Just a short note...

Yet again posting here will be short: I've got 1400 equations to redo.

Finally a fisking ...

Hi -

Posting here has been weak, due to work, family and and and and...

My father sent me the following link to an article by Peter Drucker in The National Interest.

There's so much wrong with it I felt I had to take a wing at fisking it...

Let's fisk this one: go get a cuppa, 'cause this is gonna be a long one.

The New world economy is fundamentally different from that of the fifty years following World War II. The United States may well remain the political and military leader for decades to come. It is likely also to remain the world's richest and most productive national economy for a long time (though the European Union as a whole is both larger and more productive). But the U.S. economy is no longer the single dominant economy.

First of all, the EU is not more productive than the US. Second, he's using a sleight of hand to confuse the reader: the EU is not richer and more productive than the US, but does have a larger population, given the recent expansion. US GDP has been larger than that of the EU for about 2 years when you take into account the differing ways that people calculate GDP (don't get me started on chained weights and hedonic deflators, no one except economists have that sort of attention spans...).

The emerging world economy is a pluralist one, with a substantial number of economic "blocs." Eventually there may be six or seven blocs, of which the U.S.-dominated NAFTA is likely to be only one, coexisting and competing with the European Union (EU), MERCOSUR in Latin America, ASEAN in the Far East, and nation-states that are blocs by themselves, China and India. These blocs are neither "free trade" nor "protectionist", but both at the same time.

Here Drucker leads into the paragraph as if the world economy was never a pluralist economy. But what is he really leading to? In the last sentence of the previous paragraph, he claims for the US to date the role of the dominant economy on the planet.

Duh. After WW2 the US produced something on the order of 40% of world output. It's now "down" to 25% and will head to 20%-15% over the next 20 years. But this is meaningless: what is happening is that the rest of the world is catching up, that the rest of the world is becoming wealthier. And this is a bad thing? But this digresses from the fundamental point: Drucker is severely confused. There are no "pluralist" economies: you can't have a free market economy mixing with revolutionaries appropriating the means of production. You can have pluralist politic systems, as does the EU and to a lesser extent the US (the EU has centralist democracies, constitutional monarchies, federalist republics and kleptocracies all mixed together, while the US has Napoleon code of justice in Louisiana and California with all its myriad attempts at direct democracy with referendums), but using the word pluralism to describe economies is like using the word evil to describe a tidal wave.

Further these blocs exist right now. They aren't the monolithic, 1984-style blocs that Drucker seems to think they are, but more a collection of interests with some common trade policies than the mercantilist, monolithic blocs of Drucker's fantasy world. The problem of nominally free-trade economies also being protectionist of certain industries is a political choice, not a consequence of economic policies. Here Drucker is deliberately muddling the waters.

Even more novel is that what is emerging is not one but four world economies: a world economy of information; of money; of multinationals (one no longer dominated by American enterprises); and a mercantilist world economy of goods, services and trade. These world economies overlap and interact with one another. But each is distinct with different members, a different scope, different values and different institutions. Let us examine each in turn.

Here Drucker again confuses aspects of economic activity by making them into autonomous economies, placing them on the same level as national economies. He is looking at four aspects of one thing, the world economy. He points this out by saying they overlap and interact: duh, they don't just do that, they are deeply and fundamentally intertwined and interdependent. If the world economy of manufacturing falters, it takes down the world economy of money, multinationals and information. This is intellectually sloppy, while sounding neat: these economies are constructs that represent aspects of a greater reality.

Information as a concept and a distinct category is an invention of the 18th century--of the newspaper in England and the encyclopedia in France. Within a century, information became global with the development of the modern postal system in the 1830s, followed almost immediately by the electric telegraph and the first computer language, the Morse Code. But unlike the newspaper and the encyclopedia, neither the postal service nor the telegraph made information public. On the contrary, they made it "privileged communication." "Public information" by contrast--newspapers, radio, television--ran one way only, from the publisher to the recipient. The editor rather than the reader decided what was "fit to print."

