Death of Democracy

Contents

Introduction 5

CHAPTER 1
Death of democracy and the rise of the techno-autocracy 9

CHAPTER 2
Globalisation: the cracking sound? 21

CHAPTER 3
A big deal 31

CHAPTER 4
Price and prejudice 47

CHAPTER 5
Of rabbits, bankers and what matters 59

CHAPTER 6
Technology — saviour or curse? 63

End Notes 73
 

Introduction

Is democracy in the 21st century dying? Will it become a rare beast in an

autocratic world full of old people, robots and AI? There are certainly signs
that this will happen. In the major developed economies, the mainstream
forces for democracy: middle-ground political parties; rising productivity
and relative equality of income and wealth; and a social contract between
government and people, have been seriously eroded. Populist parties of right
and left, standing for an end to the post-war social consensus, have gained
hugely. The supposed benefits of internationalism and globalisation have
increasingly given way to nationalism, protectionism and anti-immigrant
rhetoric. Rising inequality of incomes and wealth and deteriorating demo-
graphics have broken social consensus. In the emerging economies, many
autocratic regimes have surfaced and the ability of the leading democracies
of the world to sustain geopolitical stability has dissipated. What was once
a relatively stable geopolitical landscape (even given the ‘cold war’) has
been replaced by the ‘war against terror’ and a multi-polar world of rival and
competing economic and political powers.

In this short book, through a series of essays, we argue that there is more than
the rise of populism afoot. New politico-economic models are being formed
that could replace the old democratic model.

The authoritarian command economy of the Soviet Union failed, but now
there is an even more potent rival to the traditional democratic model: a
techno-autocracy where the market economy flourishes (under some state
direction), but social and political freedoms are restricted. China is the prime
example of this. China now threatens to rival the old democracies of North
America, Europe and Japan, not only economically, but also as a future poli-
tical model. There are still many tin-pot dictatorships (often elected!) who
haven’t a clue how to deliver economic well-being to the masses. Examples
are the Philippines’ Duterte and Turkey’s Erdogan. But techno-autocracies
like China are far removed from the tin-pot dictatorship model and are both
economically savvy and socially oppressive.

Even Russia, which threatens the old geopolitical order as much as China,
provides a reasonably successful alternative social model for its citizenry,
which continues to vote for it in droves. Russia has seen its poverty rate halve
to below 14% in less than a decade, on par with the US. Population decline
has been reversed. Its automobile ownership is now equal with Poland and

5
DEATH OF DEMOCRACY

Hungary. And individual connectivity to the internet is around 75%, level

with the EU and ahead of the US.

The ability of techno-autocracies to challenge wealthy democracies is not

just based on the autocracies’ economic success. It is also a function of how
democracies are weakened by populism penetrating and then operating within
the institutions of state, causing them to malfunction and further undermining
confidence in civic society. It is a far more lethal and insidious form of attack
than a revolution!

How and why is this happening? In this book, we consider several develop-
ments. The first is the attack on globalisation, free trade and internationalism
by populism and nationalism, as most strikingly trumpeted by the US
President, as the leader of the ‘free world’. In Europe, many governments in
the east stand for no further integration and aim to block the free movement
of labour, while in the west scepticism with the great post-war European
project has multiplied. At least three EU members, Hungary, Poland, and the
Czech Republic are attacking the rule of law and civic society in ways that
makes nonsense of their right to be in the EU, which in turn is powerless to
kick them out. And the UK is taking the seminal step of breaking with the
European Union after over 50 years of membership.

Driving this attack on democracy and internationalism are three factors:

demography; disinflation; and disruptive technologies. The world is getting
older, particularly in the old democracies. This will reduce long-term pro-
ductivity growth globally, with more dependants to feed and be suckered by
fewer active adults.

Global population growth is happening in areas of the world that have scant
hope of providing their burgeoning populations with decent living standards.
This threatens increasing numbers of failed states and massive movements
of labour across the globe from those areas with fast growing populations
(Africa) to those with falling populations (Europe), and all the attendant
tensions and conflict that could involve.

Also, contrary to the conventional wisdom, lower economic growth and

demand suggest permanently lower inflation rates. That makes unattainable
the perpetual inflation targets set by central banks and monetary authorities
around the world with easy money policies merely fuelling rising global debt
and consequent financial instability.

And third, there are the new disruptive technologies of AI, robots, big data
and blockchain. These technologies are no longer the preserve of the old

6
 

democracies. On the contrary, China’s techno-autocracy is leading the race

to apply them to take its economy quickly to the levels of the old developed
democracies, while using the new technologies to control its population.
Other autocracies may not be far behind.

The challenge to democracy in a multi-polar world is now potent. It is con-

tested from within and without. If it fails, it is more likely to be replaced by
governments that cannot deliver on their promises but resort to incoherent,
fragmented and divisive polices that appeal to their undereducated electorate,
than by absolute dictatorship. The economic, and therefore the investment,
damage would be even greater than from a dictatorship or autocracy that had
a clue about what it was doing.

7
CHAPTER 1

Death of democracy… and

the rise of the techno-autocracy

Democracy is under attack. This calls into question the global leadership of the
world’s most significant rich economies which are all democratic. From within
they are under siege from populism. Externally, their status is being under-
mined by alternative social systems which are delivering improved economic
well-being, but at the expense of increased surveillance and more oppression.

This is new. Dictatorship has always stood in the opposite corner of the ring
to democracy. Over the past two centuries, dictatorships never came close
to rivalling the economic dividends of the ballot box. Now, in relatively few,
but highly significant cases, dictatorships have developed integrated political,
social and economic models that can do so.

China doubles real living standards every 13 years. It now takes the US
and Europe 50 years and Japan even longer (Figure 1). Russia has seen its
poverty rate halve to below 14% in less than a decade and population decline
has been reversed. Its automobile ownership is now on par with Poland and
Hungary. And individual connectivity to the internet is around 75%, level
with the EU and ahead of the US. All of which makes the rich democracies,
struggling with the aftermath of crisis, look bad.

Real GDP per capita (PPP terms), 2003 = 100

350.0
China US UK Japan EZ
325.0
300.0
275.0
250.0
225.0
200.0
175.0
150.0
125.0
100.0
75.0
Mar-03

Mar-06

Mar-09

Mar-12

Mar-15
Dec-03

Dec-06

Dec-09

Dec-12

Dec-15
Sep-04
Jun-05

Sep-07
Jun-08

Sep-10
Jun-11

Sep-13
Jun-14

Sep-16
Jun-17

Figure 1. Source: Datastream

9
DEATH OF DEMOCRACY

And it’s no better if we look at how this economic strength feeds into the
capacity of both Russia and China to assert themselves geopolitically and
diminish the power of rich countries — especially the US and Europe. It’s
here the similarities between the alternative systems of Russia and China
ends. The Russians may be happy with their development model. But no-one
else envies it. The Chinese model is, in contrast, exportable (in whole or part)
and will be. For that reason, we will focus on the Chinese alternative system.

Democracy evolved messily, inefficiently and imperfectly. But due to this

it is highly shock absorbent. It cushions dissent and social discontent well.
The downside to this is that it is slow and inefficient at addressing the causes
of such shocks. There may be internal breaking points out there (such as
populism in collision with the EU machine). But they are far into the mists
of time. For the moment, democracy’s performance is unenviable for citizens
in many alternative systems.

The alternatives are dictatorial, effectively single party or strong-man-rule,

socially repressive but economically savvy. Most important of all, they are
created by design and not by evolution. That may make them brittle. Humans
are bad at planning for everything — particularly exogenous shocks created
by their own failures (e.g. climate change).

It is fair to describe successful alternative systems, like China, as techno-auto-

cracies because technology empowers these regimes in two vital ways. It
provides the means to achieve high economic growth. And it enhances the
ability of the state to control society. The two are opposite sides of the same
coin.

There was a time when the western liberal mantra and our humbler belief
was that rising living standards create the demand for civic society and rule
of law. And that civic society is a basic building block for an economy to
achieve rich country status.

So the two trends were self-reinforcing: as societies got richer they became
more civic. Becoming more civic empowered the creativity that allowed
them to become rich.

Right now, all major rich countries are democracies and enjoy the rule of law.
But this increasingly appears to be less of a rule that governs the future than a
historical accident that typified the past. China is conceivably the laboratory
test that will prove or disprove this.

10
 Chapter 1

THE CHINA MODEL

China’s blueprint is almost the antithesis of the western concept of econo-
mic development. China’s model creates a green meadow of considerable
economic, technological and scientific freedoms, surrounded not by hedges
but by towering grey prison walls. That’s where you go for stepping out of
line politically. The greater the economic freedom, the more restricted social
freedoms become. But as long as economic freedom delivers wealth the
people will sign-off on social oppression and support the political system.

The political architecture to make this social contract work is being moder-
nised and consolidated at a stunning rate. Take the latest National People’s
Congress (NPC) which ….

1. approved President Xi’s personalised and unlimited rule;

2. did away with the separation of Party and State (put in place by Deng
Xiao Ping to prevent the recurrence of Mao’s personalised dictatorship);

3. cut the number of ministries (by eight) to increase efficiency;

4. upgraded and consolidated the committees in charge of running the eco-

nomy and set up reporting lines that run straight to the top (effectively to
Liu He, as Xi’s right-hand man in charge of the economy);

5. reinforced the anti–corruption drive, giving it vastly increased resources

and reorganised it in terms of law, justice and investigatory bodies and
their leadership;

6. consolidated regulatory bodies for finance (banking, insurance and markets).

The political architecture is only as solid as its ability to deliver the goods.
If things go well, all is well. But if things go wrong economically, the cracks
will spread quickly.

Western democracies with all their lasagna-like political and bureaucratic layers
have an ability to absorb shocks and cushion discontent, without ever really
tackling the causes of either. But autarkies and dictatorships are much more
fragile, which is why they are more sensitive to social discontent than rich
countries’ elected leaders. And interestingly, the new techno-autarkies, thanks
to their sophisticated technical abilities, are better equipped at sussing out social
discontent and not only suppressing it, but addressing its causes efficiently.

The Chinese economic model has little to do with that of yesteryear.

11
DEATH OF DEMOCRACY

No longer is the landscape to be dominated by state-owned heavy industry,

hoovering up badly-allocated credit and pouring out goods in excess of
domestic demand that have to be exported at vile prices to beget the dollars
to oil the creaking wheels of malinvestment.

This may be Trump’s nightmare vision of China. But Don Quixote too had
notions about windmills. It is a view as out of date as that of rebuilding smo-
ke-stack America. Unlike the US political leadership, China’s knows when a
development model is past its use-by-date. And knows to change it rapidly, or
the Party may not survive the economic damage inherent in persisting with it.

So, what is that economic model for the future? Disruptive technologies are
to be both the economic drivers and means of social control.

China is spending more on R&D than any other country in the world except
the US (Figure 2). Its academic papers on key areas of research and techno-
logy are now quantitatively ahead of the US, Europe and Japan (Figure 3,
page 13), even if they are still lacking qualitatively. This progress is being
bankrolled by massive state support that dwarfs government-funded research
in the US and elsewhere. The change has already transformed global research
and information flow (Figure 4, page 13).

The environment for these “new economy” sectors is relatively free with
few constraints in medical research (genome or stem-cell technology) and
little or no data protection laws. In contrast to personal data, the protection
of intellectual property enjoys increasingly effective legal cover. This is

Research and development spending, % of GDP

3.0

2.5

2.0

1.5

1.0

China US Eurozone
0.5
1996
1997
1998
1999
2000
2001
2002
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2017

Figure 2. Source: World Bank WDI, Independent Strategy

12
 Chapter 1

International intellectual property applications

2,500,000
Patent Applications Trademark Applications

2,000,000

1,500,000

1,000,000

500,000

0
China US EZ Japan

Figure 3. Source: World Bank WDI, Independent Strategy

significant. For example, you can get more uninhibited access to citizens’ big
data in China than anywhere else. You can then use it to create a new process
or application, which you can then legally protect effectively.

Focus, funding and brain power make it highly likely the Chinese will
succeed in becoming globally dominant in a wide range of ‘new economy’
sectors, as Xi targeted with in his “Made in China 2025” plan. This is
designed to push China up the value chain, giving it the lead in a number
of nascent technologies (e.g. AI, quantum computing, clean energy). The
edict also calls for a push into industrial automation while reducing Chinese
dependency on imported components, aiming for a domestic content of
70% in manufactured products.

What could cause all this felicity to flop is China’s over-leverage (Figure 5,
page 14) and malinvestment problem. But that is unlikely — partly because

Change in the evolution of cross-patent citations within and across regions, 1995-2014

1995 2014

Figure 4. Source: IMF

Figure 4. Source: IMF

13
DEATH OF DEMOCRACY

China non-financial debt by sector, % of GDP

300

NFC HH Govt 256.8

250

200

144.9
150

100

50

0
Dec-07

Dec-08

Dec-09

Dec-10

Dec-11

Dec-12

Dec-13

Dec-14

Dec-15

Dec-16
Jun-08

Jun-09

Jun-10

Jun-11

Jun-12

Jun-13

Jun-14

Jun-15

Jun-16

Jun-17
Figure 5. Source: BIS, Independent Strategy

the money is owed to themselves as borrower and lender are all state control-
led. But there is another reason for thinking a crisis can be avoided, which
is wrapped up in the drive towards new technologies.

