Productivity – cutting both ways

Far from being a cure-all, productivity gains are instead cutting into the number of jobs

Higher productivity seems like the answer to all of our economic woes but being more productive is not all good.  Doing more with less is a way of making us wealthier by getting more out of the limited resources available.  Improvements in productivity often thus translate into more profits or lower prices (or both).  But there is also a nasty side in that one of the resources that can be done away with is workers.  Trends such as greater globalization and improvements to technology have resulted in many (well paying) jobs being put to the chop and we should not be expecting any respite soon.

Doing more with less

Economics is a discipline which is based on the notion of scarce resources.  It is no surprise then that economists rave about how improvements to productivity are the key to prosperity.  Any business that can produce the same products using fewer inputs is bound to do well.  Being more productive as a worker is also opens up the way for the opportunity to demand higher wages.  Any gains from higher productivity are split between companies, employees, and consumers but it is not always the case that everyone gets a share.

My favourite example of productivity gains where everyone got their cut was Henry Ford and the motorcar.  Ford did not invent the automobile or the assembly line but he did figure out a way of manufacturing cars cheaply.  The continued existence of the Ford Motor Company is testament to how much he and his family have thrived.  On top of this, workers at the firm also benefited from the new jobs that were created as well as the higher wages on offer.  Cars also became available to many more people thanks to the mass production of the Model T resulting in a lower price tag.

Suffering from cut backs

The example of Henry Ford and the Model T shows how more can be produced cheaply using more workers.  But this is only a viable way of making money when there is a rapidly expanding consumer market and an appetite for more and more goods.  This seemingly came to an end in the richer countries when most households became wealthy enough to buy the basics such as a car, a fridge, and a TV.  Without being able to tap into economies of scale by producing more and more, the emphasis has since shifted to producing goods at the lowest cost. 

One of the main avenues for cutting costs has been outsourcing manufacturing and some services to countries where wages are lower.  Computers and the Internet have also helped companies save money by better optimising their operations and reducing the need for some clerical work.  Companies have obviously benefited from this and we have as consumers (due to lower prices) but not as workers.  There is no modern-day version of the Model T that might provide a new source of lucrative job opportunities.  Instead we spend our money on services (eating out or going away on holiday) or goods where much of the value is in design rather than the goods themselves (such as clothing or electronic gadgets).

Cut yourself free

The challenge for developed countries is to create more high paying jobs for its educated workforce.  Instead, the opposite seems to be happening and the economic recovery after the global financial crisis has been characterized by a proliferation of jobs with low pay.  Higher unemployment allowed companies to hire workers on the cheap and this has dulled incentives for business investment.  It is easier to get things done using cheap labour than spending money on making your current workers more productive. 

Unemployment in countries such as the US and the UK has fallen but this has yet to translate into significantly higher wages.  Neither is a rapid improvement likely as companies are still timid about investing due to the weak momentum of the economic recovery.  Government policy is also a hindrance due to the focus on austerity measures rather than taking advantage of low interest rates to invest.  

The only way out for beleaguered workers seems to be setting up their own business which has become increasingly more popular.  The jump in entrepreneurship may be one of the few silver linings as people cut themselves free to become their own boss and to have productivity gains there for the taking.

Let's not (Christmas) party like it's 2007

The heady days leading to the global financial crisis were never meant to last so there is no point in expecting to turn back the clock

It is the time for great merriment but Christmas office parties across London still leave many wishfully thinking back to the good old days.  Despite much talk of an economic recovery, it can still be tough to find reasons to be cheerful about and less cash being spent by companies on seasonal festivities is another reminder of this.  But we should not be asking Santa for a return to the days of lavish Christmas dos with workmates and big entertainment budgets (if they ever did exist).  The economy of old which allowed such excesses could only bring in a few good years of partying before the good times inevitably turned bad. 

Living the high life on borrowed time

The boom times that were still in swing a decade ago seem a long way off.  It was a time when all seemed good with the economy and nothing much would go wrong.  This spirit seemed best exemplified by the exuberance among economists who (mistakenly) thought that their ideas had conquered the ups and downs of the economy.  The great evil of past decades, inflation, had been kept in check and the recession following the dotcom bust passed without much strife. 

This new stable economic environment seemed to benefit the finance sector most of all.  Banks came up with new ways of making lots of money with bankers themselves reaping much of the rewards.  Even some among the rest of us got to enjoy a sprinkling of the good life with many companies splashing out the odd treat on their workers (especially around Christmas time) even if this generosity was not reflected in wages.

The enthusiasm was infectious and we all wanted our share.  The result was loads of new debt as our spending reflected these new aspirations even if our income was lagging behind.  Even the governments in many countries spent beyond their means and got their finances in a mess.  Since inflation remained subdued despite the elevated spending, interest rates never rose by much enabling the debt levels to soar beyond what was prudent.  And banks were only too happy to lend since new financial products, such as mortgage-backed securities, allowed them to pass on increasingly dubious loans to others.

Not banking on trouble

This was one party that could not go on for ever.  An increase in debt is good for spurring the economy along but this can only go so far until lending becomes more reckless.  The final straw was mortgage lending in the United States where new rules encouraged housing loans to individuals who were never likely to be able to afford repayments (so-called sub-prime mortgages).  The many who lost their jobs (including Your Neighbourhood Economist) and even their homes in the ensuing financial turmoil ended up with little to show from the good years.  Yet, on the other hand, the exorbitant pay packets received by many bank employees left them sitting pretty whatever was to happen.

We should all feel repentant like Christmas drinks where we get carried away and make a fool of ourselves.  One way of stopping ourselves getting into trouble is to rein in the banking sector.  This does not mean the equivalent of alcohol-free Christmas festivities but just stricter rules to make sure that things don’t get out of hand.   The perils of too much debt should have always been obvious but it is inability of the banking sector and the financial markets to suitably regulate lending that is perhaps the biggest lesson that we need to address.

Time to sober up

Any economic growth does not count for much if we have to give back most of the gains after a few good years.  Yet, giving up on this easy way of making ourselves richer also means that we cannot expect the economy to grow like in the past.  It will take hard work and sensible policies rather than financial wizardry to make genuine improvements in our standard of living.  The trade-off being that we can create a world where our jobs and what we make for ourselves is more secure.

The government could have a big role to play in this especially since companies are not investing as much as they used to.  Greater spending on infrastructure and education as well as lower medical costs would be a good start to help increase productivity (and wages) as well as going some way to propping up spending.  The solution sounds simple enough but politics is never easy especially at a time when the easy option is for politicians to offer up false promises.  It is voters most of all that need to be realistic in terms of what is achievable.  No party is worth a hangover on the scale of the global financial crisis.

