Edward Luce’s The Retreat of Western Liberalism

This book is a sobering read.

Luce’s hypothesis is that the world liberal elite “ruling classes”, particularly on the left, have lost touch with the heartland of their countries and that, together with new developments in technology and the rise of China, this is leading to some tectonic shifts in geopolitics which are evidenced in phenomena like the election of Trump and the vote for Brexit. Luce makes a strong case that in the world, liberal democracy is on the decline, and that unless leaders come to truly grasp and understand the malaise that has led to these events, then we may fail to protect Western ideals of democracy. In Russia, China and many other places in the world, there is nothing inevitable about the rise of democracy, or progress to human liberty and individual freedoms, as we tend to believe in the West. The potential failure of Western democracy may just be a return to much longer-term pre 20th century norms.

My sense in reading it, is that he is starting to weave together several themes that will be essential to understanding the world over the decade to come, and therefore essential to navigating the coming years from an investment and political perspective.

This post is longer than usual since it’s about a complete book and not a podcast. Basically I have sought to précis my main takeaways of the book, either by summarising them in my own words or by liberally quoting Edward and the people he quotes. He is a eloquent journalist and I am certainly a new fan, so anything eloquent you read is almost certainly his wording. As you read this please realise that these are my interpretations of his ideas, and not necessarily my own views on life or an accurate representation of his views. To frame his views, he is clearly not a fan of Trump and appears to focus mostly on politics from a liberal and left perspective. Where I have discussed my own ideas or views, I have written these in italics.

In the first part of the book he sets out how the golden era of Western democracy rose up over the 20th century and puts that into wonderful historical context.

The rise of China and India today are less a revolution and more a restoration – a return to normality after a two century interlude, before which Europe and the West were tiny and the East was the dominant contributor to global GDP and trade. During the industrial revolution we had massive movements from agriculture to industry, from the country side to the cities, from Europe to the new world, accompanied by massive economic growth but rising inequalities.

Then in the early 20th century you started having the introduction of more social saftey nets and a social contract. This lead to the growth of the middle classes. The golden era of Western middle class income growth was in the period from 1940 to 1970 with median growth of 2 to 3 pct and high productivity. However that has now changed in subsequent decades, as productivity has fallen except for a brief period in the 1990’s (productivity is a huge topic I want to explore in future posts).

He explains how globalisation has meant strong economic growth at headline levels but how beneath the surface that is increasingly unequal. Since 2009 the US economy has grown GDP by 2 percent per year but it took 6 years to get median income back to the same level as pre the Global Finical Crisis. By contrast much of the developing world has grown incomes at a healthy rate over the period. He discusses at a global level how the gap between the very wealthy and the median or poor has grown tremendously. The median household in the West still enjoys a far better lifestyle than in the developing world, but their income growth has stagnated and the gap is closing. In the 1950s it took the median US worker 45 hours to earn the income to pay the rent for the month in a big city in America. Today is takes 101 hours.

Adam Smith, the father of economic theory, sets out in his Theory of Moral Sentiments that capitalism works best in societies where there is a high level of trust between participants. There is a psychological importance to possessing faith in a better future. As their personal experience of income growth slows but income inequality increases, people feel less like everyone in society is in the same boat together. Ironically it is today’s millennial who are most accepting of the new status quo. For the generation slightly older than them, its much more difficult since they have high expectations set by the fact that they saw their parents circumstances improve so much, they expect that to continue.

The Western political elites have a narrative of an ideal meritocracy. A British sociologist Michael Young coined the term meritocracy in a 1958 book about an imagined ruling class of the future. The belief of the meritocrat is that they owe their success only to effort and talent, that luck and social background have nothing to do with it. However, for many outside this lucky elite, they see the economic system as self perpetuating, keeping them where they are. The growth of the working class means more and more people feel like they are shut out of society. The ‘meritocratic’ elite can be insufferably smug, while the unluck majority can easily become demoralised by being looked down on by people who have done well for themselves.

