The continued economic decline of the west
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The continued economic decline of the west The continued economic decline of the west Presentation Transcript

  • The continued economicdecline of the WestDiagnosis and prognosisJon Moynihan23 February 2012
  • The continued economic decline of the West The challenge Potential actions Likely outcomes© PA Knowledge Limited 2012 Page 2
  • How has the West’s economic decline happened? Will it continue? Real GDP per capita Real GDP per capita Change from 2007 to 2012 (forecast), % (1992 = 100)United Kingdom 550 520 United States 490 460 Japan 430 400 China France 370 India 340 United Kingdom Germany 310 United States Russia 280 250 Germany Brazil 220 Japan 190 Brazil India 160 130 China 100 70 -20 0 20 40 60 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010Source: IMF.© PA Knowledge Limited 2012 Page 3
  • There are many competing explanations, some more persuasive than others: 5-Year CDS of Eurozone countries vs. percentage of men living with parents 3500 Greece 5Y CDS of founding Eurozone countries 3000 2500 2000 1500 Portugal 1000 Ireland Italy 500 France Belgium Spain Finland Germany Austria 0 Netherlands 0 10 20 30 40 50 60 % of men aged 25-34 living with parents R2 = 0.75282Source: EuroStat, Bloomberg, via Boaz Weinstein, Saba Capital. © PA Knowledge Limited 2012 Page 4
  • The central dilemma facing ‘Western’ economies: The paradigm The paradigm for the 1900s for the 2000s Average annual growth in 2% Negative number of jobs: Average annual growth in real 3% Negative wages:© PA Knowledge Limited 2012 Page 5
  • The continued economic decline of the West The challenge Potential actions Likely outcomes Ineffectual Global wage Poor allocation of governments and ‘Entitled’ groups disparity tax monies credulous voters© PA Knowledge Limited 2012 Page 6
  • A global wage disparity… The global wage disparity, potentiated by the global adoption of capitalism, is driving an unprecedented loss of wealth and growth for the Western economies. Wage disparities between OECD and emerging With no job As a result, a job The jobs drained supply, i.e. less countries result drain continues are not returning; demand for in an almost and is indeed rather, more will labour, wages in insuperable accelerating. be lost. the OECD must competitive inevitably fall. advantage for the ‘East’*.* Includes Brazil etc. © PA Knowledge Limited 2012 Page 7
  • A global wage disparity… This jobs drain is taking place, driven by the wage disparities that exist between West and East: Advanced Developing Waiting to Economies1 Economies urbanise (urban)2 (rural)2 Labour pool 500 million 1.1 billion 1.3 billion $135 $12 Average daily wage $1-2? (OECD, 2010) (China, 2008) “Alarmist” worries about this were dismissed as overblown, even as many millions of jobs migrated (indeed continue to migrate) from OECD to Third World 1995-2011.Sources: 1 OECD; 2 Estimated: UN World Urbanization Prospects, 15-64 year olds, assuming 65% LFPR.© PA Knowledge Limited 2012 Page 8
  • A global wage disparity… The global wage disparity, potentiated by the global adoption of capitalism, is driving an unprecedented loss of wealth and growth for the Western economies. Wage disparities between OECD and emerging With no job As a result, a job The jobs drained supply, i.e. less countries result drain continues are not returning; demand for in an almost and is indeed rather, more will labour, wages in insuperable accelerating. be lost. the OECD must competitive inevitably fall. advantage for the ‘East’.© PA Knowledge Limited 2012 Page 9
  • A jobs drain continues… Since globalisation began in earnest in the 1990s, OECD economies have, despite government stimulus policies, been unable to sustain rates of job growth: Total employment (1983=100) Europe USA160 160150 150140 140130 130120 120110 110100 100 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 Source: OECD© PA Knowledge Limited 2012 Page 10
  • A jobs drain continues… The last decade was the first decade since the Great Depression to see no net job creation in the US: Compound annual jobs US job growth by decade, 1940s – 2000s growth by decade (%) 3.5% change in non-farm payroll employment (%) 45 40 1940s, 37.7% 3 35 1960s, 31.1% 30 2.5 1970s, 27.6% 25 1950s, 24.7% 2 1980s, 20.2% 20 1990s, 19.8% 15 1.5 10 1 5 0 2000s, -1.1% 0.5 -5 0 1 2 3 4 5 6 7 8 9 10 0 40s 50s 60s 70s 80s 90s 00s Year in decade -0.5 © PA Knowledge Limited 2012 Page 11
  • A jobs drain continues… Wages have increased for those with the most education, while falling for those with the least: Changes in wages for full-time, full-year male U.S. workers 1963-2008 190 180 Graduate school 170 160 150 140 College graduate 130 120 110 Some college 100 High school graduate 90 High school dropout 1963 1965 1967 1969 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007Source: Acemoglu and Autor (MIT), Skills, Tasks and Technologies: Implications for Employment and Earnings (2010). © PA Knowledge Limited 2012 Page 12
  • In 1955, the biggest company in the world by value was GM A jobs drain continues… (revenues: $105bn).* Today it is Apple (revenues: $108bn). Employment patterns have, however, changed somewhat: US employees Overseas employees Overseas contractors 800000 700000 600000 500000 400000 300000 200000 100000 0 GM 1955 Apple 2012* At 2011 prices. At 1955 prices, revenues were $12.5bn. © PA Knowledge Limited 2012 Page 13
  • A jobs drain continues… The US labour market is the most flexible in the world. Unlike in previous recessions, it looks as if lots of these jobs are not coming back: Percent job losses in US recessions 1974 1980 1981 1990 2001 2007 1 0-1-2-3-4-5-6 6 million jobs lost 9 million jobs lost-7 1 2 3 4 Number of years after peak employment© PA Knowledge Limited 2012 Page 14
