Say’s Law

Why Bill Gates is Right About Robots Paying Taxes

Bill_Gates_June_2015

In the recent past, there have been a spate of predictions about robots taking over human jobs.  One such prediction was made on October 3, 2016, by the World Bank President Jim Yong Kim, when he said in a speech: “Research based on World Bank data has predicted that the proportion of jobs threatened by automation in India is 69 percent, 77 percent in China and as high as 85 percent in Ethiopia.”[i]

As per predictions being made, it is not only jobs in the developing countries that are at risk. As Rutger Bergman writes in Utopia for Realists: “Scholars at Oxford University estimate that no less than 47 per cent of all American jobs and 54 per cent of those in Europe are at the high risk of being usurped by machines. And not in a hundred years or so, but in next twenty years.” He then quotes a New York university professor as saying: “The only real difference between enthusiasts and skeptics is a time frame.”[ii]

I have view which is different from robots destroying human jobs and I wrote about it in late January 2017. The fear of robots or automation destroying human jobs is not a new one and has been around for a while. So, what is it that makes this fear so believable this time around?

As Yuval Noah Harari writes in Homo Deus—A Brief History of Tomorrow: “This is not an entirely new question. Ever since the Industrial Revolution erupted, people feared that mechanisation [which is what robots are after all about] might cause mass unemployment. This never happened, because as old professions became obsolete, new professions evolved, and there was always something humans could do better than machines. Yet this is not a law of nature and nothing guarantees it will continue to be like that in the future.”[iii]

The question is: What has changed this time around?

Human beings essentially have two kinds of abilities: a) physical ability b) cognitive abilities i.e., the ability to think, understand, reason, analyse, remember, etc. As Harari writes: “As long as machines competed with us merely in physical abilities, you could always find cognitive tasks that humans do better. So machines took over purely manual jobs, while humans focussed on jobs requiring at least some cognitive skills. Yet what will happen once algorithms outperform us in remembering, analysing and recognising patterns?”

And given this, robots will takeover human jobs is the conclusion being drawn. This conclusion has one basic problem—it assumes that human beings will sit around doing nothing and let robots take over their jobs. Now that is a very simplistic thing to believe in. Hence, if and when, it seems likely that robots are really look like taking over human jobs, it is stupid to assume that the governments will sit around doing nothing. There will be huge pressure on them to react and make it difficult for companies to replace human beings with robots.

Over and above this, governments will lose out on tax. When an individual works, he earns an income and then pays an income tax on it to the government. Income tax is a direct tax. Over and above this, in India, when he spends this money, he pays other kind of other taxes, which are largely indirect taxes, like excise duty, service tax, etc. A similar structure works all over the world.

Now let’s say this individual paying taxes gets replaced by a robot. So, the government does not get the income tax that it was getting in the past. Over and above this, the individual who has lost his job, will not spend as much as he was in the past. He will go slow on spending in order to ensure that his savings last for a longer period of time, or at least until he finds another job. If a substantial number of individuals lose their jobs to robots, in this scenario, the government will lose out on a portion of indirect taxes that it was earning earlier. It will also lose out on direct taxes.

So, what is the way out of this?

In a recent interview to Quartz.com, Bill Gates, the founder of Microsoft, said: “Certainly there will be taxes that relate to automation. Right now, the human worker who does, say, $50,000 worth of work in a factory, that income is taxed and you get income tax, social security tax, all those things. If a robot comes in to do the same thing, you’d think that we’d tax the robot at a similar level.”

Basically, taxing the robot means, taxing the company which owns that robot. And how will this help? It will help the government to finance other jobs. As Gates put it: “And what the world wants is to take this opportunity to make all the goods and services we have today, and free up labor, let us do a better job of reaching out to the elderly, having smaller class sizes, helping kids with special needs. You know, all of those are things where human empathy and understanding are still very, very unique. And we still deal with an immense shortage of people to help out there… So if you can take the labor that used to do the thing automation replaces, and financially and training-wise and fulfillment-wise have that person go off and do these other things, then you’re net ahead.”

