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Bad audits – a problem with incentives

March 6, 2019

The first article in this two-part series looked at how the accounts and annual report gave no hint of the impending collapse of Carillion and highlighted a surprise £40m accounting black hole at Patisserie Valerie. This article considers the role of the auditor and why the system of incentives  may mean audits fail to identify large errors in company accounts.

The objective of an external audit by an independent auditor, according to the Financial Reporting Council, is to obtain reasonable assurance about whether a company’s financial statements “as a whole are free from material misstatement”. It is accepted by accountants, if not the general public or politicians, that it is not an auditors’ job to detect fraud. The Chief Executive of Patisserie Valerie’s auditor Grant Thornton confirmed this to the Business, Energy and Industrial Strategy Committee on 30 January 2019 as part of its inquiry into the future of audit. This caused some consternation among the Committee members who thought an audit should find fraud. Strictly speaking he was right. Following a landmark case in 1896, re Kingston Cotton Mill Company, the judge clarified that auditors have a role more like that of a bloodhound than a watchdog meaning that they are not supposed to seek out fraud; it is their job, however, to detect material misstatement of the accounts however caused which includes material misstatement caused by a fraud. As with Carillion we can reasonably expect auditors to spot when accounts are massively wrong. In the case of Patisserie Valerie we can expect the auditor to spot a missing £40m when material to the accounts and as the reported profit for the year ending 30 September 2017 was just £16m a £40m fraud would have been material. The Times and others have disclosed that a forensic investigation by PwC for the company identified a £40m fraud involving forged company minutes, forged signatures on bank contracts and fictitious invoices for shop refurbishments. The PwC report has not been made public but reports suggest the fraud had been undetected for at least three years.

According to the Financial Times the motivation for the fraud was “trying to keep people happy. Luke Johnson had certain expectations. He is hard-nosed and results-driven. It was easier to fiddle the numbers than admit to bad results.”

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Keeping people happy may have been the incentive to perpetrate a fraud. Let’s consider the incentives to ensure accounts are reliable and an audit is thorough. The diagram shows the main incentives for each of the main players involved in the preparation and audit of a set of accounts.

On the left we have people who we can reasonably expect will want fair, balanced and understandable accounts and a good audit. Junior auditors, new to the profession will want to do a thorough job and keep their bosses, mainly the audit senior happy. We expect non-executive directors (NEDs) to ensure the accounts are right but they have little real incentive to do so. They would probably prefer a quiet life to looking for problems in the accounts and risking being called trouble makers. For each day they work they are paid a fraction (around 10%) of what a chief executive would earn so why should they try to second guess what management say? Shareholders ought to want reliable accounts but what they really do not want is bad news so will not thank a board or an auditor who reveals problems before they have had a chance to sell their shares.

On the right we have people who may not really care if the accounts are reliable, may avoid following up possible problems or even worse manipulate them or stand idly by knowing that accounts are misleading. By the time an auditor becomes an audit senior or manager, a few years into their career, they will be under no illusion that what the audit partner wants is an audit done profitably within budget. The financial budget will be based on estimated hours for different parts of an audit. The time budget is likely to be challenging, leaving little or no time for audit staff to look into problematic audit findings. An auditor soon learns it is wise to look the other way rather than escalate an unresolved audit finding for a manager or partner to worry about. Auditors who are too dogged in their job may find themselves looking for another position. The audit partner’s main concern will be to have a profitable audit and hopefully procure more profitable consulting work for the team. S/he knows that raising problems with the client could jeopardise getting consulting work and even lose the audit contract. The audit firm as a whole wants to be highly profitable and avoid public censure or negligence claims although it is willing to accept both to an extent as the price of doing business.

Finally we have executives whose main priority may be to keep their jobs and maximise their performance related pay. It has been conclusively demonstrated by peer-reviewed research that executives have manipulated earnings to boost their pay. It is also well known that pressure to meet expectations can lead people to corrupt behaviour. I have written more on this in a publication by Transparency International looking at the role of formal and informal incentives in corrupt behaviour.

