By Dr. Ivo Pezzuto, Professor of Global Economics and Disruptive Innovation at the International School of Management (ISM) of Paris
Engaging in international business these days can be very exciting for dynamic, highly competitive and innovative firms and startups, thanks to a vibrant and highly interconnected global business environment, eagerly driven knowledge-sharing communities, and ease of access to smart and seamless enabling technologies. The innovation potential at the core of today’s revolutionary smart technologies and their applications in lean startups, agile business models and groundbreaking digital-transformation programs seem to benefit the “Creative Destruction” power that was first advocated by economist Joseph Schumpeter (1883-1950) as a catalyst for the disruption of entire industries.
Despite the rising threat to the global economy of protectionism, populism, anti-globalization and anti-immigration movements, and the social and economic concerns about macroeconomic imbalances and other serious challenges, it seems that Globalization 4.0 is still achievable.
Notable challenges include: the potential disruptive impact on the labor market of groundbreaking technological innovations; public/federal and corporate debt overhang; high levels of leverage in the corporate world; distressed assets; red tape; uncertainties about the pace of central banks’ monetary-policy normalization; the risk of falling asset prices and valuations due to “quantitative tightening”; and a potential liquidity squeeze in the financial markets. More generally, a potential risk-off scenario in the future might lead to more cautious lending and investment strategies for riskier assets classes and to a liquidity dry up.
Other relevant potential future challenges include according to Alasdair Macleod of GoldMoney: rising global macroeconomic imbalances and in particular, the massive imbalances accumulated between the intra-regional central banks in Europe as reported by the TARGET2 system (Figure 1)—with the risk of a potential deterioration in the eurozone of collateral values, which might trigger potential risks for the creditors of the TARGET2 imbalances.
Relevant risk factors include: rising interest rates and debt-sustainability issues; the tendency of some banks to have a higher balance-sheet gearing than those in other jurisdictions; a potential spillover effect of banking crises to the global banking sector.
Furthermore, central banks might also find themselves in a potentially challenging position as governments’ debt traps may continue to grow, while economic growth and productivity improvements may remain stagnant.
Finally, a few additional potential risks, may be related to the following circumstances: aging societies and challenges related to the sustainability of retirement systems; risks of global economic slowdown and flattening (or inverted) yield curves; rising inequality and sluggish improvements in social mobility; geopolitical tensions and the risk of trade tensions, trade wars and cyber-attacks; climate change and ecological sustainability issues.
Figure 1: TARGET2 Balances (billion euros)
According to Klaus Schwab of the World Economic Forum, the solution to these challenges lies in bold reforms to build a better future for all stakeholders. The author advocates a new approach to global governance and a new mindset to promote “new global norms, standards, policies, and conventions” inspired by environmental sustainability and social inclusiveness that may “safeguard the public trust”.
Scholars such as Michael Porter and Mark Kramer argue that there is an urgent need for business to rethink its role in society by incorporating social purpose into core competitive strategy. For this scope they have proposed the concept of creating shared value (CSV), which is an innovative “approach that treats social issues as a source of economic opportunity and competitive differentiation for business, rather than a social obligation or cost of doing business”.
In the last decade, despite the benefits of sustained growth led mostly by emerging and developing markets, a number of factors have contributed to increasing uncertainty, complexity and volatility in advanced economies.
Among the critical factors are: the aftermath of the “Great Recession” and the social costs of the financial firms’ bail-outs; a tough fiscal austerity in a number of countries; a growing distrust of the open-markets mantra and neoliberal global order; massive liquidity injections in the financial markets by central banks after the financial crisis but also an increasing number of precarious workers at risk of poverty (i.e., in the European Union–Figure 2) and wage stagnation for the average employee, despite recent salary improvements in some economies at or close to full employment (i.e., United States); reduction in health insurance, retirement and welfare benefits; wealth loss; declining economic mobility for less educated and skilled employees in advanced economies (Pezzuto, 2013; 2014; 2017).
Figure 2: Share of Working Poor in all Major EU Economies
Alarming levels of sovereign debt, speculative-grade bonds and leveraged loans have accumulated in the past decade due to a prolonged period of low interest rates, ease of access to excess liquidity, favorable exchange rates against the US dollar (the “global reserve currency”), and ultra-expansionary fiscal and monetary policies that have ultimately encouraged the adoption of less rigorous fiscal discipline in a number of countries. High levels of debt have often been used by speculative-grade firms of many industries to fund mergers and acquisitions, buyouts, dividends or share buybacks. The International Monetary Fund (IMF) reports that while these highly leveraged loans have risen to alarming levels, investors have been left with limited protections.
