The US Economy is a Casino, and Not Enough People Get a Chance to Play

With the Dow Jones Stock Index at an all-time high of over 30,000, and the S&P 500 and NASDAQ indices at similar historic levels, the reasonable conclusion should be that the end of 2020 was a boom-time in the United States. Presumably, people are prospering, and the economy is in excellent shape. Regrettably, even the most tertiary look at the current state of the US would disprove this – the country has been ravaged by a pandemic, claiming over 560,000 lives and 12 million jobs. Even before this, the US economy has failed to outgrow it’s debt burden by a large margin for over a decade, and has seen stagnant wages for half a century. This paper intends to reconcile this schizophrenic divergence between the capital markets and the real economy. Specifically, it will detail that 1) the US economy has had structural issues for half a century, 2) these structural issues were initially caused by globalization, which also increased inequality, 3) Governmental Policy and the Federal Reserve have done little to mitigate the damages of globalization and have exacerbated inequality, and 4) these issues have culminated in the US having a casino economy and a poverty trap.

1.   Structural Issues in the US Economy

There is a widespread misconception that before the COVID-19 Crisis, the US economy was in good shape – it was growing after all. Although the US economy was growing nominally, after adjusting for inflation and deficient spending, the economy hasn’t grown for quite some time and is actually in decline. Worse still, wages have been stagnant for half a century, while inequality has increased.

1.a. The Illusion of US Economic Growth

It is easy to look at a graph of the US’ GDP (the blue line in the chart below) and conclude that overall, things have been going well. Sure, there are some hiccups, and the slope of the line doesn’t appear to be as steep as it once was, but it’s hard to argue with exponential growth. The only problem with this conclusion is that the growth rate of federal government debt (red dotted line) has an even higher exponent:

Making adjustments for federal deficit spending and inflation (the grey dashed line above), we get a very different picture of the health of the US economy over time:

The US economy, adjusted for inflation and deficient spending, steadily grew from the mid-60s to the mid-70s before starting to head downward in the late-70s, when the balance of trade began to dip negative (as detailed in the next section). This downward trajectory continued through the illusory, debt-fueled, growth of the Reagan administration before bottoming out in the early-to-mid 90s. From there, the economy grew again, attributable at least partially, to a productivity boost from the IT sector2. Then, a slight dip occurs after the dot-com burst, with a slight recovery from 2004-2007, before falling off a cliff during the Financial Crisis. The steep decline in debt-adjusted GDP becomes more gradual from 2013-2019 before heading off a cliff again, into deeply negative territory with the onset of COVID-19.

Although an imperfect analysis, further adjustments for private sector debt, non-federal government debt, population growth, and monetary policy, would only serve to make the recent performance of the US economy worse, not better. The inability of the US economy to produce economic growth in excess of deficient spending since the Financial Crisis has perhaps most famously been analyzed by Larry Summers in his work on Secular Stagnation3. Most of the debate, and criticism4,6, of Secular Stagnation has been around his view of negative equilibrium rates; however, outside academic circles, this topic is irrelevant. The key underlying historical phenomenon that preceded the paper remains irrefutable – despite Summers’, Greenspan’s, and Rubin’s overly loose monetary policy during the 2000s that ushered the US from the dot-com bubble to the housing bubble, and further aided by disastrous levels of private sector borrowing, full employment and production capacity were never reached and real growth was marginal. Since then, the economy has been in a tailspin, producing below its economic potential3,5, with current levels of consumption only maintained by unsustainable government borrowing. Clearly something is very wrong with the US economy.

1.b. The Troubled US Labor Market

The labor market has the same misconception of health, aided by headline statistics that betray signs of decay underneath.

Although there has been slight growth in average wages in the US, these figures are deceiving for two reasons:

1.     Increasing levels of educational attainment for women have lifted averages wages8, and

2.     The average is skewed by extraordinary outlier growth for the top of the income distribution7

To adjust for this, we can look at real median weekly earnings for men, which have been flat for nearly half a century:

Issues extend beyond the wage at which people are employed, to the number of people employed as well. The US unemployment rate is similarly misleading, because to be counted as unemployed:

1.     A person must have been employed within the last 6 months, and

2.     Actively searched for a job within the last 4 weeks

This systematically underrepresents those who are structurally unemployed or under employed. To get a better sense for the true level of employment, the labor force participation rate (for men) must be examined, along with the rate of unemployed, marginally attached, and part-time but willing to work full-time:

This reveals a very troubling trend – the labor force participation rate has been declining, while the true unemployment rate has been trending, though erratically, upward. Even when further refining the labor force participation rate for prime-aged men between 25-54, the US has the lowest participation rate in the OECD9. This suggests that even at the stagnant wages, ever more people are having a hard time finding work.

1.c. The Rise of Inequality

Nearly all the gains that the US economy has made have accrued to those at the very top of the income distribution, both in the form of annual earnings and wealth.

