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Posted on July 6, 2025

THE BUSINESS OF ECONOMIC CONTRACTION

Foreword

As you may know, it seems clear that the World economy has either already stopped growing and started to shrink, or will have done so by 2030.

Some readers are interested in the theoretical analysis which leads to this conclusion, whilst others want to know more about what this process is going to mean in practice. The best solution might be to aim for a simultaneous advancement of clarity about the fundamentals and an advancement of consequence where practical matters are concerned.

In Henry’s paradox, we take a look at some of the practical consequences for business of the ending and reversal of growth. In a future article – the working title is Robert’s paradigm – we’ll examine some of the political implications of economic inflexion. Finance might merit a further article in this series.

‘Big business’ has always excited suspicion, and this has only intensified in an age in which greenwashing, greedflation, financial engineering and corporate welfare have been added to the lexicon.

So it needs to be stressed that this article looks at the consequences of economic contraction from a business perspective. The behaviour and motives of corporations belong in the sphere of politics and government, not of business itself.

1

A tale is told about the first robots introduced onto car assembly lines. A factory manager shows one of these new machines to a labour leader, saying “try to get that to join your union!”

The union man’s response, of course, is “try to get it to buy one of your cars”.

The story might be apocryphal, but the paradox is real. In microeconomic terms, paying high wages eats into the bottom line. Macroeconomically, though, low wages in the economy mean weak demand for all businesses’ products and services.

This was why Henry Ford favoured paying his employees a lot more than might have been strictly necessary, understanding that his (and others’) workers were the motorists of the future. He famously more than doubled the daily wage of most of his employees in 1914.

In more recent times, a partial answer to “Henry’s paradox” has been to augment comparatively low real wages with an abundant availability of credit.

Consumers nowadays routinely use credit for purchases which in earlier times were paid for out of disposable incomes or savings. Rapid credit expansion carries serious risks but, until quite recently, they have not been immediate risks.

And, as J.M. Keynes famously put it, “in the long run, we’re all dead”.

2

The resort to credit expansion gained enormous impetus from the globalization trend which took hold in the 1990s.

In the broadest of terms, the aim of globalization was to combine – profitably – the outsourcing of production to the low-wage East and the continuation of high and rising consumption in the affluent West.

For Western economies, this created a structural gap between subdued wages and high consumption, a gap which could only be bridged by making large amounts of credit readily available.

The adoption of the “credit adventurism” of abundant accessible debt thus served two purposes. In microeconomic terms, it provided the financing for profitable globalization whilst, macroeconomically, it seemed to offer a possible solution to the perceived “secular stagnation” of the 1990s.

It was no coincidence at all that the soundtrack for the inflow of cheap manufactured goods from the Far East was the thud of credit offers dropping into Westerners’ letter-boxes.

This trajectory necessarily led towards lowering the real cost of credit, in order to keep the rising mountain of debt and quasi-debt affordable.

This, as we know, put the financial system onto an arc of inevitability, whereby the “credit adventurism” of the 1990s led directly, via the global financial crisis (GFC I) of 2008-09, to the “monetary adventurism” of QE, ZIRP and NIRP.

Even without the onset of economic contraction, the next destination along this arc is the value-destroying monetisation of debt.

“But this”, as the saying goes, “is to anticipate”.

3

Globalization also led to the hollowing out of Western economies, and to an enormous rise in the proportion of Western economic output attributable to services rather than to production.

A customer in Baltimore might buy a car made in Beijing, or a washing machine manufactured in Bratislava, but he isn’t going to get his hair cut in Barcelona, or summon a taxi from Brisbane.

Globalization, then, drove a seismic shift of emphasis from manufacturing to services in the Western economies.

Using BEA data, we can usefully divide reported American GDP into globally-marketable output (GMO) and internally-consumed services (ICS).

The latter, which includes services provided by the government, grew by 96% between 1997 and 2023, whilst globally-marketable output increased by only 41%.

ICS accounted for fully 88% of all GDP growth during that period.

Because of the government component, these internally-consumed services have been boosted by escalating Federal debt. They also include imputations, which are statistically-calculated values ascribed to services for which no money actually changes hands.

Net exports of services are included here in globally-marketable output, but these net exports have never been big enough to make much of a dent in the swing from GMO to ICS.

