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Sunday 23 June 2013

Niall Ferguson, The Great Degeneration, What We Can Learn - Part 1

Niall Ferguson, one of my favourite historian is Laurance A. Tisch Professor of History at Harvard University, a Senior Research Fellow of Jesus College, Oxford, and a Senior Research Fellow of the Hoover Institution.  Mr. Ferguson, a British historian in 2004 was named by Time magazine as one of the 100 most influential people in the world.  He is a prolific writer having published over a dozen books and often makes appearances on Bloomberg and other news channels.  He is well followed as his writings are seen as jump off points from history to understand our current maligned world economy and debilitated political class.  It is comforting to note from his writings that our current problems are not uniquely 21st century, it has happened before.  It is a matter of scale and the players are different this time round. 

His latest book, The Great Degeneration is an important read.  I will try to summarize the main points of interest.  However, it is a difficult book to read, not least there are many moral and philosophical questions that are raised; understanding the historical context is also of equal importance for one to truly appreciate the book.  There are a few areas which falls short and seemed disjointed or rushed through but in his defense, this is an extremely large subject and it is a balancing act between over analyzing and losing the main thrust of the book.  Put simply this a book that is a primer for further debate and research.


Why It Matters

Before I begin to disect the book, I go on record that I am no expert in the intricacies of government and legislature.  Although I try to observe from a distance, my views are coloured by personal experiences. I have lived in UK for a long time and have followed political developments both in UK, US and Europe. I have experienced, read and observed these institutions long enough - it is all that which, I trust enables me to share my views.  More importantly, I am the product of Asian politics and culture and for me it is about the adoption of Western political ideas, economic, law and social values and how it has evolved and will evolve in the future.

For those who know me, I have been an ardent follower of Ron Paul for some years now.  My political views have been very much shaped by Mr. Paul as over the many years I have not found solutions both on the left and right side of the political spectrum to our most protracted modern day issues.  It is the lack of answers from both political divide that I find his views attractive.

Ron Paul, is an American physician, author and congressman for Texas' 14th and 22nd congressional districts until he retired from politics in early 2013.  On and off, as a Republican candidate, he had served his constituentcy for more than 35 years.  Mr. Paul is a God fearing libertarian, a student of Fredrich Hayek, Ludvig von Mises and Murray N. Rothbard.  Throughout his time at congress, he had consistently called for the audit and abolition of the Federal Reserve Bank, the return to sound money (i.e. the gold standard) and the substantial reduction in the size and role of government (particularly where it interferes with our civil liberties).  He is also very much against American military adventurism abroad prefering a policy of non-inteference.  As you can see, what he advocates are difficult to digest as it requires a "slash and burn" attitude towards the way modern monetary systems and how government apparatchiks operate.

Proponents on both side of the political divide and mainstream media have not taken kindly to his policy prescriptions for the ills of this world.  Those intent on keeping the welfare/nanny state contend that his policies are inhumane whilst unfettered 'capitalism' will cause inequality to stretch further.  On his own Republican turf, he is borderline fringe due to his opposition to the war in Iraq and the dismembermnent of large swathe of the US monetary system.  In short he is the true president we would never have.

Mr. Paul is a deeply misunderstood politician and his seemingly radical views can only be understood through the study of the works of his teachers.  I have only started the journey.  It is where, I belive The Great Degeneration forms a bridge between the ideals of civil liberty and the current government and monetary framework.

You might ask, Asia is on the other side of the world, it is well to talk about the West, how does it applies to Asia?  How does it affect me?  Here are my top reasons:

(1) For a start, modern monetary system is a construct of the Western world.  In fact Hu Jin Tao, the former Chinese president rightly said, "The current monetary system is a construct of the Western world"*

We have created central banks controlling a sovereign's money supply similar to the Fed - limited by scope and tools.  However the actions of individual Asian nations (ex. Japan) would not have much impact on the global economy as Asian currencies (even collectively) is not a world reserve currency.  But the importance of Asian currencies have grown considerably over the past few years as foreign governments seek to diversify currency holdings.

