An Allegory for What Troubles Developed Economies

Metaphors can bring focus to complex situations, like what underlies the troubles of the American and European economies. My allegory conjures moons and tides to create an image that is easy to grasp but difficult to solve. It hints at why public dialogue about what to do about it has, increasingly, taken on toxic qualities.

To set-up the imagery, recognize that a mega-trend drives the economic disquiet that is so evident among voters; the return on labor is falling while the return on capital remains relatively high. Here, the return on capital is rents, interest, dividends and capital gains while the return on labor is real wages and proxies for a sense of security, belonging, and purpose.

The relationship reflects slow economic growth and rising income inequality. This trend has three interweaving drivers—technology, economic theory and the supply of labor. Their effect came into play in the 1980s and have gathered strength since.

Technology

Computers and telecom technologies made it easier to perform all manner of work and be more productive. However, and significantly, it also made it easier to relocate where it is performed. Once digitized, work took far less time and effort to recreate. And it was easily shared, willingly or not.

It is difficult to identify job categories where the income potential has not been adversely affected by ability to move the work elsewhere. Robotics and other forms of machine learning represent a permutation of the trend—they move work away from humans altogether

Economic Theory

Philosophers provide the intellectual framework for movements. Technology enabled schools of thought that led businesses to conclude that they didn’t need to do everything in-house. The initial expression of this idea was outsourcing. It first affected support functions like computer operations and payroll, then migrated to those that had been considered central to competitiveness, manufacturing and customer support. Offshoring was just a skip and a hop away.

The outsourcing and offshoring movements were aided by two other economic theories. One was that countries are net beneficiaries of free-trade. The other was that management’s principal duty was to maximize the wealth of shareholders—this exerted a negative effect on the return on labor for non-management employees.

Lean organizational philosophies are a variant of the idea that companies need not do everything themselves. They view activities that do not add value to the final product as superfluous and something to eliminate. They are especially popular among emerging companies, which foretells the future of work, given that these types of businesses are responsible for most job creation.

Supply of Labor

The Soviet Union dissolved in 1991. With the end of the Cold War, Russia, along with China, sought to transition from a centrally controlled economy to one that was more market oriented while minimizing political instability. Countries indirectly affected by the Cold War, like India, had adjustments to make as well. As these nations became export oriented, the supply of labor increased significantly. As a result, the battle for the commanding heights of the world economies shifted from one based on political ideology to one driven by market economies.

In 1992, the European Union was formed. Member countries came to share a currency; citizens were free to travel, live and work within the E.U. and commerce within it was free of restrictions and border taxes. In part, E.U. countries sought to emulate the United States of America. Additionally, they sought a response to rising imports from Japan and the so-called Asian Tiger countries—Hong Kong, Singapore, South Korea and Taiwan.

Similar trade concerns led to the 1993 NAFTA trade agreement between the U.S., Canada and Mexico. “Globalization” was coined to describe what was going on, increased integration of economies around the world.

The Allegory

Tribes were an early form of social order for unrelated humans. Often, tribal affiliation reflected familial connection; it always reflected shared interests.

Advantages of scale led to city-states, where tribal affiliation weakened in importance. Ancient Athens and Rome were city-states; similar clusters were common in Europe in the Renaissance period.

Over time, nation-states supplanted city-states because larger affiliations of common interests promoted economic and political influence.

Metaphorically, the tide of support rose to the nation-state level.

 

It remained there until the effect of technology, economic theory and an expanding supply of labor began to be apparent to developed economies. These forces, depicted here as rising moons, created a tide of support for trans-national pacts like the E.U. and NAFTA. It spurred other regional trade activity as well, such as the 2006 framework agreement between Mexico and the Common Market of the South (Mercosur) and the Trans-Pacific Partnership Agreement (TPP) negotiated by the Obama administration.

The highwater mark for trans-national solutions is depicted by the effect that the rising moons have on the tide of popular opinion. It was reached in 2016, when the U.K. voted to exit the E.U.—Brexit.

Shortly thereafter, Donald Trump was elected U.S. president. He promised to withdraw from the TPP, to cancel and/or re-negotiate NAFTA and to label China an unfair currency manipulator. He summed up his approach as America First, which mirrored his campaign slogan, Make America Great Again. In France, the leader of the nationalistic National Front party, Marine Le Pen was a finalist in the 2017 presidential contest.

Each of these political outcomes defied traditional thinking. Collectively, they suggest a dynamic—loss of confidence in trans-national solutions because they didn’t protect voters from the forces that pressure the return on labor. The stock and housing markets made it easier to overlook their effect before the Great Recession. The subsequent job losses, tight credit and collapses in asset values made it impossible to ignore. That pain was felt widely and optimism about the future sagged.

