So far in this blog, posts have focused on how advanced technology makes it possible for knowledge professionals to understand better and faster the policy developments around them. Disruption has been addressed as a technology issue. Today, we expand the focus.
Today’s post focuses on how multiple macrotrends are coinciding to deliver disruptive impacts. All those trends share one common element: all trends point towards distributed (rather than centralized) shifts. This post thus expands on issues first raised in blogposts earlier this year for the Bretton Woods Committee, the Atlantic Council, and the Washington International Trade Association.
Welcome to the Distributed Age.
The so-called “fourth industrial revolution” mobilizes technology to empower a broad range of private actors to reimagine the relationship between the individual and the government. Technology makes it possible to consider new ways to think about how individuals can and should delegate their sovereignty to governments and how governments can and should cooperate across borders to pursue shared objectives.
This can create disruptive challenges since governance structures domestically and globally require centralization of authority in order to function. The more a government relies on strong central structures, the more threatening it will find the distributed era.
Background – The End of the Centralized Age
It is deeply ironic to see the distributed age arrive in a year marking multiple major milestone anniversaries. The main milestones include:
Euro (21 years)
NATO (70 years)
DDay (75 years)
Bretton Woods institutions (75 years)
San Francisco Convention (74 years)
Georgetown University’s School of Foreign Service (100 years)
These milestones laid the foundation for a set of centralized institutions designed to foster increased cross-border economic and political integration.
Yet the fabric of cross-border cooperation has never seemed so thin. Technological communications increase the connections among people and ideas across time zones and geographies. But this interconnectedness has also generated backlash against international institutions from the World Trade Organization to the European Union to the Basel Committee on Banking Supervision.
Let’s be clear -- the last 75 years have not been full of stability. Increased cross-border integration certainly expanded opportunities for economic growth. But it also generated vulnerabilities to cross-border spillovers which have occurred nearly once a decade since the late 1960s. Policymakers have periodically puzzled over the challenge of how to handle oversight of financial institutions that are national in corporate form but international in their reach.
The tension between cross-border economic activity and national sovereign laws has long contributed challenges to policymakers charged with safeguarding financial stability. The tension initially was resolved by creating informal cross-border institutions to generate international common minimum standards. A brief history of the main cross-border financial regulation institutions can be found HERE.
However, as the financial crisis made clear, cross-border consensus on minimum standards is meaningless without parallel political will to share or delegate enforcement authority.
Today’s macrotrends indicate that such centralization is politically impossible and potentially undesirable. Across a broad range of sectors and interests, the prevailing trend politically and technologically is all about decentralization. The conundrum, of course, is that the technology itself depends critically on substantial centralization (cloud computing, platforms, telecoms infrastructure) with private sector entities rather than governments at the center.
The next decade will determine whether the post-war cooperation structures can evolve to accommodate more distributed frameworks for cross-border coordination. History suggests strongly that a failure to evolve will generate tensions for more dramatic change.
Macro Trends Pointing Towards Decentralization
1. Geopolitical Rebalancing (aka, economic sovereignty): Much has been written about China’s global geopolitical ambitions in recent years. Political scientists and international relations theorists have been prolific in describing how China’s economic and technological growth inevitably lead to tensions as it creates a counter-balance to Western (particularly American) leadership.
When China articulates its priority is to exercise “economic sovereignty” or it creates its own international organization (the Asian Infrastructure Investment Bank), many bemoan the centrifugal forces on display that spin away from the accepted post-war institutional structure (particularly the IMF, the World Bank and the WTO).
The Chinese government’s recently released White Paper accentuates these concerns. It delineates an approach to economic sovereignty focused on bilateral rather than multilateral negotiations in which “mutual respect…(for) each other’s social institutions, economic system, development path and rights, core interests and major concerns…(and) a country’s sovereignty and dignity must be respected.”
China is not alone in seeking to define a new, distributed paradigm for economic sovereignty independent from centralized international entities. Nor is China the first to push back against the post-war institutional structure.
