The great rebalancing

http://www.mckinseyquarterly.com/The_great_rebalancing_2627

As the center of economic growth shifts from developed to developing countries, global companies should
focus on innovation to win in low-cost, high-growth countries. Their survival elsewhere may depend on it.

JUNE 2010 • Peter Bisson, Rik Kirkland, and Elizabeth Stephenson

In This Article

 Exhibit: Executives weigh in on the major developments that will be important for business over the next five years.
 Comments (3)

The vibrancy of emerging-market growth will not be the only major disruption reshaping the global economy
in the next ten years, but it may prove the most profound. This decade will mark the tipping point in a fundamental
long-term economic rebalancing that will likely leave traditional Western economies with a lower share of global
GDP in 2050 than they had in 1700.

Two socioeconomic movements are under way.

 Declining dependency ratios. Virtually all major emerging markets are undergoing demographic shifts
that historically have unleashed dynamic economic change: simultaneous labor force growth and rapidly declining
birthrates. Simply put, there will be more workers, with fewer mouths to feed, leaving more disposable income.
 The largest urban migration in history. Each week, nearly one-and-a-half-million people move to
cities, almost all in developing markets. The economic impact: dramatic gains in output per worker as people move
off subsistence farms and into urban jobs. China and India are seeing labor productivity grow at more than five
times the rate of most Western countries as traditionally agrarian economies become manufacturing and service
powerhouses.

These same factors powered Western economic growth for the better part of two centuries. (And they should last
well into the next decade—at least until China’s population, finally seeing the full effects of the one-child policy,
begins to go gray.)

In the next decade, emerging-market economies will rapidly evolve from being peripheral players, largely reacting to
events set in motion by wealthy Western nations, into powerful economic actors in their own right. They will shed
their role as suppliers of low-cost goods and services—the world’s factory—to become large-scale providers of
capital, talent, and innovation. (One hint of what’s to come: the number of BRIC 1 companies on the Fortune 500 has
more than doubled in the past four years alone.) </P...< p...>

The productivity imperative

To sustain wealth creation, developed nations must find ways to boost productivity; product and process
innovation will be key.

JUNE 2010 • Peter Bisson, Elizabeth Stephenson, and S. Patrick Viguerie

In This Article

 Exhibit: Executives weigh in on the major developments that will be important for business over the next five years.
 About the authors
 Comments (4)
Emerging markets are riding a virtuous growth cycle, propelled by larger and younger working populations. In
the wealthy nations of the developed world, by contrast, low birthrates and graying workforces will make it
enormously difficult to maintain what economist Adam Smith called “the natural progress of opulence.”

These countries’ best hope for keeping the wealth creation engine stoked is improved productivity—producing more
with fewer workers. Paradoxically, doing that well across an economy is also the only way to generate lasting
employment gains. In the United States, for example, every point of productivity-led GDP growth has historically
generated an incremental 750,000 follow-on jobs.

The great tension here arises at the level of politics. Over time, the world’s rebalancing demands greater
consumption and lower savings among the large developing countries, even as developed ones, the United States
foremost among them, save, invest, and export more. Fostering policies that raise productivity, and avoiding or
altering polices that impede it, will help ensure a smooth transition. Getting this wrong—failing to generate at least
modest and broad-based continued income and employment gains in developed countries—raises the odds of a
political backlash that will hurt the citizens of wealthy nations and of those moving up the wealth curve alike.

We call the productivity challenge an imperative because the need is so compelling. But to eke out even modest GDP
increases, OECD1 nations must achieve nothing short of Herculean gains in productivity. In the 1970s, the United
States could rely on a growing labor force to generate roughly 80 cents of every $1 gain in GDP. During the coming
decade, assuming no dramatic increase in hours worked, that ratio will roughly invert: labor force gains will
contribute less than 30 cents to each additional dollar of economic growth. To maintain a GDP growth rate of 2 to 3
percent a year, productivity gains will have to make up the other 70 percent.

The challenge is even greater in Western Europe, where no growth in the workforce is expected. Here, in other
words, 100 percent of GDP growth must come from productivity gains. And in Japan, the hurdle is higher still:
because of a shrinking labor force, each worker will have to increase output by 160 yen to generate an additional 100
yen of growth.

To complicate things further, we are seeing a growing talent mismatch. The Western economies have built a
workforce optimized for mid-20th-century national industries, yet the jobs now being created are for 21st-century
global ones—we need knowledge workers, not factory workers. And there just aren’t enough of the former.
Anywhere. Companies across the globe consistently cite talent as their top constraint to growth.

In the United States, for example, 85 percent of the new jobs created in the past decade required complex knowledge
skills: analyzing information, problem solving, rendering judgment, and thinking creatively. And with good reason:
by a number of estimates, intellectual property, brand value, process know-how, and other manifestations of brain
power generated more than 70 percent of all US market value created over the past three decades.

Western economies can do many things to change the equation. Deregulation has often raised productivity in the
past and can continue to do so. Changing the boundaries around the work–life balance—encouraging people to stay
in the workforce longer or increasing the numbers of hours worked each week—could add a few points of absolute
growth too. Improving education is a no-brainer.

Businesses can and should advocate these and other policy changes that could have a long-term impact, such as
easing immigration restrictions. But in the end, the real game changers will be breakthrough innovations created by
companies: history shows that a majority of productivity growth—more than two-thirds—comes from product and
process innovation.
The productivity economy will reward ‘do it smarter’ companies that build a better business
model

Besides providing powerful incentives for companies to deliver their traditional products and services more
efficiently, the new environment may make selling productivity—finding marketable ways to “do it smarter”—the
most transformative business model of the next decade.

