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"Dutch Disease" was a term coined in the 1970s by the magazine The Economist to describe the syndrome suffered by the Netherlands after the discovery of the massive Groningen field propelled natural gas into the driving seat of the economy. The extractive sector became so profitable that it attracted the lion's share of new investment, and the resulting gas export boom altered the trade balance and boosted the currency, causing difficulties for the rest of an export-oriented economy. And, as with the "oil curse" that has struck other countries, depletion of the resource has since proved to be extremely painful.

On a larger scale, but of similar nature, is the high-profitability disorder that has, until recently, characterised the financial sector.  The biggest single sector in the 2007 S&P 500 market capitalisation index, weighing 7%-8% of US GDP, its share in total corporate profits stood last year at over 40% from below 20% in the 1970s. Net total income growth in recent years has predominantly benefited a relatively small number of people either working directly in the sector or owners of financial assets. In the UK, where the sector's share of GDP rose to 9.4% in 2006, from 5.5% in 2001, City-dominated London received 50% of total foreign investment. Per capita Gross Valued Added rose by between 8% and 9% over the last decade in London while, in all other regions of the UK, it stagnated or fell. In fact, the phenomenon is so firmly based in the money centers of New York and especially London, that the label "Anglo Disease", by allusion to "Dutch Disease", might appear to be no unfair moniker.

How to describe the pathology of this ailment? Financiers, now unchecked by regulation or restrictions on leverage, can monetize many kinds of future revenue streams today, generating instant profits they and their clients can capture. That capacity to create apparent wealth out of thin air without limit cannot be matched by any other sector in the economy. Unsurprisingly, it sucks in talent, resources and skills that are not available for infrastructure investment or other economic activities.

Meanwhile, the investors who have made those immediate profits possible still want to ensure that the future flows that underpin them do in fact materialize--and so they will impose their rules and discipline on the underlying economic activity. The result is an unrelenting focus on profits and shareholder value. Struggling to meet "return on capital" criteria, many non-financial activities experience yet further reductions in capital allocation, and relative decline. Meanwhile, public debate is dominated by financial analysts, as "net present value" becomes the standard prism through which to view any human activity.

Public policy attempts to provide balance are hamstrung by the fact that, from the financial viewpoint, regulations and tax are restrictions on entrepreneurship and profit to be opposed and if possible eliminated. As for labor, return on capital is improved if its cost can be reduced. Outsourcing, offshoring, and labor market flexibility have helped keep wages in check. Hence a major symptom of the Anglo Disease is long-term stagnation of the majority of incomes.

Flat incomes might constrain domestic demand, but easy credit (to the further benefit of the financial industry that channels it) has buttressed household spending. Expansionist monetary policies in the West have combined with Chinese mercantilism to offer rapid asset price increases with no consumer goods or wage inflation, generating high corporate profits. Global trade imbalances and what was a massive asset bubble created an economy blessed with the appearance of strong, inflation-free growth--an illusion that helped validate the underlying policies, despite rising inequality and ballooning, unsustainable, debt burdens. Starting with subprime lending, but now extending to other financial activities, market players have suddenly become scared by their collective imprudence and have engaged in a brutal process of deleveraging. While the credit crunch devastates bank balance sheets, the wider economy is also suffering.  Credit available to businesses is shrinking, and the spigot of house equity withdrawals is turned off for consumers. The reality of declining or stagnant incomes for the majority can no longer be camouflaged. Prospects are dire, and  further damage to the banking sector and the overall economy is likely.

The imbalances will only be unwound, ultimately, if incomes match spending more closely. That can, of course, happen through a consumer spending slump and an  inevitably painful recession. The financial wagers and high-priced assets that surfed on a nicely growing economy will, at some point, have to be marked down as losses, as is happening already. The Anglo Disease will face treatment by the kind of drastic purge that threatens the patient's very life.

There remains another way: higher wages across the board, and a more modest financial sector restrained by regulators and unable to impose the artificially high return-on-capital requirements made possible only by excessive leverage. Making banking boring again is, compared to the alternative, a fairly gentle cure for the Anglo Disease.

John Evans, a writer, and Jérôme Guillet, an investment banker in the energy sector, are editors of the European Tribune, a current affairs website.

John, would you post it again on the FP?

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

by Jerome a Paris (etg@eurotrib.com) on Mon Sep 15th, 2008 at 06:21:03 AM EST
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