Eminent academic insights on the global economy
This week the advisers at APW Partners attended an Investment Symposium where some of the world’s leading financial academics, including 1997 Nobel Prize in Economic Sciences recipient Myron S. Scholes and former White House adviser and chairman of the U.S President’s Council of Economic Advisers, Prof. Edward P. Lazear, gave presentations.
It was an opportunity for us to talk to them and hear their views on recent global economic events and their thoughts on possible future outcomes. We have aggregated the key points made at the Symposium.
Four pillars drive an economy
- Myron Scholes considers four key components when considering how economies operate:
1. Population – impact of ageing, employment and movement of people;
2. Technology – medical advances, innovation, internet and productivity
3. Scarcity – of resources, people and assets
4. Politics – the political system and legislative framework
- Economies are such complicated systems that it is almost impossible to forecast the implications, particularly over the short term, of single changes and decisions. Too many commentators take overly simplistic views on how one factor may impact an economy.
Where is the US economy now?
- The US economy is the world’s largest, so it is important to everyone, even though locally Australia’s economic growth has become more closely tied to China in recent times.
- If long term economic growth trends had continued over the past 5 years (post war average has been 3.1% pa), the US economy would be 12% larger today. If government stimulus packages hadn’t occurred, the economy would be 3% smaller than today. So the value of doubling U.S government debt over the past 5 years has been minimal. The US economy was never on track for a repeat of the Great Depression as many commentators speculated – 3.5 years after the Great Depression started the US economy was 38% smaller.
- Current US economic growth is the same as Australia at 2.4% pa, which is lower than some developed nations like Germany (3.3%) and Canada (2.8%), but higher than most.
- The potential of the US economy is much greater than current output, with 8 million jobs still required to get employment back to pre-GFC levels. To some extent the stockmarket is already forecasting a gradual recovery based on current pricing.
- US labour market is still in quite bad shape, with the number of hires today less than in 2009. If this persists, it will take until 2017 to get employment levels back to pre-GFC levels, so it needs impetus.
The significance of Lehman Brothers failing has been overestimated by most political and media commentators, which may have unfortunate implications for future regulatory policy.
- Edward Lazear was in the White House the day Lehman Brothers failed, and he considers it a minor event in the US recession.
- By the time Lehmans collapsed on 15 September 2008, the following had already occurred:
- US recession had started in December 2007
- Bear Stearns failed in March 2008
- In the summer of 2008 the Dow Jones lost 3000 points and 1 million jobs were lost
- Fannie Mae and Freddie Mac failed before Lehmans, and AIG failed on the same weekend. With hindsight, the US government should have focused on AIG as a priority rather than Lehman Brothers.
- The fallout from Lehmans is that many people now believe that contagions can spread if one event is allowed to occur. This takes the focus off fundamental policy and onto short term policy responses. Almost all short term policies in recent years have failed to jump start the economy.
- As an example, the US had a ‘cash for clunkers’ scheme, encouraging people to trade in their old cars to buy new ones. The results show zero improvement in new car sales over the last few years compared to what was expected. The ‘spike’ upwards was matched by an equal ‘spike’ downwards over the following years for no net benefit. Australia had a similar failed scheme.
Fears of a ‘contagion’ in Europe are misplaced
- Following on from the Lehmans lessons, we should not believe the media hype that if one Euro country fails, more will follow.
- As an example, the day after the recent Greek elections – when Europe received the best outcome with Greece remaining in the euro – interest rates on Spanish and Italian bonds rose, meaning the market now thought these bonds were more risky.
- Each country in Europe has its own domestic problems – they have little to do with Greece.
- Spain, like the US in 2008, has a housing market problem that has leaked into a banking problem as property prices fall. This is why their banks recently needed additional capital from the government.
- Italy has a government problem, where a lack of control over government expenditure over many decades has resulted in high government debt. If not for Italy’s annual interest payments on its debt, the country would actually run a government budget surplus. So Italy’s problems aren’t new, they’re just getting greater focus with the other problems in Europe.
Governments need to focus on productivity to stimulate growth
- Academic research clearly demonstrates that the most effective way to stimulate economic growth is by focusing on productivity, as this has the greatest impact on real wage growth and thus expands the tax base. This close linkage is true in every economy around the world.
- Reflecting on Australia, current government policy is doing little to stimulate productivity. The introduction of a new carbon tax at a time when the rest of world is not will certainly stifle our productivity relative to other countries. A better policy to reduce carbon emissions but drive productivity may have been to set emission targets for industry whilst delivering new energy projects.
What are potential scenarios for the global economy going forward
- Main themes for the next decade
- Technology will make the US more competitive, so production and manufacturing will grow domestically as the costs in countries such as China increase. Many Chinese businesses are themselves outsourcing to lower cost nations like Indonesia and Vietnam.
- US will become more self-sufficient for energy, particularly from shale oil and gas.
- US trade deficit should start to reverse and the US currency become relatively stronger
- Peak oil may have already occurred due to nations like Saudi Arabia spending less on exploration and more on delivering services to their domestic populations. Some estimate that all of Saudi Arabia’s oil production will be consumed internally within 15 years.
- Edward Lazear, who was responsible for releasing US economic growth forecasts, reconfirmed how difficult it is to make short term forecasts about anything, but much easier over the longer term. However, Myron Scholes presented two potential scenarios for the global economy:
- Reversion to a normal economic cycle from a severe recession. Europe will continue to be a drag on global economic growth due to uncertainty rather than any real economic issues. The additional cash being made available to European economies will provide sufficient liquidity to allow banks to rebuild their balance sheets. No real signs of inflation in Europe or the US may see interest rates remain low until 2014
- Debt/deflation and fiscal concerns with monetary reflation. Various parts of the world will repeat the Japanese experience over the past 20 years, where the economy grew but at the cost of large growth in government debt to support it. In response, governments could impose greater regulation on economies that stymies innovation and increases uncertainty, which in turn acts as a drag on growth. New enterprises will be vital to provide employment opportunities for those displaced by the effects of automation. For example, Walmart employs 1.9million people whilst Google employs 20,000 people. (Walmart’s market capitalisation is only 25% higher than Google).
Author: Rick Walker
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