Key Points from Think Again: The Power of Knowing What You Don’t Know

by Adam Grant

When people reflect on what it takes to be mentally fit, the first idea that comes to mind is usually intelligence. The smarter you are, the more complex the problems you can solve—and the faster you can solve them. Intelligence is traditionally viewed as the ability to think and learn. Yet in a turbulent world, there’s another set of cognitive skills that might matter more: the ability to rethink and unlearn. Imagine that you’ve just finished taking a multiple-choice test, and you start to second-guess one of your answers. You have some extra time—should you stick with your first instinct or change it? About three quarters of students are convinced that revising their answer will hurt their score. Kaplan, the big test-prep company, once warned students to “exercise great caution if you decide to change an answer. Experience indicates that many students who change answers change to the wrong answer.” With all due respect to the lessons of experience, I prefer the rigor of evidence. When a trio of psychologists conducted a comprehensive review of thirty-three studies, they found that in every one, the majority of answer revisions were from wrong to right. This phenomenon is known as the first-instinct fallacy.

We don’t just hesitate to rethink our answers. We hesitate at the very idea of rethinking.

Part of the problem is cognitive laziness. Some psychologists point out that we’re mental misers: we often prefer the ease of hanging on to old views over the difficulty of grappling with new ones. Yet there are also deeper forces behind our resistance to rethinking. Questioning ourselves makes the world more unpredictable. It requires us to admit that the facts may have changed, that what was once right may now be wrong. Reconsidering something we believe deeply can threaten our identities, making it feel as if we’re losing a part of ourselves.

We favor the comfort of conviction over the discomfort of doubt, and we let our beliefs get brittle long before our bones. We laugh at people who still use Windows 95, yet we still cling to opinions that we formed in 1995. We listen to views that make us feel good, instead of ideas that make us think hard.

A hallmark of wisdom is knowing when it’s time to abandon some of your most treasured tools—and some of the most cherished parts of your identity.

We’re swift to recognize when other people need to think again. We question the judgment of experts whenever we seek out a second opinion on a medical diagnosis. Unfortunately, when it comes to our own knowledge and opinions, we often favor feeling right over being right. In everyday life, we make many diagnoses of our own, ranging from whom we hire to whom we marry. We need to develop the habit of forming our own second opinions.

Two decades ago my colleague Phil Tetlock discovered something peculiar. As we think and talk, we often slip into the mindsets of three different professions: preachers, prosecutors, and politicians. In each of these modes, we take on a particular identity and use a distinct set of tools. We go into preacher mode when our sacred beliefs are in jeopardy: we deliver sermons to protect and promote our ideals. We enter prosecutor mode when we recognize flaws in other people’s reasoning: we marshal arguments to prove them wrong and win our case. We shift into politician mode when we’re seeking to win over an audience: we campaign and lobby for the approval of our constituents. The risk is that we become so wrapped up in preaching that we’re right, prosecuting others who are wrong, and politicking for support that we don’t bother to rethink our own views.

If you’re a scientist by trade, rethinking is fundamental to your profession. You’re paid to be constantly aware of the limits of your understanding. You’re expected to doubt what you know, be curious about what you don’t know, and update your views based on new data.

Research reveals that the higher you score on an IQ test, the more likely you are to fall for stereotypes, because you’re faster at recognizing patterns. And recent experiments suggest that the smarter you are, the more you might struggle to update your beliefs.

In psychology there are at least two biases that drive this pattern. One is confirmation bias: seeing what we expect to see. The other is desirability bias: seeing what we want to see. These biases don’t just prevent us from applying our intelligence. They can actually contort our intelligence into a weapon against the truth. We find reasons to preach our faith more deeply, prosecute our case more passionately, and ride the tidal wave of our political party. The tragedy is that we’re usually unaware of the resulting flaws in our thinking.

Research shows that when people are resistant to change, it helps to reinforce what will stay the same. Visions for change are more compelling when they include visions of continuity. Although our strategy might evolve, our identity will endure.

In theory, confidence and competence go hand in hand. In practice, they often diverge. You can see it when people rate their own leadership skills and are also evaluated by their colleagues, supervisors, or subordinates. In a meta-analysis of ninety-five studies involving over a hundred thousand people, women typically underestimated their leadership skills, while men overestimated their skills.

They found that in many situations, those who can’t . . . don’t know they can’t. According to what’s now known as the Dunning-Kruger effect, it’s when we lack competence that we’re most likely to be brimming with overconfidence.

As Dunning quips, “The first rule of the Dunning-Kruger club is you don’t know you’re a member of the Dunning-Kruger club.”

If we’re certain that we know something, we have no reason to look for gaps and flaws in our knowledge—let alone fill or correct them. In one study, the people who scored the lowest on an emotional intelligence test weren’t just the most likely to overestimate their skills. They were also the most likely to dismiss their scores as inaccurate or irrelevant—and the least likely to invest in coaching or self-improvement.

It’s when we progress from novice to amateur that we become overconfident. A bit of knowledge can be a dangerous thing. In too many domains of our lives, we never gain enough expertise to question our opinions or discover what we don’t know. We have just enough information to feel self-assured about making pronouncements and passing judgment, failing to realize that we’ve climbed to the top of Mount Stupid without making it over to the other side.

What he lacked is a crucial nutrient for the mind: humility. The antidote to getting stuck on Mount Stupid is taking a regular dose of it. “Arrogance is ignorance plus conviction,” blogger Tim Urban explains. “While humility is a permeable filter that absorbs life experience and converts it into knowledge and wisdom, arrogance is a rubber shield that life experience simply bounces off of.”

What we want to attain is confident humility: having faith in our capability while appreciating that we may not have the right solution or even be addressing the right problem. That gives us enough doubt to reexamine our old knowledge and enough confidence to pursue new insights.

From time to time, though, a less crippling sense of doubt waltzes into many of our minds. Some surveys suggest that more than half the people you know have felt like impostors at some point in their careers. It’s thought to be especially common among women and marginalized groups. Strangely, it also seems to be particularly pronounced among high achievers.

Plenty of evidence suggests that confidence is just as often the result of progress as the cause of it. We don’t have to wait for our confidence to rise to achieve challenging goals. We can build it through achieving challenging goals. “I have come to welcome impostor syndrome as a good thing: it’s fuel to do more, try more,” Halla says. “I’ve learned to use it to my advantage. I actually thrive on the growth that comes from the self-doubt.”

In a classic paper, sociologist Murray Davis argued that when ideas survive, it’s not because they’re true—it’s because they’re interesting. What makes an idea interesting is that it challenges our weakly held opinions.

“Presented with someone else’s argument, we’re quite adept at spotting the weaknesses,” journalist Elizabeth Kolbert writes, but “the positions we’re blind about are our own.”

he genuinely enjoys discovering that he was wrong, because it means he is now less wrong than before.

He’s a scientist devoted to the truth. When I asked him how he stays in that mode, he said he refuses to let his beliefs become part of his identity. “I change my mind at a speed that drives my collaborators crazy,” he explained. “My attachment to my ideas is provisional. There’s no unconditional love for them.”

Most of us are accustomed to defining ourselves in terms of our beliefs, ideas, and ideologies. This can become a problem when it prevents us from changing our minds as the world changes and knowledge evolves. Our opinions can become so sacred that we grow hostile to the mere thought of being wrong, and the totalitarian ego leaps in to silence counterarguments, squash contrary evidence, and close the door on learning. Who you are should be a question of what you value, not what you believe. Values are your core principles in life—they might be excellence and generosity, freedom and fairness, or security and integrity. Basing your identity on these kinds of principles enables you to remain open-minded about the best ways to advance them. You want the doctor whose identity is protecting health, the teacher whose identity is helping students learn, and the police chief whose identity is promoting safety and justice. When they define themselves by values rather than opinions, they buy themselves the flexibility to update their practices in light of new evidence.

The single most important driver of forecasters’ success was how often they updated their beliefs. The best forecasters went through more rethinking cycles. They had the confident humility to doubt their judgments and the curiosity to discover new information that led them to revise their predictions.

That was a common mistake in 2016. Countless experts, pollsters, and pundits underestimated Trump—and Brexit—because they were too emotionally invested in their past predictions and identities. If you want to be a better forecaster today, it helps to let go of your commitment to the opinions you held yesterday. Just wake up in the morning, snap your fingers, and decide you don’t care. It doesn’t matter who’s president or what happens to your country. The world is unjust and the expertise you spent decades developing is obsolete! It’s a piece of cake, right? About as easy as willing yourself to fall out of love. Somehow, Jean-Pierre Beugoms managed to pull it off.

If we’re insecure, we make fun of others. If we’re comfortable being wrong, we’re not afraid to poke fun at ourselves. Laughing at ourselves reminds us that although we might take our decisions seriously, we don’t have to take ourselves too seriously. Research suggests that the more frequently we make fun of ourselves, the happier we tend to be.

What forecasters do in tournaments is good practice in life. When you form an opinion, ask yourself what would have to happen to prove it false. Then keep track of your views so you can see when you were right, when you were wrong, and how your thinking has evolved.

Andrew Lyne is not alone. Psychologists find that admitting we were wrong doesn’t make us look less competent. It’s a display of honesty and a willingness to learn. Although scientists believe it will damage their reputation to admit that their studies failed to replicate, the reverse is true: they’re judged more favorably if they acknowledge the new data rather than deny them. After all, it doesn’t matter “whose fault it is that something is broken if it’s your responsibility to fix it,” actor Will Smith has said. “Taking responsibility is taking your power back.”

Relationship conflict is destructive in part because it stands in the way of rethinking. When a clash gets personal and emotional, we become self-righteous preachers of our own views, spiteful prosecutors of the other side, or single-minded politicians who dismiss opinions that don’t come from our side. Task conflict can be constructive when it brings diversity of thought, preventing us from getting trapped in overconfidence cycles. It can help us stay humble, surface doubts, and make us curious about what we might be missing. That can lead us to think again, moving us closer to the truth without damaging our relationships.

We learn more from people who challenge our thought process than those who affirm our conclusions. Strong leaders engage their critics and make themselves stronger. Weak leaders silence their critics and make themselves weaker. This reaction isn’t limited to people in power. Although we might be on board with the principle, in practice we often miss out on the value of a challenge network.

Agreeableness is about seeking social harmony, not cognitive consensus. It’s possible to disagree without being disagreeable. Although I’m terrified of hurting other people’s feelings, when it comes to challenging their thoughts, I have no fear. In fact, when I argue with someone, it’s not a display of disrespect—it’s a sign of respect. It means I value their views enough to contest them. If their opinions didn’t matter to me, I wouldn’t bother. I know I have chemistry with someone when we find it delightful to prove each other wrong.

Experiments show that simply framing a dispute as a debate rather than as a disagreement signals that you’re receptive to considering dissenting opinions and changing your mind, which in turn motivates the other person to share more information with you. A disagreement feels personal and potentially hostile; we expect a debate to be about ideas, not emotions. Starting a disagreement by asking, “Can we debate?” sends a message that you want to think like a scientist, not a preacher or a prosecutor—and encourages the other person to think that way, too.

A good debate is not a war. It’s not even a tug-of-war, where you can drag your opponent to your side if you pull hard enough on the rope. It’s more like a dance that hasn’t been choreographed, negotiated with a partner who has a different set of steps in mind. If you try too hard to lead, your partner will resist. If you can adapt your moves to hers, and get her to do the same, you’re more likely to end up in rhythm.

In a war, our goal is to gain ground rather than lose it, so we’re often afraid to surrender a few battles. In a negotiation, agreeing with someone else’s argument is disarming. The experts recognized that in their dance they couldn’t stand still and expect the other person to make all the moves. To get in harmony, they needed to step back from time to time.

Most people think of arguments as being like a pair of scales: the more reasons we can pile up on our side, the more it will tip the balance in our favor. Yet the experts did the exact opposite: They actually presented fewer reasons to support their case. They didn’t want to water down their best points. As Rackham put it, “A weak argument generally dilutes a strong one.”

We won’t have much luck changing other people’s minds if we refuse to change ours. We can demonstrate openness by acknowledging where we agree with our critics and even what we’ve learned from them. Then, when we ask what views they might be willing to revise, we’re not hypocrites.

Research suggests that the effectiveness of these approaches hinges on three key factors: how much people care about the issue, how open they are to our particular argument, and how strong-willed they are in general. If they’re not invested in the issue or they’re receptive to our perspective, more reasons can help: people tend to see quantity as a sign of quality. The more the topic matters to them, the more the quality of reasons matters. It’s when audiences are skeptical of our view, have a stake in the issue, and tend to be stubborn that piling on justifications is most likely to backfire. If they’re resistant to rethinking, more reasons simply give them more ammunition to shoot our views down.

When someone becomes hostile, if you respond by viewing the argument as a war, you can either attack or retreat. If instead you treat it as a dance, you have another option—you can sidestep. Having a conversation about the conversation shifts attention away from the substance of the disagreement and toward the process for having a dialogue. The more anger and hostility the other person expresses, the more curiosity and interest you show. When someone is losing control, your tranquility is a sign of strength. It takes the wind out of their emotional sails. It’s pretty rare for someone to respond by screaming “SCREAMING IS MY PREFERRED MODE OF COMMUNICATION!”

Research shows that in courtrooms, expert witnesses and deliberating jurors are more credible and more persuasive when they express moderate confidence, rather than high or low confidence.

there’s evidence that people are more interested in hiring candidates who acknowledge legitimate weaknesses as opposed to bragging or humblebragging.

We might as well get credit for having the humility to look for them, the foresight to spot them, and the integrity to acknowledge them. By emphasizing a small number of core strengths, Michele avoided argument dilution, focusing attention on her strongest points. And by showing curiosity about times the team had been wrong, she may have motivated them to rethink their criteria. They realized that they weren’t looking for a set of skills and credentials—they were looking to hire a human being with the motivation and ability to learn.

In every human society, people are motivated to seek belonging and status. Identifying with a group checks both boxes at the same time: we become part of a tribe, and we take pride when our tribe wins. In classic studies on college campuses, psychologists found that after their team won a football game, students were more likely to walk around wearing school swag. From Arizona State to Notre Dame to USC, students basked in the reflected glory of Saturday victories, donning team shirts and hats and jackets on Sunday. If their team lost, they shunned school apparel, and distanced themselves by saying “they lost” instead of “we lost.” Some economists and finance experts have even found that the stock market rises if a country’s soccer team wins World Cup matches and falls if they lose.

Once we’ve formed those kinds of stereotypes, for both mental and social reasons it’s hard to undo them. Psychologist George Kelly observed that our beliefs are like pairs of reality goggles. We use them to make sense of the world and navigate our surroundings. A threat to our opinions cracks our goggles, leaving our vision blurred. It’s only natural to put up our guard in response—and Kelly noticed that we become especially hostile when trying to defend opinions that we know, deep down, are false. Rather than trying on a different pair of goggles, we become mental contortionists, twisting and turning until we find an angle of vision that keeps our current views intact.

In an ideal world, learning about individual group members will humanize the group, but often getting to know a person better just establishes her as different from the rest of her group. When we meet group members who defy a stereotype, our first instinct isn’t to see them as exemplars and rethink the stereotype. It’s to see them as exceptions and cling to our existing beliefs.

In ancient Greece, Plutarch wrote of a wooden ship that Theseus sailed from Crete to Athens. To preserve the ship, as its old planks decayed, Athenians would replace them with new wood. Eventually all the planks had been replaced. It looked like the same ship, but none of its parts was the same. Was it still the same ship? Later, philosophers added a wrinkle: if you collected all the original planks and fashioned them into a ship, would that be the same ship?

We found that it was thinking about the arbitrariness of their animosity—not the positive qualities of their rival—that mattered. Regardless of whether they generated reasons to like their rivals, fans showed less hostility when they reflected on how silly the rivalry was. Knowing what it felt like to be disliked for ridiculous reasons helped them see that this conflict had real implications, that hatred for opposing fans isn’t all fun and games.

In psychology, counterfactual thinking involves imagining how the circumstances of our lives could have unfolded differently. When we realize how easily we could have held different stereotypes, we might be more willing to update our views.* To activate counterfactual thinking, you might ask people questions like: How would your stereotypes be different if you’d been born Black, Hispanic, Asian, or Native American? What opinions would you hold if you’d been raised on a farm versus in a city, or in a culture on the other side of the world? What beliefs would you cling to if you lived in the 1700s?

Psychologists find that many of our beliefs are cultural truisms: widely shared, but rarely questioned. If we take a closer look at them, we often discover that they rest on shaky foundations. Stereotypes don’t have the structural integrity of a carefully built ship. They’re more like a tower in the game of Jenga—teetering on a small number of blocks, with some key supports missing. To knock it over, sometimes all we need to do is give it a poke. The hope is that people will rise to the occasion and build new beliefs on a stronger foundation.

Motivational interviewing starts with an attitude of humility and curiosity. We don’t know what might motivate someone else to change, but we’re genuinely eager to find out. The goal isn’t to tell people what to do; it’s to help them break out of overconfidence cycles and see new possibilities. Our role is to hold up a mirror so they can see themselves more clearly, and then empower them to examine their beliefs and behaviors.

The process of motivational interviewing involves three key techniques: Asking open-ended questions Engaging in reflective listening Affirming the person’s desire and ability to change

Listening well is more than a matter of talking less. It’s a set of skills in asking and responding. It starts with showing more interest in other people’s interests rather than trying to judge their status or prove our own. We can all get better at asking “truly curious questions that don’t have the hidden agenda of fixing, saving, advising, convincing or correcting,” journalist Kate Murphy writes, and helping to “facilitate the clear expression of another person’s thoughts.”*

New research suggests that when journalists acknowledge the uncertainties around facts on complex issues like climate change and immigration, it doesn’t undermine their readers’ trust. And multiple experiments have shown that when experts express doubt, they become more persuasive. When someone knowledgeable admits uncertainty, it surprises people, and they end up paying more attention to the substance of the argument.

Evidence shows that if false scientific beliefs aren’t addressed in elementary school, they become harder to change later. “Learning counterintuitive scientific ideas [is] akin to becoming a fluent speaker of a second language,” psychologist Deborah Kelemen writes. It’s “a task that becomes increasingly difficult the longer it is delayed, and one that is almost never achieved with only piecemeal instruction and infrequent practice.” That’s what kids really need: frequent practice at unlearning, especially when it comes to the mechanisms of how cause and effect work.

Lectures aren’t designed to accommodate dialogue or disagreement; they turn students into passive receivers of information rather than active thinkers. In the above meta-analysis, lecturing was especially ineffective in debunking known misconceptions—in leading students to think again. And experiments have shown that when a speaker delivers an inspiring message, the audience scrutinizes the material less carefully and forgets more of the content—even while claiming to remember more of it. Social scientists have called this phenomenon the awestruck effect, but I think it’s better described as the dumbstruck effect. The sage-on-the-stage often preaches new thoughts, but rarely teaches us how to think for ourselves. Thoughtful lecturers might prosecute inaccurate arguments and tell us what to think instead, but they don’t necessarily show us how to rethink moving forward.

I was teaching a semester-long class on organizational behavior for juniors and seniors. When I introduced evidence, I wasn’t giving them the space to rethink it. After years of wrestling with this problem, it dawned on me that I could create a new assignment to teach rethinking. I assigned students to work in small groups to record their own mini-podcasts or mini–TED talks. Their charge was to question a popular practice, to champion an idea that went against the grain of conventional wisdom, or to challenge principles covered in class. As they started working on the project, I noticed a surprising pattern. The students who struggled the most were the straight-A students—the perfectionists. It turns out that although perfectionists are more likely than their peers to ace school, they don’t perform any better than their colleagues at work. This tracks with evidence that, across a wide range of industries, grades are not a strong predictor of job performance.

I believe that good teachers introduce new thoughts, but great teachers introduce new ways of thinking. Collecting a teacher’s knowledge may help us solve the challenges of the day, but understanding how a teacher thinks can help us navigate the challenges of a lifetime. Ultimately, education is more than the information we accumulate in our heads.

Rethinking is more likely to happen in a learning culture, where growth is the core value and rethinking cycles are routine. In learning cultures, the norm is for people to know what they don’t know, doubt their existing practices, and stay curious about new routines to try out. Evidence shows that in learning cultures, organizations innovate more and make fewer mistakes.

Over the past few years, psychological safety has become a buzzword in many workplaces. Although leaders might understand its significance, they often misunderstand exactly what it is and how to create it. Edmondson is quick to point out that psychological safety is not a matter of relaxing standards, making people comfortable, being nice and agreeable, or giving unconditional praise. It’s fostering a climate of respect, trust, and openness in which people can raise concerns and suggestions without fear of reprisal. It’s the foundation of a learning culture. In performance cultures, the emphasis on results often undermines psychological safety. When we see people get punished for failures and mistakes, we become worried about proving our competence and protecting our careers. We learn to engage in self-limiting behavior, biting our tongues rather than voicing questions and concerns. Sometimes that’s due to power distance: we’re afraid of challenging the big boss at the top. The pressure to conform to authority is real, and those who dare to deviate run the risk of backlash.

How do you know? It’s a question we need to ask more often, both of ourselves and of others. The power lies in its frankness. It’s nonjudgmental—a straightforward expression of doubt and curiosity that doesn’t put people on the defensive.

It takes confident humility to admit that we’re a work in progress. It shows that we care more about improving ourselves than proving ourselves.* If that mindset spreads far enough within an organization, it can give people the freedom and courage to speak up.

Research shows that when we have to explain the procedures behind our decisions in real time, we think more critically and process the possibilities more thoroughly.

When we dedicate ourselves to a plan and it isn’t going as we hoped, our first instinct isn’t usually to rethink it. Instead, we tend to double down and sink more resources in the plan. This pattern is called escalation of commitment. Evidence shows that entrepreneurs persist with failing strategies when they should pivot, NBA general managers and coaches keep investing in new contracts and more playing time for draft busts, and politicians continue sending soldiers to wars that didn’t need to be fought in the first place. Sunk costs are a factor, but the most important causes appear to be psychological rather than economic. Escalation of commitment happens because we’re rationalizing creatures, constantly searching for self-justifications for our prior beliefs as a way to soothe our egos, shield our images, and validate our past decisions.

