World Excellence International Edition N°31 | Jan-Jun

WORLD EXCELLENCE €20,00 January - June 2019

THE #1 MAGAZINE FOR CEO S

CHINA

A COUNTRY IN TRANSITION Significant progress has been achieved since 2013, when President Xi Jinping articulated a comprehensive reform plan that would put China onto a path of inclusive, green, innovation-driven growth.

Xi Jinping

- China President

LE FONTI AT LAS VEGAS CES 2019

REIMAGINING DAVOS

The live streaming television took part in the most important international Consumer Electronics Show

At the World Economic Forum annual meeting in Davos, participants made the same mistake they always do www.worldexcellence.com

CONTENTS

WORLD AFFAIRS

OVERVIEW

6

What’s Happening

NOW?

SUSTAINABILITY

8

When will China achieve quality growth?

30

Disrupting multilateral climate finance

12

Brexit: sweat and tears

34

16

Trump’s North Korean road to nowhere

The right investments to address the human capital crisis

20

A solution to the US - China trade dispute

SPOTLIGHT

World Excellence The #1 Magazine for CEOs Publisher/Director

4

26

Guido Giommi

New TV developements have been disclosed

Editor, Asia:

January / June 2019

Editors, America: Rosalyn Williams Eric Davide

Editors:

Alessia Annicchiarico, Claudia Chiari, Alessia Liparoti, Alessia Rosa, Simona Vantaggiato

BUSINESS & FINANCE

INNOVATION & TECHNOLOGY

ECONOMICS

38

Franco-German friendship is not enough

50

Lies, damned lies, and AI

62

The Euro’s first 20 years

42

Reimagining Davos

54

Digital dangers to democracy

66

The three revolutions economics needs

46

How Germany lost its Einsteins

58

AI for human development

70

Risks to the global economy in 2019

International Subscription Kate Rios

Art Director Nick Lowen

Graphic Design Giulia Andreoli

Editorial Offices:

London, Milan, New York, Dubai and Hong Kong

© Project Syndicate 2019

Volume 31

Head Office

Copyright © 2019 All rights reserved.

Reproduction in whole or in part is prohibited without the prior written consent of World Excellence. Information is based solely on sources believed to be reliable, though the accuracy has not been verified by World Excellence.

Neither the information in World Excellence nor the opinions expressed should be taken as a solicitation for investment. World Excellence accepts no liability for actions based on the information herein.

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January / June 2019

5

OVERVIEW

WHAT’S HAPPENING NOW? - WEIE Market Review UNITED KINGDOM The terrifying prospect of a nodeal Brexit on March 29 remains in play after the British Parliament emphatically rejected Prime Minister Theresa May’s withdrawal agreement with the EU. Leaving the European Union is painful by design. The process any member state must follow to exit the EU is governed by Article 50 of the bloc’s Lisbon Treaty, which, ironically, was authored by a British diplomat keen to deter exits from the EU. That is why Article 50 sets a two-year negotiation period ending with an ominous deadline: If negotiations have not produced

6

January / June 2019

a divorce agreement within the prescribed period – March 29, 2019, in Britain’s case – the member state suddenly finds itself outside the EU, facing disproportionate hardships overnight. With fewer than three months left, the prospect of Britain falling out of the EU without a deal is, understandably, terrifying. A natural response is to call for an extension of Article 50, to reset the clock and give negotiations more time. That instinct must be resisted. Any resetting of the clock would simply extend the

paralysis, not speed up convergence toward a good agreement. The worst aspect of May’s deal, which Parliament emphatically and wisely rejected, was that it extended the transition process until 2022, with the UK committing to paying around $50 billion, and possibly more, to the EU in exchange for nothing more than unenforceable promises of some future mutually advantageous deal. Had Parliament voted in favor of May’s deal, it would have prolonged the current gridlock to a new cliff edge three years hence.

NEW ZEALAND Global rules and norms are again coming under threat, and cooperation in meeting the world’s biggest challenges is faltering. New Zealand’s close and long-standing ties with Europe are therefore vitally important, on issues from climate change to trade. Climate change is the defining

global challenge of our time. New Zealand is working together with our EU partners to set ambitious targets for emission reductions, and sharing information and expertise that will support domestic initiatives to meet these targets.

The partnership in the field of global

peace and stability is equally valuable.

New Zealand and EU work together to combat terrorism through peace support operations, promote the rule of law, and address emerging threats such as cyber security. Global threats require global responses, and a strong partnership is essential to this.

NEWS PILLS “TOWARDS A STRONGER INTERNATIONAL ROLE OF THE EURO” The European Commission, like most European policymakers, takes it as given that the eurozone would benefit if the euro played a more global role.

But that is not necessarily true.

THE “CARBON LAW”

The world needs to follow a trajectory called the “carbon law,” which requires reducing CO2 emissions by half each decade until, 30-40 years from now, we have achieved a carbon-free global economy.

THE QUOTE CORNER “ It is the function of science to discover the existence of a general reign of order in nature and to find the causes governing this order. And this refers in equal measure to the relations of man - social and political - and to the entire universe as a whole. ” - Dmitri Mendeleev

January / June 2019

7

WORLD AFFAIRS

THE QUEST FOR QUALITY GROWTH

China has not yet realized President Xi Jinping’s vision of an inclusive, green, innovation-driven economy. But if policymakers continue to strengthen property rights and work to improve market confidence and foster fair competition, a breakthrough should not be far off.

WHEN WILL CHINA ACHIEVE QUALITY GROWTH? 8

January / June 2019

January / June 2019

9

WORLD AFFAIRS

H

ONG KONG - Even before

the 2008 global financial crisis laid bare the limits of China’s export-oriented growth model, the country’s leaders were stressing the need for quality growth.

In 2007, then-Premier Wen Jiabao argued that Chinese economic growth had become “unstable, unbalanced, uncoordinated, and unsustainable.”

More than a decade later, how close is China to overcoming Wen’s “Four Uns”?

Significant progress has been achieved, particularly since 2013, when President Xi Jinping and his team articulated a comprehensive reform plan that would put China onto a path of inclusive, green, innovation-driven growth. Since then, China has taken major steps forward, especially in rooting out corruption, alleviating poverty, and implementing supply-side reforms.

But China has not quite reached the authorities’ goal that the market should become the “decisive” force in resource allocation. And the implementation of Xi’s reform plan has been hampered by multiple

10 January / June 2019

internal and external shocks – including, in recent months, escalating trade tensions with the United States.

As the external environment becomes shakier and more hostile, China is facing a cyclical downturn at home. In 2018, China’s GDP growth slowed to 6.6%, the lowest level since 2010, though unemployment and consumption have so far remained stable. Moreover, while trade grew by 9.7% for the whole year, it shrank by 4.8% in December, reflecting the uncertainty created by trade tensions with the US. As market sentiment turned bearish, growth in fixed-capital investment in infrastructure and housing declined to only 5.9%. The Shanghai Composite Index fell about 25% – the largest drop in a decade – and the market capitalization of Chinese companies listed on the Shanghai and Shenzhen stock exchanges dropped by as much as $2.4 trillion.

The silver lining of the challenges – and, in particular, of protectionist pressure from the US –is that they have given Chinese policymakers

added motivation to address structural imbalances and work toward leveling the playing field for private and foreign businesses. For example, the Ministry of Finance has launched a series of tax-cut programs, aimed at easing the burden on low-income households, the service sector, and small enterprises.

Moreover, financial, trade, and industrial regulations that previously hindered private business and innovation are being streamlined. And, on the monetary front, the People’s Bank of China has cut the mandatory reserve ratio for banks four times over the last year, to maintain appropriate liquidity.

As part of its negotiations with the US, China is also moving to open its markets further. But there is a limit to the extent to which China can appease the US. As it stands, China has largely eliminated its trade surplus with the rest of the world. If it eliminates its trade surplus with the US, as President Donald Trump has repeatedly demanded, it may end up having to reduce imports from other

countries to keep its overall trade balanced. This would disrupt global trade.

Another barrier impeding China’s quest for quality growth relates to timing. While delivering sustainable development, raising living standards, and eliminating imbalances will yield massive long-term benefits, the policies needed to get there may weaken growth in the short term.

In order to offset this effect, China hopes that the private sector can deliver innovative, productivityboosting breakthroughs in the near future. To help bring this about, Xi has met with various private business leaders to reassure them that they can count on the government to support fair competition and innovative activities.

But, if the private sector is to fulfill its potential, it needs financing.

To this end, China must deepen its domestic capital markets, in order to support varied and efficient long-term investments by institutional players, such as social security and pension funds, that can convert savings from debt to long-term equity.

At the same time, the private sector needs stronger institutions to underpin fair competition. According to the late economist Harold Demsetz, institutions that define, protect, and refine private property rights will emerge only when the benefits of such a system exceed the costs of establishing it. China is in the

As the external environment becomes shakier and more hostile, China is facing a cyclical downturn at home midst of this transition.

The private sector also needs greater incentives to take risks. Here, clarifying the balance between local-government autonomy and central-government regulation is crucial. While excessive freedom for subnational governments can lead to instability, excessive control can choke off the local-level experimentation and competition that has long driven growth in China.

Indeed, though the central government provides essential infrastructure and policy coordination, only local (including municipal) governments can identify and implement “lastmile” public-infrastructure projects that create market potential for new growth. Such projects – and the public services they support – are crucial to creating an ecosystem that attracts entrepreneurs and innovators.

To enable local governments to fulfill this important role, innovative financing mechanisms are needed to reduce their debt and increase overall capital productivity. For example, public assets could be leased to private

businesses capable of providing more efficient management.

This speaks to a broader need for China to dismantle bureaucratic roadblocks. As Demsetz observed, the decision not to lower barriers to market entry does more to undermine competition than, say, excessive market concentration. Though the Chinese digital giants Tencent and Alibaba have natural monopoly power in their domains, relatively low barriers to market entry have enabled them to provide low-cost services to vast numbers of consumers and businesses.

