the continued economic decline of the west.pdf

7/31/2019 The continued economic decline of the West.pdf

1/95

The continued economic

decline of the WestDiagnosis and prognosisJon Moynihan

23 February 2012


2/95

PA Knowledge Limited 2012 Page 2

The continued economic decline of the West

The challenge Potential actions Likely outcomes


3/95


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


4/95


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.


5/95


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:


6/95



The challenge

Global wagedisparity

Ineffectualgovernments andcredulous voters

Entitled groupsPoor allocation of

tax monies

Potential actions Likely outcomes


7/95


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.


8/95


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?



9/95



Wage disparities

between OECDand emerging

countries resultin an almostinsuperablecompetitiveadvantage

for the East.



be lost.





10/95


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


11/95


-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



12/95


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

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

2007


13/95


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


GM 1955 Apple 2012


14/95


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



15/95


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



16/95


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.



17/95


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



18/95



Wage disparities

between OECDand emergingcountries result

in an almostinsuperablecompetitiveadvantage

for the East.



be lost.





19/95


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


20/95


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



21/95


Just catching up?

Kings CrossHongqiao

Wuhan


Liverpool St


22/95


Barriers that


the West tothe East




Propensity to invest new capital Vanishing


Existing IP




23/95


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



24/95


Barriers that


the West tothe East







Existing IP




25/95


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)



26/95


Barriers that


the West tothe East







Existing IPCyber and

physical theft




27/95


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.



28/95


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



29/95


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.


Source: World Intellectual Property Organization, McKinsey Quarterly.


30/95


Barriers that

could preventjob loss fromthe West to

the East







Existing IPCyber and

physical theft

Ability to generate IPCollapsing

education set-up



31/95



Wage disparities

between OECDand emergingcountries result

in an almostinsuperablecompetitiveadvantage

for the East.



be lost.






32/95


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


33/95


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.



34/95


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.



35/95



The challenge




tax monies


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.


36/95


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


37/95


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:



38/95


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



39/95


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



40/95


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



41/95


Entitled groupsThe problems are exacerbated by the claims made on shrinkingWestern economies by an oddly disparate set of entitled groups:


The challenge




tax monies


Bankers CEOs Public sector Benefit claimants


42/95


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)


43/95


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


44/95


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)


45/95




The challenge




tax monies




46/95


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


47/95




The challenge




tax monies




48/95


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)


49/95


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


50/95




The challenge




tax monies



B fit l i t


51/95


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


52/95


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


53/95


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


54/95


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


55/95


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


56/95



The challenge




tax monies


Poor allocation


57/95


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


58/95



The challenge Potential actions Likely outcomes

Reform thebanks

Tax properlyDevelop newtechnologies

Reorientgovernment

spending

Acceptimmediate cuts

in livingstandards


59/95


Potential actions

Reorientgovernment

spending

Education

Infrastructure



in livingstandards

Reform thebanks

Reallocating public spending towards infrastructure and Reorient spending


60/95


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


61/95


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


62/95


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


63/95


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


60th

percentile teacher




p g

Reorient spending


64/95



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

Reorient spending


65/95



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

Reorient spending


66/95



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


67/95


Potential actions

Reorientgovernment

spending

Education

Infrastructure



in livingstandards

Reform thebanks

Reorient spending


68/95


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


69/95


Potential actions

Reorientgovernment

spendingTax properly

Develop newtechnologies


in livingstandards

Reform thebanks

Th lti l i hi h b k k fitReform the banks


70/95


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


71/95


Potential actions

Reorientgovernment




in livingstandards

Reform thebanks

Tax properly


72/95


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


73/95


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


74/95


Potential actions

Reorientgovernment




in livingstandards

Reform thebanks

Support manufacturingHelp industry ecosystems

to flourishEncourage development

of new technologies

Consensus states that manufacturing is no moreManufacturing


75/95


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


76/95


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


77/95


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


78/95


Potential actions

Reorientgovernment




in livingstandards

Reform thebanks



of new technologies

Policies need developing to support existing ecosystems and develop newEcosystems


79/95


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


80/95


Potential actions

Reorientgovernment




in livingstandards

Reform thebanks



of new technologies

New technologies


81/95


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


82/95


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


83/95


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


84/95


Potential actions

Reorientgovernment




in livingstandards

Reform thebanks

A t l li i t d d

Living standards


85/95


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


86/95


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


87/95


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:


88/95


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


89/95


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?


90/95



The Challenge Potential actions Likely outcomes

Short term

Long term


91/95




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)


92/95


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


93/95


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


94/95


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


95/95

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

the continued economic decline of the west.pdf

Documents