  • A jobs drain continues… Whole industries – the ones the West was built on – are disappearing to the East: Crude steel production (megatons) China USA Europe 800000 700000 600000 500000 400000 300000 200000 100000 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source: World Steel Association.© PA Knowledge Limited 2012 Page 15
  • A jobs drain continues… Whole industries – the ones the West was built on – are disappearing to the East: The commodity car industry is going the same way. Luxury cars will take slightly longer: Car production USA Japan Europe China 25,000,000 20,000,000 15,000,000 10,000,000 5,000,000 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: International Organization of Motor Vehicle Manufacturers.© PA Knowledge Limited 2012 Page 16
  • A jobs drain continues… With each stage of advancement up the industrial ladder in the East, there is a corresponding jobs drain from the West: The industrial development cycle: from delivery to creation Low education Professional Scientific and Other high Low capital Medium and services creative know-how investment high capital Financial intensity Design High-tech IP Low know-how services Know-how Entrepreneurialism Steel è Auto Legal Light manufacturing Ecosystem growth Venture capital Accounting Assembly Cash surpluses in developing Time We are here countries Western hostility to high earners Critical mass Innovation centres ecosystems Enablers of (universities) advancement: Education© PA Knowledge Limited 2012 Page 17
  • A global wage disparity… The global wage disparity, potentiated by the global adoption of capitalism, is driving an unprecedented loss of wealth and growth for the Western economies. Wage disparities between OECD and emerging With no job As a result, a job The jobs drained supply, i.e. less countries result drain continues are not returning; demand for in an almost and is indeed rather, more will labour, wages in insuperable accelerating. be lost. the OECD must competitive inevitably fall. advantage for the ‘East’.© PA Knowledge Limited 2012 Page 18
  • The jobs are not returning… At the same time, our own competitive advantages are steadily crumbling: Competitive wage rates Unfeasible Existing physical and intellectual Half-life is some capital base 10-15 years Barriers that Propensity to invest new capital could prevent job loss from the West to Encouragement of VCs the East and entrepreneurs Existing IP Ability to generate IP© PA Knowledge Limited 2012 Page 19
  • The jobs are not returning… China has been investing almost half its GDP, while the West barely invests a fifth: Gross capital formation (% of GDP)605040302010 0 1970 1975 1980 1985 1990 1995 2000 2005 2010 China United Kingdom United States Source: World Bank© PA Knowledge Limited 2012 Page 20
  • The jobs are not returning… “Just catching up”? Wuhan Liverpool St Hongqiao King’s Cross© PA Knowledge Limited 2012 Page 21
  • The jobs are not returning… Competitive wage rates Unfeasible Existing physical and intellectual Half-life is some capital base 10-15 years Barriers that Propensity to invest new capital Vanishing could prevent job loss from the West to Encouragement of VCs the East and entrepreneurs Existing IP Ability to generate IP© PA Knowledge Limited 2012 Page 22
  • The jobs are not returning… Western attitudes to high earners contrasts with some other countries: “We need to get tough on irresponsible and unjustified top remuneration” Nick Clegg, UK Deputy Prime Minister “To get rich is glorious” 致富光荣 zhìfù guāngróng Deng Xiaoping, Former Leader of the People’s Republic of China© PA Knowledge Limited 2012 Page 23
  • The jobs are not returning… Competitive wage rates Unfeasible Existing physical and intellectual Half-life is some capital base 10-15 years Barriers that Propensity to invest new capital Vanishing could prevent job loss from the West to Encouragement of VCs Western hostility the East and entrepreneurs to high earners Existing IP Ability to generate IP© PA Knowledge Limited 2012 Page 24
  • The jobs are not returning… The West has been haemorrhaging intellectual property, with little sign of abatement: Global value of counterfeit and pirated goods (2015): $1.5 trillion… Known jobs lost due to counterfeiting and piracy: 2.5 million. Source: Frontier Economics, Estimating the global economic and social impacts of counterfeiting and piracy (Feb 2011) “The Chinese government has a national policy of economic espionage in cyberspace… Although a rigorous assessment has not been done, we think it is safe to say [this] easily means billions of dollars and millions of jobs. ” Source: Mike McConnell, Director of National Intelligence (2007-09), Michael Chertoff, Secretary of Homeland Security (2005-09), William Lynn, Deputy Secretary of Defense (2009-11), Wall Street Journal (Jan 27 2012)© PA Knowledge Limited 2012 Page 25
  • The jobs are not returning… Competitive wage rates Unfeasible Existing physical and intellectual Half-life is some capital base 10-15 years Barriers that Propensity to invest new capital Vanishing could prevent job loss from the West to Encouragement of VCs Western hostility the East and entrepreneurs to high earners Cyber and Existing IP physical theft Ability to generate IP© PA Knowledge Limited 2012 Page 26
  • The jobs are not returning… A fifth of Western school leavers are functionally illiterate: Percentage of students who do not attain the essential reading skills needed to participate productively in society 30 25 20 15 10 5 0 Source: OECD PISA 2009.© PA Knowledge Limited 2012 Page 27
