The Ego/Self-System Part II: A Neuroscience Perspective

Article by Robert F. Steele, MA


In the first part of this series on self and ego, we presented the traditional attitude toward ego, namely that it is essential for mental health, as humans basically need a distorted sense of reality to continue efficient functioning. This was contrasted with heretical positions from Ernest Becker and J. Krishnamurti, who contended that the ego is dangerous and responsible for much global strife and suffering. It was Krishnamurti, though, who presented the epitome of heresy concerning self and ego. In this part, we will examine Krishnamurti’s positions in relationship to recent discoveries in the field of neuroscience. I find this comparison especially interesting, as Krishnamurti’s positions were first made public in the late 1920s long before there was any technology to scientifically investigate the operations and functions of the brain. This also reminds me of the positions of Copernicus and Galileo, concerning their inflammatory heresy that the Earth is not the center of the universe.

Much of the material presented is the province of experts, and since I am not a neuroscientist, I will rely heavily on extensive quotes to secure positions taken. My role will be to assemble a montage of various views that, when presented, will hopefully illuminate self and ego from a scientific point of view in comparison to Krishnamurti’s positions. I will follow comments to the articles and will respond to questions or comments concerning this and the previous installment.

Is the Self/Ego a Real Thing?

Krishnamurti stated that we are nothing, that the self is not real, in the sense of it not being a thing. What does brain science have to say about this very radical position? Antonio Damasio, an eminent neuroscientist, says in his book, Self Comes to Mind: Constructing the Conscious Brain: “The answers are unequivocal. There is indeed a self, but it is a process, not a thing, and the process is present at all times when we are presumed to be conscious. We can consider the self process from two vantage points. One is the vantage point of an observer appreciating a dynamic object … The other vantage point is that of the self as knower” (Damasio, 2010, Amazon loc. 205).

If there is no physical structure central to self, a self-structure that runs the brain, a me that is in control, what creates this uncanny sense of self as the operator of the system? An answer may lie in looking at how the brain produces consciousness, since this sense of self as operator and knower resides in consciousness.

Consciousness is an emergent property. From moment to moment, different modules or systems compete for attention and the winner emerges as the neural system underlying that moment’s conscious experience. Our conscious experience is assembled on the fly, as our brains respond to constantly changing inputs, calculate potential courses of action … The psychological unity we experience emerges out of the specialized system called “the interpreter” that generates explanations about our perceptions, memories and actions and the relationship among them (Gazzaniga, 2011, p. 102).

Meditation really is a complete emptying of the mind. Then there is only the functioning of the body; there is only the activity of the organism and nothing else; then thought functions without identification as the me and the not-me. Thought is mechanical, as is the organism. What creates conflict is thought identifying itself with one of its parts which becomes the me, the self and the various divisions in that self. There is no need for the self at any time. There is nothing but the body and freedom of the mind can happen only when thought is not breeding the me. There is no self to understand but only the thought that creates the self.

– Krishnamurti

The Invisible Brain

It appears then that there is a close agreement between Krishnamurti and brain science that self is not a physical structure or some immutable, and perhaps sacred or eternal, element. It is a function that emerges from brain activity, as does all that constitutes consciousness, but it is also invisible to itself as far as its internal operations go. It took technology for researchers to be able to peer inside the brain to understand the functions of the brain.

The faculty with which we ponder the world has no ability to peer inside itself or our other faculties to see what makes them tick. That makes us the victims of an illusion: that our own psychology comes from some divine force or mysterious essence or almighty principle (Pinker, 1997, p. 4).

Since the brain’s functions are not part of consciousness, this could explain, at least in part, why the sense of self seems so real; there is nothing in consciousness to compete with or to contradict the self-image, as it is the sole inhabitant of consciousness. Krishnamurti appears to agree with this in his comments about consciousness being its own content. He presents it as a unit, making no separation for the part self occupies in consciousness, along with the other elements that at any given time may be part of consciousness.

Consciousness is its content. The content is consciousness. The two are not separate. That is, the thoughts, the anxieties, the identifications, the conflicts, the anxiety, the attachments, detachments, the fears, the pleasures, the agony, the suffering, the beliefs, the neurotic actions, all that is my consciousness.

– Krishnamurti

Additionally, if we look again at the Damasio quote above, he proposes consciousness is composed of objects and a knower of those objects. It certainly feels that way, but a more removed view might see these elements are really one flow of consciousness. Is this what Krishnamurti is talking about when he talks about the thinker and the thought being one?

The root of contradiction is this division between the thinker and the thought. And the two cannot be integrated. But if one observes the structure of the thinker, you will see the thinker is not, when thought is not. It is the thought that breeds the thinker, the experiencer, the entity that creates time, and the entity who is the source of fear.

