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The continued economic
decline of the WestDiagnosis and prognosisJon Moynihan
23 February 2012
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The continued economic decline of the West
The challenge Potential actions Likely outcomes
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How has the Wests economic decline happened? Will it continue?
Source: IMF.
-20 0 20 40 60
China
India
Brazil
Russia
Germany
France
Japan
United States
United Kingdom
Real GDP per capita
Change from 2007 to 2012 (forecast), %
70
100130
160
190
220
250
280
310
340370
400
430
460
490
520
550
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Real GDP per capita
(1992 = 100)
China
IndiaUnited Kingdom
United States
Germany
Japan
Brazil
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There are many competing explanations, some more persuasive than others:
20 30 4010 50 600
0
1000
1500
2000
2500
3000
3500
500
% of men aged 25-34 living with parents
5YCDSoffoundingEur
ozonecountries
R2 = 0.75282
5-Year CDS of Eurozone countries vs.
percentage of men living with parents
Greece
Portugal
Italy
Spain
Ireland
AustriaGermany
BelgiumFrance
Finland
Netherlands
Source: EuroStat, Bloomberg, via Boaz Weinstein, Saba Capital.
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The central dilemma facing Western economies:
The paradigmfor the 1900s
2%
3%
The paradigmfor the 2000s
Negative
Negative
Average annual
growth innumber of jobs:
Average annualgrowth in real
wages:
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The continued economic decline of the West
The challenge
Global wagedisparity
Ineffectualgovernments andcredulous voters
Entitled groupsPoor allocation of
tax monies
Potential actions Likely outcomes
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The global wage disparity, potentiated by the global adoption of capitalism,is driving an unprecedented loss of wealth and growth for the Western economies.
Wage disparities
between OECDand emerging
countries resultin an almostinsuperablecompetitiveadvantage
for the East*.
As a result, a jobdrain continuesand is indeedaccelerating.
The jobs drainedare not returning;rather, more will
be lost.
With no jobsupply, i.e. less
demand forlabour, wages inthe OECD mustinevitably fall.
A global wage disparity
* Includes Brazil etc.
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This jobs drain is taking place, driven by the wagedisparities that exist between West and East:
Alarmist worries about this were dismissed as overblown, even as many millionsof jobs migrated (indeed continue to migrate) from OECD to Third World 1995-2011.
Sources: 1 OECD; 2 Estimated: UN World Urbanization Prospects, 15-64 year olds, assuming 65% LFPR.
Waiting tourbanise
(rural)2
AdvancedEconomies1
DevelopingEconomies
(urban)2
1.1 billion
$12
(China, 2008)
$135
(OECD, 2010)
500 millionLabour pool
Average daily wage
1.3 billion
$1-2?
A global wage disparity
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The global wage disparity, potentiated by the global adoption of capitalism,is driving an unprecedented loss of wealth and growth for the Western economies.
Wage disparities
between OECDand emerging
countries resultin an almostinsuperablecompetitiveadvantage
for the East.
As a result, a jobdrain continuesand is indeedaccelerating.
The jobs drainedare not returning;rather, more will
be lost.
With no jobsupply, i.e. less
demand forlabour, wages inthe OECD mustinevitably fall.
A global wage disparity
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100
110
120
130
140
150
160
1983 1986 1989 1992 1995 1998 2001 2004 2007 2010
USA
Since globalisation began in earnest in the 1990s, OECD economies have,despite government stimulus policies, been unable to sustain rates of job growth:
Source: OECD
Total employment (1983=100)
100
110
120
130
140
150
160
1983 1986 1989 1992 1995 1998 2001 2004 2007 2010
Europe
A jobs drain continues
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-0.5
0
0.5
1
1.5
2
2.5
3
3.5
40s 50s 60s 70s 80s 90s 00s
Compound annual jobsgrowth by decade (%)
The last decade was the first decade since theGreat Depression to see no net job creation in the US:
2000s, -1.1%
10
1990s, 19.8%1980s, 20.2%
1950s, 24.7%
1970s, 27.6%
1960s, 31.1%
1940s, 37.7%
2 3 41 5 6-5
0
20
25
30
35
40
45
15
Year in decade
%c
hangeinnon-farmpayrollemployment(%)
US job growth by decade, 1940s 2000s
10
5
0
7 8 9
A jobs drain continues
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Wages have increased for those with the most education,while falling for those with the least:
High school dropout
High school graduate
Some college
College graduate
Graduate school
Source: Acemoglu and Autor (MIT), Skills, Tasks and Technologies: Implications for Employment and Earnings (2010).
Changes in wages for full-time, full-year male U.S. workers
1963-2008
A jobs drain continues
90
100
110
120
130
140
150
160
170
180
190
1963
1965
1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
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In 1955, the biggest company in the world by value was GM(revenues: $105bn).* Today it is Apple (revenues: $108bn).Employment patterns have, however, changed somewhat:
* At 2011 prices. At 1955 prices, revenues were $12.5bn.
0
100000
200000
300000
400000
500000
600000
700000
800000US employees Overseas employees Overseas contractors
A jobs drain continues
GM 1955 Apple 2012
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The US labour market is the most flexible in the world. Unlike in previousrecessions, it looks as if lots of these jobs are not coming back:
-7-6
-5
-4
-3
-2
-1
0
1
Number of years after peak employment
Percent job losses in US recessions
1974 1980 1981 1990 2001 2007
9 million jobs lost6 million jobs lost
1 2 3 4
A jobs drain continues
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Whole industries the ones the West was built on are disappearing to the East:
Source: World Steel Association.
