Category: Economics

HIDDEN BUSINESS MODELS

In business, things are not always as they seem. Take the ubiquitous McDonald’s – it’s synonymous with burgers and fries, yet it’s actually a real estate company disguised as a fast-food restaurant. Profits from menu sales at the golden arches are overshadowed by the significant bottom-line contribution the global chain receives in rental income from its franchisees.

While customers have been chomping on Big Macs, the brand has been sinking its teeth in to prime land. Globally, 93 per cent of McDonald’s 38,000 stores are operated by franchisees, but the burger titan owns the land and buildings beneath its franchised locations. This is McDonald’s real secret sauce – leveraging fast-food to lease properties to restaurant owners at large markups.

Being able to collect rents as the landlord to its franchisees insulates the McDonald’s Corporation from the ups and downs of the business of flipping burgers. When you break down the company’s multi-billion-dollar earnings, it boils down to real estate. Profit margins on food sales are slim, whereas the return on McDonald’s $38 billion commercial investment portfolio is lucrative.

McDonald’s controls one of the biggest property portfolios in the world. From Times Square in New York to Red Square in Moscow, McDonald’s owns thousands of iconic pieces of real estate around the globe. Each franchisee pays rent in addition to royalties on food sales and this enables McDonald’s to maintain inexpensive menu prices.

McDonald’s 2020 financial report confirms that rent contributes more to the company’s profitability than royalties. Out of the $10.7 billion McDonald’s collected in fees from restaurants in 2020, $6.9 billion came from rent and $3.8 billion was generated from royalty payments. Profit from franchise-operated stores stood at $8.5 billion (as it cost McDonald’s only $2.2 million to run these outlets) whereas company-owned stores recorded a profit of only $1.15 billion (as they are dearer to run).

Another company that makes billions from a seemingly non-core activity is Amazon. When you peel back the layers at the world’s largest online retailer, you discover that Amazon is a major provider of cloud computing services via its subsidiary, Amazon Web Services (AWS). AWS controls around a third of the global cloud market – substantially more than its nearest rival, Microsoft.

Amazon’s business is divided into three segments: North America, International, and AWS. AWS is Amazon’s largest source of operating profits and is growing at a robust pace. The commercially rewarding cloud computing arm supplies over 63 per cent of Amazon’s profits, making it an extremely important part of the Amazon empire.

AWS provides data storage and processing for companies that don’t want the headaches of running their own IT infrastructure. AWS has been very successful in selling its technology services and, as a consequence, has become a cash cow for its parent, Amazon. According to an article in The New York Times, AWS is ubiquitous online.

If you watch Netflix, that’s A.W.S. If you have a meeting on Zoom, there’s a good chance that’s A.W.S., too. If you check Pinterest, that’s A.W.S. If you spend any time scrolling through Twitter, well, A.W.S. provides “global cloud infrastructure to deliver Twitter timelines.” These examples are just a few of the thousands of A.W.S. customers big and small (including The New York Times).

AWS was launched in 2006 with little fanfare as a side business for Amazon and has since morphed into a highly successful enterprise in its own right. Before it was AWS, it was just Amazon’s backend technology. Amazon developed expertise in building state-of-the-art technology infrastructure for itself and ultimately decided to rent those services to other businesses.

Today, AWS provides a low-cost infrastructure platform in the cloud, which is highly reliable and scalable and powers hundreds of thousands of businesses in 190 countries around the world. While Amazon has helped revolutionise the way people shop, AWS has disrupted the technology industry by making computing services accessible through the web.

Like McDonald’s and Amazon, Google is another behemoth that, at first appearance, deceives many. While it has always portrayed itself as a tech company, its main business line is online advertising. Even so, most people understandably believe that Google is a web search engine which provides free access to searches, Gmail, Google maps, and other online tools.

Of course, all of these complimentary services must somehow be paid for and that’s where advertising enters the equation. The bulk of Google’s multi-billion-dollar revenue is generated from its proprietary advertising service, Google Ads. Google makes money by selling ad space with its search results – and it processes a staggering amount of search requests.

Roughly half of the world’s population, or 3.8 billion people, use the Internet every day. Most users rely on Google to carry out their daily searches, making Google the most visited website in the world. It is estimated that in 2021, 5.5 billion searches were undertaken per day using Google – this equates to a mind-boggling 63,600 searches every second.

Each search provides an opportunity for Google to display ads and make money. You see those ads each time you search on Google – they are displayed alongside the search results. The ads are paid for by advertisers on a pay-per-click (PPC) basis. If you do not click on a link, Google does not make any money directly from your search.

Advertisers submit ads to Google which include a list of keywords relating to a product, service, or business. The price for a particular keyword or keywords depends upon the competition among advertisers for that/those word/s. Google uses an auction system, so the company which outbids other competitors wins the right to use the relevant word/s.

Google could not attract advertisers without readers – and it needs lots of them. The more readers it attracts, the more interest that is generated from advertisers. Google lures in users, collects their data, and then sells access to eager advertisers across the planet. The more Google knows about an individual, the better it can target ads, and the more it can charge for ad space.

Demand for Google’s services surged in 2021 as the pandemic forced people to spend more time online. This was a financial bonanza for Google and its parent company, Alphabet. By the numbers, Google is an ad company, and it is getting bigger all the time.

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The outstanding success of McDonald’s, Amazon, and Google is testament to what corporate strategists have long known – businesses should focus on what they do best. Corporations that concentrate on a few core businesses, based on their core competencies, invariably do better than those that try to be all things to all people.

History shows that when most companies diversify in to new markets, their profitability is diluted, and acquisitions are subsequently unwound. They quickly discover that they do not have the experience and capabilities needed to expand beyond their core business. So, the challenge is to find “business adjacencies” in adjacent markets.

Adjacency is about identifying new markets that intersect with what a business already does. It is a strategy where a business leverages something they are good at to develop a new product or service in a related market. No technology company exemplifies adjacent innovation better than Amazon. As one technology strategist noted in an online article:

While Amazon.com was becoming a retail juggernaut, Amazon’s technical teams were optimising internal cloud operations and building a world-class technology infrastructure to serve their own retail business. In 2006 Amazon launched Amazon Web Services (AWS) – yet another adjacent business – for cloud-computing services that has evolved into an enormously profitable product on its own.

It’s been said that Google’s core competency is matchmaking – pairing Internet surfers with advertisers and taking a cut along the way. As the digital world continues to evolve, Google has taken a multi-pronged approach to maintaining its dominance in the search and ad business. Search continues to migrate across mediums with users increasingly moving from desktop to mobile devices. As outlined in a research report:

To maintain its foothold and protect its main source of revenue, Alphabet (Google’s parent company) is positioning itself to dominate adjacent sectors – such as digital commerce, branded hardware products, and content – and attempting to integrate its services into every aspect of the digital user experience.

McDonald’s also utilised an adjacent innovation strategy with the introduction of the McCafé in 1996. This enabled the chain to move beyond burgers into premium coffee – competing directly with Starbucks. McCafé coffee outlets act as an adjacent or related product to McDonald’s main menu. McCafé is based on the company’s core competency of standardisation – every coffee has precisely the same taste and texture.

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McDonald’s, Amazon, and Google prove that masquerading as one thing but doing another can be very profitable. All three have followed the same broad playbook to gain market share and cultivate a world-beating brand. Their hidden business models are profit machines which have made them juggernauts.

It pays not to be a one-trick pony.

Regards

Paul J. Thomas
Chief Executive Officer
Ductus Consulting

MEASURE WHAT MATTERS

It’s a deceptively simple number which captures headlines, makes or breaks governments, and dominates public discourse. Gross domestic product (or GDP) is used to measure the size and health of a nation’s economy and the prosperity of its citizens. Each country’s economic performance is ranked and judged using this common top-line metric.

GDP measures the economic activities of individuals (personal consumption), businesses (private investment), and governments (public outlays). It also factors in the difference between the value of a nation’s exports and imports. GDP became the prime economic indicator during the Second World War to monitor war production and measure a country’s economic progress.

Workers and businesses are generally better off when an economy is expanding as growth drives profits, jobs, and wages. Still, money isn’t everything which is why an increasing number of economists and politicians believe that GDP is a poor gauge of societal well-being. As a macroeconomic index, GDP has limitations and many are pointing out its deficiencies.