– Krishnamurti

Behind the screen of consciousness is the functioning brain, and what is going on within the brain’s silent functions is amazing. Billions of nerve cells called neurons are being created at early stages of the brain’s development, and throughout our life, root-like connections called axons are constantly adding to the trillions of connections between neurons via locations called synapses. “Moreover, when enough new synapses form in a neuron, the length and number of branches in its dendritic “tree” often expand as well, increasing the strength and number of the neurons that can talk to it” (Sapolsky, 2017, Amazon loc. 2283). These connections are learning. Once these networks are in place, matrix-like assemblies interconnect via electrical and chemical reactions to form representations of elements in the outer world. Basically, these representations are assemblies of simultaneously reacting neurons that, when stimulated, cause what we call memories. They can be assembled and downloaded to become a flow of consciousness that also contains a sense of self claiming to be responsible for the flow, and brain science says a sense of self as a center is necessary for there to be consciousness.

The mere presence of organized images flowing in a mental stream produces a mind, but unless some supplementary process is added on, the mind remains unconscious. What is missing from that unconscious mind is a self. What the brain needs in order to become conscious is to acquire a new property – subjectivity – and a defining trait of subjectivity is the feeling that pervades the images we experience subjectively (Damisio, 2010, Amazon loc. 248).

It does not necessarily follow that in needing a sense of center, a knower, there must also be an attached causative agent to the center, the self as a doer, an ego. This brings up the issue of free will.

Is There Such a Thing as Free Will?

In neuroscience, the issue of free will is a hot and undecided topic that, for now, centers around a study first conducted in the 1980s. The physiologist Benjamin Libet famously used EEG to show that activity in the brain’s motor cortex can be detected some 300 milliseconds before a person feels that he has decided to move at the moment they decided to press one button or the other … One fact now seems indisputable: some moments before you are aware of what you will do next – a time in which you subjectively appear to have complete freedom to behave however you please – your brain has already determined what you will do. You then become conscious of this “decision” and believe that you are in the process of making it. (Harris, 2012, p. 8).

Libet (1985) and Libet et al. (1967) conducted experiments showing that brain activity preceded seemingly conscious decisions of subject instructed, for example, to raise their finger at will. Since then, it has become very clear that unconscious processes are involved even when we feel we make deliberate choices (Ginot & Schore, 2015, Amazon loc. 756).

This can be strange and shocking information that challenges the sense of who or what is actually determining our thoughts and behaviors. Another source puts it this way:
Our subjective awareness arises out of our dominant left hemisphere’s unrelenting quest to explain these bits and pieces that have popped into consciousness. Notice that popped is in the past tense. This is a post hoc rationalization process. The interpreter that weaves our story only weaves what makes it into consciousness. Because consciousness is a slow process, whatever has made it to consciousness has already happened. It is fait accompli (Gazzaniga, 2011, p. 104).

Concerning superstition, Bruce M. Hood in his book SuperSense: How the Developing Brain Creates Supernatural Beliefs points out that “In other words, there is no free will in making the decision to believe or not” (Hood, 2009, p. 67). The same could be said of consciousness. One likes music, but was that decided upon or found by discovery? Where do talents or abilities come from? According to science, anything we decide to “do” is not only dependent on brain processes that happen prior to the formation of something in consciousness, but our actions also depend on neurological functions to carry out the decision. Beethoven could no longer conduct because he became deaf, and Ravel could no longer read music after a stroke in his 60s. Yes, we make choices, but in no way are they free. They are forever dependent upon underlying, silently functioning brain systems. What may be important here is that, regardless of what we may or may not be able to choose, the fact that stands out in brain science is that behind everything we do is not a self but a brain. This may be particularly important concerning how the issue of free will may or may not intersect with the teachings of Krishnamurti.

Choiceless awareness implies to be aware both objectively, outside, and inwardly, without any choice. Just to be aware of the colours, of the tent, of the trees, the mountains, nature – just to be aware. Not choose, say, ‘I like this’, ‘I don’t like that’ or ‘I want this’, ‘I don’t want that’. To observe without the observer. The observer is the past, which is conditioned, therefore he is always looking from that conditioned point of view, therefore there is like and dislike, my race, your race, my god, your god, all the rest of it. We are saying to be aware implies to observe the whole environment around you, the mountains, the trees, the ugly walls, the towns, aware, look at it. And in that observation there is no decision, no will, no choice.

– Krishnamurti

Nobody Home

If, as neuroscience indicates, the brain has created the self/ego system, and if its functions are silently behind all behavior, this may turn our idea of who we are and what life is in a very different direction, and the conclusion may be that we are not running things as we thought, perhaps not running them at all. Furthermore, statements from Krishnamurti may support this. First, let us look at what he says about effort:

Effort implies control, effort implies conflict, inwardly, psychologically and outwardly. To this state of things we have become accustomed. Religious people, business people of every kind must make effort. And in that effort there is involved a great deal of energy, in conflict and so on.

– Krishnamurti

He also comments on how the self is trying to reach an ideal position by creating a desired view of the self in the future:

Why does each one of us want to be something? If I am ugly, I want to be beautiful; if I am stupid, I want to be clever; if I am envious, I want to be free from envy. So there is a constant battle between what I am and what I think I should be. The ‘should be’ is the aim of every person who wants to become, and in this process there is infinite struggle, pain, fear, frustration. And seeing this process, being aware that my mind is caught in the web of sorrow, how am I to be free from sorrow?

