Sunday, August 11, 2019

Low interest rates, globalization, technological change and ageing

“May you live in interesting times," is claimed* by non-Chinese to be a Chinese blessing or curse and we are today living through not only interesting times in economics and finance but unique ones in the history of commerce.

Richard Freeman, the former Harvard economist, has calculated that:

"In 1980 the global workforce consisted of workers in the advanced countries, parts of Africa and most of Latin America. Approximately 960m persons worked in these economies. Population growth — largely in poorer countries — increased the number employed in these economies to about 1.46bn workers by 2000. But in the 1980s and 1990s, workers from China, India and the former Soviet bloc entered the global labour pool. Of course, these workers had existed before then. The difference, though, was that their economies suddenly joined the global system of production and consumption. In 2000, those countries contributed 1.47bn workers to the global labour pool — effectively doubling the size of the world’s now-connected workforce."

Economists at the Deutsche Bundesbank, the German central bank, estimated the deflationary impact of China on interest rates of 38 countries in the period 2002-2011 and found that producer prices tended to be more strongly affected than consumer prices by Chinese shocks. The overall share of international inflation explained by Chinese shocks was notable at about 5% on average overall in the countries but not more than 13% in each region.

Following the Asian financial crisis of 1997/1998, countries introduced measures to buildup foreign exchange reserves and coupled with their traditionally high savings rates (partly in response to little or no social safety nets), they became net exporters of capital depressing further global long term interest rates.

In 2005 Ben Bernanke, then a member of the Federal Reserve Board, in a speech addressed the issue of a "global savings glut." 

In 2017 China's gross savings rate was 46% of GDP while in 2018 it was 13% in the UK. 

Andrew Haldane, chief economist at the Bank of England, said in a speech in 2015: 

[At a Parliamentary Committee hearing a few years ago I asserted, boldly, that global interest rates were at their lowest-ever levels. A wise colleague challenged me afterwards: “How do you know they weren’t lower in Babylonian times?” Several exhausted research assistants later, I can report that luckily I was on safe ground. Interest rates appear to be lower than at any time in the past 5,000 years…] See chart on top of page.

The Bank of England was founded in 1694 and the official rate of 0.5% was set in March 2009. It is now 0.75%. The rate was 6% in Oct 1694 while it had never been below 2% until January 2009.

The genesis of loan interest was in places like the Sumerian city of Uruk, which in the fourth millennium had an official accounting system using clay tablets. William N. Goetzmann, professor of finance and management studies at the Yale School of Management, details here how in the "the Sumerian language, the word for interest, mash, was also the term for calves. In ancient Greek, the word for interest, tokos, also refers to the offspring of cattle. The Latin term pecus, or flock, is the root of our word pecuniary."

Later, Hammurabi, king of Babylonia in Mesopotamia, who ruled from 1792 to 1750 BCE, produced a legal code that was set forth on a basalt stone stele currently in the Louvre Museum in Paris. Hammurabi's code was based upon similar legal codes issued earlier by Akkadian and Sumerian rulers of Mesopotamia,. He limited the rate of interest to 20% on loans of silver, 33-1/3% on loans of grain. According to 'A History of Interest Rates' by Sidney Homer and Richard Sylla, in China banking transactions can be traced back over 2,000 years and in 200 to 300 CE, Buddhist temples like counterparts in Rome, Babylon and Athens, ran pawnshops.

No simple answers 

HL Mencken (1880-1956), the American journalist, writer, social critic and wit, in a 1920 collection of essays noted, "Explanations exist; they have existed for all time; there is always a well-known solution to every human problem — neat, plausible, and wrong. The ancients, in the case at bar, laid the blame upon the gods: sometimes they were remote and surly, and sometimes they were kind. In the Middle Ages, lesser powers took a hand in the matter, and so one reads of works of art inspired by Our Lady, by the Blessed Saints, by the souls of the departed, and even by the devil."

Mohamed El-Erian, the former PIMCO bond fund manager, in a Project Syndicate piece in the Guardian newspaper in May opined that what he calls "the Amazon/Google/Uber effect has turbocharged a disinflationary process that began with the acceleration of globalisation, bringing far more low-cost production online and reducing the power of organised labour in advanced economies (as has the gig economy more recently).."

The size of so-called gig-economy in the US has been revised down and economists now estimate "a modest rise in the share of the workforce in nontraditional jobs over the last decade — probably on the order of 1 to 2 percentage points." 

While Amazon accounts for 49% of US online retail, its slice of total US retail is only 5%.  

Web price comparisons are a factor but hardly the only ones.

For example, ordering groceries online is likely to be more motivated by convenience than price (within reason, of course!).

In 1965, Dr Gordon Moore (b. 1929), head of research and development at Fairchild Semiconductor, 3 years ahead of becoming a co-founder of Intel, in a paper on the integrated-circuit business predicted that the number of components per integrated circuit would grow “at a rate of roughly a factor of two per year. Certainly, over the short term this rate can be expected to continue, if not to increase. Over the longer term, the rate of increase is a bit more uncertain, although there is no reason to believe it will not remain nearly constant for at least 10 years.”

What became known as Moore's Law is down to an annual exponential growth of about 35% but there is a finite limit.

Pan American World Airway's first scheduled overseas jet flight was from New York Idlewild to Paris Le Bourget (stopping at Gander, Canada to refuel) on October 26, 1958, with Boeing 707–121 Clipper America (N711PA) carrying 111 passengers. 

