An economist explains what the heck is happening to the global economy

It’s the end of the world as we knew it.
It’s the end of the world as we knew it.
Image: AP Photo/Andy Wong
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The dawn of the twenty-first century has proved unsettling. It was not what we expected. Only a few years ago, the world was full with apparently justified optimism. The new century would be free of the ideological fights that plagued the twentieth. A consensus emerged that markets and democracy were the basis for healthy societies; the prospect of a war between superpowers faded into the past; a “new economy” born out of the combination of computers and telecommunications was emerging and globalization was uniting the world into a happy global village. Countries all over the world liberalized their economies and joined the ranks of democracy.

As the new century settled in, however, worrying facts are deflating all these optimistic expectations. Each and every one of the reasons for optimism has failed to deliver what it promised and many problems that we thought we had left well behind have come back to haunt us. Negative turns in the distribution of income and wealth, financial crises, terrorism, fundamentalist terrorist states trying to spring out of the Middle East and Africa, a visible turning away from democracy in many countries that had just become capitalistic or democratic, Russia expanding its territory just like the aggressive powers of yesteryear… All these things point towards one single impression: life has suddenly become chaotic as the political order that existed in the twentieth century collapsed all around us, leaving the world at the whim of fanatical Islamic groups and rogue states, authoritarian great powers, and petty tyrants in Latin America. It seems that a faraway past is coming back.

What is happening? What do we have in common with the turn of the last century to bring back a host of problems that we thought had become part of the past?

The disruptions

What we have in common with the people of one hundred years ago is that we, like they did, are going under the sway of a technological revolution that will change our lives as deeply as the Industrial Revolution changed theirs.

Profound technological advances, while opening the road for a better future in the long run, are terribly disruptive in the short term. They render obsolete the capital accumulated in physical assets, in human knowledge and skills, and, even more fundamentally, in the shape of the institutions linking together the fabric of society. People who thought they had their future assured suddenly find that their skills have been turned obsolete by the new technologies or by the new styles of life derived from them. Activities that had been for decades the mainstay of an economy suddenly become unprofitable, either because their product disappeared or because, to be profitable, they have to be relocated to another part of the world.

This brings about all kinds of economic and social disruptions, including unemployment, negative turns in the distribution of income, bankruptcies, frequent financial crises, and depression. Life becomes unstable, the future unbearably uncertain.

This is what was happening a hundred years ago under the influence of the last stage of the Industrial Revolution, that which introduced electricity, the telephone, the internal combustion engine, the car, and the airplane.

This is what is starting to happen in our times as well under the influence of the new revolution that was set in motion by connectivity, the power to manage complex tasks from afar in real time, an ability that the combination of computers, telecommunications, and fast means of transportation has made possible. As much as the Industrial Revolution multiplied the power of the muscle, the new revolution is multiplying the power of the mind. It promises to improve dramatically the way we live.

In the short run, however, the transition to this new connected world implies the disruption, even the destruction, of what we have today in terms of skills, investments, ways of life, and basic institutions for our social order.

Income distribution

Technological revolutions result in negative turns in the distribution of income, as income flows towards those who take early advantage of the new technologies. This effect is more pronounced in the case of the current revolution. Being based on the multiplication of the power of the mind, it privileges education. As a result, the educational premium in incomes has become very large in the labor markets. The 2008 population survey by the US Census Bureau showed that the median wage of someone with an undergraduate degree was 72% higher than that of someone with just a high school degree. This gap was 43% in the 1970s. That of someone with a professional degree was 213% higher. This was 72% in the 1970s. These are averages. In the enormous markets of our times, the opportunities to make staggering amounts of money out of connectivity are there for the people who know how to use them.

In a recent article, I noted that Facebook bought Instagram for a whopping $1 billion. The company, launched in 2010, happened to have 13 employees at the time it was sold. That comes to about $76 million per worker. Then in February, Facebook bought Whatsapp for $345 million per worker. The purchasing company, Facebook, created in 2004, has a market value of $22 million per employee. Apple has $14 million per worker, Google $10 million. This can be compared with Chiquita, the banana company founded in 1870, valued at  $50,000 per employee. In the same article I noted how companies based on knowledge have markets values much higher than the price of their physical assets.

Eventually, we could expect that education would improve in response to the premium paid for it in the new economy, thus improving the distribution of income and wealth. However, this improvement would take a long time. In the meantime, politicians have been hard at work looking for measures that could make feel better those falling behind.

Financial crises

In Fault Lines: How Hidden Fractures Still Threaten the World Economy, Raghuram G. Rajan, now the Governor of the Reserve Bank of India, links the 2008 explosion of financial instability with the growing deterioration of the distribution of income.

