Inequality in Western societies

An interesting article by John Kay in Financial Times tracks trends in inequality in developed countries. It suggests that in most countries inequality fell from 1920 – 1970 and public expenditure on social benefits increased. However, from 1970 onwards, societies generally became more unequal, the pace of inequality varying with culture. 

I can state at least one major reason why this was so. I refer to my previous post in which I track global economic trends. During time period 1950-1970, governments implemented managed privatization where they controlled large parts of economy and privatized certain sectors. Large government control also coincides with large welfare expenditure. 1970s was the decade of oil crises and consequent liberalization programs, thus reducing government role in economies. This led to growth but also higher inequality. 

If we agree with this, then in today’s world, solutions proposing preserving existing economic structures will lead to even greater inequality (as is happening). Slow economic growth and high inequality is a very inflammable mix, and Europe is walking right into it. Expect a very volatile year for Europe.

Long Term Trends in Global Growth

There is an interesting pattern I found during my study of economic history of different countries. Irrespective of their location, size and affluence level, they all went through similar growth trends. The countries include Mexico & Brazil (developing countries, Latam region); Spain, Italy, Ireland (developed countries, Europe region); and Korea, Australia (developed country, Asia-Pac region).

If we look at their history since WWII, 1950s-60s were periods of growth, 1970s-early 80s saw economic slowdown, 1980s-1990s were periods of liberalization and growth, late 1990s saw growth hiccup again and 2000s mostly higher growth again.

Most of these countries started out as struggling economies. However, the period in 1950s-60s was mostly of high growth owing to reconstruction post-WWII. Another common feature was tendency for high government control and protection of domestic markets. Some countries focused on exports, others didn’t. 1970s-early 80s was a period of slow growth for most countries. Oil shocks were the most common reasons. Following this, most countries decided to implement reforms in the economy and liberalize it. For European countries a big driver was the membership of EU. All the countries also benefited from lower interest rates globally. All in all situation improved in late 1980s-90s and economic growth accelerated again. However, economic growth was hit again in late 1990s for various reasons. The most common response of developed countries was lower interest rates and they experienced a debt fueled growth in 2000s until 2008.

All these time periods are approximate and reflect a general trend. These won’t exactly be true for each country, but generally true for aggregate whole.

There are several interesting suggestions given by this pattern:

1. There have been common drivers for global economic growth in the past. Then, the interconnected world of today will also need a new global growth driver. In absence of this, global growth will stay low. 
2. The drivers of growth have varied with time and were in accordance with the political and economic situation at a given time. Given that, drivers of growth today will have to be those that help solve today’s issues, and not necessarily a rehashed version of previous years. 
3. Economic liberalization was widely adopted only in last 20-30 years. While it did lead to rapid growth, it has not been the only driver of growth in long term. Therefore, further liberalization is not necessarily the best way forward. However, the countries where significant inefficiencies exist will benefit from reforms.

I am curious to know your thoughts also, about this pattern and its implications.

Fed's QE taper - will it end this time?

US Fed's QE program has been very good for the markets. Now it's close to ending and markets are concerned. The question is - does the US economy slow down along with rest of world or can it diverge for long? If we don't believe in decoupling then Fed may have to keep its QE supply open.

Is Europe really shining?

I expect Eurozone's growth to stagnate this year, in contradiction with consensus views.

Latest IMF projections in its World Economic Outlook are for global economic growth to rise from 3.0% in 2013 to 3.6% in 2014. This increase is expected to be led by developed countries, primarily euro area. Euro Area itself is projected to grow at 1.2% in 2014, up from -0.5% in 2013, with the key drivers being reduced fiscal tightening and rise in net exports.

Consensus view is also for euro area growth to pick up pace and increase over 2014-15. Additional reasons for the optimistic view are mainly given as increasing PMIs, improving Current account balances and stabilizing growth in general.

However, I am struggling to get convinced about Eurozone being on a sustainable growth path (assuming Eurozone being the growth engine for Euro area). In all likelihood Europe is entering the league of US and Japan – countries with sluggish growth sustained by quantitative easing, and low inflation.
 

Eurozone’s economy is now more dependent on exports for its growth than prior to 2012 crisis. Dependence on exports implies that it depends on consumption growth in US & China (its two main export destinations) for its own growth. With China expected to grow slower this year and US domestic demand staying sluggish, Eurozone’s exports will struggle to pick up pace.

Current extremely low inflation numbers show that domestic demand growth in most of the world, particularly Europe is weak. Then, that cannot be a driver of sustainable Europe growth. Moreover, demographic trends also support the argument that Europe is unlikely to experience a domestic demand led recovery.

Then, Europe lacks clear growth drivers to take it to sustainable growth path. I expect European growth to stagnate in 2014, due to lack of credible drivers. Given that, investors need to be careful while investing in Europe.

What are your expectations of Eurozone’s growth this year?