The “new economy” sectors need less capital to grow. Rising consumption
lowers the savings rate. The result is less and better-allocated savings. This
also means China’s net savings (saving minus investment) are likely to fall,
thus reducing the current account surplus.

Becoming capital-lite will help address China’s malinvestment and excessive

leverage problems. China will be using less debt per unit of (relatively rapid)
GDP growth. In other words, the efficiency of capital investment will be
rising. So, leverage gradually declines. The efficiency of capital allocation
will rise too as SOE borrowers are replaced with profitable ‘new economy’
privately-owned corporates.

There are four ways in which the new technology paradigm reinforces the
Chinese state.

First, as long as technological progress drives economic productivity and

delivers growth that continues to raise real living standards to China’s citi-
zens, as it is doing at the moment, social tolerance for a politically oppressive
regime can be sustained.

Second, the corporations at the heart of China’s technology revolution — in

particular those engaged in internet and mobile services, social media, online

14
 Chapter 1

consumption and payment systems — provide access to their data to the

state, as the law stipulates. So, the same corporations that provide consumer
satisfaction also feed mass surveillance intelligence to the authorities.

The state is also advanced in using this data and that from its own sophi-
sticated intelligence network, for social profiling with the aim of matching
an individual’s access to resources (like social pay-outs, housing, education
and travel permits) with how well the individual meets the Party’s criteria.
A rather amusing example is the Beijing sperm bank that carries notices on
its website that only donors with excellent conformity to Communist Party
ideals need apply.

Third, the technological revolution in China is highly nationalistic and is closed

to the world in significant parts. For example, VPNs are illegal in an attempt
to stymie access to the global internet. So, for individuals, the offshoring of
communications is hard and hazardous. Put it this way: the aim of the techno-
logical revolution is to make China a world leader. China’s research in fields
like AI, robotics and medical research will compete globally. But access for its
citizens to unfettered extra-China communication will remain strictly controlled.

Fourth, the technological revolution reinforces China’s ability to project

power geopolitically. At its simplest, sustained growth in the economy means
China can continue to finance big increases in military spending (Figure 6)
and grand projects like One Belt One Road (OBOR)1, which will tie client
states (via debt) to the Chinese economic machine.

Military spending, US$bn (PPP terms)

800
US China Russia Japan
700

600

500

400

300

200

100

0
1992
1993
1994
1995
1997
1998
1999
2000
2001
2002
2004
2005
2006
2007
2008
2009
2011
2012
2013
2014
2015

Figure 6. Source: BIS, Independent Strategy

15
DEATH OF DEMOCRACY

Much of China’s current R&D boom is directly linked to weaponry and com-
munications. For example, drone deliveries are already a consumer reality
in China today. But they are also a key military technology (both offensive
and defensive).

Mega projects, such as domination of AI and robotics globally, are essentially

being funded and driven by an institutional framework in which the state and
private sector are partners. And it is matched by the root and branch reform
of the military.

WESTERN DEMOCRACY — A BANKRUPT MODEL?

The liberal democratic model compares badly with China’s for the average
person on the street.

Nearly a decade ago our book, Democrisis2, predicted bad things for democracy
based on these observations:

• Fragmentation of the political system after the fall of the Berlin wall, which
heralded the end of ideological politics, would deprive much of the political
structure of its purpose.

• Trivialisation of political discourse by new technologies. The sound-

bite replaced debate and ideas, something social media has accelerated.
Elections would become marketing campaigns, catering to delivering
unfulfilled promises to groups of swing voters with narrow focus and
interests.

• Perversion of the political process by money, politics, lobbying and the

power of giant global corporations.

• Excessive deregulation of financial markets. This led to the democratisa-

tion of credit, but excessive borrowing. It fuelled asset bubbles globally.
Both helped to gloss over falling wages in rich countries, due in part to
globalisation. But both set up the financial crisis. This will have even
longer-lasting political repercussions than the economic legacy from the
global financial crisis (GFC).

All of this happened and it was made worse by the rise of populism fuelled
by inequality, the collapse of social services and lack of education.

Take the European Union today:

16
 Chapter 1

Traditional elitist leadership and parties in many countries, but most markedly
in Germany, Italy and the Netherlands, now garner less than 50% of the vote.
Populists make up the difference.

The UK is already a working example of both a populist takeover, not by a

party but by an idea, and the most significant retreat from globalisation so
far, as the EU is by far the UK’s biggest market and the biggest free-trade
zone in the world.

To keep the populists at bay in many EU states, coalitions have been formed.
But it is not evident that these coalitions have a vision or are capable of the
decisiveness that are needed to address the root causes of the rise of populism.
Only rejuvenation of the popularity of the EU as a widely supported ideal,
will work. Economic expansion and more jobs will not work alone, although
it gives the politicians a window to achieve reform.

The hope is that the Macron-Merkel axis delivers EU reform. The list of
mooted changes includes the creation of an EMF (an EU version of the IMF)
to enhance and potentially replace the European Stability Mechanism (ESM);
completion of the banking union; establishment of a more democratically
accountable European Parliament; and the partial mutualisation of sovereign
debt. All of these would be positive steps. But at best it is a 50:50 bet that
they will enthuse the masses, even if they help deliver stability and growth.

If the EU’s traditional political parties fail in this, then populism will continue
to spread and strengthen, threatening the EU itself.

This process will take many years to evolve. During this time, the EU may
provide a counterweight to China and the US in terms of its liberal values,
but hardly as a political-economic entity that makes China’s look bad.

What the EU will do, along with its trading partners, is to continue to further
globalisation and open markets. The EU’s recent trade agreements with
Canada and Japan point the way here. Of itself, that is sufficient to ensure
that globalisation will continue with or without the US.

President Trump is doing a good job at .... Making China Great Again! And,
in the process, weakening the US, both geopolitically and economically.

As America withdraws from international treaties and agreements and retreats

into economic isolationism, China will make a claim to fill the void — unju-
stifiably so in many cases (e.g. China’s trade openness) — but effectively, in
terms of global perception.

17
DEATH OF DEMOCRACY

The economic case for failed populism in the US is striking.

The policy mix to recreate industrial America and put President Trump’s voters
back in jobs is fiscal spending and protectionism, together with some social
deregulation (mainly at the expense of the environment and social justice).

The absurdity of increasing the fiscal deficit, while seeking to reduce the trade
deficit through protectionism is contained in the simple economic equation
and accounting identity:

NS = S + GS = I + NX

This says that national savings (NS) is made up of private sector savings
(S) and public-sector savings (GS). If public sector savings fall due to fiscal
deficit spending, then either private sector savings have to compensate, or
investment (I) has to drop (meaning lower growth or recession), if the current
account deficit (NX) is to even stay the same. Put it another way;in a full
employment economy at the peak of its economic cycle, the US government
spending more money will suck in more imports, increasing both the fiscal
and current account deficits.

Rising twin deficits (Figure 7) can only be funded if China (and other current
account surplus countries) that are willing (in economic jargon ‘ex-ante’) to
invest more of their external surpluses in US Treasuries. That is an unlikely
if there is a US-China trade war.

US “twin deficits”, % of GDP

0.0

-2.0
-2.4

-4.0 -3.6

-6.0

-8.0

-10.0
C/A Budget Balance
-12.0
Mar-04

Mar-07

Mar-10

Mar-13

Mar-16
Dec-04

Dec-07

Dec-10

Dec-13

Dec-16
Jun-03

Sep-05
Jun-06

Sep-08
Jun-09

Sep-11
Jun-12

Sep-14
Jun-15

Sep-17

Figure 7. Source: Financial Management Service, BEA

18
 Chapter 1

The deficits will be funded eventually because dollars leaked abroad by the US
current account deficit and held overseas have to be held and invested by some-
one. But not at today’s price. So the US will have to pay more, either in terms of
higher interest rates or in a weaker US dollar (falling to a level where investors
can count on exchange rate gains plus higher interest payments going forward).

The second absurdity of US policy is protectionism itself. Trade protectionism

substitutes high-cost less-efficiently produced goods for low-cost goods. This
holds even if the goods are “dumped” at below-cost prices, which effectively
represent a subsidy by the exporter to the buyer.

The real driver of job losses in the US is technology, not trade. In nearly
every manufacturing sector, it takes less people to produce a given level of
output than ten years ago. That is called productivity and it drives econo-
mic growth and progress from low- to high value-added activities, ensuring
that workers earn more. It is by far the major reason why the US produces
approximately the same amount of steel products today as ten years ago, but
with 40% less people. Protectionism is an attack on technological progress.
That won’t stop technology advancing. It just means the cost will be paid in
terms of productivity, growth and living standards in the US.

The impact on China of US trade tariffs is small in economic terms, but

politically big and thus certain to produce retaliation. The effect of US tariffs
on China is economically small because of a lack of substitute products (e.g.
85% of US mobile phone sales are produced in China by US corporations)
and low elasticity of demand (US people will still buy iPhones). This means
US consumers, not Chinese producers, will ultimately pay the cost.

US attempts to impede the flow of ideas and technology will only succeed
in isolating the US. It would mean that the US is effectively cutting itself
off from the global flow of ideas that underpins research and development
of new technologies. And it ignores history: evolving states always benefit
from the innovations of others, which they enhance. The US took the ideas of
the industrial revolution from Europe and then surpassed Europe. Moreover,
China does not need US technology anymore. Those days are long gone.

AN UNSAFE WORLD
The world will have to look for new alliances and balances of power as US
influence declines and is increasingly mistrusted. That is highly destabilising
as there really is no replacement for the US on the global stage. But a sta-
bilising factor will be a continued commitment to globalisation outside the
US, as one means of achieving stable relations between states.

19
DEATH OF DEMOCRACY

As the US retreats into isolationism, China steps up: economically and geopo-
litically. Economically, China is increasingly self-sustaining. Technologically,
China is way beyond the point of depending on the US.

Europe is unlikely to provide an attractive economic and political alternative

model compared to China for third countries for many years. This reinforces
the ability of China to export its way of doing things. This is key in achieving
the geopolitical and economic goals of the OBOR project, which already
absorbs more of China’s exports than the US.

China’s rising power economically and geopolitically and the decline of

US power raises issues about security in Asia, Europe and the Middle East.
Rearmament in Asia is a feasible response to China’s increasing assertiveness,
as well as to a nuclear North Korea that the US ultimately fails to disarm. This
will be expensive (3-6% of GDP) for Asian economies, Japan in particular,
that have been able to shelter under the US defence umbrella for decades.
But it would also raise the probability of Japan, South Korea and Taiwan
becoming nuclear powers in their own right.

In Europe, trust in the US commitment to NATO will continue to wane, mea-

ning the EU will sooner or later have to ensure its own containment of Russia.

In the Middle East, President Trump’s aim to withdraw from Syria opens
the door for Iran to increase its influence and open a supply route to its
Hezbollah allies in Lebanon. To contain Iran, Israel and Saudi Arabia would
be empowered to act as US surrogates, with arms to match!

The only constant in such a multi-polar world is instability.

20
CHAPTER 2
Globalisation: the cracking sound?

Globalisation has been under assault. Populist movements in developed

economies have sought to blame trade for their own domestic ills. The loss
of blue collar jobs has provided a captive audience for such a narrative. It
has delivered anti-globalists to the White House and helped facilitate Brexit.
But globalisation’s demise is being prematurely declared despite these shifts.
Indeed, much of the slowdown in global trade can be attributed to the financial
crisis and its aftermath. Now with the recovery, trade activity is on a fairly
powerful upswing.

Meanwhile, new trade agreements are being forged. Trump might have
dumped the Trans-Pacific Partnership (TPP), but the treaty should be imple-
mented by the remainder of the group. Europe is also signing major deals.
China meanwhile is leveraging its economic might to launch the One Belt
One Road (OBOR) project that will ultimately reach right to the doorstep of
Europe. Globalisation will persist because of the benefits it brings, both in the
form of lower inflation and ultimately through higher levels of productivity
and growth. It also serves geopolitical aims like furthering European and
Japanese ‘soft power’ as bulwarks against populist isolationism and China’s
aim of filling the US’s shoes on the global stage. The only thing the populists
pursuing more inward-looking ideologies will discover is that they’ve been
left further behind economically, technologically and geopolitically.

Wherever you look, it seems that someone has trouble with trade. While globa-
lisation hefted global living standards by boosting incomes, raising productivity
and slashing the price of goods, the perception that ‘someone has benefited more
than you’ reinterpreted the issue (certainly in many developed markets) from
one of gain to one of pain. Populists have sought to exploit this fundamental
misunderstanding, blaming globalisation for job losses and income stagnation.
And voters have responded, ushering in Brexit and Donald Trump.

The boom in global trade pre-crisis was driven by two distinct events. The
first was the end of the cold war, which brought shackled consumers stuck
behind the ‘iron curtain’ into the global market place. The second wave was
driven by China’s accession to the WTO, the culmination of the economic
reforms started by Deng Xiaoping which then gained traction under Jiang
Zemin (Figure 1, page 22). This surge pushed global trade as a share of GDP
up from around 35% to a peak of 60% before the financial crisis hit.

