Globalization: Wharton’s Davos! Rise of Asia’s Capitalism & Fall of Western Capitalism

Humble respect to Wharton

Blog Note: We just want to remind our readers that today, US President, Obama, said the US will get tough on trade with China. Also, some analysis points to a continuing slow-down in global trade-as Singapore dollar and the cost of shipping indicates.

The following is from Knowledge@Wharton latest analysis:

Rising Asia Capitalism & Mercantilism

Klaus Schwab organized a “European Management Symposium” in February, 1971, in the Swiss mountain town of Davos, the venue of Thomas Mann’s The Magic Mountain. The event, which drew 450 participants, was intended to provide European executives with a chance to learn about the latest management concepts from prominent thought leaders, including the president of IBM and Harvard economist John Kenneth Galbraith.

Renamed the World Economic Forum in 1987, the organization has orchestrated more than a thousand meetings around the world, but its annual meeting in Davos in January remains the crown jewel. I first attended in 1997, a year that drew some 1,000 participants, and though such notables as South African President Nelson Mandela and Egyptian President Muhammad Hosni Mubarak walked the halls, attention seemed riveted on those who were at that time driving the American business juggernaut, including Intel CEO Andrew Grove and Microsoft CEO William Gates.

Failure of Western Capitalism:

For the 2,500 attending the just concluded 2010 meeting in Davos, the Forum’s 40th, the shift in tone was pronounced. Any whiff of American triumphalism had given way to U.S. contrition in the wake of the great financial crisis of 2008-2009. Capturing the essence of the mood, one of the event’s leading figures put it bluntly: The calamity was caused by a “failure of leadership” in both financial services and government. Since America’s AIG and Lehman Brothers and Britain’s HBOS and Royal Bank of Scotland were at the center of the vortex, the national locus for that leadership failure was all too clear.

Still, French President Nicolas Sarkozy spread the blame. “All of us must learn from the crisis,” he said, “because all of us are responsible for the crisis.” Market capitalism is here to stay, since the alternatives are all worse, he warned, but we also must build a better capitalism that “reflects shared values” and a “common morality.” Tougher regulation to prevent excessive speculation and risk taking in both Europe and the U.S., he declared, was thus essential. Two of America’s key players in shaping the tougher regime — Congressman Barney Frank, chairman of the House Financial Services Committee, and Lawrence Summers, director of the President’s National Economic Council — made the same point.

Too Big and Connected too Fall?

Among the regulators’ objectives on both sides of the Atlantic: Ensuring that no companies again become TBTF, “too big to fail,” or even TITF, “too interconnected to fail.” In addition, private sector leaders now understand, in the words of Barclays President Robert Diamond, that financial institutions have, in any case, become TBTGW, “too big to get wrong.”

The Move to Prime Time

As attention at this year’s World Economic Forum thus shifted toward rewriting the rule book for “Market Capitalism 2.0” in the U.S. and some European countries, attention also shifted as never before to the rapid rise of Chinese and Indian capitalism.

Business and political leaders from Asia have long attended the annual meeting of the World Economic Forum. In 1997, Indian Prime Minister H. D. Deve Gowda hosted a dinner session on the challenges facing India, and four Chinese leaders presided over a session on “Business in China.” This year, however, China and India moved from special session to prime time.

On the first morning of the 2010 annual meeting, for instance, CNBC’s Maria Bartiromo moderated a packed debate on “The Next Global Crisis.” Two of the three featured commentators were the chairmen of JPMorgan Chase International and Lloyd’s. But responding to them were the deputy governor of the People’s Bank of China and the managing director of Mahindra & Mahindra, one of India’s leading enterprises.

Rise of China and India:

The Forum provided Davos participants with a host of statistical trends, many pointing toward the rise of China and India. One chart showed that public trust in business in China and India far outranked that in the U.S.; another chart confirmed that international trade increasingly favored China and India, less than the U.S. Participants received invitations to private parties hosted by Coke, Google and McKinsey, but also to gatherings sponsored by Infosys, Wipro and the Confederation of Indian Industry.

A telling moment came in a packed room of some 1,000 participants who had come to learn about “the pressing global, industry and societal issues that business leaders must address in the wake of the ‘Great Recession.'” The chief executives of HSBC, PepsiCo, Google and China Mobile gathered on stage. Although English has long served as the lingua franca of global business and therefore the World Economic Forum, simultaneous interpretation was made available for the China Mobile CEO, Wang Jianzhou.

When it came to Wang’s turn to speak, a rustle spread across the room as most of us donned our ear phones to hear in translation this leader of the world’s largest mobile telephone company. But when he began to speak in fluent English, a ripple of laughter also spread across the room as we acknowledged our mistake in assuming that leaders of Chinese companies were now any less global than their counterparts elsewhere. Reinforcing the point, immediately behind us sat a number of Chinese participants, none of whom had opted to hear Wang’s English commentary in translation.