China has not achieved quality growth yet. But if the country’s leaders continue to strengthen property rights and work to improve market confidence and foster fair competition, a breakthrough should not be far off. WEIE

Andrew Sheng & Xiao Geng

January / June 2019 11

WORLD AFFAIRS

A SHIFT IN THE COUNTRY’S FORTUNES

BREXIT Sweat and Tears For years after World War II, Britons were aware of the palpable shift in the country’s fortunes. But there was a deep aversion to accepting the UK’s diminished status, and the failure – beginning with Winston Churchill – of successive generations of politicians to address it is what has led to the current impasse.

12 January / June 2019

L

ONDON - I recently saw an American play in London called “Sweat,” written by the Pulitzer Prize-winning dramatist Lynn Nottage. It was performed previously on and off Broadway and was described by the Wall Street Journal as a play that helped to explain Donald Trump’s election as president.

Nottage had spent some time talking to the residents of a poor city in Pennsylvania which was losing jobs and its modest prosperity because of the contraction of the steel industry. Competition from cheaper manufacturers and lowerpaid workers around the world had devastated an already-weak economy and provoked conflict between friends, relatives, and races.

Economically marginalized workers were also feeling culturally beleaguered. The world in which they had grown up – its values and fixed identity – was, it seemed to them, being systematically trashed.

They turned – not necessarily in the expectation of answers – to a billionaire outsider who, unlike the political elites, had not yet let them down and appeared to share their contempt for the establishment.

Some politicians and commentators have sought to explain the vote for Brexit in the United Kingdom along similar lines. But while economic grievances and a generalized

While the majority of older voters backed Brexit, the young voted overwhelmingly to stay. hostility to immigration and the political establishment help to explain the results of the 2016 referendum, they are far from a complete explanation.

The first thing to note is that while only a minority of Labour voters chose to leave the European Union, a large majority of Conservative voters in well-off areas outside London did so, as the newspapers they mostly read advised. Today, moreover, the anti-European virus in the Conservative Party membership has spread widely – though, given the paucity of Conservative members, this has not involved a very long journey.

As their numbers have fallen, Conservative Party members have moved increasingly to an English nationalist view of the world. That is not unusual. When a political party’s active membership declines, its views become more extreme, and a spiral begins: as the party becomes more extreme, membership falls further, fueling greater extremism,

and so on.

Conservative Party membership has also become older. One wag recently said that virtually all Conservative activists could fit into Wembley Stadium, though they might have difficulty with the steps.

While the majority of older voters backed Brexit, the young voted overwhelmingly to stay. Gloomy forecasts have calculated that death and the arrival of new young voters on the electoral register have already demolished the majority support for leaving the EU. That calculation does not include what is now a perceptible shift in attitudes in favor of Remain.

It also seems significant that a majority of Anglican church members voted to leave, and that Leavers were likely to live outside London and to be English. Scotland and Northern Ireland voted heavily to remain. I suspect that what we have witnessed is less a feeling of economic insecurity than a sense that times have changed in a way

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WORLD AFFAIRS

that older, Conservative nationalists do not like.

For years after World War II, the British – and especially the English – were aware of the palpable shift in the country’s fortunes. But there was a deep aversion to accepting the UK’s diminished status. We had been a great imperial power, whose economic and political authority had been waning since the beginning of the twentieth century. Yet we were still capable of great things. Under Winston Churchill’s leadership, we played a major role in defeating fascism. But, despite Churchill’s own somewhat ambivalent attempts to teach us to adjust to a new European role in the world, we continued to see ourselves as a bigger power than we were.

Churchill himself was reluctant to say that the days of Britain’s empire were at an end, and that we earned our place at the world’s top table

14 January / June 2019

principally because of what we had been, rather than what we might be able to contribute – in demographic, military, or economic terms – in the future.

One of Churchill’s own wartime scientific advisers, Henry Tizard, said that we had once been a great power as well as a great nation. But if we continued to try to behave like a great power, he continued, there was a danger that we would compromise our ability to remain a great nation. The debacle of Britain’s military intervention in 1956 in Egypt to try to retain control of the Suez Canal should have taught us that we were living in a new post-imperial age.

When the UK joined the European Union in 1973, we were in danger of becoming an object of sympathy, the sick man of Europe. Over the years, we prospered in Europe, shaping it in

our own interest and avoiding the bits of the European enterprise that we did not like – a single currency and social policies that would inhibit growth. But, naturally, we accepted that to ensure the fairness and success of the single European market, we needed to pool sovereignty and share in decisionmaking about some European laws and regulations. Equally, as a medium-size power, we were more likely to be able to protect and advance our interests by negotiating trade and other matters as part of a bloc of other mostly medium-size countries.

But all of this has been deeply unpalatable to those who think that working with others somehow undermines our sovereignty. They fail to comprehend that international cooperation is required to solve most of the big national problems – from illegal immigration to climate change – that face us today and will

face us in the future. Moreover, on our own we would have to accept many of the rules and regulations made by others, not least in earning our living around the world. There is no point in crying about it.

Gunboat diplomacy is a thing of the past, and even if it wasn’t, we have very few gunboats anymore!

Many older voters have had considerable difficulty in adjusting their aspirations to a world that has changed. We are still a remarkable country. But we can no longer get our own way by asserting our will and invoking our history. No one owes us a living.

British Prime Minister Theresa May must confront many of her supporters with this hard truth if she is to secure the UK’s national interest. She cannot deliver what many of them believe they were promised, namely that we could leave the EU without any loss

of economic stability or political influence.

Recognizing that opinion in Parliament is moving strongly against leaving the EU on the terms proposed by May, with a growing number of members even in favor of a second referendum to test whether we should leave at all, some right-wingers have flirted with the idea of trying to close down the House of Commons for a time. They want the government to be able to get its own way without any democratic opposition. It is a sign of their desperation to get Britain out of the EU whatever the constitutional or economic cost.

Is May prepared to get to grips with this? If she runs away from the task, despite growing Parliamentary unease about the path we are on, Britain is in big trouble. WEIE Chris Patten

January / June 2019 15

WORLD AFFAIRS

A SONG SUNG ALONE

TRUMP’S NORTH KOREAN ROAD TO NOWHERE Less than a year after his unprecedented face-to-face meeting with North Korean leader Kim Jong-un, US President Donald Trump is planning to hold another summit to discuss denuclearization. Judging by the outcome of the first meeting, US allies in the region have good reason to be deeply concerned.

16 January / June 2019

A

TLANTA - When US President Donald Trump meets again with North Korean leader Kim Jong-un next month, he will be staging the second act in a comedy of manners that now passes for US foreign policy on the Korean Peninsula.

Between Kim’s billets-doux to the White House and Trump’s gushing praise of Kim, the script could have been written by Oscar Wilde. Like any drawing-room farce, the plot is simple enough: Kim will pledge to abandon his nuclear weapons someday, while coquettishly concealing any details about the program that produces them, and Trump will promise to shower wealth on the Kim dynasty if he does.

But, of course, this play is more tragedy than comedy. Like Trump’s threats to abandon longstanding alliances, withdraw US forces from strategically important regions, and tear up trade deals, the prospect of more presidential shooting from the hip is unnerving US allies, soldiers, diplomats, and even some politicians.

There is good reason to worry, given the outcome of the two leaders’ summit in Singapore last June. Trump’s naive acceptance of Kim’s empty promises over the past eight months has done nothing but erode the US’s leverage in South Korea and

January / June 2019 17

WORLD AFFAIRS

Trump has not only failed to halt Kim’s nuclear ambitions; he has also undermined America’s role as a deterrent in Asia beyond. The North has continued to pursue its ballistic-missile program; and through his overtures to South Korea and China, Kim has succeeded in weakening the sanctions on his regime.

Trump has not only failed to halt Kim’s nuclear ambitions; he has also undermined America’s role as a deterrent in Asia. With North Korea’s conventional arsenal already threatening Japan and other countries that host US forces, Trump’s public intimations about drawing down troops in South Korea and elsewhere have fundamentally altered the regional strategic calculus. If asked, leaders in Tokyo, Seoul, Taipei, and Southeast Asia might dissemble and avoid stating the obvious. But the fact is that Trump has cast doubt on US defense commitments at a time when both North Korea and China are increasingly pursuing their own regional ambitions.

This problem weighs heavily on the minds of other US

18 January / June 2019

policymakers. Hence, whenever Trump travels abroad, a squad of senior officials follows in his wake – like street sweepers after a parade – to reassure allies. Yet, no matter how effective their talking points, they cannot undo the damage that Trump has done to America’s credibility.

Consider Trump’s statement last June declaring that North Korea is “no longer a nuclear threat.” That would certainly come as news to Japan, America’s most important ally in the region. Even if the Kim regime did agree to abandon its effort to develop reliable intercontinental nuclear missiles, it would still have thousands of nuclear-capable short- and medium-range missiles pointing at Japan.

The Trump administration is also neglecting the threat posed by the North’s conventional arms. Trump’s unilateral decision to suspend US military exercises in South Korea is a case in point.

Exercises involving US and South Korean forces are vital for refining war plans, resolving operational and cultural issues, and honing military skills. As such, they play a central role not just in preparing for various contingencies on the Korean Peninsula, but also in Japan’s own self-defense. Ensuring the seamless cooperation of allied units in the region is as important to Japan as it is to the US or South Korea, and perhaps even more so now that relations between Japan and South Korea are fraying.

Whatever emerges from his next summit with Kim, it is already clear that Trump’s disregard for US alliances is taking a toll. Creating effective defense partnerships takes time and hands-on effort. If there is rancor among allies, cooperation on high-priority goals can be set back indefinitely.

For example, three years ago, US officials brokered an important agreement to facilitate the exchange of intelligence data between Japan and South Korea. Yet today, Japanese-South Korean relations have grown tense once again over the issue of wartime reparations.

So far, this renewed acrimony has compounded the fallout from an incident last month in which a South Korean warship targeted a Japanese patrol plane. In the absence of US mediation, the prospects for ongoing military cooperation between the two allies

will likely continue to decline, pushing the government of South Korean President Moon Jae-in closer to North Korea and China.

