How The West Was Lost: Fifty Years of Economic Folly - And the Stark Choices Ahead (2011)
How the West was Lost is the story of how the world’s most economically powerful nations have seen their wealth and dominant political position decline to the point where, today, they are about to forfeit all they have strived for – economic, military and political global supremacy. There are three main reasons why the West has seen its substantial advantage erode; an erosion whose pace is accelerating with every passing year.
How the West was Lost charts how, over the last fifty years, the most advanced and advantaged countries of the world have squandered their once impregnable position through a sustained catalogue of fundamentally flawed economic policies.
But there is a bigger story to be told. It is a mistake to view what happened as an isolated and relatively contained episode. In fact, what happened in 2008 marked yet another step in a fundamental transition from one economic power to another; from the West, to the Rising Rest.
Christopher Tassava wrote: ‘economically strengthened by wartime industrial expansion … possessed of an economy that was larger and richer than any other in the world, American leaders determined to make the United States the centre of the post-war world economy.’ The Cold War would continue for the next fifty years, but it was this strategy that ultimately prevailed. Barely scathed, fantastically rich, no country could come close to the United States. The world was hers.
But fast-forward to today. See how much has changed. Western states are facing untold financial calamity, their populations ageing with few resources to sustain them, much of the necessary political reform remaining politically unpopular, and their economic supremacy susceptible to challenges from around the globe in a way never envisaged before.
Even capitalism’s most vigorous detractor, Karl Marx, recognized the overwhelming power that capital impresses on us all; it is, after all, the lifeblood of every economy. It should come as no surprise, therefore, that early economists identified capital as the prime ingredient for growth.
However capital is defined, governments have tended to view it all in terms of that man-made stuff – cold, hard cash (itself, of course, originally partially made of the precious minerals). So much so that in today’s parlance capital has become synonymous with money.
The story of the West’s rise and fall is primarily a tale of how it has viewed, stored and wasted its capital. The West’s behaviour over the last fifty years has been like that of a profligate son, squandering the family wealth garnered over the centuries – frittering it away on heady indulgences and bad investments.
Not long ago the world would have baulked at the notion of China and the Middle East riding to the rescue of a financially weakened United States. But now a survey of 600 senior business executives by the law firm Eversheds concludes that Shanghai will probably overtake London in the next decade, just behind New York, as a global financial centre, thus becoming a leading contender in the competition to be the world’s capital of finance. Meanwhile, these emerging regions have already been propping up failing Western financial institutions (and potentially the broader economy) on the brink of collapse.
The uncomfortable truth is that the West is desperately strapped for cash. Like the rules of engagement that have governed the market economies of the industrialized West for more than 200 years, it all boils down to cash; who has it and who doesn’t.
In the global bidding war – for property, for companies, for commodities, for anything of value – the West will rarely be seen: it’s fast running out of money. But it wasn’t always this way. It once had plenty, and even surplus. The reason the West finds itself in this predicament is because of what it did with the money when it had it – it misallocated it.
Perhaps it was folly, perhaps wilful blindness, or perhaps capricious political myopia – regardless of the motivation, in the last fifty years Western policymaking has placed an unbearable burden of unsustainable mounting costs on future generations, the full extent of which the Western world has just begun to experience,
In the specific case of capital, for example, the unintended consequences of Western (American) policies to broaden access to capital for its citizens (i.e. to fulfil the American dream) have left the United States and indeed the Western world at large teetering on the verge of bankruptcy.
The direct consequence of the subsidized homeownership culture was the emergence of a society of leverage, one where citizen and country were mortgaged up to the hilt; promoting a way of life where people grew comfortable with the idea of living beyond one’s means. So deeply engrained has this ideology become that even though it was ruinous debt that led to the 2008 financial crisis, it is debt itself that governments have, in the post-crisis era, offered as the panacea to getting out of the quagmire.
When, in June 2009, some of the UK’s banks audaciously started marketing 125 per cent mortgages, it served as a reminder of just how little we’ve learnt and how spellbound society has become on the idea of debt cure-all. Equally astonishing, first-time homebuyers in Britain are being told to live on their credit cards; this is the only way to secure a mortgage.
It is perhaps no surprise that the industry which over time has shown the greatest appetite for risk is precisely the industry that has had the most government guarantees on its debts: the banking sector.
Remember, these banking activities are not illegal. Banks and bankers are simply operating under the policies stipulated by the governments. These are the rules of the game.
Lying at the heart of capital misallocation is the issue of debt – its excess, its consumption, its perverse hold on the way Westerners today conduct their lives and manage their economies. Most crucially, leverage has distorted our understanding of ownership versus merely control, and has helped fuel our craving to keep up with the Joneses. But least forgivable is that our ability to gorge on debt – as governments, corporations and individuals – has persuaded us to waste valuable cash resources on objects of little worth. Debt, as a way of Western life, has become an addiction.
