The VIX Is In

One of the measures I like to track when markets get crazy (and markets have been cray-cray people), is the Chicago Board Options Exchange (CBOE) Volatility Index, or VIX. The VIX measures investors’ expectations of near term volatility in markets. If the VIX rises, investors expect more volatility. When the market has daily shifts similar to what we have seen the past several weeks, the VIX is going to spike. And it has.

While markets seem to be riding a roller coaster right now, a little historical perspective is always helpful.

The average daily close of the VIX in 2017 was just over $11. During this most recent spate of volatility, the VIX spiked to $41 and change on February 9th and the average close of the VIX this year is approaching $18.  But…during the Global Financial Crisis in 2008, the VIX crossed $80 a few times, and closed above our current cycle peak of $41 for 63 consecutive business days.  While your stomach may be feeling queasy these last few weeks from all these fits and starts, we are basically on the equivalent of a kiddie ride at the local carnival compared to the high speed, triple loop coaster that was 2008.

The February 9 spike in the VIX marked its highest point since August 2015, when China devalued its currency and sent financial markets reeling. That’s right, Brexit and the surprise 2016 US election outcome have nothing on 2018! Some other notable spikes in the VIX since the Global Financial Crisis include the 2010 Greek Debt Crisis, and in 2011, the US Debt Ceiling fiasco.

While many pundits comment on sudden spikes in the VIX, today I am looking at how long volatile cycles last. By one measure, the current cycle (for the optimistic, markets do

seem to be emerging from this cycle) has stretched on longer than all others since 2009.

I compared the current day close of the VIX to the 90-day moving average close, and Monday April 16th marked the 63rd straight day the VIX closed higher than its 90-day moving average. Granted, market volatility was low prior to this stretch, but compare to other spiked-VIX events:

The good news is we broke the streak this week, with volatility easing. But why have markets been so volatile this year? Two major reasons:

1.We are in a trade war.

When President Trump was Candidate Trump, he proposed policy actions that were decidedly against free trade. But President Trump did not act on any of his trade policy until recently, a full year into his presidency. Market volatility was going to be the likely result whenever this policy took root.  Secretary of the Treasury Steve Mnuchin went on CNBC a couple weeks ago and said the administration did not want to enter into a trade war. That ship has sailed! We are in a trade war with China and markets don’t know how long this war will last or how far into industry it will reach. It should be noted that rhetoric and press coverage of the trade war has slowed considerably over the past several days to a week, and not coincidentally, volatility has in turn eased

2. Midterm Elections Are Coming

The second reason for the recent spate of volatility is the increasing likelihood that the democrats win back one or both of the chambers of congress in the mid-term elections this fall. This may seem to contradict reason #1. Shouldn’t a change in Congress limit President Trump’s ability to wage a trade war? It might, but a congressional power shift likely will return us to the crippled legislative environment we saw when President Obama was dealing with a Republican- controlled Congress.

Despite Trump’s anti-trade rhetoric, when he took office he was aligned with Congress and markets welcomed that togetherness. During much of President Obama’s tenure, Republicans foolishly rubber stamped “NO” to any and all of Obama’s policy proposals, and Obama was an ineffectual leader when it came to reaching across the aisle. As a result, nothing got done. Markets surged when this toxic dynamic disappeared. But the prospects of having policy derailed again by even stronger levels of executive and legislative branch hostility has markets jittery.

Volatility has ebbed this week but expect it to increase again as trade tension with China continues and as we get closer to the mid-term elections. It’s not going out on a limb to predict that market volatility will be higher this year than last.

The Pros and Cons of Protectionism

The Pros and Cons of Protectionism

Just kidding about the title, this is really just about the cons of protectionism. False advertising. You’ll get over it. But I’m not going to talk about the cons that you hear about over and over again. Today I am going to dig a bit deeper to examine some examples of unintended consequences of protectionism that could have a negative impact globally.

There is no denying that the globe is on a protectionism kick. The kick was just a toe tap a few years ago as nationalistic parties in France and other European countries gained a bit of prominence, coming out of the shadows of the periphery of politics. At the same time, and really for years prior, several major countries had policies and even social norms written into the fabric of their population that were protectionist in nature. I’ll touch on one of those later.

