Krugman: The New Luddite

I know, I post too often on Krugman's musings in the New York Times. However, I could not resist the later missive from Krugman regarding automation (robots, and I presume he also means software that automates tasks currently performed by humans, but that is a guess):

If this is the wave of the future, it makes nonsense of just about all the conventional wisdom on reducing inequality. Better education won’t do much to reduce inequality if the big rewards simply go to those with the most assets. Creating an “opportunity society”, or whatever it is the likes of Paul Ryan etc. are selling this week, won’t do much if the most important asset you can have in life is, well, lots of assets inherited from your parents. And so on.

I think our eyes have been averted from the capital/labor dimension of inequality, for several reasons. It didn’t seem crucial back in the 1990s, and not enough people (me included!) have looked up to notice that things have changed. It has echoes of old-fashioned Marxism — which shouldn’t be a reason to ignore facts, but too often is. And it has really uncomfortable implications.

But I think we’d better start paying attention to those implications.

Welcome to the new Luddite approach to the improvement of the human condition. The robots will move wealth to the holders of capital from the workers.....and that is bad for us all. And what, might I ask, does he think happened in the industrial revolution? The hand loom weavers were put out of business due to automation. It was one of the heralds of the greatest changes in the history of mankind, and one from which we all now benefit. The industrial revolution was, in some respects, a painful process, but also served to create the potential for the huge benefits that we now enjoy.

In the modern and developed world, the adjustment to this new source of productivity should be less painful, albeit that the transition will not be easy either. However, unlike the industrial revolution, we are not transitioning from a system that was for many people barely above subsistence. Today, we are not barely above subsistence, but that is not to say that the transition will not be hard for some people. If you have spent years learning to do something like a search for legal precedents, the automation of this process will be a hard blow. However, for all of this pain, automation will have positive benefits alongside of these costs. In the case of legal services, access to the support of the law will be more affordable to those who would otherwise struggle to have access to the services, and that may matter a lot to many people. It is no different to the access to relatively cheap cloth that will have made new clothes more affordable to poorer people; at a cost to the hand loom weavers in the short term.
Just as the spinning jenny benefited the capitalists, the providers of automated legal searches will benefit the owners of law firms who adopt the technologies that are now available.

The examples of automation creating wider economic benefits are so many that it is difficult to know where to start. The end of canals in the face of the competition from more efficient trains (which created a boom and bust that left the UK with a railway system paid in full by the loss of the capital owners), the redundancy of the typing pool with the advent of the PC and so forth. In all these cases, automation has the result of getting more from less labour, and that means more 'stuff' per unit of employed labour, even in the case of the indirect effect of removing the typing pool. As fast as labour is being removed, more output is being created per worker, meaning that more 'stuff' is available per worker. With greater output of stuff per unit of labour, labour is freed to do new things. It is, just as happened in the industrial revolution, a situation in which new jobs arise to replace the old jobs, as people find new stuff to produce, as the emerging surplus of labour is absorbed in producing 'stuff' that was previously only afforded by the few. It is the process which generates greater wealth.

One wonders, when Krugman says that there are 'uncomfortable implications' and suggest that those implications 'need attention', what exactly he might mean? Does he mean that we should halt the current process of automation, perhaps smash the robots? I mean really, what does he mean? He leaves his article vague and open, hinting at ominous consequences. However, those consequences have precedents that (for once in economics) are clear. We see the result of the precedents all around us in the developed world; more than enough food, better health, heated and comfortable homes, our many forms of entertainments, our freedom to access information, and so the list goes on.

Think of the example of the impact of the PC on the typing pool. It saw what was a hard earned skill eventually made redundant (however, I taught myself touch typing, so not entirely redundant, but I do not need the level of skill of the typing pool where there is no 'backspace'). Should we have looked at the 'uncomfortable implications' of this shift? For a typist, it was undoubtedly not a good situation. However, would we turn back the clock, and stop this change if we could? We could certainly reverse the change, by making word processing software illegal, and blocking any web services that might offer a similar facility. In a few year time, with the magic of backspace button gone, we would have huge numbers employed in typing pools. Those same individuals will be drawn from the labour force, and will be an opportunity cost; the opportunity to do something else which is genuinely in more demand.

