This post has already been read 416 times!
As an economy evolves from primary industry, through labour intensive and capital intensive manufacturing, to the services sector, what comes next?
What is economy?
According to the OED, economy is:
“The state of a country or region in terms of the production and consumption of goods and services and the supply of money”
Let’s break economy down to its basics. Economy is a measure of the ways that people can find to do beneficial things for each other. The more ways people can find to exchange goods, services and ideas with each other, the greater the economy. Economy is also about the flow of some sort of currency, which is useful as barter economies are not that efficient.
Assume there are two closed loop economies; A and B. Economy A has a total money supply of £1000 which gets spent freely and flows through individuals’ bank accounts numerous times over. This is a rich society. We have butchers, bakers, candlestick makers, and they all pay each other for their respective services many times over. There is sufficient money in the system to provide the means of exchange commensurate with the economic activity taking place i.e. People have sufficient liquidity (hold sufficient cash) to transact with each other as necessary.
Then we have Economy B which also has £1000 money supply, but one individual owns £990 and hoards them, while the rest own £10 between them. The same amount of money is present, but it is not flowing through the economy to the same extent as Economy A. This is not only a liquidity issue (there is not enough cash to allow transactions), but also a deflationary one as the same services exist with a constrained money supply so the value of that money goes up / prices go down to reflect the increased value of the means of exchange (the relative scarcity of money).
“What matters in an economy is the flow of cash, not how much cash there is”
Economy B is an example is what happens in a credit crunch. People hoard money, and because our money supply is debt, when others hoard cash, those on the other side of the coin (hose who went into debt to create that money) cannot service their debts and default. As they do, the money supply shrinks, banks become less willing to lend any more out debt, reducing the money supply further. The vicious cycle continues until confidence is restored. This is an example of a poor society. Even though the amount of money is the same in both, the second ’economy’ is far less prosperous than the first. What matters in an economy is the flow of cash, not how much cash there is.
What Does it Mean to be Rich?
A rich person is not someone who has money, it is someone who has money flowing through their bank account. They may have very little in the bank, but if they experience the benefit of having money flowing through their life, they are benefitting from that money, as are those they spend their money with.
There are many people with lots of money who are misers, hoarders of money. They live meagre existences; buy cheap clothes, eat meagre rations and don’t use their financial resources to accentuate their lives one bit. To the outside world they appear poor, and to all intents and purposes, they are.
Then we have an individual who has a great deal of money flowing through their experience, they run a tight ship; money in = money out. Their life is in balance, they take in £6000 pounds a month and the flow out approximately the same. Being rich is about spending lots of money in a way that is comfortable and benefits the world.
The family benefits from the flowing of these resources: good food, private schooling, a reliable comfortable car (less than five years old), a nice spacious home and time to enjoy life, with family holidays coming twice a year. They look at their finances, and see the bank account empty, but in reality they have all the money they need for a very good life. Despite having meagre reserves, they are benefitting more from their financial resources. An economy full of individuals who behave like this is a thriving economy. The more people spend, the more others are benefitted in the process.
Supply and Demand
Economics is about supply and demand. It always has been and it always will be. Supply and demand sets market price discovery. The purchase (consumption) of consumer goods is certainly part of the economical picture, but so is the production of goods, services and ideas. But modern ’developed’ economies such as those of the UK and USA needn’t hold huge factories full of workers. Labour intensive manufacturing is part and parcel of the process of production, but not nearly the most lucrative bit.
The curve of development of any economy starts in primary production, before it advances to labour intensive manufacturing. As workers’ education levels and salary expectations rise, so the labour gives way to machines as capital intensive manufacturing takes over. Finally a ‘mature’ economy moves into the services sector. As workers demand a bigger slice of the pie, they end up working in higher valued, higher skilled sectors commensurate with their education, training and contribution.
Modern ‘developed’ economies are founded on and derive their value from ideas. Apple may design its iProducts in California, but they are manufactured by whoever can meet Apple’s minimum manufacturing standards at the best price.
This currently means Foxconn in China. Yet Apple makes a lot more money than Foxconn does, and very soon, when the world is deplete workers who are prepared to work for less than the cost of robotics, the robots will take over and the cost of transport will likely render Chinese factories less competitive than their American counterparts.
Commentators in countries like the UK and USA frequently bemoan the loss of so much of their manufacturing base, but moving out of less competitive sectors such as labour intensive manufacturing is not a bad thing per se. These labour intensive manufacturing roles are just handed over to the countries which are best placed in their economic evolution to perform the task most effectively.
