Adapting to a Fast-Forward World

The world is going through a period of accelerating change, as four secular developments illustrate. Firms and governments must make timely adjustments, not only to their business models and operational approaches, but also to both their tactical and strategic mindsets.

Mohamed A. El-Erian

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LONDON – Firms and governments must increasingly internalize the possibility – indeed, I would argue, the overwhelming probability – of an acceleration of four secular developments that influence what business and political leaders do and how they do it.

Decision-makers should think of these trends as waves, which, especially if they occur simultaneously, could feel like a tsunami for those who fail to adapt their thinking and practices in a timely manner.

The first and most important trend is climate change, which has evolved from a relatively distant concern, on which there is ample time to take remedial action, to an imminent and increasingly urgent threat.

The mobilization of various concerned segments of society, owing partly to unusual climatic disruptions in recent years, has greatly increased the pressure on companies to act now. BP’s recent announcement that it intends to achieve “net-zero” carbon emissions by 2050 – a notable promise by an energy company that operates in several highly challenging settings – is the latest example of business responding to such calls.

It is only a matter of time until this pressure also prompts governments to take further steps, not only to encourage green activities, but also to tax and regulate those that cause pollution.

Second, privacy concerns have grown alongside technical innovations involving artificial intelligence and big data.

Society is increasingly recognizing that recent technological advances allow not only for more efficient compilation of huge amounts of personal data, but also for using this information to monitor and alter behaviors.

Broadly speaking, data are controlled and exploited either by governments (particularly in China), Big Tech companies (as in the United States), or more by users (as in Europe).

But none of these three general operating paradigms seems to provide sufficient comfort and assurance to most people.

The third secular force involves disruptions to the multi-decade process of economic and financial globalization.

The initial trigger for this was the trade-policy pivot by US President Donald Trump’s administration – from cooperative conflict resolution to explicit confrontation, from multilateralism to bilateralism (or even unilateralism), and from rule-based to more ad hoc arrangements – aimed at creating a still-free but fairer trading system.

But de-globalization has been turbocharged by the outbreak of the deadly COVID-19 virus, which has disrupted the flow of goods and services in China and beyond.

These challenges to globalization have opened the door for governments to weaponize economic tools to meet objectives that transcend economics, such as national security. This, in turn, is calling into question conventional wisdom about cross-border supply chains, just-in-time inventory management, and reliance on external demand to boost domestic growth.

The final trend is demographic and concerns more than the aging of societies in Europe and Asia and this trend’s economic and political implications. It also goes beyond the growing realization that millennials’ starkly different expectations – regarding professional careers, personal engagement, political action, and the delivery of goods and services – will persist and deepen.

For starters, businesses need to be smarter about “anywhere, any place, any time” delivery.

Furthermore, job loyalty and tenure are decreasing, while expectations of comprehensive job fulfillment and engagement are rising. Self-mobilization for political and other causes, often with no visible leadership structure, has become a lot easier, yet often is less durable and raises tricky questions about what comes afterward. And all of this is taking place amid the continued migration of an ever-expanding range of interactions from physical to virtual spaces.

Each of these secular forces will have an important impact on the effectiveness and success of companies and governments alike. And while being challenging overall, the four trends involve a diverse and geographically dispersed set of winners and losers. Executives and policymakers therefore must make timely revisions (including pre-emptive changes) not only to their business models and operational approaches, but also to both their tactical and strategic mindsets.

Getting this right will require cognitive diversity, openness to constructive criticism, repeated scenario analyses, and multi-disciplinary approaches. Moreover, because each of the secular forces involves a considerable degree of uncertainty (with lots of known unknowns, and probably more than a few unknown unknowns behind them), a combination of resilience, optionality, and agility also is important. And this is even before one considers unanticipated periodic shocks such as the COVID-19 outbreak.

The challenges to sound decision-making and leadership in both business and government are not limited to mapping each of the four secular forces and the required adaptation. Decision-makers also must consider correlations and causalities between these trends that can make their total impact multiplicative rather than merely additive.

