With historic shifts underway globally among the economic powers, can Western nations adjust? A look at their capital, labor and productivity challenges. Excerpted from “Dambisa Moyo: How the West Was Lost,” February 17, 2011.

DAMBISA MOYO, International Economist; Author, How the West Was Lost: Fifty Years of Economic Folly and Dead Aid

 

The running theme between [my] two books is unintended consequences – good intentions that our policymakers have that yield bad outcomes. In the context of aid to Africa, we see horrendous pictures in the newspapers, on television, of people suffering from diseases and living very impoverished lives, and we feel we need to do something. The good intention is that we want to do something; the bad outcome is that by using aid, we end up with a huge list of economic problems like inflation, the debt burden and corruption – a lot of the stuff I talked about in Dead Aid. [See The Commonwealth, September 2009, page 8.]

Very much in the same way, I’d like to talk about good intentions: things like pensions, like artifacts of the subprime crisis, which is the idea of everyone having housing – which are all good intentions, but [they have] put Western countries, the United States included, on a precarious path toward economic decline.

I want us to suspend our ideological beliefs today. We have become too wedded to what we think we know. Unfortunately that makes us slightly hamstrung, not only when thinking about the problems we’re facing, but also when brainstorming about what the solutions might be. We’re in the middle of quite an inflection point in terms of where we are and where the world is going. In 2050 we can be as many as nine billion people on the planet, and issues of natural resources – like arable land, access to water, access to energy and access to minerals – are some of the things we are absolutely going to have to contend with. It’s therefore essential that we come together and not only find out what the real issues are, but also start to come up with some credible solutions.  

Economists tend to look at the economy by looking at three key ingredients. The first one is capital, basically money. The second one is labor, basically the workforce. And the third one is productivity, which I often joke is sort of a cheat sheet for economists; it is everything else that isn’t capital or labor. The reason, however, that productivity is important is because economists think that it explains about 60 percent of why some countries grow and other economies don’t. So it’s a very crucial issue.

Policymakers in the United States and across Europe have over the last 50 years specifically designed and implemented policies that have eroded these three key factors. I’d also like you to bear in mind that it’s not just the quantity of labor and capital that matter; it’s also the quality that matters. Therefore, what we see when we compare what is going on in the United States to China or other places in the world, it’s important that our discussion is much more nuanced and doesn’t just focus on the big headline numbers.

 

Capital wealth

So let’s talk a little about capital. We all know where the United States and European countries are. They are essentially characterized by very large debts and very large deficits. This is an unfortunate situation that is not just at the government or public level, but it’s also very much reflected at the individual household level. If you drill down to what has happened in recent years, in particular the subprime crisis, I argue in the book it is really an artifact of the “housing for all” policy, which is a good intention that has, unfortunately, yielded a bad outcome. I understand why policymakers would try to give us all a roof over our head, but the manner in which the government set out a policy environment clearly disincentivized people from doing the right thing. More important, it led to a situation where the average American invested a large proportion of their wealth in a particular sector, in this case the real estate sector, that was artificially made to look attractive by government policy. What did the government do? It kept interest rates low, it built in Fanny Mae and Freddie Mac, for example. It created an environment where there were guarantees in subsidies. And it was these sorts of artificial factors that make the housing sector look much more attractive than other sectors like bonds, stocks, commodities and even cash.

Look at where the United States is today versus, for example, China in terms of capital. China has about $3 trillion in reserves, but there’s a more subtle point worth stressing here. In China, a lot of the money is concentrated. While the United States is still a $14 trillion economy and one of the largest economies, it’s definitely much more diffused across pension funds, individuals, hedge funds and so on. That matters, because when governments have to deal with big problems like resource shortages or financial crises, the issue becomes, “How flexible, how capable is your government to do that?” In the case of China, the government has been able to maintain a lot of flexibility by being able to have this access to capital, whereas in the United States, we’ve seen the government is very hamstrung now by a lot of catastrophic errors that have happened, not just in the last few decades, but also over a much longer period.

If you move into the labor sector, there are so many things that are cause for concern in the United States and across Europe. With regard to pensions, for example, even at this stage it is pretty unclear how much the United States government owes to us as individuals in terms of pension liabilities. The most recent number I’ve heard is $2.5 trillion. We all know that there is a serious problem emerging; there’s just not enough discourse [about] what is going to be done. There are some estimates that as we move into 2040, there will be a 250 percent increase in the amount of people who are 65 years old or older. That has a serious implication for the pension costs and the health-care costs. Already in the United Kingdom, 75 percent of the cost of the National Health Service is for long-term services associated with people in later life.

Now this is not to say we want to shut off the taps, but we do have to understand that the way the pension schemes were structured has decimated industries. In effect, we have built a ponzi scheme where we know the later participants are paying for the older participants, and it’s simply unsustainable. So what are we going to do? Are we going to make sacrifices today for America to be competitive tomorrow? Or are we going to find solutions that help us today but in the longer term make the American government and companies find many more challenges around pensions?

[Regarding] health-care costs, McKinsey has estimated that in the years to come, the United States will have 100-percent health-care-bill-to-GDP [ratio]. It is clearly unsustainable, and a country can’t spend every dime that it earns only on health care. So the question is: What is it exactly we are doing now to tackle issues of obesity and other issues associated with health care in the longer term? These elements act as a drag on society in the long term; the manner in which they were structured absolutely leads to a drag on the broader economy.