In the 1990s politicians responded to the income and wealth distribution problem “with an attempt at a panacea: facilitating the flow of easy credit to those left behind by growth and technological progress.” That is, if those falling behind could not increase their wealth through higher incomes, they could be made to feel that they were increasing it through indebtedness.

To facilitate this operation, politicians relaxed the regulations that kept the financial system stable. Since the 1990s, credit flowed toward those left behind (the subprime and the ninjas: no income, no job and no assets) especially for the acquisition of housing.

Credit cannot substitute for income growth. People could not repay those loans. The 2008 crisis was the result of these credit flows.

The Japanese disease

Japan has not grown noticeably since its own financial crisis of two and a half decades ago. It does not grow even if its government and central bank have created money to finance fiscal deficits in navigable quantities. This is happening because the natural remedy that the market applies to insolvency—the bankruptcy of the unprofitable activities that cannot grow—has been deactivated by government intervention. The immense liquidity created by the central bank keeps the inefficient activities afloat even if they are insolvent. The new world cannot replace the old one, and the economy cannot grow.

The Japanese disease extended to the rest of the globe in the first decade of the millennium. Central banks all over the world are swamping their economies in an immense liquidity that keep financially dead governments and companies alive while the economies stagnate. The incredibly large monetary creation will come back to haunt us with more instability in the medium term.

Fundamentalism and terrorism

Fundamentalism, the extreme form of resistance to change, is the urge to force the return of society to mores and social structures of an idealized past, when things did not change and people could plan their lives within a predictable structure.

It emerges in all processes of radical transformations. It becomes strong, however, only in the last stages of dissolution of a society, when people think that they are veering into chaos. People try to escape the present by going to the past, thinking that nothing could be done with the existing society except destroying the forces that are dissolving it—which, in the old times were capitalism and democracy, and today are the western customs and mores expanded to the Middle East through all the channels of connectivity.

It is not by chance that countries in the region forbid all forms of communications with the West, including movies, television and radio, and that they want to reestablish a form of state that disappeared so long ago—the caliphate, which aimed at controlling the entire world and imposed religious authority on every aspect of life. For the fundamentalists, the enemy is change.

Disillusionment with democratic capitalism

As the problems of adjustment increase, disillusionment with democratic capitalism is spreading all over the world. Problems that are attributable to the turmoil of the changes are blamed on “the system.”

Many of the formerly communist countries (including China and Russia), which were widely expected to become democratic when they liberalized their economies, are hailing their nondemocratic systems as more effective than democracy, and many people are listening. Many Latin American countries that seemed to have become democratic have fallen back into their old populist regimes.

Calls for more control of the state over the economy to prevent changes from taking place have become more common all over the world: stop globalization, stop job exports, stop bankruptcies, stop competition from abroad, stop everything that would threaten our position of comfort. To stop all these and other things, governments have to become more authoritarian and democracy must then suffer.

The invasive great power

Russia’s annexation of parts of Georgia and Ukraine brought back another monster that we thought had disappeared between the 1930s and the 1940s—the territorially acquisitive authoritarian Great Power. Well into the twentieth first century, Putin’s Russia behaved in the same predatory way as Hitler’s Germany had done with Czechoslovakia, Austria and Poland in the late 1930s. Along with these territorial attacks, the possibility of new wars between great powers came back as well.

Russia has been aggressive against Georgia, Ukraine and the Baltic countries for ages. Its aggressiveness, however, has turned into actual aggressions depending on the strength of its potential enemies. The collapse of the global order that prevailed since the fall of the Soviet Union as a result of the world’s economic woes and the rise of fundamentalism, which in turn owe a lot to the disruptions of the technological revolution, has opened a window for Russian opportunism. Others may follow.

What is to be done?

There is a curious contradiction between the people’s highly positive attitude towards the Connectivity Revolution and their highly negative disposition towards its short-term consequences. While adopting the new technologies with great enthusiasm, many of them organize a strong opposition to the changes they are introducing. The politics of today’s world are gradually moving toward resistance to change as the main means to deal with the problems caused by the transformation. People want strong governments to stop change.

Trying to keep the current shape of society unchanged, however, is the best way to fall into stagnation, destructiveness, or both. The countries that had more state intervention in the economy—like Russia and Germany one hundred years ago—were the ones that broke under the pressures of change and fell under destructive regimes. In their search for stability through authoritarian governments, these countries sold their souls to the devil and rather than the stability of older, romanticized times, they got the order of slavery and destructiveness.

Those arguing for policies that would stop change say, correctly, that the functioning of society needs an element of permanence to prevent chaos. However, the element of permanence that all societies need should be provided through the enforcement of the rights of the individual, not by protecting the economic or political status of some vociferous sectors.

This article draws liberally from Manuel Hinds, The Triumph of the Flexible Society: The Connectivity Revolution and Resistance to Change. Praeger, Westport, Connecticut, 2003.