What we are discussing here is nothing more than a variant of the broken window fallacy; that breaking a window is a good thing as it creates employment. In breaking the window as a deliberate act, it creates employment, but employment with no real point. Better that the people employed in repairing the window are engaged in productive labour with a genuine demand, rather than an artificial 'created' demand. In the same way, better people are employed in new avenues than artificially supporting, or creating, employment through the rejection of more efficient means of engaging the same labour. It is a make-work scheme where there is no need for the work. Better that the labour is employed in creating real value.

If ever there were evidence that Krugman has nothing to offer, this rather odd article is the evidence. It is no wonder that he leaves the 'implications' and solutions unsaid. If he were to say clearly what his article implies, he would be ripped to pieces. It is, as the title of this post implies, nothing more than a disingenous revival of Luddism. Krugman hides in ambiguity, but the 'implications' are clear; break the machine to save the interest of labour. He cannot see that, painful as the adjustment might be, labour is also the recipient of the benefits of automation.

Further, Krugman writes from a US perspective, and the potential benefits to the US worker are obvious; the cost of labour differential is diminished through automation. Maybe the labour will no longer be the crude repetitive labour of yesteryear, but all those 'on-shored' factories that benefit from automation will nevertheless create new employment opportunities. There may, in other words, be losers from automation, but there will be many more winners; and the win will keep on delivering, just as the industrial revolution today reverberates to the benefit of all in our day-to-day lives. 

Krugman and Money Bubbles

In a recent NYT piece, Krugman suggests that 'money is only a “social contrivance”. It’s a convention, which works as long as the future is like the past.' He then goes on to say later:

A final thought: the notion that there must be a “fundamental” source for money’s value, although it’s a right-wing trope, bears a strong family resemblance to the Marxist labor theory of value. In each case what people are missing is that value is an emergent property, not an essence: money, and actually everything, has a market value based on the role it plays in our economy — full stop.

Before reading the rest of the post, you should really read his full discussion, as this post will not make sense without you doing so. For me, the problem is his idea that there is no fundamental source for the value of money. It is wholly fantasy.

Here, for the sake of simplicity, I will treat the following as 'money'; base money (e.g. bits of green paper, and money created by the central bank through open market operations, and debt money (e.g. bonds, bank credit etc.). I know that we could debate the question of differences between these money types, what should be included in money etc. However, my purpose here is specific, and you will (I hope)understand why I characterise money in this way.

For me, the most important thing about money is not about the nature of the money, but about the demands that money might make on the economy. For example, each unit of money is a future demand for x value of product and services in a particular economic unit, typically but not always a country. The interesting thing about money is that it can very broadly be divided into 'now' money, and money in y period of time, or money in y period of time and z now etc. In other words, money units have a temporal dimension. This gives us something of an idea of how money can be seen to be founded in something. This is that the value of money is determined by the demands that might be made on the total value of output in the economic unit.

The important point about this is that, at given moments in time, there is a combination of credit money and base money in any economy. However, at any given moment, there is a total level of output of value in the economy. I use the word value here because what value might be is subjectively derived; for person A, they may value a new television over a Wedgewood tea set, even where the tea set has a higher price. However, regardless of what individuals value, there is a total output, however difficult that might be to measure accurately, but with relative prices making the best proxy that we have for perceptions of value. The point is that, with a given labour force, given technologies, given skill sets, and so forth, there is finite amount of value that can be created in an economy at any given moment.

You will notice here that I am treating an economy as if it is an economic island, which is false. Economies are not islands, and an economy's output is also contingent on the value creation in other economies. For example, if country B makes a product better/more cost effectively (I leave this loose here) than country A, then the country A output of value is questionable unless they do something to match the country B output of value. As such it possible to have potential for output of value that will not be realised, as there is a real world of competition. Therefore, the potential output of value of an economic unit is not its potential, but its potential in relation to other economic units. That potential is continually shifting, dictated by policy, individual and corporate endeavour etc.

