The long arc of Tory progress (and why the SNP can be ignored)

Cameron Boris

On election night, I – unlike some around me (they know who they are) – was not losing my head. I had reasonable confidence of a substantial Tory majority, and had even put my money where my mouth was – being a buyer of a Tory majority at 44 in the spread betting markets. I had one central thesis: that the British electorate does not produce hung parliaments when there is a clear choice before them. Rather, hung parliaments only occur when the parties cannot distinguish themselves from one another (1974, 2010), or when they are unknown quantities (2017, pre-war). By this logic, Boris was in a good position to win outright.

This was despite the best attempts by the media to misread the polls. Like sub-par generals, journalists are always doomed to fight the last war, and the pollster who did “best” last time always exercises a disproportionate influence on their discourse the next time around. This year it was the YouGov MRP’s turn for lazy writers to place too much faith in, never remembering that no one pollster has ever been the “most accurate” twice in a row. In the event, the polls-of-polls were all broadly correct.

Of course there are other points of note about the Tory performance. On the one hand, there can surely be no denying Theresa May her contribution to breaking the Red Wall, and perhaps it really needed two heaves to get there; on the other hand, the media narrative on Boris being unpopular was I think well wide of the mark. Amongst key voter demographics, Boris was a positive, not a negative, and not just in contrast to Corbyn. Anyone who witnessed the acceptance speech by Ian Levy, the winning candidate in Blyth Valley, or to the reactions in Workington or Darlington, cannot doubt how central Boris was and how well he played on the doorstep as a loveable scamp who transcended class in his determination for Brexit.

Yet hidden amongst all the shock and turmoil lies a more profound truth: the Tories have been quietly improving their standing amongst the electorate for the last twenty years. Indeed the party have improved on their share of the vote at every election since 1997. They have also improved on their absolute numbers of votes since 2001 (the one surprise here being the considerable popularity of John Major even in 1997).

Conservative Party vote share and vote totals since 1997

Tory progress

This has not always translated into increased numbers of seats, due to the vagaries of the electoral system. 2017 saw Theresa May lose seats even as she surged to the highest vote share since Thatcher’s first election in 1979. William Hague, too, managed only a single net gain in 2001 despite a whole percentage point increase in votes. But set against this is the extraordinary fact that the party have now managed twice, in three elections, to work its way out of a hung parliament and back into a majority – a particularly difficult feat.

The cherry on the cake, of course, is that for those of us who lived through the dark days of the 1990s, we live to see a Tory government now likely to rule for at least fourteen years, and maybe nineteen. And whereas every other administration has won their biggest victories at or near the beginning (1945, 1966, 1983, 1997) only to see a long slow decline, somehow we have endeavoured to our greatest moment so far at the fourth time of asking, after a decade of being in power and all the scrutiny that comes with it. This is unprecedented and we are I think, allowed just a moment of self-satisfaction.

Majorities won by successive single party governments since 1945

Majorities

The one dark cloud being touted is Scotland. It will prove impossible for Boris not to yield to the SNP for a second referendum, they say. Yet for my own part, I reject this media interpretation. We should be clear that the SNP, whilst doing well in absolute terms, underperformed their own expectations and their previous results, and ended the night a slightly disappointed party. At 45%, their vote share was notably lower than the milestone 50% that they achieved in 2015, at the height of their post-referendum popularity. In seats, too, they failed to obtain the psychologically important 50 seats which they had set for themselves, and which would have cost Ruth Davidson a chilly outing in Loch Ness.

SNP and Conservative Party vote shares since 2015 vs support for Scottish independence

SNP

Source: Scottish independence polling from YouGov / The Times

Reading overlying themes onto partisan performances has its limitations. Reading Brexit results onto Tory or Labour support is impractical, for instance. But this is less so for one-issue parties such as the SNP or the Brexit Party. Their secular decline in their vote share since 2015 reflects the commensurate decline in popularity of the Scottish independence proposition over the same period. Much as the SNP have made headlines with the help of simplistic reporting, they are actually worse off than they have been in the recent past.

And here, given the success of my previous theory, is my second one: the popularity of independence in Scotland correlates directly with the efficacy of government in Westminster – not the nature of that government or its political colours, just plain ability to govern. Hence why the build up to 2014, with a coalition in place, led to one peak; the minority of 2017-2019 another (as were the mid-to-late 1990s). But I predict that as Boris gets his feet under the table and gets on with life, Brexit included, Scottish sentiment will begin to recede. Boris need not pay such calls for independence any heed, and all credit to him, he seems to be headed this way.

Support for Scottish independence (1978 – 2012)

Westminster effifacy

The progress that the Conservative Party has made since the mid-1990s is a tribute to various leaders, each in their way: William Hague for his “night shift”; Michael Howard, the man who arguably saved the Conservative Party with his performance in 2005; David Cameron and his decontamination; May and the recognition of the new tectonic plates of class and economics; and finally Boris, who with his ambiguity over Brexit somehow captured the skeptical but generous spirit of the age. Even Iain Duncan Smith was a useful placeholder. The fact is that this 80 seat majority is a tribute not just to Boris’ political skills, but rather to a long, slow, and painful rebuild which for all its highs and lows, has seen indomitable progress towards power. Just what the Conservative Party has always been about.

************************************************************************

A slightly self-congratulatory update (2 Jan 2020)

First, it seems this theme of long term progress has been picked up by various commentators, such as Martin Kettle at the Guardian, who notes that:

“The Tories have now formed four governments in a row. Remarkably, they have increased their share of the vote for the last six elections. They have 200 more MPs today than in 1997. Those who sit for seats in the north and Midlands have got most of the attention, and rightly so. But the tightening Tory grip in parts of the south that were once marginal also matters. The Tory advance across Wales is dramatic. And they remain a player in Scotland, something Labour can barely claim. They are UK-wide again. And they now have a new generation of MPs who can shape their party.

Secondly, there was an interesting graphic from the Financial Times talking about the Tories and the working class:

However whilst the FT was trying to make the point about Tory inroads, much of this graphic simply demonstrates the underlying improvement in performance, which would naturally eat into traditional Labour voters since Conservative success basically equates to Labour decline. Either way, the choice of 1997 as the starting point is notable and the story a component of what I outlined above in the original post.

Pochettino, Rationalism and St John the Baptist

“There was a man sent from God, whose name was John. The same came for a witness, to bear witness of the Light, that all men through him might believe. He was not that Light, but was sent to bear witness of that Light. That was the true Light, which lighteth every man that cometh into the world.”

John 1:6-13

The news of Pochettino being “relieved of his duties” was one of those events which, while an enormous shock at the time, with every passing day become more and more comprehensible; such that having had a couple of weeks to digest, it now seems the most natural thing in the world. Then Mourinho arrived so quickly that, as the Taoist saying goes, “if you use a sharp enough knife, the cow does not even know it is dead”.

