the continued economic decline of the west

The continued economic decline of the West Diagnosis and prognosis

Jon Moynihan 23 February 2012

© PA Knowledge Limited 2012

The continued economic decline of the West

The challenge Potential actions Likely outcomes


How has the West’s 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), %

70 100 130 160 190 220 250 280 310 340 370 400 430 460 490 520 550

1992

19

94

1996

19

98

2000

20

02

2004

20

06

2008

20

10

Real GDP per capita (1992 = 100)

China

India

United Kingdom

United States

Germany

Japan

Brazil


There are many competing explanations, some more persuasive than others:

20 30 40 10 50 60 0

0

1000

1500

2000

2500

3000

3500

500

% of men aged 25-34 living with parents

5Y C

DS

of fo

undi

ng E

uroz

one

coun

trie

s

R2 = 0.75282

5-Year CDS of Eurozone countries vs. percentage of men living with parents

Greece

Portugal

Italy Spain

Ireland

Austria Germany

Belgium France

Finland Netherlands

Source: EuroStat, Bloomberg, via Boaz Weinstein, Saba Capital.


The central dilemma facing ‘Western’ economies:

The paradigm for the 1900s

2%

3%

The paradigm for the 2000s

Negative

Negative

Average annual growth in

number of jobs:

Average annual growth in real

wages:



The challenge

Global wage disparity

Ineffectual governments and credulous voters

‘Entitled’ groups Poor allocation of tax monies

Potential actions Likely outcomes


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 OECD and emerging

countries result in an almost insuperable competitive advantage

for the ‘East’*.

As a result, a job drain continues and is indeed accelerating.

The jobs drained are not returning; rather, more will

be lost.

With no job supply, i.e. less

demand for labour, wages in the OECD must inevitably fall.

A global wage disparity…

* Includes Brazil etc.


This jobs drain is taking place, driven by the wage disparities that exist between West and East:

“Alarmist” worries about this were dismissed as overblown, even as many millions of 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 to urbanise (rural)2

Advanced Economies1

Developing Economies

(urban)2

1.1 billion

$12 (China, 2008)

$135 (OECD, 2010)

500 million Labour pool

Average daily wage

1.3 billion

$1-2?






for the ‘East’.



be lost.





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…


-0.5

0

0.5

1

1.5

2

2.5

3

3.5

40s 50s 60s 70s 80s 90s 00s

Compound annual jobs growth by decade (%)

The last decade was the first decade since the Great 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 4 1 5 6 -5

0

20

25

30

35

40 45

15

Year in decade

% c

hang

e in

non

-farm

pay

roll

empl

oym

ent (

%)

US job growth by decade, 1940s – 2000s

10

5

0

7 8 9



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


90

100

110

120

130

140

150

160

170

180

190

1963

19

65

1967

19

69

1971

19

73

1975

19

77

1979

19

81

1983

19

85

1987

19

89

1991

19

93

1995

19

97

1999

20

01

2003

20

05

2007


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

800000 US employees Overseas employees Overseas contractors


GM 1955 Apple 2012


The US labour market is the most flexible in the world. Unlike in previous recessions, 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 lost 6 million jobs lost

1 2 3 4



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



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.



With each stage of advancement up the industrial ladder in the East, there is a corresponding jobs drain from the West:

Low education Low capital investment

Low know-how Light manufacturing

Assembly

Medium and high capital

intensity Steel è Auto

Scientific and creative Design

Know-how Ecosystem growth

Professional services Financial services

Legal Accounting

Other high know-how High-tech IP

Entrepreneurialism Venture capital

Education

Innovation centres (universities)

Critical mass ecosystems

Western hostility to high earners

Time We are here

The industrial development cycle: from delivery to creation

Enablers of advancement:

Cash surpluses in developing

countries






for the ‘East’.



be lost.





