#206. The paradox of growth

THE PURSUIT OF GROWTH IS THE FASTEST ROAD TO DECLINE

An odd paradox emerges when we consider our economic objectives, and question the priority routinely accorded to “growth”.

If we continue our obsession with growth, we will accelerate the deterioration of the energy-driven economy, worsen our environmental predicament and squander the resources which might otherwise have formed the basis of a sustainable economy. If, further, we continue to see the financial system as an adjunct of our pursuit of “growth”, we invite systemic collapse.

The irony here, of course, is that the pursuit of growth is, in any case, the pursuit of a chimera.

Conversely, if we aim for stability, and redesign our failing financial system accordingly, we might yet succeed in combining prosperity with sustainability.

Context – failure on two fronts

If – just for a moment – we ignore financial issues, and concentrate wholly on material metrics such as resources, the environment, population numbers, food supply and the physical output of goods and services, it soon becomes clear that we are either at, or very near, the end of “growth”, unless indeed we have already passed the point of down-turn. Essentially, the modern industrial economy is the product of the use of abundant, low-cost energy from fossil fuels. These fuels are ceasing to be cheap at the same time that their use is colliding with the limits of environmental tolerance.    

Conversely, if we focus entirely on the financial, it becomes equally clear that a system reliant on QE and other forms of monetary gimmickry is at existential risk. We can trace the origins of this process back to the 1990s, and the recognition (though not the explanation) of “secular stagnation”. The authorities’ chosen ‘fix’ for this perceived problem was to use debt to stimulate demand, on the assumption that cheap and abundant credit would prove to be a magic elixir for the restoration of growth to the economy. From there, it was a dangerously easy step from credit expansion to the back-stopping of debt (and asset markets) with monetization.

What we have, then, is (a) a material, physical or real economy that has reached or passed peak output, and (b) a counterpart financial economy which, barring a drastic change of direction, is heading towards collapse.

We’re not yet at the point where there are “no fixes” for these issues, but the odds seem stacked against the determined and effective efforts that would be required to achieve sustainability in the aftermath of growth. Might we yet be forced, kicking and screaming, into wiser decisions?

These situations are set out in fig. 1, using data sourced from the SEEDS economic model. Aggregate prosperity has continued to increase (but is nearing the point of down-turn), whilst prior growth in prosperity per capita has already gone into reverse. Both debt and the broader and much bigger category of financial assets (in effect, the liabilities of the household, corporate and government sectors) have soared, and seem destined to carry on doing so, unless and until the financial system implodes.  

Fig. 1

Two excellent, must-read recent papers have reached stark conclusions about the ‘real’ and the ‘financial’ economies. Gaya Herrington, in a report which concentrates on physical, non-financial metrics such as population numbers, natural resources and the environment, concludes that, under any BAU (“business as usual”) scenario, we face “a collapse pattern” which can only be softened (into “moderate decline”) by advances in technology far beyond historic rates of innovation and adoption. 

In Quantitative easing: how the world got hooked on magicked-up money, published by Prospect, Ann Pettifor says that “[g]oing cold turkey would finish off a dysfunctional global financial system that’s now hopelessly addicted to emergency infusions”.

Neither paper gives us no hope at all, but both point to the need for radical change. On the financial situation, Ms Pettifor concludes that “[t]he only solution is surgery on the system itself”. Ms Herrington sets out an alternative SW (“sustainable world”) scenario which, whilst it cannot restore growth, does at least offer stability.  Unfortunately, SW does not correlate well with what’s actually happening.

We can put these ‘potential positives’ into a single conclusion. The best, indeed the only way to achieve economic sustainability is to abandon all aspects of BAU that are geared towards the attainment of growth, and to shift our objectives from growth to resilience. The financial system, likewise, needs to transition way from an obsession with expansion, and aim instead for functional effectiveness in a non- or post-growth World.

In short, the precondition both for economic and for financial stability is that we ditch our obsession with “growth”. The same, of course, applies to our environmental best interests. The biggest single threat to environmental sustainability is our worship of “growth”.

