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OP-ED: Will America tear itself apart in 2021?

  • Published at 02:43 am January 31st, 2021
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The American political system is one of words, not deeds BIGSTOCK

Biden will strive to reduce inequality, but he will make very little progress

Forecasting or guessing the future used to be fun. Now, it is terrifying. The Earth is over-populated with human beings, soon 10 billion persons. Apart from Canada, New Zealand, and a handful of European and Asian countries, no major country is governed with democratic values, integrity, and responsibility. 

Of the 10 largest countries by population, only Japan is in this category. The United States in particular has failed to achieve an acceptable level of governance. Nine nations are armed with nuclear weapons, which if used would cause massive destruction and deaths. We have discovered that one of the consequences of such a large population of humans with advanced technologies is that we are increasingly exposed to viral threats. 

More plagues will infect us. We are driving up the temperature of the planet with potential catastrophe. Our wealth and economic systems are built on complex supply chains that, if interrupted cause acute economic distress.  

We face a trade-off between wealth and risk. We have built financial systems that we do not understand, and that could collapse any time. We are unable to act in the face of these challenges. Our responses are limited and inadequate, and we cannot govern ourselves.  

Of course, humanity is not stupid. We have built a remarkable picture of the universe and how it works. We have used this knowledge to improve our lives. We are running on an explosive growth of science and technology.  We have the ability, as John Kennedy said in his inaugural speech in 1961, to manage these problems. Will we?

For much of the period after World War II the US provided an anchor to the world: Its powerful army restrained military conflicts. The world economy was stabilized not perfectly, but quite well by the management of the dollar. There was consistent progress towards free trade, resulting in strong growth of the advanced economies. The US gained from these conditions, but so did much of the rest of the world.  

Indeed, the greater part of the developing nations' population was lifted out of poverty; education and health improved almost everywhere. Conditions for the average man or woman had never been better.  

The 1980s onwards

Within the US, however, beginning about 1980, things began to change. Prior to 1980, the slow, steady growth of the middle class and a reasonable degree of social mobility led to a more or less free society where people, whatever their starting position in life, could make progress.  Tragically, the very bad situation of Black Americans was a stain, and little effort was made to remove it.   

The wealthiest 20% of society needed to be taxed enough to prevent their income from increasing in real terms faster than the other 80%. 

This need arose as the income of the top 20% was a combination of income from capital (property, stocks, and financial investments) plus their labour income that was high due to their greater education. The other 80% was earning largely labour income. 

Without proper taxation levels, the 20% would get further and further ahead of the rest. The social separation of the society would grow.  

This is what happened in the US: Reagan reduced income taxes on the top 20% more than on other groups. This was the beginning of the catastrophe that has struck the US. With increasing inequality and reduced social mobility, the bottom 80% of the society found themselves in a comparatively worse position.  

In absolute terms, economic welfare for the average household was unchanging. But this meant, for a large share of the population, things were getting worse.  

Humans tend to judge themselves relative to others, not on an absolute scale. I once asked the staff of Bangladesh Bank, would they accept their salary being doubled if everyone else in the bank received a three times increase.  All said they would reject the offer.  

Everyone else is doing better

A typical middle class view in America: “Everyone else seemed to be doing better than I was. I felt resentful. More and more of us felt themselves outsiders, looked down on by those better educated and wealthier. I came to resent African-Americans who seemed to get more from the government than I did. Why am I paying taxes so others can live it up?”  

A large literature was being published detailing conditions for 30% of the population that were finding life a downward spiral. Trump was the first politician who grasped this American reality.  

Trump’s view was that this situation arose from the European Union, China, Japan, and South Korea maintaining undervalued currencies. This, he argued, arose from the practice of their central banks buying dollars, building up foreign reserves to maintain their undervalued exchange rates, and selling goods to the US at prices far lower than the Americans could match.  

The result was the destruction of American industry. The remedy, Trump believed, was higher tariffs; given time, the American manufacturing sector would come back, American workers would go back to work in factories, and the destruction of the middle class would be reversed.  

This was his argument in 2016: The American government had failed to fight back against these undervalued exchange rates; the carnage this caused was featured in his inaugural speech, and he promised it would be overcome.    

But reality was more difficult. The American economic and political system wanted to consume and invest more than it had available, so it borrowed from the rest of the world to do so. This borrowing was the other side of the trade surpluses.  

Japan runs a large surplus and lends the money to the US to buy imports. Tariffs do not solve this; tariffs just raise the prices to Americans for the goods that are imported.   Trump was not interested in reducing expenditures, on the contrary, he increased government expenditures and lowered taxes, making things worse. 

The current account portion of balance of payments got worse!  

What Trump tapped into

Trump’s political campaign in 2016 mobilized a large number of persons who felt that they were left out of American progress. 