In some ways, identity foreclosure is the opposite of an identity crisis: instead of accepting uncertainty about who we want to become, we develop compensatory conviction and plunge head over heels into a career path. I’ve noticed that the students who are the most certain about their career plans at twenty are often the ones with the deepest regrets by thirty. They haven’t done enough rethinking along the way.*

Psychologists find that the more people value happiness, the less happy they often become with their lives. It’s true for people who naturally care about happiness and for people who are randomly assigned to reflect on why happiness matters. There’s even evidence that placing a great deal of importance on happiness is a risk factor for depression. Why? One possibility is that when we’re searching for happiness, we get too busy evaluating life to actually experience it. Instead of savoring our moments of joy, we ruminate about why our lives aren’t more joyful. A second likely culprit is that we spend too much time striving for peak happiness, overlooking the fact that happiness depends more on the frequency of positive emotions than their intensity. A third potential factor is that when we hunt for happiness, we overemphasize pleasure at the expense of purpose. This theory is consistent with data suggesting that meaning is healthier than happiness, and that people who look for purpose in their work are more successful in pursuing their passions—and less likely to quit their jobs—than those who look for joy. While enjoyment waxes and wanes, meaning tends to last. A fourth explanation is that Western conceptions of happiness as an individual state leave us feeling lonely. In more collectivistic Eastern cultures, that pattern is reversed: pursuing happiness predicts higher well-being, because people prioritize social engagement over independent activities.

when it comes to careers, instead of searching for the job where we’ll be happiest, we might be better off pursuing the job where we expect to learn and contribute the most. Psychologists find that passions are often developed, not discovered.

When my students talk about the evolution of self-esteem in their careers, the progression often goes something like this: Phase 1: I’m not important Phase 2: I’m important Phase 3: I want to contribute to something important I’ve noticed that the sooner they get to phase 3, the more impact they have and the more happiness they experience. It’s left me thinking about happiness less as a goal and more as a by-product of mastery and meaning. “Those only are happy,” philosopher John Stuart Mill wrote, “who have their minds fixed on some object other than their own happiness; on the happiness of others, on the improvement of mankind, even on some art or pursuit, followed not as a means, but as itself an ideal end. Aiming thus at something else, they find happiness by the way.”

At work and in life, the best we can do is plan for what we want to learn and contribute over the next year or two, and stay open to what might come next. To adapt an analogy from E. L. Doctorow, writing out a plan for your life “is like driving at night in the fog. You can only see as far as your headlights, but you can make the whole trip that way.”

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Deng Xiaoping and the Transformation of China

Recently, in an effort to better understand the Chinese culture and history, I decided to read a well-acclaimed book on Chinese history between the 1960s until early 1990s that centered on the leadership of Deng Xiaoping, arguably one of the most respected leader during the era. In the book, Ezra F. Vogel managed to provide a relevant background for policies chosen by the Chinese government, which many times would puzzled Western readers unaccustomed to the local culture. The quotations below serve as a reminder to me personally on the important policy decision the CCP and Chinese government made, that has translated to the magnificent growth of the country in the 21st Century.

He realized what some free-market economists did not, that one could not solve problems simply by opening markets; one had to build institutions gradually.

In short, Deng faced a tall order, and an unprecedented one: at the time, no other Communist country had succeeded in reforming its economic system and bringing sustained rapid growth, let alone one with one billion people in a state of disorder.

He had disciplined himself not to display raw anger and frustration and not to base his decisions on feelings but on careful analysis of what the party and country needed.

And although he welcomed what he considered constructive suggestions to resolve problems, he bristled when foreigners and political dissidents criticized the party. He vividly remembered the chaos of the civil war and the Cultural Revolution and believed that social order in China was fragile; when he judged that it was at risk, he would respond forcefully.

In 1978, because of the Soviet Union’s aggressive behavior following the American withdrawal from Vietnam, Western countries were receptive to helping China loosen its ties with the Soviet Union. With the global expansion of trade that followed, China had access to new markets and advanced technologies—Japan, Taiwan, South Korea, Hong Kong, and Singapore—and nearby examples for how latecomers to the international scene could modernize quickly.

While Deng was studying in Moscow, the Soviet Union had not yet built its socialist structure. The Soviet Union was still under the National Economic Policy (NEP). Under the NEP, independent farmers, small businesspeople, and even larger businesses were encouraged to prosper while the socialist economy was beginning to develop heavy industry. Foreigners, too, were invited to invest in the Soviet Union. Deng believed, as did others at that time, that such an economic structure—whereby private enterprise was allowed and foreign investment was encouraged, all under Communist Party leadership—promoted faster economic growth than could be achieved in capitalist economies.17 The fundamentals of the NEP, a market economy under Communist leadership, were similar to those of the economic policies that Deng would carry out when he was in charge of China’s Southwest Bureau in 1949–1952 and those that he would reintroduce in the 1980s.

Deng’s speech to the United Nations was received with an unusually long period of applause. Because of its size and potential, China was seen as a rallying force among the developing countries. The delegates of the developing countries were especially pleased with Deng’s statement that China would never become a tyrant and that if it were to ever oppress or exploit others, then the rest of the world, especially the developing countries, should expose China as a “social imperialist” country and, in cooperation with the Chinese people, overthrow the government.

This was vintage Deng. Paint the broad picture, tell why something needed to be done, focus on the task, cover the ideological bases, and seek public support for replacing officials who were not doing their jobs.

If people did not perform their jobs, they were to be fired. They should “shit or get off the pot hole” (buyao zhan maokeng bu lashi).58

Deng went on to explain that it would not do to take what Mao did on one occasion and to make that the explanation for something Mao did in a different place and time. Mao himself admitted he made errors; anyone who does things makes mistakes. If what a person did was 70 percent correct, that is very good. If after my death people say that what I did was 70 percent correct, Deng said, that would be quite good.

Deng thought it was a terrible waste to send young intellectuals off to do physical labor when they should be advancing Chinese science. Although he did not use the term, in fact he believed in a meritocratic elite. He sought to attract the best and the brightest and to provide the conditions that would allow them to achieve the most for China.

Wang Dongxing had exploded just a week earlier when an article entitled “Pay According to the Work Performed” (anlao fenpei) had appeared, demanding to know which Central Committee had authorized that article (only later did he find out that Deng Xiaoping and his staff had supported it).

Marshal Ye believed deeply that the errors of the Great Leap Forward and the Cultural Revolution had been caused by the excessive concentration of power in the hands of one person. He urged both Hua Guofeng and Deng to work together in leading the party and the country. When Ye met with Deng, Deng agreed that they should strengthen the collective leadership and limit the publicity given to a single person.

People, he said, must be allowed to express their views about the real situation. “Centralism can be correct only when there is a full measure of democracy. At present, we must lay particular stress on democracy, because for quite some time . . . there was too little democracy. . . . The masses should be encouraged to offer criticisms. . . . There is nothing to worry about even if a few malcontents take advantage of democracy to make trouble . . . the thing to be feared most is silence.” Deng did not then or at any other time advocate unlimited free speech. In fact, by November 29, a few days after some people began posting their views on a wall not far from Tiananmen Square, Deng had already stated that some opinions posted on “Democracy Wall” were incorrect.

Deng expressed the prevailing view at high levels that China’s two huge disasters, the Great Leap and the Cultural Revolution, were caused by a system that allows one person to dominate without any input from other voices. China therefore needed to develop a legal system so that a single individual, no matter how able, will not dominate. If laws are initially imperfect and incomplete, they can be made fair and just, step by step, over time.

Deng declared that the theory of collective responsibility had meant, in practice, “that no one is responsible.” He advocated assigning responsibilities to individuals and acknowledged that to do so, one must also give individuals power.

On November 26, the day after Hua Guofeng addressed the work conference and publicly backed away from the “two whatevers,” Deng Xiaoping told Sasaki Ryosaku, the head of the Japanese Democratic Socialist Party, “The writing of big-character posters is permitted by our constitution. We have no right to negate or criticize the masses for promoting democracy and putting up big-character posters. The masses should be allowed to vent their grievances.”5 He rhetorically asked, “What is wrong with allowing people to express their views?”6 In addition, Marshal Ye and Hu Yaobang both expressed support for the people posting their opinions.

During his visit, Deng not only saw things that previously he had only read about; he wanted to study how Japanese organized workers to maximize their dedication and efficiency, which he summed up as “management.” From his trip he concluded, “We must firmly grasp management. Just making things isn’t enough. We need to raise the quality.”36 A century earlier, Chinese patriots had insisted on retaining the “Chinese spirit” while adopting Western technology. By using the neutral term “management” to refer to studying Western ways, and by keeping his unwavering commitment to socialism and the Communist Party, Deng allowed the introduction of far more than technology while reducing the resistance of Chinese conservatives. Indeed, Deng argued that socialism could also use modern management, and the Communist Party could champion it.

Deng asserted that the United States and Japan could make a contribution to world peace if they urged Taiwan to negotiate with Beijing and if the United States reduced arms sales to Taiwan. He told Carter that Beijing would go to war over Taiwan only if, over a long period of time, Taiwan refused to talk with Beijing, or if the Soviets became involved in Taiwan.77

Mao had talked of how a single spark could set off a prairie fire of revolution, but China after 1979 underwent a revolution far greater and longer lasting than the one Mao began. This massive revolution ignited from many sources, but no single spark spread more rapidly than the one resulting from Deng’s visit to the United States.

When Fallaci asked about the mistakes of the Great Leap Forward, Deng replied that they were not Mao’s alone; rather, they were mistakes for which all those who had worked with Mao must share the blame.45 When she inquired about Mao’s selection of Lin Biao, Deng said that it was feudalistic for a leader to choose his own successor. Deng’s implication was unmistakable: it was also wrong for Mao to have chosen Hua Guofeng as successor. And when asked how experiences like the Cultural Revolution could be avoided in the future, Deng explained that party leaders were looking into restructuring China’s institutions in order to achieve socialist democracy and uphold socialist law.

Deng took no notes when he read. Documents were to be delivered to his office before 10 a.m., and he returned them the same day. He left no papers around his office, which was always clean and neat.

Deng did reserve the right to make final decisions, but he was ordinarily not a micromanager; rather he set the agenda and let Hu and Zhao carry out his directives as they thought best. In making the final decisions, Deng did consider the overall political atmosphere and the views of other key leaders. He was authoritarian and bold but in fact he was constrained by the overall atmosphere among Politburo members.

Deng embraced the notion of “inner-party democracy,” by which he meant that leaders would listen to “constructive opinions” to reduce the danger of making serious errors. But once a decision was made, party members, following “democratic centralism,” had to implement it.

The “cat theory”—“it doesn’t matter if the cat is black or white as long as it catches the mouse”—was a creative way of winning further support for diminishing the importance of Mao’s ideology; it suggested that doing what worked was more important than following a particular ideology. If Deng had simply said “ideology is unimportant,” he would have provoked enormous controversy, but his “cat theory” made people smile (in fact, some entrepreneurs even made and sold decorations with the cat theme). Another saying, “some people can get rich first,” helped lower the expectations of many who hoped to get rich quickly after the reforms, and helped disarm those who might feel envious of those who prospered before the benefits of reform had reached everyone.

For Deng, being a successful leader meant not just determining the correct strategic direction for the long run, but also knowing how to shape the atmosphere and how to time his bold steps so that they occurred when other officials and the public were ready to jump on board.

As Guangdong officials put it, “Beijing has its policies and we have our counter-policies” (shang you zhengce, xia you duice).

Guangdong’s progress cannot be explained simply by “opening markets,” for many countries with open markets did not achieve the progress that Guangdong made. Instead, in Guangdong, a Communist organization that less than a decade earlier had engaged in class warfare became an effective vehicle to promote modernization. The party provided overall discipline and encouraged study and competition, and Hong Kong and Japanese enterprises were quick to offer assistance. The special policy for Guangdong and Fujian and the unique leeway given to the SEZs made these areas into incubators for developing people who would be able to function well in modern factories, stores, and offices in cosmopolitan settings. Many of the lessons learned from these enterprises spread quickly from Guangdong to other places.

By the fall of 1978, officials in Anhui, cheered by the successful midyear harvests produced by the smaller work groups, reported their successes, setting off arguments with those who supported large-scale cooperatives. At a meeting of the National Agricultural Economic Association held in Suzhou in the fall of 1978, an official from the Anhui Agricultural Policy Research Office had the courage to say that one should not blindly follow the Dazhai model and that the government should not launch so many political movements that interfered with local economic initiatives.55 But on the other side, Chen Yonggui, still vice premier in charge of agricultural affairs, accused Wan Li of secretly promoting individual household farming. Newspaper articles, too, denounced Wan Li for opposing Dazhai and for restoring capitalism. But Wan Li had gained confidence from the successful harvests in the areas that had tried decentralized work assignments and he was rapidly winning support within the party. In November 1978, when criticized by Chen Yonggui, Wan Li, living up to his reputation for bravery, replied: “You say you are speaking from the Dazhai experience; I say Dazhai is an ultra-leftist model. . . . You go your way and I’ll go mine. . . . Don’t impose your views on me and I won’t impose mine on you. As for who is right and who is wrong, let’s see which way works best.”

After household farming was introduced, grain production continued to rise rapidly. Indeed, as early as 1984 grain production surpassed 400 million tons, compared to 300 million tons in 1977. After 1981, the growth in the grain supply led the government to encourage farmers to diversify into vegetables, fruits, and industrial crops. Official estimates of per capita grain consumption rose from 1977 to 1984 from 195 kilograms to 250 kilograms, and consumption of pork, beef, poultry, and eggs increased even more sharply.72   The government had been completely unprepared for the huge grain harvest of 1984. As a result, there was not enough warehouse space to store the grain, and some local governments, lacking sufficient funds to purchase all the grain that had been produced, had to give the farmers paper IOUs. Before then, the government, fearing urban unrest, since 1978 had not passed on to the urban consumer the increase in prices paid to the farmers for rice. This subsidy was a strain on the government budget, and after 1984 the costs were passed on to the urban consumer. On January 1, 1985, the government announced that it was no longer obligated to buy grain produced by the farmers. Because farmers planting their fields in 1985 worried that they might not get full payment for rice, they planted smaller rice crops and grain production consequently dropped 28 million tons, or about 7 percent (which was still 60 million tons more than that produced in 1980, when household farming first began to take hold). It took several years after the 1985 adjustments for grain production to recover to the 1984 levels and to put rural production on an even keel, but by 1989 grain output had surpassed the 1984 peak, and it continued at high levels thereafter.73 By then, there was sufficient rice production so that the government abolished grain rationing and consumers could buy all the rice they needed.

Deng had scored another victory by using his basic approach to reform: Don’t argue; try it. If it works, let it spread.

The conference conclusions supported a dual-price system—that is, one set of prices for items on the state plan and another set of prices that would be more responsive to market changes. State-owned enterprises that met their quotas would be allowed to sell whatever other products they could make at market prices. As a result, many enterprises would likely orient their practices to the market, while still relying on set prices to provide some stability during the transition to increased use of markets. Some World Bank officials criticized the dual-price system because it created opportunities for officials at state companies to purchase goods at state prices and then to make a quick profit by selling them in the market at higher prices. Higher-level Chinese officials, however, felt confident that they could keep the corruption under control with administrative punishments.

The cumulative effect of the new machinery and the new systems introduced by firms based in Japan, Europe, Hong Kong, and (beginning in the late 1980s) Taiwan had at least as much of an influence on economic growth as the system reforms introduced by Beijing officials. The new opening had, in effect, brought about an imported industrial revolution, information revolution, and consumer revolution.

Deng advanced step by step, rather than with a “big bang.” After 1991, Russia had followed the advice of economists who recommended opening markets suddenly, with a “big bang.” In contrast, Deng, with the advice of experts brought in by the World Bank, accepted the view that a sudden opening of markets would lead to chaos. He understood what many Western economists who took institutions for granted did not: that it was vitally important to take the time to build national institutions with structures, rules, laws, and trained personnel adapted to the local culture and local conditions. China did not have the experience, rules, knowledgeable entrepreneurs, or private capital needed to convert suddenly to a market economy.

Deng knew China would face huge adjustment problems from changes wrought by outsiders and from returning students, but he firmly believed that nations grow best when they remain open. Unlike some of his colleagues who feared that China would be overwhelmed by foreigners and foreign practices, Deng was confident that the Communist Party was strong enough to control them. He strongly supported sending officials and students abroad, translating foreign books and articles, and welcoming foreign advisers and businessmen to China. He was prepared to face criticism from those who feared that Chinese lifestyles and interests would be adversely affected by foreign competition. He believed competition from foreign companies would not destroy the Chinese economy but rather stimulate Chinese businesses to become stronger. He also did not worry if a substantial percentage of those who went abroad did not return, for he believed that they too would continue to help their motherland.

In reports to Beijing, all these organizations exaggerated the support for communism in Hong Kong, thus causing Deng and other officials to underestimate the extent to which ethnic Chinese residents in Hong Kong were in fact content with British rule. In fact, most residents feared what China, having just undergone the Cultural Revolution, might do to Hong Kong.

In talks with British officials, Deng vowed that political power after 1997 would be in the hands of the people of Hong Kong. Always focused on training successors, Deng requested that during the remaining fifteen years, Hong Kong leaders in business, education, and culture suggest the names of promising “patriotic” Hong Kong young people who could begin immediately preparing for responsible positions in various fields after 1997, thereby ensuring a smooth handover and continued stability and prosperity.

In a BBC interview before leaving China, she said, “If one party to a treaty or a contract says, ‘I cannot agree to it, I am going to break it,’ you cannot really have a great deal of confidence that any new treaty they make will be honored.” China specialists in the British Foreign Office cringed when she repeated these comments at a press conference in Hong Kong, for they knew that these words would dampen the goodwill with China that they had been working to build. As they expected, China complained, strongly. In the week after the Thatcher visit, the Hong Kong stock market fell 25 percent, and by the end of October, the Hang Seng Stock Index, which had registered 1,300 in June, had fallen to 772.66

The local Communists in Hong Kong, long accustomed to passing on what Beijing wanted to hear, had been repeating the mantra that the residents of Hong Kong were opposed to the imperialists and were eagerly awaiting liberation by the mainland. Even Hong Kong businesspeople, who were always eager to win Beijing’s favor, would report how enthusiastic the people of Hong Kong were about the prospect of Communist leadership. Xu, however, bravely relayed the unpleasant truth: he reported that the people of Hong Kong had a deep mistrust of the Communist Party and sometimes felt doomed.74 He also described the dominant view of Chinese businesspeople in Hong Kong, which was that they respected British administration and the rule of law and doubted that Beijing would be able to provide good leadership. Moreover, many businesspeople in Hong Kong who had fled the mainland soon after 1949 felt they could never again trust the Communists. They had seen how the Communists in the 1950s had betrayed their promises to work with businesspeople who had cooperated with them, by attacking them and appropriating their businesses.75 Disturbed by Xu’s reports, Li Xiannian responded by saying that Beijing’s top priority should be to win over the Hong Kong public.

At the meeting, when Sze-yuen Chung, head of the Hong Kong Executive Council, expressed doubts about the capacity of lower-level Communist officials to manage the complex problems of Hong Kong, Deng snapped back that this view amounted to saying that only foreigners can govern Hong Kong. Such an attitude reflects, he said, the influence of colonial mentality. Deng continued by telling the group that they should seek a better understanding of the Chinese people and of the People’s Republic of China. He assured them that Hong Kong’s capitalist system would be in place for fifty years, and he added that a patriot is one who respects the Chinese nation, supports China’s resumption of sovereignty, and does not want to hurt prosperity and stability in Hong Kong.

In Hong Kong, the basic political and administrative policies would not change for fifty years. He added that Hong Kong had been operating under a system different from that of Britain and the United States, so it would not be appropriate to adopt a fully Western system with three separate branches of government. He then articulated the kind of personal freedoms the public should expect: After 1997, China would still allow people in Hong Kong to criticize the Communist Party but if they should turn their words into action, opposing the mainland under the pretext of democracy, then Beijing would have to intervene. Troops, however, would be used only if there were serious disturbances.92 Deng’s speech provided the kind of straight talk that the people of Hong Kong were hoping for. It eased their concerns, even as it effectively ended all discussion of establishing three separate branches of government.

After the Basic Law was announced, it was received warmly in both China and Hong Kong.   Only four months after the signing, however, the optimism in Hong Kong was destroyed by the news of the tragedy in Tiananmen Square. To Hong Kong people, the specter that they would soon be ruled by a regime that could shoot its own people on the streets was terrifying. On June 4, 1989, out of sympathy for the students protesting for freedom in Beijing and out of concern for their own future, an estimated one million of Hong Kong’s five million people took to the streets. The demonstrations were far larger than any in the history of Hong Kong. After June 4, thousands of Hong Kong people who could afford it purchased foreign property, sent their children abroad to study, and took out foreign citizenship. Sino-British relations, which had been proceeding smoothly prior to June 4, deteriorated rapidly.

China’s problems with Tibetans erupted after 1955 when provincial leaders throughout China were told to accelerate the collectivization of agriculture. Mao said that “democratic reforms,” including collectivization, would be implemented among minority peoples if conditions seemed right, but they were not yet to be implemented in Tibet itself. The two million Tibetans outside Tibet proper were largely living in Sichuan, Yunnan, Qinghai, and Gansu. The leaders of Sichuan put together a plan not only to collectivize agriculture rapidly, but also to start “democratic reforms” in Sichuan’s Tibetan and other minority areas. Collectivization that was launched in the Tibetan areas in Sichuan at the beginning of 1956, including the taking over of some monasteries, quickly precipitated a serious and bloody uprising in Sichuan’s Tibetan areas, especially among the Khampa Tibetans, who constituted a large portion of Tibetans in Sichuan. The uprising was bloody because virtually every family in the Khampa Tibetan areas in Sichuan, where blood vengeance and raiding were endemic, had modern firearms and knew how to use them. After initial successes, the Khampas were overwhelmed by the much stronger PLA; in 1957–1958, they fled to Tibet proper with their guns. In 1957 at the height of the Cold War, the CIA began to train a small number of Khampas in Colorado and then dropped them back into Tibet to collect intelligence.106 Beijing directed the Dalai Lama to send the Khampas back to Sichuan, but the Dalai Lama refused. India had earlier invited the Dalai Lama to settle in India, and in March 1959 he led many of the most militant Tibetans across the mountains into India. Other Tibetans followed over the next two to three years.

