“Inclusive economic and political institutions do not emerge by themselves. They are often the outcome of significant conflict between elites resisting economic growth and political change and those wishing to limit the economic and political power of existing elites.”

― Daron Acemoğlu, Why Nations Fail: The Origins of Power, Prosperity, and Poverty

After the global financial crisis, many people lost trust in the financial system. The Fed came to the rescue, and market prices recovered. Yet the sense of economic unfairness remained. Rising asset prices helped those with assets, while wages stagnated.

With COVID-19, again the Fed and global central banks came to the rescue for asset owners. Asset prices are back up. But for the 40% of Americans making less than $40,000 per year who lost their jobs, the pain will be long-lasting.

According to anthropologists, over thousands of years humans acquiesced to increased government authority if that government provided better security - safer lives, property security, defense, and disaster relief. In most developed societies, basic healthcare, food aid, and education also became part of the social contract.

Poor governance in the USA has been evident this year in COVID-19 mismanagement, heavy economic losses, and now loss of trust in the police. Economic security and healthcare are not a clear part of the social contract in the USA, so the financial crisis and COVID-19 mismanagement are disappointing, but they aren’t deal-breakers between citizens and the government.

However, if Americans can’t trust the police to protect them, and the police withdraw from rioting while the military is (unconstitutionally) called out to restrain protestors, then clearly the social contract is frayed.

We've already seen evidence of the tattered social contract in liberal U.S. gun laws. To enhance their own security, many Americans carry guns. With guns, the potential for violent social unrest increases. Individuals begin to self-justify vigilantism - performing “citizen’s arrest,” looting businesses, shooting suspects without a trial, etc… - behaviors in the news lately - because the police don’t help.

FEEDBACK SYSTEMS AND SOCIETIES

“Liberty needs the state and the laws. But it is not given by the state or the elites controlling it. It is taken by regular people, by society. Society needs to control the state so that it protects and promotes people’s liberty rather than quashing it like Assad did in Syria before 2011. Liberty needs a mobilized society that participates in politics, protests when it’s necessary, and votes the government out of power when it can.”

― Daron Acemoğlu, Balance of Power: States, Societies, and the Narrow Corridor to Liberty

In college at the University of Texas at Austin, I was in a small group of 20 students who majored in both Liberal Arts and Engineering. Our mentor (leading light) for this group was the Chancellor of the University system, a man named Hans Mark. Mark believed that every engineer should be educated in the arts and humanities, otherwise the world would be dominated by those who think only technically and build inhuman systems. He saw this first-hand as a Jew growing up in Nazi Germany.

He said to us one day as he reminisced on his career (I’m paraphrasing), “The USA is the only country in the world where a minority immigrant like me, born in a former enemy, could rise to become the Secretary of the Air Force.” As the conversation moved on to how a government could trust a foreigner’s (Mark’s) military leadership, he went on, “The USA is a stable country because its government is designed as an open feedback system. If the system sees a way of improving itself to grow bigger, it incorporates it. If it builds up too much pressure because something isn’t working, it lets off steam - the citizens vote to change it - and the equilibrium is restored. Countries like the Soviet Union had no feedback from citizens to government. When the system was too stressed from beneath, it broke down.”

I’ve often thought of this insight while watching China’s assertiveness in Hong Kong. Freedom is more than economic, it entails the ability for citizens to collectively guide a society towards an equilibrium. If they don’t fully trust the government, how hard will they work to build local economic capital and support the economy? However, the technocrats in the Chinese leadership do try to ascertain and respond to citizen feedback, and they generally do their jobs well once motivated. The same cannot be said of the governments - democratic governments - that responded poorly and slowly to the COVID-19 outbreak in China.

However, in upcoming elections we may see political leaders who made mistakes in underestimating the virus voted out. That’s the direction of current polls in the USA and Brazil, for example, with the public turning against leaders who mismanaged the COVID-19 response.

ANGER RISING

“Traditionally economics has ignored politics, but understanding politics is crucial for explaining world inequality.”
― Daron Acemoğlu, Why Nations Fail: The Origins of Power, Prosperity, and Poverty

In the below chart of GovernmentAnger expressed in the media about each country from 1999 - 2020, we see the US in the lead (orange line), by far. China has had a recent uptick due to Hong Kong, putting strain on it’s relatively feedback-intolerant system (green). The Eurozone has been declining (purple) as, remarkably, the Eurozone crisis appears to be contained and members are moving toward a joint fiscal guarantee on Eurozone bonds (financial union is slowly coming together).

The social feedback system is working in the Eurozone (purple). In the US it appears stalled with high tension (orange). In China (green line) the pressure is low but building.

Living in Europe, I see that Hans Mark’s story could have included Europe. Yes, there are housing projects with disadvantaged Surinamese immigrants. And Banlieues in France. But compared to disadvantaged areas of US cities, these are generally benign.

Two of my favorite reads over the past 12-months are “Why Nations Fail” and “The Narrow Corridor.” Like Hans Mark the authors lay out the detailed case that without social feedback (e.g., democracy of some form), citizens will rightly fear for their intellectual and physical property rights. An autocratic society can still function and advance for a long while, but it will lack spontaneous innovation and creativity. (It can have excellent government-sponsored innovation). Capital and entrepreneurs seep out.

In the USA lately we’re seeing a democratic feedback system that has built up pressure and is unable to discharge it. Why? Media algorithmically capitalizes on human emotion, harvesting profits by pressing the key emotional triggers (often anger, unfairness, and fear) of each individual. Personally-targeted news stories create dual realities. Each person believes narratives catered to their own self-interest, irreconcilable with other side of an issue.

Why the Market is Rallying

“[P]oor countries are poor because those who have power make choices that create poverty.”
― Daron Acemoğlu, Why Nations Fail: The Origins of Power, Prosperity, and Poverty

ECB announced it will buy $600 billion in bonds. The Fed is buying junk bonds (it they are offered). In both cases, the printers of money are providing a backstop on asset prices. What could possibly go wrong? Short-term it’s good for asset prices (“Don’t fight the Fed”). Long term, it creates more inequality - the haves get more, the have-nots less.

Income tax-based redistribution won’t solve this either. Ultimately, I’m sad to say, perhaps only an asset tax or a significantly higher estate tax could create a more equal playing field. The Asset Tax is the idea made famous by Thomas Piketty in Capital. As noted in the quote by Darren Acemoglu, Elites will fight it, but for the long-term heatlh of a society, there needs to be a more level playing-field for meritocracy to thrive, or ultimately stagnation sets in.

There is an asset tax here in the Netherlands, and it is quite unpleasant and unwieldly to entrepreneurs. I can’t imagine such a tax in the US, perhaps a heavier estate tax would fly however.

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