Saturday, January 28, 2012


FORBES

As Eurogeddon Approaches, Swiss Become Even More Optimistic

English: Coat of Arms of Switzerland. Česky: Z...
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There are few countries as dependent as the Swiss on Europe’s economic lynch-pin, Germany. Even as Germany wrestles with the Euro woesand Eurogeddon, the probability of widespread social unrest in Europe in reaction to austerity, the possible collapse of its currency (or alternatively the possibility of compromise), close neighbours Switzerland are becoming more optimistic about their own economic future.
Switzerland is dependent on Germany for exports, tourism and for specialist workers. If you want a view of Europe from the economic coalface there’s no better place to go. And the view is more positive than 2010, even though you’d be forgiven for thinking that Eurogeddon is nigh if you read the English language press.
The news comes from Credit Suisse whose annual Megatrends survey shows Swiss small and medium-sized companies becoming both more optimistic about their businesses and more positive about globalization.
Nicole Brandle Schlegel, who is Head of Industry Analysis at Credit Suisse, says the survey specifically probes Swiss SMEs on their long term perspectives.
Overall, 51% of a 380 company survey perceive current developments as, broadly, an opportunity for their businesses against 26% who perceive conditions as a threat.
On balance globalization is perceived positively, whereas in the past the Swiss saw globalization as a threat.
And in terms of where the innovation for future growth will come from the majority of Swiss companies believe innovation will arise from the creative efforts of their employees and not from management or external advisers.
It’s a curiously rosy picture. One that says with the right approach to nurturing labor and acceptance of turbulent global markets as a norm,  the future will be good. Contrast that with British coverage of the Eurozone – this morning leading economic commentator Jeff Randall says in The Telegraph: Game over for the Euro. For those with a real vested interest in Germany’s control of the Eurozone, however, things are looking up.
Haydn Shaughnessy, Contributor


http://www.forbes.com/sites/haydnshaughnessy/2011/12/19/as-europe-frazzles-swiss-become-more-optimistic/

Monday, January 16, 2012


La nouvelle situation économique mondiale est une chance pour la Suisse.
Markus R. Neuhaus, administrateur délégué, PwC Suisse
CEO Magazine, PWC, Déc 2011


La situation économique mondiale connaît actuellement une extrême précarité. Une nouvelle récession – et avec elle le spectre tant redouté du double V – ne fait plus guère de doute. Pourtant, malgré l’incertitude régnante, de nombreux dirigeants écono- miques témoignent, en privé, d’une plus grande confiance pour leurs affaires que les perspectives économiques générales ne le permettraient. La réticence à exprimer ouver- tement sa confiance se justifie sans doute par une prudence naturelle ou par un sentiment de vulnérabilité face à des facteurs incontrô- lables. Mais, le rôle d’un CEO est précisément de se concentrer sur ce que l’on peut influen- cer afin d’accroître la résistance de ses pro- pres affaires face aux revers.


Je pense que c’est exactement ce qu’a fait la grande majorité des présidents de conseils d’administration et des CEO ces quatre der- nières années. Ils ont gardé leur calme et par- faitement maintenu le cap dans une époque qui met tout le monde à rude épreuve.


Mais nous savons qu’il faut aussi retrouver une croissance durable dans les entreprises pour maintenir la prospérité collective à l’ave- nir. Et le contexte reste difficile – même si la
Suisse, en tirant le frein de l’endettement il y a des années déjà, quitte à se faire accuser de vouloir économiser à outrance, n’en a pas moins pris la bonne décision au bon moment ce qui lui permet aujourd’hui de faire meil- leure figure que ses voisins.

La fameuse crise de l’euro est en fait une crise de la dette qui s’étend de la Grèce à la France, en passant par l’Italie, l’Irlande, le Portugal et l’Espagne. L’endettement des États-Unis ou du Japon est également gigantesque. Les États vivent à crédit, les gouvernements s’achètent ainsi leur réélection, et la prochaine géné- ration devra se débrouiller. Ces agissements iconoclastes, qui font fi de l’avenir, sont pré- sentés par le philosophe Dieter Thomä dans ce magazine comme une maladie de notre temps qu’il appelle l’obsession du présent. Tout ceci a des conséquences pour l’économie suisse. Le commerce extérieur de la Suisse avec l’espace UE va reculer pendant un cer- tain temps, tout comme la consommation
des ménages et les investissements privés et publics. Il est d’autant plus important de
se concentrer sur les marchés de croissance émergents. Dans quelques années, ces mar- chés détrôneront les États occidentaux et deviendront les économies leaders. 

Le PIB cumulé des pays de l’E7, à savoir la Chine, l’Inde, le Brésil, la Russie, le Mexique, l’In- donésie et la Turquie, dépassera celui des pays du G7 d’ici 2032, en termes de taux de change du marché. L’évolution démographi- que sera à elle seule source de forte crois- sance durable sur ces marchés.

La nouvelle situation économique mondiale est une chance pour la Suisse – à condition que les exportateurs suisses tiennent compte des besoins de ces marchés et que la politique crée le cadre pour des échanges économiques durables avec eux. La Suisse, et avec elle l’économie suisse, a donc toutes les raisons de garder confiance en l’avenir. Nous avons toujours prouvé, jusqu’ici, notre aptitude à conjuguer les valeurs au futur. La présente édition du magazine ceo vous en livre quel- ques exemples éloquents.

