In April 2007, New Century Financial Corporation filed for what was then a little noticed bankruptcy protection. Their mortgage-backed securities had become worthless and by summer Bear Stearns began liquidating hedge funds. Come the autumn, Britain’s fifth largest mortgage lender Northern Rock was on the ropes propped up by the Bank of England. The rest is well known history.
Five years on, after bank failures and bailouts, foreclosures, and rising unemployment, the crisis that started as an obscure financial scheme has led to an unusual triple failure in all three of the world’s traditional growth engines, the United States, Europe and Japan. Though boom-bust cycles are nothing new, they tended to peak and trough at different times. Germany’s early 20th century malaise was paired with America’s roaring twenties. Japan’s first lost decade of the 1990’s coincided with a western tech-driven high.
Now, industrialized nations are facing their greatest economic threat in nearly a century – a troubled middle class losing its purchasing power to drive world growth. If current trends aren’t reversed, and soon, 2012 may be the year the middle fails and a century of economic modernization grinds to a halt.
The upwardly mobile middle class is a relatively new phenomenon. For most of history, the wealthy stayed rich and most everyone else never had a chance. Over the last sixty years, the U.S. as world consumer of first resort created a golden age of opportunity along with a strengthening Europe and Japan. The new middle class that emerged bought homes, cars and appliances powering mass-market adoption of every major innovation of the time – from electricity and the telephone to medical technology and the Internet.
Without this purchasing power, investing in innovation loses its main appeal – the ability to profit from new products and ways of doing things sold into a mass market that can afford to buy them. Notice the shift already underway. Companies like Proctor and Gamble are diversifying their product mix to appeal to budget consumers and premium brand buyers, while the middle market shrinks. They’ve introduced low-priced dish detergent and expensive replacement razor blades while their laundry brand Tide has become so expensive it has attracted thieves that sell it on the black market or trade it for drugs.
Contrary to the decline of the West, rise of the rest narrative in vogue these days, even fast growth economies like China, India, Russia and Brazil can’t pick up the slack. Burdened with years of lax planning and excessive state ownership of diverse industries from banks to airlines and steel mills, the BRIC’s middle class purchasing power remains weak. Even overly optimistic forecasts of a new Asian century routinely use unsustainable growth rates that are already beginning to slow. Note China’s revision to a more modest 7.5 percent growth target and India’s struggle to keep growth alive.
A shift is now underway, risky but necessary for developing economies that looked to industrialized nations for demand. When Chinese President Hu Jintao addressed the National People’s Congress last month, he emphasized the need to re-direct the economy towards more domestic consumption. The World Bank in a recent report warned that China faces increasing risks of a hard landing if policies changing the role of government in the economy aren’t enacted soon. Several leading economists believe that day has already come. Growth fueled by investment and infrastructure spending has done little for small and medium sized enterprises, the core job creators, a social safety net or healthcare.
A triumphant Vladimir Putin in his election victory speech declared a shift in growth away from Russia’s state-owned enterprises and towards more free market reforms. Burma has started to free up its state owned economy after decades of dictatorship. Hotels in Rangoon are filled with businesspeople eager to get in early to the unveiling of a relatively untouched Southeast Asian gem. Here, too, state capitalism appears on its way out, not up.
Unfortunately, reorienting growth towards the middle is much easier said than done, more like changing the direction of an ocean liner than a speed boat. Russia’s great wealth has flowed to powerful oligarchies. China’s income gaps are widening into chasms and social unrest is on the rise. India’s companies are hampered by excessive government intervention, frequent power outages and corruption. Even Brazil’s rapid, but thin growth is based heavily on natural resources.
In the end, there has been no greater engine of growth than the power of the consumer. Both developed and developing economies need to get back basics – education, access to capital, rule of law, and labor mobility. Without them growth stalls, inequality worsens, and political instability rises. Absent change, our collective futures look surprisingly like a not so distant past. That was feudalism, and it’s making a comeback as well.
The great age of opportunity that was a hallmark of the 20th century can last well into the next if countries focus on winning the race back to the middle – and not to the destructive financial top.
Brian P. Klein is a macroeconomic and geopolitical strategist and former U.S. diplomat. His articles and op-eds have appeared in Foreign Affairs, the New York Times, Newsweek Japan, the International Herald Tribune and South China Morning Post, among others. He’s at work on his first book about the rise and fall of the global middle class and blogs at www.brianpklein.com