Fig. 1

4

The adverse implications of hollowed out economies have recently become glaringly apparent, an issue which Mr Trump seems determined to address.

This is critically important to the international balance of power and influence. At its most extreme, for example, a country which has no domestic steel industry ultimately has no defence capability whatsoever.

Manufacturing capacity matters a lot more than the small and falling share of Western GDP ascribed to it. It’s been estimated that China can now build 230 tonnes of shipping for every tonne made in the United States.

The truism that ‘access to oil decided the outcome of the Second World War’ needs to be modified to ‘access to oil plus manufacturing capacity was decisive’. No amount of oil could have ensured an American victory in the Pacific without a corresponding ability to use that oil for the production of warships, guns, tanks and military aircraft.

It isn’t the job of business leaders to determine the optimal balance of manufacturing and service activities in the economy.

Western governments seem to be discovering – somewhat belatedly – that we can’t base an effective defence capability on an abundance of social media posts, advertise our way to global influence, or base national security on advanced military technologies alone.

But these are calls that need to be made in the corridors of power, not in the boardrooms of for-profit organizations.

5

The task of the corporate leader is to make profits for shareholders, not to promote innovation for the sake of innovation.

This is why some pharmaceuticals companies don’t concentrate research on clinical voids (conditions for which no treatment currently exists), but invest instead in developing me-too competitors in fields where there are already plenty of available products.

America’s six big technology companies have been hugely effective in generating profits, but haven’t, in recent years, done this with much in the way of wholly new, ground-breaking technologies.

Meaningful progress was made when cell-phones were scaled down from the heft of a brick to something the size of a card wallet. On-line retailing was a genuinely revolutionary idea, but it dates back to the late 1990s.

Social media, likewise, is now an old invention, whilst unit sales of smartphones peaked back in 2015. Google’s mapping was a real innovation, but that, again, is no longer new.

Credit for more recent breakthroughs could be accorded to Nvidia. But it’s far from clear that lack of access to the company’s advanced chips has hampered Chinese technological advance, which may, indeed, even have been stimulated by the need to innovate around this obstacle.

“Where’s my flying car?” is a question that’s often posed, highlighting the differences between actual achievements and the technological promises of the past. To be sure, 2064 is still a long way in the distance, but it’s unlikely that, by then, a Thunderbirds world of nuclear-powered aircraft, and manned rockets capable of travelling as far as the Sun, will have been realised.

Quite rightly, the validity of technology depends not just on practical feasibility, but also upon potential returns on investment.

If self-driving cars do eventuate in large numbers, they will do so, not because the ordinary motorist necessarily wants to pay a premium for them, but because their higher costs are outweighed by the savings to be made by running taxi services without the expense of paying drivers.

On the same basis, even if travelling to Mars became technically feasible, it would be hard to make a profitability case for actually doing it.

6

This view of technology, of course, takes us back to “Henry’s paradox”, in the form of how to support demand when workers are replaced by machines.

And this is where AI comes into play, representing – perhaps – the first big technological leap forward since the invention of the internet, the development of the smartphone and the mapping of the human genome.

For its critics, AI is little more than a ‘search engine on steroids’, or a way of accessing creative content (music, film, books) without paying for it.

Enthusiasts counter that AI will bring about an industrial revolution, and claim that artificial intelligence can deliver genuinely transformative technological advances.

This may be true, but two questions – not one – need to be asked here.

First, can AI deliver satisfactory returns on the enormous amounts of capital invested in it? This question has been given greatly enhanced importance by the unveiling of China’s low-cost DeepSeek product.

Second – and even more importantly, in a world of increasingly constrained natural resources – it’s not enough just to find ways of making AI profitable, or of finding financial solutions for the demand effects of eliminating swathes of skilled jobs.

We also need to ask – not just of AI, but of all potential technologies – ‘can they earn worthwhile returns on the very large quantities of energy and raw materials which their development and operation will require?’

This re-frames the question of where the “big prizes” in technology are to be sought.

Does success still lie in the invention of the new, or has it shifted to the discovery of better, more resource-efficient ways of accomplishing what already exists?

7

The new wild card in the deck is the ending and reversal of growth in the “real” economy of material products and services. This moment of inflexion from economic expansion into contraction is undoubtedly imminent, and might, indeed, have already arrived.

Stated at its briefest, the productive process which uses energy to convert raw materials into products, artefacts and infrastructure has long been losing momentum as fossil fuel energy is depleted.