In contrast to the industrial era, today’s inequality is accompanied by declining mobility, both geographically and socio-economically.

He makes some fascinating observations about how the worlds global cities are changing. 50 years ago people abandoned city centres where crime was high for the suburbs. Today that is reversing, gentrification and renaissance of the city centres has lead to increasing home prices and a move of the wealthy back from suburbs to the city centres, and pushed the poor further and further to the periphery of the suburbs, requiring longer commute times to multiple part time jobs. In US cities since 2000 murder rates in city centres have dropped 16.7 % while the they have risen by 16.9 % in the suburbs.

Western metropolises often have more in common with their global counterparts than their national hinterlands. These cities used to be regional locomotives, linked to the surrounding geographies, consuming the country side’s produce and raw materials and converting them to products. Now they are parasitic on that surrounding country side. Chicago and London are sucking the best and brightest talent from the surrounding countryside as it plugs them into the global economy. Their success is no longer symbiotic with the countryside, it comes at its expense.

And as the cities get more expensive the middle classes find it increasing hard to keep up with rising costs and those with fewer qualifications find themselves shut out. The more fortunate inhabitants pay lip service to a progressive world view but how they spend their money is not progressive: the more liberal a cities politics, the higher the rate of inequality; consider London, San Francisco and New York. The city’s essential workers, service workers like police officers, and school teachers are priced out of living in the town, replaced by wealthy cosmopolitans who often divide their lives between different locations. Vast swaths of the city consists of unoccupied investment properties. And the new residents lock in their investment gains by supporting legislation to restricting land use which keeps property values high. Cities are becoming too successful for their own good. They have been the engine rooms of the new economy, embracing the diversity necessary to attract talent. Yet they are squeezing out income diversity, and so they shut off the opportunity for many to escape their less fortunate circumstances as new ghettos develop on the outskirts of the cities.

He also believes that the forces of artificial intelligence and “remote intelligence” are likely to further many of these trends. “One of the bedtime stories we tell ourselves is that technology is everybody’s friend”. Some have a view that this will lead to great abundance, new forms of work hitherto unimagined and greater leisure time. It will, but will we be paid for such work as we are in today’s world?

Many young people are advised today to “get an engineering degree” but this is no guarantee of remunerative employment for the masses: a third of Americans with science, technology, engineering and maths degrees are in jobs that don’t require any such qualification. Many programmers are working as office temps and fast food servers. In the age of artificial intelligence more and more workers will drift into obsolescence. The latest AI driven technological revolution may be different from previous ones that affected only certain sectors, todays revolution is more general purpose: few jobs will be immune. Profits at companies may soar but this value may not accrue to wider society. In 2006 Google bought YouTube with 65 employees for $1.65bn, $25m per employee. In 2014 Facebook bought WhatsApp with 55 employees for $19bn, a staggering $345m per employee. Facebooks data servers require one human technician for every 20,000 computers. The wealth is being distributed between very few individuals.

By skewing the gains of the new economy to a few, robots/technology weakens the chief engine of growth: middle class demand. As labour becomes expensive relative to machines, spending power falls.

Technology is often treated as a separate force from globalalisation. In reality they are the same thing. Blue collar workers over the last generation were affected by the shift of routine physical tasks from the West to the factory floors of the developing world, enabled by the relentless drop in the cost of transporting goods (first by steam, then by aeroplanes, supertankers and mechanised ports). The explosion of communications technology this century is enabling Western companies to do precisely the same in the knowledge economy today.

In the short term it is not artificial intelligence the West should worry about but “remote intelligence”. Remote intelligence is the ability to apply intelligence from a distance: your doctor may not to have the same room with you or even in the same country if they are able to operate from a distance. The next generation of offshore jobs will be devoted to more complex tasks, like medical diagnosis, writing legal briefs and remotely supervising factories and plants.

