Thursday, February 11, 2010

The end of consumption

I don't know whether you have noticed, but the world economy is a real mess.  To summarise how we got where we are:
  1. During the first decade of this century, economic growth in the West wasn't based primarily on productivity increases (i.e. innovation, technological progress etc.).  Instead it was based on consumers taking on increasing amount of debt, refinancing their houses, maxing out on their credit cards.  By steadily increasing their borrowings, consumers steadily increased the money they were pumping into the economy.
  2. China was an integral part of the system that was created.  Westerners would effectively borrow money from China (through their governments and banks), and use the money to purchase Chinese goods.  As a result, rising western borrowing not only kept the developed world's economies growing, but also kept China's millions in work.
  3. It couldn't last however.  Borrowers got to the point when they simply couldn't afford to take on any more credit, or in some cases to repay what they had already borrowed.  Demand for major assets (notably houses) slumped as a reaction, which in turn triggered defaults on mortgage backed bonds and insurances, bringing down Lehmans and many other financial institutions, and finally threatening the confidence and trust that necessarily underlies the world's financial system.
  4. Governments were forced to step in with massive financial aid.  The aid had two purposes:  first of all it was necessary to stop banks failing and restore confidence in the system through massive recapitalisations (think of the billions poured into AIG).  This government spending probably helped the world economy dodge a bullet and spared us from another great depression.  The second purpose was to replace the private sector demand that had evaporated, so as to keep people in work (the car scrappage schemes are a good example of this)
  5. Now unfortunately, the bill for all of the financial largesse is being delivered to the table.  Economies have bottomed, but have not really started to recover.  Government deficits in many countries are running at truly scary levels of around 10% of GDP, meaning that national governments are piling on debt at rates unheard of (in my lifetime at least).  Greece is the first cab off the bankruptcy rank in this sense; a nation of 10m has a debt of EUR 300bn!  Others will follow.
So that brings us up to date.  Unfortunately it doesn't seem to get any better from here on:
  1. Unless governments rapidly reduce their spending, many are going to follow Greece into effective bankruptcy.  On the other hand, if they stop spending, their national economies will slip back into deep recessions, from which they will not be able to recover until debt levels are restored to 'normal' levels many years down the track.
  2. Something will have to give soon with oil prices.  Brent crude is currently a little over $70 a barrel.  Apparently it needs to be over $80 a barrel to promote discovery and exploitation of new fields.  What's more, this figure is slowly rising.  It is also believed that an oil price over $100 would push most western economies back into recession.  So we have a sweet spot of $80-$100 where we can keep building supply without killing demand.  The problem is that that range is becoming ever smaller as new oil depositis become increasingly expensive to find and exploit.  At some point we will be confronted with high oil prices, unsatisfied demand and recession all at the same time.  Our oil-based economy will cease to function.
  3. We're sitting on a demographic time bomb.  The large baby-boom generation of the 1950s is starting to retire, and they will live longer in retirement than any generation before them.  They haven't saved enough for their retirements, and, among other things, will be forced to unload their large family houses and move into granny-flats to free up money to live on.  The much smaller generation replacing them in the workforce won't be able to absorb that much housing and as a result house prices will fall again.  What's more, taxes will need to rise as a smaller group of workers funds state pensions for a larger group of retirees.  This will reduce demand even further.
  4. Did I mention climate change and the mess that's going to make of many econonmies around the world as they transition to different types of agriculture and try to adjust to a warmer world with higher sea levels?  I forgot, didn't I.
So from where I'm sitting things don't look very pretty.  We're not entirely without hope, however.  The key to getting us out of the woods is, I believe, the recognition that we are stuck in a trap.  We keep promoting increased consumption (even debt-financed consumption) in order to keep people in jobs.  This, however, is a road which will ultimately lead to disaster, as set out above.  We actually need to reduce consumption (of physical things).

That sounds sacriligious, but think about it:
  1. Do westerners really need to live in big houses and pay big heating bills?  Would they be any less happy living in a comfortable, smaller home?
  2. Do they really need to own and run so many cars?  If they all took public transport, then the quality and frequency of public transport could be improved.
  3. Do they really need to fill their houses with cheap manufactured junk from China?  Why not buy quality goods and repair them from time to time like their grandparents did?
  4. Do they need to eat as much as they do, becoming fat and unhealthy in the process?
But, I hear you say, actions such as 1-4 above would cause a massive collapse in  demand and cost hundreds of millions of jobs worldwide...

Not necessarily.  There are new sectors opening up where massive numbers of jobs will be created.  Some of these will be in secondary industry (e.g. the manufacture of wind power and bio-fuels, the exploitation of space), but many others need to be created in service industries.  The large population of elderly will need to be cared for and nursed.  We will need more doctors, dentists and teachers, especially in less developed countries.

The path from a consumption-based economy to a service-based one is deceptively easy.  We gradually stop taxing service provision (i.e. personal income) and instead start taxing consumption (i.e. resource use).  Through taxation, we make the energy and material inputs to manufacturing much more expensive, discouraging wasteful, unnecessary consumption.  By reducing taxation on income, we make labour cheaper; people who today can't afford a nanny to look after their kids will find that this 'luxury' will fit within their budget.  And so on and so on.

We end up with an economy in which westerners will live more simply in material terms but will have more enjoyable lives due to the higher level of services they can access.  Jobs aren't lost from the transition, just replaced.  Capitalist / market structures don't need to be thrown away, just harnessed to serve a different goal.

We probably need a pilot project in a small economy where excessive consumption hasn't yet fully taken hold and income taxes haven't proved very effective.  A country which is in need of some new, bright ideas to rebuild its economy in a sustainable and socially acceptable manner.  I think I might know just the place...


  1. Good suggestions. Unfortunately they may be a bit difficult to implement, no? candango.

  2. It depends. You could develop a system in which taxes are related to the cost of restoring a resource that has been used to its initial state, however this would be complex to calibrate and administer.

    A simpler method would be to just tax fossil fuel use, as this is the main non-renewable resource

  3. Here's another angle on the issue: