The End of the Nation State: The Rise of Regional Economies

Chapter 1 THE CARTOGRAPHIC ILLUSION

A funny -- and, to many observers, a very troubling -- thing has happened on the way to former U.S. President Bush's so-called "new world order": the old world has fallen apart. Most visibly, with the ending of the Cold War, the long-familiar pattern of alliances and oppositions among industrialized nations has fractured beyond repair. Less visibly, but arguably far more important, the modern nation state itself -- that artifact of the 18th and 19th centuries -- has begun to crumble.

For many observers, this erosion of the long-familiar building blocks of the political world has been a source of discomfort at least and, far more likely, of genuine distress. They used to be confident that they could tell with certainty where the boundary lines ran. These are our people; those are not. These are our interests; those are not. These are our industries; those are not. It did not matter that little economic activity remained truly domestic in any sense that an Adam Smith or a David Ricardo would understand. Nor did it matter that the people served or the interests protected represented a small and diminishing fraction of the complex social universe within each set of established political borders.

The point, after all, was that everyone knew -- or could talk and act as if he or she knew -- where the boundary lines ran. Everyone's dealings could rest, with comfortable assurance, on the certain knowledge, as Robert Reich has put it, of who was "us" and who was "them." The inconvenient fact that most of the guns pointed in anger during the past two decades were pointed by national governments at some segment of the people those governments would define as "us" -- well, that really did not matter, either. Boundaries are boundaries.

Politics, runs the time-worn adage, is the art of the possible. Translated, that means it is also the art of ignoring or overlooking discordant facts: guns pointed the wrong way, democratic institutions clogged to the point of paralysis by minority interests defended in the name of the majority -- and, perhaps most important, domestic economies in an increasingly borderless world of economic activity. So what if average GNP per capita in China is $317 but, in Shenzhen, whose economy is closely linked with that of Hong Kong, it is $5,695? Boundaries are boundaries, and political dividing lines mean far more than demonstrable communities of economic interest.

No, they don't. Public debate may still be hostage to the outdated vocabulary of political borders, but the daily realities facing most people in the developed and developing worlds -- both as citizens and as consumers -- speak a vastly different idiom. Theirs is the language of an increasingly borderless economy, a true global marketplace. But the references we have -- the maps and guides -- to this new terrain are still largely drawn in political terms. Moreover, as the primary features on this landscape -- the traditional nation states -- begin to come apart at the seams, the overwhelming temptation is to redraw obsolete, U.N.-style maps to reflect the shifting borders of those states. The temptation is understandable, but the result is pure illusion. No more than the work of early cartographers do these new efforts show the boundaries and linkages that matter in the world now emerging. They are the product of illusion, and they are faithful to their roots.

This, too, is understandable. Much of the current awareness of the decay of the modern nation state has been driven by the wrenching experiences of the former Soviet Union and Czechoslovakia, which have formally ceased to exist as single national entities. Perhaps even more frightening, of course, is the noxious brew of ancient hatred, more recent antagonism, and unbridled ambition in what used to be Yugoslavia. These are extremes, to be sure, but they are deeply representative of the kind of erosion that has at last begun to capture an important share of public attention.

In a newly unified Germany, for example, unprecedented amounts of power have been ceded to the individual Länder. In Canada, before the recent elections in Quebec and even before the failure of the Meech Lake accords, the French-speaking province had been moving to cut its constitutional ties with the other, English-speaking provinces. In Spain, an explicit program of devolution is transferring much of the apparatus of independent statehood to the country's 17 "autonomous communities," especially those like Catalonia with a deeply entrenched historical identity of their own. In Italy, long-preoccupied with the problems of the Mezzagiorno in the south, recent elections have shown the Lombard League in the north to be a real and growing factor on the political scene. Even in dirigiste France, the prefects of Mitterrand's government can no longer unilaterally veto local decisions in the country's 22 provinces.

