Wealth and opportunity gap

The Origins of Wealth and Opportunity Gaps, and a Possible Way Out

Wealth and opportunity gap

1) If you grew up in late 1980s and early 1990s like me, you certainly remember ALF—the furry irreverent extraterrestrial featured in the NBC sitcom of the same name. At the beginning of the show, ALF crash-lands in the garage of the suburban middle-class Tanner family, who lives in the San Fernando Valley and gives him shelter for the next four years.

One of the most interesting things about the sitcom, apart from its lighthearted humor and hilarious gags, is the way in which it shows American suburbia. Coming from another planet, ALF soon learns to appreciate the charm of the late eighties consumer society, where almost everything can be ordered on the phone and delivered right away.

Even more important, the series allowed an unusual glimpse of the everyday life of the American middle-class that was increasingly getting squeezed during the Reagan and Bush Senior years.

There was less money and less security, and when ALF accumulated $6000 gambling debt, the Tanners had to struggle quite a bit to pay it off. In the series, loss of social status didn’t come across as a real danger, but it was looming on the horizon. Thirty years later the horizon has been reached.

2) Wealth and opportunity gaps in the present-day world is a real issue. In his book about the changing world order, Ray Dalio, like many other astute observers, argues that large differences in wealth distribution tend to lead to internal political divisions, oftentimes causing major social and political conflicts.

On a very general level, there’s little you can object to that. Unfortunately, Ray Dalio remains pretty vague on this subject. As opposed to the analysis of money and debt cycle and the factors responsible for the success of great powers he refers to the wealth and opportunity gap rather fleetingly (though it’s true that he has written somewhere else about why and how capitalism needs to be reformed).

At any rate, social policy and equal opportunity seem to be important enough to have a closer look at it.

3) When talking about wealth, opportunity and values, Ray Dalio contrasts what happened in the US and the UK during the 1930s with what was going on in Germany and Japan at the same time. However, he largely fails to do the same for the time after 1945.

If you want to understand what is happening now, a close comparative look at the last thirty years of the 20th century might be helpful. This period is widely referred to as the Age of Neoliberalism. The history of the idea itself is extremely insightful, but for our purposes here we’ll focus on how it found its way into politics and what kind of impact it made there.

To cut the long story short: in the 1970s, when many Western countries were in deep economic distress, several free-market scholars suggested that the socially-minded economic policies applied for forty years in the wake of Roosevelt’s New Deal were responsible for the problems governments were increasingly facing. They also offered a solution, which basically consisted in deregulation and tax cuts.

Whether their analysis and the measures proposed were accurate is debatable. The point is that these guys had a clear idea about what to do, and were successful in convincing politicians to listen to them.

But here comes the surprise: in some countries neoliberal politics were extreme, in others they were moderate. Sure enough, the outcomes were not the same.

4) While Ronald Reagan in the US and Margaret Thatcher in the UK interpreted neoliberal prescriptions in a radical manner, politicians in capitalist West Germany made rather careful adjustments that allowed to refloat the economy without compromising social security, union power and domestic manufacturing.

Present-day debates about the legacy of Reagonomics and Thatcherism tend to be lopsided. While Marxist-inspired scholars like David Harvey consider economic egoism fostered by neoliberalism as absolutely pernicious for public interest, free-market radicals from organizations like the Cato Institute and Mercatus Center praise this policy highly for creating economic growth.

If you look at it in a less passionate manner, you’ll realize that it’s difficult to come to a definite conclusion about the value of neoliberal prescriptions. The comparison between the UK and West Germany suggests, however, that many decisions made by Margaret Thatcher were not predicated on their economic effectiveness, but rather ideologically motivated.

5) The same goes for the politics of the Reagan administration. Now, it is true that in the face of the Soviet Union, which seemed still very powerful in the early 1980s, the US had to come up with an effective solution for its economic problems. It is also true that neoliberalism allowed to reach this goal and to shoulder significant increases in military spending, which arguably contributed to the demise of the Soviet Union.

In other words, reinforcing an economic and social climate where moneymaking was easy and laudable might have been justified at that point. You could see it as the price that had to be paid for winning the Cold War.

But once this goal had been accomplished, nobody thought about rebalancing the economy and society. And why should they? After all, communism was gone. The unravelling of the Soviet Union seemed to prove the case for an approach in which profit seeking was considered the single most important factor in human relations, and everything else was thought to be a derivative of it.

