A Discussion on Modernization by Li Lu

This is more of a paper than a book but is very informative. Warren Buffett gets asked a lot about how he thinks the stock market and economy are going to perform in the future and during bear markets and recessions he always talks about how our economic system works and human civilization finds a way to figure things out and progress forward but Warren never expands on that. When I was first reading about the stock market I wondered why he felt this way. Was it is just experience or intuition, was he making a mistake always thinking the past would resemble the future?

Li Lu wrote this paper which answers that question that I had about why humanity continues to progress forward despite the wars, epidemics, diseases, terrorist attacks, etc. Li Lu is the founder of Himalaya Capital which Warren’s partner, Charlie Munger, invested in. Li Lu is known for discovering an unknown electric car company in China called BYD and bringing the idea to Charlie Munger. Charlie told Warren about it and Warren invested in it as well.

When Li Lu mentions modernization, he is talking about the current world we live in today. Homo sapiens originated in Africa about 200,000 years ago and this paper is all about how they progressed from there earliest times in Africa to where they live all over the world today. The very earliest days in Africa for homo sapiens were the days that Li Lu refers to as civilization 1.0. This is where humans were hunters and gathers for tens of thousands of years. Then there was a major shift in climate on planet earth and this gave way to the second civilization that homo sapiens experienced, civilization 2.0. This period was known for agriculture and the domestication of animals. After this period, the next one is the one that we’re currently living through now which started around the 1700’s and really flourished over the next 250 years. It is civilization 3.0 or the science and technology and free market period coupled with consitutional democracy.

There is a lot to discuss from this paper but to sum up, a major reason we are where we are today and why as Warren said "our system works and always recovers" is because of the free market system that allows for private property (the invisible hand as opposed to the visible hand which is government intervention), constitutional democracy and freedom, fossil fuels which allow for much more capture and efficiency of energy use, and the human ability to learn science and technology and incorporate it into everyday life and business.

To read the paper you can click the pdf link below. It’s a free download from Li Lu’s website www.himalayacapital.com.

http://www.himalayacapital.com/index_files/Li%20Lu%20on%20Discussion%20of%20Modernization%202016%20Final.pdf

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In 1919, the Serbian geophysicist Milutin Milankovitch proposed Milankovitch cycles. This theory was finally verified in the 1970s, and it was mathematically proven that the centrifugal force related to the earth’s angle of rotational axis and its precession influenced the distance between the earth and the sun. This creates long-term major cycles in the earth’s atmosphere, each lasting approximately 100,00 years. This theory helped people to understand for the first time the cause and timing of the ice age as well as to predict when future ice ages would occur within a major cycle.

In 1987, scientists led by American geneticist Rebecca Cann came to a conclusion that astounded people at the time: all females share a common ancestor who lived in Africa. She was called the African Eve, and was born approximately 200,000 years ago.

I have divided the development of human society into three stages: hunter-gatherer civilization, or Civilization 1.0; agriculture (farming and animal domestication) civilization, or Civilization 2.0; and the science and technology civilization following the industrial revolution, or Civilization 3.0.

To our best knowledge today, the Earth has a history of 4.5 billion years, but living creatures only have one of 1.5 billion years and Homo sapiens only have one of 150,000 years.

Cattle, horses, sheep, lions, and tigers all can independently stand, grow, survive, and even hunt for food soon after birth. However, newborn humans are still far from maturity and from being able to survive independently. They require a number of years of growth before they can stand, walk, and talk, and before their brains fully mature.

Starting in 60,000 BC, humans departed Africa from Somalia and went to Arabia and Eurasia. They then traveled from northern Africa to Europe, from Eurasia to eastern Asia, from southern Asia to Australia, from Eurasia to North America via Alaska, and from North America to South America.

Through a global study of mitochondrial DNA which is only found in females and which can only be passed on by females, Cann came to the following conclusions: first, there is greater human genetic variation in Africa than in any other region; second, all human genetic variations in other regions of the world are derived from variations found in Africa; and third, the earliest mitochondrial DNA found by scientists originated in Africa. These three discoveries led to an inescapable conclusion: (everyone around) the entire world shares a common female ancestor who resided in Africa and is referred to as the “African Eve.” Many subsequent studies have confirmed Cann’s discoveries to varying degrees, except they have moved forward the time of Eve’s appearance to approximately 150,000 BC. In the 1990s, by examining Y chromosomes which can only be passed down through the DNA of males, other geneticists came to an almost identical conclusion: namely, the common ancestor of all human males also lived in Africa, 23 and is referred to as the “African Adam.”.

