Reconnecting the virtuous circle

In a recent article titled “Is US business abandoning the middle class?”, Chrystia Freeland of Reuters (and former US managing editor of the Financial Times) sums up the bedrock of American prosperity for the past century:

Twentieth-century American capitalism was built on what you might call the Henry Ford model — generously compensated workers (Ford paid double the existing rate) created a mass middle class that bought the products of the country’s entrepreneurs. That virtuous circle made the United States the world’s economic behemoth, and created a society and a political discourse defined by a proudly acquisitive middle class — the United States’ much admired and much maligned consumer culture.

When the chief of General Motors, Charles Wilson, told a Senate confirmation hearing in 1953 that he believed that what was good for the country was good for G.M. and vice versa, he took some flak for uttering such a self-serving line. But we all remember it because Mr. Wilson captured something axiomatic about the connection between the fortunes of U.S. business and the welfare of the country as a whole.”

From there, she goes on to contrast today’s situation where the fortunes of Wall Street and US middle-class consumers are increasingly diverging:

Wall Street, which is paid for smarts, not sentiment, has this figured out. In a newspaper interview earlier this month, Robert C. Doll, chief equity strategist at BlackRock, the largest money manager in the world, pointed out that the fortunes of U.S. companies and the fortunes of the country as a whole were diverging: “The U.S. stock market and the U.S. economy are increasingly different animals.”
Mr. Doll’s explanation for the shift was the growing importance of international markets rather than the domestic one — of the rising middle class in emerging markets, rather than the stagnating one back home. He said that over the next five years, 70 percent of the incremental earnings of S&P 500 companies would come from outside the United States.

So what happened? In essence, the virtuous circle between American buyers and sellers has been considerably weakened. What began as a tightly-coupled, nation-centric ecosystem during the time of Henry Ford has morphed into a global ecosystem that enables a company to design anywhere, build anywhere, and sell anywhere. And the resulting complexity of this global network obscures our ability to see the complete, end-to-end circle of value between buyers and sellers.

In many ways, the current opaqueness of the global flow of goods and services is a lot like the ancient Indian game of snakes and ladders (or chutes and ladders in the Western world) as a metaphor for the winners and losers of globalization. So far, the winners are the emerging economies (evidenced by their rising middle class) and the global multinationals (evidenced by record levels of corporate profits) who have found opportunities to accelerate wealth creation, whereas the losers have been the people (and the local economies) who have either lost jobs or seen wages stagnate, either directly or indirectly due to globalization.

While those on the losing side of the game tend to favor some form of protectionism as a means to level the playing field, this will not work. Any broad brush trade policy ignores the complex inflows and outflows of the global value matrix because the typical consumer who spends their hard-earned money doesn’t really know which economy is actually getting the lion share of it. After 9-11, President Bush famously asked Americans to go out and consume to stimulate the economy as an act of patriotism. But in today’s world, injecting US taxpayers money with the intent of pumping up the US economy is about as random as rolling the dice in a game of snakes and ladders, especially in the tradable sectors.

Where does your money go when you buy something (e.g., iPhone)?

For example, if I go out and purchase an iPhone today, I really don’t know whose economy would be the largest beneficiary of my consumption – the only way to do that would be to take apart the iPhone and track the origins of its components and its sub-components. And that’s only part of the challenge. If I sign up for the service contract, there is another even more complex supply chain that is connected to feeder supply chains in the telecom industry, the software industry, and the entertainment industry, etc.

Both business and society are equally to blame for weakening the virtuous circle. It is easy to make the large multinational companies look like the “bad guys” who are singularly driven by profits for shareholders. But that would ignore the fact that all these structural changes have also come about because customers demanded “better, faster, cheaper.” Naturally, businesses responded with a strategy to go global to meet both customer and shareholder objectives.

While globalization cannot (and should not) be reversed, what we can do is to try to bring a level of transparency that can help reconnect that virtuous circle because it serves not only US interests but the national interests of every economy that is part of the global value chain. While economies with positive trade balances might see this as a problem, it is nevertheless important because ongoing global trade imbalances are not sustainable and represent one of the major fault lines for future economic meltdowns (as Raghuram Rajan points out in his excellent book, Fault Lines.)

Interestingly enough, Freeland’s article ends on a note that offers an important clue:

We do not know yet how American democracy — where the middle class has the votes, but the business class has the money — will respond to this tough new economic logic.

Democracy thrives on participation and transparency. Democratic governments  respond to voters and businesses respond to customers. Since American consumers “vote” with their wallets every day, they have the power to shape and realign the virtuous circle. But it requires a greater level of transparency into where our money is going when we buy goods and services. And we are already headed in that direction.

The good news is that most of the developed nations already have the basic infrastructure to track “country of origin” information through existing laws and trade agreements. The bad news is that such efforts are largely reactive and fragmented. It often takes a major crisis to highlight the need for regulation (e.g., traceability into global supply chains) and disclosure tends to be uneven and across product categories and managed by silos of different agencies. For example, the food and beverage industry looks to the US Department of Agriculture for labeling laws governing food safety including Country of origin labeling (COOL) laws, many of which came about as response to food contamination events. Occasionally, regulation can be proactive, as in the case of hazardous materials and substances in electronic waste, where the European Union has led the way through a number of directives that govern the disclosure by product manufacturers.

While businesses tend to view such reporting rules as burdensome, improving visibility to the virtuous cycle brings about greater balance and predictability to the global game of snakes and ladders. At the moment, the global multinationals are ahead of the game because the events of the last 30 years have given them many “ladders” that have resulted in spectacular growth and profits. But the next roll of the dice might result in “snakes”, and as history shows, social unrest is perhaps the most unpredictable snake of all disruptions, and thus, supporting the need for greater transparency would be self-serving in the long run.

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