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The world economy is broken

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You can see the hallmarks everywhere. Rising inequality, flatlining real wages, and the weakest productivity growth for more than a century. The rift between haves and have-nots has been widening for decades. Money has flowed out of our economies and into company coffers and into tax havens, reported Sky News (UK).

Is it any surprise what has transpired? Trust in the establishment has collapsed. Electorates around the world are punishing their politicians at every vote.

Everyone is angry. And you know what? They're right to be angry. Because the unwritten contract between citizens, business and government has broken down.

This crisis won't be solved by Brexit. It won't be solved by Donald Trump or Emmanuel Macron. It will bubble on beneath the surface for years, pushing people and politics to even greater extremes as their discontent builds. And that is because it's not merely that we have yet to come up with a solution; we have yet to agree on the problem.

So bear with me while I have a go.

The system we built to manage the global economy has broken. It is kaput. It is an anti-system. And this anti-system is at the heart of the discontent. This doesn't answer every complaint in 21st century politics/economics. But it does at least get us some of the way.

Let's start with a brief history lesson.

During the Second World War (actually, strictly speaking in the run-up) it became clear that the unwritten contract between politicians and citizens had broken down.

In the 1920s and 30s, the gap between rich and poor had risen to unprecedented levels. In Britain there was the General Strike and even a mutiny. In the US there was the Great Depression. In Germany there were reparations, followed by hyperinflation, followed by the rise of Hitler.

Rapidly, a consensus developed: the origins of World War Two were economic. More specifically, that it only happened because the mess left by World War One was never properly cleaned up.

So as the war raged, politicians started to devise a new contract. On the domestic side, that meant a new welfare state: the NHS, free state education, a more generous system of unemployment insurance and a state pension.

The US poured billions of dollars of Marshall Plan money into Europe in an effort to rebuild the continent. It encouraged the creation of institutions which later gave birth to the European Union. It created organisations designed to help harness global stability: the International Monetary Fund, the United Nations, the World Bank, the General Agreement on Tariffs and Trade (the forefather of the World Trade Organisation).

It created a monetary system that would ensure there wouldn't be another global financial crisis: the Bretton Woods system. Flows of capital between countries were regulated. Currencies were fixed against the dollar and the dollar against gold. Countries were to keep their trade accounts in balance (though Britain, with its massive post-war debts, struggled from crisis to crisis for decades).

For their part, private companies more or less went along with it. Riding on the wave of money invested by the US government around the world, ostensibly to fight communism, the corporations created jobs for life. They gave their employees generous final salary pension schemes.

In the US, where the welfare system was less generous than in Europe, those corporations supported their employees with comprehensive medical insurance. They rode on the economic wave laid by the US, as it spent billions to attempt to fight communism around the world. And, after rationing came to an end, the next generations enjoyed a prosperity their parents and grandparents could only have dreamed of.

Taxes were high - too high perhaps - but because there were restrictions on capital moving from one country to another, it was relatively difficult for companies to avoid them.

Globalisation, such as it was, was a pretty straightforward affair: a company makes a car in country A, ships it to consumers in country B - voila, that's trade. Best of all, everyone was benefiting. According to Comparative Advantage, the famous economic theory devised by David Ricardo 150 years or so earlier, provided there was free trade, and provided every company concentrated on making what they were best at, everyone would get richer.

And so it proved. During this period (from 1945 to the early 1970s), inequality around the world fell more than ever before. Economic growth was strong and stable. The incidence of financial crises dropped to the lowest level ever. The number of recessions was lower than in any other comparable period.

Then, at first gradually and then very abruptly, something changed.

As the US waged the Vietnam War and attempted to fund Lyndon Johnson's Great Society, its current account and government finances dropped from surplus into deficit. Investors had found more and more clever ways to circumvent those capital controls (the City of London was at the vanguard). The dollar came under attack and eventually Nixon declared that it was no longer exchangeable for gold.

The house of cards collapsed very quickly after that. The Bretton Woods system - fixed currencies, rules over capital flows and so on - was over.

In the years that followed, finance was deregulated on both sides of the Atlantic. Suddenly the idea that you could or should control flows of money over borders was considered nonsensical - past it.

This was also, of course, the dawn of the computer age. Suddenly, it was possible to transfer billions of pounds from one side of the world to another at the press of a button. And with computers and the internet came grand new opportunities for companies. Where once they had been forced to locate most of their production in a single site, companies found they could use computers and, in the following years, the internet, for new possibilities.

Now that you could communicate electronically between one factory to another, with far greater speed and sophistication than with telephones and fax machines, there was no end to the potential for long distance co-ordination.

You could have a lean, tight supply chain that could bestride the world.

You could make an aircraft's wings in one country, the tail in another and the fuselage somewhere else.

Assemble them in another country and it would be almost as if they came from the very same building.

And so, in a process which really accelerated in the late 90s and 2000s, companies began to offshore their production.