Western economies can boost productivity not only through deregulation but also by adjusting the work–life balance—keeping flexible

hours and staying in the workforce longer, as 95-year-old Sydney Prior of Britain has.

This push is bound to have a “no pain, no gain” dynamic. Innovation, by definition, is a disruptive process. Think
about the book-publishing industry. Only two years after the release of the Kindle, Amazon.com now sells half of its
books electronically for the titles it offers customers in both bound and digital formats. The Kindle is short-circuiting
the entire physical supply chain, and Apple’s new iPad is sure to accelerate that process.

Something similar is shaking up the world of computing. It’s considered the poster child of productivity—and for
good reason. But probe further and it’s not hard to find evidence of waste. Companies spend, on average, 5 to 10
percent of their total revenues on IT. Yet reliable estimates suggest that upward of 70 percent of server capacity goes
unused—even more at midsize and small companies, since they can’t achieve scale. Advances in “cloud computing”
(sharing computer resources remotely rather than storing software or data on a local server or PC) have vast
potential to raise utilization rates and simultaneously help companies to increase their computing capacity, while
slashing IT costs by 20 percent or more. Little wonder tech giants as divergent as Google, IBM, and India’s Wipro
Technologies are investing furiously to win the battle for the cloud.

Companies that can master productivity techniques, such as robotics, and sell that expertise may capture the coming decade’s most

transformative business model.

Health care is another arena where do-it-smarter businesses will thrive. On average, health care spending in OECD
countries has outpaced GDP growth by nearly two percentage points a year, and even more in the United States.
Still, in most countries, increased health care spending actually creates a productivity drag on the economy overall,
because the sector has lagged behind in adopting productivity measures. (To take just one indicator, health care
organizations spend, on average, only 20 percent of what financial-services companies do on IT.)

But multiple innovations promise to improve outcomes significantly while reducing costs. For example, some 75
percent of health care spending in many OECD countries pays for chronic-disease management. France Telecom’s
Orange is partnering with health care providers to offer services that constantly monitor diabetics and cardiac
patients remotely. Low-cost mobile-monitoring devices ensure better compliance with treatments and reduce the
number of high-cost, life-threatening events. Germany’s T-Systems has linked up with the health insurance provider
Barmer to provide mobile systems that track and monitor exercise patterns, so patients—and doctors—can monitor
progress and reduce risk more effectively.

A raft of industries and services are poised to benefit from productivity improvements. Huge gains could be
extracted just by applying the insights learned over the past 15 years in the most productive sectors, such as telecoms
and financial services, to less productive ones, such as health care, education, and government.

The best companies will learn how to maximize returns from people who think for a living
Just as the early 20th century saw the development of management theory for improving the productivity of factory
workers, the 21st century will see the evolution of myriad better techniques for managing people who think for a
living.

The potential stakes are enormous. Companies that have higher concentrations of knowledge workers (above 35
percent of the workforce) create, on average, returns per employee three times higher than those of companies with
fewer knowledge workers (20 percent or less of the workforce). Yet companies with more knowledge workers also
show more variable returns: differences between competitors in the same industry with fewer knowledge workers.

Turning this gap into a key source of competitive advantage requires much more than reverting to the well-worn
“attract, deploy, develop, and retain” talent wheel found in HR manuals everywhere. Yes, the road to success still
starts with capturing more of the right talent. But to increase productivity dramatically, companies will then need to
think aggressively about how to increase the pace of talent development, to deploy the best talent against the
highest-value opportunities, and to improve the way such workers engage with their peers. Our analysis suggests
that at many large multinationals, nearly half of all interactions between knowledge workers do not create the
intended value—because people have to hunt for information, do not know where to find what they need, or get
caught in the maws of inefficient bureaucracies.

Companies will need to reinvent work—what, where, when, how, who, and why

Companies such as Best Buy have increasingly recognized that work is not a place where you go but rather
something you do. To get the most out of its corporate workforce, the company has adopted a “results-only work
environment,” which gives workers big targets but lets them meet these goals any way they see fit. This approach has
improved worker productivity by as much as 35 percent in departments that have deployed it.

Transforming process flows will also unlock new kinds of productivity. Companies such as Cisco and IBM are
aggressively developing approaches—from social networks to videoconferencing—that tear down silos and reinvent
how far-flung employees collaborate and exchange knowledge. What’s more, these approaches work: UK grocer
Tesco, for example, saved up to 45 percent of the travel budgets of key departments by substituting
videoconferencing for long-haul travel. The Hong Kong apparel supplier Li & Fung now uses videoconferencing to
connect clothing designers with fabric and notions suppliers around the world, dramatically speeding the design
process. That’s no mean feat for a company known for its ability to turn around “fast fashion” in weeks, not months.

Although the demand for knowledge workers is sure to grow, the supply will not. Governments aren’t moving fast
enough to educate workers with the skills needed to meet the productivity imperative, and businesses can’t afford to
wait. That means companies must get much more innovative at sourcing talent, whether by tapping global labor
markets, building part-time workforces, or making better use of older workers. Firms also will need to rethink work
progressions in a world with much flatter age pyramids—young workers no longer outnumber old ones, which has
been the premise for role advancement in most companies for decades. BMW has experimented with auto
production lines geared for older workers. Retailers such as CVS and Home Depot are pioneering “snowbird”
programs, which let retirees go to warm climates in the winter and to work in stores there, returning to their original
stores in the summer.

Information streams are the infinite by-product of a knowledge economy—the best companies
will turn this free good into gold

A final productivity driver will be something businesses are creating in digital bucket loads: information. Although
the volume of data created is expected to increase fivefold over the next five years, best-guess estimates suggest that
 less than 10 percent of the information created is meaningfully organized or deployed. That number will only shrink
as the rate of information production goes up.

