The Veil of Circumstance: Technology, Values, Dehumanization and the Future of Economics and Politics 9789814762564

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The Veil of Ci rcu msta nee

The ISEAS – Yusof Ishak Institute (formerly Institute of Southeast Asian Studies) was established as an autonomous organization in 1968. It is a regional centre dedicated to the study of socio-political, security and economic trends and developments in Southeast Asia and its wider geostrategic and economic environment. The Institute’s research programmes are the Regional Economic Studies (RES, including ASEAN and APEC), Regional Strategic and Political Studies (RSPS), and Regional Social and Cultural Studies (RSCS). ISEAS Publishing, an established academic press, has issued more than 2,000 books and journals. It is the largest scholarly publisher of research about Southeast Asia from within the region. ISEAS Publishing works with many other academic and trade publishers and distributors to disseminate important research and analyses from and about Southeast Asia to the rest of the world.

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The Veil of Circumstance Technology/ Values1 Dehumanization and the Future of Economics and Politics

J~rgen 0rstr~m M~ller

I5EA5

YUSOF ISHAK INSTITUTE

First published in Singapore in 2016 by ISEAS Publishing 30 Heng Mui Keng Terrace Singapore 119614 E-mail: [email protected] Website: All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the ISEAS – Yusof Ishak Institute. © 2016 ISEAS – Yusof Ishak Institute, Singapore The responsibility for facts and opinions in this publication rests exclusively with the author and his interpretations do not necessarily reflect the views or the policy of the publisher or its supporters. ISEAS Library Cataloguing-in-Publication Data Møller, J. Ørstrøm. The Veil of Circumstance : Technology, Values, Dehumanization and the Future of Economics and Politics. 1. Technology—Social aspects. 2. Technology—Political aspects. 3. Technology—Economic aspects. I. Title. T14.5 M71 2016 ISBN 978-981-47-6255-7 (soft cover) ISBN 978-981-47-6256-4 (e-book, PDF) Typeset by Superskill Graphics Pte Ltd Printed in Singapore by Mainland Press Pte Ltd

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Contents Foreword vii Preface ix Acknowledgements xvii 1.

The Conventional Outlook

1

PART I: THE PROBLEM 2. How Did We Get into This Mess? How Do We Get out of It? An Overview

21

PART II: POLITICS 3. Steering System

51

4.

Cost of Running a Society

94

5.

Concentration of Capital, Corporate Governance, Power

116

6.

Business Model — The Firm

135

PART III: ECONOMICS 7. The Transition

151

8.

164 164 176 183 193 198

Change in Economics 8.1 Consumption Function 8.2 Production Function 8.3 Market, Prices and Sharing/Renting 8.4 Relative Factor Prices 8.5 Distribution of National Income

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8.6 Tax System 8.7 Work

204 208

9.

Human Behaviour

216

10. Interdisciplinary — Complexity

230

PART IV: GEOPOLITICS 11. Power Shift — Values

245

PART V: CONCLUSION 12. Conclusion

265

Bibliography 277 Index

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Foreword* It is more than fifteen years since Joseph Stiglitz wrote Globalization and its Discontents, with the message that there is evidence of much unhappiness with the way global reforms have been taking place and how they have impacted developing and poor countries. Stiglitz concluded that the main issue is not with globalization, but rather that the process of management was very much lacking. And now Stiglitz in his latest book, Rewriting the Rules of the American Economy, has argued that the message he had about globalization is now affecting the advanced economies. Professor Jørgen Ørstrøm Møller is never one to evade the complexities and subtleties of current affairs. He pursues the issues of the day with an intellectual curiosity, clarity of thought, and completeness that is enriched by his vast experience in the Danish diplomatic service, policymaking and academia. In this book he uses an interdisciplinary approach to discuss the intrinsic issues, including globalization, that are shaping the world. Professor Møller identifies the pessimism in current affairs and the apprehensiveness in the global economy as a veil over policymakers. He proposes that a paradigm shift is needed to lift this veil. The concept of a paradigm shift — a fundamental change in approach or underlying assumptions when existing ones can no longer serve as a framework to a discipline — is rooted in science and technology. While there is much debate on the effect of science and technology on the economy, they are much more profoundly felt across the human landscape. In health sciences, advances in biotechnology such as embryo selection, where we can cultivate and screen embryos for genetic diseases, and gene splicing, where we can then proceed to edit out the diseases we have missed, promise to revolutionize human reproduction and healthcare. *This Foreword has benefitted from a discussion with and additional materials from Zach Lee Jian Lin.

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Robotics, big data and artificial intelligence form the basis of technologies such as self-driving vehicles, drones and 3D printing that loom over our contemporary workforce. The use and usefulness of social media continue to be topics of debate. The Pokémon Go phenomenon has shown how virtual reality is being inverted into augmented reality. In the current political and societal climate, where populism and personalities trump logic and reasoning, how do we grapple with political and power structures, societal values and economic theory to reasonably frame and implement a conversation about the impact of these technologies on our future? One would hope that this will not be hindered by a veil of ambiguity in forming an accord on applications and regulations that could have serious implications for the human race. This need for clarity and balance is maintained in the book with a discussion on dehumanization and denaturalization. The decoupling of economic theory and environmental challenges can be seen as such. A convergence towards the valuation of the environment through a combination of engineering, earth sciences and social sciences, with a healthy dose of assessing the human appreciation of our environment, can help us in creating policies and systems that will be vital in maintaining a balanced world of growing scarcity. With such a broad canvas, this book is an excellent platform for policymakers seeking to lift the veil of current affairs and take a glimpse at the future. It serves as a companion piece to Professor Møller’s previous volume on How Asia Can Shape the World, and both books will do well to trigger further meaningful debates on the progression of human civilization. While Stiglitz’s point is about managing the needed change in globalization, Møller’s argument is to reinforce a better global governance, and a challenge for world leaders and policymakers to create a new world where not only science and technology matter but also to achieve some semblance of sanity where deep consciousness can take root, where inspiration, thought and creativity, strong bonds and cohesion in and across societies deepen, making cultural identities count, and above all where materialism fades. Professor Euston Quah President, Economic Society of Singapore Head of Economics, Nanyang Technological University Singapore

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Preface Over the last two decades, three issues have occupied my mind: 1. Has the digital era segmented or united the world? Has instant access to data and global networking made people more broad-minded and tolerant of diversity, or has it merely reinforced the views of likeminded individuals? 2. People accept globalization when it delivers prosperity and winners outnumber losers. But will globalization be more resented and resisted as the world enters a long period of slow or no growth? 3. How can in-groups that share common values deal with out-groups that don’t? Is it possible to be truly inclusive without demonizing those that are outside the tent? My modest aim in this book is to dissect these questions from an historical perspective — to see how far the world has come, and what lies ahead if current trends continue. * * * * * So, let us begin with history. From 1618 to 1648 Europe was torn apart by a devastating and ruthless war. It was waged with a fanaticism nourished by religious extremism, which absolved soldiers who committed atrocities because it was God’s will and done in God’s name. Out of this debacle came the Westphalian system, giving rise to the nation-state. Fundamentally, the conflict in Europe was about who should have the right to define ethics, norms, values and behavioural patterns in a Europe baffled after Martin Luther’s challenging of the Catholic Church, and still struggling to digest the social repercussions of the information revolution inaugurated by the printing press and movable type.

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The global picture today resembles this earlier situation in many ways — the religious fanaticism, the chaotic warfare and social breakdown all speak to our liveliest fears of today, especially when their effects can be multiplied by the sinister use of modern weaponry and technology. The Thirty Years War put Europe on the road to a unique constellation of military power, economic influence and political thinking. The main thread was the jump from the local to the national level. People lost their affiliations to smaller communities and stopped knowing or caring about their neighbours. This initiated a long march towards dehumanization, denaturalization and high power distance. Before the Thirty Years War, “power” was rarely exercised outside the local level. After the Thirty Years War, the nation-states and their monarchs reached out for power over larger geographical areas. * * * * * Most people take it for granted that the current state of political and economic affairs has universal and general validity. The foundation for societies now and into the future is simply more of what we have seen over the preceding three decades, since Deng Xiaoping’s reforms and the collapse of the Soviet Empire. Political systems around the globe are moving towards a kind of democracy, though the definition may differ, and similarly moving towards a market economy. The nation-state is maintaining its status as the basic unit of power, while at the same time taking part in globalization and a broader international power structure anchored in military, economic and political parameters. Such an analysis is simplistic. This state of political economy has been with us only since the industrial revolution at the end of the eighteenth century, and for most of that time was largely confined to the Western world. Before the industrial revolution, economics was not a major influence in shaping people’s thinking or behaviour. Indeed, the real revolution at that time was not industrial or technological, but a revolution of values, which introduced wealth and money as novel social forces. The title of Adam Smith’s book, An Inquiry into the Nature and Causes of the Wealth of Nations, would have been unthinkable just fifty or a hundred years earlier. Yet, in the last third of the eighteenth century, people in Europe began to act in accordance with economic thinking — that was what changed the world. A parallel process was the gradual development of liberal, representative democracy. It took a long time. Universal suffrage only became the norm

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for most Western democracies well into the twentieth century. Before that, voting was confined to a limited segment of the population — normally those in possession of wealth and education. Liberal representative democracy and the market economy forged a new social system. Its organization took place within nation-states, which offered an institutional structure (particularly a political and legal system) and logistic and transport systems to make the products of industry available to the population, and to facilitate the migration of workers from rural to urban districts. People became nationalistic, because the nation-state delivered a better life. They replaced their village culture, based on personal relations, for the institutionalized life of cities — not because they felt better or happier in such an environment, but because their materialistic living standard rose sufficiently to overshadow what they had lost in human relationships. Gradually the nation-state became too small for the production process, opening the door to economic globalization. The first wave was purely economic. Big corporations started to operate globally, giving rise to multinational companies, who felt little allegiance to any nation-state. Production, marketing and management made the jump from the national to the international level. The second wave was the counterattack by the nation-states, when they discovered that they had lost political control over economic life, with the multinational companies beyond their reach. Legislation, rules and regulations were all national and could not rein in companies operating internationally. Therefore, nation-states, too, began to cooperate internationally, and in Europe the nation-states went as far as to pool their sovereignty. Power was exercised through military, economic and political parameters. It was still almost exclusively vested in the nation-state, which projected power beyond its borders according to acknowledged behavioural norms. An inchoate system of global governance was set up under the aegis of the United Nations (UN), but it served mainly as an instrument for the strongest power to shape global developments. This was acceptable to the global community only because the strongest power — the United States — offered a political system and an economic model that most other countries wanted to emulate. Over the years these elements coalesced into a global model that worked. * * * * *

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Economic thinking and reasoning — Homo oeconomicus — has outpaced people’s instinct for stability and predictability, and at the same time crowded out their desire for a secure cultural identity. The result is a clash between economics, rationality and logic on the one hand, and feelings, emotions, human contact and well-being on the other. Economics is not winning. In short, the world is taking leave of the age of economics — in control for over 250 years — and is now casting about for a new model. The technologies we have created — globalization and digital networks — cannot prosper inside a system built on the concept and structure of the nation-state. Nor can these two revolutions survive the nation-state mentality, value system and philosophical background. The nation-state is a kind of in-group which thrives by defining out-groups, against whom the nation-state must defend itself. National ideas and values must be replaced by trans-national ideas and values, which must in turn develop a new political system and economic model. Mass communication and the dawning age of scarcities suggest that the distribution of benefits and burden sharing will be the key concerns of society; individuals and groups cannot expect to share in the one unless they share in the other as well. Global governance must gradually replace the nation-states and develop a system — not a mondoculture, not merely harmonized values — but guidelines for how people and groups adhering to different and in some cases conflicting cultural, ethnic, religious and behavioural values can live together. The prevailing worldview is changing towards a new mix of attitudes, assumptions and convictions. The components are ideals, culture and cohesion. Ideals are what motivate political passions and political extremism, including terrorism. Many people have had enough of materialism. They hunger for inspiration, in spite of the consequences it may have for their standard of living — and despite the common sense of the industrial age. Culture is a hunger for identity and for a sense of belonging, felt to be under constant attack from mass consumption and globalization. People are bewildered about who they are, under the pressure of the deluge of sensory impressions let loose by the audio-visual instruments that surround us. Cohesion is important because people long for companionship, for connection with those who think like them, in their search for identity, stability, human and social security. These three elements interlock almost seamlessly, and provide the glue for building stronger groups, stronger communities and lower power distance.

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The established model is run by the elite. People’s instinctive reaction is that the model is not theirs and does not meet their needs. Out of this comes an erosion of trust, of consensus, of a common mental and social space and sense of responsibility. This erosion is insidiously conducive to depoliticization, dehumanization and denaturalization and further feeds the hunger for inspiration, identity and connection. Depoliticization appears in the shape of the bureaucratized leadership’s growing isolation from the lives of the people being governed, and of authority’s separation from responsibility. Dehumanization is the isolation of individuals from themselves and one another, which makes it hard for them to complain effectively about their diminished political effectiveness, or take steps to rectify it. Denaturalization subverts the sense that the individual, and humanity as a whole, has of being a part of nature, introducing a strange obtuseness in our relations with our surroundings and encouraging us to classify nature as just one more thing that can be reengineered and retooled. Today, the simple faith that technology can solve everything is crumbling. The surfacing of long-term negative side effects — some of which, like global warming, may be irreversible — reinforce the trend towards depoliticization, dehumanization and denaturalization — towards, in short, an artificial world. * * * * * Edward Gibbon1 states in Chapter 3 of his monumental study of the decline and fall of the Roman Empire, If a man were called to fix the period in the history of the world during which the condition of the human race was most happy and prosperous, he would, without hesitation, name that which elapsed from the death of Domitian to the accession of Commodus. The vast extent of the Roman Empire was governed by absolute power, under the guidance of virtue and wisdom. The armies were restrained by the firm but gentle hand of four successive emperors whose characters and authorities commanded involuntary respect. The forms of the civil administration were carefully preserved by Nerva, Trajan, Hadrian, and the Antonines, who delighted in the image of liberty, and were pleased with considering themselves as the accountable ministers of the laws. Such princes deserved the honour of restoring the republic, had the Romans of their days been capable of enjoying rational freedom.

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Gibbon wrote in an age when history was the history of the Western world; there may have been Chinese dynasties and empires or nations in other part of the world deserving the same accolade, but the world outside Europe was unknown to Gibbon. Future historians may classify the half-century from 1950 to 2000 as a period of unrivalled progress. The large majority of the global population enjoyed material progress in the form of a better living standard, high global economic growth, a widespread feeling that children would be better off than their parents, and growing respect for fundamental human rights and freedom. Decolonization, gender equality, civil rights, tolerance and respect for others were all acknowledged as indispensable virtues within nation-states and between nation-states. There were limited conflicts but no major wars, and there was a general feeling that the world was on the right course. Over the last decade or two this picture has changed dramatically for the worse. There is a feeling of angst for what the future will bring and fear that the progress made towards a better world, during those fifty years, is being rolled back. For some readers this book may confirm their feeling of angst and their distress at the picture of an inept humanity, confronted with what can well be described as the most profound challenge it has ever faced. Its author’s purpose is quite different, however. It is to give policymakers a bearing towards the future, to provide a sketch of what can be done — and what should be done — and thereby to convey confidence to their people that we are on a sound course and weathering the storm. * * * * * I am inspired by Kuhn’s remark2 of more than fifty years ago, that a scientific revolution occurs when scientists encounter anomalies which cannot be explained by the universally accepted paradigm. The paradigm is not simply the current theory, but the entire worldview in which it exists, and all the implications that come with it. Whenever an economic paradigm is unable to provide useful answers to a period’s greatest challenges, society enters a transitional period in which, sooner or later, it replaces the existing logic and synthesized understanding with a new and better one. There are two driving forces for moving an economy or a society from one paradigm to another.3 Exterior challenges (the push factor), which

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formed the foundation for my 2011 book How Asia Can Shape the World, and the development of consciousness (the pull factor), which I try to put forward in this book. Jørgen Ørstrøm Møller

Notes 1. Edward Gibbon, Decline and Fall of the Roman Empire (published 1776–89). 2. Thomas S. Kuhn, The Structure of Scientific Revolution, 50th anniversary ed. (Chicago University Press, 2012). 3. Otto Scharmer and Kathrin Kaufer, Leading from the Emerging Future (San Francisco: Berett-Koehler, 2013).

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Acknowledgements This book draws on my reflections about why the world I grew up in more than fifty years ago now suffers from a strange kind of dysfunctionality. I considered the title “How did we get into this mess and how do we get out of it?” — because this is exactly how I feel. It is difficult to understand why the phenomenal progress in civilization, from the end of World War II to the turn of the century, is not only under attack today, but being rolled back. The blunt answer, from all my soul-searching, is that the elite has failed. A gap has been allowed to arise between an international, wealthy elite and a large group of people left behind — people still living and interacting inside their nations and societies, but very much outside the supra-national system of decision-making (within which those nations and societies operate), and with no interest in supporting it. Turning my perplexity and bafflement into some kind of coherent analysis — accompanied by useful ideas and prescriptions for redirecting the course of world affairs away from its current path towards a new dark age — proved difficult. I have benefitted from the freedom to concentrate on this work given to me by the Director of the ISEAS – Yusof Ishak Institute, Ambassador Tan Chin Tiong. I am truly grateful for that. Without his interest and support I doubt that I would have had the strength to put down on paper in a coherent way the many impressions and deductions that constantly crossed my mind. The Chairman of the institute, Professor Wang Gungwu, has been an invaluable source of inspiration. My thanks also go to colleagues and staff at the institute, for helping me in many ways, and to ISEAS Publishing for its great work in producing the book within such a short time span. A number of people have for many years showed interest in my work, scrutinized my ideas, explained to me what I really meant, offered new

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ideas or corrections to my original thinking, and done me great service as sparring partners, no matter how time-consuming it must have been. Arun Bala has been kind enough to set time aside for numerous meetings and discussions. His influence and encouragement have been second to none. Louis-François Pau read the text and helped me to deepen several points, and to avoid misunderstandings and mistakes — as well as offering ideas to supplement my own thinking. My first friend, Ole Bang Mikkelsen whom I met in 1944, read the whole manuscript and offered suggestions and comments. Interdisciplinary and intersectoral analyses, particularly given their ramifying complexity, are not easy projects to tackle. I have benefitted from seminars, meetings, and conferences organized by several institutions — where I participated in some cases as presenter or discussant. In particular I would like to express my gratitude to the Nanyang Technological University (NTU) Complexity Program and Jan W. Vasbinder, as well as to the Singapore Civil Service College (CSC). Euston Quah kindly agreed to write the foreword. Pang Eng Fong, Yeo Lay Hwee, W. Brian Arthur and Alfred Scheidegger wrote endorsements. They also offered suggestions to sharpen the views put forward. Deep and warm thanks to all of them. Jeff Ewener took upon himself the tedious task of improving and smoothing the language, making the text more accessible to readers. Some of the issues draw on ideas I have explored in a number of journal articles. In particular I would like to acknowledge the journals Singapore Economic Review (Part II, Chapters 4–6 and Part III; Moeller 2011b and Moeller 2014) and YaleGlobal online (Part III, 8.1) for their kind permission to revisit the material here — particularly in this era in which commercial interests limit access to information (a factor identified in the book as a threat to Research & Development). My mind has been shaped over many years, in a rather segmented way, through books, articles, newspapers, websites, interviews, and not least from lectures around the world. Now I feel able to put the picture together — to turn the jigsaw into a painting. The goal of presenting a coherent analysis — which covers not only politics and economics but also individual and societal impacts, dehumanization and denaturalization — is where this book offers something new compared to previous publications. The price one pays for this kind of analysis — which pulls together many separate threads, trends, observations, tendencies — is a certain

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degree of overlap or repetition, as we return to a topic already introduced in an earlier context, and re-present it in a new and broader context, resulting, when successful, in a deeper and more comprehensive presentation of the topic. I have done my best to ensure that this “spiral” approach to the material does indeed take us deeper at every turn, in our understanding and insight, and I hope the reader will be indulgent towards my efforts. My wife, Thanh Kieu Møller, has supported me all along and encouraged me to pursue and deepen my ideas. Her love is my strength.

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1 The Conventional Outlook

Economic indicators augur lower global growth over the next quarter of a century. The main culprits are debt and falling productivity. At the same time, we are experiencing a shift in global economic power — to the disadvantage of existing economic heavyweights such as the United States, Europe and Japan — due to major trends in demographics and savings. Africa may turn out to be a major economic player, while Russia and the Middle East may diminish in power. All this will influence geopolitics, but it may also be instrumental in the economic sphere — forcing a change in global economic policies and the way people look at economics.

The Global Outlook Horizon, 2030 Over the next fifteen years, new or accelerating trends in debt, demography, urbanization, global savings, innovation, productivity and energy will transform the global power structure, with unprecedented speed, magnitude and impact. Debt: Debt will lower the rate of global growth and limit the room to manoeuvre, especially for Japan, the United States, Britain and South Korea. In 2013 the Bank for International Settlements (BIS 2013) analysed how much fiscal tightening major countries will need to make in order to

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achieve a sustainable position in their public debt by the year 2040. For the United States, the figure was 14.1 per cent, for Japan 14.9 per cent, Britain 13.2 and Korea 11.9. The eurozone countries — often considered to be languishing in a debt trap — presented a much more promising picture. Germany was expected to need only an additional 3.4 per cent of fiscal tightening, France 5.4 per cent, Italy 4.0 and Spain 11.4. China, meanwhile, will need 2.5 per cent and India 3.7 per cent. When it comes to private corporate debt, it is the emerging markets and developing economies (EMDE) that appear to be in a more vulnerable position, compared to developed countries. Their share of world corporate debt has risen steadily in recent years, while in the industrial countries there has been a slight deleveraging in this segment of debt (The Economist 2015). A more immediate concern is the proposed interest rate hike by the U.S. Federal Reserve, which threatens the position of industrial economies and EMDEs alike, though in different ways. For industrial countries it will add the burden of higher interest rates to their already sluggish economies. For EMDEs it will mean that public and corporate debt will have to be repaid in major currencies that are growing in value, while the revenue from which those repayments are made will be in currencies that are shrinking in value. It is estimated that the outstanding mass of U.S. Treasury bonds (about $5 trillion) is completely renewed about every seventy months. This means that about six years after tightening, the cost of servicing the national debt, as a share of the U.S. federal budget, will rapidly balloon. The Congressional Budget Office (CBO) calculates that net interest payments will increase from 1.4 per cent of GDP in 2013 to 3.2 per cent in 2023 (CBO 2013, p. 4). If economic growth turns out to be lower than expected, or interest rates higher, the figure may surpass 3.2 per cent. A similar fate threatens Japan, Britain and South Korea. As for corporate debt (excluding financial institutions), many corporations in the United States and around the world have taken advantage of the prevailing low interest rates to borrow more. It is debatable how vulnerable they will be to rate hikes as a result — the figures are not always transparent or comparable. But they will unquestionably face rising costs from any rise in interest rates and — as many may be exposed to exchange rate risks as well — it could turn into a crisis reminiscent of the Asian financial crisis of 1997. It thus seems likely that governments will have to allocate revenue from taxes or sales to service a high and growing debt burden. Non-financial

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3

corporations, and perhaps some financial institutions as well, may try to transfer their debt burden to the public sector, as many did successfully in 2008–9. Economically, the long-term consequences cannot be anything but lower demand. Frequently, economists and policymakers see debt as a purely monetary phenomenon. It is not. Debt means over-consumption in the past compared to production. Repayment will inevitably take the form of under-consumption in the future, compared to production. The question is, who will be the one under-consuming — creditors or debtors? Some observers lament the present state of low inflation because it means the real value of debt does not go down. But inflation simply transfers the burden of debt-repayment under-consumption to creditors, since the purchasing power of their loans would fall compared to what it was when the loans were made. Deflation has the opposite effect, and transfers the under-consumption burden to debtors. An in-depth analysis might well discover that the savings rate of debtors is lower than that of creditors — an expectation supported by common sense. Total consumption over time will therefore be lower as repayment (future under-consumption) is shifted to creditors, who will consume less overall, especially compared to the over-consumption debtors enjoyed in the past. Demography:1 In 2050, Africa will be the continent with the most rapidly growing population — jumping from 1,200 million today to 2,400 million. Asia will rise from 4,300 million to 5,200 million, Northern America from 355 million to 466 million, Latin America from 617 million to just below 800 million. Europe’s population will actually fall, from about 750 million to 700 million. The availability of labour determines where labour-intensive manufacturing will take place. We saw this in recent decades in Asia; first in Japan more than fifty years ago, and then China since 1980. No country has ever managed to achieve high and sustained growth without labour-intensive manufacturing providing the take-off platform. It only works, however, if supporting policies are implemented. The economic and industrial model must keep wage levels down, even if the price is inequality. Migration from rural to urban areas will expand the labour supply. Public investment in infrastructure and in facilities for basic training is imperative. Eventually, population growth will taper off, forcing wage levels up and eroding the support for the model. This is what the World Bank labels “the middle income trap”, where a country is not “poor” enough to compete

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with other low-cost producers, with their still-abundant labour force, yet not “rich” enough to take on the advanced economies in competition over technology, design, performance, accompanying services, branding, etc. China’s labour force is expected to peak in 2015, at 1,030 million, after which it will steadily fall, to reach 825 million in 2050. This will force a shift of competitive parameters. A rapid increase in research and development (R&D) — currently running at about 1.9 per cent of GDP — bears witness to that. India’s labour force will rise from 800 million in the year 2000 to 1,000 million in 2025 and 1,100 million in 2050. Africa faces an explosion in its work force — from 500 million in 2015 to 1,410 million in 2050, and 2,592 in 2100. The labour force of its most populous country, Nigeria, is expected to rise from 50 million in 2000 to 110 million in 2025, 240 million in 2050, and 602 million by 2100. The American labour force will likely remain strong — rising from 195 million to 230 million in 2050. Those of Japan, the main European countries and Russia will all see a sharp decline. In many European countries, a higher participation rate (as more women enter the labour market), as well as a rise in the pension age, may mitigate the negative repercussions of a shrinking population. A modest increase is on the table for the Latin American labour force, rising from 385 million in 2015 to 480 million in 2050, before falling to 361 million in 2100. The dependency ratio (the share of population over 65 years of age, relative to that of the working-age population, aged 15 to 64) presents a similar trend. Japan’s dependency ratio will hit 74 per cent by 2050, and the EU 48 per cent. That of China is expected to be 39 per cent, and after 2035 it will exceed even the American one, forecast to be 34 per cent. Meanwhile, India’s will be about 21 per cent and Africa’s a mere 11 per cent. Brazil’s dependency rate in 2050 is expected to be 40 per cent — on a sharply rising continuum from 10 per cent in the year 2000 to 60 per cent in 2100. Argentina shows a similar though less steep rise, from about 20 per cent in year 2000 to 55 per cent in 2100, while Mexico rises from 10 per cent in 2000 to 35 per cent in 2050 and 60 per cent in 2100. Thus, the relative size of the labour force and dependency rate unequivocally favours South Asia until 2050 and Africa until 2100, while Japan and Russia face an alarming demographic collapse. In between these extremes, Europe, China and the United States will all face some difficulties, though the outlook for the United States is slightly better than China’s and significantly better than Europe’s.

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Urbanization: The overwhelming majority of economic activity and technological development occurs in very large urban areas — megacities and megaregions with 20, 30 or even 40 million people. In 2020, fifteen of the thirty biggest megacities will be in Asia. Three will be in the United States (New York, Los Angeles, Chicago) and three in Europe (Moscow, Paris, London), or four if we include Istanbul. Analysts of urbanization expect 75 per cent of the world’s population to live in cities by 2050, concentrated in a relatively limited number of megacities/megaregions. Yet these agglomerations will produce 66 per cent of global economic output and 85 per cent of technological innovation. Urbanization is a driver of economic growth. Housing, infrastructure and economic foundations stimulate investment to a degree never seen before. Estimates of investment in urban infrastructure over the next decade run as high as US$8 trillion in Asia alone. These vast new urban centres must achieve a much higher level of sustainability if they are to avoid collapsing under their own weight, from pollution, waste and congestion. Carbon neutral cities are certainly desirable, but soon total recycling — zero net waste — will be imperative. The race is on to shape that kind of city; and China, which is currently suffering the effects of high-speed urbanization, is also leading the quest for solutions. Such considerations bring to light a crucial but little noticed factor in economic competitiveness: the quality of infrastructure. For instance, Americans concerned with competition with China have observed that labour arbitrage is increasingly tilting more towards the United States, making outsourcing and offshoring less and less attractive, and raising the possibility of “reshoring” — bringing manufacturing back to the United States. But this hopeful analysis ignores China’s enormous investments in new and efficient infrastructure, compared to the crumbling state of neglect in the United States. Manufacturers will soon discover that the savings earned from relatively lower wage costs are quickly lost to queues, congestion and wasted time. But perhaps the most intriguing challenge of urbanization is the social one. The movement of more than a billion people from rural districts to cities is a human migration on a massive scale, and it will change the way people live. In the villages, social order was anchored in the family, working in the fields together. Neighbours and village elders provided clear rules for behaviour, as well as benevolent and sometimes less

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benevolent social controls. These controls were mutual ones, in which everyone shared, based on unwritten but well-known ethical norms which kept the community together. Power distance is low in the village. In the cities, power distance is high — families break up, relatives live far away, neighbours are strangers and sometimes foreigners with unfamiliar customs. Enforcement is in the hands of a faceless state, the police or the army, and the familiar unwritten behavioural norms are replaced by rules and regulations carefully written down but often incomprehensible to migrants. Global savings: For years the majority of global savings have originated in China, Japan and the Middle East. The savers trusted in the competence of Western financial institutions to invest their money, which they did — though according to Western priorities, not those of Asia or the Middle East. This began to change when the financial crisis of 2007–8 weakened the world’s faith in Western financial competence. A country is considered a net international “saver” if its domestic savings exceed its domestic investment. China is the world’s greatest international saver and will remain so for the next decade or two, barring any radical changes in its demography or domestic consumption, which does not seem likely. China has made massive investments in recent years, particularly in infrastructure and urban construction, but this investment has not exceeded its savings. The United States, in stark contrast, has over-consumed over decades, which in economic theory should push the consumption rate lower and the savings rate up as households try to free themselves from debt. There are no significant signs of that, however. Moreover, U.S. investment, particularly in public goods, has been extremely low for decades — even the massive investments in the shale gas and oil boom have not been enough to rebalance the savings gap. Any forecast beyond 2020 is increasingly conjectural, but the United States seems on-track to continue its role as a consumer of global savings — the global debtor. Psychologically, the household, business and government sectors have got used to living on debt, unshaken in their belief that the standard of living enjoyed by all sectors can be had for less than it actually costs. Europe’s future balance sheet is harder to predict — the Europeans have not over-consumed and the Euro-crisis has undoubtedly created a widespread desire for balanced books. The continent is likely to continue

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as neither a borrower nor a lender. Japan has had an almost unblemished record for half a century as an international creditor, but this appears unlikely to continue much longer. Politically and psychologically it may come as a shock for Japanese politicians and citizens, who have never entered the global capital markets before as borrowers. The salient facts are that China is likely to continue as a creditor and the United States as a debtor over the coming decades. The geopolitical question is whether China will choose to continue to feed funds into U.S. Treasury bonds. The answer is almost certainly no. At some stage China will be stronger and the United States weaker, and an abrupt return to reality will take place. Exactly how it will happen is open to conjecture — even should China decide at some point to exercise its power as creditor, it would hardly be in its interest to push the United States over a cliff. But as China emerges as the world’s largest investor, global investment patterns will increasingly follow Chinese interests. China and a few other international creditors/investors will emerge as the owners of a large and growing share of the world’s production capacity. Currently, China invests around US$100 billion abroad (overseas foreign investment, outgoing = ODI), compared to a little over $100 billion entering China from abroad (foreign direct investment, ingoing = FDI). The West may be surprised at the outcome. It is open to discussion just how far Western multinational companies have acted in conformity with their national interests, but given China’s political and economic setup, we may expect Chinese companies to align their corporate and political interests more closely. Africa’s growth prospects are excellent, starting from a very low base. GDP rose from US$1.6 billion in 2008 to a forecast $2.6 billion ten years later, with a trajectory for further growth above the global average. Aggregate FDI coming into Africa is about equal to that coming into China. But whilst for China it has probably peaked, it is still rising for Africa. The burning question is what will happen to Africa’s savings–investment balance. The standard answer is that for an emerging economy, investment overshadows savings, leading to a savings gap as an international borrower. The snag is that the same would have been said about China in 1980, but we know that it turned out to be the opposite. The propensity to save among Africans is unknown — the continent is so diverse that people’s behavioural patterns are far from uniform. Having said that, it seems most likely that Africa will turn out to be a borrower in view of

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the demand for investment and the likely upwards trend in household consumption. Innovation: The global innovation indexes published by Cornell University, INSEAD, and WIPO,2 reveal who will do well in this crucial economic characteristic over the coming decades. As expected, the leaders are North America and a number of European countries, plus Japan, Korea, Australia, New Zealand, Israel, Singapore and Hong Kong. More interesting are the statistics for efficient versus inefficient innovators — measuring “input” to innovate against results per unit of GDP. In theory this is an omen of who will continue to do well, even move upwards on the scale, and who will slide downwards. And while all the innovation leaders are currently doing well, the United States, Japan and South Korea are rated as inefficient innovators, and may lose their leadership positions in the near future. The group of learners — less innovative, but more efficient at the innovation that they do — includes countries from all continents. The pertinent observations to be made in looking for efficient innovators in this group, is that China is number 14, India number 11, and several Asian countries like Vietnam and Malaysia do quite well. Russia finds itself close to the group of underperformers and an inefficient innovator; Brazil, Mexico and Argentina are not so far from Russia, but all three merit the label efficient innovators, as is also the case for Ukraine, which is close to getting into the leaders’ group. Indonesia also catches the eye, closer to the learners than the underperformers, being ranked number 6 among efficient innovators. Among the African countries, none are found among the leaders, and only a few are among the learners, with South Africa scoring the highest but classified as inefficient. Senegal, Uganda, Kenya and Mali make it into the group of efficient innovators. Nigeria is just above the group of underperformers but scores well with regard to efficiency, ranking number 7 globally. Listings and rankings have to be taken with a grain of salt, but they cannot be completely brushed aside, especially when compared to common sense observations. The interpretation is good for Asia, with China, India, Indonesia and Vietnam all scoring, not only well, but on an upward curve. Results are mixed for Africa, but overall African countries are moving forward and fast — Uganda is the most improved low-income country.

