The Western Economies Are Much Weaker Than We Thought Lack of innovation and the high cost of generous welfare programs led to stagnation or decline

WASHINGTONThe Economist warns us in a recent Leader (Editorial) that the world economy is “Weaker than it Looks“. Indeed, Except for Britain and the US, within the developed West anywhere you look you see only very modest growth or recession, with Germany now possibly joining the ranks of the weak.

Monetary policies will not do it

Much can said about the real impact of loose monetary policies pursued by all central bankers. But the idea that cheap credit alone will perform some kind of (cost free) economic miracle borders on lunacy.

Likewise, the parallel notion that weak countries by devaluing their currencies can create an export-led boom that will in turn create widespread prosperity is a dangerous fantasy.

Lack of innovation and negative demographic trends

The truth is that at least two major systemic problems are affecting the economic performance of all developed countries. The first one is lack of innovation capable of improving productivity and quality of life while creating new jobs.

The second is the now umbearable cost of large and now super expensive entitlement programs. Retirement and health care benefits were designed long ago by policy makers who could not have imagined that over time there would be too much money spent on too many people who also live much longer, therefore costing a lot more. There simply is not enough revenue to fund all these programs while investing in infrastructure, education, national security, justice and everything else.


Yes, we do live now in the “Great Stagnation”. At the beginning of the last century there was an eruption of great inventions that quickly transformed in a very positive way the lives of millions in the Western World. Think about it: electricity instead of candles, the internal combustion engine instead of horses, airplanes instead of steamers, improved sanitation that cut the impact of diseases, mass production that made basic consumer goods affordable, improved agriculture that allowed limited land to feed many more millions. And the most critical point is that the combined impact of all this innovation was the creation of new employment. Modern factories needed millions of workers.

A different universe

But now we are in a different universe. Globalization has encouraged the mass migration of all labor intensive manufacturing and services from the West to lower cost countries. Besides, whatever manufacturing we have left is becoming more and more automated, therefore requiring fewer workers.

Meanwhile, we do not see innovation that will cut costs, while improving quality of life. Try as we may, we still do not have any breakthrough in creating new sources of clean and really cheap energy. Efficient electric cars are now a possibility; but not yet a reality. For our long distance travel we still use the same antiquated jet engines that were developed at the end of WWII. Medical researchers have yet to come with major cost-effective discoveries. Stem cell research is in its infancy. Cancer therapies, when they exist, are stupendously expensive. We cannot prevent or cure Alzheimer disease, or other forms of dementia. This means spending colossal amounts of money to care for more and more elderly people who have lost the ability to be autonomous. We control AIDS but we cannot cure it. And we do not even have sure remedies to combat yearly outbreaks of influenza that kill thousands while costing a lot.

Sure, we have ICT. The internet has changed the world. But that’s about it when it comes to IT truly historic breakthroughs. And, quite frankly, while social media used by millions may have enriched its founders I fail to see its broader economic impact in terms of enhanced productivity or as an engine of innovation.

All this means that, unlike in the past, technology is not opening large new sectors that create new high paying jobs, while improving economic productivity.

Entitlements cost too much

And then we have the welfare state and its growing cost. Simply stated, various entitlement programs were designed in a different era, with different demographics. Social Security or equivalent programs always assumed a large pool of active workers who would support a relatively small number of retirees who would live only a few more years after they stopped working. Well, this is no longer so. Fertility rates have plunged across the Western World, with declining populations in Southern Europe, South Korea and Japan, while life expectancy has improved substantially.

This means that a smaller and smaller number of active workers now is supporting a larger number of retirees who live much longer. This is clearly becoming financially unsustainable. However, since the very idea of cutting benefits is politically unpalatable, most governments carry on with the same programs. As they cannot pay for them, they borrow the difference, this way creating an equally unsustainable public debt.

Add to this enormous burden the cost of publicly provided health care and other benefits to other deserving constituencies and you have the crisis of the modern state. Too many benefits. Not enough revenue.

Not enough wealth produced

Well, even though this may look simplistic, here are the key causes for economic under performance. Not enough wealth is produced, while states keep spending money they do not have. The fact is that we are much poorer than we think.

Given the size and significance of these large systemic problems, the very notion that the US Federal Reserve, the European Central Bank and the Bank of Japan can fix all this with clever monetary policy borders on lunacy.

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