26 Oct 2012, 2:18pm
economy
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  • The next recovery won’t improve living standards for most people

    All around there seems to be relief at the end of the recession, but also a feeling that respite is still some way away. There’s a growing awareness that households aren’t really going to be experiencing any of the benefits either, and this surprisingly accessible IMF report describes why, in the piece Stable Disequilibrium. The thesis is that there are still serious imbalances between consumer economies in the West and producing economies mainly in Asia, and there is no theoretical or analytical understanding of why these persist. Without an operating theory of why something is happening it is difficult to formulate policy of how to address the problem. All is lost to policymakers in the fog of war:

    The global economy today is in the midst of secular and structural realignments at the national, regional, and international levels as relative dominance and dynamism shift from the older advanced economies to emerging market economies. These realignments are occurring during a period that includes a highly unusual economic downturn that spawned a degree of policy experimentation in advanced economies trying to shake the recession that not long ago would have been deemed unthinkable. These developments also explain why markets have tended to fluctuate violently—as investors alternate from being risk friendly to risk averse.

    The prognosis isn’t that good for Western economies. Without a working hypothesis it is difficult to see how the IMF expects their preferred second scenario to happen

    There are two ways to resolve the inherent [...] contradiction of a stable disequilibrium over the medium term.

    The unpleasant resolution involves the advanced economies tipping once again into recession. [...] The policy responses would inevitably be less effective now that central bank balance sheets have ballooned to 20 to 30 percent of GDP in the major advanced economies while deficits and debt remain high.

    The better resolution is one in which policymakers are proactive and preemptive. [...] In this scenario the United States regains competitiveness and growth, Europe reforms itself into a more robust and harmonious economic union, and systemically important emerging markets encourage their growing middle class to consume as well as produce. All of these developments would have to take place simultaneously

    Hmm. Guess which one of those is more likely to happen? My money’s on the first rather than the second, for the simple reason that the second demands simultaneous and proactive action from governments that have been reactive until now. So we are looking at either a triple-dip recession on a bit of recovery followed by a second recession in a year or so.

    In particular, the population of the West is in deep shit. It was called out in in The True Lessons of the Recession by Raghuram Rajan

    For decades before the financial crisis in 2008, advanced economies were losing their ability to grow by making useful things. But they needed to somehow replace the jobs that had been lost to technology and foreign competition and to pay for the pensions and health care of their aging populations. So in an effort to pump up growth, governments spent more than they could afford and promoted easy credit to get households to do the same. The growth that these countries engineered, with its dependence on borrowing, proved unsustainable

    This is also shown in the flatlining improvements in living standards across the generations, highlighted in The Jinxed Generation in the FT. It shows some interesting conclusions.  The generation following me (Gen Y) achieved faster career progression in material terms. I was in my mid twenties before I could afford to go on holiday abroad and I was in my thirties before I got on a passenger aircraft for the first time. This would align with the massive increase in disposable income in the 21-mid thirties. People reaching working age two decades after me had a better income boost, particularly in their 20-30 year mark, but it is possible that career progression is slower after that. My career progression roughly tripled my pay in real terms (ignoring casual jobs at the start), or doubled it from the first graduate-level job I had.

    Although the FT brings out the biggest gains among the pensioner cohorts, it is grinding the jinxed generation axe somewhat, as there are also these large gains early on in people’s working lives too. Integrated over time I would say the front-end gains are larger. I am starting to wonder if this doesn’t explain some of the nutty increase in house prices. But wages aren’t increasing any more. And they probably won’t increase in real terms for a long time, because of that drag of accumulated debt, which must either be forgiven or paid down.

    Nevertheless, we should beware of being trapped in hedonic adaptation. The so-called Austerity Britain of today is immeasurably richer on nearly all fronts than the Britain I grew up in. Indeed, on the measures where it is a lot poorer – the freedom of children to roam  and the cohesion of society, I would venture that it is not more money that we need to improve these. It is more heart.