Enter business analytics software, which increasingly allows companies to make sense of data “noise”—helping them
“de-average” data to eliminate waste, more closely target customers, and identify new opportunities. In general,
companies that are aggressive adopters of business analytics are proving twice as good at predicting outcomes and
three times as good at predicting risk as those that aren’t.

The Swiss telecom operator Cablecom, for example, reduced customer churn nearly tenfold through the better use of
customer information. Both Amazon and Google have developed predictive models that use enormous amounts of
data to figure out what products customers might like, based on past searches and clicks. IBM, Microsoft, Oracle,
and SAP have spent a combined $15 billion in the past several years snapping up companies that develop software
for advanced data analytics. Expect a host of new offerings that help turn information into gold.

Soon, Web 3.0 technologies—which create “smart” data, or data that can be combined intelligently with other data,
mostly without direct human involvement—should extend the power of information even further. We fully expect
Web 3.0 to begin disrupting information networks within the decade.

In short, companies that deploy technology more successfully to get more from the higher-quality knowledge
employees they attract will gain large business model advantages—and drive substantial growth and productivity
gains.

The global grid

The global economy is becoming increasingly interconnected, and innovative businesses are harnessing
the power of this network.

JUNE 2010 • Peter Bisson, Elizabeth Stephenson and S. Patrick Viguerie

In This Article

 Exhibit: Executives weigh in on the major developments that will be important for business over the next five years.
 About the authors
 Comments (1)

Over the past two decades, globalization and digital technology have combined to create vast, complex networks
that weave themselves through every economic and social activity. Money, goods, data, and people now cross
borders in huge volumes and at unprecedented speed. Since 1990, trade flows have grown 1.5 times faster than
global GDP. Cross-border capital flows have expanded at three times the rate of GDP growth. Information flows
have increased exponentially.

These networks form a global communications and information grid that enables large-scale interactions in an
instant. Within this digital fabric, old boundaries begin to blur; cross-border capital flows also become information
flows; and just-in-time supply chains also serve as just-in-time information chains. Case in point: only one in ten US
dollars in circulation today is a physical note—the kind you can hold in your hand or put in your wallet. The other
nine are virtual.

On this grid, trillions of large and small transactions synchronize instantly. The striking thing about the recent
economic downturn wasn’t just the rapidity of the decline but the fact that so many seemingly diverse markets
plunged at once. By the end of 2008, the volume of trade had fallen by more than 10 percent in more than 90
percent of OECD1 economies. Why? Trade declined everywhere because, increasingly, products are made
everywhere. These days, a typical manufacturing company relies on more than 35 different contract manufacturers
around the world to provide the necessary parts for its goods, which for some companies, such as auto and airplane
manufacturers, can range in the tens of thousands. No wonder that over the past 40 years, trade in intermediate
goods as a percentage of total trade has doubled.

These interconnections are even more pronounced in capital markets. Who would have imagined that Iceland’s
financial system might collapse when mortgages in Las Vegas went belly up?

Such complex adaptive systems create their own organizing dynamic. In the absence of direction from a single
center, they grow, evolve, interconnect, disrupt, and—quite important—heal themselves. Even as capital flows
temporarily shut down during the crisis’s darkest days in the winter of 2008–09, for example, the global
information grid kept growing. Estimates by Cisco Systems suggest that in 2009, global data flows expanded by
nearly 50 percent. In China alone, more than 150 million new people connected to the Internet last year, giving that
country a digital population almost as large as the world’s biggest social-networking site, Facebook. And last year,
Facebook’s user base more than tripled, to upward of 400 million members—a population that would make it the
world’s third-largest country.

Alongside this relentless advance in digital connectivity, the financial crisis has underscored the commitment by
most countries to maintain market-based economies and free flows of capital and trade—though the precise shape of
new regulations remains to be determined. On average, governments across the globe have passed three
protectionist measures a day since the advent of the crisis, but they haven’t added up to much: less than 1 percent of
global trade has been affected by these rulings.

Meanwhile, links form in new directions. Trade flows between China and Africa, for example, have been growing by
30 percent annually, creating robust commercial networks that barely existed a few years ago. Similarly, Asia has
supplanted North America and Europe as the Middle East’s largest trading partner. Transactions between emerging
markets are on the rise. The Indian wireless operator Bharti’s recent bid to acquire Kuwait-based Zain’s African
assets could create a global wireless giant that would reach across more than 20 countries in South Asia and Africa.

Every company is now a global company—and the most innovative ones are building the
global grid into their DNA

Innovative businesses will grow by harnessing the interlocking power of these new grids. Some will be disruptive
newcomers like Skype. Formed less than seven years ago, and lacking any network infrastructure, Skype nonetheless
ranks as the world’s largest carrier of transnational telephone calls. Even if companies eschew such radical business
models, they need to think strategically about how to use these new networks to advance their existing business
models. Techniques such as “near-shoring,” “crowd sourcing,” and sophisticated labor arbitrage help companies
efficiently build products, source ideas, find employees, deliver services, and reach customers efficiently.

As an English nurse orders medicine on a wireless electronic tablet, she links her hospital up to the global information grid, which will help

innovative businesses grow and become increasingly international.

Similarly, companies that can figure out how to capture winning positions in the global supply chain will thrive.
Japanese companies have mastered that strategy as no others have. In 30 different technology sectors with revenues
of more than $1 billion, Japanese companies control 70 percent or more of global market share. They have done so
by creating an array of “choke point” technologies on which much larger industries depend. Mabuchi Motor, for
instance, makes 90 percent of the micromotors used to adjust car mirrors worldwide. Nidec makes 75 percent of the
world’s hard-disk drives. Japanese companies own nearly 100 percent of the global market for the substrates and
bonding chemicals used in microprocessors and other integrated circuits.