Vaclav Smil, the renowned Czech-Canadian energy economist who is a professor emeritus at the University of Manitoba, wrote in the Financial Times this week that in contrast with Moore's Law, modern economies depend on an enormous range of inputs whose yields, performances and capabilities have been constantly improving; but only at rates of an order of magnitude in low single digits

"The introduction of new plants and increased use of fertilisers, herbicides and pesticides have boosted global crop yields since the 1960s by 3.2% annually for wheat and 2.6% for rice. Corn yields have risen 2% annually since the 1950s. Chicken meat, the ascendant protein, has been produced with increasing efficiency, but since 1930 the annual gain in the US has averaged less than 1.4%."

"During the 20th century... the efficiency of electricity generation improved by about 1.5% annually. Since the 1880s, indoor electric lighting has been through several revolutions (incandescent, fluorescent, halogen, LED) but annual efficiency gains have averaged about 2.6%. Steel remains the dominant metal. Gains in the efficiency of its production have averaged less than 2% since 1950. Turning to transportation, annual growth of the highest speeds of inter-city travel by rail tripled during the 20th century (to 300km/h), implying average annual gain of 1.1%. Since the US introduced fuel efficiency rules in 1973, the average efficiency gains for cars (not counting SUVs and pick-up trucks) has risen 2.5%. The speed of intercontinental travel shot up from less than 40km/h in 1900 (ocean liners) to 885km/h by 1958 (the first Boeing 707 to Paris). While that averages to an annual growth rate of about 5.5%, the speed has not (Concorde aside) increased at all during the past 60 years."

Since 1950, the average real US GDP per capita has been 2%.

The Organisation for Economic Cooperation and Development (OECD), representing mainly advanced country members, says a current productivity slowdown has multiple and partly interlinked causes, some related to the global financial crisis and its aftermath (e.g. reduced credit availability affecting investment) and some more structural, such as a decline in business dynamism and the poor performance of low-productivity firms.  "The aggregate productivity gains from digitalisation have not been sufficiently large to offset these headwinds, at least not to date."

In addition, the OECD adds that the nature of certain digital activities has given rise to a small number of highly productive “superstar” firms, which other firms increasingly struggle to compete with. Even in relatively low-tech industries, the growing availability of online user ratings and reviews tends to shift demand towards the more productive firms. "Looking ahead, new technologies, such as artificial intelligence, that require complex skills, large intangible investments (e.g. in R&D, algorithms and data) risk further increasing the edge of the most productive firms relative to less productive ones.‌‌"

Technological change slowing

Technological change has been a feature of the modern world since the start of the Industrial Revolution which began in Britain and in modern times, most tech-related changes are incremental. Statisticians take account of improvements in quality where they can be identified.  

The sluggish economic growth since the financial crisis has not been counterbalanced by significant tech breakthroughs — the 50thanniversary of the landing of humans on the Moon last month highlighted the contrast with earlier decades.

Last November in The Atlantic magazine, Patrick Collison, the Irish co-founder of Stripe, the US online payments firm, and Michael Nielsen, of Y Combinator Research, a unit of the eponymous startup incubator, show that despite huge increases in the time and money spent on scientific research, progress is barely keeping pace with the past.

In the 'The Great Stagnation,' published in 2011, Tyler Cowen of George Mason University wrote: "apart from the seemingly magical internet, life in broad material terms isn’t so different from what it was in 1953.”

Robert Gordon of Northwestern University who calls himself "a prophet of pessimism" in a paper concludes that the growth of multi-factor productivity in the US non-farm business sector peaked in the first half of the 20th century and collapsed between 1972 and 1996. It rose in the “new economy” wave but then faded.

In 'The Rise and Fall of American Growth' Gordon challenges the view that economic growth will continue unabated, and shows that the life-altering scale of innovations between 1870 and 1970 cannot be repeated. He argues that American productivity growth will be further held back by the headwinds of rising inequality, stagnating education, an ageing population, and the rising debt of college students and the federal government. 

Source: Bank for International Settlements, AEs (advanced countries); EMEs (emerging economies)   

Low rates to continue for some time

Low-interest and inflation rates are set to continue with the fading of the recent spurt in economic growth giving rise to recession worries.

Absent fiscal moves by governments, central banks have effectively very little firepower with interest rates so low. 

The European Central Bank has purchased €365bn of Italian sovereign debt since 2015 and renewing for example bond-buying for a country that hasn't the will to pull itself out of two decades of stagnation, will only defer a crisis.

A paper published this year shows how "low-interest rates encourage market concentration by raising industry leaders’ incentive to gain a strategic advantage over followers, and this effect strengthens as the interest rate approaches zero."

US data show that big incumbents have had a jump in profits over a decade even though the Economist writes, "Large firms no longer employ all that many people in America: the domestic employee base of the S&P 500 is only around a tenth of total American employment." 

Economists at the Bank for International Settlements said in a 2018 paper using data from 1870 to 2016, that the young and old are generally associated with higher inflation while working-age cohorts are associated with lower inflation. The authors note, "Our findings suggest that the inflationary pressure from the increasing share of the old is not yet strong enough to offset the disinflationary pressures from the declining share of the young. Yet, the Great Recession may also have had large and lasting additional effects on inflation, which are difficult to disentangle from those deriving from the age structure."  

There is a useful chart here on low inflation from the Reserve Bank of Australia, the central bank, as part of a speech transcript by Guy Debelle, deputy governor, in August 2018.

In the period 1993-2018, the cost of consumer durables had an average rise of 0.1% from 1993 and -0.1% from 2015.

Market services, housing and government charges had the main rises.

An example of quality improvement is that the average age of a car on European roads is 11 years; it's 12 years in the US.   

Low-interest rates? The average US rate on interest-bearing card accounts hit 17% in May, according to Federal Reserve data — the highest in the 25 years of tracking by the central bank.
*Many claimed English language Chinese aphorisms are a puzzle to English-speaking Chinese and that is my own experience too!