Chinese leaders, frustrated by the growing resistance of Tibetan monks as a result of the Dalai Lama’s success abroad, have used whatever leverage they have with foreign groups to isolate the Dalai Lama. Some foreigners have yielded to Chinese pressures, but overall, Chinese efforts have increased foreign attention to the Dalai Lama and strengthened foreign criticism of China. In Tibet, the growing resistance of monks caused Chinese officials to fortify their security forces and to exercise stricter control over monasteries.

By the middle of the 1980s a tragic cycle had emerged that continues to this day: The Dalai Lama’s popularity abroad emboldens local Tibetans to resist, leading to a crackdown by Beijing. When foreigners learn of the crackdown, they complain, emboldening Tibetans to resist, and the cycle continues. But the Tibetans and Han Chinese both recognize there is a long-term change that began with the opening of Tibet to outside markets in the mid1980s and the input of economic aid to Tibet: an improvement in the standard of living and a decline of economic autonomy. In the 1950s outsiders settling in Tibet were mostly Han party officials and troops sent in by Beijing. After the mid-1980s settlers from the outside were overwhelmingly merchants who went to take advantage of economic opportunities generated by inputs of Chinese economic assistance to Tibet; many were members of Hui or other minorities from nearby poor provinces. Almost no outsiders settled in Tibetan villages but by the late 1990s, outsiders were already threatening to outnumber Tibetans in Lhasa.116 With more Tibetan youth learning Mandarin and receiving a Chinese education to further their careers, both Tibetans and Chinese see that the long-term trend is toward Tibetans absorbing many aspects of Chinese culture, and becoming integrated into the outside economy, while not giving up their Tibetan identity and loyalty.

Cambodian leader Pol Pot, who by the summer of 1978 had begun to realize the seriousness of the Vietnamese threat, asked Deng to send Chinese “volunteers” to Cambodia to resist the invasion of the Vietnamese, as Mao had done in Korea to resist the invasion of the South Koreans and the Americans. Deng was ready to cooperate with Pol Pot despite the atrocities he had committed against his own people and the vehement opposition these acts had caused in the West because Deng judged him to be the only Cambodian leader capable of offering significant resistance to Vietnam.

Meanwhile, China used these continuing border skirmishes—and occasional larger conflicts involving entire Chinese divisions—to train its troops. By the 1980s units from most of the infantry armies in China had been rotated to the Vietnam border to take part in the border skirmishes. As military analysts noted, assigning Chinese troops to fight against some of the most experienced ground troops in the world provided excellent combat training. The presence of large numbers of Chinese troops also made the Soviets cautious about sending additional aid to the Vietnamese.

In addition to negotiating with the Soviet Union, Deng also sought to reduce the risk of Soviet and Vietnamese advances by involving the United States. Deng knew that the United States was then in no mood to engage in a land war in Asia; what better way to ensure that the Soviets would not dominate the seas near Vietnam than to have a large American oil company conduct oil explorations there?

Deng’s reactions to the 1980 Polish strikes resembled Mao’s reactions to the Hungarian and Polish uprisings in 1956. First, allow more open criticism to help correct some of the worst features of the bureaucracy and to win over those critics who felt some changes were needed. But if hostility to the party threatened party control, clamp down. Having noted how Mao’s virulent anti-rightist campaign in 1957 had destroyed the support of intellectuals, Deng in 1980 tried to walk a fine line between curbing expressions of freedom and retaining intellectuals’ active support for modernization.

In March 1985, during this atmosphere of greater freedom, leading investigative journalist Liu Binyan, who three decades earlier had been labeled a rightist, published The Second Kind of Loyalty, in which he contrasted party members who automatically accept orders from higher party officials with party members with a conscience who serve the ideals of the party. Liu Binyan’s book hit a deep nerve among those who had agonized about whether to carry out party policy during the Great Leap and the Cultural Revolution. It also had a tremendous influence on idealistic Chinese youth who sought independence from the party. Deng, who always believed in the importance of party discipline, regarded Liu’s message as a challenge to party leadership, and as a result in 1987 Liu was expelled from the party.

In dealing with protests, Deng, like other Chinese Communist leaders, tried to maintain tight control while alleviating the cause of the complaints. As news of demonstrations spread abroad, Deng continued to explain to the Chinese public that the socialist system of public ownership was superior to bourgeois democracy; he pointed to the capitalists’ exploitation of workers and to the difficulties of making timely decisions in countries where there was a separation of powers among the executive, legislative, and judicial branches. But Deng also was determined to stay ahead of the popular movements by introducing timely political reform. He therefore directed that China undertake serious study of political systems to determine which systems endure for the long term, which systems collapse, and why.

The 1986 demonstrations were the first large student demonstrations in China since April 1976, when students had taken to the streets to honor Zhou Enlai and support Deng Xiaoping. On May 29, 1987, some weeks after these Chinese student demonstrations subsided, Zhao Ziyang explained to Singapore’s Deputy Prime Minister Goh Chok Tong that when China opened up, its students, who had had no previous contact with the outside world, could not judge what was good or bad. When they saw that the United States and Japan were more advanced, some came to the wrong conclusion, advocating total Westernization for China, without understanding that this was not possible in China where conditions were so different. Zhao admitted that it was not surprising some students had come to this conclusion, because the socialist system before 1978 did have its failures. But Zhao blamed the loosening of party controls for the demonstrations.74 He did not mention the name of the official who was considered responsible for this loosening: Hu Yaobang.

When launching his four modernizations, Deng had warned that some would get rich first, but in the view of most students, the people getting rich first were the least deserving—greedy individual entrepreneurs and corrupt officials—not the morally upright government employees working in the national interest after years of hard study. Students often lived in poor conditions, crowded eight to a small room. Able students who had sacrificed for years to be among the very small percentage to pass the examinations to enter good schools were outraged that the children of high officials received better opportunities and lived in a grander style because of their connections.75 Furthermore, university graduates were then not yet free to choose jobs; they were assigned jobs by the state based in part on reports compiled by the political guides who lived with the students. Many students felt they had no choice but to ingratiate themselves to these political guides, who often appeared to them to be arbitrary, arrogant, and poorly educated.76

On December 30, 1986, Deng summoned Hu Yaobang, Zhao Ziyang, Wan Li, Hu Qili, Li Peng, and others and announced to them that it was necessary to end the permissiveness toward the student movement. He told them, “When a disturbance breaks out in a place, it is because the leaders there didn’t take a firm clear-cut stand. . . . It is essential to adhere firmly to the Four Cardinal Principles; otherwise bourgeois liberalization will spread unchecked.” Hu Yaobang, aware that he was being held responsible for this lack of a “clear-cut stand,” knew that it was time to submit his resignation.

Deng also aimed to counter the broader appeal of Western ideals such as humanism, freedom, and democracy that in his view were being used to challenge the ultimate authority of the party.

The student movements that senior leaders had taken part in before 1949 were well organized, with thought-through plans and agenda, and by 1949, the student leaders had worked together for many years. Students in the late 1960s had experience as Red Guards. But the tight controls in the decade before 1989 had prevented the growth of an independent organized student movement. In 1989 the students who came together did not have any experience in organizing. Articulate orators emerged as leaders, but, lacking organization, an agenda, and procedures for ensuring compliance, they had no basis for negotiating with political leaders on behalf of other students.   Urban residents did not join in restraining the demonstrators, for they sympathized with their complaints. Even some older intellectuals who tried to keep the students from taking radical actions in fact admired the students for boldly expressing views that they themselves, beaten down by years of political pressures, were afraid to express. What began as an unplanned peaceful outpouring of mourning for Hu Yaobang was transformed into parades, political forums, campouts, angry protests, hunger strikes, and clashes that spiraled out of control.   Student demonstrators wanted improvements in their living conditions and they were upset that they were receiving fewer economic rewards for their ability and hard work than were uneducated entrepreneurs.

Chinese leaders, for their part, could see that foreign attention and support encouraged the protestors. They found it difficult to believe that Chinese citizens could be that angry at the leadership and found it easy to believe that the protests were being controlled behind the scenes by domestic and foreign “black hands.” Stories and rumors of such “black hands” circulated widely among high officials and were used by the conservatives to push Deng to take stronger action.

As students invoked the memory of Hu Yaobang to advance the cause of freedom and democracy, the parallels between the April 5, 1976, demonstrations (to mourn Zhou Enlai) and the April 1989 demonstrations (to mourn Hu Yaobang) were striking enough to inspire the demonstrators and to worry the Chinese leaders. The demonstrations in 1989 were taking place in the very same place as the April 1976 “Tiananmen Incident.” Like Zhou Enlai, Hu Yaobang had fought to protect the people and had died a tragic death. In both 1976 and 1989, the public was outraged that a man whom they revered had not been treated with more respect. In 1976 the demonstrators had taken advantage of the occasion to attack the Gang of Four. Now, was it not possible to use the occasion to criticize Deng Xiaoping and Premier Li Peng? By the fall of 1978, too, those arrested in the spring of 1976 had been rehabilitated and called patriotic. In the same way, was it not possible that the demonstrators in 1989 would later be called patriotic as well? Among those Chinese who hoped for a more humane government, Hu Yaobang had replaced Zhou as the great hero of the time.

Most Chinese students in the late 1980s were less concerned about political freedoms than about their personal freedoms, such as the ability to choose their own jobs and to escape from their “political guides.” After already having proved their talent and dedication by preparing for the difficult university entrance examinations, they felt entitled to pursue whatever jobs they wanted. But in 1989, with a shortage of trained graduates in key industries and government offices, government policy still mandated that graduates be assigned their jobs. Since one’s job assignment was based in part on what the political guides who lived with the students wrote in the “little reports” in each student’s secret records, the political guides became the symbol of government surveillance. The political guides were rarely as well educated as the students on whom they were reporting; some were suspected of favoritism and flaunted their authority to influence a student’s future. Many cosmopolitan, independent-minded students detested the constant worry about pleasing them. “Freedom,” to them, meant eliminating these political guides and being able to choose their jobs and careers on their own.

Party and government workers, state enterprise employees, and others with fixed salaries were furious to see rich private businesspeople flaunting their material wealth and driving market prices higher, threatening the ability of salaried workers to pay for their basic food and clothing needs. The problem was exacerbated by corruption: township and village enterprise workers were enriching themselves by siphoning off needed materials and funds from state and public enterprises; independent entrepreneurs were making fortunes, in part due to government loopholes; and “profiteering officials” were finding ways to use society’s goods to line their own pockets as the incomes of law-abiding officials stagnated.

Protesting students, furious at “profiteering” officials, demanded that these officials’ incomes and expenses be revealed, along with the number of villas they owned and the sources of their children’s money.7 In 1966 many children of high officials had joined the Red Guards against those who had “taken the capitalist road,” but in 1989 few children of high officials joined the protestors. Instead they were under attack, along with their parents, for the privileges they enjoyed as a result of turning their powerful positions into sources of profit in the new market economy.

Sympathy for the students was so widespread that Li Peng had difficulty retaining support of lower-level officials for the crackdown. Hu Qili, the Politburo Standing Committee member who supervised propaganda work, explained to his fellow officials that many newspaper reporters were upset because their articles about what was actually happening in the square were not being published. University officials who were told to quiet down the demonstrations dutifully passed along the message to the students, but for many their hearts were not in it.23 Li Peng could not even count on the official media to support him. For several days no newspapers of any kind appeared. On one national television station, reporters describing what was taking place in the square were interrupted, and for a brief time the picture went dark and the voiceover simply stopped. One day, an announcer said, “There is no news today.”24 After June 4, the head of the Propaganda Department and the editor of People’s Daily, who were considered too sympathetic to the students, were both removed from their positions.

The world press, assembled in Beijing to cover the reconciliation between China and the Soviet Union, found the student movement spellbinding; indeed, the dramatic events on the square quickly eclipsed the Gorbachev visit as the center of media attention. For foreign reporters, it was impossible not to get caught up in the idealism and enthusiasm of the students, who were far more open than Chinese had previously dared to be. With a vast international audience watching, the students grew even more confident that the PLA would not attack. Some, recognizing an opportunity to present their case to the world, assigned English-speaking demonstrators to the outside columns of the marchers, so they could tell the world about their desire for freedom and democracy and the need to end high-level corruption. A few persistent foreign reporters, trying to maintain balance, reported that most students in fact knew little about democracy and freedom and had little idea about how to achieve such goals.

Outside the Politburo, a group of retired liberal officials on the Central Advisory Commission—including Li Chang, Li Rui, Yu Guangyuan, and Du Runsheng—gathered to make final arrangements for releasing a declaration that the student movement should be declared patriotic. And early the next morning, with his back to the wall, Zhao called Deng’s office, hoping that if he could meet privately with Deng, he might be able to persuade him not to bring in the troops.

In Hungary, for example, national leaders had made concessions that had only led to further demands. If Chinese leaders were to yield again, China would be finished. In Shanghai, Deng added, Jiang Zemin had successfully restored order in 1986 by taking a tough, top-down approach, closing down the World Economic Herald for failing to follow directions (which had helped calm student demonstrations there). Deng believed that a similar steely resolve was needed now. But at present, Deng concluded, the police in Beijing were insufficient to restore order: troops were needed. These troops would have to be moved in quickly and decisively, and for the time being, plans for their deployment needed to remain secret.4 When some in the room expressed worries that foreigners would react negatively to any use of force, Deng replied that swift action was required and the “Westerners would forget.”5   Li Peng and Yao Yilin immediately supported Deng’s views, and although Hu Qili raised some concerns, only Zhao Ziyang clearly disagreed. When Zhao spoke up, he was reminded that the minority must follow the lead of the majority. Zhao replied that as a party member he accepted this, but he still had some personal reservations.6 As general secretary, Zhao realized that he would be expected to announce the imposition of martial law and then to oversee its implementation. He feared that the decision to bring in the military, even if unarmed, would only inflame the conflict.   Immediately after the meeting with Deng, Zhao asked his assistant, Bao Tong, to prepare his letter of resignation. Zhao knew that he could not bring himself to implement martial law and that this decision would mean the end of his career, but he also was confident that his decision would place him on the right side of history.

Neither the students in the square nor the high officials anticipated what happened next: the people of Beijing overwhelmed and completely stalled the 50,000 troops coming in from the north, east, south, and west, on six major and several minor routes. In his May 20 diary entry Li Peng simply noted: “We had not expected great resistance” and he then went on to record that troops everywhere had been stopped. Some troops had tried to enter Tiananmen Square by subway, but the subway entrances were blocked. Some had attempted to come in by suburban trains, but people lay on the tracks. In one instance, two thousand troops coming from some distance managed to arrive at the train station, but as soon as they got off the train, they were surrounded and unable to move.15 Cell phones were not yet available, but people used regular phones to call acquaintances, and those with walkie-talkies set themselves up at key crossings to warn of the arrival of troops so that people could swarm to attempt to stop them. People organized motorcycle corps to speed ahead and carry news of the troops’ movements as they entered Beijing. Some officials blame Zhao Ziyang’s assistant Bao Tong for leaking to the student protesters the plans for how and where the troops would arrive, but even if Bao Tong were a brilliant organizer, he could not have been able to alert or organize the vast throngs that took to the streets.

In his diary entry of May 22, Li Peng acknowledged that the troops were unable to move for fifty hours. He also reports that Deng was worried that the “soldiers’ hearts may not be steady” (junxin buwen). For Deng, this became the crucial issue. Would the soldiers maintain order when so many young people opposed them? Might the soldiers be influenced by the students and lose their determination to impose discipline? Some soldiers appeared weary and hungry.18

Melanie Manion, a perceptive Western scholar who was there at the time, explained Deng’s rationale. In her view, it was “highly probable that even had riot control measures cleared the streets on June 3, they would not have ended the protest movement. . . . The protestors would have retreated only temporarily, to rally in even greater force at a later date . . . the force used on June 4 promised to end the movement immediately, certainly, and once and for all.”34 Deng’s family reported that despite all the criticism he received, he never once doubted that he had made the right decision.35 Many observers who saw the dwindling numbers in Tiananmen Square toward the end of May believe it may have been possible to clear it without violence. But Deng was concerned not only about the students in the square but also about the general loosening of authority throughout the country, and he concluded that strong action was necessary to restore the government’s authority.

In explaining his rationale for sending in the troops, Deng acknowledged that political reform was needed, but he was firm about maintaining the four cardinal principles: upholding the socialist path, supporting the people’s democratic dictatorship, maintaining the leadership of the Communist Party, and upholding Marxist–Leninist–Mao Zedong Thought.

The leaders had expected some resistance from demonstrators on June 2, but they had underestimated the strength of the opposition: Chen Xitong reported that people “surrounded and beat soldiers. . . . Some of the rioters even seized munitions and military provisions. Offices of the Central Government and other major organs came under siege.” Li Peng was so distraught at the scale and determination of the resistance that for the first time he used the term “counterrevolutionary riot,” indicating that those resisting would be treated like enemies.

Students of this generation, as well as the following generations, took away from their tragic experience the lesson that direct confrontation with the leadership would likely cause a reaction so forceful that it was not worth the costs.

The tragedy in Tiananmen Square evoked a massive outcry in the West, far greater than previous tragedies in Asia of comparable scale elicited.59 For instance, on February 28, 1947, as the Guomindang took over Taiwan, the Guomindang general Chen Yi killed off thousands of the most prominent local leaders so as to eliminate any local leader who might have resisted the Guomindang. In Taiwan the incident embittered relations between “locals” and “outsiders” for decades, but it received little attention abroad. In 1980, too, Korean president Chun Doo Hwan led a bloody crackdown during which he slaughtered far more people than were killed in Beijing in 1989 in order to eliminate local resistance in Kwangju. Yet the Kwangju events were not covered by Western television, and global condemnation of the South Korean leaders did not compare with the condemnation of the Chinese leaders after the Tiananmen tragedy.

In the aftermath of the Tiananmen incident, businesspeople, scholars, and U.S. government officials who believed that U.S. national interests required working with the Chinese government were vulnerable to criticism for cooperating with the “evil dictators” in Beijing. As the Cold War was coming to a close, many outspoken U.S. liberals were arguing that our policies should reflect our values, that we should not coddle dictators but instead should stand on the side of democracy and human rights. And what better way to display Western commitments to these ideals than to condemn those responsible for the Tiananmen crackdown? After June 4, then, Deng Xiaoping was confronted not only by disaffected youth and urban residents in China, but also by Western officials who espoused the same values as the Chinese demonstrators.

For the Westerners, the killing of innocent students protesting for freedom and democracy in Beijing was a far worse crime than the decisions of their countries that had brought about the deaths of many more civilians in Vietnam, Cambodia, and elsewhere. Western human rights groups began lecturing Chinese about freedom and regard for human life. High-level Western officials stopped visiting China, and restrictions were placed on the export of technology, especially military technology. Foreign trade and tourism suffered.

Deng began by expressing his sorrow over the deaths of the soldiers and police who had died while heroically defending the interests of the party and the people during the struggle. He said that given the global atmosphere and the environment in China, such conflict was inevitable. It was fortunate, Deng said, that the conflict had occurred when many experienced senior military leaders—men who had the strength and courage to resolve the issue—were still around. He acknowledged that some comrades did not understand the need for their action, but he expressed confidence that eventually they would come to support the effort. Difficulties arose, Deng claimed, because some bad people who had mixed with students and onlookers had the ultimate goal of overthrowing the Communist Party, demolishing the socialist system, and establishing a bourgeois republic that would be the vassal of the West.

Deng began the meeting by reminding them that, as he had often declared in the past, one of his final responsibilities would be to establish a mandatory retirement system, so that aged officials would automatically pass on their responsibilities to younger leaders. Deng expressed the view to his assembled colleagues that the lack of a mandatory retirement age had been a critical weakness in the system, not only in Mao’s later years but in imperial days as well.

Particularly devastating to the Chinese and to Deng personally was the growing mass movement in Romania against China’s friend Nicolai Ceauescu and his wife that culminated on December 25, 1989, with their execution. Ceauescu was the only Eastern European leader to order troops to fire on civilians, and no Chinese leader could avoid seeing the parallels with the recent military action in Beijing just seven months earlier. Indeed, the sudden turn of events in Romania that led to his execution caused Chinese leaders to wonder if they were immune to the fate of Ceauescu, who had earlier expressed approval of Beijing’s June 4 crackdown.

Like Deng in 1957, Jiang affirmed that democracy is a worthy target and that the amount of democracy achieved will depend on the political steadiness of the situation in China.

In February 1990, as the Soviet party plenum discussed giving up the party’s monopoly over political power, the People’s Daily printed nothing. Instead, on the day the plenum ended, without mentioning the Soviet Union, the People’s Daily announced, “In China, without the strong leadership of the Chinese Communist Party, new turmoil and wars would surely arise, the nation would be split, and the people, not to mention state construction, would suffer.” The following day the paper carried the news that the Moscow plenum had agreed to give up the party’s monopoly of power.54 As the Soviet Union was falling apart, some Chinese intellectuals were as joyful as many Westerners. Some even repeated to trusted friends one of the great Chinese slogans of the 1950s when China was introducing Soviet-style industrialization, now used with a very different connotation: “The Soviet Union’s today is our tomorrow.”

The collapse of communism in Eastern Europe and the USSR had revealed that youth in the Communist world had lost faith in Marxism-Leninism, the socialist economy, and Communist orthodoxy. Deng and his fellow party elders realized that political training in Marxism-Leninism or even Maoism could no longer be expected to appeal to the sensibilities of Chinese youth. Nor, even if Deng had personally supported it, would class struggle against the landlord and bourgeois classes resonate with the youth as it had at the height of the Mao era.   What should replace Marxism-Leninism and Maoist ideology to win the hearts and minds of China’s youth? The answer seemed obvious: patriotism.67 Patriotic education that emphasized the history of the century of humiliation by foreign imperialists had been the main theme of propaganda in the 1940s, and it had never disappeared. It had, however, played only a secondary role as China had built up socialism beginning in the 1950s, and it had languished in the 1980s as Deng tried to build closer relations with the West. Yet after 1989, when Western countries were imposing sanctions, there was a widespread patriotic reaction against foreign sanctions. To many Westerners, sanctions on China were a way of attacking Chinese leaders who used force on June 4, but to Chinese people the sanctions hurt all Chinese. Patriotic “education” linked nationalism to the Communist Party, as the Communists in World War II appealed to patriotism and nationalism to rally support against the Japanese. Conversely, criticism of the Communist Party was ipso facto unpatriotic.