What Gates has explained is perhaps a solution to the problem that too much automation or too many robots are going to create. There is a basic law in economics which goes against the entire idea of robots destroying human jobs. It’s called the Say’s Law. One of my favourite books in economics is John Kenneth Galbraith’s A History of Economics—The Past as the Present. In A History of Economics, Galbraith writes about the Say’s Law.

This law was put forward by Jean-Baptise Say, a French businessman, who lived between 1767 and 1832. As Galbraith writes: “Say’s law held that out of the production of goods came an effective aggregate of demand sufficient to purchase the total supply of goods. Put in somewhat more modern terms, from the price of every product sold comes a return in wages, interest, profit or rent sufficient to buy that product. Somebody, somewhere, gets it all. And once it is gotten, there is spending up to the value of what is produced.”

Say’s Law essentially states that the production of goods ensures that the workers and suppliers of these goods are paid enough for them to be able to buy all the other goods that are being produced. A pithier version of this law is, “Supply creates its own demand.”

What does this mean in the context of robots destroying human jobs? If robots destroy too many human jobs, many people won’t have a regular income. If these people do not have a regular income, how are they going to buy all the products that robots are going to produce? And if they are not going to buy the products that robots are producing, how are these companies driven by robots going to survive?

Gates has offered a solution where he says that the government taxes the companies using robots, more. That money can then be used to retrain people and deploy them in areas where people are still needed.

This means that such people will be paid by the government. And when they are paid by the government they will pay income tax as well. Over and above this, these workers will also spend that money and pay several indirect taxes to the government. Hence, the government will use the money generated from taxing robots to generate more taxes for itself.

Gates suggestion is also in line with what I had said earlier about the fact that once automation becomes a real danger to human jobs, the governments will not just sit and wait it out, but will do something about it, given that there will be tremendous pressure on them from people who elected them. It will also work towards protecting its tax revenues. Hence, any government taxing the output of robots, will be in line with this.

Gates suggestion depends on several assumptions. First and foremost is that people who lose their jobs to robots will be trained for other professions. While, this sounds simple enough, it clearly isn’t. Second, it expects the governments to do the right thing. That as we all know, is easier said than done. Third, it assumes that companies will willingly pay tax on their robots and not look at loopholes to avoid making these payments.

Having said that, Gates’ suggestion still shows one way of getting through the economic mess that the robots are likely to create.

To conclude, if my job doesn’t get replaced by a robot as well, I hopefully will be around to keep writing about this trend in the months and the years to come.

Watch this space!

[i] Speech by World Bank President Jim Yong Kim: The World Bank Group’s Mission: To End Extreme Poverty, October 3, 2016

[ii] R.Bergman, Utopia for Realists—The Case for a Universal Basic Income, Open Borders and a 15-Hour Workweek, The Correspondent, 2016

[iii] Y.N.Harari, Homo Deus—A Brief History of Tomorrow, Harper, 2016

The column originally appeared in Equitymaster on February 23, 2017

Why Robots Are Not Going to Screw Humans-At Least Not Yet

Sony_Qrio_Robotot

If you are the kind who reads the inside pages of newspapers carefully, you would know that these days stories around robots replacing human jobs are quite common. Most of these stories are written in a way that suggest that doomsday is upon us.

But is it as straightforward as the newspapers and the media makes it out to be? I really don’t agree. I had first written about this issue a few months back in the weekly Letter that I write, but given the importance of the issue, I am sharing my thoughts with the Diary readers as well.

In the recent past, there have been a spate of headlines in the media on the capabilities of robots having reached a stage wherein they can take on human jobs. Here are a few news items, along these lines, which I have come across over the last few months.