Economic Recovery and the Politics of Slow Growth

When the economic pie stops expanding, everyone wants their fair share and politicians are unfortunately only to keen to oblige

Slow economic growth is like hot weather – people become easily irritable and argue a lot.  This because, while economic growth makes it easier for everyone to feel better off, the opposite is true when the economy stagnates.  A sluggish economy leads to a shift in focus from creating more wealth to dividing up whatever is already there.  This creates fights over resources with people mostly looking out for themselves. 

Politicians pander to such self-interest among voters and constructive policy making goes out the window.  Voters are get all hot and flustered as the economic recovery since the global financial crisis has proven anything but balmy.  With the outlook for the economy not looking so bright for years to come, politics may continue to get people steamy under the collar.

Politics turns cold

Democracy is the best political system we have for ensuring the implementing of policies for the common good.  Politicians get elected by pushing a package of measures that the majority of voters believe will make them better off.  When times are good, policies tend to be aspiration in promoting economic growth with some resources also going to the less well off.  But things are not going so well, the focus of voters narrows to their own specific well-being.  As such, voters become less generous in terms of social spending and immigration while wanting the government to do more for them. 

The result is that politics become short-sighted and politicians pick more policies that target their own particular support base.  Honest assessment of the economic ills are typically in short supply while voters grow increasing frustrated as timid government policies can only provide limited relief.  Many voters have been tempted with the false hopes of more extreme policies offered by populist politicians.  However, turning back time with less government or less globalization will only create bigger problems rather than providing answers. 

The political infighting comes at a bad time for many developed countries who are increasingly feeling the heat of global competition.  This process was already underway with the rise of China and other emerging economies and the global financial crisis has been a further setback.  The narrow-minded politics currently prevailing in many countries will further hasten the relative decline of the West.  On top of this, government action is also hampered by economic theory that argues for less intervention in the economy. 

Still sweating it out

It is more than a tad ironic that it is now more than ever that positive and proactive government measures are needed more than ever.  This is because government has traditionally been the guardian of the long-term health of society.  The government has even more to offer at a time when businesses are not investing and gains in productivity (output per worker) are proving hard to come by.  Higher productivity is the main route to increases in wages and consumer spending at a time when low skilled work is carried out in developing countries.   

Yet, as described above, governments have been more of a hindrance rather than helpful with regard to the economy.  A push for austerity has dominated in many countries such as the UK despite going against the grain of economic theory.  In the place of increasingly distracted politicians, central banks have take centre stage in reviving the economy (which comes with its own problems).  With minor squabbles often dominating politics, it may take time before governments and voters are ready to sweat over the big issues.  Like a muggy summer that never seems to end, the combination of economic and politic malaise is not a problem that will go away any time soon.

Measuring the Economy – A Knotty Problem

A change in focus is needed to make a real difference when measuring economic growth

Measuring the economy can be a bit like estimating the length of the proverbial piece of string.  Even pinning down what to measure before taking out your tape measure is tricky.  What is measured takes on even more importance when it is tied into government policy which aims to make us all better off.  This is a sobering thought at a time when improvements according to the traditional yardstick of GDP often fail to make a difference to the lives of many of us.  Changing what is used as a gauge for economic improvement can have significant consequences for the outcome of economic policy.

Being strung along by GDP

Rising inequality is a hot topic among economists at the moment.  Data shows that the wealth of the rich has increased considerably faster than for the less well-off over the past few decades.  Much of this can be attributed to the forces of globalization - a shortage of

skilled workers in the global marketplace has pushed up their pay while the opening up of countries such as China has resulted in a glut of low-skilled workers which has depressed their wages.  Technology has also added to this trend with computers reducing the clerical and administration work that had been a source of jobs for middle class workers.

Some see inequality as a necessary part of a capitalist economy with industrious people earning more due to their own hard work.  Others point to the social costs of inequality such as higher crime and more health problems and call for more policies to stem this trend.  The lack of advances in the earning power of a large portion of the population will inevitably have serious political consequences such as the rise of populist movements or a growing mistrust of capitalism among young people.  The issue is all the more urgent as it comes at a time when Western countries are struggling to maintain their place at the top of the global pecking order.

The combination of austerity measures and loose monetary policy in most countries is not doing much to address this issue and may be making the situation worse.  Cuts to government spending disproportionately hurt the less well-off while the wealthy have benefitted as quantitative easing has driven up stock prices.  These policies are based on the premise that creating growth in the overall economy will benefit us all.  But the data shows that, for example, while GDP in the UK is expected to reach its previous 2008 high this year, it will take a few more years for average earnings to recover lost ground. 

A different piece of string

The overall size of the economy is becoming increasingly difficult to measure.  So it might be better to focus more on the bit that matters most to people – what they earn and can spend.  Using median (real) earnings as a gauge of the economy would mean that economic growth would be more tangible for more people.  It is also a more simplistic measure which would require less manipulation although it would require some adjustments (to take into account changes in what we spend our money on and whether those goods change in price).

It would be a simple alteration that would have major implications for economic policy.  The welfare of normal people would be the central focus with other related issues such as unemployment also taking on greater importance.  Yet, this would not be a license for wages to rise inexorably as businesses would suffer and any artificially manufactured gains would only be temporary.  On the other hand, measures to help companies, such as lower corporate taxes, would also need to have a positive effect on wages. 

Increasing the median wage would have a more profound effect on the health of the economy and would involve more than simply boosting spending through an increase in debt.  Making progress on this goal would require more long-term policies such as investment in education and reskilling workers in declining sectors.  Lifting earnings would be hard work but the positive results would be genuinely worth the effort.

The Economics behind Populist Parties in Europe

Voters kick up a stink in the European elections but mainstream politicians only have themselves to blame

The success of anti-EU parties in the European elections has been in the news over the past week but it is economics that provides much of the backstory.  Voters in Europe have flocked to political parties offering the illusion of a way of opting out of the changes that threaten their livelihoods.  Such frustration is understandable considering that the more established parties have only offered up piecemeal measures as a solution.  Acceptance of the limited options available will be the first step to making real progress.

Going with the flow

The economic prospects of those with few skills are dire.  Many of the sectors that provided jobs for workers in earlier generations have shrunk due to the double whammy of technology and globalization.  Gains in technology have seen a rise in the mechanization or computerization of many tasks.  Globalization has allowed firms to search the world to find the cheapest workers.  These are not trends that are expected to change anytime soon.