0
100000
200000
300000
400000
500000
600000
700000
800000
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Crude steel production (megatons)
China USA Europe
A jobs drain continues
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Whole industries the ones the West was built on are disappearing to the East:
The commodity car industry is going the same way.
Luxury cars will take slightly longer:
0
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Car production
USA Japan Europe China
Source: International Organization of Motor Vehicle Manufacturers.
A jobs drain continues
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With each stage of advancement up the industrial ladder in the East, there is acorresponding jobs drain from the West:
Low education
Low capitalinvestment
Low know-how
Light manufacturing
Assembly
Medium andhigh capital
intensity
SteelAuto
Scientific andcreative
DesignKnow-how
Ecosystem growth
Professionalservices
Financialservices
LegalAccounting
Other highknow-how
High-tech IPEntrepreneurialism
Venture capital
Education
Innovation centres(universities)
Critical mass
ecosystems
Western hostilityto high earners
TimeWe are here
The industrial development cycle: from delivery to creation
Enablers ofadvancement:
Cash surplusesin developing
countries
A jobs drain continues
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The global wage disparity, potentiated by the global adoption of capitalism,is driving an unprecedented loss of wealth and growth for the Western economies.
Wage disparities
between OECDand emergingcountries result
in an almostinsuperablecompetitiveadvantage
for the East.
As a result, a jobdrain continuesand is indeedaccelerating.
The jobs drainedare not returning;rather, more will
be lost.
With no jobsupply, i.e. less
demand forlabour, wages inthe OECD mustinevitably fall.
A global wage disparity
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At the same time, our own competitive advantages are steadily crumbling:
Barriers that
could preventjob loss from
the West tothe East
Competitive wage rates Unfeasible
Existing physical and intellectualcapital base
Half-life is some10-15 years
Propensity to invest new capital
Encouragement of VCsand entrepreneurs
Existing IP
Ability to generate IP
The jobs are not returning
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China has been investing almost half its GDP, while the West barelyinvests a fifth:
0
10
20
30
40
50
60
1970 1975 1980 1985 1990 1995 2000 2005 2010
Gross capital formation (% of GDP)
China United Kingdom United States Source: World Bank
The jobs are not returning
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Just catching up?
Kings CrossHongqiao
Wuhan
The jobs are not returning
Liverpool St
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Barriers that
could preventjob loss from
the West tothe East
Competitive wage rates Unfeasible
Existing physical and intellectualcapital base
Half-life is some10-15 years
Propensity to invest new capital Vanishing
Encouragement of VCsand entrepreneurs
Existing IP
Ability to generate IP
The jobs are not returning
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Western attitudes to high earners contrasts with some other countries:
We need to get tough on irresponsibleand unjustified top remuneration
Nick Clegg, UK Deputy Prime Minister
To get rich is glorious
Deng Xiaoping, Former Leader of the Peoples Republic of China
zhf gungrng
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Barriers that
could preventjob loss from
the West tothe East
Competitive wage rates Unfeasible
Existing physical and intellectualcapital base
Half-life is some10-15 years
Propensity to invest new capital Vanishing
Encouragement of VCsand entrepreneurs
Western hostilityto high earners
Existing IP
Ability to generate IP
The jobs are not returning
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Source: Frontier Economics, Estimating the global economic and social impacts of counterfeiting and piracy(Feb 2011)
The West has been haemorrhaging intellectual property,with little sign of abatement:
Global value of counterfeit and pirated goods (2015): $1.5 trillionKnown jobs lost due to counterfeiting and piracy: 2.5 million.
The Chinese government has a national policy ofeconomicespionage in cyberspace Although a rigorous assessment hasnot been done, we think it is safe to say [this] easily means billionsof dollars and millions of jobs.
Source: Mike McConnell, Director of National Intelligence (2007-09), Michael Chertoff, Secretary of HomelandSecurity (2005-09), William Lynn, Deputy Secretary of Defense (2009-11), Wall Street Journal(Jan 27 2012)
The jobs are not returning
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Barriers that
could preventjob loss from
the West tothe East
Competitive wage rates Unfeasible
Existing physical and intellectualcapital base
Half-life is some10-15 years
Propensity to invest new capital Vanishing
Encouragement of VCsand entrepreneurs
Western hostilityto high earners
Existing IPCyber and
physical theft
Ability to generate IP
The jobs are not returning
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A fifth of Western school leavers are functionally illiterate:
0
5
10
15
20
25
30
Percentage of students who do not attain the essentialreading skills needed to participate productively in society
Source: OECD PISA 2009.
The jobs are not returning
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The Chinese take advantage of the best education in the West:
Number of Chinese students returning homeNumber of Chinese students studying abroad
0
20000
40000
60000
80000
100000
120000
140000
160000
1978
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007 0
5000
10000
1500020000
25000
30000
35000
40000
45000
50000
1978
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
1978 - 2007
Source: National Bureau of Statistics of China, 2009; Tina Hsieh and Ershad Ali, Auckland Institute of Studies.
When our thousands of Chinese students abroad return home, you willsee how China will transform itself.