Information is an invention of the 18th century? Several millenia of philosophers would tend to disagree. What he means is that the business of information is an invention of the 18th century. But this is also a simplification at best. But he is right on one thing: public information today remains fundamentally filtered and priveleged, with someone between you and reality who is telling you the way he/she thinks you should think how things are.

The Internet, in sharp contrast, makes information both universal and multi-directional rather than keeping it private or one-way. Everyone with a telephone and a personal computer has direct access to every other human being with a phone and a PC. It gives everyone practically limitless access to information. And it gives everyone the ability to create information at minimal cost, that is, to create his own website and become a "publisher."

First: This is a bad thing?

Second: he is naive to think that this means that you have practically limitless access to information. Information isn't "created": rather, it is reported and by the mere act of reporting you introduce human bias and distortion into the information. We all know how small nuances in reporting can bias a piece to create one impression, deliberate or not, and the use of punctuation is a primary tool: by placing "scare quotes", you can alter the meaning of straight reporting significantly. There is a huge difference when you say "An expert determined x" and "An 'expert' determined x".

What the internet gives you is the ability to create opinion at minimal cost and get your opinions out there: now, given the amount of rancor over the role of the internet in the last US election with opposing web sites spewing out an enormous amount of vitriol - and if you don't think this has an effect, then welcome to the real world - can one make the case that opinion is information? The electorate wasn't informed, but rather pounded by opinions demanding to be accepted as facts, which meant that winnowing facts from fancy was really hard. This is, if anything, the exact opposite of information: disinformation is in some circles of political activity a highly polished tool, and you don't want to know who I am thinking of. But let's "move on" ...

In the long run, the most important implication is probably the impact of information on mentality and awareness. It creates new affinities and new communities. The woman student in Shanghai who taps into the Internet remains Chinese, but she sees herself at the same time as a member of a worldwide, non-national "information society."

Really? I guess then that I can understand why the Chinese government thinks it is justified in keeping the internet under government control. There is no "information society": what you have is an inceasing openness of communication. It doesn't create affinities, it merely aids them: 'new' communities do emerge, but they are virtual and intellectual, not real and societal.

Businesses and professional groups such as lawyers and doctors have, of course, had access all along to worldwide information in their own field. But the Internet gives such access to the ultimate customer. In the United States at least (but apparently also in Japan and Europe), the ultimate customer now gets his information about plane schedules and airfares from the Internet rather than from a traditional travel agent. And while a good many book buyers in the United States still pick up and pay for the book of their choice at a bookstore in their neighborhood, an increasing number of them decide what books to buy by reading about them online first. An automobile still has to be serviced by a local dealer. But increasingly, buyers first study both their choice for the new car and their options for trading in their old car online before visiting a dealer.

Businesses and professional groups' access to worldwide information about their own fields is most certainly an invention of the 20th century and not one that has been there all the time. The number of businesses that failed to see international developments and went under is too long for any post that can be read by a normal email reader. The same applies to lawyers and doctors. In fact, the only professionals that really worked at having international information about what was going on has been academics of any field, the Catholic church and the various intelligence agencies, and if anyone has excelled at this, it's probably the Catholic church. The rest of his examples have to do with channels of how people do business: it's a great deal simpler to use the internet, just as it was a great deal simpler to use a travel agent instead of dealing directly with dozens of airlines and other means of transportation.

But this doesn't mean that there is more information or that the information is available to users on the internet: in the case of travel agents and booking online, the savings you can achieve online - which is why you use it, right? - isn't the result of you having the same information as the travel agent or even more, but rather you, as the online user, are being targeted by what is available online. You don't get access to the same systems that travel agents have, but rather to online systems that have significantly less information.

So he's really making the case that it's easier access to information that is driving internet usage: duh. But making access to information easier doesn't mean that there is an "information economy", as he argues.

What is already discernible is that, like all new distribution channels, this new information economy will change not only how customers buy, but what they buy. It will change customers' values and expectations, and with them how to promote goods and services, how to market and sell them, and how to service them online. In other words, Internet customers are becoming a new and distinct market. In the early years of the 21st century, power is shifting to the ultimate consumer.