The information grid makes every company, no matter how small, a global company. Even individual proprietors
now sell to customers around the world via sales platforms such as eBay or Alibaba. Snaproducts, a US-based
product-development company with fewer than 40 employees worldwide, uses virtual sourcing to supply US
retailers with an array of low-cost seasonal and basic products: summer flip-flops, Christmas decorations, beauty
products, socks—more than 50 million pairs in the past three years. The company marries a high-touch, customer-
centric design process with low-cost production; it collaborates with retailers to predict fickle consumer trends and
then designs and sources products in collaboration with a range of low-cost manufacturers across Southeast Asia.
This approach provides retailers with rapid sales on high-margin products and allows Snaproducts to deliver year-
over-year growth rates as high as 400 percent, without ever taking ownership of inventory.

Your customer is tweeting—how will you answer?

The global grid’s most important impact on business over the next decade may come from the disruptive changes in
consumer behavior that it will spur. These changes may well overshadow the radical pricing transparency,
ubiquitous information availability, and massive new networks of engaged consumers that we have already
witnessed. Recall that 15 years ago, less than 3 percent of the world’s population had a cell phone and less than 1
percent was online. Today, those numbers are 50 percent and 25 percent, respectively.

These technological changes are altering behavior that was once thought impossible to shift. For example,
Americans now spend 30 percent more time reading than they did a decade ago, thanks to the explosion of text
messaging, e-mail, and social networking.

The complex digital networks that form the current global communications and information grid have brought mobile phones and Internet access

to nearly every corner of the world.

What’s more, these readers also write. More than 15 million Americans (or 10 percent of the US workforce) now post
online product reviews every week. Aside from recommendations by friends, US buyers now rate online user reviews
as the top influencer of their buying decisions—nearly twice as influential as old-style advertising. Traditional media
companies know just how large a hole this behavioral shift has blown in their bottom lines.

But it’s not just Big Media’s problem. Companies everywhere are struggling both to capture the benefits of this
always-on, user-driven world—and to contain the damage it can cause. Product problems can become global issues
overnight, putting a premium on constant monitoring. Viral networks also help inflame nationalist passions around
formerly isolated incidents. (Carrefour learned that lesson when negative remarks made by French politicians
promoted an overnight boycott of its Chinese stores in the run-up to the 2008 Beijing Olympics.) In such situations,
speed and agility in crafting a response can make the difference between successful crisis control and enormous
economic harm.

Imagine the power of four billion connected minds—are you prepared for the innovation about
to be unleashed?

The spread of mobile broadband will multiply these challenges and opportunities. Users of the iPhone surf the
Internet 75 percent more than do users of regular cell phones, and more than half use their phones to watch video.
In just three years since the iPhone’s launch, developers have created more than 200,000 applications, and this is
only the beginning: nearly 50 percent of all new mobile phones purchased in developed markets are now Web-
enabled smartphones. That rush of new Net surfers includes a growing number of emerging-market users too: in
China last year, more than 100 million people logged on using the country’s new 3G network, which is why global
mobile data usage rose 2.5 times in 2009.

The global grid’s interconnectedness can bring volatility as well as stability to the marketplace. Stock traders in São Paulo were no more immune

to the financial crisis than their counterparts in New York were.

Emerging markets are where the information grid’s influence may be most profound. The explosion of mobile
networks is giving billions of people their first real entry point into the global economy, helping them become more
informed consumers, connecting them with jobs, and providing much better access to credit and finance. The
economic impact is tangible: every 10 percent increase in cell phone penetration in India corresponds to a nearly 0.6
percent rise in national GDP.

Kenya shows how the future might unfold: just four in ten Kenyans have cell phones, yet half of all users—or one in
five Kenyans—now make purchases via mobile-payment systems. Kenya’s largest employer is txteagle, an SMS-
messaging company, which provides jobs to more than 10,000 Kenyan citizens by doling out “microwork”: small
tasks that can be accomplished over mobile networks.

A world where not just everyone but also everything is connected opens up radically new
possibilities

Increasingly, people plugging into the planet’s digital nervous system will be joined by inanimate objects in a
phenomenon we call “the Internet of Things.” At present, more than 35 billion “things” are connected to the Internet
—sensors, routers, cameras, and the like—but this phenomenon is just getting started. More than two-thirds of new
products feature some form of smart technology.

For example, John Deere tractors now deploy GPS guidance systems to apply fertilizers to cropland precisely,
reducing farmers’ costs and increasing annual yields. The Dutch start-up TomTom has created systems of “smart”
traffic lights that improve traffic flows. Nortura, Norway’s largest food supplier, uses radio-frequency identification
(RFID) technology to trace chickens from the farm to the store shelf, helping to monitor optimal refrigeration
temperatures throughout the supply chain. Kraft and Samsung have partnered to develop the Diji-Touch, a Web-
enabled vending machine that allows real-time updates of rich-media images of products for sale. The stakes are
high: as objects and devices connect online, some estimates suggest that at least $3 trillion of current spending could
be disrupted.

Expect a bumpy ride—a connected world will be a volatile world

A profound tension remains at the core of this expanding global grid. In theory, all this interconnectedness is
supposed to increase stability by helping to diversify risk. But while the ability to diversify risk has risen, so has the
ability to identify and channel resources instantaneously toward or away from opportunities. The global financial
crisis painfully underscored how interconnectedness can actually amplify the impact of a particular shock, so the key
will be to focus on building in greater redundancy and resilience. In the meantime, we should not be surprised if the
years ahead bring long stretches of stability—the payoff from a larger and more resilient system that is still subject to
bubbles and powerful shocks.