Developments as striking as these clearly merit the attention they have received in the media and in the regular comments of opinion makers and public officials. Nearly a half century of Cold War cannot end without dramatic -- and eminently noteworthy -- changes on both sides. Relaxation of the long-entrenched bipolar discipline imposed by the United States and the former USSR cannot help but allow even older fault lines to spread. Equally striking, however, is the way in which such attention has been framed and articulated. To the extent these developments have been treated as evidence of a systemic challenge to traditional nation states (and not just as a challenge to this or that current policy or set of leaders), they have been interpreted for the most part in political terms. Whatever their root, the centrifugal forces now at work have been seen to be meaningful, first and foremost, as statements about the inadequacies of established modes and processes of political order -- that is, as evidence of troubling realignments within previously established borders.

Thus, as today's public debate would have it, the fission represented by local autonomy and by ethnic or racial or even tribal irredentism, no less than the proposed fusion represented by Maastricht, shows clearly that the postwar writ of central governments no longer holds with anything like the power it enjoyed even a generation ago. And as that debate would also have it, this failure of the political center is a legitimate cause for concern. When no one seems to know where we are -- or should be -- going, initiative stagnates, special interests reduce each other to paralysis, and the consensus necessary for effective policy moves still further out of reach. In tones of despair, the more literary pundits like to cite Yeats: "Things fall apart; The center cannot hold." But the truer message comes from Matthew Arnold: we are "wandering between two worlds,/One dead, the other unable to be born."

These lamentations at least have the virtue of taking the erosion of nation states seriously. But they view it almost entirely as the result of long-repressed political aspirations bursting into the open once the various imposed restraints of the Cold War era have been relaxed. No matter how deeply rooted, however, these aspirations are not the only -- or arguably, even the primary -- forces now at work. Something else is going on. The battle and the battlefield have shifted.

A QUESTION OF CULTURE?

In a recent, highly influential article, "The Clash of Civilizations?" Samuel Huntington offers an interpretation of what that "something else" is. According to Huntington, the fault lines in our new, post-Cold War world do not flow from politics or ideology, but from culture. From now on, when large masses of people join in common purpose, the primary link between them will increasingly be their shared heritage of language, history, tradition, and religion -- that is, civilization. And when they stonily face each other across a divide, the unbridgeable gap between them will be the lack of just such a shared civilization. Groupings based on culture will become -- in fact, have already become -- the most powerful actors in world affairs.

For all the truth of these observations, Huntington's argument ignores the fact that, even within the same civilization, people have often fought against each other. From the outside, the differences between Catholics and Protestants in Northern Ireland do not seem like a good reason for intense hatred. But for political leaders and mass agitators, they are good enough. Again, from outside, it is awfully difficult to tell the Hutu from the Tutsi in Rwanda. But they have mutually created, during the past decade, one of the bloodiest clashes in the world. People usually fight when their political and/or military leaders inflate minute differences so as to stir up latent hatred -- not when "civilizations" clash. If leaders are enlightened, they can make their people believe in the power of working together. This is the case today with the multiple races and cultures linked peacefully by Lee Kwan Yew in Singapore and Dr. Mahathir in Malaysia (and was true in the Yugoslavia of Josip Broz Tito and the India of Mahatma Gandhi and Jawaharlal Nehru after World War II). It is not civilizations that promote clashes. They occur when old-fashioned leaders look for old-fashioned ways to solve problems by rousing their people to armed confrontation.

Such skirmishes confuse the ground of geopolitical interpretation. But they confuse the ground of economic interpretation as well. The glue holding together older constellations of nation-based political interests has visibly begun to wear thin. In economics as in politics, the older patterns of nation-to-nation linkage have begun to lose their dominance. What is emerging in their place, however, is not a set of new channels based on culture instead of nations. Nor is it a simple realignment of previous flows of nation-based trade or investment.