 

Source of national wealth

I’m going to spend a minute on education, because I think here too is a very serious problem that everyone is aware of. We’ve heard President Obama and other people talk about how, in one generation, the United States has gone from number one in college graduates to twelfth. You only have to look at the Organization of Economic Co-operation and Development’s statistics. They have something called the Program for International Student Assessment survey and another survey called the Trends in Mathematics Science Study. If you looked at those statistics in aggregate, the United States and many European countries are seriously falling behind in mathematics, sciences and reading. Just to give you an example, the United Kingdom, where I live, has gone from seventh in reading to seventeenth. This is in reading in English, which is their language. In things like mathematics they’ve gone from around eighth to number 24.

Why does it matter? The fact is that American society is still the absolute front-runner in innovation, technology and R&D. As I said, there will be nine billion of us on the planet in 2050, and some of the biggest problems are not just about poverty and environmental concerns, but issues around energy and infrastructure that can only be solved by innovation in technological solutions. Just to illustrate, we are living on oil finds from the 1950s and 1960s. Since the 1960s there has not been any major oil find. So clearly just by the fact that America consumes 20-25 percent of the world’s energy, or 85 million barrels a day, we know it’s going to be hard to live in a free, fair global society when countries like China, India and Brazil are aspiring to the living situation of the United States. Something has to give, and the fact of the matter is we need American innovation up there to help solve these problems.

But to solve these problems, America has to create the incentives that drive the innovators and entrepreneurs to try to solve these problems. These people need mathematical backgrounds, they need science and they certainly need education. As someone from Africa, I find it particularly distressing, because I know that people around the world are relying on America getting things right. So the fact that we aren’t investing in education is very distressing. If you look at the demographics of the United States, some of the estimates I’ve seen say we will have a minority population larger than the majority population by 2042.  If you look at disaggregated performance in math and science of minority groups, it’s really distressing. We’ve got to get back to that basic value of getting education. It’s not just a priority for America, but also for the rest of the world.

 

Total factor productivity

What has happened in the last few decades where productivities are concerned? There have been some gains in the United States, but meanwhile in the last few years, China has posted the largest productivity gains on record. Some people might say that’s not surprising, it’s coming from a low base.

But the question then becomes: Has the United States benefited from being part of the international community? Has America given away too much in terms of competitive advantage by having these productivity gains? Now, I’m a free-marketeer. I believe that there are gains to be had in society if we can trade more, [have] free capital movement, movement of labor, and so on. But the fact of the matter is that when America has been open over the last 30 years, many Americans have ended up with more debt, flat real wages and not much of an upside. In fact, professors at the University of Chicago have compared the United States when she was closed from the 1950s to the 1980s to the period when America was really open, which was from 1980 to 2007. They found that GDP growth in these two periods was identical, at 2.1 percent.

This is quite distressing for someone like me, because in theory there should be productivity gains and benefits from being much more open, but in practice that’s not the case. The reason we haven’t seen those gains is once again because of policy: good intentions, bad outcomes. What is it that has happened over the past 30 years that has made it impossible for Americans to benefit from the huge windfall of wealth and improvements that we’ve seen globally?

So what happened? It has been a confluence of factors. The government artificially kept interest rates low and encouraged us to invest our money into the housing market, which meant that our money was wrapped up in real estate, and we missed out on other opportunities to invest. I think it’s not the responsibility of government to alter the market and encourage people to invest in one asset class over another. It’s pretty clear, in retrospect, that while China and India and other countries have done exceptionally well, people who have invested in those markets over the last 30 years have benefited from the return on [their] capital. But people who invested in labor have not benefited as much as they could have, and certainly not as much as theory would tell us they should.

What choices does America have today? The choice is quite simple. Either the United States is going to stay open to the rest of the world – which is what I would prefer and I think many people would prefer – and by that I mean open to trade, capital flows and the international community. That is, for now, the option that the policymakers have chosen. Things like education, energy efficiency, infrastructure – and infrastructure is the big area where America continues to suffer – the U.S. government has decided to try to solve those problems in the context of being open to the rest of the world.

But the problem with this strategy is that it has to be much bolder and much bigger than the pussyfooting around that the U.S. government is doing right now. Three percent of GDP in education is simply not good enough. Besides, if you look at the way in which the education sector operates in the United States, it is almost a mirror image of the aid sector and the issues around aid to Africa. We as a society are beholden to vested interests, and people are being rewarded for poor results. It is unacceptable that the grades and the performance and trends that we’re seeing in education in the United States should be ignored, but that is exactly what the education sector is doing in this country.

But the second problem with being open and trying to solve things within the context of being open is that it really relies on other countries playing fair. It really relies on China moving her exchange rate. It relies on other countries playing fair where oil is concerned and not manipulating the markets, such as the OPEC countries. But very often governments put their own interests ahead of the international community.

This leads me to the second choice, which is that America could become much more closed, which would be a great loss and a big disappointment to many people. Protectionist ideas are very much rampant in the United States already, so the leap toward more protectionism is not that far. We all know that the United States engages in very aggressive protectionism when it comes to agricultural products, for example, against African goods. So could the United States become more protectionist to save the 30 million Americans who are out of work in the manufacturing sector and who arguably will not get their jobs back because they’re simply uncompetitive? Protectionism used to be some kind of a crazy, crackpot, fringe issue, but now it has moved to the center.

Ultimately, whether you stay more open or more closed or how you evolve as a society is up to U.S. citizens; it’s got nothing to do with the rest of the world. But I will remind you that FDR in his first inaugural statement [said] that the United States does want to be part of the international community, but that is second to economic stability. My reading of that is that America will absolutely put her national interests ahead of whether or not she will stay a part of the international community.