The year ahead is going to be a tumultuous one, challenging in political, economic, and financial terms. Despite this, there are opportunities for those prepared to take advantage of them, because uncertain times mean that market share is up for grabs. And no, it’s not a coincidence that there are 12 trends for 2012. I discarded a bunch more, but it’s such a catchy title I couldn’t resist.

I’m going to approach these 12 trends with three objectives: What is important? Why is it important? And what does it mean to you?

And I’m going to start with the bad news, and end with the silver linings.

1)    Declining American influence – America’s absolute and relative influence in geopolitics, economics, finance, and the military is declining for a host of reasons: the rise of competing powers like China, India, Brazil, and others; the very expensive military adventures in Iraq and Afghanistan, which have sapped America’s willingness to engage in aggressive political and/or military action; the Arab Spring, which eliminated Middle Eastern strongmen like Mubarak who followed America’s political lead, and the continued stalemate over the fate of the Palestinians, means that America’s influence over this critical and unstable region is at or near an all-time low; the Great Recession, which has sapped America’s economic and financial clout; and the dysfunctional stand-off between Republicans and Democrats that has frequently led to policy paralysis.

The implications of this are a less stable, more dangerous world. America may have gone back and forth on whether it wanted to be the world’s policeman, even though it truly was the global cop, and it’s inability to fill that role now means that the world is a more dangerous place.

This sets the stage for sticky situations to emerge, such as the twin nuclear threats from a suddenly even less-stable North Korea, and the only slightly more stable and geopolitically ambitious theocracy in Iran. It also leaves more elbow room for the ever-ambitious China to expand its power and influence, notably in south Asia and the South China Sea. It also leaves critical global issues, like what to do about climate change, without essential leadership.

The implications of this is a world where there are more likely to be more, and more serious, geopolitical, financial, and economic crises, and greater uncertainty in virtually every aspect of life. Others may not always have agreed with American policies, but they will miss America’s steadying influence as it ebbs from their lives.

2)    Ho-hum! Just another financial crisis (European edition) – The daily drumbeat of scary headlines dealing with the financial crises in Europe have gradually deadened everyone’s awareness for how dangerous the situation truly is. In particular, Angela Merkel is juggling hand-grenades, and hoping that she won’t drop any, and that none of them will go off unexpectedly. Germany is the only European country with the potential to stop the rolling crises that are affecting Europe, and then only if Merkel acts in a timely basis. To do this, she must let Greece go bankrupt instead of propping it up, shore up the banks, notably German banks, that have bought far too many dodgy EU bonds in the past, allow the European Central Bank (ECB) to become a lender of last resort, with the ability to stop a run on European bonds, and halt the bond market attacks on other European countries, starting with Portugal and Ireland, but extending to the much bigger countries like Spain, Italy, and even France. But Germany doesn’t want to do these things, and German voters are adamant that they won’t subsidize what they see as the lazy, profligate lifestyles of southern Europeans. But if Germany doesn’t act, and in a timely fashion, it may lose the ability to act at all, and come under attack from the bond markets as well. Indeed, German bonds are no longer being bought with as much enthusiasm as they were even two months ago. If Germany doesn’t act soon, it may lose the ability to do so at all.

Remember what happened in the American financial markets in 2008? If Germany doesn’t act in time, we could see the same kind of thing happen in 2012, this time starting with a run on European government bonds. From there a run could spread to those banks – American as well as European – that hold too many of these bonds. And once such a run started, the most dangerous question of all would emerge: “Who’s next?” Investors, frightened by the panic, would look to sell any and every questionable credit, and their attention might turn to the various U.S. state and local governments, like Illinois, California, and Harrisburg, Pennsylvania, among many others, that are struggling with their finances.

The U.S. Federal Reserve has become the de facto lender of last resort to the entire developed world, and would undoubtedly step in and support the banks and markets with everything they had. But this time, remembering the callous, greedy ingratitude of last rescue of the banking industry, American voters and the American Congress would likely tell the banks to drop dead. It was a hard enough last time to get Congress to bail out the banks; this time I suspect it would be impossible, even though failing banks would take the global economy down with them. Moreover, the Fed doesn’t have anywhere near as many bullets today as they did in 2008, and Fed Chairman Bernanke already has some Republicans, notably Ron Paul, baying for his blood over the quantitative easing from the last crisis.

The danger here is frighteningly real, and even greater than the risks we faced in the panic of 2008. Yet, the steady drip of crisis headlines and last-minute rescues has left many people convinced that nothing will happen. If it does, it will catch people flat-footed, not because they didn’t know there was a crisis, but because they have been hearing about it for over two years now, and have tuned it out. We could muddle through, and probably will – but the risks are far higher than most people realize. It will be important to have thought out a Plan B to deal with the unthinkable, if it happens, one that prepares you and your finances for a bigger repeat of the 2008 panic. Again, it probably won’t happen – but it’s better to have a plan and not need it, than need a plan and not have it.

3)    Yes, China’s influence will continue to rise, but…  Napoleon famously said, “China is a sleeping giant. Let it sleep.” Well, China’s very much awake now, and throwing her weight around – although cautiously. If I were (God forbid) Emperor of China, I would require my minions to tread cautiously, to smile a lot at our trading partners and neighbors, and to make our gains slowly, one salami slice at a time, never appearing too greedy or overreaching. I would practice soft diplomacy, offering aid and comfort where I could do so cheaply, loudly proclaiming our respect for other countries’ internal policies, taking leadership positions in things, like climate change, where I knew I was going to have to make changes anyway, and generally trying to look like a good global citizen. I would act, in short, as if time were on my side, and I was going to be the next Big Thing.

And generally speaking, that is precisely what China is doing – except that every once in a while the mask slips, and the avarice and aggression shows, as with the boundary disputes with other countries, especially as related to the South “China” Sea, which China (the nation) seems to be trying to interpret literally as being a Chinese lake.

But China has an Achilles’ heel – several of them, in fact – and does not have (much) time on its side. Its biggest weakness is that it is aging faster than any other significant country on Earth. Because of its One Child policy, China’s population is expected to peak, and begin declining, sometime around 2020 – within the next 10 years. And its labor force is already in decline, even as the demands for higher wages push its cost structures higher.

Meanwhile, although there is a great deal of pride in China’s new affluence among the Chinese, that affluence is not evenly spread, and there is unrest among those who remain poor. Add to this the widespread corruption of Chinese officials at all levels, which often provokes revolts, like the one in Wukan, which leads to simmering dissatisfaction among many Chinese.

This will further be exacerbated by the fact that China’s factories are automating almost as quickly as those of the developed world, which threatens to slow the rate of job creation, productivity, and affluence markedly over the next 10 years. Yet, China dare not automate; to do so would mean a loss of competitiveness, which would produce even worse results as industries would move elsewhere.
So, with that in mind, what would I, as self-appointed Emperor of China, do? Worry about a future I couldn’t control, and for which I could not see a clear path forward. The next 10 years will mark the beginning of the end of China’s ascension, and if I were Emperor, I’d think about retiring to some warm, cushy haven before the revolution came. Chinese Spring, anyone?

The implications are for China to step up its attempts to increase power and influence, and throw its weight around even more actively before that power starts to wane, but as quietly as possible. Look for China to try to make this the China Decade, especially in finance, trade, and geopolitics, as it attempts to pull in as much as it can while it can.

4)    American Spring? Meanwhile, closer to home, while those on the political right like to dismiss the Occupy movement (e.g., Occupy Wall Street), the fact that the movement happened at all is the most significant part of it. Indeed, Time magazine made protestors its “Person of the Year”, and that’s not restricted to just the Arab countries. The Occupy movement and protests against cut-backs in many developed countries had many of the earmarks of the Arab Spring: protestors saying that their governments serve an elite clique and not the people; lots of people, especially young men, who cannot find work despite months or years of trying; and a belief that the political system is neither representative nor responsive. Just because winter has fallen, and the Occupy settlements have been disbanded does not mean that the dissatisfaction has gone away. And with increasingly dysfunctional government in America, the potential is there for a much stronger protest movement against the System, however that is defined. American Spring, perhaps? It sounds unlikely, but not as unlikely now as it did before, and it won’t be restricted to America for discontent will grow in all developed countries.

This is especially true as the boomers move towards retirement, only to find that their either don’t have the resources to retire and that no one is going to donate them, or that the civil servant pensions that they were promised are unaffordable.

The protest movements have only just begun, and they are going to be acrimonious, disruptive, and at times hijack the political process.

5)    Mixed signals for both weaker – and stronger – economic growth.  Europe and its prospects are dragging the global economy down. The uncertainty in Europe, combined with the painful budget cuts in Greece, Ireland, Portugal, Italy, Spain, and the United Kingdom, mean that Europe is now in recession and a drag on the global economy.

Meanwhile, China, which had been concerned about inflation, and hence was hiking interest rates in a bid to slow it, has now reversed itself, which I can only interpret as concern that growth will slow more than they want. That’s a potential positive, as it will add stimulus to the global economy.

Canada, which has to date seemed to skate above most of the problems of the rest of the developed world, now seems to be experiencing slower growth, with an unexpected jump in the unemployment rate, while its housing market is looking pricey, frothy, dangerous, and much like America’s prior to the collapse in 2008, especially in condo development in its major cities like Toronto, Vancouver, and Calgary. Moreover, its consumer debt levels are exceeding the levels of American consumers in 2007, and no less a figure than Mark Carney, the highly respected Governor of the Bank of Canada, has warned consumers and banks alike to cut back on consumer borrowing. Canada could be arriving late for the financial meltdown of 2008 – but if its consumers don’t mend their ways, they will get there.

And yet, America, which until 2008 was seen as the world’s engine of growth, seems to be picking up for no specific reason. Actually, this was almost inevitable because of the natural dynamism and entrepreneurship of the American economy. What has prevented America from rebounding earlier, or more strongly, has been the housing market, which is still in horrendous shape – but slowly improving.

So how will this balance out through 2012? Assuming that Europe doesn’t crash and burn, and drag everyone else down with it, and that Iran doesn’t precipitate a significant war in the Middle East, then America will continue to recover, its jobless rate will continue to decline (slowly), the world will lick its (economic) wounds, and things will slowly get better.

Accordingly, while I continue to counsel my clients to have a Plan B in their back pocket if things do go bad, my primary advice is the prepare now for better times ahead. There are problems – big problems – ahead, and the American election in 2012 is not going to help, but for 2012 we are likely to see an improving environment, and opportunities re-emerging for those with the courage to grasp them, as I outline in Trend #7 below.

6)    Climate change accelerates – and the consequences will multiply. The most significant and portentous climate news of 2011 was the discovery of methane gas bubbling up in the Arctic Ocean off the north coasts of both Siberia and Alaska. Methane is a far more potent greenhouse gas than carbon dioxide, and the melting of the Arctic ice cap, combined with the rise in the temperature of the Arctic Ocean, has started to release methane from the ocean floor. As well, as temperatures rise in the northern polar regions of Siberia, Alaska, and Canada, the permafrost melts, releasing even more methane into the atmosphere. The amounts of methane that could be released by both sea floor methyl hydrates and permafrost are staggeringly huge, and could dramatically accelerate the rate of climate change. If this trend continues, not only will the debate over climate change be over, but humanity will be forced to race to keep up with the potential changes.

As it happens, the vast majority of climate scientists – something approaching 95% – now agree that climate change is happening, and that humanity is at the very least a significant contributor to it. Since I speak to lots of different kinds of audiences, I can tell you that most groups now accept that climate change is happening, even those that have been among the most vocal doubters. The doubts they now raise are more along the lines of whether humanity is to blame. But from my point of view, it no longer matters: if your house is on fire, you don’t throw gasoline on the fire, regardless of how it started. That’s roughly the position we’re in now.

In 2012, we will get more information about the release of methane, and can only pray for good news. Meanwhile, brace yourself for more strange, and increasingly extreme weather. And because climate is a chaotic system (where chaos theory is a branch of mathematics), it is literally unpredictable. This means we can’t tell whether we will get floods or drought, hurricanes or tornados, or something else unforeseen. But it won’t be business as usual, either.

7)    Innovation as Steve Jobs’ legacy.  Jobs didn’t invent innovation, but he sure popularized it! Innovation has become a corporate religion in recent years, and with good reason: innovation can allow you to disrupt the marketplace, scoop up market share, increase profits, and win friends and influence people, just as Jobs and Apple have done. Yet, innovation is hard, especially because there’s a natural resistance to change and to the real risk-taking that innovation requires.

But if there is a theme for the corporate world in 2012, it is that now is the time to get serious about innovation. As an innovation specialist who runs seminars and workshops for corporate clients, I’m seeing this on a daily basis in genetic and medical research, agriculture, the automotive industry, the insurance industry and finance generally, plus just about every other sector of the economy. And technology itself embodies innovation. Indeed, the idea of a technological company not working hard at innovation seems like recipe for extinction. The world is changing rapidly, and there are lots of new opportunities – and disasters – out there. It’s raining soup, but if you just stand there, looking up in surprise, you’ll drown!

8)    Who dares, wins. Such is the motto of Britain’s fabled SAS – one of the world’s premier commando groups. But their motto applies equally to unsettled times. During such times, it’s easy and very, very tempting to hunker down, conserving cash, and wait for lazy, easy times to return. But study after study shows that companies that continue to market aggressively, and pursue research into new ideas, new products, and better results for their customers make far more inroads with modest expenditures during bad times than spending far more during good times, when everyone else is competing hard. Moreover, loyalty is won when times are bad, both among consumers, and among employees. And best of all, you can often accomplish a great deal with careful planning and foresight rather than lavish expenditures. This is where strategic planning comes to the fore. The time to be thoughtfully aggressive is when your competitors are playing turtle.

9)    The Red Invaders. The emergence of a Chinese middle class not only means upward pressure on food and fuel prices, it also means a vast invasion of Chinese tourists bearing money. For those countries and regions able to attract such tourists, it means a new source of revenue, and a big shot in the arm. And, as with all ethnic groups, it also means serving them the way they want to be served in terms of language, food, and customs. To the winner go the mega-spoils.

10) Haggling returns to North American retailing. Smart retailers are recognizing that it’s no longer enough to post a sign saying “10% off” to attract consumers, but that consumers are more demanding now, and are moving away from the traditional “no haggle” approach to buying. Moreover, haggling offers two additional benefits to consumers: it’s become somewhat of a game where they can enjoy the thrill of the hunt; and it offers bragging rights when talking with their friends. As a result, haggling has been emerging in two different ways, one passive, and the other active.

The passive form of haggling is to wait for sales. You can witness this almost anywhere when consumers see an item they like in a store, and ask if it’s on sale. When they’re told that it’s not, they turn up their noses, and say they’ll wait until it is. This might be described as “temporal haggling”, where the consumer is saying, “I’ll wait until you lower the price before I buy it. And if you don’t lower it enough, I won’t buy it.” Smart stores are responding in creative ways. Some salespeople say, “No, that’s not on sale, but it will be starting next week,” which amounts to a counter-offer. A smart consumer will reply by saying, “Can you put it aside for me until then?”, implicitly offering to buy it if they do. Some salespeople say no, others say “Sure.” The net result is that store and consumer have haggled over the price to agree on a sale/purchase. Yet the smart retailer actually has an advantage in this exchange: they get to name the sale price in temporal haggling.

By comparison, in active, more traditional haggling the consumer takes the initiative, saying something like “What’s your best price on this widget?” If the salesperson replies with the sticker price, the haggle is over and the consumer leaves. If the salesperson names a price, the consumer responds dismissively, and says, “I wouldn’t pay a nickel over $X for that”, and the salesperson can choose to respond or not. This is, as I say, traditional marketplace haggling.

