SYNOPSIS

 

CHALLENGES TO GROWTH IN DEVELOPED ECONOMIES

The global economic crisis that continues to spread for the fifth year is a crisis that has mostly affected developed economies. Even though each country in this crisis has a different set of problems, the problem common to all is anemic economic growth. Insufficient economic growth in developed countries is causing this economic crisis to continue and spread.

Higher levels of development generally leave smaller room for further growth; this is particularly true if future growth is to follow the same course as past development. Most developed countries are trying to grow on the same trajectory that started with the industrial revolution; therefore their potentials for further growth are getting increasingly smaller with higher cumulative growth and higher levels of development.

However, tightening constraints on fossil fuel, particularly oil, and competition from developing countries are the factors that have converted the diminishing potentials for growth in developed countries into negative growths. A brief analysis of the effects of these factors on growth in developed economies follows.

 

Tightening constraints on fossil fuels

Oil price hikes

During most of the 20th century oil was under $5 a barrel. When oil was cheap higher oil consumption increased the size of the economy. The marginal benefit from using oil was much higher than the cost of oil and the economy kept growing by using more oil. No wonder the largest economy of the world uses the most oil.

Cheap oil driven growth built large economies with huge segments that are dependent on cheap energy. Even the physical layouts of towns and cities assume cheap use of cars, trucks and other means of transportation. Developed economies are literally built around cheap oil and energy.

Consequently, the rate of oil consumption in developed countries is very high, a fact evident in this data available for 2007. Oil consumption in theUSwas 69 barrels per day for 1000 people; in contrast, it was 6 barrels in China and 2.4 barrels in India. In Germany, Japan and theUK the oil consumption rate was 30, 39, 29 barrels per day respectively.

However, cheap oil that helped build the high consumption rates in most developed economies is a thing of the past. Oil price went from a low of $9.10 a barrel in December of 1998 to a high of $143.95 in July of 2008; it has mostly remained over $75 a barrel in 2010 and 2011, gradually inching higher over time and averaging approximately $100 a barrel in the first half of 2012.

A more than 1000 percent increase in the price of oil in the recent decade, or so, has seriously affected most developed economies. It has rendered unviable a wide range of economic activities that previously made sense; examples include suburban living, driving big cars and over reliance on trucking and aviation. It has put in retreat economic growth that started with the building of the Interstate Highways and subsequent creation of huge urban and suburban sprawls. Huge segments of the economy have become unviable due to oil price hikes. All sectors including energy, transportation, housing, recreation and tourism, and retail are affected.

Even though oil is very expensive the economy continues to use huge quantities of oil because it is structurally required. For example, people have to drive to work and live where there are houses. The way people live, where they live and the equipments and appliances they use, all assume cheap oil and energy. The structural need to consume massive amounts of expensive oil leaves less money for other economic activities and burdens consumers and producers. Consequently, demand for other goods and services are falling, businesses are failing and few new businesses opportunities are available.

Developed countries have economies that were built on $20 barrel oil. (Oil prices started rising in the 1970s and oscillated around $20 a barrel for the remaining part of the century.) Now that oil is around $100 a barrel the economic structure in developed countries has started to fail. That is, the economies are not able to generate enough economic activities to provide rising real incomes for their populations and keep them employed.

The USand other developed countries are extremely affected by oil prices directly and indirectly. The direct effects are obvious; the indirect effect is on the size of their economies i.e. higher oil prices mean smaller economies for them; as cheap oil in the past meant larger economies. Their economies have started to shrink. Vulnerable European countries are just starting points.

That high oil prices are exerting a pressure on developed economies to shrink is evident from the fact that oil prices generally rise when demand picks up in developed countries.  Sharp hikes in oil price have preceded 10 of the last 11 US recessions.

Constrained growth in demand from developing countries

If oil prices had not risen as much as they did during the recent decade, real incomes in developing countries would have risen much faster. Higher real incomes in developing countries would have translated into demand for high value and high end consumer, industrial and service products, substantially increasing their imports from developed countries.

