The general call from politicians and economic commentators is for growth. We all instinctively accept this will solve our economic problems and somehow believe that growth is always possible and within the capability of our politicians to engineer. Alas, sadly our belief is misplaced!
Before continuing let us examine growth.
Growth like many other words can mean different things to different people. We all have our own perceptions of growth, to you and me it probably means that people are able to find jobs commensurate with their skills and abilities, that our earnings are rising and we are actually able to save. To the politician and commentator it is more likely to be that GDP is increasing.
As it is technically virtually impossible to derive truly accurate figures for GDP in much less than 3 years (after all tax returns have been received and processed), the figure we are looking at is a statistical estimate. This may be fairly accurate but is never absolutely right. Further because we need to compare the number with the previous year we adjust it for inflation … another statistical estimate, that seldom agrees with what we are experiencing.
With those reservations put aside, there are still a few points we need to keep in mind. For the economy to simply stand still, it needs to be creating jobs (expanding) at a rate equal to our population growth. Failure to do this must result in an ever increasing rate of unemployment and or under employment. This would mean that for you or me a growth rate of 1% would feel like recession as we have a population growth of approaching 1.5%.
As the main constituent of GDP is consumption, we should ask ourselves if an ever increasing consumption is truly sustainable. On the philosophical level we must answer no! The resources of the world are finite and while I have always believed technology would find ways to overcome shortages, there is indeed a point at which we will be forced to decrease our consumptionÂ in probability sooner than we think.
If we look again at the diagram we should be able to see that increased consumption, without borrowing (money creation) can only take place if exports exceed imports. Until 2006 the UK had hidden earnings from the rest of the world that exceeded our deficit in trade. That picture is no longer clear, with outflows now exceeding inflows, which I will discuss under Capital Markets. This is partially why we see a continual drive by politicians for foreign investment into the UK.
For a moment look at the diagram and consider that exports equal imports.
We should be able to see that provided all profits from the Corporate sector are flowing back to the population, either directly or through the Government sector the same level of consumption is possible. Any increase, requires money fromÂ a source other than income. Here there are two possibilities, either from previously built up savings or else borrowings. Neither of these are sustainable in the long run. Eventually savings are exhausted, while increasing borrowings must also eventually result in a debt crisis.
Perhaps there was some truth in my father’s saying that “Money does not grow on trees!”
While in my diagram I have omitted Investment as a constituent of GDP, this does little to change the picture and I will deal with it later. For a moment let us assume that there are savings by the population of around 15% of their income which in turn flows back into the corporate sector to finance their Investment requirements.
If we assume that the output of goods and services by the corporate sector increases, the population will be able to consume that output provided that the proceeds of the increased level of sales is flowing back to the population. Alternately prices of the goods and services would need to fall, to the level of the population’s income. This is commonly called deflation.
Up to now I have drawn a picture that assumes profits flow from the Corporate sector back to the Population in a reasonably short period of time. This is seldom the case. Common wisdom says that business needs to retain at least 50% of it’s profits to finance Investment requirements (expansion). We earlier assumed that the population’s savings would flow into the corporate sector for this purpose. However retaining part of it’s profits is far cheaper than having to pay Interest.
If we sit and consider the diagram for a moment and factor in to our minds that all profits of the Corporate sector are not going to flow back in to the population. We should see that the same level of consumption is now impossible without borrowings, given that prices are static or rising. Growth under these circumstances becomes dependent on rising exports and or falling imports. If the proportion of profits from the corporate sector not flowing back into population are being used by the corporate sector for investment in plant, machinery and increased output we should see increased employment and therefore an increase in the income flowing from the corporate sector to the population and thereby increased growth or consumption by the population.
If however we see those profits are resulting in an increase in the cash holdings or other financial instruments by the corporate sector there can be no growth barring an improvement in the balance of trade with the rest of the world, unless that growth is being fuelled by increased borrowings and or withdrawals from past savings. This is the current situation in the UK.
We should be able to see that growth is dependent on several factors;
1.Â Â Â Â Â Â Â Â Improvement in balance of international trade.
2.Â Â Â Â Â Â Â Â Increase in income of population.
3.Â Â Â Â Â Â Â Â Increase in Investment by Corporate Sector.
Alternately growth is possible only through money creation (borrowing).
The sustainability of growth through money creation depends largely on where the borrowing is taking place. In essence this should be happening in the corporate sector.
From this graphic, we can see that in order to achieve the 2011 GDP the population collectively had to reduce it’s savings and or increase it’s borrowings by Â£ 85.71 billion and that the economy as a whole required Â£ 208.76 billion of money creation or savings reduction.
Prior to 1991 we used to publish Money Supply figures, we stopped after the Soros attack on Sterling as those figures tend to highlight the weaknesses in economic policy.
Growth in the medium term is only feasible if there is a step change in the attitudes of corporations to the distribution of profits and investment, for without money being put in the hands of the population, either as dividends or increased wages / employment growth will only prove to be an illusion! In the long term we must correct our international trade balance and reduce our overall consumption.