TIME Retirement

2030: The Year Retirement Ends

The real debt-and-deficit crisis facing our country isn’t national—it’s personal. A look at the coming retirement apocalypse and what we have to do to avoid it

The retirement scenario everyone wants to avoid arrives in 2030. That’s when the largest demographic group in U.S. history, the baby boomers, will have nearly depleted the Social Security trust fund. It’s also when older Generation X-ers will begin moving out of work and into their golden years.

But these won’t be the years of leisure that recent generations have known. Consider a typical 2030 retiree–an educated Gen X woman, around 65, who has worked all her life at small and midsize companies. Those firms have created most of the new jobs in the economy for the past 50 years, but only 15% of them offer formal retirement plans. Our retiree has put away savings here and there, but she’s also part of the middle class, which took the biggest wealth hit during the financial crisis of 2008. That–along with the fact that average real wages have been virtually flat for three decades, even as living costs have risen–means she has minimal savings, even less than the $42,000 that today’s average retiree leaves work with.

More than half her retirement income comes from Social Security. When you factor in health care spending, she’ll be living on only about 41% of the average national wage. Despite her best efforts to work and save, our Gen X retiree will have trouble maintaining her standard of living. She won’t be alone: the Center for Retirement Research at Boston College estimates that 50% of American retirees will be in the same boat.

In all likelihood, then, she won’t actually be retired. Like many of her peers, our Gen X-er finds herself needing a part-time job; she shares her home and many living expenses with her son, a millennial who isn’t doing so well himself. More members of his generation live with Mom and Dad than any generation before, according to the Pew Research Center, in part because they came of age in the post-financial-crisis era, when wages were stagnant and unemployment high. (If you enter the workplace during such cycles, your income never catches up.) As he struggles to pay down student loans and save enough money to move out, there’s very little left over–which means he’s on course for an even less secure retirement than his mother.

Boomers scrambling to get by on a minimal income. Gen X-ers who can’t afford to stop working. Millennials staring at a bleak financial future. This is the retirement apocalypse coming at us fast–unless we do something about it now. As with other big, slow-moving crises (climate change, health care, the quality of education), it’s difficult to create a sense of urgency over retirement security. But in the past few years, the financial meltdown and its aftermath have thrown the problem into sharper relief. Now, in a retirement landscape that has witnessed few big innovations since the Reagan Administration and the rise of the 401(k) account, we’re suddenly seeing a range of new ideas.

Controversially, many of the new approaches call for a greater role for government after three decades of pushing responsibility for retirement onto individuals. They include everything from President Obama’s MyRA plan, which would let some individuals save in a fund administered by the U.S. Treasury, to a spate of state-run programs. The most intriguing–and hotly debated–approach is taking shape in California, where state senator Kevin de León has pushed through a bill that aims to guarantee every Californian working in the private sector a living wage in retirement, a plan some experts say could become a new model for the nation.

Advocates say the government role will help recruit more people to save and can keep costs low with efficiencies of scale derived from all those participants–much as some big public-employee plans do. But the reforms are being challenged by everyone from small-government conservatives, alarmed by a growing public role, to financial-services companies, which fear that government-run plans will put money into simple index funds rather than the managed funds that generate more lucrative fees for the industry.

Regardless of the eventual solution, few dispute that we’re on a dire course at present. Experts estimate that half of Americans are at risk of becoming economically insecure in retirement. Our system is in desperate need of a fix. “We’re facing a tsunami,” says Senator Tom Harkin, a Democrat from Iowa who has proposed his own program. “And we’ve got to deal with it–now.”

GROUND ZERO

If there’s one place in America that best captures the complex mix of economic, social and demographic trends that play into the looming retirement crisis, it’s California. Like many other national stories, this one bubbled up early in the Golden State. Long before Detroit went bust, the state was in the news for its public-pension troubles, including massive bankruptcies in Stockton, Vallejo and San Bernardino. California is also emblematic of all the worrisome trends: it has more retirees, young people without benefits, poor people, immigrants and small and midsize businesses than most states. In other words, it checks all the boxes of groups most at risk of an insecure retirement.

Yet the Golden State is also coming up with some of the most forward-thinking ideas. De León’s approach, called the California Secure Choice Retirement Savings Program (CSC), was signed into law in 2012 by Governor Jerry Brown. It aims to combine the best of old-style defined-benefit plans (traditional pensions that guarantee workers a set level of yearly income in retirement) with the flexibility and mobility of a 401(k). CSC will cover workers in California who don’t currently have access to formal retirement savings via their work. “I’m a big fan,” says Monique Morrissey, an economist with the liberal Economic Policy Institute who recently testified before Congress on retirement security. “It’s probably the farthest along of all the retirement-reform ideas in terms of practical implementation.”

Details of the plan, which will launch in early 2016, are now being hashed out in consultation with a variety of industry and academic experts. It’s likely that CSC will use behavioral nudges to get as many eligible people as possible to participate–for instance, by making enrollment automatic unless a worker opts out, rather than requiring a sign-up to opt in.

Participants in CSC would sock away at least 3% of their income, most likely in a conservative index fund, in which money is invested in all the stocks listed in a specified index. For instance, in an S&P 500 fund, the pooled money is invested in all 500 stocks in that index. Index funds are considered a simple way to ensure that investors see the same return as the overall stock market–and they’re cheaper too, since index funds don’t employ stock-picking wizards and charge the related fees.

