Tuesday, June 14, 2011

Doom and The Gloom with a flicker of light

I read a couple of lengthy economic pieces that are on unrelated topics, but dovetail together to at least bring a little optimism to the table.  Both are relatively long, the excerpts are long but they only touch on the matters they discuss.  I will go to the more immediately topical first.

The Endgame Headwinds

John Mauldin, guest writing at the Big Picture

I have written repeatedly about the Endgame in the weekly letter, as well as in a New York Times best-seller on the same topic. By Endgame I mean the period of time in which many of the developed economies of the world will either willingly deleverage or be forced to do so. This age of deleveraging will produce a fundamentally different economic environment, which the McKinsey study referenced below suggests will last anywhere from 4-6 years. Now, whether this deleveraging is orderly, as now appears to be the case in Britain, or more resembles what I have long predicted will be a violent default in Greece, it will create a profoundly different economic world from the one we have lived in for 60 years
So many leaders in so many countries think that with the right policies they can grow (export) their way out of the problem. As I have written, not everyone can grow their way out of a crisis at the same time. Someone has to buy.
There is rule in economics: If something can’t happen, it won’t happen. That may seem obvious, but so many people think the current linear trend can go on forever.
Look at the projected debt for the US, compiled last year by the Heritage Foundation, based on realistic assumptions, not with rose-colored glasses. This is a chart of something that will not happen. Long before we get ten years of multi-trillion-dollar debt, the bond market will being to require much higher rates than we currently experience, driving up the interest-rate cost as a percentage of tax revenues to very painful levels, forcing cuts in all sorts of things we currently think of as absolutely necessary, like military, education, and Medicare spending…
Let’s quickly look at a few basic economic equations. The first is GDP = C + I + G + net exports, or GDP is equal to Consumption (Consumer and Business) + Investment + Government Spending + Net Exports (Exports – Imports). This is true for all times and countries…
There are only two ways to grow an economy. Just two. You can increase the working-age population or you can increase productivity. That’s it. No secret sauce. The key is for us to figure out how to increase productivity. Let’s refer to the last equation…
The I in the equation is investments. That is what produces the tools and businesses that make “stuff” and buy and sell services. Increasing the government spending, “G”, does not increase productivity. It transfers taxes taken from one sector of the economy and gives them to another, with a cost of transfer, of course. While the people who get the transfer payments and services certainly feel better off, those who pay taxes have less to invest in private businesses that actually increase productivity. As I have shown elsewhere, over the last two decades, net new jobs in the US have come from business start-ups. Not large businesses (they are a net drag) and not even small businesses. Understand, some of those start-ups become Google and Microsoft, etc. But many just become small businesses, hiring 5-10-50-100 people, but the cumulative effect is growth in the economy and productivity.
Now, if you mess with our equation, what you find is that
Savings = Investments.
If the government “dis-saves” or runs deficits, it takes away potential savings from private investments. That money has to come from somewhere. Of late, it has come from QE2, but that is going away soon. And again, let’s be very clear. It is private investment that increases productivity, which allows for growth which produces jobs. Yes, if the government takes money from one group and employs another, those are real jobs, but that is money that could have been put to use in private business. It is the government saying we know how to create jobs better than the taxpayers and businesses we take the taxes from.
This is not to argue against government and taxes. There are true roles for government. The discussion we must now have is how much government we want, and recognize there are costs to large government involvement in the economy…

The Rate and Direction of Invention in the British Industrial Revolution: Incentives and Institutions  or for direct to pdf, Ralf Meisenzahl, Joel Mokyr, Rate and Direction of Inventive Activity, 2011.

Are there any policy lessons from this for our age? The one obvious conclusion one can draw from this is that a few thousand individuals may have played a crucial role in the technological transformation of the British economy and carried the Industrial Revolution. The average level of human capital in Britain, as measured by mean literacy rates, school attendance, and even the number of people attending institutes of higher education are often regarded as surprising low for an industrial leader….what counted most were the characteristics of the top few percentiles of highly skilled and dexterous mechanics and instrument-makers, mill-wrights, hardware makers, and similar artisans.

Finally, the supply of competence reminds us of something rather central about the direction of innovation, which seems very generally relevant. The direction is dependent on those supply factors that reflect what engineers and skilled workers actually can do regardless of what they would like to do. The drive toward improvement was quite general in the eighteenth century, but the results were highly uneven, with major productivity improvements in textiles, iron, civil engineering, and power technology, but few in farming, medicine, steel, chemicals, and communications. These reflected the difficulties on the supply side rather than any obvious demand-side bias. Competence as defined here was an integral part of the supply side, as inventors would not be able to carry out their ideas without the trained workers they employed.

So what you have is a pessimistic prediction of future activity, based on our current situation.  It does not deal with resource constraints, or the potential slowing of the innovative growth rate, but it is about as pessimistic as a someone selling within the mainstream market is likely to get.

But the second piece does give us some grounds for hope.  As Mr. Mauldin noted, productivity gets you out of the soup ; you are not going to get more productive than the industrial revolution.  The industrial revolution was not lead by the Titans of the day, but by a small island country, with a relatively small population, that on the whole was not better educated than their primary competitors.  They simply had a small (3% of workforce) cadre of people who at the cutting edge of their technology were untouched by anyone else.  It was not exactly an accident, but they had an awful lot of people in the right place and the right time.

For the world, this is encouraging news.  China makes garbage, and we are so ossified as an economy and political system that improvements from the system as a whole seem unlikely.  Many leading edge countries/empires have plataued and lost their progressive edge over time.  But as Britain showed in the 18th and 19th centuries, you don’t need a Titan to push through major technological change.

What that change may be of course is unknown at this point: Genetically modified people, space stationed solar collectors….  But if you are going to find it, look for a cohesive elite working under limited restrictions:  "Calling all mad scientists, please report to the front desk".

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