1) In May 2016, the shoemaker Adidas announced that it would start manufacturing shoes in its home country of Germany after nearly two decades. But it shall use robots and not human beings to do the same. The company calls its robot factory the speed factory. A second such factory is being planned in the United States as well.[i]

2) In another similar case, Foxconn, a company which manufactures mobile phones for both Samsung and Apple, is replacing 60,000 workers with robots.[ii]

3) In July 2016, HfS Research, a research firm based in the United States, predicted that by 2021, India’s information technology companies will lose around 6.4 lakh jobs to automation. This is something that high ranking officials of Indian IT firms have also said.

4) In mid-September 2016, the textile major Raymond said that it was planning to slash 10,000 jobs across its manufacturing centres all across India and replace them with robots and technology. The company currently employs 30,000 employees.[iii] Hence, robots are likely to replace one-third of its workforce.

5) Driverless cars have already arrived. As Ruchir Sharma writes in The Rise and Fall of Nations—Ten Rules of Change in the Post-Crisis World: “The most common job for American men is driving, and one forecast has driverless smart cars and trucks replacing them all by 2020.”[iv]

6) And if all this wasn’t enough, on October 3, 2016, the World Bank President Jim Yong Kim said in a speech: “Research based on World Bank data has predicted that the proportion of jobs threatened by automation in India is 69 percent, 77 percent in China and as high as 85 percent in Ethiopia.”[v]

These are just a few examples of the expectation that robots will take over human jobs that I have come across over the last few months. As can be seen, this threat looms not just over India but over large parts of the developed as well as the developing world.

As Rutger Bergman writes in Utopia for Realists: “Scholars at Oxford University estimate that no less than 47 per cent of all American jobs and 54 per cent of those in Europe are at the high risk of being usurped by machines. And not in a hundred years or so, but in next twenty years.” He then quotes a New York university professor as saying: “The only real difference between enthusiasts and skeptics is a time frame.”[vi]

Indeed, the threat of robots taking over human jobs is nothing new. So what makes the threat this time around so different from the previous ones? As Yuval Noah Harari writes in Homo Deus—A Brief History of Tomorrow: “This is not an entirely new question. Ever since the Industrial Revolution erupted, people feared that mechanisation [which is what robots are after all about] might cause mass unemployment. This never happened, because as old professions became obsolete, new professions evolved, and there was always something humans could do better than machines. Yet this is not a law of nature and nothing guarantees it will continue to be like that in the future.”[vii]

The question is: What has changed this time around?

Human beings essentially have two kinds of abilities: a) physical ability b) cognitive abilities i.e., the ability to think, understand, reason, analyse, remember, etc. As Harari writes: “As long as machines competed with us merely in physical abilities, you could always find cognitive tasks that humans do better. So machines took over purely manual jobs, while humans focussed on jobs requiring at least some cognitive skills. Yet what will happen once algorithms outperform us in remembering, analysing and recognising patterns?”

Hence, the robots used until now essentially replaced the physical things that human beings did in factories. The trouble is that now the robots have also started thinking (in the form of algorithms) and hence, many more human jobs are on the line. Harari feels that “as algorithms push humans out of the job market, wealth might become concentrated in the hands of the tiny elite that owns the all-powerful algorithms, created unprecedented social inequality.”

This argument along with the evidence offered before seems to be pretty convincing, if seen in isolation. But there is a lot more to this than just the evidence that is currently being offered. As Sharma writes: “While the robotics revolution could come faster than most previous technology revolutions, it is likely to be gradual enough to complement rather than destroy human workforce. A huge gap still exists between the size of the world’s industrial robot population—about 1.6 million—and the global industrial labour force of about 320 million humans. Most of the industrial robots are currently unintelligent machines, committed to a single task like turning a bolt or painting a car door, and indeed half of them work in the car industry.”[viii]

As per the International Federation of Robots, South Korea currently has the highest penetration of robots. The country has 437 robots per 10,000 employees. Japan and Germany come in second and third with 323 robots and 282 robots per 10,000 employees, respectively. China has 14 robots per 10,000 employees.[ix]