The possibility of more workers putting savings into such low-cost funds may help explain why CSC is getting resistance from the Securities Industry and Financial Markets Association (SIFMA), a trade group for securities firms and asset managers. But a version of this plan has already been enacted for nonprofit workers in Massachusetts, and plans similar to CSC are being discussed by governors and legislatures in states including New York, Illinois, Oregon, Washington, Connecticut, Maryland, Minnesota and Arizona. If successful, CSC and plans like it would put the government deeper in the business of guaranteeing retirement security. They would also underscore the fact that a 100% private, do-it-yourself system isn’t working–at least for many Americans.

De León, the force behind CSC, was raised by his Mexican mother, who died of cancer at 54, and his aunt. Both women worked as maids in various affluent California homes. De León says he became focused on retirement security last year when his aunt, who is 74, fell ill and couldn’t work.

“She was still cleaning homes in La Jolla when she had a stroke. She had no IRA, no 401(k), nothing. She had been working essentially freelance,” says de León. “I became her 401(k). I had to give her money because her Social Security didn’t suffice for her basic expenses, like housing, food, medication, a bus pass.”

De León’s district, in downtown Los Angeles, is home to many people in a similar fix. A melting pot that includes the city’s Chinatown, Koreatown, Little Armenia and other ethnic enclaves, it’s full of small entrepreneurs, immigrants and freelancers who work not at big blue chips but in the less secure firms and “gig economy” that’s increasingly becoming the norm in America.

STILL WORKING

Paula Dromi is one of those workers. A 75-year-old social worker, Dromi lives in a small three-bedroom bungalow near de León’s office in downtown L.A. with one of her two grown sons (who moved back to save money after a period of unemployment) as well as a friend. Both housemates help Dromi pay major living expenses. Her Social Security plus the money she makes working as a part-time freelance therapist amounts to about $1,700 a month. But her home insurance, property taxes and mortgage alone are nearly $1,500. Both she and her journalist husband (who died in 2000) saved for retirement, but years of co-payments on medical bills for his brain illness depleted both his $35,000 IRA and their $30,000 in savings.

Dromi was left with her $60,000 IRA–lower than it might have been because she changed jobs often and, like many other women, took time off to raise children–and her home, which is valued at $442,000. She could always sell the house. But if she did, she says, she’d have to move out of L.A. because of its lack of cheaper housing. Instead she has pieced together a multigenerational home and a freelance work life that she hopes she can maintain indefinitely. “I’ll be working another 20 years, assuming I can,” says Dromi.

In a way, Dromi is lucky. She has a home that she can share and is healthy enough to work, at least for the time being. But the fact that an educated professional who saved and had health insurance can end up scraping to get by in retirement underscores how fragile the system is.

That fragility is in large part due to the massive shifts in the American retirement system since 1980. That’s when the 401(k) plan was invented, by a benefits consultant working on a cash-bonus scheme for bankers, who had the idea to take advantage of an obscure provision in the tax code passed two years earlier, allowing for deferred compensation of individuals to be matched by their company.

The result was the 401(k), a savings account that lets employees contribute pretax income from their paycheck (sometimes with employers matching some or all of the amount) but, unlike the traditional pension, does not promise a specific regular payment upon retirement. Holders of 401(k)s amass a hopefully growing fund from which they can draw money when they retire.

This system is largely based on accident and anomaly–401(k)s were never meant to replace traditional pensions as a primary retirement vehicle, but they have. We’ve ended up with a bifurcated system that has the upper third of society doing better and everyone else doing worse. Statistics show that people retiring now who have been invested in 401(k)s rather than traditional defined-benefit pensions are less well off than those who came before them. That’s because 401(k)s typically work best for people who work for big companies, with salaries that allow them to put away double-digit percentages of their income, and who have either the sophistication to choose their own asset allocations well or a benefits department that offers up smart options and auto-enrolls them in the plan.

The problem is, most Americans don’t fall within that group. Only 64% of private-sector workers have any kind of formal retirement plan, and fewer than half sign up for one. What’s more, the number of people with access to plans is declining; part-time and freelance workers usually don’t qualify. With the situation becoming increasingly dire, there is a drumbeat to reform the 401(k) system. Options include making enrollment mandatory, providing state-sponsored IRAs (or even national ones like Obama’s MyRA, which is based on the highly successful, low-fee Thrift Savings Plan offered to federal workers) and cutting red tape and costs so that more small businesses could offer employees 401(k) plans.

But the efforts have been piecemeal and ineffectual. Some critics blame the financial-industry lobby. In a letter to the California treasurer late last year arguing against the CSC plan, SIFMA contended that such programs would “directly compete for business with a wide range of California financial-services firms” and that state money should be put not into creating universal retirement plans but into educating individuals “about the benefits of early and regular savings for retirement.”

De León responds that it’s asking a lot of many workers to navigate the complex investment choices in many private plans. Indeed, over time, passive index funds typically beat all but a handful of actively managed funds, and many individual workers don’t have access to the highest-performing vehicles.

