My seven-year-old son got up in class recently and declared there is no Father Christmas.
The little rascal undoubtedly upset some of his classmates who, nevertheless, have already begun to question fairy tales and the supposed ‘truths’ about the world around them.
What came as a surprise was the reaction of his teacher. Mrs Smith was so unsettled at this deliberate and unprovoked attack on the ‘establishment’ that she called me in and threatened to suspend my son from any extra-curricular activities as punishment. No more rugby.
Perhaps her reaction should not be surprising. The cost of believing in the ‘magic’ of Christmas as a child is small, compared to the myth that a ‘tooth fairy’ government and their policies can change the dire state of the UK economy.
Admittedly, politicians do get a fair share of scepticism and criticism, because that is broadly acceptable. It is always marginal. Similarly, if my young son questioned the existence of Rudolph, he would have got away with a light caution.
Established academics, and their theories, are taken too literally and often applied in real life without much consideration for the consequences, nor the rationale for their initial postulation.
Like father, like son. I am convinced the thoughtless application of economic theory in recent decades is flawed and very dangerous.
Far be it for me to belittle John Maynard Keynes, widely held as the father of modern macroeconomics. The man was obviously very intelligent, especially with respect to the manner in which mathematics was applied to his economic theories. However, his theoretical genius should have never been adopted so literally and embraced by policy-makers and governments of capitalist societies throughout the world.
An economic theory should not be treated as a manual for a kitchen appliance. It is never as simple as that. Indeed, Time magazine in 1999 reported Keynes as one of the 100 most important people of the last century, suggesting “his radical idea that governments should spend money they don’t have may have saved capitalism”. Sure, but who gets to define capitalism?
Hailing borrowing and consumption as the sole engines for economic growth is flawed. Developed markets have just had one of the biggest crises in history that was caused by uncontrolled and seemingly unlimited debt creation at a government, corporate and household level. What is even more worrying is that Western governments are ‘bailing’ their economies out by printing money and borrowing even more.
The economic gap between economies that have embraced ‘borrow and spend’ (developed markets) and those who chose a non-conformist path over the past decade (emerging markets) is startling.
Major emerging economies have significantly lower debt levels, hold 75% of global FX reserves (excluding gold) and their current account and budgets are in a much stronger position too. Their growth rates are also far superior to those in developed markets. This is not magic, but merely a different interpretation of the Keynesian approach.
The famous formula for generating income and growth is as follows:
Y = C + I + G + X
(Y = income/growth; C = household spending; I = investment; G = government spending; X = net exports).
The factors on the right of the equation drive income growth. Clearly, there is no explicit savings aspect to this equation. One must spend, invest and export more than one imports to grow income. Simple. But the equation can be changed a little. If we take household spending (C) and government spending (G) out of the equation it makes for interesting reading. We merely eliminate them as explicit growth drivers. We simply deduct C and G from both sides of the equation, et voila – the emerging market growth equation:
Y – C – G = I + X
This is where you have an economy where investment and exports (to the right of the equal sign) drive growth. Everything else is dilutive (household and government spending detracts from growth).
The emerging market approach is more than just the magic of mathematics. It is a victory of pragmatism over perceived genius and intellectual elitism. There is more than one type of capitalism, not just the version the developed countries espouse. This limited view of capitalism has also been used as a political tool for decades.
So, we have established investing and exporting is good, but household and government spending probably less so. But where do savings come in to the equation?
There is a huge global imbalance in savings – the emerging markets have it and the developed markets generally do not. Simply stated, household savings are Income (Y) minus household spending (C) and taxes (T). Savings = Y – C – T. We all relate to that. But we also know government saving (an oxymoron) is taxes (the only form of revenue they receive) minus government spending (G). Government saving = T – G. So what ?
Well, total saving (household and government) = Y – C – T + T – G, which is actually Y –C – G.
Therefore, total saving is also I + X as we saw earlier. Income growth is a function of changes in I + X. So a change in total savings will lead to a change in income growth – savings are not so bad, after all! The magic of maths.
To be fair, after the recent economic shock, quantitative easing is inevitable, so this is a short-term solution only the governments and central banks can sort out. I agree with this ‘pump priming’, in the short term.
A long-term policy framework for savings growth needs to be implemented. It has significant and wide-ranging implications for policy and habits.
It could imply a decade or more of below-trend growth for the US, Europe and the UK as savings build, consumption drops and government shrinks. But ultimately, this will lead to an improved global structure and more balanced growth prospects.
I doubt whether governments and central bankers will withdraw this stimulus quickly. History provides evidence of this risk. It will not be popular to undertake. But, if it is not withdrawn and policy is not put in place, there will be another crisis, and we will have more debt, bigger budget gaps
and the UK can again encounter economic trauma. We will all be older though. Not ideal.
I am not comforted by the fact that “in the long run we will all be dead” as Mr Keynes joked.
The future depends on policy decisions taken today and our will to change our economic mindset. There is no fairy. We need to save more and consume less. That is the truth. We cannot spend our way out of a spending-induced recession, nor borrow our way out of debt. Yet, many adults believe in such magic.
Bryan Collings is managing director of Hexam Capital Partners