Rapid leaps in language translation software are opening up whole new areas. These days you speak to a computer system rather than an Indian call centre. The individuals dealing with the query may not be able to speak your language at all and still be able to deal with your query.

How far will it go? Much further than we think. Between 25 and 33pct of the labour force in Britain, the US, France and Spain are already independent workers (self employed part or full time). This sort of employment accounts for almost all job growth since the Global Financial Crisis. And the gig economy is not just dominated by millennials. Britain has more pensioners doing independent work than people under thirty. As the real value of pensions and social security goes down, the pressure to postpone retirement grows. These new economy jobs are generally less secure with fewer benefits than traditional jobs.

Jaron Lanier calls the big firms cornering the consumer data market the ‘siren servers’. In exchange for access to social media, we surrender more and more of our personal data for free, like sailors being lured onto the rocks. This data is the heart of the wealth creation in these new technology businesses. The exchange is increasingly one sided as many of our jobs are squeezed by this invisible bargain and our earnings never seem to rise. Lanier says, ‘the dominant principle of the new information economy, has lately been to conceal the value of information. Ordinary people will be unvalued. While those closest to the top computers will be hyper valuable.’

Henry Ford in the 1920s raised the wages to factory workers to $5 a day, with the idea that by creating a middle class income, more would be able to afford his cars. In the 1950s he began to invest in automation. On a tour of the plant with Walter Reuther, the auto union leader, Ford pointed at the robots and said ‘How will you get union dues from them?’ Reuther replied ‘How will you get [the robots] to buy your cars?’ We could ask a similar question of today’s Big Data companies as their innovation replaces swathes of middle class jobs.

Even for the owner of the siren servers this will ultimately prove self defeating. The new economy requires consumers with spending power, just as the old one did. Big Data is gobbling up its source of future revenue. McKinsey says almost half of existing jobs are vulnerable to automation.

The basic conclusion is a relentless downward pressure on middle class incomes. And the implication:

Yascha Mounk and Lee Drutman, two political scientists predict that ‘the rich with live in gated compounds, that are protected by drones and connected by driverless cars. Ever smarter surveillance technology will help monitor the activities of the malcontents outside…’ As Larry Summers complains, we are witnessing ‘the development of stateless elites whose allegiance is to global economic success and their own prosperity rather than the interests of the nation where they are headquartered.’ Elites of the world unite! You have everything to lose.

In one sense we live in a hyper-democratic world: where everyone with a grievance wields more digital power the palm of their hands than the computers than sent Apollo 14 into orbit. It made economic sense for Victorian elites to buy social peace by broadening the electoral franchise. What price are our elites prepared to pay this time round?

Larry Summers advises governments to focus on ‘responsible nationalism’ with the idea that ‘the basic responsibility of government is to maximise the welfare of its citizens, not pursue some abstract concept of the global good.’ Global elites need to catch up with how most people view the world, not the other way around.

The second part of the book explains the political reactions to this and what we are now seeing in our Western democracies.

He argues that for many countries, common values are insufficient to hold them together if there is not economic growth that is broadly shared. When that growth fails, the system itself gets questioned. When that growth is monopolised by a fortunate few, the unfortunate many will turn, and in that turning will seek scapegoats. The worlds elites have provoked what they feared: a populist uprising against the world economy. He sees a world of few choices: reversal of some of the globalisation, or a practical choice of “thin globalisation” being possibly the only realistic way of salvaging a peaceful world order. The other choice he fears, but sees an increasing trend towards, is moving away from democracy towards forms of autocracy.

This is evident in Russia under Putin, China under Xi Jinping, but many other coutries: Pakistan, Hungary, the Philippines, Turkey.