Now he recognizes that the internet is "merely" a distribution channel: how does this make it an economy? It doesn't: Drucker is being sloppy about his language. Lack of information, information asymmetry, is a long-studied problem in economics, especially market economies (but it was also one of the fundamental reasons, if not the primary reason, for the collapse of command economies as well: if you look at the feedback loops involved in, for instance, the East German NOeSPL command economy cybernetic system, adapted from a Soviet system, you can see where deliberate information management could lead to positive feedback loops that first paralyzed and then shattered the command economies of Communism of all kinds). Hence consumes are making decisions based in increasing knowledge, reducing the asymmetric information friction that causes market inefficiencies. That doesn't mean that power is shifting to the consumer: it means that companies can no longer rely on consumer ignorance about prices and product quality to exploit information inefficiencies. In our economies, the consumer is always been and always will be in power: it's simply a question of how much he or she knows about this. Consumer boycotts aren't something new, but date back to the middle ages, where guilds simply ensured that challengers to the guild system would be boycotted by consumers who believed the guild members that a toolmaker whose tools weren't sanctified by the guild were fundamentally inferior, if not outright heretical.

But that doesn't make an information economy, especially when you see how sloppy Drucker is with his wording: at one point he means by information opinion; here he means an aspect of a distribution channel. I don't think Drucker knows what an information economy really is: it's an economy where the fundamental value added in the economy is based on the usage of information, rather than the making of things. It doesn't mean that things aren't made, but rather things are made based on information, i.e. you don't make 10,000 plush toys and hope you sell enough to cover your costs, but rather are making 10,000 customized plush toys that are pre-ordered by your consumers. That's how Dell works and has been so enormously successful.

But I digress...

There is no distance in this world economy. Everything is "local." The potential customers searching for a product do not know--and do not care--where the products come from. This does not eliminate or even curtail protectionism. But it changes it. Tariffs can still determine where a product or service has to be bought. But they are increasingly unable to protect the domestic producers' price.

Now this is silly. In the internet, there is no "there" there. Local, international, it means nothing: it doesn't mean that everything is local, but rather that the laws of geography are meaningless. Unless, of course, you are at the very long end of a thin internet pipe. :-)

Here Drucker also makes a leap: customers don't care where products come from, but this doesn't change protectionism. Huh? Where is the connection here that Drucker is trying to make?

First of all, many consumers do care where things come from: think of "Buy American" or the international equivalents (try buying Louisiana rice in Japan...). However, as homo oeconomics rationalis, consumers may well rant about cheap and shoddy foreign products, then go to his local media supermarket and buy himself a new TV and chortle about getting such a great deal while not noticing he's helping put the national TV maker out of business. That's an old economic problem: that maximizing consumer benefits can often have negative effects.

And tariffs most certainly have something to do with domestic producers' prices: they destroy them, since under ceteris paribus demand drops when prices rise. But that doesn't have anything to do with where a product or service has to be bought: I can buy my software from a dealer in the US and pay a 15% import tariff and still be better off than a local purchaser, since there remain significant price differentials based on incomes and costs. The tariff doesn't change that, especially if I want an English-language version of a program that is otherwise not available due to a decision by the software maker that versions sold overseas are only available in the localized version (Hi there, Adobe and AutoCAD). And this is more a threat to the local seller than the price problem is.

One example: To get the industrial Midwest with its 140,000 steel workers to vote Republican in congressional elections, President Bush slapped a prohibitive tariff on imports of steel from Europe and Japan in 2001. He got what he wanted: a (bare) Republican majority in the Congress. But while the large steel users (such as automobile makers, railroads and building contractors) were forced by the tariff to buy domestic, they immediately set about cutting their use of steel so as not to spend more on it than they would have had to spend had they been able to buy the imports. Bush's tariff action thus only accelerated the long-term decline of the traditional midwestern steel producers and the jobs they generate. Tariffs, in other words, can still force users to buy domestic, but they are no longer capable of protecting the domestic producers' prices. Those are set through information and on the world-market level.