– Krishnamurti

Krishnamurti seems to be challenging the very role of consciousness in human life. Self/ego, as research presents it, is a projection from the brain that gives a sense of control, and effort and direction in the future. But what is it that is “sensed” as effort? If it is in consciousness, as it obviously is, the sensation must also be a projected image from prior brain activity. Science says the brain’s real efforts have no sensation to them at all. Now, of course, we need some of these sensations to protect the body from damage and danger etc., but those challenges are in the present. I think that if we are honest, we can see self/ego has a preoccupation with a future projection of its fears and desires and, as such, much, or maybe most, of consciousness is filled with these images:

Can the eyes observe without the past? Let me put it differently: I have an image of myself, created and imposed upon me by the culture in which I have lived. I also have my own particular image of myself, what I should be and what I am not. In fact, we have a great many images; I have an image about you, about my wife, my children, my political leader, my priest, and so on; so I have dozens of images. Don’t you have them? Now, how can you look without an image, because if you look with an image, it is obviously a distortion.

– Krishnamurti

An honest appraisal may indicate that we are seldom in the present. There was a passage in one of Krishnamurti’s books where he is speaking to a group of Buddhist monks in which one of the monks, after an extensive discussion, says to Krishnamurti something to the effect that Krishnamurti had led a life of observation, and Krishnamurti replied, “Quite right, sir.” This statement could be taken as a casual reply, but what if the monk had an insight and Krishnamurti’s reply was very literal? Would this mean that Krishnamurti’s utilization of consciousness was predominantly a place of intense observational awareness largely free of future concerns and the sensations of effort associated with the sense of self/ego? Seen from another perspective, Krishnamurti’s position seems to be a complete negation of free will because the behavioral motivators of free will can only exist as a sensation of desire and conflict within the self/ego system as it struggles with the various rules and regulations of life. Would it be logical to say that, without the self/ego system, the future of the self as a projection in “the act of becoming” cannot happen, nor can all the necessary defenses the self employs to guard itself. But also lost are all the attractions and addictive sensations associated with self/ego as desires. Krishnamurti once asked of a questioner: “Do you really want it? Right? What price are you willing to pay for it … ?” Clearly, if one is in conflict about this price, the effort to understand Krishnamurti may be nothing more than just another “act of becoming.”

Since neuroscience is quite clear that the self is an image and therefore imaginary, so the clear indication is that the brain is the source of all that is going on with us rather than the construct we call self. The brain desires and feels it needs the fantasy of self as a controller. In Part I of this series, the motivation for this was explored and proposed to issue from fear. Not fear in the present, but remembered fear projected into the future that has long since been buried deep in the subconscious, and, though buried, still is the source of a preoccupation with the future. Dreaming of a nice future to fill consciousness displaces darker concerns. Does this mean then that consciousness is clogged with obsessive images from memory that creates more obsessive images as future projections? If so, does that mean we are blocking observation of and participation in the present? If we are neglecting the present, how does that influence the actions we take to manage our lives?

When one looks at all this, one asks, if you are serious: what is right action? What is the right thing to do in life? Not in one particular department of life, but the whole, total process of living, what is the right thing to do? Right being the word ‘accurate’ – accurate, precise, without any distortion – what is the accurate thing to do, the right thing to do in life? Do you ask that question? So we are going to investigate into this question because unless we find out, every action that we do leads to further confusion, further misery and man becomes utterly a mechanical entity – which we are gradually becoming. So it’s very important for a serious person, and I hope you are serious, to find out what is the right thing to do.

– Krishnamurti

Other questions are also raised from these concerns. Our brain/body system is a product of the universe. Its elements have been brought to existence over about 3.75 billion years of evolution as a part of the evolving continuity of life on Earth. We are here, just as every aspect of life is, as a development and creation within the same universe. But only the human species seems to not trust the equipment we were given to handle life. Of course, in all fairness, other creatures and lifeforms apparently do not understand the ultimate predicament life puts us in, namely of not having absolute security. Knowing that leaves us either simply accepting things the way they are or creating different diversions and fantasies to push that awareness aside. However, we may pay a high price for psychological escape, and it may cause disintegration with the life systems that we are enmeshed with at the physical level. What we seem to not trust is that, if we take care of the present by being fully aware, the best security will come about without effort simply because that is what the basic design of the brain is intended to do. Not perfect, but the best. In creating the self/ego, has the brain attempted to weasel out from the reality of life as a system of incessant change? Is it possible that, in so doing, misery and uncertainty has been introduced on an unimaginable scale that issues from the connivance of the brain’s own monster creation, the ego?

We begin to discover that when there is the destruction of all the authority which man has created for himself in his desire to be secure inwardly, then there is creation. Destruction is creation. Then, if you have abandoned ideas, and are not adjusting yourself to your own pattern of existence or a new pattern which you think the speaker is creating – if you have gone that far – you will find that the brain can and must function only with regard to outward things, respond only to outward demands; therefore the brain becomes completely quiet. This means that the authority of its experiences has come to an end, and therefore it is incapable of creating illusion.

