Jul 29th 2013

The West’s unfounded defeatism

I read an article recently that made me wonder once again whether the negative outlook on the future of the West, often expressed in the United States and Europe, is justified.

In America, people seem to believe that the country’s best days are over. Washington is considered to be broke beyond repair. Europe, of course, is in everybody’s mind old, uncompetitive and deeply in debt. The economic activity in the world is increasingly moving to the East. China will be the world’s biggest economy, if it is not already. China’s example is followed by India, and other emerging countries. This century will be the century of Asia. This makes one wonder if democracy is after all a good way of running a country. Can efficient bureaucrats manage a country better -- as seems to be the case in China?

The demise of the Rest

The article mentioned above was written by Ruchir Sharma, the head of Emerging Markets and Global Macro at Morgan Stanley. The article appeared in the November/ December 2012 issue of Foreign Affairs.

Sharma writes that the per capita income gap between the advanced and the developing economies, in fact, steadily widened from 1950 until 2000! The past decade was exceptional. There was a lot of easy money around, which lifted every country and gave the wrong impression that the rest, i.e. countries other than the Western countries and Japan, would be catching up with the West. Sharma claims the next decade will bring us back to normal and concludes:

“Although some nations will break away from poverty the new economic order will probably look more like the old one than most observers predict…..The rest may continue to rise, but they will rise more slowly and unevenly than many experts are anticipating. And precious few will ever reach the income levels of the developed world.”    

There is, of course, one very big exception i.e. China, but Sharma is not optimistic about it either:

“In the next decade to come, the United States, Europe, and Japan are likely to grow slowly. Their sluggishness, however, will look less worrisome compared with the even bigger story in the global economy, which will be the three to four percent slowdown in China…and possibly even deeper slowdown in store.”

According to Sharma, China is running out of surplus labor, while over 50 percent already live in cities, and because of the one child policy, China’s economy is maturing, making growth more difficult.

Sharma’s views are certainly not shared by the public in the West. Sharma himself writes that over 50 percent of Americans think that the Chinese economy is already bigger than that of the U.S., even though the U.S. economy is still more than twice the size of the Chinese economy and seven times higher in terms of income per capita.

Sharma:

“In due time, the sense of many Americans today that Asian juggernauts are swiftly overtaking the U.S. economy will be remembered as the country’s periodic bouts of paranoia…”

China and why nations succeed or fail

The authors of the book “Why Nations Fail”, Daron Acemoglu and James Robinson, arrive at similar conclusions about China, but from a different perspective. In their article “Will China rule the world?” posted on Facts & Arts on March 23, 2012 they start with the following:   

“….[It] is hardly the first time observers have been swept up in the growth potential of a communist state….. Nobel Prize winner Paul Samuelson's introductory economics textbook predicted in its 1961 edition that the Soviet national income would overtake that of the United States by 1997. In the 1980 edition there was little change in the analysis, though the overtaking was delayed to 2012.”

In their research Acemoglu and Robinson have come to the conclusion that it is a nation’s institutions that determine its success, not culture, religion, geography, weather or anything else. An example is South and North Korea. They are otherwise the same, but with very different institutions. One of them has become rich the other is utterly poor. The same applied to West and East Germany.

About China Acemoglu and Robinson write in the above mentioned article: 

“Our research on national economies throughout world history shows that long-term economic growth, while indeed based on technological innovation, only sustains itself in the presence of democratic political institutions that provide people with incentives to innovate. China may continue to grow in the near term, but the limited rights it affords its citizens places major restrictions on the country's longer-term possibilities for prosperity.”

“There will be limits on how much innovation such a system can generate, even if China keeps growing this decade. For all its changes, China still has what we term "extractive" political institutions, those that direct resources away from the people and toward the state and a small number of its elites. History is littered with states that have had some democratic or "inclusive" features, but remained essentially extractive: from ancient Rome to early-modern Venice to many authoritarian nations within the last century, these states have ultimately failed to deliver sustained growth.”

“By their nature, extractive states are against the kind of innovation that leads to widespread prosperity: this kind of change threatens the hold on political and economic power that elites in such states fight to maintain. And fight they will…”

The development of a mature economy requires that new replace the old. As for instance, the development of IT has led to the partial destruction of print media, and accordingly paper manufacturing industry, a process called ‘creative destruction’ a concept first coined by the Austrian economist Joseph Schumpeter. According to Acemoglu and Robinson, a democracy allows this process, but the elite of a centrally managed country does not. For instance, still in the 80’s the dominant companies in the U.S. were the car manufacturers General Motors, Ford and Chrysler. Today completely new companies have taken their place, such as Microsoft, Apple and Google. The democratic America not only allows the redistribution of economic power for the benefit of the economy as a whole, but in fact it has no institutions that could stop the process. China has. The party conference of the Chinese communist party is said to be the biggest gathering of billionaires in the world. They have the interest and the means to stop creative destruction if needed to protect their assets.

