The global economy is facing one of its most challenging tests today. Structural problems are obvious, everywhere we look. European States and the United States of America are dealing with serious and growing debt problems. And despite the recent debt deal in the U.S., the agreed-upon spending cuts will do very little to restore financial stability.
Not only are the agreed-upon spending cuts too little too late, the timing of these spending cuts is of concern. At a time when private households are in the process of de-leveraging and businesses are not willing to make investments, a significant cutback of government spending will significantly increase the chances of a recession in coming months. For many people in Europe and the U.S., today’s sluggish economy already feels like a recession. And when we look beyond the official statistics, economic growth is already stagnant or even negative.
After a small recovery last year, jobless rates are already on the rise and will likely climb higher in coming months. There is just not enough economic activity to create jobs, and a growing number of people have pretty much given up looking for jobs. The likely response from central banks will be more stimulus programs, but it is unlikely to change much. The coming year 2012 is a true election super year. Several major countries will hold elections; and with the global economic outlook turning increasingly negative, we could see some huge changes next year. In total, countries holding elections next year make up almost 50 percent of world gross domestic product (!!).
The stimulus packages introduced by many Western countries in the past two years have all failed to revive economic growth because most of these measures look to create liquidity and reduce the cost of borrowing by lowering interest rates. However, most of these measures can’t solve the main problems such as the huge debt dilemma.
In the past two decades, the common response of governments and central banks has been to introduce tax cuts and reduce interest rates temporarily. The problem is that all of these measures can only help to smooth smaller fluctuations in economic activity. Now, most major governments have accumulated such a huge amount of debt that they are not able to add (and finance) stimulus anymore; the market just won’t tolerate it any longer. Lower rates alone are not helping to solve structural problems; in fact, they might even make things worse and create asset bubbles.
The general uncertainty and the lack of visibility directly result in lower economic activity by depressing consumption and investment. Less consumption, lower investment spending and a reduction of government spending will likely result in a recession. This is true for the U.S. and most parts of Europe today. The fact that exports are on the rise in these economies, primarily because of the falling values of the U.S. dollar and the euro, will do very little to improve the situation.
It is possible for a country to create and sustain economic growth which is primarily driven by exports (for example, China), but neither Europe nor the United States is positioned to benefit enough from exports. So there is a growing risk that the West will yet again fall into a recession going into 2012 and the likely increase in jobless rates, the forced reduction of government spending (especially reduction in social benefits) and growing uncertainty about the future political and economic outlook have the potential to make 2012 a real turning point. I think the chances that we see rather large changes in next year’s election are significant.
With these changes it is also very likely that for the first time in a long time, we are starting to see the influence of governments being reduced. The past few decades have seen an almost never-ending increase of government spending, especially in the area of social security and welfare. I think that some of this spending had good intentions, but now it becomes increasingly hard to finance it. With the huge number of baby boomers that have recently started to retire (and many more will be following incoming years), there will be fewer and fewer young people that can finance government spending.
The growing scarcity of labor in Western countries might help to bring down unemployment somewhat, but the problem is that we are dealing with high levels of structural unemployment and it will be hard to reduce that. Structural unemployment refers to people who have either dropped out of the workforce or young people who have never really entered the workforce. Many of them have no prospects for a better life in the future, and this is adding to social tensions and has the potential to cause social conflicts. The riots seen in London last week were primarily caused by young people, many of them unemployed and without any hope that things will get better for them. This is not only the case in London, but for many major cities in the West. These riots could also take place in New York, Paris, Los Angeles, Madrid and many more.
These problems will intensify in coming years. The enormous amount of outstanding debt, the aging of Western societies and structural changes in the economy will be a huge burden for younger generations. With a growing number of people retiring and more and more people living off some kind of governmental help, it will become impossible to continue to fund the current social systems in the West. To make things even worse, many people in the West are not willing to work beyond a certain age. Just think of countries like France when most people retire between the ages of 58 and 62. But since life expectancy has increased dramatically in the past 50 years, people would need to work until the age 70, at least.
The current economic situation gives a lot of conflict potential for the coming years and will most likely result in significant changes on the political level. Governments have no other choice than to downsize and get leaner. It also means governments will be able to afford only smaller financial aid for its people. The common response in the past couple of decades has been the exact opposite. However, this was done under the assumptions of only minor changes in demographics — a huge mistake, as we know today.
What we will see in the West in the coming decade is a breakdown of the welfare state as we know it. With that will come some huge changes, both politically and economically. This will be a real stress test for every nation in the West, because the problems are very similar. These changes will not come smoothly. They will most likely create enormous tensions among societies and also create conflicts between the different generations. Too many young people are without jobs and without hope today. And many older people will be frustrated because the governments is not able to provide them with the kind of benefits they were promised. The uncertainty created by this will not be good for the economy, since people will be reluctant to spend and invest in such a climate.
So in my view, we are already in the middle of the first phase of the adjustments, and the current political fight about social welfare spending is a clear sign. But eventually, we have to face economic reality that in the long run we can afford only what we can finance. It would be the logical consequence to see strong shifts within the political landscape next year, and I think the chances for it are increasing rapidly. The year 2012 could be a real turning point for many Western countries.