– Krishnamurti

Can it be that the life Krishnamurti lived was one of accepting the unfolding of events in the universe both inwardly and outwardly? If so, it may indicate that the “now” moment of ongoing creation for the movement of Krishnamurti’s mind and everything happening outwardly were essentially the same; everything going on internally for him, his brain’s functions, issued from the same source as everything else. The irony is that what seems to block the brain from understanding this is the imagination of self which, if this is right, is the memory of fear motivating the creation of a self-system, which necessitates the need for an imaginary future. Krishnamurti replied to a question concerning what his secret is by saying: “I’ll tell you what my secret is. I don’t mind what happens.” From the comments assembled here concerning brain science and Krishnamurti’s own quotes, it seems to be a comment about time. Is Krishnamurti implying that he fully accepted the unfolding of what may happen both within himself and outside of himself, not as a choice or something to practice but as an inescapable fact concerning himself as a creation of the universe interacting with the rest of creation? Would this not mean that the unfolding of creation is a fact beyond control, uninfluenced by the human desire for the basic dilemma, the impermanence of everything, to be different?

In summary, it seems amazing that the statements of this man, Krishnamurti, are so closely aligned with the latest scientific discoveries about the brain. But, in addition, he speaks of insight as a function of the brain too, and this has not, and perhaps cannot, be investigated by the tools of science. Krishnamurti seems to indicate that insight is a special operation and special alignment between the brain and the outer elements of creation that results in perception not limited by the inherent bias in the storehouse of memory. One can only wonder if insight is the result of a truthful relationship between the brain and creation, which brings to consciousness an inescapable sense of reality that transcends opinion and interpretation. If so, it would truly represent a radically different dimension in the ability of the brain to perceive reality.

To perceive this whole movement of the individual and its activities and its organisations, is to have an insight into the whole movement of it. And that very insight is out of time. I don’t know if we have understood that. Insight is not a remembrance, is not a calculated, investigated, investigative result, it is not a process of recording and acting from that, and it’s no longer the activity of thought, which is time. Therefore insight is the action of a mind that is not caught in time.

– Krishnamurti

Robert is a retired mental health counselor and lifetime student of Krishnamurti.

America is the revisionist power on trade

Meanwhile China wants to preserve the model of globalisation that has served it well

Gideon Rachman

Both China and America are dissatisfied with the current world order. The nature of their unhappiness is very different. But the two countries’ rival ambitions have produced a trade war that now threatens globalisation.

The problem as conceived by Donald Trump is that the world economic system is operating hugely to America’s disadvantage. The US president complains that “globalism” has helped China to rise at America’s expense — undermining US prosperity and global pre-eminence. It is that view that underpins Mr Trump’s dramatic decision last week to raise tariffs on $200bn worth of Chinese exports to America, from 10 per cent to 25 per cent.

For Xi Jinping, the problem with the current world order is America’s political and strategic dominance. The Chinese president has made it clear that he wants his country to displace the US as the dominant power in the Asia-Pacific region. Many Xi-supporting nationalists go further, speaking openly of their hope that China will become the dominant global power. Mr Xi is well aware that globalisation has been critical to China’s rise over the past 40 years. So he is determined to preserve the current trade model.

The two presidents’ complaints about the world system are thus mirror images of each other. Mr Xi wants to change the world’s strategic order, and to do that he needs to maintain its economic order. Mr Trump wants to preserve the strategic order, and to do that he needs to change the economic order.

America and China are therefore both revisionist powers. And they are also both status quo powers. America is the status quo power on geopolitics, so it has become the revisionist power on economics. China is the revisionist power on geopolitics, so it has become the status quo power on trade.

But the mirror-image positions of Beijing and Washington also imply a convergence of view on globalisation. The actions of both countries suggest that they basically agree that the current system works better for China than for the US. While many economists would dissent from that view, it now seems to be the consensus political position in America. Chuck Schumer, the leader of the Democrats in the US Senate, has tweeted his support for the Trump administration’s confrontational policies on trade with China.

In both Washington and Beijing, however, there are divisions between moderates who want the current trade row to end with a deal and radicals who would welcome a lasting breakdown in trading relations.

Protectionist radicals in the Trump administration believe that the Chinese political and economic model is fundamentally hostile to the interests of the US. And they want to “rebuild” the American economy behind high-tariff walls. For those who hold this view, a compromise deal that preserves the essence of the current globalised world trading system would be a defeat.

On the Chinese side, the hawks see the trade dispute as a chance to make China less dependent on foreign technology. Ardent nationalists also interpret the Trump administration’s position on trade as evidence of American weakness. The correct response, they believe, would be for Beijing to forge ahead with efforts to create a China-centred world order.

The increasingly bellicose attitudes of nationalists in both the US and China look like an illustration of the “Thucydides’s trap” made famous by Graham Allison, a Harvard professor. Prof Allison has pointed out that, throughout history, rising powers such as China have often gone to war with established powers such as the US.

But the current US-China conflict is a trade war, not a shooting war. And when it comes to trade, it is the US that is seeking to overturn the current system. That presents Mr Xi with a difficult tactical choice. Should China make concessions that are painful, and even humbling, in the interests of preserving the essence of the economic system that has facilitated its rise?