Although wages have been stagnant for the average person, they have been rising for those at top:

 Indeed, the problem is not just that the gains have accrued to those at the top, but that they are accruing, exponentially so, to those at the very top, with the average real earnings for the top .1% being more than double those for the top 1%, over the last 40 years, and growing.

 We see a very similar trend for wealth as well, where the bottom 50% of the US population has almost no wealth at all, while those at the higher end of the distribution continue to gain share:

There is very clearly a growing divide between the haves and the have-nots in the US.

2.   Globalization’s Role in Structural Economic Issues and Inequality

In all the previously shown economic indicators, issues with the US’ GDP, labor market, and inequality generally start to arise in the late 1970s. In the next sections we will show how this correlates with a dramatic decrease in the US balance of trade, and how some misconceptions on global trade and poor planning for it by the US government, diminished the benefits of trade and exacerbated the costs.

2.a Globalization’s Impact on the US Labor Markets

After the 2nd World War, when most of the developed world’s infrastructure was decimated by wars and the developing world was not yet advanced enough for industrial production, American workers faced little competition from abroad. During this honeymoon phase, wages rose in the US lockstep with productivity. This lasted until the 1970s, when the US industrial base began to feel pressure from a recovering Japan and Europe. Once the US’ balance of trade begins to trend negative (red dotted line below), the pricing of labor starts to become global, and a divergence between productivity growth (orange line) and wage growth (blue line) begins, which has only grown over time:

The steady pressure on US’ balance of trade continued throughout the 80s as other countries, most notably the Asian Tigers, matured.  Then in the late 90s, the balance of trade plunges downward, likely due to the signing of NAFTA in 1994, the creation of the WTO in 1998, and China’s admittance to the WTO in 2000. A slight recovery in 2009 is attributable to the Financial Crisis and the shale revolution, with the trade balance under pressure yet again.

2.b. Misconceptions About Trade

An interesting, and important, phenomenon to note is that even though wages have stagnated, they have not fallen, which could be expected to happen in neoclassical economic models when lower cost labor provides competition. Indeed, this misconception was widespread during the Great Depression, and is one of the reasons the Hoover administration did very little to help people at its onset – there was a belief that unemployed individuals would lower equilibrium labor wages and that everyone would be able to find a job relatively quickly, just at a lower level. In practice, this never happened, because:

1.     Existing workers violently protest wage cuts – potentially explainable by people’s irrational loss aversion as detailed in Daniel Kahneman’s Prospect Theory

2.     Displaced workers might not have the same skill set as those who are not displaced and are therefore not substitutable

This lesson from the Great Depression was overlooked by economists and has caused significant structural issues in the US labor markets because provisions were never made for the onslaught of global labor competition.

Another widely touted, though incorrect, belief is that trade makes everyone better off. All that the neoclassical models of trade say is that trade will exploit relative competitive advantages and will allocate production to those who can undertake it most efficiently/cheaply, thereby maximizing total production, not necessarily production for each participant. It is known that there are many scenarios in which individual trading parties can become worse off14. For everyone to become better off, winners from trade need to compensate losers, which can take the form of:

1.     International Transfers – producers in a country with a comparative trade advantage can compensate producers in a country with a disadvantage for the right to trade, e.g. tariffs

2.     Intranational Transfers – producers who do have a comparative advantage within a country can compensate those who don’t for the right to liberalize trade, e.g. taxes

Without transfers and assistance in reallocating resources, it is very possible for a nation to lose from trade.

2.b How a Lack of Planning Created Problems

What many economists and politicians seemed to take for granted is that the US has a very high cost structure compared to the rest of the world. Globally the median income is $2,010 per year. Someone living at the poverty line in the US of $12,760, is nearly within the ~10% of global earners, and someone at the median income of $35,977, is in the top ~3%15.

Such a large disparity can only be maintained if the median American worker is more productive than 97% of the world’s population. For the first half of the 20th century, this was the case. People in the developing world lacked access to the basic necessities of industrial production, such as electricity, transportation infrastructure, and an educated and literate workforce. As the developing world developed, this gap has closed:

For the US’ high relative standard of living to be maintained, it needed to continue to progress, evolve, and innovate to stay one step ahead of the competition. Sadly, provisions were not made for this to happen. In fact, by many standards, including high school graduation rates and infrastructure, the US is falling behind, with devastating impacts on the economy and population. 

Through this lens, one could conclude that structural unemployment and a declining labor force participation rate are the result of more American workers becoming less competitive, at current prices, on a global basis as the rest of the world catches up. Evidence for this is supported by statistics on unemployment by education level, which shows a direct correlation between educational attainment and levels of employment:

Furthermore, we can see that individuals with lower levels of education, specifically an Associates degree or less, have experienced slightly declining real wages:

It’s important to note that although individuals with an Associate’s degree or less have seen declining wages, those with a college degree or more have, on average, seen increasing wages. Furthermore, there is a proportional relationship between the level of educational attainment and the amount of wage increase/decrease – with those with the most education seeing the biggest increases, while those with the least education have seen the biggest decreases.