  • The jobs are not returning… The Chinese take advantage of the best education in the West: 1978 - 2007 Number of Chinese students studying abroad Number of Chinese students returning home160000 50000140000 45000 40000120000 35000100000 30000 80000 25000 60000 20000 15000 40000 10000 20000 5000 0 0 1978 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 1978 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007Source: National Bureau of Statistics of China, 2009; Tina Hsieh and Ershad Ali, Auckland Institute of Studies. “When our thousands of Chinese students abroad return home, you will see how China will transform itself.” Deng Xiaoping, Former Leader of the People’s Republic of China© PA Knowledge Limited 2012 Page 28
  • The jobs are not returning… And, indeed, they are innovating: Patents granted to China Global percentage of patents granted to 90,000 China 10 80,000 9 70,000 8 60,000 7 50,000 6 40,000 5 4 30,000 3 20,000 2 10,000 1 0 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 China’s universities graduate more than 10,000 science PhDs each year.Source: World Intellectual Property Organization, McKinsey Quarterly. © PA Knowledge Limited 2012 Page 29
  • The jobs are not returning… Competitive wage rates Unfeasible Existing physical and intellectual Half-life is some capital base 10-15 years Barriers that Propensity to invest new capital Vanishing could prevent job loss from the West to Encouragement of VCs Western hostility the East and entrepreneurs to high earners Cyber and Existing IP physical theft Collapsing Ability to generate IP education set-up© PA Knowledge Limited 2012 Page 30
  • A global wage disparity… A global wage disparity… The global wage disparity, potentiated by the global adoption of capitalism, is driving an unprecedented loss of wealth and growth for the Western economies. Wage disparities between OECD and emerging With no job As a result, a job The jobs drained supply, i.e. less countries result drain continues are not returning; demand for in an almost and is indeed rather, more will labour, wages in insuperable accelerating. be lost. the OECD must competitive inevitably fall. advantage for the ‘East’.© PA Knowledge Limited 2012 Page 31
  • OECD wages must fall… In the West, average wages have plummeted - from 3% real annual increases to 3% real annual declines: Average annual growth rates of real average wages 1995-2000 2001-07 2008-10 2011 4 3 2 1 0-1-2-3-4 United States United Kingdom Source: OECD; 2011: BLS and ONS.© PA Knowledge Limited 2012 Page 32
  • OECD wages must fall… Precisely as one would expect, it is the low- and medium-skilled workers who are losing out, while the most skilled retain their comparative advantage: Annual percentage change in nominal weekly pay in UK by pay percentile 2010 2011 2.5 2.5 2 2 1.5 1.5 1 1 0.5 0.5 0 0 -0.5 -0.5 -1 -1 -1.5 -1.5 10 20 30 40 50 60 70 80 90 10 20 30 40 50 60 70 80 90 Note that inflation in the UK has been 5%, so wages are in fact plummeting. Source: Annual Survey of Hours and Earnings (2009, 2010, 2011) UK Office for National Statistics.© PA Knowledge Limited 2012 Page 33
  • OECD wages must fall… We have every reason to think the trend will continue, leading to enormous downward adjustment, disruption and dislocation for Western workers: 2010 2020? Equilibrium Beyond price 2025* that? OECD daily wage $135 $100 $60 ? China/India daily wage $2-12 $20 ? Inflation and currency collapse seem to be the most likely ways by which this process will be managed in the medium term * Assumes annual world GDP growth rate of 5%; constant prices.© PA Knowledge Limited 2012 Page 34
  • The continued economic decline of the West The challenge Potential actions Likely outcomes Ineffectual Global wage Poor allocation of governments and ‘Entitled’ groups disparity tax monies credulous voters Starting with the Greenspan Put (1987), governments, corporates This has been elevated Continued indefinitely, and individuals have to a religion by the neo- this will destroy our sought to borrow to fund Keynesians. economies. the maintenance of an unmaintainable lifestyle.© PA Knowledge Limited 2012 Page 35
  • Ineffectual governments… Since 1987, the response to any economic downturn has been to flood the system with cheap money: Fed Rate25201510 5 0 36© PA Knowledge Limited 2012 Page 36
  • Ineffectual governments… For today’s Keynesians, there seems never to be a good time to run a surplus: Surpluses and deficits (% GDP) 6 4 2 0 -2 -4 -6 -8-10-12-14 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Japan United Kingdom United States Euro area Source: OECD.© PA Knowledge Limited 2012 Page 37
  • Ineffectual governments… The result of low interest rates (‘easy money’) and government deficits is staggering levels of debt: Total debt in selected countries around the world as percent of GDP Households  Nonfinancial business  Government  Financial Institutions  Ireland Japan PortugalUnited Kingdom Spain Greece France United States Italy Germany 0% 100% 200% 300% 400% 500% 600% 700%Source: McKinsey Global Institute (MGI), "Debt and deleveraging: Uneven progress on the path to growth," January 2012. “The relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more.” Reinhart and Rogoff, ‘Growth in a Time of Debt’, American Economic Review (May 2010) © PA Knowledge Limited 2012 Page 38
  • Ineffectual governments… All are agreed: we should spend our way out of this. “Unfortunately, with savings going up to 5, 6, 7 percent, aggregate demand is going to be weak. The only thing to fill it is government.” Joseph Stiglitz, Aug 4 2010 “Standard macroeconomic analysis, applied in a standard way, says that aggressive tightening of fiscal policy, of the kind we are seeing now, is inappropriate and unnecessary.” Jonathan Portes, New Statesman Aug 24 2011 “The idea, amazingly widely accepted, that the UK cannot borrow any more seems quite absurd.” Martin Wolf, Financial Times Nov 24 2011 “Isnt the truth of the matter, Mr Alexander, that you are collaborating in a doctrinaire Conservative experiment which is not working?” Jeremy Paxman, Newsnight Jan 25 2012 “That which cannot go on forever… wont.” Herb Steins Law© PA Knowledge Limited 2012 Page 39
