Critics of Globalisation

Your anger is justified; your position is not

In my previous post, I outlined the similarities between the last 15 years, and 100 years ago, with the most recent parallel being between post-Depression protectionism and trade wars, and current events and groups. Across Europe, a rising new nationalism is threatening to pull apart the EU, evidenced by the rising popularity of groups such as:
·         UKIP in Britain and the resultant Brexit decision
·         Freedom Party in Austria
·         ELAM in Cyprus
·         Golden Dawn in Greece
·         Danish People’s Party in Denmark
·         Finns Party in Finland
·         National Front in France
·         Alternative for Germany in Germany
·         Jobbik in Hungary
·         Northern League in Italy
·         Party for Freedom in the Netherlands
·         People’s Party – Our Slovakia in Slovakia
·         Sweden Democrats in Sweden
·         Swiss People’s Party in Switzerland

Many of these groups appear to focus on immigration issues but if a desire to regain control of their borders (whether they can or not) results in countries leaving the EU entirely, this can easily affect not just immigration but also trade and foreign investment – as will be the impact of Brexit on Britain. And this can be seriously detrimental to an economy’s prosperity, especially ones heavily reliant on export markets, imported goods and foreign capital.

Donald Trump’s rhetoric regarding China, Mexico, NAFTA and the TPP has a similar potential to unwind international relations and integration. And Pauline Hanson’s crusade against Islamic Banking also has the potential to prevent a significant amount of valuable infrastructure investment in Australia.

It is my position that a retreat from globalisation is, at best, a second-best option, and at worst, could undo decades of wealth-creation, international relations, and global poverty-reduction success. I also concede that part of the blame belongs with how globalisation has been sold to the world.

The goal of globalisation has been to generate wealth – by giving producers access to a larger global (rather than just local) market, it would encourage them to specialise in the tasks at which they had greatest advantage, becoming as efficient as possible.

For example, massive iron ore and natural gas operations in Australia are possible because, even though they produce far too much iron ore and gas for Australia alone to consume, globalisation allows much of it to be exported (at higher-than-local prices too). In an insular society, such operations wouldn’t exist in Australia.

Globalisation, in very simple terms, allows individual people, businesses, industries and countries to produce more than they individually consume, and export the rest in exchange for things they ordinarily wouldn’t produce for themselves (or wouldn’t produce as efficiently). Consequently, a gloablised world should produce much more wealth than an insular world.

And from this perspective, globalisation has been a spectacular success. As illustrated below, since 1961, the world economy has expanded 6.40-fold (in terms of real GDP). Moreover, over the same period, world population increased only 2.39-fold.

The first graph below illustrates some well-known countries that out-performed the world as a whole. Most of these are developing countries, as to be expected (developing countries inherently have greater growth potential than developed countries). Some surprises were Iceland, Luxembourg and Australia, which marginally out-performed the world over this period. But the real stand-out was China, which expanded 95.86-fold in real GDP and only 2.10-fold in population! For perspective, that is like a childless couple on a $50,000 combined annual salary in 1961, having two children and earning a combined $4.8 million annual salary now.

The second graph below illustrates some countries that under-performed the world economy – mostly developed countries, as to be expected. But even Switzerland, the slowest, expanded its real GDP 3.06-fold since 1961, and its population only 1.54-fold. Furthermore, of all 48 countries above and below, Zimbabwe is the only country whose population out-grew its real GDP over this period.

This appears to be spectacular wealth-generation over and above population growth. Moreover, beyond mere growth, the percentage of the global population considered to be living in poverty (poverty being someone who lives on under $1.90 a day, as defined by the OECD) has fallen from 42.15% to 10.68% in just over 30 years (1981-2013). This is real progress and one would have to be quite bold to assert that globalisation had nothing to do with this, or that this progress was made despite globalisation.

The problem was not in globalisation’s ability to generate wealth, but in how that wealth was subsequently distributed. It didn’t particularly care who generated it and where it went – just that the total amount of wealth was as high as possible given limited resources. It was then government’s job to redistribute this wealth ‘fairly’. But the failure of governments to do this resulted in blame being levelled at globalisation.