Then, on a beautiful June morning a couple summers ago, my phone blew up as Great Britain shockingly voted to exit the European Union – what has become known as Brexit. But this was just the appetizer! The main course was Donald Trump’s victory in the U.S. elections in 2016.  The protectionist light dimmed a bit in 2017 as French voters slowed down the advances made by Marine LePen and other nationalist candidates. But at that time, in speeches, I warned audiences that they should not breath a sigh of relief. In fact, I believed the protectionist wave was only just pausing. The next big vote would be the Italian elections in 2018. They would likely show that protectionism was alive and well, and perhaps launch the coolest term since Brexit: Italeave.

The Italian Job

The recent Italian elections did result in significant gains for Euro-skeptic nationalist parties, increasing the odds of an Italeave. A poor economy, chronically high youth unemployment, and an influx of migrants from the Middle East and Africa have raised nationalistic ire. Leaving the monetary union would ripple across Europe. An Italeave scenario would play out something like this: Once they left, Italy would be on the hook to immediately repay the hundred of billions it owes the European Central Bank (ECB), which Italy would likely default on. The ECB then would assign portions of Italy’s defaulted debt to other members of the Eurozone. Imagine Greece getting a bill to pay for Italy’s default! Some of these countries also directly hold Italian debt, which again could be defaulted on. A protectionist spawned Italeave would cause an economic meltdown in Europe and most likely the globe.

My Yoko Always Said, Give Peace a Chance

Free trade agreements (FTA’s) have taken a big hit as a result of the rise of protectionism.  FTA’s are both a direct target of many protectionist politicians and get taken out by collateral damage inflicted as a result of protectionism. The Trans Pacific Partnership (TPP) was a proposed trade agreement between the U.S., Japan, South American and ASEAN countries. TPP would have opened new markets for the U.S. agriculture industry, brought other industries free trade access to the massive Japanese market, and installed U.S.-strength intellectual property protection regulations into the Asian emerging markets that were part of the pact. This last bit was a tactic designed as a warning shot to China that IP protection needed to be taken seriously in the region.

But the TPP FTA was DOA even before the 2016 election took place. Donald Trump made it a direct target, and Bernie Sanders’ Trump-leaning policies convinced Hillary Clinton to denounce the pact, making the TPP a victim of a targeted hit by candidate Trump and collateral damage of the Sanders-Clinton battle. Though the TPP has recently been revived, the U.S. is not part of the current list of signatories.

In an article about pros and cons I’m not going to argue the pros and cons of trade agreements like the TPP. There are plenty of economists who have made intelligent arguments for either side of the debate, and plenty of radio and cable news talking heads who have made unintelligent arguments for either side of the debate. I would suggest that trade agreements between countries are de-facto peace treaties, and when we do away with them, or refuse to enter into them, we remove or prevent a buffer between signatory countries that helps keep peace. If a portion of a country’s economy is dependent on open trade with other countries, the existing lines of communication in place would make it less likely that those countries go to war.

Protectionist policies also breed bitterness in the populations that are negatively impacted.  There is no love lost for host countries by Central and Eastern European workers being compelled to leave Britain, Latin American families being displaced in the U.S., or workers losing jobs as Saudi Arabia looks to transition to a domestic workforce in the face of structurally lower oil prices. Countries that were looked on as bastions of opportunity are being thought of in an entirely different light. Creating blocs of foreign populations that hold your country in disregard is not the greatest plan.

Japan’s Labyrinth

While some countries in Europe and North America are moving toward more protectionist policies, other countries have had policies in place that espouse some of the protectionist trends that are gaining traction today. In general, these policies have not been beneficial. Take Japan for example, which has long been reluctant to allow immigrant foreign workers to be a part of the workforce. Combining low levels of immigration with a damagingly low fertility rate creates a shrinking working age population, a rising old age dependent population, and a stagnating economy. Japan has quietly allowed more foreign workers to enter over the past several years, but continues to deny almost all refugee requests.  Throw in the fact that female participation in the workforce is also traditionally low, the economy will continue to struggle with workforce issues. Until changes are made, it’s likely Japan will continue to stagnate – economic growth over the past 25 years has averaged less than one percent per year.

