[p2p-research] Who will be Paying the Bills?

[Ryan]

This blog represents the "Austrian" (or Chicago School) viewpoint. It
argues rather frequently (see the previous post) with a much better
thought out Keynesian (actually post-Keynsian) point of view. For those
interested in advanced economic theory at a macro non-math level...I
recommend this and the blog it responds to very much. Both writers are
clear and very smart and use evidence as well as theory extensively.
Their argument is at the core of the future of the Western World right
now in terms of economics. Which boils down to stimulus and debt versus
austerity and recession. Europe seems bent on the latter. The US on the
former. That's a lose lose proposition probably. Stimulus must be
coordinated, and recession in the face of trade partner growth is
particularly crushing.

Sent to you by Ryan via Google Reader: Who will be Paying the Bills?
via CynicusEconomicus by CynicusEconomicus on 6/26/10
My last two posts have prompted a lively debate on the blog, and it is
interesting to see how the debate parallels that which is taking place
around the world. The G20 and G8 summits appear to be seeing the same
divisions, with Obama on one side encouraging continuance of massive
deficit spending, and the Canadian and many Europeans (e.g. Merkel,
Cameron, Borroso) saying that the deficit spending has gone far enough
(or perhaps already too far). This is from the Guardian:


Signs of deep rifts at the G8 and G20 summits in Toronto over how
quickly governments should cut deficits added to financial market
jitters today, with the Americans warning of the dangers of a double
dip recession if all countries started to rein back spending at once.

The leading European economies, especially Germany, are putting a new
emphasis on cutting back government spending, and there is a
possibility that a G20 communique, due to be released on Sunday , will
set out an indicative timetable of how far and fast countries should
retrench spending.

David Cameron, making his first appearance at a world summit and
packing in a frantic round of bilaterals to start building personal
relations, was praised by the summits' host for his deficit slashing
budget earlier this week.

The Canadian prime minister, Steve Harper, said that he welcomed
Cameron's responsible and difficult decisions, saying the British prime
minister's budget "had raised the very fiscal consolidation agenda that
we are trying to steer the G20 towards".

Canada wants the G20 to endorse the idea that national deficits should
be halved by 2013.
I highlight this, as the gap between the US approach to deficit
spending and that of (for example) Germany can not be wider. There is a
major fracture in the perspectives on economics between different
countries.

The problem is that, there is no opportunity for either side to ever
prove itself right, except through enacting their different approaches.
However, in one respect, the Obama camp will be proven correct. That
is, if there is a major move towards cutting of expenditure, a
recession will almost certainly be the outcome. This will then give
them an opportunity to say 'I told you so' and blame the problem on the
cuts.

What we will never actually see, is what happens next if countries
continue to rack up huge deficits, and the dangers that might flow from
this enactment of policy. It will allow history to be rewritten to say
that, had the spending continued, then the world would economy would
have recovered, and all would have been well.

Set against this, I would point to the following article, which points
to the underlying change in the world economy, a change which I have
continually highlighted on this blog as inevitable, and the real driver
behind the economic crisis:


Ten years ago, the world’s richest countries accounted for a
significant majority of the globe’s economic activity. But the pendulum
is swinging in the other direction, according to the Organization for
Economic Cooperation and Development.
A new O.E.C.D. report finds that rich countries and poor countries now
each contribute about an equal share of the global economy. And by
2030, developing countries will account for 57 percent of world G.D.P.

This has been at the heart of the thesis of this blog. The world has
changed; the distribution of wealth in the world is changing, and it
means that the developed world is no longer in the position where it
might assume eternal wealth. We are now at the stage where month by
month, we can see the reality of the change, and the attempts by many
developed countries to turn back the reality failing. My argument,
since before even starting to write this blog, has been that, for over
a decade, we have misconstrued apparent economic growth for real
economic growth. This is the view of the Economist:


Throughout the 1980s and 1990s a rise in debt levels accompanied what
economists called the “great moderation”, when growth was steady and
unemployment and inflation remained low. No longer did Western banks
have to raise rates to halt consumer booms. By the early 2000s a vast
international scheme of vendor financing had been created. China and
the oil exporters amassed current-account surpluses and then lent the
money back to the developed world so it could keep buying their goods.

Those who cautioned against rising debt levels were dismissed as
doom-mongers; after all, asset prices were rising even faster, so
balance-sheets looked healthy. And with the economy buoyant, debtors
could afford to meet their interest payments without defaulting. In
short, it paid to borrow and it paid to lend.
I was one of the doom-mongers when I first started writing about the
economy. I was seen as (at best) a part of a mad fringe, but today we
see the Economist saying exactly what I was saying long ago. However,
even now, the problem remains that growth in debt is still mistaken for
economic growth, and I despair of the mainstream ever 'getting' the
distinction.