Because largely, governments have been pursuing globalisation-friendly policies for decades now. Global trade increased 30-fold between 1950 and 2007 (between WWII and the GFC). Consequently, enormous amounts of wealth were generated. But some governments failed to redistribute it properly. Ill-conceived notions of ‘trickle-down economics’ perpetuated the idea that giving tax breaks and concessions to the wealthy will cause them to hire more people and invest more productively than the government could ever do, thereby trickling down to the rest of the economy and stimulating growth. But this is something that has been shown time and time again to be ineffective – even slowing down economic growth – especially when compared to investment in infrastructure, or even just tax concessions to the low end of the socio-economic spectrum.

Consequently, this will cause the rich to get richer, the poor to get poorer, and the middle class to disappear. As illustrated below, there appears to be a very clear relationship whereby countries that do not adequately tax the top end and redistribute to the middle and lower ends have higher income inequality. For all OECD countries (except Lithuania, for which data was unavailable), there is quite a strong negative relationship between each country’s Gini coefficient (a measure of income inequality) and its tax revenue as a percentage of GDP. Put simply, it is probably not a coincidence that the US, Chile and Mexico have the highest income inequality, as well as some of the lowest rates of taxation in the OECD, while Finland, Belgium, Norway and Denmark have some of the lowest income inequality while also having some of the highest rates of taxation in the OECD. There are exceptions, of course: Korea has a below-average income inequality while also having one of the lowest rates of taxation in the OECD; conversely, Italy has one of the highest rates of taxation and an above-average income inequality. But the trend is quite clear – higher tax rates are likely to improve income inequality in countries such as the US, Chile and Mexico.

Note: tax rates in the above graphs are calculated using a 10-year average and a 3-year lag, and compared to the latest Gini coefficient data available for each country so that any changes in tax rates over time are properly absorbed into the economy without causing too many statistical anomalies

But instead of blaming government and demanding their fair share of the ‘pie’, the victims of this inequality are blaming globalisation. What they don’t realise is that to wind back globalisation will reduce the overall size of the ‘pie’ without any guarantee that the smaller ‘pie’ will be shared any more fairly.
John Maynard Keynes observed a similar trend following the Great Depression in the 1930s. Economies such as Britain were pegged to the Gold Standard at the time. Consequently, when the Depression hit, exchange rates couldn’t fall to absorb some of the shock, and Central Banks couldn’t sufficiently drop interest rates and flood the market with liquidity, lest they break their ‘pegging’. Keynes, an ardent free-trade supporter, realised that the solution was to devalue the pound (or ideally, abandon the Gold Standard altogether and allow the pound to float), not retreat from globalisation and enact protectionist measures. History has shown quite well that countries that abandoned the Gold Standard earliest in the Depression had the fastest recoveries. Keynes knew that the solution was to make globalisation work properly via a more efficient monetary system, not retreat from globalisation.

The situation now is quite reminiscent of this insight - the solution is for people to demand of their governments their fair share of the globalisation ‘pie’, not throw half of it out the window and hope that the smaller ‘pie’ will somehow get shared more fairly. The difference is, this time, it’s the tax system that needs improving, rather than the monetary system – though I’m sure we could debate about some improvements to the latter too.

History will remember us

In my first ever post, I remarked that Brexit was just one event in a much more significant era:

“the Brexit saga … was yet another major global development that could make this period in time – and my youth – one the most (academically) fascinating economic and political periods in the last century”

And this week, another thing happened – President Trump. The implications – social, economic, political, environmental – are truly global.

This period in time is really starting to become reminiscent of 100 years ago:

THEN - the assassination of Franz Ferdinand (the Archduke of Austro-Hungary) caused war between Serbia and Austro-Hungary (even though the assassin was arguably just a rebel and not acting on behalf of the Serbian government), triggering World War I
NOW – the 9-11 terrorist attacks triggered the US invasion of Iraq, even though Iraq had nothing to do with it

THEN – WWI was supposed to settle long-held tensions in Europe, but just buried them temporarily, with Germany harbouring resentment for the next 20 years
NOW – the Iraq war was supposed to defeat terrorism, but ended up creating ISIS

THEN – the ‘Roaring 20s’ came to a dramatic end with the 1929 stock market crash and subsequent Great Depression
NOW – the ‘Great Moderation’, characterised by low global inflation and strong global growth, ended spectacularly with the biggest crash since the Depression, and the subsequent Global Financial Crisis

THEN – national governments stubbornly keeping their economies attached to the Gold Standard of fixed exchange rates resulted in countries being impotent to bring themselves out of the Depression for the best part of a decade
NOW – the Federal Reserve drops interest rates to zero and floods the markets with liquidity, preventing a Depression-scale event in the US, but inadequate fiscal stimulus resulted in a recovery that was weaker and took longer than it had to, causing long term uncertainty and hardship. Moreover, delayed monetary stimulus and misguided austerity in Europe caused a true repetition of a Depression-scale event across the Atlantic.