A Bull in The China Shop

China is presenting an open policy in contrast to the global trend toward protectionism, and it seems to be paying off. This open policy is exemplified by the One Belt One Road Initiative, which is meant to create trade routes from China into other parts of Asia, Europe and Africa, and The Asia Investment Bank. The recent release of GE’s annual Innovation Barometer survey found that China is increasing in significance as a country that leaders from around the globe look to as an innovation champion. At the same time, the high opinion seen in previous iterations of the Innovation Barometer toward traditional innovation champions like the U.S. and European countries is waning.

Investment in infrastructure and innovation creates good will. This was highlighted in GE’s report, as executives from Africa now look at China as the globe’s innovation champion. Remember that in Africa it’s not AI and autonomous vehicles and blockchain that are important innovations. It’s simple innovations like running water and transportation infrastructure that are needed. China is providing this and it creates goodwill toward China within the countries reaping the benefits of these investments.

So yes, I am Con-Protectionism, and I’ve tried here to lay out some deeper arguments why you should all join me! But it’s important to remember, whether in the U.K., U.S., or most recently Italy, the shift toward protectionism was decided by vote. In most of these cases the margins were slim, but nevertheless, populations voted for more nationalistic policies. This should ring alarm bells. Many people in developed countries feel they have been negatively impacted by globalization – whether by illegal immigration, job automation, or weak income growth. Those of us who believe in globalization need to do a better job promoting its benefits and ensuring those benefits are clear.





Funding Infrastructure Investment

The challenges of increasing the gas tax, and making sure infrastructure improvements are done right

We live in a mixed up, muddled up, shook up world. So should it surprise us that a Republican president backs a Democratic and Chamber of Commerce supported tax increase that compels a couple of conservative rabble rousing think tanks to pen an opposition paper on said tax? Probably not, but it’s still kind of funny, no?

President Trump rattled friendly feathers last week when he echoed a recommendation from the U.S. Chamber of Commerce to impose a 25-cents per gallon increase on fuel consumption, in order to pay for long needed improvements to American transportation infrastructure. The tax has remained at 18.4 cents per gallon since 1993, when you were much younger. (state taxes on gas have moved since then – just not the federal tax).  Americans for Prosperity and Freedom Partners, the conservative action groups, raced to their quill and ink sets, crunched some data, and found that the increased tax would have the biggest impact on households in places like Alabama, Alaska, Arkansas and even states that don’t start with the letter A.  The mixed up, muddled up, shook up world part: many of the states impacted the most by the Trump proposed tax are Trump supporting red states.

Interpreting the Data
The study compiles data from several sources, including total gasoline consumption for transportation in 2016 from the US Energy Information Administration. Then the authors do a couple of basic calculations, no PhD in stats needed: First they take that total consumption and multiply by the proposed 25 cent tax; then they divide that total by the number of households in each state to determine what the added burden per household would be. By this calculation, households in Alabama will see an annual $360 hit, Wyoming $380 and Mississippi leads the race, with households projected to be hit with a $390 annual burden. Of the top 10 states, only 1*, Delaware, went blue in 2016. (*Maine was in the top 10, but split its electoral delegates in 2016).

We can expand on the authors' analysis and bring in median income data, which amplifies the impact on some states.  Mississippi has the lowest median income of any state in the nation at about $41,000. A $390 burden is almost a full percentage point of annual income. Conversely New Hampshire has the highest median income, so their added tax burden of $332 will seem far less drastic.

When studying the data, I noticed something veeeeeery interesting. Alabama and Arizona guzzled a similar amount of gasoline in 2016. How could this be when Arizona has at least 2 million more people than Alabama and over 1 million more passenger vehicles registered? Digging a bit deeper into data from the Auto Alliance, I discovered a couple reasons why despite having significantly fewer vehicles, Alabama consumed a similar amount of gas to Arizona.

