It’s a Slow-Growth Kind of World

Entrepreneurs are an impressively optimistic bunch: They estimate their chances of surviving at about 60 percent, whereas the true figure is only a third of that. But even these glass-half-fullers must be getting a bit worried about the state of the global economy. Wherever you look, hope seems to be fleeting while gloom endures.

Pundits have repeatedly discovered powerful engines of growth—the BRICs or the “next 11” or oil-revitalized America. Some have even praised Europe’s hidden strengths (which brings to mind the joke that they are “very well hidden”). But these engines have proven to be disappointing. Several roared for a bit, then went hoarse. Others have failed to catch at all. The result is a disappointing global growth rate.

The most worrying slowdown has come from the BRICs—Brazil, Russia, India and China. The rise of the BRICs over the past couple decades has been one of the greatest revolutions in economic history. In the first decade of this century, China grew at more than 10 percent a year, and India by 6.5 percent. This BRIC-powered growth was obviously good for the emerging world, pulling billions out of poverty and creating new business empires. It was good for the rich world as well. Companies gained because they could contract out jobs to millions of willing workers in the emerging world. Consumers gained because they had access to a flood of cheap products. And governments gained because globalization put a downward pressure on inflation. Australia and Canada enjoyed a particular bonanza as commodity producers.

Alas, the BRIC age is coming to an end. Brazil’s growth rate slowed from 7.5 percent in 2010 to 2.7 percent in 2011 to 0.9 percent in 2012. The International Monetary Fund now reckons China will grow by just 7.8 percent in 2013, India by 5.6 percent, and Russia and Brazil by 2.5 percent. In 2008, the BRICS accounted for two-thirds of world GDP growth. In 2012, they accounted for less than half, and the IMF predicts that they will stay at that level for the next five years.

There are obvious reasons for this. After two decades of rapid growth, emerging-market countries have picked all the low-hanging fruit. They are learning that the next stage of growth demands high-quality infrastructure and inquiring minds. But democratic countries (particularly India) lack the right infrastructure, and authoritarian countries like China lack the inquiring minds.

Optimists are now looking for the next engines of growth in the emerging world. The ever-inventive Goldman Sachs touts “the Next 11” (which includes Bangladesh, Indonesia, Mexico, Nigeria and Turkey). But, even if they continue to grow at a significant clip—and that’s a big if—the “Next 11” will not have the same impact as the BRICs. They lack the scale—they are collectively only a bit more populous than India—and they are more developed than the BRICs were when they embarked on their explosive growth. They are also grappling with many of the same problems as the BRICs: dysfunctional governments, discontented populations, cosseted national champions and underdeveloped domestic markets. There is no escaping the big problem confronting the global economy: The world has less catch-up potential than it used to. Its most populous countries are no longer all that poor, and its poor countries are no longer all that populous.

Many have shifted their hopes from the emerging world to the United States. America was the engine of the world economy in the 1950’s and 1960’s, when it grew at 3 percent a year despite being a mature economy, and in the 1990’s, when it again grew at 3 percent a year in the Goldilocks era of Clintonism. The shale-gas revolution has ignited hopes that the U.S. will be able to pull off the miracle once again. America is, after all, an extraordinarily diverse economy, with many centers of excellence; and shale gas is revolutionizing the energy industry, transforming America from a net importer to a net exporter and reducing the cost of one of the major inputs into the economy. The shale-gas development is one of the best things that have happened to the global economy in general and the U.S. economy in particular. But powerful forces are dragging America down. As Robert Litan and Carl Schramm point out forcefully in their book “Better Capitalism,” three of the great growth engines of the U.S. economy are in trouble.

America regards itself as the original start-up nation. But venture capitalists have been slashing their spending and dumping more adventurous companies, not least because about 90 percent of them failed to produce a positive return. The number of initial public offerings is down from an average of 547 a year in the 1990’s to 192 since then, reducing the supply of new high-growth companies, the biggest engines of job creation.

The start-up nation is also an immigrant nation. Fully 18 percent of the Fortune 500 list as of 2010 were founded by immigrants (among them AT&T, DuPont, eBay, Google, Kraft, Heinz and Procter & Gamble). Include the children of immigrants and the figure is 40 percent. Immigrants founded a quarter of successful high-tech and engineering companies between 1995 and 2005. They obtain patents at twice the rate of U.S. natives with the same educational credentials. But America’s immigration policies have tightened dramatically over the past decade, and a vocal faction of the Republican Party is determined to tighten them further. (Meanwhile other rich countries, such as Canada, have continued to woo skilled immigrants.) Comprehensive immigration reform is unlikely to pass Congress. A growing number of highly skilled immigrants are returning home or not bothering to come to America in the first place. Why endure America’s visa obstacle course when other countries are rolling out the red carpet?