SYSTEM REBOOT

That’s why many retirement scholars would like to see the entire system changed, starting with 401(k) plans themselves. Harkin’s bill, the USA Retirement Funds Act, aims to make it more difficult for people to borrow from 401(k)s. This “leakage,” when savers tap their retirement funds prematurely, is a big reason people come up short in retirement. Harkin’s proposal would also shift the standard payout from a lump sum to a steady income stream in retirement.

Some experts would also like to see the government force more workers to save. For those who have access to 401(k)s, “Congress should make automatic enrollment mandatory, and plans should invest people in low- or no-fee index funds,” says Alicia Munnell, director of Boston College’s Center for Retirement Research. She and others also suggest establishing third-party administrators that would run the programs for groups of companies–bringing together more workers, creating better economies of scale, lowering fees and raising returns.

Governments are, of course, a possible candidate to run such programs–that’s essentially what de León is proposing to do for workers who are currently not covered by any other plan. Critics say government has a poor track record when it comes to protecting retiree savings, citing public-employee pensions in cities like Stockton, Calif. De León counters that unlike public-pension plans that promised 8% returns a year and cushy retirements, the CSC model has more modest aspirations–around 3% returns and a “livable yearly wage in retirement.”

Unfortunately, truly fixing American retirement will likely take more than even mandatory 401(k) plans and diminished expectations. Social Security reform is a subject that must be debated soon, in a real way, if we want to avoid having a generation of elderly poor. The fact that fewer than 10% of America’s elderly are currently poor largely reflects the contribution of Social Security to their income. Without it, says Pew’s Paul Taylor, author of the book The Next America, about half of people over 65 would be poor.

Beyond that, it’s probably inevitable that we’ll all be working longer. Munnell of the Center for Retirement Research points out that delaying the start of Social Security benefits from age 62 to 70 could increase monthly payouts by 76%. “Most of us are healthier and have less physically demanding jobs than our parents and grandparents,” Munnell says. “Stretching out our work lives is a sensible option.”

Changing our households to return to a once common multifamily structure, as Paula Dromi and her son have done, may be another. Taylor is hopeful that such forced communal living may actually help spark the tough political debate needed to reform entitlements and enhance retirement security while continuing to invest in our economy for the sake of the young. The portion of the population most worried about retirement are the 20- and 30-somethings who see an uncertain future as they struggle to pay off student loans and establish themselves in the work world, and perhaps lean on their parents for support. “There’s a growing sense, for all the generations, that no one has been spared and everyone is suffering to some extent,” says Taylor. “There’s also a sense that we’re all in this together–and maybe that has the potential to change this zero-sum debate.” If we’re lucky, that may help us find the way to a system in which people of all generations can retire with security and dignity.

TIME Economy

We’ve All Got GM Problems

Insular management and lack of responsibility are hurting big firms around the world

General Motors CEO Mary Barra may have summed it up best when she described former U.S. Attorney Anton Valukas’ 325-page report on the company’s ignition-switch problems, which resulted in numerous deaths and millions of recalled vehicles, as “extremely thorough,” “brutally tough” and “deeply troubling.” It was all three and then some. But the report also illuminates a systemic problem in most big corporations as well as governments–insular management or, in the parlance of gurus, information silos.

Valukas found that GM didn’t fix its ignition-switch issues quickly or correctly because the company’s many departments and employees literally weren’t communicating with one another. The engineers who were looking into reports of cars’ stalling while moving didn’t know that engineers elsewhere in the company had designed air bags that would not deploy when cars were technically off. That meant engineers made different decisions about fixing the switch problems–decisions that ultimately led to over a dozen deaths.

But it was GM’s culture, in which silence and buck-passing were raised to a Kafkaesque art form, that kept these silos in place. Valukas’ report brings to light a number of tics that were unique to GM. There was the “GM nod,” for instance, in which everyone nods with respect to a certain course of action before leaving a meeting and then does nothing at all. And there was the “GM salute,” firmly crossed arms pointing outward toward others, signaling a steadfast refusal to take personal responsibility.

The problems of information not being readily shared and personal responsibility not being assumed are old ones. “Napoleon wanted to create a military without silos,” says Ranjay Gulati, a Harvard Business School professor who has spent 15 years studying silos. “Adam Smith spoke about the problem of labor silos. Events like 9/11 could have been prevented if there had been more sharing of information across organizational divisions.” Indeed, many of the biggest corporate debacles in recent years have been linked to information silos. The Rana Plaza disaster in Bangladesh, in which more than 1,100 garment workers were killed when a poorly built factory collapsed, was due in part to the fact that major Western retail brands didn’t know who their suppliers were or what they were doing.

Big, complex companies are typically structured so that decisionmaking is separated according to function, geography and product. That naturally creates silos. Indeed, McKinsey research shows that the most globalized firms pay an economic price for this. Examples of silos in blue-chip firms abound: Sony once had two separate divisions working on creating the same electrical plug without anyone realizing it. (It’s not just old-school companies that are at fault. I was once offered a job at a well-known tech firm where I would run around talking to C-suite executives about what they were doing and report back to other top people in the organization.)

So-called silo busting is already a hot topic in academic circles. Economists, for instance, are trying to do a better job of predicting market movements by calling on experts in areas like biology, psychology and the humanities. Major brain-science initiatives now routinely bring together researchers across many fields to share data. But in big corporations, silos are a problem that is becoming only more pressing as the world becomes more interconnected.