First, a higher percentage of passenger vehicles in Arizona are trucks (26% to 21%) which generally get poorer gas mileage than cars. Second, the average age of a passenger vehicle in Arizona is 11.9 years. In Alabama, the average age of a passenger vehicle is nearly two years older at 13.6. Both of these states are above the national average of 11.2 years. Older cars, again in general, are less fuel efficient. An increase in the gas tax will impact states with less fuel efficient vehicles more drastically.

Another interesting table from the Americans for Prosperity and Freedom Partners report is the ranking of states by what percent the new tax will increase their current gas tax burden. Alaska, Oklahoma and Missouri lead the way with their tax burden increasing over 70%. What this data shows us is that residents of state’s that already impose high taxes on gas usage won’t feel the increase as dramatically. Californians are already taxed 72 cents per gallon while Alaskans are currently taxed about 30 cents per gallon. An additional 25 cents nearly doubles the burden in the land of the midnight sun.

This is important because in places that already have a high tax, which in most states pays for infrastructure improvement anyway, state governments could offset the federal increase by lowering the state tax. Six out of the top 10 states with the highest tax burden voted blue in 2016.

Other Solutions
An alternative, or complimentary solution to raising the gas tax would be to enact or raise tolls on highways. (Is a toll at tax? Semantics!).  In places like Connecticut tolls were removed from the turnpike decades ago because they caused congestion which in turn caused pollution. But current toll collection technology like EZ Pass or SunPass is making the toll booth a thing of the past (which would have been really helpful for Sonny Corleone). Charging drivers for using state roads with this technology could help fund the improvement of transportation infrastructure. Rates could be lower for in-state drivers and the tolls could be temporary. A finite time frame would force states to use the revenue for its intended purpose within specific time parameters.

Wherever transportation infrastructure investment comes from, it is essential to avoid the same mistakes that were made with the establishment of the interstate highway system in the 1950’s and 1960’s. Highways through cities were designed to accommodate driving patterns of the day, with little thought about how usage of this infrastructure would grow in the coming decades. The result has been congestion, pollution and lost productivity due to the crippling commute times we see today.

The coming wave of investments in transportation infrastructure need to do more than improve existing roads, bridges and tunnels.  A future of ride-sharing, autonomous and electric vehicles, drone package delivery and personal use aircraft needs to be considered as guiding factors of infrastructure investment.

Data Protection, An Open-Door Policy, and The Puppy Bowl

How the Puppy Bowl got me thinking that we take our Data Security more seriously than our personal and property security.

Let’s get this out of the way first: I did sit with my kids and watch the Puppy Bowl this year on Animal Planet. The whole thing. Start to finish. We were rooting for Team Fluff.  Now that I got that off my chest…

One of the commercials during a stoppage in play was for Wag, a dog-walking app. You sign up with Wag, and you can schedule someone to stop by your home and walk Rover when you are away. The Wag website advertises a cost of $20 for a 30-minute jaunt around the neighborhood.

(This got me envisioning the future of work for some: rent your apartment on Air B&B, jump in your car and do a shift picking up fares for Lyft while delivering meals for GrubHub all the while taking breaks to walk dogs for Wag).

What struck me about the Wag spot was that a basic premise of the service is that Wag walkers need to gain entry to your home when you are not there. The Wag FAQ’s explain that they will provide customers with a lock box to store a key for the walker, they “vet and test” all their walkers (though no indication that any background check is done), and they claim your home is protected up to $1 million when you use a Wag walker.

And it’s not just dog walkers we are inviting into our homes. Last September Walmart announced a partnership with smart lock maker August in which customers who are not at home will be notified on their mobile device when a delivery person arrives. The delivery person will get a one-time access code to open a lock box, and he or she will bring the packages inside the house – even putting perishable items in the fridge or freezer. August provides an in-home camera so you can watch the delivery person in action (and theoretically direct said action … "no, the eggs go on the second shelf. Behind the yogurt.”)  Amazon Prime members in certain cities can take advantage of a similarly secure service where packages will be delivered and left “just inside the door”.