The sanctions imposed by foreign countries and the criticism of foreigners that followed June 4 provided Deng and his colleagues with a useful vehicle for enhancing this patriotism. Within weeks after the Tiananmen tragedy, Deng began emphasizing his patriotic message. The Propaganda Department skillfully publicized anti-Chinese statements by foreigners that caused many Chinese, even students who advocated democracy, to feel outraged. The efforts by foreign countries to keep China out of the GATT (General Agreement on Tariffs and Trade, which in 1994 was replaced by the World Trade Organization) were publicized so as to focus Chinese anger on the prejudices of foreigners toward China. The refusal by foreign countries to supply modern technology was framed as an effort to unfairly prevent the Chinese from sharing in the fruits of modernization. Foreign criticism of China for its treatment of Tibetans, Uighurs, and other minority groups was presented to the Chinese public as part of an organized effort by foreign powers to weaken China. The West’s support for Taiwan and resistance to China’s claims to the islands in the South China Sea and the East China Sea were also offered up to the public as examples of efforts to keep China down. These stories and others had their intended effect. In the years after 1989, students who had shouted slogans against the government for corruption and for not granting more democracy and freedom began supporting the government and the party by shouting slogans against foreigners, who they felt were unfairly criticizing China.

He cautioned: “China should maintain vigilance against the right but primarily against the left.”29 In frank talks with local officials, Deng countered his critics who said that the SEZs were capitalistic and controlled by foreigners by saying that only a quarter of the investment came from foreigners. Moreover, Deng said, China had political control over all foreign-owned firms, so it could be certain that they served Chinese interests. Instead of worrying about the current level of foreign involvement, Deng advised, China should increase foreign investment and form more joint ventures: foreign firms pay Chinese taxes and provide local workers with jobs and wages.

He praised local leaders’ success in using markets to further the cause of socialism, and credited socialism in turn for aiding in that success: he said that capitalism could not match the socialist system in terms of focusing on talent to make things happen quickly.

On the issue of governance and freedom, Deng said that the concept of “democratic centralism” was still the “most rational system” and should remain the country’s basic governing principle. Leaders should find ways to encourage people to express their opinions, but once a decision is made, people should follow the collective decision.

Deng’s successors are under pressure for not being more successful in stopping China’s widespread corruption and for not doing more to resolve the problems of inequality. And it may be even harder in the future to combat these problems: given global economic fluctuations, China faces the potential of an economic slowdown before a substantial portion of the population has had the chance to enjoy the benefits of the earlier rapid growth period. To prepare for this possibility, Chinese leaders will have to look beyond fast economic growth for legitimacy and accelerate progress on some of the issues that the public is most concerned about: reducing corruption and inequality, providing a reasonable level of universal medical care and welfare, and finding a way to show that public opinion is being respected in the selection of officials.

Deng, as the first Chinese leader to address the UN General Assembly in 1974, said that China would never become a tyrant and that if it ever oppressed and exploited other nations, the world, and especially the developing countries, should expose China as a “social imperialist” country and, in cooperation with the Chinese people, overthrow the Chinese government. In August 1991, upon receiving the news that Soviet leader Gennady Yanayev had staged a coup against Gorbachev, Wang Zhen sent a telegram to the party center proposing that they lend support for Yanayev’s coup. Deng replied “taoguang yanghui, juebu dangtou, yousuo zuowei.”14 (Incorrectly translated by some Westerners as “avoid the limelight, don’t take the lead, bide your time.” What it means is “avoid the limelight, never take the lead, and try to accomplish something.”) In Deng’s view, China should not get involved in other countries’ domestic affairs.

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Key Points from The Cost of Free Money

Another well-written and provocative economic book I read last month was written by Paola Subacchi, Professor of International Economics at Queen Mary University of London and thought leader in global capital flow. In her book published last year, she argued that unfettered capital flow has caused disruption in Emerging Markets in the past few decades and the need for multilateral institutions similar to the Bretton Woods era post-WW II. Her book touched on the subject of inequality, geopolitics and the role of China in global order. The key points below serve as a personal note for me and my friends to come back to in the future.

As money moves around, it binds the global economy together. Developing countries have enjoyed strong economic growth in the last thirty years by becoming more integrated in the world economy through trade and investment – a process that is referred to as globalisation. We, as consumers, have all benefited from lower prices – but only if we don’t include environmental and human costs in our calculations. But what happens, then, when the world enters into a phase of transition where economic growth no longer lifts all boats,4 where rules become confused, confidence evaporates and politics becomes conflictual?

The Bretton Woods monetary system was designed to limit the scope for domestic policies that are detrimental to other countries, indeed ‘beggar-thy-neighbour’ policies – such as securing an unfair advantage for one’s own country through a competitive devaluation of the exchange rate, at the expense of another country. It also aimed to establish a level playing field for international trade, while at the same time providing the flexibility to pursue domestic interests such as full employment. Under these arrangements, the dollar came to replace sterling as the key international currency and the United States came to replace Great Britain as the leading global power, rendering it responsible for the provision of public goods: finance for development and the global financial safety net.

In desperate need of exchange rate stability, many developing countries have anchored their currencies to the dollar, but in doing so they have tied themselves to the monetary and policy decisions of the United States and consequently run into a whole heap of problems.

Until the end of the 1970s, living standards in the United States grew in line with the growth of the economy, but between 1980 and 2016, 90 per cent of the population’s income grew at a pace that was slower than the national average, with that of workers in the bottom 40 per cent of the income distribution growing by 0.3 per cent a year. Over more than three decades, pre-school teachers and carers saw their annual income grow from $26,400 to just $29,800. On the other hand, those in the top 0.1 per cent of the income distribution – for example, an investment banker or a corporate lawyer – almost quadrupled their post-tax income.

The post-Second World War golden age was the result of extraordinary economic and political conditions. These conditions supported the expectations that progress could only be linear and ascendant – that is, that social, economic and physical conditions could only improve. In the opening of this chapter I identified four trends – demographics, health conditions, economic growth and geopolitics – that, through their interplaying, came to shape the golden age.

The postwar years were blessed with exceptional economic activity that resulted in strong and sustained economic growth. In the two decades after the war, the advanced economies, including Western Europe and the United States, saw their annual real gross domestic product (GDP) grow at a steady average rate of 5 per cent.11 Unemployment was low. By the mid-1960s, the average unemployment rate across Europe was 1.5 per cent – effectively a situation of full employment. The United States also saw a significant improvement, with the unemployment rate dropping to around 4 per cent at the same time.

The overlapping of these trends meant that, for the first time ever in human history, people who were not endowed with wealth and capital, exceptional talent or even just sheer luck, could aspire to a decent life for themselves and their children. For many people from blue-collar backgrounds, a white-collar middle-class future was no longer a wild dream.

Brands have become global because the world economy has become global. The world has changed beyond recognition in the last forty years; it has become larger, ‘flatter’19 and more connected. The reduction or removal of trade barriers (as in the case of Europe’s single market), the opening of new markets and the integration of transnational supply chains have become the defining stories of our time.

Barriers to mobility started to crumble around the time of the fall of the Berlin Wall in 1989, which marked the end of the Cold War and the beginning of an intense period of trade and financial integration. With the barriers to mobility removed or reduced, markets opened up, fostering innovation in technology, information, ideas, governance and institutions. This in turn created the conditions for more cross-border business, shaping the development path of many countries and underpinning the transformation of the world economy. These dynamics are reflected in the dramatic increase in international trade flows over the last three decades.

What really differentiates the later phase of globalisation, however, is not the speed of integration within a relatively short space of time, nor the rate at which international trade grew. It instead lies in the fact that the countries that had, for the last seventy years, largely remained at the periphery of the world economy, are now key components. These include China, India, Russia and Brazil, with South Africa added at a later stage – the BRICS as they have become known (as I will discuss in chapter 7) – but also Mexico, Indonesia, Thailand, Vietnam, Nigeria and Turkey. All of these countries have come to epitomise the broadening of the world economy both in terms of the increase in the share of the world GDP they currently produce (about 40 per cent at current market prices) and their contribution to global growth (approximately 60 per cent).

Capital flows, even more than trade, have grown robustly since 1990. This is true of both portfolio investments and foreign direct investments.

In the mid-1990s, gross cross-border capital flows accounted for approximately 5 per cent of world GDP; at their pre-crisis peak in 2007 they were about 20 per cent. Capital flows, then, increased at a pace approximately three times faster than that of world trade flows.39 Nowadays, foreign direct investments account for around 1.4 per cent of the world’s total GDP.40 (Foreign direct investment are a type of investment that reflects lasting interest and control by a foreign investor, such as when an investor who resides in one country buys or establishes a firm in another country.) In 1990 this figure was much lower, at approximately 0.9 per cent. Portfolio investment – such as when an investor buys shares in a foreign company or a portion of a country’s or a company’s debt such as stocks and bonds – are by far the bulk of the overall investment activity. They account for approximately $58.7 trillion – approximately 68 per cent of global GDP.41 Since 2001, when the data series began, they have increased by four times their level.

Capital flows are a positive force for the economy as they support economic activity and growth. If they are directed towards activities that increase productivity and add value, they can – directly or indirectly – create new jobs and have a long-term impact. However, when international capital flows are directed towards speculative activities without any intrinsic value creation, they can often end up feeding speculative bubbles or excessive and unstable credit growth, generating significant risks for financial stability. When this happens the recipient countries can make themselves hostages to fortune and vulnerable to external shocks. Not only do these developments make it difficult to manage the domestic economy – for instance, by creating inflationary pressures – but they make countries vulnerable if money inflows suddenly reverse. The Organisation for Economic Co-operation and Development (OECD) has estimated that after large capital inflows, the probability of a banking crisis or a sudden stop increases by a factor of four.

The outbreak of the First World War, however, showed that geopolitical rivalries and even personal antagonism could overcome commercial and economic considerations.55 Despite this, the call for a sound international economic order that promoted cooperation and minimised ‘beggar-thy-neighbours’ actions remained embedded in the intellectual debate of the interwar years.

In The Economic Consequences of the Peace (published in 1919), Keynes identifies trade as the key driver of prosperity which, in turn, was believed to promote domestic order and moderation, resulting in international stability and peace. He further argued that obstructions to trade lead to impoverishment, which then fosters domestic extremism and disorder, and eventually international conflict. By the same token, those who identify their interests with trade are more likely to pursue peace than those who do not, and those who recognise that their well-being depends on trade will be much more likely to pursue policies of international ‘peace and amity’.

Playing by the rules seems to work better when economic conditions are symmetric, such as when the countries in Western Europe were rebuilding their economies at the end of the Second World War. Asymmetric economic conditions – in terms of economic growth and domestic welfare, for example – prevail when some countries experience stronger activity and better labour market conditions than others, as is currently the case in Europe. Even within Europe’s monetary union, divergent economic and financial conditions indicate that some countries (such as Italy) find it more difficult than others (such as Germany) to play by the rules and reduce public spending in order to rein in the public debt.

three supranational institutions – the European Commission, the ECB and the IMF, otherwise known as the Troika – played critical roles during the resolution of the sovereign debt crisis that affected Greece between 2010 and 2015. As I will discuss in chapter 5, the urgency of the crisis and the need to minimise the risk of financial contagion to other economies in Europe – especially Italy with a public debt far larger than that of Greece – put the Troika, i.e., unelected public servants, in charge of crisis resolution. This raised the question of whether the management of global capitalism – of which crisis resolution and crisis prevention are important components – transcends the traditional model of democracy, possibly even making it impracticable.

In a document that the British government had published in 1940 in response to Nazi Germany’s plan for a ‘New Order’ in international economic relations,6 Keynes made it clear that the mistakes of 1919 could not be repeated; a return to the Gold Standard – the monetary arrangements in place until the First World War and reinstated from 1925 to the early 1930s – was not a viable option.

The experiences of the interwar period – during which unemployment rates peaked at roughly 20 per cent in Great Britain and roughly 25 per cent in the United States – had also shown the need for a system that could accommodate domestic policy objectives, such as full employment, as well as the objective of maintaining the external balance. The risk, otherwise, was to again undergo a competitive struggle for markets – the key economic cause of war.

The system worked as long as wages and prices were flexible enough to allow adjustments and maintain the external balance. In the event of a deficit in the trade balance, for instance, domestic prices and wages would drop, making exports more competitive and imports more expensive relative to domestic prices. Restoring the trade balance thus ensured that gold reserves were maintained to back national currencies – having too low gold reserves increased the risk of a convertibility crisis, i.e., when countries were unable to convert their outstanding liabilities into gold at the fixed parity.22 The system, however, was not suitable for an expanding world economy. There simply wasn’t enough gold to support the economic expansion of the late 1890s and early 1900s, for example, and it was difficult for domestic prices to adjust during this period.

Being reinstated in 1925 as the Gold Exchange Standard,23 it came under pressure during the Great Depression that followed the Wall Street Crash in 1929, when the commitment to gold convertibility proved to be an impossible stranglehold for the countries that adhered to it. As countries in the euro area know all too well (I’ll discuss this in Chapter 5) attempts to restore the external balance in a situation where the exchange rate is fixed lead to an undesirable dilemma. In these circumstances, labour productivity – that is, the output produced given a certain amount of labour force – needs to increase for the balance to be restored. As productivity increases, the cost per unit goes down; exports then become cheaper and therefore more competitive, helping to restore the required balance. Output per worker can be increased through improvements in skills – due to education and training – and in technology and innovation. But both these routes take time to deliver the desired effect and so are of little use when the situation requires urgent action. In this case, there are two options. The first one is to decrease wages, either by paying less for the hours worked or getting people to work for longer for the same pay; the second is to decrease the number of workers, leaving the remainder to pick up the slack. The internal adjustment therefore requires an internal devaluation that in turn is conditioned on an increase in unemployment and/or a cut in wages; neither option is fair or politically feasible.

To combine rules with flexibility, the new system had to focus on achieving the two objectives of internal and external balance – rather than subordinating one to the other as was the case within the Gold Standard. Fiscal policy and adjusting exchange rates when they came to differ from their ‘fundamental equilibrium exchange rate’ values became the key policies of the new system.26 Fiscal policy would be used to manage domestic demand to ensure full employment and contain unemployment and the consequent downward impact on wages. At the same time, the cooperative approach to the exchange rate adjustment would restrain governments’ discretionary power of pursuing competitive devaluations and their potential ‘beggar-thy-neighbour’ impact. The way to achieve this was through an adjustable peg system of fixed parities that could be changed only under exceptional circumstances.

Put otherwise, the IMF was designed as a financial safety net – an insurance policy that member countries could turn to when they could no longer control the exchange rate. Its goals were to help countries maintain full employment, support rapid economic growth, keep exchange rates stable and avoid competitive devaluations. In addition, the IMF was tasked with creating a multilateral payments system, eliminating exchange restrictions and supplying funds to backstop and contain balance of payments disequilibria.

Thus the whole international monetary system relied on the ability of the United States to maintain liquidity in the system – that is, its ability to supply dollars ‘on demand’. As the economy of Western Europe was expanding on the back of the postwar reconstruction, the private and official demand for dollars was growing too. Dollars were supplied through private and official long-term capital outflows in excess of a current account surplus.

There were three issues that were undermining the Bretton Woods system and would ultimately result in the American decision to unilaterally unravel it. The first problem concerned the adjustment of countries with a persistent deficit in the balance of payment, as was the case for Britain. Like in the 1920s, deficit countries were bearing the burden of adjustment,

The second problem consisted in an increased risk of a run on the dollar. Although the dollar convertibility outdid the Gold Standard in creating liquidity, the link between the dollar and gold had been exacerbated by the perceived gold shortage – even more so than it had been the case in the past. As the United States provided dollars to the fastest growing economies, such as those of continental Europe and Japan, they ran persistent deficits in the balance of payments. The result was that the outstanding dollar holdings increased relative to the US monetary gold stock, ever widening the gap. The third problem, related to the second one, was brought to light by economist Robert Triffin in his 1960 testimony before the US Congress. He heeded that the ‘dollar overhang’65 was growing larger than America’s gold stock. The persistent deterioration of the United States’ net reserve position would ultimately undermine confidence in the value of the dollar. Lacking this confidence, the dollar would lose its standing as the world’s leading reserve currency. The so-called Triffin dilemma came to express the choice that the United States faced. On the one hand, they could improve confidence in the dollar by embracing contractionary policy that would have a deflationary impact on international liquidity. Alternatively, they could support liquidity by embracing expansionary policy, but in doing this they would risk undermining dollar-holders’ confidence.66 Put otherwise, the United States could retain confidence in the dollar by reducing the deficit, but only at the cost of reducing liquidity in the global system and constraining the growth of the domestic economy.

The deterioration of confidence in the United States vis-à-vis the dollar indicates the fundamental problem within the Bretton Woods system that eventually resulted in its dismissal. Indeed, once confidence was damaged, governments and central banks began to question what they should do with their large dollar holdings and whether they would be better off converting them into gold before the dollar is devalued. If the Bretton Woods countries had requested to convert just a quarter of their dollar holdings at the same time, the United States would not have been able to meet its obligation.

As public opinion in the United States was becoming more hostile towards the war in Vietnam, it was also becoming increasingly aware and less tolerant of the cost of putting the needs of foreign allies before domestic policy objectives. In particular, there was a growing concern over the commercial threat posed by Europe and Japan. Governments and central banks in Europe and Japan, in turn, were growing increasingly uneasy about holding dollars. The Europeans and Japanese had just one critical tool to hand that could rein in the monetary policy autonomy of the United States – the right to demand to convert their dollar holdings into gold. As each side accused the other of being uncooperative, the cracks in the Bretton Woods system deepened even further.

Thus the end of Bretton Woods was more than just the end of dollar convertibility; it ushered in a new light-touch policy framework focused on deregulating domestic financial systems and limiting fiscal policy so to minimise political discretionality and attempts to manipulate the economy. As a result, monetary policy became the main policy tool for managing domestic demand. Alongside floating exchange rates, monetary policy can manipulate movements in the exchange rate which can result in the required changes in demand. Indeed, demand can be stimulated by cutting interest rates, which will in turn support growth and boost employment rates. Part of this stimulus happens through the depreciation of the exchange rate, as a reduction in the interest rate curbs demand for financial assets denominated in the domestic currency. A weaker exchange rate helps increase exports while making imports more expensive. As such, it was concluded that all that was needed in terms of active policies was flexible exchange rates, disciplined fiscal policies and government budget deficits that are balanced in the longer term.

Starting in the 1980s, the advanced economies and many developing countries removed capital controls to stimulate international trade and expand output. It was the beginning of the financialisation of the world economy. Thatcher liberalised Britain’s capital movements in 1979 – one of her government’s first moves. This was followed by the French socialist government’s ‘tournant de la rigueur’ in 1983, which paved the way for more financial liberalisation within Europe. As a result, capital has accumulated globally and the global economy has developed strong interdependencies, trans-border linkages and global networks; compared with earlier versions, its scale and scope are both wider and deeper. This has translated into bigger markets, lower labour costs, tax cuts, less regulation and new opportunities for accumulating wealth through intangible assets such as information and knowledge.77 This process of financial integration has considerably delinked money and finance from territorial space.

the liberalisation of capital movements that followed the breakup of Bretton Woods, coupled with the belief that markets should be left to their own devices with little intervention and limited regulation, resulted in recurrent episodes of financial instability. These, in turn, have eroded the rules-based international order

grappling with capital flows becomes even more daunting when foreign capital is underpinning the domestic banking sector; the necessary adjustment of the exchange rate to support the real economy can trigger speculation and eventually capital outflows. This can result in the collapse of domestic banks, as happened in Asia in 1997 and then in Argentina in 2001. The British and Italian ‘Black Wednesday’ of 1992, which I also discuss, seems like an odd choice, but it is here to show the risks of embracing a monetary straightjacket while keeping free movements of capital – exactly the opposite of Bretton Woods.

After the 1990–91 recession in the United States, the Fed responded to high and rising unemployment rates by reducing the federal funds rate from 6 per cent in mid-1991 to 3 per cent by October 1992, where it stayed until February 1994. These Mexican and US policy decisions resulted in large amounts of capital flowing into Mexico in the early 1990s, as many mutual funds and other financial intermediaries were chasing higher returns. As a result, portfolio capital inflows became a critical source of foreign savings for Mexico.

The large amounts of capital that were flowing into Mexico did not help. The appreciation of the exchange rate worsened even further as the supply of domestic non-tradables – for example, services such as hairdressing that need to be performed locally – came under pressure, undermining the policy of containing inflation. This caused actual inflation to again be higher than the target, even though the Mexican government’s reforms had overall contributed to reducing it. Savings fell in line with an increase in investments, and widened the savings-investment gap. Private investments increased on the back of positive expectations about Mexico’s future economic performance; the Mexican government’s market-oriented reforms (which began in the mid-1980s) complemented its stabilisation efforts and turned investors’ sentiment.

The real exchange rate appreciation penalised exports and encouraged imports, resulting in a widening gap between what was produced and what was consumed, and a growing disequilibrium in the current account. There is an important point here that is worth stressing. The fixed exchange rate system embraced by Mexico could be sustainable, but only if the growth in productivity was fast enough to impact on the real exchange rate. Otherwise, the economy would experience sluggish growth or – at worst – if imports continued to be stronger than exports, Mexico would fall into a balance of payments crisis yet again. Such a crisis could be held off for as long as the current account deficit was financed by foreign capital inflows.

