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Further to my entry of March 25, I prepared a comment to a PSD blog note on foreign direct investment

http://psdblog.worldbank.org/psdblog/

Since they didn’t publish it there, I am reproducing it here.

Whether or not foreign direct investment, FDI, contributes to development is very much a function of country conditions, particularly two: the adaptability of the wider population to the transferred technology and the flexibility to do so. It is foolhardy to generalize. Instead agencies like the IFC and World Bank can help shape local conditions so that FDI does have positive effects. Let me explain.

Since retiring from the Bank Group 12 ago I have been synthesizing a lifetime of observations and study, including in the private sector making and managing new investments, of what makes some peoples and countries more successful than others. I have developed a comprehensive model that identifies the important properties, structures and processes, and how these interact, that I am currently writing. In the meantime here are some conclusions.

Recently [March 25] I entered in the Bank Group’s retiree society blog a brief note that captures well and dramatizes the importance of adaptability and flexibility. The book I refer to there (Ian Morris, “Why the West Rules—For Now,” New York: FSG, 2010) makes clear the extraordinary magnitude of the changes that have taken place since the beginning of the Industrial Revolution with Watt’s introduction of a practical steam engine in 1776. It is difficult to overemphasize how disruptive is the process of change. FDI brings with it an entirely new and different work culture. Often it is difficult enough for the workers alone to adapt but if the FDI is to have any impact it must establish roots throughout the surrounding community. For that to happen the local community and often the country itself also have to adapt. That is a very difficult process.

Adopting the culture and rules of new investments is disruptive. Local communities have traditions that must be modified. The problem is magnified many times when the workers migrate to a new community as was the case with the larger cities in Marx’s day. Workers are not only asked to learn new ways of doing things but they have to do this away from the protective cocoons of their communities of origin. In the new environment they have to develop new mechanisms to cope, including all of the elements of security to which they were accustomed. These include a wide range of supports, including spiritual, family, health and other survival mechanisms, however primitive some of these are. Often these are not available even in rudimentary form in the new environment.

Adapting presents large challenges of its own but in addition there are numerous man-made obstacles or rigidities that make the process more difficult. Worse than the natural obstacles, people are often met in the new cities, and even in smaller communities, with highly hostile environments like corrupt petty officials and police supposedly there to help and protect.

These all make change very difficult and stressful, and create insurmountable barriers for the FDI to spread its roots widely beyond its physical perimeter. All of those obstacles detract from the flexibility necessary for the community to adapt and adopt even a few of the new rules necessary to make new investments function and spread effectively. Whether and how these obstacles are overcome will determine whether the FDI has a positive impact or not.

For FDI to be successful institutions like the Bank and IFC can help shape the terrain to make it more flexible and adaptable. This doesn’t mean telling the locals what to do and how. It means helping them to learn, and identify and remove for themselves the rigidities that only they are equipped to understand. Ultimately the most successful change will be that which happens internally from within, with minimum government intervention except to help remove obstacles.

The most effective support is education, and not just education of potential workers. The whole community needs to be better educated and more knowledgeable and adaptable if they are to take their destiny into their own hands and help shape their environments, including the new rules that are made necessary by the new investments. Traditional cost-benefit and economic rate of return analyses are inadequate to measure the social change required to make new technology, including organizational technology, take root. Such analyses can be short sighted. Time and again history has shown that social development happens more rapidly in societies with higher literacy rates and education (Morris, 522).

Just as important, governments need to deal with the problem of petty bureaucrat corruption that is endemic to so many developing countries. Governments can have the best intentions but what the people see and believe is what they must deal with in their daily lives. To them that is much more indicative of reality. With the help of the Bank Group governments can undertake programs to educate and turn bureaucrats from obstacles into teachers that help the people understand their rights and take advantage of the opportunities that their rapidly changing countries present.

In the posting that I just made that starts as “In 1776 two momentous events took place…” the following introduction was somehow left out:

John Nellis wrote a new report titled “Eight centuries of financial folly and counting” based on a talk by Kenneth Rogoff. I just added the entry below.

