The Winner-Take-All Economy

When the majority of Americans examine the world around them, they see a stock market at record highs and modest apparent improvement in the economy, but, as John Hussman notes, they also have the sense that something remains terribly wrong, and they can't quite put their finger on it.

Exceprted from John Hussman's Weekly Market Comment,

According to a recent survey by the Federal Reserve, 40% of American families report that they are “just getting by,” and 60% of families do not have sufficient savings to cover even 3 months of expenses. Even Fed Chair Janet Yellen seemed puzzled last week by the contrast between a gradually improving unemployment rate and persistently sluggish real wage growth.

We would suggest that much of this perplexity reflects the application of incorrect models of the world.

Before the 15th century, people gazed at the sky, and believed that other planets would move around the Earth, stop, move backwards for a bit, and then move forward again. Their model of the world – that the Earth was the center of the universe – was the source of this confusion.

Similarly, one of the reasons that the economy seems so confusing at present is that our policy makers are dogmatically following models that have very mixed evidence in reality.


Several factors contribute to the broad sense that something in the economy is not right despite exuberant financial markets and a lower rate of unemployment. In our view, the primary factor is two decades of Fed-encouraged misallocation of capital to speculative uses, coupled with the crash of two bubbles (and we suspect a third on the way). This repeated misallocation of investment resources has contributed to a thinning of our capital base that would not have occurred otherwise. The Fed has repeatedly followed a policy course that sacrifices long-term growth by encouraging speculative malinvestment out of impatience for short-term gain. Sustainable repair will only emerge from undistorted, less immediate, but more efficient capital allocation.

In recent years, the U.S. has experienced a collapse in labor participation and weak growth in labor compensation, coupled with an increasingly lopsided distribution of whatever benefits the recent economic recovery has generated. This is not well-explained by Phillips Curves or simplistic appeals to "insufficient demand," and it is unlikely to be improved by endless monetary “stimulus” (the targets that clearly occupy the Fed’s thinking). While our economic challenges can be largely traced to more than a decade of persistent Fed-enabled misallocation of capital, most of the costs of this misallocation have fallen on labor because of a) shifting composition of labor demand that has resulted from an increasing share of international trade with countries with heavy populations of relatively unskilled labor; and b) economic features that increasingly create a “winner-take-all” distribution of economic gains. 

One of the key results in international economics is that as trade opens up between nations, those nations will tend to export goods that intensely use the factor (skilled labor, unskilled labor, capital) with which they are relatively well-endowed. In a world where we have opened up trade with countries that are densely populated with unskilled workers, and where the U.S. is relatively better endowed with skilled labor and capital, the result has been something of a hollowing out of the middle class among households that aren’t themselves endowed with skilled labor or capital. Essentially, the U.S. obtains the services of low-skilled labor more cheaply from abroad than domestically. There is no great debate on this point.

Meanwhile, transfer payments like welfare and unemployment compensation allow many households to maintain consumption despite being out of those jobs, and given the ability of households to take on debt, even if they are actually living paycheck to paycheck, the produced goods get purchased, companies make a profit, government runs a deficit, the Fed keeps interest rates low which allows all the debt to be serviced, and everyone is pleasantly, if unsustainably, happy. That’s particularly true as long as nobody asks how the debt will be repaid, which is certainly what Fed policy encourages.

Now, looking at nations as a whole, academic economists proudly derive various theorems to prove that both nations actually benefit in aggregate from international trade. The problem, however, is in the distribution of those gains. This is particularly true in what might be called “winner-take-all” economies.

Why do professional athletes, movie actors, and even some 23-year-old computer programmers earn so much more than teachers, nurses, and factory-line workers? The answer is simple. They’ve found a way to spread the impact of their efforts over a very large number of individuals, while the teachers, nurses, and factory-line workers can apply their efforts to a dramatically smaller number of “units,” be they students, patients, or boxes of Corn Flakes. For massive too-big-to-fail banks, the units are dollars. The downside is that as certain winners are able to spread their efforts over an enormous number of people, the required number of winners declines – ask anyone who has ever tried to become a movie actor or a pro-basketball player. International trade and internet communications, among other developments, have significantly increased that tendency toward winner-take-all outcomes. When that effect is expanded through international trade, the result is that yes, each country benefits in aggregate, but you also observe a “hollowing out” of the middle class, particularly for families that don’t have labor or capital that shares in the distribution.


As for the U.S. economy, QE-induced speculation misallocates resources that might otherwise contribute to long-run growth, and while conditions could certainly be worse, the benefits of this economic recovery have been highly uneven. Again, 40% of families report that they are “just getting by,” with the majority essentially living paycheck to paycheck without enough savings to cover even a few months of expenses. We could be, and should be doing better, except that this complex adaptive system of ours responds to good incentives as well as bad ones, and has been repeatedly crippled by policies that have produced waves of malinvestment, bubble, and collapse. The economy is starting to take on features of a winner-take-all monoculture that encourages and subsidizes too-big-to-fail banks and large-scale financial speculation at the expense of productive real investment and small-to-medium size enterprises. These are outcomes that our policy makers at the Fed have single-handedly chosen for us in the well-meaning belief that the economy is helped by extraordinary financial distortions. The Federal Reserve is right to wind down quantitative easing, and would best terminate reinvestment of maturing holdings, ideally beginning in October or quickly thereafter. The issue is not whether the U.S. economy does or does not need “life support.” The issue is that QE is not life support in the first place.