The New ROE: Returns to Extravagance; 2011 Trend Line Looking Shaky

During the past six weeks the world has watched in amazement as seemingly downtrodden and largely forgotten citizens of the Arab world have risen up to demand economic and political rights. Thanks to technology, they have learned the truth about global living standards - and their place in the queue. Repressive regimes are right to fear rapid communication and the dissemination of knowledge; people do act when they sense they are getting a bad deal.

In the west, particularly the US, we have observed, but perhaps not fully comprehended a few seemingly unrelated events in the past few weeks that may shed some light on current socio-political attitudes reflective of the larger world. First, and most emblematic of the distance between business leaders, government big-wigs and 'the people' is the relative disinterest with which most of the known world, including the chattering classes, regarded the annual World Economic Forum at Davos. Michael Elliott provides below a cogent assessment of the limited truths to emerge from this year's event, but the most significant fact appears to have been how little attention was paid, especially in contrast to the uprising in Cairo which analysts say has become the most widely followed event in history. Whether this means that the 'net and associated social media have finally come to dominate global thinking about priorities remains to be seen but one is left with the impression that the musings of business moguls and photogenic politicians carry less heft than they have in the past.

Secondly, the annual US football Super Bowl, held this year in Dallas, Texas, the US capital of excess-worship, was the most widely watched in history (history being 45 years in this case). However, there was an air of disapproval surrounding the event; the $ 1 billion-plus stadium and its self-promotional owner were greeted less by the usual smarmy accolades than by overwhelming media schadenfreude at the cold, snowy weather which caused innumerable problems and not a few injuries. The capstone story was about a ticketing snafu that caused approximately 1,000 fans with tickets not be seated (their temporary seats had not been completed in time). The Super Bowl is an annual feel-good event at which politics are put aside so that food, drink and sports can be celebrated. That such negative tidings dominated the event is perhaps reflective of the increasing sense that all is not right in this country - and many others - so that those who flaunt their wealth may expect less adulation than they have hoped for.

Finally, theater-lovers have been treated to a similar spectacle on Broadway in New York. Noted director Julie Taymor (The Lion King, etc) created an extravaganza costing $65 million to produce, several times the all time record. The production has been plagued by injuries to actors who have fallen, been hit or otherwise damaged by the complex workings required for this attempt at bringing movie screen sensibilities to the stage. The reviews, which came out before the production even formally opened, were uniformly critical, even hostile. Surveys have suggested that ticket-buyers are going to witness tech problems and injuries, not the script. There again appeared to be a sense that an elitist and possibly self-absorbed ego had sacrificed common sense and other people's safety for her own edification.

In all these cases, there is an underlying recurrent theme of resentment towards elites and extravagance at a time when not only many are suffering, but those who have benefitted from the public largesse have not shown the good grace to acknowledge that. This is consistent with diminshed corporate and government reputation. The returns to extravagance (ROE) mentioned above may be a useful metric for determining whether putatitve leaders continue to enjoy the support of the crowd or whether the actions in Cairo may be reflect a growing determination to demand better, whatever that may be.

Michael Elliott in Time magazine reflects on this year's Davos:

"The most interesting sessions at Davos this year were not about emerging markets but about the prospects for the Atlantic core of the developed world. With memories of the 2010 bailouts in Greece and Ireland still fresh — and the fear of more trouble to come in Portugal and Spain — top European policymakers arrived in Davos with a tough task ahead of them. They not only had to convince investors that the measures taken last year had stabilized the financial system; much more significantly, they had to give a sense that policy decisions made in 2011 would ensure that such crises did not happen again. Those policies — to enhance the Financial Stability Fund, to increase the surveillance of fiscal and budgetary decisions by euro-zone member states and generally to create a framework of "economic governance" in Europe without moving toward full-blown federalism — are both complex and contentious.

That did not deter policymakers one bit. One after the other, European leaders went to the podium or spoke in private meetings with a single message: Europe escaped a meltdown last year by the skin of its teeth, and its leaders were now united in an effort to make sure that systems are put in place to reduce sovereign risk and enhance cooperation. Above all, the euro would be defended. Those savants on the other side of the Atlantic who had long predicted its demise could go choke on a fistful of dollars.

With variations appropriate to each speaker's circumstances, that was the message from European Central Bank (ECB) president Jean-Claude Trichet (for my money, the true star of Davos this year); French President Nicolas Sarkozy and his Finance Minister, Christine Lagarde; German Chancellor Angela Merkel and her Finance Minister, Wolfgang Schäuble; and even British Prime Minister David Cameron and his Chancellor of the Exchequer, George Osborne. (One of the interesting side notes at Davos was how European both Cameron and Osborne sounded — none of the pandering to the euroskeptic wing of the Conservative Party in which they might be tempted to indulge at home.) The European choir was in such harmony that I assumed (as did others) that the score and parts had been agreed to in advance, though I was reliably informed that they had not been.

