Renewal: keeping the rich world wealthy

Renewal: keeping the rich world wealthy.

Abstract

The tide of wealth in the currently rich world has tended to raise all boats, and an aristocracy of birth has established a sense of entitlement for itself. It is very clear that competitive forces will not respect this.

This paper considers two aspects of the necessary adaptation to these forces. First, the implications for those poorly prepared to compete of the required adjustments by the current industrial powers. There are few policy solutions that preserve the status quo for this cadre: essentially, isolation, subsidy or economic renewal, The first two of these are incompatible with the legacy of the sovereign debt crisis and also with latent demographic change.

Second, the kinds of renewal that favour the current industrial nations have specific requirements of the social and regulatory backdrop. These requirements are explored, showing that required skill base is far removed from the aspirations of current systems of education. The analysis is primarily diagnostic, although some points of attack are broadly defined.

High wages and poor skills: an unhappy combination

In formal economic rationality, what an economic agent earns is related both to the value that they add and to their rarity. When scarcity is not an issue, the capacity to add value should be closely related to net income. If a German car worker is to earn thirty times as much as their industrialising world-equivalent, then – in strict rationality if not in fact - they need to be thirty times as productive. Otherwise, in an open world, their income will fall (or their jobs will migrate) to bring production costs into equilibrium.

Differences in capital efficiency, protectionism and subsidy have all played roles in making sure that this has not - so far! - come about in daily life. However, none of these defences appear to be practical for the medium term.

Capital has been used in ways that are either more effective than in low wage countries, or which are simply impossible for them. Much of this form of defence has been linked to the use of technology, and particularly to "organisational" technologies, such as supply chain management and the associated quality and working capital management. Today, however, low wage economies have the advantage of being able to replicate best practice in such issues, in effect leap-frogging over the rather older and less streamlines capacity that led the way a decade or so ago. It is hard for France, for example, to use an amount of capital more effectively than Taiwan whilst pursuing identical goals. It is, usually, possible to invest more effectively than India or Indonesia, but that situation will nor persist indefinitely.

Protectionism and subsidy have affected (but not much benefited) many industries, notably primary production such as agriculture, often in proportion to their exposure to low wage production centres. These measures have been adopted as populist responses to local pressures – for example, US 'earmarked' clauses in Federal bills that afford protection to local industries at the behest of their elected representative – or they are understood to be "transitional", helping regions or industries adjust to changing circumstances.

Such transitional protection tends to be durable. Protected industries do not adapt, and are often given protection in return for deliberate labour inefficiencies: "job creation". The consequences are higher costs for everyone who lives behind the trade barrier, and of course higher costs for those nations seeking to export to that region. The advantages inherent to trade are lost. In effect, the rest of the nation is paying a subsidy to the protected industry. The sums can be extremely large, and the consequences to an industry that now does not have to adapt itself to change can be dramatic. Industries that are riddled with obsolete practices may be unable to change, and labour interests may prolong their death agonies for many years. British industries that had been nationalised were protected from competition for decades, usually in the name of "creating jobs". Such industries had no interest in productivity or even economic efficiency. British Leyland is alleged to have sold every single Mini that it produced at a variable cost loss. The nuclear industry sold power at a cumulative loss of something in the order of £250 billion up to 1983.

The British coal industry collapsed from 130 to 10 million tonnes of annual production after it was opened to competition. Pits had been run that would have lost money from their inception to their closure if they had faced market conditions. Instead, the (nationalised) electricity industry was forced to buy from them, and sold power at the consequent high prices, paid or passed on to the nation a as a whole, increasing the costs of exports and lessening wealth all round. UK consumers paid this de facto tax to maintain an industry that it did not in fact need, which brought with it considerable health issues and which was not remotely acceptable as a source of emissions to the environment of oxides of sulphur and nitrogen, toxic elements and carbon dioxide.