If this is true then the countries that have a tradition of democratic governess have a better ability to renew themselves in the changing world. Most counties are not democracies and it is difficult to implement democracy if there is no tradition for it.

China has no democratic tradition and has no intention of implementing it. Its state philosophy, Confucianism, is a philosophy for good governance by the elite bureaucracy. After Mao’s horrific rule that killed tens of millions of Chinese and kept the country poor, China adapted Western type of market economy, first in a small scale, then more fully. The results of the policy have been very good indeed, but it would not have been possible had not the rich U.S. allowed the imports of Chinese goods, a policy that much harmed the American manufacturing industry and its workers, but has probably helped the U.S. economy to develop yet onto another level of sophistication. Now China must find the growth from within itself. Whether it can adapt to a new situation remains to be seen.

Europe

Democracy, of course, is originally a European concept, more specifically Greece. In modern times democracy was developed in England at a time of the industrial revolution. Nascent democracy together with property rights were a prerequisite for the industrial revolution to emerge, according to Acemoglu and Robinson. It led to England to become a world power. The democratic principles were adapted by most European countries. After the Second World War democracy in Europe was secured by the U.S., even forced upon to then Western Germany. After the dissolution of Soviet Union, its European satellite states adopted democracy and joined the European Union consisting of democratically run states. The borders after the Second World War were effectively redrawn without a shot and even without a peace agreement. Democracy had won.

Today Europe is rich. Within Europe the countries with the most decentralized economic institutions, like Switzerland and Germany, seem to be fairing best. The countries experiencing economic difficulties at the very moment were, in fact, dictatorships fairly recently, namely Portugal, Spain, Greece, even Italy. The very Paris-centred France, although democratic, is increasingly having difficulties.

Europe produces some of the finest products in the world, like world’s largest airliner the Airbus 380, the world’s finest cars, finest fashion ware, it has the worlds most international banking and insurance hub in London, it has the world’s finest tourist attractions. Europe’s has traditions, yes, but its production facilities are far from being out of date.

Even the euro zone debt crisis is a misnomer. During its existence the balance of payments of the zone as a whole has been more or less zero during its existence, i.e. the euro zone has not indebted itself at all. The euro-zone states that have a debt problem are mostly in debt to their own citizens or to other Europeans, especially to German and French banks, as is Luigi Zingales writes in his article “German Banks on Top” posted on Facts & Arts on July 17, 2013. Instead of using the term “Debt problem” one could equally well say that Europe has a “Receivables problem”.

Japan

After the Second World War the United States forced democracy and market economy upon Japan. By the 1970’s Japan was a miracle economy. It was thought, at least in the West, to be heading to a level larger than the U.S. economy. It did not, but today Japan is, however, one of the richest countries in the world. It has been able to transform its economy from a low-cost producer of relatively simple products to a producer of most sophisticated products that are sold throughout the world. It is a democracy with well-established human rights.

Japan is now able to provide its citizens a frame for a good life that would have been completely unimaginable in the past. This does not only refer to the material living standards, but also to the security and rights of the individual such as equality in front of the law, right for education, right for medical care, property rights, right to participate equally with all others in the process of choosing a government, freedom of speech, freedom of movement etc. - all originally basically Western values based on the individual rather than a group of individuals such as a family or a clan.

The Japanese economy has, however, been stagnant for more than a decade expressed in terms of the growth of the GNP. The GNP might tough be a wrong measurement. The Japanese population is ageing and decreasing. The Japanese are doing quite well when measured in terms of growth of income per capita.

The Japanese government has very high debts, circa 2.5 times more than its yearly GNP. However that debt is to the Japanese themselves. Japan has had for many decades a surplus in its balance of payments, in other words it has accumulated receivables from the rest of the world.  

Russia

It is not easy for a country to install democracy if the country has no tradition for it.