The Chinese are very mindful of the precedent of the Plaza Accord of 1985, in which, under intense US pressure, Japan agreed to revalue its currency. Many in China believe that, in retrospect, the Plaza Accord represented a successful American attempt to thwart the rise of Japan.

The Trump administration faces a variant of the same dilemma. Should America aim to exert maximum pressure, with the aim of eventually reaching a “great deal” that fixes flaws in the current system? Or would a partial victory in the trade war actually amount to a defeat if it failed to halt the rise of China?

By temperament and political interest, Mr Trump is probably still on the side of the dealmakers. He also continues to set great store by his friendship with Mr Xi, recently praising a “beautiful letter” he had received from the Chinese president.

Yet a close relationship between leaders is no guarantee that conflict can be avoided. In the July crisis that preceded the outbreak of the first world war in 1914, Kaiser Wilhelm of Germany and Tsar Nicholas of Russia exchanged numerous friendly notes and telegrams. But it did not prevent their two countries sliding into conflict. In a similar way, the US-China trade war now risks escalating to a point where it escapes the control of the two countries’ leaders.

US-China trade war risks global technology split

Decoupling will not support American security or economic interests

The editorial board

Forcing Huawei to move to its own system may weaken US security, according to Google © Reuters

Chinese technology firms such as Huawei have been among the chief targets of the trade dispute with the US. The Trump administration’s desire to exclude them from the US is driven by security and economic concerns, and the hope of preserving America’s tech dominance. In reality, banning Chinese companies may do more to harm the US.

A “Fortress America” approach, restricting access to the global marketplace, may only spur Chinese innovation. At worst, it could lead to the splitting of the internet between US and Chinese spheres. In the long term, the Trump administration could be hoisted with its own protectionist petard.

American restrictions on Chinese technology have intensified since 2018. Last August, a defence bill prohibited the US government and its grantees from using Huawei telecoms equipment. The Chinese company was added last month to the US “entity list”, requiring American companies to receive a government license to sell to it. President Donald Trump has also empowered commerce secretary Wilbur Ross to ban any technology company considered to pose a national security risk. Mr Ross is due to make his decision in just over three months.

The desire to protect national security is understandable, not least given the close relationship between Chinese tech companies and the state. Security in the digital age is porous, however. By engaging with Chinese technology, western intelligence services can glean important information. Forcing Huawei to move to its own system may actually weaken security, according to Google. The US tech group, which restricted Huawei’s access to parts of its Android operating system last month, has warned that a Chinese version might be more vulnerable to hacking.

The second belief is that the US can stifle Huawei and other tech companies by delinking China from global tech supply chains. In the short term, the US blacklist will limit Chinese companies’ access to components from outside the country. Huawei’s problems with mobile phone chips — over half of which it imports from the US — may strengthen the argument for this militant approach to trade.

Forcing Chinese technology companies into a corner, however, could speed up domestic innovations. These companies could source products from cheaper markets such as South Korea and produce their own software. At the most extreme, competing Chinese and US-led internets could emerge — as former Google chairman Eric Schmidt has warned. An industry body said this week that standards for 5G internet were at risk of this kind of divergence. That could mean devices produced in one market might be incompatible with those from the other.

This would force countries, and companies, to choose sides in the technological trade war. Recipients of Chinese funding through programmes such as the Belt and Road Initiative will face a diplomatic balancing act. Malaysia’s prime minister has said the country would use Huawei’s technology as much as possible. Powerful US allies including the UK and Germany have come under pressure to ban Huawei. At least two European telecoms groups, meanwhile, have been reported to be weighing setting up separate units for the eastern and western hemispheres.

Keeping supply chains global does not mean being naive. Suppliers should be carefully vetted — particularly when there are historical grounds for concern. But isolating China will not improve national security, or remove the economic threat of Chinese tech groups. Despite its apparent appeal, protectionism is a self-defeating ideology.

China Could Lose Face, Get Rich From a Trade Deal

By Nathaniel Taplin

China is a manufacturing juggernaut, an enormous force in global markets and, according to many in the Trump administration, a threat to U.S. technological and military supremacy.

It is also, however, no longer as cheap as it once was. The country is beginning to bump up against income levels where some scholars believe nations are at higher risk of rapid growth slowdowns, as their cost advantage in cheap exports erodes but they fail to innovate rapidly enough in high-tech. China has legions of engineers and a rising weight in scientific publications, but it has still only produced a handful of global technology champions. Beijing’s answer is so-called “industrial upgrading” with the help of massive government capital. But state-led innovation has a checkered history in China, and the plan is sparking aggressive pushback from the U.S., which slapped new tariffs on China on Friday.

Only a handful of low and middle-income nations have managed to power into the high-income ranks since 1960—just 25 out of 156 as of 2016, according to Capital Economics. Whether China can buck those odds is probably the most important economic question of our time and will reshape the global investment environment.