Deng Xiaoping, Former Leader of the Peoples Republic of China
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And, indeed, they are innovating:
0
10,000
20,000
30,00040,000
50,000
60,000
70,000
80,000
90,000
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Patents granted to China
0
1
2
3
4
5
6
7
8
9
10
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Global percentage of patents granted toChina
Chinas universities graduate more than 10,000 science PhDs each year.
The jobs are not returning
Source: World Intellectual Property Organization, McKinsey Quarterly.
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Barriers that
could preventjob loss fromthe West to
the East
Competitive wage rates Unfeasible
Existing physical and intellectualcapital base
Half-life is some10-15 years
Propensity to invest new capital Vanishing
Encouragement of VCsand entrepreneurs
Western hostilityto high earners
Existing IPCyber and
physical theft
Ability to generate IPCollapsing
education set-up
The jobs are not returning
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The global wage disparity, potentiated by the global adoption of capitalism,is driving an unprecedented loss of wealth and growth for the Western economies.
Wage disparities
between OECDand emergingcountries result
in an almostinsuperablecompetitiveadvantage
for the East.
As a result, a jobdrain continuesand is indeedaccelerating.
The jobs drainedare not returning;rather, more will
be lost.
With no jobsupply, i.e. less
demand forlabour, wages inthe OECD mustinevitably fall.
A global wage disparity
A global wage disparity
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In the West, average wages have plummeted- from 3% real annual increases to 3% real annual declines:
-4
-3
-2
-1
0
1
2
3
41995-2000 2001-07 2008-10 2011
Average annual growth rates of real average wages
United States United Kingdom Source: OECD; 2011: BLS and ONS.
OECD wages must fall
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Precisely as one would expect, it is the low- and medium-skilled workers whoare losing out, while the most skilled retain their comparative advantage:
Note that inflation in the UK has been 5%, so wages are in fact plummeting.
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
10 20 30 40 50 60 70 80 90
2010
-1.5
-1
-0.5
0
0.5
1
1.5
2
2.5
10 20 30 40 50 60 70 80 90
2011
Annual percentage change in nominal weekly pay in UK by pay percentile
Source: Annual Survey of Hours and Earnings (2009, 2010, 2011) UK Office for National Statistics.
OECD wages must fall
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We have every reason to think the trend will continue, leading to enormousdownward adjustment, disruption and dislocation for Western workers:
Equilibrium
price 2025*
$20
$2-12China/Indiadaily wage
OECDdaily wage
2020?2010
??
Beyond
that?
Inflation and currency collapse seem to be the most likely waysby which this process will be managed in the medium term
$135
$100
$60
* Assumes annual world GDP growth rate of 5%; constant prices.
OECD wages must fall
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The continued economic decline of the West
The challenge
Global wagedisparity
Ineffectualgovernments andcredulous voters
Entitled groupsPoor allocation of
tax monies
Potential actions Likely outcomes
Starting with theGreenspan Put (1987),
governments, corporatesand individuals have
sought to borrow to fundthe maintenance of anunmaintainable lifestyle.
This has been elevatedto a religion by the neo-
Keynesians.
Continued indefinitely,this will destroy our
economies.
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Since 1987, the response to any economic downturnhas been to flood the system with cheap money:
36
0
5
10
15
20
25
Fed Rate
Ineffectual governments
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Source: OECD.
-14
-12
-10
-8
-6
-4
-2
0
2
4
6
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Surpluses and deficits (% GDP)
Japan United Kingdom United States Euro area
For todays Keynesians, there seems never to be a good time to run a surplus:
Ineffectual governments
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Source: McKinsey Global Institute (MGI), "Debt and deleveraging: Uneven progress on the path to growth," January 2012.
The result of low interest rates (easy money) and government deficits isstaggering levels of debt:
The relationship between government debt and real GDP growth is weak for debt/GDPratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall byone percent, and average growth falls considerably more.
Reinhart and Rogoff, Growth in a Time of Debt,American Economic Review(May 2010)
0% 100% 200% 300% 400% 500% 600% 700%
Germany
ItalyUnited States
France
Greece
Spain
United Kingdom
Portugal
Japan
Ireland
Total debt in selected countries around the world as percent of GDP
Households
Nonfinancial business
Government
Financial Institutions
Ineffectual governments
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All are agreed: we should spend our way out of this.
Unfortunately, with savings going up to 5, 6, 7 percent, aggregatedemand is going to be weak. The only thing to fill it is government.
Joseph Stiglitz, Aug 4 2010
Standard macroeconomic analysis, applied in a standard way,says that aggressive tightening of fiscal policy, of the kindwe are seeing now, is inappropriate and unnecessary.Jonathan Portes, New Statesman Aug 24 2011
The idea, amazingly widely accepted, that the UKcannot borrow any more seems quite absurd.
Martin Wolf, Financial Times Nov 24 2011
Isn't the truth of the matter, Mr Alexander, that you are collaboratingin a doctrinaire Conservative experiment which is not working?Jeremy Paxman, NewsnightJan 25 2012
That which cannot go on foreverwon't.