21
DEATH OF DEMOCRACY

WHAT HAS DRIVEN THE TRADE SLOWDOWN?

Since then there has been a notable slowdown in trade growth. Part of this
is structural. For example, Chinese exports have been shrinking as a share
of its GDP not because of a decline in external demand but because of the
continuing outperformance of the Chinese economy. In dollar terms, exports
have doubled over the past decade, but as a share of GDP they’ve nearly
halved (Figure 2). Basically, the one-off gains of integrating into the global
economy can’t be repeated into perpetuity.

World trade openness (goods & services)*

0.65

0.60

0.55

0.50 China joins

the WTO
0.45

0.40 End of the

cold war

0.35
*= (Imports + Exports) / GDP
0.30
Mar-92

Oct-01

Mar-15
Aug-82

Dec-97

Aug-05
Jan-96

Nov-99
Sep-80

Jun-86

Feb-94

Sep-03

Jun-09

Feb-17
Jul-84

May-88

Jul-07

May-11
Apr-90

Apr-13

Figure 1. Source: CPB, Independent Strategy

Chinese exports, US$bn & % of GDP

2600 33.0

2400 31.0

29.0
2200
27.0
2000
25.0
1800
23.0
1600
21.0
1400
19.0
1200 17.0
US$ bn as % of GDP - rhs
1000 15.0
Mar-09
Oct-09

Mar-16
Oct-16
Aug-08

Dec-10

Aug-15
Jan-08

Nov-13

Jan-15
Feb-12
Sep-12

Jun-14
May-10

Jul-11

May-17
Apr-13

Figure 2. Source: Datastream

22
 Chapter 2

But growth in trade volumes has also slowed. There is something a little
‘chicken and egg’ about this as the shock of the crises mechanically dampened
trade. This was most acute during the global financial crisis itself, but the
slowdown in global growth thereafter was also a significant factor in trade’s
sluggish expansion. That period captures the Eurozone debt crisis and the
emerging market recession which hit commodity producers in 2015 as well
as the slowdown in China during 2015-16.

Although a bout of extreme protectionism was avoided in the aftermath of the

crisis (the G20 pledging “not repeat the mistakes of the past”), there is clear
evidence that countries opted for subtler tweaks to try to protect their citizens
from global competition in the face of weaker demand. Some of the measures
had merit, for example, steps to counter the dumping of goods spat out from
China’s industrial binge (specifically from the subsidised state-owned enterprise
(SOE) sector) aimed to create a level playing field in an otherwise distorted
market. But the rise of protectionism was broader than a simple reaction to that.

A study from the Peterson Institute shows how barriers crept up. Between 2008
and 2013 Peterson clocked the imposition of 117 local content requirement
measures, estimating this affected $928bn of trade in goods and services. WTO
data corroborates the scale of the problem. Between 2008 and the middle of
2016, the G20 economies had introduced 1,196 restrictive measures.

Multilateral efforts also faltered. The WTO’s Doha round of trade talks —
which started in 2001 and collapsed in 2008 — is still unresolved. Other trade
agreements have also run into obstacles post-crisis. The American withdra-
wal from the TPP is the most high-profile case of a multilateral agreement
stumbling. Trump is also posturing to recalibrate the US’s trading relationship
with China, which is pitched as “deeply unfair”. And the administration is
meddling counter-productively with the NAFTA agreement. While some sort
of re-negotiated pact might not materially impact existing North American
supply chains, uncertainty creates execution risk for future investment projects
and the efficiencies these would generate, acting as a break on trade-deepening
and the associated gains in productivity.

Meanwhile, the most visible example of this de-globalisation wave — Brexit

— ticks closer to execution. The project’s backers cite opportunities available
for the UK to forge its own trade agreements, oblivious to the contradiction
that to pursue such deals the UK will have to restrict its access to its closest
neighbour, which also happens to be the largest free trade bloc in the world.
Indeed, the EU still soaks up around half of UK goods exports while the EU
provides an even greater proportion of UK imports (Figure 3, page 24). But
the idea that there is a world beyond the world you exist in seems to be an

23
DEATH OF DEMOCRACY

UK trade: EU Imports & exports as % of total

63.0

61.0

59.0

57.0

55.0 55.1

53.0

51.0

49.0
48.5
47.0
EU as % of Total Exports EU as % of Total Imports
45.0
Oct-02

Oct-05

Oct-08

Oct-11

Oct-14
Jan-05

Jan-08

Jan-11

Jan-14

Jan-17
Jul-03

Jul-06

Jul-09

Jul-12

Jul-15
Apr-04

Apr-07

Apr-10

Apr-13

Apr-16
Figure 3. Source: ONS, Independent Strategy

appealing one for certain British romantics. The Bank of England is more
realistic, acknowledging that this is likely to lead to lower productivity, lower
growth and higher prices, which has clear implications for monetary policy.

AMERICA FIRST, AND LAST

Does all this mark the death knell of globalisation? Any insular shift in US
trade policy traditionally meant it could. And the election of Trump has cer-
tainly brought about such a change. His ‘America first’ rhetoric has feasted
on blue-collar real wage stagnation and the offshoring of jobs to lower cost
centres. This view overlooks the reality that much of this adjustment in heavier
manufacturing industry was an unavoidable consequence of technological
change and is irreversible. Any business reshoring now would have a vastly
different impact (there’d be fewer jobs, but they’d be of a higher quality).
The traditional blue-collar worker would be stranded either way. This insular
critique also glosses over the many benefits globalisation delivered to these
very consumers, including lower prices and greater variety.

President Trump’s ‘deal maker’ vision of replacing multilateral agreements

like the TPP with unilateral treaties that prioritise American interests (leverage)
has been sold as an antidote to these changes. It is sometimes difficult to
disentangle rhetoric from reality, but the signal it sends is clearly harmful
for US investment and potential growth.

While the US remains the world’s largest economy in nominal dollar terms,
its importance in global trade has been diminishing since the start of the mil-
lennium. Indeed, US exports at the turn of the century were around 12% of

24
 Chapter 2

the world total compared to 9% today whereas China has grown from about
3.5% to over 13% (Figure 4). This mirrors the general pattern seen between
advanced and emerging economy trade activity.

THE BIGGER PICTURE

While the US might appear to be turning inward, the rest of the world moves
on. There are a number of significant projects that will counterbalance these
corners of ‘anti-globalisation’ sentiment. The EU remains committed to the
globalised economy. A free trade agreement with Canada is in the final stages
of ratification and the EU aims to conclude talks on a deal with Japan shortly
(the end of year deadline looking rather optimistic). Discussions between the
EU and the US might have died a death, but there could be scope to revive
plans with future administrations.

Meanwhile, China is pursuing its own strategy to expand trade ties, most
notably with its OBOR project. That is designed geographically around
the old Silk Road but has been repurposed to serve the needs of Chinese
development3 Critics point out that this is merely a way to redirect Chinese
excess capacity while expanding its geopolitical influence across tra-
ditionally more neglected parts of Asia. And that many of the planned
investments are likely to be decided by political considerations rather
than economic. All of which is probably correct. But that doesn’t detract
from the growth such a programme will still generate (both in terms of
reshaping value chains and creating the foundations for future demand
growth) and underlines the lesson China learnt from its own development

World exports, % share

16.0

14.0

12.0

10.0

8.0

6.0

4.0

2.0
US Germany Japan China
0.0
Oct-98

Oct-05

Oct-12
Dec-99

Dec-06

Dec-13
Aug-97

Aug-04

Aug-11
Jun-96

Feb-01

Jun-03

Feb-08

Jun-10

Feb-15

Jun-17
Apr-95

Apr-02

Apr-09

Apr-16

Figure 4. Source: IMF DOTS, Independent Strategy

25
DEATH OF DEMOCRACY

— free trade lifts all boats.

The TPP also looks set to live on despite the US’s withdrawal, having been
revamped into the CPTPP (Comprehensive and Progressive Agreement for
Trans-Pacific Partnership) with ratification likely in early 2018 between the
remaining members (Inset 1) after which it would head to national parliaments
to approve. Even China has expressed an interest in signing up, somewhat
ironically given that the TPP was initially created to try and counter the threat
of Chinese dominance in the region.

The data also suggest the trade revanchists remain on the wrong side. Indeed,
trade volumes are on the up again. Growth rates are now only around 1%
pt below pre-crisis levels (Figure 5, page 27). The structure is also positive,
being driven by the factory economies of Eastern Europe and Asia rather
than the commodity producing states in the Middle East and Latin America.
This reflects the upswing we’ve seen in global economic growth, emanating
specifically from the broadening eurozone recovery and rebound in Asia
ex-China.

This is being complemented by stronger investment spending — something

that has been distinctly lacking for nearly a decade. Investment still falls short
of where it would desirably be, momentum though is what counts and that is
finally moving in the right direction. The only visible cloud is probably how

CCTPP, or just TPP lite?

The withdrawal of the US reduces the instant boost to global trade
the project might have triggered, but it still brings down non-tariff
and tariff barriers among nearly a dozen Pacific nations, specifi-
cally Japan, Canada, Australia, New Zealand, Mexico, Malaysia,
Vietnam, Peru, Chile, Brunei and Singapore. The TPP paperwork
also allows other members of either APAC or any trading bloc a
country is a member of to apply. Colombia, Philippines, Thailand,
South Korea, Taiwan and Indonesia have all expressed a desire
to sign up.

While the economic impact of US withdrawal will be significant,

the ‘lite’ version could still lift real growth rates by 0.1-0.3% pts
per annum over the next decade and the treaty would retain the
incentives for further reforms, as tariff and non-tariff barriers come
down. Enactment might also be speeded up. The initial agree-
ment required six member states, representing 85% of GDP of
the TPP nations, to ratify in order to come into force. The CCTPP
seems likely to drop the GDP element of this clause.

Inset 1. Source: Independent Strategy

26
 Chapter 2

World trade volumes, % chg yoy

20.0

15.0

10.0

5.0

0.0

-5.0

-10.0
World Trade

-15.0 Pre-crisis Avg

Post Crisis Avg
-20.0
Sep-01

Sep-03

Sep-05

Sep-07

Sep-09

Sep-11

Sep-13

Sep-15
Jan-01

Jan-03

Jan-05

Jan-07

Jan-09

Jan-11

Jan-13

Jan-15

Jan-17
May-02

May-04

May-06

May-08

May-10

May-12

May-14

May-16
Figure 5. Source: CBP, Independent Strategy

the US fares given it is ‘late cycle’, having soaked up the vast majority of
its domestic spare capacity. But that is unlikely to dent world demand near
term and could in fact provide an additional catalyst once the Republican tax
reform package goes through. A large chunk of the estimated ~$1trn increase
in the US deficit will end up being financed from the recycling of flows from
an even larger US trade deficit.

Of course, the improvement in trade may just be cyclical, disguising a nega-

tive longer-term secular shift. But the fact remains, if de-globalisation was
taking hold, it would take a decade or more to reveal itself. It would require a
wholesale unbundling of highly complex cross-border supply chains that have
developed over decades. Even if barriers appeared, reshaping the deployment
of capital from country A, B and C back to country D would be an extremely
prolonged process. It would also require a permanent change in the collective
mindset of investors, who need to be convinced that any change in attitudes
towards globalisation is permanent and to their advantage. These are all inputs
that lie apart from the normal drivers of the economic cycle.

Technological innovation could also provide a boost to trade. Containerisation

might have dramatically reduced the cost of shipping goods from one side
of the planet to the other, but it is still bureaucratically complex — requiring
a lengthy list of documents from quality certification to letters of credit.
These are needed to protect against counterfeit goods, smuggling and fraud.
Digitisation of documents using blockchain technology (could be transforma-
tive, unifying all the documentation for a transaction into a distributed digital
ledger verifiable by all relevant parties. No one in the chain could modify

27
DEATH OF DEMOCRACY

or amend details for the shipment without the corroboration of the network.
That could dramatically improve efficiency and productivity, greasing the
wheels of global trade.

Digitisation is a further disruptor. Services trade has continued to expand, even

as goods growth dropped (Figure 6). This reflects the ongoing shift towards
intangibles — both the consumption of and investment in. The information
revolution now means many of these are infinitely scalable. No one is deprived
of a piece of software, media or other digital service by another purchasing
a digital copy. Although services exports account for only a quarter of goods
trade, momentum is firmly on its side. Digitisation is already stripping back
barriers and recent innovations, for example smartphones alongside increasing
mobile internet penetration and blockchain, will further enhance this trajectory.

Trade suffered an almighty hangover after the financial crisis, the collapse
in global demand hit volumes and the recovery was stretched out by ensuing
crises in Europe and emerging markets. While protectionism was vilified by
policy makers there was still an increase in less direct barriers to trade. The
sum of these parts was an effective stagnation in global trade growth and
investment for much of the past decade. This narrative has been compoun-
ded more recently by a populist political wave that has ridden the post-crisis
stagnation in living standards.