Dissatisfaction with the pace of the recovery left voters Mad as Hell but, in a peculiar way. They knew what they were against—the situation they were in. They knew what they wanted—restoration of what they had and more. However, they were unsure how to achieve it and so were the politicians who represent them.

Economic growth is measured by the growth in gross domestic product but it comes from increases in population and/or improvements in productivity. Few developed countries see population growth as their economic engine. And it is hard to increase domestic productivity when work can be easily moved elsewhere or, increasingly, to machines.

Conventional policy solutions were not designed to address the reasons for the declining return on labor. Lower income taxes, for example, may encourage economic growth but not necessarily domestic job creation—a business that hires locally and pays well can have customers willing to buy from foreign competitors who don’t. Fewer regulatory requirements benefit foreign and domestic producers alike—and fewer regulations can harm domestic providers of services that help businesses satisfy the requirements. Better training can make a workforce be more competitive, but the specter of lower cost foreign workforce will pressure wage growth and job security.

These challenges help explain why an undertow of tribalism increasingly colors economic talk, especially on social media. Keith Payne, author of The Broken Ladder: How Inequality Affects the Way We Think, Live and Die, put it well when he said

When inequality becomes too large to ignore, everyone starts acting strange. It divides us, makes us believe weird things and erodes our trust in one another.

The tide suggests that protectionist trade policies may gain support, which will fuel debate about how to change the effect of one moon, economic theory—little can be done about technology and the supply of workers. It will be a remarkable debate, since economies are more interconnected than ever. Also, because it will confront the grand premise of the dogma of deregulation, free-trade and shareholder wealth maximization…that economies work best when government gets out of the way of its participants.

A nation with high labor costs need not resort to protectionism. It can compete based on workforce training, infrastructure, legal process, capital markets and an intolerance of corruption. An economy can compete based attitudes of its participants—entrepreneurs and those who decided to back them; advisers, investors, marketers, suppliers, regulators and even those willing to buy new products. In other words, economies compete based on business ecosystems, not just parts. Unfortunately, a holistic approach offers little solace to those who feel most damaged by the declining return on labor.

Perhaps we need philosophers from across the political structure to describe what it means to live a good life in the times we face and what a vital, innovative economy might look like—one that allows for self-actualization by more people. Essentially, we need a framework to re-imagine capitalism.

+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

Karl M. Sjogren is the author of a forthcoming book called “The Fairshare Model, a performance-based capital structure for companies that raise venture capital via a public offering.”

It will be published about five months after 250 people pre-order a copy from Inkshares, a publisher that relies on reader support to decide what to publish.

Preview the first chapter at https://www.inkshares.com/projects/the-fairshare-model

Reduced Employer Payroll Taxes: A Direct Path to Job Creation

A mega-trend drives economic disquiet in developed countries; the return on labor is falling while the return on capital remains relatively higher. You intuitively sense this. Economist Thomas Piketty provided data to support it in his 2013 book, Capital in the 21st Century.

This trend explains the restiveness about anemic economic growth and rising income inequality that is so evident in western nations. Brexit supporters in the United Kingdom reacted to foreign workers who drove down wages. Declining prospects for a better life motivated U.S. voters to elect Donald Trump; immigration and free trade were the lightning rods he raised. Similar sensibilities have a following in France, as evidenced by the support garnered by Marine Le Pen, the nationalist party’s presidential candidate.

There are three interweaving drivers of the declining return on labor—technology, management theory and a greater supply of labor:

  • Technology: the digitization of information makes it easy to relocate work. It is difficult to name jobs where earnings growth is not adversely affected by the ability to move work elsewhere. Robotics and other forms of machine learning have a similar effect—they move work from humans.
  • Management Theory: Beginning in the 1980s, companies decided they didn’t have to do everything themselves. Outsourcing took root with computer operations, payroll and customer support then moved to manufacturing. Offshoring was a skip and a hop away. Lean organizational philosophies are a variation of the idea and they are popular among emerging companies, which provides an ironic foretelling about the future of work. Since the 1970s, these types of employers have been responsible for more job creation than Fortune 500 companies.
  • Greater Supply of Labor: The end of the Cold War led China and India to develop an export orientation and this created wage pressure on workers in higher wage countries. It is unrelenting; China, for instance, faces wage competition from other Asian nations while it competes with western economies for high skill work.

The political landscape looks startling different once you recognize the drivers. As different as the moment in The Wizard of Oz when the screen transforms from black and white to color. Essentially, optimism among those who rely on the return on labor has been eroding because it is easier to change where their work is done.

In the face of these three drivers, is it possible for today’s job market to look much better? Might protectionist trade policies have significantly blunted their effect? If so, might government administration of those policies made the economy less competitive?

We can’t change what these drivers have wrought–the genie is out of the bottle. Today, there are two forward-looking questions. What policies will enhance productivity and thus, economic competitiveness? And, what can be done to ease the social unrest that has been unleashed?

Since economies are complex, policy prescriptions tend to rely on indirect cause and effect. Advocates of lower income tax rates, for example, believe that the prospect of higher after-tax income will lead businesses to make investments that, in turn, create domestic jobs. The idea relies on plenty of speculation.  Those who favor investments in education also rely on indirect solutions—more education makes a workforce more attractive to employers and that, in turn, creates more and better jobs.

Indirect solutions rely on theory, logic and intuition for validation, however, it can be easier to find hard evidence for direct solutions.

There is a direct solution for job creation—one that can test the effect of lower taxes on employment. Simply reduce employer payroll taxes. If it costs less to employ people, theory has it that businesses will hire more of them, right? Employers and employees share the payroll tax burden.  Employees see their portion on payday but may not realize that their employer pays about the same amount. The self-employed pay both portions.

The employer portion is a vestige of an age when job creation wasn’t such a concern and when labor was a larger component of product cost.  Increasingly, the cost is in materials with low labor content and business infrastructure/overhead; the drivers of the declining return on labor also reduce its cost.

The relationship between taxes and employment is intimate at the payroll tax level; all employers pay it and all would benefit from a reduction. By contrast, a reduction in the income tax rate only benefits employers with taxable income. The correlation between that and the payroll is weak—companies with lots of workers may be unprofitable and profitable ones need not have many domestic employees.

Tax code reform is desirable for many reasons…but job creation isn’t a direct one. Cause and effect between income taxes and job creation is indirect and uncertain.

Furthermore, lower income tax rates don’t affect the three drivers for the declining return on labor.  They could, however, increase income inequality; the rates on capital gains is already much lower that the rates on earned income.

Another problem with relying on the income tax code to encourage job creation is that law-making is influenced by special interests. Congress is the Wizard of Oz of tax policy: a benefit of an employer payroll tax reduction is that legislators will not feel compelled to cry out “Pay no attention to the (lobbyist and campaign contributor) behind the curtain!”  That’s because there will be broad support for changes that encourage employment of U.S. workers.

How to pay for it? A tax on the sale of securities in the secondary markets. One paid when a stock or bond is sold by an investor to another investor (i.e., not when it is sold by a company to raise capital). Effectively, it would be a sales tax on transactions that generate the return on capital. A minuscule tax rate would cover it. A higher one could be used to help make healthcare and education more affordable, something that would ease workforce anxiety and position it to be more productive.

Direct solutions trump indirect ones. A tax on the return on capital to underwrite the needs of those who rely on the return on labor makes economic sense—it promotes job creation and growth. It makes political sense too: the net loser from the three drivers vote—foreign workers and robots don’t.

………………………………………………………………….

Karl M. Sjogren is writing a book about an idea for a performance-based capital structure for companies that seek to raise venture capital via a public offering. It is called The Fairshare Model because it balances and aligns the interests of investors and employees…capital and labor.

Storm of Beta, a behavioral finance website, interviews Karl Sjogren of the Fairshare Model

On October 10, 2015, the financial/economic education website Storm of Beta (www.StormofBeta.com) published an extensive interview with me.

The interview is here https://stormofbeta.files.wordpress.com/2015/10/a-penny-for-your-stocks-karl-sjogren.pdf

Storm of Beta is a website that focuses on financial and economic insights. Its “penny for your thoughts” series covers insights into behavioral finance and its implications and applications to financial markets. That focus brought The Fairshare Model to the attention of Storm of Beta, as it is nothing if not an application of behavioral finance to the public venture capital market..

Karl

Three new chapters address objections to equity crowdfunding

The September 24, 2015 update to the draft of The Fairshare Model book adds three chapters that discuss concerns that have been raised about equity crowdfunding. The principal focus is fraud, overvaluation and business failure. Particular attention is focused on the cause of failure and a common cause of it–management.

Other objections discussed as well such as unethical sales practices and the sensibility that is expressed as “why don’t we simply rely on VCs to meet the needs of young companies?”

See the resources tab!

NewFinance presentation on May 28, 2015

On May 28, 2015, I made a presentation on the Fairshare Model to the NewFinance Meetup group in San Francisco. The slide deck is under the Resources tab.