  • Ineffectual governments… Indebtedness becomes a vicious downward spiral, Keynes à la grecque Consumer borrowing Starts with normal counter-cyclical deficit spending Corporate borrowing Spending proves sticky (civil servants, benefits culture, etc.) Banking borrowing Debt-to-GDP levels begin to rise, Credit market Government but below Reinhart/Rogoff levels rebellion leads deficit to financial Deficit spending distorts economy spending crisis Borrowing masks the problem Calamity exposes those without swimming costumes Greater Increase in funding stock of Deficits suddenly massive need debt Judgment day can be put off by devices such as QE (lowering the rate of interest) Keynesian monetary Higher level Keynesian voices warn against any pullback in tactics of interest spending as per prior point (e.g. QE) payments temporarily The pain of restructuring becomes increasingly lower interest impossible with every iteration rates Higher rate Worsened The doom loop accelerates of interest credit rating Voila! Greece goes to Argentina© PA Knowledge Limited 2012 Page 40
  • ‘Entitled’ groups… The problems are exacerbated by the claims made on shrinking Western economies by an oddly disparate set of ‘entitled’ groups: The continued economic decline of the West The challenge Potential actions Likely outcomes Ineffectual Global wage Poor allocation of governments and ‘Entitled’ groups disparity tax monies credulous voters Bankers CEOs Public sector Benefit claimants© PA Knowledge Limited 2012 Page 41
  • The problems are exacerbated by the claims made on shrinking Western economies by an oddly disparate set of ‘entitled’ groups: Bankers’ sources of excess profits (that also lead to massive socialised losses) Cheap funding from government stimulus Oligopoly in many markets (corporate lending, mortgages, credit cards) Foolish acceptance of high prices by customers where oligopoly does not exist Excessive leverage Inside trading knowledge Big bet culture Willingness of boards and shareholders to countenance excessive rewards, in particular, because the previous points create excessive profits© PA Knowledge Limited 2012 Page 42
  • Bankers… The financial sector has claimed a growing share of Western economies: Financial sector compensation and profits as share of GDP 1929 - 2010 8 7.6% 7 6.9% $547 billion in 2010 dollars Share of overall GDP (%) 6 3.8% 3.7% 5 4 3 2 1 0Source: Bureau of Economic Analysis (BEA) data on National Income and Product Accounts (NIPA), tables 1.1.5 and 1.1.4.© PA Knowledge Limited 2012 Page 43
  • Bankers… The excess profits in turn lead to excessive remuneration: Historical excess wage in the financial sector relative to nonfarm private sector, accounting for education level, skill premium and unemployment risk 40% 1933 Glass-Steagall Act 1933 Securities Act 1934 Securities Exchange Act 1939 Trust Indenture Act 1940 Investment Advisers Act 1940 Investment Company Act 1956 Banking Holding Company Act 30% 1980-84 Removed interest-rate ceilings (from Glass-Steagall Act) 1994 Riegle-Neal Interstate Banking & branching efficiency act (repeals parts of Bank Holding Co. Act) 1996 Investment Advisers Act amended 1999 Graham-Leach-Bliley Act (repealed Glass-Steagall & parts of Bank Holding Co. Act) 20% 2002 Sarbanes-Oxley Act 10% 0% 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010Source: Philippon and Reshef, Wages and Human Capital in the U.S. Financial Industry: 1909-2006 (2008).© PA Knowledge Limited 2012 Page 44
  • ‘Entitled’ groups… The problems are exacerbated by the claims made on shrinking Western economies by an oddly disparate set of ‘entitled’ groups: The continued economic decline of the West The challenge Potential actions Likely outcomes Ineffectual Global wage Poor allocation of governments and ‘Entitled’ groups disparity tax monies credulous voters Bankers CEOs Public sector Benefit claimants© PA Knowledge Limited 2012 Page 45
  • CEOs… CEOs in the US and the UK have also ‘captured’ their companies’ remuneration processes: Ratio of average annual CEO compensation to average worker compensation, 1965-2010 350 299-to-1 300 277-to-1 243-to-1 250 200 185-to-1 150 126-to-1 100 100-to-1 24-to-1 35-to-1 50 0 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Rectifying this would be important to ensure a cohesive society, but the impact will be limited (too few CEOs). Source: Adapted from Lawrence Mishel and Josh Bivens, Economic Policy Institute Briefing Paper #331 (2011).© PA Knowledge Limited 2012 Page 46
  • ‘Entitled’ groups… The problems are exacerbated by the claims made on shrinking Western economies by an oddly disparate set of ‘entitled’ groups: The continued economic decline of the West The challenge Potential actions Likely outcomes Ineffectual Global wage Poor allocation of governments and ‘Entitled’ groups disparity tax monies credulous voters Bankers CEOs Public sector Benefit claimants© PA Knowledge Limited 2012 Page 47
  • Public sector… With the exception of the highest skilled, public sector workers are significantly overpaid: Average public/private sector pay gap by qualification % Pay gap (public minus private sector) The government’s UK US (excluding pensions) (including pensions) own conclusion:8 406 30 “Allowing for [job]4 20 differences as far as2 10 possible, in April0 2010, public sector 0-2 employees were paid -10-4 on average 7.8 per-6 -20 cent more than-8 -30 private sector High School Some Bachelors Masters Prof. degree No qual. Other qual. GCSE A-C A-Level Higher ed. Degree Diploma college degree degree or PhD employees.”NB: UK analysis excludes pension contributions, so greatlyunderstates the already large pay gap (private sector companies mostlyno longer have DB schemes).Source: ONS, Estimating differences in public and private sector pay (July 2011); Source: ONS.CBO, Comparing the compensation of federal and private-sector employees (Jan 2012). © PA Knowledge Limited 2012 Page 48
