Creative Class

Writing in the Globe and Mail, my good friend and Prosperity Institute “builder” Geoff Beattie nails the key difference between two kinds of development strategies. One creates fictitious wealth, the other is key to real, sustainable development.

The two approaches – building versus trading – are profoundly different. What we have seen in recent months are the consequences for the markets of both domination for too long by a trading mindset and ever decreasing levels of regulation. In other words, as the game was getting faster and tougher, the rule book was getting thinner and easier.

The pattern of constant trading had ever more deleterious effects. As return expectations grow, traders become exposed to ever-escalating levels of risk. Because the pipeline of new, high-quality investment opportunities is not infinite, traders are forced to tolerate higher levels of risk. When returns start to suffer, they have to leverage their capital by investing borrowed money to help juice the investment return …

In contrast to traders, builders invest with the intent of seeing a business opportunity develop over time … Builders invest over the long term and integrate risk management into their strategies as they must inevitably ride the highs and lows of the economy. Builders expect, and navigate through, the downturns based on a confidence in the underlying fundamentals of the business, its market and its management. Builders understand and engage in the businesses in which they invest and thus contribute both to the businesses’ success as well as that of investors …

The influence of the trader mentality has crept beyond Wall Street and the business world and infiltrated government policy, with devastating results. Decades of deregulation by the American and other governments has allowed a free-for-all in the financial markets – not to mention airlines, telecoms, energy and even prescription drugs. It has been supported by a political philosophy that disregarded the long term, expected markets to resolve their own problems, threw money at problems when they did arise, and let diplomacy and relationship-building wither away in business and foreign affairs.

How do we recover the builder orientation? I hope the discipline of the markets will start us off. It is extremely valuable to have a new generation of investors live through a major market downturn …We also need to revisit how we judge and compensate our business leaders and, for that matter, government leaders…The average lifespan of a CEO of a Fortune 500 company is now less than four years. How can we expect them to be interested in the long-term health of their business when their tenure lasts only a few years?

There is also an important role for government and public policy …Good government isn’t big government or no government; it is smart government that embraces its responsibility to look decades ahead and build the appropriate policy infrastructures for growth and prosperity. Our tax, corporate and securities laws need to foster and reward the builder mentality with incentives and stability.

In short, we need to restore a builder mentality in government, on Main Street, in our boardrooms, among institutional investors, and around the kitchen table. The pain we all feel now will be wasted if we don’t learn from it.

My new Globe and Mail column is out.

Individual identity vs. the financial crisis

Most experts agree this is the worst financial meltdown since the Great Depression. The stock market is down almost 25 percent so far this year. Housing prices in the United States are off more than 20 per cent since their peak in 2006. Manufacturing output is falling and consumer confidence has slipped.

Martin Feldstein, former head of the National Bureau of Economic Research, past chairman of the Council of Economic Advisers and a Harvard economics professor – usually a voice of calming reassurance – wrote in The Wall Street Journal: “Sliding into recession, monetary policy already at maximum easing, and fiscal transfers impotent … an unenviable situation, to say the least, for any incoming president.”

All of this raises two fundamental questions: Where did this financial mess come from? And what does it mean?

The easy answer is to blame the housing market. People took out adjustable-rate mortgages and subprime loans offered with no down payment and easy terms by mortgage brokers who then resold them as securities. As the housing market has weakened and loans have reset, a growing number cannot repay and many more owe more on their mortgages than their homes are worth. Banks and financial institutions, so the story goes, are clogged with this bad debt, now dubbed toxic waste. This is the kind of thinking behind the U.S. financial bailout: Remove the toxicity and all will magically be well again.

The real reason is that the roots of the current crisis are tied to the fundamental nature of the postwar model of economic development called “Fordism.” That model drew a tight connection between assembly-line mass production and mass consumption – ultimately fueled by massive suburbanization.

After introducing the assembly line and making car production more efficient and cars cheaper, Henry Ford realized that a bigger market for his cars was needed – so he boosted workers’ wages by introducing the “five-dollar day.” But even that was not enough, and so North America and the world lapsed into the Great Depression.