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Germany, France, Britain and a few smaller European countries not only score well but are highly efficient innovators as well. Italy is close to being the highest scorer on both counts. Spain innovates as well as Italy but does not do well for efficiency. Among the top-twenty high-income efficient innovators, seventeen are European countries. The big losers would seem to be Japan and South Korea — whose heavy outlays on R&D make them leading innovators, but inefficient — and, more particularly, Russia, which is ranked low on both scales. A strong rate of innovation takes decades to achieve, not only through investment in R&D but also, and more importantly, by embedding innovative and creative thinking throughout the social fabric. To a certain degree this is a self-reinforcing process, especially in a globalized world where there is an insatiable demand for talented leaders and efficient innovators. Productivity: To lead the world out of the low-growth doldrums, the United States as the biggest economy would need to return to the trend of growth seen before the financial crisis. Yet, as the above arguments suggest, this is unlikely to happen. Gordon (2012, 2016) points to a number of elements indicating continued lower growth. The first industrial revolution (steam engines, cotton spinning, railroads) started in the eighteenth century and was succeeded by the second (electricity, the internal combustion engine, indoor plumbing). This began about 1870 but took about a hundred years to percolate fully through the economy. After 1970, productivity growth slowed markedly, most plausibly because the second industrial revolution had changed the economy, production processes and consumer function to their full potential. The computer and Internet revolution (in my vocabulary, the audiovisual revolution) began around 1960 and reached its climax around 2000, after which productivity gains are still being reaped but not to the same extent as before. Gordon offers the observation that in this century inventions have centred on entertainment and communication devices that are smaller, smarter and more capable, but do not fundamentally change labour productivity. Gordon wrote this before some potential productivity game-changers appeared on the horizon. One is the industrial Internet — Industrie 4.0, and “the Internet of Things”. The basic idea is to control the production process

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through the Internet, exploiting capacity, communication, analytics, etc. This new technology is still embryonic, though it is rapidly developing, especially in Germany and the United States. Another potential gamechanger is 3D assembling and, in the context of waste, 3D disassembling. A third is robots, with some forecasts suggesting the replacement of a third to a half of the workforce (Stewart 2015). If these new technologies really take off and deliver what the optimists hope, it might represent a new jump in productivity, with a spillover effect on economic growth. Gordon’s pessimistic outlook on the U.S. economy is more widely shared, however, and is supported by a number of other studies. Fernald and Wang (2015) conclude that the information and communication technology (ICT) revolution brought extraordinary productivity growth from the mid-1990s to the middle of the first decade of the twenty-first century. Over the last ten years this productivity growth has weakened considerably, with no signs of reverting to its earlier strong growth path. The implication is a long-term trend of lower growth for the U.S. economy. They estimate annual productivity growth of 1.9 per cent, annual GDP growth of 2.1 per cent and GDP growth per hour of 1.6 per cent. Jorgenson and Khuong (2010) look at economic growth and productivity going back several decades, both for the United States and the global economy. They compare 1998–2008 to a forecast for 2009–19, and conclude that the base-case projections for both productivity and economic growth for the world economy are lower going forward. They forecast a fall in productivity growth for the United States from 2.1 per cent in 1998–2008 to 1.5 per cent for 2009–19. And, for the world, a smaller decline from 3.0 per cent to 2.6 per cent. The worrying message is that the rest of the world will not compensate for the fall in U.S. productivity — on the contrary, productivity will fall everywhere, with few exceptions. All G7 members are expected to show declining productivity, with Britain and Japan suffering the strongest, and Germany and France the smallest, decline. For seven major EMDEs, the decline is less sharp, with India and Mexico actually expected to show higher productivity and China a comparatively small decline.3 Looking at seven industrial countries, Hughes and Saleheen (2012) came to a similar conclusion: labour productivity has recovered slowly, and not to its former levels. The figures available are fairly unambiguous, disclosing that (1) the ICT impact on productivity is petering out in the United States, and even

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if it is still substantial, it does not have a similar effect on the rest of the global economy. And (2) no other new technology capable of reversing this trend is on its way. There have been candidates for this role — for instance, biotechnology — but none have lived up to the promise. The conventional theory was that productivity growth went hand in hand with employment growth. The economy would be able to create jobs at a rate that more than compensated for the immediate replacement of labour through automation. This can no longer be taken for granted. Demographic forecasts are fairly solid and conclude that the global labour force will grow, albeit at a slowing pace, until around 2050. It will shift geographically from China to South Asia and Africa. Applications of new technology may be more important for growth and productivity than the technology itself. The human capital — skills — takes over as the decisive factor for productivity. Thus, the ability of the education system to deliver a sufficient number of people with the skills that are in demand may well determine future productivity, economic growth and income equality. On the downside, a mismatch between supply and demand for the “right” skills acts as a brake on productivity, while contributing to high and rising income inequality. Energy:4 Forecasts of energy markets differ in detail, but not in their broad trajectory. From 2010 to 2040, world energy consumption is expected to increase by 56 per cent. This growth is extremely skewed geographically — in non-OECD (Organization for Economic Co-operation and Development) countries, consumption will grow by 90 per cent, and only 17 per cent in OECD countries. Fossil fuels, including natural gas and to a certain extent coal, will account for some 80 per cent. China recently surpassed the United States as the largest energy consumer and, together with India, these two Asian countries accounted for 24 per cent of energy use in 2010, a figure expected to rise to 34 per cent by 2040 — an increase of 112 per cent. Africa follows, with an expected 85 per cent increase in its share of global energy consumption, then the Middle East with 76 per cent and Central and South America with 62 per cent. In last place we find Russia and the former states of the Soviet Union outside Central and Eastern Europe with a 42 per cent increase. If present trends continue, the United States will soon be the world’s largest oil producer, and will become self-sufficient in energy before 2030 — primarily through shale gas and oil, but including other sources as

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well. Certainly, if this really happens — and it is too early to take it for granted — much of geopolitics and global economics will change. The recent boom in production of shale gas and oil has intriguing implications for geopolitics. For the first time since the age of oil began about a hundred years ago, energy sources are available where the demand is — with the exception of Japan. Large economic and industrial centres in Northern America, Europe, China, and now also India, have access to energy inside their own territory. Economically, that presages decades of infrastructure investments that will boost economic activity. Nations that have invested in and built large fleets of oil tankers may suffer. Geopolitically, the fear of being cut off from energy sources may be a smaller consideration in strategic thinking. A pillar of geopolitics for several decades has been the common interest among energy consumers — the United States, Europe, China, Japan, India — in keeping the oil price contained, and preferably low. The main producers, like Saudi Arabia, have mostly accommodated this policy, which is in their long-term interests. It is not too much to say that the oil price has never been set by the market, but rather by tacit negotiation between producers and consumers in a cartel-like fashion. It is likely that the oil price decline over the second half of 2014 was engineered by Saudi Arabia in order to drive home the message that non-OPEC producers like the United States and Russia would have to rein in production and share the burden as well as the benefit of being an oil producer, even if they are not members of OPEC. Neither country got the message. Until they do, Saudi Arabia will likely continue to pump, engineering an oil price that may go very low compared to $100 per barrel, its price in summer 2014. This will undermine the profitability of some offshore operations, especially in the Arctic, and hold back development of shale gas and oil in a number of countries, including the United States. And that is what Saudi Arabia wants. Investment in these projects is long-term and expensive. Knowing that the major producer can and will step in to create havoc in the market is bound to dampen ardour among investors, which serves the Saudi purpose. However, China, India and the EU will certainly draw the conclusion that self-sufficiency is more vital than ever — stimulating domestic sources, increasing development of sustainable energy sources, and favouring coal — inevitably pushing world demand for oil, and its price, downwards.

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The losers include most of the Middle East countries, Russia and countries embarking on marginal projects. The winners will be the energy importers such as China, India, Japan and Europe. The effect on the United States will probably be positive, but the surge into higher production, and even the export of energy, makes the net benefit difficult to calculate. It will probably be smaller than that won by most other energy importers. One uncertainty with large potential negative consequences for the United States is the role of the U.S. dollar. The break-up of the U.S.– Saudi alliance could pave the way for a switch away from the dollar as the oil industry’s unit of account. If this move gains momentum, it may not stop there but spread to other resources. China and Russia may be entertaining ideas of that sort. This could precipitate a large-scale crisis of confidence in the dollar as a global reserve currency, which would be difficult for the United States to manage in view of its existing internal and external debts. Conclusion: China scores well in all categories. The demographic problems — inter alia dependency — will not really be felt until sometime in the 2030s. Investment in urbanization works as the main driver of growth. The endeavour to swing the Chinese economy around from labourintensive manufacturing to more sophisticated higher-value products is under way. The energy and resource problems are challenging, but will not be likely to derail China’s expansion. China’s score for its overall quality of infrastructure according to the World Economic Forum is not good — ranking 69 out of 142 countries — but backward rural districts weigh down the average. The question is whether the Chinese Communist Party (CCP) can avoid major social unrest. Numerous policy statements suggest that the CCP leadership is well aware of the danger, but Chinese history repeatedly shows that defining policies is much easier than implementing them. China’s main tool for assuaging social problems is money. Yet, at the same time the country buys large proportions of its energy, food and resources from abroad. This creates vulnerability. The current liberal rules governing the world’s foreign direct investment are important to Chinese stability. But if resource-rich countries change course and put up barriers, China will face a new and dangerous situation. Southeast Asia, admirably situated geographically and with a diversified economy, may plug into the continued Chinese expansion.

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Africa is on the verge of a big jump forward of its own — almost analogous to China from 1979 onwards. The opportunities and the risks, however, are both on a much grander scale. It can go awfully wrong. Africa’s main assets are a vast potential labour force, equally vast resources — food, energy, minerals — and nascent political change, liberating markets and countries from the extractive political systems and misguided economic policies that have held much of Africa back. The main question is whether the most can be made of these assets, given the political, economic, ethnological and topographical divisions that criss-cross the continent. Governance will be crucial, as will a growing economic integration, to share benefits across borders. Europe will do well in the foreseeable future, but gone are the days of high growth and flamboyant policies. Its demographic situation looks bad at first glance, but Europeans are capable of alleviating the negative impact by raising the pension age and enhancing the participation rate in the labour market. Economics, demography and behavioural patterns point to continued savings keeping the eurozone a net international lender, in contrast to the net borrowing United States. Much will depend on the eurozone’s attempt to reconcile Europe’s welfare societies with the exigencies of the global competitive environment. Structural programmes have been launched, but it is too early to know whether they will be successful. The European Union faces severe tests in the coming decades. Events such as the terrorist attacks in Paris and Brussels underline the identity issue brought to the fore by immigrants adhering not only to another religion — primarily Islam — but applying a different set of values (societal norms) in their lives and communities. Another is the attitude of Britain towards European integration and its commitment to Europe. External to the EU, Russia’s policies and instability in adjacent countries — Ukraine, Turkey and North Africa — present a formidable challenge that calls for a determined European response. The United States remains in its leading role, but faces severe challenges to its ability to stay there. Demography is a neutral factor, with a growing labour force more or less cancelled out by a higher dependency ratio. Urbanization works against the United States. Its cities have been built to serve the car, yet higher petrol prices and rising environmental awareness eats into the cost advantage of car use and damages U.S. competitiveness. Debt — domestic and international — continues to rise

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in absolute figures and as a share of GDP, diverting sums from productive use to servicing debt. The worst challenge is the crumbling of the United States’ once-supreme status in innovation. Figures suggest that the U.S. rate of innovation is no better than that of most European countries, while its innovation efficiency is low. Added to this is a dependency on foreigners — mainly Asians, living temporarily in the United States — for a large part of the innovation the country does manage. The large numbers of foreign students at the top universities narrow the hopper for talented Americans. Energy is a bright spot, but even if it reduces costs it will not be able to reverse the depressing trend of the U.S. balance of payments, and will leave the negative savings–investment balance in place. Infrastructure does not look good, with the United States at number 24 on the quality list. Latin America’s demography is more or less neutral. Urbanization is coming to the continent, as for China and India, but the benefits have to be weighed against the continent’s inability — going by experience — to turn it into a growth factor. Innovation is far from promising. The continent will do well as a supplier of food and a number of resources, but not well enough to get it on to a sustainable growth pattern exceeding previous decades. Russia is losing heavily in all areas except energy and some other resources. But even here, the rundown economy makes it doubtful whether revenue will continue to flow into the country, as maintenance and updating have been so neglected. The demographic outlook is dismal (its 2015 labour force of about 90 million falling to about 65 million in 2050 and 55 million in 2100). Innovation is low, and agriculture has not been developed to take advantage of the rising global demand for food. It is number 100 on the infrastructure quality list. Japan’s demographic situation is the worst among the major countries. It is almost 100 per cent dependent on energy and resources, while it defends a high-cost domestic food production system. Innovation could make up for that, but Japan has never really managed to get out of the box as a producer of high-price and high-quality investment goods — an economic sector that was lucrative until the 1980s, but not anymore. The Middle East is relying on oil and the oil price. The forecast points to an oil price which will maintain the economy, but not boost it. Economic diversification is slow and opportunities outside the oil sector are limited.

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South Asia has posted fairly good growth over recent years, but behind the curtain looms a number of serious risks. Demography may help in the short to medium run, by attracting labour-intensive manufacturing, but supportive government policies — training of the labour force, housing, infrastructure, etc. — have not been sufficient to develop the competitive advantage. Urbanization will be difficult to manage given the sheer scale of migration into cities and governments that are particularly weak on sustainability. Innovation is quite good in India; properly encouraged it may bring real benefits, but government policies will be crucial. The resource outlook — food, energy and minerals — is extremely worrying. As for quality of infrastructure, India is number 86, Pakistan 109, and Bangladesh 129. The global geopolitical structure has largely been forged by economics and economic interests — or to use a broader perspective, by societal systems — seeking together to defend their political and economic interests. The Atlantic alliance is the best example. Yet it is unlikely that these alliances and partnership will survive unscathed in a fundamentally different economic environment. The rising superpowers (China and India) may form their own alliance, to which other nations could be attracted in preference to aligning themselves with Western economic power. These two new economic superpowers will be compelled to defend their global economic commitment, as were Britain and the United States before them. It is not a question of whether a power wants to do so or not. Events and interests dictate policies.5 The question is how far and fast it will go, and how the declining powers will react. It cannot be taken for granted that the United States and Europe will gracefully accept a realignment of the economic world. They may acquiesce under pressure, seeing no viable alternative. They may also discover down the road that, even if the Euro–American alliance is held together by shared economic and military values, their interests are far from as congruent as they once were during the Cold War. The United States classifies China as a challenger to its hegemonic position, and continues to wrestle with the problem of whether to accept the rise of China and seek an accommodation or to block it with the assistance of hemispheric allies (Japan, Australia, perhaps India). So far no decision appears to have been made, which has made U.S. allies uncertain how far they will support policies they do not know much about, and which may change. It does not help that the United States continues to operate

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in a fairly autocratic way — taking allies’ support for granted, but rarely bothering to consult them. Europe clearly sees China as an economic rival, but, lacking global superpower status and its concomitant concerns, Europe does not find it a threat to itself, politically, and even less militarily. Europe’s security is linked to developments in Russia, Ukraine, the Middle East, North Africa and perhaps the rest of Africa. Here, too, American and European interests may not be completely analogous. There is a certain parallel between U.S. interests vis-à-vis China and Europe. The China dilemma has been described. The European dilemma is whether a strong and united Europe is in America’s interest — and, if so, whether the United States has enough resources to assist the Europeans in overcoming their crises and is willing to use them — or whether Washington will decide to leave Europe to fend for itself.

Wrap-Up In broad strokes, and assuming no fundamental shifts in the medium term, these are the basic facts, and ones which should guide us towards a reasonably solid forecast. Unfortunately, it is almost certain that fundamental changes will take place. The industrial epoch of history has ended. Its leftover political and economic system increasingly struggles to deliver the goods. Economic operators — consumers, producers, individuals, corporations, the public sector, business leaders and politicians — continually change their behavioural patterns, so that the past can no longer guide us to predict the future. The models used as an instrument for governing and policymaking no longer work when behavioural patterns change. First we need to understand that the world faces a starkly transitional moment. Then we need to take a hard look at how we can manage that transition, into a new world which we do not, as yet, know much about.

Notes 1. Source for demography figures: UN 2015. 2. and .

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3. Russia was predicted to show a strong jump in productivity. Considering events since Jorgenson and Khuong made their study, this seems unlikely. 4. Sources for energy: International Energy Agency and the U.S. Energy Information Administration. 5. See, for example, Parello-Plesner and Duchatel, 29 May 2015.

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I The Problem

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2 How Did We Get into This Mess? How Do We Get out of It? An Overview

The political system, the economic model and the business model have stopped providing answers to the challenges facing the global system. In a growing number of places, populism and nationalism are creeping into the political system. A whole range of new elements distort the economic model. Greediness and short-sightedness dominate the business sector, distorting its societal role. Policymaking is still anchored in industrial age thinking. General equilibrium — once thought to be an ideal state — is replaced by permanent disequilibria. The social contract linking business, governments and societies around a common interest is in danger of abrogation. Humans cut the links to other human beings, and even more so to nature, risking an artificial worldview which threatens the whole of humanity in the long term. Industrialization transformed everything we do — it also transformed who we are. Conceptually, industrialization introduced economic thinking as the governing factor in human relationships, breaking from feudal thinking such as honour, social status and dignity. To distribute industrialization’s

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vast new accumulation of wealth, a political system was needed, and the response was liberal, representative democracy. The nation-state was born to provide for the logistical, infrastructural and legal organization of society — all of which were necessary to reap the fruits of industrialization, first at a national level and subsequently at international and global levels. These radically new ways of living have been blended together into a coherent worldview which seemed to be obviously accurate and true — for had it not produced miracles, in the form of unprecedentedly high material standards of living? To analyse and understand the implications of industrialization, the social sciences were invented. These differ fundamentally from the natural sciences, and it is permissible to ask whether they even deserve the label “science”. They are about human behaviour, which is such a unique phenomenon that it escapes objectivity and the kind of research protocols (such as laboratory testing) that normally underpin science.1 The raison d’être for the social sciences is their ability to deliver solutions or guidelines for policymakers. If they are not able to do that, why should societies continue to support them? Yet, here they have failed miserably — proving unable either to predict major crises or to offer solutions for them after they happen. The social sciences seem never to have fully digested Kuhn’s monumental work on “the structure of scientific revolutions” (1970). Kuhn himself was a physicist and wondered how and why science (the natural sciences) had developed. He found it impossible to compare what scientists wrote several centuries ago (he goes back as far Aristotle) with current scientific thinking — thus eliminating a simple incrementalism. This led him to a number of crucial observations. Scientists study those phenomena that seem odd in relation to the currently accepted theory, or, in Kuhn’s vocabulary, in relation to the paradigm. Discrepancies attract their curiosity. Frequently these discrepancies can be explained by errors or temporary deviations. In these and many other cases, the ruling theory — the paradigm — is valid, but it has to be amended at particular points, and these incremental changes are sufficient. This is not always the case, however — and even when it is so, incremental changes accumulated over years undermine the existing paradigm. When this happens, scientists are no longer able to explain or predict events. The whole scientific worldview has to be changed, leaving existing science behind the curve. These tumultuous and revolutionary

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changes do not follow a continuous and predictable trajectory, but occur suddenly and without notice, brutally sweeping away everything held up to that point as correct scientific thinking. Adam Smith’s philosophy and his observations on the free market and competition, under the guidance of the “invisible hand”, underpins more than two hundred years of a political and economic model: “By pursuing his own interest [the individual] frequently promotes that of the society more effectually” — because society’s wealth is the accumulation of individuals’ wealth (Smith [1776] 1937, p. 423). Together, liberal democracy, the nation-state and the free market economy interoperated as a “holy trinity”. And it worked. The modern, industrialized world thrived in an extremely propitious environment — where access to commodities was unrestrained, productivity was measured as performance by the individual and competition actually existed among individuals and enterprises. All in all, the model was a coherent one. Its various elements — consumption, production, the individual, enterprises, the state and the nation-state — supplemented one another in a win-win interaction. But today, at the start of the twenty-first century, hardly any of the premises for the model are valid anymore. Individuals still pursue wealth, but the expectation that the sum of wealth coalesces into societal wealth has been exploded. Often the growing wealth of individuals depletes resources needed for the future — thus actually impoverishing society, not enriching it. Individual wealth may still be measured in money terms, but the measurement of social wealth (or poverty) has grown much more complicated. Scarcities and demand for non-productive activities such as social welfare invalidate such theories. The wealth of individuals may sum up to higher social wealth measured in monetary terms, but that is not synonymous with social wealth. Social wealth may be regarded as a combination of environmental sustainability and the ability to adapt and take on new challenges that confront society. Sustainability has already found its way into policymaking, even if there is a long way to go. Societies are beginning to understand that using up resources — their own or imported — makes them poorer in the long run, even if production and income go up. The ability to adapt can be defined as the ability to direct a high proportion of financial resources to stimulate a shift of production factors, while requiring only a minimum of financial resources to keep production

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factors the way they are. For example, a society’s ability to transform its education system to develop new skills to meet employers’ needs, and its ability to minimize the cost of running its own operations, would provide a measure of its general adaptivity. Externally, the nation-state — as the locus for economic activity and consequently the provider of a political system capable of organizing society — is crowded out by economic globalization. When economic activity is global or international, economic policy cannot be merely national. And when it is moved from the national level to the international or global level, the nation-state loses its authority in the eyes of citizens as the guarantor of human security and economic welfare. On the individual level, we see questions of identity and belonging and of shared values acquiring growing importance in personal decisionmaking. For policymakers, this means that social capital, rather than economic capital, becomes the decisive factor in economic development and political control. The nation-state worldview depends on a symmetry between the citizens/voters, who benefit or suffer from political decisions, and the politicians who make those decisions and are accountable to the voters at the next election. Until the last decades of the twentieth century, the economy in the nation-state was still predominantly national. Now, in the era of globalization, politicians in one country make decisions which, by virtue of the mutual openness of their economies, transcend borders to impact citizens in other countries — who cannot react to the decision by punishing the actual decision-makers, but can only blame their domestic politicians who were not directly involved and are therefore impotent. In short, political systems cannot be national when the economy is international. And international political systems require a degree of transfer of sovereignty to be exercised in common, which only the Europeans have thus far been willing to do. Instead, groups or societies or communities — forged by values and identity — take over as the provider of human security and economic welfare. It counts more to the individual to be a member of such a society or community than it does to belong to a nation-state. Increasingly, too, it counts more to possess that social wealth than to be in possession of economic wealth measured in money. At the same time, new economic relations are rising in importance as the sharing of knowledge replaces the division of labour as the predominant

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factor determining productivity. Workers will no longer do only one thing — what they are best at — but will be partners in a team where their skill depends upon the skills of the other partners. The composition of the team overshadows the capabilities and competences of the individual. A team made up of superior individuals, compared to those in another team, may still deliver lower productivity, if they are wrongly put together. The production function will adjust. Knowledge becomes the most important production factor, but it enhances productivity only if it is shared among people working in groups. The impact of scarcity means that the input of labour will go up, relatively, while the input of resources will go down, with significant consequences for relative factor prices — wages down, resources up. Consumption theory will evolve to incorporate people’s willingness to pay. In more general terms, consumption will be less focused on material consumption as preferences change. But risk evaluation will become more and more important, in view of uncertainties about what resources will be available. Interdisciplinary methods of thinking, analysing and working will prove more useful, compared to the industrial focus on specialization and individualization. And this will diminish the role of systematic learning focused on a single discipline. Fundamental research, as we have become used to seeing it — digging deeper and deeper in a smaller and smaller radius — faces an uncertain future, as a premium is placed on the ability to combine and arrange knowledge, instead of merely accumulating more and more knowledge. The science of economics holds that people behave rationally and are able to calculate gains and losses, and act to reap a tangible economic benefit which can be measured. Reality, however, is not like that. In 1954 the statistician Leonard Savage (1954) demonstrated that if people follow certain axioms of rationality, they must behave as if they know all the probabilities and do all the appropriate calculations. They don’t. The conventional theory assumes that transparency reigns and people or decision-makers have access to all the relevant information — all the facts — and can correctly calculate all the probabilities to reach a rational decision. They don’t. Facts are rarely available in their entirety. Probabilities cannot be gauged without uncertainty. And people do not know whether the past will repeat itself or whether events will take another turn.

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Research into how the brain functions — and controls our decisions and subsequent actions — tells quite a different story. Two researchers, mathematical economist Donald Brown and psychologist Laurie Santos (Shiller 2009), have come to the conclusion that “bull markets are characterized by ambiguity-seeking behaviour, and bear markets by ambiguity-avoiding behaviour”. In other words, in bear markets people want more certainty than in bull markets, and the market’s behaviour is not symmetrical. This fits in with anecdotal observations about the way people react to a potential gain compared to a potential loss — their behaviour is not symmetrical. This constitutes a real break with classical economics, which assumes symmetrical responses to market signals. Clearly, economics needs to break out of its old assumptions and ways of thinking and to incorporate other social sciences — and indeed other sciences — if it wants to make forecasts based on valid assumptions about human behaviour. Brain research goes much further. Some researchers speculate that the reasons for herd behaviour in markets is that our brains have a fundamental bias towards learning by doing and learning by imitation. If this is the case, it explains herd behaviour, especially if the original actions — which everyone else was watching — were successful. But what may have been successful when done by a few individuals can lead to disaster when done by a large number of people simultaneously. Other research suggests that every individual develops their imitative ability by observing their own actions and comparing them to those of others. Studies have focused on the activation of the human brain. Research EU (de Caritat 2008) cites Ludwig Huber as saying that “up to now, imitation was thought to be the most crucial ability for understanding the actions of others. A case of watch and imitate. EDICI research2 suggests that the most important thing is the brain’s intentional control over what it imitates.” This means that humans are not automated copying machines. Brain imaging reveals that the area of the brain that is active during imitation is the same area that is active when we are aware of what is happening to ourselves or others. A pension fund manager may know that over the next six, twelve, or eighteen months the fund has to pay out a certain amount of money, and he or she needs to be sure that the money is there. To do so he or she will make many decisions a day, as responsibly and cautiously as possible, and continually measure the success or failure of those decisions.

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What the theory of imitation tells us is that the manager will observe how other fund managers are acting in the market. Fund managers normally strive to make safe, conservative decisions — but not with regard to how well the fund is doing or how well positioned it is to meet its obligations, but how it operates compared with other funds. The manager seeks safety in conformity. This is risk-avoiding behaviour, but defined very differently than in conventional economic theory. The risk avoided is behavioural, not economic. Similar insights come from theories about the “wisdom of the crowd”, and in such folk maxims as, for example, “one ant is not intelligent, but an ant colony is” — seeking to explain how a large number of animals grouped together behaves in conformity with one another and completely rationally. We do not know how they communicate with each other; but certainly there is some form of communication taking place, which influences their common behaviour. Globalization is also making it increasingly difficult to maintain that unemployment is purely a cyclical phenomenon, as new technologies and the service sector has replaced manufacturing in the industrialized countries. Jobs in shipbuilding and the automotive industry do not come back, or if they do in a small way, they require radically new skills. Unless policies to restructure the labour market3 keep step with the restructuring of the economy as a whole, full employment is out of reach. This points to a stronger role for non-economic policies in the adjustment process to overcome recession, even on a granular, even individual level. Productivity changes over the business cycle, but there is another and less diagnosed asymmetry. Jobs lost may be more labour-intensive than new jobs. The evidence may be scant, but it is reasonable to assume that manufacturing is more labour-intensive than higher-end services. The lower end of the service sector may be more labour-intensive, but most people (except immigrants and, especially, illegal immigrants) do not want to take such jobs anyway. Yet, after each recession the high-end service sector becomes stronger and the economy as a whole continues to shift from more labour-intensive to less labour-intensive activities. Costs savings are embedded in a recession, and, as labour costs are still a large share of costs, it introduces new initiatives to retrench workers, making production less labour intensive. Only if the economy shows very high growth — higher than after previous recessions — will it be possible to maintain full employment.

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There is strong evidence of a decline in productivity in the United States. Jorgenson and Khuong (The Economist 2010) forecast a global downward trend shift from 3 per cent in 1998–2008 to 2.6 per cent in 2009–19 and for the U.S from 2.2 per cent to 1.5 per cent. Fernald (2012) shows that total factor productivity started to slow in the early to mid-2000s, made a sharp rebound just after the great recession, but fell quickly back to previous lower trend growth. The U.S. Bureau of Labour Statistics notes that from 1947 till 2000, productivity growth was correlated with employment growth. Since 2000 they have diverged. Productivity may rise, but employment falls (Zakaria 2011). Superficially, the American economy may look like a job machine, but an analysis by Spence and Hlatshwayo (2011) reveals that out of 27 million jobs created from 1990 to 2008, only 700,000 were in the tradable sector. Of the 27 million jobs, the majority was created in the public sector. To this can be added the likelihood that, over these nearly twenty years, the growth in the labour force was largely driven by demographics and immigration, of which a large portion was illegal. New jobs were created in housing, construction and the public sector, but perhaps most significantly in the low paid, low-productivity segment of the service sector (doormen, security guards, cleaners, servers in restaurants, or employed by private individuals in roles such as drivers, etc.). Thus, those 27 million jobs contributed little to the strength of the American economy. They may have helped to maintain a kind of social stability, of course — but when the property bubble burst, a large part of this labour force became redundant, reversing any positive social achievements. The United States’ exports of agricultural goods runs at about US$140 billion, accounting for about ten per cent of total exports. It is doubtful whether those figures could have been achieved if illegal labour had not been available, pushing down wage costs. The dilemma is aggravated by a yawning gap between supply and demand for skills, which threatens not only economic growth but also social stability in a number of countries. A large number of analyses (inter alia Dobbs et al. 2012) have found a continuing mismatch between the supply and demand for skills at the global level. The mismatch becomes worse when looking at individual countries. Economic growth is constrained because the skilled people are not available. Goldin and Katz (1999) show that inequality is linked to this mismatch between supply and demand for skills. An educational infrastructure that expands sufficiently to match demand with the right supply of skills is

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an indispensable requirement to avoid inequality. Otherwise, not only the economy but social stability is at risk. The OECD’s Survey of Adult Skills (PIAAC; 2013) reports that highquality early education is an important predictor for success in adult life. Countries must combine this with flexible, skills-oriented learning opportunities throughout life, in particular for working-age adults. Looking at the link between inequality and skills, the OECD study adds that countries with greater inequality in skills proficiency also have higher income inequality. A report by ManpowerGroup (2012) highlights the complexity of matching supply and demand for skills, and exposes the faults and shortcomings of economics in addressing this issue. Between 30 and 40 per cent of employers, in 41 countries, reported having difficulty filling vacant positions due to a lack of available talented people. In 2011 and 2012 the percentage was steady at 34 per cent. There are wide differences from country to country, with 81 per cent of employers in Japan reporting difficulty compared to only 2 per cent of employers in Ireland. What is relevant in this context is that a large number of developed nations, suffering from persistent high unemployment levels in the wake of the global debt crisis, have jobs to fill, but no people qualified to fill them. Economics alone cannot solve this mismatch. Not even the strongest stimulus can bridge the skills gap. Yet the economic and social consequences of this waste are enormous. Economically, countries stay below their optimal level of production if the supply of and demand for skills do not match. Socially, large numbers of people find themselves on the fringes of society, forced to perform jobs they know they are overqualified for. Matgouranis and Robe (2010) say that in 1992, 5.1 million people with bachelor’s degree held jobs that did not require a degree. In 2008 the number was 17.4 million. Another analysis concludes that, from 1992 to 2008, about 20 million students were added to the U.S. workforce, and 60 per cent of them work in jobs that do not require the skills they acquired (Center for College Affordability 2010). Trends e-magazine published a survey in August 2012 showing that one-third of students with a college degree worked in jobs for which a degree was unnecessary. The main explanation for the mismatch is the segmentation of societal functions. The education sector follows a monodisciplinary/monosectoral approach. Countries such as Germany, with a tradition of consulting with

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business during the education process, have fared much better because the feedback from industry indicates what future skills will be in demand. According to economic theory, market pricing is determined by supply and demand — the price is set at a point where they match each other. This philosophy suffers from a number of deficiencies. It assumes conditions that very rarely exist — such as flexibility, transparency and competition. Most important, it takes for granted that every individual acts as a rational, dispassionate, utility-maximizing Homo oeconomicus. It also overlooks the role of prices as the way in which a market economy allocates its physical, financial and human resources. Prices serve as a guide for producers, telling them where they will earn profits, and for consumers, telling them how large a share of their income they will need to buy this or that product. Market pricing provides short-term profit-oriented signals in a market economy, affecting only those directly involved in the transaction. In the industrial age, this was all that was considered. But in today’s more sophisticated societies it leads to disaster, where the very advantages sought by market forces undermine and disadvantage larger social concerns. The short-term focus prevents any consideration of the future supply of resources. Even if a resource is expected to have only a limited time left — say ten or twenty years — the market price does not adjust accordingly, but continues to be set primarily by extraction costs. This is at odds with the rapidly spreading awareness of our need to be more conscious of resource use for production and consumption, given the limited availability of several resources, some of which may be exhausted within a few decades. Side effects, external to the immediate transaction, are widely disregarded, including negative repercussions on the environment. Pricing is unaffected by the fact that enormous environmental costs may be seen in other parts of the world or in other sectors, as long as it is profitable to extract and produce within the particular market. One of many striking examples is the loss of forests around the globe, with obvious harmful environmental effects in the short term, and disastrous long-term consequences for the climate. Some corporations and some consumers have taken it into their hands to correct this price setting through various means, but they constitute a small minority and, significantly, they do it not through economics, but through ethics or other approaches that make them willing to pay more even if, economically, they should not do so.