In fact, Daniel Sneider of Stanford University points out that some in Japan have begun to take seriously the possibility of a US withdrawal from the region. With Trump constantly whining about allies not paying their fair share, and with South Korea going its own way, Japan’s leaders are being forced to reconsider longstanding assumptions about Japanese defense and security policy.

Trump’s disdain for US security commitments and the relationships that sustain them has not been lost on Asia’s leaders. Few find comfort in his proclamations about expanding America’s role in the world, given his more frequent threats to trash “unfair” alliances.

As it happens, Trump recently signed the Asia Reassurance Initiative Act, pledging $7.5 billion over five years to bolster US engagement in Asia. The program’s acronym – ARIA – is all too appropriate for Trump’s policies and their effects on America’s standing in Asia. An aria, after all, is a song sung alone. WEIE

Kent Harrington & John Walcott

January / June 2019 19

WORLD AFFAIRS

NOT-SO-FREE-TRADE AGREEMENTS

A SOLUTION TO THE US-CHINA TRADE DISPUTE The advanced economies are right that China needs to take steps to redress unfairness in its trade relations with other countries, not to mention its own economy. But if global trade is to be truly fair, the advanced economies – and, in particular, the US – also have to make some changes.

20 January / June 2019

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EW YORK - For many

allies of the United States, the flaws in President Donald Trump’s trade war with China – which is on hold for 90 days following the Xi-Trump meeting in Argentina – lay in the approach, not the motivation.

Indeed, Europe and Japan share many of Trump’s grievances. What they fail to acknowledge is that there is also plenty they can do to make the global trading system – and their relationships with China – fairer and more efficient.

To be sure, China needs to take steps to reform its policies. For

starters, China’s tariffs and nontariff barriers are higher than those of the US and other high-income countries (though not higher that most developing countries with comparable income levels). And there are many restrictions on foreign firms wishing to operate in China, including limits on foreign ownership of domestic firms.

Reducing barriers to the Chinese market would benefit not only foreign producers, but also Chinese households and firms that use imported parts. Trade liberalization would function like a tax cut, raising income and improving efficiency without requiring the government

to increase the budget deficit.

China’s past trade liberalization, following its accession to the World Trade Organization 17 years ago, indicates that such a move would not lead to a spike in unemployment, as long as the Chinese labor market remains sufficiently flexible.

China would also do well to respond to another key complaint, by strengthening protection of intellectual property. The Chinese government claims that it abandoned the policy of requiring foreign multinationals to share their IP in exchange for market access two decades ago. But

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WORLD AFFAIRS

the US and European chambers of commerce in China say that the actual practices are different.

In the past, when China’s own innovative capacity was weak, stronger IP protection would have meant merely more rents for foreign firms. Today, however, as China’s firms are developing their own valuable IP, and their global footprint has grown much larger, stronger and reciprocal IP protections would benefit Chinese firms as much as foreign companies.

China should also reform its subsidy programs and industrial-policy regime. Most countries use taxes and subsidies to promote certain economic activities. Still, the proportion of government programs that create distortions and inefficiencies, rather than address market failures, is higher in China than in highincome countries.

Such policies include subsidies that favor state-owned firms over private firms, leading to waste and lost productivity. In order to level the playing field among Chinese firms and for foreign firms, government programs should be subjected to more systematic costbenefit analysis.

But if global trade is to be truly fair, the advanced economies – and, in particular, the US – also have to make some changes. In fact, these countries’ barriers on Chinese

22 January / June 2019

goods and investment are not as low as commonly believed.

In the US, for example, tariffs on many textile and garment imports, of which China has been the world’s most efficient producer, are in the 20% range, much higher than the average US rate. Further raising the effective tariffs Chinese firms face is an anti-dumping regime that is often used as an instrument of protectionism, with rules that are biased against Chinese producers.

The average US tariff rate severely understates the actual tariff rates applied to Chinese goods.

Similarly, US free-trade agreements have artificially tilted US demand away from more efficient Chinese producers toward less costeffective firms in countries like Mexico. Despite the word “free” in the name, free-trade agreements are not truly about freer trade, as they discriminate against firms in countries outside the FTAs in favor of sometimes less efficient firms in the participating countries. This effect – which is not sufficiently limited by existing World Trade Organization rules – undermines efficient resource allocation and hurts not only workers in countries outside an FTA, but also, in many cases, low-income households within it.

Furthermore, the US regime governing foreign investment is not always fair, predictable,

The US regime governing foreign investment is not always fair, predictable, or transparent or transparent. When it comes to labeling a proposed investment a national security threat, the criteria appear very discretionary.

According to the US lawyers with whom I have spoken, who advise on cross-border mergers and acquisitions, because US screening processes for deals involving Chinese investors can face long and unpredictable delays, Chinese firms often have to pay an extra 15% to make their bids viable. In this manner, the US foreign-investment regime effectively expropriates Chinese firms that wish to invest in the US. Inefficient or distortionary policies are rarely simple mistakes. As a rule, they serve the interests of powerful and wellorganized special interest groups that are likely to resist any change.

But if China and the US reach a grand bargain on a package of policy changes that would reduce or eliminate distortions on both

sides, domestic resistance may be easier to overcome.

Such cooperation could be extended to help reach a bargain on WTO reforms that would further support fairness in the global system. For example, anti-dumping rules could be better harmonized with domestic anti-monopoly rules, and regulations could be created or strengthened to minimize the discriminatory effects of FTAs and to prevent governments from using subsidies to state-owned firms to bypass WTO rules.

Such a balanced and reciprocal approach would help to ease tensions over cross-border trade and investment. Equally important, it would bolster fairness and efficiency in the world’s two largest economies – a change that would benefit not just the US and China, but the entire world. WEIE

Shang-Jin Wei

January / June 2019 23

LE FONTI NIGHT

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SPOTLIGHT

LAS VEGAS CES 2019

NEW TV DEVELOPMENTS HAVE BEEN DISCLOSED The live streaming television took part in the most important International Consumer Electronics Show

26 January / June 2019

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AS VEGAS - This year’s

edition, which has just ended, has been a record-breaking one for Las Vegas CES, the most important international consumer electronics show, that never fails to set new trends in the field of technology. Owned and produced by the Consumer Technology Association, CES attracts those who thrive on the business of consumer technologies, world’s business leaders and pioneering thinkers.

Over 4,500 companies - among which 1,200 start-ups – have showcased thousands of products in front of an audience of 180,000 insiders, including a delegation of Le Fonti, the live streaming television with an all-news broadcasting service focused exclusively on economic, financial, legal, and infotainment topics around the clock, 24/7.

«I was quite impressed by the presentation delivered by Sony’s CEO - Kenichiro Yoshida. During his forty-five-minute speech he has neither mentioned, nor shown any products», commented from Las Vegas Guido Giommi, President of Le Fonti. «A change of strategy for the Japanese electronics giant.

Obviously, technology still constitutes a central element but, at the moment, what matters the most are experience and contents. It is precisely on these aspects that Le Fonti Tv is concentrating on. We are focusing on contents, formats and high-level personalities in preparation for an

official presentation, which will take place in the spring time and will unveil the new tv programming schedule».

Le Fonti, whose work has always revolved around excellence, leadership and innovation, couldn’t miss the chance to attend an exhibition which hosted over 4,500 exhibiting companies, including 44 Italian startups operating in the fields of wellness, food, smart city, robotics and much more.

Among the Italian excellences who participated at CES 2019 there were: a device capable of purifying the air in enclosed spaces, which was invented by three boys from the North of Italy, a wearable equipment to mak e driving safer and a robot-vehicle which is able to autonomously deliver packages.

«It’s the ideal opportunity to see our companies emerge and to pick up new global trends», added Giommi. After attending the MIPCom in Cannes, the most important exhibition in the market for entertainment content, Le Fonti continues its international activity to anticipate trends, especially but not exclusively, in the television industry.

After Las Vegas, Le Fonti will host a series of its LeFonti Awards, which will take place in Milan on 28 February at Palazzo Visconti, on 6 March at Palazzo Mezzanotte and in Hong Kong on 29 March. WEIE

Alessia Annicchiarico

January / June 2019 27

SPOTLIGHT

OUR TOP PRODUCTS An accurate selection performed by our editors regarding the new products introduced at Las Vegas CES

1 New 8K LCD TV SONY

2 Jarvish X-AR Jarvish

3 Filterless natural air purifier Clairy

28 January / June 2019

Oled TV R9 LG

4

Excellence of the Year Innovation & Leadership Sports Protective Equipment

www.vemarhelmets.net

SUSTAINABILITY

ADDRESSING CLIMATE CHANGE

DISRUPTING MULTILATERAL CLIMATE FINANCE If the world is to avert climate calamity, multilateral finance institutions must begin looking to large institutional investors as their partners and clients. The creation of a new global climate finance facility, appropriately ring-fenced from current financing initiatives, could help.

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EIJING - A recent report

by the United Nations Intergovernmental Panel on Climate Change warns that to avoid the direst consequences of global warming, societies must make social and economic changes on a scale with “no documented historic precedent.”

As we have noted previously, only institutional investors – like pension funds, sovereign wealth funds, and insurance companies – hold enough financial firepower to address climate change.

However, to minimize risk, institutional investors generally prefer to allocate their capital to operational infrastructure that is already generating stable revenue, rather than

to new projects. For the same reason, their investments are focused in advanced economies, which in recent decades have received more than 70% of private-sector investment in infrastructure.

Climate change requires institutional investors to move beyond these boundaries. But they need help to mitigate the associated risks, which is why we believe the world needs a new global climate finance facility (GCFF), exclusively targeted at mobilizing institutional investor capital, and designed to address the shortcomings of current multilateral initiatives.

Aside from several promising enterprises, governments and multilateral finance institutions are struggling to mobilize private capital at a scale relevant to climate change.

