Macro Thesis Update #1: Initial Draft

The latest version of the macro thesis can be found here.

The broad questions that this project is seeking to answer are:

Why and how is the "global dynamic" - i.e. the economic, diplomatic, and security relationships between nations - changing?
How will the U.S. respond to these changes?

The "Macro Thesis" is organized by major topic areas, each of which forms an important piece of a comprehensive answer to the above questions. Each topic area is in turn divided into a meta framework (in italics) followed by the application of that meta framework to the current situation in ways that shed light on the questions we are interested in.

As I read and learn more, this hypothesis will evolve. It’ll be updated regularly.

Demography

Demographics are fundamental to determining the trajectory of a society. The key assumptions underlying the nature of their influence are: 1) the production of goods, services, and capital in an economy ultimately comes from the aggregate useful activity of the people, 2) people exhibit different behavior patterns regarding consumption, production, and investment at different stages of life, and 3) those patterns of behavior are largely consistent across time and geographies.

The behavior pattern at different stages of life are as follows:

· Younger adults (between the ages of 25 and 45ish) form the primary consumption group. Traditionally, this group was in the process of family formation which drove a lot of consumption. They are relatively lower skilled, hence they earn less income. And their consumption needs mean they can only save a small portion of that income. Hence, they do not generate much capital for investment. But they generate the brunt of the demand that incentivizes the whole system of production.

· Older adults (45–65) represent the highly skilled labor. They are the most productive part of the economy and generate the highest income. Traditionally, they also consumed less per capita since the kids were on their way out by this point. Hence, they generated most of the risk capital for investment in the economy.

· Retirees (65+) are in the process of disconnecting from the economic system which they contributed into their whole adult lives. They do not produce and therefore do not generate income, and hence don’t generate savings for investment. They liquidate their risky investments and pour money into safer assets. Living off a fixed income, this age cohort does not add much consumption demand to the economy either. And they draw down on resources via healthcare and pension programs.

Nations’ demographic structures can be mapped using demographic pyramids. There are three major structural patterns that these pyramids can take: simple pyramid, columnal, and inverted pyramid. Any society, at any given point in time, will either be in one of these three structural patterns, or in a transition phase between them. The intersection between a nation’s demographic structureand the behavior of people at different stages of life will inform, to a significant degree, how that nation’s economy will perform going forward.

[For more on this demographic-economic-financial model, see the article profiling Peter Zeihan’s analysis.]

Much of the developed world today is moving inexorably towards inverted pyramidal demographic structures. Industrialization brought with it lower birth rates which are now pushing the average age of industrialized nations higher and higher. Several European and East Asian countries will be incapable of replenishing their populations without significant immigration.

Older generations significantly outnumber younger generations in these countries and a large block of these older workers will be moving into retirement within this decade. As they do so, they will move out of the “older adults” behavior pattern and into the “retiree” behavior pattern. This will lead to significant losses in productivity, consumption demand, and available risk capital throughout these economies. This will add powerful, supply-side inflationary pressures to the economy, both in terms of prices for goods and services and the cost of capital.

The U.S. exhibited slightly different reproductive behavior than other developed nations post-WWII. The Millenial generation in the U.S. is comparable in size to the aging Baby Boomer generation, unlike in many other industrialized societies. Hence, the U.S. is likely to experience some of the same supply-side inflationary pressures from the retirement of the Baby Boomers, but these pressures may be muted and transitory, as the Millenial generation will eventually be able to replace the lost productivity and risk capital.

The large Millenial cohort will also provide a significant quantity of demand to support American businesses and justify a potential build-out of American manufacturing capacity. It will also serve as an attractive consumer base for nations seeking to grow their economies via export, as one among a shrinking list of rich nations with a large consumption pool.

Technology

Perhaps one of the reasons that history only rhymes, rather than repeating itself, is that technology is always growing more powerful. Advancements in a nation’s technological abilities have enormous implications for how that society and its relationships will evolve.

Technological advancement can generate increased productivity for a country’s economy, increasing its efficiency of production and allowing consumer surplus to expand. The increased efficiency can improve the comparative advantage of the country’s exports, not to mention that the new technology itself becomes a highly valuable item to sell to others and leverage in trade negotiations.

The attractiveness of advanced technologies, and, perhaps more importantly, a demonstrable culture of innovation, brings investment capital to a nation which drives down the cost of capital and increases future productivity, launching a virtuous cycle of productivity gains.

