How do we get back to growth?

Last week UBS held a conference in Edinburgh. They didn’t invite me. I was as shocked as I imagine you are. So I went anyway and hung around until the girls handing out name badges agreed to go and get George Magnus for me.

I’ve been meaning to interview him for ages, and this seemed like a good way to do it without having to spend ages fiddling around with diaries. Luckily, Magnus said he wanted to talk to me too (what grace!) and that he didn’t mind in the least being door-stopped at the Balmoral Hotel.

So we went to sit in a noisy corridor just down from the throng. What had he been talking about to his smartly dressed audience, I asked. His answer: the “intrusion of politics into business and economic outcomes”.

Most of the people of “my generation have grown up thinking that politics doesn’t matter” because there is a world apart from politics that is all about “the efficiency of markets and the primacy of markets in allocating resources efficiently and ensuring prosperity”. As far as they could see, “all you needed was independent central banks to back the system up and everything would be fine”. Then it “just kind of exploded”. Now we have a “crisis of capitalism”.

A crisis of capitalism or a crisis of statism? I ask. It seems to me that you could say that the huge credit bubble of the last decade wouldn’t have happened in a purely capitalist environment. It happened thanks to state intervention – ultra-low monetary policy and the like.

Magnus has a “certain sympathy” with that, but, as he notes at this point, the only question we need to ask is: how do we get back to growth? All the drivers of the last ten years have just gone “kaput”. We can’t create jobs and we can’t create incomes and because of that “we can’t consume all the products and services that our companies can provide”. We hear a lot about how cash-rich companies are, but let’s not forget that they are only cash-rich because they have “squeezed down on labour costs so much”.

Underconsumption and growth

I ask if he is saying that the large corporations of the West are instruments of their own destruction (something I have been writing about). Does he agree, I ask, that as profit margins and compensation have gone up at big companies, and as incomes at the bottom have fallen in relative terms, we have created a situation in which spare cash sloshes around the place at the top, creating toxic bubble after toxic bubble, while the lack of spare cash at the bottom crimps demand?

He does – “precisely”, he says. Do I agree that what I have just said is Marxist? Come to think of it, I suppose I do. As Magnus says, it isn’t much of a step from where he and I are to talk about underconsumption and overproduction – “which is its mirror image” – and how Marx and Engels described “the problem of what is endogenous to capitalism”.

So given all this, how do we get growth? Perhaps, says Magnus, we just give in to statism. After all, we are competing with all sorts of countries that run various types of state capitalism, so perhaps what we need is something very politically contentious: “some kind of industrial policy that incorporates a much expanded role for government”.

Might the state perhaps provide “strong incentives and the physical infrastructure for the successful sectors of tomorrow”? Let’s not forget that, even in America, which is supposed to be a bastion of capitalism, key industries such as aerospace and autos are state-supported.

I wonder how we might pay for that – what with the deficit and the rising national debt. Magnus is keen on the idea of the government backing infrastructure bonds, which could be subscribed to by pension funds. The average pension fund, he says, is “crying out for uncorrelated diversified assets”, yet only has around 2.5% of its assets in infrastructure.

I ask if the only way out of our problems is “more state”. Isn’t there also a case for “less state”? Perhaps we are where we are not because of capitalism but because we have banished real capitalism with our endless rules and regulations. Take the big investment banks. They only make the super-profits they need to pay super-bonuses because regulation creates such high barriers to entry. Take those away and the problem profits and problem bonuses disappear.

Magnus could only subscribe to this “to a degree”. Yes, the government can and should deregulate a bit and attempt to create the conditions for more competition. But we are operating in a pretty tricky environment. You just can’t “deleverage the private and the public sectors simultaneously without causing a depression”.

Those of a Tea Party disposition might like to “abandon government” and banish red tape. They might then think that “this is going to give rise to the spontaneous combustion of private activity”. But it just isn’t.

The private sector has to deleverage and this “takes time and is very painful”. So the “transition to renewed sustainable growth over the next ten or 20 years” has to be managed. “I just don’t think the private sector can do it on its own.”

A Minksy moment

We move on to talk about Hyman Minsky and his financial instability hypothesis (read his 1986 classic Stablizing An Unstable Economy for more on this). The last chapter of his cycle theory deals with the fact that, post-financial crisis, you pretty much always end up with “Big Government”.

The challenge is then to “figure out how to contain the bigness of government so it doesn’t frustrate natural animal spirits and private-sector enterprise, but make sure that it’s big enough so it can continue to make employment – the lodestone of future economic stability”. The big issue and the one that we can never really deal with is that financial crises are inevitable because “leverage is endogenous to capitalism”.