This highlights the truth of globalization – it creates winners and losers. Specifically, for workers at the lower end of the educational spectrum in the US, they have seen both their wages and likelihood of employment decline, because they are generally not as competitive on a global basis compared with their cost. Conversely, those at the higher end of the spectrum have benefited from access to new markets in which to apply their highly specialized and rare skills. This has helped to increase inequality in the US, with the impact compound by the lack of preparation or infrastructure to redeploy displaced workers into other areas of the economy.

3.   How Government Policies and the Fed Failed to Prepare for Globalization and Contributed to Inequality

Although it was known by economists in the US that globalization would displace workers and industries, they were na?ve in their assumption that people and resources would magically be reallocated to higher-value industries, transforming the US from industrial economy to a digital one19. The dearth of policies to help displaced workers, combined with coddling, rather than taxing, the winners from globalizations, and extremely loose monetary policy, helped to create the US’ highly unequal society.

3.a Lack of Transfers, Retraining, and Rehoming

The gains from trade come from:

1.     The specialization of countries’ economies on the goods and services for which they are most competitive thereby boosting production, and

2.     The ability to purchase the displaced goods and services more cheaply from abroad. 

The undisputable fact is that trade creates winners and losers in an economy – those people and companies who are highly competitive on a global basis gain access to new markets in which to sell their wares, while those who are not are displaced. As previously mentioned, everyone is only guaranteed to benefit from trade if the winners compensate the losers through transfers from tariffs and taxes. This never happened in the US and is one of the reasons structural economic and employment issues persist.

Rather than easing trade restrictions slowly to foster a transition period, creating workforce training programs to re-train displaced employees, and housing assistance programs to enable displaced employees to move to other areas of the country where they could find jobs, people were left to fend for themselves with disastrous consequences. 

To this day, the US has no cohesive infrastructure to train citizens outside of a primary education, making it very difficult for the unemployed to attain the skills they need to find a job. Indeed, the US education system is a vestige of an agrarian society that disappeared over a hundred years ago, with a long summer break to enable children time to work the fields. This practice has persisted despite the overwhelming evidence that it is disruptive to the learning process20.

Beyond access to training, many displaced individuals needed assistance moving to other regions of the country where they could find work, which similarly never happened. Given the level of employment displacement caused by globalization, one could have expected a great migration to occur of people from the areas that lost out from trade to those that benefited. In reality, the opposite occurred:

Geographic mobility has fallen in the US, not risen. This is likely attributable to people in the Rust Belt and other impacted areas being stuck in a poverty trap – they cannot afford housing in the prospering cities along the coasts, and so are stuck in regions with limited employment opportunities. Overly restrictive zoning, which limits housing supply in the coastal cities who benefited from trade, has pushed prices in these regions to stratospheric heights and reduced employment. This has led some economists to conclude that the inability of people to move to high productivity cities where they can find jobs is the largest structural impediment to higher employment and economic growth21. Furthermore, the suffering felt by people stuck in withering ex-manufacturing towns is immense. So much so that the life expectancy in the US is falling because people in these regions, mostly middle-aged white males, are killing themselves with drugs, alcohol, and suicide at alarmingly high rates24.

Of course, programs to retrain and rehome displaced individuals need to be paid for somehow. Economic theory dictates that the beneficiaries of trade would happily pay higher taxes for access to new markets, so long as their gains from trade exceeded the tax, and that the redistribution would leave everyone better off. Unfortunately, at a time when the US was supposed to become more redistributive, it became less, with the tax rates falling dramatically for both the highest earning individuals and corporations:

3.b Corporate Codling

Although there was undoubtedly a corporate shakeout at the onset of globalization, because of this, a survivor bias has emerged – the companies remaining are largely those who have benefited from global trade. It therefore did not make sense for tax rates to fall, since those remaining are the “winners”. Indeed, corporate profits have outstripped GDP by a wide margin, starting ~2000 when China was admitted to the WTO:

The myth that the US needed to drop tax rates to stay competitive is not true. Corporations need to pay taxes in the countries where they are earned, not where they are domiciled, so there is little advantage to being in a low tax country. The only policy change that perhaps should have been made was the tax on foreign profits repatriated to the US, which largely does not exist in other countries25.

Beyond taxes, there is considerable evidence that US industries are becoming more concentrated, as measured by Justice Department’s HHI Index:

In addition, research suggests that the outsized power of ever larger firms is being utilized to extract rents in the economy, thereby gaining an ever-greater share27.