So, this is the first time Drucker gets it half-way right. But only half-way, since he confuses cause and effect. It wasn't the workers who were lobbying, but rather the steel companies. The benefit were the votes, not the cause. The cause is the fact that there is a world-wide excess capacity in steel manufacturing, excaberated severely by Chinese and to a lesser extent Russian and Korean dumping - and dumping really does exist and is used as trade policy by a number of countries - and prices had at that point in time collapsed. They are now drastically higher in the wake of huge demand from China for raw materials - coke and iron ore - that have driven costs and therefore prices up massively, but I digress.

Steel users weren't forced to buy from domestic makers, but rather chose to do so because they were cheaper than imports. But prices went up and users started looking for altenatives. And the point is? This is really basic economics. And Drucker's premise is wrong, wrong, wrong: tariffs can only cause prices to increase, they cannot force users to buy domestic: there was no limit to the amount of steel imported, but rather a tariff imposed. And I am intimately aware of the one attempt to limit via the amount of an import: the Voluntary Trade Agreement (which was not voluntary at all and not much of a trade agreement) with the US, Japan, Taiwan and South Korea in the 1980s: the number of machine tools that these countries could import into the US was curtailed according to a complex equation of market demand and volume. It had the unintended effect of making these countries switch from commodity goods to high-value goods, since if you can only import 2000 machines of a certain kind, you were able to bring in higher-value machines, thus worsening US competitiveness in high-end machinery in an attempt to protect them in commodity goods. And it gave the importing countries effectively guaranteed market shares as well.

But let's also take a look at how prices are set, which Drucker has only half right. Prices for goods are largely determined by supply and demand, at least in the industrialized west. There are exceptions, such as defense goods and pharmaceuticals, but these are a different story entirely.

How does a company determine prices? Now, y'all know I'm an industrial economist specializing in forecasting and rating of industries. Where I work we're expanding into the rating of individual companies within a complete forecasting framework, providing something much better than S&P or Moodies, which rate on the basis of past performance and balance sheets. We rate on the basis of past performance, balance sheets, and benchmarking forecast growth against the average forecast growth of the average company of the given industrial sector. So I have a inkling of how industrial pricing works.

First you've got fixed and variable costs: any company selling at under cost will either go bankrupt or receives significant subsidies for doing so. No other way about it: those selling under cost at time x will have to recoup those costs at a future time x1 in order to stay in business. Fixed costs are those costs that you always have to pay: payroll and capital costs; variable costs are the inputs into your products. The fixed costs change according to capacity and worker productivity, the variable costs change according to input factor prices and can be varied by choosing different suppliers, buying differently (economies of scale), and changes in the production process. Any company intending on staying in business for the long-term must cover these costs and be prepared to react when they change.

Prices, unfortunately for the making company, aren't autonomously determined, but rather are a function of competitors on the market. If everyone were to agee on a price without running foul of anti-trust, then prices would probably reflect what is called a monopoly rent, i.e. would be as high as possible without reducing demand. But given the fact that price competition is the major factor in market position, prices are a function of domestic demand (maintaining market share) and foreign competition (based on foreign prices plus exchange rate effects). Hence a company may well have domestic price x with export price 2x because foreign markets allow it to price its goods at that price; not unusual for the reverse to also be true (which is why dumping is a very thorny problem: determining whether a price is under cost is not that easy).

But prices aren't set on information - which "information"? opinion or distribution channel? - and only world-level based on the degree of market participation by foreigners. The price of haircuts in China has no bearing on the price of haircuts in Chicago, unless you are willing to go to China for a haircut. Even knowing that price won't help you in getting a better price in Chicago, since any barber should quite properly retort that if you don't like his prices, then go get a haircut in China. Prices are set by managers who want to maximize any number of factors: perhaps they need to show maximum profits, or keep capacity used, or meet a market penetration criteria. By setting such a price, they enter the market and demand decides whether they are successful or not.

But not "information".