The growth of autocracy across the globe has happened as the West and the US specifically lost leadership: in the war on terror as the West chose to cooperate with countries regardless of their human rights records, allowing many to create global terror lists which conveniently included local political opposition;the Iraq war and the aftermath of how Iraq was governed; under Obama with a confused indecisive foreign policy as the various “Arab springs” withered; and now under Trump. There are now 25 fewer democracies in the world than there were in 2000. Larry Diamond a scholar of democracy states “there is not a single country on the African continent where democracy is firmly consolidated and secure”.

Economic performance is also no longer modelled by the US. The Global Financial Crisis in 2008 was really a Western economic crisis but China continued to grow steadily. China’s seemingly successful model of growth also brings hope. (Incidentally the “miracle growth” of China has been fuelled by a good old fashioned credit boom over the last 10 years, of a size and pace seldom witnessed before. When the rocket fuel runs out as it must, that may appear less miraculous to all)

Andrew Nathan, a leading Sinologist says “by demonstrating that advanced modernisation can be combined with authoritarian rule, the Chinese regime has given new hope to authoritarian rulers everywhere.”

China now gives loans to many developing countries without the West’s typical “pro democracy” strings attached. China does not seek to export revolution, its goal is to disrupt the West’s claim to democratic universalism. China’s mantra is respect for civilisational diversity – a code term for autocracy. And now we have Trump. Eric Li, a Chinese VC says “Chinese liberals are in a bind. They despise Trump. But they can’t quite bring themselves to say ‘the people are wrong’. Such an admission would not help them make the case for Western style democracy in China. After all, if the people can be so wrong, how can you give them the vote?”

The malady in the Western liberal left’s approach lies in a detachment from the societies they had once been anchored in. Instead of UK Labour MPs from working backgrounds and factory floors, these days many (prior to Corbyn) are educated in the same private schools and the universities associated with the Conservative and Liberal Democratic parties. A technocratic mindset has gripped political elites across the Western world. While he does not make the point in the book probably because it was written slightly before the latest developments, I think it likely that, going forward, we will see even stronger support for the likes of Bernie Sanders in the US and Jeremy Corbyn in the UK, for that sense of connection back to the common man.

He makes the point that it is very dangerous to boil the arguement down to simple xenophobic or racist views, or ethnic shoehorning like a “white backlash” for those who voted for the Trump. ”This post-mortem is convenient because it sanctions a conviction of moral superiority” amongst the leftist elite. A larger portion of Hispanics voted for Trump in 2016, than voted for Mitt Romney in 2012. Failure to diagnose the reason for Hilary Clinton’s defeat will only make Trump’s re-election more likely. A better explanation is that many Americans feel alienated from an establishment that has routinely sidelined their economic complaints. Obama offered hope. Trump channelled rage. The left has given a higher priority to ethnic or cultural identity than to people’s common interests.

In Britain it is seen in the surge of support for UKIP. ‘They are fed up to the back of their teeth with the cardboard cutout careerists in Westminster. The spot-the-difference politicians’ said Nigel Farage. Recall Gordon Browns description of a ‘bigoted women’ when he encounters a voter concerned about the effects of immigration. But remember that a significant portion of the Asian population also voted for Brexit. People are impacted by both cuts to the welfare state and simultaneous increases in demand placed on the system by persistent immigration. On both sides of the Atlantic the younger millennial have been apathetic whilst older voters have turned out to voice their concerns.

Plato believed that democracy was the rule of the mob, the word literally comes from the Greek words for ‘mob’ demos and ‘rule’ kratos. In his view, the mob could not distinguish between knowledge and opinion. Aristotle’s answer was to combine the rule of the knowledgable with the consent of the many.

Edward Luce makes a distinction between the way the public typically think democracy works: the ‘folk theory of democracy’ which is a simple process whereby the people elect their representatives to carry out their instructions. Versus the realistic view of democracy, which is that democracy can only work if democracy itself is a series of tradeoffs and backroom deals governed by a system of balances of power, between individual rights, the legislature, and the judiciary. In reality there is no such thing as the popular will, just a messy series of deals between competing interests. It is hard to watch any legislature making laws without thinking that the whole business is corrupt. Yet it is the only alternative to rule by dictate.

