The 2008 financial crisis is now 6 years behind us. It was one of the most broadly felt economic events of the last 100 years, and had it not been for the quick response of central banks and governments, the destructive force could have rivalled the 1930’s depression. Bankers are seen as the villains, both by the public and in most of the 300 plus books written on the subject, with greed and asymmetric risk reward structures central to the problem. Some blame ill-conceived financial products, or the regulators and rating agencies for abdicating responsibility of good judgement. Others blame specific events such as the 1999 repeal of the Glass-Steagall Act or the planned implementation of Basel III. While all these views have their merits in explaining where and how the financial crisis came to the surface, they were just vents through which structural pressures and imbalances were temporarily released.
Remarkably, the workings of the economy are so poorly understood that only a few of the books touch on the real reasons behind the crisis, and even then, only from the perspective of labelling some the contributing factors, rather than explaining the resultant structural imbalances. The authors clearly understand the detailed mechanics of their speciality far better than I ever will, but as is frequently the case in life, hey have no idea what it actually is that they are doing and how it relates to other aspects of the economy or to society more generally. This narrowness of comprehension is also prevalent in economic rules and policy that has inbuilt contradictions, such as Keynesian stimulus, which boosts growth in the short term, but at the cost of slower growth in the long term due to the misallocation of capital it invariably infers.
Politicians and the press blame the banks for the crisis, yet there was little blame attributed to those who borrowed, or to the central bankers that kept interest rates low. U.S. banks are seen as largely fixed today, yet U.S. productivity grew just 0.1% in 2014. How can a bank be fixed if its assets are not performing beyond the banks’ collective monetary expansion? An asset’s value must ultimately be the present value of its productive capacity. Any speculation beyond that is destructive. Whether financed by debt, monetisation or even factor mobilisation, the wasteful premium above the productive value is at the expense of the capital stock; it is a tax on productivity. It should be no surprise that with U.S.apparent wealth relative to GDP being at record levels, that U.S. productivity growth has trended down and is barely positive. Had both wealth and GDP been at record levels, productivity would clearly have been the driver, and therefore it would be sustainable and would be genuine wealth creation. As it has been a relative move, it has clearly come at the cost of the depletion of capital stock, and therefore lower potential GDP going forward.
Despite the printing of trillions of dollars and governments running up huge budget deficits, world economic growth has continued trending lower. Western living standards have fallen, and deflation is staring us squarely in the face. Every year economists and politicians look to increased investment and employment to drive growth, yet when their prophecies fail, they do not even question the logic of their assumptions, instead just assuming it will happen the following year. There is an absolute belief that the economy will resume its trend. No account is even made of the distortions around which the trend was based, and which are no longer sustainable. What analysts don’t seem to understand is that the debt and imbalances we have associated with economic “growth” in recent decades were the financial representation of the consumption of capital rather than its creation, and therefore cannot continue at the same pace.
The continuous innovation of technology is beyond question in modern society; it is the god in which we all believe. Technology has always pushed the boundaries, and it will continue to do so, driving our living standards with it, and giving our children longer and better lives than we have enjoyed. Whilst this is the accepted wisdom, technology has in fact been failing us. Innovation and productivity’s relevance to economic growth has declined dramatically over the last 40 years, actually falling in 2013 and 2014. Today’s “growth” is a measure of the destruction rather than productive creation of capital. The fact that productivity has contributed less to GDP growth means the factors of production are being consumed as their supply is dependent on productivity, and without it, the resources will exhaust. Growth will slow and the economy will decline.
Because growth over recent decades was about factor mobilisation rather than productivity, there is little behind our savings. Once productive assets are now actually becoming liabilities. Having not invested in growing or even maintaining our populations, workforces are starting to shrink, but because we want to look after the elderly and extend their lives as long as possible, these factor inputs are not just becoming obsolete; they are becoming economic liabilities. This not only applies to the pensioners themselves, but also their associated savings. Without productivity, the only thing that stands behind Japanese pensioners’ holdings of JGB’s for example, are the workers who are about to retire and whose savings are about to be consumed. The same is true of the capital stock which is already at a record age, and still ageing. At a certain point, the capital stock will become less productive, and like the elderly, will require more servicing, maintenance and downtime. At that point, the real cost of capital will increase, but without central bank intervention, this will be from nominal GDP falling faster than bond yields which is already the situation at a global level. Even the ratings agency Moody’s recognises this, saying that the funding of Japanese public debt is at risk from the stagnation of the country’s savings. Western education levels are no longer increasing, and in certain countries are actually deteriorating. Resources are being depleted without the technological advancement to compensate, and even the economic returns from exhausting waste into the environmental sink may be deteriorating.....
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It describes how the increasing resource and capital intensity of innovation has reduced potential GDP growth, leaving assets such as labour stranded and in need of monetary growth to accommodate the resultant inequality.
The capital intensity of innovation has reshaped the world from competing systems and the insurance that provides into a single global economy, where the safety net has increasingly fallen on the central banks and base monetary expansion. Whilst government has certainly added to the problems, the real issues are far bigger. Understanding the driving forces behind productivity is vital to understanding why the economy is where it is, and where it can and will go, and what it means for asset prices. Falling productivity also suggests a lack of resources to continue growing the economy without major reforms, and then only for a limited time without the development of completely new science, which politicians need to be aware of if they are to reposition the economy to come out a winner.
The Productivity Engine explains why innovation and productivity are failing, and the economic and policy implications.
“Blind belief in authority is the greatest enemy of truth.” Einstein