The point is that there aren’t as many robots going around as there are made out to be. Also, it is worth remembering here that large parts of the Western world and Japan are currently seeing their population decline. China will also soon reach that stage as well. Hence, in that sense the robots will arrive at the right time replacing the decline in the labour force. As Daniel Kahneman the Noble Prize winning psychologist (he won the Economics prize) told John Markoff, a journalist, who covers science and technology for The New York Times: “You just don’t get it…In China, the robots are going to come just in time.”[x]

The point is that when it comes to big predictions like robots taking over human jobs, there are always a few ifs and buts. The trouble is that these ifs and buts are not being highlighted as much as the core argument of robots taking over human jobs, currently is.

Other than these factors there is a basic law in economics which goes against the entire idea of robots totally destroying human jobs. It’s called the Say’s Law. One of my favourite books in economics is John Kenneth Galbraith’s A History of Economics—The Past as the Present (In fact, anyone who wants to understand economics should mandatorily make Galbraith a part of his readings). In A History of Economics, Galbraith writes about the Say’s Law.

This law was put forward by Jean-Baptise Say, a French businessman, who lived between 1767 and 1832. As Galbraith writes: “Say’s law held that out of the production of goods came an effective aggregate of demand sufficient to purchase the total supply of goods. Put in somewhat more modern terms, from the price of every product sold comes a return in wages, interest, profit or rent sufficient to buy that product. Somebody, somewhere, gets it all. And once it is gotten, there is spending up to the value of what is produced.”

Say’s Law essentially states that the production of goods ensures that the workers and suppliers of these goods are paid enough for them to be able to buy all the other goods that are being produced. A pithier version of this law is, “Supply creates its own demand.”

As Bill Bonner writes in Hormegeddon—How Too Much of a Good Thing Leads to Disaster: “French businessman and economist, Jean-Baptiste Say, discovered that “products are paid for with products,” not merely with money. He meant that you needed to produce things to buy things.”

So what does this mean in the context of robots destroying human jobs? If robots destroy too many human jobs, many people won’t have a regular income. If these people do not have a regular income, how are they going to buy all the products that robots are going to produce? And if they are not going to buy the products that robots are producing, how are these companies driven by robots going to survive?

This is a basic question that none of the analysts, who are predicting doom on the basis of robots taking over human jobs, have bothered to ask. For capitalism to survive, it is essential that human beings work and earn an income, only then can they go around buying everything that is being produced.

The basic problem with the robots taking over human jobs argument is best explained through this example. As Bergman writes: “When Henry Ford’s grandson [Henry Ford II] gave labour union leader Walter Reuther a tour of the company’s new, automated factory, he jokingly asked, “Walter, how are you going to get those robots to pay your union dues?” Without missing a beat, Reuther answered, “Henry, how are you going to get them to buy your cars?””[xi]

Also, another point that most analysts seem to miss is that if and when robots actually do start destroying many human jobs, it is stupid to assume that the governments will sit around doing nothing. There will be huge pressure on them to react and make it difficult for companies to replace human beings with robots.

To cut a long story short, it will be interesting to see how the robots taking over human jobs trend evolves in the years to come, but it will not be as straightforward as it is currently being made out to be.  If we are still in business, we will surely keep a lookout!

The column originally appeared in Equitymaster on January 25, 2017

[i] Agence France-Presse, Reboot: Adidas to make shoes in Germany again – but using robots, May 25, 2016

[ii] J.Wakefield, Foxconn replaces ‘60,000 factory workers with robots’, BBC.com, May 25, 2016

[iii] TNN and Agencies, Raymond to replace 10,000 jobs with robots in next 3 years, September 16, 2016

[iv] R.Sharma, The Rise and Fall of Nations—Ten Rules of Change in the Post-Crisis World, Allen Lane, 2016

