The Bear’s Lair: The flat world that never happened

Thomas Friedman’s 2005 “The World is Flat” postulated a world growing ever closer together, with diminishing barriers both trade and political and a gradual move towards at least elements of world government. With all due respect to Mr. Friedman, this never happened, and does not appear likely to. The questions that arise are: Why not? and Where are we going instead?

“The World is Flat” appeared plausible in the decade after 2005, which is all you can ask a successful book to do, but it was always based on an illusion. After the collapse of Communism in 1991, it had appeared that there were no major divisions between the world’s major powers, so one could envisage the world converging on a kind of lowest-common-denominator social democracy (one could envisage the world converging on truly free capitalism as well, but only if one were completely delusional!)

If the world’s major powers were indeed converging on social democracy, then there would seem little reason why their economies should not converge as well. The “Washington Consensus” a kind of social democrat version of the free market with supposedly benign governments guiding the market so that everybody got gradually richer, could in the Friedman view gradually allow the world to “globalize” with no trade barriers, benignly run large corporations with good governance managing the economy, under the overall control of benign governments, who would set the “ground rules” by international consensus. Living standards would converge worldwide, and over time more and more of the functions of government could be taken over by international bodies, theoretically selected by national governments, but staffed with all-knowing, benign bureaucrats.

For anyone who believes in individual freedom, it was a ghastly prospect. It was also completely contrary to human nature, not allowing at all for the human failings of the Platonic guardians who ran the international bureaucracies. But New York Times writers like Friedman don’t believe in freedom and have very little understanding of human nature.

Make no mistake, there are still powerful forces pushing us towards this dystopia. Google and Facebook, for example, are near-monopolies in their spheres, and their management appears infected with the Thomas Friedman way of thinking. Since their worldview offers no place for dissent from itself, those companies will continue doing everything in their power to prevent contrary voices from emerging. They are instruments of a failed globalist police state, just as the labor camps were instruments of the Soviet tyranny.

Globalization would have stopped expanding within a decade of the fall of Communism had it not been artificially supported by funny money. Interest rates held for decades far below the natural cost of capital artificially flattened the natural differential in cost of capital between capital rich Western states and capital poor Third World countries, including most notably China.

With Communism gone, and global communications revolutionarily improved by the twin inventions of cellphones and the Internet, there was bound to be a lengthy period of profit for Western multinationals from constructing global supply chains, that take advantage of cheap labor in Third World countries and supply final products to rich Western consumers. However, over the last twenty years, ultra-low interest rates have hugely reduced the capital cost of that $1 billion factory in Vietnam, or that assembly shop employing 300,000 serfs in China. Before 1995, those facilities would have cost real money to build in interest and risk equity capital. With low interest rates, their cost was magically reduced almost to zero in terms of the annual bottom line.

With decades of ultra-low interest rates, the volume of cost-marginal outsourcing has been increased and the period during which modern telecoms made it artificially profitable has been artificially extended. Now however the plague of artificially low interest rates is finally coming to an end, and the true costs of these gigantic Third World facilities and extended supply chains are appearing. The result will be the bursting of the outsourcing bubble.

As this column has noted several times, ultra-low interest rates impose huge costs on those economies that employ them. Over time, holding interest rates far below their natural level sends a heavily distorted price signal to all capital investment decisions. This results in a plethora of spurious real estate investments, a plague of stock buybacks that decapitalize major corporations, a blizzard of spurious private equity investments in companies such as Uber and Lyft that have no hope of making money, a tsunami of ill-thought-out buyout deals, etc. The result is a disappearance in productivity growth, which becomes more severe as ultra-low interest rates continue. In addition, good manufacturing jobs are outsourced to the Third World, while wealth flows only to the ultra-rich, who can borrow more cheaply. (President Trump reported large tax losses in 1985-94 when interest rates on his real estate borrowings were high and came close to bankruptcy; I bet he doesn’t declare large losses now. Naturally he favors foolishly low interest rates, he can’t help it.)

The result of Western economies with zero productivity growth and hence zero real wage and economic growth, wealth being sucked into the ultra-rich through asset price inflation and manufacturing jobs disappearing through outsourcing is a seriously disgruntled electorate, and rightly so. Provided democratic mechanisms work properly, this situation is thus unstable. Electorates do not know enough Austrian economics to demand higher interest rates, so they demand tariffs and immigration controls. Only where democratic forces do not work properly, notably in the European Union, are these demands ineffective.

At the other end of the world, also, globalization becomes after a time self-correcting. As the living standards of Third World workers increase, their demands for reasonable working conditions increase also, and so the costs of employing them spirals out of control. Even with low capital costs, companies that have set up large manufacturing facilities in China have found the profitability of those facilities sharply declining. In addition, it proves impossible to ring-fence the intellectual property of the outsourcing company, or the know-how of its local employees, so the pure outsourcing strategy quickly leaks know-how. That produces new Third World domiciled competitors for the outsourcers, whose profitability and market presence collapses. Slick financial engineering can disguise this for a time, but only for a time.

With the profitability of outsourcing declining, and Western electorates demanding protectionism, the globalist Nirvana disappears quite quickly, never to reappear. Relations between the rich-world and poor-world governments deteriorate, so military forces, which had been allowed to run down, get rebuilt. Tariff barriers are raised, and globalist strategies become distinctly inferior, politically as well as economically.

The re-emerging military itself plays a role in the political collapse of globalization. It naturally wishes to protect its own position, so the emergence of global government structures is deeply unattractive to it. Its participants are in any case naturally nationalist and protectionist; their increasing power increases those forces in both Western and emerging market governments. Thus, the re-emerging military pushes politically in the same direction as the collapse of globalization is pushing economically.

For the global elite left, and their friends at Google and Facebook, this is all very unattractive. The globalized structure is being atomized into national economies once again, and the political supranational forces are losing power. Google and Facebook can no longer enforce their global monopolies in the information arena, while the additional opportunities for elite over-educated leftists at international organizations are declining; indeed those organizations are being de-funded and losing their legitimacy. Economically, large multinational companies are losing their exceptional profitability while those polities that keep interest rates artificially low are faced with a resurgence of inflation, forcing interest rates finally upwards.

Individual governments are forced by higher interest rates and tighter capital market conditions to run more closely balanced budgets; the sloppiness of the Obama years is no longer possible. However, there is a welcome new source of revenues available, from the rapidly increasing tariffs, which cause a flood of revenues into the Treasury, just in time to pay for the increasing military expenditures and to avoid raising taxes on ordinary citizens. Even so, there is a new spirit of careful budgeting in the world’s governments, that causes such subsidies to the rich and useless as the U.S. charitable tax deduction to be sharply cut back.

For the cognitive elite and the very rich, the disappearance of globalization is a nightmare. For those of the elite without money, the job-opportunities in ever-expanding international bureaucracies and their armies of lobbyists are sharply cut back. For the ultra-rich, asset prices collapse and debts must be repaid.

Collapsing also are the possibilities of enforcing politically correct speech codes. With Google and Facebook no longer global monopolies, national and local successors to them grow up, in which expressions of national pride and localist, even ethnic chauvinism are entirely acceptable. Of course, the New York Times and its online equivalents do not go out of business – there is still a market for its comfortable globalist quasi-socialist platitudes, and Thomas Friedman will never be short of a buck. But blue-collar self-expression, like blue-collar living standards, is once again on the rise, and the freedom of a protectionist world of multitudes of competing polities and companies, with strong militaries, will ensure that the globalist nightmare will stay dead.

(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.)