This article first appeared in the Harvard Business Review
Over the last two decades, business leaders in the West have been responding to risks posed by profound changes in the global economy, in technology, and in demographics. The successful ones have, at least.
Rather than being undercut by new, lower-cost competitors in rapidly developing economies, such as China and India, companies have globalized their supply chains or offshored their production. They have used advances in information technology, which might have destroyed their businesses, to improve their offerings and cut their cost of production. They have transformed employment conditions to be more inclusive and better suit the preferences of women and Millennials. And by shifting from defined benefit to defined contribution pension schemes, they have avoided the risks from increasingly long-lived retirees and persistently low interest rates.
They have used advances in information technology, which might have destroyed their businesses, to improve their offerings and cut their cost of production.
In other words, business leaders have been dealing with the direct, market-based risks presented by major economic, technological, and demographic trends. But these trends, and the business responses to them, carry secondary, nonmarket risks — which may turn out to be even greater. Having navigated globalization and rapid technological change, businesses may be scuppered by the social and political responses to them. Effective risk management requires business leaders to attend to these nonmarket threats and to develop nonmarket strategies. When the public and politicians see businesses as agents or enemies of social policy, businesses cannot avoid becoming political.
Gobalization’s Winners and Losers
International trade and technological progress improve aggregate productivity in ways that have been understood for at least 200 years, since the work of Adam Smith and David Ricardo. Over the last 40 years these forces have brought about unprecedented gains in global prosperity. The percent of the world’s population living in absolute poverty has declined from 40% in 1980 to 10% today. Large middle classes have emerged in countries where until recently all but a tiny minority were poor.
Some people in advanced economies have benefited from these trends: those in a position to benefit from markets expanded by globalization, whose productivity has been increased by technology, or who can readily shift capital to where it is most productive. Over the past 30 years, the biggest multinational corporations have taken advantage of open borders to spread their innovations and cut their production costs and tax burdens. The value of these multinationals has grown at more than three times the rate of less global companies, our research shows.
But these winners represent a small fraction of Western populations and businesses. For the rest, the gains are less obvious. Consumer goods are cheaper, of course. But competition with low-cost foreign labor has suppressed wage growth for low-skilled workers. The internet has even exposed skilled Western workers, such as accountants, to competition with cheaper foreign labor. The expectation that Western children will grow up to be richer than their parents, an idea taken for granted throughout the 20th century, is beginning to fade in the West.
Over the past 30 years, the biggest multinational corporations have taken advantage of open borders to spread their innovations and cut their production costs and tax burdens.
This shift is undermining the liberal “Washington Consensus” that has guided policy making since the 1990s. The globalization backlash has moved from anarchist rioters at G8 summits into the political mainstream. Donald Trump won the U.S. presidency by promising to protect ordinary Americans from the ravages of international trade and immigration and by threatening punitive action against firms that offshore production. Economic nationalism is resurgent in Europe as well.
American and European businesses face the prospect of being cut off from the talented immigrants many of them depend on and having their costs driven up by tax regimes, which effectively forces them to use expensive domestic workers and suppliers. In fact, this is already happening. While still merely the president-elect, Donald Trump pressured several firms to give up plans to move jobs outside the U.S.
Some social scientists, pundits, and politicians saw this coming, but the risks these developments pose to business have not been high on boardroom agendas — not until Donald Trump won the Republican nomination, and not until British voters chose to leave the European Union.
The Political Response to Robots
The end of globalization would be bad enough, both for businesses that have adapted to it and for global prosperity. But even worse sociopolitical outcomes are in the cards. The disruption to employment that has been caused by globalization could end up looking trivial compared to the disruption caused by emerging technology.
In 2013 research by the Oxford Martin Programme on the Impacts of Future Technology estimated that advances in artificial intelligence and robotics will eliminate the jobs that now account for about 45% of employment: no more truck drivers (driverless cars), no more legal secretaries (AI that searches documents), no more credit analysts (AI that draws on big data), no more warehouse workers (robots), and on and on.
