Commentary: The Shape of our World – The Year Ahead

For 2012, in common with the few years preceding it, we are being well trained to expect international macroeconomic gloom and political stalemate or stasis. Although political leaders and strategists continue to struggle with myriad challenges - including the flagging global economic turnaround, the European sovereign debt crisis, rising inflation in emerging markets and its implications, on-going instability in the Middle East and North Africa, confrontation with Iran over its nuclear programme, and the potential transitions of power in the governments of four of the five permanent U.N. security council members - the issues seem to continue to remain on the ‘things to do’ list rather than being transferred to the mission accomplished list. While 2012 may well not mark the end of the world as predicted by the Mesoamerican Long Count Calendar, the prospect of another grim year appears to be confusing business and political leaders and investors alike and stalling progress. There seems to be at heart the lack of a clear vision of the world we live in and this is negatively impacting broader strategic thinking and action. We will make an attempt to define the characteristics of the world we live in, explore what that means for financiers and investors and then put a stake in the future ground to say about what we can be “certain” (in so far as such a thing exists anymore as a working assumption).

What are the forces shaping our world today? Two factors for change stand above the rest in our world today. The first is the increased consciousness of peoples around the world on their own relative position and the resulting demand for human rights and opportunity. The second is the dilemma of scarcity in the face of growing demand which we can expect to be accentuated as prosperity increases. In the absence of a more fundamental shift in leadership values and innovation these two forces are set to be enduring disruptive features of our world. The world we live in is complex but with some very clear characteristics, which are closely interlinked. A few of the important ones are:

