Last week I was invited to attend JP Morgan’s annual Investment Trust Director’s Seminar. This is always a good event including both a number of in-house analysts of the investment scene and a key note speaker. This year’s speaker was John Micklethwait, Editor-in-Chief of The Economist, arguably the world’s leading business and current affairs weekly. John is one of the world’s foremost authorities on globalisation – how it works and where it’s headed- and a leading proponent of its positive impact and potential. That same understanding lets him explain how globalisation sometimes turns sour, as in today’s European financial crisis. He is the co-author/co-editor of two books on globalisation: A Future Perfect: The Challenge and Promise of Globalization and Globalisation: Making sense of an integrating world.
His book, The Company: A Short History of a Revolutionary Idea, was named one of the ten best books of 2003 by BusinessWeek. John is also an expert on American business and culture, and on US politics and US foreign and defence policy. He was head of the newspaper’s U.S. section from 1999 to 2006. He is the co-author with Adrian Wooldridge, of The Right Nation: Conservative Power in America and best seller The Witch Doctors. He is a winner of the Wincott Award, Britain’s leading prize for financial journalism and was named Editors’ Editor of the Year at the British Society of Magazine Editors 2010 annual awards. He is also a Trustee of the British Museum.
John told us that he was feeling a kind of paranoid optimism about the future. He would give us three big reasons for his optimism, but share with us three reasons for his paranoia. He would also share with us two ideas which were probably pretentious and certainly contradictory.
First his three big reasons for optimism:
The success of emerging nations. When the history books are written about the past 25 years the single biggest thing to have happened is that one billion people climbed out of poverty through the growth of their economies. We should not dwell on the frauds of Madoff, the recklessness of Goodwin or the behaviour of Goldwyn Sachs but the joyous fact that through their own efforts so many people improved their lives.
The West is not much worse that you would expect. A balance sheet recession has occurred as expected. The US is on track to recovery; the UK is not far behind. The Euro area is worse off but a few things are changing. In Europe the big worry is over the shape of the banks. While Citibank put aside $400 billion to deal with its issues no European bank has reserved even a tenth of that.
The creative destruction of globalisation continues as with the Microsoft merger with Nokia. 3D printing, the internet and so on all add up to a third Industrial Revolution. The first harnessed steam power, the second brought in conveyor belt mechanisms as pioneered by Ford and the third will give us customisation. As an aside, if an iPad costs the customer $500 manufacturing only accounts for $33 of that of which only $8 stays in China. So why make it in China?
But there are many reasons why one could be paranoid. Portugal looks in big trouble over the Euro. He rates the chance of Israel attacking Iran as 25%. And conflict is more likely than not between China and Japan over the Senkaku Islands. But these are events that may or may not happen. Some events are certain, it’s the question of timing that is uncertain. Herbert Stein, chairman of the Council of Economic Advisers under Presidents Richard Nixon and Gerald Ford said “if something cannot go on forever, it will stop.”[i]
Thus we should be looking at smouldering volcanoes rather than black swans. John identifies three reasons for such paranoia:
The US budget deficit. The USA cannot continue indefinitely to spend like a big government and tax like a small government. Thus the recent disgraceful brinkmanship between Obama’s democrats and the Tea Party was actually over a substantive issue. In some ways the Tea Party are right although they were quite wrong to fight on the issue of Obamacare which is the law of the land. However the budget deficit cannot continue to rise forever as it has been doing for generations. If it cannot go on forever, it will stop.
China. Its growth rate cannot just be a straight line. The big risks in China are political not economic. To demonstrate the size of the challenges facing Xi Jinping, the new General Secretary of the Communist Party of China, John quoted a few numbers:
38 million. The number of Chinese who moved from the countryside to the cities during 2000-2005, not including those who made such a move but stayed in the same province as the statistics don’t count them. This compares with the 30 million who emigrated from Europe to the United States in the century from 1820.
100 million. The number of Chinese estimated to go to a Christian church each Sunday. This estimate might range from 80 to 120 million but in any case it exceeds the 70 million who are members of the Communist Party.
100,000. The number of Indian troops on its border with China. That is more than Britain ever sent to Afghanistan or Iraq.
$96 billion. It was discovered that the 50 richest members of the US Congress have net assets of $1.6 billion. Most of this was inherited or transferred through marriage. When comparisons were made with the top 50 in the Chinese politburo their net assets were $96 billion, almost $2 billion per man. This flags up an unspeakable level of corruption.
$13,000. The level of GDP per head when Taiwan and South Korea each became democratic. China is currently around $7,500.
So how will Xi manage these challenges is an open question. But what is certain is that Chinese politics and society have to change.
3. The Euro. John does not think it will collapse. The establishment are more cohesive in Germany, France and Italy than they are in the US or the UK. They are determined to keep it together in a way that we Anglo-Saxons fail to appreciate. But in that case it has to change. Something has to give.
So what about his two ideas?
The first problem is the level of inequality which is worsening everywhere but cannot go on. (See my blog The Inequality Crisis 9th March 2013). The trouble is that it drags politics to the left and raises stupidities like Hollande with his 75% tax driving thousands of Frenchmen and women out of France or Miliband with his threatened price controls which will scare off the investment in new forms of energy that is essential if we’re going to keep the lights on. John had just visited Chile where a right wing government has done an excellent job with the economy but has no chance of winning the upcoming election because of general unease about where the benefits of growth are going.
The second problem is the ever-growing state. In 2013 the US state share of GDP was 7%, by 1960 that had doubled to 14% and by 2009 that in turn had trebled to 42%. In the UK the figures are even greater. This has not just been a question of populist left-wing governments. Both sides of the political divide have been guilty as the left spend on welfare and the right spend on defence and giving themselves tax breaks. There is no money left. The fiscal adjustment required to balance the budget is 11% in the US, 15% in Japan and even more in Europe.
In the private sector competition has worked in improving product quality to the point of excellence. Noone survives by making poor quality cars any more. In the public sector the absence of competition means that poor quality schools and hospitals are allowed to survive. So we should invest in companies that do more of the state’s work. Swedes tend to be leftish in their politics but don’t care who provides and in consequence have a more mixed-economy public sector with better results. And a great deal of state spending goes to increase inequality e.g. net mortgage deductions are greater than the cost of building new social housing.
If these things cannot go on forever, they will stop. It’s just a question of when.
Copyright David C Pearson 2013 All rights reserved