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Professor Lew Spellman’s teaches financial markets and institutions at the McCombs School of Business at the University of Texas. The emphasis is on analyzing and interpreting macro developments as they affect financial market pricing trends and turning points.  He is author of... More
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  • The Knockout Punch: Has America Turned To Socialism? 0 comments
    Dec 13, 2012 12:11 PM

    The Knockout Punch: Has America Turned to Socialism?

    Posted on December 7, 2012 by Lew Spellman

    In the days following the election there was a numbing silence. It was as if the body politic was dazed by a heavyweight champion's blow to the head. It staggered and sought clarity to understand what's to become of our future. Even the 24/7 financial market / economic blogosphere went silent in contemplation.

    What began to emerge from the cobwebs was a trickle of semi-coherent commentary of what was learned in the 1930s. Was it again a New Deal tilt toward socialism? References to past classicists such as Von Mises, Hayek, and H.L. Mencken were everywhere. Ayn Rand's Atlas Shrugged sold more than 1.5 million copies since the first Obama election - a startling comeback for a 55-year-old work of fiction - and sales are again soaring. It has also spawned a series of film adaptations.

    A realization set in that Obama's victory in 2008 was not a one-off reaction to the George W. Bush presidency. Rather, it validated the notion that the U.S. was now a left-leaning democracy in the European style.

    If there were any doubts, as the first order of business by Friday of election week, the president asserted that the election was a referendum revealing that Americans want taxes to increase for the wealthiest citizens but not anyone below the $250,000 income level. In his words, "Nobody - not Republicans, not Democrats - wants taxes to go up for folks making under $250,000," he proclaimed. The definition of the bad guys has hardened.

    While a very good case can be made for all taxpayers to pay more, apparently the imperative to redistribute income was more important than the goal of growing jobs and the economy or containing the fiscal deficits.

    The question is whether the goal to redistribute and regulate is a shift in fundamental American values or merely a reflection of the president's own agenda.

    While a morphing of the American willingness to redistribute is a socialistic ideal, it is also possible that the redistribution reaction to events that began to unfold in the early 1980s and could even be nearing its end.

    At that time, the globe was bifurcated into the developed world (the U.S., Europe and Japan) and a large number of countries that fell into the category of Less Developed Countries (LDCs). There were extreme differences in wages and income per capita.

    With wages differing between the developed nations and the LDCs - in some cases with a ratio of 100 to 1 - producers naturally would gravitate to the ultra-low-wage countries. But there was a catch: Tariffs deterring "cheap" goods from entering the high wage countries needed to be dismantled.

    At first, exports to the developed world proceeded in a trickle as producers sought cracks in the tariff structure, but such vast cost differences would lead to creative means of dismantling trade barriers.

    The major break in protectionism of goods to high-wage countries came in the form of multi-country treaties to systemically eliminate trade barriers among countries.

    NAFTA broke the ice and the post-WWII efforts to lower tariff barriers - the General Agreement on Tariffs and Trade - was replaced by the more effective World Trade Organization (WTO) with membership leading to a phasing out of trade barriers. Even Russia, the latest of more than 150 WTO participating nations, pledged to open trade and the momentum continues with a proposed U.S.-EU free trade agreement making headway.

    As trade opened and production and jobs gravitated to the low-cost producers, new terminology was invented. Off-shoring and globalization meant that LDCs were "emerging" and then "developing." All in all, Ross Perrot was right in his great debate with Al Gore. There would be a "Giant Sucking Sound" of jobs (and income) gravitating to the low-wage countries.

    Of course, as the process of globalization unfolded, wages in the formerly ultra-low-wage countries have subsequently risen while those in the U.S. have declined, leading to a convergence of labor costs across countries. We are not at absolute convergence, but enough movement has occurred so that the U.S. is not as relatively expensive a place to produce any longer. While the exportation of jobs is not over, we are beginning to see the end of the tide going out and a trickle of the tide coming in (see: Made in America Again).