In the United States, bank regulation has been relaxed; the quick rise of highly leveraged loans could turn out to be a particularly cumbersome challenge in case of an adverse market scenario or changing economic cycle. Janet Yellen, former chair of the US Federal Reserve System, raised a warning claiming that there has been a “huge deterioration” in lending standards, which could potentially lead to systemic risks associated with these loans. As reported in Figure 3, the rapid growth in the leveraged loan market is part of a boom in collateralized loan obligations (CLOs), which are often being built up by nonbank lenders (E. Nelson, 2018).
Figure 3: Outstanding US CLO Market
In a rapidly changing business environment characterized by rising interest rates, central banks’ monetary-policy normalization, trade-war threats and geopolitical tensions, weaker economies are under considerable pressures. To remain competitive, they may continue to pursue currency devaluations, aggressive fiscal stimuli and reduced fiscal discipline, loose monetary policies and credit standards—and they may transfer leveraged loans’ credit risk to investors through the securitization process (i.e., CLOs). Thus, regulators should remain vigilant regarding a potential build-up of risks related to such practices.
It is no surprise that all of these alarming signs of increased uncertainty, complexity and volatility may have a strong, lasting impact on consumers’, investors’ and firms’ confidence levels. If not properly monitored and controlled by multilateral institutions and leading international regulators, these potential tail-risk factors may escalate into new systemic risks with spillover effects across markets, due to severe macroeconomic imbalances and financial instability risks—unless a proper fiscal backstop mechanism and a coordinated global governance is ensured.
Under severe adverse scenarios, banks may be forced to take such measures as rapidly cleaning up their balance sheets, undertaking tough recapitalizations, seeking government support and guarantees on troubled assets, accepting debt-restructuring agreements and “bail-in” rules, or transferring most of their crisis-resolution costs to their own bondholders.
Supporters of protectionism claim that “free trade” and unchecked models of globalization have damaged their economies and generated increased inequality. They question the widespread diffusion of unfair practices in global trade, unfit models of multilateralism, excesses of government interventions and subsidies to foreign firms, dumping practices, intellectual-property thefts, artificial currency devaluations, looser environmental-protection standards, looser human rights and labor-market laws in foreign markets. They may even question the validity of international trade agreements and the credibility and survival of the World Trade Organization (WTO).
Some authors have dubbed the complex, challenging and vulnerable business environment in the global economy as the “New Normal”. An OECD (Organisation for Economic Co-operation and Development) study reported that “income inequality in OECD countries is at its highest level for the past half century. The average income of the richest 10 percent of the population is about nine times that of the poorest 10 percent across the OECD, up from seven times 25 years ago”.
Figure 4: Rising Inequality Hurts Everyone, Even the Rich
There is no doubt that many less skilled and competitive people have been caught unprepared or unable to react to the revolutionary pace of globalization and technological disruptions and have been unable to cope with the challenges of the New Normal. Thus, a large number of these people have eventually surrendered to the idea that only a nostalgic return to the past can protect them from the risks of an unchecked model of globalization. Many have advocated for more protectionism, more defense of local interests and less globalism, thus confusing, as correctly stated by Klaus Schwab, globalism for globalization.
Yet, as shown in Figure 5,social mobility has indeed dramatically decreased in the past decades in a number of advanced economies, due to globalization, technological change, changes in the labor market and industry structure, and to inadequate economic and structural policies. Figure 5indicates that only about half of 30-year-old Americans make more money than their parents did at a similar age (N. Smith, 2018). For many, this downward social trend means the end of the “American Dream”.
Figure 5: Social Mobility in the US (1970-2014)
Globalization has certainly improved employment rates, living standards, wages, human rights and quality of national institutions and infrastructures of many emerging and developing markets. Globalization through its four waves has helped lift more than one billion people out of extreme poverty and turned their economies into attractive targets of firms’ growth strategies. Some of these markets are becoming the innovative and high-growth-potential markets of the future.