Despite the large number of those put out by these trends, the benefits for the economy as a whole have been unprecedented.  Technology has brought a wealth of information and possibilities to our fingertips and outsourcing has made the bulk of things we buy much cheaper.  There is no one who has not gained in some way with the overall gains far outweighing the costs.  The problem is that these costs are borne by a relatively limited number.

In an ideal world, some of the wide spread benefits would be used to compensate those missing out due to the rise of technology and globalization.  However, governments in the Western world have been moving in the opposite direction.  People are increasingly left to fend for themselves with few hand-outs from the government.  The affected workers need money during periods without work as well as help with reskilling to move into growing industries.  Yet, unemployment benefits are being trimmed back and education is becoming more expensive. 

Instead, governments look to shield themselves from the blame, and since no one is going to come out against technology, globalization is the obvious fall guy.  The EU takes the blame in Europe as the epitome of the uncontrollable external forces pushing for more open borders.  Rather than admit that they are almost powerless in the face of outside influences which are part of globalization, politicians offer temporary reprieves.  Typical responses include attempts to limit immigration, moves to block factory closures, railing against takeovers by foreign firms, or moaning about a strong currency hurting exports.  The failure of such actions to have any substantive effect leaves governments open to criticism.  Hence, the rise of political parties proposing to do more.

A dose of honesty

The policies of populist parties will not offer any long-term respite.  It is possible for an economy to shut itself off from the global economy.  However, fighting against the tide of history is not a long term option - a faster pace of economic growth in other countries which are more open will inevitably reveal the folly of such isolation.  Instead of being a viable alternative, the anti-immigration political parties tend to function as a form of protest for voters to vent their frustration at the status quo.  But there is still the possibility of one of these protest parties snatching power, likely with dire consequences.

The main remedy might be something as simple as a bit of honesty.   Politicians need to be more open with voters about the limits of their policies.  This would give them the scope needed to deal with the negative effects of technology and globalization which need more than ad hoc measures.  Long term investment in education and infrastructure will be key in terms of both dealing with the negative and reaping the most benefits.  Now is the time for governments to step up and act or else face a more rapid tumbling down the global pecking order.  Politicians and voters need to come to their senses.  And soon.

Free Trade – Missed by Many

Free trade is a route to greater prosperity and better government but its biggest advocate has retreated from its crucial role

US foreign policy was something that people loved to hate.  America was portrayed as a global bully who pushed everyone else into playing by its rules.  The Iraq War is perhaps the most obvious example of this but the conflict also marked a turning point when the US started to withdraw from its dealings with other countries.  While this might appear to be cause for rejoicing, the retreat of the US from international affairs has left a gap that has yet to be filled.  A lack of impetus in the promotion of free trade is one key area where the world is missing the US in a way that is not yet widely understood.

More than just buying and selling across borders

Free trade is something that many people would be glad to see the end of.  It allows for greater globalization which has been vilified as costing jobs and hurting our economy.  Although a source of pain for some in the West, globalization has been a boon for most of us, providing a range of cheaper goods for everything from bananas to iPhones.  At the same time, export industries in less developed countries have pulled millions out of poverty.

Openness to free trade with the rest of the world involves more than just exporting and importing.  It is part of a bigger package that includes less overall regulation and more economic freedom.  This may not seem like much to those in countries that already have this in place, but to places under the rule of an autocratic government, it is something worth fighting for.  Such a battle has dominated the news so far this year as it plays out in Ukraine.

The protests that overthrew the oppressive regime in Ukraine were triggered by the government stepping back from an EU trade agreement and instead opting for a closer relationship with Russia.  This was taken to have the broader meaning that the Ukrainian government was choosing the autocratic style of government characterised by Russia rather than the democratic freedoms of the EU.  Yet, the unrest in Ukraine shows the preference of its citizens and how opening up to trade (and expansion of the EU) can spur on hearts and minds when seen as part of a bigger picture. 

Free trade can have a positive influence in other ways as in Japan.  Political lobbyists such as farmers have tended to block greater access for imports into Japan.  Japanese politicians are apt to side with such vested interests instead of with voters in general who would benefit from cheaper imports.  In the past, it has only been pressure from outside the country - typically from its main ally, the US – that has helped open Japan up to free trade.  Delayed but critical reforms needed to fire up the Japanese economy could be pushed through if a deal were to be done on the Trans-Pacific Partnership which is a free trade zone encompassing countries on the Pacific Rim.

China can only offer so much

The fight for free trade typically needs a champion.  This is because the negative impact of greater trade is concentrated in a few sectors which are proactive in their opposition.  The gains from more open borders are, on the other hand, spread out amongst us all, resulting in only weak support.  Thus, despite the substantial advantages of free trade, progress has been halting.  The problem is exacerbated by each country having its own boisterous domestic forces against free trade so that getting a large number of governments to sign up is a tricky proposition. 

The US government had been the driving force behind free trade, using access to its own lucrative domestic economy as a bargaining piece.  Rather than being a bully, the US spread economic freedoms through trade like a benevolent power.  But, the US no longer has the ability or willingness to play this role.  A rebalancing of the global economy means that the lure of the US economy pales in comparison with other countries such as China.  The weakening of its relative economic strength also means that the US is less generous in its bargaining with other countries.  This is reflected in the stalling of what was supposed to be the next big round of global trade talks which started in Doha in 2001.

The lure of Western ideals as embodied in free trade still remains.  Countries clamber to join the European Union despite its recent troubles.  Economic power may be shifting away from the US and Europe but their democratic style of government is still sought after by many (although politicians have not been showing themselves in a good light).  Free trade in itself is not the answer but it will help push many countries in the right direction. 

Dysfunctional Politics – Time for a Reboot?

The failings of democracy have become more obvious and need more than just a tweak

Some things get better over time but politics seems to be getting worse.  Like a clunky computer that takes ages to get anything done, our political system has outdated hardware and buggy software which means that programs often don’t proceed as planned.  In computing terms, our governments’ failure to deal with the aftermath of the global financial crash is the equivalent of a number of flashing warnings and error messages.  With the faults more obvious than ever, perhaps it is time to look into rebooting the system.

Viruses in the system

Politics needs a remake as it has moved away from the ideals of democracy.  Our leaders have gradually become more and more separated from the world of the voters.  Direct contact has been replaced with communication through the media.  Policies espoused by the different parties take the form of grandstanding statements that fit into a newspaper headline.  The message contained in anything more complicated is often lost on voters with short attention spans. 