Fordism emerged as a full-blown economic and social model during the 1930s, marked by president Franklin D. Roosevelt’s New Deal programs, and flourished after the Second World War, when government policies brought about the rise of longer-term mortgages and a new system organized under the now infamous Fannie Mae to purchase those mortgages and thus lubricate the system.

Add to that massive tax breaks for homeownership and gargantuan subsidies for highway construction and infrastructure, and a whole new model of suburban-fueled mass consumption was born – family after family purchased new homes, filling them with TVs, appliances and all manner of furnishings, while also purchasing record numbers of cars to get to and from work.

While Fordism looks stable on the surface, it suffers from a fatal flaw: It’s impossible for consumption to keep up with the ever-growing pace and efficiency of production. This is particularly true of recent times, when a great deal of production has been sent to China, India and other places where labour is cheaper. It’s hard for the working and middle classes to consume more when their wages are essentially stagnant. Low-wage workers in emerging economies do not have the income to fill the gap. And while the ranks of the rich have grown, the wealthy are a relatively small group that can buy only so many luxury cars, designer products, homes and yachts.

That’s where credit comes in. Those new fancy mortgage instruments were meant to turn homes into veritable “piggy banks” that could be used to finance bigger and better cars and homes and toys.

Almost a century ago, Austrian economist Rudolf Hilferding identified this basic contradiction of modern capitalism in his monumental work Finance Capital. Capitalist economic development stands on a shaky foundation, he argued – workers always produce more than they can consume, more even than society as a whole can consume.

As one leading blogger, Yves Smith at Naked Capitalism, recently put it: “Since consumption has come to depend on growth in indebtedness, a reversal, however painful, is necessary. Our excesses have been so great that there is no way out of this that does not lead to a general fall in living standards.”

There you have it. The financial crisis is in reality a much deeper crisis of our underlying economic model and our way of life. It’s a crisis of the way we have come to define ourselves.

If Fordist mass consumption had a catchphrase, it was “Keeping up with the Joneses” – and in the past decade it became a fearsome standard. So many of us came to define ourselves not through our work or creative endeavors, but through what we could purchase. We were fooled into believing that our identity and self-worth somehow depended on acquiring expensive or impressive belongings – much of it on credit.

Regardless of how or when the financial markets are restored, credit will be much harder to get – the age of the house as piggy bank is long gone.

How will we define ourselves when we can’t get a quick self-defining “makeover” at the dealership, the electronics store or the mall? How will we rebuild our way of life and our very identity? Those are the questions that many of us, and our society as a whole, will be confronting long after the financial markets have been restored.

Whether you ultimately agree or disagree with his conclusions, this essay by John Gray of the London School of Economics in today’s Globe and Mail is a succinct statement of the deep issues confronting the American political economy.

The fate of empires is very often sealed by the interaction of war and debt. That was true of the British empire, whose finances deteriorated from the First World War onward, and of the Soviet Union … Despite its insistent exceptionalism, the United States is no different. The Iraq war and the credit bubble have fatally undermined U.S. economic primacy. The United States will continue to be the world’s largest economy for a while longer, but it will be the new rising powers that, once the crisis is over, buy up what remains intact in the wreckage of the U.S. financial system …

The irony of the post-Cold War period is that the fall of communism was followed by the rise of another utopian ideology. In the United States and Britain, and to a lesser extent other Western countries, a type of market fundamentalism became the guiding philosophy. The collapse of U.S. power that is under way is the predictable upshot. Like the Soviet collapse, it will have large geopolitical repercussions. An enfeebled economy cannot support the United States’ overextended military commitments for much longer. Retrenchment is inevitable and it is unlikely to be gradual or well planned.

Meltdowns on the scale we are seeing are not slow-motion events. They are swift and chaotic, with rapidly spreading side effects … A U.S. retreat from Iraq will leave Iran the regional victor. How will Saudi Arabia respond? Will military action to forestall Iran acquiring nuclear weapons be less or more likely? China’s rulers have so far been silent during the unfolding crisis. Will U.S. weakness embolden them to assert China’s power, or will China continue its cautious policy of “peaceful rise”? At present, none of these questions can be answered with any confidence. What is evident is that power is leaking from the United States at an accelerating rate. Georgia showed Russia redrawing the geopolitical map, with the United States an impotent spectator.