In my view, what is really at stake is not really which party or policy agenda dominates the apparatus of a nation state's central government. Nor is it the number of new, independent units into which that old center, which has held through the upheavals of industrialization and the agonies of two world wars, is likely to decompose. Nor is it the cultural fault lines along which it is likely to fragment.

Instead, what we are witnessing is the cumulative effect of fundamental changes in the currents of economic activity around the globe. So powerful have these currents become that they have carved out entirely new channels for themselves -- channels that owe nothing to the lines of demarcation on traditional political maps. Put simply, in terms of real flows of economic activity, nation states have already lost their role as meaningful units of participation in the global economy of today's borderless world.

In the first place, these long-established, politically defined units have much less to contribute -- and much less freedom to make contributions. The painful irony is that, driven by a concern to boost overall economic well-being, their efforts to assert traditional forms of economic sovereignty over the peoples and regions lying within their borders are now having precisely the opposite effect. Reflexive twinges of sovereignty make the desired economic success impossible, because the global economy punishes twinging countries by diverting investment and information elsewhere.

The uncomfortable truth is that, in terms of the global economy, nation states have become little more than bit actors. They may originally have been, in their mercantilist phase, independent, powerfully efficient engines of wealth creation. More recently, however, as the downward-ratcheting logic of electoral politics has placed a death grip on their economies, they have become -- first and foremost -- remarkably inefficient engines of wealth distribution. Elected political leaders gain and keep power by giving voters what they want, and what they want rarely entails a substantial decrease in the benefits, services, or subsidies handed out by the state.

Moreover, as the workings of genuinely global capital markets dwarf their ability to control exchange rates or protect their currency, nation states have become inescapably vulnerable to the discipline imposed by economic choices made elsewhere by people and institutions over which they have no practical control. Witness, for example, the recent, Maastricht-related bout of speculation against the franc, the pound, and the kronor. Witness, also, the unsustainable but self-imposed burden of Europe's various social programs. Finally, witness the complete absence of any economic value creation, save for those around the world who stand to benefit from pork-barrel excesses, in such decisions as the Japanese Diet's commitment -- copied from the New Deal policies of Franklin Roosevelt -- to build unnecessary highways and bridges on the remote islands of Hokkaido and Okinawa.

Second, and more to the point, the nation state is increasingly a nostalgic fiction. It makes even less sense today, for example, than it did a few years ago to speak of Italy or Russia or China as a single economic unit. Each is a motley combination of territories with vastly different needs and vastly different abilities to contribute. For a private sector manager or a public sector official to treat them as if they represented a single economic entity is to operate on the basis of demonstrably false, implausible, and nonexistent averages. This may still be a political necessity, but it is a bald-faced economic lie.

Third, when you look closely at the goods and services now produced and traded around the world, as well as at the companies responsible for them, it is no easy matter to attach to them an accurate national label. Is an automobile sold under an American marque really a U.S. product when a large percentage of its components comes from abroad? Is the performance of IBM's foreign subsidiaries or the performance of its R&D operations in Europe and Japan really a measure of U.S. excellence in technology? For that matter, are the jobs created by Japanese plants and factories in the Mississippi Valley really a measure of the health of the Japanese, and not the U.S., economy? The barbershop on the comer may indisputably be a part of the domestic American economy. But it is just not possible to make the same claim, with the same degree of confidence, about the firms active on the global stage.

Finally, when economic activity aggressively wears a national label these days, that tag is usually present neither for the sake of accuracy nor out of concern for the economic well-being of individual consumers. It is there primarily as a mini-flag of cheap nationalism -- that is, as a jingoistic celebration of nationhood that places far more value on emotion-grabbing symbols than on real, concrete improvements in quality of life. By contrast, we don't hear much about feverish waves of Hong Kong nationalism, but the people in Hong Kong seem to live rather well. With much fanfare, Ukraine and the Baltic states have now become independent, but do their people have more food to eat or more energy to keep them warm during the winter or more electricity for light to see by?