The result of this is that politics has become just another form of marketing vying for our attention.  We, in return, now also struggle to relate to political parties.  The number of those among us who are affiliated with a political party has been falling for decades.  Politicians instead work with pollsters and media firms to guess at what voters might want and how to package their policies. 

At the same time, politicians can only offer voters less bang for their buck.  In an increasingly globalized world, many choices that had previously been available to governments have been taken out of their hands.  No country can make decisions in isolation and this limits what politicians can offer voters.  Not that they will ever admit as much.  Yet this unspoken reality further separates voters from politicians who offer too much and can seldom deliver on their policies. 

Some rewiring needed

A good place to start in terms of rebooting politics would be to re-establish links with voters.  As with all forms of communication, this needs to be two-way street.  Politicians need to not only listen to the concerns of voters before forming policy, but more importantly to explain their actions.  Too often politicians sound as if they are talking in code with formulaic messages devoid of content or meaning.  More direct contact with normal people might help politicians to rediscover the benefits of speaking frankly and honestly.

The best politics these days seem to be happening at the city level.  Mayors are closer to the people they govern, even in the larger cities of London and New York, and they are better at solving problems with regard to things that matter in peoples’ lives such as transport, schools, and crime.  From personal experience, the mayor of my city is having a positive effect on the world around me even though I did not vote for him.  I cannot say the same for my representative in parliament (who only turns up once every four years at election time) - let alone our Prime Minister in the UK. 

Politicians serve many roles in their jobs.  At a time when politicians are offering less in terms of leadership, the least they could do instead would be to spend more time among those who elected them.  Something needs to be done to fix the systems that will only become more of a problem (see here for one idea).  A malfunctioning computer is a hassle but a broken-down political system is far more dangerous.  

Dysfunctional Politics Needs Economic Reforms

Politics typically operates like a badly run economy with unappetising choices between limited options

Current politics could be compared with the old Soviet economy – consumers frustrated due to few choices between ill-conceived products designed to fit what most people want but ultimately satisfying very few.  Replace “consumers” and “products” with “voters” and “parties” and this is an apt description of many Western democracies.  The analogy is even more appropriate in that the solution in both cases is the same – reforms to make participation easier for newcomers so as to create more competition.

How have things gone wrong?

Public perception of politicians seems worse than ever.  The aftermath of the global financial crisis has further exacerbated this.  Governments showed themselves to be inept in managing their finances before the crisis and misguided in their response to the ensuing economic slump.  Though elected to serve for the good of the country, governments often prove themselves unable or unwilling to do so.

A number of examples spring to mind.  The United States came to the brink of defaulting over its debt and almost triggered another global financial crisis due to a reluctance on the part of its politicians to compromise.  The nation states of Europe almost destroyed more than half a century of integration and spreading democracy across the continent by refusing to band together to help out the weaker EU members until the central bank stepped in.  The economic recoveries in many countries have also struggled to gain traction as government policies have been more of a hindrance than a help.

The argument could be made that this is not the Soviet Union and democracy gives us a choice of government.  But this choice is often an illusion and often times boils down to selecting the least worst option.  To take a more pessimistic view, the most common political strategy appears to be to make voters dislike the other party more than your own.  This only works when the electorate is faced with limited options as is typically the case in countries where two parties dominate.

Outflank the other party on a few key issues and the voters have no other choice but to tolerate your policies.  The UK Labour Party lost the public trust by overspending in the lead-up to the global financial crisis, thus giving the current Tory-led government a freer rein on its economic policy.  As a result, the British have been lumped with austerity despite the need for measures to boost aggregate demand.  In the US, the Tea Party has infiltrated the Republican Party making it unpalatable for most voters resulting in a second term for an Obama administration which has been slow to act and disappointing in delivering on its promises of change.  The results of the European elections in May 2014 are yet another example of how mainstream parties are failing voters.

Change is possible

An economy with such poor products on offer would collapse but our political system continues to stumble on with voters choosing to tune out instead.  Reforms more typical in economics provide an option for changing this – more competition.

One key area would be changes to the voting system.  Elections using the first-past-the-post format hamper change by ensuring a large number of safe seats for each party while preventing smaller parties from getting into power.  New political parties would shake up politics by bringing in ideas in contrast to the stale left and right divide that still dominates politics.  Coalition governments do not always work (such as in Italy), but are not a recipe for sclerosis in politics as the experiences of the UK government have shown over the past few years.

Such changes may not bring about anything as profound as the fall of the Berlin Wall, but any change from the status quo is likely to be an improvement.

Insights from Asia: New Opium Needed

China has always been a tricky country to trade with but there are still ways of tapping into its growing wealth

Your Neighbourhood Economist has just returned from a four week trip around Asia which provided a few insights worth mentioning.  The first of these came during a layover in the bustling metropolis of Hong Kong with its unique mix of the old and new.  It was the history behind Hong Kong becoming a British colony that caught the attention of Your Neighbourhood Economist because it now seems as if history is repeating itself.

Similarities between Past and Present

In the 18th century China was beginning to open up to trade with European countries.  Goods from China including tea, silk, and porcelain were proving popular in Europe but there was nothing that Europeans merchants could tempt the Chinese into buying in return.  Thus, payment for Chinese goods was made in the form of silver which became a drain on finances.  As a solution, Britain increasingly relied on bringing opium into China but this created conflict between the two countries as importing opium into China was illegal.  The result was the Opium Wars which ended with a British victory and the island of Hong Kong being ceded to Britain by the Chinese as part of their surrender.

Move the clock forward a hundred and fifty years or so and some things are still the same.  China is again exporting goods that the West is keen to purchase – nowadays it is not luxuries but items produced using cheap Chinese labour.  Further similarities include the strong grip exerted by Chinese leaders over the management of the local economy.  Western firms are still eager to sell to Chinese consumers but their options for doing so are limited.  However, this is not because foreign companies have nothing with which to entice the Chinese.  This time the reason is that the Chinese government is acting to stall an invasion of multinational firms until local businesses become large enough to compete.

It makes sense for China to keep control over one of its main resources – a domestic consumer market with one billion enthusiastic participants.  Your Neighbourhood Economist would also advise the same policy of protecting up-and-coming Chinese firms from their battle-hardened Western rivals.  There are few things that China needs at its current state of economic development that it cannot provide for itself.  One of the handful of sectors where imports are important is commodities but China already gets most of its supplies from other emerging economies.

