#93: The prosperity equation

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.

Measuring prosperity

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.

ANNEX

 

23 thoughts on “#93: The prosperity equation

  1. Very interesting, Tim. Congratulations on the work you have done here. Economics is often counterintuitive, although it’s because people don’t really examine their notions. MMT is in the same boat, which makes acceptance difficult, even for classical economists.
    To extend your argument economics should factor in resources. Gold for example has no economic measure of what is in the ground, only what is already mined. But it matters because we persist in saying that exports are a benefit, when in reality they can be a cost.
    Resources exported impoverish the nation. I hazard a guess that Australia’s national worth is only half what it was in 1788. One only has to look at the Middle East to see how impoverished it looks 10,000 years after it was named the Fertile Crescent. Economics avoids this sort of measure so far as I can tell. Also we actually should measure the national economy’s worth by comparing it today to the Output Gap, the fiscal space for expansion based not on tax receipts as per annual government budgets, but what are the available resources for sale. This should measure resources available at a future date, an estimate only but still valuable. Then we might see that exports are not so good,and may even be bad.

    • Good points. It is interesting that the discovery of a major oil field, though a big boost to national prosperity, has no impact on published numbers, but producing (i.e. depleting) it increases GDP.

  2. Such interesting points made, a healthier view would indeed be a more holistic approach to seeing how an economy works, conventional economic models were flawed precisely because they ignored important/relevant variables.

    Surely an input to measure the wealth of a country & by extension it’s inhabitants, should be the sustainability of the economy, so not just untouched available resources, but the amount of pollution for example because that has a price whether in paying the health consequences of the population or cleaning up the environment.

    Similarly degradation of resources available/the environment, be it a failing education system that impoverishes future human potential, the consequences of soil exhaustion on agricultural yield, or increased susceptibility to environmental disasters due to self-imposed climate changes.

    • Agreed. In a sense, this is what I’m trying to do with ECoE – the energy cost of energy rises as resources are depleted. Something much more holistic has become imperative now that we face no less than three major headwinds to growth:

      1. The environment – this acts as an “economic rent”, curtailing choices.

      2. Resource depletion – at a minimum, rising costs leave us with less to spend on, or invest in, other things.

      3. Debt and other “hostages to futurity”, such as pension deficits – by any objective measure, these make us poorer.

      The soil degradation issue is very serious, and does not attract nearly enough attention – whilst water shortages pose a potentially lethal threat.

  3. If the population size of the UK had fallen by 5.3% instead of rising by 8.5%, prosperity would have remained level. The ordinary person on the street can see their prosperity going down as health care, house building, school resources, roads etc. fail to cope with population growth.

    Many Brexit voters understood this at a subconscious level I think, sort of. Racist elements and the main stream media (MSM), I’m afraid, channelled this into horrible anti-immigrant sentiment.

    Anyone, included myself, who point out we should be actively putting in policies to reduce our population size IN GENERAL in order to maintain our prosperity during our fossil fuel Net energy descent, such as encouraging smaller families though tax and incentives, are just ignored or dismissed.

    • In my book I show the striking correlation between two exponential curves – a soaring world population, in tandem with a dramatic escalation in energy consumption.

      In fact it’s surplus energy that’s been the driver – total energy accessed, less energy consumed in the access process. This has supported population growth, not least through huge energy inputs to the supply of food and water.

      Growth in aggregate surplus energy seems to be over, and surplus energy per person is already in decline. This puts to the test my thesis that access to surplus energy is the master exponential – we will find out whether a reversal in the surplus energy exponential really does bring down other exponential curves, such as population numbers and (real) economic output.

  4. The fundamentals under our currency system is trust. Most people heard about that, but they don’t really understand the implications of failure in this system. Politically, we can see there’s a shift towards mistrust. Politics floats on our current monetary environment.

    The shift from growth to degrowth is, indeed, a Seneca cliff. Slowly at first, fast at last. I’ve read a few thousand articles on finance and energy. That doesn’t make me a sorcerer, but it turns me into a lover of facts presented on this website.

    Excellent work doc, and many thanks for your hospitality.

    • I agree, For other readers not so well read, let me expand on your comment, if I may.

      GDP will follow a Seneca (shark’s fin) curve instead of a Gaussian (bell-shaped) curve. (The area under each curve is equal). Here is the reasoning.

      Debt brings future consumption and hence GDP forward in time, into the present. This delays the roll-over from growth to degrowth for a few years or a few decades, Debt has to grow exponentially, to stop the present catching up with the future. Eventually the present overtakes the future and boom, as you say, we fall over the cliff, the Seneca cliff, as we discover that future GDP has already been used up.