For several millennia, the primary cause of war was the struggle between nomadic peoples and farming populations, and a main source of migration was movement between agricultural populations. Another direct result of nomadic movements on farming populations was the dissemination of germs and viruses and the ensuing large-scale epidemics. This was one of the major causes of population reductions in history.

In general, humans faced five types of disaster in the age of agricultural civilization: famines, wars caused by population movements, epidemics, climate change, and the failure of governments.

In Keju system, candidates of government officials were assessed based on their learning abilities, levels of knowledge and administrative abilities. Everyone was given an opportunity in a fair, transparent and open manner, and participation was not limited by family background or bloodlines. (Li Lu thinks that the Keju system is the 2nd best form of government and constitutional democracy is the best.)

Due to many years of continuous warfare in Europe, its people already possessed abundant battle experience and a great capacity to organize for war. Technologically, they also had cast iron, guns and cannons. Therefore, resistance by the indigenous populations was doomed to fail. However, the most lethal weapon the Europeans brought was not their cast iron, guns or cannons, nor was it their skills in warfare. Rather, it was the germs and viruses that they and their livestock carried. Over the past several thousand years, humans had gradually gained the upper hand in their battle with germs. However, these diseases took a tragic toll. The Black Death killed one third of Europe’s population in one instance, and other illnesses such as smallpox also led to the deaths of almost 10% of the population during the Middle Ages. While the survivors had developed antibodies, these germs and viruses did not die out, and they continued to coexist with humans and livestock. They were not a threat to the Europeans who had already been tested by them and carried antibodies. However, the indigenous peoples of North America had never been exposed to these germs and had absolutely no immunity. Only a few 53 generations after Columbus’s arrival in the Americas, 75% of the indigenous population had been wiped out by germs.

Societies which provide their members with equal opportunities will eventually end up with prosperity, progress and lasting peace. Free market economy is the greatest innovation of social institution. Coupled with modern science and technology, they lead human race to reach a whole new stage of civilization.

Had it not been for the original anarchic state of the American continent, if England did not have such a unique history, and if the English merchant class had not so quickly risen to become important members of society because of the Atlantic economy, the English parliament could not have become such a dominating force in politics during the 18th century. In essence, this new Trans- Atlantic economy, encompassing England, the Netherlands and North America, is a free trade economy which was almost entirely dominated by private capital and where the role of government was limited.

America’s independence in 1776 offered mankind a unique opportunity to establish an entirely new form of government, one based on the Enlightenment era’s scientific understanding of society, nature, humanity and economics. The American founding fathers were deeply influenced by the Enlightenment movement, so the economic principles of this new government were strongly influenced by Adam Smith, while its political principles were deeply influenced by John Locke. What America established in 1776 was a constitutional and limited government, one whose fundamental goal was to protect property rights, and whose legitimacy came from empowerment by the people.

A free market economy backed by modern technology offers true equality of opportunity to everyone and thus unleashed the potential for each person to obtain the economic benefit he deserves. I believe it is human nature to seek equality of outcomes but settle for equality of opportunity. Achieving equality of outcomes will always remain a dream for human that can never be realized, yet never abandoned. But people does settle for equality of opportunity. Therefore, any human institution that creates equality of opportunity is by definition a hugely beneficial one.

To date, the second greatest human institutional innovation has been the imperial examination system, through which political power was distributed in accordance to one’s knowledge and capability. The greatest institutional innovation however, is the free market economy 63 built on modern S&T. This innovation allowed the human race to finally enter into a brand new stage of civilization.

The fact is that modern S&T Civilization 3.0 could not have been born in China. As stated earlier, the most fundamental reason for the birth of S&T Civilization 3.0 was the formation of the Trans-Atlantic Economy, and its most prominent feature was a free market economy which developed almost in the absence of government control. This economic system was completely different from all previous economic systems of any civilizations or any countries because private capital played a crucial role in this system, and because the role of government was limited to the protection of private property and the smooth function of the free 70 market.

On the European side of the Atlantic, the traditional powers of kings were weakest in Great Britain, and out of that political system emerged a government representing the interests of merchants – this would have been totally inconceivable in China. (A reason why modern capitalism could have never originated in China.)