The value of money is therefore contingent upon several factors; temporal, quantity, and the potential value of output of the economy which the money represents. For example, the bond market is driven by second guessing the relative influence of these factors, albeit that the second guessing is often crude and misdirected. The key point here is that each monetary unit, given these contingencies, at any given moment in time, represents one x percent of the total value of output in the economy. In other words, money is rooted in the total output of value in the economy, at a given moment in time. There can only be, as an economy is currently structured now, x amount of value of goods/services that can be purchased. I am being simplistic here, as some people simply hold the 'now' money, so that it ceases to be a demand on the economic unit, even though the money exists. In this circumstance, it makes no call on the output of value at that moment. It is another contingency on how money is valued, but by not making a call on the value in the economy now, it allows for a call on value tomorrow. For example, for a bond that has matured, might not be used as money now, but to buy more bonds with a view that this will allow an even greater capture of value in the future.

There are several things that are important when viewing money and value of output in the future. It is quite possible to issue more money now in the expectation that output of value will increase in the future to match the increase in money. Creating a greater supply of money, with the contingency that output of value will match the increase in supply is a risk. If output of value does not increase commensurate to the increase in money, then there is a problem. The value of output per unit of money has diminished. Most damaging of all, is when the demand for the value of output sits outside of the economic unit; if the demand is within the economic, it might represent a transfer, for example the liquidation of a mortgage debt.

However, even then, it is possible that the issuance of too much mortgage 'money' might be inflationary, and problematic. If the mount of money created for mortgages increases faster than the value of the value of the housing stock, this means that there is a specific and narrow price inflation, but also with a wider price inflation in the economy as a whole, as that mortgage money transfers into the economy. It just takes time. The housing bubble was this process in action. The rate of mortgage money creation increased faster than the value of housing stock, and also prompted bubble activity, such as building McMansions as a process of trying to soak up some of this new money creation. This brings me back to the problem of external credit, which is far worse, as it never represents an internal transfer.

The external funding of new money in the economy, such as mortgage debt, is a future external demand on the output of value in the economy. In all cases, it quite literally means that in the future, a demand will be made on the value of output in the economy such that some of that value output will no longer be available within the economic unit. The greater the value of the money created through external debt, the greater the demand on future output of value. This kind of demand can accumulate to the point where the external demands on the total output of value are so large, that an economy has no reasonable chance of servicing the value without having so many goods and services flow out of the economic unit that the actors in the unit will be reduced to penury. This is Greece now.

The curious part of the Greece story is that it is divorced from base money, and the problems are entirely created by creditors realising that the output of the Greek economy is not able to provide the value that they expected, or rather that Greece is unwilling to deliver that value as the loss of that value of output from within the economic unit of Greece is too hard to bear. The external debt of Greece is simply a massive demand on the value of the total output of value of the economic unit called Greece.

The idea that monetary units have no foundation, except in a social construction is simply not true. It is founded in the output of value in the economy for which a particular currency pertains. It may be complex, due to the contingencies that I describe. This is why all debt markets are so complex. However, there is one thing that is certain. If the aggregrate money supply increases faster than the value of output, the value of each unit of money will be diminished. We must also remember that the value of each economic unit is contingent upon the ability of each unit in each area of business, and that the aggregate of the ability will inherently effect the value of money, as this will impact upon the ability to realise potential output of value in an economy. Finally, externally created money is the highest risk, as it will absolutely make a demand on output of value in the future, and that value, if repaid will mean less output of value in the economic unit. Even if the economy does grow in an economic unit, a portion of that growth will no longer be available in the economic unit. The economic unit will have less output of value at the time that the demand is made for the output of value.

The final point is this; expanding money supply without an ability for increases in the output of value destroys the value of money. Borrow and spend is exactly this, and external borrowing is horrendously risky.

Note: This started as a short and quick and 'dirty' post, but did not turn out that way. I hope it all hangs together, and I have avoided some complexity that might have been added due to time constraints, and to keep the ideas as simple as possible. The nature of internally generated debt money is a case in point. Comments, as ever, welcomed. Feel free to be critical and pick holes. I published despite this despite being loose ideas with critiques in mind; I would like to refine these ideas, and critiques (constructive ones) and suggestions will help. In short, I have thrown the ideas 'into the ring' to see how they stand up to critical eyes. Regular readers will know that I have considered money before (sorry, no time to find the link, but it would help in supporting this post), and this is just some further thoughts/evolution/adaptation of the earlier longer and more detailed consideration.