For a while, Mexico’s current account deficit was ‘overfinanced’; there was so much capital flowing into the country, that its central bank was able to build up its reserves. This strategy, however, was not sustainable. The low domestic savings rate meant that Mexico was vulnerable to problems in debt servicing and subsequent swings in international investors’ sentiment.

There are three important lessons to be learned from the Mexican crisis.14 The first is that countries that rely on foreign capital instead of domestic savings do so at their peril. However, as we will see with subsequent crises, relying on domestic savings is easier said than done. This is because financial globalisation has made it much easier for developing countries to achieve high rates of GDP growth by attracting foreign capital than it is for them to do so by developing their economies slowly and sustainably. The second point, related to the first, is that policy measures to deter speculative capital flows should be applied – even if that implies reducing such flows in the short term. The final point is that exchange rate policies need to be flexible. For if policymakers can’t make adjustments without losing credibility, damaging capital flight is certain to ensue. A corollary is that when capital movements are unrestrained, a flexible exchange rate allows adjustments that a fixed exchange rate system doesn’t. The debacle of the European Monetary System (EMS) shows the problems with rigidity and lack of international cooperation,

Like the United States’ decision to end the convertibility of the dollar into gold in 1971, the suspension of the EMS was a key moment in the development of the postwar economic order. The relationship between Germany and France, and Germany and the United Kingdom, was put under strain – with consequences that last to this day. The French felt that they were paying for the cost of German reunification, just like in the 1960s when they felt that the United States was using the dollar to fund their budget deficit.20 The British shared this sentiment. As Prime Minister John Major wrote to German Chancellor Helmut Kohl: ‘German reunification is at heart of these problems [. . .] Britain strongly supported [this] but many in Britain believe that we are now having to pay a high price.’21 The British and Italians felt that the speculative attacks on sterling and the lira could have been mitigated, or even avoided, if Germany had been willing to actively drive the value of the deutsche mark down, allowing the other currencies to adjust. Recall that equilibrium in the ERM was achieved by participating nations selling the strongest currencies for the weakest ones – and the mark was the strongest currency at the time. There wasn’t a technical obstacle preventing the Bundesbank from purchasing sufficient quantities of British pounds and Italian lira to avert the precipitous depreciation of sterling and the lira against the mark. But the Germans were persuaded that their economy was booming and monetary policy should be steered towards avoiding inflation regardless of the impact on other countries in Europe.

Prior to the Asian crisis, the broad exchange rate stability and rapid credit growth muted investors’ and banks’ capacity to adequately assess risk. As such, currency mismatches on corporate balance sheets and the highly leveraged positions of the borrowers went under the radar. Banks were also increasingly exposed to maturity mismatches, so much that foreign borrowing was short-term and domestic lending long-term. Lax prudential regulatory and supervisory practices also contributed to the problem. Indeed, many non-bank financial institutions had emerged in the region in the runup to 1997. This was because the licensing requirements were much lighter in places such as Thailand, and regulations in South Korea and the Philippines – including lower capital requirements – were much less stringent than those applied to commercial banks. As long as money was flowing in, however, the system was kept in equilibrium. In 1996, Thailand amassed inflows equal to 14 per cent of its GDP. As domestic borrowers were tapping into cheap foreign-currency loans, the situation was becoming clearly unsustainable.

The Asian crisis, once again, put the problem of unfettered capital flows under the spotlight – especially for developing countries. There are four critical lessons to be learnt here. First of all, financial globalisation and the liberalisation of capital movements without an appropriate regulatory framework put the financial stability of many countries at risk. The second point, linked to the first, is that the speed and impact of financial contagion among economies interconnected through capital flows can generate a vicious cycle of debt, and hit the real economy. Third, rebuilding and expanding foreign exchange reserves in countries that were affected by the crisis is seen as a form of self-insurance against further crises. But the final and most important point is that the Asian financial crisis brought to light the need for greater financial cooperation within the region in face of a common crisis. Indeed, in May 2000, finance ministers from ASEAN+3, the Association of Southeast Asian Nations plus China, Japan and South Korea, met in Chiang Mai, Thailand and agreed on a series of bilateral swap arrangements.

The problem here is that often the monetary policy and political decisions that will benefit the United States domestically are exactly those that will cause havoc for the countries that rely on the dollar system. This highlights the broad and deep contradiction in having an international monetary system that has retained the dollar standard of Bretton Woods bar gold.

China epitomises the constraints of immature lenders13 – another is Singapore with a current account surplus in excess of 16 per cent of GDP. With a surplus in its current account, even if it has significantly narrowed over the years, China tends to offset this excess by investing abroad. In one sense, this is not dissimilar from Britain when it invested sterling all over the world in the nineteenth century, or Germany nowadays, which lends heavily to other countries in the euro area. But in another sense, it is radically dissimilar because China invests abroad in dollars – not in renminbi. Over the years, China has offset its trade surpluses by accumulating dollars and financial assets denominated in dollars and, increasingly, by expanding its financial diplomacy in Asia, Africa and Latin America. It is indeed the renminbi’s reduced international circulation and liquidity, as I will discuss in Chapter 7, that has limited worth for international lending, dictating that China’s external claims must be made in dollars. In doing so, however, China continues to take on the exchange rate risk.

Rapid credit growth underpins the overheating of domestic economies and the buildup of vulnerabilities, and it results in growth that is not sustainable and often leads to bubbles and subsequent bursts. Between 2010 and 2013, issuance of below-investment-grade debt in developing countries, especially India and Turkey, rose from 15 to 35 per cent of total debt issuance.20 When inflows turn – and they always turn when economic growth eventually slows, financial conditions become tighter and exchange rates depreciate – then a financial and banking crisis may be just around the corner. For developing countries with weak economic fundamentals and unsustainable exposure to capital inflows, this has always been the case.

The remedy devised by the Fed did kickstart the US economy and therefore the world economy after the global financial crisis, but simultaneously landed the developing countries in a difficult position. At the time QE was presented as an almost inevitable measure, but it was not the case. Given the downturn in demand was large enough to require exceptionally loose monetary policy, fiscal policy should have been used to sustain demand, but it was politically unfeasible.

The portfolio flows mainly fed into local currency sovereign and corporate bond markets. In 2013, corporate bond issuance in developing countries reached $630 billion – in 2000, they had amounted to just $13 billion. During the same period, the share of debt issued in local currency expanded from close to zero to over 50 per cent.25 We have seen in the previous chapter, with examples such as Mexico and Argentina, that mixing heavy capital inflows with sovereign debt in a developing country tends to create a breeding ground for crises. Indeed, all crises since the 1980s have been triggered by excessive indebtedness and excessive reliance on portfolio inflows, and banking crises are frequently born out of debt crises. In addition, a surge in capital inflows is conducive to stimulating strong credit growth. In some countries, as I will discuss in the next section, some of these inflows were channelled in the shadow banking sector.

So, for China, a stronger renminbi equated to a drastic reduction in the value of its dollar reserves – a lessening of the ‘wealth of the nation’. But, to some extent, China could only blame itself and its exchange rate policy. As the renminbi was appreciating against the dollar, the central bank was intervening in the foreign exchange market to curb the strength of the Chinese currency and as a result continued to expand its dollar holding. China’s official reserves would go on to peak at just over $4 trillion in June 2014.29 This story illustrates the risks of sitting on a large pile of dollars. Dollar accumulation means taking on a large exchange rate risk and also being exposed to the domestic politics of the United States as well as vulnerable to swings in US foreign policy.

But holding reserves has a cost for countries that are still developing their economies, where a significant share of the population is poor and where the income per head is relatively low. Indeed reserves are capital that is accumulated instead of being used for domestic development.

China’s central bank, the PBoC, holds onto the dollars that are earned through trade, stashes them in its foreign exchange reserves and gives exporters renminbi in return. In other words, the PBoC buys dollars in exchange for renminbi, which changes the dynamic between supply and demand of the two currencies and prevents the renminbi from appreciating against the dollar. In practice, this equates to injecting a lot of renminbi liquidity into the banking system that, in turn, feeds domestic demand and pushes up both consumer and asset prices. Coupled with capital markets’ limited diversification, this has the potential to result in the creation of asset bubbles in markets such as real estate,

To avoid any undesired effects on consumer prices, the Chinese authorities need to control monetary expansion in the domestic market. They have an array of policy tools at their disposal to mop up the excess liquidity – or sterilise it. One option is to increase the reserve requirement ratio for large domestic banks, which has been raised by up to 20 per cent of banks’ capital. Another option is for the central bank to sell financial securities such as bonds. Between 1999 and 2005, the PBoC bought nearly all of the foreign currencies that came into the country, invested them and then sterilised them by issuing local currency bills to take the funds – mainly dollars – out of circulation. Around 90 per cent of China’s reserves have accumulated from the joint process of foreign exchange intervention and sterilisation.

It is true that China’s development over the last three decades has been facilitated by the dollar. But ‘free-riding’ on the dollar – an endless source of annoyance for the United States, as I’ll discuss later – has not come without its own set of burdens. Although it may have suited the Chinese leadership’s goals in the heyday of reforms and opening up, there is no doubt that it has become a constraint. Having the dollar at the core of China’s financial and monetary system is a constant reminder of the limitations of such a system. For, despite the size of its economy, financially China remains a developing country. Further to this, there are costs implied in using the dollar such as mismatched assets and liabilities on firms’ balance sheets, and exchange rate and liquidity crunch risks. Another facet of China’s dependency on the dollar is that the renminbi is an ‘immature’ international currency with limited convertibility outside of designated markets, restricted payment facilities and so constrained international circulation. As for the United States, China’s (and other countries’) large dollar holdings highlight that the dollar can be a powerful weapon in the event of geopolitical tensions.

Being offered the possibility to rely on a dollar liquidity line from the Fed is a highly effective way to stabilise a country’s banking and financial system. The Fed indeed agrees to accept some countries’ currencies in return for a loan in dollars, acting as de facto lender of last resort.

Unlike in Japan, where well over half of the debt is public, in China it is mainly private. The rate at which China’s debt has grown is a cause for concern and this is what prompted the monetary authorities to keep a tight grasp on capital movements. As I will discuss in Chapter 7, capital controls have ensured that individuals’ and families’ savings remain in the country and are channelled back into the banking and shadow banking sectors. This means that China’s highly indebted companies and the banks that lend to them are never without financial resources. As long as China keeps control on capital movements, then, its current account surplus and large holding of foreign exchange reserves should keep its debt sustainable and ward off financial instability.

The IMF has warned that high corporate debt levels will amplify stresses and put financial stability at risk52 – and there are many potential sources of stress in the global financial system. Trade tensions could worsen the outlook and cause investor sentiment to sour, resulting in stress from an increase in risk premiums, for example. A shock of this type would result in increased interest rates, corrections in stretched asset valuations (such as properties), exchange rate volatility and sudden international capital flow reversals. Such developments would bring leveraged companies, households and sovereigns under strain, deteriorate banks’ balance sheets and cause damage to public finances, especially those of emerging market economies.

Austerity programmes and constraints on fiscal policy pushed the burden of the post-crisis adjustments on deficit countries – like Greece – while no adjustment was required from surplus countries – like Germany – which were allowed to accumulate surplus and push onto others the impact of their deflationary policies.

Europe’s monetary union has been built around the idea that the integrity of the union needs to be protected from the fiscal profligacy of its member states. This idea is solidified in the Maastricht Treaty fiscal rules, which – in addition to the sovereign debt and the annual budget deficit thresholds – state that no member country should have an inflation rate higher than 1.5 per cent, and that the union will not assume or be liable for the commitments of member states’ central governments. The bottom line of this is that the union will not bail out its members if they have not respected the rules.

Playing the role of lender of last resort means that central banks provide liquidity to the commercial banking system in times of stress by lending against good collateral and charging interest rates. This function is now critical to our modern economy. Without the assurance that a central bank is both willing and able to provide liquidity, problems specific to one single bank will likely cause savers to withdraw their funds from other banks too. What this means is that a solvency crisis that begins in a specific part of the system can quickly evolve into a systemic liquidity crisis that has the potential to bring down the entire system. Unconstrained capital flows mean that a lender of last resort cannot limit its action to commercial banks. As it became evident throughout the unfolding of the Greek crisis, the lender of last resort should be prepared to provide liquidity to the bond market by actively intervening if a lack of liquidity and rising interest rates threaten to trigger a sovereign debt default.

The issue of how to shape a balanced relationship between democratically elected bodies and delegated bodies lies at the core of organisations like the WTO, the IMF, the multilateral development banks, and the OECD. By providing the infrastructure (including data and analysis) critical for the implementation and monitoring of the rules that inform the international economic order, these institutions increasingly play a decisive role in shaping and influencing the economic policies of sovereign states that are part of such order.

Looking at Italy and Greece, the moral of the tale is clear: dealing with debt can disrupt domestic politics, especially when the adjustment required as part of the debt-management strategy disproportionally hits the most vulnerable in society. For debt-afflicted countries, either they play by the rules – and those in the single currency fit in the monetary straightjacket – or they risk losing market confidence and so undermining or even stopping capital flows that are necessary to refinance the existing debt. This, as we have seen in Greece, can bring havoc or simply push up the cost of servicing the debt as in the case of Italy.

To borrow the words of Jean-Claude Juncker who, having served as prime minister of Luxembourg between 1995 and 2013, and president of the European Commission between 2014 and 2019, is easily one of Europe’s most seasoned politicians: ‘Politicians are vote maximisers [. . .] for the politician, the Euro can render vote-maximising more difficult, as a smooth and frictionless participation in the monetary union sometimes entails that difficult decisions have to be undertaken or that unpopular reforms have to be initiated.’36 Juncker clearly refers to Europe’s monetary union, the most constraining framework that countries can sign up to. But this is true for all countries that are exposed to capital markets, for debt is in principle at odds with democracy if debt management imposes policy choices that are difficult to reconcile with voters’ preferences.

close international cooperation is critical for keeping the economic order in equilibrium and containing instability when crisis hits. International cooperation is difficult to maintain, because it often conflicts with national interests. It is impossible, however, when countries start from an uncompromising nationalistic position where domestic interests are too strong or the domestic political costs are too high.

in a world where capital moves in and out of markets freely, sovereignty – and especially fiscal sovereignty – is a fluid concept. International investors have not been shy to voice their concerns regarding Italy and, as we have seen repeatedly throughout this book, governments that struggle to maintain credibility in the eyes of international investors find it difficult – if not impossible – to refinance their debt when the money eventually leaves the country. Italy has all the ingredients for this to happen: stagnant growth, delays in the improvement of its debt position, a weak banking sector, falling saving rates – and no perceived urgency, let alone a clear plan to address structural reforms.

Putin declared that the liberal order had ‘outlived its purpose’ and become ‘obsolete’ as the political balance of power is shifting from ‘traditional western liberalism to national populism’. The reason? ‘Public resentment about immigration, multiculturalism and secular values at the expense of religion.’52 The interview – Putin’s first with a major international newspaper in sixteen years – leaves many questions unanswered. Why now? Was this a way to tell the world that Russia is back at the top table with history on its side, as the Financial Times argues? And the idea that liberalism has run its course and has ‘come into conflict with the interests of the overwhelming majority of the population’, is it what ‘our Western partners’ believe or what they are led to believe?

China’s outward direct investment really took off in the mid-2000s; by 2018 China’s direct investment outward stock had reached almost $2 trillion, making it a net exporter of capital for the first time, and the second largest outbound investor in the world.20 By investing abroad, China has managed to connect itself to a variety of resources that have been invaluable for its development, including commodities such as oil, iron ore and copper.

Thus, the large pool of savings that have been accruing in China’s domestic banks for several decades have been instrumental for the country’s rapid economic growth. Indeed, the Chinese authorities have channelled these savings towards the country’s industrial transformation. By tightly controlling the maximum deposit rate (capping savers’ returns), the minimum lending rate (and so keeping the cost of borrowing low) and credit quotas, the monetary authorities have adequately managed the allocation of these savings from the banking system into state-owned enterprises.

Such a system has created some serious distortions and vulnerabilities. Banks are saddled with too much low-quality lending and non-performing loans, and they are vulnerable to insolvency that can in turn trigger a liquidity crisis. Savers, on the other hand, feel the pressure as they do not get much for their money, and so they turn to non-bank financial institutions instead in the hope of getting better returns. Within the so-called ‘shadow’ banking sector savers can invest in unregulated short-term instruments, such as, for example, commercial papers that pay high interest over three months, but are riskier than the bank deposits – with the offer of increased returns, of course, comes an increased rate of risk. Low interest rates can create problems for borrowers too. Chinese firms often borrow more than they need, and give little consideration to efficiency or profitability. After all, if they were to incur any financial losses, this would simply be covered by state subsidies.

The so-called ‘policy banks’ – the Agricultural Development Bank of China (ADBC), China Development Bank (CDB) and Export–Import Bank of China (Exim Bank) – are the other pillars of China’s banking system. They were all established in 1994 to finance trade, development and state-led projects. Not holding any deposit, they get their capital by issuing bonds on the domestic capital market where they are dominant. Indeed, approximately three-quarters of the total bonds on the Chinese market are issued by the policy banks.

By keeping controls on capital movements, the Chinese monetary authorities are able to maintain domestic financial stability. Due to China’s combination of high savings and financial repression, unrestricted capital movements would pose a threat. If the authorities were to loosen controls, Chinese people could choose to invest their savings abroad for better returns. China’s domestic banks would then be left with two options – compete or collapse. A similar threat could also arise from a change in external conditions such as a change in the US monetary policy that could trigger domestic financial instability in China. Managing capital movements to avoid sudden shifts in the demand for renminbi and renminbi-denominated assets ultimately feeds back into the Chinese monetary authorities’ control of the exchange rate. For example, in the years after the global financial crisis when the Chinese economy was growing strongly, interest rates in the United States were zero and the dollar was weak, controls on capital movements served to restrain the inflows, helping maintain financial stability and keep the exchange rate at the level consistent with China’s economic objectives.

So, if it is true that ‘great nations have great currencies’,48 then not having a great currency is preventing China from achieving its ambition of being a great nation. But what does the obstruction actually consist in? I have already discussed the limitations that face countries lacking an international currency when they have to issue debt (the original sinners) or lend (the immature creditors) on international markets, using currencies that are not their own. With an excess of savings, China is a lender rather than a borrower and so suffers from the latter of these issues with all of its related costs and risks.

‘Made in China’ should help to push the country to the second stage of such industrialisation and achieve 70 per cent ‘self-sufficiency’ in high-tech industries by 2025. The aim is not only to reach a point similar to that of advanced economies in the earlier stage of their industrialisation, but also to respond to the competition from other developing countries. Without an ad hoc industrial strategy, the authorities felt that the advantage in terms of competitiveness acquired over the first stage of industrialisation would be dissipated, and China would be squeezed in between advanced economies and developing countries with a lower cost base.

It is the relative competitive position of different countries in international trade as a result of the rise of China – and other developing countries – that bothers the United States. Through its process of ‘opening up’ China has challenged the multilateral trade system to accommodate for the increase in cheap exports that have resulted from its exports-led growth model. The world is still grappling with the impact of this on labour market arrangements, consumption patterns and environmental sustainability.1 In addition, China’s large accumulation of savings, a consequence of its export-led growth model, has exacerbated the imbalances between creditor countries (i.e., China itself) and debtor countries (such as the United States). And controls on capital movements in and out of China constrain the adjustment through the exchange rate.

Thus, despite the catchy soundbite, the call for the ‘new Bretton Woods’ was not answered. There are a number of reasons for this. Firstly – as I have already stressed – Bretton Woods did not come out of the blue and was the result of years of intellectual debate and policy discussions. Second – again a point already mentioned – the post-2008 initiatives were driven by the urgent need to reset the system, so there was simply not enough time – and possibly not enough inclination – to consider any alternative. The third reason was the fact that the global financial crisis, despite its devastating effects and long-term impact, did not compare to the knock-on effect of two world wars. The state of affairs was undeniably severe, just not severe enough to trigger the rebuilding of the international economic order – as had happened in 1944.

As in the 1930s, and at any point of crisis in the international order, trade is the lightning rod for geopolitical tensions and rivalries even if the lightning comes from monetary imbalances. The constrained monetary system of the 1930s led to a rise in protectionism which in turn resulted in political catastrophe, global conflict and the collapse of international cooperation.

There are three broad lines along which the governance of the Bretton Woods institutions needs to be reformed: the developing countries need to be better represented, they need to be given an adequate voice in decision-making processes and the leadership needs to be appointed on the basis of merit and through a transparent process.

while China is happily heading down the path of development finance through the AIIB and to a lesser extent the NDB, it lacks the financial capacity and the political clout to mitigate and absorb the risks that are implicit in providing the global financial safety net. While the dollar remains the key international currency, the risk of supplying liquidity in dollars is far too much even for a country with deep financial resources like China. China is fully aware of this fact. And in any case, seriously challenging the long-standing Bretton Woods institutions doesn’t seem to be the ultimate goal of the AIIB and even less the NDB. Instead, these institutions appear to be a step towards the creation of a long-needed economic and financial regional network to embed and support Asia’s economic and financial integration, or regionalisation. Nonetheless, the United States’ approach to China has changed from ambiguous ‘engage and contain’ to open hostility,

The bilateral swap agreements arranged by the PBoC are fundamentally different from the CMIM and the BRICS Contingent Reserve Arrangement because they are not designed to create a liquidity line and make dollars available between central banks. Instead, their purpose is to establish a domestic currency liquidity channel between these banks to support bilateral trade and investment relations and feed, if necessary, the offshore renminbi markets. As domestic currencies are increasingly used in bilateral trade – as China has been pushing for some time – it becomes even more important that liquidity in those currencies is assured.

Ultimately, bilateral swaps are an instrument of financial diplomacy. They are flexible, quick to deploy, easy to manage and suitable for winning friends. As a result they are becoming an increasingly important tool in China’s financial diplomatic toolbox.

