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Analysis/Comment Last Updated: Oct 21, 2013 - 7:18 AM


The end of western affluence?
By Michael Hennigan, Finfacts founder and editor
Oct 8, 2013 - 6:28 AM

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Today the world is much more equal in income terms than in earlier decades while inequality grows within nations. Meanwhile, the question of the survival of the standard of western affluence is being increasingly raised at a time when in the United States, the biggest economy of advanced nations, the inflation-adjusted (real) income for the typical American household in 2012 was below the level in 1989.

Reverend Thomas Robert Malthus (1766-1834), who was also an economist, earned posterity for his 1798 prediction that population would continually increase faster than the food supply, causing chronic food shortages. He was blind to contemporary developments in Britain that would radically change societies that had been static and predicable for thousands of years. Thomas Hobbes (1588-1679) had written in 1651 of "the life of man, solitary, poor, nasty, brutish, and short."

There were about 1bn people in the world in Thomas Malthus' times and according to the late eminent economic historian, Angus Maddison (1926-2010), until 1800 about three fifths of the world’s commerce and production took place in and around China and India. So did much of the world’s scientific and technological progress, including the Chinese invention of paper, explosives, and printing, and medieval India’s launch of modern mathematics. In the early 1830s, when President Andrew Jackson sent the first US envoy across the Pacific to Siam (Thailand), Asia still accounted for over half of global GDP (gross domestic product).

China's Qing dynasty was overthrown after 267 years in power by a republican revolution in 1911. It was a colonial power with the Manchus from northeast China ruling the majority Han people. Technological advances stalled and in 1793, the emperor rejected the request of a British delegation led by George Macartney (1737-1806), an Irishman, to open diplomatic relations with the British.

Macartney wrote in his journal: "The Empire of China is an old, crazy, first-rate Man of War, which a fortunate succession of and vigilant officers have contrived to keep afloat for these hundred and fifty years past, and to overawe their neighbours merely by her bulk and appearance. But whenever an insufficient man happens to have the command on deck, adieu to the discipline and safety of the ship. She may, perhaps, not sink outright; she may drift some time as a wreck, and will then be dashed to pieces on the shore; but she can never be rebuilt on the old bottom."

Emperor Qianlong in a letter to King George III said: “we possess all things. I set no value on objects strange or ingenious, and I have no use for your country’s manufactures.”

In the prescient 1919 book 'The Economic Consequences of the Peace,' on the vengeful Treaty of Versailles, John Maynard Keynes (1882-1946), the renowned British economist, describes free trade as it existed in 1914, when a businessman in London could travel the world freely, invest wherever he wanted, and "could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep." Not only that, Keynes' Londoner "regarded this state of affairs as normal, certain, and permanent, except in the direction of further improvement."

The genesis of modern globalisation began in the 1950s with moves to reduce tariffs and Ireland was an early beneficiary of it.

In 2008, we reported on the final report of the Commission on Growth and Development, which examined examples in recent decades of what were termed growth miracles.

Dr. Michael Spence (b. 1943), a winner of the 2001 Nobel Prize in the Economic Sciences and chairman of the commission, said that sustained high growth in developing economies is a recent, post-World War II phenomenon. Using GDP figures, "high" is above 7% and "sustained" is over 25 years or more, he said that these cut-offs are arbitrary, but a similar picture emerges with variants. Growth at these rates produces very substantial changes in incomes and wealth: Income doubles every decade at 7%.

There are 13 such cases of sustained high growth, and nine are in Asia. These are Botswana, Brazil, China, Hong Kong (China), Indonesia, Japan, Korea, Malaysia, Malta, Oman, Singapore, Taiwan (China), and Thailand. Each and every one of these miracles had an export sector as a driver of growth and an increasing share of trade in GDP. There are no exceptions.

Every growth miracle involves leveraging the demand and resources of the global economy.

Finfacts: Commission on Growth & Development Report: 13 countries had sustained high growth - defined as 7% per year or more for 25 years or longer; Highlights four sets of countries where growth has stalled

Last month we wrote that the workforce in the global trading economy doubled to 3bn in the period 1980-2000.

Finfacts: Why should Europe expect ever rising standards of living?

Era of low price commodities over

Growth in the developed world for most of the 20th century was boosted by either low or falling real (inflation adjusted) commodity prices.

