WTO Deal: An Acceleration Toward The New Economy, Without A Western Middle Class

by: Zoltan Ban

Basic economic analysis tells us that it is a deal which can only benefit humanity. The WTO deal reached on further removing trade barriers is estimated to add a trillion dollars to the world's economy by increasing efficiency and cutting the cost of doing trade. Cutting red tape will not only reduce costs of compliance when moving goods across the borders but also eliminate many opportunities to collect bribes. On the surface, there seems little that we can object to when it comes to the deal. Reality is that there are many negative consequences involved in removing trade barriers as long as there are major differences in the acceptable intensity with which human and environmental capital is exploited in the process of producing goods and services from country to country. It will in my view ultimately lead to imbalances which will more than offset the trillion dollar gain in global GDP due to increase in efficiency.

It is hard to pinpoint with accuracy at what point we can say that the current intense wave of globalization started. From my personal view, it started once capitalism's main competitor, the Soviet block, collapsed. The reason I want to pick that moment is because it was when capitalism with a human and humane, considerate face no longer had to be maintained as an argument against the viability of the command economy. A few years after the collapse of communism in Eastern and Central Europe, an event took place which few people remember and still think about, but which I believe was one of the most important decisions made for the last few decades. When negotiating the 1994 GATT agreement, which led to the creation of the WTO, all considerations regarding human rights and environmental stewardship practices employed by trade partners were brushed aside. A year later, the WTO was created, which is sometimes an impediment to attempts to protect national economies from the negative effects of globalization.

Back then, this was also sold as a great way to improve efficiency, which is something that everyone will benefit from, just as it is done now. The result however was this:


As the chart shows, US median household income peaked just a few years later in the year 1999 and we now see that the gains of the 1990-2000 period were completely erased. It is no secret at this point why it happened, so I will not spend much time dwelling on it. We all know that it is a result of the loss in manufacturing and service jobs due to the increasing ease with which firms can outsource production and then bring it back across the border to the consumer of choice. We often hear statements made by politicians of all colors and stripes that "the American worker can compete with anyone," which we all know it to be false, because places like China increasingly have a workforce that is just as qualified, but works the same job for as little as one tenth of his/her American counterpart. China's infrastructure is increasingly world class, while energy and environmental costs are lower. China is not alone either, because there are dozens of mini-Chinas around the world as well as another giant called India, which is ready to pounce.

The median US household income adjusted for inflation is now the same as it was in 1990. In other words, the only two reasons half of US households are now spending more than they did 23 years ago are because they are taking on more credit and spending their inheritance and savings. This was in large part facilitated by bringing down interest rates, which in the long-term can be considered a one-off measure, which cannot be repeated again, because there is little room left for further accommodation. Therefore, from this point on, there will be only one way for this half of the population, whose income is shrinking to go in its consumption pattern, and that is towards personal and household austerity.

Effect of taking half the consumers out of action on the US economy:

Consumer demand is the main driver of the US economy. Between 1982 and 2007 it contributed 70.8% of total GDP growth. All other components, such as investments, government spending and net exports contributed the rest, which was just 29% of total GDP growth. In other words, if consumer demand would have been stagnant during the period, economic growth during the period would have been only one third of the actual rate (Federal Reserve Bank of St. Louis).

The squeeze that is currently being put on the majority of households is a real threat to our economic well-being, because at this point, there is a real risk of a cultural shift happening, which will cause a vicious cycle that will collapse the consumer economy altogether. We are already seeing a movement toward rejection of the lifestyle, which made us all good consumers thus far. Young people are increasingly choosing not to drive and live in public transit accessible areas instead. In 2000, 11% of 20-34 year olds did not have a driver's licence, by 2010 that number increased to 16%. Many are opting to live with their parents, changing the family structure we became accustomed to and consumer demand for many goods and services dependent on a continued increase in total number of households. For now population growth including through immigration is picking up the slack, but I believe a complete shift in consumption patterns among the working class may be only a recession away. With that shift, immigration fueled consumer demand growth will become impossible, because with the resulting decline in employment and rise in under-employment caused by a drop in consumption, immigration will become a zero sum game. In other words the influx of more potential workers will do nothing to increase consumption because they will compete with an increasing pool of unemployed and under-employed for the same scarce opportunities to earn a decent living.

