US shifts to Brazilian standards

Painful and "Unexpected"

By Martin Hutchinson 

President Barack Obama's victory clarifies the political and economic landscape. Unfettered in his second term, he will now be able to pursue the economic policies he truly favors. To see their result, we can look at a country with an overlarge government, low domestic savings, endless "stimulus" spending financed by its development bank, relatively high inflation, huge inequality and accompanying tax evasion, state meddling in major industries, which trade off their political connections, a high level of corruption and an education system that does a poor job of preparing its citizens for the high-tech world. 

That country is Brazil. Sadly, Brazilian economic policies will if pursued for two decades or so produce in the United States a Brazilian standard of living. 

Obama's opponents during the election campaign accused him of wanting the United States to be more like the Western countries of the European Union. Certainly the EU's all-powerful bureaucracy and its commitment to various "elite" projects such as fighting global warming and universal healthcare appeal to him. But in reality, the United States is a very different environment from Western Europe, with a different demographic profile and many attitudes that have derived from its New World provenance. 

The European approach, of large government that cements in place an industrial structure built 50 years ago is not available to a country with a rapidly growing population and a shrunken manufacturing base. In any case, Europe has its own problems; the idyllic picture of happy French peasants bicycling around with strings of gourmet onions around their necks is already hopelessly outdated. 

The tendency of US living standards to converge towards Brazilian ones is a product of globalization, and a natural result of economic arbitrage in a world of excessive and growing population and ever-easier communications. The world's average gross domestic product (GDP) per capita, on a purchasing power parity basis, was $11,640 in 2011, just below Brazil's $11,719, and somewhat below Bulgaria's $14,603 or Malaysia's $15,589. If Brazilian labor is equivalent in quality and other factors of production to US labor, then US GDP per capita of $48,442 is bound to converge on it over time. 

The reason for the US superiority in living standards is not the country's abundant natural resources - otherwise Argentina would be among the world's richest countries. It's the quality of its institutions and economic policies, which have allowed a massive investment in education and a level of high-quality entrepreneurship that is the envy of the world. 

Britain in the 18th century had the best institutions and policies in the world; the United States adopted them, and was then lucky enough, partly because of the continued existence of the "frontier" through the 19th century, to avoid the poisonous socialism that grew up in Europe's big cities. 

This factor may seem modest, but it is analogous to intellectual property or design excellence, which enable the stars in the pharmaceutical, technology and other innovation-driven sectors to enjoy returns far above the industrial norm for decades. When Apple unveils a new iProduct, it is fairly similar to other products already on the market or shortly to arrive there, but the company is able to command higher prices and enormously superior margins because of the excellence of its design and product features. 

However, Apple's margin superiority is not necessarily everlasting and is subject to erosion over time. Its early products in the 1970s and 1980s, notably the Macintosh, were equally ahead of their time, but struggled to make large amounts of money. Then the Newton series of products, introduced in 1993, were abject and expensive failures. However, Steve Jobs' return allowed the company's revenues, margins and stock price to soar once again into the stratosphere, eventually producing the iPad, a far more successful descendent of the Newton. 

Eventually, even the most successful companies lose their margin of superiority. Microsoft, which had such superiority in the 1990s, has now largely become commoditized. Polaroid, which enjoyed spectacular success with its instant photography in the 1950s and 1960s, not only lost its edge after its founder Edwin Land retired in 1980, it filed for bankruptcy in 2001. 

Similarly, Jobs' death last year is almost certainly going to lead to a gradual commoditization of Apple's product range and the descent of its margins and stock price to more normal levels. Jobs' successors at Apple, like Land's at Polaroid, are not stupid people, but in the long run they cannot preserve the company's unnatural success. 

A similar process applies to the United States. Its economic and constitutional set-up was greatly superior to its competitors, carrying it to an unimaginable superiority in wealth and living standards by the 1950s, aided by the self-destruction of its European competitors. This wealth was partly reinvested in college education via the GI Bill, allowing US living standards a further leap forward. 