He makes the point that the ruling political elite don’t always love democracy, they fear the rule of the mob, and often devise ways around it. When inequality is high, the rich fear the mob and will support those who oppose or seek to constrain democracy.

In surveys in the 1990s the wealthy backed democracy more than any of their income group in the US and Europe. That has now switched around. The poor are now democracy’s biggest fans, the rich its biggest sceptics.

As an example, in his view, the EU is not a democracy but a complex system of anonymous committtees that set the rules for its member states, very much driven by the will of the political classes of Europe. Brussels (the EU) has delegated most of the big decisions to itself, and left little more than identity politics to its member states.

And this, in his view is the crux of the West’s crisis: our societies are split between the will of the people and the rule of the experts – the tyranny of the majority versus the club of self-serving insiders who lead. The election of Trump and Brexit are a reassertion of the popular will. The new Western populism is an “illiberal democratic response to undemocratic liberalism imposed by the elites.”

So without higher growth and a fairer distribution of that growth, the return of radical politics looks set to continue.

There are also some very interesting insights into technology’s role in these events. We all have a utopian hope that new technology will bring new unity to the world. In the 1850’s the telegraph was proclaimed as the great unifier of humanity: ‘It is impossible that old prejudices and hostilities should any longer exist,’ said an editorial in the New Englander. Guglielmo Marconi, an early radio tycoon said ‘the coming of the wireless era will make war impossible, because it will make war ridiculous.’ Churchill, Roosevelt, Stalin and Hitler all mastered those mediums. Today the internet is just the same, in 1996 Nicholas Negroponte, an early evangelist for the internet said ‘the role of the nation state will change dramatically and there will be no more room for nationalism on the internet than there is for smallpox.’ Today Trump’s use of the internet is no different to previous media eras. Fake news of fake facts? What if his followers do not care? What if middle America has become so cynical about the truth that it will take its script from a political version of pro wrestling? One journalist summarised the two opposing views of Trump during the election campaign : “the press take him literally but not seriously, his supporters take him seriously but not literally.” It turns out both were wrong. Trump should have been taken seriously and literally.

Manipulation of the media is crucial. In Russia ‘the new Kremlin won’t make the same mistake as the old Soviet Union did: it will never let TV become dull. Like London, more than half of Moscow voted against Putin. But Putin’s mastery of reality TV, an industry that is scripted by the Kremlin, and by it business acolytes, outweighs what ever cynicism he generates in the cities.

So will the balance of powers in the US defend democracy at this time? With Trump in the presidency, what about congress and the judiciary? The panoply of intelligence and national security agencies which always seem to grow no matter which administration is in office – has run rings around Congress for years. Although Congress is supposed to oversee their activities, they rely entirely on the agencies themselves to keep them informed. And on the judicial front, “there is nothing to stop a US president from ignoring the courts. Pretending otherwise has been the civic duty of almost every US president baring Nixon.” Presidential constraint is the most essential ingredient in the proper functioning of the American system.

As time goes on, the true populist loses patience with the rules of the democratic game. The countries constitution gets rewritten and laws can be changed. Particular examples include Hungary under Victor Orbán. A true populist is not just opposed to the elites, he is also an enemy of pluralism. The true populist claims to speak exclusively for 100percent of the true people. Only they can know the identity of the true people. ‘The only important thing is the unification of the people – because other people don’t mean anything’, said Trump.

The West has forfeited much of its prestige. As Western democracy has come into question so has hits global power. The worlds centre of gravity, meanwhile, is shifting inexorably towards the east.

The third part looks at the implications of declining US and Western hegemony on the world stage.