A simple example illustrates the stakes. If China keeps growing around 6% a year and the U.S. keeps growing around 2%, 15 years from now China’s economy will be the largest in the world. If, however, China only grows at a compound annual rate of 4%, the U.S. economy will remain about a fifth larger. To be sure, that would still mean a massive Chinese economy. It also would mean a markedly poorer overall populace, upending growth plans of consumer-focused multinationals and making rising military expenditures more difficult. Any deterioration in the yuan’s value would widen the gap.

A worker welds a liquefied natural gas tank at a factory in Nantong in China's Jiangsu province. Photo: str/Agence France-Presse/Getty Images

Despite its obvious advantages, several of the key factors driving China’s spectacular growth are moving into reverse. The total working-age population peaked in 2013, according to official figures. That means higher costs, and also slower growth in savings to finance investment, as a rapidly graying population stops saving for the future and starts spending. Meanwhile the nation’s export machine is already so large—13% of global shipments in 2017—that it is running into stiff political resistance abroad at much lower income levels than when trade tensions peaked for Japan in the 1980s. Continued rapid export growth, another key source of capital for investment, could prove difficult to sustain, even without competition from lower-cost aspirants like Vietnam.

Scarcer labor and savings ahead means that the big hope for keeping growth chugging along is boosting productivity and leveraging China’s massive internal market as a testing ground for new products, technologies and globally competitive champions.

It isn’t clear, however, that Beijing is taking the steps needed to make this happen. Rather than bold new reforms, public policy in recent years has focused on shoring up the debt-addled state sector through industry consolidation—often at the expense of private competitors.

Return on assets for privately owned industrial companies, nearly 13% in 2014, was less than 8% last year. Even in the fast-growing information-technology sector, highfliers such as Tencent have found themselves facing tighter government scrutiny and subject to “mixed ownership reform,” encouraging them to invest large sums in ailing state giants. The state share of total investment, which declined steadily for most of the 2000s, has since 2012 stabilized at around 35%-40%.

A big internal market with ample state finance could indeed help build many new globally competitive innovators—but only if those financial resources find their way into good hands, and government interference doesn’t pose too much of a problem for winners. In today’s China, this seems more, not less, questionable than a few years ago.

A 2018 analysis from Capital Economics finds that, while in most countries large firms tend to have higher return on assets than smaller firms due to economies of scale, in China the reverse is true for both private and state-owned companies. One explanation could be that many small private manufacturers in China are part of international export supply chains and therefore directly exposed to global market discipline, unlike large, domestically focused companies.

Other explanations are more disturbing. Even successful Chinese companies like Tencent are exposed to a high level of government interference once they reach scale. That weighs on returns. Or the companies that grow to scale may do so primarily because of political connections and cheap finance, rather than quality per se. Either way, the conclusion isn’t encouraging.

What is encouraging are subtle signs in recent months that Beijing realizes that the past year in particular has been very rough for entrepreneurs. Large banks are being ordered to lend more to small companies, substantial business tax cuts have been rolled out and official rhetoric on lowering private-sector costs has hardened. None of this is the same as big-bang reforms like full interest rate liberalization or opening more state-controlled sectors to domestic and foreign competition, but it is a step in the right direction.

Ironically, China’s best hope to keep growing rapidly might be a trade deal featuring exactly the sort of competition-boosting reforms the Trump administration is asking for—a fairer, wider playing field for private capital and toothier intellectual-property enforcement. That would also help preserve Chinese access to Western markets and technical expertise. Chinese nationalists may disagree. In the long run, though, a deal forcing real change might help, not hinder the Chinese rejuvenation the current leadership proselytizes.

Dirty Floating in Emerging Markets

Central banks are supposed to use the interest rate to achieve an inflation target and let the exchange rate float freely. So why do they often intervene in currency markets by buying and selling international reserves, and use a host of other measures to limit their currencies’ volatility?

Andrés Velasco

velasco93_Panuwat Sikham Getty Images_digitalworldmoneytransfer

LONDON – Say one thing and then do something else. That pretty much sums up current orthodoxy in emerging economies regarding exchange-rate management. Countries are supposed to use the interest rate to achieve an inflation target and let the exchange rate float freely. In practice, Asian and Latin American central banks often intervene in currency markets by buying and selling international reserves, and use a host of other measures to limit their currencies’ volatility.

That exchange-rate make-believe will be harder to keep up after a landmark speech last week by Agustín Carstens, General Manager of the Bank for International Settlements (BIS), at the School of Public Policy at the London School of Economics. In the past, the BIS has been regarded as a bastion of orthodoxy. But now the BIS is arguing that orthodoxy should be updated. Markets are bound to listen.

Inflation targeting can claim important achievements, which Carstens duly listed. It has helped bring inflation rates down in most emerging markets. It has also helped reduce what economists call exchange-rate pass-through – the immediate impact of exchange-rate depreciations on domestic inflation.

But this does not mean that when confronted with massive capital flows, emerging markets can or should exercise benign neglect of the exchange rate, as prevailing orthodoxy suggests. This standard dictum “is honored more in its breach than in its observance as a guide for monetary policy,” Carstens observed dryly.

