The political conference season is over, with all parties promising a better future after current austerity. But politicians, just like investors, are inveterate optimists, and few are willing to contemplate the realities of the “new normal”.
The underlying future
The Atlantic world is ageing rapidly, is over-borrowed, and tied into a level of spending which is neither affordable nor sustainable. RDR has been designed for this reality, even if unconsciously. IFAs need to interpret the investment reality of the ‘new normal’ to investors still not saving enough for a comfortable retirement and expecting double digit stock market growth to resolve their problems.
A report to the European Central Bank (ECB) a few years ago spelled out this reality very bluntly: “Europe is growing old and we have to afford it. On the basis of current projections the old-age dependency ratio is expected to more than double from around 25 per cent today to more than 50 per cent by the middle of the century. And the overall dependency ratio is expected to increase from around 50 per cent today to 80 per cent in fifty years’ time.”
The old-age dependency ratio measures the number of older people aged 65 years or above for every 100 persons of working age – those defined as aged between 15 to 64. As Chart 1 shows, this ratio is rising throughout Europe. It is important because it shows the relationship between the economically active compared to economically inactive.
The economically active pay more income tax, corporation tax and, to a lesser extent, more sales and VAT taxes; the economically inactive – those under 15 and over 65 – tend to be the beneficiaries of those taxes through government spending on education, pensions and healthcare. If today our children are complaining that they find it hard to make ends meet, why should we expect them to support us at a level higher than they themselves enjoy?
Demographic message
But the old-age dependency ratio is one of only two parts of the total dependency ratio, which is the sum of the old-age dependency ratio and the youth dependency ratio, or number of children under 14 for every 100 workers. The rising costs of youth dependency, especially in developed countries, are easily underestimated. The youth dependency ratio assumes that children over 14 can work but in practice in developed countries, only a relatively small proportion of people under 18 years of age are financially independent.
Economic growth comes from an increasing work force, as well as improved productivity so, without the political will to encourage immigration, Europe’s demographics spell slow growth and rising debt. An alternative was spelled out in a last minute addition to the Conservative conference message: no benefits for the under-25s but ‘work or learn’ instead. This is only the beginning of the necessary rethink of Europe’s social welfare system.
Back to the future
Modern economic growth is also based on mass demand – some 70 per cent of America’s GDP is made up of consumer spending, and this reflects the efforts of socially imaginative politicians, such as US President Theodore Roosevelt and the UK’s Prime Minister David Lloyd George. It was they who forced through a redistribution of income from capital and the rich, to the middle classes and the poor. The apogee of this political movement was the 1960s and 70s in Britain but, since then, the process has been in reverse.
The productivity gains of the technological revolution of the past three decades have mostly benefited the top 1 per cent of the population and, as capital has benefited, the workers share of the cake has sharply reduced. As Gavyn Davies wrote recently in the Financial Times, “After a century or more in which the profit share in GDP had fluctuated around a constant mean, the rise in the last few years has taken it above previous peaks, and the wage share has plumbed unprecedented depths.
“This has occurred because real wages in the US have grown much more slowly than output per head, which means that all of the gains from productivity growth have dropped into the hands of shareholders rather than workers.
“…In the past, market economies have tended to erode unusually high profit margins through price competition, which has restored real wages to their previous trends.
“That has always been seen as the natural order of things in a capitalist system. But there is no sign of it happening this time. It is important to recognise that similar patterns have been seen not just in the US, but also throughout the developed world, starting in the late 1970s.
This is an enormous upheaval in the distribution of income in the global economy, and it has happened in an almost continuous straight line over the entire period. It seems to have been impervious to every kind of shock.”
Effectively, we have reverted to that Edwardian world of enormous wealth disparity, against which politicians and economists battled to create general prosperity.
Future of middle class wealth
It is impossible to predict how this will affect the financial comfort to which we became accustomed since 1945, nor GDP growth, nor the behaviour of stock markets. Nevertheless, no sensible person should plan for anything but meagre GDP growth in Europe, or an end to austerity, even if solely defined as a chipping away of the welfare state as it is currently known.
The causes for the changes described above are unknown, but the declining labour share is not caused by a shift from labour-intensive to more capital-intensive industries. It is happening across all industries. Possible explanations include technological change, globalisation, the rise of financial markets, the decline of unions, and a fall in the bargaining power of labour. Globalisation has certainly played a part in reducing this bargaining power. But it is changes in information and communication technology that fed globalisation, as well as part of what led to the inordinate rise of the financial sector.
The years since 2007/8 have proved that while governments can save banks, they cannot reform them. That crisis is far from over. The most sensible analysts expect no return from bond markets – as was the case for more than a generation after the imposition of the last financial repression in 1945. But this time there will certainly not be the growth in equities that balanced the loss of wealth from bonds, nor the ability to borrow at less than nothing to buy houses.
What has also become apparent over the past year is that individual investors and IFAs have very different ideas of what financial advice should cost. For the moment IFAs can continue to charge a percentage on the assets of the investor – helped by the willingness of the platforms to accept the instructions of savers – but IFAs need to look forward to a time when assets are not increasing but decreasing.
This may happen faster than now seems likely so both sides need to come to terms on what is a sensible hourly rate; savers definitely need advice on this new investment world and IFAs need payment for their time.
And both savers and IFAs can think about the comments of an earlier governor of the Federal Reserve when he was reflecting on the disaster of the 1930s:
“A giant suction pump had by 1929-1930 drawn into a few hands an increasing portion of currently produced wealth. In consequence, as in a poker game where the chips were concentrated in fewer and fewer hands, the other fellows could stay in the game only by borrowing. When the credit ran out, the game stopped.”
This is Russell Taylor’s view on 7 October 2013. He will be happy to answer readers’ letters arising out of Investment Spotlight.