What to do differently this time around

All this has left Western governments scratching their heads with regard to selling to China.  Some countries such as Germany have prospered by selling machinery for Chinese firms to use in their factories.  But most other developed countries are struggling to find their own niche products to sell to China.  As a consequence, large numbers of container ships sail back to China mostly empty.  Opium is obviously no longer an option yet countries like Britain do need to find a way to tap into the growing wealth in China.

It is trade in services that is likely to be key.  Britain has lots of creative and business savvy firms specialising in the design and technology sectors.  Finance is one area which is still out of bounds in China but other sectors are open to outsiders.  Education, on the other hand, is a service that China is finding it hard to provide for itself in either sufficient quantity or quality.  Countries such as Britain can access Chinese wealth while also expanding its educated workforce either through Chinese students who study aboard or foreign schools set up in China.  In the future, higher paying service jobs rather than employment in declining industries such as manufacturing are more likely to provide the bulk of “good jobs”.  China will not always be so closed off or in need of education services but a focus on education seems like a winning formula in the meanwhile.

Generational Differences - Rise of the Socialists

Young people have a different view on the world than older generations who have made the most from capitalism

Youth is the one thing that most people would want – a chance to live it all over again – but it is not an easy time to be young at the moment.  Young people are facing the toughest job market in decades after having gone through an education system which has been neglected for years with more money being spent on pensions instead.  So it may not be surprising that youngsters are not as keen on capitalism as older generations.  And this is not just part of a rebellious phase but rather a response to an economic system which is geared to benefit long-time members to the detriment of new-comers. 

To start with, let’s look at the job market.  Unemployment rates remain stubbornly high in most countries with developed economies but the proportion of young people without jobs is typically substantially higher.  For example, more than half of younger workers in Spain and Greece are unable to find work.  Joblessness not only has temporary effects such as a loss of income but studies have shown that youngsters who enter the market when the economy is sluggish often earn less over their lifetimes.  The current situation for young people goes beyond this to talk of a “lost generation” who may become disillusioned with the job market and remain disengaged even when employment prospects improve.

This situation is made worse by a system fronted by labour unions geared to protecting the jobs of existing workers who come from an older generation.  This trend has been most damaging in Europe where the efforts of unions have resulted in a two-tier labour market.  Older workers have secured themselves stable jobs due to rules resulting in high redundancy costs whereas younger workers are typically employed on short-term contracts which are first to be terminated when job cuts are needed.  The rise of globalization also means that new-comers to the workforce are competing for jobs with workers in China and India as well as people in their hometown. 

This increased competition for jobs along with automation of work using computers and other new technologies has taken away many of the administration jobs that were the mainstay of work for the older generation.  Better paying jobs are increasingly limited to jobs requiring higher levels of education but this too is an area where young people have been short-changed.  Education is faced with spending cuts and students are being asked to bear a substantial portion of the costs as countries deal with high levels of debt as well as demands from older workers for lower taxes.  The irony of this situation is that spending on pensions and medical bills for the elderly is on the rise at the same time as education is suffering from cutbacks – societies are spending money on the old rather than investing in a new generation.

The housing market provides further evidence of the different fortunes of the older and younger generations.  Trying to get onto the property ladder is only getting tougher for first-time buyers whereas existing owners of property are benefitting from higher prices.  House prices have been surging in some places despite the economic doom and gloom as governments in many countries have even been bringing in measures to push up prices for real estate as a means to revive economic growth (which is why a rebound in UK house prices is not all good news).

With lower pay in less stable jobs (or unemployment) awaiting many youngsters, they are likely to be the first generation in a long time that will end up worse off than their parents.  The older generation must take part of the blame with many elements of the economy set up for their benefit – a seemingly obvious outcome in a world defined through competition where everyone from companies to political parties are battling it out.  The spoils from winning in this competitive environment are on the wane in wealthier countries as global economic rebalancing shifts more wealth to China and other countries on the rise (which is part of A New Inconvenient Truth).

Youngsters have experienced the harsher side of a market economy and it is no surprise that they see the current system as not working in their favour.  Surveys show a growing distrust of capitalism and increasing support for social spending among young people.  The disillusionment of young people has also extended to politics so it is later generations which vote and give direction to the policies of government.  But it seems obvious that changes beckon as the younger generation with their different experiences and views on the world take over the levers of power.  Marketing experts have been quick to jump on changes in habits of different age groups such as Generation X or Y.  Politics may see similar changes coming with the rise of a new generation – it will be interesting to see what world they will build for themselves.

Debt Ceiling: Once more unto the breach

Politics in the United States is starting to cause more problems than it solves as compromise still seems far off.

Politicians are not usually seen in the best light.  Even in that context, the partial shutdown of the federal government in the United States is exasperating, so much so that Your Neighbourhood Economist was not even going to bother to comment.  The situation leading to the shutdown brings to mind kids in a playground fighting over a toy with everyone losing out after all of the toys are put away.  However, behind all the antics and posturing, there are bigger themes at play which is even more depressing.

October is marked with a number of dates which gradually ramp up the economic stakes.  The month began with the US government having failed to pass legislation for its spending budget for the 2014 fiscal year which starts on 1^st October.  While the bulk of spending by the government, such as benefits for the elderly or unemployed, is not affected, a significant portion of money doled out by the government must first be ratified by Congress before being spent.  As a result, not passing the budget resulted in a partial shutdown of the federal government with around 800,000 out of 2.8 million public employees being sent home without pay.  The parts of government affected include bodies such as the Environmental Protection Agency and the Food and Drug Administration, meaning that many procedures such as permits for certain business activities will not be processed.  NASA will also mostly shutdown as will many of the tourist sites overseen by Federal government employees.

But the partial government shutdown is just a precursor to something more threatening – the government running out of money to pay its bills.  While such an outcome may sound preposterous, it stems from the current budget deficit (with the government spending more than it receives) and the need to borrow to make up the shortfall.  The total amount of debt that the US government can take on is also something that requires approval from Congress.  With the government having racked up a string of budget deficits in the aftermath of the global financial crisis, the amount of borrowing has been steadily rising.  More debt is needed but the government has reached the debt ceiling which was raised in 2011 and is expected to run out of money by around 17^th October.

The stakes are higher if no deal can be done with regard to the debt ceiling.  While the partial shutdown of government can be seen as a bit of a nuisance, a government cash shortage could have global ramifications if it means that the government misses an interest payment on its bonds and thereby triggers a default.  Given that US government bonds are akin to another form of currency in the financial system, a default has the potential to bring the global financial system to its knees. 