As a quick illustration, consider another aspect of demographic change: migration and the humanitarian challenges that often come with it. Climate change confronts countries with the possibility of waves of migratory human flows that they will find hard to accept and inhumane to refuse.

The combination of de-globalization and the misuse of AI and big data to infringe individual privacy is similarly troubling. This could lead to questionable behavior by some governments and encourage malicious non-state actors to disrupt societies and economies.

The world is in a period of accelerating change, the leading edge of which is the ever-growing list of developments that have gone from impossible to inevitable. Many (though by no means all) of the challenges facing business and political leaders may be broken down into four secular changes that can help anchor the timely formulation of required responses at the local, national, regional, and global levels.

The faster that companies and governments recognize this, the likelier they will be to alter the balance of benefits, costs, and risks in their favor.

Mohamed A. El-Erian, Chief Economic Adviser at Allianz, the corporate parent of PIMCO where he served as CEO and co-Chief Investment Officer, was Chairman of US President Barack Obama’s Global Development Council. He is President Elect of Queens’ College (Cambridge University), senior adviser at Gramercy, and Part-time Practice Professor at the Wharton School at the University of Pennsylvania. He previously served as CEO of the Harvard Management Company and Deputy Director at the International Monetary Fund. He was named one of Foreign Policy’s Top 100 Global Thinkers four years running. He is the author, most recently, of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse.

Locked down

China’s coronavirus semi-quarantine will hurt the global economy

It may affect industries from tourism to plastic flowers

THE YU GARDEN, a 16th-century complex of pavilions and ponds in the heart of Shanghai, is all gussied up for the Chinese new-year holiday. Its walkways are bedecked with colourful lanterns, its stalls laden with dumplings, its entrances flanked by dozens of security guards to handle crowds. Just one thing is missing: people.

Fearful of coronavirus, they are staying home. “I’ll be doing well if I make a few sales today,” says Li Xinming, manager of a silk-scarf shop. Last year Yu Garden attracted 700,000 visitors during the holiday week, peak season for it and its merchants. This year, Mr Li says his losses might wipe out his earnings for months to come.

The question for China, and for the many companies and countries around the world linked to its economy, is whether Mr Li’s travails are indicative of a much broader problem. The obvious reference point is China’s battle with SARS, another coronavirus, in 2003.

Growth slowed sharply at the height of the epidemic but rebounded swiftly after it was contained. Other recent epidemics have reinforced the impression that economists should not be overly worried, so long as good doctors are on the job. Neither avian flu in 2006 nor swine flu in 2009 dimmed the global Outlook.

Yet even flint-hearted investors are wondering whether the new epidemic might be worse. Stocks in Hong Kong have fallen by more than 5% as reported infections have steadily increased. Tremors have also rippled through global markets.

The concern is less the severity of the virus, which seems less lethal than SARS, but rather the nature and potential duration of China’s efforts to bring the outbreak under control. And disruption in China, the world’s second-biggest economy, has global consequences. “It’s not the disease, it’s the treatment,” wrote analysts with Gavekal Dragonomics, a consultancy.

The World Bank has estimated that as much as 90% of the economic damage from epidemics stems from people’s fear of associating with others, which leads offices and stores to close. In China, this is being magnified by the government’s policy of isolating affected areas and limiting interpersonal contact throughout the country. While public-health experts debate whether this is the right approach, economists will count the costs.

The most direct impact is being felt in Hubei province. First Wuhan, its capital, was placed under quarantine. Then the rest of the province, home to 59m people, was locked down, too. Apart from food trucks and medical supplies, little can enter its cities and villages, and few are permitted to leave. Such a large-scale isolation is unprecedented as a public-health strategy. Economic activity of just about any kind, short of hospital care and movie streaming, has ground to a halt. Hubei generates 4.5% of China’s GDP, so the closure will leave a hole.

Other cities in China may not be under quarantine but that is what life feels like for their residents. Instead of getting together with family and friends, attending temple fairs and going to restaurants—all, depending on where one lives, staples of the holiday—people have shut themselves in. The government has encouraged them to avoid crowds; many need little prodding.