At the same time, our own competitive advantages are steadily crumbling:

Barriers that could prevent job loss from the West to

the East

Competitive wage rates Unfeasible

Existing physical and intellectual capital base

Half-life is some 10-15 years

Propensity to invest new capital

Encouragement of VCs and entrepreneurs

Existing IP

Ability to generate IP

The jobs are not returning…


China has been investing almost half its GDP, while the West barely invests 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



“Just catching up”?

King’s Cross Hongqiao

Wuhan


Liverpool St



the East




Propensity to invest new capital Vanishing


Existing IP




Western attitudes to high earners contrasts with some other countries:

“We need to get tough on irresponsible and unjustified top remuneration”

Nick Clegg, UK Deputy Prime Minister

“To get rich is glorious”

Deng Xiaoping, Former Leader of the People’s Republic of China

致富光荣 zhìfù guāngróng




the East







Existing IP




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 trillion… Known jobs lost due to counterfeiting and piracy: 2.5 million.

“The Chinese government has a national policy of economic espionage in cyberspace… Although a rigorous assessment has not been done, we think it is safe to say [this] easily means billions of dollars and millions of jobs. ”

Source: Mike McConnell, Director of National Intelligence (2007-09), Michael Chertoff, Secretary of Homeland Security (2005-09), William Lynn, Deputy Secretary of Defense (2009-11), Wall Street Journal (Jan 27 2012)




the East







Existing IP Cyber and physical theft




A fifth of Western school leavers are functionally illiterate:

0

5

10

15

20

25

30

Percentage of students who do not attain the essential reading skills needed to participate productively in society

Source: OECD PISA 2009.



The Chinese take advantage of the best education in the West:

Number of Chinese students returning home Number of Chinese students studying abroad

0

20000

40000

60000

80000

100000

120000

140000

160000

1978

19

85

1987

19

89

1991

19

93

1995

19

97

1999

20

01

2003

20

05

2007

0 5000

10000 15000 20000 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 will see how China will transform itself.”

Deng Xiaoping, Former Leader of the People’s Republic of China



And, indeed, they are innovating:

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

1995

19

96

1997

19

98

1999

20

00

2001

20

02

2003

20

04

2005

20

06

2007

20

08

2009

20

10

Patents granted to China

0

1

2

3

4

5

6

7

8

9

10

1995

19

96

1997

19

98

1999

20

00

2001

20

02

2003

20

04

2005

20

06

2007

20

08

2009

20

10

Global percentage of patents granted to China

China’s universities graduate more than 10,000 science PhDs each year.


Source: World Intellectual Property Organization, McKinsey Quarterly.



the East







Existing IP Cyber and physical theft

Ability to generate IP Collapsing education set-up






for the ‘East’.



be lost.



A global wage disparity… A global wage disparity…


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

4 1995-2000 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…


Precisely as one would expect, it is the low- and medium-skilled workers who are 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.



We have every reason to think the trend will continue, leading to enormous downward adjustment, disruption and dislocation for Western workers:

Equilibrium price 2025*

$20

$2-12 China/India daily wage

OECD daily wage

2020? 2010

?

?

Beyond that?

Inflation and currency collapse seem to be the most likely ways by which this process will be managed in the medium term

$135 $100

$60

* Assumes annual world GDP growth rate of 5%; constant prices.




The challenge





Starting with the Greenspan Put (1987),

governments, corporates and individuals have

sought to borrow to fund the maintenance of an unmaintainable lifestyle.

This has been elevated to a religion by the neo-

Keynesians.

Continued indefinitely, this will destroy our

economies.


Since 1987, the response to any economic downturn has been to flood the system with cheap money:

36

0

5

10

15

20

25

Fed Rate

Ineffectual governments…


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 today’s Keynesians, there seems never to be a good time to run a surplus: Ineffectual governments…


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 is staggering levels of debt:

“The relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one 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 Italy

United 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



All are agreed: we should spend our way out of this.