Herb Stein's Law
Ineffectual governments
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Indebtedness becomes a vicious downward spiral, Keynes la grecque
Governmentdeficit
spending
Increase instock of
debt
Higher levelof interestpayments
Greaterfunding
need
Worsenedcredit rating
Higher rateof interest
Credit marketrebellion leads
to financialcrisis
Keynesianmonetary
tactics(e.g. QE)
temporarily
lower interestrates
Consumer borrowing
Corporate borrowing
Banking borrowing
Voila! Greece goes to Argentina
The doom loop accelerates
The pain of restructuring becomes increasingly
impossible with every iteration
Keynesian voices warn against any pullback inspending as per prior point
Judgment day can be put off by devices such as QE(lowering the rate of interest)
Deficits suddenly massive
Calamity exposes those without swimming costumes
Deficit spending distorts economy
Debt-to-GDP levels begin to rise,but below Reinhart/Rogoff levels
Spending proves sticky(civil servants, benefits culture, etc.)
Starts with normal counter-cyclical deficit spending
Borrowing masks the problem
Ineffectual governments
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Entitled groupsThe problems are exacerbated by the claims made on shrinkingWestern economies by an oddly disparate set of entitled groups:
The continued economic decline of the West
The challenge
Global wagedisparity
Ineffectualgovernments andcredulous voters
Entitled groupsPoor allocation of
tax monies
Potential actions Likely outcomes
Bankers CEOs Public sector Benefit claimants
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The problems are exacerbated by the claims made on shrinking Westerneconomies by an oddly disparate set of entitled groups:
Cheap funding from government stimulus
Oligopoly in many markets (corporate lending, mortgages, credit cards)
Foolish acceptance of high prices by customers where oligopoly does not exist
Excessive leverage
Inside trading knowledge
Willingness of boards and shareholders to countenance excessive rewards, in particular,because the previous points create excessive profits
Big bet culture
Bankers sources of excess profits(that also lead to massive socialised losses)
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The financial sector has claimed a growing share of Western economies:
Financial sector compensation and profits as share of GDP1929 - 2010
Source: Bureau of Economic Analysis (BEA) data on National Income and Product Accounts (NIPA), tables 1.1.5 and 1.1.4.
0
5
6
7
8
4
3
2
3.7%
6.9%
3.8%
7.6%
$547 billion in 2010dollars
1
ShareofoverallGDP(%)
Bankers
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Source: Philippon and Reshef, Wages and Human Capital in the U.S. Financial Industry: 1909-2006(2008).
Historical excess wage in the financial sectorrelative to nonfarm private sector, accounting for
education level, skill premium and unemployment risk
1920 1930
0%
1910
30%
40%
20%
10%
1940 1950 1960 1970 1980 1990 2000 2010
The excess profits in turn lead to excessive remuneration:
Bankers
1933 Glass-Steagall Act1933 Securities Act1934 Securities Exchange Act
1939 Trust Indenture Act1940 Investment Advisers Act
1940 Investment Company Act1956 Banking Holding Company Act
2002 Sarbanes-Oxley Act
1980-84 Removed interest-rate ceilings(from Glass-Steagall Act)1994 Riegle-Neal Interstate Banking &branching efficiency act (repeals parts ofBank Holding Co. Act)1996 Investment Advisers Act amended1999 Graham-Leach-Bliley Act (repealedGlass-Steagall & parts of Bank Holding
Co. Act)
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Entitled groupsThe problems are exacerbated by the claims made on shrinkingWestern economies by an oddly disparate set of entitled groups:
The continued economic decline of the West
The challenge
Global wagedisparity
Ineffectualgovernments andcredulous voters
Entitled groupsPoor allocation of
tax monies
Potential actions Likely outcomes
Bankers CEOs Public sector Benefit claimants
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CEOs in the US and the UK have also captured theircompanies remuneration processes:
Source: Adapted from Lawrence Mishel and Josh Bivens, Economic Policy Institute Briefing Paper #331 (2011).
0
50
100
150
200
250
300
350
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
24-to-1 35-to-1
126-to-1
100-to-1
299-to-1
185-to-1
277-to-1
243-to-1
Ratio of average annual CEO compensation to average worker compensation, 1965-2010
Rectifying this would be important to ensure a cohesive society,but the impact will be limited (too few CEOs).
CEOs
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Entitled groupsThe problems are exacerbated by the claims made on shrinkingWestern economies by an oddly disparate set of entitled groups:
The continued economic decline of the West
The challenge
Global wagedisparity
Ineffectualgovernments andcredulous voters
Entitled groupsPoor allocation of
tax monies
Potential actions Likely outcomes
Bankers CEOs Public sector Benefit claimants
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With the exception of the highest skilled,public sector workers are significantly overpaid:
Source: ONS, Estimating differences in public and private sector pay (July 2011);CBO, Comparing the compensation of federal and private-sector employees (Jan 2012).
NB: UK analysis excludes pension contributions, so greatlyunderstates the already large pay gap (private sector companies mostly
no longer have DB schemes).
The governmentsown conclusion:
Allowing for [job]differences as far as
possible, in April
2010, public sectoremployees were paid
on average 7.8 percent more than
private sectoremployees.
Source: ONS.
-8
-6
-4
-20
2
4
6
8
No qual. Otherqual.
GCSEA-C
A-Level Higher ed. Degree
Average public/private sector pay gap by qualification
% Pay gap (public minus private sector)
Public sector
-30
-20
-10
0
10
20
30
40
High SchoolDiploma
Somecollege
Bachelor'sdegree
Master'sdegree
Prof. degreeor PhD
UK(excluding pensions)
US(including pensions)
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Public sector workers are also getting less productive, while the privatesector company necessarily finds improvements, or closes down. Thus thepublic sector is becoming a heavier and heavier drag on the public purse:
Source: ONS, Estimating differences in public and private sector pay(July 2011).
