Tackling Inequality

Yves Smith over at Naked Capitalism has a post with a rather spectacular statistic as a headline: "58% of Real Income Growth Since 1976 Went to the Top 1% (and why it matters)". That's a pretty devastating statistic though it clearly points to the salient development in the American economy, a widening, and dangerous in my view, social inequality.

That stat comes courtesy of the Financial Times' Martin Wolf who in turn is citing the work of the Indian born economist Raghuram Rajan, now a professor at the University of Chicago but previously the Chief Economist at the IMF. Dr. Rajan, who is a rather unorthodox economist even if he does lean right on regulatory reforms, has a new book out called Fault Lines: How Hidden Fractures Still Threaten the World Economy which is the subject of both Smith and Wolf posts.

From Martin Wolf:

In his book, Prof Rajan points to domestic political stresses within the US. Related stresses are emerging in western Europe. I think of it as the end of “the deal”. What was that deal? It was the post-second-world-war settlement: in the US, the deal centred on full employment and high individual consumption. In Europe, it centred on state-provided welfare.

In the US, soaring inequality and stagnant real incomes have long threatened this deal. Thus, Prof Rajan notes that “of every dollar of real income growth that was generated between 1976 and 2007, 58 cents went to the top 1 per cent of households”. This is surely stunning.

“The political response to rising inequality ... was to expand lending to households, especially low-income ones.” This led to the financial breakdown. As Prof Rajan notes: “[the financial sector’s] failings in the recent crisis include distorted incentives, hubris, envy, misplaced faith and herd behaviour. But the government helped make those risks look more attractive than they should have been and kept the market from exercising discipline.”

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Andy Grove on Jobs and the Need for US Industrial Policy

Andy Grove, the founder and former CEO & Chairman of Intel Corporation, wrote a short op-ed for Bloomberg News last week that takes a hard look at our serious unemployment question. Perhaps because it was published on the eve of a long holiday weekend, Grove's op-ed didn't get much discussion (Yves Smith at Naked Capitalism linked to it but that was pretty much it). That's regrettable because Grove, one of the driving forces in the tech boom of the past 30 years, covers some important ground asking some very poignant questions including one of the ones that has so troubled me over the past decade.

I am fortunate to have lived through one such example. In 1968, two well-known technologists and their investor friends anted up $3 million to start Intel Corp., making memory chips for the computer industry. From the beginning, we had to figure out how to make our chips in volume. We had to build factories; hire, train and retain employees; establish relationships with suppliers; and sort out a million other things before Intel could become a billion-dollar company. Three years later, it went public and grew to be one of the biggest technology companies in the world. By 1980, which was 10 years after our IPO, about 13,000 people worked for Intel in the U.S.

Not far from Intel’s headquarters in Santa Clara, California, other companies developed. Tandem Computers Inc. went through a similar process, then Sun Microsystems Inc., Cisco Systems Inc., Netscape Communications Corp., and on and on. Some companies died along the way or were absorbed by others, but each survivor added to the complex technological ecosystem that came to be called Silicon Valley.

As time passed, wages and health-care costs rose in the U.S., and China opened up. American companies discovered they could have their manufacturing and even their engineering done cheaper overseas. When they did so, margins improved. Management was happy, and so were stockholders. Growth continued, even more profitably. But the job machine began sputtering.

U.S. Versus China
Today, manufacturing employment in the U.S. computer industry is about 166,000 -- lower than it was before the first personal computer, the MITS Altair 2800, was assembled in 1975. Meanwhile, a very effective computer-manufacturing industry has emerged in Asia, employing about 1.5 million workers -- factory employees, engineers and managers.

The largest of these companies is Hon Hai Precision Industry Co., also known as Foxconn. The company has grown at an astounding rate, first in Taiwan and later in China. Its revenue last year was $62 billion, larger than Apple Inc., Microsoft Corp., Dell Inc. or Intel. Foxconn employs more than 800,000 people, more than the combined worldwide head count of Apple, Dell, Microsoft, Hewlett-Packard Co., Intel and Sony Corp.

