Monthly Archive for October, 2009

The Next Five Years

The medium-term outlook for the economy is clearly coming into focus. And so too is that of society, bound tightly as it is to the pace of economic activity. While the latter point should be obvious, it is often overlooked. But the economy sustains and constrains most social activity and consequently the debates, policies and norms of society. Whether through  provision of a public service by government, a humanitarian act by a charity or a gardener in her backyard, all are affected by the economy.

There is near unanimous opinion that the economies of the mature industrial states will grow slowly, at best, over the next five years. China is expected to be the exception, with growth in the high single digits. The prospects for India appear favourable, but to a lesser degree that those for China. But that is the old story, less interesting than what slow growth portends.

Indeed, to speak of slow growth casually, without noting its implications, is almost misleading. Most economic and social challenges, whether high government deficits or an aging population, are made more difficult by slow growth. By contrast, inflationary risks are usually eased by slow growth, although they not be in the present circumstances. Nevertheless, on balance, slow growth must mean a high degree of economic and social stress. Solutions become more painful, timid initiatives are rendered ineffective and issues are delayed only to worsen. Courage will be in short supply.

Let us review quickly why growth cannot be more than slow. The financial industry in much of the industrial world has not yet fully reconstituted itself, with much debt yet to be written off. U.S. consumers, a key segment of the world’s consumers, are also struggling with high debt levels and an eroded job market. Of course, slow consumer demand produces slow growth which in turn slows employment growth subsequently killing consumer confidence. Many of the world’s governments are running high deficits that must be restrained. The issue is urgent in the United States and merely important in Canada. The central bankers remain anxious to withdraw the abnormal amount of liquidity that they have added to the system; their natural tendency would be to do so as soon as credible growth is underway. While consumer inflation may be moderated by slow growth, there is a strong concern that a surge of asset inflation awaits. In addition, currency instability adds to the burden of the global economy.

Against this backdrop, the systemic challenges facing the industrial world will remain to a large degree unaddressed. That in turn suggests continuing disruption, dislocation, waste of resources and waste of talent.

Regulatory “reform” of the financial system, much discussed is likely to have little effect. First, the proposals are far too timid to actually have their intended effect. In the United States many of them might not even be implemented. It hardly matters.

Of course there are changes that could have a dramatic effect but there is no determination, never mind discussion, of these alternatives.

The cynics suggest that boom-bust is impossible to halt, an inherent characteristic of human behaviour. That would mean that humanity is inherently stupid. But that argument merely demonstrates the stupidity of its proponent.

As a result, the next bubble is already gathering force.

Most of the major governments of the industrial world, having had their economies savaged by the financial meltdown, are now being forced to reduce public services. Spending on education can be expected to fall on real terms. This is hardly surprising given that we live in a dark and primitive world where the values of education is recognized only by a few. Services for the vulnerable will also decline and spending on health care will be under intense pressure. With retirement plans under siege, there are limited public resources to respond. Older workers will have little choice but to stay in the labour force longer than they had intended.

As the environment becomes meaner, expect consumer confidence to remain at risk. A weak consumer confidence inevitably affects the confidence of those who invest in expanding productive capacity. (These real investors should be distinguished from financial investors whose investment decisions are often disconnected to any reality whatsoever.) These issues are especially acute in the United States.

In addition, there are few signs that structural imbalances both in the United States and China are going to be addressed. The U.S. remains reluctant to re-balance the commitment of resources from private to public purpose. So for the foreseeable future, the United States will draw on the resources on other countries to avoid making difficult choices. China is equally reluctant to restructure its unbalanced economy. It continues to fake its exchange rate, keeping it below the market rate to bolster its exports in the face of slow global demand. But it cannot drive its high growth on the back of manipulated currency markets and infrastructure spending indefinitely.

For the moment, Chimerica continues its unsustainable jig, albeit at a slower pace. Further advances in global trade are unlikely. Most of our attention will be diverted to stopping the inevitable outbreaks of protectionism.

Resources for innovation will be in short supply. That and pervasive caution will limit the advance of innovations and thus the associated economic stimulus.

The young will struggle to find meaningful employment. The older will keep working under greater stress, for even longer hours and limited real income gains.

Taking these factors together, it is difficult to expect other than future disruptions, as a system fractures under unaddressed stresses.

Some voices will look at the progress made (and progress will have been made) and describe the disruption as yet one more interruption in our upward path to prosperity. Others will look at what could have been and see calamity. While the age of radical change is upon us, the game has yet to be played out.

However, as is often the case, for those of rigorous mind and strength of heart, great opportunity awaits. All the major players are vulnerable. The trail of an epoch-changing comet is visible in the sky.

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