As part of the Future of Capitalism Project at the Council on Foreign Relations (CFR), Roger W. Ferguson Jr. is inviting a diverse range of thought leaders from academia, the private sector, and government to contribute to a series of blog posts to provide perspectives on the different types of capitalism in practice around the world, the challenges these systems face, and their future in the twenty-first century. This post comes from Raghuram G. Rajan, former Governor of the Reserve Bank of India (RBI) and chief economist at the International Monetary Fund (IMF). Dr. Rajan is currently the Katherine Dusak Miller distinguished service professor of finance at the Booth School of Business at the University of Chicago.
As new technologies integrate markets across the world, making them more competitive and more demanding, small manufacturing towns in industrial countries bear the brunt of the disruption. Their big employers move factories overseas or automate operations and reduce workforces. While this trend started decades ago, the expansion of China has significantly accelerated the process.
Historically, markets have created new jobs as they destroyed old ones. Unfortunately, the new jobs today are typically emerging in the service sectors of flourishing megacities like London, not in single-employer-dominated manufacturing towns where job losses have been most acute.
Naturally, those who have been left behind are angry, focusing their ire on a system they think has pummeled them unfairly. In response, a clamor for deglobalization has begun and the world is becoming less open as a result.
Yet even as countries turn inward, Covid and climate change suggest global cooperation will be required to a degree never seen before. The further closing of the world would make this kind of cooperation virtually impossible. Fortunately, there are ways to restore faith in the open market system that has brought the world so much prosperity and many of the answers lie in reviving the very communities that have suffered under modern globalization.
Top-down solutions devised in remote capitals do little, however, to tackle the impediments to recovery. Locals typically know far more about what needs to be fixed—and they must be empowered to help their communities pull themselves up.
Technological change is disruptive, not just because it destroys old jobs but because it alters significantly the capabilities needed for new ones. Advanced training in science, technology, math, or highly developed interpersonal skills have become necessary to succeed. Local institutions that can impart these skills are also dragged down as a community experiences job losses, unemployment is just the beginning of a vicious cycle of decline.
A 2017 study of areas in the USA that suffered large trade-related unemployment found that as economic opportunity declines, social disintegration increases. Unemployed workers are unattractive partners; consequently, there are fewer marriages, more divorces, and more single-parent families. Broken families, loneliness, and the associated despair often lead to alcoholism, drugs and sometimes crime.
A declining community is unable to support local schools, both because of a shrinking tax base and because parents in stressed families cannot provide their children with a good learning environment at home. Meanwhile, the few firms left in the community have little ability to provide mentorship, financial support or apprenticeships.
As institutions deteriorate in quality, they cannot help unemployed workers retrain. Worse, without good schools, children have bleak prospects. People who have the means to go, leave for thriving areas elsewhere, taking their children with them. This secession of the successful leaves the rest further mired in poverty and unemployment.
In a world with limited mobility, policies ought to be directed at reversing these vicious cycles, resurrecting communities so that there are more jobs and capability-creating institutions like schools and colleges thrive again. Fortunately, technological change, which created the imbalances in the first place, can be instrumental in the resurrection, helping to build a more sustainable capitalism.
As markets have integrated, spanning regions, then countries, and then the world, the power to make decisions has moved away from local political entities toward national and international structures. In the 19th century, for instance, support for the unemployed used to be provided by the local parish. Community solidarity, coupled with local knowledge and information made it work, the community helped families that had fallen on hard times.
However, as markets became more integrated and recessions became deeper, communities were overwhelmed. Only regional or national governments had the resources to provide support. Naturally, if they were called on to provide support, they wanted the power to set the rules.
Similarly, as interregional trade increased within countries, firms pressed for seamless regional borders and common national regulation and taxation, after all, financial firms find it harder if each locality they operate in regulates compensation, liquidity and minimum capital differently.
Throughout the 20th century, the governments of industrial countries centralized power. Emerging markets are now doing so too. In turn, as globalization has accelerated, national governments have given up some of their powers to international bodies and treaties. For example, the EU limits the discretion of individual member states so that firms face similar harmonized regulatory environments across the union.
While some harmonization is beneficial, centralization, indeed globalization, of governance has obtained momentum. National and international administrators, egged on by powerful large firms, find restraint difficult. The recently negotiated United States-Mexico-Canada Agreement, for example, mandates that Mexico ensure internet companies are not liable for content their users post even though this is still being democratically debated in the USA. Top-down imposition is even more common within countries.
The net effect has been a steady disempowerment of local, and even national, government. It is hardly surprising, therefore, that voters have directed their anger at distant authorities and embraced populists closer to home. The Brexit slogan that resonated in the devastated Northern towns was “Take back control”, not just from Brussels but also from London. People wanted more democratic control over their futures after decades of market forces pummeling them.
If governments want to preserve the global integration of markets, they may have to give up the hyper-integration of governance. They must be much more careful about new international agreements, especially if they go way beyond low tariffs. The goal should be to bring more powers back to country level, provided global markets remain open.
Yet the devolution of power cannot stop at the national level. Capitals must devolve power and funding further so that communities can re-instill a sense of engagement and identity in their members.
Delegation should be guided by the principle of subsidiarity, which requires decisions to be taken by the lowest level capable of taking them effectively. So, for instance, communities will not decide their own auto emission standards. That should be a national decision. But what businesses will be licensed to operate locally and choices over minimum wages, qualifications, operating hours and benefits (obviously all above national minimums) should be a community decision.