An arresting, if often overlooked, fact about today's borderless economy is that people often have better access to low-cost, high-quality products when they are not produced "at home." Singaporeans, for example, enjoy better and cheaper agricultural products than do the Japanese, although Singapore has no farmers -- and no farms-of its own. Much the same is true of construction materials, which are much less expensive in Singapore, which produces none of them, than in Japan, which does.

Now, given this decline in the relevance of nation states as units of economic activity, as well as the recent burst of economic growth in Asia, the burgeoning political self-consciousness of Islam, and the fragmentation, real or threatened, of such "official" political entities as Italy, Spain, Somalia, Rwanda, Canada, South Africa, and the former Yugoslavia, Czechoslovakia, and Soviet Union -- given all this, it is easy to see why observers like Huntington should look to cultural, religious, ethnic, even tribal affiliations as the only plausible stopping point of the centrifugal forces unleashed by the end of the Cold War.

Once bipolar discipline begins to lose its force, once traditional nation states no longer "hold," or so the argument goes, visionless leaders will start to give in to the fear that older fault lines will again make themselves felt. And given the bloody violence with which many of these lines have already begun to reappear, these leaders will find it hard to see where this process of backsliding can come to rest short of traditional groupings based on some sort of cultural affinity. In other words, in the absence of vision and the presence of slowly rising panic, the only groupings that seem to matter are based on civilizations, not nations.

But are cultures or civilizations meaningful aggregates in terms of which to understand economic activity? Think, for a moment, of the ASEAN countries. In what sense is it useful to talk about them as a single, culturally defined economic area? As they affect local patterns of work, trade, and industry, the internal differences among their Buddhist, Islamic, Catholic (in the Philippines and the Sabah state of Malaysia), and Confucian traditions are every bit as large as, if not larger than, the differences separating any one of these traditions from the dominant business cultures of New York or London or Paris.

But in ASEAN, at least, differences of this sort do not provoke the same kinds of conflicts that often arise elsewhere. Most Western observers know, for example, that Spanish and Portuguese speakers can converse with each other, if with some minor degree of difficulty. Many fewer, however, know that the same is true of Indonesians and Malaysians. Or that, in border regions between Thailand and Malaysia, such as Phuket, there are peaceful, economically linked villages, some of which have mainly Buddhist and some mainly Islamic populations. These on-the-ground realities have made it possible for ASEAN leaders to accept and to reinforce, with little fear of internal friction, the development of cross-border economic ties like those stretching across the Strait of Malacca which are represented by the Greater Growth Triangle of Phuket, Medan, and Penang.

Even more important than such cultural differences within a civilization, and what Huntington's line of thought leaves out, is the issue of historical context. The particular dissolution of bipolar, "great power" discipline that so greatly affects us today is not taking place in the 1790s or the 1890s, but the 1990s. And that means it is taking place in a world whose peoples, no matter how far-flung geographically or disparate culturally, are all linked to much the same sources of global information. The immediacy and completeness of their access may vary, of course, and governments may try to impose restrictions and control. Even if they do, however, the barriers will not last forever, and leakages will occur all along the way. Indeed, the basic fact of linkage to global flows of information is a -- perhaps, the -- central, distinguishing fact of our moment in history. Whatever the civilization to which a particular group of people belongs, they now get to hear about the way other groups of people live, the kinds of products they buy, the changing focus of their tastes and preferences as consumers, and the styles of life they aspire to lead.

But they also get something more. For more than a decade, some of us have been talking about the progressive globalization of markets for consumer goods like Levi's jeans, Nike athletic shoes, and Hermés scarves -- a process, driven by global exposure to the same information, the same cultural icons, and the same advertisements, that I have elsewhere referred to as the "California-ization" of taste. Today, however, the process of convergence goes faster and deeper. It reaches well beyond taste to much more fundamental dimensions of worldview, mind-set, and even thought process. There are now, for example, tens of millions of teenagers around the world who, having been raised in a multimedia-rich environment, have a lot more in common with each other than they do with members of older generations in their own cultures. For these budding consumers, technology-driven convergence does not take place at the sluggish rate dictated by yesterday's media. It is instantaneous -- a nanosecond migration of ideas and innovations.