A key fact explains the gap between theory and practice. Emerging economies’ financial conditions tighten when their currencies depreciate, and vice versa. It was not supposed to happen that way. Letting their currencies float was supposed to allow countries to seize control of their domestic interest rates, which could then be adjusted as necessary to smooth domestic economic fluctuations. Alas, reality has turned out to be considerably more vexing.

One problem is well understood. Because of emerging economies’ checkered financial history, their governments, banks, and firms often have no choice but to borrow abroad in dollars. When the exchange rate depreciates, the domestic-currency value of those loans increases. In a mild scenario, this can cause a slowdown in domestic lending, investment, and growth; in extreme cases, it can cause defaults, bankruptcies, and a financial crisis. Those adverse balance-sheet effects are one reason why emerging-market central banks are allergic to sharp exchange-rate movements.

The good news is that the original sin that prevented emerging markets from borrowing in their own currencies seems to have been forgiven. Today, foreign investors hold large portfolios of local-currency bonds in Colombia, Mexico, South Africa, and Turkey, among other countries. The bad news, argue BIS economists, is that borrowing in local currency helps, but is no panacea. Their research shows that a sharply depreciating exchange rate is associated with widening sovereign interest-rate spreads: when the peso, rand, or lira tank, domestic long-term interest rates rise! This is certainly not what received wisdom on the transmission mechanisms of monetary policy would predict.

The reason for this paradoxical behavior is that global investors are bound by value-at-risk rules and care about returns in dollars. When they suffer exchange-rate losses, they automatically restrict credit to that country, causing the exchange rate to fall further and local interest rates to spike.

The BIS concludes that when changes in advanced-economy monetary policy or shifts in investor appetite cause massive capital outflows, “the exchange rate may … act as a transmitter and amplifier of financial shocks, rather than an absorber of real shocks.”

This is a big problem for central banks that worry – as they should – about financial stability. But even for central banks that claim to care about inflation and nothing else, exchange-rate volatility poses a dilemma. An appreciating currency puts downward pressure on inflation, but it also loosens domestic financial conditions. As debts and risk pile up, the stage is set for a sharp devaluation and upward price pressures in the future.

What should central bankers do about this inflation-today-versus-inflation-tomorrow tradeoff? One possibility is to include the exchange rate among the factors they consider when setting interest rates. This could be achieved through a modified Taylor rule – named after Stanford University economist John Taylor – that added the deviation of the exchange rate from some target level to the standard targets for inflation and the output gap.

Many emerging-market central banks do this already. After a depreciation, they often tighten monetary policy in order to contain so-called second-round effects (whereby the weaker exchange rate contaminates expectations and wage-setting behavior). The problem is that when investors panic and the exchange rate becomes unhinged, there be may be no interest rate sufficiently high to calm things down. Even worse, a sky-high interest rate that sinks the economy and causes central-bank short-term debt to pile up may reduce credibility, rather than enhancing it.

Witness Argentina today: the central bank has vowed to keep the money supply constant (and is keeping its word), short-term interest rates are 70%, and the government is slashing the fiscal deficit. But inflation keeps rising (it is near 55% over the last 12 months) and the peso remains under pressure.

An alternative is to use sterilized exchange-market intervention, as many Asian countries routinely do, and as Argentina is close to doing, despite earlier vows to the contrary. Intervention during the exchange rate’s upswing allows the central bank to accumulate international reserves, which is a desirable macroprudential policy. And during the downswing, when global investors withdraw their funds, exchange-market intervention via the sale of reserves can be stabilizing, because it supplies the dollar liquidity the local economy desperately needs.

Skeptics will claim that sterilized exchange rate intervention is not supposed to have any effects. Those skeptics are wrong, BIS researchers counter. Their work, Carstens noted, shows that “sterilized FX purchases in EMEs [emerging-market economies] exert a statistically and economically significant depreciating effect on exchange rates, at least temporarily.”

Should this intervention be guided by discretion or rules? If the latter, can rules be sufficiently flexible to avoid establishing a quasi-fixed exchange rate against which markets will inevitably bet? These questions and many others remain to be answered.

But one thing is clear: clean floating is out and dirty floating is in. Theory is at last catching up with practice.

Andrés Velasco, a former presidential candidate and finance minister of Chile, is Dean of the School of Public Policy at the London School of Economics and Political Science. He is the author of numerous books and papers on international economics and development, and has served on the faculty at Harvard, Columbia, and New York Universities.

The Answer to Populism? Looking Forward, Not Back

There are solid economic reasons for the populist outrage expressed toward all elite institutions (governments, corporations, universities) in so many democracies today, writes Wharton dean Geoffrey Garrett in this opinion piece. The questions is, what should we do about it? One thing appears to be clear, however — today’s capitalist democracy is in crisis.

Britain’s Brexit and Brazil’s Jair Bolsonaro. Italy’s Matteo Salvini and our Donald Trump. The Yellow Vests in France. Populism is the trend in democratic politics today. But how should we understand it? How should we respond to it?