They were. This is the reality of the US. The oppression of the society by the wealthy 20%! Much of this wealth is inherited. Much is earned. Few of this 20% have served in the military or lifted a finger for their country.  

Most support the Republicans because they want their taxes lowered. The wealthy 20% talk a good game of social responsibility, but most are not prepared to make any sacrifice.  

Much of the American service industry is taking care of the richest 20%: Restaurants where you can pay $200 a person for a meal and double that with a little wine. Hotels and spas that cost $1,000/night. Fancy clothes to flaunt your superiority. Larger houses with unneeded space. More fancy junk, symbols of the wealthy.   

A tremendous number of persons labour to provide these services. Further, to make this system work, the rich have to persuade the poor to go into debt; it is the rich that are doing the saving. 

This works only by keeping interest rates low, but the poor remain indebted and low interest rates drive up share prices.  

America tearing itself apart

The reaction to Trump’s argument by Asians is: We are poorer than the Americans so we should be given a chance to compete in the American market. We cannot really do this unless we have undervalued currencies. 

The continental economists in Europe argue that the euro is not undervalued. However, they are aware that it is the protectionist policies of the EU that are the underlying reason for the difficulties that the Americans have in competing in Europe.  

This is why American is tearing itself apart. 2021 will see things get worse. The American political system is one of words, not deeds. Biden will strive to reduce inequality, but will make very limited progress. The inequality arises from the structure of the economy. 

What Biden will achieve

With the Senate having an equal number of Republicans and Democrats, the new vice-president has the determining vote in the Senate.  

Except that under Senate rules, one needs 60 votes in support to pass legislation. There is a little freedom to pass money bills with a simple majority, but permanent change requires 60 out of 100 senators to vote in favour. 

The Republican Senate will make it difficult for the Biden government to achieve anything. They will make funding the government difficult. They will refuse much of the legislation that Biden will want to pass. The American economy will stagnate or decline, and the stock market will probably fall substantially. Biden will try to compromise, but will find it difficult.  

In response to this assault of the Republicans, the Biden administration will carry out a detailed investigation of Trump and his cabinet and senior political officials. Trump may be placed on trial, one charge after another. These will cover his financial behaviour before he became president, his behaviour as president with multiple obstruction of justice charges such as perhaps inciting the January 6 riots. Trump will have enough civil charges and criminal charges to bankrupt him.  

The two political parties will tear each other apart. The Republicans making it impossible for Biden to govern as they did with Obama. It is possible the Republicans will split into two parties.  

The Democrats will break the rule that we do not go after the other party for their financial misdeeds. Despite Biden’s effort to achieve unity, the forces of American society are likely to increase differences. 

Biden will use his administrative powers to raise effective tax rates. He has many ways to do this without legislation.  He has many ways to tighten the rules on the financial system and try to end the exploitation of the poor by the rich through behaviour of the financial institutions.  

Biden will use his regulatory powers to curb the actions of the big energy companies. The large tech companies will be forced to surrender market shares in complex, long court trials. All of this will cause the stock market to decline in value. This will anger the wealthy 20%, further splitting the country.  

Growth will slow down

In this political conflict, the American economy will experience slow growth. Monetary policy has no effective power, as interest rates must be kept low. The Republicans will limit the use of fiscal policy to support the economy as they did during Obama’s presidency.  

In 2022, American history indicates the Republicans will very likely take control of the House of Representatives and the Senate. However, if the Republicans split into pro-Trump and anti-Trump factions then the outcome of the 2022 election could be different. The second half of Biden’s four years will see limited progress in tackling American problems.  

Trump did nothing for the people who are supporting him.  Indeed, the economy was running well before the pandemic struck. Wages of people at the bottom of the income distribution were rising quite rapidly and unemployment was virtually gone.  

His tax policies helped the rich. His approach was to run large government deficits at the time the economy was booming, increasing the government debt. It is hard to imagine a more irresponsible fiscal policy.  

It was based on the Republican’s false, but self-serving myth that lower taxes would accelerate growth so much that taxes would increase. (A recently released study by Hope and LImberg, LSE, concludes that tax reductions on the rich have no impact on economic growth or employment.)  

The Republicans will return to strong resistance to increasing government deficits. This is indeed the correct position. Financing programs that actually reduce the income and social inequality will mean higher taxes or reductions of military expenditure. 

A widening gap

The widening income inequality in the US means that the poor are not improving their relative position. The bitterness and sense of desolation continue. There is no obvious path to things getting better.  

The condition of African-Americans will not improve. I doubt any political party will be able to govern the country in the sense of solving these problems. 

Forrest Cookson is an economist who has served as the first president of AmCham and has been a consultant for the Bangladesh Bureau of Statistics.

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