The Future Of The American Economy Depends On 2 Crucial Factors: Education And Technology

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Includes: DV, LNKD, SMT, TAL
by: ANG Traders

Summary

The best economies have always been the most technologically advanced.

High educational achievement is required for technological advancement.

America has been falling behind in education for thirty years.

The U.S. must attract world researchers and provide them with sane patent protection legistlation.

Our recent Seeking Alpha exclusive, "The Story of America's Economic Future, as Told by Demographics," outlined how America has the opportunity to capture a demographic dividend over the next three decades thanks to an addition of 100 million people to the population, and a persistent "prime-age bulge." In this paper, we deal with a likely headwind to this dividend; technological advancement and its foundation, education. We also provide several suggestions for investing in this knowledge.

The Education Effect

There is little doubt that the success of an economy is intimately tied to the level of technology. Technology itself is routinely misunderstood to be the same as science, which can, and does lead to inadequate funding levels for science.

Science (basic research) is the curiosity-driven pursuit of knowledge and understanding by way of the scientific method, while technology is the application of scientific knowledge to create labor-saving devices - in other words, tools. Not properly funding basic science, but expecting cutting edge technologies is analogous to demanding gourmet meals while refusing to spend money on groceries. Unless science is properly capitalized, technology will be reduced to cutting and pasting others' second-hand inventions, which historically has never been a characteristic of leading economies.

Good science is a creation of a good education system. If you want good science and technology, you better place education at the front of the funding line. The GI Bill that was put in place after the Second World War provided free education or training to any veteran that was accepted into an institution of higher learning, regardless of the cost. The Bill provided free tuition to any and all universities, including the private Ivy Leagues. "The scientists and engineers and teachers and thinkers who brought in the information age, who took us to the moon, who waged the cold war, you name it - all those men and women were educated through the GI Bill." (Ed Humes, as quoted in Marketplace)

In contrast to the post-WWII period of widely affordable education, the situation today and into the future does not look promising:

The cost of a university education has risen since 1972 at more than triple the overall rate of inflation. Between 2001 and 2012 funding by states and localities for higher education declined by fully one-third when adjusted for inflation. In 1985, the state of Colorado provided 37 percent of the budget of the University of Colorado, but last year provided only 9 percent. Presidents of Ivy League colleges and other elite schools point to the lavish subsidies they provide as tuition discounts for low- and middle-income students, but this leaves behind the vast majority of American college students who are not lucky or smart enough to attend these elite institutions. (Gordon)

The chart below from the Minnesota Private College Council shows the linear correlation between income and educational attainment.

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The relationship demonstrated above is not a reflection of a difference in abilities between low and high income students. This is evident in the chart below where high-scoring, low-income students have essentially the same college completion rates as low-scoring, high-income students. It comes down to having the financial resources to survive a college education without having to work part-time or interrupt your studies in order to work.

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America has some of the best educational institutions in the world, but these excellent institutions are primarily accessible only to the very rich. According to the OECD, U.S. citizens spend 1.4 percent of GDP on private university education, outdone in the G20 only by Korea at 1.5 percent. Those that can afford it, buy a better education.

The education that is left over for the general public is substandard, as evidenced by the most recent (2012) international PISA testing of fifteen year olds: America ranked 24th in reading, and 36th in mathematics, and 28th in science. At the college level, the ACT college entrance test organization reports that only 25 percent of high school students have adequate scores in reading, math, and science. This does not sound like fuel with which to launch a future technologically-driven economy.

In addition to the quality of education, there is now a concern with the quantity of education in America. The surge in high-school graduation rates from 10 percent in 1900, to 80 percent in 1970, was the single most important driver of economic growth in the last century. However, by 2000 the graduation rate had fallen to 74 percent. (Gordon) A discussion of the possible explanations for this drop in graduation rates is beyond the scope of this paper, and interested readers should refer to Murnane (2013).

We will say, however, that our own anecdotal observations over the last three decades have noticed a societal shift in paradigm when it comes to intellectual pursuits; a shift from respect and admiration for academics, thinkers, and scientists, to one of suspicion, mistrust, and even pejorative labeling of intellectually accomplished individuals (elites, nerds).

This anti-intellectualism is even evident in the political sphere where the popularity of politicians seems to increase as the inverse of their intellect and education level. We are arguing that society's anti-intellectual mindset is a bigger obstacle to increasing educational levels than money alone can overcome.

The chart below shows the effect that increased spending has had on educational outcomes since 1970. The chart clearly shows the total lack of demonstrable gains in academic outcomes despite the huge spending increase.

The most immediate hope lies in the importation (through immigration) of research and innovation from countries where education levels will be increasing into the future. Fernald and Jones summarize it well:

… growth in educational attainment, developed-economy R&D intensity, and population are all likely to be slower in the future than in the past. These factors point to slower growth in the U.S. living standards. Second, a counterbalancing factor is the rise of China, India, and other emerging economies, which likely implies rapid growth in world researchers for at least the next several decades. (Fernald et. al., 2014)

(Note: We disagree with Fernald et. al. when it comes to U.S. population growth slowing. As we pointed out in our Seeking Alpha article, The Story of America's Economic Future, as Told by Demographics, the U.S. will add one hundred million people to its population and the prime-age bulge will last through to 2050.)

America's continued technological and economic supremacy will depend on the immigration of highly educated researchers, and on the provision of a fertile landscape for innovation. The latter will only happen if the U.S. regains its political senses and changes the proposed patent reform legislation that has been hurting research and development for several years now.

As we questioned in a recent SA article, why would any individual or corporation spend time, money and intellect on R&D if there is no way of owning the work and profiting from it? Former Republican candidate Carly Fiorina realized the danger when she stated, "Some of our greatest inventors would be trolls under this law." The patent reform legislation in its present form, when combined with the problems in education, will result in long-term economic suicide for America.