During the push for globalization it was mostly assumed, by economists, in developed economies that business lost to developing countries will be more than made up by increasing demand from them. But due to constraints on fossil fuel use and consequently on growth in real incomes, that kind of increase in demand did not materialize. Globalization has so far not yielded its promise for developed countries because of oil price hikes.

Zero-sum global economy

The planet has a finite amount of fossil fuel, particularly oil, a fact increasingly evident in the rising price of oil. If the global economy continues its increasing dependence on fossil fuel, its growth will be greatly determined by fossil fuel supply and related constraints, including the environment.

Fossil fuel constraints will not allow the global economy to grow freely; therefore growth in developing countries will exert offsetting downward pressure on growth in developed countries. As developing countries grow developed ones will tend to shrink. Economic growth is fast becoming a zero-sum game among countries because of these fossil fuel constraints. Falling economic growth and incomes in developed countries are outcomes of fossil fuel constraints and the resulting zero-sum nature of the global economy.

 

Competition from developing countries

Low wage competition

Wages in developing countries are really low. The wage differences between developing and developed countries are huge, much higher than that reflected in the differences in their per capita GDP. According to 2011 World Bank figures, per capita GDP in the US was $48,442 whereas in China it was $5,445; in India and Bangladesh it was $1,489 and $735 respectively.

After the collapse of communism and the onset of globalization, two billion people in developing countries joined the global workforce creating massive industrial capacities to produce goods at low wages. Tough low wage competition from developing economies is forcing many businesses in developed economies to either close down or move to developing countries to take advantage of their low wages. Consequently, industries in developed countries exposed to low wage competition are forced to pare down their domestic presence.

Low wage competition is here to stay because: wage differences between developed and developing countries are really huge, fossil fuel constraints don’t allow incomes to rise freely in developing countries, and there is a huge pool of unemployed labor in developing countries.

Competitive disadvantage of developed economies

Due to high and ubiquitous use of fossil fuel the cost structures in developed countries get pushed up from multiple directions by oil price hikes; even wage standards are now pushed up or lose downward flexibility because of the cumulative effect of hikes in the recent decade.

In developing countries, on the other hand, oil price hikes do not significantly affect wages and other costs due to their low usage of fossil fuel. Developing economies do not generally go into an economic recession due to oil price hikes. Low intensity of energy use helps them keep wages low in spite of rising oil prices.

The economic effects of oil price hikes are many times higher in developed countries than in developing ones. Competitive abilities of business in developed countries are therefore diminished by oil price hikes and related expectations. Developing countries gain some competitive advantage over developed countries every time oil price increases. As long as oil prices are high and rising developed countries will keep losing business to developing countries.

 

SUSTAINABILITY WILL ENABLE DEVELOPED ECONOMIES TO GROW  

It seems from the above analysis that oil price hikes are not only directly causing this crisis but they are also the reason why competition and other factors mentioned above are working against growth in developed economies.

The factors causing downward spiral in developed economies are: resource and environmental constraints, increasing competition from developing countries, and their own higher levels of development.

Sustainability will mitigate or reverse the effects of all three of these factors. Sustainability here only means: sustainability with respect to resource consumption, particularly fossil fuel, and environmental quality.

Sustainability will free economies from resource and environmental constraints. Oil prices and environmental constraints won’t matter for economic growth. Plentiful and cheap sustainable energy (yes it will be cheap if there are no interest costs, details in the following pages) will help economies grow the way cheap oil did in the past. There will be no pressure on developed economies to shrink.

Oil price hikes will no longer affect the competitive abilities of developed countries because oil will be replaced by cheap sustainable energy.

Building of sustainable industries and infrastructure would improve employment conditions everywhere. Absence of resource constraints and better employment opportunities will raise real wages in developing countries. Consequently, the threat of cutthroat low wage competition would gradually subside for developed economies.

Sustainability will help raise incomes because there will be higher investment, employment, production and other economic activities. It will help raise incomes also because fossil fuel constraints will no longer limit growth in real incomes. Consequently, developing countries will be better able to afford high value products from developed countries. There will be high volume of trade flows in both directions. There will be growth everywhere.  

