Richard Douthwaite on: “which crash are we revisiting?”


Jan Slakov

From: Paul Swann <•••@••.•••>
Subject: Fwd: Richard Douthwaite on . . . "which crash are we re-visiting?"

*** Original message:

Date: Sun, 13 Dec 1998 19:51:37 +0100
To: •••@••.•••
From: Aubrey Meyer <•••@••.•••>

How will the present economic crisis turn out? As I write, stockmarkets in
Europe and North America have almost returned to their pre-panic levels.
Does this mean that the worst is over and that the people who lost their
jobs in Asia will soon be back at work? If so, we're essentially going
through a re-run of 1987, when the markets also gave everyone a bad fright
by taking a sharp tumble. Back then, the authorities quickly restored
normality by cutting interest rates and laying on lavish supplies of bank
credit, exactly as they are trying to do today.

If this 'repeat of 1987' scenario applies, the events of the past eighteen
months have done no real harm and the world economic system will soon be
growing again on the lines it did before. If not, however, and earlier
economic crises prove a better guide to current events, we've got a long
drawn-out period of misery ahead of us with no clear end in sight. For
example, the stockmarket crash in 1929 ushered in over a decade of plant
closures and mass unemployment which was only ended by massive spending on
armaments for the Second World War. We might even be in for something akin
to the world-wide depression which followed the Wall Street crash in
September 1873. This dragged on for twenty-five years.

So which is it to be? A few months of roller-coaster excitement or
something very much longer, more miserable and more serious? The only way
to decide is to look beyond the share price indices and work out what is
really going on.

As the famous phrase has it, the rich are different and one way in which
they are is that they save a much higher proportion of their earnings than
the rest of us. Consequently, if the rich get richer, as has happened
recently in almost every country in the world, the average level of saving
and investment tends to go up. In the US, for example, the richest 20% of
the population are considerably richer now that they were thirty years ago.
In 1996, they received 46.8% of the national income, up from 41.4% in 1967.
As a result, the total value of the investments they owned rose from 81% of
the nation's wealth in the mid-1960s to 84.3% in 1996. The bottom 20%, by
contrast, got only 4.2% of national income in 1996, down from 5.4% in 1967,
a drop of around a quarter in the proportion they received. This forced
them to borrow, with the result that when their assets are set against what
they owe, as a group they possess less than nothing at all.

No-one will continue to invest year after year unless they are making
satisfactory profits. For example, a firm won't build a new factory this
year if the one it built last year didn't hit its sales target and still
has an unacceptable level of excess capacity. Similarly, a property company
won't build a new shopping centre or apartment block if rents are falling
and it can't find tenants for its earlier developments. To put this in
general terms, investing won't continue if the markets aren't absorbing the
capacity that previous investments created at prices which generate a high
enough income to make it attractive to plunge more money in.

In other words, unless demand expands to keep up with the increased output
the investment brings about, the income from productive investments will
drop and savers will begin to look at more speculative ways of using their
capital. So where is the increased demand to come from? The best potential
source is obviously the poorer 80% of the population, most of whom have
long wish-lists of things they would like to buy. However, if their incomes
aren't adequate to purchase the extra output because the rich are taking
too much, they will be unable to spend enough to keep the economy going at
full capacity. The proportion of manufacturing capacity in use will fall
and investment will slow or stop.

>From World War II until a few years ago, governments, especially those in
Western Europe, used high top rates of income tax and the social welfare
system to ensure that a fair proportion of the gains from growth went to
the less well-off. Although this redistribution was mainly for reasons of
social justice, its by-product was an excellent market for investors to
exploit year after year. Indeed, the main problem during the period was not
a demand deficiency but inflation whenever demand out-ran supply. This
problem occurred again and again in the UK where the proportion of national
income going to the wealthiest 10% fell by almost a quarter between 1948
and the mid 1970s. Middle income Britons were the main beneficiaries rather
than the least well-off and a massive market for foreign holidays, home
improvements, cars, clothes and other consumer goods developed.
Redistributive processes were at work during this period in the US too
because between 1947 and 1973, the proportion of national income going to
the poorest fifth of the population rose from 5.0 to 5.5% while the top 5%
of the population saw its share decline from 17.5% to 15.5%.

