The advanced capitalist economies are in trouble. Economic growth is anaemic or negative; government debt mounting; banking systems are on life support. There are big differences between the individual economies, but some combination of these three, or at least two of them, afflicts more or less all major economies – Australia and some Scandinavian economies excepted perhaps. The crisis may not be as severe as the one in the 1970s (it is if you measure GDP statistics but not by any other measure), but there is a pervasive sense of hopelessness. Nobody seems to have a convincing solution.
Broadly two narratives are offered. On the left the crisis is attributed to greedy bankers and corporate bad behaviour – and the answer is to ratchet up state spending to provide a Keynesian stimulus together with some very vague ideas on improving regulation of big business. On the right the crisis is attributed to an excessive state, and the answer is to roll it back to get out of the way of free enterprise. Neither is very convincing. For a much more convincing narrative, go to the eminent American economist and Nobel Laureate Joseph Stiglitz. He recently published a book on the topic: The Price of Inequality: How Today’s Divided Society Endangers our Future. I haven’t read it, alas, but it is reviewed by the Economist here, and Professor Stiglitz wrote an article for the FT here. A weakness is that his comments are focused especially on the US – but they have a global resonance.
This crisis has been evolving since the 1980s, while two important trends have been evident: the advance of technology and globalisation. These have rendered much of the earlier economic infrastructure obsolete and forced a major restructuring of the world economy, with big impacts in both the developed and devoping worlds – many of them very positive. Running alongside this has been a major shift in the balance of economic power from labour to capital. This is evidenced by a declining proportion of GDP attributed to wages and salaries and an increasing proportion to business profits. This in turn has led, especially in the US, to a dramatic rise in the inequality of wealth and income distribution. I have not been able to lay my hands on a clear set of statistics to demonstrate this – and not being a student any more I do not have access to the OECD or other statistical databanks – or not in a form I can work with. But this is widely attested to. Incidentally income inequality is not the only aspect of this problem, the amassing of corporate power that we can see in Japan and Germany, for example, is another dimension of the same problem.
This is where it gets interesting. One of the characteristics of the very wealthy (including big corporations) is that they do not spend as much of their income as poorer folk. They like to amass wealth, to exercise power, to pass on to later generations, or simply because they are too busy creating it to spend it. This creates a problem made famous by Maynard Keynes, and explored by all Economics undergraduates: if there is a surplus of saving over investment opportunities then the economy as a whole starts to shrink: people are producing more than is being consumed. That, in essence is what the crisis is about. Changes to the world economy have skewed the distribution of income in such a way that it is slowly suffocating the economy as a whole. This is not unprecedented: something like this happened in the early days of capitalism in the mid 19th century, but was resolved when the balance of power shifted back to labour. I have read a claim that there was a similar crisis in the 1920s and 1930s – but I am less convinced that skewed income played such an important role in then.
Now there are broadly four ways that sinking domestic demand from excess savings can be countered. First, an economy can run an export surplus which transfers the excess supply to other economies; this might be called the German solution. Second investment levels can be stoked up to absorb the surplus savings: this is roughly what happened in America in the 1990s with madness of the high-tech boom. Third consumption can be ramped up amongst the less well off by encouraging private debt, usually aided and abetted by a property bubble – the US and UK economies did in the 2000s. Finally government spending can take up the slack, either financed by taxes or, more usually, by borrowing.
Each of these four solutions has been tried by the major world economies, and all have given rise to problems. Export surpluses simply transfer the problem elsewhere – and are only globally sustainable where the counterpart deficits are being used to finance worthwhile investment. But the developing world, where most such investment is taking place, has often been running trade surpluses. Otherwise surpluses build up into assets that have to be unwound painfully. Investment looks like a good idea, but to work these investments have to pay back, otherwise you simply postpone trouble. This has proved much more challenging than many have allowed – I did not use the word “madness” in connection with the high tech boom of the 1990s for nothing. Private debt amongst the less well off might work if their incomes are rising – but the problem arises because they are not. And finally excess state funding carries its own problems. It is economically inefficient, and, financed by debt it simply builds a future financial crisis.
So what to do? It is worth noting that the left’s narrative on the crisis is closer to mark than the right’s. Cutting taxes and the power of the state will not unleash a flood of new investment, as the right claims – it will make matters worse by choking demand further. The left is right (as it were) to see that a large state is part of the solution, rather than the problem. Where they are wrong is to think that a bit of fiscal stimulus will restore the economy back to health – because it fails to deal with the root causes of the problem. Taxes have to rise, and especially on capital and the rich. And there is rather a tough consequence. This may help break the cycle of the rich not spending enough – but at a cost to the overall efficiency of the economy. We have to lower our expectations of what an economy can deliver.
And what of the megatrends that caused the problem in the first place? As I have argued on this blog before, I think globalisation is running its course and will not be the force it once was. There will be less pressure on developed societies from developing world competition. As for technology, let us hope that it starts to fulfil its promise of empowering the individual. Only this will ultimately restore the balance of power between businesses and their employees in a way that does not suffocate enterprise.