The Next Global Stage: a borderless world means an end to old economics.

The global economy is a reality. Yet so many of those who should know better appear to be asleep, as if cocooned in a dream.

The old economic model tried to clarify the relationships between demand and supply, and supply and employment. It attempted to explain how supply/production and inventory increase as interest rates or money supply change. Because economists are convinced that these relationships are well-established, they can recommend that politicians and bureaucrats use one or more to influence the other, to generate employment, to increase gross national production or to stimulate housing starts.

They have invented still another tool to borrow money from the future when none of these levers seems to be responding sharply: minting promissory notes or bonds. Most governments have used the money in public works to artificially inflate their economies. This, of course, is certainly not what such towering figures as John Maynard Keyes or Friedrich Hayek originally meant. But governments act as though they are still within the bounds of economists' theories.

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The world has changed dramatically since these original thinkers were active in the early 1900s. An economy is no longer enclosed within a country's borders, with the world an assembly of autonomous and independent nation-states. Instead, the world consists of interdependent units of nations and regions. Yet economists today are developing variations on the old masters' themes by modifying antiquated equations and building mathematical models that explain only a part of the global economy.

No one is thinking about the global economy and its cause and effect on a national economy. For example, a higher interest rate is good means to attract money from the rest of the world, as Alan Greenspan (under Bill Clinton's presidency) demonstrated. The U.S. economy from 1992 to 2000 was euphoric because the rest of the world pumped money into the country to take advantage of high interest rates.

In fact, we can argue that high interest rates are good, period. A higher interest rate means consumers can increase their financial asset base faster and their borrowing capacity increases. This is why consumption--and, hence, the economy--often moves against the preachings of the old masters who lived in societies made up of workers, not wealthy consumers with 401(k) plans. If money comes from the rest of the world, businesses can raise money in the capital markets and do not have to borrow money from banks. So again, the interest rate is no longer a decisive factor in a business's decision to make a capital investment.

In the borderless world, an excessive money supply held by the central bank can slip out of the country if there are no attractive opportunities within the nation. In this way, a government is constantly arbitraged, or disciplined, by its own citizens and also by investors in the rest of the world.

There is no model to describe the global economy as such because we are dealing with so many parameters, variables and "units of economy." Furthermore, advances in information technology have made inventories significantly less necessary. Companies such as Toyota and Dell have demonstrated that they can make their products "just-in-time" and in response to orders. So, the grand theory that a government can lower interest rates to persuade businesses to stockpile inventories is no longer as effective.

Another complication is that the cyber-economy is growing fast and the cross-border exchange of goods, services and even financial instruments is taking place in areas unbeknownst to the economists, let alone to the government.

Finally, there is an increase--or even explosion--of funny money. Bonds and Treasury bills are funny money from the perspective of traditional economists because they act as money with liabilities for taxpayers to pay later. The trouble is that the buyers of these public liabilities are no longer the residents of an issuing country--in fact, two-thirds of the reserves of the central banks of developed countries are in dollars.

In March 2004, the IMF published statistics revealing that Japan had foreign reserves of $817 billion, while China had $432 billion, the European Union had $230 billion, and Taiwan had $227 billion. So the effectiveness of any government's fiscal policy is at the mercy of not only what businesses and consumers do at home, but also what other governments, individual companies and consumers in the rest of the world do. Money sitting on one side of the globe can be deployed, with huge multiples, halfway around the world either to accelerate the prosperity of a region or to destroy a nation's economy. There is no effective global mechanism to govern superliquidity resulting from an individual government's political situation, even though the collective effect is serious and sometimes destructive.

In fact, no economic model can begin to address these issues, and there may never be a suitable mathematical methodology to describe the 21st century economy. But there may be an approach possible through a different model, such as the theory of complexity. Global and cyber-economies today are fundamentally different from those of 20th century economics.

I see a number of parallels between the global economy and the world of complexity. The former has many variables and is not always predictable. A small change in one variable can have a huge and inexplicable impact elsewhere. One area that attracted the attention of those interested in complexity was the study of phase transitions--what happens when a body changes from being a solid to a liquid, or a liquid to a gas. Maybe the global economy reflects such a change, from the old world of manufacturing to the new world that owes so much to technology.

Perhaps the greatest similarity is in attitudes toward order and equilibrium. Much of traditional economics accepts that economic systems move toward equilibrium, which reflects the influence of physics. Complexity theory holds that "classical" equilibrium is an attractor toward which some, but by no means all, events conform. For these, there are other attractors that infuse events with their own order while being imperfectly understood.

Theorists from the Santa Fe Institute have applied complexity theory to economics. Not surprisingly, they have rejected much of traditional economics in light of complexity, believing that it makes fundamentally erroneous assumptions about the effects of technology and the behavior of economic networks.