Keynes commented in 1938 as he looked back on the period just prior to World War One (the Great War) that the average middle class Englishman believed that “life offered, at low cost and with the least trouble, conveniences, comforts and amenities beyond the compass of the richest and most powerful monarchs of other ages. Comfortable Edwardians regarded this state of affairs as normal, certain, and permanent, except in the direction of further improvement, and any deviation from it as aberrant, scandalous, and avoidable. We were not aware that civilisation was a thin and precarious crust erected by the personality and the will of very few, and only maintained by rules and conventions skilfully put across and guilefully preserved.” Like today, people believed that ever deepening ties of commerce rendered the idea of war irrational. It was thus unthinkable. People had grown complacent after decades of peace (but for periodic colonial wars). The last real clash between ‘civilised powers’ had been more than 40 years before. Much like our generation, people at the time were unlikely to have had any real experience of direct conflict. Just as we exult in our Apple products and artisanal coffee, so Keyne’s generation revelled in their Darjeeling tea and the internal combustion engine. Sounds awfully like today.

But the loudest echo according to Luce is geopolitical. It’s what historians call the Thucydides trap: the response of Sparta to the rise of Athens. How does an incumbent established power respond to the rise of a potential challenger? A Harvard study of 15 such instances since 16th century found that 11 culminated in war. In the late 19th century it was the rise of Germany when Britain was the worlds superpower. Luce finds many parallels in the relationship between China and the US today. The Obama administrations pivot towards Asia was aimed at containing China whose military power is expanding rapidly.

To China, Taiwan is the key component and objective. China wants reunification of Taiwan with the mainland and the US is committed to a One China policy. In 1996 the US seemed to weaken its commitment to this and Lee Teng-hu, Taiwan’s president with potentially separatist tendencies, was invited to speak in the US. Beijing launched a series of ballistic missed tests in the Taiwan Straight. President Clinton ordered two US aircraft carriers, into the region and the USS Nimitz patrolled the Taiwan Straight. China backed down and Lee won a thumping reelection the next year. Drawing the obvious conclusions from the setback, China embarked on a military modernisation program, including anti-ship missiles, nuclear submarines and its own aircraft carrier. As a result, a decade later, America no longer wields undisputed sea control over China’s neighbourhood.

The chance that Trump will casually threaten China and get pulled into a dynamic that he can not control should be taken very seriously. The key to good diplomacy is to put yourself in your opponents shoes. Even Trumpts vastly better informed predecessors found it hard to see the world from China’s point of view. For China, the transfer of power in Hong Kong from Britain in 1997 closed the curtain on a “century of humiliation”. China has a deep routed desire to be treated with respect and dignity. China’s incentive to maintain Hong Kong’s relative freedoms has less to do with is obligations to Britain, than with convincing Taiwan that its way of life would be secure under China’s rule. Taiwan is the big prize. Washington is the obstacle.

By cancelling the Trans Pacific Trade Partnership (which did not include China), Trump has driven Americas regional allies into China’s arms. Even Australia is now looking to join China’s rival Regional Comprehensive Economic Partnership. How secure to Japan or India feel with the US’s new direction?

Trumps animating spirit is to make a demoralised American middle class feel better about itself. His goal is to channel rage, not cultivate knowledge. In doing so, he has a license to indulge his most authoritarian impulses. China is his most obvious external target. (Along with Mexico).

China meanwhile faces its own challenges. Beijing’s legitimacy depends on continued economic growth. China’s labour force is subject to precisely the same forces of automation as its American counterparts, and suffers from even greater inequality. The potential for a populist backlash in China cannot be overlook

Not to mention for the potential Trump to upset, and start another war, in the Middle East.

The final part looks briefly at what’s to be done and I am afraid does not offer much solid prescription. But the prescription does start with a clear eyed understanding of what is happening.

So there it is. How will the West cope with these shifting tectonic plates? Political uncertainty introduces much greater economic uncertainty as we look forward. Whether it is the threat of real war, trade war or radical populist domestic policies, financial markets are going to have to deal with these unfolding realities. It seems unlikely that the unprecedented low volatility of markets in recent years is likely to remain the case over the coming decade.