They laid off workers in the US and the UK and set up factories in Mexico or China (the latter had, in the meantime, embraced capitalism). There was no rational reason not to: gone was the Bretton Woods era capital controls, gone were the technical constraints. If you wanted to maximise shareholder value, the sensible thing was to shift production.

And if you were shifting production, then why not also shift your profits too, so they appeared in the cheapest jurisdictions? Again, there was no legal constraint, nor any capital restrictions - and, guess what, it would also help reduce your tax bill.

The global tax system, constructed on that old fashioned notion that a company makes goods in country A and ships them to country B - simply wasn't set up to deal with this kind of accounting behaviour. So governments suffered falls in their corporation tax receipts - and in their income tax receipts, as some of those jobs were shipped off to Eastern Europe, Mexico and China.

For those developing nations, this was a remarkable period. Levels of poverty dropped dramatically and a new middle class began to emerge. China began its ascent to global dominance.

But for those left behind in the US, those skilled manufacturing workers who lost their jobs, things never really recovered. Some of them found work again, but for many that meant low-wage, insecure service sector jobs.

This was particularly devastating for many families in the US, without a national health system to fall back on when the company medical insurance expired.

The post-war contract was fraying in other ways, too. Those final salary pensions had proved too expensive, so businesses started to replace them with cheaper, less generous alternatives.

In the UK and much of Europe, there was at least a welfare state displaced workers could fall back on, but this, too, was becoming less generous. Governments were facing bigger and bigger government deficits, in no small part thanks to the fact that companies could now shift their profits and activity overseas at the press of a button. So they trimmed back the generosity of the welfare state.

Imperceptibly, the pendulum had swung away from the average middle class worker. Lo and behold, as the 1970s gave way to the '80s and then the '90s, inequality started to rise.

In hindsight, it doesn't take an expert to realise why. Welfare was becoming less generous, blue collar jobs were being shut down and meanwhile the proportion of profits accruing to managers and directors who managed these new global supply chains leapt even higher.

The income gap peaked just after the turn of the millennium, at least in most European countries, but shifts like that take years to be felt. Domestic productivity rates started to diminish too. In the US, real wages were flatlining for years before the financial crisis.

At the time, it didn't feel like a crisis, but that was in large part down to another phenomenon.

Thanks to China's entrance to the global economy, enabled by those global supply chains, prices of goods had plummeted. This was a supply shock the world had rarely seen. And with inflation so low, central banks pushed interest rates lower and lower. Loosely regulated banks had financial products to sell. And with interest rates going down and down, low income households were encouraged to borrow.

They borrowed for mortgages. They borrowed to help finance their spending. They borrowed to help sustain a standard of living their wages could no longer support. In the UK, consumer borrowing hit the highest level ever in the years running up to 2007. In the US, sub-prime mortgages allowed millions to get onto the housing ladder - provided they didn't read the small print which would consign them to penury a few years later.

We all know what happened next.

The financial crisis may have been the episode which finally drew the world's attention to its economic problems. But the reality is that many of its issues were the fruit of gradual phenomena that have been shifting for decades. It is only now that we are starting to see just how badly the post-war contract has frayed.

The unwritten promises to the middle classes on both sides of the Atlantic were quietly scrapped. But they were lost amid a sea of complexity that only made their disappearance all the more intractable, flummoxing and frustrating.

In short, the world changed, and no-one was given a vote on it.

In fact, it's worse than that. For at no point have politicians started to engage in this debate, mostly because they too are largely ignorant about what has happened. They had not realised how dramatically new supply chains had changed the contract between workers and companies, and between companies and governments. They had not realised that, in this new world of footloose capital the institutions set up by the US after WWII - the IMF, the UN, the WTO - are powerless to intervene.

When bien pensant left-leaning columnists rail against "neoliberalism" - the nebulous word they give this phenomenon of 21st century globalisation, it only serves to mislead. It implies that there is a conspiracy afoot (indeed, many of them actually believe this).

It implies that the shifts I've outlined above are part of a broader, strategic plan - a credo.

This is naive and, frankly, wrong. There is no-one in charge here. There is no co-ordination between companies or countries. This was an unfortunate sequence of unpredictable events - more chaos theory than conspiracy.

Tempting as it is to moan about the Bilberberg Group, about tax havens, about the IMF, about Thatcher and Tony Blair, there is no single scapegoat here, because to a greater or lesser extent, we are all responsible. We are all investors in tax havens, without necessarily knowing about it. We are all beneficiaries of global supply chains, whether that's the cars we drive or the phones we use.

This is life in the anti-system. It is what the absence of real international economic policy feels like.

There are no straightforward solutions, but politicians could start by trying to grasp the scale and subtlety of this shift.

And they need to start learning fast.

For one thing, the offshoring revolution will soon be followed by the automation revolution, with white collar jobs being lost where blue collar jobs were lost in previous decades. But more importantly, they should note that we have been here before.

The last time the unwritten contract between governments and their citizens broke down was in the 1920s and 1930s. We all know what happened next.

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