At this stage, it is worth offering a perspective on the scale and
depth of the existing levels of debt in the developed world. The
Economist has a special feature on indebtedness and produced the
following chart which ranks countries by debt sustainability (sorry
about the size):


I strongly recommend taking a look at the interactive debt chart at the
Economist here (sorry, can not be reproduced here). They follow their
chart with this commentary:


THE headlines are all about sovereign debt at the moment. But that is
only part of the problem. Debt has risen across the economy, from
consumers on credit cards, though industrial companies borrowing for
expansion and financial companies using debt to buy risky assets.

The interactive graphic above [in the Economist article] shows the
overall debt levels for a wide range of countries, based on data
supplied by the McKinsey Global Institute. In theory there is no
maximum level for debt relative to GDP, but Ireland and Iceland (not on
this map) found the limit in practice when they hit eight-to-ten times
GDP.
The massive debt accumulation does not tell the whole story. What we
can see is that the debt is simply being used for consumption. It is
not creating growth, but is leading to diminishing returns in growth -
in other words, the real growth is taking place outside of the
developed world, and the developed world is just living off that real
growth. The chart below from the Economist tells the story:



What this chart shows is the reality that has long been the subject of
this blog, including in a recent post on post-Keynesianism. The money
that is being borrowed and thrown into developed world economies is not
producing a return. I made a comparison with China, where the
government spending can make a return. It is very clear from the chart
that borrowing more is not the answer (I know that the post-Keynesians
will claim that their kind of borrowing and spending will be
different....but see my post for why it will not).

However, it is quite possible for the US, for example, to continue to
borrow from the new wealth creating countries and the oil states and
appear to continue to be relatively prosperous. However, underneath
such apparent prosperity is the reality that there are now the emerging
economies that are being coming increasingly competitive, and taking a
greater share of global wealth. Countries like China and India
commenced with low end, low added value goods, but are rapidly rising
up the value chain, and are starting to compete in the higher added
value segments. The emerging economies will increasingly be meeting the
developed world in the market for higher added value goods and
services, and the developing world will win market share.

This leads to the question of whether there will be a miracle of a
return to the pre-crisis 'normality'. Can the developed world return to
past levels of wealth, at the same time as new and aggressive entrants
are entering into more segments of the world market. The Obama solution
is built on the believe that, at some point in the future, growth in
the economies of the developed world will return, and this will then
allow for the existing economic structures to be maintained, and at the
same time producing enough growth to repay debts accumulated now. After
all, this has been what has taken place following previous recessions.

This view ignores the changes that are taking place in the
apportionment of wealth, and also ignores internal factors that will
further diminish potential for wealth creation, as well as the problem
of structural entitlement programmes that will push up costs and
diminish the ability to pay down debt. The first problem is one I have
already discussed, the second and third are resultant from the basic
demographic problem of ageing populations. In order for developed
countries to simply stand still, there would need to be a significant
productivity miracle, which will allow a shrinking workforce to support
a growing population of retired people. The problem is that the
developed world is not standing still, but is falling backwards.

If government borrowing and spending is removed from the equation, it
is apparent that the economies of most developed countries are facing
reversals in wealth as a result of the competition from the emerging
economies. I think I might now be in a position where, when discussing
the economic growth in the pre-crisis decade, few would propose that
there was an underlying increase in the wealth, but rather an illusion
of wealth created by debt. Since the crisis commenced, governments have
replaced this debt with government debt, and this can only be sustained
for so long. What this creates is a moment in time where existing
economic structures might be retained, but no more than that.

In order for the changes in both the internal and external environments
to be accommodated in the medium to long term, something must change.
On the one hand, in response to the internal changes, there is the
choice of using ever greater taxation to pay for the costs of a growing
pool of retired people from a diminishing workforce. This would place a
significant burden on the upcoming generation, whose potential for
a 'good' lifestyle would be diminished through significantly higher
taxation. Alternatively, the structure of the economy might be reformed
through the reduction in entitlement programmes, or through allocation
of funding now to support future entitlement programmes. At present,
however, the assumption is that 'growth' will allow these entitlement
programmes to proceed without any action now, or negative consequences
on the upcoming generation.

Furthermore, when considering these future increases in costs from a
shrinking tax base, they will also need to service the debts that are
being accumulated in the present. As such, in addition to having to
service the cost of a growing retired population, the shrunken tax base
must also apportion more of their income in order to service debt. As
such, there seems to be a huge assumption that either the upcoming
generation are going to be hugely more productive than the previous
generation and / or they will be willing to see much higher tax levels
than the previous generation.

