capital-gains

In the coming months, we will come together to offer a tangential view — not a consensus view, and certainly not the average view. We seek to synthesize information and ideas from different vectors and extrapolate a resultant vector in an orthogonal dimension. Raj is an entrepreneur/technologist born and raised in India, educated in the United States, who now markets green energy solutions globally. Leslie is a clinical psychologist with an M.B.A. in strategy and finance from Chicago Booth who specializes in working with private equity investors. Through writing about capitalism, economics, education, the environment, and value creation, we aspire to create a social good. Economic disparity is what creates value because at every level there is an opportunity for arbitrage. I may have a particular way to leverage my status or technology to create a good, such as more economic wealth relative to someone else, on an average basis, not on an absolute basis. In emerging economies like India and China and in the past in America, this opportunity differs greatly from what we have in the U.S. today. By stratification of wealth, we do not mean what happened under Communism, where a few, few party elite lived like kings and almost everyone else had beans and water for dinner. What matters is a continuum with easy mobility upwards and a finite probability to jump across multiple layers. It is only capitalism that allows individuals to move up. The very rich and the very poor exist under capitalism and communism. We must look to the middle class, and its size and growth, to see the secret of capitalism. Look to the middle class. That is the where the action is. In Czarist Russia, the number of levels was 1,000. The top echelon lived like kings and the rest of the nation starved. Mao Tse-tung starved tens of millions and lived a lawless and disgusting life well beyond the way anyone in the U.S. lives. Look to mobility. What we want is the chance to apply our talents. Give us the chance to move up! China has decided to invest in us simply out of selfishness. We are among the best places to be right now for their money. If we continue to run peace-time deficits to the sky, as we presently are, that will change. Our worry is not that China will harm us; they want us to be able to pay them back. It is rather that our own Congress will harm us. Milton Friedman did a wonderful study on wealth stratification (cited in Free to Choose , 1980). He showed was that way back when, wealth was far more widely spaced between poor and rich (and there were far more poor) and worst of all, the poor did not move into being rich, ever. Capitalism allows those, like you and me, who work very hard, to move up. No other system really does. “You cannot multiply wealth by dividing it.” And hence, capitalism was born. Raj had a car driver in India who said that in 1958 he moved from a small village in the south into the same slum featured in Slum Dog Millionaire. There, he raised two kids. His oldest son is a civil engineer in Mumbai. His youngest son entered graduate school in electrical engineering and hopes to pursue a Ph.D. in the United States. Their father sold his property and made a large profit. But he still drives a taxi. This family has leaped across several wealth layers from abject poverty to middle class, all in one generation. This is the true story of Dharavi, the largest slum in the world. If businesses in the U.S. cut salary and fringe costs by 35-65% (fringe costs consisting mostly of health care and dental, disability, life insurance), we will become a more competitive economy, especially compared to countries with an edge in information technology. We recognize we need to reflect on this issue and will do so in coming posts. If in addition we also replaced “cash for clunkers” with “capital for entrepreneurs,” especially those pushing the boundaries on solar, vehicles, biological sciences, and computer sciences, we would create thousands of new enterprises and businesses across the country. These would generate more wealth, which would benefit not only the U.S. economy; it would also create a forward path for the rest of the world. The federal government should quit bailing out uncompetitive large industries and financial institutions and instead become a potent venture capitalist! A fundamental macroeconomic factor that must happen is to bring down the cost of labor in the U.S. rather than enacting trade barriers. That is why it is important to visit places like India and China. The tax policies in India are far more progressive than in the U.S.; the social policies are also very friendly. The socialist policies that existed in India during the 60s, 70s, and 80s are very different from what one sees today in India. A true capitalistic tax system would be to have an inheritance tax. Taxing the wealth from one generation to the next is the answer. Unfortunately, the Bush administration changed that. In India, the rise in taxation as one’s income grew used to be exponential. At the top levels of income, the tax rate was close to 99%. The result was an underground economy. Now the capital gain tax is a flat 15% (up from 10% a year ago) and the maximum individual income tax rate is 30%. India had policy makers who created a smart taxation policy. At the same time, the Indian government is involved in other socially beneficial programs. Our fear is that discourse in the U.S. has become so polarized that it will become impossible to enact the economic policy that will inspire entrepreneurial activity in the short- and medium-term and the correct socioeconomic policy for the long-term. Entrepreneurship is created by less governmental intervention and lower capital gains taxes. It has been shown a hundred times. In the end, rising consumption in India will raise U.S. income levels. As an example, most Indians are used to income disparity. It is not that different income levels are bad; social and economic systems are not designed to give parity at the same time. Any economic system will say there must be a path to happiness. Either the system offers a path up or the individual accepts his or her station. What policy makers in the U.S. should be doing is to understand, analyze, and empathize with the competition. Then, we can