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Furthermore, the current price system is dichotomized. Prices in the market for goods and services are stable, but prices in the asset sector are going up. The financial crisis was partly triggered by asset inflation, yet surprisingly asset prices have continued their upward trend, though at a slower pace. This is also true of commodity prices (gold, oil, minerals), which, while fluctuating, are still above the level prior to the start of the global financial crisis in 2008. Part of this can be ascribed to inequality. A large part of total income and wealth is in the hands of comparatively few people, who spend relatively little on goods and services but a great deal on wealth-preserving and income-generating assets. Their lack of confidence in governments and central banks may also incline them more favourably towards assets they see as beyond the control of politicians and central bankers. Economists disagree about the effects of inequality on growth, though a consensus is building that too much inequality, at least, is bad for growth. The role that inequality plays in deepening the dichotomy between the goods and services market and the asset market provides another reason to oppose inequality. This points to another significant flaw or shortcoming in economic theory: its lack of understanding of the interaction between the market for goods and services and the market for assets. The challenge for economics is to determine the exact ratio between asset prices and prices for goods and services at which the dichotomy happens — the threshold or breaking point. Intuitively, one suspects that there is a ratio between claims on GDP in the form of assets and the size of GDP — general equilibrium — that allows movement in and out of these markets, leaving us not with two markets, but one market in relative balance. If that ratio is surpassed by some X per cent, the bubble bursts — the real economy can no longer transform assets into goods and services. General equilibrium cannot be restored through price inflation because the fall in purchasing power — through the erosion of wealth for those who have stayed in the asset sector — exceeds the purchasing power released to those who left it successfully. Aggregate purchasing power falls as a result. Except for a small number of very wealthy people, assets are not held just to keep assets, but to augment consumption over a lifetime — thus it can be taken for granted that the two markets are linked to each other, with people moving in and out. Intuitively, again, one would moreover expect the ratio between the

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two markets to be proportional to the level of inequality. The higher the level of inequality, the higher asset prices can rise (relative to prices in the goods and services market) without triggering a bubble. Capital formation, investment, and interest rate theories have changed completely over the last century. Before Keynes, economics was exclusively about capital formation, its function as investment, the supply side, and production. Interest rate theories told how the interest rate steered capital formation (the Austrian School, Alfred Marshall, and Knut Wicksell, to mention a few). Keynes turned all this on its head saying that the objective of economics is consumption — the demand side. He rejected the established antirecession theory relying on monetary policy and interest rates. Instead, the public should step in, stimulating the demand through public consumption and public investment to replace the private sector’s falling demand. Many economists have overlooked this focus on aggregate demand — Keynes talked about replacing private demand. His prescription only works, even if he did not say so himself, if private demand does not react negatively to public stimulus. If it does, aggregate demand will not rise. He did not incorporate the effect of debt for the simple reason that, at the time he was writing, national debt was not an issue. Britain had through the 1920s been running a debt to GDP ratio at about 160 per cent because of World War I financing, but this ratio remained stable or even fell slightly. When the Great Depression hit the United States in 1929, federal debt was just above 16 per cent of GDP, after eleven consecutive years of federal budget surpluses. Total U.S. debt (private plus public) was about 160 per cent, compared to about 360 per cent when the great recession struck in 2008. For some decades we have lived in a third epoch of economic thinking — post-classical, post-Keynesian — which has not yet been given a name, but it could be called fiduciary economics. The interest rate — monetary policy — is linked neither to supply, as with the classics, nor to demand, as in Keynesian analysis, but is regarded as an instrument to influence liquidity flows, mainly inside the financial sector. It fits in nicely with the faith of monetary economics, which turns its back on the real world and prefers instead to build models for various new types of financial institutions, new financial instruments, and investment theories for financial assets — and not for investing in coarse material things like machinery, equipment, etc.

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It is conventional wisdom that we live in the era of economic globalization, but do we have a uniform global Homo oeconomicus? The answer is almost certainly, no. It is dismaying to read analyses in established Western newspapers and journals (almost exclusively American and British) which attempt to look at economies in other countries — Europe, Asia and particularly China, Africa and South America. These authors take it for granted that people living there act in conformity with economic theory formed on the basis of behaviour observed in the United States and Britain. Behavioural patterns are set by many elements beyond economic considerations, including social and cultural background. Real human beings repond to circumstances on the basis of culture, sociology, possibly even genes, and within the context of inherited norms for individual and group behaviour. For over a decade, Westerners have been expecting mass consumption in China to take off — in vain. The Chinese consumer lives in a social environment in which savings are needed to finance welfare, education, health insurance, and other goods that in a Western society are offered by the state or corporations. The Chinese banking system is ruled by state-owned banks, is aligned to the goals of the Chinese Communist Party, and acts accordingly — which means that market-driven profits are not necessarily the motivation. Most enterprises in Asia are either familyowned or state-owned, in contrast to most Western corporations owned by stockholders — they get capital from the families or the state, while Western corporations use the stock market, which also tends to motivate different behaviours. Economics has always operated under the hypothesis that market forces move the economy towards general equilibrium. Observing the business cycle over the past two hundred years — and especially over the last twenty-five years — it is clear that this assumption is not valid. The system finds itself in perpetual disequilibrium, and sometimes centripetal forces aggravate this state of affairs rather than pushing supply and demand back to the state that the theory assumes to be normal — general equilibrium. There may be several reasons for this lack of willingness on the part of reality to conform to theory, but the most likely culprits are human beings themselves — and their persistent rejection of economic advantage as the sole or even the predominant factor influencing their behaviour. Vague concepts such as “the market”, “corporations” and “government” float around without any acknowledgment that decisions, in every case, are

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taken by human beings. If, as is likely on the evidence, human beings are not exclusively rational calculators, why should we expect the social frameworks they create for themselves to be so? “The market” is a number of real people — even if today’s heavy concentrations of capital have drastically limited that number. “The market” is not a deus ex machina. As a result, economic policy crafted to bring about general equilibrium fails. It might be more profitable for economic policy to focus on managing disequilibria instead — trying to keep the economy, domestic and global, functioning in the face of large and persistent imbalances. With the exception of just five years, the U.S. current account has been in deficit since 1961. Germany and Japan and now China are in surplus. There is little or no prospect that these imbalances will go away. So it may be that the economic model and political system — born when the industrial age and mass consumption began, 200–250 years ago — have run their course. Every economic age has its economic model and political system. We have got used to the market economy, to capitalism in its various iterations, and to profit incentives — all accompanied by a gradual development around the world of some kind of liberal, representative democracy, though sometimes with peculiarities that differentiate and sometimes remove them from this category of political system. There is, however, no guarantee that this political system will stay with us when the underlying economic model starts to disappear. Yet this seems to be the case now. The gap between theory and reality is so deep and so apparent that it can no longer be ignored. Most economic concepts — the market, competition, flexibility, pricing of production factors, consumption theory — do not line up with reality. Most models are based on an analysis of past behaviour, which works fine when the economy is fairly stable, but stumbles when people change behaviour. A philosopher, not mincing his words, put it this way: “Economists build models by subtracting from reality the characteristics they deem inessential to the economic situations they model. The result is a bare bones description consisting of what economists deem economically essential. Everything that is discarded (not taken into consideration in the model) is called an “externality”. So the models only work when the externalities that were in effect before the models are implemented do not change afterward” (Kozy 2012). The state of economics is strongly reminiscent of Kuhn’s model of a paradigm shift — a scientific revolution occurring when scientists encounter

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anomalies which cannot be explained by the universally accepted paradigm, within which scientific progress has hitherto been made. The paradigm is not simply the current theory but also the underlying assumptions on which it rests, and indeed the entire worldview in which it exists, and all of the implications which come with it. So strong is this philosophicalpsychological-social context, that during the paradigm’s ascendancy, anomalies are brushed away as acceptable levels of error, or simply ignored — until they can’t any longer. The political system, which used to function, guided and helped by economic models, stumbles when confronted with the bankruptcy, not of banks, but of modelling. Few people realize how fast, how deep and how far economic modelling over the last decade or two has taken over policymaking. Ministries of finance have built up a colossal and indeed frightening power base, which forces politicians and other public sectors to comply with their models. And sometimes the models are wrong, surpassed by seminal changes turning societies upside down. Policies based on wrong assumptions cannot and do not deliver good answers. Bad models in the world of economics become bad policies in the world of politics — with real consequences for real people. Thus, around the world the political system has been enlisted in a campaign for cost-efficiency and management, partly driven by the difficulty of making genuine political choices — which are often cumbersome, sometimes boring and nearly always difficult to explain, and their benefits all too often appear only after a relatively long timespan. The public, and more importantly the voters, may not be prepared to wait. The basic policymaking processes — analysing problems and formulating solutions — and indeed the whole political sphere itself, has been subordinated to a narrow and limited worldview bounded by two mutually supporting Ms. Modelling4 looks admirably objective — even though it is not; far from it. Figures, statistics, arithmetic all provide a false sense of security, of being safely grounded on the facts. Such precision may exist in the natural sciences, but not in the social sciences. Modelling lures those who use it, primarily economists, and those who rely on them, primarily politicians, into the trap of a specious scientific certainty. Politicians confronted with models find it impossible to disagree. They generally fail to bring out their most powerful objection to any policy model — that they are politicians, and not accountants or managers — perhaps because they secretly envy

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the working conditions of accountants and managers, who after all can only be either right or wrong. Measurement is the other M — and is increasingly indispensable, irrespective of what public policy is being considered. Einstein is usually credited with the wise words and warning that not everything that counts can be counted, and not everything that can be counted counts. Politics is not merely about cost-efficiency. It is above all the struggle to build a social framework in conformity with the values held by the majority, and if possible the overwhelming majority, of citizens. Many of these values will be non-economic. Polls and elections show time after time that people do not always put the economy at the top of the list of their main concerns — and often it is very far from the top. Is it profitable for governments to close down local hospitals and replace them with bigger and more efficient hospitals further away from citizens? Is it good to look for market economy profit in a public transit system with the inevitable result that non-profitable lines are closed, even if they fulfilled important non-economic functions for a local community, whose members are now stranded unless they have a car? Privatization is still in vogue, in policymaking circles, despite a host of analyses showing that it is often not profitable for society, except in narrowly defined competition with the market economy. Political parties in all major democracies go back one hundred or more years. They were born by industrialization to tackle the question of the distribution of wealth. This worked well for a long time, but today it works increasingly less so as other, more complicated, issues crowd the agenda. Political parties still expect members to stick to their founding agenda, thereby continuing to legitimize their existence, and they cajole their members to toe the line. This gives them an odd appearance in the eyes of the voters, who are no longer obsessed with the distribution of wealth but are seeking solutions to new and completely different issues in their daily lives. The established political parties may search for different platforms on these issues when campaigning, but once elected they stick to their decision-making comfort zones, with the result that there is very little to distinguish one party in government from another. The former Speaker of the U.S. House of Representatives — Tip O’Neill — coined the phrase “all politics are local”. Nowadays, many observers feel tempted to say that “all politics are identical”. The result is a diminishing, and all but vanishing, confidence in the political system. Voters watch with growing disgust and conclude that

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the game seems to be about which politicians will get to do the same thing every other politician would do in their place. Voters have reacted by voting for extremist parties in growing numbers, or for any party that seems to break the established mould. In Europe, the Front National in France, the Five Star Movement in Italy, Podemos in Spain, and UKIP in Britain, though differing in politics, converge in their impatience and frustration. In the United States the Republican presidential candidacy of Donald Trump has shocked many observers, but he can also be seen as the latest in a line stretching back through Ben Carson, Michele Bachmann and Sarah Palin. All of them built their reputations on breaking the rules of normal politics and rhetoric, and each attracted a large number of supporters precisely by doing so. Modern political systems have operated in a form of symbiosis with the population. It has been the service provider delivering economic welfare and guaranteeing better living standards for the people, who in turn supported the system. This simple model no longer works. Nowadays the state — the political system — does not have a monopoly on being the service provider. In many countries a large part of welfare is offered by private corporations or through individual savings, and citizens do not necessarily value the state’s offerings very highly. Welfare has become more complicated than just a question of economics. People expect human security, social and cultural security, and access to learning and health facilities in a broad sense, which the state finds it increasingly difficult to deliver. Wealth may still go up in almost all countries, but inequality means that it flows to a smaller part of the population, inviting the majority to wonder whether the model is good for them. Lower growth distributed in a more equitable way could be politically preferable. Even better would be a perception of the range and quality of welfare available to the individual in the form of education, health and social mobility. Yet the hollowing out of public services in the name of costefficiency actually cuts the quality of services. Globalization brings in a large number of permanent or temporary migrants, diverting funds earmarked for social welfare or old age pensions, and fuelling fear among those who have paid taxes all their lives that there may not be money left to pay their pensions. The basic justification for the welfare state — that over a lifespan it is better to be inside one than outside — is not so self-evident anymore. Income inequality allows people who have sufficient money, to buy their own services, for instance healthcare. Not surprisingly, the best facilities

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(doctors, nurses, hospitals) tend to move out of the public sector and into the private sector, where the rewards are deemed to be more lucrative. What is left behind, as public facilities, are less able to offer high-quality services, which pushes more people out of the public welfare system. The process becomes a vicious circle, with a public sector starved of funds and personnel and a private sector doing better and better. For many people, liberal, representative democracy was seen as an instrument to bring about a high degree of equality — fairness and income equality — to guarantee social mobility. To a certain extent it succeeded, at least up until the end of the twentieth century. Gradually, however, this political system has been utilized to accomplish the opposite: income inequality, distortions of markets, concentration of economic power in fewer and fewer hands, blurring the distinction between public and private interests and activities, and a widening of the economic power distance. How was the purpose of the political system transformed in this way? One possible explanation is that its prime function — that of distributing income and wealth — readily lent itself to the seductions of economic thinking and cost-efficiency. For a time, liberal democracy brought about a broadly shared political consensus, despite the parties’ different political values. Governments were formed by different political parties, but the people governing came from the same education system and similar social backgrounds. There was a higher social and cultural consensus than was apparent. When working well it developed social capital and coherence, and provided a sense of human security and welfare that reached beyond mere economic welfare. This trend was derailed by the rise of economics, which began to dominate, and eventually to eliminate, non-economic thinking in governance. The consequences of this can now be seen. Values become the most salient political concern for more and more people, replacing formerly dominant issues such as the distribution of wealth. The machinery of the nation-state — established and geared to address the problem of wealth distribution — are inadequate and ineffective in the face of values challenges. People look for other social frameworks in which to find and root themselves in their values — and they are often, not surprisingly, crossborder communities, transcending the nation-state itself. Multiculturalism means that people adhering to a religion or ethnicity or tribe identity find

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more common ground in a community of “cultural compatriots” (possibly online) than with national compatriots who do not share their values, even if they belong to the same nation-state. The nation-state cannot reproduce these communities, which explains why a minority of national citizens fail to find solidarity with their fellow nationals, and in some cases may even see them as cultural opponents, and even enemies. The idea formulated by Samuel Huntington in 1992 about a clash of civilizations may not have been accurate, but he was correct in diagnosing the shift to values as the point of conflict between human beings. People today are much more likely to signal their values — religion or racial — through dress code than a couple of decades ago. The purpose is to profess values and let others know where you stand — who do you want to link up with and who do you not want to link up with. Cultural compatriots can approach you without any inhibitions. Rituals play a similar role, but have the added function of inviting people with common and shared beliefs and values to come together and enjoy the spirit of togetherness without fear of interference from those who disagree. It reinforces the sense of solidarity and of being in the right, while others outside the circle are wrong. Inside the circle, the signal draws others together — outside the circle, it pushes others away. In many multicultural nation-states, groups are strong enough in their collective identities to mix with one another, but they do not combine. In a longer-term perspective, this spreading and deepening cultural identification may make it difficult to maintain the political system built around the nation-state, as its citizens feel a closer connection with citizens of other nation-states who share their values, rather than with citizens of their own nation-state whose values are different. Democracy as it is known in the United States and Europe, and a few other places around the globe, can no longer claim primacy. Its inability to deliver effective solutions to social ills fuels anger and resentment among the population. Inept politicians connote a feeling of untrustworthiness. Terrorism also threatens democracy, but so too do the state’s actions in defending itself against terrorism. When panic or ineptitude allows this to slide towards police state behaviour, it can and probably will corrupt the political elite and police. Democracy can be hijacked by politicians who pay lip service to the virtues of democracy on their way to power, but who, once installed, dismantle the safeguards that protect individual freedom. The extremist

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political movements on the rise in the United States and Europe present just such risks — even if we cannot know exactly how they would act once in power. It would be a grave mistake to forget that Adolf Hitler came into power in Germany in 1933 fully complying with — on paper — the German constitution. The business model adds to the complexity and inadequacies of the political system. During the industrial age, business, society and government worked together inside an unwritten social contract. They supported each other and negotiated agreements about how to distribute the wealth generated by the business sector. The business sector saw itself as an important element in securing the nation’s well-being. In 1953 the president of General Motors, Charles Wilson, under a congressional hearing prior to confirmation as Secretary of Defence, stated that what is good for the nation is good for General Motors and vice versa. Big companies saw themselves as part of the jigsaw of the nation-state. And they acted accordingly, taking the nation’s interests into account when planning and executing operations. Economic globalization puts an end to this relationship. When a large and growing share of their operations take place outside the nation-state, corporations no longer see their interests as congruous with the nation-state. International competition also broke up the relationship between local communities and corporations. As long as corporate operations were distributed around the country, with close links to the local communities and citizens, they tended to act in conformity with local interests, even if sometimes that meant a lower profit. Globalization, with its enhanced competition, forced companies to restructure, consolidate and centralize — local plants were closed, and the bonds between owners, citizens and local politicians disrupted. Finance profited enormously from economic globalization. In some countries the financial sector’s share of GDP grew from two per cent in 1950 to nearly ten per cent prior to the global financial crisis in 2008–9. Instead of seeing themselves as the source of local economic life and manufacturing, the financial institutions took over a role as inventor, introducing one financial instrument after another that had very little impact on the production capacity of the nation-state. Over the past fifty years a business model has emerged in rich countries, focussed on short-term market-economy profit, and caring very little for societal costs, such as unemployment, and long-term diseconomies, such

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as negative impacts on the environment such as global warming. Society and, increasingly, politicians fought back by imposing restrictions on business activities. This has worked to a certain extent, but it has also reinforced the view inside the business sector that the social contract no longer exists — the reaction was to relegate the public sector to the role of trash can. The wage bill was retrenched by cutting the workforce — transferring the resulting social problems to government. Tax-avoidance increased to an unprecedented degree — becoming a globalized industry of its own. When years of reckless lending overwhelmed their balance sheets, financial institutions kicked their bad loans into the lap of governments, fully expecting to be bailed out. Paying for environmental clean-ups was the government’s problem. The public sector staggered under this burden, while continuing to treat the corporate sector as its partner in social governance, even as it was increasingly turning against the very concept of government. The business sector tried a public relations offensive, introducing a policy of corporate social responsibility — but the actual results have been disappointing. There have been numerous anodyne activities, such as sponsoring social and cultural events — none of them, however, can be said to have come close to a genuine partnership in any kind of social contract. The emergence of investment funds, entering into ownership of productive enterprises, may have contributed to, and even reinforced, this development. The weakening of the public sector pushed people towards higher savings, signing on to private health insurance and retirement pensions. The money flowing into these coffers used to go through the public sector — no longer. The private investment funds receiving the money looked for investment opportunities that were more profitable than treasury bonds and similar passive financial instruments. So they moved into the productive sector. Instead of buying a fixed stream of payments in the form of a bond, they bought a share of future production. This is sensible from their point of view as long as national production and income continue to grow. And at a time when global growth rarely fell below 3.5 per cent, that looked a safe bet. Investment funds, however, had no experience in running productive enterprises. They bought themselves into ownership in order to augment their ability to finance claims from the citizens who put their savings at the funds’ disposal. Competition between the funds led to a race for

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short-term profit. Enterprises and companies were bought and split up or dismantled or forced into mergers based on short-term financial analysis — irrespective of the longer-term productive strength of the enterprise. The anonymity of investment fund owners aggravated the disruptive effects on the social contract. There was little transparency and a lack of rules that would force them to disclose how they had placed their investments and what they owned. Corporations were created because it made economic sense to put a large number of transactions and operations together under one roof. Today it is different. Almost every day one corporation or another announces that it is cutting its workforce by five thousand or twenty thousand. What is not announced is that much of this work will continue to be done anyway, but outside the corporation. A bank firing twenty thousand staff worldwide will not cease to offer clients the services those workers had performed, nor will the customers cease to ask for them. They will continue to be provided by people working elsewhere — outside the bank. Advances in information and communication technology make it cheaper and more profitable for the corporation and the customer to move many long-established functions outside the corporation.5 Overhead costs, contributions to health and old age pensions and similar wage costs will all be cut. That explains why unemployment figures do not react more strongly to these gigantic layoffs. People are still at work, doing what they used to do, but now they do it outside the corporation. We can identify another fundamental rupture with the traditional understanding of political economy. In Karl Marx’s analysis, the worker did not sell her product to the employer, but sold instead her general ability to produce. The value of the product was higher than the value (and market price) of the worker’s ability, which gave rise to “surplus value”, or value added — the source of the employer’s profit. With the movement of production out of corporations, workers no longer sell their ability to produce to the company — they sell the actual product of their work to the company, suggesting that the value added, on which the company’s profit depends, is disappearing. If this tendency continues and increases — which looks likely — the consequence will be not only a fading role for corporations in the economy, but also a seminal shift in the distribution of income and wealth. This uncertainty about economics, politics and the business model coalesces into a more general anxiety about what the future will bring.

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Nothing is certain anymore. The structures of a worldview spanning two hundred years are breaking down. The unwritten social contract between business, government and society, facilitating growth and social development, is no longer acknowledged by the key partners and — consequently — no longer exists. The human factor is being sacrificed on the altar of cost-efficiency. Growing inequality not only restricts economic growth, but jeopardizes social mobility. In many countries the basic idea of fairness belongs to the past. What may be even more worrying is a noticeable swing away from scientific thinking — logic, reason, the demand for facts to support statements — and towards fluidity and subjectivity, questioning the foundations our modern societies are built on. When we look at the twentieth century, what is striking is the degree to which optimism and a shared belief in progress prevailed. People trusted the future to be better than the present. Although the world lived through some of the most disastrous events in history, there was optimism. And despite excess and extremism, the world moved forward. Before World War I, politicians broadly speaking enjoyed the trust of the people. The gold standard reigned supreme, and although the business cycle fluctuated, the economy delivered wealth for all groups in society. In the inter-war period, France and Britain seemed to have shaped a workable system for “peace in our time”, an illusion that held till 1938. Finally, after World War II, the United States rose to the occasion in the spirit of magnanimity and statesmanship. The Americans believed in their own system, they wanted to offer it to other countries out of idealism, and many other countries found it worthwhile to adopt its basic principles. The U.S.-led global system — operating through the United Nations, the International Monetary Fund (IMF), the World Bank and the World Trade Organization (WTO) — lasted sixty years. It survived not through projection of power, but because it worked. After the fall of its challenger, the Soviet Bloc, in 1989, an era of universal progress and peace seemed at hand. But now, who really believes in the future anymore? At best the world has come to a standstill; at worst it is going into reverse. A hundred years ago Einstein and Bohr opened the door to a new scientific age not seen since the age of Newton. Today’s scientific picture, our understanding of the world and the universe, is still anchored in the revelations flowing from the brains of Einstein and Bohr. Implicitly, this creates a worldview of a stationary or stagnating world. What is today’s equivalent of the theory of relativity and the model of the atom? We are proud of technology such as the Internet, portable communication and biotechnology, but will it really

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change our daily lives the way the car and the aeroplane did? And new technology, though useful, is no substitute for new scientific understanding. The economic model serving industrialization — and providing enormous increases in living standards — has run out of steam. What is worse, the operators of the model, business leaders, appear to be either incompetent or morally flawed to a degree unheard of just a few years ago. The great entrepreneur of the past — proud to create a massive enterprise and jobs for thousands of people — does not exist anymore. Today’s wealthy earn their money through speculation in financial instruments, diverting funds out of the productive part of the economy, or by buying and selling property, without augmenting the capacity of the economy to deliver goods and services to human beings. The political system delivered human security, prosperity and gradually welfare to the people as well. The Great Depression of the 1930s disrupted this picture, but did not really uproot its foundation, and the world worked its way out of the crisis. Today’s political system has lost its connection to the people, failing to come up with solutions to the problems that citizens care most about. The legitimacy of any political system, irrespective of how its leaders are selected, rests on its ability to deliver. The political system in the United States, Europe and Japan — the mighty economic powers called the G-3 — has not delivered. People have started to wonder why their politicians are there at all — raising the spectre of other, less palatable and even less effective systems winning popular appeal. So far we have been spared a rerun of the “isms” of the 1930s. But those sinister responses to the current political fumbling are there, lurking just around the corner. Who would like to live in a world governed by nationalism, xenophobia, populism and bigotry? Not many — yet such simplistic solutions, based on the blaming of the Other, especially the foreigner, are gaining traction around the world. Even the wonderful advances in information and communication technology, which have put so much processing power into everyone’s pockets, have their dark side — in a strange kind of dehumanization of society. We communicate more and more with other human beings, while we see them, and certainly touch them, less and less. We often cannot be sure we’re not dealing with fake identities, created for some nefarious purpose. Human feelings, detectable when we’re face to face with another human

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being, fade away in the digital age — which is one of the reasons that modelling and measurement have arisen, to fill the gap in our experience of the world. And the world itself turns into a kind of movie, blurring the difference, in many people’s minds, between what is real and what is artificial. Life becomes more and more like a video — which appears even more real than real life. In video games if you are killed or you kill your opponent, you just start over and everybody is alive again. We do not see and feel the pain suffered or happiness enjoyed by other people. The terrorists have seen that, and in many ways they are using digital media to offer a kind of theatre of terror to the world. And modelling and measurement, far from providing recourse for our lack of real-life experience, in fact represent a similar kind of dehumanization — a mechanical decision-making process, overruling human relationships to gain cost-efficiency. In business life, human interaction is a rarity. When contacting a bank or an airline or many other businesses, particularly in the service sector, a customer will be lucky to speak with another human being at all. Normally, customers are referred to a machine configured to answer the twenty or so most common questions. If the problem falls within the scripted answers, the customer will get a fast and correct reply; if not, the customer can waste hours trying to get in contact with a human being capable of dealing with their problem. The word Anthropocene was introduced some decades ago to signal that human activity has had a significant impact on the earth’s ecosystem. Yet it goes further than that. Current business thinking tries to eliminate nature from production, including food production. Genetically modified organisms (GMOs) are intended to lift food production out of nature’s grip and turn the manufacturing process into a human-controlled one. This actually seems like a viable solution to many people. With more than fifty per cent of the world’s population already living in cities, and more on the way, the majority of human beings have lost contact with nature and do not understand such simple processes as the seasons and natural cycles. But can we stay human unless we see and feel ourselves as a part of nature? While our relationships with our fellow humans suffer from dehumanization, our relationship with nature is suffering from denaturalization. These two disruptions — dehumanization and denaturalization — represent the two most crucial challenges to our political system and our economic model. The way ahead, if there is one, must be to renew our

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understanding of the vital importance of human relationships, and what nature means for the individual and for society. The current political system — with professional politicians turnedmanagers combined with a greedy business model and an economic model controlled by short-term profits — does not deliver solutions to our current and future problems.

Wrap-Up The free market, the capitalist business model, liberal representative democracy and the nation-state worked well together over the industrial age, in Europe, the United States and a few other countries. From our present perspective we can see it as an age of transition, during which economic thinking opened the door to a massive and sorely needed creation of wealth, infrastructure and production capacity. With that capacity now in hand, humanity has the means to move forward into another age, characterized by instant communication and less materialistic consumption. The industrial provided the scientific and technological foundation for such a new age. This combined business, economic and political system lost its allure when these objectives were more or less accomplished. A point of saturation was reached, where the pursuit of more and more industrialization and materialism appeared not only undesirable, but pointless. As the economic world became increasingly distorted, in order to remain with the prevailing political system and economic model, a majority of people began to have serious doubts about the virtue and benefits that the social system offered them. Values and cultural identities, which were put on the backburner in the age of industrialization, resurfaced again as industrialism lost its allure. This only further aggravated the dilemmas that politics and economics were already proving unable to resolve. In a way, all this happened not because the political system and economic model had failed, but because they had been successful. Their task accomplished, something new was needed. The inability to grasp this need has deepened the crisis — a crisis that policymakers and economists still see as just one more datapoint on the curve. In fact, it is a clear signal of the world’s need for a fundamental paradigm shift.

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Notes 1. Aristotle (384 BCE – 322 BCE) stated: “Man is by nature a social animal; an individual who is unsocial naturally and not accidentally is either beneath our notice or more than human. Society is something that precedes the individual. Anyone who either cannot lead the common life or is so self-sufficient as not to need to, and therefore does not partake of society, is either a beast or a god.” 2. EDICI stands for Evolution, Development, and Intentional Control of Imitation. See . 3. I dislike the term “labour market” but use it to avoid needlessly elaborate wording. 4. On this point I was inspired by Professor Ove Kaj Pedersen of Copenhagen Business School. 5. As is the case for R&D work being offered to bidders on the Internet instead of given to the corporation’s R&D division.

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II Politics

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3 Steering System

This chapter addresses the political system that evolved in tandem with the industrial age — liberal representative democracy. It was a system that worked well for a long time, by gradually and cautiously enlarging the right to vote and the influence of the people on government. But today, growing inequality and anxieties induced by the ancillary effects of globalization threaten its survival, giving rise to nationalism and populism, even as politicians increasingly shy away from conveying unpopular messages to potential voters, while at the same time tailoring their policies to opinion polls. In the long run, globalization is beneficial for the political system, the people and the politicians, but the short-term adjustments it demands pose risks of antagonism towards other nations, people and cultures as they impinge on the daily lives of citizens — suddenly the outside world is right next door. Digitalization creates opportunities for social networking, but opens up the danger of social segmentation — making it easy to restrict one’s contact with the world to communication with like-minded people, and reinforcing the alienating belief that I am right and everyone else is wrong. Thus, globalization and digitalization presents a challenge, not only to political systems, but to the existing societal structure that keeps societies and communities together. The very nature of these technologies increases the distance

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between people, and between people and decision-makers, flying in the face of people’s natural and time-honoured wish for low power distance.

Political System Any political system is judged by its ability to “deliver”. There exists an unwritten yet enduring social contract between the people, government and business sector, which holds society together based on an assurance of common interests, social mobility and an equitable distribution of benefits. Three basic tasks for a political system transcend time and space. Every political system, no matter where or what kind, must deliver basic needs, guarantee human and social security and offer welfare services such as health, old age care and education. There is a quid pro quo between citizens and rulers. The system must be certain of its citizens’ loyalty; confident that in case of conflicts, they can be counted on. That will only be the case if the citizens feel the system fulfils the tasks enumerated above. The rulers must earn this loyalty. Formerly, legitimacy rested inter alia on heritage (Roman Emperors used to adopt their chosen successor as a son, to make sure the succession was legitimate), or in China on the perception of the Emperor as the Son of Heaven. Bad times — natural catastrophes, floods, etc. — were interpreted as the Emperor’s loss of “the mandate of Heaven”, removing his legitimacy. Today in China, the Communist Party bases its legitimacy and the loyalty of its citizens on its ability to deliver. A society, a nation-state or other political entity — be it regional, national or international — is kept together by discipline perceived as the citizens’ understanding of the need to respect certain rules, written or unwritten. The citizens must see such behaviour to be in their own longterm interests. Ordering people to respect the norms will be successful, at best, only in the short term; loyalty must be given. Discipline can for some time be imposed by rigour or repression, but is only viable in the long run if the political system lives up to expectations and fulfils its tasks. Self-discipline is crucial. Citizens obey rules and regulations, not because they have to, but because they realize that it is the right thing and the best thing for themselves. Studies have shown that societies resemble natural organisms or herd animals, in that survival is based on a system of discipline according to defined rules. These rules must be understood and accepted by citizens

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and rulers, with clear and regular flows of information — feed-out and feedback — exchanged between them. The people must be able to communicate to the rulers what they want, how they expect it to be achieved and whether the rulers are on the right track — this is feedback. The rulers must communicate to the people what needs to be done and why, and how it can be accomplished — this is feed-out. In some cases a gap can arise between what the people want and what the rulers see as possible or necessary. This has become more frequent with the increase of economic globalization, which has narrowed the room for manoeuvre for most nation-states — a fact frequently recognized by the rulers, but much more rarely by the people. People attribute their current living conditions, good or bad, to the incumbent political leaders, irrespective of whether those leaders bear any responsibility for the situation. This gap often goes unacknowledged. At the end of the day a political system rests on the premise that the people trust their leaders — and the gap represents erosion in the foundations of the system. If it is not acknowledged, then the perception of stability and strength in the system corresponds less and less to reality. A political system that allows a discrepancy between reality and perceptions to persist is living on borrowed time. Just such a discrepancy is starting to haunt political systems around the globe. After two hundred years of industrialization, the benefits — in the form of more to consume — are being replaced by an era of scarcity, with less to consume. Politicians find it difficult to come to grips with this phenomenon — partly because they do not want to and partly because they may not realize it is happening. Electoral promises contribute to the erosion of the political system’s authority because politicians know the promises cannot be fulfilled — and the voters suspect it. A strange kind of dishonesty poisons the atmosphere. The economic recession is at the root of this, since the near-universal political reaction is to call for more economic growth — to get back to “the good old days”, as if that were possible. Those days are gone and cannot be recalled. A recession makes a large number of jobs disappear, permanently. Restructuring and adjustments are effective only when there are new jobs to replace the old jobs. Scarcity pushes up commodity prices and makes a global mass consumption model unthinkable — yet politicians continue to promise that mass consumption in China and India will give us a way out of the recession. This is, simply speaking, not possible. But

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when they fail to make good on their promises, voters lose confidence — not only in some politicians or those from certain parties or political orientations, but in all politicians. Since the recession started, voters have thrown out incumbent leaders in most countries and replaced them with new leaders — who make the same promises and follow the same model, with the same general results. The convergence of economies around the globe through economic globalization has obliterated the traditional political framing of opposing models — market economy versus socialist versus social democratic. Politicians no longer position themselves against other political parties, by highlighting another economic model. Conservative, liberal and social democratic governments in Western industrialized countries adopt almost identical economic policies — though they do not dare to say so. So how do political parties differentiate themselves from other parties? They select other issues, such as education, health, the environment, and in many European countries — and to a growing degree in the United States and Asia — immigration. They lose contact with their traditional core supporters. Political preferences on these issues do not break along the same lines as those on economic policy and the distribution of income. They are highly political issues, certainly, but not in the mould of traditional party issues. Voters start to float, producing large swings in election results according to which topic is current and where politicians stand on it. The picture becomes fluid and new political forces sense an opening. In most European countries the same political parties monopolized the debate until the end of the twentieth century — since then, a whole new array of political parties has emerged. The Tea Party in the United States and the nationalist, anti-immigrant and anti-European parties in various European countries have all arisen in recent years — some starting from scratch, others moving from obscurity on the social fringes into the political mainstream, with a serious chance to win power. Some decades ago, the Greens, with their calls for sustainability, were the newcomers — in many places they have now joined the old guard. People, and indeed also politicians, become baffled when they suddenly find themselves agreeing with somebody they never agreed with before, and disagreeing with people with whom they have soldiered on as party comrades for decades. These values-driven issues cut across political brands. The conventional political machines do not really have an answer. They try to rally the new

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players around their flag, but in doing so they alienate their traditional supporters. The result is a strange de-politicizing of the political debate — defining “politics” as it has been known for more than a hundred years. It becomes harder and harder for politicians to explain why voters should support them and their political party. Political contention grows more vicious, becoming less to do with the issues — such as they are — and more about exploiting personal weaknesses and missteps. The privilege of opposition is forgotten. Formerly, in the British Parliament, the Government stood across the aisle from Her Majesty’s Loyal Opposition — the sense was that the opposition should hold the government accountable and offer an alternative, but not simply oppose or obstruct the public business for political advantage. Voters understandably draw two simple conclusions. First, politicians are not interested in policy, but only in getting into power, irrespective of the methods used to achieve that. And second, that all politicians are alike, and none of them deserve the voters’ trust. It has become a rarity to see a leading politician take a principled stand on what they deem to be right if it runs the risk of losing power. Instead they cater to the electorate’s lowest common denominator, trying to never antagonize public opinion. The widespread use of opinion polls to gauge public opinion, and efforts to get feedback from the people and reactions after a major political speech, aggravates this dissolution of political principle and undermines politicians’ credibility. Leaders — the rulers — are there to lead and to govern: what else? Their job is to show the way and tell the public how they evaluate the situation and what needs to be done, regardless of whether the public agree with them or not. The problem is not the valid attempts to find out what the public thinks — let alone to communicate with and educate public opinion — but the risk that unpopular but necessary political action is delayed or avoided under the weight of unfavourable popular feedback. Looking back over the last quarter of a century or so, we can identify three very distinct eras of political leadership. In the 1980s the world saw politicians with conviction who introduced national policies that actually set a course for their nation-states, and they then stuck to that course. The examples of Ronald Reagan in the United States, Margaret Thatcher in Britain, Francois Mitterrand in France

