Negative earnings surprises by Pfizer and Caterpillar at the end of last week may indicate a new reality: the income premium for bring a Westerner and having access to the centuries of Western intellectual property and business acumen may be sharply diminishing. We can all rejoice as poor and middle income countries are brought up to Western levels of affluence, but our rejoicing will presumably be sharply diminished if we come to realize that much of their gains may be at the expense of our children’s living standards.

The vision of the world of 2050 or 2100, in which the great majority of Third World peoples enjoy more or less Western living standards, has always been a but fuzzy. Thirty years ago, if you had asked people to imagine the world of 2050, all but the most manically environmentalist would have envisaged Third World residents enjoying living standards comparable to those of current Westerners, while the affluent West had reached living standards that could currently be dreamed of only by an affluent few.

The more thoughtful would have recognized that there was simply not enough space for the squirearchical dream of robot servants for all, together with country houses and rolling parklands. However the 18th century customers of Capability Brown didn’t enjoy modern plumbing, found travel impossibly time-consuming and uncomfortable, and had a nasty tendency to die in childbirth at 30 or of flying gout at 50. 2100’s median Western real income of $250,000 or so would have to be spent differently, but the income itself seemed pretty assured, given the continuance of technological development.

That is no longer the case. Elite opinion remains wedded to globalization as the best of possible economic policies, and believes with fanatical devotion that David Ricardo’s Doctrine of Comparative Advantage will ensure that there will be no significant class of people, even in rich countries, who lose out because of it. However it is becoming increasingly obvious to the populace as a whole that globalization produces substantial numbers of losers, particularly among the less well educated inhabitants of Western countries. No amount of cheaper consumer goods will assuage your pain if you have been forced to exchange a $25 an hour factory job for a $8 an hour service job.

I have discussed previously the effect of outsourcing and international migration on living standards at the bottom of the scale. Here I want to examine the extent that the advantages which have traditionally kept Western countries affluent — in particular those of financial capital, intellectual capital and a near-monopoly on innovation — are all losing their power to differentiate living standards.

The period of monetary expansion since 1995 has reduced both interest rates and risk premiums on emerging market investments. This has caused a huge reorientation in the world financial markets, albeit so far of a very comfortable type. The lack of credit discrimination in world bond markets, for example, is shown by the total lack of emerging market defaults since Argentina in 2001-02. Capital has become more readily available for emerging markets, narrowing their traditional capital cost disadvantage against Western countries and speeding the process of outsourcing and resource transfer to cheap-labor environments.

If this were all that had happened, it would be a purely temporary phenomenon. Once monetary policy was finally tightened and interest rates rose, risk premiums would reappear and the flow of resources to emerging markets would be correspondingly slowed. However, on the savings side, very low interest rates and continued asset price inflation have depressed savings rates in Western countries far below their historical norms. This has caused not only an excess in consumption but also in the United States a persistent and very large payments deficit that has transformed the country as a whole into the world’s largest debtor.

This is much more serious. Once interest rates rise again, the US and much of Europe will find themselves in a major savings deficit position, having run down their savings through consumption and devoted excessive amounts of capital to unproductive investments such as luxury housing. Asset prices will decline, causing bankruptcy among those consumers who have over-borrowed on mortgages and credit cards, and the world’s capital stock will be found largely concentrated in Asian countries such as China, Taiwan, and (because of high oil prices) the Middle East, where savings rates have remained robust.

At that point, the wealth of the West will no longer be an advantage to it in the search for resources. Instead the major Asian countries will have the lowest real interest rates and capital will flow to projects in those countries, which will offer the prospect of the greatest net returns. The imagined nightmare of the late 1980s, in which Japan’s lower capital costs were thought likely to transfer much of the West’s industrial base to Tokyo, will be played out in reality on a much larger scale with respect to East Asia as a whole. With lower capital investment and higher financing costs, the West’s living standards will inevitably enter relative decline.

Intellectual property is a second area where the value of the West’s assets is declining. As globalization intensified in the 1990s, the major Western media, IT and pharmaceutical companies saw it as an opportunity. Poor countries could only be expected to buy modest quantities of US software, media products and drugs, and would operate active black markets to keep prices low. However countries that were becoming richer, and exporting their products to the West, could be compelled to enforce intellectual property rights, raising the domestic prices of software, media products and pharmaceuticals to world levels. US IP owners imposed a draconian new US copyright regime in 1998, they ensured that the World Trade Organization’s membership rules included protection of intellectual property, and they pushed for a further extension of Western intellectual property rights via the Doha round of trade talks.