The next few years in particular may well be bumpy as a massive deleveraging process rolls through many Western
economies. The eurozone will prove especially tumultuous as structural imbalances get worked out between savers,
such as Germany, and debt-laden countries, such as Greece, Ireland, Portugal, and Spain. It’s important to note that
these bumps will occur across all markets—capital and currency markets, trade markets, and labor markets.
 In response, businesses should strive to improve their peripheral vision by gaining a better understanding of the full
range of areas where disruptions could emerge and by scanning the horizon for potential shocks. Volatility is here to
stay. Learn to recognize it, prepare for it, adapt to it, manage it, and profit from it. But don’t ignore it.

Pricing the planet

Understanding a company’s full exposure to energy and environmental risks will in many cases be a—if not
the—decisive factor determining its long-term viability.

JUNE 2010 • Peter Bisson, Elizabeth Stephenson, and S. Patrick Viguerie

In This Article

 Exhibit: Executives weigh in on the major developments that will be important for business over the next five years.
 About the authors
 Comments (1)

The tension between rapidly rising resource consumption and environmental sustainability is sure to prove to
be one of the next decade’s critical pressure points. Natural resources and commodities account for roughly 10
percent of global GDP and underpin every single sector in the economy. No one will sit on the sidelines in this
debate.

The interplay of three powerful forces will determine what resources we use, how we use them, and what we pay for
them:

 Growing demand. Even the most conservative projections for global economic growth over the next
decade suggest that demand for oil, coal, iron ore, and other natural resources will rise by at least a third. About 90
percent of that increase will come from growth in emerging markets.
 Constrained supply. As easy-to-tap and high-quality reserves are depleted, supply will come from harder-
to-access, more costly, and more politically unstable environments.
 Increased regulatory and social scrutiny. Around the world, political leaders, regulators, scientific
experts, and consumers are gravitating to a new consensus that is based on fostering environmental sustainability.
Climate change may be the most highly charged and visible battleground, but other issues loom: water scarcity,
pollution, food safety, and the depletion of global fishing stocks, among other things. For businesses, this new
sensibility will present itself in two ways: stricter environmental regulations and increasing demands from
consumers—and employees—that companies demonstrate greater environmental responsibility.

To understand how the world is likely to change as these forces collide, start by distinguishing between resource
stocks, which are not likely to change much over the next decade, and resource flows, which will change enormously.

The fossil fuel consumption infrastructure is so large that, despite recent clean-energy investments, the ratio of fossil fuel to renewable

and nuclear power use in 2020 will still be 80 percent, as it is today.

Despite huge investments in clean energy, in 2020 the ratio of fossil fuel consumption to renewable and nuclear
power will remain largely as it is today—roughly 80 percent. No realistic scenario will move the needle: the
embedded resource infrastructure is so large that any transition away from fossil fuels will take decades.

But the view changes dramatically when you look beneath the supply stock to the flows of new investment. Suddenly,
clean tech emerges as one of the next decade’s biggest growth industries. Upward of $2 trillion will probably be
invested in building clean-energy capacity globally over the next ten years. In the United States, 90 percent of this
expanded capacity will be in renewable or nuclear energy—66 percent in the European Union and China. Before
2020, this investment will probably create a clean-tech industry generating well over $1 trillion a year in sales.

No country better epitomizes this contradictory dynamic than China, which in recent years has emerged as both the
world’s biggest carbon emitter and—if future actions speak louder than words—arguably its leading clean-energy
champion. Buoyed by strong economic tailwinds, Chinese electricity demand is growing by 15 percent a year,
creating the world’s largest market for power generation equipment. To date, China has kept pace by adding a slew
of coal-burning power plants that emit a lot of carbon. But motivated both by the huge costs of environmental
degradation and by fears of overdependence on Middle Eastern oil, Beijing has moved decisively to support the
development of clean-energy technologies. China may be the world’s number-one polluter, but it is also the world’s
largest consumer—and manufacturer—of wind turbines and solar panels. And it will soon take a commanding lead
in the use of clean-coal and nuclear technology.

In fact, China is building the clean-energy businesses of the 21st century—not just locally but globally too. Suntech
Power, China’s largest manufacturer of solar panels, now commands 12 percent of the US solar market. The
company, which will soon open its first factory in the United States, hopes to capture 20 percent of the US solar-
panel market over the next two years.

As a result of this enormous shift in flows, some business models will be obliterated, others will thrive, and yet
others, especially outside the resource sector, may barely change. For CEOs, understanding their true exposure to
energy and environmental risk will require more sophistication than ever and will emerge for many as a—if not the—
decisive factor determining the long-term viability of their companies.

Commodity prices will rise higher—and fall harder

For most resource commodities, the question is not whether supply will be sufficient but rather what will happen to
the price. And that depends in part on what it takes to gain access to resources.

With 12 percent of the US solar market, China’s Suntech Power leads the country in solar-panel manufacturing and in building the

21st century’s clean-energy businesses, both at home and abroad.

Just four countries—Iran, Iraq, Saudi Arabia, and Venezuela—hold some 50 percent of known oil and gas reserves.
Nationally owned oil companies now control over 85 percent of them. Many of the key providers are highly exposed
to broader geopolitical instability, which makes security of supply a major risk. Meanwhile, new supply is proving
harder to find. Most new sources, such as deep-sea reserves or oil sands, require high-priced, environmentally
controversial approaches to extraction.