The reason that a certain section of the fans – the majority, I suspect – were so saddened at Poch’s departure was because of how much we had all bought into “the Project”. Almost five and a half years is a life time in football today, and for parts of that, it really did seem that he was the one who had come to lead us to the Promised Land: a new stature, a new stadium, and an end to the trophy drought. Yet it had been clear for a long time that Pochettino also had limitations – limitations which, frankly, may yet prevent him from really becoming a top class manager anywhere else, even if he were to have more resources.

First amongst them was that he never really displayed tactical nous, and was instead a system manager. He belonged, in his way, to a tradition which places the system above all else, a tradition which can be traced from Guardiola, Bielsa and Wenger, all the way through Poch down to the likes of Eddie Howe and Ralph Hasenhüttl. System managers – perhaps we can call them “Rationalists” – when they are right, are irrepressible: their teams play throughout the season as a single unbroken line, constantly possessing, attacking and scoring, not punctuated by the mere whistle of referees starting and ending matches. The end of one game and the beginning of the next is seamless. This is what makes them so resilient and machine-like – scoring against them does not really achieve anything more than insects hitting the windscreen of an onrushing car. When it works, individual moments of adversity make no impact on a team’s mentality or emotion.

Against these Rationalists are the Empiricists, the school of management which takes each match as it comes and deals with them one at a time, often with tailored tactics for specific parts of the pitch or even windows of time. In this tradition belongs Mourinho above all others, the man who makes double substitutions at half-time and who famously defeated Pep’s Barcelona in 2010 with ten men. But there are others: Ancelotti, Allegri and Conte for instance; Marco Silva and, I would guess, even Big Sam. Italy was always the home of tactical men such as Lippi and Trap, with little acceptance of outsider Rationalists such as Sacchi. With them, the moment and the match are everything: these teams win cup semi-finals and finals, derbies, and top-of-the-table clashes. By and large, a siege mentality is useful; but so, too, is the ability to discard players when needed. In a sense, it favours a little bit of the under-dog.

The problem for the Rationalists is that when trying to make the system work, there is a fine line. Success is magnified by compounded success; but loss is likewise exaggerated. There is no “middle”. For an Empiricist, your last game can prove you right; for the Rationalist, only success over a long period can justify the seemingly rigid adherence to the system. Poch did not make substitutions. He did not, until near the end, introduce formational changes. He remained loyal to players at all times. More than anything, he was not good at incorporating new players and needed the constancy of his core group, pressing them repeatedly to come up with the same goods, game after game, season after season.

And this would have been fine, if players had rotated. But the iron law is that either the players have to be freshened up … or the manager does. But there was a further dichotomy with Poch which was that he was so dogmatic that he struggled to bring in new players at all. I believe there is every truth to the claim that he rejected new signings during the summer of 2018, because he did not feel they would fit. Additionally, he did not have a great track record of new signings anyway after the departure of Paul Mitchell in 2016. His teams were always thrown by resets such as summer breaks and even normal international breaks – form was always randomised after such events like the dice in a game of Boggle. Yet at the same time he refused to introduce new talent, meaning the squad was tired out. It was intensity without any possibility to refresh.

Which brings us to what Pochettino should be seen as: not as the Saviour, but as St John the Baptist, crying out in the wilderness before the coming of the real thing. Poch understood that for a few seasons he had to ignore the noise of fans and media and demands for silverware, and just concentrate on stature. The rest would come. He was specifically the right man for bringing Tottenham out of being a probable-top-six club to a regular-top-four one – a role he may be destined to repeat, since if he were to join either Man Utd or Arsenal, they would rightly want this particular trick repeated. His five years at Spurs were a necessary time and place, and he leaves a platform ideal for the next step, whether that be under Mourinho or anyone else. He fit that stage of Levy’s development plan perfectly, and in retrospect, it was never likely to be anything more. Much like Bielsa, he may be destined to never achieve true greatness; and much like St John, he may not himself be the True Light, but rather be destined for undignified decapitation.

Pochettino

Nonetheless St John has his retinue of true followers and believers, and good luck to them. There are those who might want the Rationalist system despite the tactical rigidity and squad management. These are perhaps the purists, though they are destined to be as tangential as the Mandaeans. For myself, despite the initial shock, I am all for the man who may well turn out to be the True Light.

In nomine Domini, Amen

Of China, Brexit, and Consumption Downgrade

Britain China

“Consumption downgrade” has been a term bandied around the China-watching community for over a year now. The idea is that slowing income growth has begun to restrict middle class spending, whether it be on luxuries or the day-to-day. Analysts point to disappointing results from JD.com and NIO, the growth of lower-class commerce platforms such as Pinduoduo and VIP.com, and even the rise of social media such as Toutiao in support of this assertion. The anecdotal reporting, accurate as ever, interprets this as households actively downgrading: yesterday buying a Mercedes, tomorrow buying a Geely.

Yet I would posit a different theory. Whilst around the edges, some downgrade of consumption within individual households may hold true, by and large the evidence points the other way: luxury car sales are forecast to grow at a healthy clip of 9%, for instance, which whilst a slower than the previous decade (the market is clearly maturing) is hardly indicative of like-for-like belt-tightening. Rather, what we are seeing is a stratification of Chinese development, where the likes of Pinduoduo actually serve not the middle classes of today, but the newly emerging consumers of lower-tier cities – “the other 50%” as it were. And here, there is genuinely noteworthy, namely that it now appears many of these newer middle classes may never reach the same level of affluence as the pioneers in Shanghai and Beijing (sketched out theoretically below):

Consumption downgrade

Consequently it is the weighted average of the total incremental growth – in other words, of all the new consumption coming online – which is getting lower. Individuals however are still spending in-line with the past, and even still upgrading. The fact that lower-tier cities may not emulate the top cities is of course some cause for concern – but it is hardly unusual by OECD standards. It merely means that whilst luxury still has a market, mass premium and even mass common have more exciting times ahead. This is important, since is supports signs that Chinese growth remains surprisingly robust in the face of recent headwinds, and in particular that nominal GDP (at this stage in the cycle a far more relevant indicator than real GDP) is stubbornly consistent at 8%+.

On the other hand, “consumption downgrade” has been alive and well in OECD economies for some time now. One need simply look at the emergence of the sharing economy to see it in action: Uber, Airbnb and WeWork are all examples of capacity-sharing which reflect the fact that today’s younger people will never have what their parents had. However trendily dressed up as a “lifestyle” choice, it is not; if given the option, the majority of Uber users would rather have their own car; Airbnb customers would rather be able to afford a hotel; and WeWork tenants rather the funding needed to have their own office. Nobody has chosen to be reduced to this kind of life, although they are putting a brave face on it. It gave rise, in part, to Trump; it gave rise to Brexit; and it is a major driving force for the economy and innovation in the West today:

Social mobility

Source: The Fading American Dream: Trends in Absolute Income Mobility Since 1940 (Opportunity Insights, December 2016)

Which brings us to Brexit. Having long been a Remainer, I see Brexit being a self-inflected economy wound which is less than ideal. However, I have also always maintained that Brexit is a political debate, not an economic one; and it would and should be won and lost on the political questions and not on economic. On political grounds too, I am a Remainer. Nonetheless, it would be remiss not to see the opportunities that Brexit actually does present, not in terms of the fantasistic national resurgence posited by some on the fringes of the Conservative Party – let us call them the Liam Fox wing – but rather in acting as a test bed for innovation in consumption downgrade.