This development underlies the steady shift in protectionism: from tariffs--the traditional way--to protection through rules, regulations and especially export subsidies. World trade has grown spectacularly in the last fifty years. The largest growth has been in subsidized farm exports from the developed world: western and central Europe, Australia, Canada and the United States. Farm subsidies are now the only net income of French farmers, as their crops produce nothing but net losses and are grown only as the entitlement for the subsidies. These subsidies are in fact a major--perhaps the major--cement of the Franco-German alliance, and with it, of the European Union.

Now here I don't understand where Drucker is coming from at all. First of all, this development isn't new, but has been around since the 19th century. Tariffs are also not the traditional way - except perhaps in the US - of protecting domestic industries. No one remembers, I guess, the Japanese import inspections of the 1950s-today or the French review of electronic imports in the 1960s through the 1980s (for a while, all French imports of video recorders went through a very small customs office in the middle of nowhere, where each videorecorder was unpacked, plugged in and verified that it was indeed a videorecorder. Took around 2 hours for each VCR, effectively blocking all imports. Ended when the French electronics makers started making VCRs in Korea. Just magically disappeared).

I won't argue with Drucker on farm subsidies: they are an evil that has directly caused starvation in Africa, done by French companies to destroy domestic markets in their former colonies to ensure that export markets for subsidized French companies would be created. Disgusting and despicable. And it's not merely the cement ensuring the functioning of the EU, it's also one of the major causes of corruption within the EU, which makes the rest of the industrialized west look like pikers.

The international organization designed to set world economic policy is the World Trade Organization (WTO). But its meetings and agreements deal less and less with trade and tariffs, and instead with rules, regulations and subsidies. The discipline of international economics still, in large measure, concerns itself with international trade--that is, with the flow of money, goods and services. But the essence of the new world economy is that it is, above all, an economy of information and truly a global economy.

The WTO sets economic policies, but these policies are the result of conflicting national interests, not anything else.

And considering the "new world economy" as new is an indictment of how far-off Drucker is here: the world economy has always been a global economy: international trade has always been strong despite the efforts of mercantilists and protectionists. Italy wouldn't be eating pasta if it hadn't been imported from China (and the Koreans claim the Chinese got it from them...), and that was an exchange of information and not one of products. Drucker is once again stating the obvious.

The next major economic crisis will most probably be a crisis of the U.S. dollar in the world economy. It will put to a severe test the oligopoly of the central banks of the developed countries that now rules over the world financial economy.

Sixty years ago, in the Bretton Woods meetings of 1944, which tried to refashion a world economy that had been devastated by depression and war, John Maynard Keynes, the 20th century's greatest economist, proposed a supra-national central bank. It was vetoed by the United States. The two institutions that Bretton Woods established instead, the Bank for International Development (World Bank) and the International Monetary Fund (IMF), are, despite their impressive names, auxiliary rather than central--the former mainly financing development projects, the latter providing financial first aid to governments in distress.

Sigh. Where to start?

Fundamentals: economies around the world develop differently and at different rates. Some have strong inflation, others very low; as a result, the cost of money - aka interest rates - differs between countries. As a result of differing rates of economic growth and differing costs for money, exchange rates differ. This is how markets deal with differing environments between countries.

As a result there are imbalances in the world system. A country with high interest rates will, ceteris paribus, attract internationally mobile capital since the returns are higher. As demand for that country's currency increases, so increases the exchange rate and the resulting shift in values makes the investment look less attractive: this is a basic description of the international currency market. It can be manipulated - Hi, George Soros - and is not always efficient, but that is how exchange rates are driven.

Now, how can you deal with such imbalances if you were to have a single supranational central bank?

No idea?

Really?

Guess what: no one else does either. The US handles differentials in the US economy by changing reserve requirements in the seven Fed districts, effectively slowing or increasing banks' ability to loan money. The EMU and the EU central bank here in Frankfurt don't want to do this and lets the old national central banks meet the targets set in their own manner, which is usually basically the same solution.

But both of these set-ups work within a single currency. Hence there is no devaluation of the dollar betwen Alabama and New York, nor is there a devaluation of the Euro between Ireland and Germany.

