The Levelling

by Michael O'sullivan

  Governance Bubble

  In a number of respects, the United States is building a governance bubble: executive pay levels are very high and are often out of kilter with many metrics of performance (nearly two-thirds of top US companies benchmark executive pay against earnings per share, which is a very malleable metric), debt levels are rising to record highs, and in general shareholders are exhibiting a disturbing degree of docility. The last time the United States was troubled by a corporate governance crisis was in the first years of the twenty-first century, when WorldCom and Enron Corporation became prominent examples of poor governance. In both cases, suspect accounting and high debt led to high-profile bankruptcies. The title of a book about Enron, The Smartest Guys in the Room, gives a sense of the hubris involved.38 At the time of writing, corporate debt ratios and levels and executive pay and its relation to performance metrics are more stretched than they were in the run-up to the Enron scandal in 2001, and the overall pattern suggests that there is a growing, systemic governance problem in the United States.

  There are two ways to resolve this. One is the traditional approach of letting markets discover and price corporate governance issues. The other is to try to frame the governance problems and ensure they do not happen again. In the United States specifically, this would entail a much tighter linking of executive pay to long-term increases in the value of a corporation (and possibly to the welfare of stakeholder workers, the environment, and suppliers, though this approach is not popular in the United States) and the organic growth of an enterprise. Another requirement would be for debt and equity holders to take a more active approach to governance.

  Furthermore, the introduction of a governance code like the Cadbury framework in the United Kingdom (based on a 1992 report by Sir Adrian Cadbury that set out a number of measures designed to raise the standard of corporate governance)39 would be revolutionary for Wall Street and Silicon Valley (many technology companies have very weak governance provisions in areas like voting rights). Clearer, cleaner earnings- and tax-reporting standards would also help. Much of these criteria can also be applied, in a slightly different way, to the private equity industry, which for a long time has been a silent governance offender. The question remains, however, of whether internationally respected corporate governance criteria can be transmitted across the major economic blocs, and whether American corporations will tackle their governance risks before a crisis of governance.

  Risky Business

  As the importance of good corporate governance and the risks of high levels of indebtedness become clear, the future appears gloomier. Currently high levels of debt suggest that the ongoing international problem of indebtedness has not been cured but has simply been put off for another day. This, in turn, clogs up economies and financial systems and in many countries leads to distributional consequences (i.e., wealth inequality). Over the past twenty years, the policy community has failed to come to grips with indebtedness. We could easily make the case that since the 1998 Asian and emerging-market crises, policy responses to various crises have postponed a reckoning—that is, debt bubbles have not been allowed to clear in the way they did in the nineteenth century. Instead, the approach has been to prop up bad debt, bad banks, and bad investments in the hope that reflation would wash away the underlying risks. This view is an expression not of financial bloodlust but, rather, of a desire for those taking and building risks to accept the consequences when things go wrong.

  There have been a few exceptions to this risk dodging. One I recall was the collapse of the Long Term Capital Management (LTCM) hedge fund. In the mid 1990s, LTCM was one of the world’s largest hedge funds, run by a team of high-profile bond traders and famous academics. It had a range of highly leveraged positions in fixed-income markets. In the face of market volatility, it was forced to unwind, in turn crashing financial markets and provoking the rescue of the fund by a consortium of investment banks. I recall witnessing a presentation on the collapse of the fund from one of its principals, whose voice broke as he recounted its demise. More generally though, the architects of many episodes of financial volatility have gone unpunished or have been relatively untouched by the consequences of their actions. Few bankers involved in the more egregious episodes of risk taking that led up to the global financial crisis have gone to jail. Consumers and households in Ireland, Greece, and the United States will also bear testimony to an absence of a sense of justice following the financial crisis. This is in contrast to more historic crises (à la the nineteenth century) in which the end effects of risk taking were often brutal. At a very broad level, one might say that there is a contemporary and repeated tendency for there to be a mismatch between risk takers and risk bearers. In other words, in recent history, those taking risks have not borne the downside consequences of their actions.

  This has come about partly because policy makers have sought to spread risk across the financial system, partly through a desire to save the world. The trouble with saving the world is that very often it saves those who have the means to be saved (and who may not deserve to be saved), leaving others floundering. In the white heat of the global financial crisis, much of this was readily apparent to policy makers, and some serious policy initiatives were implemented (such as the Dodd-Frank Wall Street Reform and Consumer Protection Act), though as the postcrisis fear fades, legislation designed to reduce risk taking is being whittled away.

  Risk taking cannot be eliminated, and it should not be, for some very healthy economic reasons. But in the spirit of the Levellers’ declaration in the 1649 agreement that “laws ought to be equal, so they must be good, and not evidently destructive to the safety and well-being of the people,”40 we would be much better off if the consequences of risk taking were better aligned with or matched to those taking them.

  If my earlier sense of the need for a debt conference is correct, then such a conference could well be accompanied by a Treaty on Risk, which, in the spirit of the nuclear arms reduction treaties or other more traditional treaties in the international relations arena, might be undertaken between the large regions. The aim of the treaty would be to ensure greater sensitivity to risk taking and better alignment of the consequences of risk with those who instigate them.