Because ultimately Brexit is a localized process which is only bringing forward long-term secular trends of declining middle-class income which are happening anyway, and which will be increasingly and universally visible across the OECD in the coming years. Britain will merely be ahead of its time. Therefore, any innovations that the British economy produces through this would be well-positioned for the broader decline across adjacent markets, ready to be rolled-out into the rest of Europe and America just as others too begin to experience their own downturns.

McKinsey consumption downgrade

Source: Poorer than their parents? A new perspective on income inequality (McKinsey, July 2016)

What will these innovations be? If I could tell you, I would have a substantially larger bank account; but my own sense is that it lies somewhere in areas such as consumer financing and potentially further changes in shared services. The irony is that the consumption curve for Gen Z will resemble something akin to a Giffen curve. For all the debate between ‘boomers on the one hand, claiming that the kids are “wasting their money on iPhones”, and young people on the other, lamenting that they will never be able to afford a home, the truth lies somewhere in between. The more that large capital investments such as housing feel unreachable, the more people will spend their remaining income on frivolous goods. The current younger generation can indeed be both poorer and more prone to disposable consumption at the same time – something I will for now label the Paradox of Chic Poverty (again, helpfully sketched out below):

Poor get poorer

In short, consumption downgrade is not what it seems (China), and at the same time has been with us for some time (Uber / WeWork / Airbnb) whilst potentially presenting a great opportunity (Brexit). Three cheers, then, for the rich getting richer!

Daily News – Hong Kong protests to emulate the success of King Cnut

Joshua Cnut

In the latest bid for foreign recognition, protestors in the troubled city of Hong Kong have turned to 11th century monarch King Cnut. Organisers hope that Cnut’s influence may bring the movement credibility, and have rebuffed suggestions that the Norwegian’s policy of holding back the tide met with mixed success.

“Like King Cnut, these protests have supernatural powers that show we can in fact hold back history”, said a visibly emotional Joshua Wong, who has been courageously leading the protests from The Front Line, the name of a yacht currently anchored off Bermuda.

“Besides, if this all goes nowhere, just like Cnut some of us will also be able to sail to sea and avoid the consequences.” Speaking via Skype, Wong noted that he could “practically smell the grapeshot.”

“I have been assured that police brutality on the ground closely resembles what I can see online”, although he went on to note that he may have been confusing news reports with back episodes of Peaky Blinders which he has been catching up on.

Asked about Wong’s likeness to the long-dead Norwegian, one local store owner in Causeway Bay suggested that Wong may have chosen ‘Cnut’ only due to a misspelling. “They’ve burned down my only way home now so I guess I’m going to have to swim across to the New Territories. But that’s what real freedom is, right?” another said.

Unconfirmed reports suggest that the protest movement is also taking advice from Ned Ludd.

On the big picture, the Hong Kong protestors have got it wrong

Even an effective government could not achieve what many assume would be the paradigm of a future in offshoring

HK protests

The protests in Hong Kong have had quite a few different narratives – the extradition treaty, democracy, police violence. Amongst one resolute strand of this riotous assembly, however, lies the optimistic idea that with a few tweaks here and redistribution there, the fundamental economic model of the city is a sustainable one. In that context, many protestors feel that it should be left well alone to prosper with its trade and rule of law. The only problem is, this is not true for at least two reasons, neither of them immediately do to with China.

The first is, as I have previously expounded upon, the changing shape of regional trade and the underlying end of entrepôts as they have historically existed. The vast majority of such centres’ lifeblood comes from a structure of trade which only exists in broadly imperial contexts. Nonetheless, even given that change, the world still sustains Bermuda, and Luxembourg, and Switzerland. The second point, therefore, is that Hong Kong could not emulate any of those examples, because ultimately it has too many people, and they are too poor.

To demonstrate the structural limitations of Hong Kong’s economic development, I have contrasted several key metrics against a selection of jurisdictions who represent, to a greater or lesser extent, paradigms of what an independent trade-based Hong Kong is supposed to look like. For this exercise, I look at Singapore, its long-standing regional counterpart which faces its own problems; three European examples of various sizes (Switzerland, Luxembourg and Malta); and finally the true offshore example of Bermuda although this has limited statistics.

One basic point is the city-state’s size: unlike other “offshore centres”, the population is of the same scale as Singapore and Switzerland. We will look at per capita numbers below but it should be remembered that absolute population size brings its own difficulties, not least in terms of proportionality between the offshore centre in question vs the large economies they seek to serve. Bluntly put, OECD economies can ignore Luxembourg, Malta and Bermuda as competitive threats; Switzerland, Singapore and Hong Kong they will keep a suspicious eye on – and have been closing in on for decades.

Total population (m)

HK chart 1

Population density (‘000 people per sq km)

HK chart 5

Source: CIA Factbook

So then onto the per capita numbers. We know that Hong Kong and Singapore are by far more densely populated than other “offshoring centres”. This has an inevitable knock-on effect of downward pressure on wealth (not least property) – median asset ownership per capita is significantly lower in Hong Kong and Singapore than Switzerland and Luxembourg, and only on a par with somewhere like Malta.

Median assets per capita (US$’000)

HK chart 2

Source: Credit Suisse Global Wealth Report 2018

Why does this matter? Well, there are two further calculations that arise from these figures. The first is the population size to asset base, which tells us whether a given country might be considered relatively over-populated. By this score, Hong Kong fares poorly, at more than double that of Switzerland and almost double Bermuda and Luxembourg. The wealth base of a country represents all the things it has accumulated over time and gives an indication of the future – ranging from capital assets such as production capability to softer things such as IP and skills. The higher this ratio, the more people there are dependent on a flimsy asset base and the more susceptible it is to the vagaries of neighbouring economies.

Ratio of population to asset base

HK chart 3

The second calculation is that of inequality. For this, I use my proprietary “Pang Coefficient” instead of the rather dated Gini numbers, where as a rough rule of thumb I look at the ratio of mean to median wealth per capita – the greater that ratio, the greater the inequality. (The antiquated use of Gini, which is based on incomes and therefore ever less relevant, is the subject of another discussion). In this, Hong Kong again stands out, being notably higher even than Singapore which is partly to do with Singaporean policy of public housing. And whereas Malta is even more over-populated than Hong Kong, this is mitigated somewhat by its equal spread of wealth.

Inequality as measured by ratio of mean to median asset distribution (the higher, the greater the inequality)

HK chart 4

When we put this together, we begin to see a picture of where Hong Kong lies in this landscape of offshore centres. It is the only one of these jurisdictions which suffers the double-whammy of being both over-populated and highly unequal – and the unrest it is encountering today is the result:

HK chart - full

Notes: inequality axis based on Pang Coefficient score +/- the average for the group; over-population score is based on population-to-asset ratios +/- the average for the group; size of bubble indicates total asset base.