Sustainability will create numerous new avenues for growth. The transformation of a fossil fuel based economy into a sustainable economy will require huge amounts of economic activities in which the entire production and supply chains of most products will be built or rebuilt and numerous new infrastructure and economic development projects will be undertaken. There will be plenty of room for lasting growth in this new direction. High level of development will no longer be an impediment to growth.

Sustainability will also help address the challenges posed by climate change and other environmental problems. The economic effects of environmental constraints have very significant constraining effects on economic growth.

There may be significant disagreements about what caused this crisis because different countries took different paths to this crisis. However, there should be little disagreement about what will get those economies out of this crisis: sustainability. It is easy to visualize millions of new jobs and rapid economic growth in an economy embarked on a path to sustainability. Growth and prosperity in the largest economy of the world will certainly come about if it changes its course towards sustainability.

 

THE OBSTACLE TO SUSTAINABILITY: INTEREST

Sustainable energy industries, such as wind and solar power, are extremely capital-intensive. A one-gigawatt wind facility costs more than $2.5 billion to build whereas a gas facility of the same capacity costs $600 million. Since sustainable energy industries require huge capital investments, many times of that required in fossil fuel power-plants, they have low financial returns on capital. As a result they cannot be counted on to pay interest consistently which makes them financially unviable.

Currently short term interest rate is near zero; it has been so for more than four years. However, the threat of interest rates rising in future keeps sustainable businesses from becoming financially viable. Interest has hovered around 5% for centuries. Just the existence of interest based system will prevent a sustainable economy from ever taking root. The biggest obstacle to sustainability is the interest based financial system or simply: interest.

If interest is eliminated sustainable sources of energy will become financially viable. There would be economic growth everywhere and the threat of global warming would start to recede.

 

NEW CAPITALISM

Abundant supply of fossil fuel has been a fountainhead of economic growth since the advent of the industrial revolution. The interest based system worked very well in the economic engine driven by fossil fuel. Now that the fossil fuel fountainhead cannot support further growth we have to design a new capitalistic engine which runs well on forces of nature such as wind or sunshine. As mentioned above this new economic engine is very capital intensive and will not become financially viable if it is burdened with the cost of interest on capital.

This book titled “New Capitalism – Capitalism for 21st Century” proposes fundamental changes in the financial system to adapt capitalism for the new fountainhead of economic growth: forces of nature such as wind or sunshine. “New Capitalism” will enable economies to become sustainable and will preserve the spirit of capitalism and free markets. The salient features of New Capitalism are:

1.     Eliminating interest on money from the economic system;

2.     Discontinuing Income tax;

3.     Instituting Asset tax.

The proposed system basically replaces Interest and Income tax with Asset tax, an annual tax on all assets including cash. Asset tax will perform the functions of interest and income tax and will also serve as a tool for achieving macroeconomic and societal objectives such as sustainability, employment, economic stability, and economic growth.

Asset tax on cash will create the incentive for lenders to lend i.e. the incentive to shift the tax burden onto the borrower. Lending will continue due to asset tax on cash. Credit risk will be compensated separately.

Asset tax structure will incorporate incentives for investing in sustainable capital assets and disincentives for unsustainable ones; e.g. low Asset tax for sustainable assets and industries and high Asset tax for resource depleting and polluting ones.

 

Eliminating Interest

Since the industrial revolution humans have been getting their supply of energy from reservoirs of energy stored in the planet in the form of fossil fuel. Now that source is drying up humans have to rely on the natural flow of energy in the planet e.g. wind, wave, sunshine, kinetic etc. for their supply of energy. Wind and sunshine power plants give so little energy (output) per unit of capital ($) that they cannot turn out any consistent profits if they are made to pay interest on capital. These plants cannot be expected to accommodate interest in their cost structures and still be profitable. Therefore eliminating interest has to be a cornerstone of the capitalistic system that will bring growth and prosperity in the 21st century.

Interest has to be eliminated because it is the major reason for most unsustainable choices being made in capitalistic economies. Interest does not allow investments to pick up in sustainable energy and similar industries. Interest also incentivizes rapid extraction and consumption of mineral resources because minerals in the ground don’t earn interest. Interest favors resource intensive industries because they are bale to pay interest.