When I made my October 2014 presentation (slide deck under Resources as well), I had just one chapter posted online–what is chapter two in the May draft.

Now, fourteen chapters are online! Therefore, this latest slide deck has more to summarize. In particular, chapter ten on the Tao of the Fairshare Model (my favorite) and chapter five, Target Companies for the Fairshare Model.

Check out the submissions for the world’s 1st crowd-sourced book on FINTECH

Quote

What is the FinTech Book?  http://thefintechbook.com/

It is the 1st globally crowd-sourced book on FINTECH which will compile the insights and stories of the FINTECH community. [And the Fairshare Model is a candidate for inclusion]

Why is it important?

To date there only exits a fragmented source of knowledge on the Sector. This is reflected by the fact that the FINTECH sector is both recent in its development and wide in its scope. Therefore crowd-sourcing its content appears the best way to create a comprehensive book on the sector.

Who is the Audience:

Unlike other tech sectors the FINTECH industry will impact every one either directly or indirectly. Indeed if before finance was “needed by all but benefited a few” the FINTECH sector is now changing this by bringing back value to retail and institutional clients.

The FINTECH book aims to become an educational and inspiring piece of work targeted to entrepreneurs, financial institutions, decision makers, investors and consumers.

How does the Crowd-source process work?

There is a 5 step process for authors and the community spanning from March until July 2015.

  • Authors – Pitch their ideas by submitting via e-mail an initial 300 word article to the editors before the 30 April 2015.
  • Authors – Define their ideas by choosing one of the pre-selected topics.
  • Community – Throughout May the community can select the initial articles they wish to see in the FINTECH book

See Fairshare Model abstract https://medium.com/the-fintech-book/the-fairshare-model-90943089ae59

  • Authors – Selected authors must expand on their initial articles to have a 2,000 word chapter by the 30 July 2015.
  • Authors – Non selected authors will have their details and topic acknowledge in a special chapter.

The editors will then compile and edit the work ahead of the publication of the Book, due November 2015.

March 8, 2015 Update

The March 8, 2015 update adds two chapters. Chapter ten explores the potential for cooperation–cooperation within a company’s micro-networks of shareholders, employees, customers and suppliers–to provide a tool for competition. Chapter ten explains the Tao of the Fairshare Model. This is my favorite chapter and it will pride grist for thought for anyone with an interest is the defining characteristics of capital structures.

Here’s how chapter ten ends:

 This chapter concludes Section II, which began by examining a range of ideas about two macro-economic concerns that provide context for the Fairshare Model—economic growth and income inequality. It then considered how the ability to cooperate creates might offer diverse ways to address these twin challenges and how Fairshare Model promotes this. This chapter identified two structural elements that determine how a capital structure allocates uncertainty in an equity financing, something that will inform the discussion about economic growth, income inequality and equity crowdfunding. It also presented the most remarkable aspect of the Fairshare Model—it provides venture-stage companies a reason to offer public investors a low valuation. As a consequence, the model enables a well-performing team to create more wealth for themselves than if they use a conventional model and to create competitive advantage when it comes to managing human capital.
The tao of the Fairshare Model is clear—it is to balance the interests of entrepreneurial companies and public investors.
This section has been broad in content and philosophical perspective. Section III returns to narrower micro-economic matters, issues that come into play when venture-stage companies raise venture capital in a public offering—valuation, fraud and failure.

Karl

Jan. 29, 2015 exposure draft adds chapters on economic growth & income inequality

The exposure draft uploaded Jan. 29, 2015 moves the discussion about the Fairshare Model to a macro-economic level. The first two chapters in Section II deal with how the model fits into the on-going debate about how to spur economic growth, job creation and address growing income inequality.

All are topical subjects. Although the Fairshare Model is not designed to address any of them, they provide a macro-economic context for the micro-economic matters that were discussed in the first six chapters that comprise Section I.

I’ll add two more chapters to Section II in the weeks ahead. One  will deal with the potential for the ability to cooperate to be a competitive differentiator in the decades ahead and the other will deal with philosophic matters.

By the end of February, I’ll start Section III, which will lead off with chapters on valuation.

Karl

Jan 14, 2015 exposure draft of book has two new chapters

A new exposure draft of my book-in-progress is available in the Resources section. Two new chapters have been added, bringing the total to six. Chapter five will be of particular interest because it describes five types of companies that may adopt the Fairshare Model and illustrates scenarios for Performance Stock conversion.

I am grateful to those who comment on my book-in-progress. This crowdvetting process is very helpful to me on many levels.

Karl