Difficult, straightforward, paradoxical

Simply stated, the required transition is from a state of mind which obsesses over growth to a state of mind which prioritizes stability. 

Attaining this transition is at once difficult, straightforward and paradoxical.

It’s difficult, because the desirability of “growth” is deeply entrenched both in institutions and in the collective mind-set. Political leaders routinely promise growth, businesses strive to achieve it, and the financial system is entirely predicated on it. Advocates of voluntary “de-growth” have never managed to make meaningful inroads into this obsession with “growth”.

It’s straightforward, in the sense that growth is already over. The continued pursuit of growth is the pursuit of the unattainable. As the ECoEs (the Energy Costs of Energy) of coal, oil and gas have risen, the economic value that we derive from the use of fossil fuels has started to diminish. Assertions that we can replace all of this value using renewable sources of energy (REs) are based on little more than wishful thinking and mistaken extrapolation. Apart from anything else, RE expansion requires inputs which, at least for the present, can only be provided by the use of energy from fossil fuels.   

To be clear about this, we must make every effort to develop renewable energy supply, but we shouldn’t delude ourselves into the belief that REs can replicate the economic characteristics of fossil fuels. Well-managed, a transition to REs can contribute to stability. What REs cannot do is deliver a return to growth.       

As well as being both difficult and straightforward, the required transition is paradoxical, because the pursuit of growth is the best way to ensure economic decline. If sustainability is set as the primary objective, this aim might be achievable. But the biggest obstacle to the attainment of sustainability is our obsession with growth.

Measuring our predicament

The purpose of the SEEDS economic model is to provide holistic interpretation by putting together the ‘real’ and the ‘financial’ economies. SEEDS does this by calibrating prosperity from energy principles, and delivering results in a monetary format which enables us to benchmark the financial system.

SEEDS demonstrates a clear linkage between ECoEs and prosperity. For much of the industrial age, ECoEs trended downwards. This meant that, for so long as aggregate energy supply at least kept up with increases in population numbers, the material prosperity of the average person improved.

The fundamental change occurred when ECoEs stopped declining, and started to rise. At first, this happened only gradually. However, the upwards trend in the ECoEs of fossil fuels is an exponential one.

During the 1980s, a rise in trend all-sources ECoEs of 0.8% – from 1.8% in 1980 to 2.6% in 1990 – didn’t matter all that much, and was, in any case, well within margins of error that are accepted in economic calibration. In short, this early rise in ECoEs wasn’t large enough to force itself upon our attention.  

What happened during and after the 1990s, however, was far more serious. In the 1990s, ECoEs rose by 1.5%, from 2.6% in 1990 to 4.1% in 2000. Trend ECoEs then increased by 2.2% between 2000 and 2010, and by a further 2.6% between 2010 and 2020. This put ECoEs at 8.9% last year, compared with 1.8% back in 1980.

Since an ECoE of 8.9% still leaves surplus (ex-ECoE) energy at more than 90% of total energy supply, it might at first sight seem surprising that prior growth in per capita prosperity should already have gone into reverse.

The explanation for this sensitivity lies in the complexity, and the correspondingly high maintenance demands, of the modern economy. The vast bulk of the economic value derived from energy is required for the upkeep and renewal of systems. Even under the best of circumstances, the scope for growth is constrained by the ‘burden of maintenance’.

SEEDS analysis reveals two very strong correlations here. One of these is between ECoE and prosperity, and the other connects complexity with ECoE-sensitivity. In the advanced economies of the West, prior growth in prosperity goes into reverse at ECoEs between 3.5% and 5.0%. Less complex EM economies can carry on increasing their prosperity until ECoEs are between 8% and 10%.

The latter connection helps explain the apparent divergence between the advanced and the emerging economies over the past twenty years. As of 2000, global trend ECoE was, at 4.1%, well within the threshold at which Western prosperity starts to contract. At that level of ECoE, however, EM countries remained capable of growth. This is why, whilst people in countries like America and Britain have been getting poorer since the early 2000s – and using financial gimmickry to delude themselves to the contrary – Chinese, Indian and other EM citizens have continued to get better off.