Prosperity's Link to Capital Flow

For possibly the first time in human history, prosperity and riches are not dependent on existing wealth. In the past, the prosperity of Great Britain depended on industry, large resources of coal, and a network of colonies producing raw materials. The prosperity of the United States was also based on industry and innovation, as well as a seemingly inexhaustible supply of land and workers. Both countries converted their advantages into tangible wealth that was used to sponsor industrial and infrastructure development elsewhere in the world.

In the global economy, there is no need for mineral resources or colonies. An area can be very poor in traditional resources. Consider Ireland and Finland, which were historically unable to support their populations and part of other countries' empires. Both experienced devastating famines that wiped out significant sections of their populations. Yet both countries are now at the forefront of the global economy.

China, too, is very rich in mineral resources, but it has never succeeded in providing sufficient income levels for all its people. Those region-states that are prospering, such as Dalian, do not have natural resources, whereas others in the far west and northeast that possess natural resources are still poor. China has allowed wealth to come in from the rest of the world to certain areas.

The world has an excess of capital, and as prosperity spreads, so does the number of investment funds. Locations include not just the traditional G7 economies, but areas such as Singapore, Latin America, Russia, Australia and India. These investment funds are all cash rich, and they are constantly searching for investment opportunities. It goes without saying that fund managers are not careless or negligent in making decisions about fund allocations. So it follows that a region must prove itself worthy and compete for investment, which is necessary for prosperity.

Another element of competitiveness that has been altered by the global economy is size. It followed from the traditional obsession with nation-states that, before a company could be successful internationally, it had to cut its teeth at home. To see how this is no longer the case, we need only to consider Finland and Nokia. The Finnish domestic market numbers a mere 5 million people, less than the population of a large U.S. city. But its success has depended on looking outward--less than I percent of Nokia's sales in 2003 came from Finland. Such global success is no longer a rarity.

Diversity Matters, Not Nation-States

The geographic and economic unit of the global economy is the region. Putting regions center stage demands some radical rethinking of the way we view the world. The global stage is borderless. This means a lot of our cozy concepts about geography must be discarded, the most obsolete of these is the nation-state.

The nation-state promised much, delivered little and threatens to make things worse. For starters, it has the potential to hold back human development through artificial compartmentalization of skills and markets. Quite simply, the world has moved past the absurd idea of a hermetically sealed, self-sufficient nation-state. By breaking up the world's population into supposedly self-sufficient entities, nation-states have stymied the realization of interdependence.

Economics and societies thrive on diversity. If we look at a city such as Dubai in the United Arab Emirates, we see a prosperous metropolis. Many of those who work there and contribute to its prosperity are not Arabs. They may be managers from Western Europe or taxi drivers from India or Pakistan. (In fact, it is so dependent on workers from India that it offers direct flights to 15 Indian cities.) The same diversity is at the heart of Singapore's continued success.

We must be careful not to define region-states too tightly, especially in terms of population. A region must have a domestic market to attract internal investment, so a population of 500,000 to 1 million is desirable. An international airport, at least one large and efficiently functioning harbor, a sprinkling of forward-looking universities and research facilities capable of attracting good students and graduating highly trained workers is very important, too.

But the most essential element of any successful region must be openness to the outside world. The concept of native versus foreigner must be erased, and rules limiting foreign investment or foreign ownership of land or capital must be abolished. Instead, the rest of the world must be viewed positively as the source of prosperity.

A powerful definition of a region-state is that it is a unit for creating a positive virtual cycle. The more people who come in, and the more varied their backgrounds and skills are, the more varied the region becomes over time. If it starts out in manufacturing, other services associated with manufacturing enter the region, and in time, financial institutions offering domestic and retail financial services arrive. A positive cycle thus occurs, and the region becomes a totality with a deeper, wider economic and business base.

Globalization is really the liberalization of the individual, consumers, corporations and regions from the legacy of the nation-state. Eventually, the information available to each of them will give them the wisdom of choice. Whether consumers buy the best and cheapest from anywhere in the world is also their choice and is not the decision of any government. Likewise, corporate activities will eventually shift to the best host regions. Instead of begging, the regions will polish themselves so that the rest of the world comes to help them prosper. Ultimately, it is a competitive world, and one that will discipline all members of the global village because wealth will migrate across national borders.

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ACCORDING to Kenichi Ohmae, these three region states are well positioned for rapid growth:

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Dalian, China

Northeast China's hub combines old-line manufacturing with new service sector and technology ventures. Very open to foreign presence, particularly Japanese.

Dublin, Ireland

Geography was once a handicap, but with the Internet and high education levels, it has created 300,000 new jobs in business process outsourcing, customer relationship management and R & D in a decade.

Hyderabad, India

City is also conducting fixed-line, outsourced business functions on behalf of U.S. and European companies.

Source: The Next Global Stage

Adapted with permission from The Next Global Stage: Challenges and Opportunities in Our Borderless World (Wharton School Publishing, 2005) by Kenichi Ohmae.