THEN – isolationism takes hold, with countries turning away from the world and focusing inwards, causing protectionism and trade wars that only served to make the global situation worse
NOW – Brexit, Donald Trump and extreme right isolationist groups across Europe and Australia threaten to once again pull the world apart

THEN – World War II
NOW – ???

We’re going to be teaching our grandkids about these years. How will we want this history lesson to end?

Will the retirement village market trigger the next financial crisis?

It is common in the Australian retirement village market for retirees to sell their family home after the kids move out and buy into a smaller (and cheaper) retirement village unit. The ‘profit’ that was made from downsizing like this could then be used to pay periodic management fees to the village for the upkeep of its facilities (community centres, gardens, recreation facilities, village/ medical/ security staff, etc.), with enough ‘profit’ left over on which to live for the rest of their retirement. Fair enough, right?

However, the majority of retirement villages in Australia (I don’t know about the rest of the world) are allowing something called ‘deferred management fees’ – where these periodic payments don’t have to be paid until after the retiree leaves the village and the unit is sold. The village would collect these deferred management fees from the proceeds of the unit’s sale.

Not having to pay all upfront and ongoing costs straight away makes the initial entry into retirement more affordable. It also supposedly encourages villages to be well run and managed and maintained so that these units keep appreciating in value, and can eventually be sold for enough to cover these costs. And if prices keep appreciating, more and more retirees can be temporarily forgiven from paying larger and larger components of their management fees/ unit purchase costs, because the village can simply recoup it later upon sale of the unit – as long as the unit prices keep appreciating.

However, what if there’s a crash in the retirement village market? Maybe through overinvestment in construction of retirement villages based on overly-optimistic demand projections. Subsequently, retirement unit prices will drop to correct for this over-supply, and through no fault of the village operators, their units may not sell for enough to cover these deferred management costs, forcing them to put more of their units on the market at even further reduced prices just to guarantee a sale and cover these losses, causing unit prices to fall further, and down the rabbit hole we continue to spiral until the entire market collapses.

Let’s illustrate this with a couple of simple examples. Ideally, deferred management fees would work as follows: ·        A retiree buys into a $300,000 retirement village unit, paid upfront (a small and affordable unit price by recent Australian capital city standards) ·        Deferred management costs of 2% per year are incurred for 10 years (a relatively standard return and term recently) ·        The unit appreciates in value by 5% per year – twice the RBA’s inflation target, so a good return, and yet still very conservative compared to the rate at which Perth residential prices grew during their recent mining boom years ·        After 10 years o    The unit sells for $488,668 o    The retiree owes $60,000 in deferred management fees o    Therefore, the retiree walks away with a net $428,668 ·        Everybody’s happy Now let’s change some of these numbers in a not-impossible manner: ·        A retiree buys into the same $300,000 unit, but is allowed to pay nothing up front (something that actually occurred with zero-deposit sub-prime mortgages before the GFC) ·        Deferred management fees of 12% per year are incurred over 10 years, in order for the village to recoup the $300,000 deferred purchase cost plus still earn a 2% return on the value of the unit ·        The unit appreciates by o    5% per year for the first three years o    2% per year for the next two years as the market gets adequately supplied (below expectation but still near inflation) o    Then the market crashes and loses 25% of its value over the final five years (precisely what happened to US house prices in the GFC, so not an impossible scenario) ·        After 10 years o    The unit sells for $270,988 o    The retiree owes $360,000 in deferred management fees and purchase costs o    The retiree loses all of these proceeds and, depending on the contract, may have to incur/ share a further loss of $89,012 If losses of this scale are sufficiently widespread, retirees and villages alike could suffer enormous consequences, as well as the whole economy.