The 2008 housing crisis is the West’s worst bubble since the Great Depression, not simply in its impact on the financial sector but because of its reach into the real economy – people’s jobs, companies and the governments themselves. The true scale of the fallout is yet to be felt.
In 2007 the sub-prime market, so favoured up to this point, collapsed. This would be the catalyst that would herald the beginning of the end of the post-war capitalist financial model, as we know it.
Despite the opprobrium heaped upon the bankers for their enthusiastic role in the financial wizardry around the sub-prime industry, the responsibility must also lie with well-intentioned policymakers stretching as far back as the post-Second World War period. Well-intentioned policies also created vested interests, which then ran out of control. Once the financial sector was able to benefit from the subsidies meant for homeowners, the process of lobbying for and maintaining these policies was set in motion – and, not long after, it became the norm.
The sub-prime crisis has affected the American psyche as much as the American purse – and indeed that of the world. It shattered the illusion of prosperity and left people dumbfounded. The poorest pockets of America had been led to believe that they could own their own homes, and thus share in the American dream, only for those hopes to be dashed, and the reality to sink in that it was just a pipedream.
Thus far, the discussion has focused on the West’s misallocation of capital. However, its labour too has been misallocated, again to the West’s detriment.
The rapid introduction of pension plans in the period after the Second World War inadvertently led to a widespread mispricing of labour contracts that, in turn, has made the cost of labour look cheaper than it actually is. The postponement of these hidden pension costs to the future – essentially delaying the cost of labour – is coming to haunt the West now. Second, the broad societal shift to favour the service sector over the productive industry has created a society where exorbitant salaries and rewards are stacked in favour of those whose societal benefits seem relatively narrow (sportsmen, CEOs, hedge fund managers), and less towards sectors with arguably broader societal gains (e.g. doctors, nurses, teachers); an exodus driven by bad labour-pricing signals. Third, laws governing the global migration of labour are becoming ever more stringent, and more restrictive. America was always known to be the destination of the best and the brightest, but today government policies are making it much more difficult to draw on the global pool of talent.
Based on the sheer size of their populations the West’s most obvious challenges come from China and India. With their inherently overwhelming numbers, China and India were always going to give the West a run for its money, particularly once they figured out the key policy ingredients for economic success.
The West is getting older. The less productive and more expensive to maintain this growing ageing population becomes, the greater the burden on already stretched fiscal balances, and of course on an economy overall, raising the prospects of labour shortages, lower productivity and invariably slower economic growth.
The trouble is that although there is some tacit acknowledgment that the costs of a large pensioner population are huge, few are facing up to the reality of just how monumental these hidden costs truly are. They are bound to overwhelm the economies of the West.
Forget Bernie Madoff, forget Allen Stanford, the biggest Ponzi scheme has got to be the looming car crash that is Western pension funds. And like any well-run Ponzi game, its results will be devastating. It will all end in tears.
Governments across the Western industrialized world have, through pension funds, very successfully sold their citizens something that they can never possibly finance.
The new monies flowing in from the incomes of the young workforce of today will never be able to meet the financial demands of the ever-growing army of pensioners.
According to an August 2009 report by the actuaries Lane, Clark & Peacock, Britain’s biggest company pension funds face their largest shortfall ever as a result of the financial crisis. They estimate a pension fund deficit of more than US$160bn – more than double the US$65bn estimated for these companies a mere twelve months previously.
The frightening thing is that all the hallmarks of the 2008 financial crisis, the elements that brought the global economy to the brink – faulty financial engineering, mispriced options and misallocated resources – can be seen in the unfunded pension benefits.
Today, virtually all Western countries have government-sponsored defined benefit plans in place, and virtually all of them are significantly underfunded and therefore unsustainable.
If these staggering pension shortfalls sound bad enough, remember that Western governments have masked the true size of the pension deficits by deliberate obfuscation – known as off-balance-sheet accounting. This form of accounting trickery, by which the true value these staggering pension shortfalls sound bad enough, remember that Western governments have masked the true size of the pension deficits by deliberate obfuscation – known as off-balance-sheet accounting. This form of accounting trickery, by which the true value of the future pension usually as a mere footnote to the core balance sheet, enables governments to distort the figures they publish and conceal the true value of the debt burden that the public are carrying.
It’s as simple as this: cheques that were written thirty years ago are, today, impossible to cash, in essence leaving government and some corporate defined-benefit pension schemes little more than Ponzi schemes.
