Sunday, December 23, 2012

False Assumption, Ponzi, and the Developed World

We are now heading towards 2013, and it very, very striking that the world is still mired in an economic crisis. It is very easy for people to be caught up in the 'events' that comprise the daily news stories in the media; the events appear as more real than the abstractions that are the explanations that sit under the events. The explanations of 'events' is 'events'. Thus we have an event such as a government announcement A, leading to event B. It is wonderfully tempting and seductive to take this view, as the correlations between events can be easily determined, easily seen, and easily explained. However, the event A does not take place in a vacuum, and the event B that follows likewise does not take place in a vacuum. Instead, what is really happening is the events sit in a messy context of broader drivers, the beliefs and perceptions of innumerable actors, contesting interests, and sometimes just plain irrationality.

For example, take the belief that seems to be common in the developed world that relatively high levels of wealth are a given, a natural state of affairs. Would anyone contest that this belief is firmly entrenched? Whilst some might argue about the distribution of the wealth, for example arguing that true wealth should see more even distribution, they would still proceed from an assumption that there is and will be a relatively high level of wealth for distribution. I have now been blogging for several years, and have been thinking about economics for longer, and have not found any examples which do not proceed from an assumption that the developed world should just somehow be more wealthy. Even when articles bemoan the rise of China, they do so on the basis that, somehow, it is a natural place/position/state of affairs that the developed country should, well...... just be more wealthy.

The articles that worry about the sliding position of the developed world are the most interesting. They have a sense that 'something must be done', and often they will offer their policy prescriptions to fix the problem. It does not matter whether the author is left or right leaning, the aim is to maintain the relatively high levels of wealth in the country under discussion. With the right tweak of policy here, tweak there, all will be fixed. They assume that the natural position of relative wealth might be maintained, if only we could just do x, y or z.

Most of the readers of this blog seem to be well informed about economics. As such, I ask you to think about the many articles you read, and the assumptions that underpin them. You will find an assumption that the developed world not only is naturally more wealthy than the rest of the world, but also should be more wealthy than the rest of the world. There are some exceptions, in particular on the left, that the developed world is somehow sinful for being wealthier, and that the developed world should actively redistribute its wealth to the poorer parts of the world. Even here, we see an assumption of natural wealth.

The problems with the assumption of natural wealth, and that the developed world should be more wealthy is that it is just that; an assumption. It is treated like a natural force, and a right that is dictated by some kind of natural law. The problems is that there is no natural law, and no right that can be supported or defended in any way whatsoever. When a less well developed country pulls itself up by its metaphorical boot straps, sees rapid economic development, and contests for a position in the top tier of wealthy countries, there is no natural force that might stop them, or reverse the ascent. Instead, there are the complexities of the trillions of individual purchase decisions, the choices of individuals in economic entities such as firms, regulators, and policy makers.These are the real forces at work in economics, rather than some unseen and non-existent forces and rights.

I too have been guilty of the assumption that the developed world should be more wealthy. Like many others, I have argued that the developed world should act to defend its position as 'wealthy', including offering my own solutions. In some respects it is wrong-headed. There is no real reason why any particular country should be more wealthy than its neighbours, if the people of each country are equally as hard working and innovative. It seems that, in this situation, there can be no justification for one country being wealthier than another. There are, of course, situations where a particular country is just blessed, as in the examples of the oil resources available to countries in the Middle East. Putting it crudely, they just do not have to work as hard as others. Resenting such good fortune is, of course, pointless and sometimes such blessings also turn out to be a curse.

However, the world is not so simple as I paint it here. It assumes a world of competition between economic entities, based upon hard work and innovation. However, there is another competition at work, and that is the competition of systems; systems of how society is ordered. At one extreme we have what might be described as a something like a fascist state; China. All ideas that are imported into the country are subject to 'sinification', so China's system is uniquely Chinese. I use the word fascist therefore in a very loose way as the nearest equivalent. It would then be tempting to say that, on the other side, we have liberal, democratic and free market countries of the developed world. It would be a neat narrative of black versus white, but it does not hold.