Oh dear, Prof. Krugman

This is a very short post. This from the Guardian on the ever more odd discussions of Prof. Krugman:

On the day the Nobel prize for economics was announced in Stockholm, a former winner was in London urging the government to ditch the "mad" austerity policy that was keeping the British economy depressed. Paul Krugman joined Jonathan Portes for a debate on whether the government had gone too far, too fast.

In what world is the current level of government spending 'austerity'? It is the oddest idea that can be imagined. The deficit is huge (from the Guardian):


Apparently this is 'austerity'. Or at least according to the ever more unreal Prof. Krugman this is 'austerity'. Nevertheless, his words will be taken seriously by many. He may have won a nobel prize, but that does not make his pronouncements any more sensible than any other of the many economists that failed to recognise the problems in the world economy until they were already in plain sight.

Positives and Gloom

Please accept my apologies for the long time since my last post. As ever, the choice of subjects for discussion is overwhelming. As such, I thought I would write briefly on several subjects.

Richard Duncan's Presentation

A commentator recently left a link to a talk by Richard Duncan, and it proved to be very interesting. I strongly recommend it, and this section will only make sense if you have watched it (start at the 10 minute mark to save watching a dull introduction). The most interesting point about the talk is the dispassionate approach to the current and future situation. He simply accepts that, in a few years time, the world economy will have a horrendous crash, that states are now fully in the driving seat of the world economy, and most importantly that investment choices should now be based upon state action rather than market drivers. In simplistic terms, whenever a government prints money, his answer is buy, buy, buy!

The talk has been weighing on my mind since I saw it. I am not sure about his timescales, but much of his analysis is very good. However, what has been weighing on my mind is his call to enjoy the investment opportunities in the lead up to the big crash, alongside his advice on how to not lose everything when the crash comes. Put another way, you can make pots of money now, and later on you can hold on to a large proportion of what you made, and protect yourself from the various and different terrible potential outcomes that will follow from state action. It is a hard and cynical approach. The reason it has weighed on my mind is that I wonder if what he is saying explicitly is what many others in the financial industry believe. Certainly, there are many analysts in the financial industry who have expressed concern with state policy, but there is a strong incentive for the financial services industry to play along with the current 'game', with individuals ensuring that they are buffered against the eventual crash. As long as they get the timing correct, they can play the markets based upon state action, and can still come out at the end significantly richer (albeit they will lose some proportion of their gains).

In short, the longer that states continue their current policy, the greater the damage in the future. However, fFor those who understand the nature of the game, the longer the game continues, the more time they have to secure wealth to insulate against the inevitable crash. It is a worrying thought, as the financial industry has an out-sized influence on government policy.

A Positive Note


Longstanding readers of the blog will know my thesis that one of the factors underlying the economic crisis was the growth in the world labour force in relation to a lack of commensurate growth in the supply of commodities (see here for a fuller explanation). This, I argued, led to an emergence of what I termed as 'hyper-competion' for the limited supply of resources.

One of the examples I have used to highlight the problem was the lack of sufficient growth in the supply of oil during the entry into the world of the (then) emerging economies such as China. For a while now, I have been reading about and watching the results of the shale gas revolution. The US has embraced this new source of energy and it has resulted in an astonishing drop in natural gas prices, as shale gas extraction has increased. Although it is not a substitute for oil, it does provide a source of cheap and plentiful energy, and this increase in the input of energy into the world economy is a major positive. However, there is a lot of 'politics' surrounding the process of extracting the shale gas, and this means that it has yet to be exploited everywhere. If the political questions can be resolved, shale gas has the potential to make a major positive impact on the world economy by increasing the supply of energy into the world market. I would not go as far as saying that it will resolve all the problems of energy, but it certainly ameliorates the problems.