If interest is not eliminated most investments would continue to be made in unsustainable industries till the world manifestly starts running out of resources. In the meantime developed economies will suffocate from increasing resource constraints and lack of business opportunities.

If interest is eliminated developed economies will have a chance to grow by investing in sustainable industries. Higher investments in sustainable industries will help change the mix of products being produced and consumed to a sustainable one. A sustainable mix of products will not suffer from resource constraints, therefore aggregate demand can increase without limits. Growth rates can easily reach double digits in developed countries.

Eliminating interest will create room in the cost structure to accommodate the high wage levels common in developed countries. Cutting wages will not solve the competiveness problem nor will it make developed economies grow (details in the following chapters). Eliminating interest will also improve global competitiveness by reducing energy costs. Sustainable energy e.g. from wind and sunshine will be cheap if interest is eliminated. Eliminating interest will significantly improve the global competitiveness of developed economies.

The competitiveness benefits of New Capitalism will not be reversed when developing countries also eliminate interest (and become sustainable) because their incomes and wages will rise and their costs will start to approach that of developed countries. New Capitalism by freeing the global economy from resource constraints will create a win-win situation for both developed and developing countries, both will be free to grow and prosper. The global economy will embark on a new trajectory of sustainable economic growth lasting generations.

Interest is a relic of the gold system, which required payment of interest to keep the limited amount of money (gold) in circulation. Under fiat money interest is not necessary because money can be created.

Massive industrialization of developing countries has tremendously increased global industrial capacities to produce and supply capital. Consequently, there is abundance of capital; which is also reflected in huge savings inAsiaand elsewhere. Increased supply of capital has reduced the rate of return on capital, thanks to the law of diminishing marginal returns. Lower returns are reflected in interest rates that have been at historical lows for most of this century.

Since interest rates are near zero they are far likely to go up than down; the fear of interest rates rising is preventing businesses from making investments which would otherwise be feasible at these rates. When interest rates are low the expectation of higher interest rates in future keeps industries with inherently low returns from making use of capital. Lower rates generally don’t bring in new industries as borrowers.

Since interest rates can’t go below zero the expectations of its rising increases as it approaches zero. This asymmetry of expectations seems to start at 5%. Interest rates have hovered at 5% for centuries, therefore 5% can be thought as the buoyancy level of interest rates. When interest rates go below its buoyancy level the expectation of its rising tends to be higher than falling. Due to this asymmetry of expectations interest rates start to lose effectiveness as they go below their buoyancy level of 5%.

The interest based system is not very effective in allocating capital through lowering rates i.e. during times of abundant capital. Interest is ineffective in dealing with abundance of capital; it can only handle scarcity of capital.

This inability of interest to be effective during abundance of capital results in huge sums of unallocated capital which in turn drives interest rates even lower, particularly short term, and increases speculative activities. Speculative activities increase asset prices and cause asset bubbles. In the presence of interest, money is far more likely to be invested in bubble forming assets than in low return industries. Asset bubbles can promise to pay interest, sustainable industries cannot. Currently the major reason for capital being wasted in asset bubbles is: interest.

Trillions of dollars that were wasted in asset bubbles could have been productively employed in sustainable energy and other 21st century industries if the interest based system did not stand in the way of sustainable industries. Interest rates and their threat of rising is the only reason massive amounts of new investments are not being made in sustainable and related industries.

Interest creates imbalances in the financial system through geometric growth in debt. These imbalances cause asset bubbles, recessions, freezing of credit markets and other financial crises. Interest is ineffective in increasing economic activity when the economy is under challenging conditions because it cannot go below zero. Instead of bringing stability to the financial system interest is one of the causes of instability in the financial system. It is difficult to imagine a worse capital allocation system for the 21st century.

 

Discontinuing Income Tax

Income Tax has to be discontinued because it is not needed in the proposed system – New Capitalism.  Currently, income tax performs the function of generating revenue for the government.  Asset tax would do that with higher efficiency and fairness. Wealth is a better measure of an entity’s ability to pay tax and its fair share than its income in a particular year.

 

Instituting Asset Tax

Asset tax will perform the function of both interest and income tax.