This effort is now coming unstuck. The widespread adoption of broadband technology and high-level cellphones has increased the means by which media products can be reproduced to such a point that it appears unlikely that rights owners can protect their property adequately, except to a limited extent in their domestic markets. The slowing rate of innovation hardware has made “open source” software much more competitive with copyright software, so that the Linux operating system now has a world market share of 15% and the Firefox browser a market share of 25%. The Doha round of trade talks has collapsed, as dying Western farming industries proved themselves more politically powerful than soaring Western IP owning industries.

Probably most important in terms of long term value, two changes have weakened the hold of the major pharmaceutical companies on the patent system. First, new competitors have arisen in emerging markets, and their research capabilities have become comparable to those of the drug majors. Thus in any third country in which property rights are weak, drug buyers will quickly have a credible alternative to patented drugs, manufactured outside the magic circle of the major Western drug companies. Second, drug research itself is changing. Many of the new drugs invented in the future will be designed through gene manipulation, and will be effective only for patients with the appropriate genetic markers. With more new drugs being invented and smaller potential markets for each one, the patented “blockbuster” drug is likely to disappear, and Third World drug manufacturers with lower research and manufacturing costs will prove themselves highly competitive against the majors.

Intellectual property isn’t just a mechanism to reward the likes of Time Warner, Microsoft and Pfizer, it is the principal barrier to entry protecting millions of highly paid skilled workers in Western countries. If that barrier disappears, and those workers are subjected to competition from countries with much lower labor costs, their living standards must inevitably decline.

Finally, the West has lost its near-monopoly on innovation. Knowledge, capital and entrepreneurial skill are much more broadly shared globally than was the case in the past, so a much higher share of innovation, in the form both of new products and new ideas, will come from non-traditional sources. This is important; innovative products and services, by definition, face limited competition in their earlier years and so can bear higher prices than would be the case if their provision were fully competitive. Again, not only will Western entrepreneurs find returns lower and commoditization faster than was previously the case, but the returns to higher education will also decline, as a PhD from Harvard will prove to be worth little more than a PhD from Kolkata.

Westerners have always supposed that a free-market regime and high levels of international trade will allow the world’s economic growth to accelerate, providing higher living standards not only for the newly enfranchised citizens of emerging markets, but also for Westerners themselves. There is in reality no reason why this should necessarily be the case. If the West’s advantages of capital, intellectual property and near-monopoly on innovation are dissipated more rapidly than global growth enriches the planet as a whole, then the West’s share of global wealth will decline more quickly than global wealth itself increases. The result will be declining Western living standards, likely to be a major feature of the next generation’s economic changes.

There are no solutions to this problem, whose causes have been mostly a decade of cheap money and the communications revolution of cellphones and the Internet, together with technological changes reducing the salience of intellectual property. However, there are palliatives. Tight money, imposed as quickly as possible, will preserve the remainder of the West’s capital stock and begin the lengthy process of rebuilding it. Increased resources to education will indeed produce a more highly skilled workforce, which will be able to command higher remuneration. A tax system heavily weighted towards taxes on consumption will increase savings rates. Restricting immigration will preserve as far as possible the living standards of those engaged in the vast personal service sector – a barber in Bangalore is paid less than in Boston – thus providing adequate opportunities for those unable to benefit from the highest levels of education.

Above all, steps should be taken to reduce the level of population growth, particularly in the poorest countries. In a market that is becoming increasingly global, only by reducing the supply of undifferentiated labor will it be possible to maintain its price. A more modestly growing African population will allow Africa to enter more quickly into the joys of rapid economic growth, and will lessen the disruption to the rich West from it doing so.

By speeding the rate of global growth, while at the same time reducing the rate by which the West’s share of the world’s income is reduced, policymakers can ensure that the decline in Western living standards from globalization is moderate, and hasten the day when the entire world is close to Western living standards, so that the free market of ideas, products and services increases the wealth of all.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)