As the broken see-saw in the diagram suggests the system is broken. The Competition and Markets Authority has been looking at what’s wrong with audit and reported in December. The CMA proposes legislation to separate audit from consulting services. Although the report makes 91 references to incentive it does not look at the incentives within audit firms in the way set out above. As a result any reforms are unlikely to address the real problems which are lack of professionalism by auditors and incentives to look the other way rather than do a good job. The Big Four audit firms seem likely to act before legislation comes into force and ban themselves from offering non-audit services to FTSE 350 audit clients. Time will tell whether this amounts to little more than placing a fig leaf over the problem. There is not much room for optimism.

Written by Paul Moxey, SAMI Fellow and a chartered accountant and fellow of ICSA – the Governance Institute. He is also Visiting Professor of Corporate Governance at London Southbank University, a Fellow of SAMI Consulting and author of a text book on corporate governance published by ICSA. In the past he has been both an external auditor and the CFO and company secretary of a listed company and responsible for the preparation of reliable accounts.

The views expressed are those of the authors and not necessarily of SAMI Consulting.

SAMI Consulting was founded in 1989 by Shell and St Andrews University. They have undertaken scenario planning projects for a wide range of UK and international organisations. Their core skill is providing the link between futures research and strategy.

If you enjoyed this blog from SAMI Consulting, the home of scenario planning, please sign up for our monthly newsletter at newreader@samiconsulting.co.uk and/or browse our website at http://www.samiconsulting.co.uk

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Misleading company accounts

February 27, 2019

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This is the first of two articles about recent problems with accounting and auditing and considers factually what went wrong with the accounts of Carillion and Patisserie Valerie. The second considers audit and how the system of incentives may have played a part in auditors apparently not detecting when accounts are materially wrong.

A year after the compulsory liquidation of the construction and outsourced contracts provider Carillion it was the turn of cake chain Patisserie Valerie to collapse last month. According to their most recent annual financial statements both companies were profitable and both had reported rising profits and rising sales. The accounts of both companies suggested they were in good financial health with rosy prospects and the audit reports were both unqualified. So how come they both collapsed?

Carillion’s accounts for the year ended December 2016 were issued in March 2017. It boasted a strong order book, financial strength, high standards of corporate governance and accountability, a responsible culture and a highly effective board. The company also claimed strong risk management and the directors confirmed that they had “carried out a robust assessment of the principal risks facing the Group, including those that would threaten its business model, future performance, solvency or liquidity“. They said “on the basis of both reasonably probable and more extreme downside scenarios, the directors believe that they have a reasonable expectation that the Company will be able to continue in operation and meet its liabilities as they fall due over the three-year period of their assessment.” The report confirmed the Audit Committee had “reviewed the Group’s Annual Report and Accounts and recommended them to the Board as representing a fair, balanced and understandable assessment of the Group’s position”.

A few months later in July 2017 a ‘trading update’ issued to the London Stock Exchange reported “an unexpected contract provision of £845m”. In layman’s language this meant a loss. The loss wiped out all the group’s retained earnings and turned what had been the accounting value of its net assets at 31 December 2016 of £729m into a net liability of £116m – meaning in balance sheet terms that the company was worse than worthless. By 29 September, in its interim statement on the results to 30th June, further losses were reported taking the net liabilities to £405m. Nevertheless the Group reported that it was “compliant with its (banking) covenants at 30 June 2017 and is forecast to be in compliance with covenants as at 31 December 2017 and 30 June 2018”and that “taking account of the projected trading for the Group over the remainder of the year and the additional bank facility, the Board has a reasonable expectation that the Company and the Group will be able to operate within the level of its available facilities and cash for the foreseeable future”. Other parts of the trading update (which is also known as a profits warning) and the interim statement were upbeat about the group’s prospects and gave no hint of immanent failure. By January 2018 Carillion was so bust the Government had to pay the liquidator.

The subsequent Parliamentary joint inquiry by the Business, Energy and Industrial Strategy and the Work and Pensions Committees revealed that both the directors and the external auditor had been taken by surprise by both the need to make the contract provision and by the company’s subsequent failure. It was clear that governance was poor, the board was ineffective, the financial statements misleading and the claims about risk management and the group’s viability for the next three years were wrong. The inquiry report said “in failing to exercise professional scepticism towards Carillion’s accounting judgements over the course of its tenure as Carillion’s auditor, KPMG was complicit in them”.