Devolution of powers will be hard, especially since strong interests prefer centralization. However, sensible devolution on issues such as education, business regulation, local infrastructure, and funding is critical to community revival.
If smaller towns and semi-urban areas depend only on local demand, there won’t be many new jobs. However, if the menu includes national or global demand, there are plenty of possibilities. Technology helps connect the local to bigger markets, online platforms allow small enterprises to advertise niche products across the world. For instance, an Amish family in Ohio, have built a flourishing business selling high-tech horse-drawn farm equipment, a niche market if ever there was one. The buyers? Other Amish farms across the USA.
Such enterprises need continued easy access to national or global networks through online platforms like Amazon and Alibaba, but these are also gaining in market power. Small entrepreneurs can share some of their profits with the platform, but when platforms replicate a successful seller’s products and offer them under their own brand, while charging high fees off others, they make it much less attractive for such enterprises to start up.
To make the platform space more friendly to small entrepreneurs, antitrust authorities should be vigilant. For instance, mandating interoperability across networks will allow small networks to challenge large ones, keeping them competitive. Faced with breakup or interoperability, giants like Amazon might choose the latter. Allowing clients to own their data and to share them with other platforms (as the EU is in the process of doing in financial services) will also keep clients from getting tied to a provider.
Successful small enterprises can help lift a sinking community, not just by providing jobs but because they belong fully within it and can help support its activities. In the past, large corporations also provided such help. Local management was given substantial autonomy, and they worked with community leadership on issues of mutual interest. However, as technology improvements have allowed headquarters to respond quickly to local developments, more staff resources have moved to the headquarters in big cities where they can service corporate units across the country more efficiently. Each local unit is left with far less autonomy.
Left-behind communities in industrial countries face similar challenges to those historically found in underdeveloped countries, but they have an important advantage: they are located in rich countries. The easiest way to generate economic activity is to restore community links to thriving national and global economies so they can piggyback on broader growth. While there is no magic formula, four elements that appear repeatedly in successful revival efforts are leadership, engagement, infrastructure, and funding.
Finding effective leaders is difficult because existing leadership is often paralyzed, and many capable people have left. Indeed, one of the main arguments against devolving power is that the available local decision-makers are incompetent and corrupt. Yet, even in seemingly hopeless situations, local leadership can emerge. Chicago’s Pilsen neighborhood was a war zone in the late 1980s; 21 different gangs fought each other on a two-mile stretch of the main thoroughfare, with horrific death rates. In Pilsen, new leadership emerged from desperation: a group of young community members chose one of their own, Raul Raymundo, to lead the Resurrection Project. Three decades later, he is still there, having attracted hundreds of millions of dollars of investment.
Pilsen’s leaders engaged the community to lobby licensing authorities to close down bars where criminals congregated, involved local businesses in creating training opportunities for youth as an alternative to crime and encouraged locals to report criminal incidents to the police collectively so that gangs could not target individual informants. As Pilsen crowded out crime, businesses crowded in. While Pilsen is not rich today, many residents have decent livelihoods, the community is safer, its schools are better and its children have a future.
Such communities need creative ways to draw able people back and increase the talent pool from which such leaders can emerge. Those leaders can draw communities into focal projects, such as reducing crime in Pilsen.
New technologies can help hold leaders accountable. Engaged communities can use information technology to monitor their officials, thus curtailing corruption and laziness. For instance, the ‘SeeClickFix’ app allows residents in Chicago to photograph and upload the location of a pothole, graffiti or an abandoned car to the municipality website. It stays there until an official fixes the problem.
Physical and digital infrastructure is also important. The UK government plans to spend billions to link hollowed-out towns through road and rail with flourishing regional centers like Manchester. This shows that not every decision needs to be local but that taking local needs into account when reconfiguring infrastructure is vital and can be transformative. Access to digital broadband also must be remedied if economic activity is going to be better distributed geographically.
Communities in economic decline may not have much ability to raise new taxes and financial support from governments or bodies like the EU or World Bank comes with significant strings attached on how it must be used. To facilitate local input into spending decisions it is better that money comes in the form of government grants or private philanthropies free from spending constraints.
The community can still be held to performance standards, but it should have freedom to decide what to spend on. The current US administration’s proposal for tax-incentivized investments into ‘opportunity zones’ could work if investments are designed in cooperation with community leadership to address actual needs. Without any community involvement, however, they may just be an ineffective tax windfall to the wealthy.
Healthy local communities can also help mitigate conflict as people from different cultures come together in increasingly ethnically mixed industrialized countries. Populist nationalists inflame majority groups with fears that their culture will be diluted. They want the majority culture to be imposed throughout the nation and immigration restricted severely so that their culture is not diluted. Countries like Canada embrace a different choice: to celebrate culture within community. Any choice should be respected so long as everyone is united by shared national values and no one is deliberately excluded. National governments can help, preventing communities from segregating by enforcing laws against discrimination.
Ideally, the community should have boundaries, giving its people a sense of empowerment and belonging, but kept porous enough that goods, services, and people can flow freely across them. An inclusive localism may be the best answer to the challenges from technological change and globalization.
Sustainable capitalism is not just about competitive markets. It is also about the societal underpinnings that allow most people to benefit from them and give the markets their democratic support. Rather than closing borders and abandoning capitalism, the leaders of the industrialized world must fix capitalism, starting with the communities it has left behind.
*This post originally appeared on the website of The Law Family Commission on Civil Society. Click here to read*