Crucially, institutional investors have been largely absent from such initiatives, for several reasons. First, MFIs and institutional investors have different priorities. The activities of MFIs are based on member countries’ policy goals and client countries’ needs, and do not always reflect investor demand. By contrast, institutional investors, as commercial actors beholden to pensioners and other stakeholders, will not invest in projects that are deemed too risky or unlikely to yield adequate financial returns. To attract their interest, MFIs’ terms must be competitive with those offered by the private asset-management companies used by

institutional investors. Moreover, many institutional investors are unfamiliar with infrastructure investment in general, let alone in emerging markets.

Consequently, MFIs must also build capacity to address these investors’ concerns about engaging in unfamiliar sectors and regions.

Second, there is a disconnect between promoting private investment in lowincome and fragile countries, and mobilizing private capital for climate action in middle-income countries, where carbon emissions are far higher.

Whereas green investments in the first group of countries may appeal mainly to a small set of specialized private investors and “impact investors,” larger sums of private capital, including from institutional investors, could be mobilized in the second group. At the moment, however, MFIs’ policies do not distinguish sufficiently between these two contexts, which require entirely different strategies, resources, and institutional structures.

Third, MFIs need to raise their presence on institutional investors’ collaborative platforms, take on more risk, strengthen partnerships with local strategic investment funds, and adjust their governance structures to conform with the corporate governance principles to which private investors are accustomed. According to a recent G20 report, MFIs should also strengthen their capacity to mobilize equity investment.

Finally, with few exceptions, existing multilateral initiatives – such as the

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SUSTAINABILITY

Green Climate Fund and the Clean Technology Fund – mobilize private capital at the project level, rather than at the portfolio level. But, because most institutional investors manage large amounts of capital with small investment teams, they typically do not have the capacity to invest directly in individual projects; they need a vehicle or fund to channel their investments.

In light of these challenges, investor control is the key to mobilizing private capital for green infrastructure. Private investors are extremely hesitant to relinquish control to public entities, owing to fears that public bodies can be swayed by political influence and may not invest on commercial terms.

To assuage these concerns, MFIs must emphasize the independence of the investment allocation process. One interesting model is India’s National Investment and Infrastructure Fund (NIIF), a $6 billion governmentsponsored investment fund that has been highly successful at mobilizing institutional investors’ capital.

The Indian government holds a fixed 49% minority share in the NIIF itself, and in the company that manages it, with private and institutional investors controlling the majority stake. The NIIF operates like a standard commercial investment fund, and the government has only two representatives on the six-member board. The fund’s investment committee, which makes all investment decisions, is made up entirely of investment professionals, who (like the NIIF’s staff) are recruited

32 January / June 2019

Governments and multilateral finance institutions are struggling to mobilize private capital at a scale relevant to climate change mainly from the private sector. These curbs on public-sector control are designed to free the NIIF from possible political influence, thereby reassuring investors that the fund operates on fully commercial terms within its policy-defined mandate.

According to a recent paper by researchers at Stanford University and Maastricht University, to mobilize institutional investor capital for financing the fight against climate change, MFIs must start functioning in a similar way. But large institutions change slowly, and the urgency of climate action requires disruptive changes, rather than incremental reforms.

That is why a new GCFF, targeted at mobilizing capital from institutional investors and modeled on the NIIF structure, may be an important part of the answer.

To be sure, while MFIs would be minority investors in the proposed GCFF, they would still play a key role

in helping private investors assess risks in new contexts. MFIs would also need to share these risks and supply technical support based on their expertise across a broad range of sectors and regions. Critically, to reassure MFIs that their AAA credit rating and preferred-creditor status would not be threatened, the GCFF’s budget would need to be “ring-fenced” from other financing initiatives. But these challenges can be managed.

In general, MFIs inhabit a different world from the institutional investors whose capital they seek to mobilize. To attract enough private capital to advance climate-change solutions, MFIs must start to treat large institutional investors as their partners and clients. A new GCFF, with the right resources and highlevel support, would help drive the required change. WEIE Håvard Halland & Justin Yifu Lin

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SUSTAINABILITY

INVESTING IN PEOPLE

THE RIGHT INVESTMENTS TO ADDRESS THE HUMAN CAPITAL CRISIS The world faces a growing human capital crisis that demands urgent attention. By making the right investments in people, especially the poorest and most vulnerable, we can help to give them the health, knowledge, and skills they need to realize their full potential.

34 January / June 2019

January / June 2019 35

SUSTAINABILITY

W

ASHINGTON D.C. -

For 75 years, the World Bank has been at the forefront of development, helping countries make smart investments to prepare their citizens for the future.

It has been particularly focused on the poorest and most vulnerable – their access to infrastructure, health, education, assets, jobs, and markets.

In recent years, it has embraced policies and investment in areas critical for the world’s future, such as combating climate change and making technology work for the poor.

Everywhere I travel – from Rwanda to Zambia, or from Indonesia to my home country, Bulgaria – I see the difference that technology can make in people’s lives. The impact is apparent in a multitude of ways, such as digital payment systems or the emerging gig economy, leading to remarkable success stories.

But just as technology is improving the lives of millions around the world, it is also changing the nature of work. Our 2019 World Development Report focused on how innovation is changing or doing away with existing jobs and launching entirely new fields of employment that didn’t exist a few years ago.

This raises some difficult questions: What jobs are people going to do?

How will they support their families?

How will they fulfill their potential in an increasingly complex world?

36 January / June 2019

Investment in human capital can help drive inclusive, sustainable economic growth We have powerful new tools to help developing countries answer those questions. At the World Bank Group-IMF Annual Meetings in Bali in October, we launched the Human Capital Index. Initially covering 157 countries, the Index is a summary measure of the human capital that a child born today can expect to attain by age 18, given the risks of poor health and education where he or she lives.

The Index focuses on outcomes in three key areas. First, survival: What is the probability that a child

born today will survive to age five?

Second, health: Will children be stunted before age five? Will they be healthy into adulthood, ready for work, with a foundation for lifelong learning? And third, education: How much schooling will children complete, and more importantly, how much will they learn?

The Human Capital Index is unique because it focuses on productivitylinked indicators such as child survival, stunting, learning-adjusted years of school, and adult survival, and it draws a direct line between future economic growth and better

health and education outcomes.

Above all, it paints a clear picture for leaders of how much more productive their workers could be when they are healthy, educated, and equipped with the skills needed for a rapidly changing labor market.

A country can score between 0 and 1 on the index, with 1 representing the best possible frontier of complete education and full health. In our first index, the average value for the world was just 0.56. This means that, across the 157 countries covered, children born today will grow up to be roughly half as productive as they could be.

The implications for growth – and therefore poverty reduction – are enormous. If a country has a score of 0.50, its future GDP per worker could be twice as high if that country reached the frontier. Over a half-century, this works out to 1.4 percentage points of GDP growth

every year.

Investing in people is even more urgent because of two challenging global trends. First, global growth is slowing. Our Global Economic Prospects report, released earlier this month, is appropriately titled Darkening Skies. Global growth has moderated – in 2019, it is expected to slow to 2.9%, from 3% in 2018.

And growth in emerging markets and developing economies is expected to stall at 4.2%, the same pace as in 2018.

Second, the pace of poverty reduction is slowing. Our Poverty and Shared Prosperity report found that in 2015, the most recent year with robust data, extreme poverty reached 10%, the lowest level in recorded history. But the 736 million people still living in extreme poverty will be harder to reach. The poverty rate in areas suffering from fragility, conflict, and violence climbed

to 36% in 2015, up from a low of 34.4% in 2011, and that share will likely increase.

Investment in human capital can help drive inclusive, sustainable economic growth. But this is not just the domain of health and education ministers. Heads of state, finance ministers, CEOs, and investors need to make these investments an urgent priority. If we act now, we can create a world where all children arrive at school well-nourished and ready to learn; where they can grow up to be healthy, skilled, productive adults; and where they have a chance to fulfil their potential. The children of today deserve this future. The employers of tomorrow will demand it. The leaders of the world owe it to them to act now. WEIE

Kristalina Georgieva

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BUSINESS & FINANCE

EUROPEAN DEFENSE UNION

Franco-German friendship is NOT ENOUGH By signing the Treaty of Aachen, German Chancellor Angela Merkel and French President Emmanuel Macron have taken an important step toward firming up the Franco-German partnership at the heart of the European project.

But insofar as the pact excludes all other EU member states, it risks deepening Europe’s divisions even further.

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ERLIN - The recent signing

of the Treaty of Aachen invites us to reflect on how the Franco-German partnership’s role in Europe has evolved since the two countries first adopted a bilateral friendship pact, the Élysée Treaty, in 1963.

At the heart of the Treaty of Aachen is a plan to form a European Defense Union. This is not a new idea. Similar proposals were discussed as far back as 1950, when the United States was being drawn into the Korean War. The US called for West Germany to be brought into the fold of a new European Defense Community. But in 1954, the formation of a defense union – under the Pleven Plan and

the Treaty of Paris – was rejected by the French Parliament, which feared becoming too dependent on the US. Still, during the negotiations over the Élysée Treaty less than a decade later, French President Charles de Gaulle saw an opportunity to push for more Western European independence from the US. Hence, the original text of the treaty made no mention of France or Germany’s relationship to the US, the United Kingdom, NATO, or any other important international agreements. But this omission did not go unnoticed. Bowing to pressure from President John F. Kennedy, the German Bundestag added a preamble calling on France

and Germany to cooperate closely with the US and the UK. This new language frustrated de Gaulle’s plans for establishing a Western European counterweight to the US, and ultimately led to discord between France and Germany. According to de Gaulle’s confidant Alain Peyrefitte, the French president complained that the Germans were “behaving like pigs. They fully subject themselves to US power. They betray the spirit of the Franco-German Treaty.

And they betray Europe.” Later, de Gaulle would describe Germany’s behavior during this episode as his “biggest disappointment.”

The concept of European

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“strategic autonomy” was an essential component of Gaullism.