So: an oligopoly of central banks?? First of all, central banks aren't in business and don't take part in market activities. Rather, they regulate market activity via interest rates and reserve requirements, coupled with intervention in exchange rate markets. But they don't form an oligopoly, which is defined as a limited number of suppliers facing a very large number of consumers. Or is the SEC called a monopolist because they're the only one regulating capital markets?

This is incredibly sloppy from Drucker and he should be ashamed of trying to pull this one over anyone.

The Bretton Woods system was never the stable, "non-political" system Keynes wanted. It could not and did not prevent currencies from being overvalued or undervalued. Still, although it limped from one crisis to the next, the Bretton Woods system worked for most of the half-century after World War II. And there was only one reason why it worked (however poorly): the commitment to it of the United States and the strength of the U.S. dollar as the world's key currency.

I think that what Keynes wanted is plain and simple wrong: I've tried to show above that you need a non-stable system in order to deal with the differences in international development. It will undergo changes and won't be nice to failing countries, but that is how any good system of maintaining equilibrium works: if something is off balance, it will be corrected over time to recover balance. But that leads to long-term stability of the entire world economy, rather than allowing it to crash and burn because some yahoo politican decides that an industry must be protected.

Of course Bretton Woods didn't prevent currencies from being over- or undervalued: it tried to be more clever than markets, and history is full of such corpses. That it worked for so long was due to a political commitment and not anything else. Ok, Drucker says that. Like I said, he gets some things right. But appeal to authority (Keynes) is a logical fallacy.

The dollar is still the world's key currency. But the Bretton Woods system is being killed by the U.S. government deficit, which is fast becoming the sinkhole of the world financial economy. The persistent U.S. deficit creates a persistent deficit in the U.S. balance of payments, which make both the U.S. economy and the government increasingly dependent on massive injections of short-term and panic-prone money from abroad. The U.S. savings rate is barely high enough to finance the minimum capital needs of industry. It could, in all likelihood, be raised considerably by raising interest rates. But that is not only politically almost impossible; it would also require that a larger share of incomes go into savings rather than into consumption, with an inevitable collapse of an economy based on consumer spending and low interest rates, as for instance, the U.S. housing market.

Present tense with Bretton Woods? Sorry, Nixon killed that one! Bretton Woods collapsed in 1971 and was buried with the Smithsonian Agreement. And in 1973 it was completely abandoned. Drucker should be saying: it was killed by the US government deficit, but even this is a question that economists continue to debate (we're easily amused). Bretton Woods was a deal to maintain exchange rates within a very narrow range and was doomed to failure.

Now Drucker gets silly: what is his basis for viewing foreign investments in the US as short-term and panic-prone? If anything the opposite is the case: foreign investments are usually long-term and based on either serving the US market or as a safe haven.

While the US savings rate as defined in the NIPA (National Income and Product Accounts) used to determine GDP is low, this is less a savings problem and much more an accounting problem (for instance, 401k payments are taken off your gross salary before taxes, reducing the level of disposable income before taxes, but the NIPA starts with looking only at taxable income). If you look instead at the Fed's Flow of Funds accounts, a rather different picture appears.

The government deficit is therefore being financed almost in its entirety by foreign investments in the United States, mostly in government securities like short-term treasury notes and medium-term bonds. The Japanese are converting most, if not all, of their trade surplus with the United States into dollar-denominated U.S. government securities and have thus become the largest U.S. creditor.

Superficially correct, but meaningless. Truly meaningless, since US debt is held in US dollars. This becomes more important shortly.

It is often argued, especially in Washington, that the deficit is mostly an accounting mirage. Defense spending--the main cause of the deficit--enables other free countries to keep their own defense spending low, which then generates the surpluses these countries invest in U.S. government securities. But this is a political argument. The economic fact is that the United States increasingly borrows short term (U.S. securities can be sold overnight) to invest long term and with very limited liquidity. This, needless to say, is an unstable and volatile system. It would collapse if the foreign holders of U.S. government securities (above all, the Japanese) were for whatever reason (such as a crash in their own economy) to dump their holdings of U.S. government securities. It certainly cannot be extended indefinitely, which, among other serious drawbacks, calls into question the long-term viability of the Bush Doctrine's goal of defending and extending the "zone of freedom" around the world.