At a time when we seem to be more than willing to allow strangers into our personal space and property, concerns about data privacy and cybercrime are growing rapidly. The World Economic Forum recently released its 2018 Global Risks Report with Cyberattacks and Data Fraud landing in the top 4 of the most likely global risks. A recent Consumer Payment Study by TSYS suggests than consumers overwhelming choose their credit cards based on level of fraud protection as opposed to rewards program quality.

Why are we so eager to let strangers through our door, while at the same time we have widespread concern about the safety of our data? These two trends seem to directly contrast one another. While it does not explain the contrast, the willingness to have an open-door policy likely stems from a trust in institutions that is more prevalent among younger generations. People are increasingly willing to entrust Wag and Walmart and Amazon with the task of vetting a whole host of individuals who are going to have access to their homes.  A 2016 Gallup poll showed that Millennials have more trust in a wide array of institutions -  from banks to health insurance to retailers to the government - than do other generations.

A few years back I theorized that the secret to marketing to Millennials was in identifying when they reached certain life stages. They stayed in college longer, buy houses, get married and have kids later than previous generations did, so when you market to them is just as important as what or how you market to them.  It’s possible that as this generation ages and collects more valuables in their homes (including children) their blind faith in institutions gets tinged with a bit more proactive due diligence.

Of course, maybe it doesn’t happen that way. Maybe we are on a path to greater trust in institutions and more transparency in all aspects of our lives. Innovations like Blockchain depend on it and in fact enable it by adding transparency to every transaction.

In the future, when you get home from your job walking dogs for Wag, you will come home to find another Wag walker has walked your dog for you, the Walmart delivery woman has your pantry and fridge stocked and perfectly arranged, the Blue Apron delivery guy has actually cooked the meal he delivered and it’s ready to eat, and the dry cleaner has laid out your next day’s outfit. That’s a lot of people walking through your house....but it's long as they don't guess your passwords.

Is The U.S. Heading Toward a Recession?

With the market deciding to honor the late great Tom Petty this week with it’s cover version of Free Fallin, it would be unwise to stoke the fuels of fire by pointing out reasons why the U.S. could be heading toward a recession. Damn the torpedoes! Let’s do it anyway.

Why are we heading toward a recession? Because…

  1. Economies are Cyclical

This school of thought could be called the “We are due for a recession” theory. Since 1930, according to the National Bureau of Economic Research, the average economic expansion in the United States has lasted about 5 years. We are currently in an expansion that is 8.5 years long and is the third longest expansion since Prohibition ended. Only the expansion between 1991 and 2001 (120 months) and the one between 1961 and 1969 (106 months) have lasted longer.

At 4.1% the U.S. unemployment rate has been dropping steadily since it peaked at 10% in October 2009. According to the Bureau of Labor Statistics, the last time it was this low was at the end of 2000, when the rate sat at 3.9% in December of that year. Many economists believe the labor market has been at or near “full employment” for several months now, meaning there are very few people who want a job that don’t have one. For the unemployment rate to drop much further, wages would have to reach a level where those who don’t really want to work are lured into the work force.

With the length of the economic expansion and the once-a-generation unemployment rate at cyclical tipping points, “we are due for a recession.”

  1. Demand from abroad may have peaked.

The World Bank released its Global Economic Prospects report this month and the subtitle of the report says it all: Broad Based Upturn, But For How Long? Economies across the globe are relatively strong, but in some places like Europe growth and demand have likely peaked due to structural issues like a shrinking working age population and entrenched weak productivity limiting potential.  While the Euro Area saw better than expected growth of 2.4% in 2017, the The World Bank report expects growth to drop to 2.1% this year and below 2% for 2019 and 2020.

Economic growth in China also peaked several years ago as the country has undertaken a transition to an economy more balanced between exports and domestic consumption. The World Bank reports that growth in China will fall from 6.8% in 2017 to 6.2% in 2020.  Still strong growth, but well below the double-digit growth seen earlier in the decade.

  1. Wage growth continues to flounder

Wage growth in the U.S. continues to be less than dynamic. While wages seemed to be ticking upwards toward 3% annual growth near the end of 2016, 2017 saw growth slow down to about 2.5%. Growth in wages continues to outpace inflation, which the Bureau of Labor Statistics listed at 2.1% in December. However, if the gap between the two shrinks with rising inflation and stagnating wages, increases in wages will not make up for the higher costs of goods and services.