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and Helmut Kohl in Germany spring to mind, as, in Asia, do Deng Xiaoping and Lee Kuan Yew. They did what they genuinely believed should be done. The interesting observation is that they were rewarded by re-election, even though their standing in the polls from time to time augured a different outcome. It seems that political leaders nowadays fear the voters — while experience would show that voters actually prefer leaders who lead! In the 1990s the world saw managers take the helm. The business cycle was favourable. Economic growth was good. The rivalry between the Western/Capitalist camp and the Eastern/Socialist camp was over, freeing resources for more valid and productive use than military hardware. There seemed no need to change course; why, when everything was going so well? So political leaders managed the economy and social development, successfully avoided stupidities for the most part, and threw no spanners into the works. Bill Clinton in the United States set the tone, followed by John Major in Britain, then Jacques Chirac in France and Gerhard Schroeder in Germany. Over the first decade of the twenty-first century, a new generation of politicians took over — leaders who were led by public opinion, under the direction of spin doctors who also had as one of their tasks to influence public opinion by carefully orchestrating news and information. The divide between reality and imagination became blurred, political debate became increasingly less relevant to actual issues, and the distinction between leaders and followers more confused. Tony Blair in Britain is the shining example. U.S. President Barack Obama is in the same category. The second decade of the twenty-first century is producing politicians who appear surprised by events they had neither foreseen nor prepared for. They fall back on a kind of intellectual stalemate aggravated by the failure of the social sciences — in particular, the science of economics — to understand what was going on, let alone to predict what was going to happen or to offer solutions. They are even more surprised by their own electorate, especially when these voters see through the maze of fumbling and obfuscation and begin to look for political movements that promise radical change, from top to bottom. People no longer believe in a common destiny, shared between themselves and other members of society. They start to look after themselves alone, in any way they can. Tax evasion, fraud, moonlight work, kickbacks and corruption become widespread, undermining policies and distorting

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the economy. People do not want to interpret the spirit of legislation; instead they analyse the text literally, looking for loopholes, to determine precisely how much they can get away with. To prevent abuses, legislators are forced to make the text ever more sophisticated and elaborate, further widening the gap between the political system and the people. With some justification it can be said that any political system is heading for trouble if legislation cannot be comprehended by the large majority of the population. This is certainly the case now. The result is a rising share of human and intellectual resources steered into occupations designed to understand and, increasingly, to exploit legislation. Consultancies, auditors and other specialists flourish — diverting resources from productive use into what can safely be categorized as totally unproductive industries. Governance loses its lustre, becoming less a matter of serving one’s society and more a question of manoeuvring through a minefield and serving one’s clients — in order to hang on to the reins of power or to wrestle them away from those who currently hold them. This is done by offering benefits to special interest groups able to throw their support behind a politician or a party in forthcoming elections. Corporate governance goes the same way, as enterprises discount any goal of contributing to society and focus entirely on achieving the maximum profit. We move towards a social structure that incentivizes and rewards egoism and maximizing one’s own advantage. The lack of firm government leadership forces a change in the business sector’s strategic planning. In the traditional industrial society, business accepted social tasks and burdens on the understanding that this was payback for the services it needed — in the form of education, infrastructure, the system of justice, economic regulation, etc. — provided by government. These services degrade as public investment and spending decline — one of many consequences of deregulation and privatization — and business is pushed into the unenviable task of having to finance and organize some of these activities privately. When business is forced to look after itself to a greater and greater extent, why should it feel any obligation towards the wider society? It does not. In the nation-state scenario, business had an intimate relationship with government. Globalization, however, breaks down mutual interests and mutual support. Business operates, asks for services and faces the dilemma

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of being a good corporate citizen — while at the same time having the option of picking up and moving its operations, if that becomes the more advantageous solution. The tax system works in the same way. Businesses, like people, accept the need to pay taxes as long as there is a reasonable balance between what you pay and what you get back. In most Western industrialized countries — the core of industrial societies — taxes remain very high even as services are scaled down. Transfer payments to groups and people outside the productive part of society can only be paid by those who actually produce something. They see a rising share of their output channelled to groups not taking part in productive life — and perhaps not willing to do so — and furthermore exerting their political influence against the interests of business. In many Western industrialized countries, the balance between the productive and non-productive sections of society is tipping increasingly to the disadvantage of business. The political consequence is not difficult to see. Those who benefit from the welfare society, while not contributing, are gaining power, and use it to impose conditions for economic activity by those who earn the money to finance the welfare services. This cannot last. The first reaction is a refusal by business to consider the interests of social stakeholders in its decision-making. The second reaction comes from society, asking why we should continue to cater to the needs of business when they so blithely ignore ours? The spiral of conflict ratchets up, with business exploiting economic globalization — moving jobs, revenues and profits wherever it wants to — while the non-productive part of society calls for governmental action to prevent this. Any prospect of reconciling the interests of business and the non-productive section of society diminishes rapidly. The social contract breaks down. The link or “contract” between owners and employees has been severed. In the industrial age, owners knew who the employees were and the employees knew who the owners were. They lived and worked in a kind of symbiosis — sometimes unstable, but for most of the time it actually worked. Jobs themselves, in the industrial age, were generated by corporations and were directly visible. This is not the case in the global and communication-controlled age — they do not “know each other”. The example of General Motors versus Facebook is sometimes brought forward.1 General Motors is valued at US$35 billion and has 77,000 employees in the United States and 208,000 worldwide. Facebook is valued at US$70 billion

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(as of January 2012) but has only 2,000 employees. This comparison misses the reality, which unfortunately is even worse. Facebook may generate many more jobs than General Motors, but, unlike General Motors, its job-creation activities are not visible; the jobs may be found in countries and business sectors without any tangible or visible link to Facebook. The employees who owe their jobs to General Motors may have some kind of relationship or sense some kind of social contract with the company. Even if many of the jobs are spread around the globe, they all know their jobs are due to the company. The jobs created by Facebook do not bear any kind of link to Facebook. People taking them up may not know that they result from Facebook. Economic analysts may not even know it and the government may miss the point as well. In such cases there does not exist any kind of social contract. Furthermore, the jobs created by General Motors can be linked to the automobile industry. If General Motors runs into difficulties, other auto manufacturers can step in to fill the vacuum and to a certain extent, depending on circumstances, the people who lost their jobs may move to another carmaker. Not so with Facebook. A few years ago no one had heard of Facebook. In a few more years, a new idea, a new invention, may wipe out some of the jobs created by Facebook. And though another company may step in to fill the void, it is unlikely that the same people will be able to take them. Job exporting increases insecurity and uncertainty among workers, further contributing to the breaking-up of the social contract.

Inconsistencies Nationalism and populism can be characterized as a defensive reflex against globalization and digitalization. Many people feel left behind. The growing inequality (unfairness) inside nation-states and between nation-states fuels this counterattack, born out of the simple question “what’s in it for me?” Any political system and economic model must respond to the challenge of the predominant worldview of its era. Industrialization gave birth to liberal democracy and American-style capitalism. As it now fades away, the accompanying political system and economic model will do so too. We face three strong challenges to our ability to make a stable transition — from the system we know to a future system whose outline we can only just discern in the distance.

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The explanation for growing nationalism is found in globalization and the growing and spreading uncertainties about jobs which it creates. Former British minister and former member of the European Commission Peter Mandelson (2011) sums up the situation this way: “opportunities for many, uncertainty for most”.2 Fundamentally, people shy away from sharing jobs, income and wealth with others outside the circle of common culture, common and shared values — particularly if there is no assurance that their own welfare will not deteriorate in the process. Growing immigration in countries that used to be uni-cultural, but now harbour several and in some cases not congruous cultures, accentuates what is fast becoming an identity problem. Under pressure from economic uncertainty and clashing cultures, many people seek refuge in nationalism and blaming “foreigners” for the problems they encounter in their daily lives. This poses a danger to the future of globalization for two reasons. First, because it lures politicians into the trap of playing along with what appears to be a popular mood, and gradually eroding the post-war gains of freedom of trade and investment, and of less restrictive immigration.3 In short, the international division of labour, on which globalization depends, is threatened. Second, because a xenophobia that grows in intensity and respectability threatens the power of globalization to move forward and resolve its own contradictions, by transferring political decision-making from the national to the multinational and even global level. Parag Khanna (2016) shows how connectivity, joining up communities into growing political agglomerations — megacities and megaregions — will shape the future and become indispensable for the global economic system. But how can nation-states take this necessary step forward if their peoples are obsessively suspicious of “foreigners”? Internally, the dialogue between politicians and populations breaks down under the weight of mutual distrust. Gradually, countries become ungovernable, increasingly relying on the international institutions and international communities or, for that matter, other countries to impose discipline upon them. Discipline and self-discipline is one of the virtues of economic integration as seen in Europe. Member states do not take decisions judged to be harmful to adjacent countries. Economic policies are designed not only to serve national interests, but with an eye to the effects on the EU as a whole. This has been vilified since the global financial crisis, using the Greek case as an illustration, but disregards the

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colossal benefits of discipline and self-discipline. The problem, seen to a certain degree in Greece, but also in other cases, is weak politicians using international institutions and commitments as a scapegoat, sowing the feeling among people that hardship is due to these institutions and not their own irresponsible governments leading them into the crisis. This merely confirms the view of a large part of the population that foreigners are indeed to blame. Any attempt to lift the political decision-making process to the same level as the economic and industrial phenomena it is designed to oversee, encounters the barrier of nationalism, maintaining the dichotomy between the global economy and a national decision-making process, and consolidating the impotence of the system. Globalization or internationalization means inevitably that power distance grows. That may be manageable, but the danger embedded in this process is a diminished transparency, as people see their familiar national, regional or local institutions replaced by an obscure and remote decision-making process which is fully democratic for its participants, but to outsiders — in other words, the people — is arbitrary and bureaucratic, and appears out of control. This is the situation in the EU. Not a single decision is taken without strict democratic control exercised by member states through EU institutions. But ask European citizens and many will say the process is undemocratic and controlled by civil servants. The same can be said a fortiori about the IMF, the World Bank and the WTO — which work with far less democratic control than the EU. One wonders whether internationalization and globalization can work unless accompanied by high economic growth. The EU took off in 1958 precisely at the moment when the global business cycle turned upwards. People ascribed the growth to the EU — rightly or wrongly. For most people, an equation exists. They know well that economic globalization through trade and investment encroaches on their identity. But as long as the growth is sufficiently high to bring about a tangible and visible rise in their living standard, while respecting the fundamentals of their identity, they are ready to make the necessary compromises that accompany the process. But the equation turns negative when growth stumbles, especially at the same time when unpopular economic policy measures must be introduced and even greater compromises of people’s identity are demanded. People ask how much they are getting out of globalization in return for what they are giving up.

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Something like this happened at the time of the global financial crisis in 2008–9. Politicians, economists and other “experts” explained time and again that the crisis would have been far worse without globalization — particularly in Europe, where the EU acted as a bulwark against a return to 1930s-style beggar-thy-neighbour policies (trade barriers, capital export limits, competitive devaluations, etc.). People do not buy it. They tend to see only the immediate costs of global policies on their own lives, rather than accepting them as solutions to larger global problems — which would eventually exact a much greater cost on their immediate lives if left unchecked. They confuse policy measures, which are visible, with the problems, often not so visible, that these measures are designed to solve. Perhaps globalization, or internationalization, has gone too far too fast. The political system is partly, and perhaps inadvertently, complicit in this process. To win popular support for globalization, promises were made of large economic benefits. This was the case in Europe, with the EU treaties, and in the United States, with the North American Free Trade Agreement (NAFTA). If the global business cycle had continued to deliver growth, people would probably still be solidly behind NAFTA, the new EU treaties, the single currency (euro) and the enlargement of the EU to include Central and Eastern European countries — but it did not. People naturally ask their politicians why the benefits they promised did not materialize. This question still lacks a convincing answer, aggravating popular distrust in politicians and giving support to nationalism. The long decades of steadily increasing standards of living convinced people that they have a right to get more every year. Unfortunately, we now move into an era where there is less to distribute, at least relatively. Politicians hold office on a mandate given by the people. More clearly so in democracies than in other systems, but basically all political systems depend upon the support of the people — and shy away from presenting the truth, even though they know it, to the people. Populism makes the politicians popular now, and is therefore attractive in a system where political leaders are elected by universal suffrage. Thus the merry-go-round begins. Politicians try to circumvent the hard facts by doing two things. First, they encroach upon the future by running up deficits and debts, shifting to the next generation the burden of the present one’s overconsumption. This buys some time, but the birds let loose come home to roost. Deficits and debts demand acrimonious adjustments. People react by accusing politicians of having broken their

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promises. Politicians in their turn try to keep their promises by making further drains on future income, hiking deficits and debts. Second, the nationalistic card is brought into play. The angry public is told that the problems are due to foreigners or the outside world or globalization, a story which only adds fuel to the already burning fire of nationalism. The whole basis of representative democracy is jeopardized when politicians fail to explain complicated problems. People have never been expected to fully understand such issues, but formerly there was a high degree of trust between politicians and populations. The large majority may not really have understood, but they trusted their politicians when they said that overall it was beneficial for society, despite what it will cost in the short term. Not any longer. The panoply of new instruments of communication constantly undermines the trustworthiness of politicians — even more importantly, the distinction between politicians and experts becomes blurred. Who to believe? The ordinary person ends up believing no one and takes refuge in simple solutions — which is the populists’ stock in trade. Outside forces, very often populist in nature, use the new communication instruments faster and more effectively by marketing simple answers, appealing to a public unable to see that the wool has been pulled over their eyes. The political system is forced into a defensive role, responding to all kinds of criticism, claims and loose allegations — often without any evidence to support them — convincing no one of anything except that someone is hiding something. Gradually the perception gains ground that the political system itself cannot be relied upon. It is impossible for the established political culture to guess or foresee where and how its efforts will fail, because the system’s tendency is to act by reason and logic and the public is so often guided by emotions. Formerly, the debate was directed by political parties; now it is dominated by unknown voices, each having its own agenda and rejecting any kind of responsibility. It is almost comparable to a military superpower fighting a guerrilla war — it has the forces necessary to win, but no idea of where to apply them. Nationalism and populism coalesce into a new form of xenophobia that in some cases comes close to racism. Globalization has opened up borders for guest workers, migrants and refugees on a scale never before seen. The great wave of migration out of Europe more than a hundred years ago created multicultural societies, including those of the United

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States, Canada, Australia and New Zealand, which have not found it too difficult to extend multiculturalism to non-Europeans. Hitherto, very few European societies and nation-states were multicultural, but were dominated by the culture of the majority of the population which had lived there for a long time. More than ninety per cent of Europe’s population had their values and ethics shaped by Christianity in various forms. The migration into Europe in the last thirty years caused little turmoil in the beginning, even if the majority of the migrants were Muslim. Many of them were guest workers. In Britain and France many came from former parts of these nation’s empires. They accepted their conditions — good or bad — because they compared the situation with how they lived before. Their children and grandchildren do not. They find it difficult to integrate or to find themselves at home; neither where they live, nor where their parents lived. They have no genuine identity telling them where they belong. That makes them open to the message that they are victims of the nation-state in which they live. The presumed link between citizen and service providers is broken, if it ever existed. The temptation to join groups like al-Qaeda and ISIS for some of them becomes irresistible; a tiny minority perhaps, but one big enough to present a credible threat to the nation-state and to spread the message of revolt to those who passively acquiesce to their situation. The flagship of globalization and mass communication — the Internet — is transformed into an instrument to maintain links with groups in societies and countries where their parents and grandparents once lived. Parallel societies with their own legal system, and sometimes their own financial system, are built inside European societies, constituting an obstacle to the authorities’ ability to impose law and order, as the nationstate defines them. Europeans start to feel a measure of angst. Neighbours suddenly appear following other traditions and behaviours than have been seen before in that place — instilling at best uncertainty about the way the world is changing. The migrants may boost economic growth in the longer term, in view of Europe’s falling population, but in the short term it is costly to receive them and start the integration process. The Europeans, having contributed to social welfare funds over decades, fear that the money to settle the newcomers will be taken from what they themselves expected to receive.

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Such reciprocal uncertainties compound angst and fear among both groups — Europeans and migrants — which, unless addressed in a robust way by authorities, will spill over into xenophobia. Especially vulnerable are those segments of society — again in both camps — that find it difficult to cope in a competitive society. The strong manage very well and get along with each other, irrespective of religion, race and culture. The weak find it much harder. It is among the potential social losers the reciprocal hatred arises. Psychologically, hatred is nourished by the feeling that if “I cannot manage, it cannot be my own fault” — but if not, whose fault is it? The others, the foreigners, strangers and those who behave differently. Few dispute that economic globalization, in its American-stylecapitalism edition — delivers higher economic growth than any other imaginable model. The problem is that the flow of benefits does not seem to be distributed in a balanced way. Inequality is increasing. The Gini coefficient, used to measure inequality, has increased in recent decades for almost all countries. In the United States the share of income going to the top 1 per cent is now 20 per cent, up from just 8 per cent in 1973 (for a Gini coefficient of 0.46 per cent). The top 1 per cent owned 33 per cent of the wealth, while the bottom 80 per cent owned just 15 per cent (giving a Gini coefficient of 0.80). For China the Gini coefficient rose from 0.32 in 1978 to 0.50 in 2006. The red line for social distress is generally considered to be about 0.40. Most people approve of high growth, but they also want their share of it. Otherwise, why should they support the model? Another model might lead to lower growth, but if it were more evenly distributed the majority could actually be better off. On top of all this, the economic system is producing unquestionably negative side effects on the environment, a problem compounded by the waste of resources in an era where resources are becoming scarce. There is an inequality of impact here that closely tracks income inequality — those at the low end of the income scale will be disproportionately hit by the degradation of the environment, in the form of pollution, low labour standards and the use of hazardous substances. Those left behind by globalization’s advances feel aggrieved and angry — they constitute an inviting field for recruitment to nationalism and populism. These people likely form the backbone of the backlash to globalization.

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The upper segment of income earners seem, at least up to now, unwilling to give up their privileges, forestalling meaningful change to a biased and lopsided model. Marx predicted that the middle class would become extinct or at least not play any constructive role in society. He was wrong. Indeed, one of the reasons explaining capitalism’s endurance was the creation of a large and growing middle class, which shared in the fruits of industrialization and willingly assumed the role of a stabilizing social force. No party or politician could get into power without moving towards the centre. This constituted a barrier to more adventurous policies — in the 1930s, for example, when the middle class lost faith in the system, the door was opened for extremist policies. But perhaps Marx was right after all. The growing inequality of today may not wipe out the middle class, but it is certainly eroding its power and its stabilizing influence. In the United States, in particular, it is abundantly clear that the middle class is slipping behind, economically. This has worrying repercussions for society, not only through their growing feeling of grievance in the short term, but also in the long run, as the cost of financing their children’s higher education grows out of reach for more and more families, further aggravating the insecurity of the middle class. A number of studies indicate that social mobility is falling in the United States and point to a lack of financial means among parents to support their children’s higher education. Social mobility — hitherto regarded as one of the key factors in U.S. growth — is falling below what is seen in Canada and several European countries.4 Three-quarters of students at the top 146 universities in the United States come from the richest 25 per cent of the socio-economic stratum, compared to just 3 per cent from the poorest 25 per cent. Meanwhile, 85 per cent of graduates in 2011 had to move back to live with their parents because the debt they had accumulated in financing their education would have been unsustainable if they had lived on their own. An analysis brought out that 57 per cent of Americans believe education is not worth the cost, and 75 per cent think that the price is too high for most Americans to afford.5 To mention one example: tuition costs alone amount to US$32,000 a year to be a student at Berkeley in California, a state-owned institution. Putnam (2015) shows how a wider inequality, beyond the merely economic, freezes social mobility in the United States. Either children grow up in a wealthy family — able to afford a degree from a top university,

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graduating into the American social elite and likely to marry a spouse from the same social stratum — or they grow up in a not so rich family, unable to afford the best universities, marry a spouse from their own stratum. Children are thus locked into the social strata where they are born. There is very little chance of upward mobility.

The Clash Power distance is growing and so is the gap in communication and understanding between politicians and the voter. The main political issues are no longer economic, but have shifted to “soft” issues, such as migration, refugees, education, health and the environment. Politicians find it difficult to tune into this new pattern. Voters, increasingly annoyed, use digitalization and social networking to form opinions outside the existing framework, eroding the power of political parties. A growing gulf between the elite and the people is becoming visible. More than half the global population now live in cities, and this urbanization has removed the old and well-functioning social network of earlier generations, anchored in human contact and the common values that govern people’s lives in villages. In the industrial age, people linked their identity to the nation-state based on economics — the standard of living, employment, etc. The nation-state secured access to the international division of labour, without which growth would be lower; the regional or local community could not make those vital long-distance linkages. In the process, people lost part of their autonomy, and even part of their traditional identity, but in return they received economic gains of such size and abundance that the trade-off seemed like a good one. The shifting architecture of these linkages — whether regional economic integration like the EU, multinational corporations, or supranational corporations — allowed old regions like Bavaria in Germany, Scotland in the United Kingdom and Catalonia in Spain to connect themselves to economic globalization in a way that circumvented their own nation-states, making such superfluous. Yet, despite their willing trade-offs, people continue to look for culture, values, norms, ethics as the anchor for their identity. They find it in ways that again circumvent the nation-state — by joining groups that are not anchored in nationality, both inside the nation-state and beyond national borders. Migration, global mass communication, the disappearance of

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national media and of state or state-supported monopolies for transport and other public services, all add to this process of fragmentation of the individual’s social identity, beyond the national one. An increasing number of people are choosing multi-identities. Inside the nation-state a large number of people favour a more populist political agenda, aggravating social problems and undermining social coherence. They look for strong social capital as the platform for their daily life. As the nation-state cannot deliver, they find it inside groups — national or international. Cyberspace offers a means of connecting with other members of the group, irrespective of geography. The elite, too, tends to be increasingly international (even supranational), feeling little in common with the majority of their country’s population, and preferring to link up with likeminded people in other nation-states. They become more and more mobile, less and less attached to the nation-state. Thus we have on one hand the majority, less mobile geographically and relying on digitalization, and on the other hand a minority in the form of a highly mobile elite — yet both of them are increasingly international and global in their own ways. Supranational corporations and international non-governmental groups act as a booster for this growing dichotomy. The clash between changing populations and static structures spells doom for the current political system and economic model. This clash will erupt in two ways. The first is the shift in perception of who is the service provider, when the nation-state, and the “model” linked to it, no longer delivers. In the industrial age, discontent with their services led people to vote another party into office. In the future, discontent will lead people to change the service provider altogether. The second is a peculiar change of attitude6 towards paying taxes, seen most clearly in the United States, but also visible in other nation-states. Formerly, people paid taxes to finance the running of the state and felt confidence in the political system’s ability to manage the revenue in an orderly and honest way. People knew from the annual budget how their money was spent, and it seemed all right. Now their non-confidence and mistrust in the political system and its politicians are leading people to refuse to pay taxes without knowing specifically where their money is going and why. They are not ready to simply give politicians a lump sum of money to spend. So we move into a system with earmarked sums of public revenue. This has been clear for

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some time, for instance with the increasing use of fees for public services, even though tax revenues ought to be sufficient to finance the activities of the state. The recurrent debate in the United States about the debt ceiling brings this attitude out in the open. Conservatives demand that in future, any higher spending in one area must be “paid for” by corresponding spending cuts in some other area. This foreshadows what may be termed a “cigar box system”, where people pay to finance certain specific activities, without giving the state full power to simply spend its tax revenues. No service provider can function under such constraints. The clash is aggravated by nine crucial elements. First, the democratic process. Three principles provide the underlying strength of a representative democracy: 1. The role of the parliament is to constitute the government, certify its legitimacy and control its activities.7 2. The role of the opposition is to constitute an alternative to the government. 3. Government and opposition can trade roles — and they do so as long as votes are cast according to performance and political preferences, and not locked into the same party irrespective of performance. The highest political values for political scientists are clarity, transparency and accountability. Integrity and honesty are the highest values for the voters. The role of the government is to govern. Unfortunately, this simple fact is nowadays almost completely obscured by parliaments that introduce devious and intricate mechanisms to erode the prerogatives of the government. Laws are passed by parliament, but at the same time parliament encroaches into governing and administration by retaining a good deal of implementation in its own hands. The vehicle for doing this is to insert clauses requiring approval by parliamentary committees, or similar kinds of supervisory rules. Government then loses its primary role and the public becomes uncertain about who is actually governing. The political wrestling between the U.S. Congress and the Obama Administration is an example that comes

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to mind. The same phenomenon can be seen in many European countries as well, except for those few where the party in government enjoys a clear parliamentary majority. Not only does this phenomenon introduce a high degree of impotency and wrangling — blocking legislation or imposing delays or watering down proposals to the point of emasculation — but in the eyes of the voting public, it is no longer clear who is in government and what the role of parliament is. They do not know who to hold accountable, and consequently the voting system begins to seem futile. The same political party rarely holds on to power for more than a decade, if for no other reason than that mental fatigue sets in. The opposition uses its time out of power to recharge batteries so to speak. It gets new ideas, finds time to make in-depth studies and to consider what the best policies should be. When in government, events take control of the government’s agenda, leaving little time for strategy and planning. Traditionally, the opposition gained in reputation by being serious, conveying the impression that if elected to form a new government it would be “sound”, reliable and in possession of innovative ideas that would dramatically improve government functions and people’s lives. Today, by contrast, parliamentary oppositions concentrate on preventing the government from implementing any policies at all, forcing the nationstate into a political stalemate, one the opposition feels will be a vote winner for them. They seek out even the smallest flaws in the government’s policies and statements, and exploit them ruthlessly. Instead of using their time and power to recreate themselves as a credible alternative, the opposition devotes all its energy to showing that the government’s policies are at fault or that its leaders are flawed as individuals, citing their private lives, their use and abuse of parliamentary privileges, their tax returns and their families. In the eyes of the people, politics ceases to be a choice between policies and becomes a choice of which personalities will form the government and implement more or less identical policies. Voters lose interest in this game, which seems so full of interest to politicians. For voters, democracy begins to feel more like a reality TV show — one they are paying for — than something that will have a real impact on their lives. In nation-states with several religious, ethnic and cultural groups, one of the conditions for a well-functioning liberal, representative democracy may not be met. In such cases, people do not vote for political parties, but

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according to racial or religious preferences. If one ethnic or religious group constitutes a majority, its supporters will vote for the party representing that group, irrespective of its performance. The result becomes a kind of cultural imperialism, where the cultural majority can oppress minorities and keep them out of power indefinitely. The minorities feel alienated, cut off from both the majority group and from the nation-state itself. Democracy malfunctions in such cases, particularly when the majority, knowing full well that they are in power indefinitely, do not resist taking advantage of their position to introduce policies that deliberately favour the majority at the expense of the minority. The result can be highly illiberal democracies. Examples of this situation can be seen in several countries of the Middle East, such as Iraq and Syria. In both cases the only way to keep the nation-state together was to ignore democracy and to select a leader from a minority group — one who could be above suspicion of exercising cultural imperialism. The former president of Iraq Saddam Hussein selected most of his advisers from the town of Tikrit where he was born. Syria’s President Bashar al-Assad and his father belong to the Alawite group, which accounts for only a little more than 10 per cent of the country’s population. The difficulties encountered when universal suffrage gives a permanent majority to the largest cultural group were tragically demonstrated by what happened in Iraq after the 2003 war. Second, the role of the media. The media used to be labelled the watchdog of democracy, but it has turned into a kind of scavenger hound. The trend primarily in the United States and Europe is for quality newspapers to lose out to newspapers excelling in bad taste, jumping at every occasion to highlight weaknesses, frailties and failures — and occasionally abuses — never bringing good news. The counterattack by the political system is the rise of the spin doctor — meeting the media on its own terms and fighting a strange kind of warfare with the media about how to set and dominate the agenda. Seen from the point of view of the public, this produces a kind of artificial, if not surreal, coverage of political news. The media seeks to expose the political system and politicians. The politicians reply with orchestrated views. It is rare to find serious unbiased coverage of what is actually going on.

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In modern newspaper coverage of a major statement by a political leader, the overwhelming part is about what he or she did not say or deliberately skirted around, what ambiguous phrasing actually meant, with comments by political supporters and quotes from the pack of political opponents. The public has to use a good deal of time and ingenuity to figure out what the political leader actually said. Often it is not even reported verbatim, and the public needs to go to the Web to find what was actually said. This poisonous climate prevents a genuine dialogue between political leaders and the public. The Watergate stories of the 1970s in the Washington Post which unmasked President Nixon were obviously good and necessary, but the lessons journalism seems to have learned were bad. Nowadays, journalism starts from the premise that political leaders are hiding something and that it is their job to find out what it is. This has distorted political journalism out of all proportion. Politicians themselves have contributed to this by frequently abusing their power. The price for this game of mutual distrust has been high, and it has been paid by society. Third, the professionalization of politics. A liberal and truly representative democracy implies that the composition of parliament will, broadly speaking, reflect the composition of the population. This principle is fast fading away as parliament is increasingly composed mainly of professional politicians. Politics as a livelihood means that the political system rotates upon itself. It introduces its own rules and measures success or failure, not on the achievement of political objectives or the response of the electorate, but on the reaction of their political adversaries. People are rarely interested in this. A strange form of governmental isolation takes shape, in which politicians form their own caucus and play according to their own rules. Many politicians have come up through the ranks of political parties or pressure groups and have never worked outside the circle of professional politicians. In several European countries the majority of members of parliament are either in this category or they used to work in the public sector before their election.8 They take very little interest in life outside the political machine and the public sector. The people do not feel represented by this system in any meaningful way, and end up feeling increasingly alienated from a political system that resembles a self-perpetuating machine.

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In the United States, money constitutes an almost insurmountable barrier to getting elected. According to Nicholas Carnes (2013), about 2 per cent of members of the U.S. Congress come from a working-class occupation. For the average state legislature the figure is 3 per cent and about 9 per cent for the average city council. Of the members of the Senate, just 7 reported personal assets at less than $100,000, 30 between $100,000 and $1 million, 42 between $1 million and $10 million, and 19 over $10 million. Politicians have turned into a kind of political managerial class — they resemble one another, in their words, their ideas and their actions, in or out of office. Political struggle becomes a question of — like MBA students at business school — a race to see who is best at doing the same thing. In business life the winner reaps profits and market share. In politics it is different. Politicians have to be elected and need to stress differences. When elected, however, they become managers doing what their predecessors did and obliterating what separates them from their political opponents. To keep the party united, compromises of all sorts are constantly sought, further wiping out any differences between the parties, and leaving only the managerial residue behind. Fourth, the imbalance between rights and responsibilities. Politicians have allowed the balance between rights and duties, and responsibilities and benefits to spin out of control. Most developed countries have crafted a social welfare system that is excellent — if it is underpinned by discipline and self-discipline among the citizens. This was the case for the first generation of beneficiaries, who had known harsher times. It is not the case for the next generation, many of whom see social welfare as a cash cow. Explosive growth in welfare expenditures is the result. Many “good” proposals are adopted which would have limited repercussions for public expenditure if people looked at it in the context of the problem to be solved by this legislation. But that is no longer the case. Instead, people scrutinize legislation to find out how much money they can get for themselves, without giving a thought as to whether they need it or belong to the group of people the legislation is trying to help. In a strange way, it is not only the nation-state and the government that are responsible for the breakdown of the social contract, but also the citizens deviating from the rule of give and take and focussed only on the take.

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The cost of this breakdown is not merely economic and social, but individual and value-based as well, as citizens begin to feel that the personal and political rights promised them by the nation-state are not available. They get angry and ask for more, to compensate. The nation-state obliges and slides into a morass of increasingly complicated rules and regulations, covering almost everything on anyone’s wish list — in particular, that part of the population not participating in productive life. Without realizing it and without wishing to do so, the social welfare system creates more and more social losers who feel more and more alienated. The political system has not learned from anthropology how tribal systems survived and prospered. They operated on a systematic basis of give and take, with mutual rights and obligations. There was no room for free riders in such societies. The tribe may care for those who cannot survive on their own — but not always, depending on the environment — but not for those who can, but do not wish to do so. The tribe demanded that its members contribute according to their ability, as a quid pro quo for membership, without which a recalcitrant member would perish. Many trade unions worked in the same way. They asked for benefits for their members, but had little sympathy for those of their “own” who were not contributing — no free riders inside their ranks. Anyone who has tried to work in a team remunerated according to a piecework contract for the team will know exactly what this means! The refugee and migrant crisis in Europe has highlighted the fact that many European nation-states seem unaware of this basic human phenomenon. Based on Europe’s tradition for humanism and social welfare, they refrain from telling migrants that there is a quid pro quo, without which neither the migrant nor the European nation-state can survive. That quid pro quo is that each contributes individually and shares in collective benefits — but not just one or the other. Societies only function if responsibilities are put on the shoulders of its members, and most people actually thrive best when that is the case. Otherwise they float around aimlessly without a rudder. Fifth, the opening up of the political system. In the industrial age the political system was a closed system. All the main participants, all those who had a stake in political decisions, were inside the system, part of the system itself. There were very few, if any at all, operating outside the system. Today it is almost the opposite situation.

