Mikhail Fridman & Anatole Kaletsky: The current economic and political volatility
Discussion: Mikhail Fridman, Chairman of LetterOne, and the award winning economist and journalist Anatole Kaletsky, talk about what lies behind current economic and political volatility, the emergence of a new economic era, and the implications for globalisation, and the pace of economic development of developing and emerging markets.
[Anatole Kaletsky has written for The Economist, The Financial Times, and was the Economics Editor of The Times. In 2010 he wrote a book titled Capitalism 4.0: The Birth of a New Economy in the Aftermath of Crisis. He suggests that capitalism is "not a static set of institutions but an evolutionary system that reinvents and reinvigorates itself through crisis”. He was elected to the governing Council of the Royal Economic Society in 1998. In 2012, he was appointed Chairman of the Institute for New Economic Thinking, a foundation established after the 2008 financial crisis to challenge the mainstream assumptions in contemporary economic research.]
A - Mikhail Fridman: One year ago I wrote an article in the FT about the oil price – “Tricks of the mind turned oil into gold” – in which I said that the price had remained high because people perceived there was a shortage. I said that I believe that we are probably facing a new phase when people do not fear the end of oil. Right now, and one year after this article, it’s more or less clear that this is so….
Q - Anatole Kaletsky: I was very struck by that article. I have a similar view about the oil price. If you look back over many years, there have been periods when people believed in Malthus - that the world’s population was running out of oil or food or whatever and that natural resources were the basis for all human wealth, and these have alternated with periods when the world re-discovered Schumpeter - that there is always capacity for innovation and that innovation is the main source of economic progress and of wealth. And there is a related point about competition, which I think you also made: Monopolies can be preserved for a long time but not forever. It is widely believed that oil is different from other commodities because the oil price has always been set by a monopoly, but actually you can break up the last 40 years into two halves. Half the time the oil market really was a monopoly but for half the time between 1985 and 2005, oil traded just like any other commodity with prices determined by supply and demand and production costs.
A - Mikhail Fridman: That’s also my view. So, as we agree on the causes, we should discuss the broader consequences of the falling price of oil. Today, in my view, the impact of the lower oil price, coupled with other economic factors, is leading to volatility in politics and markets and that are signals of a major tectonic shift that is happening before our eyes.
The economic outlook is unstable. Extreme volatility in the markets has become the norm. This instability is usually attributed to two main factors: the sharp decline in the price of natural resources; and the slowing of China’s economic growth. These two factors are actually contradictory. Cheaper resources should, in theory, benefit China, the largest importer of natural resources. Western economies, which are the main consumers of Chinese exports, should also be helped by cheap energy, but there is no sign of that either.
What unites these factors is that we are living in an era of globalisation but globalisation is not working in the way that was expected a few years ago.
People get access to information almost immediately, all over the world, and the world believed that effectively globalisation, access to knowledge and information, would allow more backward countries to join the club of more successful countries more quickly than before. So it was believed that the emerging markets would develop faster rather than developed countries, because the base was much lower. It’s now clear that globalisation is not a linear, progressive process, but a circular process, and I think this is very alarming in some respects.
Q - Anatole Kaletsky: What do you mean by a “circular process” and what consequences does this imply?
A - Mikhail Fridman: If you look at the whole picture, and not a single piece of data, like US market data or China slowdown or the migration crisis, there is a whole series of seemingly unconnected events that I believe are actually connected.
Fragility and instability are spreading like a virus, infecting countries and continents. Those who only yesterday were on the margins of European politics are bursting onto centre stage. Some are left-leaning, like Syriza in Greece and Podemos in Spain. Some are right-leaning, such as the National Front in France, Fidesz in Hungary or AfD in Germany. But all are populists and anti-establishment. And it is not just Europe that is being shaken up.
The United States of America, which was built on the principles of free markets and openness, is rallying to presidential candidates who are either propagating socialist views or arguing for isolationism. This populist advance reflects an obvious and sad fact: old and tested truths no longer satisfy modern societies and need to be reviewed and redefined.
Q - Anatole Kaletsky: Why do you think this is happening and how is it connected with globalisation and natural resources? I wrote during the banking crisis that turmoil was a predictable response to the breakdown of one specific model of global capitalism. Judging by past experience, a likely outcome could be a decade or more of soul searching and instability, leading eventually to a new settlement in both politics and economics. I argued in my book Capitalism 4.0 that the breakdown of deregulated financial capitalism would trigger a fourth seismic change in both politics and economic thinking, that global capitalism is entering a new phase of its evolution. Are you suggesting something along these lines?