If a retailer wants to capitalize on the re-emergence of haggling into the North American marketplace, they need to anticipate it, and come up with a range of responses. One might be to say, “We can’t discount this item today, but it is going on sale next week. Would you like to put a deposit on it to hold it until then?” The retailer regains the initiative this way, and moves towards a close. Or better still, the retailer should look for a way to add value rather than cut price by making a counter-offer like, “No, I’m sorry, we can’t discount that item. But we can offer you a 50% discount on a matching accessory if you buy it.”

Regardless of approach, though, retailers should be prepared to return to marketplace haggling, and have a range of responses ready to deal with it. Consumers, as always, should decide what they want, and what their bottom line is in getting it.

11) Health care magic blossoms. Putting aside the issue of cost, which concerns everyone, the ability of health care to solve problems is beginning to move at computer speeds, in part because IT is increasingly being used by doctors, nurses, hospitals – and patients – to manage health care, and in part because research is increasingly being done using smart, powerful computer tools to perform research and execute treatments. Among the changes in the immediate future of health care are:

• The rapidly rising ability to repair failing hearts and minds (or at least brains) and other organs with stem cells. Stem cell treatments are starting to move out of the laboratory and into the operating room, and 2012 will see hundreds of people receiving this kind of therapy.
• Similarly, 3D printers, which have been in development for roughly 20 years, are now good enough that they are starting to be used to create replacement organs from a patient’s own tissue. This will gradually move into mainstream medicine, with replacement hearts, livers, and kidneys being at the top of the list.
• Quadriplegics will increasingly be able to interact with the world through prosthetics controlled by thought alone, either through electrodes that interpret brain wave patterns, or implanted chips which interpret specific thought-impulses.
• Retinal implants are starting to emerge that can help blind people discern light, shapes, and some objects. The implication is that we may be able to help aging boomers improve their failing eyesight as they age – one of the biggest complaints of old age!
• Health care is increasingly falling into the hands of the patient – literally. Smartphones, which are fundamentally wearable computers with all the capabilities of what used to be called “supercomputers”, can now work with Bluetooth-enabled sensors to monitor various aspects of health, from the vigor of your workout, to the health of your heart, to the level of your blood sugar. This will lead to a revolution in health management, with consumers sometimes way out in front of practitioner.
• Likewise, as patients become more and more comfortable with researching medical conditions and treatments online; they are demanding an increasing role in their own diagnosis and treatment; becoming active, important advocates for fund-raising and acceptance of treatments; and blunt critics of health care practitioners through social media and word of mouth. Smart practitioners are accepting this trend and rolling with it. Old school practitioners are resisting, but may wind up steamrolled by it.
• Crowdsourcing of tough diagnoses, and novel solutions to the medical and financial problems of health care promise to open yet another front in the health care revolution. This follows on with the success of crowdsourcing in helping leading-edge research scientists in astronomy (galaxyzoo.org) and protein research (Foldit game softwear).
• Sequencing your genome gets cheap. Sequencing the first genome cost billions of dollars and took decades to perform (culminating in the Human Genome Project). Today it costs about $1,000 (although analysis costs significantly more). Within 10 years, it will cost $100, and analysis will cost about $500 more, and will provide you a complete run-down of where your vulnerabilities lie, and what you can do to forestall future health problems. For 2012, we will see incremental advances towards that goal, with major diseases identified, and a short list of things you do – and don’t – want to do or eat prescribed. This is the true beginning of personalized medicine, and it will revolutionize health care.

12) Technology accelerates in 2012. It’s hard to know what to leave out: electronic mind-reading? Glasses that emit sounds and smells to allow you to enhance social media? The proliferating tablets and smartphones with ever-more wondrous abilities? Here’s a partial list of things I think demonstrate trends that will become increasingly important:

• 3D printers – As well as making replacement organs, 3D printers are coming into the price range of consumers, and may mean that you can buy your own desktop factory. Need a replacement screw for a door? Make it yourself. Need to duplicate a key? Ditto. See a nifty device on TV? Download the plans and make it yourself. Of course, who knows what the ink cartridges will cost.
• Near-eye monitors – These look like glasses, but are computer monitors. They’re the lineal descendents of jet fighter heads-up displays, and will revolutionize the way we use computers, particularly smartphones, but have been hampered by high costs. Prices are starting to approach luxury consumer levels, so applications will start to appear in things like immersive gaming, personal entertainment theaters, medical imaging, and augmented reality.
• Augmented reality through your smartphone – Augmented reality is overlaying information on top of the view from your Mark 1 eyeball, much as Google Street View overlays the names of shops on a photo. You’ll be able to hold up your smartphone’s camera and have your phone overlay directions, stores, infrastructure views, or whatever else might be useful to you. This gets better when you can view the results in your near-eye monitors.
• Cloud computing explodes – Owning a computer is so 2010. Cloud computing is rapidly placing the resources of today’s supercomputers in your hands for pennies a minute. One researcher used one of the commercial clouds to try to break his password to a social media website by brute force, just to see if he could do it. Using the cloud and standard code-breaking techniques he did it in minutes, and it cost him 39¢. As the tools to harness this power get more powerful and easier to use, the potential of the cloud will be adapted by more and more users.
• Siri & copycats + babbling to your smartphone – Siri is an application of the iPhone 4S that allows you to speak to your iPhone and get it to do things for you. This might be setting a count-down timer, converting milliliters to fluid ounces, finding an address and directions from your present location, or looking up a phone number (all of which I’ve done). Apple is offering this technology as a beta version now, but every Siri request goes through Apple’s servers. This means the potential exists to assess what people want to do, and come up with solutions, improving the results really quickly, making personal avatars (also called PDAs, butlers, or assistants) much more valuable in short order. And that means everyone will rush into the field. This will lead to lots of really bad copycat applications, but ultimately a revolution in how we use technology.
• Biometric passwords – Our world is becoming so full of passwords that need to be foolproof (meaning our tendency to forget them) that biometric passwords are almost inevitable, and they are beginning to appear. They will be expensive at first, but gradually retina, fingerprint, voiceprint, and other means of making sure you are you will become cheap and commonplace, and then you will become your own password, no memory required.
• Robots – Everyday robots are here, but they are clunky, expensive, or just plain cute. That’s changing very quickly, and 2012 will see more and more of them appearing in more and more places. Typically these will be commercial settings, but health care is one place where robots make sense and will be used. Rosie the Robot won’t be washing your dishes this year, but she’s coming – if you’re willing to pony up the equivalent of the price of a luxury car.

The Occupy movement is most significant not for what the protestors say, but rather that the movement is happening at all. It demonstrates significant unrest, and the greatest dissatisfaction with the capitalist system that we’ve witnessed since the fall of the Soviet Union. But where is it headed? That’s a much more worrisome question.

The fuel that powered the Vietnam war protests was the draft. There were many other issues – objections to the military-industrial complex, objections to American foreign policy, objections to the money misspent on the war, dislike and disagreement with McNamara and Johnson, even objections to war per se – but without the draft, the protests could not have been as sustained or as widespread as they were.

In the same way, the fuel that powers the Occupy movement is jobs – or rather, lack of jobs. In America, and most other developed countries, the official unemployment rate is high, but the true unemployment rate is obscenely so. In the U.S., for instance, the official rate is 9%. But if you include those who have stopped looking for work, and therefore are no longer counted in the official unemployment statistics, then add those who are underemployed, the true rate approaches 20%. And if you look at the rate for young men, particularly among minorities, it approaches 40%. There is immense frustration with the lack of opportunity, and the smug, self-righteous people who look at the protestors and sneer, “Get a job!” only reveal the vast depths of their ignorance.

It’s true there are many issues embraced by the Occupiers, but without the lack of jobs, the movement would never have developed into much of anything. Americans are not generally a jealous people. If people were prospering, the middle class was expanding, and young people were able to find jobs and start their careers, they wouldn’t really have cared what percentage of total wealth is held by the top 1% of income earners. What rankles is that the rich continue to get richer through a perceived manipulation of “the system”, while the vast majority of other people suffer economically. It leads to the belief that the game is fixed in favor of those who can afford to buy the politicians. Whether this is right or not may not matter – it’s the perception that’s important here. And that perception may be explosive.

But where is this movement going? What’s next?

The Future of Work

If the future holds more jobs, and greater prosperity for most workers, then the Occupy movement will collapse from lack of fuel, and be remembered as a strange fad that came and went, like pet rocks or hula hoops. That’s not the case, because the future of work is much bleaker than people, even most top economists realize.

There are two forces that are squeezing workers in all developed countries: foreign competition, and domestic automation. One is going to get much worse, and the other is going to get slightly better.

The one that will get slightly better, at least in manufacturing, is foreign competition. There have been headlines for decades about the offshoring of jobs. There was even a management cliché for it in the 1990s: “Emigrate, automate, or evaporate,” which meant move your factories offshore in order to take advantage of dramatically lower wages in developing countries; decrease the labor content of your products in order to reduce the advantage of cheap labor in developing countries, or go out of business. (As an aside, there’s actually a fourth option: innovate, but that’s another story.)

This happened because of the emergence of the global economy. A global marketplace implies a global labor pool. If workers in developing countries can do similar work, but at much lower wages, then the work will naturally gravitate to them, and away from workers in developed countries. This has been going on since the 1970s, and is a familiar tale. It makes headlines, and becomes the subject of learned papers by economists, and protests by industries and unions that want protection. And the offshoring of jobs will continue until there is a rough parity between those producing things offshore, using cheaper labor, and the cost of producing things at home, using more expensive labor.

One way this could happen is through wages falling in developed countries, and rising in developing countries. But wages tend to be sticky; not many people are willing to take a cut in pay. As a result, what has tended to happen instead is that workers here are let go, and their jobs disappear, even as the wages in places like China and India are, indeed, rising.

The mild good news here is that much of this adjustment has already happened. Indeed, there are a few reports of manufacturers moving production back to America as the cost of labor in China, for instance, has risen, and as governments, particularly in the southern American states, have reduced legal protections for workers, effectively lowering their cost. (Whether you view this as a good thing or not is a separate issue. Indeed, it’s a difficult issue: do we want good worker protection, but no jobs, or bad worker protection and some jobs?)

The other way for workers in developed countries to compete is through higher productivity, and many companies have survived and kept their production in America that way. Yet, even when they succeed, the number of jobs required goes down. Businesses survive, but only by shedding jobs, leaving a trail of unemployment in the wake.

This is the past and present. The future will be different.

Increased productivity comes most notably through increased automation, and we’ve all experienced that, as when we go to the gas pump, swipe our credit card, and pump our own gas, all without an attendant. But automation is about to become supercharged.

The rate of change in computing speed and cost-effectiveness is not only accelerating, but the rate of acceleration is increasing. Some technology forecasters believe that computers will increase in power by 1,000 times over the next 10 years. With this growth in computing power available at steadily cheaper prices, automation is going to accelerate dramatically, eating its way up the workplace food chain. Only this time, it’s not going to be primarily blue-collar jobs that disappear – that’s pretty well already happened – but white-collar jobs that are hard hit. Indeed, anyone who uses a contemporary computer can experience this for themselves.

With the Macintosh laptop that I’m using to write this blog, I could (if I had the talent) write a new piece of music, score it, perform it with dozens of (computerized) instruments, record it and release it for sale. I could take videos with my iPhone, download them to my laptop, edit them, add titles and special effects, add in the music that I had created, and then publish the end result on YouTube. In effect, with these two tools, a laptop computer and a smartphone, I can replace composers, performers, and an entire movie making team – and that’s using today’s technology. Very shortly, I could make an entire movie, using technology to create photo-realistic virtual actors and background scenes, dub the voices myself, then change the sound of my voice using technology, and produce an entire movie without anyone else. True, it would be a terrible movie as I know nothing about directing, editing, or acting, and not much about composing or playing musical instruments – but that’s not the point. The point is that the tools we use are becoming so powerful that high-end jobs that used to require skilled people can now be done by ordinary folk.

Likewise, computers will move into medicine, performing research using Genetic Programming, and assisting doctors to do complex diagnoses using smart computers like IBM’s Watson; performing clerical work in almost every conceivable industry, and displacing millions of white collars workers along the way; drive cars, trucks, and trains unassisted; and almost any other kind of routine work. Indeed, computer intelligences and everyday robots will move towards replacing workers in any and every kind of repetitive work, leaving only creative, innovative, entrepreneurial work – and leaving millions, or even tens of millions of people unemployed.

What Happens When Too Many People Are Unemployed?

If you look at the Arab Spring from earlier this year, it wasn’t so much a yearning for the freedom to read newspapers not approved by dictators, or the desire to vote that was the driving force that caused people to revolt, but unemployment, especially among young men – leading the inability to create a life, to feed your children, or even to be able to afford to get married and start a family – that drove the revolutions, and inspired young men to face bullets and tanks. If you look at the protests in Europe, it’s not just the anger that a lazy, luxurious way of life is being taken away from Greek citizens, but a very real fear that they won’t be able to live that drives citizens to the barricades.

Unemployment, the specter of want, and the inability to make a decent living, to have a decent life, is historically a very potent, very scary force in geopolitics, and it’s with us now. The Occupy movement is not just about fairness, but driven by the fear and anger that there is no opportunity unless you are one of the privileged class that has a job. As the number of jobs lost to automation rises, so too will the number of people who will respond to the goad of fear and anger about their future.

Worse, it’s not just about finding a job – it’s also about keeping one. Jobs appear and disappear faster than at any time in history, and someone who is a valued employee and a rising star one day can be redundant and valueless the next. A person in that position can try to retrain and find new work, but they find themselves among the multitudes of people desperately seeking work. Without the in-demand skill that got them a job in the first place, they are reduced to the same pavement-pounding, resuming-producing, faith-sapping odyssey that afflicts so many out of work people today.

I’ve seen this coming for some time. In 1993, I wrote a book called Facing the Future. In that book I wrote the following passage:

It’s an overall decline in the need for work that concerns me, brought about by the increasing capabilities and sophistication of computers.

I seem to be very much in the minority on this view, and I may be dead wrong. The conventional view is that as jobs disappear from manufacturing and clerical work, for instance, the steadily rising productivity of workers using increasingly sophisticated automation will create a new prosperity that will increase demand and create new jobs. This is certainly reasonable, because it is precisely what has happened throughout history. But where, I wonder, will the new jobs appear? The conventional view is that new services will spring up, and that higher living standards will allow people to spend money on things they could never afford before, and that much of this will be for personal and personalized services.

I can see logic in this. New services do appear. There were no aerobic instructors, for example, in my grandfather’s day. But how much personal service can we use? Moreover, generally speaking, service jobs pay less than manufacturing jobs. As for being able to buy things that we couldn’t afford before, since manufacturing will increasingly be automated the higher demand for manufactured goods won’t necessarily generate more jobs.

This is not a problem that will burst on the scene in the next five to ten years. Humans are still capable of offering a flexibility, initiative, and creativity that machines cannot duplicate. But at some point, whether it’s twenty years away or one hundred, I’m afraid that the time will come when there will be very few jobs that computers can’t do better, faster, cheaper, and more reliably than humans. As that day approaches, we will be confronted with several problems.

