When Wealth Disappears
By STEPHEN D. KING
LONDON — AS bad as things in Washington are — the federal government
shutdown since Tuesday, the slim but real potential for a debt default,
a political system that seems increasingly ungovernable — they are going
to get much worse, for the United States and other advanced economies,
in the years ahead.
From the end of World War II to the brief interlude of prosperity after
the cold war, politicians could console themselves with the thought that
rapid economic growth would eventually rescue them from short-term
fiscal transgressions. The miracle of rising living standards encouraged
rich countries increasingly to live beyond their means, happy in the
belief that healthy returns on their real estate and investment
portfolios would let them pay off debts, educate their children and pay
for their medical care and retirement. This was, it seemed, the postwar
generations’ collective destiny.
But the numbers no longer add up. Even before the Great Recession, rich
countries were seeing their tax revenues weaken, social expenditures
rise, government debts accumulate and creditors fret thanks to lower
economic growth rates.
We are reaching end times for Western affluence. Between 2000 and 2007,
ahead of the Great Recession, the United States economy grew at a meager
average of about 2.4 percent a year — a full percentage point below the
3.4 percent average of the 1980s and 1990s. From 2007 to 2012, annual
growth amounted to just 0.8 percent. In Europe, as is well known, the
situation is even worse. Both sides of the North Atlantic have already
succumbed to a Japan-style “lost decade.”
Surely this is only an extended cyclical dip, some policy makers say.
Champions of stimulus assert that another huge round of public spending
or monetary easing — maybe even a commitment to higher inflation and
government borrowing — will jump-start the engine. Proponents of
austerity argue that only indiscriminate deficit reduction, accompanied
by reforming entitlement programs and slashing regulations, will unleash
the “animal spirits” necessary for a private-sector renaissance.
Both sides are wrong. It’s now abundantly clear that forecasters have
been too optimistic, boldly projecting rates of growth that have failed
The White House and Congress, unable to reach agreement in the face of a
fiscal black hole, have turned over the economic repair job to the
Federal Reserve, which has bought trillions of dollars in securities to
keep interest rates low. That has propped up the stock market but left
many working Americans no better off. Growth remains lackluster.
The end of the golden age cannot be explained by some technological
reversal. From iPad apps to shale gas, technology continues to advance.
The underlying reason for the stagnation is that a half-century of
remarkable one-off developments in the industrialized world will not be
First was the unleashing of global trade, after a period of
protectionism and isolationism between the world wars, enabling
manufacturing to take off across Western Europe, North America and East
Asia. A boom that great is unlikely to be repeated in advanced economies.
Second, financial innovations that first appeared in the 1920s, notably
consumer credit, spread in the postwar decades. Post-crisis, the pace of
such borrowing is muted, and likely to stay that way.
Third, social safety nets became widespread, reducing the need for
households to save for unforeseen emergencies. Those nets are fraying
now, meaning that consumers will have to save more for ever longer
periods of retirement.
Fourth, reduced discrimination flooded the labor market with the pent-up
human capital of women. Women now make up a majority of the American
labor force; that proportion can rise only a little bit more, if at all.
Finally, the quality of education improved: in 1950, only 15 percent of
American men and 4 percent of American women between ages 20 and 24 were
enrolled in college. The proportions for both sexes are now over 30
percent, but with graduates no longer guaranteed substantial wage
increases, the costs of education may come to outweigh the benefits.
These five factors induced, if not complacency, an assumption that
economies could expand forever.
Adam Smith discerned this back in 1776 in his “Wealth of Nations”: “It
is in the progressive state, while the society is advancing to the
further acquisition, rather than when it has acquired its full
complement of riches, that the condition of the labouring poor, of the
great body of the people, seems to be the happiest and the most
comfortable. It is hard in the stationary, and miserable in the
The decades before the French Revolution saw an extraordinary increase
in living standards (alongside a huge increase in government debt). But
in the late 1780s, bad weather led to failed harvests and much higher
food prices. Rising expectations could no longer be met. We all know
what happened next.
When the money runs out, a rising state, which Smith described as
“cheerful,” gives way to a declining, “melancholy” one: promises can no
longer be met, mistrust spreads and markets malfunction. Today, that’s
particularly true for societies where income inequality is high and
where the current generation has, in effect, borrowed from future ones.
In the face of stagnation, reform is essential. The euro zone is
unlikely to survive without the creation of a legitimate fiscal and
banking union to match the growing political union. But even if that
happens, Southern Europe’s sky-high debts will be largely indigestible.
Will Angela Merkel’s Germany accept a one-off debt restructuring that
would impose losses on Northern European creditors and taxpayers but
preserve the euro zone? The alternatives — disorderly defaults, higher
inflation, a breakup of the common currency, the dismantling of the
postwar political project — seem worse.
In the United States, which ostensibly has the right institutions (if
not the political will) to deal with its economic problems, a
potentially explosive fiscal situation could be resolved through
scurrilous means, but only by threatening global financial and economic
instability. Interest rates can be held lower than the inflation rate,
as the Fed has done. Or the government could devalue the dollar, thereby
hitting Asian and Arab creditors. Such “default by stealth,” however,
might threaten a crisis of confidence in the dollar, wiping away the
purchasing-power benefits Americans get from the dollar’s status as the
world’s reserve currency.
Not knowing who, ultimately, will lose as a consequence of our past
excesses helps explain America’s current strife. This is not an argument
for immediate and painful austerity, which isn’t working in Europe. It
is, instead, a plea for economic honesty, to recognize that promises
made during good times can no longer be easily kept.
That means a higher retirement age, more immigration to increase the
working-age population, less borrowing from abroad, less reliance on
monetary policy that creates unsustainable financial bubbles, a new
social compact that doesn’t cannibalize the young to feed the boomers, a
tougher stance toward banks, a further opening of world trade and, over
the medium term, a commitment to sustained deficit reduction.
In his “Future of an Illusion,” Sigmund Freud argued that the faithful
clung to God’s existence in the absence of evidence because the
alternative — an empty void — was so much worse. Modern beliefs about
economic prospects are not so different. Policy makers simply pray for a
strong recovery. They opt for the illusion because the reality is too
bleak to bear. But as the current fiscal crisis demonstrates, facing the
pain will not be easy. And the waking up from our collective illusions
has barely begun.
Stephen D. King, chief economist at HSBC, is the author of “When the
Money Runs Out: The End of Western Affluence.”