  • Growing Global Interconnectedness and interdependence. We all know that the world is set to be even more interconnected along multiple dimensions. The evidence of the few years leading up to 2008 suggested an upward and broadly smooth trajectory to peace, prosperity and freedom for all. We felt that if we grew fast enough, everyone would be swept up in the momentum. This was shaken in 2008. The core of the new challenge is that progress is uneven within and across national boundaries but expectations are increasingly not. Personal interconnectedness is growing exponentially with the number of global internet users set to triple between 2010 and 2020, to around 5 billion people, so there is nowhere to hide for governments who do not deliver. Given that resources and products, economic performance, finance, diseases and expectations now move much more freely across national boundaries, opting out of the international system is not an option for nations any longer unless the people opt out of the game of material progress. Not playing fairly and being excluded means a lack of participation and ultimately a failure to deliver. Greater interconnectedness transfers expectations across boundaries and creates demands in every country for prosperity and freedom. The cumulative effect is that one nation winning at the expense of another is not a sustainable option; we are interdependent. This recognition will affect China’s resource acquisition strategy, America’s approach to peace in the Middle East, India’s reforms, Britain’s membership of the EU, African leaders’ wealth distribution approach and other critical win-lose decisions. What pro-democracy governments could not achieve through selling or forcing the ideology is set to be achieved through technology and the free-will of individuals who are willing to die in large numbers for their freedom. It is uncertain whether we will win or lose on things we care about but it will be increasingly together.
  • Scarcity of Supply of Clean, Low Cost and Timely Energy Delivery. By 2050, it is expected that the world will have over 9 billion people. The growth of the BRICs economies, the rapid development of China, in particular, the increase in global consumption, the development of frontier economies, the rise in globalisation and the alleviation of poverty are all marks of the success of our times. Such success leads to an increased demand for the foundations of our civilisation, namely, oil, materials, food and water. If we stay in recession, defer paying the environmental costs to another generation, the price remains somewhat affordable and our demand can perhaps be satisfied. The IEA’s World Energy Outlook, 2010, showed the rise from just over 60 million barrels per day (mb/d) of oil in 1990 to around 90 mb/d to be produced by 2035, split by sources. For 2012, the report identifies each source but by 2035 over half of the production is to come from “fields yet to be developed or found”. Numerous subsequent reports see an increase in reserves especially from new finds and given consumption is low in the on-going world recession. Importantly, they expect gas to save the world from disastrous energy shortages of which unconventional sources such as shale gas and shale oil are expected to make the biggest difference. However, discrete events and disruptions can have a major long-term impact on energy supply and policy as evidenced by the disaster in the Mexican Gulf, the escalating prospect of a conflict with Iran and the nuclear disaster in Japan. The role of shale gas and shale oil buys us time and is at the euphoric pre-event risk stage of its evolution. It is not the clean fuel that can drive the lifestyles of the population of 2050 or take us beyond our many global issues. As the IEA warned, “If we don’t change direction soon, we’ll end up where we’re heading.”
  • Continued U.S. Strength. In 2008, the U.S. shook world confidence in its economic leadership and surveys showed widespread doubts about capitalism itself. There was much talk of the decoupling of the BRICs economies from the U.S. and the looming global leadership of China. In the end, national economies have sunk together and the top-line Indian and Chinese GDP growth of 6% to 9% p.a. have not enabled them to break free of the U.S. What is clearer is that the U.S. will remain a strong force, despite its slow reinvention, for a long time to come. Indeed, it is also clearer, that the untimely fall of U.S. power would only create a dangerous vacuum. Although economists’ consensus holds that China can be expected to overtake the U.S. in terms of nominal GDP shortly after 2025, the U.S. is set to continue to be the most powerful force internationally for some time to come. American innovation, financial markets and banking, military power and corporates lead the world in their respective fields by considerable margins. Similarly, the U.S.’s voice in international bodies (NATO, IMF, the World Bank and others) is commensurate with this leadership. A change of leadership at the top would require not only prolonged and comprehensive American weakness but also the development of a credible and accepted alternative, which neither the European Union nor China or India are likely to provide any time soon for very different reasons. Neither China nor India have shown a tendency to exert geo-political influence beyond their domestic needs. Their domestic needs may well lead them in the future on many foreign political and perhaps in the distant future even military adventures but it would be untoward without a catalyst of the order of another world war to read too much into such events. As any foreign observer of the U.S. media can attest, especially in an election year, the emotional strength of U.S. internal divisions show a corruption from the inside that historians may well look back on and point to as one of the most important seeds of its weakening.