build our competitive strategy. Smart people in power should travel. When they travel, they should get a full, rich view of the landscape. On October 15, 2009, The New York Times reported that the European Union and South Korea took a major step toward a free trade agreement aimed at generating billions of euros in new commerce. With talks on global trade deadlocked and rising concern about protectionism, analysts said the deal could signal other nations to press ahead with their own bilateral pacts. After two years of negotiations, an agreement was signed in Brussels by the European trade commissioner and her South Korean counterpart. The pact now needs approval from the European Union’s member states, some of which face intense opposition to the deal from sectors like the automotive industry. Under the agreement, the two sides will remove virtually all tariffs between their economies, as well as many non-tariff barriers, over a five-year period. The European Commission, the executive arm of the union, said the trade in goods between Europe and South Korea was worth about 65 billion euros ($97 billion) in 2008, and that the deal was worth 19 billion euros to European exporters alone. The European Union runs a deficit with South Korea in goods trade. A free trade agreement between the United States and South Korea, reached in 2007, has yet to be ratified and is stuck in Congress. Some American politicians oppose the deal over concerns it will harm automakers. This furor over free trade versus protectionism is relatively minor compared to issues implicating a combination of a floating exchange rate system and the end of all currency controls and trade barriers, even “voluntary” export quotas. As Paul Krugman points out, “Trade barriers are a minor issue for the United States today; even small wrinkles in health care policy, like overpayment to Medicare Advantage plans, probably matter more to public welfare than all the trade restrictions now in place.” His point is well taken. Political discourse and policy making in the United States has become too myopic and insular. He also noted recently, “U.S. officials have been extremely cautious about confronting the China problem.” He believes China’s caution makes little sense. “Suppose the Chinese were to do what Wall Street and Washington seem to fear and start selling some of their dollar hoard. Under current conditions, this would actually help the U.S. economy by making our exports more competitive.” With the world economy in a precarious state, seeking economic policies by major players that worsen the problems of other countries cannot be tolerated. Something must be done about China’s currency. In addition, we should keep a watchful eye on China’s increasing hunger for commodities and the implications thereof on commodity prices. Take for example, China National Offshore Oil Corporation (CNOOC). CNOOC is in talks with oil-rich Nigeria to buy large stakes in some of the richest oil blocks in the world. In a research note dated October 19, 2009, Deutche Bank writes: China has grown closer economic and business ties with emerging markets across the globe, raising its profile and enhancing its economic and political clout. Thus far, China’s interests have been driven mainly by its thirst for energy and commodities — in short, commercially-driven. It is pointless for traditional powers to try to stop China’s growing influence. It would be more productive if traditional powers responded to China’s emergence by enhancing their own positive engagements with EM regions. Given that nations are economically tied, it is hard for one nation to wage a differential war against another. We should become more cooperative and look at larger interests of humanity. Not that we would confuse that argument with entrepreneurship and the ability to make wealth. Milton Friedman argues in Essays in Positive Economics , that “current economic and political conditions make a system of flexible or floating exchange rates-exchange rates freely determined in an open market primarily by private dealings, and like other market prices, varying from day to day-absolutely essential for the fulfillment of our basic economic objective: the achievement and maintenance of a free and prosperous world community engaging in unrestricted multilateral trade. There is scarcely a facet of international economic policy for which implicit acceptance of a system of rigid exchange rates does not create serious and unnecessary difficulties.” “The sooner a system of flexible exchange rates is established, the sooner a system of unrestricted multilateral trade will become a real possibility.” (pp. 157-158) If there is no major incentive to move up in the income strata, why work harder, unless I am motivated by altruism. One can either argue that spiritually it’s the right thing to do. Or one can strap on a rational argument: Every human being has the underlying energy to work and establish a differentiation between oneself and the rest of society. The potential to move up the wage ladder is what makes great nations. In order for the U.S. to keep a dominant world position, we need to be 10 steps ahead of the rest of the world. We need to propel the rest of the population up but by generating new wealth, by creating new avenues for wealth, rather than taxing everyone more. It is critical to have the incentive to move up the curve. Silicon Valley is an example. Overnight, entrepreneurs could jump up income levels radically, from making $200,000 to making $2 million after an IPO. The promise of wealth creation drives innovation. A government that takes away the potential to jump across brackets of income will not have sustained global influence. Raj Alur is Chief Marketing Officer responsible for global marketing and sales at Silicon Valley energy storage startup whose products will become an essential complement to all renewable energy power generation. Raj was previously a venture capitalist with Vesbridge Partners and St. Paul Venture Capital, a CEO of a Boston area wireless data startup, VP of Marketing at Lucent Technologies amongst others. He started his career as a software engineer designing operating systems and file systems. Raj holds a M.S in Computer Science from Boston University and an M.B.A. from Cornell.