5 Why’s: A Different Take on the Current Economic Malaise

I found myself asking Five Whys about the current economic difficulties in the Euro zone and the world in general. The 4th question is the really hard one and one that I had not seen answered well anywhere. I suggest that even if you disagree with my answer, do not believe any commentator on the current situation unless they have a rather good answer to this question.

Q1: Why did Lehman Brothers collapse?

Lehman got caught in the bursting of the housing bubble. Their losses were too great to survive.

Q2: Why was there a housing bubble?

Interest rates have been at historic lows for the past 10 years or so. Because credit has been cheap, too many, and too many expensive houses were built in the US and many other places.

Q3: Why were interest rates so low for such a long time?

To prevent the economy from going into recession. Unusually, this has been a real danger for the past 10 years and so unusually low interest rates have been required for an unusually long time.

Q4: Why hasn’t the economy started growing the ‘normal’ way again, after all this stimulus, and after so many years?

[This is the interesting one. Historically recessions haven't lasted this long, and this time around, record-low interest rates for a record-long time have not made growth appear. Note that while arguably today total debt is too high to allow economies to grow well (a balance sheet recession), we had to have record-low interest rates in the US and other countries, with little effect, for some years *before* the debt became so large, so that is not a sufficient explanation.]

So why doesn’t the economy grow?

I have looked around for explanations, and found very little even remotely compelling. The consensus seems to be “let’s just try harder what we’ve doing so far and magic will happen”, which becomes less and less plausible to me every passing year.

My answer: the economy isn’t growing because it is going through a fundamental change that so far has not been recognized by mainstream economists or commentators. (One economist who does is Carlota Perez; watch Fred Wilson’s highly interesting interview with her.)

I would put it as “the information age finally has arrived”. In my view, the fundamental reason for a lack of GDP growth is that what used to be mostly atoms (that almost always cost money i.e. GDP) are rapidly becoming bits (that, more often than not, are free, or far less expensive than atoms).

Think of all the atoms that don’t need to be moved around any more: physical CDs, DVDs, games, now books. Entire supply chains work 10x better while moving less atoms around, all by moving bits around instead. Avoiding sending atoms around increases quality of life, but it shrinks GDP! And new innovations like 3-D printing will cut even further into GDP.

Bits, by and large, do not generate (much) GDP! If some new software can avoid that three new widgets are being produced and shipped and displayed in stores and driven home and used and discarded and recycled, the new revenue is only for the software, while each stage in the lifecycle of the old widget would have contributed to GDP! That GDP is all gone and won’t come back.

Yes, technological revolutions always make old revenue disappear, e.g. for carriage makers when cars appeared. But the information revolution is different because the old revenue is replaced by a lot less new revenue. Not by new cars that are even more expensive than old carriages. But by bits, most of which are free.

Great example: playing chess on-line with somebody exactly at my level of skill instead of buying the chess set and driving the friend all over town once a week. Less bits moved, less resources consumed, more fun being had, more health etc. And far less GDP from chess set makers and gas stations etc.

So, my prediction: the current economic malaise is not going to go away because GDP isn’t going to grow as much as it is used to. The “malaise” is the new normal, it is here to stay, and likely will intensify as the information technology revolution continues.

(Where that leaves the financial system, I have no idea. In fact, I have no idea where economics as a discipline goes in an era where the era’s primary good — bits — is not scarce but becomes more valuable the more people use it. But that’s a topic for another day.)

Now if we had just one presidential candidate in the race, just one, who had something to say about anything like this?!? In any country? No wonder the world is disoriented, angry, and feeling adrift …