In the first place, we will need a new economic system. Much as it grieves me to say so, free market capitalism may be dying, for it only pays those who are part of the production process. If virtually no one is part of this process, all the fruits of production will belong to those who own the machines – a recipe for the peon-and-aristocracy patterns of Third World economies. But where will the machine-owners find their customers? People can’t be consumers unless they have money to spend. …[1]

In the intervening 18 years, I’ve seen nothing to change my mind. We are, indeed, heading towards a world of aristocrats and peons. Indeed, that is precisely what the Occupy forces are demonstrating against, only they use a slightly different terminology: the 1% and the 99%. Same thing.

So where is this leading us? If I’m right, then even if the economy and employment picks up, and mollifies the Occupy protestors and their spiritual kin, the concerns will return again and again as the long-term rates of unemployment, especially among the young, continue to rise. And that way lies revolution.

What Should We Do About This?

If we lived in Naples in 79 A.D., and saw steam pouring out of the top of Mount Vesuvius, we would try to warn the residents to flee. We are in an analogous situation. This volcano won’t erupt in the next month or next year – but as things are trending, we need to take action, and soon, or we risk precisely the kind of revolution we witnessed in the Arab Spring earlier this year.

It’s no good trying to stem the tide of automation. That smacks of the 19^th century luddites smashing mechanized looms that they felt were stealing their jobs. Moreover, it would be like trying to hold back the tide, and about as successful. It is possible that politicians, under voter pressure, will seek to ban automation and the productivity increases that automation produces in order to preserve jobs. (This is also called “featherbedding”.) All that means is that countries that do not ban automation will see their relative productivity increase, their cost structure decrease, so that the jobs will migrate from here to there rather than being lost to automation.

Instead, politicians, economists, and anyone else interested in our future prosperity and stability should be taking a serious look at how to create new, better jobs that people can do best. These will largely be entrepreneurial, I suspect, and will all be creative, and focus on innovation. This also implies a complete revamp of our education system, away from rote learning and memorization, and towards creativity and individually customized education, to enable each person to emphasize the things they are best at.

None of this will happen quickly or easily. It requires a very different view of “job creation” and a very different understanding of the future of work. The “magic of the markets” won’t solve this problem. Capitalism, left to itself, will emphasize greater productivity through automation, leading to greater profits for the owners of the machines – until profits collapse because there aren’t enough consumers to by the goods and services industry produces. Capitalism will lead to a dead end.

This is not the conventional view, and many will decry my message as “socialist”, although I’ve said nothing at all about redistributing wealth. Some will pillory me for being alarmist, but without attempting to refute my reasoning. And some will just hide their heads in the sand and say “it can’t happen here.”

To this last group, I would suggest that they tell that to Moammar Gadhafi and Hosni Mubarak. They were sure it couldn’t happen there, either.

There are innovations in the field of innovation itself, as well as older principles of innovation that have been around so long that many people either aren’t aware of them, or ignore them despite their value. I thought it was about time to explore both trends.

The particularly interesting thing about innovation is that its entire purpose is to carve out a future in the shape you want. It is a true tool for inventing the future. In this blog, I’m going to talk about what you should be trying to achieve with your innovation, the manner in which you should be focusing your innovation, rather than how to go about it. I’ve talked about how elsewhere (like here), so with that in mind, let me outline the 9 trends in innovation that I see emerging – or re-emerging – today.

1) Exclusivity is overrated; fanaticism is more valuable

There’s a natural tendency in sales to discount prices in order to boost volume. Unfortunately, this is a bad trade-off. Suppose you have a 25% pre-tax profit margin on your widgets, and offer a 10% discount to boost sales. That 10% comes right out of your profits, cutting your pre-tax profits by 40%, from 25¢ on the dollar to 15¢. Moreover, in today’s environment, offering people a 10% discount is virtually an insult, and may actually reduce sales rather than increase them.

One strategic way that companies attempt to counter the discounting impulse is to create a premium brand, and one of the ways of creating a premium brand is to foster a sense of exclusivity about your products or services. Their reasoning is that people are less likely to expect discounts on something that only certain people are eligible to own. Of course, if you look at the ads for luxury goods, most notably luxury cars, you can see that this doesn’t always work – and may not even work any better than for a mass-market brand.

A better way to avoid discounting is to seek to create a fanatical customer base that is devoted to belonging to, or being a member of the experience you create. A classic example of this is the Disney Company, and the clearest example I know of is found with the Disney Cruise Line (“DCL”). People rarely think of Disney offerings as being “exclusive,” yet, on one of the Disney ships, the cost of a one-bedroom suite with concierge service can be 50-100% higher than a comparable suite on a competitor’s boat. If you read some of the online forums for DCL, you will see repeated queries from confused consumers wondering why DCL suites are so overpriced. The simple answer is that whereas other cruise lines have fans who buy suites, Disney has fanatics that would rather pay more for the Disney experience than less for anything else. As a result, the suites sell-out almost as quickly as they go on sale, with the result that Disney can charge big premiums for them.

Of course, creating fanatics is not easy. It takes years of work, meticulous attention to detail, and outstanding customer service. In an environment where management wants instant results, where the bottom line seems to scream for cutting corners, and where customer service is known simply as “overhead”, none of these are popular choices. But look at those companies that have fanatics instead of fans, look at their profit margins, and then ask yourself whether it’s worth it or not. Nobody said innovation was easy, but if you’re serious about it, ask yourself what you would have to do to convert customers into fanatics. (I’ll come back to Disney because they do so many things so well, as you would expect from a company where innovation has always been part of the corporate culture.)

2) Create ecosystems, not products

If you look at the best technology names in the world today, they don’t create individual products, they create systems that interact and support each other. The Macintosh computer was a marginal success with less than 5% of market share when Apple introduced the iPod in October of 2001. But under the revitalizing and visionary influence of Steve Jobs, who had returned to the company he co-founded, the iPod was not just another “me too” MP-3 music player (and remember that Apple wasn’t the first to introduce such players). It was merely the front end of a music-and-information system that included iTunes in cyberspace, arrangements with most of the major music companies that made it easy, legal, and relatively inexpensive to download music, plus provided a means for entrepreneurs to plug in and use the iPod for their own ends. Podcasting became a way for people to become their own broadcasters, and create an audience for themselves without having to work through a media company. And along the way, the revamped iMac became the world’s first computer that sold essentially as an accessory to an MP-3 player, the iPod.

When Apple introduced the iPad, they also introduced an App Store, which resulted in thousands of entrepreneurs creating applications and selling them to iPad owners. This storm of creativity was supported by Apple, and Apple was able to sell and profit from things they hadn’t created. But they benefited even more than mere profits because competing touchpads had to cahse after not only the Apple interface, but also all of the apps available for the iPad.

facebook is perhaps the best example of creating an ecosystem, only here they’ve created the ground, and allowed others to plug into it and grow their own businesses, from games, to advertising, to organizing groups for disparate reasons, and much more. It has become the de facto means for communicating for many people, especially the young and the technologically adept, to the point where many people no longer use email or IM outside of the facebook ecosystem. And facebook gets paid through advertising for providing this fertile ecosystem, and benefits from the entrepreneurial instincts and efforts of those who create more networks, games, recipe groups, political groups, and more. They have become an engine that entrepreneurs can plug into.

Likewise, Google has created an ecosystem that includes free tools, free email, free news, free tracking systems, free data storage, and more. And it all integrates, and funnels down into their revenue generation. People like free things, they like useful, powerful free things even more, and they’re willing to put up with the attendant ads that make it possible.

3) “It’s not the customer’s job to know what they want”

This comment, apparently, is something that Steve Jobs has said repeatedly within Apple. If you are innovating, then you are, by definition, doing something new. And if you’re doing something new, then your customers won’t know if they like it until they’ve actually tried it. Hence, it’s your job to figure out what your customers are likely to want before they know themselves. Let me give you an example of why this is so.

When the very first cellular licenses were being offered, I was working with a group that bid (unsuccessfully) for one of the licenses. My job was to write the science fiction section of the application; you know, the part that said people would be able to send fax messages from their cars, and walk down the street talking on the phone. Since, at that time, most portable phones had their guts in the trunk of a car and were highly unreliable, this was all very wild and wooly, and people wondered what kind of funny-smelling cigarettes I had been smoking.

Meanwhile, our financial backers were nervous about whether there was actually a market for this very expensive technology, so we commissioned a consumer survey to find out how many people were likely to want a cellular telephone. The survey results came back, and everyone was pleased and relieved that there was, indeed, a big enough base on which to build a business: the survey indicated that fully 7-8% of working adults would consider acquiring a cellular telephone. Of course, now this seems foolish as our survey results were short by more than a factor of 10. But it was difficult for people to know if they wanted a pocket telephone, something they had never experienced.

To truly innovate, you have to imagine not only what might be, but also how your clients or customers might like something they’ve never experienced before. Fortunately, there are some guidelines to help, one of which is next.

4) Seek beauty and perfection in what you offer

I did some work for Lexus US, and the CEO, Mark Templin, told me a story to make a point about their cars. He said that one of his neighbors came over and knocked on his door to tell him that she was going to buy an SUV, but not from Lexus. He blinked, and said, “OK, I appreciate you telling me. May I ask why?” It was because, she said, that too many people owned Lexus RX’s, and she wanted something that stood out. He thanked her, they finished the conversation, and she went home.

A couple of weeks later, he saw her again, and she was driving a Lexus RX, just as she had said she wouldn’t, so he went over to her house and knocked on her door, asking her what happened. “You know,” she said, embarrassed, “I tried all of the others, then tried the RX, and yours was just so much better that I couldn’t imagine owning anything else.”

Seeking perfection sounds like a hippy-dippy, naïve, lamb-choppy thing to say, so let me approach it in another way. If you asked your mother to use your product, would she find it easy to do so? Would she enjoy it? Do people connect with what you offer in an emotional way that makes them feel good about themselves as well as with what you’ve sold them? Are they proud of owning or using what you offer?

It’s easy to make something “good enough”, and good enough often sells. But if you are truly trying to innovate, good enough is never enough. Magnificent is what you’re after. Or, again quoting Steve Jobs, you want to create something “insanely great.”

Indeed, the insanely great 1984 Macintosh created such a powerful impression that it is still benefiting Apple today. Apple’s head of design is an Englishman named Jonathon Ive. In a September 5^th, 2011 article in the Los Angeles Times, reporter Jessica Guynn related the story of Ive’s first encounter with the Macintosh computer:

“He says the company’s revolutionary nature was clear to him from the moment he first touched a Macintosh computer. At the time he was nearing the end of his four-year industrial design studies in England. Not one to read an instruction manual, he was frustrated with personal computers and feared he was ‘technically inept.’ Then he turned on a Mac and said he felt an instant connection to the computer and to the people who designed it.

‘I could just use the product straightaway. It was a really profound moment. I don’t think I ever had actually quite the same sense of ‘wow’ with a product before,’ Ive said.”

If Ive had not felt such a strong and immediate connection with the original Macintosh, he would almost certainly not have joined the company. And if he had not, himself, sought to create perfect, intuitive products while he was working within Apple, he would not have come to Jobs’ attention when Jobs was seeking a new head of design. But because both things happened, Ive wound up as Apple’s Head of Design, and become an internationally renowned designer. His goal is always to “make something that looks like it wasn’t really designed at all because it’s inevitable.”

Seeking perfection supports the goal of creating fanatics, as described in #1 above, but while related, it’s separate. Indeed, if you don’t have beautiful, magnificent, insanely great products, you’re not going to be able to develop fanatics. The two complement each other.

5) Create experiences, not products or services

Companies often become so focused on what they’re doing that they lose the customer’s perspective, thinking only of what they’re trying to do, how they need to market, distribute, sell and deliver their offering. But if you think about it, the customer doesn’t care about any of that. The customer only thinks about what they experience, and what they would like to experience (if, indeed, they know).

There’s an old marketing cliché that “Nobody wants a quarter-inch drill; what they want are quarter-inch holes.” That’s still true, but what has also happened is that consumers are looking past or through the product or service, and considering their experience with the results. Or at least, that’s what they want to do. This is particularly evident among car companies.

For 31 years, BMW used the marketing slogan “The Ultimate Driving Machine.” Then, in 2006, they changed it to “The Ultimate Driving Experience.” This would be consistent with the quarter-inch hole dictum: do people want a driving machine, or a driving experience? Clearly, BMW decided that, at least for now, they want a driving experience.

Lexus is perhaps an even more powerful illustration of the importance of experience instead of product. In a 2009 interview with David Brimson, the head of Lexus UK, publication The Executive Issue commented on Lexus’ rise among luxury cars in Europe that:

Customers had to fall in love with the complete experience, the product and the customer handling, this made the Lexus brand famous, then customers were more loyal and told their friends about Lexus.

“A car is new and exciting for a while, but after the ‘honeymoon’ people get used to it,” Mr. Brimson explained. “After one or two service cycles the car is just a tool. But if customers have a real relationship with the retailer, that helps to bond them to the brand.”

Brimson went on to describe why focusing on the experience is actually quite difficult:

…automotive retail has remained largely [unchanged]. By looking through [the customers’] eyes we learned more. We saw that we were forcing them to perform the way WE wanted.

E-mail is a great example. Many of our premium customers live on their Blackberries, an increasing percentage want to use e-mail or use mobile internet, just as they would normally in their jobs. But very few retailers have processes to respond to e-mail in anything like an acceptable time, so customers really have to use the phone.

So forget the quarter-inch drill; go for the experience. And the experience starts and ends when the customer thinks it does, not when you think it does. Sticking with cars for the moment, the customer experience begins when she first thinks, “I wonder what it would be like if I bought a new car? What’s out there?”, not when they walk through the door of a dealership. This means that the experience includes how easy it is for them to get information about the cars you sell, if they can find the information that they actually want (even if they don’t know what they want), if that information is satisfying to them and encourages them to continue moving forward, and so on.

And the ideal is that the experience persists even beyond the customer’s life span, that they have talked glowingly about you and what you do so that their kids or their friends want the experience as well. You are aiming not just womb-to-tomb, but beyond as well. Their experience becomes a permanent relationship (which is fanaticism) – and that leads me to the next trend.

6) Eat your own lunch – and everyone else’s

The world changes. This is such an obvious statement that people never really think about what it means. It implies that your market changes as well. And that means your offerings have to change. Yet, many companies resist the idea of introducing significant changes to what they do for fear it will eat into their existing sales and hurt their revenues. The reply is obvious, and again, it’s so obvious that people never actually think about it: whether you introduce changes that eat into your existing sales or not, someone else will. So the question then becomes: do you want to cannibalize your sales, or let one of your competitors do it? This is an old, established principle in innovation, but one that is so well known that people take it for granted – and don’t, as a result, make use of it. And with the speed with which things are changing now, this old principle takes on a new urgency.

Worse, you also need to take risks when you introduce new things, precisely because the world is changing so fast. If you make timid changes, you risk being left behind.

I have to come back to Apple again, because Apple does this better than anyone else. Apple popularized the use of the mouse-and-desktop metaphor. (They didn’t invent it – that was done by Xerox at their PARC research group, but they were too timid to exploit it.) And Apple were the ones to first push customers to move beyond it. People still use mice with their computers – but Apple found them too limiting for their iPods and iPads, so did away with them, substituting touch and tap technology instead. They were the first to do away with floppy disks, and, more recently, with any kind of external drive, including CD and DVD drives in their MacBook Air.

Yet, what Apple and Jobs did was far more profound than just leapfrogging their own creations. They went outside of the computer industry and ate other industries’ lunches as well. In the words of a New York Times article (David Carr, “Steve Jobs Reigned in a Kingdom of Altered Landscapes”, August 27^th, 2011, NYT website), “[Jobs] didn’t set out to destroy existing business models, he just noticed their lack of relevance and came up with new ones that kept consumers happy and Apple fat. Along the way, he changed the vocabulary of media: Songs became files, subscriptions became apps, and media became just one more way to make that thing in your hands appear all the more magical.”