Hong Kong did not exist two hundred years ago; and it will not exist in two hundred years from now – at least, not in the way it has thus far. The Asian entrepots are a curiosity of time and place, as a rent-seeking tolling gateway to an imperial trade flow which had fat margins during that structure. Those fat times led to an abnormally swollen population which, accepting inequality, were able to be live off the crumbs of the China through-trade. As those imperial structures receded, the margins have become thinner also, meaning that the number of people which can be sustained from that base will have to decrease.

It has been well-noted that house pricing is the most prominent driver of the current discontent – I have previously written on the “aspiration deficit” for young people in Hong Kong and Taiwan due to their comparative uselessness within the modern economy. But the reality is that even solving this through redistribution will only alleviate the problems for a while, not long term. Furthermore, the reliance on property rather than capital assets for wealth within the Hong Kong economy (it just does not and cannot “make” anything) severely limits the efficacy of this. Unlike redistributing the “means of production”, redistributing land is only going to reduce the value of the land leading to a division of misery all round. Any gains made in equality would be more than offset by a reduced asset base.

In other words, even a good, effective, popular, well-meaning government of an independent Hong Kong would not actually resolve the underlying issues from which the SAR is suffering. Bermuda does exist – because it is tiny and serves a niche that Hong Kong is far too big for now. Switzerland makes stuff – Hong Kong does not. There is nothing Carrie Lam or her successors can do about the diminishing role of entrepot states within the multi-polar post-colonial regional and world context. And here we face the other problem of Hong Kong: parochialism.

Those fat-margined imperial times also created a whole rent-seeking mentality amongst a (largely immigrant) population who are ill-equipped for the post-imperial age. The youth of Hong Kong are notably unadventurous and unenterprising; if they were offered steady civil service jobs which could lead to buying a small apartment, most would take it. Despite having the world’s third largest financial centre and the world’s second largest market on their doorstep, there are few startups of any scale and the lack of innovation is astonishing. Whereas 2m of Taiwan’s 13.5m working population is abroad, mostly in China, only a fraction of the same can be said of HK. Furthermore, overseas Taiwanese inhabit many Mainland startups and businesses in Beijing and Shanghai; I have yet to meet a single Honkie in the same position. Hong Kong was adventurous in its birth but is not as it approaches its death.

The travails of Cathay Pacific demonstrate in microcosm that Hong Kong’s destiny simply is not in its own hands; being a better airline does not save Cathay from the fact that people do not need to fly through Hong Kong to reach their destination. Furthermore, many wealthier Chinese actually prefer Chinese airlines, strange as that might seem, because ultimately mature markets will have their own localised preferences, and the outsider – however international they pitch themselves as – will never provide this as well. Of course, Hong Kong exercises a disproportionate position within the sentiment and consciousness of foreigners, because like locals, those foreigners need to believe that China would continue to need Hong Kong. If they do not, the role of foreigners and their comfortable if tenuous existence disappears also.

Arguably though, the end of that world was symbolised as long as ten years ago by the closure of the Far Eastern Economic Review, a journal valiantly propping up the viewpoints and pretences of the post-colonial 1.0 model. Looking forward, the people of Hong Kong will have to move on – either, optimistically into the GBA where house pricing and other pressures will be alleviated; or else through emigration or even lower birth rates. The positive version of this story is one where younger people embrace the opportunities in China and start making something of it; but having now lived and worked here, I would not hold my breath.

Physics, philosophy and why people don’t want “Centrism”

Physics & Philosophy

For a while, it seemed that “centrism” was back on the agenda. In the US, Howard Schultz, the “burnt coffee magnate”, was considering a run for Presidency and was only one of a long queue that included Beto O’Rourke and Michael Bloomberg (who has decided not to run). In Britain, renegade Labour and Tory MPs founded The Independent Group, designed to coral a fragmented anti-Brexit sentiment in into a movement, replete with the usual platitudes about a “new type of politics”. Every centrist potential presidential candidate is feted by the media as an answer to Trump and AOC; the TIG has actually had success in forcing policy changes from the Labour Party. It seems that, three years after the events that led to 2016, and two decades after the Third Way of Bill Clinton and Tony Blair, sensible politics was hoisting itself back into the public consciousness and relevance.

But here’s the problem: people don’t actually want “centrism”. Politicians on both sides of the Atlantic have taken onboard the very real desire for non-partisanship and somehow mangled this interpretation into support for centrism which is about as far from reality as they could be. It is unclear whether this misunderstanding is at least rooted in good faith about what ordinary people want, or whether it is part of a more sinister move to hijack the non-partisan agenda into something more appealing to those who only ever considered Trump and Brexit as aberrations. Indeed, from some parts of the spectrum supporters of these centrist trends are even preparing themselves for failure, by raising the red herring of “polarisation”. According to this, it is the public’s problem – they are too polarised these days to accept the logic of centrism. Shame on them.

There are two principal reasons why centrism is destined for failure, and none are the problem of the electorate. They are rooted in the two things which centrism stands for. First is compromise. There is some truth to the idea that the electorate is too polarised for compromise today; but this has always been the case. In politics, compromise has rarely been highly regarded since it inevitably results in the worst of all worlds, and usually are a by-word for kicking the can down the road. The Missouri Compromise or “Don’t Ask, Don’t Tell” come to mind for US history. The Barnett Formula, the EVEL answer to the West Lothian Question, and even the British opt-outs at Maastricht in 1992, are cases in point for Britain. The fact is that compromise is rarely satisfactory and tells of an inherently unstable equilibrium which as yet still needs to be resolved. Voters are quite tired of this given the questions thrown up by two decades of globalisation, automation and the 2008 financial crisis, and compromise is not going to answer them.

The second reason is that “centrism” above all (be it consciously or surreptitiously) is about defending the status quo – the exact opposite of popular opinion today. Whether Schultz or the TIG, advocates of the new politics are effectively trying to preserve a now discredited consensus around major issues of the day including free trade of the sort we have come to know, liberal immigration, a focus on GDP, the pursuit of “growth” and exports, keeping interest rates and inflation low and above all the protection of large corporates rather than SMEs. But that is from a pre-2016 world. Today the electorate, having been woke by the events of that year want something quite different – in a weird way, what they want is not centrism but extremism at both ends. Yes, they want to break the deadlock of existing parties, but they don’t want to return the consensus of old. Yes, they do not want the old “Left” vs “Right”, but neither do they want the compromise and consensus of the old “Centre”.

I have previously referred to what I call the Physics and Philosophy paradigm, and it is perhaps worth explaining more here. The problem with studying physics and philosophy is that each seems so different at the beginning and none of it makes sense until the loop completes at the end. Nothing makes sense until everything makes sense – whether in academia, business or anything else.

