Why the loss of middle class jobs will usher in the rise of political extremism

Jobs, jobs, jobs, jobs. After four years of recession in Western economies, a new theme is beginning to emerge: this time things really are different. It appears that we are not witnessing a conventional recession where over production results in excess supply, resulting in collapsing prices, resulting in mass layoffs, resulting in dramatic contractions in supply and run down of excess inventory, resulting in insufficient supply, resulting in increasing prices and then increased employment to increase production.

Why this recession is different

One of the reasons why this recession is different is because the world in which we live is different compared to during previous recessions. Your traditional oversupply, cutting of supply, increase of supply recession was typically confined to one economy (eg the US) or to one particular region (eg parts of the EU) and whilst they had knock on impacts on other economies or regions, the market that they affected was primarily internal.

This recession was caused by regulatory changes in the finance sector that has enabled spectacular levels of household and government debt. This has enabled many in the finance sector to become spectacularly rich, whilst encouraging companies to focus on clever financial engineering at the expense of real engineering.

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Simultaneous to this, the run up to the year 2000 resulted in significant investments in data connections to places like India, where Indian engineers were put on dull IT work trying to ensure that there were no Y2K bugs that would devastate Western IT systems, and China entered the World Trade Organisation in 2001. This set off a subsequent wave of IT outsourcing to India, followed by other countries, and a wave of manufacturing outsourcing to China, followed by other countries, all financed by Western companies and, ultimately, the Western middle class.

The impact of India and China, and countries like them, on Western economies is being accelerated during this recession. Cost conscious managers of Western companies are shifting increasing parts of their business to low cost countries for both higher end intellectual work and lower end manufacturing work. From the perspective of a Western manager, this makes perfect sense: with the mantra “flat is the new growth”, the only way that they can increase profits is by reducing their cost base. Since mangers get compensated as a result of their profitability, the more they offshore, the more profit they will make.

But this does have an impact back home, on the numbers of jobs that are available for Westerners. The conventional recession cycle described at the beginning of this column has shifted to one of over production resulting in excess supply, resulting in collapsing prices, resulting in mass layoffs in Western economies, resulting in dramatic contractions in supply and run down of excess inventory, resulting in insufficient supply, resulting in increasing prices and then increased employment in India and China and other countries to increase production. The lost Western jobs are not only not coming back, but they are spawning new competitors in Asia.

Phillip Brown and Hugh Lauder wrote an interesting article earlier this month called The great transformation in the global labour market” in which they describe a number of major trends in the global labour market which reinforce this perspective. It is worth reading in full, but some key points are as follows:

First, the globalisation of high skills. Not only has the global workforce increased, but university enrolments have doubled – to about 140m worldwide as of 2007. There are more students in higher education in China than in the US and while education quality varies, it is worth noting that over half of those taking post graduate degrees in science, technology, engineering and mathematics – key subjects for economic growth – in British and American universities are foreigners. Western university graduates are competing with a significantly larger talent pool.

Second, the quality cost revolution. Emerging economies are producing “oasis operations” within their own borders which can provide high tech factories, offices and research facilities even in countries that are generally poor with bad infrastructure. Many global banks now use Indian sub contractors to perform not just menial call centre jobs but also complicated high value system design work. This is enabling Asian companies to compete higher up the value chain for goods and services, undercutting Western competitors. They can do things at higher quality and at lower cost.

Third, the rise of digital Taylorism. Digital Taylorism is the concept of turning high value intellectual work into a smaller, less complex, blocks of activities, in the same way that Taylorism enabled complex, integrated, highly skilled artisanal work to be transformed into repetitive work done by unskilled labour in factories. This trend is emerging and many of the clever programmes developed by Western computer programmers are making it increasingly easy and cost effective.

The combination of these three trends makes it easier to outsource relatively complex service sector jobs, such as law, accounting and movie making, to less educated or talented counterparts using digital Taylorism, and very complex work, such as materials science and biotechnology, to high tech oases where it can be done more cheaply by a deeper, more talented, and motivated resource pool.

Putting things into historical perspective…

In many respects, the West has only itself to blame for the radical changes that are currently afoot in the labour market. Cheap finance created a wealth bubble, which helped provided capital for developing economies, and the short term benefit of outsourcing low cost manufacturing and information technology to developing countries would inevitably lead to those countries to move up the value chain to compete head to head with advanced manufacturing (see article on China and high tech trains and aircraft here) and research and development.

Equally, however, the West’s dominance is arguably a historical aberration, which it has exploited and enjoyed for almost 500 years. Most Westerners do not understand the unique circumstances which enabled the West to succeed for so long and why those circumstances are not permanent: Jared Diamond’s superb Guns, Germs and Steel: A short history of everybody for the last 13,000 years describes the macro factors on why Eurasia and then Europe dominated over Africa, the Americas and Australasia; Ian Morris’ Why The West Rules – For Now: The Patterns of History and what they reveal about the Future picks up off Diamond’s book and highlights why the West, rather than China, dominated over the past 500 years; and Niall Ferguson’s Civilization: The Six Killer Apps of Western Power describes specific advances that made the West dominant over the past few hundred years.

