Does the West need a new growth model?

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As shown by yet another global stock selloff, investors have finally woken to the reality that we have not yet recovered from the 2008 financial crisis. Many smart economists had been warning that this time was different, that we wouldn’t enjoy that simple, V-shaped return to normalcy after the Great Recession. But the global investment community had been living in some sort of alternative universe, oblivious to how persistent unemployment, ongoing housing meltdowns, soaring commodity prices, European debt crises and misguided government policy were conspiring to derail global growth.

One way to explain the stubborn downturn is as a natural result of the intensity of this last financial crisis. The process of deleveraging within the world’s most advanced economies – first of the consumer and financial sectors, now of the public sectors – will be so difficult and protracted that it could drag down growth for years to come. We can probably help that process along, but I doubt we can completely alter or alleviate it. The situation makes me recall a moment in the movie Rocky III when a reporter asks Rocky’s opponent, Clubber Lang (played by Mr. T), for his forecast for their bout, and Lang answers: “Pain!” The outlook for the developed world is likely that straightforward, and about as awful to endure at that Rocky film.

But I’m also wondering if the problems facing the economies of the West are even more fundamental. Perhaps the West can never get back to normal, even after the long, post-crisis workout. Perhaps the entire model that has driven economic growth in the West over the past two decades is entirely broken. Here’s what I mean:

Let’s take a quick walk through the West’s recent economic history. For the first 25 years after World War II, the West basically had no competition. The U.S., and then after reconstruction, Western Europe, more or less dominated every aspect of the global economy. Emerging markets primarily exported commodities and were mired in desperate poverty, while the Soviet Bloc was trapped in its own self-imposed, command economy wonderland. That began to change with the rise of Asia, first Japan, then the four dragons (South Korea, Taiwan, Singapore and Hong Kong) and later China and India. These emerging economies challenged the West’s economic dominance, especially in industry, helped by advances in communications technology and transport that allowed the movement of work around the globe. The West benefited tremendously from the cost advantages of outsourcing and offshoring, and growth became driven by more and more by consumerism, in the U.S. assisted by hefty quantities of debt, and in Europe, by state welfare policies. Jobs were created in overblown housing and retail booms. To a great degree, it is that very growth method that has gotten the West into trouble – the overburdened consumer in America, the overburdened state in Europe.

So far, though, policymakers, investors and business leaders in the U.S. and Europe seem focused on simply returning to that same growth model. In the U.S., everyone is waiting for a revival in consumer spending and housing construction. In Europe, the focus is on restoring financial health to besieged governments, but not on what sort of economic system will emerge from that effort. There seems to be an assumption that, with a tweak here and a budget cut there, we can all happily go back to doing what we were doing before.

But can we? The old system produced a bunch of Americans with too much debt and too little savings, all desperately hoping they could rely on an overstretched government social security program when they retired. In Europe, aging populations and low growth are bringing into question the future viability of welfare-state systems. On both sides of the Atlantic, pressure from globalization, technological change, idiotic tax policies, greedy corporate management, and (in Europe) overly protected and distorted labor markets have been sapping the earnings potential of the middle class, especially the younger generation. Sure, eventually, the U.S. consumer will return to financial health and European governments will stabilize their debt. But in order to restart the old growth models, we’d need to restart the debt machine in the U.S. and finance government payouts in Europe. The old engines of growth may not rebuild to where they were before the financial crisis. It may not be smart to rebuild them anyway, based on the damage that they’ve done. In other words, we can question whether the economic models of the West are sustainable. I think they are not. But no one in policymaking circles in the U.S. or Europe seems to be thinking of what comes next.

So where do we go from here? I’m still working that out in my brain, and I’m interested in all of your ideas. But here are a few preliminary thoughts.