A failure to recognize the differing effects of ECoEs on differing economies has led to a great deal of mistaken interpretation of the divergence between growth in countries like China and “stagnation” (in reality, de-growth) in the West. Westerners haven’t become uniformly lazy or complacent over the past two or three decades, any more than EM citizens have been uniformly more industrious and productive.

Rather, the greater complexity of the Western economies has resulted in their earlier exposure to the consequences of rising ECoEs. With ECoEs set to exceed 9% this year, we are well into the ‘zone of inflection’ in which EM prosperity, too, starts to decline.

An accommodation with de-growth?

In this sense, then, growth is over, and “de-growth” has begun. But there’s a world of difference between an economy getting gradually poorer and an economy careering towards a cliff-edge. If we continue our frantic pursuit of growth, the likelihood is that our options will diminish, as resources are exhausted, population numbers continue to increase, environmental and ecological deterioration accelerates and a rickety, Heath Robinson financial system reaches the point of self-destruction.

Of course, nobody would expect political leaders to stop promising growth, or businesses to stop pursuing it. No president or prime minister is likely to proclaim, like the fictional Duke of Omnium, that the country is fine how it is, and the job of government is to keep it that way. No business leader is likely to tell shareholders that corporate strategy is to turn away from expansion, and instead to maintain the company as a reliable generator of value for its owners.

But to concentrate on stated intentions is to overlook mechanisms. If the Holy Grail of “transition to renewables” fails to replace the energy value hitherto derived from fossil fuels, then it will be futile to carry on denying the reality of de-growth.

As we’ve seen in previous discussions, prosperity is declining, whilst the real cost of estimated essentials is rising. As you can see in fig. 2, it’s clear that discretionary prosperity is being compressed, and that continued increases in discretionary consumption have been made possible only by continued credit expansion.

Three processes – prosperity deterioration, the rising cost of essentials and the approach of credit exhaustion – are likely to force businesses into the adoption of policies consistent with the Surplus Energy Economics taxonomy of de-growth.

Some companies, for instance, will work out that switching from a ‘high-volume, low-margin’ to a ‘high-margin, low-volume’ model can support revenues and earnings as the discretionary prosperity of the median consumer declines. Producing less, whilst charging more for it, is one way of maintaining profitability whilst also driving down emissions of CO2.

A de-growing economy is also a de-complexifying one, and this trend is likely to encourage, or indeed to compel, businesses to simplify both their product offerings and their production processes, at the same time tightening their supply lines in pursuit of resilience. Of course, the continuing contraction of discretionary prosperity may shrink or eliminate some sectors, whilst others will be de-layered by customer pursuit of simplification.

Governments, too, will not be immune from these processes. As bridging the ‘discretionary prosperity gap’ by taking on yet more debt ceases to be feasible, the public is likely to become increasingly discontented about the increasing slice of their resources being taken by essentials, be these household necessities or the services provided by government. We should anticipate demands for intervention, particularly over the rising cost of energy.

In other words, businesses and governments might not disavow the pursuit of “growth” – it would be remarkable if they did – but trends are likely to push them in this same direction. If we’re looking for some encouragement, scant though it is, we might note that governments, in promising to “build back better”, have not promised to “build back bigger”.     

Fig. 2

#205. “Discretionary retreat, pockets of collapse”

INTERPRETING THE FUTURE ECONOMY

Anyone seeking a view about the probable shape of the economy of the future has a choice between two schools of thought. The version favoured by governments, businesses, the financial sector and orthodox economists can be labelled ‘continuity’, and amounts, essentially, to ‘growth in perpetuity’. The alternative – very much a minority view, though gaining in influence – warns of imminent economic and broader “collapse”.

It probably won’t surprise you that the evidence supports neither point of view. Properly understood, meaningful “growth” ceased a long time ago, starting in the West, and the World’s average person is now getting poorer.

