Tuesday, 9 April 2013

Will economic growth still be the norm?

Capitalism is an economic system that has generated masses of wealth but can we expect that to continue?

The recent trials and tribulations of the global economy would have made more than a few people question their faith in capitalism.  Stagnating economies shackled by convoluted politics and a chronic lack of business confidence have made economic growth seem like a thing of the past.  The capitalist system has powerful forces within it that drive the generation of wealth but the mechanisms which generate growth have been damaged by excesses built up in the run up to the global financial crisis.  It is still too early to tell when and even if the previous rate of economic growth can be reached any time soon. 

At its core, capitalism is a battle for productivity and efficiency.  Companies compete against each other to supply goods and services for a better price or higher quality than their rivals with higher profits as a reward.  Any products that are offered with even a slightly lower price tag or in a way that attracts more customers will ensure a greater market share and prosperity for the business selling it.  As such, firms have to constantly strive to improve their offering or else their survival will be called into question.  Companies that can do a better job of satisfying the needs of their customers lure in more business and increase in size.  This results in resources in the economy such as workers and money for investment being drawn into firms with the best business plans where typically fewer inputs are required to make customers happy.  And it is this relentless shift to businesses which produce more for less that is the key to growth. 

So, trying to stop capitalism is like trying to stop people making money.  But capitalism can suffer when resources are not available for successful companies.  Take workers for example.  A business looking to grow needs more employees but high levels of mortgage debt and the drop in house prices in many Western countries mean that people are not free to sell up and move somewhere else for a new job.  Immigrants, both skilled and unskilled, provide greater access to the necessary human resources but places such as the US and the UK are making it tough for foreigners to get visas.  

Lending by banks allows for rapid expansion of businesses but the finance industry is struggling with the consequences of having been too generous in the past and banks prefer to keep the cash in their vaults.  As a consequence, successful firms are hamstrung by a lack of funds for expansion. A further hurdle to success is competition from so-called zombie firms – companies that should go bust but are kept alive by low interest rates and banks not wanting to incur any bad debt.  This stops the productive firms from grabbing the market share that should reflect their better business practices.

The situation with the banks is made even more complicated by new regulations applied to the finance industry.  Deregulation over the previous decades unleashed creativity at banks which boosted the economy to begin with but went on to sow the seeds for the global financial crisis.  Re-regulation is necessary to ensure that banks can’t bring the global economy to its knees but the financial sector also needs to be free enough to move money around to more productive uses.  The uncertainty over where this new balance might be makes for a difficult environment for banks to operate in.

Whether the current growth path will be a temporary slowdown or a permanent shift to a slower rate of expansion is as yet unclear.  Capitalism has bounced back from previous setbacks but the past is not always a good guide for the future.  Even if a revival of the previous pace of progress is a possibility, more than three years have passed since the worst of the financial crisis hit the global economy in 2009 and the light at the end of the tunnel still seems some way off.  While capitalism has been seemingly unstoppable in the past, only time will tell if or when economic growth can be kick started once more.