Outside the United States, most people have long accepted that the development of new economies that goes with globalization will undermine the country’s central position in the world. They imagined that this would be a change in the United States’ comparative standing, taking place incrementally over several decades or generations. Today, that looks an increasingly unrealistic assumption.

Having created the conditions that produced history’s biggest bubble, U.S. political leaders appear unable to grasp the magnitude of the dangers the country now faces. Mired in their rancorous culture wars and squabbling among themselves, they seem oblivious to the fact that U.S. global leadership is fast ebbing away. A new world is coming into being almost unnoticed, where the United States is only one of several great powers, facing an uncertain future it can no longer shape.

The ultimate outcome of this ongoing financial crisis will be a new and different geography of capitalism – within nations and across them.

As an academic, I welcome criticism of my research because it helps me refine and improve my work. Over the years, I’ve benefited tremendously from reasoned debates with people on the left and right sides of the ideological spectrum. From time to time, however, my findings are misrepresented by commentators.

A week or so ago, my Globe and Mail colleague Neil Reynolds wrote a column comparing my work to the findings from a new ranking of “best-performing” U.S. cities by the Milken Institute, a think tank in California. Comparing the Milken measures to my own, Reynolds asserts that the former are “non-ideological” and avoid “creativity scores” and “subjective assessments.” But our measures are data-driven and objective, just like those of the Milken Institute. Indeed, I know Ross DeVol, the principal author of the Milken Institute report, quite well. I respect his work and we have shared data and indicators.

While Reynolds focuses on the differences between the Milken measures and my own, he misses some overlap between the two. Provo, which ranks first on the Milken measures, comes up eighth on my creativity index for medium-size regions. Austin, which ranks fourth on the Milken Index, takes first place on my creativity index for large metros; while Raleigh, which ranks second on the Milken measure, comes in sixth on my creativity index rankings for large metros.

At bottom, the basic difference between the Milken measure of best-performing cities and my own creativity index stems from what we try to measure. The Milken measure attempts to gauge year-over-year economic performance through factors like employment growth. My creativity index focuses on the key factors that shape economic development in the long-run. To reflect that, the creativity index has three components – technology, talent, and tolerance. There is a general consensus among economists that the first two are the key determinants of economic growth. It’s worth pointing out that one of our technology measures – the Tech Pole Index – is based on Milken Institute research and was provided to us by Mr. DeVol. To these two fundamentals our team adds a third – tolerance – which has been shown to shape the economic development nations as well as regions, in as wide range of independent studies from University of Michigan professor Ronald Inglehart’s world value surveys to the Institute for International Economics’ Marcus Noland’s research on global economic performance. There is no ideology at work here at all. Our measures are designed to reflect state-of-the-art theory and research and apply that thinking to objective measures of regional development.

When all is said and done, there are two fundamental gauges of regional development: how much people make – that is, their income – and how much they pay for housing. Provo, Utah – first on the Milken Index – has an average income of around $47,200 (about equal to the national average) and a median housing value of roughly $175,000 (also about the national average). McAllen, Texas, which is seventh on the Milken measure, has an average income of $24,500 (about the half the national average) and a median housing value of $61,200 (37 percent of the national average). Compare that to San Francisco, which ranks first on the creativity index, where the average income is $65,382 (40 percent more than the national average) and the median housing value is $655,300 (three times the national average and 10 times more than McAllen).

To get a better handle on how the two measures stack up in assessing long-run development, my team conducted a simple statistical correlation analysis between them, income levels and housing values as well as human capital, another key measure of regional development. The creativity index has substantial correlations with each (for the statistically minded, they equal .75 with human capital, .55 with income, and .44 with housing values); while the Milken Index shows no correlation at all.

Mr. Reynolds’ column implies that my approach is drawing the greater Toronto region down a misguided path of economic development policy. But an earlier report by U of T’s Merc Gertler, Waterloo’s Tara Vinodrai, UCLA’s Gary Gates, and myself, which took a close look at the economic performance of greater Toronto and all of Canada’s metros alongside U.S. regions, shows that all three Ts play a key role.  It also shows that Canada’s cities and regions benefit greatly from openness and tolerance – something that our ongoing research at the Martin Prosperity Institute confirms. Stay tuned for much more on that front in the next few months.