This does mean that discretionary (non-essential) consumption will decrease, as a rising share of resources is required for necessities. But it doesn’t make a proven case for systemic “collapse”. This isn’t to say, of course, that collapse can be staved off indefinitely, if we keep on making the wrong decisions. 

The future scenario set out here differs from both of the ‘continuity’ and ‘collapse’ extremes, primarily because SEEDS – the Surplus Energy Economics Data System – models the economy as an energy system. The outlook projected by SEEDS modelling combines “discretionary deterioration” with “pockets of collapse”. Parts of the economy will contract, and parts of the financial system will implode, but that describes neither continuity nor a general collapse.

If you want this in the proverbial nutshell, “continuity is finished, but collapse needn’t be inevitable”.    

As so often in economic affairs, we need to be wary of extremes. For example, the collapse of the Soviet economy did demonstrate that extreme collectivism doesn’t work, but it didn’t prove that the opposite extreme – a deregulated “liberal” free-for-all – was necessarily the best way to run an economy.

The same caution applies to economic “-isms”. We can leave it to polemicists to decide whether the USSR was, or was not, a ‘communist’ or a ‘socialist’ system, but we do need to be quite clear that what we have now is not, by any stretch of the imagination, either a ‘capitalist’ or a ‘market’ economy.

A ‘capitalist’ system, after all, requires real, risk-weighted returns on capital, whilst a ‘market’ economy presupposes that losers – victims either of folly or of bad luck – are not bailed out by the state.

Extreme collectivism brought down Soviet Russia, but China escaped this fate by opting for the pragmatic course of ‘allowing capitalism to serve China without letting China serve capitalism’.

An equivalent choice needs to be made now, between following the ultra-“liberal” road to localized collapse, or adopting pragmatic alternatives which can, in short-hand, be called ‘the mixed economy’ of optimized private and public provision. This, of course, would require both effective regulation and the acceptance of a new ethic.

With hindsight (though some observers said this at the time), it would almost certainly have been better if, during the GFC (global financial crisis) of 2008-09, market forces had been allowed to run to their natural conclusions. If this had happened, we might well have benefited from the kind of “reset” which has now become an impossibility. It would have been better still, of course, if we hadn’t made the colossal mistakes which caused the GFC in the first place.

The ‘chronology of error’ merits more than the passing attention it can be given here. As regular readers will know, the economy is, self-evidently, an energy system, and today’s large and complex economy is a product of our development of the heat-engine, which gave us access to the vast (but not infinite) reserves of energy contained in coal, petroleum and natural gas. For the first time, economic activity escaped from the constraints of a cycle comprising the labour of humans and animals and the nutritional energy which made this labour possible.

Remarkably, this connection seems to have been ‘hidden in plain sight’, enabling generations of economists to contend that growth has been a property, not of energy, but of money. Extreme collectivists might argue that money should be directed by the state, and their equally extreme opponents that it should be directed entirely by markets, but neither side has seriously questioned the illogical belief that money, rather than energy, determines the performance of the economy.

When – because of depletion – the fossil fuel dynamic began to falter, decision-makers leapt to the fallacious conclusion that “secular stagnation” could be ‘fixed’ with monetary tools. Accordingly, they poured abundant credit into the system from the mid-1990s, and expressed genuine surprise when this largesse brought the banking system to the brink of collapse. The ‘fix’ for credit excess, they then decided, was monetary excess, and they will no doubt express equally genuine surprise when it transpires that this can result only in cascading defaults, the hyperinflationary destruction of the value of money, or a combination of the two. 

The outlook, quantified by the SEEDS economic model, is that the average person will become less prosperous over time. When we look behind the financial gimmickry of credit and monetary “adventurism”, this is already an established trend in the complex economies of the West. The average person in many EM (emerging market) economies, too, is already getting poorer, though a small number of Asian economies may not experience this climacteric for another five or so years.