*It's a bit rich for ex-president Hu to make such a remark because China did have its version of paper money, but perhaps he was referring to those arcane construct of alphabet soup of toxic products.

(2) A lot of our laws (in South East Asia) evolved from either the British, Dutch or French legal systems.  These laws continue to regulate commerce.

(3) Many Asian leaders have studied in the West and bring back Western ideals.  There are of course the Asian way of policy implementation but nevertheless the foundation from which our legislature and government is formed has its roots in Western civilisation.

(4) The West is drowning in high debt levels.  Governments inertia at structural reforms to get public finances in order; relying instead on unconventional monetary tools is not the panancea.  It is a grave cause of concern for Asia's trade relationship with the West.  For now, it continues to fuel our prosperity and increase our level of living standards.

(5) Quantitative easing and zero interest rate policies by all major Western economies have resulted in massive 'hot money' inflows resulting in asset bubbles popping up all over the world from Brazil to Australia, Hong Kong, China, Malaysia and Singapore.  Even Rwanda, the site of a genocide that left 800,000 dead managed to sell $400m bonds at a yield of 6.875%.  It has also incited violence and uprising in Middle East and North Africa, and more recently Turkey and Brazil over inflation and untenable increase in the costs of living.  A lot of the anger has somewhat been misdirected at state governments underscoring that we live in a globalized world of trade and finance.

(6) China is increasingly flexing its muscles - a tit-for-tat response to America military complex refocusing on the East as its adventures in middle east and North Africa purportedly dies down.

In short like it or not, our connectedness continues for now.

The Stationary State

The central theme

Mr. Ferguson outlines the Western world's economic failures from 36,000 feet.  He describes the aftermath of the Great Recession of 2007 - 2009 in terms of global deleveraging, tarnished economic liberalism and the rise of state capitalism chiding Western style democracy.  He goes on to demonstrate how wealth titling towards East as a sign the West's hegemony is at an end.

The book's takes inspiration from two seldom quoted passages of The Wealth of Nations*, where Adam Smith describes what he calls 'the stationary state'.  The Great Degeneration is an attempt to define the causes of the stationary state.

*Adam Smith (1723 - 1790) is moral philosopher and a pioneer of political economy.  He is best known for his classic work in "An Inquiry into the Nature and Causes of the Wealth of Nations". 

According to Adam Smith, the first characteristic of a stationary state is that it is socially regressive.

"Through the wealth of a country should be very great, yet if it has been long stationary, we must not expect to find wages of labor very high in is in the progressive state, while the society is advancing to the further acquisition, rather than when it has acquired its full complement of riches, that the condition of the laboring poor, of the great body of the people, seems to be the happiest and the most comfortable.  It is hard in the stationary, and miserable in the declining state.  The progressive state is in reality the cheerful and hearty state to all the different orders of the society.  The stationary is dull; the declining melancholy."

According to OECD, income inequality increased by more in the first three years of the crisis to the end of 2010 than it had in the previous twelve years.  In the US, average real income of the 99% rose between 1933 and 1973 and from 1973 until 2010 it actually fell.  Another way of putting this is that a massive proportion of the benefits of the last thirty-five years of economic growth has gone to the super-elite.  You can read more about the wealth inequality from this Credit Suisse report.

The second hallmark of the stationary state is the ability of a corrupt and monopolistic elite to exploit the system of law and administration to their own advantage.

"In a country too, where, through the rich or the owners of large capitals enjoy a good deal of security, the poor or the owners of small capitals enjoy scare any, but are liable, under the pretence of justice, to be pillaged and plundered at any time by the inferior mandarins, the quantity of stock employed in all the different branches of business transacted within it can never be equal to what the nature and extent of that business might admit.  In every different branch, the oppression of the poor must establish the monopoly of the rich, who, by engrossing the whole trade to themselves, will be able to make very large profits."