The only way we have to alleviate that is to ensure that government policy is targeted at “sustaining very, very high levels of employment and I don’t think there was ever in my career a truer moment when that should be the case”. So the British government needs a change of strategy? More of a bending, says Magnus.

The coalition has done a fine job of impressing on its creditors that it is really making progress in restraining spending. Now they just need to show that they also understand that, without growth and jobs, “this thing is going to fall flat on its face” and to take the lead in steering the private sector to a future that’s “not based on housing, financial services and credit”.

We are running out of time fast (no surprise given that we didn’t have an allotted time slot in the first place). So I ask him about Europe. Will the European Central Bank (ECB) print its way out of trouble?

He isn’t sure it will do it in the way people expect. There is an “inbuilt conservatism within the ECB” that makes it unlikely that it would print money to buy the debt solely of the sovereign states in trouble. He still hopes that the ECB will end up doing just enough to make it clear that it is the lender of last resort and to keep the core of the eurozone together, “although it’s not 17 countries”. However, the much-used argument that a euro break-up is so nightmarish that it can’t happen holds no water: “nightmarish things happen”.

Hmmm. I ask if he worries about inflation. “No.” Not at all? Deleveraging puts up a “sufficiently strong barrier” against it: “the money supply figures are down in the dumps”. But what about the issue of trust? If people lose faith – as they clearly have in Greece – in the value of their money, due to social unrest and quantitative easing, might the velocity of money suddenly rise and rapid inflation result? Magnus concedes that this is a “good point”. So I ask him if he owns any gold, just in case things turn really nasty. He does.

Who is George Magnus?

George Magnus

George Magnus, 62, is senior economic adviser at UBS. Previously he worked at Lloyds Bank International (1974-1977), the British government’s Central Office of Information (1972-1974), and he has taught at Westminster University and the University of Illinois.

Magnus received an MSc in economics from the School of Oriental and African Studies, and did postgraduate research at the University of Illinois.

He has long experience of analysing the global economy, specialising in themes such as demographic change, the creation and deployment of petrodollars and sovereign wealth funds, the re-emergence of a new Silk Road in Asia, and the credit cycle in the global economy.

In March 2007, Magnus predicted that the US sub-prime crisis would result in a “Minsky Moment” – a full-blown credit crunch. His most recent book, The Age of Aging, a study of the economic and social implications of the world’s shifting demographics, was published in October 2008. He is working on a new book, examining what impact the crisis may have on the role of emerging markets in the global economy. He is married, has four children, and lives in London.

This article was originally published in MoneyWeek magazine issue number 574 on 2 February 2012, and was available exclusively to magazine subscribers. To read all our subscriber-only articles right away, sign up for a three-week free trial now.

  • Critic Al Rick

    Sustainable Growth will not be possible to achieve before we undergo either:

    1) a true Depression (one to eliminate the Budget and Balance of Payments Deficits), or

    2) the resultant Catastrophe (of one sort or another) by virtue of forestalling a true Depression.

    Forget about attaining a real GDP greater than that of 2007/8, probably forever. We, as a whole, have been living way beyond our means; a much lower real GDP would be commensurate to our present means.

    Regrettably, in consideration of the selfish and short-sighted nature of human nature at large, the path of least resistance will
    be followed and the Catastrophic scenario will eventually ensue.

    It’s just as much the intrusion of (big) business into politics as the intrusion of politics into businesss that’s crippled efficiency and sapped enterprise by handicapping us with Parasites and Over Regulation. Academic excellence!!

  • PD

    The problem simply put is, corporates using labour arbitrage to suppress labour wages (even nominally) and at the same time govt welfare spending increasing and taxing productive workers to the hilt. This has depressed the spending power of consumers and reduced incentives to work. Deficit spending is future taxation, despite the conservatives claim that the deficit would be reduced by 20% increase in taxation and 80% decrease in state spending they have despite raising VAT and other indirect and direct taxation like fiscal drag, employee NI still have not really addressed excessive state spending, see climbdown on pensions. This indicates that the state will be using even more taxation to plug the deficit in the future and causes private consumers to hunker down even more. cont…

  • PD

    The financial sector had been let loose and they used the opportunity to privatise the temporary profits and socialise the losses and extend the deficit. This has made it even more difficult now. The government has to start reducing the taxation gradually, corporation tax is as good a place to start. Employer NI would be the next area. This would create jobs, incentivise people to work more, increase the tax revenues collected and kick start growth which would then plug the deficit.