What happens after that – when gimmickry fails, and deteriorating prosperity can no longer be disguised – is that households, and entire economies, will have to concentrate their diminishing resources on the provision of the essentials. These are hard to define, and harder still to quantify, but SEEDS modelling demonstrates that, in the Western world. the scope for discretionary (non-essential) consumption not supported by borrowing has already fallen markedly.

As well as absorbing a larger share of prosperity, “essentials” are very likely to become steadily more expensive in real terms, to the point where we may be forced to re-define what we mean by “essential”. This results from the high energy-intensity of necessities, including the supply of food and water, utilities and the provision of housing, health care and education.

An obvious implication is that energy-intensive discretionaries will be the first sectors to experience contraction, as soon as the ‘credit prop’ ceases to be tenable. The public won’t like this, of course, but will be far more concerned about the rising cost of necessities. The challenges for governments include (a) ensuring that the essentials are available and affordable for everyone, and (b) managing both expectations and the retreat of discretionary sectors.

These trends can be expected to take place within a ‘taxonomy of de-growth’ that we have discussed before. Briefly, the retreat of prosperity can be expected to involve a process of de-complexification, as we start to relinquish some of the economic and social complexity which, in the past, has developed in tandem with the expansion of prosperity.

Astute businesses will opt for simplification, both of product lines and of production processes. Part of this will be forced upon them by utilization effects (where diminishing sales volumes push unit fixed costs upwards), and by loss of critical mass (where necessary inputs cease to be available through loss of supplier viability).   

These, then, are the factors that can be expected to drive “discretionary retreat”. The contraction of discretionary sectors will, of course, involve job losses, but this will be happening in a context in which economic activity becomes more dependent on human labour and skills as the supply of high-value exogenous energy decreases.

What, though, of “pockets of collapse”? This term is used here to describe the financial consequences of an economy that is contracting, and is doing so in a way leveraged against discretionary sectors.

Hitherto, a financial system wholly predicated on growth has continued to become both larger and more complex even as the underlying economy has been moving in the opposite direction. Parts of the financial system will implode as the sectors to which they are linked enter irreversible decline.

But the big challenge for finance will come when we are forced to recognize that we can neither ‘stimulate’ our way to prosperity nor borrow (or print) our way out of a debt problem. Like the economy of goods and services, the financial system will need to be simplified back into alignment with a ‘de-growing’ economy.

The challenge now – for households, governments and businesses – is to unlearn some harmful preconceptions, and to understand, quantify and prepare for what is happening in the ‘real’ economy of energy.

Wishful thinking, petulance, gimmickry, ideological inflexibility and the placing of blind faith in the ability of technology to trump physics form no basis for effective preparation.                     

 

 

 

#204. How it happens

DISCRETIONARY DISTRESS AND THE DYNAMIC OF REALIGNMENT

Even those who continue to think of the economy as a financial system must be feeling, at the least, bafflement and concern over a situation characterised by massive stimulus, worsening monetization of debts, negative real returns on capital, and clear signs of surging inflation, certainly in asset markets, and very probably in consumer prices as well.

For those of us who understand the economy as an energy system, none of these symptoms is at all surprising. We know that the energy dynamic that has driven growth and complexity since the start of the Industrial Age is deteriorating, because of relentless rises in the ECoEs (the Energy Costs of Energy) of fossil fuels.

We also know that there’s no ‘fix’ for this situation.

From this perspective, it’s easy to see that the financial economy of money and credit is becoming ever further detached from the underlying, material or ‘real’ economy of goods and services. This divergence is intrinsically unstable, and is – as the old saying puts it – ‘unlikely to end happily’.

Two immediate questions naturally follow. First, when will this instability culminate in some kind of crisis? Second, how will this come about, and what are the processes that are likely to shape it?

Nobody can be sure about timing, but we can, at least, be reasonably clear about process. With or without a surge in inflation – and/or tumbling markets and a cascade of defaults – what’s likely to happen is that the cost of essentials will carry on rising, whilst top-line prosperity continues to erode.