That will be a drag on consumption. The extent of the damage will depend on how long it takes to stop the virus, but the timing is already rotten. Last year retail sales topped 1trn ($144bn) yuan during the new-year week, a third more than an average week. This year, sales are sure to fall well short of that.

Some industries are being hit especially hard. The holiday accounted for 9% of China’s box-office revenues last year. This year almost all of the country’s 11,000 cinemas are closed. Spending on domestic tourism during the new-year week reached more than 500bn yuan last year, about 8% of the annual total. This year, fearful of the virus, people have cancelled trips.

There are also worries about how the virus will affect factories and offices. Several major economic centres, including Shanghai and Guangdong province, have extended the new-year holiday by a week, telling companies to wait until February 10th to restart. Chinese businesses are always slow to get back up to speed after the holiday.

The extra week will make them slower, even if some firms such as Tencent, a tech giant, let employees work from home. Moreover, tens of millions of migrant workers, back in their hometowns for the holiday, may wait for the epidemic to recede before crowding onto trains and buses to return to their jobs.

I feel your pain

One crucial difference compared with SARS is China’s importance for the rest of the world. In 2003 China generated 4% of global GDP. Last year, it was 16%. The slowdown in consumption and the disruption to production will not stop at its borders.

Countries accustomed to big-spending throngs of Chinese tourists face a brutal stretch. China’s government has ordered all tour groups to be suspended until the virus is contained. In Thailand, authorities expect the number of Chinese visitors will fall by 2m to 9m this year, reducing tourism revenue by some $1.5bn. Share prices of airlines have plunged; past epidemics have caused huge, if temporary, drops in passenger traffic, and China is the world’s biggest outbound international travel market.

Companies that have hitched themselves to China’s fast-growing middle class are also vulnerable. Starbucks has temporarily closed more than half of its 4,292 cafés in China.

Footfall in those still open is scarce, with some posting signs that patrons may only enter if they are wearing face masks. Sales of masks are, indeed, a rare bright spot for companies such as 3M. Disney closed its resort in Shanghai for the new-year holiday, one of its busiest weeks of the year (adding insult to injury, China has just entered the Year of the Rat and the Chinese term for rats also refers to mice, a fine marketing opportunity for a brand built around them).

The closure of factories will cascade through the global economy. Wuhan itself is a manufacturing hub, especially for the auto industry. Nissan, Honda and General Motors, among others, have plants there. Bloomberg ranks Wuhan 13th out of 2,000 Chinese cities for its role in supply chains. One local company, Yangtze Optical Fibre and Cable, is the world’s biggest maker of the wires that carry data around the planet.

Even if the work stoppages elsewhere are milder, they, too, will be a risk for a wide range of sectors. Some are vitally important; roughly 80% of active ingredients for all medicines come from China. Others are less so; China supplies nearly 90% of the world’s plastic flowers.

Many companies were already working to reduce their reliance on China’s factories because of its trade war with America. The virus is a powerful reminder that, politics aside, a diversified base of suppliers is a good insurance policy. But the past year provided a lesson in how difficult that is; despite the tension with America, China’s share of global exports actually increased. Companies will struggle to find substitutes for its manufacturing muscle.

Adding it all up, the Chinese economy is in for a grim start to the Year of the Rat, and this will cast a shadow globally. Chen Long of Plenum, a consultancy, thinks China’s growth could slouch to 2% year-on-year in the first quarter, its weakest in decades, down from 6% in the final quarter of 2019.

But he expects a strong rebound when the country gets back to normal. People long cooped up will flock to shops and restaurants. Factories will rush to make up for lost time. To give the recovery a push, officials will increase infrastructure spending.

The unknown is when normality might resume. In Yu Gardens, Mr Li could not wait. With business way down, he has told the three assistants in his silk-scarf shop to stay home, unpaid—typical for small businesses in China. The death toll from the coronavirus remains mercifully low. But the whole country is paying a Price.

