12/23/13 – That ‘70s Show – How the Economy May Grow in the Next Decade

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Dec 23, 2013 8:02:49 AM

and tagged Outlook 2014, Commentary

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After writing about how growth could slow going forward, based on my own analysis and supported by several even more pessimistic analysts, notably Jeremy Grantham and Professor Robert Gordon of Northwestern, I have been spending some time thinking about how the argument is wrong.

I wanted to think more deeply about it for a couple of reasons. First, the growth pessimists have been wrong for some time. The famous bet between Julian Simon and Paul Ehrlich on the resource price changes is a great example. The new growth pessimists (among whom I can reasonably be numbered) have what are seemingly better reasons this time, but, at the core, the argument is the same: limited resources, whether human or material, will constrain future growth. We simply don’t have enough people or stuff to keep growing indefinitely.

The basis of this argument is correct. There simply are not enough resources to support China, for example, living at the material and energy consumption levels that the present-day U.S. enjoys.

In the 1970s, however, using precisely the same argument, you could have said—correctly—that there was no way that China or the other emerging markets could have made the astonishing progress in living standards they actually have.

The disconnect is efficiency, which can either be expressed as better technology or capital investment. The Green Revolution in agriculture, the rise of global supply chains, and the connection of the large Chinese population to the West’s consumer demand cycle have all allowed the progress from the 1970s through now. But the new pessimists argue that these have played out. There is not another China out there, and the Green Revolution is hitting its limits.

Again, both are true, but to argue that present-day technologies don’t allow future growth again smacks of the 1970s. Fracking and unconventional oil, not to mention wind and solar, could easily turn out to be the 21st century’s game changers— equivalent to the Green Revolution from last century. Think about it. Last century, food was seen as the primary constraint, due to the “population bomb.” It did not turn out that way. Now energy is seen as the primary constraint, and now, just as then, new technologies are on the rise that should help enable us to dodge that bullet.

The population bomb is also worth another look. The fear then was of too many people; the evolving fear now is of too few. China is in the process of lifting its “one-child policy,” as it faces a decline in its workforce and overall population. The U.S. and Europe face an evolving pension crisis, caused largely by too few young people. Although unemployment rates are currently too high in the U.S., in the mid-2000s, they were worryingly low. Even the statement that there is no new China on the horizon is not actually correct. In my opinion, companies are investing in Vietnam, India, and other emerging economies, which, in aggregate, could keep adding workers to the global economy for the next decade.

At some point, of course, we will run into material limitations, and the population may stabilize. Can’t we argue that, although we may be able to continue to grow for a while, that this is just putting things off again? Arguably, life itself is just about putting off the inevitable, but that doesn’t really answer the question. What may answer it is a shift of growth from material to virtual goals.

Think about Maslow’s hierarchy of needs. In my opinion, we are getting closer and closer to widely satisfying the basic needs, which allows us to shift consumer spending—and growth—to objects that don’t actually require a lot of material support and that do require nonphysical labor—the sort that can be done by an aging population. We are actually seeing this in the real world, as well, with nonmaterial games and goods becoming a growing part of the economy.

Just as in the 1970s, we are in a transition period. The oil shock forced Western economies to retool to become more efficient. The demographic and pension shock may force an equivalent, and even larger, transition to be more people- and financially efficient. When old models, built in good times, don’t work anymore, the transition is painful. But, when completed, the change can lead to a new boom.

We are also at the start of a larger growth cycle—the transition from material growth to virtual growth. Economic growth is driven by human desire, which can be essentially limitless, and this transition can open the door to growth, which is not constrained by the very real material limitations imposed by Earth itself.

Of course, if I wanted to get wildly optimistic, I could point out the speculative but very real proposals for asteroid mining and orbital solar power installations. But that is a story for another day.

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