PhyPhi

Politics, too, is like this. At the beginning, one only sees things labelled for us as “Left” and “Right”, and the expanse of the political firmament is limited by lines of sight from traditional perspectives. Hence, at the beginning of 2016, this is what the American political world imagined it was seeing:

PhyPhi - pre 2016 politics

What we do not see at first glance is how these two ostensibly opposed directions may link up again at the other end of the circle. Yet if we tilt the planet up to peak behind, it is revealed what the political firmament had become by the end of the that year:

PhyPhi - post 2016 politics

Trump and Sanders were not, at the end, all too far away from each other in many of the crucial questions being posed on a number of areas such as trade, international companies and overseas cash-piles, and even infrastructure and healthcare. Both had moved right around the planetary orbit until they almost met again at the other side – the dark side of the planet invisible to the conventional commentariat sitting comfortably on the light side. And in that dark side are all the commonalities which are so hard to digest, principally amongst them the sense that the starting point for policy had to be the domestic and national, not the trade or people beyond the borders. In a sense, Trump and Sanders were in the “centre”, but a “centre” a world away from the “centre” prescribed by Bloomberg. The old centrists are wrong: their centrism was not being rejected due to cultural, regional and partisan polarization – it was not because the two sides were too different, but rather because they were too similar.

And this, ultimately, is where we are today. The TIG’s polling numbers have dramatically collapsed in the face of Nigel Farage’s new Brexit Party, declining from the mid-teens to low single digits since the party’s inception earlier this year. Bloomberg never ran. Howard Schultz has been non-committal about a presidential campaign and Democrats have been begging him not to run; the likes of known centrist Amy Klobuchar are failing to gain traction whilst complete outsiders like Andrew Yang are doing so. Yang, if anyone, is the 2020 heir to the 2016 dark-side-of-planet movement.

“Centrism” is an idea of a bygone age, one where the recent past was a story of success, where defending the status quo seemed like common sense and where just a small amount of compromise would be enough to navigate through foreseeable difficulties. But politics has changed in the last few years. Whether you are for or against Brexit, or whether you are for or against Trump or Sanders or Andrew Yang, the stasis engendered by the old “centre” is as irrelevant as defeating Communism or the Nazis. Although much of the mainstream media remain seduced by the familiarity of what was, voters on both sides have moved on; and most of them have now marched so far around the unseen side of the planet that only candidates who themselves see the future, will be positioned to reap its rewards. Centrism is dead; long live the Dark Side!

 

 

Out really means out – why Britain should reject the “WTO option” even under Hard Brexit

brexit-trade-barriers-810x521

The sheer amount of ignorance in British public discourse about how trade works is one of the most disappointing lessons from the whole sorry Brexit drama. As a Remainer I have no qualms in picking out the likes of Dan Hannan as an example of this, whose comprehension of the subject (and of economics in general) seems to have been plucked from half-remembered A-level text books, or, at a stretch, incidental discussion from reading History at Oxford. Amongst his favourite refrains is that which tells us that “at least we will still have WTO to fall back on”. Yet of all the options, this is probably the very worst. In the event of Hard Brexit, Britain should actually reject the WTO too.

This is not the place to get into the minutiae of what the WTO actually is or how it works. There are plenty of people who have written in easier detail that I can about this. Instead there are two common misconceptions about the WTO which need to be digested before we even get onto whether it is good for Britain or not. The first is that the WTO is not actually about regulating tariffs; its core notion is that of making sure that everyone abides by the Most Favoured Nation (MFN) principle, meaning that however you structure your trade (higher tariffs, lower tariffs, no tariffs) you must at least treat everyone the same. Clearly, this is a starting point on lowering tariffs but it does not actually reduce tariffs in and of themselves. Secondly, the WTO is not a single set of regulations, but rather applies to each country differently depending on their schedules of entry. In other words, upon joining the WTO, each country basically agrees to its own unique set of tariffs and commitments.

The blog referred to above gives the helpful example of shoes – a sector in which the UK happens to be an exporter:

8% is charged by the EU on shoes imported from all other WTO members (except under a free trade agreement, such as EU-Japan, or preferences on shoes from developing countries). The import duty rate in other countries will be different. The US’s import duties on shoes vary from duty-free to around 10% or higher. Japan charges 20%–30% duty on many shoe imports.

In other words, the WTO does not set monolithic rules, even at a lowest common denominator, as many casual observers seem to believe. The reason I highlight this is to emphasise that the WTO is not some magic bullet for providing a minimum level of trade freedom. It is merely a mechanism for getting countries to discuss ways to lower tariffs. How much each country has to commit to upon entry to the WTO is, much like any other trade deal or indeed any other non-deal trading relationship (which is how most trade is done), dependent on their economic strengths. A larger economy, offering both greater consumption power and usually some irreplicable exports, will always get a better “deal” out of the WTO as a whole (or any other trade negotiation such as an FTA) than a smaller economy. With or without the WTO, with or without an FTA. That is just the way life works.

Moreover, the WTO largely does not cover services, which matters for Britain. After all according to the ONS, British services exports constituted 44% of total exports in the 2017-2018 fiscal year, representing a trade surplus of +£107bn (+€124bn) compared to the trade deficit of -£139bn (-€161bn) in goods. Contrast this with Germany, France and Italy for instance who have a trade surplus in goods and deficit in services. Yet if you delve into the WTO’s website to look at something like architectural services, something Britain has had some success at, you will find the following wording:

Currently, architectural and engineering services, like all services are included in the new services negotiations, which began January 2000. Principles of trade in architectural and engineering services are contained, like for all services, in the GATS.

In other words, nothing has been agreed. The same wording applies to everything else including finance, law, advertising and so on. GATS itself, the precursor to the services agreement, is essentially toothless. As a result, you might have noticed that prior to the Brexit referendum in 2016 nobody anywhere had been talking about the WTO for almost a decade. Instead, partly in order to cover services, most countries have gone on to think about regionally integrated trade deals like ASEAN, the TPP, APEC, the East African Union, Mercosur and, er, the EU.

The problem for Britain is that the WTO is an unfinished project. People seem to forget that the intention for global “free trade” was supposed to be a multi-step process, starting with the trade in goods before moving onto the trade in services, tackling non-tariff barriers and eventually encompassing freedom of labour and capital. The trade in goods came first, naturally, because in the era in which the GATT discussions commenced, most economies including the OECD were still ones that made stuff. There was no real asymmetry in economic structure at that time and if anything, GATT and WTO were forecast to open up emerging markets to developed nation goods such as industrial equipment whilst the latter continued to develop their basic industries such as agriculture and natural resources.

However over the course of time this changed. The OECD became notably more services-based, including in their export mix. On the other hand the emerging markets, led by China, came to dominate the manufacturing industry not just at the low end but increasingly at the higher ends too – Korean autos for instance, Chinese industrial equipment and so on. It was therefore imperative that the next phase of global “free trade”, that of services, was completed – but it never was. The Doha Round, in the back of everyone’s memories, collapsed ignominiously. China’s accession to the WTO in 2001 on these ossified terms has probably contributed significantly to its rise and America’s comparative decline. It certainly led to Trump. If you are a modern economy, the WTO is probably bad for you.