Populist political trends from both the left and the right have been pushing back against an expanding international policy perimeter since the late 1990s. Consider these developments placed in chronological order:
--Seattle Riots/WTO (1999, ongoing): Left-leaning activists protested, then rioted, against the World Trade Organization and increased cross-border trade integration. Their intellectual heirs continue to protest a range of trade agreements and individual issues within trade agreements, joined by far-right activists and protestors (e.g., phyto-sanitary standards, dispute resolution processes, environmental and labor standards). Whether on the left or the right of the ideological spectrum, these advocates share with the Chinese government (ironically) a priority for placing a primacy on policy choices made at home rather than defined through a consensus-based cross-border negotiation. They reject growth models premised on cross-border economic integration – which is the foundation of the post-war economy, compliments of the Bretton Woods agreements – when they perceive that such growth and integration comes at the expense of preferred local priorities.
--EuroArea Crisis (2010, ongoing): The financial crisis shone a spotlight on the foundational weaknesses underpinning the common currency in Europe. Lack of political will to share fiscal liabilities when the common currency was founded persisted throughout the financial crisis. To this day, policymakers continue to reject policies that would create a common deposit insurance system within the European Union system and the bank resolution system remains incomplete.
For example, as noted in this Breugel analysis, it is unclear how EU authorities would resolve a financial institution which could not produce sufficient collateral to support central bank liquidity assistance. In addition, as Spain’s central bank governor recently noted in this speech, many of the EuroArea banking sector vulnerabilities have receded precisely because the solutions have followed decentralization or fragmentation paths. Banks in Europe decreased substantially their cross-border claims, which means that the majority of their exposures are now to borrowers in their home countries.
The EuroArea's common currency was stabilized through a distributed structure that relied on capital markets for funding rather than central government solutions.
National governments agreed to establish the European Stability Mechanism and sit on its board, but they did not agree to share responsibility for funding the entity. Instead, they merely authorized the entity to raise funding in the capital markets. As such, the European Stability Mechanism is a distributed entity.
--Brexit (2011, ongoing): The referendum results and the rhetoric surrounding Brexit in the UK highlight a range of populist policy priorities that many find abhorrent as well as economically undesirable. However, the origins of the Brexit policy choice within the UK government date back to financial crisis. The policy drivers indicate decentralized decision-making (also known as “financial sovereignty”) was at the core of the initiative.
As noted earlier this spring in this Atlantic Council post, “Before migration issues, xenophobia, unicorns, Russian Internet trolls, extremist politicians, trade policy, Northern Ireland, the Withdrawal Agreement, indicative votes, and the customs union dominated the Brexit dynamic, British and EU leaders were locked in opposition regarding governance and sovereignty issues with respect to who exercises what kind of regulation over the euro and the financial system in which the euro trades.” The UK arrived at the December 2011 European Union summit seeking to safeguard UK sovereignty over financial sector policy. Euro area heads of state arrived seeking to save their common currency. Their interests were not aligned. For more information, see this article from The Telegraph which published a leaked document showing the UK government demands.
Economists may be united against the Brexit initiative, but at the political and legal level, policymakers both in Europe and in the UK increasingly seem to welcome the decentralization opportunity which will enable them to develop norms and standards without having to compromise with each other. Consider this speech from France’s central bank governor. He outlined three pillars for the European Union’s “financial sovereignty” after Brexit which included a distributed system for generating equivalence decisions which grant access rights to foreign financial institutions into the EU financial system as well as detailed elements for a Euro-centered suite of initiatives.
--Central Bank Independence (2010, ongoing): The key role central banks played in maintaining financial stability during the 2008 crisis shone a spotlight on how these institutions operate. The modern era of central banking institutionally centers around twentieth century mandates which guaranteed central banks independence from political interference in their decisions to determine interest rates.
Increased populist pressure to rein in that political independence paired with the possibility of floating central bank digital currencies that create direct relationships between central banks and individual people is creating the incentive for central banks to start considering more distributed mechanisms for pursuing their policy objectives. For example, Bank of England policymakers indicated recently that “There is scope to decentralise more of central banks’ activities, giving them greater reach, voice and engagement locally.” Intriguingly, this speech cited as a precedent decentralized community-based initiatives at the Federal Reserve.