Being slightly more technical about this, we can call this a squeeze on the discretionary (non-essential) sectors of the economy.       

The issue around discretionary prosperity – defined as the difference between top-line prosperity and the cost of essentials – is scoped, using the SEEDS economic model, in fig.1.     

Fig. 1

Introduction

Less than a century ago, even in the World’s most prosperous countries, most of the incomes of ‘average’ people were spent on necessities. Car ownership was a luxury, and the typical holiday was likely to be spent in a boarding-house at a seaside resort, reached by train. Indeed, domestic appliances now taken for granted only started to reach the status of normality from the 1930s.

Historians of the future might well describe the post-1945 era as ‘the Age of Discretion’, with economic growth channelled into a rapid expansion of discretionary (non-essential) consumption. One of the clearest implications of the onset of deteriorating prosperity is that the scope for discretionary consumption will now contract, a trend as yet almost wholly unanticipated by governments, businesses and households.

As we shall see, it’s difficult to draw a hard-and-fast line between the essential and the discretionary, but non-essential – ‘want, but not need’ – goods and services probably account for at least two-thirds of the economic activities of Western countries. The idea that this part of the economy might contract will come as a great surprise, and an extremely unwelcome one.

In fact, though, the continuity of discretionary consumption has already, and over an extended period, become a function of credit expansion. Borrowing, whether by households, businesses or governments, has become the ever more important prop supporting everything from travel and leisure to the purchase of non-essential goods.

The ability of the average Western person to afford discretionary consumption without recourse to borrowing ceased growing, and started to shrink, between fifteen and twenty years ago. 

Anyone trying to understand how involuntary “de-growth” is likely to unfold can best focus on two issues – the contraction of discretionary activity, and the failure of a financial system manipulated to sustain growth in discretionary consumption long after organic growth in prosperity went into reverse.

Context – the onset of “de-growth”

If you’ve been visiting this site for any length of time, you’ll know that there are two, diametrically-opposite ways in which we can endeavour to make sense of the economy.

One of these is the ‘conventional’, ‘orthodox’ or ‘classical’ school of economics, which states that the economy is wholly a monetary system, not constrained by resource limitations, and assured of ‘growth in perpetuity’ through our control of the human artefact of money.

Quite aside from its lack of logic, this interpretation is discredited by the truly extraordinary financial and intellectual gymnastics that have been required in order to try to square this comforting thesis with what we see happening around us. The “temporary” (since 2008) expedient of negative real interest rates is just the most extreme (and arguably the most harmful) of the many exercises in gimmickry that have been necessary to sustain the myth of an ever-expanding economy, shaped entirely by money.

The alternative – advocated here, and modelled using SEEDS – is to interpret the economy as an energy system. From this perspective, growth in economic output since the 1770s has been the product of huge increases in the use of low-cost fossil fuels. Now, though – and quite apart from harming the environment – these fuels are losing the ability to support the complex modern economy as they cease to be ‘low-cost’.

In this context – in which energy is the economy, with money a medium of exchange – the only meaningful definition of ‘cost’ is the proportion of accessed energy that is consumed in the access process, and hence is not available for any of the other economic uses that constitute prosperity. Known here as ECoE – the Energy Cost of Energy – this equation is the primary determinant of economic prosperity.

Driven by depletion – since the earlier benefits of geographic reach and economies of scale have reached their limits – the ECoEs of fossil fuels are rising relentlessly. Assertions that this trend can be reversed using renewable energy sources (REs) such as wind and solar power – let alone that we can somehow “de-couple” the energy economy from the use of energy – are exercises in wishful thinking.

REs are indeed vitally important for the future, but we need to recognize that they are highly unlikely to provide like-for-like – scale and economic value – replacements for oil, gas and coal.

SEEDS modelling indicates that prior growth in the prosperity of complex, high-maintenance advanced economies goes into reverse at ECoEs of between 3.5% and 5.0%, territory that was traversed by global ECoEs between 1997 (3.6%) and 2005 (5.0%). Trend ECoEs have now entered the equivalent range (between 8% and 10%) at which prosperity turns down in less-complex, lower-maintenance EM countries. The lower bound of this range was reached in 2017, and the average person in some EM economies is already getting poorer.    