6) In the long run, the hidden costs of that approach have proven to be immense. A part of them is six feet two inches (188 cm) tall and is called Donald Trump. The rise of populism is, as the economic historian Barry Eichengreen has argued, a pretty common political response to economic hardship and social turmoil.

It is then no wonder that in an increasingly chaotic world with growing wealth and opportunity gaps, populist leaders have been winning elections and putting their ideas into practice. Their political activity spans the globe, and is unlikely to come to an end any time soon, even though occasional electoral defeats show that the populist surge isn’t invincible.

Ray Dalio is well aware of this particular dynamic. But the way he puts it, you might think that economic policies swing between different extremes in a cyclical and basically uncontrollable manner, like “the width of ties and the lengths of skirts.” It is, however, difficult to argue that there are apparel companies, designers and trendsetters who have a strong influence on what becomes fashionable, even though they don’t control it fully. This is also true for large-scale economic and social policies.

Neoliberalism was not a coincidence or a cyclical phenomenon, but a conscious choice of policymakers, which means that they are at least partially responsible for the rift in wealth distribution, political polarization and the lack of equal opportunity.

The huge debt the US government incurred in the 1980s, its massive tax cuts and loosening control over financial markets are elements of a deliberate policy that put up with paying a high price to achieve its goals.

To be sure, deregulation started before Reagan was elected, and went on long after he was out of office. A part of Ray Dalio’s success as an investor is closely connected to this lax legislation. And while it would be too easy to decry unrestrained speculation with financial assets as the root of all evil, it makes sense to ask to what extent the current wealth and opportunity gaps result from calculated decisions to leave the markets largely unregulated.

7) Add to that the digital revolution, the lack of a rival communist superpower that would make you pay more attention to your poor, and the increasing competition from the developing countries where people are willing to work hard for little money—and you’ve got the perfect storm.

Smart observers have long realized the self-destructive potential of unrestrained markets. The problem is that there’s no quick fix for the wealth, opportunity, value and political gaps of the last years. Neither is there an easy solution for reducing the immense load of public and private liabilities accumulated over decades. Unlike ALF, the US government has no spaceship it can lease to a set decorator of a science-fiction movie in order to repay its debt.

As a shipwrecked entrepreneur, you have of course the option to move to your Mom’s basement, eat rice and beans, and work your way back to sound economic condition. But what would happen to a country that would have to do exactly that?

All You Should Know about the Changing World Order

The Changing World Order

May you live in interesting times

(an allegedly Chinese saying, in fact not Chinese at all)

1) We live in extremely interesting times. The world order around us is changing quickly and profoundly. The COVID-19 pandemic and the recent Ukraine crisis are just two most talked-about elements of larger transformations that are taking place on our planet.

These transformations are both fascinating and full of risk. Understanding them is therefore the first step to riding the wave without drowning in the stormy sea.

2) Recently, the hedge-fund manager Ray Dalio has published a highly insightful take on the changes that are occurring in the world, as a book and as a Youtube video. From his vantage point as the proverbial Yankee up in capitalist Connecticut, he has suggested a framework that can help understand why great powers rise and fall, and what can be done to stop the decline.

While these ideas are not nearly as humorous as Mark Twain’s novel, they can compete with the ingenuity of its approach. There is no doubt, that Ray Dalio has a point. However, there are also parts of his reasoning that are not quite exact.

What do I mean by that?

3) At the beginning of his book, Ray Dalio suggests that you can’t focus on the details to see the big picture. He is of course right, but also wrong on that account – because the devil is in the detail. And while his model is sound on the whole, there are several aspects of it that deserve a closer look.

As an experienced investor, actually one of the best of his kind, Ray Dalio approaches problems from the economic perspective and tries to elaborate general models that will work under all circumstances. There’s nothing particularly wrong about this approach, but just like any angle it has its limitations.

4) Unlike economic models, history is full of exceptions and irregularity. The sheer amount of actors and factors is so big that it makes any accurate prediction extremely difficult. The comparisons Ray Dalio draws between different historical situations that are similar to our own are striking. But what about the differences?

I’m confident that they are at least as important as the features these situations have in common. If we want to get the right picture, we should pay at least some attention to them.

According to Ray Dalio, there are three big cycles (money and debt; internal order; international order) and eighteen key drivers that explain the rise and fall of great powers.

5) In the following weeks I will have a closer look at these cycles and key drivers. I will stress test them against historical evidence and other perspectives in order to see where Ray Dalio is right and where he is wrong.

