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The Anglo Disease (3) - an introduction for non-economists

by Jerome a Paris Sun Jun 24th, 2007 at 05:19:39 PM EST

I've been developing in a couple of recent diaries over at the European Tribune (The Anglo Disease - Financiers worried about end of great bull run and Anglo Disease (2) - Martin Wolf's take, with afew adding input of his own in Anglo-Disease Sidelights (1): UK = Tax Haven) a concept which I think can usefully describe our current economic system, that of the Anglo Disease, mirrorring the "Dutch disease", a term coined in the 70s to describe the economic effects of the rapid development of one sector (in that case, natural gas, today, the financial industry) on the rest of the economy.

This text is meant as an attempt to explain what this 'disease' might be, trying to be as pedagogic as possible. You are my guinea pigs, so all comments and questions are welcome - indeed, they are hoped for - so that this text can be improved upon and refined.


In the Netherlands, the discovery of the large Groningen gas field which brought about a boom in that resource sector, with a lot of - highly profitable - investment concentrating in that sector. The reason that something which sounds like good news is called a disease is that the investment in that profitable sector tends to cause a drop in investment in other industrial sectors, because it is so much more profitable; at the same time, there is a lot of extra revenue from the export of the resource, which generates new demand which cannot be fulfilled by domestic production and gives rise to increased imports. The fact that resource exports grow strongly also tends to cause the domestic currency to get stronger, thus further penalising other sectors of activity on international markets. The result is a weakening of the rest of the economy, and increased reliance on the resource sector.

This then becomes a problem when the new sector is based on finite resources, and eventually goes into decline. At that point, exports dry up, but the rest of the economy, having become uncompetitive and fallen behind, can no longer pick up the slack and has become too small to carry the economy over. Thus the overall economy suffers.

In effect, the displacement of existing activity by the new sector is, to some extent, irreversible, and thus, when the resource dries up, the overall economy is permanently weakened. It's also part of the "resource curse", which usually includes additional symptoms like corruption and weakening of democratic rules as a lot of money gets concentrated in relatively few hands (those that own and those that regulate the resource industry). In the worst cases, it can include militarisation of society (weapons being an easy way to spend a lot of foreign currency and being occasionally useful against those that might want to take your sweet spot overseeing the cash cow).

:: ::

I think that the above is increasingly relevant to describe the economy of the UK and, to a lesser extent, that of the US, which are increasingly dominated by the financial services industry.

That prevalence of the financial world is no longer a matter of dispute. In fact, it is celebrated with increasingly euphoric words in most business publications and current affairs books. There is an air of hegelian (or marxist) inevitability about the triumph of markets and Anglo-Saxon capitalism, led by the powerhouses (banks, hedge funds and assorted accomplices) in the City of London and on Wall Street.

But just as Britain led the world into industrialisation, so now Britain is leading it out. Today you can still find a few British engineers and scientists making jet engines and pharmaceuticals—and doing rather well at it. But many more are cooking up algorithms for hedge funds and investment banks—where in many cases they add more value. The economy has boomed these past 15 years, as manufacturing has been left behind and London has become the world's leading international financial centre. Britain's deficit in manufactured goods is hitting record highs. But so are the capital inflows.

The Economist (editorial, this week)

The collapse of the trade balance, linked to the long term (relative) decline of the manufacturing sector is indeed one of the most noteworthy commonalities between the US and UK economies, along with the reliance on the sale of services, in particular financial services:

(from this text, which deserves a diary of its own)

Unfettered finance is fast reshaping the global economy (by Martin Wolf, senior editor, Financial Times, 19 June 2007)

It is capitalism, not communism, that generates what the communist Leon Trotsky once called “permanent revolution”. It is the only economic system of which that is true. Joseph Schumpeter called it “creative destruction”. Now, after the fall of its adversary, has come another revolutionary period. Capitalism is mutating once again.

Much of the institutional scenery of two decades ago – distinct national business elites, stable managerial control over companies and long-term relationships with financial institutions – is disappearing into economic history. We have, instead the triumph of the global over the local, of the speculator over the manager and of the financier over the producer. We are witnessing the transformation of mid-20th century managerial capitalism into global financial capitalism.