10-to-1 Ratio
Until a recent spate of suicides at Foxconn’s giant factory complex in Shenzhen, China, few Americans had heard of the company. But most know the products it makes: computers for Dell and HP, Nokia Oyj cell phones, Microsoft Xbox 360 consoles, Intel motherboards, and countless other familiar gadgets. Some 250,000 Foxconn employees in southern China produce Apple’s products. Apple, meanwhile, has about 25,000 employees in the U.S. -- that means for every Apple worker in the U.S. there are 10 people in China working on iMacs, iPods and iPhones. The same roughly 10-to-1 relationship holds for Dell, disk-drive maker Seagate Technology, and other U.S. tech companies.

You could say, as many do, that shipping jobs overseas is no big deal because the high-value work -- and much of the profits -- remain in the U.S. That may well be so. But what kind of a society are we going to have if it consists of highly paid people doing high-value-added work -- and masses of unemployed?

It is my contention that economic inequality poses a mortal danger to democratic values and democratic societies. In the United States we have moved away from the notion of a relative egalitarian distribution of the national income and indeed championed policies that lead to increased inequality. This, in turn, is now putting pressure on our democratic governance. It is not by accident that we are seeing billionaires of the most unusual stripes run for public office, largely to defend their largesse and create what amounts to an aristocracy, or that we have a Supreme Court overturn a century of restraint on the corporate financing of political campaigns. Indeed these are the logical conclusions of a society that placed the desires of a few over the needs of the many. Avarice is triumphant, poverty evermore commonplace and American democracy under stress if not in serious jeopardy.


The Corporate Savings Glut

Yves Smith who runs the Naked Capitalism blog and Rob Parenteau who is editor of The Richebächer Letter and the head of the financial advisory firm MacroStrategy Edge have an op-ed in the New York Times that points to one of the significant developments in the global economy over the past twenty years, a switch in the behaviour of corporations which are eschewing investment in productive assets in favour of financial ones as well as passing on a greater share of profits to corporate executives and shareholders. This switch in corporate behaviour has significant implications for the global economy.

Over the past decade and a half, corporations have been saving more and investing less in their own businesses. A 2005 report from JPMorgan Research noted with concern that, since 2002, American corporations on average ran a net financial surplus of 1.7 percent of the gross domestic product — a drastic change from the previous 40 years, when they had maintained an average deficit of 1.2 percent of G.D.P. More recent studies have indicated that companies in Europe, Japan and China are also running unprecedented surpluses.

The reason for all this saving in the United States is that public companies have become obsessed with quarterly earnings. To show short-term profits, they avoid investing in future growth. To develop new products, buy new equipment or expand geographically, an enterprise has to spend money — on marketing research, product design, prototype development, legal expenses associated with patents, lining up contractors and so on.

Rather than incur such expenses, companies increasingly prefer to pay their executives exorbitant bonuses, or issue special dividends to shareholders, or engage in purely financial speculation. But this means they also short-circuit a major driver of economic growth.

Their op-ed references a 2005 report by Jan Loeys and David Mackie of JP Morgan entitled Corporates Are Driving the Global Savings Glut which found that rise in the corporate savings rate has truly been a global phenomenon cutting across all regions and including both financial and non-financial corporates. They also found that relative to the past, the financial sector has played "an unprecedented role in boosting corporate saving, as benefited from record low funding rates, and the impact that this had on interest sensitive sectors."

While we normally think of savings as a net positive, that's not the case here. What we are seeing a pilfering of corporate assets primarily for the benefit of their executives. Rather than invest in productive capacity, profits are being redistributed internally to upper echelon management and shareholders in part because taxes on retained earnings, a policy switch that dates to the Reagan era, are too low. Indeed, Smith and Parenteau find that policymakers need to create incentives for corporations to reinvest their profits in business operations. They suggest two approaches: one way to do this would be to impose an aggressive tax on retained earnings that are not reinvested within two years. Another approach would be a tax on the turnover of corporate financial investments that would raise the cost of speculating with profits, rather than putting them into the business.