In other words, geopolitical rebalancing goes far beyond the economic rise of China. Shifts in economic and political placed pressure on all government entities accustomed to command-and-control negotiated solutions.
2. Geopolitical Rebalancing (Non-State Actors)(aka, individual sovereignty): Geopolitical rebalancing is not limited to sovereigns. A growing range of non-state actors diversify the number of entities ready, willing and able to provide alternatives to government-based solutions.
Some of these non-state actors are themselves centralized entities (e.g., non-governmental entities like charitable foundations and large corporations). These entities have the geographic scope and funding to provide solutions to underwrite initiatives designed to alleviate urgent needs like clean water, malaria treatments, and sustainable development solutions.
But the most consequential non-state actors ultimately are individuals.
Whether it is small scale donations from a mobile device or large-scale cryptocurrency mining operations, individuals increasingly have the ability to opt out of established centralized systems in order to generate a more direct impact regarding their preferred cause than voting for an elected politician could provide.
In many ways, the trend towards distributed decisions regarding data sharing or charitable contributions merely uses technology to implement a bedrock principle of Western-style democracies: sovereignty starts first with the individual who delegates that sovereignty to government for specific shared purposes (e.g., building and maintain roads, foreign policy, emergency services, etc.).
In countries that follow this principle, legitimacy is derived from the consent of the governed, not from the effectiveness of government services. The mobile and data revolutions make it possible for less sovereignty to be delegated to government because in theory people can accomplish more merely with the assistance of technology.
The less optimistic analysis would suggest that people prefer to rely on technology to perform certain functions because their trust in government has been dented severely by the recent financial crisis.
3. Distributed Ledgers (aka, data sovereignty): Consider the roiling debate regarding data privacy. Who owns the right to an image of your face or your iris? Who owns the right to information regarding your health and spending habits? Increasingly, advocates for distributed ledgers make the case that individuals going forward will have far more control over their data because distributed ledgers empower them to grant permission to specific entities for specific purposes.
For example, a health insurance company might receive authorization to receive your fitbit data but a marketing company or the government might be denied the same information.
Fast forward to a world where distributed ledgers are used by individuals for daily purposes. This is where things become tricky. At present, fiscal and monetary policy decisions are made by policymakers using aggregated data collected from cash registers and banks and other economic agents.
In a universe where those transactions are effected within a distributed ledger, if the individuals do not consent to share the data with the government, policymakers will over time have less information on which to form their decisions.
The disruption to economic policy making could be quite substantial.
4. Services-Based Economies (aka, professional sovereignty): Finally, the multilateral economic system itself is experiencing growing pains associated with the distributed age. Advanced economies today are driven predominantly by services rather than manufactured goods. Even when those services are delivered by large companies (e.g., consulting), they are performed by individuals and teams often located in different geographic areas. Yet their work may be governed by regulatory standards emanating from a different jurisdiction.
From the post-war era to today, the underlying assumption has been that the international trade framework was moving steadily (if slowly) in the direction of increased economic interdependence. But the importance of local regulatory standards and legitimate national security issues raises the possibility that there might be a limit to how much and what kind of cross-border economic integration is possible at the global level if not the regional level.
Since economic activity is distributed well past national boundaries, national regulatory standards and policy choices create more frictions than they did in the past and across a larger range of economic activity than in the past.
The Bretton Woods system is ill-equipped to handle the shift towards a services-based economy. As discussed in this Atlantic Council post, efforts to extend the traditional Bretton Woods trade policy framework to the services sector continue to experience substantial difficulties. Those difficulties are only increasing as the bilateral trade dispute between the United States and China increasingly begins to focus on strategic 21st century economy issues like forced technology transfer and intellectual property protections, as noted in this Atlantic Council post.
It is hard to escape the conclusion that an inflection point approaches quickly. It is also hard to escape the conclusion that the Bretton Woods system must evolve in order to continue supporting welfare-enhancing cross-border economic activity.
The traditional frameworks for international governance both at treaty-based international organizations and at informal standard-setting bodies will have to evolve if they are to survive and thrive in a decentralized world where political legitimacy is determined at least as much by activity using handheld devices as it is by citizens and voters.