That GDP is not a perfect metric has been known for decades. It’s a measure of raw economic activity, not a complete picture of human progress. As Senator Robert Kennedy famously articulated in a 1968 election speech, GDP fails to capture a lot of what actually goes on in life.

… the gross national product does not allow for the health of our children, the quality of their education or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country. It measures everything in short, except that which makes life worthwhile.

GDP is the market value of goods and services produced in a year in a nation – its domestic production. GDP is derived by counting up the dollar value of all new goods and services produced, and includes things such as smart phones, cars, taxi rides, haircuts, music downloads, computers, steel, apples, university education, and cups of coffee.

Most goods and services are produced for sale, so the money spent by individuals, businesses, and governments buying these outputs is used to measure production. GDP only recognises goods and services that pass through official markets. Therefore, production that is not bought or sold does not get counted as GDP works by measuring market price.

So, volunteer work or domestic work – like caring for an aged relative or knitting a jumper – does not get counted in GDP as it is “unpaid production”. Yet most would agree that family caretaking is of enormous value to society and should be included in GDP calculations. (To be clear, if a family hires someone for childcare, that counts in GDP accounting.)

The GDP framework also takes no account of leisure time. Two countries might have equal GDP but one has workers toiling for 12-hours per day while the other only eight hours. Likewise, GDP is not adjusted for pollution costs. If two economies have the same GDP per capita, but one has polluted the air, the well-being of citizens is different, but that’s not captured by GDP per capita.

Another metric not included in GDP is the state of the environment. Economic growth is largely fuelled by consumerism and the rampant rise in household spending is depleting the Earth’s natural resources. Scientists warn that perpetual growth on a finite planet is not sustainable and is causing environmental calamities such as climate change.

A further criticism of the embattled GDP is its failure to reflect inequality as it doesn’t measure the distribution of growth. Income and wealth disparities in society have grown exponentially and extreme inequality is evident in many nations. The rich are getting richer and this skewing of wealth has created universal inequities in accessing education, health care, and finance.

The shallowness of GDP thinking is further evident in the way it counts catastrophes and natural disasters as economic bonuses. When assessing a tragedy such as a bushfire, GDP treats the rebuilding of homes destroyed as a positive economic impact. Yet, it does not capture the negative social consequences on regional tourism or the trauma suffered by townspeople.

Most glaringly, GDP is unable to account for the full impact of technology on our lives. Most of us could not get through the day without utilising digital media. But as GDP assigns a zero value to goods with a zero price, complimentary services like Google searches, Facebook posts, and app downloads go largely uncounted in official measures of economic activity. Similarly, the vast amount of knowledge that Wikipedia provides free of charge is worth zilch in GDP terms.

It’s clear that GDP does not incorporate many of the negative effects of economic growth and misses the main pillars of a progressive society. Certainly, it does not reflect the quality of life or happiness in any given country which is why there is a concerted effort to find alternatives to measure the wealth and welfare of nations.

A CBS News article, quoting The New York Times’ journalist, Catherine Rampell, provides a precis of some of the possible replacements for GDP including:

… China’s “green GDP”, which attempts to adjust for environmental factors; the OECD’s “GDP alternatives”, which adjust for leisure; the “Index of Sustainable Economic Welfare”, which accounts for both pollution costs and the distribution of income; and the “Genuine Progress Indicator”, which “adjusts for factors such as income distribution, adds factors such as the value of household and volunteer work, and subtracts factors such as the costs of crime and pollution”. Finally, there are more direct measures of well-being such as the Happy Planet Index, Gross National Happiness and National Well-Being Accounts.

Half a century on from Senator Kennedy, the world is still obsessed with increasing GDP at almost any cost. Indeed, our economies have become structurally dependent on growth. Governments pursue economic expansion as a primary goal, with rising GDP providing ever more taxes. From GDP’s perspective, bigger is always better – but not according to an article in the Oxford Business Review which states:

GDP is no longer an appropriate goal by which to measure economic and societal success …. It is paramount that something must replace the goal of infinite GDP growth. After all, growth for the sake of growth is the ideology of a cancer cell.

Growth as a metaphor for prosperity is deeply imbedded in our language – we like to see our children grow and gardens too. Growth equates to progress, even though too much can be cancerous. At a UN climate-change summit in 2019, Swedish environmental activist, Greta Thunberg, declared: “We are in the beginning of a mass extinction, and all you can talk about is money and fairy tales of eternal economic growth”.

I reject the notion that growth is always synonymous with improved well-being and therefore accept that the current fixation on perpetual economic growth is not sustainable. But that does not mean that I embrace the other extreme – promulgated by the “degrowth moment” – which calls for advanced countries to adopt zero or even negative GDP growth.

As sometimes happens, I find myself in the middle of an important debate – on this occasion between economists and environmentalists. To be clear, I believe that the economy should not be forced to stop growing or even shrink. Nonetheless, it should be required to adopt more environmentally friendly practices and aim for a slower growth rate.

As I outlined in a previous post, which explained the benefits of sustainable capitalism, we all have a vital role to play as consumers because:

If we don’t like what a company is doing, we can stop buying their products and services and force them to change. Consumers drive markets and sustainable consumer choices can change corporate behaviour. But we all need to take a stand and, for many of us, this will require a lifestyle overhaul, particularly with regard to saying “no” to unnecessary and/or environmentally unfriendly household items.

While I believe that the world-renowned abbreviation, GDP, remains a valuable tool for economic discussions, it does not tell the real story of human well-being. There is more to life than buying and consuming stuff which is why economic and other data would be better presented with a dashboard of broader indicators rather than a single GDP number.

We can have our cake and eat it if we are prepared to change our ways.

Regards

Paul J. Thomas
Chief Executive Officer
Ductus Consulting

RISE OF DIGITAL OWNERSHIP

Collectors have long been willing to shell out huge sums of money on unique items such as fine art, classic cars, and antique books. Collectables are tangible assets which can be hung on a wall, stored in a garage, or displayed in a cabinet. Historically, the buying and selling of rare and desirable items has occurred at auction houses. Regardless, a new trend is emerging which enables investors to buy intangible, digital assets online.

Collectable items have moved into the virtual world using trendy new technology called non-fungible tokens (NFTs). An NFT (also called a crypto-collectable) is a one-of-a-kind asset which can be bought and sold like any piece of property even though it has no physical form of its own. Almost anything can be minted as an NFT including digital art, music videos, film clips, video games, luxury goods, and sports collectables such as football cards.

NFTs are changing how musicians and artists can earn a living. NFTs offer a way for “creators” of music and art to monetize their work via the sale of a token and get a slice (in the form of a royalty) of any resale value in the secondary market. Each token is unique, can’t be duplicated, and is basically a certificate of authenticity. While other people might have a copy of the artefact that you have purchased as an NFT, they don’t own the original item.

Think of Leonardo da Vinci’s painting, the Mona Lisa. It is the most famous portrait in the world and there are hundreds of thousands of reproductions of this masterpiece – but only one original. The same principle applies to NFTs – you can copy and paste an image, though only the original – digitally signed by the artist – holds value. Buying an NFT is like buying the original Mona Lisa, but instead of receiving an oil painting on wood, you get a JPG file.

Some people compare owning a crypto token to buying an autographed print. Each token contains computerised code that verifies it is the only asset with its specific digital identity. The tokens, as asset identifiers, are considered to be non-fungible since their uniqueness makes them irreplaceable and impossible to swap. As non-fungible tokens cannot be replicated, they are incapable of mutual substitution. An example will help here.

You and a friend are travelling together on a plane and have been issued with boarding passes. If the information on each pass was identical, they would be considered fungible – i.e., capable of being swapped for one another. However, each boarding pass contains unique information such as passenger name, seat number, and airline membership details. Consequently, they cannot be randomly exchanged with anyone else thereby making them non-fungible.

In contrast, a fungible asset is something that can be readily interchanged – like money. If I lend you $20, it doesn’t matter whether you pay me back with a different $20 banknote from the one that I gave you – any $20 bill will do. Equally, you can repay me with two $10 bills since the total equals $20. Items are considered fungible if exchanging them is meaningless, such as two people swapping $5 notes with each other.

Details of (non-fungible) digital tokens are recorded on an encrypted and publicly accessible ledger called a blockchain. Blockchain is the software architecture that underpins Bitcoin and other cryptocurrencies. Blockchain ledgers are not stored in one place but are distributed over thousands of computers around the world. These replicated ledgers are spread geographically across multiple sites, countries, and institutions.