How can companies bust silos? according to Gulati, the best way is to create a set of core values or a core mission that everyone in the firm understands. A good example of this is IBM’s decision, under previous CEO Sam Palmisano, to create a safer and healthier society via its Smarter Planet initiative. That goal, says Gulati, helped facilitate cooperation across divisions. It’s also important for firms to consider issues from the point of view of customers rather than insiders. Consider longtime Cisco CEO John Chambers, who famously was 30 minutes late to his first board meeting because he felt it was more important to take a call from an irate customer than to meet the people who’d be deciding his salary. Another way to bring down silos: hire outsiders. Research shows that women and minorities often communicate better across divisions.

On that score, Barra is perhaps better placed than most to solve her company’s problems. During her announcement about the report, she set a communal goal for GM–“to set a new industry standard in safety”–and told employees to email her personally if they felt customers’ safety was ever in doubt. Silo busting starts at the top, and if Barra does it at GM, it could set an example for all large institutions.

TIME Economy

The Economy Is Back—Barely

Jobs have recovered, but wages aren't growing

Let’s get the good news out there first: Yes, the U.S. has finally, after four years of recovery, exceeded its pre-recession jobs peak of 138.4 million new jobs. There are now more jobs out there in the economy than ever before, though it’s worth saying there are also a lot more people in the labor market than there were back then, even given the historically low workforce participation rate of 62.8 percent (the lowest since 1979).

The big question is “who are those jobs for?” That’s where the May jobs report, the fourth strong report in a row, gets more interesting. Unlike previous reports, the gains have been broad based—there were new jobs created in many sectors, including higher paying and important ones like manufacturing and construction. But 50% of all the jobs being created in this country are still in the low-wage category—retail clerk positions, home heath aids, waitresses and the like. And more importantly, pay isn’t going up much—only a little more than 2% month on month, compared to an average of 3.5% to 4.5% before the recession. If you aren’t jumping up and down about this report, that’s probably why—a lot of us just don’t feel the recovery in our pocketbooks.

Screen Shot 2014-06-06 at 1.13.13 PM

That’s underscores the key difference in the pre-2008 economy versus now. Yes, the jobs debate has officially shifted from quantity, to quality. But, as the McKinsey Global Institute has been pointing out for some time now, that shift has taken longer than in any recovery of the past. From the period between World War II and the 1980s, “there was a fairly predictable pace for recoveries,” says MGI director and economist Susan Lund. It took roughly six months 
for U.S. employment levels to recover after each post-war recession 
through the 1980s. Then, things changed. It took 15 months after the 1990–91 recession for employment to reach its pre-crisis levels, and
 39 months after the 2001 recession. This time around, it’s taken 40 months, and $4 trillion of Federal Reserve stimulus to boot.

What’s more, while we’ve created as many jobs as we had before, the nature of the work has changed—the labor market is bifurcated, with people at the top doing quite well and those in the middle and bottom, not so much. Another fascinating tidbit from MGI that reflects this shift: employment for people with a bachelor’s degree or more has actually been growing since the crisis in 2008. It never stopped growing. But work for those with a high school degree or less has been shrinking, and only just began to rebound. “For those people, it still feels like a jobless recovery.”

Screen Shot 2014-06-06 at 1.13.25 PM

Increasingly, though, the question is whether it will be a wage-less recovery. It usually takes several months of job growth for income to start to pick up, and once it does, it’s possible that a broader range of companies will start adding more employees higher up the food chain. The National Association of Business Economists is bullish on the next six months. But I tend to think that even as jobs will grow, these key trends— the shrinking of the middle labor market, and flat wages—will continue. One of the main reasons could be that technology related job destruction is continuing in blue chip America, and it’s going higher up the food chain. I recently sat in on a conference with a high level group of C-suite employers, and all were planning to spend on technology that would displace more white-collar workers. Research shows the only way to shift that trend is to increase levels of education in society faster than technology change—and given the speed at which the latter is advancing, that will be a tough assignment indeed.

TIME Autos

GM CEO Pledges ‘New Industry Standard for Safety’

GM CEO Mary Barra Testifies To House Hearing On The Company's Ignition Switch Recall
General Motors Company CEO Mary Barra testifies during a House Energy and Commerce Committee hearing on Capitol Hill, on April 1, 2014 in Washington, DC. Mark Wilson—Getty Images

Mary Barra is taking personal responsibility for the problem plaguing GM's corporate culture, despite an internal report revealing that top management didn't cover up the defects leading to the auto company's recalls.

It’s hard to overstate how unprecedented GM CEO Mary Barra’s announcement this morning of the findings of U.S. attorney Anton R. Valukas’ investigation of the company’s ignition switch scandal was. Barra called the report, based on 350 interviews with 230 individuals, as well as the examination of 41 million documents, “extremely thorough,” “brutally tough,” and “deeply troubling.” The National Highway Traffic Safety Administration will be posting the whole report later today on their website, but in the meantime, here are the three things you need to know about the case and its ramifications, based on Barra’s preview of the report.