McKinsey Global Institute says that with the notable exception of the 1970s, oil and gas prices (in real terms) were flat or fell throughout the 20th century. Yet energy prices have soared by an average of 260% since 2000 as a result of a combination of strong demand (notably from China) and rising supply costs. For instance, the average real expense of bringing a new oil well online doubled between 2000 and 2010 -- an increase of more than 7% a year.

While metal prices fell (in real terms) throughout the 20th century, they have jumped 176% since 2000. Many observers attribute the increase largely to demand from emerging markets, but McKinsey’s Basic Materials Institute finds that geological challenges and the rising cost of inputs, notably energy, have also boosted prices. In the case of gold, for example, more than 45% of the increase in supply costs between 2001 and 2011 resulted from geological factors that we believe will persist and an additional 30% from shortages of inputs, including equipment and skilled labour.

Demand for food increased throughout the 20th century, but thanks to higher yields, prices fell (in real terms). Yet they have risen by almost 120% since 2000 as yield improvements slowed, demand for feed went up, and agriculture endured droughts, floods, and variable temperatures. The net result is that global buffer stocks are running low but demand for food, largely in Asia and Africa, is expected to go up by 35% during the next 20 years. In addition, higher production of biofuels is boosting demand for land. So is the fact that more than 20% of the world’s arable land has been seriously degraded through, for example, pollution and soil salinization. Finally, the land shortage is further exacerbated by the mass migration of people from rural areas to cities: urban sprawl could reduce the world’s cropland by two million hectares a year.

Download Full Report [pdf]

When the money runs out?

Stephen King, group chief economist of HSBC, a banking giant, has written a book, 'When the Money Runs Out: The End of Western Affluence,' that was published in the early summer. It raises relevant issues and of course, a bank economist has to avoid some sensitive ones.

The author acknowledges that in a paper currency system, the money in a narrow  sense may never run out but he argues that the ability of the developed world to generate significant economic growth, and thus wealth, has declined. He highlights that in the first four decades of his own life real British incomes per head almost tripled; in his fifth decade, they rose just 4%.

In an op-ed piece in The New York Times on Monday (the reader comments are also interesting), he wrote:

"The underlying reason for the stagnation is that a half-century of remarkable one-off developments in the industrialized world will not be repeated.

First was the unleashing of global trade, after a period of protectionism and isolationism between the world wars, enabling manufacturing to take off across Western Europe, North America and East Asia. A boom that great is unlikely to be repeated in advanced economies.

Second, financial innovations that first appeared in the 1920s, notably consumer credit, spread in the postwar decades. Post-crisis, the pace of such borrowing is muted, and likely to stay that way.

Third, social safety nets became widespread, reducing the need for households to save for unforeseen emergencies. Those nets are fraying now, meaning that consumers will have to save more for ever longer periods of retirement.

Fourth, reduced discrimination flooded the labor market with the pent-up human capital of women. Women now make up a majority of the American labor force; that proportion can rise only a little bit more, if at all.

Finally, the quality of education improved: in 1950, only 15 percent of American men and 4 percent of American women between ages 20 and 24 were enrolled in college. The proportions for both sexes are now over 30 percent, but with graduates no longer guaranteed substantial wage increases, the costs of education may come to outweigh the benefits."

King makes a plea for "economic honesty, to recognise that promises made during good times can no longer be easily kept."

He proposes reforms such as raising pension ages, increasing immigration in ageing societies and a social pact where an older population does not cannibalise benefits at the expense of the young.

The economist also recognises that rising inequality is part of a process that feeds mistrust within nations.

Stephen King writes in his book:

"Based on our collective belief in ever-rising living standards, we have spent the last half-century watching our financial wealth and our political and economic 'rights' accumulate at an incredible pace. We all, directly or indirectly, own pieces of paper or rely on political promises that make claims on future economic prosperity. Only a handful of years ago, we were so confident in continued economic progress that we could be educated yesterday, consume today, retire tomorrow, have excellent healthcare the next day and create a better life for our children while, at the same time, saving very little. We hadn’t just mastered our economies. We had mastered time itself.

What happens, however, if the future is worse than we hoped it would be? What happens if, collectively, the claims incorporated in our pieces of paper and our political promises cannot be honoured?"

Finfacts: Company cash hoards rise to $8tn; Taxes, squeezed labour and 'trapped' cash

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