[v] Speech by World Bank President Jim Yong Kim: The World Bank Group’s Mission: To End Extreme Poverty, October 3, 2016

[vi] R.Bergman, Utopia for Realists—The Case for a Universal Basic Income, Open Borders and a 15-Hour Workweek, The Correspondent, 2016

[vii] Y.N.Harari, Homo Deus—A Brief History of Tomorrow, Harper, 2016

[viii] Sharma 2016

[ix] Ibid

[x] A Conversation With John Markoff. Available at https://www.edge.org/conversation/john_markoff-the-next-wave. Accessed on October 12, 2016

[xi] Bergman 2016

 

Problem with Robots is…

Sony_Qrio_RobototIn the recent past, there have been a spate of news-reports talking about robots taking over manufacturing. A recent news-report talked about the German shoemaker Adidas manufacturing shoes in its home country after more than two decades.

But instead of using human beings it has decided to use robots. Another news-report points out that Foxconn, a company which manufactures mobile phones for both Samsung and Apple, is replacing 60,000 workers with robots. Closer to home, information technology companies have also talked about robots taking over low-end activities.

On the face of it, it makes immense sense for a company to replace a human being with a robot. Robots can work all the time. They don’t sleep. They are not moody and there are no days when they don’t feel like working. They don’t need lunch and dinner breaks. They don’t need to go to the loo. And they don’t need to be paid every month or given an increment every year, either.

As Rutger Bergman writes in Utopia for Realists: “Scholars at Oxford University estimate that no less than 47% of all American jobs and 54% of those in Europe are at the high risk of being usurped by machines. And not in a hundred years or so, but in next twenty years.”

He then quotes a New York university professor as saying: “The only real difference between enthusiasts and skeptics is a time frame.”

The idea that machines will take over human jobs is nothing new. It has been around for the past two centuries. But nothing of that sort has happened as productivity levels (or output for every unit of input) have gone up. Nevertheless, it takes fewer and fewer employees now to create a successful business than it did in the past.

Take the case of the Indian manufacturing sector and the share of population it employs in various states. As Amit Amirapu and Arvind Subramanian write in a 2015 research paper titled Manufacturing or Services? An Indian Illustration of a Development Dilemma: “No major India state has achieved more than 6.2% of employment from registered manufacturing in the last 30 years, and many major states peaked at less than half that… most states have not been experiencing secular growth in employment shares over time (the only exceptions are Himachal Pradesh, Tamil Nadu, Haryana and – possibly – Karnataka).”

What this basically means is that even though the absolute size of the manufacturing sector in India has gone up over the years, the proportion of the population working for it, hasn’t. This is primarily because more and more manufacturing now is carried out by machines rather than human beings. In the Indian case, one of the major reasons are the hare-brained labour laws that companies need to follow.

But globally the basic reason is different. As Bergman writes: “The reality is that it takes fewer and fewer people to create successful businesses, meaning when a business succeeds, fewer and fewer people benefit.”

Take the case of Kodak, the company that invented the digital camera. In the 1980s, it employed 1.45 lakh people. It filed for bankruptcy in 2012. On the other hand, Instagram, the Kodak of this era, had just thirteen employees on its rolls, and was sold to Facebook for a billion dollars.

Nevertheless, there is a basic problem with all this, best explained through this example. As Bergman writes: “When Henry Ford’s grandson gave labour union leader Walter Reuther a tour of the company’s new, automated factory, he jokingly asked, “Walter, how are you going to get those robots to pay your union dues?” Without missing a beat, Reuther answered, “Henry, how are you going to get them to buy your cars?”

The point being if people don’t have a job, they don’t have any income or not much income. And in that situation they are going to buy only the most basic stuff that they require for survival. They will not have money to spend on all the goods being manufactured by companies which use robots.