So, when you set out to innovate, make no small plans, and don’t even think about protecting your own business and your existing sales. Think beyond the boundaries of what you sell your clients, and think instead what you could do for them with what you have.

7) Speed kills – your competitors

Carrying on the discussion of how Apple has grown seemingly effortlessly over the past 10 years, they have forced the pace of change to the point where competitors are struggling to catch up to their last innovation while they’re already working on its successor.

I remember when Apple introduced the iPhone in January of 2007. There was a lot of criticism of what it couldn’t do, and of its shortcomings. I thought such criticisms, while perhaps warranted, were short-sighted because I knew that Apple’s pattern was to introduce a product, and then immediately and rapidly work to improve it. Sure enough, most of the shortcomings of the original iPhone were corrected (or at least improved) in subsequent releases, first of the software operating system, and then of the device itself.

There’s even a management cliché about this process: “Ready! Fire! Aim!” Introduce your revolutionary device, even if it’s not quite ready for primetime. Meanwhile, work like fury to smooth out the shortcomings, and listen carefully to the bitching and complaining about it so you can make the improvements that will make a difference to people who are using it. Use the market as the beta tester, because waiting too long saps your speed and allows competitors to catch up.

Of course, speed can kill you, too, if you don’t listen, or don’t want to listen, to criticism of your offering, or are unwilling to change it. If you bet the farm on a new offering, and then refuse to tinker with it, you will create enormous momentum – towards the scrap heap. So, you need to keep ahead of your competitors, and force them to make bad choices and introduce poor imitations of what you’ve done – but you also need to treat your own offering as a poor imitation of what it is going to become when you improve it.

8) Make lots of small mistakes

This seems to contradict trend #6, but it doesn’t. In a handbook I created for my consulting clients, titled “Innovation and Leadership: Techniques to Lead Creativity”, I talk about why companies proclaim their dedication to innovation when they secretly loathe and despise it because of the risks it forces them to take, and the fear of failure that comes with such risks. I then suggest that the way to overcome that fear is to institute a process of continuous improvement (from the Japanese process of kaizen), introducing a steady flow of minor changes that, collectively, add up to massive improvements over time. There are two aspects of this that complement, rather than contradict, my “speed kills” trend.

First, when you create a culture of continuous, all day, everyday improvement, and everyone is always looking to do things better today than they did the day before, the cumulative changes add up very quickly, supporting the Need for Speed. Creating that culture is not easy, but in today’s market, I believe it is essential.

And second, when you use creativity-enhancing techniques in the quest for a steady flow of small improvements, you will occasionally stumble across a really big idea as well. Of course, most people either back away from a big idea because it’s so scary, or fail to recognize it at all because it seems so different, so out of context, so “outside the box.”

What’s more, pursuing incremental improvements on an on-going basis does not preclude making a concerted effort to find the Next Big Thing, either, although that is harder.

I worked with one client, taking them and their people through an “Inventing the Future” process. At the end of that process, two things happened. First, the workshop participants came up with what I thought was a brilliant new approach to their market that was a relatively simple (although not easy) extension of their existing customer service process. It would have created substantial market differentiation, setting them apart from everyone else in their very busy market. Yet, their reaction was definitely ho-hum. They didn’t see it as being that important. This is, in my mind, a classic example of failing to recognize. They were looking for something dramatic and flashy. This was – but they didn’t see it that way, and so chose not to pursue it.

Meanwhile, as a result of preparing and running the visioning sessions for them, I had an idea that went ’way outside the box, bringing technology into their business in a dramatically new and different way. However, they hadn’t hired me for my ideas, but for my ability to stimulate their thinking and facilitate their brainstorming process. Indeed, this was explicitly spelled out in the terms of engagement. Accordingly, I approached the management privately, told them I had an idea that might be of value to them, but warned them it was a radical departure from their current way of doing business. They didn’t want to hear about it. They didn’t ask any questions. They basically just brushed it off without knowing anything about it.

9) Use technology to make magic

When people marvel to me about all the changes technology has introduced over the past 10 years, my reply is always, “You ain’t see nothin’ yet!” Technology is advancing so quickly that it’s almost inconceivable what we will experience over the next 10 years.

Yet, technology is doing things that even 20 years ago people would have dismissed as improbable, impossible, or thought was just plain magic. So exploit that magic. You may be in an established, mature industry that uses very little technology. But look for ways of improving your customer experience of your offerings by using technology to make it magical. Again, Disney is great at this.

I was on one of their new cruise ships in January of 2011, and while there were lots of interesting, well-executed things on this ship, one thing caught my imagination and stuck in my mind as really neat: they had magic pictures on the walls (or bulkheads, if you insist). When you were walking through some of the public areas, there were all kinds of pictures, illustrations, photographs, and decorations from their movies and creations. A few of them, though, were magic: while they looked like pictures, for example of a pirate ship, when you walked up to them, a motion sensor turned it from a static picture to a cannon battle between the pirate ship, and a port city fort, complete with sounds.

There was no compulsion to do this. Disney’s earlier ships had static decorative pictures and such on the walls. But this was an opportunity to use technology to make something ordinary into something magical. And since Disney sells the experience of magic (even though they don’t actually have magic), it was a natural progression for them.

You don’t have to be Disney to do this. You could run a lunch counter, and offer your regulars the opportunity to order their lunches by email. Once you had that established, you could email photos of what they normally ordered, along with suggestions for sides that might complement such dishes, and an offer for a (first time) discount if they were ordered together. Once you got your regulars used to that, you could match similar taste combinations from the things that other customers who liked what this customer liked, and make suggestions of things they haven’t tried, along with a (first time) discount to encourage them to experiment. In short, you could use technology to look for ways to make their experience (Trend #5) easier, better, and more memorable. In fact, I’m sure there are lunch counters that are doing just this, even though I don’t know about them.

“Any sufficiently advanced technology is indistinguishable from magic,” said author Arthur C. Clarke. Technology is making magic on a daily basis – so find a way to bottle this lightning, and turn it to your advantage.

There are many other developments in innovation beyond what I’ve said here. I started work on this blog by listing ideas, and then wound up discarding a bunch of them in order to focus on the ones I thought were most relevant right now. If you are truly interested in innovating, then it must become a way of life, not just something you think about when reading an online article.

And if I can help, contact me.

The stock markets have fallen out of bed since President Obama signed the ludicrous debt ceiling deal. I don’t wonder about that; what I wonder is why they took so long. I was expecting stocks to fall two weeks earlier than they did. But now the question becomes: What happens next? This is actually a much deeper question than it seems, because it goes far beyond just the behavior of stock prices and markets. But let’s start with stocks.

When I started work on this blog, the S&P 500 index was at 1,119 which put it almost exactly half way between the October 4th, 2008 high of 1,565 and the March 6th, 2009 low of 667. Specifically, it was 452 points below the high, and 446 above the low, so almost exactly half way. (And if you want to look at that in percentage change terms, it’s 40.4% down from the high and 39.9% up from the low.) That would seem to imply that while there may be more risks yet in holding stocks, we may be getting through the worst, and should start compiling lists of stocks we want to buy. Indeed, since I went to virtually all cash in my personal and corporate investment accounts more than two weeks ago, I am waiting for buying opportunities, and creating just such lists.

But there’s an old stock market cliché for times like this: Never try to catch a falling knife. Don’t buy when markets are in free fall, because you’ll only wish you waited longer. Barton Biggs, a well-respected market analyst and money manager, was interviewed on Bloomberg TV, and said he had a list of great stocks that were now bargains, but that he wished he’d waited longer to buy them – and that was 150 points higher. So, that being said, what are the risks, and how will we know when the worst is over?

Well, first of all, you need to consult a properly licensed investment advisor for specific information, someone who knows your financial position, tax status, age, risk tolerance, cash flow, and all the other pieces of information that go into making a proper assessment of your investment needs. I am not that person, and this is not intended as investment advice. Here endeth the small print.

Risk management

Let’s take a step back and see if we can find some benchmarks. To do so, I want to go back to a concept that I’ve written about repeatedly in this blog, and use regularly with my consulting clients: the ratio of risk managment. What are the possible risks? And what are the potential returns? Once you’re assessed those, you’re in a better position to make decisions, rather than just guessing whether the markets will go up or down.

By my definition, risk is the cost of being wrong. So, if we invest in stocks now, or don’t invest in stocks now, what are the risks either way? Let’s start with the potential positive risks, because, unfortunately, this is a much shorter list.

Could the markets surprise us on the upside? There are three factors that drive stock prices: interest rates, corporate earnings, and investor psychology. I don’t foresee any upward pressure on interest rates unless there’s a true financial panic. Even if there were a panic, there are so many trillions of dollars invested in U.S. Treasury securities that there is nowhere else for them to go. Accordingly, absent an end-of-the-world type scenario, I believe interest rates are a neutral influence at worst, and probably slightly positive.

Next are corporate earnings, which have been surprisingly good of late. Yet, I believe the outlook for the U.S. economy – and all others that are at least partly reliant on it, which is everyone – is worse now than it was before the manufactured debt ceiling crisis. That political stunt by Tea Party fanatics shook people’s faith in the American political system, and raised doubts about the American economy that weren’t there before. As a result, more people are talking about a double-dip recession now than before, and such talk tends to become self-fulfilling. Moreover, falling stock markets tend to make people feel poorer, which makes them spend less, which slows demand, which slows the economy. All told, then, I would have to assess corporate earnings as being neutral at best from here, and possibly negative.

Finally we come to investor sentiment, which is always the hardest to get a handle on. Moreover, if the markets have a couple of high-flying up days, then psychology can change from being deeply fearful to being deeply greedy overnight. But one solid indicator of market sentiment which has been consistently good is market volatility. High volatility times, even when markets are rising, are times when there’s lots of uncertainty, which is why values seem to change overnight. The best environment for bulls is one where markets make a slow, steady advance, not ones where markets zip up, then down, then up again. And a handy index for this is the Chicago Board Options Exchange SPX Volatility Index, or VIX index (VIX:IND). This index recently reached levels unseen since April of 2009. All told, then, I would suggest that market sentiment is unsettled and nervous, which is definitely bad.

So could markets surprise us on by running away from us on the upside? There’s always that possibility, but I think the odds are pretty small that we will lose a lot by staying on the sidelines. If the market recovered to where it was in May, the S&P 500 could go back to 1360, which would mean we might miss a gain of about 22%. And that’s if the market took off so fast we couldn’t respond. So the risk of being left behind by the market is, in my view, relatively limited.

Possible Positives

Another positive development is that falling stock prices have also brought down commodity prices, notably oil. Since high oil prices act like a tax on the economy, lower oil prices clearly benefit economic growth.

And banks are generally in much better financial condition now than they were in 2007 – except those that have loaned too much to weak European sovereign credits.

Beyond these points, what might is likely to happen to the economy? Well before the phony debt crisis, the outlook for the U.S. economy was disappointing at best, with feeble growth, weak employment, and nothing on the horizon promising to change that. Now the outlook is worse, as I said, so at best we could see the economy return to that slightly depressing, feeble outlook. So, again, the potential to be surprised on the upside, or the return half of the equation, seems limited. Now let’s turn to the potential risks. Alas, here the list is much longer and more compelling.

Potential Negatives

I’m going to list the risks, and merely touch on most of them rather than go into exhaustive detail. The prospects are dreary enough without dwelling on them. I’m going to save the worst ones for last. Here are the major risks that I see now:

• Stocks go down because they go down. Markets develop a mind and momentum of their own, and while I don’t believe you should ever rely on momentum investing, it’s also clear that when investors become fearful, and especially when they panic, it’s dangerous to get in their way. In particular, investors, particularly boomers hoping to retire, were deeply shaken by what happened to their investment portfolios in 2008, and are likely to be faster to bail out on markets rather than try to ride them out. This increases volatility, which, as I’ve said, is a bad thing.

• A possible double-dip recession. There is no real reason why the U.S. economy should go back into recession. I had been expecting it to dribble along in a slow growth, jobless recovery that was disappointing. Now, though, the talk about a double-dip is, as I said, likely to become self-fulfilling. There’s no fundamental reason for it, but the phony debt ceiling crisis shook confidence, and ultimately the economy. And the markets run on confidence.

• America’s downgrade from AAA. This doesn’t help, but it is currently a split rating, with only Standard & Poor’s lowering America’s credit rating, and only on long-term debt. If the two other major agencies, being Moody’s and Fitch’s, were to follow suit, that would be an enormous negative, but that doesn’t seem to be in immediate prospect. Neither, though, is America likely to get its AAA rating back anytime soon. Canada was downgraded from AAA in 1992, and then got it back ten years later. But that was during a period of strong economic and productivity growth, and the Government of Canada, under Prime Minister Jean Chrétien and Finance Minister Paul Martin ran 10 years of budget surpluses, paying off big chunks of government indebtedness. The odds of America doing that are vanishingly small. The only reason American debt has performed as well as it has so far is because, in the words of one commentator, “It’s the best looking horse in the glue factory.”

• Weak economic growth compounding American government indebtedness. The Tea Partiers have overlooked the primary fundamental of government finance: that government revenues and expenditures are inexorably tied to economic performance. A weak economy will sap government revenues and force up expenditures, compounding deficits, and piling up debts. Slashing spending in such an environment cuts jobs, lowers economic growth, and increases deficits. This is precisely what happened in the 1930s under President Herbert Hoover. He and his counterparts in Congress kept slashing spending to try to bring the deficit under control, only to find that economic growth fell further, increasing the deficit. In response, they slashed spending even more. It became a vicious cycle, and this is still the textbook example on how a government can turn a recession into a depression. Unfortunately, right-wing politicians in America seems to be embarking on precisely the same policies now.

• Another negative that has ramifications that go far beyond stock prices is the high rates of unemployment for men and young people. We can see the results in the riots in Greece and Portugal, but now in London as well. In America, the official unemployment rate is 9.1%, but the percentage of working age (16 to 64) American men who are employed has fallen from about 85 percent in the early 1950s to under 65 percent now. Some put the actual unemployment rate of men in America at 25%, and that for young people at 45%. These numbers are hard to confirm, because unemployment surveys don’t include people who are so discouraged that they’ve given up even looking for work. Whatever the true numbers are, this is bad news economically, bad news socially, and bad for America’s future.

• The political deadlock in the American Congress. America has become steadily more polarized over the past 20 years. There have been many analyses of why this is, but I think there are two primary reasons. First, the media have discovered that it is more profitable to be biased and outraged than it is to be balanced and thoughtful. Fox News in America, and News of the World in England are or were the exemplars of this trend. And with the splintering of media caused by the Internet, people can now choose to consume only those viewpoints with which they agree. This creates the echo chamber effect, where like-minded people reinforce their own prejudices. The result is rather like being surrounded by yes-men: you become convinced that your point of view is the only valid one. This pushes people with different viewpoints farther apart, and causes them to summarily dismiss any views that don’t coincide with theirs as being obviously, even maliciously wrong.

The other reason is jerrymandering. As I’ve discussed this at length in another blog (found here), I won’t go through the arguments again. But the result is that the extremes in American politics are being over-represented, and the center is being ignored. According to The Economist newsmagazine (14 April 2011), the results are pretty stark: “On average, House Republicans have voted with their party’s majority 91% of the time and Democrats 90% of the time. The picture is very similar in the Senate.” This is making American ungovernable, as was clearly on display during the unnecessary debt crisis, and an America that cannot govern itself becomes a danger to itself and others, geopolitically as well as economically.