The following charts, familiar to regular readers, show the correlation between trend ECoEs (in black) and prosperity per person (blue) in America, Britain and Australia. In these versions, though, discretionary prosperity has been superimposed (in purple), revealing the extent to which changes in this critical indicator are leveraged by the relatively invariable (and, in general, rising) cost of essentials.

It should be emphasised that discretionary prosperity, as calculated for these charts, makes two assumptions about essentials. The first is that we do not, going forward, tame the rate at which the cost of essentials is rising, perhaps by redefining what we think of as ‘essential’. The second is that there is no acceleration in the rate of increase in this cost.

Fig. 2

The role of discretion

In order to anticipate the probable chain of events, we need to start by looking at how we use prosperity. A critical distinction needs to be drawn between essentials and discretionaries, the latter perhaps best described as “things that people want, but don’t need”. Even this distinction involves judgement calls, in that everyone needs food, but nobody necessarily needs caviar.  

The first call on economic resources is made by essentials. These are defined here in two parts. One of these is household necessities, and the other is public services provided by the government.

The latter qualify as ’essential’, at least in the sense that the citizen has no choice (‘discretion’) about paying for them. The public service and household categories of essentials overlap, particularly where services like health care and education are provided by the government in some countries, but are purchased privately in others.               

The definition of essentials changes over time, and varies by location. Televisions, for example, were still luxuries in most Western countries in 1950, but were regarded as necessities by the 1970s. Cars made a similar transition from luxury to necessity over a not-dissimilar period.

Something regarded as essential in contemporary America might be regarded as a discretionary purchase in less affluent countries. Another example of geographical variation is state-funded health-care, which is seen as vital in most of Europe, but is still no more than an aspiration (and a matter of debate) in the United States, where Obamacare was and remains controversial, and where implementation of a worthy ambition seems to have been surprisingly ill-judged.     

Variability, both over time and between locations, makes the calculation of ‘essentials’ a complicated issue, and it might not even be possible to arrive at a universally-applicable calibration meeting both sets of requirements.

Calibrating the essential

Where SEEDS modelling is concerned, “essentials” are a development project, and the model applies formulae whose results are to be regarded as indicative, not precise. The aims are (a) to calibrate an approximate and consistent measurement, and (b) to assess changes in the cost of essentials over time.

Public services are the more straightforward of the two components of ‘essentials’. Governments spend money in two main ways. One of these is the transfer of resources between people, in the form of benefits such as welfare and pensions payments. These transfers net out to zero at the aggregate and at the average per capita levels, so are not part of essentials for our purposes.

The other part of government spending, sometimes known as ‘government consumption’ or ‘own account’ spending, is used to provide public services. Whatever the individual’s opinion about the merits of various forms of service provision, these outlays rank as ‘essentials’ for our purposes, because the citizen has no choice about paying for them. This means that they are ‘non-discretionary’ outlays.

Household ‘necessities’ are the second – and the harder-to-define – component of ‘essentials’. It’s obvious that everyone needs food, water, accommodation, health care, education, some forms of transport and, of course, energy for direct consumption. Beyond this, what we regard as ‘necessary’ varies geographically and over time.

Amongst ‘obvious’ necessities like food, water and shelter, most are very energy-intensive, such that household energy use far exceeds amounts purchased directly for heating, cooking and fuel.

Critically, the deterioration of the energy equation caused by rising ECoEs makes it probable that the real (ex-inflation) cost of household necessities will continue to rise over time.

Tracking the discretionary squeeze

The group of charts shown earlier (fig. 1) sets estimates of essentials against SEEDS calibrations of prosperity per capita for America, Britain and Australia. The common tendency is for the real cost of essentials to rise, whilst prosperity per person has been declining in America since 2000, and in both Britain and Australia since 2004.