Is this not hauntingly reminiscent of the sub-prime mortgage market crash that triggered the GFC? People being lent huge sums of money that the banks/ financial institutions would only get back if the person paid it (unlikely with sub-prime mortgage holders) or the house prices kept increasing sufficiently so that a defaulted house could just be foreclosed and sold off without loss (or even with a profit). As soon as house prices started to slow/ fall, the banks/ financial institutions couldn’t recoup their losses from their bad loans (because the houses were worth less than the loans), forcing them to sell even more assets to cover these losses, thereby causing the problems to spread to the whole world – even those parts not directly invested in the crashing market (this is a downside of globalisation – crashes can be globally contagious).

Moreover, these deferred management fees are now being securitised and sold off in pieces to investors all over the world. This kind of securitisation of debt has been going on at least since the 1960s, and has largely been an effective way of bringing additional liquidity to traditionally illiquid markets like housing. But when they started using it on sub-prime mortgages in the early 2000s, additional risks started accumulating not just in the risky market itself, but everywhere that was indirectly invested in it.

I’m not sure what regulations are in place to manage the amount of these fees that can be deferred (and for how long), but it seems that there is quite a bit of discretion between the retiree and the village to write their contract how they like. And as the retirement village sector becomes more and more significant with Australia’s ageing population, is it not a big risk that retirees would be allowed larger and larger amounts of their management fees (even their unit purchase costs) to be deferred (especially if, for social reasons, government encourages villages to do this so that everyone gets an affordable retirement)?

Then, if (when) the market takes a turn, villages won’t be able to recoup these deferred costs just by selling off the units, and the whole market/ economy/ world could feel the shock. Especially if the retirement market booms like it might.

The true extent of these problems will depend on how large the retirement village market becomes, and how carried away they get in terms of deferring more and more of the costs. The market is still growing and likely to be quite profitable for many in the near future. I just hope that self-control on the part of the retirement village market and/ or regulatory restrictions keep the system closer to the optimistic scenario above, and not the pessimistic one.

The Communist Utopia

Are we there yet?

Most people understand why Communism doesn’t tend to work – even in theory. By promising everyone an equal share of everything, people have less incentive to work harder (even with other motivations like altruism, guilt, obligation, pride and fear) – they wouldn’t get to personally enjoy the fruits of their labours. Moreover, they would actually have an incentive to work less hard because they will still be guaranteed an equal share of society’s wealth, regardless of how much they personally contribute.

This is one of the reasons the USSR failed. Personally, I think the main reason it lasted as long as it did is because the previous system in Russia – under Emperor Nicolas II – was so lousy for so many (and worsened by the pain and suffering of World War I) that any change of system would probably have been successful for a while. But once people hit that ‘wall’ where the broader economy started to slow, their living standards weren’t growing as fast, and/ or they weren’t being personally rewarded (or punished) for working harder (or less hard), the disincentives to production and innovation become a problem.

People need individual incentives. Every time a country tries to take away all (or just too many) private incentives and replace them with government – the USSR, Cuba, North Korea, China just a few decades ago – the whole system suffers. Don’t get me wrong – there is plenty wrong with Capitalism too, and most successful modern countries have realised that the middle ground – the ‘mixed market economy’ – is the ideal, not one of the two extremes – and I will discuss this further in future blogs. But a simple lack of private incentives is why attempts at Communism tend to fail.

BUT … I recently had a thought about how Communism could be made to work successfully – technology.

Many have long assumed (rightfully so?) that for every job that is replaced by technology/ automation, more than one new job will be created in another (new) industry – at least in the long term. This appears to have been true over the centuries.