Today, it features heavily in debates about European integration, and it is central to French President Emmanuel Macron’s own vision for EU reform. France’s goal today is the same as it was back in the 1960s, when it first acquired nuclear weapons: to free Germany and the European Union from America’s overwhelming influence.

In the intervening decades, the seeds of Gaullist mistrust toward the Germans have been covered up by celebrating the Élysée Treaty. That pact had achieved the seemingly unattainable: friendship with the Erbfeind – the hereditary enemy – just a few years after the two countries had engaged in the most savage war mankind has ever known.

As a follow-up to the Élysée Treaty, the Treaty of Aachen can be touted as a symbol of Franco-German friendship. But Germans should not overlook the fact that both agreements enshrine a political strategy that is at odds with Germany’s own longstanding approach of balancing the friendship with France alongside strong transatlantic relations with the US and the UK. This is not to suggest that the two Franco-German friendship agreements are worthless. But by putting too much store in the

40 January / June 2019

idealistic notion that “we can do it, together,” France and Germany could find that they have achieved a Pyrrhic victory for the European project.

After all, there is reason to worry about how the new agreement will be perceived in other European capitals. Any Pole, Italian, Greek, Swiss, or Spanish citizen who reads the text might find it strange that the two European poster children of multilateralism would sign a bilateral deal, excluding everyone else. What

ever happened to the principle of sovereignty and equality among all EU member states?

Moreover, France and Germany view the world differently.

Whereas integration into the Western liberal order is enshrined in the German constitution (Grundgesetz), French foreign policy is guided by the country’s national interests at any given time.

The Treaty of Aachen, like its precursor, obscures these different

outlooks with a fog of good intentions.

The Élysée Treaty symbolized the end of enmity between Germany and France. But with the Treaty of Aachen, the two countries have gone beyond that. Their stated intention now is to prevent the internal splintering of the EU. To be sure, there are deepening divisions over matters of finance and economic policymaking between north and south (and also between France and Germany).

Western member states are worried about the rule of law in eastern member states, and those in the northwest want to tackle corruption, organized crime, and weak governance in the southeast.

Yet it is precisely on these EUwide challenges that the Treaty of Aachen lacks specificity.

Though the European project no doubt depends on France and Germany, that does not mean that they alone can preserve it.

Without an approach that is more sensitive to their European partners, the two countries risk giving the impression that mere obedience to the Franco-German axis is all that is expected or required.

But France and Germany have distinct interests. While Germany would fully support a reversal of Brexit in order to preserve the EU’s internal balance, France might see in Britain’s withdrawal an opportunity to increase its own relative political, economic, and military clout within the bloc. Never mind that a more “French Europe” without the UK would be weaker on the world stage.

Even with two countries wielding nuclear arsenals, the EU is already considered by other powers to be politically irrelevant.

In a world of geopolitical carnivores, we Europeans are the last vegetarians. Without the UK, we will become vegans, and possibly prey. What really matters, then, is not “strategic autonomy” but the preservation of European sovereignty in a rapidly changing international context.

France and Germany must both commit themselves to achieving that objective. The Franco-German friendship is necessary for Europe; but it will not suffice to guarantee our place in the world. WEIE Sigmar Gabriel

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BUSINESS & FINANCE

NO-PEACE-NO-WAR

REIMAGINING DAVOS At the recent World Economic Forum annual meeting in Davos, participants made the same mistake they always do: extrapolating from the recent past rather than looking genuinely into the future. Three key changes would enable the event to fulfill its considerable potential.

42 January / June 2019

N

EW YORK - I do not

attend the annual meeting of the World Economic Forum in Davos. But my sense is that, as in previous years, this year’s participants ended up extrapolating more from the recent past than genuinely looking into the future for pivots and tipping points. This was true both at the macro level and in terms of the key individual issues that attracted the most attention, according to multiple media reports (and the media are

extremely well represented at this event). As a result, this globally renowned gathering of influential government and corporate leaders appears to have missed, once again, an opportunity fully to realize its considerable potential.

There is a reason why Davos tends to be backward-looking.

Leaders naturally come to it focused on what they have experienced most recently. If others have experienced the same thing, the Davos echo

chamber amplifies the themes so that they dominate conversations about both recent developments and future prospects.

The two meetings before the 2008 global financial crisis had a rather optimistic tone, dismissing the warnings of the few who sensed that the “great moderation” and the era of unfettered finance were likely to come to a painful end.

The January 2009 meeting was the complete opposite, projecting crisis and global recession well into the

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BUSINESS & FINANCE

future.

Such misreadings of what lies ahead haven’t been limited to periods surrounding crises. Just consider what happened at the previous gathering, in January 2018, and compare it to this year.

A year ago, most leaders had just come off the strongest quarter of global growth in years. What’s more, activity was picking up in virtually every country around the world. As they heard about one another’s experiences, the Davos

44 January / June 2019

delegates embraced the notion that the world had entered a period of synchronized growth in which positive feedback loops would turbocharge the process. They gave little attention to the fact that, with the notable exception of the United States, most countries were experiencing largely one-off growth drivers.

At this year’s Davos meeting, by contrast, the macro mood is said to have been much gloomier. The

consensus was that we are heading for a synchronized slowdown in global growth, with a heightened risk of self-feeding vicious cycles.

But again, this fails to distinguish between one-off factors whose impact is temporary and largely reversible – such as the partial US government shutdown and an episode of miscommunication by the Federal reserve – and the sort of secular weakness that Europe is experiencing.

Most of the issue-specific

discussions this year focused on China-US trade tensions and Brexit.

Here again, the temptation was to extrapolate future developments based excessively on what had just happened.

The Davos consensus seemed to be that China-US trade disputes would intensify during 2019. But the likelier scenario is that tensions diminish as China

no-peace-no-war process or, alternatively, a hard exit for the United Kingdom from the European Union. Yet, because this has already proved to be a very “slow Brexit” process, with Britain’s Parliament repeatedly unable to agree on a replacement for the current EUUK relationship, the probability of a soft Brexit is materially increasing.

So is the probability, albeit lower, of a second referendum, which was

The temptation was to extrapolate future developments based excessively on what had just happened realizes what South Korea, Mexico, and Canada already did in dealing with the US administration: rather than a tit-for-tat tariff escalation, the best approach for a country’s short-term growth and longer-term development is to make concessions to the US on issues of genuine grievance. These include rules that force technology transfers – such as joint-venture requirements – and the theft of intellectual property.

On Brexit, the central scenarios at Davos focused on either a continuation of the current

once thought an unlikely, if not unthinkable outcome.

Simply extrapolating the future from what has just occurred usually leads Davos delegates down false trails.

Davos – both its organizers and its participants – would do a much better job by making three changes to the way the event is managed.

First, the meeting should actively propose alternative scenarios for serious discussion. This year’s agenda, for example, should have included a possible return in 2019 to

divergent growth and the associated risks and opportunities. In addition, Davos should collect and discuss best practices for dealing with usual levels of uncertainty for both businesses and government policymaking. Finally, when it comes to short-term prospects, the event needs to spend a lot more time on other themes that I suspect will prove more important than either Brexit or China-US trade tensions in the period ahead. These include the changing attitude toward regionalism, central-bank policy challenges, and the scope for more government-policy coordination among advanced economies.

The annual Davos gathering is too big an opportunity not to be exploited properly. Yet year after year the focus has ended up more backward-looking than forwardlooking, and the just-concluded iteration appears to have been no exception. A revamp would play an important role in fulfilling the stated objective of Davos: engaging “the foremost political, business and other leaders of society to shape global, regional and industry agendas.” And it would ensure that more of the participants go looking for actionable, substantive content rather than ending up being there primarily to see and be seen. WEIE Mohamed A. El-Erian

January / June 2019 45

BUSINESS & FINANCE

THE CHANCE TO THRIVE

How Germany lost its EINSTEINS Recent research shows that the high inequality of opportunity associated with low inter-generational economic mobility is shrinking America’s pool of potential inventors. In Germany – where social mobility is even lower than in the US – this dynamic is severely undermining innovative entrepreneurship.

46 January / June 2019

M

UNICH - Why has Germany, the land of history-making innovators like Johannes Gutenberg and Albert Einstein, not produced high-tech giants like Google, Amazon, or Facebook? Some blame the stigma associated with failure in Germany for discouraging innovative entrepreneurship.

Others point to high bureaucratic hurdles to starting a business. But there is another, more worrying reason why Germany has lost its innovative momentum: its potential pioneers from disadvantaged households are not getting the chance to thrive.

According to the OECD, intergenerational earnings elasticity in Germany stands at about 50%, meaning that if person A’s parent earned double what person B’s parent earned, person A will earn, on average, 50% more than person B. With such persistent earnings differentials across generations, Germany has one of the lowest rates of inter-generational mobility in the OECD – where the average elasticity is 38% – and it seems to be declining.

Low rates of intergenerational mobility in the advanced economies often correspond to high rates of income inequality.

What Princeton University economist Alan Krueger has calledthe “Great Gatsby curve”

High inequality of opportunity associated with low inter-generational economic mobility is shrinking America’s pool of potential inventors illustrates the connection between concentration of income in one generation and the ability of those in the next generation to move up the economic ladder.

In the United States, as high levels of income inequality – and the concomitant inequality of opportunity – impede intergenerational economic mobility, the country’s pool of potential innovators is shrinking.

In groundbreaking recent research – The Opportunity Atlas: Mapping the Childhood Roots of Social Mobility– Harvard economist Raj Chetty and his coauthors use Big Data to demonstrate this phenomenon – and the massive costs it implies.

Based on data about 1.2 million inventors and their parents – covering education, test scores, and earnings – the study showed that 8.3 children per thousand from the top 1% of households (in terms of income) become inventors. For below-median-income households, that figure drops to just 0.84

children per thousand.

This is not because children from high-income families are more gifted. According to The Opportunity Atlas, for every 1,000 third graders from higherincome households (the top 20% of earners) who score in the 90th percentile in mathematics, seven become inventors. Among children from lower-income households (the bottom 80%), that rate drops to just three in 1,000.