If the writing sounds eerily Dickensian today, it is.  Despite numerous evidence of corrupt behavior by those that caused this crisis, no prosecution have been made.  Attempts at reigning in control of TBTF has backfired and rather than reducing the size of TBTF, it has increased it.  Legislation crafted in the wake of this crisis, Dodd-Frank Act in particular have been hijacked by special interest groups and so as it stands the Act is inoperable.  Two books I recommend readers for further information is by Neil Barofsky, Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street and Nomi Prins, It Takes a Pillage.  The nations' wealth have been directed in the name of 'saving them to save ourselves' increasing don't cut the mustard.

Rampant corruption in Asia between big business and the political class is also a cause of this increasing chasm between rich and poor.  If you are interested in this topic please look at GNI stats as a starting point, as I will not address it here.

The Four Black Boxes

He asserts that Adam Smith's insight that both stagnation and growth are in large measure the results of 'laws and institutions'.  Mr.Ferguson's thesis that Western institutions have degenerated can be examined through 'four black boxes' which together are the key components of our civilization.
  • Democracy;
  • Capitalism;
  • Rule of law; and 
  • Civil Society
The book is an attempt to show that inside these political, economic, legal and social black boxes are highly complex sets of interlocking institutions.  And it is these institutions that are the causes of the Great Degeneration.


This part draws heavily on the work done by Douglas North, John Wallis and Barry Weingast, Violence and Social Orders: A Conceptual Framework for Interpreting Recorded Human History (Cambridge, 2009).  Here the writers describes the two phases or patterns of human organization, 'limited excess pattern' and 'open access pattern'.

Limited access pattern are characterized by:
  • a low-growing economy;
  • relatively few non-state organizations;
  • a small and quite centralized government, operating without the consent of the governed; and
  • social relationships organized along personal and dynastic lines.
The second is 'open access pattern', characterized by:
  • a faster growing economy;
  • a rich and vibrant civil society with lots of organizations;
  • a bigger, more decentralized government; and
  • social relationships governed by impersonal forces like the rule of law, involving secure property rights, fairness and (at least in theory) equality.
They argue that it was the West that transitioned from a limited to open access that advanced Western economies to become richer.  In a similar vein, Francis Fukuyama's Origin of Political Order makes a point that it was the West rather than East because the idiosyncratic development of Western Christendom tended to undercut the importance of extended family lines or clans.

Another complementary source is from a book from Daron Acemoglu and Jim Robinson, Why Nations Fail where the writers make a striking comparison between Egypt today and England in the late 17th century.  They reasoned that Britain is richer than Egypt is because in 1688, England...had a revolution that transformed politics and thus the economics of the nation.  People fought for and won more political rights and used them to expand their economic opportunities.  The result was a fundamentally different political and economic trajectory culminating in the Industrial Revolution.  In other words Democracy is complementary to economic progress.

He posits that as a result, England was the first country to move from an 'extractive' to a more 'inclusive' or 'pluralistic' political institution.

Mr. Ferguson makes a point that understanding Western success is vital to frame the right questions about the recent past, the present and possible futures.  He draws up a multitude of examples: China's stasis before the end of dynasties, South and North Korea, East and West Germany where changes have brought prosperity to nations.

Asia Downloading Western Civilization 'Killer Applications'

In Asia, it is an undeniable fact that Asia's collective standard of living since the passage of the Asian financial crisis in 1997/1998 have leaped.  And living standards in some countries are on par or even better (Singapore is a good example) than that of the West.

Mr.Ferguson points out that this improvement lies in the fact that Asia have downloaded most (not all) of what he calls the 'killer applications' of Western civilization: economic competition, the scientific revolution, modern medicine, the consumer society and work ethic.  Japan was the first country to embrace theses 'apps' and belatedly China and a number of East Asian countries.  In the process, it has seen average wealth increased dramatically, for example, the average American was 20 times richer than the average Chinese in 1978, now it is just 5 times.  Even educational attainment and life expectancy have narrowed.

So according to him, we are witnessing in our time, the dramatic reconvergence of the East and West.

The Glorious Revolution and Inglorious Revolution

He concludes that if it was these 'Glorious Revolution' such as that happened in England, France and America that brought about institutions and laws that lays the foundation for economic progress, then it is these same institutions' degeneration that are now bringing down Western civilization competitive advantages.  And the concerns over excessive debts, mismanaged banks and widening inequality are merely symptoms of an underlying institutional malaise. 