  1. This wasn’t a trade-off between cost and safety – Barra says that the report found no evidence that the bean counters within the firm pushed the engineers to compromise safety in order to save 90 cents on an ignition switch that ended up costing lives. Rather, this was about a company with lots of divisions and moving parts that didn’t talk to one another. The ignition switch scandal was, in the end, a kind of death from a thousand cuts in which multiple divisions had information that could have prevented the safety issues, which they didn’t share, and for which no one person took ultimately responsibility. Those “silos” are what Barra is going to try and break down over the next few weeks and months – one of the key steps she’s taking to do that is putting responsibility for safety issues in the C-suite, as well as appointing a single VP of safety to coordinate everything, with the help of 35 new safety investigators.
  2. Barra isn’t guilty herself, but she’s taking personal responsibility for fixing not only the problem, but also GM’s corporate culture. Barra didn’t know about the problem – indeed, she said that she believed “deeply in my heart” that if information had traveled out of various corporate silos and up the food chain, “we would have dealt with this issue very differently.” In one of the most telling moments of her speech, she told employees that if any of them saw a problem with safety that should be addressed, they should tell their supervisors, and would be commended for doing so. And, if they still didn’t feel it was being addressed, they should come to her – she actually said “contact me directly,” which is the first time I’ve ever heard a CEO say that in a similar press conference.
  3. This is a scandal that could change not only GM, but also the auto industry itself, and the broader business landscape. The “silos” that Barra kept referring to, those divisions within the company that don’t talk to each other, are a problem not just for GM, but for nearly every big company in America. Finding examples of this is like shooting ducks in a barrel – there’s the famous anecdote about two Sony divisions building plugs for a single product without knowing what the other was doing, or the blue chip tech companies that hire PR reps to follow around executives and write down what they are saying so that they can tell the rest of the company, because the leaders don’t do it themselves.

Expect “de-siloing” to become a major management topic. And expect Barra to continue to be in the spotlight – she gave a rock star performance at this conference, and has set the bar for herself even higher, pledging to set a “new industry standard for safety.” If she can get all the many parts of GM to talk to one another, she may set a new standard for corporate management, too.

TIME Regulation

Carl Icahn Denies Insider Trading

The investor says he has "never given out inside information”

Is Carl Icahn, one of the world’s best known and most successful investors, guilty of insider trading? When I reached him at his vacation home in the Hamptons on Saturday to discuss the topic following reports that the SEC, FBI, and Manhattan prosecutors are investigating whether he may have leaked illegal stock information to golfer Phil Mickelson and Vegas gambler William T. Walters, his answer was an unequivocal “No.”

“I am very proud of my 50 year unblemished record,” Icahn said, “and I have never given out inside information.” Icahn said he’s never met Mickelson or even spoken to him. But he does know Walters—indeed, the two are friendly, and socialize a couple of times a year (Icahn makes trips to Vegas and has business interests there).

That relationship seems to be the crux of the case that prosecutors would like to build around Icahn, which begins three years ago back in 2011, when the billionaire activist investor got interested in the consumer goods company Clorox. By February of that year, Icahn had built up a 9.1 percent stake in the company, and in July of the same year, he announced an unsolicited takeover bid. According to news reports about the investigation, just a few days before that bid, both Walters and Mickelson made big money trading Clorox. The question is, did Icahn tip Walters, who then tipped Mickelson, whom he ran into occasionally on the golf circuit (Walters owns a course)?

Icahn and Walters certainly chatted about stocks—Icahn talks about stocks with everyone. But I think it’s probably unlikely that Icahn, who’s one of the savviest investors around, would have knowingly given Walters insider information that would have compromised his multi-decade career and put him in the line of fire of regulators eager to bring down a big Wall Street fish. I think what’s much more likely is that Walters was a close listener, and observer, of Icahn. Walters, like many people close to Icahn (and even more who don’t know him personally at all), followed what he was doing in the markets. When they met, in Vegas or elsewhere, they’d sometimes talk about stocks. But that in itself isn’t illegal—in fact, under insider trading laws, it’s not even illegal to tell someone that you are planning to trade a stock, unless it breaches a duty of confidentiality to your own investors (which doesn’t appear to have been the case here, but that’s a legal matter that still has to be teased out).

In the end, Icahn never completed the tender offer for Clorox. But anyone who follows his career knows that he often buys up a lot of a stock before ultimately trying to gain a board seat or even buy the company. It’s not exactly a stealth strategy. And all of those moves typically drive up the price of the stock in question. That’s exactly why people follow his moves and try to buy what he does. It’s possible that Walters was a good observer of that behavior, and it’s also possible that Icahn may have talked up his interest in Clorox to him in the run up to his buyout offer. But I’m disinclined to think that this is a guy who’d risk an iconic career by giving illegal insider tips to anyone. It will be interesting to see how this investigation shapes up. Icahn claims he has yet to be contacted by any of the authorities. “We are always very careful to observe all legal requirements in all of our activities,” he told me.

You can bet that prosecutors will be looking closely in the coming weeks and months to make sure that every i has been dotted.

TIME

China’s Culture of Compliance Is Crippling the Country

Demonstration at Tiananmen Square in Beijing, China on June 01st, 1989.
Standing tall A Chinese youth at a demonstration in Beijing’s Tiananmen Square on June 1, 1989 Eric Bouvet—Gamma-Rapho/Getty Images

Next week will be the 25th anniversary of Tiananmen Square. It was a turning point not only for China, but also for the world, in the sense that it heralded a new era in which growing wealth and growing political freedom in emerging markets didn’t necessary go hand in hand. This year, China will very likely overtake the U.S. as the world’s largest economy. It has certainly become wealthy. But it has also become less free–as have so many of the world’s largest developing nations–think Russia, Turkey, many parts of Africa and Latin America, etc.

