PART ONE: BUSINESS IN A NEW ERA
Under current conditions, it’s increasingly hard to understand why the inevitability of economic contraction remains so very much a minority point of view.
Many of us have long understood why past growth in material prosperity has gone into reverse.
Here, with the SEEDS economic model, we can go still further, quantifying past trends, and charting a future in which economies get poorer, living standards are squeezed by rises in the real cost of energy-intensive essentials, and the financial system buckles under the weight of its own contradictions.
None of this has to be a disaster, but the management of involuntary economic ‘de-growth’ requires innovative strategies, most obviously in business and government.
The aim here is to concentrate on the PNFC (private non-financial corporate) sector, evaluating strategies that could mitigate the worst effects of economic contraction.
Other sectors – government, households and the financial system – may be the subject of future instalments, whilst the role of technology might merit separate discussion.
Rather, future trends will be more nuanced than a simple decline in all forms of discretionary consumption.
What emerges from this analysis is that businesses will need – and will be pressured by market forces – to front-run the process of de-complexification that will parallel contraction in the size of the material economy.
To be clear about this, we’ve reached a point at which there are no easy choices, and certainly no painless ‘fixes’.
Transition to renewable energy (RE) alternatives to fossil fuels, imperative though it is on environmental and economic grounds, isn’t going to restore the energy abundance of the past. It would be wholly irrational to expect financial stimulus to produce a supply of low-cost energy that does not exist in nature.
The idea that technology can solve all problems is one of the greatest delusions of the age.
Just as businesses now need to front-run a process of de-complexification that will accompany de-growth, there’s a corresponding requirement for governments to reset priorities, and increase efficiency as resource availability declines.
The reality of involuntary de-growth
For the purposes of this discussion, it’s going to be assumed that readers understand the inevitability of de-growth.
The fundamental principle is that prosperity is a function of the supply, value and cost of energy. The relentless rise in the ECoEs – the Energy Costs of Energy – of fossil fuels has put prior economic expansion into reverse.
Efforts to counter this material problem with financial responses have failed, in the process creating enormous risk by driving a wedge between the ‘real’ economy of goods and services and the ‘financial’ economy of money and credit.
At the same time that the prosperity of the average person is declining, the cost of essentials is rising, not least because the supply of so many necessities is energy-intensive.
Essentials make the first call on prosperity, which means that other uses of economic resources are being compressed by this process. One of these ‘other uses’ is capital investment, meaning the addition and replacement of productive capacity.
The other is the supply of discretionary (non-essential) goods and services to the consumer.
Meanwhile, and because prices are where the material and the financial intersect, rising inflation is a logical consequence of the imbalance between the ‘two economies’ of energy and money.
The authorities face unenviable choices, mainly because the costs of necessities (including energy and food) are rising within a broader inflationary context. What’s being called the “cost of living crisis” has far-reaching political implications.
Unchecked, it could open the door to ‘left-populist’ parties offering to provide subsidies (paid for by “the rich”), perhaps reinforced with promises to nationalize “fat-cat” utilities.
The lack of logic in such broad-brush proposals cannot be counted upon to reduce their popular appeal.
Letting events take their course risks undermining what consumers can afford to spend on discretionary (non-essential) goods and services, a process which can’t be guaranteed to tame inflation, but would be certain to drive unemployment higher, and induce a recession.
Much the same applies to raising interest rates from deeply negative real levels, which would have the added consequence of triggering sharp falls in the prices of stocks, bonds, property and other assets.
Nominal rates will need to be increased – though this might do little or nothing towards pushing the real cost of capital back into positive territory – and asset prices cannot be propped up indefinitely.
But monetary policy offers no “magic bullet” fix for financial instability.
In these circumstances, subsidizing the cost of living might, to decision-makers, seem the least-bad policy option. But this would send already-elevated public debt soaring, with the almost inevitable consequence of monetization by central banks.
Not for nothing has inflation been called “the hard drug of the capitalist system” – though market economies certainly have no monopoly on the debasement of the purchasing power of money.
The implications for business
Where strategies are concerned, we need to be clear about two things.
First, the rapid economic growth of an Industrial Age powered by fossil fuels was accompanied by ever-greater complexity, making it inevitable that involuntary quantitative ‘de-growth’ will be accompanied by a process of de-complexification.
Second, policy trends during a growth climacteric which began in the 1990s have added unproductive complexity to the economy.
Efforts to use monetary expansion to stem the onset of economic deceleration and contraction have boosted activity (measured as GDP) without improving the delivery of value.
Where businesses and governments are concerned, this has had the effect of adding to complexity without improving profitability, efficiency or resilience.
From a business perspective, the issues have at least the merit of clarity. Consumer prosperity is deteriorating, whilst resource constraints are the primary factor driving business costs upwards. The appropriate responses are (a) cost control and (b) the pursuit of resilience. These need to be seen as distinct but connected challenges.
There are two stand-out risks to business resilience.
The first of these is adverse utilization effects. As sales volumes shrink, the unit equivalent of fixed costs increases, and passing on these unit cost rises to customers in higher prices is likely to exacerbate the decline in volumes.
The copybook example here is a road bridge, which has high fixed expenses and low user-variable costs. If, say, fixed costs are $10m, and 2 million customers use the facility, a cost of $5.00 has to be incorporated into tariffs. If user numbers fall to 1 million, the fixed cost per user rises to $10. The consequent increase in tariffs may cause further declines in user numbers.
The second risk to resilience is loss of critical mass, where components, inputs or services either cease to be available, or their cost becomes prohibitive. When calculating fade rates for the economy of the future, these factors need to be considered in tandem.
Carried forward, simplification will reduce managerial and other overheads, and will lead to de-layering, where external service inputs are reduced, taken in-house, or eliminated altogether.
Globally, SEEDS analysis shows that prosperity increased by only 31% between 2000 and 2020, whilst the estimated cost of essentials rose by 80%.
At the aggregate level, prosperity excluding essentials (PXE) was essentially flat over that period, but PXE per capita turned downwards in 2007, since when it has declined – making people feel poorer – by 18%.
By 2030 – with top-line prosperity deteriorating, and the real cost of essentials continuing to rise – even the aggregate PXE number is likely to be 28% lower than it was in 2020.
Logically, this relentless squeeze on PXE implies that the greatest pressures will be imposed on sectors supplying discretionary goods and services to consumers.
But – and even if it were appropriate to do so here – we cannot simply list discretionary sectors ranked by their exposure to contraction or, for that matter, to the rising cost of energy and other inputs.
Any such listing would be based on the mistaken assumption that neither businesses nor governments will react to declining prosperity and the rising cost of essentials – which, of course, they will.
As we’ve seen, the likelihood is that businesses will react along the lines of the taxonomy of de-growth, shown below. Though different, more positive-sounding phraseology will no doubt be employed, the operative trends can be listed as simplification of products and processes, de-layering and cost reduction within the general theme of de-complexification.