• Finally, the greatest immediate risks out there right now relate to the financial crisis in Europe. Greece is functionally bankrupt, and all that is left is to decide how to cope with the financial mess. The other weak members of the EU are being shunned by the credit markets with more or less justification, but the net result is a potential run on European sovereign credits. The results of this could be very much like the run on Bear Sterns or Lehman Brothers in 2008, with the same kind of knock-on consequences. Worse, this financial crisis could lead to the possible collapse of the Euro as a currency, which would endanger the survival of the EU. And that would be a very big economic (and financial) shock indeed, especially as the world’s central banks don’t have as many resources left to battle a global financial crisis.

The Costs of Being Wrong

So the cost of being too pessimistic is the potential to lose a market gain of perhaps 20-25%. The market cost of being too optimistic would be a repeat of the kind of bear market we saw following the 2008 market panic, which could be a further 40% drop. But the greatest risk is that the problems in Europe and America are compounded by policy mistakes, such as those followed by Herbert Hoover in the 1930s, or a market collapse brought about by forces that overwhelm the world’s central banks, such as the collapse of the European Union with the subsequent economic catastrophe. Either of these could produce a market drop similar to that of the 1929 to 1932 period, which was a fall of 89% would take the S&P 500 down to the vicinity of 170 points – an 85% drop from where it was when I started writing this blog. That, and the very dangerous economic fallout that would come with it, are the real risks.

So if you’re only mildly pessimistic, weigh the potential for a 25% gain against a 40% drop. If you’re really scared, weight that 25% upside against an 85% downside. Add in your assessment of the probabilities of each, and place your bets accordingly. As for me, at the moment, I’m staying on the sidelines and watching the carnage, biting my fingernails all the while.

There’s an unusual amount of dissension among economists and other commentators about whether we’re heading towards higher inflation or devastating deflation, and whether the economy will continue to grow, or slip into a double-dip recession. This is happening because we are in uncharted waters, with few, if any, precedents to guide us.

My own view is that the American economy will continue its anemic growth in a mostly jobless recovery; that the prices of necessities, particularly food and energy, will continue to tick upwards, gnawing away at workers’ real take-home pay; and that the economy’s precarious growth could be tipped over into a renewed recession by one of several different crises. I believe, in short, that all of the scenarios described above are possible. So, how do you plan for the future, whether it’s your investment portfolio or your company’s marketing plans?

Let’s start by looking at the various different forces at work on the economy today.

Inflation

Those concerned about inflation are connecting dots and concluding that inflation or even hyperinflation are ahead of us. They see the U.S. Federal Reserve Bank (the “Fed”) pour newly-printed money into the economy via so-called quantitative easing, and they watch oil and food prices rise, and decide that one is causing the other. And since monetary inflation, caused by printing too much money, affects all prices, oil and food prices are merely harbingers of a much broader, more rampant inflation. This is not the case because these two dots aren’t, in fact, connected.

The Fed is, indeed, printing money, but it’s a kind of money with a relatively low inflation potential. Normally, the Fed, or any central bank, creates money by encouraging the banking system to create it. They do this by lowering reserve requirements, or by lower interest rates. Reserve requirements are the amount of cash that banks must hold for every dollar of money they loan out. Since this requirement is a small fraction of the loans on their books, every dollar in increased cash reserves creates many dollars loaned out and placed into the economy. Likewise, lowering interest rates makes it more attractive for corporations and individuals to borrow money, increasing the loans outstanding, which again multiplies the amount of money in the economy. This is high-impact money.

What the Fed is doing is almost literally printing money, then using it to pay the government’s bills. (There’s a bookkeeping entry where the U.S. Treasury issues bonds, then the Fed buys the bonds for cash, which the Treasury then uses to pay bills. Hence, the U.S. government borrows from itself, and prints money as a result.) But while this money winds up in the economy, the effect is only of the amount of money printed, not some multiple of that amount. This is a technical issue, but the effect is that while, yes, there is some inflationary effect from the Fed’s quantitative easing, it is nowhere near as important as the inflation hawks fear, especially in an economy where demand is weak, and there is virtually no leverage for workers to increase their wage demands.

Meanwhile, the prices of food and oil are going up because of the supply and demand for food and oil, without reference to the amount of money being created in the United States. Hence, the prices of food and oil are going up even in Japan, which is experiencing persistent deflation, not inflation. Both are global commodities, and the demand for both is being driven by the rapid expansion of the Rapidly Developing Countries (“RDCs”), like China, India, Brazil, and Indonesia. Hence, in an example I’ve used before (because it’s so compelling), China’s middle class expanded dramatically during the 40 years from 1960 to 2000, with the result that China’s food consumption tripled in forty years. As the developed world economies emerged from recession (albeit slowly), and added their demand to that of the RDCs, the demand for both rose faster than the supply, pushing prices up.

Unless the developed world slips back into recession, or the growth of the RDCs slow significantly, the prices of both food and oil will continue to move up.

Deflation

Deflation is a widespread, persistent decline in prices, and is actually more dangerous than inflation (although neither are desirable). To see this, consider what happens if you’re considering buying a new car, but believe that the price will go down if you wait a month. Chances are you and others like you will postpone your purchase. A month later, if you are proven correct, but believe that the price of the car  you want will fall further in the next month, you’re likely, again, to wait to buy the car. Hence, deflation creates a vicious, downward spiral: people postpone purchases, which lowers demand, which causes prices to fall, which cause people to postpone purchases. When entrenched, deflation can wreak havoc on an economy – as has happened with Japan. Japan has experienced almost 20 years of recession-like non-growth in part because of deflation. (The Japanese government has also made persistent policy mistakes that have prevented the economy from breaking out of this cycle.)

So, are we likely to experience the same kind of persistent, widespread declines in prices? Based on what I’ve said above, not in oil and food, but what about beyond that?  In many ways that depends on what happens to the economy. If the U.S. economy continues to grow, even weakly, then the prospect of serious deflation is remote. I could see the possibility of weakness in discretionary consumer purchases, such as TVs and consumer electronics, if employment growth remains weak. When people are hurtin’ financially, they’re less likely to splurge on a large luxury item. So let’s turn to the prospects of a renewed recession, which is the scenario where I can see widespread deflation.

Recession

There are several reasons why this recovery is weak. First, it was provoked by a severe financial debacle, and such recessions typically take longer to recover from as people feel poorer. It will take time – years – for people to rebuild their balance sheets, and meanwhile, demand will remain weak.

Next, there is no group within the economy to really stimulate demand. Most recoveries are lead by the consumer, but as I’ve just said, that’s not happening this time. Governments, notably the U.S. federal government, have largely shot their bolts, and are now more worried about repairing their balance sheets. And businesses, which are actually in pretty good financial shape as a group, see no reason to overextend themselves. In particular, businesses are not eager to take on more staff. Instead, they are either asking their current employees to work longer hours or take on additional shifts as demand slowly rises, or they are investing in increasingly sophisticated automation. The knock-on effect of this is that employment is likely to stay weak. In total, then, this is a recovery without leadership.

A longer-term problem is that all countries are going to experience a squeeze in employment growth, but it will be particularly noticeable in the developed countries. First, a global economy implies a global labor force, which means that workers in Canada or America, for instance, are competing with workers everywhere. It used to be most noticeable in low-skilled industries, but as RDCs increase the number of highly educated people they have, and as they build up more sophisticated commercial bases, they are competing in broader swaths of the global workplace, including very highly skilled areas that used to be the exclusive preserve of rich countries. Meanwhile, in an attempt to minimize the differential in labor costs, companies in developed countries are automating as quickly as they can. This is helping in that companies that might otherwise go out of business are surviving, but even when they do, it means that they do so with fewer employees. Hence the economy will grow faster than the number of jobs.

Automation is also affecting RDC economies and workers as well, but their faster rate of GDP growth is masking the effects. Still, the Chinese government worries about not creating enough jobs to maintain social stability.

But beyond economic growth and employment growth, there’s another factor that’s in play: the fragility of governments, notably because of their heavy debt loads, means that the recovery is not as robust. It also means that the recovery would be easier to derail, much as an overloaded boat is easier to sink.

This brings me to my major point: we are vulnerable to nasty surprises or shocks. If, for example, Greece defaults on it’s debts (or perhaps I should say “when” as it seems pretty inevitable to me), this could trigger a re-evaluation of all sovereign and sub-sovereign (i.e., state and local) debts. This might throw a jurisdiction like California or Illinois into the spotlight, or trigger a run on Portuguese bonds. It could, in short, trigger a panic that could produce another financial catastrophe. Only this time, governments have fewer bullets available to stop a financial stampede, and we could well see the financial collapse that we so very, very narrowly avoided in 2009.

Is this likely? Probably not, but the odds of it happening are higher than I would like. And if a scenario like that does happen, then deflation is a real threat, and you can forget about inflation because even the RDC economies will slow or go into reverse.

So what do we do now?

The highest probability is still for continued economic growth in the developed world, albeit slower than we would like, and that’s how I’m placing my bets right now. I believe that the cost of necessities will continue to rise, but that it won’t degenerate into high, widespread inflation. This is consistent with a slow growth scenario coupled with rising demand from RDCs.

But I’m also watching developments very carefully, and have an exit strategy in mind in case I don’t like the way things develop in Europe, with the foolish, almost-suicidal discussions over the U.S. federal debt ceiling, and with credit watches on shaky governments (both national and American states). I’ve been saying this for some time, and it may be that readers are getting bored with the message, but this is a time to plan for the worst, and hope for the best. I’m not sure, in the current situation, what else you can do.

© Copyright, IF Research, June 2011.

I’ve noticed a strange development recently: two indicators that I follow for inflation and deflation are both rising, implying that we may be headed for a period of both inflation and deflation at the same time. Since no reputable economist that I’ve ever read would conceive of such an apparent oxymoron, this caught my attention. First let me describe the indicators, discuss how it might happen despite the apparent contradiction, and then talk about some of the potential implications and what you might do about them.

These indicators are based on the number of times the words “inflation” and “deflation” appear in online news media, as counted by news.google.com, and I’ve been tracking them weekly since September, 2005. Because they’re based on media reports, they probably indicate more about sentiment than about economic developments. This idea is based on a similar indicator that I follow that tracks the incidence of the word “recession.” It’s been known for decades that tracking the incidence of “recession” can be a leading or real-time indicator of recession, in part because it may become a self-fulfilling prophecy: the more people talk about a recession, the more worried they’re likely to be – and become – about the possibility. Below is the “recession” indicator up to this week. Because a recession is a negative thing, I’ve inverted the Y axis, so that the greater the number of times that the word “recession” appears, the lower the line falls.

You’ll notice that the indicator implied that the economy collapsed in October of 2008, bounced off the bottom in February of 2009 and began a rapid climb back, but then slowed significantly in the late Spring or early Summer of 2009. Since mid-Summer of 2010, the indicator has essentially stalled. This pretty much matches what the economy has done: the world didn’t end, and the economy did recover, but hasn’t come even close to recovering its pre-crash strength. Now we seem to be experiencing slowing economic growth, and a sluggish, painful recovery. Moreover, if anything, this indicator foreshadows even more anemic growth ahead for America – not a double-dip recession, but barely a recovery. This will have significant implications in a whole range of areas, including the 2012 presidential election. I’ll circle back to these implications a little later.

Now let’s look at what the “inflation” and “deflation” indicators seem to be saying:

First notice that from August of 2008 (line A) until December of 2009 (line C) the use of the term “inflation” declined dramatically. This is to be expected, as a softening economy isn’t expected to have rising inflation, so inflationary expectations would naturally be in decline as the economy went into recession. Next, notice that the incidence of the word “deflation” started to shoot up in August of 2008, just as the incidence of “inflation” was falling. This, too, is to be expected: when an economy goes into severe reversal, the possibility of deflation grows substantially.

Why deflation is so dangerous

Incidentally, deflation is much more dangerous than inflation. If consumers think that the price of a car, for instance, is going to be lower next month than this month, they will tend to postpone buying. But if next month they expect it to be lower still the month after that, they will continue to wait. This creates a downward spiral of consumers withholding purchases, which lowers demands, which causes prices to fall, which causes consumers to postpone purchases further, and so on. This kind of stuff makes central bankers wake up screaming in the night, and explains why virtually all of the major central banks flooded the world with liquidity by printing money during the dark days following the Panic of 2008.

Interestingly, the incidence of both inflation and deflation declined around December of 2008 (line B). I interpret this as meaning that although the economy was still in recession (so that inflation expectations were low), folks concluded that the world was not going to end, so that concerns about deflation began to fall as well. This continued up to line C, in December 2009, and it is at this point that something strange begins to happen: expectations of both inflation and deflation begin to rise at the same time, and this trend continues today. What does this mean?

Well, it could mean that these indicators aren’t consistently reliable or worthwhile. I don’t believe this. I think this strange development means something important. Let’s look at the possibilities.

It could just be confusion in the marketplace…

First, it’s clear that there is a lot of confusion in the marketplace, and a lot of disagreement among economists and investors, and the indicators could just be registering the split in opinion. Those who expect rising inflation point to the unprecedented low levels of interest rates and the flood of liquidity produced by central banks. In normal times, you would expect that this would lead to asset booms and rising consumer prices – inflation, in short. Meanwhile, those who expect deflation point to high debt levels, especially in the “rich” countries, which are leading to “deleveraging” (which means paying off debt instead of spending money), and the subsequent anemic demand. They then draw parallels to Japan’s experience since the 1990s, the so-called “lost decades,” when Japan suffered through an extended bout of deflation, and a stalled economy with effectively no growth. It’s pretty clear that most (but not all) central bankers in the developed world fall into this crowd, with Ben Bernanke of the U.S. Federal Reserve leading the pack. Time alone will tell which crowd is right. There are legions of commentators on both sides of the debate, which makes the situation even more confusing.

But let’s consider the possibility that both indicators are right, and that this isn’t an oxymoron: is it possible that we might see pervasively rising prices and pervasively falling prices at the same time? That we might experience both inflation and deflation simultaneously? Well, first we have to explore how that could happen, as it seems to be a contradiction in terms.

…or it could be something much more significant

I think the key is that we are going to see lots of prices rising, and lots of prices falling at the same time, and I think it’s going to happen because of a fundamental realignment in the world’s economic order. The Rapidly Developing Countries (“RDCs”), like China, India, Brazil, Mexico, Malaysia, Indonesia and others, are growing much more rapidly than the developed countries. Indeed, while the developed countries of North America, Europe, and Japan continue to struggle with anemic growth in the range of 2% or less, the RDCs have bounced back vigorously with growth rates in real GDP as high as 10%. Moreover, the RDCs, because of their higher growth rates, represent a steadily increasing share of global GDP. Because of this, the RDCs are having more and more influence on the global demand for goods and services, and particularly for commodities. In particular, they are driving up demand for food, oil, copper, and many other essential items.

Take China, for instance. The average food intake for a Chinese citizen in 1960 was about 1600 calories a day. As China prospered, and developed a middles class, one of the first things its more prosperous citizens did was to feed their children and themselves with more and better food. As a result, by 2000 the average Chinese was consuming 2600 calories – and an increasing share of that 2600 calories was in the form of meat, which takes far more resources to produce – and is therefore substantially more expensive – than an equivalent number of calories from grain. Moreover, Chinese population doubled in that period, from 660 million to 1.3 billion. The overall result was that China, as a nation, tripled its consumption of food in a 40-year period – an astonishing rate of growth. And the same increase in middle class prosperity also drives the demand for consumer goods and the means to produce them (although not as dramatically as the demand for food).