Above all, the financial sector, which was placed in chains after the Depression of the 1930s, is once again unbound. Many of the new developments emanated from the US. But they are ever more global. With them come not just new economic activities and new wealth but also a new social and political landscape.

The ability of the financial world to generate high returns on capital has fuelled the massive financial boom we've been in for most of our lives and which has so transformed our economic landscape. By demonstrating regular high returns possible, it has generalised the requirement for such returns in all economic activities, and thus the need for constant restructuring of businesses, for cost-cutting, offshoring and, often, for the wholesale dismantlement of whole sectors of activity that could not generate the required profitability.

Sectors like manufacturing have seen their share of economic activity shrink , as many activities were outsourced, offshored or eliminated altogether. The trade balance has gone south, and jobs have disappeared under relentless pressure for higher competitivity.

This might not be so bad if the jobs created in the service sector, and in finance in particular, were as numerous and high paying - and durable as those in the industry. All statistics on median wages suggest that this is not the case: median wages have been stagnant over the past couple of decades, with a stark increase in inequality. Increased wealth (as measured by GDP or average income) has been captured by a small number of people at the top, something strikingly similar to the remuneration structure of big investment banks and the rest of the financial industry.

The inequality might be acceptable if there was a prospect of reversing it as increasing prosperity is created (this is essentially the argument of Martin Wolf and other proponents of globalisation), but is in fact a structural and necessary feature of the system. Globalisation has spawned a whole ideology about efficient allocation of resources, optimisation of investment decisions, and the invisible, but natural, and morally neutral hand that allow markets to reveal the best price at any given moment for any item. It brings along a vicious hate for taxation, and sees government, and its core functions, redistribution and regulation, as something to be avoided and eliminated as much as possible, being fundamentally anti-efficient. It also brings the core idea that only things that have a price have a value, that everything can be measured in dollars, and that what isn't so measured has no worth nor legitimacy. It fosters a culture of individualism ("freedom") and consumerism ("success"). Social policies (which require distribution), common goods (which need to be defined and managed) and non-economic measures of well-being are spurned and actively fought. Growth is paramount.

While I think that this is more than enough to disqualify neoliberalism (as I have mande abundantly clear in many earlier diaries), there is actually worse. and that's where the concept of the 'Dutch disease' comes in.

:: ::

One of the core triggers of the Dutch disease is that the resource sector which has unbalanced the economy eventually shrinks as the underlying resource is depleted. In our case, the industry that causes activity-substitution (finance) can appear to be able to grow ad infinitum, without any limitation to actual resources. Just borrow more money to do bigger deals and enjoy the very real income taken along the way. Find another lender to refinance or another buyer to re-purchase, and you're home and dry. Or just do deals where the actual burden to repay is pushed back into the future (and you won't be around anymore if and when they falter). Thus the City and Wall Street can appear to generate more jobs than the industries they kill off destroy. In addition, with New York and (even moreso) London dominating finance worldwide and not just domestically, they can create jobs and capture wealth locally while imposing their requirements on companies and activities in other countries, thus creating little or no pain at home (see the graph below on how the UK as a whole can be defined as an offshore financial center, just like any Caribbean Island...)

So, while to some extent parasitic on other economies, it might at least make sense for the UK and the US - as nimbler, faster, smarter economies, they reap the benefits of globalisation and are understandably promoting their interests by defending globalisation. And hey, they are providing real services to investors around the world, who are "free to seek out the best returns around" and "voting with their feet/money."

But in fact, this is but a transitory phenomenon, underpinned by a single underlying factor: the long decline of inflation, and thus of interest rates, over the past 25 years.

We've been living in a long, massive bull market for bonds, born off the inflation of the 70s, and the grand ride which was made possible by the new financial tools offered by the IT revolution and by Reagan/Thatcher inspired deregulation is about to come to an end. The returns we've grown used to were just a long but temporary phase in a natural long term economic cycle, and, despite the final boost provided by 'Bubbles' Greenspan in the last few years, not something that can be sustained on a permanent basis. Put simply, it is not possible to generate 15% per annum returns on capital forever when the underlying economy is growing only by 3%.