Je vous souhaite une bonne lecture.
Markus R. Neuhaus 


http://www.pwc.ch/user_content/editor/files/publ_corp/pwc_ceo_11-3_f.pdf


Saturday, January 14, 2012



The Future of the Yuan 
China’s Struggle to Internationalize Its Currency 
Sebastian Mallaby and Olin Wethington
Foreign affairs Feb 2012.
According to a growing chorus of pundits and economists, China—already the world’s most prolific exporter, largest sovereign creditor, and second-largest economy—will someday soon provide the world’s reserve currency. According to this view, just as the dollar dethroned the British pound in the interwar years, so the yuan will soon displace the dollar, striking a blow to U.S. interests. As the economist Arvind Subramanian recently wrote, the yuan “could be- come the premier reserve currency by the end of this decade, or early next decade.”
This view has gained traction as Chinese leaders have launched a concerted eaort to internationalize the yuan. During the g-20 summit in November 2008, at the height of the financial crisis, Chinese pres- ident Hu Jintao called for “a new international financial order that is fair, just, inclusive, and orderly.” Beijing soon began to encourage the use of its currency in international trade, swap arrangements between central banks, and bank deposits and bond issuances in Hong Kong. During the first six months of 2011, trade transactions settled in yuan totaled around $146 billion, a 13-fold increase over the same period during the previous year. By mid-2011, yuan deposits in Hong Kong equaled $85 billion, a roughly tenfold jump since Hu’s 2008 statement. The yuan is already accepted as a form of payment in Mongolia, Pakistan, Thailand, and Vietnam. Chinese authorities have in- dicated that as soon as 2015, they want the yuan to be included in the basket of major currencies that determines the value of Special Drawing Rights (sdrs), the reserve asset issued by the International Monetary Fund. And Beijing has announced its intention to transform Shang-hai into an international financial center by 2020.
There is also no denying that the dollar is vulnerable. Central banks traditionally hold foreign currency reserves to ensure their ability to buy imports. But today, more of the world’s imported goods come from China than from the United States. Central banks also hold reserves to ensure their ability to service debt payments to foreigners. Yet such payments flow increasingly to China, and although China’s lending is largely conducted in dollars, domi- nant creditors ultimately tend to insist on lending in their own currency. To make matters worse for the dollar, it is losing value— instead of storing it, as reserve currencies are expected to do. Meas- ured against the currencies of the United States’ main trading partners, the dollar has lost a quarter of its value since the advent of the floating currency system in 1973. Over the past four decades, it has lost four-fifths of its purchasing power as measured against a basket of consumer goods. This decline makes central bankers in emerging economies understandably nervous about holding dollar reserves.
Yet the emerging narrative about the yuan’s ascendance is mostly wrong. The global rise of China’s currency will be slower than com- monly predicted, and the yuan is more likely to assume a place among secondary reserve currencies—the euro, the yen, the Swiss franc, and the British pound—than it is to displace the dollar as the dominant one. Nor is it even clear that China wants the yuan to replace the dollar. Beijing’s steps toward currency internationalization reflect not a fully formed, coherent long-term strategy but rather an evolving process
The emerging narrative about the yuan’s ascendance is mostly wrong. shaped by splits among China’s policymakers over the scope and speed of financial reform. Far from confirming the inevitability of the yuan’s rise, China’s uncertain eaort to internationalize its currency has exposed the profound struggles that lie behind the country’s larger push to transform its economic model.