A - Mikhail Fridman: I think that the crash of the oil price symbolised to a certain extent, the end of the era of economic development based on natural resources. The history of mankind was always fighting for the access to natural resources, so people fighting just to conquer the new piece of land, because they look for that as part of the social agenda. Social wealth, land, harvest, minerals, oil and gas, water and all national resources were the main components of the national treasure or wealth of the nation. This seems to me to be changing, although of course not overnight.
Q - Anatole Kaletsky: And what in your view could replace national resources as the main form of what you call national treasure?
A - Mikhail Fridman: I believe that the main source of national wealth is not now the resource rent but the social infrastructure that allows every person to realize his or her intellectual and creative potential. This represents a paradigm shift in economic development, to a new era where ideas can now be turned into new scalable services in a short space of time, and the consequences of this are far reaching.
I think that has happened in the developed countries, and Silicon Valley is not the only example, but it’s probably the brightest one. If you look for at a company like Google. In 1991 there were two young guys in a garage, who made some piece of IT programme, which has now became the world’s largest company. I think the West now has the best conditions for making breakthroughs in different spheres of human activity, be it biotechnology, robotics, logistics, or transportation. It is also clear that countries lacking, what I call socio-political eco-systems, in which these businesses are created, are disadvantaged. The creation of a balanced social system and a competitive, rule-based environment requires big shifts in values and thinking as well as the breaking of stereotypes.
Q - Anatole Kaletsky: That’s a point you make very clearly, so to speak the diagnosis I think. But where do we go from this diagnosis? What is the prescription that follows?
A - Mikhail Fridman: To understand this shift in economics and technology, and therefore what a country needs to do to replicate it, you need to look at how it happened.
There are three pillars to this new competitive advantage. Firstly you need talented people who are also very well educated, like these two guys at Google, one of whom was born in Russia, and his family immigrated to the United States, when he was young. This combination of exceptional talent and education is more crucial than ever because we are entering a disruptive era driven by extraordinary levels of human creativity. The term “Indigo” has been used to refer to children with special or unusual abilities. Today we are in a new era where abnormally talented individuals and entities are now able to realize new levels of human potential and economic achievement. So I refer to an “Indigo” generation that is shaping tomorrow’s economy and creating national wealth.
We know from biology that human intelligence, talent and creativity exist everywhere and are equally distributed among all nations and races. Good education may not be available everywhere, but all large developing countries have serious universities. Moreover, people from these countries have a chance to study abroad or undertake online courses provided by the best universities in the developed world.
Q - Anatole Kaletsky: So talent and education are available everywhere. What, then is missing?
A - Mikhail Fridman: The second of my three pillars is probably the most important, critical issue. It is what I call an “eco-system”: legal infrastructure which can protect property rights; competition policies to ensure that a small company could not be oppressed by the big ones; hundreds of suppliers of different business services, starting from venture capital, banks ready to finance, suppliers of services like web design, IT support, whatever. This kind of collateral which enables ideas to arise and businesses to be created quickly and to expand within a very short period of time to the final point where they reach their customers.
Thirdly, this Indigo economy need a digital world which allows the innovators to almost immediately distribute their products to everybody and collect data to understand human behaviour and the behaviour of their potential customers.
Q - Anatole Kaletsky: So how can developing and emerging markets take advantage of these new conditions?
A - Mikhail Fridman: Well, the most problematic area for the functioning of a new era economy is the creation of the social and institutional environment that is congenial to innovative companies, what might be called the politico-economic “cloud”, which is even more important than the technological cloud that everyone now talks about. This institutional “cloud” cannot be created overnight. It has evolved as a result of a profound social and political development that Western societies have experienced over centuries. A firm legal system, competition rules and a system of checks and balances does not automatically result in the creation of a Silicon Valley, but it is a necessary pre-condition.
Q - Anatole Kaletsky: That’s very persuasive but why should it be so much more difficult for emerging economies to create this social infrastructure, if the understanding, the analysis exists. If you look at Singapore or Taiwan or Korea, and their achievements, why are you convinced that other developing countries will find it more difficult to create this infrastructure? Because there is a contrary argument: A few years ago, people believed that globalisation and technological progress would allow emerging economies to catch up faster than ever before. Because it takes 15 or 20 years and hundreds of billions of dollars to build a railway network and an electricity grid and a road system, but in principle, at least in theory, it doesn’t take that long or cost that much to create a properly functioning legal system, or an accounting system?
