By Sell on News, a macro equities analyst. Cross posted from MacroBusiness
I have been reliably informed by Houses & Holes that we are “all going to die”, and rather sooner than we all imagined. Something to do with the economic meltdown in Europe and America, I believe. While I have no reason to doubt such potent insight — after all, death is the best one way bet available — I think it could do with a little refining. What is dying is the industrial era in the developed world, a trend that is obscured by the fact that the developing world is industrialising at an accelerating pace. Australia is caught in the middle. It provides the raw materials to rapidly industrialising nations, but is itself entering a post-industrial era. So the nation both is, and is not, in a mess, buffeted by contrary forces.
Over the last 15-20 years we have witnessed many symptoms of this death in developed nations. There was the death of Japanese mercantilism, which began on the dot of the 1990s and has worsened ever since. It is only because Japan is hermetically sealed, owes all its money to itself, that it has not spread further.
The dot.com boom, which was largely about monetising existing forms of commerce or creating transactions from what had previously been non-economic behaviour (social networking, for instance) rose and fell. Then we have had the mother of all death throes in the bizarre financialisation of Western economies, a debt driven exercise in making money out of air or algorithms. The latest iteration is high frequency trading, and, like derivatives such as CDOs and CDSs it, too, shall fail. To think it is alright to make finance into an infinite regress is so irresponsible it can only be because there are no other, normal ways of creating wealth. A death throe, in other words.
The same applies to Europe’s stagnation and hopelessly high unemployment. It is a society that has run out of ideas. Meanwhile, America seems to have only one idea: reward the fabulously wealthy at the expense of the middle class. In other words, fight over the deck chairs as the Titanic dies.
This is why “politics” is starting to assume centre stage in investment analysis. For some reason, governments, which have been demonised as useless for a quarter of a century, are now expected to fix things. They will not, because the problem is about a lack of creating the new, something governments have little or no influence over. About four fifths of so called “new products” are refinements of old products. Tyler Cowan is calling it the “great stagnation“. Yes, there is growth in areas like health care, but that hardly parallels the invention of the car, or fridges or any of the other big changes of the first half of the twentieth century. Most things that are new are just refinements – a mobile phone is just a phone made mobile, a microwave oven is just a quicker oven — or an enablement of something old: the digital revolution is mostly an enabler of existing, non digital forms of commerce or functions.
The most telling sign of death is the loss of a cost of capital in the developed world, which kills investment. American companies in particular are sitting on piles of cash, but they do not want to invest because they do not see the growth in developed markets (especially as the middle classes are being eviscerated). They can see hope in the emerging markets, but the middle classes are still emerging there.
It all adds up to gloom. Or does it? I do not believe so. Growth, it must be remembered, is transactions, not necessarily consumption of resources (something the Greens, with their Arcadian dreams do not understand). There is no doubt at all that what needs to be the defining characteristic of post-industrial society is a reduction of both the consumption of finite resources and a reduction of pollution. This can, and should, lead to initiatives as profound as the invention of the mass produced automobile or the aeroplane. Which in turn will lead to new growth.
There are many potential technologies; there is no lack of invention. But there is a lack of capital, because capital mostly prefers the industrial and the familiar. Capital is losing all those certainties. The catch is that the changes need to be system wide, and that is where governments will really matter. Given that governments have concentrated on getting elected by creating fear, shifting to showing vision will be an enormous challenge. But in the end, investing in the post-industrial world is the only way to go. As Michael Spence pointed out in the Financial Review this week, what is happening is the end of a cycle that is about a century old:
In the 100-year view of Nobel laureate economist Michael Spence, the current global economic woes are linked to the slow and painful adaptation of the developed world to the growing economic clout of China, India, Brazil and other developing economies.
Spence says it has not yet been fully recognised that the economic malaise is not just a cyclical downturn caused by excess debt, over-consumption, low interest rates and lax regulation, but part of a long-term structural change brought about by globalisation and technology, which are shifting the comparative advantage in a range of industries and services towards the developing world.
Europe, the US and other advanced economies must make long-term reforms to labour markets and boost productivity as well as encourage public and private sector investment in infrastructure, education, skills and training to remove growth constraints. Short-term fixes, such as Europe’s bailout packages and the US Federal Reserve’s promises of low interest rates for longer, can do little more than “kick the can down the road”, he says.
As chairman of the World Bank Commission on Growth and Development since 2006, Spence is uniquely informed on the subject of growth. In his new book The Next Convergence, he judges that it will take until mid-century for developing economies, which represent 60 per cent of the world’s population, to reach advanced status.
Further growth of developing economies could bring about more unemployment in developed economies unless they restructure, he says, citing Germany as a model between 2000 and 2005 when it loosened labour markets, committed to high-value manufacturing and accepted the trade-off between high income and employment. The weakness in global economic and political leadership in the developed world is “a real puzzle”.
In the US “people want things they aren’t prepared to pay for. There’s a fair amount of ideology – maybe people think those are real solutions when they are not”.
In contrast, Spence says, developing countries in general have “evolved a kind of pragmatic, persistent, problem-solving model. They’ve got some reasonable balance between government on the one hand and the private sector on the other”.
But, he says, we’ve entered a “high risk mode”. If the advanced countries can keep growing and avoid another recession, China and the developing world can keep expanding apace.
“But they can’t sustain enough demand to withstand a [US and European] downturn” he says. That would slow everyone, including China, Brazil, India and Australia.
Australia must remember “that natural resource wealth is volatile and impermanent”, Spence says. We should be investing “a fair amount” of the income from natural resources wealth abroad – thus mitigating the effects of the Dutch disease where a high exchange rate hollows out the rest of the economy.