Unfortunately, the inquiry did not reveal how or why they were so wrong. The UK corporate governance system confers much of the initial responsibility for the financial statements and risk management on audit committees while leaving the board as a whole ultimately responsible. It was a pity that the inquiry did not ask Carillion’s audit committee members to give evidence. We do not know whether they were simply inept, failing to understand the significance of what the committee claimed it considered, failed to investigate where it should have been curious, dishonest in the statements made or whether there is a wider problem. The wider problem being whether expecting audit committees to ensure accounts are reliable and risk management effective is just too big an ask for them.

There is unlikely to be a Parliamentary inquiry into Patisserie Valerie. Unlike Carillion it has not left tens of thousands without jobs, a £2.6 billion hole in the pension fund, £2 billion owed to 30,000 suppliers, £1 billion owed to banks or government contracts in turmoil. So we know less about what happened. We do know that on 10th October 2018 Patisserie Valerie announced to investors that the board had “been notified of significant, and potentially fraudulent, accounting irregularities and therefore a potential material mis-statement of the Company’s accounts“. This, it said, had “significantly impacted the Company’s cash position and may lead to a material change in its overall financial position”. As a result the company requested that its shares be suspended from trading on AIM while it conducted a full investigation with its legal and professional advisers into its true financial position. Two days later the company said it required an immediate cash injection of £20 million without which there was no scope for the Group to continue trading in its current form. Its chairman and major shareholder, Luke Johnson, a highly successful investor and entrepreneur, would loan the company £20m while fresh capital was being raised. Further finance would be required and various reports suggested a black hole of £40m.

In mid January the company reported that work carried out by the forensic accountants had revealed that the misstatement of its accounts was extensive, involving very significant manipulation of the balance sheet and profit and loss accounts and thousands of false entries into the Company’s ledgers. A week later the company was unable to renew its credit facilities and as a result was put into administration. Ironically, perhaps, Johnson in September 2018, a month before the fraud was revealed, had written a column ‘A business beginner’s guide to tried and tested swindles’ in the Sunday Times. He called it an aide-memoire for those looking to spot the next fraud. How could such a financially experienced person have been taken by surprise by what seems to have been a large scale fraud in a company he owned part of and whose board he ran?

The next article will discuss why audits may fail to alert people to massive misstatements in a company’s annual accounts.

Written by Paul Moxey, SAMI Fellow and a chartered accountant and fellow of ICSA – the Governance Institute. He is also Visiting Professor of Corporate Governance at London Southbank University, a Fellow of SAMI Consulting and author of a text book on corporate governance published by ICSA. In the past he has been both an external auditor and the CFO and company secretary of a listed company and responsible for the preparation of reliable accounts.

The views expressed are those of the authors and not necessarily of SAMI Consulting.

SAMI Consulting was founded in 1989 by Shell and St Andrews University. They have undertaken scenario planning projects for a wide range of UK and international organisations. Their core skill is providing the link between futures research and strategy.

If you enjoyed this blog from SAMI Consulting, the home of scenario planning, please sign up for our monthly newsletter at newreader@samiconsulting.co.uk and/or browse our website at http://www.samiconsulting.co.uk

Megatrends and how to survive them – Mobility

February 20, 2019

Megatrends and How to Survive Them is the title of our book published by Cambridge Scholars Publishing and available on Amazon.

This is one of a series of blogs based on the work we have done for the book. We chose Mobility as a topic for discussion because people have always travelled over land and sea, later through the air and into space. Mobility of people and freight looks likely to continue to increase though the next decades, with major growth in air travel and passenger vehicles in Asia. Freight and goods transport may increase less due to localised manufacturing and changes in supply chains and trade wars.

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The focus of this blog is automated (driverless) vehicles.