However, the Progressives and the New Deal had already reduced the US advantage over Western Europe and the Great Society reduced it further, so by the 1970s, the United States was finding it increasingly difficult to preserve its living standards advantages against the rest of the world. Good leadership in the 1980s created a new ability to increase wages, so that by the late 1990s, with the United States having invented the Internet and much of modern communications, and the post-Soviet peace dividend reducing its overheads, its ability to charge a premium for its capabilities was restored and all seemed well. 

Since 2000, weak management has allowed the US competitive advantage to erode. Fiscal and monetary laxity has drained the US capital base, an advantage similar to the cash hordes of Microsoft, Google and Apple. The country's integrity has slipped; from 16th place on Transparency International Corruption Perceptions Index in 2011, with a score of 7.6, the country had slipped to 24th place in 2011, with a score of 7.1. 

Similarly, heavy immigration created a society with permanently high unemployment (when those "not in the workforce" are included) and inequality at a level the country had only briefly touched before, in the late 1920s. The result has been an 8% decline in median real wages, mostly in the recession since 2007 but continuing in the most recent years when growth had nominally resumed. 

This is why calls for the Republicans to abandon their opposition to immigration controls are especially misguided. High-skill immigration in moderation is highly beneficial to the economy. But very heavy immigration, even of the highly skilled, depresses job prospects and earnings for those in professions especially subject to it - which is why median earnings for college-trained software engineers are lower than those for college-trained lawyers, where professional restrictions to immigration apply. 

Mass low-skilled immigration, legal or illegal, inevitably puts pressure on living standards at the bottom of the scale. The barber in Boston is paid more than the barber in Bangalore because he benefits from geographical proximity to rich neighbors, but if large numbers of immigrant barbers move to Boston, his wages will decline towards the global norm. 

In addition, the presence of large numbers of immigrants puts pressure on the political system to adapt to the norms they are used to. In the United States of 1900, this did not happen; first generation immigrants were forced to assimilate to US norms and were given little political power until they had abandoned the collectivist nostrums of their home countries. 

However, today we rightly assimilate less brutally and encourage immigrants to preserve much of their home cultures. Hence, since a high proportion of immigration is Latin American in origin, there is a danger that political norms will be forced towards the corruption, hatred of the rich and caudillo cultures that have impoverished Latin America for the past two centuries. In other words, if US living standards converge towards the global norm, it is to Brazil and not to Malaysia or Bulgaria that the society will converge. 

Globalization is immensely beneficial to the welfare of the world economy in general, but most of its benefits accrue to residents of poor countries, as it provides them with opportunities to which they would not otherwise be exposed. If technological advance is rapid and rich country governance truly superior this will not matter much; rich countries' living standards will continue to advance even as poor countries' standards advance faster, and the world gets richer overall at a rapid clip. 

However, poor countries are catching up with US education and governance standards all the time, just as Apple's competitors are seeking all the time to erode Apple's competitive advantage. Hence, if the United States suffers a period of poor governance, an increase in the costs of government, a long-term distortion of its markets, a draining of capital by misguided monetary policy and a partial convergence on the inferior governance norms and higher corruption of poorer countries, its living standards will erode. 

Technological advances continue (as I wrote a few weeks ago, I do not expect their economic benefits to disappear anytime soon). However, such advances arrive in bursts, with periods of unimaginable change interspersed with periods of relative stasis and adaptation to past advances. If such a period of technological quiescence coincides with a period of erosion of US advantages in governance and capital base, the descent of US living standards towards Brazilian levels may be quite swift. 

For the rich, of course, it does not matter; they can enjoy themselves on Rio's Copacabana Beach just as easily in the Hamptons, albeit with some personal security problems. But for the poor, the middle classes and even aspiring professionals, electing governments of Dilma Rousseffs (the current president of Brazil) is likely to produce an economic decline that is both painful and unexpected.