“Unfortunately, with savings going up to 5, 6, 7 percent, aggregate demand 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 kind we are seeing now, is inappropriate and unnecessary.” Jonathan Portes, New Statesman Aug 24 2011

“The idea, amazingly widely accepted, that the UK cannot 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 collaborating in a doctrinaire Conservative experiment which is not working?” Jeremy Paxman, Newsnight Jan 25 2012

“That which cannot go on forever… won't.” Herb Stein's Law



Indebtedness becomes a vicious downward spiral, Keynes à la grecque

Government deficit

spending

Increase in stock of

debt

Higher level of interest payments

Greater funding

need

Worsened credit rating

Higher rate of interest

Credit market rebellion leads

to financial crisis

Keynesian monetary

tactics (e.g. QE)

temporarily lower interest

rates

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 in spending 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



‘Entitled’ groups… The problems are exacerbated by the claims made on shrinking Western economies by an oddly disparate set of ‘entitled’ groups:


The challenge





Bankers CEOs Public sector Benefit claimants


The problems are exacerbated by the claims made on shrinking Western economies 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)


The financial sector has claimed a growing share of Western economies:

Financial sector compensation and profits as share of GDP 1929 - 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 2010

dollars

1

Shar

e of

ove

rall

GD

P (%

)

Bankers…


Source: Philippon and Reshef, Wages and Human Capital in the U.S. Financial Industry: 1909-2006 (2008).

Historical excess wage in the financial sector relative 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 Act 1933 Securities Act 1934 Securities Exchange Act 1939 Trust Indenture Act 1940 Investment Advisers Act 1940 Investment Company Act 1956 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 of Bank Holding Co. Act) 1996 Investment Advisers Act amended 1999 Graham-Leach-Bliley Act (repealed Glass-Steagall & parts of Bank Holding Co. Act)




The challenge







CEOs in the US and the UK have also ‘captured’ their companies’ 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…




The challenge







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 greatly understates the already large pay gap (private sector companies mostly no longer have DB schemes).

The government’s own conclusion:

“Allowing for [job] differences as far as

possible, in April 2010, public sector

employees were paid on average 7.8 per

cent more than private sector employees.”

Source: ONS.

-8

-6

-4

-2

0

2

4

6

8

No qual. Other qual.

GCSE A-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 School Diploma

Some college

Bachelor's degree

Master's degree

Prof. degree or PhD

UK (excluding pensions)

US (including pensions)


Public sector workers are also getting less productive, while the private sector company necessarily finds improvements, or closes down. Thus the public 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…




The challenge







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…


Under Blair and Brown, spending on benefits should have fallen as the economy boomed. It didn’t – becoming a redistribution 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


Welfare spending (% GDP, LHS)

Unemployment rate (%, RHS)


0

500

1000

1500

2000

2500

3000

Job Seeker ESA and incapacity benefits

Lone Parent Carer Others on income 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.



The cost is exacerbated by the large amount of money spent on those not in need, as the state seeks to develop a dependency mentality in its clients:

0

10

20

30

40

50

60

70

80

90

Maternity pay Child benefit Disability living allowance

Retirement pension

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).


“With universal suffrage, it becomes impossibly expensive to bribe all of the electorate.”


0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

HMRC Department for Work

and Pensions

Home Office

Department for

Education

Department of Health

DEFRA Department for

Transport

HM Treasury

DECC

Employees by Government Department (2011)

Source: ONS, DWP.

Managing the welfare state is, in itself, a very expensive operation:

Stop climate change

Manage the

economy

Give it back to you

Take your money

DWP salaries in 2011: £3.5bn




The challenge






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…



The challenge Potential actions Likely outcomes

Reform the banks Tax properly Develop new

technologies Reorient

government spending

Accept immediate cuts

in living standards


Potential actions

Reorient government

spending

Education

Infrastructure

Tax properly Develop new technologies


in living standards

Reform the banks


Reallocating public spending towards infrastructure and education has a large and highly statistically significant effect on the long-run growth rate.

-0.06

-0.04

-0.02

0

0.02

0.04

0.06

0.08

0.1

0.12

0.14

Transp & Comms

Education Health Defence Econ services

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 and Economic Growth: Some Evidence from OECD Countries”, European Economy (2008).