We have not even touched on the specifics of how and whether Britain could easily join the WTO and on what conditions. The likelihood is that Britain could join pretty quickly – if it did so exactly on the current EU schedules (ie the 8% tariff for shoes above). But as noted, each set of schedules was designed to suit a specific economy and the existent schedules suit the EU as a whole. With a focus on protecting agricultural exports for instance, they are probably not ideal for Britain. If it wanted to join on a different, bespoke set of schedules, this would require agreement from all WTO members which would almost certainly throw up objections both legitimate (British government subsidy for financial services for instance) and illegitimate (Russia or Argentina purposefully creating trouble). Furthermore this would require time, unlike the replication of the EU schedules – the shortest period of time for a WTO accession has been several years.

This brings us to the central conclusion that if Britain goes through with Hard Brexit, it would be better to reject the WTO altogether and act unilaterally. The WTO as it exists today suits some countries like Germany and China and Japan, but specifically ill-suits the UK given the commitments Britain would have to make on accepting manufactured goods but getting no such commitments on services in return. Neither is Britain a big enough an economy to enter into renegotiations to remake the rules in its own favour, as the Quadrilateral could. Moreover, rushing into the WTO would actually undermine Britain’s ability to strike independent trade deals as most of what it has to offer – a market for consumer goods – would be given up already. Leverage in bilateral negotiations by trading goods access for services access, would be eliminated including with the EU.

Indeed in recognition of Britain’s place as a middle-sized economy, it makes more sense to try and protect certain industries, even at the cost of near-term price increases.  Whilst signing up to the WTO does not restrict Britain’s ability to lower tariffs, it would prevent the country from strategically increasing tariffs where necessary, for instance incubating industries struggling to find their feet after seventy years in the wilderness. The fact is that a vibrant SME sector really only exists in economies that have reached a critical mass in exports such as the US, Germany and Japan. For all other economies, creating national champions is a better guarantee of long-term economic survival (more of this in future posts).

Brexit is a political, not an economic, debate. That political choice should be made on its own merits, but decisions about trading relationships need to be clear-headed afterwards. Relying on the WTO sounds like a short-cut for preserving some stability for British trade, but it is a false friend. The reason why nobody else pays attention to the WTO anymore is the same reason why Britain must abandon it too – if indeed it actually ends up with Hard Brexit come 29 March.

Why the Hong Kong passport is probably better than China, the US or Britain

passport-grid

Various sets of passport rankings have recently come to my attention, for the most part offered by private wealth management firms discussing how best to migrate for asset protection. Looking at this carefully though reveals a great deal of lazy thinking which mostly show rankings like the following:

Henley rankings

Source: Atlas & Boots 2019

This kind of assessment has become confused in recent years given the slow evolution from full visas to visas-on-arrival and electronic visas, as the above table demonstrates. For me, a visa-on-arrival satisfies the “get on a plane right now” rule, whereas electronic visas, whilst making life much easier, does not. Even without these nuances however, it should be obvious that the major problem with this simplistic ranking is that not all countries are of equal attraction, and the fact that one has visa-free access to Belize probably should not be considered on the same level as visa-free access to the European Union.

To combat this problem, a few more useful rankings have been created, looking at exposure to GDP and exposure to population for instance (a full overview of the various rankings can be found here). Both are useful in their way, but neither tell the full story. Of these various systems though, my preferred one is that created by Simon Black on his investment and thought blog The Sovereign Man (a great name, I must say) which basically uses a formula of 50% GDP and 50% “attractiveness” based on various things like UNESCO World Heritage sites and so on. This produces a rather different ranking and one which makes a lot more intuitive sense:

Sov Man passport rankings

The heart of the matter, as can be seen in the central columns above, really revolves around who has access to both the US and China, of which there are very few. It is pretty clear that of non-tinpot countries, Japan and Singapore have the best passports by some distance and reflects the two countries’ substantial efforts to build the access network over the last few decades. Given their economic model, this does merit praise for the foresight and dedication – Japanese people are restricted only from Russia and some parts of the Middle East and Africa, with Brazil needing an e-visa. Altogether a very generous deal.

Japanese passport access as of 2018

Japan passport

Source: The Sovereign Man

Yet there is still an additional angle I would like to look at, which returns us to the “economic opportunities” component of such an analysis. Currently, a GDP-based ranking typically favours OECD passports since they have access to the US, the EU and Japan. But the problem is, this reflects the past, not the future: if you were a businessman, investor or entrepreneur today the historical economic clout of individual countries is not the important metric; rather it is the areas of future growth. To this end, I wanted to look at where global growth is coming from and the best proxy I have devised is that of the 5-year forward incremental GDP additions, as forecast by the IMF. In other words, how much more GDP is being added by each country over the next five years, in dollar terms. Furthermore, I also applied the IMF’s PPP adjustment to these, which as discussed previously on this blog, is I think a meaningful if imperfect way of looking at spending power. This is again relevant from the perspective of someone trying to understand where real economic opportunity might lie.

Therefore when looking at this “economic opportunity access”, a completely different picture begins to emerge. I do not have the resources to put all the numbers through for every nationality but below take a small sample to give an indication of my point:

Passport rankings

Note: 5-year forward adjusted for PPP; e-visas (eg India) are weighted at 50% access

I have looked at just four passports (China and the US, Hong Kong and the UK); and looked at the access to the ten largest countries of future opportunity. In this analysis, Japan and Singapore would of course again come out on top since they have access to almost every country on the list. China and the US, as the largest economies, are included merely for benchmarking. But looking at third party countries one can see that Hong Kong maintains quite an advantage. The UK for instance represents most of those countries in the OECD which “side” with the US; whilst Hong Kong represents many of those who do not. Based on the top ten future economies, a Hong Kong passport holder has visa-free access to an additional US$7 trillion of GDP growth in the next five years compared to the UK. In many ways, it is positioned for the future like few others.

I will finish with the caveat about all this offered by Simon Black, and which applies to my analysis also:

The only goal behind The Sovereign Man Global Passport Ranking is to assess each passport’s quality as a travel document. We did not attempt to measure the merits of being a citizen in any country. This means we didn’t account for any country’s political stability, wealth of its citizens, freedom of press and speech, ease of doing business, or any other factors. And we didn’t account for the ability to move to another country with the passport. For example, Portugal’s passport didn’t get any additional points because Portuguese citizens can freely move to any other European Union country such as France or Germany. The goal of this project was to assess each passport’s quality as a travel document only.

Nonetheless, even with this caution I believe it is an important way to look at this passport analysis over which so many fight so fiercely. From a business perspective, not all economic access is the same.