Which leaves Europe. In the book “Europe’s Hidden Potential,” Burkhard Schwenker and Thomas Clark point to Europe’s hidden strengths (such as its tradition of skilled craftsmanship and its culture of consensus) and argue that these could turn the old continent into an unexpected powerhouse. Europe certainly has islands of excellence, from Denmark’s pharmaceutical industry to Germany’s middle-sized manufacturers. But it is unlikely in the extreme that these islands can transform an otherwise sclerotic continent.

Europe has a dismal record of producing high-growth companies. Thirty of California’s top 100 companies were founded since 1970. The comparable figure for Sweden—one of Europe’s most pro-business countries—is just two. The European economy continues to be crushed by the logic of the euro. Peripheral countries such as Greece, Spain and Italy are locked in a near-depression. But Europe’s strongest economy, Germany, worries about bailing out spongers, worries that translate into opposition to debt forgiveness and banking union. German Chancellor Angela Merkel’s re-election in September will ensure more of the same.

The lack of an obvious engine for global recovery is worrying enough. But even more troubling is the fact that structural problems can halt any surge of growth—or potentially push the global economy into the doldrums.

The two biggest problems are debt and demography. The financial crisis was partly precipitated by unprecedented levels of debt, particularly in the rich world. The Bank of International Settlements estimates that debt has grown to $33 trillion around the world since 2007. That is equal to half the world economy’s annual output. Debt will continue to haunt the world economy for years, hindering growth and producing periodic crises. For example, the severe underfunding of America’s pension systems (and the unrealistic assumptions about rate of return on investment) will lead to a succession of bankruptcies as cities and states find that they cannot honor their obligations to public-sector retirees. Detroit’s bankruptcy in 2012 was not so much a freak occurrence as a harbinger of things to come.

The rapid aging of the rich world will turn an entitlement problem into a crisis. The dependency ratio is rising fast as the number of people paying into the system goes down and the number of people taking money out goes up. The relatively speedy growth of the post-war years was made possible by the addition of young women to the labor force. We have now reaped all the benefits of new workers and are beginning to subtract people from the work force. The challenge of dealing with an aging population is compounded by poor returns on financial assets: returns that are much lower than those needed to keep pension funds solvent—let alone provide retirees with the rising living standards that they see as their birthright.

The demographic problem reaches beyond the rich world. China’s working-age population began to shrink for the first time in 2012. Thanks in part to its own policies, China will soon have to tackle the problems of an aging populace without the advantage of generations of wealth. And as China and the developed world deal with aging populations, some of the poor world will have to grapple with a surge in youth unemployment. India failed to add any net new jobs between 2004/2005 and 2009/2010 when it was growing rapidly. As many as half of the young people in North Africa and the Middle East are unemployed. The only solution to this vast misallocation of human resources is an equally vast migration. But resistance to further immigration is mounting.

The third problem is innovation-stagnation. Tyler Cowen, an economist at George Mason University, talks of a “great stagnation.” Peter Thiel, a cofounder of PayPal, the Internet payment company, and the first outside investor in Facebook, complains that we wanted flying cars and all we got was 140 characters. Lots of statistics suggest that we are getting ever smaller returns on investments. Federal spending on health-related research increased from $20 billion in 1993 to $30 billion in 2008, for example, but the number of new drugs approved by the Food and Drug Administration fell from a peak of 50 in 1996 to 15 in 2008.

This position is controversial. Commentators argue that the Internet is a powerful technology, one that is reorganizing everything from corporate supply chains (which are becoming more global) to education (which is becoming more virtual).

But even if you discount talk of a technological stagnation, two things seem to be going on. The first is that inequality is reaching levels not seen since the Gilded Age: a tiny minority of people are reaping a disproportionate share of the gains of technological innovation. The second is that many of us are confronting huge changes without getting any richer. This raises a terrifying prospect: that we may be living through a combination of a great disruption and a great stagnation. Rapid change is tolerable if it makes us all feel richer. But rapid change that leaves most of us staying where we are while enriching a fortunate few threatens to create another big problem: surging political discontent.

Besides these structural problems, we need to keep in mind the possibility of explosions: low-risk events that could plunge the world into an extreme depression. The euro could still collapse, though that is looking less likely than it did a year ago. Terrorists could blow up the information superhighway. The more interconnected the economy becomes, the more it is dependent on the smooth workings of the Internet. China could suffer from a political meltdown as the politburo is pulled apart by internal wrangling or as revolts in the provinces gather momentum. Recent events in Egypt have reminded us that authoritarian regimes are always vulnerable to sudden collapse. The fact that a growing portion of the world economy is under authoritarian control adds a new set of perils to an already risky environment.

There will be plenty of rich pickings for the fortunate few. Entire sectors of the global economy are being rapidly reorganized: Education will change more in the next decade than it has for the past century. High-growth companies can become global forces easier than ever before. But the prospect for the vast majority looks grim. Most of us will be struggling to maintain our current living standards even as the world is upended around us.

Authors

  • Adrian Wooldridge

    Contributor, Korn Ferry Institute