The Sovereign Economic Model. A manifesto for rising nations. Stefan Demetz

happened in reality? In Country 1, $30 billion of wealth was created; in Country 2, $70 billion was created. So Country 1 was credited with $100 billion of GDP, but only created $30 billion of wealth. In fact, Country 2 produced 70 percent of the wealth, more than double that of Country 1.

      The Sovereign Economic Model prefers to focus on wealth creation and not just meaningless GDP numbers. This concept can be called the sovereign economic margin. That is why, with industrialization and import substitution policies, wealth is created. It happens with the production of final goods and the sub-production of intermediate goods or parts within a country. Anything built in another country and imported is wealth for the producing foreign country. Employment is wealth. Employment implies the use of labor for useful productive activities, so the more productive workers, the more wealth creation increases. Evidently, not all employment means doing productive tasks; some types even destroy wealth, such as in these cases:

      • The cost of employment is higher than the wealth produced (e.g., communism).

      • Bureaucracy is slowing down wealth creation.

      • Wealth is offset by productive activities with high adverse social costs.

      As with any other improvement process, the reduction of defects, i.e., unproductive economic activities, is a significant step in the right direction.

      Wealth Creation Instead of GDP as a KPI for Economic Policies

      Understanding the principles of wealth creation allows governments to devise economic policies and related legal and fiscal frameworks to stimulate creation and creators of wealth. Also, their policies must rein in wealth wasters and wealth destroyers. While GDP is easier to count and show off, it is a highly unreliable accounting method. It is often abused and massaged to suit political needs. Unexpectedly, Japan’s longtime manipulation of GDP numbers was recently exposed. Wealth creation is unquestionably a more precise indicator.

      There are four horsemen of wealth creation:

      1. Labor, with raw resources, is an essential input for production that transforms resources from natural elements into intermediate or finished goods. It includes both physical and intellectual work. Tools, machinery, and equipment can help increase the amount of production a worker can output. This increase is called productivity.

      2. Raw resources, with labor, are essential inputs for production as the basic building blocks to manufacture any category of goods. They may be either natural elements or energy sources.

      3. Capital is an important catalyst of production. It finances increased labor, raw resources, or knowledge to produce a larger number of items or items with a higher value, creating superior levels of wealth. Capital by itself cannot be wealth.

      4. Knowledge allows the production of increasingly complex, higher-wealth products. High-tech industries need input from thousands of highly educated and skilled specialists. Knowledge can therefore be a consequence of long experience doing a particular job.

      These four input factors create wealth. Offshoring manufacturing and production moves the wealth creation process to those countries. In times when a knowledge economy prevails, offshoring outsources the knowledge and teaches it to a potential competitor, so it is always a bad idea in the long term.

      Business Environment in a Sovereign Economic Model

      «What’s in for me?» is the question most ask. For every rule and regulation, people and business evaluate the changed status quo and ask this question. While the government tries to use carrot and stick and to balance pros and cons with the interests of various stakeholders, the fact of life is that some will win and some will lose.

      In state capitalism, the government takes ownership or majority control of companies in strategic sectors of the economy. This creates a big headache for private companies in that sector, who are asking what’s in it for them. If the state-owned enterprises are non-aggressive and compete fairly, not using specially biased laws in their favor, competition is normal, as with other private companies. They may sometimes even collaborate to create common tech or cooperate with foreign operations. In fair conditions, the government is interested in a tide that lifts all boats. This is the case in Russia, with Novatek as the largest LNG exporter and Lukoil as the second-largest oil company; both companies happily coexist with state giants Gazprom and RosNeft. On the contrary, if the government behaves aggressively and moves into some sectors, companies and their owners must drastically adapt. Some might even have to sell a majority stake or the entire company at a fair market price because they cannot resist the onslaught from the government.

      In the Sovereign Economic Model, the economic KPI is wealth creation. The sectors producing wealth are agriculture (first sector of the economy), industry (second sector) and the knowledge economy (quaternary sector). Therefore, these fields will receive the most state support, effort, and attention. Industrialization, exports, and import substitution are policies meant to drive real production and thus the real economy. Consequently, the service sector will not get preferential treatment. Similar activities that do not bring prosperity to the country and its people are also excluded. Economic policies should favor large capital flows into wealth-creating industries and out of less productive ones. Inefficient industries and unproductive industries will suffer the most as the state limits and curtails them. Such a situation is noticeable in China, where the government has cut back on economic excesses, speculation, and other systemic imbalances.

      Each rule change produces winners and losers. If a government implements economic policies favoring the wealth creation KPI, there will be a set of winners and losers.

      The winners

      • People will win as increasing employment and wider wealth distribution give them a more comfortable lifestyle.

      • Governments will win as increased production brings greater tax revenue and consequently more well-balanced budgets.

      • Agriculture, infrastructure, industry, and high tech will win as they will be the net receivers of government attention, subsidies, and lower taxes.

      • The service industry will win as more people will have surplus wealth to spend on a variety of services, such as vacations, entertainment, and personal care.

      The losers

      • Companies relying on rent-seeking businesses will lose out against government.

      • Financial services will lose as unproductive investments and mere accumulation will be curbed.

      • Products and services promoting unproductive activities will be restricted.

      • Economic activities with high social costs will be regulated strictly. Examples:

      • Taxation of sodas and junk food, coupled with a de-taxation of healthy or less unhealthy foods

      • Taxation of ecologically polluting materials

      Economic policy creation and changes must consider potential winners and losers. A government can, with prior notice and support, steer the businesses in new directions.

      How to Apply the Sovereign Economic Model by Level of Development

      The Sovereign Economic Model contains concepts that have usually been applied in developed nations when they were developing and emerging countries themselves. Most countries have had to protect their markets, such as the US at the end of the 19th and beginning of the 20th centuries; most European countries after World War II; Japan and South Korea slightly later; and many countries in Africa and Latin America in the 1960s and 1970s when, after being colonies, they became independent.

      Countries in the developing phase should focus on these priorities:

      • Agriculture, natural resources, and infrastructure

      • Low-to-medium-technology industry

      • One