And therein lies the basic problem with robots.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared in the Bangalore Mirror on June 1, 2016

GDP growth at 5.3%: A lot needs to be done for the economy to see acche din again

deflationVivek Kaul

India has largely been a centrally planned economy since independence. The central planning increased dramatically in the second term of the previous United Progressive Alliance (UPA) government.
This led to a situation where India’s economy grew at greater than 8% in the aftermath of the financial crisis, when economic growth was collapsing all around the world. But this extra central planning has created many problems for the Indian economy since then.
As Bill Bonner writes in Hormegeddon—How Too Much Of a Good Thing Leads to Disaster, “Central planning can do a good job of imitating real progress at least in the short run.” And that is what precisely what happened in India, in the aftermath of the financial crisis.
The government expenditure exploded. In 2007-2008, the total government expenditure stood at Rs 7,12,671 crore. This doubled to Rs 14,10,372 crore by 2012-2013. This increased spending by the government landed up as income in the hands of the citizens, and they in turn spend the money. And this ensured that the Indian economy kept growing at a fast pace though economic growth was slowing down world over.
A substantial amount of this increased government spending was directly distributed to citizens through schemes like Mahatma Gandhi National Rural Employment Guarantee Scheme. The minimum support price offered on rice and wheat was also increased much more than was the case in the past.
This led to rural income growing at a faster rate than it had in the past. Initially, it did not matter. But as time passed this increased income translated into high inflation, particularly high food inflation.
Further, the trouble was that the government wasn’t earning all this money that it was spending. Between 2007-2008 and 2012-2013, the total income of the government did not go up at the same pace as its expenditure (it went up by around 57%), and the government borrowed more to make up for the difference.
The fiscal deficit in 2007-2008 was Rs 1,26,912 crore. This shot up by 286% to Rs 4,90,190 crore by 2012-2013. Fiscal deficit is the difference between what a government earns and what it spends. And the government makes up for the difference through increased borrowing.
This increased borrowing by the government crowded out other borrowers, that is, there wasn’t enough left on the table for other borrowers to borrow. This meant banks had to offer higher rates of interest to attract deposits. This pushed up interest rates at which they loaned out money as well.
Also, to control the high inflation, the Reserve Bank had to push up the repo rate, or the rate at which it lends to banks. Further, during the good years, the corporates loaded up on debt, borrowing much more than they could ever repay. A major portion these loans were taken by crony capitalists from public sector banks.
All these reasons led to what analysts call the “India growth story” coming to an end. High inflation forced people to cut down on spending as incomes did not keep pace with expenditure. Economic growth fell to around 5% from double digit levels and that is where it has stayed for a while now.
It was widely expected that with Narendra Modi taking over as the prime minister, the Indian economy will start seeing acche din soon. But that hasn’t happened. For the three month period July to September 2014, the economic growth, as measured by the growth in the gross domestic product (GDP), was at 5.3%. During the period April to June 2014 the economy had grown at 5.7%.
The financing, insurance, real estate and business services sector which formed a little over 22% of the GDP during the period, grew by an impressive 9.5%. But other sectors did not do so well.
