Thursday, July 28, 2016

Immigration and Brexit - Jeremy Grantham commentary -

Somalian Refugees/US Navy
Jeremy Grantham, British investor and co-founder of Grantham, Mayo, & van Otterloo - one of the largest fund managers, based in Boston - is well-known as a leading and prudent investor, but also as being prescient regarding economic trends, bubbles, and geo-political risks, such as climate change.

Union Jack and EU Flag
In his  recent quarterly commentary,  "Immigration and Brexit", Grantham discusses the events in the UK (i.e. Brexit) and the US (i.e. Trump as presidential candidate) and the challenges of immigration.

He begins with calling the current economic (i.e. central banks' policies) and political developments (i.e. Brexit) as "Black Hole Experiments in which the further we push them, the more the laws of physics, finance, or politics begin to change in unknowable ways."

Even though we are experiencing these unusual political times, and even though Grantham believes assets are overpriced, he expects the (US) stock market for the time being to keep rising thanks to what he calls the "two remarkable pillars of support", which are the continuing Fed's policy of low interest rates and  the US corporations buying back their stock.

Furthermore, although he believes Brexit will be bad for the UK economy, it could turn out to have a positive effect by stimulating the EU to reconsider its many weaknesses. But more importantly Grantham believes Brexit is an indication of how problematic immigration from outside Europe can become. He then comes up with an in my view very important statement about social cohesion in society. This is something that many European politicians and policymakers seem to forgot about or take for granted. Grantham states:

"There is a consensus that social cohesion is the key to a successful society. It brings with it the broadest range of advantages: 

  • greater economic mobility; 
  • longer lives and better health; 
  • fewer babies born to teenagers; 
  • fewer traffic deaths, murders, suicides and robberies; 
  • a smaller percentage in prison; 
  • and less stress and higher levels of contentment, amongst others."

In order to strengthen social cohesion, income equality is required: the more income equality, the higher the social cohesion, Below graph shows the ranking of developed countries regarding social cohesion and income equality. Not surprising, Japan has the highest social cohesion combined with lowest income inequality, followed by the Scandinavian countries and the Netherlands. On the other side of this spectrum, the US has the highest income inequality and the lowest social cohesion, with the UK closely behind it.

Source: Wilkinson & Pickett, The Spirit Level (2009), Equality Trust

Grantham elaborates on the income situation in the US - which offers a good explanation for the rise of political outsiders such as Donald Trump and Bernie Sanders during this election year:

"In the US, there has notoriously been no material progress since 1970 (45 years!) in the real hourly wage, even as the income of the top 1% has more than tripled. Tax rates have not attempted to balance this but have actually changed to lower the relative burden on the well-off! Blue-collar work,
especially in manufacturing, has been hard to get in both countries. Since 2009 in the US about 10 million new jobs have been created and a remarkable 99% have gone to workers with at least some college education."

According to Grantham, not only has social cohesion in the US (and the UK) diminished over the years, but at the same time immigration has become a major issue in the Brexit and Trump campaigns. For example, according to British research, in the UK over 50% of the public has answered yes to the question "do you think there are already too many immigrants?" (while this percentage is over 40% for the general European public.) (See also the pamphlet “Race and Faith: The Deafening Silence” by Trevor Phillips, a former head of the British Equality and Human Rights Commission, who warns that Britain is “sleepwalking to catastrophe” because politicians are too squeamish to face up to the threats from the multicultural society.)

Grantham refers to academic research on the impact of immigration, which shows - obviously, I would add - that "trust is usually lower in diverse groups than homogeneous groups: that religious and visible differences – dress and skin color – are less easily dealt with, not surprisingly, than immigrant groups with similar cultures."  Grantham concludes that "when times are good immigrant flows are perceived as a moderate and manageable stress to social cohesion. When times are seen as bad, though, especially when jobs are scarce as they are for blue-collar workers now, new immigrants are seen as far more problematic."

Grantham doesn't believe that the UK and many other European countries have had a net benefit from immigration. In any case he says: "Possible productivity gains from immigration seem at best to be insufficient to offset increased social stresses."

Against this backdrop and with a weakened EU due to Brexit, Grantham believes the most underestimated risk for Europe is coming from refugees and non-European immigration. Grantham is pessimistic about Africa and parts of the Near East, that he sees beginning to fail as civilized states:

"They are failing under the pressure of populations that have multiplied by 5 to 10 times since I was born...........Country after country is tilting into rolling failure.This is producing in these failing states increasing numbers of desperate people, mainly young men, willing to risk money and their lives to attempt an entry into the EU."

As an example of the upcoming pressure on the European borders, Grantham points to Nigeria, that had 21 million people in 1938 and now 187 million. According to a recent poll, 40% of Nigerians (75 million - sic! -) said they would like to emigrate, mostly to the UK (population 64 million).  In the meanwhile, the United Nations estimates Nigeria’s population in 2100 to be over 800 million.

Unless the EU and Europe can come up with a uniform and controlled immigration, it risks not only becoming a failed EU, but also a failing Europe. It's doubtful that Grantham is very confident that this will happen, when he describes the EU "behaving like headless chickens faced with the problems they already have. Problems that will, when viewed from the future, appear to have been just moderate in scale."

Grantham ends his illuminating but quite distressing commentary by saying:

"This does not mean that a country based on immigration (trained, if you will) cannot integrate not just immigrants, but the whole idea of immigration. If times are good, or good enough, for a sustained period and income inequality is held in some check and social welfare is fine, you could end up like Toronto, everyone’s heroine in this respect. If not, you could even easily end up with a melting pot history and the current conflicted attitudes to immigration that we have in the US."

In summary, the takeaways from Grantham's Commentary are:

  • These are unusual times with low or even negative interest rates; with the Brexit and the advent of Trump in the US. 
  • Although stock markets are overpriced, they can keep increasing due to the Fed's policy and (US) corporate buy backs.
  • Brexit will hurt the UK economy for several years, but may stimulate the EU to reconsider its many weaknesses.
  • On the other hand, Brexit could be the fuse making immigration from outside Europe a potentially explosive problem.
  • Social cohesion is the key to a successful society and income equality is key to social cohesion.
  • Trust is usually lower in diverse groups than homogeneous groups.
  • The worst risk to the EU - and Europe - comes from immigration and refugees from outside Europe, that would stress Europe and Western Europe's liberal traditions.
  • Africa and parts of the Near East are beginning to fail as civilized states.
  • Net benefit from immigration is not obvious.
  • Immigration with social welfare and reasonable income equality could be positive if times are good (if not, then you could end up with America's current problems)
  • To avoid these risks to its economy and society, EU must get a uniform policy on immigration as soon as possible.

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