Social subsidy is also extremely expensive. The majority of the industrial nations collect around 40-50% of value added as taxes. They spend something under a fifth of this on the basic business of government: roads, security, administration, health and education. The remainder – 25-25% of all value added – goes in social subsidies. Some of this supports the chronically sick, disabled and old, but as much goes to regions that support particular political interests. President Bush, under the rubric of energy independence, passed enormous sums to US agriculture. The successive Labour governments in the UK after 1997 funnelled tax revenues to their Northern heartland, such that there are now cases in which three quarters of all economic activity is bound up in the state sector, and all but a small fraction of the rest operates with the state as its prime customer.

The sovereign debt crisis now ties the hand of virtually all industrial states. Personal debt was almost unheard of amongst the poorer people in the OECD states up the middle to late 1980s. Credit cards were hard to obtain, mortgages were offered under strict conditions and short term personal bank loans were rare. All of this changed in the 1990s. A huge amount of debt was taken on by a new class of borrower, those of less than median income. As savings rates were extremely low in many industrial nations, it was balanced by an influx of Asian savings. In essence, Asians were lending to low income individuals in the rich world.

In addition, due to the doubling of the world labour force in the 1980-90 period, many goods became cheaper and the standard of living for the low income groups improved sharply. Borrowing was cheap for states, and many indulged in a lengthy period of deficit spending. Much of this went to protect inefficient practices, or to avoid taking painful decisions, all under the rubric of the "fair" or the "decent" society.

This situation survived the 1997-8 Asian crisis and the 2001-2 dot.com collapse; indeed, it accelerated under slack political and regulatory oversight and the internal dynamics of the world's banking industry. When the sovereign debt crisis began in 2007, national governments were ultimately required to reimburse Asian savers (under the guise of supporting failing banks) and future revenues were mortgaged for decades into the future. There had been, in essence, a de facto transfer of assets from the middle classes of the industrial world to their poor. This had been financed by Asian and other savers, but when its unsustainable nature was finally recognised the books had to be balanced. This was done through sovereign debt, ultimately to be paid back by above average earners.

As already noted, wage differences can only be sustained by rarity or productivity in an open marketplace, and only by protection and subsidy in a closed one. The final and irreversible termination of the transfer of wealth that occurred in the 1990-2007 period, as just discussed, means that the industrial world cannot continue to subsidise on the scale to which it has become accustomed. If it does not subsidise its producers or protect its markets, then wages will fall. If wages are not to fall to global parity for the low skilled – indeed, for everyone – then skills have to rise proportionately. In some cases, a proportionate rise in productivity may be more than an order of magnitude in size.

Nations may, of course, opt for (continued) protection. This will come huge cost to all but those specifically protected, and – for reasons already discussed - at considerable danger to the protected industries. Where is their spur to improvement? Enmeshed in a welfare bureaucracy, how are they to innovate? Studies suggest that such industries tend to focus on methods through which to arbitrage or manipulate the rule so as to get support on better terms– tax rebates, labour subsidies – rather than product or process innovation. Plainly, this is not a sustainable solution, however wrapped in kindly-sounding rhetoric about decent societies, national solidarity and the like.

There is an additional and crucial theme to add to this dark picture, that of demographics and the funding of old age. Japan, much of Europe and to a lesser extent, the US are strongly aging. This is a natural consequence of the demographic transition – the cessation of net endogenous population growth – and, of course, these populations will renew themselves in the 2030s, when the current industrialising world grows old. At present, however, half of all the people alive under the age of sixteen live in Africa. By contrast, half of the German population will soon be of retirement age.

According to the OECD, up to a quarter of GNP will have to be spent on care and support, up for 8-10% today. Pension provision is generally weak: at least five US states will be unable to pay their legal pension liabilities within the next five years, but the situation is far worse for nations such as Italy, with both a dire demographic profile and essentially no pension savings. States and societies in such a situation face a harsh future. Once again, the OECD, looking both at the demographics of Japan and the confused state of its public finances, does not expect more than nominal per capita economic growth out to 2040. India, by contrast, is expected to become 10-15 times richer over that period.