From a security perspective, advancements in technology make a nation’s military stronger and more capable of defending itself and securing its interests globally. From a cultural perspective, successful advancements in technical capabilities can impact Social Mood. They can add to a sense of national pride, self-confidence, and belief in its ability to solve its own problems.

Managing complex global supply chains makes economic sense if the gains from labor arbitrage outweigh the costs of transportation and managing logistic complexity. Advancements in manufacturing automation continue to erode this labor arbitrage. As automation becomes more effective across a wider array of functions, and as perceived geopolitical risks rise, companies will seek to shift manufacturing closer to their end consumer markets. Governments will increasingly demand that goods that are sold in their countries are produced in territories that they trust.

Terms like “reshoring” and “friend-shoring” have already become popular. The U.S. has taken major legislative action to bring manufacturing back to the United States, especially of products deemed critical to national security and competitiveness, like semiconductors.

Increasing automation will drive down the need for human labor in manufacturing, reducing the economic importanceof manufacturing as a sector. Economic importance - measured as the ability to sustain prices, revenue, and potential employment – will shift increasingly towards services globally. The parts of the services sector that can be globalized will be, to gain the benefits of cheaper labor costs. However, services are not as easily globalized as manufacturing. Certain aspects of the services sector require in-person interaction and are local by nature. Hence, as manufacturing-led globalization reverses, with companies increasingly seeking to produce closer to their end-consumer markets, services will only partially globalize.

Geography

Geography is something that does not change on human time-scales, hence it forms an inexorable constraint around national decision making. Geography has critical implications for security. The juxtaposition between a nation’s political boundaries (drawn on a map) and its natural boundaries (mountain ranges, oceans, deserts, etc.) heavily inform the country’s security policy and posture.

The internal geography of a country, in the form of natural resources, natural transportation routes, arable land, etc. represent foundational resources for a country’s economy. It provides raw materials that can be traded or used to build up infrastructure, determines the cost of connecting population centers to supplies, and determines what the country will need to import to sustain its people. This, in turn, shapes the nation’s relationship with other societies.

The U.S. has some of the best geography of any country in the world. It is a massive nation which can sustain a large population. It has plenty of arable land to supply its people with their nutritional requirements. It is also endowed with large quantities of fossil fuels which can be extracted for energy production and exports. Due to advancements in fracking technology, the U.S. is close to independent from needing foreign energy imports to sustain its energy consumption.

The internal river systems of the U.S. are some of the best navigable water transport systems in the world. Water-based goods transport costs a fraction of rail and road-based transportation, with road-based transportation (trucking, etc.) being the most expensive. Currently, these rivers are not being used to transport goods internally as America has emphasized road and rail. However, as domestic manufacturing grows, and if worker shortages in trucking persist, we may see more legislators and business interests push to lift restrictions and promote investment into water-based transportation.

Security

The ancient Indian philosopher and strategist, Kautilya, in his mandala siddhanta, declared the principle that “one’s neighbor is one’s natural enemy.” Today, one can see this principle in action in national security relationships throughout the world.

However, there are nuances to this framework. Nations exist on a gradient of power, not all nations are equally powerful. The geopolitical power of a nation can be roughly approximated as a product of mass and coordination. “Mass” is a function of factors including population, territory, natural resources, volume of military and other technologies, etc. “Coordination” refers to the ability of the nation, in particular its various major institutions, to effectively marshal and synchronize its mass of resources in the direction of a coherent goal.

Roughly speaking, the world can be divided into major and minor powers. Minor powers will rarely pick fights with major powers, even if they are neighbors. Rather, they are more likely to fall into that major power’s sphere of influence (albeit begrudgingly, most likely). Meanwhile, the security interests of major powers do not stop at their national borders, but extend to the borders of their (perceived) spheres of influence.

All nations are concerned about threats to their sovereignty and integrity. Minor powers are concerned about their national boundaries, while major powers are concerned about the size of their spheres of influence.

Almost immediately after the end of World War II, the U.S. and the U.S.S.R. became locked in a struggle for global influence. Part of the U.S. strategy to check to the growing power of the Soviets was to win allies in exchange for securing global trade. The U.S. deployed its navy, the most powerful in the world at the time, across the world’s oceans, promising to secure the oceans for any country that wanted to grow its economy through exports. In exchange, the U.S. expected a seat at the table in determining that nation’s security policy. This strategy was quite successful, winning the U.S. many allies, stemming the spread of Soviet power, and laying the groundwork for the modern era of globalized trade.