There is no sense in keeping manufacturing if the cost of doing so means that you are uncompetitive. What the UK, Japan, the U.S. And Europe does very well is capital intensive manufacturing; robotics, metrology, and specialist industries from large scale metallurgical forgings in Sheffield to leading-edge composites, powertrain and combustion technology in Formula 1 (virtually all of the F1 teams are based in the UK).
What is important in any mature economy which has moved into the services sector is that it produces products that the rest of the world wants to purchase; flowing cash from other countries’ economies into its own.
It’s All down to the Baby Boomers, Silly.
The UK, the USA and Western European countries have been and are still currently in a recession because of a wave of retiring baby boomers and the corresponding drop off in consumer demand. The timing of the recession coinciding with the peaking of productive age of those baby boomers. When the median age boomers in an economy moves out of the 24–55 age range which is associated with maximum consumption and maximum production, the economy reaches a tipping point from which it will never recover.
What the Western world, USA, Europe and Japan need to do is seek to meet the real demands of those same baby boomers who have caused the biggest economic boom ever seen, but who are now entering their retirement years, or abandon the current measurement methods of GDP, and start to assess success of economies by other means such as how happy people are.
To really thrive, an economy needs:
- To encourage meaningful spending (not borrowing to spend)
- To produce products, services and ideas which other people want to purchase in exchange for the benefits they offer
- A low tax on economic exchange (to dis-incentivise unproductive rent-seeking activites, lower economic transaction fees, and reduce or (better) remove productivity taxes such as income tax)
- A low cost of overhead (government and bureaucracy)
It’s a simple premise where the outcomes are clearly beneficial to all parties involved. Here’s how it looks:
- Individuals are encouraged to earn money for themselves, rather than having their earnings taken by the government.
- Government and its public offices are a fraction of their former size, and so taxes can be appropriately smaller, and simpler (a 15% flat tax across the board for individuals as well as businesses). Simpler taxes means less bureaucracy and greater compliance.
- People will hold onto the bulk of the money they earn, and they will get to choose what they spend their cash on, rather than the government. This will lead to more effective free market economics, rather than what the government thinks is noble (like its crony climate change policies which hand out subsidies to giant corporations)
- The notion where the government handles everything will be replaced with individuals who are aware; aware of what they are buying, aware of what they are investing in, aware of the social issues which affect them and their communities; and aware of which social issues they want to contribute towards. A beggar sitting behind his cardboard sign will be met with more that just the usual “I pay enough in bloody taxes, I don’t see why I should have to give this guy more. If the government wants to take my money and spend it on my behalf, the government can sort out the problem”. The current state of affairs where compassion is outsourced to the government will cease, and the big business charities will be joined by smaller groups funded by private individuals.
The Fallacy of Austerity
When observing politicians and their handling of the economy, we have to wonder what is going on. Are they so stupid that they cannot see the folly of their actions, or are they actually aware of what they are doing to the detriment of the societies they purport to serve? I hope for the good of society that they are just unaware of the level of the errors they are making.
Let’s take austerity for example. The government doesn’t seem to understand the very simple link between debt and money. In modern western fiat money economies, money = debt; 97% of all of the money in the economy is created by banks when they make loans. As long as we live in a society where money = debt, the following is going to happen.
- Banks are going to tax the productive economy for effectively issuing its money supply. The more money we have, the more the banks are taxing productive exchange through debt money issuance.
- For the economy to have lots of money flowing around it, individuals and businesses must be in debt. In the balance of the Eurozone debt = money equation, Germany holds all the cash, the rest of the eurozone holds all the debt.
- If all of the debts were paid off, the money supply in the economy would shrink to near zero, which would adversely affect economic exchange.
- Every X years, the debt cycle reaches unsustainable proportions, and the debts become unpayable. The only logical solution is the inflate them out of existence (money printing or QE), or to carry out a debt amnesty and write off the debts, particularly those debts of households who are required to carry out productive economy in order to pay for government and public services through the taxes which ensue (Income and Value Added taxes).
And yet the government seems to be interested in using austerity to pay down the debts and run a surplus. Is this such a good thing? Let’s investigate. The government is an overhead, it takes your money from you, and spends it on your behalf. Now, if the government runs a surplus, this means that it has taken your money and given you less of your money back in public services. Does that sound like a good premise for any government charged with spending public taxpayers money? The ideal situation is one where the government, in keeping a close eye on GDP (which it clearly has no idea about), tops up tax revenues where necessary with deficit spending.
If society wants to change the status quo, to remove debt cycles and their boom and bust economics, and the asset speculation bubbles inherent in such a system, it must also move away from debt based fiat currencies. Don’t expect the banking sector to want to change a system which benefits them enormously; in market rigging, fraud, money-lending and in controlling the value of money. We need to come up with an alternative solution, for example to create an alternative currency without any debt burden attached, and to ensure that the economy has sufficient money in it to allow it to function to its maximum extent possible. Without the lubrication effect of a means of exchange, the wheels of an economy cannot move. This is the electronic cryptocurrencies that the Bank of England are considering employing.