History doesn’t repeat itself, but it rhymes. Even though Mark Twain actually never said that, it certainly makes good sense. Given that, it might be worth learning how to rhyme elegantly.

Next week we’ll be starting with the money and debt cycle. In the meantime, you might be interested in taking a look at this.

Negotiation, War and Peace

Back to the future? What history tells us about the Russian-Ukrainian conflict and the world of the coming decades

Negotiation, War and Peace

1) Since the beginning of the armed conflict between Russia and Ukraine in February 2022, both sides have referred to the enemy’s allegedly fascist nature, striving to frame the opponent’s actions as manifestations of the destructive and ruthless spirit displayed during the Second World War. In many respects, however, the war we are witnessing in Ukraine is more reminiscent of the wars of the long nineteenth century.

Taking a look at some of these wars can help us better understand what is happening now. Like many nineteenth-century disputes, the current conflict is marked by issues related to state independence, national identity, and rivalry among the great powers (and not so much by the extreme ideologies and totalitarian systems that set the context of the Second World War).

2) In the nineteenth century, the willingness to employ military force to achieve strategic and tactical goals was part of the political repertoire of any European and North American government. Its widespread use could be observed both in international and in internal conflicts. Italian unification in the mid-nineteenth century was accomplished through a series of armed uprisings, local revolutions and interstate wars. Apart from the Italians themselves, the French Empire of Napoleon III and the Austrian Empire of the Habsburgs intervened heavily to shape the outcome of the unification process in their favor.

In a similar way, the creation of the German Empire was the result of the complicated diplomatic and military game run by Otto von Bismarck in his role as head of the government of the Kingdom of Prussia. His political credo, known as Realpolitik, was based on the level-headed calculation of state interests and the deliberate use of armed force. Prussian victories against the Habsburgs in 1866 and Napoleon III in 1870 paved the way for the foundation of a German state governed from Berlin. Indirectly, they created highly a conflictive and messy European order that was conducive to the start of the First World War.

3) Further east, the Russian-Turkish rivalry led to numerous wars between the two empires. Between 1853 and 1856 the Ottoman Empire, allied with France, the United Kingdom and the Kingdom of Sardinia, defeated the Russians in the Crimean War. A quarter of a century later, the modernized Russian Empire conducted an extensive and successful military campaign, which forced the Ottoman Empire to recognize Romania, Bulgaria, Serbia and Montenegro as independent states.

In the Russian Empire itself, the Tsarist government had to face two Polish uprisings (1830 and 1863), which partially took place in the territories of present-day Belarus and western Ukraine. Here, complex identity issues clashed with disagreements over regional self-government, which peaked in secessionist demands from the Poles, who wanted to re-establish their own independent state. In both cases, the Russian Empire succeeded in defeating the insurgents, albeit with great difficulty and extensive use of military force.

Russian elites were not the only ones to face secessionist challenges and unresolved identity issues. In the US, socio-economic contradictions between North and South led to a bloody civil war (1861-1865). Meanwhile, the British Empire failed to accommodate the interests of the Irish within its constitutional system. When after several decades of unsuccessful attempts it became clear that home rule would not be achieved peacefully, the Irish started a bloody guerrilla war against the British (1919-1921), which ended in the division of the Emerald Isle and led to violent outbreaks until 1998.

4) At the beginning of the twenty-first century many Europeans have forgotten the extent to which the history of their own continent is marked by armed conflicts. Precisely for this reason, the war between Russia and Ukraine, which contains several elements of the conflicts mentioned above, has such a devastating psychological effect. Today, the existence of vast nuclear arsenals makes another world war an event with a prohibitive cost and disastrous consequences. Smaller-scale armed conflicts are, however, not only possible, but likely. The elites in the US, Russia and China know this. It is high time that it was understood in Europe as well.

The way out of this blind alley, as always, involves long and tedious negotiations with difficult compromises, which will leave all those implicated relatively dissatisfied. But given the possibility of continuous wars, creating an imperfect but functional order that would take into account the concerns of all the countries of the continent, including Russia and Turkey, is undoubtedly a better alternative.

Understanding the Ukrainian crisis: a talk at the UPF Barcelona

For all Spanish speakers: Recently, I’ve had the honor to participate in a talk about “The Ukraine catastrophe. Russia and the West,” together with the diplomat Eugeni Bregolat, the journalist Rafael Poch, and professor Tamara Djermanovic. During the event at the Universitat Pompeu Fabra in Barclona we discussed the keys to the conflict and the repercussions it will have on the global order. Click the video link below to learn more!