America’s fast-growing population – and indeed that of the West as a whole – of unskilled, unemployed and disaffected citizens is at the core of the threat to the country’s wealth and economic stature. Any economic system requires a skilled and innovative labour force – something that Western economies are fast running out of.
To a very large extent the West’s pre-eminence has been all about its inventions.
The middle of the last century saw Japan emerge as a leading technological innovator in the car industry, electronics and steel manufacture.
Since then, the emerging Rest have also, in one form or another, been making their presence felt in technological and medical spheres for decades.
Over time, efforts to usurp the West’s technological edge have grown much more fierce and insistent, and evident in mainstream technology as well as in medical science.
China and Peru are leading the pack in stem cell research… Laser eye surgery, based on the lasik technique, now a commonplace operation, was pioneered by a Colombia-based ophthalmologist, José Barraquer, in 1950 in his clinic in Bogotá, and perfected by the Russians in the 1970s.
While this has been going on, three disturbing trends around technology and innovation have emerged in the West to undermine its position: First, Western technological advancements are being stolen, misappropriated or simply handed over to the rest of the world for free. Second, even when technological acumen is not stolen, monies earmarked for research and development are being reduced, leading to a lack of technological investment in innovation and the key areas of America’s industry that need it most. Third, a lot of the money left over is redirected to endeavours that have arguably little benefit to society as a whole.
Superior know-how should have always given the West a leading edge. But it didn’t. Even when technology has not been stolen, it’s been given away. Western companies fell for the allure of low costs of production, and set up shop across the emerging world in droves.
The West believed its economic superiority would always win – it was wrong. The technology that was conceived and built for the West’s advantage has ultimately been used against it, and taken for a song.
Just as capital has been misallocated, and labour has been misallocated, technology is also being misallocated. There is no doubt that technological gains over several centuries have been the engine that has powered the West’s economic dominance.
But technology can go too far, and what is known as high-frequency trading is a case in point.
A consultancy company, the Tabb Group, recently estimated that high-frequency trading accounts for as much as 73 per cent of US daily equity volume, this figure being up from 30 per cent in 2005.
So what has this technology done except provide an intermediary with the opportunity to make more money – quickly. To what end technological advancement?
While technology is largely being deployed to the financial sectors, rapidly emerging over the horizon is what Sir John Oldham, a physician and UK government adviser on long-term healthcare issues, calls a ‘tsunami of healthcare needs’.
He estimates that between 2010 and 2050, there will be a 252 per cent rise in the number of people who are sixty-five years old or older in the industrialized West.
So although we are extending people’s lives, the length of time that people will be ill will also be longer. Already in the UK 75 per cent of in-patient stays involve long-term conditions. The cost burdens of this are staggering.
A McKinsey report forecasts that by 2065 US health cost will represent 100 per cent of the country’s GDP, with Japan and the major European countries achieving the same numbing statistic soon after. Because by its very nature such an equilibrium cannot exist, something is going to have to give.
It’s not just education and healthcare that are causing headaches for policymakers across developed economies. There are very real and warranted concerns around energy, and what is rightly seen as an over-reliance on fossil fuels.
Just as the cataclysm of the Second World War revealed the fundamental shift, once and for all, in world power from Great Britain to the USA that had been going on behind the scenes for roughly a generation, so too the financial crisis of 2008 has exposed another world upheaval many decades in the making: namely, the first tangible indication that a new transference of economic power has already begun; that of the West to the East, and perhaps more crucially from the US to China. If nothing else changes, this new transference of power portends to have even greater ramifications than the last.
Now for the first time in over half a millennium it is the East that is in the ascendant, China and India in particular. For the moment it is precisely in economic terms that this change is most visible – but make no mistake, sooner or later, other changes to the ways things are done will be made too.
The continued erosion of the quantity and quality of its capital, its labour and its monopoly in technology has set the American economy on a path of long-term, structural and fundamental destruction.
Over the last fifty years, the West’s policies have principally been policies of exclusion – a culture of ‘us’ versus ‘them’. In nearly all cases, the major international agencies – the organizations that set the policy agendas for world security, economics, trade and development – are dominated by the developed West, with virtually no representation from the emerging world. The G8, the boards of the IMF and the World Bank – the list goes on.
The case for a government-led capitalistic approach (and for not allowing the free market to run roughshod) has seen no more compelling evidence than the 2008 credit crisis.
Nothing would have bolstered the view of the emerging Rest of the need for and efficacy of state-led capitalism than the 2008 financial crisis.