Austerity is about cutting government spending. Closing the taps which flow money into an economy from an ’organisation’ as large as the government is always going to have a detrimental impact. Governments implement austerity in an attempt to pay down their budget deficit (reduce the country’s debt burden).
Politician struggle to balance their books for a number of reasons:
- Politicians want more than anything else to be re-elected so would rather borrow more than tax their voting public to pay for their services.
- Politicians want to look after their own, so wouldn’t dream of slashing the size of the government overhead, or looking at what’s required to make the current system more efficient.
- Unlike companies, countries with their own fiat money issuing central banks cannot be bankrupted
- Governments with their own central banks issue their own money supply and they can print as much of it as they like.
Let’s Discuss the ‘Velocity’ of Money
The government doesn’t understand the basic concept of ‘economy’; the flow of cash, and aims its policies, taxation and welfare programs in a way that doesn’t encourage productive economy.
In the current economies of the UK and USA, the real consumption of the baby boomers has gone, but central bank ‘stimulus’ programmes aimed at stimulating more spending based upon the ‘wealth effect’ created by soaring house prices and equity withdrawal have all failed. They have pushed house prices up, however. This has shifted the focus away from productive economy toward rentier economics. The money flows from those without assets towards those with assets. Rentiers needn’t do anything productive, all they need is access to credit, which rich people generally have and poor people generally don’t have. The banks themselves are happy to play the government’s “housing Ponzi scheme”, gaining significantly from “lending” money into the fixed assets of land and property, pushing up prices and collecting their percentage.
The less productive individuals are, the more they need state assistance, and the more sick and the more helpless they become. Helpless, powerless individuals do progressively worse until whole generations are caught in a poverty trap from which it is nearly impossible to escape under the present system. Rather than helping them, Government welfare has actually made them the most wretched of individuals. This is the Labour Party’s issue and one they would do well to consider.
In a similar manner, austerity, instead of helping matters, has the opposite effect. The taxpayers of the land who fund government spending are not typically the top 1% or even the top 5% of the earning population. The majority sit somewhere in the middle, the bulge on the Normal Distribution curve, and these are the people who are impacted by austerity; people who work in the real economy, providing goods and services to others. The rent seekers who work in banking and finance, and their accomplices on the property ladder, get their money as long as people can afford their interest repayments, the banks are fine. In a heavily leveraged, debt burdened society such as the UK, where household debt is at astronomical levels, ratcheting up interest rates by even half a percent can push households into bankruptcy. This is why Mark Carney keeps talking about raising interest rates, but his mates at the commercial banks are pushing him to keep rates low, and to keep their income streams alive. Expect more chat and no rate rises.
I don’t dispute that the state has got too big, and that austerity may work in the long run, mainly through the gradual dismantling of the costly state overhead, and getting people involved in productive work, but the interim is uncomfortable.
Under the Tories ’austerity’ programme they have borrowed an additional £465bn, nearly half a trillion pounds. This more than Labour borrowed in 13 years in power, and they were hardly spendthrifts. Most of that cash went to the financial sector after their reckless lending (money creation) caused a credit bubble which imploded in 2008. Any time more borrowing is required rather than less, this points to a failure of austerity as a policy, and a requirement to prop up falling taxation revenue with additional borrowing.
Is there an Easy Solution to the Global Economic Problem?
There is. But the actions must come from a basis of reality, and from a basis of straight talking sense. It is easy to imagine, but not so easy to implement.
For an economy to function efficiently, it requires a shift of focus away from the current measures of economic success, and going back to basics. Economies which thrive have low proportions of the population dependent on the state, and low proportions of administrators. People are encouraged to make and spend their own money on things that they want. The proportions of the unproductive economy, those who are not contributing to the economic benefit should be minimised or discouraged as far as reasonably practicable.
When I speak of unproductive economy, I am of course talking about government and bureaucracy, and predominantly rent-seeking activities, which have replaced productive economic exchange as the de-facto British economic model. Examples of rent seekers are: moneylenders; those who have access to cheap debt to buy assets and rent them out, owners of assets (particularly land and property). Meanwhile, income is taxed, while capital gains on buy to let property gets a tax cut.
We need to encourage productive economy, and discourage rent seeking, and we need to have a grown up debate about pensions (and the fact that we cannot afford to pay them and that you’re going to have to work or sell your house to fund your retirement, because there’s not enough money to go round.
This post has already been read 416 times!
Also published on Medium.