By John Richardson
AN important study by the Boston Consulting Group (BCG) underlines most of the views we put forward in our e-book, Boom Gloom & The New Normal.
“The developed world’s Ponzi scheme is caused by record-high levels of public and private debt. And it is exacerbated by huge unfunded liabilities that will be impossible to pay off owing to long-term changes in developed-world demographics,” write the authors.
“Since the Second World War, debt levels in the developed economies have continually risen, with a notable increase since 1980.
“According to a study by the Bank for International Settlements (BIS), the combined debt of governments, private households, and nonfinancial companies in the 18 core countries of the OECD rose from 160% of GDP in 1980 to 321% in 2010. In real terms, after inflation is taken into account, governments have more than four times, private households more than six times, and nonfinancial companies more than three times the debt they had in 1980.”
The vast majority of this debt has not been used to increase future income, but has instead been employed to speculate on stocks and real estate, and to pay interest on previous debt, continues the study.
“One indication of this trend: During the 1960s, each additional dollar of new credit in the US led to 59 cents in new GDP; by the first decade of the new century, that same dollar of credit was producing just 18 cents in new GDP,” says BCG.
“These rapidly rising debt-to-GDP levels are a sign of the growing share of what the late economist Hyman Minsky termed ‘Ponzi financing’ in the global economy.”
The threshold for sustainable government debt in the developed world is a debt-to-GDP ratio of roughly 60%, continue the autors.
“Applying that threshold to nonfinancial corporate debt and private-household debt as well gives an overall sustainable debt-to-GDP ratio of 180%. Currently, the amount of debt above that level is approximately $11 trillion for the US and €7.4 trillion for the Eurozone.”
“Although it is nearly five years since the onset of the financial crisis, we are still just beginning to unwind these massive sums.”
But debt is only part of the problem, as the developed world’s crisis has been greatly exacerbated by the hidden liabilities of governments and companies, especially in the case of health-care related spending.
The problem is that life expectancy has doubled and fertility rates have declined by more than half in the developed world.
Meanwhile, the retirement age has been lowered significantly – so much so that the number of retirees supported by the working population has grown precipitously.
“The financial implications of this growing welfare burden are dramatic. According to another BIS study, even in a benign scenario in which current deficits were reduced to pre-crisis levels and age-related spending was frozen at current levels of GDP, public debt would continue growing at a significant rate,” says the study.
“Only Germany and Italy would be able to stabilise their debt levels in such a scenario (see chart at the beginning of this post). Nor are states and local governments immune. In the US, for example, one estimate puts the unfunded liabilities for city and state employees in the neighbourhood of $3 trillion to $4 trillion.
Other problems identified by BCG include:
*Private households have relied too long on rising home-asset prices and the promises of politicians and corporate managers instead of putting aside dedicated funds for retirement.
*A shrinking workforce. A critical problem in the decades to come will be labour scarcity. According to projections by the United Nations, between 2012 and 2050, the working-age population between the ages of 15 and 64 in Western Europe will shrink by about 13% (to 15.8 million people). In Japan, it will drop by 30% (to 23.8 million people). China will suffer the same problem.
*Slower productivity growth. There are signs that the rate of improvement in productivity is in decline.
*Diminishing returns from innovation. The space for truly fundamental innovations that result in step-change improvements in living standards is getting smaller and smaller.
*Deteriorating Education Systems. The deteriorating quality of education in most advanced countries also undermines future growth potential.
*Systemic underinvestment in the asset base. Despite record-high profit margins, businesses in the developed economies have significantly reduced their investment in new machinery and equipment. A recent Goldman Sachs report argues that Europe has witnessed a decade of underinvestment, starting before the financial crisis and intensifying since then.
*Intensifying international competition and rising inequality. Globalisation has brought the promise of economic prosperity to billions of people around the world. But it has also contributed to tougher international competition and the creation of new inequalities of wealth and income in the developed world.
Next week we will look at some of the solutions proposed by BCG.