Fascinating, and I can’t resist a new comment that builds on my April 15 comment [above] to your FPD Forum 2010 report of March 18.

Reinhart and Rogoff’s “This Time is Different: Eight Centuries of Financial Folly” is on my pending list. Given the scope of the work implied in my last entry, there is so much I need to read that I don’t know where to go next. I have physically set aside a number of books that cover the last eight centuries and suggest cycles or oscillations from different perspectives—religious, social, economic, ecological, warfare strategy, in Europe, the US.

My intention is to determine whether when these oscillations coincide they can help explain larger swings in Western history like the crisis of the 14th Century that was punctuated by the Black Death, that of the 17th Century punctuated by the Thirty Years War and the Peace of Westphalia, then at the end of the following century and the beginning of the 19th the French Revolution and Napoleonic Wars, and finally the Great Wars of the 20th century.

In an odd way I believe Reinhart and Rogoff are right and wrong that “This Time is Different.” From abstracts of their work I understand that their premise is actually that this time is not very different from others in the last eight centuries. Indeed it isn’t. The processes that lead to change, development, and collapse remain the same. But, as I will argue, the world system has developed new unusual bignesses and is now much more dependent on many more interconnections. As a whole the international system may thus be more vulnerable than it has ever been.

Rogoff’s subsidized debt and other observations confirm in spades my own about lumpiness or bigness and the size of oscillations. Over the last eight centuries and before, and in the social, religious, and economic realms, excessive bigness has always led to larger failures and oscillations. By excessive I mean localized change that has grown and dominated faster than the broader society is able to absorb and adapt to.

A number of changes in the last one or two hundred years are particularly interesting. Gone are the days when numerous relatively small decentralized sociopolitical structures—city states, principalities, feudal monarchies of Medieval Europe—innovated to stay ahead of each other and ecological forces, and thus arguably eventually helped produce the Renaissance. Gone are the much more recent days when private bankers like the House of Rothschild or House of Morgan were large enough to finance and even bail out governments.

In their place we now have governments that are huge in comparison to other players. It is only those more recent governments that are able to subsidize debt in amounts large enough to determine decisively the future course of their societies. Such relatively large governments were only made possible by taxation of a very large industrial and commercial base, itself the result of the Industrial Revolution.

In between those two periods there is a thread that I am currently exploring that I believe was instrumental in creating the Industrial Revolution and the United States. That thread is characterized by a people that are unusually individualistic and self-controlling, people that helped form a Britain that is arguably different than Continental Europe, a Britain with characteristics that predate Christianity and may go back to northern peoples including from Scandinavia.

To understand what may be significant about these people let me go back to my April 15 comment. There I wrote that societies “learn” through trial and error, and that those that are better able to generate innovations, adapt these to their needs, and then more homogeneously absorb the changes, including the new rules each change requires, throughout the society will grow more and last longer. Moreover, this mechanism works better if all of the players remain relatively small and the society sufficiently homogeneous.

Obviously societies that are more individualistic produce more trials and therefore more opportunities for innovation. They also produce more flexible social glues better capable of allowing innovations to take root throughout the society, and continuously change and adapt, including the deeper and slower changing moral and ethical components of the social glue.

It is seldom appreciated about Britain that it exemplifies these characteristics better and for far longer than other Western societies. Instead, when we follow more closely the more compelling narrative of the French Revolution and the overthrow of monarchy, and we couple that with the American Revolution, we tend to mistakenly elevate the British monarchy too high and attribute to it exaggerated power and suffocating influence.

In point of fact the British sociopolitical structure for centuries before the French Revolution had been a symbiotic blend of monarchy, some form of parliamentary government, religion, and the people. Indeed, even as some individualistic self-controlling people like the Puritans began leaving Britain and eventually found their way to America, many others remained to help shape the English Civil War of the mid-17th Century and later “The First Modern Revolution” of 1688.

It is the relative freedom afforded by that sociopolitical structure that helped produce Britain’s major contributions to the Scientific Revolution (and why Rousseau wanted to visit with Hume in Scotland). And later it is the 1688 Revolution and the new blend of more flexible government or social glue, coupled with the arguably more homogeneous and individualistic people that it produced that I believe led to the Industrial Revolution that began in the following century.

