. In The Wall Street Journal article, Richmond Federal Reserve President Tom Barkin was quoted as saying, “If you had all of your supply chain in just one country, you have to question why take that risk in a world where pandemics could hit or country relations could deteriorate or wars could happen between countries. It is difficult to predict just how durable such changes will be.”
Labor Markets Reflecting Changed Emphasis
The globalization factor that led to the period of lower overall inflation pressure was largely fueled by trade with both China and India, which have massive and cheap labor forces. I have read former British central banker Charles Goodhart’s book “The Great Demographic Reversal,” in which this influential economist argues that low inflation pressures from 1990 onward had little to do with central banking activities but were directly tied to the increase in globalization, which was highly driven by the addition of hundreds of millions of lower-wage Asian workers.
This activity held down prices of manufactured goods and benefited consumers in richer (U.S., Europe and Japan) countries. The trend leveraging the massive labor force in China, according to the Goodhart book, is rather mature. Moving workers from low-productivity farms to higher-productivity factories in the east has benefited China specifically and the world generally.
Now nationalism and militarism in China are on the rise, and the developed world’s leaders have become worried that China is becoming “un-investable.”
Even if one doesn’t agree with this concerning view, one has to ask, “Where is the next pool of one billion underproductive workers going to come from? Where is the next China that will fuel the next stage of globalization, worker productivity and lower inflation pressure?” I argue there isn’t another China to continue fueling the world’s need for ever lower-cost labor. Goodhart argues the same in his “Reversal” book.
Labor Markets—Fighting Long-Term Demographic and Productivity Trends
As noted, growth and lower inflation trends both benefit by rising labor-productivity rates. Higher inflation is more tolerable during times of high labor-productivity growth. Why? If costs are rising (inflationary), managers and owners don’t need to raise the prices of their products if their labor pools are producing more “stuff” to sell per hour worked. Along with long-term societal wealth creation, labor productivity is the great nonmonetary “elixir” with which to fight inflation trends.
Over the four decades of 1950-1990, U.S. labor productivity gained an average of 2.37% annually. Since 1990 annual labor productivity has averaged 1.44%. Since the turn of the millennium, the average has been 1.28%.6 As far as labor-productivity growth is concerned, the U.S. is moving in the wrong direction.
What of the other side of the labor output coin—that being the size of the labor pool? According to the earlier-noted Wall Street Journal article, the U.S. labor force has roughly 2.5 million fewer workers now than before the pandemic compared to what it would have been if the pandemic hadn’t happened, assuming the previous trend in workforce participation had continued.7
I argue the slower level of workforce growth may play into the sustainability of recent higher-inflation trends. Lately workers have been demanding higher wages and, in many cases, are getting the raises they desire, regardless of productivity growth. Why? Note the 2.5 million fewer workers mentioned above. Employers appear desperate to hold on to workers.
Part of the country’s current labor force problem can be attributed to immigration or the lack thereof. About a million people moved into the U.S. annually in the years after the 2007-2009 recession. The immigration pace started to slow while Trump was president and slowed rapidly while the pandemic was in full bloom. According to research completed by Giovanni Peri, a labor economist at the University of California, Davis, the U.S. now has 1.8 million fewer immigrants of working age than if the immigration slowdown hadn’t happened. This gives leverage to the existing labor force as employers scramble to find workers to fill empty slots.
Demographics Are Destiny
Some of the labor force issues noted above are cyclical and not secular in nature. There is an old saying in economic science—demographics are destiny. If one knows how many 40-year-olds you have in your country, you can comfortably forecast how many 60-year-olds you will have in 20 years.
|% of Population Age 65+ in the World’s Five Largest Economies8|
|Average - Big 5||20.5%||24.4%|
As noted, about 21% of the population of the world’s largest economies are now 65+ years old. These individuals have entered “retirement” age and probably are no longer productive but in many cases are now financially supported by the other 79% of the population. Going forward, this “load” will do nothing but get heavier. The size of this less-productive, more financially needy group is going to continue growing more rapidly than the population in general in all five countries noted.
The aging of economies is global in its reach. The trends aren’t as dire for many “emerging” economies because the average age of these countries tends to be younger than that of the developed world. But the global trends are unmistakable. The world is aging and, with it, labor forces are shrinking as a percentage of the total population.
So, we see the following definitive signs in the U.S. that:
- The developed world and the U.S. are aging, and labor force growth is being challenged.
- Longer-term U.S. data suggests labor-productivity growth has been slowing with few signs of serious longer-term improvement on the horizon.
Both of these noted factors lead one to the conclusion that our economy is facing a longer-term growth challenge. We are seeing signs that lead me to believe the economic environment going forward will be challenged with two main problems—low growth and increased inflation. The keys to both of these outcomes appear to be present and not just on a cyclical basis. My view of inflation has little to do with today’s oil prices or food costs. My view of lower-than-trend economic growth has little to do with where we are in the current economic cycle.
My views of both inflation and slow growth—read: stagflation—are driven by fundamentals much deeper than those cyclical considerations. The noted fundamentals of increased nationalization and demographics are more powerful than oil and food prices.
2World Population Review
5“Officials Fear Sticky Inflation,” The Wall Street Journal, August 25
65-year rolling data per the St. Louis Federal Reserve
7Research by Didem Tuzeman, an economist at the Kansas City Federal Reserve
8Ned Davis Research
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