This trend is already in place, without the new WTO deal. With this new deal in place, the US worker will be exposed to further competition from much lower paid workers capable of doing the same job under far cheaper conditions. This can only mean one thing and that is that the median household income will continue to decline at least at the same pace as it did until now. By the time we will have another recession, possibly before 2020, we could see US median household income reach only $45,000, in other words the average US family will have to do with more than 20% less income than in the year 2000. In such circumstances I wish those who are looking to sell unnecessary goods and services best of luck, because even with the growth in income in the developing world, the pace of hollowing out of the middle class in the developed world will eclipse the growth in consumer demand coming from the rising middle class.

Back to 19th century style business cycles:

Building up the Western World's middle class, which became the main engine of growth all the way up to the present, due to its role as the world's main consumer, started in the 19th century, with reforms introduced by Germany's first chancellor Otto Von Bismarck. His introduction of the basic social safety net was the launching pad of the consumer driven economy. The hollowing out of the Western Middle class started with the globalization drive of the 1990s and the effects are just now starting to be obvious. The direction of the world's economy as a result of this new trend can only be a return to the 19th century's problems.

The main problem in the 19th century was a constant overshoot of production capacity, given the limited consumer base, due to a general lack of decent wages and lack of a basic social safety net meant to provide the working class with the consumer confidence necessary to help them venture into major purchases with their family budget surplus. They preferred to save any surplus in order to have something to fall back on during times of hardship. The result was a business cycle environment characterized by very deep and painful recessions. The economic upswings had little momentum because good times led to people saving up for the bad times again, which meant that consumer demand upswings were never very robust.

The reason why this short history lesson is very relevant to us today is because we have to recognize that the world's new middle class members in the developing world are in many ways no different than our ancestors in the 19th century. In China for instance, average savings rate is currently 53% of GDP (link). While consumer demand has been rising steadily over the past few decades, it is rising at a slower pace than GDP growth. In other words, Chinese growth has been dependent on external demand for their goods, which comes mainly from the Western world. The Chinese and other developing nation consumers would not be able to sustain current global consumption if the western consumers would turn into savers as a response to increasing scarcity of good quality jobs and increasing lack of job security.

This time it is different:

As we enter the fifth year of recovery in a few weeks, it is easy to get swept up in the wave of optimism fueled by the realization that we had a close encounter with the edge of the economic cliff and we managed to pull back. It reinforced our confidence in the global economy, not so much because we are now in a strong recovery (average yearly global growth has been about 1% less since 2010 compared to pre 2008 long-term average), but simply because we survived and now we can afford to celebrate our survival. This wave of optimism seems to be leading us into a complacent mindset, which suggests to us that we are back to business as usual.

What makes this current recovery very different is its lack of an engine to push it forward. Consumer demand is increasing in the United States. It increased by almost a trillion dollars per year since the lows of 2009 (link). It will be interesting to see what will happen once the Federal Reserve will start to ease off the stimulus and interest rates will rise as a result. One has to wonder whether the strong car sale recovery is part of an overall strong trend or a push by consumers to replace their old cars with new ones at a favorable rate of interest. Once interest rates rise, it is probable that so will people's savings rates as they pull back from spending in response to the new mindset of low rate expectations, which is setting in now due to a long period of low rates. Credit fueled consumption will also pull back because of the lower real income of the average US household, which makes it hard to accept a higher debt load at a higher interest rate. It is therefore conceivable that the current recovery can only continue in the current low interest rate environment. There is no other engine of growth and even this one has an expiration date, because even at the current low interest rates, there is only so much debt that the consumer can carry, given that we will likely never see a new peak in median US household income again.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.