Agriculture which formed around 10.8% of the total GDP during the quarter grew by 3.2%. It had grown by 5% during the same period last year. Manufacturing which formed around 14.6% of the total GDP during the quarter was more or less flat at 0.1%. In fact, the size of manufacturing sector has fallen by 1.4% in comparison to the period between April and June 2014.
What this tells us clearly is that sustainable economic growth cannot be created by the government giving away money to citizens and then hoping that they spend it and create economic growth. For sustainable economic growth to happen a country needs to produce things. As the Say’s Law states “A product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value.” The law essentially states that the production of goods ensures that the workers and suppliers of these goods are paid enough for them to be able to buy all the other goods that are being produced. A pithier version of this law is, “Supply creates its own demand.”
In an Indian context this is even more important given that nearly 60% of the population remains dependent on directly or indirectly dependent on agriculture, even though agriculture now forms a minor part of the overall economy. What this tells us is that the sector has many more people than it should. Hence, people need to be moved from agriculture to other sectors like manufacturing. And for that to happen jobs need to be created in these sectors.
The government recently launched the Make in India programme to create jobs in the manufacturing sector. But just launching the programme is not good enough. For companies to make products in India a lot of other things need to be provided. They need access to electricity all the time and for that to happen we need to sort out the mess our coal sector is in. The physical infrastructure of roads, railways and ports needs to improve. The ease of doing business needs to go up considerably and so on.
As Daron Acemoglu and James A. Robinson write in Why Nations Fail—The Origins of Power, Prosperity and Poverty regarding the industrial revolution that happened in Great Britain in the 19th century: “The English state aggressively…worked to promote domestic industry…by removing barriers to the expansion of industrial activity.” Similar barriers need to be removed in India as well. Also, entrepreneurs need to be confident that their contracts and property rights will be respected.
These things are easier said than done. What makes the scenario even more difficult in the Indian case is that Indian businessmen who operate in the infrastructure sector are not the most honest people going around. Raghuram Rajan, the governor of the Reserve Bank of India, more or less hinted at it in a recent speech.
As he said “The amount recovered from cases decided in 2013-14 under DRTs (debt recovery tribunals) was Rs. 30,590 crore while the outstanding value of debt sought to be recovered was a huge Rs. 2,36,600 crore. Thus recovery was only 13% of the amount at stake. Worse, even though the law indicates that cases before the DRT should be disposed off in 6 months, only about a fourth of the cases pending at the beginning of the year are disposed off during the year – suggesting a four year wait even if the tribunals focus only on old cases.”
If incumbent businessmen do not repay their loans and then banks cannot recover those loans, banks will not lend or charge a higher rate of interest when they lend. And this does not help the businessmen currently looking to expand their businesses by borrowing.
To conclude, there is a lot that the government needs to do to get economic growth up and running again. The only action that one has seen from the government until now is demanding that the RBI cuts the repo rate. Now only if creating economic growth was simply about cutting interest rates.

