Why are Real Wages Stagnating and the Stock Markets Booming?
The news is full of how the Sensex, S&P, Dow Jones Index, and the Nikkei Index zooming to ever greater heights and breaking “records” every day. At the same time, the “real” economy is stagnating and the reports of farmer distress, worker angst, and the sufferings of the man/woman on the street are all too “visible”, even if mainstream media chooses to gloss over the latter and celebrate the former.
So, what explains this “disconnect” and “divergence” between the Stock Markets and the broader economy? Moreover, the returns from savings like Term Deposits (the favorite savings instrument of choice for the middle classes and more so, for the retirees) decline every year even as the Sensex “smashes” through “ceilings”, much like Thalaiva in the blockbusters).
This dichotomy can be explained by The Law of Diminishing Returns, which states that returns from investment begun to taper off after a while and diminish in value leading to marginal gains. So, when returns start to turn into trickles, why would any Entrepreneur or Industrialist invest in building factories, plants, and other tangible assets, which not only require humongous Capital outlays, but also take time to fructify, before they start offering meager returns.
In recent years, maverick economists have theorized that Four Units of Investment are required for Each Unit of Return, as measured in the GDP or the Gross Domestic Product calculations. On the other hand, stock markets are “played “ anticipating the arbitrage based profits wherein each unit invested in them yields returns relative to the prevailing interest rates.
So, when Central Banks keep interest rates at historical lows and in some countries, at Zero, capital flows wherever relative returns are higher. In other words, speculative investments yield higher returns than investments in Fixed and Tangible Assets. This is the key reason why more and more investors flock to the Stock Markets and fewer and fewer of them invest in Physical and Employment generating activities.
The only solution to this would be to incentivize capital intensive investments and raise interest rates to discourage excessive speculation. Of course, the present schism between the speculative and capital intensive cogs of the economy can be traced as far as 1971, when President Nixon took the United States off the Gold Standard and set in motion the Neoliberal Dogma that haunts us to this day.
With so much of our lives being dominated by neoliberal principles, it is hard to see if anything would change in our lifetimes unless Bernie Sanders becomes President. This is also the reason why the Democrats are finding it hard to garner votes for their ambitious Spending Bills, as Biden has promised to undo the damage caused by the Reagan-Thatcher neoliberal consensus of Supply Side Economics, with Tax Cuts for the Rich and Limited Government for the Poor.
Originally published at https://rammohansusarla.substack.com on October 17, 2021.