First of all, a new growth model has to embrace the global economy. It is too simple to blame globalization for the ills of the West, which many have already done with talk of China stealing jobs, free trade destroying American industry, blah, blah, blah. Yes, foreign competition has been tough on the worker of the West, especially those with limited skills. But the fact is globalization was inevitable with the advancements in technology we’ve seen over the past half century. And there was no way of keeping the vast majority of the world’s population impoverished to ensure the West’s continued dominance. Plus the gains in productivity, efficiency and cost savings from globalization have been too huge to be rejected. Anyone who wants to reverse globalization and protect the advanced economies should have come with me on my first trip to India in 1991, before the onset of market reform. The protectionist, anti-trade mindset of India’s policymakers kept Indians driving around in vintage cars and crammed into slums. Going backwards on globalization means going backwards, period.

The answer is just the opposite, to embrace the opportunities of the new world order. A richer China, India and Brazil may mean more competition, but also new consumers to buy new products and enjoy new services, on a scale never seen before in human history. The emergence of the emerging world means more options for entrepreneurship than the global economy has ever offered. No, the problem is not globalization. The problem is how the West has responded to it.

The U.S. and Europe have simply not prepared themselves for the realities of this new world order. They haven’t prepared themselves to compete. They’ve lived off credit cards and pension checks, borrowing from the future to prosper today, rather than investing to capture the growth potential of the future. They’ve built too many houses and wasted effort in dreaming up pointless financial instruments rather than focusing on productive innovation. That can’t continue.

So what would a new growth model look like? The West has to improve its ability to compete with emerging economies. We need massive investments in education and job retraining, to upgrade the knowledge and skills people require to take advantage of the new world. If low-skilled workers can’t compete with Chinese laborers, then their skills have to improve. There is no other way. More education will prepare more people to work in new industries, or to invent new industries of their own. Secondly, we have to invest just as heavily in the infrastructure of the future, whether that means new airports or new communications systems. After traveling around Asia, I can assure you that the mobile phone networks and transport systems of the U.S. are an embarrassment. Making such new investments not only would improve efficiency but also create jobs. The notion that more infrastructure means more government spending is also flawed. Why can’t the private sector finance smart and worthy infrastructure projects? Third, we need to focus more on entrepreneurship. I was watching Tom Friedman of the New York Times on CNBC the other day, and he was correctly pointing out that the old days when Ford would swoop into town, build a factory and employ 50,000 people are over. He’s right. The future, as he pointed out, is fostering many small entrepreneurs each hiring a few workers at a time. We’re simply not doing enough to encourage such small-scale innovation. Fourth, we need corporate reform. The maximize-shareholder-value-at-all-costs model isn’t working to spread the benefits of globalization to the masses. The rich are getting richer and the poor poorer. We need a new social contract that recognizes the reality that the future of corporate America depends on the future well-being of its workforce. For a start, I’d link executive bonuses to LONG-TERM gains in profitability and stock prices, not immediate-term jumps, to get companies thinking about developing their businesses and talent well into the future.

But instead, I feel we’re doing just the opposite. In Europe, budgets are being sliced and diced with no thought of the future at all, while the young generation is being condemned to second-class status by unfair, union-controlled labor systems. In the U.S., budget cutting is worsening income inequality and ignoring the future needs of the American economy. Rather than investing in education, the U.S. is curtailing access to it for the average American (that downright stupid decision in the debt-ceiling compromise to eliminate subsidized loans for graduate studies, for example). Tax breaks best given to entrepreneurs are being handed over to oil companies. Politicians pandering to unions are blocking free-trade agreements in the misguided hope of preserving jobs in uncompetitive industries. Ideological nonsense from the Republican right is preventing badly needed, job-creating investments in American infrastructure.

Clinging to the old is suppressing the new. If the West wants to get out of the mess it is in, its leaders have to drop outdated notions, break from ideological strictures and stop kowtowing to wealthy special interests. Instead, everyone is just hoping for a return to the good old days. But we need to go forward, not backward.

More on this subject to come.