Recently I was interviewed by Haydn Shaughnessy for his Forbes blog. We discussed the debt-driven plight of the US and UK economies, whether innovation and leadership can help get us all out of the mess we are in and the one thing that would make the difference to our economies which I firmly believe is facing up to reality and telling people the truth. You can read the full interview below or on the Forbes website (click here).
Forbes Blog by Haydn Shaughnessy
Can America Innovate Its Way Out Of Debt?
When companies like Google and Apple turn to their ecosystem to build apps, they are turning to a new organizational form. A decade ago we had very few, if any, ecosystems like this, loose associations of companies and individuals that would pitch their ideas and development time into a Darwinian soup.
In the days before the app developer community, ecosystems were disciplined, educated and controlled by companies like Microsoft that took a hierarchical view of their network.
The ecosystem has quickly become established as a new wealth creating mechanism. Now look around at companies like Ubiquity Networks, with $300 million in revenue and about a hundred employees.
American companies remain the most innovative in the world, with an ability to devise or adapt to new corporate forms and new technologies at frightening speed. But that gift is not translated into a better economy. Can it be?
I talked with Terry Smith about that problem. Smith is a London-based fund manager and many years ago co-author of Accounting for Growth. As an analyst earlier in his career he called companies out for accounting practices that exaggerated growth, and was fired for doing so.
He also writes the Straight Talking blog. I talked to him about the US economy and that of the UK. Can they innovate their way out of trouble ad as pertinently will the US ever lead the world economy again?
Terry let’s start with the US economy. How significant is its loss of leadership, if at all. Will it ever lead the world out of recession again?
America’s loss of economic leadership takes three forms:
1. A much-reduced share of the global economy, down from 50% in the immediate post-war years to about 19% today.
2. The US, once the world¹s largest creditor nation, is now its biggest debtor.
3. The US economic model, previously the world default position (and known as the Washington consensus), has suffered significant reputational loss through the credit super-cycle.
There is no likelihood of the US share of the global economy returning to 50%, or anywhere near that level. There is no likelihood, either, of the US reverting from leading debtor nation to leading creditor.
The US is most unlikely to lead the world out of recession again, because America has ceased to be the dominant economy.
Rather, we have a global economy in which no single country is dominant.
Many western economies assume they can maintain their debt burdens and meet their social welfare obligations. Could you comment on that from US and UK perspective?
The debt burdens of the US and the UK (and of other Western economies) are sustainable only if strong real growth (of at least 3% compound) can be assumed. Even growth at that rate might not be anywhere near enough.
In both the US and the UK, social welfare obligations are already unsupportable on any remotely realistic basis of forward projection. Governments have taken on unsustainable commitments because of:
(a) Over-confident assumptions of perpetual growth,
(b) The politicians responsible for taking on these obligations know that they will no longer be in office when the tab turns up.
(c) Politicians have learnt to buy votes by creating client voters who will vote for whomsoever is promising to pay them.
Do you see scope for the US economy to innovate its way back to significant growth?
Innovation is critical. However, three vital points need to be borne in mind:
- Technology uses energy it does not create it and the US seems dangerously complacent about future energy availability (and shales are not the answer-they are not as energy efficient as previous oil and gas discoveries).
- The US all too often makes a free gift of its technology to competitors such as China, most notably through joint ventures with technology-transfer strings attached. See companies like Caterpillar for details.
- The US education system produces too few science and engineering graduates, with colleges being biased towards law and graduates attracted to finance rather than industry.
How about the UK? In both cases I am amazed by the lack of policy innovation. Like them or loathe them the Thatcher and Reagan governments gave us privatization, urban regeneration and similar initiatives. Now there seems to be nothing.
In economic policy, we are trapped in a debate between ultra-free-market economics and Krugman-style neo-Keynesianism.
The weaknesses of neo-classical free market economics have been exposed by the credit super-cycle, whilst the likelihood of a return to Keynesian management is remote (not least because of existing burdens of debt and welfare commitments).
Of course proponents might argue that the only reason these policies have failed is because we have not tried them to their maximum. The neo-Keynesians say that with regard to the poor performance of these policies so far a) matters would have been worse if we hadn’t applied them; and b) we just need to borrow and spend more. B) certainly looks unlikely given the diminishing returns from this since long before the crisis, and in any event it is clear that they have spoilt their pitch by forgetting to run a surplus in the boom, as Keynes suggested.
I have more sympathy with the view that free market economics is not to blame as it was never really applied. The crisis was caused not by free markets but by interference with free markets: Clinton’s policy on mortgage lending to those who could not afford to service it, the ‘Greenspan put’ which meant that market operators were always saved by the Fed, Chapter 121 which has keep zombie companies alive, etc.
Do you have any sense of why there is a policy vacuum?
The political structures of both the UK and the US are not fit-for-purpose, mainly because of a bias which favours short-term popularity over strategic thinking. This has been typified by the way in which the Simpson-Bowles warnings have been ignored in the US, and by Britain¹s failure to cut public spending more markedly.
Increasingly, politicians lack real-world experience, and are controlled by media consultants whose focus does not stretch beyond the next headline or sound-bite.
My personal view is that no one should be allowed into high political office unless they satisfy two conditions: a) served in the armed forces or played a full contact team sport; and b) worked in a successful for profit enterprise.
Tim Morgan’s recent paper (see a summary here) was gloomy for the future prospects of what we used to call the advanced economies. What in your view is the end game?
Tim is trying to move the debate onwards by highlighting the ultimately physical (energy) nature of the economy, and the widening chasm between the physical and the financial economies.
Logically, the next stage in the end-game will be hyper-inflation as we try to accommodate the monetary structure to the physical economy. The fact that inflation has been explicitly targeted by the Bank of Japan, that the Fed’s QE programme is targeted at unemployment and the new Bank of England Governor elect wants to scrap inflation targeting suggests where this will end. None of the current generation of political leaders or central bankers have any experience of high inflation. They do not realise that once the inflation genie is out of the bottle he may not go back in on cue.
At the same time that his paper came out Bain and Co published a paper that said there has never been a better time for long term investment in innovation because borrowing costs are so low and opportunities for a return are so skimpy. Isn’t this a time to be bold with industrial policy?
They are entitled to their view. Tim calls such rosy forecasts flat-earth economics, because these projections assume a business-as-usual economy delivering steady growth, and ignore the physical constraints emerging in energy-related economic research.
Specifically, low borrowing costs are likely to become incompatible with escalating inflation. Actuarial studies point to a severe squeeze on capital if slow economic growth continues to undercut the economics of pension schemes.
Moreover, investment can only earn satisfactory returns if we assume adequate consumer purchasing power in the future. If the proportion of consumer incomes required for essentials continues to increase, the scope for discretionary purchases will be squeezed.
Remember that the majority of the consumer spending of the pre-crash years was debt-funded.
What one thing would make a positive difference to the US and UK economies?
Well, there are several specifics, but the big one would be facing up to reality. That way, we could tailor our welfare expectations to fit our likely future economic resources. Tell people the truth. As Abraham Lincoln said I am a firm believer in the people. If given the truth, they can be depended upon to meet any national crisis. The greet point is to tell them the facts.