One might assume that as a country approaches great-power sta- tus, it will naturally attempt to internationalize its currency. In fact, rising powers have often done just the opposite. As the economist Jearey Frankel has shown, that is what the United States did in the interwar period and what Germany and Japan did in the 1970s, even though the currencies of all three countries later became interna- tional. In each of these cases, both the public and policymakers were initially skeptical of the benefits of allowing their currency to be used widely abroad.
Rising powers have had two reasons to fear the internationalization of their currencies. The first concerns competitiveness. When foreign- ers buy and hold a currency, they increase its value. This appreciation persists as long as the buyers hang on to the currency as a store of wealth. A stronger currency hurts a nation’s exports by making its goods more expensive abroad and creates more competition for domestic companies by making imports cheaper for consumers.
The second reason to fear currency internationalization concerns control of the financial system. Like China today, Germany, Japan, and the United States all emerged as trading powerhouses at a time when their financial systems were tightly regulated. Governments capped interest rates on bank deposits and restricted the investment opportunities of pension and insurance funds so that capital remained cheap. But this “financial repression” stuck savers with low returns, and the demand for artificially cheap capital often exceeded the supply, leaving some borrowers frustrated. Currency international- ization threatened the cheap-capital development model by freeing savers and borrowers to find one another abroad, beyond the reach of regulators.
These reservations about currency internationalization have con- tributed to long lags between a nation’s emergence as a first-rank power and the widespread use of its money by foreigners. The United States became a larger economy than the United Kingdom in 1872, but the dollar did not begin to displace the pound as the reigning international currency until World War I, and the process was not completed until after World War II. Even then, the United States frequently appeared indiaerent to its currency’s newfound status. In the 1970s, President Richard Nixon abandoned the gold standard, sacrificing the international prestige of the dollar on the altar of domestic stimulus. Likewise, Japan resisted currency international- ization until the 1980s, when it became impossible to resist American pressure to allow U.S. financial firms to enter the Japanese market. The deutsche mark became a reserve currency because foreigners wanted to hold it, not because German authorities actively sought that outcome.
If other rising powers have resisted the internationalization of their currencies, why is China’s policy so diaerent? The answer is that the recent global financial crisis confronted China with the dangers inherent in dollar hegemony. China’s economic model had relied on boosting exports by keeping its exchange rate undervalued. This required China’s central bank to purchase large quantities of dollars, reinforcing the dollar’s status as the global reserve currency. But the crisis revealed that the benefits of this model were smaller than they appeared and that the costs could be significantly higher.
The crisis showed that by basing its growth on exports, China had laid itself open to a sharp reversal if foreign markets seized up. In the first quarter of 2009, collapsing demand in Europe and the United States caused China’s annual growth rate to fall to 6.2 percent, after hitting ten percent or more in each of the previous ten quarters. The crisis also highlighted the potential costs to China of accumulating dollar reserves. To keep the yuan undervalued, China had bought $1.5 trillion worth of U.S. financial assets, including about seven per- cent of all the bonds issued by government-linked lenders, such as the disastrously overleveraged Fannie Mae and Freddie Mac. The crisis convinced Beijing that it could one day take a serious loss on those investments.
China’s leaders responded to the shock by criticizing the interna- tional financial system. The eaort was launched by Zhou Xiaochuan, the governor of the People’s Bank of China (the country’s central bank). In an article posted on the bank’s Web site in March 2009, he called for far greater use of sdrs as an alternative to the dollar. Other Chinese o⁄cials followed Zhou’s lead, arguing that the basket of currencies that determines the value of sdrs should be expanded to include the yuan and that, in preparation for that change, the yuan should be internationalized. Echoing the complaints French leaders made in the 1960s about “exorbitant privilege”—a country’s ability to borrow cheaply and seemingly without limit in its own currency—Chinese o⁄cials and scholars argued that the United States abuses its monetary freedom and passes on the costs to the rest of the world in the form of currency depreciation and financial insta- bility. The U.S. Federal Reserve’s subsequent quantitative easing and the U.S. Congress’ chaotic eaorts to grapple with the national debt only increased China’s frustration.
Even before the crisis, China had been engaged in an internal debate about its export-led growth model. Several years ago, reformers began arguing that an excessive reliance on exports could be dangerous and that China needed to rebalance its growth by encouraging more domestic consumption. In place of financial repression and cheap capital, these reformers wanted savers to get a decent return, which might give them the confidence to consume more. In place of an artifi- cially low exchange rate, they wanted to allow the value of the yuan to rise, which would reorient Chinese firms away from exports and toward the domestic market.
The reformers claimed a small victory in 2005, when China loosened its exchange-rate peg. But in general, the reform agenda has struggled. State-owned banks do not want to pay depositors market interest rates. Politically connected borrowers, such as the state-owned construction companies that build China’s impressive infrastructure, do not want to give up access to cheap capital. Politically connected exporters, on whom provincial governors count to create jobs in their regions, do not want to give up the competitive advantage created by a favorable exchange rate. Groups that have an interest in reform—savers who receive artificially low returns and consumers who pay a high price for imports—are no match for powerful producers.
Prior to the financial crisis, the case for reform was also tainted by the suspicion that it represented a capitulation to U.S. demands to let the yuan appreciate. But once the crisis exposed China’s vulnera- bility, reform acquired a fresh patriotic gloss: advocates could paint themselves as challenging the dangerous hegemony of the dollar. This reframing was enough to tip the political center of gravity away from the status quo. Criticism of what Chinese scholars called “the dollar trap” became widely accepted, and by extension, internationalization of the yuan became an o⁄cial goal, even though many of China’s lead- ers continued to believe in export competitiveness, highly regulated capital markets, and a state-controlled banking system.
In eaect, the government wanted to have it both ways: booming exports, but reduced accumulation of dollars; continued funneling of cheap loans to favored companies at the expense of savers, but also more domestic consumption. Internationalization of the yuan emerged as an o⁄cial goal not because it resolved the long-running debate between reformers and mainstream opinion. Rather, it became policy precisely because it blurred that division, allowing people who disagreed to unite—at least in the short term.
One consequence of these internal conflicts is an unorthodox sequencing of reform. As the economist Takatoshi Ito has explained, the best way to open a repressed, autarkic financial system is to begin with domestic financial reform. Before large amounts of foreign capital are permitted to flood in and out of a country’s system, banks need to be well capitalized and competently regulated. Bond markets must be deep and liquid, so that they can absorb foreign money without experiencing dramatic price swings. The authorities must welcome a variety of investors, with diaering time horizons, invest- ment objectives, and worldviews—a form of diversity that reduces destructive herd behavior. Only once the domestic financial system has been fortified in this manner is it safe to open the economy to foreign capital inflows, allow the exchange rate to float, and let the country’s money circulate oashore. Currency internationalization should be the endpoint of reform, not the starting point.
China is not following this sequence. Mainstream Chinese political opinion still resists rapid domestic financial reform and exchange-rate flexibility, so reformers have pushed forward with currency internation- alization before the standard preconditions
have been met. Since Hu’s speech in 2008, China has signed largely symbolic central-
bank swap agreements with 13 countries, including Argentina, Belarus, Indonesia,
Malaysia, and South Korea. In September 2011, Nigeria’s central bank announced that it would convert between five and ten percent of its reserve assets into yuan. But the
most significant reforms began in April 2009, when China’s government permitted five pilot regions—Dongguan, Guangzhou, Shanghai, Shenzhen, and Zhuhai—to begin conducting trade with Hong Kong in yuan on a trial basis. In June 2010, the experiment was extended to 20 provinces, cities, and autonomous regions. Last year, it was extended to the entire country. The resulting explosion of yuan-based trade has been hailed by some as a success. But as Peter Garber of Deutsche Bank has ex- plained, the growth has been revealingly lopsided, resulting in some serious unintended consequences.
Because foreigners expect China’s currency to appreciate against the dollar, they are eager to buy any yuan that reach Hong Kong, where the currency is called cnh, to distinguish it from the mainland currency, which is sometimes referred to as cny. As a result, cnh tend to command a premium against the dollar, opening up a gap between the onshore yuan-dollar exchange rate, which the Chinese government manages, and the oashore cnh-dollar exchange rate, which it does not. This diaerential creates an incentive for Chinese importers to pay foreign suppliers in cnh, rather than in dollars purchased from the central bank at the lower o⁄cial exchange rate.
As Chinese importers take advantage of the favorable Hong Kong exchange rate, they move money from the mainland into cnh accounts in Hong Kong and then use those cnh to purchase goods from foreign exporters. The foreigners then either hold the cnh in expectation of appreciation or, if they are not interested in currency spec- ulation, sell the cnh to other foreigners who are keen to take the bet. In this way, Chinese currency piles up in Hong Kong. Some market analysts predict that, having already grown tenfold since Hu’s speech in 2008, Chinese currency deposits in Hong Kong will quadruple from today’s level by the end of 2012, rising to the equivalent of around $340 billion.
That is not what Chinese policymakers intended. Technically,
the deregulation of yuan-denominated trade payments applies to Chinese exporters as well as importers. If exporters took advantage of the new freedom, the pools of cnh building up in Hong Kong would be drained as quickly as they accumulated. But the incentives for exporters are the opposite of those facing importers. Rather than going through Hong Kong, exporters are better oa taking payment in dollars and then selling the dollars to the central bank at the managed rate, which renders the dollar artificially valuable.
The upshot has been a classic demonstration of the law of un- intended consequences. Before the opening of the Hong Kong cnh market, Chinese importers bought foreign exchange from China’s central bank, reducing the bank’s stock of dollar assets. Now, im- porters can obtain foreign exchange indirectly from foreign speculators in Hong Kong, leaving more dollars on the central bank’s balance sheet. Put another way, Chinese importers’ ability to pay foreign- ers in cnh has the eaect of removing a significant source of dollar purchases from the world’s currency market. Assuming that the central bank wants to maintain the yuan-dollar exchange rate, it must oaset this eaect by increasing its own dollar holdings. China’s attempt to internationalize the yuan, which sprang partly from a desire to reduce the government’s exposure to dollars, has actually had the reverse eaect of increasing the central bank’s already vast dollar holdings.
Even beyond this irony, the policy is proving costly. Assuming that China will one day stop holding down the value of its currency, China’s central bank will eventually suaer a portfolio loss as the dol- lar falls to its natural exchange rate against the yuan. The more dollars the central bank accumulates, the larger this eventual loss will be. Moreover, as the central bank acquires additional dollars, it pays out yuan. To avoid inflation, this monetary expansion has to be “steril- ized” by the issuance of bonds or the acceptance of bank reserves on which the government pays interest, imposing a further cost on the Chinese government. The challenge of sterilization grows when the money in cnh bank accounts is used to purchase cnh bonds and then the issuers of these bonds repatriate the capital to the mainland. As long as the Hong Kong market remains comparatively small, China can absorb these costs with little di⁄culty. But if the author- ities are serious about internationalizing the yuan in a sustained way, the costs will quickly grow and the unintended consequences will likely become harder to manage, especially in the absence of domestic reform.