On land, freight traffic and trains will adopt autonomous vehicles before their wide use in passenger cars, and there are already many systems in operation. Some examples are:

  • In Singapore, there is a shortage of truck drivers and an ongoing requirement to transport containers between ports. This is being tackled with “platoons” of four trucks with a single shared driver, on public roads, in a three-year pilot from 2017. The approach is designed to build up public trust.
  • From Perth, engineers manage autonomous trucks and trains connected with robotic drilling systems across Western Australia under the Rio Tinto Mine of the Future programme.
  • The first fully automated driverless mass-transit rail network is the Port Island Line in Kobe, Japan. The second in the world (and the first such driverless system in Europe) is the Lille Metro in northern France. The DLR, Barcelona Metro line 9 and Copenhagen Metro use trains capable of operating automatically at all times, including door closing, obstacle detection and emergency situations.

Air traffic globally is expected to increase at a rate which will depend on regulations and trade protectionism. The increase will be mostly in Asia, with internal traffic in China due to quadruple and in India to increase five-fold.

Not counted in the air traffic data is traffic from drones which are currently in use for instance in:

  • Agriculture and land management, to look for signs of disease, examine crops or apply chemicals.
  • Law and order – monitoring, and search and rescue after incidents.
  • Smuggling drugs across borders.
  • Atmospheric monitoring to improve weather forecasts.
  • Tracking wildlife and combating poachers.
  • Taking wedding photos from the air!
  • Delivery of parcels by Amazon and others.

So, for leaders, the questions to ask themselves and their organisations could include:

  • How will autonomous vehicles affect your supply chain? If the delivery of supplies to your premises is by autonomous vehicles, how will your goods inward people handle problems?
  • How can you keep contact and build the relationship with your customers if delivery to them is via automated vehicles?

We live in exciting times!

Written by Patricia Lustig, SAMI Associate and MD, LASA Insight, and Gill Ringland, SAMI Emeritus Fellow and Director, Ethical Reading.

The views expressed are those of the authors and not necessarily of SAMI Consulting.

SAMI Consulting was founded in 1989 by Shell and St Andrews University. They have undertaken scenario planning projects for a wide range of UK and international organisations. Their core skill is providing the link between futures research and strategy.

If you enjoyed this blog from SAMI Consulting, the home of scenario planning, please sign up for our monthly newsletter at newreader@samiconsulting.co.uk and/or browse our website at http://www.samiconsulting.co.uk

10 uncomfortable truths about Brexit

February 13, 2019

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Following the historic defeat of the Government’s Brexit withdrawal proposal on 15thJanuary, the tactical moves of the coming weeks are hard to forecast. However, the outcome will be determined by the fundamental forces underpinning the UK and Brexit – not by the tactics.

1 We are at the start of the Brexit debate, not the end.

Negotiations with the EU for a new trading relationship will only begin after the UK leaves the EU and will take a number of years. Even after the final trading relationship is formalised – perhaps by 2022 – the political debate will continue because there will be significant dissent from both ends of the Brexit spectrum.

2 The first wave of Brexit harm has already damaged the UK – and will not reverse.

Industrial investors’ perceptions of the UK as a stable destination for investment and as the entry-point for Europe have shifted. The UK’s influence internationally has been diminished by perceptions of unstable and irrational decision-making.

3 The Brexit process has inflicted long-lasting harm on the Civil Service.

Civil Service numbers have rocketed by 20,000+ in the last 2 years while turnover in most Departments has reached 20% per annum. The Civil Service has been publicly attacked by pro-Brexit Ministers and media when the conclusions of work have not suited their views. New practices of not sharing papers or consulting across Departments were introduced to control leaks and information but are adopted as the ‘new normal’ by recruits.

4 The current leaders of the 2 major parties are pre-occupied with avoiding schism in their own party.

The Prime Minister stated irreconcilable ‘red lines’ upfront and launched the Article 50 process before agreeing a plan within the Government. In crisis, she does not share her views, sticks to unsustainable positions until forced to move and says different things to different factions. The Leader of the Opposition resists committing to a policy until forced to move and says different things to different groups of Labour voters. If either the Prime Minister or the Leader of the Opposition moves to a compromise that would command a majority in Parliament, they risk splitting their party for a generation – as Conservatives have done in the past over trade policy and Labour did in the 1930s.