  There already exist risk policy guidelines for countries; notably, the OECD has already produced a risk governance framework, though it seems that many countries do not regard them as in any way binding on policy.41 Though fields like corporate governance offer means of potentially reducing risks, or at least of better elucidating them, corporate governance is so rooted in national cultural norms that achieving homogeneity across nations will be difficult. In this respect it may be better to concentrate on areas where nations and regions face common problems and to propose agreed frameworks to help curb them.

  The central pillar of such a Treaty on Risk would be an agreement to limit the use of extraordinary monetary policy in all but extreme market and economic situations. By restricting the use of quantitative easing in all but emergency circumstances (which could be defined according to threshold levels of inflation, growth, and market or financial system stress), governments and central banks would prevent quantitative easing being deployed in ways that dull markets’ sensitivities and that thereby encourage reckless leveraging and financial engineering by corporate actors. This treaty would also attune political leaders to the fact that the monetary comfort blanket could not be deployed against every threat and that they would thus have to adopt a more proactive approach to avoiding and curing economic crises.

  A final point worth making here concerns the degree to which individuals bear the consequences of the financial risks that they create. My own sense is that relatively few people in the financial services industry bear the consequences of their decisions. Corporate actors and their shareholders are punished more often than are individuals, and in many cases, the end consumers of savings and mortgage products bear a very high cost.

  Here, the story of Robert Morris is i
nstructive. He was one of the Founding Fathers of the United States and was known as the “financier of the Revolution,” having conceived the idea of the Nova Constellatio, a monetary unit that would facilitate the change of Spanish, Portuguese, and British currencies into an American one. It can be seen as a precursor of the dollar (and even the euro). One of its innovations was that the currency would use decimal accounting, something that is generally accepted today. He also turned down George Washington’s offer of the position of first treasury secretary in favor of Alexander Hamilton. His fortunes took a turn for the worse when he lost his capital in a land speculation (the Panic of 1796–1797) and spent three years in a debtor’s prison, until the Bankruptcy Act of 1800 was passed.

  His case is sometimes taken to support the argument that risk taking should not be too harshly punished and that failure in business should not be stigmatized. Today, in the United States, bankruptcy procedures can be more ruthless, though more rapid and less stigmatizing, than comparable procedures in Europe. The underlying aim of such laws should be to achieve two purposes: to enable the relatively speedy recycling of assets encumbered by debt and to do so in a way that is just in terms of the risks taken in accumulating that debt. In this respect, Morris’s story might echo through the International Debt Conference of 2024, where the aims will be to unclog the world financial system of the burden of debt that has accumulated through the age of globalization and to do so in a way that will ensure that in the future those who take on too much debt will directly bear the consequences and, very importantly, that the burden of risk taking is felt by the architects of speculative and debt-laden projects rather than by the projects’ end consumers.

  EIGHT

  A MULTIPOLAR WORLD

  As the World’s GDP Moves Eastward

  IN 2018, I HAD THE OPPORTUNITY TO VISIT ONE WORLD TRADE CENTER, the skyscraper in Lower Manhattan that has replaced the two towers of the World Trade Center destroyed on September 11, 2001. The new building showed a splendid riposte to the evil visited on New York that day. As the tallest building in the Western Hemisphere, it affords a spectacular view of New York City and the environs of the Hudson River.

  There was a time when the majority of the skyscrapers in the world grew out of the granite of Manhattan. They were a mark of progress and confidence. Today, an attractive and intuitive way of seeing how the world has evolved from a unipolar, US-focused one to a more multipolar one is to look at the location of the world’s hundred tallest buildings. The construction of skyscrapers (two hundred meters or more in height) is a nice way of measuring hubris and economic machismo (think of Trump Tower). Between 1930 and 1970, at least 90 percent of the world’s tallest buildings could be found in the United States, with a few standing in South America and Europe. In the 1980s and 1990s, the United States continued to dominate the tallest-tower lists, but by the early twenty-first century there was a radical change, with Middle Eastern and Asian skyscrapers rising up.

  Today about 50 percent of the world’s tallest buildings are in Asia, another 30 percent are in the Middle East, a meager 16 percent are in the United States, and a handful are in Europe. In 2015 three-quarters of all skyscraper completions were located in Asia (China and Indonesia principally), followed by the United Arab Emirates (UAE) and Russia. Following the trail of skyscrapers illustrates the way growth, urbanization, and the notion of progress have spread beyond the United States to other parts of the world. On a related note, as of 2018, the United States only had three (Hartsfield-Jackson International Airport in Atlanta, Georgia; Los Angeles International Airport; and O’Hare International Airport in Chicago) of the eleven-busiest airports in the world, a number of which (Beijing Capital International Airport, Dubai International Airport, and Shanghai Pudong International Airport) were fledgling airports twenty years ago. This pattern of infrastructure also illustrates how the center of gravity of the world economy has shifted eastward, to the extent that some writers now describe a process of “Easternisation.” Danny Quah, a Singaporean academic has a wonderful chart that shows how the center of gravity of the world’s GDP has moved eastward over the past twenty years.1

