While Capital Flywheels is not and does not aim to focus on politics (I continue to believe investing in secular tailwinds makes the most sense), we are unfortunately entering a period where many secular tailwinds are becoming entwined with geopolitics such as digital communications technology and payments.
As a result, understanding at least the underlying forces driving geopolitics is an important task even if the ultimate political outcomes cannot be forecasted.
In my recent post, “How the US and China Have Played Different Games to their Own Advantage Throughout History“, I argued that US and China relations are fraying because the different games that both countries have relied on successfully throughout their respective histories are reaching their limits.
China’s historically successful strategy of labor and trade dominance is reaching its limits as its labor force ages (median age of Chinese citizens is already older than that of US citizens) and eventually declines. Similarly, the US’ historically successful strategy of relatively open immigration policies married with capital and technology development advantages is reaching its limits as China closes the gap in both capital and technology.
These forces were already underway decades ago, but very few, including even the Chinese, likely expected convergence to happen this soon.
With hindsight, it’s clear that the US’ two lost decades starting with the tech boom/bust of the late 90s, demoralizing Middle East wars of the mid-2000s, crippling financial crisis of the late 2000s, and now trade and virus disruptions, materially accelerated convergence of the two economies.
In fact, many China watchers and experts believe that the 2008 financial crisis was the first event that started to convince Chinese officials that the US may be weaker than assumed and potentially a paper tiger.
While the US absolutely has enormous underlying imbalances that need to be addressed, the US is also fundamentally stronger in many ways while weaker in others than can be captured in simple GDP numbers.
Capital Flywheels believes that the US is stronger in ways that are not captured in numbers, and it ultimately, again, comes down to the different game that the US plays compared to the rest of the world.
Perhaps the area easiest to be bearish on the US is its labor force. Although the US continues to house the world’s most robust higher education system, the average academic performance of US citizens by young adulthood is certainly not something to brag about.
For years, the OECD has conducted educational surveys of 15 year olds across a number of countries. Leading cities in China come out far ahead of the US. Yes, the leading cities in China is not the same as the rest of the country…China on average is likely not that far ahead of the US on average, but the populations of these leading cities are approximately similar to the US population as a whole.
Source: OECD PISA 2018 Results
You do not have to spend that much time in an average US high school to understand that academic achievement is likely not culturally or socially important to many US students (though nerd / geek culture has made some headway in supplanting jock culture within Gen Z). This is a particularly troubling problem for the US since economic development globally is increasingly tied to innovation and technology, which requires firm understanding of mathematics, science, and logic. The longer this problem remains unaddressed, the further and further behind the American labor force will be.
Although the US continues to have an advantage in labor force growth compared to other countries due to relatively open immigration policies, that benefit may be squandered if the labor force is not appropriately skilled for the jobs most relevant in the 21st Century.
This is the US’ Achilles heels.
This is also a material source of socio-political discontent in the US.
However, the US is also stronger in ways that are not captured by numbers.
The truth is the US is not a land of averages, but rather a land of right tails. This is a different game that has always been played throughout most of US history. The US has almost always rewarded risk and entrepreneurialism beginning with land grants to adventurous colonists willing to move out west 200 years ago during the US’ period of westward expansion and Manifest Destiny. This period was later followed by the right-tailed eras of the railroad era and Gilded Age.
These periods led to large inequalities not too different from the growing inequalities in our present time. But as I argued in “Renewal Through Restructuring“, what makes a society robust is the asset side of the balance sheet and ensuring that resources continue to recycle and flow into the most productive assets. The liability and equity side of the balance sheet are important but are mostly ethical and moral questions for how to divide a pie with limited bearings on the strength of the assets themselves.
This is important because US labor is quite unremarkable on average. But as long as the conditions continue to exist for right-tailed outcomes with respect to the rest of the world, the US should continue to surprise again and again.
In what other country would it be possible for a college dropout by the name of Steve Jobs to go on to create the world’s most valuable enterprise? In what other country would it be possible for a 19 year old by the name of Mark Zuckerberg to go on to connect effectively everyone on Earth (excluding China)? In what other country can three Indian immigrants from the same high school rise to become the CEOs of Microsoft, Adobe, and Mastercard simply because they are the best CEOs for the job?
Another important aspect that is not captured in the numbers is the advantage of language. The jobs and economies of the 21st Century is very likely to be driven by math, science, and technology. These fields are knowledge-driven fields unlike the process driven economies of the industrial era. This means that people learn to do by understanding how to do. This is different from industrial era jobs where people learn to do by watching how to do. And because these fields are knowledge-driven fields, communications and access is an important but often overlooked factor.
The US has an incredible advantage in this area that often goes undiscussed – the language of science and technology is not only math but also English.
The vast majority of papers published in science and technology journals are English:
Not only are science publications dominated by English, but English proportion of publications is increasing.
