defense and law enforcement. In many other countries the state owns major oil companies, aircraft manufacturers and so on, in which case it is involved in productive wealth creation. But the type of ownership doesn’t affect the points I’m trying to make.
As an economy develops, more raw materials are taken from the earth, more crops are grown and more goods are produced, resulting in overall growth in the economy and continued expansion of the workforce. Figure 4 shows how the world’s population grew in the 20th century, and how that growth was supported by the extraction and harvesting of the earth’s natural wealth.
Figure 4
As the population grows, demand for goods increases, more jobs are created and the cycle feeds itself. As Henry Ford understood when he raised wages so that his employees could buy Ford cars, the workers are also the consumers.
A developing economy moves from reliance on the Primary Sector, through an expanded Secondary Sector until eventually the majority of its workforce is engaged in the Tertiary Sector.
This transition occurs because human ingenuity, when applied to the needs of these developing industries, leads to increased mechanization, which brings productivity gains in the first two sectors. The wealth of an industrial society accumulates over time, and this wealth supports the growth in services.
Figure 5 illustrates the development of the US economy from 1850 to the present day. We can see the trend away from working on the land, the rise and fall of factory work (with a boost during the Second World War) and the eventual domination of the service sector. This can also be read as a move away from the wealth-creating sectors to the wealth-distributing sector. We see also how the trend begins to flatten out as the development cycle reaches its limits, or even overshoots its limits, as I will explain later.
Figure 5
I use the US as an example of a developed economy because of its size and the variety of its industry, and also because it provides reliable historic data, but the pattern for countries such as Britain and France is similar. We can see the same pattern in a different way by looking at three countries at different stages of development in 2010, as shown in Figure 6.
So most developed countries these days rely overwhelmingly on the service sector for the bulk of their economic activity, and especially for employment. There are a few exceptions to this rule, however. Canada and Australia, for example, have large mineral-extracting industries, and the German economy still has a substantial manufacturing base. And it just so happens that these three countries were less affected by the crash of 2008, because they earn more real wealth. Germany exports high-value goods such as cars and machine tools to the booming economies of China (where there is new wealth from manufacturing) and Russia (which has wealth from oil and gas).
Figure 6
I would suggest, therefore, that the economic problems affecting most developed nations today are primarily a result of the decline in the primary and secondary sectors relative to their overall economies. Too much reliance has been placed on the service sector for employment, and, although during the boom years the service sector created millions of well-paid jobs, the wealth still had to be created originally by the primary and secondary sectors. We lost sight of this fact.
We came to believe that the financial services ‘industry’, for example, created wealth, when all banks really do is take wealth that has already been created in the real economy, much of which is now held in large investment funds (in other words, other people’s savings and pensions), and try to profit by lending that money, or by borrowing more money against it (leveraging) and speculating in things like derivatives, in the hope of making still more money. But this whole business, which according to GDP figures adds around five trillion dollars a year to the global economy, does not actually create a penny in real wealth. The nature of derivatives, which form the bulk of financial trading these days, is such that when one trader gains, someone else must lose. This is comparable to the more obvious forms of gambling, only worse, because the loser might not be another gambler, but rather an innocent investor, or pretty much anyone (more on this in later chapters). Does the betting shop or the casino create wealth? Of course not.
So that five trillion dollars wasn’t really new wealth at all – it was a combination of wealth that already existed and credit that had been artificially created by leverage. A lot of that existing wealth will have crossed international boundaries, so in that respect nations such as Britain and Switzerland gain, but, from a global perspective, financial services don’t create wealth. What they create is debt.
As the proportion of actual wealth creation in the economy declines relative to wealth that has accumulated from past industry, as it inevitably must do, the dynamics of the global economy change with it. The influence of the financial sector grows at the expense of the productive sector, with unfortunate consequences for the majority of the world’s population.
Yes, banks provide a useful service to industry, and have done for thousands of years, but since the 1970s, after money lost its link to gold, the bulk of banking activity has been increasingly detrimental to the economy. If it weren’t for the rapid growth of the financial sector, the last recession would not have happened – or at least it would have been a lot less severe, and the Eurozone wouldn’t be in the mess it’s in now. The credit bubble gave us artificial growth, and now we must return to reality. The value of the dollar, and currencies generally, has been falling, and will have to keep falling until the amount of supposed wealth in the world corresponds to the amount of real wealth that’s been created. This has serious implications for the global economy over the next decade or two, as the long-term trend for falling prices, as shown in Figure 7, goes into reverse.
I’ll return to the issue of rising prices later, but first I want to think a bit more about the balance between the productive and non-productive sectors.
Figure 7
Different kinds of wealth
Perhaps I should clarify this point about wealth creation, because although in some respects it might seem obvious, I have a feeling that some politicians and economists might disagree with me when I suggest that what amounts to almost 80% of the British economy, according to GDP figures, doesn’t create any wealth. Is it really possible that 20% of the workforce – around 10% of the population – is supporting the rest of us?
Well, no, it isn’t. For one thing, Britain imports wealth from other nations via the City of London, and for another thing, as I’ve already mentioned, GDP figures give the wrong picture.
Let’s think for a minute what service jobs involve. Whether you’re a shop assistant, a hairdresser, a bus driver, a waiter, a banker, a marketing manager, you aren’t really creating wealth. All you are doing is taking money from your customers in exchange for a particular service. Even if you’re a doctor or a lawyer, a police officer or a judge, the same principle applies – you are paid for providing a service. That service enriches the economy, certainly.