These factors all suggest that oil prices will be both higher and more volatile. Adding to the complexity is the fickle
nature of global commodities markets. The number of “virtual” barrels of oil, in the form of futures and derivatives,
traded on global exchanges each day exceeds the number of real barrels by an estimated ratio of 30 to 1. This
“market effect,” enabled by the global grid, amplifies any market tremor—a key reason oil prices collapsed to just 20
percent of pre-crisis levels in the immediate wake of the financial crisis, falling from above $150 to roughly $30 a
barrel. Few other industries could experience such pricing changes in just six months.

Yet oil isn’t the only commodity susceptible to wild price swings. For example, more than half of the world’s copper
production is concentrated in a handful of countries with limited infrastructure and high extraction costs. Producers
know that over the long term, demand for copper can only grow. At the same time, they’re wary of investing in
infrastructure ahead of the demand cycle—a strategy that practically guarantees future pricing volatility.
In uncertain times, the need to plan for widely different outcomes is the one clear certainty

Regulation will prove another wild card. Virtually every major economy in the world is contemplating stricter rules,
but there’s little consensus over which regulatory schemes will be adopted, much less how they will be enforced.
Some could dramatically transform business models. How, and if, carbon is priced, for example, could
fundamentally alter many industries. The same is true with water.

Large regulatory changes are sure to disrupt entire value chains. Agriculture, for example, is one of the world’s
leading carbon emitters. If it becomes regulated under a carbon regime, that will affect not just farmers but also
their suppliers—for example, equipment manufacturers, seed producers, and fertilizer providers—as farmers
scramble to adopt emission-reducing agronomic techniques, such as no-till planting.

Consumer behavior may prove the great unknown. Although consumers are becoming much more environmentally
aware, to date they have not shown much proclivity either to reduce their resource consumption or to pay for
environmentally friendly products—and certainly not if such products cost more. (There are some notable
exceptions, such as the Toyota Prius, which captured more than 2 percent of the US market, despite being 20
percent more expensive than a similar vehicle powered only by gasoline.) That resistance could change dramatically
as we have seen before: recall the backlash against chemical companies in the 1960s, following the publication of
Rachel Carson’s Silent Spring.

The implication: companies can no longer rely on business-as-usual scenarios when it comes to resources; they must
factor in higher base-level prices and increased volatility. They also need to weigh any number of factors that are not
yet—but may become—priced in the future, such as carbon and water. And they need to understand how customers
might respond. Since these are huge uncertainties, companies will have to consider their options and outcomes
under multiple scenarios.

Business models that drive resource productivity will be just as important as those that drive
labor productivity

Despite the hype over clean energy, the biggest impact from rising pressure to price the planet may well come from
something much more mundane: conservation. Boosting resource productivity—like labor productivity—will become
an increasingly important way for businesses to reduce both their costs and their pricing exposure. Many of these
gains require low capital investments and are comparatively easy to adopt.

Advances in fields such as environmental product design and “green software” (which helps optimize resource
usage) will become important ways for companies to reduce resource consumption. UPS, for example, has saved 2
percent on fuel costs by using software that helps plan delivery routes with fewer left turns (which use more fuel
than right turns). Similarly, Apple has created approaches to reduce waste in its products: since it launched the
iMac, it has reduced raw-material content by 50 percent and energy consumption by 40 percent. Boeing designed its
new Dreamliner with both the environment and costs in mind: by using lightweight composite materials, the
company improved fuel efficiency by more than 20 percent, reducing both a customer’s lifetime ownership costs and
potential future environmental exposures.

Regulatory decisions will foster clean-energy innovation as well. Long-term Spanish subsidies of wind power are
major reasons for the rise of two Spanish companies, Iberdrola Renewables and Gamesa, as global leaders in wind
energy.

Customers, too, are pushing companies to become more environmentally friendly—and helping to spawn some great
new businesses. Clorox, for example, captured 40 percent of the US natural-cleaning-products market within the
first quarter of launching its GreenWorks line, increasing the size of the overall category substantially. Moreover, it
did so by offering a suite of products that were up to 25 percent cheaper than other natural products. That made
customers happy, and GreenWorks pleased shareholders as well by generating margins 20 to 25 percent higher than
the company’s average.

Of course, not every green investment is a good investment, so companies need to assess the puts and takes on their
options carefully. The future of some green businesses, such as carbon trading, depends hugely on still-murky
regulatory environments. Other opportunities, particularly in clean energy, will take years to scale. Still others, such
as “smart” building technologies, may have an immediate payoff today, both for customers adopting them and
businesses selling them.

Plan for regulatory change—but don’t count on global consensus

Governments everywhere hear the clamor for sustainability, but most also know they will retain power only if they
keep delivering economic growth. Couple that imperative with the high coordination costs and fundamental
resource usage inequities that persist across countries—China, for example, emits less than a fifth of the carbon
dioxide per capita that the United States does—and it’s hard not to conclude that while broad agreements may be
possible, they will more likely prove elusive, as first Kyoto and now Copenhagen have demonstrated.

Future natural disasters seem inevitable, and so does the rise of “adaptation” businesses and offerings—for instance, new insurance

and building products that respond to environmental challenges.

Nonetheless, we should fully expect a flurry of environmental regulations at the regional and local level. Local
environmental problems, especially those (such as water safety) with immediate health consequences, will be solved
more easily than global ones. Companies should identify where regulation is most likely to occur and get ahead of
potential challenges—not always by taking action but, at least as a first step, by having a plan for what to do if laws
change.

Without coordination, this likely future patchwork of varied global regulatory standards may create unexpected
opportunities. The model example is hybrid-electric-motor technology. First commercialized in Japan in response to
stricter emission guidelines there, it later proved a commercial hit with US consumers, even though US regulations
did not require the same standards. Expect more such arbitrage plays in the years ahead.