Populists seek to apportion blame and the trade boom driven by globalisation
has been top of the list. Trump’s America has been conditioned to believe
trade is bad and the country now looks inward. Brexit was a further expression

World exports (nominal US$), 2005 = 100

220.0
Nom GDP Goods Exports Services Exports
200.0

180.0

160.0

140.0

120.0

100.0
Jan-05

Jan-07

Jan-09

Jan-11

Jan-13

Jan-15

Jan-17
Sep-05

Sep-07

Sep-09

Sep-11

Sep-13

Sep-15

Sep-17
May-06

May-08

May-10

May-12

May-14

May-16

Figure 6. Source: Oxford Economics, Independent Strategy

28
 Chapter 2

of electoral disappointment with rising inequality of wealth and opportunity

and will inflict a permanent hit on UK economic potential. If these attitudes
took hold more broadly it would lower productivity and potential growth as
well as raise inflation. It would also make convergence between emerging
and developed economies more difficult, except in the cases of countries like
China where sheer size ensures economies of scale.

But globalisation is not yet dead and certainly not at a point of unwinding
even if the US (directly) and the UK (via its own twisted logic) are pushing
against this trend. Some trade deals might have faltered, but others are moving
ahead and grand plans, such as China’s OBOR project should drive a further
round of trade growth in Asia over the next decade or so. Although many
western leaning states in the region view China warily, intra and extra-Asia
trade is now growing strongly.

The Eurozone recovery is also supporting the recovery in global trade volu-
mes. And with global growth likely to pick up further in 2018, trade will
continue to quicken. That is positive for the investment outlook and for
productivity and living standards, most notably for the middle-income coun-
tries of Asia and the higher-income German feeder economies of Eastern
Europe. It also fits with the lower-for-longer inflation narrative and further
complicates the job of central bankers still trying to reconcile the world in
traditional monetary terms.

If we are wrong and globalisation is dying, the post mortem will be a long,
drawn-out process. It will be logistically complex and, beyond that, require
a shift in mind-set to facilitate it. Such adjustments only ever happen gradu-
ally. The quantifiable impact is well beyond any normal investment horizon.

29
CHAPTER 3
A big deal

Demography is perhaps the single most important investment theme over the
next half century. Many of its implications will begin to bite much sooner.
Three trends are happening simultaneously:

First, global population is expected to expand by nearly 40% through

2065. But there’s going to be a dramatic regional tilt. While non-Japan
Asia accounted for over 60% of net population expansion in the last half
century, almost 90% of the growth will happen in the AIME bloc (Africa/
Indian sub-continent/Middle East) in the next 50 years. This might offer
exciting investment opportunities if new supply chains emerge. But it
could just as easily lead to chaos. Europe remains at the forefront of
migration risk.

Second, population growth is slowing globally as fertility rates drop. By

the end of the century, births per woman in all regions will be below the
natural “replacement rate”. Meanwhile, with life expectancy on the rise,
there will be a sharp deterioration in dependency ratios. In developed
markets (DMs) this will mean heavily-indebted governments scrabbling
to earmark funds for existing welfare commitments. In many emerging
countries (EMs), it’s even worse — governments are wholly unprepared
to carve out the resources to fund their populations’ pension and healt-
hcare needs.

Third, and most important for investors, working-age populations will be

shrinking outright in Japan, much of Europe and, most dramatically, in China.
This is likely to keep economic growth and financial asset returns low by
historical standards. Labour scarcity could easily drive up inflation unless
technology can be harnessed to satisfy demand with fewer workers. But fewer
workers would cause the tax take to drop just as public sector liabilities for
healthcare and pensions soar. Super-profitable corporations may be forced
to fill the financing gap, while home owners will increasingly be required to
fund their own dotage.

Once in a while, there are developments so important that they define the
investment era. That moment was in the 1950s when the cult of the equity
took hold; Japan’s economic miracle and Germany’s Wirtschaftswunder of
the 1960s; the collapse of the gold exchange standard in the early 1970s;

31
DEATH OF DEMOCRACY

Paul Volcker’s hard-nosed attack on double-digit 1980s inflation; the fall

of the Berlin Wall; globalisation; the internet revolution. You might even
include central bank money printing in the post-financial crisis era — cul-
minating in negative interest rates and sky-high asset valuations — in the
same breath.

Most of these epoch-defining events are obvious only with the benefit of
hindsight. Occasionally, however, we get to see one well in advance. And
no matter how slow-burn it might be, its force is irresistible. Demography is
one such theme. It’s so gradual that many investors struggle to get excited
about it. But that doesn’t mean it isn’t of central importance to future asset
returns. Here we try to bring out the kernel developments and consider their
implications.

The challenges can be summed up, in the first instance, by a single chart
(Figure 1). We are entering a new paradigm in which the combined working
age populations of the richest nations, coupled with that of the world’s
most populous, are about to start shrinking. Instead of adding 15-25 mil-
lion new workers every year, as they had reliably done for half century
or more, we’re going to have to adjust to an era in which the number of
workers from the countries that dominate global demand and supply chains
is actually declining.

Simultaneously, we are going to see a rapid greying of these countries’

populations. The dependency ratio, defined as the size of the over-65
population relative to the pool of economically active, is going to rocket

Working age population (15-64yr olds), mn per annum

30.0
China Adv Econ
25.0
20.0
15.0
10.0
5.0
0.0
-5.0
-10.0
-15.0
-20.0
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
2030
2035
2040
2045
2050
2055
2060
2065

Figure 1. Source: UN, Independent Strategy

32
 Chapter 3

Old age dependency ratio (65yr+ as % of 15-64yr olds)

80%
Europe China Japan N Amer 72%
70%
61%
60%
49%
50%
43%
40%
41%

30% 26%

20% 22%

10% 13%

0%
1965

1970

1980

1990

2000

2010

2015

2020

2030

2040

2050

2060

2065
Figure 2. Source: UN, Independent Strategy

(Figure 2). Within 30 years, most regions are going to have an age-profile
like Japan’s today. And Japan will be off the charts, with three workers
responsible for funding the dotage of two senior citizens — as well as their
own living expenses!

Of course, this isn’t the whole story. The advanced economies and China
together only account for 40% of today’s global working population. By 2065,
the UN Population Division’s base case scenario predicts that their combined
share will have dropped to less than a quarter (Figure 3).

Global working age population distribution

(15-64yr olds), %
80%
Adv Econ RoW China
76%
70%

60%
60%
50%
47%
40%

30% 32%
21%
20%
21% 19% 14%
10%
11%
0%
1965

1970

1980

1990

2000

2010

2015

2020

2030

2040

2050

2060

2065

Figure 3. Source: UN, Independent Strategy

33
DEATH OF DEMOCRACY

TOO HOT
Overall, however, the world’s population will still be growing rapidly.
According to the UN, within 50 years, there are likely to be three billion
more inhabitants on the planet. Adjusting their assumptions for different fer-
tility and mortality scenarios, gives a wider range of “extreme” outcomes for
population increase — from a low-ball estimate of +1.3bn, to an eye-popping
+5.9bn. But under any scenario the numbers are vast.

Of course, this is not a new phenomenon. The global population has more
than doubled from 3.3bn in 1965, to 7.3bn now. That represents an average
annual growth rate of 1.6% p.a., with the fastest expansion being in devel-
oping economies (Figure 4).

“So what’s the big deal?” one might ask. We coped with 4bn new mouths to
feed in the last half century, so surely we can cope with another 3bn over the
next 50 years? Well maybe, maybe not. Hidden beneath these headline numbers
are some dramatic shifts with consequences of potentially biblical proportions.

While people are living longer in almost all countries due to giant medical
advances4, fertility rates are dropping faster (Figure 5, page 35). Indeed, by
the end of this century, all regions are expected to fall below the “replace-
ment rate” of 2.1-3.4 children per woman (depending on regional infant
mortality rates). So the phenomenon of a growing global population is
actually finite.

World population growth by region, % chg per annum

3.0
1965-2015 2015-2065 2.6
2.5
1.9
2.0 1.8 1.8
1.6 1.6
1.5
1.0 0.9
1.0
0.7
0.5 0.5 0.4
0.5 0.3 0.4

0.0
-0.2
-0.5
-0.5
-1.0
Oceania
Asia (xJap)
World

Japan
Europe

Lat Am
North Am

Africa

Figure 4. Source: UN, Independent Strategy

34
 Chapter 3

World population growth forecasts, % chg per annum

3.0

2.5

2.0

1.5

1.0

0.5

0.0

-0.5

-1.0
1950-60

1960-70

1970-80

1980-90

1990-00

2000-10

2010-15

2015-20

2020-30

2030-40

2040-50

2050-60

2060-70

2070-80
Africa Oceania North Am Lat Am Asia (xJap) Europe Japan

Figure 5. Source: UN, Independent Strategy

From today’s 7.3bn starting point, under the UN’s base case, global popula-
tion growth is expected to slow sharply, declining from an historical 1.6%
p.a. since 1965 to just 0.7% annually through 2065. All regions are affected,
with particularly eye-catching slowdowns in northern Asia, Latin America
and Europe. Indeed, Europe and Japan will see their populations shrink stea-
dily, by almost 60m and 30m respectively over the next half century, while
China’s will fall by an astonishing 140m.

At the other end of the spectrum, while Africa’s population growth will also
slow, it will remain at least 1% point p.a. faster than any other region. This
will have significant implications for the distribution of global population,
with Africa’s share almost doubling from 16% now to 30% in 2065 (Figure
6, page 36).

The last half century was undoubtedly about the rise of Asia, which accounted
for 62% of the global population increase. Over the next 50 years, almost
two-thirds of it will be in Africa, where the population is expected to grow
at 1.9% p.a. This will drive the continent’s headcount up from 1.2bn today
to 3.1bn in 2065. At least ten African countries will see their populations
expand by more than 50m each.

Indeed, when we rank countries by absolute population increase, there appears

a vast, contiguous region of the world where almost all population growth
is going to be concentrated. We call it the “AIME” bloc. It includes Africa,
the Indian sub-continent (including Pakistan and Bangladesh) and a group
of four countries in the Middle East (Iran, Iraq, Saudi Arabia and Yemen).

35
DEATH OF DEMOCRACY

World population distribution by region, % of total

100%
9.7
90% 16.1 Africa
7.6 30.0
80% 8.6
Lat Am
70%
7.6
Oceania
60%
53.5
50% Asia (xJap)
58.1
40%
49.9
Japan
30%
2.9
20% Europe
19.1 1.7
10% 10.0 0.9
6.6
6.6 4.9 North Am
0% 4.4
1965 2015 2065

Figure 6. Source: UN, Independent Strategy

Together they’ll account for 2.7bn, or almost 90%, of the 3.0bn global popu-
lation increase anticipated by the UN through 2065 (Figure 7). And over
half of this is due to just six countries — India, Pakistan, Nigeria, Tanzania,
Ethiopia and DR of Congo. The AIME bloc goes from representing 41%
of the global population today, to 55% in 2065. Were population growth to
slow more rapidly than in the UN’s base case, all net population growth in
the world would, in effect, be African.

Share of world population growth by region, %

100%
11.3
90% RoW 4.1
80%
49.4 20.9
70%
Iran, Iraq,
60% Saudi, Yemen

50% 2.9

40% Ind, Pak, Bangl 89%

26.2
30% 63.7

20% Africa
10% 21.5

0%
1965-2015 2015-2065

Figure 7. Source: UN, Independent Strategy

36
 Chapter 3

Demand for food and housing will be the main challenge. The countries in
question need to buck historical trends and develop themselves rapidly with
sensible governments implementing structural reforms. If they can, growth
could make these the investment hotspots of the future. But there are serious
dangers to stability if they can’t, such that people aren’t adequately fed or
housed.

According to the UNHCR, there are already 65m displaced persons today,
representing almost 1% of the world’s population5. Given the concentration
of population growth outlined above, it seems highly likely that the flow of
displaced persons is going to increase. 2.7bn more people in the AIME region
implies half a million new refugees every year if just 1% find themselves
displaced. On that basis, the idea that Europe has solved its refugee crisis
is delusional.

TOO COLD
If population expansion in the AIME bloc of countries is too hot, that in much
of Europe, Japan and China is too cold (Figures 8 and 9, page 38). Declining
fertility rates and lengthening lifespans mean that by 2050, a third of the
population will be over 65. The inevitable consequence? There will be too
many old people and not enough workers to generate the tax revenue to pay
for seniors’ pension and healthcare needs.

Even the richest countries are ill-prepared. A 2015 study by the National
Institute on Retirement Security showed that 45% of all US households — 40

Population change (mn), 2015-2065

500
400
300
200
100
0
-100
-200
-300
Total Working age
-400
Ethiopia

Italy
Nigeria

DR Congo

Japan

China
Tanzania
India

Germany

E Europe
Pakistan

Thailand

Figure 8. Source: UN, Independent Strategy

37
DEATH OF DEMOCRACY

Change in working age & elderly populations (mn),

2015-2065
400

300 275 263 258

230
200
114 124
100 60
33 13 21
2
0
-27
-100
-106
-200
Working age (15-64yr)
-300
Elderly (65+)
-338
-400

DR Congo

Nigeria
China

Japan

India
Europe

Pakistan

Figure 9. Source: UN, Independent Strategy

million of them — had no retirement savings at all. Two-thirds had assets

equivalent to less than one year’s expenditure. The recommended level of
savings was at least 8x final salary in order to fund 85% of pre-retirement
expenditure levels through dotage. Yet less than 5% of households met that
threshold (even counting entire household net worth, only a third of house-
holds get there).