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Large business corporations are undoubtedly the main players wielding strong influence, indeed power, but are not really from inside the system. They exercise their influence and power through such instruments as lobbying, support to political parties and business organizations — but at the end of the day the initiative and the decision-making rest with the government and the parliament, where corporations have no seat. In the case of disputes, the matter is referred to the courts. This outside role is worrying in view of the fact that large business corporations have resources available that dwarf small or medium-sized nation-states — revenue and profits of enormous size. They can employ more people than the entire workforce of some small and medium-sized nation-states. Toyota Motors has annual sales of US$230 billion. Compare this to the GDP of Denmark at US$208 billion. ExxonMobile has profits of US$40 billion, compared to Vietnam’s GDP of US$55 billion. Walmart employs 2.1 million people, compared to Singapore’s population of a little more than 4 million, and its annual revenue of US$378 billion far exceeds Singapore’s GDP of US$230 billion. These corporations are powerful, and power is easy to abuse. As they are outside the political system the likelihood that they will choose to act in their own interests instead of seeing themselves as responsible stakeholders cannot be ignored. The example of how the financial institutions behaved prior to the global financial crisis gives proof that they cannot be counted on to act as insiders, adjusting their behaviour to society’s needs and interests. We can see the same phenomenon at work in civil society. In the spring of 2011, some Arab countries showed how pent-up demand for political influence can lead to explosions. Civil society used to be confined to pressure groups focusing on limited and well-defined issues such as human rights, religious freedom, or the environment — but now the demand for political influence spreads like a prairie fire. The system as it has developed is simply not capable of adjusting to this request. It reacts either by repressing those demands, with the results seen in the Arab world, or by desperately trying to do “something” to accommodate the demands, without satisfying anyone — what is being demanded is not adjustment, but change. Sixth, the short-term horizon of governments. Most democracies operate with three, four, or at the most five years between elections. The idea is

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laudable. People — the voters — can throw out political leaders they dislike or who do not respond to a swing in the public mood. The downside is that few governments can count on public support for measures beneficial — and even imperative — for their country in the longer term, if there is a price to pay in the short term. At the very least it requires a tremendous amount of communication skills, together with an electorate ready to absorb costs, to persuade a majority of voters that the price demanded is worth it in the long term. The change of parliamentary majority, which is one of democracy’s strengths, tempts incumbent governments to push unpopular policies into the next session — to kick the can down the road — to a time when another party may well be in power and has to deal with it. This mindset might have been one of the reasons countries ran up debt during the good times before the global financial crisis, when they should in fact have brought debt levels down in preparation for rainy days — but why would they want to present this gift to the next government? Governments have followed stock market listed companies adopting short-term horizons. Companies report quarterly results putting pressure on management and the board of directors to deliver within a tight time horizon. Unless long-term planning can be demonstrated to produce indisputable gain, such an approach becomes difficult to pursue. One wonders about the impact this has on the business sector’s commitment to fundamental research. One wonders about long-term investment in communities and countries. Seventh, a new issue confronts individuals, organizations, businesses and government: privacy. We have learned in recent years that electronic networks can and are used to collect information about individuals. In some cases it is regarded as relatively harmless — as when supermarkets collect data to find out what a customer normally buys. Gradually, electronic advertisements are becoming capable of monitoring the reaction of the person watching to form a database about this particular individual. At a first glance the efficiency and cost savings look marvellous, but on reflection the threat to privacy cannot be disregarded. The corporations (and the government) may, and in many cases will, get a window into a person’s privacy far beyond what was possible before digitalization. As several cases show, databases can be penetrated by hackers to get access to the information of a great many individuals for nefarious purposes.

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Very few people have any idea of how much data about their daily habits, behaviour and routine is collected unobtrusively by ubiquitous electronic instruments like their personal computer, tablet and cell phones. But unless the user takes precautionary steps, data is fed back to the service provider without the person knowing it or, even worse, without knowing how this data will be used. The price for efficiency, access to knowledge and information, easy communication and convenience is a loss of privacy compounded by not knowing how much of our privacy has been lost, to whom, and what it will be used for. The relevant point in this context is the clash between the individual’s perception of privacy, which many still believe in, and the reality that privacy no longer exists. It is still early days, but the long-term consequences may be a breakdown in confidence and trust between citizens and the political system in its current form. As long as citizens trust governments to handle these sensitive issues in conformity with the accepted values and ethics governing social life, the ship is steady. But if or when this bond is broken (and very little is needed for this to happen), citizens’ trust will be replaced by suspicion, and benevolent government monitoring will turn into surveillance and repression. All nation-states have constitutions that establish the freedom of the individual and privacy, though these function in various ways and to varying degrees. But these constitutions were written at a time when globalization was not an issue and the network of information and communication technology had not been invented. Precisely these two contemporary facts have transformed the question of privacy and freedom around the world. How do you deal with a situation where freedom of expression is a constitutional right in country A, but used by a citizen of country B to voice expressions forbidden in country B and disseminated via electronic networks? As the world grows more multicultural, the clash between freedom of expression and respect for other cultures’ taboos becomes increasingly acute and difficult to handle. What is allowed in one country can be expressly forbidden in another. Within nation-states, the balance between an individual’s freedom and the collective is essential to keep the social community alive. Traditionally, Western democracies tilted towards individual freedom while Asian societies favoured the collective side.

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Globalization and digitalization have made it more difficult to maintain the strict criteria in Western constitutions that guarantee individual freedom, mainly because individuals can act in ways that undermine the community. The crucial question then becomes exactly how far respect for individual freedom can legitimize harm to the rest of society or to groups within society. This question is increasingly important in Europe, where multiculturalism is a new phenomenon, and religious and ethnic topics never before on the agenda suddenly turn into social flashpoints. In a broader context, the interaction between citizen and government takes on a dehumanized character. Citizens no longer communicate with a person, but with a machine. Since machines cannot deviate from their programmed script, this means that discretionary powers no longer exist. One of the vital ingredients of a well-functioning democracy is that citizens have access to decision-makers, whether local politicians or civil servants working locally. The virtue is that such access provides a tangible experience of how the system works and serves as a counterweight to second-hand information received in the news or on the Internet. People measure what they hear against what they have experienced themselves — if they have the personal experience of being listened to and responded to by the political system, they will discount arguments that tell them they have no stake in the system. Thus, the long-term effect of automation and dehumanization of government communication may well be a distortion of citizens’ relations with their government, and an increase in their feelings of powerless and political alienation. The outcome might be the withering away of the state.9 In the industrial age, people were kept together by coercive enforcement by the government of the law, rules and regulations. It was a strict system of rule by law, where the overwhelming majority complied with the law, and those who did not were punished. The laws were basically written to generate wealth and distribute wealth — purely directed by economics. Without this system of enforcement, the industrial age would not have been possible. People joined society and stayed within society because they were better off economically inside it than outside. If, on the other hand, societies, communities and groups revert to personal values as an organizing principle, as used before industrialization, the role of the state changes dramatically. The need for enforcement fades. Instead, the set of common and shared values exerts a kind of peer pressure on the individual. People keep an eye on each other to help and assist,

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but also to ensure actions in conformity with the set of common values. Information and communication technology (digitalization) makes this kind of peer pressure possible and workable on scales far beyond the village. In such a case the state will still be around, but it will be much less powerful than it is currently. The gradual dismantling of the state machinery seen in the United States and many European nation-states are signs that this is happening. Privatization is one of many signs of the state losing or rather abandoning the exercise of power. It is mainly for reasons of economy, and may thus not directly support this thesis, but it does, in effect, in so far as public services are privatized. Vital services, such as the granting of visas to enter a nation-state — once the exclusive prerogative of the state — are often done now by private companies. Even the issuing of passports has been privatized in many countries, a fact which surely underlines the withdrawal of the state. Incarceration is partly privatized in some countries, with private companies providing the labour force in for-profit prisons. In the United States a whole industry has developed around prison labour as an indispensable source of income for prisons exposed to cuts in public spending. Eighth, the implications of instant and global electronic communication. Technology in this century has brought about a revolution in the exchange of information and knowledge, but it has also introduced opportunities for abuse, mismanagement and the distortion of facts. People communicate much, much more, in volume and frequency, and on a global scale. This is certainly good. But less good is the ability also provided to communicate exclusively with those we agree with. This creates the “echo chamber” phenomenon, reinforcing our certainty that we are right and that those who take another view are wrong. In the long term, tolerance and respect for other’s opinions may not survive this tendency. From a political perspective it becomes an open question of whether free access to information and knowledge can be maintained in the long run. It may not be so much a question of the political leadership applying some kind of censorship, but whether societies can allow everybody to say everything aloud on the net, reaching millions, not all of whom will be able to discern what the purpose is — does the author want to state his own views or mobilize support for a particular political or normative stance? Is there any factual basis to the information? The core issue is whether we

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have confidence in our education system and values to give people such critical skills, whether people are willing to acquire and accept them and put them to use when accessing news on the net. In a gloomy perspective, mass communication could turn into mass seduction. The wisdom of crowds has been a favourite topic of many observers of late, but what we see from the Internet is actually something more complex and worrying. People are lured into adopting the view of the majority. They look for the consensus and rally around it. It is comfortable to be part of the consensus, a member of the majority. Perhaps the explanation is that most people shirk from assuming responsibility or leadership. Few are ready to step forward and show the way ahead; most are willing to join a consensus emerging before their eyes. Seduction may even go as far as putting this sense of belonging ahead of looking for the facts or even recalling what the individual knows as the facts. Everyone has access to put his or her views on the net. This is a great advance, and opens the political process to a level of participation not seen since the ancient city-states — when a crowd of citizens small enough for everyone to hear what everybody else was saying could deal with all their political issues. The problem, however, is that facts are mixed with opinions and attitudes, and the difference between them is not clear for those without prior knowledge of the topic. Sometimes this happens because of the writer’s ignorance. But in many cases there is a deliberate intention to present a specious and distorted case, supported by “facts” that on closer examination are revealed to be nothing of the kind — but few readers have the means to make that closer examination, while others accept them at face value because they are already predisposed to agree with them. Human beings tend to choose information and arguments that confirm their already formed views. The sheer volume of information on the Internet makes it dangerously easy to limit one’s reading or viewing solely to those whom one already agrees with in advance. A long-term consequence may be a growing intolerance for views one disagrees with or do not want to accept. A more self-righteous society and narrow-minded political system thus emerges — a trend that can be seen in the United States and certain parts of Europe, with the gradual abolition of political compromises and a growing determination to force one’s own view through, regardless of opposing opinion.

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The commercialization of media has aggravated this state of affairs. The print media, radio and TV channels have an incentive to immediately attract attention, because attention is profitable. The technique is to start with facts (the truth) and thereafter gradually twist the truth towards people’s existing beliefs. This works because people tend to believe what they want to believe. Studies show that once an individual has decided, and that happens in a few seconds, facts can rarely change that position. The wisdom of crowds was for many years an interesting and attractive theory. Many observers felt a certain degree of gratification and contentment knowing that a large group of human beings would probably “get it right”. It confirmed our belief in the capability of human beings. Perhaps it also opened the door for assuming that human brains could communicate without letting us know they did so, thus enhancing our intellectual capability. But mass communication and the cascade effect might create a quite different situation — that is, new methods of communication may affect the crowd differently. The most easily accessible information may win the competition for attention, but it will not necessarily be the correct one. The superficiality or even stupidity of the crowd may be the likelier and more dangerous reality. And the crowd’s desire for quick and easy answers may promote a tendency to deal with any current problems as fast as possible, irrespective of how complex it may be, in order to get on to the next exciting media sensation. Ninth, a conflict between perceptions and realities. The political system’s authority is challenged by a conflict between perceptions and realities. This may not be a totally new phenomenon, but the scale, speed and impact on society is. Those who are able to ensure that perceptions match realities, and to persuade the public of this, win by gaining credibility. They create the standard by which good or bad, right or wrong, permissible or impermissible is established, making it easier for people to act in conformity with what they are thus persuaded are the correct values. The shaping of perceptions may have become the most important parameter of power. Perceptions shaped through a kind of cascade effect give authorities little space or time to bring in realities. If the prevailing political environment is one of distrust, the task may be impossible, regardless of what those realities are. People’s tendency to feel comfortable

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inside a majority or consensus creates an enormous inertia of belief and enhances the power of those able to shape perceptions. The torrent of electronic information presents the individual with a high-pressure stream of impressions and the dilemma of determining within a few seconds whether to stay or leave the page. The truth and perceptions blend together, obliterating the dividing line. Technologies can be readily used to this effect by those contesting the authorities, but not by the authorities themselves, who are held responsible for the information they disseminate. This makes the struggle for popular attention lopsided, especially as information from the authorities is pushed to be responsible and “boring”, while others can make their messages as entertaining and attractive as necessary. Authorities lose their prerogative to communicate to the population how they should see events, especially when people have fallen into the habit of automatically classifying statements by authorities as uninteresting and even deliberately misleading. The agenda can be, and actually is, set by those who know how to shape perceptions — by controlling and exploiting new instruments of communication, and understanding the power of two-way traffic. The traditional filter of editors of journals, newspapers, radio and TV channels no longer exists, inviting everybody to disseminate whatever information supports their own perceptions. This raises the prospect of disinformation — deliberately or by ignorance. This introduces a number of challenges. How should authorities react — by defensively repudiating “wrong” information or by taking the offensive and trying to set the agenda? What are the risks that “irresponsible” forces will hijack the agenda? If the majority of people are not able to distil and evaluate information, will they be led into populism, nationalism and egoism? And, eventually and unavoidably, will there emerge a need for some kind of control over mass communication, even with the laudable goals of defending “the truth” and freedom of speech? The rapidly growing number of people getting access to the net without the benefit of a basic education, and without knowledge of how information and communication worked in the paper age, makes societies vulnerable. Inbuilt scepticism and questioning may be less strong in those societies that have gone through a fast cycle of economic growth and whose education levels (primary, secondary and tertiary) have not been able to keep up. The lack of training in acquiring knowledge — including

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the critical examination and verification of sources, figures and facts — leaves some societies open for baseless perceptions. At that point, it is not a matter of perceptions blurring into reality, but of perceptions crowding out the truth entirely. The philosopher John Locke argued that freedom depends on a certain amount of self-discipline. Confucianism reflects a somewhat similar ideology, praising the family, the authorities and scholars. Countries that have gone through a fairly long period of fundamental rights and freedoms, often spanning several generations, may have an implicit understanding of this. Other countries may find it less easy — especially those that move rapidly from one kind of governance, or in some cases no governance at all, to another, or from colonization and social dependence to independence. The problem is compounded by the existence of communities of different ethnicities, religions and cultural identities that find the Web irresistible as an instrument to voice their own values. Herein lies the difficulty of holding a multicultural nation-state together around a common set of values. Values rooted in ethnicity, religion and other basic cultural patterns define what is right or wrong, true or false, and permissible or not permissible. Truth and perceptions clash because the truth for one cultural group may not be so for another, and vice versa. The same message phrased in the same way with the same words may have very different — and even opposite — meanings, depending on the cultural identity of the recipient. Cultural groups use mass communication to fortify their values, and in doing so wittingly or unwittingly create an “us versus them” impression — deepening the segregation of different groups, and automatically alienating citizens of the same nation-state who identify with a different culture. The more culturally heterogeneous a country is, with deeper cultural divergences established over centuries, the more likely it is that mass communication will develop into a struggle between the authorities and cultural groups that question the view of the authorities. Cultural minorities may find that their views are not given due consideration for the simple reason that people employed by the authority are recruited mainly from the majority group. The dilemma is aggravated by the way humans make decisions, as revealed in the research findings of psychology and brain research. A good part of this has grown out of research in marketing, where such

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knowledge has a commercial value, but it is equally applicable in politics and other areas of social interaction, where human beings have to take a stance vis-à-vis societal issues. Most human beings make decisions instantaneously, based on intuition, instinct and their cultural roots (their upbringing, family life, interaction with neighbours, school and playground activities). It is very difficult to convince individuals to change their decisions once made. Arguments based on rational thinking, logic and calculations of advantage and disadvantage, in an economic sense, are not notably effective. Frequently, indeed, the more people are exposed to arguments based on logic and rationality, the more they harden their already-formed opinions. Often they may de-rationalize logic, selectively picking the arguments that support their position, convincing them even more strongly that they were right in the first place. Brain research offers some explanation. Most, though not all emotions are directed by the brain’s limbic system, while rationality and logic are not. In earlier and simpler political systems, where the distribution of income and wealth were the major political issues, political leaders enjoyed a relatively large and stable level of voter confidence, based on this emotional predisposition. With the erosion of confidence in politicians and a much more complicated political landscape, the emotions of voters shift away from automatic support for the leadership and incline them to dispute the leaders’ search for rational and logical decisions. A cognitive gap, due partly to normal brain functioning, opens up between voters and political leaders.

Conclusion and Suggestions The existing political system may endure — who knows? — but cracks are developing. As Spinoza predicted, it is eroding from the inside — making it increasingly difficult to govern and aggravating the discontent with a failure to deliver. A number of almost revolutionary challenges, in addition to those posed by globalization and digitalization, need to be addressed. The general lines of a solution might be to reduce power distance and to resist the tendency towards dehumanizing automation, at a time when digitalization is making both these temptations more attractive. But digitalization can also be used to improve feedback and feed-out, to ensure people of their right to privacy and help them to arrive at decisions via perception and intuition.

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Several trends disrupt the existing political system and explain why it no longer performs the functions expected of it — offering solutions, serving as a vehicle for feed-out and feedback in the interplay between voters and politicians, instilling trust and mutual confidence, and intercepting the changing moods of the people. The distribution of wealth is replaced by values and personal issues as the most urgent areas of political concern. Globalization facilitates communication across borders and among analogous cultural groups living in different nation-states. Few nationstates are prepared and ready to live in a multicultural world, and even fewer have managed to become genuinely multicultural. Yet the Internet enables a kind of virtual multiculturalism. Mass migration from rural districts to cities has disrupted the close human contact that created societies and kept communities together. Rules and regulations — which, from a rational point-of-view, should promote social coherence by creating a level playing field of equal rights and obligations — in reality produce the exact opposite: a feeling of discrimination on the part of minorities, because the rules tend to be set by the cultural majority. International conventions about refugees have become obsolete because they primarily deal with political refugees, while the majority of today’s refugees are motivated by a wider set of factors, such as economics or the collapse of their nation-state. International migration on the scale seen from some Latin American countries to the United States, or from the Middle East and North Africa into Europe, are unprecedented and unplanned-for. They pose not only an economic problem, of how to integrate the migrants into economic life, but an even more vital question of cultural identity of the citizens of the host nation-state. The composition of the global population, too, is undergoing enormous change. The populations of the old industrial countries are falling, while those of South Asia, the Middle East and Africa keep growing. Islam is increasing its share of the world’s religious population. In political terms, the transformation threatens the pre-eminence of the Western political model rooted in liberal representative democracy and secularization. Migrants to Western countries who are not brought up with such a political model do not understand how it works and may not subscribe to its virtues — no matter how obvious they may be in the eyes of the Europeans and

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Americans themselves. The migrants have doubts, and in some cases explicitly reject the societal model and political system of the countries they have chosen as their new home. People from developing countries do not feel any imperative to adopt the Western model, though they cannot offer an alternative model that would be workable in the era of globalization. All this coalesces into an identity crisis. Populations in industrialized countries feel themselves under attack. Their fear and angst leads them to the suspicion that globalization has been sold to them under a false pretext. The combined result is that people in both rich countries and poorer countries congregate defensively towards groups that share their values. Inevitably, this enhances the risk of classifying others — who do not share their values and do not join their group — as “cultural enemies” trying to exercise cultural imperialism over them and undermine their identities. The next step is a hardening of attitudes towards those not belonging to the same cultural group. The challenge is to intercept these trends and design a political system that is anchored in values, not in economics, one that comprehends the significance of cross-border communication of values. Success or failure will depend on establishing direct links to the people, beyond the representative system, and on whether people who can establish such links will be able to resist the temptation of populism. A successful solution must take the following elements into consideration: First: The nation-states of the industrial age got the problem of power distance reasonably right. One of the reasons is that the electorate in the initial phase was quite small. Denmark’s 1849 constitution granted voting rights to approximately 14 per cent of the population. The gradual movement towards universal suffrage meant that people were well prepared for the vote by the time they got it and had acquired a basic understanding of society’s complexity. Universal suffrage came after a long struggle, so people appreciated it as a privilege instead of taking it for granted. This enhanced their interest in politics as well as their involvement, for instance as members of a political party. Currently, Britain’s Conservative Party has about 150,000 members and the Labour party about 270,000. At their peak, in 1950, those numbers were 2.8 million and 1 million respectively. Clearly, an active interest in the political system is now considerably less common.

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Economic questions cannot be dealt with adequately by the nationstate — it is outranked by the forces of economic globalization. As for local issues like the environment or schools, the nation-state is too large and too distant. This remoteness is compounded by the fashion in policy circles for rationalization and cost-effectiveness, which leads policymakers to amalgamate communities into larger agglomerations, which further alienates them from local citizens. Local communities cease to be local. A small country like Denmark has seen the number of local communities cut from 1,098 before 1970 to 98 in 2007. This trend can be seen in most industrialized countries to various degrees, though the exception of France should be pointed out, where the number of local communities is the same as it was 150 years ago. Low power distance for citizens means that local solutions are found for local issues, under local conditions. The goal for different communities may be similar — even identical — but a local solution makes it possible to choose instruments and tools appropriate to the specific place, instead of lumping everybody together. Common interests among the local citizens can be taken into account. The two-way channels of communication are simple and easy to understand. People can assess the workings of the political system by personal experience. The human factor can still play a role, which is not the case when the digitalization of societies is made compulsory. Low power distance implies that people are not only heard and consulted when choosing political leaders and policies; they are involved in the decision-making about issues of direct relevance to their daily lives. People understand — even if they may not like it — that foreign policy, military matters and, to large degree, economic policies have to be determined at a high level in the decision-making pyramid. But they are baffled and annoyed when the same happens for their local issues.10 It sounds arrogant, but history unequivocally stresses the need for an electorate with sufficient knowledge and education to exercise good judgment. This does not come by itself, but is the result of a long process of accumulated lived experience. Second: The political system must incorporate new players. Multinational corporations, regions, non-governmental organizations and many others have a strong influence on policies and politics, but in a representative democracy they are relegated to lobbying and classified as outsiders. This

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turns them automatically into critics of the system, who spend their efforts looking for its flaws and seeking opportunities. An example of powerful players outside the system and how they react can be found in the Korean chaebols, which dominate Korea’s economy and exert great influence over its economic policy. This creates uncertainty about who is actually governing the country. At the same time they exercise strong influence over the media, which they utilize for what they clearly understand to be the vital task of shaping public perceptions. The recent financial crisis has revealed not only fundamental flaws in both corporate governance and the political governance of nation-states, but even more the fact that corporations operate without any reciprocal support, fending for themselves, often against each other. To bridge the gap, a redefinition of corporate governance is needed. The basic idea of business is not to make money, but to deliver goods and services to society. The border between private and public enterprises has shifted over the past thirty years in favour of private enterprise; now it should be redrawn with much more thinking on what are private and public enterprises.11 Remuneration of the elite should be brought well into line with how the elite serve society, and less calibrated to the profit their enterprises generate. Most of these players are international and even global in size. They do not really feel attached to a particular nation-state, and consequently do not operate from the perspective of a member of a national society or community. Corporate governance, as outlined above, has not entered their mindset. In 2010, General Electric posted worldwide profits of US$14.2 billion, of which $5.1 billion came from operations in the United States. The company did not pay any taxes to the United States. On the contrary, it claimed US$3.2 billion in tax benefits (Kocieniewski 2011). Large corporations are able to exploit economic globalization to skirt national rules — be they regarding taxes, environmental protection, labour standards, etc. The only way to address this is to bring them into the political system and give them a stake in the fortunes of society, giving them a greater respect for the rules of the system. This can only be managed through some form of global political governance, where those setting national rules coordinate their efforts to avoid competing against one another to offer the most favourable rules to attract multinational companies. Multinational companies must comprehend that their role is not to exploit divergences between various systems of national rules, but to assist in the shaping of international or global rules.

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Consider the example of a tax on financial transactions, which is currently growing in popularity in policy circles. Financial services can easily be switched from one location to another. A number of factors combine to make any financial centre competitive — and most if not all of these factors are geographically transferable. So if a few or a limited number of nation-states introduce such a tax, it is likely that financial institutions will simply move the transaction — if not their entire operations — to another location. Building into the tax a criterion that focuses on the transaction’s country of origin may obviate this particular tax-avoidance strategy, but others will certainly be developed. The example highlights the asymmetry between economic transactions, operating globally, and economic policy decisions, still originating on a mainly national or regional level. The same dichotomy bedevils efforts to combat global warming. The correct way, perhaps the only way, is to shift the burden to those ultimately responsible for carbon dioxide emissions — and that is neither nationstates nor companies, but the consumers enjoying the fruits of production, irrespective of their geographical location. As long as a large part of international negotiations concentrate on distributing the burden among nation-states, they are doomed to fail. Transfers of production from the United States to China, assuming output is grosso modo unchanged, will only to a very limited extent affect the global level of emissions. As long as international efforts operate through nation-state quotas or certificates allowing certain levels of emissions to plants or companies, it will, however, shift the burden from the United States to China. The right way to attack the problem is to introduce PPP (the Polluter Pays Principle) at a global level, and the only way to do that is with a global tax. The underlying logic, then, is that either global governance must gain ground and important outsiders to the system be brought inside, or else economic globalization will crack. The next step in this logic is to allocate the revenue from such taxes to global efforts, which must be linked to the problem they address. Third: The values used to be set by a comparatively small number of human beings — the elite, well-educated stratum, who communicated across borders with one another, understood each other, and set the global agenda. After industrialization, this was mainly an Anglo-American culture.

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Today, both values and the sharing of values across borders have slipped out of the elite’s control. Millions, or perhaps billions, of people use social networking to criticize the reigning values and the role of the elite. Global communication takes place on separate levels, with insiders (the elite) and outsiders (the majority) communicating independently. Taking a long-term perspective, this division overshadows economic inequality as a threat to globalization. It may not be politically correct to say so, but the non-elite do not have the same upbringing and education; they tend to be more nationalistic and less interested in the many facets of globalization. The non-elite act more by intuition and automatic response, governed by emotions and “near-to-me values”, making its members easy prey for enthusiasm, snap decisions and short-term solutions, often at the expense of others less apparently connected to them. They are, in short, less critical and more emotional. The application of rationality, logic and critical analysis are rejected as too time-consuming and laborious. The question is whether civilization as we know it can survive the transformation from values laid down by a small elite to a global marketplace offering different and often conflicting values and perceptions. With luck, a kind of benign global civilization may emerge. The alternative is the prospect of escalating values-based conflicts and violence against all those who think differently from us. This, alas, is the more likely way. “People power” may look wonderful, but it is dangerous to overlook the fact that it can open the door to values that for many years have been kept under control by a wider understanding and concern for the potential repercussions that the actions of one group may have upon another. With that control suddenly gone, populism lurks just around the corner. The Dutch philosopher Baruch Spinoza (1632–77) pondered this dilemma.12 Democracy is the most reasonable form of government, he argued, for in it, “every one submits to the control of authority over his actions, but not over his judgment and reason; i.e., seeing that all cannot think alike, the voice of the majority has the force of law”. The defect of democracy is its tendency to put mediocrity into power — and there is no way of avoiding this except by limiting office to men of “trained skill”. Numbers by themselves cannot produce wisdom, and may give the biggest political prizes to the grossest flatterers. “The fickle disposition of the multitude almost reduces those who have experience of it to despair; for it is governed solely by emotions, and not by reason.” Thus, democratic government becomes a procession of brief-lived demagogues, and men

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of worth are loath to enter a contest where they must be judged and rated by their inferiors. Sooner or later, the more capable men will rebel against such a system, though they be in the minority. “Hence I think it is that democracies change into aristocracies, and these at length into monarchies.” People at last prefer tyranny to chaos. Equality of power is an unstable condition; men are by nature unequal, and “he who seeks equality between unequals seeks an absurdity”.

Wrap-Up A new political system will be born out of globalization — in the context of the expansion of digitalization and Web communications — with the attendant rise of social groups and a more anxious, values-focussed electorate. Whatever shape it may take, it will offer apparent solutions to: • Power distance growing too big for most citizens. • A breakdown of the quid pro quo between governments and citizens — responsibilities that need to be made known openly to citizens. • The uncertainty many people feel when confronted by the cultural effects of globalization — amplified by politicians who represent globalization as a solely economic phenomenon. • Disruption of the feed-out and feedback between citizens and politicians. • The question of personal privacy in an era when citizens are seduced by information and communication technology that surreptitiously collects data on them and transfers it not only to public institutions but also to corporations. • The lack of a global governance protocol equal to the tasks created by expanding globalization. • The implications of the swing from economic issues to values as the determining element for the citizen in selecting leaders and seeking redress. • Cross-border value-based political movements and parallel societies, openly challenging the societies and nation-states in which they exist. • Freedom of expression in a multicultural world, and discontinuities between nation-states — the use of one nation-state’s rules to disseminate information to another nation-state where such information is not permitted.

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The optimal solution will perform five core functions: • Take into account the fact that people make decisions intuitively, based on emotions, making it imperative to use digitalized media to capture their attention and keep it. • Prepare the ground meticulously for events and decisions to come later — so that voters will have gone through the emotional phase of decision-making and be more ready to listen to the logic and reason underpinning a maximally beneficial solution, which may differ from their originally preferred choice. • Shape public perceptions all the time instead of letting somebody else do it. • Realize that the existing form of representative, liberal democracy — asking the electorate to vote periodically, at long intervals — cannot last in the digital age. Some kind of continuous direct public involvement will be imperative. • The old-fashioned political parties are obsolete unless they can adapt to these new conditions. Voters do not want to be locked into positions on issues they have not yet been confronted with.

Notes   1. See for, example, Kupchan (2012).  2. The Simpsons has a wonderful scene where the CEO informs Homer and his colleagues that the company is outsourcing. The CEO tells them, “your job is safe, only it will be done by somebody else!”   3. Another trap is to brush away “ordinary people’s views”, as was seen during the British election campaign in 2010 when then prime minister Gordon Brown was not aware that his microphone was still on and called a lady voicing her anxiety about foreigners “a bigoted woman”. Sir Winston Churchill put the dilemma this way: “The best argument against democracy is a five-minute conversation with the average voter.”  4. New York Times, 4 January 2012 .  5. .   6. Thanks to Professor Jack Knetsch for inspiring me on this point.   7. I first learned about these principles by reading the works of Professor Alf Ross, University of Copenhagen.

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  8. To take Denmark as an example, one fifth of the 179 members of Parliament have not completed their education or worked outside politics.   9. Marx and Engels operated with a similar concept, saying that socialism would remove the need for the state to enforce the law. 10. Most people would prioritize having quick access to a hospital capable of performing an appendectomy or set a broken arm rather than being two to three hours away from a regional hospital with the latest equipment able to scan for brain tumours. 11. It is surely correct that the market knows best, but what it knows best is how to make a profit, and if necessary at the expense of society! 12. Summarized after Will Durant, The Story of Philosophy, “Chapter IV: Spinoza” (New York: Simon & Schuster, 2012).

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4 Cost of Running a Society

Societies are not free. The benefits of living with others have been recognized since our species first emerged, but those benefits have never been without cost — and in modern society we can calculate costs very precisely and distribute them in different ways. This is the very subject matter of politics. What is needed is a holistic approach summarizing public, private and hidden costs, and the added opportunity costs. Over decades an ongoing debate has tried to compare these costs in a welfare society versus a more free-market economy. In a straight-line comparison of public costs, the free-market economy wins, but including the other elements in a holistic approach makes this result uncertain. A welfare society could better mobilize a society’s entire talent mass and costs of enforcement, with less loss of working time. The objective is to forge a smooth running society at the lowest total cost.

Key Concepts The basic question is what kind of society do the majority of voters want? From there, the society can consider specific sectors — such as education, healthcare and infrastructure — and move on to decide whether public or private ownership is preferable. How the key concepts are tackled depends to a large degree on how equality and fairness is perceived.

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A society is, broadly speaking, a network of individuals, organizations/ institutions and businesses kept together through congruent interests, analogous political goals and a sense of fairness. It costs money. The large majority must feel better off inside than outside, after having paid their share of expenditures to finance common activities. It may well be that some of them would be even better off by moving to another society or community or country, but there are at least two barriers. First, they may be better off economically in a different country, but suffer significant personal and psychological “costs” from living outside the culture they were raised in and understand — their identity, values and group associations. Second, moving costs money as well and brings uncertainty and the risk of a net loss. The challenge is how to maximize the level of goods and services, minimize the number of people and capital in non-productive sectors, and generate the highest possible social coherence. We want to minimize the number of people who feel socially and culturally outside or sidelined. The two big “money guzzlers” are the sticking points and the exceptions. Sticking points are issues that ask for tailor-made solutions, making legislation complicated, disorderly and often confused because society can no longer rely on general rules. Exceptions call for specific legislation and add to administrative costs. For instance, the administrative costs of paying state pensions to everybody over seventy years of age are negligible. But make it subject to an individual’s financial means or other criteria and administrative costs explode. In economic and sociological phraseology, we might say that our objectives are to minimize the output gap, to mobilize production factors, to live in a community with mutual trust between individuals, to maximize human security, to use their abilities to full capacity, to keep social alienation to a minimum, and in general to make as many people as possible “happy”. Happiness has worked itself into the social sciences without any clear definition. We might define it as a situation where people do not pursue fundamental changes in their own position, and are basically content with what society offers them compared to what they contribute. Their own personal cost-benefit analysis must be positive. This perspective lifts the analysis out of the realm of purely economic considerations. In fact, non-economic factors such as history, experience, traditions and culture may be more important. What works in one society

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may not work in another. There is no uniform scale to fall back on — but, as revolutions and wars tell us, if policymakers get it wrong, people react. It is rarely useful to import or introduce societal measures from one country to another without being certain that the cultural background makes such a move propitious. People’s cultural backgrounds determine how they respond to economic incentives and social rules. The main elements of running a society or a country are infrastructure, health and education. An international comparison is useful in order to note which countries are seen as the leaders, doing the best for their citizens in these three areas. According to the World Economic Forum (2015), countries are ranked for the quality of their infrastructure, institutions, health and primary education, and higher education as follows: For the best infrastructure, the top ten are:   1. Hong Kong (SAR)  2. Singapore   3. United Arab Emirates  4. Netherlands  5. Switzerland  6. Japan  7. Germany  8. France  9. Spain 10. United Kingdom The United States is number 12, China number 46, and India number 88. For the best institutions, the top ten are:   1. New Zealand  2. Finland  3. Singapore  4. Qatar  5. Norway  6. Luxembourg   7. United Arab Emirates   8. Hong Kong SAR

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 9. Switzerland 10. Netherlands The United States is number 30, China number 47, and India number 70. For health and primary education, the ranking is:  1. Finland  2. Belgium  3. Singapore   4. New Zealand  5. Netherlands  6. Japan  7. Canada  8. Ireland  9. Cyprus 10. Iceland The United States is number 49, China number 46, and India number 98. For higher education and training, the top ten are:  1. Finland  2. Singapore  3. Netherlands  4. Switzerland  5. Belgium   6. United Arab Emirates   7. United States  8. Norway   9. New Zealand 10. Denmark China is number 65; India is number 93. Not surprisingly, the “winners” are comparatively small countries, most of which have a long history as self-contained societies. These are factors conducive to creating a common identity, making people more willing

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to enter into an equation of give and take, anchored in trust between individuals and trust in institutions and the authorities. Infrastructure: It is only in recent years that the quality of infrastructure has been recognized as a competitive parameter. Bad infrastructure not only hurts competitiveness but also produces frustration among companies and individuals. It aggravates distrust in the political system, especially when it is compounded by suspicions about kickbacks and corruption. In the advanced economy, with complicated production supply chains, bad infrastructure can wipe out the comparative advantages from production in clusters (such as, in the United States, high-tech clusters in Silicon Valley, oil refining clusters along the Gulf of Mexico, etc.). An example can be found from the last eighteen months of World War II. Nazi Germany’s manufacturing remained highly efficient, and deadly for the Allies — as in the case of the production of submarine engines in the Ruhr area. But Allied bombing of the railways drastically slowed the movement of the finished engines to the shipyards at the Baltic ports, where the hulls of the U-boats were built. Infrastructure might be the best illustration of holistic thinking. A bridge or a freeway is a classic example, but the analysis can be broadened to public services such as electricity, water, heating and, nowadays, access to the Internet. All these investments have a positive impact on the economy, but the decision to undertake them is often subordinated to a narrow public finance view or, in a privatized environment, profitability.1 A bridge may be turned into a toll bridge, on the reasonable argument that those who use it gain a benefit, for which they should pay. But this is a one-sided view. Those who use it also contribute to GDP, benefitting other sectors of society and the nation-state as a whole. Furthermore, when the bridge is linking large parts of a society or a country together, the widespread benefit of keeping society together, stimulating social capital and enhancing cohesion, should not be underestimated. Similarly, access to public Wi-Fi is normally (but not always) paid for by the individual user — but the positive effect on growth is significant, and the benefit often extends to all sectors of society.2 Infrastructure investment undertaken by the public is too often seen solely through the prism of the market economy: Is it profitable in a short-term market-economy analysis? This is clearly the wrong approach; instead what may be termed “societal profitability” should be applied.