Finally—and sadly for regions especially exposed to climate change and other forms of environmental degradation—
we should prepare for the strong likelihood that an effective global regulatory regime will not appear in time. Look
for the emergence of “adaptation” businesses, which develop in response to environmental disasters or challenges.
New kinds of insurance products, building products, commercial fisheries, and other businesses designed to respond
to tomorrow’s environmental realities may well grow and thrive.

The market state

Governments around the world are facing complex, difficult decisions. Business leaders would do well to
work with them to develop solutions.

JUNE 2010 • Peter Bisson, Rik Kirkland, and Elizabeth Stephenson

In This Article
 Exhibit: Executives weigh in on the major developments that will be important for business over the next five years.
 About the authors
 Comments

While we expect the steady advance of market capitalism to continue, the state—far from withering away—is
likely to play an ever-larger role over the next decade, for three reasons.

First, even before the financial crisis hit, governments everywhere found themselves increasingly called upon to
mitigate the sometimes negative impact of globalization on individual citizens.

Second, the crisis itself has prompted large-scale direct government intervention, both through fiscal stimulus and
calls for increased regulation. That tilt in the power balance has been reinforced in much of the world by the
perceived failings of the US-led free-market model and the success so far of a Chinese model that, while market-
oriented, assumes that the state’s guiding hand will stay firmly clasped around many levers of power.

Third, the spread and dispersal of economic power around the world is making it harder to reach consensus on
multilateral approaches to setting the rules of the global game. Bilateral and regional deal making is increasingly
common, and these more local arrangements will remain largely market-based. Yet for business, this continuing
shift away from a single set of rules will inevitably make it more challenging to seize opportunities globally. It will
also require companies to engage across many fronts with many critical regional and national government actors.

A standoff between police and demonstrators in Greece: rising debt-to-GDP ratios and expanded demands for government services will

raise political tensions in the developed and developing worlds alike.

Business executives, of course, face no shortage of challenges. But the tensions confronting policy makers in the
coming years are truly daunting. On the one hand, states have been charged with driving prosperity by fostering
economic growth and job creation. Most of them understand that this goal requires a strong role for the market
rather than a reverse march toward command economies (hence our term, “market states”). On the other,
governments must also ensure social stability and maintain social-safety nets. What’s more, they must accomplish
these ends for citizens who continue to live within distinct national borders, even though those citizens’ ultimate
fortunes will be hugely influenced by transformative shifts in flows of capital, goods, labor, and information that
recognize no borders. How governments respond to these pressures, both individually and collectively, will do more
to shape outcomes over the next decade than the actions of any other single kind of economic actor.

Let’s drill into the complications. In the developed world, virtually all major economies are struggling with expanded
claims for government services, rising debt-to-GDP ratios, and looming entitlement time bombs. Debt levels in
OECD1 countries will, on average, likely rise to 120 percent by 2014—up from less than 80 percent today. In
emerging economies, governments may enjoy better demographics, but their aspiring citizens and growing
economies demand huge investments in physical and social infrastructure—from roads to education to health care—
if they are to avoid social disruptions and build thriving 21st-century economies.

Then there’s this consideration: over the past 100 years, an income inequality gap split the world into two large
camps—Western economies buoyed by an increasingly prosperous middle class, and other nations caught in a
seemingly endless cycle of poverty. Now, while inequality among nations (and across this former divide) is
thankfully shrinking, the gaps between rich and poor within individual nations are widening.

While overall standards of living have risen across the globe, the gap between rich and poor has grown in almost
three-quarters of OECD countries over the past two decades. Inequality is rising even faster in emerging markets: in
China, it is increasing more quickly than in any Western economy.
This shift is partly structural. As economies develop, overall living standards tend to rise but so does income
inequality. Manufacturing economies tend to be less equal than agrarian ones, service-based economies less equal
than manufacturing ones. (The Gini coefficient—the measure of the difference between top and bottom earners—is
two-thirds higher for service sectors than manufacturing sectors, and 150 percent higher for service sectors than
agrarian sectors.)

Globalization further compounds the problem—and not in ways that are intuitive. Trade, though often blamed for
aggravating income inequality, is not the key culprit. Instead, the rate of technology adoption is by far the biggest
driver, accounting for more than three-quarters of the impact, mainly by automating away many low-skill jobs. The
shortage of knowledge workers and capital deepening (which increases the productivity of top talent, hence raising
its earning potential) accentuate the problem by causing salaries for top earners to soar.

The effect can be eye-popping. While a US unemployment rate topping 10 percent has drawn headlines in the
current recession, the reality is starker. The unemployment rate in the top income decile of the population is barely 3
percent, but in the bottom decile, it’s ten times higher—more than 30 percent. Upward of a third of the US
unemployed are now considered to be long-term (or structurally) unemployed and thus unlikely to rejoin the
workforce any time soon.

While the gaps in Europe and Japan are generally smaller—Spain is a notable exception, with unemployment now
approaching 20 percent—these nations pay a price. Estimates suggest that Germany and Japan, for example, have
given up over a point of GDP growth a year for at least the past decade as a result of labor and taxation structures
designed to produce a more robust safety net. In other words, to ensure a more equal society, they give up a third of
the potential growth they could achieve each year.

Income volatility is another key issue. Despite the “great moderation”—the decline in overall economic volatility in
the years preceding the recent downturn—the volatility of individual incomes has actually been increasing. In the
United States, from the 1970s to 2008, it rose by as much as one-third. On average, 15 percent of US households can
now expect their incomes to fall by as much as 50 percent each year. This isn’t just a US issue: more than 50 percent
of middle-class Brazilians worry that they are at risk of losing their jobs or otherwise seeing their incomes plummet.