The burden will inevitably fall on the state. How heavy might this burden be?
The social contract for the elderly principally covers two kinds of entitlement:
pensions and healthcare. The cost to the public purse of these two items, across
a range of advanced economies, is currently in the order of 14-23% of GDP.
By 2050, however, due to demographic shifts, this will increase by a further
5-10% pts of GDP. This incremental burden will account for a much larger slice
of government revenue — in the case of the US, almost 30% of it! (Figure 10
& 11, page 39).

Unless taxes go up or entitlements go down, this will inevitably cannibalise

all other areas of discretionary public sector expenditure. And if you thought
the situation was better in emerging economies, you’d be wrong. As popula-
tions age, there will be a dramatic increase in public pension and healthcare
spending. South Korea, Brazil and Russia are probably the worst off in this
respect, with an incremental burden of 10-16% pts of GDP. That’s equivalent
to a marginal 30-50% claim on government revenue.

Squaring this circle can only be done by increasing tax rates, raising the reti-
rement age and reducing entitlements. But higher taxes will dampen growth

38
 Chapter 3

Increase in public sector outlays on healthcare & pen-

sions (% pts of GDP), 2015-2050E
18.0
Healthcare Pensions
16.0
14.0
12.0
10.0
8.0
6.0
4.0
2.0
0.0
-2.0
Spa
Ger

Pak
Kor
Brz

Arg
Ita

SAfr
Rus

Chn

Mex
Indo
Fra
US

UK
Jap

Tur

Ind
Figure 10. Source: PEW, Independent Strategy

Increase in public sector outlays on healthcare & pen-

sions (% pts of govt revenue), 2015-2050E
60.0
Healthcare Pensions
50.0

40.0

30.0

20.0

10.0

0.0

-10.0
Spa

Ger

Kor
Brz

Arg

Pak
Ita

SAfr
Rus
Chn

Indo

Mex
Jap

Fra
US

UK

Tur

Ind

Figure 11. Source: PEW, Independent Strategy

while curtailed entitlements will lead to rising inequality and civil unrest.
There is no easy way around it.

A POST-GROWTH WORLD?
There are two other consequences of aging populations. First, they repre-
sent a drag on productivity (Figure 12, page 40), with the increased costs
of caring for society drawing workers away from more productive sectors.
There is ample evidence from countries like the US, Japan and Australia

39
DEATH OF DEMOCRACY

Labour productivity per hour worked, % chg per an-

num, 5yr trend rate)
3.0

2.5

2.0

1.5

1.0

0.5

0.0

-0.5
Can Fra Ger Jap US UK Ita
-1.0
1996

2001

2006

2011

2016
Figure 12. Source: AMECO, Independent Strategy

US private sector payrolls growth, % of total

60.0
% of Total Employment % of Total Jobs Created Last 10yrs
50.0
40.0
30.0
49.5

20.0
32.7

27.8
22.0

18.6

10.0
16.8

12.8
10.0

5.6

0.6

8.4
2.2

6.8
2.2

4.6
3.3

0.0
-13.9

-6.4

-0.1

-3.6

-10.0
-20.0
Other Services
Prof & Bus
Resources

Wholesale, Retail
Manufacturing

Hospitality
Education
Activities
Construction

Information

& Health
Financial

Services

Leisue &
Natural

& Transport

Figure 13. Source: BLS, Independent Strategy

that job creation is being dominated by the care sectors (Figure 13).

Second, as wealth is disproportionately concentrated in the hands of older and

retired workers, both directly in the form of assets and indirectly in the form of
unfunded liabilities, this dampens demand in two ways. Older workers spend
less (peak consumption is in the 35-55 age range when family pressures are
at their most acute), so structural demand within the economy falls. And con-
centrated wealth dampens consumption in the next cohort, which has to cover
not only its own savings needs, but also the shortfall of the earlier generation.

40
 Chapter 3

This is reflected in the growing imbalance between fiscal spending on welfare

liabilities and discretionary spending, which continues to shrink. It is also
evident in asset prices and consumer debt levels, with leverage increasingly
concentrated in more vulnerable demographic groups.

It’s a corrosive self-reinforcing cycle, compounding the productivity slow-

down by transferring spending from investment to welfare liabilities.

In reality, it is only investment spending that can create the foundations for
the strong growth needed to fund these growing liabilities. But that would
require a rebalancing of the spending pie, which given electoral participation
is unlikely to happen voluntarily. In fact, the political appeal of maintaining
entitlements has long undermined investment (Figure 14), which might go
some way to explaining the current productivity dilemma.

Countries with deficient public investment, in terms of both fixed capital and
education, alongside large unfunded liabilities, will find it difficult to raise
productivity and growth rates. Fiscal accounts will see continual pressure.
Historical investment returns will not be repeated. Increases in real per capita
incomes will fall.

One possible solution would be to means-test all benefits, apply constant taxa-
tion into retirement on income (i.e. pensioners continue to pay social security
contributions into retirement, like most commercial insurance policies require)
and introduce wealth taxes. This would allow for increased investment in
infrastructure, education and state backing for new technologies that are not

G4 public sector investment, % of GDP

5.25

5.00

4.75

4.50

4.25

4.00

3.75

3.50
G4 (Weighted) Trend
3.25
Mar-94
Mar-95
Mar-96
Mar-97
Mar-98
Mar-99
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
Mar-10
Mar-11
Mar-12
Mar-13
Mar-14
Mar-15
Mar-16
Mar-17

Figure 14. Source: Datastream, Independent Strategy

41
DEATH OF DEMOCRACY

yet commercially viable. It is the latter that historically have proved critical to
driving the technological breakthroughs needed to cope with such challenges.

Globally, both savings and investment rates, as well as potential output growth,
are likely to fall as these demographic tailwinds become headwinds. The
Bank of International Settlements (BIS) contends, however, that ex ante
savings will fall faster than ex ante investment. The net impact will be a
higher “market-clearing” real interest rate (ex post, of course, savings and
investment must balance).

That might be right. But bear in mind also that the real cost of capital is partly
a function of the real return that can be generated on it; and this is likely to
fall as growth slows. Furthermore, inflationary pressures are likely to rise.
The cheap expanding labour from productive areas of the world (i.e. the esta-
blished global supply-chain) may be replaced at the margin by unproductive
and forcibly-subsidised labour from other areas of the world (principally
the AIME bloc, currently outside the supply-chain).This can only be highly
inflationary. So even if real interest rates rise only gradually, nominal inte-
rest rates would be pushed up more significantly. Most governments in the
western world have reached a debt limit that is only made sustainable due to
historically low interest rates (Figure 15).

Zombie corporations, loaded with debt, survive for the same reason.
Productivity growth is declining because too much cheap capital is being
allocated to those who use it inefficiently or to speculate on high-yielding,
high-risk assets. Central banks (CBs) co-opted as economic agents of last

Real 10-year bond yields (core CPI-deflated), %

5.0

4.0

3.0

2.0

1.0

0.0

-1.0
US Jap Ger UK
-2.0
Nov-03

Nov-04

Nov-05

Nov-06

Nov-07

Nov-08

Nov-09

Nov-10

Nov-11

Nov-12

Nov-13

Nov-14

Nov-15

Nov-16

Nov-17

Figure 15. Source: Bloomberg, Independent Strategy

42
 Chapter 3

(and first!) resort, have been painted into a corner, unable to raise interest
rates much even if they wanted to. This is a vicious cycle. Shrinking and
ageing populations in the rich world, coupled with weak labour productivity
growth, effectively limit the capacity of economies to “grow” their ways out
of these debt burdens.

The implications for financial asset markets are profound. Lower savings
and less growth reduce the capacity to pay down debt burdens or work
them out. It’s hard to see the discount rate dropping much from current
levels. Similarly bond yields further along the curve are unlikely to go
lower either in real or nominal terms. As growth slows, richly-valued
equities would seem to be particularly vulnerable, not least given how
complacent investors have become about risk (Inset 1). A more dramatic
shift into a post-growth world could even bring to an end the golden age
of investing.

Near term, of course, the question of CBs’ reaction function comes into play.
Falling stock prices, probably driven by contracting multiples, would under-
mine private sector balance sheets and investment confidence. Certainly, if
there were to be a precipitous drop in equity markets, it seems likely that
CB monetary policy would remain highly accommodative to offset the dete-
rioration in “secondary market” liquidity conditions (under the mantra of
maintaining financial stability).

Bubble trouble
• A painting sold for $450 million
• Bitcoin soared over 1600% from $952 to ~$17,000
• The BoJ and the ECB bought $2 trillion of assets
• Global debt rose to $225 trillion, or more than 324% of world
GDP
• US corporations sold a record $1.75 trillion in bonds
• European high-yield bonds traded under a 2% yield
• Argentina, a serial defaulter, sold 100-year bonds in an
oversubscribed offer
• Illinois, hopelessly insolvent, sold 3.75% bonds to bondholders
fighting for allocations
• Global stock market capitalization skyrocketed by $15 trillion to
over $85 trillion and a record 113% of global GDP
• The market cap of the FANGs increased by more than $1 trillion.
• S&P 500 volatility dropped to 50-year lows and Treasury
volatility to 30-year lows
• Money-losing Tesla Inc. sold 5% bonds with no covenants as it
burned $4+ billion in cash and produced very few cars

Inset 1. Source: Independent Strategy

43
DEATH OF DEMOCRACY

This is the sort of Orwellian world where governments and CB’s distribute
cash as universal basic income to individual accounts (held at CBs?) using
blockchain ledger technology and force spending through time limits on
these transfers. It would make the achievement of financial stability, the
key challenge CBs face in the next decades, illusory. Where this all comes
unstuck is if inflation rises and CBs are backed into a corner from which
they can’t escape.

There is, of course, a more bullish scenario. If technological developments

(AI, Big Data, blockchain etc.) push up productivity by reducing the demand
for labour (just as its supply is shrinking), growth might remain more or less
buoyant. And inflation would be kept at bay.

So where should investors and savers look to invest?

• Countries with young, dynamic populations, competitive economies, low

public sector liabilities and governments that implement essential structural
reform ahead of the curve should fare best.

• Governments in most DMs and many EMs will have to spend an ever-greater
proportion of their tax revenue on pensions and healthcare. This diminishes
the resources available for other discretionary expenditure items. Or else
taxes will have to go up.

• Rising “unproductive” expenditure, as well as rising taxes, are bad for

growth.

• Citizens in ageing societies will have to work for longer before gaining a
pension. Those with assets (including their own home) will increasingly
be relied upon to fund at least part of their own dotage.

• Pensions are likely to be lower as a share of final salary than in the past.

• Demographic shifts in China, as one of the fastest-ageing countries and for

the time being the most populous, will have an enormous impact. Lower
demand will weigh on export-dependent economies, especially the com-
modity producers. This reverses one of the major demographic drivers of
globalisation, productivity and rising living standards through the supply
of cheap and plentiful labour. After all, between 1990 and 2014 China and
Eastern Europe alone increased the workforce available for global produc-
tion by a staggering 120%.

44
 Chapter 3

• Boosting productivity will come into focus. Competition for skilled labour
will rise and wages will reflect this, incentivising the substitution of capital
for labour.

• Economic migration and refugee flows from war-torn and famine-ridden

areas of the world will remain a constant theme. Europe is particularly
vulnerable.

45
CHAPTER 4
Price and prejudice

The reflation trade took on renewed urgency in the first half of 2018, as the
late-cycle fiscal stimulus delivered by the White House brought those already
fretting over resurgent price risks to a fresh pique. The short-term cyclical
drivers are certainly all pointing to a quickening of inflation. Indeed, head-
line US price levels have picked up and even core PCE is not too far from
the Fed’s 2% target. The gradual increase in nominal wage growth has also
continued (Figure 1).

But do these glimmers of inflation present a meaningful risk? The recovery

in wages has been the missing piece of the jigsaw for many. But real wage
growth has been negligible in most top economies. In the US, real total
economy earnings peaked back in 2015, alongside employment growth, and
has been on a downward trajectory ever since (Figure 2, page 48). While the
backdrop still points to slightly faster headline inflation rates and wages, the
US economy still doesn’t seem to be in a state to generate any real inflation
risk. This is largely due to structural factors that the Fed and Wall Street’s
models struggle to capture.

The persistence of low inflation has not simply been an overhang from the
financial crisis. Disinflation was present well in advance of the downturn. It

Measures of US nominal wage growth, % chg yoy

4.5

4.0

3.5

3.0

2.5

2.0

1.5

1.0
Dec-07

Dec-08

Dec-09

Dec-10

Dec-11

Dec-12

Dec-13

Dec-14

Dec-15

Dec-16

Dec-17
Jun-07

Jun-08

Jun-09

Jun-10

Jun-11

Jun-12

Jun-13

Jun-14

Jun-15

Jun-16

Jun-17

Avg Hourly Earnings All Employee Hourly Atlanta Fed ECI (Wages) Avg

Figure 1. Source: BLS, Independent Strategy

47
DEATH OF DEMOCRACY

just took this shock to create some clear water between the hangover from
the 1970s and 1980s to the structurally low inflation environment that has
dominated since the mid-1990s. While most academic economists (and the-
ories) are wedded to the lessons learnt from the 1970s shock, the fact is this
period is the historical outlier (Figure 3).