I am increasingly convinced of three things:

First, the populist outrage expressed toward all elite institutions (governments, corporations, universities) is not a top-down case of charismatic leaders inflaming a rudderless society. Rather, today’s populist leaders are the product of profound societal dissatisfaction with an elite-driven political economy.

Second, the rise of populism is at its core an economic phenomenon – with enormous social and political consequences – driven above all by the deteriorating economic situation of the middle class.

Third, there is negativity toward “the system” including democracy itself. The deep potential support base for populist leaders who want to blow it up – not reform it through the established push and pull of democratic politics – is highest among millennials. We used to think of young adults as being the most idealistic and committed to democracy. No longer.

Put it all together and we are living in societies that are much more pessimistic – some resigned, many angry – than at any time I can remember. Today’s strong economic growth, low unemployment and high stock prices do not provide the support for the status quo that they have before. That’s because they no longer translate into material or psychological well-being throughout society, breeding rampant pessimism.
Here is the evidence supporting my contention about the links between populism and pessimism.

Fact 1: People don’t believe the future will be better for their children.

I suspect that there has been one fundamental indicator of optimism in the Western world since at least the Industrial Revolution: parents believing that their children’s lives will be better than their own. Today, according to the Pew Research Center this optimism only persists in emerging markets.

The high-water mark for optimism in the West is Sweden, the utopia of social democrats, where 44% of citizens believe that when today’s children grow up they will be better off financially than their parents. At the bottom of the pessimism barrel are the countries with long term and likely irreversible economic malaise — France, Japan, Greece, and Italy. America has long been the paragon of inveterate optimism. But today, only 37% of Americans believe their kids will be better off, slightly less than in Venezuela.

Source: Pew Research Center

Fact 2: The root cause of pessimism is deteriorating economic life chances.

Take a look at the graph below about America from the Equality of Opportunity Project, now known as Opportunity Insights and led by Harvard economist Raj Chetty. Instead of asking people how they feel about the future economic prospects of their children, the graph plots what actually has happened to Americans based on when they were born. The data are striking.

Ninety percent of children born in America in 1940 went on to earn incomes that exceeded those of their parents — justifying that generation’s faith in the American dream. For millennial Americans born in the 1980-1985 window, it is a coin toss whether their incomes will exceed those of their parents. No wonder they are anxious about their futures and disillusioned with the institutions — government, big business, and higher education — promising to make their lives better.

Source: The Equality of Opportunity Project

Fact 3: Younger people are less committed to democracy.

The graph below is as astonishing as it is disturbing, but it is the consequence of deteriorating opportunities for younger people in most, if not all, Western countries.

It’s no surprise that there was a vast difference between people born in the 1930s in America and Europe regarding their attitudes to democracy. But after World War II, the two paths converged around support for democracy among baby boomers born in 1950. A solid majority believed that it was “essential” to their overall quality of life that they lived in a democracy.

For the first millennials born in 1980, the percentage believing democracy was essential to their lives has dropped to under 45% in Europe and to a staggeringly low 30% for Americans — all according to the World Values Survey.

These data should not be over-interpreted. They do not mean that most people would prefer to live in autocracies. But the data do show that younger people have become at minimum complacent and at maximum disenchanted when it comes to the value proposition of democracy.

Source: Financial Times

What should we do now? The obvious answer is more inclusive economic growth. But that will require real political leadership that seems so absent today. And this is not a fleeting thing. Rather, the left-right party divisions that became entrenched in the 20th century are ill-suited to generate the leadership the West so desperately needs.

What we need are leaders who do not channel outmoded partisan divides. Populists avoid and often defy partisan labels. But they represent a back-to-the-future view of the world that I believe is ultimately futile and self-defeating. Instead we need forward-looking “progressive” leaders who highlight actionable ways to spread the profound benefits of technology and globalization more broadly than they have been in recent decades.
Progressive might sound like “left” to many, but I don’t intend it that way. At their core, progressives are optimists – people who believe the future will be better than the past and are committed to working to get there. By contrast, conservatives cling to the past because the future is just too risky. On my definition, Ronald Reagan was progressive. Remember this opening line from one of his 1984 campaign ads – “It’s morning again in America”? But British Labour leader Jeremy Corbyn is conservative – if only Britain never entered Europe in the first. So, too, is Donald Trump, with Make America Great Again.

What we need is a new generation of 21st century progressives who can lead us to a future in which increasing prosperity is shared throughout society, not who try to reverse the irreversible tide on globalization and technology. I don’t know who they will be, but I would certainly filter them based on their embrace of a better future and whether their optimism is anchored in reality.

The jury is still out on Emanuel Macron in France. Who knows how long Pete Buttigeig’s time in the sun will last in America. But their approach – eschewing partisan labels, being relentlessly positive, and focusing on actionable solutions – seems directionally correct to me. Certainly more promising than Boris Johnson’s Trump 2.0 plan for Britain.

Crisis is a wildly over-used term. But I join the many who believe today’s capitalist democracy is in crisis. The way ahead is to go forward, not to look back. Left-right partisan politics can no longer be looked to for solutions. Our political paradigm must transform before our economic challenges can be met and society can heal.