In spite of this, the financial markets, while on edge, have not panicked - negotiations regarding the raising of the debt ceiling are still on-going, and even if a deal cannot be brokered, the effects are still unclear.  There are other sources of income such as money from taxes so the government will be able to keep up with some outgoing payments.  But that in itself creates another dilemma – which, if any, payments to forgo.  Investors would hope that debt payment would take priority over, for example, the payment of pensions.  Despite the potential consequences to the international financial system, it would take a brave politician to cut off pensions for old people.

Considering what is at stake, the consensus view is that the politicians will sort themselves out before the government is forced into making such choices.  Your Neighbourhood Economist would like to assume that this will be the case.  But the two main political parties have been squabbling for number of years with the situation getting worse rather than showing any signs of improvement.  Over the past few years, there have been skirmishes over a previous increase of the debt ceiling in 2011 as well as the negotiations regarding the fiscal cliff less than 12 months ago (for more on this, see Winning the election was the easy part) and one of the key obstacles to compromise is growing in strength – that being the so-called Tea Party portion of the Republican Party.

The Tea Party is the radical anti-government element of the Republican Party which is not afraid to be aggressive in pushing for a reduction in the size of government among other policies.  Its members in Congress are targeting large concessions from Obama to raise the debt ceiling – a position which is further fortified by Obama having conceded little in previous showdowns.  Perhaps the biggest concern is that the anti-government fervour of the Tea Party will translate into a view that the debt ceiling is an effective way of slashing government spending irrespective of the costs involved.

The Tea Party has found growing support among Americans disillusioned with the role of the government.  It is part of the rise of populist movements that can also be seen in Europe which rail against mainstream policies, such as an opposition to immigration.  The multi-party political systems in Europe can include such movements as separate parties which often struggle to get the necessary level of support to make it into government.  The political system in the United States only has two political parties and the Tea Party essentially controls a large portion of the Republican Party.  With voting districts in the United States having been shaped over the years to produce safe seats for either the Republicans or the Democrats, Tea Party candidates in Republican seats are typically better at whipping up support enabling them to win out over more moderate candidates. 

The Republican Party as a whole has increasingly felt the need to pander to this radical fringe which has brought a heightened level of conflict to US politics, within the Republican Party itself as well as between the two major parties.  Its unique system of democracy has been a key element behind the successful rise of the United States to global dominance.  But with the country’s place at the top of the global pecking order no longer assured (as described in A New Inconvenient Truth), it would be ironic if its political system was central to its downfall.

Detroit – Just the beginning?

A city is driven into bankruptcy by the same problems that plague the United States as a whole but will the outcome be any different?

We have become all too accustomed to firms going bust recently amid the economic doom and gloom but a city going bankrupt seems a little strange.  But that is what happened to Detroit last month as years of decline culminated in the city admitting that it was no longer able to pay its bills.  Having thrived along with the auto industry, Detroit was always doomed to struggle as American car makers lost out to foreign rivals but its problems are not that different from those facing the country as a whole – overgenerous spending commitments from politicians focusing on the short term.  Can the politicians in Washington do any better in dodging a budgeting accident?

Detroit’s demise has come after it lost the industrial base that was the foundation of the city – the manufacturing industry around Detroit was decimated as overseas firms took a large chunk of the US auto market.  The population of Detroit was close to two million in 1950 but has since plunged to around a third of its peak as the deteriorating job market prompted people to move elsewhere to find work.  The exodus created a downward spiral with a growing number of boarded up houses and deteriorating public services as tax payers fled to more prosperous locations. 

The sharp decline still left Detroit with a large number of bills to pay, and along with having to maintain the infrastructure of a shrinking city, there was also the pensions for its public sector workers.  Its debts are estimated at $18.2 billion but around half of this money is owed to its present and past workers in the form of promises of retirement pay-outs.  It is common for government workers to be paid pensions which are a percentage of their salary (referred to as defined benefit plans) which is different to the private sector where workers must pay into their own pension pot from which pensions are paid out (referred to as defined contribution plans). 

Promises made by politicians have come back to haunt their successors – offering up bigger pensions rather than higher wages as a means to placate government workers with lower pay rates.  Pledges made when times are good are difficult to uphold when things turn bad especially since officials fail to put away sufficient funds to cover future pension payments.  The fixed sums offered to public sector employees after retirement have become more of a burden with people living longer and investments yielding a lower return after the global financial crisis (which means that the initial level of funding of pension pots is higher).  It is like a massive scheme of offering up IOUs with big pay-outs in a few decades but not bothering to put away much money to settle up in the future.

Detroit was not the first city to go bankrupt (Stockton, Mammoth Lakes and San Bernardino in California did in 2012) and it will not be the last (even some of the largest firms in the United States such as General Motors and most of the airline companies have been laid low by lavish pension schemes), but more crucial are the similar problems faced by the federal government in the United States.  The US government has committed to paying pensions and medical bills for the old and poor which will gradually ramp up the pressure on the government budget as the baby boomer generation heads into retirement and the number of workers per pensioner falls (i.e. costs will rise as revenues fall but more slowly than in the case of Detroit).  Social spending on these and other entitlements accounted for 56% of government spending or almost 14% of GDP in 2012 and increasing spending is threating to overwhelm the government spending plans.

The approach of a fiscal disaster comes at a bad time - the US government is already struggling to sort out a considerable budget deficit equal to 7.0% of GDP in 2012.  The timing is made even worse when considering that the dominant global position of the United States is under fire due to the rise of new powers such as China (for more on this, see A New Inconvenient Truth).  Instead, politicians would rather squabble than deal with the raft of problems facing the country with numerous other areas such as taxation and immigration also crying out for reform.  Even sensible adjustments to policy, such as increasing the retirement age to account for people living longer, get vilified with both the Democratic and Republican parties at each other’s throats.  Elections do little to resolve the issues with politicians happy to just target their own supporters (refer to Election with no winners for more detail).  The country as a whole is being driven toward the same destination as Detroit and politicians would rather play a game of chicken amongst themselves than steer clear of trouble – watch out for accidents in the road ahead.

Good and Bad from Slowdown in China

When something is as inevitable as the growing dominance of China, the only option is to take the bad with the good.

It seems as if everyone is keen to know more about China.  The high level of interest is a result of both benefits and threats that China poses to the lives of us all.  China has an undue influence, be it the prices we pay for petrol or for running shoes, due to its dual role as a dominant consumer and producer in the global economy.  So slower economic growth in China and the reasons behind it will have effects that will ripple through the global economy.  But there will be good along with the bad and here is how it may play out.

