Avoiding Global Depression?

Historians have the benefit of hindsight.  In hindsight it will seem inevitable that after the popping of the real estate bubble and the collapse of financial institutions due to wild speculation and excessive credit, states would suffer next.  After all, the huge increase in debt — private debt has soared as much as government debt has — created an unsustainable economic pattern.   You can’t borrow and spend forever.

The problem is that this pattern, which has persisted for at least thirty years, has yielded unsustainable practices and expectations that have not yet disappeared.   The equivalent on the micro level is the market for construction workers and electricians during the housing bubble.  People built life expectations and planned careers based on economic conditions which could not last.   Now hundreds of thousands of people face making major life changes due to the economic collapse.   For countries like Greece, the pattern of the last thirty years allowed continued accumulation of debt, and inept governmental practices.

At the same time, another factor was at play — demographics.   Social welfare systems, especially pension plans, were designed when populations were young.   That meant one could be generous to senior citizens, assuring them a comfortable retirement with quality health care.    Yet as a society gets wealthier, fertility rates decline.   People want to enjoy the material comforts of the modern age, and frankly, kids mess that up.    Add to that increased life spans due to improvements in medical care, and the elderly become an unsustainable burden on the young.

Finally, there is the energy situation.  The 20th century was built on cheap oil, and that era has past.   Even as we try to suck more oil from deep sea wells, oil shale, and possible new finds, it’s clear that world oil production has peaked and the future will mean more expensive oil.   That means that just as our imbalances are becoming unsustainable, the thing that kept the economy moving is becoming more expensive.

So we have three structural imbalances: 1) governments (and private citizens) addicted to debt, building an economy that relies on consumerism and government largess; 2)  demographic changes that create an aging society; and 3) the end of cheap oil.   Can we deal with these without another “Great Depression?”

A “great depression” is the equivalent of a major heart attack to a person who has spent his or her entire adult life over eating, not exercising, and enjoying an unhealthy lifestyle.    This person has probably read the warnings, heard about the dangers, and knew that the extra fries and beer were harming his or her body, but would think “yeah, I have to get healthier but hey, I’m OK now, and I’m enjoying life…”   The heart attack forces the person to rethink his or her fundamental behaviors, and perhaps chart a new course.   The alternative is early death.

A “great depression” is similar.   When we’ve had unhealthy economic behaviors and policies long enough, the system collapses, it can’t continue.   If changes aren’t made we will enter a period of sustained pain, ended by the political equivalent of death — warfare, anarchy, and chaos.    So, following the metaphor, one way to think about this is to figure out what kinds of practices are sustainable within the new economic conditions, and what we need to do to alter our “economic life style.”   A few things come to mind:

1.  Reduction of debt.  This is being forced upon us anyway.   Debt requires someone willing to loan the money, expecting to earn interest.  In the current environment, people are not certain they’ll ever be paid back, and so credit dries up.   Governments need to work for balanced budgets.   The hard part of this is that cutting government spending also means taking money out of the economy, potentially harming any recovery.    A structural stimulus (money spent on building the infrastructure for a sustainable economy and not trying a quick ‘spend all at once’ stimulation of the economy) is rational, but as it is implemented, real cuts in other spending must take place.   This includes rethinking social welfare programs, slashing unnecessary military spending, and assuring that money spent is not wasted.

2.   Ending the culture of consumerism.   Americans especially, but really everyone in the advanced industrialized world, has been partying for decades now thanks to increased debt and cheap energy.    We’re now fat, lazy, and expect “something for nothing.”   Whether it’s people living on welfare, or the pseudo-capitalists who thought getting rich was as easy as simply finding clever ways to invest (flipping real estate, buying dotcom stocks), the idea that we can have it all without much effort has to be rejected.    Already people are moving that direction, but too many still expect that “once this is over,” they can go back to the habits of the past.   Think of it as a life style change like similar to the one forced upon our heart attack victim — we won’t enjoy the excesses that we were addicted to in the past, but ultimately we’ll find a sustainable life style not simply defined by material pleasures of the moment more satisfying.