At the end of the day, my measures – and the entirety of our work at the Prosperity Institute – is empirical and objective and non-ideological. All of it is designed in light of the state-of-the-art theory. Unlike Mr. Reynolds, there is little place in our world for ideological spin.

Canada is upping its game in the global competition for talent, liberalizing immigration for students and skilled workers. As the Globe and Mail reports, the country

is creating a new fast-track immigration route for skilled foreign workers and students who’ve already proved employable in Canada: an effort to prevent an erosion of talent as global competition heats up for higher-value labour.

Unlike existing programs, the Canadian Experience Class immigration stream will make work experience in this country a key criterion for vetting applicants. It will also allow temporary foreign workers and students living here to apply from within Canada rather than having to leave first. It’s expected to grant permanent resident status to 12,000 to 18,000 economic immigrants in the first year, a figure that’s forecast to rise to 25,000 annually over time …

The goal is to improve the quality of immigrants and retain the most valuable workers and educated students: arrivals who’ve already proven they can integrate into society and meet labour market needs. “If we’re going to compete internationally for the best and for the brightest, we need to improve the way that we attract and retain those who want to work in their fields and contribute to Canadian society,” federal Immigration Minister Diane Finley explained.

In Flight, I argued it would be just these sorts of incremental improvements in competing for global talent – by Australia, the UK, New Zealand, and northern European countries, as well as the ability of the BRICs to lure back emigres – that could begin to undermine the U.S. lead in global talent. And with the situation in Iraq, the sub-prime meltdown and credit crisis, not to mention a watershed election, the U.S. seems incapable of addressing this issue.

Do you think the U.S. will be able to turn the corner on this one, or will some combinations of other nations inexorably undermine its long-standing talent advantage?

My latest Globe and Mail column is out.

This week, the mayor of Canada’s biggest city did something
remarkable: He basically declared war on firearms. In response to
several highly publicized shootings, David Miller announced that he
wants Toronto’s City Council to crack down on gun clubs, firing ranges
and businesses that manufacture, assemble and distribute weapons.

“Do we as a society value safety, or do we value a hobby that creates
danger?” he asked. “That hobby directly results in people being shot
and killed on the streets of our city.”

Not surprisingly, Mr. Miller’s bold move has generated a great deal of
controversy. At the same time, it reflects a growing trend in the
world’s major cities.

Just as he is taking the lead in trying to control guns, figures such
as Michael Bloomberg in New York City, Richard Daley in Chicago, Job
Cohen in Amsterdam and Ken Livingstone, the former mayor of London,
have explored new approaches to everything from education, crime and
smoking bans to environment and climate change – even bringing modern
management techniques to government. While there remains more work to
do, their efforts and those of their peers have made their
jurisdictions safer, smarter, greener, more aesthetic, more efficient,
wealthier and more globally competitive.

state and national leaders.

Overall, these mayors, as well as premiers and governors, are proving
themselves to be much more in tune with global trends than are heads of

In today’s world, cities, regions and mega-regions composed of two or
more cities and their suburbs have become key competitive players
alongside global companies and nation states. Canada and the U.S., for
example, are not competing against China and India. Rather, specific
regions in North America are competing with dynamic regions such as
Bangalore and Shanghai.

Two new books –
The Post-American World by Fareed Zakaria and
The Second World by Parag Khanna – argue that the new global economy power will be more dispersed and multipolar.

Mr. Zakaria believes we are experiencing modern history’s third great
power shift, after the rise of the West from the 15th century on, and
the rise of the U.S. in the 19th century. But he argues that this
latest transition is not so much about the decline of America as it is
about “the rise of the rest,” and by that he means much more than
simply China or India. The end result will be a “landscape that is
quite different from the one we have lived in until now – one defined
and directed from many places and by many peoples.” Mr. Khanna
similarly predicts that we are headed toward a “global,
multi-civilizational, multipolar” world with three superpowers: the
U.S., China and the European Union.

Each of the Big Three powers will assert its influence differently, but
the intense demand for energy and resources means that the underlying
goal will be the same. And the main battlefield for this geopolitical
competition, Mr. Khanna argues, is the “second world” – about 40
strategically important “transition” states whose relationships with
the superpowers have the capacity to tip the balance.