A - Mikhail Fridman: This is the nub of the problem. Everything depends on whether there is the political will to do what’s required for a modern business system. It doesn’t need financial investment, it needs a social consensus. By the way, the former Soviet Union was a great counter-example that shows what I mean.
When the USSR collapsed, I remember at the end of 80s, beginning of 90s, I started to meet some foreign investors and foreigners. All were fully convinced that the Soviet Union would overcome its problems because of a very convincing argument: They said “you have a very well educated population, you have a huge amount of natural resources, you have technological achievements in areas like rockets or atomic energy or military techniques or all these kinds of things. So therefore you will very quickly reach the level of developed countries.”
It didn’t happen in Russia, because the mind-set of people or cultures, is not based on a piece of paper which is called law; it is based on history, tradition, beliefs, religion, going back hundreds and hundreds of years. The culture of any society is probably the most nurtured parameter of any society. To change the culture, for you and me as cosmopolitan people who travel internationally from one place to another, know that it’s impossible to change culture quickly. It’s possible to make a new leader but if his culture is not respectful of the society, all his changes or her changes will be very temporary, very artificial.
Let’s continue with the example of Russia. All these “new” concepts of freedom of the press, freedom of speech, of democracy and elections, privatisation, everything is very vulnerable. Why? Not because Mr. Putin is imposing a new form of law, which is believed here in the west, but because the reforms that were done by Mr. Yeltsin never deeply penetrated down to the bottom of the soul of Russian people, never.
Q - Anatole Kaletsky: So this is cultural infrastructure that you describe is key to global economic development? You cannot just sign a piece of paper like Yeltsin, which is what Yeltsin thought was enough to create a new kind of society. You recall when Yeltsin rescued Gorbachev after the coup in 1991: he turns up, signs a piece of paper – and the Communist Party is abolished, Communism is finished, we are now in the new world. I think you are saying that the of your Indigo economy is that creating a modern economy and business system is actually more difficult, more time consuming, more costly than rebuilding the railway or electricity system. So what does this mean for developing economies like China and India that are more important than Russia as engines of growth for the world economy?
A - Mikhail Fridman: All emerging market Governments have typically favoured fast physical infrastructure projects at the expense of building institutions, independent legal systems and encouraging competition. These seemed like long and difficult tasks that did not match traditional values and often contradicted the interests of the ruling elite.
The most obvious example of this approach was China. There the development of institutions was sacrificed for the sake of building new cities. Having realized the scale of problems related to the weakness of its institutions, the government has responded in its usual way: employing its usual tactics of further centralization and repression.
Another great example of this thesis is Brazil. It seemed like it had been completely fixed, with Lula. He had set up a proper system of laws, and everything, but the moment you begin to peel away the surface, it turns out that nothing has changed and it’s worse than ever before. Turkey is another unfortunate example of this.
In short, with the possible exception of India, a repeat of China’s economic miracle or a boom in any of the other big emerging markets is unlikely.
Q - Anatole Kaletsky: Isn’t there are contra argument in Eastern Europe? Look at the Eastern European countries which have relatively quickly joined the European collaboration, like the Czech Republic, or even Poland. Why? Because there was unity of people, because they were mentally ready?
A - Mikhail Fridman: Well, look at Poland and Hungary, even there it turns out that perhaps these western values are not as deep rooted as we imagined two years ago. But this brings me onto another important point. I believe that religious rules and traditions are crucially important, even though in the modern world religion is not so visible anymore.
Q - Anatole Kaletsky: Is this because cultures are built on religion? That seems to be one lesson of history.
A - Mikhail Fridman: Yes, religion is a part of culture, the seed of that is so deep. Look at the Baltic States. , You know when they broke free of the Soviet Union they, just immediately switched. Look at Estonia. It’s a normal country. Of course, you could not avoid completely the effects of 40, 50 years of Soviet rule. There is still a generation there who are ex-soviet people, but nevertheless in principle, it’s much easier than Romania or Hungary. So that’s the evidence about cultural things.
Q - Anatole Kaletsky: So if you are living in Brazil or Turkey, do you just give up and say, if I’m an intelligent person I have to emigrate to the United States, or to Western Europe? Or is there something else, some kind of hope that we could hold out?