Economic renewal in the currently-wealthy world

The new economic reality of the currently-industrialised nations is fairly bleak. However, we need to add another dimension to this, one which somewhat mitigates this. Although immediately recognisable, this cluster of interaction has not yet acquired a generally-accepted portmanteau name. It lies at the heart of innovation and the harnessing of knowledge. Its task is to recognise ill-defined, messy potential, often embedded in complex and plural social situations, in order to generate a continuous renewal of insight, capability and performance. Such capabilities grow from clarity, knowledge and technology, and from issue-focused social networks. Markets have a role to play in it, but it is not entirely or even primarily "about" markets.

History gives us many examples in which latent capability was blunted by muddle; and where the ability to manage complexity brought forth miracles of growth. It is a cliché of development theory that consistent institutions and open, honest political systems deliver economic and social improvement. The capacity of commerce to understand its environment and to react to change by seizing latent opportunity is also well understood. These capabilities appear to vary between nations, and to persist in them for long periods.

Nations have equivalent and characteristic rates of economic growth, which tend to persist over very long periods. Canada, for example, has experienced few checks and has delivered about 3.5% annual growth for well over a hundred years. During which time, of course, both the economy and the culture changed beyond recognition. This is true of almost all of the now-industrialised nations: true, that is, that the rates are constant, but not true that the rates are the same. The then-superpower Great Britain lost steadily to other nations as its growth persisted at 2.25% over the same period. Readers will object that nations such as Japan, Germany and France showed periods of very fast growth, well above trend. Where there are such periods of fast growth, however, these represent periods of "catch up" after a major check, for example, World war II. When these economies reach the level that pre-war projections would have suggested, they slows to its historical rate.

Why is this observed? One convincing explanation is that rebuilding is comparatively easy when set against the complexities of doing new things from scratch. For example, when London was burnt to the ground in 1665, the King had schemes for grand boulevards and majestic squares. However, properties rights proved too complex and intricate to manage, and houses and streets rebuilt largely to the plan that had existed before the fire. Copying the achievements of a previous generation, or of another nation, is much easier than being a pioneer. China's telephone infrastructure did not have to invent and install manual exchanges before reaching out for cell phone technology. It simply adopted best practice from elsewhere. However, inventing best practice takes a deal longer, and it requires a much more complex chain of events. Britain, when inventing the industrial revolution, took around 80 years to double its output. China does the same every eight or so years. However, China is also running into limits to which it will have to create unique solutions, and these will slow its progress accordingly.

There has been considerable research into what constitutes a complexity-managing, renewal generating milieu. Whilst we see some aspects of this fairly clearly – it requires concentrations of capable people, clear goals and constrains, direct career and reward pathways - it is equally clear that the broad sweep of it still eludes us. We can, however, describe such a system in a less analytical, more top-down manner, characterising a process that delivers its benefits in a characteristic style. That style brings together able people towards clear goals in ways that reflect individual motivation but which is coupled to collective goals. That is, it is a highly social and "micro" set of processes that revolve around individual and collective values, insight and achievement. Bringing this about requires a many of factors to be in play, most of them of an intangible, fragile and largely indefinable nature. That is, the system runs as much through engrained habits of collaborative behaviour as it does on strict economic rationality. The political and security institutions which underpin this have a lightness of touch such that people are barely aware of their existence, but they are nonetheless institutions which have a rationality, strength and accessibility that enable all of this to fall into place.

We see bits of this phenomenon in place in some companies, in some industrial clusters, in some milieux of some cities. It is usually confined to elite groups and leading-edge activities. These are elite in the sense of being a self-selected group the very best practitioners, whatever their broader background, and it is also elite for being unusually committed to the overall goals of the group with which they are working. Members are unusually, obsessively dedicated and competitive, and yet simultaneously appreciative of the efforts of their competitors. The ethos to which they work is often only semi-pecuniary, in the sense that commercial success is excellent, but an adjunct to bringing about something which is creatively astonishing to the peer group. We can see how the magic of its touch generates stability and wealth, opens doors to collaboration and makes as good a use of talent as it can. It is the exact opposite to the obfuscating, end-game playing protected industry. The future is its friend and it dances on change. Might we, perhaps, call this gestalt of capabilities "collective intelligence? It is the midwife of innovation and the handmaid of graceful renewal in the face of complex change.

