A global recovery amidst longer-term uncertainty
We are in a relatively unique period right now. For the first time in several years, we are seeing economic growth everywhere in the global economy. No one is talking about recession. It’s just the opposite; people are raising economic forecasts and worried about overheating. And wage growth seems to be headed in the right direction — the Walmart announcement last week representing a marker for optimism.
Yet, after the Great Financial Crisis, it almost seems too good to be true. There is a lot of lingering anxiety because of the depth of the last crisis. And I think there are good reasons to have these anxieties. So I want to put this upbeat economic period in context and talk about where I see the opportunities and where I see the threats for policy makers going forward.
The Big Shift of Risks to Individuals
Let’s take out the wide lens here first. If I were forced to pick out one macro concept that is paramount in thinking about the last few decades, I would go with “Burden Shifting”. Over the last 40 years, workers in advanced economies have seen a tremendous amount of risk shifted onto them from employers and government. I’m talking about retirement savings, healthcare costs, education costs, you name it. And this has happened without a whole lot of education to help get people up to speed.
A lot of this shift was initiated in reaction to the trauma of the 1970s, when the developed economies went through an economic crisis due to high levels of inflation. This big risk shift was seen as a necessary step to maintain economic and productivity growth in volatile and uncertain times. The thinking was that advanced economies were too cosseted by government control and centralization that it was stifling growth and leading to inflation. The solution was thought to be liberalization, privatization, globalization and deregulation anywhere it was possible.
The UK and The US were the first to get religion on this in the late 1970s and early 1980s, with western Europe following behind to varying degrees. If we look at the European sovereign debt crisis through this lens, we can see a liberalizing Germany and like-minded countries like the Netherlands trying to force countries like Greece and Italy to move further in this direction in return for a deeper, closer relationship for all EU countries.
One could make arguments about how helpful all this change has been in making our economies more ‘competitive’. But, from the perspective of the average worker, all of this has been disorienting — catastrophic even. People have had their sense of security shredded on a host of fronts from job security to healthcare costs to education costs to elder care.
Think of this insecurity has discontent or unhappiness. So, what we are seeing, then, is a decline in happiness across developed economies. I looked up a few happiness measures to see what they say about these changes. Here are a few representative quotes from the World Happiness Report 2017,
- “Norway has jumped from 4th place in 2016 to 1st place this year, followed by Denmark, Iceland and Switzerland in a tightly packed bunch. All of the top four countries rank highly on all the main factors found to support happiness: caring, freedom, generosity, honesty, health, income and good governance. Their averages are so close that small changes can re-order the rankings from year to year.”
- “Our China chapter is led by Richard A. Easterlin, who pioneered the economics of happiness more than 40 years ago. It contrasts the sharply growing per capita income in China over the past 25 years with life evaluations that fell steadily from 1990 till about 2005, recovering since then to about the 1990 levels. They attribute the dropping happiness in the first part of the period to rising unemployment and fraying social safety nets, with recoveries since in both.”
- “The USA is a story of reduced happiness. In 2007 the USA ranked 3rd among the OECD countries; in 2016 it came 19th. The reasons are declining social support and increased corruption (see Chapter 7) and it is these same factors that explain why the Nordic countries do so much better.”
What comes through in surveys like these is that increased wealth does not translate into greater contentment. Instead a feeling of connectedness, community, and security were the driving factors of happiness. The Nordic countries lead these surveys because they provide “caring, freedom, generosity, honesty, health, income and good governance.”
And so it would make sense that we see a rise in populism in politics in countries where happiness has dipped and insecurity has increased.
The Great Moderation
Now let’s remember that the fruits of economic gains have not been shared equally. You’ve probably seen the infamous productivity – pay chart showing a tandem rise in pay and productivity, disrupted during the inflation of the 1970s with productivity rising as before but pay stagnating as the great risk shift occurred.
Source: Economic Policy Institute (EPI)
And while happiness indices don’t show wealth as the driving factor in terms of happiness, the stagnation of wages can also be seen as a proxy for financial instability and insecurity given the rise of healthcare and education costs and the burden of defined-contribution retirement plans.
But as interest rates and inflation declined after the 1970s, the uncertainty and anxiety associated with this burden shifting was attenuated significantly by increasing household debt levels that afforded increased consumption. When the Great Financial Crisis brought all of that to an end and a great deleveraging occurred as workers readjusted their outlook to a new lower level, happiness levels declined.
In this sense, the Great Moderation, the name given to the long period of low financial volatility leading up to the crisis a decade ago, is a misnomer. The low volatility was created by an unsustainable increase in private indebtedness and masked an underlying loss of security and increasing anxiety that we now see today in the declining happiness numbers in the US.
I believe we have had a unique opportunity to rectify this problem by creating more connected and caring communities that instil the kind of emotional security that breeds happiness, while at the same time increasing job, financial, healthcare and retirement security. Some of this has happened as efforts to shore up bank and corporate balance sheets have been paramount in policymakers’ minds. Household balance sheets have also recovered due to the rise in house prices. And a lot of healing has happened simply through waiting for the economy to heal.
But despite the global synchronized upturn, I believe the time has now passed to seize opportunities and is making way for time to worry about threats. In the US, the economic model remains largely the same, with the Trump Administration increasing deregulation to help industries like financial services and oil make more money. In Europe, the tacit pact between Macron in France and Merkel in Germany is that France will lead the southern eurozone countries in liberalizing more in exchange for a financial safety net and greater institutional cohesion at the EU level.
What this effectively means is that, as the economy turns up and private debt levels increase again, no mechanisms are being put into place to bolster safeguards against economic and personal hardship when the economy turns down. For example, just yesterday I saw that the Brookings Institution is predicting a student loan default crisis by 2023, probably to occur in the next recession. Nothing is being done to prepare for this.
In Italy, investors are scooping up subordinated debt from Monte dei Paschi, despite the bank’s recent escape from near insolvency. Were we to have a recession in 2019, this nonchalance would turn to panic and the sovereign debt -bank debt nexus would re-assert itself since nothing has been done to at the EU level on bank solvency issues except creating bail-in rules.
These are but two examples. But overall, as companies and banks have benefitted from low interest rates and central bank liquidity to repair their balance sheets, nothing has been done to actively bolster household financial security.
I would like to be optimistic that this upturn will be followed by a shallow recession and then continued economic growth. After all, banks have been recapitalized and companies are flush with cash. But on the household side of things, it’s a different story. What I see is rising economic and social anxiety and a broken social compact in advanced nations. This is feeding political populism, even as the economy enters its best phase of growth in a decade. When the economy turns down, the social, political and economic environment will be even more precarious. And the populism will be more extreme.