In spite of the popularly acclaimed “convergence theory”—which holds that because poor countries grow at a faster rate than rich countries over time, the gap between the two will automatically diminish—currently the income gap (gross domestic product per capita) and economic inequality between countries have not significantly decreased, as indicated in Figure 6.
Figure 6: GDP per capita emerging vs. developed markets
The 2018 Global Competitiveness Index 4.0 of the World Economic Forum (Figure 7) reveals that the innovation powerhouses in the world remain those countries that have developed such strengths as innovation capabilities, high levels of investment in RD (research and development) and technological innovation, positive attitudes towards entrepreneurial risk, advanced financial systems and venture-capital expertise.
Figure 7: 2018 Global Competitiveness Index 4.0
Technological innovation, free trade, real-time information flow and knowledge exchange are some of the main drivers of growth, productivity, competitiveness and development in the global marketplace.
Digital revolution and technological breakthroughs,
Change in demographics, social change, and opportunities for better education,
Structural changes in the labor market,
Diffusion of innovative solutions to boost productivity and growth strategies,
Focus on welfare sustainability, corporate social responsibility, creating shared value (CSV) strategies, impact investing and socially responsible investing (SRI),
Climate change, resource scarcity, ecological constraints, green economy, circular economy and renewable energies,
Disruptive utilities and agricultural innovations,
Changes in regulation/deregulation,
Increasing datafication of people’s lives—data-protection and privacy issues,
Improvements in closing the gender pay gap and global gender gap index,
Defense and security industry expansion and aerospace exploration,
Shifts in global economic power and political influence, and the advent of a multi-polar international order,
The rise of the sharing economy and disruptive innovations for improving social inclusion and eradicating poverty,
Rapid increase of urbanization,
Applications of AI and mobile technologies for personalized telemedicine services.
Paul Bakus, President of Corporate Affairs of Nestlé, described the way forward for a more sustainable future: “More or less all business started out with a social purpose of some kind…. What’s been lost in recent decades is the interconnectivity between the ne of society and the innovative dynamism of business…. So, the future may look more like a rediscovery of this social purpose of business.”
Given the current scenario of fast-paced technological developments, a new model of economic growth and sustainability will likely unfold, in which workers spend less time on repetitive tasks and more on activities that machines may not perform equally well, such as “managing people, applying expertise and communicating with others” (McKinsey Global Institute, 2017).
When the Creative Destruction wave breaks with its revolutionary innovation power on traditional and outdated business models and technological solutions, it often carries with it the force to disrupt entire industries and economic and social models. The role of a forward-looking international governance and regulation is not to curb innovation but ensure that its introduction and expansion is successfully achieved while minimizing the side effects and unintended consequences on those who could be harmed.
There are many reasons to be optimistic about the promising future scenario of international business, thanks to the unprecedented and exciting growth opportunities that breakthrough innovations and technological developments bring to firms, households and overall global prosperity. There are already many “sound” empirical evidences of the great benefits that technological innovations are having on firms’ value creation and on people’s social and economic inclusion. Notable examples include: advancements in telemedicine; fintech and innovative banking; blockchain technology, digital identity, peer-to-peer value exchange and payments systems; highly scalable payment services for low-income, unbanked individuals.
Along with these amazing new opportunities, a more aggressive global competition is also likely to rise, which ultimately can be a positive boost for knowledge sharing and enhanced global professional communities’ collaborations, increased RD investments, technological upgrading, increased productivity, improved infrastructures, and increased global trade and economic growth and prosperity—as long as fair trade agreements are guaranteed. This is a likely scenario as long as the struggles of the major competitive forces in the global economy to achieve technological superiority, economic and political influence, and global dominance do not turn a potential synergic and win-win road to global prosperity into a reckless and ruthless zero-sum game.
It is essential that policymakers and regulators, multilateral institutions, citizens and stakeholders continue to play a critical role in assuring that the pursuit of long-term goals of improved prosperity will bring economic and social benefits and inclusive growth for all through fair global competition and greater commitment and collaboration on RD, innovation, poverty reduction, sustainability projects and CSV strategies. The international community has to remain vigilant in ensuring that the race to global leadership does not turn into a self-defeating strategy for stakeholders and the natural environment due to potential risks associated with economic and financial instability, rising inequality, excessive risk-taking, systemic risks, geopolitical tensions and conflicts among countries, and the economic consequences of short-sighted policies on climate change and global warming or their impacts on sustainable development and efforts to eradicate poverty.
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