Perhaps no episode of corporate welfare is more glaring than the bailout of the financial sector in 2008, and nearly the entire corporate sector during the COVID Crisis. During the financial crisis the federal government spent around two trillion dollars propping up the financial sector through artificially low-cost loans and by buying trouble assets at artificially high prices. The issue is not so much that the bailouts occurred, they definitively needed to, but that they came at such a cheap price28. If a firm has mismanaged itself to the point of needing a rescue from the government, its shareholders should at least lose their equity and management should lose their jobs; they should not get cheap taxpayer money to pay bonuses and buyback shares. Even more egregious is the response to COVID, where through the CARES, Paycheck Prevention, and Response & Relief Acts, about $935B has been given freely to companies without the need to be paid back29.

Such outlandish accommodations to the otherwise prospering corporate sector has made the US’ economic system what economist Joseph Stiglitz has called Ersatz Capitalism – a perverse system where loses are socialized among the population, while gains are privatized, stoking inequality.

3.c Loose Monetary Policy

In some ways the Fed has been stuck in a double bind for the last decade or two – with serious structural issues growing in the real economy the Fed has had to print money to buy assets to keep interest rates low, asset prices high, and maintain employment, even though the perception of economic strength these actions impart help to maintain the status quo and prevent structural changes from ever being made.

The Fed has not only been imparting complacency in the political arena, but also it has extended to the financial markets. Every time the price of financial assets has dipped (the red line below), the Fed has printed money to purchase assets (the blue line) to keep their prices high:

These continuous bailouts have created a moral hazard in the financial markets. There is no incentive to buy safe assets since the Fed is guaranteeing they provide no return, and there is no risk to buying speculative assets since the Fed is guaranteeing their pricing levels. Therefore, the only apparent strategy is to use as much cheap debt as possible to buy risky assets, since the Fed, and broader government, is protecting the downside. To maintain this pseudo–Ponzi Scheme, the Fed has had to print six trillion dollars over the last decade, roughly equally split between the Financial and COVID Crises.

One fear many economists had with the unfettered printing of money in the US is that it would lead to inflation, which has not happened. An interesting nuance is that unlike many other instances of money printing such as Chile, Mexico, and the Weimar Republic, where the printed cash was being used to fund government fiscal deficits, the money the Fed has printed has only gone into the capital markets, not the real economy. Consequently, the US only has only seen asset-price inflation, not consumer-price inflation.

The fact that so much money can be printed with such little impact on the real economy is a clear sign that trickle-down economics is a failure. Considering that the bottom 45% do not own any stocks30, the $6T printed has mostly gone into the pockets of rich individuals and corporations who have a low marginal propensity to spend or invest – as evidenced by the low levels of inflation in the real economy. These six trillion dollars, likely the largest wealth transfer of all time, has not gone to the people who need it least, instead of those who need it most, stunting economic growth.

4.   The Casino Economy and Poverty Trap

In conclusion, the sad state of the US is that its economy is a casino. If someone can find themselves in possession of corporate equity, as a business owner or C-suite executive, through skill, luck, privilege, or some combination thereof, the gains are stratospheric. You are granted the title of “job creator”, with the Fed buying your financial assets thereby inflating their price, and the government is standing by to grant you cash gifts should anything bad ever happen – jackpot.

However, behind the glitz and glamour of the flashing lights and jubilant screams of the winners is anxiety and decay. The educated working class anxiously has stayed in the game, wondering if their number is every going to get called or if they will lose their shirts next, while the uneducated working class increasingly finds comfort in the bottom of a bottle or needle in the alley outside. Such is the state of a nation with downward social mobility, where nearly every cohort of people born 1976 and later has failed to out earn their parents:

Although the future is uncertain, it does not look bright. The US is a precarious casino because it pays out more to winners than it takes in from losers - an unsustainable proposition. Many are hoping that a new age of economic growth will miraculously appear to grow our way out of this malaise, but according to economists such as Robert Gordon, economic growth is likely to be slower than in the past, largely due to aging demographics, declining educational attainment, and increasing inequality31.

This has led to the conclusion that the US economic casino is in fact a poverty trap. Instead of pursuing the optimal strategy of compensating, retraining, and relocating the losers from globalization into regions of the country where they can find jobs and raise children who have goods odds of playing their hand at creating some innovation the whole world wants:

Wealth is consciously being given to a select few individuals with the hope that they will use it to create jobs. Unfortunately, the data shows that these individuals have no interest in spending it or investing it into the real economy, causing massive inequality and destroying the US’ economy, society, and democracy.

References

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24.  Case, Anne; Deaton, Angus. “Deaths of Despair and the Future of Capitalism”. Princeton University Press. 2020.

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28.  https://phys.org/news/2020-09-qa-bailout-financial-sector-great.html

29.  https://www.investopedia.com/coronavirus-aid-relief-and-economic-security-cares-act-4800707

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