Botswana: Between a Rock and a Hard Place

Few companies have controlled an industry as De Beers has controlled the diamond industry. De Beers, established in 1888, is the world's leading diamond company with unrivalled expertise in the exploration, mining and marketing of diamonds. Effectively, the company's history is that of the diamond industry. Among the founders of the company was Cecil Rhodes, the man most responsible for British dominion over most of southern Africa. Historically, the company has controlled 85 to 90 percent of the world's diamond trade. The company only sells its wares at limited sightings called "single channel marketing" where diamond merchants can only buy or reject diamonds sold in lots determined by De Beers. The price is fixed and the company is able to maintain its pricing structure by limiting the amount of diamonds that are made available. The size of the diamond industry is approximately $30 billion USD.

The company created the slogan "A Diamond is Forever" in 1939 to suggest an emotional value to diamonds that did not really exist prior. The goal behind that marketing campaign was to ensure that women keep their diamonds literally forever and to prevent a secondary market from being created. The campaign is perhaps the most successful ever creating a mass market for diamonds. The main use for diamonds is industrial. One factor that has helped De Beers maintain its control of the diamond market is that until the end of the Cold War, Russia kept its diamonds off the global market - engagement rings were just not a Marxist-Leninist value. In the past twenty years that changed with the Russians forming the Alrosa Diamond company, 90 percent owned by the Russian government. De Beers' share of the diamond trade has fallen to 40 percent. In 2009 Russia quietly passed a milestone this year: surpassing De Beers as the world's largest diamond producer.

Recently, De Beers' fortunes have sunk even further. Short of cash, the company had to raise $800 million from stockholders in just the past year. The onset of the global recession also coincided with a settlement with European Union antitrust authorities that ended a longtime De Beers policy of stockpiling diamonds, in cooperation with Alrosa, to keep prices up.

It is hard to shed tears for De Beers even as if the transformation of De Beers over the past decade or so is a remarkable and little-known story but the collapse of the diamond trade is having repercussions in Botswana, perhaps the best managed economy in Africa. The collapse of global diamond trade bodes ill, not only for Botswana's mineworkers and diamond cutters, but also the country's economy as a whole.  At independence in 1967, Botswana was one of the poorest countries in the world, with a per capita income of about $80 a year. Today, it is among the most prosperous countries in Africa, with a real middle class, and a per capita income approaching $6,000 a year.  Its economy is the diamond industry and the income from that industry has allowed Botswana to build Africa's longest-lived democracy after that of Senegal.

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SoS Clinton Delivers the Right Message in the DR Congo

Before her arrival in the DR Congo, the former Zaire, a coalition of 88 humanitarian and human rights groups issued a statement calling on Secretary Clinton to press the Congolese government and the U.N. Mission in Congo, or MONUC, to instate more effective measures to protect civilians and bring perpetrators to justice.

"The U.N.-backed offensive that was supposed to make life better for the people of eastern Congo is instead becoming a human tragedy," said Marcel Stoessel, head of Oxfam in DRC. "Secretary Clinton needs to make it very clear that US support for the U.N.'s efforts in Congo is not a blank check and that civilians should be protected."

UN peacekeepers have been backing Congolese military operations, known as Kimia II, against the Rwandan Hutu rebel group, the Democratic Forces for the Liberation of Rwanda (FDLR), since March. This support followed earlier joint operations between the Congolese and Rwandan armies against the rebel group.

As one of the main financial backers of the UN peacekeeping force, the US government has an opportunity to spotlight the deficiencies in civilian protection in a way that will reverberate within MONUC and the Congolese government and bring this nasty affair to an end. The eastern Congo is the world's deadliest conflict zone. The war in the DR Congo has been on-going now for 15 years in one form or another. The conflict has claimed an estimated 5.4 million lives, the largest loss of life since World War II.

The origins of the conflict lie across the border in Rwanda and the genocide committed there in 1994 when the extremist Hutu militias responsible for that tragedy crossed the border into what is now the DR Congo. Rwanda, now run by a Tutsi government, has twice invaded its much larger neighbor, in pursuit of Hutu militias aiming to finish them. Then in 1998, a five-year war - sometimes termed "Africa's world war" began drawing in Angola, Namibia, Zimbabwe, Uganda and Rwanda. The formal war ended in 2003 with the formation of a transitional government in the DR Congo and subsequent elections but the horrors continued.

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