Capitalism requires capital. The process of industrialization is partly one of technological advance, but it is also one of increasing capital use in the economy. But when the return to capital is forced below zero, as in the last decade, the capital base shrinks, the economy misbehaves and productivity declines, in spite of technological wizardry. Thanks to the world’s central banks, that is happening now in every advanced country. The rich world’s economy is thus in a death spiral, and it is not clear what forces can be used to get us out.
Productivity growth is the key statistic to measure economic progress. Without it, citizens will never get any richer, and if low-skill immigration is plentiful, they will become poorer. Without it, technological progress is utterly futile; it produces change without progress, disrupting the patterns of life without adding any value. Technological change without productivity growth is what the Luddites thought they had; it is only the productivity growth of the last two centuries that makes us better off than early 19th Century handloom weavers.
From the late 18th Century to 2007, Western residents could rely on a steady, even increasing rate of productivity growth. At less than 1% per annum in the decades before 1850, it gradually accelerated in the late 19th and early 20th century, reaching a high of 2.8% annually in the United States quarter-century to 1973. The invention of the EPA and the OSHA in the early 1970s caused a sharp downturn in U.S. productivity’s exuberant growth, but even so it managed to average 1.8% annually over the 1973-2010 period.
Other countries increased their productivity at similar rates to the U.S.in 1990-2007. Britain did slightly better at 2.0% annually while Japan, in spite of its slump from 1990, did better still, increasing productivity at 2.3% annually. Thus, there was no sign of secular slowing in productivity growth except perhaps in the European Union, where productivity growth was slightly slower, at 1.4% (figures for the eurozone are not available back to 1990.)
After 2007, the picture changed drastically. Following a couple of years recovering from the financial crisis, U.S. productivity growth in 2010-16 was a pathetic 0.6% annually. However, that beat everywhere else. Eurozone productivity growth in 2007-16 was minus 0.2% annually, British productivity growth was nearly as low at plus 0.2% while Japanese productivity growth was an appalling minus 0.6% annually.
In our modern industrial economy, it is difficult to imagine productivity growth going substantially negative. Products cannot be un-invented, and everybody concerned is trying all the time to find new and more efficient ways of doing things. Central bankers take pride that in the last decade they have found ways of pushing interest rates negative, which nobody thought was possible. However, they have also achieved the even more difficult and hugely damaging feat of pushing annual productivity growth substantially negative.
For those with eyes to see, given the evidence worldwide (except in emerging markets, where productivity has continued to grow) there can be little doubt that the world’s central bankers, by pursuing historically unprecedented monetary policy, have produced a historically unprecedented malaise in the global economy. The correlation between negative real rates of interest and very low or negative productivity growth is everywhere apparent. The United States partial reversal of monetary policy in 2017 has even intensified the correlation; interest rates have risen to around 1%, close to the level of inflation, while productivity in the last two quarters of Trumponomics has averaged 2.3%, a historically normal rate.
Japan, where productivity growth continued until 2007, may at first sight seem a counterexample, but in Japan, short-term interest rates only went to zero at the end of 1998 (at the suggestion of the ineffable Ben Bernanke), while inflation between 1999 and 2006 averaged minus 0.5%, so even then real rates were not negative. In 2007-16, inflation averaged 0.3% annually while interest rates went negative and massive “quantitative easing” bond purchases became common, so policy was notably more cuckoo than in the previous decade.
The mechanism by which central banks have achieved this disaster is again clear once you look for it. You would expect interest rates set a long distance from the equilibrium level to distort resource allocation, and they have. I discussed last week the way U.S. blue chips have been “hollowed out” and there is no doubt that process has been thoroughly unnatural, driven by monetary policy. Companies that repurchase their shares or engage in empire-building acquisitions do very little to build productivity, and they suck resources out of true productivity-building investment. Furthermore, Schumpeter’s creative destruction has been stymied by cheap money. Operations that should have been shuttered a decade ago have instead been passed around from buyer to buyer like last year’s wedding presents.
GE Inc. is a classic example of this problem. First it was shoved into financial services by the madman “Neutron Jack” Welch, who retired at the exact peak of the 2000 boom, having asset-stripped the company and decapitated its numerous and valuable long-term research activities. Then it was leveraged to the eyeballs by Jeff Immelt, who took advantage of the decade of monetary madness, buying shares back at $40 that are now worth $18. As a result, America’s iconic foremost conglomerate, which was forced to abandon its dividend in 2008-09 because of the damage done by its financial services juggernaut, has now been forced to halve the dividend again – which would of course have been completely unnecessary had it not been for the share repurchases. As usual, real long-term shareholders have been taken to the cleaners, while short-termist institutions, hedge funds and GE management benefited from the economically suicidal share repurchases. It will be decades before GE once again plays its traditional role in U.S. innovation – if it ever can.
The real problem will come in the downturn, when blue chip follows blue chip into the knackers’ yard while President Trump scratches that wonderful toupee and wonders why a monetary policy admirably designed for his speculative hotel and casino business doesn’t work for the rest of the economy.
Of course, if Schumpeter is permitted to play his gloomy part, and the overleveraged blue chips are liquidated and replaced by new investment, productivity will rebound nicely. But that won’t be allowed to happen. The new Fed chairman Jerome Powell appears to be nearly as committed to witless “stimulus” as were his two predecessors, and if he weren’t, the pressure from Trump and Congress to avoid any kind of short-term pain would be overwhelming. So as soon as the economy hiccups – and it is likely to do much more than that – interest rates will be reduced to zero yet again, to see if there is any other tiny corner of the world economy that can be “stimulated” by the ability to borrow infinite amounts of money at negative real interest rates.
Similarly, Japanese, EU and British leaders are all currently committed to their own policies, all of which are even more insane than U.S. policy (British inflation is running at over 3%, for example, while the short-term rate is 0.5%). They are thus unlikely to change them when recession hits. There is some chance that next year Theresa May will appoint a Bank of England governor less committed to lunatic Keynesian monetary stimulus than the hopeless Mark Carney, but frankly not much.
It is not at all clear whether we will get out of this mess, at least in the short term. Another decade of negative real interest rates will destroy the capital base of the West – how can the capital base survive if it is subjected for decades to negative rates of return? That will cause productivity not just to stagnate, but to decline in a worsening economic death spiral. Inventions will continue, but they will do nothing to improve the economy’s productivity – they will be frivolities and distractions, like the tail fins on 1950s Detroit automobiles.
Historians in the 22nd Century, if new Dark Ages have not swallowed them, will see perfectly clearly the mistakes we are making and the economic disaster those mistakes are causing, but it is now very unlikely that any political leaders will appear who see the disaster before it arrives. Human civilization will not cease; China and India, each of which has more population than the United States and Europe combined, are not making the same mistakes we are, and will thus not suffer the productivity disaster into which we are careening.
Real innovation will increasingly be concentrated in those diligent if imperfect societies, while the United States, Europe and indeed Japan collapse like seventh century Byzantium, artistically interesting but beset by besieging forces they are unable to repel properly and no longer producing any of even the limited technological and intellectual advances of that century. No doubt the Grand Logothetes of Brussels, Tokyo and Washington will spend even more money they don’t have, competing to design ever more useless government programs.
From a Chinese or Indian point of view, this might be thought to represent an appropriate and much deserved reversal of the disaster of the European enlightenment and the Industrial Revolution. But really, the Chinese emperors between Qianlong and the Dowager Empress Cixi were spectacularly useless, so the country’s steep nineteenth century decline was explicable. Here, with democracy, we ought to be able to do better. Shouldn’t we?
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)