THE BEAR'S LAIR Worse than the Great Depression
By Martin Hutchinson
In spite of Friday's alarming rise of 533,000 in US unemployment, there still
seems little chance when you look at the near-term future that the current
unpleasantness will turn into a rerun of the Great Depression, or anything like
Gross domestic product (GDP) may decline by more than the 3% to 4% declines
seen in 1974 and 1981-82, but there seems no immediate danger of it shrinking
anywhere near the magnitude of the 1929-33 decline. However, in the long term,
things are not so rosy; over the next 15 years, Americans and Europeans may
suffer a worse fall in their living standards than during the Great
Depression, albeit played out agonizingly slowly.
Benchmarking first: According to Bureau of Economic Analysis statistics, GDP
declined 26.6% between 1929 and 1933 while real personal income declined 25.7%.
Real personal consumption expenditures declined 18.2%. Per capita, with US
population increasing about 1.5% per annum during those years, real personal
income declined 30% and consumption 23%. In terms of living standards, real per
capita personal consumption expenditures did not recover to their 1929 level
until 1941, giving American consumers 12 years of living standards lower than
they had become used to.
There is only one way (apart from gross government ineptitude, which
fortunately under president-elect Barack Obama seems fairly unlikely) that US
or Western European GDP could fall anything like it did in the Great
Depression, and that is through globalization.
It is now abundantly clear that, through the simultaneous arrival of the
Internet and cheap cell-phone technology, the pace of globalization increased
markedly around 1995, with global supply chains for time-sensitive products and
services being for the first time possible without enormous effort, thus
propelling new participants, notably India and China, into the global
This has had the apparently benign (though less so in reality) effect of
allowing rich-country monetary authorities, particularly in the United States,
to keep monetary conditions lax without stoking inflation, except in the prices
of stocks and housing. The low interest rates and easy credit produced by the
lax monetary policy in turn sped globalization by increasing the availability
of capital for emerging-market production facilities and reducing the cost of
conducting global trade.
In the long term, a major effect of economic globalization is to reduce the
income gap between rich and poor countries by bringing the latter fully into
the nexus of the global economy. While factors of differential education,
capital, natural resources, infrastructure and work ethic remain, they can be
expected to diminish as globalization proceeds. Thus the world becomes more
equal, even as it becomes richer.
Eventually, it may become fully equal, with difficulties of geography making no
difference to earnings, and a capable hardworking educated Lesothan earning the
same as a capable hardworking educated American. Kumbaya!
There is one snag, at least for rich countries such as the United States,
Western Europe and Japan. If the world becomes more equal more quickly than it
becomes richer, then living standards in rich countries must decline. If the
world were suddenly to achieve equal income levels between countries without a
significant increase in output, US living standards would fall by over three
Some quantification: the GDP per capita at purchasing power parity of the
United States in 2007 was $45,800, thus 4.58 times the $10,000 average GDP per
capita of the world as a whole. World GDP per capita grew by 2.58% in
1960-2000, a period of gradually increasing globalization involving no global
wars and no depression eras akin to the 1930s. So 2.58% per capita per annum
must thus be close to the available "speed limit" of global GDP growth.
If world per capita GDP grows at 2.58% per annum, it will come to equal US GDP
per capita of $45,800 in 60 years. Thus, if the globalization process attains
final equality in that year, that is to say, US and Lesothan GDP per capita are
equal, for instance, the Americans of 2067 will be able to enjoy just the same
living standards they can today. To allow for any growth in US living
standards, we must suppose that even by 2067, the world will still be unequal,
so that major areas of the world (not just "pockets of poverty") have failed to
integrate fully into the world economy. That is quite possible, but not
inevitable - one can imagine the liberalization pressures on say a repressive,
self-reliant North Korean regime if not only South Korea but also rural China
and Vietnam are enjoying Western living standards.
While the final approach to worldwide income inequality between countries may
be slow, there is every reason to suppose that globalization's recent
acceleration has greatly reduced the level of inequality at which the global
economic system is in equilibrium. Whereas in an autarkic global economy with
poor communications and limited trade, it is quite possible to imagine one
country being 20 times richer than another, in a globalized world it is
unlikely that two countries with literate work forces and free-market economic
systems could differ so much in per capita output.
Suppose, for example, that globalization's acceleration is sufficient to reduce
the gap in global living standards by half in 15 years, so that instead of the
United States having 4.58 times the world's living standard in 2022, it will
have only 2.29 times that average. Then if global growth remains constant, the
world's average GDP per capita in 2022 will be $14,653. 2022's US per capita
GDP, at 2.29 times global per capita GDP, would be $33,556, a 26.8% drop from
today, close to the drop in the Great Depression.
However, whereas the Great Depression enjoyed a softening effect from a sharp
decline in the savings rate, to produce a drop in per capita consumption of
only 23%, that option is not available today, since the US savings rate is
unsustainably low, ought to increase and would almost certainly be forced to
increase as Asian investors proved reluctant to invest ever more billions in
the T-bonds of a declining economy. Thus under the scenario painted here, per
capita personal consumption in 2007-22 would decline at least 26.8%, compared
with 23% in the Great Depression.
