MEASURING THE BOTTOM LINE
In the previous article, we looked at some fundamental principles which belong in the realms of philosophy and ideals. Such discussions are valuable, and are all too often neglected in a world seemingly obsessed with immediacy. But we do also need to focus on the tangibles – and nothing is more tangible than prosperity.
Strange though it may seem, conventional economics is really pretty weak on this fundamental matter of prosperity. The claim put forward here is that the surplus energy economics approach can provide unique insights into prosperity. What follows is an explanation of how the SEEDS system measures prosperity, together with some conclusions which might be surprising.
Prosperity isn’t assets
Let’s start by noting that the link between assets and prosperity is far weaker than we might assume. If you buy a house for £100,000, and its value doubles to £200,000, that sounds like an increase in prosperity which, superficially, it is. It’s certainly possible for you to sell the property and pocket the gain (always assuming that you don’t need, as most people do, to buy another house to live in, which will have risen in price by just as much).
But this process does not add to the aggregate wealth of the economy – it would not be possible for all homeowners, or most of them, or even a sizeable minority of them, to monetize these gains. If huge numbers of properties were put on the market, prices would slump, which is a simple example of supply and demand. But the really fundamental point is that the housing stock cannot be monetized because the only people who can buy that stock are the same people who already own it.
What this really means is that transactions at the margin do not value the aggregate in any meaningful way. Likewise, the aggregate value of, say, all the equities or all the bonds traded on a market is meaningless, because that value simply cannot be monetized.
Prosperity and income
Financial assets, such as houses or investment instruments, then, are not the same thing as “prosperity”, though cash in the bank comes nearer to it.
Rather, real prosperity depends on incomes, provided that we qualify this statement in some critical ways. First, if an extra £10,000 comes into your hands because your pay has risen, or even because you backed the right horse at Cheltenham, your prosperity has increased. But this is not the case if you have an extra £10,000 to spend because you have taken out a loan of that amount – in this instance, your prosperity has neither increased nor decreased.
Second, even incomes do not correlate directly to prosperity. Let’s say that someone’s employer raises his pay by 5%. If, at the same time, the cost of all the things he has to spend money on – things like fuel, food, water and so on – has risen by 10%, this person’s prosperity has diminished, not increased.
This gets us to a definition of prosperity, something mentioned here before but so important that it bears repetition. Prosperity is “discretionary” income.
To measure it, we start with income. From this, we deduct the cost of essential or “non-discretionary” expenses. What remains is “discretionary” income, meaning the amount that the recipient can choose to spend in whatever way he or she chooses. Put simply, if the money in your pocket after essential spending increases, you are more prosperous.
Surplus energy economics provides unique insights into prosperity because the trend cost of energy is the principle driver of non-discretionary costs. The cost of essentials is massively linked to the cost of energy. Fuel, power and light are themselves significant components of the non-discretionary spend. But energy also drives the cost of water, minerals, food and the various manufactured goods which need to be acquired and replaced over time.
Let’s illustrate this taking China as an example, and making a ten-year comparison between 2006 and 2016. Over that period, and stated at constant 2016 values, China’s reported GDP increased by 134%. This does not, however, make the average Chinese citizen better off by 134%. For a start, the population of China increased by almost 16% over that period. This dilutes the per capita share of GDP, so that the increase thus measured is 123%, not 134%.
Then there’s the question of debt, remembering that adding to your overdraft does not increase your prosperity. Between 2006 and 2016, China’s inflation-adjusted GDP increased by RMB 42 trillion, but debt increased by RMB 141tn, or RMB 3.37 for each RMB of growth. Clearly, some of that borrowing was used to fund consumption expenditure, thus inflating reported growth to levels higher than the “organic” or “underlying” situation.
The SEEDS calculation is that, of the total RMB 141tn borrowed, nearly RMB 23tn (16% of all net borrowing) inflated GDP by financing debt-funded consumption. Adjusting for this, underlying GDP growth over the decade wasn’t 134%, but 87%. Underlying per capita GDP, meanwhile, didn’t rise by 123%, but by 65%.
