Can demographic force determine demand side or supply side economic policy?

By Shahab Sabahi – Energy and Environment for Development – Research Group

Developed countries once praised themselves for creating robust economic growth. They pronounced that their success had stemmed from innovative monetary and fiscal policies. They encouraged other nations to adopt their ideas through IMF (international monetary fund). In reality, it turned out that socio-economic system did not really work out the ways policy had desired (e.g. Asia crisis in the 90s). Socio-economic system is a complex dynamic system. Its emergent property always manifests that planning can do little for taking the system in a desirable trajectory.  For example, in developed countries, the Great Recession was primarily caused by the collapse in economic demand as 80 million “baby-boomers” born between 1946 and 1964 moved out of their peak spending years in their mid-30s to mid-50s and into retirement in their late 50s and early 60s. In the US, the government tried to resuscitate this demographically shrinking demand with spending $7.6 trillion on Keynesian demand-side stimulus over the last five years. With only 23 million born between 1995 and 2012, this population is just too small for demand-side stimulus to revive the economy. Now the government faces high unemployed people with a budget deficit, and further needs to fund the baby-boomer’s retirement. Under this circumstance, will really demand-side stimulus work?

Our world today is different from the time of the Great Depression. To tackle the great depression, politicians borrowed the idea of Keynesian “demand-side” economics from Great Britain. Demand-side economics argues that in the “short-run” productive activity is influenced by aggregate demand (total spending in the economy) and that aggregate demand may not always equal aggregate supply (the total productive capacity of the economy). Therefore, governments set a demand goal through targeted spending, that has led to short-term growth since 1948.  

Studies demonstrate that 50% of all durable (cars and houses) and non-durable (food and clothing) expenditures are directly related to household demographics. Spending tends to peak as families grow and people reach their mid-30s to mid-50s. Then spending declines rapidly after the mid-50s.

In the 80s when the US switched to supply-side economic policy, the first baby-boomers born in 1946 were just turning 35 years old. By the time those first baby-boomers hit 55 in 2001, the NASDAQ over-the-counter index of growth stocks had risen 2600%, from 190 to over 5000. As the boomers hit 55 and begin to retire through 2019, only 30% as many generation members will replace them in the work force.

Leftist politicians advocate demand-side economics, as they get to look busy spending lots of money creating “demand” for the crony capitalism system. But as we have been observing, governments have been at the edge of bankruptcy cliff long before politicians can “create” enough demand to replace the shrinking consumption spending as the baby-boomers continue to rapidly retire. On the other hand, rightists try to promote a supply-side economics, since these sorts of policies believed once to encourage long-term economic growth.

Now developed countries are either relatively in national debt and recently suffered a credit downgrade (like the US) or suffer low growth. Also, in the theoretical sphere, there is no policy option but supply-side, therefore governments tend to return to supply-side economics to encourage growth. Perhaps governments can encourage population growth policies. 

Break away from obsolete monetary policy instruments (Orthodox school of thought)

By Shahab Sabahi – Energy and Environment for Development – Research Group

 Since July 2007 and particularly June 2011 onwards, the stock market in the US is undervalued. Stock’s prices are lower than the estimate of their fair value. It raises the questions “why the investors’ expectations are so low while real yields are negative” and “why the decrease in interest rates have not produce the increase in investments expected by the central bank”.

It can be argued around investments decisions behaviors. They are based on cost of capital of which interest rates are just one part. The other part, the cost of equity is so high that it takes promising exceptional high rate of return on capital to invest. In a world with uncertainty and complexity as the dominants factors, these investments are difficult to find. It is quite different from a probabilistic environment. In a probabilistic environment businesses can simulate business models with the increasing supply of data. However in the presence of complex systems where, interdependence, connectedness, diversity, and adaptation/learning rule, additional data does not help. In such an environment, businesses find hard, even with data analysis, to distinguish the market signal from the noise. We now face a complex world rather than a complicated one. A complex system stands between order and chaos. A complex system produces non-periodic patterns and emergent structures and functionalities. We should not expect a reduction in the cost of capital under the existing regulatory systems. Even if the real interest rates continue to decrease, businesses should overcome the uncertainty and the complexity of new investments. It is the real cost of capital in the present competitive environment.