Blockchains work by using a network of computers to create a shared digital ledger that no one computer can change. All computers must approve a transaction that has taken place before it is recorded in a “chain” of computer code. Every transaction is cryptographically chained to the previous transaction making blockchains perfect for creating unique digital identifiers which can be easily and securely exchanged — hence the creation of NFTs.

The idea of registering digital assets as NFTs on a blockchain began with CryptoPunks in June 2017. CryptoPunks are a set of unique collectable characters (10,000 to be precise) of randomly generated pixel-based avatars. However, NFTs did not come to prominence until October 2017 with the release of the blockchain based CryptoKitties game which enables players to buy and “breed” limited-edition virtual cats.

This past August, the global card payments processor, Visa, bought a CryptoPunk for nearly $150,000. Visa’s CryptoPunk is a pixelated digital image of a woman with a mohawk (see image below). Commenting on the purchase, Visa’s Head of Fintech, Terry Angelos, said: “We see an emerging new category of commerce that we’re calling NFT commerce”.

Cuy Sheffield, Head of Crypto at Visa, believes that NFTs will play an important role in the future of retail, social media, entertainment, and commerce. “To help our clients and partners participate, we need a first-hand understanding of the infrastructure requirements for a global brand to purchase, store, and leverage an NFT.”

Sheffield remarked that CryptoPunks have become a “cultural icon for the crypto community” and that Visa’s CryptoPunk purchase signalled that the company was “jumping in feet first”. He added: “This is just the beginning of our work in this space”.

According to online financial magazine, Barron’s, Bitcoin was predicted to take middlemen, like Visa, out of commerce entirely by allowing people to transact directly over the Internet, but that has not come to pass. That leaves an opening for incumbent players to maintain their importance. To quote Barron’s:

Visa sees an opportunity to be the rails for the new digital economy just as it has been the rails for the current one. It’s already connected to consumers and businesses, so people don’t need to use a completely new system. Visa’s interface with the public can be similar whether they pay through cryptocurrencies or dollars. The company already has helped crypto exchanges issue credit cards and other products.

Other companies to jump on the NFT bandwagon include Pizza Hut (pixelated pizza), Pringles (CryptoCrisp, the chips you can’t eat), Nike (Cryptokicks, limited edition sneakers), Vodaphone (augmented reality game), and McDonald’s (pixelated Big Mac). These brands have seized on NFTs as a way to engage with their audiences and promote their products. All want a seat at the NFT table because the crypto economy is expected to evolve rapidly.

Recently, the Australian Federal Government, along with the Reserve Bank of Australia, leading companies, and universities set up the Digital Finance Co-operative Research Centre (CRC). The CRC will undertake a decade-long research program examining the digitisation of real-world assets. The projected growth in this market is staggering, with tokenised assets expected to grow from almost nothing today to $US24 trillion ($A32 trillion) by 2027.

The government believes that the CRC’s work could add billions of dollars to Australia’s gross domestic product each year. The aim of the project is to unlock new assets and make them efficient to trade*. As reported in the Australian Financial Review, the CRC’s CEO predicts that the creation of digital versions of real-world assets “will have a profound impact on the rate of achievable economic growth and pave the way for new types of investable assets”.

As the craze of cryptocurrencies gains momentum, NFTs are emerging as a new investment option. New age collectors and investors are paying thousands and even millions of dollars to own digital collectables. Still, is this a bubble waiting to burst? Are NFTs highly speculative bets or do they offer value for money? The bottom line is that the NFT market is too immature to judge its long-term worth as an investment option.

So, it’s a case of buyer beware because the NFT market’s recent stratospheric rise is no guarantee of future returns. The harsh reality is that while some early investors have achieved insane windfalls, others will fork out inflated amounts for digital assets that may wind up being worthless. Another point to note is that the underlying technology is complicated for a layperson to understand, let alone use on their own.

Right now, NFTs are in the midst of a hype-cycle and trending upwards. Still, there is no assurance that demand for digital assets will continue at current levels. As with any new disruptive technology, there are pros and cons. So, take care to closely examine what could go wrong – the dark side of investing in NFTs is real, particularly as the value of art and other collectables is fundamentally subjective.

When it comes to NFTs, value (like beauty) lies in the eye of the beholder.

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*To be clear, the work of the CRC is not focussed on digital assets like virtual cats. Rather, its mandate is to ensure that Australia is in a position to exploit the coming universal digitalisation of all real-world assets (such as gold, real estate, fine art, and carbon credits) so they can be traded and exchanged directly and in real-time between any individual or organisation.

Regards

Paul J. Thomas
Chief Executive Officer
Ductus Consulting

DEFENDING CAPITALISM

It’s been called the greatest engine of material prosperity in human history. It’s lifted people out of poverty, raised living standards, funded research to cure diseases, given us better nutrition, driven mind-blowing innovations, revolutionised the way we live and work and provided us with access to goods from around the world.

Capitalism has done all these things and more, which is why I believe it’s a force for good. Capitalism has made the world a better place by alleviating human suffering. Today, we enjoy lives that are longer, healthier, and better. This is largely because of advances in science, medicine, agriculture, and technology. These advances have been driven by the foundation stone of a capitalist economy – private enterprise.

Central to a global capitalist system is international trade and this, according to the capitalist peace theory, offers a path to world peace. Free trade is built on voluntary interactions of buying and selling and this encourages nations to live in harmony. Free trade raises the cost of war by making nations more economically interdependent. The more that people rely on trade with others, the greater the cost to all parties of a conflict.

The essence of capitalism is economic freedom. Individuals and businesses are free, within the bounds of the law, to engage in commerce at their will and peril. The father of modern economics, Adam Smith, asserted that economic behaviour is driven by self-interest. The Global Financial Crisis (GFC) painfully revealed that the pursuit of self-interest does not always lead to outcomes that benefit society overall.

So yes, capitalism is not perfect, but that’s because human behaviour is not perfect. Economic theory is premised on the assumption that humans make rational choices. However, the GFC showed that we don’t always weigh facts objectively when making financial decisions. As to the ill-conceived subprime lending programs, borrowers, bankers, and brokers were united in the delusional belief that house prices never go south.

Another criticism of capitalism is that it leads to inequalities of wealth and income. Again, this is absolutely true and it’s an undeniable fact that the rich are getting richer. But the poor are not poor because the rich are rich – the two conditions are generally unrelated. The rich did not steal their wealth from the poor. While some do inherit their fortune, most people work very hard to make their money – it has little to do with luck.

No two people are exactly the same – and I say that as an identical twin! You have only to look around you to see that we are not equal in height, weight, looks, intelligence, or on a multitude of other dimensions. Everyone has a unique set of abilities which helps them achieve success. As pointed out by one writer:

Our inherent human inequality should not lead you to despair. On the contrary, imagine how dull life would be if things were otherwise. The fact that I am not equal to LeBron James is a good thing, and so is the fact that LeBron James is not equal to Albert Einstein and that Albert Einstein is not equal to Katharine Hepburn, inequalities are diversity, and diversity is the spice of life.

People will never be wholly equal. Still, those who advocate economic equality would view LeBron James’ basketball superiority as unfair. They would call for James to be handicapped in some way, perhaps by forcing him to give less skilled opponents credit for some of the baskets he scores. Of course, this would do nothing to improve the performance of his opponents nor provide them with any incentive to lift their game.

That’s why taxing the rich more is not the solution to inequality. Around the world, higher income workers already pay the overwhelming majority of taxes. In the words of Abraham Lincoln, “You can’t make the poor rich by making the rich poorer”. To paraphrase Warren Buffett, we all live far better lives because of Henry Ford, Steve Jobs, Bill Gates, and the founders of Google. These brave entrepreneurs helped expand the global economy and this assists the poor as much as the rich.

An open-market, capitalist economy is not designed to deliver equal economic status for everyone. People receive varying financial rewards for the jobs they do and the contribution they make to society. While excessive greed benefits no one, trying to make all of us financially equal is a recipe for disaster. Capitalism rewards productive achievement and provides the necessary incentive for entrepreneurs to take risks and innovate and this benefits society overall.

Even if we somehow managed to redistribute wealth so that every adult in Australia had exactly the same amount of money, it would be fleeting. The smart, the strong, and the devious would quickly acquire the wealth of the slow, the weak, and the gullible. Moreover, people would use their money in different ways. The prudent would save and invest their money while the irresponsible would squander it.

