From the Notebook

           The word “Change” had gotten much of the attention during last Presidential election, most will agree that the theme of “change” helped President Obama to be elected.  Although the concept of change is often well received, change in reality is difficult, especially if you want to actually change for the better.

            One of the problems with democracy political system is that politicians are often awarded with praises and admirations for their policies when the long term effects are disasters, and people set out to save the country from disasters are wrongfully blamed. 

            I am always amazed when some well respected investment experts or economic policy makers declared that they did not see the coming of financial crisis.  This does raise the question of how much we can trust the “experts”.  Are they all focus on the fancy tricks and ignore the fundamentals completely?  For some, this is a possibility.  I remember reading about some comments of financial professionals, that no one actually are reading “The Wealthy of the Nation” any more, or at least not paying attention to it. 

            But how the simple fundamental principles can be completely ignored is still beyond me.  For example, I remember several years ago I heard investment professionals were citing average gains of stock market since seventies as ways for predicting future investment returns, but the increase of the stock price in average is well above the increase of GDP, where did it come from?

            Both the real estate market and stock market share common characteristics, that the supply cannot easily and instantly respond to the demand.  When demand for a product increases, adjustment to increase the production can be relatively easily made, so there would not be significant increase in prices.  However, in the real estate market, and stock market, supplies cannot easily and instantly made to respond to demand (lands are limited, and building projects takes long time to complete, and it take longer time to build a company than to increase production.) 

            In the recent history of United States, there are several policy changes that increase the demands on real estate market and stock market significantly, primarily started during the Regan Administration, some extending during the Clinton Administration.   Starting with interest tax deduction for mortgage payments, which seemed to help ordinary people obtain home ownership, while the real effect is tax payer is subsiding the profit of mortgage companies. 

            If you go back to some time in 1970s, the cost of a home is a fraction of what it is cost today.  Comparing to the average wage levels of the relevant times, it is far more likely a person or family in the 70s can save up and buy a house without mortgage than it is today.  So, even with interests tax deduction, the average person or family spend a lot more on the house in the price of the house, and with payment including interests.  This would not be a problem for the individuals if the housing prices keep on rising at a pace that can justify their out of packet payment.  So, the model of this format is that there will always be incentive to generate an up market, and when it is down, it could drop down hard. 

            The up trend started in the stock market started when mutual funds emerged, along with tax reduction on capital gains.  Same as the housing market, additional demands could artificially generate an up market, which in turn will attract more demands, to the results that stock prices could be inflated significantly.  The inflated stock prices mean high P/E ratio, and along with tax policies (capital gain taxes vs. ordinary income), people are more into speculative investment, than investment for dividends. 

            I just heard the analogy of slow sheriff and fast villains for wall street and its regulators.  I think the same kind of problem exists for the policy makers as well.  Obviously there are people that know exactly what going to happen (at least in the ball park).  This is evident by the proposal to privatize social security in George w. Bush era.  Obviously there are people knew that in order to create the up market, there has to be new demands.  Fortunately even in the financial sector many just thought it went too far.  With the fresh memory of stock market crash, the public rejected the idea as well, while the derivative market with complicated operation escaped the attention, became the new source of the investment scheme.

            The impact of the stock market on business is that companies focus more on M&A (merger and acquisition) than R&D (research and development).  In order to justify high stock prices, the pressure for cost cutting is always high, and increasing market share through merger and acquisition is an easier solution for maintaining high stock prices.  As companies relied more on market share, there will be less incentive for R&D for existing companies and less new companies will emerge.  The vigorous cost cutting and relying on market share naturally lead to large scale outsourcing as the political and technological environment of countries such as China and India improved, and living standards in these countries are low. 

            There is also another side of the story.  Historically in United States, most of the private companies do not undertaking huge projects without government supports (tracing back at least to the boom of railways).  World War II and the subsequent Cold War boosted government spending on R&D related with military projects which can be accredited for many of the technology developments (aerospace, electronics, computers, internet, etc.)  But since the end of the Cold War and the change of the front end of technology development, government involvement on technology development has been reduced significantly. 