  • Public sector workers are also getting less productive, while the private Public sector… sector company necessarily finds improvements, or closes down. Thus the public sector is becoming a heavier and heavier drag on the public purse: Annual growth in productivity in the UK (1997 = 100) Private Sector Public Sector 130 125 120 115 110 105 100 95 90 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Source: ONS, Estimating differences in public and private sector pay (July 2011).© PA Knowledge Limited 2012 Page 49
  • ‘Entitled’ groups… The problems are exacerbated by the claims made on shrinking Western economies by an oddly disparate set of ‘entitled’ groups: The continued economic decline of the West The challenge Potential actions Likely outcomes Ineffectual Global wage Poor allocation of governments and ‘Entitled’ groups disparity tax monies credulous voters Bankers CEOs Public sector Benefit claimants© PA Knowledge Limited 2012 Page 50
  • Benefit claimants… Real spending on welfare continues to outstrip GDP growth: Growth rates in GDP and welfare spending1200 CAG: 3.87%1000 800 600 CAG: 2.39% 400 200 0 Source: HMT, IFS Social Security GDP© PA Knowledge Limited 2012 Page 51
  • Under Blair and Brown, spending on benefits should have Benefit claimants… fallen as the economy boomed. It didn’t – becoming a redistribution rather than a safety net. UK welfare spending and unemployment 1974 - 2011 14.5 Welfare spending 12.0 13.5 (% GDP, LHS) 12.5 10.0 11.5 8.0 10.5 9.5 6.0 8.5 Unemployment rate 4.0 (%, RHS) 7.5 2.0 6.5 5.5 0.0 Source: HMT, IFS.© PA Knowledge Limited 2012 Page 52
  • Benefit claimants… The system really has broken: Caseload (1,000s) of working age clients by type of claim and duration (May 2011)30002500200015001000 500 0 Job Seeker ESA and Lone Parent Carer Others on Disabled Bereaved incapacity income related benefits benefit Up to 3 months 3-6 months 6-12 months 1-2 years 2-5 years 5 years and overSource: DWP.© PA Knowledge Limited 2012 Page 53
  • The cost is exacerbated by the large amount of Benefit claimants… money spent on those not in need, as the state seeks to develop a dependency mentality in its clients: Percentage of benefit expenditure going to middle class households 90 80 “With universal suffrage, it becomes impossibly 70 expensive to bribe all of the electorate.” 60 50 40 30 20 10 0 Maternity pay Child benefit Disability living Retirement Housing benefit Student support allowance pension 1998-99 2008-09 Source: Reform, The money-go-round (Oct 2010).© PA Knowledge Limited 2012 Page 54
  • Benefit claimants… Managing the welfare state is, in itself, a very expensive operation: Employees by Government Department (2011)140,000 Take your Give it back to money you120,000100,000 Manage Stop the climate 80,000 economy change 60,000 40,000 20,000 0 HMRC Department Home Department Department DEFRA Department HM DECC for Work Office for of Health for Treasury and Education Transport PensionsSource: ONS, DWP. DWP salaries in 2011: £3.5bn© PA Knowledge Limited 2012 Page 55
  • The continued economic decline of the West The challenge Potential actions Likely outcomes Ineffectual Global wage Poor allocation of governments and ‘Entitled’ groups disparity tax monies credulous voters© PA Knowledge Limited 2012 Page 56
  • Poor allocation… Since 1992, spending on health has ballooned (mostly on salaries), while growth in education spending has fallen behind: UK public spending (real £bn) NHS Education140.0 CAG: 4.89%120.0100.0 CAG: 3.14% 80.0 60.0 40.0 20.0 0.0 1953-54 1958-59 1963-64 1968-69 1973-74 1978-79 1983-84 1988-89 1993-94 1998-99 2003-04 2008-09Source: ONS. Compound annual growth calculated from crossover point (1993).© PA Knowledge Limited 2012 Page 57
  • The continued economic decline of the West The challenge Potential actions Likely outcomes Reorient Accept Reform the Develop new immediate cuts government Tax properly in living banks technologies spending standards© PA Knowledge Limited 2012 Page 58
  • Potential actions Reorient Accept Reform the Develop new immediate cuts government Tax properly in living banks technologies spending standards Education Infrastructure© PA Knowledge Limited 2012 Page 59
  • Reallocating public spending towards infrastructure and Reorient spending… education has a large and highly statistically significant effect on the long-run growth rate. Effect of public spending mix on the long-run growth rate 0.14 0.12 0.1 0.08 0.06 0.04 0.02 0 -0.02 Education and -0.04 infrastructure the key -0.06 Transp & Education Health Defence Econ Housing Gen. pub. Welfare Comms services servicesSource: Gemmell, N., Kneller, R. and I. Sanz, “The Composition of Government Expenditure andEconomic Growth: Some Evidence from OECD Countries”, European Economy (2008).© PA Knowledge Limited 2012 Page 60
  • Reorient spending… The importance the West assigns to good teachers has plummeted: Percentage of new American teachers who graduated in the upper third of their classes 100 90 80 70 60 50 40 30 20 10 0 1930 2012Source: McKinsey & Company, “Closing the talent gap” (2010); Milken Institute.© PA Knowledge Limited 2012 Page 61
  • Reorient spending… The strongest performers among high-income countries tend to invest more in teachers: 545 540 OECD analysis Korea Finland “In general, the 535 countries that perform 530 well in PISA attract theMean reading scores best students into the 525 teaching profession by 520 Japan offering them higher salaries and greater 515 Australia professional status. 510 High-performing Netherlands Belgium countries tend to 505 Norway prioritise investment in Poland 500 Estonia Iceland teachers over smaller United States classes.” 495 Source: 0 0.5 1 1.5 2 2.5 OECD Does Money Buy Ratio of teacher salaries to GDP per capita Strong Performance in PISA? R² = 0.61227 © PA Knowledge Limited 2012 Page 62