Now step back and consider that the same thing is happening in all of the other RDCs: as their billions of people move out of poverty into a more prosperous middle class, their demand for goods and services, especially food, will skyrocket. And this is going to be the major driver of global growth in demand for food, for consumer goods, and for the plant, equipment, and materials needed to produce them. As a result, I fully expect that the global economy is going to experience significant inflation, starting with food and energy.

While the RDCs grow quickly, the developed countries get poorer

Now let’s talk about what is happening in the developed world. The economies of North America, Europe, and Japan are experiencing continuing and protracted weak growth, high rates of unemployment, and a fear-inspired desire to pay off some of the mammoth debts that they have incurred. The result is that demand will be weak, and companies will struggle to sell their goods and services. At the same time, competition from the emerging economies of the RDCs, coupled with increasingly powerful and sophisticated automation in the developed world, is putting downward pressure on the prices of consumer goods, most of which are at least to some extent discretionary. Families can usually postpone buying a new car, have a washing machine fixed instead of replaced, or tell Junior that he has to live with his 3-year old game console instead of getting a new one. The result is that the setting is right for deflation in many consumer goods. Consumers will step back from that marketplace – indeed, in many areas, they have already stepped back – which will put downward pressure on demand and prices. And when consumers see that prices of consumer goods are falling, they may decide to wait some more – especially as an increasing share of their paychecks may be being taken up in buying essentials like food and energy. This puts further downward pressure on demand and prices, which encourages consumers to wait even more.

What this means is that the cost of essentials will go up (inflation), while the prices of discretionary goods will go down (deflation). And what this means is that consumers in the developed world effectively become poorer, spending more of their incomes on essentials, and less on discretionary luxuries, even as consumers in the RDCs move out of poverty, and start having more money to buy things beyond the essentials. This development could mean that there is a further leveling of standards of living between the “rich” world and the “poor” world.

Now let’s look at some of the implications of all this, and let me start with something that’s a truism in the futurist community: Someone always benefits from change. Given the relatively bleak outlook in the developed world, the first and most obvious way to benefit from the changes that I’ve projected would be to focus on building business in the RDCs. That’s easier said than done, but is clearly something that all businesses should be thinking about.

Someone always benefits from change

This truism also means, though, that companies should be looking for opportunities at home as well. Let me draw an analogy. I’ve written two books on entrepreneurship, drawing on my experience working with entrepreneurs when I worked in venture capital financing. One of the things I suggested to those wishing to start a business is that they should look at entering mature, slow-growth or even declining businesses, which I collectively called “ugly industries.” The reason I suggested this is that such industries attract very little competition, and the entrenched companies tend to plod along, doing the same old things in the same old ways. Accordingly, it’s often relatively easy to enter such industries with fresh perspectives, new ideas, and pick up market share relatively easily. And if you can gain market share, even in a declining industry, you can make good money.

Likewise, in the current environment, many companies have just hunkered down, and are waiting for good times to return. They’ve laid off people, slashed advertising budgets, and are mostly relying on price cutting to maintain their markets. This makes it a great time for companies with imagination and a willingness to innovate to come up with new offerings, better offerings, more efficient products, more inventive pricing, hire creative people, and generally wreak havoc on their catatonic competitors. I’m not saying this will be easy, but the history of business is filled with companies that started and thrived in bad times, including GE (1873), Newsweek magazine (1933), Hewlett-Packard (1939), Hyatt Hotels (1957), Fedex (1971), CNN (1980), and Flickr (2004).

This is the new normal; get used to it

The next implication is that you shouldn’t wait for the economy to return to “normal,” meaning the way things were in the mid-2000s, or even the late 1990s. This is the new normal; anemic growth is going to be with us for some years to come while consumers pay down debts, and governments struggle to get their financial houses in order. Indeed, if you’re a pessimist, it can be argued that things aren’t going to get better, and the days of easy living are over for good, in part because of the aging of the boomers in the developed world, and the burden their retirement and health care needs will place on our governments and economies.

Turning to the implications for politics, bad times breed voter discontent. The pivotal moment in the Reagan – Carter debates was when Ronald Reagan asked voters “Are you better off than you were four years ago?” Voters decided they weren’t, and the peanut farmer went back to Georgia, while Reagan went to the White House. Indeed, the single most reliable predictor of American electoral success is how Americans’ personal incomes change in the year before an election. That would seem to strongly indicate a large Republican victory in this year’s mid-term elections. And given the outlook for America over the next two years – continued sluggish growth and high unemployment – I would guess that there’s an excellent chance that Obama will be a one-term president regardless of what he has done or will do in the next two years. He fell into an enormous mess but will get the blame for not fixing it.

The greatest danger

Next, there’s a very real risk that voters in the developed world will conclude that our problems here are being caused by workers in the RDCs stealing jobs, income, and prosperity from us. There is a tiny grain of truth in this, but nowhere near as much as people believe. It is true that China is cheating by keeping its currency artificially low, and that they are doing it to give their exports an unfair advantage in world markets. But it’s not as clear that if they let their currency appreciate significantly that it would make all that much difference to American workers or the developed economies. It would remove a significant irritant from global trade, but it would not be a panacea that would fix everything. And if China does not let its currency float, and America decides to impose punitive measures, this could lead to a truly devastating result: a global trade war.

This has happened before. There was an emergence of a global economy at the beginning of the 20th Century, starting with the reduction in tariffs in the 1890s among the major trading nations, and it caused a global boom. Indeed, one of the reasons that Roaring 20s roared was because global trade soared. The stock market collapse of 1929 exacerbated already mounting trade irritants, which produced mounting pressure on politicians to start protecting domestic jobs and industries. Protection always sounds like a good idea, but it only works if your trade partners let you get away with it by not reacting. Since that doesn’t happen, protectionism on one side breeds retaliation on the other side, which provokes counter-retaliation, and so on. In particular, the Hawley-Smoot Act passed by the U.S. Congress in 1930, and named for the two Republican senators who sponsored it, raised tariffs to levels that had not been seen since 1828 in order to “protect” American industries and American workers. Economists by the dozens begged President Herbert Hoover to veto it, but he signed it anyway, triggering equally massive retaliation by America’s trading partners. As a result, global trade fell by two-thirds in the three years from 1929 to 1932, pushing the world into a downward economic spiral which was only relieved (if that’s the word) by World War II. This is one of the lesser-known, but more important, causes of the Great Depression of the 1930s.

Ironically, all governments know that protectionism doesn’t work, and that a trade war would badly hurt everyone. Yet, in the heat of the moment, with voters demanding action, who knows what a nervous government might do?

One inescapable conclusion

Whether my interpretation about the possibilities of these two indicators turns out to be correct or not, one thing is clear: we are in uncertain and dangerous times. There are few useful precedents, and the risks are great. In particular, watch what happens with the currency wars, and be prepared to take unusual, even drastic steps to protect yourself, your business, and your family for the difficulties ahead. This is not a drill.

This article was originally published in Teach magazine.

For most of the 18 years I’ve written this column, I’ve focused on how education will change. This time, I’m going to focus on why it must change, and it relates to the purposes of education.

There are two major schools of thought about the purpose of education, and for some strange reason, most people believe they are mutually exclusive. One school believes that education should primarily be devoted to the enlightenment of the individual, to equip them with the mental tools to enable them to appreciate the fine and important things of life, and to enable them to contribute to their society and the world. The other school believes that education should provide the individual with the skills they need to  get a good job and a vocation, so that they can support themselves, contribute to the economy, and enjoy the material things of life. Both are right, and they are actually mutually supportive, not mutually exclusive – but that’s a topic for another day.

For both purposes, education must change. Let’s look first at the enlightenment of the individual. The world around us is being driven largely by commercial interests. This has become such a normal part of our lives that we hardly even notice the daily bombardment of advertising, and the pervasive, subtle pressures to own something, or behave in a particular way. And there is nothing especially wrong with society because these pressures exist – this pressure has largely been responsible for the richness and luxury of our daily lives. Yet, there is more to life than just commercial offerings, and most commercial offerings are shallow, and lack deeper purpose. Moreover, commerce and society generally tends to emphasize novelty, and while, again, there’s nothing wrong with new things per se, there is much more to life than just the novel.

On their own, few people would delve deeper than today’s satisfactions – which is where education enters the picture. Education provides context, history, art, depth of understanding, and perspective that most people would not otherwise be exposed to. This is part of the traditional role of education as it fulfills part of the purpose of culture, which is the transmission of our society’s values.

But the world is changing, and at ever accelerating rates. And the shiny baubles that novelty and commerce provide are increasingly being designed to be “sticky” or addictive. If education is to capture the attention of children, and persuade them of the value of what we know, what we have, where we’ve come from, and who we are, then it must compete with the increasingly effective seductions of commercial offerings. Assuming that just because we can hold students captive for six hours a day, 180 days a year, for 12 years is enough to allow us to brainwash them into appreciating the riches or our society is, in my view, a short-sighted and foolish view. Instead, I believe that education must compete for attention, not just for enforced time, and the only way we can do that is to seduce students into a state of fascination with what the wider world has to offer. As I say when I’m invited to speak to groups of students, we adults have perpetrated a cruel hoax on you: we’ve convinced you that learning is an intolerably boring process that you have no choice but to endure, when the reality is that learning is the most fun you can have with your clothes on.

We need to change that. Today’s students are, in my view, smarter, hipper, more skeptical, and less likely to believe propaganda than any other generation in history. They know that no matter what the school system tells them, the odds of them needing, wanting, or using most of the crap we teach them is vanishingly small once they leave their formal education. And yet, there are things that they will need to know that we’re not teaching them, and there are things they would love to know if we could present them in a way that doesn’t bore than pants off them. And as far as I can see, the only way we can seduce students into loving education is if we approach that education by appealing to those things that the individual students themselves are passionate about. We have to stop teaching the curriculum, and start teaching the individual – each individual, every single individual, and teach them as individuals, with unique interests and abilities. We have to stop teaching Mr. Smith’s grade 11 English class, Ms. Phansalkar’s grade 9 geometry class, or most of the groupings that assume that 25 kids are all the same simply because that makes education simple for us (and excruciatingly boring for them). And I don’t see any way that our current education system can achieve the level of interest or seduction necessary to compete with the enthralling, but shallow, offerings of commerce and society.

Now let me turn to the vocational aspects of education. And if anything, the need for change is even more compelling here.

We are all aware that countries like China and India, plus fast gaining countries like Brazil, Mexico, Indonesia, and Malaysia, are providing enormous competition for low-level and low-skilled jobs. What is not as well known is that these same countries are aiming for the best jobs that require the highest levels of education. They will not be satisfied with low-skilled jobs that don’t pay well and offer little opportunity. This means that our students will be competing with the best in the world in almost any field. Worse, they are starting at a big disadvantage: our school days are shorter, our school years are shorter, and our society no longer has the devotion to higher education that parents in developing countries have.

Some commentators and politicians contend that the way to deal with this issue is to lengthen school years and school days, pile on the homework, and really get “back to basics.” I think this is precisely the wrong answer, because it means making our education system even more boring than it already is. Moreover, we are headed into a world where creativity and innovative thinking will be more valuable than rote learning of any depth. Indeed, what’s the point of memorizing facts if you can command them with a wave of your search engine? Understanding and context, on the other hand, are critically important. Accordingly, if our kids are to compete with smart kids from around the world, our children will be better equipped if we focus on helping them identify their peculiar talents and abilities, and then develop them.

But there’s another threat that is, perhaps, even more worrying than rising competition from smart kids abroad, and that is automation. Most people are familiar with Moore’s Law, coined (and repeatedly reframed) by Gordon Moore, one of the founders of Intel. In economic terms, Moore’s Law states that computers will double in speed, and halve in price, every 18 months. Yet, it turns out that Moore’s Law is wrong because it’s too conservative. Moore’s Law posits an exponential growth rate – which means a constant rate of change (i.e., doubling every 18 months). But computers are evolving faster than that, and not only is the rate of change accelerating, but the rate of acceleration is increasing. As a result, a rough estimate indicates that computers will become about 1,000 times faster and more cost-effective over the next 10 years. And, as we develop new, more effective tools and techniques to harness this power, it means that automation will become dramatically more powerful in the next decade.

Automation has been increasing in power for millennia, since the invention of fire and the wheel. It really started to accelerate with the advent of the Industrial Revolution in the 18th century. Now it is moving at a rate that may be beyond our comprehension.

In the past, automation has led to a steadily rising standard of living, as well as new, better paying jobs that offer more opportunity. And so it still does. However, the major difference now is that automation is changing things so fast that the skills we develop at the beginning of our careers may not be enough to allow us to make a living for more than a few years – and eventually a few months – before they become obsolete. We are being thrown out of work at ever-faster rates, and if we are to hope to continue to work, we will need to constantly upgrade our abilities.

To some extent, the effects of both of these developments – foreign competition and domestic automation – are already evident. Whereas when I and my peers left our formal educations, we had a choice of jobs available to us, today students finish a university education, and spend years looking for anything more than menial labour. Worse, the next 10 years are going to make this seem like a happy outcome. Within the next 10 years, we will face an employment crisis that will shake the foundations of our society, our political system, and our economy. And the only answer is education, and education for adults as well as young people.

But it can’t be the same old education. It has to be education that emphasizes our human talents and abilities, our creativity and our ability to improvise and innovate. Skills training in most fields, with a few exceptions, will become obsolete at faster and faster rates. We will, instead, need to fall back on those things that are uniquely human, like art, teamwork, leadership, empathy, understanding, creativity, ingenuity, and all of the deeper aspects of human life and society. Computers, robots, and cheaper competition from abroad will take everything else.

And for those who say that the way to combat these things is by protecting domestic jobs, and halting the use of automation, let me say that like King Canute, you might as well try to stop the tide from coming in. Such efforts are not only doomed to fail, they will also make it even harder for us to succeed by diverting our attention and efforts away from the real task for tomorrow’s education: helping us to blossom into self-actualization, to become the best people we can be.

Do we have the wit to see the problems that are racing towards us? And do we have the will do to something about them? Those are the questions that will determine why we need to change education.

© Copyright, IF Research, September 2010.

If we’re lucky, 2010 could be a lousy year. If we’re unlucky, 2010 could be a disastrous year, worse than 2008, because there are potential nasty surprises lurking out there. Such surprises could precipitate another, even worse financial crisis, and dump us into a global depression, instead of the recession from which we are now emerging. I’m going to deal with the issue of the nasty surprises in a later blog, so just for the moment, I’m going to assume that none of them will happen, and the economic future will unfold about as it looks now. And, although I’m looking out to the year 2020, I’m going to start by looking at 2010 on its own before moving beyond there.

The Prospects for 2010

America is out of its recession, but I would hesitate to call what we have now a recovery. It’s true, U.S. GDP grew by a reported 3.5% in the third quarter of 2009, but that was, in many ways, misleading. In the first place, it was heavily influenced by government stimulus, especially the “cash for clunkers” program. Since government stimulus will be tapering off in 2010, and the car incentives are finished, this source of economic strength will be missing. But even more revealing, barely was the ink dry on the reports of 3.5% GDP growth when they were revised downwards to 2.8% – an unusually large and rapid downward revision.

To see what’s ahead for the U.S. economy, let’s start with public sentiment. One of my favorite indicators of economic strength is the frequency with which the word “recession” appears in the mainstream media (“MSM”). This indicator has been known and used for decades, but before the Internet, you had to be in the MSM to have the ability to perform this count. In 1995, I realized that I could do it myself using Googles’ news website, and since September of 1995, I’ve done just that every week, and then graphed the results. Here’s how this graph looks today (the X-axis has been inverted since “recession” is inherently a negative idea):

© Copyright, Richard Worzel, December 2009.