Like both of them, I agree that it’s a big mistake to view power in
this new world as a competition confined only to large nations. In
fact, small states will increasingly find themselves with more
influence and more room to manoeuvre. Their competitive position will
be strengthened and they will have the opportunity to act as important
stabilizers in the global system.

They are already doing very well, economically speaking.

According to my Global Creativity Index, Sweden (first), Finland
(third), Switzerland (fifth), Denmark (sixth), Iceland (seventh),
Canada (11th) and Australia (12th) are right up there with the U.S.
(fourth) and Japan (second). Interestingly, Russia, China and India sit
well down the list: 25th, 36th and 41st, respectively.

Canada and Australia are seen as models for open immigration and talent
attraction, Ireland as a prototype for economic revitalization. Denmark
and Sweden show how markets and welfare states can work together and
why high taxes do not necessarily mean low competitiveness.

In my view, these small states, among several others, are the best
places to look for innovative, alternative models of economic
prosperity and social cohesion.

A big reason for the improved competitive stature of smaller nations
stems from the shifting nature of global competition. Today,
competitiveness no longer turns on market size, raw material, control
over natural resources or even business costs, but rather on which
places can best attract and retain innovative and entrepreneurial
talent.

Ultimately, it is less in nations and more around these regional
locations that talent wants to be and where it clusters. Global talent
is not migrating to England but to London; entrepreneurs and technical
talent are not going to China and India, but to Beijing, Shanghai and
Bangalore.

In this regard, even the most thoughtful commentators remain overly
enthralled with the power of the nation state and miss the rising
importance of the city region.

In fact, the best way to understand the past century of U.S. global
hegemony is through this lens. It’s not the size of America’s market or
its natural resources or its military supremacy that defined its
ascendance and dominance. Rather, it is America’s role as an attractor
of (and haven for) the world’s top talent.

That history includes many great entrepreneurs, from Andrew Carnegie
(born in Scotland) in steel to Andy Grove (Hungary) in semi-conductors,
as well as the influx of scientists (Albert Einstein, Enrico Fermi) and
artists (Marc Chagall, Igor Stravinsky, Ludwig Mies van der Rohe) who
fled Europe in the 1930s and 1940s. In Silicon Valley, a third to a
half of all start-ups have someone born overseas on their founding team.

Yet our system for making global policy shows little sign of
adjusting to this shift, because it remains overwhelmingly organized
around heads of states, foreign affairs ministers and central bankers.
Mr. Zakaria worries that even as U.S. companies pioneer globalization,
and while America remains “the most open, flexible society in the
world,” its government is impeding the country’s ability to adapt.
Regions such as New York, San Francisco, Los Angeles and Chicago are
well positioned to compete for global talent, but restrictive U.S.
government policies on immigration and homeland security make it harder
for them to do so.

U.S. presidential candidate John McCain says a new “League of
Democracies” – composed of about 40 advanced democratic nations – is
needed to inform global policy-making and bring stability to the world
system. While national leaders have shown themselves to be increasingly
ineffective and out of touch, it is mayors, premiers and governors who
have consistently demonstrated their ability to navigate today’s
wrenching economic and social shifts.

For my money, a League of Cities and Regions – made up of the world’s
largest cities, regions, states and provinces – is more in tune with
what the emerging “post-American” world really needs.

The Globe and Mail has a nice interview with CCG friend, editor, and author, Megan Hustad:

Why do people have such a strong desire to reprogram themselves for the
workplace? What happens in a corporate setting is not something that
comes naturally. There’s an art to doing well in these contrived
situations, and it’s difficult to do well without preparation and
training …

Being snarky and cynical have become totally mainstream and it works
well with Internet culture because it’s fast, snappy and dismissive. [A
lot of young people] are surrounded by people who are so quick to take
any sincere effort down. My set associated careerism with being an
unimaginative Republican. I thought that if you’re really clever and
smart, things will take care of themselves and it will be enough. It’s
not ….

Wanting to be of service to other people is a deep human need. Some
people underestimate how much they’ll enjoy their job once they stop
thinking it’s all about them and what they need to do to accomplish
their own ends. That’s not to say you need to be a brainless team
player. … It’s a paradox: If you want a more self-determined future
and career, you start getting there by extending yourself toward other
people more than you think you ever have to.