The ECoEs – the Energy Costs of Energy – of fossil fuels have been rising rapidly, and no proven equivalent or lower cost alternatives exist.

At the same time, non-energy resources – including minerals, water and agricultural land – have been gradually but relentlessly degraded.

We can’t ‘fix’ this problem using financial innovation, because money is an operating adjunct of the underlying material economy. Since these issues relate to the characteristics of materials, their parameters are framed by the laws of physics, laws which no amount of technological advance can repeal.

What we are left with is a shrinking material economy whose adverse implications are exacerbated by the rising real costs of energy-intensive necessities. This imposes relentless compression on the affordability of discretionary (non-essential) products and services.

This process is going to call time on our ability to sustain a simulacrum of ‘business as usual’ through the juicing of the financial system with ever-accelerating credit expansion.

8

This situation presents business leaders with a critical choice.

They can accept the reality of the onset of material economic contraction.

Alternatively, they can continue to rely on the pronouncements of an out-dated economics orthodoxy which has always assured us that “exponential growth can go on forever in a finite world”.

There might be popularity, but there has never been much merit, in disregarding the unpalatable, and the ending and reversal of growth is about as unpopular and as unpalatable as it gets.

It would come as no surprise at all if the smartest corporations started to investigate, privately, the possibility that the economics orthodoxy is mistaken, and that they might need to establish a leadership stake in a very different future.

The point to be pondered is this. Can the illusion of the infinite in economics last long enough for present purposes, or will the consequences of material limits arrive within a commercially meaningful timeframe?

Fig. 2

9

How, then, will economic contraction play out in business?

Start by imagining that you own a bridge, of which the fixed costs – including operation, maintenance, repair and administration – total $10m per year.

On top of that, you need to set aside $5m annually in depreciation for the building of a replacement bridge when the existing one reaches the end of its useful life, plus another $5m to provide investors with a satisfactory return on their capital.

If 2 million people use this bridge, you need to charge each customer $10 to cover your $20m of aggregate costs (operation, depreciation and capital).

If, though, the number of users falls to 1 million, you have to raise your unit price to $20.

But doing this might very well trigger a vicious spiral by driving further declines in customer numbers, if people are unwilling – or unable – to pay this higher usage charge.

To stay viable, you might need to reduce the depreciation charged against earnings. This means that you won’t be able to build a new bridge when the current one wears out.

You might also be forced to reduce the return that you provide to investors.

These prospective diseconomies of scale have negative implications, then, both for returns on existing invested capital and for future investment in new and replacement productive capacity.

But they are by no means the only, or even the largest, adverse business consequences of a contracting material economy.

10

Another is the potential loss of critical mass. As other businesses suffer the effects of material economic contraction, some of the components or other inputs that you need might become unaffordable, or cannot be sourced at all.

Cost reduction can only go so far in countering the effects of the taxonomy of de-growth, although de-layering the organization, and cutting down on the outsourcing of the non-essential, are obvious defensive moves.

A critical process here is simplification, which comes in two forms.

Simplification of product means reducing the variety of goods or services offered to the customer. Does the consumer really need to choose between 50 varieties of breakfast cereal, or will his or her needs be met by an offer of just ten?

Simplification of process means reducing the complexity of the ways in which goods or services are produced. This could involve standardisation of methods and inputs, and using a smaller number of components to manufacture a widget whose production process has been intelligently re-designed. This simplification can provide some defence against the risks of loss of critical mass.

Of course, discretionary compression might mean that some businesses are just the wrong places to be. There seem to be various versions of the statement that ‘a recession is when you have to tighten your belt, and a depression is when you have no belt left to tighten. If you’ve lost your trousers as well, you’re probably in the aviation business’.

11

As the economy grew larger, so it became ever more complex. As the economy shrinks, the tide of complexity can be expected to recede.

Simplification of product and process is a strategy consistent with this broader trend towards the de-complexification of the economy.

The eventual destination – for governments as well as for businesses – might be the disappearance of top-down, centralized organizations and their replacement by more localized, bottom-up alternatives. This could result in pockets of growth which offset, if only in part, the broader trend of contraction.

If this is the case, the successful portfolio business of the future might be based, not just on the avoidance of discretionary sectors, but on constructive engagement with the new shape of a shrinking and de-complexifying economy.