A - Mikhail Fridman: This is very difficult challenge to overcome. To medicate problems, you should have a clarity about what kind of bitter pill you need to take. It seems to me that the support these countries expect from all their natural resources or their cheap labour will diminish quickly and they should focus on building eco-systems. It’s sad news but on the other hand it’s good news. You should not be dependent on this presence of your land, deposit of oil or ore, or whatever.
Q - Anatole Kaletsky: Yes, but I think there’s a contradiction here. You’re saying that changing their societies is what they need to do, but actually you’ve established that they really can’t do it quickly. It takes a very long time. Even if they’re trying, even if the people at the top understand your diagnosis, do you think they can implement the necessary reforms before their people lose patience and turn against the necessary reform process?
A - Mikhail Fridman: I think most governments in emerging markets have never addressed this very clearly. They have to create a more just society in the sense that the sense of justice and rule of law and that’s what was lacking. It is still clearly lacking in almost all emerging countries. What’s important, is to create an open society and a functioning open society depends on the infrastructure, on which then voting is built. Just having a vote doesn’t give you anything of all the social infrastructure that you’re talking about.
Q - Anatole Kaletsky: I think that is an important conclusion. Of course you need voting. But democracy may be a necessary condition; it is not a sufficient condition. So it could happen in some parts of the developing world move in the right direction, but many will not.
A - Mikhail Fridman: Yes. The Indigo Economy means that the rate of economic growth in many emerging markets will increasingly lag behind that of the developed world, further widening the gap in incomes and standards of living. The mutual resentment driven by the inability of emerging markets to catch up with the developed world will increase. Emerging countries are likely to feel increasingly jealous and hostile toward rich countries while rich countries will try to isolate themselves from their poorer and embittered neighbours. This could heighten the tension in international affairs.
On the other hand there will be some successes. Among other developing nations India is a good example of a country on the rise. Because historically India never got the authoritarian type of regime, there was always to a certain extent of let’s not call it democracy, let’s call it a system of checks and balances.
Q - Anatole Kaletsky: With a proper legal system based on English law?
A - Mikhail Fridman: Of course it’s not perfect but still it’s working somehow, and that’s why I see the chance of a breakthrough in India, because somehow the infrastructure required for business there does work.
Q - Anatole Kaletsky: So India in your view has a good chance because of its legal and political infrastructure. This relates, by the way, to one of the points that I have been making for the last few years about China. One of the biggest contributions to the China’s remarkable development of China in the last ten or 15 years was actually made by Margaret Thatcher. Why? Because Thatcher gave China something that they could not have created for themselves in ten years, 15 or 20 years by handing over Hong Kong. Hong Kong was a functioning, legal financial centre, which had developed over 99 years precisely the legal and social infrastructure that you have been taking about. The Chinese were able to import this for nothing and rely on it to a very significant extent, to help the development of Chinese business and finance. Without that gift of the Hong Kong financial centre a lot of China’s business development might not have happened. On the other hand, Taiwan, Korea and Japan, have managed to set up their own successful business and financial cultures. But to some extent were forced to create these infrastructures of legal rights and so on under American occupation or influence. Another way of expressing this phenomenon you’re describing, is that emerging economies are facing partly a resource trap and partly the so-called middle income trap. Many countries have got up to a middle income of average, say $7,000 to $10,000 a year. But to make that next leap, only three or four countries have ever accomplished that.
A - Mikhail Fridman: That’s exactly the point when we get to the level…You can’t go any further, unless you change, reshape, you reshuffle the whole system.
I think globalization is becoming circular. A few years ago it contributed to the narrowing of the gap between emerging markets and the Western world. But now it could be used as a channel for selling the products of Indigo economies to the countries that cannot compete in quality or price.
Heightened resentment and tension could further empower political populists who exploit the feelings of fear, jealousy and inability to change one’s circumstances to fan hatred toward the more prosperous and successful, and a desire to destroy their riches. These populist politicians are already among us, promising simple solutions to complex problems. It is a dangerous recipe.
But in this new economic era, even in theory, one cannot build an economy based on the creative energy, free spirit and self-fulfilment of millions of individuals if they are cut off from making the most important decisions about their own society. I hope that the Indigo era toward which we are heading will finally end these dangerous misconceptions. The successful economy is an economy of free people. And this means that the world must become more and more free.