As the interest rates go up again, and liquidity tightens again, the financial industry is going to run out of the underlying resource that sustained it - easy and plentiful access to money. As that constraint imposes its implacable discipline, and the financial industry finds out that it no longer has anything to offer to its clients (trading stuff, or trading imaginary products remotely backed by stuff, will no longer be so much more profitable than making stuff), it is going to shrink and withdraw. And the countries and cities that have bet on that industry for their prosperity will face the resource curse, as their core activity loses steam and alternative activities, having being neglected for so long, no longer exist or are too small or uncompetitive to make a difference, and cannot pick up the slack. This is what I propose should be called the Anglo Disease.

As this reversal has not yet taken place, and as this prediction threatens the livelihoods of many of my readers, I expect to be mocked and dismissed, but bear with me and help me work on the concept.

I hope to expand on the idea in further diaries, and I hope to get your feedback (including questions if you're not sure you understand what I wrote - maybe I am actually talking nonsense, for all my apparent trust in my assertions). The topic ties in neatly with the critique of neoliberalism I've been trying to write about in the past, to our unsustainable focus on growth as a sign of success, to worries about resource availability, and to the "inevitability" of the Western model - or rather of its financial brat, the Anglo-Saxon capitalist market economy, so there is a lot of matter to write about, and I hope you'll join in the fun.

Display:
http://www.dailykos.com/story/2007/6/24/174042/787

Thanks for your support for this one.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sun Jun 24th, 2007 at 06:00:07 PM EST
DL:

You might enjoy Kevin Phillips' Wealth and Democrary, available cheap at Abe books, if you have not read it.

"Highly readable for all its charts and graphs"

Now that I have gotten your attention:

Had to read this one two times, it was so meaty.

Phillips compares the great economic empires, Spain, Dutch, thru American of the last 5 centuries.

As I recall, Phillips argued that Britain and US are reenacting now, more exaggeratedly, the same finance capitalism frenzy that gripped Britain at the turn of the twentieth century.

"When the abyss stares at me, it wets its pants." Brian Hopkins

by EricC on Sun Jun 24th, 2007 at 06:16:17 PM EST
That book has indeed been recommended to me before. But as I have (I take) so little time to read book these days , and my pile to-read is biiig, I hesitate to buy more...

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Sun Jun 24th, 2007 at 06:23:56 PM EST
[ Parent ]
Adding something about the impossible durability of financial industry growth :

Functionnaly, the role of banking and financial markets in our large capitalist societies is the optimal allocation of real world resources. In other words, it is the industry in charge of establishing and putting into practice the plan. (This is how I justify my working in banking to my extreme leftist consciousness). Well, the impressive growth of banking is the same symptom as the growth of the Plan in the Soviet Union, and wealth capture by the nomenklatura in that place ; the deciders are improductively getting the larger share of production. The results will likely be the same.

Un roi sans divertissement est un homme plein de misères

by linca (antonin POINT lucas AROBASE gmail.com) on Sun Jun 24th, 2007 at 06:36:04 PM EST
That's an interesting, and actually pretty insightful, way of seeing it. Frank Herbert wrote somewhere that bureaucracy would grow until it used up all the free energy of any civilisation. I suppose this could be applicable here, with a adapted definition of bureaucracy...

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Sun Jun 24th, 2007 at 07:06:57 PM EST
[ Parent ]
Bureaucracy indeed is the word I should have been using. Let's remember that a generation ago, before the age or the computer, banking was the epitome of bureaucracy, along with government. The image of the rond de cuir, the banking paper pusher, has only recently disappeared.

That's also why computers have increased productivity in banking so much : automating bureaucracy is what computers do best. From the point of view of the computer programmer in banking, the amount of bureaucracy going on is staggering ; most computer power is used to do daily, monthly, quaterly and yearly reports...

Also, the amount of money traders can put in their information systems is astonishing, compared to "industry", i.e. the real world. It feels that the IT teams could double in size overnight and it still would be felt. (I also will remember for quite sometime the sentence I saw in an email, saying 200k€ was less that a pen's width...)

As a side note about bureaucracy : it is now considered equivalent to government, a great victory of the neolib view. That's false and need to be repeated : bureaucracy still exists in the financial world. Indeed, I think our PDG is a dozen hierarchical levels above me... Successful companies can afford to be much more wasteful than any government, and often are.