The speed and immediacy of such migrations take us over an invisible political threshold. In the post-Cold War world, the information flows underlying economic activity in virtually all comers of the globe simply cannot be maintained as the possession of private elites or public officials. They are shared, increasingly, by all citizens and consumers. This sharing does not, of course, imply any necessary similarity in how local economic choices finally get made. But it does imply that there is a powerful centripetal force at work, counteracting and counterbalancing all the centrifugal forces noted above.

The emotional nexus of culture, in other words, is not the only web of shared interest able to contain the processes of disintegration unleashed by the reappearance of older fault lines. Information-driven participation in the global economy can do so, too, ahead of the fervid but empty posturing of both cheap nationalism and cultural messianism. The well-informed citizens of a global marketplace will not wait passively until nation states or cultural prophets deliver tangible improvements in lifestyle. They no longer trust them to do so. Instead, they want to build their own future, now, for themselves and by themselves. They want their own means of direct access to what has become a genuinely global economy.

INCONVENIENT AVERAGES

What this combination of forces at last makes clear is that the nation state has become an unnatural -- even a dysfunctional -- organizational unit for thinking about economic activity. It combines things at the wrong level of aggregation.

What sense does it make, for example, to think of Italy as a coherent economic entity within the EU? There is no "average" Italy. There is no large social or economic group precisely at the midpoint represented by such averages, no constituency specially advantaged by -- and, therefore, eager to support -- split-the-difference political compromises. There is, instead, an industrial north and a rural south, which are vastly different in their ability to contribute and their need to receive. In economic terms, there is simply no justification for treating Italy as a single-interest entity. Doing so forces you -- as private sector manager or public sector official -- to operate on the basis of false, implausible, and inconvenient averages. They are a fiction, and a destructive fiction at that.

But the root problem goes deeper. In a borderless economy, any statistical regime that takes the nation state as its primary unit of analysis is -- and must be -- badly out of date. For well over a decade now, I have been arguing just this point in the context of the perennial squabbles between Japan and the United States on questions of trade and trade balances. On both sides, however, most officials and even most commentators remain perversely afflicted with trade blindness -- an inability to see, let alone understand, in the broad daylight of media attention, the core facts about cross-border economic activity.

Position papers and headlines notwithstanding, the trade problem between Japan and the United States is neither the American trade deficit nor the Japanese surplus. The reason is quite simple: the flows of activity measured by official trade statistics represent a tiny and steadily diminishing share of the economic linkages between the two countries. These data, remember, do not count the revenues from services, licenses, or intellectual property, or from goods manufactured by U.S. firms in third countries but sold in Japan, or from goods both manufactured and sold in Japan by U.S. firms. All they count is that relatively small universe of things physically produced in the United States, crated, loaded onto ships or planes, passed through customs, and then uncrated and sold in Japan.

When a U.S. software house sells its leading-edge program in Tokyo, the trade data capture little, if any, of the value added. When a U.S. chip manufacturer sells its products in Osaka, the sales may count toward the 20 percent of the market earmarked for U.S. firms, but -- if the chips were, as is likely, actually produced in Malaysia -- they will not show up in U.S. export statistics. When a U.S. sportswear company retails in Hokkaido garments sewn in Indonesia or Taiwan, the sales do not matter to those who count bilateral trade flows. When enough Japanese consumers see a U.S. movie to generate, say, US $200 million in box office revenues and, perhaps, US $40 million in royalties, these figures show up in Japan's current account, but not in its trade statistics. But if the moviemaker "sold" each copy of the film to be shown in Japan for US $1 million, those monies would count as trade revenue.