Education and infrastructure the key

Reorient spending…


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 graduated in the upper third of their classes

Source: McKinsey & Company, “Closing the talent gap” (2010); Milken Institute.



Korea

Finland

Japan

Australia

Netherlands Belgium

Norway Estonia

Poland Iceland

United States

R² = 0.61227

495

500

505

510

515

520

525

530

535

540

545

0 0.5 1 1.5 2 2.5

Mea

n re

adin

g sc

ores

Ratio of teacher salaries to GDP per capita

The strongest performers among high-income countries tend to invest more in teachers:

OECD analysis “In general, the

countries that perform well in PISA attract the best students into the

teaching profession by offering them higher salaries and greater professional status.

High-performing countries tend to

prioritise investment in teachers over smaller

classes.” Source:

OECD Does Money Buy Strong Performance in PISA?



Quality of teaching matters above all:

Source: Raj Chetty (Harvard), John N. Friedman (HKS), and Jonah E. Rockoff (Columbia), The Long-Term Impacts of Teachers: 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

Impa

ct o

n st

uden

t life

time

earn

ings

$1,000,000

$500,000

-$500,000

-$1,000,000

$0

90th percentile teacher









A teacher one standard deviation above the mean effectiveness annually generates marginal gains of over $400,000 in present value of student future earnings with a class size of 20 and proportionately higher with larger class sizes. Alternatively, replacing the bottom 5-8 percent of teachers with average teachers could move the U.S. near the top of international math and science rankings with a present value of $100 trillion. Source: Eric A. Hanushek (Stanford), The Economic Value of Higher Teacher Quality, NBER Working Paper No. 16606 (Dec 2010).




Replacing a teacher whose value added is in the bottom 5% with an average teacher would increase the present value of students’ lifetime income by more than $250,000 for 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 Student Outcomes in Adulthood, NBER Working Paper No. 17699 (Jan 2012).




With an annual discount rate of 5%, the parents of a classroom of average size should be willing to pool resources and pay an 84th percentile teacher considering quitting approximately $130,000 ($4,600 per parent) to stay 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 Student Outcomes in Adulthood, NBER Working Paper No. 17699 (Jan 2012).



Potential actions

Reorient government

spending

Education

Infrastructure

Tax properly Develop new technologies


in living standards

Reform the banks


Opportunities for high-return infrastructure investment abound: Reorient spending…

A B C D nil nil Solid waste (+)

Bridges Public parks and recreation (-) Rail (-)

Energy (+) Aviation Dams Hazardous waste Schools Transit Drinking water (-) Inland waterways (-) Levees (-) Roads (-) Wastewater (-)

Exemplary infrastructure needs in the UK

Wolfson’s ‘Brain Belt’ Oxford-Cambridge motorway/science ecosystem

Other university/science/business ecosystem infrastructure

Manchester-Sheffield motorway

Other removal of congestion through building new roads 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’


Potential actions

Reorient government

spending Tax properly Develop new

technologies


in living standards

Reform the banks


Make them pay for that through tax,

levies, ringfencing bonuses

Split commercial from trading; don’t 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

Reform the banks…

Cheap funding from government

stimulus

Oligopoly in many markets (corporate lending, mortgages,

credit cards)

Break them up

Foolish acceptance of high prices and risk by customers

even where oligopoly does

not exist

Get customers to behave better and

think harder

(for retail) Educate the populace and

force far more, and better disclosure

Excessive leverage*

Require more capital

Ban abuse of derivatives: better

regulation

Prevent concealment of

true size of assets; punish auditors for

allowing OBS vehicles

Prevent other arbitrage of capital

regulation

Pass ‘duty of care’ legislation

Manage ratings agencies better

Manage regulators better

Manage auditors better

Remove too big to fail

Excessive remuneration

Pressure the banks

Reform board behaviour

Pressure investing institutions

Inside trading knowledge

Ban front running

Throttle or tax flash trading

Enforce insider trading laws

Big bet culture

Require more capital

Better transparency on daily exposures

Remove profit element of subsidies

Ban exploitative behaviour

Eliminate politically biased decision

making


Potential actions

Reorient government


technologies


in living standards

Reform the banks


Taxes affect the determinants of growth:

GDP per capita

Labour utilisation

•  Employment

•  Hours worked

Labour productivity

•  Physical capital

•  Human capital

•  Total factor productivity

Taxes •  Consumption

•  Property

•  Income

•  Corporate

Tax properly…


A significant reorientation of tax policy to less populist methods is needed:

* Note that punitive taxes on the richest don’t help much as the base is always relatively small.