Top China Executive Opinion:

Speaking for many of the business leaders from China and India, Wang advised companies worldwide to “take more social responsibility” for delivering products and services that people really need. Telecom analysts, he said, had warned China Mobile not to enter rural areas where operating costs would be high and consumer income low. But China Mobile did precisely that, deciding that hundreds of millions of Chinese villagers deserved affordable telephone service that only his company could provide.

The ascendance of China, India and other developing countries — a profound “power shift” noted by many at the annual meeting and obvious to anybody who had been in Davos in the 1990s — may thus offer a useful antidote to the driving forces of private gain that had fueled the market capitalism 1.0 so much on display in Davos in 1997, but whose social ravages had become all too evident by 2010. With the rise of mission-driven business enterprise and leadership ethos in China and India — and with the rise of the Chinese and Indian economies — social responsibility may come to better define market capitalism 2.0 in the decade ahead than the ethos of shareholder value that had characterized the 1.0 version of the decade past.

A Measured Optimism:

Delegates to the just-ended World Economic Forum in Davos, Switzerland, found plenty of positive economic signs — but not enough to keep them from wringing their hands. The consensus at the five-day gathering called for strong growth in emerging markets like China, India and Brazil, and poor growth in Japan and much of Europe, with the United States somewhere in between. The Forum’s official statement called the global recovery “fragile.” (See Wharton management professor Michael Useem’s op-ed article on the event.)

But Skepticism Remains:

Nouriel Roubini, a New York University economics professor who had predicted the financial crisis at the Davos meeting three years ago, sent jitters through the meeting with his forecast for a slow recovery worldwide, “subpar growth” and risk of a double-dip, or second recession. Yet most speakers viewed the world as better off than it was a year ago.

The question remains: What’s next? Will the world’s economic recovery — assuming it has started — follow the hoped-for V pattern, form a less desirable but acceptable U or turn into a much-feared W? There was little agreement on how the recovery will proceed. Threats, like panic sparked by a possible government-bond default in Greece or Spain, could roil the financial markets and world economy, many said.

At the start of February, economists and financial experts have mixed opinions as to the strength of the recovery, although Wharton finance professor Jeremy Siegel sounded a note of optimism. “We got some very good news today,” he said on Monday, citing the latest purchasing managers’ report showing manufacturing at its highest level since August 2004. Others are more cautious. “It all boils down to jobs at this point,” says Mark Zandi, chief economist and co-founder of Moody’s, analyzing the U.S. economy. “We’re still losing them. There’s widespread optimism that we will start creating them soon. If we don’t, then the recovery will be stillborn.”

The Us, Vs and Ws refer to the shape of a graph plotting the ups and downs of economic gauges, like gross domestic product (GDP). Siegel expects a V — with the upturn mirroring the downturn as the economy climbs to the old heights. Of course, he notes, there can be a distorted V, with the right-hand side — the recovery — taking longer than the decline, or progressing faster. Among the other patterns, U signifies a delay between the downturn and recovery, while W is a downturn and recovery followed by another downturn and another recovery — a kind of bouncing on the bottom.

World Trade Crucial:

In the U.S., GDP grew at an annual rate of 5.7% in the fourth quarter of 2009, a surprising turnaround given the weak 0.4% growth in 2008 and falling GDP for much of last year. The GDP figure was cheering, even though much of the growth came from an inventory buildup that will end when supplies are restored to normal, Siegel says. “Exports and imports are growing very strongly. World trade is definitely bouncing back, no question about that.”

Exports accounted for about 2 percentage points in the 5.7% GDP figure, says Wharton finance professor Richard Marston. He agrees with Siegel that “most of the rest was inventory buildup. Inventories are not a source of sustained growth, so many experts expect that U.S. growth this year will be considerably slower.” Analysts at Morgan Stanley predict that U.S. GDP will grow 3.1% this year, while Citigroup puts the figure at 2.9%. Morgan Stanley forecast global growth at 4% and Citibank at 3.2%.

Asia’s Power Houses

A number of speakers at Davos argued that emerging economies like China and India are the key to worldwide recovery. Siegel concurs. “They are already helping us. China’s recovery is helping all of Asia, and Asia is experiencing a very nice recovery…. India and China are doing well.”

Morgan Stanley expects China’s economy to power ahead by 10% this year, and India’s by 8%. Citigroup puts the figures at 9.8% and 8.4%. The weak spots: Japan, the United Kingdom and the euro zone. Both firms expect growth of less than 2% in those areas. Morgan Stanley is especially pessimistic about Japan, forecasting growth of just 0.4% in 2010 and 1.5% in 2011. “The Davos discussion was correct that a lot of the prospects for world growth lie with the emerging markets, particularly China and India,” Marston says. Most experts point out that the world economy is fragile and much could go wrong. “Oil prices could shoot up,” Siegel warns. “We could have a very serious development in Greece that causes disruption to the euro zone.” Spain looks even more worrisome to many observers.