It fell to Sarkozy, with all the brio he brings to special occasions, to make the key point. In an impassioned defense of the euro, Sarkozy made an argument that few Americans fully understand. "The euro," Sarkozy said, in a passage worth quoting at length, "spells Europe, and Europe means 60 years of peace on our continent. We and the Germans fought three barbaric wars. If Europe has become the most peaceful continent, it is because we built the European Union. The single currency is a magnificent symbol of that. [The euro] is not an economic or monetary issue. It has to do with our identity as Europeans. We will be there whenever it needs to be defended." A day later Merkel made the same point, if without Sarkozy's passion. "The euro," she said, "is the embodiment of Europe. Should the euro fail, Europe will fail."

For Europe in 2011, the key question is whether the public will always think that being "European" is worth some economic pain. Or to put it another way: Will those nations on the periphery of Europe and most at risk of a new or renewed sovereign-debt crisis sacrifice short-term economic prospects for the long-term benefit of remaining members in good standing of the euro zone? My guess — based on the Greek and Irish cases and the reform now under way in Spain — is that they will. But whether they can at the same time build economies that are creative and entrepreneurial enough to satisfy the aspirations of their young people is a different matter, one that will take more than a year to resolve.

The question for the U.S. is the same. Secretary of the Treasury Timothy Geithner was in Davos, making the argument that the American recovery was on track and that President Obama's commitment to policies that encourage innovation was the key to future success. There are obvious risks, of course — notably, the U.S.'s deteriorating fiscal position, which the real doom merchants imagine will one day lead to a flight from the dollar — or the jacking up of interest rates when the economy is still too frail to cope with it.

He resisted calls for immediate deep budget cuts, and more than one commentator pointed out that in the debate over whether to make cuts now (the British position) or make cuts later (the American one), Washington seems to have the evidence on its side. Cameron and Osborne arrived at Davos in the shadow of awful U.K. growth figures for the last quarter of 2010.

Yet Geithner was realistic about what recovery means. The U.S. expansion, he said, was "not a boom — it's not going to offer the prospect of a rapid decline in the unemployment rate." American companies have a tendency to get through tough times by shedding labor, especially at home. The result is that the U.S. is likely to see "a tragically more moderate reduction in unemployment as the economy recovers."

A sustained period of high unemployment means that what one U.S. official called "exceptionally high income inequality" will continue to be a feature of the economy for some time. In this, the U.S. won't be alone. The breathtaking speed of economic growth in nations such as China, India and Brazil often obscures the fact that the benefits of that growth are unevenly spread: more go to the cities and to those with marketable modern skills; fewer go to the villages and those with ancient work practices. Zhu Min, a well-known Chinese economist who is now a special adviser to the IMF, went so far as to call growing income inequality "the single most severe challenge facing the world." It's a problem that will only intensify as rising commodity prices put pressure on the developing countries' poor, who spend half their income on food and oil.

The social and political dangers of inequality are well understood in emerging markets. Chinese leaders routinely stress the need to extend growth inland from the coastal provinces (labor shortages and high wages on the coast are helping the transition), while the Indian government is committed to "inclusive" growth that delivers benefits to the villages.

Not so in the Atlantic world. One senior business leader said frankly that during the crisis, companies around the world had "sacrificed the workers to please the shareholders" and called for a more "humanistic" approach. Another mused that although new technology had done wonders in creating marvelous products, so far it had not demonstrated that it could create millions of middle-class jobs to replace the ones disrupted out of existence. Add to that the opportunity for shifting high-skilled, high-paid jobs from the Atlantic core to Asia and other areas of the developing world on a scale never seen before and it becomes easy to understand why frustration with conventional policies and institutions may grow.

In these circumstances, those who have done well from global capitalism might at least show a degree of sensitivity. At one plenary panel, there was a priceless exchange between Lagarde and Bob Diamond, the CEO of Barclays Bank. Meaning well, no doubt, Diamond expressed heartfelt thanks to the authorities for rescuing the global financial system in 2008-09. Thanks, Lagarde told him tartly, were not enough. What the banks needed to do was lend more, improve their capital ratios and reform their compensation structures.

It was a reminder that plenty of people have not yet seen any benefit from the recovery; millions of small businesses need capital as much as middle-class families need jobs. Until they get those things, there will be the risk — which, of course, will manifest itself in different ways in different societies — that ordinary people in the rich world will lose confidence in the processes of globalization that have done so much to lift millions in the developing world out of poverty. As they looked to the sunlit uplands at the Schatzalp, did the Davos attendees this year feel a chilly breath from those who have not yet felt any warmth at all from the recovery? If they were wise, they did.