Central banks are swimming against the tide on inflation

If they are serious about their mandates, the Fed and ECB should consider other strategies

Megan Greene

IMF Director Christine Lagarde (L) speaks with US Chairman of the Federal Reserve Jerome Powell during the family picture of the G20 Finance Ministers and Central Bank Governors meeting in Buenos Aires, on July 21, 2018. - Global trade conflicts triggered by the protectionist policies of US President Donald Trump are set to dominate this weekend's meeting of Group of 20 finance ministers in Buenos Aires. (Photo by EITAN ABRAMOVICH / AFP) (Photo credit should read EITAN ABRAMOVICH/AFP via Getty Images)
Christine Lagarde, now ECB president, with Fed chairman Jay Powell during the G20 meeting in Buenos Aires in 2018, when she was IMF managing director © Eitan Abramovich/AFP/Getty

The policy framework reviews under way at the Federal Reserve and now the European Central Bank are the monetary equivalent of swimming upstream: a lot of energy will be expended, but they won’t really get anywhere. To the extent that these reviews continue to focus on tweaking inflation targets as a strategy, they will be largely pointless.

The Fed and the ECB have been clear that it is not their mandates that are in question, but how to fulfil them. The prevailing strategy has been to set an explicit target for inflation. The idea is that this builds credibility with markets and consumers, who will then know what inflation is likely to be over the medium to long term. This worked when inflation was high and variable.

But now we have the opposite problem. Since 2009, the Fed’s favourite measure of inflation, the personal consumption expenditures price index, has averaged 1.5 per cent, well below the 2 per cent target. The ECB has fared even worse, with its favourite measure, the Harmonised Index of Consumer Prices, averaging only 1.3 per cent over the decade. (The ECB target is “close to, but below, 2 per cent”).

Stubbornly low inflation pulls benchmark interest rates down, giving a central bank less ammunition to fight future recessions. And persistently failing to hit an inflation target undermines a central bank’s credibility.

Inflation targeting can also result in counterproductive monetary policy in the face of supply side shocks, such as oil price spikes or jumps in productivity. Nevertheless, both the Fed and the ECB seem determined to stick with some variation of inflation targeting. The Fed has said it will not change its 2 per cent target. The other options it is deliberating appear to be price-level targeting and average inflation targeting.

The ECB, which has only just started its review, has made no commitment to its target. But according to a Bloomberg survey of economists, nearly 90 per cent expect any new strategy to enable the central bank to under- and overshoot an inflation goal.

Obliging a central bank to overshoot on inflation after undershooting lacks credibility given that central banks have persistently failed to hit their targets for the past decade. If they are serious about achieving their mandates more effectively, the Fed and ECB should consider other strategies.

One has been circulating for decades: target the sum of inflation and total real output, or nominal gross domestic product. With NGDP targeting, a central bank automatically lowers rates as output falls, to push up inflation. That eases real debt burdens and lowers real interest rates, helping to generate growth. As output rises, rates adjust higher to bring inflation down and maintain the target.

A potential obstacle is that NGDP is reported quarterly, with a lag. But NGDP could be reported more frequently and accurately if the Fed treated it as a priority. The Fed could also target the forecast of NGDP instead, which is reported in the monthly blue-chip economic indicators survey of business economists.

Another strategy is yield curve control, employed by the Bank of Japan. If growth and inflation are weak, the central bank can peg rates low, reducing borrowing costs, raising stock prices and weakening the currency.

Consumption and investment rise, boosting growth and inflation. If investors believe the central bank is determined to maintain the peg, it can achieve this without buying up many assets. But if investors are sceptical, the central bank is forced to expand its balance sheet or lose credibility.

There are no silver bullets. And this shouldn’t be just a public relations exercise. The Fed and ECB should think boldly about alternative approaches.

The writer is a senior fellow at Harvard Kennedy School

What the Middle East Peace Plan Really Means

By: Caroline Rose

The “Deal of the Century,” the name the Trump administration has given the Middle East peace plan released yesterday, is historically significant – just not for the reasons you’d think.

Territorially, it wouldn’t change much for Israel and the Palestinian Territories; it lets Israel retain most of the land it currently controls, keeping a third of the West Bank for itself, while conceding very little to the Palestinians, who have already enthusiastically rejected the proposal.