-2.5

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2 Corporate income taxes Personal income taxes Consumption taxes Property taxes

Effects of the tax mix on long-run GDP per capita

Source: OECD

Tax properly…


Potential actions

Reorient government


technologies


in living standards

Reform the banks

Support manufacturing Help industry ecosystems to flourish

Encourage development of new technologies


“Obama’s surrender to the ‘manufacturing fetish’ is a disaster.”

Jagdish Bhagwati, Professor of Economics, Columbia University Financial Times, 6 Feb 2012

Consensus states that manufacturing is no more important than any other sector of the economy:

Manufacturing…

“A persuasive case for a manufacturing policy remains to be made.”

Christina D. Romer, Professor of Economics, UC Berkeley New York Times, 5 Feb 2012


But in fact, manufacturing is crucial to economic growth:

Economies of scale more likely to be

realised

Substantial and disproportionate role in

innovation

Primary source of middle-class jobs

(especially for workers without a college

degree - 75% of UK workforce)

Manufacturing…

It’s also vital that we rebalance growth away from consumption and imports financed by foreign borrowing toward exports.


The proof: employment multipliers

Every job in manufacturing supports 2.91 jobs elsewhere in the economy, compared to only 1.54 in business services and 0.88 in retail trade: Supplier effects (e.g. car plant sustains jobs in steel industry); Respending effects (where workers spend their paycheques); Government effects (taxes that support jobs in government).

“Almost every industry within manufacturing supports much more secondary employment than other sectors.” Source: Economic Policy Institute, Updated Employment Multipliers for the U.S. Economy (2003).

0 1 2 3 4 5 6 7

Manufacturing

Services

Manufacturing…


Potential actions

Reorient government


technologies


in living standards

Reform the banks




Policies need developing to support existing ecosystems, and develop new ones:

•  Local micro-industry ecosystems drive innovation:

–  London’s Square Mile: bankers, lawyers, accountants.

–  Birmingham’s F1 ecosystem: a huge ‘driver’ of innovation and economic success.

–  China found concentration key for e.g. semiconductor success.

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 90 80 70 60 50 40 30 20 10 0 100

Radial distance

z-sc

ore

Physical encounters best

at ¼ mile

Skills pool peaks at c. 40 miles

35

Ecosystems…


Potential actions

Reorient government


technologies


in living standards

Reform the banks




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

New technologies…

1900 1920 1940 1960 1980 2000 2020 2045

2015: Computer that surpasses brainpower of mouse

2023: Computer that surpasses brainpower of human

2045: Computer that surpasses brainpower equivalent to that of all

human brains combined


•  Neuroceuticals •  Genetic

engineering

•  Thin films •  Fine particles •  Chemical

synthesis •  Advanced

microlithography

•  Networking •  Telecommunic-

ations

•  Humanoid robotics

•  Humanoid computation

•  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 Europe and the UK, the process seems to be ineffective and insufficient:

“State Capitalism is on the march, overflowing with cash and emboldened by the crisis in the West.” The Economist, January 21st 2012

“Our industrial 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 did in 1970 from leaks.” Matt Ridley, The Rational Optimist

New technologies…


A 20-50 year view, and a cross-party consensus that this is needed, is essential:

Selected technologies

Innovation centres (universities)

R&D support

Ecosystem support

Manufacturing policy

An integrated industrial policy

New technologies…


Potential actions

Reorient government


technologies


in living standards

Reform the banks


Accept lower living standards:

The bureaucrats’ own conclusion

“The relentless increase in the

sustainability gaps suggests the

urgency in considering in

earnest profound reforms in social

protection systems.”