The tensions in China’s currency policy emerge clearly from the wide range of o⁄cial statements intended to explain it. Some lead- ers openly state a preference for diversification away from the dollar but are careful not to call for the yuan’s preeminence, even within the next several decades. Rather, they predict a lengthy and com- plex process of change in the international monetary system, with increased demand for yuan restricted mostly to East Asian markets. Other policymakers in Beijing advocate including the yuan in sdrs and believe that sdrs should ultimately displace the dollar as the world’s main reserve asset. But even as they advance this vision of a radically transformed monetary order, these o⁄cials shy away from acknowledging a policy of currency internationalization, speaking instead of a more limited agenda of trade and investment facilitation. They suggest that their policy is a response to market demand; by allowing yuan to be used in trade transactions, these o⁄cials maintain, China is merely acceding to requests from importers and exporters. China has concluded swap agreements with foreign central banks only because foreigners requested them, they claim—despite the fact that foreigners have drawn down only a small fraction of the yuan swaps that Beijing has provided.
Yet even though China’s leaders struggle to rationalize a conflicted policy, it would be wrong to conclude that yuan internationalization is doomed. After all, China has managed such contradictions success- fully before, often pursuing reform not by tackling the status quo head-on but rather by allowing an alternative to grow up around it. For example, in the 1980s, during the early stages of the transition away from central planning, farmers were still required to meet Mao- era quotas and were paid at prices set by the central planners, but farmers were also allowed to sell anything they produced in excess of their quotas on the new free market. Today, private companies coexist with state-run firms and five-year plans exist alongside a capitalist free- for-all. In a similar fashion, China is allowing a free yuan capital market to grow up in Hong Kong in parallel with the largely unreformed, restricted capital market on the mainland. The policy mix might not be consistent, but it could ultimately prove eaective.
Indeed, inconsistency might hold some advantages. It allows China to experiment with change while retaining the option to retreat if the side eaects become intolerable. It could permit policymakers to foster the development of the Hong Kong market, so that the insti- tutions necessary to make a currency market function can gradually take shape there. If Chinese and foreign companies issue greater volumes of cnh bonds of short and long duration, a market-driven yield curve will emerge, Chinese traders will learn the art of interest- rate arbitrage, and Chinese companies using this market will learn the ropes of treasury management. The system can be tweaked and tested before it is rolled out on the mainland, and in the meantime, it may generate price signals useful to China’s government. If the cnh appreciates suddenly against the dollar, this will warn the authorities of rising pressure from speculation. If short-term interest rates rise
relative to long-term ones, this might signal that investors have be- come pessimistic about the economic outlook. In time, the onshore and oashore markets could conceivably converge as capital controls are loosened.
Of course, there is a significant risk that a gradual approach— and the resulting tension between a free oashore market and a con- trolled onshore one—could prove hard for
the Chinese government to manage. The rising cost to the central bank of purchas-
ing dollars to oaset foreign yuan holdings in Hong Kong might encourage foreign
speculators to bet that the central bank will seek to reduce that cost by allowing faster
yuan appreciation; the result could be even more speculative purchases of cnh, setting
oa a vicious cycle. Likewise, leakage of capital from Hong Kong to the mainland could fuel inflation; as the economist Robert McCauley has explained, this fate befell the United States when it clung to capital controls in the face of growing oashore dollar markets in the 1970s. But it is also possible that the benefits of China’s experimental technique could outweigh its obvious costs and contradictions. Any- one who has watched China’s extraordinary economic performance, achieved while it ignored many of the West’s textbook development prescriptions, should be modest in predicting that China will in- evitably trip up this time. But even if China’s policy of gradualism with regard to its currency succeeds, the yuan is not going to displace the dollar anytime soon. The dollar enjoys an advantage that its pre- decessor, the pound, never had: formidably deep capital markets both inside and outside the United States, which operate mainly in dollars.
The chief purpose of a reserve currency in today’s global economy goes beyond its traditional ones. Central banks hold foreign exchange war chests not just as a cover for essential imports and debt payments; they hold them as insurance against the virulent crises to which modern finance is susceptible. As capital markets have gone global, banks all over the world have borrowed in e⁄cient dollar-based markets. As a result, when markets suddenly dry up, borrowers are left screaming for dollars. So long as dollar funding remains attractive to private firms, central banks will hold a large proportion of their reserves in dollars, too. Even if the dollar loses value steadily, central banks will probably be prepared to absorb that cost, which amounts to an insurance premium.
Given China’s economic strength and the likely appreciation of its currency in the future, the yuan might eventually emerge as a secondary reserve currency. If a reliable yuan bond market develops, first in Hong Kong and then perhaps on the mainland, foreigners will increasingly include yuan assets in their portfolios, alongside British pounds, euros, Swiss francs, and yen. Asian nations, with deep economic links to China, will be particularly likely to do so; the yuan already serves as an uno⁄cial anchor for several of their exchange rates. But that is a far cry from displacing the dollar. China is rapidly catching up to the United States in terms of the overall size of its economy, and perhaps in other measures, too. But China’s monetary dominance should not be assumed. If it ever does arrive, it will have been long in coming.
Sebastian Mallaby is Director of the Maurice R. Greenberg Center for Geoeconomic Studies at the Council on Foreign Relations. Olin Wethington is Chair of Wethington International and previ- ously served as Assistant Secretary for International Aaairs and as Special Envoy on China at the U.S. Department of the Treasury.