Another problem I identified was that, even though some commodities did increase significantly during the period of 'economic emergence', one of the problems was that the emerging economies (and in particular China) growth was infrastructure intensive. Building of new highways, factories, rail lines, cities and so forth, all created a massive demand for basic commodities requiring a larger increase in supply than actually took place. In the case of China, many analysts have noted that the infrastructure heavy growth of China may be coming to an end, or at least will slow down significantly (Richard Duncan discusses this in relation to industry if I recall correctly). The result of slowing infrastructure development should start to ease the pressure on the supply of many commodities, and this in turn may see some reduction in commodity prices. Much depends on government policy, in particular in China where the desire for social stability may see ongoing investment in infrastructure (whether needed or not) to maintain employment and social stability. However, if there is a reduction in intensity of infrastructure development, this is also good news for the world economy.


If demand for resources reduces, and supply of other resources such as energy, are now starting to move in a positive direction, the outlook for the world economy should (in principle) improve. The 'hyper-competition' should return towards 'competition' and that would be major a positive. The only problem with this idea is that, since the economic crisis became visible, states have now taken ever greater and ever more risky policy decisions. We are now saddled with the consequences of these decisions, and the interventions are ongoing and will create ever greater problems going forwards. As such, despite the possibility of the underlying causes of the crisis starting to be ameliorated, the actions of states in response to the crisis will have to be paid for regardless of these positive developments. In other words, what should be a bright outlook remains bleak, albeit slightly less bleak than before. 

How History will View the Economic Crisis.

In recent posts, I have discussed the criticism of so-called austerity. In particular, I have highlighted how ongoing borrowing is being used to support the repayment of previous government borrowing, creating an unsustainable cycle of needing to borrow ever more. The logic of those who argue for more and more state borrowing appears sound until you examine what they really mean. If you would like to grasp the problems, you may wish to look at the post here, and also take a look at the insightful comments at the end.

The reason I talk about how history will view the economic crisis is because the economists who are calling for ever more borrowing (Krugman comes to mind as an exemplar) will argue that the depression that is here/about to arrive (depending on your reading of the current situation), was the fault of 'austerity'. If only governments had borrowed and spent more......all would have been well. The interesting thing about this is that, if you read the analysis of the causes of the Great Depression, there is a similar retrospective analysis. This then guides economic analysis of the current situation, as the aim of the borrow and spend economists is to use policy to avoid another Great Depression. However, just as in the future the analysis of the borrow and spend economists will be wrong, so is much analysis of the Great Depression that now guides their policy advice. Nevertheless, these economists have influence, with Bernanke for example being a 'scholar' of the Great Depression.

If the analysis of the Great Depression is as wrong (and I would argue that it is) as some economic analysis of the current situation, then their policy advice commences on flawed foundations. Furthermore, the current situation is very, very different from the period of the lead up to the Great Depression, such that using it as a guide is in any case questionable. For example, the rapid entry of the emerging economies into the world economy is a quite unique event. This is not to say that nothing can be learned from this period, but it must be remembered that the circumstances today are very different. Overall, it is therefore worrying that much of the policy advice today is founded on analysis of the Great Depression, and that analysis of the Great Depression will one day determining the analysis of the current crisis, and the analysis of the current crisis will then be used to support the previous analysis of the Great Depression. I am not sure I am making my point as well as I might, but I hope that you get the gist of it.

Update on Krugman Post

I am making a very quick post, as James Galbraith has responded to my last post on the Seeking Alpha version of the post. I have copied the response below:

On the matter of my beliefs. Krugman's quote from me was this:

"So long as U.S. banks are required to accept U.S. government checks — which is to say so long as the Republic exists — then the government can and does spend without borrowing, if it chooses to do so … Insolvency, bankruptcy, or even higher real interest rates are not among the actual risks to this system."

Read it again with the *very next sentence* included:

"So long as U.S. banks are required to accept U.S. government checks — which is to say so long as the Republic exists — then the government can and does spend without borrowing, if it chooses to do so … Insolvency, bankruptcy, or even higher real interest rates are not among the actual risks to this system. The actual risks in this system are (to a minor degree) inflation, and to a larger degree, depreciation of the dollar."

Does this help resolve what I "appear to believe."? I trust so. What I actually believe is now so thoroughly on the record, there really is no excuse for writing about it without getting it right.