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Will the investment over the long term contribute more to GDP than the cost of building and maintaining the infrastructure? In many cases the answer may be: market-economy profitable, no; societally profitable, yes. But even this public economy approach is too limited. In addition, there is a possible political benefit — whether it helps to keep the society or country together. In many European countries, in Japan, and in many emerging markets and developing countries (EMDE), narrow cost-benefit analyses are resulting in the closing down of public services, such as post offices, police stations, hospitals and, perhaps the most important of all, transport networks. When essential services are withdrawn, people stop living in these areas, turning them into social deserts. The social costs for those living in areas that have been abandoned by society may in the longer term be quite high. Healthcare: There are many analyses showing healthcare costs as a percentage of GDP and per person. All of them reveal that the United States is spending far more than any other country. Statistics are not always reliable, and exact figures for healthcare depend on the definition, but analyses indicate that the United States spends more than 16 per cent of GDP compared to an OECD average of 9 per cent. France and Germany spend around 11 per cent. China and India a little over 5 per cent and a little below 4 per cent of GDP (OECD 2015), respectively. The difficulty of finding these figures is nothing compared to the challenge of finding out exactly what the health system offers. There are two major factors to consider. The first is preventive measures versus the curing of diseases. The other one is the coverage — i.e., how large a proportion of the population has access to healthcare. High expenditure could be societally profitable if it prevented disease, thereby allowing a large part of the population to remain healthy and productive, which in this context amounts to a low output gap. Some countries have introduced compulsory screening for certain diseases, such as different forms of cancer. At first glance this may seem costly, but a closer look reveals that by intercepting cancer at an early stage, the total costs to society may be lower. The opposite approach — doing nothing until the disease breaks out and the symptoms become obvious — demands high-cost treatment and the removal of the individual from the work force. Coverage, too, is both an economic and a social question. A public healthcare system should in principle cover everybody, while private

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healthcare covers only those who pay. The long-term costs of not covering the whole population may be quite high, as measured in lost GDP, since the workforce shrinks as people are not able to work, or if they are only able to work with lower productivity. Education: Societies and countries depend more and more on skills and competencies. The education system should supply the skills that are in demand. If it fails to do so, a mismatch arises and the cost in terms of lost GDP can become enormous. This will not only keep growth lower — creating a rising output gap — but it stokes frustration and anger among people who have foregone their income and time in higher education only to find out that the skills they have acquired are not in demand and useless to their working life. Societies must tune into their economy. A country like India is fast moving into manufacturing — a place formerly occupied by China — and needs basic skills for its vast workforce. China moved out of this bracket and has to upgrade the education of its workforce to tackle more skill-oriented functions. This is not only about education for young people joining the workforce. It is to a large extent a question about what has been labelled life-long education — reflecting the fact that as the economic structure rapidly changes, so too must the skills embedded in the workforce. Analyses of the U.S. economy illustrate the importance of labour market “churn” — the freedom of workers to move from a job with lower productivity to one with higher productivity, in principle pushing workers towards job functions where they are most productive (Lazear and Spletzer 2012). An expanding or changing economy absorbs workers — but only those who have the right skills, and these must be acquired simultaneously with their working careers. Hence, life-long learning. Job functions will certainly change, and quickly, over the coming decades. The most dynamic job functions in one or two decades from now are probably barely known today. Few people will remain in the same job function and, if they do, they will work differently. Sometimes societies or countries are tempted to enrol an increasing share of the population in higher education. This is not always the best way to proceed. Over-qualification can be a curse, as job seekers ask for too high a salary, which business is unwilling to pay. Even if the high salary is paid, it can lead to frustration for both the worker and the business, because over-qualification means that skills do not match

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requirements. A study from 2010 disclosed that “In the United States (using 2008 data), we have estimated that there were approximately 17.4 million college graduates working in occupations requiring less than a bachelor’s degree (our favourite example: the 317,000 college educated waiters)…. in 1992, 5.1 million employed college graduates (17 per cent of grads) were underemployed.… in 1967, this was true of only 953,000 grads…. The growth in these figures suggests that American taxpayers are reaping less of a public economic benefit from their support of higher education” (Matgouranis and Robe 2010). The authors admit that the statistical material is not fully satisfactory, but even allowing for that, over-expenditure on college education can lead to a social loss, or, in other words, in the context of this chapter, it can drive up the costs of running the society and waste money. The education sector may provide the best example of the importance of the social contract in underpinning the functioning of society and, in this case, making the education system, the business sector and the government (the public sector) work as partners. Two challenges arise. The first is determining who pays for education and who reaps the benefits. If the balance here is wrong, cohesion between the partners starts to break down, as one will be paying for benefits that go to the other. The second challenge is to determine what job functions will be needed in the future. It is doubtful that a good estimate can be obtained if the business sector is not involved in defining the purposes of education. The money spent on education — primary, secondary and tertiary — is substantial. According to the OECD (2014a), the average figure for member countries is 6.1 per cent of GDP, with the lowest at 4.2 per cent (Turkey) and the highest at 7.9 per cent (Denmark). For tertiary education the OECD average is 1.6 per cent, spanning 1.0 per cent (Hungary, Italy, and the Slovak Republic) to 2.8 per cent (Canada). The OECD study also reports that the share of private expenditure on educational institutions varies from a high of close to 70 per cent (Chile, followed by Korea, the United Kingdom, Japan and the United States) to negligible in Denmark, Norway, Finland and Luxembourg (OECD 2014b). Public versus private ownership: The crucial points here are: how large a share of the population has access to essential services? Is enrolment in public services such as health or education obligatory? Are the activities seen as a business or as a public service? Is the financing public or private?

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How are benefits measured — in terms of economics and finance alone or in a societal context? These questions can be boiled down to the label “public versus private”. In the era of globalization, a nation-state’s gateway to the world may be an airport, an airline, a telecommunication company, an energy company. In all four cases, the company can be managed in a short-term market perspective to return a market-economy profit. It is, however, far from certain that such a policy will generate the highest GDP. Creating high quality and efficiency in these areas may be more than enough to produce a small hike in GDP — say 0.5 per cent — even though it causes a deficit in terms of the market economy, but the nation-state as a whole will be better off. An airport is used for many different social purposes: to attract people (tourists), to position a city as an attractive place for multinational companies, to brand the nation-state, etc. Without a national airline the capital will be served, but will not likely be seen as a hub serving passengers from other continents in transit to nearby countries. A telecommunications company, operated from a social perspective, may take extra, precautionary measures to ensure nation-wide coverage in the case of a major accident, perhaps by having surplus capacity to allow the rerouting of traffic in case major routes break down. It may be socially profitable to offer low prices that reduce communication costs for multinational companies. Global warming and sustainable energy, too, can drive major changes in a nation-state’s energy policy. It will probably not be economically profitable, but it may well be socially profitable in the long term, or help meet other policy goals that create a social profit. Germany has opted for the so-called “Energiwende”,3 with a massive shift to sustainable energy over the coming decades. This will not likely be economically profitable in the short term — it may not be so in the medium term, depending on oil and gas prices — but the decisive factor is that it reflects a determined political will to take this road to the future. In many places there has been a lack of interest in long-term maintenance and repair undertaken by private companies — the investment funds of too many companies are not interested in servicing society. In some cases such owners have bought themselves in to split the original company or take money out of the company, creating a situation where, in order to protect public safety, the public sector is forced to take over to restore maintenance and repair.

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This analysis does not advocate a rejection per se of private companies operating in the public sector, but calls for due diligence as to whether their business philosophy is congruous with what society, the public and the political leadership actually want. In general, public ownership is not working well in a competitive environment. The auto manufacturing and mining industries serve as illustrations. The exception may be industries that require high levels of capital investment, where there are some positive cases in, for instance, shipping and airlines. The government may choose to classify such companies as strategic companies, in which a potential loss is acceptable, either because the nation-state wants to own such companies or because a positive spillover to other sectors is judged to more than compensate for a loss. The virtue from a social point of view is that knowledge and experience gained from operating the industry can be made available to private corporations, stimulating further economic activity, where private ownership would have kept these assets for the company. Perhaps that explains some of the overseas investment undertaken by Chinese state-owned Enterprises. Inequality: Inequality is not only a moral or social problem; it also influences economic growth. Conventional economic thinking tells us that inequality is “good” for growth primarily because of a higher savings rate enhancing the financing of investment, and the incentive inequality creates for people to work harder. This has been the conventional wisdom of economists for many decades. It is in fact not substantiated by empirical analysis. In the real world, inequality may in some cases and under certain assumptions stimulate growth, but under other assumptions it can actually impede high growth and deserves the label of “destructive” inequality. This has been shown by Alberto Alesina and Dani Rodrick (1994),4 using data from the World Bank and the OECD. The verdict becomes easier when recalling that situations of income inequality with a Gini coefficient above 0.40 are mainly found in countries with a comparatively small public sector, a strong role for private financing of health and education, and with social welfare left to a large extent to private institutions and financing. Such societies create barriers to social mobility, reserving higher education — and consequently the top posts in the public and private sectors — for those social strata already well off and well educated. The loss to society is large, for the obvious reason that the recruitment base

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narrows, leaving those not already inside the charmed circle permanently outside it. The United States is an example (Putnam 2015). The potential talents embedded in a very large share of the population are wasted. Furthermore, those “outside” harbour grievances against society, that may lead to crime or other kinds of violent conduct, up to and including terrorism. The feeling that society is not fair generates the most dangerous sentiments, legitimizing personal action to compensate for unfairness. Social inequality undermines attempts to build a well-functioning society, setting up different groups of people against each other — not only because of money, but also due to resentment over feelings of being held back. A glance at statistics from the World Bank and the Human Development Report from the United Nations Development Programme (UNDP) supports the idea that many EMDEs move towards a more fair society, with opportunities still open for lower social strata — though this is happening less in recent years than a decade or two ago — while the opposite movement is seen in richer nations, where the middle class finds itself threatened by economic restructuring. What kind of society do we want? This is a simple question that many societies and countries prefer to avoid. Economically, the Washington consensus has driven societies and countries towards the market economy and privatization. The overwhelming majority of American- or British-trained economists praise this model and continually point to high technology as the only vehicle for achieving high growth. This near-unanimity has distorted the global debate and evolution of opinion inside societies and countries. What is wrong in producing high quality red wine or quality cars or haute couture as some high-growth countries in Europe do? Research and development, innovation and invention are needed, but not all countries need companies like Apple or Microsoft. The preference between work and leisure, and the perceived constituents of happiness, vary widely from society to society. Trying to run after a certain model for which a particular society may be ill adapted may incur costs that are simply not worth the reward. The majority of the population might well feel better off and more satisfied with a slightly lower income per capita combined with more equality and more leisure.

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The economic structure, economic development and economic prospect of societies and countries are not only questions of economics. Tradition, culture, social coherence and values may be more important factors indicating what type of society it is and what should be done to improve its standard of living. Comparative advantage is not only a question of economics. Skills and competences in a broad sense play a role, and societies would do well to realize this. Forcing economic activities into an unfamiliar social structure and sociological framework leads to both economic and social losses. The costs of running the society in this way will be higher than if policies were implemented that made use of the society’s existing strong points. The debate about global trade rounds such as the Trans Pacific Partnership (TPP), Transatlantic Trade and Investment Partnership (TTIP) and the Doha Round of the World Trade Organization illustrates that people, societies and countries may be wary of going too far — knowing well that these agreements may augment their economy’s income per capita but exact a high social price. There is no doubt that agriculture enjoys protection in some countries. The OECD5 found that state subsidies account for 18 per cent of farmers’ incomes in member states (2013 figures), and in some cases run as high as 50 per cent. Dismantling barriers for agricultural trade would unquestionably hike income per capita, but farmers would suffer. In most industrial countries they are elderly people who would not be able to adapt to life in a city. In some countries — Japan may serve as an example — they have become the only link to a traditional life that is increasingly alien to young people, but that exists in folklore. Is it worth the price of undermining the life of the traditional Japanese farmer merely to derive a marginal or even negligible increase in income per capita? The answer may be yes or no — according to society’s political preferences and its willingness to support a non-competitive lifestyle — and either choice is a perfectly legitimate one for a society to make for itself. The point is that there is more to the choice of an economic growth model than just looking at economic statistics and concluding that this or that step is advantageous because income per capita goes up.

Transaction Costs and Opportunity Costs Transaction costs can be defined as the costs incurred in providing services to the public — regardless of whether the public or private sector provides them or pays

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for them. Public and private ownership may adopt different attitudes towards these costs, since private ownership obviously looks for a profit in market-economy terms. Opportunity costs are the consequences for the long-term structure of society of decisions made today — “wrong” decisions are often highly resistant to change later on. The costs of an education system are difficult to calculate, but if one tries to rein in costs, one may end up paying a very high opportunity cost if the new system fails to provide people with the skills in demand 10, 20 or 30 years down the road. Of course, keeping the system as it is may be subject to the same opportunity cost, if it is a system in real need of reform. Transaction costs: Having lived most of my life in Denmark, I have witnessed nationwide social capital and seen how it works — though not without flaws — to promote creativity and lower social transaction costs, conceived as the cost of managing a well-functioning society. The cost of running Danish society is not high compared to the costs of running U.S. society, for example, even though a narrow comparison of the two countries’ public expenditures may conclude otherwise. But it is a mistake to believe that social transaction costs can be measured by simply looking at expenditure. Many of them will be financed outside the public budgets by institutions or private persons. Activities not undertaken do not, of course, give rise to expenditure, but they may incur other costs on society. It is far from obvious that money saved from the public budget is money saved for society as a whole. Many items paid for through public budgets in countries like Denmark are financed privately in the United States. Studies reveal that total costs for social welfare, for instance, does not differ much between the United States and Europe, but the number of people covered and the type of financing does. Adema, Willem and Maxime Ladaique (2009) have tried to compare publicly mandated social expenditure in different countries as a percentage of GDP (using 2003 as a base), which should in principle wipe out differences due to public versus private financing. They come up with figures of 18.9 per cent for the United States and 23.8 per cent for Denmark.6 Jacob S. Hacker points out (2002) that considering private and public spending on healthcare and pensions (including direct government spending and tax subsidies), the American “welfare state” is approximately the same size as other advanced countries as a proportion of GDP. These figures tell us what the welfare state costs, but do not disclose advantages in the form of better long-term health or enhancements to productivity,

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let alone consider the social benefits of conveying a feeling of coherence to society as a whole. This is social capital, and while it has a real value to any society, it is difficult to quantify what it is worth, or what it costs. Perhaps one measure can be found in a presumed result of a low level of social capital — the need to resort to the rule of law to resolve issues and conflicts. We can then compare the ratio of lawyers to the population as a comparable measure of a society’s level of social capital. The United States has 265 people per lawyer, Germany 593, France 1,403, Denmark 1,135, Finland 2,888.7 Henderson (2011) observes that spending on legal services in the United States grew from just 0.4 per cent of GDP in 1978 to 1.8 per cent8 in 2003, after which it fell slightly when the economic recession began in 2008. It is interesting to note that a number of analyses of Denmark (Lundvall 2008) have determined that the social welfare system promotes creativity, while mainstream thinking in the United States is that such a system holds back risk-taking and ingenuity. These two positions seem to contradict one another, but it may be that creativity is linked to the social structure in each country, taking different forms from country to country. In recent years the tendency to consider the role of the public sector solely in spending terms, and to seek efficiency and cost-containment in this area, has resulted in considerable degradation of those public services so necessary to run the economy at low transaction costs. Take postal services as an example. Formerly a monopoly existed — formally or in practice — for sending letters and parcels around the country. It was done effectively and for a relatively low price, as a percentage of GDP. Then it started to become too cumbersome. Somebody discovered that slicing out lucrative segments of the system made it possible to offer lower prices and a better service for those customers. Service providers such as FedEx and DHL emerged. The effect was to nibble at the national postal service, and thereafter to take business away from it ever more aggressively. Losing a part of its lucrative business made life more difficult for the national carrier, with the inevitable consequence that its business fell, reducing its revenue and increasing its need for public funds, which lawmakers hesitated to make available. It is often forgotten that as a former monopoly, the post office transferred funds from profitable activities to non-profitable ones, thereby allowing it to service society as a whole. If lucrative business activities are surrendered to private companies, depriving “weak” sectors of the economy

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of public services, there are two basic options open to policymakers: Increase public financing, or close money-losing operations. This has the effect of further boosting inequality. We see the same effect in almost all industrial countries. When there are several service providers instead of one, the resulting overlap of work engages a higher share of production factors than if it were carried out by a single service provider. The proponents of this approach, which has become widespread in most countries, take the view that competition is good and lowers costs and prices. It may well be that some customers get a better service, but society as a whole sees an overall depreciation of services. The palpable and immediate benefits in the form of lower public expenditure and better service for some segments of society may in the long run be outweighed by higher social costs. Inequality grows because people living on the periphery — socially and geographically — receive lower public services than they did before, and markedly lower than the enhanced services received by newly privileged sectors. In fact, the philosophy behind slicing public services calls into question the very notion of society and why we even have public services. It used to be seen as a cohesive factor, holding society together by offering more or less the same services to all citizens. Profitability as defined by the market economy obliterates this idea and turns public services into a private market-economy business offered to those who can pay for it. The next step in this analysis is to look at the economic and social costs that arise for society when public services are financed through borrowing over the long run. Public debt has always existed and, provided that it is kept at a level around half of GDP, experience suggests it is not really a problem. The problem arises when it grows — and especially when a country finances a part of public services over the long term through borrowing. This is what happened in the United States. Since 1961 the federal budget has been in surplus only five years — in forty-nine years it has showed a deficit. The economic cost is the net interest payments that commandeer an increasing share of GDP and the federal budget. In 2013 the Congressional Budget Office (CBO 2013) calculated that net interest payments would amount to 3.2 per cent in 2023, which is equivalent to about 20 per cent of the federal budget. Since then a revised calculation (CBO 2015 Update)

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points to a rate of 2.8 per cent in 2025 — illustrating how fragile such forecasts are, being dependent on the growth rate, interest rates and laws passed by Congress. Socially and politically there is another and perhaps more sinister effect of such debt financing, in that it corrupts the political mindset. People and politicians do not get a true picture of what it costs to run the society. Borrowing makes it seem cheaper than it is, letting society continue to buy what it cannot afford to. This mental distortion may be more detrimental than the economic effect. It implants the idea that something costing 25 per cent of GDP can be had for 20 per cent. With this perception ingrained in people’s minds, they lose their willingness to pay taxes to cover transaction costs, which allow the effectiveness and efficiency of public services to further degrade. Social opportunity costs: Social opportunity costs can be defined as the costs incurred by society of running inefficient systems of an economic or social character — social waste. How much better could society be at the same cost-level, or how many resources could we free for other purposes if we accepted the same service level, but did it more efficiently? To measure these costs we can bring in cost-benefit analysis or benchmark them against other systems or common sense. Unemployment is the first one to catch the eye — the waste of human resources, strength, skills, intelligence — but the caveat is that a certain degree of unemployment may actually be good for society, by allowing the labour force to adjust. In some cases it may be cheaper for society to simply accept that some people are going to be unemployed, and that paying them social welfare is cheaper than forcing them into employment for which they are ill-suited, thereby reducing the average productivity for the group. Energy efficiency is clearly an item to be considered as well. Comparing, for instance, what proportion of GDP China spends on energy versus Japan informs us that China could get the same productivity for almost 50 per cent of the energy actually used. Add to that the external diseconomies and the sum wasted is very high. The most interesting one, and the most difficult one to measure, is the education sector. Goldin and Katz (2008) point out that technological development may have a “dark” side in the form of adverse distributional consequences

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that may foment social tension. Technological progress may result in the earnings of some groups increasing more than those of others. In order to have an equitable distribution of increasing income, people’s skills must be flexible and there must be an educational infrastructure in place that expands to match the demand for particular skills. Growth and the income-premium paid for skills will then be balanced. If, on the other hand, the education system does not provide a wide distribution of skills, imbalances will arise. Not just the education sector but the whole social fabric will become unsettled. Goldin and Katz divide the wage structure and education system in the United States during the twentieth century into three phases. The first one was from 1920 to around 1940 — wage differentials narrowed, and the earnings of the more educated were reduced relative to those of the less educated. The second one, from the 1940s to the beginning of the 1970s, saw wage differentials widen only slightly and income distribution remain fairly stable. The third one, from the 1970s to the end of the century, saw inequality rise steeply, but productivity only slightly (productivity later rose sharply, but not in this period). The income-premium for college education rose. This represents a mismatch between the demand for skills from industry and the education system’s ability to deliver students who possess these skills.9 This is how social opportunity costs mount. First, we have the cost of a mismatch between the number of educated people and the skills in demand. Second, we have the costs of inequality. Third, we have the costs (both social and private) of educated people out of jobs. Growing inequality acts as an obstacle to mobility, especially in societies where education is not free or enjoys subsidies from the government. Only students with parents able to finance tuition fees and living costs enter the universities, and in particular the top universities, creating an “economy of privilege”. The opportunity costs of the lost development of talent are high. Figures from a number of countries, including the United States, show how the mismatch of supply and demand for skills results in a rising concentration of income and wealth among a small — and with every year, smaller — percentage of the population. Piketty and Saez (2006) have calculated that over the last hundred years the share of total income (labour, business and capital income excluding capital gains) received by the top one per cent of individuals was 8.2 per cent in 1928, fell to a low of about 2 per cent in

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the 1960s and 1970s, after which it started to rise again, to reach about 7.5 per cent in the first decade of this century. This is almost a perfect validation of Goldin and Katz’s analysis. The growing inequality of income seen in the United States over the last three decades in the rising Gini coefficient is not due to an increasing share going to capital, but rather to a redistribution within the share going to labour, as the top bracket increases its share of total labour income. This, it may be argued, is good for the economy in the short run, since the increased remuneration of exceptional skills boosts total productivity, but in the medium and long term, detrimental effects overwhelm any benefits. It supports an economy of privilege as shown above. Much of the additional income accruing to the few may be channelled into conspicuous consumption, and not used for productive purposes. It may go into the banking system, but whereas the banking system in its traditional role would lend to productive purposes, it becomes “sterilized” through the creation and sale of financial instruments that are not designed to support production. It is significant that the development and diffusion of a number of dubious financial instruments unconnected to the productive part of the economy took place simultaneously with the expansion of the share of income going to the top one per cent. In the same breath can be mentioned the costs — both economic and social — of the apparent disappearance of the middle-income bracket. Katz and Kearney (2008) show that employment has risen for high-end skills and low-skilled workers, but fallen for middle-level skills. Economically, this indicates that society has been unable to intercept the erosion of middleskill jobs that are easy to replace by ICTs, while failing to put in place facilities for training, upgrading skills and otherwise helping displaced workers to find new jobs to replace those that have disappeared. Socially, this is a bad omen — history gives ample evidence of the destabilization of societies when the middle class is under attack. Auguste et al. (2009) compare the American education system with that of a number of other countries taking part in the PISA (Program for International Student Assessment) ranking. They identify educational gaps on a scale they describe as the economic equivalent of a “permanent national recession”. If the United States had closed their achievement gap in education as it emerged at the start of the 1980s, and raised its overall performance level to the highest ranking — on a par with countries like Finland and Korea — U.S. GDP in 2008 would have been between US$1.3

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trillion and US$2.3 trillion higher than it was. This represents 9 per cent to 16 per cent of total U.S. GDP. A 2012 study (Pew 2012) revealed how social mobility is falling steeply in the United States. Among other conclusions were: • Eighty-four per cent of Americans have higher family incomes than their parents did. • Those born at the top and bottom of the income ladder are likely to stay there as adults. More than 40 per cent of Americans raised in the bottom quintile of the family income ladder remain stuck there as adults, and 70 per cent remain below the middle. • African Americans are more likely to be stuck at the bottom and fall from the middle of the economic ladder across a generation. • A four-year college degree promotes upward mobility from the bottom and prevents downward mobility from the middle and the top. Alan Krueger (Woellert and Stilwell 2013) draws a curve showing inequality and generational mobility (parental income as a factor explaining a child’s future earnings). He shows graphically that as inequality goes up, generational mobility goes down. In other words, inequality serves as a barrier to social mobility, making it increasingly difficult for young people to break out of their parents’ income bracket. The uncreated wealth as a result of this waste of talent is enormous. The coming scarcity of resources introduces another element of social opportunity cost. Society cannot afford its established throwaway mentality. Nor can it afford inefficient waste management systems or a failure to promote recycling. From a business perspective, waste management already is and will continue to be a fast-growing industry. The next step is to develop production and consumption systems that do not produce any waste at all. For social planning, the problem to a certain extent is to distinguish the short-term and long-term costs, as well as market-economy and social costs. Setting up an efficient public organization to deal with waste may not be market-economy profitable in the short term, but when seen from a societal point of view over a longer time horizon, the cost-savings may be huge. For an example of how even the most innovative waste-reduction ideas can be distorted by the failure to recognize the distinction between short term and long term, and between market-economy costs and social

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costs, consider a proposed plan to use the falling water running down the drain in skyscrapers as a source of electricity generation (McMillan 2013). Technologically, the idea can be transformed into reality, and it is already being done, though not without difficulties, and it is only providing a comparatively small amount of power. The price is the main problem — it is up to five times more expensive than the normal supply of electricity, and the payback time could be as long as thirty years. But consider the waste factor. Because the water is priced in a market economy, wastewater is considered a cheap input. The social benefit of moving to a zero-waste footing, and of reducing the cost of running society in the long term, is ignored. U.S. business history since the 1930s provides numerous examples of policies developed with a singular focus on market forces, in complete disregard of the environmental consequences or the long-term negative repercussions on the national economy. According to Peter Newman and Jeffrey Kenwork (1999), a holding company bought up the private electric streetcar systems in forty-five U.S. cities — and closed them down. This holding company was owned by companies with interests in expanding the use of automobiles — particularly the oil, tyre and auto manufacturing industries. In 1949 a grand jury convicted General Motors, Standard Oil of California, Mac Trucks, Philips Petroleum and Firestone Tires on a criminal indictment of antitrust conspiracy, but in the meantime 280 million passengers had been chased from streetcars on to buses and into cars. The big companies earned a fortune while the U.S. economy suffered badly, and the United States was left with an urban transport infrastructure wholly dependent on the auto industry. The societal cost stems from the fact that American cities for the last seventy years have been constructed so that workers can — and often must — use their cars to go to work. This severely limits policymakers’ ability to use an increase in the petrol price as an element of energy or climate change policy. It would lead to immediate demands for higher wages and hollow out the U.S. economy’s competitive position. Although the conspiracy initially increased U.S. GDP through higher car production, it resulted in a series of highly negative repercussions on the economy and the social structure, increasingly locking it into a specific structure and preventing changes that have become increasingly necessary for a variety of reasons.

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Wrap-Up The cost of running a society can be lowered — or made more costefficient — when there is a clear idea of what kind of society is preferred. This objective is a major determinant of which public services should be publicly owned and which ones privately owned, since it has immediate consequences in terms of the share of the population with access to public services. The more value-driven a society or nation-state is, the smoother it will run. The need for governmental action to ensure compliance with rules will be relatively low, as people act in accordance with their common values. They know, through their upbringing and education, what is the right or wrong thing to do. They act in conformity with the spirit and purpose of legislation instead of scrutinizing laws and regulations for loopholes to find out how much can be squeezed out of the public sector. The government can rely more on incentives rather than the cumbersome and expensive machinery of rules and regulations. Coercion is not only costly but also conveys the impression that there are insiders and outsiders, undermining efforts to achieve the highest possible degree of cohesion, with as few people as possible outside society.

Notes 1.

2.

Some years ago I took a taxi from Michigan Street (Chicago) to O’Hara airport. In the opposite direction a massive jam on the freeway was visible and when we took the flyover to the airport it stretched for as far as I could see. I asked the taxi driver, why? His reply: Roadworks at the exit in the city centre, and Chicago could not afford to pay overtime, so the repairs had to be done during normal working hours, which obviously was when traffic was the heaviest. Many times I have speculated about the cost for Chicago of the delays for what might easily be twenty thousand cars waiting for several hours. Suppose that a city wants to ensure safe crossing of a major road for pedestrians. There are two ways to do it. One is to put up a traffic signal inviting pedestrians to push a button to stop traffic. Another is to build a bridge for pedestrians. In the first case the costs are borne by the car owners — waste of time, wear and tear. In the second case, society shoulders the costs and reaps the benefits of no waste of time or wear and tear. In the long run the second solution is societally profitable, but often the traffic signal will be chosen due to the lower initial costs and that car owners may live in other communities and are thus not paying taxes to the community where the bridge is built.

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3. . 4. For an overview, see Birdsall (2005). 5. OECD, Agricultural Policy Monitoring and Evaluation 2014 (Paris, 2014). 6. 15.6 per cent for Ireland; 29.8 per cent for France. 7. Sources: and . 8. Higher than the defence budget of almost all European countries! 9. The works by Goldin and Katz analyse U.S. education over the last hundred years and touch on several aspects not relevant for other countries. The basic message is, however, of crucial importance for Asia, spelling out that the education system is contributing to growth according to how well it is geared to society, but at the same time is embedded with the seeds of disruptive forces if policies are out of tune with societal and technological development.

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5 Concentration of Capital, Corporate Governance, Power

The massive concentration of capital is threatening the survival of the capitalist economic model and opening a sluice gate for the abuse of power. Business has lost interest in the business–government–society triangle — choosing instead to pursue its own interests separate from those of society. Despite the prevalence of ideas and philosophies about corporate social responsibility, the main target of corporate governance, as invented and practised in the United States, is to generate rising quarterly profits — full stop. Part of the cause may be found in the system of corporate ownership through the stock markets, and even more through billiondollar investment funds, which have the effect of blurring the identity of those who actually own the companies. Asia, where ownership is more commonly in the hands of either the state or of families, may give rise to a new and different form of corporate governance.

