Rouse on Transformation

We have been awash in protests of racial inequality. Assuming we agree inequality is bad — not everyone does — what can be done to greatly diminish this inequality?

Those who have suffered this discrimination are poor, unhealthy, and uneducated. How can we address these discrepancies?  We could just give everybody money.  This idea has merits, but it should only be part of a more integrated response. Quick cash to spend does not suddenly make one healthy and educated. However, these are the keys to long-term success.

What if we created an economic, health, and education system so that everybody has the potential to succeed? Everyone is prepared, regardless of race, ethnicity, gender or sexual orientation. This could be powerful. The US should help to make sure that everyone succeeds relative to their abilities and motivation to succeed.

How could we afford this?  We are already paying for the lack of this. For example, according to NIH, the cost of substance abuse in the US is $0.75 trillion per year. A good portion of those monies could be redirected towards mitigating the causes of substance abuse.

There is a broader message here. Why don’t we invest in addressing pandemics before they get out of control? Why don’t we invest in fixing infrastructure before it fails?  Why don’t we invest in people so they are never uneducated and unhealthy?

We need to think in terms of a Social and Economic Balance Sheet that values investments in human capital.  It has been argued that human capital is an intangible asset owned by an individual, not the organization where they are employed.  Hence, this asset is not owned by the organization.  People can leave the organization at will.

However, despite this mobility, this asset remains in the economy, perhaps locally but certainly globally.  Thus, the Social and Economic Balance Sheet should reflect human capital assets at perhaps the national level.  Where will the money come from to invest in creating these assets?

It is unlikely to come from companies, especially for investments in the education and health of children, where such investments need to start.  Federal, state, and local governments need to be the primary investors.  Their returns on these investments are healthy, educated, and productive citizens who contribute to society, in part by paying taxes.

How might these investments be economically justified?  Somewhat simplistically, governments invest X dollars per year for 20 years and then receive Y dollars per year for the subsequent 45 years.  X includes education ($10,000) and healthcare costs ($2,300), which totals $12,300 per year, on average for, children and teens.  Y includes Federal incomes taxes paid ($10,500), state and local income taxes paid ($5,000), property taxes paid ($3,300) — which typically pay for schools — and contributions to social security ($8,000), half of which is paid by the employee and the other half by the employer, which totals $26,800 per year, on average, for adults 20 to 65 years old.

Would an investor be willing to invest $12,300 for each of 20 years and then receive returns of $26,800 for each of the subsequent 45 years?  Ignoring inflation for the moment, we need to take into account the discount rate that any investment analysis would typically consider.  The discount rate (DR) is the interest rate used to determine the present value of future cash flows in a discounted cash flow analysis because a dollar received in the future is worth less than a dollar received today.  Using DR, one can calculate the Net Present Value (NPV) of future cash flows.  The table below shows NPV for several values of DR.

What about inflation?  Any inflation rate above 0% increases the above numbers. For example, assuming 3% inflation increases the leftmost bar from $330,751 to $729,104.  This happens because the $26,800 annual return on investment has increased to $98,395 when an individual is 65 years old.

The current yield on US treasury bonds is 1.25%.  That is the interest rate that the government would have to pay on funds borrowed to invest in this idea.  Inflation in the US has been running at 0.3%, historically a very low number.  Using these rates, the NPV of the proposed investment is $538,253.  Thus, this investment in people should be very attractive.

These projections are of the direct returns of creating a healthy, educated, and productive citizen who contributes financially to society.  Not shown are the indirect and often intangible contributions of citizens.  For example, having children creates new human capital that can repeatedly provide the magnitude of returns shown above.  Creating art enhances the lives of many.

With such impressive returns, why wouldn’t the government invest in creating healthy, educated, and productive citizens?  A primary difficulty is that the US Congress has no Balance Sheet.  It is totally focused on this year’s and next year’s Income Statement, which totally ignores future returns on human capital investments beyond next year.

Government does not have to inherently operate this way.  Having conducted government-funded research projects in Singapore, I have encountered much greater emphasis on the long term.  How can we know whether that makes a difference?  One key indicator is home ownership. 91% of the population in Singapore owns their home; home ownership in the US is 65%.

We somehow have to convince Congress that investing in people can yield enormous returns*.  A primary difficulty is getting started. Members of Congress that approve the above investments in children and teens will not see the impressive returns during their time in office.  However, if there was a Social and Economic Balance Sheet that showed $500,000 in assets for each child and teen benefitting from these investments, we could watch the legacy growing.  Years later, then Members of Congress would look back with gratitude for the commitments made years earlier.