3.   New economic policies.   The fear of protectionism and how that hurt the world in the thirties has led to acceptance of free trade that isn’t truly free.   If countries like China keep their currency value artificially low, or if other countries exploit workers with extremely poor wages, we have to be willing to say that we don’t need their products.   The notion of fair trade has to replace free trade.   Free trade too often has been a kind of defacto slavery (the poor in the third world supply us our material toys, even as they toil with little), and has created first world economies which no longer produce the stuff we need.    Our economy shifted from production to more service sector jobs, which added little real to the economy, sustained only by debt and bubbles.

US tax rates are at historic lows, we need to consider higher taxes to pay for the infrastructure investments to get us to a sustainable economy.   A fair tax, or some kind of system that avoids the loopholes and perks to the wealthy in the current tax system would be a clear way to do this.  A value added tax might work too, though if it’s simply added to the current structure, it could do more harm than good.

All of this will be difficult to sell to a public used to “something for nothing.”  The government will give you less, you’ll pay more, and the consumer life style you’ve grown accustomed to will have to change.  Populist movements will rebel against this pragmatic and necessary message, and the danger is we’ll end up in economic and political stagnation, weakening the country (or even western civilization as a whole) to the point that a stable transition becomes impossible.   Key will be energy.  If we can start making real infrastructure changes which produce jobs and new technologies, a path may emerge to at least stabilize the situation, even as we make difficult cultural adjustments to new economic conditions.

Avoiding global depression requires societies to pull together to solve problems, recognize that debt and consumerism got us here, to rethink cherished social welfare concepts, and cut military spending.   It’s possible.  The alternative will be social division, resource wars, increased terrorism, and stagnation of a civilization that for better or worse has been exceedingly dynamic for the past four centuries.    We live in interesting times.

UPDATE: I just read a piece from John Judis of The New Republic on “the case for gloom and doom.”  He cites the theory that overproduction (producers making more than consumers can purchase) is the cause of the current crisis.  This is the flip side of too much debt — debt drives up demand, yielding even higher (and ultimately unsustainable) levels of production.   This also brings into question the ability to re-balance by simply increasing demand — that ceases to work when debt levels are already high and there is so much over-production.    To me that further points to the need to have any stimulus be long term (spent over years, not injected right away) and focused on building the infrastructure of a sustainable economy.  The open question is whether going through a major global depression is the only way to rebalance and restructure the world economy.

  1. #1 by Mike Lovell on May 12, 2010 - 14:45

    ” or if other countries exploit workers with extremely poor wages, we have to be willing to say that we don’t need their products.”

    The question of wages here also has to take into consdieration the comparative….is it low wages in that country or low wages comparative to US worker earnings here domestically?

    Recently read an article penned by John Stossel. While I don’t know if I fully agree with everything he says here, the idea of comparative wages and perceptions of them kind of piqued my curiosity a bit. I’d like your thoughts on this piece.


  2. #2 by Mike Lovell on May 12, 2010 - 14:52

    sorry, wrong link listed above. here’s the link I meant to send:

    • #3 by Scott Erb on May 12, 2010 - 15:10

      I used to be more sympathetic to Stoessel’s argument, but here’s the problem. Yes, people line up for the jobs and they do pay a premium over local jobs, but they also warp the economy of the region. Often the result is that those jobs become the only possibility for many workers, and their conditions are worse than anyone anticipated. Workers also lined up for jobs in the British sweat shops in the early 18th century, getting money better than they could get in the villages — but their working conditions were inhumane.

      But that’s not the worst of it. If the Judis article is right that there is global over-production, those jobs were created based on debt-driven demand from the industrialized world. If that debt dries up, those factories will themselves close (or try to cut costs further at the cost of workers) and leave the states which hosted them worse off than before. Moreover, unless we produce, we’ll have nothing to use to pay for our trades (we’ve been relying on increasing debt).

      Stoessel’s argument seems to me a very simple one that doesn’t really look at the impact of these jobs, both on us and the third world countries. It was an easier argument to make when the bubble economy made it seem that demand was ever growing (again, I was more sympathetic to that view then — I had arguments with colleagues in which I was known as the free trade advocate), but now I think it’s not so convincing. I think ultimately free trade is good, but the imbalances between the first and third world need to be taken into account, and we need to produce as well as consume.

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