Job-destroying technological advances are nothing new, but economic theory and history tell us that they do not cause long-term, systemic unemployment; mechanical looms did not in the late 18th century, nor did desktop computers in the 1990s. Labor is eventually redeployed elsewhere, often to produce what were unaffordable luxuries before new technology increased aggregate output, or to supply goods and services made possible by the new technology. No one worked in a gas station until cars replaced horses in the early 20th century.
Job-destroying technological advances are nothing new, but economic theory and history tell us that they do not cause long-term, systemic unemployment; mechanical looms did not in the late 18th century, nor did desktop computers in the 1990s.
Yet this time really may be different, not in the long-run effect of technological advances on rates of employment, but in the political response to short-run labor market disruption. When voters and politicians think that governments should prevent companies from engaging in foreign trade that eliminates domestic jobs, why should they not also stop companies from using technology that eliminates domestic jobs? Even Bill Gates, whose Microsoft products have eliminated jobs that once employed tens of millions of people, recently called for a tax on robots.
The public and political responses to mass layoffs are likely to be extremely hostile and damaging to traditional business strategies. Similarly, businesses that have shifted their staff from defined benefit to defined contribution pension schemes may find that they have not actually avoided the cost of retirees living longer. Many middle-aged Westerners have inadequate private savings for their retirements, and many state pension schemes are insolvent. The temptation to pass the burden of providing retirement incomes to businesses may prove irresistible to politicians.
The Necessity of Nonmarket Strategies
In short, business leaders cannot afford to make plans about supply chains, production technology, and employment conditions without regard to the probable political responses. To do so would be to ignore what is becoming their greatest business risk. Market strategies are not enough; business leaders also need nonmarket strategies. They need to work with social and political imperatives, rather than inviting resistance. They need to be part of the solution.
What will this entail? The avowed environmentalism of energy companies is an example. In the 1990s and 2000s, Western populations became increasingly concerned about global warming. Hostility to oil companies was a natural corollary, creating the risk of (even more) punitive taxes and regulatory constraints. Oil companies responded by trying to clean up their image. This wasn’t a matter of marketing alone. Most major energy companies are now investing in renewable sources of energy, such as wind, solar, and biofuels. That strategy is, of course, not enough to fully immunize them from criticism. Nonetheless, it represents a plausible nonmarket strategy for addressing political and social risk.
The new public and political anxieties about economic security are not sector-specific in the way that environmental concerns are. Any company might be punished, by consumers or politicians, for replacing its staff with machines or with cheaper foreign labor. Any company might be held to account for the inadequate incomes of its employees in retirement.
Most major energy companies are now investing in renewable sources of energy, such as wind, solar, and biofuels.
To avoid reputational damage and new tax or regulatory burdens, large companies may need to take a pastoral approach to their employees. A company that can foresee replacing many of its staff with machines, or shifting production to Mexico, should consider retraining staff for other kinds of work, perhaps coordinating such initiatives with government programs. In Singapore, where commercial enterprises have long been used as vehicles of social policy, a government agency, Workforce Singapore, works with businesses to retrain their employees, providing them with skills that are expected to be in increased demand.
Similarly, firms that offer only defined contribution pension schemes may nevertheless take responsibility for ensuring their staff make contributions large enough to ensure decent retirement incomes. This should involve not only education but also incentives, such as employer contributions that go beyond what is required by law. And such efforts should be advertised.
It is too soon to say how economic policy will change under the Trump presidency or in a post-Brexit UK. The direction of coming European politics is uncertain: Centrists defeated the insurgent nationalists in the Dutch elections in March, and may also be victorious in the final round of the French presidential election in May. Yet there are clear signs of a major shift in the economic policy of Western governments. Business leaders who pay no heed to it, and fail to develop their own social and political policies, risk finding themselves on the wrong side of history.