    That is perhaps the core of a lot of our problems. We confuse quality of life with standard of living. As an individual my standard of living plunged as I started to save to retire early. Initially, my quality of life took a hit as well, as some of that spending was on distracting myself from the pressures at work and interacting with stupid objectives dreamed up to push the wage bill down. Now my standard of living is still massively lower than it was in 2007. But my quality of life has improved immeasurably, because I have the freedom of self-determination. Money isn’t the only thing that makes live worth living, and yet you’d get that impression at times when people talk about Austerity Britain.

    Spending on some things improves quality of life. It is frightening just how much spending doesn’t do that, once you choose to live your own values, rather than the ones pushed by consumerism.

    The next recovery whenever it shows, won’t improve most Britons’ standard of living. It still is pretty good on average compared to what it was a decade or two ago. The problem is that it’s not that good compared to five years ago, and that doesn’t feel good because the party is still a recent memory. As time goes on that memory will recede. The Kubler Ross model of grief seems to apply

    • Denial – it’s not happening, we just need to remortgage, flex the credit cards
    • Anger – it’s all the fault of the bankers or the 1%, string them up by the lampposts
    • Bargaining – Keynes will save us now, more spending, more borrowing will fix it and make it go away
    • Depression – we’re probably getting to this stage now…
    • Acceptance – we have a little way to go for that, to acknowledge the good times aren’t coming back any time soon.

    According to this, I’d probably agree with Monevator that we are halfway through the recession. Until acceptance is achieved, there will always be the hankering for policy to get back to where we were before, which blinds us to looking at what we have in front of us and what needs to be done to steer a straight way forward.

    It’s a shame the IMF prognosis is so bad and understanding of what is going on and why is so limited. I guess on the upside personally, I will be a net buyer in my S&S ISA for the next ten years or so, and it looks like the first years of that at least will still be under a cloud. Which is a good time to buy, though it never feels that way at the time ;)

    26 Oct 2012, 5:29pm
    by Frugal Scot


    Good article. What comes after acceptance? My feeling is that once the bad times have been accepted, peoples values change and the good times begin, albeit measured by different criteria. Unusually upbeat for cynical old me.

    @Frugal Scot The original KR sequence was for mortality so there wasn’t a next stage ;) I’d agree with your prognosis, and perhaps that in hindsight the cause of the problem and what, if anything, could have been done better will be clearer.

    it’s hard not to get a little bit depressed about the future – vastly increasing world population and dwindling resources are a clear issue, especially as the new middle classes in the newly-developed economies like India, China and other are going to want all the stuff we take for granted (and who can blame them).

    There can only be one direction for prices of goods and that is up. It is quite frightening to think how people will get-by. Perhaps our brightest and most skilled people will begin migrating to the newly-minted economies for better standards of living, reversing the trend for the last few hundred years.

    The Internet and mobile comms are +ve but they are not game changers like coal, oil or electricity. Without a big technological breakthrough in energy, deleveraging will mean that most developed economies will struggle to get above 2% growth for many, many years to come. Modest inflation will hit the poor hardest and a more economically polarised world beckons.

    We will muddle through, but we will not find the sunlit uplands.

    @Donal There’s some evidence of the migration you were thinking of starting to happen, eg the BBC’s chasing the Indian Dream

    There may be some hope if we can remember that standard of living and quality of life aren’t the same thing. Britons sped a lot of money on crap which falls squarely into the wants, not needs camp. There may be some fat there to trim ;)

    @SG It wasn’t you who wrote the Great Stagnation report by any chance ;)

    8 Nov 2012, 7:17pm
    by Win Haslam


    I’d be interested to hear your views on an article posted in the Mail Online – femail section – today, 8/11/12 re a woman who thinks she’s as poor as a church mouse on £80,000 a year…..

    [...] the off. There’s a lot of pain coming to the ordinary man in the street in the UK, because living standards are going to fall. We’ve been spending money that wasn’t ours to spend, and the hangover is usually worse [...]

    9 Nov 2012, 6:46pm
    by ermine


    @Wim wow, I’ve never lived in a household with that much wedge coming in!!!! I guess I’ll have to sign up as a flea on the church mouse ;) Interesting article, indeed.

     

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