And in America an even more individualistic and looser sociopolitical structure comprised of very symbiotic and synergistic secular and religious rules, with a strong central government now also removed, eventually led to the industrial and commercial powerhouse of the mid-20th Century. Its secular government of limited powers and strong checks-and-balances proved very flexible and able to adapt rapidly and effectively to continuous change.

The religious component of the sociopolitical structure also proved flexible and provided a very effective if slower changing set of moral and ethical values. In my opinion those values supplied a critical additional layer of very important individual checks that helped buffer errors in the ever changing relatively more temporary secular rules made necessary by continuous innovation.

It is from this foundation that I believe one can more meaningfully understand the transformation in governments made possible by the tax base that the Industrial Revolution produced. It included an organizational revolution that made possible a virtuous cycle with economies of scale that led to ever larger industrial and commercial entities and an ever growing tax base.

Every new change required new rules and with them ever growing governments. Very soon, however, the pace of change and the increasing size of secular governments began to outpace the ability of societies to reconcile, adapt and absorb change, including in the deeper and more durable moral and ethical values that provided the additional checks that helped buffer mistakes.

When I first began to study in some depth the events and mechanisms that led to the most recent financial crisis I was struck by what appeared as a loss of some of the more ethical values in business that I had been brought up with. Long ago I was deeply troubled with what I perceived to be the necessary but unrestrained greed of private enterprise; it was necessary as engine of innovation, but it was troubling by how it appeared that it could lead to abuse.

My disquiet peaked in business school almost fifty years ago. But even there I began to realize that even the more aggressive of my classmates operated by strong sets of restraining moral and ethical values that were common to most. I was finally set at ease when I joined the private sector, became intimately exposed to the upper echelons of management, and came to realize that most if not all of the people at those levels held to very high ethical and moral standards. They were all playing by essentially the same rules and these included very refreshing values.

Many of these values may have been lost in the last thirty or forty years, and while they weren’t the immediate cause of the financial crisis, they did contribute to some degree. Robert Putnam has collected a lot of very intriguing data that may indirectly help validate my observation. (This comment is meant more for an American audience. The ascendancy of dominant secular societies began elsewhere more than a century ago and is in large part what led to the many tens of millions lost in the two World Wars and other social upheavals of the 20th Century.)

I further fear that as bignesses continue to develop, including particularly but not limited to the bigness of government, these values will be increasingly lost. And I fear that without these values to help check individual behaviors the bignesses that are continually growing as a result of the pace of development will only lead to even bigger economic and social swings or oscillations until one of them proves definitively destructive.

The above interpretation is all based on a model and methodology to analyze change that I referred to in my April 15 entry. As evidenced here, I still have much work to do—even as I was writing this note I was doing another historical note about those who have leaders, as in the old Mexico, and those who lead themselves, as in the old United States. This trial run for the methodology is the first time I pull together so much material. The result is that I managed to scare even myself!

And there are important processes in that model that I only gloss over or don’t even mention. Among them are processes for discarding what no longer works, and for reconciling different interpretations of the outcomes of change before the differences escalate into major conflict. Both are important to sustain change without very large oscillations, and recently there have been signs that they are breaking down even in countries where they had worked well.

If I am even remotely right, the younger are in for some rough times. Last century there was the US to save an ever more advanced rational secular man from himself. If now the US oscillates itself to near destruction, even if for different reasons, who will save them this time?

By the way, the 1945-1980 lull in defaults and banking crises is perfectly understandable if we remember that there were far smaller cross-border flows of capital until the early-70s nationalization of oil and the large recycling of petrodollars that followed. I have another draft where I try to explain the crises that followed and the huge reversal of flows after the 1997/98 financial crises that coincided with loosening of lending for housing to use the “Peace Dividend.”

It is all a very complex never ending process. And I believe that we will never get smart enough to get ahead of the unintended consequences of change. Which takes me back full circle to my conclusion in the April 15 entry that everything that has gotten too big should be resized.