The bottom line: risk is shifting to individuals in a market-driven global economy—and governments are
increasingly responsible to help pick up the pieces.

While Japan and most European countries don’t share Spain’s punishing 20 percent unemployment

rate, they have sacrificed GDP growth to support a robust social-safety net.

Businesses need to recognize that governments bear the burden of legitimate challenges—
and work in partnership to help solve them

In such a world, companies can no longer shrug off policy makers and legislators as interfering meddlers to be
managed. Governments are facing legitimate and difficult decisions and will be forced to make trade-offs. Business
leaders would do well to acknowledge these problems and to work with governments to help solve them. The risk of
a populist antibusiness backlash is high—and companies will need to continue to earn “the right to operate” in
relatively unconstrained, probusiness environments.

Successful business leaders already recognize this reality. Wal-Mart Stores, for example, has worked alongside
national and local governments, as well as other stakeholders, to help reshape US health policy. Innovative
approaches born of the effort, such as the company’s $4 prescription plans and in-store clinics, are helping to reduce
the cost of health care delivery in the United States, while also helping Wal-Mart’s customers and employees to pay
less for care.

Helping governments to improve the public sector’s productivity will not only save them
money but can also generate profits for the providers

Some of the most agile businesses will turn the ability to help solve the state’s challenge into an opportunity. As the
tax base for many governments shrinks and burdens grow, states too face a productivity imperative: how to increase
services and decrease costs. Governments have been notoriously bad at adopting the lean processes and IT
improvements that have driven years of productivity gains in the private sector. Creative approaches by businesses
to help solve the public sector’s problems will be part of the solution. In Spain, the health insurance provider Adeslas
is partnering with the provincial government of Valencia to run hospitals and clinics more efficiently. In the United
Kingdom, when the British Airport Authority built Terminal 5 at Heathrow Airport, it created an incentive plan to
get private suppliers to finish the project faster and under budget. (And that example showed both how these new
approaches can be successes and also hit bumps along the way—more than 50,000 pieces of luggage got hung up
when the terminal opened, as baggage systems worked out kinks.)

States will be competing for jobs and growth, and selecting the right nations to partner with
can be a competitive advantage for companies

While politicians will continue to be pressured by—and may sometimes pander to—the antibusiness backlash, most
governments will continue to see working well with business as the best way to resolve their biggest dilemmas. Just
as businesses need to recognize the legitimate challenges facing governments, governments must recognize the
legitimate role businesses must play in contributing to the solution. After all, only a strong, expanding private sector
can provide the revenue required to meet the state’s burgeoning needs. More and more, countries will be competing
for investment and wooing enterprises to generate jobs and growth.

Two cases in point: Poland has recently created special tax breaks for companies relocating operations there, and
both HP and IBM have put centers in Wroclaw to take advantage of these provisions. Similarly, Singapore’s
government has invested heavily in education and training in an effort to attract investment by leading
multinational firms and also offers subsidies to companies locating there. As corporations think about where to
invest, build factories, locate offices, and source talent, they should explore such opportunities actively.

In an interesting twist, governments sometimes turn to private-sector businesses to enhance their prospects of
attracting more private-sector business. For example, the city of Shanghai enlisted the employment-services firm
Manpower to help it qualify entrepreneurs for government subsidies.

Global companies need to learn to work within and across multiple—and often divergent—
regulatory environments

As companies expand globally, they will need to become even more sophisticated about navigating an increasingly
complex regulatory landscape. Take financial services as an example. In Europe and the United States, banks have
traditionally been managed as a profit-maximizing industry—an approach that has generated no end of second-
guessing given the tumultuous outcomes of the past two years. By contrast, banks in Asia have, in effect, been
treated as capital-providing utilities. However these regulatory regimes evolve, they will not soon converge.

Google’s recent challenges show just how hard it can be to drive a global business model while coping with widely
different political and social cultures. In China, the company has strongly reasserted its own right to privacy,
maintaining that data stored on its servers cannot be probed by the state. Meanwhile, in Italy, Google executives
have been convicted for impinging on the privacy rights of others; several executives received suspended jail
sentences for providing a platform, via YouTube, that allowed individuals to post videos with no oversight from the
company.

Information standards, such as those for safety and labor, will remain fragmented and variable across countries and
regions. Continued globalization will not homogenize cultural norms and expectations. Yet, as the global grid
expands, the reaction and interaction from a single misstep in one country will ripple at the speed of light to more
and more places, in new ways that will make the earlier experiences of companies such as BP and Nike seem
relatively simple. Companies will need to become even more proactive and dynamic to cope effectively.

Finally, if national governments feel challenged, the multinational institutions established under US leadership after
World War II—the traditional enforcers of the “Washington consensus”—are doubly challenged. With little true
authority, they struggle to gain agreement from an expanding group of key global players with divergent interests.
That’s why the Doha Development Round of trade talks has been in limbo since 2001, despite the ongoing struggle
to revive it. Efforts at coordinated regulation on issues as diverse as intellectual property, environmental protection,
and capital markets may well see important progress on some fronts, but achieving large-scale solutions will
continue to be a daunting task.

Business leaders must recognize their vested interest in the success of the state—perhaps
the biggest risk of all is its failure to meet its challenges

Business executives should wish the leaders of aspiring market states well, wherever their leaders may fall on the
light-versus-heavy-touch spectrum of government intervention. The reason is simple and compelling: no single
factor is more likely to reverse the global economic expansion than a widespread failure by these states to meet the
challenges that face them. This threat cannot be taken lightly. Suboptimal policy choices will dampen economic
growth; bad choices could, in the worst-case scenarios, threaten geopolitical stability and this may well be the
biggest macro-risk business faces in the decade ahead.