The government on the American continent faced neither serious internal problems nor external threats. The Atlantic and Pacific Oceans essentially kept out foreign enemies while domestically, the indigenous population had largely been decimated by germs. This made it possible for government to assume no major responsibilities other than the protection of the private property and to maintain domestic peace, at least for the first half of American history. In contrast, the Chinese government had to constantly deal with invasions from nomadic peoples throughout its history. Whenever it ran into fiscal difficulties, it turned the business class into its ATM. Business activities existed to serve the government and its goals, which was the opposite of the model of the Trans-Atlantic Economy.

Herein lies an interesting question: the economies of scale resulting from market exchanges were also present in agrarian Civilization 2.0, so why did that era not produce such extreme globalization? The primary reason was that in Civilization 2.0, there was still no modern S&T, product variety was extremely limited and so was room for cost reduction. When there was trade, particularly private sector trade not subject to government regulation, wealth would increase, and so would division of labor. However, such increases were not unlimited. Once factors of production such as land and money reached certain levels of concentration and a further social division of labor was required, some social turmoil and instability would appear. Governments would then often intervene in the name of maintaining social stability and heeding public opinion.

So where is China now in terms of its modernization process? Here we define that when the coupling of constantly-advancing S&T and a free market causes an entire economy to enter a stage of sustainable, compound growth, such a society will have arrived the modern era of Civilization 3.0. The market economy in China today has already taken embryonic form, but is not yet completely free. Both the visible and invisible hands are still at work, and often at odds with each other.

The most important transformation of China’s economy in the coming decades will be moving from a government-dominated market economy to a mostly free market economy where the government plays only a supporting role. Domestic consumption and services will account for the bulk of its GDP. During this transition, it will still be possible for China to sustain growth for a long period at a rate higher than the global average until it has roughly reached the level of developed countries.

The most important transformation of China’s economy in the coming decades will be moving from a government-dominated market economy to a mostly free market economy where the government plays only a supporting role. Domestic consumption and services will account for the bulk of its GDP. Economic resources will become accessible to everyone. Financial, energy and land resources will no longer be skewed toward foreign trade and SOEs (state-owned enterprises); rather, they will become accessible to everyone through market mechanisms and circulate throughout the entire country at fair prices. The special operating privileges of SOEs will be abolished and free competition between them and private companies will gradually take place.

Any culture is shaped by time and place. People from different places have different histories, religious beliefs, lifestyles and customs living habits, which collectively makes people feel “at home.”

Trust is precisely the lubricant of a free market economy. If one can deceive strangers without any sense of guilt, then a “good” person who observes all the principles of the five cardinal relationships could still become an evildoer in the business world. The loss of trust has a destructive impact not only on the business environment, but also on the development of science and technology. The latter is a process of continual buildup and gradual progress which needs broad-based and long-term cooperation among lots of people. Without a foundation of trust, it is very hard to establish such a trust-based cooperative system.

As in the free market, language enjoys economies of scale, and the first to be used by many will become the language of all. At present, English is such a common and open system. Like the Microsoft OS or Android, everyone uses the same system to write apps. Today, almost all important innovative ideas first appear in English, whether they are in natural sciences, social sciences, commerce, culture or the arts. English is no longer the exclusive province of the USA and Great Britain. It has long since become the common language of world business and of professionals in creative fields.

Constitutional democracy has its own share of shortcomings. Under fully democratic circumstances, the politics of public opinion are better at representing small group and short term interests, but are often at odds with the overall and long term interests of society as a whole. The corrupting effect of money in the election process only exacerbates the problem. When conflicts cannot be resolved, they can almost paralyze long term policies which safeguard overall public interests

[The Keju] has its weaknesses. First, it was only limited to (selecting) bureaucrats. It was subordinated to imperial power, and imperial power was a hereditary system, not a merit-based one. There is no necessary link between lineage and ability, and as a result, throughout its history all politics in China was limited by the abilities of its emperors/empresses.

The first constraint is the Iron Law of Civilization 3.0. Once a robust international market has been formed, no nation will be able to leave it. Any nation that does so will fall behind, and the longer it stays away, the more quickly it will fall behind, until it is finally forced to rejoin. This is the first constraint. 112 The second constraint is due to the fact that in the age of nuclear weapons, major powers all possess nuclear strike capabilities that can destroy each other many times over, and in the process destroy all the living things on earth. Thus in this era relations between the great powers are guided by the principle of mutually assured destruction (MAD). Under such a mechanism, an all-out war with no bottom line is unlikely between major national powers. The third constraint comes from the unique challenges posed by the age of Civilization 3.0 to the entire human race. These can only be addressed through international cooperation, particularly cooperation between major powers.

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