  • Reshaping the Relationship with China. The process of engaging China to play a “partnership role”, as defined by the incumbent powers, would require ‘The West’ to have an internally consistent, long term and measured series of subtle as well as more overt confrontational engagements with China. This seems a tall order for the various parties that constitute The West. China has yet to emerge as a visionary regional and international partner on key global issues such as development and poverty alleviation, climate change, intellectual property development and peace and conflict management. To date, China has emerged as highly successful at building the relationships it requires to acquire the assets it needs to maintain a thus far successful increase in prosperity in its country. The country’s leadership remain understandably focused on the sometimes diverging goals of domestic social stability and economic development. Virtually all of China’s foreign policy initiatives and positions reflect these twin objectives and need to be evaluated in this context. China’s reluctance to support international endeavours on major global issues reflects this “China first” approach too. Indeed, many of China’s more overt foreign policy actions can be seen as part and parcel of this focus on keeping their population stable, patriotic and supportive of the Party’s agenda. The challenge for the leadership will of course require adaptation to a modern China where the people set the agenda without formal processes long before the politics and structure of the Communist Party allow them to. The past 30 years have seen an evolution of China’s leadership from charismatic absolute rulers with clarity of vision and ruthlessness of execution to a more technocratic consensus-driven oligopoly focused on stability and manageable, and therefore incremental, change. Against this backdrop, it will be difficult for the international community to convince or coerce China to play a partnership role. Doing so will require Western powers to rethink their mode of engagement with China, away from ad hoc confrontation towards a more sophisticated persuasion which has the aim of “Strategic Alignment”. For another time, we will argue that China has little to lose and a lot to gain by playing along with this strategy. Given the interconnectedness we have talked about in this note, it is likely that the risk for China’s leadership is that the partner of the West will be the people of China if the obvious partner, the Party, fails to deliver change fast enough.
  • India’s Emergence as an Alternative Growth Destination and a “Hedge”. India’s population is expected to grow from 1.2 billion to 1.6 billion by 2040. At another time, we will discuss whether this is likely to boost or imperil the country. For now, India is widely expected to become the world’s third largest economy within the next 15 years. As such, India is in some ways “naturally” positioned, given its size and geography, as a “hedge” to China. Although it is clearly exerting its influence as a private sector entrepreneurial force, it will be slower, longer and more volatile in the making as anything more than that. A consequence of the success of an India that has left behind its socialist past and started to deliver a 6% to 9% p.a. growth rate is that the distribution of the that success will be unevenly distributed and this in turn will be the driver of significant dislocations in India’s social and political fabric. India’s electorate, long counted on to be en-masse docile by its political elite, are increasingly demanding accountability and liberty from their inherited place in society in rhetoric and tone (if not yet the full breadth of action) reminiscent of Ghandhian times. The recent popular outrage at a string of corruption scandals and nationwide protests are harbingers of the political discourse and conflict to come along multiple fronts. While the political and corporate class feel the disruption today to India’s economy and standing, it is clear that this is a boon. If it does not play out, India’s success will be jeopardised. Greater accountability and reform of political institutions can be the first step in the transformation to a fairer society, with wider participation, that has a greater chance of success. The process itself will be a messy one no doubt but for India’s sake should be unavoidable. India it seems will have to deliver on its long-held promise.
  • Expectations and Time to Maturity. The maturing of India and China to become full members of the leadership group of the world political and economic stage will be long and disruptive. Two aspects of maturity are how one works with “self” and how with “others”. “Self” defines who we consider “us or ours”. Mature conduct would involve creating an environment where the people live peacefully, prosper and are free. “Others” defines who we consider not ours, that is, everyone else. Mature conduct would see others as we see ourselves and so would lead to participation in the international community with the same aim of promoting peace, prosperity and freedom. This is a struggle for any of us as individuals let alone two nations with over a billion people each. Today, both are experiencing disruptions to their hopes and plans. The development of both will be a lengthy process with twists and turns along the way. Recent events in both countries demonstrate the pain of maturing: in India, political deadlock and a population that now publicly distrusts its politicians is delaying much needed reforms for growth while sporadic but persistent social unrest in China is consuming government energy and financial resources from the development agenda. Success itself has bred expectations and an intolerance for uneven progress and so expectations are set to be one of the most dynamic and disruptive forces. China has set up the apparatus the process to shield its mass population people from information effectively to date. Censorship and closing information channels is a short term solution that ultimately only accelerates the breakdown of trust and economic progress. As the Middle Eastern uprisings have shown, people cannot be shielded from information and especially not in societies like India and China that aspire to be first world modern economic societies. Likewise, governments cannot be shielded from expectations. Both governments may need a far more radical approach than negotiating or giving in to each new set of protestors. People with information form their own views of their best interest and governments can no longer count on passive and pliable populations. We can expect disruptive political, social and cultural changes commensurate with the economic transformations that are expected to take place in both these rising economies.

