West risks economic collapse with its ‘paper boom’

By Mark Bourrie, Third World Network Featuures/IPS, 1927/99, July 1999

Canadian economist Jim Stanford says that much of the prosperity of the West is built on investment securities such as stocks, derivatives, mutual funds and commodities futures that have values that bear no relation to the real economy. Money raised by the stock market isn't going into new factories, machinery, job hires, or research. It's lining the pockets of speculators.

Ottawa: The West is in the midst of a paper boom, economic prosperity built on speculation, rather than on creation of real goods and services, says economist Jim Stanford.

In his book Paper Boom: Why Real Prosperity Requires a New Approach to Canada's Economy (published by Lorimer Co. and Canadian Centre for Policy Alternatives, Toronto, 473 pp), Stanford says that, as factories in developed countries become older and research and development slows down, investment shifts from productive enterprises to the casinos of Wall Street and the world risks the kind of economic collapse that it faced in 1929.

The book is written for a Canadian audience, but the economic models it uses fit the economic situations in the United States, Great Britain, Hong Kong, Australia, and other countries where the current economic boom is built primarily on increases in the values of securities, especially those with very high price-to-earnings ratios.

During the past decade, unemployment in Canada has hovered around 10%, with only a slight drop since the 1990-92 economic recession ended. Interest rates, adjusted for inflation, are near an all-time high.

The Canadian dollar has rebounded slightly this year, but has been in a steady decline against the US dollar since the 1970s.

More distressing, Canadian industry was ravaged by the Canada-US Free Trade Agreement of 1988 and the North America Free Trade Agreement of 1994.

Factories moved to Mexico or to the right-to-work states in the south of the US. Workers in many of the factories that stayed behind were threatened with job loss if they tried to negotiate higher wages or went on strike.

And, since 1994, nearly 100,000 public sector jobs have been cut in Canada as local, provincial and the federal governments balance their budgets. Wages for those government workers who still have jobs have been frozen for most of the decade.

Yet Canadians believe they are in the midst of a period of economic prosperity, Stanford says.

Governments are consistently re-elected, and conservative opposition parties blame the decaying buying power of the average wage-earner on high taxes and push for more public sector cuts.

Stanford, a Cambridge-trained economist with the Canadian Centre for Policy Alternatives, a progressive think-tank, asks the question: What do Canadians actually create?

It turns out that Canadian wealth, and much of the prosperity of the West, is built on investment securities such as stocks, derivatives, mutual funds, and commodities futures that have values that bear no relation to the real economy. Money raised by the stock markets isn't going into new factories, machinery, job hires, or research. It's lining the pockets of speculators.

Those financial investments are worth no more to society, ultimately, than the paper they're printed on, Stanford said in an interview.

It is real investments, in real world assets, which are useful to the actual production of valuable goods and services—things like machinery, equipment, computers, factories, offices, shopping malls, infrastructures, mines. Those real investments are a crucial source of job creation.

The connection between financial investment on one hand and real investment on the other has never been more indirect and uncertain than in the 1990s, Stanford says. As the paper economy boomed, the real economy went nowhere. In fact, the paper boom in many ways has had a perverse impact on real growth, on real capital formation, and real job creation.

People and politicians in Canada should worry when the paper economy grew per capita by 40%, while real capital investment in physical plants and research grew by only 4% this decade. Much of that growth was in commodity production, which has prospered from the fire sale prices set by the low Canadian dollar.

Stock markets have virtually nothing to do with real investment by real businesses. Between 90 to 100% of real investment by businesses in Canada is financed internally by their own cash flow, Stanford says.

The paper boom was engendered by the permanent rise in real interest rates engineered since the 1980s, the subsequent slowdown in real economic growth and the fall in capacity utilisation in business, and the sustained fall in business profitability that has been experienced in the post-war era.

At best, the world of finance is mostly a sideshow to the nitty-gritty real world processes of accumulating capital gods, creating jobs, and producing things of real value, he says.

And at worst, of course, the booms and busts of finance can be an actual hindrance to real growth and real investment, especially at times of financial crisis and instability.

Governments, he says, must shift the emphasis of government policy and private entrepreneurship away from the financial sphere and the paper economy, and focus it on real capital accumulation and real growth.

But he also believes tax incentives must be established to reward investment in real capital and dampen speculation in securities.

There's a gap between words and deeds that permeates both right-wing and left-wing views regarding real investment spending, Stanford says.

Conservative politicians wax eloquent about the need to improve the investment climate, but most of their policies are about redistributing the economic pie, not growing it, and, strangely, promoting real investment seems very low on their economic priorities.

Take the issue of tax cuts, he says. This tax revolt has been focused almost exclusively on cuts to personal income tax but economists of all stripes agree that if there's one area where taxes could be cut to create jobs, it's in corporate taxes for re-investment.