How the West Was Lost: Fifty Years of Economic Folly and the Stark Choices Ahead

By Dambisa Moyo

This article originally appeared in Aberdeen Investment Management's "The Bulletin". Issue 25, August 2010.

International economist and writer on the macroeconomy and global affairs. She is an author and economic expert, described by Time Magazine as one of ‘the world’s 100 most influential people’.

She recently presented at Aberdeen’s Annual Investment Conference.

If one word appropriately characterises the current global economic and financial

outlook, it’s uncertainty. Fundamental asset classes are pricing contradictory market

signals, with equity markets suggesting the US economy remains well supported,

but the US 10 year bond yield hovering at historical lows of around 2.5 per cent,

signalling a renewed economic slowdown.

It is, of course, true that contradictory opinions make for a functioning market.

However, the persistence of a lack of clarity around tax, fiscal and industrial policies,

as well as banking capital requirements and regulation in developed markets,

makes for an especially challenging trading environment.

Despite this on-going uncertainty in the tactical trading environment,

structurally, there seems to be one fact that many investors can reasonably

be in broad agreement. This is that the Chinese economy is broadly on the

right track, whereas the US economy (and Western European economies as well), is broadly on the wrong track.

Indeed, a cursory analysis of the three key ingredients well-known to drive economic growth

– capital, labour and total factor productivity – underscores this very point. Take capital, for instance. As is well-

known, the US economy (and Western economies in general) continues to be

characterised by soaring debt to GDP ratios and gaping double-digit fiscal

deficits, both of which are unsustainable.

While it is true that there has been substantial repair of stretched balance

sheets across US households, financial and non-financial corporations, public

debt remains at worrying levels. IMF projections suggest US debt to GDP

ratios could reach 108 per cent of GDP by 2014: up from around 60 per cent today.

China much more nimble

The economists Carmen Reinhart and Kenneth Rogoff find that countries with a

gross public debt exceeding about 90 per cent of annual economic output tend to

grow significantly more slowly – average annual growth about two percentage

points lower – than countries with public debt of less than 30 per cent of GDP, thus

not boding well for the US economy.

China’s public balance sheet, in contrast, has a debt-to GDP ratio around 9 per cent,

and an uncharacteristically low deficit to GDP ratio (around -0.4 per cent) given her

relatively early stage of economic growth.

There is also the fact that in terms of foreign exchange reserves, China’s stand

at nearly US$3 trillion, versus America’s at US$135 billion. However, to focus

only on these pooled headline figures masks an important, though more subtle

point on capital. That America’s stock of cash assets is, to her disadvantage, much

more diffused amongst corporations and a broad array of money managers

(hedge funds, pension funds etc), whereas China’s reserves is much more

concentrated (in Sovereign Wealth funds and state-owned corporations).

This structure of pooled capital undoubtedly makes China much

more nimble, but places the US on the back-foot in times of widespread

economic crisis or when there is a need to tackle strategic decisions (such

as global Commodity purchases).

Then there is Labour, around which there are 3 key issues: First, is the

imminent well-known cost burden around pension provision and healthcare needs,

both which have placed significant cost pressures on corporations, and corporate

business strategy in the US. Estimates suggest a 252 per cent rise in the number

of people who are 65 years old or older in the industrialised West that between

2010 and 2050. This will be accompanied by a concomitant 164 per cent increase

in people with diabetes in the West.

Data on Alzheimer’s disease, similarly offer sobering statistics. The number of

Americans age 65 and older who have or will have Alzheimer’s disease is projected

to increase from 5.1 million in 2010 to 13.5 million in 2050. Over the same

period, the costs for care of people with Alzheimer’s is expected to soar to over

US$1 trillion. There is, perhaps, no surprise, therefore, that a McKinsey report portends

that by 2065 the US health costs will represent 100 per cent of the country’s

GDP. Meanwhile such a debilitating defined benefit pension system and healthcare

structure does not exist in China. Second, the West continues to grapple

with an increasingly unfavourable demographic profile which places an

increased burden on the economically productive part of the population versus

the economically dependent. Already, in the US almost 20 per cent (1 in 5 Americans is

considered aged), as compared to China where the ratio is just 1 in 10.