Before starting on what might happen, it will be useful to look at the reason behind the slowdown.  The Chinese economy has reached a point of change in its development.  In the past, higher wages would prompt people employed in agriculture in rural China to move into the cities and work in factories.  This trend spurred the size of the economy to expand as these workers were being put to more economically productive uses compared to scratching out a living on small-scale farms. 

The first factories in China made basic goods such as clothing in the same way that the growth in textile factories was behind the Industrial Revolution in England around 200 years ago.  But as the economy has become more sophisticated, Chinese firms have invested massive amounts in new factories to produce more complex goods while the government has spent heavily on infrastructure.  But the driving force of growth came from the seemingly endless supply of cheap labour that would be put to use producing goods of higher and higher value.

But the end of economic growth fuelled by cheap labour and piles of investment seems near.  Rising wages in China are a sign that workers are proving tougher to find (refer to End of the end of the world).  Benefits from further investment are not as easy to come by considering the splurge in spending which lifted investment to around 50% of GDP compared to around 15% in the United States.  So the growth of a domestic consumer market as wages rise in China is seen as key as the next phase of economic development.  But the effects of this will not just be felt in China but across the globe. 

China has been the engine that is driving the meagre growth in the global economy.  Economies in places such as Germany and Australia have been kept perky by supplying machinery and minerals for the hungry Chinese economy.  Without this extra boost from China, the slowdown in the global economy would have been a lot worse even in countries which do not have links with China.  As such, a slowdown in China will be reflected in growth statistics across many other countries.  While the Chinese economy is still expected to expand by around 7% this year, the transformation of the Chinese economy from a manufacturing powerhouse to a consumer mecca is bound to be a bumpy ride and the effects of this on economic growth is still unclear (but there is good reason to be positive – see China brings out the Big Guns for more).

The economic rise of China has changed the shape of the global economy.  Everything from the price of coal to cows has been pushed upwards due to the seemingly insatiable appetite of the Chinese economy.  Much of the commodities have gone into providing the building blocks of the Chinese economy (steel girders and concrete slabs) and the fuel needed to drive the growing economy.  Less investment and slower growth will halt the upward rise in prices in some areas such as steel and other metals.  This will help lower construction costs all over the world and will be a blessing for places like Europe and the United States where investment has been weak. 

The slowdown in China is expected to provide other benefits for Western countries as well.  As shown by Chinese shoppers’ desire for luxury bags and shoes, demand for goods from overseas will increase as consumer demand picks up in China.  Whether it be producers of chocolate bars or fancy cars, there will be ample opportunities for Western firms to target Chinese consumers in the future as there will be strong demand for foreign goods until Chinese companies can build up their own brands.  The flipside of higher wages in China is that goods produced with a “Made in China” label will not be so cheap anymore.  Despite grumblings of firms faced with competition from exports, Chinese goods have been a boon for consumers in the West and have helped meagre pay packets go further.

For all of the good and bad, a slowdown is needed so that the Chinese economy does not implode under the weight of massive debts and reckless investment (for more detail, seeWhy China needs a slowdown).  The way forward will include some rocky patches but the rise of China is inevitable and will throw up challenges both within and beyond its borders.  Trying to fight it would be like trying to push back a rising tide – the only option is to make the most of it.

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. 

Disappearance of the “Strong Dollar”

The demise of this phrase from the lexicon of politicians in the United States says a lot about the changing landscape of the global economy.

It is easy to notice when a new term pops up but harder to spot when a phrase falls out of use.  Adherence to the principle of a “strong dollar” was a cornerstone of government policy in the United States for generations but it is not something that is referred to by politicians anymore.  Your Neighbourhood Economist would argue that this change in thinking by politicians about the US dollar that has mostly gone unnoticed is part of a wider picture of the changing global position of the United States.

It may seem strange at a time when countries are vying with each other to weaken their currencies (for more, see Currency Wars), but not so long ago, politicians in the United States would pledge their support for the notion of a strong dollar.  But the origin of the strong dollar was from a previous era when the United States was the dominant global trading power.  Trade flows in the thirty years following the Second World War typically followed a certain pattern – rich, developed countries such as the United States would import agricultural products and raw materials for manufacturing while importing manufactured goods back to the poorer, less developed countries. 

Manufacturing at this time was limited to a small group of privileged countries that benefitted from economies of scale stemming from their large and wealthy domestic markets.  Most other countries were limited to importing materials which ended up being plentiful and cheap due to the large number of other countries having nothing else to offer in terms of trading.  So the United States was in an advantageous position of being one of a few that supplied crucial manufacturing products but having a wide choice of trading partners in other goods.  Its dominance was extenuated with many other manufacturing countries being decimated following the War. 

This central role of the United States in the global economy also extended to its currency and the US dollar was used in trading between different countries and as a means for any country to store its wealth.  The widespread popularity of the US dollar increased its value which put the United States in an even better position.  A strong currency helped businesses in the United States by making imports cheaper but was only helpful in so far that there was minimal competition regarding exports.  

While the United States remained on top for a few decades after World War II, it inevitably faced numerous challenges.  The oil embargos in the 1970s were a shock to the system but it was the rise of Japan as a manufacturing rival that signalled that the good times were coming to an end.  Companies in the United States had grown flabby and slow due to a lack of competition.  Focused and ambitious Japanese firms easily outperformed their US rivals in areas such as cars and consumer electronics.  The revival of business in the United States was facilitated in part due to an agreement in 1985 to revalue the Japanese yen at a higher value. 

However, the new competition from Japan was just a sign of things to come as other countries in Asia such as South Korea and Taiwan followed in the footsteps of Japan culminating in the re-emergence of the sleeping dragon, China.  The global economy was in the process of becoming increasingly interlinked due to lower costs for transport and communication and the resulting surge in imports into the United States devastated some local manufacturing industries.  Surviving businesses in the United States lobbied for support from the government through protectionist measures.  Yet, politicians maintained their belief in the benefits of a strong dollar with reiterations of this policy being repeated as recently as during the Bush Junior administration.

The United States government policy regarding its currency eventually caught up with the realities of the repositioning of the United States in the global pecking order.  Nowadays, the only mention relating to the US dollar by politicians is belligerent moaning about the perceived injustices stemming from a belief that China is manipulating its currency.  This is part of an increasing vocal backlash looking to stem the flood of goods from overseas and reflects the difficulties that businesses in the United States are having as globalization increases the number of rivals.  Slower economic growth and an increasingly high debt burden means that exporting is becoming more important as the United States economy has to work harder to generate growth.  This is one of the many challenges that are likely to lie ahead as the United States scrambles to hold onto its global crown.