Given our differing attitudes to money, the equal distribution of wealth is clearly an unattainable goal. Even so, I believe that the widening gulf between workers and executives has become excessive. I find it hard to accept that any one individual is worth an annual salary of, say, $10 million. Equally, I don’t believe that sports stars and Rock ‘n’ Roll artists are worth the millions that they are paid.

Nonetheless, I accept that in a free-market economy based on supply and demand, captains of industry, the sporting elite and entertainment celebrities can command multi-million-dollar incomes. While excessive greed benefits no one, trying to make us financially equal is a recipe for disaster. As Winston Churchill observed:

The inherent vice of capitalism is the unequal sharing of blessings; the inherent virtue of socialism is the equal sharing of miseries.

The world has seen a number of socio-economic systems including slavery, feudalism, socialism, communism, and capitalism. For all of its imperfections, it’s my contention that capitalism, like democracy, is better than the alternatives. This is certainly the view of economist, Ha-Joon Chang, who is a reader in economics at the University of Cambridge and the author of 15 books.

In his international bestseller, 23 Things They Don’t Tell You About Capitalism, Chang identifies some of the pitfalls of capitalism. In highlighting these shortcomings, Chang is careful to point out that his book is not an anti-capitalist manifesto. “Despite its problems and limitations, I believe that capitalism is still the best economic system that humanity has invented”, he underscores.

Notwithstanding his tough assault on capitalism, Chang acknowledges that there’s no real alternative to free-market capitalism describing it as “the worst economic system except for all the others”. He says that “being critical of free-market ideology is not the same as being against capitalism”. Rather, his aim is to tell “some essential truths about capitalism”.

I am the first to acknowledge that capitalism has failed to cover itself in glory over the past couple of decades and that public opinion has turned against it. Capitalism is not without its faults because economics is an imperfect social science. Still, humanity as a whole (as I outlined in my previous post) is doing better than it ever has thanks to capitalism. While we still have problems to solve, they are less severe than at any time in history.

As for those nations suffering severe poverty, they must be helped and encouraged to adopt capitalism. The uneven distribution of wealth in the world is due to the uneven distribution of capitalism. Swedish writer, Johan Norberg, makes this very point in his book, In Defense of Global Capitalism, wherein he states:

The poor countries that have liberalized their economies have shown impressive results, while those that have not are stuck in deep misery. Therefore, we need more capitalism and globalisation if we want a better world, not less.

Capitalism offers a practical way to nourish the hungry. Handouts are not the solution to poverty in places like Africa. As Bill Clinton explained: “No country can work itself out of poverty with aid alone”. Training and assistance must be provided to Africa’s private sector to help them drive economic growth and make Africa self-sufficient. Capitalism can do this and more.

Capitalism has changed the world for the better.

Regards

Paul J. Thomas
Chief Executive Officer
Ductus Consulting

IGNORE THE DOOM-MONGERS

There’s no shortage of bad news – it dominates the headlines. The media concentrates on the negative aspects of life because bad news sells. As readers, viewers and listeners, we thrive on human drama, so the news is replete with stories about terrorism, murders, epidemics, and crashes.

News broadcasts begin with the most traumatic story of the day, in line with the media’s maxim – if it bleeds it leads. This relentless “death and destruction” focus triggers our innate negativity bias and causes us to believe that the world is descending into disaster and chaos.

Following our exposure to a negative event, we tend to overestimate its significance due to a phenomenon called the availability bias. If you have just watched a news report of a plane crash in Sydney and are then asked about aviation safety, you might think (as it’s top of mind) that plane crashes are a problem in Australia whereas they rarely happen here.

In reality, the world is not full of doom and gloom – lots of positive things do happen. However, good news unfolds over time and receives fleeting coverage whereas bad news – such as a rise in coronavirus cases – explodes daily and attracts rolling coverage. Steady progress – like a gradual fall in coronary disease – is not breaking news.

Most positive developments are not camera-friendly as they aren’t built in a day. So, a single act of brutality will capture the headlines while hundreds of acts of kindness over time are ignored. In the words of Harvard University Professor of Psychology, Steven Pinker:

News is about things that happen, not things that don’t happen. We never see a journalist saying to the camera, “I’m reporting live from a country where war has not broken out” – or a city that has not been bombed, or a school that has not been shot up.

In a time when so many things seem dire, it’s refreshing to learn how many important trends are improving. Providing a balanced view of humanity’s progress is the motivation behind a book which helps us see how the world is really faring.

In Ten Global Trends Every Smart Person Should Know, Ronald Bailey and Marian Tupy debunk the belief that the world is getting worse. In fact, for the most part, it’s getting better. The authors have assembled a superb collection of factual information which provides an uplifting report card on humanity’s progress.

Despite its title, the book actually presents 78 trends. The first chapter, Top 10 Trends, has a global focus. The remaining eight chapters identify other significant trends covering people, health, violence, work, natural resource, farm, technology, and US trends.

Ten Global Trends serves as a counter-argument to doomsayers and leaves the reader in no doubt that human progress over recent times has been nothing short of stunning. As the top ten trends reveal, the world is becoming richer, healthier, greener, safer, freer and a more pleasant place to live.

TREND 1 | THE GREAT ENRICHMENT

The size of the world’s economy has grown more than a hundredfold over the past two centuries. Economic growth leads to higher average incomes, enabling consumers to buy more goods and services and enjoy better standards of living. If global economic growth maintains its 2.8 per cent average rate since 2000, GDP will increase to a whopping $1.1 quadrillion by 2100.

TREND 2 | THE END OF POVERTY

Extreme poverty has plummeted from 84 per cent of the world’s population in 1820 to under 10 per cent today. Over the course of the last generation, more than a billion people left the most destitute living conditions behind. Extreme poverty (living on less than $1.90 per day) is expected to retreat further by 2030 with less than 5 per cent of the world’s population experiencing penury.

TREND 3 | ARE WE RUNNING OUT OF RESOURCES?

Despite claims to the contrary, humanity has not run out of a single supposedly non-renewable resource. Fossil fuels and most minerals are more abundant than in the past. Indeed, most resources are so plentiful they will last for centuries. There are compelling reasons to challenge the claims of resource depletion.

TREND 4 | PEAK POPULATION

World population will peak lower (at 8.9 billion) and sooner (by 2060) than UN forecasts and will decline to 7.8 billion people by the end of the century. The significant decline in fertility rates in most nations means that global population will not continue forever on a runaway upward trajectory, but will ultimately drop below its current level. [NB: In a previous post, I explained in greater detail why global population is set to fall.]

TREND 5 | THE END OF FAMINE

Famines have all but disappeared outside of war zones. Adequate nutrition is a basic requirement for human survival, yet throughout history, food has always been scarce. Today, the world’s poorest region (Sub-Saharan Africa) enjoys access to food that is equivalent to that of the Portuguese in the early 1960s.

TREND 6 | MORE LAND FOR NATURE

The global tree canopy increased by 2.24 million square kilometres between 1982 and 2016. This equates to seven-per-cent of the Earth’s surface covered by new trees. Mother nature is beating deforestation resulting in expanding woodlands. There are just over three trillion trees on our planet – that’s roughly 422 trees for every person on Earth.

TREND 7 | PLANET CITY

The world’s urban population in 2018 was 4.2 billion people – more than the world’s total population in 1975. Cities are the centres of innovation and the engines of growth. No country has grown to middle income without industrialising and urbanising and none has grown to high income without vibrant cities. Urbanisation is also good for the environment – fewer humans habituating rural areas enables some land to revert to nature.

TREND 8 | DEMOCRACY ON THE MARCH

Since the collapse of the Berlin Wall in 1989, democracy has spread rapidly across the world, beating the communist and fascist regimes that had arisen since the 1920s. The supremacy of democracy is reflected in free elections, the rule of law and constraints on executive power. Autocrats reject these democratic norms in favour of ruthless behaviour which limits rights and liberties.

TREND 9 | THE LONG PEACE

Over the past half-century, wars between countries have become rarer, and those which do occur kill fewer people. International trade offers a path to world peace as it encourages nations to live in harmony. Free trade raises the cost of war by making nations more economically interdependent. The more that people rely on trade with others, the greater the cost to all parties of a conflict.

TREND 10 | A SAFER WORLD

The chances of a person dying in a natural catastrophe – earthquake, flood, drought, epidemic, etc. – has declined by nearly 99 per cent over the past century. Today, buildings are better constructed to survive earthquakes, weather satellites provide early storm warnings, and swift medical interventions limit the spread of diseases.