The Chinese New Economy: Alibaba as Sauron and why the old economy will be the winners

Sauron eye

Anyone familiar with the Chinese new economy will be aware of the rise of the internet giants of Alibaba and Tencent, along with their satellite businesses. Most will also be aware of the largely exclusive ecosystems within which Chinese online life is led – platforms that encompass everything from messaging to shopping to transport to payments and beyond.

It seems astonishing to remember that barely five years ago many commentators fretted over whether China could ever achieve real innovation. The Harvard Business Review for instance posed the question “Why Can’t China Innovate?”, baldly stating:

Can China lead? Will the Chinese state have the wisdom to lighten up and the patience to allow the full emergence of what Schumpeter called the true spirit of entrepreneurship? On this we have our doubts.

This of course is all rather a fading memory now. Innovation can broadly be divided into three areas: upstream (essentially, “how it works”), midstream (“how it’s made”) and downstream (“how it’s used”). For years, China as a manufacturing hub had made quite noteworthy progress on midstream innovation but most uneducated observers – including many in government – have an unhealthy obsession with upstream blue-sky invention. Yet as we can see with the likes of Berners-Lee, inventors are rarely rewarded and rightly so, since the real creativity and invention from the likes of Steve Jobs, Mark Zuckerberg and Jeff Bezos is in the downstream. Jobs was an arch innovator in how technology is actually used and therefore spread through an economy, with a vision of how lives are actually impacted and changed. Chinese companies, particularly through the big online giants, are clearly doing the same: modern life in China is now lived in quite an advanced but different manner to modern life in OECD countries. Alibaba and Tencent have contributed towards the creation of a real and organic Chinese modernity and technological innovation within China arguably outpaces even the US even leaving aside issues of theft.

So it is worth spending a moment to look at these two major ecosystems and how they really behave – who they are, as it were. First, there is a question of why ecosystems exist in China in the first place in a way which outside of China they do not. Amazon comes the closest of the American tech players to demand a closed ecosystem but even they seem to find limits. Western shareholders have always rewarded single-capacity specialization, and often find the idea of any conglomerate absurd, let alone a tech company offering bicycles and banking.

In China though, this has been natural, for two reasons. First, there is the historical socio-anthropological tendency within Chinese society to build a “closed loop universe” within one’s own family or clan, which has extended to the national level through the Communist Party and SOEs. My own preference for explaining this remains Karl Wittfogel’s hydraulic empire theory, which tells us that most ancient civilisations relied on centralized power to deliver water to its people, enshrining the principles of autocracy and top-down governance at the government and family level. This in turn typically leads to closed-loop systemic thinking since everything has to work together or else nothing works – diversity of thought is only bad news. Secondly though, and somewhat ironically, these ecosystems have become so broad precisely because they are making up for assurances which the Chinese government cannot offer. When you make a purchase on TMall, you have more faith in the Alibaba-backed guarantee that your products will be delivered and that your payment is safe, than one does with the disparate parts of the national banking, postal or legal system offered by the government. The tech giants had to offer a total universe, or else consumers would have been reluctant to actually engage with the new business model in the first place.

Chinese ecosystems (2)

Source: SCMP

So much for why they exist – the bigger issue is how to understand who they are, what their personalities and identities are and how they should be understood from the outside. One possibly analogy, given their conflict, is that of the Cold War. In this world, Alibaba are the Soviet Union – a sprawling empire with a strong centralized view on how things are supposed to be done. Tencent on the other hand are the United States, a beacon of freedom and inspiration but which has its own agenda focused on generating and owning consumption. JD.com are Britain: commercially-minded, focused on trade and fully acquiescent into the American (Tencent) world. Lastly you have Meituan – which owes its existence to Tencent, but like France to the US is entirely ungrateful and maintains the pretence of wanting an ecosystem of its own.

Upon reflection however, a new analogy came to me which may be a touch more accurate, which is Middle Earth. In this version of events, Alibaba are indisputably Sauron, the lurking, evil presence which looks across the lands of men with an unrelenting will to dominion. They provide you the tools to “help” only so that they can own them and you. They invest in you because they need to control your system from the inside. Resistance is futile; eventual subjugation can be the only outcome. The interesting one is Tencent, who I liken to the High Elves of Rivendell. The things about the Elves is this: they are generally on the side of good, and can facilitate it; but they are not themselves a force for good since they sit far away from the battle, detached from it all. They too provide tools, but they may not tell you how to use them; their attention is ultimately elsewhere. The forces of Men ranged against Sauron – let us assume these are essentially a proxy for traditional retail and consumer business in the region – ultimately have to find the solution for themselves, aided at times by the Elves but not reliant on them. If I were to stretch this analogy ad absurdum, perhaps this makes the Dwarves JD.com with their grubby focus on gold and commerce; whilst Meituan the slightly nobler Rohirrim, since they, er, move around a lot on delivery scooters like the horses of the Riddermark. Which start-up will be the valiant hobbit which destroys Alibaba, God only knows.

The serious point to all this is that for old economy companies, it feels like making a choice is inevitable. But the more one looks at the giants of the new economy, the more apparent it is that in the conflict of “internet+” vs “+internet”, it will likely be the latter – especially established asset owners – that win out. In particular, it is difficult to imagine that in this inflated global asset price environment, that the business which need, as Alibaba and JD.com especially are doing, to build out a network of physical infrastructure can be the eventual winner. Well, maybe one early mover can, but the world is not about to be flooded with online victors – by and large, the winners will be whoever of the old economy players adapts best to the new, rather than a new economy player.

And this then comes down to the vision thing. I have another analogy: I call it the “Physics & Philosphy” dilemma™. P&P is a little known but highly intellectual degree at Oxford (arguably the most esoteric of all) which combines two subjects that are not immediately connected. Yes, it is true that in the first term, courses such as Logic may play a part in both areas but then it would appear the two diverge. Yet we should see this like the rings of Saturn: you start off at one point travelling in two opposite directions on the ring, and whilst they move far apart to begin with in the end they meet again. In P&P, the questions at the other end of the circle see the two disparate subjects poetically rejoin on questions such as: what lies beyond the Universe? What happens if time stops? What if light bends? What is not obvious when you start the degree, become enormously obvious by the time you end it.

And seeing what is on the other end of this ring – what exists on the “dark side of the planet” as it were – is the very thing that marks out business geniuses from mere mortals. It took Amazon 14 years to become profitable, but there seems little doubt that Bezos had an idea of what lurked out of his sight in the distance. Likewise Jobs as he labored through various versions of Apple. But the point is, old economy companies can equally achieve this. We know the famous examples of IBM and Intel reinventing themselves based on their competencies; Apple itself did so. Further back in history are companies like Berkshire Hathaway and General Electric, and even Nokia who started life in rubber products. Reinvention is hard, but the world has not ended just because a series of new giants seem to own everything in sight. If the old economy is to learn anything, it is that with courage and vision, and a will to innovate internally if imperfectly, the future is still going to be theirs. For every Amazon which succeeds, there will still be a dozen Walmarts and Targets which make it, stronger than before.

