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"To recover, you have to retrench. To grow, you have to invest. To avoid the fate of Greece, you must shrink government expenditure."



$135 – $12 = the pay gap the West can’t bridge

Jon Moynihan

The Times

15 August 2012


We can’t compete with China on wages and are living beyond our means. We must retrench before we grow again

Two numbers — $135 and $12 — explain why Britain’s and Europe’s economies are stagnant or shrinking. Pundits and economists have lined up with suggestions about how to stimulate our economy: more quantitative easing; clever schemes such as “funding for lending”; while others say enough of austerity, let’s stop the cuts. But all that assumes that growth is the natural order of things.

None of these proposals will solve our problems because they ignore the two numbers $135 and $12. The first is what the average worker in the West earns per day; the second what the average worker in urban China earns.

This inequality in pay is the main reason our economy is in peril. What entitles the rich world’s 500 million workers to salaries ten times greater than the 1.1 billion workers in urban bits of the developing world who toil and study so much harder, let alone nearly 100 times greater than the 1.3 billion adults who live in rural poverty?

In the global marketplace it is now impossible to preserve well-paid jobs for Westerners. Many of those jobs have gone or are going south or east. In the 1950s the most successful company by market capitalisation was General Motors. In 1955 it employed nearly half a million Americans and 80,000 foreigners. Today Apple, the world’s biggest company, employs 4,000 Americans and more than 700,000 overseas contractors. And in jobs that have not moved, wages are under severe downward pressure: US high- school dropouts now earn less in real terms than their dropout grandfathers.

It was not always like that. For 55 years after the Second World War annual growth in jobs in Western economies was about 2 per cent and real wages grew by about 3 per cent year after year. The idea that we would all earn more without having to work harder, and that there would be jobs for our children, became a democratic “right”. But this right is now broken because, starting in 1990, developing nations ditched the failed socialist and Marxist policies that kept them poor. Since 2000 China’s economy has quintupled — while jobs, wages and GDP growth over the cycle for Western economies was, with few exceptions, negative.

For the first time in centuries we have to compete on a level playing field. We cannot compete on wages. Do we have other advantages that will protect our living standards? Aren’t Europe’s workers better educated? More creative? No: 10,000 science PhDs graduated from Chinese universities last year. In 1995, global patents granted to China amounted to 0.5 per cent of the total; in 2010 it had reached 9 per cent and is rising exponentially. Our best universities are educating many future business leaders and scientists of developing countries. Our advantage in physical and intellectual capital is eroding fast. What the developing world does not create, it can steal; the global value of counterfeit and pirated goods is forecast to rise by $1.5 trillion by 2015.

Most importantly, we consume more and invest less. China’s investment levels (however misdirected some of those investments may be) have risen to almost half of GDP, while the West is at about 15 per cent and falling. The truth is that Western nations have been living beyond their means. Our build-up in total debt — corporate, individual and government — has now become an enormous overhang. The UK is more indebted than Greece, Spain or Italy and only Japan and Ireland’s total debt per head is greater than ours.

So how do we get out of this mess? First, we must live within our means. Since the 1950s, the UK economy has quadrupled but welfare spending is up tenfold. Entitlements will have to be cut. We all want a compassionate society that helps the disadvantaged but if it is done in unaffordable ways there will be no money for any benefits. Nearly 80 per cent of maternity pay and more than 40 per cent of child benefit goes to middle-class households in the UK; and why give a winter fuel allowance and free bus passes to middle-class pensioners?

Not only must we live within our means, the Government should prioritise spending that will lead to an economy that grows soundly. OECD studies indicate that redirecting funds to education and infrastructure has the greatest impact on long-term growth. The OECD also says that the way we tax should be rebalanced away from corporate and income taxes, which discourage wealth creation, towards consumption and property taxes.

Since the 1950s, health spending has grown at a much faster clip (nearly 5 per cent a year in real terms) than education (just over 3 per cent). Yet 22 per cent of healthcare spending is said to go on the final year of life. Which is more important: the last year of life or the first 20? Education is at the heart of our dilemma: 60 per cent of STEM (Science, Technology, Engineering, Mathematics) graduate students in the UK are from abroad, and most will leave after graduating, particularly given our unwelcoming approach to immigration.

And yet it is in a highly educated workforce, particularly in science, that our future lies. According to the OECD, almost 20 per cent of children leave school without the reading skills essential to be a productive member of society. In Shanghai it is less than 4 per cent. If we were to transform education in the UK, and Michael Gove’s reforms could go some way to achieving this, there is a glimmer of hope. With an educated population we can develop the technologies and companies that will underpin a sound economy.

The Government could do more to support new technologies — in cod parlance, bio-, nano-, info-, neuro-, cogno-, anti-carbo-. Infrastructure projects could boost the economy in the long term — Simon Wolfson’s “brain belt” (the Oxford-Cambridge motorway and science park); universal WiMAX or other ultra-high speed broadband; local bypasses; a Manchester -Sheffield motorway; the “Boris Island” airport.

But over the next few years, a lower standard of living is almost inevitable. By my reckoning, a decline of about 15 per cent could be needed to balance Western economies. Many households have already implemented this but with government spending so large, private retrenchment alone is not enough. It would be better to choose to restructure our national spending priorities rather than have it forced upon us in more brutal fashion by the markets. Yet we cannot expect politicians to stand up and say this to us unless we are prepared to accept facts and admit it ourselves.

It’s a bleak view, but it contains the truth that all of us know: to recover, you have to retrench. To grow, you have to invest. To avoid the fate of Greece, you must shrink government expenditure. Capitalism works by creating surpluses and investing them productively not by borrowing money and squandering it on consumption.

This article is based on a talk given at the LSE by Jon Moynihan, click here for more information.  

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