Despondent youth of Japan

Japan is losing its fight for economic revival. Its young are losing hopes – of getting good job, becoming wealthier, or charm of building assets or starting a family. According to an article in Japan Times ‘Generation Resignation youngsters defy stereotypes’:

“Today, a sense of passivity is believed to prevail among the young, who are often referred to as “Satori no Sedai” (“Generation Resignation”) — those born just around the time the economy started its slide two decades ago.”

“Critics say youths in this generation are unambitious, averse to risk and reluctant to engage in romantic relationships. They are also said to have little appetite for luxury goods and generally are not willing to go the extra mile to achieve goals.”

“Critics say some young people don’t have high hopes because they don’t know how to realize their ambitions and dreams amid the long-standing economic slump.”

Japan’s young people are leading a comfortable lifestyle so they probably see no threat of losing anything if they give up. This is way different from developing countries where there is much heavier cost of doing nothing.

I think Japan needs massive dose of enthusiasm – either via competition with someone, or threat of some sort, or maybe immigration, to start growing again. Another route could be economic pinch – fall in fiscal support, fall in wages, fall in living standards, rise in desperation. In that scenario, the government should withdraw all artificial support, and let the country go through a steep recession to cleanse the systems. In absence of that it might continue its slow crumbling.

Taking advantage of Emerging Markets turmoil

Let’s focus on the positives. The current turmoil in Emerging markets is not all bad. It is also throwing up some good opportunities for investors. Let us discuss a top down approach to shortlisting EM countries.

A few of my observations about EM economies in last few years are summarized in table below. The table suggests which emerging markets will do well in different scenarios of economic growth (rows) and monetary policy (columns) in developed markets (DM).

	Easy DM monetary policy	Tight  DM monetary policy
DM economic growth high	All EM	Export oriented
DM economic growth low	Domestic demand	No one rule applies

When developed markets have high growth rate, export oriented emerging market countries benefit the most and grow fast. In the flip scenario exporting countries are hurt the most. When DM central banks are going around dropping money from helicopters, their monetary policy also influences EM growth. In times of easy monetary policy, money flows in to all EM countries, and all see outflow in times of tight policy. The amount of money making these rounds is determined by prevailing DM growth rates.

• The first filter for shortlisting countries comes from this table, depending on our expectation of events in developed markets.
• My views of what makes a country structurally strong determine additional filtering criteria. One is economic driver for EM countries – whether it is domestic consumption, fixed investments or exports. I believe that for long term, EM growth should be driven by exports or fixed investments and slowly transition to domestic demand. A country dependent on domestic consumption for growth should have a high GDP per capita or sustainable income source to fund the consumption. In absence of that, it is risky to invest in such an EM country.
• Then, choose a country which knows what its core competence is, and sticks with it. Such a country will be competitive in its area of strength. Even in an unfavorable economic environment, it can afford to sit out and wait, assuming that domestic finances are managed well. A country which tries to change its economic drivers needs more careful assessment. Iceland is a good case study. The country was mostly engaged in fishing and related industries before its rapid growth and subsequent crisis in 2008. Now it is moving back to its original business and economy is stable. I bias in favor of such countries.
• Another important point to consider is quality of management of economy and country. Credibility of policy is important. Its continuity over political cycles is pure gold. A country with such characteristics will be a good place to invest money irrespective of its short term growth trends.
• Lastly, I also look at social situation in countries. Mass protests for apolitical reasons are sign of popular pain. This may be due to economic, political or social reasons, or a combination of these. Presence of such movements suggests caution in investing in such countries, especially in times of slow global growth.

Using all these filters, some undoubtedly involving qualitative judgment, we will arrive at a short list of EM countries which are potentially good places to invest in.

Inheritance and Growth

An interesting article in FT – ‘Inheritance should not be an alternative to hard work’ talks of rising importance of inherited wealth, on a scale that will make it a viable alternative to work. This is a result of slow economic growth in rich countries. Slow growth reduces wealth created by other sources and hence increases importance of inheritance.

The phenomenon is noteworthy for its social, political and economic implications. If it persists over long term, it would influence direction of economies, their efficiencies & sustainability. It would also present risk to belief in fairness of society. The issue, and all its effects gain importance in an environment of slow growth over a long time horizon.

One solution to this issue is higher economic growth. However, the structure of this growth is important. To be sustainable, growth should be based on productive activities, i.e. those that produce goods or services of some utility, and not just an asset price increase. Another attribute of sustainable growth is perception of fairness of opportunity, i.e. a perception that everyone gets an opportunity to benefit from the growth. The existing economic structure should also have an element of meritocracy, a belief that at least to some extent people have a control over their destiny. When inherited money becomes more important, perceptions of fairness and meritocracy become weak.

These factors are useful benchmarks to evaluate government stimulus programs in different economies. Measured this way, most governments today need to do more to ensure sustainability of growth. Scrambling for growth in any form is not the way to do that.

Reference: http://www.ft.com/intl/cms/s/2/d8b97920-76eb-11e3-807e-00144feabdc0.html#axzz2qETu7tZb