It has been half a decade that the world has been struggling with recession.
While some would say that the increase in purchasing power of the common man has lead to the crisis, many believe that it is safe to say that the low lending rates for a prolonged period were responsible for the crisis. Now, in order to undo what has been done, high interest rates have become the solution. This is what the banks around the world are currently looking at doing.
One of the most obvious reasons why the general health of the world economy has weakened is because of certain market areas that remain hugely untapped. Historically, the world economy performed its best when the access to newer market areas was constant, open and reciprocal. This way the mass production of one country may significantly reduce the inflation of the trading country.
The decline of the global economic health can be marked from the late 2000’s and can be attributed to a lack of innovation, just as Schumpeter had warned, and also due to over-investment in certain sectors that have yielded profits at the cost of efficiency of production.
The summation of actualities that point towards the two skewed factors that dissipate the level of production are:
– Over Investment: The Production Function analysis thoroughly describes efficiency and the ways to optimize the combination of various inputs and output. Hayek also theorized about over investment and the dangers of it. But the current happenings in the market tend to point this towards the herd behavior of investors while there are quite a few, if any, ineffective measures to counter over investment.
– Lack of Innovation : The economy is at equilibrium until an entrepreneur forays. The collision of entrepreneurship is by all means a failure of innovation. There has been a significant drop in innovation of newer sectors, while the development of already existing products remains unharmed.
The fact that the production mechanisms are not efficient or innovative enough to keep investors or consumers interested is the end result of these processes.
Hence, to curb the rising costs of production, the manufacturers turned to East Asia in order to tap the available abundant resources and poured in billions of dollars worth of investments for the local labour force to mass produce in order to satiate the burgeoning demands of the West. The demands have further increased due to the low lending rates maintained by the traditional banking institutions.
While the Orient kept manufacturing with the investment that poured from abroad, it subsequently lead to higher labour wages coupled with inflation. The rise in prices created a demand for more wages and an increase in wages lead to higher prices that would once again add up to the inflating price indicators. So, we are looking at a scenario where GDP growth rates are the main creators of the so-called bubble in the market, as the projected increase in production is due to inflation and is disproportionate to output in terms of goods and services.
However, the imminent market bubbles will not prevent the manufacturers from investing in countries that have cheap production costs, at least not for the time being. In fact, reports suggest that in a few years time the production costs in China will be the same as the production costs in the US while, two decades earlier, the production costs in China on were, on average, between 30-50% the cost of manufacturing in the US.
In many developing countries, particularly the export oriented ones, the rise in fixed costs are higher than the rise in variable costs, which is the reason why companies are unlikely to relocate. Companies decide to stay on based on the level of output generated. Incomplete technology transfers and a manufacturing base focused on the production of cheaper, non-hi-tech products is responsible for lack of scope for innovation and saturation in terms of fund-allocation.
The path to recovery seems long and arduous but it can be cut short by adopting the same basic principles of Production Economics by tweaking the prevalent monetary policy of “Cheap Lending and Over Production”. Whether the current methodology is likely to change, however, is entirely another matter.