May 1, 2011

What You Don’t Know Might Eat You

Jeffrey Garten, formerly of Yale, the Commerce Department and the U.S. Special Forces, has the habit of saying the most frightening things. Then they come true.

The last time Jeffery Gartenz spoke at a metals industry conference, in November 2007, he said that emerging, unsustainable economic imbalances would lead, soon, to a serious downturn. Welcome to the Great Recession.

Now, Garten has addressed a metals industry conference again. Once again, he has identified significant, threatening issues that he says will subject North American companies to a kind of “hypercompetition” that will overwhelm them unless they make significant changes.

“We are headed towards a totally different world,” Garten told the Metals Service Center Institute's Specialty Metals Division Conference in March. “You face a huge shakeout. This is a dam that's going to break — a massive historical change.”

Garten's premise is straightforward and very much in step with thinkers who believe the best days of North America's economy are behind us. It goes like this: The growth of a very large middle class across energetic emerging markets, coupled with their urbanization at a “mind-boggling” pace, will further stress markets for natural resources, further encourage the growth of relatively rootless multinational corporations hungry to exploit growth markets and, finally, create platoons of sophisticated, innovative multinational companies based in those growth markets.

The consequence of these trends will be, globally, a “seismic shift in the center of economic gravity that we see today,” and, domestically, completely unanticipated competition from tough new business groups with novel strategies honed in markets worldwide, he says.

Now, why should we believe this doomsayer more than any other? Why shouldn't we believe, instead, those prognosticators who see our best days still ahead — never mind such problems as our rising national debt, our flagging educational system, our lack of a thoughtful industrial policy, the slow hollowing of North America's manufacturing base and weakened infrastructure.

Garten, who was dean of Yale University's School of Management for 10 years, doesn't rely on his accurate 2007 recession prediction. He suggests that his forecasting credentials are based on a lifetime of hands-on experiences that go to the heart of why emerging economies succeed.

Quickly: He's a former U.S. commerce undersecretary for international trade who focused on emerging markets; he was directly involved in negotiating China's entry into the World Trade Organization; he served on the White House Council on International Economic Policy in the Nixon administration and on the policy planning staffs of Secretaries of State Henry Kissinger and Cyrus Vance in the Ford and Carter administrations. As a Blackstone Group managing director, he focused on emerging markets. His Johns Hopkins University Ph.D. is in international economics and organizations. Even during his military service, as a captain in the U.S. Special Forces, he was a military advisor to the Royal Thai Army.

The man has been around, in other words, and his viewpoint, while dark and stark and potentially wrong, is informed and direct from the front lines of economic growth. It merits consideration.

Garten says that the economic opening that has driven growth in emerging markets was “the mess that the West made of its own economic policies.” The recession, the continuing Euro crisis and the slow pace of Western economic recovery are indicative of ineffective monetary and fiscal policies. Meanwhile, business development in the emerging markets of the East has surged in terms of management skill, technological base and global viewpoint, “an inversion of the world that we have always known.” Developing countries now represent about 50% of global GDP, and in the next decade are destined to account for 60% of the world's economic activity.

Garten refers to this as the third “historical super-cycle,” following the industrial age that began in the 1850s and the dramatic era of Western growth after World War II.

While population growth in the West is low, populations in the East, already immense, will continue to grow at a much faster rate. A November 2010 study by The Boston Consulting Group found that the middle class in China alone will grow by 270 million people in the next decade, Garten notes.

All those new members of the middle class will want better places to live. Each day, Garten says, 180,000 people in the world move to urban areas in “the biggest migration ever to the cities,” requiring construction of new cities and rebuilding of the infrastructure of existing ones. The imperative in these areas will be for new technologies to cope with teeming populations, “a different kind of urban strategy,” with homegrown businesses adapted to fit the growing needs.

With size comes the potential for scarcity. Garten believes that for business everywhere, the most noticeable scarcity will be for cheap capital because of far more intense global competition for financial resources. “The competition for capital will be like none of you in this room has ever experienced,” Garten says. Not only money will be in short supply. Resources such as food, water and metals will be continually pressed.

For multinational corporations, the interesting markets won't be in North America. They will be, and already are, in places such as China, India, Brazil, Malaysia, Indonesia and the like. General Electric (GE), which already generates 60% of its revenue outside of the United States, expects 70% of its growth in the future from emerging markets, Garten says. Moreover, GE has based three of its five research centers in Bangalore, India; Shanghai, China; and Rio de Janiero, Brazil — all located where the action is. GE's announced plan is to develop ways to benefit from emerging market growth and bring the best of those ideas back, eventually, to the slow-growth West.

Which brings us to Garten's view of how these many developments will strike at the heart of Western competitiveness. He notes, simply, that “we are used to thinking of the world in terms of Western companies” and their overseas operations. “Those days are over,” he suggests. More than half of the companies on the Financial Times global 500 list — ranked by market value — will soon be from emerging markets, he predicts. Already, the No. 1 company on that list is PetroChina.

But it's not just size that will matter. Governments in emerging markets are far more comfortable with organized industrial policies that give their companies a distinct edge. Witness China, which is far from the only emerging nation with a deliberate industrial growth policy. Those policies have helped global multinationals from emerging nations build supply chains that are wholly independent of Western competition or influence.

Garten says virtually nothing can alter these developments. The immense debt piled up in the West won't disappear. Young, hungry populations in emerging markets won't, either. Only some unanticipated “very bad” event might derail these expectations, such as the potential for social instability in China.

So, how can Western companies cope with the consequences of these trends? Garten encourages companies to broaden their viewpoints and challenge long-held assumptions. Embrace change, he says, and above all, stay alert to ideas that arise from companies with unfamiliar or unpronounceable names, based in those many burgeoning super-cities of Asia. Those are the companies and places from which the major challenges will arise.

For an entirely different view of the outlook for North America, see Forward's interview with Wayne Bassett, president and CEO of Samuel, Son & Co.