■      ■      ■

Clearly, the world is not going to the dogs and these are not bleak times. Almost everywhere you turn, you can find evidence of some positive trend – if you are prepared to look. The remaining 68 trends outlined in Ten Global Trends show that on all key dimensions of human well-being, the world is in an extraordinarily better place today than just a few decades ago.

Most people are better educated, better fed, more literate, and have more life options than at any other time in human history. Incomes and life expectancy are rising while child mortality and cancer death rates are falling. Stocks of nuclear warheads have plummeted and digital technology has transformed how we live, work, and play.

The world isn’t as horrific as we have been led to believe. Indeed, there’s never been a better time to be alive. In bygone years, life was shorter, sicker, poorer, more dangerous, and less free. So, we need to stop bingeing on bad news and seek out the positives in the world as good news lifts our spirits. We should also follow the advice of the Monty Python song – Always Look on the Bright Side of Life.

And if you want to appreciate the simple things in daily life, just listen to the lyrics of Louis Armstrong’s song – What a Wonderful World.

Before you go …
The astounding ascent in living standards over the past 200 years has been driven largely by capitalism. Yet this innovative, free-market system – which has delivered untold benefits to humanity – is under attack by anti-capitalists. I’m a proud proponent of capitalism and in my post next fortnight I will mount a strident defence of capitalism and argue that it remains a force for good – despite its many imperfections.

Regards

Paul J. Thomas
Chief Executive Officer
Ductus Consulting

WINNERS IN A PANDEMIC ECONOMY

COVID-19 has wrought economic disruption on a monumental scale. Around the world, businesses of all shapes and sizes have fought a life-and-death battle for survival. Business owners have grappled with forced closures, plummeting revenues and surging losses. Despite drastic measures – including slashing jobs – many businesses have been unable to stay afloat.

The decision by policymakers to induce massive economic suffering to save lives was a brutal trade off – but not for the technology industry. While other industries were decimated by store, restaurant and office closures, the technology sector powered ahead. Government stay-at-home orders were a godsend for technology companies – demand for their just-a-click-away services skyrocketed.

Specifically, the COVID crisis turbo-charged the profits and share prices of the technology industry’s Titans – Alphabet (Google’s parent company), Amazon, Apple, Facebook and Microsoft. The quintet benefited enormously from a greater reliance on their services during the pandemic as the world moved almost entirely online for work, school and entertainment.

Each of these leading digital powers was able to capitalise on being viewed as an essential service for a public in lockdown with their shares enjoying a jaw-dropping bull run. As noted in a report in The Wall Street Journal, their combined revenue during 2020 surged by a fifth to a mammoth $1.1 trillion while their aggregate market capitalisation soared by half to a staggering $8 trillion.

Thanks to the pandemic, the technology conglomerates now make up five of the six largest companies in the world. During 2020, their stocks soared to dizzying heights and all are now valued at over $1 trillion. According to an analysis conducted in March this year by MacKeeper, these companies are worth more than most countries. MacKeeper noted that:

• Apple’s gargantuan $2.2 trillion valuation makes it richer than 96 per cent of the world. Only seven countries have annual GDP figures that outrank Apple’s market capitalisation.
• Microsoft’s colossal $1.8 trillion market cap puts its value on par with the GDP of Canada and makes it richer than many developed economies including Australia. Only nine countries are worth more than the developer of Windows.
• Amazon’s $1.6 trillion valuation would make it the 14^th richest “country”. Its revenue per employee is $351,531 annually, which exceeds the highest GDP per capita in the world.
• Alphabet, Google’s parent company, is valued at $1.4 trillion, putting it ahead of all but 12 nations.
• Facebook, while falling short of the trillion-dollar mark, is valued at a respectable $763 billion. (NB: Facebook’s cap passed $1 trillion on 28 June 2021.)

The economic effects of COVID have catapulted the tech Titans to heights that few would have imagined possible prior to the pandemic. They now account for nearly a quarter of the total value of companies in the S&P 500 index – the barometer of corporate America – and that is almost double the percentage of just five years ago. Never before has this level of market influence been seen from one sector.

These behemoths have phenomenal corporate power and have been dubbed the “Frightening Five”, which is why some believe that their wings need to be clipped. Together, they control much of the critical digital infrastructure which underpins global commerce. Over recent years, their digital services have played a greater role in our daily lives.

The imposition of social distancing and travel restrictions during the pandemic dramatically increased our dependence on digital platforms to service our basic needs, including staying connected with family, friends and colleagues. This reliance was tangibly demonstrated in the exponential rise in spending on computers, online retailing, cloud-computing services and digital advertising.

The pandemic has made a clutch of tech firms an even more integral part of work and personal life. Indeed, the coronavirus has created huge tailwinds for these juggernauts by driving behavioural shifts that will long outlive the health crisis. “Digital adoption curves aren’t slowing down – they’re accelerating”, said Microsoft Chief Executive, Satya Nadella.

Big tech is on a roll and their deep pockets will enable them to withstand almost any challenge to their market dominance. Investors have been astonished at their earnings growth and resilience in marching unscathed through the health chaos. In the words of one analyst, “the digital revolution is here to stay, and these businesses are embedded in our lives”.

One journalist who tried to live without the tech heavyweights claimed that it was impossible. Another journalist found that she could reduce but not eliminate the Frightening Five from her life. Despite her goal of wanting to “excise these companies from my life as completely as possible,” she discovered that “these tech giants dominate the Internet in so many invisible ways,” it’s not possible to avoid them.

According to an article in The New York Times, the Big Five’s platforms “are inescapable; you may opt out of one or two of them, but together, they form a gilded mesh blanketing the entire economy”. Many of these digital platforms generate what economists call “network effects” – they keep getting more indispensable as more people use them.

Millions of people find it hard to imagine going through a single day without using an Apple iPhone, conducting a Google search, reading a Facebook News Feed, receiving a package from Amazon or launching Microsoft Office. Nonetheless, these same people find it unsettling that a handful of unelected tech executives wield so much power.

Governments around the world also worry about the misuse of monopoly powers and the gobbling up of competitors. Government probes have been conducted into their business practices and have uncovered privacy concerns and data security breaches. Governments from Australia to the US are starting to crack down on big tech companies to rein in their power.

Over recent times, US tech companies have faced increased scrutiny in Washington over their size and power. Republican and Democratic lawmakers have banded together to introduce a package of bills which will change antitrust laws which regulate the conduct of business corporations. The legislation should level the playing field by ensuring that tech companies are held to the same rules as everyone else. As noted in one report:

The new laws would make it easier for the government to break up dominant companies. It could also prevent these companies from snuffing out competition through pre-emptive acquisitions. And it could curtail the tech giants from entering different businesses where they’d be able to use their market power to crush smaller competitors.

In any market, regulators like to see competition as this gives consumers choice. Having one dominant player lessens competition which typically leads to higher prices. But in the case of Google and Facebook, their services are free thereby making concerns over pricing irrelevant. The companies themselves say they are successful because of the quality of their offerings, so why punish success? To quote Bloomberg Technology:

Consumers appear to agree it’s hard to beat Google’s suite of free products or Amazon’s convenience. Their dominance may not be about predatory practices so much as the nature of competition in the digital marketplace, where tech platforms benefit from network effects: As more people use them, the more useful – and dominant – the platforms become.

So, the focus must be on whether there are other harmful political, economic or social effects. Some believe that the tech giants have become more like governments than companies given the staggering amount of money at their disposal and the enormous influence they have over democracy in society. Case in point, Facebook has become a global political force as the largest and most influential entity in the news business.

The digital economy knows no national borders and this is a threat to the jurisdiction of governments around the world. Given this, we will likely see increasing friction between the Big Five companies that rule the tech industry and the governments that rule the lands these companies are invading. The nation-state is fighting not to lose its grip.

Love them or hate them, there’s no escaping the tech superstars. They have become part of the fabric of our lives and will continue to cast a long shadow over the political, economic and social landscapes. They have created an Internet oligopoly which has changed the face of modern capitalism and made them indomitable.

The Big Five have only one question: What pandemic?