  • Reorient spending… Quality of teaching matters above all: Impact on student lifetime incomes by class size and teacher effectiveness (compared to average teacher) $1,000,000 90th percentile teacher Impact on student lifetime earnings $500,000 75th percentile teacher 60th percentile teacher $0 40th percentile teacher 25th percentile teacher -$500,000 10th percentile teacher -$1,000,000 Class sizeSource: Raj Chetty (Harvard), John N. Friedman (HKS), and Jonah E. Rockoff (Columbia), The Long-Term Impacts ofTeachers: Teacher Value-Added and Student Outcomes in Adulthood, NBER Working Paper No. 17699 (Jan 2012).© PA Knowledge Limited 2012 Page 63
  • Reorient spending… Quality of teaching matters above all: A teacher one standard deviation above the mean effectiveness annually generates marginal gains of over $400,000 in present value of student future earnings with a class size of 20 and proportionately higher with larger class sizes. Alternatively, replacing the bottom 5-8 percent of teachers with average teachers could move the U.S. near the top of international math and science rankings with a present value of $100 trillion. Source: Eric A. Hanushek (Stanford), The Economic Value of Higher Teacher Quality, NBER Working Paper No. 16606 (Dec 2010).© PA Knowledge Limited 2012 Page 64
  • Reorient spending… Quality of teaching matters above all: Replacing a teacher whose value added is in the bottom 5% with an average teacher would increase the present value of students’ lifetime income by more than $250,000 for the average classroom. Source: Raj Chetty (Harvard), John N. Friedman (HKS), and Jonah E. Rockoff (Columbia), The Long-Term Impacts of Teachers: Teacher Value-Added and Student Outcomes in Adulthood, NBER Working Paper No. 17699 (Jan 2012).© PA Knowledge Limited 2012 Page 65
  • Reorient spending… Quality of teaching matters above all: With an annual discount rate of 5%, the parents of a classroom of average size should be willing to pool resources and pay an 84th percentile teacher considering quitting approximately $130,000 ($4,600 per parent) to stay and teach their children during the next school year. Source: Raj Chetty (Harvard), John N. Friedman (HKS), and Jonah E. Rockoff (Columbia), The Long-Term Impacts of Teachers: Teacher Value-Added and Student Outcomes in Adulthood, NBER Working Paper No. 17699 (Jan 2012).© PA Knowledge Limited 2012 Page 66
  • Potential actions Reorient Accept Reform the Develop new immediate cuts government Tax properly in living banks technologies spending standards Education Infrastructure© PA Knowledge Limited 2012 Page 67
  • Reorient spending… Opportunities for high-return infrastructure investment abound: Infrastructure needs in the US Exemplary infrastructure needs in the UK US infrastructure ‘GPA’ Wolfson’s ‘Brain Belt’ Oxford-Cambridge motorway/science ecosystem A B C D nil nil Solid waste (+) Energy (+) Other university/science/business ecosystem infrastructure Bridges Aviation Public parks and Dams Manchester-Sheffield motorway recreation (-) Hazardous waste Rail (-) Schools Other removal of congestion through building new Transit roads and improving efficiency of existing roads Drinking water (-) Inland waterways (-) Local bypasses Levees (-) Roads (-) Boris Island Wastewater (-)Source: American Society of Civil Engineers. Universal WiMAX or fibre broadband © PA Knowledge Limited 2012 Page 68
  • Potential actions Reorient Accept Reform the Develop new immediate cuts government Tax properly in living banks technologies spending standards© PA Knowledge Limited 2012 Page 69
  • Reform the banks… The multiple ways in which banks make excess profits, and how that might be reversed: Foolish acceptance Oligopoly in many of high prices andCheap funding from markets (corporate risk by customers government Inside trading Excessive lending, mortgages, Excessive leverage* knowledge Big bet culture remuneration even where stimulus credit cards) oligopoly does not exist Make them pay for Get customers to Require more that through tax, Break them up behave better and capital Require more Pressure the think harder Ban front running capital banks levies, ringfencing bonuses Ban abuse of Manage regulators (for retail) Educate derivatives: better better the populace and regulation Throttle or tax Better Split commercial force far more, and flash trading Reform board from trading; don’t Prevent transparency on better disclosure behaviour subsidise trading/ Remove too big to concealment of daily exposures investment banking fail true size of assets; punish auditors for allowing OBS Enforce insider Pass ‘duty of care’ trading laws Pressure legislation vehicles Remove profit investing element of institutions subsidies Prevent other arbitrage of capital regulation Ban exploitative behaviour Possible progress Manage ratings agencies better Only slow progress Eliminate politically Essentially no progress biased decision making * Traditional high beta in trading business. Manage auditors better© PA Knowledge Limited 2012 Page 70
  • Potential actions Reorient Accept Reform the Develop new immediate cuts government Tax properly in living banks technologies spending standards© PA Knowledge Limited 2012 Page 71
  • Tax properly… Taxes affect the determinants of growth: Labour utilisation •  Employment •  Hours worked Taxes •  Consumption •  Property GDP per capita •  Income •  Corporate Labour productivity •  Physical capital •  Human capital •  Total factor productivity© PA Knowledge Limited 2012 Page 72