The technology giants will go down in history mostly as the midwives of change, delivering the new baby to their old economy counterparts. We are already seeing them do this, below the surface as Alibaba and JD.com start to crystalise value in real businesses where they can (finance, technology etc rather than the core e-commerce platforms which have rarely made money for anyone). In many ways they are merely pioneering the examples of what the future looks like, so that old economy companies can learn from it but probably implement it better – the Chinese O2O supermarket businesses are a case in point. Indeed the cheerleading nature of the new economy player’s roles in businesses like retail, ahead of its time, loss-leading and ultimately doomed as a standalone business, begs another more controversial comparison. The tech giants are St John the Baptist, crying in the wilderness; the old economy players are Jesus.

Why commentators like Martin Wolf are still firmly thinking inside the box on China

aging-population

China’s rise is not about following the conventional economic norms, and the reality is that an ageing population is probably better than a young one

China has always been a black box. For the whole of my professional life, companies (investment banks being amongst the worst) happily hire someone – anyone at all – who claims to know the Chinese market if they can make even a sliver of money. Consequently, these people are given free rein to build their own silos. For boards in London or New York, China remains “a faraway nation of whom we know nothing”. It is from this mysterious, exotic ignorance that reliably insightful commentators, from publications which should know better, produce some tired answers to tired questions. Sad to say, amongst them was a recent piece from Martin Wolf at the Financial Times titled The Future May Not Belong to China.

Now, the future may very well not belong to China. Much of what Wolf outlines from his Capital Economics report (rather too much from one source for my liking) is unarguably true: the over-investment, the under-consumption, the increasing corporate debt and reliance on exports. But they only change from fact to “problem” when seen through the same old prism of economic development. China though has been disrupting the whole framework through which one sees these issues, confounding a whole mini-industry of untiring China bears. Who can forget the inflation crisis of 2010 – 2011? The Chibor crisis in the summer of 2013? The stock market crisis in 2015? The capital outflow crisis over 2016 – 2017? In each of these and many others besides, China was to be “found out”; it never was, not because the facts were inaccurate but because the basis for observation by outsiders was so incomplete (although to be fair some of the facts were also inaccurate). The fact that the naysayers and doom-mongers have been consistently wrong may be a cheap point to make, but it is worth making nonetheless. The only laws of economics, it seems, are the ones amateur journalists derive from their undergraduate readings of Adam Smith, Ricardo and Keynes.

china bears

A non-exhaustive list of China bear headlines since 1990

However I would submit two additional unrelated and possibly more controversial theses. The first is that the way China encounters these perceived crises is actually a mark of its success in terms of being on a pathway to global power, rather than a failure. There is a reason why China encounters “difficulties” where Japan, during its own precipitous rise in the 1970s, did not: China is actively trying to change the world it is living in. These crises are the tremors generated by moving tectonic plates, as Chinese objectives grate against the rules and outcomes it is being measured against. Currency and capital flows, interest rates, debt and the banking system – these are all examples of Chinese policy that do not make macro-economic sense until you factor in that it wants to change the system and if it plays its cards right, it probably can. We are faced with the first occasion since the United States back in the 1840s, where the world may have to accommodate a new power, and accordingly the rules will change. For China, this friction is good.

japan china gdp

Source: The Economist (2010)

To run through just one example of this, let us look at capital outflows. The reason capital outflows seem like a “crisis” is that the Chinese government wants to control the currency rather than let it be determined by the market. To pay for this, it must use foreign exchange reserves to keep the exchange rate stable. This becomes a huge cost when the environment is weak – except that the reason China does this is to try and make the RMB a regionally accepted trade and reserve currency. This could be done through just trade alone, but in China’s case it will also be done through the crypto-imperialism of the Belt & Road and other initiatives. If it succeeds, it will both eat into America’s ability to project power through the dollar, as well as ultimately encourage greater consumption of Chinese-made goods which in turn once again brings capital flows back into balance. It is a risky and expensive, all-or-nothing gamble; but unlike merely acquiescing into the current world system, if it succeeds it will have changed the regional financial and trade landscape. A price, some would say, worth paying.

The second thesis focuses on the cliché that China may be facing the middle income trap – that it may “get old before it gets rich”. This is typically paired with the curiously British trait of enthusiasm for India as an alternative story. Yet I would argue that with the coming of automation, China is actually on the right side of history on this and that far from fearing age, the adage should be turned on its head: for many comparable countries it is youth, not age, which will be a great peril; and these countries may be too young to ever get rich.

We have for some decades been fed the neoliberal trope that a younger population is good for the economy, and that pursuit of youth, through birthrates or immigration, is a Good Thing. Yet we are fast approaching the point where this notion is being exposed, because automation is actually a process which will eat into youth employment rather than any other. China’s workforce is actually declining and has been for some years, just in time for robots to start taking over.

The process of classic industralisation is just one of various models for a country to develop. But in this particular model, families can contribute labour rather than capital in order to obtain greater earnings, and thereby over time accumulate household assets. For many countries though, this industrialisation may never now be possible. The Economist noted as much when opining that the pathway of development exhibited by the China + ASEAN axis is probably irreplicable by anyone else including markets in Africa and South America. Goods may be manufactured in some of these economies, but it will be robots that do most of it and young median households will never cross either the asset-owning or educational thresholds required to survive automation before it hits.

Now, it may be that these countries find other models to become rich, but I doubt it. Agriculture or resource extraction will be possible for only a precious few. The mercantile model is not stable or sustainable. Services, as we have seen, actually produce a lower return on labour than industrialization does since jobs are often of a lower quality. In any case one of the stark lessons of 2016 was the fact that in 29 out of 50 states in the US, trucking was the single most common form of employment – and this, more so than manufacturing, is where automation will first hit.

us job types

Source: NPR (2015)

The fact is that to weather automation, median family assets need to reach a critical mass enough to be “invested” into the economy such that they can be gainers from robot productivity rather than victims. The most obvious if questionable form of asset-ownership would be home-ownership, but in an ideal world it would take other forms. China’s urban population has just about caught this train (financial income growth has far outstripped wage growth in recent years), but younger populations in India or Vietnam may not make it. Young people inevitable have fewer assets having had less time to earn; if their family does not reach this critical automation-neutralising financial position, they face eternal unemployment. OECD economies mitigate this conundrum somewhat through welfare transfers, but welfare is another privilege of long term asset accumulation by Society – a privilege emerging markets do not have. It is a race against time and any country that fails to achieve this will be left without a chair when the music stops.

In this context, I have little time for those who argue, as Wolf does, that India is “the most interesting other economy” (Americans I have noticed, tend to use Vietnam as their preferred example). As one of my friends commented, “the human race will probably be extinct before India has an airport like Pudong”. Taken individually, each of these points (China’s extra-economic rise and youth being a greater concern than age) have huge implications about the rules and framework for emerging market development theory. Taken together however, they may represent a perfect storm which leading to an inflection point in global economic development. In this case, being wedded to the old ideas, commentators like Wolf are probably missing it.