Regards

Paul J. Thomas
Chief Executive Officer
Ductus Consulting

VALUING ECONOMIC LITERACY

Economics touches every part of our lives. We encounter it as workers, parents, citizens, savers, investors and borrowers. It’s at the centre of public debate on everything from education to immigration to the arts. Yet most of us struggle with basic economic concepts such as bond yields, trade deficits and GDP growth.

Turn on the TV or radio and you’ll be bombarded with economic data that screams for your attention. We are surrounded daily by talk of falling interest rates, rising oil prices, ballooning national debt and seesawing exchange rates. This statistical information helps explain the world in which we live.

Even so, most of us have not read an economics textbook, which is why the discipline remains shrouded in mystery. The technical language and mathematical models of economists are not well understood by the populace. Surveys confirm that most people have a poor grasp of economics.

This deficit in economic understanding hinders us in making informed judgments about the accuracy of economic statements that are made. Many people do not have the economic literacy necessary to critically analyse the economic headlines which dominate the 24/7 news cycle.

One of the primary activities of modern governments is to determine economic policies. The media play a central role in informing the public about these polices and explaining them in clear terms. Together, politicians and the media shape public beliefs and attitudes about economic matters.

Public perceptions about the economy have important political consequences. Governments are largely re-elected or rejected based on economic perceptions. Yet on many economic issues, the gap between public perceptions and economic reality is very wide.

This is not entirely the fault of voters who are constantly exposed to plausible-sounding economic misconceptions. These fallacies include many beliefs widely disseminated in the media and by politicians. As noted by American economist Thomas Sowell in the preface to his book, Economic Facts and Fallacies:

Some things are believed because they are demonstrably true. But many other things are believed simply because they have been asserted repeatedly – and repetition has been accepted as a substitute for evidence.

Fallacies abound in economics, affecting everything from domestic housing to international trade. Fallacies also have staying power – even in the face of irrefutable evidence against them. Economists could spend an inordinate amount of their time debunking the scores of economic fallacies.

In Fifty Economic Fallacies Exposed, Geoffrey Wood – Professor Emeritus of Economics – examines a range of popular economic misconceptions and explains how these mistaken beliefs misinform economic discussion. Among other things, he looks at the supposed dangers of international trade, the alleged ability of governments to control the economy and the purported benefits to consumers of regulation.

People embrace economic fallacies due to a phenomenon called the fallacy of composition. This fallacy infers that what is true for an individual is also true for a whole group. A classic non-economic example is that of a person who stands up at a concert so that he/she can see better. But if everyone stands, the view of many spectators will worsen. So, what is true for one individual in the crowd, is not true for the whole stadium.

Thinking about economic issues using the same flawed logic can also lead to incorrect conclusions. For example, our individual experience as a worker is a poor guide to the workings of an economy as a whole. Despite this, those who lose their jobs due to automation typically surmise that technology is a threat to all workers. However, this is an erroneous assumption as new technology does not result in higher overall unemployment.

The misconception that new technology destroys jobs is referred to as the Luddite fallacy. In the early 19^th century, English textile workers and weavers protested against the changes ushered in by the Industrial Revolution. These “Luddites” smashed mechanised knitting machines as they believed the new labour-saving devices would steal their jobs.

Paradoxically, by the end of the 19^th century, there were – according to economist and author James Bessen – four times as many factory weavers as there had been in 1830. Automation reduced labour costs for factory owners. This, in turn, enabled the price of garments to be lowered. This, in turn again, increased product demand leading to the need for more workers. 

Automation allows workers to deliver better, faster, and cheaper services and that’s good for growth and therefore good for the economy. What’s also undoubtedly good for the economy is immigration – but not according to the lump of labour fallacy.

This fallacy is premised on the mistaken belief that the amount of work available in an economy is fixed, so no one can get a job without taking one from someone else. Unsurprisingly, this fallacy is used to prosecute the entrenched myth that migrants steal jobs from native-born workers. It’s an understandable supposition, but it’s incorrect.

Immigrants who gain work also gain income to spend, creating new jobs. Immigration, therefore, increases the demand for labour and stimulates employment. Commenting on the positive impact that immigrant workers have on the US economy, The New York Times Magazine explained that imported workers:

… use the wages they earn to rent apartments, eat food, get haircuts, buy cell phones. That means there are more jobs building apartments, selling food, giving haircuts and dispatching the trucks that move those phones. Immigrants increase the size of the overall population, which means they increase the size of the economy. Logically, if immigrants were “stealing” jobs, so would every young person leaving school and entering the job market; countries should become poorer as they get larger. In reality, of course, the opposite happens.

It is axiomatic that the conventional wisdom which says that immigrants take jobs and lower wages is absolutely wrong. In reality, immigrants create jobs and make native workers more prosperous. As world renowned economist and Nobel Laureate, Paul Krugman, commented “… the (lump of labour) fallacy makes a comeback whenever the economy is sluggish”.

One final economic myth – which has been perpetuated for decades – is the household fallacy. A government is not a household and therefore does not need to manage its finances like a household. The household fallacy disguises this truth by falsely claiming that what is true for an individual household regarding debt is similarly true for a government.

The household analogy is simple: Governments need to live within their means (like households) by not spending more than they receive or risk going broke. In reality, governments do not always need to have a balanced budget. In fact, they can run prudent annual deficits indefinitely, as many countries do. Britain has maintained a national debt for more than 300 years. Going back to 1776, the US has been in continuous debt except for seven short periods.

Balancing the national budget sounds appealing and promising to get it back in the black resonates with many voters. Still, policymakers should avoid playing populist politics by trying to imitate family budgets. Fiscal austerity is commendable at a household level but can equate to economic irresponsibility at a sovereign level. As noted in a UK media article:

The familiar logic of the household analogy has become so embedded into public life that spending proposals that would help tackle some of our most pressing challenges – climate change, the housing crisis, unsustainable household debt – can barely make it out of the door. All too often, such proposals are stopped in their tracks by rival politicians and the media asking where the money is going to come from.

[Note: A fuller explanation of the benefits of government debt can be found in my recent post – Modern Monetary Theory.]

It can be seen that economics is replete with fallacies and has a bad reputation for its lack of precision and certainty. As economics is not a natural science – like physics, chemistry or biology – its propositions are rarely absolutely true or false. Broadly speaking, economics is the study of human behaviour as it relates to money and we humans are neither rational nor predictable.

Even so, it is incumbent on all of us to better educate ourselves in the workings of the economy. What currently passes for a conversation among the electorate about economic issues is often amateurish. So, learning about economics often starts by unlearning what you thought you knew.

We are ignorant of our own ignorance when it comes to economics.

Regards

Paul J. Thomas
Chief Executive Officer
Ductus Consulting

MANIFESTO FOR A BETTER WORLD

Humans are exploiting the Earth in an unsustainable manner. The current model of capitalism is cited as the main culprit with a burgeoning chorus of scientists challenging the economic mantra of “grow or die”. They argue that perpetual growth on a finite planet will lead to environmental calamity.

In the ongoing debate on sustainability, conservationists feel hampered and business people feel vilified. Meanwhile, ecologists and economists disagree about the limits of economic growth and the ecological capacities of the Earth. There is a mounting view that preserving the planet and expanding the economy are mutually exclusive. But is this really the case?

The reality is that environmental and economic issues are interconnected. The planet is part of the economic system and the economic system, in turn, is part of the planet. In order to grow, the economy feeds on natural resources and emits waste which pollutes the air and threatens the delicate climate on which life relies.

We must reduce the use of fossil fuels by switching to clean energy such as natural gas, nuclear and renewables (solar and wind). The energy sector matters greatly in our efforts to slow climate change. Electricity generation has long been the world’s biggest source of greenhouse gas emissions. The rest comes mainly from transportation, manufacturing and agriculture.

Around the world, businesses are making changes to their production systems in order to help stop the degradation of the planet. But what role do consumers play? Businesses argue that they merely supply the products and services that consumers demand. In an age of rampant consumerism, many of us crave the latest “must haves” thereby fuelling an endless cycle of spending.

To understand our insatiable appetite for products and gadgets that are newer and better, you need only look at the hordes of people around the world who queue for days outside an Apple store for the latest iPhone. Consumerism has caused us to confuse a good life with a goods life. The more we have the more we want, creating a cycle of compulsive buying.

But many of us buy things we don’t really need and this particularly applies to clothing. Open your wardrobe and take stock of all the clothes that you have either never worn or not worn in the past 12 months. It is claimed that most people wear 20 per cent of their clothes 80 per cent of the time. Put another way, we barely wear 80 per cent of what’s in our closet.