  1. Interest rates on the rise

As the economy continues to improve and a new regime takes over the Federal Reserve Board, expect interest rates to increase at a more rapid rate than they had during the Yellen years. Higher Interest rates bring with them a few side effects that could limit economic growth. First, higher interest rates make it more expensive to borrow money. Granted, even with a few ticks up, rates will still be at historically low levels, but the cost of borrowing money will be greater a year from now than it is today. Second, debt repayment becomes more expensive as rates rise. As variable rates rise, those with these types of loans will have a higher debt burden resulting in more of their disposable income going toward debt servicing. Third, while higher interest rates raise the debt burden, they also provide more incentive for personal saving if your money can earn more sitting in the bank. While saving more money is good for your household balance sheet, spending instead of saving is better for the economy.

  1. Black Swans

The data I have laid out points to several issues that are going to have a negative impact on the economy – issues we can see coming a mile away.  But unknowns can always hit the economy when it least expects them.  There are three Black Swans that I believe are most likely to shock the economy. First, some type of event that would impact the supply of oil to global markets would result in higher gas and heating oil prices and more consumer dollars being spent filling up fuel tanks in cars and for home heating. What we have found over the past several years is that such an event would have to be a major one, as minor disruptions to oil supply have not triggered significant price inflation since the Shale Gale.  Second, a hard landing for the Chinese economy, where economic growth stalls to below 3% would negatively impact global demand and hurt world economies. Finally, an increase of tension or potential military action on the Korean Peninsula could result in widespread market panic.

Saying all this, it is not my expectation that we will see a recession in the U.S. this year. The short-term benefits from tax cuts, the potential that the tight labor market results in an increase in wages and in turn disposable income, and the potential for an infrastructure investment package indicate the economy still has some ammunition left to fire. But if we do see a recession, some combination of the reasons I have listed will likely be the cause.

China’s Demographic Problem

China’s Ageing Challenge
Like many countries, China made the transition from third world to emerging market by focusing on low cost manufacturing. The ability to cheaply manufacture products for developed markets is a time-honored tradition for countries that are looking to join the ranks of global traders and it was no different in China.

One of the reasons why developed markets look to emerging markets to manufacture goods is the lower cost of labor. To make a product in China where labor costs are very low compared to the U.S. makes financial sense even when factoring in the cost of transportation and logistics involved in getting the completed product to market.

As time goes on, countries like China need to maintain their competitive edge as other countries enter the market as new low-cost manufacturers. They can stay competitive by improving product quality and lowering defects, ensuring intellectual property protection, maintaining a labor cost advantage over new entrants, and by highlighting the advantages of having more highly skilled workers.

China has shown varying degrees of success on these fronts, but a demographic issue could have a long-term impact on the country’s competitiveness as a low-cost manufacturer of global goods.

Dependency Ratio Explained
This demographic issue is the dependency ratio, which measures the difference between the working age population (aged 15-64) and the non-working age population in a given country. Non-working age dependent populations are broken into youth (younger than 15), and old age (over 65) dependency. The ratio tells us how many dependent age people there are in a country for every 100 people of working age.

Let’s take Japan as an example as China’s neighbor to the east will enter a crisis stage in their dependency ratio over the coming decades. The Dependency Ratio chart shows that by 2050, for every 100 people of working age in Japan, there will be over 95 people of dependent age. And the majority of these will be old age dependents. In fact, Japan's youth dependency will have shrunk by over 30% between 2000 and mid-century while old age dependency will have grown by over 350%.

This poses a crisis because once workers leave the labor force, they become eligible for government sponsored social support programs. Government sponsored programs like these are typically funded by working age tax payers. As the ranks of old age dependents increases, there are more people for the government to support. As the working age population shrinks in Japan, a perfect storm is created. Fewer people are paying into social programs and more people are pulling money out of them. This creates a situation where the workers still funding the programs have to put a higher percentage of their pay into the programs in the form of taxes, while governments could have to incur debt to supplement the costs of social programs.