Demand for higher cost of equity will promote the notion of rent seeking and short termism.  The world will encounter poor quality and high risky investments. Unfortunately our regulatory systems are still practicing traditional monetary policy. The regulatory systems have not come up with new innovative instruments and not prepared for addressing our today’s real challenges.

 

On the origin of short term attitude: Is it really against sustainable development?

By Shahab Sabahi – Energy and Environment for Development – Research Group

In the realm of socio-economic development, the short-term attitude is regarded as the enemy of sustainable development. So often, investors are blamed for their short-term attitudes. Do investors not really take into account long-term sustainable development? Do they look after immediate profits? If the answer is positive, why do they do so? Do short-term strategies really overlook sustainable development?

To answer these questions, first we should define the short-term attitude and then try to find out what trigger it. It is defined as humans’ attitude for acquiring profits or capital gains over a relatively brief time. Therefore this attitude fails to appreciate the scarcity of resources and the rights of next generations. Indeed, human nature and socio-economic system structures contribute the most into the emergence of the short-term attitude. Researches show that human’s brain functions in a way to choose short cuts in order to achieve certain objectives. Thus short-term attitude seems to be a common approach among all humans, not solely investors, which is a behavioral aspect of humans. Another aspect is to be the system structure through which a society organizes its internal and external interactions. Complex and less regulated systems often encourage the short-term attitude for survival reasons and attracting more resources. It is eloquently described itself through the lack of ethical and moral culture. Today’s financial systems, for example, promote higher gains through more risky operations that ultimately increase the chance of gains. It urges a comprehensive push is needed for regulating financial markets.

Societies and all stakeholders (including shareholders) should be more aware of ultimate purposes of businesses’ investment decisions. It does not at all mean that short term gains are immoral and ruin sustainable long term sustainable development. However regulation is needed to balance the positive-negative effects of the short term attitude. We should not forget that short term strategies are to react effectively to internal and external changes while long term strategies are to build sustainable future for a society.

The notion of slow economic growth - Vacuum of genuine ideas

By Shahab Sabahi – Energy and Environment for Development – Research Group

Robert Gordon in his recent paper, titled “Is U.S. Economic Growth Over? Faltering Innovation Confronts the Six Headwinds”, challenges the notion of “indefinite economic growth”. He argues that regardless of cyclical trends, long term economic growth may grind to a halt. Over two and half century growth of rising per capita could become a history account. The nutshell of his argument is that growth has been driven by the genuine innovations which led to general purpose and resource augmented technologies. Indeed this growth trend has deeply and broadly transformed human’s lifestyle.

The paper is deliberately provocative and suggests that fast economic growth was a one-time thing centered on 1750-2050, and it happened because there was no growth before 1750. He looks after 2050 or 2100 when there might conceivably be no growth.

Opponents to Gordon’s view (see M. Wolf, Financial Times) point out catch-up by developing nations could still drive global growth at a high rate for long term and the speed with which innovation is adopted is determined by finance.

Also the advocates of efficiency improvement argue that growth can still occur as there is massive potential for productivity improvement. The process of innovation may be battering its head against the wall of diminishing returns. Indeed, this is already evident in much of the innovation sector.

It holds true that the global growth can still be achievable as long as the developing countries markets can accommodate more consumption, and developing countries allow the exploitation of their resources. But it should not be necessarily translated to sustainable and long-term growth.

The opponents miss two points.

First, inevitably finance and risk-taking have driven innovation and growth. However, over the two decades, this risk-taking approach has burdened external costs on societies. The miserable pain of external costs has gradually been felt by societies. It could change the risk-taking behavior. Thus so-called innovative finance instruments also cannot be the utmost source of growth.  
Second, the share of productivity in boosting growth decreases and accounts average for 15% while the rest, 75% comes from more resource exploitation (Hulten 2001; Jorgenson and Griliches 1967; Young 1995).

Up to now, economies of scale, market expansion, trade and finance, productivity improvement and financial innovation have modestly contributed to growth. But this show cannot go on any more. Externality, limited resources and the sheer size of growth that are needed to sustain the globe expansion, will defuse the traditional influence of trade-finance in growth.

Yes, Gordon’s message is right; a genuine economic growth needs genuine innovations.