However, the latter categorization is nevertheless partially true. With differing degrees of dysfunction, the developed world is democratic, and to different degrees 'liberal'. I say dysfunctional, because democracy is not working well. The system is failing. There are certain types of dysfunction that I will put to one side here, such as the shocking amount of money that is necessary to compete for the US presidency (albeit that such problems also relate to my area of concern). My concern is rather with the dysfunction of the electorate.

A significant economic challenge has developed, and that challenge is very real. We have seen a significant shift in the economic structure of the world. It has been assumed that what we are witnessing is a game of 'catch-up', in which countries such as China are seeking to chase after the on-going growth of wealth in the developed world. The idea that 'surpass' might take place is only in aggregate, not at the level of individual wealth. However, the developed world is not growing in wealth, but seeing a diminishment of wealth. The developed world is on a down escalator, even whilst the developing world is on the up escalator. As I have pointed out recently, those on the up escalator now face their own problems, but to assume that they will not continue upwards and the developed world downwards would be complacent.

It is here that I return to the dysfunction of the electorate and the question of liberal democratic and free market. In the developed world, the electorate have been seduced by the idea of the natural right to wealth in their own country. They know that there are now challengers to their position of wealth. They cannot avoid seeing this reality. Even those with the most passing interest in economics will be aware that the world has changed. Faced with the challenges of a new economic structure, instead of facing the new competition, electorates have demanded that the world remains unchanged. However, demanding that the world remains unchanged does not make the world unchanged. All that has happened in response to this demand, is that the politicians have responded to the demand by developing a pretense that the world is unchanged. Happy days are just around the corner. But the corner continues to be elusive. So what is the pretense?

The pretense is that we still operate in a world of free markets and that the world has not changed. Of course, it has never been the case that markets have ever been truly free, so we are talking about degrees of freedom. The point is that, since the economic crisis came into view, the marketplace has come to be dominated not by market signals, but monetary and fiscal policy of governments. Governments have always had a role in the marketplace, but underlying market signals could still (mostly) be discerned from the noise created by government. This is no longer true. More pertinently, it is now being recognised, even in conservative organisations like the Boston Consulting Group, that current policy is simply impossible to sustain.  They are blunt; they call current policy in the developed world a 'ponzi scheme'. This is just one extract from the report, and the content will be no surprise to regular readers of this blog:

Intensifying International Competition and Rising Inequality. Globalization has brought the promise of economic prosperity to billions of people around the world. But it has also contributed to tougher international competition and the creation of new inequalities of wealth and income in the developed world. The growth in the global labor force continues to put pressure on labor costs in developed economies. At the same time, globalization is leading to increasing inequalities in income and wealth within countries, as some groups (such as investors) benefit more from increased globalization than others (such as manufacturing workers).

Income statistics highlight this development: between 1979 and 2007, the income of the average U.S. household grew by 62 percent. Over the same period, the income of the top 1 percent of households grew by an extraordinary 275 percent and the income of the rest of the top 20 percent grew by a slightly above-average 65 percent, while the income of the remaining U.S. households grew by less than 40 percent. The incomes of the lowest quintile grew by only 18 percent.

Inequality increases the risk of social unrest and declining support for capitalism and a free society. As University of Chicago economist and former IMF chief economist Raghuram Rajan points out, “Ultimately, a capitalist system that does not enjoy popular support loses any vestige of either democracy or free enterprise.”
In the last passage, they capture the problem of democracy, and why it is that the response of governments is to pander to demands. All of the new workers who have entered the global workforce are not going to go away. The advantage of capital over labour will not disappear for a long time. This is the reality and no amount of propping up of demand, printing of money or borrow and spend will make this reality disappear. Demanding a standard of living will not make it so.

When starting this blog, I was largely a lone voice. The economic crisis was called a financial crisis, with a suggestion that, with bailouts, and some largess from central banks, the problems would disappear. They have not. They have simply been magnified. I argued for the idea that the world had entered a world of 'hyper-competition' and that is still where we stand. I am no longer a lone voice in this, and the BCG report is just one of the more 'conventional' sources that has finally recognised the changes that have taken place. The problem was not, as I have always argued, some isolated financial crisis, but a shocking change to the world economy - to the very structure of the world economy. Globalization was more than a word, but was a description of an accelerating revolution. On my bookshelf, I have a long unopened book on globalization; even when I read it several years ago, it appeared fanciful and arrogant. It now seems positively quaint. So here we are now in a world of hyper-competition. I will highlight a quote from the BCG report:

Fortunately, there is still time to act. But leaders from all social sectors—government, business, organized labor, environmental and other stakeholder groups—need to act decisively and quickly in order to secure future economic prosperity, social cohesion, and political stability. It is in the nature of Ponzi schemes to collapse suddenly, without warning. No one knows what event may send the developed world and the global economy as a whole back into crisis.
They get what I did not get when I first started writing this blog. The absurdity of a ponzi scheme continues till it doesn't. The magic of a ponzi scheme is that they can sustain themselves for so long, before the weight of the fraud finally topples them. I thought that people would see through it much earlier because, in reality, it has always been in plain sight. People just had to choose to see it. And that is the problem. When confronted with reality, we (the electorates, the policy makers, the economists, the politicians) choose to look away. A while ago, I saw a film about the Madoff ponzi scheme (sorry, I forget the name), and the most striking point in the film was the stubborn refusal to see what was in plain sight. It is the same situation in the developed world economies. After all, it can run a little longer, and we will be ok, won't we?

Note: I did think about posting this after Christmas. It is not full of festive spirit, after all. However, when is the best time for bad news? I am not sure. So, I end here by wishing that you all enjoy Christmas, and only give thought to economics after enjoying Christmas with your families. On Christmas day, I will raise a glass of appreciation to all the regular readers of the blog, as it your interest that keeps me posting. Thank you, and have a great Christmas.


  1. "No one knows what event may send the developed world and the global economy as a whole back into crisis."

    Fred Foldvary predicts it will be at the end of the next land cycle (business cycle):

    "We are now into a new cycle, in which once again the Federal Reserve has expanded the money supply, this time more massively than ever before, to keep interest rates low, again a subsidy to real estate, which is again reviving, and will again a decade from now, crash. The next crash will be even worse than that of 2008, since there will also be a fiscal crisis from the ever growing federal debt, as the government will no longer be able to borrow funds cheaply." -

    He accurately predicted the 2008 crash in 1997:

    "The 18-year cycle in the US and similar cycles in other countries gives the geo-Austrian cycle theory predictive power: the next major bust, 18 years after the 1990 downturn, will be around 2008, if there is no major interruption such as a global war." -

    Hyper-competition in the global labor market is a consequence of a lack of access to that land being back from the current market in anticipation of future capital gains, that is, capitalized land rents (bricks and mortar do not appreciate). The global paper ponzi scheme is built of speculative claims on future land rent.

    You may wish to study the works of Fred Harrison:

    1. Thanks. If I have time, I will try to take a look. I am always interested in the thoughts of those who saw the crash coming.

  2. There's a dark thought that sometimes occurs to me: the free market is reputedly similar to evolution i.e. a blind process which does not necessarily have any regard to the quality of existence of its participants. How do we know that the only system that is stable is one where there are two distinct groups whose members are actually prevented from leaving their respective groups: the privileged, idle rich, and the worker drones? It does sometimes feel as though the great ideas that give rise to growth can only come from people who actually have the time, money and security to become bored. And the only way this can be supported is if there are other people who have no choice but to work so hard that they never have the chance to play about and experiment with ideas. Do we know that 'the system' doesn't naturally tend towards this polarisation? Tough luck for anyone born in the worker drone group...

    1. My own view is that this current circumstance is that it is unique - the massive influx of labour. It will advantage capital for a time but then, as the labour is eventually absorbed, things will improve; or at least they might improve if the madness of current policy were abandoned. It is just unfortunate that we live through this transition, and that the response is so bad.

    2. By the way, Mark, a Merry Christmas to you too, and thanks for all the effort you put into your blog. I look forward to every new post.

    3. A Real Black PersonDecember 25, 2012 at 8:10 AM

      Mark, the belief that things will "improve" when that "labour is eventually absorbed" is untrue. Why would capitalists, or the haves, want anything to improve for those who are beneath them? Even if they did, are there enough resources to support several billion people at anything close to a middle class lifestyle?

      From my observation, it seems that some of the rational actors who frequent this blog have a supernatural understanding of economics, one based on faith and ideology instead of empirical evidence.