Here is the fallacy that many are seemingly buying into: that foreigners would dump US government securities.

Even if Drucker's basic nightmare scenario would come true, that significant holders of US securities were to liquidate their holdings in order to deal with a national emergency (in their countries): what are they going to do with their holdings? If they were to dump, the price of securities would drop dramatically, since excess supply depresses prices. But their holdings would remain in US dollars: if they were then to try to repatriate the dollars, it would depress the value of the dollar for the exact same reason, resulting in a further reduction.

International investors don't behave this way. They are rational actors. First of all, international holdings don't care where their money is, just that capital appreciation gives them a decent return with a minimum of risk. Poeple buy US government securities because it gives them liquidity within the US dollar sphere, coupled with adequate return and basically no risk.

Without getting bogged down, the scenario is so unlikely that it is akin to asking what the effects on the New York Stock Exchange would be if Kansas was hit by a major earthquake.

The World Economy of the Multinationals

There were 7,258 multinational companies worldwide in 1969. Thirty-one years later, in 2000, the number had increased ninefold to more than 63,000. By that year, multinationals accounted for 80 percent of the world's industrial production.

But what is a multinational? Most Americans would answer: a big American manufacturer with foreign subsidiaries. That is wrong in almost every particular.

American-based multinationals are only a fraction--and a diminishing one--of all multinationals. Only 185 of the world's 500 largest multinationals--fewer than 40 percent--are headquartered in the United States (the European Union has 126, Japan 108). And multinationals are growing much faster outside the United States, especially in Japan, Mexico, and lately, Brazil.

So what? Why is this a problem? He keeps on going and proves that multinationals are not the boogeyman:

Furthermore, most multinationals are not big. Rather, they are mostly small- to medium-sized enterprises. Typical perhaps is a German manufacturer of specialized surgical instruments who, with $20 million in sales and with plants in eleven countries, has around 60 percent of the world market in the field. And only a fraction of multinationals are manufacturers. Banks are probably the largest single group of multinationals, followed by insurance companies such as Germany's Allianz, financial-services institutions such as GE Finance Corporation and Merrill Lynch, wholesale distributors (especially in pharmaceuticals), and retailers like Japan's Ito Yokado.

So we don't need to be afraid of multinationals, is this the message?

The traditional multinational was indeed a domestic company with foreign subsidiaries, like Coca-Cola. But the new multinationals are increasingly being managed as one integrated business regardless of national boundaries, and the managers of the "foreign subsidiaries" are seen and treated as just another group of "division managers" rather than as top managements of semi-autonomous businesses. Internally, new multinationals are often not even organized by geography, but worldwide by products or services, such as one worldwide division for cleaning products or short-term inventory loans. They are increasingly organized by "markets": fully-developed markets (such as western and northern Europe or Japan); "developing markets" (eastern Europe, Latin America and parts of East Asia); and the "underdeveloped markets" and big "blocs" (China, Russia and India)--each with different objectives and strategies.

Ah, so it's not multinational we need to worry about, it's "new" multinationals. Earth to Drucker: he's describing the way that multinationals have been managed and run since companies start making more money overseas than domestically. That's as true for German makers of laser cutting equipment as it is for any megabusiness. This is supposed to be something new? Repackaged International Business Economics from 1983 if you ask me (that's when I learned it).

Finally, the new multinationals are increasingly not domestic companies with foreign subsidiaries, but are more likely to be domestic companies with foreign partners. They are being built through alliances, know-how agreements, marketing agreements, joint research, joint management development programs and so on. They require very different management skills; they must persuade, not command. The typical old multinational began planning with the questions: "What do we want to achieve? What are our objectives?" The first question in the new multinational is likely to be: "What do our partners value? What do they want to achieve? What are their competencies?" And in turn: "What do they need to know about our values, our goals, our competencies?"