More fighting talk

Along with the large amounts borrowed by governments, the younger generation are also set to be saddled with more debt which is not of their own making.

Talks of battles and fighting in the previous blog got Your Neighbourhood Economist thinking about a struggle so epic that it makes the currency wars seem like kids throwing toys in the playground (or, more literally, central bankers throwing money at the economy).  This fight pits a battle-hardened and organised army against a smaller force that increasingly has its back up against the wall.  So who is fighting over what?  It is a battle between old and young over pensions.  The money that government pay the elderly in their retirement adds a further weight to the mountain of debt already depressing the global economy but pensioners form a potent force in politics and loathe to give up what had been promised to them in the past.  Yet pensions that would have been tough to pay even in good times may be set to bankrupt a younger generation.

Pensions have traditionally been based on pay-as-you-go schemes where payments for pensioners come from the taxes paid by current workers.  This was an arrangement that was acceptable to workers to begin with because it was assumed that they would also be eligible for pensions after retirement.  This system relied on a growing population where the work force was expanding so that the burden of pensions was never too great.  This social contract has broken down due to the demographic accident of the baby boomers.  The surge in births following the end of the Second World War resulted in a bulge in the population due to the so-called baby boomers having fewer babies than previous generations.  The drop in child birth means that there will be fewer people in jobs paying taxes to fund the retirement of their parents’ generation.  Not only is the number of pensioners growing relative to the working age population, but the costs of pensions themselves are increasing as people live for longer.  The prolonged lives of the elderly will add bigger medical bills as well.  So something has to give – high taxes and less spending in other areas or a reduction in pay outs to the elderly.

As one would imagine, the baby boomers are not keen to give up what has been promised to them.  They believed that they paid their fair share of taxes, part of which funded the pensions of their parents’ generation, and now expect to receive the same treatment as they head into retirement.  Not only do baby boomers outnumber the younger generation but they also form a political force to be reckoned with.  The older generation have much higher voting turnout and are more politically active after experiencing dramatic changes during the post war years.  The young, on the other hand, are typically seen as being disillusioned with politics and can’t be bothered voting.

Politicians are aware of the potential shortfall in government finances with pension costs expected to balloon in the coming decades.  Baby boomers have added to the problem after years of voting for lower taxes.  There have been recent attempts to forge a solution through raising the retirement age but it is a political minefield (the new government in France even lowered the retirement age which was a reversal of the previous government).  Immigration would also help but voters in many countries can’t stomach the thought too many foreigners even if they are paying taxes.  So even though the elderly with their failing eye sight and walking canes may not seem to be able to wreck much havoc, they are set to demolish government finances. 

So it seems likely that young people will be left to foot the bill and they are already paying the consequences of a system that is geared toward their elders.  The older generation has benefited from rising property prices through their lifetime but now youngster struggle to buy their first home and end up stuck living with their parents.  The job market is also tough as unions protect the jobs of current workers who are typically older while the young miss out on work as no new jobs are being created due to economic stagnation.  And when people from the younger generation do find work, they have to pay taxes which go toward pensions as well as putting money into pension accounts to pay for their own retirement – paying for pensions for both themselves and for their parents.  This may be the first generation in centuries that will be worse off than their parents.  And you thought it was tough growing up!

A New Inconvenient Truth

The reality which faces the West that politicians dare not speak of

The rise of countries such as China, India, and Brazil will be a tectonic shift in economic power but it is also a change that is long overdue.  The relative dominance of Europe and the United States in the global economy is a historical accident brought about by the early formation of capitalist economies in these parts of the world.  The response to these new challengers will define the role that the United States and Europe play on the global stage in the future and the initial signs do not look good. 

The Western world spearheaded by Europe and the United States have generated the bulk of the wealth in the global economy for most of the past century.  As early ago as 1990, the United States accounted for around 23% of global GDP and the countries which now constitute the European Union accounted for roughly 32% while respectively only making up 5% and 9% of the world’s population.  Yet, growth in the countries such as those grouped together under the label of BRICs (Brazil, Russia, India, and China) is the beginning of the end to this distortion in the distribution of global wealth.  The BRICs countries, who accounted for just 8% of global GDP despite making up 43% of the number of people worldwide in 1990, have seen their share of global GDP increase to 18% as of 2010.  The figures for the United States and the European Union have dropped back respectively to 23% and 26% in 2010 and this is a trend that will continue for decades into the future.

It is not that the economies in the United States and Europe have not been expanding in size but growth is not as easy to generate as elsewhere.  Loading up on debt helped to create a booming economy for a while but excessive lending eventually brought about a deep economic slump (for more info, refer to Tale of Two Recessions).  The global financial crisis has instead allowed other countries to catch up faster and to lay siege to the position of the United States and Europe at the top of the global pecking order.  The concentration of wealth in these Western countries has allowed them easy access to resources such as agricultural produce and mineral deposits from around the global as well as ready markets for their manufacturing goods.  But industrialization in countries which were previously just mainly sources of raw materials for the United States and Europe has given rise to competition – both in terms of other countries snapping up resources and of creating rivals to Western firms.  Economic power has also allowed Europe and the United States to shape global institutions to their liking. 

But this imbalance of wealth was never destined to last.  The gap between the rich and poor became too great and plummeting transport costs meant that goods could be manufactured anywhere.  The changes stemming from this will shape the world for generations to come and in ways which cannot yet be grasped.  Rather than bracing themselves to face the reality of this new challenge, both Europe and the United States have been embroiled in domestic issues as politicians struggle to deal with growing levels of debt. 

Economic theory espouses the benefits of free trade and an open economy where countries should specialise in what they are good at.  For the United States and Europe, this would be high-tech or high-value-added sectors such as product design, computer software, and precision manufacturing which make use of their skilled workers.  Yet, Western governments have shot themselves in the foot through mismanagement of their finances.  The resulting masses of public debt have restricted the ability of governments to invest in, for example, education which has suffered in many richer countries as governments focused more on cutting taxes.

Politicians in the United States and Europe need to be more honest with voters.  It is easy to convince voters that the good times will return and to try and hold off the inevitable.  But this will merely delay the day of reckoning and will make it so much worse than it needs to be when it does come around.  Many current policies, such as reducing immigration even for skilled overseas workers, run completely against what needs to be done and suggest that politicians either do not grasp the changes already underway or prefer to pander to the preferences of a public who is adverse to change rather than confront them with reality.  Sooner or later, this inconvenient truth will become apparent, but by then, it may be too late.