Thursday, January 12, 2012


The Future of History
Something strange is going on in the world today. The
global financial crisis that began in 2008 and the ongoing
crisis of the euro are both products of the model of light-
ly regulated financial capitalism that emerged over the
past three decades. Yet despite widespread anger at Wall
Street bailouts, there has been no great upsurge of left-
wing American populism in response. It is conceivable that the Occupy Wall Street movement will gain traction, but the most dynamic recent populist movement to date has been the right-wing Tea Party, whose main target is the regulatory state that seeks to protect ordinary people from financial speculators. Something similar is true in Europe as well, where the left is anemic and right-wing populist parties are on the move.
There are several reasons for this lack of left-wing mobilization, but chief among them is a failure in the realm of ideas. For the past generation, the ideological high ground on economic issues has been held by a libertarian right. The left has not been able to make a plausible case for an agenda other than a return to an unaffordable form of old-fashioned social democracy. This absence of a plausible progressive counter narrativeisunhealthy,becausecompetitionisgoodforintellectuald ebatejust as it is for economic activity. And serious intellectual debate is urgently needed, since the current form of globalized capitalism is eroding the middle-class social base on which liberal democracy rests.
THE DEMOCRATIC WAVE
Social forces and conditions do not simply “determine” ideologies, as Karl Marx once maintained, but ideas do not become powerful unless they speak to the concerns of large numbers of ordinary people. Liberal democracy is the default ideology around much of the world today in part because it responds to and is facilitated by certain so- cioeconomic structures. Changes in those structures may have ideological conse- quences, just as ideological changes may have socioeconomic consequences.
Almost all the powerful ideas that shaped human societies up until the past 300 years were religious in nature, with the important exception of Confucianism in China. The first major secular ideology to have a lasting worldwide effect was liberalism, a doc-
trine associated with the rise of first a commercial and then an industrial middle class in certain parts of Europe in the seventeenth century. (By “middle class,” I mean peo- ple who are neither at the top nor at the bottom of their societies in terms of income, who have received at least a secondary education, and who own either real property, durable goods, or their own businesses.)
As enunciated by classic thinkers such as Locke, Montesquieu, and Mill, liberalism holds that the legitimacy of state authority derives from the state’s ability to protect the individual rights of its citizens and that state power needs to be limited by the ad- herence to law. One of the fundamental rights to be protected is that of private prop- erty; England’s Glorious Revolution of 1688–89 was critical to the development of modern liberalism because it first established the constitutional principle that the state could not legitimately tax its citizens without their consent.
At first, liberalism did not necessarily imply democracy. The Whigs who supported the constitutional settlement of 1689 tended to be the wealthiest property owners in England; the parliament of that period represented less than ten percent of the whole population. Many classic liberals, including Mill, were highly skeptical of the virtues of democracy: they believed that responsible political participation required educa- tion and a stake in society -- that is, property ownership. Up through the end of the nineteenth century, the franchise was limited by property and educational require- ments in virtually all parts of Europe. Andrew Jackson’s election as U.S. president in 1828 and his subsequent abolition of property requirements for voting, at least for white males, thus marked an important early victory for a more robust democratic principle.
In Europe, the exclusion of the vast majority of the population from political power and the rise of an industrial working class paved the way for Marxism. The Commu- nist Manifesto was published in 1848, the same year that revolutions spread to all the major European countries save the United Kingdom. And so began a century of com- petition for the leadership of the democratic movement between communists, who were willing to jettison procedural democracy (multiparty elections) in favor of what they believed was substantive democracy (economic redistribution), and liberal de- mocrats, who believed in expanding political participation while maintaining a rule of law protecting individual rights, including property rights.
At stake was the allegiance of the new industrial working class. Early Marxists be- lieved they would win by sheer force of numbers: as the franchise was expanded in
the late nineteenth century, parties such as the United Kingdom’s Labour and Ger- many’s Social Democrats grew by leaps and bounds and threatened the hegemony of both conservatives and traditional liberals. The rise of the working class was fiercely resisted, often by nondemocratic means; the communists and many socialists, in turn, abandoned formal democracy in favor of a direct seizure of power.
Throughout the first half of the twentieth century, there
was a strong consensus on the progressive left that some
form of socialism -- government control of the command-
ing heights of the economy in order to ensure an egalitar-
ian distribution of wealth -- was unavoidable for all ad-
vanced countries. Even a conservative economist such as
Joseph Schumpeter could write in his 1942 book, Capitalism, Socialism, and Democracy, that socialism would emerge victorious because capitalist society was culturally self- undermining. Socialism was believed to represent the will and interests of the vast majority of people in modern societies.
Yet even as the great ideological conflicts of the twentieth century played themselves out on a political and military level, critical changes were happening on a social level that undermined the Marxist scenario. First, the real living standards of the industrial working class kept rising, to the point where many workers or their children were able to join the middle class. Second, the relative size of the working class stopped growing and actually began to decline, particularly in the second half of the twentieth century, when services began to displace manufacturing in what were labeled “postindustrial” economies. Finally, a new group of poor or disadvantaged people emerged below the industrial working class -- a heterogeneous mixture of racial and ethnic minorities, recent immigrants, and socially excluded groups, such as women, gays, and the disabled. As a result of these changes, in most industrialized societies, the old working class has become just another domestic interest group, one using the political power of trade unions to protect the hard-won gains of an earlier era.
Economic class, moreover, turned out not to be a great banner under which to mobi- lize populations in advanced industrial countries for political action. The Second In- ternational got a rude wake-up call in 1914, when the working classes of Europe abandoned calls for class warfare and lined up behind conservative leaders preaching nationalist slogans, a pattern that persists to the present day. Many Marxists tried to explain this, according to the scholar Ernest Gellner, by what he dubbed the “wrong