Furthermore, developing economies such as China are also major lenders
into many of the developed economies, meaning that, as they continue to
develop, they will have access to future resources and output of the
developed world as they continue their growth, possibly allowing for an
accelerated rate of growth. The upcoming generation must therefore
achieve all of this as the emerging economies continue to grow their
share of the economy, and move ever further up the value chain in
competition with developed economies. I am now not alone in this point
of view, and again from the Economist:




But in parts of the rich world such optimism may now be misplaced. With
ageing populations and shrinking workforces, their economies may grow
more slowly than they have done in the past. They may have borrowed
from the future, using debt to enjoy a standard of living that is
unsustainable. Greece provides a stark example. Standard & Poor’s, a
rating agency, estimates that its GDP will not regain its 2008 level
until 2017.

Rising government debt is a Ponzi scheme that requires an ever-growing
population to assume the burden—unless some deus ex machina, such as a
technological breakthrough, can boost growth. As Roland Nash, head of
research at Renaissance Capital, an investment bank, puts it: “Can the
West, with its regulated industry, uncompetitive labour and large
government, afford its borrowing-funded living standards and
increasingly expensive public sectors?”


Some of the commentators on the blog might note the use of the
expression Ponzi scheme, as there has been a debate in the comments
section of the blog on just this subject. The point is that there is no
way in the world that the current economic structure of the developed
world can be maintained. I have asked, and asked and asked where the
real growth might come from to support developed world economies. It
now seems that even the mainstream is coming to this question, and it
is about time.

As such, when we look at the current debate, we can see two simple
divisions. On the one side, there are a series of assumptions that
there will be a growth miracle that will outstrip the results of
demographic change in a world of increasing competition. On the other
side is an assumption that something must be done now to accommodate
the changes in the world. The consequence of the former, barring a
miracle in productivity, is that the upcoming generation are going to
be saddled with huge burdens, even assuming that the borrowing might be
sustained into the near future.

On the other hand, the consequences of cutting now is to commence a
process of realigning the economy to the actual wealth creating
potential of the economy, and starting to face the problems that are
rapidly accumulating. At its most basic, it is accepting that there
needs to be a restructuring now, rather than imposing a huge (and
probably in reality an unsustainable) burden on the future. I believe
that, in the past, I commented on another Economist article that
pointed out that, in the future, there will be a conflict of interest
between the generations. The current debate about continuing of
spending versus cutting now is in reality exactly this debate.

I have always realised that, if governments cut now, the consequence
will be shrinking economies. I have never seen any way out, except to
take this 'pain' sooner or later. However, I have always argued that
sooner is better than later, as the accumulation of debt can only
compound the existing problems. No doubt, if governments manage to
really cut now (and that is still uncertain), then we will later see
retrospective history claiming that the cuts were responsible for
future problems that will indeed arise. However, such a perspective
would be to ignore the real changes in the world economic structure,
and these changes are not of the sort that can be wished away or
ignored. The choices are simple, and the choices are 'who pays, and
when?'

Notes:

A long time ago I wrote some posts which proposed reforms which would
try to maintain the essential underlying principles of several
entitlement programmes in the UK (e.g. NHS, Education and Benefits) . I
wrote them from a basic principle; that we could not afford the current
structures going forwards. I sought to balance the underlying social
and political demands with the coming shrinking of wealth. What we are
now seeing is the discussion of necessary cuts, and I can only hope
that these are undertaken in conjunction with the necessity for reform
of the systems themselves.

What I would like to see is that, in the recognition of the
difficulties ahead, that those in the future might enjoy something
similar to what we (in the UK) have grown used to. In other words, the
same underlying protections but pared down to achieve the original
basic principles at the time of the establishment of the benefits. In
addition to cuts, it is therefore necessary to reform, and I hope that
this is the next phase in the transition. Unfortunately, since the time
of writing the proposed reforms, governments have racked up ever
greater debts, making it ever less possible to achieve this goal. This
is why I have, since the start of this blog, argued against government
borrowing.

As a further note to US readers, the examples of reform I give might
seem to be puzzling in the context of the US experience. I am a firm
believer that safety nets, education, and health care should be
available to people, and you will see in the examples methods that
might allow for these to be achieved in the context of the UK's history
and situation.



Things you can do from here:
- Subscribe to CynicusEconomicus using Google Reader
- Get started using Google Reader to easily keep up with all your
favorite sites
-------------- next part --------------
An HTML attachment was scrubbed...
URL: <http://listcultures.org/pipermail/p2presearch_listcultures.org/attachments/20100627/605562bb/attachment-0001.html>