  This shift in the center of gravity of the world is an essential part of the levelling: the levelling out of economic power between the regions of the world. It also helps put in context the trade tension between the United States and China, which is simply an expression of the realization by America’s political, military, and commercial elite that China has caught up. What will alarm many, especially in the United States, is that the levelling is not about the rise or fall in the GDP of one country compared to another; rather, it is about a change in the system, the way of doing things internationally, or, as many put it, the world order. Changes to systems tend to produce unpredictable and volatile consequences. Earlier chapters in this book have outlined them. To reiterate: inequality, indebtedness, and political volatility are now at multidecade highs. Trade tensions and the envelopment of entire economic systems by their central banks are leading to a more regional approach to economics and politics. America’s disengagement from world affairs, a more confident European Union, Brexit, and China’s One Belt, One Road program are all reverberations of the end of one way of doing things and the passage to another. Most worryingly, democracy is no longer a magnetic policy goal for many countries, and lesser and weaker forms of democracy are now considered acceptable around the world.

  Those in the West may view the levelling with trepidation, but that is not necessarily the case in emerging nations, where the idea of a more balanced, multipolar world is recognized and welcomed. Many of those nations will have little patience for the tendency of Western institutions and governments to lecture and condescend to them.

  The uncertainty that the passage of the levelling brings, even at this early stage, will make many in the West yearn to roll back the clock so that they can continue to enjoy the fluid prosperity of globalization. Many politicians and institutions are in denial that globalization has come to an end, and fewer still ask what will replace it.

  Sustaining globalization in its current form would require several nearly miraculous policy steps. There would be an onus on proglobalization political leaders to develop a tangible narrative on globalization’s benefits, followed by actions that would better distribute its positive effects. A new, imaginative trade round would need to be launched, possibly encompassing the implications of Brexit, the desire of the United States to recast nearly all its trade relations, and the cementing of more stable trade relations between Japan and China. Yet when one considers the political effort and goodwill required to enact such measures, globalization fades away into the distance. There is already entrenched skepticism over its benefits, and the reality is that demographics, indebtedness, and to a large degree productivity weaknesses are likely to persist and hold down the trend rate of growth.2

  Some of the policy steps to reinvigorate globalization and limit its perceived negative side effects could be controversial and populistic. For instance, we may hear calls for “taxes on technology” or levies on monopolies, which would be attention-grabbing means of turning public opinion but which may only replace right-wing populism with that from the left. Another policy strand associated with limiting the overreaches of globalization is the reining in of the very large technology and social media companies. Today, tech is as big as banking was before the global financial crisis, and, with a little irony, bigger (in terms of revenues and earnings) than tech was in 1999. There is growing evidence to show that the large technology companies are dominating the industries in which they operate. A paper from the staff at the Richmond Federal Reserve highlighted the fact that the concentration of a small number of large companies is in some cases as high as it was during the Gilded Age.3 This has allowed the dominant companies to enjoy higher margins, higher stock returns, and more-profitable merger deals. The authors flag lax regulatory oversight (as well as technological barriers to entry) as one reason for the rise of dominant f
irms.

  In this light, one proposal that we may hear more of is that, echoing the 1933 Glass-Steagall Act that separated the activities of commercial and investment banks (some banks and the sectors they had invested in—oil, railways, and steel companies—were nearly as dominant as the large technology companies are today), there would be a Glass Steagall–themed act that would break up corporate giants such as Amazon, Google, and perhaps even Tencent Holdings, China’s media-enabled e-commerce player. This could involve separating cloud-computing businesses from e-commerce ones, with data-intensive activities split to preserve privacy. Widely used search engines may be classified as public goods and required to have a truth filter that, for example, would prioritizes information from verified data sources. As an example, a search for “climate change” would prioritize data and research from NASA, governments, and the United Nations. As interesting as this proposition is, large tech companies in both the United States and China are strategic assets for their governments and are unlikely to be treated in an overly harsh manner.

  Good-bye to Globalization

  It may well be better that those who have grown fond of globalization get over it, accept its passing, and begin to adjust to a new reality. Many will resist and, like the thirty-five foreign-policy experts who published an advertisement in the New York Times on July 26, 2018, under the banner “Why We Should Preserve International Institutions and Order,” will feel that the existing world order and its institutions should be maintained. I disagree. Globalization, at least in the form that people have come to enjoy it, is defunct. From here, the passage away from globalization can take two new forms. One dangerous scenario is that we witness the outright end of globalization in much the same manner as the first period of globalization collapsed in 1913, as I outlined earlier. This scenario is a favorite of commentators because it allows them to write about bloody end-of-the-world calamities. This is, thankfully, a low-probability outcome, and with apologies to the many armchair admirals in the commentariat who, for instance, talk willfully of a conflict in the South China Sea, I suggest that a full-scale sea battle between China and the United States is unlikely.