When it comes to poor practices that contribute to climate change, the fashion industry is cited as one of the worst offenders. Never have consumers been so quick to buy pieces of clothing, but this apparel runs out of style within weeks. The fashion industry has a vested interest in selling more clothes, so it sets new trends several times a year to keep consumers buying. It’s claimed that throwaway garments contribute more to climate change than air and sea travel.

For consumers, sustainability means getting the most out of the products they buy and not throwing them away on a whim. More than 1.7 billion people worldwide now belong to the “consumer class”. These people live on diets of highly processed food, own bigger houses and cars, carry higher levels of debt and have lifestyles devoted to the accumulation of non-essential goods.

Not surprisingly, many of the environmental issues we see today can be linked to consumption. Disposable cameras, plastic garbage bags, and other cheaply made goods with built-in product obsolescence inflict a devastating toll on the Earth’s water supplies, natural resources and ecosystems. Demand for cheaply manufactured goods fuels our throw-away mentality.

A magazine article titled Climate Change Is the Symptom. Consumer Culture Is the Disease. notes that “… industries are spouting carbon because customers demand their products: travel, electronics, entertainment, food, all sorts of stuff. So, what if, instead of solely measuring emissions by economic sector, we looked at consumer demand within those sectors?”

Researchers have done just that, and the results tilt the blame away from businesses toward a different villain – ourselves. The article goes on to say:

C40 Cities, a network of 94 of the world’s biggest cities, released a report … estimating how much consumption habits drive the climate crisis. The results were staggering: In those nearly 100 cities, where a combined 700 million live, the consumption of goods and services “including food, clothing, aviation, electronics, construction and vehicles” is responsible for 10 percent of global greenhouse gases. That’s nearly double the emissions from every building in the entire world.

Billions of citizens around the world are looking to governments and businesses to do something about climate change. But the real power for change is in our hands. Our collective actions can provide the leadership necessary to combat climate change. We support governments with votes and businesses with dollars, which means that we can choose who governs and where we spend our money.

If we don’t like what a company is doing, we can stop buying their products and services and force them to change. Consumers drive markets and sustainable consumer choices can change corporate behaviour. But we all need to take a stand and, for many of us, this will require a lifestyle overhaul, particularly with regard to saying “no” to unnecessary and/or environmentally unfriendly household items.

Research reveals that having more and more possessions does not make us happier, which is why some have adopted a minimalist approach to life. There is a growing minimalist movement which advocates that we should get by with less. The basic premise of the movement is to live without excessive possessions in order to have more meaningful and thoughtful experiences.

I remain an avid fan of capitalism and believe that it is the greatest vehicle the world has ever known for creating wealth and prosperity. Even so, it is an economic system in need of repair. All of us as individual consumers working together can drive that repair by making better choices in our day-to-day lives regarding the products and services we consume.

Let’s prove that sustainable capitalism is not an oxymoron.

Before you go…

My next blog post will be the final one published for 2020 and will take the form of a Christmas parody. It will be set to the rhyme scheme of Clement Moore’s classic poem, The Night Before Christmas. It will imitate the style and form of Moore’s original lyric while addressing a different subject matter – a look back at the biggest news stories of 2020. I hope that you enjoy this twist on the famed poem.

Regards

Paul J. Thomas
Chief Executive Officer
Ductus Consulting

CREATING MONEY OUT OF NOTHING

Governments around the world are spending up a storm. They have loosened their purse strings and are shovelling truckloads of cash into their respective economies. Collectively, it represents the biggest relief package in history – in excess of US$10 trillion globally. For most nations, every penny of their mind-boggling spendathon is borrowed.

In doing “whatever it takes” to combat the COVID-19 pandemic, governments have shown that they can sustain levels of debt far greater than previously thought. Consequently, the coronavirus has challenged orthodox economics in just a few weeks. The belief in balanced budgets has been thrown out the window. Public debt is no longer seen as a drag on economies but a critical lifeline.

Proponents of an unconventional economic framework – Modern Monetary Theory (MMT) – welcome the ramp-up in government spending. MMT posits that countries which issue their own currencies can’t go bankrupt as they can never run out of money in the way businesses and households can. That’s because governments with their own sovereign currency are able to “print” (or more precisely “create” with a few keystrokes) as much money as they need to pay creditors.

Not surprisingly, traditional economic thinking warns that such spending is fiscally irresponsible as the debt balloons and inflation skyrockets. Critics of MMT cite Hungary in the 1940’s, Brazil in the 80’s and Mexico in the 90’s as examples where easy money policies (governments creating piles of cash) led not just to inflation but hyperinflation.

But this has not deterred MMT advocates who argue that increased government spending will not generate inflation as long as there is unused economic capacity or unemployed labour. It is only when an economy hits physical or natural constraints on its productivity that inflation happens, because that is when supply fails to meet demand, jacking up prices.

This is what occurred in Zimbabwe in the late 1990s and mid-2000s. The economy collapsed, but not because Robert Mugabe printed ever-more Zimbabwean dollars. Rather, the economy nosedived when farming production plummeted by 60 per cent as Mugabe forced experienced white farmers off their land and gave it to inexperienced soldiers to farm.

The resultant decline in output caused a shortage of goods. At the same time, demand rose as Zimbabweans had more paper money. The combination of more money chasing fewer goods – the classic definition of inflation – caused a supersonic rise in prices. Wallets were replaced with wheelbarrows as hyperinflation peaked in the African nation in November 2008 at an estimated 89.7 sextillion per cent – an eye-watering number with 21 zeros after it.

Of course, Robert Mugabe’s gross economic mismanagement of Zimbabwe cannot be compared to Shinzo Abe’s savvy stewardship of the Japanese economy. A basket full of groceries in Japan in 2020 does not cost a bucket full of money as it did in Zimbabwe in 2008. That’s because Japan’s expansionary monetary policy has not been inflationary – spending has not exceeded the economy’s capacity to produce.

Despite having the highest public debt in the developed world, Japan has not experienced runaway inflation (in fact, it has been battling deflation for two decades!) and remains an economic powerhouse. Supporters of MMT cite Japan’s success as proof that their unorthodox ideas work. But critics – including world renowned economist and Nobel laureate, Paul Krugman – strongly disagree.

Both sides of this debate were outlined in a 2019 article published in The New York Times – Modern Monetary Theory’s Reluctant Poster Child: Japan. Notwithstanding Japan’s hesitance to be labelled an MMT practitioner, proponents of the theory insist that Japan has been a testing ground. As explained in the article:

The country (Japan) is their (MMT’s) equivalent of Charles Darwin’s Galápagos Islands: a natural experiment that reveals a fundamental truth about the way the world really works. Since the country’s boom ended in the early 1990s, Japan has borrowed deeply. Currently, its debt level is approaching 250 percent of its annual economic output. Critics say it is an economic basket case. Despite all that, Japanese inflation and lending rates remain low. In fact, some bond rates are negative, meaning Japan can profit when it borrows money. Its standard of living remains competitive with those of the United States and other developed countries.

Bill Mitchell is a professor of economics at the University of Newcastle in Australia and one of the founders of Modern Monetary Theory. He has been closely studying Japan since the 1990s. “It is my laboratory,” he explains, calling the country “a really good demonstration of why mainstream macroeconomics is wrong”. He argues that Japan has established “the principles of MMT and the consequences of different fiscal and monetary policy initiatives”.

Japan has blurred the lines that traditionally divide fiscal and monetary policy. Other nations, including Australia, are currently doing likewise with their pandemic stimulus packages. Historically, governments have raised money to fund spending by issuing bonds which are bought by a range of investors. But some nations are now self-funding their stimulus packages by issuing and then buying their own bonds, thereby creating money out of thin air.

This funding mechanism bypasses the need to pay interest to investors on newly issued money and is at the heart of MMT – the fusion of fiscal and monetary policy. MMT links fiscal policy to monetary policy by using the central bank to buy the debt (bonds) issued by its government. If all of that sounds double Dutch, then let me share with you another explanation.

In a recent article in the Sydney Morning Herald, Don’t add government debt to your list of things to worry about, economics writer, Jessica Irvine, quite rightly points out that the Reserve Bank of Australia (our central bank which is responsible for monetary policy) has exhausted its traditional method of stimulating our economy (lowering interest rates). So, the RBA is helping the federal government (which has responsibility for fiscal policy) stimulate the economy by buying Australian government bonds.