Developing people to thrive in self-renewing environments

The world that we face is not one that can be addressed only by incremental change in our educational systems. Unchallenging education which leaves no child behind, but which holds back the best will not do. Creeping up the international league tables will not do. Schooling has to be changed both in what it teaches and the means that it uses to teach it.

What do we need to teach? We tend to separate taught skills from those acquired informally. The former follow the normal current progression, from basic capacities to professional skills and beyond. The latter start with the acquisition of our native language and basic comportment, a moral education and the acquisition of the mores of our society; dealing with enmity and friendship, the basic reflexes and tools. We learn how not to annoy and how to charm a small informal group, we acquire knowledge of bits and pieces of how our society works. Then we learn how to deal with impersonal entities, large groups or people and the rest of adult non-family life.

It is interesting that the crucial skills that are needed for renewal come from both routes, but probably more form the "social" that from the "formal" path. Formal schooling teaches only a limited layer in this dual hierarchy. The lower rungs are supposed to come from our family, which may be all to the good if our family is competent in this way. This is frequently not the case, however.

The "social" path are supposed to be absorbed by osmosis, or to emerge as innate talents. We have no idea how much potential is lost through this assumption, not least as the issues are multi-factorial and remedial support in one area would open up broad pastures when the rest came into play. We do know that we can improve performance at each of these levels, from working with a group to high level leadership of huge organisations. As noted, a gap at one level tends to prevent progress in any level above it. However, it is through the highest level skills that value is most added and where – crucially for the future – the nameless capabilities that make for collective intelligence are found.

We need to fill these gaps in the educational profile. Plainly, these things are delivered and refined at different life stages: education needs to extend in ways that go beyond lifelong learning to accept a responsibility by the "engine" that drive education for the career and something of the life choices of the individual.

Change is deeply stressful to those unsuited by outlook or skill to meet its challenges. Unless we enable adaptation, the politics of the next decades will polarise between the views of those who can adapt and those who cannot, but who can nevertheless vote and riot on the streets. The outcomes for which such votes are be cast may be populist, protective of the status quo, doomed to bring about the swift decline of the elderly, rigid industrial nations that take such choices.

This demands a radical and perhaps dirigiste – certainly elitist – approach to education. The current model is that an individual is given their choice, and if they fail to take it, then they are set adrift, and the welfare system will eventually takes them in tow. It may be that welfare for those with potential to realise should be focused solely on realising that potential, and never on chronic support. Excellence, by contrast, should be given all the boost that it is capable of handling. Such an effort is truly a national investment, and has been shown in innumerable studies to be a use of resources on a par with venture capital. However, much as primary science yields astronomical economic returns, but not necessarily to those who made the initial investment, effort has to be made to reap the human potential that is being created.

One essential feature of any such education system is that the people in it need to have the relevant experience and aptitude. Some layers in learning schedule can be taught by traditional educators, but others cannot. In part, the exposure to the broader society of the typical teacher or academic has been a very focused. They inhabit somewhat closed, self-referential groups which evolve behaviours and values that may seem quaint – and perhaps unhelpful – to the rest of society. These are not individuals who can pass on hard-learned lessons about how to run a start up company, manage an awkward group of people or settle a dispute.

It is also the case that the teaching skills of a reasonable fraction are not what they might be and, perhaps, overly-traditional in a world in which the classroom may be an incidental rather than a primary place of learning. Unionisation, unworldly systems of tenure and the like have blocked efforts to measure and improve or remove individual teachers. This, too, cannot persist.

This paper offers more of a diagnosis than it does a prescription. We head for an unknowable world, in which many social certainties will become social casualties unless strong action is taken. The dangers of a self-reinforcing spiral of populist decline is extremely real for many industrial countries. The origins of World War I were, of course, complex, but they were much influenced by the inability of the existing powers to cope and compete with the emergence of Germany as a new, virile economic force. Much the same is true today, but on a global stage and with the ability to do harm enormously multiplied. Solutions come from competitive capabilities and a competent and satisfied population, not from isolation and confrontation.