The Money Runs Out…

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By Stephen D. King

I count myself as one of the last of the so-called baby boomer generation. We were the lucky ones. Over the years, we enjoyed extraordinary increases in living standards. Born in 1963, I am sadly a bit too young to have experienced at first hand The Beatles, Jimi Hendrix and the Summer of Love but, economically, my birth couldn’t have been better timed. In the first ten years of my life, per capita incomes in the United Kingdom – adjusted for inflationary distortions – rose around 37 per cent. By the time I reached my twenties, per capita incomes had risen a further 13 per cent. Over the following ten years, incomes went up another 29 per cent. And, as I settled down to celebrate my fortieth birthday, incomes had risen a further 36 per cent. All told, in the first four decades of my existence, per capita incomes in the UK almost tripled.

Now that I’m fifty, however, something seems to have gone horribly wrong. Over the last decade, per capita incomes in the UK have risen a mere 4 per cent. Other developed countries find themselves in more or less the same boat. Some, including the United States, have done a bit better. Others, notably those in southern Europe, have fared a lot worse. Most, however, have performed poorly relative to their own histories. The economic dynamism that provided the backdrop to my formative years has gone, replaced by what increasingly appears to be an enduring – and distinctly unappealing – era of stagnation. Even as China, India and other parts of the emerging world continue to press ahead, the West has lost its way: indeed, it is now in danger of entering its second ‘lost decade’. For my children – and for the children of millions of other baby boomers – it is hardly an encouraging picture.

This is no ordinary period of economic setback. The recessions of my childhood and my early adulthood were extraordinarily painful affairs both for nations as a whole and, on a personal level, for my own family: in Thatcherism’s darkest days, my father was unemployed for many months. Even during the deepest recessions, however, there was always the hope of subsequent recovery. Long- term economic growth was supposedly God-given. Recessions were merely annoying interruptions, blamed variously on policy-making incompetence, excessive union power, short-sighted financial institutions, lazy managers and nasty oil shocks.

Our modern era of economic stagnation is a fundamentally different proposition. Many of the factors that led to such scintillating rates of economic expansion in the Western world in earlier decades are no longer working their magic: the forces of globalization are in retreat, the boomers are ageing, women are thankfully better represented in the workforce, wages are being squeezed as competition from the emerging superpowers hots up and, as those superpowers demand a bigger share of the world’s scarce resources, Westerners are forced to pay more for food and energy.

In the 1990s, it looked for a while as though new technologies might overcome these constraints. We hoped our economies would still be able to expand thanks to the impact of technology on productivity. The story didn’t last. The technology bubble burst in 2000. Fearing the onset of a Japanese-style stagnation, Western policy-makers pulled out all the stops: interest rates plunged, taxes were cut and public spending was boosted. Yet, even before the onset of the subprime crisis in 2007, it looked as though these policies had led only to a serious misallocation of resources: too much money was pouring into housing and financial services (and, particularly across Europe, into public spending) and not enough into productive investment. The underlying rate of economic growth began to slow. Following the failure of Lehman Brothers in September 2008, Western economies seemed to be heading for a repeat of the 1930s Great Depression. In response, policy-makers offered even more stimulus. Alongside interest rate cuts and fiscal support to an ailing financial sector, they even began to pursue so-called ‘unconventional’ monetary policies. Thankfully, with one or two unfortunate exceptions in the eurozone, there has been no repeat – at least, not yet – of the total economic and financial collapse of the 1930s.

Yet, for all the stimulus on offer, the growth rates of old are now no more than a distant memory. By the standards of past recoveries, economic growth remains pitifully weak. Credit systems are partially frozen. Levels of economic activity in the major Western economies are between 7 and 15 per cent lower than forecast before the onset of the financial crisis. The West appears to be suffering a structural deterioration in economic performance. Economists, politicians and the media insist, however, in analyzing the problem in old-fashioned cyclical terms, primarily through the ‘stimulus versus austerity’ debate.

Oddly, the protagonists on both sides believe in much the same thing, namely that the appropriate macroeconomic policies will ultimately deliver a return to the growth rates of old. It just so happens – as is often the case in the economics profession – that the two sides fundamentally disagree over the necessary policies. Those in favor of stimulus believe that, without a sizeable shot in the arm through a loosening of fiscal policy, households and companies will continue to repay debt, hoard cash and save rather than spend, condemning economies to years of contraction. Those in favour of austerity fear that, in the absence of appropriate and credible fiscal consolidation, high and rising levels of government debt will eventually spark a financial crisis, leading to interest rate spikes, currency wobbles and stock-market meltdowns. Both sides believe in economic recovery. Each happens to think that the opposing view is totally wrong.