Living off future generations

Many observers comparing recent economic problems in the West to that of growing East and developing nations (which usually are shades of Authoritarian regimes) have put the blamed on the failure on Western style democracy.

Mr. Ferguson argues democracy per se is the preferred model because it is representative it is more responsive to the changing needs of the people governed.  The heart of the problem lies in the breakdown between generations.  Public debt that have ballooned uncontrollably because it has allowed current generation of voters to live at the expense of those too young to vote or as yet unborn.  To illustrate, he sites the work done by Laurence Kotlikoff an eminent professor of economics at the university of Boston on generational economics.  According to Kotlikoff, debt on the balance sheet of America does not take into account of unfunded pension promises and other welfare programs.  Taken together these liabilities are as high as $238 trillion or nearly 15 times stated by the US treasury.  It is a similar story for Britain ( £70 trillion) and major European economies.

Settle your debts

The current ongoing debate between 'Austeritorians' and Keynesians is a moot point.  These 'tweaks' are unlikely to resolve the problem.  And the reforms put forward to reduce debt is not savage enough.  For reform to succeed it needs a 'generational bargain' to make sacrifices now for the betterment of future generations.  This is hard to achieve, but the alternative of muddling through like Japan's lost decades is an alternative version of Adam Smith's Stationary State.  To make it more likely to succeed the problem would have to be laid out honestly.  The current system of publishing revenues and income statements by the government to put it bluntly is fraudulent according to Mr. Ferguson. 

Publishing balance sheets is a step towards recognizing the problem and starting to address it.  Governments should follow the lead of businesses and adopt Generally Accepted Accounting Principles (GAAP).  And above all, inter-generational accounts should be prepared on a regular basis to make absolutely clear the inter-generational implications of current policy.

Concluding remarks

The prescription to take a small step to resolving the West's political impasse is the right approach.  Innovation and market changes aside, companies are able to survive economic cycles because it builds a 'fortress balance sheet'.  It accumulates earnings not only to invests but to save for a rainy day.  Businesses that have little or no debt are more able to absorb strains in the economy.  Take Norway and Singapore as an example, it has one of the largest Sovereign Wealth Funds in the World.  Norway saves most of its oil and gas production, it invest heavily on renewable energies for its energy needs rather than simply consuming its natural resources.  While Singapore, a country of no natural resources have over S$200 billion (Temasek only) in investments with a population of about 5.2 million.

Indeed, if a substantial part of a nation's wealth is linked to its SWFs, then it too would have moved to a GAAP model.

But if everyone were to save who is going to consume? Which now leads us to the next level of accounting.  Countries should publish 'Consolidated Accounts'.  It should produce its income statements clearly and consolidate all its various investment holdings and liabilities.  It would then have a clearer picture on generational issues and whether it is 'over' or 'under' saving in order to loosen or tighten the purse strings.

Accountants are still relevant after all in this digital economy! 

Asians culturally are savers and investors.  Chinese people for example, place huge emphasis on the success of their children.  They invest substantial amount of time, money and effort to see to it that their children gets the best start in life.  It is a form of saving for the future because when the child grows up he/she is supposed to take care of their parents and the cycle repeats.  This requires economic progress, i.e. the next generation ought to be richer than the previous.  To date this has been true of my own generation.  Governments in Asian too have limited resources to support its people, so it is largely left to careful planning by individual households.  There is no need to create a large government apparatus to move to a welfare model which ultimately means less government taxation. 

I circle back to Ron Paul's argument of a smaller government.  Government should only be there to provide the appropriate institutions and environment for ideas to flourish and human (including nature) progress.  It should understand its role between providing security and over protection.  For Asian countries, we have to ensure the continuity of small governments.  More importantly, we must always be alert to the erosion of civil liberties and hence clean and fair elections have to be maintained at all costs.

In Part II, I will move from politics to the market economy to examine if it is also witnessing institutional degeneration.

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