Still in the early 1980’s the leaders of the Soviet Union believed it would take over the Western Europe in not too distance future. It did not happen either. Instead the next generation of Soviet leaders was forced to throw in the towel. They knew that their economy was no match to the Western democracies.  Soviet Union ceased to exist; its main successor state, Russia, adapted, or at first seemed to intend to adapt, a Western type of market economy and democracy. Its economy started to grow, though much enhanced by the fact that oil price went from $ 20 per barrel to higher than $ 100 due to demand in West and gradually from China. Its democracy has become increasingly managed from the Kremlin, ownership of the privatized production apparatus has been concentrated to a few individuals with close ties to the Kremlin, and its legal system is not independent from the Kremlin. It is, as if Russia is falling back to a system that is reminiscent to the rule of the communists and the tsars.

Russian economy has largely remained as a supplier of raw materials to more sophisticated economies. Its growth has stagnated in spite of the fact that the price of oil has remained high. The more the power in the country is concentrated to the elite in or around the Kremlin the more stagnant Russian’s economy is likely to be.

Islam and democracy

There are of course also countries that have no intention to implementing democracy. A large group of them are countries where the dominant religion is Islam. 

Tony Blair, the former prime minister of the U.K. writes in an article posted on June 11, 2013 Facts & Arts:    

“There is not a problem with Islam. For those of us who have studied it, there is no doubt about its true and peaceful nature. There is not a problem with Muslims in general…” 

 “But there is a problem within Islam, and we have to put it on the table and be honest about it. There are, of course, Christian extremists and Jewish, Buddhist, and Hindu ones. But I am afraid that the problematic strain within Islam is not the province of a few extremists. It has at its heart a view of religion – and of the relationship between religion and politics – that is not compatible with pluralistic, liberal, open-minded societies. At the extreme end of the spectrum are terrorists, but the worldview goes deeper and wider than it is comfortable for us to admit.”

If so these countries are likely to remain poor. There are, of course, some very rich countries that have Islam as a state religion. Say for instance Dubai that has become rich due to its oil and gas reserves. But it is the West that has primarily made oil valuable. The modern Dubai has been largely built under Western management with Asian labor. How sustainable is such an economy?  The West even might, in due course, make oil redundant with new innovations.

Israel

Israel is a democracy. Its economy has developed magnificently, even taking into account the financial help it has received from the U.S. It is called a start-up nation. But this applies only for the Jews. Ben Gurion once said that Israel can consist of greater Israel, be Jewish and democratic, but not all three at the same time. Today approximately half of the people who live in Israel proper, West Bank and in Gaza are Palestinians, who are outside of the democratic process and remain poor. This might be an unsolvable problem. Settlement movement might have gone too far to allow a two state solution. The demographic trends are on the side of the Palestinian population.

Summary

The negative outlook that exists both in the U.S. and in Europe seems for me to be unfounded. We seem to be too aware of our own problems, not realizing that others have theirs. Few of us have the ability to eye our present with a longer time perspective both in regards to the past as well as to the future.

Should the U.S. and Europe be able to agree upon a free trade pact the West would most probably continue to set the standards for the rest of the world for a long time to come. This is probably the main reason why the negotiations are held, even though they are marketed mainly as a tool to enhance growth in the U.S. and in Europe.

Related articles on Facts & Arts:

First evidence supports Sharma’s prediction. Nouriel Roubini writes in his article “Trouble in Emerging-Market Paradise” posted on Facts & Arts on July 23, 2013:

“Brazil’s GDP grew by only 1% last year, and may not grow by more than 2% this year, with its potential growth barely above 3%. Russia’s economy may grow by barely 2% this year, with potential growth also at around 3%, despite oil prices being around $100 a barrel. India had a couple of years of strong growth recently (11.2% in 2010 and 7.7% in 2011) but slowed to 4% in 2012. China’s economy grew by 10% per year for the last three decades, but slowed to 7.8% last year and risks a hard landing.”

Acemoglu and Robinson write about “The problem with U.S. Inequality” posted on Facts & Arts on March 23, 2012. Quote:

“Almost a quarter of total U.S. national income now accrues to the richest 1 percent of the population…..….the real reason to worry about this picture is not the unfairness of it all. Any discussion of inequality should distinguish economic inequality from inequality of opportunity and from political inequality.  …….The problem is that economic inequality often comes bundled with inequality of opportunity and political inequality.

Prosperity depends on innovation, and we waste our innovative potential if we do not provide a level playing field for all: we don't know where the next Microsoft, Google, or Facebook will come from, and if the person who will make this happen goes to a failing school and cannot get into a good university, the chances that it will become a reality are much diminished. There is a lot to worry about here.”







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