This is Not a Recession, This is the New Normal

OVERVIEW

According to professional economists and the media, much of the developed world  (i.e., North America, Europe and Japan) is currently in a recession.

A “recession” is generally defined as a slowdown in economic activity for a period of time. This definition implies that economic activity will eventually recover to its previous level.

However, what if the economists and business media are reading this incorrectly?

We are in fact entering into a new sustained phase of economic reality. The middle class will cease to exist in the developed world, as each successive generation becomes poorer than the previous generation. This is due to a number of factors:

  • Globalization will accelerate the outsourcing of work to the developing world, particularly India and China. During the 1990s to today, the North American manufacturing base has been hollowed out and transported to China. This is also happening with the services sector with respect to India. Even high-paying “knowledge economy” jobs are not exempt, as exemplified in this article from the New York Times about the outsourcing of legal work to India.
  • Technology, particularly the internet, has threatened the existence of entire industries. Take for example the media sector – which includes the music, print media, television & publishing industries. More people now get their entertainment and news for free over the internet, which has resulted in year to year decreases in sales and advertising revenues . Layoffs have been prominent in these industries as companies operating therein attempt to survive.

The consequences are as follows:

  • As production and service activity gradually ceases in Western countries, more of its citizens will become permanently unemployed or will only be able to find employment in menial low-paying jobs. Citizens of the  developed world will simply cease to earn a good living manufacturing products or providing services as most of these activities will move offshore.
  • Consequently, citizens in Western countries will become more heavily indebted as they use credit to finance basic living expenses.
  • Conversely, as per capita income in the Western world declines, it will increase in the developing world, particularly in India and China as these nations continue to increase their respective service and manufacturing sectors. In essence, India and China will be the service and manufacturing centres for the entire world.
  • Under political pressure from its citizens, Western governments will expand social welfare programs to enable their citizens to finance basic living costs. However, with a shrinking tax base (due to lower per capita income of its citizens and declining birth rate), governments will be forced to finance expanded social welfare programs through debt financing. Much of this financing shall come from newly developed “BRIC” countries such as China, Russia and Brazil. This will limit the ability of Western countries to influence these nations with respect to geopolitical or human rights issues due to their financial exposure to their BRIC creditors.

ANALYSIS

The natural question to ask is this: if all of the above is true, then why has there been an economic boom during the last two decades?

To answer this, let us start with a simple fact: there are only two ways to purchase something – with your own money or by getting into debt.

The economic boom of the last two decades was not due to increases in real wages (which in fact decreased during this period), but due to an increase in debt financing by consumers. This trend accelerated due to a decrease in interest rates (the average interest rate for a home mortgage in Canada during the late 1980s was about 15%, today it’s about 4%) as well as more relaxed lending standards on the part of banks.

During the 1990s, people made money in the stock market, leading up to the internet bubble of the late 1990s. Once the internet bubble popped in 2000, people started investing in something more “real”, that is, real estate. This was facilitated by the low interest rates and lax lending standards noted above. Of course, this led to the real estate bubble and subsequent financial crisis of October 2008.

Therefore, economic growth in Western countries during the last 20 years was not “real” in the sense that it wasn’t driven by an increase in per capita income, but by consumer debt accumulation.

So now to the present day: it’s much harder to borrow than it was before due to the economic crisis. Therefore, real economic growth will have to come from an increase in spending power. How likely is this to happen in the developed world going forward? Unfortunately, the odds don’t look very favourable for the following reasons:

  • There is only so many goods and services the world can consume and consequently, only so many goods and services the world can produce. This is because the population growth rate of potential customers in Asia, Europe, North America and Latin America (where people can actually afford to purchase goods and services produced) is decreasing year over year. The percentage of the world population living in these regions was projected at 84.5% as of 2010. This is projected to shrink to 77.7% in 2050 according to United Nations estimates calculated in 2008. This implies that there will be less customers globally for goods and services.
  • A shrinking customer base (which implies shrinking revenues) will motivate Western corporations to decrease costs (and stabilize profitability) by shifting manufacturing and service overseas to China and India, and employ a workforce which is well educated and willing to work harder for less money.

To conclude, per capita income will continue to decrease in the developed countries. In our analysis, Chinese and Indian workers are the winners and workers in Western countries shall be the losers.

CONSEQUENCES FOR CANADA

Western provinces will do quite well due to demand for natural resources from China. Demand for British Columbia lumber, Alberta oil and Saskatchewan potash will create jobs and prosperous communities in these provinces.

Ontario will continue in its economic decline. The manufacturing base in Ontario has essentially ceased to exist with the notable exception of the automobile industry. The North American automobile industry will be under threat as China and India develop their automobile technologies to a level that is competitive in terms of quality and much cheaper in terms of price. In order to survive, North American car companies will eventually outsource all of their production to China or India.

CONCLUSION

It is quickly dawning on academics and normal working people that globalization is a zero-sum game – if someone is gaining, then somebody else is losing. This is a harsh reality that many people in the Western world are starting to realize. However, there are a number of ways which one can adjust to this new reality:

  • Consider moving out West. Despite the economic downturn, the resource sectors in the Western provinces are holding up quite well. For example, the province of Saskatchewan has been aggressively recruiting skilled workers due to its expanding economy.
  • Learn to speak Mandarin Chinese. This seems like such a cliché, but this will become (along with English) the lingua franca of business. It will also expand your career opportunities if you want to consider relocating to China. Major cities such as Shanghai and Beijing already have significant expatriate communities which will only get larger as demand in China increases for English language teachers and for employees fluent in both Mandarin and English.

Here is an excellent video by the American legal scholar Elizabeth Warren. She lectures on the “Coming Collapse of the Middle Class”:

The Coming Collapse of the Middle Class

© Copyright Victor Fong, 2010

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