Of course, income is not the only determining factor. Only about two high-scoring girls per 1,000 become inventors, compared to six boys per 1,000. Race also has an effect, with black and Latino children, for example, being less likely than their white peers to become inventors.

What lies at the root of these differences? The Opportunity Atlasshows that communities with higher patent rates produce many more inventors per 1,000 children.

But this is not because children

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of inventors somehow inherit a natural aptitude for innovation.

Instead, the answer may lie in exposure to innovation during childhood. Chetty and his colleagues found that the experience of seeing innovation happen is enough to spur children to innovate themselves. Their research also indicates that, if girls were exposed to stories of female inventors to the same extent that boys are exposed to those of male inventors, the gender gap in innovation would fall by half.

The economic implications of these findings are profound. The Opportunity Atlas estimates that, if women, minorities, and children from low-income families invented at the same rate as high-income

48 January / June 2019

white men, the innovation rate in the US would quadruple.

In Germany, income inequality is lower than in the US, and Germany offers free education for all, including at the tertiary level – a powerful social equalizer. But Germany’s rate of social mobility remains lower than that of the US – and the country is paying the price.In one recent survey, German entrepreneurs cited a lack of relevant talent as a major hindrance to start-up activity.

Clearly, Germany must do a better job of fostering innovative talent in its young people of all socioeconomic backgrounds, races, and genders. Judging by the findings of The Opportunity Atlas, this can be achieved through,

say, tailored mentoring and internship programs that increase children’s exposure to innovation.

As it stands, Germany’s efforts to boost innovation focus on new tax incentivesfor research and development. But shaving a few percentage points from the taxes paid by leading inventors – who earn more than $1 million per year, on average – is unlikely to have an appreciable impact on their behavior. If the talent pool remains limited, tax incentives to promote innovation are more likely simply to increase the earnings of those who are already innovating, rather than increase the overall number of innovations.

Compounding this effect is the fact that it becomes more challenging to reach new frontiers as the total amount of knowledge grows. According to one estimate, producing the same amount of new knowledge today as 80 years ago requires some 20 times the number of researchers.

This implies that if Germany – or any country – is to reach its innovative potential, it will need a people-focused strategy. And that strategy must emphasize equality of opportunity and exposure to innovation, especially among the highest-scoring children. WEIE Dalia Marin

INNOVATION & TECHNOLOGY

ALGORITHMIC DECISION-MAKING

LIES, DAMNED LIES, AND AI As algorithmic decision-making spreads across a broadening range of policy areas, it is beginning to expose social and economic inequities that were long hidden behind “official” data. The question now is whether we will use these revelations to create a more just society.

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AMBRIDGE - Algorithms

are as biased as the data they feed on. And all data are biased. Even “official” statistics cannot be assumed to stand for objective, eternal “facts.” The figures that governments publish represent society as it is now, through the lens of what those assembling the data consider to be relevant and important. The categories and classifications used to make sense of the data are not neutral. Just as we measure what we see, so we tend to see only what we measure.

As algorithmic decision-making spreads to a wider range of policymaking areas, it is shedding a harsh light on the social biases that once lurked in the shadows of the data we collect. By taking existing structures and processes to their logical extremes, artificial intelligence (AI) is forcing us to confront the kind of society we have created.

The problem is not just that computers are designed to think like corporations, as my University of Cambridge colleague Jonnie Penn has argued. It is also that computers think like economists. An AI, after all, is as infallible a version of homo economicus as one can imagine. It is a rationally calculating, logically consistent, ends-oriented agent capable of achieving its desired outcomes with finite computational resources. When it comes to

“maximizing utility,” they are far more effective than any human.

“Utility” is to economics what “phlogiston” once was to chemistry.

Early chemists hypothesized that combustible matter contained a hidden element – phlogiston – that could explain why substances changed form when they burned.

Yet, try as they might, scientists never could confirm the hypothesis. They could not track down phlogiston for the same reason that economists today cannot offer a measure of actual utility.

trying to do as well as they can for themselves.

Moreover, economists’ notion of utility is born of classical utilitarianism, which aims to secure the greatest amount of good for the greatest number of people. Like modern economists following in the footsteps of John Stuart Mill, most of those designing algorithms are utilitarians who believe that if a “good” is known, then it can be maximized.

But this assumption can produce troubling outcomes. For example, consider how algorithms are being used to decide whether prisoners

Algorithms are as biased as the data they feed on.

And all data are biased.”

Economists use the concept of utility to explain why people make the choices they do – what to buy, where to invest, how hard to work: everyone is trying to maximize utility in accordance with one’s preferences and beliefs about the world, and within the limits posed by scarce income or resources.

Despite not existing, utility is a powerful construct. It seems only natural to suppose that everyone is

are deserving of parole. An important 2017 study finds that algorithms far outperform humans in predicting recidivism rates, and could be used to reduce the “jailing rate” by more than 40% “with no increase in crime rates.” In the United States, then, AIs could be used to reduce a prison population that is disproportionately black. But what happens when AIs take over the parole process and African-

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Americans are still being jailed at a higher rate than whites?

Highly efficient algorithmic decision-making has brought such questions to the fore, forcing us to decide precisely which outcomes should be maximized. Do we want merely to reduce the overall prison population, or should we also be concerned about fairness?

Whereas politics allows for fudges and compromises to disguise such tradeoffs, computer code requires clarity.

That demand for clarity is making it harder to ignore the structural sources of societal inequities.

52 January / June 2019

In the age of AI, algorithms will force us to recognize how the outcomes of past social and political conflicts have been perpetuated into the present through our use of data.

Thanks to groups such as the AI Ethics Initiative and the Partnership on AI, a broader debate about the ethics of AI has begun to emerge.

But AI algorithms are of course just doing what they are coded to do. The real issue extends beyond the use of algorithmic decisionmaking in corporate and political governance, and strikes at the ethical foundations of our societies.

While we certainly need to debate the practical and

philosophical tradeoffs of maximizing “utility” through AI, we also need to engage in selfreflection. Algorithms are posing fundamental questions about how we have organized social, political, and economic relations to date.

We now must decide if we really want to encode current social arrangements into the decisionmaking structures of the future.

Given the political fracturing currently occurring around the world, this seems like a good moment to write a new script.WEIE

Diane Coyle

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INNOVATION & TECHNOLOGY

PREVENTING INTERFERENCE

DIGITAL DANGERS TO DEMOCRACY While we may see the dangers that digital technologies pose to the political system, others see new opportunities to influence election outcomes.

Managing and containing these threats must now be an urgent priority for democrats everywhere.

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AN JOSÉ - Hardly a day

goes by without some new allegation that social media are undermining democracy.

Actors across the political spectrum are exploiting digital technologies to spread disinformation and fuel polarization. While “fake news” and hate speech are nothing new, the digital age has provided, if unwittingly, an environment conducive to both.

The potential of new technologies to improve the human condition is beyond question, but the risks they pose to democracy are now increasingly apparent.

Tech companies, governments, and citizens alike are grasping for solutions to a set of connected challenges.

How do we deal with rapid online communication that makes well-timed disinformation easy to disseminate and difficult to rebut?”

How do we deal with rapid online communication that makes well-timed disinformation easy to disseminate and difficult to rebut? How does the desire to create watchable content, which is often based on emotion and sensation rather than evidence, fit with reasoned democratic debate?

How do we identify the real sources of information when the Internet’s anonymity hides the origin of a post?

And given the reach and market dominance of Google and Facebook, are we, and by extension our political views and debates, captives of their algorithms?

In one of his last initiatives before he passed away in August 2018, former UN Secretary-General Kofi Annan convened a Commission on Elections and Democracy in the Digital Age,which was launched earlier this month at Stanford University. In particular, Annan wanted to sound the alarm on behalf of countries that have few, if any, means to defend themselves against these twenty-first-century threats to the integrity of elections.

And, because these problems could affect almost any country, he fervently believed that a global perspective was crucial for tackling them.

As the Commission, which comprises experts from the worlds of tech and politics, prepares to start its work, four challenges loom large.

The first is the rise of an election interference industry. Just as we study the 2016 US presidential election for lessons on how to prevent interference, others look to that campaign for insights into electoral manipulation.

Commercial consulting groups already appeal to potential clients with ideas about how social media, fake news, and micro-targeting can be effective in swaying elections. Furthermore, this new industry will be bipartisan, if recent allegations of social media manipulation and fake news in the 2018 Alabama senate election are any guide.

The danger to democracy worldwide can hardly be overstated. If election outcomes in a country as powerful

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and technologically advanced as the US potentially can be influenced, how will other countries fare?

Another emerging challenge comes from increasingly popular “home assistants.”

Online information monopolies already have the power to determine what much of a country’s population sees and believes. And as home assistants such as Google Home, Alexa, and Siri become more commonplace, users will soon get single-answer responses to queries, instead of multiple suggestions. Such ultra-curation will diminish our search activity, investigation, and discourse, giving a few companies and algorithms even greater power to shape what we know and believe.

The third threat is the emergence of fake video material – the so-called deepfakes. These use artificial intelligence and image synthesis to create video images that

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are indistinguishable from authentic footage. Imagine, for example, the speed at which manufactured footage of the Iranian president telling his military chiefs to prepare an invasion of Israel would spread around the Internet. As deepfakes become widespread, overall trust in video will decline. And as the real and virtual worlds continue blending into each other, we may lose confidence in our ability to determine what is real and what is not in democratic politics.

Last, and by no means least, are encrypted peer-to-peer platforms.

WhatsApp, with more than 1.5 billion monthly active users in 180 countries, has been used to spread rumors and stoke violence in Brazil, Mexico, and India in the same way that Facebook was used to stir up communal violence in Sri Lanka, Myanmar, and Bangladesh. True, the anonymity and encryption offered by WhatsApp are potent protections for

citizens fighting for their democratic rights under murderous authoritarian regimes. But these same features make it difficult to identify the sources of rumors, hatred, and incitement to violence, and therefore hard to gauge the extent to which WhatsApp is used to manipulate elections.