  • Asset tax will perform the economic function performed by interest, i.e. allocating capital. Currently capital gets allocated only to entities that can pay interest; similarly, in New Capitalism, capital will get allocated only to entities that can pay Asset tax.
  • The proposed Asset tax system will incorporate incentives for investing in sustainable economic assets, and disincentives for unsustainable ones. This will be accomplished by the Asset tax rate structure, e.g. low Asset tax for sustainable assets and industries and high Asset tax for resource depleting and polluting ones.
  • Asset tax on cash will create the incentive for lenders to lend, i.e. to shift the tax burden to the borrower. It is a dependable tool for restoring liquidity in financial markets because it can be increased till credit flow is restored.
  • Asset tax is a powerful tool for increasing investments: it can create a push to invest by increasing asset tax on cash (increasing the cost of leaving money idle), and a pull to invest in particular assets or industries by lowering asset tax on those assets or industries. The effects of both incentives add up; together they can achieve growth promoting investment targets even under difficult economic conditions.

Once interest and income tax are replaced by asset tax, economic growth will immediately resume driven initially by the huge potentials of sustainable industries and related businesses. Most other businesses would also prosper because of better prospects for economic growth and a dependable capital allocation system.

Since the capital allocation system would be better equipped to achieve macroeconomic investment and growth targets, the regularity of recessions, freezing of credit markets and other boom-bust events, common in an interest based system, will be significantly reduced. Better growth prospects and greater stability in the economic system will translate into attractive and stable financial returns for investors.

Financial return drives capitalistic economic system and it should; asset tax rate structure will insure that search for higher returns does not lead to unsustainable business choices and does not work against the future of mankind. Under asset tax system, financial return will again become a measure worthy of driving economies.

Asset tax will be easier to assess and administer than income tax. As in any tax system, there will be exemptions, thresholds, moratoriums etc. to keep the system fair and productive.

 

Salient benefits of New Capitalism

It is difficult to imagine a single plausible scenario under which developed capitalistic economies will have lasting recovery without becoming sustainable (Some commonly suggested false recovery efforts, e.g. oil self sufficiency, are discussed in the next chapter). Short of a devastating global war or other catastrophe there seems to be no way that developed economies will have lasting growth unless they become sustainable.

“New Capitalism” will enable developed economies to become sustainable and to grow. Some of the obvious ways it will help these economies are as follows:

  • New Capitalism will provide economic tools (Asset tax) to handle environmental and other planetary resource constraints. The role of sustainability is so fundamental in New Capitalism that it could as well be called “Sustainable Capitalism.”
  • New Capitalism by promoting investments in sustainable energy and other resource enhancing industries will change the mix of products to a sustainable one. A sustainable product mix will usher in an era of limitless economic growth.
  • New Capitalism will help create many new and advanced industries, e.g. commercialization of space, harnessing wind, sunshine and tidal energy, building sustainable desalination plants and coastal cities, and cultivation of oceans. These      industries will require advanced know how and innovation which in turn will enable developed countries to maintain their high wages and high standards of living.
  • The path to a prosperous future is through innovation, high tech and advanced knowhow; New Capitalism will provide the economic underpinnings and incentives to make that a business norm, rather than an exception.

Unemployment, which is increasingly becoming an existential challenge for most governments in developed economies, will subside to a desirable level under New Capitalism. This will happen because interest, which is an impediment to an economy’s natural tendency to gravitate towards full employment, will be eliminated; and the economy will work as it is supposed to in the classical theories of employment and income. The Keynesian fiscal intervention to achieve full employment won’t be needed. Full employment is a normal state of economy under New Capitalism.

New Capitalism is inherently friendlier to employment, investment, and other economic well being needs of individuals and societies. In short

New Capitalism is:   Planet friendly       Maximum Investment       Full Employment                                             Capitalism                        Capitalism                          Capitalism              

It would not be an exaggeration to say that New Capitalism is a once in a lifetime solution to a once in a lifetime crisis. New Capitalism will bring about an economic revolution. The explosion of economic growth and potentials that will be brought about by this revolution will be comparable to that brought about by the industrial revolution!

 

 

 

Growth challenges in developed economies, is here

Chapter 1 begins here… 

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