As everyone should know by now, the official statistics that attract so much political attention are unreliable. I'm being polite: they are an out-and-out falsehood. They are not an accurate reflection of real flows of economic activity. They are not an accurate reflection of anything. Indeed, in the mid-1980s, if you included in these official numbers all the sales in Japan of "American" (as consumers perceive them) goods and services, you would find that the Japanese bought -- per capita -- four times as much "American" stuff as Americans bought "Japanese" stuff. Since then, the ratio has only gotten larger.

Trade, however, is only the most visible of the areas in which official, nation state-based statistics prove their worthlessness. The list is long and varied. Some countries, for example, classify life insurance as savings; in others, it is an expense. Some treat government-funded pensions as part of individual income; others, as a public liability. Some view mortgage investment in a home as consumption; others, as a form of savings. Some categorize devices like microwave ovens as white goods; others, as consumer electronics or even furniture. At even the simplest level, therefore, meaningful comparisons are hard to come by. Apples and oranges are not the problem. It's fruit salad.

These differences matter. In the mid-1980s -- in 1986, to take a particular example -- the official Japanese domestic savings rate was 16.6 percent; the U.S. rate was 4.3 percent. The result: loud and acrimonious debate between the two countries, with the United States calling on Japan to boost domestic consumption and Japan insisting that the United States get its own fiscal house in order by reducing wasteful, deficit-financed consumption. These charges and countercharges continue to fly. Neither then nor now, however, do they bear much relation to the underlying facts: the savings rate in both countries is pretty much the same.

Japanese data on savings, like those for most other countries, are based on a System of National Accounts (SNA) advocated by the United Nations. By contrast, the U.S. data are based on National Income and Product Accounts (NIPA), which are administered by the Department of Commerce. Converting from NIPA to SNA would boost the 1986 U.S. savings rate from 4.3 percent to 6.8 percent. This is a substantial jump, to be sure, but still far less than Japan's 16.6 percent. If you also removed the other structural inconsistencies between SNA and NIPA -- the differing treatments of government social insurance, for example, which SNA views as personal savings and NIPA as government savings -- the 6.8 percent figure would rise further to 10.9 percent. And much of the remaining 5.7 percentage point gap (16.6 percent v. 10.9 percent) would disappear if you corrected for essentially social differences between the two countries.

In the United States, for example, if you buy a house for $200,000 and invest the same amount again in renovation, the government counts the first number as savings and the second as consumption. When you sell the house, of course, you hope to get at least $400,000 for it, which effectively equates overall resale value with savings. In Japan, however, where renovations are usually not appreciated by later buyers and only land is treated as having real value, the equivalent of $200,000 spent on fixing things up truly is consumption.

There are still other adjustments to be made. Americans tend to buy on credit; the Japanese, given low resale values, "save to buy." Adding savings to consumer credit in both countries gives roughly the same number: 29 percent of disposable income. The only difference is the timing of payment: the Japanese buy later, thus showing more money in the bank at present; Americans buy now and pay later, thus borrowing from the future. Moreover, for major purchases like homes, Japanese banks require a much larger down payment than their U.S. counterparts. If, in addition to the other adjustments noted above, Japan's banks were to reduce their requirements to the low end of the U.S. spectrum -- say, 10 percent or so of the down payment -- virtually all of the statistical "savings gap" between the two countries would disappear. The numbers everyone knows and everyone uses are simply untrue.

So, it is not culture that produces the huge statistical differences between the Americans and the Japanese. It is the differences in their systems -- taxation, say, or banking on the statistical treatment of things like pensions -- that collectively make the two peoples behave very differently. Certainly, the Japanese are not by nature more hardworking or more inclined to save than the Americans. The crucial point, of course, is that if these systems were changed, both would behave pretty much the same.

The evidence, then, is as exhaustive as it is uncomfortable: in a borderless economy, the nation-focused maps we typically use to make sense of economic activity are woefully misleading. We must, managers and policymakers alike, face up at last to the awkward and uncomfortable truth: the old cartography no longer works. It has become no more than an illusion.

Copyright © 1995 by McKinsey & Company Inc.