  • ted1935

    I love these doomsday permabears. People in the know have never had it so good. I’ve heard these doomsday scenarios for over half a century (gives my age away). That’s why they never make anything with their lives because they’re pessimistic in everything they do, not just investing. Everything is always going to implode, same old story. They continually miss the boat. When I bought my first home many years ago some people told me that I was crazy, it was too risky, there will be a recession/depression etc etc. It was the best investment I ever made. Heck, some people even delayed ever buying a house and lost out altogether. That’s my nugget of wisdom for the day. So to be completely frank, if you want to achieve anything with your life before you end up a pile of dust you have to take the plunge in whatever you do. If you are waiting for an economic depression you’re going to waste your time and life. Sorry for being so blunt.

  • Critic Al Rick

    It’s OK ted1935, you’re entitled to your opinions.

  • spidrs

    I moved the majority of my investments away from the west many years ago. I’m very happy to have my wealth in supposed emerging markets where there is little or no debt. For the remaining portion of my assets held in the West I’m content that steady inflation will erode national debt over time. Corporate balance sheets look good in developed and non-developed markets so equities are attractive.

  • ted1935

    Sooner or later people decide that they have to get on with their lives and that’s why economies pick up. The ones who can only foresee economic fallout are the ones who are ultimately left behind. But by all means Critic Al Risk do as you wish, each to their own

  • Critic Al Rick

    The Fall of the Roman Empire would be a point in case, ted?

  • Chris

    At last some sensible dialogue! IMO we need less of these silly generic arguments like bigger/ smaller state and higher/ lower taxes and instead to look at how the public and private sector roles can be utilised positively on a case by case basis and as a whole.
    George Magnus for PM!! Or at least a role in government.

  • bazzer

    I am very supportive of the view that, due to ‘peak everything’ particularly fossil fuels, we have reached the end of real, aggregate economic growth. While there may be residual growth in some economies and occasional growth one year relative to the previous, the overall trend will be down. And yet, we seem to be oblivious to the reality that in a world of finite resources there cannot be infinite growth.

  • Critic Al Rick

    @ 4.

    Furthermore, ted, we’re in an economic depression right now; albeit a depression by stealth. But the main victims are presently mostly those least deserving of it; like (probably) you and me. The ones being largely sheltered from it (presently) include the main perpetrators of it.

    Life isn’t fair; it’s also a gamble. Some take risks and are largely lucky if and when they pay-off. The elite make their own luck; but that luck may, slowly but surely, be running out.

    As I see things, they’re steadily running out of control. Inflation may be aiding the Debt problem but is hampering the Deficit problem. Not stuffed?

  • NeutronWarp9

    ‘ Thou Shalt Not Avoid Responsibilty ‘ should have found room on one of Moses’ tablets (perhap it was on the back of one of them). How can business blame the government for cheap money leading to excess? In the same way that Ronald is to blame if somebody is overweight for eating too many Big Macs?
    A lack of self-control, personal honour and responsibility (I think we need another tablet) is the reason for so many ills – mainly because the rules are ignored or cynically re-interpreted.
    We are in a cycle don’t you know. As decadent Rome fell, perhaps the West will re-enter a Dark Age for a couple of centuries or s0, but let our immortal souls be patient in the knowledge that one day we shall enjoy the inevitable Renaissance. Amen.

  • Nev

    This piece was written 13 months ago. Has anything changed?
    Was Mr Magnus correct? Has inflation stayed under control? Has the ECB indirectly printed money? Is Big Government still looking like the safest way forward? Has any change in government strategy been observed?

  • Moderator

    Nev, the article was actually written in February 2012, not 2011. Apologies for the confusion.

MoneyWeek magazine

Latest issue:

Magazine cover
Don't panic!

The Greek vote is a great opportunity to buy Europe

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 4 FREE Issues

Paul Hodges: house prices could fall 50% in 'Great Unwinding'

Merryn Somerset Webb interviews Paul Hodges about deflation, the global economy's 'Great Unwinding', and how Britain's house prices could halve.

Which investment platform?

When it comes to buying shares and funds, there are several investment platforms and brokers to choose from. They all offer various fee structures to suit individual investing habits.
Find out which one is best for you.

30 January 1933: Adolf Hitler takes power

Adolf Hitler came to power on this day in 1933 following a political gamble that went disastrously wrong, and allowed the Nazi leader to call fresh elections.