Concentration The conditions underpinning the philosophy of the free market are twofold: (1) relatively easy entry to markets in order to establish new enterprises, and (2) genuine competition in the market place. But nothing of the sort is evident in

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what is labelled the free market economies of today. An enormous concentration of capital puts a limited number of corporations in charge of the global economy — erecting huge barriers to market entry, and reducing and managing competition almost to extinction — and these corporations are run by a relatively small number of people. The relationship between the two major institutions of the nation-state — the business sector (primarily the large corporations) and the public sector (primarily the government) — can be organized in several different ways. They can pursue mutually beneficial goals, supporting each other and looking upon each other as partners in shaping the future of the society and nation-state. Alternatively, they can pursue mutually inconsistent objectives — and find themselves continually in conflict with each other in a more or less openly adversarial relationship. A third option is that the business sector ceases to see itself as part of society at all, viewing the government and the public sector as irrelevant to its own decision-making, which is focussed on its own self-serving objectives. In the course of industrialization, corporations grew so big that, almost unavoidably, they loosened their relationship with the nation-state. They no longer need the nation-state, and in many cases see the nationstate as an impediment to their move into the international or global marketplace. Many of the same advantages and disadvantages that colour the relationship between corporations and governments within nationstates have jumped from the national to the international level. On the one hand, the nation-state may find it profitable or more in conformity with its policies to attract multinational companies; on the other, national companies may find governments in other countries to be better partners. The revolution in technology and logistics has furthered this development. Corporations can operate in many countries at the same time with minimal costs of maintaining communication, and they can ship components between plants in various countries, playing for competitive advantage. Globalization has opened the door to other countries; the enlarged market has brought productive scale into the picture to a degree never seen before. A corporation used to recruit its staff from its home country — hence, it had a strong interest in the education system located there. Operating internationally or globally, it recruits globally, and quickly loses interest in paying for the home country’s education system through its

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taxes. The link between owners, workers and the public sector has been broken, undermining the corporation’s interest in the welfare of its workers after retirement. The social contract does not exist in a global world. Corporations shop around to see where they can find the best and most promising environment to locate activities. They may receive government help in the form of advice, cheap property, low taxes, infrastructural improvements, or a grace period for contributing to public activities. The national social contact is replaced by a purely profit-driven strategy to search for the most lucrative places to locate. Corporations play governments off against each other. According to the U.S. Congressional Research Service (Keightley 2013), American multinational companies reported 43 per cent of their overseas profits (US$940 billion) in five tax havens abroad — while having only 4 per cent of their foreign workforce and 7 per cent of their foreign investments in those countries.1 An Australian analysis disclosed that of 1,500 corporations with an annual income above A$100 million, 579 did not pay taxes. Many companies managed to produce a taxable income less than 25 per cent of total revenue, leading to a tax amounting to 5–10 per cent of total income. Big corporations get away with what is obviously tax evasion — but in a legal form — because their size makes them so important to nationstates and their governments. Proposals to institute a global system for corporations to register their tax in the country where the income-earning activities take place have so far come to nothing. A total of 1,318 corporations control about 80 per cent of global business activities, either directly through their own operations or through cross ownership; 147 of them control fully 40 per cent of global business. The corporation controlling the largest single share of global business life, directly or indirectly, is the British bank, Barclays, followed by Capital Group and FMR from the United States, the French insurance giant AXA, and State Street Corporation from the United States (Hassel 2011). The Economist (7 December 2013) points at BlackRock saying that “it has US$4.1 trillion in assets under management, making it bigger than any bank, insurance company, government fund or rival assetmanagement firm”. Many of these corporations are unknown to the public and their ownership is opaque. It is not only the sheer concentration of capital and control that distorts any notion of the free market, but the very limited interest these corporations have in any kind of competition,

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as cross-ownership in various forms frequently makes them compete against each other. At the beginning of 2008, Microsoft offered US$41.7 billion for Yahoo and the battle seemed to be on. Would Yahoo be taken over by Microsoft? Who would profit; who would lose? Then RiskMetrics (a financial risk management company) revealed that 90 per cent of Yahoo’s institutional investors had substantial holdings in Microsoft, were actually among the top-twenty holders of Microsoft shares, and most of them had more money invested in Microsoft than in Yahoo (Reuters 2008). With few exceptions, markets have developed into oligopolies instead of anything resembling the theoretical competitive free market. The U.S car industry today consists of three companies, but a hundred years ago there were several hundred. The last one fighting it out with the three big car manufacturers was American Motors, which only gave up in 1987. Brands like Studebaker, Nash & Hudson and Essex died in 1966, 1956 and 1932, respectively. The big three are now exposed to competition from overseas producers, but the number of these is also dwindling. Many observers think that in five or ten years time the world will have ten large car manufacturers at most. The number of tyre manufacturers2 has gone through the same cycle, from several hundred to a handful, and the market today is dominated by three main producers: Bridgestone from Japan, Michelin from France and Firestone from the United States. Together these three command a global market share of 55 per cent (Thomas 2011). Interestingly, two of them have vigorously pursued a strategy of vertical acquisition — buying into rubber plantations, partly to make sure that raw materials are available for their own operations but at the same time exercising a significant degree of control over the entire market and the global supply of rubber, making it very difficult for others to enter the market. A similar concentration can be seen in the manufacture of television sets, fridges, audio-visual equipment, cell phones — the list is endless. When an innovation reaches the point of commercialization, a large number of manufacturers pop up, competing vigorously. At some point — for the car business it was somewhere between 1910 and 1920 — this phase comes to an end. Concentration begins, but still with a degree of competition — for the car industry in the United States until the 1930s, and for Europe until the 1970s. Finally, when the product is established and used by a large share of the population, or at least its market is saturated, the number

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of major producers — all except the specialized or artisanal — falls to between five and ten.3 We can draw a curve showing that, immediately after the innovation, a few entrepreneurs test the water, followed by an avalanche of new entrants. As these struggle in the new market, the number dips slightly for a decade or two, before suddenly plummeting, leaving just a few gigantic corporations standing. In the following graphs, the horizontal axis represents time passing; the number of years is only indicative, as the scale may be different for different products, even though the general relationship holds. The same is true for the vertical axis of Figures 5.1 and 5.3. In the case of a new market, Figure 5.1 shows a curve with a reasonably high concentration of capital (relative to production) at the outset — only a few entrepreneurs want to risk their own or their investors’ money on an untested proposition (years 0 to 4 on the graph). But as the market proves to be profitable, more investors are enticed to enter the market, production and sales expand, and capital is dispersed over a large number of producers (years 4 to 10). Then, as the industry is said to “mature”, the market is saturated and stabilized, with little change in the number of customers or the size of their consumption, and the number of producers begins to dwindle (years 8 to 12). As the concentration of capital picks up Figure 5.14

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momentum, the number of producers falls precipitously, leaving only a handful still operating at the end of the cycle (year 15). Figure 5.2 is essentially the inverse of Figure 5.1, showing the concentration of capital as it starts high in the early days of the market, falls to a very low level as new entrants compete for market share, then steeply rising again as a smaller and smaller number of producers remain in the market, controlling between them a much larger amount of capital than at the beginning of the cycle. Note that the y-axis shows the concentration of capital as a proportion of the total capital in the market, not as an absolute number. There is certain to be a much larger absolute amount of capital invested in the market at maturity than there was at the outset. Figure 5.3 shows how the “boom years” draw capital into the new market from the total store of capital in the economy. As the concentration of capital reaches completion, the “efficiency” of the market (by one definition) increases, so that production ties up less and less of the economy’s total store of capital. As long as we had a large number of companies fighting to gain market share, none of them were able to exercise much power for the Figure 5.2

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simple reason that they did not have the economic clout to do so. In a competitive market, any action undertaken by any single operator will have no significant effect on the industry as a whole, and competitors are loath to combine their efforts for fear of giving an undue advantage to their opponent. As economic activities become dominated by a limited number of companies, each one’s ability to single-handedly exert influence on the market as a whole becomes significant — and producers’ willingness and ability to combine their efforts tends to grow as well — creating a strong temptation to abuse that power. Thus, corporate governance — how these powerful companies are managed and run — has attracted the attention of scholars and policymakers in recent years.

Corporate Governance There is little evidence that the limited number of people controlling the global economy look beyond their own interests and those of the corporations they manage. High compensation for executives, questions about paying taxes, and the alleged

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use of globalization to circumvent unpleasant rules and regulations are all too apparent to be ignored. Ideally, corporate governance should be directed at making the economy and business activities inclusive — spreading the benefits to society as a whole. But the data conveys the exact opposite impression — an extractive approach designed to keep the benefits exclusively within the sector. Despite much high-minded talk about combating corruption, laudable and necessary, the Western business sector seems blind to its own distorted way of operating. Business–government relationships in the past may not have been entirely based on mutual love, but there was at least some kind of common understanding about reciprocal support and mutual interdependence. The social contract was visible and respected. The profit motive is necessary for the obvious reason that this is what keeps corporations in business. But profit alone cannot be the objective. Textbooks talk about a balanced relationship between profit, social responsibility and environmental concerns. Reading the financial newspapers, one increasingly comes to the conclusion that the balance is tilting towards profit alone. This is borne out by economic statistics which reveal a decreasing share of GDP going to wage earners. They also show the emergence of large and growing inequality in many countries. A case in point is that of the investment bank Goldman Sachs, which allegedly gambled on a collapse of the U.S. housing market. For how long can governments and society live with a situation where major economic players actually follow policies that wilfully undermine the national economy and, indeed, the global economy? Not very long, one might think. But the business sector does not seem to share this view. The concentration of power in the financial sector continues. Many questions have been raised about the motives behind the advice and guidance many financial institutions give to their clients. So-called vulture funds speculated openly in the lead-up to the Greek meltdown — thereby increasing the likelihood of it happening. They accelerated a development which was profitable for them and the financial institutions to which they are symbiotically tied. This is not merely a case of private companies operating rationally in the market — it is trying to force an event by persuading clients into speculative positions against governments.5 How long can business get away with creating an adversarial relationship which actively and purposely works against government objectives?

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The financial sector’s role over the global financial crisis, the U.S. debt crisis and the euro crisis is raising serious concerns among politicians and indeed ordinary people. What is going on here? These companies have for years lived as a part of society and benefited from a kind of symbiosis — you scratch my back and I scratch yours. Some decades ago, political leaders could call upon them and they answered the call of loyalty, responsibility and duty, to rally behind the goals and plans of society — because they realized that ultimately we are all in the same boat. Yet, today this link with society has been completely broken. The financial institutions see the rest of society as a rented cow — to be milked without any reservations or limits. If a catastrophe for society could have been avoided, had they chosen to play along with instead of against society, well, so much the worse for society. In Europe many of the government advisers who are making key decisions on how to deal with the debt crisis come from the financial sector. Many Europeans wonder exactly where these people’s loyalties lie: with the governments, with society, or with their financial institutions? This is a situation that goes directly against the principle of separation of powers — not in the sense put forward by Montesquieu, but as it applies to economics. Those who advise upon, let alone implement policies, should not be the same people who benefit from those policies. But in almost every Western country these are exactly the people who have been in charge of the debt crisis. The same isolation from the public interest is evident in the high-tech sector. Companies are created in the societies that supported them and helped them to grow and prosper. But as soon as it seems most profitable, the owners or management immediately sell the company to overseas owners, without giving the slightest regard to what they owe the society that nurtured their success. The basic principle of common interests among owners, management and employees, which characterized most enterprises in the industrial age of capitalism, as was still widespread a few decades ago, no longer exists. The owners have become anonymous — anchored in obscure and opaque funds with strange names, located in exotic places chosen for their tax incentives or other benefits. The owners care about neither the local society nor the employees. The “contract” between owners and employees has been broken. Owners seek the short-term profits that drive their share price and attract buy-out offers, or enable them to dismember their business and sell off each piece separately.

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The common corporate practice of shuffling profits among various national units illustrates the utter lack of acknowledgment of the symbiosis between the enterprise, the local society and the local employees. The concept of the master limited partnership (MLP), developed in recent decades in the United States, illustrates this trend. An MLP is a company owned by several partners of whom only one needs to be a general partner; the others can be limited partners. This formula allows the company to be a publicly traded security — enjoying easy access to capital — while at the same time enjoying the tax advantages of a limited partnership, which in reality means they rarely pay taxes at all. The model is growing in popularity and accounts for a considerable share of new U.S. companies. For a variety of reasons it is, so far, largely confined to the oil and gas sector, indicating that the advantages are particularly attractive in capital-intensive industries. The MLP model poses two problems for corporate governance. The first is its distortion of business conditions. If some companies, but not others, enjoy the benefits of tax exemption — de facto, if not de jure — the flow of investments will be less attracted to the businesses that are the best-run, or the most viable in business or economic terms, and more attracted to those enjoying special tax privileges which can deliver higher returns as a result. The other problem presented by the MLP model is that it deepens the trend described above, making businesses increasingly isolated from society and less inclined to contribute to society’s welfare. It deepens the fault lines of inequality and pushes the nation-state in the direction of political and social upheavals (DeMuth 2013; The Economist, 26 October 2013). The rise of the financial sector to predominance in economies like those of the United States and Britain has undermined economic activity based on producing “something”. Originally, a bank was an institution where savers deposited their money so that the bank could channel it into investments to augment total production — the economy’s clutch pedal, so to speak. A bank became profitable by being good at evaluating investments and selecting the best projects out of those it was offered. In this way, banks implicitly pursued their own profits and benefitted society. Bad investment projects were weeded out, so there was little or no waste resulting from the suboptimal allocation of production factors. Profit for a bank became synonymous with society’s development. Even if not stated

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explicitly, corporate financial governance was congruous with helping society to function at the lowest level of social costs. Nowadays, many financial institutions — especially the largest — specialize in investing in and managing sophisticated financial instruments. This amounts to shuffling funds around without actually producing anything — redistributing society’s wealth and income into ever fewer hands, enhancing inequality and reducing growth. Like law firms, the financial sector has developed into one adding to the cost of running a society rather than making the task easier. The risk to a society when its financial sector loses the sense of its traditional role is suggested in U.S. National Accounts figures. The financial sector’s share of the United States’ GDP rose from about 2 per cent in 1860 to about 6 per cent in 1929. Over the Great Depression it dropped to its former level of 2 per cent — only to start rising again from 1950, eventually reaching more than 8 per cent in the first decade of this century. In Britain the share reached about 9 per cent in 2008.6 This strongly suggests that the rise of the financial sector’s share of GDP augurs a recession — even if it may be difficult to substantiate, there is sufficient evidence to point to the reasons mentioned above. The notions of extractiveness and inclusiveness in economic systems is relevant here. Looking at the financial sector, it seems odd that a sector whose share of GDP has grown by four or five times in sixty years (for the United States and Britain) is not taxed more heavily. The basic question about taxation of economic and industrial sectors is to ask how much they contribute to economic growth and societal development. The more they keep their wealth inside their own sector, the higher the tax that should be applied.7 The worrying element is not that the financial sector has increased its share of GDP, but that in so doing it has introduced a higher degree of instability and risk, undermining policy efforts to keep the economy at an even keel, while at the same time diverting production factors away from activities that produce “something” to those that merely redistribute income and wealth and enhance inequality. In his General Theory, published in 1936, John Maynard Keynes focused on fiscal policy as a stabilizing tool. He advocated public stimulus when demand in the private sector fell, and public savings when private sector demand was high. What he did not foresee was the role of the financial institutions as destabilizing forces. Looking at the development in the run up to both the Great Depression of the 1930s and the great recession

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that started in 2008, it is quite obvious that in both cases an important contributing factor was a drive towards reckless lending combined with the creation of novel financial instruments not liable to “normal” scrutiny about profitability and collateral. Moreover, as well as being opaque, they were often designed specifically to avoid regulatory restrictions and the rules that ensured such scrutiny. Had central banks, especially the U.S. Federal Reserve System (the Fed), done their jobs properly and implemented a restrictive monetary policy earlier — to make sure financial institutions were doing what they were supposed to do — the world might not have escaped a correction, but the risk of a calamitous global recession would have been smaller. One of the claimed benefits of globalization was that it was supposed to diminish risks. It was assumed that if ten banks got involved in an operation, each one would shoulder ten per cent of the risks. This spreading of the risk would have considerably reduced the costs of any disruption. But it turned out quite differently. It was not ten banks sharing the risks, but all ten banks taking on the full risk — raising the risk to each participant and creating the drastic system-wide risk of a domino effect. Thus, financial institutions have acquired the power and strength to counterbalance fiscal policy by continuing to lend even when the government applies restrictive fiscal policies. The invention and profusion of intricately complex new instruments enables them to circumvent the monetary policies of the central banks. Keynes showed the impotence of pre-1929 policies to smooth out business cycles, and identified fiscal policy as the lever that needed to be pulled. In much the same way today, economists need to come up with policy prescriptions to control liquidity and how it is used by the financial system, in order to prevent future pro-cyclical tendencies in the system. One way to proceed may be to introduce rules for reserves that depend on the distribution of portfolios — with more restrictive rules for more sophisticated financial assets, traded primarily or exclusively between financial institutions and unconnected to productive activities. A second step could be to diversify tax rates using the same criteria. Both policies would make financial institutions more interested in channelling funds into production than in financial activities that simply reshuffle funds. A third way might be to increase demands for solvency according to an index comparing asset prices and consumer prices, such that if a discrepancy appears, institutions are required to augment solvency.

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The main problem seems to be a lack of understanding of how policy can deal with asset price inflation — and, in a possible future context, asset price deflation. Economic theory has worked inside the box of asset management, but never really tried to come up with a theory of how asset prices can destabilize the economy. Central banks have been fixated on consumer price inflation and have believed that everything was all right as long as inflation was under control, without paying much attention to asset prices. Reading statements by the Fed and the European Central Bank (ECB) over the last ten years, it is obvious that they focused on consumer prices, while the really disturbing factor came from asset prices. In the wake of 2008, we can see that this approach was wrong. Asset inflation may be as destabilizing as consumer price inflation, and central banks need to be much more vigilant about it in future monetary policy. Recent research by Jorda, Schularick and Taylor (2014) has revealed hitherto unnoticed behaviour by banks over the course of the twentieth century. Their primary function has gradually moved away from receiving savings from households and lending them to business, stimulating production. Instead they have turned into mortgaging institutions, creating credit-financed property booms. It is easier to give a loan for the purchase of real estate, as the collateral is palpable, while loans for business activities require the bank to do the hard work of evaluating the proposition. These chickens came home to roost. As banks sought an increasing amount of their profits from real estate, they had to sell more mortgages on an increasing amount of property sales. Prices were driven up, at some stage creating an asset boom out of touch with the real economy. For seventeen advanced economies, the ratio of bank lending to GDP rose by 150 per cent. It fluctuated without any clear trend from the beginning of the century to the late 1970s and early 1980s. The share of mortgage lending in the banks’ total lending portfolios roughly doubled over the twentieth century, from 30 per cent to 60 per cent. There are, it should be noted, considerable variations among countries. In the United States, mortgages accounted for 68 per cent of the banks’ portfolios in 2007, in Britain 63 per cent, in Germany 51 per cent, Italy 48 per cent, and France 47 per cent. The analysis also shows that credit booms have important consequences for business-cycle dynamics. The ratio of real estate lending to total lending rose phenomenally in the 1920s, with a similar though somewhat weaker expansion from about 1990 till 2010.

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It is difficult to escape the conclusion that in pursuing their own goal of profitability, the banks have created unsustainable credit levels in relation to the real economy, and channelled it into speculation, fuelling an asset boom. The deepening cleavage between business and society has been tangible for a number of years. Watching this development, I wrote in 2010, The time seems to have come for society and governments to step up and say enough is enough. The business sector cannot choose to live its life outside society, which at the end of the day is what they serve. There is a need for a drastic change of perception among business leaders. While it is good to make a profit, they must realise that the ultimate reason they are in business is to deliver goods and services to people. The trend is clear in the US and clearly visible in Europe. Asia, however, still operates in the traditional mould, where business feels responsibility for developing society and keeps friendly relations with governments. Seen in the perspective of governance and stability, Asia’s great opportunity may be to hold on to this somewhat old-fashioned model. (Moeller 2010)

Michael Porter and Mark A. Kramer (2011) wrote in 2011, “A big part of the problem lies with companies themselves, which remain trapped in an outdated approach to value creation that has emerged over the past few decades. They continue to view value creation narrowly, optimizing shortterm financial performance in a bubble while missing the most important customer needs and ignoring the broader influences that determine their longer-term success.” Corporate governance is primarily an American concept fitted to an economic model looking for and rewarding constant growth in profits. This is not bad. What is bad is that this effort is conceived as only a short-term and “this corporation only” way — excluding long-term effects, external economies in a broad sense, and what is good or bad for society. In a way, this encourages the enterprise system to work in an extractive manner. As long as profits are growing, any detrimental effects on social development are disregarded. The American economy suffers from grave deficiencies, of which its deteriorating infrastructure, education and social costs of running a society are symptomatic. Yet, at the same time, the corporate sector is doing very well indeed. The list of the five hundred biggest global enterprises is dominated by U.S. companies, and will continue to be so

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for the foreseeable future, even if its membership gradually changes to reflect the growing importance of emerging economies. American corporations may engage in philanthropic work, but they do not see themselves as essentially a part of society — dependent on societal development and sharing with society the benefits of their operations on a give-and-take basis. In 2011, of the hundred highest-paid U.S. corporate CEOs, twenty-five took home more in pay than their companies paid in federal income taxes (Klinger et al. 2011; BBC 2011). It is hard to avoid the suspicion that, despite the talk about entrepreneurship and innovation, the management of most businesses are confined to unimaginative, conventional thinking. The focus on profit, and in particular short-term profit, has accelerated this development. At the same time, most management courses devote considerable time to strategy. At first glance it seems an excellent idea to teach systematic management skills to future business leaders. The price, however, is that they all think the same way. This is often described as part of the “level playing field” — meaning that all companies do more or less the same thing. Competition becomes a question about doing the same things slightly better, which means that companies offer the same services to customers and differentiate themselves on marginal differences. Innovative thinking, so vital for creating new products and companies, are not appreciated amongst management, and become less instrumental, and less rewarded, as boards of directors tend to fall back on well-known MBA programmes instead of testing new methods and thinking.8 On those occasions when a business does break the norm, the result is a phenomenal upheaval and turmoil, turning the whole sector upside down. We saw this with Apple a few years ago, when the iPod and then the iPhone upended more than one market. Such a coup becomes increasingly difficult, however, for two reasons. First, newcomers need a huge amount of dedicated capital just to enter the market, in the face of ferocious opposition from the established players. The second is that established companies are reluctant to introduce a whole new product or business model, as the first victim will be their own business — why should they shoot themselves in the foot? A third reason is that up-andcoming companies are much more likely to take the necessary risks, since they have less to lose than established companies. Market leaders, by contrast, have a lot to lose, and are therefore prone to be more cautious

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and to weigh potential opportunities against very real and measurable risks. A different kind of corporate governance is emerging in Asia, and perhaps also in Europe, in which corporations see themselves essentially as a part of society, understanding the long-term consequences of their decisions and recognizing the need to include other objectives, beyond pure profit, in their ambitions (Moeller 2012). In China, an alternative attitude is surfacing, stimulated and encouraged by ancient Chinese cultural norms, ethics and values. In a 2011 article published by the Journal of Management Development, Mike Thompson from China Europe International Business School (CEIBS) lay bare how ancient Chinese values are finding favour as an instrument for turning Chinese business thinking and management away from pure consumerism and the market economy towards societal values (Thompson 2011). The Chinese concept of guanxi refers to an extensive network among people who gain benefits through their connections together. A central element in the concept is trustworthiness among individuals, which rests on the assumption of shared and common values. In such a context there is little use for law, litigation, or even written agreements. People understand each other and act in conformity with their shared expectations, thus ruling out disagreements, misunderstandings or surprises. This makes the management of joint projects easier, and at the same time minimizes transaction costs — management by shared values is much more costeffective than management through control or command. Through the ren-yi concept, profit is accepted on the condition that a high degree of morality, social values and righteousness is respected by the parties, making profit secondary to moral values. Deng Xiaoping said “to be rich is glorious”, but he did not say that it was the sole purpose, nor did he rule out other purposes. In truth, we do not know exactly what he meant, but a close examination of his policies supports the interpretation that he saw “getting rich” as a prerequisite for developing China inside the Communist Party of China (CPC) framework, but not as a goal in itself, nor as a substitute for Chinese socialism. Mike Thompson refers to the Junzi (a person whose humane conduct — ren — makes him a moral exemplar) who, in the words of E.J. Romar (2009), “conceives an organisation to be what it truly is: a community with multiple goals including profit, survival, ethics and meaning for all workers”.

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The CPC unquestionably sees corporate governance as being answerable to itself, and not to the shareholders as in a Western business context. Huawei, the Chinese telecommunication corporation, sees itself as part of the effort to develop China in conformity with the CPC’s goals. Like many other Chinese corporations, Huawei may be listed on the stock market, but catering to the desires of shareholders comes far down its list of priorities. The Chinese perception of corporate governance has very little to do with the Western definition. It is anchored in the idea that corporations serve society by delivering goods and services. Their purpose is not to reward shareholders through profits gained by marketing and pricing decisions defined by the market-economy system. The cornerstone of this philosophy is the preponderance of state-owned enterprises (SOEs). Contrary to the opinion of many Western observers, the share of China’s GDP coming from this sector is approximately onethird of the economy at present, and is not changing fast. The private sector and foreign direct investment are not seen as the bringers of a new epoch or a different enterprise system, but serve primarily as benchmarks, indicating how enterprises in a market-economy system are managed. SOEs can and probably should measure their performance against this yardstick, but it is a mistake to believe that they intend to mimic their objectives and operations. There is no prospect that the centrality of SOEs in policymaking will diminish going forward, or that the share of SOEs in the Chinese economy will fall significantly. It is equally unlikely that, except in its role of serving as a benchmark, the market-economy model will be embraced. It is certainly not seen as the future of China’s enterprise system. The interesting question for the rest of the world is whether this tilt towards societal purposes, instead of purely market-economy profits, will continue to be the platform for developing the Chinese economy. Or, in other words, whether the goal of production in China will be to contribute to societal development and growth, or will it be to generate private profit for the individual enterprise and its owners, as measured by the market economy. It is too early to judge, but if the societal perspective emerges as the central vision for what may already be the world’s largest economy, the whole edifice of the Western economic model — based on Adam Smith’s dictum that the wealth of a nation is the simple aggregation of individual

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wealth — will come crashing down, along with the enterprise model it created. The root of this difference is that American corporations are not only quoted on the stock market, but owned by stockholders, and raise capital through the stock market in competition with many other suitors for investors’ money. Profit, then, is a natural lure for those evaluating different investment opportunities and trying to decide where their money should be placed. In China and most of Asia, corporations are owned either by families or the state. They may be quoted on the stock market, but they are not majority-owned by stockholders. They do not raise their capital through the stock market. Capital comes from the families or the state, both of whom may be more interested in the effect of their operations on society as a whole, rather than on profits per se.

Wrap-Up What may be termed the “holy trinity” — the free market, liberal representative democracy and the nation-state — worked well within a national framework, generating reciprocity through a social contract between the business sector, the public sector and the population. But now, cultural globalization and economic globalization have tilted power sharply towards the business sector. A concentration of money in a very few hands has led to a similar but less obvious concentration of political power. The large corporations operate globally and extend their power on that level. Nation-states that baulk at the prospect of creating political structures at the same level are forced to acquiesce to global corporations and relinquish their power by degrees.9 It has not been possible to establish a similar social contract at the international level, even less so at the global level, leaving the door wide open for abuse of power by the large corporations. They do not want to see themselves in a give-and-take position with the public sector, as their incessant efforts to minimize their tax payments demonstrate. The question then becomes whether rising economic powers such as China and India will be willing and able to shape a new kind of corporate governance — one that emphasizes the idea that, in the final analysis, corporations are there to contribute to society. For what other raison d’être could they have? This point of view by no means rules out their making

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of profits — but the principal objective of business can never be simply to make profit for the owners.

Notes 1. 2. 3. 4. 5.

2008 figures. Wilson Wong Kia Onn drew my attention to tyre manufactures. A deeper analysis can be found in Møller 2010, Chapters 2 and 3. I am grateful to Ho Koi Foong for help in drawing Figures 5.1, 5.2 and 5.3. In 2005, when Greek, Portuguese and Irish bonds were trading at rates barely higher than Germany’s, Connolly’s work at AIG Financial Products persuaded a small group of hedge funds and independent investors to bet on a eurozone breakup. They did so by buying the credit-default swaps of what he saw as the most vulnerable European countries. When fears that those countries would default took off in 2008 and 2009, sending the values of those swaps skyward, they were able to sell — reaping large profits. Source: International Herald Tribune, “Words of a Euro Doomsayer Have New Resonance”, 17 November 2013. 6. Sources for this paragraph: T. Philippon, “The Evolution of the US Financial Industry from 1860 to 2007: Theory and Evidence”, November 2008 ; ; . 7. The discussion about a tax on financial transactions (Tobin tax) reflects this point of view, though it is born out of different considerations. 8. There is a strong similarity for the design of products. It is being carried out by computers — not human beings. Some decades ago, car brands could be distinguished easily; now it is difficult as they all look alike, coming out of the computer, leaving only a few things like door handles to individualization. The same can be seen with websites; access Reuters and Bloomberg and the reader is confronted with exactly the same outline. 9. Only the European Union has made a serious effort to transfer political decisionmaking to the same level as economic transactions, but the Europeans do not seem to fully appreciate that.

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6 Business Model — The Firm

Broadly speaking, the economic theory of the firm says that it is more profitable to conduct all activities under one roof in order to achieve increasing economies of scale and to minimize transaction costs such as transport and logistics. This assumption is being contradicted today by new technology. At the same time, firm ownership is undergoing fundamental changes, which call into question the firm’s role in society.

Ownership Industrialization created enterprises which operated locally, and constituted a bond between owners, citizens and the local community. This belongs to the past. Very few major enterprises operate in a local environment. Blurred ownership means that owners take no interest in local communities. In many cases, those owners are financial or investment funds, looking for a surge in the stock price so they can get out with a quick profit, with no interest in the long-term future of the company they own. The world is moving into a new kind of corporate capitalism — combining a concentration of financial power with comparatively few corporations controlling communication, increasing anonymous ownership, a business

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sector decoupling from the public sector and the population, the breakup of big corporations, and the movement of employment out from large corporations. The expansion of ICTs and globalization have also contributed. This is a model the world has not seen before and does not fully understand. Yet it entails massive social and economic upheavals. The business sector no longer sees much reason for working inside a social contract with the government and the population. On the contrary, it looks upon the government as a cash cow to take over burdens it is unwilling to shoulder itself, and the population as a mass of consumers to be squeezed. One of the principal causes of the global economic crisis was the financial sector’s success in convincing the government and the population that deregulation would stimulate economic activity and bring benefits to all. What happened was something very different. The financial sector used deregulation to undertake high-risk, high-return operations, and reaped the profit without preparing for rainy days. The crisis was largely a result of reckless lending. In the years leading up to the crisis, the financial sector used its earnings to continue enriching itself as rapidly as possible, and had little set aside in prudent investments to cover contingencies. The crisis was a contingency on a massive scale, and the financial institutions turned to the government and the population with their shameless plea of “too big to fail”. In the years prior to the crisis, the financial sector had been on a mergers-and-acquisitions spree which had created an unprecedented concentration of capital in the sector, and this, ironically, made their “too big to fail” claim all the more believable. The financial institutions acted selfishly in transferring the debt to the public sector. They got off the hook and could start to improve their balance sheets in preparation for an economic upturn. The price paid by society — the taxpayers — was that the financial sector’s debt crisis was converted into a government debt crisis. In the United States the deficits on the federal budget rose and, since 2008, the debt as a share of GDP has continued to grow, and is now close to 100 per cent. In Europe the still new and fragile euro came under heavy attack, and for a brief but dangerous time observers doubted whether it would survive, particularly with Greece balancing on the edge of the abyss. Shifting the debt burden to the public sector locked governments into a kind of financial stalemate, with no fiscal room to manoeuvre, and thus no tools available to stimulate their stagnant economies.

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Debt is often regarded as a monetary phenomenon, but it is not. It is a real phenomenon. Debt means that a society has over-consumed in the past relative to what it has produced. Repayment must inevitably take place, and equally inevitably it will take the form of future underconsumption relative to production. The question is, who will have to do the under-consuming? The answer has to be either the creditor or the debtor. If the government chooses to allow inflation to accelerate, the real value of assets goes down — this effectively shifts a portion of the repayment to creditors, who see the purchasing power (or real value) of the returns on their lending fall. If government instead chooses to keep prices stable, then repayment is shifted to debtors. In the United States and the eurozone, the debt trap has meant that an inflation policy could not be implemented, thus maintaining the real value (and prices) of assets and consumption, and putting the burden of under-consumption squarely on the shoulders of debtors. The financial sector had held on to most of their assets in the aftermath of the financial crisis, so the under-consumption was confined to the government and consumers, which is one reason it has been so difficult to achieve growth again in the United States and the eurozone. The business sector often complains about taxes being too high, claiming they are obstacles to investment and entrepreneurial initiatives. It is conveniently forgotten that taxes finance social welfare, and that over several decades tax cuts have been a device by the business sector to shrug off its social responsibility, leaving this more and more to the public sector. Social welfare policies, including unemployment allowances, allowed the business sector to shed workers in bad times without much cost.1 The corporations happily did so to avoid losses or increase their profits. Over the years, chief executives who let go many thousands of workers under the label of cutting “fat” have been rewarded with an almost cultlike status, and been celebrated in management journals and business newspapers. Yet the economic effect on society can be summarized like this: Business sector profit goes up, public expenditure goes up, unemployment goes up. In reality the business sector shifts a large part of the cost of restructuring itself on to the public sector — the taxpayers. This double effort by the business sector — demanding and receiving ever more cuts to their taxes and avoiding those that remain, while at the same time pushing more social costs on to the increasingly depleted public purse — is almost scandalous.

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In some countries, in particular the United States, workers over the years have paid into funds to finance their pensions when retiring. This worked well as long as economic growth was high, the workforce was young with only a small proportion collecting pensions, and the number of years over which a worker could be expected to draw their pension limited. The sums paid into by the workers were at the disposal directly or indirectly of the corporation, which greatly expanded its cash flow. The promise of future pensions was an effective way to keep down wage demands — effectively to defer wage payments — enhancing the firm’s competitiveness. This situation continued for some time, at considerable benefit to the employers, without anyone inquiring too deeply or recognizing it as a potential time bomb. Of course, had the corporations invested the premiums they collected wisely, and calculated future claims against them according to a realistic scenario, such as is merely routine for a life insurer, things might have turned out positively. It might have served as a cornerstone in a social contract, showcasing how a capitalist economy could meet its societal responsibility and build up social welfare — but this did not happen. The workforce grew older, more workers went on pensions, they lived longer and many corporations saw their markets diminish, partly because of the transformation of the economy. They were caught wrong-footed, without the money to redeem their workers’ claims. It looks likely that the same scenario as played out with the financial sector’s debt will eventually take place here. The corporations will admit that they cannot pay. The workers will demand that they be paid. The buck will stop at the desk of the government, which will have little choice but to step in and effectively bail out corporations that have behaved recklessly, once again. Deregulation has opened the door for a change of ownership in some previously publicly owned enterprises, and their sell-off to the private sector. The argument for doing so has always been that the private sector could do the same job better and for a lower cost. Yet there is scant evidence to support this thesis — and indeed some question about how well private ownership has attended to repair, maintenance and future investment in the enterprises it has taken over. What is known, however, is that a typical pattern has included further changes in ownership, from one private company to another, with money diverted from the enterprises into the coffers of the new owners. The constant selling and buying embedded in the shift of ownership makes it

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difficult for observers to get a clear look at the actual business activities being carried out. TeleDanmark was sold in 1997, and between then and 2015 has had four owners. In a sector like telecommunications — where continual long-term planning and investment is essential to success — this does not bode well for the company’s core business. In 2006 TeleDanmark’s equity capital was reduced from DKK 44 billion to DKK 2 billion as the owners decided on a hefty dividend for the stockholders.2 The following figures indicate fundamental shifts in the concentration of capital, who is managing that capital, and who owns the major shares of capital in the largest U.S. corporations:3 • From 1950 to 2012, the market value of all stocks listed on the New York Stock Exchange (NYSE) rose 1,500 per cent from about US$94 billion to more than US$14 trillion. To this should be added another US$4.5 trillion on the NASDAQ market, which did not exist before 1971. • The proportion of U.S. public equities managed by institutions has risen from about 7 or 8 per cent of market capitalization in 1950, to about 67 per cent in 2010. • In 2009, institutional investors owned in the aggregate 73 per cent of the outstanding equity in the thousand largest U.S. corporations. Since U.S. GDP was US$300 billion in 1950 and a little bit above US$15 trillion in 2012, the market value of all stocks has jumped from 31 per cent of GDP to 123 per cent of GDP.4 This signifies an increase in financial power, with more capital generated and channelled into equities. It goes without saying that the way these funds are invested will profoundly affect the economy — and especially the volatility of the economy, and the relationship between the business sector and the government. If the business sector loses interest in a win-win relationship with government, and opts instead for an adversarial one, there is not all that much the government can do about it. The balance of money and power has tilted strongly in favour of the business sector over the last sixty years, and its interest in an active engagement with society as a whole — inter alia in education, and in particular higher education plus fundamental research — has waned. Financial institutions manage more than two thirds of U.S. equities. More American families participate in the capital markets but shy away from managing their investments themselves, instead confiding in the

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expertise of professional fund managers. Some observers would applaud this, saying that the investor — the citizen — will enjoy a higher yield, as professional managers know best. Empirically, this is far from certain. As was revealed in the wake of the financial crisis, at least some funds see their investors not as customers whose interests they need to serve but as naïve sources of money which can be used to benefit the fund — and the fund managers, through bonuses. One of the less offensive complaints is that fund managers recommend frequent rearrangements of the customer’s portfolio — for no other reason than the fund earns extra fees each time. Allegedly, some funds encourage customers to give them full power to make such rearrangements without consulting the investor. It is also conventional thinking that professional fund managers make the financial system more stable, but again this is far from certain. Fund managers are all trained at the same schools — they tend to all think and act the same. In fact, their uniformity makes them far more likely to stoke pro-cyclical developments, following the crowd as the market rushes up or down. Investment apologists will object that if the investor is not satisfied they can transfer their money to another fund. But unless different funds offer their customers a palette of different strategies — which in general they do not — a change can make little difference. Apologists will also point out that the fact of investment funds owning 73 per cent of the outstanding equity in the largest thousand U.S. corporations is actually a good thing — since the funds’ money comes directly or indirectly from citizens. However, this is a mixed blessing at best. Far from representing some kind of people’s capitalism, in fact the people have transferred their ownership and influence over U.S. corporations to the small number of individuals who run the investment funds — often with little accountability, in a sometimes obscure legal environment. The crisscross of ownership, resulting from the same funds holding equities from competing companies, casts a spell of uncertainty over the question of who makes decisions about the allocation of capital, and what they are trying to achieve. The funds will avoid outright collusion, but there are many other ways to manoeuvre in the pursuit of the highest profit — not for the business enterprises they own — but for the funds themselves, avoiding the competition that can eat into profits. It is difficult to know precisely how investment funds exercise influence over the corporations. They may be represented on the board of directors.