Arguably the AIIB and the NDB are China’s own contributions to the global financial architecture, based on forty years of reform and development experience. China is also taking greater responsibility in providing financial support to countries that are experiencing short-term liquidity problems. Here it has chosen to work collaboratively with the ASEAN. There are, however, two operational issues for which, at least for the foreseeable future, China is both unwilling and unable to take up the mantle of leadership and create a system parallel, or in competition with, the existing one. First of all, as long as the renminbi remains an immature international currency with limited circulation and liquidity, China fundamentally lacks the financial capacity to take up this role. Providing finance for development and stability are the critical goods that the country at the helm of the international order must provide, but China would have to do so in dollars, which would be costly and risky. It would have to tap into its dollar reserves which, admittedly, are large, but ultimately finite. China would emerge as a lender of last resort with limited capacity, essentially a contradiction in terms.

‘The 1929 depression was so wide, so deep and so long because the international economic system was rendered unstable by British inability and the United States unwillingness to assume responsibility for stabilizing it’, writes Charles Kindleberger in the last chapter of his magisterial book The World in Depression.3 According to Kindleberger, when the Wall Street stock market crashed, the United States should have stepped up and taken responsibility for: ‘(a) maintaining a relatively open market for distress goods; (b) providing countercyclical long-term lending; and (c) discounting the crisis’.4 Put otherwise, the United States should have provided liquidity and ensured policy coordination among the main economies. Instead, it chose to raise import duties by implementing the Smoot–Hawley Tariff in 1930, opening the door to other countries to embrace ‘beggar-thy-neighbour’ trade policies and exchange rate depreciation in order to protect their domestic markets. ‘When every country turned to protect its national private interest, the world public interest went down the drain, and with it the private interests of all.’

As a ‘new Bretton Woods’ is unlikely to emerge, the best option is to create resilience to respond to economic and financial instability. Regional arrangements and regional currencies will lend resilience to this framework. If the large economies can agree to blend their rivalries within existing, but reformed, international institutions and new multilateral regional ones, then the economic and monetary system will accommodate regional arrangements and regional currencies so to balance the fading US leadership.

If the United States begins to use the dollar to confront its adversaries in an increasingly challenging geopolitical background and selectively supply dollars in line with its foreign policy objectives, then this situation could easily materialise. These questions inevitably lead to the key issue of how long the dollar should remain at the helm of the international monetary system – is it finally time to take suggestions of an alternative seriously? Inevitably, there will come a time when dollar-holders will lose confidence in the value of the American money, taking it to be less predictable and less secure. Geopolitical reasons have driven recent shifts in the use and holding of dollars, but these have been on the margin. The most notable case is that of Russia, where the central bank’s dollar holdings have been halved in favour of euros, renminbi and yen; 32 per cent of Russian reserves are now in euros and 22 per cent in dollars.

There is no indication that the Chinese leadership’s plan is for the renminbi to replace the dollar as the pivotal currency in the international monetary system, and the authorities have actively sought to play down such expectations since the launch of the renminbi strategy in 2009.

The development of the renminbi as the reference currency for Asia is consistent with China’s strong trade ties in the region. As the renminbi becomes more frequently used to settle trade transactions between China and its neighbours, China’s persistent trade deficits with other Asian countries – it is a net importer in the region – suggest that renminbi are expected to accumulate in their reserves.39 Initiatives such as the BRI are likely to drive the use of the renminbi for payments in the region as the Chinese companies involved in the construction of these projects will offer renminbi, or even demand them, for settling payments.40 In addition, closer links to China mean that movements in the renminbi should become more relevant for Asian exchange rate markets. For example, the currencies of Asian economies in the same production chain as China and those of large commodity exporters are likely to respond to global demand shocks in the same way as the renminbi. By the same token, China’s neighbouring countries will have an incentive to stabilise their currencies against the renminbi and hold more foreign exchange reserves denominated in renminbi.

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Key Points from A World Without Work

The world is rapidly changing and many tasks that has historically deemed to be impossible to be automate are now either done completely by robots, or aided by it. With technological advancement only to accelerate, what is the value of human work and where is the trend heading? In his great and mind-blowing book, Daniel Susskind provides a clue on the answers. The key points below are an excerpt from the book and serves as a personal note to me and my friends.

A WORLD WITHOUT WORK: TECHNOLOGY, AUTOMATION, AND HOW WE SHOULD RESPOND by Daniel Susskind

It was John Maynard Keynes, the great British economist, who popularized the term “technological unemployment” almost fifty years before Leontief wrote down his worries, capturing in a pithy pairing of words the idea that new technologies might push people out of work. In what follows, I will draw on many of the economic arguments that have been developed since Keynes to try to gain a better look back at what happened in the past, and a clearer glimpse of what lies ahead. But I will also seek to go well beyond the narrow intellectual terrain inhabited by most economists working in this field. The future of work raises exciting and troubling questions that often have little to do with economics: questions about the nature of intelligence, about inequality and why it matters, about the political power of large technology companies, about what it means to live a meaningful life, about how we might live together in a world that looks very different from the one in which we have grown up. In my view, any story about the future of work that fails to engage with these questions as well is incomplete.

Even at the century’s end, tasks are likely to remain that are either hard to automate, unprofitable to automate, or possible and profitable to automate but which we will still prefer people to do.

Machines will not do everything in the future, but they will do more. And as they slowly, but relentlessly, take on more and more tasks, human beings will be forced to retreat to an ever-shrinking set of activities. It is unlikely that every person will be able to do what remains to be done; and there is no reason to imagine there will be enough demand for it to employ all those who are indeed able to do it.

A useful way of thinking about what this means is to consider the impact that automation has had already had on farming and manufacturing in many parts of the world. Farmers and factory workers are still needed: those jobs have not completely vanished. But the number of workers that is needed has fallen in both cases, sometimes precipitously—even though these sectors produce more output than ever before.

But it is still helpful in highlighting what should actually be worrying us about the future: not a world without any work at all, as some predict, but a world without enough work for everyone to do.

It is not a coincidence that, today, worries about economic inequality are intensifying at the exact same time that anxiety about automation is growing. These two problems—inequality and technological unemployment—are very closely related. Today, the labor market is the main way that we share out economic prosperity in society: most people’s jobs are their main, if not their only, source of income. The vast inequalities we already see in the labor market, with some workers receiving far less for their efforts than others, show that this approach is already creaking.

Technological unemployment, in a strange way, will be a symptom of that success. In the twenty-first century, technological progress will solve one problem, the question of how to make the pie large enough for everyone to live on. But, as we have seen, it will replace it with three others: the problems of inequality, power, and purpose.

From the outset, it seems, economic growth and automation anxiety were intertwined.

Yes, people did tend to find new work after being displaced by technology—but the way in which this happened was far from being gentle or benign. Take the Industrial Revolution again, that textbook moment of technological progress. Despite the Luddites’ fears, the unemployment rate in Britain remained relatively low, as we can see in Figure 1.2. But, at the same time, whole industries were decimated, with lucrative crafts like hand weaving and candle making turned into profitless pastimes. Communities were hollowed out and entire cities thrust into decline. It is noteworthy that real wages in Britain barely rose—a measly 4 percent rise in total from 1760 to 1820. Meanwhile food became more expensive, diets were poorer, infant mortality worsened, and life expectancy fell.21 People were, quite literally, diminished: a historian reports that average physical heights fell to their “lowest ever levels” on account of this hardship.22

Take the Industrial Revolution again, that textbook moment of technological progress. Despite the Luddites’ fears, the unemployment rate in Britain remained relatively low, as we can see in Figure 1.2. But, at the same time, whole industries were decimated, with lucrative crafts like hand weaving and candle making turned into profitless pastimes. Communities were hollowed out and entire cities thrust into decline. It is noteworthy that real wages in Britain barely rose—a measly 4 percent rise in total from 1760 to 1820. Meanwhile food became more expensive, diets were poorer, infant mortality worsened, and life expectancy fell.21

In the OECD—the Organisation for Economic Cooperation and Development, a club of several dozen rich countries—the average number of hours that people work each year has continuously fallen over the past fifty years. The decline has been slow, about forty-five hours a decade, but steady nonetheless.

Importantly, a large part of this decline appears to be associated with technological progress and the increases in productivity that came along with it. Germany, for instance, is among the most productive countries in Europe, and also the one where people work the fewest hours a year. Greece is among the least productive, and—contrary to what many might think—the one where people work the most hours a year.

Technological change may affect not only the amount of work, but also the nature of that work. How well-paid is the work? How secure is it? How long is the working day, or the working week? What sort of tasks does the work involve—is it the fulfilling sort of activity you leap out of bed in the morning to do, or the sort that keeps you hiding under the covers? The risk, in focusing on jobs alone, is not so much failing to see the proverbial forest for the trees, but failing to see all the different trees in the forest.

Yes, machines took the place of human beings in performing certain tasks. But machines didn’t just substitute for people; they also complemented them at other tasks that had not been automated, raising the demand for people to do that work instead. Throughout history, there have always been two distinct forces at play: the substituting force, which harmed workers, but also the helpful complementing force, which did the opposite.

new technologies may automate some tasks, taking them out the hands of workers, but make those same workers more productive at the tasks that remain for them to do in their jobs.

In all these cases, if productivity increases are passed on to customers via lower prices or better-quality services, then the demand for whatever goods and services are being provided is likely to rise, and the demand for human workers along with it. Through the productivity effect, then, technological progress complements human beings in a very direct way, increasing the demand for their efforts by making them better at the work that they do.

if productivity increases are passed on to customers via lower prices or better-quality services, then the demand for whatever goods and services are being provided is likely to rise, and the demand for human workers along with it. Through the productivity effect, then, technological progress complements human beings in a very direct way, increasing the demand for their efforts by making them better at the work that they do.

technological progress has made the pie far bigger. As previously noted, over the last few hundred years, economic output has soared.

Intuitively, growth like this is likely to have helped workers. As an economy grows, and people become more prosperous with healthier incomes to spend, the opportunities for work are likely to improve. Yes, some tasks might be automated and lost to machines. But as the economy expands, and demand for goods and services rises along with it, demand will also increase for all the tasks that are needed to produce them. These may include activities that have not yet been automated, and so displaced workers can find work involving them instead.

As an economy grows, and people become more prosperous with healthier incomes to spend, the opportunities for work are likely to improve. Yes, some tasks might be automated and lost to machines. But as the economy expands, and demand for goods and services rises along with it, demand will also increase for all the tasks that are needed to produce them. These may include activities that have not yet been automated, and so displaced workers can find work involving them instead.

Kenneth Arrow, a Nobel Prize–winning economist, likewise argued that historically, “the replacement of men by machines” has not increased unemployment. “The economy does find other jobs for workers. When wealth is created, people spend their money on something.”

If we think again of the economy as a pie, new technologies have not only made the pie bigger, but changed the pie, too. Take the British economy, for example. Its output, as we noted, is now more than a hundred times what it was three centuries ago. But that output, and the way it is produced, has also completely transformed. Five hundred years ago, the economy was largely made up of farms; three hundred years ago, of factories; today, of offices.

Again, it is intuitive to see how these changes might have helped displaced workers. At a certain moment, some tasks might be automated and lost to machines. But as the economy changes over time, demand will rise for other tasks elsewhere in the economy. And since some of these newly in-demand activities may, again, not have been automated, workers can find jobs involving them instead. To see this changing-pie effect in action, think about the United States. Here you can see displaced workers tumbling through a changing economy, time and again, into different industries and onto different tasks. A century ago, agriculture was a critical part of the American economy: back in 1900, it employed two in every five workers. But since then, agriculture has collapsed in importance and today it employs fewer than two in every hundred workers.37 Where did the rest of those workers go? Into manufacturing. Fifty years ago, that sector superseded agriculture: in fact, in 1970, manufacturing employed a quarter of all American workers. But then that sector also went into relative decline and today fewer than a tenth of American workers are employed in it.38 Where did these displaced factory workers go? The answer is the service sector, which now employs more than eight in ten workers.39 And there is nothing distinctly American about this story of economic transformation, either. Almost all developed economies have followed a similar path, and many less-developed economies are following it, too.40 In 1962, 82 percent of Chinese workers were employed in agriculture; today, that has fallen to around 31 percent, a larger and faster decline than the American one.41

puzzle was that in the twentieth century, there were prolonged periods where the reverse appeared to happen in the world of work. In some countries, there was huge growth in the number of high-skilled people pouring out of colleges and universities, yet their wages appeared to rise rather than fall compared to those without this education. How could this be? The skill-biased story provided an answer. The supply of high-skilled workers did grow, pushing their wages downward, but new technologies were skill-biased and so caused the demand for high-skilled workers to soar. The latter effect was so great that it overcame the former, so even though there were more educated people looking for work, the demand for them was so strong that the amount they were paid still went up.

Another way to see the skill-biased story at work is to look at how wages have changed over time for a variety of different levels of schooling. This is shown in Figure 2.3. As the charts show, people with more years of schooling not only tend to earn more at every point in the past half century, but the gap between them and those with less schooling has tended to grow over time as well. (For women, this story becomes clearer from the 1980s onward.)

This longer view suggests that technological change has in fact favored different types of workers at different moments in history, not always benefiting those who might have been considered skilled at that particular time. Take the nineteenth century, for example. As we saw in the previous chapter, when the Industrial Revolution got under way in Britain, new machines were introduced to the workplace, new production processes were set up, and so new tasks had to be done. But it turned out that those without the skills of the day were often best placed to perform these tasks. Technology, rather than being skill-biased, was “unskill-biased” instead.

These new machines were “de-skilling,” making it easier for less-skilled people to produce high-quality wares that would have required skilled workers in the past.

At the turn of the twenty-first century, then, the conventional wisdom among economists was that technological progress was sometimes skill-biased, at other times unskill-biased. In either case, though, many economists tended to imagine that this progress always broadly benefited workers. Indeed, in the dominant model used in the field, it was impossible for new technologies to make either skilled or unskilled workers worse off; technological progress always raised everyone’s wages, though at a given time some more than others. This story was so widely told that leading economists referred to it as the “canonical model.”

Starting in the 1980s, new technologies appeared to help both low-skilled and high-skilled workers at the same time—but workers with middling skills did not appear to benefit at all. In many economies, if you took all the occupations and arranged them in a long line from the lowest-skilled to the highest-skilled, over the last few decades you would have often seen the pay and the share of jobs (as a proportion of total employment) grow for those at either end of the line, but wither for those near the middle.

In many economies, if you took all the occupations and arranged them in a long line from the lowest-skilled to the highest-skilled, over the last few decades you would have often seen the pay and the share of jobs (as a proportion of total employment) grow for those at either end of the line, but wither for those near the middle.

This phenomenon is known as “polarization” or “hollowing out.” The traditionally plump midriffs of many economies, which have provided middle-class people with well-paid jobs in the past, are disappearing. In many countries, as a share of overall employment there are now more high-paid professionals and managers—as well as more low-paid caregivers and cleaners, teacher’s aides and hospital assistants, janitors and gardeners, waiters and hairdressers.17 But there are fewer middling-pay secretaries and administrative clerks, production workers and salespeople.18 Labor markets are becoming increasingly two-tiered and divided.

With time, it became clear that the level of education required by human beings to perform a given task—how “skilled” those people were—was not always a helpful indication of whether a machine would find that same task easy or difficult. Instead, what appeared to matter was whether the task itself was what the economists called “routine.” By “routine,” they did not mean that the task was necessarily boring or dull. Rather, a task was regarded as “routine” if human beings found it straightforward to explain how they performed it—if it relied on what is known as “explicit” knowledge, knowledge which is easy to articulate, rather than “tacit” knowledge, which is not.23

That was why labor markets around the world were being hollowed out, taking on hourglass figures. Technological change was eating away at the “routine” tasks clustered in the middle, but the “non-routine” tasks at either end were indigestible, left for human beings to undertake.

Technological progress, it appeared, was neither skill-biased nor unskill-biased, as the old stories had implied. Rather it was task-biased, with machines able to perform certain types of tasks but unable to perform others. This meant that the only workers to benefit from technological change would be those well placed to perform the “non-routine” tasks that machines could not handle. In turn, this explained why certain types of middling-skilled workers might not gain from new technology at all—if they found themselves stuck in jobs made up largely of “routine” tasks that machines could handle with ease.

The point is driven home by a 2017 study carried out by McKinsey & Company, which reviewed 820 different occupations. Fewer than 5 percent of these, they found, could be completely automated with existing technologies. On the other hand, more than 60 percent of the occupations were made up of tasks of which at least 30 percent could be automated.30 In other words, very few jobs could be entirely done by machines, but most could have machines take over at least a significant part of them.

some of today’s greatest pragmatist triumphs have grown out of earlier purist attempts to copy human beings. For instance, many of the most capable machines today rely on what are known as “artificial neural networks,” which were first built decades ago in an attempt to simulate the workings of the human brain.27 Today, though, there is little sense that these networks should be judged according to how closely they imitate human anatomy; instead, they are evaluated entirely pragmatically, according to how well they perform whatever tasks they are set.

In sum, both the theologians and the AI scientists believed that remarkable capabilities could only ever emerge from something that resembled human intelligence. In the words of the philosopher Daniel Dennett, both thought that competence could only emerge from comprehension, that only an intelligent process could create exceptionally capable machines.43 Today, though, we know that the religious scholars were wrong. Humans and human capabilities were not created through the top-down efforts of something more intelligent than us, molding us to look like it. In 1859, Charles Darwin showed that the reverse was true: the creative force was a bottom-up process of unconscious design. Darwin called this “evolution by natural selection,” the simplest account of it only requiring you to accept three things: first, that there are slight variations between living beings; second, that some of these variations might be favorable for their survival; and third, that these variations are passed on to others. There was no need for an intelligent designer, directly shaping events; these three facts alone could explain all appearances of design in the natural world. The variations might be tiny, the advantages ever so slight, but these changes, negligible at any instant, would—if you left the world to run for long enough—accumulate over billions of years to create dazzling complexity. As Darwin put it, even the most “complex organs and instincts” were “perfected, not by means superior to, though analogous with, human reason, but by the accumulation of innumerable slight variations, each good for the individual possessor.”

The pragmatist revolution in AI requires us to make a similar reversal in how we think about where the abilities of man-made machines come from. Today, the most capable systems are not those that are designed in a top-down way by intelligent human beings. In fact, just as Darwin found a century before, remarkable capabilities can emerge gradually from blind, unthinking, bottom-up processes that do not resemble human intelligence at all.

The ancient Greek poet Archilochus once wrote: “The fox knows many things, but the hedgehog knows one big thing.” Isaiah Berlin, who found this mysterious line in the surviving scraps of Archilochus’s poetry, famously used it as a metaphor to distinguish between two types of human being: people who know a little about a lot (the foxes) and people who know a lot about a little (the hedgehogs).20 In our setting, we can repurpose that metaphor to think about human beings and machines. At the moment, machines are prototypical hedgehogs, each of them designed to be very strong at some extremely specific, narrowly defined task—think of Deep Blue and chess, or AlphaGo and go—but hopeless at performing a range of different tasks. Human beings, on the other hand, are proud foxes, who might now find themselves thrashed by machines at certain undertakings, but can still outperform them at a wide spread of others.

For many AI researchers, the intellectual holy grail is to build machines that are foxes rather than hedgehogs. In their terminology, they want to build an “artificial general intelligence” (AGI), with wide-ranging capabilities, rather than an “artificial narrow intelligence” (ANI), which can only handle very particular assignments.

In short, when thinking about the future of work, we should be wary not of one omnipotent fox, but an army of industrious hedgehogs.

Economists had thought that to accomplish a task, a computer had to follow explicit rules articulated by a human being—that machine capabilities had to begin with the top-down application of human intelligence. That may have been true in the first wave of AI. But as we have seen, it is no longer the case. Machines can now learn how to perform tasks themselves, deriving their own rules from the bottom up. It does not matter if human beings cannot readily explain how they drive a car or recognize a table; machines no longer need those human explanations. And that means they are able to take on many “non-routine” tasks that were once considered to be out of their reach.

The idea that such machines are uncovering hitherto hidden human rules, plunging deeper into people’s tacit understanding of the world, still supposes that it is human intelligence that underpins machine capability. But that misunderstands how second-wave AI systems operate. Of course, some machines may indeed stumble upon unarticulated human rules, thereby turning “non-routine” tasks into “routine” tasks. But far more significant is that many machines are also now deriving entirely new rules, unrelated to those that human beings follow. This is not a semantic quibble, but a serious shift. Machines are no longer riding on the coattails of human intelligence.

If machines do not need to copy human intelligence to be highly capable, the vast gaps in science’s current understanding of intelligence matter far less than is commonly supposed. We do not need to solve the mysteries of how the brain and mind operate to build machines that can outperform human beings. And if machines do not need to replicate human intelligence to be highly capable, there is no reason to think that what human beings are currently able to do represents a limit on what future machines might accomplish. Yet this is what is commonly supposed—that the intellectual prowess of human beings is as far as machines can ever reach.45 Quite simply, it is implausible in the extreme that this will be the case.

We can think of this general trend, where machines take on more and more tasks that were once performed by people, as “task encroachment.”9 And the best way to see it in action is to look at the three main capabilities that human beings draw on in their work: manual, cognitive, and affective capabilities. Today, each of these is under increasing pressure.

First, take the capabilities of human beings that involve dealing with the physical world, such as performing manual labor and responding to what we see around us. Traditionally, this physical and psychomotor aptitude was put to economic use in agriculture. But over the last few centuries, that sector has become increasingly automated.

That human alternative, not perfection, should be the benchmark for judging the usefulness of these diagnostic machines.

At times, the encroachment of machines on tasks that require cognitive capabilities in human beings can be controversial. Consider the military setting: there are now weapons that can select targets and destroy them without relying on human deliberation. This has triggered a set of United Nations meetings to discuss the rise of so-called “killer robots.”56 Or consider the unsettling field of “synthetic media,” which takes the notion of tweaking images with Photoshop to a whole new level. There are now systems that can generate believable videos of events that never happened—including explicit pornography that the participants never took part in, or inflammatory speeches by public figures that they never delivered. At a time when political life is increasingly contaminated by fake news, the prospects for the misuse of software like this are troubling.