The rising pressure on energy resources is well known. In 2002, for example, the United Kingdom became a net importer of gas; this, after decades of being one of the world’s leading exporters of oil and gas as well as being able to satisfy its own domestic demand. Already Europe imports 30 per cent of its gas from Russia, having depleted much of its own resources. Today, with just 5 per cent of the world’s population, the US uses 25 per cent of the world’s energy.
As oil-exporting countries (and indeed the rest of the emerging world) continue to create their own middle classes that demand (domestic) energy, the global picture becomes even more precarious.
But energy demand is only half the story – the other half is the very real concern that supply is not likely to meet this. A report by the UK Energy Research Council said worldwide production of conventionally extracted oil could ‘peak’ and go into terminal decline before 2020 and that there is a ‘significant risk’ that global oil production could begin to decline in the next decade. US oil production peaked in 1970 and gas in 1973.
The bottom line is this. Given where forecasts for resources are (energy, land, water) there is no way that one billion Chinese can live like 300 million Americans. Ceteris paribus, this is not possible; but it is exactly Western standards of living that the Chinese (never mind the hundreds of millions of people from other emerging states) are striving for.
The logic goes like this: there is a finite amount of arable land in the world and there’s more and more competition to get it. It’s not just private sector individuals, companies and funds leading the charge to purchase land from governments in the remaining fertile areas around the globe.
With 80 per cent of the world’s remaining untilled arable land in Africa it’s not just about competition, but about security, with the side effect of food inflation as food scarcity becomes a relative certainty.
No one ever said it would be plain sailing, but the Rest have something the West hasn’t got – the political mettle to drive the decisions that they need to take to keep their societies afloat.
Herein lies the essential difference between the mindset of the Rest and the mindset of the West. In places like China, the state is paramount and its government acts in the interest of and for the greater good of China as a whole, even if at the expense of the individual. Western governments, in contrast, have embedded in their very foundations that the rights of the individual supersede all.
It may not have seemed obvious at the time, but this undisputed position of Western economic superiority changed for good when, in the middle of the twentieth century, American and Western policymakers made a conscious decision to open up their economies to the free movement of goods and services.
There is a long history of governments – Western ones included – taking no notice of the rules of the game. Indeed, the very countries which were so vigorous in setting up the open markets system were among the first to break ranks.
These practices are not a thing of the past. Even today, the West pursues self-interested policies at the expense of developing countries, be they the US$300bn US farm subsidy programme, the European Common Agricultural Policy11 or the European aeroplane-manufacturing industry which all involve billion-dollar handouts each year.
While China has not always played fair (and perhaps has no intention of doing so – why would it? It’s not in China’s interest), the opening of the US capital markets on the back of the Bretton Woods agreement laid the foundations for when US corporations would become more powerful than the US government itself. This transfer of control helped seal America’s fate.
When US policymakers decided to open its capital account, thereby allowing the unfettered movement of capital through its borders, this set America up for a big fall. Now any returns on American capital invested abroad would end up in the pockets of company shareholders, and they had no obligation to invest their money domestically for the betterment of America; they could just put their money in private secure bank accounts abroad. That’s the beauty of globalization.
More worrying is the fact that the returns accrued on capital go to companies and the wealthy – the two parties most likely to leave the country.
Consider, in contrast, the state-owned sovereign wealth funds across the emerging world, which collect any positive returns on capital earned and distribute them for the benefit of the whole country as they see fit.
Economically the world stands something like this: the US and much of Western Europe are running out of capital, their labour dynamics are damaged (ageing population and falling academic standards) and their grip is loosening more and more on the monopoly they once held in technology. The rising Rest, led by China, but by no means on its own, have money in the bank, a superior labour outlook and a drive to take the technological lead.
If nothing else happens, and growth and structural economic changes continue on the current path, it’s a virtual certainty that America, as well as most advanced European economies, will, by the end of the twenty-first century, trundle along and most likely become, at best, second-tier economies. Hard as this is to swallow, difficult as it is to fathom, and as unacceptable as this notion may be, ceteris paribus, this is a dead-on certainty.
America, and to a lesser extent Europe, could fight back. Rather than sit back and let the apparently inevitable unfold around it without a fight, it could launch a counter-attack. This would, however, require the most radical of solutions, and the most aggressive of political wills.
Across the West, everyone is culpable. As argued in this book, for example, over the last fifty years in the US, governments, corporations and private individuals have implemented catastrophic decisions that at the time looked cost-less, but in fact were extremely costly and detrimental to the core long-term sustainable operation of the economy.
This book has been about economics. While economics is one sort of warfare, one country seeking dominance over another, it’s never just about the money. Other factors, political, social, even natural, shape and modify our world. Change is unsettling, unpredictable. But sometimes some things are clear; there is, if you like, a feeling in the air.