The question is, that can juxtaposition last another 25 years—or even another five? It’s something I’ve been thinking about a lot lately, particularly as I delve into New Yorker writer Evan Osnos’ very interesting new book on China, “Age of Ambition: Chasing Fortune, Truth and Faith in the New China” (FSG). The core premise of the book is that individual ambition and authoritarianism in countries like China will inevitably come into conflict with one another. As people get richer, they want more freedom, and they put pressure on their governments to deliver it. The problem is that these governments are often much better at delivering wealth than they are at delivering anything close to liberal democracy.

I think we may be reaching a tipping point in the next few years around that juxtaposition between growth and choice in the emerging world. China is, as always, the most dramatic example of this. The recent cyber-hacking scandal, for example, was portrayed by many pundits as yet another example of how the Middle Kingdom is leaping ahead of U.S. government and business interests, stealing American intellectual property and using it to gain a competitive edge. But as I argued, China’s IP theft actually underscores what a “me too” economy the Middle Kingdom still is. China is good, very good, at copycatting other people’s ideas (Osnos’ stories of various Chinese entrepreneurs, like the village woman behind the Chinese version of match.com, are fascinating on this score), but it has yet to create many global brands–aside from Lenovo’s computers and the college mini-fridges made by the low-end white goods producer Haier.

I think the lack of a top-shelf innovation culture has a lot to do with the lack of choice in Chinese society. I once spoke to a Wal-Mart executive in China who told me that he had trouble getting employees in one department to address basic problems in another–picking up boxes that had fallen off a shelf, or order new supplies, for example–because they were afraid of stepping out of their silos. That’s not about work ethic–the Chinese have that in spades–but a culture of compliance. In China, it’s important, sometimes deadly important, to swim in your own lane.

Another issue with the growth of higher end Chinese business is that entrepreneurs don’t trust the stability of the government. I’ve heard time and time again from wealthy people in China (many of whom are looking to get their money out – witness the percentage of high end property purchases in luxury real estate markets worldwide that are made by the Chinese) is that it doesn’t pay to develop businesses for the long haul here, because uncertainly and political risk is so high. People tend to get in, get out, and become serial entrepreneurs, rather than spending decades working on innovation, a la developed countries like the U.S., Japan, or Germany.

How will all this affect China? If the Middle Kingdom can’t make the leap to the “middle income” stage of development, which history shows is the trickiest one (only a handful of developing countries globally have made it), then unemployment will rise and social stability will fall. How will that affect Americans? In a sense, it already is. Trade tensions mean many U.S. companies are rethinking how, or if, they’ll do business in China, with myriad ramifications for us all. For more on all of that, as well as the economic legacy of the Tiananmen event, listen to my radio show, Money Talking, on WNYC this week.

TIME russia

Russia’s Blockbuster Gas Deal Makes It Look Weak

Russian President Vladimir Putin speaks during a meeting with Ministy of Defence representatives at the Bocharov Ruchey State Residence on May 15, 2014 in Sochi, Russia.
Russian President Vladimir Putin speaks during a meeting with Ministy of Defence representatives at the Bocharov Ruchey State Residence on May 15, 2014 in Sochi, Russia. Sasha Mordovets—Getty Images

The politics of energy are getting ever more interesting following the signing of a historic 30 year gas deal between China and Russia. The deal has been portrayed as Putin’s revenge for Western sanctions imposed following the conflict in the Ukraine. He’s sending a message that Russia has other options aside from exporting its natural resources to Europe. (The U.S. is increasingly energy independent and doesn’t need Russian gas.) The photo-op of Chinese president Xi Jinping and Putin downing a shot of vodka following the deal close was classic.

But it’s not time to click glasses quite yet. In fact, I’d argue that the China deal makes Russia–and Putin–look weaker, not stronger. For starters, as a recent Capital Economics report on the topic points out, “while the headline figure of $400 billion seems large” given that it’s 20 percent of Russia’s current GDP, that take is spread out over 30 years. That means we’re talking about $13 billion in additional annual export revenues for Russia–less than a quarter of what they typically export to Europe. Selling to China isn’t going to mean that sanctions won’t hurt. Europe remains Russia’s most important energy market.

Secondly, Russia has been in talks with China for years about this deal, and it’s not an accident that they signed only now, when the country is in a tough spot. The Chinese got a bargain in terms of gas price–they are apparently paying $350 per thousand cubic meters, $50 bucks less per unit than the Russians had wanted, and $20 bucks less than what the Europeans currently pay. No wonder Gazprom shares trade at a huge discount, despite the fact that the company made more money than any other firm in the world last year.

The Russians are also picking up the bulk of the infrastructure development required for the deal (the Chinese are only committing to $20 billion in spending so far, while the project will require at least $55 billion). And, they have plenty of other gas import options from the central Asian republics, which they can of course play off of each other, and Russia, in the years ahead.

What’s particularly sad about this deal is that it just solidifies the image of Russia as a low-end natural resource exporter to more savvy developing nations. This is a country that used to be a world power, and still has plenty of human capital and growth potential. With Putin focused mainly on doling out the country’s resources on the cheap in order to appear politically stronger, it’s unlikely either will be developed.