There are systems that can outperform human beings in distinguishing between a genuine smile and one of social conformity, and in differentiating between a face showing real pain and fake pain. And there are also machines that can do more than just read our facial expressions. They can listen to a conversation between a woman and a child and determine whether they are related, and tell from the way a person walks into a room if they are about to do something nefarious.62 Another machine can tell whether a person is lying in court with about 90 percent accuracy—whereas human beings manage about 54 percent, only slightly better than what you might expect from a complete guess.63 Ping An, a Chinese insurance company, uses a system like this to tell whether loan applicants are being dishonest: people are recorded as they answer questions about their income and repayment intentions, and a computer evaluates the video to check whether they are telling the truth.

Economists often label tasks according to the particular capabilities that human beings use to perform them. They talk, for instance, about “manual tasks,” “cognitive tasks,” and “interpersonal tasks,” rather than about “tasks which require manual, cognitive, or interpersonal capabilities when performed by human beings.” But that way of thinking is likely to lead to an underestimation of quite how far machines can encroach in those areas. As we have seen time and again, machines can increasingly perform various tasks without trying to replicate the particular capabilities that human beings happen to use for them. Labeling tasks according to how humans do them encourages us to mistakenly think that machines could only do them in the same way.

The Rise and Fall of American Growth is magisterial and yet, in a sense, self-contradictory. It argues with great care that growth was “not a steady process” in the past, yet it concludes that a steady process is exactly what we face in the future: a steady process of decline in economic growth, with ever fewer unexpected innovative bursts and technological breakthroughs of the kind that drove our economies onward in the past. Given the scale of investment in technology industries today—many of our finest minds, operating in some of the most prosperous institutions—it seems entirely improbable that there will be no more comparable developments in years to come.

The general lesson here is that, in thinking about whether or not it is efficient to use a machine to automate a task, what matters is not only how productive that machine is relative to the human alternative, but also how expensive it is relative to the human alternative. If labor is very cheap in a particular place, it may not make economic sense to use a pricey machine, even if that machine turns out to be very productive indeed.

Perhaps the most interesting implications of relative costs are the international ones. In part, these cost variations between countries can explain why new technologies have been adopted so unevenly around the world in the past. A big puzzle in economic history, for instance, is why the Industrial Revolution was British, rather than, say, French or German. Robert Allen, an economic historian, thinks relative costs are responsible: at the time, the wages paid to British workers were much higher than elsewhere, while British energy prices were very low. Installing new machines that saved on labor and used readily available cheap fuel thus made economic sense in Britain, whereas it did not in other countries.

countries that are aging faster tend to invest more in automation. One study found that a 10 percent increase in the ratio of workers above fifty-six to those between twenty-six and fifty-five was associated with 0.9 more robots per thousand workers.

there is still work to be done by human beings: the problem is that not all workers are able to reach out and take it up.

“Frictions” in the labor market prevent workers from moving freely into whatever jobs might be available. (If we think of the economy as a big machine, it is as if there is sand or grit caught up in its wheels, stopping its smooth running.) Today, there are already places where this is happening. Take men of working age in the United States, for instance. Since World War II, their participation in the labor market has collapsed: one in six are now out of work, more than double the rate of 1940.4 What happened to them? The most compelling answer is that these men fell into frictional technological unemployment. In the past, many of them would have found well-paid work in the manufacturing sector. Yet technological progress means that this sector no longer provides sufficient work for them all to do: in 1950, manufacturing employed about one in three Americans, but today it employs fewer than one in ten.5 Plenty of new jobs have been created in other sectors as the US economy changed and grew—since 1950, it has expanded about fourfold—but critically, many of these displaced men were not able to take up that work. For a variety of reasons, it lay out of their reach.

human beings are likely to find this race with technology ever harder, because its pace is accelerating. Literacy and numeracy are no longer enough to keep up, as they were when workers first made the move from factories to offices at the turn of the twentieth century. Ever higher qualifications are required. Notably, while workers with a college degree have been outperforming those with only a high school education, those with postgraduate qualifications have seen their wages soar far more,

a third of Americans with degrees in STEM subjects (science, technology, engineering, and math) are now in roles that do not require those qualifications.18 And when economists took all the jobs performed by US college graduates and examined the tasks that make them up, they found a collapse in the “cognitive task intensity” of these roles from 2000 onward—a “great reversal in the demand for skills.”

There is a common fantasy that technological progress must make work more interesting—that machines will take on the unfulfilling, boring, dull tasks, leaving behind only meaningful things for people to do. They will free us up, it is often said, to “do what really makes us human.” (The thought is fossilized in the very language we use to talk about automation: the word robot comes from the Czech robota, meaning drudgery or toil.) But this is a misconception. We can already see that a lot of the tasks that technological progress has left for human beings to do today are the “non-routine” ones clustered in poorly paid roles at the bottom of the labor market, bearing little resemblance to the sorts of fulfilling activities that many imagined as being untouched by automation. There is no reason to think the future will be any different.

On the face of it, Americans appear to be remarkably mobile: about half of households change their address every five years, and the proportion of people living in a different state from the one where they were born has risen to one-third.32 But there are two important caveats. First, this is not the case everywhere. Europeans, for instance, are far more immovable: 88.3 percent of Italian men aged between sixteen and twenty-nine still live at home.33 And second, those who do move tend to be better educated as well. In the United States, almost half of college graduates move out of their birth states by the time they are thirty, but only 17 percent of high school dropouts do so.

Some workers, rather than dropping out of the labor market because they lack the right skills, dislike the available jobs, or live in the wrong place, will instead pursue whatever work does remain for them to do. And when this happens—where workers find themselves stranded in a particular corner of the labor market but still want a job—the outcome will not be technological unemployment, with people unable to find work at all, but a sort of technological overcrowding, with people packing into a residual pool of whatever work remains within their reach. Rather than directly cause a rise in joblessness, this could have three harmful effects on the nature of the work. The first is that, as people crowd in, there will be downward pressure on wages. Curiously, whereas technological unemployment is a controversial idea in economics, such downward pressure is widely accepted.36 At times it can be puzzling that economists tend to make such a hard distinction between no work and lower-paid work. The two are treated as unrelated phenomena—the former regarded as impossible, the latter as entirely plausible. In practice, the relationship between the two is far less straightforward. It seems reasonable to think that as more people jostle for whatever work remains for them to do, wages will fall. It also seems reasonable to think that these wages might fall so low in whatever corner of the labor market a worker is confined to that it will no longer be worth their while to take up that work at all. If that happens, the two phenomena become one. This is not an unlikely possibility: in 2016, 7.6 million Americans—about 5 percent of the US workforce—who spent at least twenty-seven weeks of the year in the labor force still remained below the poverty line.

It is sometimes said, in a positive spirit, that new technologies make it easier for people to work flexibly, to start up businesses, become self-employed, and to have a more varied career than their parents or grandparents. That may be true. But for many, this “flexibility” feels more like instability. A third of the people who are on temporary contracts in the UK, for instance, would prefer a permanent arrangement; almost half on zero-hour contracts want more regular work and job security.

Parts of our economic life already feel two-tiered in the way that Meade imagined: many of those fast-growing jobs in Figure 6.2, for instance, from retail sales to restaurant serving, involve the provision of low-paid services to the wealthy. But these “hangers-on” need not be all be “immiserated,” as Meade expected. In rich corners of cities like London and New York it is possible to find odd economic ecosystems full of strange but reasonably well-paid roles that rely almost entirely on the patronage of the most prosperous in society: bespoke spoon carvers and children’s playdate consultants, elite personal trainers and star yoga instructors, craft chocolatiers and artisanal cheesemakers. The economist Tyler Cowen put it well when he imagined that “making high earners feel better in just about every part of their lives will be a major source of job growth in the future.”41 What is emerging is not just an economic division, where some earn much more than others, but a status division as well, between those who are rich and those who serve them.

As task encroachment continues, human capabilities will become irrelevant in this fashion for more and more tasks. Take sat-nav systems. Today these make it easier for taxi drivers to navigate unfamiliar roads, making them better at the wheel. At the moment, therefore, they complement human beings. But this will only be true as long as human beings are better placed than machines to steer a vehicle from A to B. In the coming years, this will no longer the case: eventually, software is likely to drive cars more efficiently and safely than human beings can. At that point, it will no longer matter how good people are at driving: for commercial purposes, that ability will be as amusingly quaint as our productivity at hand-fashioning candles or cotton thread.

Kasparov’s experiences in chess led him to declare that “human plus machine” partnerships are the winning formula not only in chess, but across the entire economy.8 This is a view held by many others as well. But AlphaZero’s victory shows that this is wrong. Human plus machine is stronger only as long as the machine in any partnership cannot do whatever it is that the human being brings to the table. But as machines become more capable, the range of contributions made by human beings diminishes, until partnerships like these eventually just dissolve. The “human” in “human plus machine” becomes redundant.

We live in the Age of Labor, and if new tasks have to be done it is likely that human beings will be better placed to do them. But as task encroachment continues, it becomes more and more likely that a machine will be better placed instead. And as that happens, a growing demand for goods may mean not more demand for the work of human beings, but merely more demand for machines.

It is true that people in the future are likely to have different wants and needs than we do, perhaps even to demand things that are unimaginable to us today. (In the words of Steve Jobs, “consumers don’t know what they want until we’ve shown them.”)15 Yet it is not necessarily true that this will lead to a greater demand for the work of human beings. Again, this will only be the case if human beings are better placed than machines to perform the tasks that have to be done to produce those goods. As task encroachment continues, though, it becomes more and more likely that changes in demand for goods will not turn out to be a boost in demand for the work of human beings, but of machines.

We imagine that when human beings become more productive at a task, they will be better placed than a machine to perform it; that when the economic pie gets bigger, human beings will be better placed to perform the freshly in-demand tasks; that when the economic pie changes, human beings will be better placed to carry out whatever new tasks have to be done.

a fallacy that people are often accused of committing when they seem to forget about the helpful side of technological progress, the complementing force.28 The idea is an old one, first identified back in 1892 by David Schloss, a British economist.29 Schloss was taken aback when he came across a worker who had begun to use a machine to make washers, the small metal discs used when tightening screws, and who appeared to feel guilty about being more productive. When asked why he felt that way, the worker replied: “I know I am doing wrong. I am taking away the work of another man.” Schloss came to see this as a typical attitude among workmen of the time. It was, he wrote, a belief “firmly entertained by a large section of our working-classes, that for a man … to do his level best—is inconsistent … with loyalty to the cause of labour.” He called this the “theory of the Lump of Labour”: it held “that there is a certain fixed amount of work to be done, and that it is best, in the interests of the workmen, that each man shall take care not to do too much work, in order that thus the Lump of Labour may be spread out thin over the whole body of workpeople.”30 Schloss called this way of thinking “a noteworthy fallacy.” The error with it, he pointed out, is that the “lump of work” is in fact not fixed. As the worker became more productive, and the price of the washers made by him fell, demand for them would increase. The lump of work to be divided up would get bigger, and there would actually be more for his colleagues to do. Today, this fallacy is cited in discussions about all types of work. In its most general terms, it is used to argue that there is no fixed lump of work in the economy to be divided up between people and machines; instead, technological progress raises the demand for work performed by everyone in the economy. In other words, it is a version of the point that economists make about the two fundamental forces of technological progress: machines may substitute for workers, leaving less of the original “lump of work” for human beings, but they complement workers as well, increasing the size of the “lump of work” in the economy overall.

It may be right that technological progress increases the overall demand for work. But it is wrong to think that human beings will necessarily be better placed to perform the tasks that are involved in meeting that demand. The lump of labor fallacy involves mistakenly assuming that the lump of work is fixed. But the LOLFF involves mistakenly assuming that that growth in the lump of work has to involve tasks that human beings—not machines—are best placed to perform.

On average, one more robot per thousand workers meant about 5.6 fewer jobs in the entire economy, and wages that were about 0.5 percent lower across the whole economy as well. And all this was happening in 2007, more than a decade ago, before most of the technological advances described in the preceding pages.

hunter-gatherers did not pursue solitary lives of the kind that Rousseau imagined. Instead, they lived together in tribes that sometimes numbered a few hundred people, sharing the literal fruits (and meats) of their labor within their band of fellow foragers—some of whom, inevitably, were more successful in their foraging efforts than others.4 There is no forest that lets human beings retreat into perfect solitude and self-sufficiency, nor has there ever been. All human societies, small and large, simple and complex, poor and affluent, have had to figure out how best to share their unevenly allocated prosperity with one another.

technological progress does have a role in making the economic pie bigger, but the growing power of these supermanagers also allows them to take a much bigger slice of it. Forty years ago, the CEOs of America’s largest firms earned about 28 times more than an average worker; by 2000, that ratio stood at an astounding 376 times.

labor income accounting for about two-thirds of the pie and income from traditional capital making up the remaining third.27 Keynes called this “one of the most surprising, yet best-established, facts in the whole range of economic statistics” and “a bit of a miracle.” Nicholas Kaldor, one of the giants of early work on economic growth, included this phenomenon among his six “stylized facts.” Just as mathematicians build up their arguments up from indubitable axioms, he believed, so economists should build their stories around these six unchanging facts—and they did. The most popular equation in economics dealing with how inputs combine to produce outputs, the Cobb-Douglas production function, is built around the fact that the capital-labor ratio was thought to be fixed.

In the two decades since 1995, across twenty-four countries, productivity rose on average by 30 percent, but pay by only 16 percent.31 Instead of going to workers, the extra income has increasingly gone to owners of traditional capital. This “decoupling” of productivity and pay, as it sometimes known, is particularly clear in the United States, as seen in Figure 8.6. Until the early 1970s, productivity and pay in the United States were almost perfect twins, growing at a similar rate. But as time went on, the former continued upward while the latter stalled, causing them to diverge.

The OECD is quoted as saying that technology was directly responsible for up to 80 percent of the decline from 1990 to 2007, encouraging firms to shift toward using more traditional capital relative to labor.33 The IMF puts it at a more modest 50 percent in developed economies over a slightly longer period, a finding that fits with the work of other economists.34 But once you look at the explanations offered by the IMF for the rest of the decline, technological progress often has a role to play there as well. Part of this decline in the labor share, for instance, is thought to be explained by globalization, the increasingly free movement of goods, services, and capital around the world. The IMF believes that this explains another 25 percent.35 But what is actually responsible for this globalization? Technological progress, in large part. After all, it is falling transportation and communication costs that have made globalization possible.

beneath the headline story of growing inequality around the world lie three distinct trends. First, human capital is less and less evenly distributed, with people’s different skills getting rewarded to very different degrees; the part of the economic pie that goes to workers as a wage is being served out in an increasingly imbalanced way. Second, human capital is becoming less and less valuable relative to traditional capital; that part of the pie that goes to workers as a wage is also shrinking relative to the part that goes to owners of traditional capital. And third, traditional capital itself is distributed in an extraordinarily uneven fashion, an inequality that has been growing more and more pronounced in recent decades.

Inequality, then, is not inevitable. And the same is true for the economic imbalances that technological unemployment would bring about. We have the power to shape and constrain these economic divisions—if we want to.

a college degree in the United States has an average annual return of more than 15 percent, leaving stocks (about 7 percent) and bonds, gold, and real estate (less than 3 percent) trailing far behind.3 Education also does more than just help individuals: it is responsible for thrusting entire economies forward as well.

All we really know with any confidence is that machines will be able to do more in the future than they can today. Unfortunately, this is not particularly useful for deciding what people should be learning to do. But that uncertainty is unavoidable. And so we are left with just our simple rule for the moment: do not prepare people for tasks that we know machines can already do better, or activities that we can reasonably predict will be done better by machines very soon.

People will have to grow comfortable with moving in and out of education, repeatedly, throughout their lives. In part, we will have to constantly reeducate ourselves because technological progress will force us to take on new roles, and we will need to train for them. But we will also need to do it because it is nearly impossible right now to predict exactly what those roles will be. In that sense, embracing lifelong learning is a way of insuring ourselves against the unknowable demands that the working world of the future might make on us.

The question of whether universities are “just selecting for talented people who would have done well anyway … isn’t analyzed very carefully,” Thiel complains.24 In fact, though, many economists have spent large portions of their lives thinking specifically about this issue. The problem is so popular that it has its own name: “ability bias,” a particular case of what’s known in econometrics as “omitted variable bias.” (In this case, the omitted variable is a person’s innate ability: if higher-ability people are more likely than others to go to university in the first place, then attributing their greater financial success to their education alone leaves out a significant part of the story.) Economists have developed a tool kit of techniques to address this omission, and their sense—contrary to Thiel’s—is that even once ability bias is accounted for, universities still appear to have a positive impact. Talented people might earn more than others in any case, but education helps them earn even more than they would otherwise.

It would be nice to think that as human beings we are all infinitely malleable, entirely capable of learning whatever it is that is required of us. And you might argue that the difficulty of education is no reason to avoid it. After all, did President Kennedy not say that we do important things “not because they are easy, but because they are hard”?28 The thrust of Kennedy’s comment may be right. But we have to temper our idealism with realism. If “hard” turns out to mean impossible, then inspirational rallying cries to reeducate and retrain are not helpful.

In calling for a Big State, however, I mean something different: not using the state to make the pie bigger, as the planners tried and failed to do, but rather to make sure that everyone gets a slice. Put another way, the role for the Big State is not in production but in distribution.

A more practical difficulty is that the idea of taxing traditional capital is very ambiguous, far more so than taxing labor. Recently, public discussion has veered toward so-called robot taxes. Bill Gates is partly responsible for this, having caused a stir with his views on the subject. “Right now, the human worker who does, say, $50,000 worth of work in a factory, that income is taxed,” he said in a recent interview. “If a robot comes in to do the same thing, you’d think that we’d tax the robot at a similar level.”

And perhaps most important, we must remember that technological progress (of which robots are a part) drives economic growth—it makes the economic pie bigger in the first place. That is why Larry Summers calls the robot tax “protectionism against progress.”17 A robot tax might mean fewer robots and more workers, but it might also mean a smaller pie as well.

The wide range of support for the UBI disguises the fact that key details of it are subject to uncertainty and disagreement. For instance, how are payments made? UBI supporters often argue that payment in cash is a “fundamental” part of their proposal, but in practice there are other reasonable ways to make people more prosperous.34 One approach, for instance, is to make important things available in society at no cost: rather than just give people cash, the state in effect makes certain purchases on their behalf. Already in the United States, about forty million people use the Supplemental Nutrition Assistance Program, or “food stamps,” to receive basic sustenance for free, worth about $1,500 a year.35 In England, health care and primary and secondary education are free for everyone who wants them, each worth thousands of pounds per year.36 Add up such initiatives, and you end up with a sort of UBI—though one that the state has already spent for you. And if the income payments do get made in cash, how generous should they be? The UBI says “basic.” But what does that mean? Some economists think it implies a minimal payment, not very much at all. John Kenneth Galbraith, for instance, said that introducing “a minimum income essential for decency and comfort” is the right thing to do.37 Friedrich Hayek similarly spoke of “a certain minimum income for everyone.”38 Today’s prominent UBI advocates often agree. Annie Lowrey, author of Give People Money, makes the case for “just enough to live on and not more”; Chris Hughes, author of Fair Shot, argues for $500 a month.39 But there are others who feel differently. Philippe Van Parijs, today’s leading UBI scholar, wants to use UBI to build a “truly free” society, where people are not tied down by what they earn. That is a far loftier goal than what is envisaged by Galbraith and Hayek—and a far more expensive one, too.

As we approach a world with less work, this sort of struggle over who counts as a member of the community will intensify. The Native American experience shows that dealing with questions of citizenship is likely to be fractious. The instinct in some tribes was to pull up the drawbridge—a reaction we can see in other settings, too. Consider the financial crisis in 2007 and its aftermath. As economic life got harder, the rhetoric toward immigrants in many countries hardened as well: they were said to be “taking our jobs,” “running down our public services.” There was a collective impulse to narrow the boundaries of the community, to restrict membership, to tighten the meaning of ours. In much the same way, support for so-called welfare chauvinism—a more generous welfare state, made available to fewer people—is on the rise. In Europe, for example, a survey found “both rising support for redistribution for ‘natives’ and sharp opposition to migration and automatic access to benefits for new arrivals.”

UBI advocates argue that universal payments remove any stigma associated with claiming support. If everyone receives the payments, nobody can be labeled by society as a “scrounger” and no individual will feel ashamed to have to claim theirs. As Van Parijs puts it, “There is nothing humiliating about benefits given to all as a matter of citizenship.”

The UBI fails to take account of these responses. It solves the distribution problem, providing a way to share out material prosperity more evenly; but it ignores this contribution problem, the need to make sure that everyone feels their fellow citizens are in some way giving back to society. As the political theorist Jon Elster put it, the UBI “goes against a widely accepted notion of justice: it is unfair for able-bodied people to live off the labor of others. Most workers would, correctly in my opinion, see the proposal as a recipe for exploitation of the industrious by the lazy.”

There are two reasons why sharing out capital might be attractive. The first is that it would reduce the need for the Big State to act as an income-sharing state. If more people owned valuable capital, income would flow more evenly across society of its own accord. The second reason is that such sharing would also help to narrow economic divisions in society. If the underlying distribution of capital stays the same, and the state only shares out income, then profound economic imbalances will remain. If left unresolved, such divisions could turn into noneconomic strife: ruptures of class and power, differences in status and respect.56 By sharing out valuable capital, and directly attacking the economic imbalances, the state could try to stop this from happening.

the state’s labor-supporting efforts should be focused primarily on changing the actual incentives that employers face, forcing closer alignment between their interests and those of the society of which they are a part.

For Schumpeter, economics was all about innovation. He called it the “outstanding fact in the economic history of capitalist society.” His argument for monopolies is that, were it not for the prospect of handsome profits in the future, no entrepreneur would bother to innovate in the first place. Developing a successful new product comes at a serious cost, in both effort and expense, and the possibility of securing monopoly power is the main motivator for trying at all. It acts as the “baits that lure capital on to untried trails.”22 Moreover, monopoly profits are not simply a consequence of innovation, but a means of funding further innovation. Substantial research and development very often draws on the deep pockets established by a company’s past commercial successes.

In the twentieth century, our main preoccupation was with the economic power of large companies. But in the twenty-first, we will increasingly have to worry about this political power as well.

From this viewpoint, the threat of technological unemployment has another face to it. It will deprive people not only of income, but also of significance; it will hollow out not just the labor market, but also the sense of purpose in many people’s lives.1 In a world with less work, we will face a problem that has little to do with economics at all: how to find meaning in life when a major source of it disappears.