America will be receiving a demographic dividend from its future growth in population, but the size and distribution of this dividend will depend on the scientific and technological preparedness of the country. It seems that the slowing of educational attainment that has been occurring since 1970 will continue for the foreseeable future, and without the importation of world-class research minds, and without sane patent legislation, growth and living standards could actually deteriorate for the majority of U.S. citizens.

On a more optimistic note, if history shows us anything, it's that in the end, the U.S. always seems to fix things even if sometimes it takes too long. If Americans can get rid of slavery as an economic model, then surely they can fix education and research. However, if they take too long fixing the present situation, the demographic dividend could become a demographic disaster; a huge prime-age cohort with no prospects.

How Do We Invest This Knowledge?

When America realizes it needs immigrants (like it always has), and it goes looking for foreign talent (as it must), then we would like to be invested in the entities that likely will have a hand in their creation. The Chinese are not as anti-intellectual as Americans, and they are willing to sacrifice in order to secure the best education for their offspring.

TAL Education Group (XRS) is a holding company for a group of companies engaged in provision of after-school tutoring programs for primary and secondary school students in the People's Republic of China (the PRC). The company is a K-12 after-school tutoring services provider in the PRC. The company offers tutoring services to K-12 students covering core academic subjects, including mathematics, physics, chemistry, biology, history, geography, political science, English and Chinese, among others, as well as, through its Mobby tutoring services, young learners tutoring services for students aged two through eight. It delivers its tutoring services primarily through small classes (including Xueersi Peiyou and Mobby tutoring services), personalized premium services and online course offerings. Its educational network consists of approximately 289 learning centers and approximately 267 service centers in 19 cities throughout China.

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Closer to home, the online education sector looks set to play a larger role as both professionals and the public become increasingly comfortable with the idea of learning online.

LinkedIn (NYSE:LNKD) purchased Lynda.com for $1.5 billion last year, a website offering different online courses, mostly in areas that can help professional students bolster their resume or enter a new field. Lynda.com is the type of education business that can help fill the education gap that exists at the moment and LinkedIn is positioned to profit from it.

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Educational tools is another area that should benefit from the increasing need to educate America.

SMART Technologies Inc. (NASDAQ:SMT) is a provider of technology solutions. SMART solutions include interactive large-format displays, collaboration software and services that enable teaching, learning and work experiences in schools and workplaces around the world. SMART operates through three segments: Education, Enterprise and NextWindow. The Education and Enterprise segments provide interactive displays and related hardware, software and services focusing on education and enterprise customers. The NextWindow segment provides desktop and large-format interactive display components. SMART offers a range of interactive display products, including SMART Board interactive whiteboards and interactive flat panels, the kapp digital capture board, LightRaise interactive projectors, the SMART Table interactive learning center and the SMART Podium. Its SMART collaborative learning solutions combine collaboration software with a range of interactive displays, software and services.

SMART is planning to consolidate its stock one for ten, so we recommend waiting until after the reverse split when the share price has settled down.

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DeVry Education Group Inc. (NYSE:DV) is a provider of educational services. DeVry Group's institutions offer an array of programs in business, healthcare and technology, and serve students in post-secondary education as well as accounting and finance professionals. DeVry Group operates through three segments: Business, Technology and Management, Medical and Healthcare, and International and Professional Education. The company's Business, Technology and Management segment comprises the operation of DeVry University; the company's Medical and Healthcare segment includes the operations of DeVry Medical International, which operates three institutions: American University of the Caribbean School of Medicine (AUC), Ross University School of Medicine (RUSM) and Ross University School of Veterinary Medicine, and the company's International and Professional Education segment includes the operations of DeVry Brasil and Becker.

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Along with the need for research talent, America must also provide reasonable patent protection for the technologies that arise from that research talent.

Wi-Lan Inc. (NASDAQ:WILN) is a patent licensing company. The company focuses on intellectual property, and manages and licenses the patent portfolios of various companies. The company operates in a range of markets, including automotive, digital television, Internet, medical, semiconductor and wireless communication technologies. The company develops and commercializes patented technologies, and licenses these inventions to various companies. The company enables patent owners to sell or license patented intellectual property. Within a partnership arrangement, the company offers a solution to owners of patents, and implements the licensing program on their behalf. The company's patent portfolio includes various technologies, such as lighting, remote diagnostics, vehicle locator, and media encoding and decoding. The company focuses on the areas of mobile Quality of Experience (QoE), streaming video optimization and physical layer (PHY) capacity enhancements for wireless networks.

Wi-Lan is in the process of recovering from several years of pressure that was caused by the uncertainty surrounding the patent reform legislation. We expect that the legislation will be modified to ensure that legitimate patent holders will be protected, and Wi-Lan, with thousands of patents and $100 million in cash (and a dividend), is well positioned to appreciate substantially.

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In conclusion, America's expected demographic dividend is in danger of becoming a demographic disaster because of a decline in educational outcomes which will directly affect its technological advancement. The only short-term solution that is visible to us is the importation of scientists and technologists from other regions of the globe, and a reasonable patent reform legislation that allows for technological innovation, while society reverses its anti-intellectual biases.

Sources:

Fernald, John, and Jones, Charles (2014), "The Future of U.S. Economic Growth", National Bureau of Economic Research, working paper no. 19830.

Gordon, Robert (2014), "The Demise of U.S. Economic Growth: Restatement, Rebuttal, and Reflections", National Bureau of Economic Research, working paper no. 19895.

Murmane, Richard J. (2013), "U.S. High School Graduation Rates: Patterns and Explanations," Journal of Economic Literature 51 (June, no. 2), 370-422.

Disclosure: I am/we are long WILN.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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