The Age of Austerity

Thoughts on the next hundred years.

While Canada might avoid the worst of the austerity and sacrifice that is sweeping through Europe on the heels of Greece’s near bankruptcy, the effects on the global economy, including ours, cannot be ignored.

Stimulus spending may have mitigated the worst of the past 24 months of global financial crisis, but the accumulated deficits and mounting debts they added to may lead to a prolonged period of muted growth if not recession. And so in order to meet the financial obligations set by a divergent set of interests related to labour on one hand and service provision on the other, something has to give.

In theory, governments have three choices when mired in what most would call near-default positions:

1.      Raise taxes.
2.      Cut services.
3.      Cut the cost of service.

The most straightforward approach would be to simply raise taxes in order to increase government revenue. However given already strained constituent pocketbooks, there’s a limit to how much even the most progressive taxes could be raised.

Moreover, raising taxes is usually tantamount to political suicide and thus ranks quite low on a politicians radar. This despite the fact that at some point citizens may need to re-examine how much universal services cost and what share we’re willing to pick up in order to keep them going.

The next alternative is to cut back on services. Yet as I’ve written previously, despite our complaints on service provision and social spending, Canada on a whole ranks in the middle of the pack when it comes to spending on what most would think are the most important elements of a sound economy (education, health and social services). Most would tell you that there are no extraneous services left.

So far then, we’re neither ready to pay more in taxes, nor cut back in the current level of service provision we receive.

What’s left to be done?

Well, perhaps we’re due for a pay cut.

Heresy, you say?

Well before we go finding our effigies of Bob Rae and the memories of his infamous Rae Days of the early 1990s, we might want to look around us at what’s happening in countries hit harder than ours.

In Spain, civil servants have been hit with a 5 per cent pay cut across the board. Spanish government leaders have taken a 15 per cent hit. And all Spaniards will feel the heat of the end of inflation-adjustments for their pensions. In Ireland, austerity has taken the form of public sector wage cuts of between 5 and 15 per cent and deep cuts to health, education and welfare programs. In Romania, public sector wages are to be pruned by up to 25 per cent. While in Portugal and the Netherlands, a tightening budgetary environment will see freezes in public sector wages, tighter access to social services, increased taxation, and the privatization of state assets. And in Greece, anything not tied to the floor is being slashed in the hopes of finding financial salvation.

The Age of Austerity has arrived.

And, to be sure, we haven’t exactly been spared.

The province of Ontario, which currently owns a $20-billion plus deficit – one that is expected to persist in the red until 2017 – has sought to avoid program cuts and instead is focusing on longer-term efforts to curb wage inflation through wage freezes, and by reducing the size of the public service by 5 per cent by 03/12. The first salvo lobbed in this direction was a direction to freeze all public sector wages for three years. In Ottawa, a hush-hush public sector hiring freeze is already in place, as are wage freezes.

And while that may hurt, it’s far from the shock therapy our public sector spending needs.

For the deficits brought about by recession and financial crisis are just the tip of a growing iceberg that represents Canada’s economy, and to be more accurate, most of the developed world’s economic structures.

Prosperity over the past several decades has been built in large part on the ability to outsource production to low-wage economies, while retaining ownership of capital and thus the majority of the proceeds of trade. With a well-diversified economy, the theory was that we’d use those proceeds to transfer employment from low-skill manufacturing, etc, to services and higher-value added employment.

And so over the past several decades (especially since China’s post-1978 emergence) we’ve hummed along happily with economic theory and enjoyed the fruits of this trade.

More recently, however, something has started to change. And it’s not about bank lending, government spending and NINJA loans.

Rather it’s about the assumptions that globalization could only help us, and could only increase our aggregate incomes.

Before I continue let me insert one large caveat emptor: this is not a call for protectionist measures but rather a call for some real thought about we’ve structured our economy and, more important, how we’ve structured our expectations around salary, public services and the future of “us” in a shifting global order.

The essence of what I’ll call optimistic globalization was as I noted earlier – trade low paying jobs for higher paying ones, financed with the proceeds earned off of increased profits enjoyed thanks to lower wage costs. And this holds so long as the largest share of capital used to create profits is held in our hands.

But what happens when that capital, and thus ownership of the proceeds of trade, is increasingly owned by others? In this case, by those who were once on the short-end of the globalization-equation.

Well here’s my theory – let’s call it pessimistic globalization – and let me be the first to admit that this needs a lot of fine tuning and is possibly completely erroneous.

Economies that begin as homes to low-skill, low-wage labour thanks to comparative advantages in labour eventually see upward momentum into higher-value add manufacturing and industry and eventually into services.

This is fantastic for those economies as it shows real economic and social development. However for mature economies such as those in Europe and North America, it poses a massive risk. For as new, lower-wage economies enter the competitive field for higher-value add, international work, it should, at some point, create wage deflation in their equivalent industries and fields.

Case in point is the North American (and European) auto industry which went bankrupt due in large part to its inability to restructure wages to match prevailing international competition.

To be sure, we can (and have been able to so far) avoid real structural change to wages in a specific industry by bailing them out with funds from other, more competitive sectors of the economy but theory should indicate that there are limits, temporal and quantitative, as to how long this can persist.

For while today it’s manufacturing, who’s to say that financial services, research, sales, etc aren’t around the corner? For today’s emerging economies hold something very unique relative to previous economic challengers – size.

India and China may still be very much developing countries, but as levels of education and the quality of their research and science rise across, their potential to have a huge deflation-inducing effect on the global economy is real.

Let’s say those two countries have labour forces of, combined, near 1.5 billion people.