In 2019, there will be more than 80 presidential, general, and parliamentary elections around the world. While we may see the dangers that digital technologies pose to the political system, others see new opportunities to influence outcomes. Managing and containing these threats must now be an urgent priority for democrats everywhere.

As Annan warned us, “Technology does not stand still; neither can democracy.” WEIE Laura Chinchilla

INNOVATION & TECHNOLOGY

THE LAST-MILE IMPLEMENTATION

AI FOR HUMAN DEVELOPMENT Technologies powered by artificial intelligence are being applied to some of the world’s most challenging human-development issues.

But while AI has considerable potential to serve the public good, key bottlenecks – from education to risk reduction – must be overcome.

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AN FRANCISCO - The

excitement surrounding artificial intelligence nowadays reflects not only how AI applications could transform businesses and economies, but also the hope that they can address challenges like cancer and climate change. The idea that AI could revolutionize human wellbeing is obviously appealing, but just how realistic is it?

To answer that question, the McKinsey Global Institute has examined more than 150 scenarios in which AI is being applied or could be applied for social good. What we found is that AI could make a powerful contribution to resolving many types of societal challenges, but it is not a silver bullet – at least not yet. While AI’s reach is broad, development bottlenecks and application risks must be overcome before the benefits can be realized on a global scale.

To be sure, AI is already changing how we tackle human-development challenges. In 2017, for example, object-detection software and satellite imagery aided rescuers in Houston as they navigated the aftermath of Hurricane Harvey.

In Africa, algorithms have helped reduce poaching in wildlife parks.

In Denmark, voice-recognition programs are used in emergency calls to detect whether callers are experiencing cardiac arrest. And at

the MIT Media Lab near Boston, researchers have used “reinforcement learning” in simulated clinical trials involving patients with glioblastoma, the most aggressive form of brain cancer, to reduce chemotherapy doses.

Moreover, this is only a fraction of what is possible. AI can already detect early signs of diabetes from heart rate sensor data, help children with autism manage their emotions, and guide the visually impaired. If these innovations were widely available and used, the health and social benefits would be immense. In fact, our assessment

accessibility is among the most significant hurdles. In many cases, sensitive or commercially viable data that have societal applications are privately owned and not accessible to nongovernmental organizations. In other cases, bureaucratic inertia keeps otherwise useful data locked up.

So-called last-mile implementation challenges are another common problem. Even in cases where data are available and the technology is mature, the dearth of data scientists can make it difficult

The idea that AI could revolutionize human wellbeing is obviously appealing, but just how realistic is it? concludes that AI technologies could accelerate progress on each of the 17 United Nations Sustainable Development Goals.

But if any of these AI solutions are to make a difference globally, their use must be scaled up dramatically. To do that, we must first address developmental obstacles and, at the same time, mitigate risks that could render AI technologies more harmful than helpful.

On the development side, data

to apply AI solutions locally. One way to address the shortage of workers with the skills needed to strengthen and implement AI capabilities is for companies that employ such workers to devote more time and resources to beneficial causes. They should encourage AI experts to take on pro bono projects and reward them for doing so.

There are of course risks. AI’s tools and techniques can be misused, intentionally or inadvertently. For example, biases can be embedded in

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AI algorithms or datasets, and this can amplify existing inequalities when the applications are used. According to one academic study, error rates for facial analysis software are less than 1% for light-skinned men, but as high as 35% for dark-skinned women, which raises important questions about how to account for human prejudice in AI programing. Another obvious risk is misuse of AI by those intent on threatening individuals’ physical, digital, financial, and emotional security.

Stakeholders from the private and public sectors must work together to address these issues.

To increase the availability of data, for example, public officials and private actors should grant broader access to those seeking to use data for initiatives that serve the public good. Already, satellite companies participate in an international agreement that commits them to providing open access during emergencies. Data-dependent partnerships like this one must be expanded and become a feature of firms’ operational routines.

AI is fast becoming an invaluable part of the human-development toolkit.

But if AI’s potential to do good globally is to be fully realized, proponents must focus less on the hype and more on the obstacles that are preventing its uptake. WEIE

Michael Chui & Martin Harrysson

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ECONOMICS

LEARNING FROM PAST MISTAKES

THE EURO’S FIRST 20 YEARS According to public opinion polls, 20 years after its introduction, the euro is highly popular, with 64% of eurozone citizens supporting the common currency. This offers hope that, if the eurozone’s leaders can learn from past mistakes, the monetary union will survive and even thrive in the future

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AMBRIDGE - Since its

introduction two decades ago, the euro has faced serious challenges. So far, it has survived intact. Yet, on the common currency’s 20th anniversary, it is worth identifying problems that have been encountered and, one hopes, to learn from past mistakes.

A first critical problem was inherent in the application of a common currency to a large and varied set of countries: They did not meet the criteria for an “optimum currency area,” as American economists pointed out.

In particular, the members lacked cyclical synchronization. It is much harder to go without monetary independence if your economy’s needs are not aligned with those of the other countries in the union.

In 2004-2006, for example, Ireland needed a tighter monetary policy than the European Central Bank was prepared to set, given a housing bubble and economic overheating; but it had ceded the authority to

revalue its currency or raise interest rates. Likewise, in 2009-2013, when Ireland needed an easier monetary policy than the ECB’s, given a steep recession, it was unable to devalue its currency, print money, or lower its interest rate.

A second mistake was that some peripheral eurozone countries maintained large current-account deficits during the euro’s first decade. At the time, these countries’ large net capital inflows were viewed as a sign of efficiency-improving financial integration. In retrospect, the imbalances, attributable in part to a rise in the periphery’s unit labor costs relative to Germany’s, were less benign.

Many countries – most notably, Greece – also maintained large budget deficits and high debt levels.

They confirmed longstanding fears among wealthier members – especially Germany – that they would end up being forced to bail

The eurozone’s failure to shift more fiscal authority to the supra-national level was repeated in the area of banking regulation

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out their profligate partners, for which the expectation of being rescued amounted to a perverse incentive. To their credit, the architects of Europe’s monetary union recognized moral hazard as a central vulnerability, and tried to address it by requiring that countries cap their budget deficits at 3% of GDP, and including a “no bail-out” clause in the Maastricht Treaty.

But the fiscal rules proved unenforceable. Virtually all eurozone

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members (including Germany) soon breached the 3% deficit ceiling. And though governments repeatedly claimed that fiscal targets would be achieved in the future, those expectations were based on overly optimistic growth forecasts.

It did not help that, with the creation of the eurozone, highly indebted periphery governments were suddenly able to borrow at virtually the same interest rates as Germany. Even within the United States, indebted states like Illinois

must pay an interest-rate premium relative to other states.

The eurozone’s failure to shift more fiscal authority to the supra-national level was repeated in the area of banking regulation. European economists had warned that paneurozone banking regulation is essential to the common currency’s long-term sustainability, only to be ignored. To be fair, these problems cannot really be called mistakes by eurozone leaders, as any attempt to address them would have faced overwhelming political opposition.

In other ways, however, the eurozone’s leaders really did shoot themselves in the foot.

For example, the ECB mistakenly raised interest rates in July 2008 and again, twice, in 2011, despite the global recession.

Moreover, when the Greek crisis erupted at the beginning of 2010, European leaders did not respond effectively. Instead, they delayed sending Greece to the International Monetary Fund and writing down Greek debt, even though the debt-to-GDP ratio was clearly on

an unsustainable path, even with stringent fiscal austerity.

In fact, the push for austerity after 2009 backfired spectacularly, as it caused incomes in periphery countries to fall far more than the European Commission, the ECB, and the IMF had anticipated. Even leaving aside the economic cost of the recession and the political cost of the resulting populist anger, fiscal austerity did not achieve its goal of putting countries like Greece onto sustainable debt paths.

On the contrary, the fall in GDP was larger than any fall in debt, causing debt-to-GDP ratios to rise even faster.

The implementation of fiscal austerity during a time of crisis, together with the high spending of the eurozone’s early years, constitutes pro-cyclical fiscal policy.

Indeed, Greek fiscal policy is among the world’s most pro-cyclical. That does not put the eurozone on a strong footing to weather future crises.

This is not to suggest that the euro has not had its successes.

For starters, the transition from 11 individual currencies to the euro went very smoothly. The European currency crises of 1992 and 1993, as well as more recent chaotic demonetizations elsewhere, show that a successful transition was far from guaranteed.

A second early success was

that, by virtually all measures of international use, the euro instantly became the world’s second global reserve currency. Moreover, the desire to be admitted to the club led to favourable reforms in many aspiring member countries, particularly the Central and Eastern European countries that later joined the European Union.

More recent entries on the “success” side of the ledger include the progress of some periphery countries, particularly Spain, reducing their previously uncompetitive unit labor costs.

ECB President Mario Draghi deserves top marks for balancing Germany’s demand for fiscal discipline and the Mediterranean need for accommodation. His July 2012 declaration that the ECB would do “whatever it takes” to preserve the euro calmed markets, a vital turning point in the crisis.

Perhaps most important, public opinion polls indicate that, in recent years, the euro has achieved strong popular support, with 64% of citizens supporting the common currency in November 2018. This offers hope that, if the eurozone’s leaders can learn from past mistakes, the monetary union will survive and even thrive in the future. WEIE

Jeffrey Frankel

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ECONOMICS

A VOYAGE INTO THE UNKNOWN

THE THREE REVOLUTIONS ECONOMICS NEEDS The silence of most economists on the underlying causes of the political ructions erupting throughout the West – and on what, if anything, can be done to restore economic vigour – has been deafening. And it provides further evidence of the profession’s refusal to acknowledge the need for change.

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ARIS - The West is in crisis

– and so is economics.

Rates of return on investment are meager. Wages – and incomes generally – are stagnating for most people. Job satisfaction is down, especially among the young, and more working-age people are unwilling or unable to participate in the labour force. Many in France decided to give President Emmanuel Macron a try and now are protesting his policies.