Source:

European Commission, Sustainability Report 2009

Reductions in primary spending or increases in revenues in various years needed to close the 25-year fiscal gap in the US

(% GDP)

Increase the retirement

age Lower

entitlements Lower wages

Act immediately

4.9 5.9

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

Living standards…


Germany

Portugal

Italy

France

UK

Ireland US

Japan

Greece

-15

-10

-5

0

5

10

15

0 25 50 75 100 125 150

Net

bor

row

ing

(% d

ispo

sabl

e in

com

e) 2

008*

Household debt (% GDP) 2011

Households

A decline in living standards of between 10 and 15% is needed to rebalance Western economies today. Tomorrow's continued job loss and 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

Living standards…

Germany

Portugal Italy France

UK Ireland

US

Japan

Greece

0

2

4

6

8

10

12

14

16

18

20

0 30 60 90 120 150 180 210 240 270 Def

icit

(% e

xpen

ditu

re) 2

000-

10 (w

eigh

ted

avg)

Debt (% GDP) 2011

Governments


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.

Living standards…


In the short term, America is better positioned to recover:

America has successfully kicked the can down the road:

It has the firepower

It is more resilient

Much less is nationalised

The nationalisations are less political

Debt restructuring (reduction) has been far more responsive and swift

Much smaller government so less impact

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:

Economic growth and the future of the West: ‘happiness’ studies

Neuroscience shows that

wanting, striving and acquiring are major and fundamental

drivers of human

behaviour.

An equilibrated world would

have few Western

‘necessities’ (cars, flat screens, etc.) per capita

[at current prices]

Continued growth means

further strain on global

resources.

Can insights from

neuroscience, coupled with education, reengineer

human behaviour

towards less consumption?

Living standards…



The Challenge Potential actions Likely outcomes

Short term

Long term




Reorient government spending Not happening

Curb the banks 50/50

Tax properly Little sign

Accept immediate cuts in living standards

10% - mob resistance more likely

Educate better Promising signs (but only in some countries, e.g. UK)

How it looks now

No sign in most countries of electability of Grinches

50/50

Worsening: ‘soak the rich’

Cuts will happen only through inflation, currency depreciation

Privatisation of education?

How it may be (10-30+ year view)


The pressing short-term issue is whether the neo-Keynesian disaster can be

avoided. Probably not…


Broad money falling

Severe risk of deflation

Money multiplier suspended

Money multiplier restored

QE: What they understood…

BoE buys gilts off private bondholders

BoE credits their reserves

Commercial banks lend out a little of the money

Broad money soars

Mild inflation

Growth rebounds Accelerating inflation

1. BoE raises interest rates

BoE owns £325bn gilts

Gilts plunge in value

BoE tightens monetary policy

2. BoE reverses QE

Assets Liabilities

BoE credits £325bn

to commercial bank reserves

HMT still on hook for £325bn

HMT indemnifies Asset Purchase Facility

Auctions gilts, gets ?£175bn

Gilt yields soar to e.g. 8%

Broad money still bloated

3. Even higher interest rates

…and what they (apparently)

didn’t.

Growth does not rebound

BoE does not tighten monetary

policy

Hyperinflation

Deflation

Deflation-driven recession

Households default

Wage rises not enough to service

debts

Household debt

accelerates rapidly

Households default

Eurozone Armageddon?

Inflation-driven recession, Taxpayer loses £150bn In addition, government debt overhang permanently limits growth

Alternative scenario

Capital flight from ‘Western’ government bonds and currencies


In summary: things don’t look great.

We’re teetering on a balance between:

V.

Wilful disregard

Recession

Deflation

Acceptance

Growth

Inflation

Long-term catastrophe Short-term pain

…In the short term, the outcomes are unknowable. For the long term, as things stand, the continued economic decline of the West is highly predictable.

* * * * *


Further reading

•  “The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems”, Presidential Address to the American Finance Association, originally published in the 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

the continued economic decline of the west

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