What, however, if both sides are wrong? What if both sides suffer from what I call an ‘optimism bias’? Thanks to Reinhart and Rogoff, we know that, in the aftermath of major financial crises, the subsequent recovery can be long and arduous. This, however, is a financial crisis without parallel. Never before have we seen so many economies so weak at the same time and never before have we seen a global financial system so badly damaged. Some are beginning to ask whether the West will ever regain its former poise. In 2012, Robert J. Gordon, an American economist, asked a very simple question: ‘Is US Economic Growth Over? Even with continued innovation – which was by no means a certainty – Gordon concluded that ‘the US faces six headwinds that are in the process of dragging long-term growth to half or less of the 1.9 percent annual rate experienced between 1860 and 2007. These include demography, education, inequality, globalization, energy/ environment, and the overhang of consumer and government debt.’ And it’s not just those whose crystal balls claim to offer very long-run predictions who are having doubts about the underlying rate of economic growth. In a November 2012 speech, Ben Bernanke, the then Chairman of the Federal Reserve, noted that ‘the accumulating evidence does appear consistent with the financial crisis and the associated recession having reduced the potential growth rate of our economy somewhat during the past few years.  Pimco, a major California-based financial company, raised the possibility in 2009 of a ‘new normal’, a persistent period of lower ‘trend’ growth than we’ve experienced before.

Of course, these can all be readily dismissed as no more than Cassandra-like predictions of a less bountiful future. Who, after all, knows what sort of technological innovation might materialize in coming decades? Our disturbing early twenty-first century reality of continuing stagnation cannot, however, be so easily ignored. Yet we haven’t even begun to think about the consequences for society of a world in which levels of activity are persistently much lower than we all-too-casually used to assume.
Without reasonable growth, we cannot meet the entitlements we created for ourselves during the years of plenty. We have promised ourselves no end of riches, from pensions through to health care, and from education through to big stock-market gains. These promises can only be met, however, if our economies continue to expand at a rate we’ve become accustomed to. Stagnation chips away at our entitlements, bit by bit.

Meanwhile, we are now far removed from the ‘push button’ economic policies that governed the Western world before the onset of the financial crisis, when a tweak in interest rates in one direction or the other would be good enough to keep an economy on an even keel. Economic policy is no longer for the technocrats. It has become inherently political. To understand the consequences of this change, I have gone back through history, uncovering periods when monetary decisions were politically charged, when economic shocks upset the political applecart, when a desire to stick to the conventional thinking of the time led to acts of rebellion and when nations simply ran out of money.

There is much to be gained from economic and political history: it is such a shame that so little of it is taught to budding economists working their way through their university degrees. History may not repeat itself but it is a brilliant way of highlighting issues that modern-day economists have, foolishly, brushed to one side. And it offers a sobering reminder of the risks associated with enduring economic disappointment: inequality, nationalism, racism, revolution and warfare are, it seems, the ‘default’ settings when economies persistently fail to deliver the goods. Put simply, our societies are not geared for a world of very low growth. Our attachment to the Enlightenment idea of ongoing progress – a reflection of persistent post-war economic success – has left us with little knowledge or understanding of worlds in which rising prosperity is no longer guaranteed.

We have arrogantly ignored the experiences of countries like Argentina and Japan, nations that have suffered from persistent economic stagnation, arguing that they are, somehow, special cases, the economic equivalent of genetic mutations that have no relevance for ourselves. Yet the gathering evidence suggests that, like those two once-successful economic powerhouses, the West has begun to stagnate. Without decent growth, social and political strains will surely emerge. Already, there are more than enough battles taking place in response to weak fiscal positions. The southern states within the eurozone appear to be on the road to perdition, the UK has failed to deliver on its fiscal promises, Republicans and Democrats in the US cannot agree on the appropriate budgetary model and Japanese government debt appears to be spiraling out of control.

None of this is surprising. It is rare for governments to plan on the basis of anything other than an extrapolation of past trends. Economic performance in the 1980s and, with the exception of Japan, the 1990s gave rise to a mixture of commitments – low taxes, generous welfare benefits and large increases in public spending – that could be afforded only so long as the economic goose kept laying golden eggs. Unfortunately, at the beginning of the twenty-first century, the goose became, at best, menopausal.