address theory”:
Just as extreme Shi’ite Muslims hold that Archangel Gabriel made a mis- take, delivering the Message to Mohamed when it was intended for Ali, so Marxists basically like to think that the spirit of history or human con- sciousness made a terrible boob. The awakening message was intended for classes, but by some terrible postal error was delivered to nations.
Gellner went on to argue that religion serves a function similar to nationalism in the contemporary Middle East: it mobilizes people effectively because it has a spiritual and emotional content that class consciousness does not. Just as European national- ism was driven by the shift of Europeans from the countryside to cities in the late nineteenth century, so, too, Islamism is a reaction to the urbanization and displace- ment taking place in contemporary Middle Eastern societies. Marx’s letter will never be delivered to the address marked “class.”
Marx believed that the middle class, or at least the capital-owning slice of it that he called the bourgeoisie, would always remain a small and privileged minority in mod- ernsocieties.Whath appenedinsteadwasthatthebourgeoisieandthemiddleclass more generally ended up constituting the vast majority of the populations of most ad- vanced countries, posing problems for socialism. From the days of Aristotle, thinkers have believed that stable democracy rests on a broad middle class and that societies with extremes of wealth and poverty are susceptible either to oligarchic domination or populist revolution. When much of the developed world succeeded in creating middle-class societies, the appeal of Marxism vanished. The only places where leftist radicalism persists as a powerful force are in highly unequal areas of the world, such as parts of Latin America, Nepal, and the impoverished regions of eastern India.
What the political scientist Samuel Huntington labeled the “third wave” of global de- mocratization, which began in southern Europe in the 1970s and culminated in the fall of communism in Eastern Europe in 1989, increased the number of electoral democracies around the world from around 45 in 1970 to more than 120 by the late 1990s. Economic growth has led to the emergence of new middle classes in countries such as Brazil, India, Indonesia, South Africa, and Turkey. As the economist Moisés Naím has pointed out, these middle classes are relatively well educated, own proper- ty, and are technologically connected to the outside world. They are demanding of their governments and mobilize easily as a result of their access to technology. It should not be surprising that the chief instigators of the Arab Spring uprisings were
well-educated Tunisians and Egyptians whose expectations for jobs and political par- ticipation were stymied by the dictatorships under which they lived.
Middle-class people do not necessarily support democracy in principle: like everyone else, they are self-interested actors who want to protect their property and position. In countries such as China and Thailand, many middle-class people feel threatened by the redistributive demands of the poor and hence have lined up in support of au- thoritarian governments that protect their class interests. Nor is it the case that democracies necessarily meet the expectations of their own middle classes, and when they do not, the middle classes can become restive.
THE LEAST BAD ALTERNATIVE?
There is today a broad global consensus about the legiti-
macy, at least in principle, of liberal democracy. In the
words of the economist Amartya Sen, “While democracy
is not yet universally practiced, nor indeed uniformly ac-
cepted, in the general climate of world opinion, democra-
tic governance has now achieved the status of being tak-
en to be generally right.” It is most broadly accepted in countries that have reached a level of material prosperity sufficient to allow a majority of their citizens to think of themselves as middle class, which is why there tends to be a correlation between high levels of development and stable democracy.
Some societies, such as Iran and Saudi Arabia, reject liberal democracy in favor of a form of Islamic theocracy. Yet these regimes are developmental dead ends, kept alive only because they sit atop vast pools of oil. There was at one time a large Arab excep- tion to the third wave, but the Arab Spring has shown that Arab publics can be mobi- lized against dictatorship just as readily as those in Eastern Europe and Latin Ameri- ca were. This does not of course mean that the path to a well-functioning democracy will be easy or straightforward in Tunisia, Egypt, or Libya, but it does suggest that the desire for political freedom and participation is not a cultural peculiarity of Euro- peans and Americans.
The single most serious challenge to liberal democracy in the world today comes from China, which has combined authoritarian government with a partially marke- tized economy. China is heir to a long and proud tradition of high-quality bureau- cratic government, one that stretches back over two millennia. Its leaders have man-