One of the interesting things about this indicator is the date when it said we felt the best about the world, which was July 30th, 2007. This was just five months before the indicator dropped suddenly at the beginning of 2008, indicating that concerns were rising. This subsided in the Spring of 2008, but then collapsed in earnest in October of last year – a trough from which we haven’t yet recovered. Clearly, we were all feeling fat, dumb, and happy in mid-2007, without realizing how bad the underlying fundamentals were. And the most important lesson to draw from this is that sentiment indicators are not good predictors of problems, only feelings.

Yet sentiment is important. It embodies what economists call the “animal spirits” of an economy, being the courage to go out and do things, like take risks to make and spend money, and the willingness to trust that the other side of a transaction can and will fulfill their part of an agreement. Without these feelings of courage and trust, people hunker down in a hole, don’t spend money, and the economy’s heartbeat stops, which pretty much describes what happened last year.

Now, looking at the chart again, we can see that although our “animal spirits” have recovered from the depths, we are nowhere near where we were at the beginning of 2008. We’ve climbed back, but seem stuck halfway – and that’s a pretty fair estimate of what I expect for 2010. The economy will grow – but slowly. Unemployment will stop exploding, but employment will be painfully slow in coming back. Indeed, employment typically is slow to return at the beginning of a recovery because business owners are still wary of potential problems, and because they can increase working hours, through additional shifts and overtime, without hiring additional staff. This increases productivity and profits without increasing risks – a good bet in perilous times, but tough on those out of work. So, the prospects for America’s economy in 2010 are weak, at best.

Despite this, the outlook for inflation is dismayingly bad. I consider the price of oil to be the bellwether of rising prices, because of its pivotal position in the global economy. The price of a barrel of oil dropped from $147 to $30, and has bounced back to over $70. Now, it’s true that $30 a barrel was clearly an overreaction by a market that was wondering if the world was coming to an end, but you still have to ask why it would bounce back so far and so fast. The answer, as it often is in this day and age is simple: China, India, Brazil, and the other Rapidly Developing Countries (RDC’s). They barely went into recession, or merely experienced growth slowdowns, which were over relatively quickly. As their economies bounced back, their thirst for oil began growing again. And when the developed country economies begin growing again, all of the bottlenecks that caused the price of oil to spurt upwards in 2006 & 2007 will come into play again, and the price of oil will, once again, spurt upwards, stoking the next inflation cycle. And because of the growing relative importance of the RDC’s in the global economy, we will all experience more inflation much earlier than we would normally expect in this economic cycle.

This same combination of RDC growth and developed world recovery will play out again and again beyond oil. Food will be one of the next places it will happen, followed by other commodities and resources. The net result is that we will start hearing about an indicator that went out of fashion in the 1980s: the “Misery Index.” The Misery Index is the unemployment rate plus the inflation rate, and reached an annual high of 20.76% in 1980[1]. For comparison, it reached a modern low in 1998 at 6.05%, and its post-World War II low was in 1953, when it was 3.74% If America’s unemployment rate sticks somewhere around 10%, which I expect it will, and inflation reaches 5%, which it might despite the weak U.S. economy, then the Misery Index will reach 15% – a level not seen since 1982 when Ronald Reagan was president. All of which is why I say that if we’re lucky, 2010 will be a lousy year.

Canada’s 2010 – Canada will have an uneven year, which is to say that some parts of Canada will do quite well, while others will continue to suffer. Most of the suffering will be done in Central Canada – Ontario & Quebec – because of their reliance on manufacturing, especially in cars, their overwhelming ties to the United States, and the strength of the Canadian dollar. All of these mean that the two former powerhouses of the Canadian confederation will now lag most of the rest of the country in recovery. Indeed, if the loonie continues to strengthen against the greenback, Central Canada could have an even worse year than the United States.

Meanwhile, those provinces that supply natural resources, particularly Alberta and Saskatchewan, and to a lesser extent B.C. and Newfoundland, will do much better. With oil strengthening, and food following, the two Prairie provinces will build on their previous strengths and outperform the rest of Canada, as well as the United States, and their strength could continue to boost the price of the loonie. The resource provinces will also increase their trade with the developing countries of the world, notably China. Indeed, I would suspect that we will see a return of corporate takeovers of Canadian resource companies that could cause the Toronto Stock Exchange to outperform most developed world counterparts in 2010.

All of this will add political friction between the new “have” and “have-not” provinces that will make life testy and interesting in Parliament in Ottawa.

RDCs – Meanwhile, the RDCs, again lead by China and India, but also including Brazil and to a lesser extent Mexico, Malaysia, and Indonesia, are bouncing back from a fairly traditional inventory-led recession or growth slowdown.

There is more to RDC growth than China. Everyone has heard of India, and India will continue to try to accelerate its growth. However, watch Brazil as well, which is becoming the next powerhouse after having settled its long-standing problems of political and economic stability. We will be hearing more and more about the giant emerging in South America.

China’s ambitions – One particularly important issue for the future is China’s pegging of its currency to the U.S. dollar, which means that it has effectively executed a competitive devaluation against the Euro, Yen, and other currencies while maintaining its undervalued status against the greenback. This will cause the U.S. trade deficit to continue to run unsustainably high, and will inflict even more damage on other developed country economies. This is not the behavior of a player concerned about its image in the world, or even in its own long-term enlightened self-interest, but it does accord with my beliefs about what motivates China.

I believe that China has two primary objectives that trump all other concerns; one immediate, and the other long-term. The immediate one is the Chin’s leaders are desperate need to keep economic growth high in order to keep employment growing. If they aren’t able to achieve at least 8% growth in real GDP per year, then by their own reckoning, unemployment will rise, and with it, social and political unrest. And, from what I’ve seen, China’s leaders are more concerned about hanging on to their political power – which means political stability – than anything else. The welfare of its trading partners pales into insignificance in comparison to this critical domestic need, especially when you consider that in 2007 – the last year of strong global growth – China experienced a reported (but unverified) 10,000 spontaneous demonstrations about economic and living conditions around the country. The Red Army may be large, and it may be strong, but it can’t be everywhere, so political instability scares China’s leaders like nothing else. Accordingly, if China’s economy needs exports for strong growth, then it will contrive to have exports at any cost, especially if someone else pays that cost. China is not the first country, or the only country to play the trade game entirely selfishly. Indeed, you could say they’ve stolen Japan’s playbook from the post-war era. But China is playing it very well, if cheating for narrow self-interest is your yardstick.

The second motivation is long-term: China wants to dominate the world, replacing America as the only superpower. This again is supposition on my part, but is, I think, pretty obvious. And if they want to supplant the U.S. as the only global superpower, than inflicting economic damage on your principal geopolitical competitors is not a bad long-term strategy, even if it costs you something in lost trade along the way. It reduces the amount of money your competitor has for military and diplomatic strength. It focuses their attention on domestic issues. And it creates friction between domestic political parties. All of these are helpful to a China that is eyeing the top spot, and would prefer to get there without military conflict.

Beyond 2010

If we assume, once again, that none of the terrible “what-if” scenarios happen, then what happens after 2010?

America’s economy will continue to recover, but more slowly than desirable, and more slowly than in earlier recessions. This was not a typical recession, but was precipitated by too much debt accumulated by consumers, state governments, and, ultimately, the U.S. federal government. It takes time to pay off debts and recover spending power after the excesses of the last 25 years, which is why this recovery will be so anemic. Moreover, with so much of the U.S. housing market still under water, with mortgages bigger than current property values, it will take a long time for home owners and mortgage lenders alike to recover from the scars. This means that 2011 and 2012 are likely to continue to be less than robust.

Beyond 2012, I expect that the U.S. economy, pulled along by the global economy, the Rapidly Developing Economies, and American ingenuity and grit, will begin to pick up speed. And unless some additional shocks or surprises occur, I would expect the economy to continue to grow, and prosperity to return, through the balance of the 2010′s. It will also be accompanied by persistent high inflation – perhaps not high by 1970s standards, but higher than we’ve been used to in the past 20 years or more. This may make it tempting, beyond 2012, for central banks, lead by the U.S. Federal Reserve Bank, to put on the brakes, raising interest rates significantly in order to slow inflation. However, higher interest rates will actually have relatively little effect, because this bout of inflation will be driven primarily by bottlenecks and shortages, particularly in oil production and food, as mentioned earlier. This is going to pose a real quandary for central banks: How can they temper inflation when it’s mostly caused by too little supply rather than by too much money? The only way to lower inflation in that kind of environment is to lower economic growth – and that won’t be very appealing to any central government after years of soft growth.

All told, then, this is going to be a fragile decade for America and her mature trading partners, and the potential for bad things to happen will remain high for quite some time.

RDC’s – The RDCs will continue to grow rapidly, boosting each other’s growth, and gradually pulling the rest of the global economy with them. They will be the principal drivers of the global economy this time around, not the U.S. The bigger question, and one worth watching carefully, is whether their consumers begin to increase their consumption, taking the place of consumption-happy Americans. And how the RDCs deal with the challenges of rising, and persistent, inflation will also tell a great deal about how mature their governments and central banks are.

Canada – Canada’s economy will continue to be uneven, with Ontario and Quebec lagging behind, and the resource economies moving forward with the prices of their resources. However, both Ontario and Quebec are committing significant resources to capture some of the new industrial strength of the green economy. This, along with the slowly improving automotive market, will gradually allow Central Canada to begin strengthening with the advent of the ‘teens of this decade. Meanwhile, low interest rates, kept in place to stimulate economic growth, may produce a bubble in real estate prices in Canada, especially in the major cities, that may threaten Canada’s stability. It would be ironic, indeed, if Canada dodged the bullet that knocked off the American economy in the financial crisis of 2008, only to get hit by it in the next economic cycle. And yet, that is, implicitly, what Mark Carney, the Governor of the Bank of Canada, has been warning for some time. As well, the leading edge of Canada’s baby boom will be entering their 70s by 2020, and that will lead to lower economic growth, and shortages of skilled labor in many areas of the economy. The next 10 years will be a decade of real potential combined with real challenges for Canada.

Europe – In theory, Europe should be the strongest region of economic growth in the developed world. Yet, it is going to struggle at least as much as America, if for different reasons. Britain’s housing market and mortgage market went through pretty much the same wringer as America, and it’s government ran persistent deficits through the fat years that leave it without much ammunition to face the challenges ahead. China has instituted what amounts to a competitive devaluation by pegging its currency to the U.S. dollar, which has been persistently weak compared to the Euro, and will make it harder for Europe to compete with China in world markets. But the clincher really is that Europe is old, and the labor forces of its member countries offer either no-growth or are shrinking. Since, simplistically, GDP growth is composed of labor force growth plus productivity growth, this means the either Europe must massively improve its productivity, or it is going to see its economic growth stagnate, and its share of global output shrink throughout the next 10 years.

Let me start by defining risk management as the process of asking the right questions about what might happen in the future, and then preparing the best plans you can to deal with events that might occur. Hence, if there’s a major pandemic, and if you’ve considered that possibility, have a plan prepared to deal with it, and the plan works reasonably well, then you have adequately managed that risk.

And yet, I very much doubt that any contingency plan, no matter how well you prepare it, will deal with everything that happens – you will still be caught by surprise in some regards. This is why you always need to do a “lessons learned” assessment after each crisis. Your task in risk management, though, is to both to be able to cope with problems as they arise, and to be prepared to change your plans when new, unexpected developments occur.

I’m going to approach risk management from a futurist’s viewpoint, not from the body of risk management literature, so my view will be different from the risk management texts that are out there.

And let me start by making three comments about risk management. First, the best kind of risk management is where you forestall problems rather than cure them. Hence, successfully promoting the use of condoms for safe sex is better than being prepared for a widespread outbreak of AIDS. Second, risk management can’t always allow you to stop problems from happening. You can’t stop a plane crash, because that’s out of your control, so the appropriate response then becomes containing the problems, keeping difficulties to a minimum, and producing the best possible corporate outcome in the most cost-effective manner. Hence, while you may not be able to stop a plane crash, you can make sure that you don’t allow too many key corporate leaders to fly in the same plane. And third, not all risks are negative. This last point is often not considered at all, or is considered to be outside the purview of risk managers, but I contend it is critically important to proper risk management.

Suppose, for instance, in-house research allows you to cut carbon emissions, reduce costs, and improve customer satisfaction (which, by the way, is not that far-fetched as it might sounds as it has been the focus of work I’ve done for number of clients). Or consider a significant increase in productivity, due to new technological tools. Does your organization have the awareness and ability to capture the benefits of such improvements, or will you waste the opportunity? I know that, for many groups, this has more to do with the responsibilities of senior management; my point is that not all the changes we face in future are negative, and managing positive outcomes can be just as important as managing negative ones – they just don’t get as much attention. I call this the “lottery effect”; if improperly managed, positive outcomes can be frittered away, as often happens when someone wins a lottery and blows all the money.

Three fundamental types of risk

Next, I believe there are three fundamental kinds of risks to be concerned about: Rapid onset, gradually developing, and unexpected.

Typically with rapid onset risk, you will have considered a catastrophic event, but when it happens, it’s still a shock because of the speed with which it occurs. Examples include SARS, a flu pandemic, a plane crash with senior management on board, or a major product defect that causes harm to customers or clients.

With a gradually developing risk, you can see it coming, but because it happens over a long period, no one day seems that urgent and you can usually justify deferring action. Examples include the rising level of financial stress due to an aging population, and the growing abuse of mortgage financing in the States from 2000 and before. Eventually such gradually developing situations reach a tipping point where they become a crisis. At that point, if you haven’t prepared for it, you can look awfully foolish. After all, after the fact, everyone saw it coming, so why didn’t you? This is precisely what happened with the financial panic of 2008.

Finally, let’s consider the unexpected. The unexpected risk is something that happens that you haven’t foreseen or considered, and to which you must respond. Among the more recent classic examples are the terrorist attacks of 9/11, the south-Asian tsunami of 2003, or a tornado hitting downtown Chicago.

The classic responses to these three kinds of risk also tend to vary, according to the type. The classic response to rapid onset risk is to deploy the contingency plans you’ve prepared, if they exist; otherwise people will treat it as they will an unexpected risk. With a gradually developing risk, the classic response is to ignore it, and hope for the best. With an unexpected risk, the classic response is panic.

You need to think through all three kinds of risk, and have plans to deal with them. Most of the effort devoted to risk management is spent on the first category, rapid onset risk, but you can be devastated by all three. It can be argued that the second category, gradually developing risk, actually falls more into the area of corporate management rather than risk management. That may or may not be appropriate, but however you define it, you still need to manage it. And, of course, managing the unexpected is, by definition, hard to do, but you can try to whittle down the types of things that are unexpected. I’ll return to this later.

Environmental scanning

Next, I’m going to discuss risk management in two parts. First, I’m going to survey the future, which is also called “environmental scanning,” and talk about some of the risks I see ahead of us at this time. Then, I’m going to talk about a particular approach to risk management. I’m also going to give you some tools to take home and use, and discuss how you can use these tools to improve your strategic foresight and develop appropriate contingency plans to cope with all three kinds of risk. So let’s start by talking about what risks are out there that we can see

Let’s start big, first with global health, and then the global economy.