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The fund managers are money managers. They do not know much if anything about how to run a corporation — they know how to make it pay, and quickly. It is not part of their training or mindset to manage a corporation from a long-term perspective. Many corporations have adopted a similar short-term attitude — good for the stock price this year or this quarter, but not necessarily good for either the corporation’s long-term prospects, or for society. Planned obsolescence serves an example of this kind of thinking, especially for technology products. Corporations push consumers to replace the gadgets they bought a year or two ago by deliberately putting a ceiling on their performance over time. Another tactic is to market new models every year, with incremental improvements designed to lure consumers to replace their devices, even if they are still performing perfectly. Cell phones are an example. Pointless consumption is thus increased, diverting money into products for which the need is small, or even non-existent, but boosting corporate profits. Scarce resources are used up, with high costs for society, which not only loses those resources but has to pay for the disposal of perfectly good cast-off devices, which frequently contain toxic minerals requiring special treatment. And often this need for special treatment is simply ignored — planting an environmental time bomb in landfills and rubbish dumps.

Theory of the Firm Digitalization overturns the standard theory of the firm. With innovations like cheap processors and cloud computing, it may be cheaper to locate production outside the firm, reducing overhead costs and cutting down on concentrated production facilities, handling only the final assembly in-house. Employees leave the company to work for other firms, or on their own, selling the product to the company. Innovation is outsourced. An unparalleled scaling-down of employees working for companies is taking place, reallocating work to small companies or individuals in the firm’s supply chain. The transformation from mass consumption to mass communication, and from the era of plenty to the era of scarcities, undermines the theory of the firm as we know it. Fundamentally, this theory says that firms have come to exist because it is cheaper and more efficient to produce under one roof than in many different places. The central reasoning is that transaction

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costs go down. This theory suited the age of industrialization with the large assembly line, and the technological and managerial thinking that grew out of it. There are four fundamental changes driving this process. The first fundamental change is that the old-fashioned product no longer exists. Formerly, a corporation manufactured a tangible product and marketed it without much accompanying services, except simple maintenance. Production, marketing and after-service were dominated by silo thinking. The product was in focus. The corporation was in business to produce and sell this particular product. Gradually, processor chips and computer power transformed this picture, enabling technological gadgetry to be added to the product and enhance its function. Nowadays it is almost the other way around. The tangible product is designed around the technology determining the performance level of the product. For a corporation there are three core notions. Its core business is what the corporation makes; it is good at producing this particular product. Core value added is the reason customers should prefer the corporation’s product over that of its competitors. The core message is the understanding conveyed to customers and staff — and maybe also to competitors — about the corporation’s cultural values, and what it stands for. During the industrial age the core business was at the centre of corporate management’s thinking. It was all about manufacturing; making stuff. The emergence of ICT introduced new perspectives. It shifted the emphasis from the core business to a combination of core value added and core message. The accompanying services — the chip and computing power — is what gives the product value in the eyes of the consumer, because this “software” determines how much the consumer can get out of the product, “the hardware”. Without constant upgrading of the software — and even more importantly, without the constant training of staff to impart the right skills — the product underperforms, irrespective of how good the “hardware” is. Therefore, it is correct to talk about a product concept perceived as the overall ability to meet the customer’s demand — or rather, the underlying demand. Take, for example, a corporation that used to produce water pumps. In the industrial age it was focused on its core business. It manufactured, sold and delivered pumps. As its focus changes to the combination of core value added and core message, the corporation no longer sells pumps —

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it delivers a total solution to the management of the water supply. The pump becomes just one part of a long chain of services, some of which are tangible (like the pump) and many of which are not (like the installation and operation of computers to measure and control water flows and conserve the use of water). On the production side, transaction costs fall when the company’s activities are no longer confined to a manufacturing process and a considerable part of its inputs come from “intangibles”, such as computer power, which does not need to be developed in the same location as the manufacturing. The second fundamental change concerns employees. ICT has introduced new relationships between employees and employers, and between employees and the production process — what is termed cloud job functions. The functions are still performed, but not necessarily by staff under the same roof or within the same company. With the almost cost-free transfer of information and knowledge, there is no longer any incentive to bring workers together, with all the costs that entails — overhead costs for the corporation, and transport and travel time for the workers. It becomes more efficient to let staff do their work at home and use ICT to bring it where it is needed. This trend will be enhanced by 3D technology, Industrie 4.0, the Industrial Internet Consortium (IIC), and similar industrial initiatives, undermining the need for bringing workers together. From the point of view of the staff, there is little incentive to stay employed by the firm under such conditions. It may be more lucrative to establish themselves as freelance workers, or to create a small company and to offer their “production” services to their former employer and its competitors. They can capitalize on their skills to perform and deliver certain categories of goods and services. When companies layoff large numbers of staff, observers take it for granted that these workers leave the labour market, but it is far from that simple. Many of them continue to work in another capacity, including some of them, as mentioned, as independent operators. In the statistics, employment may go down and unemployment may go up, but if measured by how many people continue to do similar functions outside the firm after the layoff, the picture might be quite different. The U.S. participation rate (share of the working-age population working or actively seeking jobs) has fallen over the last fifteen years. There are unquestionably many

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explanations for that phenomenon, including that people despair of getting a job and leave the labour market. Another one, not mentioned so often, is that some of the people losing their jobs react as described above, which means that they do not count in the statistics anymore, although they are still performing the same or a similar work function as before. Sharing and renting businesses extend this fragmentation of large corporations, while illustrating the shift to even greater concentrations of capital — highlighting the paradox of corporations employing fewer people with more capital. Uber is valued at about US$60 billion, while “employing” only a handful of people. There is no longer any of the traditional common interest between the “employer” — Uber — and those who “work for” the company. The whole edifice of social and economic structures surrounding the firm crumbles. The firm disengages from any other obligation towards those who “work for” it beyond a financial contract. The “employee” disengages from any kind of duties other than respect for certain criteria for qualification and operations. They work for the firm when they want to, and if it suits them they do it part-time, possibly combining it with similar activities for another company. They come and go, with no costs for them or for the firm. The drivers perform their task through a combination of skills and ICT-enabled communication. Manual work is disappearing, and it was those that provided economies of scale and diminished transaction costs when they were combined under a single roof. Skilled work does not require an assembly line. Human contact may be good for us, but the worker can find it elsewhere, and it is not certain that human contact inside the firm is of the best quality. Communication makes it possible to channel the output of skills to where it is needed. The third fundamental change is the outsourcing of innovation. Large corporations used to have their own R&D department taking care of all innovation for the firm and located within the firm. The costs of this were high for a number of reasons. Research staff are expensive, and neither the supply nor the demand for innovation can be assumed to be constant, and may sometimes move in opposite directions. It is very difficult to optimize the size of R&D teams, and some of the results were of doubtful value for the firm. Today’s firms have access to a much deeper and broader mass of talent. The firm’s own R&D department is dominated by researchers hired

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over a number of years, with certain specific skills. That is good in many respects. But if the firm is looking for alternative methods or a completely new departure, it may find that the existing staff, hired for their skills and steeped in the company’s culture, are unable to deliver. The escalating legal battles over patents, with patent trolls speculating in the control and resale value of patents, have complicated the picture. R&D-intensive corporations have been forced to beef up their legal capacity, either to protect their own patents or to get access to patents filed by other corporations. Unless their own core activities are at stake, where the firm cannot and will not run any risks, many firms are more than willing to enter into the open market for innovations developed elsewhere, and even to announce the areas they are interested in and in which they will entertain offers. Research institutions, corporations and private individuals thus have an incentive to enter the open market — with the result that a firm’s internal R&D department loses business, and eventually funding. The fourth fundamental change is decentralization, driven not only by ICT, but by sustainable energy as well. Firms are becoming less energy intensive — which in itself reduces the weight of transaction costs, some of which were a result of the need to transport goods around the production plant. The smaller and closer together the component aspects of the production process are, the less transport is needed, and the less energy is consumed, with a consequential cost reduction. Sustainable energy is in most cases a decentralized energy supply, making it cheaper to produce in many different locations — and even more so when the energy is needed primarily for services and the supply of programming and information to the company. These four fundamental changes increasingly confront all large corporations. They will be forced to respond to the logic inherent in the changes, and to the competitive pressure to remain productive. The corporation’s current tendency — towards concentration of capital, anonymous ownership, neglect of its social contract with the government and the public — is exactly the opposite of what needs to be done. If this trend persists, corporations will alienate its productive workers (whether inside or outside the corporation), and the firm, as a well-established notion, will undergo tumultuous upheavals.

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The corporation has the opportunity to move into the vacuum created by the nation-state’s gradual abdication of its role as the sole social service provider, and to use shared values as the glue that will keep staff, whether inside or outside the firm, together under a group identity. If handled in the right way, those selling their products to the firm — cloud job functions — and those outside the firm engaged in R&D can still share in the same sense of belonging. The core message is that they are no longer staff or workers; they are part of the firm, and should feel they are better off inside this value-defined circle of production than outside it. The firm needs to lower power distance by attacking and steadily removing hierarchical structures. The firm, and the workers linked to the firm, must understand that the thread keeping their loose relationship together is not only that they become better off, but that they share a mutual recognition of responsibilities, duties and rights. It is not a free ride. Globalization offers an opportunity to build transnational firms on this concept of shared values — as is in fact the case with some companies such as Google, where the staff reportedly feel that they work there because they want to work there, and not just because they need the money. In a fluid world, with so many people baffled and perplexed by rapid and unsettling change, the firm has a shining opportunity to transform itself from just a place where people work to a community where people come together not only for economic well-being but to express and enjoy their common human values. It will be a much looser structure than what we are used to, and production will take place not under one roof but outside, and often far outside the corporation, in thousands of different places, but held together by information and communication technology. The firm must realize that the first step in this direction is not by staking its reputation on fancy ideas about corporate social responsibility, but by entering into a genuine social contract with governments and populations, sharing benefits in a give-and-take policy with its other two partners.

Wrap-Up The severance of owners from workers has cut the sense of mutual interest between these two social and economic groups. An increasing share of economic life is controlled by obscure funds. The consequence is that the

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firm’s role as service provider has been eroded and the workforce is losing loyalty and motivation. A number of factors break down the traditional incentives for establishing firms and minimizing transaction costs. The workforce falls almost dramatically, with most of the work being done outside the firm. This, however, presents an opportunity for corporations to build a different and looser, but values-based, relationship with those working for the firm, even though they are not necessarily working inside the firm. Many of the challenges to the political system can also be seen when analysing the firm, but the opportunities firms have to tap into new technologies, and to link the changed workforce to its broader corporate culture, seem at first glance better than the ones political systems have to establish new links with their electorates.

Notes 1. In some European countries this has proved more difficult, as legislation or rules “protected” the workforce, imposing a financial burden on corporations who aimed to reduce their workforces. 2. . 3. Luis A. Aguilar, “Institutional Investors: Power and Responsibilities”. Speech made at Georgia State University, 19 April 2013, U.S. Securities and Exchange Commission . 4. Nominal prices.

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III Economics

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7 The Transition

No economic model lasts forever. Industrialization served the world for more than two hundred years, but is now crumbling — by faster and cheaper communications and growing resource scarcities.

Key Concepts The object of economics is to satisfy human needs, to make people happy. Increasingly, mass communication is replacing mass consumption as the main vehicle in this search for “happiness”. The availability of resources dictates production processes. From the beginning of the industrial revolution to the year 2000, the international terms of trade favoured resource-importing countries. Since then the trend has reversed, foreshadowing an era of economic or possibly physical scarcity. A transition in economics occurs when the conditions underlying economic transactions force fundamental changes in the economic behaviour of companies, individuals and the public sector. It is not important whether these conditions are economic, technological or cultural — what matters is that they change economic behaviour. Economic operators and decisionmakers start to do things they did not do before, and the things they were doing before, they now do differently.

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The industrial revolution was itself such a transition — going far beyond just economics — constituting a paradigm shift as defined by Kuhn (1970). Basically, economic operators replaced manpower with steam engines. About a hundred years later, electricity triggered a new transformation, as did the motor car. Around 1950, the first signs of an audio-visual revolution became visible, initiating new methods of communication. Economists have jumped at the opportunity to explain why, when and where these revolutions happened. Explanations based on interactions between technology, societal norms and the organization of societies takes us some of the way.1 To this must be added the size of the market as a driver. Britain could not rely on the British Isles solely, and was forced by economics to build an empire. The United States had a larger market than Germany, which enabled it to make itself Britain’s successor. At the beginning of the twenty-first century, two new transitions loom ahead of us, promising opportunities, risks, and even dangers. The first of these is the transition from mass consumption to mass communication, turning on the most basic question of all — what constitutes human happiness or well-being? What makes human beings feel comfortable and at ease? The second transition is that the age of plenty — dating from the dawn of the industrial revolution to the beginning of the twenty-first century, when broadly speaking there was enough of everything — is coming to an end. Scarcities — physical, economic or man-made, as in the case of our once-clean environment — will increasingly limit the resources available to global production and force producers to conserve resources and to consume less.

The Transition — From Mass Consumption to Mass Communication Information and communication technology is the most illustrative example of a new technology that changes how people think, act and behave. The crucial factor is not the technology itself, but how it is applied. Open communication and trust help to benefit the whole society. Productivity is enhanced, bringing cheaper production processes and expanded consumption. No society — whether developed, emerging or poor — can prevent this wind of change from blowing traditional patterns of behaviour away.

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Mass communication has taken over from mass consumption as the driver for growth, while at the same time changing the whole idea of growth — material consumption is resource intensive, communication less so. The mentality of material consumption is different from that of mass communication. The production process has to incorporate not only knowledge but also the dissemination of knowledge. Mass communication has exploded around the world thanks to the spread of both new devices and new ideas about how to use them. The crucial technology is mobile communication, allowing human beings to communicate with anybody, anytime, anywhere about anything — in text and images, audio and video. In China there is approximately one cell phone per person, and the number is still rising. More than 600 million people use the Internet, the majority accessing it through mobile networks. India has about 900 million cell phones, but lags behind China in Internet access. All over the globe, developing or even poor nation-states are catching up to the richer countries in communications. Mass communication among machines is just as important. In 2012, IBM’s chairman Samuel J. Palmisanto explained: We’re all aware of the approximately two billion people now on the Internet. This number is growing rapidly in every part of the world, thanks to the explosion of mobile technology. But there are also upwards of a trillion interconnected and intelligent objects and organisms — what some call the Internet of Things. There are a billion transistors today for every human being on the planet. Intelligence is now embedded in the systems that enable services to be delivered … physical goods to be made and sold … everything from people and freight to oil, water and electrons to move … and billions of people to work and live. All of this is generating vast stores of information. It is estimated that there will be 44 times as much data generated over the next decade, reaching 35 zettabytes2 in 2020. And thanks to advanced computation and analytics, we can now make sense of that data in something like real time. This enables very different kinds of insight, foresight and decision making. (Palmisanto 2012)

This opens the door to Big Data analysis — managing all the data available, for a specific purpose and a particular client or user. The data is the same,

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but the analysis is customized to the purpose. Judged by what we have seen over the preceding decades, it is only a matter of time before the use of this modelling becomes routine (Weinberger 2011). A number of multinationals (GE, Alcoa, Danone, Diageo, and Nestle) use it already to adjust their planning for different degrees of water shortage — feeding the analysis “backwards” into their production models, procurement systems and supply chain to adjust their economic and technical parameters accordingly. The most important question is how this combination of communication among people and communication among machines, on an almost unimaginable scale, will — or will not — stimulate economic growth and social development. Figures published by Clancy (2011) show that Japan is the undisputed world leader for R&D, measured by expenditure as a share of GDP and by the number of scientists and engineers. One would expect this to lead to a flood of innovations and new products pouring out of Japan — but nothing of that kind has happened. I would suggest that the reason for this is a lack of openness in Japanese corporate culture, and an unwillingness to share knowledge. This constrains the ability to move research forward into new products — a process that requires imagination, creativity, risk-taking and other characteristics found far more readily in the open market than in a corporate headquarters. The decisive importance of social structure as the fuel for innovation is borne out by the ranking of the most innovative countries, as published by INSEAD-WIPO-Cornell University (2015), covering 141 countries studied. The top ten are Switzerland, the United Kingdom, Sweden, the Netherlands, the United States, Finland, Singapore, Ireland, Luxembourg and Denmark. Hong Kong SAR ranks at 11, Korea 14, Japan 19, China 29, and India 89. Even more interesting is what the report (Lanvin 2013)3 says about how they got there: “The reason why these countries have emerged as the upcoming future champions of innovation is basically they are focused on three main pillars of innovation: They have generally fostered education, they have attracted talents and created talents for innovation; second they have also nurtured the climate of investment around innovation, they have created a culture of venture and risk capital which has helped local investors; and last but not least they have also built strong and dynamic structures of innovation, that is the institutional part of it which should not be neglected.”

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The report tries to produce an efficiency index, which is quite surprising and probably should be taken with some reservation. The top ten in order are Angola, Switzerland, Luxembourg, Iceland, China, Moldova, Malta, the Netherlands, Vietnam and Cote d’Ivoire. In terms of innovation quality — as measured by university performance, the reach of scholarly articles, and the international dimension of patent applications — the United States holds the top place within the high-income group, followed by the United Kingdom, Japan, Germany and Switzerland. Top scoring middle-income economies are narrowing the gap on innovation quality: China leads this group, followed by Brazil and India, fuelled by an improvement in the quality of their higher-education institutions. Classified according to R&D as a share of GDP,4 the report’s top ten innovative countries do fare well, but not particularly so. Switzerland is number 9, Sweden number 4, the United Kingdom and the Netherlands are outside the top ten, the United States is number 6, Finland is number 5, Singapore is number 9, Denmark is number 7, and neither Hong Kong nor Ireland are on the list. Money can help, yes, but money alone cannot buy innovation. Much more is needed. Bringing in the list of the world’s most innovative companies 5 (Gregersen and Dyer 2013) consolidates this observation. The top fifteen come from the United States (with 7), China (2), Japan (2) and the United Kingdom, Brazil and Denmark, each with one. These companies do not display much in the way of size or economic power, though they may be dominant in their respective markets. Not surprisingly, innovation is linked to encouragement from top management, instigating ideas and new ways to do things, rather than trying to institutionalize innovation as a profit centre. They also avoid making the company’s innovativeness dependent on one or a few people — an approach that may be highly productive in the short run, but discourages the rest of the staff from being “creative”. A company culture of thinking “new” or “differently” seems to explain why many of those companies prosper with a continuous string of new products. Boston Consulting Group (2015) drew similar conclusions in 2015, with a world ranking of the top fifty innovative companies. The list includes 29 from the United States, 11 from Europe and 10 from Asia (3 from China and 1 from India). Acemoglu and Robinson (2012) point to the political system as the determining factor for success or failure of nations, saying “An inclusive

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political system allows for an inclusive economic system with incentives for people to acquire skills, work hard, save, invest, and innovate. An extractive political system benefits a small elite leading to an extractive economic system.” And, “Inclusive economic institutions that enforce property rights, create a level playing field, and encourage investments in new technologies and skills are more conducive to economic growth than extractive economic institutions that are structured to extract resources from the many by the few.” The same analysis can be applied to access to ICT. A low degree of access to information works extractively, reserving the benefits for those already in possession of knowledge. A large pool of information and knowledge remains dormant. The patent system serves as an example. Countries with a high share of patents — filed by institutions uninterested in using them or putting them at the disposal of others — sits on a pile of knowledge which is potentially useful, but in reality is sterilized. The United States has seen a whole industry grow up around “dormant” patents, as companies buy patents from owners who are not interested in using them because they do not fit into their business or may be too costly to turn into saleable products. At first this may sound like a flexible market-based solution to an inefficiency. But the problem is that these “patent trolls” are no more interested in developing the innovation than the owners; they pursue profit by piling fees of various kinds and profits on top of the price companies have to pay. The result is a loss to the U.S. economy calculated at US$29 billion in 2011 (BBC 2012) — equal to approximately 10 per cent of total expenditure on R&D. This “industry” functions as a levy not only on R&D but on its application in sectors outside the one in which it was developed. In other words, it is a levy on the mobility of knowledge. Despite these abuses and distortions, knowledge works as a stimulant for growth. Du Rausas et al. (2011) analyse thirteen countries and concludes that the Internet contributes 3.4 per cent of GDP. The technology sector benefits from this income, of course, but the majority (75 per cent) goes to traditional industries who see their productivity rise through the use of the Net. A World Bank study supports and extends these findings (Mohsen Khalil, Dongier and Qiang 2009). Analysing 120 countries, the study concludes that for every 10 percentage points increase in the penetration of broadband services, economic growth rises by 1.3 percentage points. This

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effect is more significant for developing countries than for developed ones. The study measures this value differential by comparing the percentage growth in GDP gained by developing economies to that gained by developed countries, resulting from a 10 per cent growth in specific types of ITC. Thus, the development of broadband raises GDP by 1.38 percentage points in developing economies, compared to 1.21 for developed countries; the Internet 1.12 for developing versus 0.77 for developed; mobile phones 0.81 versus 0.60, and fixed lines 0.73 percentage points for developing countries compared to 0.43 for developed economies. Knowledge is emerging as the most important element of productivity, in its traditional definition. These studies also give evidence to the common sense observation that more of the benefits of technological advancements accrue to less technology-intensive industries. Successful societies must follow the model of inclusiveness in the extension and use of technology, and avoid the extraction model. Growth depends on openness and policies that promote the free flow of information and knowledge, and remove barriers, whether of a fiscal or regulatory character. Knowledge sharing is the ultimate condition for reaping the benefits of R&D. Manyika et al. (2013) examine the degree of openness of information in the industries of forty countries6 and conclude that economic activity worth US$3.2 trillion to US$5.4 trillion (representing about 25 per cent of total U.S. GDP) could be stimulated by unlocking the data in seven domains: education, transportation, consumer products, electricity, oil and gas, healthcare, and consumer finance. The willingness to share information is less of an economic phenomenon than it is a question of social fabric and social structure. Economic incentives may work and may be a necessary strategy, but they will only be effective to the degree that social structures facilitate them in this task, removing barriers instead of raising or tolerating them. The key ingredient is essentially cultural — an attitude of mutual trust and confidence that pushes people to work in groups together, in a framework of shared and common values. The impact of technology on society and the economy depends more on how it is applied than the technology itself — and it is applied by people, whose social and cultural predispositions will incline them either to seek solutions together, or else to hoard knowledge and limit its mobility and, ultimately, the spread and degree of its application.

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Education and training becomes pivotal. Put a non-trained person behind a PC and not much will come out of it. Choose instead a person trained to use the PC and productivity will rise. A cost analysis for a manufactured product — a car — is not difficult, bringing together the use of various production factors such as land, labour and capital, including human capital. These costs are borne by the company, and show up on its books. But economics has great difficulty analysing the cost of production of knowledge and information. Some of the initial costs can be readily identified, such as investments in labs or computers. But the cost and value of indispensable factors like brainpower, ingenuity and the ability to combine ideas, and how they all relate to education, eludes economics. Furthermore, the costs of getting an individual or a researcher to the point where he or she can produce knowledge and innovation are primarily shouldered by the public sector. For many companies the costs are negligible. Knowledge and ideas do not need repair or maintenance in the economic sense of these concepts. They can be used again and again and, unlike normal production factors, they get better and more efficient the more they are used. Their impact on productivity depends to a larger extent on how many users there are, as communication between economic operators enhances productivity. People actually enjoy producing knowledge, and even more they enjoy sharing their new knowledge and putting it at the disposal of other people. Gaining insight excites us, and passing it on to others makes us proud. Economically, it may almost be said that the cost of producing a large part of new knowledge and ideas (as opposed to new products) is close to nil — and may even be negative — because such production is driven by the innate human drive for “happiness”. Information should in principle be a free good, but it is turned into a commercial product when companies gain control over its dissemination. A strange kind of symbiosis — driven in part by the public sector’s incentive to look for tax revenue — allows private companies to erect barriers to the dissemination and transformation of knowledge, which explains the price, sometimes high, for getting access to what in reality should be freely available. The consumers know this, and they react by trying to escape the tollbooths of information — the prices, levies, taxes or custom duties imposed upon them by the business sector and the public sector.

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Another repercussion on economics is that transparency and access to information changes consumer behaviour. Formerly, if people needed transportation, they would buy a car. Now more and more people prefer to rent a car for those periods when they need transport. Why buy a car if one only needs it for minutes in the morning one way and forty-five minutes in the evening the other way? If people have access to a product when and as they actually need it, they will be less inclined to own it, and they will use it more efficiently, at least on an individual basis.

The Transition — From the Era of Plenty to the Era of Scarcities Food, commodities, energy, water and a clean environment are all becoming scarce goods. People are willing to pay a rising price for not giving up what they have — most visible in the endeavours to achieve a clean environment. The world has heard talk of scarcities before, but now they are actually here. Not for the first or last time, a “doomsday” scenario is being rolled out. The differences between current and previous warnings are manifold: physical and economic scarcities are visible in the statistics; there are not one or two, but several scarcities; they interlink with each other, making any solution complex; and elements of previous solutions, in particular technology and the opening up of new territories, cannot be counted upon again. The United Nations Organisation for Food and Agriculture (FAO) (2006) does not predict malnutrition in the future, but lays out evidence of undernourishment now in forty countries. They call for an increase in food production to 2030 of 40 per cent to maintain the status quo — unsatisfactory as it is. Commodity price indexes remain high even as global growth has dipped, which according to experiences should lead to a fall. Over the twentieth century, commodity prices halved — a shift in terms of trade that favoured manufacturing nations. This is no longer the case. According to the Reserve Bank of Australia’s index of commodity prices (2016) — measured in Special Drawing Rights (SDR), with the 2011/12 average set at 100 — commodity prices rose from about 30 in 1989 to 60 in 2007 and more than 110 in 2010, and fluctuated thereafter, though never falling below any figure recorded by the index before 2007.

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The Veil of Circumstance Figure 7.1 RBA Index of Commodity Prices

Source: Reserve Bank of Australia.

Oil prices display the same phenomenon. The breakthrough in shale gas helps, but does not eliminate the scarcity, and has not really depressed energy prices worldwide. A string of analyses produced by various organizations and oil companies points unequivocally to demand remaining strong enough to keep the oil price at a high level.7 A large part of the globe suffers from physical or economic water shortage. According to the UN, approximately 1.2 billion people (nearly a fifth of the world’s population) live in areas of physical water scarcity, and another 500 million are approaching this situation. Assuming that no water productivity gains are made in the meantime, the 2030 Water Resources Group estimate that total global demand will jump from the current 4,500 billion cubic metres to 6,900 billion cubic metres by 2030. The World Bank (2007) put the overall cost of China’s water crisis at 1 per cent of its GDP in 2007. According to The Economist (12 October 2013), this figure has since been raised to 2.3 per cent. A clean environment is fast turning into something precious that people want to pay for. At the least it has pushed economics into unknown

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territory as researchers seek to discover what people are ready to pay for the benefit of not having a clean environment taken away from them. This is an area economics has never really considered in the context of consumer behaviour and various forms of price/income elasticity. Established economic theory does not deliver explanations for or solutions to these problems. Economists attempt to apply models based on traditional expectations of growth, with the unsurprising result that the policy recommendations they put forward do not work. The approaches taken to the issue of scarcities reflect conflicting perceptions about space, religion and cultural behaviour. It is no wonder that countries like the United States may in some cases be in the forefront of environmental thinking — but that the American business model still functions under the happy assumption that there is plenty of everything. In a resource-rich nation-state, the idea that resources should be classified as scarce is not easily assimilated. Add to that the American experience of cities distributed over a vast geographical area, and the awareness of scarcities all but vanishes. China, India, Japan and Europe have a different approach, having lived for centuries without easy access to resources, and in crowded cities with houses and people close together. Scarcities change even the most basic economic concepts, such as the production function, consumption, the notion of work. They also open the door to rethinking the tax system — revenue hitherto classified as the tax base may be repurposed as a resource-saving system.

The Transition — The Common Denominator of Mass Communication and Scarcities Mass communication — striving to benefit from knowledge through sharing it — and scarcities — burden-sharing instead of benefit-sharing — drive people towards groups and group behaviour based on values they hold in common. The new worldview based on groups and values takes form. Mass communication and scarcities converge to form a new and different kind of social thinking, breaking with 250 years of earlier thought dominated by the industrial revolution. Economic incentives will change. They will be less important for individual behaviour and business strategy. This recognition guides us

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towards a new kind of economic thinking, and new prescriptions for economic policies. Economics primarily is about human behaviour, and in a world where values grow in relative importance, mere economic incentives will no longer be sufficient to explain social behaviour. The increasing complexity of human behaviour calls for an interdisciplinary and intersectoral approach. Several disciplines must be amalgamated (psychology, sociology, anthropology) and incorporated into the analysis. They may do more than economics to explain human behaviour. It is a dead end to separate disciplines in the social sciences: we need to draw from the best insights and perspectives available from a range of social science disciplines. Group behaviour challenges and conditions both mass communication and scarcities. People will only share knowledge with others if others share their knowledge. People will only accept burden-sharing if they are convinced that it is fair and equitable. To achieve this understanding, people must work inside groups anchored in common and shared values. Values take over as the driving force, directing the ways in which people connect with each other, which rules describe how they interact, how societies can be governed, and which economic activities will be undertaken, as well as how the benefits will be distributed and the burdens shared. An illustration of how mass communication (information and communication technology) and the scarcity factor combine to form a new business model is found in Uber. Without digitalization, this kind of business would be unthinkable. The driver and the customer need to be registered via computer networks, and payment operates via similar technology. Compared to traditional taxi services, there is a tangible saving of resources. As a result, people pay to use a car only when it is needed — this is less capital-intensive production. Transport is more energy-efficient, needing less petrol and less maintenance per person. The supply of these transport services is less capital-intensive and more labour-intensive than normal taxi services. There can be little doubt that analogous models combining digitalization and resource savings will be applied in other areas, with a huge impact on the economy.

Wrap-Up Two strong historical forces — ICT and scarcities — will force major political and economic changes. The key will be the replacement of incentives by

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explicit rules and regulations. This is in conformity with values and groups taking over as the driving factors in decision-making. It may not be politically correct, but it is nevertheless true that cyberspace and its vast information flows call for some kind of reaction. The ability to reach out to millions of people, and to start a cascade effect without any kind of responsibility or mechanism of accountability, is not sustainable. False statements and fabricated stories are planted and believed. The authorities do not really count anymore against this tsunami. There are signs that groups of people are trying to take it upon themselves to counter these abuses, but what will their authority be? Add to this the technical problem of building and maintaining networks in the future, and some kind of control or regulation appears necessary. Scarcities cannot be dealt with in a free market environment — even in theory — because the price mechanism counteracts or thwarts any long-term consequences. The only policy instrument available looks to be a kind of regulatory economics with quota systems. This has long been the case with several EU policies, inter alia the Common Fisheries Policy — where they have worked reasonably well — and policies to reduce carbon dioxide emissions on a global level, where they have worked less well.

Notes 1. 2. 3. 4. 5. 6. 7.

I have written about this interaction in earlier books, in particular in How Asia Can Shape the World (Møller 2011). A zettabyte is a one followed by twenty-one zeros. The full report is available at . See the Wikipedia entry at . The full list is available at . The release of information by governments and private institutions and the sharing of private data to enable insights across industries. U.S. government’s Energy Agency Administration and OECD’s International Energy Agency.

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8 Change in Economics

The transition brings along fundamental changes in virtually all economic reasoning, relationships and models. The whole panoply of economics and its tools, primarily in the form of models, are based on reading and interpreting behaviour. When that behaviour is fundamentally changing — and this transition inevitably means changing behaviour — the validity of tools and techniques based on earlier forms is certainly questionable.

8.1  Consumption Function Private consumption is no longer the driver of the global economy as it was before the global financial crisis. As the global economy grows, albeit more slowly, consumption goes up in absolute figures, but not as a share of GDP in the major economies. There are no signs of a reversal of that trend — on the contrary. Changing patterns of usage of durable consumer goods, such as cars — in view of resource scarcities and efforts to reduce pollution and stop global warming — reinforce the consumer’s tepid attitude towards materialistic consumption. A swing towards non-materialistic consumption, and an emphasis on “what is good for society”, is detectable. Private consumption has long been the engine of growth for the global economy — especially with U.S. private consumption gobbling up around

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70 per cent of U.S. GDP. The worrying factor from a growth perspective is that the chances of the consumer in other countries being able to replace the U.S. consumer in this role are not good. On the contrary, a number of elements point to lower or at least flat consumption, as a share of GDP. Current consumption is not living up to expectations, which explains why global growth keeps falling, now running at 3 to 3.5 per cent instead of the 4.5 per cent rate of a decade ago. Behavioural trends, annoyingly persistent, vindicate this assertion, but these are rarely emphasized by economists, mired as they are in mainstream economic theories and prejudices. They generally ignore factors outside economics, and if they do notice them, they brush them aside as irrelevant. In the 1930s, John Maynard Keynes singled out consumption as the core of economics. Before Keynes, the classical school of economics maintained that the economy was controlled by production capacity, or the supply side. The Keynesian revolution turned to the capacity and willingness of people to consume, the demand side, as an explanation for the business cycle. Demographics are a major culprit. At the time Keynes developed his thesis, the life expectancy for a British male was 60 — and just over 40 worldwide. Today, life expectancy for the global population is 71. The pension age, however, has hardly budged for decades in most countries — standing near 60 to 65. Better health services offer more workers the prospect of fitness during retirement. But in Keynes’s era, people preferred immediate consumption, because they did not expect to have an active life, lasting a decade or two, after retirement. Acting quite rationally, they consumed before retirement, and before they expected to pass away. If asked to postpone consumption and save instead, they wanted compensation in the form of interest. Now it is the other way round. People save to be able to consume after retirement, when they anticipate more leisure time and higher health expenses. Diminished expectations of future welfare benefits reinforce the hike in the savings rate. People fear poverty during old age. They are aware that public finances are under stress, particularly in Europe, and that private pension schemes, mainly in the United States, are inadequate. The combined result is a higher savings rate and a lower propensity to consume. Some will have long retirements: Women generally can expect to live longer, with more years in retirement; due to reforms and adjustments, official ages for retirement vary in China (ages 50 to 55), India (55 to 58), the United States (65 to 67) and France (65 to 67).1

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The Veil of Circumstance Figure 8.1 Life Expectancy and Starting Pension Age: Men, Selected Countries

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