Ultimately, whether it is due to self inflicted damage or bringing the West back to a historical norm, what is clear is that significant structural changes are afoot which will change the nature of the West’s middle classes, who have enjoyed years of steadily increasing standards of living.

…and what we can expect for the future.

New developments in artificial intelligence, robots and 3D-printing are likely to have significant impacts on jobs as well: not just in the West but also in newly industrialising economies, as described in Where are all the jobs going? Lessons from the first Industrial Revolution and 150 years of pain.

The consequences for the middle class in the West are going to be devastating. Youth unemployment in Europe and America is at an all time high. In Spain and Greece, over 50% of young people are jobless, millions of whom also have university educations. In a world where more people are better qualified for work than ever before in history, a BA or BSc is no guarantee of entry into the workforce, let alone a well paying job.

But the consequences for wider society are going to be even worse, as the major engine of tax revenue – the middle class- shudders to a halt. This will have significant economic and political repercussions.

First, it is the middle class who pay the greatest amount of tax in any Western society. The very rich can offshore their income and hide it through clever accounting practices. The very poor pay little tax, if they are employed and if you include Value Added Taxes and payroll tax.

If the middle classes are competing head to head against millions of workers with whom they never had to compete with historically, you can expect wages to either stop rising above inflation, or to decline relative to inflation. Either way, long term government forecasts should budget for lower tax income from the middle class and an increase in the numbers of people who are claiming unemployment insurance.

Second, as government income receipts go down, expenditure will have to follow. The economic costs of our social security programmes and health care are enormous (see article: Renewable energy: victim of subsidy discrimination?). Throw in the education budget and a few other “non discretionary” items such as interest on debt, and the UK has about 15% of its budget remaining for other activities, such as defence, public order, industry and housing. It is inevitable that these expenditures will decline, impacting the quality of schools, hospitals and size and security of pensions.

Third, the percentage of foreign ownership of our debt will go up. As middle class household incomes decline, domestic funds available for insurance and pension funds will fall. This will mean that fewer Westerners will be able to purchase government debt. This will mean that as a percentage, more of our government debt will be owned by foreigners. In order to keep funding our debts and rolling them over, foreigners will demand increased assurances that their debts will be repaid. This is the issue that Spain and Greece are currently going through, with heavy cuts to traditional expenditures – such as education – being made to pay interest and capital repayments.

Fourth, power projection will decline. The European Union’s expenditure on its military is already low compared to that of the United States. They already struggle to project power onto the other side of the Mediterranean, let other regions of the world. As military budgets are cut, you should expect an increase in rhetoric and a decrease in the usage of military power. While some in the West may welcome this, the loss of even the potential to use force will have knock on consequences – especially in places like North Africa (see article: How climate change will drive new barbarian hordes into Europe).

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The rise of political extremism

Finally, you should expect a decline in the influence of centrist parties and a rise in political extremism, on both the left and the right. Both will have policy ideas that will promise to solve the middle class crisis.

The left will make aggressive moves to tax and expropriate wealth from the rich. Foreign rich should expect to be targeted first as they are politically less powerful and subject to anti-foreigner sentiment. The left will justify these expropriations as a “rebalancing” of previous levels of insufficient taxation on the rich. This will result in a temporary tax income bump, but ultimately will prove futile as the rich get taxed out or get out. You should also expect calls for defaulting on public debt obligations as unemployed voters weigh up the pros and cons of default vs getting unemployment insurance.

The right will call for more free market legislation, reduced labour market regulations, reduced taxation levels and a reduction in payments to the poor and needy. They will argue that this will spur investment and encourage employment. These policies would result in a reduction in expenditures, but also result in a significant rise in social inequality, resulting in a large underclass. There would be a rapid race to the bottom as workers would be fully exposed to foreign competition. You should expect a significant drop in the value of assets ranging from housing to company share prices as income levels would not be able to keep up with mortgage payments, unless there was a large scale propping up of the housing and equity markets by foreigners.

You should also expect a rise in nationalist parties, either linked to left and right wing parties, or as independents. These will vote for legislation that will freeze new immigration and deport foreigners, hoping to increase employment at home. Nationalisation of foreign owned companies might be promoted, bringing higher end jobs back to their home countries. This will not solve the issue of work being sent offshore and so you should also anticipate legislation that will try to push back the tide of history and restrict offshoring of brain and brawn work.

Balance of payments is likely to be an issue and so a preference on products being made at home is likely, resulting in a decreased appetite for unfettered free trade. Bizarrely, wind, solar and nuclear power are all likely to make it on the nationalist agenda as they cut off, or reduce dependence on imported oil and gas, as is organic farming as it reduces the need for foreign imports of fertilisers, seed and oil.

While this crisis caused by the collapse of the middle class is unfolding, it is worth remembering that the environmental issues of population growth, fresh water shortages, food shortages and migration pressure are all expected to be move up a gear over the next 5-10 years (see article: Standing on the shoulders of toddlers- why we have never grown up and what this means for our future).

This toxic mixture of global environmental problems and political extremism does not sound pleasant. As such, it is hard to believe that this might happen.  It is worth remembering, however, that change happens all the time, and sometimes not pleasantly.

What do you suggest policymakers do about it?

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