Even the very long-term averages don’t look different. If you take US infla-
tion all the way back to 1872 the annual change averages 2.2%. Ex-out the
inflationary 1970/80s decade and it falls to just 1.8%. For a ten-year period

US total real (non-farm) economy earnings, % chg

7.0 % chg m/m % chg y/y - rhs
6.0
5.0
4.0
3.0
2.0 2.09
1.0 0.70

0.0
-1.0
-2.0
Aug-13

Aug-14

Aug-15

Aug-16

Aug-17
Nov-13

Nov-14

Nov-15

Nov-16

Nov-17
Feb-14

Feb-15

Feb-16

Feb-17

Feb-18
May-13

May-14

May-15

May-16

May-17

* = Private Non-farm Employment x Real Hourly Earnings x Hours Worked

Figure 2. Source: BLS, Independent Strategy

US PCE inflation, % chg y/y

12.0

10.0

8.0

6.0

4.0

2.0

0.0
PCE Avg 1960-2017 Avg 1960-2017 (Ex 1973-1982)
-2.0
1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
2008
2011
2014
2017

Figure 3. Source: BEA, Independent Strategy

48
 Chapter 4

within a near 150-year sample to have such an effect underlines how unique
a time the stagflationary 1970s was. It also shows central banks have been
undershooting their mandates for over a century!

Of course, pre-WW2, the volatility of both prices and growth was far more
extreme. Jumps in inflation were followed by periods of equally acute defla-
tion (Figure 4) while the economy naturally snapped back from recessions
with bursts of rapid growth (Figure 5, page 49). That meant there were not
ruinous periods of runaway prices where wealth was destroyed (outside of

US pre-WW2 consumer price index, % chg yoy

25.0

20.0

15.0

10.0

5.0

0.0

-5.0

-10.0

-15.0
CPI Avg 1873-1949
-20.0
1873
1877
1881
1885
1889
1893
1897
1901
1905
1909
1913
1917
1921
1925
1929
1933
1937
1941
1945
1949

Figure 4. Source: Robert Shiller, Independent Strategy

US GDP since 1871, % chg yoy

20.0

15.0

10.0

5.0

0.0

-5.0

-10.0

-15.0
% chg y/y 10yr Rolling Avg
-20.0
1871
1877
1883
1889
1895
1901
1907
1913
1919
1925
1931
1937
1943
1949
1955
1961
1967
1973
1979
1985
1991
1997
2003
2009
2015

Figure 5. Source: Robert Shiller, Independent Strategy

49
DEATH OF DEMOCRACY

the Great Depression). Losses one year were often recouped the next, while
the underlying direction of travel remained positive.

Obviously, the economy changes over time, so it’s reasonable to argue

that the swings of pre-1945 are irrelevant today. Many of the institutions
that we take for granted either did not exist, or were new — for example
the Federal Reserve was not founded until 1913. Similarly, most of the
economic theories policy makers now take for granted were either in
their infancy or hadn’t been thought of at all. Government’s role in the
economy was also far more limited. The result of these developments is
a socio-economic structure that can now deliver counter-cyclical mea-
sures — both monetary and fiscal — as needed, theoretically smoothing
the economic cycle.

The economy that delivered the inflationary rush of the 1970s is also fun-
damentally different to the one we live and work in today. Many of these
structural shifts should influence price-setting behaviour. There were also
other unique factors at play, most notably the adjustment which followed the
demise of the post-war monetary regime — the gold standard.

The most visible structural difference is demography. It impacts the economy

in a variety of ways and over varying timeframes. As it’s a slow-moving
beast, having little bearing on immediate inflationary pressures, it is perhaps
neglected as an input into understanding underlying price risks. But it does
have significant effects on levels of both supply and demand.

US Federal government spending forecasts, % of GDP

14.0

12.0

10.0

8.0

6.0

4.0
Health & Entitlements Discretionary
2.0
1970
1973
1975
1978
1981
1983
1986
1989
1991
1994
1997
1999
2002
2005
2007
2010
2013
2015
2018
2021
2023
2026

Figure 6. Source: CBO, Independent Strategy

50
 Chapter 4

There are two main demographic forces at currently at work.

First, population ageing. This is the combination of the baby boomer hump
reaching its twilight years and the more general increased longevity. This
is rapidly feeding in to entitlement and healthcare costs, creating signifi-
cant fiscal stress. One only has to look at the shift in federal spending in
the US to see the damage this has inflicted on value-added “discretionary
expenditure”. Unreformed entitlement programmes soak up an ever-grow-
ing (and increasingly disproportionate) share of revenues and the political
class, representing this demographic bulge, has paid for this at the expense
of future generations and more productive endeavours today (Figure 6,
page 50).

The resulting decline in government investment (e.g. infrastructure, R&D and

education) weakens the foundations the rest of the economy is built upon.
It’s no coincidence that government investment and productivity have been
trending lower in lockstep (Figure 7). Nor that private non-residential fixed
investment, net of depreciation, has also been in cyclical decline (Figure 8,
page 52). Putting the accumulated capital deficit right will be a multi-year,
multi-trillion dollar challenge.

The drag from demographics not only impacts the fiscal and investment story
but also structural demand economy-wide. Older groups spend less, a function
of the move to lower retirement incomes as well as the lifestyle changes that
happen as we age. Taken together, these demographic shifts risk creating a
demand and investment vortex.

US government capital investment & productivity (5yr

rolling averages)
5.0 7.5
Non-Farm Productivity, % chg
4.5 7.0
Gross Govt Investment, % of GDP - rhs
4.0 6.5
3.5
6.0
3.0
5.5
2.5
5.0
2.0
4.5
1.5
1.0 4.0

0.5 3.5

0.0 3.0
Dec-55

Aug-62
Dec-65

Aug-72
Dec-75

Aug-82
Dec-85

Aug-92
Dec-95

Aug-02
Dec-05

Aug-12
Dec-15
Apr-59

Apr-69

Apr-79

Apr-89

Apr-99

Apr-09

Figure 7. Source: BLS, BEA, Independent Strategy

51
DEATH OF DEMOCRACY

US net annual fixed investment, % of GDP

6.0

5.0

4.0

3.0

2.0

1.0

0.0
IP Structures Equipment Total Investment
-1.0
1950
1953
1956
1959
1962
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007
2010
2013
2016
Figure 8. Source: BEA, Independent Strategy

Demography & constant living standards

Figure 9. Source: Independent Strategy

Ironically, this does not necessarily lead to a collapse in living standards.

Living costs change over one’s lifetime, which can be simply illustrated
(Figure 9). The rot can be obscured for perhaps decades. Japan is an extant
example of this, with a stark divergence between GDP and per capita income
growth. This proves you don’t need to maintain real GDP growth to maintain
living standards if the population is ageing, and then shrinking.

The second major aspect of demography is the slowdown in growth of the

working-age population. And not just in relative terms due to the bulging

52
 Chapter 4

boomer bracket. The post-war baby-boom created a hump which drove labour
market growth sharply higher until the late 1970s. But they didn’t “recipro-
cate”. Birth rates have since fallen, constricting labour market supply. This
was a function of improvements in infant mortality, the advent of cheap
effective contraception and the surge of women into the workforce — most
noticeably between 1950 and 1990 (Figure 10).

More lately, declining fertility has been a contributor. These trends are difficult
to reverse once culturally engrained. The US actually has a higher fertility rate
than most DMs (the Eurozone’s fertility rate is a lowly 1.5 while in Japan it’s
just 1.4), but with a birth rate of 1.8 children per mother it’s still well below
the 2.1 line needed to keep the general population stable.

The rate of change of the labour market has numerous impacts on inflation.
The worker cohort has the highest propensity to consume and thus is the
primary determinant of demand growth. This is the group that needs to buy
a home and furnish it. Then raise children — an even more expensive hobby,
which no doubt is another contributor to the decline in birth rates. It’s hardly
surprising that the period which saw the fastest growth in the labour force
was the period where inflation was at its least controlled (Figure 11). This
was the natural peak of the post-war demand boom. And it’s a pattern that
will not be repeated.

The 1970s were also a time when markets were beholden to labour, negating
the supply-side response that the economy could be expected to generate today.
Indeed, this was the golden age of unionisation with a quarter of US workers

US civilian labour force by gender, mn

180.0 100.0
Male Female Female as % of Male
160.0
90.0
140.0

120.0 80.0

100.0
70.0
80.0

60.0 60.0

40.0
50.0
20.0

0.0 40.0
1951
1954
1957
1960
1963
1966
1969
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
2008
2011
2014
2017

Figure 10. Source: BLS, Independent Strategy

53
DEATH OF DEMOCRACY

US labour force (% chg yoy 5yr avg) & CPI (% chg yoy)
3.0 16.0
Civilian Labour force CPI - rhs
14.0
2.5
12.0

2.0 10.0

8.0
1.5
6.0

1.0 4.0

2.0
0.5
0.0

0.0 -2.0
Mar-64

Oct-78

Mar-99

Oct-13
Dec-72

Aug-84

Dec-07
Jan-70

Nov-75

Jan-05

Nov-10
Jun-55

Feb-67

Sep-81

Jun-90

Feb-02

Sep-16
May-58

Jul-87

May-93
Apr-61

Apr-96

Figure 11. Source: BLS, Independent Strategy

US manufacturing output & employment, 2007 = 100

130.0

120.0

110.0

100.0

90.0

80.0

70.0

60.0
Manu Output Manu Employment
50.0
Oct-94

Oct-01

Oct-08

Oct-15
Feb-97

Feb-04

Feb-11

Feb-18
Aug-93

Aug-00

Aug-07

Aug-14
Apr-91
Jun-92

Dec-95

Apr-98
Jun-99

Dec-02

Apr-05
Jun-06

Dec-09

Apr-12
Jun-13

Dec-16

Figure 12. Source: Federal Reserve, Independent Strategy

in a labour organisation in 1970, compared to just 10% today. Manufacturing

employment was still high (Figure 12), accounting for 40% of total private
sector employment. The well-paid full-time blue-collar worker — fulfilling
the American dream — was still base reality.

But just a decade later and the rot had set in. De-unionisation and the growth
of part-time and temporary employment, in response to the inflation surge,
created a far more flexible labour force. And the globalisation that followed
in the 1990s, with the formation of the WTO, opened up domestic labour

54
 Chapter 4

markets to more international competition. The effect of these changes is most

visible in the real wages of male workers (Figure 13), which, based on BLS
data, are actually lower now that they were forty years ago. Households that
could survive supported by a sole male breadwinner have been consigned
to history.

It’s not the entire story of course. Non-wage income has grown over this
period, which adds a few percentage points to the tally. And there are argu-
ments that the deflators used don’t accurately capture the actual rise in living

US median full-time wages, 1970 = 100

130.0
Full-time Real Wages Men Women
125.0

120.0

115.0

110.0

105.0

100.0

95.0

90.0

85.0

80.0
1981
1982
1984
1985
1987
1989
1990
1992
1993
1995
1996
1998
2000
2001
2003
2004
2006
2008
2009
2011
2012
2014
2015
2017

Figure 13. Source: BLS, Independent Strategy

US personal compensation & wages, % of GDP

59.0 53.0

58.0
51.0
57.0
49.0
56.0

55.0 47.0

54.0
45.0
53.0 53.0
43.0
52.0 43.0
Personal Compensation Wages - rhs
51.0 41.0
Oct-64

Oct-69

Oct-74

Oct-79

Oct-84

Oct-89

Oct-94

Oct-99

Oct-04

Oct-09

Oct-14
Apr-62

Apr-67

Apr-72

Apr-77

Apr-82

Apr-87

Apr-92

Apr-97

Apr-02

Apr-07

Apr-12

Apr-17

Figure 14. Source: BLS, Independent Strategy

55
DEATH OF DEMOCRACY

standards over this period. It’s doubtful any worker today would swap their
life and its comforts for a trip back to 1975. But it’s difficult to find a single
metric that suggests workers have shared in the growth of the overall eco-
nomy. Indeed, wage share has fallen from around 50% of GDP to just 43%
(Figure 14, page 55). That acts as a further drag on demand, which in turn
filters through to price levels.

In addition to changes in the size, there have been interesting shifts within the
labour force that have similar effects. The decline in prime-age participation
rates is the most visible variation. The bulk of the decline in the participa-
tion rate can be explained by boomers exiting the workforce. But there is
a substantial residual that suggests there is still a large amount of “hidden”
slack that low headline unemployment rates obscure. Indeed, the number of
working-age people not in the labour force is some 15 million higher than it
was pre-millennium (Figure 15). It’s quite possible this reflects labour market
flexibility, which makes dropping in and out of the labour force far easier.
But there seems to be some fundamental social shift embedded here as well.
This is evident in the decline in prime working male participation rates, the
US being the only major country to exhibit this trend.