90
95
100
105
110
115
120
125
130
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Annual growth in productivity in the UK
(1997 = 100)Private Sector Public Sector
Public sector
E titl d
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Entitled groupsThe problems are exacerbated by the claims made on shrinkingWestern economies by an oddly disparate set of entitled groups:
The continued economic decline of the West
The challenge
Global wagedisparity
Ineffectualgovernments andcredulous voters
Entitled groupsPoor allocation of
tax monies
Potential actions Likely outcomes
Bankers CEOs Public sector Benefit claimants
B fit l i t
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Real spending on welfare continues to outstrip GDP growth:
0
200
400
600
800
1000
1200
Social Security GDP
CAG: 3.87%
CAG: 2.39%
Source: HMT, IFS
Growth rates in GDP and welfare spending
Benefit claimants
U d Bl i d B di b fit h ld h B fit l i t
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Under Blair and Brown, spending on benefits should havefallen as the economy boomed. It didnt becoming aredistribution rather than a safety net.
Source: HMT, IFS.
UK welfare spending and unemployment 1974 - 2011
0.0
2.0
4.0
6.0
8.0
10.0
12.0
5.5
6.5
7.5
8.5
9.5
10.5
11.5
12.5
13.5
14.5
Benefit claimants
Welfare spending(% GDP, LHS)
Unemployment rate(%, RHS)
Benefit claimants
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0
500
1000
1500
2000
2500
3000
Job Seeker ESA andincapacitybenefits
Lone Parent Carer Others onincome related
benefit
Disabled Bereaved
Caseload (1,000s) of working age clients by type of claim and duration(May 2011)
Up to 3 months 3-6 months 6-12 months 1-2 years 2-5 years 5 years and over
The system really has broken:
Source: DWP.
Benefit claimants
Th t i b t d b th l t f Benefit claimants
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The cost is exacerbated by the large amount ofmoney spent on those not in need, as the state seeksto develop a dependency mentality in its clients:
0
10
20
30
40
50
60
70
80
90
Maternity pay Child benefit Disability livingallowance
Retirementpension
Housing benefit Student support
Percentage of benefit expenditure going to middle class households
1998-99 2008-09 Source: Reform, The money-go-round(Oct 2010).
Benefit claimants
With universal suffrage, it becomes impossiblyexpensive to bribe allof the electorate.
Benefit claimants
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0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
HMRC Department
for Workand
Pensions
Home
Office
Department
forEducation
Department
of Health
DEFRA Department
forTransport
HM
Treasury
DECC
Employees by Government Department (2011)
Source: ONS, DWP.
Managing the welfare state is, in itself, a very expensive operation:
Stopclimatechange
Managethe
economy
Give it back toyou
Take yourmoney
DWP salaries in 2011: 3.5bn
Benefit claimants
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The continued economic decline of the West
The challenge
Global wagedisparity
Ineffectualgovernments andcredulous voters
Entitled groupsPoor allocation of
tax monies
Potential actions Likely outcomes
Poor allocation
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Source: ONS. Compound annual growth calculated from crossover point (1993).
Since 1992, spending on health has ballooned (mostly on salaries),while growth in education spending has fallen behind:
0.0
20.0
40.0
60.0
80.0
100.0
120.0
140.0
1953-54 1958-59 1963-64 1968-69 1973-74 1978-79 1983-84 1988-89 1993-94 1998-99 2003-04 2008-09
UK public spending (real bn) NHS Education
CAG: 4.89%
CAG: 3.14%
Poor allocation
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The continued economic decline of the West
The challenge Potential actions Likely outcomes
Reform thebanks
Tax properlyDevelop newtechnologies
Reorientgovernment
spending
Acceptimmediate cuts
in livingstandards
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Potential actions
Reorientgovernment
spending
Education
Infrastructure
Tax properlyDevelop newtechnologies
Acceptimmediate cuts
in livingstandards
Reform thebanks
Reallocating public spending towards infrastructure and Reorient spending
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Reallocating public spending towards infrastructure andeducation has a large and highly statistically significanteffect on the long-run growth rate.
-0.06
-0.04
-0.02
0
0.020.04
0.06
0.08
0.1
0.12
0.14
Transp &Comms
Education Health Defence Econservices
Housing Gen. pub.services
Welfare
Effect of public spending mix on the long-run growth rate
Source: Gemmell, N., Kneller, R. and I. Sanz, The Composition of Government Expenditure andEconomic Growth: Some Evidence from OECD Countries, European Economy(2008).
Education andinfrastructure the key
Reorient spending
Reorient spending
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The importance the West assigns to good teachers has plummeted:
0
10
20
30
40
50
60
70
80
90
100
1930 2012
Percentage of new American teachers who graduatedin the upper third of their classes
Source: McKinsey & Company, Closing the talent gap (2010); Milken Institute.
Reorient spending
Reorient spending
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Korea
Finland
Japan
Australia
NetherlandsBelgium
NorwayEstonia
PolandIceland
United States
R = 0.61227
495
500
505
510
515
520
525
530
535
540
545
0 0.5 1 1.5 2 2.5
Meanrea
dingscores
Ratio of teacher salaries to GDP per capita
The strongest performers among high-income countries tendto invest more in teachers:
OECD analysis
In general, thecountries that performwell in PISA attract thebest students into the
teaching profession byoffering them higher
salaries and greaterprofessional status.