We know we are experiencing a flu pandemic, but what we don’t know is how bad it will be. Although there have been deaths from the H1N1 strain, the number of deaths in the Southern Hemisphere was significantly lower than for the normally expected seasonal flues of recent years. However, this was also the pattern we experienced with the Spanish flu of 1918-20, so let’s review that pandemic. We don’t really know how bad it was, because there weren’t as accurate global statistics as there are today. However, the estimates I’ve read indicate that roughly one-third of the world’s population, or about 500 million people, caught Spanish flu, and between 10 and 20% of that third died from it. This death rate is between about 3 and 6 times normal, and would overwhelm our health care system.

Now transpose these sickness and death rates to your own staffs. Imagine having 12% of your staff sick at any one time, and having 5-10% of your staff die from a pandemic. What would that do to your company’s ability to operate? Probably decimate it, regardless of any contingency plans you’ve made – but the real issue becomes how badly you are affected, and how quickly and well you recover.

Of course, global pandemic plans aim to break the cycle of infection and transmission, so it’s quite possible that isolation and inoculation could keep these numbers down. But in your plans, this is the kind of rapid onset risk you need to be considering. So far, this kind of killer flu pandemic has been a once-a-century risk – but we’re due, and there is, now, a potentially nasty pandemic that we know is happening.

By comparison, there’s another pandemic that is also happening, but as a gradual onset risk, which is why you haven’t heard much about it. The rise of antibiotic-resistant bacteria represents a very real threat to public health, but its rise has been relatively slow and steady, so we’ve tended to ignore it. We know it’s happening, but there isn’t the same kind of outcry about it – it doesn’t get the media or political attention, even though it may ultimately claim more lives than the H1N1 flu.

Now let’s step back and consider a more complex probable risk. Suppose we get hit by a combination of events, such as the emergence of a hyperbug – resistant to all known antibiotics – while we are fighting the flu pandemic. This is not an improbable scenario: if health professionals are overworked and tired, or overwhelmed with patients even after triage, as might well happen in a flu pandemic, then they may get sloppy with protection procedures. Then, add to this the inevitable overcrowding of hospital facilities and there is a real increase in the probability of the emergence of a hyperbug, leading to substantially higher death rates, and a dramatic decrease in the effectiveness of health care facilities and practitioners. Have you thought about or planned for these kinds of combined risks?

The potential for nasty economic surprises

Now let’s turn to the economy. At this stage of the cycle, when the economy is starting to grow again, it’s easy to assume that things will continue to get better. That’s probably the case, but the economy and the global financial systems are still fragile, so we could be shocked by new nasty surprises that still might happen. I’d like to mention three possibilities, although there are others.

The first is that the American banks – and others – are now starting to register significant losses on commercial real estate loans. If things go badly, this could push more banks into insolvency, trigger a new run on banks, reigniting a financial crisis. These aren’t the same big, money-center banks, by and large, but a lack of confidence in some banks could easily spread throughout the system, as we saw last October.

The second is one we’ve all rather conveniently forgotten: toxic debt. It was lack of due diligence on the part of all the financial players in the States – and elsewhere – that led to the creation of all of the toxic, asset-backed securities in the first place, and there are trillions of dollars of this stuff still out there. At some point, someone has to figure out how to value these securities – which may be impossible – or write them off entirely. However they are dealt with, someone is going to have to take big losses – and taxpayers are almost certain to figure prominently in this group.

And the third, and potentially most dangerous, is a wild card: the possible insolvency of the government of the United States. Let me cover this with a quote from the blog I posted on my website in June, 2009, “Is America Too Big to Fail?”:

“… the U.S. federal government, unless it makes a Herculean effort to change direction, will fail. … With the U.S. already the biggest debtor nation in the world, with its biggest [external] creditor, China, already musing publicly about whether the U.S. government is capable of supporting the debt loads projected, and with market players musing about whether the U.S. government will lose its AAA credit rating, who is going to want to step up and buy more U.S. securities than have ever been sold before? Why would any sane investor want to take that kind of risk? … If the American government tries to sell all of this new debt, and doesn’t find enough takers, than the U.S. government won’t have enough money to pay the bills it is so freely running up. Its checks (or cheques) will start to bounce; it will be functionally bankrupt.”

Am I sure that these things will happen? No, and I clearly hope they don’t. But the difference between a crisis and an opportunity is foresight, and foresight implies taking a hard look at reality, whether you like it or not. And just as clearly, you need to have a Plan B ready to deal with these kinds of possible shocks. I would classify a possible default by the government of the United States as a gradual onset risk – and, as such, one that we all tend to ignore.

The aging of the population: another gradually developing risk

Now let’s turn to one aspect of demographics that is clearly defined and falls into the gradual onset category of risk: the aging of the population. Average per-capita health care costs tend to remain reasonably stable from about age 2 until around age 55 – but then they start rising almost exponentially. The baby boom – the biggest generation in history – is entering the high-rent district of health care. They were born between 1947 and 1967, so the leading edge is turning 62 this year. This is inevitably going to push up spending on health care, as will happen not only in America and Canada, but throughout the developed world.

Three things will happen as a result: First, program spending in every other area will have to be cut to allow for greater health care spending – which will make for uncomfortable choices, acrimonious cabinet meetings, and unhappy users of government services. Next, governments and corporate payers will try to cut back on the things that government- and corporate-sponsored health insurance covers (you can already see this happening), with the result that there will be pressure from unhappy voters to spend even more on health insurance. And finally, there is a high probability, in my view, that taxes will rise, and might rise significantly.

This is clearly an example of a gradual onset risk – and yet, it’s one that governments and the private sector alike are ignoring, but which will have significant, even dire, consequences. There is a very real risk that these problems could bankrupt not only American and Canadian national, state, and provincial governments, but the governments of developing (and rapidly aging) countries around the world as well. I’ll bet that very few organizations here have even considered this in their risk management planning

Unexpected risks

Now we come to unexpected risks.

There are positive risks ahead of us that are highly probable, but hard to anticipate. There are going to be immense new opportunities opening up to do things that have never been done before – but they are difficult to forecast precisely because we have no experience with them. For example, I worked on one of the first applications for cellphone licences in the early 1980s. Our group (which did not get a license) did a feasibility study of the potential demand for cellphones, and concluded that it had money-making potential because almost 8% of consumers said they were likely to use a cellphone. This was good enough to establish a business case, but our projections were wrong by almost a factor of 10. Neither we, nor anyone else, expected the extent of the market penetration of cellphones at a time when they cost over $2,000 each, and were so heavy that you had to store them in the trunk of your car. The reality turned out to be much better than we had projected – and could have bankrupted us if we had won the license, but had not had the necessary working capital to fill demand.

Next, have you considered the risk to your business of someone you don’t know applying technology in novel ways? Let me use as an example a prognostic test for cancer, for instance, that is about to be submitted to the Food & Drug Administration for approval. (And pause for disclosure: I’ve worked with this company, and hold shares in it, but it’s not publicly traded, so you couldn’t buy shares in it anyway.) This test has been produced by a young upstart of a company that applies patented, problem-solving computer software to come up with tests and treatments for cancer. The test promises to be significantly more effective than current techniques in telling patients who have had surgery for colorectal cancer whether they should have follow-on therapy or not.

Now suppose you were a pharmaceutical company that had just come up with a new drug to treat Stage III colorectal cancer, only to find that this young upstart could tell half of your market that they don’t need any additional cancer treatment, and a third of the remaining market that they can get results that are as good, or better, with a cheap, out-of-patent drug? Tufts University estimates that in 2006 it cost $1.2 billion to develop and market a new drug, and suddenly you find that market for your drug has just been scooped by a company offering two tests that cost about one-tenth of a course of your new drug. Where were the risk managers in your organization while this was happening?

Governance risks

Which leads, rather naturally, into governance, both corporate and public sector. I would suggest that a number of the things I’ve characterized as risk most organizations tend leave to senior management, particularly gradual onset risks, and positive risks. But what about management itself as a risk?

Looking back at last year’s financial collapse, it’s clear that the interests of the organization and the interests of management don’t always coincide. What happened in the U.S. financial system (and elsewhere) was that senior managers were chasing the prospect of enormous bonuses by pushing their organizations into taking unreasonable risks. This is a classic case of “heads I win, tails you lose”, because all that could happen to the executives would be that they were fired, whereas many corporations lost everything, either by being taken over (Bear Sterns, Merrill Lynch) or going to the wall (Lehman Brothers, AIG).

The problem is only partly recognizing these risks; the other part is how do you deal with someone to whom you report who is putting the corporation at risk? Especially if the Board of Directors is involved as well? I would suggest that you’ve already lost if you encounter a situation where you are trying to change the behavior of senior management that is pursuing personal gain at corporate expense. Instead, this is the kind of risk that, probably, can only be dealt with by anticipating it. In particular, you should seek to have corporate policies in place that identify such behavior, and provide an accepted means of blowing the whistle if it happens. Even then it’s dicey – which only heightens its importance.

Next let’s consider external governance risks. We’ve already talked about two potential government risks: rising taxes because of health care costs; and over-reaction because of privacy violations. I think you should also consider what happens when governments are faced with a world where they have less and less influence at a time when their constituents are feeling more and more anxious. You are likely to get governments that act irrationally, and look for scapegoats and whipping boys. And if your company happens to be handy for that purpose, it may be your turn in the barrel. I would strongly suggest that one of the risks you should consider preparing for is arbitrary government actions. You should watch for it, and have contingency plans in place for dealing with it. And remember; it’s easier to head off such developments than to undo them once they’ve become law. This also argues strongly for working together as a group, both here, and within your own industries, because an industry has more chance of influencing outcomes than a single company.

The balance of this article, dealing with techniques for risk management, will appear next week.

Well, first of all, the developing countries had a really rough first half – but mostly that was due to what has classically been described as inventory overhang, about which more in a moment. They had been doing so much business with the developed countries, especially America, that they had a whole raft of product in the pipeline when the U.S. economy hit the skids. Now they’ve liquidated that inventory by cutting production, which slashed growth rates in the first half, and are now back to filling current demand. As a result, they’ve taken a hit, but are bouncing back.

Next, the developing countries, especially in Asia, have stimulated their economies, and are seeing the response. Their investment in infrastructure, both at the governmental level, and plant and equipment for corporations, is strong, and consumers have responded to stimulus with demand, just as it says in the textbooks. But in addition to that, the developing countries are trading more and more with each other, and, consequently, are not as reliant on demand from America, Europe, and the other OECD nations as they were before. Hence, as the fast growing countries start picking up steam, they help each other grow even faster, even without their biggest customers. For example, Brazil now buys more from China than it does from America, it’s traditional major supplier, with the result that as Brazil rebounds, it helps China, and vice-versa.

Meanwhile, things don’t look as bad as they did back home. The governor of Canada’s central bank, The Bank of Canada, has declared the recession in Canada is over. The U.S. Federal Reserve has said that the bad news isn’t as bad any more and we are probably at or near the bottom of the recession. France and Germany are starting to look better as time goes on, and will see positive growth this quarter. But it’s not going to be a quick rebound, because this is not a typical recession.

Not your traditional recession

A traditional, inventory-liquidation recession happens when the economy has been booming along, and everyone’s making easy money. As a result, organizations try to sell as much as they can, filling their pipeline with products to be sold, and operating at or near capacity. In the process, they take on short-term debt, typically bank debt, to finance their operations and inventory. As a result, when something happens to slightly jiggle the apple cart, or when the interest paid to the bank to finance inventory start to hurt more than the potential profit warrants, corporations decide to try to lighten up a bit by cutting back on new purchases and production. When everyone tries to do this at the same time, demand nosedives, and the economy goes into the tank. When the inventory has been cleared, the bank debt has been paid off, and the smoke clears, a few companies go broke, but the economy as a whole resets, and starts growing again in a new cycle, typically with strong growth for the first couple of years following the recession. This kind of traditional recession & clearing process took anywhere from 6 months to 2 years.

This is not that recession, not in America. This recession was triggered principally by consumers having too much debt through 25 years of using their home mortgages as an ATM. That kind of long-term debt takes time to pay off, and consumers have to consume less than they make in order to do it. This puts a long-term damper on the economy that takes a long time to wear off.

If we are lucky, America’s economy will be almost flat for the balance of this year, but start growing – slowly – next year. By 2011, it will start to pick up, but growth will still be anemic, and people will be complaining that the recession hasn’t ended. In fact, we are likely to see an unusual combination of rising economic output AND rising unemployment for an uncomfortably long time, perhaps even into 2012.

Possible shocks to be wary of

If we’re not lucky, then the American consumer, having been shocked into a penitent, saving mode, will stay in his or her shell and refuse to buy anything, or will only buy what they have to, for a long time. Add to this the potential for further financial market shocks, which I’ll describe in a moment, and you have a very gloomy scenario indeed. Moreover, if growth stays weak, and unemployment stays high, President Obama may wind up losing the White House in 2012, despite the structural weaknesses of the Republican party, because the economy is the single most consistent indicator of electoral success.

Now, what might be the possible further shocks? Well, if economic growth stays weak, the U.S. government will want to continue to stimulate demand, which means running deeper budget deficits for longer than currently planned. And as I’ve said before (“Wild Card Warning”) the U.S. government is already at risk of running out of money because of the enormous amount of debt it must raise on the open market. If lenders grow weary or leary of U.S. debt, then the U.S. government faces a credit crunch of its own that could precipitate a new financial crisis, and tip the global economy into a renewed depression. Or, if that can be avoided, the banking system is not yet out of the woods, because loans they made for commercial properties are turning bad, and may put further holes in bank balance sheets, again precipitating a new crisis. Neither of these are inevitable, but are real dangers that should be watched carefully, and for which contingency plans should be formulated now.

Canada’s dilemma

In contrast, Canada will experience an interesting dilemma: the demand for oil and food is already growing again, in large part because of the developing countries, and Canada is a major producer of both. (Most people are not aware that Canada has the second largest petroleum reserves in the world, after Saudi Arabia, and is America’s biggest supplier of oil. It’s very expensive tar sands oil, but it is flowing, and makes Canada a petro-power.) As a result, on average the Canadian economy will do pretty well among OECD nations – but this average is deceptive. Demand for Canadian commodities will and is already pushing up the Canadian dollar. This will further damage the country’s industrial heartland in Ontario and Quebec, which are already being hollowed out by the woes of the auto industry, and the transfer of manufacturing to lower cost producers like China. Meanwhile, the parts of Canada that produce commodities, notably Alberta and Saskatchewan, will be feeling no pain. This will exacerbate the real political stresses within the country, where almost two-thirds of the voters come from Ontario and Quebec, but virtually all of the strength in tax revenues, and the large majority of the economic growth, is coming from the western part of the country. It creates an almost impossible situation for the national government, quite aside from the current government’s short-comings and evident weaknesses.

Looking farther out into the future, unless the nasty contingencies described earlier occur, growth and prosperity will return to the “rich” countries, although slowly, and this time people will be more cautious. Some of the thrifty virtues our parents preached will once again be rediscovered, and time will heal the wounds, investment will once again accelerate growth, and (more measured) good times will roll again. This pain, too, shall pass.

Destruction carries the seeds of recovery

In its wake, it will leave the developing countries stronger, the developed countries growing again, but more cautious, and a more interconnected and interdependent world. If we have learned nothing else, we have learned that in today’s world, no one crashes on their own. This cautionary tale may well pave the way to a more stable world economy, and one where fair trade for all is seen as the only alternative to disaster.

Every boom carries the seeds of its own demise. Likewise, every crash sows the seeds of new growth, and new innovation, just as many forests require forest fires to renew themselves. This time will be no different. Carrying the metaphor forward, we’re not out of the woods yet, but that glow on the horizon is more likely to be the dawn than a renewed conflagration. Hold on to that.