China’s Boom and Bust Cycle:

Wharton Management Professor Marshall W. Meyer notes that China is prone to boom and bust cycles, with booms introducing damaging factors into the world economy, such as higher commodities prices. Currently, he says, China appears to be in a real estate bubble. “Real estate prices are way beyond the reach of ordinary Chinese, particularly in the cities.” If the bubble continues to expand and then bursts, it could spark panic in world financial markets, he notes. “I think the psychological impact of a sudden drop in real estate prices in China would be far more important than any economic impact.”

Fortunately, he says, the Chinese government is aware of the problem and is tapping the economic brakes. Meyer thinks this will gradually slow the Chinese economy, but not enough to hurt the rest of the world.

US Trailing Behind:

In the U.S., the world’s largest economy, many signs are positive, but not all. A Federal Reserve survey released February 1 found that none of the 50 banks questioned had tightened lending standards for large and medium companies, while only two had tightened lending for small firms. The findings showed the business-lending situation is no longer getting worse, but money remains tight. “Banks are not lending very much,” says Wharton business and public policy professor Howard Pack. “There’s still a huge amount of unemployment and no prospect that it will be reduced very rapidly. And there are still foreclosures.”

The burst real estate bubble was a key factor to the recession in the U.S. Now there are signs of improvement. On February 2, the National Association of Realtors said its index of pending home sales was strengthening. The Standard & Poor’s Case-Shiller Home Price Indices show home price declines are slowing substantially. “We appear to be forming a bottom in the housing market,” says Wharton real estate professor Susan M. Wachter, noting that in some parts of the country, prices are actually rising. “We have stabilization of the housing market, which is very important to the banking system.” Low interest rates, the $8,000 tax credit for home purchases and government support for the mortgage market via purchases of mortgage-backed securities are key factors, she says.

Residential Property Question:

But, Wachter adds, high unemployment will dampen the housing recovery. “People who don’t have jobs are not going to be purchasing homes.” Also, she notes, home prices are not likely to rebound given that the market is flooded with foreclosed homes being sold at fire-sale prices. Various studies have found that between 4.5 and 5 million homes are worth less than their owners owe on their mortgages, a condition that leads many to stop making loan payments, spurring foreclosures. “The foreclosure problem is what will keep a V-shaped recovery from happening in the housing market,” she says.

Commercial Real Estate Problems:

Even if the housing market improves, there are growing problems in commercial real estate, warns Pack. Rents are not rising as developers had projected, and there have been a number of high-profile failures. In New York City, investors recently defaulted on $4.4 billion in debt on a development called Stuyvesant Town and Peter Cooper Village. “The ongoing problem is huge,” Pack says, noting that the health of the commercial real estate market is very difficult to gauge.

More Hiring and Spending

The big problem in the U.S. is jobs. The February 5 unemployment report “is probably going to be the most important report of the next few weeks,” says Siegel, adding that employment figures have been improving for months. “We will get job creation this year, [probably] this quarter.”

About a third of recent GDP growth was due to government stimulus programs over the past year or so, according to Zandi. Now prospects are getting better. Businesses have cut to the bone and are likely to begin hiring soon to increase production as the economy strengthens, he says, arguing that President Obama’s proposed tax credits for businesses creating jobs could be enough to spark improved confidence among business owners. “All they need is a little bit of benefit to overcome their fear and start hiring again.” Still, he warns that it will take a lot for the unemployment rate to drop from the current 10% to a normal level around 5%. “To get there, you need to create at least 10 million jobs,” he says. “That’s doable, but it feels like a reach” to expect it by 2013 or 2014. Marston notes that the U.S. economy is heavily dependent on domestic demand, including consumer consumption. He expects that to strengthen this year.

Optimism on US consumption:

“How can consumption revive with 10% unemployment? I believe that a lot of the fall in consumption was in families who could have spent more but were unnerved by the financial crisis,” Marston says. “These are families that have seen wealth — houses, stocks — decline, but still have maintained their income. Now they are in a position to resume their spending. With the revival of the stock market and the good news on third and fourth quarter GDP, we are seeing a modest revival of consumer demand…. We can’t rule out a double dip, but I think it’s very unlikely. Instead, we are likely to see growth this year, though at a modest rate.”

Still, many experts debate whether the economy needs more help in the form of another government stimulus. Siegel argues against it, suggesting that an additional stimulus like government spending could overheat the economy, sparking inflation. “I do not see a major stall in the recovery,” Siegel says, predicting GDP will grow at a 3% rate in the first quarter of 2010.

Zandi believes another stimulus shot, such as Obama’s proposed tax credit for job creation, would help insure against a double dip. “While the job market and economic recoveries are likely to gain traction even without substantially more fiscal stimulus, odds remain uncomfortably high — about one in four — that they won’t,” he writes in his Dismal Scientist newsletter.

“For the next year or so, most Americans will swear we are still in recession,” Marston concludes. “I can’t blame them because unemployment will respond only sluggishly to the upturn. But the fact is that the recession is over. I predict that the [National Bureau of Economic Research] will announce shortly that the recession ended last summer, or perhaps early last fall.”

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