High-performingcountries tend to
prioritise investment inteachers over smaller
classes.Source:
OECD Does Money BuyStrong Performance in PISA?
Reorient spending
Reorient spending
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Quality of teaching matters above all:
Source: Raj Chetty (Harvard), John N. Friedman (HKS), and Jonah E. Rockoff (Columbia), The Long-Term Impacts ofTeachers: Teacher Value-Added and Student Outcomes in Adulthood, NBER Working Paper No. 17699 (Jan 2012).
Impact on student lifetime incomes by class size and teacher effectiveness
(compared to average teacher)
Class size
Impactonstudentlif
etimeearnings
$1,000,000
$500,000
-$500,000
-$1,000,000
$0
90th percentile teacher
75th percentile teacher
60th
percentile teacher
40th percentile teacher
25th percentile teacher
10th percentile teacher
p g
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Quality of teaching matters above all:
A teacherone standard deviation above the meaneffectiveness annually generates marginal gains ofover $400,000 in present value of student futureearnings with a class size of 20 and proportionately
higher with larger class sizes. Alternatively, replacing thebottom 5-8 percent of teachers with average teacherscould move the U.S. near the top of international mathand science rankings with a present value of $100trillion.
Source: Eric A. Hanushek (Stanford), The Economic Value of Higher Teacher Quality,NBER Working Paper No. 16606 (Dec 2010).
p g
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Quality of teaching matters above all:
Replacing a teacher whose value added is in the bottom5% with an average teacher would increase the present
value of students lifetime income by more than $250,000for the average classroom.
Source: Raj Chetty (Harvard), John N. Friedman (HKS), and Jonah E. Rockoff(Columbia), The Long-Term Impacts of Teachers: Teacher Value-Added and StudentOutcomes in Adulthood, NBER Working Paper No. 17699 (Jan 2012).
p g
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Quality of teaching matters above all:
With an annual discount rate of 5%, the parents of aclassroom of average size should be willing to poolresources and pay an 84th percentile teacher consideringquitting approximately $130,000 ($4,600 per parent) tostay and teach their children during the next school year.
Source: Raj Chetty (Harvard), John N. Friedman (HKS), and Jonah E. Rockoff(Columbia), The Long-Term Impacts of Teachers: Teacher Value-Added and StudentOutcomes in Adulthood, NBER Working Paper No. 17699 (Jan 2012).
p g
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Potential actions
Reorientgovernment
spending
Education
Infrastructure
Tax properlyDevelop newtechnologies
Acceptimmediate cuts
in livingstandards
Reform thebanks
Reorient spending
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Opportunities for high-return infrastructure investment abound:
A B C D
nil nil Solid waste (+)BridgesPublic parks and
recreation (-)Rail (-)
Energy (+)AviationDams
Hazardous wasteSchoolsTransitDrinking water (-)Inland waterways (-)Levees (-)Roads (-)Wastewater (-)
Exemplary infrastructure needs in the UK
Wolfsons Brain Belt Oxford-Cambridge motorway/scienceecosystem
Other university/science/business ecosystem infrastructure
Manchester-Sheffield motorway
Other removal of congestion through building newroads and improving efficiency of existing roads
Local bypasses
Boris Island
Universal WiMAX or fibre broadband
Infrastructure needs in the US
Source: American Society of Civil Engineers.
US infrastructure GPA
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Potential actions
Reorientgovernment
spendingTax properly
Develop newtechnologies
Acceptimmediate cuts
in livingstandards
Reform thebanks
Th lti l i hi h b k k fitReform the banks
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Make them pay forthat through tax,
levies, ringfencingbonuses
Split commercialfrom trading; dont
subsidise trading/investment banking
The multiple ways in which banks make excess profits,and how that might be reversed:
* Traditional high beta in trading business.
Possible progress
Only slow progress
Essentially no progress
Cheap funding from
governmentstimulus
Oligopoly in manymarkets (corporate
lending, mortgages,credit cards)
Break them up
Foolish acceptanceof high prices andrisk by customers
even whereoligopoly does
not exist
Get customers tobehave better and
think harder
(for retail) Educatethe populace and
force far more, andbetter disclosure
Excessive leverage*
Require morecapital
Ban abuse ofderivatives: better
regulation
Preventconcealment of
true size of assets;punish auditors for
allowing OBSvehicles
Prevent otherarbitrage of capital
regulation
Pass duty of carelegislation
Manage ratingsagencies better
Manage regulatorsbetter
Manage auditorsbetter
Remove too big tofail
Excessive
remuneration
Pressure thebanks
Reform boardbehaviour
Pressureinvestinginstitutions
Inside trading
knowledge
Ban front running
Throttle or taxflash trading
Enforce insidertrading laws
Big bet culture
Require morecapital
Bettertransparency ondaily exposures
Remove profitelement ofsubsidies
Ban exploitativebehaviour
Eliminate politicallybiased decision
making
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Potential actions
Reorientgovernment
spendingTax properly
Develop newtechnologies
Acceptimmediate cuts
in livingstandards
Reform thebanks
Tax properly
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Taxes affect the determinants of growth:
GDP per capita
Labour utilisation
Employment Hours worked
Labour productivity
Physical capital Human capital Total factor productivity
Taxes
ConsumptionProperty
Income Corporate
Tax properly
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A significant reorientation of tax policy to less populist methods is needed:
* Note that punitive taxes on the richest dont help much as the base is always relatively small.