How likely is this scenario? Optimists may object that rapid globalization of
this type would boost the global economic growth rate, and so reduce the hit to
US living standards. The current global growth rate of 2.58% is mostly caused
by three factors: technological progress, capital deepening and worldwide
diffusion of new capabilities. Rapid globalization would increase the rate of
diffusion of new capabilities, and might also modestly increase the efficiency
of capital allocation, but it seems unlikely to speed technological progress
more than modestly. Even so, there would at first glance appear to be some hope
of avoiding the "worse than the 1930s" scenario through faster global growth.
There are, however, a number of factors leading in the opposite direction,
toward an even greater decline in US living standards.
First, there is the political effect on the US public and through them, on
elected politicians, of a decline in living standards through globalization.
Rather than a gradual decline in life's possibilities shared by all, the
decline in US living standards would probably take the form of an increase in
unemployment save for those in secure jobs that, safe from international
competition and entrenched in their position, suffer no real reduction in
Indeed, November's unexpectedly sharp unemployment increase, which was
accompanied by a significant rise in real hourly income, could be an early
indication of such a trend: education, health and government, all immune to
international competition, were the only sectors to enjoy job growth. The
political result of declining US living standards accompanied by rising
unemployment, fairly clearly linked to globalization, would surely be harsh
protectionism among both voters and political leaders.
In the days of US domination, a rise in US protectionism might have led to a
reversal of globalization and maintenance of US living standards, albeit at the
cost of a marked reduction in global growth. That is to some extent what
happened in the 1930s. Today, however, globalization has gone so far that US
self-reliance would be economically impossible except at inordinate cost. All
kinds of global supply chains and product relationships would have to be
unwound, as the US consumer reverted to buying sweatshirts made in North
Carolina rather than China or Vietnam. Emerging market manufacturing
capabilities would not be lost, and emerging market living standards not much
affected. Thus, the main effect of US protectionism would be to reduce US
living standards still further.
A second factor intensifying the decline in US living standards is the
appallingly low US savings rate and the reduction in the US capital pool that
has resulted from over a decade of excessively low interest rates. Capital is
the principal ingredient of successful capitalism, and its concentration in
first Britain, then the United States and Western Europe and later Japan was
the major factor behind those countries' economic development and rising
wealth. In the era of funny money since 1995, capital has been inadequately
rewarded worldwide, and risk premiums have compressed, so that it is little
more expensive to make a $1 billion investment in Hanoi than in Harrisburg.
Now capital will become once again scarce, but the US and to a lesser extent
European problem is that they no longer have a monopoly of it. Hence emerging
markets will be better able to finance their own investment programs, assisting
their economic growth but providing yet more competition to a suddenly
capital-short West. Eventually the US savings rate must rise, so that the
capital stock can be rebuilt (and Americans can pay for their old age and
medical care) but that rise will itself further depress consumption.
The final factor depressing long-term living standards is the unwise policy
response in the last few months to the credit crunch and the beginnings of
Throughout the world, but particularly in the United States and Western Europe,
governments have resorted to bailouts and "stimulus packages" that have
exploded public sector deficits and increased the power of government in the
economy. Contrary to popular and journalists' beliefs, these expenditures are
not free; they must be borrowed. In a time of tight credit such as we are now
experiencing and are likely to continue experiencing for some time to come,
that borrowing crowds out other more productive uses of capital.
It has been remarked the total cost of bailouts by the Federal Reserve, the
Treasury and other public sector authorities approaches that of World War II,
corrected for inflation. However, from World War II, we got the jet engine,
rocketry and the computer, whereas no significant technological spin-off is
likely to result from US$600 billion invested by the Fed in redundant home
Crowding out of lesser credits by the Treasury, which already appears to be
happening with respect to Latin America, could theoretically have worked to the
relative advantage of the United States in the days when the US had all the
capital. However, capital is today broadly spread and the biggest pools of it
are in Asian and Middle Eastern public sector funds. Hence the principal effect
of "crowding out" by national governments will be on their domestic economies,
and in particular on the small and medium-sized businesses from which growth,
innovation and jobs principally come.
The speed of globalization and the balance between factors tending to mitigate
its adverse effects on the US and Western Europe and those tending to intensify
those effects is unclear. Nevertheless, the probability of a long-term decline
in US living standards comparable to if not deeper than the Great Depression
must be rated as fairly high. It will take the form, not of a single
catastrophic collapse as in 1929-33, but of a series of sharp unpleasant
recessions, interspersed with feeble unconvincing recoveries in a downward
saw-tooth pattern. The result will be the same, albeit over a longer period.
The only saving grace is that the decline will eventually bottom out and be
followed by gradual recovery, as global growth continues and the United States
shares in it. Even so, this is far from the future Americans have envisioned
There are few policy responses that will do any good. Probably the most
important is to raise the real return on risk-free savings as quickly as
possible to around 5% to 6%, higher than the equilibrium rate, while
eliminating the federal budget deficit. These actions will rebuild the US
capital stock, whose depleted state is currently the most dangerous factor
facing the US economy. Since the United States is still an important factor in
the global economy, particularly if its money tightening is followed by the
European Central Bank to solve the similar but less extreme savings problem
there, interest rates and risk premiums worldwide will increase.
That will raise the cost of building new production facilities in such emerging
markets as India that are short of capital, though not in those such as China
where capital appears to be plentiful. By doing so, the US can slow the pace of
globalization, so that the increasing wealth in emerging markets involves less
wealth decline domestically.
Before you dismiss this speculation as far-fetched, remember: everyone used to
think house prices could not fall nationwide.
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-08 David W Tice & Associates.)