English is increasingly the language of science, and any country that does not use English widely likely is running against the wind in trying to innovate and develop cutting edge science.
For all the issues that the US has with its own labor force and lack of skills, the proportion of the population that is positioned well for right-tail outcomes continues to benefit from soft advantages like language that few seem to discuss or recognize.
This is also true in other countries. Having spent a material amount of time abroad in an investing context including in emerging markets like China, India, and Brazil, it’s clear that countries with populations that understand English can more quickly converge with US in terms of technology as well as attract foreign capital (since foreign capital tends to speak English but also increasingly Chinese, too).
Beyond Labor, the area that I think the US is significantly stronger in than understood through GDP numbers is Capital.
For those that have studied economics, you will know that GDP only includes economic activity occurring within a country’s borders. This means that economic activity conducted by American enterprises abroad is not included in US GDP but rather included in foreign GDP (e.g. China, Europe, etc).
This is problematic because almost half of S&P500 revenues are now generated abroad:
In 2018, the percentage of S&P 500 sales from foreign countries decreased, after slightly increasing last year, and declining the prior two years. The overall rate for 2018 was 42.90%, down from 2017’s 43.62% and 2016’s 43.16%. The recent high mark was 2014’s 47.82%, and the recent low mark was 2003’s 41.84%. S&P 500 foreign sales represent products and services produced and sold outside of the U.S.
Over the last 5 decades, the US economy has increasingly shifted from labor towards capital, and part of that shift also meant that the full power and might of American Capital was increasingly not being captured in GDP numbers.
The growth in that Capital is benefiting the economies and labor of foreign countries, but this does not mean that that American Capital does not have value. Because at the end of the day, Americans own those businesses and the economic value created.
A simple example should make this point clear.
Consider China’s recent economic and technological development. Alibaba (along with Tencent) are likely the two pinnacles of Chinese technological development. Long-time readers of Capital Flywheels will know that I have been and remain a major believer in what Alibaba has accomplished and will continue to accomplish. Not only has Alibaba created a model of ecommerce and payments that has leapfrogged US and global alternatives, Alibaba continues to drive transformation of Chinese society in a way that is deeper than what US tech firms have accomplished. For example, ecommerce is now >25% of retail in China and Alibaba is >50% of that. In comparison, ecommerce penetration in the US is still <15%. During China’s COVID19 lockdown, Alibaba also played an integral role in helping citizens manage through the disruption.
That is all to say that Alibaba is a very important component of China’s economy and GDP.
But did you know that the US / Americans owns 62% of Alibaba?
Source: Bloomberg
This is not just isolated to Alibaba. The fact is American Capital owns a significant portion of economic activity abroad. But the value created and the US’ ownership of that value creation is often not recognized when narrowly comparing GDP.
American Capital is both a strength and a monumental failure of this country. It is a strength because so much of the world’s economic activity actually belongs to Americans. But it is also a monumental failure that this country has found a way to capture value on the backs of foreign workers, yet, has not figured out a way to ensure those benefits also accrue to the laborers living in this country.
The US’ GDP remains largest in the world, but GDP has become essentially meaningless because the world has already changed. GDP represents the old game. GDP represents the game that countries with borders play. But since the end of World War II, the US has not been a country with borders. The borders only belong to the laborers. The US has become a hybrid country of labor and capital and technology. And increasingly, a narrow view of economic strength based solely on GDP will fundamentally underestimate the power of the US.
This ultimately brings us back to one of the key points Capital Flywheels tried to make in the prior post, “How the US and China Have Played Different Games to their Own Advantage Throughout History“:
On the Capital dimension, we need to keep in mind that the US’ Capital advantages are all predicated on a system that protects and celebrates personal property rights. However, increasingly US capital formation is actually happening abroad. For example, Apple investing in China. (For those that have studied economics before, you will know that this is not counted in US GDP…and that is a very important point that is worth discussing in a future post.) I believe a lot of the disagreements over systems of governance largely comes down to this: China likes its own system and believes it is the best system for protecting its own interests globally. The US needs its own system to be projected abroad in order to protect the Capital that it is increasingly creating abroad. The proliferation of more authoritarian systems of governance like the ones supported by / pushed by China puts American Capital at risk.
The concept of the US is not the 50 states anymore. The US is its citizens. Many of these citizens are laborers in the 50 states, but many of its citizens are also capital owners with assets across the world. Many US citizens might not even live in the 50 states. The US has played a different game and to ensure that they can continue to play this game, the US needs to ensure that the world is friendly for US capital. Many years ago, the US fought a Cold War against the Soviet Union (and against Communism). On face value it was about Democracy and Capitalism. China is still controlled by a Communist government but China is very much a Capitalist society already. The disagreement today isn’t about Democracy or Capitalism, it’s about systems of law and governance that will protect what makes America strong today.