All over the world, central bankers have hinted that the great 10-year period of very low interest rates is coming to an end and all over the world, millennials are complaining that they can’t make a decent crust. Are these developments linked? If so, what does it mean?
Since 2007, interest rates have been slashed and pushed below zero to avoid mass bankruptcy and to refloat balance sheets that were crushed by the crash. Now that economies are motoring along, central bankers want to raise rates.
But there’s one problem: inflation, which usually builds as the economy picks up, is nowhere to be seen.
The good news is that the absence of inflation around the western world might be the new normal — meaning interest rates will stay relatively low. This is good news for the highly leveraged.
But if the reason inflation is not re-emerging is because wages are not rising as they should be, then we have a problem. This problem is particularly acute for the so-called millennial generation — people born in the 1980s and early 90s. I prefer to call them, at least in Ireland, the Pope’s Children.
Wasn’t this the generation that was supposed to be liberated by the white heat of technology? What if the dream is over? And what if technology is the reason? If this generation is suffering from lower wages and job insecurity, we all have a dilemma.
Let’s tease out the conundrum and the link between technology, the rest of the economy, and the Pope’s Children in particular.
Although economics can sometimes seem remote, economics is about you, and the reason global interest rates and wages could stay low, even as the economy expands, might come down to you, the way you live today and the way you use technology.
If, like me, you sometimes admit to binge-watching Netflix, take heart. I realize that there’s something unsettling about finding yourself at home in bed, under the duvet, Pringles in one hand, remote in the other, overdosing on ‘House of Cards’.
As you try to come to terms with where you have ended up, take some comfort in the fact that a significant chunk of the reasonably well-balanced population is equally addicted. At all hours of the night, many of us are gorging on Netflix, checking emails, responding to Whatsapp groups, booking an Uber or buying something on Amazon.
If technology is taking over your world, what does it mean for the global economy and for our way of thinking about the world?
At the beginning of every year, when my students sit down in front of me at Trinity College in Dublin, I can’t stress enough the importance of not only what they’ll learn in textbooks, but what they see happening in the world around them. As the world changes, our understanding of the economy should change too. But sometimes it doesn’t because of intellectual inertia.
Regularly, economists — and in particular policymakers — display a form of “groupthink” and seem wedded to old models about how the world works that appear to be impervious to the changes that are taking place in the real world. As the global economy is growing and unemployment is falling, central bankers’ default position is that inflation must be around the corner — but what if it’s not?
What if policy makers in their ivory towers wedded to old ideas do not appreciate that millennial technological change and the likes of Whatsapp, Uber, Amazon and Netflix, is driving deflation not inflation?
To understand why central bankers might be misreading what is going on, it’s crucial to understand the traditional model that central bankers use to weigh up what is going on in the economy.
Central bankers believe in the Phillips Curve. The Phillips Curve is the traditional relationship between inflation and unemployment. Every religion has a creed — a set of core beliefs — and the creed of all central bankers is the Phillips Curve.
The mantra goes like this: as unemployment falls, more and more firms want to employ more and more workers, but there are fewer and fewer workers available. So wages rise. The worker knows that if his boss doesn’t give him a rise, he can go across the road to the guy with the “vacancies” sign in the window and get paid more. This process triggers wage inflation.
At some point, the economy runs out of workers and wages rise. Traditionally, it was thought that point was an unemployment rate of between 5pc and 6pc.
While higher wages give more income to workers, they constitute higher costs to employers and ultimately less profit. Because companies traditionally work on a fixed profit margin basis, as the employer’s costs go up, the company simply increases retail prices to sustain profit margin. And, because everyone is getting a pay rise, they have more income. This increased income allows the market to absorb the increases in prices as everyone has more money.
Therefore, the traditional mantra of central banking is based on two crucial beliefs: first, the ability of the worker to push up wages when unemployment is falling (or at least falls to a certain level), and second, the subsequent ability of the employer to pass on the increased costs in higher prices.
However, the relationship between unemployment and inflation appears to be breaking down, or at least shifting. Unemployment is falling but general wages are not rising. Could technology be the reason?
All this new technology we are using forces us to reconsider a competing economic theory called “creative destruction”, which may now be the most useful way to look at our new Amazon-inspired world.
The Austrian economist Joseph Schumpeter came up with the term “creative destruction” to explain the natural process whereby recessions and human ingenuity create innovations and these innovations produce “disruptive technologies”. Such disruptive technologies like Uber, Amazon, Whatsapp, Google maps or Netflix, destroy old industries, slash prices and change the ground rules. Schumpeter argued that these forces are so strong they drive down inflation permanently.
In terms of Uber, Whatsapp and Amazon, these new technologies are driving down prices undermining the old fixed margin business. Taxis, retailers, telecom companies and all sorts of companies can no longer add margin to their price to make up for increased costs.
Wages are being pushed down too because everywhere the “middleman” is being squeezed out. Interestingly, in a services economy like ours, the vast majority of employees are “middlemen”, taking a cut on a product or idea somewhere between when it is produced and when it is finally sold to the customer. But the “gig economy” destroys that because technology destroys the middleman. The “gig economy” is only millennial shorthand for the elimination of the middleman!
Before you start rejoicing, appreciate that in fact we are all the middleman.
The middleman is human value added. It’s what most of us do. If that is eliminated by technology, wages are forced downwards. This is precisely what is happening to the millennials.
Millennialism and all its attendant technologies are actually devouring these technologies’ greatest adherents — the millennials themselves.