No, the Deal of the Century is remarkable for the overwhelming support it has among Gulf Arab states. Saudi Arabia, the United Arab Emirates, Egypt, Bahrain, Qatar and Morocco have all endorsed the proposal, though they have offered nothing specific about what they would do to see it through.

Still, their collective rush to champion the deal is notable for what the breach between Arab Gulf states and the Palestinian Authority signifies: the new geopolitical reality emerging in the Middle East, one arrayed against the actions of Turkey and Iran.

The Israeli-Palestinian conflict has defined the battle lines and the foreign policies of Sunni Arab states for more than half a century. Siding with the Palestinian cause and opposing Israeli aggression was a policy fixture of Arab countries, particularly of Egypt, which led the pan-Arab movement in the mid-20th century. Arab support in this regard was formalized in the Arab League, the Palestinian National Council and, later, the Palestine Liberation Organization.

The Palestinians relied on Arab funds and weaponry in their intifadas and, in some cases, multilateral intervention in the face of Israeli military action. Even after Arab states began to engage in limited cooperation with Israel, they still rhetorically advocated for Palestine. But over the past few years, Israel and Arab Gulf countries have found more common ground on matters of mutual interest, which means the unconditional backing of Palestine is coming to an end.

The alliance between Gulf states and Israel had been developing over the past 20 or so years, as evidenced by informal intelligence-sharing and limited security cooperation over terrorist threats and Iranian proxies, but the new sense of urgency reflects the Arab Gulf’s growing fears over the rise of Turkey and Iran and the need to confront both with a united front.

Put simply, the expansion of Iranian influence has become the security priority to which all other foreign policy issues take a back seat. The same could be said in response to Turkey, which has been aggressively advancing its interests in Syria and the Eastern Mediterranean.

Unsurprisingly, Iran and Turkey, neither of which are Arab, have been the loudest voices outside the Palestinian Territories that oppose the Trump administration’s peace deal.
In that sense, the “Deal of the Century” is not about an Israel-Palestine peace; it’s about reconfiguring the alliance structure of the Middle East.

Sunni Arab countries are beginning to pivot from foreign policies grounded in post-WWI realities and nationalisms stemming from 20th-century colonial mandates that defined the regional balance of power. Now they are becoming more visible in redefining regional geopolitics and aligning with former adversaries, grounded in new, emerging security threats.

Re-Engineering China’s Economy

The recent “phase one” trade deal between the United States and China does not resolve core outstanding bilateral issues, and the two countries’ strategic rivalry will likely intensify in the medium to long term. But the accord gives China’s leaders a new opportunity to develop better and more open domestic markets.

Andrew Sheng , Xiao Geng

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HONG KONG – On January 15, US President Donald Trump and Chinese Vice Premier Liu He signed a “phase one” agreement aimed at containing the two countries’ long-running bilateral trade war.

But no sooner had the deal been concluded than China was confronted with an emergency in the form of the deadly coronavirus outbreak in Wuhan.

These recent developments indicate that China is still struggling with what the father of the country’s nuclear program, Qian Xuesen, called in an influential 1993 paper an “open complex giant system” issue.

Qian, a leading student of systems engineering, argued that because human brains have one trillion interacting neural cells, individual humans are themselves open complex giant systems that are open to complex material, energy, and informational exchanges with other humans.

Likewise, a social system is a macroscopic open giant system that interacts with other social systems, and thus is too complex for any computer to model.

Indeed, any systems engineering aimed at civilizational development would have to address even more complex material, political, and spiritual aspects of transformation and interaction that are not reducible to quantitative terms.

The only solution, therefore, is a process of qualitative analysis followed by rigorous and reiterative testing against empirical facts until different paths or policy options are found – or, as Deng Xiaoping famously said, “crossing the river by feeling the stones.”

Qian’s analysis was far-sighted. “All this shows that the one-track mind and piecemeal reform just does not work,” he wrote. “Reform needs overall analysis, overall design, overall coordination, and [an] overall plan. This is the realistic significance of […] social systems engineering to the reform and opening policy in China.”