That’s more than the total populations of Europe and North America combined, and double the labour force. So their entry into higher-value added, and more productive, sectors of the global economy will undoubtedly allow them some massive competitive advantages versus mature economy labour forces.

And while wages will inevitably rise in broader Asia due to gradual skill scarcity, the sheer size of the labour force makes the likelihood that Asian wage levels will rise to European standards quite unlikely.

All of which begs a question – if developing economies become semi-developed ones with labour structures (read: labour force size and quality) that are bigger and equivalent respectively to ours, then doesn’t that mean that traditional developed economies will need to take a pay cut to compete?

It does. And while there’s likely a decade or two before this becomes a reality, there’s a short-term wrinkle that will start the process rolling.

Notably, for the past two decades of ‘optimistic globalization,’ while those who own capital have benefitted (as they should have) from the proceeds of outsourcing, incomes for the poorest have decreased in relative, purchasing-power terms. So while we’ve become richer on aggregate, income inequality has risen dramatically.

Ultimately, the rich have been subsidizing the poor on an unprecedented basis. (I realize I need some numbers here but my day job is getting in the way.)

And thus, if something should happen to wealth creation at the top, our economies could be in real trouble.

But the top is exactly where there has been trouble – first, with the past two years of stock market turbulence, and second, with the much deeper issue of the ownership of capital  and the increased share of global profits owned by emerging power countries.

Strictly speaking, and again this exercise is speculative economics at its best, if the share of profits held by developed economies decreases, then so too does our ability to redirect profits into higher-value add employment. We can’t subsidize anymore.

Worse yet, a collapse of competitiveness at the top-end of developed country economies, in addition to the previous outsourcing of the bottom of those same economies, would lead to a massive decrease in tax revenue, an inability to subsidize non-competitive industries, and would leave us with some stark choices to make regarding public sector services.

And thus we’re back at the Age of Austerity, except then it will be staring us in the face.

So while today we can look to Europe and pretend it’s not our problem, there’s a much bigger problem coming around the corner.

That’s not to say there aren’t solutions. For if we really had some foresight we might start to think about wage reductions in the present to forestall crisis and possibly chaos in the future. And, with apologies to my public sector friends, there’s no better place to start but with government employment.

For when upwards of 60 per cent of government budgets go to wages and benefits, and when that sector alone represents nearly 20 per cent of total employment, its offers the greatest potential for a gradual wage-correction that could keep us moving towards international competitiveness well into the future.

And while Europe has seen wage cuts upwards of 25 per cent, I’d be very happy to start with a more minor, albeit very significant step: an end to annual inflation-indexed wage adjustments that have, since their introduction in the 1960s and 1970s, created an unbreakable cycle of wage inflation (and subsequently consumer price inflation) in our economies.

Some will argue that if the economy were to continue growing, ceteris paribus, then we’d never have a problem. Salaries would gradually inch higher in order to meet rising costs. And if we lived in a vacuum that might just be the case.

However, in a globalized world, one where capital can move freely to take advantage of lower labour costs, these assumptions don’t hold. Eventually we need to compete in most, if not all, sector of the economy against countries with labour force structures that allow them to undercut our wages.

If we want to keep the bulk of our willing labour employed then we’ll have to join an increasingly global market, and doing so, will mean taking a wage cut in the process. Sure, protectionism might offer a temporary reprieve for some industries. Unfortunately for proponents of that school of thought, we’ve become far too interlinked financially to pull back effectively. Doing so would simply usher in economic belligerence and perhaps worse.

Instead we need to look at the age of globalization with objectivity, and start to understand that if the rest of the world is to develop to a standard, both economic and social, near ours, then we might need to take a paycut to meet them half-way.

And so as the Romans said, ‘Si vis pacem, para bellum.’ If you wish for peace, prepare for war.

The Age of Austerity is coming, so let’s prepare for wage-deflation and economic war, in the hopes of finding the common ground that will allow both developed and developing economies to enjoy the standards of living that we have for the past century or more.


One Comment on “The Age of Austerity”

  1. theyenguy says:

    You relate: “we might need to take a paycut to meet them half-way”.

    I can assure you that greater sacrifice will be required that that; in fact, total sacrifice will be required.

    Debt deflation is coming to Canada; and it will hit hard as there is a terrific amount housing built with interest only homes; as interest rates skyrocket, then these homes will likely be charged off to the banks or the borrower who will have to rent somewhere or lease from the bank.

    In my article The Security And Prosperity Partnership Partnership Of North America Puts Natural Resource Investments At Risk For Expropriation, I write that In March 2005, the three leaders of the North American continent announced the Security and Prosperity Partnership of North America, The SPP, at Baylor Baptist University; in so doing they abrogated Constitutional law; and waived sovereignty, and established a home, or better stated, a homeland. Those living in Mexico, Canada and the US now reside in region of global governance.

    During a time of continental emergency, natural resources, will likely be expropriated for the security needs of the homeland. These resources are publically traded investments in Tar sands: Canadian Natural Resources, CNQ, Imperial Oil, IMO, Husky, HUSKF.PK, Nexen, NXY, Suncor, SU, EnCana, ECA … The Yahoo Finance Chart of CNQ, IMO, HUSKF.PK, NXY, SU, ECA shows Canadian Natural Resources to be the extractive and synthetic crude oil production leader … When a continental emergency arises, such as a financial breakdown, then the resources of these companies will have to be used for the homeland’s good; and the bond holders and stockholders will get wiped out. The economic dislocation that is coming via imposition of the terms of the Security and Prosperity Announcement will be quite terrific.

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