Un roi sans divertissement est un homme plein de misères

by linca (antonin POINT lucas AROBASE gmail.com) on Sun Jun 24th, 2007 at 07:27:09 PM EST
[ Parent ]
This is very, very prescient Jerome - the kind of analysis I'd like to read in the FT and Econo but which of course don't appear there.

I can't think of anything useful to add, apart from an anecdotal data point from today's Sunday Express, which was suggesting that private equity pirates shouldn't be taxed because they 'create wealth.'

So the disease really seems to be the belief that if you create wealth you don't have to share. That's currently very much an Anglo-Saxon pathology, for some reason. As I've said before in Anglo-Saxonia we don't seem to like ourselves much, and we certainly don't like other people, and don't see why we should have to give them anything of ours.

Maybe it's a child rearing issue. I don't know. But it seems there's something very pinched and aggressively retentive about it which is somehow characteristic.

The financial markets have a huge amount in common with the enclosures of the 17th century. The view held by the markets is that capital is owned by the markets. My view is that capital is a common resource, and placing limitations on access to it inevitably creates an economic crash.

This is partly because growth which is based solely on speculation and gaming the market is fictional and inherently inflationary - the system is currently set up to make it appear real, but it's a convenient self-serving and self-referential lie.

And partly because contraction of access to high quality education, to R&D and to funding means that the useful skills base contracts. This means the economy has no resilience - when the game is up there's no fallback position.

What you're left with is a fantasy economy where the markets reward themselves by 'creating wealth' - effectively producing money to order out of nothing more solid than faith and perception management - and quite deliberately having as little contact with physical or social consequences as possible.

Part of the problem is that capital has become increasingly decoupled from reality. As long as it can flit from here to there it can 'maximise profit' in the most conveniently brutal ways, and go somewhere else once companies start to falter after they've been sucked dry, there's no incentive to face the consequences of bad or exploitative decisions.

This isn't going to stop until it falls off the rails, or until someone bold appears and starts placing limits on what capital is allowed to do.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Sun Jun 24th, 2007 at 06:51:19 PM EST
One fundamental thing I think is the notion that the wealth the financial world 'creates' is, to a large extent, wealth it captures, i.e. that already exists. That kind of parasitic behavior can only happen in times of plenty - and the glorious years of the middle classes underpinned by plentiful and cheap energy are just the ticket.

As scarcity reappears, looting will no longer be an effective solution. Will it simply subside, or disappear, or will it try to create the conditions for its further existence (via wars, for instance), is the big question.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Sun Jun 24th, 2007 at 07:05:20 PM EST
[ Parent ]
I still find the concept of wealth almost completely nebulous, so it's not clear what's being captured. Or created.

You and Linca have already made a point I was thinking about yesterday, which is that it's about the capture of free energy and resources rather than 'money.'

But I think during bubble periods there's a kind of financial indeterminacy. It's a bit like virtual particle creation in physics - you can create as many particles as you want, providing they don't last long enough to be noticeable. Sooner or later there has to be a real world accounting.

Similarly you can create as much virtual money as you want, as long as the markets are prepared to believe it's real. Eventually there's a crash, but a lot can happen before you get to that point.

The question I don't have an answer to is - is this a zero sum game?

As for scarcity - I'd expect war to be a more likely outcome, because some people happen to enjoy it, and others find it profitable.

It's hard enough to make a relatively simple change like enforcing mpg restrictions to avoid conspicuously stupid consumption.

When it's not about SUVs but about food, I expect the crowd to get nasty.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Mon Jun 25th, 2007 at 06:47:10 AM EST
[ Parent ]
by TGeraghty on Sun Jun 24th, 2007 at 07:28:02 PM EST
As the interest rates go up again, and liquidity tightens again, the financial industry is going to run out of the underlying resource that sustained it - easy and plentiful access to money. As that constraint imposes its implacable discipline, and the financial industry finds out that it no longer has anything to offer to its clients (trading stuff, or trading imaginary products remotely backed by stuff, will no longer be so much more profitable than making stuff), it is going to shrink and withdraw.

How important in all this are the Japanese yen's consistently low interest rate and its role in so-called carry trades?