5 The UK electorate is divided 50:50 and is not inclined to debate and compromise.

Europe was never top of voters’ agenda. The referendum legitimised and identified a wide range of social and national ills with leaving or remaining in the EU in a simplistic and rancorous debate. Voters’ views were largely fixed in 2016, immune to debate/new information from the past 3 years, and irritated by the complexity of compromise. Although a second referendum might produce an ‘answer’, it would not end the conflict nor would it encourage constructive compromise.

6 The agreement negotiated between the Government and the EU is what compromise looks like.

The proposal is actually quite a good deal and, if it had been offered in 1972, would have been accepted by the UK rather than full membership – we pay for access to most of the single market and the customs union, without applying the common agricultural policy and without accepting freedom of movement. However, the compromise appears overwhelmingly worse to both Leavers (minimal change from the status quo) and Remainers (no say in the EU rules and direction) – and neither side faces any political cost in continuing to resist.

7 The EU has delivered on its strategy to manage Brexit and will continue to do so.

The EU27 have remained united and have delivered their goals throughout the Brexit process. Given the UK’s initial poor bargaining position and the lack of coherence arising from having a disunited minority Government, the UK will only obtain cosmetic and marginal compromises in negotiation with the EU. For the Remain side, that is a positive situation – the UK will stay close to the EU. The Leave side are left complaining about EU intransigence and claimingthe EU will be forced to offer a better deal eventually.

8 Ultimately the UK will prosper economically regardless of Brexit – but it is transition that kills you.

Regardless of the eventual UK-EU trading relationship settled over the coming years, the UK economy will prosper due to its flexibility and capabilities. Whether it will do better than maintaining the current EU membership is unlikely to be evident for decades. However, any substantial change in trading relationships will cause disruption over 5-10 years – especially if it is imposed in a short period. As an analogy, the closure of the UK coal mining industry is positive over the long term (stopping unsafe extraction of a polluting high-cost fuel) but, by concentrating the closures into a 10-year period, caused immense social pain in already-deprived regions.

9 Brexit has shown up multiple inadequacies in the UK Constitution.

The UK’s unwritten constitution performs poorly under stress and, once crises have been patched-up, constitutional issues are typically neglected until the next crisis. UK law does not address the conflict between referenda and representative democracy, there is no entrenched settlement between the different levels of government (local-devolved-national-European), and the Westminster Government controls money and Parliament – as long as it has a majority. The Government breached numerous conventions to suppress debate 2016-18 and now Parliament is seeking to un-do conventions to control Government. This accentuates the risk that the ‘losing side’ in the eventual Brexit solution will challenge the legitimacy of the solution and the debate will not cease. In Scotland and Northern Ireland, the perceived illegitimacy of the Brexit debate is challenging the continuation of the Union.

10 Civil discourse is poisoned and domestic issues largely unaddressed.

The fantasy politics and the polarisation of views has been reinforced by both sides in the Brexit debate rejecting balanced analysis and seeing compromise as costly rather than beneficial. The serious domestic challenges facing the UK – welfare, education, health and social care, policing, declining tax base – are largely being postponed and public trust in institutions, experts and political leadership is declining. The positive view is that there is a wide-open space for someone to occupy with trusted solutions and which would win broad national support.

Written by Keith Leslie, SAMI Associate

The views expressed are those of the author and not necessarily of SAMI Consulting.

SAMI Consulting was founded in 1989 by Shell and St Andrews University. They have undertaken scenario planning projects for a wide range of UK and international organisations. Their core skill is providing the link between futures research and strategy.

If you enjoyed this blog from SAMI Consulting, the home of scenario planning, please sign up for our monthly newsletter at newreader@samiconsulting.co.uk and/or browse our website at http://www.samiconsulting.co.uk

 

“Immature” Superintelligence

February 6, 2019

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I met up with Tony Czarnecki of Sustensis recently to follow up some of his ideas on superintelligence, and the Singularity.  Tony is the author of a book called “Who can save Humanity from Superintelligence?”, and is concerned that such developments could happen very quickly and would need international co-operation to manage the risks.