Third, labour dynamics are being adversely impacted by poor and slipping education

standards in the US; particularly as she aims to become less of a manufacturing

powerhouse and more dependent on the R&D and service sectors.

Decline in college graduation

Setting aside quality issues for a moment, the number of Americans (and

across much of Europe for that matter) graduating from college is declining. In

just one generation the US has fallen from first place to 12th place in college

graduation rates for young adults; the science and engineering and technology

sectors being particularly hit hard.

Indeed, international comparison studies, such as the Programme for

International Student Assessment, or Trends in International Mathematics and Science

Study (TIMSS), point to a rapidly declining performance in key subjects (mathematics,

science, reading and writing etc) across the developed West as opposed to the

new economic upstarts (China, India etc).

Finally, macroeconomists believe that economic growth is in large part driven

by total factor productivity (TFP). In fact, growth theorists and empiricists purport

that TFP explains as much as 60 per cent of why one country grows versus another.

US on wrong economic track

In the last decade US productivity has improved, yet over roughly the same

period, China has posted the world’s fastest productivity gains on record.

Although the US undoubtedly remains amongst the global leaders in technological

development, which drives efficiency and productivity in both labour and capital

utilisation, the worrying emerging trend is around increasing investment in productivity

gains where benefits accrue to a relatively small segment of the population, very often

with no direct or broader societal benefits.

For example, billions of dollars are now directed towards substantial investment in

technological areas, such as high efficiency trading (with ostensibly narrow economic

benefits), in lieu say of investment in important sectors such as energy

efficiency, food security, or healthcare.

Inasmuch as the quality and quantity of these 3 elements – Capital, Labour, and

Total Factor Productivity – drive economic growth, it is clear that China seems poised

to capitalised on these factors, whereas their misallocation is hurting the US.

If the prognosis that China is on the right economic path, whereas the US is

on the wrong economic track is broadly correct, the question becomes, what can

policy makers do about it? There seem to be two fundamental choices for the US.

The US can remain relatively open to the international economy – where US

barriers to trade and the movement of capital are kept to a minimum. The other

choice is for the US to become more closed to the world, by adopting more

protectionist policies – giving her the time and space to redress the pervasive

structural issues outlined previously.

Sizeable investment

For now, the US is, quite clearly, focused on fixing her economic

problems in the context of current global framework and remaining

largely open to the global economy.

Over the past two years, the Obama administration has pledged sizeable

investment and policy support in critical areas. The Science and Technology

bill earmark 3 per cent of US GDP to education, the American Recovery and

Reinvestment Act of 2009 assigns more than US$45bn towards transportation

and infrastructure spend, doubling the federal budget for this purpose. And in

his 2010 Carnegie Mellon Speech after the BP oil spill in the Gulf of Mexico),

President Obama outlined new US policy efforts aimed at encouraging investments

that would help move the US away from fossil fuel energy dependency,

towards energy alternatives such as clean energy and even nuclear energy.

While laudable on paper, the problem with this strategy as a panacea to remedy

America’s economic ills is two-fold.

First, given the scale and depth of America’s problems, the strategy as

outlined thus far, is too narrow and small, thereby making in inadequate. In order

to be transformational the approach needs to be necessarily big and bold,

and certainly much more aggressive. This should include a hard-look and

a serious revaluation by the US of its role as virtually the sole underwriter of

global public goods (such as policing the sea lanes, international security etc).

Second, the plan to address America’s economic ills while remaining open, also

crucially relies on the rest of the world playing fair. The recent spat around

global competitive devaluations is a stark reminder that issues of economic policy

fairness (such as currency manipulation) fall outside the bailiwick of US policymakers.

Dambisa Moyo is the author of How the West Was Lost: Fifty Years of Economic

Folly and the Stark Choices Ahead, published in January 2011. If you would like

to purchase a discounted copy of the book,

email [email protected]