aged a hugely complex transition from a centralized, Soviet-style planned economy to a dynamic open one and have done so with remarkable competence -- more com- petence, frankly, than U.S. leaders have shown in the management of their own macroeconomic policy recently. Many people currently admire the Chinese system not just for its economic record but also because it can make large, complex decisions quickly, compared with the agonizing policy paralysis that has struck both the Unit- ed States and Europe in the past few years. Especially since the recent financial crisis, the Chinese themselves have begun touting the “China model” as an alternative to liberal democracy.
This model is unlikely to ever become a serious alternative to liberal democracy in re- gions outside East Asia, however. In the first place, the model is culturally specific: the Chinese government is built around a long tradition of meritocratic recruitment, civil service examinations, a high emphasis on education, and deference to techno- cratic authority. Few developing countries can hope to emulate this model; those that have, such as Singapore and South Korea (at least in an earlier period), were already within the Chinese cultural zone. The Chinese themselves are skeptical about whether their model can be exported; the so-called Beijing consensus is a Western in- vention, not a Chinese one.
It is also unclear whether the model can be sustained. Neither export-driven growth nor the top-down approach to decision-making will continue to yield good results forever. The fact that the Chinese government would not permit open discussion of the disastrous high-speed rail accident last summer and could not bring the Railway Ministry responsible for it to heel suggests that there are other time bombs hidden be- hind the façade of efficient decision-making.
Finally, China faces a great moral vulnerability down the road. The Chinese govern- ment does not force its officials to respect the basic dignity of its citizens. Every week, there are new protests about land seizures, environmental violations, or gross corrup- tion on the part of some official. While the country is growing rapidly, these abuses can be swept under the carpet. But rapid growth will not continue forever, and the government will have to pay a price in pent-up anger. The regime no longer has any guiding ideal around which it is organized; it is run by a Communist Party supposed- ly committed to equality that presides over a society marked by dramatic and grow- ing inequality.
So the stability of the Chinese system can in no way be taken for granted. The Chi-
nese government argues that its c itizens are culturally different and will always pre- fer benevolent, growth-promoting dictatorship to a messy democracy that threatens social stability. But it is unlikely that a spreading middle class will behave all that dif- ferently in China from the way it has behaved in other parts of the world. Other au- thoritarian regimes may be trying to emulate China’s success, but there is little chance that much of the world will look like today’s China 50 years down the road.



DEMOCRACY’S FUTURE
There is a broad correlation among economic growth, social change, and the hegemo- ny of liberal democratic ideology in the world today. And at the moment, no plausi- ble rival ideology looms. But some very troubling economic and social trends, if they continue, will both threaten the stability of contemporary liberal democracies and de- throne democratic ideology as it is now understood.
The sociologist Barrington Moore once flatly asserted, “No bourgeois, no democra- cy.” The Marxists didn’t get their communist utopia because mature capitalism gen- erated middle-class societies, not working-class ones. But what if the further develop- ment of technology and globalization undermines the middle class and makes it im- possible for more than a minority of citizens in an advanced society to achieve mid- dle-class status?
There are already abundant signs that such a phase of
development has begun. Median incomes in the United
States have been stagnating in real terms since the 1970s.
The economic impact of this stagnation has been soft-
ened to some extent by the fact that most U.S. house-
holds have shifted to two income earners in the past gen-
eration. Moreover, as the economist Raghuram Rajan has persuasively argued, since Americans are reluctant to engage in straightforward redistribution, the United States has instead attempted a highly dangerous and inefficient form of redistribution over the past generation by subsidizing mortgages for low-income households. This trend, facilitated by a flood of liquidity pouring in from China and other countries, gave many ordinary Americans the illusion that their standards of living were rising steadily during the past decade. In this respect, the bursting of the housing bubble in 2008–9 was nothing more than a cruel reversion to the mean. Americans may today benefit from cheap cell phones, inexpensive clothing, and Facebook, but they increas-