Many Americans decided to give Donald Trump a try, and have been similarly disappointed. And many in Britain looked to Brexit to improve their lives.

Yet economists have been largely mute on the underlying causes of this crisis and what, if anything, can be done to restore economic vigour. It is safe to say that the causes are not well understood.

And they will not be understood until economists finally engage in the task of reshaping how economics is taught and practiced.

In particular, the profession needs three revolutions that it still resists.

The first concerns the continuing neglect of imperfect knowledge. In the interwar years, Frank Knight and John Maynard Keynes launched a radical addition to economic theory. Knight’s book Risk, Uncertainty, and Profit (1921), and Keynes’s thinking behind his General Theory of Employment, Interest, and Money (1936) argue that there is no basis – and could be no basis – for models that treat decision-makers as having correct models with which to make decisions. Knight injected an uncertain future, Keynes added the absence of coordination.

But subsequent generations of economic theorists generally disregarded this breakthrough.

To this day, despite some important work on formalizing Knight’s and Keynes’s insights (most notably

by Roman Frydman and his colleagues), uncertainty – real uncertainty, not known variances – is not normally incorporated into our economic models. (An influential calculation by Robert J. Barro and Jason Furman, for example, made predictions of business investment resulting from Trump’s corporate profits tax cut without bringing in Knightian uncertainty.) The Uncertainty Revolution still has not succeeded.

Second, there is still a neglect of imperfect information. In what has come to be known as the “Phelps volume,” Microeconomic

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would be outside their world and how long it might take to find a job; so they might remain unemployed for months or even years. There is a deficiency of information, not “asymmetric information.”

More than that, the volume sees every actor in the economy as being thrown back on whatever sense he or she can make of it, as Pinter depicted, and to do the best they can, as Voltaire urged.

But theorists at the University of Chicago created a mechanical location model in which unemployment is merely frictional and thus transitory – the so-called island model. As a result, the Information Revolution has not yet been absorbed.

Foundations of Employment and Inflation Theory, we brought to light a phenomenon overlooked by economists.

Overestimation by workers of wage rates outside their towns brings inflated wages and thus

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abnormally high unemployment; underestimation brings bargain pay levels and thus abnormally low unemployment. When workers lose their jobs in, say, Appalachia they have little idea – no well-based estimate – of what their wage

The last great challenge is the utter omission from economic theory of economic dynamism.

While economists have come to recognize that the West has suffered a massive slowdown, most of them offer no explanation for it. Others, wedded to Schumpeter’s early thesis on innovation in his classic 1911 book The Theory of Economic Development, infer that the torrent of discoveries by scientists and explorers has shrunk to a trickle in recent times.

Schumpeter’s theory operated on the explicit premise that the mass of people in the economy lack inventiveness. (He famously remarked that he never met a

businessman with any originality.)

This was an extraordinary premise.

One can argue that the West as we know it – the modern world, we might say – began with the great scholar Pico della Mirandola, who argued that all mankind possesses creativity. And the concerns of many other thinkers – the ambitiousness of Cellini, the individualism of Luther, the vitalism of Cervantes, and the personal growth of Montaigne – stirred people to use their creativity.

Later, Hume stressed the need for imagination, and Kierkegaard emphasized acceptance of the unknown.

Nineteenth-century philosophers such as William James, Friedrich Nietzsche, and Henri Bergson embraced uncertainty and relished the new.

As they reached a critical mass, these values produced indigenous innovation throughout the labour force.

The phenomenon of grassroots innovation by virtually all sorts of people working in all sorts of industries was first perceived by the American historian Walt Rostow in 1952 and described vividly and voluminously by the British historian Paul Johnson in 1983. I discuss its origins in my 2013 book Mass Flourishing.

So it was by no means clear that the Schumpeterian thesis would be incorporated into economic theory.

Imperfect knowledge, imperfect information and economic dynamism: three concepts the economists keep on ignoring But when MIT’s Robert Solow introduced his growth model, it became standard to suppose that the “rate of technical progress,” as he called it, was exogenous to the economy. So the idea that people – even ordinary people working in all industries – possess the imagination to conceive of new goods and new methods was not considered. And it would have been dismissed had it been mooted.

The Dynamism Revolution in economic theory was put on hold.

With the great slowdown and a decline of job satisfaction, however, there now appears to be a chance to introduce dynamism into economic modeling. And doing so is imperative.

The importance of understanding the newly stagnant economies has sparked an effort to incorporate imagination and creativity into macroeconomic models.

I have been arguing for a decade or

more that we cannot understand the symptoms observed in the Western nations until we have formulated and tested explicit hypotheses about the sources, or origins, of dynamism.

That theoretical advance will give us hope of explaining not only the slow growth of total factor productivity, but also the decline of job satisfaction.

America cannot be America again, France cannot be France again, and Britain cannot be Britain again until their peoples are once again engaged in thinking of better ways to do things and excited at embarking on their voyages into the unknown. WEIE - This commentary was adapted from a speech given at Paris Dauphine University on January 15, 2019.

Edmund S. Phelps

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ECONOMICS

THE THREAT OF RECESSION

RISKS TO THE GLOBAL ECONOMY IN 2019 Over the course of this year and next, the biggest economic risks will emerge in those areas where investors think recent patterns are unlikely to change.

They will include a growth recession in China, a rise in global long-term real interest rates, and a crescendo of populist economic policies.

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AMBRIDGE - As Mark

Twain never said, “It ain’t what you don’t know that gets you into trouble. It’s what you think you know for sure that just ain’t so.”

Over the course of this year and next, the biggest economic risks will emerge in those areas where investors think recent patterns are unlikely to change.

They will include a growth recession in China, a rise in global long-term real interest rates, and a crescendo of populist economic policies that undermine the credibility of central bank independence, resulting in higher interest rates on “safe” advancedcountry government bonds.

A significant Chinese slowdown may already be unfolding. US President Donald Trump’s trade war has shaken

US President Donald Trump’s trade war has shaken confidence, but this is only a downward shove to an economy that was already slowing confidence, but this is only a downward shove to an economy that was already slowing as it makes the transition from export- and investment-led growth to more sustainable domestic consumption-led growth. How much the Chinese economy will slow is an open question; but, given the inherent

contradiction between an ever-more centralized Party-led political system and the need for a more decentralized consumer-led economic system, long-term growth could fall quite dramatically.

Unfortunately, the option of avoiding the transition to consumer-led growth

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and continuing to promote exports and real-estate investment is not very attractive, either. China is already a dominant global exporter, and there is neither market space nor political tolerance to allow it to maintain its previous pace of export expansion.

Bolstering growth through investment, particularly in residential real estate (which accounts for the lion’s share of Chinese construction output) – is also ever more challenging.

Downward pressure on prices, especially outside Tier-1 cities, is

making it increasingly difficult to induce families to invest an even larger share of their wealth into housing.

Although China may be much better positioned than any Western economy to socialize losses that hit the banking sector, a sharp contraction in housing prices and construction could prove extremely painful to absorb.

Any significant growth recession in China would hit the rest of Asia hard, along with commodity-exporting developing and emerging economies.

Nor would Europe – and especially

Germany – be spared. Although the US is less dependent on China, the trauma to financial markets and politically sensitive exports would make a Chinese slowdown much more painful than US leaders seem to realize.

A less likely but even more traumatic outside risk would materialize if, after many years of trend decline, global long-term real interest rates reversed course and rose significantly. I am not speaking merely of a significant overtightening by the US Federal Reserve in 2019. This would be problematic, but it would mainly affect short-term real interest rates, and in principle could be reversed in time. The far more serious risk is a shock to very long-term real interest rates, which are lower than at any point during the modern era (except for the period of financial repression after World War II, when markets were much less developed than today).

While a sustained rise in the longterm real interest rate is a lowprobability event, it is far from impossible. Although there are many explanations of the long-term trend decline, some factors could be temporary, and it is difficult to establish the magnitude of different possible effects empirically.

One factor that could cause global rates to rise, on the benign side, would be a spurt in productivity, for example if the so-called Fourth Industrial Revolution starts to affect growth much faster than is currently

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anticipated. This would of course be good overall for the global economy, but it might greatly strain lagging regions and groups. But upward pressure on global rates could stem from a less benign factor: a sharp trend decline in Asian growth (for example, from a long-term slowdown in China) that causes the region’s longstanding external surpluses to swing into deficits.

But perhaps the most likely cause of higher global real interest is the explosion of populism across much of the world. To the extent that populists can overturn the marketfriendly economic policies of the past several decades, they may sow doubt in global markets about just how “safe” advanced-country debt really is. This could raise risk premia and interest rates, and if governments were slow to adjust, budget deficits would rise, markets would doubt governments even more, and events could spiral.

Most economists agree that today’s lower long-term interest rates allow advanced economies to sustain significantly more debt than they might otherwise. But the notion that additional debt is a free lunch is foolish. High debt levels make it more difficult for governments to respond aggressively to shocks. The inability to respond aggressively to a financial crisis, a cyber-attack, a pandemic, or a trade war significantly heightens the risk of long-term stagnation, and is an important explanation of why most

serious academic studies find that very high debt levels are associated with slower long-term growth.

If policymakers rely too much on debt (as opposed to higher taxation on the wealthy) in order to pursue progressive policies that redistribute income, it is easy to imagine markets coming to doubt that countries will grow their way out of very high debt levels.

Investors’ skepticism could well push up interest rates to uncomfortable levels.

Of course, there are many other risks to global growth, including everincreasing political chaos in the United States, a messy Brexit, Italy’s shaky banks, and heightened geopolitical

tensions. But these outside risks do not make the outlook for global growth necessarily grim. The baseline scenario for the US is still strong growth.

Europe’s growth could be above trend as well, as it continues its long, slow recovery from the debt crisis at the beginning of the decade. And China’s economy has been proving doubters wrong for many years.

So 2019 could turn out to be another year of solid global growth.

Unfortunately, it is likely to be a nervewracking one as well. WEIE

Kenneth Rogoff

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