Thank you. James Galbraith

I have, of course, copied this over as James Galbraith should be in a position to set the record straight on what his actual views are.

Who will be Paying the Bills?

My last two posts have prompted a lively debate on the blog, and it is interesting to see how the debate parallels that which is taking place around the world. The G20 and G8 summits appear to be seeing the same divisions, with Obama on one side encouraging continuance of massive deficit spending, and the Canadian and many Europeans (e.g. Merkel, Cameron, Borroso) saying that the deficit spending has gone far enough (or perhaps already too far). This is from the Guardian:

Signs of deep rifts at the G8 and G20 summits in Toronto over how quickly governments should cut deficits added to financial market jitters today, with the Americans warning of the dangers of a double dip recession if all countries started to rein back spending at once.

The leading European economies, especially Germany, are putting a new emphasis on cutting back government spending, and there is a possibility that a G20 communique, due to be released on Sunday , will set out an indicative timetable of how far and fast countries should retrench spending.

David Cameron, making his first appearance at a world summit and packing in a frantic round of bilaterals to start building personal relations, was praised by the summits' host for his deficit slashing budget earlier this week.

The Canadian prime minister, Steve Harper, said that he welcomed Cameron's responsible and difficult decisions, saying the British prime minister's budget "had raised the very fiscal consolidation agenda that we are trying to steer the G20 towards".

Canada wants the G20 to endorse the idea that national deficits should be halved by 2013.

I highlight this, as the gap between the US approach to deficit spending and that of (for example) Germany can not be wider. There is a major fracture in the perspectives on economics between different countries.

The problem is that, there is no opportunity for either side to ever prove itself right, except through enacting their different approaches. However, in one respect, the Obama camp will be proven correct. That is, if there is a major move towards cutting of expenditure, a recession will almost certainly be the outcome. This will then give them an opportunity to say 'I told you so' and blame the problem on the cuts.

What we will never actually see, is what happens next if countries continue to rack up huge deficits, and the dangers that might flow from this enactment of policy. It will allow history to be rewritten to say that, had the spending continued, then the world would economy would have recovered, and all would have been well.

Set against this, I would point to the following article, which points to the underlying change in the world economy, a change which I have continually highlighted on this blog as inevitable, and the real driver behind the economic crisis:

Ten years ago, the world’s richest countries accounted for a significant majority of the globe’s economic activity. But the pendulum is swinging in the other direction, according to the Organization for Economic Cooperation and Development.

A new O.E.C.D. report finds that rich countries and poor countries now each contribute about an equal share of the global economy. And by 2030, developing countries will account for 57 percent of world G.D.P.

This has been at the heart of the thesis of this blog. The world has changed; the distribution of wealth in the world is changing, and it means that the developed world is no longer in the position where it might assume eternal wealth. We are now at the stage where month by month, we can see the reality of the change, and the attempts by many developed countries to turn back the reality failing. My argument, since before even starting to write this blog, has been that, for over a decade, we have misconstrued apparent economic growth for real economic growth. This is the view of the Economist:

Throughout the 1980s and 1990s a rise in debt levels accompanied what economists called the “great moderation”, when growth was steady and unemployment and inflation remained low. No longer did Western banks have to raise rates to halt consumer booms. By the early 2000s a vast international scheme of vendor financing had been created. China and the oil exporters amassed current-account surpluses and then lent the money back to the developed world so it could keep buying their goods.

Those who cautioned against rising debt levels were dismissed as doom-mongers; after all, asset prices were rising even faster, so balance-sheets looked healthy. And with the economy buoyant, debtors could afford to meet their interest payments without defaulting. In short, it paid to borrow and it paid to lend.

I was one of the doom-mongers when I first started writing about the economy. I was seen as (at best) a part of a mad fringe, but today we see the Economist saying exactly what I was saying long ago. However, even now, the problem remains that growth in debt is still mistaken for economic growth, and I despair of the mainstream ever 'getting' the distinction.