ingly cannot afford their own homes, or health insurance, or comfortable pensions when they retire.
A more troubling phenomenon, identified by the venture capitalist Peter Thiel and the economist Tyler Cowen, is that the benefits of the most recent waves of technolog- ical innovation have accrued disproportionately to the most talented and well-educat- ed members of society. This phenomenon helped cause the massive growth of in- equality in the United States over the past generation. In 1974, the top one percent of families took home nine percent of GDP; by 2007, that share had increased to 23.5 percent.
Trade and tax policies may have accelerated this trend, but the real villain here is technology. In earlier phases of industrialization -- the ages of textiles, coal, steel, and the internal combustion engine -- the benefits of technological changes almost always flowed down in significant ways to the rest of society in terms of employment. But this is not a law of nature. We are today living in what the scholar Shoshana Zuboff has labeled “the age of the smart machine,” in which technology is increasingly able to substitute for more and higher human functions. Every great advance for Silicon Valley likely means a loss of low-skill jobs elsewhere in the economy, a trend that is unlikely to end anytime soon.
Inequality has always existed, as a result of natural differences in talent and charac- ter. But today’s technological world vastly magnifies those differences. In a nine- teenth-century agrarian society, people with strong math skills did not have that many opportunities to capitalize on their talent. Today, they can become financial wizards or software engineers and take home ever-larger proportions of the national wealth.
The other factor undermining middle-class incomes in developed countries is global- ization. With the lowering of transportation and communications costs and the entry into the global work force of hundreds of millions of new workers in developing countries, the kind of work done by the old middle class in the developed world can now be performed much more cheaply elsewhere. Under an economic model that pri- oritizes the maximization of aggregate income, it is inevitable that jobs will be out- sourced.
Smarter ideas and policies could have contained the damage. Germany has succeed- ed in protecting a significant part of its manufacturing base and industrial labor force
even as its companies have remained globally competitive. The United States and the United Kingdom, on the other hand, happily embraced the transition to the postin- dustrial service economy. Free trade became less a theory than an ideology: when members of the U.S. Congress tried to retaliate with trade sanctions against China for keeping its currency undervalued, they were indignantly charged with protection- ism, as if the playing field were already level. There was a lot of happy talk about the wonders of the knowledge economy, and how dirty, dangerous manufacturing jobs would inevitably be replaced by highly educated workers doing creative and interest- ingthings.Thiswasagauzyveilplacedoverthehardfactsofdeindustriali zation.It overlooked the fact that the benefits of the new order accrued disproportionately to a very small number of people in finance and high technology, interests that dominat- ed the media and the general political conversation.
THE ABSENT LEFT
One of the most puzzling features of the world in the aftermath of the financial crisis is that so far, populism has taken primarily a right-wing form, not a left-wing one.
In the United States, for example, although the Tea Party is anti-elitist in its rhetoric, its members vote for conservative politicians who serve the interests of precisely those financiers and corporate elites they claim to despise. There are many explana- tions for this phenomenon. They include a deeply embedded belief in equality of op- portunity rather than equality of outcome and the fact that cultural issues, such as abortion and gun rights, crosscut economic ones.
But the deeper reason a broad-based populist left has failed to materialize is an intel- lectual one. It has been several decades since anyone on the left has been able to artic- ulate, first, a coherent analysis of what happens to the structure of advanced societies as they undergo economic change and, second, a realistic agenda that has any hope of protecting a middle-class society.
The main trends in left-wing thought in the last two gen-
erations have been, frankly, disastrous as either concep-
tual frameworks or tools for mobilization. Marxism died
many years ago, and the few old believers still around
are ready for nursing homes. The academic left replaced
it with postmodernism, multiculturalism, feminism, criti-
cal theory, and a host of other fragmented intellectual trends that are more cultural
than economic in focus. Postmodernism begins with a denial of the possibility of any master narrative of history or society, undercutting its own authority as a voice for the majority of citizens who feel betrayed by their elites. Multiculturalism validates the victimhood of virtually every out-group. It is impossible to generate a mass pro- gressive movement on the basis of such a motley coalition: most of the working- and lower-middle-class citizens victimized by the system are culturally conservative and would be embarrassed to be seen in the presence of allies like this.
Whatever the theoretical justifications underlying the left’s agenda, its biggest prob- lem is a lack of credibility. Over the past two generations, the mainstream left has fol- lowed a social democratic program that centers on the state provision of a variety of services, such as pensions, health care, and education. That model is now exhausted: welfare states have become big, bureaucratic, and inflexible; they are often captured by the very organizations that administer them, through public-sector unions; and, most important, they are fiscally unsustainable given the aging of populations virtu- ally everywhere in the developed world. Thus, when existing social democratic par- ties come to power, they no longer aspire to be more than custodians of a welfare state that was created decades ago; none has a new, exciting agenda around which to rally the masses.
AN IDEOLOGY OF THE FUTURE
Imagine, for a moment, an obscure scribbler today in a garret somewhere trying to outline an ideology of the future that could provide a realistic path toward a world with healthy middle-class societies and robust democracies. What would that ideolo- gy look like?
It would have to have at least two components, political and economic. Politically, the new ideology would need to reassert the supremacy of democratic politics over eco- nomics and legitimate anew government as an expression of the public interest. But the agenda it put forward to protect middle-class life could not simply rely on the ex- isting mechanisms of the welfare state. The ideology would need to somehow re- design the public sector, freeing it from its dependence on existing stakeholders and using new, technology-empowered approaches to delivering services. It would have to argue forthrightly for more redistribution and present a realistic route to ending interest groups’ domination of politics.
Economically, the ideology could not begin with a denunciation of capitalism as such,
as if old-fashioned socialism were still a viable alternative. It is more the variety of capitalism that is at stake and the degree to which governments should help societies adjust to change. Globalization need be seen not as an inexorable fact of life but rather as a challenge and an opportunity that must be carefully controlled politically. The new ideology would not see markets as an end in themselves; instead, it would value global trade and investment to the extent that they contributed to a flourishing middle class, not just to greater aggregate national wealth.
It is not possible to get to that point, however, without providing a serious and sus- tained critique of much of the edifice of modern neoclassical economics, beginning with fundamental assumptions such as the sovereignty of individual preferences and that aggregate income is an accurate measure of national well-being. This critique would have to note that people’s incomes do not necessarily represent their true con- tributions to society. It would have to go further, however, and recognize that even if labor markets were efficient, the natural distribution of talents is not necessarily fair and that individuals are not sovereign entities but beings heavily shaped by their sur- rounding societies.
Most of these ideas have been around in bits and pieces for some time; the scribbler would have to put them into a coherent package. He or she would also have to avoid the “wrong address” problem. The critique of globalization, that is, would have to be tied to nationalism as a strategy for mobilization in a way that defined national inter- est in a more sophisticated way than, for example, the “Buy American” campaigns of unions in the United States. The product would be a synthesis of ideas from both the left and the right, detached from the agenda of the marginalized groups that consti- tute the existing progressive movement. The ideology would be populist; the mes- sage would begin with a critique of the elites that allowed the benefit of the many to be sacrificed to that of the few and a critique of the money politics, especially in Washington, that overwhelmingly benefits the wealthy.
The dangers inherent in such a movement are obvious: a pullback by the United States, in particular, from its advocacy of a more open global system could set off pro- tectionist responses elsewhere. In many respects, the Reagan-Thatcher revolution suc- ceeded just as its proponents hoped, bringing about an increasingly competitive, globalized, friction-free world. Along the way, it generated tremendous wealth and created rising middle classes all over the developing world, and the spread of democ- racy in their wake. It is possible that the developed world is on the cusp of a series of
technological breakthroughs that will not only increase productivity but also provide meaningful employment to large numbers of middle-class people.
But that is more a matter of faith than a reflection of the
empirical reality of the last 30 years, which points in the
opposite direction. Indeed, there are a lot of reasons to
think that inequality will continue to worsen. The cur-
rent concentration of wealth in the United States has al-
ready become self-reinforcing: as the economist Simon
Johnson has argued, the financial sector has used its lobbying clout to avoid more onerous forms of regulation. Schools for the well-off are better than ever; those for everyone else continue to deteriorate. Elites in all societies use their superior access to the political system to protect their interests, absent a countervailing democratic mo- bilization to rectify the situation. American elites are no exception to the rule.
That mobilization will not happen, however, as long as the middle classes of the de- veloped world remain enthralled by the narrative of the past generation: that their in- terests will be best served by ever-freer markets and smaller states. The alternative narrative is out there, waiting to be born.

The Future of History | Foreign Affairs
1/8/12 9:36 AM