Since then, however, the increasing ease with which investors have been
able to move their funds around the world and, where necessary, shelter
them in tax havens, has forced governments to reduce their top rates of
personal tax sharply. Corporation taxes have been cut too, with the result
that countries can no longer use the tax system to redistribute the
proceeds of growth and ensure that the less-well-off aren't left behind. So
the poor have become poorer and the market they might have provided has
failed to develop. The result? In May this year, the rate of capacity
utilisation in US manufacturing was 20% less than the 1987 level.

The power the free movement of capital gives investors to play off one
state or country against another over tax rates is not the only reason the
gap between rich and poor has widened within countries. International
investors have also been responsible for keeping wages rates down, as the
Irish case shows particularly well. Since the 1960s, Ireland has based its
whole economic development strategy on persuading foreign companies -
mostly American and Japanese - to use it as an offshore manufacturing base
to supply the European market. Among the carrots it has dangled before
these companies have been ultra low tax rates on corporate profits (the
rate is currently 10% but was zero for many years) and generous grants for
capital equipment purchases and training.

Much the most important incentive, however, has been the low wage costs
Ireland has been able to boast for well-educated, intelligent workers and,
in recognition of this, successive governments have done everything they
could to see that wages stayed down They have achieved this through a
series of agreements between themselves, the business sector and the unions
which have set out the maximum amount that wages can go up during the
period for which the agreements run. The present three-year agreement,
Partnership 2000, for example, provides for a general pay increases of only
2.5% in its first year, 2.25% in the second, and another 2.5% in the final
year which ends on April 1st, 2000. As these increases are less than the
rate of inflation, workers' incomes will inevitably fall further behind
those of the better off, particularly as the total income of all the groups
which comprise the Irish economy can be expected to go up by 8% or more
annually in the years to which Partnership 2000 applies. In other words,
the strategy that Irish governments have adopted to keep investment flowing
into their country has had the unfortunate side-effect of ensuring that
most of the extra income they generate goes to the better-off. Many other
countries, including the United Kingdom, have done essentially the same thing.

While the free movement of capital has widened the gap between rich and
poor within countries, free trade has widened it between them. This is
because almost everywhere in the world is trying to generate a higher
incomes by selling goods and services to countries that are richer than
they are, a strategy that doesn't often bring the desired results. Here's
why. Westport, the town in Ireland where I live, decided a few years ago
that it would attempt to lengthen its tourist season by advertising
golfing-holiday packages in Sweden. Why Sweden? Well, the Swedes are
regarded as rich and therefore a potentially lucrative market. But as one
golfing holiday is much like another, pretty soon Westport found itself
competing for business with Scottish and Portuguese golf resorts.
Everyone's prices came down in the ensuing promotional battle, lowering the
return to the holiday providers and effectively raising the incomes of the
Swedes as they could now buy the same vacations for less money. In other
words, the rich got richer and the (relatively) poor, poorer.

Essentially, the golf holidays had become a commodity, sold largely on the
basis of price. Most goods we buy are commodities in this sense, although
manufacturers spend a lot on advertisements to try to convince us that
their products have features which make them non-commodities and it's worth
paying much more to get them. Such firms - Nike, Levi Strauss and so on -
are desperate to avoid competing on the commodity market because the price
of commodities in relation to the price of other goods and services has
been falling for many years. This is the reason why the gap between the
rich and the poor parts of the world has widened rather than narrowed as
world trade barriers came down. During the past three decades, the ratio of
the income share of the richest 20 per cent of the world's population to
that of the poorest 20 per cent has more than doubled from 30:1 to 61:1 The
poorest 20 per cent saw their share of global income decline from 2.3 per
cent to 1.4 per cent in the same period. In other words, globalisation has
doubled international inequality in a single generation.

James Speth, the administrator of the UNDP, spelled out the consequences of
this at the launching of the 1996 Human Development Report. "We live in a
world that has become more polarised economically, both between countries
and within them. If current trends are not quickly corrected, economic
disparities will move from inequitable to inhuman. In more than a hundred
countries per capita income is lower than it was fifteen years ago, and, as
a result, more than a quarter of humanity - 1.6 billion people - are worse

What this means is that free trade and the free movement of capital have
destroyed the basis on which the prosperity and stability of the post-war
world was built. Moreover, the fact that so many people are actually poorer
now means that the new economic arrangements have not merely failed to
develop an adequate market for the additional products which high levels of
investments produce - they have actually reduced the purchasing capacity of
a large part of that market.. As a result a massive amount of production
capacity in the world economic system was surplus to requirements and
prices were beginning to fall even before the Thai economy collapsed last
year. Almost every type of commodity was affected, from raw materials and
food, to clothing, electronic goods and cars.

The situation is even worse today because the problems in Asia, Russia and
Latin America have removed hundreds of million more would-be consumers from
the world market in the past year. Roughly 40% of the world economy is in
severe difficulties with the result that producers are desperately bidding
for sales in countries in Europe and North America where incomes are still
expanding. Many American manufacturers have seen their profits hit by the
fiercer competition and the US trade deficit has soared.

When the first signs of over-investment began to appear  a few years ago,
people with funds to invest began to look for other ways of earning money
with their money. Some invested in countries like Mexico and Brazil - the
so-called 'emerging markets' - despite the unquantifiable risks to which
this exposed them. Extra funds were placed in the stockmarkets at home,
too, and share prices began to move up strongly. This produced capital
gains which encouraged more people to move their money in, which in turn
produced further capital gains. The net result of this speculative bubble
has been to lift the market significantly above previous price-earnings
ratios at a time when corporate profits are generally on the way down. In
some sectors, ridiculous prices were paid. During November this year, for
example, a company which had just lost $11.5 million on sales of only $2.7
million was valued by the market at $622 million. Why? Because the firm
helped people design web pages and anything to do with the Internet was
seen as having capital-gains potential. Even a stockbroking company's
analyst thought the price was crazy and compared it with those paid for
tulips in 17th Century Holland.

The lust for higher returns than productive investments could deliver
encouraged other forms of speculation, too. Newspapers started running
features on the profits rather than the pleasure to be had from collecting
stamps, coins, medals and books. Real estate prices jumped in many
countries, along with those for Old Masters and antiques. For the most
part, however, this speculative activity merely created paper profits for
the already rich and did nothing to boost the deficient demand. Indeed, it
could even have exacerbated the situation because it kept interest rates
higher than they would otherwise have been and thus ensured that the
less-well-off had to pay more interest on their loans and thus had less
left for consumption.

So now we have come to the crunch. Since virtually no part of the global
economy is not suffering from inadequate demand at the moment, the
proportion of national income being invested is falling almost everywhere
and even near-completed projects are coming to a sudden halt. In Oregon
alone since the summer, Intel has delayed completion of a new $2 billion
semiconductor plant and office complex, Komatsu has closed two of its three
semiconductor plants before workers had even finished paving the parking
lots and DuPont halted construction on a chip-making equipment plant
leaving the empty shell standing in a field.

As a result, people who last year were building and equipping factories,
office blocks and retail centres are being thrown out of work and thus have
less to spend themselves. This is causing other people to lose their jobs
as well, cutting consumer demand even further. A downward spiral is
developing which will take the world into a depression which I believe will
be worse than that in the 1930s if only because everywhere now is much less
dependent on their own resources and more on an uncontrolled international

As globalisation has destroyed the systems which enabled new wealth to be
shared fairly well  in the 1960s and 70s and has produced the economic
polarisation which is the cause of the crisis, it is difficult to see how
it could contribute to its cure. After all, for as long as multinational
corporations and other investors are able to force countries and groups or
workers to compete against each other, the gap between rich and poor is
bound to grow. And if we end the competitive bidding-down of wages, social
protection and environmental safeguards by preventing money and goods from
moving freely around the world, would globalisation exist any more?

So how can we end the current crisis? The first step is to accept that a
whole-world economic system would be a disaster even if it could be
re-engineered to ensure that it no longer continually undermined its own
markets by shifting incomes towards the better-off. This is because a
sustainable world - or at least one with anywhere near the current human
population - has to be made up of a multitude of micro-economies based on
cultural systems which enable communities to very differently so as to stay
within the sustainability limits imposed by the ecological niches which
they occupy. In this light, a global monoculture in which we all live in
much the same way and consequently compete for the same limited range of
foods, building materials and other resources is an obvious nonsense.

Once we've accepted this, it becomes apparent that instead of trying to
find remedies for the global system's faults, we need to abandon it as a
terrible mistake and re-localise. In other words, our national governments
need to recover the powers they gave up to create the world economy so that
they protect their citizens' economic, social and environmental interests
once again. And each of our cities, towns and villages need to re-establish
systems which enable them to do more things with their own resources for
themselves rather than for distant markets.  Most importantly, net capital
movements between countries need to be stopped completely and trade flows
closely controlled.

This form of protectionism is not a dirty word. Handled correctly, it would
be a liberating experience. Moreover, it is essential if we are to
implement the second stage of the strategy, which is to make it attractive
to invest again.. This could be done in two ways, one conventional, the
other not. The conventional approach is to use a combination of low
interest rates and a rag-bag of uncoordinated public works projects to pump
money into the system and thus increase consumer demand for the range of
goods and services which was being produced before to the crisis broke to
above pre-crisis levels. The idea is to make capacity shortages appear so
that prices rise enough to encourage investors to come back.

The problems with this conventional solution are, however, that it could
take years to have much effect and that it would simply enable a wasteful
way of living to waste resources at an even faster rate. Accordingly, the
novel approach is to create a completely new range of demands so that
investment becomes profitable long before the surplus capacity for the
existing range of products has been absorbed.

What new demands - and hence investment opportunities - would we create if
we decided to follow this second course? Well, the capital stock of a truly
sustainable economy would be very different from the present one. Transport
systems and production methods would be totally changed and, in particular,
the majority of its energy would come from renewable sources. So the second
strategy could involve using public money to make it attractive for
investors to install energy-saving technologies and develop renewable
energy sources, thus opening up a vast and relatively undeveloped market.
In addition, it could create jobs immediately by paying part of the wages
of those involved in, say, installing triple-glazing or loft insulation.
And scrappage schemes could be introduced to enable people to move to more
energy- efficient domestic appliances - which would, of course, have to be
domestically produced to ensure that the income streams we are trying to
restore did not get diverted overseas.

What I'm essentially saying here is that the current crisis presents us
with a marvellous opportunity which we must not allow to go to waste. Would
it have been possible for the globalised economic system to have evolved
sufficiently to become sustainable had it not run into its present severe,
and possibly fatal, problems? I think not, at least within whatever period
we have left before it does catastrophic damage to our planet. If I'm
right, it would be folly to allow such a destructive system to be built up
again. Instead, we need to analyse just what it was about it which caused
it to go wrong and have the courage to build a replacement based on what
we've learned.

In particular, the replacement must not need to grow each year to avoid
collapsing into a depression. It must not concentrate power and wealth into
very few hands. And it must not allow countries which are building
sustainable economies to be overwhelmed by countries which are not. This,
indeed, would the most important characteristic of the new economy - that
it allowed sustainability to be achieved piece-meal, place by place, rather
than on the basis of the whole world doing so simultaneously, which is the
only way it could ever come about under a global system.

The challenge is huge. A friend of mine thinks that the closest parallel to
our present situation is not 1987,  1929 or 1873 but 1845, the year the
Irish potato famine started. As he sees it, pre-famine Ireland had adopted
the potato-based monoculture because it was the least-work way to live on a
little land. As we all know, however, the monoculture proved unsustainable
and millions of people died. Now, he suggests, billions of people have
adopted a  global monoculture because it is the current way of living for
least work. But, as we all know, that monoculture is unsustainable too..

I hope my friend is wrong and that the problems we are experiencing now are
the equivalent of the frequent crop failures which presaged the Irish
famine. Those failures were ignored and the system went on unaltered.
Today, perhaps, we will heed the warning -  if that is what this crisis
proves to be - and make a dash towards sustainability. But can we overcome
the vested interests and still get there in time?.


Richard Douthwaite is an economist and writer living in the West of
Ireland. His latest book, Short Circuit: Strengthening Local Economies for
Security in an Unstable World  (1996) is distributed in North America by
Chelsea Green. A new edition of his pathbreaking book The Growth Illusion:
How Economic Growth Enriched the Few, Impoverished the Many and Endangered
the Planet will be published by New Society in the spring.