TIME

One of CEOs’ Most Powerful Tools Is Starting to Look Dull

NYSE Opens For Trading A Day After Major Losses
John Moore—Getty Images

A lot has been made in recent years of the record amount of corporate cash on the balance sheets–around $2 trillion in U.S., and the same amount in firms’ bank accounts abroad–as well as the fact that companies aren’t spending it. But the latter isn’t totally true. Firms have shelled out some cash, just not by investing in factories or equipment or new workers. They’ve done it with share buybacks, which involves a firm buying back its own shares on the open market. This almost inevitably raises a company’s share price, thus enriching existing shareholders.

Many companies see this as a more flexible way of returning cash to shareholders than giving out dividends, because they don’t have to set and meet specific dividend targets but can just buyback shares as and when they like. But some critics say that it’s just a way to make the rich richer, without actually putting a firm’s capital to use creating jobs and growth in some more sustainable way. Either way, it’s been one of the major trends in the market in the last five years. As I’ve written in many stories, including this cover profile of Carl Icahn, the volume of share buybacks in the US has been at record levels in recent years. Indeed, the total volume of buybacks in the first quarter of this year amongst S&P companies was higher than it’s been since the third quarter of 2007, before the subprime crisis really got going.

Now, that’s changing. As a new report by London-based Capital Economics points out, share buybacks have begun to slow just a little bit. Having risen by more than the broader market in each of the last five years, the S & P 500 Buyback Index has risen by less than that so far in 2014. To understand what that might mean for the markets, you have to understand what the history of share buyback data actually tells us.

The most interesting research on this topic has been done by William Lazonick, a professor at the University of Massachusetts, whom I’ve written about in the past. His data show that while firms may want you to think that buybacks are a vote of confidence in their own stock, buybacks are typically done not during bear markets in which stocks are undervalued, but during bull markets, particularly end bull markets, when companies are trying to ride a wave of price increases that have little to do with fundamentals. Indeed, Lazonick shows that while buybacks provide a short-term sugar hit, they tend to go hand in hand with lower margins and growth prospects over the longer term (paging Apple and Yahoo). That may be because if you look at four decades of data, buybacks tend to increase at the same time that spending on research and development is falling. In short, companies pay out their seed corn to investors, rather than re-investing in themselves by developing new businesses, hiring or retraining workers, building new factories, etc., etc.

I think the fact buybacks are now slowing could foreshadow a larger market slowdown, or even a broader correction in stocks (the Capital folks agree). We’ve already seen a correction, of course, in very over valued areas like technology and certain emerging markets. And the fact that the big blue chips are finally starting to buy back less of their own stock could indicate that they see a slowdown coming, too.

Ultimately, the valuation of stocks reflects the future earning potential of companies. While there are lot of things in the economic environment right now that are good for companies–interest rates are still low, the U.S. economy is improving–I keep thinking about the fact that people having gotten a raise in five years. As long as wages stay flat, and spending is relatively constrained, it’s hard to imagine the market staying this high forever. The slowing of share buybacks may turn out to be the canary in that particular coal mine.

TIME trade

What Chinese Cyber-Espionage Says about the Chinese (and U.S.) Economy

The Obama Administration's outrage over Chinese hacking has its roots in conflicting views of the government's role in private business. So don't expect a meeting of the minds anytime soon.

Imitation is the sincerest form of flattery, but that’s probably cold comfort to firms like Westinghouse and U.S. Steel, which the U.S. Justice Department says have been hacked by Chinese cyber-espionage teams. By indicting the Shanghai-based team allegedly responsible for the attacks, which are largely conducted in order to give the Chinese an edge in the global economy, Attorney General Eric H. Holder Jr. is trying to draw a line between the sort of snooping that the U.S. National Security Agency does for strategic security purposes, and the kind that the Chinese do, which often involves intellectual property theft or the culling of business secrets for competitive advantage.

The problem is that the Chinese don’t recognize that difference, because in China, the state is the economy. I was actually in China as the Edward Snowden story was breaking in 2013, and I remember the Chinese being indignant about what they perceived as U.S. hypocrisy around cyber-snooping.

The importance of the Chinese state in the Middle Kingdom’s economy, which has been growing over the last 15 years or so, is crucial to understanding the hacking affairs. During the period of China’s highest growth, in the years leading up to 1995, the country was all about unleashing the private sector, and paring back the public. A lot of public sector workers were laid off, Beijing liberalized various sectors of the economy, and the private sector took off. But since the mid 1990s, that trend has been shifting.

State-owned enterprises, or “SOEs” have been sucking up more of the countries financial resources (they get about 80% of all debt financing, while providing only 20% of employment), which is one of the reasons that the Chinese economy is slowing. That makes it harder for the country to move up the economic food chain, from lower-end manufacturing to higher-end products and services, which is what it needs to do to move from being a poor country to one in which most of its citizens are middle class. It’s telling that some of the highest levels of unemployment in China are amongst new white-collar college graduates; the country just isn’t creating enough high-level companies, or jobs.