Truth unfolds in time through a communal process.

by marco on Mon Jun 25th, 2007 at 02:49:28 AM EST
It's a very important source of the "naturally low interest rates" that have propelled the financial services industry over recent years...
by Metatone (metatone [a|t] gmail (dot) com) on Mon Jun 25th, 2007 at 03:57:15 PM EST
[ Parent ]
Globalisation has spawned a whole ideology about efficient allocation of resources, optimisation of investment decisions, and the invisible, but natural, and morally neutral hand that allow markets to reveal the best price at any given moment for any item. It brings along a vicious hate for taxation, and sees government, and its core functions, redistribution and regulation, as something to be avoided and eliminated as much as possible, being fundamentally anti-efficient. It also brings the core idea that only things that have a price have a value, that everything can be measured in dollars, and that what isn't so measured has no worth nor legitimacy. It fosters a culture of individualism ("freedom") and consumerism ("success"). Social policies (which require distribution), common goods (which need to be defined and managed) and non-economic measures of well-being are spurned and actively fought. Growth is paramount.
I think that you are right in placing the sentence I've highlighted outside the description of the ideology, and instead among the things that the ideology has fostered.

As I've noted before, however, this idea is a heresy in the high church of market economics. This presents and opportunity to shame them with their own religion.

Words and ideas I offer here may be used freely and without attribution.

by technopolitical on Mon Jun 25th, 2007 at 04:31:48 AM EST
BruceMcF made a somewhat similar point in one of the previous threads, i.e. that this was not a logical consequence of the underlying ideology, but it was its inevitable political effect.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Mon Jun 25th, 2007 at 04:45:41 AM EST
[ Parent ]
This comment was actually in the separate diary on competition - the thread is worth reading too.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Mon Jun 25th, 2007 at 04:59:11 AM EST
[ Parent ]
It brings along a vicious hate for taxation, and sees government, and its core functions, redistribution and regulation, as something to be avoided and eliminated as much as possible, being fundamentally anti-efficient.

This is what strikes me the most, the Liberal Globalization concept openly pushes for economic inefficiency, and still it is hugely popular.

I can't contribute much more to this essay, it looks pretty accessible and solid on its reasoning. Great work Jérôme.


Vencit omnia veritas.

by Luis de Sousa (luis[dot]a[dot]de[dot]sousa[at]gmail[dot]com) on Mon Jun 25th, 2007 at 04:48:17 AM EST
Looking for historical rate data, I found this amusing rate curve animation which comes with simple explanatory text for major curve shapes. They don't put the dot on the I and tell outright that the US economy is in for a rough ride next 24 months, but I let you play with the applet...

http://www.smartmoney.com/onebond/index.cfm?story=yieldcurve

I'm still looking for another animation that would give me some 3D with GDP growth on the side wall to visualize the predictive strength of the inverted curve.

Also an animation that would have a "shadow" would be nice: at any instant in the film, superimpose the curve with the one you got from the implied forward rates (for accordingly shifted maturities) in the previous curves - this would tell you how smart the market was, historically, in guessing future rates...

If anybody knows of a good public repository of historical data, maybe I could build it with simple excel charts.

Pierre

by Pierre on Mon Jun 25th, 2007 at 11:21:48 AM EST
I don't have any, but your concept sounds good.

"When the abyss stares at me, it wets its pants." Brian Hopkins
by EricC on Tue Jun 26th, 2007 at 01:29:32 AM EST
[ Parent ]
  1. Regarding the fact that profits from the financial sector have overtaken profits from manufacturing: is this historically unprecedented? Is it limited to the US and the UK? Are global trends pointing in the same direction?

  2. What's the current effect of (global I presume) savings (if any) on interest rates and liquidity in general?

  3. Is it my idea or is the situation you are describing similar to a Ponzi Scheme? Are we living in a Ponzi Scheme Economy?


The road of excess leads to the palace of wisdom - William Blake
by talos (mihalis at gmail dot com) on Mon Jun 25th, 2007 at 11:35:41 AM EST
One feeling I had was that it might be worth describing an example based around a 3rd world country that is dependent on one resource (pick the example that works best for you) as well as the Dutch example to help people understand what you're talking about.
by Metatone (metatone [a|t] gmail (dot) com) on Mon Jun 25th, 2007 at 03:39:24 PM EST


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