Lastly, we come to the cost of essentials, which SEEDS measures using the trend ECoE (Energy Cost of Energy). This, as outlined in previous articles, is an “economic rent”. As such, it does not diminish GDP or the income of the average person, but it does increase “non-discretionary” costs, so the effect is to reduce “discretionary” incomes and, hence, prosperity. According to SEEDS, the trend ECoE of China increased from 10.3% in 2006 to 14.3% in 2016. The effect of this was to reduce growth in the real economy over that decade to 71%. The per-capita equivalent of this was 58% – and that’s the real extent by which prosperity per person increased over that period.
To sum up, then, we can list the sequence for China like this:
- GDP: +134%
- Population change effect: -11% (growth now 134% – 11% = 123%)
- Adjustment for debt-funded consumption: -58% (growth now 123% – 58% = 65%)
- Increased ECoE, increasing non-discretionary spend: -7% (growth now 65% – 7% = 58%)
International prosperity – an overview
That the average Chinese person saw his prosperity increase by “only” 58% over a decade remains pretty impressive. But the same adjustments, when applied to less vibrant economies, have some very adverse implications for prosperity.
Here is a league-table showing the itemised path from growth to prosperity for the SEEDS universe of 21 economies. Its implications are far-reaching.
Fig. 1: Prosperity per capita, 2016 vs 2006
In the United States, growth of 14.6% in GDP translates into a decrease of 7.0% in prosperity, which might go a long way to help explain why Donald Trump was able to wrest the White House out of the clutches of the political establishment.
In Britain, GDP growth of 12.2% translates into a slump of 13.8% in prosperity, which might likewise help explain “Brexit”. Italian prosperity fell by 9.7% between 2006 and 2016 – a worse fall than any other country except Britain – which no doubt influenced the resounding voter rejection of Matteo Renzi’s reform proposals.
More positively, personal prosperity over that decade increased by 48% in India, 18% in Russia and 12% in Poland.
The French conundrum
All of which brings us, topically, to the situation in France. Until recently, it was generally assumed that, after the first round of voting on 23rd April, the second and decisive round on 7th May would pitch the anti-establishment Marine Le Pen against a “centrist” (meaning “pro-establishment”) contender, presumably Emmanuel Macron.
Latterly, however, the meteoric rise in the popularity of far-left candidate Jean-Luc Mélenchon has created, for the establishment, the potential nightmare scenario of the nationalist Ms Le Pen confronting Mr Mélenchon, whose policies include a marginal tax rate of 100% on incomes over €360,000.
As well as vanquishing the incumbent elite, this outcome would ensure an anti-EU occupant of the Elysée because, whilst Ms Le Pen takes a nationalist view of the EU, Mr Mélenchon seems to see the whole thing as a neoliberal cabal. The view expressed here is that leaving the EU would almost certainly push France into default, something which would terrify the country’s creditors (most obviously Germany) and have knock-on effects throughout the world. The viability of the Euro, and even of the EU itself, could be fatally undermined by the reintroduction of the Franc, “Frexit”, or both.
What part might prosperity (or the lack of it) play in the voters’ decision? According to SEEDS, per capita prosperity in France declined by 6.6% between 2006 and 2016 and, looking ahead, is projected to carry on deteriorating, albeit at pretty modest rates.
Of course, the average voter, in France or anywhere else, does not spend his or her time studying economic indicators. But voters do have a very immediate sense of prosperity, because they know how far their money goes after essentials have been paid for.
It’s impossible to say whether the 6.6% ten-year deterioration in French prosperity will be enough to oust the establishment from power – but a not-dissimilar deterioration (of 7%) was followed by the election of Mr Trump, whilst Italy’s 9.7% decline was more than enough to see off Mr Renzi.
If France does elect Ms Le Pen or Mr Mélenchon, the consequences could be drastic – and not just for France herself.