What does this imply in terms of the approach to financing and investing? In the picture we have just painted, the baseline for our world is set to be driven by demands (for increased freedoms and opportunities) that cannot be easily met (because of scarcity and dislocation in the timing of cheap delivery of resources and food). This implies either a period of deep change due to competition and confrontation or one of sharing based on our deep interdependence. The outcome will be delivered through swings between these two extremes. The financing industry can of course become profiteers of scarcity. During disruptive times and times of famine the greatest fortunes are made! Some may prefer this option. It is possible that governments will tire of the effort of pressuring the industry and it will survive broadly as is. One would hope that the industry will either reinvent itself to become a trusted partner in financing the solutions to the world’s biggest issues as John Pierpont Morgan had done for America at the turn of the 20th Century. For this to happen, the industry would need to return to its traditional role of financing the issues of the time for a “reasonable” return (whatever that means in our times) rather than making money from the derivative of the derivative of the issues. Rather than becoming the new aristocracy, the revolution in the making is to re-create financiers as partners and service providers. More about that revolution for another Sign of the Times.

In the interim period, two extreme approaches stand out for investors; essentially there are the quick and the patient. The first is what we will call ‘Active Risk Adaption’ and the other is what we will call ‘Enduring Strategic Patience’. Active Risk Adaptation requires the active selection of the risk that one wishes to take and requires timely perception of changes to risk and rapid and effective adaptation. In the current disruptive environment, it is easy to see that the risk we originally choose to take is not the one we ended up with; one factor being that risk compounds as one assigns accountability down the investing chain from investor to fund manager to portfolio company CEO. The one is not suited to manage the next along in the chain in terms of the content of the business. So, the skill required in assessing the risk of the whole chain lies in the selection of the next manager in the chain. The objective is to choose someone who is aligned on what is a risk worth taking, is highly perceptive and adaptive and will do the same in their selection. Given the disrupted world we live in, the antenna to see an emerging risk, to sense and calculate its implications and adapt speedily will be differentiating. The alternative approach, Enduring Strategic Patience, is based on the thematic perspective and selection of positions of longer term value. This requires investors who will think through the world we live in to find the “certainties” in times of uncertainty and place the long bets and have their patience built into their financing structures and organisational cultures to ride out the inevitable short term events and volatility. The last few years demonstrate that not choosing whether we are fit to adapt continuously or whether we are fit to ride out the storms leads to an unfitness to survive. The collapse of more financial institutions is the last thing the world needs obviously. At some point, the Arab Spring will come more forcefully to the investment community than Wall Street sit-ins unless the revolution is led by the banks and financiers themselves.

A word of warning. It is popular to develop simple models and perspectives that drive us to assume inevitability. This would be a mistake. Governments do not have to be overthrown and the world does not need to suffer scarcity or polluting solutions. It takes a government to start the revolution to stall the revolution and it takes capital of the scale of “put a man on the moon” to spur the innovation to avoid the scarcity scenario. Both of which are very feasible. The problem is that too many policy and planning departments have a tendency to build our assumptions and fears into our and models as fixed factors rather than variable ones and then we assume inevitability.

So, what are the certainties in times of great uncertainty? With a reliable reference point, we could plan better for our political, economic, military, societal, environmental and personal affairs. This does not negate the need for adaptation of course. Barring Hollywood style world-ending scenarios, which we clearly cannot rule out especially in a distributed nuclear weapons world, the longer term shape of the world is clearer than many believe. We highlight nine key Macro Defining Trends:

  1. Population. Over 9 billion people in the world by 2050.
  2. Chinese and Indians. 1.2 billion Chinese and 1.6 billion Indians by 2040.
  3. Oil. At US$147/barrel the world economy collapsed and the price is correlated to global GDP growth.
  4. Israel. 83% of Israeli youth believe that Israel faces a threat of destruction and 70% of American Jews support the United States proactively putting forth a peace plan that proposes border and security arrangements
  5. Islam. The Islamic population, estimated today at 23%, is expected to be 26% of the world by 2030 and over 30% by 2050.
  6. Environmental Destruction and Consumption. By 2030, 80% of the world’s rainforests that existed in the 1800s are on track to be destroyed.
  7. Nuclear Power Proliferation. By 2030, 30% of energy are expected to be uranium-based and include Iran, Saudi Arabia, Yemen, Syria, Jordan, Libya and North Korea.
  8. Older Population and Leverage of the Youth. By 2050, the U.N. estimates that the proportion of the world's population aged 65 and over will more than double, from 7.6% today to 16.2%.
  9. Interconnectedness. In 2020, it is estimated that there will be 5 billion Internet users up from 1.8 billion in 2010.

In the coming year’s Sign of the Times, in addition to providing an investing window into current events and trends occurring globally and in India and China, we will explore more deeply some of these broader global themes and how they will impact our target markets.


1. See appendix for definitions and sources