Take Alfred Marshall, another giant of economic history. He proclaimed that “man rapidly degenerates unless he has some hard work to do, some difficulties to overcome,” and that “some strenuous exertion is necessary for physical and moral health.” To him, work was not simply about an income, but the way to achieve “the fullness of life.”3

Jahoda and her colleagues wanted to know what the impact of such widespread worklessness would be. Their methods were unconventional: to collect data on residents without making them realize they were being watched, the researchers embedded themselves in everyday village life. (Their various enterprises included a clothes cleaning and repair service, parent support classes, a free medical clinic, and courses in pattern design and gymnastics.) What they found was striking: growing apathy, a loss of direction in life, and increasing ill will to others. People borrowed fewer library books: 3.23 books on average per resident in 1929, but only 1.6 in 1931. They dropped out of political parties and stopped turning up to cultural events: in only a few years, the athletic club saw membership fall by 52 percent and the glee club by 62 percent. Unemployment benefits required that claimants do no informal work; in those years, Marienthal saw a threefold increase in anonymous denunciations of others for breaking that rule, yet almost no change at all in the total number of complaints that were judged well-founded. Researchers watching at a street corner even noted a physical change: men without work walked more slowly in the street and stopped more frequently.

Work matters not just for a worker’s own sense of meaning; it has an important social dimension as well, allowing people to show others that they live a purposeful life, and offering them a chance to gain status and social esteem.

For those with a job, the connection between work and meaning is wonderful: in return for their efforts, they get both an income and a sense of purpose. But for the unemployed, this link may become instead a source of further discomfort and distress. If work offers a path toward a meaningful life, the jobless may feel that their existence is meaningless; if work provides status and social esteem, they may feel out of place and deflated. This may partly explain why the unemployed often feel depressed and shamed, and why their suicide rate is about two and a half times the rate of those in work.10 A prevailing political philosophy of our time, the idea of meritocracy, does little to help.11 This is the notion that work goes to those who somehow deserve it, due to their talents or effort. Yet if work signifies merit, then those without it might feel meritless. Michael Sandel once quipped that in feudal times, at least those at the top knew that their economic fortunes were a fluke of birth, the simple brute luck of being born into the right family—whereas today, the most fortunate imagine they actually merit their positions, that being born with the right talents and abilities (and, often, supportive and prosperous parents) has nothing to do with luck at all.12 An unpleasant corollary is that the less fortunate now often think they merit their bad luck as well.

Aristotle, likewise, wrote that “citizens must not lead the life of artisans or tradesmen, for such a life is ignoble and inimical to excellence.”22 He believed that meaning could only come through leisure, and that the only purpose of work is to pay for leisure time: “We work in order to enjoy leisure, just as we make war in order to enjoy peace.”23 In fact, the Greek word for “work,” ascholia, literally means “the absence of leisure,” schole; for the Greeks, leisure came first, the opposite from how many think today.24

Work is a source of meaning for some people at the moment not because work itself is special, but because our jobs are where we spend the majority of our lives. We can only find meaning in what we actually do—and freed up to spend our lives differently, we will find meaning elsewhere instead.

Today, that sense of value is overwhelmingly shaped by the market mechanism: a thing’s value is the price that someone is willing to pay for it, and a worker’s worth is the wage that they receive. For all its flaws, there is something extraordinary about the inexorable simplifying power of this mechanism. In the white heat of the market, the clash between people’s infinite desires and the hard reality of satisfying them gets boiled down to a single number: a price.

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Key Points from The Costs of Inequality in Latin America

The Costs of Inequality in Latin America: Lessons and Warnings for the Rest of the World by Diego Sánchez-Ancochea

Inequality has historically contributed to many social ills, from low economic growth to weak democratic institutions and high levels of violence. Populism, financial crises, bad jobs, social polarization: Latin America has struggled with all these problems for more than a century.

It is not only that inequality has shaped political and economic institutions in Latin America; these institutions have in turn contributed to more inequality. For example, labor market duality (with large differences between good and bad jobs) has led to growing income gaps between workers. Politics and economics have also reinforced each other: inequality has contributed to the election of leaders who, in their search for easy solutions, have ended up triggering economic crises and ultimately favoring the wealthy.

All Latin American countries have a similar history: they became colonies of Spain and Portugal during the sixteenth century, gained independence during the nineteenth century, and then had to deal with similar obstacles to building effective institutions. The state is weaker than in developed countries: corruption is an endemic problem, changes in rules and regulations are common, and policies are often inconsistent. They have always had to deal with influential external actors, including the US, and struggled with external dependence. Latin American countries also share some cultural traits, including a common language (with the exception of Brazil … but Portuguese and Spanish are similar), and many social similarities. They are some of the most urbanized countries in the developing world, and most have large non-white minorities.

the lack of economic dynamism has much to do with the control of policymaking by the wealthy—politics and economics can seldom be separated. The top 1 percent successfully pressured for low taxes: most Latin American states collect less than they should, given their level of development.

given these exclusionary policies and lack of economic dynamism, it is not surprising that citizens have repeatedly supported populist responses. Leaders like Juan Domingo Perón in Argentina in the 1940s and 1950s or Hugo Chávez in Venezuela more recently promised to provide good jobs and adequate social benefits to the poor and the urban middle classes. Unfortunately, their governments often ended up implementing unsustainable economic policies, while proving unable or unwilling to systematically confront the power of the wealthy—a lesson voters in developed countries would do well to remember.

Inequality, labor market dualism, financial crises, and political instability are growing everywhere. Wealthy countries like the US look more and more like Latin America and—if they do not reverse direction—could suffer many of the same negative interactions over the long run. Unfortunately, avoiding the costs of inequality will become harder and harder: Latin America shows that reversing the income gap is difficult precisely because of negative political and economic feedbacks.

Between 2003 and 2013, most Latin American countries improved their distribution of income, precisely at a time when income gaps were increasing in the rest of the world. Some of the drivers of this recent improvement are not particularly relevant for wealthy economies but may be important for developing countries. In some Latin American countries, the poor became the subject of social rights for the first time in history, contributing to a rapid increase in their income. The power of electoral competition to promote some level of inclusion is a second useful lesson.

Maybe the distribution of income was no worse in Latin America in the middle of the nineteenth century than in England during the Industrial Revolution; rapid economic transformation in Manchester, London, and other British cities did create wealthy winners and millions of losers, as Karl Marx eloquently explained. Yet it is clear that in Latin America institutions and policies were organized in favor of the powerful from early on: huge latifundios, underinvestment in primary education, and restrictive voting rights were the norm across the region.

When the first wave of globalization met Latin America’s traditional institutions, inequality accelerated. In Argentina, Brazil, Chile, and Uruguay the Gini coefficient increased by at least five percentage points between 1870 and 1920. Rich landowners found new opportunities to make large amounts of money through exports.

governments without resources cannot fund much-needed investments in social programs and infrastructure.

Latin America’s problems, including uneven investment in education, difficulties in taxing the wealthy, economic crises, and informal labor markets, are increasingly evident in other parts of the world and seem more widespread and entrenched than ever.

the elite had no incentive to innovate. Exporting agricultural goods and/or various mining products was much more profitable than trying to produce manufactures. Between 1850 and 1912, primary exports grew by an annual average of 3.3 percent with a particularly fast expansion in Argentina (6.1 percent) and Uruguay (5.6 percent). Meanwhile, the manufacturing sector struggled to become more productive.

The contrast with East Asia could not be more striking. In Latin America inequality contributed to underinvestment in education which, in turn, hampered the creation of a more dynamic economy. Countries such as South Korea, Taiwan, and Singapore—historically less unequal—have invested many resources in primary and secondary education since the middle of the twentieth century. A more skilled labor force helped them to promote the new economic sectors (from heavy industry to semiconductors) that were behind their economic miracle.

“for the most part, the children of the politically influential people attend private primary and secondary schools. Thus they do not directly feel the deficiencies of the public school system, because their interests are not directly and immediately affected by the success or failure of public schools. This reduces the sense of urgency that might otherwise lead influential parents to press decision makers to make tough policy choices.”

Latin America the private sector is responsible for only one-third of total spending in research and development (R&D) compared to 50 percent in Asia and 70 percent in the OECD.

the large economic gap between a few powerful business groups with limited interest in innovation and a large number of small, unproductive firms with no resources to invest is behind Latin America’s backward position. In 2011, spending in research and development was just 0.33 percent of GDP; in contrast, it was 1.1 percent in Asia and 2.0 percent in wealthy countries. The number of licenses and patents—which have increased rapidly in Asia in the last decade—is also extremely low. Unfortunately, without innovation it is hard to sustain economic growth and a dynamic transformation of the economy.

First, the elite’s control of mass media—both newspapers and TV—has allowed them to shape public debate and build opposition against tax hikes. Multiple op-eds and TV programs repeat the same half truths about the negative impact of taxes on investment, the link between taxes and corruption, and the need to limit state regulation.

Second, the use of revolving doors is quite common in Latin America. Entrepreneurs and business managers spend their professional lives moving from the private to the public sector and back.

Third, as we saw in the case of Chile, the business elite often has close links to political parties, contributing to their campaigns and lobbying through formal and informal channels. Although most governments have advanced in the regulation of campaign financing, large corporations and powerful individuals still transfer millions of dollars to presidential and legislative candidates.

Social programs not only compensate for the negative effects of external shocks and economic adjustment, but also enhance competitiveness. Universal social policies promote human capital, expand aggregate demand, and improve social capital. They contribute to higher economic growth and the creation of more dynamic sectors—something Costa Rica has shown for years. On the other hand, underfunded states are more prone to economic crises and may be regularly forced to implement costly austerity policies.

In unequal societies like those in Latin America, reaching agreement on economic adjustment between different social groups—which are far apart in terms of income and worldview—is almost impossible; there is too much distrust and not enough social cohesion. Confronted with such difficulties, governments prefer to maintain the status quo, hoping that the economic situation improves or postponing painful reforms until another administration is elected. Rodrik tests these arguments with a series of quantitative exercises, finding a positive correlation between income inequality and bad macroeconomic policies as well as between income inequality and economic growth collapses.

Keynes’s recipe—which has worked more often than not—has seldom been followed in Latin America. Instead, in times of crisis most governments have reduced public investment, cut social programs, and increased interest rates—making the construction of factories more expensive. In doing so, they have contributed to unemployment, poverty increases, and a further worsening of the income gap. Pressures from international institutions like the IMF and the World Bank, lack of access to borrowing, and right-wing ideology explain these mistaken policy choices.

In the US, the Republican Party has allied with the business elite to promote regressive tax reforms. Democrats have failed to systematically campaign against tax reductions, partly because they are increasingly dependent on funds from the wealthy. Even in more equal countries, growing income concentration has gone hand in hand with lower public revenues:

A direct relationship between a charismatic leader and the people, a certain disregard for stable institutions and political parties, and the promotion of anti-elite grievances characterized Peronism. A similar type of leadership—which many have called populist—is evident in Latin America across time and space: from Getúlio Vargas in Brazil in the 1940s to Hugo Chávez in Venezuela in the 2000s.

Inequality has thus contributed to weak, unresponsive and/or unstable political institutions which, in turn, lead to a further worsening of income distribution through several channels. First, populist experiments have often resulted in economic crises with significant costs for the low-income majority. Second, right-wing authoritarian governments have consistently adopted regressive measures, thus benefiting the wealthy significantly. In Pinochet’s Chile, for example, the Gini coefficient increased from less than 44 in the early 1970s to 59 in 1988. Third, weak democracies have protected the wealthy and often failed to significantly expand economic and social rights.

The economic elite feared people’s participation in politics; they were worried that poor voters would elect leaders who supported high income taxes and generous social programs. As a result, they did everything in their power to avoid real democracy.

As Perón’s authoritarian tendencies intensified, the Argentinian democracy entered into the kind of death spiral that political scientists Steven Levitsky and Daniel Ziblatt describe in their book How Democracies Die.25 A constitutional reform allowed the re-election of the president, strengthened presidential power, and modified electoral rules in Perón’s favor.

If populism contributed to inclusion and participation, why do I regard it as a political cost of inequality? The answer is simple: populist movements often triggered political instability and institutional volatility. Perón, Vargas, and the other populists loved conflict: politics was all about black and white, the “people” against the “oligarchs,” and the “nation” against the “empire.” While this was partly understandable in the context of income concentration, it left little room for debate and compromise.

Why did the business elite consent to, and at times even support, democratization? Two reasons are particularly relevant. First, authoritarian regimes became less attractive.

Second, the business elite made sure that the new regimes would not harm their economic interest and political power.

the expansion of neoliberal policies became a safeguard for the elite.54 On the one hand, economic liberalization reduced the freedom of new governments to adopt radical policies. If a leftist president increased taxation or the minimum wage significantly, it had to deal with capital flight and other economic difficulties. On the other hand, the World Bank and other powerful international lenders forced countries to accept neoliberal policy packages. Some areas, such as monetary policy, also moved outside governments’ purview, as central banks across the region became independent.

Protests against the expansion of markets and the lack of true democracy gradually increased.

Soon enough, street protests translated into the election of left-of-center presidents in what was then called “the Pink Tide.”

The Latin American experience illustrates the high political costs of inequality in the political sphere. The wealthy have always refused to support real democracy for fear of redistribution. In response, the poor have often searched for populist solutions that have failed to change power relations or strengthen democratic institutions over the long run. The problems, however, do not finish here: limited democracies, populism, and authoritarianism have in turn contributed to more inequality.

Populist regimes’ contribution to income distribution over the long run has also been problematic for at least three reasons. First, in their attempt to improve things, some populist governments have ended up triggering costly financial crises. Perón’s first administration provides a good illustration of this problem. In his first years in office, real wages increased by 50 percent. Initially, this expansion did not create problems because international agricultural prices—and, as a result, Argentinian exports—were growing quickly as well. Yet when external conditions deteriorated in 1949, Argentina moved from a trade surplus to a deficit and the country’s reserves were quickly depleted. Resources for industrialization also dried up as agriculture entered into crisis. Perón initially increased the money supply to keep the economy going, resulting in a 31 percent inflation rate in 1949. In the end, the attempt to redistribute income too quickly led to a crisis that forced a painful—and inequality-inducing—stabilization of the economy after 1950.76 The Brazilian progressive economist and former Minister of Finance Luiz Carlos Bresser-Pereira offers a compelling explanation of the “populist cycle.” Initially, governments adopt expansionary policies, including a strong exchange rate (to make imports cheap), higher public expenditure, and higher wages. Not surprisingly, economic growth accelerates as consumption and investment increase. Unfortunately, the positive trend is short-lived. Little by little—or quite quickly, if there is also a negative external shock like the one Argentina suffered under Perón—all economic indicators deteriorate: a trade deficit appears as imports grow faster than exports. The budget deficit increases as spending surpasses taxes. The money supply and inflation follow. All these problems consistently lead “to a severe crisis, sometimes accompanied by, at least, a change of ministers if not a coup d’état and inevitably … a radical change in economic policy.” The impact of the crisis and of the neoliberal policies that follow on income distribution is often catastrophic.

Second, many populist leaders have shown little interest in building independent social movements. From Brazil under Vargas to Venezuela under Chávez, most governments of this kind have coopted trade unions and limit dissent.

Third, the incessant polarization promoted by populists is hard to sustain over the long run. All these leaders have mastered the art of dividing the country between the “people” and the oligarchy, between a majority of supporters and a minority of enemies. Think about Hugo Chávez proclaiming “It is not me, it is the people” or Rafael Correa joyfully shouting “Ecuador voted for itself” after his 2009 electoral victory.79 Although their strategy may at times have been justified (there is a sharp gulf between the winning elite and the rest in Latin America), it has consistently generated mistrust and conflict.

The French economist Thomas Piketty suggestively links this political convergence on economic ideas to transformations in the party system: the US and many European countries have moved, he argues, from class-based competition to competition between different elites. In the 1950s and 1960s, left-wing parties were supported by unskilled, poorly paid workers, while most high-income, high-educated individuals voted for the right. Since the 2000s, left-wing parties have become an instrument of the “intellectual elite,” while right-wing parties are primarily supported by high-income individuals (the “business elite”). Meanwhile, low-income voters no longer feel represented by mainstream political parties, searching for more radical alternatives instead.

In violent societies, low-income groups suffer disproportionately, both emotionally and financially. In segregated societies, there are large education gaps between rich and poor and few cross-class social networks. In mistrustful societies, the opportunities to build coalitions between the poor and the middle class—required to expand redistributive social programs—are severely hampered. In this way, structural inequality has perpetuated itself in Latin America through various social vicious circles.

Why do Latin Americans mistrust institutions so much? There are many reasons, including high levels of corruption and poor public service delivery. Yet inequalities in income and political opportunities are probably primary drivers. Most people resent their place in society and do not feel represented by political institutions; in fact, almost four out of five Latin Americans are convinced that governments rule for the benefit of the powerful and are uninterested in the preferences of voters—a much higher percentage than in other parts of the world.

low-trusting individuals were less likely to support equity-enhancing state interventions. These groups are likely to believe that children from other families will not put in the effort to learn and achieve good results. They often see the poor as cheaters and, as a result, do not support redistributive programs.77 Unfortunately, this triggers another vicious circle: inequality leads to low trust which, in turn, prevents citizens from supporting redistributive policies, thus resulting in even more inequality.

As the sociologist Robert Putman famously noted in the early 2000s—after two decades of growing inequality—Americans are now “bowling alone,” living solitary lives and finding few opportunities to mix with other classes.85 In this context, political polarization has intensified, making the creation of cross-class coalitions in support of redistribution harder than ever.

Structuralism provided a new interpretation of inequality. In their view, the only way to understand income distribution within each Latin American country was to consider the way the global economy was organized. Most technological innovations took place in countries like the UK, France, and the US—the “center”—and in many sectors simultaneously. These economies not only grew more but were also diversified and had many high-productivity sectors. Workers in all kinds of activities, from textiles to steam engines and from wine to steel-making, were highly productive and, as a result, relatively well paid. In contrast, countries in Latin America, Africa, and much of Asia—the “periphery”—were specialized in agricultural and mining products and relied on innovations from abroad. In the periphery, many economic activities—particularly within the manufacturing sector—were underdeveloped and most wealth was concentrated in the export sector. Most jobs were informal and poorly paid.

Formal and informal education, Freire argued, reproduces oppression and limits dissent. He warned against the “banking concept of education,” which is based on the idea that the primary goal of students is to accumulate knowledge. “Instead of communicating, the teacher issues communiques and makes deposits which the students patiently receive, memorize, and repeat,” Freire explained in Pedagogy of the Oppressed.14 According to this model, students should focus on memorizing the multiplication tables, the capitals of the world, and all kinds of historical facts—but should not be encouraged to question why this is useful or important.

A liberating education should be built on dialogue. Students should participate in the process at every step of the way: when designing the curriculum, when learning new concepts, and when doing problem-solving exercises. The process of dialogue should help to break the barriers between teacher and pupil, promoting a less authoritarian and more democratic relationship. The good teacher should always link theory and practice, allow students to question her/him and promote joint discovery. How different is this approach from the way most schools are organized even today! The end goal of education in contexts of oppression and inequality is to free students from dominant thinking, encouraging them to change the world. Freire often called for a transformative education that simultaneously encouraged respect. “The ideal is to promote the transformation of rebellious consciousness into revolutionary consciousness. To be radical without becoming sectarian. To be strategic without becoming cynical. To be skillful without becoming opportunistic. To be ethical without becoming puritanical,” he eloquently explained to his niece.

what are the factors that influence your income? Economists usually consider three. Factor 1: the wealth and education you have—often called endowments. Some people have a lot of property, stocks, and other financial assets. Others have no savings at all. Large landowners coexist with individuals with no land. Some people enter the labor market after years of study, while other workers have not even finished primary education. Factor 2: the income you make from your job and all your assets. Introductory economics books use the concepts of supply and demand in different markets to explain this. For example, your wage depends on how many people with a similar level of education to yours there are. If your skills are in high demand and there are few people like you, your wage will be relatively high. By contrast, if you do not have unique skills, you will face competition from many others. If you own land in a highly sought-after area of a city, you can rent it at a higher price than if it is in an unpopular one.

Factor 3: the redistribution of income through taxes and social spending. Your final income will depend not only on your wages and the return of your savings, but also on how many taxes you pay and which social benefits you receive. In most but by no means all countries, taxes and social spending together contribute to reducing the income gap between rich and poor.

“There’s just no evidence that raising the minimum wage costs jobs,” explains the Nobel Prize-winning economist, Paul Krugman—instead they lead to “better morale, lower turnover, increased productivity.”

History tells us that an active state that interacts constructively with the private sector is particularly important. Most examples of successful economic transformation—Scandinavia, South Korea, Taiwan, China—relied on what economists call industrial policy. Even in the US, often (wrongly!) considered a free market paradise, the state drove most significant innovations—as convincingly shown by Mariana Mazzucato in The Entrepreneurial State.

The impact of this process of financialization on inequality across the world cannot be overstated. “The success or failure of the financial sector has had serious effects on the rest of the economy and most of its returns have gone to the wealthy driving inequality,” argues a contributor to the market-friendly Forbes magazine.32 Four channels have been particularly important. First, by pressuring companies to produce short-term profits, financial markets have contributed to periodic firings, growing flexibility in labor arrangements, and low wage growth. Second, high wages in the financial market have been one of the drivers of inequality at the top. For example, financial deregulation contributed to a 20 percent increase in the pre-tax earnings of the wealthiest 10 percent in the UK and a 10 percent growth in Japan.

To be effective, democracy has to go beyond free, regular elections. Truly democratic institutions must provide political equality: every citizen must have access to high-quality information and to a say—at least potentially—in the political process. This means that mass media cannot be controlled by a few interest groups and that the right to mobilize, to protest, and to organize must be protected. Campaign financing has to be regulated so that powerful individuals cannot buy presidential candidates or congressional votes. Political parties must be both strong and diverse so that they can exert effective opposition when they are not in power and can also offer true policy alternatives to choose from.

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