In most cases, these declines in top-line prosperity have, thus far, been fairly modest. In America, the average person was (as of 2019) 6.6% worse off than he or she had been back in 2000. Comparing 2019 with 2004, both British and Australian citizens were poorer by about 10.5%. Spread over lengthy periods – nineteen years in America, fifteen in Australia and Britain – these rates of deterioration have been relatively gradual.

At the same time, though, the estimated cost of essentials has been on an upwards trend in all three countries. This means that, since its highest point in each country, discretionary prosperity has fallen by far more than the top-line equivalents.

In America, discretionary (ex-essentials) prosperity fell by 31% (rather than 6.6%) between 2000 and 2019. Decreases in discretionary prosperity since 2004 have been 30% (rather than 10.6%) in Australia, and 27.5% (rather than 10.5%) in the United Kingdom.  

You’ll notice that, in each of these charts, there comes a point – typically in the late 2030s – when prosperity per capita is projected to fall below the cost of essentials. This is the moment at which, at least in theory, discretionary prosperity ceases to exist at the average level. This makes it imperative that we find ways of managing the cost of essentials if we’re to ensure the well-being of the ‘average’ person.

In practice, the likelihood is that deteriorating economic conditions will change our definitions of what is “essential”, at the levels both of household necessities and of public services. It might be, for instance, that car ownership ceases to be regarded as “essential” well before 2040, and that governments will be pressured into imposing tighter priority criteria on the services that they provide.

There are two particularly disturbing aspects of the trends modelled by SEEDS and set out here.

First, per capita averages are not the same as median numbers, and even the latter might not fully reveal widespread and worsening hardship – better-off citizens may continue to enjoy discretionary prosperity long after even the essentials have ceased to be affordable (other than through ever-deepening indebtedness) for many others.

Second, there is little or no sign that these trends are gaining the necessary recognition – and may not do so until governments and others have been compelled to realize that ‘perpetual growth on a finite planet’ is a fallacy (though, if they were to look at trends now – in debt, monetization and the cost of necessities – they could be disabused of this false perception).                

‘Indications and warnings’

As we have seen, discretionary prosperity is being squeezed between deteriorating top-line prosperity and the rising real cost of essentials. At the same time, discretionary consumption has continued to increase.

This situation reflects two important linkages. The first is rising ECoEs, which are pushing up the cost of essentials at the same time as driving prosperity downwards.

The second is that the divergence between discretionary prosperity and actual consumption of non-essential goods and services links directly to the economy’s worsening dependency on credit and monetary stimulus. If this stimulus were to contract for any reason, discretionary consumption would fall very sharply indeed.      

Where stimulus is concerned, the authorities presumably realize that a balance has to be struck between full-bore, ad infinitum monetization, with its inescapable inflationary risks, and counter-inflationary monetary tightening, which would be likely to drive markets sharply lower, and trigger cascading defaults.

The point is that, whichever way this goes, discretionary consumption has to fall back towards affordable (discretionary prosperity) levels. If inflation takes off, the cost of necessities will rise more rapidly than the price of discretionaries. If, alternatively, monetary policies are tightened, this would have a leveraged, adverse effect on discretionary purchasing.

This is going to have far-reaching effects. Commercially, entire sub-sectors and large fortunes have been built on discretionary consumption supported by credit.  Financially, both the capital values and the balance sheet viabilities of large swathes of the economy would be undermined by any check to credit-funded discretionary spending by consumers.

Business planning and investment perceptions remain firmly rooted in the false paradigm of ever-growing discretionary consumption, yet SEEDS analysis reveals that this paradigm is founded on the fallacious premise of perpetual growth, a premise whose fallacy has thus far been masked by credit and monetary activism. Politically, the rising real cost of necessities can be expected to cause a switch of focus towards alleviating the hardship caused by the rising prices of essentials.

This, then, is where the denouement occurs – and, if we want to understand how events are going to unfold, we need to keep a keen eye on the nominal and the real cost of essentials, whether purchased by households or funded through taxation.