We have almost no data on the world economy of the multinationals. Our statistics are primarily domestic. Nor do we truly understand the multinational and how it is being managed. How, for instance, does a multinational pharmaceutical company decide in what country first to introduce a new drug? How does a medium-sized multinational, like the German surgical-instrument maker mentioned earlier, decide whether to keep importing into the United States? To buy a small American competitor who has become available? To build its own plant in the United States and to start manufacturing there? Our dominant economic theories--both Keynes and Friedman's monetarism--assume that any but the smallest national economy can be managed in isolation from world economy and world society. With an estimated 30 percent of the U.S. workforce affected by foreign trade (and a much higher percentage in most European countries), this is patently absurd. But an economic theory of the world economy exists so far only in fragments. It is badly needed. In the meantime, however, the world economy of multinationals has become a truly global one, rather than one dominated by America and by U.S. companies.

Now this is so much bull: there is no world economy of the multinationals. And statistics worldwide are domestic, but you can most certainly put the numbers together. And not understanding the multinational? What do MBA schools teach nowadays if anything but this?

And for the decision making, this is no different to normal decision making. He does correctly criticize Keynes and Friedman as assuming that an economy works in splendid isolation. But hey, guess what? Keynes and Friedman aren't the only economists out there, maybe Drucker should go and check out some of the "newer" literature, like Mundell-Flemings models, which were first proposed in the 1960s. A general equilibrium theory most certainly gives the framework for an economic theory of the world economy, and it works quite well, thank you very much. I've been using general equilibrium models for the last 15 years to forecast international industrial developments, both short-term (next quarter) and long-term (right now I'm rebuilding models out to 2020 and my real-estate colleagues run their forecasts out to 2040).

This is embarrasing. Drucker really seems to have stopped learning in the 1970s or 1980s at the latest. Large-scale general equilibrium models have been around since 1983 or so on a commercial basis and there are at least a couple of multinational companies who offer them: I've worked for two of them over the last 15 years.

The modern state was invented by the French political philosopher Jean Bodin in his 1576 book Six Livres de la Republique. He invented the state for one purpose only: to generate the cash needed to pay the soldiers defending France against a Spanish army financed by silver from the New World--the first standing army since the Romans' more than a thousand years earlier. Mercenaries have to be paid in cash, and the only way to obtain a large and reliable cash income over any period--at a time when domestic economies had not yet been fully monetized and could therefore not yield a permanent tax--was a revenue obtained through keeping imports low while pushing exports and subsidizing them.

Now this is a really unique take on the establishment of the modern state. Bodin can be considered one of the early thinkers, but he didn't invent the modern state: that was done in the Treaty of Westphalia in 1648. Got news for Drucker: states don't exist for economic reasons, but for political ones. They might have economic policies that drive them, but even the Hanseatic Guild, the penultimate mercantilists, were driven by politics and not by mere economics. This massive failure to understand history - or perhaps more gently the massive bending of history - weakens his arguments significantly, such as they are.

And that is why I am not going to critique the rest of his arguments: they are based on this absurd reading of history, that multinationals are the inheritors of the mercantilist states.

Well, actually I will, but without the quoting. The errors that Drucker makes are multifold: he fails to understand how countries can act to protect their economies against mercantilistic policies, such as the French have towards Africa, without abandoning free trade. Much of his critique centers on this misunderstanding and places the onus on both parties, where in reality it is mostly the EU with its desperate attempts to retain colonial dominance in the Third World that has led it to adopt frankly mercantilistic policies.

And his "warnings" are, frankly, rather jongoistic and simplistic. The US may be facing increased competition, but also has an outstanding track record of reinventing the US economy and creating new industries out of scratch. Information technology is just one small aspect of these developments, and indeed his implied solution - that the US had better get serious about protecting its markets - is the exact opposite of what needs to be done. The US has the most flexible of all the world's economies, able to react to changes relatively quickly and without major make-or-break government intervention into markets, and to reduce this flexibility by protecting those markets and removing the need to remain flexible would be a major disservice to the US economy, if not the world economy.

What needs to be done is to increase pressure on the EU to drop its subsidies and protectionism: but the idea that their economies need to be flexible and capable of handling massive changes in operating environments is a severe anethema to the technocrats running the EU. That's got to be the challenge.