    4. Thanks for the comment. In principle, as the workforce is absorbed, then there will be a shift in power between capital and labour. This has already taken place to some extent in the coastal regions of China, where there has been significant upward pressure on wages. This is a long term process. However, in the developed world, the story is different, the reasons for which are partly explained in the post.

    5. A Real Black PersonDecember 26, 2012 at 3:44 AM

      No, I'm not buying it. Coastal China is not China's entire economy. I'm not sure why China would allow wages to rise significantly if it could cost it manufacturing jobs. The upward pressure in wages are concentrated in blue collar jobs, which many young Chinese students are told to avoid. The process you describe of rising wages, and a shift in balance between capital and labor, are things that'll make a country uncompetitive. Why would China want to be uncompetitive at this point?

    6. Thanks for the reply. You assume low wages are the key to China, and this has never been the case for many industries (in my own industry area, I saw a direct comparison between costs of the same product made in China versus Europe. Labour costs helped make China cheaper to manufacture, but was only a small contributor. There are labour intensive industries, and labour cost does make a difference in these, obviously. I read some time ago in the Economist that these industries were migrating inland in search of cheaper labour (about two years ago I think). China has many other competitive advantages, such as business clusters, and I have previously detailed just such a cluster near where I lived in China.

      Also, the Chinese government does not want to be a cheap labour economy. They have consistently incentivised FDI in high tech industry, and the result has been rapid ascent up the value chain (also with wholesale intellectual property theft as a major contributor). As it is, wages in the whole of China have continued to rise, with the exception (last time I read on the subject) being agriculture which was an early winner but has seen stagnation.

      As I have stressed recently, China is now starting to confront problems from its growth model, but it is currently climbing very fast up the value chain. The model that was China as a cheap labour economy with the developed world doing all the higher added value work was a momentary phase, and is fast becoming dated. This is not to get carried away; China still does have the cheap labour industries, but for how long? And what of the emergence of the higher value industries, that will compete on what was previously the exclusive ground of the developed world?

      You assume that the Chinese government can hold down wages. Whilst the Chinese state is powerful, not that much. Also, you assume low wages are the key to China, and this has never been the case for many industries (in my own industry area, I saw a direct comparison between costs of the same product made in China versus Europe. Labour costs helped make China cheaper to manufacture, but was only a small contributor.

    7. A Real Black PersonDecember 29, 2012 at 3:04 PM

      You assume that China will be able to maintain current employment rates as they "move up the value chain". It seems to me that service economies employ fewer people at living wages. If Japan's workforce population hadn't been shrinking as it moved up the "value chain", their unemployment and underemployment problems would be more noticeable. If the Chinese are 'smart', they will not outsource all their manufacturing and think they can get by with financialization, and military aggression, tourism, and providing higher education to foreigners.

  3. "However, there is another competition at work, and that is the competition of systems; systems of how society is ordered."

    And that's a point:
    Still I would prefer to live in some "impoverished" European country than in one of the oh-so-competitive "Bric" countries...there is more than economy and selling stuff, something that has do with a sense of civil cooperation (and not "competition"), relative lack of corruption, predictability, reciprocal trust and consideration, etc. etc.
    But I would prefer not to be too un-pc here...

    1. I agree, but what is taking place and the response will undermine the very things you value; it is already doing point is not to follow others, but make what we have more mature, by facing reality.

  4. Back in the mid 00s I travelled to both China and India, and my abiding memory of those travels is the constant thought 'Why are these people so poor, when they work so hard, and why are we so rich, when we don't?'

    I didn't have an answer then, and I don't now. But I am sure that those relative positions will not remain the same as the 21st century progresses.

    1. I think it was because the industrial revolution took place in the west, enabling rapid technological development and then the subsequent colonising of the rest of the world, robbing them of their wealth which was transported back to the west, and keeping them in a form of servitude.

      The west has lived of this wealth for too long.

      Just my penny.

    2. Hi,

      Thank you for the blog, I also look forward to your views. which I share myself.

      It is still difficult to convince "Westerners" (I live in Asia) that Asia is undergoing immense and rapid change. There are a lot of people who have the opinion that Asia is a third world full of poor people. My, are they so wrong.