The China curve on the chart shows that the country’s dependency ratio has bottomed out this decade, and is starting to rise. While the ratio is not projected to approach the levels Japan will experience, the rising rate does pose some issues.

Why has the dependency ratio risen in China?
The cause is a result of the after effects of The One-Child Policy. By limiting the number of births in the country, the government ensured there would be an era where the dependency ratio would take a turn for the worse. The One-Child Policy began to be phased out in 2015 partially in response to the realization that this demographic issue was taking place. There are a few reasons why the new Two-Child Policy might not have the desired effect of increasing the working age population.

First, during the time the policy has been in effect, there has been an uneven distribution of gender among the population. With more men than women, some of the male population will be unable to find partners, leaving a portion of the population subject to an unintended “no child policy.” Second, while the implementation of a Two-Child policy should result in an increase in the fertility rate from 1.6, it would take a far larger increase to structurally impact the working age population. Finally, even if a baby boom takes place as a result of the new policy, it will take at least 15 years for newborns to join the workforce.

The lasting effects of the One-Child Policy has put China in a precarious position, and other countries, such as Mexico, are well positioned to capitalize. Mexico has a much different demographic profile than China. Without caps on their fertility rates, the Mexican population continues to grow, so that the working age population grows with it, and dependency remains low.  This trend could accelerate. If the U.S. continues plans to limit the number of immigrants allowed into the country from Mexico, the working age population could get a further boost as fewer works head north of the border for work. If the Mexican government can address security concerns and continue to promote the manufacturing sector, the geographic proximity of Mexico to the U.S. could drive US manufacturers to opt for Mexican manufacturing over China or other Asian countries.

What should Chinese companies do to maintain business from developed market manufacturers?

  1. Think about locking in long term contracts with companies. Offer reduced rates through the life of contracts to lock in future revenue.
  2. Keep costs low by switching out low skilled workers with automation like 3-D printing and robotics.
  3. Focus on process improvements, including on time and accurately fulfilled orders.
  4. Work to ensure Intellectual Property Rights of western businesses are protected

If Chinese companies can maintain low costs and process efficiency, Developed Market companies could fear that the cost of change would outweigh any labor cost savings realized by finding new countries in which to manufacture their goods.

Other factors
Two other factors are joining forces with the changing demographic profile to impact the competitiveness of Chinese manufacturing.  First, China’s transition from a manufacturing based economy to an economy that is more balanced between exports and domestic consumption creates a shift in the types of jobs workers are taking up. At the same time population factors are shrinking the total number of people in the workforce, this economic shift is cutting down the number of Chinese who will look toward jobs in the manufacturing sector. A shrinking supply of workers increases competition for those workers, and that increased competition will result in increased wages, which means higher employment and manufacturing costs.

Second, additive manufacturing, or 3-D printing, is making it possible for companies in developed markets to re-shore manufacturing. With relatively inexpensive 3-D printers, goods that were previously produced in China can be made anywhere. While the use of 3-D printers is not conducive to large batch manufacturing, there are benefits to the customization possibilities inherent in additive manufacturing.

These three factors: a rising dependency ratio, the shift away from a manufacturing based economy, and the advent of 3-D printing are combining to disrupt China's position as a leader in low cost manufacturing.

The Nostradamus Awards

In 2012, I was asked to deliver an economic update presentation to a team that was tasked with ensuring the security of company employees across the globe. One of their requests was that I present some long- term geopolitical risks that I believed they should monitor.  Five+ years after that presentation, I thought it would be an interesting exercise to review my predictions, and analyze how accurate they were. As you can imagine, my forecasting was not completely off-base. If it had been, I would not be writing an article looking back and passing judgement on my accuracy!

To rank the accuracy of each prediction, I thought it would be fun to judge them on a Nostradamus scale. Other than the Mayans, whose reputation as futurists took a big hit when the earth survived the year (and the movie) 2012, Nostradamus was probably the world’s most famous predictor of future events.  With that, each prediction will be ranked from 5 Nostradamuses for the most accurate predictions, with a sliding scale down to 1 Nostradamus for predictions that, with the benefit of hindsight, are laughable.