Despite the many rapid advances of AI in different fields, I’ve always been sceptical about the speed with which Artificial General Intelligence (AGI) might come about. The UN has suggested maybe 2045/50 which would give us time to adjust – but even that I thought was too “optimistic”. Tony had in mind just 10 years before real threats emerge, so I was interested to hear why.

Tony’s intriguing new idea was the concept of a malevolent  “Immature” Superintelligence, which on first hearing made me think of AI behaving like an adolescent – rather terrifying!  AI doesn’t have to be fully AGI before it could deliberately pose serious threats to society. It could purposefully set off malicious process control events. Or it could make mistakes, erroneously executing its tasks. Such threats could include switching off critical infrastructure, releasing bacteria from controlled labs, creating false military postures (and hence over-reactions), even firing nuclear weapons.

The underlying reason for these risks developing is the inherent difficulty of training AI systems to meet specific objectives. In the confines of a highly structured environment like chess or Go, success or failure is clear. But in real-world situations even defining what “good” looks like is itself a challenge.  Setting up measures and metrics is fraught with difficulty often producing unwanted consequences – think of Ofsted who have just decided that education is not all about exam results. Anyone who has ever designed a bonus system for salespeople knows that their bonus-maximising behaviours are fantastic and you had better be pretty sure you are rewarding the right things.

There are also issues about AI systems setting their own goals, or at least sub-goals against some meta-level objective. And having them identify when specific rules should be broken or ignored in the context of the greater good. When do you drive through a red light (it might not be working properly)? When do you put country before party?  When do you act against your own self-interest?

This leads us into the difficult area of ethics. And, in a global context, whose ethics? Even if a UN for AI could be established, the chances of agreement on a set of “Universal Values of Humanity” must be low – the Universal Declaration of Human Rights is a major achievement, but hardly a comprehensive success. Can we expect to see religious AI? LGBTQ+ AI?

This takes on to the “wetware” argument – that human (and animal) intelligence is intrinsically related to its physical nature. Octopus intelligence is different because it senses the world differently.   Basically this is challenging the Mind-Body duality of Cartesian philosophy, which seems to unwittingly underpin much AI.  That AI cannot become superior to human intelligence until it learns to play, feel pain, become emotional, become unstable, love.

So much of my scepticism about AGI any time soon remains. But I do agree with Tony that there are huge risks in implementing AI successfully, and that concerted action is needed to make sure the world knows that and does something to control what someone called the G-MAFIA (Google, Microsoft, Apple, Facebook, IBM, Amazon) actually build.

Written by Huw Williams, SAMI Principal

The views expressed are those of the author and not necessarily of SAMI Consulting.

SAMI Consulting was founded in 1989 by Shell and St Andrews University. They have undertaken scenario planning projects for a wide range of UK and international organisations. Their core skill is providing the link between futures research and strategy.

If you enjoyed this blog from SAMI Consulting, the home of scenario planning, please sign up for our monthly newsletter at newreader@samiconsulting.co.uk and/or browse our website at http://www.samiconsulting.co.uk

Megatrends and How to Survive Them: Global Limits

January 30, 2019

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Megatrends and How to Survive Them is the title of our book published by Cambridge Scholars Publishing and available on Amazon. This is one of a series of blogs based on the work we have done for the book.

As increasing numbers of people become middle class (using Hans Rosling’s four levels, levels 3 and 4 the number is roughly 3 billion people), their wants and desires require ever more resources.  They have seen what others have (in mature economies in the global North) and they want some of it too.

The current world population and the life styles of most of us are stressing the global natural systems with unknown results. There are three main areas where our impact on the global environment is causing problems: climate change, environmental degradation and resource shortages.

Climate changeis leading to more and more extreme weather events.  It leads to higher sea levels as glaciers and polar ice melt. Droughts and heatwaves create water shortages.  Desalination of the Atlantic as the polar ice melts will have unpredictable effects on the Gulf Stream that warms northern Europe.