At this stage, it is worth offering a perspective on the scale and depth of the existing levels of debt in the developed world. The Economist has a special feature on indebtedness and produced the following chart which ranks countries by debt sustainability (sorry about the size):

I strongly recommend taking a look at the interactive debt chart at the Economist here (sorry, can not be reproduced here). They follow their chart with this commentary:

THE headlines are all about sovereign debt at the moment. But that is only part of the problem. Debt has risen across the economy, from consumers on credit cards, though industrial companies borrowing for expansion and financial companies using debt to buy risky assets.

The interactive graphic above [in the Economist article] shows the overall debt levels for a wide range of countries, based on data supplied by the McKinsey Global Institute. In theory there is no maximum level for debt relative to GDP, but Ireland and Iceland (not on this map) found the limit in practice when they hit eight-to-ten times GDP.

The massive debt accumulation does not tell the whole story. What we can see is that the debt is simply being used for consumption. It is not creating growth, but is leading to diminishing returns in growth - in other words, the real growth is taking place outside of the developed world, and the developed world is just living off that real growth. The chart below from the Economist tells the story:

What this chart shows is the reality that has long been the subject of this blog, including in a recent post on post-Keynesianism. The money that is being borrowed and thrown into developed world economies is not producing a return. I made a comparison with China, where the government spending can make a return. It is very clear from the chart that borrowing more is not the answer (I know that the post-Keynesians will claim that their kind of borrowing and spending will be different....but see my post for why it will not).

However, it is quite possible for the US, for example, to continue to borrow from the new wealth creating countries and the oil states and appear to continue to be relatively prosperous. However, underneath such apparent prosperity is the reality that there are now the emerging economies that are being coming increasingly competitive, and taking a greater share of global wealth. Countries like China and India commenced with low end, low added value goods, but are rapidly rising up the value chain, and are starting to compete in the higher added value segments. The emerging economies will increasingly be meeting the developed world in the market for higher added value goods and services, and the developing world will win market share.

This leads to the question of whether there will be a miracle of a return to the pre-crisis 'normality'. Can the developed world return to past levels of wealth, at the same time as new and aggressive entrants are entering into more segments of the world market. The Obama solution is built on the believe that, at some point in the future, growth in the economies of the developed world will return, and this will then allow for the existing economic structures to be maintained, and at the same time producing enough growth to repay debts accumulated now. After all, this has been what has taken place following previous recessions.

This view ignores the changes that are taking place in the apportionment of wealth, and also ignores internal factors that will further diminish potential for wealth creation, as well as the problem of structural entitlement programmes that will push up costs and diminish the ability to pay down debt. The first problem is one I have already discussed, the second and third are resultant from the basic demographic problem of ageing populations. In order for developed countries to simply stand still, there would need to be a significant productivity miracle, which will allow a shrinking workforce to support a growing population of retired people. The problem is that the developed world is not standing still, but is falling backwards.

If government borrowing and spending is removed from the equation, it is apparent that the economies of most developed countries are facing reversals in wealth as a result of the competition from the emerging economies. I think I might now be in a position where, when discussing the economic growth in the pre-crisis decade, few would propose that there was an underlying increase in the wealth, but rather an illusion of wealth created by debt. Since the crisis commenced, governments have replaced this debt with government debt, and this can only be sustained for so long. What this creates is a moment in time where existing economic structures might be retained, but no more than that.

In order for the changes in both the internal and external environments to be accommodated in the medium to long term, something must change. On the one hand, in response to the internal changes, there is the choice of using ever greater taxation to pay for the costs of a growing pool of retired people from a diminishing workforce. This would place a significant burden on the upcoming generation, whose potential for a 'good' lifestyle would be diminished through significantly higher taxation. Alternatively, the structure of the economy might be reformed through the reduction in entitlement programmes, or through allocation of funding now to support future entitlement programmes. At present, however, the assumption is that 'growth' will allow these entitlement programmes to proceed without any action now, or negative consequences on the upcoming generation.

Furthermore, when considering these future increases in costs from a shrinking tax base, they will also need to service the debts that are being accumulated in the present. As such, in addition to having to service the cost of a growing retired population, the shrunken tax base must also apportion more of their income in order to service debt. As such, there seems to be a huge assumption that either the upcoming generation are going to be hugely more productive than the previous generation and / or they will be willing to see much higher tax levels than the previous generation.