For instance, employment in Britain’s manufacturing industry seems to have been under perpetual attack ever since the Industrial Revolution: ·        Britain’s ‘Luddites’ protested the loss of jobs in the wool and cotton industries during the Industrial Revolution thanks to inventions like the power loom (yes, this is where the term luddite – someone afraid of technology – comes from); ·        Britain’s manufacturing industry also came under pressure in the late 1800s due to the vast scale and mechanisation of manufacturing in the emerging US and German economies (see The Tariff Problem by WJ Ashley) – a period referred to as Britain’s ‘great retardation’ (no, I’m not kidding); ·        And since the late 1960’s, manufacturing employment has been declining in Britain in both absolute and relative terms, from an all-time peak of 9.1 million workers in 1966 to just 2.6 million in 2015 And yet, all these losses have been replaced with gains elsewhere – services, but also sometimes just other more sophisticated sectors of manufacturing – and then some. Otherwise British unemployment rates would have been trending upwards ever since the Industrial Revolution. And the size of Britain’s workforce wouldn’t have continued to get bigger over time. As it is, by 1966 Britain’s manufacturing workforce was roughly the size of Britain’s total population before the Industrial Revolution. So manufacturing jobs lost were being more than replaced by other manufacturing jobs gained – at least in the long term, and not to mention other growth industries. And even though British manufacturing employment really has declined since 1966, total employment in Britain has continued to grow – but this time driven by service sectors such as health care; retail and wholesale trade; professional services; administration services; education; and accommodation and food services. This means the losses have continued to be more than offset by gains. Similarly in Australia, broadacre agriculture has become so mechanised and automated – and individual farms so enormous in land area – that rural towns suffered at the hands of formerly-employed farm workers having to move to cities. Consequently, agriculture's share of Australian employment has been declining since 1984 (probably longer but this is as far as the data to which I’m referring goes), especially since the turn of the century where it started declining not just in share but in absolute number too. But total employment across Australia has almost doubled since 1984, driven by services such as health care; professional services; retail trade; accommodation and food services; education; and public administration and safety. Again, this means that losses to technology and automation are being more than offset elsewhere.

I know many people have probably said this over the centuries, but what if we are approaching the limit, where new jobs aren’t being created as fast as they are being replaced by machines. Studies are already predicting which industries will be replaced by machines first (generally administrative and routine manual labour roles first, and non-routine professional and vocational roles – those requiring higher level cognitive or social skills and/ or significant manual dexterity – last). But thus far, human ingenuity has always provided new employment opportunities. But if artificial intelligence is properly invented, and machines are capable of actually thinking and learning, machines will be able to replace human jobs faster than they can be created.

This will lead to mass unemployment – but this may not be a bad thing, as long as a sufficient amount of the wealth consequently generated by machines is transferred to the people who are no longer needed to work. This would imply an increasingly large welfare state (Communism!), but could be sustainable.

Even now, if a greater proportion of wealth were transferred from top to bottom (especially in the US, less so – but possibly still somewhat – in Europe and Australia), more generous social safety nets could be provided sustainably without jeopardising incentives to generate wealth (still a mixed market economy, rather than full Communism).

The point of technology and automation was never to replace humans and leave those humans with nothing – it was to find a way to complete the task without the need for humans. But the humans that were replaced by technology should still be supported by the wealth generated by those machines, unless and until they can reasonably find alternative work.

The problem is that too much of that wealth has transferred to the people that own the machines – the top end. This may have worked relatively well up until recently because new jobs were constantly being created so the structurally unemployed could still survive by finding new jobs, while the top end got immensely wealthy.

But if the creation of new jobs is slowing below the rate at which they’re being replaced, the welfare state would need to expand – big time – presumably up to 100% of the economy if all jobs (including future jobs) can be taken by artificial intelligence.

Communism should therefore be the inevitable result of humans no longer being needed to work – because everything can be done by machines. And presumably (hopefully), these machines would not possess the same passions and ambitions as humans and as a result, would produce all the world’s wealth without needing the incentives of Capitalism. Then, humans would just get to live. And those who want more will just have to find something of value that they can do for the world that grants them additional rewards – better food, cooler clothes, bigger houses, etc. – and that machines can’t do.

This assumes, of course, that the world is still dealing with the basic economic issue of ‘scarcity’ – where human wants and needs are infinite, but resources to meet those wants and needs are finite. If the issue of scarcity can be overcome, this could be another avenue to sustainable Communism.

Again, I’m sure many people have said this over the centuries – that employment is being lost through automation faster that it is being replaced – and turned out to be wrong. And while humans are still better than machines at so many things, and the economic issue of scarcity remains, Communism is simply not consistent with human behaviour. But surely it is true that if machines do become advanced enough, eventually, at some point in the future, it could happen – the Communist Utopia!