  • Tax properly… A significant reorientation of tax policy to less populist methods is needed: Effects of the tax mix on long-run GDP per capita Corporate income taxes Personal income taxes Consumption taxes Property taxes 2 1.5 1 0.5 0 -0.5 -1 -1.5 -2 -2.5 Source: OECD* Note that punitive taxes on the richest don’t help much as the base is always relatively small.© PA Knowledge Limited 2012 Page 73
  • Potential actions Reorient Accept Reform the Develop new immediate cuts government Tax properly in living banks technologies spending standards Help industry ecosystems Encourage development Support manufacturing to flourish of new technologies© PA Knowledge Limited 2012 Page 74
  • Manufacturing… Consensus states that manufacturing is no more important than any other sector of the economy: “Obama’s surrender to the ‘manufacturing fetish’ is a disaster.” Jagdish Bhagwati, Professor of Economics, Columbia University Financial Times, 6 Feb 2012 “A persuasive case for a manufacturing policy remains to be made.” Christina D. Romer, Professor of Economics, UC Berkeley New York Times, 5 Feb 2012© PA Knowledge Limited 2012 Page 75
  • Manufacturing… But in fact, manufacturing is crucial to economic growth: Primary source of middle-class jobs Economies of scale Substantial and (especially for workers more likely to be disproportionate role in without a college realised innovation degree - 75% of UK workforce) It’s also vital that we rebalance growth away from consumption and imports financed by foreign borrowing toward exports.© PA Knowledge Limited 2012 Page 76
  • Manufacturing… The proof: employment multipliers Manufacturing 7 6 5 4 Services 3 2 1 0 Every job in manufacturing supports 2.91 jobs elsewhere in the economy, compared to only 1.54 in business services and 0.88 in retail trade: Supplier effects (e.g. car plant sustains jobs in steel industry); Respending effects (where workers spend their paycheques); Government effects (taxes that support jobs in government). “Almost every industry within manufacturing supports much more secondary employment than other sectors.” Source: Economic Policy Institute, Updated Employment Multipliers for the U.S. Economy (2003).© PA Knowledge Limited 2012 Page 77
  • Potential actions Reorient Accept Reform the Develop new immediate cuts government Tax properly in living banks technologies spending standards Help industry ecosystems Encourage development Support manufacturing to flourish of new technologies© PA Knowledge Limited 2012 Page 78
  • Ecosystems… Policies need developing to support existing ecosystems, and develop new ones: Agglomeration economies 35 •  Local micro-industry ecosystems 30 drive innovation: Physical encounters best 25 at ¼ mile –  London’s Square Mile: bankers, lawyers, accountants. 20z-score –  Birmingham’s F1 ecosystem: a 15 huge ‘driver’ of innovation and economic success. 10 Skills pool peaks –  China found concentration key at c. 40 miles 5 for e.g. semiconductor success. 0 0 10 20 30 40 50 60 70 80 90 100 Radial distanceSource: Reserve Bank of Philadelphia Working Paper No. 11-42, The Agglomeration of R&D Labs’. © PA Knowledge Limited 2012 Page 79
  • Potential actions Reorient Accept Reform the Develop new immediate cuts government Tax properly in living banks technologies spending standards Help industry ecosystems Encourage development Support manufacturing to flourish of new technologies© PA Knowledge Limited 2012 Page 80
  • New technologies… Technology holds the promise of massive, early breakthroughs: The accelerating pace of change 2045: Computer that surpasses brainpower equivalent to that of all human brains combined The Kurzweil 2023: Computer that surpasses brainpower of human prediction 2015: Computer that surpasses brainpower of mouse 1900 1920 1940 1960 1980 2000 2020 2045Source: Adapted from Raymond Kurzweil, The Singularity Is Near: When Humans Transcend Biology. © PA Knowledge Limited 2012 Page 81
  • New technologies… Technology is subsidised by every government. In Europe and the UK, the process seems to be ineffective and insufficient: Neuro/ Bio Nano Info Anti-carbo Cogno•  Neuroceuticals •  Thin films •  Networking •  Humanoid •  Energy storage•  Genetic •  Fine particles •  Telecommunic- robotics •  Electric cars engineering •  Chemical ations •  Humanoid •  Battery tech synthesis computation •  Renewables •  Advanced •  Human cognition microlithography •  Human emotion “Today, a car emits less pollution traveling at full speed than a parked car did in 1970 from leaks.” Matt Ridley, The Rational Optimist “State Capitalism is on the march, overflowing with cash and emboldened by the crisis in the West.” The Economist, January 21st 2012 “Our industrial policy was meant to be the government picking winners. Instead, the losers picked government.” Peter Mandelson, Today, January 26th 2012© PA Knowledge Limited 2012 Page 82
  • New technologies… A 20-50 year view, and a cross-party consensus that this is needed, is essential: An integrated industrial policy Manufacturing policy Ecosystem support R&D support Innovation centres Selected (universities) technologies© PA Knowledge Limited 2012 Page 83
  • Potential actions Reorient Accept Reform the Develop new immediate cuts government Tax properly in living banks technologies spending standards© PA Knowledge Limited 2012 Page 84
  • Living standards… Accept lower living standards: Potential actions The bureaucrats’ own conclusion Increase the Lower Lower Act retirement entitlements wages immediately age “The relentless increase in the Reductions in primary spending or increases in revenues in various sustainability gaps years needed to close the 25-year fiscal gap in the US suggests the14 (% GDP) 12.5 urgency in12 considering in10 8.1 earnest profound 8 5.9 reforms in social 6 4.9 protection systems.” 4 2 Source: 0 Actions begin in 2012 Actions begin in 2015 Actions begin in 2020 Actions begin in 2025 European Commission, Source: Congressional Budget Office. Sustainability Report 2009© PA Knowledge Limited 2012 Page 85