The article appeared originally on www.FirstBiz.com on Nov 29, 2014

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

A 200 year old economic theory tells us what is wrong with the developed world today

Jean-baptiste_SayVivek Kaul

I like to quote a lot of John Maynard Keynes in what I write. The reason for that is fairly simple—Keynes is the Mirza Ghalib of economics. He has written something appropriate for almost every occasion.
Nevertheless, I’d like to admit that even though I have tried to read his magnum opus The General Theory of Employment, Interest and Money a few times, over the years, I have never been able to go beyond the first few chapters.
The economist whose books I find very lucid is the Canadian-American economist John Kenneth Galbraith. Galbraith unlike other economists of his era was a prolific writer and was one of the most widely read economists in the United States and other parts of the world between the 1950s and 1970s. He was even the US Ambassador to India in the early 1960s.
His most popular book perhaps was The Great Crash 1929, a fantastic book on the Great Depression, which he wrote in the mid 1950s. His other famous work was The Affluent Society published in 1958.
But the book I am going to talk about today is A History of Economics—the past as the present. In this book Galbraith looks at the history of economics and writes it in a way that even non-economists like me can understand it.
One of the laws that Galbraith talks about is the Say’s Law. This law was put forward by Jean-Baptise Say, a French businessman, who lived between 1767 and 1832. “Say’s law held that out of the production of goods came an effective aggregate of demand sufficient to purchase the total supply of goods. Put in somewhat more modern terms, from the price of every product sold comes a return in wages, interest, profit or rent sufficient to buy that product. Somebody, somewhere, gets it all. And once it is gotten, there is spending up to the value of what is produced,” wrote Galbraith explaining Say’s Law.
The Say’s Law essentially states that the production of goods ensures that the workers and suppliers of these goods are paid enough for them to be able to buy all the other goods that are being produced. A pithier version of this law is, “Supply creates its own demand.”
And this law explains to us all that is wrong with the developed world today. As Bill Bonner writes in his latest book Hormegeddon—How Too Much of a Good Thing Leads to Disaster “French businessman and economist, Jean-Baptiste Say, discovered that “products are paid for with products,” not merely with money. He meant that you needed to produce things to buy things; you could not just produce money…has anyone ever mentioned this to the Federal Reserve?”
The central banks in the developed world have printed close to $7-8 trillion in the aftermath of the financial crisis which broke out in mid September 2008, with the investment bank Lehman Brothers going bust. The Federal Reserve of the United States has printed around $3.6 trillion dollars in the aftermath of the crisis to get the American economy up and running again.
The standard theory that has emerged in the aftermath of the financial crisis is that consumer demand has collapsed in the Western world and this has led to a slowdown in economic growth. In order to set this right, people need to be encouraged to borrow and spend. As John Maynard Keynes put it: “Consumption—to repeat the obvious—is the sole end and object of economic activity.” (There I have quoted him again!)
To get borrowing and consumption going again central banks have printed a lot of money to ensure that the financial system remains flush with money and interest rates continue to remain low. At low interest rates the chances of people borrowing and spending would be more. And this would lead to economic growth was the belief.
Now only if economic theory worked so well in practice. Also, it was “excessive” borrowing and spending that led to the crisis in the first place.
Raghuram Rajan and Luigi Zingales explain this very well in a new afterword to Saving Capitalism from the Capitalists, “For decades before the financial crisis in 2008, advanced economies were losing their ability to grow by making useful things. But they needed to somehow replace the jobs that had been lost to technology and foreign competition… So in an effort to pump up growth, governments spent more than they could afford and promoted easy credit to get households to do the same. The growth that these countries engineered, with its dependence on borrowing, proved unsustainable.”
It is worth pointing out here that the share of United States in the global production of goods has fallen over the last few decades. Thomas Piketty makes this point in his magnum opus Capital in the Twenty First Century. Between 1900 and 1980, 70–80 percent of the global production of goods happened in the United States and Europe. By 2010, this share had declined to around 50 percent, around the same level it was at in 1860. Also, faced with increased global competition, Western workers were unable to demand the pay increases they used to in the past.
Piketty further points out that the minimum wage in the United States, when measured in terms of purchasing power, reached its maximum level in 1969 and has been falling since then. At that point of time, the wage stood at $1.60 an hour or $10.10 an hour in 2013 dollars, taking into account the inflation between 1968 and 2013. At the beginning of 2013, the minimum wage was at $7.25 an hour, more than 28 percent lower than that in 1969.
This slow wage growth has led to Western governments following an easy money policy by making it easy for people to borrow. As Michael Lewis writes in The Big Short—A True Story: “How do you make poor people feel wealthy when wages are stagnant? You give them cheap loans.”
In case of the United States, trade with China had an impact as well. As the historian Niall Ferguson writes in The Ascent of Money: A Financial History of the World: “Chinese imports kept down US inflation. Chinese savings kept down US interest rates. Chinese labor costs kept down US wage costs. As a result, it was remarkably cheap to borrow money.”
Ironically, what worked earlier is not working now. What has happened instead is that financial institutions have borrowed money at low interest rates and invested it in financial markets all over the world, in search of a higher return. Despite the central banks printing a lot of money, Japan recently entered a recession, with two successive quarters of economic contraction.
Europe is staring at a deflationary scenario. And the economic recovery in the United States continues to remain fragile.
Further, over the coming decades, a billion more people are expected to join the work force in Asia, Africa and Latin America. This will apply a downward pressure on costs and prices in the years to come and hence, wages in developed countries aren’t going to go up in a hurry.
Moral of the story: Western nations need to go back to making things, if they want a sustainable economic recovery. But as the American baseball coach Yogi Berra once famously said “In theory there is no difference between theory and practice. In practice there is.”

The article originally appeared on equitymaster.com as a part of The Daily Reckoning, on Nov 28, 2014