Prediction 1: Chinese Democracy. With globalization moving forward and China’s economy becoming more intertwined with western developed markets, I foresaw a slow but steady pivot to a free market democracy.
Did It Happen: No! Say it again: NO!!!
Analysis: While I did not believe there would be a transformation within five years where China had become fully democratic, I believed we would have seen more signals that, from a social and economic standpoint, the country would be leaning democratic. But government controls on housing and credit and massaging economic growth to match forecasts continue to be prevalent. President Hu continues to consolidate power.  Maybe using a Guns and Roses album title for a prediction helped get the band back together. For that, I earn…
Score: One Nostradamus

Prediction 2: Vladimir Putin’s hold on the government would lead to a return of Russian Imperialism. With the 2008 war with Georgia still relatively top of mind, and 2012’s re-ascendance of Putin to the role of President, it seemed that Russia was in the early stages of reasserting itself as an imperial power.
Did It Happen: Any Ukrainians out there that would care to answer?
Analysis: Crimea, Ukraine and Syria. Enough said.
Score: 5 Nostradamuses.


Prediction 3: An Environmental Disaster would impact the global economy on a massive scale. In 2004 the Indian Ocean earthquake had killed 250,000 people. 2005 saw Hurricane Katrina devastate New Orleans. And 2011 saw an earthquake and tsunami cause a natural and nuclear disaster in Japan.
Did It Happen: Not Really. While hurricanes have impacted the U.S. on a regional basis, the situation that occurred in 2017 in Puerto Rico has a chance to have domestic political repercussions.
Analysis: A year after the Japanese earthquake and tsunami, environmental disasters were top of mind, though the ones we have seen since have not had the devastating impact to an economy that the tsunami and the resulting nuclear meltdown at Fukushima had on Japan.
Score: Two/Three Nostradomuses*


* (The dreaded asterisk). While this did not prove out, a bonus Nostradamus was awarded for making this prediction a few months before Hurricane Sandy hit the East Coast of the United States. Sandy resulted in a much publicized “bro-hug” between Republican Governor Chris Christie of New Jersey and Democratic Presidential Candidate Barack Obama which many felt aided Obama’s victory in the November 2012 election. Consider the Butterfly Effect involving Obama-Romney-Trump (and potenitally Clinton) had Hurricane Sandy not happened.

Prediction 4: Count on the U.S. getting involved in a new war. When analyzing post-WWII U.S. history, the country enters a new war arena about every 10 years. 2012 was 9 years after the invasion of Iraq. We were due.
Did It Happen: Sort of. The war on the Islamic State has been systematic, involving training and support of foreign troops, but without a specific front where U.S. troops are fully engaged.
Analysis: The score is based on the War on the Islamic State, but since the prediction was made the U.S. has not entered into a new arena. Unfortunately, if tensions continue to escalate on the Korean peninsula, the rating on this prediction will improve.
Score: Three Nostradamuses.


Prediction 5: Oil exporters in the Middle East will face social and domestic political turmoil due to lower oil prices. The increased adoption of renewable forms of energy like wind and solar would, by the 2030’s, significantly reduce global dependence on crude oil. When this happens, countries that are dependent on crude oil revenues to support social programs for their population, like Saudi Arabia, will quickly spend their reserve funds and be faced with a challenging domestic problem. Supporting social programs without oil revenue would be unsustainable, leading to radicalism and revolt, destabilizing the region.
Did It Happen: This prediction was more long term, but the impact of lower oil prices has changed the dynamic in oil revenue dependent countries.
Analysis: The prediction that oil prices would turn lower was correct, but my reasoning was off the mark. When I made these predictions in 2012 the Shale Gale in the United States which flooded the supply of global oil markets and tanked prices had yet to impact the market. While my predictions as to why oil prices would falter (renewables instead of shale supply) and the timing of when that would happen (a couple decades in the future instead of now), were off, lower prices have begun to erode social programs and decrease investment in non-oil industries in oil-rich countries.
Score: Three Nostradamuses. This may be a bit generous, but the full impact of structurally lower oil prices has yet to be felt.


Agree with the scores?