    This is a process economists call Factor Price Equalization. That is, wages (the price of labor in all countries free to trade) eventually meet in some middle ground given the incentives to shift production to the cheapest source.

    How does all of this relate to the election and socialism? The distribution of income in the U.S. got fatter in the two tails: those made poorer by being forced to get in line with the ultra-low-wages competition, and those with capital or skills that could not easily be duplicated abroad, which were made richer. The two tails in the income distribution end up fighting it out through their respective presidential candidates.

    But globalism has also significantly eroded the middle class and shaped the election result.

    According to an August 2012 Pew Research Center report, "half of American households are middle-income, down from 61 percent in the 1970s. In addition, median middle-class (real) income decreased by 5 percent in the last decade, while (middle class) total wealth dropped 28 percent. According to the Economic Policy Institute, households in the wealthiest 1 percent of the U.S. population now have 288 times the amount of wealth of the average middle-class American family" - making that a less-than-ideal group from which to select a presidential candidate.

    The trends of globalization, wage convergence and the declining numbers and income of the middle class have been in process for almost the last 40 years, which is largely attributable to declining wage income. Moreover, wage income as a percent of total income has declined by about 10 percentage points. This was an enormous reduction in the labor's share of the income pie and accounts for the middle class decline.

    However, to compensate for this loss of punch1 300x227 The Knockout Punch: Has America Turned to Socialism?income over the same period, transfer payments by governments as a share of the income pie has increased by 10 percentage points, as shown in the accompanying graph.

    Since there is no free lunch, the transfers known today as entitlements needed to be financed somehow. The two logical options for addressing this issue were to tax and redistribute corporate profits or to redistribute from the president's targeted group. Given the political stand-off in our body politic, the expeditious means to sooth the labor income shortfall was to borrow on the credit of the U.S. and subsidize via transfers or entitlements. As a result, the Census Bureau reported that 49 percent of American families receive at least one government benefit.

    So here we are in 2012, and the punch2 300x239 The Knockout Punch: Has America Turned to Socialism?ability to continue compensating for the loss of wage income by borrowing and transferring has hit up against funding limits due to baby boomer entitlements coming due. The cookie is crumbling, but the election indicates the middle class still wants its cookie - and the ability to borrow someone else's cookie and pass it around has reached an un-financeable end. We have three choices: take a cookie from "rich folks" and pass it around, grow the number of cookies, or realize there will be fewer cookies. The redistribution argument won at the ballot box.

    Personally, I don't see Obama's reelection as an enthusiastic validation of a socialistic ideal but rather a vote to sustain labor's income share - but functionally it makes no difference.

    As Forbes contributor Bill Frezza summarized it: "America has now hurtled past the dependency tipping point … and an electoral majority happily voted for itself unlimited benefits that will supposedly be paid for by a productive minority - until that productive minority starts eyeing the exits."

    Since blatant redistribution squashes incentives to produce and grow, the incentive to redistribute also grows. Once headed down that slippery slope, it takes dire circumstance, not a threat of dire circumstances, to cause a rethinking and a redirection back to free market capitalism.

    China went all the way down the slippery slope. With economic misery as a result, in the late 1970s Deng Xiaoping asked the question of how to provide more food as its state-owned farms didn't adequately feed the population (despite 82 percent of the population working in agriculture). The "reform" was to allow state farms to sell and retain the proceeds of its agriculture production in excess of its socialistic quota. Look what incentives did for China. She has never looked back and likely is now more capitalistic than the U.S.

    In the election, Obama prevailed despite receiving 10 million fewer votes than he received in 2008. This was no apparent landslide for socialism. But the outcome was also a result of a Republican dialog that failed to demonstrate how making cookies includes a reward for the wage-earning middle class.

    Both the message and the messenger were off key, and as a result we could be headed down that same slippery slope that might not be reversed until there are not enough cookies to go around. It could be generations before "reform," such as in China, prompts us to reconsider entrepreneurs and the fruits of entrepreneurship. At that time, they would once again be considered heroes rather than villains but that could be far down the road.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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