      Another way to look at it is, we are stealing from the future so we can live in denial for a extra few years or decades. The more we steal from the future, the longer we have and the steeper the drop will be when it comes

    • Thanks both.

      Let me come at this a slightly different way. We have two economies – the real economy of goods and services, and the financial economy of money and credit. Money has no instrinsic worth – it commands value only as a “claim” on what the real economy produces. When we talk about faith in money, we really mean faith in its validity as a claim on goods and services – money is trustworthy only to the extent that others will accept it in exchange for these goods and services.

      The financial economy ought to progress at roughly the same pace as the real one. But it has now grown much more, opening up a gap between the total of monetary “claims” and the things for which these claims can be exchanged. There are two main reasons for this divergence – a) financial expansion has got out of control, and b) the real economy has ceased growing, almost unnoticed by those who think that money = economic output (whereas really it’s just a claim on economic output).

      So “claim value” has to be destroyed to restore the balance. This destruction is happening now – not just debt that cannot be repaid, but commitments that cannot be honoured, with vast pension fund deficits a scary example of the latter.

      This means that we’ve made promises (essentially to ourselves, in the aggregate) that can’t be kept. I was reading about a typical US pensioner whose monthly income has fallen from $3,500 to $720. This is the shape of things to come – and will, of course, have a huge depressing effect on demand as it unfolds.

      So yes, we’ve transformed a gradual deterioration (which we could probably manage) into a cliff-edge which could wreck the financial economy. That doesn’t mean it’ll wreck the real one – but in practice the damage will be extreme, and disruptive. In Britain, America, Italy, Greece and, maybe next, France, that disruption is already driving political unrest.

  5. Thank you Tim. I think I get your model. The two economies are following different curves. The real economy will follow a Gaussian curve with a gradual decline but the financial economy will follow a Seneca curve and fall off a cliff when it is forced to comes into line, eventually, with real economy.

    Being a visual learner and thinker, the picture I have in my head is of two curves super-imposed on one another. Before about the 70’s they were aligned, going up together, but since then they have diverged, the real economy still following the Guassian and the financial following the Seneca. At some point in the future they re-align.

  6. I recall reading an article, after the financial crash in 2007/8, that students studying for economic degrees at reputable universities had no success when questioning their lecturers for the real cause of the financial crash. Lecturers could not explain what had gone wrong.

    They would have got a better understanding by reading Dr Tim Morgan’s book and reading these postings.

  7. i tim thanks interesting work as usual. what is your explication of Germany? the only western with prosperity growth
    and for poland: populism and anti EU is winning despite a +12% prosperity

    • Germany is interesting. Prosperity has been solid, in sharp contrast to most other developed economies. Going forward, the outlook is essentially flat.

      Of course there are factors other than prosperity in the political mix. Also, I’m not sure that anti-establishment groups are progressing as much in Germany as they are in America, France, Italy and Britain.

      Mrs Merkel has made herself unpopular over immigration, and I suspect that people feel inhibited from discussing this for fear of being accused of racism. I suspect that the elites will struggle to support a pro-immigration stance going forward, because of stagnant real wages (which get blamed on immigrant labour) and terrorism.

  8. “Prosperity isn’t assets” Agreed. “housing stock cannot be monetized because the only people who can buy that stock are the same people who already own it.” Agreed.

    Making all of this worse is Imputed Rent being added to GDP in various countries around the world including the UK and US. The argument is that owner occupiers are consuming a service that they sell to themselves, and the value of that service and contribution to GDP goes up with house prices. You couldn’t make it up.

    Inclusion of how much home-owners would pay if they actually rented boosted UK GDP in 2014 by £158bn – a 8.9% share

    A growing proportion of GDP is nothing more than earnings from property. 12.3%  of the UK’s measured GDP in 2014 was rent and “imputed rent”…….Since 1985, rent and imputed rent have almost doubled as a share of GDP, from 6.2%.

    https://notayesmanseconomics.wordpress.com/2016/05/23/the-problem-that-is-imputed-rent-and-hence-gdp/

    • The question of imputations is examined at length in my book. The US BEA discloses imputations of various kinds, including free banking, employer health care provision etc, as well as own-occupied rent – from recollection, these account for about 15% of GDP. Britain only discloses the owner rent bit. Even so, add this to the current account net income outflow and a pretty big chunk of UK GDP doesn’t actually exist.

      This has at least two other implications. First, debt-to-GDP ratios would be bigger if imputations were left out. Second, tax would be a larger % of GDP – logical, since imputed sums cannot be taxed because they do not exist!

      For more on this, look at shadowstats.com, and look up the Boskin report – or, of course, my book.

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