The Bear’s Lair: Back to the Middle Ages!

2019 may have marked the all-time peak in real U.S. and global GDP per capita, although statisticians will doubtless fudge the figures to disguise the fact. We can be sure that 2020’s pandemic will cause a sharp GDP downturn and that the bigger government inefficiencies introduced this year will add to previous such burdens on productivity. With worldwide economic policies getting worse not better, the astounding revolution in global living standards brought by industrialization is going into reverse.

The Congressional Budget Office has forecast a U.S. GDP of $20.4 billion in 2020, down about 5% from 2019. That would indicate a decline in GDP per capita of 6%, given the 1% annual increase in U.S. population. The CBO is likely to be somewhat conservative here; I would guess the decline in real 2020 GDP might be as much as 8%. I would also guess however that the CBO’s estimate of year-end unemployment of 12% would be about right, because I expect productivity to be badly affected by the stoppage and resulting inefficiencies. On the other hand, the CBO’s estimate of budget deficits of 18% of GDP in 2020 and 10% of GDP in 2021 are truly frightening. As I remarked last week, they bring the likely bankruptcy of the U.S. government much closer than seemed likely previously, probably to around 2030.

This would not matter all that much if we had good policies in place that would take care of the problem, or even if internationally, fiscal and monetary management was much better, so that even a bankrupt U.S. might be bailed out by a solvent Europe, Japan or China. We know however, that this is not the case and is not likely to change soon. The incentives to bad policy worldwide have been in place for more than two decades now and are not likely to reverse until the fear of God has been put into the world’s electorates. Thanks to the easy-money policies of the Fed and other central banks, God, fear-inducing or otherwise, is nowhere to be seen.

The problem is productivity. In order to get a U.S. GDP or a global GDP above the 2019 level on a per capita basis, productivity must exceed the 2019 level. However there are many major obstacles to it ever doing so, even though for the past 240 years, since the beginning of industrialization, we have been used to productivity growing year by year, sometimes faster, sometimes more slowly, but with never a break as far as we can tell (the figures for the early years of industrialization are necessarily approximate, of course).

Productivity will certainly decline in 2020, although not as much as per capita GDP because unemployment will increase, reducing the number of man-hours worked. The shutdowns will badly affect productivity, obviously, and it will not recover to February levels quickly, because the global supply chains on which it depends will have been so thoroughly disrupted.

After 2020, productivity will remain below historic levels for a considerable period. The massive budget deficits in the U.S. and worldwide are essentially a transfer of resources from the productive private sector to the unproductive public sector. Even though by the conventions of GDP accounting, public sector expenditure is accounted for as though a full dollar of value is received for every dollar spent, that dollar is inert. It does not itself become more productive over time and it acts as a drag on productivity in a private sector that has become a smaller proportion of the total. Central banks buying junk bonds will also destroy productivity, since by doing so they will prolong the lives of zombie companies that should be put out of their misery.

There are several reasons why productivity will decline in the early 2020s, once the virus closure has passed. One is the need for a second Cold War against China. We can no longer rely on China as an infinite source of cheap manufactured goods. We must also ensure that vital supplies, such as pharmaceuticals, medical supplies and crucial raw materials such as rare earths are sourced elsewhere. Beyond that, there will need to be a significant military build-up to counter the Chinese threat.

All these changes are both necessary and benign, but they will increase the costs of government and sap the efficiency of the private sector, which has become used to operating on a fully globalized basis. Most of the costs of these changes will fall on the entities most capable of bearing them: large multinational companies, their managements and the very rich, whose asset prices became hopelessly over-inflated in the 2010s. However, even if your favorite capitas are largely spared the downturn, GDP per capita will decline as productivity adjusts to the new and harsher world.

Internationally, the productivity effect may be greater than in the United States. In the U.S., it partly depends on who wins the 2020 Presidential election. If the country is subjected to a re-regulating, ecology-conscious Joe Biden administration, with higher-cost energy sources and uses dragged into a sub-optimal economic mix, and probably higher taxes, then productivity will decline significantly, more seriously than its merely flat performance during the Obama administration. In continental Europe, the same considerations apply; the EU bureaucracy is irretrievably addicted to mandating inefficient business methods and imposing additional costs, so this tendency will turn a flat productivity performance into a continued decline.

Without necessarily having worse policies, emerging markets countries will suffer the worst economic performance. The decade since 2010 has seen a deterioration in their performance compared to the 2000s, as socialism and corruption have been allowed to creep back. The new de-globalization will hit them hard, as their export markets will decline, while their excessive debt will make it impossible for them to raise capital. Debt levels will have been boosted everywhere by coronavirus spending, but emerging markets will be the first to suffer the effect of this profligacy, as capital markets will become closed to them.

The 2020s declines in productivity, whether or not accompanied by further viruses, will by 2030 or so lead to a global bankruptcy, with debt restructurings wiping out much of the world’s capital. This will cause a further huge lurch downwards in global living standards, and probably a further increase in counterproductive taxes and regulations. Whereas (absent even more destructive plagues) the decline of the 2020s will be moderate and reversible, this further collapse will prevent recovery, and cause further declines in living standards thereafter, as the world’s population continues to increase inexorably and Malthusian factors come into play.

I thought Robert Gordon’s “The rise and fall of American growth” too pessimistic when it appeared in 2016, postulating as it did that the major increases in productivity were past, and that living standards would increase only modestly for the remainder of the 21st Century. I now think it erred on the side of over-optimism. While the technological factors causing a decline in productivity growth have not disappeared (but do not necessarily mean it will vanish altogether) the poor policies that made the early 2010s so economically disappointing have been reinforced and perpetuated.

The Industrial Revolution happened because governments protected private property, remained small and allowed success to be rewarded. We are now following the opposite policy in all three areas. The return to the Middle Ages, in terms of both plagues and living standard declines, cannot be far away.

(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.)