Environmental degradationhas – in some areas – passed the point of no return.  Johan Rockstrom suggests that we have gone beyond restorable limits on biodiversity, chemical pollutants (e.g. on crop land) and deforestation.

Finally, some resourcesthat we have up until this point in time taken for granted that they are available in sufficient quantities, are becoming scarce.  You only have to remember the issues experienced by Cape Town in April of this year where an ongoing drought made the headlines and water was rationed.   Some minerals are also becoming scarce and we have known for some time of the scarcity of the rare earth elements some of which are needed for the manufacture of our ubiquitous smart phones and high-tech gadgets.

Increasing numbers of people in China and elsewhere are starting to eat more like the average American – that is, they want to eat more meat and to have a more varied diet.  China is scouring the planet in an attempt to fulfil its people’s desires.

We think it very likely that by 2032 many major cities around the world will experience more flooding which will have a knock-on effect to our increasingly urbanised world.  It won’t just be river flooding, but also rising sea levels and sea surges due to increasingly volatile weather for many coastal cities around the world.  Social systems may become stressed as urban populations swell and as the size and frequency of emergencies and disasters increases.

Unless air pollution is quickly tackled – as China realises – many more deaths will occur.  As it is, even today, living in urban areas with air pollution contributes to decreases in longevity.  It is much harder to tackle sea pollution, both visible and invisible, which requires international coordination and regulation which may well be hindered by the multi-polar world order we are approaching.  We don’t even (yet) know all the consequences of this.

It is likely that much more thought will be given to our use of resources.  As more people are able to afford more – and more varied – food, it is likely that countries and regions will take a more active planning stance in order to attempt to meet demand.

The drive to design for re-use and recycling is getting stronger and as resources become scarcer, this will be imperative.  We are likely to see innovation not just in design and recycling but also in waste management as the need for it becomes undeniable.

This may lead to devolving responsibility to people and organisations so that they manage their resource usage and waste locally.

Some questions that might be useful for you to explore:

  • How resilient are your supply chains to resource scarcity and unstable weather conditions?
  • How might flooding put your organisation at risk?
  • How might you need to innovate to better design for re-use and waste management?

Some interesting articles in this area:

Johan Rockstrom: https://www.ted.com/talks/johan_rockstrom_let_the_environment_guide_our_development

https://www.bloomberg.com/news/articles/2018-01-11/china-is-winning-its-war-on-air-pollution-at-least-in-beijing.

http://thealt.com/2017/03/20/bee-pocalypse-drastic-declines-bee-diversity-threaten-food-supplies-locally-globally/

http://news.trust.org/item/20180131175029-qezh7/

We live in interesting times!

Written by Patricia Lustig, SAMI Associate and MD, LASA Insight, and Gill Ringland, SAMI Emeritus Fellow and Director, Ethical Reading.

The views expressed are those of the authors and not necessarily of SAMI Consulting.

SAMI Consulting was founded in 1989 by Shell and St Andrews University. They have undertaken scenario planning projects for a wide range of UK and international organisations. Their core skill is providing the link between futures research and strategy.

If you enjoyed this blog from SAMI Consulting, the home of scenario planning, please sign up for our monthly newsletter at newreader@samiconsulting.co.uk and/or browse our website at http://www.samiconsulting.co.uk

China’s Obstacle Race

January 25, 2019

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The Dragon Awakes

China’s emergence as a global economic power has been spectacular and enthralling.  Back in 1977, when Chairman Mao Zedong died, China’s GDP per capita was $185.  40 years later it is $8,836.  From 1979 to 2010, China enjoyed annual average GDP growth of 9.9%. China’s economy overtook Italy in 2000, France in 2005, the UK in 2006, Germany in 2007 and Japan in 2010. In 2017 GDP by expenditure stood at $12.84 trillion, second only to the USA.  Using Purchasing Power Parity (PPP) it overtook the USA in 2014.

As a manufacturer and net exporter, China enjoyed a trade surplus of $323 billion in 2018. And China is – true to the classic development model followed by Asian tigers Japan and South Korea – moving through the gears from basic manufacturing, through assembling parts, to cutting edge technology and innovation.  On 3 January, Chang’e 4became the first spacecraft to land on the far side of the moon.  On 15 January it was announced that the craft had germinated a cotton seed on the moon’s surface.  There may be more surprises to come.  It would be quite likely that the next person to walk on the moon’s surface will be Chinese: the first non-American to do so.