Which goes right to the heart of the hacking indictments. Despite all the hoopla recently over the fact that the World Bank expects China to surpass the U.S. as the world’s largest economy this year, there’s a big difference between being big, and being rich. Average U.S. worker wages are between 6 and ten times what they are in China because U.S. companies produce higher end goods and services. The Chinese economy is still largely a copycat economy—albeit a very good one. Chinese companies tend to take ideas from developed country firms (either legally or otherwise) and try to tweak them slightly to make them cheaper, more suited to local markets, etc. That’s why Chinese hackers were searching for intellectual property secrets at Westinghouse, and probably countless other Western firms. It’s something that American firms in China complain constantly about, and have largely taken as a cost of doing business there.

What’s more interesting, though, are reports that Chinese hackers were also looking for things like the trade deals and strategies of U.S. steel firms. This may speak to one reason that the Obama administration decided to make a big deal of Chinese hacking now. In an age of slower global growth, when all boats are not rising, issues like intellectual property theft and trade tensions become more fractious. The U.S. has been complaining for some time now that China won’t play by the existing rules of the global economy, and that given its size and economic heft, this can’t be allowed to continue. Since the financial crisis and recession of 2008, analysts have been predicting that the U.S. and China would eventually come to blows over trade issues—and it’s interesting that many of the firms being hacked were also those that had approached the WTO about Chinese trade violations.

It will also be interesting to see how the Chinese respond to the Justice Department indictments; needless to say there’s no way they’ll be handing over any hackers and they’ve already pulled the plug on a cyber-espionage working group with the U.S. that was supposed to address some of the tensions between the two countries. One thing you can count on, says Conference Board China economist Andrew Polk, is that the slow growth, increasingly nationalistic environment in the Middle Kingdom is going to “make it tougher for foreign firms to do business there.” As if it was ever easy.

 

TIME Economy

Job Growth Good, Labor Market Bad

What happens with workforce participation will determine how you experience the recovery

Midway through the year, how is America’s economic recovery really doing? It’s complicated.

We’ve just gotten what in many ways appears to be a stellar jobs report. The U.S. economy created a whopping 288,000 jobs in April, and the unemployment rate fell to 6.3%, its lowest level since 2008. Unfortunately, it didn’t fall just because tens of thousands of new jobs were created in construction and retail, for example. A bigger reason it fell is that fewer people are looking for work. In fact, the workforce-participation rate–the percentage of people who are actually in the labor market–dropped to its lowest level since 1978.

The question now is whether or not people who are shut out of the labor market for various reasons will be able to return to work as the recovery strengthens. Ultimately, the answer will determine how most Americans experience the next few years–how much it will cost you to buy a new car or home or what you will pay in student loans.

It’s not hard to see why workforce participation is such a hot topic. Over the past five years, the percentage of the population working in America has dropped to the levels of Europe as a whole. Typically in the U.S., about 15% of unemployed people are among the “long-term unemployed,” meaning they’ve been out of a job for more than six months. After the Great Recession, that share reached 45%, and even today it’s still 37%. The long-term unemployed suffer not just economically but also socially: they have higher rates of divorce, depression and suicide.

Will those people ever work again? Many experts say no, because research shows that employers often discriminate against the long-term unemployed and also their skills tend to atrophy. “More than ever before, skill erosion will be a major obstacle for those who wish to return to the workforce,” declared a recent Conference Board report. And then there’s another group: the baby boomers dropping out of the workforce who had likely planned to retire anyway but may have pushed the decision up by a few years because of gloomy work prospects. Historically, few such people ever return to the workforce once they leave.

So what does all this mean for the price of your mortgage or car loan? The amount of slack in the labor market is one of the key factors helping the Fed decide whether to raise interest rates. When markets are slack, or too many people who want work don’t have it, wages and prices stay down. But if labor markets get tight, wages go up, and that causes inflation. When inflation starts to rise, so do interest rates.

But inflation is tricky. It moves fast and often unexpectedly, which means it’s important for central bankers to try to anticipate it. That’s why there are vigorous disagreements about what to make of these latest numbers. Economists who see the bulk of labor-market dropouts as a lost cause believe they don’t really matter with respect to inflation. The short-term unemployment rate, which they believe is a better measure of the true slack in the labor market, is just a little more than 6%, right around where it ought to be historically. And important metrics, like the National Federation of Independent Business survey, show the labor market is as tight as it was in 2005. Whatever the unemployment rate, we may not have enough workers with the right skills. And a tighter labor market implies that inflation could come on sooner rather than later–and that rates could rise as early as 2015.

Plenty of people in the fed believe that could and should happen, but chair Janet Yellen isn’t one of them. Yellen recently said, “My own view is that a significant amount of the decline in [labor] participation during the recovery is due to slack, another sign that help from the Fed can still be effective.” The data on her side include the recent disproportionate declines in the unemployment rate for lower-income workers. The idea is that companies are starting by hiring cheap labor and they’ll eventually hire more workers higher up the pay scale. There’s also the fact that right before the Great Recession, there was a nascent trend toward older workers staying in the workforce longer, in part because of better health and the desire to work but also perhaps out of necessity: the average retirement savings of Americans ages 55 to 64 is about $120,000, not enough to fund anyone’s golden years.

If that’s the case, we may see many of those longer-term unemployed people come back into the workforce, keeping inflation (and rates) lower for longer. In economics, three’s a trend. The next two months of data will be crucial in understanding where labor markets, interest rates and the price of your debt are headed.

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