After the Cold War ended, the U.S. kept this policy of policing global oceans, despite no longer facing a direct security threat from a peer competitor. The U.S. became the “uni-pole” of geopolitical power during this era. In the period between 1990 and the mid-2010s, the U.S. played an outsized role in securing the oceans of the world for global trade and more countries joined and benefited from the globalized trade system. Perhaps most notable among these was China.

More recently, U.S. attitudes towards globalization have shifted. National sentiment regarding the benefits of globalization have become ambivalent, with many blaming it for the loss of domestic employment and economic security. Meanwhile, a rough consensus has emerged among political elites that China represents a rival to the U.S. The rise of China as a peer competitor, or potential peer competitor, launches the world once again into a race for influence between great powers. This competition will drive, to a large degree, security, trade, and diplomatic relations throughout the world in the coming decades.

Just as individuals may interpret events differently based on their psychological state, so a society may respond completely differently to the same set of events based on the social mood, or zeitgeist. Social mood, as I am describing it, can be broken down into at least three different, interrelated factors.

First is the set of ideas or frameworks with which people tend to filter and interpret incoming data. In large, highly diverse societies, there may be a large variety of frameworks at play. However, there are usually a few dominant schools of thought at any given point in time, animating the largest and most influential factions. These frameworks serve to associate different emotional valence to events, marking them somewhere on the spectrum from very positive to very negative.

Second is the mental health of the people. Are a growing number of people struggling to maintain mental balance? Widespread mental imbalance can produce erratic and unpredictable behavior. It may also indicate that a society is more susceptible to radical, or overly simplistic interpretive frameworks and less willing to grapple with nuance or consider alternative perspectives.

Third is the level of trust between people. Societies with high levels of trust between people, between people and institutions, and between institutions will tend to foster different types of social moods than the opposite.

As far as globalization is concerned, the dominant interpretative frameworks in the West have changed significantly in the last ten years. Unbridled globalization is not seen as desirable by large segments of the population; and this thinking has made its way into political institutions as well. Policy makers are remembering the wisdom of prioritizing their own economic and security interests, and looking for ways to bring resources back within their own borders and their allies' borders. Motives of business profit maximization are more commonly balanced against competing motives like national security and economic resilience in the public discourse.

If you have been living in the U.S. for the past ten years then it is hard to not notice the heightened levels of distrust at various levels of society. This distrust is reflected in the political process via heightened polarization in partisan support. Recent record sales in firearm purchases may also indicate a weakening of social trust and social bonds. Various other polls have been conducted, measuring things like trust in media institutions, which seem to indicate a similar trend.

My personal sense is that the mental balance of the general population has declined over the past decade, though I am not precisely sure of its causes or extent. Narratives abound about drug addiction, depression, and anxiety, particularly among young people. The U.S. Surgeon General recently announced a “loneliness epidemic” in the United States which could be a major cause (or symptom…or both) of mental health problems throughout the country.

Employment

The economy is a circular system – the goods and services produced by “the people” are ultimately consumed in turn by “the people.” Hence, it is through the full and fruitful employment of the people that the wealth of society – roughly defined as the total stock of desirable and useful goods and services available – is maximized. Employment is also the primary, though not the only, mechanism for coordinating the distribution of money, which provides access to resources, in most modern societies. There seems to be a rough consensus among people in most developed economies that higher quality work should be rewarded with greater monetary compensation. Though what constitutes “high quality work” and what should the social obligations of the rich be (in terms of tax rates, etc.) is still the subject of much debate.

Meanwhile, all societies have a natural incentive to constantly increase the efficiency of their production; societies that fail to do so will be left behind and vulnerable in the long run. Human labor is expensive to support and volatile in its value. Hence, all economies are naturally incentivized replace human labor where feasible in the long run. This creates an inherent tension in all economies.

Moreover, meaningful work is an important factor in individual mental health as well. The feeling that one is contributing positively to the group, that one is “useful” to society in some way, contributes to increased self-esteem and mental balance for a large segment of people. Hence, the availability of fruitful, meaningful work has obvious implications for Social Mood.

The process of industrialization, and particularly urbanization, seems to correlate with declining birth rates. Much of the developed world today is facing stagnant or shrinking populations in the coming decades. This will produce worker shortages in the near term as the large Baby Boomer generation in these countries enters retirement. Meanwhile, automation technologies will continue to advance, rendering human inputs less necessary in several segments of the economy.

Hence, the supply of and demand for workers in the industrialized world appear to be shrinking in the short to medium term. The resultant of these two vectors will shape the employment picture for the major world economies in that timeframe. What that resultant looks like exactly remains unclear.

The latest version of the macro thesis can be found here.