-2.5
-2
-1.5
-1
-0.5
0
0.5
1
1.5
2Corporate income taxes Personal income taxes Consumption taxes Property taxes
Effects of the tax mix on long-run GDP per capita
Source: OECD
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Potential actions
Reorientgovernment
spendingTax properly
Develop newtechnologies
Acceptimmediate cuts
in livingstandards
Reform thebanks
Support manufacturingHelp industry ecosystems
to flourishEncourage development
of new technologies
Consensus states that manufacturing is no moreManufacturing
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Obamas surrender to the manufacturingfetish is a disaster.
Jagdish Bhagwati, Professor of Economics, Columbia University
Financial Times, 6 Feb 2012
Consensus states that manufacturing is no moreimportant than any other sector of the economy:
A persuasive case for a manufacturingpolicy remains to be made.
Christina D. Romer, Professor of Economics, UC BerkeleyNew York Times, 5 Feb 2012
Manufacturing
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But in fact, manufacturing is crucial to economic growth:
Economies of scalemore likely to be
realised
Substantial anddisproportionate role in
innovation
Primary source ofmiddle-class jobs
(especially for workerswithout a college
degree - 75% of UKworkforce)
Its also vital that we rebalance growth away from consumptionandimports financed by foreign borrowing towardexports.
Manufacturing
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The proof: employment multipliers
Every job in manufacturingsupports 2.91 jobs elsewhere in the economy, compared toonly 1.54 in business services and 0.88 in retail trade: Supplier effects (e.g. car plantsustains jobs in steel industry); Respending effects (where workers spend theirpaycheques); Government effects (taxes that support jobs in government).
Almost every industry within manufacturing supports much more secondaryemployment than other sectors.Source: Economic Policy Institute, Updated Employment Multipliers for the U.S. Economy(2003).
0123456
7Manufacturing
Services
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Potential actions
Reorientgovernment
spendingTax properly
Develop newtechnologies
Acceptimmediate cuts
in livingstandards
Reform thebanks
Support manufacturingHelp industry ecosystems
to flourishEncourage development
of new technologies
Policies need developing to support existing ecosystems and develop newEcosystems
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Policies need developing to support existing ecosystems, and develop newones:
Local micro-industry ecosystemsdrive innovation:
Londons Square Mile: bankers,lawyers, accountants.
Birminghams F1 ecosystem: ahuge driver of innovation andeconomic success.
China found concentration keyfor e.g. semiconductorsuccess.
Agglomeration economies
Source: Reserve Bank of Philadelphia Working Paper No. 11-42, 'The Agglomeration of R&D Labs.
30
25
20
15
10
5
0
9080706050403020100 100Radial distance
z-score
Physicalencounters best
at mile
Skills pool peaksat c. 40 miles
35
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Potential actions
Reorientgovernment
spendingTax properly
Develop newtechnologies
Acceptimmediate cuts
in livingstandards
Reform thebanks
Support manufacturingHelp industry ecosystems
to flourishEncourage development
of new technologies
New technologies
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Technology holds the promise of massive, early breakthroughs:
Source: Adapted from Raymond Kurzweil, The Singularity Is Near: When Humans Transcend Biology.
The
Kurzweil
prediction
The accelerating pace of change
1900 1920 1940 1960 1980 2000 2020 2045
2015: Computer that surpassesbrainpower of mouse
2023: Computer that surpassesbrainpower of human
2045: Computer that surpassesbrainpower equivalent to that of all
human brains combined
Technology is subsidised by every government In EuropeNew technologies
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Neuroceuticals Genetic
engineering
Thin films Fine particles Chemical
synthesisAdvanced
microlithography
Networking Telecommunic-
ations
Humanoidrobotics
Humanoidcomputation
Human cognition Human emotion
Bio Nano Info Neuro/Cogno Anti-carbo
Energy storage Electric cars Battery tech Renewables
Technology is subsidised by every government. In Europeand the UK, the process seems to be ineffective and insufficient:
State Capitalism is on the march, overflowing with cash and emboldenedby the crisis in the West. The Economist, January 21st 2012
Ourindustrial policy was meant to be the government picking winners. Instead,the losers picked government. Peter Mandelson, Today, January 26th 2012
Today, a car emits less pollution traveling at full speed than a parked car didin 1970 from leaks. Matt Ridley, The Rational Optimist
A 20-50 year view and a cross-party consensus that thisNew technologies
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A 20 50 year view, and a cross party consensus that thisis needed, is essential:
Selectedtechnologies
Innovationcentres(universities)
R&D support
Ecosystemsupport
Manufacturingpolicy
An integrated industrial policy
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Potential actions
Reorientgovernment
spendingTax properly
Develop newtechnologies
Acceptimmediate cuts
in livingstandards
Reform thebanks
A t l li i t d d
Living standards
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Accept lower living standards:
The bureaucrats own
conclusion
The relentlessincrease in the
sustainability gapssuggests the
urgency inconsidering in
earnest profoundreforms in social
protection systems.
Source:
European Commission,Sustainability Report 2009
Reductions in primary spending or increases in revenues in variousyears needed to close the 25-year fiscal gap in the US
(% GDP)
Increase theretirement
age
Lowerentitlements
Lowerwages
Actimmediately
4.95.9
8.1
12.5
0
2
4
6
8
10
12
14
Actions begin in 2012 Actions begin in 2015 Actions begin in 2020 Actions begin in 2025
Source: Congressional Budget Office.