  • A decline in living standards of between 10 and 15% is needed to Living standards… rebalance Western economies today. Tomorrows continued job loss and wage pressure will mean more of that pain in the future… Governments Households Reinhart-Rogoff threshold 20 15Deficit (% expenditure) 2000-10 (weighted avg) Net borrowing (% disposable income) 2008* 18 Japan Greece 10 16 Greece 14 US 5 UK 12 Ireland Portugal 10 UK 0 0 25 50 75 100 125 150 8 Portugal US France Japan Ireland Italy 6 -5 Germany 4 Italy -10 2 Germany France 0 -15 0 30 60 90 120 150 180 210 240 270 Household debt (% GDP) 2011 Debt (% GDP) 2011 Size of bubble, non-proportional but directionally correct, represents (L) overall size of government expenditure 2011 (% GDP); (R) household final consumption expenditure 2010 (% GDP). Source: IMF, OECD, MGI, World Bank. * Greece 2006, Japan 2007 (latest available). © PA Knowledge Limited 2012 Page 86
  • Living standards… …as will demographic challenges. Workers per retiree 5 4.5 4 3.5 3 US 2.5 Japan 2 UK 1.5 1 0.5 0 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050Source: UN Population Projections.© PA Knowledge Limited 2012 Page 87
  • In the short term, America is better positioned to recover: America has successfully kicked the can Europe (incl. the UK) has not: down the road: It has the firepower Less firepower It is more resilient Deeper and different problems Much less is nationalised More public ownership The nationalisations are less political Germany unwilling to socialise the problem Debt restructuring (reduction) has Less ability to restructure been far more responsive and swift Much smaller government so less Less determination to restructure* impact* Automatic ‘stabilisers’ = big unrestructured government that continues to batten on the corpse.© PA Knowledge Limited 2012 Page 88
  • Living standards… The biggest challenge – to transcend wanting and acquiring: Economic growth and the future of the West: ‘happiness’ studies Can insights Neuroscience An equilibrated from shows that world would neuroscience, wanting, striving have few Continued coupled with and acquiring Western growth means education, are major and ‘necessities’ (car further strain on reengineer fundamental s, flat screens, global human drivers of etc.) per capita resources. behaviour human [at current towards less behaviour. prices] consumption?© PA Knowledge Limited 2012 Page 89
  • The continued economic decline of the West The Challenge Potential actions Likely outcomes Short term Long term© PA Knowledge Limited 2012 Page 90
  • The continued economic decline of the West Potential actions Likely outcomes How it looks now How it may be (10-30+ year view) Reorient government No sign in most countries Not happening spending of electability of Grinches Curb the banks 50/50 50/50 Worsening: Tax properly Little sign ‘soak the rich’ Accept immediate cuts 10% - mob resistance Cuts will happen only through in living standards more likely inflation, currency depreciation Promising signs (but only in Educate better some countries, e.g. UK) Privatisation of education?© PA Knowledge Limited 2012 Page 91
  • The pressing short-term issue is whether the neo-Keynesian disaster can be avoided. Probably not…© PA Knowledge Limited 2012 Page 92
  • QE: What they understood… HMT indemnifies Asset Alternative Broad money falling Purchase Facility scenario BoE buys gilts off private Severe risk of deflation Eurozone Armageddon? bondholders Assets Liabilities BoE credits their BoE owns Broad money soars reserves £325bn gilts BoE credits £325bn to commercial Commercial banks lend Money multiplier Mild inflation bank reserves out a little of the money suspended Money multiplier Growth Accelerating inflation Growth does not rebound restored rebounds …and what they Capital flight from BoE tightens Deflation BoE does (apparently) ‘Western’ government monetary policy bonds and currencies not tighten didn’t. Wage rises monetary not enough Household policy 2. BoE 1. BoE raises Gilt yields soar Gilts plunge in HMT still on to service debt reverses QE interest rates to e.g. 8% value hook for £325bn debts accelerates rapidly Auctions gilts, Broad money 3. Even higher Households gets ?£175bn still bloated interest rates default Households default Inflation-driven recession, Taxpayer loses £150bn Deflation-driven Hyperinflation In addition, government debt overhang permanently limits growth recession© PA Knowledge Limited 2012 Page 93
  • In summary: things don’t look great. We’re teetering on a balance between: Inflation * * Deflation Growth * Recession Acceptance * Wilful disregard Long-term Short-term pain * catastrophe V. …In the short term, the outcomes are unknowable. For the long term, as things stand, the continued economic decline of the West is highly predictable.© PA Knowledge Limited 2012 Page 94
  • Further reading •  “The Modern Industrial Revolution, •  The Big Short – Michael Lewis Exit, and the Failure of Internal Control Systems”, Presidential •  World on Fire – Amy Chua Address to the American Finance Association, originally published in the Journal of Finance (July, 1993) •  Shall the Religious Inherit the Earth?: pp. 831-880 – Michael C. Jensen Demography and Politics in the Twenty-First Century – Eric Kaufmann •  Lost Victory – Correlli Barnett •  The Rational Optimist – Matt Ridley •  This Time is Different – Carmen Reinhart, Ken Rogoff •  Stumbling on Happiness – Daniel Gilbert •  Once in Golconda – John Brooks© PA Knowledge Limited 2012 Page 95