In a recent blog post on how to reform the United Kingdom’s civil service, Dominic Cummings, an adviser to British Prime Minister Boris Johnson, cited Qian’s observation that social systems engineering must be deeply integrated into Chinese national planning.

“If you want to change Whitehall from 1) ‘failure is normal’ to 2) ‘align incentives with predictive accuracy, operational excellence, and high performance,’” Cummings wrote, “then systems management provides an extremely valuable anti-checklist for Whitehall.”

From Beijing and Whitehall to Brussels and Washington, policymakers are struggling with problems – such as climate change, inequality, and technological and ideological rivalry – that seemingly defy simple solutions. They are thus buying time, which may be sub-optimal for the world as a whole.

For example, the “phase one” US-China trade deal does not resolve core outstanding issues such as the persistent bilateral trade imbalance, fair competition in technology and related sectors, and deep and comprehensive institutional and governance reforms. Moreover, the two countries’ strategic rivalry will likely intensify in the medium to long term. But the accord does give China’s leaders a new opportunity to develop better and more open domestic markets.

For starters, China’s commitment under the agreement to stabilize the renminbi’s exchange rate and open up its financial-services sector recalls the 1999-2005 period, when a stable exchange rate anchored important reforms. (This period ended – and the reforms subsequently stalled – when the renminbi was allowed to float after July 2005.)

Moreover, China needs a period of stable trade and economic relations with the US in order to tackle the growing systemic risks of rising debt, declining public and private investment, housing-market imbalances, and weak technological innovation. The recent deal (if it holds) gives the authorities two years to continue transforming China into a modern market economy in a way that would benefit both its own citizens and the international community.

Further clarifying and distinguishing the respective roles of the state and the market will be key to this transformation. China’s leaders recognize the usefulness of relying on the market as the dominant mechanism for allocating resources, but also emphasize the state’s essential role in providing public goods such as national security, hard and soft infrastructure, and social-security programs, including timely responses to public-health hazards such as the coronavirus outbreak.

China’s central and local governments therefore must harness the rapid growth of markets, private businesses, and information technology to work off the deadweight loss of non-performing loans and excess capacity in obsolete industries – the result of misguided, poorly designed, or outdated policies and regulations. If these efforts succeed, the newly released resources could be deployed to encourage local and national technology innovation, thereby creating new jobs and green products and services.

Clearing out the deadwood in China’s economy will be critical, and central and local governments’ role in allocating losses is vital to controlling systemic risks. Deadweight losses are sunk costs and should not affect investments that are essential to making future growth and development more sustainable.

Moving financial and real resources from low- to high-productivity projects would deepen the financial system and make it more efficient (with much lower interest rates), thereby creating more open, transparent, and market-oriented conditions for development.

Qian’s systems-engineering approach to reform suggests that boosting energy efficiency and producing more green products and services would enable China to make a major contribution to global public goods and reduce its dependence on imported energy.

By linking water, energy, health, and social aspirations within a material, political, and spiritual/civilizational systems approach, China would become less confrontational and competitive vis-à-vis the rest of world and more focused on forging mutually respectful relationships that do not threaten other countries’ national security.

Although China’s strategic options in addressing major global challenges are essentially similar to those of many other states, the country’s scale and unique complexities set it apart. In particular, the size of China and America’s combined carbon footprint means that the recent bilateral trade truce is crucial to the world’s chances of tackling the existential threat posed by global warming.

That threat is rising at a time when slower global growth and increasing social unrest – in part triggered by climate change and natural disasters – are being exacerbated by failing governance. The phase one trade deal will not end great-power rivalry between the US and China, but it could help prevent that rivalry from destroying the planet.

Andrew Sheng, Distinguished Fellow of the Asia Global Institute at the University of Hong Kong and a member of the UNEP Advisory Council on Sustainable Finance, is a former chairman of the Hong Kong Securities and Futures Commission. His latest book is From Asian to Global Financial Crisis.

Xiao Geng, President of the Hong Kong Institution for International Finance, is a professor and Director of the Research Institute of Maritime Silk-Road at Peking University HSBC Business School.