And China is investing in its future.  In 2017 40% of global investment in artificial intelligence was made in China – even more than the USA (34%) – those two tech powers leaving the rest of the world with a residual 26%.  China has invested massively in its own infrastructure, and its Belt and Road initiative is designed to link China, through Asia and the Middle East to Europe and Africa.  China is funding deep-sea ports in Asia and Africa, pipelines in Central Asia, and upgrading rail and road links in Africa.  It is now possible to travel by train from Beijing to Barking.

The Chinese Century?

Just as the 19th century was dominated by Britain – the first industrial nation – and the 20th by the USA, will the 21st century be dominated by China?  A continuation of the trends outlined above would suggest it might.

What Could Possibly Go Wrong?

Here at SAMI, we know that forecasting the future is a pretty chancy activity.  Better by far to develop scenarios that set out different ways in which the future might take shape.  Looking at China, we see plenty of evidence to suggest that China’s path in the rest of the century may not be entirely serene.  Indeed as far back as 2006, we identified, in a report for the City of London, some potential risks ahead.

Having peaked in 2030, China’s population is projected to go into decline, falling to 1.36 billion by 2050, and then projected to go on falling back to 1.0 billion by the end of the century.  And the population will be aging.  Median age, currently 38.7, is projected to rise to 48.0 by 2050, and go on rising thereafter.  As the population rises, so the ratio of workers to retirees will fall from the current, very favourable 5:1, to as low as 2:1.  The total population figure hides an imbalance, with 116 males to every 100 females.  This declining and aging population will contrast with neighbours such as India and Indonesia, and even more starkly with Africa, whose population is projected to have doubled between 2000 and 2050, and – according to UN projections – may do so again by 2100.

China’s ethnic minorities make up just 8.5% of the population, but in a large geographical spread of Western China, principally Tibet and Xinjiang, minorities make up the majority of the population.  To date China has been successful (and ruthless) in minimising dissent in these regions, but the potential for future conflicts should not be ignored.

The additional tensions of centrally managing a vast country should not be ignored.  Harsh and all-pervasive central control carries an inherent potential for implosion – the disintegration of the Soviet Union being an example of which the Chinese Communist Party is all too well aware.  As the economic differences between the industrial core cities and the countryside becomes increasingly stark, and as those cities themselves develop, the demand for increasing local autonomy and independence from the centre may become too strong to be ignored.

China has benefited from the globalisation of trade, with that global trade surplus of some $325 billion.  The rise of protectionism – especially in the USA – represents a threat to the prospect of continuing high levels of growth.  The Belt and Road initiative has seen China achieving great influence in countries in Asia (Burma and Sri Lanka, for example) and sub-Saharan Africa.  But there have also been signals that this influence could itself become a bone of contention, with resistance in some countries to alleged economic colonialism, and concerns in other countries about the extent of Chinese power, particularly in South East Asia.

The rise to economic dominance may come with a rise in military challenge.  The development of small atolls into heavily defended military bases in the South China Sea and beyond combined with the reluctance of other military powers to cede zones of influence and, particularly, rights to access international waters, will lead to a rise in military tension – especially with US allies.  Japan especially is making significant changes to its military and constitutional attitude to war.

Taken together with the domestic impact of the aging of its population, these threats to China’s economy and stability could see a steady downward pressure on economic growth. China is fully aware of these future risks, indeed they help to explain the urgency with which she is investing in infrastructure at home, in technology, and in building alliances overseas and developing in military power. It may be, though, that these trends combined are beyond even the Party’s ability to control.

Written by David Lye, SAMI Fellow and Director

The views expressed are those of the author and not necessarily of SAMI Consulting.

SAMI Consulting was founded in 1989 by Shell and St Andrews University. They have undertaken scenario planning projects for a wide range of UK and international organisations. Their core skill is providing the link between futures research and strategy.

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