Furthermore, developing economies such as China are also major lenders into many of the developed economies, meaning that, as they continue to develop, they will have access to future resources and output of the developed world as they continue their growth, possibly allowing for an accelerated rate of growth. The upcoming generation must therefore achieve all of this as the emerging economies continue to grow their share of the economy, and move ever further up the value chain in competition with developed economies. I am now not alone in this point of view, and again from the Economist:

But in parts of the rich world such optimism may now be misplaced. With ageing populations and shrinking workforces, their economies may grow more slowly than they have done in the past. They may have borrowed from the future, using debt to enjoy a standard of living that is unsustainable. Greece provides a stark example. Standard & Poor’s, a rating agency, estimates that its GDP will not regain its 2008 level until 2017.

Rising government debt is a Ponzi scheme that requires an ever-growing population to assume the burden—unless some deus ex machina, such as a technological breakthrough, can boost growth. As Roland Nash, head of research at Renaissance Capital, an investment bank, puts it: “Can the West, with its regulated industry, uncompetitive labour and large government, afford its borrowing-funded living standards and increasingly expensive public sectors?”

Some of the commentators on the blog might note the use of the expression Ponzi scheme, as there has been a debate in the comments section of the blog on just this subject. The point is that there is no way in the world that the current economic structure of the developed world can be maintained. I have asked, and asked and asked where the real growth might come from to support developed world economies. It now seems that even the mainstream is coming to this question, and it is about time.

As such, when we look at the current debate, we can see two simple divisions. On the one side, there are a series of assumptions that there will be a growth miracle that will outstrip the results of demographic change in a world of increasing competition. On the other side is an assumption that something must be done now to accommodate the changes in the world. The consequence of the former, barring a miracle in productivity, is that the upcoming generation are going to be saddled with huge burdens, even assuming that the borrowing might be sustained into the near future.

On the other hand, the consequences of cutting now is to commence a process of realigning the economy to the actual wealth creating potential of the economy, and starting to face the problems that are rapidly accumulating. At its most basic, it is accepting that there needs to be a restructuring now, rather than imposing a huge (and probably in reality an unsustainable) burden on the future. I believe that, in the past, I commented on another Economist article that pointed out that, in the future, there will be a conflict of interest between the generations. The current debate about continuing of spending versus cutting now is in reality exactly this debate.

I have always realised that, if governments cut now, the consequence will be shrinking economies. I have never seen any way out, except to take this 'pain' sooner or later. However, I have always argued that sooner is better than later, as the accumulation of debt can only compound the existing problems. No doubt, if governments manage to really cut now (and that is still uncertain), then we will later see retrospective history claiming that the cuts were responsible for future problems that will indeed arise. However, such a perspective would be to ignore the real changes in the world economic structure, and these changes are not of the sort that can be wished away or ignored. The choices are simple, and the choices are 'who pays, and when?'

Notes:

A long time ago I wrote some posts which proposed reforms which would try to maintain the essential underlying principles of several entitlement programmes in the UK (e.g. NHS, Education and Benefits) . I wrote them from a basic principle; that we could not afford the current structures going forwards. I sought to balance the underlying social and political demands with the coming shrinking of wealth. What we are now seeing is the discussion of necessary cuts, and I can only hope that these are undertaken in conjunction with the necessity for reform of the systems themselves.

What I would like to see is that, in the recognition of the difficulties ahead, that those in the future might enjoy something similar to what we (in the UK) have grown used to. In other words, the same underlying protections but pared down to achieve the original basic principles at the time of the establishment of the benefits. In addition to cuts, it is therefore necessary to reform, and I hope that this is the next phase in the transition. Unfortunately, since the time of writing the proposed reforms, governments have racked up ever greater debts, making it ever less possible to achieve this goal. This is why I have, since the start of this blog, argued against government borrowing.

As a further note to US readers, the examples of reform I give might seem to be puzzling in the context of the US experience. I am a firm believer that safety nets, education, and health care should be available to people, and you will see in the examples methods that might allow for these to be achieved in the context of the UK's history and situation.