Potential actions
A decline in living standards of between 10 and 15% is needed tob l W t i t d T ' ti d j b l
Living standards
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Germany
Portugal
Italy
France
UK
Ireland
USJapan
Greece
-15
-10
-5
0
5
10
15
0 25 50 75 100 125 150
Netborrowing(%dis
posableincome)2008*
Household debt (% GDP) 2011
Households
rebalance Western economies today. Tomorrow's continued job lossand wage pressure will mean more of that pain in the future
Size of bubble, non-proportional but directionally correct, represents (L) overall size of government expenditure 2011 (% GDP);(R) household final consumption expenditure 2010 (% GDP). Source: IMF, OECD, MGI, World Bank. * Greece 2006, Japan 2007 (latest available).
Reinhart-Rogoff threshold
Germany
PortugalItalyFrance
UK
Ireland
US
Japan
Greece
0
2
4
6
8
10
12
14
16
18
20
0 30 60 90 120 150 180 210 240 270D
eficit(%expenditure)
2000-10(weightedavg
)
Debt (% GDP) 2011
Governments
ill d hi h ll
Living standards
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0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
5
1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050
Workers per retiree
US
Japan
UK
as will demographic challenges.
Source: UN Population Projections.
In the short term America is better positioned to recover:
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In the short term, America is better positioned to recover:
America has successfully kicked the candown the road:
It has the firepower
It is more resilient
Much less is nationalised
The nationalisations are less political
Debt restructuring (reduction) hasbeen far more responsive and swift
Much smaller government so lessimpact
Europe (incl. the UK) has not:
Less firepower
Deeper and different problems
More public ownership
Germany unwilling to socialise the problem
Less ability to restructure
Less determination to restructure*
* Automatic stabilisers = big unrestructured government that continues to batten on the corpse.
The biggest challenge to transcend wanting and acquiring:
Living standards
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The biggest challenge to transcend wanting and acquiring:
Economic growth and thefuture of the West:happiness studies
Neuroscience
shows thatwanting, strivingand acquiringare major andfundamental
drivers ofhuman
behaviour.
An equilibrated
world wouldhave fewWestern
necessities (cars, flat screens,etc.) per capita
[at currentprices]
Continuedgrowth means
further strain onglobal
resources.
Can insightsfrom
neuroscience,coupled witheducation,reengineer
humanbehaviour
towards less
consumption?
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The continued economic decline of the West
The Challenge Potential actions Likely outcomes
Short term
Long term
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The continued economic decline of the West
Potential actions Likely outcomes
Reorient governmentspending
Not happening
Curb the banks 50/50
Tax properly Little sign
Accept immediate cutsin living standards
10% - mob resistancemore likely
Educate betterPromising signs (but only in
some countries, e.g. UK)
How it looks now
No sign in most countriesof electability of Grinches
50/50
Worsening:soak the rich
Cuts will happen only throughinflation, currency depreciation
Privatisation of education?
How it may be (10-30+ year view)
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The pressing short-term issue is whetherthe neo-Keynesian disaster can be
avoided. Probably not
Broad money fallingQE: What they understood HMT indemnifies Asset
P h F iliAlternative
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Broad money falling
Severe risk of deflation
Money multipliersuspended
Money multiplierrestored
BoE buys gilts off privatebondholders
BoE credits theirreserves
Commercial banks lendout a little of the money
Broad money soars
Mild inflation
Growthrebounds
Accelerating inflation
1. BoE raisesinterest rates
BoE owns325bn gilts
Gilts plunge invalue
BoE tightensmonetary policy
2. BoEreverses QE
Assets Liabilities
BoE credits325bn
to commercial
bank reserves
HMT still onhook for 325bn
Purchase Facility
Auctions gilts,
gets ?175bn
Gilt yields soarto e.g. 8%
Broad money
still bloated
3. Even higher
interest rates
and what they
(apparently)
didnt.
Growth does not rebound
BoE doesnot tightenmonetary
policy
Hyperinflation
Deflation
Deflation-drivenrecession
Households
default
Wage risesnot enoughto service
debts
Householddebt
accelerates
rapidly
Households default
Eurozone Armageddon?
Inflation-driven recession, Taxpayer loses 150bn
In addition, government debt overhang permanently limits growth
scenario
Capital flight fromWestern governmentbonds and currencies
In summary: things dont look great
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In summary: things don t look great.
Were teetering on a balance between:
V.
Wilful disregard
Recession
Deflation
Acceptance
Growth
Inflation
Long-termcatastrophe
Short-term pain
In the short term, the outcomes are unknowable. For the long term, asthings stand, the continued economic decline of the West is highly predictable.
* **
**
Further reading
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Further reading
The Modern Industrial Revolution,Exit, and the Failure of InternalControl Systems, PresidentialAddress to the American FinanceAssociation, originally published inthe Journal of Finance (July, 1993)pp. 831-880 Michael C. Jensen
Lost Victory Correlli Barnett This Time is Different Carmen
Reinhart, Ken Rogoff
Once in Golconda John Brooks
The Big Short Michael Lewis World on Fire Amy Chua Shall the Religious Inherit the Earth?:
Demography and Politics in the
Twenty-First Century Eric Kaufmann
The Rational Optimist Matt Ridley Stumbling on Happiness Daniel
Gilbert
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