In answering the question: Where does the stimulus money come from?, Irvine writes:

A large part of (it) … will come from the Reserve Bank. Weird, you might be thinking. Does that mean that one arm of government – albeit a statutory independent agency – is now lending to another arm of government, the executive branch? To whom, in such a situation, do taxpayers ultimately owe the money? Themselves? The answer is: well, yes. … And if we only owe the money to ourselves, what’s to stop us spending as much as we like? Another very good question, and one to keep in mind in the strange debates to come.

Irvine underscores that MMTers would prefer that the government simply print the money, rather than borrow it from the private sector in a money-go-round they decry as “corporate welfare”. According to MMT, government issued bonds aren’t strictly necessary. Instead of issuing $1 in bonds for every $1 in deficit spending, the Australian government could just create the money directly without issuing bonds.

The belief that governments do not need to issue public debt is supported by Dr Steve Hail, a lecturer in economics at the University of Adelaide and an MMT proponent. He sees no need to match public deficits with debt issuance for a currency issuing government. Such governments should gain the necessary political approval for additional spending and then be able to do it. “Spending is self-financing,” he asserts and “does not have to be funded”.

In a recent article Dr Hail wrote for the news and opinion website, Independent Australia, he stated:

… central governments like those of Australia, New Zealand, the USA, the UK and Japan face no purely financial constraints at all. Never mind a “money tree”, they have a money computer. They can create limitless amounts of their currencies when they need to do so. They are not dependent on the goodwill of the bond market, or of credit ratings agencies. They are monetary sovereign currency issuers.

It’s clear that MMT is a controversial idea that has detractors and admirers worldwide. The coronavirus pandemic has moved MMT from the fringes of economic debate to centre stage. It is receiving unprecedented attention now that policymakers are (knowingly or unknowingly) implementing some of its basic tenets. This is MMT’s moment in the sun and only time will tell if it works as advertised.

For the record, I do not believe that government deficits are inherently bad. Nor do I believe that government budgets, like household budgets, should always be in the black. So, my belief is that MMT should not be dismissed out-of-hand nor should it be approached with a pre-existing economic ideological bias.

Remember, the economics profession (it is jokingly said) is the only field where two people can win a Nobel prize for saying the exact opposite thing!

PS. Professor Stephanie Kelton is the public face of MMT and its foremost evangelist. Her recently released book, The Deficit Myth: Modern Monetary Theory and How to Build a Better Economy, provides a comprehensive and lucid explanation of MMT.

Regards

Paul J. Thomas
Chief Executive Officer
Ductus Consulting

DEFICIT SPENDING ON A GIGANTIC SCALE

The economic damage caused by the coronavirus is mounting across the globe. In a frantic scramble to cushion economies, governments launched massive stimulus programs. These unprecedented fiscal and monetary interventions come with a staggering price tag. Sovereign debt is set to soar with governments around the world embarking on one of the greatest peacetime borrowing binges in history.

Most governments run annual deficits as they spend more than they collect. Few have spare surplus funds sitting around that can be redirected to support struggling households and businesses. So, countries are piling on more debt to fund emergency spending to help citizens cope with the economic ravages of the pandemic. Many people understandably worry whether the world can afford this avalanche of new borrowing.

The good news is that debt is incredibly cheap at the moment. Prior to the pandemic, the world was awash with savings which pushed interest rates very low. As global interest rates are now even lower, it has never been cheaper for governments to borrow. Governments are collectively borrowing trillions of dollars to enable them to spend trillions of dollars in a synchronised shock-and-awe response to the pandemic.

A classic way for nations to “print” emergency money is to borrow it by selling government bonds. This increases national public debt and is how governments have historically dealt with economic shocks such as recessions, financial dislocations and wars. During such crises, investors prefer the safety of government bonds in lieu of putting their money into the stock market, corporate bonds or real estate.

In Australia, the federal government is expected to fork out in excess of $200 billion to keep the economy afloat during the pandemic-induced downturn. The first federal response cost $17 billion, the second round cost an additional $66 billion and the third cash splash rang the bell at $130* billion. All up, Australia’s coronavirus stimulus packages are equivalent to nearly 10 per cent of the size of our economy.

As explained by ABC business reporter, Gareth Hutchens:

Essentially, the Government will pay for the stimulus package by creating the money and racking it up as debt. Officially, it will raise the money via the Australian Office of Financial Management (AOFM), which borrows money on behalf of the Government by selling Australian Government bonds.

Institutional investors (e.g. local and overseas banks, superfunds and foreign countries) will be buyers of the bonds. However, as noted by Gareth Hutchens:

The ultimate buyer of the Government bonds could be the Reserve Bank, because at the moment, the RBA is stepping into the market regularly to purchase as many Australian Government bonds as necessary to keep the interest rate, the “yield”, on three-year Government bonds around 0.25 per cent.

The yield on Australian government bonds is the interest rate we pay on our nation’s debt. Given that the current rate of inflation in Australia is around 1.8 per cent and is expected to decline further, we are effectively borrowing for free. This is good news for Australia, yet many Aussies are fearful of our level of sovereign debt.

A recently released paper by think tank, The Australia Institute, “The Budget Surplus Objective: An example of how economics is broken” highlights the folly of this fear of government debt. Citing the report, economics writer, Greg Jericho, states:

… given Australia’s nominal GDP is expected to grow at around 4.5%, if government borrowing pays lower than that (as is currently the case) debt levels will fall over time. This is because the economy is growing much faster than is the interest on the debt. … It means to quote Larry Summers, the former chief economist of the World Bank, that “public investment is essentially costless – the classic free lunch”.

One of Australia’s foremost economic commentators, Chris Richardson, from Deloitte Access Economics, has gone public to ameliorate fears that the government has saddled our children with massive debt. According to Richardson, the budgetary impact of the fight against the coronavirus will have a much smaller impact on Australia than many expect.

Notwithstanding the “jaw-dropping” size of Australia’s stimulus package, Richardson stressed that we have not sentenced younger Australians to a lifetime of higher taxes and sub-standard services.

Although the dollars are unprecedented, what’s even more unprecedented are the interest rates we’ll be paying on this new debt. Never in the two thousand years of recorded history of interest rates has it been cheaper for governments to borrow. Never. And markets aren’t fazed in the slightest: they reacted to the latest package by dropping the rate on 10-year Commonwealth borrowing substantially further.

Richardson went on to say:

Australia’s economy will grow again on the other side of this (COVID-19) war. So, here’s a simple suggestion: Let’s just let our debts from this new war simply become a smaller share of our growing economy over time. That’s what we did with the war-time debts of the past. And it’s probably the smart play this time too. Self-imposed flagellation rarely makes sense. The same policies that were sensible ahead of this crisis will remain just as sensible after it too.

As counter-intuitive as it sounds, government deficits can be very helpful to an economy. Nobel prize-winning economist, Joseph Stiglitz, has long argued that deficit spending can be a major stimulus to economic growth and can actually lower long-term government debt. When economic growth is restored and unemployment falls, tax revenues increase which eventually lessens the need for a government to borrow.

Another world-renowned economist and Nobel Laureate, Paul Krugman, has often observed that government finances are not like personal finances. While consumers on a spending spree ultimately have to pay the piper, a government’s borrowing strategy directly affects economic growth and this delivers social benefits.

All of this means that increased national debt from COVID-19 is not our enemy – it will not leave a deep scar on our economy nor will it result in a day of reckoning. This will be hard for many Aussies to accept as they have been conditioned to believe that debt is bad and that any political leader who does not pledge to lower Australia’s national debt is not worthy of their vote.

Even though Australia has long had one of the world’s lowest debt-to-GDP ratios, we Aussies display an irrational and emotive attitude to government debt. Hopefully, the pandemic will challenge some long-standing economic theories, including the idea that responsible government means having no national debt.

The notion that governments can sustain levels of debt far greater than previously thought is the centrepiece of an economic model called Modern Monetary Theory (MMT). It proposes that governments can spend freely as they can always create more money to pay off debts in their own currency. Orthodox economists see MMT as a fringe economic movement with some labelling it as “voodoo economics”. But it is worth exploring which I do in my next blog post.

For now, please do not be spooked by the debt bogeyman.

*It has since transpired that the government’s $130 billion JobKeeper program will cost only $70 billion.

Regards

Paul J. Thomas
Chief Executive Officer
Ductus Consulting