            The artificial booms driven by housing and stock market also have significant impacts on talent pools.  From employment perspective, financial sector has been doing significantly well, while science and technology sectors had been disappointing (lack of funding translated into lack of employment), the pay grade is relatively low, and chance of employment had often been a question.  This obviously drove many people into the field of finance rather than science and technology (as these fields could share the people with certain natural abilities).  The expansion on financial sector and retraction on science and technology clearly reflected on talent migration.

            This leads to another Regan era policy change.  The two World Wars weakened Europe and strength and established the leadership position of the United States.  From culture and social development stand point, being a safe harbor during the Wars and against Soviet regime helped United States to quickly accumulate talents.  United States as a country established by immigrants had always benefited from this inheritage and culture, but talent immigrated to United States in these eras was literally a wind fall for United States. 

            Starting from the Regan years, the immigration policy change focused more on job protection than on attracting talents.  Since then, along with lack of funding for R&D, many talents in science and technology area had gone elsewhere, notability many Chinese and Indian students received education in US, and went back to establish and create environment for science and technology development. 

            Another damage of Regan immigration policy is even broader.  The policy changes largely restricted immigrants’ ability to work legally.  The restrictions made it more difficult for foreign students graduated from US education system (many of them are in science and technology fields) to find work and stay in US, then start the trend of talent migrating back to their countries.  But there is another unintended effect.  Making it illegal for immigrants to work in this country actually created a market for lower paid workers that not only taking away the jobs from the legal workers, but also reduced the demands from the consumer markets.  Coupled with economic crisis in Mexico, there are many people that are willing to take much lower pay.   This basically made the minimum wage policy useless, which not only did not reduce immigrant workers, but actually increase them.

            What is more is that this created a under-class that could significantly effect social development of United States.  United States has always been an immigrant country.  It is call the “New World” because for a significant portion of the people in the country, it is a new world for them.  The arrival of new world brings new hope for the immigrants, and the infusion of various cultures created dynamic culture development in the United States.  However, when millions of people are not officially recognized, and even the second generation could have significant obstacles in obtaining higher education, it divided the society and hurt the dynamic culture development. 

            Many people had been surprised by the louder voices of angry and anti-government crowd.  I think it is nothing new, although with a new twist.  When people experience repeative failures when they are playing by the rules of the society, there will be frustration, disappointment, and anger.  These will grow into hostile, adverse attitudes towards the society.  When the economy was in better shape, this group of people is smaller, and some political operatives had successful use racial tense and bias to attribute this problem as solely the problems of individuals.  But as many people (who recently were in the middle class) are falling into this state, the anger became more visible.  The disappointment, frustration, anger, and even rage naturally will be pointed at the government and those in charge of the government (as their disappointments are attributed to various, vague places).  Obviously they do not like the change that happening to them.  But without much of the understanding on what led to these changes that put them to where they are, and still in firm belief in the social division based on racial tense and bias, these people could be destructive force, not force to foster positive changes. 

            The lesson we learned here is bipartisan solutions are not necessarily the best (or even good) solutions.  It is obvious many of the policy decisions that led to worsen the condition of United States are bipartisan solutions.  From the surface, they benefited the special interest groups while they also seemed to provide benefits for the public.  But it seems that the policy makers did not poke under the surface to ponder the actually long term effects.  It artificial bloom helped to establish President Regan as a popular President in recent history, but it generated many problems that it is so difficult to solve (as many of effects are irreversible or at least very difficult to reverse).   

            One alarming so called bipartisan solution is in newly proposed health care reform policy.  The Republican proposed a policy to establish a government fund for high risk group.  I cannot remember another so obvious hand out.  Why don’t we just gave the insurance companies money and forgot they ever exist if we need any treatments?  There are proposed policies to force more people (mostly healthy and young people) to buy private insurance, and Medicare already is taking care of most of the high risk people (older people), if the government is going to take care of the only other high risk group, then what is left for insurance company to do other than counting money?  

            It is very disappointing to see how the so called business interests hijack the health care reform.  We see a lot of examples where democracy was not at its best.  It is a good (although costly lesson) that blindly relying on the format of democracy structure does not necessarily produce good results, people need to be alert and diligent in order to avoid costly mistakes.   

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