The loss of jobs in the US rustbelt and growth of new industries elsewhere
is a factor, creating a misallocation of both skills and labour that in hind-
sight was beyond the free markets ability to respond to. We’d note that this
period also ties with the massive increase in US incarceration rates. The
prison population has grown by nearly 2mn since 1980 and, if you include
those on parole, the net currently captures nearly 6mn Americans, or about

US working age population (16-64) not in labour force

60.0 41.0
Not in Labour force, Working Age (mn) As % of total Labour Force - rhs
39.0
55.0 54.8
37.0

50.0
35.0
33.9
33.0
45.0

31.0
40.0
29.0

35.0 27.0
Mar-84

Oct-93

Mar-07

Oct-16
Dec-89

Aug-97

Dec-12
Jan-88

Nov-91

Jan-11

Nov-14
Jun-78

Feb-86

Sep-95

Jun-01

Feb-09
May-80

Jul-99

May-03
Apr-82

Apr-05

Figure 15. Source: BLS, Independent Strategy

56
 Chapter 4

half the increase seen in the prime-age non-working population during this
time. That’s a group that, assuming it is allowed to participate in the labour
market, has far more limited bargaining power.

So there are several factors that form our structural nutshell. Demographics
is the most far-reaching as it weighs both on supply and demand, via ageing
and falling birth rates. These have proved self-reinforcing, sucking money
from the solutions (investment and productivity). The decline in the growth
of the working-age population is a further drag on demand. And falling birth
rates act as yet another anchor.

Liberalisation, followed by globalisation, comes from the other corner.

Workers have less leverage in regulated markets and globalisation has increa-
sed competition, bringing labour costs down in a mass global arbitrage. This
has delivered cheaper, higher quality, goods by optimising supply chains and
allowing the free flow of information and capital. That, in turn, has boosted
living standards in developed markets and lifted billions of people out of
poverty. But there are winners and losers in every process. In the former
manufacturing heartlands of middle-America this has led to a misallocation
of skills and resources. And capitalists who can’t adapt are very unhappy
capitalists indeed.

Furthermore, workers from everywhere are competing against technological

change and automation, which is expanding beyond its more traditional realms
into cognitive functions and services. All of these disruptive technologies
are disinflationary.

This doesn’t mean inflation can’t ever rise again. But what it does suggest is
that there will be more viscosity to short-term cyclical upswings in prices.
Changes in underlying price levels should remain modest and the chance of
any sustained period of runaway inflation is minimal, even after a lengthy
period of low interest rates and an economy that is running closer to capacity.

That raises interesting questions in a world where central banks deem 2% to

be the hallmark of price stability. It could well turn out to be the case that to
sustain inflation at these mandated levels requires a permanently depressed
real interest rate. Perhaps even negative real rates. This sounds perverse. But
so is using monetary policy to target an arbitrary price level in a world that is
structurally different from the period that conjured up modern monetarism.
Rather than trying to depress rates in the endless pursuit of 2% inflation,
central banks should focus on overall financial stability. Failure to do so
will only increase risk of a repeat of the crisis and a real deflationary shock.
Ultimately, the pursuit of price stability only contributes to economic stability

57
DEATH OF DEMOCRACY

if it also shapes financial stability.6

The Fed is moving slowly towards this viewpoint. It is normalising policy

(via both higher short-rates and quantitative tightening) not due to the risk
of an inflation overshoot — it sees inflation moving back to target, but isn’t
forecasting it running much higher — but to better balance financial stability
and, more lately, the risk of overheating from looser fiscal policy. This is
more critical at a time when productivity growth remains weak. Not because
this could trigger faster inflation, but because poor productivity is equally a
structural phenomenon. Indeed, if there is one measure that would suggest
that structural headwinds are abating, it would be an improvement in pro-
ductivity. Until then, traditional econometric inflation models are likely to
continue misfiring.

58
CHAPTER 5
Of rabbits, bankers and what matters

Central bankers’ reluctance to address the failings of their quantitative macro

models (while overlooking the qualitative forces that are affecting economies)
is nothing new. As time goes by, the risks of continuing like this multiply.
Essentially, growing unproductive debt at a rate faster than the economy can
expand to service it is self-defeating. The fact that this strategy is pursued
with the aim of generating an inflation rate of dubious value is all the more
troubling.

While the central bank money-wheel keeps spinning, asset markets will
continue to rise. But central banks need to embrace the structural forces that
are affecting economies if they are to avoid the cycle ending in more than
just an echo of recent disasters.

If central bankers were rabbits they would have three ears. This is not to say
they are monsters. They are, in the main, diligent, dutiful and moderately
paid. But they are inbred. They are selected out of a pool of academics (and
the odd senior official) and return to academia when they are done — that is
if they don’t opt to cash-in at an investment bank instead. Their central bank
conferences are peopled by their peers and academics, who present esoteric
papers inaccessible to mankind, usually about yesterday’s policy options.
The result is an unrealism of thought that is critical now. “Now”, because of
the need to return to a normalised monetary policy almost everywhere that
matters. As we’ll explain, a lack of realism makes this more unlikely to be
a smooth transition.

Left to their own devices, humans will generally concentrate on perfecting

as narrow a perception of reality as they are allowed. How universal that will
be depends on how broad their vision is. Jane Austen’s two inches of ivory
captured the universe. So does Monet’s jardin. Not to mention Wordsworth’s
use of the pastoral microcosm to paint the macrocosm. But much of today’s
‘specialisation’ of expertise lacks the imaginative gift to see this.

Dead too is the day of the ‘generalist’ like Francis Bacon, 17th century English
philosopher, author, statesman, scientist, jurist and orator who died as a result
of pneumonia caught burying a chicken in snow to test refrigeration. The
result is narrow vision.

59
DEATH OF DEMOCRACY

US simple Phillips curve, 2000-2017

11.0
U-rate, %

10.0

9.0

8.0

7.0

6.0

5.0

4.0
R² = 0.2889
3.0

2.0
0.75

1.00

1.25

1.50

1.75

2.00

2.25

2.50

2.75
Core PCE, % chg y/y

Figure 1. Source: Datastream, Independent Strategy

Today’s major central banks all have the same target — 2% inflation — and
similar tools for achieving it. But the target itself may not be relevant and
the tools used to set the policies to achieve it are based on theoretical models
which may lack reality.

Key components of these models are driven by unmeasurable variables like

R*, the equilibrium rate of interest (to achieve maximum output without
inflation or deflation), and NAIRU, the equally unobservable equilibrium
unemployment rate. And, of course, the Phillips curve (Figure 1). These hypo-
thetical models drive other models that set policy. This is at worst Kafkaesque
and at best doubtful practice. Central bankers are only just beginning to
question their models.

This fallacy of specialisation can be illustrated. All the above paraphernalia

of tools and targets boil down to saying, if the economy has no output gap
(capacity is used up and everyone who wants a job has one) growth will result
in rising inflation when it exceeds the level of productivity of the resources
employed.

But what if other forces drive the inflation rate — globalisation, technological
change and demography, for example? And what if wages do not rise with
employment because of the sorts of jobs now being created and the wages
they are worth? And what if these forces are global and not domestic? The
answer is that the models and policies are then dealing with a fantasy and
central bankers are a cavalry host of Don Quixotes tilting at windmills. That is
our view. If correct, it would mean that the traditional role of central bankers

60
 Chapter 5

Cumulative chg in global non-financial debt since end-

2007, % pts of global GDP
50.0

40.0

30.0

20.0

10.0

0.0

HHs NFCs Govts

-10.0
Mar-07

Mar-08

Mar-09

Mar-10

Mar-11

Mar-12

Mar-13

Mar-14

Mar-15

Mar-16

Mar-17
Sep-07

Sep-08

Sep-09

Sep-10

Sep-11

Sep-12

Sep-13

Sep-14

Sep-15

Sep-16
Figure 2. Source: BIS, Independent Strategy

as guardians of inflation is much diminished. But that does not mean they
have no purpose. They do.

The other day we laid out on the kitchen table all the current central bank
reports and minutes from the ECB, Fed, BoJ and also the BIS — the central
bank of central banks and in many ways their collective conscience. Only
the BIS dealt convincingly with what we see as the elephant in the room7 or
the major issue central banks should be addressing.

That elephant is the burgeoning mountain of debt in relation to GDP (Figure

2) and the misallocation of resources it entails. The proof that the increases
in debt are inefficient is that it produces less GDP at the margin. And GDP is
what should pay for it. There is also little doubt that the debt build-up is due to
the mispricing of capital for which central banks are largely responsible. This
frames the policy dilemma. If central banks raise interest rates significantly,
the debt mountain will come crashing down. If they don’t, the imbalance and
source of future instability will continue to grow apace.

Yet there is no discussion in any of the world’s major central banks about this.
Only the BIS’s Claudio Borio8 is sounding the alarm. The rest are either in
denial or aware of the danger and doing the three monkey thing. Is the obses-
sion with the unmeasurable and the model down to denial or a smokescreen?
In any case, this defines the future primary task of central banks: financial
stability. This is all very neat but what does it mean for us as investors? Some
things are already apparent.

61
DEATH OF DEMOCRACY

The inflation targets pursued by the major central banks are determined
globally more than domestically and won’t be achieved. This means bond
yields won’t rise as much as we once thought. Central banks are only likely
to raise rates very gradually because inflation targets will continue to be
elusive (or because there is a subliminal awareness of the elephant in the
room). But they will have to raise them nonetheless because they need a
buffer for future crises.

The increase in policy rates will not result in a meaningful rise in real long-
term rates. Central banks will9 endeavour to hold down term-premia and long
rates. The BoJ already does this as a part of its monetary policy targets. So
the build-up in debt relative to GDP will continue.

The result is that a future debt crisis is in the making. Timing is difficult.
But the new tools of central banks, such as high levels of excess commer-
cial bank reserves, will only be partially successful in assuaging the effects.
Until that happens, the markets will go on dancing to the music. The drivers
of currencies are likely to change. Relative monetary policies will wane in
influence. Relative growth and return on assets as well as geopolitical events
will be more relevant.

62
CHAPTER 6

Technology — saviour or curse?

The second machine age, the fourth industrial revolution, however you want
to term it, it’s undeniable that we’re living in an epoch of technological
transformation. And one that is unprecedented in history. While the indu-
strial revolution was disruptive, its reach was limited. But with the creation
of thinking machines, we face technologies that could end up competing
directly with what it means to be human. While the final outcome has yet to
be determined, this changes the rules of the game. And the policy responses
to cope will have to be equally innovative.

Optimism abounds that this revolution will transform society in a positive

way, as previous technological revolutions have done. By its very nature the
productivity enhancements that technology facilitates should raise wealth
levels. But this approaches things from a very generalised, long-term stand-
point. In the transition, such shifts can have highly variable effects. There
will be winners. There will be losers.

The sheer breadth of disruption in the information age makes analysing these
all the more problematic. Furthermore, there is a number of structural shifts
that are happening in lockstep, most of which are rooted in demography.
Disentangling these interwoven threads will be difficult. Explaining the
impact of these changes to an electorate whose lives are being disrupted will
be a task of even greater magnitude.

The low pay boom

It’s the failure to grasp the challenges presented by technological change
that have contributed to many of the problems that western democracies
are already facing. This concept is captured most simply by the ‘death
of the middle class’ thesis, which posits that the deindustrialisation wave
that gathered steam in the 1980s hollowed out the middle classes, wiping
out skilled blue collar middle-income jobs. As a result, many of these
workers found themselves in unskilled work with commensurately lower
pay, if in work at all. In the US since 1979, 66% of all job creation came
from the four lowest-paying sectors, compared to 7.4% for the top four
(Figure 1, page 64). That has lifted employment in these low pay areas from
31.4% of the total to 52.8% as of today. The US now proudly has the highest
proportion of low paying jobs in the OECD.

63
DEATH OF DEMOCRACY

While the information and technology revolution that developed over the
course of this period created millions of new jobs, these were largely white
collar posts that required higher levels of skills and education, or at least
skills that were not directly transferrable from a Michigan car plant. And
even in some of the more disruptive sectors, the surge in productivity
meant that jobs created were often lost elsewhere in the industry, or even
within individual firms. Information, for example, saw near zero net job
creation over the entire pre- and post-crisis period, whereas professional

US employment growth since 1979 by sector (mn),

ranked by average earnings
20.0

15.0

10.0

5.0

0.0

-5.0

-10.0
Wholesale

Trans & Ware

Retail
Utilities

Durable Goods
Mining

Edu & Health

Other Serv
Prof & Biz
Financial Serv

Leisure
Construction
Information

Non-Durables

Highest Pay Lowest Pay

Figure 1. Source: BLS, Independent Strategy

US employment growth by sector (mn), ranked by

aveage earnings
6.0
2009-2018
5.0
1999-2008
4.0
1989-1998
3.0
1979-1988
2.0
1.0
0.0
-1.0
-2.0
-3.0
-4.0
Wholesale

Trans & Ware

Retail
Utilities

Durable Goods
Mining

Edu & Health

Other Serv
Prof & Biz
Financial Serv

Construction

Leisure
Information

Non-Durables

Highest Pay Lowest Pay

Figure 2. Source: BLS, Independent Strategy

64
 Chapter 6

and businesses services saw the strongest growth of any area (Figure 2, p.
64). The result has been a widening of inequality and decrease in social
mobility, as the gaps between the rungs of the ladder were pulled apart.
Indeed, in the US, the GINI coefficient rose from 34.6 in 1979 to 41.5 as
of 2016, which puts America alongside Mexico and Argentina in the ine-
quality stakes.