      I meet daily 20-something Westerners, essentially "thick as shit" with some idea that they are superior and have some born right to holidays, foreign travel, benefits, social welfare and a Nanny State to look after them for life.

      Compare this to the Asians, running small to large businesses, keen, increasingly better and more relevantly educated than the Westerners, independent and self-sufficient.

      I have the feeling that the West is being played along by the Asians, taking what they want, cherry picking the best of the west, using the freedom of the west totheir advantage, and at the same time protecting their own assets.

      The Asians are not stupid and have a very long term perspective. The West has shortened its view of the future into immediate gratification.

    3. "some idea that they are superior and have some born right to holidays, foreign travel, benefits, social welfare and a Nanny State to look after them for life."

      Thats exactly it. People in the West think all that is theirs by right for merely existing, not something that has to be earned. They are going to be very shocked to find out the world does not owe them a feather bedded existence in the coming decades.

    4. A Real Black PersonDecember 29, 2012 at 2:38 PM

      To be fair the elite, the capitalists have their own sense of entitlement which primarily stems from control over who has access to what resources. Most capitalists "don't create wealth", they are rentiers and gatekeepers and because of this they think they deserve cheap labor, subsidies from the government, and privilege over the less wealthy in the eyes of the law.

      Yes, surely social Darwinism is the answer. Because the antidote to dysgenics caused by a welfare state is to take dimminishing resources and distribute them amongst fewer people, while creating the illusion of abundance, by encouraging population growth and consumption growth.

      Whether the Asians are smarter than us remains to be proven. If they imitate what has been done before, they will not have proven themselves to be anymore intelligent. If they move towards service economies with higher wages and consumption patterns, no manufacturing base, and resort to importing, from other countries, basic commodities necessary for life but are scarce for some reason, like water, food and energy, they will have the problems most service economies in the developed world are having. It's becoming very clear that interdependence is not progress anymore than fast food is an improvement over home cooked meals. After the 'service economy' phase,in modern economic development, I'm afraid there is nothing but regressions towards simpler economies, collapse, or some combination of regression and collapse. The main point is that "Growth", which is a basic summary of capitalism, has limits and consequences.

  5. In response to your post, I would argue that the west actually does deserve more credit than it gets compared to the low cost production economies like China. It is the corporate and political system system that allows a developed country to maintain a negative balance of trade, and although the pervasive economic obfuscation hides the consequences, it is this that erodes national wealth. If the UK was still on the gold standard, then the negative balance of trade would have seen our national wealth reduced by a very large amount (50% or so from memory) since 1990. Putting in controls like import tarrifs could ensure that a developed nation maintain a neutral balance of trade, but that is somehow seen as detrimental to free trade. I see it as good financial book keeping. Instead we have a system where companies make products in China, pay wages to Chinese workers which is taxed by China, sell there products to a western country, and pay corporate tax elsewhere. Essentially siphoning off the wealth of a nation. The shortfall in government tax receipts, that would have been collected if the manufacture and tax of products was kept national, is made up by government borrowing, so the taxpayer foots the bill. The actions of many corporations might make sense in the microcosm of their own business, but on a national level the same corporations actions appear to be parasitical.

    The collection of nation states that is the west, in general, have a relatively highly educated, highly creative workforce, and maintain a very good infrastructure. It can be seen that corporations with their heavy political influence are abusing these nations by not paying there dues. If we as nationals and taxpayers want to maintain the standard of living that we have now, then we need to engage in global fair trade, and not allow ourselves to be exploited by the big corporations, or nations that wont allow their own currencies to float freely.

    I disagree with the commonly held view that we all benefit from cheaper goods from China. In a system with an economic policy dedicated to a neutral balance of trade, the UK would be more competitive, could employ more people, be able to reduce tax, borrow less, and we could all afford a more expensive British build product while maintaining our standard of living.

    It is the perversion of free markets and fair trade that allow the erosion of many western economies. It has to be said though that western countries have engaged in unfair trade with underdeveloped nations for centuries. Perhaps we do deserve what we get.

    Dave L.

  6. Anonymous (25th Dec) and Sobers (26th): I couldn't agree with you more.

    Developing the theme, in my eyes there are two very silent killers that will eventually be catalysts contributing to a breakdown of Western society: the entitlement culture at one end and tax avoiders at the other end of the social divide.


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