Some argue that globalisation was as much to blame as technological change.

And this is obviously a factor, simply from the perspective that both cheap
labour and technology investment provide similar outcomes in the shor-
ter-term — they lower the cost of production. But however we split this, it’s
difficult to dispute that the gains of the computer and information revolution
have been distributed unequally.

Disruption accelerating
We take this as the starting point for analysing just how technology will
impact the economy and society over the next decade or two. We are optimi-
stic that in the long-run the current information revolution will raise living
standards across the board. There is not one sector of the economy that can’t
be improved (Inset 1, p. 66). But as these innovations wash through it’s vital
that governments take steps to prevent “winner takes all” outcomes.

Unfortunately, the network effects of the internet mean nearly all online sectors
have a monopolistic predisposition. We’ve seen this in internet search, social
media and retail for example. And new challengers are more often than not
bought up by the dominant firms, further stifling competition. That’s not to
say that there is no social good to come from the network effects these behe-
moths create. There are clearly significant productivity gains to be unleashed
from this growth and the growth of other “intangibles”, both in terms of cost-
and time-saving as well as the ability to replicate digital goods or services
instantly, infinitely and for almost zero marginal cost.

Unlike more traditional monopolistic industries, the tech sector appears

to have slightly more altruistic tendencies; at least at this stage. And the
pace of disruption has been so fast that regulators have struggled to digest
the implications of its dominance. Furthermore, by its nature tech survives
because of the innovation it delivers. This is why tech firms are well known
for funding investments in technologies that have no proven commercial
success but hold huge promise, the so-called “moon shot” projects. The best
example is Waymo, Google’s self-driving car venture that aims to leap to
fully autonomous driving in one giant step.

65
DEATH OF DEMOCRACY

Total disruption
As artificial intelligence matures as a more generalised technology
we should see breakthroughs in nearly every sector of the econo-
my. The ability of AI to sift through and analyse vast troves of data
will vastly improve the efficiency of most businesses. Medicine is
the most interesting example; already this technology is revolu-
tionising medical diagnosis, allowing diseases to be caught earlier
and treated more effectively. These advances should be comple-
mented by genetics, another field where AI is helping accelerate
development, often in lockstep with diagnostic programmes. Ad-
vanced robotics meanwhile will improve everything from surgery
to health and social care. In an aging society with a shrinking
working age population all of these advances are essential.

Self-driving cars have the ability to massively increase capital

efficiency across industries, improve time efficiency and equally
importantly improve safety in an industry that still contributes to
1.25mn deaths globally each year. The internet of things will
continue to disrupt supply chains, improving efficiency and helping
reduce waste. Advances should continue to drive disruption in en-
ergy and distribution. Battery efficiency, energy storage and smart
grids will move the global economy towards clean energy, while
fields from geo-engineering through to asteroid mining could help
pare dependency on finite natural resources. Even space based
climate management (sails in space to reduce the level of solar
energy hitting the planet) could become viable and safe options.

Inset 1. Source: Datastream

This research is driving forward some of the most critical new areas. This
includes breakthroughs in machine learning, which have accelerated develop-
ment of a number of dependent technologies such as big data, the internet of
things, robotics, self-driving cars, medical diagnostics and genetics. Innovation
is also driving down the costs of clean energy and battery storage, showing
that the exponential improvements that Moore’s law demonstrated for the
silicon chip is in fact applicable to many other innovations. But these changes
are not exclusive to new technologies. Machine learning can already process
legal documents and compose newspaper articles and it won’t be long before
it displaces call centres; one of the “new” soon-to-be “old” industries that
soaked up displaced workers from prior old industry.

The common denominator of all these innovations is that they will destroy
existing systems and replace them with new ones. They will impact the pro-
duction of things, but their real value-added is derived from their intangible
nature. They will, over time, increase living standards, lowering costs and
improving quality. Even at stable income levels, living standards will rise. It
will also make economic growth less dependent upon capital and raw material

66
 Chapter 6

US real investment, Q1 2006 = 100

160.0
Intellectual Property Equipment
150.0

140.0

130.0

120.0

110.0

100.0

90.0

80.0

70.0
Mar-06

Mar-08

Mar-10

Mar-12

Mar-14

Mar-16

Mar-18
Nov-06

Nov-08

Nov-10

Nov-12

Nov-14

Nov-16
Jul-07

Jul-09

Jul-11

Jul-13

Jul-15

Jul-17
Figure 3. Source: BEA, Independent Strategy

inputs. Weak gross fixed capital formation alongside booming R&D spending
in the US highlights this ongoing shift (Figure 3).

Disruptive technologies and the growth of intangibles also improve the qua-
lity of life. Intangibles use less material inputs (the major desecrators of the
planet) and use them more efficiently. For example, using big data and the
internet of things to improve food distribution could slash the one-third of
production that is currently left to waste. That would decrease the cost of
food, reduce the environmental damage from its production and distribution
while delivering a social benefit by allowing land to be returned to the wil-
derness for our children.

Transitions are always problematic

This all sounds very utopian. And ultimately it should be. But it’s moving
from A to B that is the problem. It requires a different type of workforce from
the one that currently exists. And there has been little sign that governments
are willing to invest to cover these eventualities. Indeed, all they have really
done is double down, protecting entitlements at the expense of investment
(Figure 4, p. 68). Prioritised spending — health, social security and defence
— has the most direct connection to voting groups. So while such behaviour
is entirely irrational on a multi-decade timespan, given the high electoral
frequency, behaving any other way would be just as odd.

Like all games everything has a finite lifespan and once the level of disruption
reaches a tipping point it’s difficult to recalibrate. That is the juncture many

67
DEATH OF DEMOCRACY

US government investment, % of GDP

8.0

7.5

7.0

6.5

6.0

5.5

5.0 L/T Avg 4.92

4.5

4.0

3.5 3.35

3.0
Nov-76

Nov-07
Oct-58

Oct-89
Mar-56

Mar-87

Mar-18
Feb-69
Sep-71

Feb-00
Sep-02
Jul-66

Jan-82
Aug-84

Jul-97

Jan-13
Aug-15
May-61
Dec-63

Apr-74

Jun-79

May-92
Dec-94

Apr-05

Jun-10
Figure 4. Source: BEA, Independent Strategy

western democracies seem to be approaching. While everyone will glow

about the benefits of technological change, the underlying stresses it inflicts
are more difficult for voters to adjust to and apportion blame for. Technology,
in fact, has demonstrated itself to be highly effective at feeding voters new
narratives to explain their misfortune!

Click for mass disinformation

One only has to look at social media. During the Arab spring and Ukraine’s
orange revolution it was championed as the propagator of freedom and
democracy, allowing protestors to live-stream abuse from the authorities,
triggering even larger popular support for anti-government demonstrations.

But the ability to push political narratives quickly, to millions, at almost zero
cost, was seized upon by the less altruistic as a way of protecting their inte-
rests (or simply agitate). These ranged from state actors to private sponsors
with specific agendas in mind. The most high-profile affront was executed
by Cambridge Analytica which rather cleverly found a way of exploiting
data on Facebook that allowed it to profile individual voters. The aim was to
predict and influence decision-making and do so without voters ever being
aware that they were being manipulated. Less sophisticated strategies have
been used in countless elections across the world, from the US Presidential
vote to Brexit.

Social media’s problem is far broader than just electoral manipulation. It’s
the selling of unqualified untruths alongside traditional reporting that has

68
 Chapter 6

successfully blurred the lines between reality and people’s perceptions of

truth and reality. And it can do so out of view of most of society, contained
for the most part within the echo chambers of online social groups. And when
it spills over it becomes Trump’s “fake news”. Manipulation is not new, but
the reach and efficacy with which provocateurs can now impact perceptions
and outcomes has increased exponentially. This is potentially toxic for the
democratic process.

A level of accountability is vital for effective discourse and this is something

the internet falls woefully short off. But regulating news and opinion is the
antithesis of many of the freedoms democracy is designed to protect. It’s
difficult to square these contradictions. Moreover, the pace of technological
advancement means that even if you could fairly regulate this space, regula-
tors would always be playing catch-up. The increasing power of big data and
machine learning will allow the creation of even more accurate algorithms,
targeting people’s prejudices in subtle, undetectable ways. This threatens to
be Orwellian brainwashing on steroids.

Big data has proven to be equally troublesome at a government level, pro-

viding the ability to embark on increasingly invasive mass surveillance.
While the legality is often blurry, the narratives wheeled out to defend such
practices are eerily similar in both democracies and authoritarian regimes:
this information is designed to protect you and your country. China already
seems to already be heading to the ultimate dystopian outcome. It aims to
create a fully-networked national video surveillance system by 2020 to keep
“citizens safe”. Alongside this, it is developing a “social credit system” which
would score citizens based on past behaviour, considering misdemeanours
such as traffic offences and court records. That in turn would determine access
to government services and even freedom to travel. There have even been
trials in schools using facial recognition that informed teachers of everything
from late arrivals and absences down to creating a digital dietary footprint
to monitor those eating too much fatty food. While we’d like to think such
extreme abuses of privacy could never happen in a democracy, much of the
surveillance infrastructure is already there. It comes down to which setting
the switch is on. It’s the unforeseen outcomes of the best intentions that
always present the greatest risk.

Ultimate benefits
It’s natural to feel slightly uncomfortable with these threats, but it really
only serves to highlight how quickly things are changing. There is no putting
this genie back in the bottle but being aware of the vulnerabilities allows
one to take steps to protect against them. The need to create more trusted

69
DEATH OF DEMOCRACY

How blockchain works

11
6
Peter sends
Paul receives the
Bitcoin from
Bitcoin to Paul 2
Peter A new Block is
created online. This
represents the
transaction
5
The validated Block is
added to the Chain,
creating a permanent, non- 33
repudiable, transparent
This Block is
record
4 broadcast to
These nodes every node
approve the
transaction and
validate it

Figure A. Source: Independent Strategy

The blockchain’s main innovation is a public transaction record of

integrity without central authority. Blockchain technology offers
everyone the opportunity to participate in secure contracts over-
time, but without being able to avoid a record of what was agreed
at that time. So a blockchain is a database based on a mutually
distributed cryptographic ledger shared among all in a system.
Fraud is prevented through block validation. The blockchain does
not require a central authority or trusted third party to coordinate
interactions or validate transactions. A full copy of the blockchain
contains all the data ever recorded (and is lodged in “heavy”
nodes), making information on the data belonging to every active
address (account) accessible at any point in history (Figure A).

An example is a cryptocurrency transaction: banks and companies

must keep detailed records of where they send money, making
it possible to detect fraud and criminal activity. The blockchain
works differently because it breaks each transaction into compo-
nents (hashes), and then routes the pieces through a computer
network - which stores the data as part of a blockchain — and
directs them to a recipient who can then re-assemble the code
together. If you don’t have the right key, you can’t own a bitcoin.
And if you aren’t at the right digital address (think your home
network’s IP address), then you can’t receive bitcoin.

Inset 2. Source: Independent Strategy

and verifiable news sources in democracies is essential. This is something

blockchain type distributed ledger technologies (Inset 2) could be suited
for, creating the ability for media networks to verify content — basically
triple-sourcing for the digital age. Verification will become all the more

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important as we enter an age where even video content can be perfectly

faked.

It equally applies to addressing the issue of inequality. It’s no coincidence

this disruption has been accompanied by concepts of the universal basic
income (UBI), which aim to address the income side of the problem of labour
displaced by technology.

That doesn’t address the bigger questions of what will become of the human
pecking order once intelligent machines are the norm. If it’s only those at
the top that will be able to capture the fruits of innovation more generalised
artificial intelligence will bring, then the systems that confer legitimacy on
these divergences will be increasingly called into question. That could lead
to a real break away from democracy. But it does at least provide a platform
from which to start to tackle the challenges presented by this process of
technological disruption.

So what to make of all this? There are several forces at work.

For rich democracies:

• Technology in the medium term will increase inequality in developed

democracies even as it lifts all living standards in the very long term.

• Social media and other forums that thrive on user-generated content will
increase in their power to exploit social grievances for political ends — mainly
in support of populism. This process erodes trust and accountability (fake
news), threatening the entire democratic model.

For techno-autocracies:

• Technology will facilitate the control of citizens through big data, blockchain
technologies and increasingly advanced forms of (AI-driven) surveillance;

• But technological advances will lift living standards as they are quickly
applied to both demand and production while the social and equality issues
are carefully controlled by the “all-seeing” state. This confers some degree
of legitimacy on regimes, even if personal freedoms are curtailed. That’s the
techno-autocratic quid pro quo!

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Endnotes

College of Physicians 2017 Harveian Oration

5   Ai Weiwei’s documentary “Human Flow” is a timely reminder of the truly
global scale of the refugee crisis
6 Escaping the hydra — Independent Strategy, 23 January 2018
7 The old monetary horse — Independent Strategy, 24 August 2017
8 Claudio Borio — Through the looking glass, 22 September 2017
9 Praeting to the converted — Independent Strategy, 17 October 2017

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